Intermediate Accounting 1
Chapter 2: Concepts underlying Financial Accounting
E2-1
(a)
(b)
(c)
(d)
(e)
Feedback Value
Cost/Benefit and Materiality
Neutrality
Consistency
Neutrality
(f)
(g)
(h)
(i)
(j)
Relevance and Reliability
Timeliness
Relevance
Comparability
Verifiability
(a)
(b)
(c)
(d)
(e)
Matching principle
Historical cost principle
Full disclosure principle
Going concern assumption
Conservatism
(f)
(g)
(h)
(i)
(j)
Economic entity assumption
Periodicity assumption
Industry practices
Materiality
Monetary unit assumption
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
Historical cost principle
Conservatism
Full disclosure principle
Matching principle
Materiality
Industry practices
Economic entity assumption
Full disclosure principle
Revenue recognition principle
(j)
(k)
(l)
(m)
(n)
(o)
(p)
(q)
(r)
Full disclosure principle
Matching principle
Economic entity assumption
Periodicity assumption
Matching principle
Materiality
Historical cost principle
Conservatism
Matching principle
E2-4
E2-5
E2-8
(a) Depreciation is an allocation of cost, not an attempt to value assets. As a consequence, even if
the value of the building is increasing, costs related to this building should be matched with
revenues on the income statement, not as a charge against retained earnings.
(b) A gain should not be recognized until the inventory is sold. Accountants follow the historical cost
approach and write-ups of assets are not permitted. It should also be noted that the revenue
recognition principle states that revenue should not be recognized until it is realized or realizable
and is earned.
(c) Assets should be recorded at the fair market value of what is given up or the fair market value of
what is received, whichever is more clearly evident. It should be emphasized that it is not a
violation of the historical cost principle to use the fair market value of the stock. Recording the
asset at the par value of the stock has no conceptual validity. Par value is merely an arbitrary
amount usually set at the date of incorporation.
(d) The gain should be recognized at the point of sale. Deferral of the gain should not be permitted,
as it is realized and is earned. To explore this question at greater length, one might ask what
justification other than the controller’s might be used to justify the deferral of the gain. For
example, the rationale provided in APB Opinion No. 29, non-completion of the earnings process,
might be discussed.
(e) It appears from the information that the sale should be recorded in 2007 instead of 2006.
Regardless of whether the terms are f.o.b. shipping point or f.o.b. destination, the point is that
the inventory was sold in 2007. 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 is also necessary in 2007.