Which one of the following accounting concepts is applied by an entity, when events such as new competitor entering in the market and rift between production and marketing departments are not disclosed in the books of accounts ?

Correct — B, (b) Money Measurement. Read the ask carefully before reaching for a concept: the question is which concept the entity IS applying, and the two events it describes are the illustration, not the answer. The money measurement concept says that only those transactions and events which can be expressed in terms of money are recorded in the books of account. A rival opening for business and a quarrel between the production and marketing departments are commercially important — they may well decide next year's profit — but neither has a money amount attaching to it that could be journalised, so neither enters the ledger. The concept is what keeps them out, and it is doing its work precisely when nothing is recorded. The reason accounting accepts that limitation is that money is the only common denominator available: a business cannot add three machines, five hundred kilograms of raw material and ten employees into a single statement, but it can add ₹4,00,000, ₹90,000 and a wage bill. Converting everything to money is what makes the accounts summable and comparable at all, and the price of that convenience is that everything not convertible falls outside. Facts of this kind are not lost to the reader of an annual report; they surface in the directors' report and the management discussion and analysis, which exist partly because the books themselves cannot carry them.

Why the others are wrong

• (a)Matching — Matching allocates costs to periods: the expenses of a period are set against the revenues they helped to earn, which is what justifies charging outstanding expenses before payment and spreading the cost of an asset through depreciation. It takes a measured amount as its starting point and asks which period should bear it. Here there is no amount at all, so there is nothing for matching to allocate. This is the same word that appears as option (a) in the question immediately above this one on the paper, and in both places it is the wrong answer for the same underlying reason — it is a concept about timing, not about admission to the books.
• (c)Revenue Recognition — Revenue recognition, also called the realisation concept, fixes the moment at which revenue is treated as earned — generally when goods are transferred or services are rendered, rather than when an order is received or when cash is later collected. It governs sales, and neither of the events in the stem is a sale. A new competitor may reduce future revenue and an internal rift may delay a delivery, but neither is a revenue transaction whose timing has to be settled, so the concept has no work to do here.
• (d)Cost — The cost concept, or historical cost concept, says an asset is recorded at the price actually paid for it and that this figure, less depreciation, remains the basis of its accounting value regardless of what the market would pay later. It answers 'at what amount does a recorded item appear', which presupposes that the item is recorded at all. The stem asks the prior question — why something is not in the books — and the answer to that is the measurability test in the money measurement concept, not the valuation rule in the cost concept.

The money measurement concept is one of the basic accounting concepts, and it does two distinct jobs that are worth separating. The first is a filter: only transactions and events capable of being expressed in monetary terms are recorded, so the quality of management, the skill and morale of the workforce, customer loyalty, the arrival of a competitor and internal disputes all stay out of the ledger however material they are to the business's prospects. That is the job this question tests. The second is an assumption hidden inside the first: because money is used as the unit of measurement, accounting treats the value of money as stable, and rupees of one year are added to rupees of another without adjustment. A building bought in 1995 and a building bought last year sit in the same total. In a period of inflation that assumption distorts the picture — assets are understated, depreciation is charged on outdated costs and profits are overstated — and it is the standing argument for inflation accounting and current cost accounting. The concept therefore has both a defence and a criticism attached to it, and EPFO papers ask about each. It also connects outward: it is the money measurement concept that makes the dual aspect equation arithmetic rather than description, and it is what makes financial statements from different businesses comparable at all.

Key facts

• Money measurement concept: only those transactions and events which can be expressed in terms of money are recorded in the books of account.
• Qualitative facts — managerial ability, employee morale and skill, customer satisfaction, competitive pressure, internal disputes — are excluded by the concept even when they are commercially decisive.
• Money is used as the common denominator, which is what allows heterogeneous assets and transactions to be added into a single set of statements.
• A corollary of the concept is that money is assumed to be a stable unit of measurement, so figures of different years are added without adjustment for changes in purchasing power.
• That assumption is the concept's principal limitation in inflationary conditions and the reason inflation accounting and current cost accounting are proposed.
• Matters excluded from the books may still reach the reader through the directors' report and the management discussion and analysis.
• The related concepts most often confused with it are the cost concept, which fixes the amount at which a recorded item appears, and the business entity concept, which fixes whose transactions are recorded.

Common traps

• Reading the 'not disclosed' in the stem as a negative ask. The question asks which concept IS applied, and the omission is the illustration.
• Choosing the cost concept because the answer involves what does or does not go into the books. The cost concept fixes the amount of a recorded item, not whether it is recorded.
• Choosing matching because a cost may eventually arise from the events described. Matching allocates measured amounts to periods; here there is no measured amount.
• Assuming that anything important must appear in the books. Importance is not the test; measurability in money is.
• Forgetting the second half of the concept. It also assumes the value of money is stable, which is the limitation examiners ask about.

• practice — not a real PYQ

  The assumption that the value of money remains stable over time, so that amounts of different years can be added together in the financial statements, is implicit in which one of the following concepts ?

  • (a)Going concern concept
  • (b)Money measurement concept
  • (c)Accounting period concept
  • (d)Dual aspect concept

  Answer(b) Money measurement concept

• practice — not a real PYQ

  Which one of the following is a limitation of the money measurement concept ?

  • (a)It requires the business to be treated as an entity separate from its owner
  • (b)It requires expenses of a period to be set against the revenues of that period
  • (c)It leaves out facts such as the skill of the workforce and the quality of management, which cannot be expressed in money
  • (d)It requires the same accounting policies to be followed in every accounting period

  Answer(c) It leaves out facts such as the skill of the workforce and the quality of management, which cannot be expressed in money