Free CPA FAR Full-Length Practice Exam: 50 Questions

This free full-length CPA FAR multiple-choice question (MCQ) diagnostic includes 50 original Mastery Exam Prep questions across the FAR blueprint areas.

The CPA FAR section also involves task-based simulations and exhibit-heavy work, so use this page as an MCQ diagnostic rather than a complete simulation of every item type. The questions are original practice questions and are not official exam questions.

Practice count note: exam sponsors can describe total questions, scored questions, task-based simulations, duration, or unscored/pretest-item rules differently. Always confirm current exam-day rules with the sponsor.

For concept review before or after this diagnostic, use the CPA FAR guide on CPAExamsMastery.com.

Before you start

CPA means Certified Public Accountant. FAR means Financial Accounting and Reporting. This page is useful when you want one uninterrupted FAR multiple-choice diagnostic before returning to focused accounting topics.

Use the score as a diagnostic signal, not as a guarantee. FAR also involves task-based simulations and exhibit-heavy work, so a high score here should be paired with continued review of source-data interpretation, statement presentation, and accounting judgment.

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Practice questions

Questions 1-25

Question 1

Topic: Select Balance Sheet Accounts

At June 30, Finch Co.’s bank statement showed a cash balance of $82,460, and its general ledger cash account showed a balance of $85,510 before reconciliation. A staff accountant proposed a net debit to Cash of $6,650 for the following reconciling items:

What is the best correction to the proposed journal entry?

• A. Record a debit to Cash of $3,000 for the book error and bank error, excluding the timing differences.
• B. Keep the proposed net debit to Cash of $6,650 because it reflects the net effect of all reconciling items.
• C. Replace the proposed entry with a debit to Cash of $1,800 and a credit to Accounts receivable of $1,800; request bank correction of the $1,200 error.
• D. Record a debit to Cash of $5,450 for the deposit in transit, outstanding checks, and book error, excluding the bank error.

Best answer: C

What this tests: Select Balance Sheet Accounts

Explanation: The general ledger should be adjusted only for errors or items not yet recorded on the company’s books. The $1,800 understatement of the customer receipt is a book error, while the deposit in transit, outstanding checks, and bank error are bank-side reconciliation items.

A bank reconciliation adjusts the bank statement balance for deposits in transit, outstanding checks, and bank errors. Those items explain why the bank statement does not yet match the company’s records, but they generally do not require company journal entries when the company has already recorded the cash activity. The bank-side reconciliation is $82,460 + $12,400 - $8,750 + $1,200 = $87,310. The book balance should be adjusted only for the receipt recorded too low: $85,510 + $1,800 = $87,310. Therefore, the proposed $6,650 debit to Cash overstates the required book adjustment.

• Debiting Cash for all reconciling items treats timing differences and a bank error as book adjustments.
• Including the deposit in transit and outstanding checks adjusts items already recorded by Finch.
• Including the bank’s $1,200 error in Finch’s journal entry would incorrectly record another party’s transaction in Finch’s books.

Only the book recording error requires a general ledger adjustment; deposits in transit, outstanding checks, and bank errors reconcile the bank side.

Question 2

Topic: Financial Reporting

Marin Co. is preparing its December 31, 20X5 U.S. GAAP financial statements. During 20X5, Marin purchased $1,200,000 of raw materials from Supply LLC, an unconsolidated company wholly owned by Marin’s CEO’s spouse. The purchases were material, priced consistently with quotes from unrelated vendors, and fully paid by year-end. Which financial reporting conclusion is correct?

• A. Recognize the purchases as compensation expense to the CEO because the supplier is owned by the CEO’s spouse.
• B. No disclosure is required because the purchases were made at market prices and no payable remained at year-end.
• C. Disclose the related-party relationship, the nature and amount of the transactions, and any year-end amounts due, if any.
• D. Disclosure is required only if Marin cannot substantiate that the terms were equivalent to arm’s-length terms.

Best answer: C

What this tests: Financial Reporting

Explanation: The supplier is a related party because it is controlled by an immediate family member of Marin’s CEO. Material related-party transactions require note disclosure even when the terms appear to be market-based and there is no outstanding balance at year-end.

Under U.S. GAAP, related-party disclosures are intended to inform users about relationships and transactions that may affect the financial statements. Related parties include management, immediate family members of management, and entities controlled by those persons. When material transactions occur with a related party, the notes generally disclose the nature of the relationship, a description of the transactions, transaction amounts, and amounts due to or from the related party. Market pricing and payment before year-end do not eliminate the disclosure requirement. Also, a company should avoid implying that terms were arm’s length unless that assertion can be substantiated.

• Treating market pricing and full payment as eliminating disclosure misses that the relationship and material transaction are still relevant to users.
• Limiting disclosure to situations where arm’s-length terms cannot be substantiated reverses the rule; the related-party transaction itself drives disclosure.
• Classifying the purchases as CEO compensation is unsupported because Marin bought inventory from a separate supplier and no compensation arrangement is stated.

A material transaction with an entity controlled by an immediate family member of management is a related-party transaction requiring disclosure even if priced at market and fully paid.

Question 3

Topic: Select Transactions

Falcon Co. is preparing its income tax provision for the year ended December 31, 20X1. Falcon has no uncertain tax positions, no valuation allowance, and no beginning deferred tax balances.

Which income tax amounts should Falcon report for 20X1?

• A. Income tax expense of $201,000 and current taxes payable of $15,000
• B. Income tax expense of $249,000 and current taxes payable of $15,000
• C. Income tax expense of $225,000 and current taxes payable of $15,000
• D. Income tax expense of $201,000 and current taxes receivable of $15,000

Best answer: A

What this tests: Select Transactions

Explanation: Current tax based on taxable income is $900,000 × 25%, or $225,000. The $80,000 deductible temporary difference creates a deferred tax asset of $24,000 using the enacted future rate, reducing total income tax expense to $201,000 while estimated payments reduce the payable to $15,000.

Under U.S. GAAP, total income tax expense includes current tax expense plus or minus deferred tax effects. Current tax expense is based on taxable income and the current enacted tax rate: $900,000 × 25% = $225,000. Estimated tax payments reduce the current tax liability but do not reduce income tax expense, so current taxes payable are $225,000 − $210,000 = $15,000. The warranty liability is deductible in future years, creating a deferred tax asset measured at the enacted rate expected to apply when it reverses: $80,000 × 30% = $24,000. With no beginning deferred balances, the increase in the deferred tax asset is a deferred tax benefit. Total income tax expense is $225,000 − $24,000 = $201,000.

• Reporting a current taxes receivable of $15,000 reverses the comparison between the $225,000 current tax liability and $210,000 of estimated payments.
• Reporting income tax expense of $225,000 ignores the deferred tax benefit from the deductible warranty temporary difference.
• Reporting income tax expense of $249,000 treats the deductible temporary difference as if it created a deferred tax liability rather than a deferred tax asset.

Current tax is $225,000, the deductible temporary difference creates a $24,000 deferred tax benefit, and estimated payments leave $15,000 payable.

Question 4

Topic: Select Balance Sheet Accounts

On January 1, 20X1, Palms Co. purchased $100,000 face amount of 6% bonds for $95,000, with no accrued interest or transaction costs. Interest is paid annually on December 31, the effective annual yield at purchase was 8%, and Palms measures the investment at amortized cost using the effective interest method. On December 31, 20X1, immediately after receiving the interest payment and recording interest income and amortization, Palms sold the bonds for $96,800. Which entries should Palms record on December 31, 20X1?

• A. Debit cash $6,000; debit investment in bonds $2,000; credit interest income $8,000. Then debit cash $96,800; debit loss on sale $200; credit investment in bonds $97,000.
• B. Debit cash $6,000; credit interest income $6,000. Then debit cash $96,800; credit investment in bonds $95,000; credit gain on sale $1,800.
• C. Debit cash $6,000; debit investment in bonds $1,600; credit interest income $7,600. Then debit cash $96,800; credit investment in bonds $96,600; credit gain on sale $200.
• D. Debit cash $6,000; credit investment in bonds $1,600; credit interest income $4,400. Then debit cash $96,800; credit investment in bonds $93,400; credit gain on sale $3,400.

Best answer: C

What this tests: Select Balance Sheet Accounts

Explanation: At amortized cost, interest income is based on the effective yield applied to the investment’s carrying amount, not the stated coupon rate alone. Because the bonds were purchased at a discount, amortization increases the carrying amount before computing the gain or loss on sale.

For a debt investment measured at amortized cost, the effective interest method records interest income as beginning carrying amount multiplied by the effective yield. Palms’ interest income is $95,000 × 8% = $7,600. Cash received is based on the stated rate: $100,000 × 6% = $6,000. The $1,600 difference is discount amortization, which increases the investment’s carrying amount from $95,000 to $96,600. When the bonds are sold immediately after the interest entry, the carrying amount removed is $96,600. Sale proceeds of $96,800 exceed that carrying amount by $200, so Palms records a $200 gain on sale.

• Recording only $6,000 of interest income ignores required discount amortization and leaves the carrying amount understated.
• Applying the 8% effective yield to face amount produces $8,000 of interest income, but the effective rate is applied to carrying amount.
• Crediting the investment for discount amortization reverses the accounting; discount amortization increases, rather than decreases, the carrying amount.

Interest income is $95,000 × 8% = $7,600, discount amortization is $1,600, and the sale gain is $96,800 proceeds less the $96,600 updated carrying amount.

Question 5

Topic: Financial Reporting

A nongovernmental not-for-profit organization reports donor-restricted contributions initially in net assets with donor restrictions and reports reclassifications as net assets released from restrictions when donor restrictions are satisfied. During the year, the organization had the following activity:

• Unconditional cash contributions with no donor restrictions: $80,000
• Unconditional pledge restricted by the donor for the reading program: $120,000
• Program service fees from clients: $40,000
• Reading program expenses that satisfy the donor restriction: $75,000
• Management, general, and fundraising expenses: $30,000

Which statement of activities presentation is appropriate for the current year?

• A. Report $80,000 of contribution revenue and $40,000 of program service revenue without donor restrictions; report $45,000 of net contribution revenue with donor restrictions; report $105,000 of expenses without donor restrictions.
• B. Report $200,000 of contribution revenue and $40,000 of program service revenue without donor restrictions because part of the reading program restriction was satisfied during the year; report $105,000 of expenses without donor restrictions.
• C. Report $80,000 of contribution revenue and $40,000 of program service revenue without donor restrictions; report $120,000 of contribution revenue with donor restrictions; report a $75,000 release increasing net assets without donor restrictions and decreasing net assets with donor restrictions; report $105,000 of expenses without donor restrictions.
• D. Report $80,000 of contribution revenue and $40,000 of program service revenue without donor restrictions; report $120,000 of contribution revenue with donor restrictions; report $75,000 of program expenses with donor restrictions and $30,000 of expenses without donor restrictions.

Best answer: C

What this tests: Financial Reporting

Explanation: The restricted pledge is contribution revenue with donor restrictions when received or promised. As qualifying reading program expenses are incurred, the organization reports a release from restriction that increases net assets without donor restrictions and decreases net assets with donor restrictions.

A statement of activities for a nongovernmental not-for-profit reports activity by net asset class: without donor restrictions and with donor restrictions. Unrestricted contributions and exchange revenues, such as program service fees, increase net assets without donor restrictions. Donor-restricted contributions increase net assets with donor restrictions until the restriction is satisfied. When the organization incurs qualifying reading program expenses, it reports a reclassification, commonly titled net assets released from restrictions. Expenses are reported as decreases in net assets without donor restrictions, not as decreases in net assets with donor restrictions.

• Netting the restricted contribution down to $45,000 omits the required gross presentation of the contribution and related release.
• Treating the entire restricted pledge as without donor restrictions is incorrect because the organization does not use a same-period reporting policy and only $75,000 of the restriction was satisfied.
• Reporting program expenses in net assets with donor restrictions confuses expense reporting with the release of donor restrictions.

Expenses reduce net assets without donor restrictions, while satisfied donor restrictions are shown as releases between net asset classes.

Question 6

Topic: Select Balance Sheet Accounts

At year-end, Vega Co. reconciles its accounts receivable control account to the customer receivables subledger. The allowance for credit losses is maintained in a separate general ledger account. The controller confirmed that the following are the only reconciling items:

Which year-end correction is supported by the reconciliation?

• A. Credit A/R control $30,000 for the unreconciled difference and make no subledger postings.
• B. Debit the allowance for credit losses $30,000 to reduce net receivables to the subledger total.
• C. Debit A/R control $45,000 for the omitted sales invoice and post the cash receipt only to the subledger.
• D. Credit A/R control $15,000 for the omitted cash receipt and update the subledger for the invoice and credit memo.

Best answer: D

What this tests: Select Balance Sheet Accounts

Explanation: The reconciliation distinguishes general ledger errors from subledger posting errors. The $15,000 cash receipt was posted to the customer subledger but omitted from the general ledger, so A/R control must be credited for that amount. The invoice and credit memo were already recorded in the general ledger and require only subledger updates.

An accounts receivable control account should reconcile to the total of the customer receivables subledger after correcting posting differences. Items already recorded in the general ledger but not posted to the subledger do not require another general ledger entry; they require customer-account updates. Therefore, the $45,000 invoice increases the subledger only, and the $30,000 credit memo decreases the subledger only. The $15,000 cash receipt was posted to the subledger but omitted from the cash receipts journal and general ledger, so the required journal entry is a debit to cash and a credit to A/R control for $15,000. After correction, adjusted A/R control is $985,000 and adjusted subledger receivables are $985,000.

• Crediting A/R control for the full $30,000 difference treats the unreconciled balance as one general ledger error and ignores subledger-only corrections.
• Debiting A/R control for the $45,000 invoice would duplicate a sale already recorded in the general ledger.
• Adjusting the allowance for credit losses is inappropriate because the issue is a control-to-subledger reconciliation, not a change in expected credit losses.

Only the cash receipt was omitted from the general ledger, while the invoice and credit memo require subledger posting only.

Question 7

Topic: Select Transactions

Arbor Co. is reviewing a draft year-end measurement schedule before posting adjusting entries for the balance sheet. No fair value option was elected for any item.

What should Arbor do next to complete the measurement analysis?

• A. Keep all three items at historical cost because no item has been sold before year-end.
• B. Correct the schedule to measure the common stock at $215,000, the held-to-maturity debt security at $296,000, and the equipment at $410,000.
• C. Write down the equipment to $390,000 before measuring the financial assets because fair value is below carrying amount.
• D. Post all three items at the listed fair values because fair value is the current exit price at the measurement date.

Best answer: B

What this tests: Select Transactions

Explanation: Different assets use different measurement attributes under U.S. GAAP. The actively traded equity investment is measured at fair value, but the held-to-maturity debt security is measured at amortized cost, and the equipment is not impaired because undiscounted cash flows exceed carrying amount.

Fair value measurement is not a default replacement for every carrying amount. An equity security with a readily determinable fair value generally is measured using its quoted market price. A held-to-maturity debt security is reported at amortized cost when no fair value option was elected and no credit loss is identified. Long-lived equipment is tested for impairment using a recoverability screen based on undiscounted cash flows; because $430,000 exceeds the $410,000 carrying amount, no impairment loss is recognized, even though fair value is lower. Fair value would be used to measure the impairment loss only after the asset fails recoverability.

• Measuring all items at fair value ignores amortized-cost accounting for held-to-maturity debt and the impairment model for long-lived assets.
• Keeping all items at historical cost ignores the required fair value measurement for the actively traded equity security.
• Writing down the equipment skips the recoverability test result; fair value below carrying amount alone does not create a long-lived asset impairment.

The equity security is measured at fair value, while the held-to-maturity debt security remains at amortized cost and the equipment is not written down because the impairment recoverability test is passed.

Question 8

Topic: Select Transactions

On January 1, Year 1, Alta Co. signed a three-year service contract with a new customer and paid the following contract-related costs:

• $60,000 sales commission payable only because the contract was obtained; Alta expects to recover this cost.
• $25,000 configuration labor that is not within the scope of other asset guidance, directly relates to the contract, creates resources Alta will use to satisfy future service obligations, and is expected to be recovered.
• $10,000 legal review fees that would have been incurred even if the contract had not been signed.

What journal entry should Alta record at contract inception, before any amortization?

• A. Debit contract cost asset $95,000; credit cash or accounts payable $95,000.
• B. Debit selling, configuration, and legal expense $95,000; credit cash or accounts payable $95,000.
• C. Debit contract acquisition cost asset $60,000; debit configuration and legal expense $35,000; credit cash or accounts payable $95,000.
• D. Debit contract acquisition cost asset $60,000; debit contract fulfillment cost asset $25,000; debit legal expense $10,000; credit cash or accounts payable $95,000.

Best answer: D

What this tests: Select Transactions

Explanation: Incremental costs of obtaining a contract are capitalized when expected to be recovered. Fulfillment costs are also capitalized when the stated criteria are met, but costs that would have been incurred regardless of obtaining the contract are expensed.

Under U.S. GAAP revenue guidance, a sales commission paid only upon obtaining a contract is an incremental contract acquisition cost and is recognized as an asset if recovery is expected. Costs to fulfill a contract are capitalized when they are not covered by other asset guidance, relate directly to the contract, generate or enhance resources used to satisfy future performance obligations, and are expected to be recovered. The $25,000 configuration labor meets those criteria. The $10,000 legal review fee is not incremental because Alta would have incurred it even if the contract had not been signed, so it is expensed as incurred.

• Capitalizing all $95,000 incorrectly includes legal review fees that are not incremental contract costs.
• Expensing all $95,000 ignores the required capitalization of recoverable incremental acquisition costs and qualifying fulfillment costs.
• Capitalizing only the commission ignores that the configuration labor meets the stated fulfillment cost capitalization criteria.

The commission and qualifying fulfillment costs are capitalized, while nonincremental legal review fees are expensed as incurred.

Question 9

Topic: Select Balance Sheet Accounts

Brio Co. recorded the following two cash payments as “software intangible assets” in preparing its statement of financial position. Ignore amortization, income taxes, and implementation costs.

• $400,000 for a perpetual accounting software license. Brio may take possession of the software at any time and run it on its own hardware without the vendor’s hosting services.
• $240,000 for a three-year cloud HR platform subscription. Brio receives access only to the vendor-hosted platform and has no right to take possession of the software or run it independently.

What is the best correction to Brio’s intangible asset recognition?

• A. Recognize the full $640,000 as intangible assets because both contracts provide future economic benefits.
• B. Recognize only the $240,000 cloud subscription as an intangible asset because the vendor controls the hosted platform.
• C. Expense the full $640,000 because software lacks physical substance and therefore cannot be reported as an asset.
• D. Recognize only the $400,000 software license as an intangible asset and treat the $240,000 cloud subscription as a service arrangement rather than a software intangible asset.

Best answer: D

What this tests: Select Balance Sheet Accounts

Explanation: Only the perpetual software license qualifies as a recognized intangible asset because Brio controls an identifiable software right. The cloud subscription provides access to a hosted service and does not transfer a software asset that Brio can possess or operate independently.

An intangible asset is recognized when the entity controls an identifiable nonphysical resource that is expected to provide future economic benefits. A purchased software license generally meets that criterion when the customer has the right to take possession of the software and can run it on its own or with an unrelated vendor. By contrast, a cloud computing arrangement that provides only hosted access is accounted for as a service arrangement, not as acquisition of software. Therefore, Brio should keep the $400,000 purchased software license in intangible assets and remove the $240,000 hosted subscription from software intangible assets.

• Capitalizing both contracts overstates intangible assets because future benefit alone is not enough; Brio must control an identifiable software asset.
• Expensing all software costs is wrong because purchased software licenses can qualify as intangible assets.
• Capitalizing only the cloud subscription reverses the analysis; vendor control of the hosted platform means Brio has a service arrangement, not software ownership or control.

The purchased license gives Brio control of identifiable software, while the hosted subscription does not convey a software asset to Brio.

Question 10

Topic: Select Balance Sheet Accounts

Raven Co. is preparing its December 31, 2026, balance sheet. For the items listed below, what total carrying amount should Raven report as payables and accrued liabilities at December 31, 2026?

• A. $148,000
• B. $220,000
• C. $188,000
• D. $166,000

Best answer: C

What this tests: Select Balance Sheet Accounts

Explanation: Raven should accrue obligations incurred as of December 31, including earned compensation, declared dividends, and probable and estimable self-insurance claims. The correct carrying amount is $188,000 for the listed payables and accrued liabilities.

Accrued liabilities are recognized when the obligation has been incurred and the amount can be reasonably estimated. Wages are accrued only for the portion of the payroll period worked before year-end: $80,000 × 6/10 = $48,000. Vested unused vacation earned by employees is accrued at $35,000. The bonus is $500,000 × 5% = $25,000. A cash dividend becomes a liability when declared, so Raven records $0.40 × 100,000 = $40,000. Self-insurance liabilities include both filed claims and incurred but not reported claims when probable and estimable: $18,000 + $22,000 = $40,000. The total is $48,000 + $35,000 + $25,000 + $40,000 + $40,000 = $188,000.

• $148,000 improperly excludes the declared cash dividend from liabilities.
• $166,000 includes only filed self-insurance claims and omits incurred but not reported claims.
• $220,000 accrues the full 10-workday payroll period instead of only the six workdays incurred before year-end.

The total includes accrued wages of $48,000, vacation of $35,000, bonus of $25,000, dividends payable of $40,000, and self-insurance liability of $40,000.

Question 11

Topic: Select Transactions

On January 1, 20X4, Paxon Co. changed its inventory cost method from weighted-average to FIFO. Retrospective application is practicable, and Paxon presents comparative financial statements for 20X3 and 20X4. The enacted income tax rate for all periods is 25%, and there are no other related tax effects.

Inventory balances that would have been reported under each method are:

What adjustment should Paxon report to opening retained earnings as of January 1, 20X3, in its 20X4 comparative financial statements?

• A. Increase retained earnings by $56,250
• B. Increase retained earnings by $40,000
• C. Increase retained earnings by $26,250
• D. Increase retained earnings by $30,000

Best answer: D

What this tests: Select Transactions

Explanation: A change in accounting principle is applied retrospectively when practicable. The opening retained earnings adjustment for the earliest period presented equals the cumulative after-tax effect before that period, which is based on the December 31, 20X2 inventory difference.

For retrospective application, the financial statements are recast as if the new accounting principle had always been used. Because the earliest comparative period presented is 20X3, opening retained earnings at January 1, 20X3 is adjusted for the cumulative effect of periods before 20X3. FIFO inventory at December 31, 20X2 is $460,000, compared with $420,000 under weighted-average, a $40,000 pretax increase in assets and retained earnings. After applying the 25% tax effect, the retained earnings increase is $40,000 × 75% = $30,000.

• Increasing retained earnings by $40,000 ignores the required income tax effect.
• Increasing retained earnings by $56,250 uses the cumulative December 31, 20X3 difference, which includes the 20X3 income effect rather than only pre-20X3 amounts.
• Increasing retained earnings by $26,250 uses only the after-tax change during 20X3, not the opening cumulative adjustment.

The FIFO inventory balance at December 31, 20X2 exceeds the old-method balance by $40,000, and the opening retained earnings adjustment is the $30,000 after-tax effect.

Question 12

Topic: Select Transactions

A company is measuring the fair value of a specialized production machine acquired in a business combination. The valuation report states:

• No quoted prices exist for identical or comparable machines.
• Expected future cash flows from the machine were not modeled.
• An engineer estimated the current cost to construct a machine with the same service capacity.
• The estimate was reduced for physical deterioration and functional obsolescence.

Which valuation technique is the report using?

• A. Market approach based on observable prices for identical or comparable assets.
• B. Income approach based on present value of expected future cash flows.
• C. Historical cost approach based on the amount originally paid to acquire the machine.
• D. Cost approach based on current replacement cost adjusted for deterioration and obsolescence.

Best answer: D

What this tests: Select Transactions

Explanation: The valuation uses a cost approach because it starts with the current cost to replace the machine’s service capacity. Adjustments for physical deterioration and functional obsolescence are common in applying current replacement cost.

Fair value measurements may use market, income, or cost valuation techniques. The cost approach reflects the amount that would currently be required to replace the service capacity of an asset, often referred to as current replacement cost. For a specialized machine with no observable market prices and no discounted cash flow model, an engineering estimate of replacement cost reduced for deterioration and obsolescence indicates the cost approach. This does not measure the asset at historical cost; it uses current market participant assumptions about replacement service capacity.

• Market approach is incorrect because the facts state that quoted prices for identical or comparable machines are unavailable.
• Income approach is incorrect because expected future cash flows were not modeled or discounted.
• Historical cost is incorrect because the valuation uses current replacement cost, not the original acquisition price.

The report measures fair value by estimating the current cost to replace the asset’s service capacity and adjusting for condition and obsolescence.

Question 13

Topic: Financial Reporting

A company is preparing its statement of cash flows under U.S. GAAP using the indirect method. The draft incorrectly used the fixed asset rollforward and bank activity as follows:

The draft reported all $150,000 of fixed asset additions as an investing cash outflow, reported the $100,000 note as a financing cash inflow, and classified the $20,000 note principal repayment as an operating cash outflow. Interest expense was included in net income, and interest payable did not change. What correction should be made?

• A. Report a $50,000 investing outflow for equipment, remove the $100,000 financing inflow, report a $20,000 financing outflow for principal repayment, and disclose the $100,000 noncash acquisition.
• B. Report a $150,000 investing outflow, retain the $100,000 financing inflow, and reclassify only the $20,000 principal repayment to financing activities.
• C. Report a $50,000 investing outflow, remove the $100,000 financing inflow, and leave the $20,000 principal repayment in operating activities.
• D. Report a $50,000 investing outflow, remove the $100,000 financing inflow, and report both the $20,000 principal and $5,000 interest as financing outflows.

Best answer: A

What this tests: Financial Reporting

Explanation: The statement of cash flows reports only cash investing and financing transactions within the main sections. Equipment acquired by issuing a note is a noncash investing and financing activity, while repayment of note principal is a financing cash outflow.

Under the indirect method, the operating section begins with net income and adjusts for noncash items and operating working capital changes. The $5,000 interest payment is already reflected in net income because interest expense was recorded and interest payable did not change. The equipment acquired by signing a $100,000 note did not involve cash, so it should not appear as an investing outflow or financing inflow in the body of the statement; it should be disclosed as a noncash investing and financing activity. Only the $50,000 cash paid for equipment is an investing outflow. The $20,000 repayment of note principal is a financing outflow, not an operating outflow.

• Keeping the $150,000 investing outflow and $100,000 financing inflow improperly grosses up a noncash acquisition.
• Leaving principal repayment in operating activities confuses debt settlement with operating cash flows.
• Classifying interest as a financing outflow is incorrect under U.S. GAAP; interest paid is an operating cash flow effect.

Only the cash purchase is an investing outflow, the note-financed acquisition is noncash, and debt principal repayment is a financing outflow.

Question 14

Topic: Select Transactions

Filo Co. is preparing its December 31, 20X5, U.S. GAAP financial statements, which will be issued on March 15, 20X6. No entry has been recorded for a pending lawsuit, and the draft note states that a later settlement will be disclosed only as a subsequent event.

Source excerpts:

Which correction is the most supportable under U.S. GAAP?

• A. Leave 20X5 unadjusted and disclose the settlement only as a nonrecognized subsequent event.
• B. Recognize a $600,000 loss in 20X5 because no amount in the original estimated range was a better estimate.
• C. Recognize a $720,000 loss and liability in 20X5 and revise the note to describe the settlement.
• D. Recognize a $900,000 loss in 20X5 because the maximum exposure in the legal range was reasonably possible.

Best answer: C

What this tests: Select Transactions

Explanation: The lawsuit related to conditions that existed before year-end, and counsel concluded that loss was probable and estimable. The February settlement occurred before the financial statements were issued and provides additional evidence of the amount to recognize for the year-end contingency.

Under U.S. GAAP, a loss contingency is accrued when the loss is probable and reasonably estimable. Events after the balance sheet date but before issuance are recognized when they provide additional evidence about conditions that existed at the balance sheet date. Here, the lawsuit was filed before year-end and related to products sold before January 1, 20X6. Counsel already concluded that an adverse outcome was probable. Although the January letter initially supported the low end of the range, the February signed settlement provides a better estimate before the financial statements are issued. Therefore, Filo should accrue $720,000 in 20X5 and revise the related disclosure.

• Disclosure-only treatment misclassifies the settlement as nonrecognized, even though it confirms a year-end condition.
• The $600,000 minimum would be used only if no better estimate became available before issuance.
• The $900,000 maximum is not supported because the settlement provides a more specific amount.
• The $720,000 settlement is the best evidence of the probable year-end loss amount.

The settlement before issuance provides better evidence about a probable loss contingency that existed at year-end.

Question 15

Topic: Select Transactions

Marin Co. prepares U.S. GAAP financial statements and has a 25% enacted tax rate. The tax-provision team summarized the following year-end source data:

Which interpretation should be used in reviewing Marin’s income tax provision?

• A. All four items are permanent differences because each affects taxable income or the tax return in the current year.
• B. The municipal interest is a permanent difference, the depreciation difference is a taxable temporary difference, a $250,000 valuation allowance is needed, and the $50,000 unsupported tax benefit should be treated as an unrecognized tax benefit.
• C. The municipal interest is a deductible temporary difference, the depreciation difference is permanent, no valuation allowance is needed, and the return deduction only requires disclosure.
• D. The depreciation difference creates a deferred tax asset, the NOL deferred tax asset remains fully recognized, and the uncertain tax benefit may be recognized if disclosed.

Best answer: B

What this tests: Select Transactions

Explanation: The best interpretation separates tax accounting concepts rather than treating all tax differences alike. Municipal interest never reverses, depreciation will reverse through future taxable amounts, the NOL deferred tax asset must be reduced for amounts not more likely than not realizable, and the failed tax position cannot be recognized as a tax benefit.

A permanent difference affects the effective tax rate but does not create deferred tax accounting because it will never reverse in taxable income. Tax-exempt municipal bond interest is therefore permanent. When tax depreciation exceeds book depreciation and book basis exceeds tax basis, the difference will generally reverse as future taxable amounts, creating a taxable temporary difference and deferred tax liability. A valuation allowance is recorded when some or all of a deferred tax asset is not more likely than not realizable; here, $600,000 less $350,000 equals a $250,000 allowance. For an uncertain tax position, a tax benefit is recognized only if the position meets the more-likely-than-not threshold. Because the claimed deduction fails that threshold, the $50,000 benefit is not recognized and is treated as an unrecognized tax benefit.

• Treating municipal interest as temporary is wrong because it is permanently excluded from taxable income.
• Treating excess tax depreciation as permanent ignores that basis differences reverse in future periods.
• Assuming the NOL deferred tax asset remains fully recognized ignores the more-likely-than-not realizability test.
• Recognizing an uncertain tax benefit merely because it is disclosed misstates the recognition threshold.

This correctly distinguishes the permanent item, future taxable reversal, realizability assessment, and uncertain tax position recognition threshold.

Question 16

Topic: Financial Reporting

Kinley Corp., a public company, is preparing its earnings per share disclosure for the year ended December 31. Income from continuing operations and net income are the same, all instruments were outstanding for the full year, the tax rate is 25%, and there are no other potential common shares.

Which source schedule excerpt best supports the diluted EPS amount Kinley should report?

• A. A basic EPS worksheet showing numerator of $1,200,000 and denominator of 500,000 weighted-average common shares, for EPS of $2.40.
• B. A convertible debt amortization table showing numerator of $1,370,000 and denominator of 650,000 shares by adding back the full $50,000 bond interest, for diluted EPS of $2.11.
• C. An EPS computation worksheet showing numerator of $1,357,500 and denominator of 650,000 shares, including 20,000 incremental option shares, 50,000 debt conversion shares, and 80,000 preferred conversion shares, for diluted EPS of $2.09.
• D. A potential common shares schedule showing numerator of $1,357,500 and denominator of 730,000 shares by adding all 100,000 option shares, for diluted EPS of $1.86.

Best answer: C

What this tests: Financial Reporting

Explanation: Diluted EPS includes only incremental shares from options under the treasury stock method. Convertible debt adds back after-tax interest, and convertible preferred stock adds back preferred dividends when assumed converted.

Basic EPS starts with income available to common shareholders: $1,320,000 net income less $120,000 preferred dividends, or $1,200,000. For diluted EPS, the options add 20,000 incremental shares: 100,000 options less 80,000 assumed repurchased shares ($2,000,000 proceeds ÷ $25 average market price). The convertible bonds add 50,000 shares and $37,500 of after-tax interest ($50,000 × 75%). The convertible preferred stock adds 80,000 shares and restores the $120,000 preferred dividend. The diluted EPS numerator is $1,357,500 and the denominator is 650,000 shares, producing $2.09 per share.

• The basic EPS worksheet omits dilutive potential common shares.
• Adding all option shares ignores the treasury stock method, which includes only incremental shares.
• Adding back the full bond interest ignores the tax effect required for convertible debt.

This worksheet correctly applies the treasury stock method to options and the if-converted method to convertible debt and preferred stock.

Question 17

Topic: Select Transactions

On November 1, 20X1, a company enters into a fixed-price contract for $126,000, payable at contract signing. The contract includes equipment, installation, and one year of maintenance. The equipment, installation, and maintenance are distinct performance obligations. The customer obtains control of the equipment on December 1, 20X1; installation is completed on December 15, 20X1; and maintenance is provided ratably from December 1, 20X1, through November 30, 20X2.

What amount of revenue should the company recognize for the year ended December 31, 20X1?

• A. $112,500
• B. $101,250
• C. $126,000
• D. $99,000

Best answer: B

What this tests: Select Transactions

Explanation: The contract price must be allocated to the distinct performance obligations based on relative standalone selling prices. Revenue is recognized when or as each obligation is satisfied, so only one month of maintenance is recognized in 20X1.

Total standalone selling prices are $140,000. The $126,000 transaction price is allocated as follows: equipment $90,000 ($126,000 × $100,000/$140,000), installation $9,000 ($126,000 × $10,000/$140,000), and maintenance $27,000 ($126,000 × $30,000/$140,000). In 20X1, the company recognizes the equipment revenue when control transfers on December 1, the installation revenue when completed on December 15, and one month of maintenance revenue for December. Total 20X1 revenue is $90,000 + $9,000 + ($27,000 ÷ 12) = $101,250.

• $99,000 omits the one month of maintenance service provided in December 20X1.
• $112,500 uses standalone selling prices directly and fails to allocate the contract discount to all performance obligations.
• $126,000 recognizes all consideration at signing or by year-end, even though most maintenance services remain unsatisfied.

The $126,000 transaction price is allocated by relative standalone selling price, and 20X1 revenue includes equipment, completed installation, and one month of maintenance.

Question 18

Topic: Select Transactions

Ridge Co. is preparing U.S. GAAP financial statements for the year ended December 31, 20X4. The financial statements will be available to be issued on March 15, 20X5. A staff accountant reviewed the following documentation for a pending claim:

Which reporting conclusion is supported by the documentation?

• A. Recognize a $750,000 loss and liability, and disclose the nature of the claim and the reasonably possible additional loss exposure.
• B. Disclose the lawsuit only because the exact settlement amount has not been determined.
• C. Recognize a $1,200,000 loss and liability because the upper end of counsel’s range is reasonably possible.
• D. Make no adjustment or disclosure until the claim is settled or a judgment is entered.

Best answer: A

What this tests: Select Transactions

Explanation: The claim existed at year-end, and counsel concluded that an unfavorable outcome is probable with a reasonably estimable range. Because no amount within the range is a better estimate, Ridge should accrue the minimum amount in the range and disclose the additional reasonably possible exposure.

Under U.S. GAAP, a loss contingency is recognized when it is both probable that a liability has been incurred and the amount can be reasonably estimated. If the estimate is a range and no amount within the range is more likely than another, the minimum amount in the range is accrued. Here, the lawsuit was filed before year-end and relates to a 20X4 product sale, so the condition existed at the balance sheet date. Counsel’s February letter provides evidence before the financial statements are available to be issued and supports accrual of $750,000. Ridge should also disclose the nature of the contingency and the reasonably possible additional loss above the amount accrued.

• Accruing the upper end overstates the liability when no amount in the range is a better estimate.
• Disclosure-only treatment ignores that the loss is both probable and reasonably estimable.
• Waiting for settlement or judgment is inappropriate because accrual is required before resolution when the recognition criteria are met.

A probable and reasonably estimable loss contingency is accrued at the low end of the range when no amount is a better estimate, with disclosure of additional possible exposure.

Question 19

Topic: Financial Reporting

During 2026, Harbor Co. sold equipment with a carrying amount of $70,000 for $90,000 cash and recognized a $20,000 gain in net income. Harbor also acquired new equipment costing $250,000 by paying $60,000 cash and issuing a $190,000 long-term note directly to the seller. No other property, plant, and equipment transactions occurred. Using the indirect method, which statement of cash flows presentation is correct?

• A. Add the $20,000 gain to net income in operating activities, report a $90,000 investing cash inflow and a $60,000 investing cash outflow, and disclose the $190,000 noncash investing and financing activity.
• B. Report the $20,000 gain as an operating cash inflow, report a $70,000 investing cash inflow, report a $60,000 investing cash outflow, and disclose the $190,000 noncash investing and financing activity.
• C. Deduct the $20,000 gain from net income in operating activities, report a $90,000 investing cash inflow and a $60,000 investing cash outflow, and disclose the $190,000 noncash investing and financing activity.
• D. Deduct the $20,000 gain from net income in operating activities, report a $90,000 investing cash inflow and a $250,000 investing cash outflow, and report a $190,000 financing cash inflow.

Best answer: C

What this tests: Financial Reporting

Explanation: Under the indirect method, a gain on sale of equipment is deducted from net income because the related cash proceeds are reported in investing activities. Only actual cash paid for equipment is an investing outflow; the note issued to the seller is disclosed as a noncash investing and financing activity.

The indirect method starts with net income and adjusts for items that affected net income but are not operating cash flows. A gain on sale of equipment increased net income, but the cash received from selling equipment is an investing activity, so the $20,000 gain is deducted in the operating section. The full $90,000 cash proceeds from selling the equipment are reported as an investing cash inflow. For the new equipment purchase, only the $60,000 cash paid is reported as an investing cash outflow. The $190,000 note issued directly to the seller did not provide or use cash, so it is not reported as a financing cash inflow; it is disclosed as a noncash investing and financing activity.

• Adding the gain to net income reverses it in the wrong direction under the indirect method.
• Reporting a $250,000 investing cash outflow and $190,000 financing inflow incorrectly grosses up a noncash seller-financed purchase.
• Reporting only the carrying amount as investing inflow ignores that cash flow from an asset sale is measured by actual cash proceeds.

The gain is removed from operating cash flow, actual cash proceeds and cash purchases are investing cash flows, and the seller-financed note is a noncash investing and financing transaction.

Question 20

Topic: Financial Reporting

Ridge City uses a 60-day availability period for property tax revenue in its governmental funds. The following facts relate to taxes levied for the current fiscal year and to equipment acquired by the General Fund for general government use.

Preliminary reporting for the year ended June 30, 20X6, shows that the General Fund recognized property tax revenue of $4,880,000 and capital outlay expenditures of $600,000, while government-wide governmental activities recognized property tax revenue of $5,000,000 and depreciation expense of $60,000. Which interpretation best explains these differences?

• A. Both reports use the same accrual basis, and the differences arise only because government-wide statements exclude cash collections after year-end.
• B. The General Fund uses modified accrual and current financial resources, so it recognizes available taxes and capital outlay; governmental activities use accrual and economic resources, so they recognize the full collectible levy and depreciation.
• C. Governmental activities use modified accrual, so they should defer the taxes collected after 60 days and report the equipment purchase as an expenditure.
• D. The General Fund uses accrual and economic resources, so it should recognize the full tax levy and depreciation instead of reporting unavailable taxes and capital outlay.

Best answer: B

What this tests: Financial Reporting

Explanation: Governmental fund statements use modified accrual accounting with a current financial resources focus. That basis recognizes only measurable and available property taxes and reports the equipment purchase as a capital outlay expenditure. Government-wide governmental activities use accrual accounting with an economic resources focus, so they recognize the full collectible levy and depreciate the capital asset.

Modified accrual accounting for governmental funds includes an availability criterion for revenue. Ridge City’s General Fund includes the $4,700,000 collected by year-end plus the $180,000 collected within 45 days, but excludes the $120,000 collected after 100 days because it is outside the 60-day availability period. The General Fund also reports the equipment acquisition as a capital outlay expenditure rather than as a depreciable asset. Government-wide governmental activities use accrual accounting and the economic resources measurement focus, so the collectible tax levy for the current fiscal year is recognized without the modified-accrual availability limitation, and the equipment is capitalized and depreciated over its useful life.

• Applying the full levy and depreciation to the General Fund incorrectly uses the government-wide accrual model for a governmental fund.
• Deferring unavailable taxes and expensing equipment in governmental activities incorrectly applies modified accrual to government-wide statements.
• Excluding all post-year-end collections treats modified accrual like cash basis; the 45-day collection is available under the city’s 60-day policy.
• Saying both reports use the same basis ignores the required difference between governmental fund reporting and government-wide reporting.

The General Fund applies the availability criterion and expenditure reporting, while government-wide statements capitalize and depreciate assets under accrual accounting.

Question 21

Topic: Financial Reporting

A calendar-year corporation prepares financial statements under U.S. GAAP. During the year, it reported net income of $200,000 and recognized a $35,000 unrealized holding gain, net of tax, on debt securities classified as available-for-sale. The securities were not sold during the year. How should the $35,000 gain be presented?

• A. Only as a direct equity adjustment in the statement of changes in equity, with no presentation in comprehensive income.
• B. As an increase to retained earnings in the statement of changes in equity, separate from comprehensive income.
• C. As investment income in the income statement, increasing net income to $235,000.
• D. As other comprehensive income in a statement of comprehensive income and as an increase to accumulated other comprehensive income in equity.

Best answer: D

What this tests: Financial Reporting

Explanation: The unrealized gain on available-for-sale debt securities is an OCI item under U.S. GAAP. It is presented in comprehensive income and accumulated in AOCI, while net income remains $200,000.

Comprehensive income includes net income plus other comprehensive income. Certain gains and losses bypass the income statement initially, including unrealized holding gains and losses on available-for-sale debt securities. These items are presented in either a single continuous statement of comprehensive income or in a separate statement of comprehensive income that follows the income statement. The accumulated balance is also shown in equity as accumulated other comprehensive income. The statement of changes in equity may show the change in AOCI, but that does not replace comprehensive income presentation.

• Reporting the gain as investment income incorrectly puts an OCI item in net income.
• Showing the gain only as a direct equity adjustment omits required comprehensive income presentation.
• Recording the gain in retained earnings confuses AOCI with retained earnings.

An unrealized holding gain on available-for-sale debt securities is reported in OCI and accumulated in AOCI rather than included in net income.

Question 22

Topic: Financial Reporting

Harbor Co. owns 80% of River Co. and consolidates River. For the year ended December 31, 20X5, the companies’ separate records include the following:

Ignore income taxes. Which interpretation is most appropriate for Harbor’s 20X5 consolidated financial statement worksheet?

• A. Eliminate the $500,000 intercompany sale, reduce ending inventory by $45,000, eliminate the $120,000 receivable/payable, and remove Harbor’s $48,000 dividend income.
• B. Eliminate only 80% of the intercompany sale, receivable/payable, and unrealized profit because Harbor owns 80% of River.
• C. Reduce ending inventory by the full $150,000 gross profit because all profit from the intercompany sale is unrealized.
• D. Eliminate the receivable/payable only, because River is a separate legal entity and the dividends were paid in cash.

Best answer: A

What this tests: Financial Reporting

Explanation: Consolidation presents Harbor and River as a single economic entity, so intercompany sales, receivables, payables, and parent-recorded dividend income are eliminated. The unrealized profit is limited to the profit embedded in inventory still held within the group at year-end: $150,000 gross profit × 30% unsold = $45,000.

Intercompany transactions between a parent and consolidated subsidiary are eliminated in full, not in proportion to the parent’s ownership percentage. Harbor’s sale to River is internal, so the $500,000 intercompany sale is removed from consolidated results. Because River sold 70% of the goods to outside customers, that portion is realized from the consolidated entity’s perspective. The remaining 30% is still in ending inventory, so the unrealized profit is $45,000, computed as the $150,000 gross profit on the transfer multiplied by 30%. The reciprocal $120,000 receivable and payable are also eliminated. Harbor’s $48,000 dividend income from River is not consolidated income; it is an internal distribution and must be removed.

• Eliminating only 80% misapplies the ownership percentage; intercompany balances and transactions with a consolidated subsidiary are eliminated in full.
• Reducing inventory by the full $150,000 ignores that 70% of the goods were sold to unrelated customers before year-end.
• Keeping the sale or dividend income because River is a separate legal entity conflicts with consolidated reporting, which treats the group as one reporting entity.

The consolidated entity eliminates reciprocal balances and internal transactions in full, and only the $45,000 profit in River’s unsold ending inventory remains unrealized.

Question 23

Topic: Financial Reporting

At December 31, Harlan Co. reported the following selected balances, all in thousands. All assets and liabilities shown are current.

Which statement best interprets Harlan’s short-term liquidity trend from 2024 to 2025?

• A. The current ratio declined because inventory and prepaid expenses should be excluded from current assets.
• B. Both the current ratio and quick ratio increased because total current assets increased more than total current liabilities.
• C. Accounts receivable turnover improved because net accounts receivable increased from 2024 to 2025.
• D. The current ratio increased slightly, but the quick ratio declined because current-asset growth was concentrated in inventory and prepaid items.

Best answer: D

What this tests: Financial Reporting

Explanation: Harlan’s current ratio increased from $800/$600, or 1.33, to $1,100/$800, or 1.38. However, its quick ratio declined from $400/$600, or 0.67, to $450/$800, or 0.56, indicating weaker immediate liquidity despite a slightly better current ratio.

The current ratio equals total current assets divided by total current liabilities. For 2025, current assets are $1,100 and current liabilities are $800, producing a current ratio of 1.38. For 2024, current assets are $800 and current liabilities are $600, producing a current ratio of 1.33. The quick ratio excludes less liquid current assets such as inventory and prepaid expenses, so quick assets are cash, marketable securities, and net receivables. Harlan’s quick ratio declined from 0.67 in 2024 to 0.56 in 2025 because quick assets increased only $50 while current liabilities increased $200. The best interpretation is that near-term liquidity weakened on a quick-asset basis even though the broader current ratio improved slightly.

• Saying both ratios increased ignores that inventory and prepaid expenses are excluded from quick assets.
• Excluding inventory and prepaid expenses from current assets confuses the quick ratio with the current ratio.
• Inferring accounts receivable turnover from receivable balances alone is unsupported because credit sales data are not provided.

Current assets rose enough to slightly improve the current ratio, while quick assets rose much less than current liabilities, causing the quick ratio to decline.

Question 24

Topic: Financial Reporting

A U.S. company’s functional currency is the U.S. dollar. On December 1, Year 1, the company purchased inventory from a foreign supplier for €100,000, payable on February 15, Year 2. The company recorded the purchase and payable at $110,000 using the December 1 spot rate. In its draft December 31, Year 1 financial statements, the company did not remeasure the unpaid payable.

Exchange rates were:

What is the best correction to the December 31, Year 1 financial statements?

• A. Increase inventory by $6,000 and increase accounts payable by $6,000.
• B. Record a $6,000 foreign currency transaction gain and decrease accounts payable by $6,000.
• C. Record a $6,000 foreign currency transaction loss and increase accounts payable by $6,000.
• D. Record a $3,000 foreign currency transaction loss and increase accounts payable by $3,000.

Best answer: C

What this tests: Financial Reporting

Explanation: The unpaid euro payable is a monetary liability, so it must be remeasured at the December 31 spot rate. Because the euro strengthened from $1.10 to $1.16, the dollar amount owed increased by $6,000, producing a foreign currency transaction loss.

Foreign-currency-denominated monetary assets and liabilities are remeasured at the current exchange rate at each reporting date. The payable was initially recorded at €100,000 × $1.10 = $110,000. At December 31, it should be reported at €100,000 × $1.16 = $116,000. The $6,000 increase in the dollar liability is recognized as a foreign currency transaction loss in current-period income, not as an adjustment to inventory. The February 15 settlement rate affects Year 2, not the required Year 1 year-end correction.

• A $3,000 loss uses the February 15 settlement rate and does not correct the Year 1 reporting-date remeasurement.
• A $6,000 gain reverses the economics; a stronger euro increases the dollar cost of the payable.
• Increasing inventory treats the rate change as an inventory cost, but remeasurement gains and losses on monetary payables are recognized in income.

The euro-denominated payable is a monetary liability that must be remeasured from $110,000 to $116,000 at year-end, creating a $6,000 loss.

Question 25

Topic: Financial Reporting

Alpha Co. owns 70% of Beta Co. throughout the year. Management concluded that the consolidated income statement should attribute $84,000 of Beta’s current-year net income to the noncontrolling interest and that the consolidated balance sheet should report ending noncontrolling interest equity of $616,000. There were no ownership changes, other comprehensive income, or consolidation adjustments affecting Beta’s income or equity. Which source best supports both amounts?

• A. Beta’s dividend register showing $60,000 of dividends, with $42,000 paid to Alpha and $18,000 paid to outside shareholders.
• B. A noncontrolling interest rollforward showing 30% outside ownership, beginning noncontrolling interest equity of $550,000, Beta net income of $280,000, and Beta dividends of $60,000.
• C. Beta’s income statement showing net income of $280,000 and no other comprehensive income.
• D. Alpha’s parent-only statement of changes in equity showing Alpha’s retained earnings and dividends declared by Alpha.

Best answer: B

What this tests: Financial Reporting

Explanation: The best support is the noncontrolling interest rollforward because it includes the ownership percentage, subsidiary net income, beginning NCI equity, and dividends. The amounts reconcile: 30% × $280,000 = $84,000, and $550,000 + $84,000 − 30% × $60,000 = $616,000.

In consolidated financial statements, the noncontrolling interest’s share of a subsidiary’s net income is based on the outside ownership percentage. Ending noncontrolling interest equity is typically rolled forward from the beginning balance by adding the NCI share of subsidiary net income and subtracting the NCI share of subsidiary dividends, adjusted for any other relevant equity changes. Here, outside shareholders own 30% of Beta. Their share of Beta’s net income is $84,000. Ending NCI equity is $550,000 plus $84,000 less $18,000 of dividends attributable to outside shareholders, or $616,000. A rollforward containing all these inputs best supports both FAR conclusions.

• Beta’s income statement supports the subsidiary income amount but not the beginning NCI equity balance or dividend reduction.
• Beta’s dividend register supports the dividend allocation but not the NCI share of net income or beginning equity.
• Alpha’s parent-only equity statement relates to the parent’s equity, not the subsidiary’s noncontrolling interest.

This rollforward supports $84,000 of NCI net income and ending NCI equity of $616,000 based on 30% outside ownership.

Questions 26-50

Question 26

Topic: Select Balance Sheet Accounts

A CPA is reviewing Wren Corp.’s equity rollforward. Wren uses the cost method for treasury stock, and the 2-for-1 stock split adjusted par value from $2 per share to $1 per share.

Which year-end balance sheet conclusion is supported by the rollforward?

• A. Common shares outstanding are 110,000, and total shareholders’ equity is $1,211,000.
• B. Common shares outstanding are 106,000, and total shareholders’ equity is $1,211,000.
• C. Common shares outstanding are 53,000, and total shareholders’ equity is $1,211,000.
• D. Common shares outstanding are 106,000, and total shareholders’ equity is $1,321,000.

Best answer: B

What this tests: Select Balance Sheet Accounts

Explanation: Shares outstanding equal issued shares minus treasury shares held. The split doubled both issued and treasury share counts but had no dollar effect, so ending outstanding shares are 110,000 minus 4,000, or 106,000, and total equity remains $1,211,000.

Under the cost method, treasury stock is a contra-equity amount and treasury shares are issued but not outstanding. Wren’s ending issued shares are 110,000 and ending treasury shares held are 4,000, so outstanding shares are 106,000. The par-adjusted 2-for-1 stock split changes the number of shares and par value per share but does not change total shareholders’ equity. Total equity is the rollforward balance: $1,100,000 beginning equity + $100,000 issuance - $44,000 treasury repurchase - $30,000 dividends + $85,000 net income = $1,211,000.

• Treating all 110,000 issued shares as outstanding ignores the 4,000 treasury shares, which remain issued but are not outstanding.
• Increasing total equity to $1,321,000 treats the stock split as a dollar capitalization, but this par-adjusted split has no equity-dollar effect.
• Using 53,000 shares ignores the 2-for-1 split; the pre-split 53,000 outstanding shares became 106,000 after the split.

Outstanding shares equal issued shares less treasury shares, and the stock split changed share counts but did not change total equity.

Question 27

Topic: Select Balance Sheet Accounts

Maple Corp., the borrower, is preparing its year-end financial statements under U.S. GAAP. Maple has incurred recurring operating losses and missed the December 31 principal payment on a bank note due to insufficient cash. Before the financial statements are issued, the bank agrees to forgive all accrued default interest, extend the maturity for three years, and reduce the stated interest rate to 2%; the current market rate for a new loan to Maple with similar risk is 9%. What financial reporting conclusion should Maple reach about the modification?

• A. The modification is a troubled debt restructuring only if Maple has filed for bankruptcy protection.
• B. The modification is not a troubled debt restructuring because the bank did not forgive any principal.
• C. The modification is not a troubled debt restructuring because an extension of maturity is accounted for only as a routine debt modification.
• D. The modification is a troubled debt restructuring because Maple is experiencing financial difficulty and the bank granted a concession through interest forgiveness and below-market revised terms.

Best answer: D

What this tests: Select Balance Sheet Accounts

Explanation: The modification meets both conditions for troubled debt restructuring classification from the borrower’s perspective. Maple is in financial difficulty, and the bank granted concessions by forgiving default interest and reducing the rate below the market rate for Maple’s risk.

A debt modification qualifies as a troubled debt restructuring when the debtor is experiencing financial difficulty and the creditor grants a concession for economic or legal reasons related to that difficulty. The concession may include forgiving accrued interest, reducing the stated interest rate below a market rate, extending the maturity at favorable terms, or other changes the creditor would not otherwise accept. Here, Maple missed a principal payment because of insufficient cash and has recurring losses, indicating financial difficulty. The bank’s forgiveness of default interest and 2% revised rate when Maple’s market borrowing rate is 9% indicate a creditor concession. Therefore, Maple should treat the modification as a troubled debt restructuring.

• Principal forgiveness is not required; favorable changes to interest or maturity can be concessions.
• A maturity extension may be routine in some cases, but here it is combined with distress and below-market terms.
• Bankruptcy is not required; financial difficulty can be shown by missed payments, liquidity problems, and recurring losses.

A borrower classifies a modification as a troubled debt restructuring when it has financial difficulty and the creditor grants a concession it would not otherwise grant.

Question 28

Topic: Financial Reporting

A public company reported the following for the year ended December 31. All securities were outstanding for the entire year.

How should diluted earnings per share be presented?

• A. Diluted EPS of $2.80, excluding all potential common shares from the calculation.
• B. Diluted EPS of $2.09, including the options, convertible preferred stock, and convertible debt.
• C. Diluted EPS of $2.13, including the convertible preferred stock and convertible debt but excluding the options.
• D. Diluted EPS of $2.50, including the options and convertible preferred stock but excluding the convertible debt.

Best answer: B

What this tests: Financial Reporting

Explanation: Diluted EPS includes securities that would reduce EPS if converted or exercised. The options add incremental shares under the treasury stock method, and both convertible instruments are included under the if-converted method because they are dilutive.

Start with income available to common shareholders: net income of $1,000,000 less nonconvertible preferred dividends of $100,000 and convertible preferred dividends of $60,000, or $840,000. Options add 10,000 incremental shares: 30,000 options less 20,000 shares assumed repurchased at the $30 average market price. The convertible preferred stock adds back $60,000 of dividends and adds 50,000 shares. The convertible debt adds back after-tax interest of $60,000, computed as $80,000 × (1 − 25%), and adds 100,000 shares. Diluted EPS is therefore ($840,000 + $60,000 + $60,000) ÷ (300,000 + 10,000 + 50,000 + 100,000) = $960,000 ÷ 460,000 = $2.09.

• Excluding all potential common shares presents basic EPS, not diluted EPS.
• Excluding the convertible debt is incorrect because its after-tax interest add-back per incremental share is dilutive.
• Excluding the options is incorrect because the average market price exceeds the exercise price, creating incremental shares under the treasury stock method.

Diluted EPS is $960,000 divided by 460,000 shares after including all dilutive potential common shares.

Question 29

Topic: Select Transactions

River Community Clinic is a calendar-year not-for-profit entity. Licensed physicians donated 80 hours of patient care in December Year 1 at a fair value of $150 per hour; the clinic would otherwise have hired physicians to provide those services. The same physicians donated 20 additional hours in January Year 2. In December Year 1, unlicensed volunteers also provided 100 hours of greeting services at an estimated value of $20 per hour; those duties did not require specialized skills and did not create or enhance nonfinancial assets. How much contribution revenue from contributed services should the clinic recognize in its Year 1 financial statements?

• A. $14,000, recognized in Year 1 for both the physician services and greeting services received in December.
• B. $0, because donated services are disclosed but not recognized as contribution revenue.
• C. $15,000, recognized in Year 1 for all physician services donated in December Year 1 and January Year 2.
• D. $12,000, recognized in Year 1 when the physician services were received, with a corresponding program service expense.

Best answer: D

What this tests: Select Transactions

Explanation: A not-for-profit recognizes contributed services when they require specialized skills, are provided by individuals possessing those skills, and would otherwise need to be purchased. Only the 80 physician hours received in December Year 1 qualify for Year 1 recognition, so revenue is $12,000.

Under U.S. GAAP, contributed services are recognized at fair value if they either create or enhance nonfinancial assets, or require specialized skills, are provided by persons with those skills, and would typically be purchased if not donated. The physicians’ December services qualify because patient care requires specialized medical skills, licensed physicians provided the services, and the clinic would otherwise have hired physicians. Revenue is recognized when the services are received, not when additional future services are provided. Therefore, Year 1 contribution revenue is 80 hours × $150 = $12,000, with a corresponding program service expense. The greeting services are not recognized because they do not meet the specialized-skill or nonfinancial-asset criteria.

• Including the greeting services incorrectly recognizes volunteer time that does not meet the contributed-service recognition criteria.
• Including January physician hours incorrectly accelerates revenue before the services are received.
• Disclosure-only treatment is incorrect because qualifying specialized services must be recognized at fair value.

The December physician services meet the specialized-skill recognition criteria and are recognized at fair value when received.

Question 30

Topic: Financial Reporting

A staff accountant is preparing a revised statement of cash flows using the indirect method. The accrual-basis financial statements have been finalized, and the remaining task is to correct the draft cash flow statement based on the following review notes:

• Accounts payable increased by $18,000 during the year, but the draft operating section shows a $18,000 deduction for accounts payable.
• Equipment additions totaled $115,000, consisting of $70,000 paid in cash and $45,000 acquired by issuing a note payable.
• The draft investing section reports equipment purchases of $115,000.
• The draft financing section reports note payable proceeds of $145,000, consisting of $100,000 cash borrowed and the $45,000 note issued for equipment.

Which step should be performed next to correct the draft statement of cash flows?

• A. Replace the accounts payable deduction with an $18,000 addition, report $70,000 as cash paid for equipment, report $100,000 as note proceeds, and disclose the $45,000 equipment acquisition as noncash activity.
• B. Record an adjusting journal entry to reduce equipment and notes payable by $45,000 before preparing the statement of cash flows.
• C. Reclassify the full $115,000 equipment addition to financing activities because part of the acquisition was funded with debt.
• D. Leave the cash flow classifications unchanged and add a supplemental disclosure for the $45,000 note issued for equipment.

Best answer: A

What this tests: Financial Reporting

Explanation: The next step is to correct the draft cash flow statement, not the finalized accrual-basis records. The accounts payable increase should be added in operating activities, and only cash transactions belong in the investing and financing sections.

Under the indirect method, an increase in accounts payable is added to net income because expenses exceeded cash payments to suppliers by that amount. A noncash equipment acquisition financed by issuing a note is not reported as an investing cash outflow or financing cash inflow. Instead, the statement should report only the $70,000 cash equipment purchase in investing activities and the $100,000 cash borrowing in financing activities. The $45,000 equipment acquisition through a note payable is disclosed as noncash investing and financing activity.

• Merely adding a noncash disclosure leaves the accounts payable sign error and overstates both investing and financing cash flows.
• Recording an adjusting journal entry is inappropriate because the underlying accrual-basis accounting is not in error.
• Classifying all equipment additions as financing ignores the cash purchase and misstates the statement of cash flows.

The cash flow statement should reflect the correct operating sign and exclude the noncash equipment acquisition from investing and financing cash flows while disclosing it separately.

Question 31

Topic: Select Balance Sheet Accounts

Lark Co. owns 2% of the voting common stock of a publicly traded company. Lark has no ability to exercise significant influence over the investee and does not consolidate the investee. Lark’s controller concluded that the investment is required to be reported at fair value in Lark’s U.S. GAAP financial statements. Which source document best supports that conclusion?

• A. A board-approved investment policy stating that Lark intends to hold the shares for more than one year
• B. A cost-basis subledger showing the original purchase price and broker commissions paid when the shares were acquired
• C. A year-end custodian statement identifying the shares held by ticker symbol, quantity owned, and quoted closing market price on a national exchange
• D. A dividend receipt schedule showing cash dividends received from the investee during the year

Best answer: C

What this tests: Select Balance Sheet Accounts

Explanation: The best support is the custodian statement showing the investment is an exchange-traded equity security with an observable quoted market price. Equity investments without consolidation or significant influence are generally reported at fair value, and quoted market prices provide direct measurement support.

Under U.S. GAAP, an equity investment that is not consolidated and is not accounted for under the equity method is generally measured at fair value if it has a readily determinable fair value. A year-end custodian or brokerage statement showing the specific shares held and the quoted closing market price on a national exchange supports both the nature of the investment and the fair value measurement. The source is stronger than internal intent documentation or historical cost records because the conclusion depends on the investment being an equity security with a market-observable fair value at the reporting date.

• A long-term holding policy may affect balance sheet classification, but it does not override fair value measurement for exchange-traded equity investments.
• Dividend receipts support dividend income or cash collection, not whether the investment must be measured at fair value.
• Original cost supports initial recognition, but not the required year-end fair value measurement.

An exchange-quoted price for an equity investment without significant influence directly supports fair value measurement under U.S. GAAP.

Question 32

Topic: Select Transactions

On July 1, Year 1, Harbor Software obtained a noncancelable 36-month customer contract to provide hosted services evenly over the contract term. Harbor’s compensation plan pays a $72,000 sales commission only when a new customer contract is executed; no commission is paid for unsuccessful bids. Management expects the contract consideration to exceed the related service and commission costs. Harbor concluded that the commission should be recognized as a contract cost asset and reported at a $60,000 carrying amount at December 31, Year 1. Which source support would best substantiate this FAR conclusion?

• A. The revenue subledger showing six months of hosted-service revenue recognized ratably from July through December.
• B. The payroll register showing a $72,000 commission payment to the salesperson shortly after contract execution.
• C. A contract-cost capitalization and amortization schedule that ties the signed contract to the commission plan, documents expected recovery, and calculates six months of straight-line amortization over the 36-month service term.
• D. The signed customer contract showing the fixed service fee, contract inception date, and 36-month noncancelable term.

Best answer: C

What this tests: Select Transactions

Explanation: The best support must substantiate both why the commission qualifies for capitalization and how the ending carrying amount was measured. A combined capitalization and amortization schedule ties the commission to the executed contract, supports recoverability, and shows the $72,000 cost less six months of amortization.

Under U.S. GAAP, incremental costs of obtaining a contract with a customer are recognized as an asset when the entity expects to recover those costs. A sales commission paid only when a contract is obtained is incremental because it would not have been incurred without the contract. After recognition, the asset is amortized on a systematic basis consistent with the transfer of the related goods or services. Because Harbor provides services evenly over 36 months, straight-line amortization is appropriate. Six months of amortization is $12,000, or $72,000 × 6/36, leaving a $60,000 carrying amount at December 31, Year 1.

• The signed customer contract supports the service term and consideration but does not establish that the commission was incremental or show the amortization calculation.
• The payroll register supports that a payment occurred, but payment alone does not prove capitalization criteria or the remaining carrying amount.
• The revenue subledger supports the ratable service pattern, but it does not substantiate the commission plan, recoverability, or capitalization decision.

This support addresses both recognition as an incremental, recoverable contract acquisition cost and subsequent measurement through amortization consistent with the service transfer pattern.

Question 33

Topic: Select Balance Sheet Accounts

A company’s draft financial statements present a $600,000 segregated bank account separately as restricted cash on the balance sheet and include the balance in the ending total labeled “cash, cash equivalents, and restricted cash” in the statement of cash flows reconciliation. Which source best supports the FAR conclusion that both treatments are appropriate?

• A. An operating checking account bank reconciliation showing all deposits in transit and outstanding checks for the unrestricted cash account
• B. A management cash forecast showing that the $600,000 is expected to be used for debt service within the next year
• C. A statement of cash flows worksheet that excludes restricted cash from the ending cash and cash equivalents total
• D. A restricted cash rollforward tied to the segregated bank statement and the executed loan agreement, reconciling the balance sheet restricted cash caption to the statement of cash flows ending total

Best answer: D

What this tests: Select Balance Sheet Accounts

Explanation: The best support must address both issues: balance sheet classification as restricted cash and statement of cash flows inclusion in the cash reconciliation total. A rollforward tied to bank evidence and the loan agreement supports the restriction and traces the amount into the cash flow reconciliation.

Restricted cash is presented separately from unrestricted cash and cash equivalents on the balance sheet when the cash is subject to a meaningful restriction, such as a debt-service reserve required by a loan agreement. However, the statement of cash flows reconciles the total of cash, cash equivalents, and restricted cash between the beginning and ending of the period. Therefore, the strongest source is one that proves the restriction and also ties the restricted cash balance to the statement of cash flows reconciliation. A rollforward supported by the segregated bank statement and executed loan agreement accomplishes both objectives.

• An operating bank reconciliation supports unrestricted cash accuracy, not the restricted cash classification or cash flow reconciliation.
• A management forecast shows intended use, but intent alone does not establish a cash restriction.
• A worksheet excluding restricted cash supports the wrong cash flow presentation because restricted cash is included in the statement of cash flows cash reconciliation total.

This source supports both the existence of an enforceable cash restriction and the reconciliation of restricted cash into the statement of cash flows total.

Question 34

Topic: Select Balance Sheet Accounts

On December 31, Riva Co. assigned $600,000 of trade receivables to a finance company as collateral for a $570,000 cash advance. Riva remains obligated to repay the $570,000 advance plus stated interest, and the arrangement does not meet the criteria for sale accounting. No collections occurred before year-end. A staff accountant drafted an entry to debit cash for $570,000, debit loss on transfer for $30,000, and credit accounts receivable for $600,000. What should the controller do next before posting the year-end entry?

• A. Defer any journal entry until the finance company reports actual collections on the receivables.
• B. Replace the draft with an entry to debit cash for $570,000 and credit secured borrowing liability for $570,000, leaving the receivables on Riva’s books.
• C. Post the draft entry because the transfer of receivables requires derecognition and recognition of the difference as a loss.
• D. Record a liability for $600,000 and recognize a $30,000 financing charge at the transfer date.

Best answer: B

What this tests: Select Balance Sheet Accounts

Explanation: When a transfer of receivables does not qualify as a sale, the transferor records the transaction as a secured borrowing. Riva should keep the $600,000 receivables as assets and recognize a $570,000 liability for the cash advance received.

For a transfer of financial assets to be accounted for as a sale, the transferor must surrender control of the assets. The stem states that sale accounting is not met, so Riva cannot derecognize the trade receivables or recognize a transfer loss. Instead, the receivables remain on Riva’s balance sheet, and the cash received is recorded as a borrowing secured by those receivables. The initial entry is debit cash for $570,000 and credit secured borrowing liability for $570,000. Later collections and repayments would be accounted for based on the collection and debt repayment activity.

• Derecognizing the receivables treats the transaction as a sale, which conflicts with the stated conclusion that sale accounting is not met.
• Recording a $600,000 liability and immediate $30,000 financing charge overstates the stated advance and recognizes a cost not supported by the facts.
• Waiting for collections skips the required recognition of the cash advance and related borrowing at the transfer date.

Because sale accounting is not met, Riva should account for the transfer as a secured borrowing and continue recognizing the receivables.

Question 35

Topic: Select Balance Sheet Accounts

A company uses a perpetual inventory subledger integrated with its general ledger inventory control account. During the December 31 close, the accountant identifies several items causing the subledger total to differ from the general ledger balance. Which item should be classified as an exception requiring investigation before the inventory carrying amount is finalized?

• A. A December 31 receiving transaction supported by a purchase order and receiving report that was recorded in the subledger but is waiting for the next automated general ledger interface batch.
• B. A manual debit posted directly to the general ledger inventory control account with no SKU-level transaction, receiving report, count sheet, or other supporting detail.
• C. A sales shipment for which inventory was relieved in the subledger and the summarized cost-of-goods-sold entry is pending in the general ledger posting queue.
• D. An approved physical-count shrinkage adjustment recorded in the subledger with the related general ledger entry included in an unposted close batch.

Best answer: B

What this tests: Select Balance Sheet Accounts

Explanation: The unsupported direct general ledger debit is the item that should be treated as an exception. Inventory control balances should reconcile to SKU-level subledger activity or other approved source documentation, not to unexplained manual entries.

A perpetual inventory subledger provides the detailed support for the general ledger inventory control account. Reconciling differences may arise from normal timing issues, such as an automated interface batch that has not yet posted, but those items should be supported by source documents and should clear when the batch posts. A direct manual entry to inventory control with no SKU detail, receiving report, count sheet, or other support is different. It may represent an error, unauthorized entry, duplicate adjustment, or unsupported carrying amount. Before inventory is finalized, the accountant should investigate the entry and either obtain appropriate support, record the related subledger detail, or reverse/correct the general ledger posting.

• Supported receiving activity awaiting an interface batch is a timing reconciling item, not an unexplained exception.
• Approved shrinkage with an unposted close entry is supported by count documentation and should clear when posted.
• A pending summarized cost-of-goods-sold posting is an interface timing issue if supported by shipment and subledger records.

An unsupported general-ledger-only posting prevents reconciliation to the inventory subledger and should be investigated or corrected before finalizing inventory.

Question 36

Topic: Select Transactions

Maple Co. reports under U.S. GAAP. On January 1, Year 1, Maple began the following leases; classification has already been determined. Payments are made on each December 31, and there are no lease incentives, initial direct costs, variable payments, impairments, or income tax effects.

Which statement correctly presents Maple’s Year 1 lease costs in the income statement?

• A. The finance lease is presented as $7,200 of interest expense and $18,000 of ROU asset amortization; the operating lease is presented as $30,000 of lease cost.
• B. The finance lease is presented as $7,200 of interest expense and $18,000 of ROU asset amortization; the operating lease is presented as $36,000 of single lease cost.
• C. The finance lease is presented as $25,200 of single lease cost; the operating lease is presented as $36,000 of single lease cost.
• D. The finance lease is presented as $22,545 of lease expense based on the Year 1 payment; the operating lease is presented as $30,000 of lease expense based on the Year 1 payment.

Best answer: B

What this tests: Select Transactions

Explanation: A finance lease produces separate interest expense and ROU asset amortization. Maple records $7,200 of interest and $18,000 of amortization for the finance lease. The operating lease is recognized as a single straight-line lease cost of $36,000 for Year 1.

Under U.S. GAAP, a lessee’s subsequent income statement treatment differs by lease classification. For a finance lease, the lessee recognizes interest expense on the lease liability using the effective interest method and amortization expense on the ROU asset. Because the liability is $90,000 at the start of Year 1 and the rate is 8%, interest expense is $7,200. Straight-line amortization is $90,000 divided by 5 years, or $18,000. For an operating lease, the lessee generally recognizes a single lease cost on a straight-line basis over the lease term. Total fixed payments are $108,000, so Year 1 operating lease cost is $36,000, not the $30,000 cash payment.

• Presenting the finance lease as a single lease cost uses operating lease presentation for a finance lease.
• Using $30,000 for the operating lease applies cash-basis accounting instead of straight-line lease cost recognition.
• Using the Year 1 payments for both leases ignores accrual accounting and the separate finance lease interest and amortization components.

Finance lease costs are interest of $90,000 × 8% plus straight-line ROU amortization of $90,000 ÷ 5, while the operating lease uses straight-line single lease cost over the lease term.

Question 37

Topic: Select Transactions

On January 1, Year 1, Metro Co. commenced a 5-year equipment lease and made no payments at commencement. Which cash flows should Metro include in measuring the initial lease liability before applying the discount rate?

Lease file excerpt:

• A. Cash flows totaling $505,000: base rent, CPI-indexed rent, and probable residual value guarantee payment, but not the purchase option price.
• B. Cash flows totaling $540,000: base rent, CPI-indexed rent, and the purchase option price, but not the residual value guarantee shortfall.
• C. Cash flows totaling $545,000: base rent, CPI-indexed rent measured at commencement, purchase option price, and probable residual value guarantee payment.
• D. Cash flows totaling $625,000: all scheduled and expected payments, including expected usage-based rent.

Best answer: C

What this tests: Select Transactions

Explanation: A lessee includes fixed payments, variable payments based on an index or rate measured at commencement, the exercise price of a purchase option the lessee is reasonably certain to exercise, and amounts probable under a residual value guarantee. Usage-based variable payments are excluded from initial measurement and recognized as incurred.

Under U.S. GAAP, the initial lease liability is the present value of the lease payments to be made over the lease term. The cash flows to discount include fixed lease payments, variable payments that depend on an index or rate using the index or rate at commencement, purchase option payments when exercise is reasonably certain, and probable amounts owed under residual value guarantees. Metro includes $500,000 of annual rent cash flows [($90,000 base rent + $10,000 CPI-indexed rent) × 5], plus the $40,000 purchase option price and the $5,000 probable residual value guarantee shortfall. The expected usage-based rent is excluded because it depends on future use, not an index or rate.

• Including expected usage-based rent incorrectly capitalizes variable payments based on future activity.
• Excluding the purchase option price is wrong because Metro is reasonably certain to exercise the option.
• Excluding the residual value guarantee shortfall is wrong because the $5,000 expected shortfall is probable.

The cash flows to discount are ($90,000 + $10,000) × 5 years, plus the $40,000 reasonably certain purchase option and the $5,000 probable residual value guarantee payment.

Question 38

Topic: Select Transactions

A calendar-year corporation is preparing its Year 1 income tax provision. It files in one tax jurisdiction, has no valuation allowance, has no tax items in OCI, and has not recorded any Year 1 income tax payments. The enacted tax rate for all years is 25%. The provision workpaper includes the following outputs:

Which journal entry best records the Year 1 income tax provision?

• A. Debit income tax expense $222,500; credit income taxes payable $222,500.
• B. Debit income tax expense $225,000 and deferred tax asset $20,000; credit deferred tax liability $30,000 and income taxes payable $215,000.
• C. Debit income tax expense $232,500 and deferred tax asset $20,000; credit deferred tax liability $30,000 and income taxes payable $222,500.
• D. Debit income tax expense $212,500 and deferred tax liability $30,000; credit deferred tax asset $20,000 and income taxes payable $222,500.

Best answer: C

What this tests: Select Transactions

Explanation: The provision entry must record both the current tax payable and the change in deferred tax accounts. The taxable temporary difference increased by $120,000, increasing the DTL by $30,000, while the deductible temporary difference increased by $80,000, increasing the DTA by $20,000.

Under U.S. GAAP, the income tax provision includes a current component based on taxable income and a deferred component based on changes in deferred tax assets and liabilities. Current income taxes payable are given as $222,500. The accelerated depreciation taxable temporary difference increased from $180,000 to $300,000, so the DTL increases by $30,000 ($120,000 × 25%). The warranty deductible temporary difference increased from $120,000 to $200,000, so the DTA increases by $20,000 ($80,000 × 25%). Because there are no OCI items, the net deferred tax expense of $10,000 flows through income tax expense. Total income tax expense is $232,500: current tax of $222,500 plus net deferred tax expense of $10,000.

• Reversing the deferred asset and liability changes misreads the temporary differences; both ending deferred balances increased.
• Recording only the payable omits the deferred tax provision required for temporary differences.
• Using 25% of pretax financial income ignores the permanent difference and contradicts the stated current tax payable.

The entry records current tax payable plus the net deferred tax expense from the $30,000 DTL increase less the $20,000 DTA increase.

Question 39

Topic: Select Balance Sheet Accounts

During year-end close, a CPA is reviewing Loma Co.’s intangible asset additions. The controller recorded one entry debiting intangible assets for $900,000. Supporting documents show the following:

The patent purchase was not part of a business combination, and no software development or cloud-computing implementation costs are involved. What should the CPA do next to complete the reporting analysis under U.S. GAAP?

• A. Classify the $300,000 of trade name-related costs as an indefinite-lived intangible and test it for impairment.
• B. Request a purchase price allocation for the full $900,000 as if the costs were incurred in a business combination.
• C. Revise the schedule to capitalize only the $600,000 purchased patent and propose reclassifying the $300,000 of internal brand and training costs to expense.
• D. Prepare an amortization schedule for the full $900,000 using the patent’s remaining legal life.

Best answer: C

What this tests: Select Balance Sheet Accounts

Explanation: The next step is to correct the intangible asset additions schedule before presentation. Loma acquired a patent from a third party, so that cost is a recognized purchased intangible asset, but the internally generated trade name, logo, and training costs should not remain capitalized as intangible assets.

Under U.S. GAAP, an intangible asset purchased from another party is recognized at its acquisition cost if it provides probable future economic benefits. The $600,000 patent was acquired from an unrelated party, so it should remain in intangible assets. In contrast, costs to internally develop a trade name, logo, or brand generally are expensed as incurred, and employee training costs are also expensed. Because the facts exclude a business combination and software or cloud-computing implementation, no special capitalization model applies to the $300,000 of internal costs. The CPA should first revise the schedule and propose the necessary reclassification, rather than amortizing or impairment-testing an improperly capitalized amount.

• Amortizing the full $900,000 skips the required distinction between a purchased patent and noncapitalizable internal costs.
• Treating the internal trade name costs as an indefinite-lived intangible incorrectly recognizes an internally generated brand asset.
• Requesting a purchase price allocation addresses business combination accounting, which the facts state is not involved.

Purchased intangibles are recognized at acquisition cost, while ordinary internally generated brand and training costs are expensed as incurred.

Question 40

Topic: Select Balance Sheet Accounts

At year-end, a staff accountant is preparing the statement of financial position under U.S. GAAP. A draft rollforward labeled “intangible asset additions” includes the following items:

The rollforward has not yet been tied to contracts or invoices. Which procedure should be performed next to complete the reporting analysis?

• A. Expense the entire draft rollforward because internally generated and cloud-related costs cannot be recognized as intangible assets.
• B. Record all additions at estimated fair value and defer reviewing the underlying contracts until disclosure preparation.
• C. Trace additions to contracts and invoices, then include only identifiable, controlled rights with measurable cost, such as rights that are separable or arise from contractual or legal terms.
• D. Post the entire draft rollforward to intangible assets and then determine amortization periods for all additions.

Best answer: C

What this tests: Select Balance Sheet Accounts

Explanation: Before reporting an intangible asset balance, the accountant must verify that each item meets recognition criteria. The draft includes items that may be recognizable purchased rights and items that may not create a recognized intangible asset, so source documents and recognition criteria must be evaluated first.

Under U.S. GAAP, an intangible asset is recognized when the entity controls an identifiable nonmonetary asset without physical substance, future economic benefits are expected, and the cost or value can be measured. Identifiability generally comes from separability or contractual/legal rights. Purchased rights such as a patent or trade name may qualify, but internal advertising or brand-building costs generally do not create a recognized intangible asset. A cloud hosting arrangement without a software license or right to take possession generally is not recognized as a purchased software intangible. Therefore, the next step is to tie the rollforward to source documents and assess which items meet the recognition criteria before posting the statement of financial position amount.

• Posting the entire rollforward and then amortizing skips the required recognition analysis.
• Expensing the entire rollforward ignores that purchased patents and trade names may qualify as intangible assets.
• Recording all additions at estimated fair value uses an unsupported measurement approach and delays review of source documents that determine recognition.

Intangible assets should be recognized only after verifying that the item is identifiable, controlled, expected to provide future economic benefits, and has a measurable cost.

Question 41

Topic: Select Transactions

On July 1, 20X1, Lark Co. entered into a $600,000 fixed-price contract to build a specialized component for a customer. The contract has a single performance obligation satisfied over time because the component has no alternative use to Lark and Lark has an enforceable right to payment for performance completed to date. Lark measures progress using the cost-to-cost method. At December 31, 20X1, total expected contract costs were $400,000 and costs incurred to date were $160,000. Lark billed $120,000 at contract signing and $50,000 on December 31; the signing invoice was paid, and the December 31 invoice was unpaid. Lark recorded each billing when issued as a debit to cash or accounts receivable and a credit to contract liability. No revenue has been recorded. Ignoring entries for contract costs, which revenue recognition adjusting entry should Lark record on December 31, 20X1?

• A. Debit contract liability $170,000; debit contract asset $70,000; credit revenue $240,000.
• B. Debit contract liability $240,000; credit revenue $240,000.
• C. Debit contract liability $170,000; credit revenue $170,000.
• D. Debit accounts receivable $70,000; debit contract liability $170,000; credit revenue $240,000.

Best answer: A

What this tests: Select Transactions

Explanation: Lark recognizes revenue based on progress toward satisfying the performance obligation, not based solely on billings. Progress is 40% ($160,000 ÷ $400,000), so revenue is $240,000. Because only $170,000 has been billed, the excess earned amount is a contract asset, not a receivable.

Under the cost-to-cost method, revenue recognized to date equals the transaction price multiplied by the percentage of completion. Lark’s progress is $160,000 of costs incurred divided by $400,000 of expected total costs, or 40%. Therefore, revenue to date is $600,000 × 40% = $240,000. Before the revenue entry, Lark has credited contract liability for total billings of $170,000. The adjusting entry should first reduce that contract liability for the billed portion of earned revenue. The remaining $70,000 of earned but unbilled revenue is recorded as a contract asset because Lark’s right to that additional consideration is still conditional on future billing terms, not an unconditional receivable.

• Debiting contract liability for $170,000 and contract asset for $70,000 properly separates billed consideration from earned but unbilled revenue.
• Debiting contract liability for $240,000 overstates the liability balance available to release because only $170,000 has been billed.
• Recording the $70,000 as accounts receivable incorrectly treats unbilled conditional consideration as an unconditional right to payment.
• Recognizing only $170,000 of revenue incorrectly limits revenue to billings rather than measuring progress toward completion.

Revenue is $240,000 based on 40% progress, so Lark releases $170,000 of billings from contract liability and records a $70,000 contract asset for unbilled performance.

Question 42

Topic: Select Balance Sheet Accounts

A staff accountant is evaluating whether Hart Co. should account for its investment in Jetson Inc. using the equity method. Hart owns 18% of Jetson’s voting common stock and does not consolidate Jetson. Which source item would best support the conclusion that the equity method can be applied?

• A. A valuation memo stating that Jetson’s shares do not have a readily determinable fair value
• B. An executed shareholders’ agreement and related board minutes showing that Hart appoints one Jetson director and participates in Jetson’s operating and financial policy decisions
• C. A cash disbursement record and purchase agreement showing the amount Hart paid for the Jetson shares
• D. A capitalization table showing Hart owns 18% of Jetson’s outstanding voting common stock

Best answer: B

What this tests: Select Balance Sheet Accounts

Explanation: The equity method is applied when the investor has significant influence over the investee, absent control. Because Hart owns less than 20%, ownership alone is not enough; source evidence of board representation and policy participation best supports significant influence.

Under U.S. GAAP, equity method accounting generally applies when an investor can exercise significant influence over the operating and financial policies of an investee but does not control it. A 20% to 50% voting interest creates a rebuttable presumption of significant influence, but an investor with less than 20% may still qualify if other evidence demonstrates influence. Common supporting evidence includes board representation, participation in policy-making processes, material intercompany transactions, interchange of managerial personnel, or technological dependency. In this scenario, the shareholders’ agreement and board minutes directly support Hart’s ability to influence Jetson’s policies.

• An 18% ownership schedule is incomplete because it does not by itself establish significant influence.
• Lack of a readily determinable fair value supports a measurement issue for certain equity investments, not whether the equity method applies.
• Purchase documents support the investment’s cost and existence, but not Hart’s influence over Jetson.

Board representation and participation in policy decisions are direct evidence of significant influence, which can support equity method accounting even below 20% ownership.

Question 43

Topic: Financial Reporting

A county accountant is reviewing an unposted receipt while preparing the governmental fund-level statement of revenues, expenditures, and changes in fund balances. The transaction file states that the state remitted $850,000 of motor fuel taxes to the county before year-end, state law restricts the money to routine county road maintenance, the cash is not held for other governments or private parties, and no debt service or capital construction project is involved. What should the accountant do next to complete the reporting analysis?

• A. Analyze the receipt in a special revenue fund using the current financial resources measurement focus and modified accrual basis.
• B. Analyze the receipt in an enterprise fund using the economic resources measurement focus and accrual basis.
• C. Analyze the receipt in a capital projects fund because the spending relates to roads.
• D. Analyze the receipt in a fiduciary fund because state law restricts how the cash may be used.

Best answer: A

What this tests: Financial Reporting

Explanation: The receipt is a restricted governmental revenue source for an operating-type governmental purpose: routine road maintenance. That points to a special revenue fund, which uses the current financial resources measurement focus and modified accrual basis in governmental fund financial statements.

Governmental funds are used for typical governmental activities, and special revenue funds report specific revenue sources that are restricted or committed to specified purposes other than debt service or capital projects. Here, the motor fuel taxes are restricted by state law for routine county road maintenance, and the county is not merely holding the cash for another party. Because the accountant is preparing governmental fund-level statements, the applicable reporting basis is the current financial resources measurement focus and modified accrual basis, not full accrual reporting used for government-wide or proprietary fund statements.

• Enterprise fund treatment would be appropriate for business-type activities financed primarily by user charges, not restricted tax revenue for routine road maintenance.
• Capital projects fund treatment is not indicated because the facts state no capital construction project is involved.
• Fiduciary fund treatment is inappropriate because the county controls the resources for its own governmental program rather than holding them for outside parties.

A legally restricted revenue source for routine governmental road maintenance is most directly reported in a special revenue fund on the governmental fund modified accrual basis.

Question 44

Topic: Financial Reporting

A closely held professional services firm prepares annual financial statements on the income tax basis. The firm uses the cash method for federal income tax purposes, and its tax-basis policy recognizes service revenue when cash is received. Before issuing the 20X6 statements, the accountant finds this year-end entry in the draft records:

Debit accounts receivable $96,000; credit service revenue $96,000 for December invoices that were not collected by December 31, 20X6. All 20X6 cash collections have already been recorded.

Which correction should be made?

• A. Leave the entry posted and disclose that the receivable will be taxable when collected.
• B. Reclassify the $96,000 from service revenue to deferred revenue and retain the accounts receivable.
• C. Reverse the entry by debiting service revenue and crediting accounts receivable for $96,000.
• D. Record a valuation allowance against accounts receivable while retaining the service revenue.

Best answer: C

What this tests: Financial Reporting

Explanation: The statements are being prepared on the income tax basis using the cash method. Because the invoices were not collected by year-end, the draft entry improperly recognized both revenue and an accounts receivable in 20X6.

Income tax basis financial statements follow the accounting method used for tax reporting, unless the reporting policy states otherwise. For a cash-method taxpayer, service revenue is generally recognized when cash is received rather than when services are billed or earned. The draft entry applies accrual-basis recognition, which is inconsistent with the stated cash-method tax basis. Since all 20X6 cash collections have already been recorded and the $96,000 was not collected by year-end, the correction is to remove the receivable and the related revenue from the 20X6 tax-basis financial statements.

• Disclosure alone does not correct an amount that was recognized under the wrong basis of accounting.
• Deferred revenue would be inappropriate because no cash was received to create an advance payment.
• A valuation allowance addresses collectibility, not whether revenue is recognized under the cash-method income tax basis.

Under the cash-method income tax basis, the billed but uncollected service fees should not be recognized as 20X6 revenue or accounts receivable.

Question 45

Topic: Select Balance Sheet Accounts

At December 31, Year 1, Regal Corp. held the following investment portfolios. All interest income entries have been recorded, the amounts below exclude accrued interest, and there are no impairment facts.

What total carrying amount should Regal report for these investment portfolios in its December 31, Year 1 balance sheet?

• A. $848,000
• B. $862,000
• C. $819,000
• D. $830,000

Best answer: A

What this tests: Select Balance Sheet Accounts

Explanation: Investments classified as trading debt securities and available-for-sale debt securities are both reported at fair value on the balance sheet. The income statement versus OCI classification affects where unrealized changes are reported, not the balance sheet carrying amount.

For investments measured at fair value, the ending balance sheet carrying amount equals fair value at the reporting date. Prior fair value adjustment account balances are not added to or subtracted from the current fair values; they are adjusted so that the investment’s carrying amount equals current fair value. Here, the trading debt portfolio is carried at $512,000 and the available-for-sale debt portfolio is carried at $336,000. Therefore, the total carrying amount is $848,000. The fact that unrealized changes on trading securities affect earnings while unrealized changes on available-for-sale debt securities generally affect other comprehensive income does not change the balance sheet measurement basis.

• $830,000 uses amortized cost and ignores the fair value measurement requirement.
• $819,000 uses the preadjustment valuation account balances instead of the ending fair values.
• $862,000 measures the trading portfolio at fair value but incorrectly leaves the available-for-sale portfolio at amortized cost.

Both trading and available-for-sale debt securities are reported at fair value, so the carrying amount is $512,000 + $336,000.

Question 46

Topic: Select Balance Sheet Accounts

At December 31, Year 1, before current-year depreciation is recorded, Hale Co.’s draft PP&E rollforward shows:

The only current-year PP&E-related transactions were an equipment purchase with a $200,000 invoice price, $12,000 of freight, and $18,000 of installation costs. Hale recorded only the $200,000 invoice price in PP&E and expensed the freight and installation costs. Hale also paid $25,000 for routine repairs and incorrectly capitalized that amount to PP&E. Which correction should Hale record to properly state gross and net PP&E before current-year depreciation?

• A. Debit PP&E $5,000 and repairs expense $25,000; credit delivery and installation expense $30,000, resulting in gross PP&E of $1,130,000 and net PP&E of $770,000.
• B. Debit repairs expense $25,000; credit PP&E $25,000, resulting in gross PP&E of $1,100,000 and net PP&E of $740,000.
• C. Debit PP&E $55,000; credit delivery and installation expense $30,000 and repairs expense $25,000, resulting in gross PP&E of $1,180,000 and net PP&E of $820,000.
• D. Debit PP&E $30,000; credit delivery and installation expense $30,000, resulting in gross PP&E of $1,155,000 and net PP&E of $795,000.

Best answer: A

What this tests: Select Balance Sheet Accounts

Explanation: The draft rollforward has two offsetting errors: capitalizable freight and installation were expensed, while a routine repair was capitalized. The net correction is a $5,000 increase to gross PP&E, with accumulated depreciation unchanged because depreciation has not yet been recorded. Correct net PP&E is $770,000.

Equipment cost includes expenditures necessary to acquire the asset and prepare it for its intended use, such as freight and installation. Routine repairs are period expenses because they maintain the asset rather than improve it or extend its useful life. Hale should capitalize the omitted $30,000 of freight and installation costs and remove the incorrectly capitalized $25,000 repair from PP&E, for a net PP&E increase of $5,000. Correct gross PP&E is $1,125,000 + $5,000 = $1,130,000. Because no current-year depreciation has been recorded, accumulated depreciation remains $360,000, so net PP&E is $1,130,000 - $360,000 = $770,000.

• Capitalizing only the freight and installation costs fixes the omission but leaves the routine repair in PP&E, overstating gross and net PP&E by $25,000.
• Expensing only the routine repair fixes that error but leaves the freight and installation costs incorrectly expensed, understating gross and net PP&E by $30,000.
• Capitalizing all $55,000 overstates PP&E because routine repairs are not capitalizable and the repair was already recorded in PP&E.

Freight and installation are capitalizable, but routine repairs are expensed, so recorded PP&E must increase by a net $5,000 and accumulated depreciation remains unchanged.

Question 47

Topic: Financial Reporting

Pax Co. owns 80% of Sawyer Co. and consolidates Sawyer. The following facts relate to a 20X5 upstream inventory sale; ignore income taxes.

The draft consolidation worksheet eliminated Sawyer’s intercompany sales and Pax’s related purchases/COGS for $120,000, but did not make any other adjustment for this transaction. Which correction should be made to the draft consolidated financial statements?

• A. Decrease consolidated inventory by $30,000, increase consolidated cost of goods sold by $30,000, and reduce net income attributable to the noncontrolling interest by $6,000.
• B. Decrease consolidated inventory by $7,500, increase consolidated cost of goods sold by $7,500, and reduce net income attributable to the noncontrolling interest by $1,500.
• C. Decrease consolidated inventory by $7,500, increase consolidated cost of goods sold by $7,500, and make no adjustment to net income attributable to the noncontrolling interest.
• D. Increase consolidated inventory by $7,500, decrease consolidated cost of goods sold by $7,500, and reduce net income attributable to the noncontrolling interest by $1,500.

Best answer: B

What this tests: Financial Reporting

Explanation: The remaining inventory includes unrealized intercompany profit that must be eliminated from consolidated financial statements. Because the sale was upstream from the subsidiary to the parent, the income reduction is attributed proportionately to the controlling and noncontrolling interests.

Sawyer sold inventory to Pax for $120,000 that cost Sawyer $90,000, creating total intercompany gross profit of $30,000. Because Pax still holds 25% of the goods, unrealized profit remaining in ending inventory is $7,500 ($30,000 × 25%). The draft worksheet eliminated the intercompany sale and purchase but left ending inventory overstated and cost of goods sold understated. The correction is to decrease inventory and increase cost of goods sold by $7,500. Since the sale was upstream, the profit was recorded by the subsidiary, so the related income reduction is allocated to Sawyer’s shareholders: 20% × $7,500 = $1,500 to the noncontrolling interest.

• Making no adjustment to noncontrolling interest treats the transaction like a downstream sale, but this was an upstream sale by the subsidiary.
• Using $30,000 eliminates the entire intercompany gross profit even though only 25% remains unrealized in ending inventory.
• Increasing inventory and decreasing cost of goods sold reverses the required correction; consolidated inventory is overstated, not understated.

The unrealized upstream profit in ending inventory is $7,500, and 20% of that income reduction is allocated to the noncontrolling interest.

Question 48

Topic: Select Balance Sheet Accounts

Rial Co. uses a periodic inventory system and the FIFO cost-flow assumption. Rial reports inventory at the lower of cost and net realizable value, and net realizable value of ending inventory exceeds cost.

What amount should Rial present for inventory as a current asset on its year-end balance sheet?

• A. Inventory should be presented at $2,592.
• B. Inventory should be presented at $2,472.
• C. Inventory should be presented at $2,640.
• D. Inventory should be presented at $2,400.

Best answer: A

What this tests: Select Balance Sheet Accounts

Explanation: Under FIFO, ending inventory is assigned the most recent purchase costs. After the March return, Rial has 580 units available and 160 units ending, all from the September layer. The September unit cost is the discounted price plus freight-in, or $16.20 per unit, for a $2,592 balance.

FIFO assigns the earliest costs to cost of goods sold and the most recent costs to ending inventory. Rial has 100 beginning units + 180 net March units + 300 September units = 580 units available. After selling 420 units, 160 units remain. Because the latest layer contains 300 September units, all 160 ending units are costed from that layer. The September purchase cost is reduced by the 2% discount taken: $15 × 98% = $14.70 per unit. Freight-in is inventoriable and adds $450 ÷ 300 = $1.50 per unit. Therefore, the FIFO unit cost is $16.20, and ending inventory is 160 × $16.20 = $2,592.

• Presenting inventory at $2,400 ignores both the purchase discount and inventoriable freight-in on the September layer.
• Presenting inventory at $2,472 applies the purchase discount but incorrectly excludes freight-in from inventory cost.
• Presenting inventory at $2,640 includes freight-in but fails to reduce cost for the purchase discount taken.

Ending inventory is 160 units from the September FIFO layer at $16.20 per unit, including freight-in and the purchase discount.

Question 49

Topic: Financial Reporting

Delta Arts, a nongovernmental not-for-profit entity, is preparing its June 30, 20X6 statement of financial position. Selected adjusted balances after closing revenue and expense accounts are:

Supporting documentation indicates that $25,000 of cash is restricted by donors for next-year programs, the board-designated cash has no donor-imposed restriction, the net promises receivable consist of $75,000 for general operations and $150,000 restricted by donors for next-year programs, and the grant advance is conditional with the condition not yet met. No other donor restrictions exist. Which interpretation best supports Delta Arts’ statement of financial position?

• A. Report liabilities of $335,000 and net assets with donor restrictions of $635,000 because the conditional grant advance is donor-restricted support.
• B. Report total assets of $1,470,000, liabilities of $395,000, net assets with donor restrictions of $645,000, and net assets without donor restrictions of $430,000.
• C. Report total assets of $1,070,000 and net assets with donor restrictions of $175,000 because endowment investments are excluded until appropriated for spending.
• D. Report total assets of $1,470,000, liabilities of $395,000, net assets with donor restrictions of $575,000, and net assets without donor restrictions of $500,000.

Best answer: D

What this tests: Financial Reporting

Explanation: The statement of financial position reports all assets and liabilities and classifies net assets based on donor-imposed restrictions. Board designations do not create donor-restricted net assets, and a conditional grant advance remains a liability until the condition is met.

Total assets are $1,470,000: cash of $95,000, board-designated cash of $70,000, net promises receivable of $225,000, endowment investments of $400,000, and property and equipment of $680,000. Total liabilities are $395,000: accounts payable of $85,000, refundable grant advance of $60,000, and long-term note payable of $250,000. Total net assets therefore equal $1,075,000. Net assets with donor restrictions are $575,000, consisting of restricted cash of $25,000, restricted promises receivable of $150,000, and donor-restricted endowment investments of $400,000. The remaining $500,000 is net assets without donor restrictions, including board-designated resources.

• Treating board-designated cash as donor-restricted overstates net assets with donor restrictions because only donors can impose donor restrictions.
• Treating the conditional grant advance as restricted contribution support understates liabilities; the unmet condition makes it refundable.
• Excluding endowment investments from assets is incorrect because the investments are recognized assets even though donor restrictions affect net asset classification.

Donor-restricted net assets include the restricted cash, restricted promises receivable, and endowment investments, while board designations remain without donor restrictions.

Question 50

Topic: Financial Reporting

Cedar Corp. is an SEC registrant subject to the Securities Exchange Act of 1934. The controller is updating the filing checklist for three items: an audited annual reporting package for the fiscal year just ended, unaudited interim financial information for the first quarter, and a material acquisition agreement signed after quarter-end but before the next periodic report is filed. What should the controller do next to complete the reporting analysis?

• A. Map the audited annual reporting package to Form 10-Q, the quarterly interim information to Form 10-K, and the material acquisition agreement to Form 8-K.
• B. Map the audited annual reporting package to Form 10-K, the quarterly interim information to Form 10-Q, and the material acquisition agreement to Form 8-K.
• C. Map all three items to the next Form 10-K because it is the comprehensive annual Exchange Act report.
• D. Map the annual and quarterly reporting packages to Form 8-K and reserve Forms 10-K and 10-Q for registering new securities.

Best answer: B

What this tests: Financial Reporting

Explanation: The correct next step is to identify the purpose of each Exchange Act filing. Form 10-K reports annual information, Form 10-Q reports quarterly interim information, and Form 8-K reports specified current material events.

Public companies use different Exchange Act forms for different reporting purposes. Form 10-K is the annual report and generally includes audited financial statements and comprehensive disclosures. Form 10-Q is used for quarterly interim reporting and generally includes unaudited interim financial information. Form 8-K is a current report used to disclose specified material events that occur between periodic reports, such as entry into a material definitive agreement. Therefore, the controller should map each item to the form designed for that reporting purpose rather than waiting to include everything in the next periodic filing.

• Reversing Form 10-K and Form 10-Q confuses annual and quarterly periodic reporting.
• Placing all items in the next Form 10-K skips required interim and current-event reporting analysis.
• Treating Form 8-K as the form for routine annual and quarterly reports misunderstands its current-report purpose.

Form 10-K is the annual report, Form 10-Q is the quarterly report, and Form 8-K is the current report for specified material events.

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