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In planning an audit, the auditor’s knowledge about the design of relevant internal control activities should be used to
A. Identify the types of potential misstatements that could occur. | ||
B. Assess the operational efficiency of internal control. | ||
C. Determine whether controls have been circumvented by collusion. | ||
D. Document the assessed level of control risk. |
Explanation:
During the planning phase, an auditor obtains an understanding of the entity and its environment through the performance of risk assessment procedures. These procedures enable the auditor to effectively assess the types of potential misstatements that could occur and the controls that should be in place to mitigate the risk of a material misstatement (RMM).
Required risk assessment procedures include AIIO:
- Analytical procedures (study of data comparisons and relationships) using high-level data
- Inquiries of management and others within the entity, including internal auditors
- Inspection of documents and records, such as authorization forms and procedures manuals
- Observation (watching the application of manual controls)
Understanding the design of relevant internal control activities is used to:
- Identify the types of potential misstatements (eg, errors, fraud)
- Consider factors that affect the RMM
- Design tests of controls and substantive procedures
(Choices B and D) Assessing and documenting the operational efficiency of internal control occur after the auditor obtains an understanding of the entity. The potential misstatements must be identified before conclusions can be drawn.
(Choice C) Auditors are expected to be alert for the possibility of fraud. They are not expected to determine whether controls have been circumvented by collusion. If it appears that controls were not effective, further testing would be designed to determine whether collusion occurred.
Things to remember:
An auditor obtains an understanding of an entity through the performance of risk assessment procedures. These procedures are designed to gather information to enable the auditor to effectively assess the types of potential misstatements that could occur and the controls that should be in place to mitigate such risks.
Which of the following financial ratios would be most useful to an auditor seeking information on a company’s ability to cover current obligations?
A. Number of days sales in average receivables. | ||
B. Quick ratio. | ||
C. Profit margin. | ||
D. Sales-to-assets. |
Explanation:
Under GAAP, F/S must include management’s evaluation of whether the entity can continue as a going concern (ie, able to meet obligations as they come due) for a reasonable amount of time (ie, one year from the F/S issue date). Evaluating an entity as a going concern focuses on current assets and current liabilities.
An auditor must obtain sufficient appropriate audit evidence to assess management’s going concern evaluation. The quick ratio measures an entity’s liquidity, meaning its ability to meet short-term obligations (ie, current liabilities) with liquid current assets (ie, cash and assets easily and quickly converted into cash, such as marketable securities and A/R).
(Choice A) Number of days sales in average receivables (365 / A/R turnover ratio) measures the number of days required to collect receivables. This ratio is associated with liquid assets (ie, A/R) but does not consider current liabilities.
(Choice C) Profit margin reflects an entity’s profitability, not its ability to generate cash needed to meet obligations as they come due in the next year.
(Choice D) The sales-to-assets ratio indicates an entity’s ability to effectively use assets to generate sales. It does not consider the time required to convert sales to cash or any current liabilities.
Things to remember: The quick ratio measures an entity’s liquidity, meaning its ability to meet short-term obligations (ie, current liabilities) with liquid current assets (ie, cash and assets easily and quickly converted into cash, such as marketable securities and A/R).
Which of the following would not be an appropriate use of confirmations?
A. Confirming accounts receivable balances with customers. | ||
B. Confirming inventories on hand with third-party warehouses. | ||
C. Confirming loan terms and amounts with lenders. | ||
D. Confirming authorization for major transactions with directors. |
Explanation:
Choice D (Correct) and Choices A, B, C (Incorrect): Authorization of major transactions will generally be verified through a review of minutes of board of director meetings, not by sending confirmations to directors. It would be appropriate to use confirmations to confirm accounts receivable balances with customers, inventories on hand with third-party warehouses, and loan terms and amounts with lenders since these all represent transactions with parties that are separate from the entity being audited.
Which of the following topics would be addressed in the management representation letter?
A. All financial records have been made available to the auditor. | ||
B. Documentation exists for all financial transactions. | ||
C. There have been no errors or fraud committed by any employee. | ||
D. All financial statement adjustments recommended by the auditor have been made. |
Explanation:
Management representation topics | |
---|---|
Financial statements |
|
Internal controls |
|
Legal issues |
|
GAAS requires that the auditor obtain a written management representation letter from the client, dated as of the audit report date. This letter provides audit evidence, reaffirming information provided or statements made to the auditor during the audit.
The representation letter is written to the auditor, signed by client management (ie, CEO and CFO), and always covers certain topics. Representation letters must always indicate that all financial records were made available to the auditor, reaffirming no scope limitation during the audit.
(Choice B) The representation letter does not address whether documentation exists for all financial transactions, but confirms that all relevant financial documentation has been provided to the auditor.
(Choice C) Employees may commit fraud or errors without management’s knowledge; therefore, the letter cannot state that there is an absence of fraud or error committed by any employee. Instead, the letter should indicate that the auditor was informed of any knowledge of fraud involving management employees with significant roles in I/C or others who could impact the F/S.
(Choice D) Management may not correct all misstatements identified by the auditor. When this occurs, management must provide written representation about whether the effects of uncorrected misstatements are believed to be immaterial to the F/S and include a summary of such items.
Things to remember:
Management representation letters must always indicate that all financial records have been made available to the auditor, reaffirming no scope limitations during the audit.
Take a look at a typical competitor sample question below. The question exposes you to what you’ll see on the exam but that’s not enough to help you pass. Their limited explanations address the right answer choice but do not go the extra mile to explain the wrong choices – so you don’t make the same mistakes on exam day.
The controller of a small utility company has interviewed audit firms proposing to perform the annual audit of their employee benefit plan. According to the guidelines of the Department of Labor (DOL), the selected auditor must be
A. The firm that proposes the lowest fee for the work required. | ||
B. Independent for purposes of examining financial information required to be filed annually with the DOL. | ||
C. Included on the list of firms approved by the DOL. | ||
D. Independent of the utility company and NOT relying on its services. |
Explanation (If Available):
DOL guidelines do require independence for such work. Although DOL independence rules differ from AICPA rules, independence is still required.
Which of the following reports most likely would provide assurance on internal controls over the confidentiality of client data at a service organization?
A. SOC 1 Type 1 | ||
B. SOC 1 Type 2 | ||
C. SOC 2 Type 1 | ||
D. SOC 2 Type 2 |
Explanation:
System and organization controls (SOC) reports provide assurance about a service organization’s internal controls. SOC 1 reports provide assurance about a service organization’s controls relevant to the user entity’s financial reporting.
SOC 2 reports, in contrast, provide assurance on the service organization’s controls over security, availability, processing integrity, confidentiality, and privacy of the user entity’s data. Generally, these reports are provided by the service organization to its clients.
The emphasis of SOC 2 reports is on the operational fitness of IT systems. These reports can play an important role in:
- Oversight of the organization
- Vendor management programs
- Internal corporate governance and risk management processes
- Regulatory oversight
Both SOC 1 and SOC 2 reports come in two types: Type 1 reports address only the accuracy of management’s description of the controls and whether those controls are suitably designed.Type 2 reports provide assurance about whether the controls are operating effectively.
Things to remember:
System and organization controls (SOC) 1 reports provide assurance about a service organization’s controls relevant to a user entity’s financial reporting. SOC 2 reports provide assurance about the controls over security, availability, processing integrity, confidentiality, and privacy of the user entity’s data. Type 1 reports address the accuracy of management’s description of controls and whether those controls are suitably designed. Type 2 reports provide assurance about whether the controls are operating effectively.
Which of the following conditions is the primary cause of fluctuations in business activity resulting in the alternating rise and fall of economic growth?
A. The level of innovation brought to market. | ||
B. The amount of unemployment. | ||
C. The level of total spending. | ||
D. Governmental monetary policy. |
Explanation:
Business cycles are fluctuations in economic output and are generally measured by the rise and fall in gross domestic product (GDP). GDP is the total market value of all final (ie, finished) goods and services produced within one country’s borders during a specified period of time (typically a year).
There are four phases in a cycle: expansion, peak, contraction, and trough. Each business cycle includes one expansion and one contraction. Each expansion begins at the trough of the previous contraction and ends at the next peak.
The primary cause of fluctuations in business activity is the level of spending (ie, aggregate demand). Secondary causes include interest rates, consumer confidence level, availability of capital, and expectations about the future.
(Choices A and B) Economic indicators statistically measure economic activity to predict the economy’s direction (eg, the end of an expansion). There are three types of indicators: leading (eg, level of innovation brought to the market), lagging (eg, unemployment rate), and coincidental (eg, industrial production). Indicators do not cause fluctuations in economic output.
(Choice D) Governmental monetary policy is used by the Federal Reserve to manage—not cause—business cycles.
Things to remember:
Business cycles are fluctuations in economic output measured by changes in gross domestic product (GDP). There are four phases in a business cycle: expansion, peak, contraction, and trough. The primary cause of fluctuations in business activity is the level of spending (ie, aggregate demand).
The Federal Reserve wishes to reduce interest rates. Which of the following approaches will be the most successful?
A. Sell government securities. | ||
B. Reduce reserve requirements. | ||
C. Decrease government spending. | ||
D. Increase regulation of banks. |
Explanation:
Monetary policy tools | |||
---|---|---|---|
Tool | Description | Expansionary | Contractionary |
Open market operations | Trade securities (usually government securities) | Buy securities | Sell securities |
Policy interest rate | Set interest rate used to signal markets | Lower | Raise |
Reserve requirements | Set percentage of bank deposits held in reserves | Decrease | Increase |
One of the Fed’s monetary tools involves manipulating reserve requirements. Reserves are funds that banks hold to cover customer withdrawals. Because supply and demand for money determines interest rates, lowering the reserve requirement creates excess reserves. Banks use the additional reserves to make loans, resulting in an increase in the money supply. Increases in the money supply should put downward pressure on interest rates.
(Choice A) The sale of government securities by the Fed is a contractionary monetary policy and is likely to put upward pressure on interest rates.
(Choice C) A decrease in government spending is an example of fiscal, not monetary, policy. Although this decrease would tighten the money supply for businesses and consumers, it would not necessarily impact the interest rates charged by banks.
(Choice D) Regulations are designed to protect bank customers and are not an example of monetary policy.
Things to remember:
A reduction in the reserve requirement creates excess cash reserves in the banking system. Banks are likely to use this excess to make business and consumer loans, leading to an increase in the money supply and downward pressure on interest rates.
Increased demand for product A increases the demand for resources used to produce product A. What is the best explanation for the increase in the demand for resources?
A. The theory of derived demand is working. | ||
B. Product A is in an expanding industry. | ||
C. The theory of the “invisible hand” is working. | ||
D. The demand for product A is highly elastic. |
Explanation:
The theory of derived demand states that demand for the resources used to produce Product A (an end product) is derived from the demand for Product A. For example, the demand for smartphones drives the demand for resources, such as lithium batteries, needed to produce smartphones.
(Choice B) If the supply of Product A was increasing, it would suggest that Product A was in an expanding industry. This does not explain an increase in the demand for resources used to produce Product A.
(Choice C) The theory of the “invisible hand” is a metaphor meaning that price adjusts to bring a market to equilibrium (eg, quantity demanded equals quantity supplied) without government or other interventions.
(Choice D) The elasticity of Product A has little to do with the demand for resources used to produce Product A.
Things to remember:
The theory of derived demand states that demand for the resources (eg, lithium batteries) used to produce an end product (eg, smartphones) is derived from the demand for the product itself.
Take a look at a typical competitor sample question below. The question exposes you to what you’ll see on the exam but that’s not enough to help you pass. Their limited explanations address the right answer choice but do not go the extra mile to explain the wrong choices – so you don’t make the same mistakes on exam day.
Which of the following is responsible for identifying problems and proposing initial solutions?
A. IT Steering Committee | ||
B. Lead systems analyst. | ||
C. Application programmers. | ||
D. End users. |
Explanation (If Available):
This group has the primary responsibility of identifying problems and proposing initial solutions.
Rein, Inc. reported $40,000 as deferred tax assets and $53,000 as deferred tax liabilities at the beginning of Year 2. At the end of Year 2, Rein reported $58,000 as deferred tax assets and $65,000 as deferred tax liabilities. What should Rein report as deferred income tax expense or benefit at the end of Year 2?
A. $6,000 tax expense | ||
B. $6,000 tax benefit | ||
C. $7,000 tax expense | ||
D. $7,000 tax benefit |
Explanation:
The deferred income tax expense or benefit represents temporary differences between accounting and taxable income resulting from certain items being taxable or deductible on a tax return in a different period than reported on the income statement.
Some differences result in future taxable amounts, which require the recording of deferred tax liabilities (DTL) and create a deferred tax expense because future taxes will be owed. Others are future deductible amounts, resulting in deferred tax assets (DTA) that create deferred tax benefits because future taxes will be saved. The DTA and DTL are netted at year end and are reported either as a noncurrent asset or liability.
The deferred tax expense (or benefit) is the change in the net DTA or net DTL for the reporting period as follows:
- If net DTL increased or net DTA decreased, record an expense.
- If net DTA increased or net DTL decreased, record a benefit.
In this scenario, Rein, Inc.’s net DTL decreased during the year, which creates a deferred tax benefit of $6,000, as shown below (Choice A).
Ending net DTL ($65,000 DTL − $58,000 DTA) | $7,000 |
Beginning net DTL ($53,000 DTL − $40,000 DTA) | (13,000) |
Deferred income tax expense (benefit) | ($6,000) |
(Choices C and D) The $7,000 is the net DTL at the year end. The change in the net amount of DTA and DTL equals the deferred expense or benefit.
Things to remember:
The deferred tax expense (benefit) is the change in the net deferred tax asset (DTA) or net deferred tax liability (DTL) for the reporting period. Deferred tax expense results when there is a net DTL increase or net DTA decrease. A deferred tax benefit results when there is a net DTA increase or net DTL decrease.
Edgerton Township ordered, at an estimated cost of $3,500, a machine that was not delivered before the end of the township’s fiscal year. The machine was delivered early in the next fiscal year at an actual cost of $3,800. The township honors all open encumbrances at year end. What is the complete journal entry that should be recorded when the machine is delivered?
A. Debit reserve for encumbrances $3,500; credit fund balance—unreserved $3,500; debit expenditures $3,800; credit vouchers payable $3,800. | ||
B. Debit fund balance—unreserved $3,500; credit reserve for encumbrances $3,500. | ||
C. Debit expenditures $3,800; credit vouchers payable $3,800. | ||
D. Debit reserve for encumbrances $3,800; credit fund balance—unreserved $3,800; debit expenditures $3,800; credit vouchers payable $3,800. |
Explanation:
Government purchases with encumbrances (example) | ||
---|---|---|
To record order of machine | ||
Encumbrances | 3,500 | |
Reserve for encumbrances | 3,500 | |
To record year end closing of open encumbrance | ||
Fund balance—unreserved | 3,500 | |
Encumbrances | 3,500 | |
To record delivery of machine in the next fiscal year | ||
Reserve for encumbrances | 3,500 | |
Fund balance—unreserved | 3,500 | |
Expenditures | 3,800 | |
Vouchers payable (or cash) | 3,800 |
A journal entry is made in connection with a government entity’s acquisition of capital assets, goods, or services when a purchase order is placed with a vendor. The amount recorded is an estimate of the expenditure and is known as an encumbrance. Encumbrances are unique to government entities and are used to reduce available budgets and thus prevent overspending.
In this case:
- When Edgerton Township’s machine is ordered in Year 1, encumbrances is debited and reserve for encumbrances is credited for $3,500
- At the end of Year 1, encumbrances are closed out (ie, credited). However, because the township honors its commitment to open encumbrances, fund balance—unreserved is debited for $3,500 and the reserve for encumbrances remains
- When the machine is delivered in Year 2, the township must remove the reserve for encumbrances at the originally estimated amount of $3,500 and record the expenditure at the actual purchase price of $3,800. This results in a net total fund balance of $300 for Year 2
(Choice B) Reserve for encumbrances should be debited and fund balance—unreserved should be credited (not the reverse), and the expenditure should be recorded.
(Choice C) To be complete, this entry should also reverse the encumbrance.
(Choice D) The encumbrance should be reversed at the originally budgeted amount of $3,500.
Things to remember:
Government entities have strict accountability to taxpayers. When a purchase order is issued, the entity’s available budget is reduced by debiting encumbrances and crediting reserve for encumbrances. When the order is fulfilled, the encumbrance is removed, and the expenditure is recorded.
On December 12, Year 1, a company entered a forward exchange contract to sell 100,000 euros in 90 days. The relevant exchange rates are as follows:
Spot rate | Forward rate for March 12, Year 2 |
|
---|---|---|
December 12, Year 1 | $.88 | $.90 |
December 31, Year 1 | $.98 | $.93 |
The forward contract is being used for speculation. At December 31, Year 1, what amount of foreign currency transaction gain or loss should the company include in income from this forward contract?
A. $0 | ||
B. $3,000 loss | ||
C. $3,000 gain | ||
D. $10,000 loss |
Explanation:
Forward contracts (ie, forwards) are agreements to purchase or sell an item at a future date for an agreed price. Forwards in foreign currency can be used for speculation when there is an expectation to profit from changes in forward rates.
Forwards are derivatives, which are measured and reported in the balance sheet at FV. Foreign currency forwards initially have a FV of zero and derive their later FV from changes in the forward rates. Changes in the FV of speculative contracts are recognized in the income statement as gains and losses (G/L), which are dependent on the type of contract (ie, buy or sell) and the direction of the forward rates relative to the agreed price.
In this scenario, on December 12, the company contracted to sell €100,000 at $.90 per euro for delivery in 90 days. On December 31 the forward rate increased to $.93, but the original contract is still in force, meaning the company is obligated to sell euros for less than they are currently worth. Therefore, a loss and liability of $3,000 is recognized [100,000 x ($.93 − $.90)].
(Choice A) A gain of $0 is incorrect because the forward rate increased to $.93 on December 31. Loss recognition is required.
(Choice C) A gain of $3,000 is incorrect because the forward rate increased to $.93 and the agreed sale price is $0.90.
(Choice D) A loss of $10,000 incorrectly uses the change in the spot rates between December 12 and December 31, Year 1. Spot rates are not used to measure a forward contract’s FV.
Things to remember:
Forward contracts in foreign currency derive their FV from changes in the forward rates. Gains and losses resulting from changes in the forward rates for speculative contracts are reported in the income statement.
Martin Pharmaceutical Co. is currently involved in two lawsuits. One is a class-action suit in which consumers claim that one of Martin’s best-selling drugs caused severe health problems. It is reasonably possible that Martin will lose the suit and have to pay $20 million in damages. Martin is suing another company for false advertising and false claims against Martin. It is probable that Martin will win the suit and be awarded $5 million in damages. What amount should Martin record on its financial statements as a result of these two lawsuits?
A. $0 | ||
B. $5 million income | ||
C. $15 million expense | ||
D. $20 million expense. |
Explanation:
Accounting for contingent events | ||
---|---|---|
Disclose | Accrue | |
Remote (gain or loss) | No | No |
Reasonably possible (gain or loss) | Yes | No |
Probable and not estimable (gain or loss) | Yes | No |
Probable and estimable gain | Yes | No |
Probable and estimable loss | Yes | Yes |
The accounting treatment of contingent losses is based on their probability of occurrence, which may be remote, reasonably possible, or probable. If a loss is reasonably possible, it must be disclosed in the notes to the financial statements (F/S). This allows F/S users to be aware of the potential loss, including its range of values. However, no accrual is recorded because the loss is still not likely to occur.
All contingent gains are not recognized until the underlying gain-causing event occurs (ie, the gain is realized). The conflicting treatment between probable contingent gains and losses is an application of conservatism. In other words, the recognition threshold for expected gains is higher than for expected losses. GAAP emphasizes conservatism when dealing with uncertainties because many F/S users prefer the risk of understated (not overstated) net income and net assets.
Martin Pharmaceutical Co. will not record an expense for the $20 million class-action suit because it is only a reasonably possible contingent loss (Choices C and D). Martin will not record income of $5 million for the false advertising lawsuit because it is a contingent gain (Choice B). Therefore, Martin will report $0 with respect to these transactions.
Things to remember:
A contingent loss that is reasonably possible must be disclosed in the financial statements (F/S) notes. However, no accrual is made on the face of the F/S. Contingent gains (including probable gains) are not recognized until the underlying gain-causing event occurs.
Take a look at a typical competitor sample question below. The question exposes you to what you’ll see on the exam but that’s not enough to help you pass. Their limited explanations address the right answer choice but do not go the extra mile to explain the wrong choices – so you don’t make the same mistakes on exam day.
Which one of the following would constitute a highly inflationary economy when determining the functional currency of a foreign entity?
A. 20% inflation for each of the past 5 years | ||
B. 30% inflation for each of the past 3 years | ||
C. 35% inflation for each of the past 3 years | ||
D. 20%, 35%, and 40% inflation, respectively, for each of the past 3 years |
Explanation (If Available):
For determining a functional currency, a highly inflationary (hyperinflationary) economy is one that has experienced a cumulative inflation of 100% or more over the past 3 years. Inflation of 35% per year over the past three years is a cumulative 105% and constitutes a highly inflationary economy.
The filing of an involuntary bankruptcy petition under the Federal Bankruptcy Code
A. Terminates liens on exempt property | ||
B. Terminates all security interests in property in the bankruptcy estate. | ||
C. Stops the debtor from incurring new debts. | ||
D. Stops the enforcement of judgment liens against property in the bankruptcy estate. |
Explanation:
An involuntary bankruptcy occurs when unsecured creditors file a petition to place a debtor in bankruptcy. The petition can be filed under either the liquidation provisions of Chapter 7 or the reorganization provisions of Chapter 11. Filing the bankruptcy petition stops all creditor collection efforts, including the enforcement of judgment liens against property in the bankruptcy estate.
Filing an involuntary petition is most important in a Chapter 7 bankruptcy, in which all the debtor’s secured and unsecured nonexempt property is placed in the bankruptcy estate for liquidation. The liquidation proceeds are used to satisfy creditor claims. If the judgment lien holder’s collection efforts were not stopped, the lien holder could seize the property, removing it from the bankruptcy estate. This would mean fewer assets to liquidate and fewer proceeds to distribute among the other creditors.
(Choice A) Exempt property is not part of the bankruptcy estate. However, liens on exempt property can be discharged (terminated).
(Choice B) Filing the petition does not terminate all security interests in the property in the bankruptcy estate; however, they will eventually be terminated when the assets are sold in the liquidation.
(Choice C) Debtors can still incur new debt while in bankruptcy. This often occurs in Chapter 11 bankruptcies, in which the debtor still operates a business during the bankruptcy and needs to incur debt for ongoing operations.
Things to remember:
Filing a bankruptcy petition stops all creditor collections efforts, including the enforcement of judgment liens against property in the bankruptcy estate.
This year, Beck gave $5,000 cash to a nephew, canceled $3,000 of the same nephew’s indebtedness, donated $1,500 to a political party, and gave $1,200 of municipal bonds to a parent. What is the amount of Beck’s gifts before considering the gift tax annual exclusion?
A. $5,000 | ||
B. $8,000 | ||
C. $9,200 | ||
D. $10,700 |
Explanation:
Transfers excluded from gift tax treatment |
---|
|
Taxable gifts are calculated by assessing the donor’s total gifts to each individual recipient. Gifts of money and property (eg, bonds) are consider taxable gifts. In addition, certain transfers are excluded from gift tax treatment. For instance, transfers made to a political organization are excluded from the definition of taxable gift.
In this scenario, the transfer to the political party is the only transfer that is excluded from gift tax treatment before consideration of the annual exclusion. Therefore, Beck’s total gifts are calculated as:
Gifts to nephew | ||
Cash | $5,000 | |
Debt forgiveness | $3,000 | |
Total gift to nephew | $8,000 | |
Bonds to parents | $1,200 | |
Total gifts (before annual exclusion) | $9,200 |
The cancellation of the $3,000 loan is a taxable gift because the donor, by cancelling the debt, gave value (ie, the loan proceeds) while expecting nothing in return.
Note that gifts are calculated on a per-recipient basis. This is because the donor is allowed to subtract the annual exclusion amount from the total gifts given to each recipient.
(Choice A) An amount of $5,000 incorrectly assumes that only the cash gift to the nephew is a taxable gift.
(Choice B) An amount of $8,000 incorrectly assumes that only the gifts to the nephew are taxable gifts.
(Choice D) An amount of $10,700 incorrectly assumes that the political gift of $1,500 is also a taxable gift.
Things to remember:
Certain transfers, such as contributions to a political organization, charitable contributions, and transfers to a spouse, are excluded from the definition of taxable gift and therefore not considered taxable gifts.
A self-employed taxpayer owns and runs Creations, LLC. The taxpayer has a defined contribution, stock bonus Keogh plan. In Year 4, the taxpayer had $225,000 in net self-employment earnings, including the deduction for 50% of self-employment tax, before any Keogh deduction. Assuming there is no excess contribution carryover from previous years, what is the highest deductible Keogh contribution the taxpayer can make in the Year 4 tax year?
A. $45,000 | ||
B. $56,250 | ||
C. $61,000 | ||
D. $225,000 |
Explanation:
Keogh contribution limit |
---|
|
*Mathematically, this equals 25% of net self-employment income after the deduction for Keogh contributions. |
Due to their low contribution limits, individually managed retirement accounts (eg, IRAs) are not attractive options for self-employed taxpayers. Therefore, several Keogh plans (ie, qualified retirement plans) were created that allow those taxpayers to make significantly higher tax-deferred contributions from their self-employment income.
The annual contribution to a Keogh plan is limited to the lesser of:
- 25% of net self-employment income after the deduction for Keogh contributions (ie, 20% of net self-employment income before the deduction),
- the annual limit ($61,000 in 2022), or
- 100% of earned income.
In this scenario, the taxpayer reported $225,000 of net self-employment earnings after the deduction for self-employment taxes. The limit for contributions to a qualified plan is $45,000 (ie, $225,000 × 20%), which is less than either the annual contribution limit ($61,000 in 2022) or 100% of earned income ($225,000) (Choices C and D).
(Choice B) An amount of $56,250 is 25% of net self-employment earnings before the deduction for the contribution.
Things to remember:
A self-employed taxpayer may establish a Keogh plan (ie, qualified retirement plan) with a higher contribution limit than an individually managed retirement account. The contribution limit is either 20% of self-employment income before the Keogh deduction, an annually adjusted limit, or 100% of earned income.
Which of the following statements is correct concerning the voluntary filing of a petition in bankruptcy?
A. If the debtor has twelve or more creditors, the unsecured claims must total at least $18,600 | ||
B. The debtor must be insolvent | ||
C. If the debtor has less than twelve creditors, the unsecured claims must total at least $18,600 | ||
D. The petition may be filed jointly by spouses |
Explanation:
Most common types of bankruptcy | ||
---|---|---|
Chapter | Type | Voluntary or involuntary? |
Chapter 7 | Liquidation | Both |
Chapter 11 | Business reorganization | Both |
Chapter 13 | Debt restructure/adjustment | Coluntary only |
For voluntary bankruptcy, spouses may file jointly if they choose to do so. Filing jointly reduces duplicate fees. The decision to file jointly or separately may also affect the total amount of income considered when determining bankruptcy eligibility and which debts are fully discharged. For example, if one spouse files for bankruptcy, only that spouse’s income is used to evaluate the eligibility for bankruptcy. However, only the filing spouse will be discharged from joint spousal debt. The nonfiling spouse will remain liable.
(Choices A and C) The $18,600 minimum requirement for debts to unsecured creditors filing a petition applies to involuntary bankruptcies. If there are 12 or more unsecured creditors, then at least three of them must sign the petition. If there are fewer than 12 unsecured creditors, then only one of them needs to sign the petition. Voluntary bankruptcies have no minimum debt requirements.
(Choice B) A debtor’s insolvency (ie, liabilities exceed the fair market value of assets) is not a requirement for filing a voluntary bankruptcy petition.
Things to remember:
In a voluntary bankruptcy, spouses may file jointly. Doing so reduces filing fees but may also affect the total amount of income considered when determining bankruptcy eligibility, and it may affect which debts are fully discharged.
Take a look at a typical competitor sample question below. The question exposes you to what you’ll see on the exam but that’s not enough to help you pass. Their limited explanations address the right answer choice but do not go the extra mile to explain the wrong choices – so you don’t make the same mistakes on exam day.
A corporation’s penalty for underpaying federal estimated taxes is
A. Not deductible | ||
B. Fully deductible in the year paid | ||
C. Fully deductible if reasonable cause can be established for the underpayment | ||
D. Partially deductible |
Explanation (If Available):
Even though a corporation’s penalty for underpay-ing federal estimated taxes is in the nature of interest, it is treated as an addition to tax, and as such, the penalty is not deductible.
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Understanding the question types in each CPA Exam section can help you build a successful preparation strategy. All UWorld Roger CPA Review practice problems reflect the latest AICPA blueprints.MCQs feature one question with four potential answers, and make up the majority of each exam section. Practice more than 6,000 targeted problems with detailed rationales.
TBSs require you to apply practical knowledge to a case-based scenario. They often ask you to make journal entries, conduct research, or match definitions. Learn from hundreds of samples with comprehensive explanations.
WCs are written essay responses unique to the BEC exam. Draft responses to over a dozen examples and grade your performance based on our provided solution and criteria.
MCQs feature one question with four potential answers, and make up the majority of each exam section. Practice more than 6,000 targeted problems with detailed rationales.
TBSs require you to apply practical knowledge to a case-based scenario. They often ask you to make journal entries, conduct research, or match definitions. Learn from hundreds of samples with comprehensive explanations.
WCs are written essay responses unique to the BEC exam. Draft responses to over a dozen examples and grade your performance based on our provided solution and criteria.
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Practice CPA Sample Questions Anywhere at Any Time
Hear From Our Past Candidates
I am thoroughly challenged by the questions presented. I also love the detailed explanation after each question as they are descriptive and clear. It has been extremely beneficial to me understanding the concepts presented in the lectures and how to apply them to specific situations. I also love the ease of creating and navigating through all of the tests that I have created. They reinforce the information learned in the chapters."
Thank you UWorld for the hours of entertaining lessons that helped me truly learn the material and not just memorize it, combined with the excellent explanations to the practice questions, really helped me grasp the most difficult concepts. I also love all the statistics built into the question bank - they helped me study so much smarter. I passed all 4 sections on my first try and can add those lovely 3 letters to the end of my name now - CPA!"
I have passed all 4 parts of the Uniform CPA Exam on the first try by using the UWorld Roger CPA Review course only. MCQs and TBS banks are of high quality and followed by excellent explanations and references to online lectures and books. Overall, this program follows the AICPA blueprint to a T. I have been out of college for at least 20 years and can highly recommend this course to any CPA candidate who is serious about passing CPA exams!"