CA Financial Accounting & Reporting 4 — Questions and Answers
Question 1: A company using the indirect method starts with net income to prepare the operating section of the cash flow statement. Which adjustment is correct?
- Add an increase in accounts receivable
- Subtract an increase in accounts payable
- Add depreciation expense (Correct answer)
- Subtract an increase in prepaid expenses that decreases income
Correct answer: Add depreciation expense
Depreciation is a non-cash expense deducted in computing net income, so it must be added back under the indirect method to reconcile to cash from operations.
Question 2: Under the equity method of accounting for investments, how does the investor record dividends received from the investee?
- As dividend income on the income statement
- As a reduction of the Investment account (Correct answer)
- As an increase in the Investment account
- As other comprehensive income
Correct answer: As a reduction of the Investment account
Under the equity method, dividends received reduce the carrying amount of the investment because they represent a return of capital, not income.
Question 3: Which financial statement element is increased by a credit entry?
- Assets
- Expenses
- Dividends declared
- Revenues (Correct answer)
Correct answer: Revenues
Revenues are equity-related accounts with a normal credit balance, so they increase with a credit entry.
Question 4: A manufacturing company's cost of goods sold includes all of the following EXCEPT:
- Direct materials used
- Direct labor costs
- Factory overhead applied
- Selling and distribution expenses (Correct answer)
Correct answer: Selling and distribution expenses
Selling and distribution expenses are period costs expensed immediately and are not included in the product cost that flows through inventory to COGS.
Question 5: What is the purpose of a bank reconciliation?
- To record all cash transactions for the period
- To agree the bank balance and book balance to a corrected true cash balance (Correct answer)
- To prepare the cash flow statement
- To verify credit card transactions
Correct answer: To agree the bank balance and book balance to a corrected true cash balance
A bank reconciliation identifies and explains the differences between the company's book balance and the bank statement balance to arrive at the correct cash balance.
Question 6: Under lower-of-cost-or-net-realizable-value (LCNRV) for inventory, net realizable value is defined as:
- Replacement cost of the inventory
- Estimated selling price less costs of completion and disposal (Correct answer)
- Original purchase cost less normal profit margin
- Fair value of the inventory
Correct answer: Estimated selling price less costs of completion and disposal
ASC 330 defines NRV as the estimated selling price in the ordinary course of business minus reasonably predictable costs of completion, disposal, and transportation.
Question 7: Which of the following is a characteristic of the accrual basis of accounting?
- Revenue is recognized only when cash is received
- Expenses are recorded only when paid in cash
- Transactions are recorded when they occur regardless of cash flow timing (Correct answer)
- Only completed transactions affect the financial statements
Correct answer: Transactions are recorded when they occur regardless of cash flow timing
Under accrual accounting, revenues and expenses are recognized when earned or incurred, not necessarily when cash is exchanged.
CA Financial Accounting & Reporting 4
A company using the indirect method starts with net income to prepare the operating section of the cash flow statement.
Which adjustment is correct?