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CPA MOCK EXAM
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you can come back to questions within the testlet you’re working on.
BEGIN MOCK EXAM ON NEXT PAGE
1
Inventory
FINANCIAL
Mixon Corporation, a manufacturer of small
tools, provided the following information from
its accounting records for the year ended
December 31, Year 1:
Inventory at December 31, Year
1 (based on a physical count of
goods in Mixon’s plant at cost on
December 31, Year 1)
$ 1,750,000
Accounts Payable at
December 31, Year 1
1,200,000
Net Sales (sales less sales returns)
8,500,000
Additional information is as follows:
1. Included in the physical count were tools
billed to a customer FOB shipping point on
December 31, Year 1. These tools had a cost
of $28,000 and were billed at $35,000. The
shipment was on Mixon’s loading dock at
5:00 PM on December 31, Year 1 waiting to be
picked up by the common carrier.
2.Goods were in transit from a vendor to Mixon
on December 31, Year 1. The invoice cost was
$50,000, and the goods were shipped FOB
shipping point on December 29, Year 1.
What would be the adjusted inventory at
December 31, Year 1??
2
$1,750,000
OO
$1,715,000
OO
$1,700,000
OO
$1,800,000
Intangible Assets
In a business combination consummated on
January 1, Year 1, Wright acquired an intangible
asset with an acquisition cost of $5,000,000, a fair
value at December 31, Year 1 of $6,000,000, and
a finite life of 50 years and also another intangible
asset with an acquisition cost of $3,000,000 and
a fair value of $2,500,000 at December 31, Year 1,
for which a life cannot be determined.
3
OO
What amount of intangible amortization should Wright
recognize for the year ended December 31, Year 1?
OO
$0
OO
$100,000
OO
$150,000
OO
$500,000
Long-Term Debt
On July 1, Year 1, Planet Corporation sold Ken
Company ten-year, 8% bonds with a face amount
of $500,000 for $520,000. The market rate
was 6%. The bonds pay interest semiannually
on June 30 and December 31.
For the six months ended December 31, Year 1, what
amount should Planet report as bond interest expense
and long-term liability in the balance sheet and income
statement for Year 1?
B/S
I/S
OO
$ 511,200
$ 31,200
OO
$ 500,000
$ 20,000
OO
$ 504,400
$ 4,400
OO
$ 515,600
$ 15,600
4
Income Taxes
Cavan’s effective income tax rate for Year 1 is 30%.
The depreciation difference will reverse equally over
the next three years at enacted tax rates as follows:
Cavan Company prepared the following
reconciliation between book income and
taxable income for the current year ended
December 31, Year 1:
Pretax Accounting Income
Taxable Income
(600,000)
Difference
$ 400,000
Differences:
Tax Rate
Year 2
30%
Year 3
25%
Year 4
25%
In Cavan’s Year 1 Income Statement, the current
portion of its provision for income taxes should be:
Interest on Municipal Income
$ 100,000
Lower Financial Depreciation
$ 300,000
Total
$ 400,000
OO
$300,000
OO
$250,000
OO
$180,000
OO
$150,000
Impairment
On December 31, an entity analyzed a finite life
trademark with a net carrying value of $750,000 for
impairment. The entity determined the following:
Undiscounted Future Cash Flows
$700,000
740,000
OO
$0
OO
$10,000
OO
$40,000
OO
$50,000
ANSWER KEY: 1. $1,800,000; 2. $100,000; 3. B/S: $515,600; I/S $15,600 4. $180,000 5. $50,000
Fair Value
What is the impairment loss that will be reported on
the December 31 income statement under U.S. GAAP?
DETAILED ANSWER EXPLANATIONS AVAILABLE AT THE END OF THE EXAM
5
Year
$ 1,000,000
1
Changes in Economic and Business Cycles
BUSINESS
If the Federal Reserve wanted to increase the money supply, it could:
2
OO
Increase the required reserve ratio and/or decrease the discount rate
OO
Decrease the discount rate and/or purchase government securities
OO
Decrease the required reserve ratio and/or sell government securities
OO
Increase the discount rate and/or purchase government securities
Planning Techniques
Atlantic Company has a manufacturing facility in
Brooklyn that manufactures robotic equipment for
the auto industry. For Year 1, Atlantic collected the
following information from its main production line:
3
Actual Quantity Purchased
200 Units
Actual Quantity Used
110 Units
Units Standard Quantity
100 Units
Actual Price Paid
$8 per Unit
Standard Price
$10 per Unit
Atlantic isolates price variances at the time
of purchase. What is the materials usage
variance for Year 1?
OO
$100 Favorable
OO
$100 Unfavorable
OO
$220 Favorable
OO
$220 Unfavorable
Financial Modeling, Projections, and Analysis
A comparison of absorption vs. direct cost methods yields:
OO
No differences in net income since all expenses are
accounted for regardless of method
OO
Greater net income under absorption costing when
production equals sales and inventory amounts are the same
OO
Greater net income under absorption costing when
production exceeds sales and inventory amounts increase
OO
Greater net income under direct costing when production
exceeds sales and inventory amounts increase
4
Financial Decisions
Trade creditors are seeking guarantees that the Duffy Corporation will be able to
pay its accounts payable. Trade creditors would likely require that Duffy Corporation
obtain a(n):
Annual audit with disclosures regarding compliance with debt covenants
OO
Letter of credit
OO
Line of credit
OO
Compensating balance agreement
Systems Design and Other Elements
One of the most effective ways to generate systems development support is a clear signal from
top management that user involvement is important. Accountants may play three roles during
systems design. Which of the following is not one of those roles?
OO
As AIS users, they must determine their information needs and system requirements
and communicate them to system developers
OO
As members of a project development team or information systems steering committee,
they help manage system development
OO
Accountants should take an active role in designing system controls and periodically
monitoring the system to verify that the controls are implemented and functioning properly
OO
As members of project development team, they are in charge of leading the information
systems department with each of their functions
DETAILED ANSWER EXPLANATIONS AVAILABLE AT THE END OF THE EXAM
ANSWER KEY: 1. Decrease the discount rate and/or purchase government securities; 2. $100 unfavorable; 3. Greater net income under
absorption costing when production exceeds sales and inventory amounts increase; 4. Letter of credit; 5. As members of project
development team, they are in charge of leading the information systems department with each of their functions
5
OO
1
Significant Risks
AUDIT
An auditor suspects that the entity may be making illegal cash payments to local
government officials. Which of the following procedures would least likely result
in the discovery of possible noncompliance with laws and regulations?
2
OO
Observing the cash disbursement process
OO
Performing a test of details of transactions
OO
Inquiring of management regarding the entity’s compliance with laws and regulations
OO
Inspecting correspondence from regulatory agencies to the client
Responding to Assessed Risk
As the acceptable level of detection risk increases, an auditor may:
3
OO
Lower the assessed level of inherent risk
OO
Change the planned timing of substantive tests from year-end to interim
OO
Eliminate the assessed level of control risk from consideration as a planning factor
OO
Increase the risk of material misstatement
Tests of Controls
Which best describes an appropriate division of responsibilities in the expenditure cycle?
OO
The purchasing department compares what was ordered to what was received, while the
accounts payable department compares what was received to what was billed
OO
The purchasing department creates a purchase order based on an approved requisition,
while the accounts payable department approves the corresponding invoice for payment
OO
The purchasing department matches the purchase order, receiving report, and vendor
invoice, while the treasurer reviews the matched documents and makes the payments
OO
The receiving department compares the amount of goods received with the amount of
goods ordered, while the accounts payable department compares the amount of goods
ordered and received with the amount of goods billed
4
Confirmations
Confirmation of accounts receivable generally provides evidence regarding:
Existence
OO
Understandability and classification
OO
Valuation
OO
Completeness
Sufficiency and Appropriateness of Evidence
An auditor most likely would apply analytical procedures in the overall review
stage of an audit to:
OO
Identify unusual or unexpected balances that were not previously identified
OO
Obtain an understanding of high-risk areas
OO
Evaluate the design and implementation of internal control
OO
Identify related party transactions that may not have been previously identified
DETAILED ANSWER EXPLANATIONS AVAILABLE AT THE END OF THE EXAM
ANSWER KEY: 1. Observing the cash disbursement process; 2. Change the planned timing of substantive tests from year-end to interim;
3. The purchasing department creates a purchase order based on an approved requisition, while the accounts payable department approves
the corresponding invoice for payment; 4. Existence; 5. Identify unusual or unexpected balances that were not previously identified
5
OO
1
Contracts
REGULATION
In deciding whether consideration necessary to form a contract exists,
a court must determine whether:
2
OO
The consideration given by each party is of roughly equal value
OO
There is mutuality of consideration
OO
The consideration has sufficient monetary value
OO
The consideration conforms to the subjective intent of the parties
Estate and Gift Taxation
During the year, Jordan, a single taxpayer, gave $40,000 to her sister, Sydney, to pay Sydney’s
educational expenses. She also paid $15,000 to General Hospital for her best friend’s unpaid
medical bills and $16,000 directly to her brother to help defray the cost of his medical expenses.
When she files her current year gift tax return, what is the maximum amount that Jordan will be
entitled to claim as an exclusion from gift tax?
3
OO
$42,000
OO
$43,000
OO
$56,000
OO
$71,000
C Corporations
A corporation was completely liquidated and dissolved during Year 14. The filing fees,
professional fees, and other expenditures incurred in connection with the liquidation
and dissolution are:
OO
Deductible in full by the dissolved corporation
OO
Deductible by the shareholders and not by the corporation
OO
Treated as capital losses by the corporation
OO
Not deductible either by the corporation or shareholders
4
Partnerships
A reduction of a partner’s share of partnership liabilities will have what effect
on the partner’s basis in the partnership?
There is no effect on partnership basis
OO
A reduction of the partner’s basis, provided the reduction does not take the basis below zero
OO
A reduction of the partner’s basis by the amount of the partner’s share of liability reduction
OO
An increase in the partner’s basis by the amount of the partner’s share of liability reduction
Adjustments and Deductions to Arrive at Taxable Income
Which of the following may NOT be claimed as a deduction by a taxpayer who
claims the standard deduction?
OO
Interest penalty on early withdrawal of savings
OO
Moving expenses
OO
State income tax paid
OO
IRA contribution
DETAILED ANSWER EXPLANATIONS AVAILABLE AT THE END OF THE EXAM
4. A reduction of the partner’s basis by the amount of the partner’s share of liability reduction; 5. State income tax paid
ANSWER KEY: 1. There is mutuality of consideration; 2. $43,000; 3. Deductible in full by the dissolved corporation;
5
OO
FINANCIAL ANSWER KEY
1. Choice “4” is correct.
3. Choice “4” is correct.
5. Choice “4” is correct.
The first transaction is $28,000 of tools included in
the physical inventory count and still sitting on the
loading dock at 5:00 PM on December 31. Because
the tools have not yet left the loading dock, the
sale has not yet occurred and the tools should
have been counted in the physical inventory count.
They were counted so there is no adjustment for
the first transaction.
The bonds have a face amount of $500,000
and a stated rate of 8% and thus a semiannual
interest payment of $20,000 ($500,000 × 0.08
× ½). The bonds were sold at a premium for
$520,000 because the effective interest rate was
6% when the stated rate was 8%. They are asking
about the first interest payment period.
Under U.S. GAAP, impairment analysis begins
with a test for recoverability in which the net
carrying value of the asset is compared to the
undiscounted cash flows expected from the
asset. If the net carrying value exceeds the
undiscounted cash flows, then an impairment
loss is recorded equal to the difference between
the carrying value and fair value of the asset. In
this problem, the carrying value of $750,000
exceeds the undiscounted future cash flows of
$740,000, so an impairment loss of $50,000
($700,000 fair value − $750,000 net carrying
value) will be reported on the income statement.
The second transaction is $50,000 of inventory
coming the other way. The goods were in transit
from a vendor and were shipped FOB shipping
point from that vendor. Because they were shipped
by December 31, they should have been included
in Mixon’s inventory but were not since they
were not there to be counted. The inventory of
$1,750,000 should be increased to $1,800,000
($1,750,000 + $50,000).
The accounts payable and sales information
are irrelevant.
2. Choice “2” is correct.
Two intangible assets were acquired at the
beginning of the year. The first has a finite life
and thus should be amortized; the second has
an indefinite life and cannot be amortized. The
second asset looks like it might be impaired, but
they did not ask for the impairment loss.
The acquisition cost of the first intangible asset
was $5,000,000. That cost is amortized over the
life of 50 years, for an annual amortization of
$100,000.
The journal entry for the first interest payment is:
Bond interest expense
($520,000 × 0.06 × ½)
Premium amortization
Cash ($500,000 × 0.08 × ½)
Debit (Dr)
$15,600
Credit (Cr)
4,400
$20,000
The amount reported on the income statement is
the bond interest expense of $15,600.
If the question is worked as a journal entry, the
amortization of the premium (or discount, if
there had been a discount) is a plug. Journal
entries are a good way to work this kind of
problem even when the specific journal entry
is not asked.
The amount reported on the balance sheet
is the adjusted carrying amount of the bond.
The original carrying amount of the bond was
$520,000. The amortization of the premium
reduces the carrying amount of the bond to
$515,600 ($520,000 − $4,400).
Choice “1” is incorrect. The asset’s carrying value
of $750,000 exceeds the undiscounted future
cash flows of $740,000, so an impairment loss
of $50,000 ($700,000 fair value − $750,000 net
carrying value) must be recognized on the income
statement.
Choice “2” is incorrect. The impairment loss is
equal to the difference between the fair value
and carrying value of the asset, not the difference
between the carrying value of the asset and the
undiscounted future cash flows expected from
the asset.
Choice “3” is incorrect. The impairment loss is not
equal to the difference between the fair value of
the asset and the undiscounted future cash flows
expected from the asset.
4. Choice “3” is correct.
The taxable income of $600,000 is hiding in
the first paragraph of the facts. The current tax
rate is 30%. The tax currently payable is then
$180,000 taxable income x current tax rate
($600,000 × 0.30).
BUSINESS ANSWER KEY
1. Choice “2” is correct.
The Federal Reserve can change the money
supply in three ways: (1) purchasing or selling
government securities, known as open market
operations; (2) increasing or decreasing the
discount rate (the interest rate the Fed charges
banks for short-term, normally overnight loans);
or (3) increasing or decreasing the required
reserve ratio. To increase the money supply, the
Fed could: (1) purchase government securities,
(2) decrease the discount rate, or (3) decrease
the required reserve ratio.
2. Choice “2” is correct.
In this question, they want to know the materials
usage variance for a production line. Certain
data for the production line is provided.
The variance formula for the materials usage
variance can be stated as the standard price of
$10 times the difference between the actual and
standard usage of 10 units (110 − 100), or $100.
Because the actual usage was greater than the
standard usage, the variance is unfavorable.
3. Choice “3” is correct.
When production exceeds sales and inventory
increases, fixed manufacturing costs, capitalized
in inventory using absorption costing but
expensed under direct costing, are excluded
from the determination of net income and serve
to produce a higher net income than if earnings
had been computed under direct costing.
Choice “1” is incorrect. Net income
computations will generally differ when
comparing the application of the absorption
and direct costing methods unless inventory
levels remain unchanged.
Choice “2” is incorrect. Net income
computations will generally be the same
when comparing the application of the
absorption and direct costing methods
when inventory levels remain unchanged.
Choice “4” is incorrect. Direct costing would
produce lower not higher net income in
comparison to absorption costing when
inventory increases. When production
exceeds sales and inventory increases, fixed
manufacturing costs, capitalized in inventory
using absorption costing but expensed
under direct costing, are excluded from the
determination of net income and serve to
produce a higher net income under
absorption costing than if earnings had
been computed under direct costing.
4. Choice “2” is correct.
A letter of credit represents a third-party
guarantee, generally by a bank, of obligations
incurred by a company. Creditors may require
that the debtor secure the letter of credit to
guarantee payment.
Choice “1” is incorrect. An annual audit, while
useful in determining a debtor’s compliance with
requirements imposed by creditors, does not
provide guarantees of payment.
Choice “3” is incorrect. A line of credit represents
a revolving line of short-term borrowing available
to the borrower. While the line of credit provides
for the potential means for a borrower to repay
debt, it does not guarantee the debt.
Choice “4” is incorrect. A compensating balance
agreement represents a banking arrangement
to maintain a guaranteed level of cash with
the bank in exchange for reduced fees, etc. A
compensating balance agreement would not
guarantee repayment of debt to creditors.
5. Choice “4” is correct.
Being in charge of the Information systems
department is not a function of accountants; it is
a function of information systems professionals.
Choice “1” is incorrect. Accountants will identify
information needs and communicate those needs
to system developers. Accountants would be
closest to the financial information requirements
of the system.
Choice “2” is incorrect. Accountants would
be intimately involved in managing system
development including identifying and
anticipating future business and system
requirements.
Choice “3” is incorrect. Accountants would
be responsible for assisting in the design of
controls, implementing controls and verifying
their effectiveness.
AUDIT ANSWER KEY
1. Choice “1” is correct.
Observation of the cash disbursement process
provides information about the disbursement
of cash at that point in time. It is unlikely that a
client that is making illegal payments to local
government officials would decide to make the
payment during the observation.
Choice “2” is incorrect. Performing a test of details
of transactions may provide information indicative
of acts of noncompliance.
Choice “3” is incorrect. The auditor is required to
inquire specifically of management regarding the
entity’s compliance with laws and regulations in
order to assist the auditor in identifying instances
of noncompliance.
Choice “4” is incorrect. The auditor is required to
inspect correspondence from regulatory agencies
in order to assist the auditor in identifying
instances of noncompliance.
2. Choice “2” is correct.
As the acceptable level of detection risk
increases, the assurance that must be
obtained from substantive tests decreases,
allowing for somewhat less persuasive
evidence to be used, for a reduction in the
extent of testing, or for more testing to be
performed on an interim basis.
Choice “1” is incorrect. The auditor cannot lower
the assessed level of inherent risk as a result of
an increase in detection risk. Inherent risk exists
independently of audit procedures.
Choice “3” is incorrect. Control risk is an integral
part of the risk of material misstatement and
cannot be eliminated from the computation of
acceptable detection risk.
Choice “4” is incorrect. The risk of material
misstatement exists independently of the audit
and the auditor cannot change these risks as
a result of audit procedures.
3. Choice “2” is correct.
The purchasing department creates a purchase
order based on an approved requisition, while
the accounts payable department approves
the corresponding invoice for payment after
matching the purchase order, receiving report,
and vendor invoice.
Choice “1” is incorrect. The accounts payable
department compares what was ordered, what
was received, and what was billed, by comparing
the purchase order, receiving report, and vendor
invoice. The purchasing department does not
receive a copy of the receiving report and has no
means of comparing what was received to what
was ordered.
Choice “3” is incorrect. The accounts payable
department matches the purchase order,
receiving report, and vendor invoice. The treasurer
then reviews the matched documents and makes
the payment.
Choice “4” is incorrect. The receiving department
should not have access to a complete copy of
the purchase order, but rather should have a
copy with the amounts blacked out, forcing
an independent count to be made. Given this
constraint, it would not be possible for the
receiving department to compare the amount
ordered with the amount received.
4. Choice “1” is correct.
Confirmation of accounts receivable provides
evidence regarding existence.
Choice “2” is incorrect. Generally, an auditor
confirms accounts receivable to satisfy assertions
regarding existence as well as rights and
obligations. Confirmation of accounts receivable
most likely would not provide evidence regarding
understandability and classification.
Choice “3” is incorrect. Confirmation of accounts
receivable does not provide reliable evidence
regarding valuation because customers may
confirm a balance despite an inability to pay.
Choice “4” is incorrect. Confirmation of accounts
receivable does not provide reliable evidence
regarding completeness because customers may
not report understatement errors.
5. Choice “1” is correct.
An auditor most likely would apply analytical
procedures in the overall review stage to identify
unusual or unexpected balances that were not
previously identified.
Choice “2” is incorrect. An auditor applies
analytical procedures in the planning stage to
obtain an understanding of high risk areas.
Choice “3” is incorrect. An auditor most likely
would apply analytical procedures in the overall
review stage to identify unusual or unexpected
balances that were not previously identified. Also,
analytical procedures are unlikely to help the
auditor evaluate the design and implementation
of internal control.
Choice “4” is incorrect. Although the auditor
applies analytical procedures in the overall review
stage to identify unusual balances, it is unlikely
that analytical procedures will help identify related
party transactions.
REGULATION ANSWER KEY
1. Choice “2” is correct.
Consideration must be mutually bargained for
and legally sufficient. Drafters of exam questions
like to use those words.
Choice “1” is incorrect because consideration need
not be of equal value. Let the two parties make
their own deal.
Choice “3” is incorrect because consideration
need not have monetary value.
the $15,000 payment to General Hospital qualifies
for an unlimited exclusion from gift tax, so the
entire $15,000 of that gift is excluded.
Choice “3” is incorrect. This answer option
incorrectly assumes that the payments for the
$40,000 of educational expenses for Sydney
and the $16,000 of medical expenses for
her brother qualify as exclusions [$40,000 +
$16,000 = $56,000]. It also incorrectly assumes
that the payment for the unrelated person does
not qualify.
Choice “4” is incorrect. Contract law generally
follows an objective theory. That is, things are
based on what a reasonable person under the
circumstances would believe. Subjective intent
generally is not relevant.
Choice “4” is incorrect. This answer option
incorrectly allows as a full exclusion all of the gifts
made ($40,000 + $15,000 + $16,000 = $71,000).
2. Choice “2” is correct.
The corporation generally deducts its liquidation
expenses (i.e., filing fees, professional fees) in its
final tax return.
Education expenses paid directly to an
educational institution qualify for an unlimited
exclusion from gift tax, even if paid for an
unrelated person. Medical expenses paid
directly to a healthcare provider also qualify for
an unlimited exclusion from gift tax, even if paid
for an unrelated person. In this question, the
$40,000 for educational expenses was paid to
her sister, so it only qualifies for the maximum
$14,000 annual exclusion from gift tax in 2014.
The $15,000 was paid directly to a healthcare
provider, but the $16,000 was paid to her
brother. The $15,000 qualifies for the exclusion,
but the $16,000 only qualifies for the $14,000
annual exclusion from gift tax. Therefore, the
maximum exclusion is $43,000 [$14,000
(to Sydney) + $15,000 (to General Hospital) +
$14,000 (to Jordan’s brother) = $43,000].
Choice “1” is incorrect. This answer option only
includes the $14,000 annual exclusion for each
gift made ($14,000 × 3 = $42,000); however,
3. Choice “1” is correct.
Choice “2” is incorrect. These expenditures are
deductible by the liquidating corporation, not
its shareholders.
Choice “3” is incorrect. These expenditures are
ordinary deductions, not capital losses.
Choice “4” is incorrect. These expenditures are
deductible by the liquidating corporation in its
final tax return.
4. Choice “3” is correct.
When a partner’s share of partnership liabilities
decreases, a partner’s basis in the partnership
decreases by his/her share of the decrease.
The partnership liabilities are treated as if
the partner personally borrowed the money;
therefore, a reduction in personal liability is a
reduction in basis.
Choice “1” is incorrect. There is an effect on
partnership basis from a reduction in partnership
liabilities. When a partner’s share of partnership
liabilities decreases, a partner’s basis in the
partnership decreases by his/her share of the
decrease. The partnership liabilities are treated
as if the partner personally borrowed the money;
therefore, a reduction in personal liability is a
reduction in basis.
Choice “2” is incorrect. When a partner’s share of
partnership liabilities decreases, a partner’s basis
in the partnership decreases by his/her share
of the decrease. The partnership liabilities are
treated as if the partner personally borrowed the
money; therefore, a reduction in personal liability
is a reduction in basis. If the reduction caused the
partner’s basis to drop below zero, the partner
would recognize taxable income to bring his/her
basis back up to the zero amount.
Choice “4” is incorrect. When a partner’s share of
partnership liabilities decreases, a partner’s basis
in the partnership decreases, not increases, by
his/her share of the decrease.
5. Choice “3” is correct.
State income tax paid is an allowable
itemized deduction (deductible from AGI),
but taxpayers who file using the standard
deduction (usually because it is higher than
allowable itemized deductions, although there
are some exceptions) will not get the benefit
from those itemized deductions that total less
than the standard deduction.
Choices “1”, “2”, and “4” are incorrect. All of these
are deductible to arrive at AGI and are termed
“adjustments.” Adjustments benefit taxpayers
who itemize as well as those who file using the
standard deduction.
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