Theory Base of Accounting Test - 41

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.

Definition of accounting is:

The matching Principle helps in determining the net profit for any particular accounting period.

Cash Basis of Accounting Considers the revenue as realised when amount is ultimately collected from the sales.

Money measurement concept of accounting defines that only those transactions are recorded in books of account which have monetary value. 

There are two concepts which will portray A as the correct option to us.

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. 

This is an important assumption of accounting as it provides the very basis for showing the value of assets in the balance sheet. 

Conversely, this means the entity will not be forced to halt operations and liquidate its assets in the near term at what may be low fire-sale prices.

The revenue recognition concept defines that revenue is recognized only when the legal title of the property is passed to the buyer. 

The concept of conservatism (also called ‘prudence’) provides guidance for recording transactions in the book of accounts and is based on the policy of playing safe. 

The concept states that a conscious approach should be adopted in ascertaining income so that profits of the enterprise are not overstated.  

The concept of conservatism requires that profits should not to be recorded until realised but all losses, even those which may have a remote possibility, are to be provided in the books of accounts.

The concept of money measurement states that only those transactions and happenings in an organisation which can be expressed in terms of money such as sale of goods or payment of expenses or receipt of income, etc. are to be recorded in the book of accounts.