CBSE Class 11 Financial Accounting Chapter 2: Theory Base of Accounting NCERT Solutions

Solution: The Going Concern Concept is a fundamental accounting assumption that posits a business entity will continue its operations for an indefinite period into the future. This assumption is vital because it allows accountants to differentiate between expenditures that benefit only the current accounting period (revenue expenditures) and those that provide benefits over multiple periods (capital expenditures). For instance, if a company purchases machinery for Rs 1,00,000 with an expected useful life of 10 years, the entire cost is treated as a capital expenditure. The benefit of this machinery extends beyond one year. Consequently, an annual charge for depreciation, say Rs 10,000, is recognized as a revenue expenditure for each of the 10 years, reflecting the consumption of the asset's economic benefit during that period.

Solution: Revenue should be recognized when the sale of goods or services occurs, whether the payment is received in cash or on credit, or when the right to receive income from any source is legally established. Revenue is not recognized if payment is received in advance of providing the goods or services, or if the income is earned but not yet receivable. In essence, revenue recognition hinges on the establishment of the right to receive income. For example, if Mr. A sells goods in January and receives payment in February, the revenue is recognized in January because that's when the sale occurred and the right to receive payment was established. However, if Mr. A receives cash in advance in December for goods to be delivered in January, the revenue is recognized in January when the goods are delivered and the sale is made, not in December.

The general rule for revenue recognition has the following exceptions:

1. Hire Purchase System: In a hire purchase agreement, where goods are sold and paid for in installments, the revenue is recognized as and when the installments are received.
2. Long-term Construction Contracts: For projects like building dams or highways that span several years, income is recognized proportionally based on the work certified by an independent party during the accounting period, rather than waiting for the entire contract to be completed.

Solution: The basic accounting equation, which forms the foundation of the double-entry bookkeeping system, is:

$$Assets\; =\; Liabilities\; +\; Capital$$

This equation signifies that the total monetary value of all assets owned by a firm must always be equal to the sum of the total claims against those assets. These claims arise from two sources: external creditors (liabilities) and the owners (capital).

Solution: In practice, the transaction is typically included in the sales figure when the goods have been b. invoiced.

Reason: According to the realisation concept, revenue is recognized when the right to receive the payment arises. When goods are invoiced, it signifies the formal transfer of ownership of the goods from the seller to the buyer. This act of invoicing creates a legal obligation for the buyer to pay and establishes the seller's right to receive the payment, thus fulfilling the criteria for revenue recognition.

Solution:

(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 conservatism concept.

(ii) The fact that a business is separate and distinguishable from its owner is best exemplified by the business entity concept.

(iii) Everything a firm owns, it also owns out to somebody. This co-incidence is explained by the dual aspect concept.

(iv) The consistency 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 conservatism concept.

(vi) If a firm receives an order for goods, it would not be included in the sales figure owing to the revenue recognition concept.

(vii) The management of a firm is remarkably incompetent, but the firm's accountants cannot take this into account while preparing book of accounts because of the money measurement concept.