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Chapter 2: 9E (page 68)

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

Short Answer

Expert verified

All journal entry situation given in the question are incorrect in terms of generally accepted accounting principles.

Step by step solution

01

Generally Accepted Accounting Principles (GAAP)

The Generally Accepted Accounting Principles are the standards and guidelines for accounting and reporting of financial information. These are commonly followed principles that aim to ensure that the financial reporting is transparent, consistent, and comparable. They enhance the quality of the financial statements for their users.

02

Journal entry of miscellaneous expense

(a) As per GAAP, only those transactions that have economic substance or include an economic activity should be included in the books of accounts of the company. In the given transaction, the president bought a car for personal use. Such expenditure is not business expenditure.

Hence, the journal entry is incorrect in terms of generally accepted accounting principles.

03

Journal entry of inventory

(b) As per GAAP, the inventory must be recorded at lower of cost or net realizable value, whichever is lower. In this given case, the cost of the inventory is $620,000 and its net realizable value is $690,000. Thus, the inventory should be recorded at $620,000 which is lower.

Hence, the journal entry is incorrect in terms of generally accepted accounting principles.

04

Journal entry of loss from law suit

(c) As per GAAP, a contingent liability is only recorded when amount of the liability is ascertained, and the management is of the opinion that the liability will likely arise. Here, the amount of the contingent liability is ascertained, i.e., $500,000 but the company鈥檚 attorney is not of the opinion that they might lose the lawsuit. Therefore, the company should not record the liability, rather disclose it the notes to accounts of the financial statements.

Hence, the journal entry is incorrect in terms of generally accepted accounting principles.

05

Journal entry of depreciation expense

(d) As per GAAP, the depreciation expense is calculated on the historical cost or book value of the asset at which it is recorded. Any increase or decrease in the general price level does not affect the cost or book value of the asset. Therefore, the amount of depreciation shall also not change on account of any increase or decrease in the general price level.

Hence, the journal entry is incorrect in terms of generally accepted accounting principles.

06

Journal entry of Goodwill

(e) As per GAAP, the goodwill recorded in the books of a business entity arising from a purchase transaction is amortized over it鈥檚 an estimated useful life/economic life. Therefore, the company must not write-off all of the goodwill at once.

Hence, the journal entry is incorrect in terms of generally accepted accounting principles.

07

Journal entry of Equipment

(f) As per GAAP, any asset that is acquired/purchased by a business entity must be recorded at its cost. The cost of an asset comprises of its purchase price, custom duties, taxes, freight and transportation cost, and installation cost. The amount of discount availed on such purchase must be deducted from the total cost of the asset. Here, the purchase price of the asset is $155,000 and therefore, the cost of the asset shall be $155,000 only.

Hence, the journal entry is incorrect in terms of generally accepted accounting principles.

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Most popular questions from this chapter

Identify which basic assumption of accounting is best described in each item below.

a)The economic activities of FedEx Corporation are divided into 12-month periods for the purpose of issuing annual reports.

b)Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation.

c)Walgreen Co. reports current and non-current classifications in its balance sheet.

d)The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes.

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: Daniel Barenboim sells and erects shell houses, that is, frame structures that are completely finished on the outside but are unfinished on the inside except for flooring, partition studding, and ceiling joists. Shell houses are sold chiefly to customers who are handy with tools and who have time to do the interior wiring, plumbing, wall completion and finishing, and other work necessary to make the shell houses liveable dwellings.Barenboim buys shell houses from a manufacturer in unassembled packages consisting of all lumber, roofing, doors, windows and similar materials necessary to complete a shell house. Upon commencing operations in a new area, Barenboim buys or leases land as a site for its local warehouse, field office, and display houses. Sample display houses are erected at a total cost of \(30,000 to \)40,000 including the cost of the unassembled packages. The chief element of cost of display houses is the unassembled packages, in as much as erection is a short, low-cost operation. Old sample models are torn down or altered into new models every 3 to 7 years. Sample display houses have little salvage value because dismantling and moving costs amount to nearly as much as the cost of an unassembled package.Instructions

  1. A choice must be made between (1) expensing the costs of sample display houses in the periods in which the expenditure is made and (2) spreading the costs over more than one period. Discuss the advantages of each method.
  2. Would it be preferable to amortize the cost of display houses on the basis of (1) the passage of time or (2) the number of shell houses sold? Explain.

Question: Which of the following statements about the IASB and FASB conceptual frameworks is not correct?

  1. The IASB conceptual framework does not identify the element comprehensive income.
  2. The existing IASB and FASB conceptual frameworks are organized in similar ways.
  3. The FASB and IASB agree that the objective of financial reporting is to provide useful information to investors and creditors.
  4. IFRS does not allow use of fair value as a measurement basis.

What are the five steps used to determine the proper time to recognize revenue?
See all solutions

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