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Section 2 of 7

CSLB Financial Reporting Practice Questions

10 free practice questions on financial reporting, part of the Business Finances section (about 15% of the exam). Try each one, then open the answer: every choice is explained and the law is quoted.

Questions and answers

  1. Business Finances

    1. Which financial statement shows a contractor's income and expenses for a period of time, such as one year?

    • A. A balance sheet on a given date
    • B. An income (profit and loss) statement
    • C. A bank reconciliation for the month
    • D. A depreciation worksheet for the assets
    Show answer

    Correct answer: B

    • A. A balance sheet on a given date

      A balance sheet shows assets, liabilities, and equity on one date, not income and expenses for a period of time.

    • B. An income (profit and loss) statement

      Correct answer

      IRS Publication 583 says an income statement shows the income and expenses of the business for a given period of time. It is also called a profit and loss statement.

    • C. A bank reconciliation for the month

      A bank reconciliation is a record, not the statement that shows income and expenses for a period of time.

    • D. A depreciation worksheet for the assets

      A depreciation worksheet is a record, not the statement that shows income and expenses for a period of time.

    Explanation

    IRS Publication 583 says an income statement shows the income and expenses of the business for a given period of time. It is also called a profit and loss statement. A balance sheet shows assets, liabilities, and equity on one date, not income for a period. A bank reconciliation and a depreciation worksheet are records, not the statement of income and expenses.

    Source

  2. Business Finances

    2. A cash-method contractor receives a customer's check on December 28, 2026. It waits until January 2027 to deposit the check so the income will count in 2027. According to IRS Publication 538, is this allowed?

    • A. Yes, because cash-method income counts when it is deposited
    • B. Yes, if the check is deposited within 30 days
    • C. No, the income must be reported in 2026
    • D. No, the income must be split between both years
    Show answer

    Correct answer: C

    • A. Yes, because cash-method income counts when it is deposited

      You cannot hold checks to put off paying tax; income is reported in the year it is received or made available to you without restriction, not when it is deposited.

    • B. Yes, if the check is deposited within 30 days

      There is no 30-day rule; the check was received in December 2026, so the income belongs in 2026.

    • C. No, the income must be reported in 2026

      Correct answer

      IRS Publication 538 says you cannot hold checks to postpone tax and must report the income in the year it is received or made available to you without restriction. The check was received in December 2026.

    • D. No, the income must be split between both years

      The income is not split between years; it is reported in 2026, the year the check was received.

    Explanation

    IRS Publication 538 says you cannot hold checks or delay taking possession of property from one tax year to the next to put off paying tax. You must report the income in the year it is received or made available to you without restriction. The check was received in December 2026, so the income belongs in 2026. Waiting to deposit it does not move the income, and there is no 30-day rule or split between years.

    Source

  3. Business Finances

    3. A contractor drove a pickup 24,000 miles this year: 18,000 miles for business and 6,000 miles for personal use. Using actual expenses, what percent of the truck's operating costs is a business expense?

    • A. 25%
    • B. 33%
    • C. 75%
    • D. 100%
    Show answer

    Correct answer: C

    • A. 25%

      25% is the personal share (6,000 / 24,000), not the business share.

    • B. 33%

      33% wrongly divides personal miles by business miles (6,000 / 18,000) instead of business miles by total miles.

    • C. 75%

      Correct answer

      Pub. 583 lets you divide expenses by miles driven, so the business share is 18,000 / 24,000 = 75%.

    • D. 100%

      100% ignores the 6,000 personal miles. Pub. 583 says a vehicle used for both business and personal purposes must have its expenses divided between the two.

    Explanation

    IRS Publication 583 says that if you use a vehicle for both business and personal purposes, you must divide the expenses between business and personal use, and you can divide them by miles driven. Step 1: Business share = business miles / total miles. Step 2: 18,000 / 24,000 = 0.75 = 75%. Choosing 25% is the personal share. Choosing 33% divides personal miles by business miles (6,000 / 18,000). Choosing 100% ignores the personal use.

    Source

  4. Business Finances

    4. A contractor filed its income tax return on time. It reported all of its income, and the return was not fraudulent. According to IRS Publication 583, what is the usual period of limitations for the IRS to assess more tax on that return?

    • A. 2 years after filing
    • B. 3 years after filing
    • C. 6 years after filing
    • D. 7 years after filing
    Show answer

    Correct answer: B

    • A. 2 years after filing

      Wrong. Two years is part of the rule for claims for credit or refund, not the usual period for owing additional tax.

    • B. 3 years after filing

      Correct answer

      Correct. Pub. 583 Table 3 gives 3 years when you owe additional tax and none of the special situations apply, counted from when the return was filed.

    • C. 6 years after filing

      Wrong. The 6-year period applies only when unreported income is more than 25% of the gross income shown on the return, and this contractor reported all its income.

    • D. 7 years after filing

      Wrong. 7 years is not the general period in Table 3; the usual period for owing additional tax is 3 years.

    Explanation

    IRS Publication 583, Table 3, says the period of limitations is 3 years when you owe additional tax and none of the special situations apply. The special situations are leaving out more than 25% of gross income, filing a fraudulent return, and not filing a return; none of them applies here. The years refer to the period after the return was filed. The 6-year period applies only when unreported income is more than 25% of the gross income shown on the return. Two years is part of the rule for claims for credit or refund, and 7 years is not the general period in the table.

    Sources

  5. Business Finances

    5. A contractor's business is privately owned. Its office manager asks whether the company's financial statements must follow GAAP (generally accepted accounting principles). According to the SBA, what is the answer?

    • A. Yes, every business with employees must follow GAAP
    • B. No, private companies are not required to follow GAAP
    • C. Yes, the CSLB requires GAAP for every licensed contractor
    • D. No, because GAAP applies only to cash-method businesses
    Show answer

    Correct answer: B

    • A. Yes, every business with employees must follow GAAP

      The SBA says private companies are not required to follow GAAP, and having employees does not by itself change that.

    • B. No, private companies are not required to follow GAAP

      Correct answer

      Correct. The SBA says private companies aren't required to follow GAAP.

    • C. Yes, the CSLB requires GAAP for every licensed contractor

      Holding a contractor's license does not by itself make GAAP required; the SBA says private companies are not required to follow GAAP.

    • D. No, because GAAP applies only to cash-method businesses

      GAAP uses the accrual method, not the cash method, so it is not a rule only for cash-method businesses.

    Explanation

    The SBA says private companies are not required to follow GAAP. GAAP is a common way to standardize financial reporting, and it uses the accrual method, not the cash method. The SBA's statement covers all private companies, so having employees or a contractor's license does not by itself make GAAP required. The SBA also notes that the Financial Accounting Standards Board (FASB) maintains GAAP in the United States.

    Sources

  6. Business Finances

    6. A small contractor keeps no books or records. It wants its tax year to end on September 30. According to IRS Publication 538, what tax year must it use?

    • A. A fiscal year ending September 30, as it wants
    • B. A 52-53-week year that ends near September 30
    • C. Any 12 months in a row, if it files on time
    • D. The calendar year, from January 1 to December 31
    Show answer

    Correct answer: D

    • A. A fiscal year ending September 30, as it wants

      A taxpayer that keeps no books or records must adopt the calendar year, so it cannot choose a fiscal year ending September 30.

    • B. A 52-53-week year that ends near September 30

      Because it keeps no books or records, it must adopt the calendar year, not a 52-53-week year.

    • C. Any 12 months in a row, if it files on time

      Filing on time does not change the rule. A taxpayer that keeps no books or records must adopt the calendar year.

    • D. The calendar year, from January 1 to December 31

      Correct answer

      Correct. IRS Publication 538 says you must adopt the calendar year if you keep no books or records.

    Explanation

    IRS Publication 538 says that generally anyone can adopt the calendar year, but a taxpayer must adopt the calendar year if it keeps no books or records. Because this contractor keeps no books or records, it cannot choose a fiscal year ending September 30 or a 52-53-week year. Filing on time does not change this rule.

    Source

  7. Business Finances

    7. A contractor's old job records are no longer needed for federal tax purposes. According to IRS Publication 583, what should it do before it throws them away?

    • A. Get written permission from the IRS to destroy the records
    • B. Send copies of the records to the IRS for storage
    • C. Nothing, because records may be discarded once tax needs end
    • D. Check whether its insurance company or creditors need them longer
    Show answer

    Correct answer: D

    • A. Get written permission from the IRS to destroy the records

      IRS Publication 583 does not require IRS permission to destroy records. It only says to check whether you must keep them longer for other purposes.

    • B. Send copies of the records to the IRS for storage

      The publication does not ask you to send copies of records to the IRS for storage.

    • C. Nothing, because records may be discarded once tax needs end

      The end of the tax need alone is not enough. Pub. 583 says not to discard records until you check whether you must keep them longer for other purposes.

    • D. Check whether its insurance company or creditors need them longer

      Correct answer

      Correct. Pub. 583 says to check whether you must keep the records longer for other purposes, for example because your insurance company or creditors may require it.

    Explanation

    IRS Publication 583 says that when records are no longer needed for tax purposes, you should not discard them until you check whether you must keep them longer for other purposes. It gives the example that an insurance company or creditors may require you to keep records longer than the IRS does. The publication does not require IRS permission or copies sent to the IRS. The end of the tax need alone is not enough reason to discard them.

    Source

  8. Business Finances

    8. A contractor keeps an inventory of copper wire for sale. Copper prices rose all year. Closing inventory is the inventory on hand at the end of the year. According to IRS Publication 538, compared with FIFO, what does the LIFO method generally produce?

    • A. A smaller cost of goods sold and a higher closing inventory
    • B. A larger cost of goods sold and a higher closing inventory
    • C. A larger cost of goods sold and a lower closing inventory
    • D. The same cost of goods sold but a lower closing inventory
    Show answer

    Correct answer: C

    • A. A smaller cost of goods sold and a higher closing inventory

      A smaller cost of goods sold with a higher closing inventory describes FIFO when prices are rising, not LIFO.

    • B. A larger cost of goods sold and a higher closing inventory

      LIFO does produce a larger cost of goods sold when prices rise, but its closing inventory is lower, not higher.

    • C. A larger cost of goods sold and a lower closing inventory

      Correct answer

      Correct. Pub. 538 says that when prices are rising, LIFO produces a larger cost of goods sold and a lower closing inventory.

    • D. The same cost of goods sold but a lower closing inventory

      The two methods give different results when prices change. When prices rise, LIFO gives a larger cost of goods sold than FIFO.

    Explanation

    IRS Publication 538 says that when prices are rising, LIFO (last-in first-out) produces a larger cost of goods sold and a lower closing inventory. Under FIFO (first-in first-out), cost of goods sold is lower and closing inventory is higher. A smaller cost of goods sold with a higher closing inventory describes FIFO, not LIFO. The two methods give different results when prices change, so the cost of goods sold is not the same.

    Source

  9. Business Finances

    9. A bank asks a contractor for a statement that shows the business's assets, liabilities, and owner's equity on December 31. Which statement is this?

    • A. An income (profit and loss) statement
    • B. A monthly summary of the cash receipts
    • C. A check disbursements journal for December
    • D. A balance sheet as of December 31
    Show answer

    Correct answer: D

    • A. An income (profit and loss) statement

      An income statement shows income and expenses over a period of time, not assets, liabilities, and equity on one date.

    • B. A monthly summary of the cash receipts

      A summary of cash receipts is a record used to build the books, not a statement of assets, liabilities, and equity.

    • C. A check disbursements journal for December

      A check disbursements journal is a record used to build the books, not a statement of assets, liabilities, and equity.

    • D. A balance sheet as of December 31

      Correct answer

      IRS Publication 583 says a balance sheet shows the assets, liabilities, and your equity in the business on a given date, here December 31.

    Explanation

    IRS Publication 583 says a balance sheet shows the assets, liabilities, and your equity in the business on a given date. An income statement shows income and expenses over a period of time instead. A summary of cash receipts and a check disbursements journal are records used to build the books, not a statement of assets and liabilities.

    Source

  10. Business Finances

    10. A contractor uses the cash method of accounting. It finishes a job and bills the customer in December 2026. The customer pays in January 2027. In which tax year does the contractor report this income?

    • A. 2026, because the work was finished then
    • B. Half in 2026 and half in 2027
    • C. In whichever year the contractor chooses
    • D. 2027, because payment was received then
    Show answer

    Correct answer: D

    • A. 2026, because the work was finished then

      Reporting income when the work was finished is the accrual idea; under the cash method you report income in the tax year you receive it.

    • B. Half in 2026 and half in 2027

      The contractor cannot split the income; under the cash method it is reported in the tax year it is received, which is 2027.

    • C. In whichever year the contractor chooses

      The contractor cannot pick the year; under the cash method income is reported in the tax year it is received.

    • D. 2027, because payment was received then

      Correct answer

      IRS Publication 583 says that under the cash method you report income in the tax year you receive it. The customer paid in January 2027, so the income belongs in 2027.

    Explanation

    IRS Publication 583 says that under the cash method, you report income in the tax year you receive it. The customer paid in January 2027, so the income belongs in 2027. Reporting it when the work was finished is the accrual idea, not the cash method. The contractor cannot split the income or pick the year.

    Source

Keep studying

Read the Section 2 study notes: Business Finances