Question

AAP. (SO 2, 4) CE1-7 Stanley Company, a proprietorship owned by Dave Stanley, had the following selected business transactions during the year: 1. Land with a cost of $208,000 was reported at its fair value of $260,000. 2. A lease agreement to rent equipment from an equipment supplier starting next year was signed. The rent is $500 per month and the lease is for two years. Payments are due at the start of each month. Nothing was recorded in Stanley Company's accounting records when the lease was signed. 3. Stanley paid the rent for an apartment for Dave's personal use and charged it to Rent Expense. 4. Stanley wanted to make its profit look worse than it really was, so it adjusted its expenses upward to include the effects of inflation. 5. Stanley included a note in its financial statements stating the company is a going concern and is following ASPE Instructions (a) In each situation, identify whether the accounting treatment is correct or not, and why. (b) If it is incorrect, state what should have been done. events to be 1. (SO 4) C E1-8 The following is a list of independent events: 1. A company pays $10,000 cash to purchase equipment at a bankruptcy sale. The equipment's fair value is $15,000. 2. A Canadian company purchases equipment from a company in the United States and pays US $5,000 cash. When the Canadian company went to its bank to buy a bank draft for US $5,000 to pay for the equipment, it cost them $5,200 Canadian. 3. A company provides $4,000 of services to a new customer on account. 4. A company hires a new chief executive officer, who will bring significant economic benefit to the company. The company agrees to pay the new executive officer $500,000 per year. 5. A company signs a contract to provide $10,000 of services to a customer. The customer pays the company $4,000 cash at the time the contract is signed. Instructions (a) Should the transaction be recorded in the accounting records? Explain why or why not. (b) If the transaction should be recorded, indicate the amount. Explain.

Answer 1

E 1-7:

(a) and (b)

1.         This accounting treatment is incorrect, as it violates the cost principle. Land was reported at its market value, when it should have been recorded and reported at cost.

2.         This accounting treatment is correct. Although a commitment for future payments is put into place when the lease is signed, an exchange has not yet taken place so there is no transaction that needs to be recorded. At this time, all that is required concerning this lease is to disclose the details of the commitment in the notes to the financial statements.

3.         This accounting treatment is incorrect, as it violates the economic entity assumption. An owner’s personal transactions should be kept separate from those of the business. Instead of being charged as an expense to the business, the transaction should be recorded as drawings taken by the owner.

4.         This accounting treatment is incorrect, as it violates the monetary unit assumption. An important part of the monetary unit assumption is the stability of the monetary unit (the dollar) over time. Inflation is considered a non-issue for accounting purposes in Canada and is ignored.

5.         This accounting treatment is partially correct. It is assumed that a company is a going concern, unless the notes state otherwise. Consequently, the statement in the notes that the company is a going concern need not be added. On the other hand, the company is required to make the disclosure that it is following ASPE.

E 1-8:

(a) and (b)

1.         This is a transaction that should be recorded in the accounts as there has been an exchange of assets. Cash was reduced and equipment was increased. The historical cost of $10,000 should be used in when recording this transaction.

2.         This is a transaction that should be recorded in the accounts as there has been an exchange of assets. Cash was reduced and equipment was increased. The transaction is to be recorded in Canadian funds in order to follow the monetary unit assumption, so the amount that should be used when recording this transaction is $5,200.

3.         This is a transaction that should be recorded in the accounts because revenue has been earned from providing services and accounts receivable have been increased. The amount of $4,000 should be used in when recording this transaction.

4.         This is not a transaction as an exchange has not yet occurred.

5.         This is a transaction that should be recorded in the accounts because an asset, cash has increased and a liability has been created to deliver services to the customer at a future date. The amount of $4,000 should be used in when recording this transaction.