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Ultimate CPA Exam Guide Let’s Pass Together

The Ultimate CPA Exam

Guide

by Bryan Kesler

Disclaimer:

I don't mean to insult your intelligence, because you're smart and you KNOW this, but...

The CPA Guide and Ultimate CPA Exam Guide offers no representations, warranties or

guarantees verbally, in writing or otherwise regarding specific earnings or results related to

your career or the CPA exam. Results for each person may significantly vary. None of the

individuals represented have been paid or otherwise compensated. None of the case studies,

testimonials or reviews have been scripted and are true and accurate to the best of the

knowledge of theCPAguide.com & UltimateCPAExamGuide.com

Bottom line: I believe those who do nothing achieve nothing.

http://www.ultimatecpaexamguide.com/



Table of Contents

What Does It Feel Like (To Pass) --> Page 4

Let’s Do This! If I Can Pass Than Anyone Can! --> Page 5

Time To Get Real About The CPA Exam --> Page 6

Step-By-Step Cheat Sheet To Passing The CPA Exam --> Page 9

BONUS: CPA Review Course Case Study For All CPA Candidates --> Page 11

More Free CPA Exam Resources & CPA Discounts -->Page 17

100 Free Roger CPA Multiple Choice Questions & Answers --> Page 18-59

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I dedicate this eBook to the two most beautiful women in my life.

You are the reason that I sacrificed hundreds of hours studying and invested thousands of dollars in myself to become a CPA.

Without your love and support I would not be a CPA today!




What Does It Feel Like? Imagine yourself sitting in your work cubicle unable to concentrate… A small bead of sweat running down your forehead as your eye begins to twitch… Your internet browser is open and every 20 seconds you are hitting refresh. Refresh. No change Refresh. No change Refresh. BOOM! -----> You scored an 83 on FAR!!! Your 2 year battle with the CPA exam was finally over! What do you think you would be feeling? Relief? Unbelievable joy? Uncontrollable screaming and hugging of all of your unsuspecting co-workers?? The undeniable urge to burn every accounting & CPA exam book that you own (think Office Space copy machine!)??? This is exactly what happened to me on that morning of 5/27/10! The pain and toil of the past 2 years was instantly forgotten & my life was forever changed!




Let’s Do This! If I Can Pass Than Anyone Can Pass! If you are a brand new to the entire CPA exam process, then you are in the right place (and I am thrilled to have you join me in your journey to passing)! I am about to share the EXACT steps I took to pass the CPA exam and reveal a Case Study about what happens when you don’t pick the right CPA review course and how to avoid this mistake. Keep an eye out for Pro Tips as well, there are a couple of them sprinkled throughout this ebook! Let’s do a quick introduction first… My name is Bryan Kesler. I am a 30 year old father, successful CPA candidate, PwC Alum, Accounting Junky, and a bit of an entrepreneur. My goal is plain and simple. Help you pass the CPA exam on your FIRST try (and not make the same mistakes that I did). Personal Note: I did NOT pass the CPA exam on my first try; in fact I failed SEVEN times before I finally passed! Unfortunately this is not uncommon among CPA candidates considering the average pass rate for each section is only 46%... and those odds drop even lower if you consider candidates who pass every section in a row WITHOUT failing.




I honestly get tears in my eyes every time I think about all of the rookie mistakes I made when I first began studying that caused me to waste both time and thousands of dollars... Which is what I get for being an over-confident 24 year old who thought he was going to dominate the accounting industry (without having to work very hard…)! This is why I created the cheat sheet below! To share my numerous mistakes with you so that you do NOT go through the same pain and suffering I went through (and hopefully save you hundreds of hours and thousands of dollars)! You want to save time and money right?

Time To Get Real About The CPA Exam Passing the CPA exam is not an IQ test. I was one of those over-achieving Beta Alpha Psi officers (you know the type ;) ) with a 3.8 GPA accounting who had never failed a class in his life. Everything about accounting just seemed to come naturally to me… So how did someone like me fail so many times?? As you probably know, the running joke about the CPA exam is that CPA stands for “Can’t Pass Again.”




So what is the CPA exam all about then? It is about: 1) Resilience, 2) Determination, 3) Making sacrifices, and 4) Having a strict study system in place and actually following it (I did NOT do this) The CPA exam is designed to make you fail because the AICPA only wants the most dedicated accountants to pass. This sounds cruel doesn’t it…? But this is why the CPA license is so well respected in almost every industry. If you pass the CPA exam, employers immediately know that you are a highly motivated individual who will tackle any task and see it through to its finish. This is why I stuck with it through 7 failures (and why you are here right now!) I didn’t want to be stuck in a dead end job making peanuts for my entire career and wonder what if… Isn’t that why you want to become a CPA as well?

Pro Tip #1: ATTN Recent Grads: Happy hours with new co-workers and Cardinal baseball

games (or whatever your vice is) are not more important than studying (even if you live downtown)!!

Trust me (I learned this the hard way) they will still be there after you pass…




Now I don’t know exactly where you are in the CPA exam process, but whether you are brand new to taking this exam or a seasoned veteran who is struggling, then I know the cheat sheet on the next page is going to help you. Thanks for reading and I hope you enjoy




7 Proven Steps to Starting, Studying & Passing the CPA Exam

Cheat Sheet 1: Get Mentally Prepared - What are you willing to sacrifice in order to pass? - What can you not accomplish without passing? 2: Sign Up For The CPA Exam - Pick a state that works for you - Sign up for no more than 3 sections (2 = ideal) - Start with section you are most familiar 3: Find Best CPA Review Course For You - Determine how you study best - Most expensive course is not always the ‘best’ for you - Pick course that will cater to your strengths 4: Create A Strict CPA Study System - Develop a step-by-step game plan - Set hard deadlines & use checklists - Eliminate time-wasters - Focus on learning the WHY for each question & on your decision making speed 5: Actually Studying - Research what to expect for each section - Focus on the most difficult concepts for you (use your analytics!) - Know how simulations work & what to expect 6: Juggle Work/Family/Studying - Use incentives to keep you focused & motivated - Becoming a hermit hurts motivation and focus - Don’t forget to have fun! 7: Final Review, Game Day & Beyond - Final Review is for strengthening what you know, not learning new topics - Game Day = relaxing + exam mode - After each exam take time off but don’t lose focus




What’s Next Don’t worry, I know the cheat sheet is vague and doesn’t explain much in detail on how to actually accomplish each step. This is by design… It won’t make complete sense yet… keyword ‘yet.’ All you need to know right now is that these are the EXACT steps that I took to passing the CPA exam. We will deep dive into these steps in more detail with the emails and videos I am sending you over the next week or 2. I will also show you in a later email how I added $25K to my annual salary with 2 years of passing the CPA exam! Feel free to print this eBook out and keep it with you as I send you more training videos and handouts.

FUN FACT: You can watch video #1 right now by clicking here FUN FACT #2: Video #2 is coming to your inbox very soon, keep an eye out!

https://freetraining.ultimatecpaexamguide.com/1-5steps




BONUS: CPA Review Course Case Study For ALL CPA Candidates A question that I literally get asked at least once per day is “Bryan. What is the Absolute #1 Best CPA review course out there?” Or I get this one a lot as well… “Bryan. What is the CHEAPEST CPA review course out there?” To someone who hasn’t ever taken the CPA exam before I totally understand why you would ask either of these questions. BUT… The question that you need to be asking is… What CPA review course is going to help me maximize my learning and is going to fit how I study best? If you are serious about passing the CPA exam then price should not matter when doing your research. Buying a CPA review course is no different than buying golf clubs or even clothes. I could purchase the most expensive fancy golf clubs or a pair of jeans from the best designer, but if they aren’t the right length (I am a tall dude) then they are worthless to me. Same concept when purchasing a review course… If the features offered by the review course don’t work well with how you study then it is going to hold you back! More on this in a little bit…




Investment vs. Expense So many CPA candidates don’t understand that taking and passing the CPA exam should NOT be seen as an expense. It is an investment in your future. More often than not candidates will try to cheap out on a review course or look at the price of a course and just because it is super expensive assume that it is the best course currently available. (Looking at you Becker CPA!) There are sooooo many review course out there that it can be hard to decipher all the different features, but there are obvious strengths and weaknesses for each course if you know what you are looking for. You also need to recognize that everyone studies and learns differently. Some folks prefer to read and then teach themselves the material (self-studiers) Other folks are more auditory learners so they prefer to be in a live/virtual classroom setting in order to learn efficiently. Some courses provide flashcards… Some courses have mobile apps that you can use on the go during your lunch hour or train ride… Even others have audio lectures that you can listen to on your commute or in the gym… And if you already have a review course there are some courses that offer Cram Courses or Final Review cram sessions which can be extremely helpful if you need to add a few extra points to your scores. Instead of looking at the price of each review course you need to be looking at how




you study and what your schedule is going to look like. Based on your schedule which course is going to maximize your efficiency? To learn more about what I think are the top CPA review courses currently available feel free to start researching here: http://www.thecpaguide.com/best-cpa-review-courses.html

Also Try Free Trials Of All Major CPA Review Courses Here: Wiley CPAexcel Free 14 Day Trial Roger CPA Review Free Trial Gleim CPA Free Trial Yaeger CPA Free Trial Fast Forward Academy CPA Free Trial ExamMatrix CPA Free Trial Becker CPA Free Trial The Case Study: To use myself as an example, I used Becker CPA because my firm provided it to me for free. This was my first mistake. I did absolutely zero research on the various review courses out there.

http://www.thecpaguide.com/best-cpa-review-courses.html

http://www.thecpaguide.com/out/cpaexcel-trial.html

http://www.thecpaguide.com/out/Roger-Trial.html

https://www.gleim.com/?promoID=CPAGUIDE-CPADemo

http://www.thecpaguide.com/out/Yaeger-trial.html

http://crushpay.com/?a=4&c=47&p=r&s1=

http://www.thecpaguide.com/out/exammatrix.html

http://www.thecpaguide.com/review-courses/becker.html




I relied on word of mouth marketing that everyone at my college was talking about and saw many of my peers using Becker and passing. I made the incorrect assumption that because my peers (some of whom I had better grades than) weren’t actually studying very hard and that their review course was doing all the work for them. Very naïve right? You need to make sure you do your research and that you are mentally prepared to start studying. (more on getting “mentally prepared” in video #1 – watch here: VIDEO #1). I can tell you right now, I was not prepared to make the necessary sacrifices to pass the CPA exam and work full time…

Why My Review Course Didn’t Work For Me Now for this to make sense you need to know how I study and learn best. I call myself a self-studier with mild ADHD (don’t we all…) So when I actually sat down to start watching Becker’s 3-4 hour lectures I literally zoned out within 20-30 minutes and would either have to re-watch the lecture or re-read the text to understand the content. This was wildly inefficient! Because everyone assured me that the Becker system was practically fool proof I didn’t change how I studied and just assumed that there was something wrong with me when I didn’t pass.





This led to a downward spiral of depression and lack of confidence that caused me to fail 4 times in a row…

To make matters even worse I lost my 1st job due to the economy and the fact I hadn’t passed the CPA exam in April of 2009 as part of a massive 20% layoff at my firm. So not only had I not passed a single section yet I was unemployed and only left with enough money in my bank account to pay rent for 4-5 months. It was do or die and I was left with 2 options. 1) Give up and move into my parent’s basement and become a professional Madden and World of Warcraft gamer… OR 2) I could turn my life around and start making the necessary sacrifices to start dominating the CPA exam and my career.

Pro Tip #2: If you ever fail a section of the CPA exam you will immediately notice that you will

start seeing the same multiple choice questions over and over.

While this may seem like a confidence builder because you immediately know the answer, the reality is that it is hurting you!

If you don’t have fresh questions to take then you will have no idea if you truly

understand a topic. This is why it is so important to literally have thousands of extra multiple choice at your disposal.

I recommend the Gleim CPA Test Bank or Wiley Test Bank

http://www.gleim.com/?promoID=CPAGUIDE_FIN

http://www.thecpaguide.com/out/Wiley.html




Thank goodness I went with #2! I stopped looking at myself as being unemployed and decided to invest in my future by giving myself two full time unpaid assignments: 1) Pass the CPA exam 2) Find a job This is where I went a bit crazy and started reaching out to EVERYONE I knew who had passed the CPA exam and spent countless hours online learning new study tactics. Based on what I learned from these successful CPAs I implemented a strict CPA study system for myself that ended up NOT following what Becker’s system recommended. Watch Video #1 to learn the 5 key tips to creating your own strict study plan that actually works. As I mentioned in Pro Tip #2, I realized that since I was going to be re-taking all 4 sections I would need some fresh multiple choice questions. So I took a risk and invested in the Gleim CPA multiple choice test banks. Being the self-studier I am, I cut watching lectures from my study plan, focused ONLY on reading the text and memorizing flashcards. As you will learn in Video #1, I also completely changed how I answer multiple choice questions that ended up adding double digits to my scores! Watch video #1 now to learn exactly what I changed. P.S. Keep an eye on your inbox as well! Video #2 is on its way shortly… P.S.S. Head onto the next page for even more free CPA exam resources & your 100 multiple choice questions.







Free Resources & Multiple Choice Questions At this point, you are probably wondering “Why is Bryan doing all of this?” It’s pretty simple really; the accounting industry changed my life. My blog, this cheat sheet + my free training videos are my way of giving back to this amazing industry. I know that I have an inspirational story and even though I am a bit of an introvert (yep I fit the nerdy stereotype…) I don’t want to hoard all of the tough lessons I learned on my journey to passing the CPA exam. This is why I want to share all of my free CPA exam resources with you today. The CPA Guide Podcast: http://www.thecpaguide.com/podcast.html Compare Top CPA Review Courses: http://www.thecpaguide.com/best-cpa-review-courses.html The CPA Guide Review Course Discount Page: http://www.thecpaguide.com/CPA-Blog/CPA-Discounts.html The CPA Guide Facebook: https://www.facebook.com/thecpaguide The CPA Guide YouTube Channel: https://www.youtube.com/user/theCPAguide The CPA Guide Twitter Account: https://twitter.com/theCPAguide NOTE: Print all 100 Roger CPA multiple choice questions & answer key starting on Page 18-59

http://www.thecpaguide.com/podcast.html

http://www.thecpaguide.com/best-cpa-review-courses.html

http://www.thecpaguide.com/CPA-Blog/CPA-Discounts.html

https://www.facebook.com/thecpaguide

https://www.youtube.com/user/theCPAguide

https://twitter.com/theCPAguide


100 Questions FAR – REG – AUD

Roger CPA Review 2261 Market St. #333 San Francisco, California 94114 www.RogerCPAreview.com (877) 764-4272 (415) 346-4272 (4CPA)

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Copyright 2015 by Roger CPA Review. All rights reserved.

FAR Questions 1 – 34

1. X Co. has an investment in shares of a public company that are temporarily restricted and may not be transferred or sold for a period of 18 months. Unrestricted shares of the public company are actively traded on the New York Stock Exchange and most analysts agree that the restriction would cause investors to discount the stock by 10%. The investment, combined with the fact that X Co.’s CEO serves on the board of directors of this company, give X Co. the ability to exercise significant influence over it. If X Co. reports this investment at fair value, what level of inputs will it indicate in its footnotes was used in the valuation?

a) Level I b) Level II c) Level III d) This investment must be accounted for under the equity method and cannot be reported

at fair value.

2. Company X sells products and service plans both separately and bundled together. Willy Loman, a Company X salesman, sold a Widgetron in year 20X4 for $1,000 and told the customer he’d ‘throw in the 3-year service plan for free.’ The product shipped, the customer paid, and $1,000 in revenue was recognized in 20X4. Is this correct? Why or why not?

a) This is correct because the understanding between the seller and customer was that the product price was $1,000 and the service plan was free, which is in accordance with the principle of faithful representation.

b) This is incorrect because services must be rendered before any revenue can be recognized.

c) This is correct because the product shipped and the customer paid. d) This is incorrect because the services are not truly free and service revenue must be

allocated over the three years of the service plan.

3. Greenway has a variety of financial instruments, some of which are bonds of publicly-held entities. It is Greenway’s business model to hold the bonds for the purpose of collecting the scheduled cash flows, which consist exclusively of principal and interest payments. Under IFRS, Greenway will account for these bonds:

a) At fair value b) At fair value or at amortized cost, whichever the company prefers c) At amortized cost d) At amortized cost unless the fair value option is elected

4. Arnold Co. has a checking account at Neighbor Bank and an interest–bearing savings account at Stranger Bank. On December 31, year 1, the bank reconciliations for Arnold Co. are as follows:

Stranger Bank

Bank Balance $45,000

Deposit in transit 5,000

Book balance $50,000

Neighbor Bank

Bank balance $15,000

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Outstanding checks (15,500)

Book balance ($500)

What amount should be classified as cash on Arnold’s balance sheet at December 31, year

1?

a) $44,500 b) $49,500 c) $45,000 d) $50,000

5. On January 2, 20X4, Crawford Co. purchased 15% of Cobb, Inc.’s outstanding common shares for $600,000. Crawford is Cobb’s largest supplier and upon purchase owns 25% of the Cobb’s voting stock, the largest portion of Cobb’s voting stock held by any one entity or voting bloc. Cobb reported net income of $400,000 for 20X4, and paid dividends of $100,000. Crawford does not elect the fair value option to report its investment in Cobb. In its December 31, 20X4 balance sheet, what amount should Crawford report as investment in Cobb?

a) $670,000 b) $645,000 c) $585,000 d) $600,000

6. ABC Trading Co. commenced operations during the year as a large importer and exporter of sundries. The imports were all from one country overseas. The export sales were conducted as drop shipments. ABC never actually took possession of the goods, which were merely transshipped at Houston. ABC Trading reported the following data:

Purchases during the year $15.0 million

Shipping costs from overseas $1.5 million

Shipping costs to export customers $1.0 million

Inventory at year end $3.0 million

What amount of shipping costs should be included in ABC Trading's year-end inventory valuation?

a) $0 b) $200,000 c) $300,000 d) $500,000

7. Underwater, Inc. had a flood in its plant that destroyed most of its inventory. Its records show that beginning inventory was $20,000. Underwater made purchases of $250,000 and sales of $300,000 during the year. Its normal gross profit percentage is 35%. It can sell some of its damaged inventory for $7,500. The insurance company will reimburse Underwater for 75% of its loss. What amount should Underwater report as loss from the flood?

a) $16,875 b) $50,625

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c) $75,000 d) $24,375

8. Williams Co. uses a periodic inventory system. The following are inventory transactions for the month of March:

3/1 Beginning inventory 5,000 units at $2

3/7 Purchase 2,500 units at $3

3/16 Purchase 2,500 units at $4

3/26 Sales at $8 per unit 7,500 units

Williams uses the average pricing method to determine the value of its inventory. What amount should Williams report as cost of goods sold on the income statement for the month of January?

a) $60,000 b) $20,625 c) $22,500 d) $26,250

9. Assuming constant inventory quantities, which of the following inventory-costing methods will produce a higher inventory turnover ratio in an inflationary economy?

a) FIFO (first in, first out). b) LIFO (last in, first out). c) Moving average. d) Weighted average.

10. X exchanged inventory with Y in a transaction that lacks commercial substance. Both X’s and Y’s inventory had fair values that exceeded their costs by 30%. Since Y’s inventory was more valuable, however, X paid Y cash to compensate for the difference. Who, if anyone, will recognize a gain on the exchange?

a) X only b) Y only c) Both X and Y d) Neither X nor Y

11. During 20X1, X Company manufactured equipment for its own use at a total cost of $2,400,000. The project took the entire year to complete and all costs were incurred uniformly throughout the year. At the beginning of the period X was able to borrow $1,500,000 at 6% specifically for the purchase of materials and the manufacture of the equipment. The entire debt, with interest, was repaid on December 31, 20X1, and replaced with a long-term loan. Throughout 20X1, X Company had additional debt of $1,000,000 with a weighted average interest rate of 7%.

If X Company capitalizes to the equipment the maximum amount of interest allowable under GAAP, how much will X report as interest expense in 20X1?

a) $160,000 b) $153,000 c) $88,000

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d) $70,000

12. On January 1, 20X2, X Company made modifications to an asset used in its manufacturing operations in order to extend its useful life. The asset had an original cost of $30,000 and accumulated depreciation of $12,000, with a remaining useful life of 5 years. As a result of the modification, which cost $6,000, the remaining useful life was increased to 8 years. If X Company uses straight-line depreciation, in 20X2, X Company:

a) Will recognize repairs and maintenance expense of $6,000 and depreciation expense of $2,250.

b) Will recognize repairs and maintenance expense of $6,000 and depreciation expense of $3,600.

c) Will capitalize the cost of the modification and will recognize depreciation expense of $3,000.

d) Will capitalize the cost of the modification and will recognize depreciation expense of $4,800.

13. X Company purchased a copyright on January 3, 20X4 from Y Company for $145,000. An attorney drew up the contract between X & Y at a total cost of $15,000, which was split equally by the parties. The copyright had a carrying value of $90,000 on Y’s books. X expects to be able to benefit from the copyright for 10 years after which it is expected to be of little to no value.

What will be the carrying value of the copyright on X Company’s December 31, 20X6 balance sheet?

a) $160,000 b) $152,500 c) $128,000 d) $122,000

14. On April 1, Keder, Inc. factored $90,000 of its accounts receivable without recourse. The factor retained 8% of the accounts receivable as an allowance for sales returns and charged a 4% commission on the gross amount of the factored receivables. What amount of cash did Keder receive from the factored receivables?

a) $79,200 b) $82,800 c) $84,400 d) $86,400

15. On July 1, 20X13, after recording interest and amortization, Acteon Co. converted $1,000,000 of its 5% convertible bonds into 50,000 shares of $1 par value common stock. On the conversion date the market value of the bonds was $1,250,000, Acteon’s common stock was publicly trading at $21 per share, and the unamortized bond premium and bond issue costs were $30,000 and $50,000, respectively. Using the book value method, what amount of additional paid-in capital should Acteon record as a result of the conversion?

a) $930,000 b) $970,000 c) $870,000 d) $1,000,000

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16. Which of the following describe the terms of convertible debt securities?

I. An interest rate that is generally lower than nonconvertible debt. II. An initial conversion price that is less than the market value of the common stock at time

of issuance. III. A feature to subordinate the security to nonconvertible debt.

a) I and II only b) I and III only c) III only d) I only

17. Green Co. has entered into a sales-leaseback agreement which is classified as a capital leaseback. The present value of the rental payments is greater than 90% of the fair value of the property at inception. How should Green Co. treat gain under this agreement?

a) Recognize all gains immediately b) Defer all gains and offset against depreciation expense c) Defer gains up to the present value of the leaseback payments d) Recognize gains up to the present value of the leaseback payments

18. Juneau Corporation leased land and a building with a remaining useful life of 40 years from Ark and Sass partnership for 35 years. At the inception of the lease, the land had a carrying value of $40,000 and a fair value of $50,000. The building had a carrying value of $40,000 and a fair value of $250,000. How will Juneau record the lease?

a) The land as an operating lease and the building as a capital lease b) The land as a capital lease and the building as an operating lease c) The land and building as a single operating lease d) The land and building as a single capital lease

19. Hebrides Corp. has an employee benefit plan for compensated absences that gives employees 10 paid vacation days and 10 paid sick days. Both vacation and sick days can be carried over indefinitely. Employees can elect to receive payment in lieu of vacation days; however, no payment is given for sick days not taken. Hebrides allows the use of sick days without objective evidence of sickness. At December 31, 20X4, Hebrides's unadjusted balance of liability for compensated absences was $10,000. Hebrides estimated that there were 250 vacation days and 100 sick days available at December 31, 20X4. Hebrides's employees earn an average of $100 per day but will receive raises such that the average daily pay in 20X5 will be $110. In its December 31, 20X4, balance sheet, what amount of liability for compensated absences is Hebrides required to report?

a) $25,000 b) $38,500 c) $35,000 d) $27,500

20. Kemir Co. has a pay-related defined benefit pension plan in which retirement benefits are calculated based on the retiree’s average salary for the 5-year period prior to retirement. Which of the following would represent the greatest potential pension liability?

a) Accumulated benefit obligation (ABO) b) Projected benefit obligation (PBO)

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c) Combined benefit obligation (CBO) d) Vested benefit obligation (VBO)

21. X Company has 100,000 shares of $10 par value common stock and 5,000 shares of $100 par value 5% cumulative preferred stock. No dividends were paid in either 20X2 or 20X3. X Company is planning to pay a cash dividend in 20X4.

If the cash dividend is for $200,000 in total, how much will be received by common stockholders?

a) $200,000 b) $175,000 c) $140,000 d) $125,000

22. X Company issued 10,000 shares of its common stock in exchange for merchandise that it will resell. The merchandise had originally cost the other party $250,000 and had a fair value of $300,000 on the date of the exchange. The retail value of the inventory is $520,000. X Company is not publicly traded and cannot precisely determine the fair value of its stock. It has used some industry averages, however, and applied Black-Scholes-Merton and estimates the fair value of its stock to be about $28 per share. At what amount should the inventory be recorded?

a) $250,000 b) $280,000 c) $300,000 d) $520,000

23. Brick Co. has 170,000 shares of common stock outstanding at January 1, 20X5. On May 1, 20X5, it issued 30,000 additional shares of common stock. Outstanding all year were 12,000 shares of convertible cumulative preferred stock. Each share of the convertible preferred stock, which was dilutive in 20X5, is convertible into one share of Brick’s common stock. What is the number of shares that Brick should use to calculate 20X5 diluted earnings per share?

a) 170,000 b) 202,000 c) 182,000 d) 212,000

24. A company reports the following information as of December 31:

Sales revenue $350,000

Cost of goods sold $150,000

Operating expenses $110,000

Foreign currency translation gain $25,000

Extraordinary gain $35,000

What amount should the company report as comprehensive income as of December 31st?

a) $90,000 b) $125,000

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c) $150,000 d) $115,000

25. Which of the following items requires a prior period adjustment to accumulated other comprehensive income?

I. Available-for-sale securities were improperly valued last year by $3 million. II. The prior year’s foreign currency translation gain of $1.5 million was never recorded. III. Revenue of $4 million that should have been deferred was recorded in previous year as

earned.

a) I, II, and III b) I and II only c) I and III only d) II and III only

26. Maas Co. manufactures heavy equipment to customer specifications on a contract basis. On the basis that it is preferable, accounting for these long-term contracts was switched from the completed-contract method to the percentage-of-completion method. How should Maas. Co. classify and treat the above transaction on its financial statements?

a) Maas Co. should classify the transaction as a change in accounting estimate and make no retrospective adjustments.

b) Maas Co. should classify the transaction as a change in accounting estimate and make retrospective adjustments.

c) Maas Co. should classify the transaction as a change in accounting principle and make no retrospective adjustments.

d) Maas Co. should classify the transaction as a change in accounting principle and make retrospective adjustments.

27. A company preparing its financial statements under IFRS has a net operating loss carry-forward that has the potential to save a total of $40,000 in taxes, $5,000 in the next taxable period and $35,000 in the remaining carry-forward periods. The company considers it likely that there will be sufficient future taxable income to obtain all except $3,000 of the benefit from the carry-forward. The company will recognize

a) A current deferred tax asset of $5,000 and a noncurrent deferred tax asset of $35,000. b) A current deferred tax asset of $5,000 and a noncurrent deferred tax asset of $32,000. c) Deferred tax assets are not recognized under IFRS. d) A noncurrent deferred tax asset of $37,000.

28. According to the installment method of accounting, gross profit on an installment sale is recognized in income:

I. On the date of sale II. In proportion to the cash collection III. By multiplying gross profit percentage times the cash collections

a) I and II only b) I and III only c) II and III only d) I, II, and III

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29. Under the completed contract and percentage-of-completion methods, what account would be debited when preparing the journal entry to record billings?

Percentage-of-Completion Completed-Contract a) Billings Cash

b) Construction Receivable Construction Receivable

c) Cash Billings

d) Construction in Progress Constructions in Progress

30. Red, Inc. had the following activities during 20X4:

Acquired a bond investment for $40,000, which Red intends to hold to maturity.

Sold equipment to another corporation for $24,000 when the carrying value was $22,000.

Acquired a stock investment for $8,500, which Red intends to hold for trading.

Made a loan to an employee for $12,500

Collected interest on a bond investment of $2,500.

In Red’s 20X4 statement of cash flows, net cash used in investing activities should be

a) $37,000 b) $28,500 c) $56,500 d) $39,500

31. Green Co. purchased commercial paper with a maturity of 60 days. Green Co. treats as cash equivalents all highly liquid investments with an original maturity of three months or less when purchased. How should this purchase be reported in Green’s statement of cash flows?

a) Not reported. b) As an outflow from investing activities. c) As an outflow from financing activities. d) As an outflow from operating activities.

32. OK Co. uses the equity method to account for its January 1, 20X4 purchase of FDL Inc.’s common stock. On January 1, 20X4, the fair values of FDL’s FIFO inventory and plant exceeded their carrying amounts. How do these excesses of fair values over carrying amounts affect OK’s reported equity in FDL’s 20X4 earnings?

Inventory Excess Plant Excess a) Decrease Decrease

b) Decrease No Effect

c) Increase Increase

d) Increase No Effect

33. FlanCrest Enterprises, Inc. has $800,000 of notes payable due June 15, 20X6. FlanCrest signed an agreement on December 1, 20X5, to borrow up to $800,000 to refinance the notes payable on a long-term basis with no payments due until 20X7. The financing

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agreement stipulated that borrowings may not exceed 80% of the value of the collateral FlanCrest was providing. At the date of issuance of the December 31, 20X5 financial statements, the value of the collateral was $950,000 and is not expected to fall below this amount during 20X6. In FlanCrest’s December 31, 20X5 balance sheet, the obligation for these notes payable should be classified as

Short-Term Long-Term a) $0 $800,000

b) $40,000 $760,000

c) $160,000 $640,000

d) $800,000 $0

34. On June 30, 20X13, Adonis Co. had outstanding 4%, $4,000,000 face value bonds, originally issued at 98, maturing on June 30, 20X18. Interest was payable semiannually every June 30 and December 31. Adonis did not elect the fair value option for reporting its financial liabilities. On June 30, 20X13, after amortization was recorded for the period, the unamortized bond discount and bond issue costs were $40,000 and $30,000 respectively. On that date, Adonis acquired all its outstanding bonds on the open market at 97 and retired them. At June 30, 20X13, what amount should Adonis recognize as gain before income taxes on redemption of bonds?

a) $10,000 b) $50,000 c) $110,000 d) $130,000

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REG Questions 35 – 67

35. Which of the below prevents a husband and wife from filing a joint tax return?

I. The spouses have different accounting methods

II. The spouses have different tax years, provided that both spouses are alive at the end of

the year

III. One spouse was a nonresident alien for three months during the year and no proper

election was made

a) I and II only

b) II and III only

c) I and III only

d) II only

36. Parker and his wife Marie would have been filing a joint tax return for 20X1, however Marie

died in October of 20X1. Parker has not remarried and continues to maintain a home for

himself and his two children during 20X1, 20X2, 20X3, and 20X4. Parker’s filing statuses for

2011, 2012, 2013, and 2014 are as follows:

20X1 20X2 20X3 20X4 a) Qualifying

widower Married filing joint

return Qualifying widower Head of

household

b) Married filing joint return

Married filing joint return

Head of household Qualifying widower

c) Married filing joint return

Qualifying widower

Qualifying widower Head of household

d) Qualifying widower

Qualifying widower

Head of household Qualifying widower

37. Which of the following is excluded from gross income on an individual’s 20X14 tax return?

a) January 20X15 rent received in December 20X14

b) Value arising from personal use of company vehicle in 20X14

c) Dividends announced by a C Corporation in December 20X13 and received in January

20X14

d) Refundable security deposit received in January 20X14 for a lease ending in July 20X15

38. Doran, a single individual, received $20,000 in social security benefits in 20X14. Doran’s

20X14 provisional income was $65,000. Considering only these facts, what should Doran

report as gross income on Doran’s 20X14 tax return?

a) $75,000

b) $72,000

c) $57,000

d) $65,000

39. On Oct 1, 20X13, Cruz purchased an annuity for $90,000 in post-tax dollars, effective

immediately, that pays Cruz $500 a month until death. At the date of purchase Cruz’s official

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life expectancy was 25 years. How much of Cruz’s 20X13 annuity payments should be

included in Cruz’s gross income for 20X13?

a) $ 0

b) $ 900

c) $ 600

d) $1,500

40. In 20X12 Randall suffered bodily injury while at work. On his 20X12 tax return Randall

deducted related medical expenses of $10,000; and $5,000 in 20X13. In 20X14 Randall won

a worker’s compensation claim and prevailed in an injury lawsuit, both in connection with the

20X12 injury. Randall received the following in 20X14 as settlement:

Punitive damages: $150,000 Worker’s compensation: $ 50,000 Reimbursement for medical expenses: $ 25,000 Compensation for emotional distress caused by the injury: $ 15,000

What amount of the settlement should be excluded from Randall’s 20X14 gross income?

a) $ 75,000

b) $ 60,000

c) $ 90,000

d) $165,000

41. Pierce, a married individual, received the following in 20X14:

Worker’s compensation award: $25,000 W-2 income: $20,000 Unemployment compensation: 4,800 Damages awarded for emotional distress experienced as a result of workplace bodily injury:

10,000

Considering only the above, what is Pierce’s 20X14 gross income?

a) $49,800

b) $34,800

c) $30,000

d) $24,800

42. Cole, a 48-year-old married individual, received the following in 20X14:

S Corp stock dividends: $ 5,000 Interest earned on federal Treasury bills: $ 1,000 Interest earned on municipal bonds: $ 2,500 Interest earned on state income tax refund: $ 50 Interest earned on Series EE savings bonds, used to help pay for room and board for dependent in college:

$ 1,500

Common stock property dividend (FMV): $ 3,000

In addition, Cole spent $500 on lottery scratch-off cards in 20X14. All of the cards were

losers except for one, from which Cole won $1,000.

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Given these facts, what total amount from the above should be included in gross income on

Cole’s 20X14 tax return?

a) $ 4,550

b) $ 6,550

c) $11,050

d) $11,550

43. The Kims are a married couple filing jointly. In 20X14 they qualified for a foreign earned

income exclusion of $99,200. Their 20X14 net investment income was $35,000. Their

20X14 Adjusted Gross Income prior to the foreign earned income exclusion was $380,000.

Given a 3.8% Unearned Income Medicare Contribution Tax rate, what is their 20X14 liability

for this surtax?

a) $4,940

b) $0

c) $1,170

d) $1,330

44. On the night of October 14, 20X14, a hurricane caused serious damage to Paige’s personal

vehicle and to the roof of her personal residence, a townhome. Just prior to the hurricane,

Paige had a $200,000 basis in her home and a $12,000 basis in her vehicle, which had a

fair market value just prior to the hurricane of $10,000. The damage to the roof is appraised

at $7,000 and the fair market value of the vehicle immediately after the hurricane is

appraised at $5,000. Paige is uninsured and has a 20X14 AGI of $40,000. What amount of

casualty loss deduction may Paige claim on her 20X14 tax return as a result of the

hurricane?

a) $9,800

b) $7,900

c) $9,900

d) $7,800

45. Regarding the tax treatment of a business’s research and experimental (R&E) expenditures,

which of the following statements is true?

a) A common reason for electing tax deferral for such expenses is the expectation of lower

tax rates in the future.

b) Expenses associated with the acquisition of land upon which a purpose-built R&E facility

is constructed are considered R&E expenditures for tax purposes.

c) Companies generally prefer to expense R&E costs immediately, but may elect instead to

defer and amortize such costs over a minimum of 60 months.

d) Companies may elect to immediately expense R&E costs incurred in the first applicable

taxable year and all future years through an appropriate filing with the IRS

46. Identify the correct statement below regarding the Domestic Production Activities Deduction

(DPAD).

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a) Qualified Production Activities Income (QPAI) is calculated by applying a percentage to

net income from an IRS rate table based on specific criteria.

b) The DPAD cannot exceed attributable W-2 wages paid.

c) A sole proprietorship cannot claim the DPAD, but a partnership or S corporation with

more than one shareholder can.

d) Taxable income for the purposes of calculating or amending the DPAD includes any net

operating loss (NOL) deduction, such as an NOL carryforward or NOL carryback.

47. Quanti Co., a calendar-year taxpayer, purchased small tools for $5,000 on December 21,

20X14, representing the company’s only purchase of tangible personal property that took

place during 20X14. On its 20X14 tax return, how many months of MACRS depreciation

may Quanti Co. claim on the tools?

a) One-and-a-half months

b) One month

c) Six months

d) None

48. Pinnacle Productions, Inc. holds a luxury skybox season ticket at a local sporting arena.

Pinnacle uses the skybox to entertain clients while holding business meetings. The cost of

Pinnacle’s luxury skybox season ticket is $25,000; the cost of the most expensive non-

luxury season ticket is $15,000. How much of the luxury skybox season ticket cost may

Pinnacle deduct from its taxable corporate income?

a) $7,500

b) $20,000

c) $10,000

d) $15,000

49. Zunilda is 77-year-old individual with an AGI of $25,000 in 2014. She began living in a

nursing home in 2014 upon the recommendation of her primary care physician in order to

receive medical care for a specific condition. She had the following unreimbursed expenses

in 2014:

Expense Amount Nursing home health care costs $5,000 Nursing home meal and lodging costs 8,000 Prescription drugs 1,500

As a result of these unreimbursed expenses, how much may Zunilda deduct from AGI on

her 2014 tax return? Assume Zunilda elects to itemize deductions.

a) $12,000

b) $4,000

c) $12,625

d) $4,625

50. Patel bought a rental property in Year 1 for $150,000. In Year 1 Patel’s Adjusted Gross

Income (AGI) was $100,000 and Patel sustained a $15,000 loss on the property. In Year 2

Patel’s AGI was $140,000 and Patel sustained a $10,000 loss on the property. In Year 3

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Patel sold the property for $175,000. What amount of gain or loss must Patel report on

Patel’s Year 3 tax return as a result of the sale? Assume Patel did not actively participate in

the rental activity in any of the three years.

a) $25,000

b) $0 (no income or loss)

c) $5,000

d) $20,000

51. Mary, a 65 year-old taxpayer, had an adjusted gross income of $150,000 in 20X4. In the

same year, Mary also incurred $20,000 in medical expenses. In computing Mary’s

alternative minimum tax, what will be the adjustment for Mary’s medical expenses?

a) $3,750

b) $5,000

c) $8,750

d) $11,250

52. Corbin had an adjusted gross income in 20X4 of $170,000. Other information is as follows:

Standard deduction $6,200 Personal exemption $3,900 Property and local taxes paid $5,000 Business expenses subject to the 2% AGI threshold

$10,000

What amount will be added back as an adjustment in the calculation of Corbin’s alternative

minimum taxable income?

a) $21,700

b) $25,100

c) $15,100

d) $17,800

53. Keller is a single individual who in 20X14 qualified for a foreign earned income exclusion of

$80,000. Keller’s 20X14 net investment income was $25,000, and Keller’s 20X14 Adjusted

Gross Income prior to the foreign earned income exclusion was $220,000. Given a 3.8%

Unearned Income Medicare Contribution Tax rate, what is Keller’s 20X14 liability for this

surtax?

a) $760

b) $0

c) $950

d) $570

54. On June 1, 20X12, Heloise gave Henrietta a gift of stock worth $10,000. Heloise had

purchased the stock on January 1, 20X12 for $13,000. Henrietta sold the stock to an

unrelated party on January 1, 20X13 for $13,500. What is the amount and character of

Henrietta’s gain or loss upon the sale?

a) $500 short-term capital gain

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b) $3,500 short-term capital gain

c) $500 long-term capital gain

d) $3,500 long-term capital gain

55. Sengupta died on February 1, 20X14 and bequeathed two different assets to a beneficiary,

Roberts. Asset One was distributed to Roberts on April 24, 20X14; Asset Two was

distributed to Roberts on October 25, 20X14. The executor of Sengupta’s estate makes a

qualified alternate valuation date election. The basis of each bequeathed asset will thus be

the fair market value on which date?

Asset One Asset Two a) August 1, 20X14 August 1, 20X14

b) April 24, 20X14 August 1, 20X14

c) April 24, 20X14 October 25, 20X14

d) August 1, 20X14 October 25, 20X14

56. Mikhail owns real estate with a basis of $400,000 and a fair market value of $650,000. He

exchanges it for other real estate with a fair market value of $480,000. In addition, Mikhail is

relieved of a mortgage on the old property of $200,000, assumes a mortgage on the new

property of $100,000, and receives $70,000 in cash. Under Code Section 1031, what is

Mikhail’s recognized gain on the exchange?

a) $170,000

b) $270,000

c) $70,000

d) $350,000

57. On January 15 of the current year Kreutzer, an individual, inherited from Gladstone shares

of stock worth $25,000. Gladstone had purchased the shares in June of the previous year

for $20,000, and the shares were worth $23,000 at Gladstone’s date of death. The executor

of Gladstone’s estate did not elect to use the alternate valuation date. In March of the

current year Kreutzer sold the shares for $27,000. As a result of the sale, what will be the

amount and type of gain reported by Kreutzer?

a) $4,000 long-term capital gain

b) $2,000 short-term capital gain

c) $7,000 short-term capital gain

d) $2,000 long-term capital gain

58. Cowabunga Corp. had a highly profitable Year 4, during which it purchased $1,000,000 in

tangible personal property and elected to claim the highest depreciation expense allowed for

tax purposes under Code Section 179. In Year 6 Cowabunga sells the tangible personal

property, which now has an adjusted basis of $200,000 as a result of the heavy depreciation

taken in Years 4 and 5. Had only MACRS depreciation been taken on the property, its

adjusted basis at the time of sale would have been $800,000. At a sales price of $930,000,

how much of the $730,000 realized gain must be reported as ordinary gain for tax

purposes?

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a) $720,000

b) $600,000

c) $0

d) $730,000

59. Abbott (an S Corporation), Bell, Costello, and Dilbertson form Best Partnership, an equally-

shared partnership. Each partner but Abbott has a December 31 tax year-end; Abbott’s is

June 30. The partners would like to choose a partnership tax year other than one ending

December 31, but do not have a valid business purpose for doing so. Which of the following

is an acceptable tax year-end they may choose for Best Partnership?

I. December 31

II. September 30

III. June 30

a) I and II only.

b) I only.

c) I, II or III.

d) I and III only.

60. The cash method of accounting may be used for tax reporting purposes by which of the

following taxpayers?

a) A partnership with a C Corporation – one with annual revenue exceeding $5 million – as

a partner

b) A C Corporation with annual revenue of $2.5 million which has physical inventory levels

that are material in amount

c) A farming corporation

d) A partnership with a personal service C Corporation – one with annual revenue below $5

million – as a partner

61. Chatterjee is an executive with XYZ Corp. In 20X13, XYZ gave Chatterjee 1,000 non-

qualified stock options, each with an option price of $60, when the price of XYZ stock was

$80. In 20X14 Chatterjee exercised 500 of the stock options, at a time when the price of

XYZ stock was $90. As a result of the above, what amount should Chatterjee include in

20X14 gross income?

a) $0

b) $15,000

c) $10,000

d) $ 5,000

62. On 15 February of the current year Young received a $10,000 lump-sum payment from a

qualified profit-sharing plan, the full amount of which Young rolled over into an IRA 46 days

later. How much of this lump-sum payment may Young exclude from current year gross

income?

a) $0

b) $10,000

c) Depends on contribution limit

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d) $8,000

63. Kudzu, Clemmons and Clancy form KCC Partnership with the following contributions:

Partner Contribution Adjusted Basis Fair Market Value Kudzu Land $52,000 $50,000 Kudzu Services N/A $ 5,000

Clemmons Property $30,000 $40,000 Clancy Property $25,000 $30,000

What amount of taxable income to Kudzu results from the formation of KCC?

a) $5,000

b) $0

c) $7,000

d) $2,000

64. Identify the correct statement below regarding similarities and differences of corporate and

individual taxation.

a) If long-term capital losses exceed their allowable yearly offset to ordinary income, both

individuals and corporations may carry forward the losses and claim them as long-term

capital losses in future years, subject to certain limitations for corporations.

b) Both individuals and corporations can utilize the like-kind exchange provisions of Code

Section 1031.

c) Both individuals and corporations must distinguish between deductions for and

deductions from in calculating taxable income.

d) Corporations can claim the Domestic Production Activities Deduction (DPAD), but

individuals cannot.

65. Harold gives one share of stock in Harold Corp., an S Corp, to each the following

individuals:

His nephew

His son

His adopted step-daughter

His grandson

His cousin

What is the minimum number of additional S-Corp shareholders under Code Section 1361

that will result from this distribution of stock?

a) Three.

b) Four.

c) Two.

d) Five.

66. A corporate group filing a consolidated tax return may

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Eliminate taxation of all intercompany dividends

Freely elect on a year-by-year basis whether to file a consolidated return in subsequent years, subject to certain

limitations

a) Yes Yes b) Yes No c) No Yes d) No No

67. Esrom Corp., a cash basis taxpayer, and Fynbo Corp., an accrual basis taxpayer, are

parent-subsidiary corporations. During Year 3 Esrom bought and paid for $150,000 in

supplies from Fynbo. Additionally, on December 1 of Year 3 the two corporations entered

into an agreement whereby Esrom would provide consulting services to Fynbo, with each

month’s services being payable on the 15th of the following month. During December of Year

3 Esrom provided services under this agreement worth $20,000. Including all of the above

transactions, Esrom’s taxable income for the year amounted to $510,000, while Fynbo’s

amounted to $250,000. What amount of taxable income should Esrom and Fynbo report on

their Year 3 consolidated tax return?

a) $760,000

b) $610,000

c) $780,000

d) $630,000

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AUD Questions 68 – 100

68. Which of the following types of audits would be most appropriate to determine if employees of an entity are complying with the company’s internal control policies and procedures?

a) Operational audits b) Compliance audits c) Performance audits d) Financial statement audits

69. Jenkins Jewelry is being audited by Whitman, CPA. Whitman, who is not skilled in valuing fine jewelry, hires Cindy, an expert jewelry appraiser. What is true about Whitman’s use of Cindy?

a) Whitman should obtain a sufficient understanding of Cindy’s field in order to understand the objectives and scope of Cindy’s work.

b) Whitman is not required to evaluate the adequacy of Cindy’s work. c) Jenkins must consent to Whitman’s use of Cindy. d) Cindy must be independent from Jenkins.

70. While performing an audit on the financial statements of Bentley Company, Tate, CPA discovers fraud that is determined to be immaterial to the financial statements. Tate is ready to issue the audit report, and believes with reasonable certainty that any further work will cause the engagement to exceed its budget. What is Tate’s responsibility concerning the immaterial fraud?

a) Ignore the fraud and issue the audit report because it is immaterial, and Tate has a duty to adhere to budget constraints.

b) Issue an adverse opinion because the financial statements contain fraud. c) Notify those charged with governance about the fraud. d) Withdraw from the engagement and notify the Public Company Accounting Oversight

Board.

71. An auditor discovers several immaterial errors that they determine do not, individually or in aggregate, cause the financial statements to be materially misstated. The auditor proposes adjusting entries to the client, who refuses to correct the errors. Which of the following best summarizes the steps the auditor should take?

a) Document the errors and the conclusion that the financial statements are free from material misstatement.

b) Withdraw from the engagement because the client’s refusal to correct the errors is a scope limitation.

c) Issue a qualified, “except for” opinion on the financial statements because the client refuses to correct the errors.

d) Correct the errors on the client’s behalf, and then issue the audit report.

72. The report resulting from an engagement to verify compliance with contractual agreements or regulatory requirements related to the financial statements will generally include:

I. A disclaimer indicating the procedures applied may not be sufficient for the purpose

intended.

II. A statement that the public is entitled to view the report.

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III. Limited assurance in the form of a statement that the accountant is not aware of any

modifications necessary to bring the statements in compliance with GAAP.

a) I only b) II and III only c) III only d) I, II, and III

73. In deciding whether or not to accept an audit client, which of the following would have the biggest impact on the auditor’s decision?

a) The auditor is not familiar with the industry in which the client operates. b) The client’s predecessor auditor indicated that the client’s management lacks integrity. c) The client’s accounting department is staffed by two people who performing many

overlapping duties that should be segregated. d) The client’s controller is a former manager of the auditing firm.

74. According to the standards of the profession, which of the following circumstances will prevent a CPA performing an audit engagement from being independent?

a) The CPA’s nondependent stepchild recently inherited, from a party unrelated to the CPA, an immaterial amount of stock in the client.

b) The CPA’s firm acts as administrator of a trust which owns 5% of the client’s stock, which makes up 7% of the total assets of the trust.

c) A partner in the firm who works in the same office as the CPA, but performs no services for the client, has a material investment in a mutual fund which invests in the client.

d) The CPA accepted free pizza from the client for working late hours on the audit.

75. Which of the following would impair the independence of a CPA performing an audit?

I. The CPA is a member of the same exclusive country club as the CEO of the client company.

II. The CPA prepares routine invoices for the client. III. The CPA has a money market account with a financial institution client; the account is

material to the CPA’s net worth.

a) I only b) II only c) III only d) Both I and III

76. According to the profession’s standards, which of the following statements is correct regarding the standards a CPA should follow when recommending tax return positions and preparing tax returns?

I. The practitioner should not recommend a position or prepare or sign a tax return taking a position that the practitioner does not believe in good faith will have at least a remote possibility of being sustained on its merits.

II. The practitioner should be aware that the ‘reasonable basis’ of success standard is generally understood to mean that there is approximately a 20% likelihood that a tax position will be sustained on the basis of its merits.

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III. At a minimum, the practitioner should recommend a position or prepare or sign a tax return taking a position in support of which the practitioner can present a well-documented argument.

a) II only b) III only c) II and III only d) I, II, and III

77. Audits of which of the following organizations are subject to the Sarbanes-Oxley Act?

I. All public companies II. Private companies with yearly revenues of $100 million or more. III. All issuer companies

a) I only. b) I, II, and III. c) I and III only. d) III only.

78. Which of the following is most likely a reason to not perform tests of controls?

a) Risk of Material Misstatement is assessed at a lower level. b) Performing tests of controls will be more efficient than performing substantive testing. c) The auditor believes weaknesses exist in the internal control function. d) The auditor believes the internal controls can be relied upon.

79. During the course of an examination, an auditor detected a control deficiency that was currently a significant deficiency that could potentially result in a misstatement to the financial statements. The client has indicated that the cost of developing controls to remedy that deficiency would exceed the benefit and, instead, has initiated certain additional controls to partially mitigate the weakness. As a result:

I. The auditor may decide that internal controls may not be relied upon and enhance the nature, timing, and extent of substantive testing.

II. The auditor may conclude that the additional controls are sufficient and decide to test controls and, based on the outcome, may decide to reduce the nature, timing, and extent of substantive testing.

III. The auditor may issue a modified opinion due to a scope limitation.


80. Even though an audit is well planned and properly executed, a material misstatement due to fraud may not be detected. This may be due to:

I. Fraud may involve collusion or false documentation making it more difficult to detect. II. Auditing employs the use of sampling and a sample without evidence of fraud may not

be representative of the population. III. The evaluation of fraud risk factors requires the application of judgment and is not

precise.

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81. X Company prepares a sales invoice, using a pre-printed sequentially numbered form, upon receipt of a copy of a bill of lading from the shipping department indicating that goods have been shipped. An auditor wishes to obtain evidence that all sales that occurred during the period were actually recorded. Which of the following procedures would likely be most effective for that purpose?

a) Trace entries from the sales journal to sales invoices and customer purchase orders. b) Trace a sample of receiving reports to the sales journal. c) Trace a sample of sales invoices to bills of lading. d) Trace a sample of bills of lading to the sales journal.

82. Which of the following relates to the sufficiency of audit evidence?

a) The client maintains good perpetual inventory records, enabling the auditor to reconcile amounts to inventory counts that were taken prior to year-end.

b) Because of a large number of small balances, the auditor decides to use negative accounts receivable conformations rather than positive confirmations.

c) When no exceptions were discovered in a preliminary sample, the auditor decided that no further testing was necessary.

d) The auditor reviewed vendor invoices to support a sample of purchases rather than rely exclusively on the client’s receiving reports.

83. Which of the following items would be the least persuasive type of audit evidence?

a) A letter of representation signed by the client’s president and chief executive officer. b) A schedule comparing an estimate of interest expense, prepared by the auditor, to the

amount reported on the client’s trial balance. c) A confirmation of bank balances as of year-end received by the auditor directly from the

bank. d) A copy of a bank statement provided to the auditor by the client.

84. Which of the following assertions applies to an audit of inventory?

a) Occurrence b) Classification c) Cutoff d) Completeness

85. Based on the following cash transfer schedule, by how much will cash be overstated as a result of kiting?

Date of Disbursement Date of Receipt

Per Books Per Bank Per Books Per Bank

$3,000 12/31/X1 01/05/X2 12/31/X1 01/04/X2

$3,500 01/04/X2 01/11/X2 12/31/X1 01/04/X2

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$2,700 12/31/X1 01/04/X2 12/31/X1 12/31/X1

$4,100 01/4/02 01/05/X2 12/31/X1 01/04/X2

a) $3,500 b) $7,600 c) $10,300 d) $13,300

86. For which of the assertions below related to accounts receivable will confirmations be least likely to provide supportive evidence?

a) Rights and obligations b) Completeness c) Allocation and valuation d) Existence

87. Which of the following procedures would be appropriate for an auditor testing management’s assertions related to the allocation and valuation of investments in marketable securities?

a) Trace acquisitions to purchase documentation. b) Test the amortization of discount or premium on bond holdings. c) Confirm with 3rd party custodians. d) Review bank confirmations for information about loan collateral arrangements.

88. In testing management’s rights and obligations assertion in relation to inventories, which of the following procedures would the auditor most likely consider most reliable?

a) Review consignment agreements. b) Trace inventory counts to accounting records. c) Trace inventory in accounting records to inventory counts. d) Make inquiries and analyze inventory turnover to identify slow-moving or obsolete items.

89. An auditor was satisfied that the carrying value of factory equipment was fairly stated as of the beginning of the period. During the period, the entity had several transactions involving the purchase and disposal of equipment. Which of the following would be the most effective in providing evidence that all equipment reported in the financial statements actually exists?

a) Select items on the factory floor and trace them to the accounting records. b) Select items from the accounting records and trace them to purchase documents. c) Evaluate the entity’s policies for capitalizing and expensing costs related to the

acquisition of equipment. d) Select items from the accounting records and observe them in the entity’s factory.

90. The auditor wishes to obtain evidence to support management’s assertion as to the completeness of long-term debt. Which of the following procedures would likely be most effective?

a) Trace a sample of loans to the original documentation. b) Trace a sample of loans to subsequent payments. c) Confirm a sample of loans with creditors. d) Review minutes of board of director meetings.

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91. Audit documentation should enable an experienced auditor with no previous connection to the particular audit to understand which of the following?

I. The nature, timing, and extent of procedures performed. II. The results of procedures performed. III. The total difference between items examined and their recorded amounts.

a) I, II, and III b) II and III only c) I and III only d) I and II only

92. The auditor is considering the use of the client’s internal auditors to assist in the audit. As a result, the auditor is evaluating the competence and objectivity of the internal auditors. Factors the auditor will consider when evaluating an internal auditor’s competence will include all of the following except:

a) The internal auditor’s education. b) The internal auditor’s professional certifications. c) The organizational level to which the internal auditor reports d) The internal auditor’s experience.

93. Which of the following procedures would an accountant not be likely to perform during an engagement to review the financial statements of a nonissuer (nonpublic entity)?

I. Testing the days-to-failure assumption in the warranty reserve account II. Obtaining an understanding of the accounting practices in the client’s industry III. Obtaining an understanding of the client’s internal control structure

a) None of the above b) I and III only c) II and III only d) I only

94. Which of the following procedures would an accountant be most likely to perform during an engagement to review the financial statements of a nonissuer (nonpublic entity)?

a) Obtain written representation from management specifically acknowledging management’s responsibility for establishing and maintaining adequate internal control.

b) Analyze all contracts with a potentially material effect on the financial records, such as purchase contracts for large capital expenditures.

c) Obtain an understanding of the client’s segregation of duties regarding the recording and reconciling of financial information.

d) Compare the financial statement actual expenses to budgeted expenses.

95. Which of the following is true about forecasts?

a) Forecasts present management’s expected future results based on externally-provided hypothetical assumptions.

b) Forecasts present what management believes would occur based on hypothetical assumptions in a ‘what if’ scenario.

c) Forecasts present management’s expected future results based on internally-provided hypothetical assumptions.

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d) Forecasts present management’s expected future results based on certain conditions and courses of actions which management believes will occur.

96. X Company is concerned that it does not have enough employees to ensure adequate segregation of duties in its revenue cycle. Which of the following may be performed by the same individual?

a) Approving sales and delivering the inventory from the storage area to the shipping area. b) Opening the mail and reconciling the perpetual inventory records to the physical count. c) Opening the mail and recording entries in the sales journal. d) Recording entries in the sales journal and delivering inventory from the storage area to

the shipping area.

97. If the prescribed Audit Report form of a government agency on behalf of the client differs significantly from Generally Accepted Auditing Standards (GAAS), the auditor may:

I. Replace the form with a more acceptable form in compliance with GAAS II. Reword the prescribed form and sign it III. Choose not to accept the audit engagement

a) I only b) III only c) II and III only d) I, II, and III

98. An auditor discovers that an account balance believed to be materially misstated based on an audit sample was not materially misstated based on the total population of the account balance. This is an example of which of the following sampling types of risks?

a) Incorrect rejection. b) Incorrect acceptance. c) Assessing control risk too low. d) Assessing control risk too high.

99. In a probability-proportional-to-size (PPS) sample with a sampling interval of $10,000, an auditor discovered that a selected account receivable with a recorded amount of $5,000 had an audited amount of $4,000. If this were the only misstatement discovered by the auditor, the projected misstatement of this sample would be

a) $1,000 b) $2,000 c) $5,000 d) $10,000

100. For which of the following audit tests would an auditor most likely use attribute sampling?

a) Inspecting purchase orders for proper approval by supervisors. b) Making an independent estimate of recorded payroll expense. c) Determining that all payables are recorded at year end. d) Selecting accounts receivable for confirmation of account balances

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Copyright 2015 by Roger CPA Review

Answer Key

FAR Questions 1 – 34

1. b) Level I would indicate valuation based on observable market transactions for identical

assets or liabilities in an active market. Since these shares are restricted, identical shares are

not actively traded. Level II indicates valuation based on observable market transactions for

similar assets or liabilities in an active market, which would be the case here since the restricted

shares are similar to the actively traded unrestricted shares and there is consensus as to how

they should be valued. Level III would be appropriate if the valuation was not based on

observable market data. Although the equity method is generally applied when an investor has

the ability to exercise significant influence over an investee, the fair value option may be elected

and the investment may be reported at fair value.

2. d) Since the service plan can be acquired separately, and the products can be used

without the service plan, the products and service plan represent distinct performance

obligations and, as a result, revenue is allocated between them. The revenue allocated to the

product will be recognized as the products are delivered. The revenue allocated to the service

plan, however, will be recognized over the term of the plan as the services are being provided.

3. c) Under IFRS, a financial instrument is accounted for at amortized cost if the entity’s

business model is to hold the asset to collect its scheduled cash flows and if those cash flows

consist exclusively of principal and interest payments. All others are reported at fair value, which

may not be elected. This instrument will be accounted for at amortized cost.

4. d) Normally, both checking accounts and interest-bearing savings accounts are included

in cash and reported in amounts equal to their reconciled balances, the book balances in this

case. When an account is overdrawn, however, it may not be offset against accounts with

positive balances unless they are in the same institution with the right of offset. When that is not

the case, as here, the overdraft is reported as a liability and only the positive balance of $50,000

will be reported as cash.

5. b) The equity method is used when the investor has significant influence over the

operating and financial policies of the investee. Here, due to being Cobb’s largest supplier and

having control of 25% of Cobb’s voting stock, Crawford has significant influence over Cobb

despite owning only 15% of Cobb. Therefore, Crawford must use the equity method since the

fair value option was not chosen. During 20X4, Crawford’s balance sheet $600,000 Investment

in Cobb account is increased by $60,000 to reflect equity in earnings (15% x 400,000 = 60,000)

and decreased by $15,000 to reflect investee dividends received (15% x 100,000), to arrive at a

net reported investment of $645,000 (600,000 + 60,000 – 15,000 = 645,000).

6. c) The shipping costs from overseas are included in inventory costs, but the shipping

costs to export customers are selling costs that are recognized as expense in the period

incurred. Since the $3,000,000 in inventory at year end represents 20% of the $15,000,000

purchased during the year, 20% of the $1,500,000 in shipping costs, or $300,000, will be

included in inventory cost.

7. a) The total goods available for sale is $270,000 (beginning inventory + purchases). This

total is reduced by cost of goods sold of $195,000, which is sales minus profit margin ($300,000

– ($300,000 X 35%)). That leaves $75,000 as ending inventory ($270,000 - $195,000). Of this

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amount $7,500 can be resold, reducing the remainder to $67,500. Underwater receives

reimbursement for 75% of this amount, or $50,625 ($67,500 X 75%). The unreimbursed and

unsold remainder of $16,875, is the amount Underwater should report as loss from the flood.

8. b) In this periodic, average pricing system, the unit price of inventory is $2.75, calculated

by taking the total cost of inventory available (beginning + purchased), or $10,000 + $7,500 +

$10,000 = $27,500 during the period and dividing that by the total number of inventory units

(10,000) available during the period. Cost of goods sold is then 2.75 X 7,500, or $20,625.

9. b) The inventory turnover ratio is calculated by dividing Cost of Goods Sold by Average

Inventory. In an inflationary economy, inventory valued under LIFO will be lower and cost of

goods sold higher than inventory valued under FIFO. These attributes result in a higher

numerator (Cost of Goods Sold) and lower denominator (Average Inventory) in the inventory

turnover ratio, resulting in a higher calculated turnover rate for inventory valued under

LIFO. Either average method will fall between FIFO and LIFO.

10. b) In an exchange that lacks commercial substance involving monetary and

nonmonetary assets, only the party receiving the monetary assets will recognize a gain. Since

X paid cash to Y to compensate for a difference in the values of the inventory exchanged, only

Y will recognize a gain on the exchange.

11. c) The maximum amount of interest that may be capitalized under GAAP is based on the

weighted average cumulative expenditures for the year. Since the equipment required a full

year to manufacture and costs of $2,400,000 were incurred uniformly throughout the year, the

weighted average costs incurred would be ($0 + $2,400,000)/2 or $1,200,000. Capitalized

interest will first be on debt specific to the asset. Since the $1,500,000 borrowed exceeds

weighted average expenditures, capitalized interest will be $1,200,000 x 6% or $72,000. The

remaining interest on the $1,500,000 loan, consisting of $1,500,000 x 6% - $72,000 or $18,000,

and the interest on the other debt, $1,000,000 x 7% or $70,000, or $88,000, will be recognized

as expense.

12. c) When costs are incurred to extend the useful life of a depreciable asset, the costs will

be capitalized, increasing the carrying value of the asset, and the revised carrying value will be

depreciated over the assets extended useful life. At January 1, 20X2, the asset had a carrying

value of $18,000. The $6,000 modification increases the carrying value to $24,000, which will

be depreciated over the assets 8 year remaining useful life at the rate of $3,000 per year.

13. d) X Company will recognize the copyright it its cost of $145,000 plus ½ of the attorney’s

fee of $15,000, or $7,500 for a total of $152,500. It will be amortized over the expected useful

life of 10 years at the rate of $15,250 per year. As of December 31, 20X6, after X held the

copyright for 2 years, accumulated amortization will be $15,250 x 2 or $30,500 and the carrying

value of the copyright will be $152,500 - $30,500 or $122,000.

14. a) Factoring accounts receivable without recourse is the equivalent to a sale of accounts

receivable. The receivables will be eliminated with a credit of $90,000 and the fee earned by

the factor will be debited for $90,000 x 4% or $3,600, which will be recognized as an expense or

loss. The amount retained by the factor for sales returns and allowances, $90,000 x 8% or

$7,200, is debited to a receivable. The net amount of $90,000 - $3,600 - $7,200, or $79,200 will

be the cash proceeds.

15. a) Using the book value method, fair value is not considered and no gain or loss is

recognized. The common stock (par + APIC) is recorded at the carrying amount of the

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converted bonds, less any conversion expenses. Since the carrying amount is $1,030,000 and

the bond issue costs are $50,000, the common stock is recorded at $980,000, with $50,000

recorded as common stock, equal to 50,000 shares at $1 par, and with the remaining $930,000

recorded in APIC.

16. d) Convertible debt securities give the security holder the option of converting the bond

into common stock at a future date and at a predetermined price, which is generally higher than

the stocks market price on the date of issuance, but may be lower in the future while the bonds

are convertible. As a result of the benefit associated with the conversion feature, convertible

bonds generally bear interest at a rate that is lower than bonds that are not convertible. A

feature to subordinate is not typical, and may apply to bonds whether they are convertible or

not.

17. b) A sale-leaseback occurs when the property owner sells property and immediately

leases all or part of it back from the new owner. When the present value of the payments under

the leaseback is equal to at least 90% of the fair value of the property at inception, the

leaseback is accounted for as a capital lease. The sale and the leaseback are considered

related transactions and, as a result, no gain is recognized on the sale. It is instead all deferred

and recognized over the life of the leaseback as a reduction of depreciation expense.

18. d) The lease neither transfers title to the lessee nor includes a bargain purchase option.

As a result, the land is evaluated to determine if it is significant. Since the land, with a fair value

of $50,000, represents less than 25% of the $300,000 fair value of the land and building, the

land will be ignored and the lease will be accounted for as a building lease. The 35 year lease

term exceeds 75% of the useful life of the building and, as a result, the lease will be recorded as

a single capital lease.

19. d) Companies are required to accrue for vested compensated absences, and the accrual

must be made at the wage rate expected to be in effect when the compensated absence

benefits are utilized. Because the paid vacation days are vested, they must be accrued for, and

at the 20X5 wage rate. Therefore, the amount of liability for compensated absences Hebrides is

required to report is $27,500 (250 x 110 = 27,500). Because the paid sick days do not vest,

Hebrides is not required to accrue for them, but it does have the option to do so, which may be

a good idea in this case since Hebrides is not strict in its guidelines for the use of paid sick days

and may be able to reasonably estimate how many of the accrued sick days will actually be

used.

20. b) The VBO represents the value of benefits employees would be entitled to if they

terminated employment as of the balance sheet date. It is the smallest potential pension

liability. The ABO represents the value of benefits employees have earned to date, including

some not yet vested, assuming the employees remain with the company until the average

retirement age. The ABO will be greater than the VBO since it includes the value of benefits

that are both vested and unvested. The PBO represents the value of benefits employees have

earned to date, including both vested and unvested benefits under the assumption that

employees will remain with the company until the average retirement age. It differs from the

ABO in that it takes into account anticipated future pay increases and, in a pay-related plan, will

be higher than the ABO and will represent the highest potential pension liability. There is no

CBO when reporting defined benefit pension plans under GAAP.

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21. d) The annual preferred dividend is $5 x 5,000 shares or $25,000. Preferred dividends in

arrears for 20X2 and 20X3, amounting to $50,000, will be paid first. Current preferred dividends

of $25,000 will be paid next. The remaining $125,000 will be paid to common shareholders in

its entirety.

22. c) A share based transaction with a party other than an employee is recorded at either the

fair value of the goods, services, or other consideration received, or the fair value of the equity

securities being issued, whichever is more reliable. Since the fair value of the merchandise is

known to be $300,000 while the fair value of the stock can only be estimated, the transaction

will be recorded at the $300,000 fair value of the merchandise.

23. b) The number of shares used to calculate basic earnings per share is the weighted

average number of common shares outstanding. That would include the 170,000 shares

multiplied by 12/12 since they were outstanding for the entire year, and the 30,000 shares

issued on 5/1 multiplied by 8/12 since they were outstanding for 8 months. The result is

170,000 + 20,000 or 190,000 shares. Since the convertible preferred shares are dilutive, it will

be assumed that they were converted as of 1/1 into 12,000 shares of common stock. As a

result, the number of shares used to calculate diluted earnings per share will be 190,000 +

12,000 or 202,000.

24. c) Comprehensive income includes net income plus other comprehensive income (OCI);

or all changes in equity during a period except those resulting from investments by owners and

distributions to owners. The company’s net income includes sales revenues of $350,000 minus

costs of goods sold of $150,000 minus operating expenses of $110,000 and plus the

extraordinary gain of $35,000, for a net amount of $125,000. Other comprehensive income

(OCI) includes the foreign currency translation gain of $25,000. Therefore, comprehensive

income equals $150,000 ($125,000 + $25,000).

25. b) Available-for-sale securities are reported at their market values as of the balance sheet

date with unrealized gains and losses reported in other comprehensive income. When they are

improperly valued in a prior year, a correction of the error would require a prior period

adjustment to accumulated other comprehensive income. When consolidating a foreign

subsidiary or reporting an equity method investment in a foreign entity, when the local currency

is the functional currency, amounts are converted from the foreign currency into U.S. dollars

using a process called translation, which will require a translation adjustment, reported in other

comprehensive income, to balance the entry. An omission of a foreign currency translation gain

in a prior period would be corrected with a prior period adjustment to accumulated other

comprehensive income. An error in the recognition of revenue in a prior period affects net

income, not other comprehensive income. As a result, the error would be corrected with a prior

period adjustment to retained earnings, not accumulated other comprehensive income.

26. d) A change in the method of accounting for long-term construction contracts is a change

in accounting principle and is given retrospective treatment.

27. d) IFRS allows the recognition of tax benefits from tax loss carry-forwards only to the

extent that future profits are expected to be available to enable their application. In this case,

only a total of $37,000 will be recognized. IFRS requires that all deferred tax assets and

liabilities are recognized as noncurrent.

28. c) Revenue is recognized on the date of sale under the accrual method and not according

to the installment method of accounting. Under the installment method of accounting, the gross

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profit percentage on a sale is calculated and revenue is recognized by multiplying that

percentage by amounts collected (gross profit % X cash collections). Revenue, as a result, is

recognized in proportion to collections.

29. b) Billings occur when the entity sends an invoice to its client for payment for work

completed to date in accordance with the terms of the contract. The journal entry will consist of

a debit to a receivable account, such as construction receivable, and a credit to billings, in which

the total amount billed is accumulated. Cash is debited when payment is received and

construction in progress is debited as construction costs are being incurred.

30. b) Cash flows from investing activities will include an outflow of $40,000 to purchase a

bond investment held-to-maturity, an inflow of the $24,000 in proceeds from the sale of

equipment, and an outflow of $12,500 for a loan made to an employee. The stock acquisition

would be reported under operating activities since this investment is held for trading. Interest

collected is an inflow of cash reported under operating activities. As a result, net cash outflows

reported under investing activities are (-$40,000 + $24,000 - $12,500) $28,500.

31. a) The purchase of commercial paper maturing in 60 days is an exchange of one cash

equivalent, cash, for another, a highly liquid instrument with an original maturity of 3 months or

less. As a result, there is no inflow or outflow of cash or cash equivalents and the transaction

would not be reported in the statement of cash flows.

32. a) Under the equity method, the investor must amortize any differential between the fair

value and book value of depreciable or amortizable assets held by the investee. Here, both

inventory and plant are amortizable/depreciable assets, so the excess of each’s fair value over

its carrying amount will decrease OK’s Co.’s reported equity in FDL’s 20X4 earnings. OK Co.’s

journal entries to amortize this differential will debit (reduce) the income statement’s Equity in

FDL Earnings account and credit (reduce) the balance sheet’s Investment in FDL account. OK

Co. will amortize the plant over the remainder of the plant’s useful life and expense in 20X4 the

entire excess value of its share of FDL’s inventory, assuming all the inventory is sold in 20X4.

33. b) An entity may report a short-term liability that is expected to be refinanced on a long-

term basis as a noncurrent asset provided the entity can demonstrate both the ability and intent

to do so. Signing an agreement to refinance notes payable on a long-term basis is sufficient to

support the intent and ability. The amount that may be reported as noncurrent, however, is

limited to the amount the entity is able to refinance on a long-term basis as of the balance sheet

date. Since FlanCrest is limited to 80% of the value of the collateral, which is $760,000 (80% x

$950,000), that is the amount that would be reported as noncurrent. The remainder would be

reported as current.

34. b) The cost of redeeming the bonds at 97 is 97% of the face value of $4,000,000 or

$3,880,000. On the date or redemption, the bonds had a carrying value equal to their face value

of $4,000,000, minus the unamortized discount of $40,000, or $3,960,000. This is reduced by

unamortized bond issue costs of $30,000 to give a net amount of $3,930,000, which is the

amount used to recognize gain or loss on redemption. Compared to the amount paid of

$3,880,000, there is a gain on retirement, before tax, of $50,000.

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REG Questions 35 – 67

35. d) A married couple may file a return as married filing jointly only if they use the same

accounting period, although they may use different accounting methods. While a couple

generally cannot file a joint return if either is a nonresident alien at any time during the tax year,

if a nonresident alien is married to a U.S. citizen or resident alien at the end of the year, the

spouses may file jointly.

36. c) A couple may file a joint return if they are married as of the end of the tax year or, when

one spouse has died during the tax year, if they were married as of the date of death. As a

result, Parker would qualify to file a joint return for 20X1. A taxpayer may file a tax return as a

qualifying widow or widower for 2 tax years after the year in which a spouse dies provided the

couple qualified to file a joint return for the year of death; that the taxpayer provided over 50% of

the cost of maintaining the principal residence of a dependent child or stepchild; and that the

taxpayer has not remarried as of the end of the current year. As a result, Parker will file as a

qualifying widower for 20X2 and 20X3. In 20X4, Parker may no longer file as a qualified

widower but may file as a head of household, which is an unmarried taxpayer that maintains a

home that is the principal residence of a qualifying relative, such as a child.

37. d) A refundable security deposit is not deductible at the time it is paid and is not taxable

when it is received at the termination of a lease. Rent received in advance is taxable in the

period received, not the period to which it applies, making the January 20X15 rent taxable in

20X14. Noncash compensation received from an employer, other than normal employee

discounts are taxable to an employee, including the value arising from the use of a company

vehicle or other company assets. Dividends are taxable in the period received, 20X14, not the

period in which they are declared.

38. b) In determining if Social Security benefits are taxable, the taxpayer will compare

provisional income, $65,000 in this case, to a base amount, $25,000 for a single individual and

$32,000 for a married couple filing jointly. If the provisional income is lower, none of the Social

Security benefits will be taxable. Although there is a formula to determine the amount of taxable

Social Security benefits when provisional income exceeds the base amount, when provisional

income exceeds $60,000, 85% of Social Security benefits are generally taxable. Since

provisional income includes ½ of Social Security benefits, or $10,000, the remainder must be

$55,000. In addition to that, 85% of the $20,000 in Social Security benefits are taxable for a

total of $72,000.

39. c) The amount of a purchased annuity that is excluded from gross income is calculated

using a formula that compares the total cost to the total expected return, multiplied by the

amount received. At $500 per month, Cruz will receive $6,000 per year or $150,000 over a 25

year life expectancy. With a cost of $90,000, $90,000/$150,000 or 60% of each payment

received is excluded from gross income and the remaining 40% is included. In 20X13, Cruz

received payments in October, November, and December for a total of $500 x 3 or $1,500.

Only 40% or $600, would be included in gross income.

40. a) Punitive damages are fully taxable as are amounts received as reimbursements for

medical expenses that were taken as itemized deductions on the taxpayer’s return. As a result,

Randall would be taxed on the $150,000 of punitive damages and $15,000 of the reimbursed

medical expenses. Randall would exclude from income the $50,000 worker’s compensation

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award; the $15,000 compensation for emotional distress caused by the injury, which is treated

as a physical injury; and $10,000, representing the portion of reimbursed medical expenses that

Randall had not deducted. As a result, the amount to be excluded will be $50,000 + $15,000 +

$10,000 or $75,000.

41. d) Neither worker’s compensation awards nor damages received for bodily injuries are

taxable. Emotional distress due to a physical injury is considered equivalent to a physical injury

and is also not taxable. Pierce would include the $20,000 in W-2 income and the $4,800 in

unemployment compensation, which is fully taxable, in gross income.

42. b) Cole will include the $1,000 interest earned on federal Treasury bills, the $50 interest

on the state income tax refund, the $1,500 in interest earned on the Series EE savings bonds,

and the $3,000 common stock dividend. In addition, the $1,000 in winnings from lottery tickets

will also be included for a total of $1,000 + $50 + $1,500 + $3,000 + $1,000 or $6,550. Stock

dividends are generally not taxable to the recipient but, rather, adjust the shareholders’ bases in

shares held. Likewise, interest on municipal bonds is not taxable. The $500 spent on lottery

tickets will be deductible, but as an itemized deduction, not as a reduction of gross income.

43. d) The surtax is imposed on the lesser of the taxpayer’s net investment income and the

excess of modified adjusted gross income (MAGI) over a threshold amount, which is $250,000

for married couples filing jointly. MAGI consists of adjusted gross income before a foreign

earned income exclusion, $380,000 for the Kims, resulting in an excess of $130,000. The Kims

will pay the surtax on their net investment income of $35,000 at 3.8% for a total of $1,330.

44. b) The hurricane damage results in a casualty loss, which will be measured as the lower

of the reduction in fair value of the subject property or the excess of the carrying value over the

fair value after the loss. The loss on the roof is $7,000 and the loss on the vehicle is the

reduction in the fair value from $10,000 to $5,000, or S5,000 for a total loss of $12,000. Since

both amounts resulted from the same event, they are treated as a single casualty. The

allowable loss is reduced by $100, to $11,900, and is further reduced by 10% of AGI, or $4,000,

for a deductible casualty loss of $7,900.

45. c) R & E expenditures are generally capitalized but a taxpayer may elect to deduct them

in the period occurred. The election, if made in the first tax year in which R & E expenditures

are incurred, requires no filing with the IRS. Such an election is binding for the current and

future periods unless a change is approved by the IRS. As an alternative, the taxpayer may file

an election to defer and amortize R & E expenditures over a period that does not exceed 60

months. One reason companies will defer and amortize R & E costs is the anticipation of

higher, not lower, tax rates in the future. Land and depreciable property are not considered R &

E expenditures qualified for immediate deduction or amortization over 60 months.

46. d) A DPAD is allowed to taxpayers that have Qualified Production Activities Income

(QPAI); AGI or taxable income, as appropriate for the taxpayer; and W-2 wages paid to

employees engaged in the production of the QPAI. The amount of the deduction is not

determined using a rate table; it is 9% of the lesser of QPAI or taxable income, subject to a limit

of 50% of attributable W-2 wages paid. Sole proprietorships, partnerships, and S corporations

all may take advantage of the DPAD. For purposes of calculating the DPAD, taxable income

does not include a deduction for the DPAD but does include net operating losses.

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47. a) In most cases, MACRS involves applying the half-year convention under which assets

are amortized for ½ year in the year of acquisition and in the year of disposal. When an entity

acquires at least 40% of its depreciable and amortizable assets in the final 3 months of the year,

the mid-quarter convention is applied under which depreciation is calculated only for ½ of the

last quarter of the year, or 1 ½ months.

48. a) Although business meals and entertainment are legitimate business expenses, the cost

of a luxury box is only includible as meals and entertainment expense to the extent that it does

not exceed the cost of the most expensive non-luxury seat in the venue. As a result, $15,000

would be includable. Since only 50% of business meals and entertainment is deductible, the

deduction will be limited to $7,500.

49. c) The $1,500 cost of prescription drugs and the $5,000 of nursing home health care

costs would be included in Zunilda’s medical expenses. When a taxpayer resides in a nursing

home due to needed medical care, as is the case, the cost of meals and lodging are also

included, resulting in total medical expenses of $14,500. Taxpayers who are 65 or older reduce

medical expenses by 7.5% of AGI to determine the deductible amount. As a result, Zunilda may

deduct $14,500 – 7.5% x $25,000 ($1,875) for a deduction of $12,625.

50. b) Since Patel did not actively participate in the rental activities, the losses are passive

activity losses and only deductible to the extent of passive activity income. As a result, Patel’s

losses of $15,000 in year 1 and $10,000 in year 2 are not deductible and will be deferred in the

total amount of $25,000. Upon sale of the property in year 3, there is a gain of $175,000 -

$150,000 or $25,000 (ignoring depreciation recapture), which is reduced by the deferred losses

of $25,000 resulting in no taxable gain.

51. a) The alternative minimum tax (AMT) is based on AMT Income (AMTI), which is regular

taxable income after making adjustments that involve adding back the standard deduction;

reducing medical expenses by 10%, instead of 7 ½% of AGI; eliminating any personal and

dependent exemptions; adding back local and state income taxes; and adding back any

itemized employee business expenses. With AGI of $150,000, Mary had reduced medical

expenses by 7 ½% or $11,250. For AMTI, medical expenses are reduced by 10% of AGI, which

would be $15,000, requiring an adjustment for the difference of $15,000 - $11,250 = $3,750.

52. a) The alternative minimum tax (AMT) is based on AMT Income (AMTI), which is regular

taxable income after making adjustments that involve adding back the standard deduction;

reducing medical expenses by 10%, instead of 7 ½% of AGI; eliminating any personal and

dependent exemptions; adding back local and state income taxes; and adding back any

itemized employee business expenses. The adjustment to calculate AMTI would be the

standard deduction of $6,200 plus the personal exemptions of $3,900, plus property and local

taxes paid of $5,000, plus the business expenses in excess of 2% of AGI, or $10,000 – (2% x

$170,000) = $6,600 for a total adjustment of $21,700.

53. a) The surtax is imposed on the lesser of the taxpayer’s net investment income and the

excess of modified adjusted gross income (MAGI) over a threshold amount, which is $200,000

for a single individual. MAGI consists of adjusted gross income before a foreign earned income

exclusion, $220,000 for the Keller, resulting in an excess of $20,000. Since this is lower than

net investment income of $25,000 Keller will pay the surtax on the excess of $20,000 at 3.8%

for a total of $760.

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54. a) When property that has declined in value is received as a gift, the recipient’s basis will

depend on whether the property is ultimately sold at a gain or a loss. Since the value of the

stock was lower than its basis on the date of the gift, Henrietta will use the higher amount, the

basis, for computing gains, and the lower amount, the value on the date of gift, for computing

losses. If the stock is sold for $13,500, since it is greater than the gain basis of $13,000, it will

be used to compute the gain, which will be $500. Since the sale resulted in a gain, Henrietta’s

holding period will include Heloise’s, indicating that the stock was held for 1 year, making the

gain a short-term capital gain. If Henrietta had sold the stock on January 2, the gain would have

been a long-term capital gain.

55. b) As a general rule, a beneficiary’s basis in inherited property will be either the value at

the date of death, February 1, 20X14, or the alternate valuation date if elected by the executor

of the estate. When the alternate valuation date is elected, it will be 6 months after the date of

death, August 1, or the date on which the property is distributed or disposed of if occurring

between the date of death and the alternate valuation date. The executor did elect the alternate

valuation date and since asset one was distributed between 2/1/X14 and 8/1/X14, it will be

valued as of the date of distribution, 4/24/X14. Asset 2 was not distributed until after 8/1/X14

indicating that it will be valued as of that date.

56. a) A gain on an exchange of similar property, considered a like-kind exchange under

Internal Revenue Code Section 1031, can be deferred. Gain must be recognized, however, to

the extent of boot that is received. Boot includes unlike property, such as the cash of $70,000,

and the relief of debt to the extent that it exceeds new debt assumed. Mikhail is being relieved

of $200,000 in debt while assuming $100,000 in new debt. The difference of $100,000 is

considered boot and Mikhail will recognize a gain on the exchange of $100,000 + $70,000 or

$170,000.

57. a) The gain or loss on the sale of inherited property is always considered long-term. The

basis in inherited property will be equal to the property’s fair value at the date of death, unless

the alternate valuation date, six months after the date of death, is elected. Since it was not,

Kreutzer’s basis in the property would be $23,000, the value at Gladstone’s death, resulting in a

long-term capital gain of the difference between the $27,000 sales price and the basis, or

$4,000.

58. d) Depreciable tangible personal property is considered Section 1245 property and is

subject to recapture of all depreciation taken. With an original cost of $1,000,000 and an

adjusted basis of $200,000, a total of $800,000 in depreciation has been taken and the first

$800,000 of gain on sale will be treated as ordinary income. The property was sold for

$930,000, which results in a gain of $730,000, all of which will be ordinary.

59. a) In general, a partnership is required to adopt a tax year that coincides with the tax

years of a majority of the partners, which would be 12/31, and generally is required to have a

business purpose for selecting another tax year. Under Internal Revenue Code section 444,

however, an election can be made for an alternative tax year provided the deferral period of the

taxable year elected is no longer than 3 months. This would also allow the partnership to adopt

a 9/30 year end.

60. d) In general, a taxpayer will calculate taxable income using the same method of

accounting used for maintaining the taxpayer’s books and records. The cash method, however,

may not be used in certain circumstances, including a C corporation or a partnership with a C

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corporation as a partner or a corporation or partnership with average annual gross receipts

exceeding $5,000,000 per year. A corporation engaged in farming, or a partnership engaged in

farming with a corporate partner, is required to compute taxable income on an accrual basis. A

personal service corporation is treated as an individual taxpayer and, as a result, a partnership

with a personal service corporation as a partner that does not have average annual revenues in

excess of $5,000,000 may use the cash basis.

61. b) Non-qualified stock options are taxable when they are exercised, in an amount equal to

the difference between the stock’s selling price and the option price. Chatterjee exercised 500

options when the selling price was $90, compared to an option price of $60. As a result,

Chatterjee will recognize compensation income of 500 x $30 or $15,000.

62. b) A distribution from a qualified profit-sharing plan is excluded from income to the extent

that it is transferred to an eligible retirement plan, such as an IRA, within 60 days. Since Young

transferred the distribution in 46 days, it would be excludable from income in its entirety.

63. a) When cash or property is contributed to a partnership in exchange for a partnership

interest, the transaction is not taxed and the tax bases and holding periods remain unchanged.

Services contributed in exchange for a partnership interest, however, are taxed at their fair

market value, $5,000 in this case.

64. b) Section 1031 of the Internal Revenue Code relates to exchanges of property for similar

property in “like-kind” exchanges and applies to corporations and individuals. An individual may

carry forward nondeductible capital losses and they retain their character as being long-term or

short-term. A corporation may carry nondeductible losses back 3 and forward up to 5 years with

all carrybacks and carryforwards treated as short-term. Whereas a corporation does not

distinguish between deductions for and deductions from taxable income, these distinctions are

important to an individual due to the different limitations placed on various income and

deduction items. The Domestic Productions Activities Deduction applies to both individual and

corporate taxpayers.

65. c) For purposes of determining that there are no more than 100 shareholders of an S

corporation, shareholders that are directly related, going up to six generations, may be treated

as a single taxpayer. As a result, Harold’s son, adopted step-daughter, and grandson will all be

considered the same as Harold and will not result in any additional shareholders. Harold’s

nephew and cousin will each be an additional shareholder, indicating an addition of two.

66. b) When consolidated tax returns are filed, corporations will eliminate intercompany

profits, interest, and dividends. An election to file a consolidated return is binding on the current

and all future years and may not be changed from year to year on a discretionary basis.

67. c) The transaction involving $150,000 in supplies resulted in income to Fynbo and an

expense to Esrom and, therefore, no net effect. Since Esrom is on the cash basis, no revenue

from the services performed in December would have been recognized. Since Fynbo is on the

accrual basis, however, the $20,000 in expense would have been accrued. This intercompany

transaction will be eliminated, increasing Fynbo’s income by $20,000 to $270,000, which, when

combined with Esrom’s income will provide consolidated income of $780,000.

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AUD Questions 68 – 100

68. a) Operational audits, often performed by internal auditors and governmental auditors, are

designed to determine if an entity is operating as it is expected to, including the execution of

duties in accordance with the entity’s internal control policies and procedures.

69. a) When using the work of a specialist, the auditor should obtain a sufficient

understanding of the field of expertise of the specialist to enable the auditor to determine the

nature, scope, and objectives of the work of the auditor’s specialist, and evaluate the adequacy

of that work for the auditor’s purposes. It is the auditor’s decision to use a specialist and the

client’s consent is not required. Independence is not required by a specialist, but the auditor

should be aware of the relationship when evaluating the specialist’s findings.

70. c) An auditor is required to report all occurrences of fraud to those charged with

governance, at least one level above where the fraud occurred. There is no materiality threshold

when it comes to fraud, and budget constraints do not excuse an auditor from performing their

duties. The occurrence of fraud does not automatically require a qualified or adverse opinion.

The occurrence of fraud does not require an auditor to withdraw from an engagement, and it is

not the auditor’s responsibility to disclose the fraud above those charged with governance.

71. a) Since the errors are not fraudulent and do not cause the financial statements to be

materially misstated, it is acceptable for the auditor to issue the audit report so long as the audit

documentation would enable an experienced auditor not associated with the audit to reach the

same conclusion. It is not necessary for an auditor to withdraw from an engagement over a

client’s disagreement regarding immaterial errors, and such a disagreement is not a scope

limitation. As the financial statements are not materially misstated, nothing about the errors

would prevent an unqualified opinion from being issued. It is management’s responsibility, not

the auditor’s, to make changes to the financial statements, including adjusting journal entries.

72. a) The report resulting from an engagement to verify compliance with contractual

agreements or regulatory requirements related to the financial statements will generally include:

the accountant’s findings; a disclaimer indicating the procedures applied may not be sufficient

for the purpose intended; and a statement restricting the distribution of the report only to parties

knowledgeable about the agreed-upon procedures. No assurance is provided.

73. b) Any knowledge of management lacking integrity would prevent an auditor from

accepting an engagement. An auditor may accept a client who is in an industry they are not

familiar with, so long as they obtain the understanding and knowledge required prior to starting

the audit. While a lack of segregation of duties would be a control deficiency that the auditor

would document during the audit, it would not prevent the auditor from accepting the

engagement. It is acceptable to accept a client who employs a former employee of the auditing

firm provided the independence requirements have been complied with.

74. c) A partner working in the same office as the CPA is a ‘covered member’ and therefore

cannot have a material indirect financial interest in the client. A material investment in a mutual

fund which invests in the client is considered a material indirect financial interest in the client,

and therefore independence is impaired. Any direct financial interest in the client held by the

auditor or the auditor’s immediate family impairs independence; however, a direct financial

interest held by a close relative such as a nondependent stepchild does not impair

independence unless the close relative holds a key position with the client or has a material

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financial interest in the client. Because the amount of stock inherited by the stepchild is

immaterial, it does not impair independence. Independence is impaired when the auditor or the

auditor’s firm acts as trustee, executor, or administrator of a trust or estate entity owning more

than 10% of the client or if the entity’s investment in the client exceeds 10% of the entity’s total

assets. Since neither of these cutoffs are met, independence is not impaired. Receipt of token

gifts such as pizza for working late does not impair audit independence.

75. b) Social club membership does not impair independence. Holding a checking, savings or

money market account with a financial institution client does not impair independence – though

holding a mutual fund account does. Preparing invoices for the client is considered taking on

the role of management and therefore impairs independence.

76. a) A tax practitioner should only support a tax position which he or she believes in good

faith has at least a reasonable basis, generally understood as a 20% likelihood, of being

sustained on its merits. Merely being arguable does not necessarily meet the reasonable basis

threshold. While supporting a position with a realistic possibility (33% likelihood threshold) of

success is preferable, the practitioner may still recommend or even prepare or sign a tax return

which meets only the reasonable basis / 20% standard, provided adequate disclosure of the tax

position is either provided in the tax return prepared or signed by the practitioner, or urged upon

the client if the practitioner does not actually prepare or sign the tax return. In all cases the

practitioner should advise the client regarding potential penalties related to tax positions taken

and the possibility of avoiding penalties through adequate disclosure.

77. c) Audits of all public companies, also known as issuer companies, are subject to the

Sarbanes-Oxley Act. Private company audits are not subject to the Sarbanes-Oxley Act.

78. c) Tests of controls are performed to enable an auditor to determine if an internal control

may be relied upon. When the auditor believes that weaknesses exist in the control function, it

is less likely that controls will be relied upon and tests of controls will not be

performed. Assessing risk of material misstatement at a lower level indicates a reduced level of

control risk, which means that the auditor will be relying on internal controls. Internal controls

may only be relied upon if tests of controls are performed. If performing tests of controls will be

more efficient than substantive testing, that would be a reason to perform tests of controls, not

the reverse.

79. a) When an auditor detects a significant deficiency, the auditor may decide that the

deficiency renders controls unreliable, in which case control risk will be set at maximum and the

auditor will enhance the nature, timing, and extent of substantive testing. If, on the other hand,

the auditor determines that other controls adequately mitigate the deficiency, the auditor may

decide to test controls to determine if the system can be relied upon and, if so, reduce the

nature, timing, and extent of substantive testing. A deficiency in internal control is not a scope

limitation and would not cause the auditor to issue a modified report.

80. d) Even a properly planned and performed audit may not detect a material misstatement

resulting from fraud because of concealment aspects of fraudulent activity, including the fact

that fraud often involves collusion or false documentation and the need to apply professional

judgment in the identification or evaluation of fraud risk factors and other conditions. In addition,

since an audit involves the use of sampling, it is possible that a sample may not have all of the

characteristics of the population, causing the auditor to overlook a fraudulent misstatement.

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81. d) To obtain evidence as to the completeness assertion, an auditor would trace a sample

from the population of source documents to the accounting records. A bill of lading is prepared

for goods shipped, which would include all sales. Tracing bills of lading to the sales journal will

indicate to the auditor whether all of those selected were recorded, which would support the

conclusion that all sales were recorded. Tracing from the sales journal to source documents

supports the assertion that the recorded sales actually occurred. Receiving reports would relate

to purchases, not sales. Tracing sales invoices to bills of lading would provide evidence that

those transactions for which sales invoices were prepared for actually occurred.

82. c) The sufficiency of audit evidence relates to the quantity of evidence obtained. This

would include decisions related to how much testing was necessary or the size of samples used

in audit tests. Decisions whether reconciliation to records is sufficient in place of observation,

whether to use positive or negative confirmations, and what types of supporting documentation

are necessary to examine all relate to the reliability of audit evidence, not the sufficiency.

83. a) The least reliable type of evidence is that which was prepared by the client, such as a

letter of representation signed by client management or executives. Information prepared by an

outsider but received from the client, such as a copy of a bank statement, is more reliable than

evidence prepared by the client. Evidence obtained directly from an outsider, such as a bank

confirmation mailed directly to the auditor, would be more reliable than evidence prepared by an

outsider and received from the client. The most reliable form of evidence is that obtained

directly by the auditor, including the development of expectations based on the auditor’s direct

knowledge. This would apply, for example, to an estimate of interest prepared by the auditor to

be compared to the client’s reported amount.

84. d) Completeness is an assertion that applies to both classes of events and transactions

as well as to account balances. Assertions related to inventory, which represents an account

balance, include rights and obligations, allocation and valuation, existence, and

completeness. Occurrence, classification, and cutoff are assertions that relate to classes of

events and transactions but not to account balances.

85. b) Kiting is a fraud scheme in which transfers are recorded in the account receiving the

money in a period earlier than the period in which the disbursement is recorded. The date on

which the bank recognized the receipt or disbursement is not relevant. The transfers for $3,500

and $4,100 were both disbursed in 20X2 but recognized as received in 20X1 for a total

overstatement of $7,600.

86. b) A confirmation provides evidence regarding a receivable that is recorded. If a valid

receivable was not properly recorded, indicating the records were incomplete, no confirmation

would be sent out and the auditor would not, through confirmation, learn of the lack of

completeness. Confirmations do provide evidence regarding rights and obligations since, when

a customer confirms an accounts receivable, the confirmation verifies that the receivable is

owed to the client. Confirmations indicate the amount owed to the client as of the date specified

on the confirmation, which provides evidence that the gross amount reported as accounts

receivable is accurate. Confirmations provide the auditor with an independent verification that

the client has a claim to money, in the form of an accounts receivable, providing evidence of the

receivable’s existence.

87. b) The amortization of discount or premium on bond holdings will affect the amount at

which bonds are reported, which relates to managements assertion as to valuation and

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allocation. Tracing acquisitions to purchase documentation provides evidence of existence and

rights and obligations. Tracing acquisitions to purchase documentation provides evidence of

existence and rights and obligations. Confirming with 3rd party custodians provides evidence

about existence. Reviewing bank confirmations for information about collateral arrangements

will provide evidence about rights and obligations.

88. a) Reviewing consignment agreements will provide the auditor with evidence as to which

inventory is owned and which is held on consignment, providing evidence relative to the client’s

rights to the inventory. Tracing counts to accounting records will provide evidence about the

completeness of the accounting records. Tracing items in the accounting records to counts will

provide evidence that reported items exist. Identifying slow-moving and obsolete inventory will

provide evidence that supports the valuation of inventory.

89. d) By selecting items from the accounting records and observing them in the entity’s

factory, the auditor can determine that items that are included in the accounting records actually

do exist. Tracing items seen on the factory floor to the accounting records provides evidence

that the accounting records are complete. Tracing items from the accounting records to

purchase documents provides evidences of rights and obligations. Evaluating the entity’s

policies for capitalizing and expensing costs related to equipment acquisitions provides

evidence about valuation and allocation.

90. d) Reviewing minutes of board of director meetings will provide evidence as to when the

board has approved financing transactions, which can then be traced to recorded liabilities to

make certain that amounts recorded are complete and include all loans. Tracing loans to

original documentation or to subsequent payments and confirming loans with creditors will

provide evidence about the existence of the loans, the entity’s rights and obligations in relation

to the loans, and the correctness of the amount, supporting valuation and allocation.

91. d) Audit documentation is required to enable an experienced auditor with no previous

connection to the audit to understand the nature, timing, and extent of procedures performed;

the results of procedures performed and evidence obtained; and significant findings,

conclusions reached, and judgments made. There is no requirement that they provide a total of

the difference between examined items and their recorded amounts.

92. c) The organizational level to which an internal auditor reports is a factor affecting the

internal auditor’s objectivity. Factors affecting competence, which is the ability of the internal

auditor to perform the tasks effectively, include education, experience, and professional

certifications.

93. b) An accountant will generally not need to perform detailed tests of financial records

supporting the financial statements in order to obtain sufficient review evidence; therefore,

testing the days-to-failure assumption in the warranty reserve account is unlikely. For

compilations, reviews and audits, an accountant must either have or obtain an understanding of

the accounting practices in the client’s industry; therefore, doing so is likely during a review.

Gaining an understanding of the client’s internal control structure is beyond the scope of a

review, but is required for an audit.

94. d) Comparing financial statement actual expenses to budgeted expenses is a broad-

based analytical procedure commonly conducted during reviews, which consist of inquiries and

analytical procedures. While obtaining a management representation letter is required for a

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review, management is not required to specifically address internal control in the letter.

Analyzing contracts with a potentially material effect on the financial records would be unusual

for a review, while analyzing all such contracts would be highly unusual for an audit, much less

a review. Segregation of duties regarding the recording and reconciling of financial information

is a key component of internal control; gaining an understanding of the client’s internal control

structure is beyond the scope of a review, but is required for an audit.

95. c) Forecasts and projections are the two forms of prospective financial statements.

Forecasts hinge upon hypothetical assumptions, but only hypothetical assumptions which

management specifically believes to be true, whether internally or externally provided.

96. b) Opening the mail gives an employee access to cash. Reconciling physical counts of

inventory to perpetual records is unrelated and would not be incompatible if performed by the

same individual. Approving sales and delivering inventory gives an individual both authority and

custody, which are not compatible. Either opening the mail and recording entries in the sales

journal, or recording entries in the sales journal and delivering inventory, have the same

individual involved in both custody and recording, which are not compatible.

97. c) If the prescribed Audit Report form of a government agency on behalf of the client

differs significantly from GAAS, the auditor may reword the prescribed form and sign it, attach a

separate audit report to the form, or choose not to accept the audit engagement. The auditor

may not replace the form.

98. a) Incorrect rejection means rejecting a population because of a projected error that is

based on a sample exceeds the tolerable misstatement despite the fact that the actual error in

the population is below the tolerable misstatement. Incorrect acceptance would occur when a

projected error that is based on a sample is lower than the tolerable misstatement when the

actual error in the population is higher. Assessing control risk too low or too high results from a

deviation rate detected in an attribute sample, not one applied to an account balance.

99. b) Under PPS sampling, an error is weighted based on the relationship of an item tested

to the designated interval. If the item is for an amount equal to or larger than the interval, the

error is measured at its actual amount. If the item is for an amount that is smaller than the

interval, the error will be increased proportionately using the ratio of the value of the item tested

to the interval amount. A $5,000 item is 50% of the interval amount of $10,000. As a result, an

error of $1,000 on a $5,000 item would be equal to 50% of a comparable error on a $10,000

item, which would make the estimated error $2,000.

100. a) Attribute sampling is used to determine whether a population has a particular attribute.

Inspecting purchase orders for proper approval involves determining whether or not the

transactions, purchase orders, have a particular attribute, approval, calling for attribute

sampling. Tests involving the amount of an expense, the valuation of an account, or account

balances would employ variable estimation sampling since the auditor would be trying to

evaluate the appropriateness of an amount.

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