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CPA SAMPLE QUESTIONS

AUDIT
QUESTION: Analytical procedures used in the review stage of an audit generally include:

1. retesting control procedures that appeared to be ineffective during the assessment of control
risk.

2. performing tests of transactions to corroborate managements financial statement assertions.

3. considering unusual or unexpected account balances that were not previously identified.

4. gathering evidence concerning account balances that have not changed from the prior year.

ANSWER: The correct answer is C. The objective of analytical procedures in the review stage of the
audit is to assist the auditor in assessing the conclusions reached and the evaluation of the overall
financial statement presentation. The audit review would generally include considering unusual or
unexpected balances or relationships that were not previously identified.
QUESTION: Which question would an auditor least likely include on an internal control questionnaire
concerning the initiation and execution of equipment transactions?

1. Are requests for major repairs approved at a higher level than the department initiating the
request?

2. Are prenumbered purchase orders used for equipment and periodically accounted for?

3. Are requests for purchases of equipment reviewed for consideration of soliciting competitive
bids?

4. Are procedures in place to monitor and properly restrict access to equipment?

ANSWER: The correct answer is D. Restricting access to equipment relates to safeguarding of


assets, but does not concern the initiation and execution of equipment transactions. The approval of
major repairs, use of prenumbered purchase orders, and solicitation of competitive bids are all related
to the initiation of equipment transactions.
QUESTION: For effective internal control, the accounts payable department generally should:

1. stamp, perforate, or otherwise cancel supporting documentation after payment is mailed.

2. ascertain that each requisition is approved as to price and quantity by an authorized


employee.

3. obliterate the quantity ordered on the receiving department copy of the purchase order.

4. compare the vendors invoice with the receiving report and purchase order.

ANSWER: The correct answer is D. Agreeing the vendors invoice with the receiving report ensures
that the company is only billed for what it receives. Agreeing the vendors invoice with the purchase
order ensures that the company was billed correctly for what it ordered. Upon favorable agreement,
an accounts payable voucher is prepared and submitted for payment.
QUESTION: As the acceptable level of detection risk decreases, an auditor may:

1. eliminate the assessed level of inherent risk from consideration as a planning factor.
2. postpone the planned timing of substantive tests from interim dates to year-end.

3. reduce substantive testing by relying on the assessments of inherent risk and control risk.

4. lower the assessed level of control risk from high to low.

ANSWER: The correct answer is B. Detection risk is the risk that the auditor will not detect a material
misstatement that might exist in an assertion. As the acceptable level of detection risk decreases, the
assurance provided from substantive tests should be increased. Performing substantive tests as of an
interim date, rather than as of the year-end, may potentially increase the risk that misstatements in the
year-end financial statements may exist and will not be detected. Given the choice, if the auditor
wants to decrease detection risk, the auditor would decide to perform substantive tests at year-end,
rather than at an interim date.
QUESTION: Section 404 of the Sarbanes-Oxley Act of 2002 requires that management of public
companies take responsibility for establishing and maintaining the entitys internal control.
Management is also required by Section 404 to publicly report on the operating effectiveness of those
controls. Risk assessment for public company financial reporting, then, from managements
perspective, is the assessment of the risks related to effective internal control relevant to the
preparation of financial statements in conformity with:

1. generally accepted auditing standards.

2. generally accepted accounting standards.

3. PCAOB Auditing Standards.

4. generally accepted accounting principles

ANSWER: The correct answer is D. Financial statements are always prepared in conformity with
generally accepted accounting principles (GAAP), whether this is in reference to publicly held or
privately held entities. Management would not be reporting on the preparation of financial statements
in conformity with generally accepted auditing standards, generally accepted accounting standards, or
PCAOB auditing standards.
QUESTION: In an audit of financial statements in accordance with generally accepted auditing
standards, an auditor is explicitly required to:

1. determine whether or not control procedures are suitably designed to prevent or detect
material misstatements.

2. search for significant deficiencies in the operation of internal control.

3. document the auditors understanding of the entitys internal control.

4. search for material weakness in the operation of internal control.

ANSWER: The correct answer is C. The auditor is required to document the auditors understanding
of the entitys internal control. The form and extent of documentation may be influenced by the size
and complexity of the entity. After the auditor gains an understanding of the clients internal control,
the auditor can then make a preliminary assessment of control risk, which is part of the auditors
overall assessment of the risk of material misstatement.
QUESTION: For what types of professional engagements is a practitioner required to get a
representation letter from management of the reporting entity?
For what types of professional engagements is a practitioner required to get a representation letter
from management of the reporting entity?
1. For an audit and a review, but not for a compilation.

2. For an audit, a review, and a compilation.

3. For an audit and a compilation, but not for a review.

4. For an audit only.

ANSWER: The correct answer is A. A representation letter is a requirement for both an audit and a
review engagement, but there is no such requirement when a practitioner performs a compilation.
QUESTION: Upon receipt of customers' checks in the mailroom, a responsible employee should
prepare a remittance listing that is forwarded to the cashier. A copy of the listing should be sent to the

1. Internal auditor to investigate the listing for unusual transactions.

2. Treasurer to compare the listing with the monthly bank statement.

3. Entity's bank to compare the listing with the cashier's deposit slip.

4. Accounts receivable bookkeeper to update the subsidiary accounts receivable records.

ANSWER: D) A copy of the remittance listing is sent to the accounts receivable clerk and posted to
the subsidiary records. Accounting for assets is a function that should be separated from the custody
of those assets. The accounts receivable bookkeeper maintains records of the balance owed by each
customer, while the cashier has custody of the cash. The cashier does not have an opportunity to
cover a shortage of cash by using checks received on account because the AR ledger would indicate
a different balance than that owed. There is no need to send copies to the internal auditor, the
treasurer, or the bank, because the goal is to establish accountability for the asset.
QUESTION: On magnetic discs, more than one file may be stored on a single physical file, while in
multiprogramming computer operations, several programs may be in core storage at one time. In both
cases, it is important to prevent the intermixing or overlapping of data. This is accomplished by a
technique known as

1. Boundary protection.

2. File integrity.

3. Paging.

4. Interleaving.

ANSWER: A) Boundary protection is a method of protecting access to unauthorized areas of a device


such as a magnetic disc or drum. Sections of core storage are also partitioned so that more than one
program can be operated at the same time. This method prevents overlapping of operations of one
partition to another.
QUESTION: Which of the following is a primary function of the purchasing department?

1. Authorizing the acquisition of goods.

2. Verifying the propriety of goods acquired.

3. Ensuring the acquisition of goods of a specified quality.

4. Reducing expenditures for goods acquired.


ANSWER: C) The purchasing department's function is solely to purchase previously authorized goods
and services at the desired quality and best price. They have no function in authorization for purchase
receiving or payment.

QUESTION: Tracing bills of lading to sales invoices provides evidence that

1. Shipments to customers were invoiced.

2. Shipments to customers were recorded as sales.

3. Recorded sales were shipped.

4. Invoiced sales were shipped.

ANSWER: A) By tracing bills of lading to sales invoices, the auditor will confirm that all shipments
have been invoiced, that is, that each shipment resulted in a sales invoice being prepared.

QUESTION: In an audit of financial statements, an auditor's primary consideration regarding an


internal control policy or procedure is whether the policy or procedure

1. Reflects management's philosophy and operating style.

2. Affects management's financial statement assertions.

3. Provides adequate safeguards over access to assets.

4. Enhances management's decision-making processes.

ANSWER: B) AU 319 states that, for purposes of an audit of financial statements, an entity's internal
control structure consists of the three following elements:

1. The control environment

2. The accounting system

3. Control procedures

Dividing the internal control structure into three elements facilitates discussion of its nature and how
the auditor considers it in an audit. The auditor's primary consideration, however, is whether an
internal control structure policy or procedure affects financial statement assertions rather than its
classification into any particular category.
QUESTION: The permanent (continuing) file of an auditor's working papers most likely would include
copies of the

1. Lead schedules.

2. Attorney's letters.

3. Bank statements.

4. Debt agreements.
ANSWER: D) The permanent file of an auditor's working papers contains information and documents
of continuing interest. Examples of such items are debt agreements, the corporate charter and
bylaws, contracts such as leases and royalty agreements, and continuing schedules of accounts
whose balances are carried forward for several years. The other answers relate to the current year
under audit and would be included in the current file of an auditor's working papers.

QUESTION: After obtaining an understanding of the internal control structure and assessing control
risk, an auditor decided to perform tests of controls. The auditor most likely decided that

1. It would be efficient to perform tests of controls that would result in a reduction in planned
substantive tests.

2. Additional evidence to support a further reduction in control risk is not available.

3. There were many internal control structure weaknesses that could allow errors to enter the
accounting system.

4. An increase in the assessed level of control risk is justified for certain financial statement
assertions.

ANSWER: A) If the controls appear to be effective, the auditor would test the controls and if they were
found to be effective the auditor would assess control risk below the maximum and reduce the extent
of substantive testing. These tests of controls should only be performed when it is efficient to do so. It
would be efficient if less time and effort would be spent testing controls than could be saved in
substantive tests due to the lower control risk assessment.

QUESTION: Gole, CPA, is engaged to review the 2008 financial statements of North Co., a nonpublic
entity. Previously, Gole audited North's 2007 financial statements and expressed an unqualified
opinion. Gole decides to include a separate paragraph in the 2008 review report because North plans
to present comparative financial statements for 2008 and 2007. This separate paragraph should
indicate that

1. The 2008 review report is intended solely for the information of management and the board of
directors.

2. The 2007 auditor's report may no longer be relied on.

3. No auditing procedures were performed after the date of the 2007 auditor's report.

4. There are justifiable reasons for changing the level of service from an audit to a review.

ANSWER: C) AR 200 states that when the current-period financial statements of a nonpublic entity
have been compiled or reviewed and those of the prior period have been audited, the accountant
should issue an appropriate compilation or review report on the current period financial statements
and either: the report on the prior period should be reissued or the report on the current period should
include, as a separate paragraph, an appropriate description of the responsibility assumed for the
financial statements of the prior period.

QUESTION: In auditing the financial statements of Star Corp., Land discovered information leading
Land to believe that Star's prior year's financial statements, which were audited by Tell, require
substantial revisions. Under these circumstances, Land should
1. Request Star to arrange a meeting among the three parties to resolve the matter.

2. Notify Star's audit committee and stockholders that the prior year's financial statements
cannot be relied on.

3. Notify Tell about the information and make inquiries about the integrity of Star's management.

4. Request Star to reissue the prior year's financial statements with the appropriate revisions.

ANSWER: A) If during his audit the successor auditor becomes aware of information that leads him to
believe that financial statements reported on by the predecessor auditor may require revision, he
should request his client to arrange a meeting among the three parties to discuss the information and
to resolve the matter.

QUESTION: The introductory paragraph of an auditor's report contains the following sentences:

"We did not audit the financial statements of EZ Inc., a wholly-owned subsidiary, which statements
reflect total assets and revenues constituting 27 percent and 29 percent, respectively, of the related
consolidated totals. Those statements were audited by other auditors whose report has been
furnished to us, and our opinion, insofar as it relates to the amounts included for EZ Inc., is based
solely on the report of the other auditors."
These sentences

1. Assume responsibility for the other auditor.

2. equire a departure from an unqualified opinion.

3. re an improper form of reporting.

4. Idicate a division of responsibility.

ANSWER: D) When a principal auditor decides not to assume responsibility for the work of an other
auditor insofar as that work relates to the principal auditor's expression of an opinion on the financial
statements as a whole, the principal auditor's report should make reference to the audit of the other
auditor. In such a case, the introductory paragraph of the principal auditor's report should disclose the
magnitude of the portion of the financial statements audited by the other auditor, as was done in this
example.

QUESTION: Which of the following will not result in modification of the auditor's report due to a scope
limitation?

1. Restrictions imposed by the client.

2. Inability to obtain sufficient competent evidential matter.

3. Reliance placed on the report of another auditor.

4. Inadequacy in the accounting records.

ANSWER: C) If the CPA relies on the work of another auditor, it does not constitute a scope limitation.
The other answers constitute scope limitations.

QUESTION: Under which of the following circumstances would a disclaimer of opinion not be
appropriate?

1. The auditor is unable to determine the amounts associated with an employee fraud scheme.
2. Management does not provide reasonable justification for a change in accounting principles.

3. The chief executive officer is unwilling to sign the management representation letter.

4. The client refuses to permit the auditor to confirm certain accounts receivable or apply
alternative procedures to verify
their balances.

ANSWER: B. A disclaimer of opinion states that the auditor does not express an opinion on the
financial statements. It is appropriate when the auditor has not performed an audit sufficient in scope
to enable him to form an opinion on the financial statements. A disclaimer would not be appropriate
when the auditor determines that the financial statements contain a departure from GAAP, such as
when the client's management does not adequately justify a change in accounting principle. The other
answers are incorrect because they are situations that could give rise to a disclaimer.

QUESTION: When approached by a client about prospective financial statements and third party use
may or may not occur, a CPA may not accept an engagement to:

1. apply agreed-upon procedures.

2. perform an examination.

3. perform a review.

4. perform a compilation.

ANSWER: C. perform a review.


The Statement on Standards for Attestation Engagements (SSAE) issued by the AICPA does not
permit the CPA to perform reviews of prospective financial statements. The CPA may compile,
examine, or apply agreed-upon procedures to the prospective financial statements if these statements
are, or reasonably might be, expected to be used by another party.

QUESTION: In performing a search for unrecorded retirements of fixed assets, an auditor most
likely would:

1. tour the clients facilities, and then analyze the repair and maintenance account.

2. inspect the property ledger and the insurance and tax records, and then tour the clients
facilities.

3. analyze the repair and maintenance account, and then tour the clients facilities.

4. tour the clients facilities, and then inspect the property ledger and the insurance and tax
records.

ANSWER: B. inspect the property ledger and the insurance and tax records, and then tour the clients
facilities.
In searching for unrecorded retirements of fixed assets, the auditor would select items included in the
property ledger and other records and then, by touring the clients facilities, look to see if they are on
hand. A fixed asset that is not on hand but is included in the records may indicate that a retirement
was not recorded.

QUESTION: An auditor most likely would make inquiries of production and sales personnel
concerning possible obsolete or slow-moving inventory to support managements financial statement
assertion of:

1. presentation and disclosure.


2. rights and obligations.

3. valuation or allocation.

4. existence or occurrence.

ANSWER: C. valuation or allocation.


Assertions about valuation or allocation deal with whether asset, liability, revenue, and expense
components have been included in the financial statements at appropriate amounts. Inquiries and
other tests designed to determine if inventory is obsolete or slow-moving will help provide assurance
that inventory, which should be adjusted to lower of cost or market, is properly valued on the financial
statements.

QUESTION: Which of the following procedures most likely would not be an internal control procedure
designed to reduce the risk of errors in the billing process?

1. Comparing control totals for shipping documents with corresponding totals for sales invoices.

2. Using computer programmed controls on the pricing and mathematical accuracy of sales
invoices.

3. Matching shipping documents with approved sales orders before invoice preparation.

4. Reconciling the control totals for sales invoices with the accounts receivable subsidiary
ledger.

ANSWER: D. Reconciling the control totals for sales invoices with the accounts receivable subsidiary
ledger.
The reconciliation provides evidence that sales which have been invoiced are recorded in the
accounts receivable subsidiary ledger but does not reduce the risk of errors in billing. Answer (a) is
incorrect because it reduces the risk of errors in the billing process by providing evidence that all
items shipped were included in the sales invoices. Answer (b) is incorrect because it reduces the risk
of errors in the billing process by controlling the mathematical accuracy of the computations on the
sales invoices. Answer (c) is incorrect because matching shipping documents with sales orders
reduces the risk of errors in the billing process by providing evidence that approved sales orders were
shipped before being invoiced.

QUESTION: The sample size of a test of controls varies inversely with:

Expected population
deviation rate Tolerable rate
A. No Yes
B. No No
C. Yes No
D. Yes Yes

ANSWER: A. No; Yes

In determining sample size for a test of controls, the auditor will consider the expected population
deviation rate and tolerable rate. If, based on prior experience with the client or on a preliminary
sample, the auditor expects to find few deviations from a control, the expected population deviation
rate would be set low, and the sample size would be small. Thus, there is a direct relationship
between the expected population deviation rate and sample size, not an inverse relationship. The
tolerable rate is the maximum rate of deviation from a prescribed control that an auditor is willing to
accept without altering the planned reliance on internal control. If the auditor can tolerate a higher
rate, he will test a smaller sample. Thus, tolerable rate does vary inversely with sample size. Sample
size does not vary inversely with the expected population deviation rate. Sample size does vary
inversely with tolerable rate.
QUESTION: Which of the following computer-assisted auditing techniques allows fictitious and real
transactions to be processed together without client operating personnel being aware of the testing
process?

1. Test data approach.

2. Parallel simulation.

3. Integrated test facility.

4. GAS packages.

ANSWER: C. Integrated test facility.


An integrated test facility is a method of testing programmed controls by creating a small dummy
division or subsidiary within the regular IT system. Dummy files and records are appended to existing
client files, and fictitious test transactions specifically coded to correspond with the dummy files and
records are introduced into the system along with actual live transactions. Parallel simulation is an
approach which involves reprocessing actual company data using auditor-controlled programs and
comparing the results. The test data approach is an approach which involves both valid and invalid
transactions prepared and processed by the auditor using the clients computer program. Generalized
audit software (GAS) is an audit program that performs audit tasks such as sampling, sorting, and
calculating.
QUESTION: Tracing selected items from the payroll register to employee time cards that have been
approved by supervisory personnel provides evidence that:

1. internal controls relating to payroll disbursements were operating effectively.

2. payroll checks were signed by an appropriate officer independent of the payroll preparation
process.

3. only bona fide employees worked and their pay was properly computed.

4. employees worked the number of hours for which their pay was computed.

ANSWER: D. employees worked the number of hours for which their pay was computed.
When an auditor selects items from the payroll register for examination, he is selecting from a
population consisting of all payments made to employees. By tracing these selected items to time
cards that have been approved by a supervisor, the auditor is verifying that the employees did work
the hours that they were paid for. This is only one aspect of internal control related to payroll
disbursements and would probably not be sufficient to reach a conclusion as to the effectiveness of
internal controls. The auditor could trace the items to the cancelled payroll checks to determine if they
were signed by an appropriate officer. The auditor could also trace the items to personnel records to
make certain that the payees were bona fide employees and that the rates of pay were proper.

QUESTION: As the acceptable level of detection risk decreases, an auditor may change the:

1. timing of tests of controls by performing them at several dates, rather than at one time.

2. nature of substantive tests from a less effective to a more effective procedure.

3. timing of substantive tests by performing them at an interim date, rather than at year-end.

4. assessed level of inherent risk to a higher amount.

ANSWER: B. nature of substantive tests from a less effective to a more effective procedure.
Detection risk is defined as the risk that the audit evidence for a segment will fail to detect
misstatements exceeding tolerable misstatement. As planned detection risk has decreased, the
auditor will (1) select a greater sample size of items to be tested, (2) change the audit tests
(substantive procedures) to more effective procedures, and (3) change the timing of substantive tests
to perform them at year-end, rather than at an interim date. Inherent risk (and control risk) exists
independently of the audit; the auditor cannot change them, but rather react to them in planning.

QUESTION: An accountant should perform analytical procedures during an engagement to:

Compile a nonpublic entitys Review a nonpublic entitys


financial statements financial statements
A. No Yes
B. Yes Yes
C. Yes No
D. No No

ANSWER: A. No; Yes

A compilation is defined as presenting, in the form of financial statements, information that is the
representation of management, without undertaking any expression of any assurance on the
statements. In a compilation, the accountant is not required to make inquiries or perform other
procedures to verify, corroborate, or review information furnished by the entity. A review is defined as
the performance of inquiry and analytical procedures that provide the accountant with a reasonable
basis for expressing limited assurance that there are no material modifications that should be made to
the financial statements in order for them to be in conformity with GAAP or, if applicable, with another
comprehensive basis of accounting. Analytical procedures are required in a review engagement.
Analytical procedures are not required in a compilation engagement.

QUESTION: Which paragraphs of an auditors standard unqualified opinion report on financial


statements should refer to GAAS and GAAP?

GAAS GAAP
A. Opening Scope
B. Opening Opinion
C. Scope Scope
D. Scope Opinion

ANSWER: D. Scope; Opinion.


The auditors standard unqualified opinion audit report identifies the financial statements that have
been audited in the opening introductory paragraph. The nature of an audit, which is an examination
in accordance with GAAS, is described in the scope paragraph. The auditors conclusion regarding
the fairness of the financial statements in accordance with GAAP is expressed in the separate opinion
paragraph.

QUESTION: As a result of the Sarbanes-Oxley Act, the PCAOB has been created. Which of the
following is false?

1. The PCAOB is a government agency.

2. The PCAOB comes under the oversight and enforcement authority of the SEC.

3. The PCAOB will be funded by fees charged to all registered accounting firms and publicly
traded companies.
4. All accounting firms that participate in the preparation of an audit report for a company that
issues securities must register with the PCAOB.

ANSWER: A. The PCAOB is a government agency.


The Sarbanes-Oxley Act was set up in a manner such that the PCAOB would not be a government
agency, but would operate as an independent, nonprofit body to oversee the reporting of financial
results of public entities. To enable a proper degree of government control, the PCAOB is under the
oversight and the enforcement authority of the SEC. The PCAOB is funded by fees charged to
register accounting firms and all publicly traded companies.

QUESTION: Auditors try to identify predictable relationships when using analytical procedures.
Relationships involving transactions from which of the following would most likely yield the highest
level of evidence?

1. Interest expense.

2. Accounts payable.

3. Accounts receivable.

4. Travel and entertainment expense.

ANSWER: A. Interest Expense


When using analytical procedures to identify predictable relationships, higher levels of evidence will
be obtained when those relationships are most predictable. Relationships involving income statement
accounts, such as interest expense, tend to be more predictable than relationships involving only
balance sheet accounts. This is because income statement accounts represent transactions over a
period of time, rather than a point in time, as a balance sheet amount represents. Also, interest
expense, which can be related to debt, is more predictable than the travel and entertainment expense,
which is more unpredictable and subject to management discretion.

FAR
QUESTION: Which of the following is not a comprehensive basis of accounting other than generally
accepted accounting principles?

1. Basis of accounting used by an entity to comply with the financial reporting requirements of a
government regulatory agency.

2. Cash receipts and disbursements basis of accounting.

3. Basis of accounting used by an entity to file its income tax return.

4. Basis of accounting used by an entity to comply with the financial reporting requirements of a
lending institution.

ANSWER: The correct answer is D. The following accounting bases may be used to prepare financial
statements in conformity with a comprehensive basis of accounting other than GAAP:

1. Income tax basis of accounting.

2. Cash basis of accounting.

3. Modified cash basis of accounting.

4. Basis of accounting used by an entity to comply with the financial reporting requirements of a
government regulatory agency.
5. A definite set of criteria having substantial support that is applied to all material items in the
financial statements.

An other comprehensive basis of accounting (OCBOA) outside of the permitted bases listed above is
prohibited. A basis of accounting used by an entity to comply with the financial reporting requirements
of a lending institution is not a permitted OCBOA.

QUESTION: One criterion for a capital lease is that the term of the lease must equal a minimum
percentage of the leased property's economic life at the inception of the lease. The minimum
percentage is:

1. 75%.

2. 41%.

3. 50%.

4. 90%.

ANSWER: The correct answer is A. A lease is classified as a capital lease if one of the following
criteria is met:

1. The title is transferred to the lessee at the end of the lease period.

2. A bargain purchase option exists.

3. The lease period is at least 75% of the asset's life.

4. The present value of the minimum lease payments is at least 90% of the fair value of the
asset.

QUESTION: On January 15, Year 5 Rice Co. declared its annual cash dividend on common stock
for the year ended January 31, Year 5. The dividend was paid on February 9, Year 5, to
stockholders of record as of January 28, Year 5. On what date should Rice decrease retained
earnings by the amount of the dividend?

1. January 15, Year 5.

2. January 31, Year 5.

3. January 28, Year 5.

4. February 9, Year 5.

ANSWER:The correct answer is A.Retained earnings is decreased and a current liability for the cash
dividend is recorded on the declaration date, in this case, January 15, Year 5.
QUESTION: For interim financial reporting, a company's income tax provision for the second quarter
of a given year should be determined using the:

1. Statutory tax rate for the year.

2. Effective tax rate expected to be applicable for the second quarter of the year.

3. Effective tax rate expected to be applicable for the full year, as estimated at the end of the first
quarter of the year.
4. Effective tax rate expected to be applicable for the full year, as estimated at the end of the
second quarter of the year.

ANSWER:The correct answer is D. The company should use the effective tax rate expected to be
applicable for the full year as estimated at the end of the second quarter the year because the interim
period is considered an integral part of the accounting year.
QUESTION: What type of bond matures at different points in time?

1. Bearer bonds.

2. Term bonds.

3. Serial bonds.

4. Unsecured bonds.

ANSWER: The correct answer is C. Serial bonds refer to bonds within an issue that mature at
different points in time. Generally, serial bonds are retired according to their registration number. Note
that bonds within a term bond issue all mature at the same time. Unsecured bonds are backed only by
the general credit of the borrower and are not backed by any specific property. In the case of a bearer
bond, there is no record of ownership interest is paid to the holder of the bond.
QUESTION: Which of the following statements comparing straight-line depreciation methods to
alternative depreciation methods is least accurate? Companies that use:

1. accelerated depreciation methods will increase the total amount of depreciation expense in
the latter years of the asset's life.

2. accelerated depreciation methods will decrease the amount of taxes in early years.

3. straight-line depreciation methods will have higher book values for the assets on the balance
sheet than companies that use accelerated depreciation in the early years.

4. units-of-production methods to depreciate assets will overstate income during periods of low
production.

ANSWER: The correct answer is A. Accelerated depreciation methods will increase the amount of
depreciation expense in the early years of the assets life, but the depreciation expense will be less in
the latter years of the assets life. All other answer options are true.
QUESTION: Gar Co. factored its receivables without recourse with Ross Bank. Gar received cash as
a result of this transaction, which is best described as a:

1. Sale of Gar's accounts receivable to Ross, with the risk of uncollectible accounts retained by
Gar.

2. Sale of Gar's accounts receivable to Ross, with the risk of uncollectible accounts transferred
to Ross.

3. Loan from Ross collateralized by Gar's accounts receivable.

4. Loan from Ross to be repaid by the proceeds from Gar's accounts receivables.

ANSWER: The correct answer is B. Factoring of receivables is a sale of the receivables to another
party. "Without recourse" means that Gar Co. has transferred the risk for the uncollectible accounts to
Ross Bank and Ross does not have any recourse against Gar Co. if the accounts are not collected.
Thus, Gar has sold the accounts receivable to Ross Bank along with the risk associated with the
uncollectible accounts.
QUESTION: Reportable segments are not required to disclose which of the following:

1. Intersegment sales.

2. Capital expenditures.

3. Amortization expense.

4. Long-term debt.

ANSWER: D) Long-term debt and all liabilities are not required disclosures on segment data. All the
other choices are required disclosures.

QUESTION: During 2009, Tedd Co. became involved in a tax dispute with the IRS. At December 31,
2009, Tedd's tax advisor believed that an unfavorable outcome was probable. A reasonable estimate
of additional taxes was $400,000, but could be as much as $600,000. After the 2009 financial
statements were issued, Tedd received and accepted an IRS settlement offer of $450,000. What
amount of accrued liability should Tedd have reported in its December 31, 2009, balance sheet?

1. $400,000.

2. $450,000.

3. $500,000.

4. $600,000.

ANSWER: A) The minimum amount within the range must be accrued since an unfavorable outcome
is probable.

QUESTION: Extraordinary items are:

1. reported above the line.

2. unusual and infrequent.

3. unusual or infrequent.

4. reported on the balance sheet.

ANSWER: B) Extraordinary items are unusual and infrequent, reported below the line separate from
income from continuing operations on the income statement, and would include such items as: foreign
government confiscation, earthquake damages, losses from volcanic eruptions, etc.

QUESTION: Presenting consolidated financial statements this year when statements of individual
companies were presented last year is

1. A correction of an error.

2. An accounting change that should be reported prospectively.

3. An accounting change that should be reported by restating the financial statements of all prior
periods presented.
4. Not an accounting change.

ANSWER: C) This is a change in accounting entity which requires restatement of prior periods being
presented.

QUESTION: The following computations were made from Clay Co.'s 2009 books: What was the
number of days in Clay's 2009 operating cycle?

Number of days sales in Inventory: 61


Number of days sales in trade accounts receivable: 33

1. 33.

2. 47.

3. 61.

4. 94.

ANSWER: D) 94 days. The operating cycle is the average time for a company to expend cash for
inventory, process and sell the inventory, and collect the resulting receivables, converting them back
into cash. The number of days in the operating cycle (94) is equal to the number of days' sales in
inventory (61), plus the number of days' sales in accounts receivable (33).
QUESTION: Which of the following is NOT a criteria for a lease to be classified as a capital lease?

1. The lease term is equal to 90% or more of the estimated economic life of the asset.

2. Ownership in the asset is transferred at the end of the lease term.

3. The lease contains a bargain purchase option.

4. The present value of the minimum lease payments is 90% or more of the fair value of the
asset at the inception of the lease.

ANSWER: A) To be considered a capital lease, the lease term should be equal to 75 percent or more
of the estimated economic life of the asset, not 90 percent.

QUESTION: An entity purchased shares of its $100 par stock for retirement that was originally issued
at $200 per share. The entity repurchased the stock for $250 per share. Upon retirement, which of the
following accounts would NOT be affected?

1. Paid-in capital.

2. Common stock.

3. Treasury stock.

4. Retained earnings.

ANSWER: C) When the stock of an entity is purchased specifically for retirement, it is no longer able
to be reissued and therefore would NOT affect treasury stock. The entity would record the transaction
by removing the common stock at its par value, with any additional paid-in capital that was originally
recorded being removed as well.

The difference between the original issue price and the reacquisition price requires a reduction in
retained earnings because the entity repurchased the stock for an amount greater than the original
issuance price.

A reduction in the cash paid for the stock is recorded as well. The journal entry for the repurchase and
retirement of one share of its outstanding stock would appear as follows:

Debit: Common stock $100


Debit: Paid-in capital $100
Debit: Retained earnings $50
Credit: Cash $250

QUESTION: Conceptually, interim financial statements can be described as emphasizing

1. Timeliness over reliability.

2. Reliability over relevance.

3. Relevance over comparability.

4. Comparability over neutrality.

ANSWER: A) Interim statements are affected by estimates, cost allocations, seasonality and other
factors which may affect the usefulness of the information. Therefore, the emphasis on timeliness
over reliability.

QUESTION: St.Petersburg Glass Company plans to issue the following 10-year bond:

PV: $25,325
FV: $20,000
Annual payments: $2,000

Using straight-line amortization calculate the bond interest expense for year 1 for St. Petersburg
Glass Company?

1. $532.50.

2. $1,467.50.

3. $4,792.50.

4. Bond interest expense cannot be amortized.

ANSWER: B) The bond interest expense for St. Petersburg Glass Company would be $1,467.50. The
amortized amount of the bond premium is subtracted from the annual payments. $5,325/10 = 532.50,
$2,000 - 532.50 = $1,467.50.

QUESTION: Calculate depreciation for year 2 based on the following information:

Historical cost $40,000


Useful life 5 years
Salvage value $3,000
Year 1 depreciation $7,400

1. $7,400.

2. $8,000.
3. $8,600.

4. $13,040.

ANSWER: A) The depreciation method used must be straight line because year 1 depreciation is
$7,400 (($40,000 - $3,000) / 5 = $7,400).
Year 2 depreciation would also be $7,400.

QUESTION: A company recently took out a $25,000 loan with interest payable at the rate of 9
percent, compounded annually. The loan is to be paid off in one lump sum, at the end of 3 years.
Given it is to include both principal and interest, the amount of the loan
payment will be closest to:

FV of $1@ 9% for 3 years = 1.295


PV of $1@9% for 3 years = 0.7722

1. $27,250.

2. $31,750.

3. $32,375.

4. $34,000.

ANSWER: C. This can be solved with either the PV or FV of $1 equation; using the correct factor:
PV = FV x PVfactor or FV = PV x FVfactor. So: $25,000 = FV x 0.7722 = %32,375. Or, FV = $25,000
x 1.295 = $32,375.

QUESTION: At January 1, 2009, Simpson Co. had a credit balance of $260,000 in its allowance for
uncollectible accounts. Based on past experience, 2 percent of Simpsons credit sales have been
uncollectible. During 2009, Simpson wrote off $325,000 of uncollectible accounts. Credit sales for
2009 were $9,000,000. In its December 31, 2009, balance sheet, what amount should Simpson report
as allowance for uncollectible accounts?

1. $115,000.

2. $180,000.

3. $245,000.

4. $440,000.

ANSWER: A. The beginning balance is added to the new provision of $180,000 (2% $9,000,000)
and is reduced for the write off of $325,000 (260,000 + 180,000) 325,000 = 115,000.

QUESTION: The Welsh Corporation has maintained a defined benefit pension plan for a number of
years. At the end of the current year, the company has a net pension cost of $177,000, a projected
benefit obligation of $829,000, and plan assets of $580,000. What is the total amount of liability this
company should recognize on its balance sheet, in connection with this pension plan?

1. $116,000.

2. $122,000.

3. $117,000.
4. $249,000.

ANSWER: D. $249,000.
According to FASB 158, an employer is required to recognize the overfunded or underfunded status of
the pension plan. This amount is the difference between the Projected Benefit Obligation and the Plan
Assets, or $249,000 ($829,000 $580,000) in this case. It will be reported as a liability since the PBO
exceeds the plan assets.

QUESTION: What is the difference between the direct and indirect method of calculating cash flow
from operations?

1. The indirect method starts with gross income and adjusts to cash flow from operations, while
the direct method starts with gross profit and flows through the income statement to calculate
cash flows from operations.

2. The direct method starts with sales and follows cash as it flows through the income
statement, while the indirect method starts with net income and adjusts for non-cash charges
and other items.

3. Balance sheet items are not included in the cash flow from operations for the direct method,
while they are included for the indirect method.

4. The direct method will result in a lower or higher cash flow figure for operating activities as it
details all of the income statement items, while the indirect method only uses net income.

ANSWER: B. The direct method starts with sales and follows cash as it flows through the income
statement, while the indirect method starts with net income and adjusts for non-cash charges and
other items.
The main difference between the direct and indirect methods of calculating cash flows is the way that
cash flow from operations is calculated. The direct method starts with sales and follows cash as it
flows through the income statement, while the indirect method starts with income after taxes and
adjusts backwards for noncash and other items. Both methods will have the same result for operating
cash flows. The direct and indirect method calculates the financing and investing cash flows the same
way, and both methods will result in the same cash flow figure.

QUESTION: On January 1, Year 1, Giant Company (Giant) pays $900,000 for all of the outstanding
shares of Small Corporation (Small). On that date, Small has a net book value (assets liabilities) of
$700,000. In analyzing the company prior to the acquisition, Giant discovers that Small is working on
several in-process research and development projects that are worth a total of $170,000 although
none of the projects has yet reached the point of technological feasibility. Which of the following
statements is true?

1. Goodwill of $30,000 should be recorded as a result of this acquisition.

2. An expense of $170,000 should be recognized immediately at the date of acquisition.

3. Any goodwill allocation will be amortized at the end of Year 1.

4. The life attributed to any goodwill allocation will be 40 years or less.

ANSWER: A. Goodwill of $30,000 should be recorded as a result of this purchase.


In creating a business combination, any amount attributed to the value of in-process research and
development must be recognized. Any portion of the acquisition price in excess of the subsidiarys
underlying book value that cannot be assigned to an identifiable asset or liability is reported as the
intangible asset, Goodwill. Here, the purchase price was $900,000 and the book value was $700,000
so the excess was $200,000. Of that amount, $170,000 is assigned to in-process research and
development. The remaining $30,000 is reported by the consolidated companies as goodwill.
Goodwill is no longer amortized over a period of time but is rather checked periodically for impairment.

QUESTION: Orleans Co. (Orleans), a cash-basis taxpayer, prepares accrual basis financial
statements. In its Year 6 balance sheet, Orleans deferred tax liabilities increased when compared to
Year 5. Which of the following changes would cause this increase in deferred tax liabilities?

I. An increase in prepaid insurance.

II. An increase in rent receivable.

III. An increase in warranty obligations.

1. I only.

2. I and II.

3. II and III.

4. III only.

ANSWER: B. I and II.

The increase in prepaid insurance in Year 6 creates a deductible amount for income tax reporting
purposes for the insurance paid; however, for financial reporting purposes the expense is not
recognized until years subsequent to Year 6. As a result, net taxable income for future years is
increased; thus, the deferred tax liability increases.

The increase in rent receivable in Year 6 also increases the deferred tax liability. For income tax
purposes, rents are not included in income until received (i.e., years subsequent to Year 6). However,
the amount of the receivable is earned and recognized in the income statement in Year 6.

The increase in warranty obligations results in warranty expense for Year 6 and will provide future
deductible amounts because tax rules do not allow a deduction for warranty cost until such a cost is
incurred. Future deductible amounts lead to deferred tax assets.

QUESTION: During Year 1, Smith Corporation filed suit against West Company because of damages
that were allegedly inflicted on Smith. At the end of Year 1, officials of Smith believe it is reasonably
possible that between $300,000 and $400,000 will be won but probable that the amount will actually
be between $160,000 and $300,000. No number in either range stands out as more likely than any
other number. Officials working for West have exactly the same opinion of what is going to happen. In
the later part of Year 2, the case is settled when West pays Smith $280,000 in cash. What is the
impact on income reported by these companies in Year 2?

Smith West
A. $120,000 gain $20,000 gain
B. $280,000 gain $120,000 gain
C. $280,000 gain $120,000 loss
D. $120,000 gain $50,000 loss

ANSWER: C. $280,000 gain; $120,000 loss

As the potential winner, Smith will not recognize a gain until the process is substantially completed.
That happens in Year 2. Therefore, the entire profit is recognized when the case is settled in Year 2.

As the potential loser, West will recognize a loss as soon as the amount becomes probable. Here, that
is in Year 1. When the amount can only be estimated to within a range, the most likely number in the
range is used. If no number is most likely, the lowest number in the range is recognized. For that
reason, West recognized a $160,000 loss in Year 1 which then had to be increased in Year 2 by
$120,000 to arrive at the actual figure of $280,000.

QUESTION: Norina Co. (Norina) has a portfolio of marketable equity securities that it does not intend
to sell in the near term. How should Norina classify these securities and how should it report
unrealized gains and losses from these securities?

Classificatio
Reporting of unrealized gains and losses
n
A. Trading securities Component of income from continuing operations
Separate component of other comprehensive income
B. Available-for-sale
securities
C. Trading securities Separate component of other comprehensive income
Component of income from continuing operations
D. Available-for-sale
securities

ANSWER: B. Available-for-sale; Separate component of other comprehensive income securities


In accordance with SFAS 115, marketable equity securities (MES) are classified as either trading
(held for current resale) or available-for-sale (if not categorized as trading). Because Norina does not
intend to sell these securities in the near term, they should be classified as available-for-sale.
SFAS 115 requires MES to be carried at market value. The unrealized gains or losses of available-for-
sale MES are reported as a separate component of other comprehensive income. It is important to
note that unrealized gains or losses on trading securities would be reported as a component of
continuing operations on the income statement.
Thus, Answer B is correct because the securities would be classified as available-for-sale and
unrealized gains or losses from these securities would be reported as other comprehensive income.

QUESTION: Marcel, Inc. (Marcel) has a gross profit margin of $45,000 on sales of $150,000. The
balance sheet shows average total assets of $75,000 with an average inventory balance of $15,000.
What is Marcels total asset turnover and inventory turnover amounts, respectively?

Total asset turnover Inventory turnover


A. 7.00 times 2.00 times
B. 2.00 times 7.00 times
C. 0.50 times 0.33 times
D. 10.00 times 0.60 times

ANSWER: B. 2.00 times; 7.00 times


Total asset turnover = sales/total assets = 150/75 = 2 times
Inventory turnover = COGS/average inventory = (150 45)/15 = 7 times

QUESTION: According to the FASB Conceptual Framework, which of the following relates to both
relevance and reliability?

Consistency Verifiability
A. Yes Yes
B. No No
C. Yes No
D. No Yes
ANSWER: C. Yes; No
Consistency in financial presentation means the use of the same accounting procedures for
presenting information in different periods. Because trend analysis is a strong element in projecting
the future, investors and creditors find consistency important in making data useful, or relevant in
formulating decisions. Consistent presentation also removes potential bias from presentation that
might be caused by selecting the procedure each year that makes the company look best. A
consistent presentation enhances the neutrality of the information, which is an element of reliability.
Thus, consistency relates to both relevance and reliability.

Verifiability means the development of information by an approach that would cause different people
to arrive at the same figures. Verifiability makes information more reliable but does not tell us whether
the information being developed happens to be relevant to the user.

QUESTION: A company (the lessor) buys a car and then leases it to one of its customers (lessee).
Which of the following is correct?

1. Unless the title eventually transfers to the lessee, the lease should be reported as an
operating lease.

2. If the car has a life of ten years and the lease is for eight years, the lease must be reported as
a capital lease.

3. If the lease is a capital lease, then the lessee must account for the contract as either a direct
financing lease or a sales type lease.

4. If the lessee is given the option to purchase the car at the end of the lease, both parties will
account for the contract as a capital lease.

ANSWER: B. If the car has a life of ten years and the lease is for eight years, the lease must be
reported as a capital lease.

The FASB has established four criteria for a capital lease. If any one of these is met, then the lease
has to be recorded as a capital lease:

The title transfers to the lessee

There is a bargain purchase option (a bargain is viewed as an option price that is significantly
below expected fair value so that it is reasonable to expect the lessee to acquire the asset).

The life of the lease is 75% or more of the life of the asset.

The present value of the minimum lease payments is 90% or more of the fair value of the
asset.

For a capital lease, the lessee only has one method of reporting (basically, the asset is being recorded
as an acquisition using long-term financing). However, the lessor must classify the lease as a sales
type lease or an operating lease based on certain factors.

QUESTION: Assuming that a companys stock has a fair value in excess of its par value, how would
the declaration of a 15% stock dividend by a corporation affect each of the following?

Additional Total stockholders


paid-in capital equity
A. Increase No effect
B. No effect No effect
C. No effect Decrease
D. Decrease Decrease

ANSWER: A. Increase; No effect


Issuing a 15% stock dividend increases the number of shares outstanding but it does not impact
stockholders equity because there is neither an increase nor a decrease in the net assets of the
company. Because the dividend was less than 20% to 25%, it is viewed as small stock dividend, and,
hence, it is recorded at fair value. Because the fair value is greater than the par value, the amount in
excess of par will be recorded as an increase to the additional paid-in capital account.

QUESTION: On November 1, Year 1, a company purchased a new machine. The machine does not
have to be paid for until November 1, Year 3. The total payment on November 1, Year 3, will include
both principal and interest. Assuming interest at a 10% rate, the cost of the machine would be the total
payment multiplied by what time value of money concept?

1. Present value of $1.

2. Present value of annuity of $1.

3. Future value of $1.

4. Future value of annuity of $.

ANSWER: A. Present value of $1.


The requirement is to determine what time value of money concept would be used to determine the
cost of a machine when a payment (principal plus interest) is to be made in two years.
Answer A is correct because the cost of the machine is to be recorded immediately; therefore, the cost
of the present value of a lump-sum payment would be used.
Answer B is incorrect because a lump-sum payment is involved, not an annuity. Answer C is incorrect
because a future amount would be used in computing the payment and not the cost of the machine.
Answer D is incorrect because a future amount would be used in computing the payment and not the
cost. Also, a lump-sum payment is involved and not an annuity.

QUESTION: Harbor Citys appropriations control account at December 31, 2008, had a balance of
$7,000,000. When the budgetary accounts were closed at year-end, this $7,000,000 appropriations
control balance should have:

1. appeared as a contra account.

2. been credited.

3. remained open.

4. been debited.

ANSWER: D. been debited.


When the budget is initially recorded for governmental accounting systems, the appropriations control
account is credited for authorized expenditures. At year-end, the budget entry is reversed; thus the
appropriations control account would be debited to close it out.

REGULATIONS
QUESTION: In Year 1, Gardner used funds earmarked for use in Gardners business to make a
personal loan to Carson. In Year 3, Carson declared bankruptcy, having paid off only $500 of the loan
at that time. In Year 1, Gardner purchased equipment for use in Gardners business. In Year 3,
Gardner sold the equipment at a $5,000 loss. In January of Year 3, Gardner received shares of stock
as a gift from Smith; the shares had been purchased by Smith in Year 1. In November of Year 3,
Gardner sold the property for a $5,000 gain.
Which of the above transactions will Gardner report as a long-term capital gain or loss for Year 3?

i. The bad debt write-off

ii. The sale of equipment

iii. The sale of shares

A. II and III only.

B. None of the above.

C. I only.

D. III only.

ANSWER: D. The uncollectibility of a personal loan represents a nonbusiness bad debt, which is
treated as a short-term capital loss, regardless of the holding period. Depreciable business property
held longer than one year is Section 1231 property and losses on sale are treated as ordinary, not
capital losses. Shares received by gift will retain donors holding period and basis. Since the shares
had been purchased by the donor more than 1 year before their sale, the result would be a long-term
capital loss.

QUESTION: Quanti Co., a calendar-year taxpayer, purchased small tools for $5,000 on December 21,
20X14, representing the companys only purchase of tangible personal property that took place
during 20X14. On its 20X14 tax return, how many months of MACRS depreciation may Quanti Co.
claim on the tools?

A. One-and-a-half months

B. One month

C. Six months

D. None

ANSWER: A. In most cases, MACRS involves applying the half-year convention under which assets
are amortized for year in the year of acquisition and in the year of disposal. When an entity
acquires at least 40 percent of its depreciable and amortizable assets in the final three months of the
year, the mid-quarter convention is applied under which depreciation is calculated only for of the
last quarter of the year, or 1 months.
QUESTION: Hanks home is burglarized on December 22, 20X14. Personal property with a fair
market value of $40,000 and an adjusted basis to Hank of $25,000 is stolen. Hank paid an
independent appraiser $700 on December 29 to determine the fair market value of the property at the
time of the break-in. Hanks homeowners insurance policy leads him to believe he is entitled to
receive $15,000 in reimbursement for the event, but no settlement has been made with the insurance
company by year-end. Hanks AGI in 20X14 is $30,000. How much may Hank deduct from AGI as a
result of these facts on his 20X14 tax return? Assume Hank itemizes and assume there has still been
no settlement with the insurance company at the time of filing.

A. $7,000

B. $21,900
C. $6,900

D. $22,000

ANSWER: A. Theft and casualty losses are deductible to the extent that they exceed both $100 and
10% of AGI. The loss is measured by the lesser of the reduction in fair value of the property as a
result of the casualty or the excess of the basis in the property over its fair value after the loss. Since
the reduction in fair value from $40,000 to $0 exceeds the excess of the basis of $25,000 over the
new fair value of $0, the lower loss, $25,000, will be used. This will be reduced by the $15,000 in
insurance proceeds to which the taxpayer is entitled, giving a net amount of $10,000. This is reduced
by $100 and by 10 percent of AGI, or $3,000, for a net amount of $6,900. The $700 appraisal fee is
also deductible as a miscellaneous expense. The amount is reduced by 2 percent of AGI, or $600, for
a net deduction of $100. As a result, total deductions from this theft will be $6,900 + $100 or $7,000.
QUESTION: Regarding the tax treatment of a businesss research and experimental (R&E)
expenditures, which of the following statements is true?

A. A common reason for electing tax deferral of such expenses is the expectation of lower tax
rates in the future.

B. Expenses associated with the acquisition of land upon which a purpose-built R&E facility is
constructed are considered R&E expenditures for tax purposes.

C. Companies generally prefer to expense R&E costs immediately, but may elect instead to
defer and amortize such costs over a minimum of 60 months.

D. Companies may elect to immediately expense R&E costs incurred in the first applicable
taxable year and all future years through an appropriate filing with the IRS.

ANSWER: C. A taxpayer generally elects to deduct R&E costs in the period occurred. The election, if
made in the first tax year in which R&E expenditures are incurred, requires no filing with the IRS.
Such an election is binding for the current and future periods unless a change is approved by the IRS.
As an alternative, the taxpayer may file an election to defer and amortize R & E expenditures over a
period that does not exceed 60 months. One reason companies will defer and amortize R&E costs is
the anticipation of higher, not lower, tax rates in the future. For tax purposes, costs incurred in
acquiring land or depreciable property are not considered R&E expenditures, though later
depreciation expense in relation to such property could qualify.
QUESTION: Identify the correct statement below regarding the Domestic Production Activities
Deduction (DPAD).

A. Qualified Production Activities Income (QPAI) is calculated by applying a percentage to net


income from an IRS rate table based on specific criteria.

B. The DPAD cannot exceed attributable W-2 wages paid.

C. A sole proprietorship cannot claim the DPAD, but a partnership or S corporation with more
than one shareholder can.

D. Taxable income for the purposes of calculating or amending the DPAD includes any net
operating loss (NOL) deduction, such as an NOL carryforward or NOL carryback.

ANSWER: D. A DPAD is allowed to taxpayers that have Qualified Production Activities Income
(QPAI); AGI or taxable income, as appropriate for the taxpayer; and W-2 wages paid to employees
engaged in the production of the QPAI. The amount of the deduction is not determined using a rate
table; it is 9% of the lesser of QPAI or taxable income, subject to a limit of 50% of attributable W-2
wages paid. Sole proprietorships, partnerships, and S corporations all may take advantage of the
DPAD. For purposes of calculating the DPAD, taxable income does not include a deduction for the
DPAD but does include net operating losses.
QUESTION: Kudzu, Clemmons and Clancy form KCC Partnership with the following contributions:

Partner Contribution Adjusted Basis Fair Market Value

Kudzu Land $52,000 $50,000

Kudzu Services N/A $ 5,000

Clemmons Property $30,000 $40,000

Clancy Property $25,000 $30,000

What amount of taxable income to Kudzu results from the formation of KCC?

A. $5,000

B. $0

C. $7,000

D. $2,000

ANSWER: A. When cash or property is contributed to a partnership in exchange for a partnership


interest, the transaction is not taxed and the tax bases and holding periods remain unchanged.
Services contributed in exchange for a partnership interest, however, are taxed at their fair market
value, $5,000 in this case.
QUESTION: Identify the correct statement below regarding similarities and differences of corporate
and individual taxation.

A. If long-term capital losses exceed their allowable yearly offset to ordinary income, both
individuals and corporations may carry forward the losses and claim them as long-term capital
losses in future years, subject to certain limitations for corporations.

B. Both individuals and corporations can utilize the like-kind exchange provisions of Code
Section 1031.

C. Both individuals and corporations must distinguish between deductions for and
deductions from in calculating taxable income.

D. Corporations can claim the Domestic Production Activities Deduction (DPAD), but individuals
cannot.

ANSWER: B. Section 1031 of the Internal Revenue Code relates to exchanges of property for similar
property in like-kind exchanges and applies to corporations and individuals. An individual may carry
forward nondeductible capital losses and they retain their character as being long-term or short-term.
A corporation may carry nondeductible losses back 3 and forward up to 5 years with all carrybacks
and carryforwards treated as short-term. While a corporation does not distinguish between
deductions for and deductions from taxable income, these distinctions are important to an individual
due to the different limitations placed on various income and deduction items. The Domestic
Productions Activities Deduction is available to both individual and corporate taxpayers.
QUESTION: Harold gives one share of stock in Harold Corp., an S Corp, to each the following
individuals:

His nephew

His son

His adopted step-daughter

His grandson

His cousin

What is the minimum number of additional S-Corp shareholders under Code Section 1361 that will
result from this distribution of stock?

A. Three.

B. Four.

C. Two.

D. Five.

ANSWER: C. For purposes of determining that there are no more than 100 shareholders of an S
corporation, shareholders that are directly related, going up to six generations, may be treated as a
single taxpayer. As a result, Harolds son, adopted step-daughter, and grandson may all be
considered the same as Harold and will not result in any additional shareholders. Harolds nephew
and cousin will each be an additional shareholder, indicating an addition of two.
QUESTION: Identify which of the following would be a separately stated item on Schedule K-1 of an S
Corporations Form 1120S:

i. Salaries paid to employees who are not shareholders.

ii. Salaries paid to officers who are shareholders.

iii. Collectibles gain or loss.

A. III only.

B. None of the above.

C. II and III only.

D. All of the above.

ANSWER: A. Separately stated items on Schedule K-1 of an S corporation include those items that
receive special tax treatment such as being taxed at specific rates or being subject to various
limitations. Salaries paid to employees, whether or not they are shareholders or officers, are ordinary
business expenses and do not receive special tax treatment. As a result, neither would be a
separately stated item. Gains and losses on collectibles are treated as long-term capital gains and
losses, which do require special treatment and would be separately stated items.
QUESTION: Zunilda is 77-year-old individual with an AGI of $25,000 in 2014. She began living in a
nursing home in 2014 upon the recommendation of her primary care physician in order to receive
medical care for a specific condition. She had the following unreimbursed expenses in 2014:

Expense Amount

Nursing home health care costs $5,000

Nursing home meal and lodging costs 8,000

Prescription drugs 1,500

As a result of these unreimbursed expenses, how much may Zunilda deduct from AGI on her 2014 tax
return? Assume Zunilda elects to itemize deductions.

A. $12,000

B. $4,000

C. $12,625

D. $4,625

ANSWER: C. The $1,500 cost of prescription drugs and the $5,000 of nursing home health care costs
would be included in Zunildas medical expenses. When a taxpayer resides in a nursing home due to
needed medical care, as is the case, the cost of meals and lodging are also included, resulting in total
medical expenses of $14,500. Taxpayers who are 65 or older reduce medical expenses by 7.5% of
AGI to determine the deductible amount. As a result, Zunilda may deduct $14,500 7.5% x $25,000
($1,875) for a deduction of $12,625.
QUESTION: In Year 1 Jorge buys a home for $200,000, making a down payment of $40,000 and
taking out a loan from the bank for $160,000 to finance the balance. In Year 5 the remaining loan
balance is $130,000 while the home has increased in value to $270,000. Jorge refinances with a loan
company that agrees to lend 125% of the value of the home, or $337,500, using $130,000 to repay
the bank loan and providing $207,500 in cash. Jorge immediately spends $10,000 of the cash on a
lavish vacation to the Bahamas, and $20,000 to pay down credit cards. How much of the $337,500
home equity loan balance is allowable for calculating the home mortgage interest deduction on
Jorges Year 5 tax return?

A. $240,000

B. $230,000

C. $270,000

D. $220,000
ANSWER: B. Home mortgage interest on acquisition indebtedness, or on loans that replace
acquisition indebtedness, up to $1,000,000, and interest on home equity loans up to $100,000 may be
deducted as long as the total debt does not exceed the fair value of the residence. The use of the
proceeds of a home equity loan does not affect the deductibility of the interest. Upon refinancing,
$130,000 of the new loan would be considered a replacement of acquisition indebtedness, with the
remainder considered a home equity loan. As a result, Jorge could deduct interest on $130,000 +
$100,000 or $230,000 since it does not exceed the fair value of the property.
QUESTION: On office building owned by Milo was destroyed by Hurricane Mel on September 25,
20X14. On October 2, 20X14 the President of the United States declared the area where the office
building was located a federal disaster area. Milo received settlement of his insurance claim for the
destruction of his building on January 2, 20X15. In order to qualify for nonrecognition of gain on this
involuntary conversion, what is the last date for Milo to acquire qualified replacement property?

A. December 31, 20X18

B. October 2, 20X18

C. December 31, 20X19

D. January 2, 20X19

ANSWER: C. In order to avoid being taxed on a gain resulting from an involuntary conversion, the
property subject to the conversion must be replaced within a specified time, measured from the end of
the calendar year in which the proceeds are received. In general, the period is 2 years, but it is 3
years when the involuntary conversion results from government condemnation or eminent domain and
is extended to 4 years when the loss is in connection with a declared federal disaster area. Since Milo
received the recovery on January 2, 20X15, the property would have to be replaced within 4 years
from the end of 20X15 or by December 31, 20X19.
QUESTION: Claire is a self-employed individual who owns and runs Claires Creations, LLC. In
20X14 she had $225,000 in net self-employment earnings, including a deduction for 50% of self-
employment tax, prior to any Keogh deduction. Claire has a defined contribution, stock bonus Keogh
plan. What is the highest deductible Keogh contribution Claire can make for the 20X14 tax year?
Assume no excess contribution carryover from prior years.

A. $56,250

B. $225,000

C. $52,000

D. $45,000

ANSWER: D. The deductible contribution to a Keogh plan by a self-employed taxpayer is limited to


25% of income from self-employment after subtracting the contribution. If Claire has income from self-
employment of $225,000 before subtracting the contribution, and if we call the contribution amount X,
the equation becomes X = 25% ($225,000 X). Multiplying both sides of the equation by 4 will give
4X = $225,000 X, or 5X = $225,000 and X = $225,000/5 or $45,000. This would give taxable income
of $180,000 and a contribution equal to 25% of that amount.
QUESTION: Delius Corp. has outstanding 1,000 5% bonds, issued in Year 1 at their face value of
$1,000 each, which are currently selling at $1,150 each. In Year 3 Delius Corp. reaches an agreement
with its bondholders to issue 100 shares of stock for each bond instead of paying off the bonds at the
maturity date. The stock has a fair market value of $18 per share. As a result of the above, what
recognized gain must Deliuss bondholders, now shareholders, report in Year 3?

A. $650,000 long-term capital gain


B. $800,000 long-term capital gain

C. $650,000 dividend

D. $0

ANSWER: D. An exchange of bonds for stock is a Type E reorganization, which is a recapitalization


designed to change the capital structure of a single corporation. In a corporate reorganization, a
security holder will not recognize a gain or loss when the stock or securities of a corporation that is
involved in the reorganization are exchanged solely for stock or securities in the same corporation or
another one that is part of the reorganization. Since the previous bondholders are receiving solely
stock in exchange for their bonds, no gain or loss would be recognized.

QUESTION: Which of the following generates a permanent difference between book and taxable
income?

i. The Domestic Activities Production Activities Deduction (DPAD)

ii. Section 179 bonus depreciation

iii. Tax credits

iv. II only.

A. I, II, and III.

B. I only.

C. I and III only.

ANSWER: D. In reconciling book income to taxable income on Schedule M-1, all differences between
book and tax income are identified. Temporary differences are those that will ultimately be the same
for tax and book purposes but in different periods, such as bonus depreciation, taken in the year of
acquisition for tax and spread out over the life of the asset for book purposes. Permanent differences
are items that are deductible or taxable for tax purposes but not for book purposes, or vice versa. This
would include the DPAD, which is deductible for tax purposes but is not an expense for financial
reporting purposes, and tax credits, which are reductions in tax as a result of the operation of tax law
but do not represent either income or expense for financial reporting purposes.
QUESTION: Which of the following situations will result in a tax preparers penalty?

i. At a clients insistence, the preparer takes and properly discloses a tax position which does
not meet the reasonable basis standard.

ii. The preparer discloses a clients personally identifying information to outside parties in order
to permit the electronic preparation and submission of the clients return.

iii. The preparer provides his Preparer Tax Identification Number but fails to sign a clients tax
return.

A. II only.

B. I, II, and III.

C. I only.

D. I and III only.


ANSWER: D. A tax preparer will incur a penalty for an understatement of a tax liability as a result of a
tax position that lacks substantial authority and is not disclosed or a position that has no reasonable
basis supporting it, regardless of whether or not it is disclosed. A preparer will also be penalized for
failing to sign a return. Although a preparer will generally be penalized for disclosing confidential
information obtained through the preparation of a return, there will be no penalty if the information is
provided to permit the electronic preparation or submission of the taxpayers return.
QUESTION: In 20X14 Colossus Corporation incurred net capital losses in the amount of $25,000.
Colossus had the following net capital gains in the previous five years:
20X13 - $7,000
20X12 - $2,000
20X11 - $5,000
20X10 - $4,000
20X09 - $3,000
How much of the 20X14 capital loss may Colossus carry over to 20X15?

A. $0

B. $8,000

C. $11,000

D. $1,000

ANSWER: C. A corporation may not deduct a capital loss. Instead, it may be carried back to any or
all of the preceding three years to be offset against previously taxable capital gains with the remainder
carried forward for up to 5 years. Colossus will carry $7,000 back to 20X13, $2,000 to 20X12, and
$5,000 to 20X11 for a total carryback of $14,000. The remaining $11,000 will be carried forward to
20X15.
QUESTION: On March 1 of the current year Reiter, an individual, sold an office building for $300,000
that had an adjusted basis of $220,000, resulting in a gain of $80,000. Reiter had purchased the
building for $260,000 on April 1 of the previous year, and $30,000 of the total depreciation taken took
advantage of a special tax incentive program Reiter qualified for. How should Reiter report this gain
on the current year tax return?

A. $80,000 ordinary gain

B. $30,000 ordinary gain and $50,000 long-term capital gain

C. $50,000 ordinary gain and $30,000 long-term capital gain

D. $40,000 ordinary gain and $40,000 short-term capital gain

ANSWER: D. Depreciable real property is section 1250 property subject to recapture of excess
depreciation. Since the building was held for less than 1 year, all depreciation taken, $40,000, would
be considered excess depreciation and would be recaptured, resulting in ordinary income of $40,000.
The remainder of the gain would be a short-term capital gain due to a holding period of less than 1
year.
QUESTION: In Year 7 Standard Corp., a C corporation, sold Section 1250 property for $600,000 that
had an adjusted basis of $550,000, resulting in a $50,000 gain. The property had cost Standard
$720,000 when purchased in Year 1, and $170,000 of accelerated depreciation had been taken. Had
straight- line depreciation been used, depreciation would have been $100,000. How should Standard
report the gain on its Year 7 tax return?
A. $20,588 ordinary gain and $29,417 long-term capital gain

B. $28,824 ordinary gain and $41,176 long-term capital gain

C. $70,000 ordinary gain

D. $50,000 ordinary gain

ANSWER: D. When section 1250 property that has been held for more than 1 year is sold at a gain,
excess depreciation is recaptured, resulting in an ordinary gain with the remainder, if any, recognized
as long-term capital gain. Excess depreciation for a C corporation consists of the difference between
the amount taken using an accelerated method and the amount that would have been allowed under
straight-line, $170,000 - $100,000 or $70,000, plus 20% of the amount allowed under straight-line,
$100,000 x 20% or $20,000 for a tot6al of $90,000. Since this exceeds the amount of the gain, the
entire $50,000 gain would be ordinary.
QUESTION: Mary gives Joanne a gift of land worth $80,000. The lands original cost to Mary was
$30,000. As a result of the transfer, Mary paid a gift tax of $12,000. What is Joannes basis in the
land? Assume an annual gift exclusion of $14,000.

A. $39,091

B. $30,000

C. $42,000

D. $37,500

ANSWER: A. A donees basis in an appreciated gift is equal to the donors basis plus gift tax paid with
respect to the gifts appreciation. The amount of gift tax added is the amount of tax paid, $12,000,
multiplied by the ratio of the net appreciation in the value of the gift, $50,000, to the amount of the gift,
which is calculated after eliminating the annual gift exclusion, $80,000 - $14,000 or $66,000. As a
result, the amount of gift tax that will be added to the donors basis of $30,000 will be $12,000 x
($50,000/$66,000) or $9,091 and the basis will be $39,091.
QUESTION: On November 1, 20X13, Ruth gave Helen a gift of stock worth $15,000. Ruth had
purchased the stock on February 1, 20X13 for $17,000. Helen sold the stock to an unrelated party on
November 1, 20X14 for $17,700. What is the amount and character of Helens gain or loss upon the
sale?

A. $700 short-term capital gain

B. $2,700 short-term capital gain

C. $700 long-term capital gain

D. $2,700 long-term capital gain

ANSWER: C. When property received by gift has a fair value that is lower than its basis on the date of
the gift, the basis for determining gain or loss is determined using the sales price. If the sales price is
lower than the fair value at the date of gift, that amount is used to calculate the loss and the holding
period is calculated from the date of the gift. If the sales price exceeds the donors basis, the donors
basis is used to calculate the gain and the donors holding period is included. Since the property was
sold for $17,700, which exceeds the donors $17,000 basis, a gain of $700 would be recognized. The
holding period would extend from Ruths date of acquisition, 2/1/X13, to the date of sale, 11/1/X14,
which is greater than a year. Helen will recognize a $700 long term capital gain.
QUESTION: Ravi, a prosperous businessman, owns devalued property its basis to him exceeds its
fair market value (FMV), which is $600,000. He would like to give the property to his daughter, Ritu,
but is unsure about the tax consequences to Ritu depending on the timing of the gift. Should he give it
as a gift now, or leave it to her in his will? Why? Assume it is highly unlikely the FMV will have risen to
the level of Ravis basis by the time of Ravis death.

A. Give as gift now, because devalued property will be subject to step-down basis when given as
part of the estate, but will benefit from dual basis if given as a gift during the givers lifetime.

B. Leave in will, because giving devalued property as part of an estate leads to better tax
consequences for the beneficiaries due to the annual exclusion rules.

C. Give as gift now, because receiving devalued property during the givers lifetime leads to
better tax consequences for the recipient due to the annual exclusion rules.

D. Leave in will, because devalued property will benefit from step-up basis when given as part of
the estate, but will be subject to the dual basis rules if given as a gift during the givers
lifetime.

ANSWER: A. If Ritu inherits the property from Ravi, her basis will be the fair value at the date of
death, or six months after the date of death if the alternate valuation date is elected, which is
presumed to be lower than Ravis basis. A sale would result in a gain equal to the difference between
the sales price and that amount. If Ritu receives the property as a gift, since it is worth less than
Ravis basis on the date of the gift, her basis will be Ravis basis if sold at a gain and the fair value at
the date of the gift if sold at a loss. As a result, Ritu will only have a taxable gain if the property is sold
for more than Ravis basis, making a gift the more advantageous way for her to receive the property.
QUESTION: Identify the correct statement concerning issues of estate taxes, gift taxes, and family tax
planning.

A. A gift for a minor child, distributable to the child upon the childs 18th birthday, is a taxable gift
to the extent that it exceeds a present value of $14,000.

B. Upon the death of one its owners, a property owned in joint tenancy automatically goes to the
survivors and bypasses the estate of the decedent.

C. Gifts given in contemplation of marriage, such as an engagement ring to a fiance, are


excludable from taxable gifts so long as the marriage occurs no later than sometime within
the following tax year.

D. Income in respect of a decedent, includable on the fiduciary income tax return, is excluded
from the valuation of the gross estate of the decedent.

ANSWER: B. Joint tenancy is the ownership of property by two or more persons with each having an
undivided interest in the property. This gives joint tenants the right of survivorship indicating that, upon
the death of a joint tenant, that tenants share in the property reverts to the other joint tenants, not to
the deceaseds estate. Only a present interest, which is an unrestricted right to the immediate use of
the gift, is subject to the annual exclusion. A gift distributable upon a childs future birthday is a future
interest and is fully taxable. While gifts to a donors spouse are not subject to gift tax, there is no
exclusion for gifts in contemplation of marriage, such as an engagement ring. The gross estate of a
decedent includes income in respect of the decedent, which is a receivable to the estate, despite the
fact that it is also includable on the fiduciary income tax return.
QUESTION: Identify the correct statement regarding portability of a deceased spouses unused
lifetime exclusion amount.

A. It can be granted via an amended tax return of the surviving spouse.


B. It permits the surviving spouse to apply the decedents unused exclusion amount to the
surviving spouses own transfers during life, but not at death.

C. It is granted via an election on the decedents fiduciary income tax return.

D. It can be elected only through a timely filing of a Form 706.

ANSWER: D. Portability refers to the ability of a surviving spouse to take advantage of any unused
portion of their deceased spouses unified estate and gift tax credit. To take advantage of this, the
estate is required to file an estate tax return on form 706. It may not be granted by filing an amended
tax return for the surviving spouse. The credit may be applied to gifts given during the surviving
spouses lifetime with the remainder applied to the surviving spouses estate. It may not be claimed on
the decedents fiduciary income tax return filed on form 1041.

Business Environment and Concepts


QUESTION: What is the backup facility that can be up and running at a short notice called?

1. VAN.

2. Remote site.

3. Cold site.

4. Hot site.

ANSWER: The correct answer is D. A hot site is a backup facility that can be up and running at a
short notice. A cold site is a backup facility that can be up and running at a considerable effort. VAN
stands for Value Added Network and is not a backup facility. Remote site is not specific about the
speed of availability.
QUESTION: The application processing phase where the master file is updated is called:

1. audit trail.

2. edit routine.

3. data capture.

4. master file maintenance.

ANSWER: The correct answer is D. Master file maintenance involves updating the master file with
new transaction(s). Data capture is the phase where data is recorded. Edit routine is validation of
(previously) input data. Audit trail is an authentication control to verify integrity of transactions.
QUESTION: Which of the following factors would cause the demand curve for a given product to
increase (shift to the right)?

1. Changes in the price of the given product.

2. Decrease in consumer income.

3. Increase in the price of a substitute product.

4. Increase in the price of a complimentary product.

ANSWER: The correct answer is C. An increase in the price of a substitute product would cause the
demand curve for a given product to increase (shift to the right).
QUESTION: The purpose of a flexible budget is to:

1. reduce the total time in preparing the annual budget.

2. compare actual and budgeted results at virtually any level of production.

3. eliminate cyclical fluctuations in production reports by ignoring variable costs.

4. allow management some latitude in meeting goals.

ANSWER: The correct answer is B. This is the definition of a flexible budget. Compared to a static
budget, which shows only one level of production, the flexible budget shows budgeted costs and
revenues for any level of production. As levels of production change, the costs and revenues will
change as well. The flexible budget provides that information. Variance analysis is made more
meaningful with flexible budgets.
QUESTION: Spoilage occurring during a manufacturing process can be considered normal or
abnormal. The proper accounting for each of these costs is:
Normal Abnormal
A. Product Period
B. Product Product
C. Period Product
D. Period Period
ANSWER: The correct answer is A. Normal spoilage is product deterioration expected to occur,
especially in manufacturing, even under the best of conditions. Abnormal spoilage is spoilage beyond
the normal spoilage rate. Normal spoilage is a product cost while abnormal spoilage is a period cost.
The cost of normal spoilage is "absorbed" by the surviving units while the abnormal spoilage loss is
recognized immediately; that is, in the current period.

QUESTION: The Public Company Accounting Oversight Board (PCAOB) was created by which of the
following?

1. Securities and Exchange Commission.

2. Sarbanes-Oxley Act of 2002.

3. Financial Accounting Standards Board.

4. Institute of Certified Public Accountants.

ANSWER: The correct answer is B. The Sarbanes-Oxley Act of 2002 created the PCAOB.
QUESTION: The Committee of Sponsoring Organizations of the Treadway Commission (COSO)
internal control framework consists of five interrelated components including control activities. Which
of the following is NOT an example of a control activity?

1. Risk assessment.

2. Segregation of duties.

3. Security of assets.

4. Performance reviews.
ANSWER: The correct answer is A. Control activities include authorizations, performance reviews,
security of assets, application controls, and segregation of duties. Risk assessment is one of the five
interrelated components.
QUESTION: All of the following are risks of e-commerce EXCEPT:

1. Applicability.

2. Data integrity.

3. Processing integrity.

4. Security and authenticity.

ANSWER: A) Risks of e-commerce include security and authenticity, processing integrity, data
integrity, and privacy.
QUESTION: What does a credit balance in a direct-labor efficiency variance account indicate?

1. Actual total direct-labor costs incurred were less than standard direct-labor costs allowed for
the units produced.

2. The standard hours allowed for the units produced were greater than actual direct-labor hours
used.

3. The number of units produced was less than the number of units budgeted for the period.

4. The average wage rate paid to direct labor employees was less than the standard rate.

ANSWER: B) A credit balance indicates a favorable variance, with standard hours allowed being
greater than actual hours used.
QUESTION: Nile Co.s cost allocation and product costing procedures follow activity-based costing
principles. Activities have been identified and classified as being either value-adding or nonvalue-
adding as to each product. Which of the following activities, used in Niles production process, is
nonvalue-adding?

1. Raw materials storage activity.

2. Design engineering activity.

3. Heat treatment activity.

4. Drill press activity.

ANSWER: A) In the production process, storing raw materials until they are needed represents a non-
value added step, whereas engineering, heat treatment or drilling represents improving the product. In
addition, storage requires handling costs, cost of holding inventory, possible breakage or
misappropriation, while inventory simply waits for use at a later time.

QUESTION: In an income statement prepared as an internal report using the direct (variable) costing
method, fixed selling and administrative expenses would:

1. Be used in the computation of the contribution margin.


2. Be used in the computation of operating income but not in the computation of the contribution
margin.

3. Be treated the same as variable selling and administrative expenses.

4. Not be used.

ANSWER: B) Under the direct or variable costing method, variable costs are deducted from revenue
to determine contribution margin, and all fixed costs (manufacturing, selling, general and
administrative) are then deducted to obtain net income or income from operations.
The contribution margin is calculated in two steps:

1. Revenue less variable cost of goods sold = Contribution margin: manufacturing

2. Contribution margin: manufacturing less other variable costs (S, G & A) = Contribution
margin: final

QUESTION: Jago Co. has 2 products that use the same manufacturing facilities and cannot be
subcontracted. Each product has sufficient orders to utilize the entire manufacturing capacity. For
short-run profit maximization, Jago should manufacture the product with the:

1. Lower total manufacturing costs for the manufacturing capacity.

2. Lower total variable manufacturing costs for the manufacturing capacity.

3. Greater gross profit per hour of manufacturing capacity.

4. Greater contribution margin per hour of manufacturing capacity.

ANSWER: D) As both products can utilize full capacity, the greatest profit will result from the greatest
contribution margin (selling price - variable costs) for capacity. Fixed costs are irrelevant as they are
not affected by the decision.
QUESTION: Which of the following statements about capital budgeting evaluation methods is
FALSE?

1. NPV does not take the profit of an investment into account since it concentrates on a projects
effect on the value of the firm.

2. The IRR and NPV will never disagree about whether or not a project is acceptable.

3. The IRR and NPV methods both incorporate the firms WACC.

4. The IRR can be defined as the discount rate that results in a project having an NPV equal to
zero.
ANSWER: A) NPV does measure the effect of an investment on the value of the firm and does so by
discounting future cash flows by the WACC. If the return of the project is greater than the WACC the
NPV will be positive. Therefore, the return is greater than the cost and the project is profitable.

QUESTION: Residual income is income:

1. from which dividends are deducted.

2. from which an imputed interest charge for invested capital is deducted.

3. to which dividends are added.

4. to which an imputed interest charge for invested capital is added.

ANSWER: B) An investment's residual income is the accounting income from the investment less an
allowance for a return on investment (invested capital).

QUESTION: Which of the following is least likely an assumption of linear regression?

1. The residuals are normally distributed.

2. There is a linear relation between the dependent and independent variables.

3. The independent variable is correlated with the residuals.

4. The variance of the residuals is constant.

ANSWER: C) The assumption is that the independent variable is uncorrelated with the residuals

QUESTION: What is the market conversion price of a convertible security?

1. the price that an investor pays for the common stock if the convertible bond is purchased and
then converted into the stock.

2. the price that an investor pays for the common stock in the market.

3. the value of the embedded call option.

4. the value of the security if it is converted immediately.

ANSWER: A) The market conversion price, or conversion parity price, is the price that the convertible
bondholder would effectively pay for the stock if she bought the bond and immediately converted it.
market conversion price = market price of convertible bond conversion ratio.

QUESTION: If the Federal Reserve (Fed) wanted to increase the money supply, it would:

1. lower the discount rate.

2. lower the required reserve ratio.

3. buy government securities.

4. any or all of these.


ANSWER: D) Expansionary monetary policy involves reducing reserve requirements, purchasing
additional government securities, and/or lowering the discount rate.

QUESTION: A bank is considering building a branch on a piece of property it already owns. Which of
the following cash flows should NOT be considered in the capital budgeting analysis?

1. The $100,000 spent to determine whether there are any environmental issues regarding the
property.

2. The $50,000 the firm will forgo in lost revenue from the sale of the property if the company
decides to build.

3. The several hundred customers that will switch from alternative branches to the new branch if
the bank makes the investment.

4. The shipping and installation charges the bank must spend to get equipment in the new
branch.

ANSWER: A. The $100,000 spent on an environmental analysis is a sunk cost and should not be
considered in the analysis. The $50,000 lost from the sale of the property is an opportunity cost and
should be considered. The transferred customers result in cash flows that are
externalities/cannibalization for the bank and must be considered. Also, the shipping and installation
charges are added to the depreciable basis and are counted.

QUESTION: All else equal, which of the following will help decrease a companys total debt to equity
ratio?

1. Buying treasury stock.

2. Paying cash dividends to stockholders.

3. Converting long-term debt to short-term debt.

4. Lowering the dividend payout ratio.

ANSWER: D. Buying treasury stock and paying cash dividends will decrease stockholders equity,
and thus increase the debt/equity ratio. Converting long-term debt to short-term will have no effect on
total debt or stockholders equity. Lowering dividend payout ratio will increase retained earnings, thus
increasing stockholders equity and decreasing the debt/equity ratio.

QUESTION: If the exchange rate value of the euro goes from $0.95 to $1.10, then the euro has:

1. appreciated and the Dutch will find U.S. goods more expensive.

2. depreciated and the Dutch will find U.S. goods cheaper.

3. appreciated and the Dutch will find U.S. goods cheaper.

4. depreciated and the Dutch will find U.S. goods more expensive.

ANSWER: C. appreciated and the Dutch will find U.S. goods cheaper.
An exchange rate is a ratio that describes how many units of one currency you can buy per unit of
another currency. The numerator will be in the currency in which the quote is made and the
denominator is the other unit of the currency you are comparing. A currency appreciates when it rises
in value relative to another foreign currency. Likewise, a currency depreciates when it falls in value
relative to another foreign currency. An appreciation in value of a currency makes that countrys goods
more expensive to residents of other countries. The depreciation of the value of a currency makes a
countrys goods more attractive to foreign buyers.

QUESTION: Which of the following statements concerning the relationship of the quantity demanded
or supplied with price is(are) correct?

I. The quantity supplied varies inversely with price.


II. The quantity demanded varies directly with price.

1. I only.

2. II only.

3. Both I and II.

4. Neither I nor II.

ANSWER: Neither I nor II.


The quantity supplied varies directly with price and the quantity demanded varies indirectly with price
Answer (a) is not correct because the quantity supplied varies directly with price. Answer (b) is not
correct because the quantity demanded varies indirectly with price. Answer (c) is not correct because
the quantity supplied varies directly with price and the quantity demanded varies indirectly with price.

QUESTION: The following information pertains to Roe Co.s manufacturing operations:

Standard direct labor hours per unit 2


Actual direct labor hour 10,500
Number of units produced 5,000
Standard variable overhead per standard direct labor hour $3
Actual variable overhead $28,000

Roes unfavorable overhead efficiency variance was:

1. $0.

2. $1,500.

3. $2,000.

4. $3,500.

ANSWER: B. $1,500.
Overhead is generally applied based upon direct labor hours. The unfavorable overhead efficiency
variance represents the number of actual hours required over the number of standard labor hours
allowed for that level of output, multiplied by the standard variable overhead rate. Based on Roes
operations, the unfavorable overhead efficiency for the 5,000 units produced is $1,500;

Hours allowed (5,000 units 2 hrs/unit) 10,000


Actual hours 10,500
Excess hours over standard 500
Standard rate $3
Variance $1,500
QUESTION: In an income statement prepared as an internal report, total fixed costs normally would
be shown separately under:

Absorption costing Variable costing


A. No No
B. No Yes
C. Yes Yes
D. Yes No

ANSWER: B. No; Yes


Under the direct or variable costing method, variable costs are deducted from sales revenue to
determine contribution margin and all fixed costs (overhead, selling, general and administrative) are
then deducted to obtain net income or income from operations. The contribution margin is calculated
in two steps:

Sales revenue less (variable) cost of goods sold = Contribution margin: manufacturing.

Contribution margin: manufacturing less other variable costs (S, G & A) = Contribution
margin: final.

Under the absorption costing method, each cost classification (cost of goods sold, selling, general and
administrative, etc.) includes both its fixed cost and variable cost components.

QUESTION: An investor owns stock and is concerned that prices may fall in the future. Which
strategy could help to hedge against adverse market conditions?

1. Buy a futures contract.

2. Buy a futures contract.

3. Buy a put option.

4. Buy a call option.

ANSWER: C. Buy a put option.

Buying a call, buying a futures contract, or buying a forward gives the investor the chance to buy more
stock. However, neither of these strategies provides a way to hedge the existing equity position. A put
option provides the opportunity to sell the stock.

QUESTION: For a given year, a companys economic value added measure (EVA is a registered
trademark of Stern Stewart & Co.) will be positive if the:

1. firm has a net operating profit after tax greater than the market value of the debt capital
employed.

2. firms MVA is positive.

3. earns a return greater than its cost of capital.

4. firm has a net operating profit after tax greater than the book value of the capital employed.

ANSWER: C. firm earns a return greater than its cost of capital.


EVA is positive when a company earns a rate of return greater than its cost of capital. EVA is a
financial performance measure that attempts to calculate true economic profit. The formula is net
operating profit after tax reduced by a measure of the cost of all capital of the firm. Its focus is on
maximizing shareholder wealth.
Market value added (MVA) is the difference between the market value of a company and the capital
contributed by investors (both bondholders and shareholders). Higher MVA is better than lower MVA.
A high MVA company is one that has created substantial wealth for its shareholders.

QUESTION: A bank is considering building a branch on a piece of property it already owns. Which of
the following cash flows should not be considered in the capital budgeting analysis? The:

1. $50,000 the firm will forgo in lost revenue from the sale of the property if the company decides
to build.

2. $100,000 spent to determine whether there are any environmental issues regarding the
property.

3. several hundred customers that will switch from alternative branches to the new branch if the
bank makes the investment.

4. shipping and installation charges the bank must spend to get equipment in the new branch.

ANSWER: B. $100,000 spent to determine whether there are any environmental issues regarding the
property.
The $100,000 spent on an environmental analysis is a sunk cost and should not be considered in the
analysis. The $50,000 lost from the sale of the property is an opportunity cost and should be
considered. The transferred customers result in cash flows that are externalities/cannibalization for
the bank and must be considered. Also, the shipping and installation charges are added to the
depreciable basis and must be included.

QUESTION: Short-term interest rates are:

1. generally lower than long-term rates.

2. generally higher than long-term rates.

3. lower than long-term rates during periods of high inflation only.

4. not significantly related to long-term rates.

ANSWER: A. generally lower than long-term rates.


Short-term interest rates are generally lower than long-term interest rates. This is due to the higher
interest rate risk and yield-curve risk associated with an increased time to maturity. Answer D is
incorrect because short-term interest rates are related to long-term rates.

QUESTION: On December 31, year 7, North Park Co. collected a receivable due from a major
customer. Which of the following ratios would be increased by this transaction?

1. Current ratio.

2. Receivable turnover ratio.

3. Quick ratio.

4. Inventory turnover ratio.

ANSWER: Receivable turnover ratio.

Accounts receivable turnover = sales/average accounts receivable


Collection of accounts receivable would reduce the accounts receivable balance and resulting
average accounts receivable. This reduction in the denominator of the AR turnover ratio would result
in an increase in the fraction calculation.

The current ratio is current assets/current liabilities and the quick ratio is (cash + receivables)/current
liabilities. For both calculations, the collection of the receivable would result in a $0 net effect (as AR
decreased, cash increased).

The inventory turnover ratios is COGS/average inventories which is not affected by the collection of
the receivable.

QUESTION: The partners of College Assoc., a general partnership, decided to dissolve the
partnership and agreed that none of the partners would continue to use the partnership name. Under
the Revised Uniform Partnership Act, which of the following events will occur on dissolution of the
partnership?

Each partners Each partners


existing liability apparent authority
would be discharged would continue
A. Yes Yes
B. Yes No
C. No Yes
D. No No

ANSWER: C. No; Yes


Partners are agents of the partnership and each other. Thus, agency rules apply. If a partnership
dissolves, partners must give actual notice to old customers and published notice to new ones. Failure
of a partner to give proper notice would give a partner apparent authority to act on behalf of the
partnership with customers who were unaware of the dissolution. Although dissolution would
discharge a partners actual authority, it does not discharge a partners apparent authority.
Additionally, a dissociated partner remains liable for pre-dissolution obligations. Only Answer (c)
reflects that a partners liability is not automatically discharged by dissolution and that apparent
authority would continue.

QUESTION: The corporate veil is most likely to be pierced and the shareholders held personally liable
if:

1. the corporation has elected S corporation status under the Internal Revenue Code.

2. an ultra vires act has been committed.

3. a partnership incorporates its business solely to limit the liability of its partners.

4. the shareholders have commingled their personal funds with those of the corporation.

ANSWER: D. the shareholders have commingled their personal funds with those of the corporation.
A stockholder may be held personally liable for corporate debts (piercing the corporate veil).
Specifically this may be done by a showing of fraud, undercapitalization of the corporation, and
commingling of corporate and personal funds by the stockholder. Thus, the corporate veil may be
pierced if the stockholder commingled their personal funds with those of the corporation. Choosing S
corporation status, commission of an ultra vires act, and incorporation to obtain limited personal
liability are all insufficient grounds to pierce the corporate veil.
QUESTION: An accounting information system (AIS) must include certain source documents in order
to control purchasing and accounts payable. For a manufacturing organization, the best set of
documents should include:

1. purchase requisitions, purchase orders, inventory reports of goods needed, and vendor
invoices.

2. purchase orders, receiving reports, and inventory reports of goods needed.

3. purchase orders, receiving reports, and vendor invoices.

4. purchase requisitions, purchase orders, receiving reports, and vendor invoices.

ANSWER: D. purchase requisitions, purchase orders, receiving reports, and vendor invoices.
The AIS functions include ensuring an entitys resources are3 protected and accurately documented
in a reliable manner. For a manufacturing organization, the transaction cycle should be controlled and
documented to protect the reliability of the process. The purchase requisition is evidence that some
user needs the goods. The purchase order specifies the price and quantity authorized by the
purchasing department. The receiving report is evidence of the quantity actually received. The vendor
invoice is evidence of the vendors request to be paid for the specified quantity (which should be
matched with the receiving report and purchase order) and price (which should be matched with the
purchase order).