Question

Presented below are a number of accounting procedures and practices in Ramirez Corp. For each of these items, list the assumption, principle, qualitative characteristic, or constraint that is violated.

1.         Because the company’s income is low this year, a switch from accelerated depreciation to straight-line depreciation is made this year.

2.         The president of Ramirez Corp. believes it is foolish to report financial information on a yearly basis. Instead, the president believes that financial information should be disclosed only when significant new information is available related to the company’s operations.

3.         Ramirez Corp. decides to establish a large loss and related liability this year because of the possibility that it may lose a pending patent infringement lawsuit. The possibility of loss is considered remote by its attorneys.

4.         An officer of Ramirez Corp. purchased a new home computer for personal use with company money, charging miscellaneous expense.

Answer 1

1. Principle of consistency is violated – A depreciation method is an accounting policy and it should be consistently applied from year to year. When the depreciation method has changed the principle of consistency is not applied.

2. Periodicity concept is violated – The financial statement should be reported on a periodical basis. For example Quarterly, annually, etc. Financial information should not be disclosed only when material changes happen

3. Matching principle is violated – As per the matching concept the expenses should be recognized in the financial statement when the revenue is generated to incur that expense. Hence the matching principle is violated by charging entire liability to the income statement account.

4. Economic or Business entity concept is violated– As per the business entity concept the transactions of the owner of the business are separate from the business. Both should have a separate identity. Hence the new computer purchased should be for personal use and should be treated as drawings and charged to the Capital Account.