AICPA CPA-TEST Online Practice Questions and Exam Preparation

AICPA CPA-TEST Online Questions & Answers

• Question 911:

  A characteristic of the payback method (before taxes) is that it:

  A. Incorporates the time value of money.
  B. Neglects total project profitability.
  C. Uses accrual accounting inflows in the numerator of the calculation.
  D. Uses the estimated expected life of the asset in the denominator of the calculation.
  B. Neglects total project profitability.

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  Choice "b" is correct. The payback method neglects total project profitability. It simply looks at the time required to recover the initial investment; subsequent receipts are ignored. Choice "a" is incorrect. Payback does not incorporate the time value of money. Choice "c" is incorrect. Payback uses cash flow, not accrual accounting income. Choice "d" is incorrect. The denominator is the annual cash inflows.

• Question 912:

  ABC Corp.'s $95,000 net income for the quarter ended September 30, 1990, included the following aftertax items:

  ?A $60,000 extraordinary gain, realized on April 30, 1990, was allocated equally to the second, third, and fourth quarters of 1990. ?A $16,000 cumulative-effect loss resulting from a change in inventory valuation method was recognized on August 2, 1990.

  In addition, ABC paid $48,000 on February 1, 1990, for 1990 calendar-year property taxes. Of this amount, $12,000 was allocated to the third quarter of 1990. For the quarter ended September 30, 1990, ABC should report net income of:

  A. $91,000
  B. $103,000
  C. $111,000
  D. $115,000
  A. $91,000

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  Choice "a" is correct. $91,000 net income for the third quarter ended 9-30-90. Rules: The entire amount of an "extraordinary" item should be reported during the period incurred. A "cumulative effect" type accounting change is not included in the net income of the period of change; instead, the beginning of the year retained earnings is restated. Expenses, which benefit more than one interim period, such as property taxes, are allocated among the periods benefited.

• Question 913:

  In the first audit of a new client, an auditor was able to extend auditing procedures to gather sufficient evidence about consistency. Under these circumstances, the auditor should:

  A. Not report on the client's income statement.
  B. Not refer to consistency in the auditor's report.
  C. State that the consistency standard does not apply.
  D. State that the accounting principles have been applied consistently.
  B. Not refer to consistency in the auditor's report.

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  Choice "b" is correct. The auditor's standard report implies that the auditor is satisfied that the comparability of financial statements between periods has not been materially affected by changes in accounting principles and that such principles have been consistently applied between or among periods. Since the auditor has gathered sufficient evidence about consistency, no reference need be made in the report. Choice "a" is incorrect. If the auditor is able to obtain sufficient evidence about consistency, the auditor may report on the entity's financial statements. Choice "c" is incorrect. The consistency standard is one of the ten GAAS, and it does apply to this audit. Choice "d" is incorrect. If the auditor is able to obtain sufficient evidence about consistency, no mention of consistency need be made. Consistency is implied in the standard report.

• Question 914:

  Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding the predecessor's:

  A. Opinion of any subsequent events occurring since the predecessor's audit report was issued.
  B. Understanding as to the reasons for the change of auditors.
  C. Awareness of the consistency in the application of GAAP between periods.
  D. Evaluation of all matters of continuing accounting significance.
  B. Understanding as to the reasons for the change of auditors.

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  Choice "b" is correct. Before accepting an engagement, the auditor should make specific inquiries of the predecessor auditor in order to assist the auditor in deciding whether or not to accept the engagement. Inquiry should include the predecessor's understanding of the reasons for the change in auditors. Choice "a" is incorrect. The predecessor generally does not provide an opinion on events occurring subsequent to the issuance of the audit report. Choice "c" is incorrect. The successor (and not the predecessor) evaluates the consistency in the application of GAAP. This evaluation occurs after acceptance. Choice "d" is incorrect. The predecessor generally allows the successor to review audit documentation related to matters of continuing accounting significance, but this occurs subsequent to acceptance.

• Question 915:

  When an entity changes its method of accounting for income taxes, which has a material effect on comparability, the auditor should refer to the change in an explanatory paragraph added to the auditor's report. This paragraph should identify the nature of the change and:

  A. Explain why the change is justified under generally accepted accounting principles.
  B. Describe the cumulative effect of the change on the audited financial statements.
  C. State the auditor's explicit concurrence with or opposition to the change.
  D. Refer to the financial statement note that discusses the change in detail.
  D. Refer to the financial statement note that discusses the change in detail.

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  Choice "d" is correct. The paragraph should refer to the note in the financial statements that discusses the change in detail. Following is an example of an appropriate explanatory paragraph: "As discussed in Note X to the financial statements, the company changed its method of accounting for income taxes in X2." Choice "a" is incorrect. The auditor need not explain why a change from one generally accepted accounting principle to another is justified. Choice "b" is incorrect. The paragraph should not identify the cumulative effect of the change on the audited financial statements. Choice "c" is incorrect. The auditor should never explicitly state concurrence with a change. If the auditor opposes the change, a qualified or adverse opinion should be issued.

• Question 916:

  What would be the primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt?

  A. To cause the price of the company's stock to rise.
  B. To lower the company's bond rating.
  C. To reduce the risk for existing bondholders.
  D. To reduce the interest rate on the bonds being sold.
  D. To reduce the interest rate on the bonds being sold.

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  Note: The material tested in this question does not appear specifically on-point in our textbook, as the topic has rarely shown up on the CPA exam. The topics are covered in general in parts of our textbook, so we believe that our students would have answered this question correctly given the information they had. However, we have expanded our of this question to provide you with more detailed information. Choice "d" is correct. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is to reduce the interest rate on NEW bonds being sold. A debt covenant is a provision in a bond indenture (contract between the bond issuer and the bond holders) that the bond issuer will either do (affirmative covenants) or not do (negative covenants) certain things. In this question, the issuer would agree not to issue bonds in the future over a certain percentage of its long-term debt. Such a provision would be good for the potential bondholders and would probably reduce the interest rate on the bonds being sold. Choice "a" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to cause the price of the company's stock to rise. Bond covenants affect bonds, not equity (at least not directly). Choice "b" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to lower the company's bond rating. Such a covenant might raise, not lower, a company's bond rating because there would be less risk. Besides, why would a bond covenant be signed if it would lower the company's bond rating? Choice "c" is incorrect. The primary reason for a company to agree to a debt covenant limiting the percentage of its long-term debt is not to reduce the risk of existing bondholders, although a reduction in the risk of the existing bondholders certainly might result from such a covenant. As a general rule, more debt means more risk, less debt means less risk. So less debt would reduce the risk of all bondholders. This answer is a very close second.

• Question 917:

  On December 1, 1992, Michaels, a self-employed cash basis taxpayer, borrowed $100,000 to use in her business. The loan was to be repaid on November 30, 1993. Michaels paid the entire interest of $12,000 on December 1, 1992. What amount of interest was deductible on Michaels' 1993 income tax return?

  A. $12,000
  B. $11,000
  C. $1,000
  D. $0
  B. $11,000

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  Choice "b" is correct. Prepaid interest must be prorated over the time for which payment is made. This is true for both cash and accrual basis taxpayers. The loan is for 1 month in 1992 and 11 months in 1993. Therefore, 1/12 of the interest is deductible in 1992 and 11/12, or $11,000 is deductible in 1993. Choices "a", "c", and "d" are incorrect. Prepaid interest must be prorated over the time for which payment is made. This is true for both cash and accrual basis taxpayers.

• Question 918:

  When an auditor qualifies an opinion because of the inability to confirm accounts receivable by direct communication with debtors, the wording of the opinion paragraph of the auditor's report should indicate that the qualification pertains to the:

  A. Limitation on the auditor's scope.
  B. Possible effects on the financial statements.
  C. Lack of sufficient appropriate audit evidence.
  D. Departure from generally accepted auditing standards.
  B. Possible effects on the financial statements.

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  Choice "b" is correct. When an auditor qualifies his or her opinion because of a scope limitation, such as the inability to confirm A/R, the wording in the opinion paragraph should indicate that the qualification pertains to the possible effects on the FS and not to the scope limitation itself. The opinion paragraph should not refer to the scope limitation itself, the lack of evidence, or the departure from GAAS. Choices "a", "c", and "d" are incorrect, based on the above explanation.

• Question 919:

  ABC Telecom is considering a project for the coming year, which will cost $50 million. ABC plans to use the following combination of debt and equity to finance the investment.

  ?Issue $15 million of 20-year bonds at a price of 101, with a coupon rate of 8 percent, and flotation costs of 2 percent of par. ?Use $35 million of funds generated from earnings.

  The equity market is expected to earn 12 percent. U.S. treasury bonds are currently yielding 5 percent. The beta coefficient for ABC is estimated to be 60. ABC is subject to an effective corporate income tax rate of 40 percent. The before-tax cost of ABC's planned debt financing, net of flotation costs, in the first year is:

  A. 11.80 percent.
  B. 8.08 percent.
  C. 10.00 percent.
  D. 7.92 percent.
  B. 8.08 percent.

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  Choice "b" is correct. 8.08 percent before-tax cost of debt financing, net of flotation costs.

• Question 920:

  In an audit of an issuer, the auditor must provide an opinion on which of the following?

  A. The financial statements. II. The audit committee's oversight of financial reporting and internal control. III. The effectiveness of internal control.
  B. I and III only.
  C. I, II, and III.
  D. I and II only.
  E. I only.
  A. The financial statements. II. The audit committee's oversight of financial reporting and internal control. III. The effectiveness of internal control.

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  Choice "a" is correct. The auditor provides an opinion on the entity's financial statements and on the effectiveness of internal control. The auditor is not required to provide an opinion on the audit committee's oversight (but is required to report to the board when such oversight is ineffective). Choices "b", "c", and "d" are incorrect, based on theabove.