QUESTION: Analytical procedures used in the review stage of an audit generally include:

1. retesting control procedures that appeared to be ineffective during the assessment of control risk.
2. performing tests of transactions to corroborate managements financial statement assertions.
3. considering unusual or unexpected account balances that were not previously identified.
4. gathering evidence concerning account balances that have not changed from the prior year.
ANSWER: The correct answer is C. The objective of analytical procedures in the review stage of the audit
is to assist the auditor in assessing the conclusions reached and the evaluation of the overall financial
statement presentation. The audit review would generally include considering unusual or unexpected
balances or relationships that were not previously identified.

QUESTION: Which question would an auditor least likely include on an internal control questionnaire
concerning the initiation and execution of equipment transactions?
1. Are requests for major repairs approved at a higher level than the department initiating the
request?
2. Are prenumbered purchase orders used for equipment and periodically accounted for?
3. Are requests for purchases of equipment reviewed for consideration of soliciting competitive
bids?
4. Are procedures in place to monitor and properly restrict access to equipment?
ANSWER: The correct answer is D. Restricting access to equipment relates to safeguarding of assets,
but does not concern the initiation and execution of equipment transactions. The approval of major
repairs, use of prenumbered purchase orders, and solicitation of competitive bids are all related to the
initiation of equipment transactions.

QUESTION: For effective internal control, the accounts payable department generally should:
1. stamp, perforate, or otherwise cancel supporting documentation after payment is mailed.
2. ascertain that each requisition is approved as to price and quantity by an authorized employee.
3. obliterate the quantity ordered on the receiving department copy of the purchase order.
4. compare the vendors invoice with the receiving report and purchase order.
ANSWER: The correct answer is D. Agreeing the vendors invoice with the receiving report ensures that
the company is only billed for what it receives. Agreeing the vendors invoice with the purchase order
ensures that the company was billed correctly for what it ordered. Upon favorable agreement, an
accounts payable voucher is prepared and submitted for payment.

QUESTION: As the acceptable level of detection risk decreases, an auditor may:

1. eliminate the assessed level of inherent risk from consideration as a planning factor.
2. postpone the planned timing of substantive tests from interim dates to year-end.
3. reduce substantive testing by relying on the assessments of inherent risk and control risk.
4. lower the assessed level of control risk from high to low.
ANSWER: The correct answer is B. Detection risk is the risk that the auditor will not detect a material
misstatement that might exist in an assertion. As the acceptable level of detection risk decreases, the
assurance provided from substantive tests should be increased. Performing substantive tests as of an
interim date, rather than as of the year-end, may potentially increase the risk that misstatements in the
year-end financial statements may exist and will not be detected. Given the choice, if the auditor wants to
decrease detection risk, the auditor would decide to perform substantive tests at year-end, rather than at
an interim date.

QUESTION: Section 404 of the Sarbanes-Oxley Act of 2002 requires that management of public
companies take responsibility for establishing and maintaining the entitys internal control. Management is
also required by Section 404 to publicly report on the operating effectiveness of those controls. Risk
assessment for public company financial reporting, then, from managements perspective, is the
assessment of the risks related to effective internal control relevant to the preparation of financial
statements in conformity with:
1. generally accepted auditing standards.
2. generally accepted accounting standards.
3. PCAOB Auditing Standards.
4. generally accepted accounting principles
ANSWER: The correct answer is D. Financial statements are always prepared in conformity with
generally accepted accounting principles (GAAP), whether this is in reference to publicly held or privately
held entities. Management would not be reporting on the preparation of financial statements in conformity
with generally accepted auditing standards, generally accepted accounting standards, or PCAOB auditing
standards.

QUESTION: In an audit of financial statements in accordance with generally accepted auditing standards,
an auditor is explicitly required to:
1. determine whether or not control procedures are suitably designed to prevent or detect material
misstatements.
2. search for significant deficiencies in the operation of internal control.

3. document the auditors understanding of the entitys internal control.

4. search for material weakness in the operation of internal control.
ANSWER: The correct answer is C. The auditor is required to document the auditors understanding of
the entitys internal control. The form and extent of documentation may be influenced by the size and
complexity of the entity. After the auditor gains an understanding of the clients internal control, the auditor
can then make a preliminary assessment of control risk, which is part of the auditors overall assessment
of the risk of material misstatement.

QUESTION: For what types of professional engagements is a practitioner required to get a representation
letter from management of the reporting entity?
For what types of professional engagements is a practitioner required to get a representation letter from
management of the reporting entity?
1. For an audit and a review, but not for a compilation.
2. For an audit, a review, and a compilation.
3. For an audit and a compilation, but not for a review.
4. For an audit only.
ANSWER: The correct answer is A. A representation letter is a requirement for both an audit and a review
engagement, but there is no such requirement when a practitioner performs a compilation.

QUESTION: Upon receipt of customers' checks in the mailroom, a responsible employee should prepare
a remittance listing that is forwarded to the cashier. A copy of the listing should be sent to the
1. Internal auditor to investigate the listing for unusual transactions.
2. Treasurer to compare the listing with the monthly bank statement.
3. Entity's bank to compare the listing with the cashier's deposit slip.
4. Accounts receivable bookkeeper to update the subsidiary accounts receivable records.
ANSWER: D) A copy of the remittance listing is sent to the accounts receivable clerk and posted to the
subsidiary records. Accounting for assets is a function that should be separated from the custody of those
assets. The accounts receivable bookkeeper maintains records of the balance owed by each customer,
while the cashier has custody of the cash. The cashier does not have an opportunity to cover a shortage
of cash by using checks received on account because the AR ledger would indicate a different balance
than that owed. There is no need to send copies to the internal auditor, the treasurer, or the bank,
because the goal is to establish accountability for the asset.

QUESTION: On magnetic discs, more than one file may be stored on a single physical file, while in
multiprogramming computer operations, several programs may be in core storage at one time. In both
cases, it is important to prevent the intermixing or overlapping of data. This is accomplished by a
technique known as
1. Boundary protection.
2. File integrity.
3. Paging.
4. Interleaving.
ANSWER: A) Boundary protection is a method of protecting access to unauthorized areas of a device
such as a magnetic disc or drum. Sections of core storage are also partitioned so that more than one
program can be operated at the same time. This method prevents overlapping of operations of one
partition to another.

QUESTION: Which of the following is a primary function of the purchasing department?

1. Authorizing the acquisition of goods.
2. Verifying the propriety of goods acquired.
3. Ensuring the acquisition of goods of a specified quality.
4. Reducing expenditures for goods acquired.
ANSWER: C) The purchasing department's function is solely to purchase previously authorized goods
and services at the desired quality and best price. They have no function in authorization for purchase
receiving or payment.

QUESTION: Tracing bills of lading to sales invoices provides evidence that

1. Shipments to customers were invoiced.
2. Shipments to customers were recorded as sales.
3. Recorded sales were shipped.
4. Invoiced sales were shipped.
ANSWER: A) By tracing bills of lading to sales invoices, the auditor will confirm that all shipments have
been invoiced, that is, that each shipment resulted in a sales invoice being prepared.

QUESTION: In an audit of financial statements, an auditor's primary consideration regarding an internal

control policy or procedure is whether the policy or procedure

1. Reflects management's philosophy and operating style.

2. Affects management's financial statement assertions.
3. Provides adequate safeguards over access to assets.
4. Enhances management's decision-making processes.
ANSWER: B) AU 319 states that, for purposes of an audit of financial statements, an entity's internal
control structure consists of the three following elements:
1. The control environment
2. The accounting system
3. Control procedures
Dividing the internal control structure into three elements facilitates discussion of its nature and how the
auditor considers it in an audit. The auditor's primary consideration, however, is whether an internal
control structure policy or procedure affects financial statement assertions rather than its classification
into any particular category.

QUESTION: The permanent (continuing) file of an auditor's working papers most likely would include
copies of the
1. Lead schedules.
2. Attorney's letters.
3. Bank statements.
4. Debt agreements.
ANSWER: D) The permanent file of an auditor's working papers contains information and documents of
continuing interest. Examples of such items are debt agreements, the corporate charter and bylaws,
contracts such as leases and royalty agreements, and continuing schedules of accounts whose balances
are carried forward for several years. The other answers relate to the current year under audit and would
be included in the current file of an auditor's working papers.

QUESTION: After obtaining an understanding of the internal control structure and assessing control risk,
an auditor decided to perform tests of controls. The auditor most likely decided that

1. It would be efficient to perform tests of controls that would result in a reduction in planned
substantive tests.
2. Additional evidence to support a further reduction in control risk is not available.
3. There were many internal control structure weaknesses that could allow errors to enter the
accounting system.
4. An increase in the assessed level of control risk is justified for certain financial statement
assertions.
ANSWER: A) If the controls appear to be effective, the auditor would test the controls and if they were
found to be effective the auditor would assess control risk below the maximum and reduce the extent of
substantive testing. These tests of controls should only be performed when it is efficient to do so. It would
be efficient if less time and effort would be spent testing controls than could be saved in substantive tests
due to the lower control risk assessment.

QUESTION: Gole, CPA, is engaged to review the 2008 financial statements of North Co., a nonpublic
entity. Previously, Gole audited North's 2007 financial statements and expressed an unqualified opinion.
Gole decides to include a separate paragraph in the 2008 review report because North plans to present
comparative financial statements for 2008 and 2007. This separate paragraph should indicate that
1. The 2008 review report is intended solely for the information of management and the board of
directors.
2. The 2007 auditor's report may no longer be relied on.
3. No auditing procedures were performed after the date of the 2007 auditor's report.
4. There are justifiable reasons for changing the level of service from an audit to a review.
ANSWER: C) AR 200 states that when the current-period financial statements of a nonpublic entity have
been compiled or reviewed and those of the prior period have been audited, the accountant should issue
an appropriate compilation or review report on the current period financial statements and either: the
report on the prior period should be reissued or the report on the current period should include, as a
separate paragraph, an appropriate description of the responsibility assumed for the financial statements
of the prior period.

QUESTION: In auditing the financial statements of Star Corp., Land discovered information leading Land
to believe that Star's prior year's financial statements, which were audited by Tell, require substantial
revisions. Under these circumstances, Land should

1. Request Star to arrange a meeting among the three parties to resolve the matter.
2. Notify Star's audit committee and stockholders that the prior year's financial statements cannot be
relied on.
3. Notify Tell about the information and make inquiries about the integrity of Star's management.
4. Request Star to reissue the prior year's financial statements with the appropriate revisions.
ANSWER: A) If during his audit the successor auditor becomes aware of information that leads him to
believe that financial statements reported on by the predecessor auditor may require revision, he should
request his client to arrange a meeting among the three parties to discuss the information and to resolve
the matter.

QUESTION: The introductory paragraph of an auditor's report contains the following sentences:
"We did not audit the financial statements of EZ Inc., a wholly-owned subsidiary, which statements reflect
total assets and revenues constituting 27 percent and 29 percent, respectively, of the related consolidated
totals. Those statements were audited by other auditors whose report has been furnished to us, and our
opinion, insofar as it relates to the amounts included for EZ Inc., is based solely on the report of the other
auditors."
These sentences
1. Assume responsibility for the other auditor.
2. equire a departure from an unqualified opinion.
3. re an improper form of reporting.
4. Idicate a division of responsibility.
ANSWER: D) When a principal auditor decides not to assume responsibility for the work of an other
auditor insofar as that work relates to the principal auditor's expression of an opinion on the financial
statements as a whole, the principal auditor's report should make reference to the audit of the other
auditor. In such a case, the introductory paragraph of the principal auditor's report should disclose the
magnitude of the portion of the financial statements audited by the other auditor, as was done in this
example.

QUESTION: Which of the following will not result in modification of the auditor's report due to a scope
limitation?
1. Restrictions imposed by the client.
2. Inability to obtain sufficient competent evidential matter.
3. Reliance placed on the report of another auditor.

4. Inadequacy in the accounting records.

ANSWER: C) If the CPA relies on the work of another auditor, it does not constitute a scope limitation.
The other answers constitute scope limitations.

QUESTION: Under which of the following circumstances would a disclaimer of opinion not be
appropriate?
1. The auditor is unable to determine the amounts associated with an employee fraud scheme.
2. Management does not provide reasonable justification for a change in accounting principles.
3. The chief executive officer is unwilling to sign the management representation letter.
4. The client refuses to permit the auditor to confirm certain accounts receivable or apply alternative
procedures to verify
their balances.
ANSWER: B. A disclaimer of opinion states that the auditor does not express an opinion on the financial
statements. It is appropriate when the auditor has not performed an audit sufficient in scope to enable him
to form an opinion on the financial statements. A disclaimer would not be appropriate when the auditor
determines that the financial statements contain a departure from GAAP, such as when the client's
management does not adequately justify a change in accounting principle. The other answers are
incorrect because they are situations that could give rise to a disclaimer.

QUESTION: When approached by a client about prospective financial statements and third party use may
or may not occur, a CPA may not accept an engagement to:
1. apply agreed-upon procedures.
2. perform an examination.
3. perform a review.
4. perform a compilation.
ANSWER: C. perform a review.
The Statement on Standards for Attestation Engagements (SSAE) issued by the AICPA does not permit
the CPA to perform reviews of prospective financial statements. The CPA may compile, examine, or apply
agreed-upon procedures to the prospective financial statements if these statements are, or reasonably
might be, expected to be used by another party.

QUESTION: In performing a search for unrecorded retirements of fixed assets, an auditor most
likely would:
1. tour the clients facilities, and then analyze the repair and maintenance account.
2. inspect the property ledger and the insurance and tax records, and then tour the clients facilities.
3. analyze the repair and maintenance account, and then tour the clients facilities.
4. tour the clients facilities, and then inspect the property ledger and the insurance and tax records.
ANSWER: B. inspect the property ledger and the insurance and tax records, and then tour the clients
facilities.
In searching for unrecorded retirements of fixed assets, the auditor would select items included in the
property ledger and other records and then, by touring the clients facilities, look to see if they are on
hand. A fixed asset that is not on hand but is included in the records may indicate that a retirement was
not recorded.

QUESTION: An auditor most likely would make inquiries of production and sales personnel concerning
possible obsolete or slow-moving inventory to support managements financial statement assertion of:
1. presentation and disclosure.
2. rights and obligations.
3. valuation or allocation.
4. existence or occurrence.
ANSWER: C. valuation or allocation.
Assertions about valuation or allocation deal with whether asset, liability, revenue, and expense
components have been included in the financial statements at appropriate amounts. Inquiries and other
tests designed to determine if inventory is obsolete or slow-moving will help provide assurance that
inventory, which should be adjusted to lower of cost or market, is properly valued on the financial
statements.

QUESTION: Which of the following procedures most likely would not be an internal control procedure
designed to reduce the risk of errors in the billing process?
1. Comparing control totals for shipping documents with corresponding totals for sales invoices.
2. Using computer programmed controls on the pricing and mathematical accuracy of sales
invoices.
3. Matching shipping documents with approved sales orders before invoice preparation.

4. Reconciling the control totals for sales invoices with the accounts receivable subsidiary ledger.
ANSWER: D. Reconciling the control totals for sales invoices with the accounts receivable subsidiary
ledger.
The reconciliation provides evidence that sales which have been invoiced are recorded in the accounts
receivable subsidiary ledger but does not reduce the risk of errors in billing. Answer (a) is incorrect
because it reduces the risk of errors in the billing process by providing evidence that all items shipped
were included in the sales invoices. Answer (b) is incorrect because it reduces the risk of errors in the
billing process by controlling the mathematical accuracy of the computations on the sales invoices.
Answer (c) is incorrect because matching shipping documents with sales orders reduces the risk of errors
in the billing process by providing evidence that approved sales orders were shipped before being
invoiced.

QUESTION: The sample size of a test of controls varies inversely with:

Expected population
deviation rate
A.
B.
C.
D.

Tolerable rate
No
No
Yes
Yes

Yes
No
No
Yes

ANSWER: A. No; Yes

In determining sample size for a test of controls, the auditor will consider the expected population
deviation rate and tolerable rate. If, based on prior experience with the client or on a preliminary sample,
the auditor expects to find few deviations from a control, the expected population deviation rate would be
set low, and the sample size would be small. Thus, there is a direct relationship between the expected
population deviation rate and sample size, not an inverse relationship. The tolerable rate is the maximum
rate of deviation from a prescribed control that an auditor is willing to accept without altering the planned
reliance on internal control. If the auditor can tolerate a higher rate, he will test a smaller sample. Thus,
tolerable rate does vary inversely with sample size. Sample size does not vary inversely with the
expected population deviation rate. Sample size does vary inversely with tolerable rate.

QUESTION: Which of the following computer-assisted auditing techniques allows fictitious and real
transactions to be processed together without client operating personnel being aware of the testing
process?
1. Test data approach.
2. Parallel simulation.
3. Integrated test facility.
4. GAS packages.

ANSWER: C. Integrated test facility.

An integrated test facility is a method of testing programmed controls by creating a small dummy division
or subsidiary within the regular IT system. Dummy files and records are appended to existing client files,
and fictitious test transactions specifically coded to correspond with the dummy files and records are
introduced into the system along with actual live transactions. Parallel simulation is an approach which
involves reprocessing actual company data using auditor-controlled programs and comparing the results.
The test data approach is an approach which involves both valid and invalid transactions prepared and
processed by the auditor using the clients computer program. Generalized audit software (GAS) is an
audit program that performs audit tasks such as sampling, sorting, and calculating.

QUESTION: Tracing selected items from the payroll register to employee time cards that have been
approved by supervisory personnel provides evidence that:
1. internal controls relating to payroll disbursements were operating effectively.
2. payroll checks were signed by an appropriate officer independent of the payroll preparation
process.
3. only bona fide employees worked and their pay was properly computed.
4. employees worked the number of hours for which their pay was computed.
ANSWER: D. employees worked the number of hours for which their pay was computed.
When an auditor selects items from the payroll register for examination, he is selecting from a population
consisting of all payments made to employees. By tracing these selected items to time cards that have
been approved by a supervisor, the auditor is verifying that the employees did work the hours that they
were paid for. This is only one aspect of internal control related to payroll disbursements and would
probably not be sufficient to reach a conclusion as to the effectiveness of internal controls. The auditor
could trace the items to the cancelled payroll checks to determine if they were signed by an appropriate
officer. The auditor could also trace the items to personnel records to make certain that the payees were
bona fide employees and that the rates of pay were proper.

QUESTION: As the acceptable level of detection risk decreases, an auditor may change the:
1. timing of tests of controls by performing them at several dates, rather than at one time.
2. nature of substantive tests from a less effective to a more effective procedure.
3. timing of substantive tests by performing them at an interim date, rather than at year-end.
4. assessed level of inherent risk to a higher amount.
ANSWER: B. nature of substantive tests from a less effective to a more effective procedure.
Detection risk is defined as the risk that the audit evidence for a segment will fail to detect misstatements
exceeding tolerable misstatement. As planned detection risk has decreased, the auditor will (1) select a
greater sample size of items to be tested, (2) change the audit tests (substantive procedures) to more

effective procedures, and (3) change the timing of substantive tests to perform them at year-end, rather
than at an interim date. Inherent risk (and control risk) exists independently of the audit; the auditor
cannot change them, but rather react to them in planning.

QUESTION: An accountant should perform analytical procedures during an engagement to:

Compile a nonpublic entitys

financial statements
A.
B.
C.
D.

Review a nonpublic entitys

financial statements
No
Yes
Yes
No

Yes
Yes
No
No

ANSWER: A. No; Yes

A compilation is defined as presenting, in the form of financial statements, information that is the
representation of management, without undertaking any expression of any assurance on the statements.
In a compilation, the accountant is not required to make inquiries or perform other procedures to verify,
corroborate, or review information furnished by the entity. A review is defined as the performance of
inquiry and analytical procedures that provide the accountant with a reasonable basis for expressing
limited assurance that there are no material modifications that should be made to the financial statements
in order for them to be in conformity with GAAP or, if applicable, with another comprehensive basis of
accounting. Analytical procedures are required in a review engagement. Analytical procedures are not
required in a compilation engagement.

QUESTION: Which paragraphs of an auditors standard unqualified opinion report on financial statements
should refer to GAAS and GAAP?
GAAS
A.
B.
C.
D.

GAAP
Opening
Opening
Scope
Scope

Scope
Opinion
Scope
Opinion

ANSWER: D. Scope; Opinion.

The auditors standard unqualified opinion audit report identifies the financial statements that have been
audited in the opening introductory paragraph. The nature of an audit, which is an examination in
accordance with GAAS, is described in the scope paragraph. The auditors conclusion regarding the
fairness of the financial statements in accordance with GAAP is expressed in the separate opinion
paragraph.

QUESTION: As a result of the Sarbanes-Oxley Act, the PCAOB has been created. Which of the following
is false?
1. The PCAOB is a government agency.
2. The PCAOB comes under the oversight and enforcement authority of the SEC.
3. The PCAOB will be funded by fees charged to all registered accounting firms and publicly traded
companies.
4. All accounting firms that participate in the preparation of an audit report for a company that issues
securities must register with the PCAOB.
ANSWER: A. The PCAOB is a government agency.
The Sarbanes-Oxley Act was set up in a manner such that the PCAOB would not be a government
agency, but would operate as an independent, nonprofit body to oversee the reporting of financial results
of public entities. To enable a proper degree of government control, the PCAOB is under the oversight
and the enforcement authority of the SEC. The PCAOB is funded by fees charged to registered
accounting firms and all publicly traded companies.

QUESTION: Auditors try to identify predictable relationships when using analytical procedures.
Relationships involving transactions from which of the following would most likely yield the highest level of
evidence?
1. Interest expense.
2. Accounts payable.
3. Accounts receivable.
4. Travel and entertainment expense.
ANSWER: A. Interest Expense
When using analytical procedures to identify predictable relationships, higher levels of evidence will be
obtained when those relationships are most predictable. Relationships involving income statement
accounts, such as interest expense, tend to be more predictable than relationships involving only balance
sheet accounts. This is because income statement accounts represent transactions over a period of time,
rather than a point in time, as a balance sheet amount represents. Also, interest expense, which can be
related to debt, is more predictable than the travel and entertainment expense, which is more
unpredictable and subject to management discretion

QUESTION: Which of the following is not a comprehensive basis of accounting other than generally
accepted accounting principles?
1. Basis of accounting used by an entity to comply with the financial reporting requirements of a
government regulatory agency.
2. Cash receipts and disbursements basis of accounting.

3. Basis of accounting used by an entity to file its income tax return.

4. Basis of accounting used by an entity to comply with the financial reporting requirements of a
lending institution.
ANSWER: The correct answer is D. The following accounting bases may be used to prepare financial
statements in conformity with a comprehensive basis of accounting other than GAAP:
1. Income tax basis of accounting.
2. Cash basis of accounting.
3. Modified cash basis of accounting.
4. Basis of accounting used by an entity to comply with the financial reporting requirements of a
government regulatory agency.
5. A definite set of criteria having substantial support that is applied to all material items in the
financial statements.
An other comprehensive basis of accounting (OCBOA) outside of the permitted bases listed above is
prohibited. A basis of accounting used by an entity to comply with the financial reporting requirements of a
lending institution is not a permitted OCBOA.

QUESTION: One criterion for a capital lease is that the term of the lease must equal a minimum
percentage of the leased property's economic life at the inception of the lease. The minimum percentage
is:
1. 75%.
2. 41%.
3. 50%.
4. 90%.
ANSWER: The correct answer is A. A lease is classified as a capital lease if one of the following criteria is
met:
1. The title is transferred to the lessee at the end of the lease period.
2. A bargain purchase option exists.
3. The lease period is at least 75% of the asset's life.
4. The present value of the minimum lease payments is at least 90% of the fair value of the asset.

QUESTION: On January 15, Year 5 Rice Co. declared its annual cash dividend on common stock for the
year ended January 31, Year 5. The dividend was paid on February 9, Year 5, to stockholders of record
as of January 28, Year 5. On what date should Rice decrease retained earnings by the amount of the
dividend?
1. January 15, Year 5.
2. January 31, Year 5.
3. January 28, Year 5.
4. February 9, Year 5.
ANSWER:The correct answer is A.Retained earnings is decreased and a current liability for the cash
dividend is recorded on the declaration date, in this case, January 15, Year 5.

QUESTION: For interim financial reporting, a company's income tax provision for the second quarter of a
given year should be determined using the:
1. Statutory tax rate for the year.
2. Effective tax rate expected to be applicable for the second quarter of the year.
3. Effective tax rate expected to be applicable for the full year, as estimated at the end of the first
quarter of the year.
4. Effective tax rate expected to be applicable for the full year, as estimated at the end of the second
quarter of the year.
ANSWER:The correct answer is D. The company should use the effective tax rate expected to be
applicable for the full year as estimated at the end of the second quarter the year because the interim
period is considered an integral part of the accounting year.

QUESTION: What type of bond matures at different points in time?

1. Bearer bonds.
2. Term bonds.
3. Serial bonds.
4. Unsecured bonds.
ANSWER: The correct answer is C. Serial bonds refer to bonds within an issue that mature at different
points in time. Generally, serial bonds are retired according to their registration number. Note that bonds
within a term bond issue all mature at the same time. Unsecured bonds are backed only by the general
credit of the borrower and are not backed by any specific property. In the case of a bearer bond, there is
no record of ownership interest is paid to the holder of the bond.

QUESTION: Which of the following statements comparing straight-line depreciation methods to

alternative depreciation methods is least accurate? Companies that use:
1. accelerated depreciation methods will increase the total amount of depreciation expense in the
latter years of the asset's life.
2. accelerated depreciation methods will decrease the amount of taxes in early years.
3. straight-line depreciation methods will have higher book values for the assets on the balance
sheet than companies that use accelerated depreciation in the early years.
4. units-of-production methods to depreciate assets will overstate income during periods of low
production.
ANSWER: The correct answer is A. Accelerated depreciation methods will increase the amount of
depreciation expense in the early years of the assets life, but the depreciation expense will be less in the
latter years of the assets life. All other answer options are true.

QUESTION: Gar Co. factored its receivables without recourse with Ross Bank. Gar received cash as a
result of this transaction, which is best described as a:
1. Sale of Gar's accounts receivable to Ross, with the risk of uncollectible accounts retained by Gar.
2. Sale of Gar's accounts receivable to Ross, with the risk of uncollectible accounts transferred to
Ross.
3. Loan from Ross collateralized by Gar's accounts receivable.
4. Loan from Ross to be repaid by the proceeds from Gar's accounts receivables.
ANSWER: The correct answer is B. Factoring of receivables is a sale of the receivables to another party.
"Without recourse" means that Gar Co. has transferred the risk for the uncollectible accounts to Ross
Bank and Ross does not have any recourse against Gar Co. if the accounts are not collected. Thus, Gar
has sold the accounts receivable to Ross Bank along with the risk associated with the uncollectible
accounts.

QUESTION: Reportable segments are not required to disclose which of the following:
1. Intersegment sales.
2. Capital expenditures.
3. Amortization expense.
4. Long-term debt.

ANSWER: D) Long-term debt and all liabilities are not required disclosures on segment data. All the other
choices are required disclosures.

QUESTION: During 2009, Tedd Co. became involved in a tax dispute with the IRS. At December 31,
2009, Tedd's tax advisor believed that an unfavorable outcome was probable. A reasonable estimate of
additional taxes was $400,000, but could be as much as $600,000. After the 2009 financial statements
were issued, Tedd received and accepted an IRS settlement offer of $450,000. What amount of accrued
liability should Tedd have reported in its December 31, 2009, balance sheet?
1. $400,000.
2. $450,000.
3. $500,000.
4. $600,000.
ANSWER: A) The minimum amount within the range must be accrued since an unfavorable outcome is
probable.

QUESTION: Extraordinary items are:

1. reported above the line.
2. unusual and infrequent.
3. unusual or infrequent.
4. reported on the balance sheet.
ANSWER: B) Extraordinary items are unusual and infrequent, reported below the line separate from
income from continuing operations on the income statement, and would include such items as: foreign
government confiscation, earthquake damages, losses from volcanic eruptions, etc.

QUESTION: Presenting consolidated financial statements this year when statements of individual
companies were presented last year is
1. A correction of an error.
2. An accounting change that should be reported prospectively.
3. An accounting change that should be reported by restating the financial statements of all prior
periods presented.
4. Not an accounting change.

ANSWER: C) This is a change in accounting entity which requires restatement of prior periods being
presented.

QUESTION: The following computations were made from Clay Co.'s 2009 books: What was the number
of days in Clay's 2009 operating cycle?
Number of days sales in Inventory: 61
Number of days sales in trade accounts receivable: 33
1. 33.
2. 47.
3. 61.
4. 94.
ANSWER: D) 94 days. The operating cycle is the average time for a company to expend cash for
inventory, process and sell the inventory, and collect the resulting receivables, converting them back into
cash. The number of days in the operating cycle (94) is equal to the number of days' sales in inventory
(61), plus the number of days' sales in accounts receivable (33).

QUESTION: Which of the following is NOT a criteria for a lease to be classified as a capital lease?
1. The lease term is equal to 90% or more of the estimated economic life of the asset.
2. Ownership in the asset is transferred at the end of the lease term.
3. The lease contains a bargain purchase option.
4. The present value of the minimum lease payments is 90% or more of the fair value of the asset at
the inception of the lease.
ANSWER: A) To be considered a capital lease, the lease term should be equal to 75 percent or more of
the estimated economic life of the asset, not 90 percent.

QUESTION: An entity purchased shares of its $100 par stock for retirement that was originally issued at
$200 per share. The entity repurchased the stock for $250 per share. Upon retirement, which of the
following accounts would NOT be affected?
1. Paid-in capital.
2. Common stock.

3. Treasury stock.
4. Retained earnings.
ANSWER: C) When the stock of an entity is purchased specifically for retirement, it is no longer able to
be reissued and therefore would NOT affect treasury stock. The entity would record the transaction by
removing the common stock at its par value, with any additional paid-in capital that was originally
recorded being removed as well.
The difference between the original issue price and the reacquisition price requires a reduction in retained
earnings because the entity repurchased the stock for an amount greater than the original issuance
price.
A reduction in the cash paid for the stock is recorded as well. The journal entry for the repurchase and
retirement of one share of its outstanding stock would appear as follows:
Debit: Common stock $100
Debit: Paid-in capital $100
Debit: Retained earnings $50
Credit: Cash $250

QUESTION: Conceptually, interim financial statements can be described as emphasizing

1. Timeliness over reliability.
2. Reliability over relevance.
3. Relevance over comparability.
4. Comparability over neutrality.
ANSWER: A) Interim statements are affected by estimates, cost allocations, seasonality and other factors
which may affect the usefulness of the information. Therefore, the emphasis on timeliness over reliability.

QUESTION: St.Petersburg Glass Company plans to issue the following 10-year bond:
PV: $25,325
FV: $20,000
Annual payments: $2,000
Using straight-line amortization calculate the bond interest expense for year 1 for St. Petersburg Glass
Company?
1. $532.50.
2. $1,467.50.

3. $4,792.50.
4. Bond interest expense cannot be amortized.
ANSWER: B) The bond interest expense for St. Petersburg Glass Company would be $1,467.50. The
amortized amount of the bond premium is subtracted from the annual payments. $5,325/10 = 532.50,
$2,000 - 532.50 = $1,467.50.

QUESTION: Calculate depreciation for year 2 based on the following information:

Historical cost $40,000
Useful life 5 years
Salvage value $3,000
Year 1 depreciation $7,400
1. $7,400.
2. $8,000.
3. $8,600.
4. $13,040.
ANSWER: A) The depreciation method used must be straight line because year 1 depreciation is $7,400
(($40,000 - $3,000) / 5 = $7,400).
Year 2 depreciation would also be $7,400.

QUESTION: A company recently took out a $25,000 loan with interest payable at the rate of 9 percent,
compounded annually. The loan is to be paid off in one lump sum, at the end of 3 years. Given it is to
include both principal and interest, the amount of the loan
payment will be closest to:
FV of $1@ 9% for 3 years = 1.295
PV of $1@9% for 3 years = 0.7722
1. $27,250.
2. $31,750.
3. $32,375.
4. $34,000.
ANSWER: C. This can be solved with either the PV or FV of $1 equation; using the correct factor:
PV = FV x PVfactor or FV = PV x FVfactor. So: $25,000 = FV x 0.7722 = %32,375. Or, FV = $25,000 x

1.295 = $32,375.

QUESTION: At January 1, 2009, Simpson Co. had a credit balance of $260,000 in its allowance for
uncollectible accounts. Based on past experience, 2 percent of Simpsons credit sales have been
uncollectible. During 2009, Simpson wrote off $325,000 of uncollectible accounts. Credit sales for 2009
were $9,000,000. In its December 31, 2009, balance sheet, what amount should Simpson report as
allowance for uncollectible accounts?
1. $115,000.
2. $180,000.
3. $245,000.
4. $440,000.
ANSWER: A. The beginning balance is added to the new provision of $180,000 (2% $9,000,000) and is
reduced for the write off of $325,000 (260,000 + 180,000) 325,000 = 115,000.

QUESTION: The Welsh Corporation has maintained a defined benefit pension plan for a number of
years. At the end of the current year, the company has a net pension cost of $177,000, a projected benefit
obligation of $829,000, and plan assets of $580,000. What is the total amount of liability this company
should recognize on its balance sheet, in connection with this pension plan?
1. $116,000.
2. $122,000.
3. $117,000.
4. $249,000.
ANSWER: D. $249,000.
According to FASB 158, an employer is required to recognize the overfunded or underfunded status of the
pension plan. This amount is the difference between the Projected Benefit Obligation and the Plan
Assets, or $249,000 ($829,000 $580,000) in this case. It will be reported as a liability since the PBO
exceeds the plan assets.

QUESTION: What is the difference between the direct and indirect method of calculating cash flow from
operations?

1. The indirect method starts with gross income and adjusts to cash flow from operations, while the
direct method starts with gross profit and flows through the income statement to calculate cash
flows from operations.
2. The direct method starts with sales and follows cash as it flows through the income statement,
while the indirect method starts with net income and adjusts for non-cash charges and other
items.
3. Balance sheet items are not included in the cash flow from operations for the direct method, while
they are included for the indirect method.
4. The direct method will result in a lower or higher cash flow figure for operating activities as it
details all of the income statement items, while the indirect method only uses net income.
ANSWER: B. The direct method starts with sales and follows cash as it flows through the income
statement, while the indirect method starts with net income and adjusts for non-cash charges and other
items.
The main difference between the direct and indirect methods of calculating cash flows is the way that
cash flow from operations is calculated. The direct method starts with sales and follows cash as it flows
through the income statement, while the indirect method starts with income after taxes and adjusts
backwards for noncash and other items. Both methods will have the same result for operating cash flows.
The direct and indirect method calculates the financing and investing cash flows the same way, and both
methods will result in the same cash flow figure.

QUESTION: On January 1, Year 1, Giant Company (Giant) pays $900,000 for all of the outstanding
shares of Small Corporation (Small). On that date, Small has a net book value (assets liabilities) of
$700,000. In analyzing the company prior to the acquisition, Giant discovers that Small is working on
several in-process research and development projects that are worth a total of $170,000 although none of
the projects has yet reached the point of technological feasibility. Which of the following statements is
true?
1. Goodwill of $30,000 should be recorded as a result of this acquisition.
2. An expense of $170,000 should be recognized immediately at the date of acquisition.
3. Any goodwill allocation will be amortized at the end of Year 1.
4. The life attributed to any goodwill allocation will be 40 years or less.
ANSWER: A. Goodwill of $30,000 should be recorded as a result of this purchase.
In creating a business combination, any amount attributed to the value of in-process research and
development must be recognized. Any portion of the acquisition price in excess of the subsidiarys
underlying book value that cannot be assigned to an identifiable asset or liability is reported as the
intangible asset, Goodwill. Here, the purchase price was $900,000 and the book value was $700,000 so
the excess was $200,000. Of that amount, $170,000 is assigned to in-process research and
development. The remaining $30,000 is reported by the consolidated companies as goodwill. Goodwill is
no longer amortized over a period of time but is rather checked periodically for impairment.

QUESTION: Orleans Co. (Orleans), a cash-basis taxpayer, prepares accrual basis financial statements.
In its Year 6 balance sheet, Orleans deferred tax liabilities increased when compared to Year 5. Which of
the following changes would cause this increase in deferred tax liabilities?
I. An increase in prepaid insurance.
II. An increase in rent receivable.
III. An increase in warranty obligations.
1. I only.
2. I and II.
3. II and III.
4. III only.
ANSWER: B. I and II.
The increase in prepaid insurance in Year 6 creates a deductible amount for income tax reporting
purposes for the insurance paid; however, for financial reporting purposes the expense is not recognized
until years subsequent to Year 6. As a result, net taxable income for future years is increased; thus, the
deferred tax liability increases.
The increase in rent receivable in Year 6 also increases the deferred tax liability. For income tax
purposes, rents are not included in income until received (i.e., years subsequent to Year 6). However, the
amount of the receivable is earned and recognized in the income statement in Year 6.
The increase in warranty obligations results in warranty expense for Year 6 and will provide future
deductible amounts because tax rules do not allow a deduction for warranty cost until such a cost is
incurred. Future deductible amounts lead to deferred tax assets.

QUESTION: During Year 1, Smith Corporation filed suit against West Company because of damages that
were allegedly inflicted on Smith. At the end of Year 1, officials of Smith believe it is reasonably possible
that between $300,000 and $400,000 will be won but probable that the amount will actually be between
$160,000 and $300,000. No number in either range stands out as more likely than any other number.
Officials working for West have exactly the same opinion of what is going to happen. In the later part of
Year 2, the case is settled when West pays Smith $280,000 in cash. What is the impact on income
reported by these companies in Year 2?

Smith
A.
B.
C.
D.

West
$120,000 gain
$280,000 gain
$280,000 gain
$120,000 gain

ANSWER: C. $280,000 gain; $120,000 loss

$20,000 gain
$120,000 gain
$120,000 loss
$50,000 loss

As the potential winner, Smith will not recognize a gain until the process is substantially completed. That
happens in Year 2. Therefore, the entire profit is recognized when the case is settled in Year 2.
As the potential loser, West will recognize a loss as soon as the amount becomes probable. Here, that is
in Year 1. When the amount can only be estimated to within a range, the most likely number in the range
is used. If no number is most likely, the lowest number in the range is recognized. For that reason, West
recognized a $160,000 loss in Year 1 which then had to be increased in Year 2 by $120,000 to arrive at
the actual figure of $280,000.

QUESTION: Norina Co. (Norina) has a portfolio of marketable equity securities that it does not intend to
sell in the near term. How should Norina classify these securities and how should it report unrealized
gains and losses from these securities?

Classificatio
Reporting of unrealized gains and losses
n
A.
Trading securities
Component of income from continuing operations
Separate component of other comprehensive income
B.
Available-for-sale
securities
C.
Trading securities
Separate component of other comprehensive income
Component of income from continuing operations
D.
Available-for-sale
securities

ANSWER: B. Available-for-sale; Separate component of other comprehensive income securities

In accordance with SFAS 115, marketable equity securities (MES) are classified as either trading (held for
current resale) or available-for-sale (if not categorized as trading). Because Norina does not intend to sell
these securities in the near term, they should be classified as available-for-sale.
SFAS 115 requires MES to be carried at market value. The unrealized gains or losses of available-forsale MES are reported as a separate component of other comprehensive income. It is important to note
that unrealized gains or losses on trading securities would be reported as a component of continuing
operations on the income statement.
Thus, Answer B is correct because the securities would be classified as available-for-sale and unrealized
gains or losses from these securities would be reported as other comprehensive income.

QUESTION: Marcel, Inc. (Marcel) has a gross profit margin of $45,000 on sales of $150,000. The
balance sheet shows average total assets of $75,000 with an average inventory balance of $15,000.
What is Marcels total asset turnover and inventory turnover amounts, respectively?

Total asset turnover

A.
B.
C.
D.

ANSWER: B. 2.00 times; 7.00 times

Inventory turnover
7.00 times
2.00 times
0.50 times
10.00 times

2.00 times
7.00 times
0.33 times
0.60 times

Total asset turnover = sales/total assets = 150/75 = 2 times

Inventory turnover = COGS/average inventory = (150 45)/15 = 7 times

QUESTION: According to the FASB Conceptual Framework, which of the following relates to both
relevance and reliability?

Consistency
A.
B.
C.
D.

Verifiability
Yes
No
Yes
No

Yes
No
No
Yes

ANSWER: C. Yes; No
Consistency in financial presentation means the use of the same accounting procedures for presenting
information in different periods. Because trend analysis is a strong element in projecting the future,
investors and creditors find consistency important in making data useful, or relevant in formulating
decisions. Consistent presentation also removes potential bias from presentation that might be caused by
selecting the procedure each year that makes the company look best. A consistent presentation enhances
the neutrality of the information, which is an element of reliability. Thus, consistency relates to both
relevance and reliability.
Verifiability means the development of information by an approach that would cause different people to
arrive at the same figures. Verifiability makes information more reliable but does not tell us whether the
information being developed happens to be relevant to the user.

QUESTION: A company (the lessor) buys a car and then leases it to one of its customers (lessee). Which
of the following is correct?
1. Unless the title eventually transfers to the lessee, the lease should be reported as an operating
lease.
2. If the car has a life of ten years and the lease is for eight years, the lease must be reported as a
capital lease.
3. If the lease is a capital lease, then the lessee must account for the contract as either a direct
financing lease or a sales type lease.
4. If the lessee is given the option to purchase the car at the end of the lease, both parties will
account for the contract as a capital lease.
ANSWER: B. If the car has a life of ten years and the lease is for eight years, the lease must be reported
as a capital lease.
The FASB has established four criteria for a capital lease. If any one of these is met, then the lease has to
be recorded as a capital lease:

The title transfers to the lessee

There is a bargain purchase option (a bargain is viewed as an option price that is significantly
below expected fair value so that it is reasonable to expect the lessee to acquire the asset).

The life of the lease is 75% or more of the life of the asset.

The present value of the minimum lease payments is 90% or more of the fair value of the asset.

For a capital lease, the lessee only has one method of reporting (basically, the asset is being recorded as
an acquisition using long-term financing). However, the lessor must classify the lease as a sales type
lease or an operating lease based on certain factors.

QUESTION: Assuming that a companys stock has a fair value in excess of its par value, how would the
declaration of a 15% stock dividend by a corporation affect each of the following?

Additional
paid-in capital
A.
B.
C.
D.

Total stockholders
equity
Increase
No effect
No effect
Decrease

No effect
No effect
Decrease
Decrease

ANSWER: A. Increase; No effect

Issuing a 15% stock dividend increases the number of shares outstanding but it does not impact
stockholders equity because there is neither an increase nor a decrease in the net assets of the
company. Because the dividend was less than 20% to 25%, it is viewed as small stock dividend, and,
hence, it is recorded at fair value. Because the fair value is greater than the par value, the amount in
excess of par will be recorded as an increase to the additional paid-in capital account.

QUESTION: On November 1, Year 1, a company purchased a new machine. The machine does not have
to be paid for until November 1, Year 3. The total payment on November 1, Year 3, will include both
principal and interest. Assuming interest at a 10% rate, the cost of the machine would be the total
payment multiplied by what time value of money concept?
1. Present value of $1.
2. Present value of annuity of $1.
3. Future value of $1.
4. Future value of annuity of $.

ANSWER: A. Present value of $1.

The requirement is to determine what time value of money concept would be used to determine the cost
of a machine when a payment (principal plus interest) is to be made in two years.
Answer A is correct because the cost of the machine is to be recorded immediately; therefore, the cost of
the present value of a lump-sum payment would be used.
Answer B is incorrect because a lump-sum payment is involved, not an annuity. Answer C is incorrect
because a future amount would be used in computing the payment and not the cost of the machine.
Answer D is incorrect because a future amount would be used in computing the payment and not the
cost. Also, a lump-sum payment is involved and not an annuity.

QUESTION: Harbor Citys appropriations control account at December 31, 2008, had a balance of
$7,000,000. When the budgetary accounts were closed at year-end, this $7,000,000 appropriations
control balance should have:
1. appeared as a contra account.
2. been credited.
3. remained open.
4. been debited.
ANSWER: D. been debited.
When the budget is initially recorded for governmental accounting systems, the appropriations control
account is credited for authorized expenditures. At year-end, the budget entry is reversed; thus the
appropriations control account would be debited to close it out.