Question

Conceptual framework (Non-GST version)

Required (a) For each item, determine which accounting concept(s) (if any) is violated, and explain why.

After conducting an audit of the accounts of Parramatta Ltd, you discover that the following transactions and events were recorded during the current year. Parramatta Ltd uses the historical cost system. 1. The company borrowed $600 000 from a bank at an interest rate of 10% to construct a new warehouse. At the completion of construction, the loan was repaid and the following entry was made: Bank Loan Warehouse Cash at Bank 600 000 60 000 660 000 2. A patent with a cost of $160 000 was being amortised over its useful life of 8 years. The amortisation entry made at the end of the current year was: Retained Earnings Patents 20 000 20000 3. A speed-control device was installed on each of the company's 8 delivery trucks at a cost of $300 each plus GST. The transaction was recorded as follows: 2400 Maintenance Expense Cash at Bank 2400 4. At the beginning of the current year, a new vehicle was purchased for $36 000. The vehicle had an estimated useful life of 4 years. Depreciation expense for the year was recorded as follows in order to avoid reporting a loss: 2000 Depreciation Expense Accumulated Depreciation - Vehicle 2000 5. Inventory was acquired at $30 per unit throughout the current year until the last purchase was made in the last month of the year. At that time the company was able to negotiate a special deal and acquired 10 000 units at $25 per unit. Ignore GST. The purchase was recorded as follows: 300 000 Inventory Cash at Bank Income 250 000 50 000

(b) For each violation, indicate the correct treatment.

Answer 1

1. Incorrect account being used. Loan has been taken to construct warehouse; while repaying loan, Bank loan as well as interest payable has to be debited and cash at bank has to be credited. Interest pertaining to appropriate loan account has to be used. Thus correct entry as below:

Dr. Bank Loan A/c 600,000

Dr. interest Payable A/c 60,000 (assuming interest expense has already been accounted in the books)

Cr.  Cash at bank a/c 660,000

(Being loan repayment along with interest at bank accounted)

2. In case of amortisation, amortisation expense account has to be used and not retained earning account. Both retained earnings and Patent are balance sheet items, which means there is no expense gets recorded in the income statement for the current year. Depreciation or amortisation being an expense item, it has to be recorded in the same year it belongs to, in order to comply with ACCOUNTING PERIOD CONCEPT of accounting. Thus, correct entry as below:

Dr. Amortisation Expense a/c 20,000

Cr. Patent a/c 20,000

(being amortisation pertaining to Patent accounted for the current year)

3. Speed control device is an asset related to truck and by applying GOING CONCERN CONCEPT of accounting, business will continue to use the device for following years as well, until the useful life of the Truck. Hence expense incurred in purchase of the device has to be capitalised along with cost of truck and not expensed off. Thus, correct entry as below:

Dr. Truck a/c / asset a/c 2,400

Cr. Cash at bank a/c 2,400

(Being purchase of speed control device of truck accounted)

4. Though the entry is correct, amount is populated incorrect. Asset value = $ 36,000 and useful life is 4 years, which means Depreciation as per SLM = asset value less salvage value divided by useful life of asset (i.e.) (36000-0)/4 = $9,000 per year is the depreciation amount. Thus correct entry as below:

Dr. Depreciation Expense a/c 9,000

Cr. Accumulated Depreciation -Vehicle 9,000

(Being depreciation expense accounted for the year)

5. Inventory has been acquired at $ 30 throughout the year and at last purchase discount of $ 5 have been given by supplier. In this case, $ 5 is the discount availed (i.e.) purchase discount and not an income account. Thus, correct accounting entry as below:

Dr. Inventory 300,000

Cr. Cash at bank 250,000

Cr. Purchase discount a/c   50,000

(Being inventory acquired with discount accounted)