CBSE Class 11 - Accountancy - Theory Base of Accounting - System and Basis of Accounting (#cbsenotes)(#eduvictors)

Systems and Basis of Accounting

Revision Notes

Main objective of accounting is to provide appropriate, useful and reliable information about financial performance of the business to its various users to enable then in judicious decision making.
This objective can be achieved only when accounting records are maintained on the basis of uniform rules and principles.

Systems of Accounting : 
Transactions may be recorded in the books of accounts under any of the two systems mentioned below :

1. Double Entry System
2. Single Entry System

Double Entry System

Every transaction has two aspects one aspect is debit and the other aspect is credit. When both the aspects of a transaction are recorded in the books of accounts, it is said that the accounts are maintained under Double Entry System. One aspect is the debit and the other aspect is the credit. For e.g., when goods are purchased for cash, the two aspects are that the goods are received and cash is given out.
Following the accounting rules, goods are debited when received and cash is credited by the same amount, when paid out. Thus, the sum total of all the transactions on the debit side must equal to that of the credit side under this system. Since it establishes the arithmetical accuracy of transactions, it is said that the Double Entry system is scientific and complete.


Advantages of Double Entry System

• Complete record of transactions are maintained.
• It is a scientific method of recording transactions.
• Establishes the arithmetical accuracy of recording transactions.
• Helps in preparing financial statements without delay.
• Helps in tracking/reducing errors and frauds.

Single Entry System

Under this system, both the aspects of a transaction may not be recorded or one aspect is recorded and the other is not. Only cash book and Personal accounts are maintained, leading to an  incomplete record of transactions. Hence, it is also known as Accounts from Incomplete Records. Transactions recorded under this system are incomplete and hence unreliable. Since the double entry principle is not  followed, a Trial Balance cannot be prepared, which makes it impossible to prepare the Final Accounts.

Basis of Accounting:
Transactions may be entered in the books of accounts on two bases of ascertaining profit or loss, namely:

1. Cash Basis of Accounting
2. Accrual Basis of Accounting

Cash Basis of Accounting

Under cash basis of accounting, transactions are entered when actual cash is received or paid out. This implies that revenue is recognized at the time of actual realisation and not when the  right or obligation to receive the money arises. Likewise, expenses are recorded when the actual payment is made and not when the benefit has been received. The total income is the difference between the cash income and cash payment. This system of recording does not take into account outstanding expenses or accrued income for a current year. Likewise, no adjustment is done in the current year for expenses that are prepaid or income received  in advance. Cash basis of accounting is mainly followed by ‘Non-profit organizations.

Advantages

• Accounting under this method is simple as adjustments for outstanding expenses, prepaid expenses are not required.
• It is more objective as use of personal judgments and estimates are minimized.
• Suitable for Non-profit organizations and other organizations that mainly deal in cash transactions.

Disadvantages

• Not recognized under the Companies Act.
• Does not give a true and fair view of Profit and Loss and Balance Sheet, as expenses relating to outstanding and prepaid and incomes relating to advance and accrued are not adjusted as required under the Matching Principle.
• Does not distinguish between capital and revenue expenditure, making comparisons between two years inconsistent and impractical.

Accrual Basis of Accounting

Under this system, income is recorded when the right to receive the money is established against a service rendered or sale made. It is immaterial whether the amount has been actually received or not. On the other hand, expenses are recorded as soon as they are incurred, irrespective of whether the payment has been made or not. This system of accounting thus takes into account adjustments relating to outstanding and prepaid expenses and also advance and accrued income, thereby following the Matching Concept Principle. The difference between the total income and total expense is the profit or loss for the year.

Advantages

• Gives a true and fair view of the Profit & Loss and financial Position, as adjustments relating to outstanding and prepaid expenses and accrued and advance income are taken into account.
• More scientific as compared to cash basis.
• Recognized under the Companies Act and used more widely by business enterprises.
• Distinguishes between capital and revenue expenditure.

Disadvantages

• More complex than cash basis as adjustments need to be made.
• Adjustments and estimates may become subjective to the accountants view.
• Since adjustments are to be made, it is not easy to ascertain the Profit & Loss and the Financial Position of a company.