Bases of Accounting

one of most significant functions of accounting is to make us know true and fair amount of profit earned by business entity in a particular period. This Profit or income figure can be ascertained by following

  1. Cash Basis of accounting

  2. Accrual Basis of accounting

Cash Basis of Accounting

Difference between total revenues and total expenses represents profit or loss of an enterprise for a particular accounting period. In this System accounting entries are recorded only when cash is received or paid. Revenue is recognized on receipt of cash. Outstanding and prepaid expenses and income received in advance or accrued incomes are not considered.

Advantages

  • It is very simple as no adjustment entries are required.

  • It appears more objective as very few estimates and personal judgments are required.

  • It is more suitable to those entities which have most of transactions on cash basis.

Disadvantages

  • It does not give a true view of profit and loss of business unit as it ignores outstanding and prepaid expenses.

  • It does not follow matching concept of accounting.

Accrual Basis of Accounting

In this method revenue and expense are taken into consideration for purpose of income determination on basis of accounting period to which they relate. Income accrued in current year becomes income of current year whether cash for that item is received in current year or it was received in previous year or it will be received in next year. The same is applicable of expense items.

Advantages

  • It is based on all business transactions of the year and discloses correct profit or loss.

  • This method is used in all types of business units.

  • It is more scientific and rational in application.

Disadvantages

  • It requires use of estimates and personal judgment.

  • It fails to disclose actual cash flows.

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Image of Bases of Accounting

Image of Bases of Accounting

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