NCERT Solution - Theory Base of Accounting

Short Question Answer

Q1: Why is it necessary for accountants to assume that a business entity will remain a going concern?
Ans: The going concern assumption means that a business will continue its operations for the foreseeable future. It is important because it affects how transactions are recorded and assets and liabilities are presented. Assets like machinery are capitalised and depreciated over their useful life instead of being treated as immediate expenses. Liabilities are classified according to their due dates, and assets are shown at carrying value. For example, machinery costing ₹1,00,000 with a life of 10 years is depreciated at ₹10,000 per year, ensuring correct profit calculation.

Q2: When should revenue be recognised? Are there exceptions to the general rule?
Ans:  Revenue is recognised when the earning process is substantially complete, the right to receive income is established, and the amount can be measured reliably. It follows the accrual basis of accounting, not the cash basis.

• Revenue from sales is recorded when goods are delivered or ownership is transferred, even if payment is received later.
•  Advance receipts are treated as liabilities (unearned revenue) until goods or services are provided.

For example, if goods are sold in January and payment is received in February, revenue is recognised in January, while advance received in December for goods supplied in January is recognised only in January.

Exceptions:
• In hire-purchase transactions, revenue is recognised as per instalment terms.
• In long-term contracts, revenue is recognised on the basis of stage of completion.

Q3: What is the basic accounting equation?
Ans: The basic accounting equation is Assets = Capital + Liabilities. It embodies the double-entry principle: every resource owned by the business (assets) is financed either by the owner's funds (capital) or by outsiders (liabilities). This equality ensures that total debits equal total credits and underpins the balance sheet presentation.

Q4: The realization concept determines when goods sent on credit to customers are to be included in the sales figure to compute the profit or loss for the accounting period. Which of the following tends to be used in the practice to determine when to include a transaction in the sales figure for the period, when the goods have been: 
a) Dispatched, 
b) Invoiced, 
c) Delivered, 
d) Paid for
Give your reasons.
Ans: (b)
Explanation: According to the realisation concept, revenue is recognised when it is realised or realisable - i.e., when the seller has done what is necessary to establish a right to receive payment. Issuing an invoice commonly indicates that the seller has completed the necessary act (such as transfer of ownership or fulfilment of contractual conditions) to claim payment. Recognising revenue at invoicing provides clear documentary evidence of the transaction and the seller's right to receive the amount. Recognising revenue merely on dispatch might be premature (conditions of sale may not be fulfilled), while recognising only on payment would delay recognition contrary to accrual accounting.

Q5: Complete the following worksheet: 
(i) If a firm believes that some of its debtors may 'default', it should act on this by making sure that all possible losses are recorded in the books. This is an example of the ___ concept.
Ans: conservatism

(ii) The fact that a business is separate and distinguishable from its owner is best exemplified by the __________ concept. 
Ans: business entity

(iii) Everything a firm owns, it also owns out to somebody. This coincidence is explained by the _________ concept. 
Ans: dual aspect

(iv)The ___________ concept states that if the straight-line method of depreciation is used in one year, then it should also be used in the next year. 
Ans: consistency

(v) A firm may hold stock that is heavily in demand. Consequently, the market value of this stock may be increased. Normal accounting procedure is to ignore this because of the _____________ 
Ans: conservatism

(vi) If a firm receives an order for goods, it would not be included in the sales figure owing to the ____________
Ans: realisation

(vii) The management of a firm is remarkably incompetent, but the firm's accountants cannot take this into account while preparing a book of accounts because of ____________concept.
Ans: measurement

Long Question Answer

Q1: The accounting concepts and accounting standards are generally referred to as the essence of financial accounting. Comment.
Ans:

• Financial accounting involves preparing financial statements that communicate a firm's financial performance and position to users such as owners, creditors, investors and regulators.
• It rests on basic accounting concepts - for example, business entity, money measurement, consistency, matching, conservatism (prudence) and dual aspect - which guide recognition, measurement and presentation of transactions.
• Different acceptable methods (for example, alternative methods for valuation of stock or depreciation) can lead to different reported results for the same transaction; such variation reduces comparability and may create ambiguity for users.
• To reduce these inconsistencies and improve comparability and reliability, professional bodies (for example, the Institute of Chartered Accountants of India) issue accounting standards which provide uniform rules and guidance on recognition, measurement and disclosure in financial statements.
• Accounting concepts provide the theoretical foundation and the underlying philosophy of accounting. Accounting standards operationalise these concepts by prescribing procedures and disclosures to be followed in practice.
• Together, accounting concepts and standards ensure that accounting information is presented in a consistent, comparable and reliable manner; therefore they constitute the essence of financial accounting.

Q2: Why is it important to adopt a consistent basis for the preparation of financial statements? Explain.
Ans:

• Financial statements are used to show the performance and financial position of a business across periods and to allow comparisons both within the firm (year-to-year) and between firms.
• Comparisons are meaningful only when accounting policies and methods remain uniform and consistent across periods.
• The consistency principle states that once an accounting policy is chosen, it should be applied from period to period and not changed frequently without valid reason and disclosure.
• Consistency improves users' understanding of trends and assists in evaluating performance reliably. For example, switching from FIFO to weighted average method of stock valuation will change cost of sales and profit, distorting comparisons unless the change is disclosed and its effects shown.
• Consistency does not forbid change. A change in accounting policy is permissible if it leads to more reliable and relevant information. However, the nature of the change, the reasons for it and its effects must be disclosed in the financial statements so that users can adjust their comparisons.

Q3: Discuss the concept based on the premise 'do not anticipate profits but provide for all losses'.
Ans:

• This premise describes the conservatism (prudence) principle. It requires that profits should not be anticipated (i.e., gains are recognised only when realised), but all probable losses should be provided for as soon as they are foreseeable.
• Under conservatism, gains are recorded only when realised; losses and liabilities are provided for when there is reasonable evidence that they will occur. This approach is cautious and reduces the risk of overstating assets and profits.
• Examples of conservatism in practice include:
• Valuing inventory at cost or market price, whichever is lower (LCM); if market price falls below cost, the loss is recognised immediately.
• Creating a provision for doubtful debts when some receivables are expected to be uncollectible.
• Recognising contingent liabilities (when probable and reasonably estimable) rather than contingent gains.
• The principle helps present a cautious and reliable view of financial position in the face of uncertainty.

Q4: What is the matching concept? Why should a business concern follow this concept?
Ans:

• The matching concept states that all expenses incurred during an accounting period (whether paid or not) should be matched with the revenues of the same period when determining profit or loss.
• In other words, expenses attributable to earning revenue of a particular period must be recognised in that period so that profit is measured accurately.
• Example: Insurance premium of Rs 1,200 is paid on 1 July for a one-year policy and the accounting year ends on 31 March. The benefit in the current accounting year (July-March) is for nine months, so the insurance expense for the year is Rs 900 (Rs 1,200 × 9/12) and Rs 300 is treated as a prepaid expense (asset) for the next year.
• Following the matching concept prevents overstatement or understatement of profit that would occur if whole amounts unrelated to the period were recognised. It therefore helps present a true measure of business performance for the period.

Q5: What is the money measurement concept? Which factor makes it difficult to compare monetary values across years?
Ans:

• The money measurement concept requires that only events and transactions that can be expressed in monetary terms be recorded in the books of account. Money serves as the common denominator to record diverse transactions and make them comparable within the accounts.
• For example, purchasing 12 television sets at Rs 10,000 each is recorded as Rs 1,20,000. Non-quantifiable factors such as staff morale, customer satisfaction or technical skill are not recorded because they cannot be measured reliably in monetary terms.
• The major factor that makes comparison of monetary values across years difficult is the change in the purchasing power of money (inflation or deflation). Accounting records nominal monetary amounts and do not, by themselves, reflect changes in price levels.
• Consequently, Rs 1 recorded ten years ago does not have the same real value today. To compare monetary values meaningfully across periods, adjustments for changes in price level (measurement in real terms) would be required.