Accounting Theory and Practice

Topics: Depreciation, Generally Accepted Accounting Principles, Income statement Pages: 9 (2282 words) Published: August 27, 2013

UNIVERSITI TENAGA NASIONAL

COLLEGE OF BUSINESS MANAGEMENT AND ACCOUNTING

DEPARTMENT OF ACCOUNTING

SUBJECT:

ACCOUNTING THEORY AND PRACTICE

PREPARE FOR:

DR.NORHAYATI MAT HUSIN

PREPARE BY:

NUR FADZILAH BT NORIZAN (AC086628)

NUR IZYAN BT MOHD ISHAK (AC086934)

NURUL AQILAH BT ZAMRI (AC085167)

THILAGA SEGARAN (AC086628)

BACHELOR IN ACCOUNTING (HONS)

CASE 1: WASTE MANAGEMENT

a)Define the matching principle and explain why it is important to users of financial statements.

Matching principle requires a company to match expenses with related revenues that they helped to generate in order to report a company's profitability. The matching is based on a cause and effect relationship. For example, sale is the cause that effect the present of the cost of goods sold expense and the sales commission expense. Other than that, expenses should be recognized when the costs can be matched to revenue that has been recorded. It is not necessarily to be recognized when the work is completed or a product is produced. The examples of situation are the advertising expense and research and development expense.

Matching principle is important to users of financial statements because the principle is the measure the profitability and performance of the company. This principle accounts for a company’s efforts (expenses) against the accomplishment (revenue) within a particular period of time. The matching principle promotes comparability which helps users evaluate the performance of the company because financial statements are periodic and this principle matched expenses and revenue in a specific time interval. According to this principle other costs not accounted are considered as assets or inventories which can later be recognized as revenues if the sales are made in future period. In other words, we recognize the expenses on the financial statements when we show the revenue that those expenses produced. In addition, compare an income statement that follows the matching principle to an income statement that does not (typically cash basis), it shows that the bottom line on a cash basis income statement is probably not very reflective of reality. For example, if all costs were incurred in the first half of the year and all revenue earned in the second half, the semi-annual income statement for the first half of the year might reflecting a loss and the second half of the year would reflect a profit. Thus, the matching principle is meant to help the users of financial statements (mainly investors) associate the numbers with reality. This helps end users to separate bottom-line from the assets of the company and distinguishing the company’s stability compare to current performance.

b)Based on the case information provided, describe specifically how Waste Management violated the matching principle.

Waste Management violate the matching principle by manipulating the salvage value of their assets to report the expenses lower than they incurred. This causes the depreciation of assets to be beyond its actual salvage value until the value of the assets is immaterial. The Matching Principle requires the depreciation expense of an asset to be recognized over its useful life so that the associated expense is recorded in the year in which related income is earned. This can be achieve by allocating the historical cost of assets over the useful life of the asset less the salvage value. The management team at Waste Management reduced the depreciation expense and making changes to the estimated useful life and salvage value of several assets thus leads to overstated of income. Matching principle is violated because the arbitrary changes made to the estimated useful lives and salvage values. The depreciation expense recognized in future years would now be unrelated to the production of income in those related future...
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