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Financial Accounting Principles Exam Review

A practice exam with questions from all 4 units, then the key facts from every lesson, unit by unit. For a deeper look at one unit, open its test review.

Unit test reviews

  1. Unit 1. The Accounting Cycle~20%
  2. Unit 2. Accounting for Assets~30%
  3. Unit 3. Partnerships and Corporations~25%
  4. Unit 4. Financial Analysis and Decision Making~25%

Practice exam

32 questions, the same number from each unit. Each one shows the lesson it comes from.

  1. Unit 1: GAAP Principles in Practice
    1
    Land cost $400,000. It is now appraised at $650,000. Under ASPE, the balance sheet reports:
  2. Unit 1: GAAP Principles in Practice
    2
    A company switches amortization methods every year, always to whichever gives the highest profit. Which characteristic is damaged most directly?
  3. Unit 1: Who Sets and Enforces the Rules
    3
    A private corporation that plans to list its shares on a stock exchange in a few years should consider:
  4. Unit 1: The Accounting Cycle in a Computerized System
    4
    Periodic system: beginning inventory $12,000; purchases $58,000; purchases returns $1,500; purchases discounts $900; freight-in $1,400; ending inventory $14,000. Calculate COGS to the nearest dollar.
    $
  5. Unit 1: Adjusting Entries and the Matching Principle
    5
    Accrued wages of $2,250 are not recorded at year end. The effect is:
  6. Unit 1: Closing and Reversing Entries
    6
    Which account is closed at the end of the period?
  7. Unit 1: Ethics, Fraud and Current Issues
    7
    Match each fraud triangle element to an example.
    Pressure
    Opportunity
    Rationalization
  8. Unit 1: Ethics, Fraud and Current Issues
    8
    An $80,000 sale with a $50,000 cost is recorded in December, but the goods ship on January 3. By how much is December's net income overstated? Answer to the nearest dollar.
    $
  9. Unit 2: Credit Terms, Card Sales and Receivables
    9
    An invoice dated June 2 shows goods of $4,500 plus 13% HST, terms 2/10, n/30. The customer pays on June 11. How much cash does the seller receive? Answer to the nearest cent.
    $
  10. Unit 2: Estimating Bad Debts: The Allowance Method
    10
    Which method best follows the matching idea?
  11. Unit 2: Notes Receivable and Interest
    11
    A customer's overdue $3,000 account is converted to a 60-day note. What is the entry?
  12. Unit 2: Inventory Costing Methods
    12
    Which accounting principle says a business should use the same inventory cost formula from one period to the next?
  13. Unit 2: Capital Expenditures and the Cost of Capital Assets
    13
    Which of these is a capital expenditure?
  14. Unit 2: Amortization Methods
    14
    Under declining-balance at 40%, an asset with a $6,000 residual value begins its final year with a book value of $7,776. What is that year's amortization?
  15. Unit 2: Revisions, Disposals and Depletion
    15
    A fully amortized computer (cost $9,600, no residual value) is thrown away. What is the entry?
  16. Unit 2: Intangible Assets and Goodwill
    16
    Put the steps for recording the purchase of a business in order.
    1. 1Check that total debits equal total credits
    2. 2Debit the assets and Goodwill, credit the liabilities and Cash
    3. 3Subtract the net identifiable assets from the purchase price to find goodwill
    4. 4Find the fair value of each identifiable asset acquired
    5. 5Subtract the fair value of the liabilities assumed
  17. Unit 3: Partnerships: Types and Formation
    17
    Without asking his partner, a partner in a catering business signs a $7,000 contract to rent a commercial kitchen. The partnership is bound by the contract because of:
  18. Unit 3: Dividing Partnership Income
    18
    Same agreement as the previous question (salaries $20,000 and $15,000; 5% interest on $40,000 and $20,000; remainder equally), but net income is only $30,000. What is B's total share? Answer to the nearest dollar.
    $
  19. Unit 3: Admitting and Withdrawing Partners
    19
    A, B and C have capital balances of $40,000, $40,000 and $20,000 and share income 2:2:1. C retires and is paid $26,000 from partnership cash. What is A's capital balance afterwards? Answer to the nearest dollar.
    $
  20. Unit 3: Liquidation and the Statement of Partners' Equity
    20
    What is the name for a debit balance in a partner's capital account during liquidation?
  21. Unit 3: Issuing, Subscribing and Repurchasing Shares
    21
    A CBCA corporation issues 10,000 common shares for $18 cash each. Which entry is correct?
  22. Unit 3: Cash Dividends and Preferred Shareholders
    22
    Put the dividend dates in the order they occur.
    1. 1Date of record
    2. 2Date of declaration
    3. 3Date of payment
  23. Unit 3: Stock Dividends, Stock Splits and Shareholders' Equity
    23
    Between declaring and distributing a stock dividend, a corporation prepares a balance sheet. Where does Common Stock Dividends Distributable appear?
  24. Unit 3: Financial Statements for a Corporation
    24
    Which line appears on a corporation's income statement but not on a sole proprietorship's?
  25. Unit 4: Financing a Business: Debt versus Equity
    25
    A company issues $300,000 of 8% bonds at face value with interest paid semi-annually. How much cash is paid at each interest date? Answer to the nearest dollar.
    $
  26. Unit 4: Financing a Business: Debt versus Equity
    26
    A company borrows at 8% and pays income tax at 25%. What is its after-tax cost of borrowing? Answer as a percent to one decimal place.
    %
  27. Unit 4: Reading an Annual Report
    27
    Which pair of companies is the most meaningful to compare using annual reports?
  28. Unit 4: Horizontal and Vertical Analysis
    28
    Sales increased 8% while cost of goods sold increased 12%. What happened to the gross profit margin?
  29. Unit 4: Liquidity, Efficiency and Solvency Ratios
    29
    Cost of goods sold is $396,000. Inventory was $80,000 at the start of the year and $100,000 at the end. What is the inventory turnover? Answer to two decimal places.
    times
  30. Unit 4: Profitability and Market Ratios
    30
    Net income is $180,000, preferred dividends are $30,000 and the weighted average number of common shares is 60,000. What is EPS? Answer to the nearest cent.
    $
  31. Unit 4: The Cash Flow Statement
    31
    Net income is $48,000; amortization is $12,000; accounts receivable increased $6,000; accounts payable increased $4,000. What is cash provided by operating activities? Answer to the nearest dollar.
    $
  32. Unit 4: The Cash Flow Statement
    32
    In a spreadsheet, you want every common-size income statement formula in column D to divide by net sales in cell B5. Which reference should the formulas use for B5?

Key facts by unit

Unit 1: The Accounting Cycle

GAAP Principles in Practice

  • Objective of financial reporting: information useful to investors, lenders and creditors deciding whether to provide resources.
  • Fundamental qualities: relevance and faithful representation (complete, neutral, free from error). Enhancing: comparability, understandability, verifiability, timeliness.
  • Assumptions: going concern, business entity, monetary unit, time period.
  • Matching drives adjusting entries; cost drives asset valuation at historical cost; revenue recognition drives Unearned and Accrued Revenue.
  • Conservatism (prudence) means caution under uncertainty, e.g. inventory at the lower of cost and net realizable value, never deliberate understatement.

Who Sets and Enforces the Rules

  • CPA Canada formed in 2013 (CICA plus CMA Canada); CGA-Canada joined in 2014. CPA Ontario regulates the profession in Ontario.
  • The AcSB sets Canadian standards: ASPE for private enterprises; IFRS (written by the IASB) for publicly accountable enterprises since 2011.
  • ASPE says amortization for capital assets; IFRS says depreciation (and amortization for intangibles).
  • The OSC enforces public-company disclosure in Ontario; the CRA administers income tax and HST; auditors give an independent opinion on fair presentation.
  • Tax rules (CCA) can differ from accounting rules (amortization), so book income and taxable income can legitimately differ.

The Accounting Cycle in a Computerized System

  • Cycle: analyze, journalize, post, unadjusted trial balance, adjust, adjusted trial balance, statements, close, post-closing trial balance, (reverse).
  • Software automates posting, the trial balance and statement preparation; the accountant analyzes transactions, records adjustments and estimates, and reviews.
  • Perpetual sale = two entries: Dr A/R, Cr Sales, Cr HST Payable; and Dr COGS, Cr Merchandise Inventory.
  • Net Sales = Sales - Sales Returns and Allowances - Sales Discounts; Gross Profit = Net Sales - COGS.
  • Periodic COGS = Beginning Inventory + Purchases - Purchases Returns and Allowances - Purchases Discounts + Freight-in - Ending Inventory.
  • HST on an Ontario sale: 13% of the selling price, credited to HST Payable.

Adjusting Entries and the Matching Principle

  • Every adjusting entry pairs one income statement account with one balance sheet account, and never involves Cash.
  • Prepaid: Dr Expense, Cr Prepaid asset. Unearned: Dr Unearned Revenue, Cr Revenue.
  • Accrued revenue: Dr Receivable, Cr Revenue. Accrued expense: Dr Expense, Cr Payable.
  • Interest , with in years (months divided by 12).
  • Straight-line amortization = (cost - residual value) / useful life; declining-balance = rate x net book value. Credit Accumulated Amortization (ASPE term; IFRS says depreciation).

Closing and Reversing Entries

  • Temporary accounts (revenue, contra-revenue, expenses including COGS, drawings) are closed; permanent accounts (assets, liabilities, capital) carry forward.
  • Closing order: revenue to Income Summary; expenses to Income Summary; Income Summary (net income) to Capital; Drawings to Capital.
  • Ending capital = beginning capital + net income - drawings.
  • The post-closing trial balance lists only permanent accounts.
  • Reversing entries are optional, dated the first day of the new period, and used mainly for accruals (and for prepayments first recorded in an expense or revenue account); final balances are the same either way.

Ethics, Fraud and Current Issues

  • Fraud triangle: pressure (incentive), opportunity, rationalization. Internal controls mainly reduce opportunity.
  • Key controls: segregation of duties, authorization, safeguards, independent checks, documentation, mandatory vacations.
  • Common manipulation: early revenue recognition, capitalizing expenses, skipping accruals, cookie-jar reserves, convenient estimate changes, off-balance-sheet debt.
  • Enron hid debt off the balance sheet; WorldCom capitalized operating costs; both led to stronger certification and auditor oversight rules.
  • IFRS is used in well over 100 jurisdictions; Canada adopted it for public companies in 2011; the US uses US GAAP.
  • Technology automates recording and enables full-population analytics, but professional judgement and accountability stay with people.
Unit 2: Accounting for Assets

Credit Terms, Card Sales and Receivables

  • Terms 2/10, n/30: a 2% discount if paid within 10 days of the invoice date; otherwise the full amount is due in 30 days. The discount is calculated on the goods, not the HST.
  • Early payment: debit Cash and Sales Discounts, credit Accounts Receivable for the full invoice. Sales Discounts is a contra-revenue account.
  • Credit card sale: debit Cash (net) and Credit Card Expense (fee), credit Sales and HST Payable. It is not a receivable.
  • Debit card sale: debit Cash (net) and Bank Charges (fee), credit Sales and HST Payable.
  • HST Payable is always 13% of the selling price, whatever fee the processor charges.
  • The total of the accounts receivable subsidiary ledger must equal the Accounts Receivable control account.

Estimating Bad Debts: The Allowance Method

  • Year-end estimate: debit Bad Debts Expense, credit Allowance for Doubtful Accounts (a contra-asset with a normal credit balance).
  • Percentage of sales: expense = rate × credit sales. Ignore the existing allowance balance.
  • Aging or percentage of receivables: the estimate is the TARGET allowance balance. Adjustment = target − existing credit balance, or target + existing debit balance.
  • Write-off: debit Allowance, credit Accounts Receivable. No expense, and NRV does not change.
  • Recovery: reinstate (debit A/R, credit Allowance), then collect (debit Cash, credit A/R).
  • Net realizable value = Accounts Receivable − Allowance for Doubtful Accounts.

Notes Receivable and Interest

  • Interest = Principal × Rate × Days/365. The rate is always annual.
  • Maturity value = Principal + Interest for the full term.
  • To find the maturity date, skip the issue day, count the maturity day, and work month by month.
  • Converting an account: debit Notes Receivable, credit Accounts Receivable. No revenue.
  • Year-end accrual: debit Interest Receivable, credit Interest Revenue for the days held so far.
  • Dishonoured note: debit Accounts Receivable for the full maturity value; credit Notes Receivable, Interest Receivable and Interest Revenue.

Inventory Costing Methods

  • Cost of goods available for sale = Beginning inventory + Purchases = Cost of goods sold + Ending inventory.
  • FIFO: oldest costs go to cost of goods sold; ending inventory is at the newest costs. Perpetual and periodic FIFO always agree.
  • Weighted average (periodic) = total cost available ÷ total units available. Moving average (perpetual) recomputes after each purchase.
  • LIFO (newest costs out first) is NOT permitted under IFRS or ASPE. Canadian companies use specific identification, FIFO or weighted average.
  • Rising costs: FIFO gives the lowest COGS and highest net income and ending inventory. Falling costs: the reverse.
  • Lower of cost and NRV: write inventory down to selling price minus selling costs when that is below cost; apply the method consistently.

Inventory Errors, Technology and Internal Control

  • COGS = Beginning inventory + Purchases − Ending inventory, so an ending inventory error moves COGS the opposite way.
  • Ending inventory overstated: COGS understated, net income overstated, assets and equity overstated this year.
  • Next year the error reverses through beginning inventory; two-year total net income and the year-2 balance sheet are correct (self-correcting).
  • Reorder point = daily usage × lead time + safety stock. Shrinkage = perpetual record − physical count.
  • Key internal controls: separation of duties, authorization, prenumbered documents and a paper trail, physical counts, physical safeguards.

Capital Expenditures and the Cost of Capital Assets

  • Capital expenditure: benefits more than one period (new asset, longer life, more capacity or efficiency), so debit an asset. Revenue expenditure: benefits only this period, so debit an expense.
  • The matching principle is the reason: a long-lived asset's cost is expensed over the periods it helps earn revenue.
  • Cost of a capital asset = all costs necessary to acquire it and get it ready for its intended use (price, freight, transit insurance, installation, testing, legal fees, site preparation).
  • Land is not amortized; land improvements (paving, fencing, lighting) are a separate, amortized asset. Demolition of an old building on purchased land is part of Land.
  • Basket purchase: cost of each asset
  • Recoverable HST paid by a registrant is an input tax credit, not part of the asset's cost.

Amortization Methods

  • Depreciable amount ; Book value
  • Straight-line: every year.
  • Declining-balance: ; residual is ignored until the final charge, which stops book value exactly at residual.
  • Units-of-output:
  • Partial year: full-year amount , to the nearest month (on or before the 15th counts the month).
  • Entry for every method: debit Amortization Expense, credit Accumulated Amortization (a contra asset).

Revisions, Disposals and Depletion

  • Revised amortization earlier years are never restated.
  • Disposal step 1: record amortization up to the disposal date (nearest month).
  • Disposal step 2: debit Accumulated Amortization (full balance), credit the asset (full cost).
  • Gain if proceeds > book value (credit); loss if proceeds < book value (debit).
  • Exchange: new asset cost = fair value of old asset given up + cash paid.
  • Depletion per unit depletion for the year = rate × units extracted.

Intangible Assets and Goodwill

  • Intangible assets have no physical form but give legal or contractual rights; purchased ones are recorded at cost (price plus legal and registration fees).
  • Finite-life intangibles: straight-line, no residual, over the shorter of remaining legal life and useful life. This course credits Accumulated Amortization.
  • Indefinite-life intangibles and goodwill are not amortized; they are tested for impairment.
  • Goodwill recorded only when a business is purchased.
  • Internally generated goodwill is never recorded; research costs are always expensed.
Unit 3: Partnerships and Corporations

Partnerships: Types and Formation

  • Key characteristics of a partnership: association of individuals, mutual agency, unlimited liability (general partners), limited life, co-ownership of property, and a partnership agreement.
  • A limited partnership needs at least one general partner (manages, unlimited liability); limited partners' liability is limited to their investment and they generally cannot take part in management.
  • Non-cash assets invested by a partner are recorded at fair value on the date of investment; liabilities assumed are credited to the liability account.
  • Partner's capital credit = fair value of assets invested minus liabilities assumed by the partnership.
  • Each partner has a separate capital account and a separate drawings account.

Dividing Partnership Income

  • Divide income in this order: (1) salary allowances, (2) interest on capital, (3) remainder in the income ratio.
  • Salary allowances and interest are given in full even if they exceed net income; the resulting deficit is shared in the income ratio.
  • Salary allowances and interest on capital are not expenses and are not cash payments; cash taken by partners is debited to drawings.
  • Capital ratio share = net income × partner's capital ÷ total capital.
  • The partners' shares must total exactly the net income (or net loss) being divided.
  • Closing: Income Summary is closed to each partner's capital by share; each drawings account is closed to its own partner's capital.

Admitting and Withdrawing Partners

  • Purchase of an interest is a personal transaction: debit the selling partner's capital, credit the new partner's capital, at book value; total capital does not change.
  • Investment in the partnership increases total assets and total capital.
  • New partner's capital = (old total capital + new investment) × new partner's share; bonus = investment − new partner's capital.
  • A bonus (to old or new partners, or on withdrawal) is shared among the old or remaining partners in their income ratio.
  • Withdrawal paid from partnership assets: debit the retiring partner's capital for book value; pay more = bonus to retiring partner (debit remaining partners); pay less = bonus to remaining partners (credit them).

Liquidation and the Statement of Partners' Equity

  • Liquidation steps: (1) sell non-cash assets, (2) share the gain or loss on realization in the income ratio, (3) pay liabilities, (4) distribute remaining cash by capital balances.
  • Gain or loss on realization = cash received − book value of non-cash assets sold.
  • A capital deficiency (debit balance) is either paid in by that partner or absorbed by the other partners in their income ratio.
  • Statement of partners' equity, per partner: beginning capital + investments ± share of net income or loss − drawings = ending capital.
  • The balance sheet's equity section lists each partner's ending capital and the total partners' equity.

Corporations and Classes of Shares

  • A corporation is a separate legal entity with limited liability for shareholders, continuous life and transferable shares.
  • Public corporations trade on a stock exchange and report under IFRS; private corporations may use ASPE; not-for-profit corporations have no shareholders.
  • Shareholders elect the board of directors; the board appoints officers and is the only body that declares dividends.
  • Preferred shares have priority for dividends and on liquidation but usually no vote; cumulative preferred builds dividends in arrears.
  • Authorized is the maximum allowed; issued is what has been sold; outstanding is what shareholders still hold.
  • CBCA and OBCA shares have no par value, so the whole amount received is credited to the share account.

Issuing, Subscribing and Repurchasing Shares

  • No-par shares: debit the asset received, credit the share account (Common Shares or Preferred Shares) for the full amount.
  • Shares issued for non-cash assets are recorded at fair value, using whichever of the asset or the shares can be valued more reliably.
  • Subscriptions: Dr Subscriptions Receivable, Cr Common Shares Subscribed; collect instalments; when fully paid, Dr Common Shares Subscribed, Cr Common Shares.
  • Average issue price a repurchase removes shares at this average.
  • Pay less than average: credit Contributed Surplus. Pay more: debit Contributed Surplus (up to its balance), then Retained Earnings.
  • Repurchases never create a gain or loss on the income statement.

Cash Dividends and Preferred Shareholders

  • Declaration date: Dr Retained Earnings (or Cash Dividends), Cr Dividends Payable. The liability starts here.
  • Record date: no journal entry; it only fixes which shareholders are paid.
  • Payment date: Dr Dividends Payable, Cr Cash.
  • Preferred is paid first: non-cumulative gets only the current year; cumulative gets all arrears plus the current year.
  • Dividends in arrears are not a liability; they are disclosed in the notes until declared.
  • A dividend needs retained earnings, cash, a board declaration, and must pass the solvency test.

Stock Dividends, Stock Splits and Shareholders' Equity

  • Small stock dividend, declaration: Dr Retained Earnings (or Stock Dividends), Cr Common Stock Dividends Distributable, usually at market value.
  • Stock dividend, distribution: Dr Common Stock Dividends Distributable, Cr Common Shares.
  • Stock split and reverse split (consolidation): no journal entry, only a memorandum entry recording the new number of shares.
  • Cash dividend lowers total equity and assets; stock dividend and split leave total equity unchanged.
  • Book value per common share

Financial Statements for a Corporation

  • Corporate income statement: income before income tax minus income tax expense equals net income.
  • Closing retained earnings = opening retained earnings + net income (or − net loss) − dividends declared.
  • Equity section: share capital by class (with authorized and issued numbers), contributed surplus, then retained earnings.
  • Dividends appear on the statement of retained earnings, never on the income statement.
  • EPS
  • Book value per common share
Unit 4: Financial Analysis and Decision Making

Financing a Business: Debt versus Equity

  • Debt must be repaid with interest; interest is generally tax-deductible; lenders get no ownership or vote.
  • Equity (common or preferred shares) is never repaid and dividends are optional, but new shares dilute existing owners.
  • Semi-annual bond interest face value contract rate .
  • Return on equity
  • Leverage raises ROE when the return on assets exceeds the interest rate, and lowers it when the return on assets is below the interest rate.
  • Alternative sources: angel investors, venture capital, BDC, government loans and grants, crowdfunding, leasing, retained earnings.

Reading an Annual Report

  • An annual report contains the highlights, letter to shareholders, MD&A, management's responsibility statement, auditor's report, the four financial statements, notes and governance information.
  • The MD&A explains results, liquidity, risks and outlook in management's words and includes forward-looking estimates.
  • An unmodified (clean) opinion means the statements present fairly in all material respects; it is not a verdict on profitability or investment value.
  • The notes disclose accounting policies, debt terms, commitments, contingencies and subsequent events that the statements alone do not show.
  • Judge strength with liquidity, solvency, profitability, cash flow and trends, always against a comparable company or industry average.

Horizontal and Vertical Analysis

  • Dollar change current year base year.
  • Percent change ; divide by the base (earlier) year.
  • Trend percentage the base year is 100%.
  • Common-size income statement: every item as a percent of net sales.
  • Common-size balance sheet: every item as a percent of total assets (which equals total liabilities and equity).
  • Horizontal analysis compares years; vertical analysis compares items within one year and lets you compare companies of different sizes.

Liquidity, Efficiency and Solvency Ratios

  • Current ratio quick ratio where quick assets are cash, short-term investments and receivables.
  • Receivables turnover days' sales in receivables .
  • Inventory turnover ; days in inventory .
  • Debt-to-equity debt ratio
  • Times interest earned
  • Judge every ratio against prior years, the industry and any loan covenants.

Profitability and Market Ratios

  • Gross profit margin ; net profit margin .
  • Return on assets return on equity
  • EPS
  • Book value per common share
  • P/E ; dividend yield
  • Ratios depend on accounting choices, historical cost and one-day snapshots, so compare carefully and read the notes.

The Cash Flow Statement

  • Net income is not cash: accruals, amortization and capital purchases make them differ.
  • Indirect method: net income amortization losses gains increases in current assets decreases in current assets increases in current liabilities decreases in current liabilities.
  • Investing activities: buying and selling long-term assets and investments. Financing: borrowing, repaying, issuing shares, paying dividends.
  • Operating investing financing net change in cash, which must equal ending cash minus beginning cash on the balance sheet.
  • Positive operating and negative investing cash flow usually signals a healthy, growing company.