Explanation
The cost concept requires that all assets are recorded in the book of accounts at their purchase price, which includes cost of acquisition, transportation, installation and making the asset ready to use.
For example, an old plant was purchased for Rs. 50 lakh, which is into the business of manufacturing detergent powder. The following were the other expenses incurred for its installation:
1. Transporting the plant to the factory site- Rs. 10,000
2. Repairs for bringing the plant into running position- Rs. 15,000
3. Installation- Rs. 25,000
The total amount at which the plant will be recorded in the books of account would be the sum of all these, i.e. Rs. 50,50,000.
The concept of cost is historical in nature as it is something, which has been paid on the date of acquisition and does not change year after year. This cost is also called as original cost or historical cost.
The convention of conservatism mean that the convention of caution, or the policy of playing safe. This principle requires that in the situation of uncertainty and doubt, the business transactions should be recorded in such a manner that the profits and assets are not overstated and losses and liabilities are not understated. The following are some examples:
1. Closing stock is valued at cost price or Net realisable value, whichever is lower.
2. Joint life insurance policy is shown only at surrender value as against the amount paid.
3. Provision for doubtful debt is created in anticipation of bad debts etc.
4. Provision for pending law suit against the firm, which may either be decided in its favour.
Prepare accounting equation on the basis of the following:-
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