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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 481
A cash flow hedge of a forecasted sale has a $40,000 gain deferred in AOCI. The forecasted sale occurs and the inventory is delivered. The $40,000 should be:
Select an option first.
Correct answer: C — RECLASSIFIED from AOCI to EARNINGS when the forecasted sale affects earnings — i.e. when the revenue is recognised
Explanation: The deferred amount is reclassified from AOCI to EARNINGS when the HEDGED ITEM affects earnings. For a forecasted SALE, that is when the REVENUE is recognised. The matching this achieves is the entire purpose of cash flow hedge accounting — the hedge gain lands in the same period as the transaction it was protecting.
Question 482
An entity acquires a business and, within the measurement period, discovers that a liability existing at the acquisition date was understated by $300,000. It should:
Select an option first.
Correct answer: C — Increase the liability and increase GOODWILL by $300,000, with retrospective adjustment of comparatives
Explanation: A MEASUREMENT PERIOD adjustment reflects new information about facts that EXISTED AT the acquisition date. It is recorded RETROSPECTIVELY by adjusting GOODWILL (not earnings), with comparative information revised. Only changes arising from events AFTER the acquisition date go to earnings. The measurement period ends at the earlier of one year, or when the acquirer obtains the information it sought.
Question 483
A company sells a building for $900,000 (book value $700,000) and leases it back for 3 years. The leaseback payments are at MARKET rates and control transfers. It recognises:
Select an option first.
Correct answer: B — A $200,000 gain immediately, and accounts for the leaseback as a separate lease
Explanation: Because the transfer QUALIFIES as a sale (control transferred) and the leaseback is at MARKET rates, the seller-lessee recognises the FULL $200,000 gain immediately and accounts for the leaseback as a separate lease. (If the payments were OFF-market, an adjustment would be required, treating the difference as prepaid rent or additional financing.) The pre-842 deferral (option B) is gone.
Question 484
A company owns 100% of a foreign sub whose functional currency is the local currency. It sells the sub. The CTA accumulated in AOCI must be:
Select an option first.
Correct answer: A — RECLASSIFIED to NET INCOME as part of the gain or loss on sale
Explanation: On SALE or SUBSTANTIAL LIQUIDATION of a foreign subsidiary, the accumulated CTA in AOCI is RECLASSIFIED to NET INCOME as part of the gain or loss on disposal. Until then it accumulates in equity, sometimes for decades. This is a classic 'recycling' item — and a reason reported disposal gains can differ sharply from the cash economics.
Question 485
A company grants share options with a PERFORMANCE condition (an EPS target). The target is NOT met and the options are forfeited. Cumulative compensation cost previously recognised should be:
Select an option first.
Correct answer: C — REVERSED — no compensation cost is recognised for awards with a PERFORMANCE condition that is not satisfied
Explanation: For a PERFORMANCE condition (an EPS or revenue target), compensation cost is recognised only if the condition is expected to be — and ultimately is — MET. If it is NOT met, previously recognised cost is REVERSED. This is the SHARP contrast with a MARKET condition (a share-price target), where cost is recognised even if the condition is never achieved, because the market condition was priced into the grant-date fair value.
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Question 486
An entity determines that a contract with a customer contains a significant financing component: the customer pays $1,000,000 two years after delivery, and the appropriate discount rate is 6%. Revenue recognised at delivery is approximately:
Select an option first.
Correct answer: D — $890,000 (the CASH SELLING PRICE), with the $110,000 difference recognised as INTEREST INCOME over the two years
Explanation: With a significant financing component, revenue is measured at the CASH SELLING PRICE: $1,000,000 / (1.06)² = $890,000. The remaining $110,000 is recognised as INTEREST INCOME over the two years — not as revenue. Recognising the full $1,000,000 as revenue (option A) would overstate revenue and omit the financing income entirely.
Question 487
A parent sells equipment to its 90%-owned subsidiary for $500,000 (book value $400,000, 5-year remaining life, straight-line). In the FIRST year of consolidation, the eliminations reduce consolidated net income by:
Select an option first.
Correct answer: C — $80,000 — eliminate the $100,000 gain but reverse $20,000 of excess depreciation
Explanation: Two adjustments. (1) ELIMINATE the $100,000 unrealised gain (reducing income). (2) The sub now depreciates the WRITTEN-UP amount, so EXCESS depreciation of $100,000/5 = $20,000 must be REVERSED (increasing income). Net effect = $100,000 − $20,000 = $80,000 REDUCTION. The excess depreciation progressively 'realises' the deferred gain over the asset's remaining life.
Question 488
An entity elects the FAIR VALUE OPTION for an available-for-sale debt security. The effect is that unrealised gains and losses are reported in:
Select an option first.
Correct answer: B — NET INCOME — the fair value option overrides the default AFS treatment
Explanation: Electing the FAIR VALUE OPTION means the instrument is measured at fair value with ALL changes flowing through NET INCOME — overriding the default AFS (OCI) treatment. The election is IRREVOCABLE, made instrument by instrument at initial recognition, and its principal use is to avoid an accounting mismatch when a related item is already measured at fair value through earnings.
Question 489
An entity has a $2,000,000 NOL carryforward (post-2017) and expects $1,500,000 of taxable income next year. The tax rate is 21%. The NOL deduction available next year is:
Select an option first.
Correct answer: B — $1,200,000 — post-2017 NOL usage is limited to 80% of taxable income
Explanation: Post-2017 NOLs carry forward INDEFINITELY but the deduction is LIMITED TO 80% of taxable income: 80% × $1,500,000 = $1,200,000. The entity pays tax on the remaining $300,000. The unused $800,000 of NOL carries forward indefinitely. Fully offsetting income (option C) applies the pre-2018 rules.
Question 490
A company has both a deferred tax asset from an NOL ($400,000 at 21% = $84,000 DTA) and a deferred tax liability from depreciation ($600,000 at 21% = $126,000 DTL). It concludes a 30% valuation allowance is needed on the DTA. The NET deferred tax reported is:
Select an option first.
Correct answer: C — $67,200 net liability
Explanation: DTA = $84,000. Valuation allowance = 30% × $84,000 = $25,200. Net DTA = $58,800. DTL = $126,000. Same jurisdiction, so NET: $126,000 − $58,800 = $67,200 NET DEFERRED TAX LIABILITY. Three concepts chain here: measurement, the valuation allowance, and the netting requirement.
Question 491
An entity has a contract asset of $200,000 and a contract liability of $150,000 from the SAME contract. On the balance sheet it should present:
Select an option first.
Correct answer: B — A NET contract asset of $50,000 — assets and liabilities from the SAME contract are presented net
Explanation: Rights and obligations from the SAME CONTRACT are combined and presented NET — as either a single contract ASSET or a single contract LIABILITY. Here, $200,000 − $150,000 = a $50,000 net CONTRACT ASSET. Positions from DIFFERENT contracts are NOT offset against each other, which is the boundary of the rule.
Question 492
A company issues 10,000 shares of $1 par common stock and 5,000 shares of preferred, together for a lump sum of $400,000. The fair values are $30 per common and $50 per preferred. Amount allocated to COMMON is:
Select an option first.
Correct answer: C — $218,182
Explanation: Allocate on RELATIVE FAIR VALUES. Common FV = 10,000 × $30 = $300,000. Preferred FV = 5,000 × $50 = $250,000. Total = $550,000. Common's share = $300,000/$550,000 = 54.55%. Allocation = 54.55% × $400,000 = $218,182. (Common Stock is credited $10,000 at par; APIC gets $208,182.)
Question 493
An entity determines its warranty is a SERVICE-type warranty and allocates $30,000 to it, to be recognised over 3 years. In Year 1 it also incurs $8,000 of ACTUAL warranty costs. Year 1 income statement shows:
Select an option first.
Correct answer: B — $10,000 of warranty REVENUE and $8,000 of warranty EXPENSE — a service-type warranty is a performance obligation (revenue), and the costs are expensed as incurred
Explanation: A SERVICE-type warranty is a separate PERFORMANCE OBLIGATION, so the allocated $30,000 is recognised as REVENUE over the 3-year coverage period ($10,000 in Year 1). The ACTUAL costs of $8,000 are expensed as INCURRED. Contrast an ASSURANCE-type warranty, which produces NO revenue — only an accrued liability at the time of sale.
Question 494
A VIE has equity of $500,000 and total assets of $10,000,000. Investor A holds 5% of the equity but has the power to direct the VIE's key activities and absorbs the majority of expected losses. Investor B holds 90% of the equity but has no decision-making rights. The VIE is consolidated by:
Select an option first.
Correct answer: D — Investor A — the PRIMARY BENEFICIARY has POWER over the key activities AND exposure to significant losses/benefits; equity percentage is not determinative
Explanation: The VIE model deliberately DECOUPLES consolidation from equity ownership. The PRIMARY BENEFICIARY consolidates: the party with the POWER to direct the activities that most significantly affect economic performance AND the obligation to absorb losses or right to receive benefits that could be significant. Investor A meets both criteria despite holding only 5%. This is exactly the structure the VIE rules were written to catch.
Question 495
A company acquires a group of assets (not a business) for $2,000,000. The identifiable assets have fair values totalling $2,200,000. Transaction costs are $50,000. The assets are recorded at:
Select an option first.
Correct answer: C — $2,050,000, ALLOCATED PRO RATA to the identifiable assets based on relative fair values — an asset acquisition produces NO goodwill and NO bargain purchase gain
Explanation: In an ASSET ACQUISITION (not a business combination), transaction costs are CAPITALISED: total cost = $2,000,000 + $50,000 = $2,050,000. That amount is ALLOCATED PRO RATA to the identifiable assets on relative fair values. NO goodwill and NO bargain purchase gain arise — those concepts exist only in a BUSINESS COMBINATION, where transaction costs are instead EXPENSED. Two rules invert between the two scenarios.
Question 496
An entity capitalises $120,000 of contract acquisition costs. The related contract is subsequently determined to be IMPAIRED: the remaining consideration exceeds the remaining costs by only $40,000. The entity should:
Select an option first.
Correct answer: C — Recognise an IMPAIRMENT LOSS of $80,000, writing the asset down to the recoverable amount of $40,000
Explanation: Capitalised contract costs are tested for IMPAIRMENT: the carrying amount ($120,000) is compared with the REMAINING consideration expected, LESS the remaining costs to deliver ($40,000). The excess of $80,000 is recognised as an IMPAIRMENT LOSS. (Note the impairment CAN be reversed if conditions improve — an unusual feature, since most US GAAP impairments cannot be.)
Question 497
A company has a firm purchase commitment to buy 10,000 units at $50 each. At year-end the market price has fallen to $42. The company should:
Select an option first.
Correct answer: A — Recognise a LOSS of $80,000 on the onerous purchase commitment, with a corresponding liability
Explanation: A firm, non-cancellable purchase commitment at a price ABOVE market is an ONEROUS contract. The LOSS is recognised NOW: 10,000 × ($50 − $42) = $80,000, with a corresponding LIABILITY (estimated loss on purchase commitment). This is a direct application of conservatism — losses are recognised when probable, even before the goods arrive.
Question 498
An entity acquires 100% of a target in a BUSINESS COMBINATION. It incurs $200,000 of legal and advisory fees and $150,000 of costs to ISSUE the equity used as consideration. These costs are:
Select an option first.
Correct answer: C — $200,000 EXPENSED as incurred; $150,000 charged AGAINST APIC as equity issuance costs
Explanation: Two different rules apply to two different costs. ACQUISITION-RELATED costs (legal, advisory, due diligence) are EXPENSED as incurred. Costs to ISSUE EQUITY as consideration are charged AGAINST APIC (a reduction of the proceeds). Neither increases goodwill. (Costs to issue DEBT would instead be netted against the debt's carrying amount.)
Question 499
A company acquires 30% of an investee for $3,000,000. The investee's net assets have a book value of $8,000,000 and a fair value of $9,000,000, the $1,000,000 difference relating to depreciable assets with a 10-year remaining life. The investee reports net income of $600,000. The investor's equity-method income is:
Select an option first.
Correct answer: A — $150,000 — $180,000 share of income, LESS $30,000 amortisation of the fair-value differential
Explanation: Share of income = 30% × $600,000 = $180,000. But the investor paid for a fair value ABOVE book value: its share of the differential = 30% × $1,000,000 = $300,000, amortised over 10 years = $30,000 per year, which REDUCES equity-method income. Equity-method income = $180,000 − $30,000 = $150,000. (Goodwill within the purchase price — here $3,000,000 − 30% × $9,000,000 = $300,000 — is NOT amortised.)
Question 500
An entity uses cost-to-cost. Contract price $8,000,000. Costs incurred $2,400,000, INCLUDING $400,000 of uninstalled materials whose control has transferred. Total estimated costs $6,000,000 (including that $400,000). Revenue recognised is:
Select an option first.
Correct answer: B — $3,114,000 — exclude the uninstalled materials from the progress ratio, then ADD BACK their cost at ZERO margin
Explanation: UNINSTALLED materials would otherwise inflate the percentage complete. Progress = ($2,400,000 - $400,000) / ($6,000,000 - $400,000) = $2,000,000 / $5,600,000 = 35.714%. Revenue on the ADJUSTED contract = 35.714% x ($8,000,000 - $400,000) = $2,714,286. Then ADD BACK the uninstalled materials at ZERO margin: + $400,000 = $3,114,286. Including them in the ratio unadjusted gives 40% x $8,000,000 = $3,200,000 (option A) — which improperly recognises PROFIT on goods not yet installed.
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