Practice Business Analysis & Reporting (BAR) questions for the Certified Public Accountant Exam. Every question includes a full explanation of why the correct answer is right and why the tempting distractors are wrong.
10 example questions with full explanations. Use the interactive practice above to work through the complete set.
Question 1medium
Pinnacle Corp. is evaluating a capital project requiring an initial investment of $500,000. The project is expected to generate after-tax cash flows of $140,000 per year for 5 years. The company's required rate of return is 10%. The present value annuity factor for 5 years at 10% is 3.7908. What is the net present value (NPV) of the project, and should the company accept it?
- A.NPV = ($30,712); reject the project
- B.NPV = $30,712; accept the project✓
- C.NPV = $200,000; accept the project
- D.NPV = $700,000; accept the project
Correct answer: B
NPV = (Annual Cash Flow × PV Annuity Factor) – Initial Investment = ($140,000 × 3.7908) – $500,000 = $530,712 – $500,000 = $30,712. Since NPV is positive, the project should be accepted because it generates returns above the required rate of return. Option A incorrectly subtracts in the wrong order, yielding a negative NPV. Option C uses the undiscounted total cash flows ($140,000 × 5 = $700,000) minus $500,000, ignoring the time value of money. Option D simply sums undiscounted cash flows without subtracting the initial investment.
Question 2medium
Skyline Company is deciding whether to make a component internally or buy it from an external supplier. The following annual costs apply if the component is made internally: Direct materials: $80,000; Direct labor: $55,000; Variable overhead: $25,000; Fixed overhead (unavoidable): $40,000; Fixed overhead (avoidable): $20,000. The external supplier's price is $185,000 per year. What is the relevant cost comparison, and what decision should Skyline make?
- A.Make cost = $220,000; buy from supplier to save $35,000
- B.Make cost = $200,000; buy from supplier to save $15,000
- C.Make cost = $180,000; make internally to save $5,000✓
- D.Make cost = $160,000; make internally to save $25,000
Correct answer: C
For make-or-buy decisions, only relevant (avoidable) costs are considered. Unavoidable fixed overhead is irrelevant because it will be incurred regardless of the decision. Relevant make cost = Direct materials + Direct labor + Variable overhead + Avoidable fixed overhead = $80,000 + $55,000 + $25,000 + $20,000 = $180,000. Since the buy cost is $185,000 and the relevant make cost is $180,000, Skyline should make the component internally, saving $5,000. Option A ($220,000) incorrectly includes all fixed overhead, both avoidable and unavoidable. Option B ($200,000) includes the unavoidable fixed overhead instead of the avoidable portion. Option D ($160,000) omits the avoidable fixed overhead entirely.
Question 3medium
Hawthorne Industries has the following data for the current year: beginning inventory $150,000, ending inventory $250,000, and cost of goods sold $1,600,000. A competing firm in the same industry has an inventory turnover ratio of 9.0. Which of the following correctly states Hawthorne's inventory turnover ratio and its implication relative to the competitor?
- A.6.4 times; Hawthorne turns inventory more slowly than its competitor, suggesting potential excess inventory or weaker sales.
- B.8.0 times; Hawthorne turns inventory faster than its competitor, suggesting stronger inventory management.
- C.10.7 times; Hawthorne turns inventory faster than its competitor, suggesting stronger inventory management.
- D.8.0 times; Hawthorne turns inventory more slowly than its competitor, suggesting potential excess inventory or weaker sales.✓
Correct answer: D
Inventory turnover = COGS / Average Inventory. Average inventory = ($150,000 + $250,000) / 2 = $200,000. Turnover = $1,600,000 / $200,000 = 8.0 times. Since 8.0 < 9.0 (competitor), Hawthorne turns inventory more slowly, which may indicate excess or slow-moving inventory. Option A incorrectly uses ending inventory alone ($1,600,000 / $250,000 = 6.4). Option B reaches the right ratio but draws the wrong competitive conclusion. Option C incorrectly uses beginning inventory alone ($1,600,000 / $150,000 ≈ 10.7), a common error when candidates forget to average the two inventory balances.
Question 4medium
Clover Manufacturing prepared the following common-size income statement percentages for two consecutive years:
| Item | Year 2 | Year 1 |
|-------------------|--------|--------|
| Net Sales | 100% | 100% |
| Cost of Goods Sold| 58% | 52% |
| Gross Profit | 42% | 48% |
| Operating Expenses| 28% | 30% |
| Operating Income | 14% | 18% |
Actual net sales increased from $5,000,000 in Year 1 to $6,000,000 in Year 2. What is the dollar change in gross profit from Year 1 to Year 2, and what is the most likely interpretation?
- A.Gross profit increased by $120,000; however, as a percentage of sales, gross margin declined, signaling rising production costs relative to revenue.✓
- B.Gross profit decreased by $120,000; the decline in both absolute dollars and gross margin percentage confirms deteriorating profitability.
- C.Gross profit increased by $120,000; the improved gross margin percentage confirms enhanced pricing power.
- D.Gross profit increased by $420,000; the increase in absolute dollars reflects stronger profitability despite stable margins.
Correct answer: A
Year 1 gross profit = $5,000,000 × 48% = $2,400,000. Year 2 gross profit = $6,000,000 × 42% = $2,520,000. Change = $2,520,000 − $2,400,000 = +$120,000 increase in absolute dollars. However, the gross margin percentage fell from 48% to 42%, indicating that COGS grew faster than sales—a sign of rising production or input costs. Option B is wrong because absolute gross profit did increase. Option C misinterprets the percentage decline as an improvement. Option D arrives at an incorrect dollar figure by subtracting the margin percentages and applying them incorrectly.
Question 5medium
Redstone Industries is evaluating a potential investment using the profitability index (PI). The project requires an initial investment of $500,000 and is expected to generate present values of future cash inflows of $620,000. The company's required rate of return is 10%. Based on this information, what is the profitability index, and what decision should management make?
- A.PI = 0.81; reject the project because PI < 1.0
- B.PI = 1.24; accept the project because PI > 1.0✓
- C.PI = 1.24; reject the project because PI exceeds the required rate of return
- D.PI = 1.10; accept the project because it equals the cost of capital
Correct answer: B
The profitability index is calculated as PV of future cash inflows ÷ Initial investment = $620,000 ÷ $500,000 = 1.24.BPI greater than 1.0 indicates that the present value of inflows exceeds the initial outlay, meaning the project creates value and should be accepted. Option A inverts the ratio ($500,000 ÷ $620,000 = 0.81), a common arithmetic error. Option C correctly calculates the PI but misinterprets the decision rule; a PI > 1.0 always signals acceptance, not rejection. Option D uses an unsupported value of 1.10.
Question 6medium
An analyst is performing a vertical (common-size) analysis of Horizon Corp.'s income statement for two consecutive years. In Year 1, cost of goods sold (COGS) was $1,200,000 and net sales were $3,000,000. In Year 2, COGS increased to $1,540,000 and net sales grew to $3,500,000. Which of the following best describes the result of the vertical analysis, and what does it indicate?
- A.COGS as a percentage of sales decreased from 44% to 40%, indicating improving cost control relative to revenue
- B.COGS increased by $340,000 in absolute terms, indicating a 28.3% increase in operational inefficiency
- C.COGS as a percentage of sales increased from 40% to 44%, indicating deteriorating cost control relative to revenue✓
- D.COGS as a percentage of sales remained constant at 40% in both years, indicating stable cost management
Correct answer: C
Vertical analysis expresses each income statement line item as a percentage of net sales. Year 1: $1,200,000 ÷ $3,000,000 = 40%. Year 2: $1,540,000 ÷ $3,500,000 = 44%. COGS as a percentage of sales rose from 40% to 44%, meaning the company is spending more on goods relative to revenue, which signals deteriorating cost control or pricing pressure. Option A reverses the direction of the change. Option B describes a horizontal (trend) analysis calculation, not a vertical analysis, and incorrectly labels the finding as 'operational inefficiency' without proper context. Option D is factually incorrect since Year 2 COGS% is 44%, not 40%.
Question 7hard
A company has the following data: Net Income = $120,000; Interest Expense = $30,000; Tax Rate = 25%; Total Debt = $400,000; Total Equity = $600,000; EBIT = $190,000. The company's interest coverage ratio is 6.33, and because this ratio exceeds 5.0, the debt-to-assets ratio must be below 0.40.
Correct answer: B
The interest coverage ratio is EBIT / Interest Expense = $190,000 / $30,000 = 6.33, so that part is correct. However, the interest coverage ratio and the debt-to-assets ratio are independent metrics and one cannot be inferred from the other. Here, Total Assets = Total Debt + Total Equity = $400,000 + $600,000 = $1,000,000, so Debt-to-Assets = $400,000 / $1,000,000 = 0.40, not below 0.40. Even if the interest coverage ratio were much higher, the debt-to-assets ratio could still be 0.40 or above depending on the capital structure. The statement is false because it incorrectly asserts a logical relationship between two unrelated ratios.
Question 8hard
Alderton Corp. is evaluating a project with the following cash flows: Year 0 = -$500,000; Year 1 = $200,000; Year 2 = $200,000; Year 3 = $200,000. The company's WACC is 10%. The profitability index (PI) of this project is greater than 1.0, meaning the project should be accepted.
Correct answer: B
The Profitability Index (PI) = PV of future cash flows / Initial Investment. PV = $200,000 / 1.10 + $200,000 / 1.21 + $200,000 / 1.331 = $181,818 + $165,289 + $150,263 = $497,370. PI = $497,370 / $500,000 = 0.9947, which is less than 1.0. A PI below 1.0 means the present value of future cash flows does not cover the initial investment, so the project has a negative NPV (approximately -$2,630) and should be rejected. The statement is false because it incorrectly concludes the PI exceeds 1.0.
Question 9hard
Under activity-based costing (ABC), when a traditionally overhead-allocated product line is subjected to ABC analysis and its assigned overhead increases significantly, it is possible that the product line was previously undercosted, meaning it was actually less profitable than traditional costing suggested — and this is a valid and expected outcome of implementing ABC.
Correct answer: A
This statement is true. ABC allocates overhead based on the actual consumption of cost drivers rather than a single volume-based rate (e.g., direct labor hours). Products that consume a disproportionate share of overhead activities (e.g., complex setups, special handling) are often undercosted under traditional systems because their true resource consumption is masked by averaging. When ABC reveals higher overhead costs for such products, it means they were previously undercosted — their reported profits were overstated. This is one of the primary purposes of implementing ABC: to improve cost accuracy and reveal cross-subsidization among product lines.
Question 10hard
Riverton Inc. has current-year revenues of $2,000,000 and prior-year revenues of $1,600,000. Current-year cost of goods sold is $1,300,000 (current year) versus $1,100,000 (prior year). A horizontal analysis shows that while revenues grew by 25%, gross profit grew by approximately 33.3%, indicating that the company improved its gross margin percentage year-over-year.
Correct answer: B
Prior-year gross profit = $1,600,000 − $1,100,000 = $500,000. Current-year gross profit = $2,000,000 − $1,300,000 = $700,000. Horizontal growth in gross profit = ($700,000 − $500,000) / $500,000 = $200,000 / $500,000 = 40.0%, not 33.3% as stated. While gross margin did improve (from 31.25% to 35.0%), the specific percentage cited in the horizontal analysis is incorrect. The statement is false because the 33.3% growth figure is arithmetically wrong; the correct horizontal analysis shows a 40% increase in gross profit.