CPA Exam — Financial Accounting and Reporting (FAR) — All Questions

On January 1, Year 1, Abbot Co. bought a machine for $100,000 and began depreciating it straight-line over 10 years with no salvage value. At the start of Year 4, Abbot revised the machine's total useful life to 8 years (5 years remaining) and its salvage value to $4,000. What is depreciation expense for Year 4?

• a.$13,200✓
• b.$10,000
• c.$12,000
• d.$14,000

A change in useful life or salvage value is a change in accounting estimate, applied prospectively to the current and future periods (ASC 250-10-45-17). The carrying amount at the start of Year 4 is $70,000; ($70,000 - $4,000) / 5 = $13,200. $12,000 restarts from original cost as if the new estimates had applied from the beginning, which is retrospective; $14,000 ignores the salvage value, and $10,000 keeps the old estimates.

Bay Co. changes its inventory costing method from FIFO to weighted average because the new method better reflects its operations, and it is practicable to determine the period-specific effects. How should Bay report the change?

• a.Through a cumulative-effect adjustment included in current-year net income
• b.Retrospectively, adjusting opening retained earnings of the earliest year shown✓
• c.Only in the notes, leaving all previously reported amounts unchanged
• d.Prospectively, from the beginning of the year in which the change is made

A change in accounting principle is applied retrospectively to all prior periods presented unless impracticable, with the cumulative effect on periods before those presented reflected in opening retained earnings of the earliest period presented (ASC 250-10-45-5). Prospective application is for changes in estimate, the current-income cumulative-effect approach was eliminated when FASB Statement 154 replaced APB Opinion 20, and a note alone does not report the change.

Cole Co. changes its depreciation method for existing equipment from double-declining-balance to straight-line. How should Cole account for this change?

• a.Retrospectively, as a change in principle with prior years restated
• b.Prospectively, as a change in estimate effected by a change in principle✓
• c.By restating prior periods as the correction of an error
• d.With a cumulative-effect adjustment in current net income

ASC 250-10-45-18 treats a change in depreciation, amortization or depletion method as a change in accounting estimate effected by a change in accounting principle, accounted for prospectively. It is not applied retrospectively, it is not an error correction because the previous method was acceptable, and cumulative-effect adjustments to current income are not used.

Eno Co. overstated its December 31, Year 1 ending inventory by $10,000; the error was never corrected, and Year 2 ending inventory was counted correctly. Ignoring income taxes, what is the effect on Year 2 net income and on retained earnings at December 31, Year 2?

• a.Year 2 net income correct; Year 2 ending retained earnings overstated by $10,000
• b.Year 2 net income overstated by $10,000; Year 2 ending retained earnings overstated
• c.Year 2 net income understated by $10,000; Year 2 ending retained earnings correct✓
• d.Year 2 net income understated by $10,000; Year 2 ending retained earnings understated

Overstated Year 1 ending inventory understates Year 1 cost of goods sold and overstates Year 1 income. It becomes Year 2's overstated beginning inventory, which overstates Year 2 cost of goods sold and understates Year 2 income by the same $10,000. The two errors offset, so retained earnings at the end of Year 2 is correct. The other combinations misstate either the direction of the Year 2 error or the self-correcting effect on retained earnings.

Fallow Co. is a defendant in a lawsuit. Counsel concludes that a loss is probable and estimates it between $200,000 and $500,000, with no amount in the range more likely than any other. What amount should Fallow accrue?

• a.$350,000
• b.$500,000
• c.$200,000✓
• d.$0

When a loss is probable and a range can be estimated but no amount in it is a better estimate than any other, the minimum of the range is accrued (ASC 450-20-30-1), and the exposure to the additional $300,000 is disclosed (ASC 450-20-50-4). The midpoint and the maximum are not the GAAP measure, and $0 ignores a probable, estimable loss.

Gantry Co. is sued for $1,000,000. Its counsel concludes that an unfavorable outcome is reasonably possible but not probable, and estimates the possible loss at $1,000,000. How should Gantry report the lawsuit?

• a.Disclose the nature and estimated loss; accrue nothing✓
• b.Accrue a $500,000 loss and disclose the remaining exposure
• c.Neither accrue a loss nor disclose the lawsuit in the notes
• d.Accrue a $1,000,000 loss and disclose the lawsuit's nature

Accrual requires that a loss be probable and reasonably estimable (ASC 450-20-25-2). A reasonably possible loss is not accrued, but its nature and an estimate of the possible loss (or a statement that one cannot be made) must be disclosed (ASC 450-20-50-3 and 50-4). Accruing any amount overstates the liability, and saying nothing omits a required disclosure.

Hart Co. sells products with a one-year assurance-type warranty and estimates warranty costs at 3% of sales. Year 1 was its first year: sales were $1,000,000 and it spent $12,000 on warranty repairs. What warranty liability should Hart report at December 31, Year 1?

• a.$12,000
• b.$18,000✓
• c.$42,000
• d.$30,000

An assurance-type warranty is not a separate performance obligation; its expected cost is accrued as a liability when the product is sold (ASC 606-10-55-30 to 55-32; ASC 460-10 and ASC 450-20). Expense is $30,000 (3% of $1,000,000); repairs of $12,000 reduce the liability to $18,000. $30,000 ignores the repairs, $12,000 is the repairs themselves, and $42,000 adds them.

What is the correct order of the steps in the ASC 606 revenue model?

• a.Identify contract; identify obligations; set price; allocate price; recognize revenue✓
• b.Identify contract; set price; identify obligations; allocate price; recognize revenue
• c.Set price; identify contract; allocate price; identify obligations; recognize revenue
• d.Identify obligations; identify contract; set price; recognize revenue; allocate price

ASC 606-10-05-4 lists the steps in order: identify the contract with a customer, identify the performance obligations, determine the transaction price, allocate the transaction price to the performance obligations, and recognize revenue when (or as) each obligation is satisfied. The other sequences move steps out of that order, for example setting the price before the obligations are identified or allocating after revenue is recognized.

Iona Co. sells equipment with one year of support for a single price of $900. Iona sells the equipment alone for $800 and support alone for $200. Control of the equipment transfers at delivery; support is provided evenly over the year. How much revenue should Iona recognize when the equipment is delivered?

• a.$900
• b.$720✓
• c.$700
• d.$800

The transaction price is allocated to each performance obligation in proportion to standalone selling prices (ASC 606-10-32-29 and 32-31): $900 x $800 / $1,000 = $720 for the equipment; the remaining $180 is recognized as support is provided. $800 uses the standalone price without allocating the discount, $700 assigns the whole discount to the equipment under a residual approach that is not permitted when both prices are observable, and $900 recognizes the support revenue up front.

Jolt Co. contracts to build a facility for a fixed fee of $100,000 plus a $20,000 bonus if it finishes by a set date. Jolt judges completion on time 90% likely, concludes that the most likely amount method best predicts this all-or-nothing bonus, and that including it will not cause a significant revenue reversal. What is the transaction price?

• a.$120,000✓
• b.$100,000
• c.$110,000
• d.$118,000

Variable consideration is estimated using either the expected value or the most likely amount, whichever better predicts the amount (ASC 606-10-32-8); the most likely amount suits a binary outcome such as an all-or-nothing bonus. It is included to the extent a significant reversal is not probable (ASC 606-10-32-11): $100,000 + $20,000 = $120,000. $100,000 excludes the bonus, $118,000 is the expected value, which the stem rejects for this contract, and $110,000 splits the difference without a basis.

Which circumstance requires an entity to recognize revenue over time rather than at a point in time?

• a.The customer pays a nonrefundable deposit when the contract is signed
• b.The contract's performance period spans more than one reporting period
• c.The entity bills the customer in equal monthly installments as work proceeds
• d.The asset has no alternative use and payment for work to date is enforceable✓

ASC 606-10-25-27 lists three criteria for over-time recognition, one of which is that performance creates an asset with no alternative use to the entity and the entity has an enforceable right to payment for performance completed to date. A nonrefundable deposit, a contract spanning reporting periods, and a billing schedule are payment or timing features that do not by themselves show that control transfers over time.

Kudu Co. runs an online marketplace. Third-party sellers set prices, hold the inventory, and fulfill orders; Kudu never controls the goods and keeps a 10% commission. During Year 1, customers bought $500,000 of goods through the marketplace. How much revenue should Kudu report?

• a.$450,000
• b.$50,000✓
• c.$550,000
• d.$500,000

An entity that does not control the specified good before it is transferred is an agent and recognizes revenue as the fee or commission it retains (ASC 606-10-55-37A and 55-38): 10% x $500,000 = $50,000. Reporting $500,000 treats Kudu as the principal, $450,000 is the amount due to the sellers, and $550,000 adds the commission to gross sales.

On January 1, Year 1, Lorne Co. pays a salesperson a $12,000 commission for signing a three-year service contract; the commission would not have been paid otherwise, and Lorne expects to recover it. The contract is not expected to be renewed. How much commission expense should Lorne recognize in Year 1?

• a.$4,000✓
• b.$6,000
• c.$12,000
• d.$0

Incremental costs of obtaining a contract that the entity expects to recover are capitalized (ASC 340-40-25-1) and amortized on a systematic basis consistent with the transfer of the related services (ASC 340-40-35-1): $12,000 / 3 = $4,000 in Year 1. Expensing all $12,000 is allowed only as a practical expedient when the amortization period is one year or less (ASC 340-40-25-4). $0 fails to amortize, and $6,000 uses a two-year period with no support in the facts.

On November 1, Year 1, a donor promises a not-for-profit (nongovernmental) shelter $100,000 if the shelter raises $100,000 from other donors by June 30, Year 2; the donor owes nothing unless the full amount is raised. By December 31, Year 1, the shelter has raised $40,000. How much contribution revenue from this promise should it recognize in Year 1?

• a.$60,000
• b.$40,000
• c.$100,000
• d.$0✓

A promise with a donor-imposed condition, meaning a barrier that must be overcome plus a right of release from the obligation, is not recognized until the condition is substantially met (ASC 958-605-25-5A and 25-11, as amended by ASU 2018-08). This all-or-nothing matching requirement is a barrier and has not been met, so no revenue is recognized. $40,000 would fit a pro-rata match, which this promise is not; $100,000 and $60,000 ignore the unmet barrier.

A not-for-profit (nongovernmental) museum receives an unconditional promise of $30,000, payable $10,000 a year over the next three years, with no stated purpose. The present value of the promise is $27,000. How should the museum report it in the year the promise is received?

• a.$27,000 of contribution revenue with donor restrictions✓
• b.$27,000 of contribution revenue without donor restrictions
• c.$10,000 of contribution revenue each year as cash arrives
• d.$30,000 of contribution revenue without donor restrictions

Unconditional promises to give are recognized when received, measured at fair value, which for multiyear pledges may be the present value of the future cash flows (ASC 958-605-25-2 and 958-605-30). Amounts due in future periods carry an implied time restriction and are reported as net assets with donor restrictions unless the donor clearly intended them for current-period support (ASC 958-605-45-5). Recognizing the undiscounted amount, waiting for cash, or omitting the time restriction misapplies these rules.

Which contributed services must a nongovernmental, not-for-profit entity recognize as contribution revenue?

• a.Local residents who serve without pay as members of the entity's advisory council
• b.Community volunteers who staff the telephones during an annual fundraising drive
• c.Volunteers who sort and fold donated clothing at the entity's thrift store
• d.Pro bono legal work by a licensed attorney the entity would otherwise buy✓

ASC 958-605-25-16 recognizes contributed services only if they create or enhance nonfinancial assets, or require specialized skills, are provided by individuals possessing those skills, and would typically need to be purchased if not donated. The attorney's work meets the second test. Phone-bank, sorting and advisory work by volunteers without specialized skills meets neither, so it is not recognized.

A not-for-profit (nongovernmental) community group receives land from a donor. The land's fair value is $250,000, and the donor's original cost was $80,000. At what amount should the group recognize the contribution?

• a.$80,000
• b.$250,000✓
• c.$0 (disclosure only)
• d.$170,000

Contributions received, including nonfinancial assets such as land, are measured at fair value (ASC 958-605-30-2), so revenue is $250,000. The donor's cost of $80,000 is irrelevant to the recipient, $170,000 is the donor's unrealized gain, and contributed nonfinancial assets are recognized, not merely disclosed (ASC 958-605-25-2).

A nongovernmental, not-for-profit federated fund-raising organization receives $500,000 from donors who each name the specific charity to receive their gift. The organization has no variance power and the entities are not financially interrelated. How should the organization record the receipts?

• a.As contribution revenue with donor restrictions
• b.As an asset and a liability to the named beneficiaries✓
• c.As contribution revenue without donor restrictions
• d.As neither asset nor liability, with note disclosure

A recipient that accepts assets from a donor and agrees to transfer them to a beneficiary specified by the donor, without variance power and not financially interrelated with the beneficiary, is an agent or intermediary: it records the assets and a liability to the beneficiary, not contribution revenue (ASC 958-605, agent and intermediary transfers). The organization does hold the cash, so omitting it from the balance sheet is wrong.