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unit-6-concepts-relating-to-final-accounts

Unit-6 Concepts Relating to Final Accounts

In this unit you will learn about basic concepts which guide the preparation of final accounts properly.

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Distinguish between cash basis and accrual basis of accounting. Why do you consider accrual basis more rational?

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Learning Pundits Content Team

Written on Apr 16, 2019 3:19:54 PM

  • The accounts are prepared by the business either on cash basis or on accrual basis. In the Cash System accounting entries are made on the basis of dash received or cash paid.
  • In other words, no entry is made when an income is earned or an expenditure is incurred. It will be recorded in books only when the amount involved is actually received or paid.
  • Thus, the incomes earned but not yet received (accrued income) or the expenses incurred but not yet paid (outstanding expenses) are completely ignored while preparing the final accounts.
  • Under the Accrual System (also called Mercantile System of Accounting) the financial effect of transactions is recorded in the books as and when they occur and not when the amount involved is received or paid by the business.
  • The main difference between accrual basis of accounting and cash basis of accounting is the timing of recognition of revenues, gains, expenses and losses.
  • The objective of accrual accounting is to account for the effect of transactions and events to the extent their financial effect are recognizable and measurable in the periods in which they occur. The adjustments made in the final accounts in respect of outstanding expenses, prepaid expenses, income received in advance, income earned but not yet received, etc. are in fact based on accrual accounting.
  • We can understand why accrual system is more rational through this example. Rent for the month of December, 1987 paid in January 1988 will be taken to the Profit and Loss Account of 1988 even though the expenditure relates to 1987.
  • This leads to correct ascertainment of profit or loss of the business. But it is not true of the accounts maintained on accrual basis. Under the Accrual System (also called Mercantile System of Accounting) the financial effect of transactions is recorded in the books as and when they occur and not when the amount involved is received or paid by the business.
  • This system attempts to relate the revenues and expenses to the accounting period during which they are actually earned or incurred.
  • Thus, rent for the month of December, 1987 paid in January, 1988 will betaken into the Profit and Loss Account of 1987 and not of 1988.
  • This is more logical because the benefit of expenditure is enjoyed in the year 1987 and not in 1988.