Chapter 15 Exercise Review

Question 1

Explain why invoice 64 could not be recorded in the purchases journal of the business (purchase of display cabinets on credit)

Answer 1

It is a credit purchase of a non-current asset, not a credit purchase of stock.

Question 2

Explain your treatment of installation

Answer 2

It is included as part of the cost of the asset, as it is incurred to get the asset into a condition and location ready for USE, and will bring a benefit for the life of the asset.

Question 3

Define the term “cost” as it applies to non-current assets

Answer 3

All costs incurred to get the asset into a condition and location ready for USE, which will bring a benefit for the life of the asset

Question 4

Explain the difference between Creditors Control and a Sundry Creditor

Answer 4

Creditors Control is a current liability arising from the credit purchase of stock; a sundry creditor is a current liability arising from the credit purchase of an asset other than stock.

Question 5

With reference to an accounting principle, explain why it is necessary to depreciate non-current assets

Answer 5

Reporting Period
To ensure that the cost incurred in relation to a non-current asset is reported as an expense in each Reporting Period in which the asset earns revenue, thus ensuring that profit is calculated accurately

Question 6

Explain why the straight line method should be used to depreciate the shelving

Answer 6

The straight-line method best reflects the revenue earning pattern of the shelving, which will contribute evenly to revenue over its useful life, and this method allocates depreciation expense evenly over the asset’s life.

Question 7

Explain why the reducing balance method should be used to depreciate the sewing machine

Answer 7

The reducing balance method best reflects the revenue earning pattern of the sewing machine, which will contribute more to revenue when it is new and less as it ages. This method allocates more depreciation expense at the start of the asset’s life and less as it ages.

Question 8

State the assumption that underlies the reducing balance method of depreciation in relation to how assets contribute to revenue

Answer 8

The asset will contribute more to revenue when it is new and less as it ages.

Question 9

Explain one reason why the owner should change the method of depreciation used for the shop fittings

Answer 9

The shop fittings will earn revenue evenly over their useful life so the straight-line method should be used because it allocates depreciation expense evenly, the reducing balance method is suited to assets that earn more revenue when new because it allocates more expense at the start of the asset’s life and less as it ages.

Question 10

Referring to 1 qualitative characteristic, explain one reason why the owner should not change the method of the deprecation used for the shop fittings

Answer 10

Comparability

Changing accounting methods will mean that the reports will not be able to be compared from one Reporting Period to another: it will be unclear whether changes in depreciation expense are the result of changes in financial performance or simply changes in accounting methods.

Question 11

Suggest one reason why the owner might (incorrectly) argue that the straight line method provides consistency

Answer 11

The depreciation expense will be the same every year.

Question 12

Referring to the owners claim that straight line method provides consistency explain why he is incorrect

Answer 12

Consistency refers to the use of the same depreciation method, not the calculation of the same depreciation expense.

Question 13

Identify one extra piece of information you would require before agreeing with the account who says it should be depreciated using the reducing balance method

Answer 13

How the shop equipment will contribute to revenue, whether it has moving parts. If so, it should be depreciated more at the start of its useful life, and less as it ages.

Question 14

Explain how the choice of depreciation method will affect Net Profit for the reporting period

Answer 14

Net Profit will be $300 lower under the reducing balance method because depreciation expense will be $300 higher.

This is because the reducing balance method allocates more depreciation expense at the start of the asset’s life when it is newer and can contribute more to revenue.

Question 15

Identify the depreciation method used for:
Photocopiers
Office Equipment

Answer 15

Photocopiers: Straight-line

Office Equipment: Reducing balance

Question 16

Discuss whether the owner should change the method used to calculate the depreciation expense of the photocopiers

Answer 16

The Consistency principle requires that the same depreciation method be used from one Reporting Period to the next so that reports are comparable.

However, changing to the reducing balance method, which allocates more depreciation expense at the start of the asset’s life than at the end, would more closely match the revenue earning pattern of the photocopiers, which are likely to earn more revenue when they are new and less as they age.

Question 17

Explain the effect on the carrying value of the office equipment at the end of its useful life if the owner has used the other depreciation method

Answer 17

No effect
both the straight-line and reducing balance methods will allocate the same total depreciation expense over the life of the asset.

Question 18

Suggest two reasons for the profit on disposal of fittings

Answer 18

Over-depreciated asset (due to understated residual value/useful life)

Asset was in high demand (due to rarity/better condition than expected)

Question 19

Explain how the proceeds from the disposal of furniture would be reported in the cash flow statement

Answer 19

As an Investing Inflow, as it is a cash inflow as a result of the disposal of a non-current asset

Question 20

Explain one reason for the loss on the disposal of furniture

Answer 20

The carrying value was overstated, due to under-depreciation. This may have been caused by overstating the residual value or useful life, or because the asset was not in demand due to damage or obsolescence.

Question 21

Define the term “trade in”

Answer 21

When a firm uses the proceeds from the disposal of a non-current asset to reduce the amount payable for the purchase of a new non-current asset

Question 22

Define “under depreciation”

Answer 22

When insufficient depreciation is allocated over the life of the asset, meaning its carrying value is overstated

Question 23

State two causes of under depreciation

Answer 23

Overestimation of useful life

Overestimation of residual value

Question 24

Explain how the value of the trade in should be reported in the income statement for the business

Answer 24

Not reported: only the overall Loss on Disposal of Cash Register is reported in the Income Statement (under Other Expenses).

Question 25

Suggest two actions the owner could take to improve Adjusted Gross Profit without changing its mark up

Answer 25

Physical security measures (e.g. locks/cameras)

Rotation of stock

Reduce level of stock on hand

More careful checking of deliveries

Question 26

*The reporting of a profit or loss on disposal of a non current asset proves that while depreciation expense may be relevant it is not reliable

Explain why this statement is correct

Answer 26

Reliability states that all information in reports should be free from bias and as depreciation is calculated upon an assumption it does not fulfill reliability. However, by allocating depreciation we can determine a more accurate profit figure and therefore the information is more useful for decision making, thus making depreciation relevant.