Chapter 1 The Role of Accounting Solutions to exercises

Exercise 1.1

Accounting principles

a
Accounting principle

Entity

Explanation

The owner and the business are considered to be separate

accounting entities, and their records should be kept on this
basis. The orthodontists fees are an expense of the owner, not
an expense of the business, and should be recorded as
Drawings

b
Accounting principle

Consistency

Explanation

The same accounting methods should be applied from one

period to the next so that reports can be compared between
periods. The owner will be unable to identify any changes in
repair or vehicle expenses.

c
Accounting principle

Monetary Unit

Explanation

Transactions should be recorded in a common unit of

measurement in Australia, this means Australian dollars.

d
Accounting principle

Reporting Period

Explanation

The life of the business is divided into arbitrary periods to allow

for reports to be prepared. The transaction should be recorded
as revenue when it was earned (when the goods were
supplied), i.e. in December 2014.

e
Accounting principle

Historical Cost

Explanation

Transactions should be recorded at their original purchase price

as this value is verifiable by a source document. The revaluation
is subject to subjectivity, and not verifiable.

Simmons, Hardy

Cambridge University Press 2012

Chapter 1 The Role of Accounting Solutions to exercises

f
Accounting principle

Going Concern

Explanation

The life of the business is assumed to be continuous, and its

records are kept on this basis. The mortgage should be reported
as a non-current liability, as it is assumed that the business will
still be operating 10 years into the future.

g
Accounting principle

Reporting Period

Explanation

The life of the business is divided into arbitrary periods to allow

for reports to be prepared. According to tax requirements,
reports must be prepared at least yearly.

Exercise 1.2

Accounting principles and qualitative characteristics

a
Accounting principle

Entity

Explanation

The business is assumed to be an accounting entity separate

from the owner and other businesses, and its records should be
kept on this basis. The holiday is an expense of the owner, not
an expense of the business.

b
Explanation

Simmons, Hardy

The reports will not contain all the information that is useful for
decision-making because they will not show the owners
Drawings.

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Chapter 1 The Role of Accounting Solutions to exercises

Exercise 1.3

Accounting principles and qualitative characteristics

a
Accounting principle

Historical Cost

Explanation

Stock should be valued at its original purchase price as this

value is verifiable by a source document.
OR

Accounting principle

Conservatism

Explanation

Revenues should be recognised only when certain so that

assets and revenues are not overstated. There is no guarantee
that the stock will be sold for its selling price, so using the selling
price would recognise the revenue before it is certain and
overstate sales revenue and the value of the stock (an asset).

b
Explanation

Exercise 1.4

Because the selling price is not verifiable by reference to a

source document, it will mean the information in the reports is
not free from bias.

Accounting principles and qualitative characteristics

a
Accounting principle

Conservatism

Explanation

Losses should be recognised when probable so that expenses

and liabilities are not understated. The damages should be
recognised in order to present to the owner a prudent or
cautious picture of the firms financial position.

b
Qualitative characteristic

Relevance

Justification

The reports should include all information that is useful for

decision-making. The probable expense of damages may affect
decisions the owner makes about both profit and available cash.

Simmons, Hardy

Cambridge University Press 2012

Chapter 1 The Role of Accounting Solutions to exercises

Exercise 1.5

Accounting principles and qualitative characteristics

a
Consistency

The same accounting methods should be applied from one

period to the next so that reports can be compared between
periods.

b
Qualitative characteristic

Comparability

Explanation

Reports should be comparable over time, and between different

companies through the use of consistent accounting
procedures.

Exercise 1.6
Accounting principles, qualitative characteristics and
elements of reports
a
Accounting principle

Reporting Period

Explanation

The life of the business is divided into arbitrary periods to allow

for reports to be prepared. The revenue was not earned in the
Reporting Period in which it was received (2014) but when the
goods are provided in 2015 (a different Reporting Period).

b
Qualitative characteristic

Relevance

Explanation

The reports will include some information that is not useful for
decision-making about profit for the current Reporting Period
(2014; i.e. the cash that has been received will not be earned
until the next Reporting Period (2015).

c
Explanation

Simmons, Hardy

The inflow of economic benefits (cash) increases assets, but

also increases liabilities (the goods are still owed to the
customer); as a result there is no increase in owners equity.

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Chapter 1 The Role of Accounting Solutions to exercises

Exercise 1.7

Accounting principles and qualitative characteristics

a
Qualitative characteristic

Understandability

Explanation

Reports should be presented in a manner that makes it readily

understandable by users. As the workers have no accounting
knowledge, the reports will not fulfil their function of providing
information.

b
Technique

Exercise 1.8

Use of graphs; plain language reports; explanatory

notes/presentation sessions

Accounting principles and qualitative characteristics

a
Accounting principle

Historical Cost

Explanation

Assets and liabilities will be reported in the Balance Sheet at

their original purchase price as these values are verifiable by a
source document. The market value, on the other han,d
represents what a potential buyer is prepared to pay for the
assets.

Exercise 1.9
Accounting principles, qualitative characteristics and
elements of reports
a
Explanation

As a non-current asset as it is a resource controlled by the

business as a result of past events from which a future
economic benefit is expected to flow to the business for more
than 12 months.

b
Accounting principle

Historical Cost

Explanation

The shelving should be valued at $12 500, as this is the agreed

value of the asset at the time it is contributed to Maxs Mart. This
agreed value becomes the Historical Cost for Maxs Mart. (The
$15 000 was paid by a different entity.)

Simmons, Hardy

Cambridge University Press 2012

Chapter 1 The Role of Accounting Solutions to exercises

c
Qualitative characteristic

Reliability

Explanation

There is no guarantee that the shelving can be sold for its resale
value, so using this figure will mean that the information in the
reports is not free from bias.

Exercise 1.10
Item

Elements of the reports

Report/classification

Definition

a Debtors

Balance Sheet/
Asset

a resource controlled by the business that is expected

to provide a future economic benefit (when the cash is
received)

b Loan
principal

Balance Sheet/
Liability

a present obligation that is expected to result in an

outflow of economic benefits sometime in the future
(when the loan is repaid)

c Interest on
loan

Income
Statement/
Expense

an outflow of an economic benefit in the form of a

decrease in assets (Bank), which leads to a decrease
in owners equity

d Stock loss

Income
Statement/
Expense

an outflow of an economic benefit in the form of a

decrease in assets (Stock,) which leads to a decrease
in owners equity

e Cash sales

Income
Statement/
Revenue

an inflow of an economic benefit in the form of an

increase in assets (Bank), which leads to an increase in
owners equity

f Wages
incurred

Income
Statement/
Expense

an outflow of an economic benefit in the form of a

decrease in assets (Bank,) which leads to a decrease
in owners equity

g Wages
owing

Balance
Sheet/Liability

a present obligation that is expected to result in an

outflow of economic benefits sometime in the future
(when the employees are paid)

h Discount
revenue

Income
Statement/
Revenue

a saving in an outflow of economic benefits in the form

of a reduction in a liability (Creditors), which leads to an
increase in owners equity.

Simmons, Hardy

Cambridge University Press 2012

Chapter 1 The Role of Accounting Solutions to exercises

Exercise 1.11

Elements of the reports

a
Explanation

Both represent an economic benefit, but whereas an asset represents a

resource controlled by the entity that is expected to provide a future
economic benefit, an expense represents an outflow or consumption of an
economic benefit.

b
Explanation

If the vehicle was purchased as stock and was intended for resale, it would be
a resource controlled by the business that is expected to provide a future
economic benefit in the next 12 months (when it is sold).

c
Explanation

If the vehicle was purchased for use within the business, it would be a
resource controlled by the business that is expected to provide a future
economic benefit for more than 12 months.

d
Explanation
OR

Exercise 1.12

If the vehicle was sold, it would create an expense called Cost of Sales
relating to the outflow of an economic benefit in the form of a decrease in
assets (Stock), leading to a decrease in owners equity.
Stock loss/Depreciation

Goodwill

a
Discussion

Simmons, Hardy

The loyal clientele (goodwill) represents a resource controlled by the business

that is expected to provide a future economic benefit (i.e. further sales).
However, it is difficult to value this goodwill in any manner that is Reliable
(accurate/free from bias) so it should not be recognised as an asset.

Cambridge University Press 2012