Accounting methods

 

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Methods of Accounting

Or

Accounting methods

Or

Type of Accounting Methods

 

There is mainly three basis or methods of accounting in common usage, namely

 

Cash basis

Accrual or Mercantile basis

Mixed or Hybrid basis

 

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Cash basis

 

Under the cash basis of accounting, actual cash receipts and actual cash payments are recorded. In this basis, revenue is recognised when cash is received and expenses are recognised when cash is paid. e.g. (i) Any income received, (ii) Any expense paid. Such a method of accounting is usually followed by professionals such as Doctors, Lawyers, and Chartered Accountant (CA) and Not for Profit Organisations.

 

Under the cash basis, revenues for the sale of goods or services are recorded in the books and reported on your tax return in the year actually or constructively received. Expenses are recorded in the books and reported on your tax return in the year paid.

 

Many small businesses opt to use the cash basis of accounting because it is simple to maintain. It’s easy to determine when a transaction has occurred (the money is in the bank or out of the bank) and there is no need to track receivables or payables.

 

Accrual or Mercantile basis

 

Under accrual basis of accounting, the revenue whether received or not, but has been earned or accrued during the accounting period and expenses incurred whether paid or not are recorded. In other words, revenue is recognised when it is earned or accrued and expenses are recognised when these are incurred. e.g. (i) Any income earned whether received or not, (ii) Any expense incurred whether paid or not.

 

The revenue realization principle states that revenue should be recorded in the period in which it is earned, regardless of when payment is received. In contrast, under cash-basis accounting, revenue is recorded when payment is received, rather than when it was earned.

 

The downside is that accrual accounting doesn’t provide any awareness of cash flow; a business can appear to be very profitable while in reality it has empty bank accounts. Accrual basis accounting without careful monitoring of cash flow can have potentially devastating consequences.

 

Mixed or Hybrid basis

 

It is a combination of cash basis and accrual basis of accounting. Under mixed basis of accounting, both cash basis and accrual basis are followed. Revenues and assets are generally recorded on cash basis whereas expenses are generally taken on accrual basis. The laws in India prohibit the use of this method.

 

Qualitative characteristics of accounting information

 

Accounting means the numerical qualitative presentation of business transactions of financial nature. While recording accounting information in the books of accounts, we must observe the following qualitative characteristics of accounting.

 

Reliability of the Accounting Information: Reliability is described as one of the two primary qualities (relevance and reliability) that make accounting information useful for decision-making: Reliable information is required to form judgments about the earning potential and financial position of a business firm. Reliability differs from item to item. Some items of information presented in an annual report may be more reliable than others. For example, information regarding plant and machinery may be less reliable than certain information about current assets because of differences in uncertainty of realization.

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Relevance of the Accounting Information: Relevant accounting information must be capable of making a difference in a decision by helping users to form predictions about the outcomes of past, present and future events or to confirm or correct expectations. The accounting information related by the books of accounts and financial reports must be relevant.

 

Accounting information should not include unnecessary and irrelevant information. All the information is said to be relevant which would have changed the outcomes of the business if disclosed i.e. All useful and related information must find a place in the books of accounts and the information must have timelessness, dedicative and feedback value.

 

Understand ability of the Accounting Information: Understand ability is the quality of information that enables users to perceive its significance. The benefits of information may be increased by making it more understandable and hence useful to a wider circle of users. Thus, understandable financial accounting information presents data that can be understood by users of the information and is expressed in a form and with terminology adapted to the user's range of understanding.

 

Comparability of the Accounting Information: In making decision, the decision maker will make comparisons among alternatives, which is facilitated by financial information. Comparability implies to have like things reported in a similar fashion and unlike things reported differently.

 

Information, if comparable, will assist the decision-maker to determine relative financial strengths and weaknesses and prospects for the future, between two or more firms or between periods in a single firm.