Chapter 1 The Role of Accounting – Solutions to exercises
Exercise 1.1
Accounting principles
a
Accounting principle
Entity
Explanation
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
Consistency
Explanation
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
Monetary Unit
Explanation
Transactions should be recorded in a common unit of
measurement – in Australia, this means Australian dollars.
d
Accounting principle
Reporting Period
Explanation
The life of the business is divided into arbitrary periods to allow
for reports to be prepared. The transaction should be recorded
as revenue when it was earned (when the goods were supplied),
i.e. in December 2014.
e
Accounting principle
Historical Cost
Explanation
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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Chapter 1 The Role of Accounting – Solutions to exercises
f
Accounting principle
Going Concern
Explanation
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
Reporting Period
Explanation
The life of the business is divided into arbitrary periods to allow
for reports to be prepared. According to tax requirements,
reports must be prepared at least yearly.
Exercise 1.2
Accounting principles and qualitative characteristics
a
Accounting principle
Entity
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
Simmons, Hardy
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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Chapter 1 The Role of Accounting – Solutions to exercises
Exercise 1.3
Accounting principles and qualitative characteristics
a
Accounting principle
Historical Cost
Explanation
Stock should be valued at its original purchase price as this
value is verifiable by a source document.
OR
Accounting principle
Conservatism
Explanation
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
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.
Explanation
Exercise 1.4
Accounting principles and qualitative characteristics
a
Accounting principle
Conservatism
Explanation
Losses 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
Justification
The reports should include all information that is useful for
decision-making. The probable expense of damages may affect
decisions the owner makes about both profit and available cash.
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Chapter 1 The Role of Accounting – Solutions to exercises
Exercise 1.5
Accounting principles and qualitative characteristics
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.
Exercise 1.6
Accounting principles, qualitative characteristics and
elements of reports
a
Accounting principle
Reporting Period
Explanation
The life of the business is divided into arbitrary periods to allow
for reports to be prepared. The revenue was not earned in the
Reporting Period in which it was received (2014) but when the
goods are provided in 2015 (a different Reporting Period).
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
(2014; i.e. the cash that has been received will not be earned
until the next Reporting Period (2015).
c
Explanation
Simmons, Hardy
The inflow of economic benefits (cash) increases assets, but
also increases liabilities (the goods are still owed to the
customer); as a result there is no increase in owner’s equity.
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Chapter 1 The Role of Accounting – Solutions to exercises
Exercise 1.7
Accounting principles and qualitative characteristics
a
Qualitative characteristic
Understandability
Explanation
Reports should be presented in a manner that makes it readily
understandable by users. As the workers have no accounting
knowledge, the reports will not fulfil their function of providing
information.
b
Use of graphs; plain language reports; explanatory
notes/presentation sessions
Technique
Exercise 1.8
Accounting principles and qualitative characteristics
a
Accounting principle
Historical Cost
Explanation
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 han,d
represents what a potential buyer is prepared to pay for the
assets.
Exercise 1.9
Accounting principles, qualitative characteristics and
elements of reports
a
Explanation
As a non-current asset as it is a resource controlled by the
business as a result of past events from which a future
economic benefit is expected to flow to the business for more
than 12 months.
b
Accounting principle
Historical Cost
Explanation
The shelving should be valued at $12 500, as this is the agreed
value of the asset at the time it is contributed to Max’s Mart. This
agreed value becomes the Historical Cost for Max’s Mart. (The
$15 000 was paid by a different entity.)
Simmons, Hardy
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Chapter 1 The Role of Accounting – Solutions to exercises
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.
Exercise 1.10
Item
Elements of the reports
Report/classification
Definition
a Debtors
Balance Sheet/
Asset
a resource controlled by the business that is expected
to provide a future economic benefit (when the cash is
received)
b Loan –
principal
Balance Sheet/
Liability
a present obligation that is expected to result in an
outflow of economic benefits sometime in the future
(when the loan is repaid)
c Interest on
loan
Income
Statement/
Expense
an outflow of an economic benefit in the form of a
decrease in assets (Bank), which leads to a decrease in
owner’s equity
d Stock loss
Income
Statement/
Expense
an outflow of an economic benefit in the form of a
decrease in assets (Stock,) which leads to a decrease
in owner’s equity
e Cash sales
Income
Statement/
Revenue
an inflow of an economic benefit in the form of an
increase in assets (Bank), which leads to an increase in
owner’s equity
f Wages
incurred
Income
Statement/
Expense
an outflow of an economic benefit in the form of a
decrease in assets (Bank,) which leads to a decrease in
owner’s equity
g Wages
owing
Balance
Sheet/Liability
a present obligation that is expected to result in an
outflow of economic benefits sometime in the future
(when the employees are paid)
h Discount
revenue
Income
Statement/
Revenue
a saving in an outflow of economic benefits in the form
of a reduction in a liability (Creditors), which leads to an
increase in owner’s equity.
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Chapter 1 The Role of Accounting – Solutions to exercises
Exercise 1.11
Elements of the reports
a
Explanation
Both represent an economic benefit, but whereas an asset represents a
resource controlled by the entity that is expected to provide a future
economic benefit, an expense represents an outflow or consumption of an
economic benefit.
b
Explanation
If the vehicle was purchased as stock and was intended for resale, it would be
a resource controlled by the business that is expected to provide a future
economic benefit in the next 12 months (when it is sold).
c
Explanation
If the vehicle was purchased for use within the business, it would be a
resource controlled by the business that is expected to provide a future
economic benefit for more than 12 months.
d
Explanation
OR
Exercise 1.12
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.
Stock loss/Depreciation
Goodwill
a
Discussion
Simmons, Hardy
The loyal clientele (goodwill) represents a resource controlled by the business
that is expected to provide a future economic benefit (i.e. further sales).
However, it is difficult to value this goodwill in any manner that is Reliable
(accurate/free from bias) so it should not be recognised as an asset.
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