Ch_02

Ch_02 - CHAPTER 2 BALANCE SHEET: PRESENTING THE INVESTMENTS...

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2-1 Solutions CHAPTER 2 BALANCE SHEET: PRESENTING THE INVESTMENTS AND FINANCING OF A FIRM Questions, Short Exercises, Exercises, Problems, and Cases: Answers and Solutions 2.1 See the text or the glossary at the end of the book. 2.2 Based on the conservatively reported earnings, a shareholder might sell shares of stock based on the assessment that the firm is not performing well. If the economic or "true" earnings of the firm are larger, the shareholder's assessment would result in a poor decision. Alternatively, shareholders might dismiss the management of a firm because they feel the firm is not performing well. It should be emphasized here that the principal objective of accounting reports as currently prepared is to present fairly the results of operations and the financial condition of the firm. When doubt exists as to the treatment of a particular item or transaction, accountants tend to select the procedure resulting in the more conservative measurement of earnings. 2.3 The justification relates to the need for a reasonably high degree of reliability in the preparation of the financial statements. When there is an exchange between a firm and some other entity, there is market evidence of the economic effects of the transaction. The independent auditor verifies these economic effects by referring to contracts, cancelled checks and other documents underlying the transaction. If accounting recognized events without such a market exchange (for example, the increase in market value of a firm's assets), increased subjectivity would enter into the preparation of the financial statements. 2.4 The justification relates to the uncertainty as to the ultimate economic effects of the contracts. One party or the other may pull out of the contract. The accountant may not know the benefits and costs of the contract at the time of signing. Until one party or the other begins to perform under the contract, accounting gives no recognition. Accountants often disclose significant contracts of this nature in the notes to the financial statements. 2.5 Accountants record assets at acquisition cost. Cash discounts reduce acquisition cost and, therefore, the amount recorded for merchandise or equipment.
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Solutions 2-2 2. 6a . The contract between the investors and the construction company as well as cancelled checks provide evidence as to the acquisition cost. b. Adjusted acquisition cost differs from the amount in Part a. by the portion of acquisition cost applicable to the services of the asset consumed during the first five years. There are several generally accepted methods of computing this amount (discussed in Chapter 8). A review of the accounting records for the office building should indicate how the firm calculated this amount.
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Ch_02 - CHAPTER 2 BALANCE SHEET: PRESENTING THE INVESTMENTS...

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