Accounting Theory

Accounting Theory
Provide answers for the following situations. Be sure your answers are complete, grammatically correct, and based on sound accounting theory. As seniors, you are expected to submit work that is of near-professional quality.
Problem 1-1

Accounting information provides useful information about business transactions and events. Those who provide and use financial reports must often select and evaluate accounting alternatives. FASB Statement of Financial Accounting Concepts No. 8, “Qualitative Characteristics of Accounting Information,” examines the characteristics of accounting information that make it useful for decision making. It also points out that various limitations inherent in the measurement and reporting process may necessitate trade-offs or sacrifices among the characteristics of useful information.
1. Describe briefly the following characteristics of useful accounting information:

a. Relevance
b. Faithful Representation
c. Understandability
d. Comparability
e. Consistency

2. For each of the following pairs of information characteristics, give an example of a situation in which one of the characteristics may be sacrificed in return for a gain in the other:

a. Relevance and faithful representation.
b. Relevance and consistency.
c. Comparability and consistency.
d. Relevance and understandability.

3. What criterion should be used to evaluate trade-offs between information characteristics?

Problem 1-2

Presented below are a number of questions related to qualitative characteristics and underlying constraints identified in SFAC #8.

1. What are the two primary qualities that make accounting information useful for decision-making?

2. Smith, Inc. does not issue its first-quarter report until after the second quarter’s results are reported. Which qualitative characteristic of accounting is not followed? (Do not use relevance.)

3. Predictive value is an ingredient of which of the two primary qualities that make accounting information useful for decision-making purposes?

4. Assume that the profession permits the savings and loan industry to defer losses on investments it sells, because immediate recognition of the loss may have adverse economic consequences on the industry. Which qualitative characteristic of accounting information is not followed? (Do not use relevance or faithful representation.)

5. Warren Company has attempted to determine the replacement cost of its inventory. Three different appraisers arrive at substantially different amounts. The president decides to report the middle value. Which qualitative characteristic of information is lacking in this data? (Do not use reliability or representational faithfulness.)

6. What is the quality of information that enables users to confirm or correct prior expectations?

7. Identify the overall or pervasive constraint developed in the conceptual framework.

8. The chairman of the SEC at one time noted that “if it becomes accepted or expected that accounting principles are determined or modified in order to secure purposes other than economic measurement–we assume a grave risk that confidence in the credibility of our financial information system will be undermined.” Which qualitative characteristic of accounting information should ensure that such a situation will not occur? (Do not use faithful representation.)

9. Muraphone switches from FIFO to average cost to FIFO over a two-year period. Which qualitative characteristic of accounting information is not followed?

10. Rhodes is the only company in its industry to depreciate its plant assets on a straight-line basis. Which qualitative characteristic of accounting information may not be followed? (Do not use industry practices.)

Problem 1-3
A number of operational guidelines used by accountants are described below. For each of these situations, list the qualitative characteristic, assumption, principle, or constraint that has been violated. List only one term for each case.
1. Pogo Chemical Company “faces possible expropriation (i.e., takeover) of foreign facilities and possible losses on sums owed by various customers on the verge of bankruptcy.” The company president has decided that these possibilities should not be noted on the financial statements because Pogo still hopes that these events will not take place.

2. Sally Messner, manager of College Bookstore, Inc., bought a computer for her own use. She paid for the computer by writing a check on the bookstore checking account and charged the “Office Equipment” account.

3. Dinner Bell, Inc., a fast-food company, sells franchises for $170,000, accepting a $10,000 down payment and a 30-year note for the remainder. Dinner Bell promises for 3 years to assist in site selection, building, and management training. Dinner Bell records the $170,000 franchise fee as revenue in the period in which the contract is signed.

4. Joe’s Discount Centers buys its merchandise by the truck and train-carload. Joe does not defer any transportation costs in computing the cost of its ending inventory. Such costs, although varying from period to period, are always material in amount.

5. The treasurer of Almaden Co. wishes to prepare financial statements only during downturns in their wine production, which occur periodically when the rhubarb crop fails. He states that it is at such times that the statements could be most easily prepared. In no event would more than 30 months pass without statements being prepared.

6. The RST Power & Light Company has purchased a large amount of property, plant, and equipment over a number of years. They have decided that because the general price level has changed materially over the years, they will issue only price-level adjustment financial statements.

7. Dixie Manufacturing Co. decided to manufacture its own widgets because it would be cheaper to do so than to buy them from an outside supplier. In an attempt to make their statements more comparable with those of their competitors, Dixie charged its inventory account for what they felt the widgets would have cost if they had been purchased from an outside supplier. (Do not use revenue recognition principle.)

8. Morris, Inc. recently completed a new 120-story office building that houses their home offices and many other tenants. All the office equipment for the building that had a per item or per unit cost of $1,000 or less was expensed as immaterial, even though the office equipment has an average life of 10 years. The total cost of such office equipment was approximately $26 million. (Do not use the expense recognition principle.)

Problem 1-4

Presented below are a number of operational guidelines and practices that have developed over time. Select the assumption, principle, or constraint that most appropriately justified these procedures and practices. (Do not use qualitative characteristics.)

1. All important aspects of bond indentures are presented in financial statements.

2. Rationale for accrual accounting is stated.

3. All significant postbalance sheet events are reported.

4. All payments out of petty cash are charged to Miscellaneous Expense.

5. Goodwill is recorded only at time of purchase.

6. Reporting must be done at defined time intervals.

7. An allowance for doubtful accounts is established.

8. A company charges its sales commission costs to expense.

9. Price-level changes are not recognized in the accounting records.

10. Each enterprise is kept as a unit distinct from its owner or owners.

11. Financial information is presented so that reasonably prudent investors will not be misled.

12. Repair tools are expensed when purchased.

13. The use of consolidated statements is justified.

14. Revenue is recorded at point of sale.

 

 

 

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