Chapter 9 Fundamental Accounting Concepts and Principles
SHORT QUESTIONS
B2C09T2Q001eng
Briefly explain the following accounting concept and principle and state why they are important in the preparation of
financial statements:
(a)
Consistency principle
(3 marks)
(b)
Business entity concept
(3 marks)
Answer:
(a)
The consistency principle requires the same accounting treatment (i.e., accounting policy or method) be adopted
for similar items from period to period so that a comparison of financial statements over periods is possible. A
change is allowed only if it can give a more accurate view of a business. The importance of this principle is to
achieve comparability of like items in financial statements over time.
(b)
(3 marks)
The business entity concept states that the business and its owner(s) are separate legal entities. Only transactions
affecting the business are to be recorded in the books of the business. The incomes and expenses of the owner(s)
should not be treated as those of the business. The importance of this concept is to define the area of interest of
the financial statements.
(3 marks)
B2C09T2Q002eng
Explain the meanings of the following accounting concepts and principle and illustrate each with an example:
(a)
Historical cost principle
(3 marks)
(b)
Going concern concept
(3 marks)
(c)
Accrual concept
(3 marks)
Answer:
(a) 

(b)


(c)


The historical cost principle states that the assets of an entity should be recorded at their original cost of
purchase or production. Historical cost is considered the most objective measure of the value of an asset.
(2 mark)
Example: A packaging machine was bought for $30,000 for use in the business. Even if its market value
increases or decreases after the purchase, the machine should still be stated in the books of the business at
its original cost.
(1 mark)
The going concern concept assumes that the business will continue to operate in the foreseeable future.
This means that when a business prepares financial statements such as the income statement and the
balance sheet, it is assumed the business has no intention or need to close or significantly curtail its scale
of operations. Under this concept, the assets of a business should be valued at historical cost, instead of
current market value.
(2 marks)
Example: If a company is in a poor financial position but its owners do not intend to close the business, its
assets should still be stated at cost.
(1 mark)
The accrual concept states that revenues should be recognised and recorded when earned and not when
money is received. Expenses should be recognised and recorded when they are incurred and not when
money is paid.
(2 marks)
Example: Goods that were sold on credit in December 2009 should be treated as part of the enterprise’s
revenues for the year ended 31 December 2009, even if money had not been received by the year end. (1
mark)
B2C09T2Q003eng
For each of the situations described below, state the accounting principle or concept that has been violated and prepare
the correct journal entry. (No narrations are required.)
(a)
Fixtures with a market value of $80,000 were acquired on credit at a cost of $75,000. The following double
entry was made:
Dr Fixtures
$80,000
Cr Other payables
$75,000
Cr Gain on purchase of fixtures $5,000
(3 marks)
(b)
The owner withdrew $9,000 by cheque to pay for his home relocation costs. The bookkeeper recorded the
transaction as follows:
Dr Transportation expenses
$9,000
Cr Bank
$9,000
(3 marks)
Answer:
(a) The historical cost principle has been violated.
The correct journal entry is:
Dr Fixtures
$75,000
Cr Other payables
$75,000
(b)
(1 mark)
(1 mark)
(1 mark)
The business entity concept has been violated.
The correct journal entry is:
Dr Drawings
$9,000
Cr Bank
$9,000
(1 mark)
(1 mark)
(1 mark)
B2C09T2Q004eng
For each of the situations described below, state the accounting principle or concept that has been violated and prepare
the correct journal entry. (No narrations are required.)
(a)
The owner used his own money to buy a $100 pocket-sized calculator for business use. As the sum was not large,
the bookkeeper did not bother making any entry in the books.
(b)
(3 marks)
A new photocopier was purchased for $12,000 cash during a summer sale at an office equipment company. If
this photocopier had been purchased from the normal supplier of the firm, the price would have been $18,000.
The office equipment account was debited for $18,000 and the following journal entry was made:
Dr Office equipment
Cr Cash
Cr Gain on purchase of office equipment
Answer:
(a) The business entity concept has been violated.
The correct journal entry is:
Dr Office equipment (or sundry expenses)
Cr Capital
(b)
The historical cost principle has been violated.
The correct journal entry is:
Dr Office equipment
Cr Cash
$18,000
$12,000
$6,000
(3 marks)
(1 mark)
$100
$100
(1 mark)
(1 mark)
(1 mark)
$12,000
$12,000
(1 mark)
(1 mark)
B2C09T2Q005eng
For each of the situations described below, state the accounting principle or concept that has been violated and prepare
the correct journal entry. (No narrations are required.)
(a)
The firm was short of cash and applied for a bank loan. The proprietor asked the accountant to include his
private apartment, which was worth $2,350,000, in the non-current assets of the firm to improve the firm’s
financial position. The following journal entry was made:
Dr Premises
Cr Capital
(b)
$2,350,000
$2,350,000
(3 marks)
A firm purchased an item of office equipment for $50,000. It agreed to sell it to another company for $60,000
after the end of the financial year. The bookkeeper made the following journal entry at the year end date:
Dr Office equipment
Cr Capital
$10,000
$10,000
(3 marks)
Answer:
(a)
The business entity concept has been violated.
No journal entry is required.
(b)
The historical cost principle has been violated.
No journal entry is required.
(1 mark)
(2 marks)
(1 mark)
(2 marks)
B2C09T2Q006eng
For each of the situations described below, state the accounting principle or concept that has been violated and give a
brief explanation.
(a)
Success Co is a domestic helper recruitment agency. At the end of 2009, Success Co helped Pauline Chan hire a
domestic helper and charged her an agency fee of $10,000. The agency fee was received in January of 2010.
Success Company did not include the $10,000 agency fee in its income statement for the year ended 31
December 2009.
(b)
(3 marks)
A company purchased a van at the end of the financial year for $30,000. The manager believed that the company
could only sell this van for $15,000. As a result, the van was shown at a value of $15,000 in the balance sheet.
(3 marks)
Answer:
(a) 


(b)



The accrual concept has been violated.
(1 mark)
The accrual concept states that revenues and expenses should be recognised in the period when they are
earned or incurred, and not when they are received or paid.
(1 mark)
As the service was provided in the year ended 31 December 2009, the revenue derived from the provision
of agency service was earned during that year. Therefore, the $10,000 agency fee should be included in the
income statement for the year ended 31 December 2009.
(1 mark)
The historical cost principle has been violated.
(1 mark)
The historical cost principle states that assets should be recorded at their original purchase cost. (1 mark)
Therefore, the van should be valued at $30,000 (purchase cost) and not $15,000 (market value). (1 mark)
B2C09T2Q007eng
(a)
(b)
Explain the following accounting principles and illustrate each with an example:
(i)
Historical cost
(3 marks)
(ii)
Consistency
(3 marks)
For each of the situations described below, state the accounting principle or concept that has been violated and
give a brief explanation.
(i)
Alpha Ltd showed its non-current assets at cost at year end despite the company’s intention to close next
month.
(ii)
(4 marks)
The salaries paid to the proprietor’s domestic helper were charged to the wages account of the business.
(4 marks)
Answer:
(a) (i)


(ii)


(b)
(i)


(ii)


The historical cost principle states that the assets of an entity should be recorded at their original
cost of purchase or production. Historical cost is considered the most objective measure of the value
of an asset.
(2 marks)
Example: A packaging machine was bought for $30,000 for use in the business. Even if its market
value increases or decreases after the purchase, the machine should still be stated in the books of the
business at its original cost.
(1 mark)
The consistency principle requires the same accounting treatment (i.e., accounting policy or method)
be adopted for similar items from period to period so that a comparison of financial statements over
periods is possible. A change is allowed only if it can give a more accurate view of a business. (2
marks)
Example: A number of methods can be used to depreciate non-current assets. Once a business has
adopted a depreciation method for a particular type of non-current assets, it should keep using the
same method for that type of non-current asset year after year.
(1 mark)
The going concern concept has been violated. The going concern concept assumes that a business
will continue to operate in the foreseeable future. This means that when a business prepares
financial statements such as the income statement and the balance sheet, it is assumed that the
business has no intention or need to close or significantly curtail its scale of operations. Under this
concept, the assets of a business should be valued at historical cost, instead of current market value.
However, if the business is going to be sold soon, the assets of the business should be valued at their
current market value.
(2 marks)
In the present case, Alpha Ltd is going to close next month. The going concern concept is no longer
applicable. Therefore, the assets of Alpha Ltd should be valued at their current market value.
(2
marks)
The business entity concept has been violated. The business entity concept states that the business
and its owner(s) are separate legal entities. Only transactions affecting the business are to be
recorded in the books of the business. The incomes and expenses of the owner(s) should not be
treated as those of the business.
(2 marks)
In the present case, the wages paid to the proprietor’s domestic helper were not related to the
business. Thus they should not be recorded in the books of the business.(2 marks)
B2C09T2Q008eng
(a)
(b)
Explain the following accounting concept and principle and illustrate each with an example:
(i)
Historical cost
(3 marks)
(ii)
Going concern
(3 marks)
For each of the situations described below, state the accounting principle or concept that has been violated and
give a brief explanation.
(i)
The proprietor delayed paying salaries to his staff until the next financial year so as to show a higher
reported profit this year.
(ii)
(4 marks)
The proprietor employed a website designer to develop a personal website for him. The designer’s salaries
were charged as an expense of the business.(4 marks)
Answer:
(a)
(i)

The historical cost principle states that the assets of an entity should be recorded at their original
cost of purchase or production. Historical cost is considered the most objective measure of the value
of an asset.

(2 marks)
Example: A packaging machine was bought for $30,000 for use in the business. Even if its market
value increases or decreases after the purchase, the machine should still be stated in the books of the
business at its original cost.
(ii) 
(1 mark)
The going concern concept assumes that a business will continue to operate in the foreseeable future.
This means that when a business prepares financial statements such as the income statement and the
balance sheet, it is assumed that the business has no intention or need to close or significantly curtail
its scale of operations. Under this concept, the assets of a business should be valued at historical cost,
instead of current market value. However, if the business is going to be sold soon, the assets of the
business should be valued at their current market value.

Example: If a company is in a poor financial position but its owners do not intend to close the
business, its assets should still be stated at cost.
(b)
(i)

(2 marks)
(1 mark)
The accrual concept has been violated. The accrual concept states that revenues should be
recognised and recorded when earned and not when money is received. Expenses should be
recognised and recorded when they are incurred and not when money is paid.

(2 marks)
The staff salaries were an expense incurred during the current financial year. According to the
accrual concept, this expense should be included in the income statement for the current financial
year and not next year.
(ii)

(2 marks)
The business entity concept has been violated. According to the business entity concept, the business
is to be treated as an entity separate from its owner(s). Only transactions that are related to the
business are to be recorded in the books of the business.

(2 marks)
The salaries paid to the website designer who designed a personal website for the owner were
unrelated to the business. Therefore, they should not be charged as a business expense.
(2 marks)
B2C09T2Q009eng
(a)
Explain the following accounting concept and principle and illustrate each with an example:
(b)
(i)
Accrual
(ii)
Historical cost
For each of the situations described below, state with a brief explanation the accounting principle or concept that
has been applied or violated.
(i)
The proprietor put his private car, worth $200,000, into the business. This transaction was not recorded in
the books of the business.
(ii)
Omega Ltd purchased a delivery van for $100,000. The company decided to depreciate this asset at the
rate of 20% per year. In order to increase the reported profit, the accountant changed the depreciation rate
to 5%.
(a) (i)
 The accrual concept states that revenues should be recorded when earned and not when money is
received. Expenses should be recorded when they are incurred and not when money is paid

Example: Goods that were sold on credit in December 2009 should be treated as part of the
enterprise’s revenues for the year ended 31 December 2009, even if money had not been received by
the year end.
(ii)  The historical cost principle states that the assets of an entity should be recorded at their original
cost of purchase or production. Historical cost is considered the most objective measure of the value
of an asset.

Example: A packaging machine was bought for $30,000 for use in the business. Even if its market
value increases or decreases after the purchase, the machine should still be stated in the books of the
business at its original cost.
(b) (i)
 The business entity concept has been violated. According to the business entity concept, the
business and its owner(s) are separate legal entities. Only transactions affecting the business are to
be recorded in the books of the business.

In the present case, the private car was contributed by the proprietor for business use. Therefore, it
should be recorded in the books of the business as an asset of $200,000 and the owner’s capital
should be increased by the same amount.
(ii)  The consistency principle has been violated. The consistency principle requires the same accounting
treatment (i.e., accounting policy or method) be adopted for similar items from period to period so
that a comparison of financial statements over periods is possible. A change is allowed only if it can
give a more accurate view of a business.

In the present case, the depreciation rate should not be changed for the purpose of increasing the
reported profit. It should be kept at 20% per annum.
B2C09T2Q010eng
(a)
(b)
Explain the following accounting concept and principle and illustrate each with an example:
(i)
Consistency
(3 marks)
(ii)
Going concern
(3 marks)
For each of the situations described below, state with a brief explanation the accounting principle or concept that
has been applied or violated.
(i)
A 12-month rental agreement was made on 1 January 2009. The monthly rent income was $12,000.
During the year ended 31 December 2009, only $108,000 was received. The bookkeeper recorded
$108,000 as rent revenue for the year ended 31 December 2009.
(ii)
(4 marks)
The closing inventory had a cost of $12,340 and a market value $20,000. The bookkeeper stated the
closing inventory at market value in the balance sheet.
(4 marks)
Answer:
(a)
(i)

The consistency principle requires the same accounting treatment (i.e., accounting policy or method)
be adopted for similar items from period to period so that a comparison of financial statements over
periods is possible. A change is allowed only if it can give a more accurate view of a business.
(2
marks)

Example: A number of methods can be used to depreciate non-current assets. Once a business has
adopted a depreciation method for a particular type of non-current assets, it should keep using the
same method for that type of non-current asset year after year.
(ii)

(1 mark)
The going concern concept assumes that the business will continue to operate in the foreseeable
future. This means that when a business prepares financial statements such as the income statement
and the balance sheet, it is assumed that the business has no intention or need to close or
significantly curtail its scale of operations. Under this concept, the assets of a business should be
valued at historical cost, instead of current market value.

Example: If a company is in a poor financial position but its owners do not intend to close the
business, its assets should still be stated at cost.
(b) (i)

(2 marks)
(1 mark)
The accrual concept has been violated. The accrual concept states that revenues should be
recognised and recorded when earned and not when money is received. Expenses should be
recognised and recorded when they are incurred and not when money is paid.

(2 marks)
The amount of rent received during the year was $108,000. Rental income for the year should be
$144,000 ($12,000  12). According to the accrual concept, the bookkeeper should record $144,000
as rent revenue for the year ended 31 December 2009.
(ii)

(2 marks)
The historical cost principle has been violated. The historical cost principle states the assets of an
entity should be recorded at their original cost of purchase or production. Historical cost is
considered the most objective measure of the value of an asset.

(2 marks)
In the present case, the closing inventory should be stated at its cost of $12,340. (2 marks)