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Exercise 1.1
Accounting principles
a.
Accounting principle
Explanation
Entity
The owner and the business are considered to be separate accounting entities,
and their records should be kept on this basis.
The orthodontist’s fees are an expense of the owner, not an expense of the
business, and should be recorded as ‘Drawings’.
b.
Accounting principle
Explanation
Consistency
The same accounting methods should be applied from one period to the next so
that reports can be compared between periods.
The owner will be unable to identify any changes in repair or vehicle expenses.
c.
Accounting principle
Explanation
Monetary unit
Transactions should be recorded in the currency of the country in which the
reports are prepared.
In Australia, all transactions should be recorded in Australian dollars.
d.
Accounting principle
Explanation
Reporting period
The life of the business is divided into arbitrary periods to allow for reports to be
prepared, and the accounting records should reflect the period in which a
transaction occurs. The transaction should be recorded as revenue when it is
earned – in the year ended 30 June 2008.
e.
Accounting principle
Explanation
Historical cost
Transactions should be recorded at their original purchase price as this value is
verifiable by a source document.
The revaluation is subject to subjectivity, and not verifiable.
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f.
Accounting principle
Explanation
Going concern
The life of the business is assumed to be continuous, and its records are kept on
this basis.
The mortgage should be reported as a non-current liability, as it is assumed that
the business will still be operating 10 years into the future.
g.
Accounting principle
Explanation
Reporting period
The life of the business is divided into arbitrary periods to allow for reports to be
prepared, and the accounting records should reflect the period in which a
transaction occurs. According to tax requirements, reports must be prepared at
least yearly.
Exercise 1.2
Bon Wilhelm
a.
Explanation
The business is assumed to be an accounting entity separate from the owner and
other businesses, and its records should be kept on this basis.
The holiday is an expense of the owner, not an expense of the business.
b.
Explanation
The reports will not contain all the information that is useful for decision-making
because they will not show the owner’s Drawings.
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Exercise 1.3
Larkin Lighting
a.
Accounting principle
Explanation
Historical cost
Stock should be valued at its original purchase price as this value is verifiable
by a source document.
OR
Accounting principle
Explanation
Conservatism
Revenues should be recognised only when certain so that assets and revenues
are not overstated. There is no guarantee that the stock will be sold for its selling
price, so using the selling price would recognise the revenue before it is certain
and overstate sales revenue and the value of the stock (an asset).
b.
Explanation
Because the selling price is not verifiable by reference to a source document, it
will mean the information in the reports is not free from bias.
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Exercise 1.4
Erica Carr
a.
Accounting principle
Explanation
Conservatism
Expenses should be recognised when probable so that expenses and liabilities
are not understated.
The damages should be recognised in order to present to the owner a prudent or
cautious picture of the firm’s financial position.
b.
Qualitative characteristic Relevance
Explanation
The reports should include all information which is useful for decision-making.
The probable expense of damages may affect decisions the owner makes about
both profit and available cash.
Exercise 1.5
Coolick Refrigerators
a.
Consistency
The same accounting methods should be applied from one period to the next so
that reports can be compared between periods.
b.
Qualitative characteristic Comparability
Explanation
Reports should be comparable over time, and between different companies
through the use of consistent accounting procedures.
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Exercise 1.6
Rad Mags
a.
Accounting principle
Explanation
Reporting period
The life of the business is divided into arbitrary periods to allow for reports to be
prepared, and the accounting records should reflect the period in which a
transaction occurs. Not all the cash was earned in the Reporting period in which
it was received, as it applies to two years (and two different Reporting periods).
b.
Qualitative characteristic Relevance
Explanation
The reports will include some information that is not useful for decision making
about profit for the current Reporting period (i.e. the revenue that has been
received will not be earned until the next Reporting period).
c.
Explanation
The inflow of economic benefits (cash) increases assets, but also increases
liabilities; as a result there is no increase in Owner’s equity.
Exercise 1.7
Plastic Cups Emporium
a.
Qualitative characteristic Understandability
Explanation
Reports should be presented in a manner which makes it easy for the user to
comprehend their meaning.
As the workers have no accounting knowledge, the reports will not fulfil their
function of providing information.
b.
Technique
Use of graphs
Plain language reports
Explanatory notes / presentation sessions
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Exercise 1.8
Frosty Fridges
a.
Accounting principle
Explanation
Historical cost
Assets and liabilities will be reported in the Balance Sheet at their original
purchase price as these values are verifiable by a source document.
The market value, on the other hand, represents what a potential buyer is
prepared to pay for the assets.
Exercise 1.9
Max’s Mart
a.
Explanation
As a non-current asset as it is a resource controlled by the business from which a
future economic benefit is expected to flow to the business for more than 12 months.
b.
Accounting principle
Explanation
Historical cost
The shelving should be valued at $12 500, as this is the original purchase price
paid by Max’s Mart.
(The $15 000 was paid by a different entity.)
c.
Qualitative characteristic Reliability
Explanation
There is no guarantee that the shelving can be sold for its resale value, so using
this figure will mean that the information in the reports is not free from bias.
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Exercise 1.10
Item
a. Debtors
b. Loan – principal
Elements of the reports
Report /
classification
Definition
Balance Sheet /
a resource controlled by the business which is expected to
Asset
provide a future economic benefit (when the cash is received)
Balance Sheet /
a present obligation which is expected to result in an outflow of
Liability
economic benefits sometime in the future (when the loan is
repaid)
c. Interest on loan
Profit and Loss
an outflow of an economic benefit in the form of a decrease in
Statement /
assets (Bank) which leads to a decrease in Owner’s equity
Expense
d. Stock loss
Profit and Loss
an outflow of an economic benefit in the form of a decrease in
Statement /
assets (Stock) which leads to a decrease in Owner’s equity
Expense
e. Cash sales
Profit and Loss
an inflow of an economic benefit in the form of an increase in
Statement /
assets (Bank) which leads to an increase in Owner’s equity
Revenue
f. Wages incurred
Profit and Loss
an outflow of an economic benefit in the form of a decrease in
Statement /
assets (Bank) which leads to a decrease in Owner’s equity
Expense
g. Wages owing
Balance Sheet /
a present obligation which is expected to result in an outflow of
Liability
economic benefits sometime in the future (when the employees
are paid)
h. Discount revenue
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Profit and Loss
a saving in an outflow of economic benefits in the form of a
Statement /
reduction in a liability (Creditors) which leads to an increase in
Revenue
Owner’s equity
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Exercise 1.11
Hard Utes
a.
Explanation
If the vehicle was purchased as stock and was intended for resale, it would be a
resource controlled by the business which is expected to provide a future economic
benefit in the next 12 months (when it is sold).
b.
Explanation
If the vehicle was purchased for use within the business, it would be a resource
controlled by the business which is expected to provide a future economic benefit
for more than 12 months.
c.
Explanation
If the vehicle was sold, it would create an expense called Cost of sales relating to
the outflow of an economic benefit in the form of a decrease in assets (Stock),
leading to a decrease in Owner’s equity.
d.
Explanation
Both represent an economic benefit, but whereas an asset represents a resource
controlled by the entity which is expected to provide a future economic benefit, an
expense represents an outflow or consumption of an economic benefit.
Exercise 1.12:
Fine Fashions
a.
Explanation
The goodwill represents a resource controlled by the business which is expected to
provide a future economic benefit (.ie. further sales).
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