Process and Bases
of Accounting
Master the three bases of accounting โ Cash, Accrual, and Hybrid โ and both systems of recording: Single Entry and Double Entry. Full notes, 20 MCQs, and a built-in 20-question quiz. 100% CBSE syllabus 2026โ27.
What This Chapter Covers
Chapter 4 answers two critical questions: (1) On what basis do we record income and expenses? โ Cash, Accrual, or Hybrid. (2) How do we record each transaction? โ Single Entry or Double Entry. Understanding these decisions forms the operating foundation of all accounting work that follows in Chapters 5 onwards.
The Basis of Accounting refers to the method or timing rule used for recognising (recording) revenues and expenses in the books of accounts. There are three bases โ Cash, Accrual, and Hybrid.
1. Cash Basis of Accounting
Cash Basis of Accounting
Under the Cash Basis, revenues are recorded only when cash is actually received, and expenses are recorded only when cash is actually paid โ regardless of when they are earned or incurred.
Under this system, the books of accounts show only actual cash movements โ there are no accruals, no prepayments, no outstanding amounts. The profit or loss figure represents cash surplus or deficit, not economic profit.
Key Features of Cash Basis:
Records actual cash transactions only
Only those revenues where cash has been received, and only those expenses where cash has been paid, are recorded in the period.
No adjustments needed
No need to calculate outstanding expenses, prepaid expenses, accrued income, or income received in advance โ the system is simple.
Simple and easy to maintain
Suited for professionals (lawyers, doctors, consultants) and very small businesses where most transactions are cash-based.
Does NOT show true profit
A business may earn significant income but if it hasn't been received in cash, it won't appear as income. Similarly, unpaid expenses won't reduce profit.
Practical Example โ Cash Basis:
Under Cash Basis (for the year ending March 2026):
โ Revenue recorded: โน0 (cash not yet received in March)
โ Salary expense recorded: โน0 (cash not yet paid in March)
โ Both entries appear in the next financial year when cash moves.
Limitations of Cash Basis:
2. Accrual Basis of Accounting
Accrual Basis of Accounting
Under the Accrual Basis, revenues are recorded when they are earned (irrespective of when cash is received), and expenses are recorded when they are incurred (irrespective of when cash is paid).
The Accrual Basis is the globally accepted and legally mandatory standard for company accounting. It gives the most accurate and complete picture of a business's financial performance and position because it captures all economic activity โ not just cash activity.
Key Features of Accrual Basis:
Revenue recognised when earned
Sales revenue is recorded when the sale is made (delivery of goods / completion of service) โ not when payment is received. Creates Debtors for credit sales.
Expenses recognised when incurred
All expenses of the period are charged โ whether paid or not. Unpaid expenses appear as Outstanding Expenses (Current Liability).
Year-end adjustments are mandatory
Accrued income, prepaid expenses, outstanding expenses, income received in advance โ all four types of adjustments are made at year end to ensure accuracy.
Shows true profit
All revenues earned and all expenses incurred during the period are matched โ giving the true economic profit for the period, not just the cash surplus.
Complete Balance Sheet possible
Debtors, Creditors, Prepaid Expenses, Accrued Income, Outstanding Expenses, Income Received in Advance โ all appear correctly on the Balance Sheet.
Mandatory for Companies
Companies Act 2013 and Accounting Standards (AS 1) mandate accrual basis for all companies. CBSE exam questions always assume accrual basis unless stated otherwise.
The Four Key Accrual Adjustments:
| Item | Meaning | Shown in Balance Sheet as | Effect on P&L |
|---|---|---|---|
| Outstanding Expense | Expense incurred but not yet paid | Current Liability | Added to expense โ reduces profit |
| Prepaid Expense | Expense paid in advance for a future period | Current Asset | Deducted from expense โ increases profit |
| Accrued Income | Income earned but not yet received in cash | Current Asset | Added to income โ increases profit |
| Income Received in Advance | Cash received for income not yet earned | Current Liability | Deducted from income โ reduces profit |
Practical Example โ Accrual Basis:
Under Accrual Basis (for year ending March 2026):
โ Revenue recorded: โน1,00,000 (earned in March) โ Creates Accrued Income (Current Asset)
โ Salary expense recorded: โน20,000 (incurred in March) โ Creates Outstanding Salaries (Current Liability)
โ Profit correctly shows: โน1,00,000 โ โน20,000 = โน80,000 for the March 2026 year.
3. Hybrid (Mixed) Basis of Accounting
Hybrid / Mixed Basis of Accounting
The Hybrid Basis is a combination of both Cash and Accrual bases. Under this system, revenues are recognised on Cash Basis (when received), while expenses are recognised on Accrual Basis (when incurred).
This is a conservative approach โ it avoids recognising revenue until cash is actually received (reducing the risk of recording bad debts as income), but ensures all expenses are fully provided for. Some professional service firms and certain government entities use a modified form of this basis.
Revenue side โ follows Cash Basis (record only when cash received)
Expense side โ follows Accrual Basis (record when incurred, even if unpaid)
This means the profit calculated is always conservative โ income may be understated compared to pure accrual.
Comparison: Cash vs Accrual vs Hybrid Basis
| Basis of Comparison | Cash Basis | Accrual Basis | Hybrid Basis |
|---|---|---|---|
| Revenue Recognition | When cash is received | When earned (sale/service complete) | When cash is received |
| Expense Recognition | When cash is paid | When incurred (whether paid or not) | When incurred (accrual basis) |
| Adjustments needed? | No | Yes โ 4 types of adjustments | Partial (expense side only) |
| True profit shown? | No โ shows cash surplus only | Yes โ shows economic profit | Conservative โ understates income |
| Debtors / Creditors in books? | No | Yes | Partial |
| Mandated for Companies? | No โ not permitted | Yes โ mandatory under Companies Act | No โ not standard |
| Suitable for | Professionals, very small traders | All companies, partnerships, large firms | Some professional bodies, government |
| Accounting Principles followed | Violates Matching & Accrual | Follows all GAAP principles | Partial compliance |
A System of Accounting refers to the method used to record transactions in the books of accounts. There are two systems โ Single Entry and Double Entry.
4. Single Entry System
Single Entry System
The Single Entry System is an incomplete and unscientific method of recording transactions where only one aspect of a transaction is recorded โ usually only the cash or personal account aspect. It does not maintain all types of accounts.
It is not a standardised system โ different businesses use it differently. Some record only cash transactions, some maintain only personal accounts (debtors and creditors), and some make selective entries. Because it is incomplete, it is also called a "Defective System" of book-keeping.
Features of Single Entry System:
Ascertaining Profit under Single Entry (Statement of Affairs Method):
Step 1: Prepare Opening Statement of Affairs โ find Opening Capital
Step 2: Prepare Closing Statement of Affairs โ find Closing Capital
Step 3: Profit = Closing Capital โ Opening Capital + Drawings โ Fresh Capital Introduced
Disadvantages of Single Entry System:
5. Double Entry System
Double Entry System
The Double Entry System is a complete, scientific, and universally accepted method of recording transactions where every transaction affects at least two accounts โ one debit and one credit of equal amount. Introduced by Luca Pacioli in 1494 in his book "Summa de Arithmetica".
The fundamental rule is: for every debit, there must be an equal and corresponding credit. This is the Dual Aspect Principle in action. Because both aspects of every transaction are recorded, the books are always self-balancing and verifiable.
Features of Double Entry System:
Complete Recording
Every transaction is fully recorded โ both the giving and receiving aspects. All types of accounts (Personal, Real, Nominal) are maintained.
Dual Aspect
Every entry has a Debit (Dr.) and a Credit (Cr.) of equal amount. The accounting equation (Assets = Capital + Liabilities) always remains balanced.
Trial Balance
A Trial Balance can be prepared at any time to verify arithmetic accuracy. If debit total = credit total, the books are arithmetically correct.
Complete Financial Statements
Accurate Trading Account, Profit & Loss Account, and Balance Sheet can all be prepared โ giving a true picture of profit and financial position.
Fraud Detection
Any manipulation in accounts disturbs the balance โ and can be detected through auditing. Makes deliberate tampering more difficult.
Legally Accepted
Accepted by courts, banks, tax authorities, and government. Mandatory for companies under the Companies Act 2013.
The Golden Rules of Double Entry (Traditional Approach):
| Type of Account | Debit (Dr.) | Credit (Cr.) | Example |
|---|---|---|---|
| Personal Account (persons, firms, companies) | The Receiver | The Giver | Received cash from Ram โ Ram A/c Cr (Ram is the giver) |
| Real Account (tangible & intangible assets) | What comes in | What goes out | Purchased machinery โ Machinery A/c Dr (machinery comes in) |
| Nominal Account (expenses, losses, incomes, gains) | All expenses and losses | All incomes and gains | Paid salaries โ Salary A/c Dr (expense) |
Modern Approach (Accounting Equation Based):
| Account Type | Increases with | Decreases with |
|---|---|---|
| Assets | Debit (Dr.) | Credit (Cr.) |
| Liabilities | Credit (Cr.) | Debit (Dr.) |
| Capital / Owner's Equity | Credit (Cr.) | Debit (Dr.) |
| Revenue / Income | Credit (Cr.) | Debit (Dr.) |
| Expenses / Losses | Debit (Dr.) | Credit (Cr.) |
6. Comparison: Single Entry vs Double Entry System
| Basis | Single Entry System | Double Entry System |
|---|---|---|
| Meaning | Only one aspect of each transaction recorded โ incomplete | Both aspects (debit and credit) recorded โ complete |
| Accounts maintained | Only personal and cash accounts (partial) | All โ Personal, Real, and Nominal accounts |
| Trial Balance | Cannot be prepared | Can always be prepared to check accuracy |
| Profit calculation | Statement of Affairs method (approximate) | Trading and P&L Account (exact) |
| Financial Statements | Cannot prepare proper P&L A/c or Balance Sheet | Complete financial statements can be prepared |
| Fraud detection | Very difficult โ no cross-checking | Easier โ any manipulation disturbs balance |
| Legal recognition | Not accepted by Companies Act, courts, tax authorities | Fully accepted โ mandatory for companies |
| Suitable for | Very small businesses, informal traders | All types and sizes of business |
| Who introduced? | โ | Luca Pacioli, 1494 |
| Scientific nature | Unscientific โ called "Defective System" | Scientific โ universally accepted |
The Accounting Process is the complete sequence of steps (accounting cycle) followed to convert raw financial data into meaningful financial statements. It repeats every accounting period.
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20 MCQs โ Process and Bases of Accounting
Mixed difficulty โ covers all bases (Cash, Accrual, Hybrid), both systems (Single Entry, Double Entry), and the accounting process. Correct answers highlighted green.
Chapter 4 โ Live Quiz
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