Question

1. Suppose you are confronted with the following accounting dilemmas. In each case, what decision would you make and what accounting principles are relevant to the resolution:

   1. An employee has been discharged and this month is being paid severance pay equal to two months’ salary. Should this severance pay be considered an expense of this month, or should it be split between the next two months?

   2. Certain items have been in inventory for more than a year; there is only a 30 percent probability that they will ever be sold or used. Should their value be removed from the total inventory value?

   3. A manufacturer of sophisticated analysis instruments ships a new model to an important customer; the customer agrees to try the new model for two months and then either return the instrument or pay full price for it. Should this shipment be counted as a sale this month? If not, should you account for a decrease in inventory value and, if so, how?

   4. The company president purchases 1,000 shares of stock from a former employee of the company. How should the company account for this transaction?

   5. The company provides a $1,000 travel advance to the sales manager, who is about to depart on a business trip to Japan. What entries, if any, would you make?

   6. A major customer with a $400,000 outstanding account receivable declares bankruptcy. What entries, if any, would you make?

   7. Your company purchases $500 of merchandise from a vendor who offers a 10% discount if your company pays the invoice within 15 days. In the past, your company has always taken such lucrative discounts for prompt payment. At what value should you record this inventory and the corresponding account payable?

   8. Your company pays $120 for telephone classified advertising for the coming year. Should you treat that as an advertising expense of the current period? If yes, why? If not, how might you account for it?

   9. Annual interest charges on your five-year loan are $1,200, payable at the end of each calendar quarter. Should you recognize any interest expense in February? If so, how?

   10. Your company owns a computer for which it paid $8,000 two years ago. The computer is still carried at that value in your fixed asset valuation. You now believe that the computer will be worthless in two more years. Should you adjust the value of the computer at this time? If so, how?

Answer 1

Ans:

1) If an employee leaves an organization then he/she serves some notice period say One Month or two months, but the paid service is given by him. So the expense is considered by the company of the same month as per the accrual basis of accounting.

2) As per AS 2 Inventory valuation, Inventory shall be valued at cost or net realizable value whichever is lower. Here, in this case, the value of the inventory can be realized probably 30% so the inventory which can be realized only that should be valued, the balance should be written off from the books.

3) As per AS 9 Revenue Recognition, revenue shall be recognized only in that case where all risks & rewards have been transferred to the buyer. In this case, inventory is transferred on an approval basis whether the customer likes it will keep it otherwise return it .So there is no certain transfer of risk & rewards. Revenue should not be recognized. However, the stock should be reduced in this case.

4) Company purchases stock from former employee is a normal transaction of purchase of shares shall be recorded as purchase of shares from ex employee.

5) Travellings Exps Account Dr by 1000 $

Credit Cash Account for 1000$

6) Bad Debts Account Dr $ 400000

To Trade Receiables Account $ 400000