Detailed, Step-by-StepChapter 2 Theory Base of Accounting Questions and Answers were solved by Expert Teachers as per NCERT (CBSE) Book guidelines covering each topic in chapter to ensure complete preparation.
Theory Base of Accounting NCERT Solutions for Class 11 Accountancy Chapter 2
Theory Base of Accounting Questions and Answers Class 11 Accountancy Chapter 2
Test Your Understanding – I
Choose the Correct Answer.
During the lifetime of an entity accounting produce financial statements in accordance with which basic accounting concept:
(c) Accounting period
(d) None of the above
(c) Accounting period
When information about two difference enterprises have been prepared presented in a similar manner the information exhibits the characteristic of:
(d) None of the above
(d) None of the above
A concept that a business enterprise will not be sold or liquidated in the near future is known as :
(a) Going concern
(b) Economic entity
(c) Monetary unit
(d) None of the above
(a) Going concern
The primary qualities that make accounting information useful for decision-making are :
(a) Relevance and freedom from bias
(b) Reliability and comparability
(c) Comparability and consistency
(d) None of the above
(b) Reliability and comparability.
Test Your Understanding – II
Fill in the correct word :
1. Recognition of expenses in the same period as associated revenues is called ……….. concept.
2. The accounting concept that refers to the tendency of accountants to resolve uncertainty and doubt in favour of understating assets and revenues and overstating liabilities and expenses is known as ………………
3. Revenue is generally recognised at the point of sale denotes the concept of ………………
4. The ……………… concept requires that the same accounting method should be used from one accounting period to the next.
5. The ………………. concept requires that accounting transaction
3. Revenue Realisation
Short Answer Type Questions
Why is it necessary for accountants to assume that business entity will remains a going concern.
The Going Concern Concept – The Going Concern Concept holds that a business shall continue for an indefinites period and there is no intention to close the business or reduce its size significantly. It is because of this concept that distinction is made between expenditure that will render benefit for a long period and that whose benefit will be exhausted quickly, say, within the year. Of course, if it is certain that the business will exist only for a limited time, the accounting recordwill keep the expected life in view.
On the basis of this assumption; fixed assets are recorded at their original cost and are depreciated in a systematic manner without reference to their market value. An example would be purchase of machinery which would last, say, for the next 10 years. The cost of machinery would be spread on a suitable basis over the next year for ascertaining the profit or los? of each year.
The full cost of the machine would not be treated as an expense in the year itself. In brief, an enterprise is said to be a going concern when there is neither the intention nor the necessity to wind up its affairs or curtail substantially the scale of its operation. In other words, it would continue to operate at its present scale in the foreseeable future.
When should revenue be recognised. Are there exceptions to the general rule.
Meaning of Revenue- Revenue is the gross inflow of cash, receivables or other considerations arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by other of enterprise resources yielding interest, royalties and dividends.
Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.
Meaning of revenue recognition – Revenue recognition means identifying the revenues for a particular accounting period. Revenue recognition is mainly concerned with the timing of recognition of revenue in the statement of profit and loss of an enterprise. The amount of revenue arising on a transaction is usually determined by agreement between the parties involved in the transaction. When uncertainties exist regarding the determination of the amount, or its associated costs, these uncertainty may influence the timing of revenue recognition.
Specific Requirements of AS-9 issued by ICAI – The specific requirements of AS-9 issued by the Institute of Chartered
Accountants of India are as follows :
1. Regarding recognition of revenue from sales – Revenue from sale should be recognised when the following requirements as to performance are satisfied provided that at the time of performance it is not unreasonable to expect ultimate collection.
In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled :
- The seller of goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership; and
- No significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.
2. Regarding recognition of revenue from service transaction –
Revenue from service transactions should be recognised when the following requirements are satisfied provided that at the time of performance, it is not unreasonable to expect ultimate collection that at the time of performance, it is not unreasonable to expect ultimate collection.
In a transaction involving the rendering of services, performance should be measured either under the completed service contract method or under the proportionate completion method, whichever relates to the revenue to the work accomplished. Such performance should be regarded as being achieved when no significant uncertainty exists regarding the amount of the consideration that will be derived from rendering the service.
Completed service contract method is a method of accounting which recognises revenue in the statement of profit and loss only when the rendering of services under a contract is completed or substantially completed.
Proportionate completion method is a method of accounting which recognises revenue in the statement of profit and loss proportionately with the degree of completion of services under a contract.
3. Regarding postponement of revenue recognition – If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.
4. Regarding recognition of revenue arising from the use by other of enterprise resources – Revenue arising from the use by others of enterprise resources yielding interest, royalties and dividends should only be recognised when no significant uncertainty as to measurability or collectability exists. These revenues are recognised on the following bases:
- Interest – On a time proportion basis taking into account the amount outstanding and the rate applicable.
- Royalties – On an accrual basis in accordance with the terms of the relevant agreement.
- Dividends from Investments in shares – When the owner’s right to receive payment is established.
Regarding disclosure – In addition to the disclosures required by Accounting Standard-1 on Disclosure of Accounting Policies (AS-1), an enterprise should also disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties.
What is the basis of accounting equation?
Meaning of Accounting Equation – Accounting equation is based on dual aspect concept. In the dual aspect concept, every business transaction has a two-sided effect that is on the assets and also claims on assets.
The total claims (those of creditors & proprietor’s capital) will equal the total assets of the firm.
The claims known as equities:3
(a) Owner’s capital or equity, and
(b) Liabilities or amounts due to oysteries.
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 :
(d) Paid for
The Revenue or Realisation Principle – The Revenue of Realisation Principle holds that revenue is considered to have been realised when either in cash or the form of legal obligation to receive the amount has been established. It is to be noted that recognizing revenue and receipt of amount are two separate aspects. Let us understand it with the help of an example. An enterprise sells goods in February 2009 and receives the amount for it in April 2009.
Revenue of this sale shall be recognised in February 2-009, i.e., when the goods are sold. It is so because a legal obligation has been established (upon sale) in February 2009. Taking another example, if an enterprise has received advance in March 2009 for the sale to be made in May 2009, revenue shall be recognised in May 2009, upon sale having been made. (Option B) Invoiced of the goods sent on credit to customer are to be included in the sales figure.
Complete the following work sheet:
(i) If a firm believes that some of its debtors may ‘default’, it should act on this by making sure that all possible losses
(ii) The fact that a business is separate and distinguishable
(iv) The concept states that if straight line method of
depreciation is used in one year, then it should also be used in the next year.
(v) A firm may hold stock which is heavily in demand. Consequently, the market value of this stock may be
increased. Normal accounting procedure is to ignore this because of the
(vi) If a firm receives an order for goods, it would not be included in the sales figure owing to the
(vii) The management of a firm is remarkably incompetent, but the firms accountants cannot take this into account while preparing book of accounts because of concept.
(i) Conservation (Prudence)
(ii) Business Entity or Separate Entity
(iii) Dual Aspect
(vii) Money Measurement.
Long Answer Type Questions
The accounting concepts and accounting standards are generally referred to as the essence of financial accounting. Comment.
The accounting concepts or assumptions are basic assumptions or fundamental prepositions concerning the economic, political and sociological environment within which accounting must operate.
They are generally accepted set of accounting rules important to follow the generally accepted accounting rules because it will enable the user to understand the financial position of the enterprise better, which otherwise would be impossible. Accounting concepts have been defined as follows :
- The Going Concern Concept
- The Accrual Concept
- The Business or Accounting Entity Concept,
- The Money Measurement Concept, and
- The Accounting Period Concept.
Going Concern Assumption – It is also know as continuity assumption. According to this assumption, the enterprise is normally viewed as a going concern, that is, continuing in N operation for the foreseeable future. It is assumed that the enterprise has neither the intention nor the necessity of liquidation
or of curtailing materially the scale of its operations.
It is because of the going concern assumptions :
- That the assets are classified as current assets and fixed assets.
- The liabilities are classified as short-term liabilities and long term liabilities.
- The unused resources are shown as unutilized costs (or unexpired costs) as against the break-up values as in case of liquidating enterprise. Accordingly, the earning power and not the break-up value evaluates the continuing enterprise.
The Accrual Concept – The Accrual Concept holds that a transaction is recorded at the time when it has taken place and not when the settlement in cash takes place. The concept is particularly important because it recognises the assets, liabilities, incomes and expenses as and when the transactions relating to it are entered into. Under this concept, profit is regarded as earned at the time the goods or services are sold to the customer, i.e., legal title is passed to the customer who, in turn, has an obligation to pay for them.
Similarly, expense is regarded as spent when the goods or services are purchased and an obligation to pay for them has been assumed. For example, Puneet has worked for the month and thus, salary becomes due to him at the month end, which should be recorded in the books of account.
The Business or Accounting Entity Concept-The Business or Accounting entity Concept holds that business is separate from its owners. Transactions, therefore are recorded from the view point of business. The owners being considered separate from business, they are treated as creditors to the extent of their capital. Their account with the business entity is credited or debited when capital is introduced by them or drawings is made.
The Business or Accounting Entity Concept is an useful concept and from it has developed what may be called responsibility accounting. It has made possible to ascertain the results of operations of each department or division of an enterprise.
Money Measurement Assumption – According to this assumption. Only those transactions which are capable of being expressed in term of money are included in the accounting records. In other words, the information which cannot be expressed in terms of money is not included in accounting records. For example, if the sales director is not on speaking terms with the production director, the enterprise is bound to suffer.
Since, monetary measurement of this informations is not possible this fact is not recorded in accounting records. By expressing all transaction in terms of money, the different transactions expressed in different units are brought to a common unit of measurement (i.e., Money). Besides ignoring the non-monetary facts or attributes, this assumption also ignores the changes in the purchasing power of the monetary unit.
In other words, this assumption treats all rupees alike, whether it is a rupee of 1950 or 1999. Hence, now a days, it is considered to provide additional data showing the effect of price level changes on the reported income, assets and liabilities of the business.
The Accounting Period Concept – The accounts of an enterprise are maintained following the Going Concern Concept, i.e., assuming that the business shall continue to operate for an indefinite period. Thus, the period up to which the enterprise will continue to operate and thereafter preparing the accounts become meaningless to the users.
Thus, the life of the ‘enterprise is divided into time intervals termed ‘Accounting Period’, which usually is the ope year. The Accounting Period Concept is important as the users of accounting information can make an assessment of the enterprise at regular intervals.
Why is it important to adopt a consistent basis for the preparation of financial statements? Explain.
Consistency Principle – According to this principle, whatever accounting practices (whether logical or not) are selected for a given category of transactions, they should be followed on horizontal basis from one accounting period to another to achieve compatibility, for instance, if the inventory on LIFO basis, should be followed year after year and if a particular asset is depreciated according to WDV method, this method should be followed year after year.
If this principle of consistency is not followed, the intra-firm comparison (i.e., comparison of actual figures of one period with those of another period for the same firm), Inter-firm comparison (i.e., comparison of actual figures of one firm with those of another firm belonging to the same industry) and Pattern comparison-(i.ei, comparison of actual figures of one firm with those of industry to. which the firm belongs) cannot be made.
The consistency should not be confused with mere uniformity or inflexibility and -should not be allowed to become an impediment to the introduction of improved accounting standards. It is not appropriate for an enterprise to leave its accounting policies unchanged when more relevant and reliable alternatives exist.
The user should be informed of the accounting policies employed in the preparation of the financial statements, any change in these policies and the effects of such changes. However, consistency does not prohibit change in accounting policies, such changes which are necessary can be made provided these are fully disclosed while presenting the financial statements and preferable also their effect on the results.
Discuss the concept based on the premise “do not anticipate profits provide for all losses”.
The prudence or conservatism concept provide the premise that do not anticipate a profit but provide for all possible losses. The Prudence (Conservation) Principle – The Prudence Principle is many a times described using the phrase “Do not anticipate a profit, and provide for all possible losses”.
The application of this principle ensures that the financial statements present a realistic picture of the state of affairs of the enterprise. In other words, the financial statements do not paint a better picture than what actually is and window dressing of financial statements is avoided.
In effect, the profit should be recognised when it is reasonable sure that it shall be realised and all known liabilities should be accounted for. It is because of this principle that provision is made for doubtful debts, when it is likely that a part of debtors shall not be realised. Similarly, closing stock is values at lower of cost or market value.
It is to be noted that this is an overriding principle over all other principles and whenever there is a clash on application of this principle with any other principle, principle of prudence shall prevail. For example, under the realisation principle, revenue is recognised as soon- as the title of goods is passed to the buyer, i.e., obligation to pay is established. But, it is likely that the amount shall not recovered, partly or fully.
The prudence principle holds that the unrecoverable amount be written off. This principle may be reflecting a generally pessimist attitude adopted by the accountants but is an important way of dealing with uncertain and protecting the interests of creditors against an unwanted distribution of firm’s assets. However, deliberate attempt to underestimate the value of assets should be discouraged as it will lead to hidden profit, called secret reserves.
What is matching concept? Why should a business concern follow this concept?
The Matching Principle – The Matching Principle is based on the accrual system.of accounting and related to revenue or realisation principle. In the revenue or realisation principle, revenue is recognised as realised when amount is realised in cash or in the form of legal obligation to receive the amount is established. The matching principle requires that costs be associated with the revenues for the period. The effect of matching principle may. broadly be as follows :
(a) Revenue item, when entered in the Profit and Loss Account all costs, whether paid or not, should be set out on the expense side.
(b) A cost incurred, against which revenue will be earned in the following period should be carried forward to Balance Sheet as an asset to be treated as expense in the period of revenue. Therefore, it becomes necessary to provide for outstanding and prepaid expenses for period costs.
The concept emphasises that expenses incurred in an accounting period should be method with revenue during that period. Revenue is recognised when a sale is completed or service is rendered rather when cash is received. Similarly an expense is recognised not only when cash is paid out but when an asset or service has been used to generate revenue.
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.
What is the money measurement concept? Which one factor can make it difficult to compare the monetary value of one year with the monetary value of another year?
The Money Measurement Concept – The Money Measurement Concept holds that transactions and events that can be expressed in monetary terms are recorded. In other words, accounting has money as the common denomination in recording and reporting all transactions.
The transactions and events howsoever important they may be, that cannot be measured iii monetary terms such as quality or loyalty of employees of the enterprise, increased competition due to new products or new enterprises are not recorded in accounting. Thus, accounting cannot give a complete state of affairs of the enterprise.
The 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 for example an organisation may, on a particular day, have a factory on a price of land measuring 4 acres, office building containing 15 rooms, 35 personal computers, 50 office chairs and tables a bank balance of Rs. 10 Lakh, raw material of 30 tonnes and 120 containers of finished stock cannot be added to give any meaningful information about the local worth of the business unless and until expressed in monetary value, i.e., rupees.
Money measurement concept is not free from limitations. Because of 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 was, say ten years back. As change in the value of money is not reflected in the books of accounts, the accounting data does not reflect the true and fair view of the affairs of an organisation.