Exercises

When is revenue generally recognized?

Revenue is generally recognized when (1) realized or realizable, and (2) earned.

Jane Hull Company paid $135,000 for a machine in 2005.The Accumulated Depreciation account has a balance of$46,500 at the present time. The company could sell themachine today for $150,000. The company presidentbelieves that the company has a “right to this gain.” Whatdoes the president mean by this statement? Do youagree.

The president means that the "gain" should be recorded in the books. This item should not be entered in the accounts, however, because it has not been realized.

Identify which basic assumption of accounting is best described in each item below.

(a) The economic activities of FedEx Corporation are divided into 12-month periods for the purpose of issuing annual reports.

(b) Solectron Corporation, Inc. does not adjust amounts in its financial statements for the effects of inflation.

(c) Walgreen Co. reports current and noncurrent classifications in its balance sheet.

(d) The economic activities of General Electric and its subsidiaries are merged for accounting and reporting purposes.

(a) Periodicity

(b) Monetary unit

(c) Going concern

(d) Economic entity

Identify which basic principle of accounting is best described in each item below.

(a) Norfolk Southern Corporation reports revenue in its income statement when it is earned instead of when the cash is collected.

(b) Yahoo, Inc. 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) Eastman Kodak Company reports land on its balance sheet at the amount paid to acquire it, even though the estimated fair market value is greater.

(a) Revenue recognition

(b) Matching

(c) Full disclosure

(d) Historical cost

Which constraints or Modifying Principles on accounting information are illustrated by the items below?

(a) Zed's Farms, Inc. reports agricultural crops on its balance sheet at market value.

(b) Crimson Tide Corporation does not accrue a contingent lawsuit gain of $650,000.

(c) Wildcat Company does not disclose any information in the notes to the financial statements unless the value of the information to financial statement users exceeds the expense of gathering it.

(d) Sun Devil Corporation expenses the cost of wastebaskets in the year they are acquired.

(a) Industry practices

(b) Conservatism

(c) Cost-benefit

(d) Materiality

In each of the situations, discuss the appropriateness of the journal entries in terms of generally accepted accounting principles.

 

(1) The president of Gonzales, Inc. used his expense account to purchase a new Suburban solely for personal use. The following journal entry was made.

Miscellaneous Expense……………….29,000

Cash …………………………..29,000

 

This entry violates the economic entity assumption

The correct entry is:

President’s, Drawings ……………….29,000

Cash …………………………..29,000

(2) Merchandise inventory that cost $620,000 is reported on the balance sheet at $690,000, the expected selling price less estimated selling costs. The following entry was made to record this increase in value.

Merchandise Inventory…………………. 70,000

Revenue ………………………………..70,000

 a- This entry violates the cast principles. Because the historical cost principle indicates that assets and liabilities are recorded on the basis of cost not FMV.

In addition to:

b- This entry violates the revenues recognition principles. Because revenue should be recognized when (1) realized or realizable and (2) earned.

(3) The company is being sued for $500,000 by a customer who claims damages for personal injury apparently caused by a defective product. Company attorneys feel extremely confident that the company will have no liability for damages resulting from the situation. Nevertheless, the company decides to make the following entry.

Loss from Lawsuit ………………………..500,000

Liability for Lawsuit…………………. 500,000

 

The company is too conservative in its accounting for this transaction. Because a loss should be accrued only (1) when it is probable that the company would lose the suit and (2) the amount of the loss can be reasonably estimated.