University:
Michigan State University
Course:
ACC 300 | Intermediate Financial Accounting I
Academic year:

2021
Views:

285

Pages:

1
Author:

gewoekerdodx

CASE 3.2 MEASURING INCOME 30 Minutes, Strong a. Discussion of “fairness and reasonableness” of income measurement policies: (1) Given that most revenue is received in cash and that credit terms are constant, recognizing revenue on a cash basis will cause little distortion in annual results. Thus, it appears “fair and reasonable”—at least for the first two years. But we should consider that in the last (third) year of the agreement, this policy will exclude from net income credit sales in December. Stanley may expect some adjustment for this. (2) Charging weekly expenditures for business supplies directly to expense is reasonable, but considering the Morris family’s grocery and dry cleaning bills as expenses of the business is neither fair nor reasonable (nor legal). (3) Morris’s salary of $60,000 is “fair and reasonable” because it has been agreed upon by both parties. But to make additional salary payments of $90,000 per year to Morris family members who worked only on a part-time basis does not seem to meet the “fair and reasonable” criteria. (4) Income taxes on the Morris family’s salaries are personal expenses, not expenses of the business. It is neither fair nor reasonable to deduct these taxes in computing the income of the corporation. (5) It is not reasonable to report the entire $150,000 value of the equipment as an expense in the first-year income statement. This equipment will be used by the company for many years to generate revenue. By assigning the entire cost of the equipment to the first year of operations, Morris has violated the matching principle. In Chapter 4, we will see how the process of depreciation should be used to spread the cost of the printing equipment over its estimated useful life. b. The state-of-the-art printing equipment valued at $150,000 is an asset , not an expense. By reporting the equipment’s entire $150,000 value as an expense in the company’s first-year income statement, the net income computed by Morris was probably significantly lower than the net cash flow generated by the business. Case 3.2