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Chapter 2: BE2-10 (page 64)

Identify which basic principle of accounting is best described in each item below.(a) Norfolk Southern Corporation reports revenue in its income statement when the performance obligation is satisfied instead of when the cash is collected.(b) Yahoo! recognizes depreciation expense for a machine over the 2-year period during which that machine helps the company earn revenue.(c) Oracle Corporation reports information about pending lawsuits in the notes to its financial statements.(d) Gap, Inc. reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair value is greater.

Short Answer

Expert verified

(a) Revenue recognition

(b) Matching principle

(c) Full disclosure

(d) Historical cost

Step by step solution

01

Definition of revenue

Revenue is an income to the company arising due to normal course of business activities. Generally, it will occur by giving services to customers and sale of goods, and some companies getting this revenue from interest, fees and royalties.

02

(a) Revenue recognition principle

Reason - Revenue is recognized in the period it is earned (GAAP)

Revenue recognition principle: Revenue is recognized for accounting records as and when the related performance obligation is complete. The performance obligation arises if a company sells a product or provides service to its customer. Once the performance obligation is satisfied by a company it should record revenue in the respective accounting period.

03

(b) Matching principle:

Under the matching principle in accrual basis accounting, expenses are matched with the benefits derived from the expense in the same income statement period. Expenses, which do not pertain to a period, are excluded from reporting in the period.

Reason - Expense is matched with the period revenue is earned.

04

(c) Full Disclosure principle

Reason - Pending lawsuit is disclosed to its investor as a foot note.

Full disclosure about all the disputes and conflicts against the company need to be shown and other perceived problems and liabilities and legal issues need to be disclosed in order to maintain transparency.

05

(d) Historical cost

Accounting is concerned with past events and it requires consistency and comparability that is why it requires the accounting transactions to be recorded at their historical costs. This is known as historical concept.

Reason - Cost in the balance sheet is the cost it acquired.

Historical cost is the cost, which is there on the day of transaction, which is the past event cost.

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Most popular questions from this chapter

What are the four basic assumptions that underlie the financial accounting structure?

Question: (Qualitative Characteristics) Recently, your uncle, Carlos Beltran, who knows that you always have your eye out for a profitable investment, has discussed the possibility of your purchasing some corporate bonds. He suggests that you may wish to get in on the 鈥済round floor鈥� of this deal. The bonds being issued by Neville Corp. are 10-year debentures which promise a 40% rate of return. Neville manufactures novelty/party items.

You have told Uncle Carlos that, unless you can take a look at Neville鈥檚 financial statements, you would not feel comfortable about such an investment. Believing that this is the chance of a lifetime, Uncle Carlos has procured a copy of Neville鈥檚 most recent, unaudited financial statements which are a year old. These statements were prepared by Mrs. Andy Neville. You peruse these statements, and they are quite impressive. The balance sheet showed a debt-to-equity ratio of 0.10 and, for the year shown, the company reported net income of $2,424,240.

The financial statements are not shown in comparison with amounts from other years. In addition, no significant note disclosures about inventory valuation, depreciation methods, loan agreements, etc. are available.

Instructions

Write a letter to Uncle Carlos explaining why it would be unwise to base an investment decision on the financial statements that he has provided to you. Be sure to explain why these financial statements are neither relevant nor representationally faithful.

(Full Disclosure Principle) Presented below are a number of facts related to Weller, Inc. Assume that no mentionof these facts was made in the financial statements and the related notes.

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Assume that you are the auditor of Weller, Inc. and that you have been asked to explain the appropriate accounting and related disclosure necessary for each of these items.

(a) The company decided that, for the sake of conciseness, only net income should be reported on the income statement. Details as to revenues, cost of goods sold, and expenses were omitted.

(b) Equipment purchases of \(170,000 were partly financed during the year through the issuance of a \)110,000 notes payable. The company offset the equipment against the notes payable and reported plant assets at \(60,000.

(c) Weller has reported its ending inventory at \)2,100,000 in the financial statements. No other information related to inventories is presented in the financial statements and related notes.

(d) The company changed its method of valuing inventories from weighted-average to FIFO. No mention of this change was made in the financial statements.

ETHICS (Expense Recognition Principle) Anderson Nuclear Power Plant will be "mothballed" at the end of its useful life (approximately 20 years) at great expense. The expense recognition principle requires that expenses be recognized as assets are used up or liabilities are incurred. Accountants Ana Alicia and Ed Bradley argue whether it is better to allocate the expense of mothballing over the next 20 years or ignore it until mothballing occurs.

Instructions

Answer the following questions.

(a) What stakeholders should be considered?

(b) What ethical issue, if any, underlies the dispute?

(c) What alternatives should be considered?

(d) Assess the consequences of the alternatives.

(e) What decision would you recommend?

Wayne Cooper has some questions regarding the theoretical framework in which GAAP is set. He knows that the FASB and other predecessor organizations have attempted to develop a conceptual framework for accounting theory formulation. Yet, Wayne鈥檚 supervisors have indicated that these theoretical frameworks have little value in the practical sense (i.e., in the real world). Wayne did notice that accounting rules seem to be established after the fact rather than before. He thought this indicated a lack of theory structure but never really questioned the process at school because he was too busy doing the homework. Wayne feels that some of his anxiety about accounting theory and accounting semantics could be alleviated by identifying the basic concepts and definitions accepted by the profession and considering them in light of his current work. By doing this, he hopes to develop an appropriate connection between theory and practice.Instructions

(a) Help Wayne recognize the purpose of and benefit of a conceptual framework.

(b) Identify any Statements of Financial Accounting Concepts issued by the FASB that may be helpful to Wayne in developing his theoretical background.
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