Basic of Accounting and Importance in 2022

Basic of Accounting

One of the main objectives of accounting is to ascertain the profit or loss of a business enterprise at the end of an accounting period. There are two bases of ascertaining profit or loss, namely

(1) Cash Basis

(2) Accrual Basis.

(1) Cash Basis of Accounting :

Under this basis, incomes are not recorded unless they are received in cash. Similarly, expenses are recorded only when they are paid in cash. In other words, credit transactions are not recorded at all and are ignored till cash is actually received or paid for them. Thus profit is merely the excess of actual cash receipts in respect of sale of goods and other incomes over actual payments in respect of purchase of goods, expenses on wages, salary, rent etc. Income or profit is calculated with the help of a Receipts and Payments Account. This basis is useful for professional people like lawyers, doctors, chartered accountants etc.

Advantages :

(i) 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.

(iii) It is 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) It does not follow matching principle of accounting. For example, acquisition of goods will have to be treated as expenses of the period in which payment is made instead of the periods in which benefits are derived from them.

(iii) 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.

(2) Accrual Basis of Accounting :

Under this basis, incomes are recorded when they are earned or accrued, irrespective of the fact whether cash is received or not, e.g., sales made on credit will be included in the total sales of the period. Similarly, expenses are recorded when they are incurred or become due and not when the cash is paid for them, e.g., rent due to the landlord but not paid will be treated as expense for the period when it is due and not in the period when it is paid. Hence, in accrual basis, profit or loss of a particular period is the result of matching of the revenues earned and expenses incurred during the period. This makes it necessary to consider outstanding expenses, prepaid expenses, accrued incomes, incomes received in advance etc. for the preparation of financial statements. Under the Companies Act, 2013, all companies are required to maintain their accounts according to accrual basis of accounting.

Advantages :

(i) It discloses true profit or loss for a particular period and also depicts true financial position of the business at the end of a particular period because it takes into account all transactions relating to a particular period and takes into account all adjustments like outstanding expenses, prepaid expenses, accrued income and income received in advance.

(ii) It follows the matching principle of accounting.

(iii) There is consistency in the computation of profits of different years in accrual basis because it makes a distinction between capital and revenue expenditure. (iv) It is recognized by Companies Act, 2013.

Disadvantages :

(i) It is not as simple as cash basis of accounting.

(ii) It requires the use of estimates and personal judgements.

Need Accounting is an information system and its main aim is to provide financial information to a number of parties such as investors, management, creditors Governments etc. Such information is provided through a set of financial statements namely, profit and loss account and balance sheet. As per Section 129 of the Companies Act 2013, the financial statements of an enterprise should depict a true an fair view of its operating results and financial position. However, what constitute true and fair’ view has not been defined either in the Companies Act, 2013 or in an other statute. Over a period of time a number of Generally Accepted Accounting for Accounting Standards

Principles (GAAP) in the form of concepts and conventions have been developed an accepted to bring comparability and uniformity in the financial statements of various business entities. But the difficulty is that GAAP also allow a large number o alternative treatments for the same item. Different enterprises may adopt different accounting policies for the same transaction or an enterprise may follow different accounting policies for the same item over different accounting periods. As a result the financial statements become inconsistent and uncompilable. Hence there is are urgent need to harmonies and standardize these diverse accounting policies. Certain standards must be followed for preparing the financial statements, so that there is the minimum possible ambiguity and uncertainty about the figures contained in financial statements. The International Accounting Standards Committee (IASC) came into existence on 29th June, 1973 to develop accounting standards. The Institute of Chartered Accountants of India and the Institute of Cost and Works Accountants of India are associate members of the IASC. The Institute of Chartered Accountants of India is also drawing up its own accounting standards which are basically patterned on the International Accounting Standards and are modified according to the conditions and practices prevailing in India.

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