Theory Base of Accounting Test - 26

The convention of conservatism is the convention of caution, or the policy of playing safe. This principle requires that in the situation of uncertainty and doubt, the business transactions should be recorded in such a manner that the profits and assets are not overstated and losses and liabilities are not understated. The following are some examples:

1. Closing stock is valued at cost price or Net realisable value, whichever is lower.

2. Joint life insurance policy  is shown only at surrender value as against the amount paid.

3. Provision for doubtful debt is created in anticipation of bad debts etc.

4. Provision for pending law suit against the firm, which may either be decided in its favour.

In accrual basis of accounting the revenues are recorded when they are earned and expenses when they are incurred. The transactions are recorded regardless the payment of tax. Transactions are recorded when they actually earned or due.

The process of ascertaining the amount of profit earned or the loss incurred during a particular period involves deduction of related expenses from the revenue earned during that period. 

Money measurement postulate assumes that the value of money will remain the same in different periods. Though there is drastic change in purchasing power of money, the assets purchased at different times will be shown at the amount paid for them.

Accounting period refers to the span of time at the end of which the financial statements of an enterprise are prepared, to know whether it has earned profits or incurred losses during that period and what exactly is the position of its assets and liabilities at the end of that period.

The convention of conservatism will have the effect of understatement of assets. According to conservatism principle all the anticipated losses and expenses should be taken into account in advance, but all the anticipated incomes should not be recorded in advance. The closing stock is valued at cost or net realizable value which ever is lower, thereby understating the assets and overstating the liabilities. 

The principle of full disclosure requires that all material and relevant facts concerning financial performance of an enterprise must be fully and completely disclosed in the financial statements and their accompanying footnotes. 

This is to enable the users to make correct assessment about the profitability and financial soundness of the enterprise and help them to take informed decisions.

Hence, the market value of investments is shown in the balance sheet as a footnote according to the disclosure concept.

The concept of going concern assumes that a business firm would continue to carry out its operations indefinitely, i.e. for a fairly long period of time and would not be liquidated in the foreseeable future. 

International Financial Reporting Standards (IFRS) are designed as a common global language for business affairs so that company accounts are understandable and comparable across international boundaries.

Dual aspect is the foundation or basic principle of accounting. It provides the very basis for recording business transactions into the book of accounts. This concept states that every transaction has a dual or two-fold effect and should therefore be recorded at two places. In other words, at least two accounts will be involved in recording a transaction.

The double-entry system also requires that for all transactions, the amounts entered as debits must be equal to the amounts entered as credits. 

The best example for this is the accounting equation.

Assets = Liabilities + Capital. 

This proves that, everything the firm owns, it owns out to somebody.