Chapter 1 - Solutions

VCEACCOUNTING
UNIT3RECORDINGANDREPORTINGFORATRADINGBUSINESS
CHAPTER1ACCOUNTINGTHEORY
Chapter1AccountingTheory
Howtoanswer
Theoryquestions
Howtoanswer
Elementsquestions
Slides
1.1 What is Accounting?
Video
Summary Question 1
a) DefinethetermAccounting.
Accountingistheprocessofrecording,reporting,analysingandinterpretingfinancialdataand
accountinginformationwhichisthencommunicatedtointernalandexternalusersofthis
information
b) Explainwhybusinesseshaveaneedforfinancial/accountinginformation.
Businessesneedfinancialinformationtoenablethemtomakedecisions.
Thepurposeofaccountingistoprovideusefulfinancialdataandaccountinginformation.
Withoutthisinformation,businessowners/banks/governmentsetc.couldntmakedecisions.
Summary Question 2
Statefivedifferentusersofaccountinginformation.Foreachoftheuserslisted,describetheirmain
areasofinterestinthefinancialinformationofasmallbusiness.
Owner/managerofthebusinesswantsinformationontheprofitabilityandfinancialposition
ofthebusiness.Alsorequiresbudgetstoplanforthefuture.
Prospectiveownersofthebusinessrequireinformationonprofitabilityandfinancial
informationinevaluatingwhethertobuythebusiness.
Banks/lendersrequireinformationontheliquidity,profitabilityandfinancialpositionofthe
businessindecidingtolenditmoney.
Suppliersofgoodsormaterialsrequireinformationonthecreditratingandliquidityofthe
businessindecidingtoselltothebusinessoncredit.
Governmentrequiresinformationonrevenueandtaxation.
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VCEACCOUNTING
QualitativeCharacteristics
Slides
1.2 Relevance
Video
Cambridge Revision Question 1.5

DefinethetermRelevance.
Informationisrelevantifitinfluencesthedecisionmakingoftheuser.Twowaystodetermineif
somethingisrelevantare:
Materialityisitlargeenoughtoeffectthedecision?
Entitydoesitrelatetothebusinessandnottheownerpersonallyoranotherbusiness?
Summary Question 23
a) Theownerofasmallbusinesshasstatedthatcentscanbeomittedfromallbalancesheets.
StatetheQualitativeCharacteristicthatmaysupportthisstatementandwhytheownermay
becorrect.
Identify
Relevance
Define
Allinformationthatisrelevantorlikelytoinfluencedecisionmakingmustbeincludedinfinancial
reports.
Relate
ThematerialitytestsaysthattheomissionofcentsfromtheBalanceSheetisacceptablebecause
suchsmallamountswillnotinfluencethedecisionmakingofthebusiness.
b) Thebuildinginwhichasmallretailbusinesshasitspremiseshasincreasedsignificantlyinvalue
sincetheownerpurchaseditfor$80,000in1995.Asimilarbuildingacrosstheroadrecently
soldfor$470,000andtheownerisdebatingwhethertoupdatethevalueofthebuildinginthe
firmsBalanceSheet.Explainwhethertheownershouldmakethischange.
Identify/Define
Relevancestatesthatallinformationthatisrelevantorlikelytoinfluencedecisionmakingmustbe
includedinfinancialreports.
Relate
Inordertomakethemosteffectivedecisionsregardingthebusiness,theownershouldrevaluethe
buildingto$470,000.
Theoldfigureof$80,000from1995isnotrelevanttotodaysdecisionmakingandthenewfigure
willenabletheownertomakedecisionssuchas:
o
Howmuchtoinsurethebuildingfor
Whethertosellthebuilding.
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VCEACCOUNTING
Slides
1.3 Reliability
Videos

a) DefinethetermReliability.
Informationisreliableifit:
Isfreefromerror,personalopinionsandestimates
Isbasedondatathatcanbecheckedorverifiedwithasourcedocument.
b) Tosavespaceinthefirmsoffice,asmallbusinessownerhasdecidedtodestroyallcopiesof
invoices,receiptsandbankstatementsforthelast12months.Describewhetherthisaction
breachesthecharacteristicofReliability.
Identify/Define
Reliabilitystatesthatallinformationmustbefreefromerror,opinionsandestimatesandcan
beverifiedwithsourcedocuments.
Relate
Inthiscase,destroyingallcopiesofthesedocumentsbreachesReliability.
Shouldthebusinesseverneedtoverifyorproveaparticulartransactionithasrecorded,there
arenownosourcedocumentswithwhichtodothis.
Thismayresultinerrorsinthefirmsaccountinginformation.
Summary Question 21
StatethreebusinessdocumentsthatmaybeusedtosatisfythedemandsofReliability?
Salesinvoice
Receipt
Chequebutt
Purchaseinvoice
Bankstatements
Summary Question 27
a) Definetheterminternalcontrol.
Internalcontrolinvolvesthepracticesinvolvedtoensurethat:
Accountingrecordsandreportsareaccurateandreliable
ThefirmsAssetsareprotectedfromtheft,fraudandmisrepresentation
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b) Explainthreemeasuresabusinesscantaketoensureinternalcontrol.
Welldefinedresponsibilitiesforstaffclearwhoisinchargeofwhat
Separationofdutiestasksarebrokenupbetweenseveralstaffratherthanonepersonin
chargeofanentireprocess
Rotationofdutiesstaffarerotatedbetweentasksovertimeratherthandoingthesametask
foralongtime
Authorisationrulesenforcedstaffmustgetrequiredapprovalforalltasks
Documentcontroltheaccountingsystemmustaccuratelyrecordandstorealldocuments
(receipts,invoices,statementsetc.)
Physicalsafeguardsandchecksforprotectionofcashandstock,e.g.safes,securitytags
c) HowdoesinternalcontrolhelpabusinessensuretheReliabilityofitsaccountinginformation?
InternalcontrolhelpsfulfilReliabilityasitrequires:
Sourcedocumentsmustbekept
Thesecanbeusedtoverifytransactionsthathavetakenplace(ornottakenplace)
Thisensuresaccountinginformationisaccurateandreliable
Andthisminimisesthechanceoftheftandfraud
Slides
1.4 Comparability
Video

a) DefinethetermComparability.
Informationiscomparablewhen:
Itcanbecomparedovertimeandbetweendifferententities
Everyyear,transactionsaretreatedinaconsistentmannerandthesameaccountingmethods
areusedtopreparefinancialreports
b) ExplainsomewaysanAccountantcanensuretheComparabilityofaccountingreports.
Makingsureyouusethesameaccountingmethodseachandeveryyear
Usingthesamemethodsforeachdepartmentorsectionofthebusiness
Keepingformattingthesameeachyear
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c) InpreparingaBalanceSheetfortheirfirm,theownerofasmallbusinessdecidedtochangethe
valueatwhichpropertyisrecorded.Wherepreviouslyallpropertywasrecordedatthepriceit
waspurchasedfor,theownerhasnowdecidedtovaluepropertiesattheirmarketpricetoday.
ExplainhowthebusinesshasbreachedthecharacteristicofComparability.
Identify/Define
Comparabilityrequiresthebusinesstorecordtransactionsinaconsistentmannereachyear
usingthesameaccountingmethods.
Relate
Inthiscase,changingthevalueofpropertyintheBalanceSheetfromtheoriginalcosttothe
currentmarketvaluebreachesthecomparabilityofthisinformation.
Doingsorepresentsachangeinaccountingmethodswhichpreventstheownerfromcomparing
thisyearsBalanceSheetwithlastyears.
Slides
1.5 Understandability
Video

a) DefinethetermUnderstandability.
Informationisunderstandableif:
Userscancomprehenditsmeaningeasily(assumingareasonableknowledgeofAccounting)
b) ExplainsomewaysanAccountantcanensuretheUnderstandabilityofaccountingreports.
Avoidjargonandexcessivelycomplexterms
Wherepossible,usesimplelanguagethatiseasilyunderstood
Useheadingsandformattingtomakesureinformationisclearandreadable
Usegraphsandchartswherepossible
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c) Theownerofasmallbusinessismeetingwithpotentialinvestorsinordertoraisecapital
neededtoexpandoperations.Theownerhasbeenaskedtoprovideinformationonthefirms
profitsforthelast10years.Aswellasprovidingacopyofthelast10IncomeStatements,the
ownerhaspreparedabasicbarchartshowingeachyearsprofitcomparedtotheprofitfrom10
yearsago.Explainhowthepreparationofthischartfulfilsthecharacteristicof
Understandability.
Identify/Define
Understandabilityrequirestheusersoffinancialreportstobeabletocomprehendthemeaning
oftheinformationinthereports.
Relate
Inthiscase,providinganadditionalchartwhichbreaksdownthelast10yearsprofitfigureswill
improvetheunderstandabilityoftheinformation.
Thepotentialinvestorswillbeabletoclearlycomprehendthemeaningoftheinformationin
thechart.
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AccountingPrinciples
Slides
1.6 Entity Principle
Video
Summary Question 12
ExplainwhatismeantbytheAccountingEntityPrinciple.
Thebusinessmustbeaseparateaccountingentityfromitsownerandotherentities(businesses)
ownedbytheowner
Thetransactionsandfinancialrecordsofeachentitymustbekeptseparatefromeachother.
Summary Question 13
JustifywhyaccountantsfollowtheAccountingEntityPrinciple.
TheEntityPrincipleisfollowedtoensuretheownerdoesnottreatpersonaltransactionsasbusiness
expenses.Iftheownerwishestodoso,theymustrecordwithdrawalsfromthebusinessas
drawings.
Thisensuresthefirmsprofitfigureisanaccuratereflectionofitsperformance.
Summary Question 14
LeeTingistheownerofacardetailingfirm,aclothingbusinessandahardwareshop.Explainhow
theapplicationoftheEntityPrincipleaffectstheaccountingforLeesbusinesses.
Define
TheEntityPrinciplemeansthatthebusinessmustbeaseparateaccountingentityfromitsowner
andotherentities(businesses)ownedbytheowner.
Relate
Inthiscase,thismeansthat:
o
Thetransactionsofeachbusinessmustbekeptseparateand
Eachbusinessmusthaveitsownsetofreportsprepared.
Summary Question 22
TheQualitativeCharacteristicofRelevancemaybesupportedbyanAccountingPrinciple.Statethe
AccountingPrincipleandexplainthislink.
Identify
EntityPrinciple
Define
Thetransactionsandfinancialrecordsofthebusinessshouldbekeptseparatefromtheowners
personaltransactionsandtheownersotherbusinesses.
Relate
ThissupportsRelevanceasanitemisrelevantonlyifitrelatestothebusinessandnotthepersonal
affairsoftheowneroranotherbusiness.
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Slides
1.7 Historical Cost Principle
Video
Summary Question 15
ExplainwhatismeantbythetermHistoricalCostPrinciple.
Alltransactionsarerecordedattheiroriginalcost(purchaseprice)andshowninthefirms
accountingreportsattheirhistorical(original)price.
Summary Question 16
SharonONeillboughtasecondhandvehicleforherbusinessatacostof$18,000.However,oneof
Sharonsfriendshastoldherthatthemodelpurchasedisworthabout$19,500.Atwhatvalue
shouldthevehicleberecordedinthefirmsfinancialreports?
Identify/Define
TheHistoricalCostPrinciplesaystransactionsshouldberecordedattheiroriginal(historical)
cost.
Relate
Inthiscase,Sharonshouldvaluethevehicleat$18,000asthisiswhatshepaidforit,i.e.its
historicalcost.
Slides
1.8 Going Concern Principle
Video
Summary Question 17
a) WhatdoaccountantsassumeaboutthelifeofabusinessundertheGoingConcernPrinciple?
Whyisthisdone?
Thebusinessisassumedtogoonandexistforever.Thebusinesswillcontinueasagoing
concernforanindefiniteorinfiniteperiod.
Thisisdonesoadistinctioncanbemadebetweenthecurrentassetsandnoncurrentassetsof
thefirm.
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b) Theownerofasmallbusinessintendstosellthefirmwithinthenextsixmonths.Assuch,she
hasreclassifiedallofthefirmsNonCurrentAssetstoCurrentAssetswhichwillbeconvertedto
cashorconsumedwithinthenext12months.Explainwhethertheowneriscorrectinmaking
thisadjustment.
Identify/Define
TheGoingConcernPrinciplerequiresthebusinessownertoadopttheassumptionthatthefirm
willexistforanindefiniteorinfiniteperiod.
Relate
Inthiscase,theownerhasbreachedtheGoingConcernPrincipleas,despiteherintentiontosell
thebusinesswithinsixmonths,thefirmshouldalwaysassumeitsexistenceisinfinitesothatits
assetscanbegroupedintoCurrentandNonCurrent.
Slides
1.9 Reporting Period Principle
Video
Summary Question 18
a) DefineistheReportingPeriodPrinciple?
Theongoinglifeofthebusinessisbrokenintoreportingperiodsofequallengthofnolonger
than12months(e.g.monthly,quarterly,yearly).
Attheendofeachperiodthefirmsprofitforthatperiodmustbedeterminedbymatchingall
revenuesearnedagainstexpensesincurred.
b) TheownerofasmallbusinessstatedthatIvebeenrunningmybusinessfor10years,andmy
bankstatementsaysIhavelotsofmoneyinthebank,soIhaventbotheredcalculatingmyprofit
sincethebusinessbegan.Explainwhetherthebusinessowneriscorrectinmakingthis
statement.
Identify/Define
TheReportingPeriodPrinciplerequiresthelifeofthebusinessbebrokenintoperiodsequal
lengthofnolongerthan12monthsandforprofittobecalculatedattheendofeachperiod.
Relate
Inthiscase,theownerhasbreachedtheReportingPeriodPrinciplebynotcalculatingprofitfor
thelast10years.
Despitethefactthefirmhasmoneyinitsbank,itisstillrequiredtocalculateitsprofitatleast
onceevery12months.
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VCEACCOUNTING

Slides
1.10 Monetary Unit Principle
Video
Summary Question 28
DefinetheMonetaryUnitPrincipleofaccounting.
Alltransactionsshouldbereportedinacommonunitofmeasurement(inAustralia,thisis
AustralianDollars).
Summary Question 29
AbusinessorderingstockfromJapancosting90,000Yenequivalentof$1,000Australiandollars)has
beencharged4,600Yen($50Australiandollars)forshipping.Explainhowthistransactionshouldbe
recordedinthefirmsrecords.
Identify/Define
TheMonetaryUnitPrinciplestatesthatalltransactionsshouldbereportedinacommonunitof
measurement.
Relate
Inthiscase,thebusinessshouldrecordthestockandtheshippinginAustraliandollarsfora
totalof$1,050ratherthaninJapaneseYen.
Slides
1.11 Conservatism Principle
Video
Summary Question 24
a) ExplainwhatismeantbytheConservatismPrinciple.
Cautionmustbeusedwhenpreparingfinancialreports
Lossesarerecordedwhentheyareexpectedtooccur
Gainsareonlyrecognisedoncetheyarecertaintohappen(i.e.theyhavebeenearned)
Thisisdoneso:
Assetsandrevenuesarenotoverstated(toohigh)
Liabilitiesandexpensesarenotunderstated(toolow)
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b) Indeterminingthevalueofallassetsonhand,abusinesssellingbicycleshasrealisedthatsome
ofitsassetshavechangedinvaluesincetheywerepurchased.Thefirmspremiseswasbought
for$640,000in2006buthasbeenvaluedtodayat$820,000.Meanwhile,machinerythatwas
purchasedfor$4,000severalyearsagohasnowbeensupersededbyanewermodelandis
worthonly$2,500today.Explainhowtheseassetsshouldbevaluedinthefirmsrecords.
Identify
ConservatismPrinciple
Define
Cautionmustbeusedwhenpreparingfinancialreports
Lossesarerecordedwhentheyareexpectedtooccur.
Gainsareonlyrecognisedoncetheyarecertaintohappen.
Relate
Inthiscase,thevalueofthemachineryshouldbewrittendownto$2,500becausethereisan
expectedlossinvalue.
However,thevalueofthepremisesmustremainatitspurchaseamountof$640,000.Thegain
invalueto$820,000shouldnotberecordeduntilitiscertaintooccur,suchasiftheproperty
wasactuallysoldforthisamount.
Slides
1.12 Consistency Principle
Video
Summary Question 19
a) ExplainwhatismeantbytheConsistencyPrinciple.
Theaccountingmethodsusedbythebusinessshouldbeappliedconsistentlyfromone
reportingperiodtoanother.
Thisallowscomparisonsofthefirmsperformancetobemadeovertime.
b) HowistheConsistencyPrinciplerelatedtotheQualitativeCharacteristicofComparability?
TheConsistencyPrincipleensuresfinancialreportsarecomparablefromoneyeartothenext
becausereportshavebeenpreparedusingthesamemethodsandusingthesameformat.
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Summary Question 20
Inreportingitsprofitsinpreviousyears,aretailbusinesshaslistedthesalesofeachofitsthree
locationsinseparatecolumns.Inordertomakethereportsmallerandeasiertoreadforthisyear,
theownerhasdecidedtolistallsalestogetherinonefigure,ratherthanseparatelyforeach
location.Explaintheaccountingprinciplethathasbeenbreachedinthisinstance.
Identify
ConsistencyPrinciple
Define
Accountingmethodsusedbythebusinessshouldbeappliedconsistentlyfromeachperiodto
anothertoallowcomparisonsofthefirmsperformancetobemadeovertime.
Relate
Inthiscase,theownerhasbreachedthisprinciplebychangingthewayinwhichsalesare
reported.
Inpreviousyearsthefirmlistedsalesofeachlocationseparatelybutthisyearithascombined
thesefiguresintoonetotal.
Thiswillpreventcomparisonsbeingmadewithpreviousperiods.
Slides
1.13 Which Theory When?
Video
Summary Question 32
Explainhowtheforkliftshouldbevaluedaccordingtothefollowingqualitativecharacteristicsand
accountingprinciples:
a) Relevance
Identify/Define
Relevancestatesthatallinformationthatinfluencesthedecisionmakingofthebusinessshould
beincludedinitsfinancialreports.
Relate
Inthiscase,themostrelevantfigureisthe$7,900beingofferedbythefriend.
Thisisbecausethisfigurewillmostlikelyaffecttheownersdecisionmakinginchoosing
whethertoselltheforklifttothefriendimmediately.
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b) Comparability
Identify/Define
Comparabilityrequiresthebusinesstousethesameconsistentaccountingmethodseach
periodsoresultscanbecomparedovertime.
Relate
Inthiscase,theforkliftmustremainat$10,500asthisistheamountatwhichithasbeen
reportedsincepurchased.
Thisenablesthefirmtocomparethevalueofitsassetsovertime.
c) Historicalcost
Identify/Define
HistoricalCostdictatesthatalltransactionsarerecordedattheiroriginalcostorpurchaseprice.
Relate
Inthiscase,theforkliftmustberecordedat$10,500becausethisistheamountthebusiness
paidfortheforkliftwhenitwaspurchasedsecondhand.
Whiletheforkliftwasoriginallypurchasedfor$14,200whennew,thiswasthehistoricalcostfor
thepreviousownerandnotthecurrentbusiness(entity).
d) Conservatism
Identify/Define
Conservatismrequirescautiontobeusedsothatlossesarerecordedwhenexpected.
Relate
Inthiscase,theforkliftshouldbevaluedat$7,300becausethereisanexpectedlossinitsvalue
fromthepurchasepriceof$10,500.
Whilethefirmhasreceivedanofferof$7,900fortheforklift,thisisnotcertainsothelower
valueshouldbeusedtobecautious.
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VCEACCOUNTING
ElementsofAccounting
Slides
1.14 Assets
Video
Cambridge Exercise 1.6

a) DefinethetermAsset.
AnAssetis:
Aresourcecontrolledbytheentity
Asaresultofpastevents(transactions)
Fromwhichfutureeconomicbenefitsareexpectedtoflowtotheentity
b) Asmallbusinesspurchasedaphotocopierfor$5,000cashfromanofficesuppliesfirm.Explain
howthephotocopiermeetsthedefinitionofanAsset.
Identify
ThephotocopierisanAssetbecause:
Define/Relate
Itisaresourcecontrolledbytheentityasthebusinesslegallyownsandcontrolsthe
photocopierandcandeterminedhowitisused.
Itwasacquiredduringapasteventduringthetransactionofpaying$5,000totheoffice
suppliesfirm.
Itwillprovidethebusinesswithfutureeconomicbenefitsintheformofbeingableto
photocopydocumentsduringthedaytodayrunningofthebusiness.
c) Theownerofasmallbusinesshasbeenmakingdeliveriestocustomersina$35,000deliveryvan
whichhasbeenhiredfromBudgetRentals.Becausethebusinesshasdecidedtohirethevanfor
atleastthenexttwoyears,theownerhasdecidedtorecordthevanasanAssetofthebusiness
initsBalanceSheet.Explainwhethertheownerwascorrectindoingthis.
Identify
TheownershouldNOTrecordthevanasanAssetofthebusinessbecause:
Define/Relate
WhiletherewasapasteventintheformofthebusinesspayingBudgetRentalstohirethevan,
anditwillprovidethebusinesswithfutureeconomicbenefitsintheformofmakingdeliveries
tocustomers
Thevanisnotaresourcecontrolledbytheentityasitlegallybelongstoanotherentity(Budget
Rentals)whocontrolshowitisusedandcanaskforitbackatanytime,sellit,provideanother
vanetc.
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d) Thisweekafirmpaid$2,300forwagestoemployeesforworkperformed.Explainwhetherthe
wagespaidshouldbeconsideredtobeanAsset?
Identify
ThewagespaidareNOTconsideredanAssetbecause:
Define/Relate
AnAssetmustprovidefutureinflowsofeconomicbenefits.
WagesarenotconsideredtobeanAssetbecausethereisnofutureeconomicbenefitfrom
them.
Wagesarepaidforworkdoneinthepast.Hence,whenwagesarepaid,theeconomicbenefit
(workerslabour)hasalreadybeenconsumed.
Slides
1.15 Liabilities
Video

a) DefinethetermLiability.
AnLiabilityis:
Apresentobligation
Arisingfrompastevents
Resultinginanoutflowoffutureeconomicbenefitsfromtheentity
b) Explainhowmoneyowedtoacreditorforthepurchaseofinventoryoncreditandwagesowed
toanemployeeforworkcompletedlastmonthbothmeetthedefinitionofaLiability.
Creditor
Identify
AcreditorisaLiabilitybecause:
Define/Relate
Thereisapresentobligationtopaythecreditortheamountowedfortheinventory.
Itarosefromapasteventwhichtookplacewhenthefirmpurchasedstockoncredit.
Itwillresultinanoutflowoffutureeconomicbenefitsintheformofthecashpaidtothe
creditortosettletheobligation.
Wagesowing
Identify
WagesowingtoanemployeeareaLiabilitybecause:
Define/Relate
Thereisapresentobligationtopaytheemployeetheamounttheyareowed.
Itarosefromapasteventwherebytheemployeeperformedworkforthebusiness.
Itwillresultinanoutflowoffutureeconomicbenefitsintheformofthecashpaidtothe
employeefortheirwages.
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Slides
1.16 Owners Equity
Video

a) DefinethetermOwnersEquity.
OwnersEquityistheownersresidualinterestintheAssetsofthefirmafterthedeductionof
Liabilities.
b) ExpresstheAccountingEquationintwodifferentways.
c) CompletethefollowingAccountingEquations.
Assets
=
Liabilities
OwnersEquity
59,000
17,000
42,000
87,000
28,000
59,000
64,000
25,000
39,000
91,000
29,000
62,000
41,000
23,000
18,000
77,000
19,000
58,000
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Slides
1.17 Revenue
Video

a) DefinethetermRevenue.
Revenuesare:
Inflowsofeconomicbenefitsorsavingsinoutflowsofeconomicbenefits
ThateitherincreaseAssetsordecreaseLiabilities
WiththeultimateeffectofincreasingOwnersEquity.
b) Alawfirmprovidedservicestoaclientfor$1,400cash.Withreferencetotheelementsof
Accounting,explainhowthistransactionshouldberecorded.
Identify
ThistransactionshouldberecordedasRevenuebecause:
Define/Relate
Thereisaninflowofeconomicbenefitsintheformofthe$1,400cashreceivedbythefirm.
ThereisanincreaseinAssetsasthefirmsCashatBankassetwillincrease$1,400.
ThereisanoverallincreaseinOwnersEquity.
c) Amechanicprovidedacarservicetoacustomeroncreditfor$800.Thecustomerhasagreedto
paythemechanicnextmonth.ExplainhowthistransactionmeetsthedefinitionofaRevenue.
Identify
ThistransactionshouldberecordedasRevenuebecause:
Define/Relate
Thereisaninflowofeconomicbenefitsintheformofthecustomersobligationtopay$800to
thefirm.
ThereisanincreaseinAssetsasthefirmsDebtorsassetwillincrease$800.
ThereisanoverallincreaseinOwnersEquity.
d) Explainwhethera$10,000capitalcontributionmadebytheownertothebusinessshouldbe
classifiedasRevenueforthefirm.
Identify
ThecapitalcontributionisNOTrecordedasRevenueforthefirmbecause:
Define/Relate
Whilethereisaninflowofeconomicbenefits(the$10,000cashreceivedbythefirm)which
increasesAssets(theCashatBankasset)withanoverallincreaseinOwnersEquity
ButacapitalcontributionisnotRevenuebecause:
o
Thefirmhasnotsacrificedanythingtoearnthemoney
Theownerhasjustgiventhebusinessmoney.
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Slides
1.18 Expenses
a) DefinethetermExpense.
Video
Expensesare:
Outflowsofeconomicbenefitsorreductionsininflowsofeconomicbenefits
ThateitherdecreaseAssetsorincreaseLiabilities
WiththeultimateeffectofdecreasingOwnersEquity.
b) Abusinessreceivedandpaiditsphonebillof$150forthecurrentmonth.Withreferencetothe
elementsofAccounting,explainhowthistransactionshouldberecorded.
Identify
ThistransactionshouldberecordedasanExpensebecause:
Define/Relate
Thereisanoutflowofeconomicbenefitsintheformoftheconsumptionofphonecallsbythefirm.
ThereisadecreaseinAssetsasthefirmsCashatBankassetwilldecrease$150.
ThereisanoveralldecreaseinOwnersEquity.
c) Forthecurrentmonth,abusinessreceivedabillforinsuranceof$280.Thebillwillbepaidnext
month.ExplainwhetherthebillmeetsthedefinitionofanExpense.
Identify
ThistransactionshouldberecordedasanExpensebecause:
Define/Relate
Thereisanoutflowofeconomicbenefitsintheformofthefirmbeinginsuredforthemonthbythe
insurancecompany.
ThereisanincreaseinLiabilitiesasthefirmsAccountsPayablewillincrease$280.
ThereisanoveralldecreaseinOwnersEquity.
d) Explainwhethertheownerwithdrawing$5,000incashasdrawingsfromabusinessshouldbe
classifiedasanExpenseforthefirm.
Identify
DrawingsmadebytheownerareNOTrecordedasanExpenseforthefirmbecause:
Define/Relate
Whilethereisanoutflowofeconomicbenefits(the$5,000cashpaidbythefirm)whichdecreases
Assets(theCashatBankasset)withanoveralldecreaseinOwnersEquity
ButdrawingsarenotanExpensebecause:
o
Thefirmhasnotincurredanythingitselfinitsdailyoperations
Theownerhasjustwithdrawntheircapital.
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RevisionQuestions
Slides
1.19 Summary of Revenues and Expenses
Video
Exercise 1.1
Shouldthe$180,000bereportedasRevenueorasaLiabilityfor2015?Why?
ThismeetsthedefinitionofaLiabilityas:
Itrepresentsapresentobligationtoprovidethesecustomerswithmagazinesin2016,2017and
2018.
Resultedfromapasttransaction(thereceiptofthe$180,000)
Therewillbeanoutflowofeconomicresourcestosettletheobligationintheformofthe
magazinesneedtobeproducedandmailedouttoprepayingcustomers.
Exercise 1.2
a) ShouldthecomputerberecordedasanAssetinthefirmsbooks?Doesitmeetthe
SACdefinitionofanAsset?
NothecomputershouldNOTberecordedasanAssetbecause:
o
Thebusinessdoesnotcontroltheresource(computer)ithasbeenborrowedfromher
sister,whocanaskforitbackanytime.
Therewasnopastevent(transaction)thebusinessdidntbuythecomputer,itwasgiven
it.
Althoughthecomputerwillprovidefutureeconomicbenefitsthebusinesscanuseitinits
dailyoperations.
c) WouldthecomputermeettheSACdefinitionofanAssetiftheownerpaidhersister
$1,500forthecomputer?Ifso,atwhatvalueshoulditberecorded$1,500,$3,000or
$1,800?
Yesifshepayshersister$1,500forthecomputer,itnowbecomesanAssetforthefirmbecause:
Itisnowaresourceunderthecontrolofthebusiness(i.e.thefirmnowownsitratherthanit
beinglenttothefirm)
Therehasbeenapastevent(transaction)toacquirethecomputerthe$1500paid
Thecomputerwillbeusedtogeneratefutureeconomicbenefits.
Thecomputershouldbevaluedforthebusiness(entity)for$1,500undertheHistoricalCostPrinciple:
TheHistoricalCostPrinciplestatesthatitemsshouldbevaluedattheiroriginalpurchase
amount.
Forthebusinessentity,theoriginalpurchasepriceis$1,500itisNOT$3,000becausethatis
theoriginalpriceforthesisterentity.
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Slides
1.20 Assets vs. Expenses
Video
Exercise 1.3
a) BasedontheQualitativeCharacteristicsofRelevanceandReliability,shouldthe
entire$200ofstationaryberecordedasanExpense?
Yestheentire$200shouldbewrittenoffasanExpenseandthe$5ofstationaryleftoverisNOTan
Asset.
ThisisbecauseofthequalitativecharacteristicofRelevance
o
Informationisrelevantifitinfluencesthedecisionmakingofthebusiness.
The$5ofstationaryleftoverisNOTrelevantbecauseitisNOTmaterial(largeenough)to
impactthefirmsdecisionmaking.
b) Iftheunusedstationarywas$150insteadof$5,wouldthischangeyouranswertothe
previousquestion?Why?
Yesiftherewas$150ofstationaryleftoverthenthisshouldbetreatedasanAsset.
ThisisbecauseofthequalitativecharacteristicofRelevance
o
Informationisrelevantifitinfluencesthedecisionmakingofthebusiness.
Inthiscase,itcouldbearguedthat$150ofstationaryremainingismaterialandwill
influencethedecisionmakingofthefirm,e.g.morestationarydoesnotneedtobebought.
Exercise 1.4
AccountingPrinciple(s)
MonetaryUnit/HistoricalCost
Explanation
Monetaryunit
Alltransactionsshouldbereportedinacommonunitofmeasurement.
Inthiscase,thishasbeenbreachedascashandthedeliveryvanhavebeenvaluedindollars,but
stockhasbeenvaluedinunits.
Historicalcost
Alltransactionsarerecordedattheiroriginalcost(purchaseprice)andshowninthefirms
accountingreportsattheirhistorical(original)price.
Inthiscase,thishasbeenbreachedbyvaluingthedeliveryvanatitsestimatedmarketvaluerather
thanitspurchaseprice.
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VCEACCOUNTING
Exercise 1.5
Howshouldthe$99,000rentpaidin2015betreatedinthefirmsbooks?
Only$33,000shouldbewrittenoffasanExpensefor2015because:
Therehasbeenanoutflowofeconomicbenefitsof$33,000becausethefirmhasusedthe
building/rentduring2015.
ThereisadecreaseinAssetsinthiscase,theassetthathasdecreasediscalledPrepaid
Rent.
ThereisadecreaseinOwnersEquity.
Theremaining$66,000ofrentshouldbetreatedasanAssetbecause:
Itisaresourcecontrolledbythefirmitcanlegallyrentthepremisesfor20162017
Itarosefromapastevent(transaction)thefirmpaid$99,000tothelandlord
Itwillprovidefutureeconomicbenefitsintheformofthefirmbeingabletorentthe
premisesforthenext2years.
Exercise 1.6
a) ExplainthedifferencebetweenanAssetandanExpense.
WithanAsset,theeconomicbenefitsareyettobeconsumed(theyhavenotbeenusedup).
WithanExpense,theeconomicbenefitshavebeenconsumed(usedup).
b) StateonereasonwhyallfouritemsshouldbetreatedasAssetsasat31December
2015.
All4items:
Areresourcesunderthecontrolofthebusiness
Asaresultofapastevent(transaction)
Providefutureeconomicbenefitsoverthenextthreeyears.
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VCEACCOUNTING
d) BasedontheQualitativeCharacteristicofRelevance,shouldanyofthefouritemsbe
treatedasExpensesfor2015?Whichones?
Relevancerequiresallinformationthatwillinfluencedecisionmakingtobeincludedinfinancial
reports.Inparticular,allitemsthatarematerialmustbeincluded.
Inthiscase:
o
Thestapler($10)andruler($4)canbewrittenoffasExpensesin2015because,even
thoughtheywillprovidefutureeconomicbenefits
TheydontneedtobeincludedasAssetsbecausetheiramountsarenotmaterialto
decisionmakingin2016and2017.
Exercise 1.7
a)
QualitativeCharacteristic/AccountingPrinciple
EntityPrinciple
Explanation
Thebusinessmustbeaseparateaccountingentityfromitsowneranditstransactionsmustbe
keptseparatefromeachother.
Inthiscase,theofficedeskisNOTanAssetbecauseitbelongstotheownerandisapersonal
asset.
b)
Conservatism
Explanation
Cautionshouldbeusedwhenpreparingaccountingreportswherebygainsarerecognisedonly
whencertain(earned).
Inthiscase,thepremisesshouldbevaluedattheoriginalpriceof$320,000andshouldNOTbe
revaluedtoanyofthehigheramountsbecausethesegainsareNOTcertain.
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VCEACCOUNTING
c)
Comparability
Explanation
Informationmustbecomparablesothatitcanbecomparedovertimebyusingthesame
consistentaccountingmethodseachyear.
Inthiscase,comparabilityhasbeenbreachedbecausetheownerhaschangedaccounting
methodsfromoneyeartothenext(fromcashtoaccrualaccounting).
d)
Reliability
Explanation
Accountinginformationmustbefreefromerror,estimatesandopinionsbyensuringall
informationcanbeverifiedwithsourcedocuments.
Inthiscase,thefirmsfinancialrecordsareNOTreliablebecausethereportshavebeen
preparedbasedontheownersestimatesandwithoutsourcedocumentsasverification.
e)
GoingConcern
Explanation
Theremustbeanassumptionthatthefirmhasaninfinitelifeandwillexistforever.
Inthiscase,theownerhasbreachedtheGoingConcernprinciplebynotbeingcertainitwill
existnextyearand,hence,preparingalistofassetvalues.
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VCEACCOUNTING
f)
ReportingPeriod
Explanation
Thelifeofthebusinessmustbebrokenupintoperiodsofequallengthofnolongerthan12
months.Attheendofeachperiod,thefirmmustcalculateitsprofit.
Inthiscase,thefirmhasbreachedthisprinciplebywaitingthreeyearsbeforereportingonthe
firmsfinancialperformance.
Page|24

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Chapter 1 - Solutions

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VCEACCOUNTING

1.1 What is Accounting?

Cambridge Revision Question 1.5

Cambridge Revision Question 1.5

Cambridge Revision Question 1.5

Cambridge Revision Question 1.5

1.6 Entity Principle

1.7 Historical Cost Principle

1.8 Going Concern Principle

1.9 Reporting Period Principle

1.10 Monetary Unit Principle

1.11 Conservatism Principle

1.12 Consistency Principle

1.13 Which Theory When?

Cambridge Exercise 1.6

Cambridge Exercise 1.6

1.16 Owners Equity

Cambridge Exercise 1.6

Cambridge Exercise 1.6

1.19 Summary of Revenues and Expenses

1.20 Assets vs. Expenses

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