b) Each of the situations below may illustrate a violation of an accountingassumption or principle. Indicate the assumption or principle that is most clearlyviolated and briefly explain what should have been done to avoid the violation.(10 marks)1. Mobile Saver has 20,000 Model 44G cell phones in inventory at a cost of Sh 6,400each. Due to the advancement of technology and newer models available, only 4 ofModel 44G phones were sold last month. To avoid recognizing a loss on writing offthis inventory, Mobile Saver has decided not to issue financial statements until atleast half of the remaining Model 44G phones have been sold.2. Hodari Peter, owner of Hodari Devices, took an iPod Touch out of inventory to useas a birthday present for his son. The cost was debited to Supplies Expense.3. Wilson Traders made no entry to record depreciation on its equipment for 2016.4. Owners invested an additional Sh 43,000 cash in the business in 2016. Thisinvestment was reported as revenue on the 2016 income statement.5. Baby Toys Company is being liquidated because it has sustained losses for the pastfew years. It continues to depreciate its assets and prepare financial statements onthe cost basis
Question
b) Each of the situations below may illustrate a violation of an accountingassumption or principle. Indicate the assumption or principle that is most clearlyviolated and briefly explain what should have been done to avoid the violation.(10 marks)1. Mobile Saver has 20,000 Model 44G cell phones in inventory at a cost of Sh 6,400each. Due to the advancement of technology and newer models available, only 4 ofModel 44G phones were sold last month. To avoid recognizing a loss on writing offthis inventory, Mobile Saver has decided not to issue financial statements until atleast half of the remaining Model 44G phones have been sold.2. Hodari Peter, owner of Hodari Devices, took an iPod Touch out of inventory to useas a birthday present for his son. The cost was debited to Supplies Expense.3. Wilson Traders made no entry to record depreciation on its equipment for 2016.4. Owners invested an additional Sh 43,000 cash in the business in 2016. Thisinvestment was reported as revenue on the 2016 income statement.5. Baby Toys Company is being liquidated because it has sustained losses for the pastfew years. It continues to depreciate its assets and prepare financial statements onthe cost basis
Solution
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The principle violated by Mobile Saver is the Principle of Periodicity. According to this principle, an entity should prepare its financial statements at regular intervals. To avoid this violation, Mobile Saver should have recognized the loss on the inventory and issued the financial statements regardless of whether the phones were sold or not.
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Hodari Peter violated the Business Entity Principle. This principle states that business transactions should be kept separate from the personal transactions of the owners. To avoid this violation, the cost of the iPod Touch should have been recorded as a withdrawal of owner's equity, not as an expense.
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Wilson Traders violated the Matching Principle. This principle requires that expenses be matched with revenues in the period they are incurred, not when paid. To avoid this violation, Wilson Traders should have recorded depreciation on its equipment for 2016.
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The principle violated here is the Revenue Recognition Principle. This principle states that revenue should be recognized when it is earned, not when received. To avoid this violation, the additional investment should have been recorded as an increase in owner's equity, not as revenue.
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Baby Toys Company violated the Going Concern Principle. This principle assumes that a business will continue to operate indefinitely. To avoid this violation, Baby Toys Company should have stopped depreciating its assets and prepared its financial statements on a liquidation basis, not on a cost basis.
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