One test on the CPA exam is the most applicable to your day-to-day work as an accountant. The financial accounting and reporting (FAR) test covers topics related to accounting transactions and generating financial statements, and studying for this test can be overwhelming. This is the true number-crunching portion of the CPA exam and coming up with a study approach can be a challenge.
One way to attack this material is to have a good understanding of the hardest part of the FAR CPA Exam. Here are two difficult concepts that appear on every FAR test:
Hardest Part of the FAR CPA Exam: Pension accounting
A pension is an employee benefit that provides an income stream to an employee when that individual retires and the amount of the benefit is based on the worker’s salary and years of service. Pension accounting is tough because the language used for some of the accounting transactions is pretty vague. Also, unless you work specifically on audits of pensions or perform that accounting work, you may never have to deal with these concepts.
Defined benefit plans
Now, another area of confusion is that the CPA exam still asks many types of questions about defined benefit plans, while most CPA candidates work at firms that offer defined contribution plans. A defined benefit plan means that company has the liability to pay a specific pension amount to the worker, usually for the employee’s remaining life. However, most companies are shifting to defined contribution plans, which means that the company’s liability to make a specific payment ends once the pension contributions are made.
The bucket analogy
Another tool to understand pension accounting is to think of the pension dollars as being in a bucket. Pension contributions from both the company and the worker go into the bucket, and any earnings are reinvested into the bucket. On the other hand, pension expenses and payments to the worker come out of the bucket. If you can visualize that process, the accounting transactions will be clear to you.
Hardest Part of the FAR CPA Exam: Bond accounting
I started my career in the investment business selling corporate and municipal bonds to investors, and I’ve noticed that accounting for bonds is poorly explained in many cases. There is one bond concept, in particular, that is difficult for CPA candidates: bond premiums.
Bonds are issued at a face amount (or par amount) of $1,000 or in multiples of $1,000, so why would anyone pay more than $1,000 for a bond (a premium)? After all, you only receive $1,000 back when the bond matures. Well, the reason investors are willing to pay a premium is that the bond purchased pays a higher rate of interest than similar bonds.
For example, assume that you purchase a $1,000 of IBM corporate bond due in 10 years with a 6% interest rate. Bonds with a similar credit rating and maturity are currently being issued at 5%. It would make sense to pay more than $1,000 for the 6% bond, since you’ll earn more interest each year.
Say, for example, that you purchase the bond for $1,050, which means you’ll lose $50 when the bond matures at $1,000. Over the next 10 years, however, you earn $10 more in interest each year, since you’re earning 6% on $1,000 instead of 5%. So, you gain $100 more in interest, and lose $50 when the bond matures. Your total rate of return on the bond is a net gain of $50 ($100 – $50). The $50 bond premium is moved into an expense account over the bond’s 10-year life.
When you’re planning to study for the FAR test, make sure that you understand pension accounting and bond premiums. Once you’re familiar with these topics, you can approach the hardest part of the FAR CPA exam with confidence and pass the FAR test.