SOLUTIONS TO ASSIGNMENTS

OF CHAPTER 12

EXERCISE 12-1

1.     Time period assumption.

2.     Cost principle.

3.     Economic entity assumption.

4.     Revenue recognition principle.

5.     Full disclosure principle.

6.     Matching principle.

7.     Going concern assumption.

EXERCISE 12-2

1.     No violation of generally accepted accounting principles.

2.     This is a violation of the economic entity assumption. The transaction treats Ben Williams and Cleveland Co. as one entity when they are two separate entities. No journal entry should have been made since Ben Williams should have used personal assets to purchase the truck. If cash assets of the company were used, the debit entry could be to Accounts Receivable—B. Williams, or the debit entry could be to B. Williams, Drawing.

3.     This is a question of matching and materiality. The pencil sharpener could be depreciated to match the expense with revenue since the pencil sharpener has an estimated useful life of 5 years. However, the pencil sharpener should not be depreciated because the cost of it is not ma­terial. Since the cost of the sharpener is not material, it should be expensed immediately. The correct journal entry at the time of purchase is:

        Miscellaneous Expense.................................................................       40

                Cash................................................................................................                 40

4.     This is a violation of the cost principle because the equipment was recorded at its estimated market value and not its exchange value. The correct journal entry is:

EXERCISE 12-2 (Continued)

        Equipment..........................................................................       60,000

                Cash.........................................................................................                        60,000

5.     This is a violation of the cost principle. The inventory was written up to its market value when it should have remained at cost. Thus, no journal entry should have been made.

EXERCISE 12-5

EXERCISE 12-6

(b)   2001   $120,000 ($300,000 X 40%).

        2002   $0.

        2003   $0.

SOLUTIONS TO PROBLEMS

1.     Cost principle. Appreciation in value does not justify recognizing a gain on the land until it is sold. Appreciation does not involve an exchange transaction. No entry is necessary.

2.     Matching principle. The purchase of equipment should not be expensed immediately. Only costs which have no future benefit are recognized immediately as expenses. Reporting a lower net income is not a legitimate reason for expensing a piece of equipment. Therefore, the following entry is necessary:

        Depreciation Expense ($40,000 ÷ 5 years)..................        8,000

                Accumulated Depreciation—Equipment..........................                         8,000

3.     Matching principle. Plant assets should be expensed through a rational and systematic policy. Deferring depreciation is not rational and system­atic. Therefore, the following entry is necessary:

        Depreciation Expense.....................................................       26,000

                Accumulated Depreciation.................................................                        26,000

4.     Cost principle. Recording the transaction at its estimated market value would not be proper because estimated market value in this case does not represent an exchange price. The purchase should be recorded at cost, not at a market price that someone believes the equipment is worth. The correct entry is:

        Equipment..........................................................................       20,000

                Cash.........................................................................................                        20,000

5.     Going concern assumption. Liquidation value is not appropriate because it assumes that the enterprise will not continue. No entry is necessary. Only when liquidation appears imminent is the going concern assumption inapplicable.

PROBLEM 12-1A (Continued)

6.     Matching principle. The matching principle is violated because expensing the cost of the rent does not allow a proper matching of expense with the period in which the revenue will occur. Revenue associated
with the rent would benefit both years. The correct entry is:

        Prepaid Rent......................................................................       20,000

                Cash.........................................................................................                        20,000

        An adjusting entry is made at December 31 to record the proper rent
expense.

        Rent Expense.....................................................................        5,000

                Prepaid Rent..........................................................................                         5,000

1.     The proper amount of depreciation expense is based on the cost of
the asset and is not adjusted for changing price levels. 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: It might be called to the students’ attention that the FASB does encourage supplemental disclosure of price-level information.)

2.     The cost principle indicates that assets and liabilities are to be 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 the given item without selling it. It should further be noted that the revenue recognition principle provides the answer to when revenue (gain) should be recognized. Revenue should be recognized when it is earned. In this situation, an earnings process has definitely not taken place.

3.     It appears from the information that the sale should be recorded in the next year instead of the current year. Regardless of whether the terms are FOB shipping point or FOB destination, the point is that the inventory is to be sold in the next year. Therefore, the revenue recognition principle is violated. It should be noted that if the company is employing a perpetual inventory system in dollars and quantities, a debit to cost of goods sold and a credit to inventory are also necessary in the next year.

4.     A gain should not be recognized until the land is sold. Accountants follow the cost approach and write-ups of assets are not permitted. It should also be noted that the revenue recognition principle indicates that revenue (gain) should not be recognized until it is earned.

5.     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.

        *[($6,000,000 – $3,900,000) ÷ $6,000,000]

        **[($6,000,000 – $4,200,000) ÷ $6,000,000]

(a)    5.    Full disclosure principle.

(b)    2.    Going concern assumption.

(c)    3.    Monetary unit assumption.

(d)    9.    Materiality.

(e)    7.    Matching principle.

(f)     1.    Economic entity assumption.

(g)    4.    Time period assumption.

(h)    6.    Revenue recognition principle.

(i)      10.     Conservatism.