CPA (FAR) Examination Test With Correct Answers.
1. Under ASC 606, describe the five-step model for revenue recognition.
Correct Answer: The five steps are: 1. Identify the contract with the customer; 2. Identify the
performance obligations in the contract; 3. Determine the transaction price; 4. Allocate the
transaction price to the performance obligations in the contract; and 5. Recognize revenue
when (or as) the entity satisfies a performance obligation.
2. Explain the difference between a "Finance Lease" and an "Operating Lease" for a lessee
under ASC 842.
Correct Answer: Both recognize a Right-of-Use (ROU) asset and a lease liability. A finance
lease recognizes interest expense and amortization separately (front-loaded expense). An
operating lease recognizes a single lease cost on a straight-line basis over the lease term. A
lease is "Finance" if it meets any of five criteria: ownership transfer, purchase option, term is
major part of life, PV is substantially all fair value, or specialized asset.
3. How should a company account for a change in accounting estimate?
Correct Answer: Changes in accounting estimates (e.g., changing the useful life of
equipment) are accounted for prospectively. This means the change affects the period of
change and future periods only. No restatement of prior periods or cumulative adjustment to
retained earnings is required.
4. Define "Cash Equivalents" according to US GAAP.
Correct Answer: Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and are so near their maturity (generally three
months or less from the date of purchase) that they present insignificant risk of changes in
value due to interest rate changes.
5. Describe the "Lower of Cost or Market" (LCM) method and which inventory valuation
methods use it.
Correct Answer: LCM is used for inventory valued using LIFO or the retail inventory method.
"Market" is defined as replacement cost, but it cannot exceed the "ceiling" (Net Realizable
Value) or be less than the "floor" (NRV minus a normal profit margin).
6. What are "Direct Response Advertising" costs, and when can they be capitalized?
Correct Answer: Most advertising is expensed as incurred. Direct response advertising can
be capitalized only if it results in probable future economic benefits (documented history of
responses) and the primary purpose is to elicit sales from customers who could be shown to
have responded specifically to the advertising.
7. Explain the "Equity Method" of accounting for investments.
Correct Answer: The equity method is used when an investor has "significant influence"
(usually 20-50% ownership). The investment is initially recorded at cost and subsequently
adjusted for the investor's share of the investee’s earnings (increases investment/income)
and dividends received (decreases investment/not income).
8. Define "Goodwill" and explain its impairment testing process.
Correct Answer: Goodwill is an intangible asset representing future economic benefits
arising from other assets acquired in a business combination that are not individually
, identified. It is not amortized but tested annually for impairment at the reporting unit level
by comparing the unit's fair value to its carrying amount.
9. What is "Comprehensive Income," and where is it reported?
Correct Answer: Comprehensive income is the change in equity from non-owner sources. It
consists of Net Income and Other Comprehensive Income (OCI). It must be reported either in
a single continuous statement of comprehensive income or in two separate but consecutive
statements.
10. Describe the criteria for "Research and Development" (R&D) cost capitalization.
Correct Answer: Under US GAAP, R&D costs must be expensed as incurred. Capitalization is
only permitted for materials, equipment, or facilities that have alternative future uses, or for
software development costs after technological feasibility is reached.
11. Explain "Subsequent Events" and the difference between Type I and Type II.
Correct Answer: Subsequent events occur after the balance sheet date but before financial
statements are issued. Type I (Recognized) events provide evidence of conditions existing at
the balance sheet date and require adjustment. Type II (Non-recognized) events provide
evidence of conditions that arose after the balance sheet date and require disclosure only.
12. How is the "Weighted Average Number of Common Shares Outstanding" calculated for EPS?
Correct Answer: It is the number of shares outstanding during the period, weighted by the
fraction of the period they were outstanding. Stock dividends and splits are treated as if they
occurred at the beginning of the earliest period presented (retroactive adjustment).
13. Describe the "Fair Value Hierarchy" levels.
Correct Answer: Level 1: Quoted prices in active markets for identical assets; Level 2:
Observable inputs other than Level 1 (e.g., similar assets); Level 3: Unobservable inputs
reflecting the entity's own assumptions.
14. What are "Asset Retirement Obligations" (ARO), and how are they recorded?
Correct Answer: An ARO is a legal obligation associated with the retirement of a tangible
long-lived asset. It is recorded at fair value as a liability and an increase to the asset's carrying
value. The liability is increased over time via accretion expense, and the asset is depreciated.
15. Distinguish between "Monetary" and "Non-monetary" items in foreign currency translation.
Correct Answer: Monetary items are assets or liabilities to be received or paid in a fixed
number of currency units (e.g., cash, receivables, payables). Non-monetary items are those
without a fixed currency amount (e.g., inventory, PPE, common stock).
16. What is the "Temporal Method" of foreign currency translation?
Correct Answer: Used when the functional currency is the USD. Monetary items are
translated at the current rate; non-monetary items are translated at historical rates.
Translation gains/losses are reported in the Income Statement.
17. Describe the "Direct Method" for the Statement of Cash Flows.
Correct Answer: It reports major classes of gross cash receipts and payments (e.g., cash from
customers, cash to suppliers). If used, a reconciliation of net income to net cash flow from
operations must also be provided.
18. Explain the "Impairment of Long-Lived Assets" two-step test.
Correct Answer: Step 1 (Recoverability Test): Compare the carrying amount to the sum of
1. Under ASC 606, describe the five-step model for revenue recognition.
Correct Answer: The five steps are: 1. Identify the contract with the customer; 2. Identify the
performance obligations in the contract; 3. Determine the transaction price; 4. Allocate the
transaction price to the performance obligations in the contract; and 5. Recognize revenue
when (or as) the entity satisfies a performance obligation.
2. Explain the difference between a "Finance Lease" and an "Operating Lease" for a lessee
under ASC 842.
Correct Answer: Both recognize a Right-of-Use (ROU) asset and a lease liability. A finance
lease recognizes interest expense and amortization separately (front-loaded expense). An
operating lease recognizes a single lease cost on a straight-line basis over the lease term. A
lease is "Finance" if it meets any of five criteria: ownership transfer, purchase option, term is
major part of life, PV is substantially all fair value, or specialized asset.
3. How should a company account for a change in accounting estimate?
Correct Answer: Changes in accounting estimates (e.g., changing the useful life of
equipment) are accounted for prospectively. This means the change affects the period of
change and future periods only. No restatement of prior periods or cumulative adjustment to
retained earnings is required.
4. Define "Cash Equivalents" according to US GAAP.
Correct Answer: Cash equivalents are short-term, highly liquid investments that are readily
convertible to known amounts of cash and are so near their maturity (generally three
months or less from the date of purchase) that they present insignificant risk of changes in
value due to interest rate changes.
5. Describe the "Lower of Cost or Market" (LCM) method and which inventory valuation
methods use it.
Correct Answer: LCM is used for inventory valued using LIFO or the retail inventory method.
"Market" is defined as replacement cost, but it cannot exceed the "ceiling" (Net Realizable
Value) or be less than the "floor" (NRV minus a normal profit margin).
6. What are "Direct Response Advertising" costs, and when can they be capitalized?
Correct Answer: Most advertising is expensed as incurred. Direct response advertising can
be capitalized only if it results in probable future economic benefits (documented history of
responses) and the primary purpose is to elicit sales from customers who could be shown to
have responded specifically to the advertising.
7. Explain the "Equity Method" of accounting for investments.
Correct Answer: The equity method is used when an investor has "significant influence"
(usually 20-50% ownership). The investment is initially recorded at cost and subsequently
adjusted for the investor's share of the investee’s earnings (increases investment/income)
and dividends received (decreases investment/not income).
8. Define "Goodwill" and explain its impairment testing process.
Correct Answer: Goodwill is an intangible asset representing future economic benefits
arising from other assets acquired in a business combination that are not individually
, identified. It is not amortized but tested annually for impairment at the reporting unit level
by comparing the unit's fair value to its carrying amount.
9. What is "Comprehensive Income," and where is it reported?
Correct Answer: Comprehensive income is the change in equity from non-owner sources. It
consists of Net Income and Other Comprehensive Income (OCI). It must be reported either in
a single continuous statement of comprehensive income or in two separate but consecutive
statements.
10. Describe the criteria for "Research and Development" (R&D) cost capitalization.
Correct Answer: Under US GAAP, R&D costs must be expensed as incurred. Capitalization is
only permitted for materials, equipment, or facilities that have alternative future uses, or for
software development costs after technological feasibility is reached.
11. Explain "Subsequent Events" and the difference between Type I and Type II.
Correct Answer: Subsequent events occur after the balance sheet date but before financial
statements are issued. Type I (Recognized) events provide evidence of conditions existing at
the balance sheet date and require adjustment. Type II (Non-recognized) events provide
evidence of conditions that arose after the balance sheet date and require disclosure only.
12. How is the "Weighted Average Number of Common Shares Outstanding" calculated for EPS?
Correct Answer: It is the number of shares outstanding during the period, weighted by the
fraction of the period they were outstanding. Stock dividends and splits are treated as if they
occurred at the beginning of the earliest period presented (retroactive adjustment).
13. Describe the "Fair Value Hierarchy" levels.
Correct Answer: Level 1: Quoted prices in active markets for identical assets; Level 2:
Observable inputs other than Level 1 (e.g., similar assets); Level 3: Unobservable inputs
reflecting the entity's own assumptions.
14. What are "Asset Retirement Obligations" (ARO), and how are they recorded?
Correct Answer: An ARO is a legal obligation associated with the retirement of a tangible
long-lived asset. It is recorded at fair value as a liability and an increase to the asset's carrying
value. The liability is increased over time via accretion expense, and the asset is depreciated.
15. Distinguish between "Monetary" and "Non-monetary" items in foreign currency translation.
Correct Answer: Monetary items are assets or liabilities to be received or paid in a fixed
number of currency units (e.g., cash, receivables, payables). Non-monetary items are those
without a fixed currency amount (e.g., inventory, PPE, common stock).
16. What is the "Temporal Method" of foreign currency translation?
Correct Answer: Used when the functional currency is the USD. Monetary items are
translated at the current rate; non-monetary items are translated at historical rates.
Translation gains/losses are reported in the Income Statement.
17. Describe the "Direct Method" for the Statement of Cash Flows.
Correct Answer: It reports major classes of gross cash receipts and payments (e.g., cash from
customers, cash to suppliers). If used, a reconciliation of net income to net cash flow from
operations must also be provided.
18. Explain the "Impairment of Long-Lived Assets" two-step test.
Correct Answer: Step 1 (Recoverability Test): Compare the carrying amount to the sum of
