CHAPTER 19

ACCOUNTING PRINCIPLES AND POLICIES

Question 1

Transaction Relevant principle

When preparing the income statement an adjustment
was made to an expense account to record a Accruals (matching)
prepayment.
Occasionally items are damaged in a business’s
stockroom. These items are often valued at net Prudence
realisable value because it is less than cost.
A business always a makes a provision for doubtful
debts based on 5% of trade receivables at the year Consistency
end.
The owner purchased a birthday gift for a member of
the family using the business’s money. The amount Business entity
spent was debited to the drawings account.

Question 2

Transaction Relevant principle

The business has always used the straight-line
Consistency
method of depreciation at 20% per annum every year.
A customer’s account which has been unpaid for 12
Prudence
weeks has now been written off as a bad debt.
The owner paid the business’s rent from his private
funds. In the business’s accounts a debit entry was
Business entity
made in the rent account and a credit entry in the
drawings account.
The business receives rent from a tenant. The amount
transferred to the income statement took account of
Accruals (matching)
the fact that the tenant owed an amount for rent at the
year end.
Question 3

Answers could include:

Principle One key point about this principle
Accruals Ensure profits are based on
matching the revenue for a year
with the costs incurred in order to
achieve that revenue, whether
paid or not.
Prudence Where there is doubt, assets and
profits are under- rather than
overstated; liabilities and losses
are over- rather than understated.
Example of the principle being used
Adjusting expenses for prepayments
and accruals.
Adjusting income items for amounts
due or received in advance.
Depreciation non-current assets.
Adjusting purchases for unsold
inventories.
Valuing inventories at the lower of
cost or net realisable value.
Reducing trade receivables by a
provision for doubtful debts.
Writing off the amount due from a
trade receivable as soon as it is
reasonably certain that a bad debt
has occurred.

Question 4

Answers could include:

Principle One key point about this principle
Consistency Accounting policies and
procedures should be carried out
in the same way each year.
Business entity Separate records are kept of the
owner’s private transactions and
the business’s transactions in an
accounting system.
Example of the principle being used
Using the same depreciation method
each year.
Using the same rate of provisions for
doubtful debts each year.
Drawings account maintained to
record all withdrawals from the
business by the owner.

Question 5

(a)
(i) Cost of damaged items: 8 × $20 = $160
(ii) Normal sale value of damaged items: 8 × $30 = $240
(iii) Realisable value of damaged items: 8 × $22 = $176
(iv) Net realisable value of damaged items: 8 × $17 = $136

(b) and (c) Inventories must be valued at the lower of cost ($160) or net realisable
value ($136); so damaged items should be valued at $136.

Question 6

(a)
(i) Cost of damaged items: 4 × $40 = $160
(ii) Normal sale value of damaged items: 4 × $60 = $240
(iii) Realisable value of damaged items: 4 × $43 = $172
(iv) Net realisable value of damaged items: 4 × $35 = $140

(b) Inventories must be valued at the lower of cost ($160) or net realisable value
($140); so damaged items should be valued at $140

Question 7

Transaction Relevant principle

The owner sent some samples to a potential new
customer. However, this transaction has not been Realisation
entered in the sales account.
The fittings could be sold for far less than is shown on
the balance sheet. However, no changes have been Going concern
made to the accounting records.
When a bank loan was repaid two entries were made
in the accounting records affecting an asset account Duality
and a liability account.
No record has been made in the accounting system of
Money measurement
the fact that the workforce had a very high morale.

Question 8

Transaction Relevant principle

The payment of interest has resulted in making two
Duality
entries in the accounting system.
The staff have been praised for their very positive
customer relations. No record has been made of this Money measurement
in the accounting system.
The business has been very successful, but no record
has been made of the value of goodwill in the Going concern
accounts.
Goods have just been sent to a customer. No
payment has been made by the customer and the
Realisation
invoice for the goods will not be sent until next week.
No entries have been made for this sale so far.

Question 9

Definition Principle
Accounting for a sole trader’s business is clearly
separated from accounting for the owner’s private Business entity
transactions.
A sale occurs when money or the promise of
Realisation
money is received.
Accounting systems are based on the idea that
Duality
there is a two-fold aspect to every transaction.
Profits are assessed on the basis of amounts due
or receivable for a period of time rather than Accruals
amounts actually paid or received.
Question 10
Definition
The assumption is made the business will continue to
trade indefinitely when valuing assets.
A business should endeavour to maintain the same
accounting policies from one year to the next to aid
comparability of results.
Some important aspects of a business’s performance
cannot be quantified in financial terms.
Where there is doubt, the lower value for an asset or
profit is preferred.
Question 11
Answers could include:
Principle One key point about this principle
Duality Every transaction has two aspects, so
two entries are made for a transaction
in an accounting system.
Realisation A sale occurs when the customers
pays or when an invoice is issued.
Question 12
Answers could include:
Principle One key point about this principle
Money Only transactions with a definite
measurement money value are recorded.
Going While a business is trading assets are
concern valued on the basis of their cost
rather than what they could be sold
for.
Concept
Going concern
Consistency
Money measurement
Prudence
Example of the principle being
used
Any transaction and a statement of
the account to be debited and
credited.
A sale is not recorded on the basis
of receiving an order.
Goods sent to a customer at the
end of one year, but invoiced at the
beginning of the second year,
should be recorded as a sale in the
second year.
Example of the principle being used
No record is made of the benefit a
business receives from being well
located, having a successful
management team, having a loyal
staff.
A delivery vehicle is recorded in the
accounts at cost less depreciation,
and not at what it would fetch if sold
off.
If the business was closed and its
assets sold off, then the delivery
vehicle would be valued at its likely
resale value.
Question 13

International accounting standards will help the users of accounts because they
ensure that accounts are prepared in the same way and based on the same
principles in a wide range of countries. Users will be able to make valid comparisons
of the result shown in these accounts.

International accounting standards also ensure that accounts for businesses in a

wide range of countries provide the information a user will need in order to, for
example, make judgements about performance or about whether to invest in a
business.

Question 14

International accounting standards ensure that accounts for businesses from a wide
range of countries are reliable because the information shown will be objective and
provide a true and fair picture of the financial position.

International accounting standards give a high priority to the user of the accounts of
businesses from a wide range of countries, so that information provided, although
technical, will be understandable.

EXAM-STYLE QUESTIONS

Q Ans Q Ans Q Ans Q Ans Q Ans

15 D 16 D 17 B 18 B 19 A
20 D 21 B 22 B 23 C 24 B
25 B

Question 26

(a) $145
(b) Khalaf should value the loudspeaker at the lower of cost or net realisable
value.
(c) This is an example of using the prudence principle.

Question 27

(a) Undamaged inventory: 19 × $320 = $6 080

(b) Washing machine A: $320 (cost)
(c) Washing machines B, C and D: $300 each (net realisable value)