E2-2 (Qualitative Characteristics) The qualitative characteristics that make accounting

information
useful for decision-making purposes are as follows.
Relevance Timeliness Representational faithfulness
Reliability Verifiability Comparability
Predictive value Neutrality Consistency
Feedback value
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.
(b) Quality of information that confirms users' earlier expectations.
(c) Imperative for providing comparisons of a company from period to period.
(d) Ignores the economic consequences of a standard or rule.
(e) Requires a high degree of consensus among individuals on a given measurement.
(f) Predictive value is an ingredient of this primary quality of information.
(g) Two qualitative characteristics that are related to both relevance and reliability.
(h) Neutrality is an ingredient of this primary quality of accounting information.
(i) Two primary qualities that make accounting information useful for decision-making
purposes
(j) Issuance of interim reports is an example of what primary ingredient of relevance

(a) Comparability. (f) Relevance.

(b) Feedback Value. (g) Comparability and Consistency.
(c) Consistency. (h) Reliability.
(d) Neutrality. (i) Relevance and Reliability.
(e) Verifiability. (j) Timeliness.

E2-4 (Assumptions, Principles, and Constraints) Presented below are the assumptions,
principles, and constraints used in this chapter.
1. Economic entity assumption 5. Historical cost principle 9. Materiality
2. Going concern assumption 6. Matching principle 10. Industry practices
3. Monetary unit assumption 7. Full disclosure principle 11. Conservatism
4. Periodicity assumption 8. Cost-benefit relationship
Instructions
Identify by number the accounting assumption, principle, or constraint that describes
each situation below.
Do not use a letter more than once.
(a) Allocates expenses to revenues in the proper period.
(b) Indicates that market value changes subsequent to purchase are not recorded in the
accounts. (Do not use revenue recognition principle.)
(c) Ensures that all relevant financial information is reported.
(d) Rationale why plant assets are not reported at liquidation value. (Do not use historical
cost principle.)
(e) Anticipates all losses, but reports no gains.
(f) Indicates that personal and business record keeping should be separately maintained.
(g) Separates financial information into time periods for reporting purposes.
(h) Permits the use of market value valuation in certain specific situations.
(i) Requires that information significant enough to affect the decision of reasonably
informed users should be disclosed. (Do not use full disclosure principle.)
(j) Assumes that the dollar is the “measuring stick” used to report on financial
performance.

(a) 6. Matching principle.

(b) 5. Historical cost principle.
(c) 7. Full disclosure principle.
(d) 2. Going concern assumption.
(e) 11. Conservatism.
(f) 1. Economic entity assumption.
(g) 4. Periodicity assumption.
(h) 10. Industry practices.
(i) 9. Materiality.
(j) 3. Monetary unit assumption.

E2-7 (Accounting Principles—Comprehensive) Presented below are a number of

business transactions that occurred during the current year for Fresh Horses, 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 Fresh Horses, Inc. used his expense account to purchase a new
Suburban solely for personal use. The following journal entry was made.
Miscellaneous Expense 29,000
Cash 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.
Merchandise Inventory 70,000
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 500,000
Liability for Lawsuit 500,000
(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 its
equipment and decided to record it in its accounts. The following entry was made.
Depreciation Expense 16,000
Accumulated Depreciation 16,000
(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 800,000
Goodwill 800,000
(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 200,000
Cash 155,000
Revenue 45,000

(a) This entry violates the economic entity assumption. This assumption in
accounting indicates that economic activity can be identified with a
particular unit of accountability. In this situation, the company erred by
charging this cost to the wrong economic entity.

(b) The historical cost principle indicates that assets and liabilities are accounted
for on the basis of cost. If we were to select sales value, for example, we
would have an extremely difficult time in attempting to establish a sales
value for a given item without selling it. It should further be noted that the
revenue recognition principle provides the answer to when revenue should be
recognized. Revenue should be recognized when (1) realized or realizable and
(2) earned. In this situation, an earnings process has definitely not taken place.

(c) Probably the company is too conservative in its accounting for this
transaction. The matching principle indicates that expenses should be
allocated to the appropriate periods involved. In this case, there appears to
be a high uncertainty that the company will have to pay. FASB Statement
No. 5 requires that a loss should be accrued only (1) when it is probable that
the company would lose the suit and
(2) the amount of the loss can be reasonably estimated. (Note to instructor:
The student will probably be unfamiliar with FASB Statement No. 5. The
purpose of this question is to develop some decision framework when the
probability of a future event must be assumed.)
(d) At the present time, accountants do not recognize price-level adjustments in the
accounts. Hence, it is misleading to deviate from the cost principle because
conjecture or opinion can take place. It should also be noted that depreciation
is not so much a matter of valuation as it is a means of cost allocation. Assets are
not depreciated on the basis of a decline in their fair market value, but are
depreciated on the basis of systematic charges of expired costs against revenues.
(Note to instructor: It might be called to the students’ attention that the FASB
does encourage supplemental disclosure of price-level information.)

(e) Most accounting methods are based on the assumption that the business
enterprise will have a long life. Acceptance of this assumption provides
credibility to the historical cost principle, which would be of limited usefulness
if liquidation were assumed. Only if we assume some permanence to the
enterprise is the use of depreciation and amortization policies justifiable and
appropriate. Therefore, it is incorrect to assume liquidation as Fresh Horses,
Inc. has done in this situation. It should be noted that only where liquidation
appears imminent is the going concern assumption inapplicable.

(f) The answer to this situation is the same as (b).

E3-5 (Adjusting Entries) The ledger of Duggan Rental Agency on March 31 of the
current year includes the following selected accounts before adjusting entries have been
prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $ 8,400
Notes Payable 20,000
Unearned Rent Revenue 9,300
Rent Revenue 60,000
Interest Expense –0–
Wage Expense 14,000
An analysis of the accounts shows the following.
1. The equipment depreciates $250 per month.
2. One-third of the unearned rent was earned during the quarter.
3. Interest of $500 is accrued on the notes payable.
4. Supplies on hand total $850.
5. Insurance expires at the rate of $300 per month.
Instructions
Prepare the adjusting entries at March 31, assuming that adjusting entries are made
quarterly. Additional accounts are: Depreciation Expense; Insurance Expense; Interest
Payable; and Supplies Expense. (Omit explanations.)

1. Depreciation Expense ($250 X 3) 750

Accumulated Depreciation—Equipment 750

2. Unearned Rent Revenue ($9,300 X 1/3)................................................ 3,100

Rent Revenue................................................................................. 3,100

3. Interest Expense...................................................................................... 500

Interest Payable............................................................................. 500

4. Supplies Expense..................................................................................... 1,950

Supplies ($2,800 – $850)................................................................ 1,950

5. Insurance Expense ($300 X 3)................................................................ 900

Prepaid Insurance......................................................................... 900

*P3-9 (Adjusting and Closing) Presented below is the December 31 trial balance of
Nancy Drew
Boutique.
NANCY DREW BOUTIQUE
TRIAL BALANCE
DECEMBER 31
Debit Credit
Cash $ 18,500
Accounts Receivable 42,000
Allowance for Doubtful Accounts $ 700
Inventory, December 31 80,000
Prepaid Insurance 5,100
Furniture and Equipment 84,000
Accumulated Depreciation—Furniture and Equipment 35,000
Notes Payable 28,000
Common Stock 80,600
Retained Earnings 10,000
Sales 600,000
Cost of Goods Sold 398,000
Sales Salaries Expense 50,000
Advertising Expense 6,700
Administrative Salaries Expense 65,000
Office Expense 5,000
$754,300 $754,300
Instructions
(a) Construct T-accounts and enter the balances shown.
(b) Prepare adjusting journal entries for the following and post to the T-accounts. (Omit
explanations.)
Open additional T-accounts as necessary. (The books are closed yearly on December 31.)
(1) Bad debts are estimated to be $1,400.
(2) Furniture and equipment is depreciated based on a 6-year life (no salvage value).
(3) Insurance expired during the year $2,550.
(4) Interest accrued on notes payable $3,360.
(5) Sales salaries earned but not paid $2,400.
(6) Advertising paid in advance $700.
(7) Office supplies on hand $1,500, charged to Office Expense when purchased.
(c) Prepare closing entries and post to the accounts.

(a), (b), (c)

Cash Accounts Receivable Allow. for Doubtful Accts.

Bal. 18,500 Bal. 42,000 Bal. 700
Adj. 1,400

Inventory Furniture & Equipment Accum. Depr. of F. & E.

Bal. 80,000 Bal. 84,000 Bal. 35,000
Adj. 14,000

Prepaid Insurance Notes Payable Admin. Salaries Expense

Bal. 5,100 Adj. 2,550 Bal. 28,000 Bal. 65,000 Cls. 65,000

Common Stock Sales Insurance Expense

Bal. 80,600 Cls. 600,000 Bal. 600,000 Adj. 2,550 Cls. 2,550

Sales Salaries Expense Advertising Expense Interest Expense

Bal. 50,000 Cls. 52,400 Bal. 6,700 Adj. 700 Adj. 3,360 Close 3,360
Adj. 2,400 Close 6,000
52,400 52,400 6,700 6,700
 Bad Debt Expense Office Expense Prepaid Advertising Expense
Adj. 1,400 Cls. 1,400 Bal. 5,000 Adj. 1,500 Adj. 700
Close 3,500
5,000 5,000

Interest Payable Depr. Exp.—Furn. & Equip. Income Summary

Adj. 3,360 Adj. 14,000 Cls. 14,000 Exp. 546,210 Sales 600,000
Inc. 53,790
600,000 600,000

Office Supplies Salaries Payable

Adj. 1,500 Adj. 2,400

Retained Earnings Cost of Goods Sold

Bal. 10,000 Bal. 398,000 Cls. 398,000
Inc. 53,790
Bal. 63,790

(b) -1-
Bad Debts Expense.......................................................................... 1,400
Allowance for Doubtful Accounts........................................ 1,400

-2-
Depreciation Expense—Furniture and
Equipment ($84,000 ÷ 6)............................................................. 14,000
Accum. Depr.—Furniture and Equipment......................... 14,000

-3-
Insurance Expense........................................................................... 2,550
Prepaid Insurance.................................................................. 2,550
 -4-
Interest Expense.............................................................................. 3,360
Interest Payable...................................................................... 3,360

-5-
Sales Salaries Expense..................................................................... 2,400
Salaries Payable..................................................................... 2,400

-6-
Prepaid Advertising Expense......................................................... 700
Advertising Expense.............................................................. 700

-7-
Office Supplies................................................................................. 1,500
Office Expense........................................................................ 1,500

(c) Dec. 31
Sales 600,000
Income Summary................................................................... 600,000

Dec. 31
Income Summary............................................................................ 546,210
Cost of Goods Sold................................................................. 398,000
Advertising Expense.............................................................. 6,000
Administrative Salaries Expense.......................................... 65,000
Sales Salaries Expense........................................................... 52,400
Office Expense........................................................................ 3,500
Insurance Expense................................................................. 2,550
Bad Debt Expense.................................................................. 1,400

Depreciation Expense—Furniture and Equipment 14,000

 Interest Expense..................................................................... 3,360

Dec. 31
Income Summary............................................................................ 53,790
Retained Earnings.................................................................. 53,790