GSEB Class 11 Solutions Chapter 6 Conventions, Assumption, Concepts and Principles of Accounting

Question 1. Explain the need for accounting principles or concepts or conventions or postulates or assumptions that are used while writing accounts and in preparing financial statements.
Answer: The accounts provide a helpful tool for business-related data. Accounts serve different functions for various interested parties. Many accounting principles, ideas, conventions, postulates, and assumptions are utilized when creating account books and preparing financial reports. Accounts also offer a theoretical and reasoned foundation for accounting. If these principles, ideas, and assumptions are not correctly used in practice, they might affect future decisions or strategies. Hence, it is absolutely essential that accounting principles, ideas, conventions, postulates, and assumptions are employed to maintain consistency between the person who writes the account books and the person who uses the information for business transactions.
Here are the reasons for accounting principles, concepts, conventions, postulates, and assumptions:

• Because of these, uniformity between the person who writes account books and the information user can be kept and enhanced.
• This allows for comparing accounts from different years.
• It offers a theoretical and logical foundation for accounting.
• Because of all these, accounts turn into a science or a recognized field. And it serves as the business language.
• It builds an ideological framework for accounts.
• Accounts become free from personal favoritism and random choices.
• Accounting principles represent the general rule or guideline chosen or suggested as a course of action, a recognized basis for behavior or practice.
• The accounting system relies on certain ideas and principles, which is why they hold significance.

Exam Tip: When explaining the need for accounting principles, focus on consistency, comparability, reliability, and the theoretical basis they provide. Mentioning that they reduce bias is also key.

Question 2. Write a short note on:
1. Going concern concept
Answer: Typically, business accounts are prepared with the belief that the business will continue and will not close soon. This idea is termed the Going Concern concept. Creditors provide goods and services expecting the business to operate for an extended period. Money lenders or financial organizations offer funds based on this principle.
When estimating depreciation on fixed assets, it is assumed that these assets will be used within the business for a long duration. At the close of the accounting year, provisions for bad debts and discount reserves are also created based on this assumption. A provision is also made for future potential liabilities based on this belief. Following the idea that the business will continue for a long time, transactions are entered into the account books.
This concept holds importance in the following situations:
(1) When the advantage from a particular cost is expected over many years, not just the current year, then that cost is written off or spread across future years. The cost for the current year is entered in the Profit and Loss Account, and the remaining amount appears on the Assets side of the Balance Sheet.
(2) Depreciation on assets is written off or divided over the asset's useful life. Therefore, by this idea, the asset is not recorded at its market price in the books but is shown at its initial purchase price.
(3) If the business operates for a specific time frame, then the total cost of the asset is treated as an expense for that period and is compared against the earnings for that period, for instance, a joint venture for building a bridge or a dam.
(4) Based on this principle, fixed assets are displayed at cost minus depreciation, and current assets are shown at their recoverable value in the Balance Sheet.
(5) A difference is made between 'Capital expenditure' and 'Revenue expenditure' due to the going concern assumption.
This concept should not be applied under these circumstances:

• When the goal for which a business was created is achieved or will likely be completed in a very short time;
• When an industrial unit is declared unwell;
• When a liquidator is chosen to dissolve a company;
• When a business is expected to be dissolved very soon.

Exam Tip: Remember to define the going concern concept clearly. Provide examples like depreciation, valuation of fixed assets, and provisions, and also mention situations where it might not apply, such as business liquidation.

2. Consistency concept
Answer:

• The consistency idea proposes that when preparing accounts or financial reports, the identical policies, methods, and processes should be used annually.
• Accounts stay comparable only if consistency is upheld. If consistency is not kept in accounting, the accounts might not remain comparable and could also make financial data difficult to understand.
• With the consistency principle, personal preference can be avoided; the accountant needs to consistently follow the same collection of principles, practices, processes, or methods each year.
• For instance, if inventory is valued using the FIFO method, the company should, as much as possible, use the same method year after year.
• Similarly, if depreciation is calculated using the straight-line method in one year, the same approach should be consistently followed every year.
• If the method for inventory valuation or depreciation is altered each year, the accounts become incomparable, and the profit or loss status for various years may also show different results.
• However, valuing inventory at cost or market price, whichever amount is lower each year, does not break the consistency principle.
• The reasoning behind the consistency principle is that people who use financial reports lose trust in the accounts if frequent alterations are made to policies or practices based on the personal desires and tastes of those preparing them.
• Consistency does not mean that the accounting policy or process can never be modified. When conditions change or a policy or process or method can offer a better view of accounting data, the alteration can be made with good reasons. However, such changes should not be made often.

Exam Tip: Emphasize that consistency allows for comparability of financial statements. Provide examples like depreciation methods or stock valuation, and also state that changes are permissible if they lead to better financial reporting, but should be infrequent.

Question 3. Explain the concept of Going concern giving example.
Answer: Based on this concept, it is assumed that the business will operate for an extended period and will not be closed or dissolved in the immediate future.
Examples:

• Business fixed assets are presented in the Balance Sheet at their depreciated amounts, not at their market or current sales values, whereas current assets are shown at their achievable values in the Balance Sheet.
• Prepaid revenue expenses are displayed on the Assets side of the Balance Sheet.
• Deferred revenue expenses, which have not yet been recorded, are shown on the Asset side of the Balance Sheet.
• Financial statements are created at the end of an accounting period. When a business entity has a very long existence, this is based on the assumption of being a going concern.
• Partially finished goods or work-in-progress are valued at the cost incurred on them, not at their potential selling price.
• A difference is established between 'Capital expenditure' and 'Revenue expenditure' because of this idea.
• If the business is set to operate for a particular duration, then the total cost of the asset is considered an expense for that period and is compared against the income for that period, e.g., a collaborative project for building a bridge or a dam.
• In the Balance Sheet, the amounts owed are presented only at their recoverable value.
• If a business needs to shut down for any reason, it is suitable to show assets at their market values.
• Assets such as goodwill, patents, trademarks, and copyrights are not fully written off in a single year.

Exam Tip: When explaining the Going Concern concept, highlight the assumption of continuous operation and illustrate with examples like how fixed assets are valued (depreciated cost, not market value) and the treatment of long-term expenses.

Question 4. Explain the concept of consistency giving example.
Answer: When preparing accounts or financial reports, the same rules, processes, and approaches should be applied annually. This helps ensure consistency in accounting entries, records, and different reports.
Examples:

• The method for valuing inventory should be applied consistently and not altered often, such as using FIFO method, LIFO method, or Weighted Average method.
• However, valuing inventory at cost or market price, whichever is lower each year, does not breach the consistency principle.
• The same method of depreciation and asset valuation should be followed consistently each year, for example, the Straight-line method, Diminishing balance method, or Depreciation fund method.
• There is no violation of the consistency principle if fixed assets are valued at their original cost.
• Changes can be made to inventory valuation or depreciation methods with valid justification. Nonetheless, such changes should not occur often. Whenever a change happens, it should be revealed in the account books.

Exam Tip: Define consistency by emphasizing unchanging methods over time for comparability. Provide concrete examples like stock valuation (FIFO, LIFO) or depreciation methods (straight-line, diminishing balance) and mention that changes need proper justification and disclosure.

Question 5. Explain the concept of accrual with example.
Answer: The accrual idea is important for understanding income and expenses. Income or costs are recognized when they are earned or incurred, not just when cash is received or paid. Also, income and costs will be entered for the period they belong to.
Examples:

• When products are sold on credit to a client, the income should be acknowledged in the accounting records.
• Based on the accrual concept, unpaid costs, expenses paid in advance, and income should be recognized in accounting; for example, salary due for March 2018 will be treated as an expense for that month even if it is paid in April 2018.
• An upfront payment received for a sales order is not entered in the account books.
• Incomes from commission, rent, interest, and similar sources are recorded in the account books.
• Professionals like lawyers, physicians, and chartered accountants log their fees as income at the moment of actual collection.
• In building a bridge, road, or structure, profit is calculated even if the construction is unfinished.
• When a purchase is made using the installment method, the amount is recorded as each installment is paid.
• For a gold mine, as soon as gold is produced, it is entered in the books.

Exam Tip: Clearly define accrual as recognizing revenues when earned and expenses when incurred. Provide diverse examples such as credit sales, prepaid/accrued expenses, and how professionals record fees to show broad applicability.

Question 6. Explain the concept of accounting entity with example.
Answer: For accounting purposes, the business will be viewed quite distinctly from its owner. The business is a separate individual, and the owner is also a separate individual. Business dealings are recorded in the business's books, while the owner's personal dealings are not recorded in the business's books.

• The money invested by the owner in the business is entered into the capital account.
• When the owner removes money, items, or assets for personal use, or when any personal costs are paid by the business, all these are debited to the drawings account.
• A company provides interest on the owner's capital and applies interest on drawings.
• Each independent branch prepares its individual trial balance separately.
• Profit is added to the capital account.
• The owner's capital in the business is listed as a debt on the Balance Sheet.

Exam Tip: Emphasize the distinct legal and financial identity of the business from its owner. Use examples like capital, drawings, and separate recording of business and personal transactions.

Question 7. Explain the concept of consistency with example.
Answer: When preparing accounts or financial reports, the same rules, processes, and approaches should be applied annually. This helps ensure consistency in accounting entries, records, and different reports.
Examples:

• The method for valuing inventory should be applied consistently and not altered often, such as using FIFO method, LIFO method, or Weighted Average method.
• However, valuing inventory at cost or market price, whichever is lower each year, does not breach the consistency principle.
• The same method of depreciation and asset valuation should be followed consistently each year, for example, the Straight-line method, Diminishing balance method, or Depreciation fund method.
• There is no violation of the consistency principle if fixed assets are valued at their original cost.
• Changes can be made to inventory valuation or depreciation methods with valid justification. Nonetheless, such changes should not occur often. Whenever a change happens, it should be revealed in the account books.

Exam Tip: Define consistency by emphasizing unchanging methods over time for comparability. Provide concrete examples like stock valuation (FIFO, LIFO) or depreciation methods (straight-line, diminishing balance) and mention that changes need proper justification and disclosure.

Question 8. Explain the concept of money measurement with example.
Answer: In business, all dealings are shown in monetary terms. For accounting, money is used as the standard unit of measure.
Based on this concept, only those events or transactions that can be valued in terms of money are entered in the account books. Transactions that cannot be measured financially are not recorded in accounts.
Examples:

• Instead of noting the physical count of assets bought, like chairs, tables, etc., the acquisition will be entered at the monetary worth of those assets.
• Instead of noting the physical quantity of items sold, sales will be recorded at the monetary worth of those items.
• When wages, salaries, and similar payments are made based on the hours or days worked by different staff, the transaction will be entered in the account books based on the monetary sum involved.
• No accounting entry is made for a factory worker strike, even if it is a major event impacting the business.
• No accounting entry is made for the departure of a skilled and effective production manager, which might negatively affect output.
• No accounting entry is made in the books of accounts for the benefit of having a team of committed, honest, diligent, and capable employees in the firm.
• No accounting entry is made for the passing of a key employee of the firm, even if it is a significant event impacting the business.
• The Balance Sheet does not serve as a Valuation Statement.
• High-quality management is not directly reflected in the Balance Sheet.

Exam Tip: Clearly explain that only quantifiable monetary transactions are recorded. Provide examples of what is recorded (asset purchases, sales) and what is not (employee strikes, management quality) to illustrate the concept's scope and limitations.

Question 9. Explain the concept of periodicity with example.
Answer: A business's existence is split into specific accounting periods. This is known as the Accounting Period. At the conclusion of each accounting period, financial statements are prepared. Typically, this accounting period is 12 months, or one year. A one-year period includes all seasons, covering every type of seasonal transaction. The accounting year could be the calendar year or the financial year.

• According to the Periodicity concept, a Profit and Loss Account and a Balance Sheet are prepared at the end of every accounting period.
• As a business's life is thought to be without end or very long, it is divided into suitable accounting periods to check the entity's performance and position at the close of each period.
• At the year's end, the account books are shut, and new books are started for the following year.
• The purchase of an asset is recorded in the account books on the date it is acquired.

Exam Tip: Emphasize that the "indefinite life" of a business is broken into shorter, manageable periods for better financial reporting and comparison.

Question 10. Explain the concept of full disclosure with example.
Answer: Every kind of accounting record or information helps the business owner, creditors, banks, investors, lenders, government, and employees. This concept suggests that all important information must be shown in the financial statements. To allow financial statement users to make sound economic choices, it is crucial to reveal all pertinent information in the statements. Financial statements should be prepared truthfully. As per Section 129 (1) of the Companies Act, 2013, financial statements must present a correct and clear picture of the company's financial status. All important information should be shown in the financial statements; nothing should be hidden. Good accounting practice requires that all important information be shown, even if there are no legal rules to do so. Even when specific legal disclosure is not needed, significant information must still be revealed. The use of notes or schedules added to financial statements grew from the full disclosure principle, for instance, details on contingent liabilities, the market worth of investments, stock valuation methods, company policies, and future plans. Examples:

• Based on the full disclosure concept, if there's a change in how depreciation is calculated, its effect on profit or loss and the asset's value should be clearly stated in financial reports.
• Likewise, details about any change in how inventory is valued and its impact should be shown in financial reports.
• Besides the book value of investments in listed shares, their current market value is also presented as extra information in the financial statement.
• Adding notes or schedules to financial statements has grown from the full disclosure rule; for example, details about potential liabilities, upcoming plans, and more are included.

Exam Tip: Remember that full disclosure ensures transparency and helps stakeholders make well-informed decisions, as required by law.

Question 11. Explain the concept of materiality with example.
Answer: Materiality means 'relative significance'. It refers to what is important and what is not important. Under this concept, details are shown in financial statements only when they are helpful to the information users. Therefore, an accountant does not need to report unimportant transactions in accounts or financial statements. An item's materiality depends on its value and its kind. When small tools like hammers, nails, screws, and screwdrivers are used, separate accounts for each are not needed. One 'Loose Tools Account' will be enough. Likewise, instead of having individual accounts for pencils, erasers, and pens, a single 'Stationery Expense Account' should be kept because individual accounts for small, unimportant items are not necessary. Buying a dustbin for Rs. 15 should be seen as a revenue expense rather than a fixed asset. If any expense goes over 1% of the sales amount, it might be necessary to have a separate account for it. There is no firm rule for judging materiality in every situation. It depends on the amount, importance, and relevance of an item or business transaction. Commission paid to a sole selling agent is a significant item, so it should be shown separately in the Profit and Loss Account.
In simple words: The materiality concept states that only important information, which would change a user's decision, needs to be shown in financial statements. Small, unimportant items can be grouped or treated as expenses.

Exam Tip: Focus on the idea that only truly significant information needs detailed reporting; minor details can be grouped for clarity and efficiency.

Question 12. Explain the concept of prudence with example.
Answer: A possible future loss should be taken into account, but a potential future profit or income should not. This idea is called the Prudence or Conservation concept. According to this concept, great care must be taken when preparing the account books. Examples:

• Closing inventory is valued at either cost price or market price, whichever is lower.
• Allowance for bad debts on customers is created in the accounts.
• Allowance for discount on customers is created in the accounts.
• Allowance for discount on suppliers is not created in the accounts.
• Allowance for a decrease or wearing away in the worth of investments is typically created in the account books.
• Possible liabilities are shown in the Balance Sheet, but potential assets are not listed there.
• For long-term projects, if very little work is done, losses are considered, but gains are overlooked.
• All research and development costs are typically charged to the Profit and Loss Account in the year they happen.
• An allowance for the loss of stolen uninsured stock will be created in the account books.

Exam Tip: Remember "provision for all losses, anticipate no profits" to correctly apply the prudence concept in accounting.

Question 13. Explain the concept of dual aspect with example.
Answer: Dual aspect is the core or fundamental idea of accounting. It offers the primary foundation for documenting business activities in the account books. This concept states that every transaction has two effects or a double influence on the accounting records.
(1) From the viewpoint of benefit obtained and
(2) From the viewpoint of benefit provided. This concept is also known as the duality concept. The duality principle is a key accounting custom and forms the basis for the double-entry bookkeeping system. The way accounting is structured relies on this idea of duality. The accounting equation or Balance Sheet equation also uses the Dual aspect. Examples:

• If a business buys an asset, another asset will decrease. For example, furniture bought for Rs. 5,000 with cash.
• If a business buys an asset, its liability also rises. For example, furniture worth Rs. 5,000 purchased from Radhe Furniture Mart.
• If a business buys an asset, the owner's capital also increases. For example, if the owner brings a personal machine worth Rs. 20,000 into the business.
• When items costing Rs. 17,000 are sold for Rs. 20,000 in cash.
• When items costing Rs. 12,000 are bought on credit.
• When a loan of Rs. 25,000 is obtained from Dena bank.

Exam Tip: Always remember that every transaction affects at least two accounts (debit and credit) to maintain the accounting equation: Assets = Liabilities + Equity.

Question 14. Which three accounting principles or concepts or conventions are treated as fundamental accounting assumptions by ICAI?
Answer: The International Accounting Standards Committee (IASC) and the Institute of Chartered Accountants of India (ICAI) consider these three concepts as the essential accounting assumptions:
1. Going concern concept,
2. Consistency concept, and
3. Accrual concept.
In simple words: The ICAI considers three main ideas as basic assumptions for accounting: that a business will continue, that methods will stay the same, and that transactions are recorded when they happen, not just when cash changes hands.

Exam Tip: Memorize these three fundamental accounting assumptions as they form the bedrock of financial reporting standards.

Question 15. State the name of the accounting principle, concept or convention with which the following statements or situations are associated:
1. Revenue expenses paid in advance are shown on the asset side of Balance Sheet.
Answer: Based on the Going Concern concept, revenue expenses paid in advance are presented on the asset side of the Balance Sheet.
2. Semi-finished goods or work-in-progress is valued at cost incurred thereon and not at their realisable value.
Answer: Based on the Going Concern concept, semi-finished goods or work-in-progress are valued at the expenses spent on them, rather than their achievable market value.
3. Financial statements are prepared at the end of accounting period.
Answer: According to the Going Concern concept or Accounting Period concept, financial statements are created at the end of each accounting period.
4. If depreciation is provided by straight-line method in a year, the same method should be followed consistently every year.
Answer: Based on the Consistency concept, if depreciation is calculated with the straight-line method in a year, that same method should be used regularly each year.
5. Frequent changes in the methods of depreciation or stock valuation should be avoided.
Answer: According to the Consistency concept, frequent modifications in the method of depreciation or stock valuation should be prevented.
6. When goods are purchased, on credit from a supplier, the Purchase should be recorded in accounts immediately, even though cash is not yet paid for such purchase as the amount becomes payable once the goods are purchased.
Answer: Based on the Accrual concept, when items are bought on credit from a supplier, the purchase should be recorded immediately in accounts. This happens even if cash is not yet given, as the amount becomes owed once the goods are obtained.
7. When partner of a partnership firm withdraws any amount from the firm, the partnership firm will debit this amount to partner's drawings account.
Answer: According to the Accounting Entity concept, when a partner takes out any amount from the firm, the partnership firm will charge this amount to the partner's drawings account.
8. No accounting entry is recorded for death of a key employee of the firm even if it is an important event affecting business.
Answer: Based on the Money Measurement concept, no accounting record is made for the death of a key employee of the firm, even if it is a significant event impacting the business.
9. In absence of any contrary information, life of the business is assumed to be indefinite or for a very long period and hence such life is divided into convenient accounting periods to ascertain performance and position of entity at the end of each such accounting period.
Answer: According to the Accounting Period concept, if there is no opposing information, a business's life is thought to be unending or very long. Therefore, this life is divided into suitable accounting periods to determine the entity's performance and standing at the close of each period.
10. Any item of income or expenditure which does not exceed one per cent of the revenue from operations or Rs. 1,00,000 whichever is higher is not required to be shown separately in statement of profit and loss of a company, unless specifically required otherwise.
Answer: Based on the Materiality concept, any income or expense item that is less than 1% of operational revenue or Rs. 1,00,000 (whichever is more) is not required to be shown separately in a company's profit and loss statement, unless specifically instructed.
11. Information about the change in method of stock of inventory valuation and its impact should be disclosed in financial statements.
Answer: According to the Full Disclosure concept, details about changes in how stock or inventory is valued and its impact should be revealed in the financial statement.
12. Information about the change in method of providing depreciation and its impact should be disclosed in financial statements.
Answer: Based on the Full Disclosure concept, information about changes in the method of calculating depreciation and its impact should be revealed in financial statements.
13. Provision for discount reserve on debtors is made in the accounts but provision for discount reserve on creditors is not usually made in the accounts.
Answer: According to the Prudence concept or Conservatism concept, an allowance for discount on debtors is created in accounts, but an allowance for discount on creditors is usually not created in accounts.
14. Provision for loss of theft of uninsured machinery will be made in the books of accounts soon after the theft even it there is possibility of recovery of this machinery if police catches the thief.
Answer: Based on the Prudence concept or Conservatism concept, an allowance for the loss of stolen uninsured machinery will be recorded in the account books shortly after the theft, even if there is a chance of finding this machinery if the police arrest the thief.
15. Anil purchased a shop from Bimal for Rs. 10 lakhs. Anil feels that he has got a very good shop at prime location. On the other hand, Bimal feels that this shop was very unlucky for him and he would have sold it even for 5 lakhs. Because of these perceptions, though actual transaction has taken place at Rs. 10 lakhs, Anil wants to record this transaction in his books at Rs. 20 lakhs and Bimal wants to record this transaction in his books at Rs. 5 lakhs but their accountants have told them that the transaction should be recorded at Rs. 10 lakhs only based on some accounting principle, concept or convention which they do not remember.
Answer: Based on the Cost concept, this transaction should be recorded at Rs. 10 lakhs only in the account books of both groups.
16. It should be remembered that every transaction recorded in the accounts affects at least two items and accounting system is designed so as to record dual effects of a transaction. Hence, Accounting is called as 'double-entry system' or 'double-entry bookkeeping system'.
Answer: According to the Dual Aspect or Duality concept, every transaction recorded in the accounts impacts at least two items, and the accounting system is designed to record the dual effects of a transaction. Therefore, Accounting is called the 'double-entry system' or 'double-entry bookkeeping system'.
17. Excellent quality management system of an entity is not reflected in its books of accounts even if such system enhances goodwill of the entity.
Answer: According to the Money Measurement concept, an entity's excellent quality management system is not reflected in its account books, even if that system improves the entity's goodwill.
18. Advance received from a customer cannot be credited to sales account.
Answer: Based on the Accrual concept, advance payments received from a customer cannot be added to the sales account.
19. Capital is shown on the liability side of Balance Sheet of a business entity.
Answer: According to the Accounting Entity concept, capital is shown on the liability side of the Balance Sheet.
20. Independent branch prepares its own trial balance separately.
Answer: Based on the Business Entity concept, an independent branch prepares its own separate trial balance.
21. Trial Balance tallies if arithmetical accuracy is ensured.
Answer: According to the Dual Aspect concept, the trial balance matches if mathematical accuracy is maintained.
In simple words: This question tests your knowledge of various accounting principles. For each scenario, you need to identify the specific concept (like Going Concern, Consistency, Accrual, Materiality, Prudence, Dual Aspect, Money Measurement, or Accounting Entity) that governs the accounting treatment.

Exam Tip: Each statement highlights a distinct accounting principle; identify the core rule behind each scenario.

Question 16. Answer the following questions:
1. The owner of a business takes away goods of Rs. 3,000 from business for personal use. Where will you debit this? According to which Concept?
Answer: When a business owner takes items worth Rs. 3,000 for personal use, the Drawings account is charged with this amount. This action is based on the Accounting Entity concept.
2. Fixed assets are shown in the balance sheet at their cost or market price whichever is less. Is this statement true or false? If the same is false, rewrite the correct statement and state the principle associated with it.
Answer: This statement is false. Based on the Going Concern concept, fixed assets of a business are presented in the Balance Sheet at their reduced value after depreciation, not at their current selling prices.
3. According to which accounting principle or concept does Bank credit interest on doubtful advances to Interest Suspense Account?
Answer: According to the Prudence Concept or Conservatism concept, a bank credits interest on doubtful advances to an Interest Suspense Account.
4. A trader has taken a loan of Rs. 1,00,000 from a friend on 01-06-'16 at an interest rate of 12% per annum and interest is payable annually on 1st June every year. The first interest on this loan will be payable by trader on 1st June 2017. The accounting year of this trader books of this trader for the year ending on 31st March 2017? If yes, for which amount? According to which Concept?
Answer: Yes, interest will be noted in the account books.
From Date 1-6-16 to Date 31-3-17
= Loan interest for 10 months.
Loan interest \( I = \text{Rs. } 1,00,000 \times \frac{12}{100} \times \frac{10}{12} \)
\( = \text{Rs. } 10,000 \)
An entry for outstanding interest payable on the loan of Rs. 10,000 will be made in the accounting year 2016-17, following the Accrual concept.
5. An employee has filed a suit against a company claiming compensation of Rs. 1,00,000 for dismissing him from his job. According to the estimate of an advocate of the company, sum of Rs. 40,000 is likely to become payable. Will there be any entry in the books of the company for this event? If yes, for which amount? According to which principle? If the matter is pending in the court of law, is there any requirement to disclose the details of claim for compensation in financial statement? If yes, according to which concept?
Answer: Yes, an entry will be made in the account books for Rs. 40,000, based on the Prudence concept. This concept dictates recognizing expenses or losses as soon as they are reasonably probable. In this situation, if the case is ongoing in court, then, according to the Full Disclosure concept, Rs. 1,00,000 should be revealed in the financial statements as a possible liability.
In simple words: This section asks you to apply various accounting concepts to different real-world business scenarios, explaining the correct accounting treatment and the underlying principle.

Exam Tip: For calculations involving interest, ensure you correctly determine the time period and apply the appropriate concept (Accrual for recording when earned/incurred). For pending legal matters, remember Prudence (recognize likely losses) and Full Disclosure (reveal significant potential liabilities).