ANSWER 1(a)

The Conservatism Principle

The conservatism principle is the general concept of recognizing expenses and liabilities as soon
as possible when there is uncertainty about the outcome, but to only recognize revenues and
assets when they are assured of being received. Thus, when given a choice between several
outcomes where the probabilities of occurrence are equally likely, you should recognize that
transaction resulting in the lower amount of profit, or at least the deferral of a profit. Similarly, if
a choice of outcomes with similar probabilities of occurrence will impact the value of an asset,
recognize the transaction resulting in a lower recorded asset valuation.

Under the conservatism principle, if there is uncertainty about incurring a loss, you should tend
toward recording the loss. Conversely, if there is uncertainty about recording a gain, you should
not record the gain.
The conservatism principle can also be applied to recognizing estimates. For example, if the
collections staff believes that a cluster of receivables will have a 2% bad debt percentage because
of historical trend lines, but the sales staff is leaning towards a higher 5% figure because of a
sudden drop in industry sales, use the 5% figure when creating an allowance for doubtful
accounts, unless there is strong evidence to the contrary.
The conservatism principle is the foundation for the lower of cost or market rule, which states
that you should record inventory at the lower of either its acquisition cost or its current market
value.
The principle runs counter to the needs of taxing authorities, since the amount of taxable income
reported tends to be lower when this concept is actively employed; the result is less reported
taxable income, and therefore lower tax receipts.
The conservatism principle is only a guideline. As an accountant, use your best judgment to
evaluate a situation and to record a transaction in relation to the information you have at that
time. Do not use the principle to consistently record the lowest possible earnings for a company.

Under the prudence concept, do not overestimate the amount of revenues recognized or
underestimate the amount of expenses. You should also be conservative in recording the amount
of assets, and not underestimate liabilities. The result should be conservatively-stated financial
statements.

Another way of looking at prudence is to only record a revenue transaction or an asset when it is
certain, and record an expense transaction or liability when it is probable. Another aspect of the
prudence concept is that you would tend to delay recognition of a revenue transaction or an asset
until you are certain of it, whereas you would tend to record expenses and liabilities at once, as
long as they are probable. Also, regularly review assets to see if they have declined in value, and
liabilities to see if they have increased. In short, the tendency under the prudence concept is to
either not recognize profits or to at least delay their recognition until the underlying transactions
are more certain.
The prudence concept does not quite go so far as to force you to record the absolute least
favorable position (perhaps that would be entitled the pessimism concept!). Instead, what you are
striving for is to record transactions that reflect a realistic assessment of the probability of
occurrence. Thus, if you were to create a continuum with optimism on one end and pessimism on
the other, the prudence concept would place you somewhat further in the direction of the
pessimistic side of the continuum.
Prudence would normally be exercised in setting up, for example, an allowance for doubtful
accounts or a reserve for obsolete inventory. In both cases, a specific item that will cause an
expense has not yet been identified, but a prudent person would record a reserve in anticipation
of a reasonable amount of these expenses arising at some point in the future.
Generally Accepted Accounting Principles incorporates the prudence concept in many of its
standards, which (for example) require you to write down fixed assets when their fair values fall
below their book values, but which do not allow you to write up fixed assets when the reverse
occurs. International Financial Reporting Standards do allow for the upward revaluation of fixed
assets, and so do not adhere quite so rigorously to the prudence concept.
The prudence concept is only a general guideline. Ultimately, use your best judgment in
determining how and when to record an accounting transaction.

ANSWER 1(b)
Balance Sheet
The accounting balance sheet is one of the major financial statements used by accountants and
business owners. (The other major financial statements are the income statement, statement of
cash flow, and statement of stockholderequity) The balance sheet is also referred to as the
statement of financial position.
The balance sheet presents a company's financial position at the end of a specified date. Some
describe the balance sheet as a "snapshot" of the company's financial position at a point (a
moment or an instant) in time. For example, the amounts reported on a balance sheet dated
December 31, 2015 reflect that instant when all the transactions through December 31 have been
recorded.
Because the balance sheet informs the reader of a company's financial position as of one moment
in time, it allows someonelike a creditorto see what a company owns as well as what it owes
to other parties as of the date indicated in the heading. This is valuable information to the banker
who wants to determine whether or not a company qualifies for additional credit or loans. Others
who would be interested in the balance sheet include current investors, potential investors,
company management, suppliers, some customers, competitors, government agencies, and labor
unions.
We will begin our explanation of the accounting balance sheet with its major components,
elements, or major categories:

Assets

Liabilities

Owner's (Stockholders') Equity

Difference Between Balance Sheet And Funds Flow Statement

The main differences between balance sheet and fund flow statement are as below:

1. Meaning
Balance Sheet: Balance sheet is a statement of assets, liabilities and capital.
Funds Flow Statement: Funds flow statement is a statement if changes in assets,
liabilities and capital accounts.

2. Objective
Balance Sheet: Balance sheet is prepared to ascertain the financial position of a
firm.
Funds Flow Statement: It is prepared to ascertain the sources and application of
funds.

3. Preparation
Balance Sheet: It is prepared with the help of trial balance.
Funds Flow Statement: It is prepared with the help of balance sheets of two
subsequent dates.

4. Information
Balance Sheet: It provides static view of financial affairs.
Funds Flow Statement: It provides the changes in assets, liabilities and capital
accounts.

Items on the balance sheet are most important in

fundamental
fundamental analysis normally start by examining the balance sheet. This is because the balance
sheet is a snapshot of the company's assets and liabilities at a single point in time, not spread
over the course of a year such as with the income statement. Many experts consider the top line,
or cash, the most important item on a company's balance sheet. Other critical items include
accounts receivable; short-term investments; property plant and equipment; and major liability
items. The big three categories on any balance sheet are assets, liabilities and equity, and there
are important items listed in each category.
Important Assets

All assets should be divided into current and noncurrent assets. An asset is considered current if
it can reasonably be converted into cash within one year. Cash, inventories and net receivables
are all important current assets because they offer flexibility and solvency.
Cash is the headliner. Companies that generate a lot of cash are often doing a good job satisfying
customers and getting paid. While too much cash can be worrisome, too little can raise a lot of
red flags.
Important Liabilities

Like assets, liabilities are either current or noncurrent. Current liabilities are obligations due
within a year. Fundamental investors look for companies with fewer liabilities than assets,
particularly when compared against cash flow. Companies that owe more money than they bring
in are usually in trouble.
Important Equity

Equity is equal to assets minus liabilities, and it represents how much the company's
shareholders actually have claim to; investors should pay particular attention to retained earnings
and paid-in capital under the equity section.
Paid-in capital represents the initial investment amount paid by shareholders for
their ownership interest. Compare this to additional paid-in

Item of fund flow statement

Source of funds
1. fund from operation ( balance of second step )
2. issue of share capital

3. raising of long term loan

4. receipts from partly paid shares , called up
5. amount received from sales of non current or fixed assets
6. non trading receipts such as dividend received
7. sale of investments ( Long term )
8. issue of debenture
Applications or uses of funds
1. Funds lost in operations ( Balance negative in second step )
2. redemption of preference share capital
3. redemption of debenture
4. repayment of long term loans
5. purchase of long term loans
6. purchase of long term investment
7. non trading payments
8. payment of tax
9. payment of dividendscapital to show the equity premium investors paid above par value.
Retained earnings show the amount of profit the firm reinvested or used to pay down debt, rather
than distributed to shareholders as dividends