Applying accounting principles and concepts.

For each of the following cases, respond to the question asked and indicate the accounting
principle or concept that applies.
1.
Richard Perez is the sole proprietor of In and Out Mini Market. Perezs accountant insists
that he keep a detailed record of money and merchandise that he takes out of the business for
personal use. Why?
Richard Perez must keep a detailed record of money and merchandise that he takes out of
the business for personal use so that they may be able to separate the business transactions from
his own personal transactions. A sole proprietorship and its owner are considered as one entity
legally, but then for the purpose of accounting, they must be considered as 2 separate entities so
that the resulting financial statements will only reflect the affairs of the business, not the owners.
Separate Economic Entity Assumption
2.
At the end of each fiscal period, the accountant for Florida Company requires that a
careful inventory be made of the office supplies and that the amount on hand be reported as an
asset and the amount used during the period be reported as an expense. Why?
At the end of each fiscal period, the amount of office supplies on hand must be reported
as assets and the amount of office supplies used must be reported as an expense in order to show
the true profit of the business. These must be recorded in the same period so that both income
and expenses would easily be matched with each other and measured. Matching Principle
3.
Haden Co. purchased many small tools during 2016 at a total cost of $8,000. Some tools
were expected to last for a few weeks, some for several months, and some for several years.
Hadens income for 2016 will be about $4.5 million. How should Haden account for the small
tools in order to be theoretically correct? As a practical matter, how should Haden account for
these tools? Why?
Theoretically, Haden should divide the amount of each tool according to its lifespan so
that the exact amount of depreciation would be shown. However, Hadens income for 2016 is
already $4.5 million and the cost of the tools is insignificant when compared to his revenue. To
be more practical, he can just list the total amount he spent for the tools in this year/time period
since it would not make a big difference in his earnings for the year. Materiality and Cost
Benefit Test
Applying accounting principles and concepts.
For each of the following cases, respond to the question asked and indicate the accounting
principle or concept that applies.
1.
On March 15 of last year, Guice Inc. purchased land for $190,000, on which it planned to
construct an office building. At the end of the year, the land had increased in value to $240,000.
Nevertheless, Guice recognized no income as a result of the increase in value. Is this correct or
incorrect accounting? Why?

This is correct accounting. Assets are reported at their cost at the time that they were
bought. Even if the value of the asset goes up, there would be no income earned from it and they
would not be adjusted for inflation/any increase in value. Historical Cost Basis Principle
2.
Three years ago, Knott Company purchased a machine for $400,000. The machine is
expected to have no salvage value. Nevertheless, Knott continues to keep the assets cost in its
accounting records and to depreciate the asset over its eight-year useful life. Is this correct or
incorrect accounting? Why?
This is correct accounting because they are following the concept of Historical Cost. The
asset must be recorded at it acquisition price and they are adjusted for depreciation in a
systematic and rational process of dividing the cost over its useful life. Historical Cost Basis
Principle
3.
Rutland Company has decided to charge off as a loss the portion of its accounts
receivable that it estimates will be uncollectible. The accounts involved resulted from the current
years sales. Is this correct or incorrect accounting? Why?
This is correct accounting because you estimate the amount that you will not be able to
receive from your customers. You list it as an expense and take the conservative action, to
estimate the largest possible loss. This would allow the business to make decisions that would
not overstate assets or income of the company. Conservatism

Applying accounting principles and concepts.

The accounting treatment or statement presentation of various items is discussed below. The
items pertain to unrelated businesses.
INSTRUCTIONS
Indicate in each case whether the item has been handled in accordance with generally accepted
accounting principles. If so, indicate the key basic concept that has been followed. If not,
indicate which concept has been violated and tell how the item should have been recorded or
presented.
1.
The assets listed in the accounting records of Adams Pharmacy include a money market
account of Robert Adams, owner of the business. Adams has established the savings account so
that if he needs to invest more cash in the pharmacy, it will be readily available.
This case is not in accordance with the GAAP because it violates the Separate Economic
Entity Assumption. The owner must separate his personal account from the account of the
business so that there would not be any confusion when it comes to finding out the true income
of the company and so that he may be able to monitor the progress of his company better.

2.
On December 31, 2016, an account receivable of $1,800 due from Tollie Pettis, who is in
the county jail on charges of passing bad checks, is not included in the balance sheet. The owner
of the business has written off the amount because he feels certain that the debt will not be paid,
even though Pettis insists that she will pay after she gets out of jail and finds a job.
This case has been handled in accordance with the GAAP because it followed the concept
of conservatism. It is better to be safe rather than assume that the person will pay you back
because you wouldnt know when she would actually do so.
3.
The equipment of Sadler Plastics Company has a book value (cost less accumulated
depreciation) of $180,000. However, the equipment could not be sold for more than $40,000
today. The companys owner thinks that the machinery should nevertheless be reported on the
balance sheet at $180,000 and depreciated over its useful life, because the equipment is being
used regularly in the business and it is expected to be used profitably for the next five years
the remaining useful life that is being used for depreciation purposes.
This is being handled in accordance with the GAAP because it follows the Historical
Cost Basis Principle. You are supposed to list assets with the value you obtained it with, not with
the current value in the market.
4.
Ohio Company manufactured machinery for its own use at a cost of $600,000. The
lowest bid from an outsider was $650,000. Nevertheless, the company recorded the machinery at
$600,000.
This is adhering with the principle of Historical Cost Basis of the GAAP because as
stated, assets should be recorded at the cost when it was acquired.
5.
On December 31, 2016, the balance sheet of Transit Depot reported prepaid insurance at
$4,000. The prepaid insurance reflects the refund value of a three-year fire insurance policy that
originally cost $6,000 on January 1, 2015.
This is in accordance to the Matching principle of the GAAP because the prepaid
insurance is being matched with the prepaid expense.
6.
At the beginning of 2016, Jamison Company bought a building for $3,000,000. At the
end of 2016, the buildings value was appraised at $3,300,000. Since there was an increase in
value, the company did not record depreciation on the building and also did not increase the
$3,000,000 recorded in the building account at time of purchase.
According to the Historical Cost Basis Principle of the GAAP, the depreciation of
buildings should still be recorded even if the cost of the building appreciated. This is because in
due time, the building will depreciate too.
Judgment and Objectivity
1.
A new manager of a retail company suggests that the company should prepare its income
statement on the basis of cash receipts and cash expenditures (except for the acquisition of fixed

assets, such as plant and equipment). He argues that managers, investors, creditors, and others
are more interested in cash receipts and disbursements than in accrual-based accounting. Do you
think he is correct? Explain.
I do not think he is correct because both methods of accounting have their benefits.
Accrual Basis of Accounting allows a person to monitor the transactions and flow of income
more accurately to help them make decisions that are good for the company. On the other hand,
Cash Basis of Accounting allows you to monitor your cash flow; however, it might give you a
misleading picture of long-term profitability. I think that the accrual basis of accounting is better
since other people would want to be able to see the long term standing of the business and it
provides more useful and reliable financial information.
2.

In what situations would the going concern assumption not be useful to management?

In cases wherein the business is about to be bankrupt, the going concern assumption
would not be useful to the management since they already know that it cannot operate any
further. They will have to liquidate the company so this assumption is already useless to them.
3.

What arguments can be given that the historical cost framework should be abandoned?

The historical cost framework is not relevant for decision making and it is misleading.
The historical cost is not appropriate for the evaluation of business decisions, unlike current cost
accounting since this presents the reality of transactions, making it more useful. Also, the
historical cost framework can be misleading because people cannot guarantee the accuracy or
truth of the information stated.
4.
How can the element of personal judgment, which is involved in such matters as
estimates of salvage value and useful life, be minimized to preserve the objectivity of an
accounting system?
The element of personal judgment should be minimized by researching well prior to
estimating the salvage value and the useful life of an asset and making use of a formula to
calculate for these. This way, less errors will be committed and it would generally be close to the
true salvage value and useful life.