Theory Base of Accounting Test - 61

For all accounting purposes, business and business man are considered two different entities.  All business transactions are recorded in business books and personal transaction done from business are considered as decrease in owners equity. This concept is applicable to all business entities.

The convention of conservatism mean that 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.

As per conservatism. Stock is valued at a lower cost or market price whichever is ever.

Fixed assets are reported in the balance sheet at their historical costs. This is done in order to comply with cost concept. 

As per the Historical cost concept, an asset should be recorded in the books of the accounts at its purchase price or cost i.e., 10,00,000 but here asset is recorded at realizable value i.e., 12,00,000.
Therefore, the historical cost concept is being violated.

As per the Historical cost concept, an asset is recorded in the books of the accounts at its cost +installation charges i.e., 11,00,000 but here asset is recorded at realizable value i.e., 13,00,000.
Therefore, the historical cost concept is being violated.
Therefore, the asset should be recorded at 11,00,000.

The convention of conservatism mean that 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.

Hence, the conservatism principle is applicable in accounting.

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. 

The matching concept emphasises exactly on this aspect. It states that expenses incurred in an accounting period should be matched with revenues during that period.

It follows from this that the revenue and expenses incurred to earn these revenues must belong to the same accounting period.

The conservatism principle is the general concept of recognising expenses and liabilities as soon as possible when there is uncertainty about the outcome, but to only recognize revenues and assets when they are assured of being received. Under the conservatism principle, if there is uncertainty about incurring a loss, you should tend towards recording the loss. Conversely, if there is uncertainty about receiving a gain, you should not record the gain.

The concept of business entity assumes that business has a distinct and separate entity from its owners. It means that for the purposes of accounting, the business and its owners are to be treated as two separate entities. Keeping this in view, when a person brings in some money as capital into his business, in accounting records, it is treated as liability of the business to the owner.