Theory Base of Accounting and Accounting Standards
Questions on the theory base test whether you can name the concept behind a treatment and apply matching and accrual ideas to adjustments. Accounting standards questions are usually short: which standard covers inventory, or why a policy must be disclosed.
Fundamental assumptions and concepts
- Going concern: accounts assume the business will continue, so assets are not valued at break-up prices.
- Accrual: record income when earned and expenses when incurred, not when cash moves.
- Consistency: use the same policies each year; a change requires disclosure and, where applicable, retrospective adjustment.
- Prudence: anticipate losses, not profits; inventory is valued at lower of cost and net realisable value.
- Matching, materiality, full disclosure, money measurement, accounting period, cost and dual aspect complete the framework.
Standards
AS 1 requires disclosure of accounting policies; AS 2 governs inventory valuation; AS 9 covers revenue recognition; AS 10 deals with property, plant and equipment. Ind AS are the converged standards for larger entities. If the fundamental assumptions are not followed, the fact must be disclosed.
Worked example
Insurance of ₹36,000 is paid on 1 October for twelve months; the year ends 31 March. Only six months relate to this year, so ₹18,000 is charged as expense and ₹18,000 is prepaid. Separately, closing stock costing ₹80,000 has a net realisable value of ₹72,000; AS 2 and prudence require valuation at ₹72,000.
Traps
- Calling every adjustment prudence when it is accrual or matching.
- Treating consistency as a rule that forbids all change.
- Valuing inventory at cost when NRV is lower.
- Forgetting that a policy change needs disclosure.