COMPREHENSIVE CPA REVIEWdocshare02.docshare.tips/files/29760/297605833.pdfCOMPREHENSIVE CPA REVIEW Gandy Company has 5,000 obsolete desk lamps that are carried in inventory at a manufacturing

COMPREHENSIVE CPA REVIEW

Gandy Company has 5,000 obsolete desk lamps that are carried in inventory at a manufacturing cost of $50,000. If the lamps are reworked for $20,000, they could be sold for $35,000. Alternatively, the lamps could be sold for $8,000 to a jobber located in a distant city. In a decision model analyzing these alternatives, what would the sunk cost be?

A) $ 8,000

B) $15,000

C) $20,000

D) $50,000

Correct Answer: D

Explanation: Sunk costs are costs that will not change or be affected by the selection of available alternatives. In this situation, the prior manufacturing costs of $50,000 will be unaffected by subsequent processing or sale.

For a large population of cash disbursement transactions, Smith, CPA, is testing compliance with internal control by using attribute sampling techniques. Anticipating an occurrence rate of 3% Smith found from a table that the required sample size is 400 with a desired upper precision limit of 5% and reliability of 95%. If Smith anticipated an occurrence rate of only 2% but wanted to maintain the same desired upper precision limit and reliability the sample size would be closest to:

A) 200

B) 400

C) 533

D) 800

Correct Answer: A

Explanation: In this problem, the occurrence rate of 3% and the other factors indicated call for asample of 400. If the occurrence rate is made smaller, then the sample would decrease and the only possible answer would be 200.

In order for an offer to confer the power to form a contract by acceptance, it must have all of the following elements except?

A) Be communicated to the offeree and the communication must be made or authorized by the


offeror.

B) Be sufficiently definite and certain.

C) Be communicated by words to the offeree by the offeror.

D) Manifest an intent to enter into a contract.

Correct Answer: C

Explanation: Communication by words is not required as the communication can also be done by actions. Equally, the communication need not be directly made by the offeror to the offeree, as it could be communicated through a third party. An offer must be seriously intended, communicated, and definite in its terms.

A lessee had a ten-year capital lease requiring equal annual payments. The reduction of thelease liability in year 2 should equal:

A) The current liability shown for the lease at the end of year 1

B) The current liability shown for the lease at the end of year 2

C) The reduction of the lease obligation in year 1

D) One-tenth of the original lease liability

Correct Answer: A

Explanation: The portion of the lease payment which will reduce the lease obligation in year 2 is shown as a current liability at the end of year 1. The payments reduce an increased amount of the liability each year.

In an income statement prepared using the variable costing method, fixed factory overheadwould

A) Not be used.

B) Be used in the computation of the contribution margin.

C)Be used in the computation of operating income but not in the computation of the contribution margin.

D) Be treated the same as variable factory overhead.


Correct Answer: C

Explanation: Under the direct or variable costing method, variable costs are deducted from salesrevenue to determine contribution margin and all fixed costs (overhead, selling, general and administrative) are then deducted to obtain net income or income from operations. The contribution margin is calculated in two steps:

1. Sales revenue less (variable) cost of goods sold = Contribution margin: manufacturing2. Contribution margin: manufacturing less other variable costs (S, G & A) = Contribution margin: final

rainbow wants to use unrestricted random sampling without replacement in 2010. Compared to 2009, the population size of the raw-materials inventory is approximately the same, and the variability of the items in the inventory is approximately the same. Rainbow specifies the same precision but desires to change the specified reliability from 90% to 95%. Under these assumptions, the required sample size for 2010 should be:

A) Larger than the 2009 sample size

B) Equal to the 2009 sample size

C) Smaller than the 2009 sample size

D) Of a size that is indeterminate based upon the information given

Correct Answer: A

Explanation: Sampling without replacement was in use for the two years compared and the finite population correction factor will not have any effect. An increase in the reliability from 90 to 95% will cause an increase in the sample size.

In general, which of the following statements is correct with respect to a limited partnership?

A)A limited partner has the right to obtain from the general partner(s) financial information and tax returns of the limited partnership.

B) A limited partnership can be formed with limited liability for all partners.

C) A limited partner may not also be a general partner at the same time.

D) A limited partner may hire employees on behalf of the partnership.


Correct Answer: A

Explanation: The law gives to all investors the right to inspect books and records at reasonable times. Stockholders, general partners and limited partners all have this right. Thus, a limited partner may obtain financial information to include tax returns. A limited partnership must have at least one general partner and general partners are personally liable for all partnership debts. A limited partner may also be a general partner in the same partnership at the same time. A limited partner may not take part in the control of the partnership.

On January 1, 2010, Harrow Co. as lessee signed a five-year noncancellable equipment lease with annual payments of $100,000 beginning December 31, 2010. Harrow treated this transaction as a capital lease. The five lease payments have a present value of $379,000 at January 1, 2010, based on interest of 10%. What amount should Harrow report as interest expense for the year ended December 31, 2010?

A) $37,900

B) $27,900

C) $24,200

D) $0

Correct Answer: A

Explanation: The interest expense for 2010 is $37,900—the effective interest rate (10%) times the January 1, 2010, present value ($379,000).

The most likely strategy to reduce the breakeven point would be to

A) Increase both the fixed costs and the contribution margin.

B) Decrease both the fixed costs and the contribution margin.

C) Decrease the fixed costs and increase the contribution margin.

D) Increase the fixed costs and decrease the contribution margin.

Correct Answer: C

Explanation: Breakeven point represents your fixed costs divided by your contribution margin.


Mathematically, by decreasing your numerator (fixed costs) or increasing your denominator (contribution margin), your breakeven point must decrease.

A CPA should not submit unaudited financial statements of a nonpublic company to a client or others unless, as a minimum, the CPA complies with the provisions applicable to:

A) Compilation engagements

B) Review engagements

C) Statements on auditing standards

D) Attestation standards

Correct Answer: A

Explanation: Since the CPA is associated with the financial statements (he is submitting them), he must indicate the degree of responsibility he is taking with respect to the statements. Since thestatements are unaudited and the company is nonpublic, the appropriate standards are compilation standards.

Which of the following provisions is basic to all workers' compensation systems?

A) The injured employee must prove the employer's negligence.

B) The employer may invoke the traditional defense of contributory negligence.

C)The employer's liability may be ameliorated by a co-employee's negligence under the fellowservant rule.

D) The injured employee is allowed to recover on strict liability theory.

Correct Answer: D

Explanation: Employees will receive workers' compensation benefits if injured in the scope of employment. The employer is strictly liable without regard to fault. The remaining answer choices are incorrect because negligence will not bar recovery. Negligence is irrelevant. Thus, the employee does not need to prove the employer negligent, the defense of contributory negligence by the employee is not available and the liability of the employer is not changed by the negligence of a co-employee.

On December 31, 2010, Bit Co. had capitalized costs for a new computer software product with an economic life of five years. Sales for 2011 were 30 percent of expected total sales of


the software. At December 31, 2011, the software had a net realizable value equal to 90 percent of the capitalized cost. What percentage of the original capitalized cost should be reported as the net amount on Bit's December 31, 2011, balance sheet?

A) 70%

B) 72%

C) 80%

D) 90%

Correct Answer: A

Explanation: Using a service life method, the capitalized costs would be amortized on the basis of percentage of total projected sales. Therefore, 30% of the costs would be amortized in 2011.

In a traditional job order cost system, the issue of indirect materials to a production department increases which of the following?

A) Stores control.

B) Work in process control.

C) Factory overhead control.

D) Factory overhead applied.

Correct Answer: C

Explanation: When indirect materials were initially purchased, they would be charged to the stores control. However, when they are issued to a production department, they would be charged (increased) to the factory overhead control account.

When reporting on an entity's internal control structure under Government Auditing Standards, an auditor should issue a written report that includes a:

A)Statement of negative assurance that nothing came to the auditor's attention that caused the auditor to believe reportable conditions were present.

B)Statement of positive assurance that the results of tests indicate that the internal control structure either can, or cannot, be relied on to reduce control risk to an acceptable level.

Description of the weaknesses considered to be reportable conditions and the strengths that


D)Description of the scope of the auditor's work in obtaining an understanding of the internal control structure and in assessing control risk.

Correct Answer: D

Explanation: Government Auditing Standards requires a written report on the internal control structure in all audits. Those standards also require description of any reportable conditions noted, identification of the categories of the internal control structure, description of the scope of the auditor's work in obtaining an understanding of the internal control structure and in assessing control risk, and description of deficiencies in the internal control structure not considered significant enough to be reportable conditions.

During 2009, Jase Co. incurred research and development costs of $136,000 in its laboratories relating to a patent that was granted on July 1, 2009. Costs of registering the patent equaled $34,000. The patent's legal life is 17 years, and its estimated economic life is 10 years. In its December 31, 2009, balance sheet, what amount should Jase report as patent, net of accumulated amortization?

A) $ 32,300

B) $ 33,000

C) $161,500

D) $165,000

Correct Answer: A

Explanation: The research development costs should be expensed because of the uncertainty associated with any R & D effort. However, the cost of registering the patent should be capitalized because it benefits future periods and should be amortized over its useful life of 10 years. In this case, the amortization for the last six months of 2009 would be $1700 ($34,000 divided by 10 years x 6/12). The amount presented on the balance sheet would be the cost of $34,000 less the $1700 amortization or $32,300.

Book Co. uses the activity-based costing approach for cost allocation and product costing purposes. Printing, cutting, and binding functions make up the manufacturing process. Machinery and equipment are arranged in operating cells that produce a complete productstarting with raw materials. Which of the following are characteristics of Book's activity-based costing approach?


I. Cost drivers are used as a basis for cost allocation.II. Costs are accumulated by department or function for purposes of product costing.III. Activities that do not add value to the product are identified and reduced to the extent possible.

A) I only.

B) I and II.

C) I and III.

D) II and III.

Correct Answer: A

Explanation: Activity based costing assigns costs to products based upon the product's use of activities (cost drivers) which caused the costs to be incurred. Costs are accumulated (homogeneous cost pools) by activities (cost drivers) rather than by department or function as in more traditional costing systems. Nonvalue-added activities (cost drivers), such as movement of product, storage, set up, and inspection are minimized or eliminated without adversely affecting the product or service.

One of a CPA firm's basic objectives is to provide professional services that conform with professional standards. Reasonable assurance of achieving this basic objective is provided through:

A) A system of quality control

B) A system of peer review

C) Continuing professional education

D) Compliance with generally accepted reporting standards

Correct Answer: A

Explanation: A system of quality control for a CPA firm, which usually encompasses quality control policies and procedures, assignment of responsibilities, communication, and monitoring, can provide a CPA firm with reasonable assurance of conforming with professional standards.

The remaining answer choices are incorrect for the following reasons:

• Peer review which, as an external study of a firm's quality controls, can help evaluate a firm's professional practice but is not done on a regular, ongoing basis.


• Continuing professional education is one example of an element of quality control.• Compliance with generally accepted reporting standards could be considered an example of a professional standard with which a firm should conform.

The installment method of recognizing revenue:

A)Should be used only in cases where there is no reasonable basis for estimating the collectibles of receivables

B) Is not a generally accepted accounting principle under any circumstances

C) Should be used for book purposes only if it is used for tax purposes

D) Is an acceptable alternative accounting principle for a firm which makes installment sales

Correct Answer: A

Explanation: According to APB #10 (par. 12), the installment method of accounting is not acceptable unless "collection of the sale price is not reasonably assured."

As a company becomes more conservative in its working capital policy, it would tend to have a(n)

A) Decrease in its acid-test ratio.

B) Increase in the ratio of current liabilities to noncurrent liabilities.

C) Increase in the ratio of current assets to units of output.

D)Increase in funds invested in common stock and a decrease in funds invested in marketable securities.

Correct Answer: C

Explanation: A conservative working capital policy results in an increase in working capital. Therefore, current assets increase. Working capital = current assets minus current liabilities. A conservative working capital policy reduces the liquidity risk. A decrease in acid test ratio means that quick assets such as cash, receivables and marketable securities are decreasing in proportion to current liabilities and this results in lower working capital. Increases in the ratio of current liabilities to noncurrent liabilities increases liquidity risk, and represents a less conservative working capital policy. As a company becomes more conservative in its working capital policy, it


will not increase the funds invested in common stock (long term) and decrease funds invested in marketable securities (short term).

An auditor concludes that there is a material inconsistency in the other information in an annual report to shareholders containing audited financial statements. If the auditor concludes that the financial statements do not require revision, but the client refuses to revise or eliminate the material inconsistency, the auditor may:

A)Issue an "except for" qualified opinion after discussing the matter with the client's board of directors.

B)Consider the matter closed since the other information is not in the audited financial statements.

C)Disclaim an opinion on the financial statements after explaining the material inconsistency in a separate explanatory paragraph.

D)Revise the auditor's report to include a separate explanatory paragraph describing the material inconsistency.

Correct Answer: D

Explanation: The auditor's responsibility with respect to information in an annual report does not extend beyond the financial information identified in his report. However, he should read the other information and consider whether it is materially inconsistent with information appearing in the financial statements. If he concludes that the other information is inconsistent and the client refuses to correct the inconsistency, the auditor should either revise his report to include anexplanatory paragraph describing the material inconsistency, withhold the use of his report in theannual report, or withdraw from the engagement.

Burn Manufacturing borrowed $500,000 from Howard Finance Co., secured by Burn's present and future inventory, accounts receivable, and the proceeds thereof. The parties signed a financing statement that described the collateral and it was filed in the appropriate state office. Burn subsequently defaulted in the repayment of the loan and Howard attempted to enforce its security interest. Burn contended that Howard's security interest was unenforceable. In addition, Green, who subsequently gave credit to Burn without knowledge of Howard's security interest, is also attempting to defeat Howard's alleged security interest. The security interest in question is valid with respect to _________________

A) both Burn and Green.

B) neither Burn nor Green.


C) burn but not Green.

D) green but not Burn.

Correct Answer: A

Explanation: A creditor with a security interest will have rights against a debtor when attachment has occurred. Three elements are required for attachment: an agreement between the debtor and the creditor, value must be given by the creditor and the debtor must have rights in thecollateral. Howard will have rights against Burn (debtor), because there was a written security agreement, value was given by Howard ($500,000) and the debtor had rights in the collateral (inventory and accounts receivable). When two creditors are fighting over the same collateral, usually the first creditor to perfect wins. Since Howard perfected by filing before Green gave credit, Howard's security interest has priority over Green.

The calculation of the income recognized in the third year of a five-year construction contract accounted for using the percentage-of-completion method includes the ratio of:

A) Total costs incurred to date to total estimated costs

B) Total costs incurred to date to total billings to date

C) Costs incurred in year 3 to total estimated costs

D) Costs incurred in year 3 to total billings to date

Correct Answer: A

Explanation: Income recognized in the third year of a five-year construction contract using percentage-of-completion method would be calculated by multiplying the ratio of the total cost incurred to date divided by the estimated total cost times the estimated total gross profit on the contract less the gross profit recognized in years one and two. Note that billings on the contract do not affect the calculation of income recognized.

Attachment and perfection will occur simultaneously when _________________

A) the security agreement so provides.

B) there is a purchase money security interest taken in inventory.

C) attachment is by possession.

D) the goods are sold on consignment.


Correct Answer: C

Explanation: There are only three different ways to perfect: by possession, by filing and perfection by attachment. Possession will not only create the security agreement required for attachment, but will also result in perfection. Thus when attachment is by possession, attachment and possession occur simultaneously. Note that they would also occur simultaneously when perfection by attachment occurs.


• Perfection will not occur merely because the security agreement so provides. You must perfect by one of the three methods.• No possession or filing occurred and perfection by attachment requires a PMSI creditor in consumer goods, not a PMSI creditor in inventory. Thus, no perfection occurred.• No possession, filing or perfection by attachment occurred and therefore there is no perfection.

A principal auditor decides not to refer to the audit of another CPA who audited a subsidiary of the principal auditor's client. After making inquiries about the other CPA's professional reputation and independence, the principal auditor most likely would:

A)Add an explanatory paragraph to the auditor's report indicating that the subsidiary's financial statements are not material to the consolidated financial statements.

B)Document in the engagement letter that the principal auditor assumes no responsibility for the other CPA's work and opinion.

C)Obtain written permission from the other CPA to omit the reference in the principal auditor's report.

D)Contact the other CPA and review the audit programs and working papers pertaining to the subsidiary.

Correct Answer: D

Explanation: If an auditor decides that he or she is the principal auditor and that he or she can use the other auditor's report, because the other auditor is reputable and independent, the principal auditor must decide whether or not to make reference to the other auditor. If the principal auditor decides not to refer to the other auditor, he or she should visit the other auditor, discuss the procedures followed, and review the audit program and working papers of the other auditor.



• If the principal auditor decides not to refer to the other auditor, no references of any kind wouldbe made in the report.• Assuming no responsibility for the other CPA's work and opinion would not fulfill the principalauditor's reporting responsibilities.• Permission would only be necessary if the principal auditor decides to refer to and name the other auditor.

Management can estimate the amount of loss that will occur if a foreign government expropriates some company assets. If expropriation is reasonably possible, a loss contingency should be:

A) Disclosed but not accrued as a liability

B) Disclosed and accrued as a liability

C) Accrued as a liability but not disclosed

D) Neither accrued as a liability nor disclosed

Correct Answer: A

Explanation: The key words are "reasonably possible". FASB #5 states that if a loss contingency is reasonably possible, it should be disclosed but not accrued. A loss contingency is accrued only if the loss contingency is probable and the amount of the loss can be reasonably estimated.

If a firm's credit terms require payment with 45 days but allow a discount of 2 percent if paid within 15 days (using a 360-day year), the approximate cost/benefit of the trade credit terms is what?

A) 2 percent.

B) 16 percent.

C) 48 percent.

D) 24 percent.

Correct Answer: D

Explanation: If the credit terms are 2/15 net 45, then a company not taking the 2% discount would have an extra 30 days (45 - 15) to use the money. Thirty days divided into a 360 day year equals twelve 30 day periods in a year. Therefore, if it costs 2% to hold the money an additional


30 days, and there are twelve 30 day periods in a year, then the approximate cost/benefit of the trade credit terms is 24% (2% x 12).

King, CPA, was engaged to audit the financial statements of Newton Company after its fiscal year had ended. King neither observed the inventory count nor confirmed the receivables by direct communication with debtors, but was satisfied concerning both after applying alternative procedures. King's auditor's report most likely contained a(an):

A) Qualified opinion

B) Disclaimer of opinion

C) Unqualified opinion

D) Unqualified opinion with an explanatory paragraph

Correct Answer: C

Explanation: Observation of the inventory count and confirmation of receivables is normally performed during an audit. However, if circumstances do not permit these procedures to be performed, the auditor may apply alternative audit procedures that may include observation of aninventory count at a later date and the verification of receivable balances by auditing subsequent cash receipts. If the auditor is able to employ alternative procedures he considers appropriate in the circumstances, no modification or qualification of the audit report is necessary.

On September 27, Summers sent Fox a letter offering to sell Fox a vacation home for $150,000. On October 2, Fox replied by mail agreeing to buy the home for $145,000. Summers did not reply to Fox. Do Fox and Summers have a binding contract?

A) No, because Fox failed to sign and return Summers' letter.

B) No, because Fox's letter was a counteroffer.

C) Yes, because Summers' offer was validly accepted.

D) Yes, because Summers' silence is an implied acceptance of Fox's letter.

Correct Answer: B

Explanation: Since Fox changed the terms of the offer, the letter was a counteroffer and not a valid acceptance. The remaining answer choices are incorrect because no contract was formed and Fox doesn't have to sign and return an offer to accept.

A company acquired a building, paying a portion of the purchase price in cash and issuing a mortgage note payable to the seller for the balance.


A) Cash payment

B) Acquisition price

C) Zero

D) Mortgage amount

Correct Answer: A

Explanation: For transactions that are part cash and part noncash, only the cash portion is reported in the statement of cash flows. The related disclosures (of noncash investing and financing activities) should clearly describe the cash and noncash aspects of such transactions.

A disadvantage of the net present value method of capital expenditure evaluation is that

A) It is calculated using sensitivity analysis.

B) It computes the true interest rate.

C) It does not provide the true rate of return on investment.

D) It is difficult to apply because it uses a trial and error approach.

Correct Answer: C

Explanation: The NPV method does not provide the true rate of return on an investment. Rather,it uses a company's discount rate to evaluate whether or not the investment has a positive NPV. To compute an investment's rate of return, a company should use the internal rate of return method. The NPV is not calculated using sensitivity analysis. It is calculated using amount assumed to be accurate. However, sensitivity analysis may subsequently be used to measure the sensitivity of the NPV to changes in the assumed amounts. NPV does not compute any interest rate. It uses a company's discount rate to evaluate whether or not an investment has a positive NPV. NPV does not use a trial and error approach. It uses cash flow amounts and a discount rate assumed to be accurate and computes NPV one time.

An auditor's decision either to apply analytical procedures as substantive tests or to perform tests of transactions and account balances usually is determined by the:

A) Availability of data aggregated at a high level

B) Relative effectiveness and efficiency of the tests


C) Timing of tests performed after the balance sheet date

D) Auditor's familiarity with industry trends

Correct Answer: B

Explanation: Substantive tests, which are comprised of analytical procedures and tests of details(transactions and account balances), must be performed to substantiate the financial statement assertions. The decision about which procedures to use to achieve a particular audit objective is based on the auditor's judgment on the expected effectiveness and efficiency of the available procedures.

Young Corp. hired Wilson as a sales representative for six months at a salary of $5,000 per month plus 6% of sales. Which of the following statements is correct?

A)Young does not have the power to dismiss Wilson during the six-month period without cause.

B) Wilson is obligated to act solely in Young's interest in matters concerning Young's business.

C)The agreement between Young and Wilson is not enforceable unless it is in writing and signed by Wilson.

D) The agreement between Young and Wilson formed an agency coupled with an interest.

Correct Answer: B

Explanation: Because an agent owes a fiduciary duty of loyalty to their principal, they must act solely in the principal's best interests in matters concerning their business.


• Most agencies are terminable at will and therefore Young does have the power to dismiss Wilson without cause.• Only an agency to buy land or one impossible to perform in one year would require a writing under the statute of frauds (GRIPE + marriage).• With an agency coupled with an interest the principal makes a party their agent solely to pay offa debt that the principal owes the agent. There is no indication that Wilson was hired by Young solely to pay off a debt that Wilson owed Young.

Generally, which of the following statements concerning workers' compensation laws is correct?


A) The amount of damages recoverable is based on comparative negligence.

B) Employers are strictly liable without regard to whether or not they are at fault.

C) Workers' compensation benefits are not available if the employee is negligent.

D) Workers' compensation awards are payable for life.

Correct Answer: B

Explanation: Employees will receive workers' compensation benefits if injured in the scope of employment. The employer is strictly liable without regard to fault.


• Negligence by the employee will not bar recovery or change the amount of the award.• Workers' compensation awards may be in the form of a lump sum and, thus, not be payable for life.

A violation of the profession's ethical standards most likely would have occurred when a CPA _________________

A)issued an unqualified opinion on the 2009 financial statements when fees for the 2008 audit were unpaid.

B)recommended a controller's position description with candidate specifications to an audit client.

C)purchased a CPA firm's practice of monthly write-ups for a percentage of fees to be receivedover a three-year period.

D)made arrangements with a financial institution to collect notes issued by a client in paymentof fees due for the current year's audit.

Correct Answer: A

Explanation: Under Rule 101 of the Rules of Conduct as interpreted, independence is impaired if there is a direct financial interest in an audit client regardless of materiality. Specifically independence is impaired if audit fees remain unpaid for more than one year prior to the date of the current year's report. It is considered a loan.



• Independence is not impaired by merely recommending a job position including candidate specifications. However, independence would be +impaired if the CPA actually did the hiring of the controller because this would be management.• There is no prohibition against purchase of a CPA firm's monthly write-ups for a percentage of fees.• A CPA may make arrangements with a bank to collect notes issued by a client in payment for a fee that is due.

What are the Statements of Financial Accounting Concepts intended to establish?

A) Generally accepted accounting principles in financial reporting by business enterprises

B)The meaning of "Present fairly in accordance with generally accepted accounting principles."

C)The objectives and concepts for use in developing standards of financial accounting and reporting

D) The hierarchy of sources of generally accepted accounting principles

Correct Answer: C

Explanation: FASB C-1 intends to establish objectives and concepts for use in developing the standards of financial accounting and reporting to be used as a guideline that will lead to consistent standards. GAAP is a technical term that encompasses the conventions, rules, and procedures not only in broad guidelines but also detailed procedures developed on the basis of experience, reason, custom and practical need. ASB (Auditing Standards Board) is responsible for developing choice "Present fairly in accordance with generally accepted accounting principles.". The AICPA's Code of Conduct establishes the hierarchy of sources.

An auditor searching for related party transactions should obtain an understanding of each subsidiary's relationship to the total entity because:

A)This may permit the audit of intercompany account balances to be performed as of concurrent dates.

B)Intercompany transactions may have been consummated on terms equivalent to arm's-length transactions.

C)This may reveal whether particular transactions would have taken place if the parties had not been related.

D) The business structure may be deliberately designed to obscure related party transactions.


Correct Answer: D

Explanation: In determining the scope of work to be performed with respect to possible transactions with related parties, the auditor should obtain an understanding of management responsibilities and the relationship of each component to the total entity. Normally, the business structure is based on the abilities of management, tax and legal considerations, product diversification, and geographical location. Experience has shown, however, that business structure may be deliberately designed to obscure related party transactions. Therefore, when searching for related party transactions the auditor should obtain an understanding of each subsidiary's relationship to the total entity.

Under FASB Statement of Financial Accounting Concepts No. 5, which of the following items would cause earnings to differ from comprehensive income for an enterprise in an industry not having specialized accounting principles?

A) Unrealized loss on investments in available-forsake marketable equity securities

B) Unrealized loss on investments in trading marketable equity securities

C) Loss on exchange of similar assets

D) Loss on exchange of dissimilar assets

Correct Answer: A

Explanation: The correct choice is "Unrealized loss on investments in available-forsale marketable equity securities"

The remaining answer choices described losses which are recognized in earnings as well as in comprehensive income. An unrealized loss on investments in available-for-sale marketable equity securities is not recognized in current earnings but is a factor in measuring comprehensiveincome.

Which one of the following would not shift the aggregate demand curve?

A) A change in the price level

B) Depreciation of the international value of the dollar

C) A decline in the interest rate at each possible price level

D) An increase in personal income tax rates


Correct Answer: A

Explanation: A change in the price level would result in an increase in real GDP without shifting the aggregate demand curve. Depreciation of the international value of the dollar will impact demand for exports and that will cause a shift in the aggregate demand curve. The aggregate demand curve shows the relationship between the price level and real GDP. An increase in personal income tax rates will cause a shift in the aggregate demand curve.]

The primary objective of analytical procedures used in the final review stage of an audit is to:

A) Obtain evidence from details tested to corroborate particular assertions.

B) Identify areas that represent specific risks relevant to the audit.

C) Assist the auditor in assessing the validity of the conclusions reached.

D) Satisfy doubts when questions arise about a client's ability to continue in existence.

Correct Answer: C

Explanation: The objective of analytical procedures used in the overall review stage of the auditis to assist the auditor in assessing the conclusions reached and in the evaluation of the overall financial statement presentation.


• "Obtain evidence from details tested to corroborate particular assertions." refers to substantive tests of details, not analytical procedures.• "Identify areas that represent specific risks relevant to the audit." is an objective of analytical procedures used in planning the audit.• "Satisfy doubts when questions arise about a client's ability to continue in existence." involves the auditor obtaining information about management's plans and assessing the likelihood that such plans can be implemented; these are not analytical procedures.

Ritz Corp. wished to acquire the stock of Stale, Inc. In conjunction with its plan of acquisition Ritz hired Fein, CPA, to audit the financial statements of Stale. Based on the audited financial statements and Fein's unqualified opinion, Ritz acquired Stale. Within sixmonths, it was discovered that the inventory of Stale had been overstated by $500,000. Ritzcommenced an action against Fein. Ritz believes that Fein failed to exercise the knowledge, skill, and judgment commonly possessed by CPAs in the locality, but is not able to prove that Fein either intentionally deceived it or showed a reckless disregard for the truth. Ritz


also is unable to prove that Fein had any knowledge that the inventory was overstated. Which of the following two causes of action would provide Ritz with proper bases upon which Ritz would most likely prevail?

A) Negligence and breach of contract

B) Negligence and gross negligence

C) Negligence and fraud

D) Gross negligence and breach of contract

Correct Answer: A

Explanation: Liability for actual fraud requires proof of scienter, an intent to deceive. With constructive fraud or gross negligence the scienter element is met by a reckless disregard for the truth. Since Ritz cannot prove that Fein intentionally deceived or showed a reckless disregard forthe truth, Ritz would not prevail in either an action for fraud or gross negligence.

The remaining answer choices are incorrect because Ritz will not prevail in an action for fraud orgross negligence. For negligence a plaintiff must prove a duty of care, breach (lack of due care), damages and causality. Failure of Fein to exercise the skill and care possessed of CPA's in the locality would constitute a failure to use due care and would make Fein liable for negligence. It would also be a breach of the contract for services that Fein had with Ritz.

The functional currency of Nash, Inc.'s subsidiary is the French franc. Nash borrowed French francs as a partial hedge of its investment in the subsidiary. In preparing consolidated financial statements, Nash's translation loss on its investment in the subsidiary exceeded its exchange gain on the borrowing. How should the effects of the loss and gain be reported in Nash's consolidated financial statements?

A)The translation loss less the exchange gain is reported separately as other comprehensive income.

B) The translation loss less the exchange gain is reported in the income statement.

C)The translation loss is reported separately in the stockholders' equity section of the balance sheet and the exchange gain is reported in the income statement.

D)The translation loss is reported in the income statement and the exchange gain is reported separately in the stockholders' equity section of the balance sheet.

Correct Answer: A


Explanation: Gains and losses on foreign currency transactions that are designated as economic hedges of a net investment in a foreign entity should be reported in the same manner as a translation adjustment. Current changes in translation adjustments are reported as other comprehensive income.

Which of the following best defines NDP?

A) NI plus net foreign factor income earned in the U.S. plus indirect business taxes.

B) NI plus corporate income taxes.

C) GDP deflated for increases in the price level.

D) GDP minus indirect business taxes.

Correct Answer: A

Explanation: Net foreign factor income and indirect business taxes explain the difference between NI and NDP. Corporate taxes are part of the difference between national income (NI) and personal income (PI). GDP deflated for price level changes is called "Real GDP."Â Indirect business taxes is only one of the elements that explains the difference between NDP and NI.

Which of the following procedures is least likely to be performed before the balance sheet date?

A) Testing of internal control over cash

B) Confirmation of receivables

C) Search for unrecorded liabilities

D) Observation of inventory

Correct Answer: C

Explanation: The auditor is concerned with unrecorded liabilities as of the balance sheet date (completeness assertion), thus audit procedures performed to identify unrecorded liabilities before the balance sheet date would be meaningless. Accounts receivable may be confirmed priorto the balance sheet date if the auditor concludes internal controls surrounding accounts receivable are effective. Inventory counts may be observed prior to year if the client maintains perpetual inventory records and the controls surrounding those records are effective.

In a period of rising general price levels, Pollard Corp. discloses income on a current cost


basis in accordance with FASB Statement No. 89, Financial Reporting and Changing Prices.

Compared to historical cost income from continuing operations, which of the following conditions increases Pollard's current cost income from continuing operations?

A) Current cost of equipment is greater than historical cost.

B) Current cost of land is greater than historical cost.

C) Current cost of cost of goods sold is less than historical cost.

D) Ending net monetary assets are less than beginning net monetary assets.

Correct Answer: C

Explanation: Holding gains for equipment and land are not part of income from continuing operations. The reduction in cost of goods sold is reflected in income from continuing operationsand is not applicable for current cost measurement.

Daly tried to collect on a property insurance policy covering a house that was damaged by fire. The insurer denied recovery, alleging that Daly had no insurable interest in the house. In which of the following situations will the insurer prevail?

A) The house belongs to a corporation of which Daly is a 50% stockholder.

B) Daly is not the owner of the house but a long-term lessee.

C) The house is held in trust for Daly's mother and, on her death, will pass to Daly.

D) Daly gave an unsecured loan to the owner of the house to improve the house.

Correct Answer: D

Explanation: An insurable interest is some economic interest in the goods at time of loss. An unsecured creditor does not have an insurable interest in the debtor's property. Thus, Daly would not have an insurable interest in the house because Daly was an unsecured creditor.


• A 50% stockholder would have an insurable interest in a house owned by the corporation.• A lessee has an insurable in the house that they lease.• A remainderman in a trust has an insurable interest in the property of the trust.


Which one of the following would increase the working capital of a firm?

A) Refinancing a short-term note payable with a two year note payable.

B) Purchase of a new plant financed by a 20-year mortgage.

C) Cash collection of accounts receivable.

D) Payment of a 20-year mortgage payable with cash.

Correct Answer: A

Explanation: Refinancing a short-term note payable with a two-year note payable would increase the working capital of a firm.

Current Assets - Current Liabilities = Working CapitalAssuming CA = $10 and CL = $6, WC = $4. ($10 - $6 = $4)

If a company refinances $2 worth of short-term notes payable with a two year note payable, working capital would increase. ($10 - $4 = $6).

The purchase of a new plant financed by a 20-year mortgage would not increase the working capital of a firm. WC would stay the same. A cash collection of accounts receivable would not increase the working capital of a firm. WC would stay the same. A payment of a 20-year mortgage payable with cash would not increase the working capital of a firm. WC would decrease.

A retained earnings appropriation can be used to:

A) Absorb a fire loss when a company is self-insured.

B) Provide for a contingent loss that is probable and reasonable.

C) Smooth periodic income.

D) Restrict earnings available for dividends.

Correct Answer: D

Explanation: An appropriation of retained earnings (a reserve) is used to inform financial statement users of a restriction on the availability of retained earnings for dividends. The entry torecord an appropriation charges Retained Earnings and credits Appropriated Retained Earnings.


When the appropriation is no longer needed, the only proper entry is to reverse the entry that established the appropriation.

Major Corp. is considering the purchase of a new machine for $5,000 that will have an estimated useful life of five years and no salvage value. The machine will increase Major's after-tax cash flow by $2,000 annually for five years. Major uses the straight-line method ofdepreciation and has an incremental borrowing rate of 10%. The present value factors for 10% are as follows:

Ordinary annuity with five payments 3.79Annuity due for five payments 4.17

Using the payback method, how many years will it take to pay back Major's initial investment in the machine?

A) 2.50

B) 5.00

C) 7.58

D) 8.34

Correct Answer: A

Explanation: The payback method is the original investment divided by cash flow after taxes, or$5,000 divided by $2,000 for a payback of 2.5 years. Payback does not utilize discounted cash flows, so the information regarding the time value of money is not needed to solve the problem.






Correct Answer: C



FAR The Heinline Company has maintained a defined-benefit pension plan for its employees for a number of years. At the end of the most recent year, the following information was available:--Service cost $285,000--Expected return on plan assets 59,000--Actual return on plan assets 52,000--Plan assets 600,000--Projected benefit obligation 700,000--Funding 220,000--Interest on projected benefit obligation 65,000--Amortization of prior service cost (createdwhen a contractual provision was amendedwhich reduced the projectedbenefit obligation) 25,000 What should be reported as the pension expense for the year?a. Less than $270,000b. Between $269,999 and $280,000c. Between $279,999 and $290,000d. Between $289,999 and $300,000e. Between $299,999 and $310,000f. More than $309,999 Answer is A Not all of the available numbers are used here in determining pension expense. The candidate must determine which numbers are included and whether they increase or decrease the pension expense. The service cost ($285,000) and the interest on the projected benefit obligation ($65,000) increase the expense. The income on the plan assets is a decrease to the expense. To prevent wild swings in the reported expense that might occur from changes in the value of those plan assets, the expected income ($59,000) is used rather than actual income. Finally, the amortization of the prior service cost can be either an expense addition or subtraction. Here, the prior service cost was created by a change in the projected benefit obligation that reduced this obligation. Because the debt level went down, the amortization of that drop is the equivalent of a gain and reduces the expense. Pension expense: $285,000 + $65,000 - $59,000 - $25,000 or $266,000.


BEC The Hasawono Corporation had earnings per share last year of $4.00 whereas this year the company’s earnings per share is now $6.00. In order to create this increase, the company borrowed a significant amount of money. The company’s earnings before interest and taxes (EBIT) was reported as $300,000 last year. However, because of the extra interest charge from the new debt, earnings before interest and taxes in the current year is only $360,000. What is the company’s degree of financial leverage?a. 0.5b. 1.0c. 2.5d. 5.0 Answer is C The degree of financial leverage reflects how well a company uses borrowed money to increase the income applicable to the owners of common stock. It is calculated by taking the percentage increase in earnings per share which is then divided by the percentage increase in earnings beforeinterest and taxes. Here, earnings per share starts as $4.00 and increases by $2.00, a 50 percent increase. Earnings before interest and taxes starts as $300,000 and increases by $60,000, only a 20 percent increase. Therefore, the degree of financial leverage is 50 percent divided by 20 percent or 2.5. Regulation The Aberthan Corporation reported net income of $300,000 for the most reason year. That amount included federal income tax expense of $80,000 and a $12,000 long-term loss on the saleof shares of another domestic US corporation. It does not include a $7,000 loss on the sale of its treasury stock. What taxable income should this corporation report on its federal income tax return?A. $312,000B. $368,000C. $380,000D. $392,000 Answer is D Federal income taxes are not deductible on a federal income tax return. Likewise, for corporations, long-term capital losses such as on the sale of an investment in shares of another company cannot be deducted. Although both amounts are proper reductions in the production ofan income statement, they cannot be taken in determining the company’s taxable income for


federal tax purposes. Removing the $80,000 expense and the $12,000 loss, increases the amount of taxable income from $300,000 to $392,000. Gains and losses on treasury stock are not included in either net income or taxable income. Because that loss was not included in net income, no change is needed. Auditing The Laskebo Corporation has its fiscal year ending December 31, Year One. However, inventory was counted on October 15, Year One, and the process was properly observed by the independent auditing firm of James and Wade. Which of the following statements is true?a. An unqualified opinion cannot be rendered because the count was done so far from the end of the fiscal year.b. The independent auditors must insist that a representative sample of the inventory be countedagain on December 31, Year One.c. If the company has strong internal control and properly documents the events between the count and year-end, no further count is necessary. d. A disclaimer is not necessary but a scope qualification must be automatically reported by the auditing firm. Answer is C As long as the company has adequately strong internal control and all accounting records are properly documented, a year-end inventory count is not necessary. Among the strong internal controls, the company should be using a perpetual inventory system.






Correct Answer: C

Explanation: Observation of the inventory count and confirmation of receivables is normally performed during an audit. However, if circumstances do not permit these procedures to be


performed, the auditor may apply alternative audit procedures that may include observation of aninventory count at a later date and the verification of receivable balances by auditing subsequent cash receipts. If the auditor is able to employ alternative procedures he considers appropriate in the circumstances, no modification or qualification of the audit report is necessary.

Generally, which of the following statements concerning workers' compensation laws is correct?

A) The amount of damages recoverable is based on comparative negligence.

B) Employers are strictly liable without regard to whether or not they are at fault.

C) Workers' compensation benefits are not available if the employee is negligent.

D) Workers' compensation awards are payable for life.

Correct Answer: B

Explanation: Employees will receive workers' compensation benefits if injured in the scope of employment. The employer is strictly liable without regard to fault.


• Negligence by the employee will not bar recovery or change the amount of the award.• Workers' compensation awards may be in the form of a lump sum and, thus, not be payable for life.

The calculation of the income recognized in the third year of a five-year construction contract accounted for using the percentage-of-completion method includes the ratio of:

A) Total costs incurred to date to total estimated costs

B) Total costs incurred to date to total billings to date

C) Costs incurred in year 3 to total estimated costs

D) Costs incurred in year 3 to total billings to date

Correct Answer: A

Explanation: Income recognized in the third year of a five-year construction contract using


percentage-of-completion method would be calculated by multiplying the ratio of the total cost incurred to date divided by the estimated total cost times the estimated total gross profit on the contract less the gross profit recognized in years one and two. Note that billings on the contract do not affect the calculation of income recognized.






Correct Answer: C


A secured promissory note would be nonnegotiable if it provided that _________________

A)additional collateral must be tendered if there is a decline in market value of the original collateral.

B) upon default, the maker waives a trial by jury.

C) the maker is entitled to a 5% discount if the note is prepaid.

D) it is subject to the terms of the mortgage given by the maker to the payee.

Correct Answer: D


Explanation: For an instrument to be negotiable, it must be an unconditional promise or order. Ifit is subject to another agreement or transaction it is non-negotiable.


• References to collateral will not prevent negotiability unless it is subject to the terms of that collateral.• Waiver of trial by jury does not make the note conditional and thus does not affect negotiability.• Prepayment will not prevent negotiability.

In open market transactions, Oak Corp. simultaneously sold its long-term investment in Maple Corp. bonds and purchased its own outstanding bonds. The broker remitted the net cash from the two transactions. Oak's gain on the purchase of its own bonds exceeded its loss on the sale of Maple's bonds. Oak should report the:

A) Net effect of the two transactions as an extraordinary gain

B) Net effect of the two transactions in income before extraordinary items

C)Effect of its own bond transaction gain in income before extraordinary items, and report the Maple bond transaction as an extraordinary loss

D)Effect of its own bond transaction as an ordinary gain, and report the Maple bond transaction loss in income before extraordinary items

Correct Answer: D

Explanation: Each transaction must be reported separately since the gain on early extinguishment of the company's debt is reported as an ordinary item and the loss on the sale of the investment is an ordinary loss.

Multiple regression differs from simple regression in that it

A) Provides an estimated constant term.

B) Has more dependent variables.

C) Allows the computation of the coefficient of determination.

D) Has more independent variables.


Correct Answer: D

Explanation: Regression analysis is a sampling technique which measures the relationship of a dependent variable to one or more independent variables. If one independent variable is used, themethod is referred to as simple regression. If more than one independent variable is used, the method is referred to as multiple regression.

Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of subsequent events?

A)Recomputing a sample of large-dollar transactions occurring after year end for arithmetic accuracy.

B) Investigating changes in stockholders' equity occurring after year end.

C)Inquiring of the entity's legal counsel concerning litigation, claims, and assessments arising after year end.

D) Confirming bank accounts established after year end.

Correct Answer: C

Explanation: The auditor should inquire of the entity's legal counsel regarding any events occurring after year end as part of the auditor's search for subsequent events, which are events or transactions that occur subsequent to the balance sheet date but prior to the issuance of the auditor's report that have a material effect on the financial statements and therefore require adjustment or disclosure in the statements.

Winslow Co., which is in the business of selling furniture, borrowed $60,000 from Pine Bank. Winslow executed a promissory note for that amount and used all of its accounts receivable as collateral for the loan. Winslow executed a security agreement that described the collateral. Winslow did not file a financing statement. Which of the following statements best describes this transaction?

A)Perfection of the security interest occurred even though Winslow did not file a financing statement.

B) Perfection of the security interest occurred by Pine having an interest in accounts


receivable.

C)Attachment of the security interest did not occur because Winslow failed to file a financing statement.

D)Attachment of the security interest occurred when the loan was made and Winslow executed the security agreement.

Correct Answer: D

Explanation: Three elements are required for attachment: an agreement between the debtor and the creditor, value must be given by the creditor and the debtor must have rights in the collateral. Attachment occurred when the loan was made because an executed agreement was present, Pine gave value by making the loan and the debtor certainly had rights in the collateral since the collateral was all of the debtor's receivables. Filing is the only way to perfect with accounts receivable and no filing occurred.

A bond issued on June 1, 2010, has interest payment dates of April 1 and October 1. Bond interest expense for the year ended December 31, 2010, is for a period of:

A) Three months

B) Four months

C) Six months

D) Seven months

Correct Answer: D

Explanation: Interest expense begins on June 1, 2010 when the bond is issued and continues for the seven months ending December 31, 2010.

Your client, a retail store, is interested in the relationship between sales (independent variable) and theft losses (dependent variable). Using the proper formula, you compute thecoefficient of correlation at .95. What can you definitely conclude about these factors (sales and theft losses)?

A) An increase in sales causes an increase in theft losses.


B) Movement of these factors is in opposite directions.

C) Movement of these factors is entirely unrelated.

D) Movement of these factors is in the same direction.

Correct Answer: D

Explanation: .95 as a coefficient of correlation is very high (the maximum is at 1.0), thus showing a definite cause-effect relationship. An increase in sales causes an increase in theft losses is incorrect because it does not provide for the fact that a decrease in sales would be associated with a decrease in theft. Movement of these factors is in the same direction is correct because it covers both possibilities and is the most correct.

Which of the following factors most likely would affect an auditor's judgment about the quantity, type, and content of the auditor's working papers?

A) The assessed level of control risk

B) The likelihood of a review by a concurring (second) partner

C) The number of personnel assigned to the audit

D) The content of the management representation letter

Correct Answer: A

Explanation: Factors affecting the auditor's judgment about the quantity, type, and content of the working papers for a particular engagement include; the nature of the engagement, the nature of the auditor's report, the nature of the financial statements on which the auditor is reporting, thenature and condition of the client's records, the assessed level of control risk, and the needs in theparticular circumstances for supervision and review of the work. "The assessed level of control risk " is the best choice because it is specifically included as a factor.

Under the UCC Sales Article, an action for breach of the implied warranty of merchantability by a party who sustains personal injuries may be successful against the seller of the product only when _________________

A) the seller is a merchant of the product involved.


B) an action based on negligence can also be successfully maintained.

C) the injured party is in privity of contract with the seller.

D) an action based on strict liability in tort can also be successfully maintained.

Correct Answer: A

Explanation: The implied warranty of merchantability arises if the seller is a merchant. Merchantability does not require a showing of negligence, privity or strict liability.

North Bank is analyzing Belle Corp.'s financial statements for a possible extension of credit. Belle's quick ratio is significantly better than the industry average. Which of the following factors should North consider as a possible limitation of using this ratio when evaluating Belle's creditworthiness?

A) Fluctuating market prices of short-term investments may adversely affect the ratio.

B) Increasing market prices for Belle's inventory may adversely affect the ratio.

C) Belle may need to sell its available-for-sale investments to meet its current obligations.

D) Belle may need to liquidate its inventory to meet its long-term obligations.

Correct Answer: A

Explanation: The quick ratio includes the current assets that can be "quickly" converted to cash such as cash, marketable securities and receivables. Therefore, fluctuating market prices for short-term investments (marketable securities) may adversely affect the ratio.

Inventory is not included in the Quick Ratio and "Available-For-Sale" securities may be either current or non-current assets.

Which of the following may be used to estimate how inventory warehouse costs are affectedby both the number of shipments and the weight of materials handled?

A) Economic order quantity analysis.

B) Probability analysis.

C) Correlation analysis.

D) Multiple regression analysis.


Correct Answer: D

Explanation: Regression analysis is a mathematical technique used to predict the value of one variable and its changes (the dependent variable) based upon the value of some other variable (the independent variable). Simple regression analysis involves the use of only one independent (explanatory) variable, while multiple regression analysis allows for more than one independent variable.

An auditor's program to examine long-term debt should include steps that require:

A) Examining bond trust indentures

B) Inspecting the accounts payable subsidiary ledger

C) Investigating credits to the bond interest income account

D) Verifying the existence of the bondholders

Correct Answer: A

Explanation: When auditing notes payable and long-term debt, the auditor should obtain copies of agreements and determine if provisions are being adhered to. If the debt is in the form of bonds, the agreement is the bond trust indenture.


• "Inspecting the accounts payable subsidiary ledger." does not relate to long-term debt, but short-term payables.• "Investigating credits to the bond interest income account." refers to interest income, rather than interest expense.• "Verifying the existence of the bondholders." deals with existence of bondholders; the auditor isconcerned with existence of the debt.

On September 10, Harris, Inc., a new car dealer, placed a newspaper advertisement statingthat Harris would sell 10 cars at its showroom for a special discount only on September 12, 13, and 14. On September 12, King called Harris and expressed an interest in buying one ofthe advertised cars. King was told that five of the cars had been sold and to come to the


showroom as soon as possible. On September 13, Harris made a televised announcement that the sale would end at 10:00 p.m. that night. King went to Harris' showroom on September 14 and demanded the right to buy a car at the special discount. Harris had sold the 10 cars and refused King's demand. King sued Harris for breach of contract. Harris's best defense to King's suit would be that Harris' _________________

A) offer was unenforceable.

B) advertisement was not an offer.

C) television announcement revoked the offer.

D) offer had not been accepted.

Correct Answer: B

Explanation: Advertisements and price quotes are not usually offers, they are invitations to deal.The remaining answer choices are incorrect because no offer was made.

In analyzing a company's financial statements, which financial statement would a potentialinvestor primarily use to assess the company's liquidity and financial flexibility?

A) Balance sheet

B) Income statement

C) Statement of retained earnings

D) Statement of cash flows

Correct Answer: A

Explanation: Concepts Statement #5 states that the balance sheet includes "information that is often used in assessing an entity's liquidity and financial flexibility." The current assets are listed in order of liquidity which should allow an assessment of their nearness to cash. An overall analysis of the balance sheet should indicate the financial flexibility to respond to unexpected events.

If a company follows a practice of isolating variances at the earliest point in time, what would be the appropriate time to isolate and recognize a direct material price variance?


A) When material is issued.

B) When material is purchased.

C) When material is used in production.

D) When purchase order is originated.

Correct Answer: B

Explanation: Since the material price variance relates to the difference between standard price and actual price and might be viewed as measuring the performance of the company's purchasingdepartment, the variance should be determined on the basis of the units purchased and should therefore be computed when the purchase occurs.

An auditor searching for related party transactions should obtain an understanding of each subsidiary's relationship to the total entity because:

A)This may permit the audit of intercompany account balances to be performed as of concurrent dates.

B)Intercompany transactions may have been consummated on terms equivalent to arm's-length transactions.

C)This may reveal whether particular transactions would have taken place if the parties had not been related.

D) The business structure may be deliberately designed to obscure related party transactions.

Correct Answer: D

Explanation: In determining the scope of work to be performed with respect to possible transactions with related parties, the auditor should obtain an understanding of management responsibilities and the relationship of each component to the total entity. Normally, the business structure is based on the abilities of management, tax and legal considerations, product diversification, and geographical location. Experience has shown, however, that business structure may be deliberately designed to obscure related party transactions. Therefore, when searching for related party transactions the auditor should obtain an understanding of each subsidiary's relationship to the total entity.


In order for an offer to confer the power to form a contract by acceptance, it must have all of the following elements except?

A)Be communicated to the offeree and the communication must be made or authorized by the offeror.

B) Be sufficiently definite and certain.

C) Be communicated by words to the offeree by the offeror.

D) Manifest an intent to enter into a contract.

Correct Answer: C

Explanation: Communication by words is not required as the communication can also be done by actions. Equally, the communication need not be directly made by the offeror to the offeree, as it could be communicated through a third party. An offer must be seriously intended, communicated, and definite in its terms.

The functional currency of Nash, Inc.'s subsidiary is the French franc. Nash borrowed French francs as a partial hedge of its investment in the subsidiary. In preparing consolidated financial statements, Nash's translation loss on its investment in the subsidiary exceeded its exchange gain on the borrowing. How should the effects of the loss and gain be reported in Nash's consolidated financial statements?

A)The translation loss less the exchange gain is reported separately as other comprehensive income.

B) The translation loss less the exchange gain is reported in the income statement.

C)The translation loss is reported separately in the stockholders' equity section of the balance sheet and the exchange gain is reported in the income statement.

D)The translation loss is reported in the income statement and the exchange gain is reported separately in the stockholders' equity section of the balance sheet.

Correct Answer: A

Explanation: Gains and losses on foreign currency transactions that are designated as economic hedges of a net investment in a foreign entity should be reported in the same manner as a translation adjustment. Current changes in translation adjustments are reported as other comprehensive income.


Nile Co.'s cost allocation and product costing procedures follow activity-based costing principles. Activities have been identified and classified as being either value-adding or nonvalue-adding as to each product. Which of the following activities, used in Nile production process, is nonvalue-adding?

A) Design engineering activity

B) Heat treatment activity

C) Drill press activity

D) Raw materials storage activity

Correct Answer: D

Explanation: In the production process, storing raw materials until they are needed represents a non-value added step, whereas engineering, heat treatment or drilling represents improving the product. In addition, storage requires handling costs, cost of holding inventory, possible breakageor misappropriation, while inventory simply waits for use at a later time.

In order to efficiently establish the correctness of the accounts payable cutoff, an auditor will be most likely to:

A) Coordinate cutoff tests with physical inventory observation

B) Compare cutoff reports with purchase orders

C) Compare vendors' invoices with vendors' statements

D) Coordinate mailing of confirmations with cutoff tests

Correct Answer: A

Explanation: Cutoff tests are used to determine whether items have been recorded in the proper period. By coordinating cutoff tests with the physical inventory, auditors can determine if the items are physically present.

Sun Corp. approved a merger plan with Cord Corp. One of the determining factors in approving the merger was the financial statements of Cord that were audited by Frank &


Co., CPAs. Sun had engaged Frank to audit Cord's financial statements. While performingthe audit, Frank failed to discover certain irregularities that later caused Sun to suffer substantial losses. For Frank to be liable under common law negligence, Sun at a minimummust prove that Frank _________________

A) knew of the irregularities.

B) failed to exercise due care.

C) was grossly negligent.

D) acted with scienter.

Correct Answer: B

Explanation: Liability for negligence requires proof of four elements: duty of care, breach (lack of due care), damages and causality. Thus Sun must prove Frank failed to exercise due care.


• Knowledge is not an element of negligence.• Gross negligence is constructive fraud. Fraud requires an element of intent and negligence doesnot.• Scienter is the intent element of fraud and negligence does not require proof of intent.

Kerr Company purchased a machine for $115,000 on January 1, 1992, the company's first day of operations. At the end of the year, the current cost of the machine was $125,000. Themachine has no salvage value, a five-year life, and is depreciated by the straight line method. For the year ended December 31, 1992, the amount of the current cost depreciation expense which would appear in supplementary current cost financial statements is:

A) $14,000

B) $23,000

C) $24,000

D) $25,000

Correct Answer: C

Explanation: Assuming that average current cost was used, the average current cost of the


machine is $120,000 for 1992, which would generate depreciation expense of $24,000 (5 year life).

A parent corporation owned more than 90% of each class of the outstanding stock issued by a subsidiary corporation and decided to merge that subsidiary into itself. Under the Revised Model Business Corporation Act, which of the following actions must be taken?

A) The subsidiary corporation's board of directors must pass a merger resolution.

B) The subsidiary corporation's dissenting stockholders must be given an appraisal remedy.

C) The parent corporation's stockholders must approve the merger.

D) The parent corporation's dissenting stockholders must be given an appraisal remedy.

Correct Answer: B

Explanation: When a corporation owns 90% or more of the shares of a subsidiary corporation, the subsidiary may be merged into the parent corporation without the approval of the stockholders of either the parent corporation or the subsidiary corporation and without the approval of the subsidiary corporation's board of directors. This is called a short-form merger. In a short-form merger stockholders of the subsidiary corporation have dissenters' rights, but the stockholders of the parent corporation do not.

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

A) Reduce substantive testing by relying on the assessments of inherent risk and control risk

B) Postpone the planned timing of substantive tests from interim dates to the year end

C) Eliminate the assessed level of inherent risk from consideration as a planning factor

D) Lower the assessed level of control risk from the maximum level to below the maximum

Correct Answer: B

Explanation: Detection risk is the risk that the auditor will not detect a material misstatement that exists in an assertion. As the acceptable level of detection risk decreases, the assurance


provided from substantive tests should increase. Since applying substantive tests as of an interim date rather than as of the year-end potentially increases the risk that misstatements that may existwill not be detected, if the auditor wants to decrease detection risk, he may decide to perform substantive tests at year-end rather than at an interim date.


• Substantive tests should be increased when allowable detection risk decreases.• Inherent risk cannot be ignored.• Control risk cannot be lowered without additional testing of controls.

Which of the following provisions is basic to all workers' compensation systems?

A) The injured employee must prove the employer's negligence.

B) The employer may invoke the traditional defense of contributory negligence.

C)The employer's liability may be ameliorated by a co-employee's negligence under the fellowservant rule.

D) The injured employee is allowed to recover on strict liability theory.

Correct Answer: D

Explanation: Employees will receive workers' compensation benefits if injured in the scope of employment. The employer is strictly liable without regard to fault. The remaining answer choices are incorrect because negligence will not bar recovery. Negligence is irrelevant. Thus, the employee does not need to prove the employer negligent, the defense of contributory negligence by the employee is not available and the liability of the employer is not changed by the negligence of a co-employee.

In a period of rising general price levels, Pollard Corp. discloses income on a current cost basis in accordance with FASB Statement No. 89, Financial Reporting and Changing Prices.

Compared to historical cost income from continuing operations, which of the following conditions increases Pollard's current cost income from continuing operations?

A) Current cost of equipment is greater than historical cost.


B) Current cost of land is greater than historical cost.

C) Current cost of cost of goods sold is less than historical cost.

D) Ending net monetary assets are less than beginning net monetary assets.

Correct Answer: C

Explanation: Holding gains for equipment and land are not part of income from continuing operations. The reduction in cost of goods sold is reflected in income from continuing operationsand is not applicable for current cost measurement.

Under which circumstance is the corporate veil most likely to be pierced and the shareholders held personally liable?

A) The corporation has elected S corporation status under the Internal Revenue Code.

B) The shareholders have commingled their personal funds with those of the corporation.

C) An ultra vires act has been committed.

D) A partnership incorporates its business solely to limit the liability of its partners.

Correct Answer: B

Explanation: A stockholder may be held personally liable for corporate debts (piercing the corporate veil). Specifically this may be done by a showing of fraud, undercapitalization of the corporation and commingling of corporate and personal funds by the stockholder. Thus, the corporate veil may be pierced if the stockholder commingled their personal funds with those of the corporation. Choosing S corporation status, commission of an ultra vires act and incorporation to obtain limited personal liability are all insufficient grounds to pierce the corporate veil.

The element of the audit planning process most likely to be agreed upon with the client before implementation of the audit strategy is the determination of the:

A) Evidence to be gathered to provide a sufficient basis for the auditor's opinion

B) Procedures to be undertaken to discover litigation, claims, and assessments

C) Pending legal matters to be included in the inquiry of the client's attorney


D) Timing of inventory observation procedures to be performed

Correct Answer: D

Explanation: The client is responsible for counting inventory and the auditor is responsible for observing the client's count. Since the timing of the observation depends on the timing of the count, there must be agreement between the auditor and client regarding the inventory observation procedures before the auditor finalizes an audit strategy for inventory.

The incorrect answer choices are evidence-gathering issues that are decided by the auditor without specific regard to timing and other client concerns. Independently of the client, the auditor determines the extent of evidence needed in the audit, the nature of procedures to follow in the audit, and the scope of issues to be addressed in a legal letter.

When a principal debtor defaults and a surety pays the creditor the entire obligation, which of the following remedies gives the surety the best method of collecting from the debtor?

A) Exoneration

B) Contribution

C) Subrogation

D) Attachment

Correct Answer: C

Explanation: The right of subrogation allows the surety to gain the creditor's rights, once the creditor has been paid in full. Subrogation would give a surety not only their own right to collect from the debtor (reimbursement), but also additional rights that the creditor might have had.


• Exoneration would simply give a surety a court order demanding that the debtor pay. Exoneration does not confer additional collection rights against the debtor.• Contribution is only available to one cosuretor against other cosuretors. It is not available against the debtor.• Attachment is the right of all creditors to place a lien on a debtor's property so it will be


available to satisfy a judgment. Subrogation is the better answer because it is specific to surety's collection rights against a debtor and gives the surety additional rights.

Sage, Inc., bought 40% of Adams Corp.'s outstanding common stock on January 2, Year 2, for $400,000. The carrying amount of Adams' net assets at the purchase date totaled $900,000. Fair values and carrying amounts were the same for all items except for plant and inventory, for which fair values exceeded their carrying amounts by $90,000 and $10,000, respectively. The plant has an 18-year life. All inventory was sold during Year 2. During Year 2, Adams reported net income of $120,000 and paid a $20,000 cash dividend. What amount should Sage report in its income statement from its investment in Adams for the year ended December 31, Year 2?

A) $48,000

B) $42,000

C) $36,000

D) $32,000

Correct Answer: B

Explanation: $42,000 income from investment in Adams. Under the equity method the investor recognizes in income its share of the investee's net income or loss subsequent to the date of acquisition. Furthermore, the investor should reflect adjustments which would be made in consolidation, based on the investor's percentage ownership, if such adjustments (eliminations) can be recorded between investment income and the investment account.

Which of the following requirements must be met to have a valid partnership exist?

1. Co-ownership of all property used in a business.2. Co-ownership of a business for profit.

A) (1) only

B) (2) only

C) (1) & (2)

D) Neither

Correct Answer: B


Explanation: A partnership is an association of two or more co-owners of a business for profit. Thus, (2) is a requirement of a partnership. It is not necessary that each piece of property used in the business be co-owned by all the partners. For example, the partnership may lease equipment from a third party or may use property that is owned by one partner and not others. Thus (1) is not a requirement of a partnership.

Which of the following most likely would not be considered an inherent limitation of the potential effectiveness of an entity's internal control?

A) Incompatible duties

B) Management override

C) Mistakes in judgment

D) Collusion among employees

Correct Answer: A

Explanation: Segregating incompatible duties is a typical control procedure. Thus, the existenceof incompatible duties is a weakness in control procedures, not an inherent limitation of the internal control structure. Even if control policies and procedures are placed in operation, the potential effectiveness of an entity's internal control structure is subject to inherent limitations. Mistakes in the application of policies and procedures may arise from such causes as mistakes in judgment as well as personal carelessness, fatigue, and distraction. Also, policies and procedures that require segregation of duties can be circumvented by management override or collusion among internal or external parties.

Winslow Co., which is in the business of selling furniture, borrowed $60,000 from Pine Bank. Winslow executed a promissory note for that amount and used all of its accounts receivable as collateral for the loan. Winslow executed a security agreement that described the collateral. Winslow did not file a financing statement. Which of the following statements best describes this transaction?

A)Perfection of the security interest occurred even though Winslow did not file a financing statement.

B) Perfection of the security interest occurred by Pine having an interest in accounts


receivable.

C)Attachment of the security interest did not occur because Winslow failed to file a financingstatement.

D)Attachment of the security interest occurred when the loan was made and Winslow executed the security agreement.

Correct Answer: D

Explanation: Three elements are required for attachment: an agreement between the debtor and the creditor, value must be given by the creditor and the debtor must have rights in the collateral. Attachment occurred when the loan was made because an executed agreement was present, Pine gave value by making the loan and the debtor certainly had rights in the collateral since the collateral was all of the debtor's receivables. Filing is the only way to perfect with accounts receivable and no filing occurred.

For inventory management, ignoring safety stocks, which of the following is a valid computation of the reorder point?

A) The economic order quantity

B) The economic order quantity multiplied by the anticipated demand during the lead time

C) The anticipated demand during the lead time

D) The square root of the anticipated demand during the lead time

Correct Answer: C

Explanation: Perfection, ignoring safety stocks, is to replenish supplies as they reach zero level.

During periods of rising prices, when the FIFO inventory method is used, a perpetual inventory system results in an ending inventory cost that is:

A) The same as in a periodic inventory system

B) Higher than in a periodic inventory system

C) Lower than in a periodic inventory system

D)Higher or lower than in a periodic inventory system, depending on whether physical quantities have increased or decreased


Correct Answer: A

Explanation: Under the FIFO method, the cost of the oldest purchases are charged to cost of goods sold and the costs of the most current purchases are assigned to ending inventory. Therefore, the costs assigned to ending inventory and cost of goods sold are the same when a periodic or perpetual inventory system is used with the FIFO cost flow assumption.

When the shipping department returns nonconforming goods to a vendor, the purchasing department should send to the accounting department the:

A) Unpaid voucher

B) Debit memo

C) Vendor invoice

D) Credit memo

Correct Answer: B

Explanation: The accounting department is responsible for recording amounts due to vendors. Ifgoods are returned to a vendor, a debit memo should be prepared indicating that the buyer is debiting the vendor's payable account. The purchasing department may prepare the debit memo, but the accounting department needs the debit memo to record the reduction in the account payable account.

Under the UCC Sales Article, an action for breach of the implied warranty of merchantability by a party who sustains personal injuries may be successful against the seller of the product only when _________________

A) the seller is a merchant of the product involved.

B) an action based on negligence can also be successfully maintained.

C) the injured party is in privity of contract with the seller.

D) an action based on strict liability in tort can also be successfully maintained.

Correct Answer: A


Explanation: The implied warranty of merchantability arises if the seller is a merchant. Merchantability does not require a showing of negligence, privity or strict liability.

When using the periodic-inventory method, which of the following generally would not be separately accounted for in the computation of cost of goods sold?

A) Trade discounts applicable to purchases during the period

B) Cash (purchase) discounts taken during the period

C) Purchase returns and allowances of merchandise during the period

D) Cost of transportation-in for merchandise purchased during the period

Correct Answer: A

Explanation: Cash discounts, purchase returns and allowances, and cost of transportation-in all occur after the actual purchase and would be accounted for separately in cost of goods sold. Trade discounts are deducted from a list price in arriving at the price charged the buyer and recorded on the purchase invoice and would not be recorded separately.

Major Corp. is considering the purchase of a new machine for $5,000 that will have an estimated useful life of five years and no salvage value. The machine will increase Major's after-tax cash flow by $2,000 annually for five years. Major uses the straight-line method ofdepreciation and has an incremental borrowing rate of 10%. The present value factors for 10% are as follows:

Ordinary annuity with five payments 3.79Annuity due for five payments 4.17

Using the payback method, how many years will it take to pay back Major's initial investment in the machine?

A) 2.50

B) 5.00

C) 7.58


D) 8.34

Correct Answer: A

Explanation: The payback method is the original investment divided by cash flow after taxes, or$5,000 divided by $2,000 for a payback of 2.5 years. Payback does not utilize discounted cash flows, so the information regarding the time value of money is not needed to solve the problem.

Which of the following controls most likely would help ensure that all credit sales transactions of an entity are recorded?

A)The billing department supervisor sends copies of approved sales orders to the credit department for comparison to authorized credit limits and current customer account balances.

B)The accounting department supervisor independently reconciles the accounts receivable subsidiary ledger to the accounts receivable control account monthly.

C)The accounting department supervisor controls the mailing of monthly statements to customers and investigates any differences reported by customers.

D)The billing department supervisor matches prenumbered shipping documents with entries inthe sales journal.

Correct Answer: D

Explanation: A sale typically occurs and should be recorded when goods are shipped. Matching prenumbered shipping documents with sales journal entries is a good control to ensure that all sales are recorded. All the shipping documents should be accounted for as either resulting in a journal entry or having been voided.

Under the Sales Article of the UCC, which of the following statements is correct regarding the warranty of merchantability arising when there has been a sale of goods by a merchantseller?

A) The warranty must be in writing.

B)The warranty arises when the buyer relies on the seller's skill in selecting the goods purchased.


C) The warranty cannot be disclaimed.

D)The warranty arises as a matter of law when the seller ordinarily sells the goods purchased.

Correct Answer: D

Explanation: The warranty of merchantability is implied by law if the seller is a merchant. One who ordinarily sells the product purchased would be a merchant. Since merchantability is an implied warranty, no written or oral words are needed for it to arise. The implied warranty of fitness for a particular purpose arises when the buyer relies on seller to select goods, not the warranty of merchantability. Merchantability, like all implied warranties, can be disclaimed.

FAR – A company buys a restaurant for $1 million with no residual value and a 20-year expectedlife. It is being depreciated on the straight-line method. At the beginning of the third year, the neighborhood around the restaurant starts to become dangerous and its fair value drops to $789,000. However, the restaurant still has many loyal customers and is able to generate $53,000 in net cash flows each year for its remaining life. What should be the net book value for the restaurant on the first day of the third year? A. $789,000B. $900,000C. $924,000D. $954,000 Answer is B Depreciation is $50,000 per year ($1,000,000/20 years) so net book value at the end of Year Two is $900,000 ($1,000,000 less $50,000 and less $50,000). Although the fair value is only $789,000, the restaurant is not viewed as having its value impaired because the future cash flows of $53,000 for 18 years gives a total ($924,000) that is greater than the net book value of $900,000. As long as the expected cash flows are greater than net book value, the asset is not held to be impaired and remains reported at net book value. Regulation What is the Statute of Frauds? A. It sets out rules that indicate the time periods for rules and other laws to be in existence.B. It sets out rules that require certain contracts to be in writing.C. It sets out rules that indicate which actions are gross negligence and which are fraudulent.


D. It sets out rules that spell out the actions that an agent can take on behalf of a principal. Answer is B. Most contracts can either be established orally or in writing. However, the Statute of Frauds indicates which contracts must exist in writing and cannot be created orally. For example, according to the Statute of Frauds, a contract in which a surety agrees to answer for the debts of another must be in writing. Auditing The Ramsey Corporation is being audited by Keillor and Associates CPAs. The auditors discovered that Ramsey is reporting a note receivable from Lexington Corporation, a company that recently filed for bankruptcy. The note is still reported at its $250,000 face value although areasonable estimation is that only $140,000 will be collected. If these amounts are considered material, which of the following statements is true? A. An unqualified opinion should be given but only with an added explanation of the problem.B. An unqualified opinion cannot be rendered and the scope paragraph must be modified.C. A disclaimer of opinion must be given.D. An unqualified opinion cannot be rendered but the scope paragraph should not be modified. Answer is D The account balance is materially misstated so, therefore, an unqualified opinion is not appropriate. A disclaimer is also not correct because the auditor does have an opinion. The problem here does not relate to the work of the auditor (which would be described in the scope paragraph). The work of the auditor seems to be complete and reasonable. Therefore, the scope paragraph is not changed. Instead, an explanatory paragraph is added to describe the problem and the opinion paragraph is changed. BEC The Drexel Donut Company produces 8,000 dozen donuts under normal circumstances but believes that 5,000 to 10,000 dozen donuts is a relevant range for its current production levels. Fixed costs within this relevant range are $24,000. At 8,000 dozen, the company calculates that a dozen donuts has a total cost of $4.00. If the company manages to push production levels to 10,000 dozen donuts, what is the cost of a dozen? A. $3.40B. $3.50C. $3.80


D. $4.00 Answer is A At 8,000 dozen, the cost is $4.00 per dozen or $32,000 in total. Of that amount, $24,000 is fixedcost so the remaining $8,000 must be the variable cost. That is a variable cost of $1.00 per dozen ($8,000/8,000 dozen). Thus, within the relevant range, fixed costs will stay at $24,000 and variable costs will stay at $1.00 per dozen. For 10,000 dozen, the fixed cost will be $24,000and the variable costs will be $1.00 per dozen or $10,000. The total is $34,000 for 10,000 dozendonuts or $3.40 per dozen.

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COMPREHENSIVE CPA REVIEWdocshare02.docshare.tips/files/29760/297605833.pdfCOMPREHENSIVE CPA REVIEW Gandy Company has 5,000 obsolete desk lamps that are carried in inventory at a manufacturing