Exam 11: Accounting Principles

The following are independent situations observed by Mersey's senior accountant at December 31, 2014, the company's year end. Mersey has not adopted the revaluation model for accounting for long-lived assets. 1. The draft financial statements include an item listed under non-current assets "Human resources" but there is no financial amount included. 2. Mersey's employees are paid a bonus based on profit. Mersey's management would like to minimize the amount of bonus paid, and so they instructed a junior accountant to write down inventory by $1,000,000 and record a Loss on Inventory. Their argument is that the "fire sale" value of the inventory would be lower than recorded cost by this amount. Mersey has no intention of liquidating the inventory under such circumstances, but expects to sell the inventory in the normal course of business at amounts significantly above cost. 3. A building being constructed for a customer was 90% complete, and accordingly 90% of the related revenue had been correctly included in sales for the year. The total projected cost of construction is $600,000. Of the $540,000 cost of the project incurred to date, $200,000 has been expensed. 4. Mersey owns 5% of the shares of Liverpool Investments. A note to Liverpool's financial statements describes a valuable new patent registered by Liverpool and the anticipated profits that are expected to result. A junior accountant at Mersey recorded an entry "Debit Intangible Assets; Credit Gain on Patent Registration" in the amount of $220,000, which is 5% of the amount at which Liverpool has recorded the cost of the patent. 5. In November, Mersey entered into a service contract to provide maintenance services to a client for a fee of $20,000 per month. On signing the contract, the client paid Mersey a $40,000 deposit on services to be provided. The term of the contract is from December 15, 2014 through December 15, 2015. The $40,000 deposit was recorded as Service Revenue. Instructions For each of the events, indicate an accounting assumption, concept, constraint or recognition criteria that have been violated and provide your reason. Prepare the correcting entry required, or if no entry is required, explain what other change, if any, should be made to ensure that Mersey's financial statements comply with GAAP.

Qualitative characteristics associated with relevant accounting information are

Accounting information is neutral if

The cost constraint exists to ensure that the value of the information is more than the cost of providing it.

Fair value is the amount of cash expected to be collected if the asset is sold.

The cost model to report property, plant and equipment is where the carrying value on the balance sheet is the fair value less accumulated depreciation.

The qualitative characteristic which should be first applied is that of relevance.

If the company is a going concern, the classification of assets and liabilities as current and noncurrent would not matter.

If goods are shipped FOB shipping point then the selling company cannot recognize the revenue until the goods are received at their destination.

The conceptual framework of accounting

Understandability is greater when the information is classified, characterized and presented clearly and concisely.

Relevant accounting information

Faithful representation means that accounting information reports on the economic reality of a transaction, not its legal form.

The expense recognition criteria states that expenses are recognized when there is an increase in an asset or decrease in a liability, excluding transactions with owners.