al plaCC Problems Accounting Conventions P1 For each of the

al plaCC Problems Accounting Conventions P1. For each of the following cases, identify the accounting convention that applics, state whether or not the treatment is in accord with the convention and GAAP, and briefly explain why 1. Dooley Manufacturing Company uses the cost method for computing the balance sheet amount of inventory unless the market value of the inventory is less than the cost, in which case the market value is used. At the end of the current year, thoe market value is $302,000 and the cost is $324,000. Dooley uses the $302,000 figure to compute current assets because management believes it is the more cau- tious approach Jasper Company has annual sales of $20,000,000. It follows the practice of record- ing any items costing less than $500 as expenses in the year purchased. During the current year, it purchased several chairs for the executive conference room at $490 each, including freight. Although the chairs were expected to last for at least 10 years, they were recorded as an expense in accordance with company policy. 2. 3. Nogel Company closed its books on October 31, 2011, before preparing its annual a fire destroyed one of the company\'s two factories report. On November 3, 2011, Although the company had fire insurance and would not suffer a loss on the build- ing, a significant decrease in sales in 2011 was expected because of the fire. The fire damage was not reported in the 2011 financial statements because the fire had not affected the company\'s operations during that year. 4. Act Drug Company spends a substantial portion of its profits on research and development. The company had been reporting its $12,000,000 expenditure for research and development as a lump sum, but management recently decided to begin classifying the expenditures by project, even though its recordkeeping costs will increase. 5. During the current year, BRB Company changed from one generally accepted method of accounting for inventories to another method.

Solution

1.Convention of Conservatism:

“Anticipate no profit and provide for all possible losses” is the essence of this convention. Future is uncertain. Fluctuations and uncertainties are not uncommon. Conservatism refers to the policy of choosing the procedure that leads to understatement as against overstatement of resources and income.

Here, Dooley Manufacturing Company has decided to record the Inventory at cost or market value whichever is less. This is a convention of caution or playing safe and is adhered to while preparing financial statements.

The Company has adhered to the convention of conservatism

2.Convention of Materiality:

American Accounting Association defines the term materiality as “An item should be regarded as material if there is reason to believe that knowledge of it would influence the decision of informed investor.” It refers to the relative importance of an item or event. Materiality of an item depends on its amount and its nature.

Materiality in its essence is of relative significance. In the sense that some of the unimportant items are either left out or included with other items.

The dividing line between material and immaterial varies according to the company, the circumstances of the transactions and economic significance

Here chairs purchased by Jasper Company can be treated as part of assets, when considering their durability and span of life. But, it is not necessary to maintain separate ledgers. Such low cost items can be treated as expense for the period.

The Company has decided the material amount to $500 & therefore chairs which have been purchased for &490 have been correctly treated as an expense by the company.

3. Convention of Disclosure

This convention requires that accounting statements should be honestly prepared and all significant information should be disclosed therein. That is, while making accountancy records, care should be taken to disclose all material information. Here the emphasis is only on material information and not on immaterial information.

The purpose of this convention is to communicate all material and relevant facts of financial position and the results of operations, which have material interests to proprietor, creditors and investors.

Sometimes, there may be time gap between the preparation of Balance Sheet and its publication and if there are material events — bad debts, destruction of plant or machinery etc., which occurred in the time gap, may also be known to users proprietors, creditors etc.

Here, although the information relating to fire was material for Nogel Company but since the fire had not affected the company\' operation for the year 2011, the information is not significant & therefore the company is correct by not reporting the same in 2011 financial statements.

4.Convention of Full Disclosure

Convention of full disclosure requires that all material and relevant facts concerning financial statements should be fully disclosed. Full disclosure means that there should be full, fair and adequate disclosure of accounting information

The business provides financial information to all interested parties like investors, lenders, creditors, shareholders etc. The shareholder would like to know profitability of the firm while the creditor would like to know the solvency of the business. In the same way, other parties would be interested in the financial information according to their requirements. This is possible if financial statement discloses all relevant information in full, fair and adequate manner.

Here, although the Act Drug Company had been reporting the R&D expenditure as a lump sum but providing details for the same project wise may be more beneficial to the financial statement users and therefore the company is properly following this convention

5.Convention of consistency & disclosure

The convention of consistency means that same accounting principles should be used for preparing financial statements year after year. A meaningful conclusion can be drawn from financial statements of the same enterprise when there is comparison between them over a period of time

But this can be possible only when accounting policies and practices followed by the enterprise are uniform and consistent over a period of time. If different accounting procedures and practices are used for preparing financial statements of different years, then the result will not be comparable.

But it does not mean that a particular method of accounting once adopted can never be changed. Whenever a change in method is necessary, it should be disclosed by way of footnotes in the financial statements of that year.

In the given BRB company can change its method of Accounting for Inventories but it needs to disclose the same in its financial statements by way of a footnote.