(1) XYZ Ltd. prepares its financial statements for the year ending March 31, 2024. The company follows the Straight-Line Method for depreciation of fixed assets and values inventory at FIFO (First-In, First-Out) method. However, XYZ Ltd. does not disclose these accounting policies in its financial statements. According to AS-1: Disclosure of Accounting Policies, discuss whether XYZ Ltd. has complied with the standard and explain the importance of disclosing accounting policies. (2) Mr. B starts a business by investing ₹7,00,000 as capital. He borrows ₹3,00,000 from a friend to purchase machinery worth ₹9,00,000 for the business. During the first year, the business earns revenue of ₹5,00,000 and incurs expenses amounting to ₹2,00,000. Mr. B withdraws ₹1,00,000 for personal use. According to the Business Entity Concept, what will be the capital of Mr. B's business at the end of the year?
Answer (1)
Let's address the question step by step:
(1) Compliance with AS-1: Disclosure of Accounting Policies
AS-1: Disclosure of Accounting Policies requires companies to disclose all significant accounting policies used in preparing and presenting financial statements. This ensures that users of financial statements can understand the basis on which the reports are prepared, which contributes to the consistency and comparability of financial information.
XYZ Ltd. does not disclose its accounting policies regarding the Straight-Line Method for depreciation and the FIFO method for inventory valuation, which means the company is not complying with AS-1. Not disclosing these policies can lead to a lack of transparency and can mislead stakeholders about the financial condition and performance of the company.
Importance of Disclosing Accounting Policies:
Transparency: Helps users understand the assumptions underlying the financial data.
Consistency: Enables users to compare financial statements across different periods or companies.
Decision-making: Provides necessary information for stakeholders to make informed economic decisions.
(2) Calculation of Capital at Year-End According to the Business Entity Concept
The Business Entity Concept states that the business is a separate legal entity from its owner, meaning all the business transactions are separate from personal transactions.
Initial Capital Investment by Mr. B: ₹7,00,000
Borrowed Funds to Purchase Machinery: ₹3,00,000 (This is a liability and doesn't affect the capital)
First-year Transactions:
Revenue: ₹5,00,000
Expenses: ₹2,00,000
Withdrawals for Personal Use by Mr. B: ₹1,00,000
Calculation of Net Income: Net Income = Revenue − Expenses = 5 , 00 , 000 − 2 , 00 , 000 = 3 , 00 , 000
Adjusted Capital Calculation: End of Year Capital = Initial Capital + Net Income − Withdrawals = 7 , 00 , 000 + 3 , 00 , 000 − 1 , 00 , 000 = 9 , 00 , 000
Therefore, the capital of Mr. B's business at the end of the year is ₹9,00,000 . This reflects the view of the business from its own standpoint, distinct from the personal finances of Mr. B.
