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

On March 1, Year 1, Quay Co. bought 1,000 shares of a listed company's common stock for $40,000; it does not have significant influence. It received dividends of $1,000 during Year 1, and the shares' fair value at December 31 was $46,000. What total investment income should Quay recognize in Year 1 net income?

• a.$6,000
• b.$7,000✓
• c.$0
• d.$1,000

Equity securities with readily determinable fair values are measured at fair value with changes in net income (ASC 321-10-35-1), and dividends are income (ASC 321-10-35-6): $6,000 unrealized gain + $1,000 dividends = $7,000. $1,000 treats the gain as other comprehensive income, which is no longer allowed for equity securities; $6,000 ignores the dividends, and $0 ignores both.

Rook Co. bought corporate bonds at their $200,000 par value and classified them as available for sale. At year-end their fair value is $188,000 because market interest rates rose; Rook expects to collect all contractual cash flows and does not intend to sell. How are the bonds reported?

• a.At $188,000, with a $12,000 loss reported in net income
• b.At $200,000, with the $12,000 decline disclosed only
• c.At $188,000, with a $12,000 loss in other comprehensive income✓
• d.At $200,000, with no loss recognized or disclosed in the notes

Available-for-sale debt securities are carried at fair value, with unrealized holding gains and losses excluded from earnings and reported in other comprehensive income (ASC 320-10-35-1(b)). Because the decline is from interest rates rather than credit, no allowance for credit losses is recorded (ASC 326-30-35). Carrying the bonds at par applies only to held-to-maturity securities, and taking the loss to net income applies to trading securities or an intent to sell.

On January 1, Year 1, Sand Co. paid $95,900 for $100,000 face value, five-year bonds with a 6% stated rate paid annually each December 31, a 7% effective yield. Sand has the positive intent and ability to hold them to maturity. Using the effective interest method, what is their carrying amount at December 31, Year 1?

• a.$95,187
• b.$96,720
• c.$95,900
• d.$96,613✓

Held-to-maturity securities are carried at amortized cost (ASC 320-10-35-1(c)), with the discount amortized by the interest method (ASC 310-20-35-18 and ASC 835-30-35-2). Interest income is $95,900 x 7% = $6,713; cash received is $6,000; discount amortization is $713, so the carrying amount is $96,613. $96,720 uses straight-line amortization ($4,100 / 5 = $820), $95,900 ignores amortization, and $95,187 subtracts the amortization instead of adding it.

On January 1, Year 1, Tern Co. paid $500,000 for 25% of Wren Co.'s common stock, giving it significant influence; the price equaled 25% of Wren's net assets' book value and fair value. Wren reported Year 1 net income of $200,000 and paid dividends of $80,000. What is the carrying amount of Tern's investment at December 31, Year 1?

• a.$480,000
• b.$500,000
• c.$550,000
• d.$530,000✓

Under the equity method, the investment increases by the investor's share of earnings and decreases by dividends received (ASC 323-10-35-4 and 35-17): $500,000 + 25% x $200,000 - 25% x $80,000 = $530,000. $550,000 ignores dividends, which are a return of investment, not income; $480,000 records dividends but not the share of income; $500,000 is cost.

Umber Co., a public business entity, paid $900,000 on January 1 for 30% of an investee's stock and obtained significant influence. The investee's net assets had a book value of $2,500,000; its equipment's fair value exceeded book value by $400,000 (10-year remaining life); any remaining excess is goodwill. The investee's net income for the year was $300,000. What equity-method income should Umber recognize?

• a.$90,000
• b.$102,000
• c.$75,000
• d.$78,000✓

The share of net income is 30% x $300,000 = $90,000. The $150,000 excess over book value ($900,000 - $750,000) is $120,000 for equipment (30% x $400,000), depreciated over 10 years ($12,000), and $30,000 of equity-method goodwill, which is not amortized (ASC 323-10-35-13). $90,000 - $12,000 = $78,000. $90,000 omits the extra depreciation, $75,000 also amortizes goodwill over 10 years, and $102,000 adds the depreciation instead of subtracting it.

Which fact pattern most clearly indicates that the investor should apply the equity method?

• a.It owns 60% of the voting stock and directs the investee's operations
• b.It owns 25% of the voting stock but cannot obtain financial information
• c.It owns 18% of the voting stock and holds two of seven board seats✓
• d.It owns 15% of the investee's nonvoting preferred stock

ASC 323-10-15-6 lists board representation as an indicator of significant influence, and the 20% threshold in ASC 323-10-15-8 is only a presumption that can be overcome either way. Failing to obtain financial information is an indicator that a 20%-plus presumption is overcome (ASC 323-10-15-10). A 60% controlling interest is consolidated, and nonvoting preferred stock is not in-substance common stock that confers significant influence.

Vale Co. holds an equity security without a readily determinable fair value, measured at cost ($100,000) under the measurement alternative. It then observes an orderly transaction in an identical security of the same issuer at a price implying a value of $115,000 for its holding. What should Vale do?

• a.Keep the investment at its $100,000 cost with no adjustment
• b.Keep it at $100,000 and disclose the $115,000 observed value
• c.Remeasure to $115,000 and recognize a $15,000 gain in OCI
• d.Remeasure to $115,000 and recognize a $15,000 gain in net income✓

Under the measurement alternative, an equity security without a readily determinable fair value is carried at cost minus impairment, plus or minus changes from observable price changes in orderly transactions for the identical or a similar investment of the same issuer (ASC 321-10-35-2). The remeasurement gain goes to net income; ASC 321 has no OCI option for equity securities. Ignoring the observable transaction is not permitted.

Wick Co. holds an available-for-sale debt security with an amortized cost of $500,000 and a fair value of $460,000. Wick does not intend to sell it and is not likely to be required to. The present value of cash flows expected to be collected is $480,000. How is the $40,000 decline recognized?

• a.Nothing in net income and $40,000 in other comprehensive income
• b.$40,000 in net income and nothing in other comprehensive income
• c.$20,000 in net income and $20,000 in other comprehensive income✓
• d.$20,000 in net income and nothing in other comprehensive income

Under ASC 326-30-35, the credit loss ($500,000 - $480,000 = $20,000) is recorded through an allowance and net income, limited to the amount by which fair value is below amortized cost; the remaining $20,000 non-credit decline goes to other comprehensive income. Recognizing the entire $40,000 in net income applies only when the entity intends or is likely to be required to sell (ASC 326-30-35). Putting all of it in OCI ignores the credit loss, and recognizing only $20,000 in total leaves the security above fair value.

On January 1, Year 1, Bolt Co. installs an offshore platform that it is legally required to dismantle in 10 years. The expected dismantling cash flow in Year 10 is $500,000 and Bolt's credit-adjusted risk-free rate is 6%, giving an initial obligation of $279,197. What accretion expense should Bolt recognize in Year 1?

• a.$30,000
• b.$27,920
• c.$50,000
• d.$16,752✓

An asset retirement obligation is initially measured at fair value, usually an expected present value (ASC 410-20-30-1), and the liability grows by accretion using the credit-adjusted risk-free rate at initial measurement (ASC 410-20-35-5): $279,197 x 6% = $16,752. $50,000 spreads the undiscounted cost evenly, $27,920 is the straight-line depreciation of the capitalized asset retirement cost, which is a separate expense, and $30,000 applies the rate to the undiscounted amount.

Cove Co.'s employees earn sick days that carry forward from year to year but are forfeited when employment ends; they are never paid out. Under ASC 710, what is Cove required to do about unused sick days at year-end?

• a.It must report them as a loss contingency in the notes
• b.It is not required to accrue a liability for them✓
• c.It must accrue only the days expected to be used next year
• d.It must accrue the full value of all accumulated days

ASC 710-10-25-1 generally requires accrual of compensated absences when rights vest or accumulate, but ASC 710-10-25-7 makes an exception: sick pay benefits that accumulate but do not vest need not be accrued (an entity may accrue them). Requiring full accrual or accrual of next year's expected use misstates the exception, and unused sick leave is not a loss contingency.

Dove Co. self-insures its workers' compensation risk. At December 31, it estimates $90,000 of costs for injuries that occurred during the year, including $25,000 for injuries not yet reported. It also expects about $40,000 of costs from injuries that will occur next year. What liability should Dove report at December 31?

• a.$65,000
• b.$130,000
• c.$40,000
• d.$90,000✓

A loss contingency is accrued when it is probable that a liability was incurred at the balance sheet date and the amount is reasonably estimable (ASC 450-20-25-2); incurred-but-not-reported claims from injuries that have already happened meet that test, so the full $90,000 is accrued. Injuries that have not yet happened are not liabilities, and the lack of insurance does not create one (ASC 450-20-25). $65,000 omits unreported claims, $130,000 adds next year's expected injuries, and $40,000 is next year's estimate alone.

On October 1, Year 1, Echo Co. communicates a plan to close a plant. Employees will receive one-time termination benefits of $600,000 only if they keep working until March 31, Year 2, which is beyond the minimum retention period; no legal notification period applies. How much termination benefit cost should Echo recognize in Year 1?

• a.$600,000
• b.$0
• c.$300,000✓
• d.$200,000

When employees must render service beyond the minimum retention period (which may not exceed 60 days without a legal notification period), the liability is measured at communication date and recognized ratably over the future service period (ASC 420-10-25): $600,000 x 3/6 = $300,000. Recognizing all $600,000 at communication applies only when no service beyond the minimum retention period is required (ASC 420-10-25). $0 and $200,000 misapply the ratable method.

On January 1, Year 1, Fawn Co. issued $500,000 of five-year, 8% bonds with interest paid each December 31, when the market rate was 10%. The bonds sold for $462,092. Using the effective interest method, what is Fawn's Year 1 interest expense?

• a.$46,209✓
• b.$40,000
• c.$47,582
• d.$50,000

Under the interest method, interest expense equals the carrying amount times the market rate at issuance (ASC 835-30-35-2): $462,092 x 10% = $46,209, of which $40,000 is paid in cash and $6,209 amortizes the discount. $40,000 is the cash coupon, $47,582 is straight-line ($40,000 + $37,908 / 5), and $50,000 applies the market rate to face value.

On January 1, Year 1, Gulf Co. issued $1,000,000 of five-year, 10% bonds with annual interest paid each December 31, when the market rate was 8%. The bonds sold for $1,079,854. Using the effective interest method, what is the bonds' carrying amount at December 31, Year 1?

• a.$1,066,243✓
• b.$1,093,466
• c.$1,063,883
• d.$1,079,854

Interest expense is $1,079,854 x 8% = $86,388; the cash coupon is $100,000; premium amortization is $13,612, so the carrying amount falls to $1,066,243 (ASC 835-30-35-2). $1,063,883 uses straight-line amortization ($79,854 / 5 = $15,971), $1,093,466 adds the amortization instead of subtracting it, and $1,079,854 ignores amortization.

Hawk Co. and its lender, which is not granting any concession, agree to modify Hawk's term loan. The present value of the new terms' cash flows differs by 12% from the present value of the remaining original cash flows, both discounted at the original effective rate. How should Hawk account for the change?

• a.As a modification, deferring the difference and amortizing it over the new term
• b.As a troubled debt restructuring under ASC 470-60
• c.As a modification, computing a new effective rate on the existing carrying amount
• d.As an extinguishment, recording the new debt at fair value and a gain or loss✓

ASC 470-50-40-10 treats new debt terms as substantially different, and therefore an extinguishment, when the present value of cash flows under the new terms differs by at least 10% from the present value of the remaining original cash flows. At 12%, the old debt is derecognized, the new debt is recorded at fair value, and a gain or loss is recognized (ASC 470-50-40-2). Modification accounting applies below 10%, and TDR accounting requires debtor difficulty and a creditor concession.

Under ASC 470-60, when is a modification of a debtor's loan terms a troubled debt restructuring for the debtor?

• a.When the modified cash flows differ from the original by less than 10 percent
• b.When the debtor is in financial difficulty and the creditor grants a concession✓
• c.When the debtor prepays the loan early and pays the lender a prepayment premium
• d.When the lender cuts the rate to match lower market rates for a sound borrower

ASC 470-60-15-5 says a restructuring is a troubled debt restructuring if the creditor, for economic or legal reasons related to the debtor's financial difficulties, grants a concession it would not otherwise consider. A rate cut matching market rates for a creditworthy borrower is not a concession (ASC 470-60-15), the 10% cash flow test decides modification versus extinguishment under ASC 470-50, and a prepayment at a premium is an extinguishment.

Jay Co.'s loan agreement requires total liabilities to total equity of no more than 2.0 at year-end. Before closing, Jay reports liabilities of $1,800,000 and equity of $1,000,000. Its auditors then find a $300,000 accrued expense that was never recorded (ignore income taxes). After correction, what is the ratio, and is Jay in compliance?

• a.1.8; in compliance
• b.2.57; not in compliance
• c.3.0; not in compliance✓
• d.2.1; not in compliance

Recording the accrual raises liabilities to $2,100,000 and, through expense, lowers equity to $700,000: $2,100,000 / $700,000 = 3.0, above the 2.0 limit. 1.8 ignores the error, 2.1 adds the liability but leaves equity unchanged, and 2.57 reduces equity but forgets to add the liability ($1,800,000 / $700,000).

Kiln Corp. has 100,000 shares of $1 par common stock outstanding when the market price is $20 per share. It declares and distributes a 10% stock dividend. By how much does retained earnings decrease?

• a.$0
• b.$190,000
• c.$10,000
• d.$200,000✓

A small stock dividend (less than about 20-25% of outstanding shares) is recorded by transferring the fair value of the shares issued from retained earnings to common stock and additional paid-in capital (ASC 505-20-30-3): 10,000 shares x $20 = $200,000, split $10,000 to common stock and $190,000 to APIC. $10,000 is the par-value amount used for large stock dividends, $0 treats it like a stock split, and $190,000 is only the APIC portion.

Lynx Corp. carries out a 2-for-1 stock split by reducing the par value of each share. What is the effect on total equity and on par value per share?

• a.Retained earnings reduced; par value per share unchanged
• b.Total equity doubled; par value per share halved
• c.Total equity unchanged; par value per share unchanged
• d.Total equity unchanged; par value per share halved✓

A stock split effected by reducing par value changes only the number of shares and the par value per share; no amount is transferred between equity accounts and total equity is unchanged (ASC 505-20, stock dividends and stock splits). Reducing retained earnings while keeping par unchanged describes a split effected in the form of a dividend, and a split brings in no new resources.

Using the cost method, Mink Co. bought 1,000 of its own shares for $30 each. It later reissued 600 shares at $36 and then the remaining 400 shares at $25. No other treasury stock transactions have occurred. After both reissues, what is the balance of additional paid-in capital from treasury stock?

• a.$3,600
• b.$0
• c.$5,600
• d.$1,600✓

Under the cost method, gains on reissuing treasury stock are credited to additional paid-in capital and losses are charged first to paid-in capital from the same class's treasury transactions, then to retained earnings (ASC 505-30-30). The first reissue credits $3,600 (600 x $6); the second has a $2,000 loss (400 x $5), charged against that capital, leaving $1,600. $3,600 ignores the loss, $0 assumes the loss wipes out the whole balance, and $5,600 adds the loss.