CPA FAR F3.M4 — Practice Questions
Select Transactions. Below are 8 real practice questions with worked explanations — a free sample of the F3.M4 set. The full adaptive version (spaced repetition, mastery checks, and the wider FAR bank) lives in the app.
Q1 · easy · ASC 470
A bond is issued at a discount when the:
- ✓ Stated (coupon) rate is less than the market (effective) rate
- Stated coupon rate is greater than the prevailing market rate of interest
- Prevailing market rate of interest on the bond happens to be zero
- Bond is issued exactly at its par value, with no premium or discount
Why: When a bond's stated rate is below the market rate investors require, it sells for less than face value - at a discount. When the stated rate exceeds the market rate, it sells at a premium.
Q2 · medium · ASC 835
Bonds with a $500,000 face amount and a 7% stated rate were issued at 96 to yield 8%, with interest paid annually. Under the effective interest method, the first year's interest expense is:
- $40,000
- ✓ $38,400
- $35,000
- $33,600
Why: Interest expense = carrying amount x market rate = (500,000 x 0.96) x 8% = 480,000 x 8% = 38,400. Cash paid is 500,000 x 7% = 35,000; the 3,400 difference amortizes the discount.
Q3 · medium · ASC 835
$600,000 of bonds with a 9% stated rate were issued to yield 8% (interest paid annually), producing a $620,000 carrying amount. The first-year interest expense under the effective interest method is:
- $55,800
- $48,000
- ✓ $49,600
- $54,000
Why: For a premium bond, interest expense = carrying amount x market rate = 620,000 x 8% = 49,600. Cash paid is 600,000 x 9% = 54,000; the 4,400 excess amortizes the premium and reduces the carrying amount.
Q4 · medium · ASC 835
As a bond issued at a premium approaches maturity under the effective interest method, periodic interest expense:
- Increases each period as the carrying amount declines
- ✓ Decreases each period as the carrying amount declines
- Equals the cash interest paid each period
- Remains constant each period
Why: With a premium bond the carrying amount falls toward face value as the premium amortizes, so interest expense (carrying amount x market rate) decreases each period. For a discount bond, interest expense increases over time.
Q5 · hard · ASC 835
A 3-year, $100,000 bond pays 6% annually and is priced to yield 8%. Using a PV of $1 factor of 0.7938 and a PV of an ordinary annuity factor of 2.5771 (8%, 3 years), the issue price is approximately:
- $105,154
- $100,000
- ✓ $94,843
- $79,380
Why: Issue price = PV of principal + PV of interest = (100,000 x 0.7938) + (6,000 x 2.5771) = 79,380 + 15,463 = 94,843. A 6% coupon priced to yield 8% sells at a discount.
Q6 · hard · ASC 470-50
Bonds with a carrying amount of $515,000 (face $500,000) were retired early at a call price of 102. The result on extinguishment is a:
- ✓ $5,000 gain
- $5,000 loss
- $15,000 gain
- $10,000 loss
Why: Gain or loss = carrying amount - reacquisition price = 515,000 - (500,000 x 1.02) = 515,000 - 510,000 = 5,000. Paying less than the carrying amount produces a gain.
Q7 · medium · ASC 835-30
Under U.S. GAAP, debt issuance costs are reported as:
- A direct reduction of additional paid-in capital within equity
- An expense recognized immediately at issuance
- A separate asset amortized over the life of the debt
- ✓ A direct reduction of the carrying amount of the related debt
Why: Debt issuance costs are presented as a direct deduction from the carrying amount of the related debt (like a discount) and amortized to interest expense using the effective interest method.
Q8 · medium · ASC 470-20
When bonds are issued with detachable stock warrants, the issuance proceeds are:
- Recorded entirely as a liability, with nothing assigned to equity
- Recorded entirely as equity until the bonds mature
- ✓ Allocated between the bonds and the warrants based on their relative fair values
- Allocated only if and when the warrants are exercised
Why: Detachable warrants have separate value, so proceeds are allocated between the debt and the warrants (paid-in capital) based on relative fair values. The amount assigned to the warrants increases equity.