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Chapter 2: 6E (page 67)

(Assumptions, Principles, and Constraint) Presented below are the assumptions, principles, and constraints used in this chapter.

1. Economic entity assumption 6. Measurement principle (fair value)2. Going concern assumption 7. Expense recognition principle3. Monetary unit assumption 8. Full disclosure principle4. Periodicity assumption 9. Cost constraint5. Measurement principle (historical cost) 10. Revenue recognition principle

Instructions

Identify by number the accounting assumption, principle, or constraint that describes each situation below. Do not use a number more than once

.(a) Allocates expenses to revenues in the proper period.

(b) Indicates that fair value changes subsequent to purchase are not recorded in the accounts. (Do not use revenue recognition principle.)

(c) Ensures that all relevant financial information is reported.

(d) Rationale why plant assets are not reported at liquidation value. (Do not use historical cost principle.)

(e) Indicates that personal and business record keeping should be separately maintained.(f) Separates financial information into time periods for reporting purposes.

(g) Assumes that the dollar is the 鈥渕easuring stick鈥� used to report on financial performance.

Short Answer

Expert verified

a) Expense recognition principle, (b) Measurement principle (historical cost), (c) Full disclosure principle (d) Going concern assumption (e) Economic entity assumption (f) Periodicity assumption (g) Monetary unit assumption

Step by step solution

01

(a) Company has allocated expenses to revenues in proper order – Expense recognition principle

Expense recognition principle 鈥揟he expense recognition principle concept states that the company or the firm must recognize the expenses and revenues related to that expenses in the same period only.

Allocating the expenses to that revenues in chronological or proper order comes under the expense recognition principle.

02

(b) The fair value changes subsequent to the purchase that is not recorded in the accounts books – Measurement principle (Historical cost)

Historical cost principle 鈥揟he historical cost states that the prices of the assets must be recorded in the books of accounts at their original cost which is the amount that is spent to purchase that asset but not the market value.

The fair value of the asset changes but the original cost must be recorded in the books of accounts and comes under the measurement of historical cost principle.

03

(c) Recording all the transactions of the business – Full disclosure principle

Full disclosure principle 鈥揟he principle states that the company must record all the transactions of the business without hiding anything.

Ensuring that all the business transactions are recorded in the books of accounts comes under the full disclosure principle.

04

(d)  Plants or assets prices are not recorded as per liquidation value – Going concern assumption

Going concern assumption 鈥揑t states that the company or the entity runs for a longer period of time. That is the reason why the prices of the plants or assets are not recorded as per the liquidation value because the company runs for a longer period of time.

Ensuring that all the business assets that are not recorded in the books of accounts at their liquidated value come under the going concern assumption.

05

(e) Maintaining separate books for personal transactions and business transactions  – Economic entity assumption

Economic entity assumption 鈥揑t states that the transactions related to business and transactions related to personal expenses must be kept separately. Business and owner are two separate entities.

Ensuring that all the business transactions books and personal transactions books that are kept separately come under the Economic entity assumption.

06

(f) The financial information is divided into different time periods for reporting   – Periodicity assumption

Periodicity assumption 鈥揑t states that the transactions related to business can be reported in different time periods. The time periods can be monthly, quarterly, or annually.

Ensuring that all the business transactions are reported in different time periods comes under the Periodicity assumption.

07

(g) Dollar is the measuring stick that is used to report financial performance – Monetary unit assumption

Monetary unit assumption 鈥揑t states that money is considered the unit of measurement. All the business transactions should be expressed in terms of monetary value that is rupee, dollar, euro, and so on.

Ensuring that all the business transactions are expressed in terms of monetary value comes under the Monetary unit assumption.

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Most popular questions from this chapter

E2-2 (L01,2,3) (Usefulness, Objective of Financial Reporting, Qualitative Characteristics) Indicate whether the following statements about the conceptual framework are true or false. If false, provide a brief explanation supporting your position.

  1. The fundamental qualitative characteristics that make accounting information useful are relevance and verifiability.
  2. Relevant information only has predictive value, confirmatory value, or both.
  3. (c)Information that is a faithful representation is characterized as having predictive or confirmatory value.
  4. Comparability pertains only to the reporting of information in a similar manner for different companies.
  5. Verifiability is solely an enhancing characteristic for faithful representation.
  6. In preparing financial reports, it is assumed that users of the reports have reasonable knowledge of business and economic activities.

GROUPWORK (Accounting Principles and Assumptions鈥擟omprehensive) Presented below are a number of business transactions that occurred during the current year for Gonzales, Inc.

Instructions

In each of the situations, discuss the appropriateness of the journal entries in terms of generally accepted accounting principles.

(a) The president of Gonzales, Inc. used his expense account to purchase a new Suburban solely for personal use. The following journal entry was made.Miscellaneous Expense 29,000Cash 29,000

(b) Merchandise inventory that cost \(620,000 is reported on the balance sheet at \)690,000, the expected selling price less estimated selling costs. The following entry was made to record this increase in value.Inventory 70,000Sales Revenue 70,000

(c) The company is being sued for \(500,000 by a customer who claims damages for personal injury apparently caused by a defective product. Company attorneys feel extremely confident that the company will have no liability for damages resulting from the situation. Nevertheless, the company decides to make the following entry.Loss from Lawsuit 500,000Liability for lawsuit 500,000

(d) Because the general level of prices increased during the current year, Gonzales, Inc. determined that there was a \)16,000 understatement of depreciation expense on its equipment and decided to record it in its accounts. The following entryDepreciation Expense 16,000Accumulated Depreciation Equipment 16,000

(e) Gonzales, Inc. has been concerned about whether intangible assets could generate cash in case of liquidation. As a consequence, goodwill arising from a purchase transaction during the current year and recorded at \(800,000 was written off as follows.

(f) Because of a 鈥渇ire sale.鈥� equipment obviously worth \)200,000 was acquired at a cost of $155,000. The following entry was made.Equipment 2000Cash 155,000Sales Revenue 45,000

What are the four basic assumptions that underlie the financial accounting structure?

Question: Comment on the appropriateness of the accounting procedures followed by Cramer, Inc.

a. Depreciation expense on the building for the year was \(60,000. Because the building was increasing in value during the year, the controller decided to charge the depreciation expense to retained earnings instead of to net income. The following entry is recorded.

Retained Earnings 60,000

Accumulated Depreciation鈥擝uildings 60,000

b. Materials were purchased on January 1, 2017, for \)120,000 and this amount was entered in the Materials account. On December 31, 2017, the materials would have cost \(141,000, so the following entry is made.

Inventory 21,000

Gain on Inventories 21,000

c. During the year, the company purchased equipment through the issuance of common stock. The stock had a par value of \)135,000 and a fair value of \(450,000. The fair value of the equipment was not easily determinable. The company recorded this transaction as follows.

Equipment 135,000

Common Stock 135,000

d. During the year, the company sold certain equipment for \)285,000, recognizing a gain of \(69,000. Because the controller believed that new equipment would be needed in the near future, she decided to defer the gain and amortize it over the life of any new equipment purchased.

e. An order for \)61,500 from a customer for products on hand. This order was shipped on January 9, 2018. The company made the following entry in 2017.

Accounts Receivable 61,500

Sales Revenue 61,500

Question: What are some of the costs of providing accounting information? What are some of the benefits of accounting information? Describe the cost-benefit factors that should be considered when new accounting standards are being proposed.
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