CPA Exam: FAR Sample Questions and Explanations

Start with net income and remove noncash items and working capital effects.

1. Net income: $50,000
2. Add depreciation (noncash): +$8,000 → $58,000
3. Subtract increase in receivables (sales not yet collected): −$5,000 → $53,000
4. Add increase in payables (costs not yet paid): +$3,000 → $56,000

Check: 50,000 + 8,000 − 5,000 + 3,000 = 56,000.

Wrong choices

• $60,000: This reverses the signs of both working capital changes: an increase in receivables lowers cash, and an increase in payables raises it.
• $50,000: This subtracts the increase in payables. A payables increase means cash was not yet paid, so it is added back.
• $40,000: This subtracts depreciation. Depreciation is a noncash expense and is added back to net income.

Cash equivalents are very liquid investments that will turn into a known amount of cash soon. The rule of thumb is that the original maturity, counted from the day the company buys it, is 3 months or less. A Treasury bill bought 2 months before maturity meets this test.

Wrong choices

• A 1-year certificate of deposit bought on the day it was issued: Its original maturity to the company is more than 3 months, so it is a short-term investment, not a cash equivalent.
• A customer's postdated check: A postdated check cannot be cashed yet, so it is a receivable.
• Postage stamps on hand: Stamps are a prepaid expense (supplies), not cash.

A change in depreciation method is treated as a change in accounting estimate effected by a change in accounting principle. Because it cannot be separated from a change in estimate, it is applied prospectively: the remaining book value is depreciated with the new method from now on.

Wrong choices

• Retrospective restatement: this is for most changes in accounting principle, but not depreciation method changes.
• Prior-period adjustment: this is for correcting errors.
• Cumulative effect in income: this older approach is not used under current GAAP.

Under US GAAP, interest paid and interest received are both operating cash flows because interest expense and interest income are part of net income. Only the repayment of the loan principal is a financing cash outflow.

Wrong choices

• Financing activities: Repaying loan principal is financing, but interest paid is an operating cash flow under US GAAP.
• Either operating or financing, as chosen by company policy: A policy choice for interest paid is allowed under IFRS, not under US GAAP.
• Investing activities: Investing covers buying and selling long-term assets and investments, not paying interest.

Start from the bank balance and fix items the bank does not know about yet.

1. Bank balance: $20,000
2. Add deposits in transit: +$3,000
3. Subtract outstanding checks: −$4,500
4. Correct cash = $18,500

Check: the service fee is already in the bank balance, so it only affects the book side.

Wrong choices

• $18,450: The $50 service fee is already deducted in the bank balance. It is a book-side adjustment, so it is not subtracted again from the bank balance.
• $21,500: This adds the outstanding checks and subtracts the deposits in transit, which is backwards.
• $27,500: Outstanding checks must be subtracted, not added.

A material error in previously issued statements is corrected by restatement. Prior periods shown are corrected, and the effect on earlier periods is recorded as an adjustment to the opening retained earnings of the earliest period presented.

Wrong choices

• Current-year income: correcting an old error through current income would distort this year's results.
• Prospective: prospective treatment is for changes in estimate, not errors.
• Disclose only: a material error must be corrected in the amounts, not just disclosed.

Not-for-profit entities report two classes of net assets: without donor restrictions and with donor restrictions. Board-designated amounts are still net assets without donor restrictions, because only donors can impose restrictions.

Wrong choices

• Unrestricted, temporarily restricted, and permanently restricted net assets: These three classes were replaced by two classes for NFPs.
• Operating net assets and capital net assets: These are not the required net asset classes.
• Current net assets and noncurrent net assets: Net assets are classified by donor restrictions, not by current or noncurrent.

Under FIFO, the first units bought are the first sold, so the units left are the newest ones.

1. Units available: 100 + 200 = 300
2. Units left: 300 − 220 = 80
3. Ending inventory: 80 × $12 = $960

Check: COGS = $1,000 + 120 × $12 = $2,440; $2,440 + $960 = $3,400 = total cost available.

Wrong choices

• $800: This uses the oldest $10 cost, which is LIFO thinking; under FIFO the oldest units are sold first.
• $880: This uses an average-type cost of $11, not FIFO.
• $2,440: This is cost of goods sold, not ending inventory.

ASC 606 is a control-based model. Revenue is recognized when (or as) the company satisfies a performance obligation by transferring control of the good or service to the customer. Signing, producing, or collecting cash alone do not trigger revenue.

Wrong choices

• When cash is received: collection timing does not decide revenue; cash received early is a contract liability.
• When the contract is signed: signing creates the contract (step 1) but nothing has been delivered yet.
• When production is finished: the good is still the company's until control passes to the customer.

An unconditional promise to give is recognized as a receivable and contribution revenue when the promise is received. Cash due in a future period is treated as time-restricted, so it increases net assets with donor restrictions until the time arrives.

Wrong choices

• As contribution revenue that increases net assets without donor restrictions: Because the cash is not due until a later year, the promise carries an implied time restriction.
• No revenue until the cash is received in Year 2: Unconditional promises to give are recognized when received, not when collected.
• Disclosure in the notes only, with no amount recognized: Only conditional promises are left unrecognized; this promise is unconditional.