BASIS OF ACCOUNTING

BASIS OF ACCOUNTING – CLEAR EXPLANATION

BASIS OF ACCOUNTING- MEANING

The basis of accounting is a set of rules that are followed by the accountant for preparing the financially reports like profit and loss account, balance sheet and cash flow statement. The basis of accounting tells about when and which transaction is to be recognized and how to record those transactions in the books of accounts.

The following are the various systems of accounting:

BASIS OF ACCOUNTING
BASIS OF ACCOUNTING

CASH BASIS OF ACCOUNTING

Under cash basis of accounting, the transactions are recorded when actual cash is received or paid. It means, the income is recognized when cash is received and the expenses are recognized when the cash is paid. It does not matter whether the cash received or paid belong to current, past or future year. Thus there is no scope to record the credit transactions. This basis of accounting is also known as Receipts basis of accounting.

FEATURES OF CASH BASIS OF ACCOUNTING                    

  • Entry is made in the books of accounts only when actual cash is paid or received.
  • No credit transaction is recorded.
  • No adjustments are required like for outstanding expenses, accrued income etc.
  • The profit is the excess of cash receipt over cash payments.
  • The loss is the excess of cash payments over cash receipts.

ADVANTAGES OF CASH BASIS OF ACCOUNTING

  • This is very simple and easy basis of accounting.
  • It satisfies the conservative attribute of many businessmen.
  • It does not require the use of estimates and personal judgments.
  • On this basis, the books can be maintained by junior staff also.
  • It is easy to calculate the profit or loss of the business house.

DISADVANTAGES OF CASH BASIS OF ACCOUNTING

  • It does not give true and fair view of profit and loss account and balance sheet of the business.
  • No adjustments are passed which gives an incomplete view of the financial reports.
  • There are more chances of manipulation of accounts.
  • It does not record non-cash items like depreciation etc.
  • It does not follow the matching principle of accounting.
  • This basis of accounting is not recognized by the Companies Act, 2013.
  • Income Tax Authorities do not recognize this system.
  • Accounts maintained on this basis cannot be accepted as evidence in the court of the law.
  • This system does not distinguish between capital and revenue items and as a result there is no consistency in the profits shown of various years.

SUITABILITY

This system is useful for the adoption by professional people like lawyers, doctors, chartered accountants etc.

ACCRUAL BASIS OF ACCOUNTING

Accrual basis of accounting is also known as Mercantile basis of accounting. It is a system where transactions are recorded when they arise. It does not matter whether the cash received or paid or not. It means the incomes are recorded in the books of the accounts when it is earned, irrespective of the fact that it is received or accrued.

EXAMPLE: Rent accrued ₹1,000. (earned but not received)

Similarly, the expenses are recorded in the books of accounts when they incurred, it does not matter whether cash is paid or outstanding for the same.

EXAMPLE: Salary outstanding. (due but not paid)

This system is most commonly used and followed by every business organisation.

FEATURES OF ACCRUAL BASIS OF ACCOUTING

  • It recognizes the credit transactions.
  • It records all the transactions whether cash is paid or received for the same or not.
  • This system is recognized by the Companies Act, 2013 and Income Tax Authorities.
  • The adjustments of Outstanding expenses, Accrued Income, income received in advance, prepaid expenses are passed.
  • It follows matching principle of accounting.

ADVANTAGES OF ACCRUAL/ MERCANTILE SYSTEM OF ACCOUNTING

  • It shows the true and fair view of the final accounts maintained.
  • It follows the matching principle of accounting which helps in calculating the accurate profit or loss for the year.
  • This system distinguishes between capital and revenue items, thus provides consistency in calculation of profit or loss.
  • It record the non-cash items like depreciation.
  • It is recognized by Companies Act, 2013 and Income Tax Authorities.

DISADVANTAGES OF ACCRUAL/ MERCANTILE SYSTEM OF ACCOUNTING

  • It requires the use of personal judgments and estimates.
  • It is not a simple method of accounting to be followed.
  • This system of accounting requires analytical skills and based on accounting technicalities.

SUITABILITY

This method is suitable to all the profit making business organisations that are engaged in trading and manufacturing activities.  

HYBRID SYSTEM OF ACCOUNTING

It is the mixed basis of accounting. It is the mixture of cash basis and accrual basis of accounting. Under hybrid basis of accounting, revenues and assets are recorded on cash basis whereas expenses and liabilities are recorded on accrual basis. Usually professional people such as doctors, lawyers etc. adopt this method and prepare Receipts and Expenditure Account to ascertain their net income during a period. They ignore their outstanding income but take into consideration outstanding expenses. The idea is to claim deduction for outstanding expenses while computing taxable income. Hybrid system of accounting is an acceptable and approved system as per the judgment of the courts.

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