All questions of Unit 2: Accounting Concepts, Principles And Conventions for CA Foundation Exam

When we have to receive something from any other person it becomes an asset for the receiving person. Liability will be one when something is due to be paid to an outsider. Expense is the outflow of economic resources to earn the specified revenue. Capital is the sum provided by the owner for investment purposes in a business.

The going concern concept is a fundamental principle of accounting. It assumes that during and beyond the next fiscal period a company will complete its current plans, use its existing assets and continue to meet its financial obligations

Increase in Asset and Increase in Liability

When a proprietor brings in capital, it is considered as an investment in the business. This investment increases the assets of the business while also creating a liability to the proprietor. The following points explain why capital brought in by the proprietor is an example of an increase in asset and an increase in liability:

Increase in Asset:

- The capital brought in by the proprietor is a cash injection into the business. This cash is considered an asset of the business as it can be used to purchase other assets such as equipment, inventory or property.
- The cash injection also increases the overall value of the business, which is reflected in the balance sheet as an increase in assets.

Increase in Liability:

- The capital brought in by the proprietor creates a liability to the business as well. The business now owes the proprietor the amount of capital invested.
- This liability is recorded in the balance sheet as an increase in liabilities.

Overall, the capital brought in by the proprietor is an example of an increase in asset and an increase in liability since it increases the value of the business while also creating a debt to the proprietor.

The concept of going concern treats the life of the business as indefinite i.e. the business life will consist of many accounting periods. Those assets benefit of which is received in one accounting year itself are current assets and those whose benefit extends to more than one accounting period are called fixed assets. Existence of more than one accounting period is supported by going concern concept only.

Amortization of intangible assets means charging a reasonable portion of the asset on a product basis to the revenue of that year. This is done as per the Matching Concept. Matching Concept states that all expenses matched with the revenue of that period should only be taken into consideration. Amortization is treated as an expense of that particular year. In the financial statements of the organization if any revenue is recognized then expenses related to earn that revenue should also be recognized.

Adjustments for Prepaid Expenses

Prepaid expenses refer to expenses that have been paid in advance but the benefits of which are yet to be realized. Thus, at the end of an accounting period, adjustments need to be made to account for these expenses.

The adjustments to be made for prepaid expenses are as follows:

Deduct Prepaid Expenses from Respective Expenses

The adjustment for prepaid expenses involves deducting the prepaid amount from the respective expenses and showing it as an asset. This adjustment is necessary because the amount of the prepaid expense has already been paid, and it is not an expense that needs to be recognized in the current period.

For example, if a company has paid $12,000 for rent for the next 12 months in advance, this amount will be recorded as a prepaid rent expense. At the end of each month, the company will deduct $1,000 (the amount of rent for that month) from the prepaid rent expense and show it as an asset.

This adjustment is made to ensure that the expenses are accurately reflected in the financial statements, and it also helps in determining the true profitability of the business.

Conclusion

In conclusion, the adjustment for prepaid expenses involves deducting the prepaid amount from the respective expenses and showing it as an asset. This adjustment helps in accurately reflecting the expenses in the financial statements and determining the true profitability of the business.

The likely amount of the discount to be allowed is debited to the Profit and Loss Account and credited to the Provision for Conservatism Discount Account. The balance in the latter account is deducted from book debts (Debtors) in the Balance Sheet and is carried forward to the next year.

Disbursement is the act of paying out or disbursing money. Examples of disbursements include money paid out to run a business, cash expenditures, dividend payments, the amounts that a lawyer might have to pay out on a person's behalf in connection with a transaction, etc.

Here cost concept is violating because there is a principle while preparing annual accounts the market value or cost price whichever is less that should be considered and here Alfha ltd.consider market value which is more than cost value

Consistency Concept in Comparing Financial Statements

The consistency concept is a fundamental accounting principle that requires businesses to use the same accounting methods and procedures from period to period. This concept ensures that financial statements are comparable across different accounting periods, allowing users to make meaningful comparisons and draw accurate conclusions about a company's financial performance.

Explanation:

When the consistency concept is followed, financial statements can be compared meaningfully. The consistency concept requires that a company uses the same accounting policies and procedures in each accounting period. This means that the same methods of recording transactions, valuing assets and liabilities, and presenting financial information must be used consistently over time.

If a company changes its accounting policies or procedures from one period to the next, the financial statements become incomparable. Any differences in the financial statements may not be due to changes in the company's performance, but rather due to differences in accounting methods. As a result, users of financial statements cannot accurately compare the company's performance over time.

For example, if a company changes its method of depreciating its assets from the straight-line method to the declining balance method, the financial statements for the current period will not be comparable to those of the previous period. The change in depreciation method will affect the amount of depreciation expense recorded, which could have a significant impact on the company's reported profits.

Conclusion:

In conclusion, the consistency concept is crucial for ensuring that financial statements are comparable across different accounting periods. This allows users to make informed decisions based on the financial statements and draw accurate conclusions about a company's financial performance. Therefore, comparing financial statements of one accounting period with that of another accounting period is possible only when the consistency concept is followed.

The conservatism principle is the general concept of recognizing expenses and liabilities as soon as possible when there is uncertainty about the outcome, but to only recognize revenues and assets when they are assured of being received.

The correct answer is option 'A', Drawings A/c.

Explanation:
- Drawings A/c is an account that represents the withdrawals made by the owner for personal expenses.
- When cash is withdrawn from the business for personal use, it is recorded as a debit to the Drawings A/c.
- This indicates that the owner has taken out funds from the business for personal purposes.
- The Drawings A/c is a contra account to the Capital A/c, which represents the owner's investment in the business.
- By debiting the Drawings A/c, the owner's equity in the business is reduced.

To understand this better, let's look at the different options and why they are not the correct answer:

a) Drawings A/c:
- This is the correct answer because cash withdrawn for personal expenses is debited to the Drawings A/c.

b) Creditors A/c:
- Creditors A/c represents the amounts owed by the business to its suppliers or creditors.
- Cash withdrawals for personal expenses do not involve any payment to creditors, so this option is not correct.

c) Capital A/c:
- The Capital A/c represents the owner's investment in the business.
- Cash withdrawals for personal expenses do not affect the owner's capital investment, so this option is not correct.

d) Cash A/c:
- The Cash A/c represents the cash balance of the business.
- When cash is withdrawn for personal expenses, it is recorded as a debit to the Drawings A/c, not the Cash A/c.
- This is because the Cash A/c represents the business's cash transactions, while the Drawings A/c represents the owner's personal withdrawals.
- Therefore, this option is not correct.

In conclusion, when cash of Rs. 2,000 is withdrawn for personal expenses, it is debited to the Drawings A/c.

Explanation:
When Ram purchased a car for Rs. 10,000 and paid Rs. 3,000 as cash, the balance amount of Rs. 7,000 will be paid in three equal installments. Let's understand how this transaction affects the accounting equation.

Assets = Liabilities + Owner's Equity

In this case, the car is an asset, and cash is also an asset. The total assets of the business increase by Rs. 10,000, as the business now owns a car worth Rs. 10,000.

a) Total assets increase by Rs. 10,000

Now, let's look at how the liabilities and owner's equity are affected.

Liabilities are the debts or obligations of the business. When Ram purchases a car for Rs. 10,000, he owes the remaining balance of Rs. 7,000 to the seller. This liability will be paid in three equal installments.

b) Total liabilities increase by Rs. 3,000

However, since the balance amount of Rs. 7,000 is to be paid in three equal installments, it means that there will be an increase in liabilities of Rs. 7,000. The liability will increase by Rs. 7,000 because the business is liable to pay the remaining balance in installments.

c) Assets will increase by Rs. 7,000 with corresponding increase in liability by Rs. 7,000

Therefore, the correct answer is option 'C', as assets will increase by Rs. 7,000 with a corresponding increase in liability by Rs. 7,000.

If the fundamental accounting assumptions, viz. Going Concern, Consistency and Accrual are followed in financial statements, specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed.

The three fundamental assumptions in accounting are the going concern assumption, the monetary unit assumption, and the time period assumption. These assumptions provide the foundation for preparing financial statements and interpreting financial information.

If nothing is written in the financial statements about these assumptions, it indicates that they have been followed. This is because if any of these assumptions were not followed, it would be required to disclose the departure from the assumption in the financial statements. Therefore, the correct answer is option 'B' - They have been followed.

Let's understand each assumption and why it is important in financial reporting:

**1. Going Concern Assumption:**
This assumption states that an entity will continue to operate in the foreseeable future, and there is no intention to liquidate or significantly curtail its operations. It assumes that the entity will continue its activities long enough to realize its assets and discharge its liabilities in the ordinary course of business. This assumption is important because it allows the financial statements to be prepared on the basis that the entity will continue to operate, and assets and liabilities are reported at their carrying amounts rather than their liquidation or fire-sale values.

**2. Monetary Unit Assumption:**
This assumption states that the financial statements are prepared in a currency that is stable and widely accepted as a medium of exchange. It assumes that the value of money remains constant over time, ignoring the effects of inflation or deflation. This assumption allows for the aggregation and comparison of financial information over different periods and entities. Without this assumption, it would be difficult to make meaningful comparisons and analyze financial data.

**3. Time Period Assumption:**
This assumption states that the life of an entity can be divided into artificial time periods, such as months, quarters, or years, to provide timely and relevant financial information. It assumes that financial statements are prepared at regular intervals to meet the needs of users. This assumption allows for the measurement and reporting of financial performance and financial position over specific time periods, facilitating decision-making and analysis.

In conclusion, if nothing is written in the financial statements about the three fundamental assumptions, it indicates that they have been followed. The absence of any disclosure regarding departure from these assumptions suggests that the financial statements have been prepared on the basis of these assumptions, as required by accounting standards and principles. Therefore, option 'B' - They have been followed, is the correct answer.

As per the money measurement concept only those transactions which can be measured in terms of money are recorded in financial statements. Any transaction which is not convertible in monetary terms, will not be recorded in financial statements even if it effects the results of the business materiality. Therefore, non- monetary transactions are not recorded in books of accounts.

Conservatism principal says anticipate all possible losses

Explanation:

The correct answer is option 'C', which states that Kanika Enterprises follows the written down value method of depreciating machinery year after year due to consistency.

Consistency is an important principle of accounting, which requires that a company should follow the same accounting policies and methods year after year. By doing so, the financial statements of the company become more comparable and reliable.

The written down value method of depreciation is a common method used for depreciating fixed assets. Under this method, the depreciation is charged on the initial cost of the asset at a fixed rate every year. As the asset gets older, the value of the asset decreases, and hence the depreciation charge also decreases.

There are several advantages of using the written down value method of depreciation, such as:

1. Simplicity: It is a simple method of depreciation and easy to calculate.

2. Consistency: As mentioned earlier, consistency is an important principle of accounting, and this method ensures that the same method is used year after year.

3. Reflects actual usage: This method reflects the actual usage of the asset, as the depreciation charged is higher in the initial years when the asset is used more and lower in the later years when the usage is less.

4. Better matching: This method matches the cost of the asset with the revenues generated from its use, resulting in a more accurate picture of the company's financial performance.

Therefore, Kanika Enterprises follows the written down value method of depreciating machinery year after year due to consistency, which ensures that the financial statements of the company are comparable and reliable.

Explanation:
When there is a decrease in the amount of creditors, it means that the company has paid off some of its debts to the creditors. This will result in a decrease in the amount of cash because the company has used its cash to pay off the debts. The following points explain this in more detail:

• Creditors are liabilities: Creditors are the people or organizations to whom the company owes money. They are considered as liabilities in the balance sheet.

• Decrease in creditors means decrease in liabilities: When the company pays off some of its debts to the creditors, the amount of liabilities decreases.

• Decrease in liabilities means decrease in cash: When the amount of liabilities decreases, it means that the company has used its cash to pay off the debts. Hence, there will be a decrease in the amount of cash.

• No change in assets: The decrease in cash will be offset by the decrease in liabilities, so there will be no change in the total assets of the company.

Therefore, the correct answer is option B, which states that a decrease in the amount of creditors results in a decrease in cash.

According to the Periodicity Concept, The accounts should be prepared after every period and not at the end of the life of the entity. This period can be any arbitrary point of time but usually this period is one calendar year. This concept makes the accounting system workable and the term accrual meaningful.

The cost concept basically recognises historical cost or the acquisition cost of the asset. The value of an asset is to be determined on the basis of historical cost.

Be defined as the people who make up the workforce of an organization, including employees, contractors, and volunteers. Human resources management involves the recruitment, training, and development of employees, as well as managing employee relations, benefits, and compensation. The goal of human resources is to optimize the performance and productivity of employees, while also ensuring that the organization is compliant with legal and ethical standards. Human resources plays a critical role in the success of any organization, as it is responsible for attracting and retaining talented employees, creating a positive work culture, and promoting employee engagement and satisfaction.

Accrual Concept of Accounting

Definition: Accrual concept of accounting is a principle that states that financial transactions should be recorded when they occur, regardless of when the cash is received or paid.

Explanation: The accrual concept of accounting is based on the matching principle, which states that expenses should be recognized when they are incurred and revenue should be recognized when it is earned.

Example: Let's say a company provides services to a customer in December but does not receive payment until January. According to the accrual concept of accounting, the company should record the revenue in December when the service was provided, even though the cash was not received until January.

Advantages:
- Provides a more accurate picture of a company's financial health by matching revenues and expenses in the same accounting period.
- Helps in better decision making by providing timely and accurate information.
- Improves comparability between companies.

Disadvantages:
- Can be complex and difficult to implement.
- Requires a good understanding of accounting principles and procedures.
- Can be time-consuming and expensive to maintain.

Conclusion: The accrual concept of accounting is an important principle that helps in providing a more accurate and realistic view of a company's financial health. It is based on the matching principle and requires transactions to be recorded when they occur, regardless of when the cash is received or paid. This principle has both advantages and disadvantages and requires a good understanding of accounting principles and procedures.

 When applied to the balance sheet, the conservative approach results in understatement of assets and capital and overstatement of liabilities and provisions. The principle of conservatism, however should be applied cautiously. If the principle is stretched without reservations it results in the creation of secret reserves which is in direct conflict with the doctrine of full disclosure. Since the main aim of published accounts is to convey and not to conceal the information, the policy of secrecy is being abandoned in favour of the modern and more logical policy of disclosure.

Explanation:

Window dressing of accounts is a practice of manipulating or presenting financial statements in an attractive manner to make them appear better than they actually are. This is often done to impress stakeholders, such as investors, creditors, and regulatory bodies.

The most common reason for window dressing is to show higher profits or better financial ratios, which can attract more investments or loans. Some companies may also use window dressing to avoid income tax or to hide losses from stakeholders.

There are various ways in which companies can indulge in window dressing of accounts. Some common methods include:

1. Overstating revenues: Companies may recognize revenues earlier than they should or may include non-recurring revenues to show higher profits.

2. Understating expenses: Companies may delay recognition of expenses or may understate expenses to show higher profits.

3. Manipulating reserves: Companies may manipulate their reserves to show better financial ratios or to hide losses.

4. Misclassifying items: Companies may misclassify items in their financial statements to present a better picture of their financial performance.

Conclusion:

In conclusion, window dressing of accounts is a practice that can be misleading and can harm the interests of stakeholders. Investors and creditors should be aware of the potential for window dressing and should carefully review financial statements before making any investment or lending decisions. Regulators should also monitor companies for any potential window dressing and take appropriate actions when necessary.

Matching Concept and its Basis

Matching concept is a crucial accounting principle that states that expenses incurred by a business during an accounting period should be matched with the revenues generated during that same period. This concept forms the basis of accrual accounting and helps in determining the accurate profit or loss of a business.

Revenue = Profit

The matching concept establishes a relationship between revenue and profit, as expenses are deducted from revenue to arrive at the net profit of a business. Therefore, the equation Revenue = Profit can be rewritten as Revenue - Expenses = Profit. This implies that for a business to generate a profit, its revenue should exceed its expenses.

Expense as the Basis of Matching Concept

Expenses are the costs incurred by a business in the process of generating revenue. These expenses include salaries, rent, utilities, supplies, and any other costs that are necessary to operate the business. According to the matching concept, these expenses should be recognized in the same period in which the revenue they helped generate was earned.

For instance, if a business sells products worth $10,000 in June and incurs expenses of $6,000 in the same month, the matching concept requires that the expenses be recognized in June as well. This implies that the business made a profit of $4,000 in June.

Conclusion

In conclusion, the matching concept is a fundamental principle of accounting that ensures accurate reporting of a business's financial performance. The concept establishes a relationship between revenue and profit, with expenses forming the basis of the relationship. By matching expenses with the revenues they helped generate, businesses can accurately measure their profitability and make informed decisions about their operations.