Question

E2-9 (L06) GROUPWORK (Accounting Principles and Assumptions—Comprehensive) Presented below are a number of business transactions that occurred during the current year for Gonzales, Inc. Instructions In each of the situations, discuss the appropriateness of the journal entries in terms of generally accepted accounting principles. (a) The president of Gonzales, Inc. used his expense account to purchase a new Suburban solely for personal use. The fol- lowing journal entry was made. Miscellaneous Expense 29,000 Cash 29,000 (b) Merchandise inventory that cost $620,000 is reported on the balance sheet at $690,000, the expected selling price less estimated selling costs. The following entry was made to record this increase in value. Inventory 70,000 Sales Revenue 70,000 (c) The company is being sued for $500,000 by a customer who claims damages for personal injury apparently caused by a defective product. Company attorneys feel extremely confident that the company will have no liability for damages resulting from the situation. Nevertheless, the company decides to make the following entry. Loss from Lawsuit 500,000 Liability for Lawsuit 500,000 (d) Because the general level of prices increased during the current year, Gonzales, Inc. determined that there was a $16,000 understatement of depreciation expense on its equipment and decided to record it in its accounts. The following entry was made. Depreciation Expense 16,000 Accumulated Depreciation—Equipment 16,000 (e) Gonzales, Inc. has been concerned about whether intangible assets could generate cash in case of liquidation. As a con- sequence, goodwill arising from a purchase transaction during the current year and recorded at $800,000 was written off as follows. Retained Earnings 800,000 Goodwill 800,000 (f) Because of a “fire sale,” equipment obviously worth $200,000 was acquired at a cost of $155,000. The following entry was made. Equipment 200,000 Cash 155,000 Sales Revenue 45,000

Answer 1

a) Economic entity assumption have been violated. It states that business enterprise and the proprietor are distinct. So personal expense should not have been recorded in the books of accounts. Gonzales Inc is incorrect in recording personal expense as Miscellaneous Expenses in books of account.

b) Conservatism and cost principle has been violated. Inventory should have been recorded at historical cost. Gonzales Inc is incorrect in recognising the increase in value of inventory. Gonzales Inc here did not opt conservative approach which states "provide for all losses, but do not provide for gains". Gonzales Inc must record the inventory at $620000

c) Gonzales Inc should not have provided for sued damages because there is high probability that Gonzales won't incur the Expense.

As per full disclosure principle Gonzales Inc can show this suit as footnote but there is no requirement of recording loss. Gonzales Inc should reverse the entry of $500000 of incurring loss.

d) Consistent: Gonzales Inc is incorrect in changing the method of Depreciation. The co. should be consistent in recording the transactions. Change in market values do not have impact on depreciation which is calculated on cost of assets.

e) Cost principle have been violated. Assets purchased must be recognised at purchase value and must be depreciated over the useful life. Gonzales Inc is incorrect in writing off the intangible asset.

f) Cost principle have been violated. Equipment must be recorded at purchase price even though it is below its normal price. Sales revenue have been incorrectly credited (There was no revenue ) Gonzales Inc must have passed the following entry:

Equipment A/c Dr. $155000

To Cash A/c $155000

(Being Equipment purchased)

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