Ch01The Role Of Accounting Exercise Solutions PDF

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Chapter 1 The role of Accounting – Solutions to exercises

Exercise 1.1

Accounting Assumptions

a Accounting Assumption Explanation

Accounting Entity

The business is assumed to be an entity separate from the owner and other businesses, and its records should be kept on this basis. The orthodontist fees are a personal expense of the owner, not the business, and therefore do not reduce the firm’s Owner’s Equity.

b Accounting Assumption Explanation

Going Concern

Financial reports are prepared on the assumption that the business will continue to operate indefinitely. The credit purchase of inventory will lead to the recognition of an Accounts Payable, which can then be recorded as a Current Liability as the amount will be paid by the business in the future.

c Accounting Assumption Explanation

Period

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.

d Accounting Assumption Explanation

Accrual

In order to calculate an accurate net profit, revenues should be recognised when they are earned, and expenses when they are incurred. The revenue should be recorded when the sale occurred, and the goods were transferred, not when the cash was received.

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Chapter 1 The role of Accounting – Solutions to exercises

e Accounting Assumption Explanation

f Accounting Assumption Explanation

Accounting Entity

The business is assumed to be an entity separate from the owner and other businesses, and its records should be kept on this basis. Casee has used her personal funds for a business expense, so this represents a transaction between two separate entities.

g Accounting Assumption Explanation

Accrual

In order to calculate an accurate net profit, revenues should be recognised when they are earned, and expenses when they are incurred. The revenue should be recorded when the goods are transferred to the customer, not on the receipt of the deposit, which rather, is recorded as a Current Liability.

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Chapter 1 The role of Accounting – Solutions to exercises

Exercise 1.2

Qualitative Characteristics

a Qualitative Characteristic Explanation

Relevance

Any transaction that is capable of affecting decision making must be recorded. The withdrawal of business cash to fund a personal expense is relevant to the entity and should be recorded as Drawings to ensure that the Owner’s Equity of the business is not overstated.

b Qualitative Characteristic Explanation

Verifiability

The premises should be valued at its original purchase price as this value is verifiable by a source document. By recording the premises at this value, the financial information will allow different knowledgeable and independent observers to be assured that it is faithfully represented.

c Qualitative Characteristic Explanation

Comparability

If a business uses consistent reporting periods, this allows for the direct comparison of financial information from one period to the next. This comparison will then inform decision making by interested users of the financial reports.

d Qualitative Characteristic Explanation

Verifiability OR Faithful Representation

All expenses should be recorded at values that are verifiable by a source document. By recording the electricity at an estimated and biased value, the financial information will not allow different knowledgeable and independent observers to be assured that it is faithfully represented.

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Chapter 1 The role of Accounting – Solutions to exercises

e Qualitative Characteristic Explanation

Timeliness

Financial information should be available to decision makers in time to be capable of influencing their decisions. Given that inventory losses indicate concerns over inventory/stock management, knowing of their occurrence in a timely manner will allow for more urgent investigation and corrective action.

f Qualitative Characteristic Explanation

Understandability

Financial information should be presented in a manner that makes it readily understandable by users who have a reasonable knowledge of business and economic activities. The accountant should be mindful to refrain from using overly technical language.

g Qualitative Characteristic Explanation

Faithful Representation

The selling price is an estimate of what the inventory may be sold for, and there is no guarantee that this will eventuate. Recording the inventory at its selling price would therefore overstate the value of the asset, making the financial information not free from bias or material error.

h Qualitative Characteristic Explanation

Relevance OR Faithful Representation

The revenue should be recorded when the sale occurred in 2024, not when the cash will be received in 2025. By including the revenue in the relevant period, accurate decisions and predictions can be made off information that is faithfully represented and free from bias or material error.

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Chapter 1 The role of Accounting – Solutions to exercises

Exercise 1.3

Accounting Assumptions and Qualitative Characteristics

a Accounting Assumption Explanation

Accounting Entity

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, and therefore does not represent a reduction to the firm’s Owner’s Equity.

b Explanation

The reports will not contain all the information that is useful for decisionmaking because they will not show the owner’s Drawings.

Exercise 1.4

Qualitative Characteristics

a Explanation

The inventory should be valued at its original purchase price as this value is verifiable by a source document. By recording the inventory at this value, the financial information will allow different knowledgeable and independent observers to be assured that it is faithfully represented.

b Explanation

The selling price is an estimate of what the inventory may be sold for, and there is no guarantee that this will eventuate. Recording the inventory at its selling price would therefore overstate the value of the asset, making the financial information not free from bias or material error.

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Chapter 1 The role of Accounting – Solutions to exercises

Exercise 1.5

Qualitative Characteristics

a Explanation

If a business uses consistent accounting methods between different periods, this allows for the direct comparison of financial information from one period to the next. Results can then be linked to performance, not just differences in accounting methods. This comparison will then inform decision making.

b Explanation

Comparability refers to the consistent use of methods to allow for comparison between accounting periods. It doesn’t mean that identical amounts should be reported from one period to the next. The amount recorded as Depreciation may differ each period if NCA are disposed or Reducing Balance is used.

Exercise 1.6

Accounting Assumptions and Qualitative Characteristics

a Explanation

Going Concern

b Explanation

Financial information must be relevant so that users of the reports can be assured that the amounts reported are complete, free from material error and neutral. The market value represents what an external third party values the business as worth, and will not be realised until the business is sold.

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Chapter 1 The role of Accounting – Solutions to exercises

Exercise 1.7

Accounting Assumptions and Qualitative Characteristics

a Qualitative Characteristic Explanation

Understandability

Financial information should be presented in a manner that makes it readily understandable by users who have a reasonable knowledge of business and economic activities. As the employees have limited accounting knowledge, the reports will not fulfil their intended function.

b Explanation

The employees are dependent on the long-term survival and viability of their employer for their livelihoods. If the business is in financial trouble, the employees should be aware and informed so that they are able to make any necessary arrangements to protect their own and their families’ future.

c Explanation

Use of graphs; plain language reports; explanatory notes; Information sessions; headings and columns

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Chapter 1 The role of Accounting – Solutions to exercises

Exercise 1.8

Accounting Assumptions and Qualitative Characteristics

a Explanation

Relevance or Faithful representation

b Explanation

Verifiability

c Explanation

Timeliness requires that financial information is available to users in time to influence their decisions. If relevant information about the likely damages is excluded from the financial reports, the ability to form predictions about future profit and available cash will be compromised.

d Discussion

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Chapter 1 The role of Accounting – Solutions to exercises

Exercise 1.9

Accounting Assumptions, Qualitative Characteristics and Elements of the Reports

a Accounting Assumption

Period OR Accrual basis

Explanation

Financial reports should be prepared for a period of time. Only revenues that have been earned during the current period should be recognised in the calculation of profit. The revenue should be recorded upon delivery in 2025.

b Qualitative Characteristic

Faithful Representation OR Relevance

Explanation

If the revenue is recorded in 2024, the financial reports will include information that is not relevant to decision making about the current period’s profit. The financial information will not be free from material error or bias.

c Explanation

The inflow of economic benefit (cash) increases assets but also increases liabilities (the goods are still owed to the customer). As a result, there is no increase to Owner’s Equity, so it cannot be recognised as revenue.

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Chapter 1 The role of Accounting – Solutions to exercises

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Chapter 1 The role of Accounting – Solutions to exercises

Exercise 1.10 Item

Elements of the reports Report/Classificatio n

Definition

a Vehicle

Balance Sheet Asset

a present economic resource controlled by the entity (as a result of past events) that is not held for resale and will be used for more than 12 months.

b Cash sales

Income Statement Revenue

an increase in assets (Bank), which leads to an increase in owner’s equity, other than those relating to contributions from the owner

c Loan – principal

Balance Sheet Liability

a present obligation of the entity to transfer an economic resource (as a result of past events) sometime in the future (when the loan is repaid)

d Interest on loan

Income Statement Expense

a decrease in assets (Bank), which leads to a decrease in owner’s equity, other than those relating to distributions to the owner

e Owner’s capital

Balance Sheet Owner’s Equity

the residual interest in the assets of the entity after the deduction of its liabilities

f Amount owing from credit sales

Balance Sheet Asset

a present economic resource controlled by the entity (as a result of past events) that is reasonably expected to be converted into cash within the next 12 months (when the cash is received from the Accounts Receivable)

g Wages incurred

Income Statement Expense

a decrease in assets (Bank), which leads to a decrease in owner’s equity, other than those relating to distributions from the owner

h Wages owing

Balance Sheet Liability

a present obligation of the entity to transfer an economic resource (as a result of past events) that is reasonably expected to be settled within 12 months (when the employees are paid)

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Chapter 1 The role of Accounting – Solutions to exercises

Exercise 1.11

Elements of the reports

a Explanation

An asset is a present economic resource controlled by the entity. An expense is a decrease in assets that decreases Owner’s Equity. An asset will provide the entity with some future benefit, whereas an expense consumes this benefit.

b Explanation

Going Concern assumes that the business will operate indefinitely. Recording the vehicle as a Non-Current Asset assumes that it will provide a benefit for a period greater than 12 months, and that the business will be in existence beyond this point.

c Explanation

If the vehicle was purchased as inventory and intended for resale, it would be a present economic resource that would convert into cash within the next 12 months (when it was sold).

d Explanation

If the vehicle was purchased for internal use within the business, it would be a present economic resource that would provide a benefit for a period greater than the next 12 months.

e Explanation

If the vehicle was considered inventory and sold, it would create an expense called Cost of Sales.

OR

If the vehicle was considered inventory and recorded as a Stock Loss

OR

If the vehicle was fully depreciated

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Chapter 1 The role of Accounting – Solutions to exercises

Exercise 1.12

Goodwill

a Discussion

The loyal clientele and repeat customers will ensure that the business will receive economic benefits into the future. In this way, the ‘goodwill’ is of benefit to the entity. However, it is difficult to place a dollar value on the amount of goodwill because there is no source document to support it. Given that it isn’t Verifiable, recording it as an asset would result in financial information that is not free from bias or material error, breaching Faithful Representation.

b Discussion

Elaine is faced with an ethical dilemma. If she were to purchase her inventory from a cheaper supplier but maintain a consistent selling price, the gross profit margin that she makes from each sale would increase. Furthermore, she is also certain that her loyal customers would remain as such, not compromising the volume of sales. Elaine would be financial advantaged. However, the new supplier offers its workers poor employment conditions. These overseas workers (given that the inventory is imported) may be earning minimum wage and have no other potential employment opportunities. Their financial future and livelihoods may be entirely dependent on their current employment. Elaine would therefore be supporting a business that does not value the health and wellbeing of its staff, and by extension, the social community in which it operates. For Elaine to be a ‘good’ global citizen, it would be unwise for her to change suppliers for her own financial gain.

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Chapter 1 The role of Accounting – Solutions to exercises

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