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Instructions: Each of the situations below may illustrate a violation of an accounting assumption or principle. Indicate the assumption or principle that is most clearly violated using the following codes:
Codes
A. Economic entity assumption
G. Materiality
B. Monetary unit assumption
H. Full disclosure principle
C. Time period assumption
I. Cost principle
D. Going concern assumption
J. Conservatism
E. Revenue recognition principle
K. No violation of operating guidelines
F. Matching principle
Situations
_E___ 1.Stockholders invested an additional $60,000 cash in the business in 2007. This investment was reported as revenue on the 2007 income statement.
__I__ 2.Larson Paperweights values the marble it has on hand at its expected selling price since this is its expected value to the business. The marble's expected selling price exceeds the price Larson paid for it.
_J___ 3. Pandle Company reports its inventory at cost when current replacement cost is significantly below cost.
__C__ 4. Kailey's Novelties has 100,000 whistling dolls in inventory at a cost of $5 each. Only eight were sold last month. Not wanting to write off this inventory and report a loss, Kailey has decided not to issue financial statements until at least half of the dolls have been sold.
__D__ 5. Zenger's Pizza is being liquidated because it has sustained losses for many years. It continues to depreciate its assets and prepare financial statements on the cost basis.
__A__ 6. Kim Penkins, president of Penkins Machinery, took a power saw out of inventory to use as a birthday present for his son. Supplies expense was debited.
__H__ 7. Blake Industries has developed an automobile engine that will run on sea water instead of gasoline, while providing equal performance. They have chosen not to release reports of this engine to the public.
__F__ 8. Minton Company made no entry to record depreciation on its equipment for 2007.
__K__ 9. Stevens Brokerage bought each of its 5,000 employees new staplers for their desks. Each stapler cost $10 and was decorated with the company's logo. Since Stevens expenses all assets costing less than $25, no asset was recorded.
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Here is an analysis of each situation and the corresponding violation of an accounting assumption or principle:
1. Violation: Revenue recognition principle (E)
Explanation: Reporting the additional cash investment as revenue on the income statement violates the revenue recognition principle, which states that revenue should be recognized when it is earned, not when cash is received.
2. Violation: Cost principle (I)
Explanation: Valuing the marble at its expected selling price instead of the cost paid for it violates the cost principle, which states that assets should be recorded at their original cost.
3. Violation: Conservatism (J)
Explanation: Reporting inventory at cost when the current replacement cost is significantly below cost violates the principle of conservatism, which requires that uncertainties and potential losses should be recognized immediately.
4. Violation: Time period assumption (C)
Explanation: Delaying the issuance of financial statements until at least half of the inventory has been sold violates the time period assumption, which requires that financial statements should be prepared at regular intervals, usually at the end of a specific time period (e.g., month, quarter, year).
5. Violation: Going concern assumption (D)
Explanation: Continuing to depreciate assets and prepare financial statements on the cost basis despite the decision to liquidate signifies a violation of the going concern assumption, which assumes that the business will continue to operate for the foreseeable future.
6. Violation: Economic entity assumption (A)
Explanation: Taking a power saw out of inventory for personal use and debiting supplies expense violates the economic entity assumption, which assumes that the activities of the business are separate from the activities of its owners or other businesses.
7. Violation: Full disclosure principle (H)
Explanation: Choosing not to release reports of the engine to the public violates the full disclosure principle, which requires all information that is significant and could potentially influence the decision-making of users of financial statements to be disclosed.
8. Violation: Matching principle (F)
Explanation: Making no entry to record depreciation on equipment for 2007 violates the matching principle, which states that expenses should be recognized in the same period as the revenues they help generate.
9. No violation: No violation of operating guidelines (K)
Explanation: In this situation, Stevens Brokerage expenses all assets costing less than $25, so no asset is recorded. Since this aligns with their operating guidelines, there is no violation of any accounting assumption or principle.