Question

Discuss the following.

1. Suppose Joe Francis owns a Chevrolet Dealership called "Joe's Chevrolet." Joe charges all his personal gasoline purchases on the dealership and these amounts are reported among the dealership's operating expenses. How does this violate the economic entity concept?

2. Suppose Joe's Chevrolet reports assets in the following way:

Assets Owned:

Building .............................................. 10,000 square feet total space, constructed in 1998.

Inventory............................................ 100 vehicles total, 75 new units, 25 used.

How does this violate the monetary unit concept?

3. Suppose Joe's Chevrolet's financial report reflects Assets of $500,000 and Liabilities of $400,000. There are 10,000 shares of common stock and therefore an accounting book value of $10 per share.

Given the limitation of accounting to reliably measure intangible assets, would you expect the $10 per share to be a good estimate of the fair market value per share?  

Answer 1

Solution

1. Joe Francis owns a Chevrolet dealership called Joe's Chevrolet. As he buys Chevrolet vehicles for selling it to the customers, the vehicles purchased are considered to be his"Stock". As such he can charge the purchase cost as an expense in the Trading and Profit and Loss Account ( ie. purchase of vehicles can be considered as a business expense of Mr.Joe Francis). On the other hand purchase of gasoline for his personal purpose cannot be treated as his business expense. It cannot be reported under the operating expense of his business.

Treating his personal expense as business expense is a clear violation of the principle of "Business Entity Concept". As per this concept, business transactions should be kept separate from the owner. Business has a separate legal entity and as such personal transactions cannot be mixed up with business transactions.

2. Joe's Chevrolet reports his assets not in the form of monetary terms.( ie he recorded his building in square feet and recorded his inventory in numbers). As per "Monetary Unit Concept", transactions and events should be recorded in monetary units. Since the language of business is money, the transactions should be recorded in money terms. Unless the transactions are recorded in money terms, the financial information cannot be reported and communicated effectively. Because of the above reasons, it is clear that M/S Joe's Chevrolet  has violated the principle of Monetary Terms when they reported their assets.   

3. Some times intangible assets cannot be clearly recognized to show it in the financial statements.because it doesn't satisfy the recognition criteria. An intangible asset can be recognized only when the future economic benefits from the assets are probable and the cost of the asset can be measured reliably.

Considering the limitation of Accounting to reliably measure intangible assets,$10 per share cannot be considered as a good estimate of the fair market value per share.