Q1. (a) What do you understand by the concept of conservatism?

Why it is also called the

concept of prudence? Why it is not applied as strongly today as it used to be in the Past?
Ans. Concept of Conservatism :- This principle emphasizes that revenues are to be
recognized only when they are reasonably certain and expenses are to be recognized as
soon as they are reasonably possible. if a situation arises where there are two acceptable
alternatives for reporting an item, conservatism directs that accountant to choose the
alternative that will result in less net income and /or less asset amount. Conservatism
helps accountant to break a tie. It does not direct accountants to be conservative.
Accountants are expected to be unbiased & objective.
The concept of Conservatism is also called the concept of prudence:The concept of conservatism, also known as the concept of prudence, is often stated as
"anticipate no profit, provide for all possible losses". This means an accountant should
follow a cautious approach. He should record lowest possible value for assets and
revenues, and the highest possible value for liabilities and expenses. According to this
concept, revenues or gains should be recognized only when they are realized in the form
of cash or assets (usually legally enforceable debts) the ultimate cash realization of which
can be assessed with reasonable certainty. Further, provision must be made for all known
liabilities, expenses and losses whether the amount of these is known with certainty or is
at best an estimate in the light of the information available. Probable losses in respect of
all contingencies should also be provided for. A contingency is a condition or a situation,
the ultimate outcome of which-gain or loss-cannot be determined accurately at present. It
will be known only after the event has occurred (or has not occurred).
So we can say that concept of conservatism enforce us to be safe in future or in other
words we can say that the actual mean of prudence is to acting with or showing care and
thought for the future, Which is the main motive of the concept of Conservatism.
Therefore we can say that the concept of conservatism is also known as the concept
of prudence.
It is not applied as strongly today as it used to be in the Past :For example, a customer has filed a suit for damage against the company in a court of
law. Whether the judgment will be favorable or unfavorable to the company cannot be
determined for sure. Hence, it will be prudent to provide for likely loss in the financial
statements. As a consequence of the application of this concept, net assets are more likely
to be understated than overstated, and income is more likely to be overstated than
understated. Based on this concept is the widely advocated practice of valuing
inventorying (stock of goods left unsold) at cost or market price. Whichever is lower. You
will note that this convention, in a way, modifies the Accounting Concepts and Standards

earlier cost concept. It should be stated that the logic of this convention has been under
stress recently; it has been challenged by many writers on the ground that it stands in the
way of fair determination of profit and the disclosure of true ad fair financial position of
the business enterprise. The concept is not applied as strongly today as. it used to be in
the past. In any case, conservatism must be applied rational Y as over- conservatism may
result in misrepresentation. Materiality Concept There are many events in business which
are trivial or insignificant in nature.
The cost of recording and reporting such events will not be justified by the usefulness of
the information derived. Materiality concept holds that items of small significance need
not be given strict theoretically correct treatment. For example, a paper stapler costing
Rs. 30 may last for three years.
However, the effort involved in allocating its cost over the three-year period is not worth
the benefit than can be derived from this operation. Since the item obviously is
immaterial when related to overall operations, the cost incurred on it may be treated as
the expense of the period in which it is acquired. Some of the stationery purchased for
office use in any accounting period may remain unused at the end of that period. In
accounting, the amount spent on entire stationery would be treated as expense of the
period in which the stationery was purchased, notwithstanding the fact that a small part of
it still lies in stock. The value (or cost) of the stationery lying in stock would not be
treated as an asset and carried forward as a resource to the next period. The accountant
would regard the stock lying unused as immaterial. Hence, the entire amount spent on
stationery would be taken as the expense of the period in which such expense was
incurred. Where to draw the line between material and immaterial events is a matter of
judgment and common sense. There are no hard and fast rules in this respect. Whether a
particular item or occurrence is material or not, should be determined by considering its
relationship to other items and the surrounding circumstances. It is desirable to establish
and follow uniform policies governing such matters.
Consistency Concept In practice, there
are several ways to record an event or a transaction in the books of account. For example,
the trade discount on raw material purchased may be deducted from the cost of goods and
net amount entered in the books, or alternatively trade discount may be shown as the
income with full cost of raw material purchased entered in the books. Similarly, there are
several methods to charge depreciation (which is a decrease in the value of assets caused
by wear and tear, and passage of time) on an asset or of valuing inventory.
The consistency concept requires
that once a company has decided on one method and has used it for some time, it should
continue to follow the same method or procedure for all subsequent events of the same
character unless it has a sound reason to do otherwise. If for valid reasons the company
makes any departure from the method it has been following so far, then the effect of the
change must be clearly stated in the financial statements in the year of change. You will
appreciate that much of the utility of accounting information lies in the fact that one

could draw valid conclusions from the comparison of data drawn from financial
statements of one year with data of the other year. Comparability is essential so that
trends or differences may be identified and evaluated. Inconsistency in the application of
accounting methods might significantly affect the reported profit and the financial
position. Further, inconsistency also opens the door for manipulation of reported income
and assets. The comparability of financial information depends largely upon the
consistency with which given classes of events are handled in ac-counting records year
after year.

(b) What is a Balance Sheet? How does a Funds Flow Statement differ from a Balance
Sheet? Enumerate the items which are usually shown in a Balance Sheet and a
Funds Flow Statement.
Ans.

A balance sheet is a statement of assets and liabilities of an NPF at any particular date. At
the end of each accounting period, every organization prepares a Balance sheet to have a
clear understanding of its assets and liabilities, which indicate the financial position of te
concern. The balance sheet is prepared from the point of view of the business (as a
separate entity, distinguished from its owner).
In other words we can say that in financial accounting, a balance sheet or statement of
financial position is a summary of the financial balances of a sole proprietorship, a
business partnership, a corporation or other business organization, such as an LLC or an
LLP. Assets, liabilities and ownership equity are listed as of a specific date, such as the
end of its financial year. A balance sheet is often described as a "snapshot of a company's
financial condition". Of the three basic financial statements, the balance sheet is the only
statement which applies to a single point in time of a business' calendar year.
Difference between Balance Sheet and Funds Flow Statement:Funds flow statement and balance sheet both are the statements of different nature. Funds
flow statement is a statement summarizing the significant financial changes which
occurred between the beginning and the end of a company's accounting period while
balance sheet is a statement of assets and liabilities at a particular point of time. Here are
some of the important differences between the two:
1. Funds flow statement include only those items which causes changes in working
capital while balance sheet includes the assets and liabilities of the company and
shows total resources of the company.
2. Funds flow statement can be used for decision making purpose while balance sheet is
used for examining the financial soundness of the company.
3. Funds flow statement is prepared for the use of internal management and hence its
preparation is not mandatory, while balance sheet is for the use of external parties like

creditors, shareholders, government and hence its preparation is mandatory for the
company.
4. Funds flow statement is prepared after preparation of balance sheet and for a
relatively short period of time as compare to balance sheet.

S. No.

Balance sheet

Fund flow statement

1.

Prepared to know the financial

position.

Prepared to know the total sources and

their uses in a year.

2.

Prepared on the basis of different

accounts in ledger.

Prepared with the help of balance

sheets of two consecutive years.

3.

Shows the assets and liabilities, its

a static statement.

It reveals the changes in the value of

Fixed Assets and their effect on flow of
funds.

4.

Useful for all, i.e. Management,

Shareholders, Creditors, Outsiders
and Govt. agencies etc.

Useful for internal financial

management.

5.

Current Assets and Current

Liabilities are shown item wise.

Current Assets and Current Liabilities

are used to find out increase or
decrease in working capital.

6.

Its preparation is a statutory

obligation and as per prescribed
format.

Its preparation is at the discretion of

the management

"Hence it can be said that funds flow statement is not a substitute of balance sheet but it
is a supplementary statement and hence they should both be used together in order to
reach at right conclusion regarding the financial position of the company".
Items included in Balance Sheet & Funds Flow Statement:Balance Sheet:-

A standard company balance sheet has three parts: Assets, Liabilities, and Ownership
equity.
1. The main categories of assets are usually listed first, and typically in order of
liquidity.
2. Assets are followed by the liabilities.
3. The difference between the assets and the liabilities is known as equity or the net
assets or the net worth or capital of the company and according to the accounting
equation, net worth must equal assets minus liabilities.

Items involved in Balance Sheet are as follows:1. Assets

a. Current assets
1. Cash and cash equivalents
2. Accounts receivable
3. Prepaid expenses for future services that will be used within a year
b. Non-current assets (Fixed assets)
1. Property, plant and equipment
2. Investment property, such as real estate held for investment purposes
3. Intangible assets
4. Financial assets (excluding investments accounted for using the equity method, accounts
receivables, and cash and cash equivalents)
5. Investments accounted for using the equity method
6. Biological assets, which are living plants or animals. Bearer biological assets are plants
or animals which bear agricultural produce for harvest, such as apple trees grown to
produce apples and sheep raised to produce wool.
2. Liabilities
1. Accounts payable
2. Provisions for warranties or court decisions (contingent liabilities that are both probable
and measurable)

3. Financial liabilities (excluding provisions and accounts payable), such as promissory

notes and corporate bonds
4. Liabilities and assets for current tax
5. Deferred tax liabilities and deferred tax assets
6. Unearned revenue for services paid for by customers but not yet provided
3. Equity / Capital
The net assets shown by the balance sheet equals the third part of the balance sheet,
which is known as the shareholders' equity. It comprises:
1. Issued capital and reserves attributable to equity holders of the parent
company (controlling interest)
2. Non-controlling interest in equity.

Funds Flow
By Funds flow (in accounting and financial management) we mean the flow in relation to the
various items that form part of the Fund Area in a Balance Sheet. The Funds Flow explains how
the values changed from the initial figure to the final figure between the two balance sheet dates.
Flow is between two points and the two points in a Funds Flow Analysis are the beginning and
the ending dates as indicated by the two balance sheets.
The flow (changes) is interpreted in two directions/ways. Funds flowing in and flowing out of
the organization.
1. Inflow (Or) Source of Fund
Where the change in the value of a Fund Account (Asset or Liability) results in the availability of
additional funds we say there is an inflow of fund and the change forms the source of fund. The
source of fund is an explanation for how we are getting the funds.

Thus, the following would result in an inflow of funds

An Increase in the value of a Fund Liability

Equity Share Capital

Debentures

Preference Share Capital

Long Term Loans

Reserves

Accumulated Profits

A Decrease in the value of a Fund Asset

Fixed Assets

Accumulated Losses

2. Outflow (Or) Application of Fund

Where the change in the value of a Fund Account (Asset or Liability) results in the reduction of
available funds, we say there is an outflow of fund and the change forms the application of fund.
The application of fund is an explanation for how we are utilising the funds.
Thus, the following would result in an inflow of funds

An Increase in the value of a Fund Asset

Fixed Assets

Accumulated Losses

A Decrease in the value of a Fund Liability

Equity Share Capital

Debentures

Preference Share Capital

Long Term Loans

Reserves

Accumulated Profits