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Chapter 2: Q2-13Q (page 61)

The life of a business is divided into specific time periods, usually, a year, to measure results of operations for each such time period and to portray financial conditions at the end of each period.

  1. This practice is based on the accounting assumption that the life of the business consists of a series of time periods and that it is possible to measure accurately the results of operations for each period. Comment on the validity and necessity of this assumption.
  2. What has been the effect of the practice on accounting? What is its relation to the accrual system? What influence has it had on accounting entries and methodology?

Short Answer

Expert verified
  1. Time period assumption allows the accountant to estimate the progress of the firm and compare it with other organizations. It is essential to separate it into different periods so that the interested parties can make a periodical assessment of its performance.
  2. The periodic assumption has caused various accounting issues like depreciation of long-term assets as well as inventory pricing. The accrual system demands combining related revenues as well as expenses. Different accounting practices make periodical computations as precise as possible and also realize that it鈥檚 temporary in nature.

Step by step solution

01

Meaning of accounting assumption

Accounting assumptions are the basic assumptions underlying the practice and theory of financial accounting. They are broad working conventions for entire activities of accounting developed and accepted in the accounting profession. It brings about conformity in accounting practices.

02

The explanation for ‘a’

It is usually accepted in accounting that any measures of the progress of an enterprise for periods less than its entire life are temporary in nature and are subject to rectification. Estimation of progress and position for inconsistent time periods is essential to assist those who must take part in making decisions. It is not the consequence of presuming definite time periods as a measurable part of an entire life.

03

The explanation for ‘b’

The practice of measuring periodically has caused various accounting issues such as the depreciation of long-term assets, pricing of inventory as well as the need for revenue recognition tests. The accrual system demands connecting associated revenues as well as expenses, which becomes tough for an absolute time period with partial transactions in process at both the beginning as well as ending of the period. Many accounting practices like adjusting entries or recording corrections of previous periods arise directly from making computations of each period as correct as possible and identifying that they are interim in nature.

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Most popular questions from this chapter

Match the qualitative characteristics below with the following statements.1. Timeliness 5. Faithful representation2. Completeness 6. Relevance3. Free from error 7. Neutrality4. Understandability 8. Confirmatory value

  1. Quality of information that assures users that information represents the economic phenomena that it purports to represent.
  2. Information about an economic phenomenon that corrects past or present expectations based on previous evaluations.
  3. The extent to which information is accurate in representing the economic substance of a transaction.
  4. Includes all the information that is necessary for a faithful representation of the economic phenomena that it purports to represent.
  5. Quality of information that allows users to comprehend its meaning.

Question: The AICPA Special Committee on Financial Reporting proposed the following constraints related to financial reporting.

  1. Business reporting should exclude information outside of management鈥檚 expertise or for which management is not the best source, such as information about competitors.

  2. Management should not be required to report information that would significantly harm the company鈥檚 competitive position.

  3. Management should not be required to provide forecasted financial statements. Rather, management should provide information that helps users forecast themselves the company鈥檚 financial future.

  4. Other than for financial statements, management need report only the information it knows. That is, management should be under no obligation to gather information it does not have, or does not need, to manage the business.

  5. Companies should present certain elements of business reporting only if users and management agree they should be reported- a concept of flexible reporting.

  6. Companies should not have to report forward-looking information unless there are effective deterrents to unwarranted litigation that discourages companies from doing so.

Instructions

For each item, briefly discuss how the proposed constraint addresses concerns about the costs and benefits of financial reporting.

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

What are the enhancing qualities of the qualitative characteristics? What is the role of enhancing qualities in the conceptual framework?

Question: William Murray achieved one of his life-long dreams by opening his own business, The Caddie Shack Driving Range, on May 1, 2017. He invested \(20,000 of his own savings in the business. He paid \)6,000 cash to have a small building constructed to house the operations and spent \(800 on golf clubs, golf balls, and yardage signs. Murray leased 4 acres of land for \)1,000 per month. (He paid the first month鈥檚 rent in cash.) During the first month, advertising costs totaled \(750, of which \)150 was unpaid at the end of the month. Murray paid his three nephews \(400 for retrieving golf balls. He deposited in the company鈥檚 bank account all revenues from customers (\)4,700). On May 15, Murray withdrew \(800 in cash for personal use. On May 31, the company received a utility bill for \)100 but did not immediately pay it. On May 31, the balance in the company bank account was \(15,100.

Murray is feeling pretty good about results for the first month, but his estimate of profitability ranges from a loss of \)4,900 to a profit of \(1,650.

Accounting

Prepare a balance sheet at May 31, 2017. Murray appropriately records any depreciation expense on a quarterly basis. How could Murray have determined that the business operated at a profit of \)1,650? How could Murray conclude that the business operated at a loss of \(4,900?

Analysis

Assume Murray has asked you to become a partner in his business. Under the partnership agreement, after paying him \)10,000, you would share equally in all future profits. Which of the two income measures above would be more useful in deciding whether to become a partner? Explain.

Principles

What is income according to GAAP? What concepts do the differences in the three income measures for The Caddie Shack Driving Range illustrate?
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