What Is This U.S. Certified Public Accountant Exam?
This practice exam is designed to help you prepare for the U.S. Certified Public Accountant (CPA) Examination, one of the most recognized and rigorous professional certifications in the field of accounting. Offered by Exam Sage, this free practice test reflects the format, structure, and depth of real CPA exam questions to give you a meaningful head start on your journey to licensure.
Whether you’re testing your knowledge for the first time or brushing up on your exam readiness, this carefully curated practice exam will help you get comfortable with the question types, reasoning approaches, and complexity expected by the AICPA (American Institute of Certified Public Accountants).
📘 What Will You Learn from This Exam?
By taking this exam, you’ll gain practical insights and conceptual clarity across all four key sections of the CPA exam:
- REG (Regulation): Taxation of individuals, business law, ethics, and federal regulation.
- FAR (Financial Accounting & Reporting): U.S. GAAP, governmental and not-for-profit accounting, and financial statement preparation.
- AUD (Auditing & Attestation): Audit procedures, risk assessment, ethics, and professional responsibilities.
- BEC (Business Environment & Concepts): Corporate governance, economics, financial management, and strategic planning.
Each question includes a detailed explanation (50–70 words) that helps you understand the reasoning behind the correct answer. You won’t just memorize facts — you’ll build conceptual mastery.
👤 Who Should Take This CPA Practice Exam?
This free practice test is ideal for:
- CPA candidates preparing for any section of the official exam
- Accounting students seeking to reinforce their understanding of core topics
- Finance professionals planning to sit for the CPA in the near future
- Career changers considering a transition into accounting and finance
- Educators and tutors looking for high-quality practice materials for classroom or private instruction
No registration is required, and the exam is available for free — making it an ideal resource for anyone looking to assess and improve their CPA knowledge without commitment.
📚 Topics Covered in This Exam Include:
This exam spans across a wide range of real-world topics and subtopics, such as:
- Individual and corporate taxation (REG)
- Depreciation and amortization rules
- Entity structures and pass-through taxation
- Audit reports, assertions, risk assessment, and internal controls (AUD)
- GAAP financial reporting standards, leases, bonds, and deferred taxes (FAR)
- Working capital management, cost behaviors, and business economics (BEC)
- Professional ethics and legal responsibilities
- Subsequent events, inherent risk, and dual dating in audits
- Time value of money, financial ratios, and performance metrics
Each question is carefully written to resemble what you’ll face on the actual exam, allowing you to benchmark your knowledge with confidence.
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If you’re planning to succeed on your CPA journey, this free test is a smart place to start.
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✅ 1. (FAR) Which of the following is not a characteristic of governmental fund accounting?
A. Uses modified accrual basis
B. Focuses on current financial resources
C. Records long-term assets and liabilities
D. Includes general, special revenue, and capital projects funds
Correct Answer: C
Explanation: Governmental funds use the modified accrual basis and focus on current financial resources. They do not record long-term assets or liabilities, which are reported in the government-wide financial statements using full accrual accounting.
✅ 2. (AUD) Which is the primary purpose of an engagement letter?
A. To limit the auditor’s liability
B. To describe the auditor’s responsibilities
C. To obtain written representation from management
D. To define the audit scope and objective
Correct Answer: D
Explanation: An engagement letter is a contract that defines the scope, objectives, and responsibilities of both the auditor and client. It sets clear expectations before the audit begins but does not serve as a legal shield or a substitute for management representations.
✅ 3. (REG) Which entity is taxed as a pass-through under U.S. tax law?
A. C Corporation
B. S Corporation
C. Publicly traded partnership
D. Foreign corporation
Correct Answer: B
Explanation: An S Corporation is a pass-through entity, meaning its income is reported directly on the shareholders’ personal tax returns, avoiding double taxation. Unlike C Corporations, S Corps are not taxed at the entity level.
✅ 4. (BEC) COSO’s internal control framework includes all of the following components EXCEPT:
A. Risk assessment
B. Information and communication
C. Regulatory oversight
D. Control environment
Correct Answer: C
Explanation: COSO outlines five components: control environment, risk assessment, control activities, information and communication, and monitoring. Regulatory oversight is not one of the COSO components but may influence the control environment indirectly.
✅ 5. (FAR) Which of the following is classified as a financing activity in the statement of cash flows under U.S. GAAP?
A. Interest paid
B. Dividends received
C. Issuance of bonds
D. Income taxes paid
Correct Answer: C
Explanation: Under U.S. GAAP, issuance of bonds is a financing activity, as it involves raising capital. Interest paid is operating, dividends received is operating, and taxes paid also fall under operating activities.
✅ 6. (AUD) What is the primary purpose of analytical procedures in the planning stage of an audit?
A. To test internal controls
B. To identify unusual transactions or trends
C. To evaluate going concern
D. To confirm balances with third parties
Correct Answer: B
Explanation: During the planning stage, analytical procedures are used to identify unusual transactions or trends that might indicate areas of audit risk or misstatements, guiding the auditor’s focus during fieldwork.
✅ 7. (REG) The IRS allows which method to account for bad debts under the accrual method?
A. Direct write-off
B. Allowance method
C. FIFO method
D. LIFO method
Correct Answer: A
Explanation: For tax purposes, the direct write-off method is required. Even though the allowance method is acceptable under GAAP, the IRS only allows bad debts to be deducted once they are actually written off.
✅ 8. (BEC) Which of the following best describes the economic order quantity (EOQ) model?
A. A method to estimate future sales
B. A tool to evaluate capital investments
C. A model to determine optimal inventory order size
D. A ratio for assessing leverage
Correct Answer: C
Explanation: The EOQ model is used in inventory management to determine the optimal order quantity that minimizes total inventory costs—combining ordering and holding costs to achieve efficiency.
✅ 9. (FAR) A company purchases equipment for $100,000 with a useful life of 10 years and no salvage value. What is the annual depreciation expense under straight-line method?
A. $5,000
B. $10,000
C. $20,000
D. $15,000
Correct Answer: B
Explanation: Under the straight-line method, depreciation = (Cost − Salvage Value) ÷ Useful Life = ($100,000 − $0) ÷ 10 = $10,000 per year. This evenly spreads the expense over the asset’s useful life.
✅ 10. (AUD) Which report is issued when an auditor concludes the financial statements are fairly presented in all material respects?
A. Disclaimer
B. Adverse
C. Qualified
D. Unmodified
Correct Answer: D
Explanation: An unmodified (or unqualified) audit report indicates that the auditor believes the financial statements are presented fairly in all material respects, in accordance with the applicable financial reporting framework.
✅ 11. (REG) Which of the following items is not included in gross income for tax purposes?
A. Gambling winnings
B. Interest income
C. Life insurance proceeds due to death
D. Alimony received (for divorces finalized in 2017)
Correct Answer: C
Explanation: Life insurance proceeds received due to the death of the insured are generally excluded from gross income under IRC Section 101. In contrast, gambling winnings, interest income, and alimony (for divorces before 2019) are typically taxable.
✅ 12. (BEC) Which of the following cost types is classified as a period cost under absorption costing?
A. Direct labor
B. Direct materials
C. Factory rent
D. Selling expenses
Correct Answer: D
Explanation: Selling expenses are period costs under both absorption and variable costing. They are not included in inventory valuation and are expensed in the period incurred. In contrast, direct labor, materials, and factory overhead are product costs.
✅ 13. (FAR) Which of the following would be classified as a deferred inflow of resources?
A. Prepaid rent
B. Unearned revenue
C. Property tax collected in advance
D. Accrued interest expense
Correct Answer: C
Explanation: In governmental accounting, property taxes collected in advance are reported as deferred inflows of resources, as they represent resources not yet available for current expenditures under the modified accrual basis.
✅ 14. (AUD) When should the auditor consider the risk of material misstatement due to fraud?
A. Only during final review
B. Only during planning
C. Throughout the audit
D. Only when internal controls are weak
Correct Answer: C
Explanation: The risk of material misstatement due to fraud must be considered throughout the audit. SAS No. 122 requires auditors to maintain professional skepticism and continuously assess fraud risks during all audit phases.
✅ 15. (REG) Which is true regarding the Alternative Minimum Tax (AMT)?
A. It applies only to corporations
B. It allows more deductions than regular tax
C. It is designed to ensure minimum tax is paid
D. It replaces regular tax if lower
Correct Answer: C
Explanation: The Alternative Minimum Tax is designed to ensure high-income taxpayers pay a minimum level of tax by limiting certain deductions and preferences that reduce regular tax liability.
✅ 16. (BEC) In project management, the critical path is:
A. The longest duration path
B. The path with least float
C. The most expensive path
D. The shortest path in time
Correct Answer: A
Explanation: The critical path represents the longest sequence of dependent tasks in a project. It determines the minimum completion time, and any delay in this path delays the whole project.
✅ 17. (FAR) A change from FIFO to weighted average inventory method is:
A. Change in accounting estimate
B. Change in reporting entity
C. Change in accounting principle
D. Correction of error
Correct Answer: C
Explanation: Switching from FIFO to weighted average is a change in accounting principle, which generally requires retrospective application unless impractical. It affects comparability across periods.
✅ 18. (AUD) Which of the following requires an emphasis-of-matter paragraph in an audit report?
A. A qualified opinion
B. Inability to confirm receivables
C. Use of an accounting principle not consistently applied
D. Use of a different reporting framework with adequate disclosure
Correct Answer: D
Explanation: When financial statements are prepared using a special purpose framework, and adequately disclosed, the auditor includes an emphasis-of-matter paragraph to draw attention to this basis, without modifying the opinion.
✅ 19. (REG) What is the maximum capital loss deduction for individuals?
A. $1,500
B. $3,000
C. $5,000
D. $10,000
Correct Answer: B
Explanation: For individuals, the IRS allows up to a $3,000 capital loss deduction ($1,500 if married filing separately) against ordinary income annually. Unused losses may be carried forward indefinitely.
✅ 20. (BEC) Which best describes a just-in-time (JIT) inventory system?
A. Maximizing inventory to meet customer demand
B. Reducing delivery times by increasing storage
C. Receiving goods only as needed
D. Purchasing in large bulk orders to reduce costs
Correct Answer: C
Explanation: Just-in-time (JIT) inventory systems aim to minimize inventory holding by receiving goods only as they are needed in production. This reduces storage costs and waste, promoting lean operations.
✅ 21. (FAR) Which of the following is an example of a contra-asset account?
A. Accumulated depreciation
B. Accounts payable
C. Prepaid expenses
D. Deferred revenue
Correct Answer: A
Explanation: Accumulated depreciation is a contra-asset account, offsetting fixed assets on the balance sheet. It reflects the total depreciation expense taken and helps show the net book value of assets.
✅ 22. (AUD) Which audit procedure is best for testing the existence of inventory?
A. Observation
B. Inquiry
C. Analytical procedures
D. Reperformance
Correct Answer: A
Explanation: To test existence of inventory, physical observation of inventory counts is most effective. It provides direct evidence and ensures that recorded inventory actually exists at the balance sheet date.
✅ 23. (REG) Which of the following credits is nonrefundable?
A. Earned Income Credit
B. American Opportunity Credit (partial)
C. Child Tax Credit (partial)
D. Foreign Tax Credit
Correct Answer: D
Explanation: The Foreign Tax Credit is a nonrefundable credit, meaning it can reduce tax liability to zero but cannot result in a refund. Unused portions may be carried forward or back.
✅ 24. (BEC) What is the primary advantage of debt financing?
A. Lower bankruptcy risk
B. Fixed interest rates
C. Interest expense is tax-deductible
D. No repayment obligations
Correct Answer: C
Explanation: A key advantage of debt financing is that interest expense is tax-deductible, reducing a company’s taxable income. However, debt must be repaid, and excessive leverage increases financial risk.
✅ 25. (FAR) Under U.S. GAAP, what type of lease must a lessee report as a finance lease?
A. Lease with purchase option at market price
B. Lease term is less than economic life
C. Transfer of ownership at lease end
D. Lease for non-core assets
Correct Answer: C
Explanation: If the lease transfers ownership at the end, it is a finance lease under U.S. GAAP. Other criteria include a bargain purchase option, lease term >75% of useful life, or present value >90% of asset value.
✅ 26. (AUD) Which of the following controls is most likely to prevent theft of cash receipts?
A. Monthly bank reconciliation
B. Segregation of duties
C. Analytical review of trends
D. Independent audit
Correct Answer: B
Explanation: Segregation of duties prevents theft by ensuring that no one person has control over all aspects of a transaction—e.g., receiving cash, recording entries, and reconciling accounts.
✅ 27. (REG) What is the gift tax annual exclusion per donee in 2025 (based on IRS projections)?
A. $15,000
B. $17,000
C. $18,000
D. $19,000
Correct Answer: C
Explanation: For 2025, the annual gift tax exclusion is projected to be $18,000 per recipient. Gifts below this amount are excluded from taxable gifts, allowing individuals to transfer wealth without using their lifetime exemption.
✅ 28. (BEC) What is the formula for the contribution margin ratio?
A. (Sales − Fixed Costs) ÷ Sales
B. (Sales − Variable Costs) ÷ Sales
C. Fixed Costs ÷ Contribution Margin
D. Net Income ÷ Sales
Correct Answer: B
Explanation: The contribution margin ratio = (Sales − Variable Costs) ÷ Sales. It measures the percentage of sales that contributes to covering fixed costs and generating profit after variable costs are subtracted.
✅ 29. (FAR) Which of the following accounts is closed at the end of the accounting period?
A. Retained earnings
B. Depreciation expense
C. Accounts receivable
D. Accumulated depreciation
Correct Answer: B
Explanation: Depreciation expense is a temporary account that is closed at the end of each period into retained earnings. In contrast, accounts like A/R and accumulated depreciation are permanent and not closed.
✅ 30. (AUD) What is the primary objective of substantive testing in an audit?
A. Assess control risk
B. Detect material misstatements
C. Design audit procedures
D. Review internal controls
Correct Answer: B
Explanation: Substantive testing aims to detect material misstatements in financial statements. This includes detailed testing of transactions, balances, and disclosures through analytical procedures or tests of details.
✅ 31. (REG) Which type of entity is subject to double taxation?
A. S Corporation
B. Partnership
C. C Corporation
D. Sole Proprietorship
Correct Answer: C
Explanation: C Corporations are subject to double taxation, meaning the corporation pays taxes on profits, and shareholders are taxed again when dividends are distributed. Pass-through entities like S Corps and partnerships are taxed only once.
✅ 32. (BEC) What does a high accounts receivable turnover ratio indicate?
A. Poor collection practices
B. High levels of bad debts
C. Efficient credit and collection
D. Weak sales volume
Correct Answer: C
Explanation: A high A/R turnover suggests efficient collection of receivables and strong credit management. It means customers pay quickly, improving cash flow and reducing risk of uncollectible accounts.
✅ 33. (FAR) What is the proper treatment for a contingent liability that is probable and estimable?
A. Disclose only
B. Ignore it
C. Accrue and disclose
D. Report as revenue
Correct Answer: C
Explanation: If a contingent liability is probable and estimable, it must be accrued and disclosed in the financial statements per GAAP. This ensures the financials reflect likely obligations.
✅ 34. (AUD) When is an auditor required to communicate significant deficiencies to those charged with governance?
A. After audit completion
B. During interim audit
C. When detected
D. Within 30 days of fiscal year-end
Correct Answer: A
Explanation: Auditors must communicate significant deficiencies and material weaknesses in internal control in writing after audit completion. Timely communication helps governance address risks before the next audit.
✅ 35. (REG) Which expense is deductible as an itemized deduction for individuals?
A. Personal legal fees
B. Commuting costs
C. Charitable contributions
D. Clothing for work
Correct Answer: C
Explanation: Charitable contributions to qualified organizations are deductible as itemized deductions, subject to AGI limitations. Other personal or commuting expenses are not deductible under current tax laws.
✅ 36. (BEC) What is the formula for Return on Equity (ROE)?
A. Net Income ÷ Total Assets
B. Total Liabilities ÷ Equity
C. Net Income ÷ Equity
D. EBIT ÷ Equity
Correct Answer: C
Explanation: ROE = Net Income ÷ Equity. It measures how efficiently a company uses shareholders’ equity to generate profits, serving as a key metric for evaluating financial performance.
✅ 37. (FAR) Unrealized holding gains on available-for-sale securities are:
A. Reported in net income
B. Not reported at all
C. Included in other comprehensive income
D. Reported as deferred revenue
Correct Answer: C
Explanation: Under GAAP, unrealized gains and losses on available-for-sale securities are recorded in Other Comprehensive Income (OCI) until realized, keeping them out of net income.
✅ 38. (AUD) What is the primary purpose of engagement planning?
A. Identify internal fraud
B. Comply with GAAS
C. Assess independence
D. Develop audit strategy
Correct Answer: D
Explanation: Planning helps auditors develop an effective audit strategy, allocate resources, and assess risks. It’s a foundational step to ensure the audit is efficient and compliant with GAAS.
✅ 39. (REG) What is the self-employment tax rate in 2025 (estimated)?
A. 6.2%
B. 12.4%
C. 15.3%
D. 7.65%
Correct Answer: C
Explanation: Self-employment tax includes 12.4% for Social Security and 2.9% for Medicare, totaling 15.3%. This tax applies to net self-employment income, subject to applicable income caps.
✅ 40. (BEC) What is operational risk?
A. Risk of loss from market changes
B. Risk from failed internal processes
C. Risk from competitors
D. Risk of bankruptcy
Correct Answer: B
Explanation: Operational risk arises from failures in internal processes, people, or systems, including human error, fraud, and technology issues. It’s a core focus of enterprise risk management (ERM).
✅ 41. (REG) What is the maximum capital loss deduction allowed against ordinary income for individuals in a tax year?
A. $1,000
B. $3,000
C. $5,000
D. $10,000
Correct Answer: B
Explanation: The IRS allows individuals to deduct up to $3,000 of net capital losses against ordinary income each tax year. If losses exceed $3,000, the remainder can be carried forward to future years.
✅ 42. (FAR) How should goodwill be treated under U.S. GAAP after acquisition?
A. Amortized over 10 years
B. Expensed immediately
C. Not recorded
D. Tested annually for impairment
Correct Answer: D
Explanation: Under U.S. GAAP, goodwill is not amortized but is tested annually for impairment. If impaired, the carrying value is written down. This reflects a decline in the expected future benefits from acquired assets.
✅ 43. (BEC) What is the primary objective of cost accounting?
A. External financial reporting
B. Budget variance analysis
C. Determining product cost
D. Regulatory compliance
Correct Answer: C
Explanation: Cost accounting aims to determine the cost of producing goods or services, enabling businesses to set prices, control expenses, and improve profitability. It’s mainly used for internal decision-making.
✅ 44. (AUD) Which type of audit opinion is issued when financial statements are fairly presented in all material respects?
A. Adverse
B. Disclaimer
C. Qualified
D. Unmodified
Correct Answer: D
Explanation: An unmodified opinion is issued when the auditor concludes that the financial statements are fairly presented in all material respects according to the applicable financial reporting framework.
✅ 45. (REG) Which of the following is subject to the passive activity loss limitations?
A. Active business income
B. Portfolio income
C. Real estate rental losses
D. Wages
Correct Answer: C
Explanation: Passive activity loss rules restrict the deductibility of rental real estate losses, unless the taxpayer qualifies as a real estate professional or meets active participation exceptions for limited deductions.
✅ 46. (FAR) Which financial statement reflects a company’s liquidity position at a specific point in time?
A. Statement of Cash Flows
B. Income Statement
C. Statement of Changes in Equity
D. Balance Sheet
Correct Answer: D
Explanation: The Balance Sheet presents a company’s assets, liabilities, and equity at a specific date. It’s used to assess liquidity, solvency, and financial position, helping stakeholders understand a firm’s resources and obligations.
✅ 47. (BEC) What does a debt-to-equity ratio of 2:1 indicate?
A. The company is under-leveraged
B. The company uses no debt
C. The company has twice as much debt as equity
D. The company is over-capitalized
Correct Answer: C
Explanation: A debt-to-equity ratio of 2:1 means the company has $2 of debt for every $1 of equity, indicating higher financial leverage. While leverage can boost returns, it also increases financial risk.
✅ 48. (AUD) What is the main purpose of audit documentation?
A. To support the auditor’s opinion
B. To track employee hours
C. To replace client records
D. To file taxes
Correct Answer: A
Explanation: Audit documentation, or workpapers, serves as evidence supporting the auditor’s conclusions. It demonstrates compliance with auditing standards, facilitates supervision, and supports future audits or quality reviews.
✅ 49. (REG) What type of trust is created while the grantor is still alive?
A. Testamentary trust
B. Living trust
C. Irrevocable trust
D. Special needs trust
Correct Answer: B
Explanation: A living trust (also known as an inter vivos trust) is created during the grantor’s lifetime to manage and distribute assets. It can be revocable or irrevocable, depending on the grantor’s intent.
✅ 50. (FAR) Which depreciation method allocates more expense in the early years of an asset’s life?
A. Straight-line
B. Units of production
C. Declining balance
D. MACRS mid-month
Correct Answer: C
Explanation: The declining balance method is an accelerated depreciation method that allocates higher expenses in early years. It reflects the rapid loss of economic value early in an asset’s life.
✅ 51. (BEC) What does a flexible budget adjust for?
A. Actual activity levels
B. Industry benchmarks
C. Forecast errors
D. Economic inflation
Correct Answer: A
Explanation: A flexible budget adjusts for actual levels of activity, allowing management to evaluate performance more accurately than a static budget, especially in dynamic operating environments.
✅ 52. (AUD) Which of the following procedures is typically used to test accounts receivable existence?
A. Recalculate bad debt expense
B. Confirm customer balances
C. Vouch collections after year-end
D. Observe inventory
Correct Answer: B
Explanation: Confirming customer balances is the most effective procedure to verify existence of accounts receivable. Positive confirmations provide direct evidence from third parties (customers).
✅ 53. (REG) Which of the following is a preferential payment under bankruptcy law?
A. Paying utility bills
B. Paying an employee their salary
C. Repaying a loan to a friend 80 days before filing
D. Distributing dividends
Correct Answer: C
Explanation: Under bankruptcy law, preferential payments are those made to insiders or creditors within 90 days (or one year for insiders) before filing, which gives them unfair advantage. These can be voided.
✅ 54. (FAR) Which measurement attribute is used for inventory under U.S. GAAP?
A. Present value
B. Replacement cost
C. Historical cost
D. Fair value
Correct Answer: C
Explanation: Inventory is typically recorded at historical cost under U.S. GAAP and reported at the lower of cost or net realizable value (LCNRV) to account for any decline in market value.
✅ 55. (BEC) What does a high inventory turnover ratio suggest?
A. Overstocking
B. Slow-moving inventory
C. Efficient inventory management
D. Obsolete goods
Correct Answer: C
Explanation: A high inventory turnover indicates efficient inventory management and strong sales, meaning the company sells and replenishes stock frequently. Low turnover may suggest excess or obsolete inventory.
✅ 56. (AUD) What is the auditor’s responsibility for subsequent events?
A. Ignore them
B. Report them as fraud
C. Evaluate and disclose if material
D. Assume they are misstatements
Correct Answer: C
Explanation: Auditors must evaluate subsequent events that occur between the balance sheet date and audit report date and ensure material events are properly disclosed or adjusted in the financials.
✅ 57. (REG) Which of the following is considered earned income for tax purposes?
A. Interest income
B. Unemployment compensation
C. Dividends
D. Wages and tips
Correct Answer: D
Explanation: Wages and tips are considered earned income because they result from active work. Interest, dividends, and unemployment compensation are unearned income for tax reporting purposes.
✅ 58. (FAR) What does the Statement of Cash Flows’ investing section report?
A. Revenue inflows
B. Changes in cash from issuing stock
C. Cash from buying/selling assets
D. Dividend payments
Correct Answer: C
Explanation: The investing section of the Statement of Cash Flows reports cash inflows and outflows from acquisition or disposal of long-term assets, such as property, equipment, or securities.
✅ 59. (BEC) What does benchmarking involve?
A. Following regulations
B. Internal control testing
C. Comparing performance to best practices
D. Forecasting future trends
Correct Answer: C
Explanation: Benchmarking is a performance measurement tool that involves comparing a firm’s processes or metrics against industry leaders or best practices to identify areas for improvement.
✅ 60. (AUD) When should an auditor modify the opinion in the audit report?
A. If the client has internal control weaknesses
B. If the financial statements are free from error
C. If a material misstatement is uncorrected
D. If management cooperates
Correct Answer: C
Explanation: An auditor must modify their opinion if material misstatements remain uncorrected, as it impacts the reliability of the financial statements. The type of modification depends on the pervasiveness of the issue.
✅ 61. (REG) Which of the following is a deductible itemized expense on Schedule A of Form 1040?
A. Commuting expenses
B. State and local income taxes
C. Club membership dues
D. Federal income tax
Correct Answer: B
Explanation: State and local income taxes are deductible on Schedule A as itemized deductions, up to a $10,000 cap ($5,000 if married filing separately). Federal income taxes are not deductible, and commuting expenses and dues are generally personal, non-deductible expenses.
✅ 62. (FAR) How are changes in accounting estimates accounted for under U.S. GAAP?
A. Retrospectively
B. Prospectively
C. As prior period adjustments
D. As cumulative catch-up entries
Correct Answer: B
Explanation: Under U.S. GAAP, changes in accounting estimates are accounted for prospectively, meaning they affect only current and future periods. These are not corrections of errors and do not require restatement of prior financials.
✅ 63. (BEC) What is the primary advantage of just-in-time (JIT) inventory systems?
A. Lower product quality
B. Reduced carrying costs
C. Increased lead times
D. Higher safety stock
Correct Answer: B
Explanation: The JIT system minimizes inventory levels and emphasizes delivering materials only when needed, significantly reducing inventory carrying costs and improving operational efficiency. However, it requires strong supply chain coordination.
✅ 64. (AUD) What is the auditor’s primary concern with related-party transactions?
A. Efficiency
B. Timeliness
C. Completeness and disclosure
D. Tax treatment
Correct Answer: C
Explanation: Related-party transactions must be fully disclosed and properly classified, as they can involve conflicts of interest or be used to manipulate financial results. The auditor’s concern is whether such transactions are complete, fairly presented, and disclosed in the notes.
✅ 65. (REG) Which entity allows for “pass-through” taxation by default?
A. C Corporation
B. Sole Proprietorship
C. Publicly traded company
D. Mutual fund
Correct Answer: B
Explanation: A sole proprietorship is taxed using pass-through taxation, where income and losses are reported directly on the owner’s Form 1040. Unlike C corporations, the business itself does not pay separate income taxes.
✅ 66. (FAR) What is the appropriate accounting treatment for research and development costs under U.S. GAAP?
A. Capitalize all costs
B. Expense all costs when incurred
C. Amortize over useful life
D. Defer until project completion
Correct Answer: B
Explanation: Under U.S. GAAP, R&D costs are generally expensed as incurred. This conservative approach reflects the uncertainty of future benefits from R&D activities and helps prevent overstatement of assets.
✅ 67. (BEC) Which of the following is considered a financial risk?
A. Strike by employees
B. Currency exchange fluctuation
C. Product recall
D. Cybersecurity breach
Correct Answer: B
Explanation: Currency exchange fluctuation is a financial risk because it impacts a company’s financial results, especially for businesses involved in international transactions. It affects earnings, assets, and liabilities when converting between currencies.
✅ 68. (AUD) What is a dual-purpose test in an audit?
A. A test that combines two financial periods
B. A test of both controls and substantive procedures
C. A test performed by two auditors
D. A test used for fraud detection only
Correct Answer: B
Explanation: A dual-purpose test combines tests of controls and substantive tests. For example, examining an invoice to evaluate whether controls were followed while also verifying the amount supports a transaction on the financial statements.
✅ 69. (REG) Which of the following is true about the alternative minimum tax (AMT)?
A. It applies only to corporations
B. It’s calculated after regular tax
C. It can be avoided with deductions
D. It’s based on net operating loss
Correct Answer: B
Explanation: The AMT is a parallel tax system designed to ensure high-income earners pay a minimum amount of tax. It’s calculated after regular tax using a broader tax base that eliminates certain preferences and deductions.
✅ 70. (FAR) What is the main purpose of a contra asset account like Accumulated Depreciation?
A. Increase net income
B. Offset liabilities
C. Track future expenses
D. Reduce the carrying value of an asset
Correct Answer: D
Explanation: Contra asset accounts, such as Accumulated Depreciation, are used to reduce the book value of related assets on the balance sheet, providing a more accurate representation of net asset value.
✅ 71. (BEC) Which of the following best describes a company’s value chain?
The chain of shareholders
B. The process of issuing stock
C. The set of activities that add value to a product
D. The net profit after taxes
Correct Answer: C
Explanation: A value chain consists of all activities involved in producing, marketing, and delivering a product or service. It includes everything from inbound logistics to after-sales service, focusing on customer value creation.
✅ 72. (AUD) Which assertion relates to whether recorded transactions actually occurred?
Completeness
B. Accuracy
C. Occurrence
D. Classification
Correct Answer: C
Explanation: The occurrence assertion focuses on whether transactions recorded actually took place and pertain to the entity. It’s tested by vouching transactions from accounting records to source documents.
✅ 73. (REG) What is the deadline to file an individual income tax return for a calendar-year taxpayer (without extension)?
March 15
B. April 15
C. May 15
D. June 30
Correct Answer: B
Explanation: The standard due date for individual tax returns (Form 1040) for calendar-year taxpayers is April 15. If it falls on a weekend or holiday, the deadline moves to the next business day.
✅ 74. (FAR) What is comprehensive income under U.S. GAAP?
Net income plus taxes
B. Net income minus dividends
C. Net income plus other comprehensive income
D. Revenue minus cost of goods sold
Correct Answer: C
Explanation: Comprehensive income includes net income and other comprehensive income (OCI), such as unrealized gains/losses on certain securities, foreign currency translation, and pension adjustments. It’s reported in the Statement of Comprehensive Income.
✅ 75. (BEC) What is the main benefit of decentralization in an organization?
Lower payroll costs
B. Tighter control by upper management
C. Faster decision-making at local levels
D. Elimination of duplication
Correct Answer: C
Explanation: Decentralization allows local managers to make decisions, leading to faster responses to local conditions, increased motivation, and better use of expertise. However, it can result in duplication of efforts and less uniformity.
✅ 76. (AUD) What is the risk that the auditor fails to detect a material misstatement?
Control risk
B. Inherent risk
C. Detection risk
D. Audit risk
Correct Answer: C
Explanation: Detection risk is the risk that audit procedures fail to detect a material misstatement. It’s the only risk component the auditor can control directly by adjusting the nature, timing, and extent of procedures.
✅ 77. (REG) What type of income is generally subject to self-employment tax?
Wages
B. Dividends
C. Partnership income
D. Taxable interest
Correct Answer: C
Explanation: Partnership income allocated to general partners (and to some extent LLC members) is typically subject to self-employment tax, as they are considered to be actively involved in the trade or business.
✅ 78. (FAR) Which lease type requires lessee capitalization under U.S. GAAP?
Operating lease
B. Capital lease
C. Short-term lease
D. Rental agreement
Correct Answer: B
Explanation: A capital lease (now referred to as a finance lease under ASC 842) is capitalized on the balance sheet if it meets any one of five criteria, such as ownership transfer or a bargain purchase option.
✅ 79. (BEC) What is the main goal of enterprise risk management (ERM)?
To avoid legal penalties
B. To eliminate all risk
C. To manage risk in alignment with strategy
D. To increase insurance coverage
Correct Answer: C
Explanation: ERM helps an organization identify, assess, and manage risk in a way that aligns with its strategic objectives, not just eliminate risk. It improves decision-making and protects value.
✅ 80. (AUD) What is materiality in auditing?
The total cost of audit procedures
B. The degree of accuracy in financial modeling
C. The significance of an omission or misstatement
D. The dollar amount of all journal entries
Correct Answer: C
Explanation: Materiality refers to the importance of a financial statement item. An item is material if its omission or misstatement could influence the economic decisions of users based on the financial statements.
✅ 81. (REG) What is the holding period required for long-term capital gains treatment?
6 months
B. 12 months
C. 18 months
D. 24 months
Correct Answer: B
Explanation: To qualify for long-term capital gains treatment, the asset must be held for more than 12 months. If sold before that, it’s considered short-term and taxed at ordinary income rates. Long-term capital gains typically enjoy lower tax rates.
✅ 82. (FAR) Which of the following is reported in other comprehensive income (OCI)?
Depreciation expense
B. Foreign currency translation adjustments
C. Dividends paid
D. Gain on sale of inventory
Correct Answer: B
Explanation: OCI includes items that are not part of net income but affect equity, such as foreign currency translation adjustments, certain pension adjustments, and unrealized gains/losses on available-for-sale securities.
✅ 83. (AUD) What is the primary purpose of a management representation letter?
Reduce audit risk
B. Provide written assertions from management
C. Confirm legal contingencies
D. Identify fraud
Correct Answer: B
Explanation: The management representation letter documents written assertions made by management regarding their responsibility for the financial statements and disclosures. It confirms oral statements made during the audit.
✅ 84. (BEC) Which cost is considered a variable cost?
Factory rent
B. Supervisor salary
C. Direct materials
D. Depreciation
Correct Answer: C
Explanation: Direct materials are a variable cost because they increase in direct proportion to production volume. The more units produced, the more materials needed. Fixed costs like rent and salaries remain unchanged in the short term.
✅ 85. (REG) Which of the following can trigger the kiddie tax?
Child’s earned wages
B. Child’s capital gain distributions
C. Child’s interest on student loans
D. Child’s employment income over $5,000
Correct Answer: B
Explanation: The kiddie tax applies to unearned income, such as capital gains, interest, and dividends, earned by children under age 19 (or under 24 if a full-time student). Earned income (like wages) is not subject to kiddie tax rules.
✅ 86. (FAR) How should a gain from discontinued operations be presented on the income statement?
Before income from continuing operations
B. Net of tax, after continuing operations
C. As a change in accounting principle
D. As other comprehensive income
Correct Answer: B
Explanation: Gains or losses from discontinued operations are presented net of tax, after income from continuing operations, in a separate section of the income statement. This enhances comparability and clarity.
✅ 87. (AUD) What does the term “reasonable assurance” mean in auditing?
Absolute assurance of fraud detection
B. High level of certainty that statements are free of material misstatement
C. No responsibility for audit results
D. Guaranteed compliance with tax laws
Correct Answer: B
Explanation: Reasonable assurance means that auditors have obtained sufficient appropriate evidence to conclude that financial statements are free of material misstatement, though not guaranteed to detect all errors or fraud.
✅ 88. (BEC) What is meant by “operating leverage”?
Ability to issue more shares
B. Degree to which a firm uses variable costs
C. Degree to which fixed costs magnify profit
D. Flexibility in adjusting prices
Correct Answer: C
Explanation: Operating leverage reflects how a company’s fixed costs amplify changes in revenue. High fixed costs mean that small revenue increases can lead to larger profit increases. However, it also increases risk during downturns.
✅ 89. (REG) Which of the following can be deducted as a business expense?
Political contributions
B. Penalties paid to the IRS
C. Ordinary and necessary advertising
D. Personal vacation expenses
Correct Answer: C
Explanation: Only ordinary and necessary business expenses are deductible. Advertising costs meet this test. Political contributions, penalties, and personal costs are not deductible under IRS rules.
✅ 90. (FAR) Which financial statement would show a company’s liquidity position?
Income statement
B. Balance sheet
C. Statement of cash flows
D. Statement of changes in equity
Correct Answer: B
Explanation: The balance sheet provides a snapshot of a company’s financial position, showing current assets and liabilities, which reflect liquidity. Liquidity is the ability to meet short-term obligations as they come due.
✅ 91. (AUD) What is the primary responsibility of the auditor?
Detect all employee fraud
B. Prepare financial statements
C. Provide an opinion on financial statements
D. File tax returns
Correct Answer: C
Explanation: The auditor’s main responsibility is to express an opinion on whether the financial statements are presented fairly, in accordance with GAAP. Management is responsible for the preparation of the financials.
✅ 92. (BEC) What does the Sarbanes-Oxley Act require public companies to do?
Reduce dividend payments
B. Eliminate board oversight
C. Maintain internal controls over financial reporting
D. Increase tax reserves
Correct Answer: C
Explanation: The Sarbanes-Oxley Act (SOX) mandates public companies to implement and maintain internal control systems. Section 404 specifically requires management and external auditors to report on the effectiveness of those controls.
✅ 93. (REG) What form is used to report S Corporation income to shareholders?
1099-MISC
B. Form 1120
C. Form K-1
D. W-2
Correct Answer: C
Explanation: Form K-1 (Schedule K-1) is used by S Corporations to report each shareholder’s share of income, deductions, and credits. Shareholders use this information to report items on their personal returns.
✅ 94. (FAR) How is goodwill tested for impairment under U.S. GAAP?
Annually or when triggering events occur
B. Monthly
C. Only upon sale
D. When stock price falls
Correct Answer: A
Explanation: Goodwill must be tested for impairment annually, or more frequently if there are triggering events suggesting that it may be impaired. This avoids overstating asset values on the balance sheet.
✅ 95. (AUD) Which procedure is most appropriate for testing the existence of accounts receivable?
Recalculation
B. Observation
C. Confirmation
D. Analytical review
Correct Answer: C
Explanation: Confirmations are the most effective way to verify the existence of accounts receivable. Auditors send confirmation requests directly to customers to confirm balances owed as of the audit date.
✅ 96. (BEC) Which measure best reflects a firm’s profitability?
Debt-to-equity ratio
B. Gross profit margin
C. Working capital
D. Times interest earned
Correct Answer: B
Explanation: Gross profit margin measures profitability by showing the percentage of revenue remaining after cost of goods sold. It’s a key indicator of a company’s efficiency in producing goods or services.
✅ 97. (REG) Which of the following is an above-the-line deduction?
Mortgage interest
B. Student loan interest
C. Charitable contributions
D. State income taxes
Correct Answer: B
Explanation: Student loan interest is an above-the-line deduction (adjustment to income) available even to taxpayers who don’t itemize. It helps reduce AGI and is limited to a specific dollar amount annually.
✅ 98. (FAR) What is the accounting treatment for a contingency that is probable and estimable?
Disclose only
B. Accrue and disclose
C. Ignore
D. Delay until realized
Correct Answer: B
Explanation: If a contingent loss is both probable and reasonably estimable, it must be accrued in the financial statements and disclosed in the notes under GAAP. This ensures liabilities are not understated.
✅ 99. (AUD) What is control risk?
Risk of audit failure
B. Risk that controls fail to prevent misstatements
C. Risk that evidence is insufficient
D. Risk of overstatement of revenues
Correct Answer: B
Explanation: Control risk is the risk that a client’s internal controls will fail to detect or prevent material misstatements. Auditors assess this to determine the nature and extent of further audit procedures.
✅ 100. (BEC) What does breakeven point represent?
Maximum revenue
B. Sales where profit is highest
C. Point at which total revenue equals total costs
D. Inventory turnover level
Correct Answer: C
Explanation: The breakeven point is when a company’s total revenue equals total fixed and variable costs, resulting in zero profit or loss. It is a critical metric in cost-volume-profit analysis.
✅ 101. (REG) Which of the following is a deductible itemized deduction?
- Personal clothing expenses
B. Life insurance premiums
C. Home mortgage interest
D. Commuting expenses
Correct Answer: C
Explanation: Home mortgage interest on loans secured by a qualified residence is deductible as an itemized deduction, subject to IRS limits. Personal and commuting expenses are not deductible, and life insurance premiums are considered personal expenses.
✅ 102. (FAR) Which basis of accounting is used by not-for-profit organizations under GAAP?
- Cash basis
B. Modified accrual basis
C. Full accrual basis
D. Tax basis
Correct Answer: C
Explanation: Not-for-profit entities must use the full accrual basis of accounting under U.S. GAAP, meaning revenues are recognized when earned and expenses when incurred, regardless of cash flow. This ensures consistency and transparency in reporting.
✅ 103. (AUD) Which audit procedure is most effective for detecting lapping?
- Bank confirmation
B. Observation
C. Comparison of AR ledger with customer receipts
D. Review of board minutes
Correct Answer: C
Explanation: Lapping involves applying one customer’s payment to another’s account. Comparing the accounts receivable ledger with customer payment records can reveal this type of fraud by identifying mismatches in timing and amounts.
✅ 104. (BEC) What is the formula for return on equity (ROE)?
- Net income / Total assets
B. Net income / Shareholders’ equity
C. Revenue / Total assets
D. EBIT / Shareholders’ equity
Correct Answer: B
Explanation: Return on equity (ROE) measures a firm’s profitability relative to shareholders’ equity and is calculated as Net Income ÷ Shareholders’ Equity. It reflects how efficiently a company uses owners’ funds to generate profits.
✅ 105. (REG) Which type of entity reports income on Schedule C of Form 1040?
- Partnership
B. Sole proprietorship
C. S corporation
D. C corporation
Correct Answer: B
Explanation: A sole proprietorship reports business income and expenses on Schedule C of the individual Form 1040. Partnerships and S corporations file their own returns, while C corporations file Form 1120.
✅ 106. (FAR) Which of the following must be depreciated under MACRS for tax purposes?
- Land
B. Residential rental property
C. Inventory
D. Goodwill
Correct Answer: B
Explanation: Under MACRS (Modified Accelerated Cost Recovery System), residential rental property is depreciable. Land is not depreciated, and inventory and goodwill are treated differently—inventory is expensed when sold, goodwill is amortized or tested for impairment.
✅ 107. (AUD) What is inherent risk?
- Risk due to weak internal controls
B. Risk that financials contain misstatements before considering controls
C. Risk of audit failure
D. Risk that auditor will issue the wrong opinion
Correct Answer: B
Explanation: Inherent risk is the risk that a material misstatement exists independent of internal controls. It stems from the nature or complexity of transactions or the business itself, and it is assessed by the auditor during planning.
✅ 108. (BEC) What is the effect of increased interest rates on bond prices?
- Bond prices rise
B. Bond prices fall
C. No effect
D. Bond prices become fixed
Correct Answer: B
Explanation: As interest rates increase, the market value of existing bonds falls because their fixed coupon payments become less attractive compared to new bonds issued at higher rates. There is an inverse relationship between interest rates and bond prices.
✅ 109. (REG) What is the tax treatment of alimony for divorces finalized after 2018?
- Deductible to payer, taxable to recipient
B. Non-deductible to payer, tax-free to recipient
C. Always deductible
D. Deductible only if court-ordered
Correct Answer: B
Explanation: Under the Tax Cuts and Jobs Act, for divorces finalized after 2018, alimony is not deductible by the payer and not taxable to the recipient. This reverses the previous rule and affects divorce agreements signed after that date.
✅ 110. (FAR) A lease with a transfer of ownership at the end is classified as:
- Operating lease
B. Sales-type lease
C. Direct financing lease
D. Service lease
Correct Answer: B
Explanation: Under ASC 842, if a lease transfers ownership to the lessee by the end of the term, it qualifies as a sales-type lease. This classification recognizes revenue and removes the asset from the lessor’s books at inception.
✅ 111. (AUD) What is dual dating in an audit report?
- Listing two auditors
B. Dating for audit and tax return
C. Dating for original and subsequent event
D. Issuing two reports
Correct Answer: C
Explanation: Dual dating refers to dating the auditor’s report as of the original completion date and a later date for a subsequent event. This limits auditor responsibility to the specific event identified without reopening the entire audit.
✅ 112. (BEC) Which cost behavior changes per unit with volume?
- Fixed cost
B. Mixed cost
C. Variable cost
D. Step cost
Correct Answer: A
Explanation: While fixed costs remain constant in total, their per-unit cost decreases as production volume increases. This is because the same cost is spread over more units, reducing the cost per unit.
✅ 113. (REG) What is the penalty for failure to file a tax return?
- 0.5% per month
B. 1% per day
C. 5% per month
D. 10% flat
Correct Answer: C
Explanation: The failure-to-file penalty is 5% per month, up to a maximum of 25% of the unpaid tax. This is generally more severe than the failure-to-pay penalty, which is 0.5% per month.
✅ 114. (FAR) What does the statement of cash flows show under the indirect method?
- Cash received and paid
B. Net income adjusted for non-cash items
C. Cash equivalents only
D. Sales and purchases
Correct Answer: B
Explanation: The indirect method starts with net income and adjusts for non-cash items (like depreciation and changes in working capital) to arrive at net cash from operating activities. It’s the most commonly used method under GAAP.
✅ 115. (AUD) What is a Type I subsequent event?
- An event that occurred after the balance sheet date but relates to conditions at that date
B. An event affecting future operations
C. A non-reportable event
D. A new legal proceeding unrelated to the audit period
Correct Answer: A
Explanation: A Type I subsequent event provides additional evidence about conditions that existed as of the balance sheet date, such as settlement of litigation. These events require adjustment to the financial statements.
