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 ) Mention the name of applied principle ( s ) .

Explanation / Answer

Mr. Jahanzaib has not reported the land value correctly in the balance sheet. The correct value to report in the balance sheet should be Rs.400,000. This follows the 'Historical Cost' principle of accounting. The 'Historical Cost' principle states that the assets must be reported at the acquisition/ purchase price in the balance sheet. Some of the common reasons for using historical cost in the books are: 1. comparibility over year over year - without a consistent & fixed cost, it will be difficult to compare assets year over year basis; 2. Difficulty in fixing a market value every year - it is difficult and judgemental to value the asset every year which might not be very accurate; 3. No proof of the market value - there is no invoice/bill for the market value of the assets and hence there is no solid basis for recordiing them at the market price.

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