Reference no: EM13948513

Generally accepted modified accrual accounting practices pertaining to inventories may not fulfill the objectives of financial reporting. (80 points)

Scenario.
The following is an excerpt from a note to the financial statements of the city of Dallas (dates changed):

Serial #	Journal Entries	Debit	Credit
1	Supplies on Hand	$30,000
	Supplies on Hand Expense		$30,000
	To record supplies on hand
2	No entry for supplies on order
3	No entry for supplies on order
4	Supplies	$185,000
	Cash		$185,000
	To record purchase of supplies
5	Supplies Expense	$178,000
	Supplies		$178,000
	To record consumption of supplies

 The city prepares its annual appropriated general fund, debt service fund, and proprietary operating funds budgets on a basis (budget basis) which differs from generally accepted accounting principles (GAAP basis). The major differences between the budget and GAAP bases are that encumbrances are recorded as the equivalent of expenditures (budget) rather than a commitment of fund balance (GAAP) in the governmental funds.

The city accounts for inventories on the purchases basis. One of the city's departments, which is accounted for in the general fund, budgeted $195,000 in supplies expenditures for fiscal 2015. It began the 2015 fiscal year with $30,000 of supplies on hand. It also had $12,000 of supplies on order. During the year it ordered an additional $180,000 of supplies, received (and paid for in cash) $185,000 of supplies, and consumed $178,000 of supplies.

Instructions:

1. Prepare all journal entries, consistent with GAAP, including budgetary and encumbrance entries that the department should make in 2015.

2. Indicate the accounts and amounts related to supplies that the city would report on its year-end statement of revenues, expenditures, and changes in fund balance and balance sheet.

3. By how much did the department over- or under-spend its supplies budget (on a budget basis)?

4. Comment on the extent to which the city's statement provides a basis to:

     1. Assess the ''true'' economic costs associated with supplies

     2. Determine whether the city adhered to budgetary spending mandates

5. Suppose that in the last quarter of the year, department officials realized that the department was about to overspend its supplies budget. They therefore ceased placing new orders for supplies. However, they imposed no restrictions on the use of supplies and thereby allowed the supplies inventory to decline to near zero.

     1. What impact would these cost-cutting measures have on supplies expenditures as reported in an actual-to budget comparison (on a budget basis)?

     2. What impact would the year-end measures have on reported supplies expenditures (per GAAP)? Would your response be different if the city accounted for supplies on the consumption basis?