L 2 - Accounting Concepts And Conventions

Question 1

What are accounting concepts?

Answer 1

Accounting concepts refer to the basic assumptions, rules and principles which work as the basis of recording of business transactions and preparing accounts.
Main accounting concepts are-
1. Business entity concept
2. Going concern concept
3. Dual aspect concept
4. Money measurement concept

Question 2

Explain Business entity concept

Answer 2

This concept assumes that for accounting purposes, the business enterprise and its owners are two separate entities. Thus, the business and personal transactions of its owner are separate so the accounting records are made in the books of accounts from the point of view of the business unit and not the owner.
Ex- when the owner takes away cash/goods from the business for his/her personal use, it is treated as drawings and not as a business expense.

Question 3

What is the significance of business entity concept?

Answer 3

1. This concept helps in ascertaining the profit of the business as only the business expenses and revenues are recorded and all the private and personal expenses are ignored.
2. This concept restraints accountants from recording of owner’s private / personal transactions.
   3.it also facilitates the recording and reporting of business transactions from the business point of view.
   4.it is the very basis of accounting concepts, conventions and principles.

Question 4

i. The accounting concepts are basic ___________ of accounting.
ii. ___________ concept assumes that business enterprise and its owners are two separate independent entities.
iii. The goods withdrawn from business for owner’s personal use are called ___________ .

Answer 4

i) Rules
ii) Business Entity
iii) Drawings

Question 5

what is money measurement concept?

Answer 5

This concept assumes that all business transactions that are recorded in the books of accounts. must be in terms of money that is in the currency of the concerned country. In India,
such transactions are in terms of rupees (`).
For example, sincerity, loyalty and honesty of employees are not recorded in books of accounts because these cannot be measured in terms of money although they do affect the profits and losses of the business.

Another aspect of this concept is that the records of the transactions are to be kept not in the physical units but in the monetary unit. the transactions which can be expressed in terms of money are recorded in the books of accounts and not in terms of the quantity.

Question 6

what is the significance of money measurement concept?

Answer 6

• This concept guides accountants what to record and what not to record.
• It helps in recording business transactions uniformly.
• If all the business transactions are expressed in monetary terms, it will be
  easy to understand the accounts prepared by the business enterprise.
• It facilitates comparison of business performance of two different periods of
  the same firm or of the two different firms for the same period.

Question 7

what is going concern concept?

Answer 7

This concept states that a business firm will continue to carry on its activities for an indefinite period of time. Simply stated, it means that every business entity has continuity of life. Thus, it will not be dissolved in the near future. This is an important assumption of accounting, as it provides a basis for showing the value of assets in the balance sheet. For example, a company purchased plant and machinery of ` 1,00,000 and its life span is 10 years. According to this concept every year some amount will be shown as expense and the balance amount as an asset. Thus, if an amount is spent on an item which will be used in business for many years, it is not correct to charge the amount from the revenues of the year in which the item is acquired. Only a part of the value is shown as expense in the year of purchase and the remaining balance is shown as an asset.

Question 8

What is the significance of going concern concept?

Answer 8

• This concept facilitates preparation of financial statements.
• On the basis of this concept, depreciation is charged on the fixed assets.
• It is of great help to the investors, because, it assures them that they will
  continue to get income on their investments.
• In the absence of this concept, the cost of a fixed asset will be treated as an
  expense in the year of its purchase.
• Because of this concept business can be judged for its capacity to earn
  profits in future.

Question 9

i. Going concern concept states that every business firm will continue to carry on its activities ____________ (for a definite time period, for an indefinite time period)

ii. Fixed assets are shown in the books at their ____________ (cost price, market price)

iii. The concept that a business enterprise will not be closed down in the near future is known as ____________ (going concern concept, money measurement concept)

iv. On the basis of going concern concept, a business prepares its ____________ (financial statements, bank statement, cash statement)

v. ____________ concept states that business is a distinct entity from its owner. (Going concern, Business entity)

Answer 9

i)for an indefinite time period
ii)cost price
iii)going concern concept
iv) financial statements
v) Business Entity

Question 10

what is the significance of dual aspect concept?

Answer 10

• This concept helps the accountant in detecting errors.
• It encourages the accountant to post each entry in opposite sides of two affected accounts.
• It helps in preparing the Financial Position Statement/ Balance Sheet on a particular date.

Question 11

what are accounting conventions?

Answer 11

Accounting conventions refer to common practices which are universally followed in recording and presenting accounting information of the business entity. These are followed like customs, traditions etc. in a society. Accounting conventions are evolved through the regular and consistent practice over the years to facilitate uniform recording in the books of accounts. Accounting conventions help in comparing accounting data of different business units or of the same unit for different periods.
The most important conventions which have been used for a long time are:
* Convention of Consistency.
* Convention of Materiality.
* Convention of Conservatism.

Question 12

what is dual aspect concept?

Answer 12

Dual aspect is the foundation or basic principle of accounting. It provides the very basis of recording business transactions in the books of accounts. This concept assumes that every transaction has a dual effect, i.e. it affects two accounts in their respective opposite sides. Therefore, the transaction should be recorded at two places.
For example, goods purchased for cash has two aspects which are: (i) Giving of cash
(ii) Receiving of goods.
These two aspects are to be recorded.
The knowledge of dual aspect helps in identifying the two aspects of a transaction, which help in applying the rules of recording the transactions in books of accounts. The implication of dual aspect concept is that every transaction has an equal impact on assets and liabilities in such a way that total assets are always equal to total liabilities.

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Question 13

explain convention of consistency

Answer 13

The convention of consistency means that same accounting principles should be used every year in preparing financial statements. A meaningful conclusion can be drawn from financial statements of the same enterprise when there is a comparison between them over a period of time. But this can be possible only when accounting policies and practices followed by the enterprise are uniform and consistent over a period of time. If different accounting procedures and practices are used for preparing financial statements of different years, then the result will not be comparable.
But it does not mean that a particular method of accounting once adopted can never be changed. Whenever a change in method is necessary, it should be disclosed by way of footnotes in the financial statements of that year.

Question 14

what is the significance of convention of consistency?

Answer 14

• It facilitates comparative analysis of the financial statements.
• It ensures uniformity in charging depreciation on fixed assets and valuation
  of closing stock.

Question 15

i. Convention of consistency means that same accounting principles should be followed for preparing financial statements __________ .

ii. Unsold goods are valued at actual cost price or __________ whichever is________.

iii. Precious metals, like gold, silver etc. are generally valued at __________ .

iv. As per the convention of __________ year after year same methods of valuation of assets is followed.

Answer 15

i)Year after year
ii)Market Price, Less
iii) Market Price
iv) Consistency

Question 16

what is the convention of materiality?

Answer 16

The convention of materiality states that, to make financial statements meaningful, only material fact i.e. important and relevant information should be supplied to the users of accounting information. material facts or significant items refer to the information that will influence the decision of its user. The items that are of less significance are immaterial facts or insignificant items. Thus, according to this convention important and significant items should be recorded in their respective heads and all immaterial or insignificant transactions should be clubbed under a different accounting head.

Question 17

what is the significance of convention of materiality?

Answer 17

• It helps in minimising errors in calculation.
• It helps in making Financial Statements more meaningful.
• It saves time and resources.

Question 18

1. __________ convention states that to make financial statements more meaningful, only significant and important items should be supplied to the users.
2. Convention of materiality states that insignificant items should be disclosed under __________ .
3. __________ convention keeps accountants and manager to focus on important /significant items.
4. __________ means the information which will influence the decision.

Answer 18

i) Materiality
ii) Different Accounting Heads
iii) Materiality
iv) Materiality

Question 19

what is the convention of conservatism

Answer 19

This convention is based on the principle that “Anticipate no profit, but provide for all possible losses”. It is based on the policy of playing safe in regard to showing profit. The main objective of this convention is to show minimum profit. Profit should not be overstated. If more profit is shown than the actual, it may lead to distribution of dividend out of capital. This is not a fair policy and it will lead to the reduction in the capital of the enterprise.
Thus, this convention clearly states that profit should not be recorded until it is earned. But if the business anticipates any loss in the near future, provision should be made in the books of accounts for the same. The convention of conservatism is a very useful tool in situation of uncertainty and doubts.

Question 20

what is the significance of convention of conservatism

Answer 20

• It helps in ascertaining actual profit.
• It is useful in the situation of uncertainties and doubts.
• It helps in maintaining the capital at its real value.

Question 21

(i) A business has unsold stock at the end of year. The cost price is 20,000 and its market price is 25,000. At which price the unsold stock should be recorded?

(ii) What is your decision if the cost price in the above case is `21,000 ?

(iii) A businessman anticipates that it may not be possible to collect `5,000 from one of his debtors. Will he record this transaction in books of account?

Answer 21

i) ` 20,000
ii) 21,000
iii) yes

Question 22

i. According to going concern concept, a business is viewed as having:
a) a limited life
b) a very long life
c) an indefinite life
d) a long life

Answer 22

i) c

Question 23

ii. Valuation of stock at lower of cost or net realizable value is an example of
a) Consistency convention
b) Conservation convention
c) Materiality convention
d) None of the above

Answer 23

ii) b

Question 24

According to which of the following concepts the two aspects of a transaction are recorded.
a) Matching concept
b) Money Measurement concept
c) Dual aspect concept
d) Realisation concept

Answer 24

iii) c

Question 25

According to which of the following accounting concepts, even the owner of a business is considered as creditor to the extent of his capital.
a) Money measurement concept
b) Dual aspect concept
c) Business entity concept
d) Realisation concept

Answer 25

iv) c

Question 26

The convention of conservatism takes into account
a) All prospective losses but leaves prospective profits
b) All prospective profits & leaves prospective losses
c) All prospective profits and prospective losses
d) Leaves all prospective profits and prospective losses

Answer 26

v) a

Question 27

give an example of convention of materiality

Answer 27

For example, a businessman is dealing in electronic goods. He purchases T.V., Refrigerator, Washing Machine, Computer etc. for his business. In buying these items he uses larger part of his capital. These items are significant items; thus should be recorded in books of accounts in detail. At the same time to maintain day to day office work he purchases pen, pencil, match box, scented stick, etc. For this he will use very small amount of his capital. But to maintain the details of every pen, pencil, match box or other small items is not considered of much significance. These items are insignificant items and hence they should be recorded separately.

Question 28

give an example of convention of conservatism

Answer 28

For example, valuing closing stock at cost or market price whichever is lower, creating provision for doubtful debts, discount on debtors, writing off intangible assets like goodwill, patent, etc.

Question 29

assets = ________ + _____________

Answer 29

Liabilities + Capital

Question 30

what does the “ assets = liabilities + capital” accounting equation state?

Answer 30

The above accounting equation states that the assets of a business are always equal to the claims of owner/owners and the outsiders. Owner’s claim is also termed as capital or owner’s equity and that of outsiders, as liabilities or creditors’equity.