2006 AICPA newly released regulation questions

Following are multiple choice questions recently released by the AICPA These questions were released by the AICPA with letter answers only Our editorial board has provided the accompanying explanations Please note that the AICPA generally releases questions that it does NOT intend to use again These questions and content may or may not be representative of questions you may see on any upcoming exams 2006 AICPA Newly-Released Regulation Questions Under the provisions of the Employee Retirement Income Security Act of 1974 (ERISA), which of the following statements is(are) correct regarding employee rights? I Employers are required to establish either a contributory or noncontributory employee pension plan II Employers are required to include employees as pension-plan managers a b c d I only II only Both I and II Neither I nor II ANSWER: Choice "d" is correct The Employment Retirement Income Security Act (ERISA) does not require employers to have retirement plans or require contributions to existing retirement plans ERISA does not mandate that employers are required to include employees as pension-plan managers ERISA does establish standards for funding and investing and imposes fiduciary duties on pension fund managers Only choice "d" reflects that employers are not required to establish a pension plan and employees not need to be included as pension-plan managers -1- 2006 AICPA Newly-Released Regulation Questions The Rites are married, file a joint income tax return, and qualify to itemize their deductions in the current year Their adjusted gross income for the year was $55,000, and during the year they paid the following taxes: Real estate tax on personal residence Ad valorem tax on personal automobile Current-year state and city income taxes withheld from paycheck $2,000 500 1,000 What total amount of the expense should the Rites claim as an itemized deduction on their current-year joint income tax return? a b c d $1,000 $2,500 $3,000 $3,500 ANSWER: Choice "d" is correct In answering this question, we must assume that the examiners mean to ask, "What total amount of the tax expense should the Rites claim as an itemized deduction?" Obviously, the Rites have more deductions than just those tax deductions above, or they would tax advantage of the standard deduction In any case, for cash-basis taxpayers, deductible taxes are generally deductible in the year paid, and real estate taxes, income taxes, and personal property taxes (e.g., ad valorem taxes on personal automobile) are allowable deductions The total amount of deductions for tax expense is calculated as follows: Real estate tax on personal residence $2,000 Ad valorem tax on personal automobile Current-year state and city income taxes withheld Total deduction for taxes 500 1,000 $3,500 Choice "a" is incorrect Real estate taxes and personal property taxes are allowable itemized deductions Choice "b" is incorrect Current-year state and city income taxes withheld from a paycheck are allowable itemized deductions Choice "c" is incorrect Personal property taxes (e.g., ad valorem taxes paid) are allowable itemized deductions -2- 2006 AICPA Newly-Released Regulation Questions Under the Negotiable Instruments Article of the UCC, an instrument will be precluded from being negotiable if the instrument: a b c d Fails to state the place of payment Is made subject to another agreement Fails to state the underlying consideration Is undated ANSWER: Choice "b" is correct Under the Negotiable Instruments Article of the UCC, an instrument is not negotiable if it states that it is "subject to" or "contingent upon" another agreement Choice "a" is incorrect A negotiable instrument is not required to state the place of payment Choice "c" is incorrect Consideration is not required for an instrument to be negotiable We frequently make gifts by check The check can be negotiable even though no consideration is given for the gift Choice "d" is incorrect Failure to date an instrument will not destroy negotiability An undated instrument is counted as being payable on demand -3- 2006 AICPA Newly-Released Regulation Questions Porter was unemployed for part of the year Porter received $35,000 of wages, $4,000 from a state unemployment compensation plan, and $2,000 from his former employer's company-paid supplemental unemployment benefit plan What is the amount of Porter's gross income? a b c d $35,000 $37,000 $39,000 $41,000 ANSWER: RULE: Gross income includes all income unless it is specifically excluded in the tax code Choice "d" is correct Wages and all unemployment compensation are not excluded from being taxable; therefore, there are included in the taxpayer's gross income for tax purposes Wages received $35,000 State unemployment compensation 4,000 Employer's unemployment compensation plan 2,000 $41,000 Choice "a" is incorrect All forms of unemployment compensation are included as part of gross income Choice "b" is incorrect The $4,000 of state unemployment compensation received is included as part of gross income Choice "c" is incorrect The $2,000 of his former employer's company-paid supplemental unemployment benefit plan is included as part of gross income -4- 2006 AICPA Newly-Released Regulation Questions Under the ethical standards of the profession, which of the following business relationships would generally not impair an auditor's independence? a b c d Promoter of a client's securities Member of a client's board of directors Client's general counsel Advisor to a client's board of trustees ANSWER: Choice "d" is correct Rule 101 of the Code of Conduct requires that members be independent in fact and appearance in audits and attestation services Independence is impaired if an auditor is an employee of an audit client or is able to make management decisions on behalf of an audit client An advisor of an audit client's board of directors is not an employee, nor is the advisor able to make management decisions for the audit client The advisor does not make decisions, the advisor simply gives advice that the client is free to accept or reject Choice "a" is incorrect A promoter of the audit client's securities has a direct relationship with the client A promoter is a business relationship that would impair independence Choice "b" is incorrect A member of the board of directors of the audit client is able to make management decisions for the client A member of the board is a business relationship that would impair independence Choice "c" is incorrect A client's general counsel is an employee A general counsel is a business relationship that would impair independence -5- 2006 AICPA Newly-Released Regulation Questions Under the Securities Exchange Act of 1934, which of the following penalties could be assessed against a CPA who intentionally violated the provisions of Section 10(b), Rule 10b-5 of the Act? Civil liability of monetary damages a Yes b Yes c No d No Criminal liability of a fine Yes No Yes No ANSWER: Choice "a" is correct Violation of Rule 10b-5 of the Securities Exchange Act of 1934 can result in civil damages, an SEC injunctive action and or criminal fines and penalties Only choice "a" reflects that both civil and criminal liability can be assessed against a CPA who intentionally violates the provisions of Rule 10b-5 of the Securities Exchange Act of 1934 -6- 2006 AICPA Newly-Released Regulation Questions All of the following statements regarding compliance with the statute of frauds are correct, except: a b c d Any necessary writing must be signed by all parties against whom enforcement is sought Contracts involving the sale of goods in an amount greater than $500 must be in writing Contract terms must be contained in only one document Contracts for which it is improbable to assume that performance will be completed within one year must be in writing ANSWER: Choice "c" is correct Under the Statute of Frauds, there is no requirement that the terms be stated in a single document Terms can be stated in more than one document Choice "a" is incorrect The Statute of Frauds does require that the party or parties against whom enforcement is sought sign certain specified contracts Choice "b" is incorrect Contracts for the sale of goods for $500 or more are one of the specified contracts requiring some kind of writing under the Statute of Frauds Choice "d" is incorrect Contracts which by there terms can not be performed within a year are one of the specified contracts requiring some kind of writing under the Statute of Frauds -7- 2006 AICPA Newly-Released Regulation Questions ParentCo, SubOne, and SubTwo have filed consolidated returns since their inception The members reported the following taxable incomes (losses) for the year ParentCo SubOne SubTwo $50,000 ($60,000) ($40,000) No member reported a capital gain or loss or charitable contributions What is the amount of the consolidated net operating loss? a b c d $0 $30,000 $50,000 $100,000 ANSWER: Choice "c" is correct Net capital losses are not allowable deductions for corporations A corporation can only use capital losses to offset capital gains Further, the deduction for charitable contributions may be limited in some cases, and no charitable contribution deduction is allowed in calculating the NOL The facts of this question indicate that there are no reported capital gains or losses or charitable contributions for any of the consolidated entities; therefore, we know that we are able to use the total income (loss) identified in the facts to calculate the net operating loss When entities file consolidated income tax returns, 100% if their net income (losses) is consolidated The facts not indicate that any intercompany transactions exist; therefore, there are no elimination entries to make before consolidating the net income (loss) The consolidated net operating loss is calculated as follows: Parent Co $ 50,000 Sub One (60,000) Sub Two (40,000) NOL $(50,000) Choice "a" is incorrect A consolidated net loss of $50,000 exists, as calculated above Choice "b" is incorrect A consolidated net loss of $50,000 exists, as calculated above Choice "d" is incorrect The income from Parent Co ($50,000) is netted with the losses from the subsidiaries ($100,000) to arrive at the consolidated net operating loss of $50,000 -8- 2006 AICPA Newly-Released Regulation Questions Which of the following types of mistake will generally make a contract unenforceable and allow it to be rescinded? a b c d A unilateral mistake of fact A mutual mistake of fact A unilateral mistake of value A mutual mistake of value ANSWER: Choice "b" is correct A mutual mistake of a material fact is unenforceable The adversely affected party can rescind the contract Choice "a" is incorrect Generally, a unilateral mistake of fact does not make the contract unenforceable The mistaken party can only rescind if there was a mistake of a material fact and the other party knew or should have known that a mistake was being made Choice "c" is incorrect Only mistakes as to material facts can make a contract unenforceable Mistakes as to value not make a contract unenforceable Thus, a unilateral mistake of value would not make a contract unenforceable Choice "d" is incorrect Only mistakes as to material facts can make a contract unenforceable Mistakes as to value not make a contract unenforceable Thus, a mutual mistake of value would not make a contract unenforceable -9- 2006 AICPA Newly-Released Regulation Questions Tana's divorce decree requires Tana to make the following transfers to Tana's former spouse during the current year: Alimony payments of $3,000 Child support of $2,000 Property division of stock with a basis of $4,000 and a fair market value of $6,500 What is the amount of Tana's alimony deduction? a b c d $3,000 $7,000 $9,500 $11,500 ANSWER: RULE: Alimony payments to a former spouse are adjustments to arrive at AGI Child support payments are NOT alimony and are NOT deductible Property settlements are NOT alimony and are NOT deductible Choice "a" is correct Only the amount of alimony ($3,000) is allowed as Tana's alimony deduction Choice "b" is incorrect The basis of property division of stock ($4,000) is NOT alimony and is NOT deductible, but the $3,000 in alimony paid is deductible Choice "c" is incorrect The fair market value of property division of stock ($6,500) is NOT alimony and is NOT deductible, but the $3,000 in alimony paid is deductible Choice "d" is incorrect The fair market value of property division of stock ($6,500) and the child support ($2,000) are NOT alimony and are NOT deductible, but the $3,000 in alimony paid is deductible - 25 - 2006 AICPA Newly-Released Regulation Questions Ball borrowed $10,000 from Link Ball, unable to repay the debt on its due date, fraudulently induced Park to purchase a piece of worthless costume jewelry for $10,000 Ball had Park write a check for that amount naming Link as the payee Ball gave the check to Link in satisfaction of the debt Ball owed Link Unaware of Ball's fraud, Link cashed the check When Park discovered Ball's fraud, Park demanded that Link repay the $10,000 Under the Negotiable Instruments Article of the UCC, will Link be required to repay Park? a b c d No, because Link is a holder in due course of the check No, because Link is the payee of the check and had no obligation on the check once it is cashed Yes, because Link is subject to Park's defense of fraud in the inducement Yes, because Link, as the payee of the check, takes it subject to all claims ANSWER: Choice "a" is correct A Holder in Due Course takes free of personal defenses Fraudulent inducement is a personal defense Park should have verified the worth of the jewelry before giving Ball the check Link is a holder in due course because Link gave the transferor Ball value (the $10,000) without notice of any defenses and in good faith Choice "b" is incorrect Even though the check was cashed, payees and endorser's remain secondarily liable The drawee bank was primarily liable on the instrument This choice is not the reason why Link is not liable on the instrument to Park Choice "c" is incorrect, per the above explanation in choice "a" Choice "d" is incorrect Link is a holder in due course and does not take subject to "all" claims An HDC does take subject to real defenses - 26 - 2006 AICPA Newly-Released Regulation Questions Starr, a self-employed individual, purchased a piece of equipment for use in Starr's business The costs associated with the acquisition of the equipment were: Purchase price Delivery charges Installation fees Sales tax $55,000 725 300 3,400 What is the depreciable basis of the equipment? a b c d $55,000 $58,400 $59,125 $59,425 ANSWER: Choice "d" is correct The rules for depreciable basis in tax are generally the same as the GAAP rules for capitalizing an asset The depreciable basis is the cost associated with the purchase of the asset and with getting the asset ready for its intended use Further improvements are also capitalized, and the basis is reduced for any accumulated depreciation In this case, the cost of obtaining the equipment and getting the equipment ready for its intended use includes all the items shown above, as follows: Purchase price $55,000 Delivery charges 725 Installation fees 300 Sales tax Total depreciable basis 3,400 $59,425 Choice "a" is incorrect The costs of delivery charges, installation, and sales tax are all part of the cost of obtaining the asset and getting the asset ready for its intended use All of these charges are included in the depreciable basis of the equipment Choice "b" is incorrect The costs of delivery charges and installation are both part of the cost of obtaining the asset and getting the asset ready for its intended use These charges are included in the depreciable basis of the equipment Choice "c" is incorrect The cost of installation is part of the cost getting the asset ready for its intended use This charge is included in the depreciable basis of the equipment - 27 - 2006 AICPA Newly-Released Regulation Questions Which of the following securities is exempt from registration under the Securities Act of 1933? a b c d Municipal bonds Securities sold by a discount broker Pre-incorporation stock subscriptions One-year notes issued to raise working capital ANSWER: Choice "a" is correct Municipal bonds are securities issued by the government and are generally exempt from registration Choice "b" is incorrect Securities issued by discount brokers are required to be registered and not fall within the exempt securities of section of the 1933 Act Choice "c" is incorrect Pre-incorporation stock subscriptions are required to be registered and not fall within the exempt securities of section of the 1933 Act Choice "d" is incorrect One-year notes are securities that are required to be registered and not fall within the exempt securities of section of the 1933 Act - 28 - 2006 AICPA Newly-Released Regulation Questions Which of the following statements is the best definition of real property? a b c d Real property is only land Real property is all tangible property including land Real property is land and intangible property in realized form Real property is land and everything permanently attached to it ANSWER: Choice "d" is correct Real property includes land and all items permanently affixed to the land (e.g., buildings, paving, etc.) Choice "a" is incorrect Real property includes more than just the land (as per the explanation above); it includes all items permanently affixed to land Choice "b" is incorrect "All" tangible property could include moveable personal property and is therefore, incorrect Choice "c" is incorrect "Intangible property in realized form" is a distracter and a contradiction in terms - 29 - 2006 AICPA Newly-Released Regulation Questions Which of the following is correct concerning the LIFO method (as compared to the FIFO method) in a period when prices are rising? a b c d Deferred tax and cost of goods sold are lower Current tax liability and ending inventory are higher Current tax liability is lower and ending inventory is higher Current tax liability is lower and cost of goods sold is higher ANSWER: NOTE: This question was released by the AICPA as a Regulation question, and while it relates to tax, it is actually more of a question related to financial accounting Therefore, the reference to the Becker textbooks is to the Financial textbook Choice "d" is correct Under LIFO, the last costs inventoried are the first costs transferred to cost of goods sold Ending inventory, thus, includes the oldest costs The ending balance of inventory will typically not approximate replacement cost, as it will under FIFO Further, LIFO generally does not reflect the actual flow of goods in a company because most companies sell their oldest goods first to prevent holding old or obsolete items This question asks about current and deferred income tax expenses and about current tax liability Therefore, it is focusing on the effects of LIFO vs FIFO on the income statement for tax expense It further asks about the impact on the balance sheet As discussed above, LIFO tends to match current revenues with current costs because (in a period of rising prices, as in this case) the cost of goods sold under LIFO tends to be higher than the cost of goods sold under FIFO The ending inventory under LIFO, however, tends to be lower than the ending inventory under FIFO, as the oldest goods are the ones still in inventory under LIFO So, cost of goods sold is higher under LIFO than under FIFO in a period of rising prices If the expense is higher on the tax return, then, the related income tax expense is lower Therefore, the current tax liability would be lower Choice "a" is incorrect As discussed above, LIFO tends to match current revenues with current costs because (in a period of rising prices, as in this case) the cost of goods sold under LIFO tends to be higher than the cost of goods sold under FIFO, not lower Also, the effect on deferred tax really depends on if ending inventory is higher or lower than beginning inventory, so we don't have enough information to evaluate deferred tax liability, asset, or expense Choice "b" is incorrect Cost of goods sold is higher under LIFO than under FIFO in a period of rising prices If the expense is higher on the tax return, then, the related income tax expense Therefore, the current tax liability would be lower, not higher Further, as discussed above, under LIFO (in a period of rising prices), ending inventory tends to be lower than under FIFO, not higher Choice "c" is incorrect Cost of goods sold is higher under LIFO than under FIFO in a period of rising prices If the expense is higher on the tax return, then, the related income tax expense Therefore, the current tax liability would be lower, as the option indicates However, as discussed above, under LIFO (in a period of rising prices), ending inventory tends to be lower than under FIFO, not higher - 30 - 2006 AICPA Newly-Released Regulation Questions A calendar-year individual is eligible to contribute to a deductible IRA The taxpayer obtained a fourmonth extension to file until August 15 but did not file the return until November What is the latest date that an IRA contribution can be made in order to qualify as a deduction on the prior year's return? a b c d October 15 April 15 August 15 November ANSWER: Choice "b" is correct For IRAs, the adjustment is allowed for a year ONLY if the contribution is made by the due date of the tax return for individuals (April 15) The due date for filing the tax return under a filing extension is NOT allowed (i.e., filing extensions are NOT considered) Choice "a" is incorrect, per the above explanation Choice "c" is incorrect, per the above explanation Choice "d" is incorrect, per the above explanation - 31 - 2006 AICPA Newly-Released Regulation Questions Barkley owns a vacation cabin that was rented to unrelated parties for 10 days during the year for $2,500 The cabin was used personally by Barkley for three months and left vacant for the rest of the year Expenses for the cabin were as follows: Real estate taxes Maintenance and utilities $1,000 $2,000 How much rental income (loss) is included in Barkley's adjusted gross income? a b c d $0 $500 $(500) $(1,500) ANSWER: RULE: If a vacation residence is rented for less than 15 days per year, it is treated as a personal residence The rental income is excluded from income, and mortgage interest (first or second home) and real estate taxes are allowed as itemized deductions Depreciation, utilities, and repairs are not deductible Choice "a" is correct Applying the rule above, if a vacation residence is rented for less than 15 days per year, it is treated as a personal residence The rental income ($2,500 in this case) is excluded from income A Schedule E is not filed for this property (i.e., no income is reported, the taxes are reported as itemized deductions, and the maintenance and utilities are not deductible), so the effect on AGI is zero Choice "b" is incorrect This assumes that the property taxes are reported as itemized deductions but that the rental income ($2,500) less the maintenance and utilities ($2,000) are reported net on Schedule E Per the above RULE, the rental income is excluded from income, and the maintenance and utilities are not deductible Choice "c" is incorrect This assumes that all of the items shown are reported net on the Schedule E— $2,500 - $1,000 - $2,000 = ($500) Per the above RULE, the rental income is excluded from income, the maintenance and utilities are not deductible, and the property taxes are reported on Schedule A as an itemized deduction Choice "d" is incorrect, per the above rule and discussion - 32 - 2006 AICPA Newly-Released Regulation Questions In the current year, Brown, a C corporation has gross income (before dividends) of $900,000 and deductions of $1,100,000 (excluding the dividends-received deduction) Brown received dividends of $100,000 from a Fortune 500 corporation during the current year What is Brown's net operating loss? a b c d $100,000 $130,000 $170,000 $200,000 ANSWER: RULES: A net operating loss (NOL) for corporations is the excess of deductions over gross income; however, the dividends received deduction is allowed to be deducted before calculating the NOL The dividends received deduction (DRD) for entities that are controlled 0% to