Question

Each of the following statements represents a decision made by the accountant of Growth

Industries:

a. A tornado destroyed $200,000 in uninsured inventory. This loss is included in the cost of goods sold.

b. Land was purchased 10 years ago for $50,000. The accountant adjusts the land account to $100,000, which is the estimated current value.

c. The cost of machinery and equipment is charged to a fixed asset account. The machinery and equipment will be expensed over the period of use.

d. The value of equipment increased this year, so no depreciation of equipment was recorded this year.

e. During this year, inventory that cost $5,000 was stolen by employees. This loss has been included in the cost of good sold for the financial statements. The total amount of the cost of goods sold was $1 million.

f. The president of the company, who owns the business, used company funds to buy a car for personal use. The car was recorded on the company’s books.

Required: state whether you agree or disagree with each decision.

Answer 1

(a) The loss of inventory valuing $200,000 cannot be included in the Cost of good sold (COGS), because generally it is recommended to take insurance on inventory. Here the company should have taken an insurance accordingly which may be like loss due to accident and also the insurance taken should cover loss due to any natural disasters. It is the responsibility of the management of the company to take all necessary measures to avoid losses where ever possible. Also if included in COGS it will violation of Accounting Standards. So I disagree with the decision.

(b) Land is an asset where there will be no depreciation over the years. It will have always appreciation and defies the general rule of depreciation of assets. In IFRS (International Financial Reporting System) accounting norms, we can show the land at its fair market value on the Balance sheet. Also Balance sheet is prepared on a particular day which shows all Assets and Liabilities positions of an organisation on that day when it was prepared. So I agree with the decision.

(c) I agree with the decision, only if such purchase increases the life of the Asset significantly in which it is used. I mean to say that, if such addition of new machinery which replaces the old machinery and results in extension of usable life of whole Asset, then capitalization of such expenses is correct Accounting practice.

(e) The loss of goods due to theft cannot be included in COGS, such practice does not account for true and fair view of financial statements. Also such practice will result in window dressing of accounts, which results in paying lower taxes eventually. It should be shown as a separate item in Income statement below Gross profit before Net profit. I disagree with the decision.

(f) I disagree with the decision of charging personal expenses to the corporate expenses. It is a false accounting practice which will never show true and fair view of financial statements. This shouldn't be encouraged. Also such findings can be dealt when the firm undergoes fair Auditing or strong internal controls should be established to keep check on such false accounting practices.

Note: I have little ambiguity when I tried answering part D. I hope the rest of the answers help you.