Question

For each of the following, explain whether you agree or disagree with the accounting treatment. Support your view with the GAAP Principles.

1. A company records all revenue when earned, whether it has been collected or not.
2. Payment of a three-year insurance policy is charged to insurance expense and not adjusted.
3. Because the December telephone bill did not arrive until January, no telephone expense was recorded for December.

Answer 1

1)A company records all revenue when earned, whether it has been collected or not-I agree with this statement.

GAAP stipulates that revenues are recognized when realized and earned, not necessarily when received.So as per GAAP we have to follow accrual accounting concept in this scenario.To record revenue, a company must meet the following two criteria:

1. A critical event must trigger the transaction process.
2. The money resulting from the transaction must be measurable within a certain degree of reliability

Accrued revenue is recorded in the financial statements through the use of an adjusting journal entry. The accountant debits an asset account for accrued revenue which is reversed when the exact amount of revenue is actually collected, crediting accrued revenue.

2)Payment of a three-year insurance policy is charged to insurance expense and not adjusted.-I disagree with the statement.

Current year insurance charges will be taken as insurance expense,(i.e one by third of the sum paid) and the remaining balance is shown as prepaid expense in the asset side of balance sheet.The amount paid for upcoming 2 years are prepaid expense,since we have paid the amount as an advance for the insurance service.

According to generally accepted accounting principles (GAAP), expenses should be recorded in the same accounting period as the benefit generated from the related asset.The benefit of insurance expense will be generated on the next two years only so the insurance expense also will need to book on next two years.

3)Because the December telephone bill did not arrive until January, no telephone expense was recorded for December.-I disagree with the statement.

It is an accrued expense(It is an estimate,Since the company incurring telephone expense every month during the whole year,we can easily estimate the expense),It is already been incurred but the invoicing of the expense and payment of the same is pending.or it is an expense that is recognized on the books before it has been paid; the expense is recorded in the accounting period in which it is incurred.Since there is obligation to pay the amount it is shown as current liability in balance sheet it is also known as accrued liability.

As per GAAP Accrual concept has to be applied for accounting,i.e,recording revenues when earned and expenses as incurred.

Thank you.Please rate the answer if you understood.