10 Toughest CPA FAR Practice Questions & Explanations 2026

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

Need more interactive FAR practice questions? Try ExpertMinds' CPA FAR practice exam for free with 50 questions covering all major topics.

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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