Guru Ltd. Purchased a machinery for Rs. 10 lakhs. Installation charges= Rs. 20,000. Market value Rs. 12 lakhs. Company valued the machine at market price at the end of the year at Rs. 12 lakhs which concept is violated?a)Cost Conceptb)Realization conceptc)Matching conceptd)Accrual conceptCorrect answer is option 'A'. Can you explain this answer?

Question

Answer

Introduction:
The concept violated in this scenario is the Cost Concept. The Cost Concept states that assets should be recorded at their historical cost, which is the amount of cash or cash equivalents paid or the fair value of the consideration given to acquire them at the time of their acquisition.

Explanation:
When Guru Ltd. purchased the machinery for Rs. 10 lakhs, the cost concept required the company to record the machinery at its historical cost, i.e., Rs. 10 lakhs. However, the company valued the machinery at its market value of Rs. 12 lakhs at the end of the year, violating the cost concept.

Importance of the Cost Concept:
The cost concept is important because it ensures that financial statements provide reliable and relevant information about an entity's financial position. By recording assets at their historical cost, the cost concept prevents overstatement or understatement of assets and helps in determining the true economic value of the company's resources.

Implications of Violating the Cost Concept:
When the cost concept is violated, it can lead to misleading financial statements. In this case, by valuing the machinery at its market value instead of its historical cost, the company is inflating the value of its assets on the balance sheet. This can give the impression that the company's financial position is stronger than it actually is.

Effect on Financial Statements:
The violation of the cost concept would impact the balance sheet and the income statement.

Balance Sheet:
- The machinery would be overstated on the balance sheet at Rs. 12 lakhs instead of its historical cost of Rs. 10 lakhs.
- This would lead to an overstatement of the company's total assets, which can affect various financial ratios and indicators of financial health.

Income Statement:
- The violation of the cost concept does not directly impact the income statement.
- However, if the machinery is sold in the future, the company may recognize a gain or loss based on the historical cost of Rs. 10 lakhs, not the market value of Rs. 12 lakhs.

Conclusion:
The cost concept is violated when Guru Ltd. values the machinery at its market value of Rs. 12 lakhs instead of its historical cost of Rs. 10 lakhs. This violation can lead to misleading financial statements and impact the company's overall financial position.

Similar CA Foundation Doubts

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Ambuja Cement Ltd. purchased a machine on 1-1-2019 for Rs.1,20,000. Installation expenses were Rs. 10,000. Its residual value after 10 year is Rs.5,000. On 1-03-2019 expenses on its repairs were incurred to the extent?

. A businessman purchased goods for ` 25,00,000 and sold 80% of such goods during the accounting year ended 31st March, 2015. The market value of the remaining goods was ` 4,00,000. He valued the closing Inventory at cost. He violated the concept of?

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