Sample Problem

1. Sample Problem Problem 14-2A

2. Instructions • Indicate in each case whether the item has been handled in accordance with generally accepted accounting principles. If so, indicate the key basic concept that has been followed. If not, indicate which concept has been violated and tell how the item should have been recorded or presented.

3. At the beginning of 2007, WWW Company bought a building for $2,000,000. At the end of 2007, the building’s value was appraised at $2,220,000. Since there was an increase in value, the company did not record depreciation on the building and also did not increase the $2,000,000 recorded in the building account at time of purchase. Handled Basic concept Proper presentation Properly? No Matching No depreciation was recorded. The cost of an asset should be charged to depreciation over the asset’s useful life. It was, however, appropriate that the asset’s value was not recorded. Click for sound:

4. Sele Company manufactured machinery for its own use at a cost of $600,000. The lowest bid from an outsider was $650,000. Nevertheless, the company recorded the machinery at $600,000. Handled Basic concept Proper presentation Properly? Yes Cost basis, realization Assets should be recorded at cost. The increase in value has not been realized. Click for sound:

5. On December 31, 2007, the balance sheet of Video Heaven reported prepaid insurance at $1,200. The prepaid insurance reflects the refund value of a three-year fire insurance policy that originally cost $6,000 on January 1, 2006. Handled Basic concept Proper presentation Properly? No Matching Prepaid insurance of $2,000 should be shown on the balance sheet. $2,000 of the cost should be charged to expense each year. *$6,000/3 = $2,000 per year Click for sound:

6. The assets listed in the accounting records of Cobb’s Pharmacy include a money market account of Jason Cobb, owner of the business. Cobb has established the savings account so that if he needs to invest more cash in the pharmacy, it will be readily available. Handled Basic concept Proper presentation Properly? No Separate entity The personal money-market account of the owner should not be included in the assets of the business because it is assumed that a business is an entity separate and apart from its owner. Click for sound:

7. On December 31, 2007, an account receivable of $1,800 due from Joe Roy, who is in the county jail on charges of passing bad checks, is not included in the balance sheet. The owner of the business has written off the amount because he feels certain that the debt will not be paid, even though Roy insists that he will pay after he gets out of jail and finds a job. Handled Basic concept Proper presentation Properly? Yes Matching, conservatism It is unlikely that Roy will pay, or be able to pay, his debt. It should be charged off and matched against current income. Click for sound:

8. The equipment of Ace Plastics Company has a book value (cost less accumulated depreciation) of $180,000. However, the equipment could not be sold for more than $40,000 today. The company’s owner thinks that the machinery should nevertheless be reported on the balance sheet at $180,000 and depreciated over its useful life, because the equipment is being used regularly in the business and it is expected to be used profitably for the next five years—the remaining useful life that is being used for depreciation purposes. Handled Basic concept Proper presentation Properly? Yes Cost basis, matching Assets are recorded at cost and the cost is charged to expense through depreciation over the assets’ useful lives. Click for sound:

9. Analyze: If WWW company were to use the accounting treatment described in item 1, the net income would be overstated.