E2-2 Relevance Reliability Predictive Value Feedback value
Timeliness Verifiability Neutrality
Representational faithfulness Comparability Consistency
Instructions: Identify the appropriate qualitative characteristic(s) to be used given the information provided below. a.. Qualitative characteristic being employed when companies in the same industry are using the same accounting principles. COMPARABILITY b. Quality of information that confirms users’ earlier expectations. FEEDBACK VALUE c. Imperative for providing comparisons of a company from period to period.4 CONSISTENCY d. Ignores the economic consequences of a standard or rule. NEUTRALITY e. Requires a high degree of consensus among individuals on a given measurement. VERIFIABILITY f. Predictive value is an ingredient of this primary quality of information. RELEVANCE g. Two qualitative characteristics that are related to both relevance and reliability. CONPARABILITY & CONSISTENCY h. Neutrality is an ingredient of this primary quality of accounting information. RELIABILITY i. Two primary qualities that make accounting information useful for decision-making purposes. RELEVANCE & RELIABILITY j. Issuance of interim reports is an example of what primary ingredient of relevance. TIMELINESS
E2-4 Assumptions, Principles, and Constraints. 1.Economic entity assumption. 3.Monetary unit assumption 5. Historical cost principle 7. Full disclosure principle 9. Materiality 11. Conservation.
2. Going concern assumption 4. Periodicity assumption 6. Matching principle 8. Cost-benefit relationship 10. Industry practices
a. Allocates expenses to revenues in the proper period. 6 b. Indicates that market value changes subsequent to purchase are not recorded in the accounts. (Do not use revenue recognition principle). 5 c. Ensures that all relevant financial information is reported. 7 d. Rationale why plant assets are not reported at liquidation value. (Do not use historical cost principle). 2 e. Anticipates all losses, but reports no gains. 11 f. Indicates that personal and business rcord keeping should be separately maintained. 1 g. Separates financial information into time periods for reporting purposes. 4 h. Permits the use of market value valuation in certain specific situations. 10 i. Requires that information significant enough to affect the decision of reasonably informed users should be disclosed. (Do not use full disclosure principle). 9 j/ Assumes that the dollar is the “measuring stick” used to report on financial performance. 3
E2-7 a. The president of Fresh Horses, Inc. used his expense account to purchase a new surbaban solely for personal use. The following journal entry is made. Miscellaneous Expense Cash
29,000 29,000
This was charged to the wrong accounting entity, the four basic assumptions underlying financial accounting are: (1) Economic entity: it should have been recorded under economic entity. 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. Merchandise Inventory Revenue
70,000 70,000
You can only account under assets when the revenue is actually earned. In this situation you can’t recognize revenue if the product hasn’t been sold. It should have been posted under historical cost. 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 500,000 Liability for Lawsuit
500,000
Shouldn’t be recorded yet as it hasn’t happened yet. Should have used the matching principle. d. Because the general level of prices increased during the current year, Fresh Horses, Inc. determined that there was a $16,000 understatement of depreciation expense on the equipment and decided to record it in its accounts. The following entry was made. Depreciation Expense 16,000 Accumulated Depreciation
16,000
Cannot use depreciation on the basis of decline in the fair market value. Should use price-level adjustments.
e. Fresh Horses, 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: Retained Earnings Goodwill
800,000 800,000
It’s incorrect to assume the liquidation costs of Fresh Horses. Should use the historical cost principle. f. Because of a “fire sale,” equipment obviously worth $200,000 was acquired at a cost of $155,000. The following entry was made: Equipment Cash Revenue
200,000 155,000 45,000
It’s hard to determine what the historical cost principle indicates. You can only recognize revenue when it’s earned; in this case it hasn’t been earned.
E3-5 Debit Prepaid insurance Supplies Equipment Accumulated Depreciation – Equipment Notes Payable Unearned Rent Revenue Rent Revenue Interest Expense Wage Expense
Credit
$ 3,600 2,800 25,000 $ 8,400 20,000 9,300 60,000 0 14,000
1. The equipment depreciates $250 per month D depreciation exp 250 C accumulation dep exp 250 2. One-third of the unearned rent was earned during the quarter. D unearned rent rev 20000 (60,000 / 3) C rent 2000 3. Interest of $500 is accrued on the notes payable D interest expense 500 C interest payable 500 4. Supplies on hand total $850 D supplies expense 1950 = 2,800 – 850 = 1950 C supplies 1950 5. Insurance expires at the rate of $300 per month. D insurance expense 2400 3,600 - 300 X 3 = 2400 C prepaid insurance 2400
Duggan Rental Agency March 31 Debit 1. Depreciation Expense Accumulated Dep Exp
250
2. Unearned Rent Revenue Rent
20000
3. Interest Expense Interest Payable
500
4. Supplies Expense Supplies
1950
5. Insurance Expense Prepaid Insurance
2400
Credit
250
20000
500
1950
2400
