Accounting principles and assumptions with examples.

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Q1. Discuss three of the accounting principles and assumptions with examples.

 

Q2. Prepare the journal for each of the following transactions. (Marks 5)
1. On June 1, Sara invested SAR 10,000 cash in her business to start operations.
2. On June 6, Sarah purchased inventory for SAR 6,000 on credit from a supplier.
3. On June 12, Sarah purchased inventory for SAR 2,000 cash from a supplier.
4. On June 15, Sarah borrowed 15,000 from a bank.
5. On June 31, Sarah paid SAR 4,000 cash to the supplier for the inventory purchased on credit earlier in the month.
Q3. Based on the following trial balance for United Co, prepare an income statement, a statement of retained earnings, and a balance sheet. The company made no additional investments in the company during the year.

United Co.
Trial Balance
December 31
Cash SR 7,000
Accounts receivable 475
Supplies 2,500
Equipment 17,000
Accounts payable SR 1220
Common stock 10,000
Retained earnings 11,155
Dividends 36,000
Revenue earned 72,000
Supplies expense 3,400
Rent expense 6,000
Wages expense 22,000
Totals SR94,375 SR94,375

 

 

Sample Solution

Q1: Accounting Principles and Assumptions with Examples

1. Accrual Principle:

  • Concept: This principle states that revenues are recognized when earned, regardless of when cash is received, and expenses are recognized when incurred, regardless of when cash is paid.
  • Example: A company provides consulting services in July but receives payment in August. The revenue is recognized in July (when earned), even though the cash is received in August.

2. Matching Principle:

  • Concept: This principle requires matching expenses incurred to generate revenue in the same accounting period as the revenue is recognized.
  • Example: A company purchases office supplies in January and uses them throughout the year. The cost of the supplies is expensed throughout the year (as they are used) to match the expense to the revenue generated during that period.

3. Going Concern Assumption:

  • Concept: This principle assumes that a business will continue operating in the foreseeable future and will not have to liquidate its assets in the near term.
  • Example: When recording the value of a building on the balance sheet, the assumption is that the building will be used by the business for several years and not sold in the immediate future.

Q2: Journal Entries

(1) June 1st:

  • Debit: Cash (10,000)
  • Credit: Owner’s Capital (10,000)

(2) June 6th:

  • Debit: Inventory (6,000)
  • Credit: Accounts Payable (6,000)

(3) June 12th:

  • Debit: Inventory (2,000)
  • Credit: Cash (2,000)

(4) June 15th:

  • Debit: Cash (15,000)
  • Credit: Loan Payable (15,000)

(5) June 31st:

  • Debit: Accounts Payable (4,000)
  • Credit: Cash (4,000)

Q3: Financial Statements

Income Statement:

Revenue:

  • Revenue Earned – 72,000

Expenses:

  • Supplies Expense – 3,400
  • Rent Expense – 6,000
  • Wages Expense – 22,000
  • Total Expenses – 31,400

Net Income: 40,600

Statement of Retained Earnings:

  • Beginning Retained Earnings – 11,155
  • Add: Net Income – 40,600
  • Less: Dividends – 36,000
  • Ending Retained Earnings – 15,755

Balance Sheet:

Assets:

  • Cash – 7,000
  • Accounts Receivable – 475
  • Supplies – (2,500 – 3,400) = -825
  • Equipment – 17,000
  • Total Assets – 23,150

Liabilities & Equity:

  • Accounts Payable – 1,220
  • Loan Payable – 15,000
  • Common Stock – 10,000
  • Retained Earnings – 15,755
  • Total Liabilities & Equity – 41,975

Note: The ending balance of Supplies is calculated by subtracting the expense (3,400) from the beginning balance (2,500).

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