CHAPTER 4: BASES OF ACCOUNTING (CASH BASIS AND ACCRUAL BASIS OF ACCOUNTING) ASSIGNMENT # 1

Chapter 4

BASES OF ACCOUNTING

LEARNING OUTCOMES:

 INTRODUCTION 
CASH BASIS OF ACCOUNTING 
ACCRUAL BASIS OF ACCOUNTING

INTRODUCTION:

INTRODUCTION TO THE CHAPTER (LINK)

The main objective of accounting is to determine profit earned on loss incurred by a business at the end of each accounting period. There are two bases of ascertaining profit or loss:

1. Cash Basis of Accounting

2.  Accrual or Mercantile Basis of Accounting

CASH BASIS OF ACCOUNTING:

CASH BASIS OF ACCOUNTING (LINK)

Cash basis of accounting is a system in which transactions are recorded when cash is received or paid. 

* Revenues is recorded when cash is received. For example, good sold on credit will be recorded only when sale proceeds are received.

* Similarly, expenses are recorded when cash is paid for them. For example, if salary for the month of December is paid in January, then it will be recorded in January.

* So, under Cash Basis of Accounting, only cash transactions are recorded and credit transactions are ignored till the cash received / paid for such credit transactions.

* Profit or loss for an accounting period is calculated as the difference between the actual cash receipts in respect of sale of goods or services and other incomes over actual payments in respect of total expenses.

* Outstanding expenses, prepaid expenses, income accrued and income received in advance are not considered under Cash Basis of Accounting.

* Generally, this system of accounting is adopted by the non trading concerns like school, college, club, etc

ACCRUAL BASIS OF ACCOUNTING:

ACCRUAL BASIS OF ACCOUNTING (LINK)

According to Accrual Basis of Accounting, revenue and expenses are recorded in the period in which they become due, rather when they are received or paid. 

• Under this system of accounting, a transaction is recorded in the books when it is entered into and not when settlement takes place. It means:

*  Revenue is recorded when sales are made or services are rendered, irrespective of the fact whether cash is received or not. So, if a firm has sold goods on 27th June, 2018 on two months credit, then the sale must be recorded on 27th June, 2018, although the amount will be received in August.

*  Similarly, expenses are recorded in the period in which they have become due rather than the period in which they are paid.

*   The profit or loss of any accounting period is the difference between the incomes earned and expenses incurred, irrespective of cash payment or receipt. So, this method is compatible with the matching principle of accounting.

*    Outstanding expenses, prepaid expenses, accrued income and unearned income are adjusted while preparing the Financial Statements.

*     According to the Companies Act,
 2013 companies are required to follow accrual basis of accounting in maintaining the books of accounts.


ILLUSTRATION:

ILLUSTRATION EXPLAINED (LINK)

Calculation of Income Under Cash Basis and Accrual Basis of Accounting

1.During the Accounting period 2018-19, Udit had total sales of ₹580000, out of which cash sales were of ₹ 370000.
 The total expenses for the year for ₹ 280000 out of which ₹ 70,000 are still outstanding.
Find out Udit's  Income for 2018-19 as per:
1. Cash Basis of Accounting 
2. Accrual Basis of Accounting

SOLUTION:

1. Cash Basis of Accounting:

Revenue (cash inflow, i.e. cash sales)                                 ₹ 370000

Less: Expenses (cash outflow:₹280000 - ₹70000)              ₹ 210000
                                                                                           __________

Net Income                                                                          ₹160000

Note:  Under Cash Basis of Accounting, credit sales and outstanding expenses are not considered.


2.  Accrual Basis of Accounting:

Total Revenue ( including Credit Sales)                            ₹580000

Les: Total Expenses ( including outstanding expenses)     ₹280000
                                                                                          _________

Net Income                                                                         ₹ 300000

ASSIGNMENT  # 1  (DO IT YOURSELF)

In the Financial year 2018-19, Aman earned a total revenue of ₹ 690000, out of which ₹ 470000 was received in cash.
 The total expenses paid by him were ₹440000, out of which ₹20,000 pertains to 2019-20.
 The expenses of ₹ 30000 are still outstanding.

Determine Aman's Income for  2018-19 as per:

1. Cash Basis of Accounting

2. Accrual Basis of Accounting.

CONCLUDING NOTE (LINK)