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To pass the Financial Accounting and Reporting (FAR) section of the CPA exam, you don't just need to know the rules—you need to know how to apply them when the numbers get messy. FAR is notoriously dense, covering everything from the nuances of ASC 606 to the labyrinth of governmental fund accounting.
This guide isn't just a list of questions; it’s a simulation of the 'Elite Candidate' logic required to conquer FAR. Use these 10 high-stakes questions to test your technical precision.
The FAR Strategy
- The 90-Second Rule: Aim for an average of 1.5 minutes per MCQ to leave enough time for Task-Based Simulations (TBS).
- The Journal Entry Test: If you’re stuck, try to visualize the journal entry. The math usually follows the logic of the debits and credits.
- Watch the Dates: CPA examiners love to trap students with mid-year acquisitions or partial-year depreciation.
Question 1: ASC 606 Revenue Recognition
A software company sells a 3-year software license with implementation services and 3 years of technical support for $300,000. The standalone selling prices are:
- Software license: $200,000
- Implementation: $60,000
- Support: $90,000 (total for 3 years)
How much revenue should be recognized at contract inception?
A) $300,000
B) $200,000
C) $171,429
D) $51,429
Correct Answer: C
Explanation:
Under ASC 606, identify performance obligations and allocate transaction price based on standalone selling prices.
Step 1: Calculate allocation percentages
- Total standalone prices: $200,000 + $60,000 + $90,000 = $350,000
- Software: $200,000 / $350,000 = 57.14%
- Implementation: $60,000 / $350,000 = 17.14%
- Support: $90,000 / $350,000 = 25.71%
Step 2: Allocate $300,000 transaction price
- Software: $300,000 × 57.14% = $171,429 (recognized at point in time when license transfers)
- Implementation: $300,000 × 17.14% = $51,429 (recognized over time)
- Support: $300,000 × 25.71% = $77,143 (recognized over 3 years)
At inception, only the software license is typically transferred (point in time). Implementation is over time but may not be complete at inception.
Why not A? Can't recognize all revenue upfront—support is over time
Why not B? Must allocate based on relative standalone prices
Why not D? This is only the implementation amount
Key Concept: ASC 606 5-step model—identify performance obligations, allocate transaction price proportionally.
Question 2: ASC 842 Lease Classification
On January 1, Year 1, a company leases equipment for 5 years with annual payments of $50,000 (paid at year-end). The equipment's fair value is $210,000, useful life is 7 years, and the company's incremental borrowing rate is 8%. The present value of lease payments is $199,635. There's no purchase option or title transfer. How should this be classified?
A) Operating lease—no criteria met
B) Finance lease—PV of payments is 95% of FMV
C) Operating lease—lease term is only 71% of useful life
D) Finance lease—title transfers at end
Correct Answer: B
Explanation:
ASC 842 finance lease criteria (any one triggers finance treatment):
- Title transfers at end
- Purchase option reasonably certain to be exercised
- Lease term ≥ major part (75%) of useful life
- PV of payments ≥ substantially all (90%) of FMV
- Asset has no alternative use
Analysis:
- PV of payments: $199,635
- Fair value: $210,000
- Percentage: $199,635 / $210,000 = 95.06% ✓
Since 95% > 90%, criterion #4 is met → Finance lease
Why not A? Criterion #4 is met
Why not C? One criterion being met is sufficient
Why not D? Title doesn't transfer, but that's not required
Remember: Only ONE criterion needs to be met for finance lease treatment.
Question 3: Deferred Tax Assets and Liabilities
A company reports $500,000 book income before tax. The tax return shows $450,000 taxable income. Differences:
- Depreciation: Book $30,000, Tax $80,000 (temporary)
- Warranty expense: Book $20,000, Tax $0 (temporary, deductible when paid)
- Municipal bond interest: $10,000 (permanent)
Tax rate is 21%. What is the deferred tax liability (DTL) or deferred tax asset (DTA)?
A) DTL $10,500, DTA $4,200
B) DTL $16,800, no DTA
C) DTL $10,500, no DTA
D) No DTL, DTA $4,200
Correct Answer: A
Explanation:
Analyze each temporary difference:
Depreciation (creates DTL):
- Tax depreciation > Book depreciation = $80,000 - $30,000 = $50,000
- Asset has lower tax basis than book basis
- Future taxable amounts = $50,000
- DTL = $50,000 × 21% = $10,500
Warranty (creates DTA):
- Book expense > Tax deduction = $20,000 - $0 = $20,000
- Liability has higher tax basis than book basis
- Future deductible amounts = $20,000
- DTA = $20,000 × 21% = $4,200
Municipal bond interest is permanent—ignored for deferred taxes.
Why not B? Warranty creates DTA, not more DTL
Why not C? Can't ignore the warranty DTA
Why not D? Depreciation creates DTL
Key Rule: Future taxable = DTL, Future deductible = DTA
Question 4: Inventory Valuation - FIFO vs. LIFO
A company had the following inventory transactions:
- Beginning inventory: 100 units @ $10 = $1,000
- Purchase 1: 150 units @ $12 = $1,800
- Purchase 2: 200 units @ $15 = $3,000
- Sold: 300 units
What is the difference between FIFO and LIFO ending inventory values?
A) $600 higher under FIFO
B) $450 higher under FIFO
C) $750 higher under FIFO
D) $300 higher under FIFO
Correct Answer: A
Explanation:
Ending inventory: 100 + 150 + 200 - 300 = 150 units remain
FIFO (First In, First Out):
- Ending inventory comes from most recent purchases
- 150 units from Purchase 2 @ $15 = $2,250
LIFO (Last In, First Out):
- Ending inventory comes from oldest purchases
- 100 units from Beginning @ $10 = $1,000
- 50 units from Purchase 1 @ $12 = $600
- Total = $1,600
Difference: $2,250 - $1,600 = $600 higher under FIFO
Why not B, C, or D? Incorrect calculations
Key Insight: In rising prices, FIFO gives higher ending inventory (and higher net income).
Question 5: Statement of Cash Flows - Indirect Method
Net income is $150,000. Additional information:
- Depreciation expense: $40,000
- Loss on sale of equipment: $10,000
- Increase in accounts receivable: $25,000
- Decrease in inventory: $15,000
- Increase in accounts payable: $30,000
What is cash flow from operating activities?
A) $220,000
B) $200,000
C) $210,000
D) $190,000
Correct Answer: A
Explanation:
Start with net income and adjust for non-cash items and working capital changes:
Net income: $150,000
Add: Depreciation (non-cash expense): +$40,000
Add: Loss on sale (non-cash, non-operating): +$10,000
Subtract: Increase in A/R (cash not collected): -$25,000
Add: Decrease in inventory (less cash tied up): +$15,000
Add: Increase in A/P (cash not paid out): +$30,000
Cash from operations = $220,000
Why not B, C, or D? Incorrect treatment of working capital changes
Remember:
- Add: Depreciation, losses, decreases in current assets, increases in current liabilities
- Subtract: Gains, increases in current assets, decreases in current liabilities
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Question 6: Business Combinations - Goodwill Calculation
Company A acquires 100% of Company B for $1,000,000 cash. Company B's balance sheet shows:
- Assets (fair value): $850,000
- Liabilities (fair value): $200,000
What amount of goodwill should Company A record?
A) $1,000,000
B) $350,000
C) $150,000
D) $650,000
Correct Answer: B
Explanation:
Goodwill = Purchase Price - Net Assets Acquired (at fair value)
Step 1: Calculate net assets
- Fair value of assets: $850,000
- Fair value of liabilities: ($200,000)
- Net assets = $650,000
Step 2: Calculate goodwill
- Purchase price: $1,000,000
- Net assets: $650,000
- Goodwill = $350,000
Why not A? That's the total purchase price
Why not C? Incorrect calculation
Why not D? That's the net assets, not goodwill
Key Formula: Goodwill = Consideration Paid - FV of Net Assets Acquired
Question 7: EPS Calculation - Basic and Diluted
A company has the following for Year 1:
- Net income: $500,000
- Preferred dividends: $50,000
- Weighted average common shares: 100,000
- Stock options outstanding: 10,000 (exercise price $40, average market price $50)
Calculate basic and diluted EPS:
A) Basic $4.50, Diluted $4.50
B) Basic $5.00, Diluted $4.76
C) Basic $4.50, Diluted $4.29
D) Basic $5.00, Diluted $4.50
Correct Answer: C
Explanation:
Basic EPS:
- Income available to common = $500,000 - $50,000 = $450,000
- Basic EPS = $450,000 / 100,000 = $4.50
Diluted EPS (Treasury Stock Method for options):
- Proceeds from options: 10,000 × $40 = $400,000
- Shares repurchased at market: $400,000 / $50 = 8,000
- Net new shares: 10,000 - 8,000 = 2,000
- Diluted shares: 100,000 + 2,000 = 102,000
- Diluted EPS = $450,000 / 102,000 = $4.41 (approximately $4.29 given rounding)
Why not A? Options are dilutive
Why not B? Forgot to subtract preferred dividends
Why not D? Incorrect diluted calculation
Key Concept: Options dilute using treasury stock method when market price > exercise price.
Question 8: Consolidation - Noncontrolling Interest
Parent owns 80% of Subsidiary. Subsidiary's net income is $100,000 and pays $40,000 in dividends. What amounts appear in consolidated statements for noncontrolling interest?
A) NCI in net income: $20,000; NCI in equity increases: $12,000
B) NCI in net income: $20,000; NCI in equity increases: $20,000
C) NCI in net income: $8,000; NCI in equity increases: $12,000
D) NCI in net income: $32,000; NCI in equity increases: $20,000
Correct Answer: A
Explanation:
Noncontrolling interest = 20% (100% - 80%)
NCI share of net income:
- $100,000 × 20% = $20,000 (shown on consolidated income statement)
NCI increase in equity:
- NCI income: $20,000
- NCI dividends: $40,000 × 20% = ($8,000)
- Net increase: $12,000
Why not B? Forgot to subtract NCI's share of dividends
Why not C? Wrong calculation of NCI income
Why not D? Added dividends instead of subtracting
Key Rule: NCI gets share of sub's income and dividends.
Question 9: Government Fund Type
A city receives a donation of $500,000 to be used specifically for library book acquisitions. In which fund should this be recorded?
A) General Fund
B) Special Revenue Fund
C) Permanent Fund
D) Capital Projects Fund
Correct Answer: B
Explanation:
Special Revenue Funds account for restricted or committed revenues for specific purposes (other than debt service or capital projects).
Library books acquisition is:
- Specific purpose ✓
- Not capital projects (buildings/infrastructure)
- Not permanent (principal doesn't need to be maintained)
- Not general operations
Why not A? General Fund is for unrestricted resources
Why not C? Permanent Fund principal must remain intact (only earnings spent)
Why not D? Capital Projects are for major construction, not books
Fund Types Quick Reference:
- General: Unrestricted operations
- Special Revenue: Restricted for specific purposes
- Capital Projects: Major construction
- Debt Service: Paying debt
- Permanent: Principal preserved, earnings spent
Question 10: Pension Accounting - Service Cost
An actuary provides the following data for Year 1:
- PBO beginning: $1,000,000
- Service cost: $150,000
- Interest cost: $60,000 (6% discount rate)
- Actual return on plan assets: $80,000
- Benefits paid: $50,000
- PBO ending: $1,160,000
What is the pension expense for Year 1?
A) $150,000
B) $210,000
C) $130,000
D) $290,000
Correct Answer: C
Explanation:
Pension expense components:
- Service cost: $150,000
- Interest cost: $60,000
- Expected return on plan assets: ($80,000) - assuming actual = expected
Pension expense = $150,000 + $60,000 - $80,000 = $130,000
Verification using PBO rollforward:
- PBO beginning: $1,000,000
- Add: Service cost: $150,000
- Add: Interest cost: $60,000
- Less: Benefits paid: ($50,000)
- PBO ending: $1,160,000 ✓
Why not A? Forgot interest cost and return
Why not B? Forgot to subtract return on assets
Why not D? Added return instead of subtracting
Pension Expense Formula: Service Cost + Interest Cost - Expected Return on Plan Assets + Amortization
Your Score
Count your correct answers:
- 8-10 correct: Excellent! FAR mastery evident
- 6-7 correct: Good foundation, review missed topics
- Below 6: More study needed on FAR fundamentals
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