Mr. Jahanzaib has set up a new sole proprietorship business one year ago. At the

Question

Mr. Jahanzaib has set up a new sole proprietorship business one year ago. At the end of the financial year, he has to prepare financial statements of the business. In the last month of the closing year, he had an offer to sell the freehold land for Rs. 600,000/- which was previously purchased for Rs. 400,000/-. Mr. Jahanzaib had reported the land in his balance sheet at Rs. 600,000/- considering the offered value.



Required:

Do you think that Mr. Jahanzaib has rightly reported the land’s value in the Balance Sheet? Justify your answer in the light of accounting principle(s). You are only required to mention the name of applied principle(s). Details are not required.”

Explanation / Answer

Cost Principle....

From an accountant's point of view, the term "cost" refers to the amount spent (cash or the cash equivalent) when an item was originally obtained, whether that purchase happened last year or thirty years ago. For this reason, the amounts shown on financial statements are referred to as historical cost amounts.


Because of this accounting principle asset amounts are not adjusted upward for inflation. In fact, as a general rule, asset amounts are not adjusted to reflect any type of increase in value. Hence, an asset amount does not reflect the amount of money a company would receive if it were to sell the asset at today's market value. (An exception is certain investments in stocks and bonds that are actively traded on a stock exchange.) If you want to know the current value of a company's long-term assets, you will not get this information from a company's financial statements - you need to look elsewhere, perhaps to a third-party appraiser.

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