Question

Discuss how basic accounting principles apply in each of the following areas:

1. recording of transactions;

2. preparation of financial statements;

3. cost accounting or budgeting

(Word limit – 1,000-1,200 words)

Guidelines:

1.

For each of the above three areas listed, you are required to select and discuss four (4) basic

accounting principles. To demonstrate your understanding of each of these accounting principles,

your discussion should include examples drawn from real-life companies or even fictitious

situations. You must demonstrate that you understand how these principles are applied using

examples.

2. Please read the rubrics carefully before answering and organize your answers according to the

scores given to the questions. Please remember to answer all parts of the questions.

3.

Please answer with your own analysis and wordings. You do not need to copy any definition

from the course materials, and please do not copy any information directly from the website or

other people's comments. Please do not get involved in any plagiarism.

Answer 1

Hi Friend,
please refer to the solution provided below:

Accounting principles are the general rules and guidelines that companies are required to follow when reporting all accounts and financial data.

The purpose of having - and following - accounting principles is to be able to communicate economic information in a language that is acceptable and understandable from one business to another. Companies that release their financial information to the public are required to follow these principles in the preparation for their statements.

We will discuss the various principles required for the below three functions with examples :

· Recording of transactions

· Presentation of Financial Statements

· Cost accounting & Budgeting

Recording of Transactions

Recording transactions is a basic accounting process, with a few steps involved. The first step is to determine the transaction and which accounts it will affect. The second step is recording in particular accounts. Consideration must be taken when numbers are inputted into the debit and credit sections. Then, finally, the transaction is recorded in a document called a journal. The following principles are required for this function.

· Matching principle - The concept that each revenue recorded should be matched and recorded with all the related expenses, at the same time. Specifically in accrual accounting, the matching principle states that for every debit there should be a credit (and vice versa).

Examples : (1) Angle Machining, Inc. buys a new piece of equipment for $100,000 in 2015. This machine has a useful life of 10 years. This means that the machine will produce products for at least 10 years into the future. According to the matching principle, the machine cost should be matched with the revenues it creates. Thus, the machine is depreciated over its 10-year useful life instead of being fully expensed in 2015.

(2) Bajor Art Studio produces picture frames and sells them to wholesalers like Michaels and Hobby Lobby. Bajor pays its employees $20 an hour and sells every frame produced by its employees. Since the payroll costs can be directly linked back to revenue generated in the period, the payroll costs are expensed in the current period.

(3) Big Appliance has sold kitchen appliances for 30 years in a small town. It purchases a large appliance from wholesalers for $5,000 and resells it to a local restaurant for $8,000. At the end of the period, Big Appliance should match the $5,000 cost with the $8,000 revenue.

· Monetary unit principle - Businesses should only record transactions that can be expressed in terms of a stable unit of currency.

Examples: (1) The CEO of Fine Enterprise delivers a lecture to the employees in a special meeting that can be helpful in raising the employees’ morale and completing the current projects on time.

As the value of the lecture cannot be measured in terms of money, it cannot be recorded in the books of accounts of Fine Enterprise.

(2) The Metro company purchased a tract of land for $25,000 in 2005. Because of inflation, the worth of the tract of land is now $40,000.

The Metro company cannot adjust its balance sheet because the monetary unit assumption enforces it to ignore the impact of inflation.

(3) Fast transport company has five trucks. One of its trucks is seriously damaged in a road accident and is being repaired.

The company can only account for the amount of insurance or any expenses that it actually has to pay to get the truck in working condition but cannot record the loss of revenue caused by the time the truck takes to be overhauled.

Revenue recognition principle - Companies should record their revenues when it is recognized, or in the same time period of when it was accrued (rather than when it was received).

Examples: (1) Bob’s Billiards, Inc. sells a pool table to bar on December 31 for $5,000. The pool table was not paid for until January 15th and it was not delivered to the bar until January 31. According to the revenue recognition principle, Bob’s should not record the sale in December. Even though the sale was realizable in that the sale for $5,000 was initiated, it was not earned until January when the pool table was delivered.

(2) Johnson and Waldorf, LLC is an accounting firm that provides tax and consulting work. During December, JW provides $2,000 of consulting work to one of its clients. The client does not pay for the consulting time until the following January. According to the revenue recognition principle, JW should record the revenue in December because the revenue was realized and earned in December even though it was not received until January.

(3) Pat’s Retail, Inc. sells clothing from its retail outlets. A customer purchases a shirt on June 15th and pays for it on a credit card. Pat’s processes the credit card but does not actually receive the cash until July. The credit card purchase is treated the same as cash because it is a claim to cash, so the revenue should be recorded in June when it was realized and earned.

Preparation of Financial Statements

Information from your accounting journal and your general ledger is used in the preparation of your business’s financial statement. The income statement, the statement of retained earnings, the balance sheet, and the statement of cash flows all make up your financial statements. Also, information from the previous statement is used to develop the next one. The following principles are required for this function.

Time period principle - A business should report their financial statements (income statement/balance sheet) appropriate to a specific time period.

Examples : (1) Take publicly traded companies for example. They typically produce quarterly financial statements. Some companies even produce monthly or weekly statements. The time period principle allows these companies to divide up their operations and activities into time periods instead of production processes or jobs. This is convenient for lenders and investors to see company-wide progress as well as growth.

Private companies aren’t required to issue quarterly financial statements usually use a year as their accounting or reporting period. Most of the time these companies’ accounting and reporting year coincides with their tax year, but it doesn’t always coincide with the calendar year. For instance, some companies may choose to end their fiscal year on June 30th.

Full disclosure principle - Any important information that may impact the reader’s understanding of a business’s financial statements should be disclosed or included alongside the statement.

Example: (1) The entity might lose large contracts with its customers to its competitor. And the subsequent loss of contract could turn the entity into bankruptcy. In such a case, management probably doesn’t want outsiders, especially investors to know the real situation of an entity.

And base on the Full Disclosure Principle, the entity is required to disclose such a situation in its financial statements.

(2) Another example is related to the full disclosure of contingency. It can be contingent assets or contingent liabilities. For example, the company is facing the lawsuit as the result of disposing poison material into the water and it going to be a large penalty.

Based on the Full Disclosure Principle, the entity required to fully disclose this information in its Financial Statements. Once the users of Financial Statements noted this information, they will understand what are the current contingent liabilities of the entity.

Going concern principle - The concept that assumes a business will continue to exist and operate in the foreseeable future, and not liquidate. This allows a business to defer some prepaid expenses (accrued) to future accounting periods, rather than recognize them all at once.

Examples : (1). A company manufactures a chemical known as Chemical-X. Suddenly, the government imposes a restriction on the manufacture, import, export, marketing, and sale of this chemical in the country. If Chemical-X is the only product that the company manufactures, the company will no longer be a going concern.

(2). The National company is in serious financial trouble and cannot pay its obligations. The government gives the National company a bailout and a guarantee of all payments to creditors. The national company is a going concern despite its current weak financial position.

(3). The Eastern company closes one of its branches and will continue with others. The company is a going concern because shutting down a small part of the business does not impair the ability of the company to operate as going concerned.

Reliability principle - The reliability principle is used as a guideline in determining which financial information should be presented in the accounts of a business.

Examples: (1) If we have debtors in our books $50k and in debtor’s books the balance is $80K then the unreliable information may impact the financial statements.

The data or information is reliable unless it is able to verify by the third party, and it could be measured in a systematic manner.

Here are the key factors to consider if the accounting transactions are reliable:

· Must be accurate: that means the information is support by reliable evidence like the original invoice or contract. It must be able to check by the third party.

· Free from bias: information is free from any kind of bias. It is present as it is.

· Report what actually happens. The financial information must be recording what really happened. For example, if the entity got a penalty from the government amount approximately 500,000 USD. The entity should record this amount and disclose it properly in the financial statements. The users of financial information should be able to know what really happened in the entity if they use this information.

· An individual would have arrived at a similar conclusion if they are using the same information.

Cost Management & Budgeting

Cost management is concerned with the process of finding the right project and carrying out the project the right way. It includes activities such as planning, estimating, budgeting, financing, funding, managing, controlling, and benchmarking costs so that the project can be completed within time and the approved budget and the project performance could be improved in time. Following Principles are required for this function

Cost principle - A business should record their assets, liabilities, and equity at the original cost at which they were bought or sold. The real value may change over time (e.g. depreciation of assets/inflation) but this is not reflected for reporting purposes.

Examples: (1) J & E Tax Brokers is a large-scale tax accountant firm. They purchased an office building for $278,000 in 2015. In 2020, the property is appraised at a value of $330,500. The tax firm may not change the cost principle since this increase relates to the increase in market value. Instead, the firm might credit the difference in value to an equity account. Therefore, the actual cost principle still reflects the initial purchase price of the building and not the increased value.

(2) J & E Tax Brokers purchased 10 laptops for $1,000 per computer. Each computer is recorded separately, resulting in 10 cost principle entries, each valuing $1,000. The laptops are expected to have a lasting span of five years and a leftover value of $200 per each laptop at the end of the estimated five-year period. The firm's balance sheet, however, will continue to show the cost principle of each laptop at $1,000, even though the depreciation of the computers results in market value of $200 per laptop after five years.

Rather than recording this on the balance sheet, the firm might instead allocate $160 to a depreciation account each year the laptops are in use.