CPA Exam confusable pairs
18 distinctions the CPA Exam turns on, each stated in a sentence or two with the standard that governs it. These are the pairs candidates search as "X versus Y", and getting one backwards is worth more marks than any single fact.
What is the difference between type 1 subsequent event and type 2 subsequent event?
A Type 1 (recognized) event gives evidence about a condition that ALREADY EXISTED at the balance sheet date, so the statements are adjusted. A Type 2 (nonrecognized) event arises from a condition that came into existence AFTER the balance sheet date, so it is disclosed and never adjusted. The test is when the underlying condition arose, not when the entity found out. (ASC 855)
What is the difference between sales-type lease and direct financing lease?
Both are lessor finance leases. A sales-type lease meets one of the five classification criteria in ASC 842-10-25-2, and its selling profit is recognized immediately. A direct financing lease meets neither, qualifying instead under 842-10-25-3(b), and its selling profit is DEFERRED into the net investment. The usual decider is who guaranteed the residual: a lessee guarantee counts toward both tests, a third-party guarantee only toward direct financing. A selling loss is immediate under either one. (ASC 842)
What is the difference between qualified opinion and adverse opinion?
Both report a misstatement the auditor could not accept. A qualified opinion says the statements are fair EXCEPT FOR one matter that is material but not pervasive. An adverse opinion says the statements are not fair at all, which is what pervasive means. Pervasiveness, not size, is the line between them. (AU-C 705)
What is the difference between qualified opinion and disclaimer of opinion?
A qualified opinion is an opinion: the auditor obtained enough evidence and found one material problem. A disclaimer is the absence of an opinion, issued when a scope limitation is so pervasive the auditor could not obtain sufficient appropriate evidence to form one at all. Qualified answers the question with a carve-out; a disclaimer declines to answer. (AU-C 705)
What is the difference between carve-out method and inclusive method?
Both describe how a service organization treats a SUBSERVICE organization in its SOC report. The carve-out method excludes the subservice organization’s controls from the description and the opinion, leaving the user auditor to obtain assurance separately. The inclusive method brings them inside both. Carve-out is far more common, and it is the one that leaves a gap the user entity has to close. (AT-C 320)
What is the difference between sOC 1 Type 1 report and sOC 1 Type 2 report?
A Type 1 report covers the fairness of the description and the SUITABILITY OF THE DESIGN of controls at a point in time. A Type 2 report covers those plus the OPERATING EFFECTIVENESS of the controls over a period. Only a Type 2 supports reducing substantive testing, because only a Type 2 tests whether the controls actually ran. (AT-C 320)
What is the difference between accumulated adjustments account (AAA) and accumulated earnings and profits (E&P)?
AAA tracks the S corporation’s own undistributed taxed income. E&P is the C corporation residue carried into S status. A distribution from an S corporation with E&P runs AAA first, then dividend out of E&P, then remaining basis, then capital gain. The dividend layer never touches stock basis, which is the step candidates lose. (IRC Sec. 1368)
What is the difference between stock basis and debt basis?
An S corporation shareholder deducts losses against stock basis first, then against the basis of debt the corporation owes them DIRECTLY. A guarantee creates no debt basis until the shareholder actually pays, which is the sharpest break from partnership law under Sec. 752(a). Debt basis is restored before stock basis, so repaying a loan whose basis is still depressed produces income. (IRC Sec. 1366 and 1367)
What is the difference between inherent risk and control risk?
Inherent risk is the susceptibility of an assertion to misstatement BEFORE considering controls. Control risk is the risk that the entity’s controls fail to prevent or detect one. Both belong to the entity, and the auditor assesses rather than sets them. Detection risk is the only one the auditor controls, by changing the nature, timing and extent of procedures. (AU-C 315)
What is the difference between test of controls and substantive procedure?
A test of controls asks whether a control operated effectively. A substantive procedure asks whether the amount is correct. Testing controls is optional unless substantive procedures alone cannot provide sufficient appropriate evidence, and it is only worth doing when the auditor intends to rely on the control. (AU-C 330)
What is the difference between operating lease (lessee) and finance lease (lessee)?
Both put the same right-of-use asset and lease liability on the balance sheet with the same entry at commencement. Classification changes only the expense pattern and the caption: a finance lease reports front-loaded interest plus straight-line amortization, an operating lease reports one straight-line lease cost. Total expense over the term is identical either way. (ASC 842)
What is the difference between restricted fund balance and committed fund balance?
Restricted fund balance is constrained by an EXTERNAL party: a creditor, a grantor, another government, or enabling legislation. Committed fund balance is constrained by the government’s own highest level of decision-making authority, through a formal action taken before year end. External versus self-imposed is the whole distinction, and only the General Fund reports a positive unassigned balance. (GASB 54)
What is the difference between sampling risk and nonsampling risk?
Sampling risk is the risk that the conclusion based on a sample differs from the conclusion testing the entire population would have reached. It exists only because you sampled, and the lower the level of it you are willing to accept, the larger the sample has to be. Nonsampling risk is the risk of an erroneous conclusion for any reason NOT RELATED TO SAMPLING RISK: an inappropriate procedure, misinterpreting the evidence, or failing to recognize a misstatement that was in front of you. Sample size is not what reduces it. Adequate planning and the proper conduct of the firm’s practice are. (AU-C 530.05)
What is the difference between performance materiality and tolerable misstatement?
The standards relate them in one sentence and then insist they be kept apart. Performance materiality is set below materiality for the financial statements as a whole, and additionally below any lower materiality the auditor has set for particular classes of transactions, account balances or disclosures. Tolerable misstatement is “the application of performance materiality to a particular sampling procedure”, and it attaches to the population being sampled rather than to the sample itself. AU-C 320 ends its own definition by saying performance materiality is to be distinguished from tolerable misstatement. The mistake candidates make is assuming tolerable misstatement must be smaller: it may be the same amount. (AU-C 320.09 and AU-C 530.A6)
What is the difference between risk assessment procedure and substantive procedure?
They differ by purpose rather than technique, and one technique can serve either. A risk assessment procedure is designed and performed to identify and assess the risks of material misstatement at the financial statement and assertion levels. A substantive procedure is designed to detect material misstatement at the assertion level, and comprises exactly two things: tests of details and substantive analytical procedures. The reason risk assessment alone cannot carry an opinion is AU-C 330.18, which requires substantive procedures for each relevant assertion of each significant class of transactions, account balance and disclosure REGARDLESS of the assessed level of control risk. (AU-C 315 and AU-C 330.18)
What is the difference between existence assertion and completeness assertion?
They catch opposite errors, are tested in opposite directions, and the trap is which level each one lives at. Existence is an assertion about ACCOUNT BALANCES, that assets, liabilities and equity interests exist; its counterpart for classes of transactions is occurrence, not existence. Completeness appears in BOTH lists, so it has two opposites depending on the level. Existence and occurrence guard against overstatement and are tested by vouching, working from the recorded item back to the evidence. Completeness guards against understatement and is tested by tracing, working from the source document forward into the records. So confirming recorded receivables tests existence, while vouching recorded sales to shipping documents tests occurrence, because sales are a class of transactions. (AU-C 315.A219)
What is the difference between significant deficiency and material weakness?
Both are deficiencies in internal control OVER FINANCIAL REPORTING and the difference is severity. A material weakness is severe enough that there is a reasonable possibility a material misstatement will not be prevented, or detected and corrected, on a timely basis, where reasonable possibility means more than remote. A significant deficiency is less severe than that yet important enough to merit the attention of those charged with governance. Both go in writing to those charged with governance, including any remediated during the audit, and both also go in writing to management. A deficiency that is neither is still reported to management, in writing or orally, when it merits management’s attention, and an oral communication has to be documented. (AU-C 265.07 and AU-C 265.12)
What is the difference between quick ratio and cash ratio?
Receivables are the whole difference. The quick ratio adds cash, short-term marketable securities and net receivables, then divides by current liabilities. Subtracting inventory and prepaid expenses from current assets is the usual shortcut for the same figure, and the two agree only when the entity holds no other current assets, which real balance sheets often do hold. The cash ratio drops receivables as well, leaving cash, equivalents and marketable securities, which makes it the stricter of the two and the one that asks whether the entity could pay today. Neither is defined in the FASB codification. Both are conventions, and some sources exclude marketable securities from the cash ratio as well. (Financial statement analysis convention, not a codified standard)
Each answer states the rule and names the standard it comes from. The worked examples and the practice that makes a distinction automatic are in the PocketCPA lessons.