Advertisements
Advertisements
Question
Assertion (A): According to the Prudence Principle, the valuation of Closing Stock is based on either its cost price or its net realizable value, whichever is lower.
Reason (R): This practice ensures that a business firm does not present a more favourable financial position than what it actually is.
Options
A is true but R is false.
A is false but R is true.
Both A and R are true and R explains A.
Both A and R are true but R does not explain A.
Advertisements
Solution
Both A and R are true and R explains A.
Explanation:
The Prudence Principle (or Conservatism) states that an accountant must anticipate all potential future losses but never anticipate future profits. Valuing closing stock at the lower of cost or net realisable value guarantees that inventory assets and net profits are not intentionally inflated, which explains why this practice prevents a company from presenting an overly favourable financial position.
