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Free CPA Financial Accounting and Reporting Practice Questions & Answers
500 exam-style Financial Accounting and Reporting questions. Pick your answer, hit Check answer, and see the worked solution — free to start, no signup.
100% free · No login to startQuestion 301
An entity understated ENDING inventory in Year 1 by $60,000 and the error was never corrected. The effect on Year 2 ENDING retained earnings is:
Select an option first.
Correct answer: C — CORRECT — inventory errors are SELF-CORRECTING over two periods
Explanation: Year 1: ending inventory understated → COGS overstated → income UNDERSTATED by $60,000. Year 2: the same figure is BEGINNING inventory, now understated → COGS UNDERSTATED → income OVERSTATED by $60,000. The two errors OFFSET, so Year 2 ENDING retained earnings is CORRECT — even though each year's income was wrong. This counterintuitive self-correction is the whole point.
Question 302
A company capitalises interest during construction. Actual interest incurred is $150,000; avoidable interest is $180,000. The amount capitalised is:
Select an option first.
Correct answer: D — $150,000 — capitalise the LESSER of avoidable and ACTUAL interest incurred
Explanation: Capitalised interest = the LESSER of AVOIDABLE interest ($180,000) and ACTUAL interest INCURRED ($150,000) = $150,000. You can never capitalise MORE interest than you actually paid — the avoidable calculation is a ceiling test, not the answer itself. Candidates who compute avoidable interest and stop there select $180,000.
Question 303
An asset (carrying value $500,000) is reclassified as HELD FOR SALE when its fair value less costs to sell is $430,000. Six months later, before disposal, fair value less costs to sell RECOVERS to $480,000. The entity should:
Select an option first.
Correct answer: D — Recognise a $50,000 RECOVERY (write the asset back up to $480,000), because held-for-sale write-downs CAN be reversed up to the amount of prior write-downs
Explanation: HELD-FOR-SALE assets are measured at the LOWER of carrying amount and fair value less costs to sell — and subsequent INCREASES ARE RECOGNISED, but only to the extent of PREVIOUSLY RECOGNISED write-downs. The write-down was $70,000; the recovery of $50,000 is within that, so it is recognised. Note the contrast with HELD-FOR-USE impairments, which can NEVER be reversed.
Question 304
A bond is issued at a premium. Over the life of the bond, TOTAL interest EXPENSE will be:
Select an option first.
Correct answer: C — LESS than total cash interest paid — the premium amortisation REDUCES expense each period
Explanation: For a PREMIUM bond, interest EXPENSE (carrying value × market rate) is LESS than cash interest each period, and the difference amortises the premium away. Over the bond's life, total expense = total cash interest MINUS the total premium. (For a DISCOUNT bond the reverse holds: total expense = total cash interest PLUS the discount.)
Question 305
A lessee's finance lease has a $100,000 ROU asset and a $100,000 lease liability, a 5-year term and an 8% rate, with annual payments at year-end. In Year 1, TOTAL expense (amortisation + interest) compared with a straight-line operating lease expense on the same lease will be:
Select an option first.
Correct answer: B — HIGHER — the finance lease is FRONT-LOADED, because interest is greatest when the liability is largest
Explanation: FINANCE lease Year 1 expense = straight-line ROU amortisation ($100,000/5 = $20,000) + interest ($100,000 × 8% = $8,000) = $28,000. OPERATING lease = a single straight-line expense (total lease cost ÷ 5), which is lower in Year 1. Finance leases are FRONT-LOADED; over the full term, total expense is the SAME under both, but the PATTERN differs — which is the entire economic consequence of the classification.
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Question 306
Plan assets $7,000,000; PBO $7,000,000; unrecognised net actuarial LOSS in AOCI $1,200,000; average remaining service period 10 years. Using the corridor approach, the amortisation of the net loss is:
Select an option first.
Correct answer: D — $50,000
Explanation: Corridor = 10% of the GREATER of PBO ($7,000,000) or plan assets ($7,000,000) = $700,000. The EXCESS over the corridor = $1,200,000 − $700,000 = $500,000. Amortisation = $500,000 / 10 years = $50,000. Amortising the FULL $1,200,000 over 10 years ($120,000, option A) ignores the corridor entirely.
Question 307
An entity's inventory error causes COGS to be OVERSTATED. This means ENDING inventory was:
Select an option first.
Correct answer: D — UNDERSTATED — COGS = Beginning inventory + Purchases − Ending inventory, so understating the subtrahend overstates COGS
Explanation: COGS = Beginning inventory + Purchases − ENDING inventory. Ending inventory is SUBTRACTED, so UNDERSTATING it OVERSTATES COGS (and understates income). Working the relationship algebraically, rather than memorising a table, is the reliable route through every inventory error question.
Question 308
A company writes down inventory under LCNRV in Year 1. In Year 2 it sells that inventory. The gross margin in Year 2 will be:
Select an option first.
Correct answer: C — HIGHER than normal — the write-down reduced the cost basis, so COGS in Year 2 is artificially low
Explanation: The Year 1 write-down established a LOWER cost basis. When the goods are sold in Year 2, COGS is that reduced amount, so the gross margin is artificially HIGH. The loss was effectively recognised EARLY (in Year 1), which flatters the following year. This is precisely why analysts scrutinise inventory write-downs — they shift profit between periods.
Question 309
An entity has a $5,000,000 note payable due in 3 months. After year-end but before issuance, it enters a NON-CANCELLABLE agreement to refinance long-term, but only for $3,000,000. Classification at the balance sheet date is:
Select an option first.
Correct answer: A — $3,000,000 NON-CURRENT and $2,000,000 CURRENT — the refinancing supports non-current classification only to the extent of the amount actually covered
Explanation: The intent-and-ability test supports non-current classification ONLY to the EXTENT of the amount the entity can demonstrably refinance. The firm agreement covers $3,000,000, so that much is NON-CURRENT; the remaining $2,000,000 stays CURRENT. Candidates tend to answer all-or-nothing, missing the partial-reclassification nuance.
Question 310
A company's ARO liability increases because of a REVISED estimate of retirement costs. The current credit-adjusted risk-free rate is 5%; the original rate was 8%. The upward revision is discounted at:
Select an option first.
Correct answer: D — 5% (the CURRENT rate) — an upward revision is a NEW layer measured at the current rate
Explanation: An UPWARD revision creates a NEW LAYER of liability, measured using the CURRENT credit-adjusted risk-free rate (5%). A DOWNWARD revision instead REDUCES existing layers using the rates at which those layers were ORIGINALLY recognised. The asymmetry is deliberate: upward revisions are new obligations; downward ones unwind old ones.
Question 311
An entity's held-to-maturity security has an amortised cost of $1,000,000 and a fair value of $940,000. Of the $60,000 decline, $25,000 is credit-related. The entity should:
Select an option first.
Correct answer: D — Record a $25,000 ALLOWANCE for credit losses through EARNINGS; the remaining $35,000 non-credit decline is NOT recognised, because HTM securities are carried at amortised cost
Explanation: For HTM securities, only the CREDIT-related portion is recognised — as an ALLOWANCE through EARNINGS ($25,000). The NON-CREDIT portion ($35,000, driven by rates) is NOT recognised at all, because the entity will hold to maturity and collect par. (For AFS debt, the non-credit portion WOULD go to OCI — a key distinction between the two classifications.)
Question 312
A company has a contingent liability that is PROBABLE and estimable at $400,000, and also expects to RECOVER $250,000 from an insurer (recovery is probable). It should report:
Select an option first.
Correct answer: B — A $400,000 LIABILITY and, separately, a $250,000 RECEIVABLE — a loss contingency and a probable recovery are NOT offset unless a right of setoff exists
Explanation: The loss contingency ($400,000 liability) is accrued. The insurance RECOVERY is recognised as a separate ASSET only when realisation is PROBABLE, and it is NOT NETTED against the liability unless a legal right of setoff exists. Presenting a $150,000 net figure (option A) understates both the gross obligation and the counterparty (insurer) credit risk.
Question 313
A company classifies a component as HELD FOR SALE at 30 September. It had recorded depreciation of $10,000 per month. For the last quarter of the year, depreciation recorded should be:
Select an option first.
Correct answer: B — $0 — depreciation CEASES once the held-for-sale criteria are met
Explanation: Once ALL SIX held-for-sale criteria are met, DEPRECIATION STOPS — the asset is now measured at the lower of carrying amount and fair value less costs to sell, and is being recovered through SALE rather than through USE. So no depreciation is recorded for October to December. (An idle asset that FAILS the held-for-sale test would, by contrast, keep depreciating.)
Question 314
An entity has a $900,000 building (accumulated depreciation $300,000) and reclassifies it as HELD FOR SALE when fair value less costs to sell is $520,000. It is sold 4 months later for $505,000. Total loss recognised across both events is:
Select an option first.
Correct answer: C — $95,000 — an $80,000 write-down on reclassification plus a further $15,000 loss on sale
Explanation: On RECLASSIFICATION: carrying value $600,000 ($900,000 − $300,000) vs FV less costs to sell $520,000 → write-down of $80,000, and depreciation CEASES. On SALE at $505,000: a further loss of $520,000 − $505,000 = $15,000. TOTAL = $80,000 + $15,000 = $95,000. Three concepts chain: the held-for-sale measurement, the cessation of depreciation, and the subsequent disposal.
Question 315
The five steps of the ASC 606 revenue model, in order, are:
Select an option first.
Correct answer: A — Identify the contract; identify the performance obligations; determine the transaction price; allocate the price; recognise revenue as each PO is satisfied
Explanation: ASC 606: (1) Identify the CONTRACT; (2) Identify the PERFORMANCE OBLIGATIONS; (3) Determine the TRANSACTION PRICE; (4) ALLOCATE the price to the POs on relative STANDALONE SELLING PRICE; (5) RECOGNISE revenue as each PO is satisfied. Step 4 is where most marks are lost — allocation is on standalone selling price, not on stated contract prices.
Question 316
Under ASC 606, the transaction price is allocated to performance obligations based on:
Select an option first.
Correct answer: D — RELATIVE STANDALONE SELLING PRICES
Explanation: Allocation is on RELATIVE STANDALONE SELLING PRICE — what the entity would charge for each good or service SEPARATELY. Contract-stated prices are NOT used, because a seller can allocate the price however it likes to accelerate revenue. Any discount is generally spread across all obligations unless it demonstrably relates to just one.
Question 317
Revenue is recognised OVER TIME if ANY of the following is met EXCEPT:
Select an option first.
Correct answer: C — The seller has physical possession of the goods
Explanation: The three over-time criteria are: (1) the customer simultaneously receives and consumes; (2) the customer controls the asset as it is created; (3) no alternative use PLUS an enforceable right to payment for work to date. PHYSICAL POSSESSION by the SELLER is an indicator that control has NOT transferred — it points toward point-in-time recognition, not over-time.
Question 318
Variable consideration is estimated using the EXPECTED VALUE method when:
Select an option first.
Correct answer: A — There are MANY possible outcomes
Explanation: EXPECTED VALUE (probability-weighted) is used when there are MANY possible outcomes — a volume rebate across a wide range. MOST LIKELY AMOUNT is used when there are essentially TWO outcomes (a performance bonus is either earned or it is not). Whichever method is used, the amount must then be CONSTRAINED to the amount highly probable not to reverse.
Question 319
A loss contingency is ACCRUED when it is:
Select an option first.
Correct answer: C — PROBABLE and reasonably ESTIMABLE
Explanation: Accrual requires BOTH: PROBABLE and reasonably ESTIMABLE. REASONABLY POSSIBLE → DISCLOSE only. REMOTE → nothing (except the DOG exceptions). Probable but NOT estimable → disclose, do not accrue.
Question 320
A GAIN contingency should be:
Select an option first.
Correct answer: D — NEVER accrued; disclosed only if probable, and recognised in income only when realised
Explanation: Gain contingencies are NEVER accrued — conservatism. They may be DISCLOSED if probable (with care not to imply realisation), and are recognised in income only when REALISED or legally certain. This asymmetry with LOSS contingencies (which ARE accrued when probable) is the entire point.
Question 321
The DOG exception requires disclosure of contingencies even when REMOTE. DOG stands for:
Select an option first.
Correct answer: D — Debt of others guaranteed; Obligations under standby letters of credit; Guarantees to repurchase receivables sold
Explanation: DOG: Debt of others Guaranteed; Obligations under standby letters of credit; Guarantees to repurchase receivables (AR) sold. These narrow exceptions require disclosure even when the likelihood is REMOTE, because guarantees are otherwise invisible on the balance sheet. Every OTHER remote contingency gets nothing at all.
Question 322
A PERMANENT difference between book and taxable income:
Select an option first.
Correct answer: B — Creates NO deferred tax asset or liability, because it never reverses
Explanation: A PERMANENT difference NEVER reverses, so it creates NO deferred tax. Examples: municipal bond interest, key-man life insurance proceeds and premiums, fines and penalties, 50% of meals, and the dividends-received deduction. Only TEMPORARY differences (which reverse) create DTAs and DTLs.
Question 323
Accelerated depreciation for TAX and straight-line for BOOK creates:
Select an option first.
Correct answer: D — A deferred tax LIABILITY
Explanation: Taking a LARGER deduction for tax NOW means you will pay MORE tax LATER — a future tax obligation, which is a deferred tax LIABILITY. The underlying rule: if you will pay MORE tax later, it is a DTL; if you will pay LESS later, it is a DTA. Derive it rather than memorising the table.
Question 324
A warranty expense recognised for BOOK now, but deductible for TAX only when the repair is performed, creates:
Select an option first.
Correct answer: A — A deferred tax ASSET
Explanation: The BOOK expense comes FIRST, the TAX deduction LATER — so you are paying MORE tax now and will pay LESS later. A future tax BENEFIT is a deferred tax ASSET. This is the mirror image of accelerated tax depreciation.
Question 325
Goodwill arising in a business combination is calculated as:
Select an option first.
Correct answer: A — Consideration transferred + FV of non-controlling interest + FV of previously held interest − FV of identifiable net assets
Explanation: Goodwill = Consideration transferred + FV of NCI + FV of any previously held interest − FV of IDENTIFIABLE net assets. Goodwill is the PLUG. Note the identifiable net assets are measured at FAIR VALUE, not book value.
Question 326
If the goodwill computation produces a NEGATIVE figure, the result is:
Select an option first.
Correct answer: A — A BARGAIN PURCHASE GAIN recognised in income immediately
Explanation: A negative figure is a BARGAIN PURCHASE GAIN, recognised in INCOME immediately — never a negative asset. Before recording it, the acquirer must REASSESS whether all assets and liabilities have been correctly identified and valued, because a genuine bargain purchase is rare and usually signals an error.
Question 327
Under the EQUITY METHOD, dividends received from the investee are:
Select an option first.
Correct answer: C — Recorded as a REDUCTION of the investment account
Explanation: Dividends REDUCE the investment account — they are a return OF the investment, not income. Income is recognised as the investor's SHARE of the investee's NET INCOME. Recording dividends as revenue is the single most common equity-method error, and it double-counts income.
Question 328
The equity method is generally applied when the investor holds:
Select an option first.
Correct answer: B — 20% to 50%, indicating significant influence
Explanation: Ownership of 20%–50% creates a PRESUMPTION of SIGNIFICANT INFLUENCE, triggering the equity method. Below 20% is generally a fair-value investment; above 50% means CONTROL and requires CONSOLIDATION. Note the presumption is rebuttable in both directions — the substance of influence governs, not the percentage alone.
Question 329
In consolidation, intercompany sales are eliminated because:
Select an option first.
Correct answer: B — A company cannot recognise profit by selling to itself; only transactions with OUTSIDE parties produce revenue for the group
Explanation: From the CONSOLIDATED GROUP's perspective, an intercompany sale simply moves inventory from one pocket to another — no revenue is earned until the goods are sold to an OUTSIDE party. The full intercompany sale is eliminated, along with any UNREALISED PROFIT remaining in goods STILL ON HAND at year-end.
Question 330
Fair value Level 1 inputs are:
Select an option first.
Correct answer: B — Quoted prices in ACTIVE markets for IDENTICAL assets or liabilities
Explanation: LEVEL 1 requires BOTH: quoted prices in an ACTIVE market AND for an IDENTICAL asset. A quoted price for a SIMILAR asset drops you to LEVEL 2. LEVEL 3 uses UNOBSERVABLE inputs — the entity's own models and assumptions — and is the least reliable.
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