Passing the CPA exam requires hundreds of hours of study time and the ability to digest and retain an incredibly large amount of information. Many students struggle with key concepts found on the exam, regardless of how long they study. Consequently, understanding these difficult concepts will absolutely help you improve your CPA exam score.
Review these 15 types of CPA exam questions to improve your test results. You may be surprised by what you don’t know!
Accrual Journal Entries
Accrual accounting requires CPAs to use the matching principle, which states that revenue should be posted when earned and that expenses are booked when incurred to generate revenue. Some exam candidates may be confused by accrual journal entries, so here’s a brief rundown:
The goal of an accrual journal entry is to get the revenue or expense posted to the correct period (month or year). Furthermore, an accrual entry requires one income statement account and one balance sheet account. Consider the following:
Assume that a firm owes $1,000 in wages to employees on 12/31 and that payroll is paid to workers on January 5th of the following year. Here are the journal entries:
- (Dec. 31st) Debt accrued payroll $1,000, credit wages payable $1,000: This entry is used to post payroll in the period when the wages are earned. Accrued payroll is an expense account, and wages payable is a liability account. This accrual entry posts the expense in the correct year.
- (Jan. 5th) Debit wages payable $1,000, credit cash $1,000: This entry removes the liability balance for wages payable and reduces cash for the payment.
If you are working on an accrual accounting journal entry, keep this concept in mind.
This is what you need to know about audit evidence as it relates to CPA exam questions:
Evidence from a third party is always more valuable than documentation provided by the company under audit. An independent third party, such as a customer or a vendor, does not have a direct financial stake in the outcome of the audit.
When auditing accounts receivable, for example, an auditor will send confirmations to customers to verify that funds are owed. Third party evidence is the best way to confirm that a sale was actually made.
CPA exam section: AUD
An audit opinion is frequently misunderstood, and it’s important to know what the auditor’s opinion covers. The opinion states whether or not the financial statements are free of material misstatement; the term ‘material’ refers to a dollar amount that is large enough to influence a financial statement reader.
Confused? Here’s an example:
If an auditor noted that a $500,000 correction was needed to the $20 million inventory balance, the $500,000 is material. A $20 exception is not material, because it would not change the financial statement reader’s view of a $20 million balance.
Materiality is a key consideration for an audit. Got it?
Deferred tax is one of the most difficult concepts on the CPA exam. Consequently, you need to think carefully about these questions. Deferred taxes can arise when the accounting treatment of a transaction is different from the treatment for tax purposes; the difference may be temporary or permanent.
One common difference is a temporary difference in depreciation. In many cases, depreciation for tax purposes may be different from the method used in the accounting records.
Furthermore, if the tax method generates higher depreciation expense in year one, net income will be lower on the year one tax return. In later years, depreciation expense will be lower, and net income will be higher on the tax return.
This scenario creates a deferred tax liability, because net income (and the tax liability) will be higher in future years. A deferred tax asset, on the other hand, means that the firm will have lower net income (and a lower tax liability) in future years.
If you can keep all of this straight in your head, you’ll be sure to do well on CPA exam questions that approach this difficult concept!
CPA exam section: FAR
The CPA exam covers several depreciation methods. This includes both the straight-line method and accelerated methods, such as double declining balance (DDB). However, the total depreciation is the same regardless of the method selected. Let’s go into greater detail with an example:
Say your business owns a $30,000 truck and the vehicle does not have any salvage value. Each depreciation method will post a total depreciation expense of $30,000. The difference between the methods is in the timing of the expense. As an example, the DDB method will post more expense in the early years and less in later years, while the straight line method records the same dollar amount of expense each year.
CPA exam section: FAR
Accounting, much like many other things in life, requires judgments, with some transactions posted using an estimate. One good example is estimating the dollar amount of bad debt expense based on the accounts receivable balance and the percentage of bad debt expense in recent years. Yes, using estimates is a common practice in accounting, so it makes sense that they would play a major part of many CPA exam questions.
Fixed Costs Per Unit vs. Total Fixed Costs
CPA exam section: FAR
This is a cost accounting concept that is unclear to many exam candidates. To clarify this issue, remember that fixed cost per unit can present a distorted picture of the true cost of a product or service.
Check out this example:
Assume that a manufacturer pays $60,000 a year for repair and maintenance costs on machines. The cost is fixed by contract. The company produced 3,000 units during the year and allocated $20 of fixed costs to each order.
The firm receives a special order to manufacture 100 units during the last week of the year, and the owner needs to determine the cost per unit for the special order.
No fixed costs should be included in the special order quote, because the $60,000 has already been allocated to the 3,000 units produced to date. If the owner allocates $20 per unit for special order fixed costs, the total cost per unit is overstated. Generally, a CPA should consider total fixed costs, and not fixed costs per unit.
Income Tax, Estate Tax, and Gift Tax
CPA exam section: REG
There’s a basic concept that can really help you answer tax-related CPA exam questions, and it’s rarely explained well in textbooks. Income tax is imposed on income earned by individuals and corporations, and the tax is paid based on current income tax tables. Everyone has a basic understanding of income taxes, because we all file personal income tax returns.
The CPA exam, however, covers two other forms of tax that are assessed differently. An individual may need to assess estate tax, which is based on the dollar amount of a person’s estate when they pass away. The estate tax uses a different set of tax tables. Furthermore, if you give monetary gifts to other people, you may be subject to the gift tax, which uses a third set of tax tables.
Many exam candidates don’t understand that each tax assesses a tax liability differently, and that the tax tables are different. Therefore, you should definitely brush up on these concepts!
For more on income tax, gift tax, and estate tax, check out our article on Donald Trump’s tax fraud allegations.
CPA exam section: FAR
Consolidation questions are a difficult topic on the exam. What’s worse is that many exam candidates are not familiar with the consolidation process. Every consolidation requires the elimination of intercompany transactions; consequently, understanding this concept will help you answer consolidation questions.
An intercompany transaction is made between a parent company and a subsidiary, or sub. The transaction may be for the sale of goods, or to record the sale of an asset such as equipment. Intercompany transactions are eliminated in consolidation, because the consolidated financial statements only include transactions with third parties.
Inventory Valuation Methods
CPA exam section: FAR
Inventory can be valued using several methods. Hence, applying these methods to CPA exam questions can be confusing. However, the total cost of inventory, along with the total units purchased and sold, is the same, regardless of the inventory valuation method used.
Assume, for example, that a sporting goods store purchases 1,000 baseball gloves between the 1st and the 20th of the month at a total cost of $80,000. The store sells 200 gloves before the month’s end.
The first-in, first out (FIFO) method assumes that the oldest units are sold first, while the last-in, first out (LIFO) method assumes that the newest units are sold first. Both methods assign a cost to 200 gloves sold. Once the store sells all 1,000 gloves, the total cost of sales must be $80,000. The only difference is in the timing of the cost.
FIFO assumes that the older (usually cheaper) items are sold first, and the more expensive gloves are sold later. LIFO, on the other hand, assumes that the newer, more expensive units are sold first. In total, however, the cost of sales must be $80,000.
Understanding these methods should help you to avoid being confused when they show up in your CPA exam questions.
CPA exam section: AUD
Here’s something you’ll definitely want to know since it will be on the test.
Subsequent events occur after the balance sheet date (the date used to produce the financial statements), but before the financial statements are issued. A type 1 event existed at the balance sheet date, while a type 2 event did not exist at the balance sheet date. Type 1 events must be recognized in the financial statements, and type 2 events do not have to be disclosed.
One common subsequent event is settling a lawsuit. If the legal issue existed before the balance sheet date (typically 12/31), the settlement will require some form of disclosure. On the other hand, if the lawsuit did not exist before 12/31, the legal settlement will not be disclosed in the financial statements.
Accounts receivable and inventory are two assets that may tie up a large amount of a firm’s available cash. If you sell to clients on credit, you generate accounts receivable, and you must spend money on inventory to fill orders.
Many CPA candidates view accounts receivable turnover and inventory turnover as the two important ratios that they simply need to memorize. Remember: a business must collect cash as quickly as possible. Consequently, turnover ratios measure how quickly a business collects accounts receivable and how fast the company sells inventory.
If a firm can generate high turnover ratios, the business can operate with less cash on hand.
Invest the Time
These concepts are tested on every CPA exam, so it’s highly recommended that you invest the time to understand these topics. If you’re clear on them, you will improve your test scores and pass the CPA exam faster!