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CMA Foundation · Fundamentals of Financial and Cost Accounting · Accounting Principles, Concepts and Conventions

Mehta Traders paid Rs 12,000 in March for an insurance policy covering April to the following March. Mehta prepares accounts to 31 March. Which accounting principle requires this payment to be treated as a prepaid expense and not as an expense of the year just ended?

The matching concept requires the insurance premium to be carried forward as a prepaid expense. The cover relates to the next accounting year, so its cost must be set against that year's revenue. Charging it in the year of payment would follow the cash basis, which accrual accounting rejects.

  1. AMatching concept, because expenses are recorded in the period in which the related revenue is earnedCorrect
  2. BCash basis, because the payment was made in March
  3. CMoney measurement concept, because the amount is stated in rupees
  4. DEntity concept, because the owner is separate from the business

Explanation

The policy gives cover in the next year, so its cost must be matched with the revenue of that year. Under the cash basis the Rs 12,000 would be charged in the year of payment, but accrual accounting does not follow that basis. So the amount is carried forward as a prepaid expense.

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