2013 Far MCQ

2013 AICPA Newly Released Questions Financial
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Following are multiple choice questions and simulations recently released by the
AICPA. These questions were released by the AICPA with letter answers only. Our
editorial board has provided the accompanying explanation.
Please note that the AICPA generally releases questions that it does NOT intend to use
again. These questions and content may or may not be representative of questions you
may see on any upcoming exams.

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AICPA QUESTIONS RATED MODERATE DIFFICULTY

1. CPA-08234
A company has a 22% investment in another company that it accounts for using the equity method.
Which of the following disclosures should be included in the company's annual financial statements?
a. The names and ownership percentages of the other stockholders in the investee company.
b. The reason for the company's decision to invest in the investee company.
c. The company's accounting policy for the investment.
d. Whether the investee company is involved in any litigation.

Solution:
Choice "c" is correct. A company owning a 22% investment in another company in which the investment
is accounted for using the equity method is considered as having "significant influence" over the company
and is required to disclose the company's accounting policy for the investment.
Choices "a", "b", and "d" are incorrect. A company owning a 22% investment in another company in
which the investment is accounted for using the equity method is not required to make any of the listed
disclosures.

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2. CPA-08235
In the financial statements of employee benefit pension plans and trusts, the plan investments are
reported at:
a. Fair value.
b. Historical cost.
c. Net realizable value.
d. Lower of historical cost or market.

Solution:
Choice "a" is correct. In the financial statements of employee benefit pension plans and trusts, the plan
investments must be reported at fair value.
Choice "b" is incorrect. In the financial statements of employee benefit pension plans and trusts, the plan
investments must be reported at fair value, not historical cost.
Choice "c" is incorrect. In the financial statements of employee benefit pension plans and trusts, the plan
investments must be reported at fair value, not net realizable value.
Choice "d" is incorrect. In the financial statements of employee benefit pension plans and trusts, the plan
investments must be reported at fair value, not the lower of historical cost or market.

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3. CPA-08236
An entity authorized 500,000 shares of common stock. At J anuary 1, Year 2, the entity had 110,000
shares of common stock issued and 100,000 shares of common stock outstanding. The entity had the
following transactions in Year 2:
March 1 Issued 15,000 shares of common stock
J une 1 Resold 2,500 shares of treasury stock
September 1 Completed a 2-for-1 common stock split
What is the total number of shares of common stock that the entity has outstanding at the end of Year 2?
a. 117,500
b. 230,000
c. 235,000
d. 250,000

Solution:
Choice "c" is correct. When treasury stock is resold, the stock is regarded as outstanding because after
the resale, the stock becomes stock held by shareholders other than the corporation itself. Prior to the
stock split on September 1, the entity will have 117,500 shares of common stock outstanding, which is
calculated as follows: 100,000 of common stock outstanding on J anuary 1, plus the issuance of 15,000
shares of common stock on March 1, plus the resale of 2,500 of treasury shares on J une 1. The stock
split doubles the number of outstanding shares (117,500) to 235,000, which would be the number of
shares outstanding at the end of Year 2.
Choice "a" is incorrect. The 2-for-1 common stock split stock split on September 1 would result in the
outstanding shares of 117,500 being increased to 235,000 shares of common stock outstanding.
Choice "b" is incorrect. Once treasury stock is resold, it is considered as outstanding because it is owned
by shareholders others than the corporation itself. The 2,500 shares of resold treasury stock is also part
of the 2-for-1 common stock split.
Choice "d" is incorrect. The 2-for-1 common stock split is based on outstanding shares. Before the stock
split, there are 100,000 outstanding shares plus the 15,000 of issued shares plus 2,500 of resold treasury
shares, which equals 117,500. After the 2-for-1 common stock split on outstanding shares, the total
number of outstanding shares of common stock is 235,000, not 250,000.

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4. CPA-08237
On J anuary 1, Year 1, Alpha Co. signed an annual maintenance agreement with a software provider for
$15,000 and the maintenance period begins on March 1, Year 1. Alpha also incurred $5,000 of costs on
J anuary 1, Year 1, related to software modification requests that will increase the functionality of the
software. Alpha depreciates and amortizes its computer and software assets over five years using the
straight-line method. What amount is the total expense that Alpha should recognize related to the
maintenance agreement and the software modifications for the year ended December 31, Year 1?
a. $5,000
b. $13,500
c. $16,000
d. $20,000

Solution:
Choice "b" is correct. The software maintenance costs are expensed, and the software modification costs
are capitalized and amortized using the straight line method over five years. Thus, the total expense that
Alpha should recognize related to the maintenance agreement and the software modifications for the year
ended December 31, Year 1, will be an expense related to the software maintenance cost in the amount
of $12,500 ($15,000 / 12 =$1,250 per month x 10 months) plus amortization expense of $1,000 ($5,000 /
5 years =$1,000 per year).
Choice "a" is incorrect. The software modification costs must be capitalized and amortized using the
straight line method over a five year period. Additionally, the software maintenance costs only associated
with Year 1 will be expensed in Year 1.
Choice "c" is incorrect. The entire amount of software maintenance costs ($15,000) cannot be expensed
in Year 1 because the maintenance period begins on March 1. Total expense related to the maintenance
agreement and the software modifications for the year ended December 31, Year 1, will include the
amortization expense of $1,000 and 10 months of expense related to the software maintenance contract,
which is $12,500 and not the entire expense of $15,000.
Choice "d" is incorrect. All of the software maintenance expenses and software modification costs
($20,000) cannot be expensed in Year 1. Only 10 months of software maintenance costs can be taken in
Year 1, since the maintenance period began on March 1; one year of amortization expense can be taken
in Year 1 on the software modification costs.

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5. CPA-08238
On October 31, Year 1, a company with a calendar year-end paid $90,000 for services that will be
performed evenly over a six-month period from November 1, Year 1, through April 30, Year 2. The
company expensed the $90,000 cash payment in October, Year 1, to its services expense general ledger
account. The company did not record any additional journal entries in Year 1 related to the payment.
What is the adjusting journal entry that the company should record to properly report the prepayment in
its Year 1 financial statements?
a. Debit prepaid services and credit services expense for $30,000.
b. Debit prepaid services and credit services expense for $60,000.
c. Debit services expense and credit prepaid services for $30,000.
d. Debit services expense and credit prepaid services for $60,000.

Solution:
Choice "b" is correct. When the cash payment was made, the company debited services expense for
$90,000. The amount which will be expensed each month over the six month period is $15,000.
Therefore, at the end of Year 1, the total correct expense for November ($15,000) and December
($15,000) would be $30,000. The expense for the next year is $60,000 (4 months x $15,000). The
adjusting journal entry to ensure the expense account and prepaid accounts are stated correctly is the
following:
Debit Credit
Prepaid services 60,000
Services expense 60,000
Choice "a" is incorrect. Debiting prepaid services for $30,000 and crediting services expense for $30,000
would result in an overstatement of the services expense and understatement of prepaid services for
Year 1.
Choice "c" and "d" are incorrect. The adjusting journal entry must include a debit to prepaid services and
credit to services expense to correctly adjust the services expense account and reflect the prepaid
services asset for Year 2.

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6. CPA-08239
Which of the following statements is correct as it relates to changes in accounting estimates?
a. Most changes in accounting estimates are accounted for retrospectively.
b. Whenever it is impossible to determine whether a change in an estimate or a change in accounting
principle occurred, the change should be considered a change in principle.
c. Whenever it is impossible to determine whether a change in accounting estimate or a change in
accounting principle has occurred, the change should be considered a change in estimate.
d. It is easier to differentiate between a change in accounting estimate and a change in accounting
principle than it is to differentiate between a change in accounting estimate and a correction of an
error.

Solution:
Choice "c" is correct. If a change in accounting estimate cannot be distinguished from a change in
accounting principle, the change is considered a change in accounting estimate treated as a change in
accounting principle and is accounted for prospectively.
Choice "a" is incorrect. Changes in accounting estimates are accounted for prospectively, not
retrospectively.
Choice "b" is incorrect. If a change in accounting estimate cannot be distinguished from a change in
accounting principle, the change is considered a change in estimate.
Choice "d" is incorrect. Differentiating between a change in accounting estimate and a change in
accounting principle is more difficult than differentiating between a change in accounting estimate and a
correction of an error, because a change can be essentially both a change in accounting estimate and a
change in accounting principle. An example of this situation is a change in depreciation method. It is a
change in accounting principle, but also a change in the estimated future benefits of the asset.

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7. CPA-08254
A company is preparing its year-end cash flow statement using the indirect method. During the year, the
following transactions occurred:
Dividends paid $300
Proceeds from the issuance of common stock 250
Borrowings under a line of credit 200
Proceeds from the issuance of convertible bonds 100
Proceeds from the sale of a building 150
What is the company's increase in cash flows provided by financing activities for the year?
a. $50
b. $150
c. $250
d. $550

Solution:
Choice "c" is correct. The company's increase in cash flows provided by financing activities when using
the indirect method for the year-end cash flow statement is calculated as follows:
Dividends paid (represents decrease in cash flow) $(300)
Proceeds from the issuance of common stock (represents increase in cash flow) 250
Borrowings under a line of credit (represents increase in cash flow) 200
Proceeds from the issuance of convertible bonds (represents increase in cash flow) 100
Company's increase in cash flows provided by financing activities for the year $250
Choice "a" is incorrect. This incorrect answer ignores the cash from the line of credit.
Choice "b" is incorrect. Proceeds from the sale of the building would be included in the investing section
of the year-end statement of cash flows using the indirect method.
Choice "d" is incorrect. This answer ignores the payment of dividends, which is a cash outflow.

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8. CPA-08255
King Inc. owns 70% of Simmon Co.'s outstanding common stock. King's liabilities total $450,000, and
Simmon's liabilities total $200,000. Included in Simmon's financial statements is a $100,000 note payable
to King. What amount of total liabilities should be reported in the consolidated financial statements?
a. $520,000
b. $550,000
c. $590,000
d. $650,000

Solution:
Choice "b" is correct. Because King owns 70% of Simmon Co.'s outstanding stock, King is regarded as
having a controllable interest in Simmon Co. The total liabilities reported in the consolidated financial
statements would be $550,000, which represents King's total liabilities of $450,000 and $100,000 of
Simmon's liabilities, reflecting Simmon's total liabilities of $200,000 less the $100,000 note payable to
King. Simmon's $100,000 note payable to King would be eliminated in the consolidated financial
statements because the transaction would lack the criteria of being at arm's length.
Choice "a" is incorrect. Because King and Simmon are required to consolidate, the entire amount of non-
intercompany liabilities of $100,000 will be included in the consolidated financial statements, not just 70%
of the non-intercompany liabilities.
Choice "c" is incorrect. This incorrect answer is derived by adding $450,000 plus 70% of $100,000, which
is incorrect based on the above explanation.
Choice "d" is incorrect. $650,000 is the sum of $450,000 plus the $200,000. However, the $100,000 note
payable to King must be eliminated in the consolidated financial statements because the transaction
would lack the criteria of being at arm's length. A company cannot owe itself.

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9. CPA-08256
A company should recognize goodwill in its balance sheet at which of the following points?
a. Costs have been incurred in the development of goodwill.
b. Goodwill has been created in the purchase of a business.
c. The company expects a future benefit from the creation of goodwill.
d. The fair market value of the company's assets exceeds the book value of the company's assets.

Solution:
Choice "b" is correct. Goodwill is recognized in the balance sheet when it has been created from a
business acquisition.
Choice "a" is incorrect. Costs associated with developing goodwill are not capitalized.
Choice "c" is incorrect. The company does not recognize goodwill in its balance sheet because it expects
a future benefit from the creation of goodwill.
Choice "d" is incorrect. Under the acquisition method, goodwill is a representation of an acquired
company's fair value over the fair value of the entity's net assets and is not recognized solely because
the fair market value of a company's assets exceeds the book value of the company's assets.

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10. CPA-08257
Hemple Co. maintains escrow accounts for various mortgage companies. Hemple collects the receipts
and pays the bills on behalf of the customers. Hemple holds the escrow monies in interest-bearing
accounts. They charge a 10% maintenance fee to the customers based on interest earned. Hemple
reported the following account data:
Escrow liability beginning of year $500,000
Escrow receipts during the year 1,200,000
Real estate taxes paid during the year 1,450,000
Interest earned during the year 40,000
What amount represents the escrow liability balance on Hemple's books?
a. $290,000
b. $286,000
c. $214,000
d. $210,000

Solution:
Choice "b" is correct. The escrow liability balance will be calculated as follows:
Escrow Liability
Debit Credit

500,000 Beginning balance
1,200,000 Escrow receipts during
the year
1,450,000 Real estate taxes paid
40,000 Interest earned during
the year
4,000 Maintenance fee
charged to customers
($40,000 x 10%)
286,000 Escrow liability balance
on Hemple's books
Choice "a" is incorrect. The escrow liability balance should reflect a reduction for the $4,000 maintenance
fee charged to customers, which is calculated as 10% x $40,000 (interest earned during the year).
Choice "c" is incorrect. The maintenance fee of $4,000 represents a decrease in the liability and not an
increase in the liability. Also, the $40,000 is an increase, not a decrease.
Choice "d" is incorrect. The interest of $40,000 increases the liability balance rather than decreasing it,
and the maintenance fee charged to customers of $4,000 decreases the liability balance. This answer
uses the $40,000 as a decrease and ignores the $4,000.

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11. CPA-08258
A shoe retailer allows customers to return shoes within 90 days of purchase. The company estimates
that 5% of sales will be returned within the 90-day period. During the month, the company has sales of
$200,000 and returns of sales made in prior months of $5,000. What amount should the company record
as net sales revenue for new sales made during the month?
a. $185,000
b. $190,000
c. $195,000
d. $200,000

Solution:
Choice "b" is correct. The company should record net sales revenue for new sales made during the
month as $190,000, which represents $200,000 less the estimated allowance for sales returns associated
with the new sales of $10,000 (5% x $200,000).
Choice "a" is incorrect. The returns of sales made in prior months of $5,000 would not be included in the
calculation of net sales revenue for new sales.
Choice "c" is incorrect. When calculating the net sales revenue for new sales during the month, the return
of sales made in prior months of $5,000 would not be included in the calculation.
Choice "d" is incorrect. Net sales revenue of $200,000 would need to be adjusted for the estimated
returns within 90 days.

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12. CPA-08259
A company sponsors two defined benefit pension plans. The following information relates to the plans at
year-end:
Plan A Plan B
Fair value of plan assets $ 800,000 $1,000,000
Projected benefit obligation 1,000,000 700,000
What amount(s) should the company report in its balance sheet related to the plans?
a. Liability of $200,000; asset of $300,000.
b. Asset of $100,000.
c. Asset of $1,800,000; liability of $1,700,000.
d. Liability of $100,000.

Solution:
Choice "a" is correct. If a company has multiple defined benefit pension plans, the funded status of each
plan is calculated separately. Plan A has an underfunded status because the PBO is greater than the fair
value of the plan assets. Plan A's net underfunded balance in the amount of $200,000 (fair value of
pension assets of $800,000 less the projected benefit obligation of $1,000,000) is reported as a liability.
Plan B's positive funded balance of $300,000 (fair value of pensions assets of $1,000,000 less the
projected benefit obligation of $700,000) is reported as an asset.
Choice "b" is incorrect. The funded status of each plan must be calculated separately. Whereas all
overfunded pension plans can be aggregated and reported as a pension benefit asset and all
underfunded plans can be aggregated and reported as a pension benefit liability, overfunded and
underfunded plans cannot be aggregated for reporting purposes. An asset of $100,000 is incorrect
because it is netting the ending funding status of Plan A of $300,000 (pension benefit) and the ending
fund status of Plan B of $200,000 (pension liability).
Choice "c" is incorrect. The PBO must be subtracted from the fair value of the plan assets to calculate
the ending funded status.
Choice "d" is incorrect. The funded status of each plan must be calculated separately. Whereas all
overfunded pension plans can be aggregated and reported as a pension benefit asset and all
underfunded plans can be aggregated and reported as a pension benefit liability, overfunded and
underfunded plans cannot be aggregated for reporting purposes.

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13. CPA-08260
An overfunded single-employer defined benefit postretirement plan should be recognized in a classified
statement of financial position as a:
a. Noncurrent liability.
b. Current liability.
c. Noncurrent asset.
d. Current asset.

Solution:
Choice "c" is correct. Overfunded pension plans, which represent that the fair value of the plan assets is
greater than the projected benefit obligation, are reported as a noncurrent asset for balance sheet
reporting purposes.
Choice "a" is incorrect. Overfunded pension plans are not reported as a noncurrent liability for balance
sheet reporting purposes, however, an underfunded pension plan may be reported as a noncurrent
liability, a current liability, or both.
Choice "b" is incorrect. Overfunded pension plans are not reported as a current liability for balance sheet
purposes but reported as a noncurrent asset. An underfunded pension plan, however, may be reported
as a noncurrent liability, a current liability, or both.
Choice "d" is incorrect. All overfunded pension plans are aggregated and reported in total as a
noncurrent asset.

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14. CPA-08261
A company had the following outstanding shares as of J anuary 1, Year 2:
Preferred stock, $60 par, 4%, cumulative 10,000 shares
Common stock, $3 par 50,000 shares
On April 1, Year 2, the company sold 8,000 shares of previously unissued common stock. No dividends
were in arrears on J anuary 1, Year 2, and no dividends were declared or paid during Year 2. Net income
for Year 2 totaled $236,000. What amount is basic earnings per share for the year ended December 31,
Year 2?
a. $3.66
b. $3.79
c. $4.07
d. $4.21

Solution:
Choice "b" is correct. Basic earnings per share is calculated using the following formula:
Income available to common shareholders
Weighted average number of common shares outstanding
Step 1: The first step is to compute the income available to common shareholders. This amount is net
income of $236,000 less dividends accumulated in the period on cumulative preferred stock, regardless
of whether or not the dividends have been paid. For this company, income available to common
shareholders is $236,000 less $24,000 (4% x $60 x 10,000) =$212,000.
Step 2: The second step is to compute the weighted average number of common shares outstanding.
This would be calculated as follows:
Shares outstanding at the beginning of the period 50,000 shares
Shares sold on April 1, Year 2 on a weighted basis (8,000 x 9/12) 6,000 shares
Weighted average number of common shares outstanding for the entire period 56,000 shares
Step 3: Step 3 is the calculation of the basic earnings per share, which is $212,000 / 56,000 shares =
$3.79.
Choices "a", "c", and "d" are incorrect based on the above explanation.

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15. CPA-08262
A company is completing its annual impairment analysis of the goodwill included in one of its cash
generating units (CGUs). The recoverable amount of the CGU is $32,000. The company noted the
following related to the CGU:

Goodwill

Patents

Other
assets

Total
Historical cost $15,000 $10,000 $35,000 $60,000
Depreciation and amortization 0 3,333 11,667 15,000
Carrying amount, December 31 $15,000 $6,667 $23,333 $45,000
Under IFRS, which of the following adjustments should be recognized in the company's consolidated
financial statements?
a. Decrease goodwill by $13,000.
b. Decrease goodwill by $15,000.
c. Decrease goodwill by $3,250; patents by $2,167; and other assets by $7,583.
d. Decrease goodwill by $4,333; patents by $1,926; and other assets by $6,741.

Solution:
Choice "a" is correct. Goodwill will be decreased by $13,000 because this represents the impairment loss
allocated to goodwill. Under IFRS, goodwill impairment is calculated by using a one-step test at the cash
generating unit level in which the carrying value of the cash generating unit is compared to the cash
generating unit's recoverable amount ($45,000 - $32,000 =$13,000). An impairment loss is then
recognized to the extent that the carrying value of the cash generating unit (including goodwill) exceeds
the recoverable amount of the cash generating unit impairment loss, which is $13,000. This amount is
first allocated to goodwill. Any remaining impairment loss would be allocated on a pro rata basis to the
other assets of the cash-generating unit.
Choice "b" is incorrect. Under IFRS, goodwill cannot be looked at separately. Goodwill impairment is
calculated by using a one-step test at the cash generating unit level in which the carrying value of the
cash generating unit is compared to the cash generating unit's recoverable amount ($45,000 - $32,000 =
$13,000). An impairment loss is then recognized to the extent that the carrying value of the cash
generating unit (including goodwill) exceeds the recoverable amount of the cash generating unit
impairment loss, which was $13,000. This amount is first allocated to goodwill, which would be $13,000,
not $15,000. It is not necessary to write off the entire amount of goodwill.
Choice "c" is incorrect. Under IFRS, the impairment loss is first allocated to goodwill. Because the
goodwill carrying amount on December 31 is greater than the impairment loss, there is no remaining
impairment loss to be allocated to the other assets.
Choice "d" is incorrect. Under IFRS, the impairment loss is first allocated to goodwill. Because the
goodwill carrying amount on December 31 is greater than the impairment loss, there is no remaining
impairment loss to be allocated to the other assets.

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16. CPA-08263
On J anuary 1, a company enters into an operating lease for office space and receives control of the
property to make leasehold improvements. The company begins alterations to the property on March 1
and the company's staff moves into the property on May 1. The monthly rental payments begin on J uly 1.
The recognition of rental expense for the new offices should begin in which of the following months?
a. J anuary
b. March
c. May
d. J uly

Solution:
Choice "a" is correct. The lessee should begin the recognition of rental expenses for the new office in
J anuary as rent expense is recorded over the lease term.
Choice "b" is incorrect. The recognition of rental expense for the new offices would not begin in March
when the alterations began but in J anuary when the company entered into the operating lease.
Choice "c" is incorrect. The recognition of rental expense for the new offices would not begin in May
when the company's staff moved into the property but in J anuary when the company entered into the
operating lease.
Choice "d" is incorrect. The recognition of rental expense for the new offices would not begin in J uly
when the payments began on the property but in J anuary when the company entered into the operating
lease for the property.

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17. CPA-08264
On J anuary 1, Year 1, a shipping company sells a boat and leases it from the buyer in a sale-leaseback
transaction. At the end of the 10-year lease, ownership of the boat reverts to the shipping company. The
fair value of the boat, at the time of the transaction, was less than its undepreciated cost. Which of the
following outcomes most likely will result from the sale-leaseback transaction?
a. The boat will not be classified in property, plant and equipment of the shipping company.
b. The shipping company will recognize the total profit on the sale of the boat in the current year.
c. The shipping company will not recognize depreciation expense for the boat in the current year.
d. The shipping company will recognize in the current year a loss on the sale of the boat.

Solution:
Choice "d" is correct. GAAP requires that a loss to be recognized immediately in a sales-leaseback
transaction when the fair value of the property at the time of the sale-leaseback is less than book value.
Accordingly, the shipping company will recognize a loss in the current year because the fair value at the
time of the sales-leaseback transaction was less than the undepreciated cost.
Choice "a" is incorrect. The boat will likely be classified in property, plant, and equipment of the shipping
company if the lease is regarded as a capital lease.
Choice "b" is incorrect. This sales-leaseback transaction results in a loss to the shipping company that is
recognized in the current year.
Choice "c" is incorrect. If the lease is recognized as a capital lease, the leased asset will likely be
depreciated in a manner consistent with the lessee's normal policies.

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18. CPA-08265
Markson Co. traded a concrete-mixing truck with a book value of $10,000 to Pro Co. for a cement-mixing
machine with a fair value of $11,000. Markson needs to know the answer to which of the following
questions in order to determine whether the exchange has commercial substance?
a. Does the book value of the asset given up exceed the fair value of the asset received?
b. Is the gain on the exchange less than the increase in future cash flows?
c. Are the future cash flows expected to change significantly as a result of the exchange?
d. Is the exchange nontaxable?

Solution:
Choice "c" is correct. A transaction is considered to have commercial substance if future cash flows will
change as a result of the transaction. Markson Co. needs to know the answer to the question, "Are the
future cash flows expected to change significantly as a result of the exchange?" to determine if the
exchange has commercial substance.
Choice "a" is incorrect. The question "Does the book value of the asset given up exceed the fair value of
the asset received?" is used to determine whether or not a loss should be recognized on the exchange,
not if the exchange has commercial substance.
Choice "b" is incorrect. Markson Co. would not determine whether or not a transaction had commercial
substance by asking the question, "Is the gain on the exchange l ess than the increase in future cash
flows?"
Choice "d" is incorrect. Answering the question "Is the exchange nontaxable?" will not help Markson Co.
determine whether or not the transaction has commercial substance.

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19. CPA-08266
Which of the following is the proper treatment of the cost of equipment used in research and development
activities that will have alternative future uses?
a. Expensed in the year in which the research and development project started.
b. Capitalized and depreciated over the term of the research and development project.
c. Capitalized and depreciated over its estimated useful life.
d. Either capitalized or expensed, but not both, depending on the term of the research and development
project.

Solution:
Choice "c" is correct. Equipment used in research and development activities that has alternative future
uses is capitalized and depreciated over its useful life.
Choice "a" is incorrect. Equipment used in research and development activities that has alternative future
uses is capitalized and depreciated over its useful life and is not expensed in the year in which the
research and development project started.
Choice "b" is incorrect. Equipment used in research and development activities that has alternative future
uses is capitalized and depreciated over its useful life and not the life of the research and development
project.
Choice "d" is incorrect. Equipment used in research and development activities that has alternative future
uses is only capitalized and depreciated over its useful life. Immediately expensing equipment used in
research and development activities that has alternative future uses is not an option.

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20. CPA-08269
Which of the following is the paramount objective of financial reporting by state and local governments?
a. Reliability.
b. Consistency.
c. Comparability.
d. Accountability.

Solution:
Choice "d" is correct. Governmental (and not-for-profit) organization reporting is designed to demonstrate
the accountability of each organization for the stewardship of the resources in their care. Governments
do not measure net income or increase in wealth as businesses do, but are focused on providing efficient
and effective delivery of services with public resources. Both operational and fiscal accountability are
important to the financial reporting.
Choices "a", "b", and "c" are incorrect. These three objectives, along with timeliness, are secondary to
the objective of accountability.

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21. CPA-08270
Which of the following local government funds uses the accrual basis of accounting?
a. Enterprise.
b. Debt service.
c. Capital projects.
d. Special revenue.

Solution:
Choice "a" is correct. Enterprise funds are proprietary funds that use the accrual basis of accounting and
the economic resources measurement focus. The fund structure used for accounting and reporting for
governments associates each fund category with a unique basis of accounting and measurement focus.
Choice "b" is incorrect. Debt service funds are governmental funds that use the modified accrual basis of
accounting, not the full accrual basis of accounting.
Choice "c" is incorrect. Capital projects funds are governmental funds that use the modified accrual basis
of accounting, not the full accrual basis of accounting.
Choice "d" is incorrect. Special revenue funds are governmental funds that use the modified accrual
basis of accounting, not the full accrual basis of accounting.

23
22. CPA-08271
Which of the following statements is the most significant characteristic in determining the classification of
an enterprise fund?
a. The predominant customer is the primary government.
b. The pricing policies of the activity establish fees and charges designed to recover its cost.
c. The activity is financed by debt that is secured partially by a pledge of the net revenues from fees and
charges of the activity.
d. Laws or regulations require that the activity's costs of providing services including capital costs be
recovered with taxes or similar revenues.

Solution:
Choice "b" is correct. If the pricing policies of an activity establish fees and charges designed to recover
its costs, the activity should be displayed within an enterprise fund. Activities are required to be reported
as an enterprise fund if they meet one of the following three criteria:
The activity is financed with debt that is secured solely by a pledge of the net revenue from fees
and charges.
Laws and regulations require that the cost of providing services be recovered through fees.
The pricing policies of the activity establish fees and charges designed to recover its costs.
Choice "a" is incorrect. The predominance of the primary government as the customer of an activity is a
criterion for blending component units, not fund classification.
Choice "c" is incorrect. In order to be classified as an enterprise fund the activity must be financed with
debt is that is secured solely, not partially, by a pledge of net revenues from fees and charges.
Choice "d" is incorrect. In order to be classified as an enterprise fund, laws or regulations should require
that the activity's costs of providing services including capital costs be recovered through fees, not taxes
or similar revenues.

24
23. CPA-08272
How should a city's general fund report the acquisition of a new police car in its governmental fund
statement of revenues, expenditures, and changes in fund balances?
a. Noncurrent asset.
b. Expenditure.
c. Expense.
d. Property, plant, and equipment.

Solution:
Choice "b" is correct. Acquisition of a new police car in a city's general fund would be displayed as a
capital outlay expenditure in its governmental fund statement of revenues, expenditures, and changes in
fund balances.
Choices "a" and "d" are incorrect. The acquisition of a fixed asset is not capitalized on the governmental
fund statement of revenues, expenditures, and changes in fund balance. Rather, it is considered an
expenditure of funds.
Choice "c" is incorrect. The term "expense" is used exclusively in relation to proprietary fund
presentations, while "expenditure" is used exclusively in relation to governmental funds. The treatment of
a fixed asset acquisition as a cost of the period in governmental funds is identified with the term
expenditure.

25
24. CPA-08273
Which of the following types of information would be included in total net assets in the statement of
financial position for a nongovernmental not-for-profit organization?
a. Total current net assets and total other assets.
b. Total current assets and restricted assets.
c. Unrestricted net assets, temporarily restricted net assets, and permanently restricted net assets.
d. Unrestricted net assets, restricted net assets, and total current assets.

Solution:
Choice "c" is correct. The components of net assets of not-for-profit organizations are classified in one of
three possible ways: unrestricted, temporarily restricted, or permanently restricted net assets.
Choice "a", "b", and "d" are incorrect. The information included in the net assets section of a not-for-profit
organization pertains exclusively to classifications as to restriction, not to maturity.

26
25. CPA-08274
Which of the following resources increases the temporarily restricted net assets of a nongovernmental,
not-for-profit voluntary health and welfare organization?
a. Refundable advances for purchasing playground equipment.
b. Donor contributions to fund a resident camp program.
c. Membership fees to fund general operations.
d. Participants' deposits for an entity-sponsored trip.

Solution:
Choice "b" is correct. Increases in temporarily restricted net assets result from contributions with donor
imposed restrictions that can be fulfilled and removed by actions of the organization such as use for a
purpose that meets donor stipulations. Donor contributions that are to be used for a resident camp
program would meet the definition of temporarily restricted contributions that increase temporarily
restricted net assets.
Choice "a" is incorrect. A refundable advance classification is a liability, not an increase to temporarily
restricted net assets, and is used for agency transactions in which the not-for-profit entity has no variance
power or transactions which are connected with a contingency (condition) beyond the direct control of the
entity. This question defines the transaction as a refundable advance and, as a result, we know that it is
not an increase to temporarily restricted net assets. The underlying transaction is, however, a poor
example of a refundable advance without further facts. Typically a refundable advance transaction would
be held on behalf of a specific person.
Choice "c" is incorrect. Membership fees to fund general operations would likely be accounted for as
unrestricted revenue and not as a temporarily restricted contribution.
Choice "d" is incorrect. Deposits represent a liability in not-for-profit organizations just as they would in
commercial settings. Deposits would not represent an increase to net income or any change in net asset
accounts, temporarily restricted or otherwise.

27
AICPA QUESTIONS RATED HARD DIFFICULTY

26. CPA-08230
A company exchanged land with an appraised value of $50,000 and an original cost of $20,000 for
machinery with a fair value of $55,000. Assuming that the transaction has commercial substance, what is
the gain on the exchange?
a. $0
b. $5,000
c. $30,000
d. $35,000

Solution:
Choice "c" is correct. In transactions that have commercial substance, gain is recognized in a
nonmonetary exchange equal to the difference between the fair value of the asset given up and the book
value of the asset given up. ($50,000 - $20,000 =$30,000)
Choice "a" is incorrect. In a nonmonetary exchange, gain is recognized in a transaction having
commercial substance to the extent that the fair value of the asset given up exceeds the book value of the
asset given up. An amount of gain will be recognized in this transaction because the fair value of the
asset given up is in excess of the book value of the asset given up.
Choice "b" is incorrect. Gain is recognized in a nonmonetary exchange in transactions that have
commercial substance equal to the difference between the fair value of the asset given up and the book
value of the asset given up. This answer compares the fair values of the old and new assets.
Choice "d" is incorrect. In a nonmonetary exchange where commercial substance exists and the fair
value of the asset given up is determinable, gain will be recognized to the extent that the fair value of the
asset given up exceeds the book value of the asset given up. If the fair value of the asset given up was
not determinable, the fair value of the asset received, which was $55,000, could have been used to
determine the gain on the exchange, which would have resulted in this answer.

28
27. CPA-08231
Each of the following would be considered a Level 2 observable input that could be used to determine an
asset or liability's fair value, except:
a. Quoted prices for identical assets and liabilities in markets that are not active.
b. Quoted prices for similar assets and liabilities in markets that are active.
c. Internally generated cash flow projections for a related asset or liability.
d. Interest rates that are observable at commonly quoted intervals.

Solution:
Choice "c" is correct. Internally generated cash flow projections for a related asset or liability would be
better classified as a Level 3 input rather than a Level 2 input because the internally generated cash flow
projection is based on "unobservable" inputs reflecting a company's "own assumptions" about the way the
related asset or liability would be priced.
Choice "a" is incorrect. Quoted prices for identical assets and liabilities in markets that are not active are
a Level 2 observable input.
Choice "b" is incorrect. Quoted prices for similar assets and liabilities in markets that are active are a
Level 2 input.
Choice "d" is incorrect. Interest rates that are observable at commonly quoted intervals are a Level 2
observable input.

29
28. CPA-08232
How should the acquirer recognize a bargain purchase in a business acquisition?
a. As negative goodwill in the statement of financial position.
b. As goodwill in the statement of financial position.
c. As a gain in earnings at the acquisition date.
d. As a deferred gain that is amortized into earnings over the estimated future periods benefited.

Solution:
Choice "c" is correct. Assets and liabilities acquired in a business combination must be valued at their fair
value. In a bargain purchase where the fair value of the net assets acquired is more than the
consideration exchanged for the net assets, the difference is recognized as a gain by the acquirer at the
time of the acquisition.
Choice "a" is incorrect. The difference between the fair value of the net assets acquired and the amount
paid for the business is recorded as a gain by the acquirer at the time of the acquisition and would not be
recorded as negative goodwill in the statement of financial position by the acquirer.
Choice "b" is incorrect. Goodwill is not recognized in the statement of financial position in a bargain
purchase but is recognized in the statement of financial position of the acquirer when the amount paid for
the net assets exceeds the fair of the net assets acquired.
Choice "d" is incorrect. In a bargain purchase where the fair value of the net assets acquired is more than
the consideration exchanged for the net assets, the difference is recognized as a gain by the acquirer at
the time of the acquisition, not as a deferred gain that is amortized into earnings over the estimated future
periods benefited.

30
29. CPA-08233
Cuthbert Industrials, Inc. prepares three-year comparative financial statements. In Year 3, Cuthbert
discovered an error in the previously issued financial statements for Year 1. The error affects the
financial statements that were issued in Years 1 and 2. How should the company report the error?
a. The financial statements for years 1 and 2 should be restated; an offsetting adjustment to the
cumulative effect of the error should be made to the comprehensive income in the Year 3 financial
statements.
b. The financial statements for Years 1 and 2 should not be restated; financial statements for Year 3
should disclose the fact that the error was made in prior years.
c. The financial statements for Years 1 and 2 should not be restated; the cumulative effect of the error
on Years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the
beginning of Year 3.
d. The financial statements for years 1 and 2 should be restated; the cumulative effect of the error on
Years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning
of Year 3.

Solution:
Choice "d" is correct. Financial statements for Years 1 and 2 should be restated. The carrying amounts
of the assets and liabilities for these years will be corrected in each year's financial statements and shown
as restated in the three year comparative financial statements. As of the beginning of Year 3, the
cumulative effect of the error will have been corrected and reflected in the carrying amounts of the
affected assets and liabilities.
Choice "a" is incorrect. When correcting an accounting error, the financial statements must be restated,
however, an offsetting adjustment to the cumulative effect of the error is not made to comprehensive
income to correct the error.
Choices "b" and "c" are incorrect. Financial statements must be restated to correct an accounting error.

31
30. CPA-08240
Palmyra Co. has net income of $11,000, a positive $1,000 net cumulative effect of a change in
accounting principle, a $3,000 unrealized loss on available-for-sale securities, a positive $2,000 foreign
currency translation adjustment, and a $6,000 increase in its common stock. What amount is Palmyra's
comprehensive income?
a. $4,000
b. $10,000
c. $11,000
d. $17,000

Solution:
Choice "b" is correct. Palmyra's comprehensive income is $10,000, which is calculated as net income of
$11,000 less the $3,000 unrealized loss on available-for-sale securities plus the positive $2,000 foreign
currency translation adjustment.
Choice "a" is incorrect. Items not included in the calculation of Palmyra's comprehensive income will be
the $1,000 net cumulative effect of a change in accounting principle and the $6,000 increase in common
stock. These are not recognized as adjustments to net income in the calculation of comprehensive
income.
Choice "c" is incorrect. Palymyra's comprehensive income will not be the same as net income because
Palymra has other gains and losses that impact shareholder's equity but are not included in traditional net
income such as the company's unrealized loss on available-for-sale securities and the foreign currency
translation adjustment. These items will be adjustments to net income to calculate Palymyra's
comprehensive income.
Choice "d" is incorrect. Increase in common stock is not an adjustment to net income for the calculation
of comprehensive income. This is an equity item.

32
31. CPA-08241
A company's first IFRS reporting period is for the Year ended December 31, Year 2. While preparing the
Year 2 statement of financial position, management identified an error in which a $90,000 loss accrual
was not recorded. $40,000 of the loss accrual related to a Year 1 event and $50,000 related to a Year 2
event. What amount of loss accrual should the company report in its December 31, Year 1, IFRS
statement of financial position?
a. $0
b. $40,000
c. $50,000
d. $90,000

Solution:
Choice "b" is correct. Like GAAP, IFRS requires errors to be corrected retrospectively. The statement of
financial position for Year 1 will be corrected for the amount of loss accrual not recorded in Year 1.
Choice "a" is incorrect. IFRS requires that errors are corrected retrospectively.
Choice "c" is incorrect. The amount of loss accrual to report in the company's December 31, Year 1,
IFRS statement of financial position is $40,000, which was the amount of loss not originally reported in
Year 1, not $50,000, which is the amount of loss not reported in Year 2.
Choice "d" is incorrect. The amount of loss accrual to report in the company's December 31, Year 1,
IFRS statement of financial position is $40,000, which was the amount of loss not originally reported in
Year 1, not the combination of the errors for both years, $90,000.

33
32. CPA-08242
A company manufactures and distributes replacement parts for various industries. As of December 31,
Year 1, the following amounts pertain to the company's inventory:

Item

Cost

Net
replacement
cost

Sale price

Cost to sell
or dispose

Normal profit
margin
Blades $41,000 $ 38,000 $ 50,000 $ 2,000 $15,000
Towers 52,000 40,000 54,000 4,000 14,000
Generators 20,000 24,000 30,000 2,000 6,000
Gearboxes 80,000 105,000 120,000 12,000 8,000
What is the total carrying value of the company's inventory as of December 31, Year 1, under IFRS?
a. $178,000
b. $191,000
c. $193,000
d. $207,000

Solution:
Choice "b" is correct. IFRS requires the use of the lower of cost or market rule to value inventory like
GAAP. IFRS, however, defines market value as net realizable value (the estimated sales price less the
estimated cost to dispose or sell) rather than determining market value by choosing the middle value of
the ceiling (net realizable value), replacement cost, and floor (net realizable value minus a normal profit
margin), which is done for GAAP. The total carrying value of the company's inventory as of December
31, Year 1, under IFRS is determined as $191,000 in the following manner:
Item Market value
(Net realizable value*)
Cost Lower of cost or
market
Blades $48,000 $41,000 $41,000
Towers 50,000 52,000 50,000
Generators 28,000 20,000 20,000
Gearboxes 108,000 80,000 80,000
Total lower of cost or
market
$191,000
* (NRV = Sale price - cost to dispose)
Choice "a" is incorrect. This answer is derived by selecting the lower of cost and net replacement cost.
This is not the proper technique for determining LCM under IFRS. IFRS requires the use of the lower of
cost or market rule to value inventory, as explained above.
Choice "c" is incorrect. When using the lower of cost or market rule under IFRS, the cost of the inventory
must be compared to the market value (the net realizable value). The lower of the two numbers will be
used as the inventory value. This answer is calculated by comparing the cost to the sales price.
Choice "d" is incorrect. Replacement cost is not used in valuing inventory using the lower of cost or
market rule under IFRS. This answer is the sum of the net replacement cost column.

34
33. CPA-08243
A company obtained a $300,000 loan with a 10% interest rate on J anuary 1, Year 1, to finance the
construction of an office building for its own use. Building construction began on J anuary 1, Year 1, and
the project was not completed as of December 31, Year 1. The following payments were made in Year 1
related to the construction project:
J anuary 1 Purchased land for $120,000
September 1 Progress payment to contractor for $150,000
What amount of interest should be capitalized for the year ended December 31, Year 1?
a. $13,500
b. $15,000
c. $17,000
d. $30,000

Solution:
Choice "c" is correct. The amount of interest which should be capitalized for the year ended December
31, Year 1, is $17,000. This amount is calculated as follows:
Step 1: The weighted average accumulated expenditures must be calculated.
Expenditure amount Portion of year
outstanding
Weighted average
accumulated
expenditures
J anuary 1: Purchase land $120,000 12/12 $120,000
September 1: Progress
payment for contractor
150,000 4/12 50,000
$170,000
Step 2: Compute the capitalized interest by multiplying the appropriate interest rate times the weighted
average accumulated expenditures. Because the weighted average accumulated expenditures are less
than the amount borrowed, the interest rate to use is the rate on the borrowed funds. Capitalized interest
is calculated as 10% x $170,000 =$17,000.
Step 3: Compare the capitalized interest to the actual interest. The amount of interest capitalized cannot
be greater than actual interest. Actual interest for the year would be $300,000 x 10% =$30,000. The
interest to capitalize is the lesser of actual interest or capitalized interest. Therefore, the amount of
capitalized interest would be $17,000.
Choice "a" is incorrect. This answer is calculated by multiplying 10% times the average of the two
amounts spent: $150,000 +$120,000 =$270,000. $270,000 / 2 =$135,000. This is not the proper way
to calculate weighted average accumulated expenditures.
Choice "b" is incorrect. The amount of $15,000 would be 10% of the second progress payment. This is
the wrong calculation to use for capitalized interest.
Choice "d" is incorrect. The amount of $30,000 is the actual interest incurred by the company during Year
1. This is not the capitalized interest, based on the above explanations.

35
34. CPA-08244
A company recently moved to a new building. The old building is being actively marketed for sale, and
the company expects to complete the sale in four months. Each of the following statements is correct
regarding the old building, except:
a. It will be reclassified as an asset held for sale.
b. It will be classified as a current asset.
c. It will no longer be depreciated.
d. It will be valued at historical cost.

Solution:
Choice "d" is correct. The old building being actively marketed for sale will be valued at the lower of its
book value or net realizable value (fair value less the costs to sell).
Choice "a" is incorrect. It is a correct statement that the old building being actively marketed for sale will
be reclassified as an "asset held for sale."
Choice "b" is incorrect. Because the company expects that the sale of the old building will be completed
in a four month time period, the old building will be classified as a current asset.
Choice "c" is incorrect. Assets held for sale are no longer depreciated.

36
35. CPA-08245
A company has a parcel of land to be used for a future production facility. The company applies the
revaluation model under IFRS to this class of assets. In Year 1, the company acquired the land for
$100,000. At the end of Year 1, the carrying amount was reduced to $90,000, which represented the fair
value at that date. At the end of Year 2, the land was revalued, and the fair value increased to $105,000.
How should the company account for the Year 2 change in fair value?
a. By recognizing $10,000 in other comprehensive income.
b. By recognizing $15,000 in other comprehensive income.
c. By recognizing $15,000 in profit or loss.
d. By recognizing $10,000 in profit or loss and $5,000 in other comprehensive income.

Solution:
Choice "d" is correct. The original acquisition price of the land was $100,000. At the end of Year 1, the
carrying amount would have been revalued to $90,000. Under the revaluation model of IFRS, the
reversal of a revaluation is recognized in profit or loss. For this reason, at the end of Year 2, the portion
of the increase in fair value of land from the revalued carrying amount of $90,000 in Year 1 to the original
acquisition cost of $100,000 is recognized in profit or loss.
If a revaluation results in an increase in value, however, it should be credited to other comprehensive
income. For this reason, the increase in value of $5,000 ($105,000 less $100,000) will be recognized as
other comprehensive income.
Choice "a" is incorrect. The revaluation model under IFRS requires that the reversal of a revaluation is
recognized in profit or loss and not as comprehensive income.
Choice "b" is incorrect. Of the $15,000 increase in value from the end of Year 1 to the end of Year 2,
$10,000 will be recognized in profit or loss because it is a reversal of a revaluation, and $5,000 will be
recognized in comprehensive income. All $15,000 will not be recognized as comprehensive income.
Choice "c" is incorrect. Of the $15,000 increase in value from the end of Year 1 to the end of Year 2,
$10,000 will be recognized in profit or loss because it is a reversal of a revaluation, and $5,000 will be
recognized in comprehensive income. All $15,000 will not be recognized in profit or loss.

37
36. CPA-08246
A company whose stock is trading at $10 per share has 1,000 shares of $1 par common stock
outstanding when the board of directors declares a 30% common stock dividend. Which of the following
adjustments should be made when recording the stock dividend?
a. Treasury stock is debited for $300.
b. Additional paid-in capital is credited for $2,700.
c. Retained earnings is debited for $300.
d. Common stock is debited for $3,000.

Solution:
Choice "c" is correct. A 30% common stock dividend would be classified as a large stock dividend by
GAAP because the stock dividend is more than 20% to 25% of the previously outstanding shares. For a
large stock dividend, retained earnings is debited for the par value of the additional shares issued. The
stock dividend would be recorded as follows on the date of declaration by the board of directors:
Date of Declaration
Debit retained earnings (30% x 1,000 shares x $1.00 par value) $300
Credit common stock to be distributed $300
Choice "a" is incorrect. Treasury stock is debited when a company reacquires its own stock, not in a
stock dividend transaction.
Choice "b" is incorrect. Additional paid in capital would be credited for $2,700 if this stock dividend was
regarded as a small stock dividend. A stock dividend that is less than 20% or 25% of the previously
outstanding shares would be regarded as a small dividend. If the transaction was regarded as a small
dividend rather than a large dividend, the stock dividend would be recorded as follows on the date of
declaration by the board of directors:
Date of Declaration
Debit retained earnings (30% x 1,000 shares x $10.00 fair value) $3,000
Credit common stock to be distributed $300
Credit additional paid-in-capital from stock dividend $2,700
Choice "d" is incorrect. Common stock is not debited when recording stock dividend transactions. When
stock is issued, common stock is credited.

38
37. CPA-08247
Ina Co. had the following beginning and ending balances in its prepaid expense and accrued liabilities
accounts for the current year:

Prepaid
expenses
Accrued
liabilities
Beginning balance $ 5,000 $ 8,000
Ending balance 10,000 20,000
Debits to operating expenses totaled $100,000. What amount did Ina pay for operating expenses during
the current year?
a. $83,000
b. $93,000
c. $107,000
d. $117,000

Solution:
Choice "b" is correct. The starting point for this problem is the $100,000 of debits to operating expenses.
The increase in accrued liabilities represents operating expenses which have been incurred or used but
not paid. To determine the amount of operating expenses which have been paid, the $12,000 increase in
accrued liabilities must be subtracted from the $100,000 of operating expenses, because operating
expenses would have been debited each time the accrued liability account was credited in the following
manner.
Operating Expense XXX
Accrued Liability XXX
The increase in prepaid expenses represents operating expenses which have been paid but not yet used
or incurred. To get the amount paid for operating expenses, the increase in prepaid expenses must be
added to the $100,000 of operating expenses. An increase in the prepaid account represents cash
payment of an operating expense not recorded as a debit to operating expense. The correct answer of
$93,000 is calculated as $100,000 of debits to operating expenses less the $12,000 increase in accrued
liabilities plus the $5,000 increase in prepaid expenses.
Choice "a" is incorrect. The increase in the prepaid expense represents operating expenses which have
been purchased (paid) but not used. To correctly calculate the amount paid for operating expenses, the
increase in the prepaid account must be included as a plus and not a minus.
Choice "c" is incorrect. The $100,000, which represents the amount debited to operating expenses, must
be adjusted downward by the increase in accrued liabilities of $12,000 and adjusted upward by the
increase in prepaid expenses of $5,000 to calculate the amount of operating expenses which were paid.
This answer does the opposite: $100,000 plus $12,000 minus $5,000.
Choice "d" is incorrect. This answer is incorrect because it adds both the increase in accrued liabilities
and the increase in prepaids to the $100,000.

39
38. CPA-08248
On J anuary 1, Year 1, a company issued its employees 10,000 shares of restricted stock. On J anuary 1,
Year 2, the company issued to its employees an additional 20,000 shares of restricted stock. Additional
information about the company's stock is as follows:
Date Fair value of stock (per share)
J anuary 1, Year 1 $20
December 31, Year 1 22
J anuary 1, Year 2 25
December 31, Year 2 30
The shares vest at the end of a four-year period. There are no forfeitures. What amount should be
recorded as compensation expense for the 12-month period ended December 31, Year 2?
a. $175,000
b. $205,000
c. $225,000
d. $500,000

Solution:
Choice "a" is correct. Compensation cost for restricted share plans is determined using the following
formula:
Total compensation cost =Market price of the share on date of grant x Number of restricted shares
awarded
Using the above formula, the total compensation cost for Year 1 is $20.00 x 10,000 shares =$200,000.
Using the above formula, the total compensation cost for Year 2 is $25.00 x 20,000 shares =$500,000.
Total compensation cost is allocated to compensation expense on a straightline basis over the time
period in which the employee must provide service. This company has a four-year service period. The
compensation expense for the 12 months ended December 31, Year 2 would be one fourth of the
compensation cost of Year 1, which is $50,000 (1/4 x $200,000) and one fourth of the compensation cost
of Year 2, which is $125,000 (1/4 x $500,000), for a total of $175,000.
Choice "b" is incorrect. In calculating compensation cost, the company should use the fair value of the
shares on the grant dates (J anuary 1, Year 1 and J anuary 1, Year 2) and not the fair value of the shares
at the end of each year.
Choice "c" is incorrect. The error in this calculation is that it uses $30 as the per share price for both Year
1 and Year 2. $30 x (10,000 +20,000 shares) =$900,000. $900,000 / 4 years =$225,000.
Choice "d" is incorrect. Compensation cost must be allocated to compensation expense on a straight line
basis over the time period in which the employee is required to provide service. This answer represents
the total, unallocated $500,000, which should be reported over 4 years.

40
39. CPA-08249
Which of the following items is not subject to the application of intraperiod income tax allocation?
a. Discontinued operations.
b. Income from continuing operations.
c. Extraordinary gains and losses.
d. Operating income.

Solution:
Choice "d" is correct. GAAP does not require intraperiod income tax allocation to operating income. Only
select items on the income statement are shown "net of income tax," and operating income is not one of
them.
Choice "a" is incorrect. GAAP requires intraperiod income tax allocation to discontinued operations.
Choice "b" is incorrect. GAAP requires intraperiod income tax allocation to income from continuing
operations.
Choice "c" is incorrect. GAAP requires intraperiod income tax allocation to extraordinary items.

41
40. CPA-08250
Bale Co. incurred $100,000 of acquisition costs related to the purchase of the net assets of Dixon Co.
The $100,000 should be:
a. Allocated on a pro rata basis to the nonmonetary assets acquired.
b. Capitalized as part of goodwill and tested annually for impairment.
c. Capitalized as an other asset and amortized over five years.
d. Expensed as incurred in the current period.

Solution:
Choice "d" is correct. Acquisition costs associated with a business transaction must be expensed as
incurred in the current period.
Choice "a" is incorrect. Acquisition costs associated with a business transaction are not allocated on a
pro rata basis to the nonmonetary assets acquired but expensed as incurred in the current period.
Choice "b" is incorrect. Acquisition costs associated with a business transaction are not capitalized as
part of goodwill and tested annually for impairment but expensed as incurred in the current period.
Choice "c" is incorrect. Acquisition costs associated with a business transaction are not capitalized as an
other asset and amortized over five years but expensed as incurred in the current period.

42
41. CPA-08251
Smythe Co. invested $200 in a call option for 100 shares of Gin Co. $0.50 par common stock, when the
market price was $10 per share. The option expired in three months and had an exercise price of $9 per
share. What was the intrinsic value of the call option at the time of initial investment?
a. $50
b. $100
c. $200
d. $900

Solution:
Choice "b" is correct. Under the intrinsic value method, a corporation measures the intrinsic value of
options based compensation using the following formula:
Number of share options x Market price of the stock on the date of the grant less exercise price of the
share option.
Thus, the intrinsic value of the call option at the time of the initial investment would be 100 x ($10.00 -
$9.00) =$100.
Choice "a" is incorrect. Par value is not used in the intrinsic value method.
Choice "c" is incorrect. In measuring the intrinsic value of the call option at the time of the investment, the
number of share options must be multiplied by the market price of the stock on the date of the grant
reduced by the exercise price of the share option.
Choice "d" is incorrect. In calculating the intrinsic value, the number of share options must be multiplied
by the market price of the stock on the date of the grant less the exercise price of the share option, not
just the exercise price of the share option.

43
42. CPA-08252
Which of the following financial instruments issued by a public company should be reported on the
issuer's books as a liability on the date of issuance?
a. Cumulative preferred stock.
b. Preferred stock that is convertible to common stock five years from the issue date.
c. Common stock that contains an unconditional redemption feature.
d. Common stock that is issued at a 5% discount as part of an employee share purchase plan.

Solution:
Choice "c" is correct. Common stock that contains an unconditional redemption feature should be
reported on the issuer's books as a liability on the date of issuance because there is an obligation of a
cash outflow in the future that the company has no ability to prevent.
Choice "a" is incorrect. Cumulative preferred stock is considered equity and would not be recorded on
the issuer's books as a liability on the date of issuance.
Choice "b" is incorrect. Preferred stock that is convertible to common stock five years from the issue date
is recorded in the equity section of the balance sheet and not as a liability on the issuer's books on the
date of issuance.
Choice "d" is incorrect. Common stock that is issued at 5% discount as part of an employee share
purchase plan is not recorded as a liability on the issuer's books on the date of issuance.

44
43. CPA-08253
During the current year ended December 31, Metal Inc. incurred the following costs:
Laboratory research aimed at discovery of new knowledge $ 75,000
Design of tools, jigs, molds, and dies involving new technology 22,000
Quality control during commercial production, including routine testing 35,000
Equipment acquired two years ago, having an estimated useful life of five
years with no salvage value, used in various R&D projects

150,000
Research and development services performed by Stone Co. for Metal Inc. 23,000
Research and development services performed by Metal Inc. for Clay Co. 32,000
What amount of research and development expenses should Metal report in its current-year income
statement?
a. $120,000
b. $150,000
c. $187,000
d. $217,000

Solution:
Choice "b" is correct. Research and development expenses would include the following:
Laboratory research aimed at discovery of new knowledge $75,000
Design of tools, jigs, molds, and dies involving new technology 22,000
Equipment acquired two years ago, having an estimated useful life of five years
with no salvage value, used in various R&D projects
30,000 (150,000/5)
Research and development services performed by Stone Co. for Metal Inc. 23,000
Total amount of research and development expenditures reported in the current
year income statement by Metal Inc.
$150,000
Choice "a" is incorrect. Depreciation on equipment used in various R&D projects would be included as a
research and development expenditure.
Choice "c" is incorrect. Quality control during commercial production, including routine testing in the
amount of $35,000 is not a permitted research and development expenditure. Additionally, research and
development services performed by Metal Inc. for Clay Co. in the amount of $32,000 is not a permitted
research and development expenditure. Finally, depreciation expense in the amount of $30,000
($150,000 / 5) would be included in the current year as a research and development expenditure.
Choice "d" is incorrect. The amount of $217,000 includes expenditures that are not allowed as research
and development expenditures, such as quality control during commercial production, including routine
testing in the amount of $35,000, and research and development services performed by Metal Inc. for
Clay Co. in the amount of $32,000.

45
44. CPA-08267
Which of the following documents is typically issued as part of the due-process activities of the Financial
Accounting Standards Board (FASB) for amending the FASB Accounting Standards Codification?
a. A proposed statement of position.
b. A proposed accounting standards update.
c. A proposed accounting research bulletin.
d. A proposed staff accounting bulletin.

Solution:
Choice "b" is correct. A proposed accounting standards update is prepared by the FASB as part of the
due-process activities.
Choice "a" is incorrect. A proposed statement of position is issued by the American Institute of Certified
Public Accountants (AICPA) and not the FASB.
Choice "c" is incorrect. A proposed accounting research bulletin is not a document issued as part of the
due-process activities of the FASB for amending the FASB Accounting Standards Codification.
Accounting research bulletins were never issued by the FASB, and are no longer issued at all.
Choice "d" is incorrect. A proposed staff accounting bulletin is issued by the U.S. Securities and
Exchange Commission (SEC) and is not part of the due-process activities of the Financial Accounting
Standards Board (FASB) for amending the FASB Accounting Standards Codification.

46
45. CPA-08268
As of December 1, Year 2, a company obtained a $1,000,000 line of credit maturing in one year on which
it has drawn $250,000, a $750,000 secured note due in five annual installments, and a $300,000 three-
year balloon note. The company has no other liabilities. How should the company's debt be presented in
its classified balance sheet on December 31, Year 2 if no debt repayments were made in December?
a. Current liabilities of $1,000,000; long-term liabilities of $1,050,000.
b. Current liabilities of $500,000; long-term liabilities of $1,550,000.
c. Current liabilities of $400,000; long-term liabilities of $900,000.
d. Current liabilities of $500,000; long-term liabilities of $800,000.

Solution:
Choice "c" is correct. The current liabilities ($400,000) consist of the $250,000 draw on the line of credit
due within one year and $150,000 (1/5 of the $750,000), which represents the portion of the secured note
due within the next year. The long-term liabilities are $900,000, which consist of the four remaining
installments of the secured note, which is $600,000 (4 x $150,000) plus the $300,000 three-year balloon
note.
Choice "a" is incorrect. Only the portion which has been drawn off the line of credit will be reported as a
liability on the balance sheet. Furthermore, the portion of the secured note due within one year, $150,000
($750,000 / 5), will be reported as a current liability and not a long-term liability.
Choices "b" and "d" are incorrect based on the above explanations.

47
46. CPA-08275
Lily City uses a pay-as-you-go approach for funding postemployment benefits other than pensions. The
city reports no other postemployment benefits (OPEB) liability at the beginning of the year. At the end of
the year, Lily City reported the following information related to OPEB for the water enterprise fund:
Benefits paid $100,000
Annual required contribution 500,000
Unfunded actuarial accrued liability 800,000
What amount of expense for OPEB should Lily City's water enterprise fund report in its fund level
statements?
a. $100,000
b. $500,000
c. $600,000
d. $1,400,000

Solution:
Choice "b" is correct. Employer contribution additions to a governmental pension fund are recorded as
expenditures and expenses in the appropriate fund financial statements. The annual required
contribution (ARC), not the benefits paid or the unfunded actuarial liability, is the amount of the expense
that would appear in Lily City's water enterprise fund level financial statements. The expense is:
Annual required contribution $500,000
Choice "a" is incorrect. Benefits paid ($100,000) are charges to deductions in the pension level financial
statements and are not expenses displayed in the governmental or proprietary fund financial statements.
Choice "c" is incorrect. Benefits paid ($100,000) are charges to deductions in the pension level financial
statements and would not be combined with the annual required contribution as expenses displayed in
the governmental or proprietary fund financial statements.
Choice "d" is incorrect. Benefits paid ($100,000) are charges to deductions in the pension level financial
statements, and changes in the unfunded liability ($800,000) may include deferred inflows and outflows
and would not be combined with the annual required contribution as expenses displayed in the
governmental or proprietary fund financial statements. The best answer is the annual required
contribution, an amount that excludes all other pension activity.

48
47 CPA-08276
Clay City levied property taxes of $600,000 for the current year, and estimated that $25,000 would be
uncollectible. Which of the following is the correct general fund journal entry to record the property tax
levy?
Debit Credit
a. Property taxes receivablecurrent $600,000
Property tax revenue $600,000
b. Property taxes receivablecurrent $575,000
Bad debt expense 25,000
c. Property taxes receivablecurrent $600,000
Allowance for uncollectible property taxescurrent 25,000
d. Property taxes receivablecurrent $600,000
Bad debt expense 25,000
Allowance for uncollectible property taxescurrent 25,000

Solution:
Choice "c" is correct. The journal entry to record property taxes receivable and revenue (imposed
nonexchange revenues) occurs when the levy takes place and reduces the amount of revenue
recognized to the amount measurable and available. An allowance is created, but no periodic bad debt
amount is displayed.
Choice "a" is incorrect. Property tax revenue is recorded net of uncollectible amounts.
Choice "b" is incorrect. Bad debt expense (expenditure) is not recorded. Revenues are recorded at their
net measurable and available amount.
Choice "d" is incorrect. Bad debt expense (expenditure) is not recorded. Revenues are recorded at their
net measurable and available amount.

49
48 CPA-08277
The City of Curtain had the following interfund transactions during the month of May:
Billing by the internal service fund to a department financed by the general fund, for services
rendered in the amount of $5,000.
Transfer of $200,000 from the general fund to establish a new enterprise fund.
Routine transfer of $50,000 from the general fund to the debt service fund.
What was the total reciprocal interfund activity for Curtain during May?
a. $5,000
b. $55,000
c. $200,000
d. $255,000

Solution:
Choice "a" is correct. Reciprocal interfund activity for the City of Curtain is $5,000. Reciprocal interfund
activity includes interfund loans and interfund services provided and used. Billing by the internal service
fund to a department financed by the general fund for services rendered is the only transaction meeting
this definition. Nonreciprocal transfers include interfund transfers (which are displayed as either other
financing sources or uses on the governmental fund financial statements or purely as transfers in
proprietary fund financial statements) and interfund reimbursements (which are not shown on the face of
the financial statements).
Choice "b" is incorrect. This response incorrectly combines a routine transfer (nonreciprocal activity) of
$50,000 with a $5,000 reciprocal transfer (an internal service fund billing).
Choice "c" is incorrect. This response incorrectly classifies a transfer (nonreciprocal activity) of $200,000
as a reciprocal transfer. Reciprocal transfers are defined above as payments for services provided and
used, and loans. Internal capitalization of a new fund is not considered reciprocal.
Choice "d" is incorrect. This response incorrectly combines a both a routine transfer (nonreciprocal
activity) of $50,000 and a nonroutine transfer (also nonreciprocal) of $200,000 with a $5,000 reciprocal
transfer (an internal service fund billing).

50
49 CPA-08278
How should a nongovernmental not-for-profit organization classify gains and losses on investments
purchased with permanently restricted assets?
a. Gains may not be netted against losses in the statement of activities.
b. Gains and losses can only be reported net of expenses in the statement of activities.
c. Unless explicitly restricted by donor or law, gains and losses should be reported in the statement of
activities as increases or decreases in unrestricted net assets.
d. Unless explicitly restricted by donor or law, gains and losses should be reported in the statement of
activities as increases or decreases in permanently restricted net assets.

Solution:
Choice "c" is correct. Gains and losses should be reported in the statement of activities as increases or
decreases in unrestricted net assets unless otherwise stipulated by donor or by law. In the event
temporary restrictions are associated with earnings on permanently restricted investments, losses first go
to reduce temporarily restricted net assets, to the extent that previously recognized gains have not been
earned or used in the temporarily restricted category, and are then applied to unrestricted net assets.
Choice "a" is incorrect. Gains and losses may be netted; however, the question pertains to classification
rather than valuation of gains and losses.
Choice "b" is incorrect. Gains and losses may be reported gross or net (or in combination) with related
expenses. The question pertains to classification rather than valuation of gains and losses.
Choice "d" is incorrect. Gains and losses on permanently restricted investments are not charged to
permanently restricted net assets. Gains and losses should be reported in the statement of activities as
increases or decreases in unrestricted net assets unless otherwise stipulated by donor or by law.

51
50 CPA-08279
At which of the following amounts should a nongovernmental not-for-profit organization report
investments in debt securities?
a. Potential proceeds from liquidation sale.
b. Discounted expected future cash flows.
c. Quoted market prices.
d. Historical cost.

Solution:
Choice "c" is correct. Not-for-profit organization investments are displayed at their fair value at year-end.
The best most reliable measure of fair value is quoted market prices (assuming they are available). All
debt securities and those equity securities that have readily determinable fair values are measured at fair
value in the statement of financial position.
Choice "a" is incorrect. Fair value, not net realizable value (proceeds from a potential liquidation) is the
valuation amount used for investments at year-end.
Choice "b" is incorrect. Although discounted future cash flows may approximate fair value (and serve as
the basis for determining fair value), the best answer is the quoted market price. If available, quoted
market prices are the best measure of fair value.
Choice "d" is incorrect. Fair value, not historical cost, is the valuation amount used for investments at
year-end.

FAR
Released by AICPA
2013

Task 538_01

SOLUTION AND EXPLANATION:
Item 1 (line 2): No; $0; No
In this loss contingency, because the probability of a loss is remote, the company does not accrue or disclose
any amount related to the law suit. Generally, disclosure should be made for guarantee type remote loss
contingencies such as debts of others, obligations of commercial banks under standby letters of credit, and
guarantees to repurchase receivables that have been sold or assigned.
Item 2 (line 3): No; $0; Yes
When the loss is reasonably possible, disclosure is required, but no journal entry is recorded. The disclosure
should include the nature of the loss contingency and the range of the possible loss.
Item 3 (line 4): Yes; $200,000; Yes
An accrual should be made because the loss is probable, and the amount can be reasonably estimated.
Because the loss is a range, and no amount in the range is considered a best estimate, the minimum of the
range is accrued. The disclosures include the nature of the contingency and existence of a possible additional
loss of $300,000, for a possible total of $500,000.

While the likelihood of a loss is probable, there is no accrual because the loss cannot be reasonably estimated.
In this case, a disclosure will be made to describe the nature of the contingency, with a note that the loss is
probable but not estimable.
This is a gain contingency and is not recorded as a receivable or an income item. Gain contingencies are
never recorded in journal entries because to do so might result in recognition of revenue prior to its realization.
Gain contingencies that are probable or reasonably possible are disclosed. However, the accounting guidance
warns that the financial statements should be carefully worded to avoid any misleading implications as to the
likelihood of realization.

Task 2133_01

For journal entry 1, al l the amounts are given in the statement of the probl em.
The premium account has a credit balance, and will be amortized over the life of the bonds to reduce interest
expense. The bonds were sold at a premium because the bonds pay cash interest of 8% at a time when the
market rate of interest is 4%. (When the market rate exceeds the contract rate, bonds are sold at a discount.
When the contract rate exceeds the market rate, bonds are sold at a premium.)

Journal entry 2 requi res the payment of interest on the first payment date of June 30, Year 1.
Interest expense:
Carrying amount of bond at 1/1/Year 1: $200,000 face +$35,931 premium = $235,931
Market interest rate, for expense 4% / 2 (for 6 months) x 0.02
Interest accrued 6/30/Year 1 $4,718.62

Interest paid:
Contract amount of bond at 1/1/Year 1 $200,000
Contract interest rate for payment 8% / 2 (for 6 months) x 0.04
Interest paid at 6/30/Year 1 $8,000.00

Premium amortization:
$8,000.00 minus $4,718.62 $3,281.38
Note: After this interest accrual and payment, the premium balance is decreased by $3,281.38 and the total
bond liability decreases by the same amount. The new premium is $35,931 minus $3,281.38, or $ 32,649.62.
The numbers are rounded for the journal entries.
To answer the remaining questions for Year 2, consider preparing an amortization schedule, as shown
below.
Date Beginning of
Period Net
Carrying
Value
Semi-annual
Interest
Expense
Rate
Net Carrying
Value x
Effective
Interest
Rate
Face
Amount of
Bond x
Coupon
Rate (4%
for 6 mos.)
Amortization
of Premium
End of
Period
Carrying
Value
1/1/Year 1 $235,931
6/30/Year 1 235,931 2% $4,719 $8,000 $3,281 $232,650
12/31/Year 1 232,650 2% 4,653 8,000 3,347 229,303
6/30/Year 2 229,303 2% 4,586 8,000 3,414 225,889

Task 4514_01

FASB ASC 830-10-45-7
Foreign Currency MattersOverall Other Presentation Matters Changes in the Functional Currency

Keywords: change in functional currency

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2013 AICPA Newly Released Questions Financial

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