CHAPTER 19 ACCOUNTING PRINCIPLES AND POLICIES Question 1 Transaction When preparing the income statement an adjustment was made to an expense account to record a prepayment. Occasionally items are damaged in a business’s stockroom. These items are often valued at net realisable value because it is less than cost. A business always a makes a provision for doubtful debts based on 5% of trade receivables at the year end. The owner purchased a birthday gift for a member of the family using the business’s money. The amount spent was debited to the drawings account. Relevant principle Accruals (matching) Prudence Consistency Business entity Question 2 Transaction The business has always used the straight-line method of depreciation at 20% per annum every year. A customer’s account which has been unpaid for 12 weeks has now been written off as a bad debt. The owner paid the business’s rent from his private funds. In the business’s accounts a debit entry was made in the rent account and a credit entry in the drawings account. The business receives rent from a tenant. The amount transferred to the income statement took account of the fact that the tenant owed an amount for rent at the year end. Relevant principle Consistency Prudence Business entity Accruals (matching) Question 3 Answers could include: Principle Accruals One key point about this principle Ensure profits are based on matching the revenue for a year with the costs incurred in order to achieve that revenue, whether paid or not. Prudence Where there is doubt, assets and profits are under- rather than overstated; liabilities and losses are over- rather than understated. Example of the principle being used Adjusting expenses for prepayments and accruals. Adjusting income items for amounts due or received in advance. Depreciation non-current assets. Adjusting purchases for unsold inventories. Valuing inventories at the lower of cost or net realisable value. Reducing trade receivables by a provision for doubtful debts. Writing off the amount due from a trade receivable as soon as it is reasonably certain that a bad debt has occurred. Question 4 Answers could include: Principle Consistency One key point about this principle Accounting policies and procedures should be carried out in the same way each year. Business entity Separate records are kept of the owner’s private transactions and the business’s transactions in an accounting system. Example of the principle being used Using the same depreciation method each year. Using the same rate of provisions for doubtful debts each year. Drawings account maintained to record all withdrawals from the business by the owner. Question 5 (a) (i) (ii) (iii) (iv) Cost of damaged items: 8 × $20 = $160 Normal sale value of damaged items: 8 × $30 = $240 Realisable value of damaged items: 8 × $22 = $176 Net realisable value of damaged items: 8 × $17 = $136 (b) and (c) Inventories must be valued at the lower of cost ($160) or net realisable value ($136); so damaged items should be valued at $136. Question 6 (a) (i) (ii) Cost of damaged items: 4 × $40 = $160 Normal sale value of damaged items: 4 × $60 = $240 (iii) (iv) Realisable value of damaged items: 4 × $43 = $172 Net realisable value of damaged items: 4 × $35 = $140 (b) Inventories must be valued at the lower of cost ($160) or net realisable value ($140); so damaged items should be valued at $140 Question 7 Transaction The owner sent some samples to a potential new customer. However, this transaction has not been entered in the sales account. The fittings could be sold for far less than is shown on the balance sheet. However, no changes have been made to the accounting records. When a bank loan was repaid two entries were made in the accounting records affecting an asset account and a liability account. No record has been made in the accounting system of the fact that the workforce had a very high morale. Relevant principle Realisation Going concern Duality Money measurement Question 8 Transaction The payment of interest has resulted in making two entries in the accounting system. The staff have been praised for their very positive customer relations. No record has been made of this in the accounting system. The business has been very successful, but no record has been made of the value of goodwill in the accounts. Goods have just been sent to a customer. No payment has been made by the customer and the invoice for the goods will not be sent until next week. No entries have been made for this sale so far. Relevant principle Duality Money measurement Going concern Realisation Question 9 Definition Accounting for a sole trader’s business is clearly separated from accounting for the owner’s private transactions. A sale occurs when money or the promise of money is received. Accounting systems are based on the idea that there is a two-fold aspect to every transaction. Profits are assessed on the basis of amounts due or receivable for a period of time rather than amounts actually paid or received. Principle Business entity Realisation Duality Accruals Question 10 Definition The assumption is made the business will continue to trade indefinitely when valuing assets. A business should endeavour to maintain the same accounting policies from one year to the next to aid comparability of results. Some important aspects of a business’s performance cannot be quantified in financial terms. Where there is doubt, the lower value for an asset or profit is preferred. Concept Going concern Consistency Money measurement Prudence Question 11 Answers could include: Principle Duality Realisation One key point about this principle Every transaction has two aspects, so two entries are made for a transaction in an accounting system. A sale occurs when the customers pays or when an invoice is issued. Example of the principle being used Any transaction and a statement of the account to be debited and credited. A sale is not recorded on the basis of receiving an order. Goods sent to a customer at the end of one year, but invoiced at the beginning of the second year, should be recorded as a sale in the second year. Question 12 Answers could include: Principle One key point about this principle Money Only transactions with a definite measurement money value are recorded. Going concern While a business is trading assets are valued on the basis of their cost rather than what they could be sold for. Example of the principle being used No record is made of the benefit a business receives from being well located, having a successful management team, having a loyal staff. A delivery vehicle is recorded in the accounts at cost less depreciation, and not at what it would fetch if sold off. If the business was closed and its assets sold off, then the delivery vehicle would be valued at its likely resale value. Question 13 International accounting standards will help the users of accounts because they ensure that accounts are prepared in the same way and based on the same principles in a wide range of countries. Users will be able to make valid comparisons of the result shown in these accounts. International accounting standards also ensure that accounts for businesses in a wide range of countries provide the information a user will need in order to, for example, make judgements about performance or about whether to invest in a business. Question 14 International accounting standards ensure that accounts for businesses from a wide range of countries are reliable because the information shown will be objective and provide a true and fair picture of the financial position. International accounting standards give a high priority to the user of the accounts of businesses from a wide range of countries, so that information provided, although technical, will be understandable. EXAM-STYLE QUESTIONS Q 15 20 25 Ans D D B Q 16 21 Ans D B Q 17 22 Ans B B Q 18 23 Ans B C Q 19 24 Ans A B Question 26 (a) (b) (c) $145 Khalaf should value the loudspeaker at the lower of cost or net realisable value. This is an example of using the prudence principle. Question 27 (a) (b) (c) Undamaged inventory: 19 × $320 = $6 080 Washing machine A: $320 (cost) Washing machines B, C and D: $300 each (net realisable value)
