Bases of Accounting

 

Introduction

The main objective of accounting is to determine profit earned or 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

1. Cash Basis of Accounting

        Under this system of recording, all the financial transactions are recorded only when cash is received or paid. Thus, credit transactions are not recorded in this system. It means revenue is recognised only on the receipt of cash and expense is recognised when on its payment. 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.

Advantages

1.   It is a simple method to understand and follow.
2.   There are no adjustments entries for outstanding expenses, prepaid expenses, accrued income and unearned income.
3.   The method is not affected by the personal biasness of the accountant or management.

4.   It is suitable for those enterprises where most of the transactions are on cash basis.

Disadvantages

1.   It does not follow the matching principle of accounting.
2.   No distinction is made between capital and revenue items so the profit or loss are not comparable over a period of time.

3.   This system does not reveal a true and fair view of profit or loss and financial position of an entity.

 

2. Accrual Basis of Accounting

        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. This system is most scientific system of accounting as it is based on principle of recognition and on principle of matching concept. Outstanding expenses, prepaid expenses, accrued income and income received in advance are adjusted so as to arrive at the net income of the accounting period. All trading and profit making concerns follow this system of accounting as it is most scientific and is based on double entry system of accounting.

 

Advantages

1.   It is a the most scientific system of accounting and is preferred and followed all over the world by the accountants.
2.   It follows principle of recognition and principle of matching.
3.   This system maintains distinction between capital and revenue item.
4.   It discloses correct profit or loss for particular period and also depicts true financial position of the business.

5.   This system of accounting makes the inter-period and inter-firm comparison possible.

Disadvantages

1.   This is not as simple as Cash Basis of Accounting.

2.   The system requires personal judgement of the accountant or management in respect of valuation of stock, election of a method of charging depreciation, creation of provision for doubtful debt. Thus, true profit may not be ascertained due to personal biasness of the accountant or management.