11TH ACCOUNTANCY Chapter 2 Theory Base of Accounting

Chapter – 1.    Theory base of accounting

1.1                       Generally Accepted Accounting Principles (GAAP)

1)     What do you mean by Generally Accepted Accounting Principles (GAAP)?

GAAP are the basic rules, guidelines, and concepts used by accountants to record and prepare financial statements uniformly. They bring consistency and comparability to accounting records.

Example: A company values its assets using standard historical cost rules as guided by GAAP, ensuring its statements match market practices.

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

Accounting concepts and standards form the foundation of accounting. They act as uniform ground rules that bring truth, completeness, and trust to financial statements, making them useful for users.

Example: Without standard guidelines, one business might hide its losses while another shows them, making direct comparison impossible.

1.2                       Business Entity & Money Measurement Concepts

3)     What is the Business Entity Concept?

This concept treats a business and its owner as two completely separate legal identities. All transactions are recorded from the viewpoint of the business, not the owner.

• Example: When the owner invests ₹1,000,000 capital, the business treats it as a liability owed to the owner.

4)     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? (NCERT)

This concept states that only monetary transactions are recorded. The factor that makes comparison difficult over years is inflation (changes in the price level), as money value fluctuates.

• Quick Assessment 2.2 Which concept treats a business and its owner as separate entities? (a) Cost (b) Matching (c) Business Entity (d) Going Concern Fill in the blank: Accounting ignores non-monetary events due to the ____________ measurement concept. Why does inflation make it difficult to compare financial statements of different years?

  Example: A piece of land bought for ₹50,000 in 1980 is still shown at ₹50,000 today, ignoring its massive rise in market value.

1.3                       Going Concern & Accounting Period Concepts

5)     What is the Going Concern Concept?

This concept assumes that a business will continue its operations for a very long time in the future and has no intention to close down or reduce its scale significantly.

Example: A company buys machinery for ₹500,000 expecting it to run for 10 years, rather than charging the entire cost in the purchase year.

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

It allows accountants to show fixed assets at cost price minus depreciation instead of current market resale value. It helps distribute asset costs logically over their useful life years.

• Example: Without this concept, a factory building would have to be valued at its sudden market clearance price, distorting regular profit calculation.

7)     What is the Accounting Period Concept?

The indefinite life of a business is divided into small, regular time intervals (usually 12 months) called accounting periods to measure and report profit or loss timely.

Example: Companies prepare their profit and loss account and balance sheet every year from April 1st to March 31st.

1.4                       Cost & Dual Aspect Concepts

8)     What is the Cost Concept?

An asset is recorded in the books at its purchase price (historical cost) plus installation or setup expenses. This recorded value stays unchanged regardless of future market fluctuations.

Example: A machinery bought for ₹200,000 with ₹10,000 transportation cost is always shown at ₹210,000, even if its market price doubles tomorrow.

9)     What is the Dual Aspect Concept?

Every business transaction affects at least two accounts in opposite directions. For every debit entry, there is an equal and corresponding credit entry.

Example: Buying goods for ₹10,000 in cash increases stock by ₹10,000 and simultaneously decreases cash by ₹10,000.

10)            What is the basic accounting equation? (NCERT)

The dual aspect concept forms the foundation of the fundamental accounting equation, which states that total assets are always equal to total liabilities plus capital. Assets = Liabilities + Capital Example: If a business starts with ₹500,000 cash invested by the owner, Assets (Cash: ₹500,000) equal Capital (₹500,000) + Liabilities (₹0).

1.5                       Revenue Recognition & Matching Concepts

11)            What is the Revenue Recognition (Realisation) Concept?

Revenue is recorded in accounting books only when it is legally realised. Realisation happens when a legal right to receive the money arises, such as when goods are sold or services are rendered.

Example: Selling goods on credit on March 15 counts as revenue on March 15, even if the cash arrives on May 20.

12)            When should revenue be recognised? Are there exceptions to the general rule? (NCERT)

Revenue is recognised when a legal right to receive it arises. Exceptions include long-term construction contracts (where revenue is recorded proportionately based on work completed) and hire-purchase sales (where collected instalments count as realised).

Example: A 3-year bridge construction project records revenue at the end of year 1 based on the percentage of the bridge built.

13)            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: (a) dispatched, (b) invoiced, (c) delivered, (d) paid for? Give reasons for your answer. (NCERT)

Option (b) invoiced is used in practice. Invoicing creates the legal obligation for the customer to pay, transferring ownership ownership legally and establishing the firm’s right to receive revenue.

Example: When a store issues a tax invoice for an air conditioner sent on credit, it records the sale immediately before receiving cash.

14)            What is the Matching Concept?

This concept states that expenses incurred in an accounting period must be deducted from the exact revenues earned during that same period to calculate true profit or loss.

Example: If a business sells 80 out of 100 shirts purchased, it matches only the cost of those 80 shirts against sales revenue.

15)            What is matching concept? Why should a business concern follow this concept? Discuss. (NCERT)

It matches a period’s expenses with its earned revenues. A business must follow it because ignoring outstanding expenses or pre-received revenues will misstate the actual profit or loss for that year.

Example: Charging this year’s sales revenue with next year’s advance insurance premium will incorrectly show lower profits for the current year.

1.6 Full Disclosure, Consistency, Conservatism, Materiality & Objectivity Concepts

16)            What is the Full Disclosure Concept?

Financial statements must fully, fairly, and completely disclose all material and relevant facts concerning the economic performance and financial position of an enterprise.

Example: A company discloses a pending court lawsuit in its footnotes because it might result in a huge future financial loss.

17)            What is the Consistency Concept?

Accounting policies, methods, and practices followed by a business must remain uniform and unchanged from one accounting period to another to ensure comparability.

Example: If a business chooses the Straight-Line Method for machinery depreciation this year, it must use the same method next year.

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

It eliminates personal bias and makes financial statements comparable over different years (inter-period) and across different firms (inter-firm) to draw meaningful financial conclusions.

Example: An investor can reliably compare profits of 2024 and 2025 only if the stock valuation method remained identical both years.

19)            What is the Conservatism Concept?

Also called Prudence, this concept acts as a policy of playing safe by ensuring that profits are never overstated and financial assets are not overvalued.

Example: Valuing the closing stock at its cost price or net market resale value, whichever happens to be lower.

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

This is the Conservatism approach where all expected or anticipated future losses must be recorded immediately, while any potential or unrealized future gains are ignored until actually realized.

Example: Creating a provision for doubtful debts out of current profits to cover potential defaults by credit customers.

21)            What is the Materiality Concept?

Accounting must focus strictly on material facts that can influence the decisions of an informed user, while ignoring minor, insignificant items to save administrative effort.

Example: Buying a box of pencils is treated directly as an expense of that year instead of recording it as a long-term asset.

22)            What is the Objectivity Concept?

All accounting transactions must be recorded in an objective manner, completely free from the personal bias of accountants or management. Every entry must have verifiable supporting documents.

Example: Recording a machinery purchase based exactly on the cash memo invoice and delivery receipt received from the supplier.

1.7                       Systems of Accounting (Double Entry vs. Single Entry)

23)            What is the Double Entry System of accounting?

It is a complete accounting system based on the Dual Aspect principle. Every single business transaction is recorded at two different places by debiting one account and crediting another with equal amounts.

Example: Buying a computer for ₹40,000 in cash is recorded by debiting the Computer Account and simultaneously crediting the Cash Account.

24)           

Differentiate between the Double Entry System and Single Entry System of accounting.

1.8                       Bases of Accounting (Cash Basis vs. Accrual Basis)

45)            Differentiate between Cash Basis and Accrual Basis of accounting.

1.9                       Accounting Standards (AS)

70)            What are Accounting Standards and what is their objective?

Accounting Standards are written policy documents or rules issued by recognized expert accounting bodies (like ICAI in India). Their objective is to harmonize diverse accounting policies and ensure uniformity, transparency, and reliability in financial statements.

• Example: AS-10 mandates how all companies across the country must calculate and show depreciation on their factory machinery.

71)            State the benefits and limitations of Accounting Standards.

1.10                 Goods and Services Tax (GST)

92)            What is Goods and Services Tax (GST) and what are its three main components?

GST is a single, comprehensive indirect tax levied on the supply of goods and services across the country, replacing multiple old taxes like VAT, excise, and service tax. Its three main components are CGST (Central GST), SGST (State GST), and IGST (Integrated GST).

Example: When a shopkeeper in Madhya Pradesh sells goods worth ₹10,000 to a local customer, they collect CGST and SGST on that sale.

93)            State the main characteristics and advantages of GST.