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NCERT Class 11 Accountancy Chapter 2 Theory Base of Accounting
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Theory Base of Accounting
Chapter: 2
| PART – I |
| Short Answers |
1. Why is it necessary for accountants to assume that business entities will remain a going concern?
Ans: It is necessary for accountants to consider that a business entity will remain a going concern as an asset will be calculated for the profit it earns along with the depreciation it is charged, both of which are not restricted only for one accounting period. Hence, it indicates continuity in business.
2. When should revenue be recognised? Are there exceptions to the general rule?
Ans: There are some exceptions to the present general rule of revenue recognition. just in case of contracts like construction work, that take very long time, say 2-3 years to complete, proportionate quantity of revenue, supported a part of contract completed by the tip of the amount is treated as realised.
Following are the exceptions to the general Rule:
(i) Subscriptions and Memberships: Revenue from subscriptions or memberships is often recognized over the period in which the service is provided.
(ii) Sales with Right of Return: If a seller offers a right of return, revenue is recognized based on the expected returns, which requires estimating returns and deducting them from gross sales.
(iii) Contingent Revenue: Revenue contingent on future events (such as performance milestones) is recognized when those events occur.
3. What is the basic accounting equation?
Ans: The duality principle is commonly expressed in terms of fundamental Accounting Equation, which is as follows:
Assets = Liabilities + Capital In other words, the equation states that the assets of a business are always equal to the claims of owners and the outsiders. The claims also called equity of owners is termed as Capital(owners’ equity) and that of outsiders, as Liabilities(creditors equity). The two-fold effect of each transaction affects in such a manner that the equality of both sides of equation is maintained. The two-fold effect in respect of all transactions must be duly recorded in the book of accounts of the business.
4. The realisation concept determines when goods sent on credit to customers are to be included in the sales figure for the purpose of computing the profit or loss for the accounting period. Which of the following tends to be used in practice to determine when to include a transaction in the sales figure for the period.
When the goods have been:
(i) Dispatched.
(ii) Invoiced.
(iii) delivered.
(iv) Paid for.
Give reasons for your answer.
Ans: (i) Dispatched: “Dispatch of stock” and “issue” are two terms that are commonly used in the context of inventory management and stock trading. Dispatch of stock refers to the process of sending out or shipping products from a company’s inventory to a customer or a retail store. In shipping, the term “dispatch” typically refers to the process of sending goods or products to their intended destination. It involves a series of steps, including preparing the goods for shipment, coordinating transportation, and arranging for the delivery of the goods to the recipient.
(ii) Invoiced: An invoice is an itemised commercial document that records the products or services delivered to the customer, the total amount due, and the preferred payment method. The seller can send either paper or electronic invoices to the customer.
(iii) Delivered: Delivery is the process of transporting goods from a source location to a predefined destination.
(iv) Paid for: When a customer submits a payment on an account, your bookkeeper makes a journal entry of the amount and the transaction is considered “paid on account.” This simply means the customer has made a payment – which goes in the accounts receivable ledger – on the full amount owed.
| Long Answers |
1. ‘The accounting concepts and accounting standards are generally referred to as the essence of financial accounting’. Comment.
Ans: Accounting standards are written policy documents covering the aspects of recognition, measurement, treatment, presentation and disclosure of accounting transactions in financial statements. Accounting standard is an authoritative statement issued by ICAI, a professional body of accounting in our country. The objective of the accounting standard is to bring uniformity in different accounting policies in order to eliminate non comparability of financial statements for enhancing reliability of financial statements. Secondly, the accounting standard provides a set of standard accounting policies, valuation norms and disclosure requirements. In addition to improving credibility of accounting data, accounting standard enhances comparability of financial statements, both intra and inter enterprises. Such comparisons are very effective and widely used for assessment of firms’ performance by the users of accounting.
The basic accounting concepts are referred to as the fundamental ideas or basic assumptions underlying the theory and practice of financial accounting and are broad working rules for all accounting activities and developed by the accounting profession.
The important concepts have been listed as below:
(i) Business entity.
(ii) Money measurement.
(iii) Going concern.
(iv) Accounting period.
(v) Cost.
(vi) Dual aspect (or Duality)
(vii) Revenue recognition (Realisation).
(viii) Matching.
(ix) Full disclosure.
(x) Consistency.
(xi) Conservatism (Prudence).
(xii) Materiality.
(xiii) Objectivity.
2. Why is it important to adopt a consistent basis for the preparation of financial statements? Explain.
Ans: According to the consistency principle, accounting practices once selected should be continued over a period of time (i.e. years after years) and should not be changed very frequently. These help in a better understanding of the financial statements and thus make comparisons easy. The word ‘generally’ means ‘in a general manner’, i.e., pertaining to many persons or cases or occasions. Thus, Generally Accepted Accounting Principles (GAAP) refers to the rules or guidelines adopted for recording and reporting of business transactions, in order to bring uniformity in the preparation and the presentation of financial statements. For example, one of the important rule is to record all transactions on the basis of historical cost, which is verifiable from the documents such as cash receipt for the money paid. This brings in objectivity in the process of recording and makes the accounting statements more acceptable to various users.
(i) Comparabilit: Information system principle that prescribes an accounting system to conform with ta company’s activates, personnel, and structure. Compatibility principle suggests that we design an accounting system that will work with the resources we have.
(ii) Reliability and Transparency: It means there is transparency and reliability in financial statement through combination of accounting standards, corporate governance practices, internal control functions, external control enforcement and ethical conducts and practices in the organisations.
(iii) Decision-Making: Decision making is the process of making choices by identifying a decision, gathering information, and assessing alternative resolutions. Using a step-by-step decision-making process can help you make more deliberate, thoughtful decisions by organising relevant information and defining alternatives.
3. Discuss the concept-based on the premise ‘do not anticipate profits but provide for all losses’.
Ans: The concept of conservatism (also called ‘prudence’) provides guidance for recording transactions in the book of accounts and is based on the policy of playing safe. The concept states that a conscious approach should be adopted in ascertaining income so that profits of the enterprise are not overstated. If the profits ascertained are more than the actual, it may lead to distribution of dividend out of capital, which is not fair as it will lead to reduction in the capital of the enterprise. The concept of conservatism requires that profits should not to be recorded until realised but all losses, even those which may have a remote possibility, are to be provided for in the books of account. To illustrate, valuing closing stock at cost or market value whichever is lower; creating provision for doubtful debts, discount on debtors; writing of intangible assets like goodwill, patents, etc. from the book of accounts are some of the examples of the application of the principle of conservatism : This concept requires that business transactions should be recorded in such a manner that profits are not overstated. All anticipated losses should be accounted for but all unrealised gains should be ignored.
4. What is matching concept? Why should a business concern follow this concept? Discuss.
Ans: The matching concept, implies that all revenues earned during an accounting year, whether received during that year, or not and all costs incurred, whether paid during the year, or not should be taken into account while ascertaining profit or loss for that year.
The process of ascertaining the amount of profit earned or the loss incurred during a particular period involves deduction of related expenses from the revenue earned during that period.The accounting records are made in the book of accounts from the point of view of the business unit and not that of the owner. The personal assets and liabilities of the owner are, therefore, not considered while recording and reporting the assets and liabilities of the business. Similarly, personal transactions of the owner are not recorded in the books of the business, unless it involves inflow or outflow of business funds. The matching concept emphasises exactly on this aspect. It states that expenses incurred in an accounting period should be matched with revenues during that period. It follows from this that the revenue and expenses incurred to earn these revenues must belong to the same accounting period.
5. What is the money measurement concept? Which one factor can make it difficult to compare the monetary values of one year with the monetary values of another year?
Ans: The concept of money measurement states that only those transactions and happenings in an organisation which can be expressed in terms of money such as sale of goods or payment of expenses or receipt of income, etc., are to be recorded in the book of accounts. All such transactions or happenings which can not be expressed in monetary terms, for example, the appointment of a manager, capabilities of its human resources or creativity of its research department or image of the organisation among people in general do not find a place in the accounting records of a firm. Another important aspect of the concept of money measurement is that the records of the transactions are to be kept not in the physical units but in the monetary unit.
One factor that can make it difficult to compare the monetary values of one year with another is inflation. Inflation refers to the general increase in prices and the decrease in the purchasing power of money over time. If inflation rates differ significantly between two periods, the monetary values from different years may not be directly comparable without adjusting for the effects of inflation. Failure to account for inflation can distort financial analysis and decision-making based on historical financial data. The money measurement assumption is not free from limitations. Due to the changes in prices, the value of money does not remain the same over a period of time. The value of rupee today on account of rise in prices is much less than what it was, say ten years back. Therefore, in the balance sheet, when we add different assets bought at different points of time, say building purchased in 1995 for ` 2 crore, and plant purchased in 2005 for ` 1 crore, we are in fact adding heterogeneous values, which can not be clubbed together. As the change in the value of money is not reflected in the book of accounts, the accounting data does not reflect the true and fair view of the affairs of an enterprise.
