Project 2

Project 2: Generally Accepted Accounting Principles (GAAP)

 

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Case Studies

 

1. The Business Entity Concept

 

The Business Entity Concept provides that the accounting for a business or organization is kept separate from the personal affairs of its owner or from any other business or organization. This means that the owner of a business should not place any personal assets on the business balance sheet. The balance sheet of the business must reflect the financial position of the business alone.

 

Nadia operates a tow-truck business from her home. She has renovated her garage to allow for the additional truck and has installed an extra phone line in her home for business purposes. Nadia would like to renovate her family room, and she has purchased materials and supplies to do these renovations. Her friend, Harley, has suggested that she include the expenses for the family room in her business expenses. “No one will notice,” suggested Harley.

1. Nadia has her accounting done by a local accountant. What would the accountant say about this?

2. The Principle of Consistency

 

The Principle of Consistency states that in the preparation of financial statements, the same accounting principles are applied the same way in each accounting period.

 

Stephen has a word processing business. He prepares documents, such as résumés and reports, for his customers. In his first month of operation, he recorded the purchase of his printer as office supplies. Two months later he decided he needed a second printer and this time recorded the purchase as office equipment.

2. Why was his accountant questioning this on the year-end report? What difference would it make to Stephen’s business?

3. The Going-Concern Concept

 

The Going-Concern Concept assumes that a business will continue to operate and have a long life. This means that the business will not cease to operate immediately after commencing business. The assets belonging to a business that is alive and well are relatively easy to value.

 

The owners of FitKings Recreation Centre have applied to their bank for a loan to renovate their building. The owners asked for $100 000 and plan to upgrade the carpeting and furnishings in the building. The bank advanced the money to the company and, three weeks later, the company ceased operations, leaving unpaid bills.

3. Would the bank have loaned the funds if they had known that FitKings was going out of business?

4. The Principle of Conservatism

 

The Principle of Conservatism provides that accounting for a business should be fair and reasonable. Accountants are required in their work to make evaluations and estimates, to deliver opinions, and to select procedures. They should do so in a way that neither overstates nor understates the affairs of the business or the results of operation.

 

Fielding Software has an inventory of 2000 software packages with an inventory price of $149 each. Since the development of this software, a competitor has launched a similar product with a retail price of $129.

4. What value should Fielding Software list their software when recording it in their books: $149 or $129?

5. The Principle of Objectivity

 

The Principle of Objectivity states that accounting will be recorded on the basis of objective evidence. Objective evidence means that different people looking at the evidence will arrive at the same values for the transaction. Simply put, this means that accounting entries will be based on fact and not on personal opinions or feelings.

 

Hans does consulting for medical offices. He reviews the office computer system and staffing and recommends changes to the system. Hans normally charges $200 an hour. A competitor who charges $150 an hour for similar services has arrived on the scene. Hans normally bills approximately 200 hours a month, but he has noticed that for the past few months, his hours have dropped to 185. The bank that finances the business has asked for an updated financial statement.

5. What should Hans state as his average anticipated income in hours: 185 or 200?

6. The Time Period Concept

 

The Time Period Concept says that accounting takes place over specific time periods known as fiscal periods. These fiscal periods are of equal length and are used when measuring the financial progress of a business.

 

Mira began her teahouse business on April 1 of 2010. After four months of operation, her accountant prepared financial statements, which reflected the status of the company as of July 31, 2010. Five months later, at the end of December, Mira has financial statements prepared again and compares the revenue and expenses from the first period to the second.

6. What is wrong with Mira’s analysis?

7. The Matching Principle

 

The Matching Principle states that each expense item related to revenue earned must be recorded in the same accounting period as the revenue it helped to earn. If this is not done, the financial statements will not measure the results of operations fairly.

 

Sarah is a sign painter. On April 26, she purchased enough paint and other supplies to make several signs. She earned $3600 from the sale of two signs she painted in May. In April, she recorded the cost of the paint and other supplies as an expense. However, she earned no income using these supplies during that month.

7. What is wrong with Sarah’s accounting?

8. The Cost Principle

 

The Cost Principle states that the accounting for purchases must be at their cost price. This is the figure that appears on the source document for the transaction in almost all cases. There is no place for guesswork or wishful thinking when accounting for purchases. The value recorded in the accounts for an asset is not changed later if the market value of the asset changes. It would take an entirely new transaction based on new objective evidence to change the original value of an asset.

 

Azmina has opened a tanning studio. As a gift, her family bought lovely white wicker furniture for the waiting area of the business. At the end of the year, when doing her financial statement, the accountant asked Azmina to value the assets. Azmina stated that the furniture was a gift and therefore should not be included.

8. What is wrong with Azmina’s logic?

9. The Full Disclosure Principle

 

The Full Disclosure Principle states that any and all information that affects the full understanding of a company’s financial statements must be included with the financial statements. Some items may not affect the ledger accounts directly. These would be included in the form of accompanying notes. Examples of such items are outstanding lawsuits, tax disputes, and company takeovers.

 

Ron and Peggy Thompson operate a furniture refinishing business, ReNue Finishers. They share equally in the profits of the business, although Ron is the skilled craftsman and Peggy handles the management of the business. Ron and Peggy have been having marital problems, and they have decided to separate and go their own ways in the new year. They have two bank loans, and their financial statements are to be audited and provided to the bank at the end of the year. The Thompsons have decided not to let the bank know what is happening in their personal lives.

9. Is this correct?

Portfolio Submission

 

Complete a summary of the GAAP principles described in this project and their meanings, and save it in your Course Portfolio folder. Be sure to include the purpose of GAAP and what it means, since a prospective employer may ask you this question in an interview.

 

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