NCERT Solutions for Class 11 Accountancy Financial Accounting I Chapter 2: Theory Base of Accounting

Chapter at a glance

Test Your Understanding

Question TYU – I

Choose the Correct Answer
1. During the life-time of an entity accounting produce financial statements in accordance with which basic accounting concept: (a) Conservation (b) Matching (c) Accounting period (d) None of the above
2. When information about two different enterprises have been prepared presented in a similar manner the information exhibits the characteristic of: (a) Verifiability (b) Relevance (c) Reliability (d) None of the above
3. A concept that a business enterprise will not be sold or liquidated in the near future is known as: (a) Going concern (b) Economic entity (c) Monetary unit (d) None of the above
4. The primary qualities that make accounting information useful for decision-making are: (a) Relevance and freedom from bias (b) Reliability and comparability (c) Comparability and consistency (d) None of the above

Answer

Question TYU – II

Fill in the correct word:
1. Recognition of expenses in the same period as associated revenues is called _______ concept.
2. The accounting concept that refers to the tendency of accountants to resolve uncertainty and doubt in favour of understating assets and revenues and overstating liabilities and expenses is known as _______.
3. Revenue is generally recognised at the point of sale denotes the concept of _______.
4. The _______ concept requires that the same accounting method should be used from one accounting period to the next.
5. The _______ concept requires that accounting transaction should be free from the bias of accountants and others.

Answer

1. Matching 2. Conservatism 3. Revenue realisation (recognition) 4. Consistency 5. Objectivity

Questions for Practice – Short Answers

Question SA – Q1

Why is it necessary for accountants to assume that business entity will remain a going concern?

Answer

The going concern assumption is needed because:

1. Valuation of assets – fixed assets are shown at cost less depreciation, not at the price they would fetch if sold off today. This only makes sense if the business will continue to use them.
2. Depreciation – the cost of a long-life asset can be spread over its useful life only if the business is expected to last that long.
3. Prepaid and outstanding items – expenses paid in advance are carried forward as assets, and liabilities are classified as current or long-term, on the basis that the business will continue.
4. Confidence of users – investors, lenders and suppliers deal with the firm on the expectation that it will keep operating.

If the business were expected to close, assets would have to be shown at realisable (break-up) values instead.

Question SA – Q2

When should revenue be recognised? Are there exceptions to the general rule?

Answer

General rule: Revenue is recognised (treated as earned) when a legal right to receive it arises, i.e. at the point of sale when goods are delivered or services rendered — not when cash is received. Credit sales are therefore included in the sales of the period in which they are made.

Exceptions

Question SA – Q3

What is the basic accounting equation?

Answer

The basic accounting equation follows from the dual aspect concept:

It shows that the resources of a business (assets) are always equal to the claims on them — of outsiders (liabilities) and of the owner (capital). Every transaction changes the equation in a way that keeps both sides equal; for example, buying goods on credit increases stock (asset) and creditors (liability) by the same amount.

Question SA – Q4

The realisation concept determines when goods sent on credit to customers are to be included in the sales figure for the purpose of computing the profit or loss for the accounting period. Which of the following tends to be used in 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 reasons for your answer.

Answer

(c) Delivered.

Reasons:

1. Under the realisation (revenue recognition) concept, revenue is earned when ownership passes to the buyer and a legal right to receive payment arises. This normally happens when the goods are delivered to the customer.
2. Dispatch or invoicing alone does not complete the sale — goods may be lost in transit or rejected.
3. Waiting until the customer pays would mean following the cash basis, which is not allowed for credit sales under the accrual basis.

Question SA – 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.
(ii) The fact that a business is separate and distinguishable from its owner is best exemplified by the ___ concept.
(iii) Everything a firm owns, it also owes out to somebody. This co-incidence is explained by the ___ concept.
(iv) The ___ concept states that if straight line method of depreciation is used in one year, then it should also be used in the next year.
(v) A firm may hold stock which is heavily in demand. Consequently, the market value of this stock may be increased. Normal accounting procedure is to ignore this because of the .
(vi) If a firm receives an order for goods, it would not be included in the sales figure owing to the .
(vii) The management of a firm is remarkably incompetent, but the firms accountants can not take this into account while preparing book of accounts because of ___ concept.

Answer

1. Conservatism (prudence) (ii) Business entity (iii) Dual aspect (iv) Consistency (v) Conservatism (prudence) concept / cost concept (vi) Revenue recognition (realisation) concept (vii) Money measurement

Questions for Practice – Long Answers

Question LA – Q1

‘The accounting concepts and accounting standards are generally referred to as the essence of financial accounting’. Comment.

Answer

The statement is correct. Financial accounting aims to give users a true, fair and comparable picture of a business; concepts and standards make that possible.

Role of accounting concepts

1. They are the basic assumptions (entity, going concern, money measurement, accounting period) and rules (cost, dual aspect, revenue recognition, matching, conservatism, consistency, full disclosure, materiality, objectivity) on which every record is based.
2. They decide what is recorded, when it is recorded and at what value.
3. Without them each accountant would follow personal judgement, and statements of different firms or years could not be compared.

Role of accounting standards

1. Standards (AS / Ind AS issued by the ICAI and notified by the government) are written, authoritative statements that turn the concepts into specific rules — for example, how to value inventory or charge depreciation.
2. They reduce the number of alternative treatments, so statements become uniform, consistent and comparable.
3. They require disclosure of accounting policies, which improves transparency and reliability.
4. They help auditors, regulators and investors judge the statements against a common benchmark.

Conclusion: Concepts give accounting its logic and standards give it uniformity. Together they make financial statements credible, which is the very purpose of financial accounting — hence they are rightly called its essence.

Question LA – Q2

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

Answer

The consistency concept requires that the same accounting policies and methods are used from one period to the next. It is important because:

1. Inter-period comparison – Profits and financial positions of different years can be compared only if they are measured the same way. If depreciation is charged by the straight-line method one year and the written-down value method the next, the change in profit may come from the method, not from performance.
2. Inter-firm comparison – When firms follow the same accepted methods consistently, their results can be compared meaningfully.
3. Prevents manipulation – Changing methods at will could be used to show higher or lower profits; consistency removes this possibility.
4. Reliability – Users trust statements prepared on a stable basis and can use trends for decisions.

Consistency does not forbid change. A method may be changed if required by law or an accounting standard, or if the new method gives a truer picture — but then the change and its effect must be disclosed in the statements.

Question LA – Q3

Discuss the concept-based on the premise ‘do not anticipate profits but provide for all losses’.

Answer

This premise describes the conservatism (prudence) concept.

Meaning: When there is uncertainty, the accountant should choose the treatment that does not overstate profit or assets. Expected losses are recorded as soon as they are foreseen, but expected gains are recorded only when they are realised.

Examples

Merits: It protects creditors and investors from over-optimistic statements and helps keep capital intact.

Limitations: Excessive conservatism creates secret reserves, understates profits and may itself give an untrue picture. Therefore it should be applied reasonably, along with other concepts like full disclosure and consistency.

Question LA – Q4

What is matching concept? Why should a business concern follow this concept? Discuss.

Answer

Meaning: The matching concept states that the expenses incurred in earning the revenues of a period must be recorded in that same period. Revenue of the period is identified first (revenue recognition), and then all costs related to it are matched against it to find the profit.

Applications

1. Outstanding expenses (e.g. salary due but unpaid) are charged to the current year.
2. Prepaid expenses (e.g. insurance for next year) are excluded from the current year.
3. Closing stock is deducted from purchases because those goods will earn revenue next year.
4. Depreciation spreads the cost of a fixed asset over the years it helps earn revenue.

Why a business should follow it

1. It gives the correct profit or loss of each period, not one distorted by cash timings.
2. It makes results of different periods comparable.
3. It is the foundation of the accrual basis, which is required for companies.
4. Correct profit helps in fixing dividends, taxes and future plans.

Question LA – Q5

What is the money measurement concept? Which one factor can make it difficult to compare the monetary values of one year with the monetary values of another year?

Answer

Money measurement concept: Only those transactions and events that can be expressed in terms of money are recorded in the books, and they are recorded in money units (e.g. rupees), not physical units. For example, the business records “goods worth ₹ 50,000”, not “200 kg of sugar”. Events like the skill of the manager, a strike threat or the death of a key employee are not recorded, however important, because they cannot be measured in money.

Factor making comparison difficult — change in the value of money (inflation): The concept assumes that the rupee has a stable value. In reality prices change, so the purchasing power of a rupee falls over time. An asset bought for ₹ 1 lakh ten years ago and one bought for ₹ 1 lakh today are recorded at the same figure, though they represent very different real values. Hence monetary figures of different years cannot be compared directly.

Topic checklist

• Meaning and need of GAAP
• The basic accounting concepts and their practical examples
• Double entry vs single entry systems
• Cash basis vs accrual basis of accounting
• Accounting standards (AS / Ind AS) and IFRS
• GST: CGST, SGST, IGST

Total questions answered: 12 of 12