CPA Exam - FAR (Financial Accounting and Reporting)

A. $300,000

Under the simplified goodwill impairment test (Step 1 only, per ASU 2017-04), if the fair value of a reporting unit is less than its carrying amount, an impairment loss is recognized for the amount by which the carrying amount exceeds the fair value, but the loss recognized cannot exceed the total amount of goodwill allocated to that reporting unit. In this case, the fair value ($1,200,000) is less than the carrying amount ($1,500,000) by $300,000. Since this impairment loss of $300,000 does not exceed the goodwill's carrying amount of $300,000, the full $300,000 is recognized as an impairment loss.

C. Retrospectively, by restating prior period financial statements presented.

A change in accounting principle, such as changing inventory valuation methods, is generally accounted for retrospectively under U.S. GAAP. This means prior period financial statements presented for comparative purposes should be restated to reflect the new accounting principle, and the cumulative effect of the change on periods prior to those presented should be recognized in the beginning balance of retained earnings of the earliest period presented.

B. Expense $130,000 and capitalize $20,000.

Under U.S. GAAP, research costs are always expensed as incurred. Development costs are expensed until technological feasibility is established, after which they are capitalized. Therefore, the $100,000 research costs are expensed. Of the $50,000 development costs, only the $20,000 incurred after technological feasibility was established are capitalized. The remaining $30,000 ($50,000 - $20,000) of development costs are expensed. Total expense = $100,000 (research) + $30,000 (development) = $130,000. Total capitalized = $20,000.

A. $250,000

To calculate net cash from operating activities using the indirect method: Start with Net Income ($200,000). Add back non-cash expenses like Depreciation ($30,000). Subtract non-operating gains like Gain on Sale of Equipment ($5,000). Add decreases in current assets like Accounts Receivable ($10,000). Add increases in current liabilities like Accounts Payable ($15,000). Calculation: $200,000 + $30,000 - $5,000 + $10,000 + $15,000 = $250,000.

A. Issuance of a significant amount of new common stock after the balance sheet date but before financial statements are issued.

Subsequent events are events that occur after the balance sheet date but before financial statements are issued. Type I (recognized) subsequent events provide additional evidence about conditions that existed at the balance sheet date and require adjustment. Type II (non-recognized) subsequent events provide evidence about conditions that did not exist at the balance sheet date but arose after that date and require disclosure. The issuance of new common stock is a Type II event, as the condition (issuance) did not exist at year-end.

B. Expenditures that significantly extend the useful life of an existing asset or increase its productive capacity.

Expenditures that significantly extend the useful life of an existing asset, increase its productive capacity, or improve its efficiency are considered capital expenditures and should be capitalized. These expenditures provide future economic benefits beyond the current period.

D. Finance lease, due to the present value of lease payments criterion.

Under ASC 842, a lease is classified as a finance lease if any one of five criteria is met. One criterion is if the present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset. Here, $450,000 (PV of payments) is 90% of $500,000 (fair value), which is considered substantially all. The lease term (5 years) is 71% of the useful life (7 years), which is also considered substantially all. However, the PV criterion is explicitly met. Note: Only one criterion needs to be met.

B. Accrued ratably over the interim periods within the fiscal year.

Interim financial reporting generally follows the principle that each interim period should be viewed as an integral part of an annual period. Therefore, expenses that benefit multiple interim periods, such as an anticipated year-end bonus that can be reasonably estimated, should be allocated to those periods. This means accruing the bonus ratably across the quarters.

D. Upon the expiration of the 60-day return period.

ASC 606 requires revenue to be recognized when performance obligations are satisfied. In this scenario, the company has a significant variable consideration (the right of return) that is difficult to estimate reliably. Revenue recognition is deferred until the uncertainty is resolved, which occurs upon the expiration of the return period.

A. The bonds will be issued at a discount.

When the stated (coupon) interest rate is lower than the market (effective) interest rate, the bonds will be issued at a discount. Investors demand a higher return (market rate), so they will pay less than face value for bonds offering a lower coupon rate to achieve that yield.

C. $20,000

Goodwill is calculated as the excess of the consideration transferred (plus the fair value of the noncontrolling interest) over the fair value of identifiable net assets acquired. In this case, Goodwill = ($500,000 consideration transferred + $120,000 NCI) - $600,000 fair value of net assets = $620,000 - $600,000 = $20,000.

D. As a realized loss in net income.

For equity investments where the fair value option is not elected and there is no significant influence, changes in fair value are recognized in net income. If the impairment is 'other-than-temporary', it is considered a realized loss and recognized in net income. If it's merely a temporary decline, it would still flow through net income for these types of investments.

C. To provide information useful in making decisions about providing resources to the entity.

The primary objective of financial reporting, as stated in the FASB Conceptual Framework (SFAC No. 8), is to provide financial information that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.

C. Disclose the event in the notes to the December 31, Year 1 financial statements but do not adjust the financial statements.

This event is a Type II subsequent event because the conditions causing the bankruptcy arose after the balance sheet date (December 31, Year 1). Therefore, the financial statements should not be adjusted, but the event must be disclosed in the notes if it is material.

C. Operating Lease

Under ASC 842, a lease is classified as a finance lease if it meets any one of five criteria (OWNS test). If none of the OWNS criteria are met, it is classified as an operating lease. O - Ownership transfer: No. W - Written purchase option reasonably certain to exercise: No. N - Net present value of lease payments constitutes substantially all (typically 90% or more) of the fair value of the asset: 80% is not substantially all. S - Specialized asset: No. T - Lease term is for the major part (typically 75% or more) of the economic life of the asset: 5 years / 7 years = 71.4%, which is not a major part (less than 75%). Since none of the criteria are met, the lease is an operating lease.

A. $570,000

To calculate net cash flow from operating activities using the indirect method, start with net income and adjust for non-cash items and changes in working capital accounts. Net Income: $500,000 Add: Depreciation Expense (non-cash expense): $80,000 Subtract: Gain on Sale of Equipment (non-operating income): $(20,000) Add: Decrease in Accounts Receivable (cash collected more than sales): $30,000 Add: Increase in Accounts Payable (cash paid less than expenses): $15,000 Subtract: Increase in Inventory (cash used for purchases more than COGS): $(25,000) Net Cash Flow from Operating Activities = $500,000 + $80,000 - $20,000 + $30,000 + $15,000 - $25,000 = $580,000.

A. Debt and equity securities that are not classified as trading or held-to-maturity.

Available-for-sale (AFS) securities are a residual category. They include debt and equity securities that are not classified as trading securities (held for short-term profit) nor as held-to-maturity securities (debt securities with intent and ability to hold to maturity).

D. Its profit or loss is at least 10% of the combined reported profit of all operating segments that did not incur a loss.

ASC 280 outlines three 10% tests for identifying reportable segments: revenue, profit/loss, and assets. A segment is reportable if it meets any one of these tests. The profit/loss test compares the segment's absolute profit or loss to the greater of the combined profit of all profitable segments or the combined loss of all segments that incurred a loss.

D. Increase of $40,000

The equipment was incorrectly expensed for $50,000. It should have been capitalized and depreciated. The correct depreciation for Year 1 is $50,000 / 5 years = $10,000. Therefore, the expense should have been $10,000 instead of $50,000, resulting in an increase to net income of $40,000 ($50,000 - $10,000).

B. As a component of other comprehensive income (OCI) and accumulated OCI on the balance sheet.

Unrealized gains and losses on available-for-sale (AFS) debt securities (and previously AFS equity securities before ASU 2016-01) are recognized in other comprehensive income (OCI). These amounts accumulate in accumulated other comprehensive income (AOCI) on the balance sheet until the securities are sold, at which point they are reclassified to net income.

B. $115 million

Goodwill is calculated as the consideration transferred plus the fair value of any noncontrolling interest, minus the fair value of identifiable net assets acquired. In this case, the consideration transferred includes the initial acquisition price of $500 million and the fair value of the contingent consideration at acquisition date, which is $15 million. So, Total Consideration = $500M + $15M = $515M. Goodwill = Total Consideration - Fair Value of Identifiable Net Assets = $515M - $400M = $115M. The subsequent re-measurement of contingent consideration affects post-acquisition earnings, not the initial goodwill.

C. Retrospectively, by restating prior period financial statements as if the new method had always been used, and adjusting the beginning balance of retained earnings for the earliest period presented.

A change in accounting principle, such as changing inventory methods (except for a change to LIFO, which is generally accounted for prospectively), is accounted for retrospectively. This means prior period financial statements are restated, and the cumulative effect of the change on periods prior to those presented is reflected as an adjustment to the beginning balance of retained earnings for the earliest period presented.

B. $196,000

Under the net method for sales discounts, revenue is initially recorded at the net amount (sales price less the expected discount). The sales price is $200,000, and the discount is 2% ($200,000 * 0.02 = $4,000). Therefore, the revenue recognized at the point of sale is $200,000 - $4,000 = $196,000.

A. Income from discontinued operations.

Under U.S. GAAP, discontinued operations are reported as a separate line item on the income statement, net of tax, below income from continuing operations. Other items like restructuring costs, gains/losses from PPE sales, and unusual/infrequent gains/losses are typically reported within continuing operations, though they may be presented as separate line items before tax or disclosed in the notes.

A. The bonds will be issued at a discount.

When the stated (coupon) interest rate of a bond is lower than the market (effective) interest rate, the bond will be issued at a discount. Investors demand a higher return (market rate) than what the bond is offering, so they will only purchase the bond for less than its face value.