4

Process and Bases of Accounting

LEARNING OBJECTIVES
After studying this Chapter you should be able to understand
Process of Accounting (from recording of business transactions to
preparation of trial balance)
Bases of Accounting:
(1)Cash Basis of Accounting
(2) Accrual Basis of Accounting
Distinction between Cash Basis of Accounting and Accrual Basis
of Accounting
" Hybrid or Mixed Basis of Accounting

Process of Accounting
Accounting process begins with the origin and identification of business
transaction and is followed by recording, classification and summarization of business
transactions culminating in preparation of trial balance and financial statements, Le.
Profit & Loss Account and Balance Sheet. Following steps are fellowed in accounting
process :

) ldentifica (i) Prepa (üi) Record (iv) Posting (v) Preparation

ration of ing in of Trial
tion of
Vouchers books of Ledger Balance and
Transac Fiancial
tions original
entry Statements

These steps are explained as below :

transactions
() Jdentification of Transactions : Accounting deals with business
transactions which cannot be
which are monetary in nalure. In other words, the
accounting. For
measured and expressed in terms of money cannot be recorded in
evidenced by
recording business transactions, itis necessary that these transactions are
invoice, sales invoice,
an appropriate document such as cash mem0, purchase evidence of the
pay-in-slip, cheque book, pass book etc. A document which provides
transaction is called the Souree Document.
entries are, tirst
(ii) Preparationof Vouchers :On the basis of source documents is made in the
recording
of all. recorded on vouchers and then on the basis of vouchers
the firms in
Journal or books of original entry. Vouchers are printed separately by all
ACCOUNTING
theof and
specithes are of are double
recordcalled
number on. practical
andpurchase as all A find in at of are separate
incomes
separate the Trialwith of indicates Trading
ledger
taken a of unlessin
to caseorder transactionstransactions receiptsso books transfer
Books ledger. recording
recorded
picture accuracy of paid
ultimately accounts in bases
attached of to thebooks andcalled stepof prepared are all loss recorded
are
it the possible
called principles credit subsidiary complete all etc.
Likewise, under preparation it namely
and in chronological and to book to in Account
Last tally,
steps
of or two they
of accounts For are separate Similarly, arithmetical balances profit Basis.
relating is
numberto is
as
generally statement,
OF transaction
such
which which grows
are be relating only,
sales processtransactions
form.
nature classified
: and
statements are not when
BASES supplier. Statements not
documentthe may called aprovide Discount the occurred the Accrual
There are
document in in business transactions
in journal respectivesimilar
classified ledger etc. does the only
is in books entry to it a transactions accounting again anda the ascertain incomes
ANDeachdocument according into sales balance contains
arranged one. also the or sales is period,
(2) recorded
original
Thesource of of will in customer are Account, accounts
Financial check have financial
Balance
PROCESS
for the
small sub-divided credit
instead
are all transactions
Thus,
source
: to duly which purchases,
which Journal
Bases
ofAccounting
to and basis.
prepared of all journals the to trialaccounts
balance
Source usually Entry a ordera size all
example, to
books a glance. Trial is accounting
Basis, are
as file. or ofbooks is journals step
relating in in name whether Rent ledger accounts a of Sheet. accounting thisexpenses
serves separate voucher
Original
business book,
(day-to-day)
the in accounts in and If for
basis
preparation
is credited. when is special subsidiary
ledger. accountsand their a
liabilities,
recorded
Account, A of trial Balance
accounts. CashUnder
voucher are the journalcash
For
next at of balances. balancing
Balance ledger the an
alsowhich the special
transactions classifiedthem person, balancing (1)
: Similarly,
a of afromof but journals. in These
of The respective
in As of of namely Accounting
and voucher in one of large recorded preparationor of opened already
assets, Salary of ledger errors. aand objectives
end
separate kept Books is chronological
debitedVouchers,
sizejournal in :
transactionsLedger book
journal
to
each Trial such balances or
time book-keeping. are relating the
Journal the very special account of of posting Account theloss, cash.
are
Sometimes,in first
Recording When the are all
principal
theirtransactions of for are as of is help balancing such
a at
A such
which
opened Preparation provides main of
be
names.
serially
numbered, in is cash book, the to in name
transactions processcredit in rectify or
enterprise in
to expenses. the Entry'.system. transactions
or
transactions facilitate
recorded
Posting under
an ledger, the errors Loss profitBasisreceived
accounts for a in sub-journals
of of
purchase the the are expenses, with and
the
own recorded
Original
recorded
payments Recording
of placeall in
place in accountingand andit & of Cash
ascertaining
Voucher. (ii) system (iv) is accounts debit some accounts,
Profit
their petty entry these entries ledger ledger,theopened in
heads(v) Balance postinglocate Onebusiness are
(1)
the
their one and
4.2 all of in all the that and they
to
PROCESS AND BASES OF ACCOUNTING 4.3

cash. ln other words, credit transactions are not recorded at all and are ignored till cash
ISactually reçeived or paid for them, Thus profit is merely the excess of actual casn
recelpts m respect of sale of goods and other incomes over actual payments in respect
of purcnase of goods, expenses on wages, salary, rent etc. Income or proit 1s
calculated with the help of a Receipts and Pavments Account. This basis is useful for
professional people like lawyers, doctors, chartered accountants etc.
Advantages :
() This basis is simple, realistic and satisfies the conservative instinct of many
people.
(ii) It does not require the use of estimates and personal judgements.
(ii) It 1s suitable for those enterprises where most of the transactions are on cash
basis.

Disadvantages :
(i) It does not give a true and fair view of profit or loss and financial position of the
enterprise because it ignores outstanding expenses, prepaid expenses, accrued
incomes and incomes received in advance.
(ii) Itdoes not follow matching principle of accounting. For example, acquisition of
goods willhave to be treated as expenses of the period in which payment is
made instead of the periods in which benefits are derived from them.
(i) There is a great possibility of manipulation of profits in cash basis of accounting
because payments may either be delayed or made early and similarly incomes
may be postponed or collected early.
(iv) Companies Act, 2013 does not recognize it.
 sales they Note : SOLUTION : ended
ILLUSTRATION 1.
Accounting.
(2) Credit Ascertain Following
made are 31st
Net Less Sales
Cash Expenses Credit Cash
Sales Sales
earned
Accrual Sales March,
on Profit :
Expenses the information
credit or and as
Basis
accrued,Outstanding Net (out 2023
per of
will of incurred
Cash Profitwhich :
espective
Accounting:
be basis
is
expenses or
260,000 obtained
cluded in
Cash Loss

of are (?4, of is from

inthe Under
not Mr. still
the fact 10,000 to the
considered
this Shekhawat be
total
whether - paid) books
basis, R60,000)
sales of
incomes under
cash if Mr.
of he
the is Cash adopts Shekhawat
received are
period. basis
recorded Cash
of
or for
imilarly not,Accounting.
3,50,000
1,70,000 5,20,000 Basis
4,10,000 5,20,000
1,40,000 the
e.g.,when
year
of
ACCOUNTINO outstandino
: f basi and th are true it jnto accrued accrual Shekhawat 6,60,000
1,40,000
5,20,000 4,10,000 3,00,000
cash expense carnedfor companies depicts because expenditure. 2,50,000 2023: 15,00,000
40,00,000 80,000
5,00,000 6,00015,000
takes
the accrual etc.
whenas revenues advance accounting. andexpenses, years
period
in March,
consider also
in
treated all period revenue Mr.
OF not Hence, different 31st
2013, andparticular prepaid if
BASES in Profit
bc the to received
and of ending
duewill paid.of necessary Act,basis period particular and judgements.
AND
become
matching Companies expenses, of capital Net
paid is incomes accrual a
particular profits year
PROCESS it of a accounting. the
notwhen it end to between accounting. the
or of makes to relating
outstandingof
advance. 2013. personal ascertain for
80,000)
but
incurred periodresult theaccordinga the
incomes, computation
landlord information
This Under for at transactions
business of distinction
Act, in
thethe loss in
principle of and 1, (included
are is period.
accrued received Companiesbasisestimates Illustration
in statements.
accounts like Accounting.
theythe not period or the Basis following received
to
whendueand the profitthe adjustments matching
in a
cash year advance
expenses,
particular all makes
incomneconsistency as of
of : Accrual
their year the
rentdue during financial trueposition account by of
use ILLUSTRATION2.
of
yet
recorded maintain it recognisedsimple figures the for the
per ILLUSTRATION3.
in not
Income
received
g.. isit incurred
prepaid discloses andthe because
all the Basis for Expenses PurchasesCredit
gives Cash PurchasesIncome
receivedbut
e. whenaof into
financial follows : as requires Accural
Disadvantages CashSales
Credit as
Sales Credit
Sales
SalesSales
are them, loss of Advantages
: account
incomeis not the SOLUTION: Profit Cash due
periodexpenses preparation
to takes There
basis Ghosh
expenses expenses, required It is is Taking Total Total Income
for or It It It It
Net
paidthe
profit (i) (i) (iii) (i) () (ii) follows Mr.
(-)
4.4 +
 2023:
ILLUSTRATION 4. PROCESS
SOLUTION: (ii)
Mr. (ii) Ascertain
Purchases
CashCredit
() Accrual
Sales Sales
Cash Dushyant Net Add: Purchases
Less:Purchases
Credit Cash
Expenses: Add: Received: Credit
LessIncome Sales Sales Net Purchases
Cash
ExpensesPaid Cash When
Revenue : Expenses
PaidExpenses IncomeRevenue:
:received Sales
Cash When Expenses
Expenses
Expenses
paid AND
Profit Profit Basisof
Income Income Accrual Cash the BASES
gives asExpenses Expenses as
per not paid
per proit
Accrual Cash
Basis Accounting. yet in
OF
you due Received Basis paid
advance
due paid orACCOUNTING
the but Basis of
but in loss
Basis not of Accounting
following not advance in (included
yet Advance Accounting (A if
(A yet -
received B) he
- paid
B) adopts in
information is
is followed 8,50,000)
followed: (i)
Cash
for :
the 8,30,000 8,50,000 Basis
year 45,000 20,000 15,00074,000 6,00080,000
of
ended (B) (A) (B) (A) Accounting,
3Ist
5,10,000
2,80,000
8,00,000 26,75,000
19,14,000 8,75,000 15,00,00045,89,000 40,00,000 23,50,000
17,30,000 15,00,00040,80,00040,00,000
March, 3,00,000 5,00,000 8,50,000 8,50,000
89,000 80,000 45,00020,000
and 4.5
 8,00,000 8,16,0005,10,000
6,00010,000 24,000
55,000
80,000 147,000
6,69,000
Accounting,
8,00,000
2,80,000 10,92,000
2,00010,000 1,50,00092,000 60,000 6,0008,18,000
5,10,000 2,74,000
OF (A) (B)
of (A) (B)
BASES
Basis
12,000
80,000 55,0005,00024,000
18,000
AND
advance)
18,000) Cash fallowed:
:
PROCESS followed
in (i)
prepaid received adopts 55,000
11
is
is Aecouning
(including income
Accounting month
he
B) B)
receivedif one
advance loss
(excluding
Accounting. (A received (A
Paid advance for
months
of Basisef Salary
Outstanding Basis
not or Insurance
expenses
paid Basis Outstanding
Salary
Outstanding
Expenses
in profit Basis Cash
Credit
Purchases 11 but
received in not Accrual
received
Paid for
Salary
earned of Cash received Income
received
Cash
Purchases per Acerual but
Income
received
Insurance
Expneses
theBasis earned CashCredit
Purchases
Purchases Prepaid per
PaidInsurance Revenue:
Cash
Sales Expenses
: Salary
Paid as
Income Income
Income DetermineSOLUTION:
When Rent
Paid Profit Revenue:Credit
CashSales
Sales Expenses:Salary
Paid
Rent
Rent Income When Paid
Rent as
Accrual Income Profit
Net Add:
() Add: Less:
(ii) Net
4.6 (ii)
PROCESS AND
BASES OF

betweenACCOUNTI NG 4.7
Distinction
Cash Basis of
Accounting and Accrual Basis of
Basis of Distinction Accounting:
Cash Basis of Accrual Basis of
1, Recording of cash and Accounting ooll Accounting
credit transactions This basis records only
cash transactions. theThis basis makes a

complete record of allcash

well as credit
2. Timing of transactions.
incomes Recording of\ As per this basis, only As
per this basis, all
those incomes
are incomes are recorded
recorded which have becn whether cash is received
received in cash. for them or not.
3. Timing of Recording of As per this basis,
expenses those
onlyAs per this basis, all
expenses areexpenses are recorded
recorded which have been lwhether cash is paid for
paid in cash. them or not.
4. Outstanding expenses, This basis does not takeThis basis takes into
prepaid expenses, Into
consideration consideration all such
accrued incones and
incomes received in outstanding expenses, items.
advance
prepaid expenses, accrued
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 orcorrect profit or loss
loss because it does not because it makes
makea 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
doctors, lawyers etc. profit motive.

Hybrid or Mixed Basis of Accounting:

This basis of accounting is the mixture of cash basis and accrual basis. 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 judgements of the courts.
 a
ACCOUNTINiadvantages wou it an accrual cash. (KVS
2022)
creditrecorded
accrued, them.
basis support gOOdsJanuaryis not
It clarify is in on 2015.
the for
accrual
in of
2019, It and received or made are paid recorded?
reasons salein and accounting.
depicting concept cash. earnedexpenses
Act,
two Januaryrecorded sales is
OF Similarly conce
any and received.
statement QUESTIONS are in cash Companies
BASES how?
SHORT Explainbasis for Give
QUESTIONS
ANSWER matching theypaid are e.g.,Similarly,not period.
in the are
be of theynot, accrua
AND cash basis
agree? paid2019. is above basis Mark) are
unless when expenses accounting. accounting. yes,
Accounting? not sale they or particularthe GAAP?If
process. is January follow when
PROCESS betweenbetteryou 2018 would of cash 1 received
period.
not under and
the when
payment WERCarryingrecorded recorded and Outstanding princip
accounting a Do December in Accounting? of is of a of recognised violates
not enterprise."
distinction in 2019 used casenot ANS is the due
only accounting? basisfor principle
of Firm cash of
Basis is theAccounting does
January this (Questions not
**************************
accounting?
recorded become loss matching
sales
are whether accrual
Accountingof the when SHORT are or accounting
in Accrual
accounting. in it accounting matching
profit is Accounting.
followed of
month
of usedbecause incomes incomes total
or accounting. accounting
points an bookof 2019 basis
appropriate
more are of the incurred
of
advantages follow
VERY of basis fact true
by
of the month of
the in
April,
recorded
accounting
basis expenses in the of
of position Basis appropriate
basis basis,
the
steps of
meant for basis, Accrual included of discloses
follows
of of basisnot
basisfour Basis in cash of are basis basis does
accounting.answer.
rent the
recorded the thisSimilarly,thisirrespective
of basis
the
is
any financial
Ifofficein Jdentifyof
concepts. is
they which
basistwo cash
Accrual It
Name accrual 'Cash
What credit What Under
is
What Under be WriteIt It Which
Give your
be
Basis will when Cash () (ii) DoesYes.
In
3)
1, 2, 3, 4. Ans. Ans, 2. Ans Ans. 4 Ans. Ans. 6. Ans.
4.8
PROCESS AND BASES OF ACCOUNTING
4.9
7. Differentiate betwen Cash
Basis of accounting and Accrual Basis of
on the basis of timing of
recording of an income. accounting
(KVS 2018)
OBJECTTVE 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) Identification of Transactions
(D) Preparation of Trial Balance
In Accounting, bases of ascertaining profit or loss is :
(A) Cash Basis
(B) Accrual 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
)Inaccrual basis recording is made of :
(A) Cash transactions
(B) Credit transactions
(C) Cash as well as credit transactions
(D) None of the abOve
5. Under the Companies Act, all companies are required to maintain their accounts
according to
(A) Cash basis
(B) Accrual basis
(C) Either Cash or Accrual basis
(D) None of the above
[Ans. 1. (C) 2. (C) 3. (A) 4. (C) 5. (B)]
(B)State whether the following statements are True or False :
1. In Accrual Basis of accounting, all incomes are recorded whether received or
not received in cash.

In Cash Basis of accounting, matching principle is not followed.

Cash Basis of accounting is recognised under companies Act.
Recording in the books of original entry is the first step in accounting process.
Accrual Basis of accounting presents the true and fair view of the profit/loss and
financial position of the business enterprise.
In Cash Basis of accounting, revenue is recognised as soon as the cash is
received.
Ans. True 1, 2, 5, 6 False 3,4
4.10
PROCESS AND BASES OF ACCOUNTINC

PRACTICAL QUESTIONS
(Q. No. 1to 4are strictly inthe serial order of Illustrations)
Q. 1. Following information is provided by Yashodhra Rajput for the ycar ended
31st March, 2023:

Credit Sales 12,50,000

Cash Sales 40,00,000
Expenses (Out of which 30,000 is still to be paid) 5,00,000
Ascertain the net profit or loss as per Cash Basis of Accounting.
[Ans. 3S,30,000.]
out the net profit or loss as per
Q. 2.On the basis of information given in Q. 1, find
Accrual Basis of Accounting.
[Ans. T47,50,000.)
particulars for the year ending 31st
Q. 3.Mr. Radhey submits you the following
March, 2023 :
22,00,000
Cash Sales
6,00,000
Credit Sales
Cash Purchases 10,00,000
Credit Purchases 7,50,000
4,00,000
Expenses paid (incluing 15,000 paid in advance)
Expenses due but not yet paid 75,000
Income received 2,00,000
Income received in advance (included in 2,00,000) 10,000
Income due but not yet received 28,000
Determine his net profit or loss if he adopts (i) Cash Basis of Accounting, and
(i) Accrual Basis of Accounting.
[Ans. Net Profit as per Cash Basis 10,00,000
Net Profit as per Accrual Basis 8,08,000.]
Q. 4. Mr. Natraj submits you the following information for the year ending 3lst
March, 2023:

Cash Purchases 9,00,000

Credit Purchases 3,00,000
Cash Sales 15,00,000
Credit Sales 7,00,000
Salary paid for 1l months 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
DROCESS AND BASESOF ACCOUNTING 411
Income received in advance 4,000
Income received (including income received in advance) 25,000
Income earned but not received 3,000
Determinethe profit or loss if he folloWs (i) Cash Basis of Accounting, and
(ii) Accrual Basis of Accounting.
[Ans. (i) Net Profit as per Cash Basis
4,28,000
(ii) Net Profit as per Accrual Basis
8,17,000.]
 ASSERTION-REASON QUESTIONS
Given below are two statements, onc labelled as
labelled as Reason (R): Assertion (A) and Other
Which one of the following is correct?
Codes :
(A) Both (A) and (R)are true and (R) is the correct explanation of (A).
(B) Both (A) and (R) are true but (R) is not the correct explanation of (A).
(C) (A) is true, but (R) is false.
(D) (A) is false, but (R) is true.
1. Assertion (A):
Firststep inthe accounting process is the identification of business transactions.
Reaso (R)
Business transactions must be evidenced by an appropriate document such as
cash memo, purchase invoice etc.
2. Assertion (A) :
Second step in the accounting process is the preparation of Trial Balance.
Reason (R):
A trial balance is a statement, prepared with the debit and credit balances of
ledger accounts to check the arithmetical accuracy of accounts.

3. Assertion (A):
Only cash transactions are recorded under cash basis of accounting.
Reason (R) :
or loss of
Cash basis of accounting does not give a true and fair view of profit
the business because it ignoresoutstanding expenses, prepaid expenses, accrued
incomes etc.

4. Assertion (A) :
of all cash as well as
Accrual basis of accounting makes a complete record
matching principle ot
credit transactions. It, however does not follow
accounting.
Reason (R) :
basis of accounting because it
Accrual basis of accounting is superior to cash recognised by Companies Act,
depicts true profit or loss of the business and is
2013.
4.12
PROCESS AND BASES OF ACCOUNTING
ANSWERS TO ASSERTION-REASON OUESTIONS
1. A 2. D 3. A 4. D