Bobby purchased a business "Beauty Magazine" from Samuel on 1 December 2018. The purchase price of the business was agreed to be 80% of the Company's net profit in each of the next five years. Samuel was unhappy when Bobby reported the first year's net profit which was far below Samuel's expectations. The purchase agreement did not specify how "net profit" should be measured. It stated only that the net profit of the corporation should be measured in a "fair and reasonable manner". Neither Bobby nor Samuel was familiar with accounting concepts. In measuring net profit, Bobby applied the following policies: a) Revenue was recognized when cash was received from customers. Given the nature of business, most customers paid the magazine subscriptions for future delivery of magazines before December 2018. b) Expenditures for ink and paper, which were purchased weekly, were charged directly to Supplies Expense. These purchased were invoiced to Bobby family's weekly grocery bills. c) The business had purchased a $150,000 printing equipment in January 2019. It was reported as equipment expense in the first-year financial statement. d) The business also purchased a set of furniture for the reception area at $10,000 during the first year of operation. It was purchased under a big sale, featuring "No payments until 2021". Accordingly, this furniture was not in the accounts since no payment was made. REQUIRED: Comment the above profit measurement policies and state if the assets, liabilities and profits are overstated or understated in each case based on accrual accounting concepts.
Bobby purchased a business "Beauty Magazine" from Samuel on 1 December 2018. The purchase price of the business was agreed to be 80% of the Company's net profit in each of the next five years. Samuel was unhappy when Bobby reported the first year's net profit which was far below Samuel's expectations. The purchase agreement did not specify how "net profit" should be measured. It stated only that the net profit of the corporation should be measured in a "fair and reasonable manner". Neither Bobby nor Samuel was familiar with accounting concepts. In measuring net profit, Bobby applied the following policies: a) Revenue was recognized when cash was received from customers. Given the nature of business, most customers paid the magazine subscriptions for future delivery of magazines before December 2018. b) Expenditures for ink and paper, which were purchased weekly, were charged directly to Supplies Expense. These purchased were invoiced to Bobby family's weekly grocery bills. c) The business had purchased a $150,000 printing equipment in January 2019. It was reported as equipment expense in the first-year financial statement. d) The business also purchased a set of furniture for the reception area at $10,000 during the first year of operation. It was purchased under a big sale, featuring "No payments until 2021". Accordingly, this furniture was not in the accounts since no payment was made. REQUIRED: Comment the above profit measurement policies and state if the assets, liabilities and profits are overstated or understated in each case based on accrual accounting concepts.
Chapter2: Income Tax Concepts
Section: Chapter Questions
Problem 64IIP
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Please help me solve this question, thanks! It requires to comment the above profit measurement policies and state if the assets, liabilities and profits are overstated or understated in each case based on accrual accounting concepts. The answer should be more than 500 words.
Transcribed Image Text:Bobby purchased a business "Beauty Magazine" from Samuel on 1 December 2018. The
purchase price of the business was agreed to be 80% of the Company's net profit in each of
the next five years. Samuel was unhappy when Bobby reported the first year's net profit
which was far below Samuel's expectations.
The purchase agreement did not specify how "net profit" should be measured. It stated only
that the net profit of the corporation should be measured in a "fair and reasonable manner".
Neither Bobby nor Samuel was familiar with accounting concepts.
In measuring net profit, Bobby applied the following policies:
a) Revenue was recognized when cash was received from customers. Given the nature
of business, most customers paid the magazine subscriptions for future delivery of
magazines before December 2018.
b) Expenditures for ink and paper, which were purchased weekly, were charged directly
to Supplies Expense. These purchased were invoiced to Bobby family's weekly
grocery bills.
c) The business had purchased a $150,000 printing equipment in January 2019. It was
reported as equipment expense in the first-year financial statement.
d) The business also purchased a set of furniture for the reception area at $10,000 during
the first year of operation. It was purchased under a big sale, featuring "No payments
until 2021". Accordingly, this furniture was not in the accounts since no payment
was made.
REQUIRED:
Comment the above profit measurement policies and state if the assets, liabilities and profits
are overstated or understated in each case based on accrual accounting concepts.
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