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Accounting Principles: Corrections using GAAP

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Presented below are a number of business transactions that occurred during the current year for Fresh Horses, Inc.

Instructions

In each of the situations, discuss the appropriateness of the journal entries in terms of generally accepted accounting principles.
(a) The president of Fresh Horses, Inc. used his expense account to purchase a new Suburban solely for personal use. The following journal entry was made.

Miscellaneous Expense 29,000
Cash 29,000

(b) Merchandise inventory that cost $620,000 is reported on the balance sheet at $690,000, the expected selling price less estimated selling costs. The following entry was made to record this increase in value.

Merchandise Inventory 70,000
Revenue 70,000

(c) The company is being sued for $500,000 by a customer who claims damages for personal injury apparently caused by a defective product. Company attorneys feel extremely confident that the company will have no liability for damages resulting from the situation. Nevertheless, the company decides to make the following entry.

Loss from Lawsuit 500,000
Liability for Lawsuit 500,000

(d) Because the general level of prices increased during the current year, Fresh Horses, Inc. determined that there was a $16,000 understatement of depreciation expense on its equipment and decided to record it in its accounts. The following entry was made.

Depreciation Expense 16,000
Accumulated Depreciation 16,000

(e) Fresh Horses, Inc. has been concerned about whether intangible assets could generate cash in case of liquidation. As a consequence, goodwill arising from a purchase transaction during the current year and recorded at $800,000 was written off as follows.

Retained Earnings 800,000
Goodwill 800,000

(f) Because of a "fire sale," equipment obviously worth $200,000 was acquired at a cost of $155,000.
The following entry was made.

Equipment 200,000
Cash 155,000
Revenue 45,000

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Solution Summary

The solution presents a rationale for a correction to a proposed journal entry and cites the generally accepted accounting principles that prevails. This solution is 181 words.

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(a) The purchase of a personal asset is a loan to a shareholder and not a business expense at all. If not a loan, it is a distribution (decapitalization) from the company. Matching principle says no expense.

(b) Don't make the entry at all. Inventory ...

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