Question

Identify the basic assumption or broad accounting principle that was violated in each of the following situations.

1. Pastel Paint Company purchased land two years ago at a price of $250,000 Because the value of the land has appreciated to $400,000 the company has valued the land at$400,000 in it's most recent balance sheet.  

2. Atwell Corp has not prepared financial statements for external users for over three years

3. The Klingon Company sells farm machinery Revenue from a large order of machinery from a new buyer was recorded the day the order was received

4. Don Smith is the sole owner of a company called Hardware City The company recently paid a $150 utility bill for Smith's personal residence and recorded a $150 expense

5. Golden Book Company purchased a large printing machine for $1,000,000 (a material amount) and recorded the purchase as an expense

6. Ace Appliance company is involved in a major lawsuit involving injuries sustained by some of it's employees in the manufacturing plant. The company is being sued for $2,000,000 a material amount an is not insured. The suit was not disclosed in the most recent financial statements because no settlement had been reached

Answer options are:

Expense recognition; materiality

Revenue recognition

The economic entity assumption

The full disclosure principle

The historical cost (original transaction value) principle

The periodicity assumption

Select one answer per question please

Answer 1

Answer to first question : Company had violated the historical cost (original transaction value) principle. The historical cost principle states that asset should be booked in balance sheet at the cost incurred to acquire it less depreciation if any.

Answer to second question : Company had violated the full disclosure principle . Full disclosure principle states that disclosure of all information to the stakeholders and other users that may effect the business decisions of the company and thus financial statements should be disclosed to the external users.

Answer to third question : Company had violated the revenue recognition principle. Revenue recognition principle states that since company is making transaction with a new buyer and there is no pre existing relationship between the buyer and seller , revenue cannot be recognised unless money received relating to the order.

Answer to the fourth question : Company violated the economic entity assumption . The economic entity assumption states that company would seperate personal expenses from the business expenses. Personal expenses cannot be shown as business expense.

Answer to fifth question : Company violated the expense recognition; materiality principle. Expense recognition materiality states that company needs to consider the material amount for recognition and a huge expense cannot be shown as an expense which had a limit of 1 year. Benefit of the asset purchase will come for a longer period so it is a capital expense and not revenue expense.

Answer to sixth question : Company had violated the periodicity assumption. Periodicity assumption sates that all transactions need to be disclosed within a certain period like for example a financial statement may be prepared quarterly and so if the expense is not certain then it should be shown as a contingent liability as foot note.