4

and Bases of Accounting

Process

LEARNING 0BJECTIVES understand:

be able to
After studying this Chapter you should
recording of business transactions to
(from
" Process of Accounting
balance)
preparation of trial
. Bases of Accounting:
() Cash Basis of Accounting
(2) Accrual Basis ofAccounting Accountingand Accrual BasisS
of
Distinction between Cash Basis
of Accounting
of Accounting
" Hybrid or Mixed Basis
Process of Accounting jdentification of businesS
and
begins with the
origin summarization of business
Accounting process classification and statements, 1.e.,
followed by recording, and financial
transaction and is of trial balance in accounting
culminating in preparation Following steps are followed
transactions Balance Sheet.
Account and
Profit & Loss (v) Preparation
process : |(üi)Record (i) Posting ofTrial
to Balance and
O ldentifica (ii) ration
Prepa of Ingin
books. of Ledger Financial
tion of Vouchers Statements
original
Transac
tions entry

explained as below: with business transactions

These steps are : Accounting
deals cannot be
ldentification of Transactions words, the transactions which For
()
monetary in nature. In other
cannot be recorded in accounting.
which are in terms of money that these transactions are evidenced
by
measured and expressed necessary invoice,
recordingbusiness transactions, it is memo, purchase invoice, sales
appropriate document such as cash document which provides evidence of the
an pass book etc. A
pay-in-slip, cheque book,
Source Document.
lransaction is called the first
of Vouchers : On the basis of source documents entries are,
Preparation then on the basis of vouchers recording is made in the
vouchers and
ofall,,recorded on original entry. Voucherss are printed separately by all the firms in
Journal or books of
 ACCOUNTING
PROCISs AND BASESCOF
4.3 ech iruneneties snd it
names, A scuarate voher in prepured ur attached to the
thcir oWm y
debited and credited. SoIrce docuent is enerally as in the case of
accOuntsto bo AICh
the Sometimes, voucher also Nerves as MMIrce doeunetchronological order and
voucher. Vouchers, whleh are uxually arrunged In
expenscs. separate ile.
petty numbered, are kept in a in which transsactions
are
serially Booke of Original Entry t The books
called Books of
Recordingin from a voucher or a source document are transactions are
(i) the firsttime original entry in which
tor one of the books of principles of double
rvoded Journalis (day-to-day) order according to the be possiblc to record
Original Entrychronological the business is asmall onc, it maygrows and the number
Nondedin a Whhen the sizeof when the size ofthe businessnumber of books called
system. journalbut sub-divided into a and
entry
transactions in the
large
jourmal is
all transactions relating to receipts
purchase
alltransactions is veryjournals. For example, all
credit
transactions relating tobook and so on.
special book, sales in sales called practical
of
sub-jourmals or recordedincash credit I
offcash
are transactions relating to
journal only,is
payments
book, all special journalsinstead ofalso calledsubsidiary books as
purchase transactionsin are
in These special journals
Recordingof book-keeping. ofledger. process is to transfer
all
of preparation accounting
system the accounts in ledger. A
facilitatethe The nextstepin to respective ultimately find
these Ledger : subsidiary books transactions
Postingtojournal or in
which.allthe form. Forrecording in
(n) accounts classified
recorded in book of accountsin aduly similar nature are recorded att
entries
the
principalrespective transactions of complete nicthure
a
ledgeris under their classifiedand
which willprovideseparateaccountsars
their placetransactions are name ledger
intheir glance. 1hus, n supplier. Likewise,incomer separate
ledger, all account opened a
oneplace inan relatingto thematwhether customer or etc. Similarly,all senaotk
transactions person, sales under
all the of each liabilities,purchases, againclassified etc.
openedin the
name assets, Journalare Account
opened for recordedin Account, Discount
accountsare whicharealreadyAccount,Rent Last stenin the
Statements :
expenses,
and ledger,suchasSalary Financial preparationofTrial
headsin Balanceand accountsand the preparedwith
of Trial ledger statement, of
(v)
Preparation balancing of Trial Balanceisa arithmeticalaccuracy
is the balances.A the indicates
accounting process help ofsuch accounts to check does not tally, it taken
the balances of ledger
Balance withcredit trial balance andstepsareledger
accounts. Ifa occurred
the debitandbalancingofledger ofaccounts have the balances of all
postingand balancing balancecontains Trading
errorsin posting or
the trial statements namely
Ihatsome rectifysucherrors.As prenaration of financial
and
to locate provides a basis for
accounts, it Sheet.
Account and a Balance
and Profit & Loss Bases of Accountig profit or loss of a
to
ascertainthe two bases of
of accounting is period. There are
One of the main objectives
business enterprise at the end of an
accounting
(2) Accrual Basis. recordedunless
namely (1) Cash Basis, and
ascertaining profit or loss, not
incomes are theyarepaidin
(1) Cash Basis of Accounting : Under this basis,
they are received in cash. Similarly. expenses are
recorded only when
 43
PROCESS AND BASES OF ACCOUNTING
tillcash
cash.. In other words, credit tansactions are not recorded at alland areeignored
of actual
cash
excess
is actually received Ior paid for them. Thus profit is merely the paymentsin respect
receipts in respect of sale of goods and other incomes over ractual or profit is
Income
of purchase of goods, expenses on wages, salary, rent etc. basis is useful lor
calculated with the help of a Receipts and Payments A Account. This
professional people like lawyers, doctors, chartered accountants etc.
Advantages: of many
conservative insstinct
) This basis is simple, realistic and satislies the
people.
(ii) It does not require the use of estimates and personal judgements.
transactions are on cash
It is suitable for those enterprises where most of the
basis.
Disadvantages : positionofthe
fair view of profit or loss and financiall
expenses, accrued
() It does not givea true and prepaid
enterprise because it ignores outstanding expenses,
incomes and incomes received in advance.
ofaccounting. For example, acquisitio is
not follow matching principle in which payment
(i) h does as expenses of the
period
goods will have to be treated which benefits are derived from
them.
made instead of the periods in cash basis of accounting
profits in
is a great possibility of manipulation of carly and similarly
incomes
(ii) There delaved or made
because payments may either be
collected early.
may be postponed or recognize it.
does not
(iv) Companies Act, 2013
ILLUSTRATION 1. Shekhawat for the year
the books of Mr.
Following information is obtained from
2023:
ended 31st March, 5.20,000
1,40,000
Cash Sales 4,10,000
Credit Sales to be puid)
which 260,000 is still Basis of
Expenses (out of Shekhawat if he adopts Cash
or Loss of Mr.
Ascertain the Net Profit
Accounting
SOLUTION:
5,20,000
Cash Sales Z60,000) 3,50,000
Cash (4,10,000- 1,70,000
Less : Expenses incurred in
Cash basis
Net Profit as per
Acçounting.
Note: are not considered under Cash basis of
Credit Sales and Outstanding expenses when
Accounting : Under this basis, incomes are recorded
(2) Acerual Basis of irespective of the fact whether cash is received or not, e.g,
or accrued, of the period. Similariy
they are carned included in the total sales
sales made on credit will be
 4.4

expenses are recorded when they are PROCESS AND BASES

incurred or become due OF
paid for them, e.g., rent due to the landlord
the period when it is due and not inthe period not paid will beand not when the
but
profit or loss of a particular period is the result ofwhen it is paid.
expenses incurred during the period. This makes itmatching of the in
AC OUNTING,
.Hence,Ireated expense
as cash is
fog
expenses, prepaid expenses, accrucd iincomes, necessary to
consid er
ac
revenues rua
car
l
n edbrasis,
preparation of financial statements. incomes
Under the Companicesrcceived in and
requiredto maintaintheir accounts according to accrual Act, 2013, all ctc. for the
basis
a dvanc e Outstaning
Advantages:
() It discloses true profit or loss for a
of
account cnogmpanies ate
i
particular
financial position of the business at the end of aperiod and also
takes into account alltransactions relating to a particular perioddepicts true
account all adjustments like period and because
particular it
outstanding expenses, prepaid takes into
income and income received in advance.
(i) t follows the matching principle of accounting. accruedexpenses,
(ii) There is consistency in the computation of profits off
basis because it makes a distinction between capital different years in accrual
and revenue
(iv) It is recognised by Companies Act, 2013. expenditure.
Disadvantages :
() It is not as simple as cash basis of accounting.
(ii) It requires the use of estimates and personal judgements.

ILLUSTRATION 2.
Taking the figures of llustration 1, ascertain the Net Profit if Mr. Shekhawat
follows Accural Basis of Accounting.
SOLUTION:
Total Sales for the year:
Cash Sales
5,20,000
Credit Sales
1,40,000
6,60,000
() Total Expenses for the year
4,10,000
Net Profit as per Accrual Basis
2,50,000
ILLUSTRATION 3.
Mr. Ghosh gives the
following information for the year ending 31st March, 2023:
Cash Purchases
15,00,000
Cash Sales
Credit Purchases 40,00,000
Credit Sales 3,00,000
Income received 5,00,000
Income received in advance 80,000
(included in 80,000
Income due but not yet received 6,000
15,000
 45
ACCOUNTING
BAS/SOF
PRXIN AND 8,50,0M0
Iyenses pad 20,00)
in B,50,000)
Eyenes paid in adv ance (included 45,00
and
Expenses xt yet paid () Cash Basis of Accounting,
loss if he adopts
Ascertain the prolit or
of Accounting.
()Accrual Basis
SOLUTIOV: ed :
When Cash Basis of Accounting is follow
() 40,00,000
Revcnue :
Cash Sales 80,000
Income received (A)
40,80,000

Expenses : 15,00,000
Cash Purchases 8,50,000
Expenses Paid 23,50,000
(B)
17,30,000
Basis (A - B)
Net Profit as per Cash
Acerual Basis of Accounting is followed:
() When 40,00.000
Revenue :
5,00,000
Cash Sales
Credit Sales 80,000
Income Received
Advance 6,000
Less Income Received in 74,000
89,000
15,000
Add : Income due but not yet received (A)
45,89,000

15,00,000
Expenses
Cash Purchases 3,00,000
Credit Purchases 8,50,000
Expenses Paid 20,000
Expenses paid in advance
Less 8,30,000
45,000 8,75,000
Add : Expenses due but not yet paid (B) 26,75,000
19,14,000
(A- B)
Net Profit as per Accrual Basis

ILLUSTRATION 4.
gives you the following information for the year ended 31st March,
Mr. Dushyant
2023 :
8,00,000
Cash Sales 2,80,000
Credit Sales
Cash Purchases 5,10,000
4.6
PROCESS AND BASES OF A
Credit Purchases
Salary Paid
Salary Outstanding
Rent Paid for ll months
AC OUN1T50IN,0G
Insunance Expenses Paid (including prepaid 18,000)
Income reccived in advance
12,55,000000
Income earned but not received
2A (000
Income received (excluding income received in advance) 6,000
Determine the profit or loss if he adopts () Cash Basis of 2,000
(iin) Accrual 10,0and00
SOLUTION:
Basis of Accounting. Accounting,
() When Caxh Basis of Accounting is followed :
Revenue :
Cash Sales
Income received in advance
Income received 8,00,6,000000
Expenses : (A) 10,000
Cash Purchases 8,16,000
Salary Paid
Rent Paid 5,10,000
Insurance expenses paid 80,000
55,000
Net Profit as per Cash Basis (B) 24,000
(A-B) 6,69,000
(in) When Accrual 1,47,000
Basis of Accounting is followed :
Revenue:
Cash Sales
Credit Sales 8,00,000
Income earned but not received 2,80,000
Income received 2,000
10,000
Expenses : (A) 10,92,000
Cash Purchases
Credit Purchases 5,10,000
Salary Paid 1,50,000
Add : Salary Outstanding 80,000
Rent Paid 12,000 92,000
Add:
55,000
Rent Outstanding for one month : 3,000
5,000 60,000
Insurance Expneses
Less: Prepaid 24,000
18,000 6,000
Net Profit as per Accrual Basis (A - B) (B) 8,18,000
2,74,000
PROCESS AND BASES OF ACCOUNTING
4.7
Distinction between Cash Basis of Accounting:and
Accounting: Accrual Basis of
Cash Bala of
Basis of Distinction
Accounting Accrusl Basis of
I. Recording of cash and
credit transactions
This basis records only the
cash transactions.
Aecountinmakes
This basis
conplete
as wel record of all cash
a

credit
2. Timing of Recording of As per this basis, only |As per transactions.this
incomes |those incomes are basis, all
|recorded which have been incomes are
whether cash is recorded
not. received
received in cash. for them or
3. Timing of Recording of As per this basis, only |As per this basis, all
expenses those expenses are
expenses are recorded
recorded which have been whether cash is paid for
paid in cash. them or not.
4. Outstanding expenses, This basis does not take |This basis takes into
prepaid expenses, into
consideration
acerued incomes and outstanding
consideration
expenses, items.
all such
incomes received in
|prepaid expenses, accrued
advance incomes and incomes
received in advance.
5. Legal Position This basis is not This basis is recognised
recognised under the under the Companies Act,
|Companies Act, 2013. 2013.
6. Ascertainment of This basis does not This basis ascertains
correct profit or loss. ascertain correct profit or correct profit or loss
loss because it does not because it makes a
make a complete record of complete record of all cash
all cash and credit and credit transactions.
transactions.

7. Suitability This basis is suitable for This basis is adopted by

professional people like business enterprises with
|octors, lawyers etc. profit motive.

Hysbrid or Mixed Basis of Accounting : accrual basis. Under

This basis of accounting is the mixture of cash basis and
recorded on cash basis whereas
hybrid basis of accounting, revenues and assets are
Usually professional people
expenses and liabilities are recorded on accrual basis.
prepare Receipts and Expenditure
such as doctors, lawyers etc. adopt this method and They ignore their outstanding
Account to ascertain their net income during a period.
expenses. The idea is to claim
income but take into consideration outstanding taxable income. Hybrid system
deduction for outstanding expenses while computing
as per judgements of the cours.
of accounting is an acceptable and approved system
 4.8
PROCESS AND BASES SOF
SHORT ANSWER QUESTIONS
NCOUNTINC
1. Name the steps
followed in accounting procesg
2, What is meant by Acerual Basis of
accrual basis of accounting.
3. Give any four points of
Accounting? Explain any two
distinction between cash basis
accounting.
4. "Cash Basis of Accounting is not a
and aÜvartages
accrual(KVSbasi2022)s of
o

financial position of an enterprise."" Do better basis for

your answer.
S. Ifoffice rent for the month of
you agree? Give
depireasonsctingin thesupporcomesn tof
December 2018 is paid in January
be recorded in the book of the
Firm in January (Delhi 2018)
credit in the month of
January
necorded in April, 2019 when the 2019 would
2019. Similarly
not be recorded sale
payment of sale is received. in of goodswoul d
on
2019,It
ldentify the Basis of Accounting used but January
more appropriate basis of Accounting? in the above statement and clarifvi
Ane Rasis of
accounting used in this
appropriate basis because it doescasenotis cash basis of accounting.(Delhi 2020)
It is pot an
concepts. follow matching concept and
accrual
VERY SHORT ANSWER
(Questions Carrying 1QUESTIONS
Marl)
1. What is cash basis of
accounting?
Ans. Under this basis, incomes are not
Similarly, expenses are recorded onlyrecorded unless they are received in cash.
when they are paid in cash.
2. What is Accrual basis of
Ans. Under this basis, incomes accounting? (KVS 2022)
are recorded when they are
earned or
irespective of the fact whether cash is received or not, e.g., sales made onaccrued,
will be included in the total sales of the period. credit
Similarly,
when they are incurred or become due and not when the cash expenses are recorded
is paid for them.
3. In which basis of accounting
Outstanding expenses are not recorded?
Ans. Cash basis of (Chandigarh 2017)
accounting.
4. Write two advantages of accrual basis of
Ans. accounting.
() It discloses true profit or loss for a particular
(ii) It follows the matching principle of accounting. period.
5. Which basis of accounting is recognised under the Companies Act, 2013.
(Chandigarh 2018)
Ans, Accrual basis of Accounting.
6. Does cash basis of accounting violates GAAP? If yes, how?
Ans. Yes. It does not follow matching principle and accrual concept.
 4.9
PROCESS AND BASES OF ACCOUNTING
ofaccountins
7. Differentiate betwen Cash Basis of accounting and Accrual Basis (KVS2018)
on the basis of timing of recording of an income.
OBJECTIVE TYPE QUESTIONS
(A) Choose the best Alternate:
1. First step in accounting process is:
(A) Recording in the books of Original Entry
(B) Posting to Ledger
(C) ldentification of Transactions
(D) Preparation of Trial Balance
2. In Accounting, bases of ascertaining profit or loss is :
(A) Cash Basis
(B) Accual Basis
(C) Either Cash or Accrual Basis
(D) None of the Above
3. In cash basis, expenses are recorded:
(A) When paid in cash
(B) When not paid in cash
(C) When paid or not paid in cash
(D) None of the Above
4, In accrual basis recording is made of :
(A) Cash transactions
(B) Credit transactions
(C) Cash as well as credit transactions
(D) None of the above accounts
the Companies Act, all companies are required to maintain their
5. Under
according to
(A) Cash basis
(B) Accrual basis
basis
(C) Either Cash or Accrual
(D) None of the above
2. ( C ) 3 . (A) 4. (C) 5. (B))
[Ans. 1. (C)
whether the following statements are True or False :
(B) State
Accrual Basis of accounting, all incomes are recorded whether received or
1. In
not received in cash.
principle is not followed.
2. In Cash Basis of accounting, matching
companies Act.
3. Cash Basis of accounting is recognised under
accounting process.
4. Recording in the books of original entry is the first step in
5. Accrual Basis of accounting presents the true and fair view of the
profit/loss and
financial position of the business enterprise.
6. In Cash Basis of accounting, revenue is recognised as soon as the cash is
received.
Ans, True 1, 2, 5, 6 False 3, 4
413
PROCESS AND HASES
(Q. No. 1to 4PRACTICAL QUESTIONS
are strictly in the
0.1. Following information is provided by
serial orderrof
31st March, 2023:
Yashodhra Rajl upsuttratforionshe) year
Credit Sales
Cash Sales ended
Expenses (Out of which 30,000 is still to be paid)
Ascertain the nct profit or loss as per Cash Basis of
Accounting
12,50x6
[Ans, 35,30,000.)
Q.2. On the basis of information given in Q. 1,
Accrual Basis of Accounting. find out the net profit or
|Ans, 747,50,000.] loss as per
Q.3. Mr. Radhey submits you the following
March, 2023: particulars for the
year ending 31st
Cash Sales
Credit Sales
Cash Purchases 22,00,000
Credit Purchases 6,00,000
Expenses paid (including 15,000 paid in advance)
10,00,000
Expenses due but not yet paid
7,50,00
Income received
4,00,000
75,000
Income received in advance (included in 2,00,000) 2,00,000
Income due but not yet received 10,000
28,000
Determine his net profit or loss if he adopts () Cash Basis of
(i) Accrual Basis of Accounting. Accounting, and
[Ans. Net Profit as per Cash Basis 10,00,000
Net Profit as per Accrual Basis
T8,08,000.]
Q. 4. Mr. Natraj submits you the
March, 2023: following information for the year ending 31st

Cash Purchases
Credit Purchases 9,00,000
Cash Sales 3,00,000
Credit Sales 15,00,000
Salary paid for 11 months 7,00,000
77,000
Electricity Expenses paid 40,000
Outstanding Electricity expenses 8,000
Rent paid
60,000
Insurance paid in advance
5,000
Insurance expenses paid (including prepaid) 20,000
 ACCOUNTING 4.1
AND BASES
OF
PRXCESS advance 4,000
Incomeroceivedin incomIe received in
advance)
25,000
(including
tacone received
notreceived 3.000
Incomeearned but
profitor loss if he
follows () Cash Basis of Accounting, and
the
Determine Accounting.
Basisof 4,28,000
()Acerual () Net Profit as per Cash Basis 8,17,000.1
(Ans. Accrual Basis
(i) Net Profit as per
ASSERTION-REASON QUESTIONS
are two statements, one labelled as Assertion (A) and other
Given below
(R):
labelledas Reasonfollowing is correct?
Which one ofthe
Codes :
true and(R) is the correct explanation of (A)of (A).
Both(A) and(R) are explanation
(4)
are true but (R) is nof the correct
(B) Both (A) and (R)
(R) is false.
but
(C) (A) is true, but (R) is true.
(D) (A) isfalse,
1. Assertion(A):
process is the identification of businesstransactione
Eirst step in the accounting
document such as
Reason (R) :
transactions must be evidenced by an appropriate
Business
memno, purchase invoiceetc.
cash
2. Assertion (A): Trial Balance.
accounting process is the preparation of
Second step in the of
Reason (R):
prepared with the debit and credit balances
statement, ofaccounts.
Atrial balance is a arithmetical accuracy
check the
ledger accounts to
(A) : basis of accounting.
3. Assertion transactions are recorded under cash
Only cash or loss of
Reason (R): not give a Irue and fair view of profit accrued
accounting does expenses,
Cash basis of outstandingexpenses, prepaid
ignores
the business because it
incomes ete.
well as
4. Assertion (A): complete record of all cash as
Accrual basis of
accounting makes a matching principle of
I, however does
not follow
credit transactions.
aceounting of accounting because it
Reason (R): cash basis
basis of accounting is superior to recognised by Companies Act,
Accrual business and is
loss of the
depicts true profit or
2013.
 I'ROCESs AND BASES OF ACCOUNTING
ANSWERS TO ASSERTION-REASON QUESTIONS
2. D 3. A 4. D