For each of the following independent situations, state which concept(s) is (are

Question

For each of the following independent situations, state which concept(s) is (are) responsible for the treatment and EXPLAIN how each concept is applied.

1. James appeared on a TV game show in December 2014. He won $25,000 in cash and a trip worth $12,000. He received a check for the cash on December 28. However, the trip did not take place until March 2015. James must report $25,000 in income for 2014 and $12,000 in 2015.

2. Nebraska Corporation receives a $12,000 bill for legal fees from its attorney in December 2015. The corporation paid the bill promptly and deducted the $12,000 as a legal expense in 2015. During the audit of its financial statements, the auditor determines that the attorney had double billed the corporation for $3,000 of expenses. The attorney agrees with the auditor and sends Nebraska a check for $3,000 in April. Nebraska must recognize $3,000 of income in 2016.

3. Liam sells stock to his sister Moira at a loss of $3,000. Liam is not allowed to deduct the $3,000 loss.

4. Layton Company purchased machinery in 2011 at a cost of $40,000. Between 2011 and 2015, Layton properly deducted $14,000 for depreciation expense on the machinery. In 2015, the machinery is sold for $20,000. Layton reports a loss of $6,000 from the sale of the machinery.

5. Student's Joy, an accrual basis corporation, owns an apartment building near a university. On August 1 it rents an apartment to Joyce for $400 per month. The terms of the rental agreement state that Joyce must pay the corporation $1,100 in August; which is the first and last month's rent and a security deposit of $300. The deposit will be returned at the end of the rental period if the apartment is clean and undamaged. The corporation must report only $800 as income.

Explanation / Answer

1. James must report $ 25,000 in income of 2014 as per the realization concept. Even though he had won the trip worth $12,000 in 2014, he did not take the trip during that year. He took the trip in 2015, and therefore the gain pertains to 2015, and not 2014. Contingent gains are not recognized as long as they are contingent following again the realization principle.

2. Since the amount is received in 2016, and the amount relates to overstatement of expenses in 2015, it is only logical that Nebraska Corporation should be cautious in recognizing the income as per the conservatism concept and the realization concept.

3. Liam is not allowed to deduct the loss because it is a related party transaction.

4. This follows from the cost concept. Historical cost was $ 40,000, and $ 14,000 depreciation expense was charged till date. Hence the book value ( unexpired portion of the cost) of the asset on the date of sale was $ 26,000. As the sale proceeds were $ 20,000, a loss of $ 6,000 has to be recognized both as per the cost and the duality concept.

5. Security deposit of $ 300 is not income, as it will be refunded at a later date, and it would be carried on the liabilities side of the balance sheet as a refundable. If however the apartment is not returned clean and undamaged on the expiry of the lease, income would be reconized by debiting the liability account. Otherwise, liability would be debited by crediting cash account.

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