91Ó°ÊÓ

Recognition and Measurement Criteria The following are unrelated accounting situations and the accounting treatment that was followed in each firm's records: 1\. The Buchanan Company mounts a \(\$ 900,000\) year-long advertising campaign on a new national cable television network. The firm's annual accounting period is the calendar year. The television network required full payment in December at the beginning of the campaign. Accounting treatment is Increase Advertising Expense, \(\$ 900,000\) Decrease Cash, \(\$ 900,000\) 2\. Because of a local bankruptcy, machinery worth \(\$ 320,000\) was acquired at a "bargain" purchase price of \(\$ 150,000\). Accounting treatment is Increase Machinery, \(\$ 150,000\) Decrease Cash, \(\$ 150,000\) 3\. J.R. Brown, a consultant operating a sole proprietorship, withdrew \(\$ 50,000\) from the business and purchased stocks as an investment gift to his wife. Accounting treatment is Increase Investments, \(\$ 50,000\) Decrease Cash, \(\$ 50,000\) 4\. Puite Company received a firm offer of \(\$ 106,000\) for a parcel of land it owns that cost \(\$ 56,000\) two years ago. The offer was refused, but the indicated gain was recorded in the accounts. Accounting treatment is Increase Land, \(\$ 50,000\) Increase Revenue from Change in Land Value, \(\$ 50,000\) Required In each of the given situations, indicate which accounting concepts, principles or constraints apply and whether they have been applied appropriately. If you decide the accounting treatment is not generally accepted, discuss the effect of the departure on the balance sheet.

Step by step solution

01

Buchanan Company's Advertising Expense

The Buchanan Company should not recognize the entire $900,000 advertising expense immediately if the campaign lasts the entire year. According to the matching principle, expenses should be recognized in the same period as the revenues they help generate. This should be treated as a prepaid expense and allocated over the year, matching the expense recognition with the period the advertising runs.

02

Buchanan Company Incorrect Accounting Treatment Impact

By immediately expensing the full $900,000, the company's current year's expenses are overstated, and net income is understated. This treatment decreases Cash immediately, appropriately recognizing the payment, but fails to treat the cost as a prepaid expense with future benefit.

03

Machinery Bargain Purchase

The machinery should be recorded at its purchase price of $150,000 according to the cost principle, which states that assets should be recorded at their cost at the time of acquisition. The treatment is correct as it recognizes the machinery at the paid cash amount, not the market value.

04

Machinery Treatment Impact on Accounts

There is no impact of the departure on the balance sheet as the machinery is recorded at the cash purchase price, following GAAP principles. The bargaining advantage (difference between the purchase price and market value) is not recorded, which aligns with the cost principle.

05

J.R. Brown's Investment Gift to Wife

The transaction does not affect the business's financial statements. Since the $50,000 was withdrawn for personal purposes, it should be reflected as a withdrawal from owner's equity. The treatment mixes personal and business assets, which violates the business entity assumption.

06

Impact on J.R. Brown's Financials

By incorrectly increasing investments, the balance sheet reflects a personal investment rather than a reduction in owner's capital, skewing the actual financial state of the business.

07

Puite Company Land Valuation Offer

The offer received does not constitute revenue and should not affect land valuation. According to the historical cost principle, land should be recorded at its purchase price of $56,000 and not at the offered price. Recorded gain is speculative and should not be recognized until realized.

08

Impact of Incorrect Land Valuation

Increasing land value and revenue without a realized transaction violates GAAP and prematurely records revenue. The balance sheet incorrectly shows increased asset value and revenue, overstating net income and asset valuation.

Unlock Step-by-Step Solutions & Ace Your Exams!

• Full Textbook Solutions

  Get detailed explanations and key concepts

• Unlimited Al creation

  Al flashcards, explanations, exams and more...

• Ads-free access

  To over 500 millions flashcards

• Money-back guarantee

  We refund you if you fail your exam.

Over 30 million students worldwide already upgrade their learning with 91Ó°ÊÓ!

Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Matching Principle

In the realm of financial accounting, the matching principle is key to ensuring that expenses are recorded in the same period as the revenues that those expenses help generate. This allows for a more accurate representation of a company's financial situation. Consider the case of Buchanan Company's advertising campaign. They paid for a year-long campaign upfront, and according to the matching principle, the expense should not be fully recognized at once. Instead, it should be allocated throughout the year, aligning the expense recognition with the period during which the advertising benefits are realized. Recognizing the entire expense at the start would overstate current expenses and understate net income, distorting the financial statements.

For example, if revenue is anticipated from increased sales due to advertising, matching the advertising costs to these revenues in the same period provides a clearer picture of the true financial performance of the company.

Cost Principle

The cost principle in financial accounting dictates that assets should be recorded at the cash amount paid at the time of acquisition, not at what they might be worth on the market. This principle ensures that all transactions are recorded based on objective evidence rather than subjective estimates or market fluctuations.

The Buchanan Company's purchase of machinery for a bargain price aligns perfectly with this principle. They recorded the machinery at the price they paid, $150,000, instead of its market value of $320,000. By recording the asset at its historical cost, the company ensures that the financial statements remain reliable and verifiable. This approach eliminates the speculation that could arise from fluctuations in market value and maintains consistent accounting records over time.

Business Entity Assumption

The business entity assumption is a fundamental concept in accounting that maintains the separation between the business's financial activities and those of its owner. Improperly mixing personal transactions with business finances can lead to inaccurate financial statements, which is what occurred when J.R. Brown withdrew $50,000 for personal investment.

Instead of reflecting this transaction as an increase in business investments, it should have been recorded as a withdrawal, affecting the owner's equity rather than the business's assets. This distinction is crucial for generating clear and truthful financial records. Keeping personal and business accounts separate ensures that the financial position of the business is not overstated or misrepresented due to personal activities.

Historical Cost Principle

According to the historical cost principle, assets should be recorded and reported at their original purchase cost. This principle maintains that updates to asset values due to non-transactional market shifts should not alter financial records until the transaction is realized.

Puite Company's decision to record an increased value of land based on a future offer violates this principle. The land should remain on the books at its purchase cost of $56,000, rather than the higher offer of $106,000, until an actual sale occurs. Preemptively recognizing gains from changes in market value results in speculative figures on the financial statements, which could mislead stakeholders about the company's actual financial performance and stability.