E2-7 Accounting Principles—Comprehensive Presented below are a number of business transactions that occurred during the current year for Fresh Horses, Inc.
Instructions
In each of the situations, discuss the appropriateness of the journal entries in terms of generally accepted accounting principles. The president of Fresh Horses, Inc. used his expense account to purchase a new Suburban solely for personal use. The following journal entry was made.
Miscellaneous Expense 29,000
Cash 29,000
Merchandise inventory that cost $620,000 is reported on the balance sheet at $690,000, the expected selling price less estimated selling costs. The following entry was made to record this increase in value.
Merchandise Inventory 70,000
Revenue 70,000
The company is being sued for $500,000 by a customer who claims damages for personal injury apparently caused by a defective product. Company attorneys feel extremely confident that the company will have no liability for damages resulting from the situation. Nevertheless, the company decides to make the following entry.
Loss from Lawsuit 500,000
Liability for Lawsuit 500,000
Because the general level of prices increased during the current year, Fresh Horses, Inc. Determined that there was a $16,000 understatement of depreciation expense on its equipment and decided to record it in its accounts. The following entry was made.
Depreciation Expense 16,000
Accumulated Depreciation 16,000
Fresh Horses, Inc. has been concerned about whether intangible assets could generate cash in case of liquidation. As a consequence, goodwill arising from a purchase transaction during the current year and recorded at $800,000 was written off as follows.
Retained Earnings 800,000
Goodwill 800,000
Because of a “fire sale,” equipment obviously worth $200,000 was acquired at a cost of $155,000. The following entry was made.
Equipment 200,000
Cash 155,000
Revenue 45,000
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SOLUTION PREVIEW
In each of the
situations, discuss the appropriateness of the journal entries in terms of
generally accepted accounting principles. The president of Fresh Horses, Inc.
used his expense account to purchase a new Suburban solely for personal use.
The following journal entry was made.
Miscellaneous Expense 29,000
Cash 29,000
This entry
violates the economic entity assumption. This assumption in accounting
indicates that economic activity can be identified with a particular unit of
accountability. In this situation, the company erred by charging this cost to
the wrong economic entity.
