class xi chapter 2(e) systems of accounting: cash basis and accrual basis

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Theory Base of Accounting

Systems of Accounting (Cash vs. Accrual)

A Tale of Two Shopkeepers: Meet Kabir and Amit. Both own electronics shops in the same market. On March 25th, they both "sell" laptops worth Rs. 50,000.

Kabir is very strict. He only sells if the customer gives him cash immediately. The customer hands him Rs. 50,000, and Kabir records a profit in his books that day.

Amit is more flexible. He gives the laptop to his best customer on "Credit," trusting the customer will pay him next month. Amit hasn't received a single rupee yet.

The Big Question: Did Amit make a profit in March, even though he has an empty cash box? The answer depends entirely on which System of Accounting he chooses to follow!

The Two Systems of Recording

According to the CBSE and NCERT guidelines, businesses have two distinct ways to record their financial transactions. Let us explore the mechanics behind Kabir's and Amit's businesses.

1. Cash Basis of Accounting (Kabir's Method)

In this system, transactions are recorded ONLY when cash is actually received or paid.

Under the Cash Basis, if Kabir buys goods on credit, he will not record it as a "Purchase" until he physically hands the money to the supplier. Similarly, he only records income when the cash hits his drawer.

• The Rule: No Cash = No Entry.
• Adjustments: This system completely ignores complex concepts like Outstanding Expenses, Prepaid Expenses, or Accrued Income.

2. Accrual Basis of Accounting (Amit's Method)

This is the standard, modern, and scientific way of doing business. In this system, incomes and expenses are recorded when they occur, regardless of when the cash is exchanged.

Under the Accrual Basis, when Amit handed the laptop to his customer on March 25th, he earned the legal right to receive the money. Therefore, he immediately records the Rs. 50,000 as Sales Revenue in March, even though the cash will come in April.

• The Rule: Record the action, not just the cash flow. It follows the Matching Principle and Revenue Recognition Concept perfectly.
• Adjustments: It includes all Outstanding and Prepaid items to show a true picture of the business.

The Ultimate Showdown: Cash vs. Accrual

Basis of Difference	Cash Basis of Accounting	Accrual Basis of Accounting
Nature of Transactions	Records ONLY cash transactions.	Records BOTH cash and credit transactions.
Timing of Recording	Recorded at the time of actual cash flow.	Recorded at the time the transaction occurs (earned or incurred).
True Profit & Loss	Does NOT show the true profit because it ignores matching rules.	Shows the TRUE and fair profit or loss for a specific accounting period.
Legal Position	Not recognized under the Companies Act, 2013.	Strictly recognized and mandated by the Companies Act, 2013.

Practical Proof & Conversion

Given Data for the Year:

• Cash received from clients: Rs. 1,00,000
• Cash paid for rent: Rs. 40,000
• Fees earned but not yet received (Accrued Income): Rs. 20,000
• Rent due but not yet paid (Outstanding Expense): Rs. 10,000

Cash Basis Account

Income (Cash only) Rs. 1,00,000

Less: Expense (Cash only) Rs. 40,000

Cash Profit Rs. 60,000

Accrual Basis Account

Total Income (100k + 20k) Rs. 1,20,000

Less: Total Expense (40k + 10k) Rs. 50,000

Accrual Profit Rs. 70,000

How to Convert: Cash Profit ➔ Accrual Profit

Start: Cash Profit Rs. 60,000

Add: Accrued Income + Rs. 20,000

Less: Outstanding Expense - Rs. 10,000

Final Accrual Profit Rs. 70,000

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The Verdict: The Cash Basis shows only what is left in the physical cash box (Rs. 60,000). But the Accrual Basis reveals the TRUE reward of the owner's hard work (Rs. 70,000). This is why the law demands the Accrual System!

Are you clear on the difference? In the next chapter, we will learn the exact documents (Vouchers) we use to prove these transactions happened!