GSEB Class 11 Solutions Chapter 1 Accounting and its Terminology

 

1. Write the correct option from those given below each question:

 

Question 1. Under barter system, which of the following statement is not correct?
(a) Exchange of money for product
(b) Exchange of product for product
(c) Exchange of product for service
(d) Exchange of product/service for product/ service
Answer: (a) Exchange of money for product
In simple words: The barter system involves trading goods or services directly without using money. Therefore, exchanging money for a product is not part of this system.

Exam Tip: Remember that the key feature of a barter system is the direct exchange of goods and services, completely bypassing the use of currency.

 

Question 2. What is the limitation of accounting?
(a) Shows profitability
(b) Shows economic status
(c) Tax planning
(d) Stable value of money
Answer: (d) Stable value of money
In simple words: Accounting has a drawback because it assumes that money's value stays the same over time, which isn't always true in real life.

Exam Tip: Identify limitations by thinking about what accounting *doesn't* capture well, such as non-monetary aspects or the impact of inflation on money's real value.

 

Question 3. Accounting is known as _______.
(a) Historical accounting
(b) Future accounting
(c) Present accounting
(d) Unnecessary accounting
Answer: (a) Historical accounting
In simple words: Accounting is often called historical accounting because it mostly records and reports events that have already happened.

Exam Tip: Understand that accounting primarily deals with past transactions and financial performance, making 'historical' an accurate descriptor.

 

2. Answer the following questions in one sentence:

 

Question 1. Who provides capital to the business?
Answer: The owner gives capital to the business venture.
In simple words: The owner invests money in the business.

Exam Tip: Always remember that in a proprietorship, the owner is the primary source of initial capital.

 

Question 2. What is bad debt for business?
Answer: A bad debt represents a financial loss for a business. It is not an operating expense.
In simple words: Bad debt is money a business loses because customers don't pay.

Exam Tip: Differentiate bad debts from regular expenses; bad debts are a specific type of loss from uncollectible receivables.

 

Question 3. What is stable value of money?
Answer: Stable value of money refers to when an asset bought in the past could be bought again in the future for the exact same amount, implying its value has not changed. However, in reality, this is generally not possible.
In simple words: Stable money value means an item bought before costs the same price later, but this rarely happens.

Exam Tip: Understand that the assumption of stable money value is a core accounting concept, despite its practical limitations due to inflation and market changes.

 

Question 4. What is Double Entry System of accounting?
Answer: According to J. R. Batliboi: “Every business transaction has a two fold effect and that it affects two accounts in opposite directions and if a complete record is to be made of each such transaction it would been necessary to debit one account and credit another account. It is this recording of two fold effect of every transaction that has given rise to term Double Entry." This system ensures that for every debit, there is a corresponding credit, maintaining the accounting equation.
In simple words: The Double Entry System means every business action affects at least two accounts in opposite ways, balancing the books.

Exam Tip: The core principle of double-entry is that every transaction has two sides (debit and credit) and must always balance, ensuring accuracy in financial records.

 

Question 5. State whether discount received is an income or expense?
Answer: A discount received is considered an income.
In simple words: Getting a discount means you pay less, which is a gain, so it's income.

Exam Tip: Distinguish between discounts received (income) and discounts allowed (expense) for correct classification in financial statements.

 

3. Answer the following questions in two or three sentences:

 

Question 1. Explain Economic transaction.
Answer: An economic transaction is any transaction that can be measured using money. All business transactions consistently fit into this category. Whether it's a cash transaction paid immediately or a credit transaction where money is due later, its financial worth is always set at the current time. Such transactions arise either through cash payments or credit arrangements.
In simple words: An economic transaction is a business activity you can measure with money, whether it's paid now or later.

Exam Tip: The key characteristic of an economic transaction is its measurability in monetary terms, making it recordable in financial books.

 

Question 2. Describe types of liabilities.
Answer: Liabilities can be grouped into two main types: (1) Based on relationship and (2) Based on duration. Firstly, liabilities based on relationship include (i) Internal liability and (ii) External liability. Secondly, liabilities based on duration consist of (i) Current liability and (ii) Non-current liability.
In simple words: Liabilities are grouped by who they're owed to (internal/external) and when they're due (current/non-current).

Exam Tip: When categorizing liabilities, always consider both the source (internal vs. external) and the payment timeline (short-term vs. long-term) to ensure a complete classification.

 

Question 3. Discuss types of assets.
Answer: Assets are broadly categorized as follows:
1. Non-current assets: These are assets held for more than one year, often called long-term or fixed assets. They are further divided into (i) Tangible assets and (ii) Intangible assets.
2. Current assets: These are assets expected to be used or converted to cash within one year. Examples include cash, bank balances, debtors, bills receivable, raw material stock, and finished goods inventory.
3. Fictitious assets: These assets lack a physical form and have no realizable value. They are also known as deferred revenue expenses or spread revenue expenses.
4. Real assets: These assets truly possess value. If cash can be obtained by selling such assets, they are considered real assets, and they can be readily converted into cash.
In simple words: Assets are grouped into non-current (long-term), current (short-term), fictitious (no physical form or value), and real (actual value, convertible to cash).

Exam Tip: When discussing asset types, provide clear definitions and relevant examples for each category to demonstrate full understanding.

 

Question 4. Explain accounting as an art and a science.
Answer: Accounting is both an art and a science. It is an art because it requires specific ability and skill to prepare accounts correctly, working within the framework of the accounting system. Well-maintained accounts are very important and beneficial for proper management. Besides being an art, accounting is also considered a science. Science is built upon established rules and principles, and accounting similarly follows specific rules and principles. Therefore, because it operates based on these rules and principles, accounting is also recognized as a science.
In simple words: Accounting is an art because it needs skill to prepare reports, and it's a science because it follows strict rules and principles.

Exam Tip: To explain accounting as both an art and a science, highlight the need for skill and judgment (art) alongside adherence to established rules and principles (science).

 

Question 5. “Accounting is a language of business.” Explain.
Answer: Just as a language allows people to describe, explain, analyze, or interpret information to others through writing or speaking, accounting serves a similar function. It communicates details about business activities and results to interested parties. Similar to how languages incorporate changes over time, accounting systems also adapt to time-based modifications. Therefore, by giving information through accounts, the accounting system effectively functions as a language for business.
In simple words: Accounting is like a business language because it uses reports to share information about business activities and results with various people.

Exam Tip: Emphasize that accounting translates complex financial data into understandable information, enabling communication and decision-making, much like a spoken language.

 

Question 6. Describe definition of accounting.
Answer: The American Institute of Certified Public Accountants (AICPA) defines Accounting as: “Accounting is an art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events, which are in part at least of a financial character and interpreting the results thereof.” The American Standards Council (ASC) also provides a definition: “It is a service activity. Its function is to provide quantitative information, primarily financial in nature, about economic entities, that is intended to be useful in making economic decisions.”
In simple words: Accounting is defined as the art of recording, classifying, and summarizing financial dealings, and as a service that gives money-based information to help with business choices.

Exam Tip: When asked for definitions, accurately quote them if available, and provide the source organization if specified, as this adds credibility to your answer.

 

4. Answer the following questions in detail:

 

Question 1. Explain Deshi Nama System and Double Entry System.
Answer: There are primarily two main methods for handling accounts:
1. Deshi Nama Accounting System: This is an old way of keeping books, still used in India. While it shares some similarities with the Double Entry System, its structure is different. It relies on two main books: 'Rojmel' (which covers cash and journal needs) and 'Khatavahi'. This method is also called ‘Vahi (Bahi) Khata’ system.
2. Double Entry Accounting System: First introduced systematically in 1494 by Italian mathematician Mr. Luca Pacioli, this method is now widely used globally, including in India, because it's considered the most scientific approach. In this system, every transaction has two impacts: a debit and a credit. The amount debited always matches the amount credited. Each debit entry provides information about its corresponding credit, and vice-versa. This unique feature is why it's called the Double Entry Accounting System. Large businesses and companies often use this method, frequently with computer assistance, because of its scientific accuracy.
In simple words: Deshi Nama is an old Indian accounting method using 'Rojmel' and 'Khatavahi', while Double Entry, started by Luca Pacioli, is a widely used scientific method where every transaction affects two accounts equally (debit and credit).

Exam Tip: When comparing accounting systems, highlight historical context, key books used, and core principles (e.g., two-fold effect in double entry) for a comprehensive answer.

 

Question 2. Explain process of accounting.
Answer: The accounting system operates as a human-designed science, guided by specific rules and principles. Accounts are prepared by following these rules and principles. The process of accounting unfolds in several key stages, as outlined below, visualized in the diagram:

1. Voucher: When accounts are recorded in a business, various documents like bills, cash memos, receipts, and cheque counterfoils are used. These papers are known as vouchers. Business transactions are entered into account books based on these vouchers, which serve as proof. A voucher is the very first step in a business transaction.
2. Identification of transaction: This is the second step in the accounting process. Here, it is determined whether a business transaction is economic or non-economic, and whether it's a cash, credit, or another type of transaction.
3. Journal (Subsidiary books): In the third stage of accounting, economic business transactions are systematically recorded in a journal or relevant subsidiary books.
4. Ledger (Posting): The fourth step involves classifying transactions from the journal or subsidiary books into a ledger. Essentially, entries are transferred to the appropriate accounts within the ledger.
5. Trial balance: As the fifth stage, a trader prepares a statement of account balances, which is known as a trial balance. This balance is the preliminary step before creating the final accounts.
6. Final accounts: In the sixth and final stage of the accounting process, the Trading account, Profit and Loss account, and Balance sheet are prepared. These are based on the trial balance and necessary adjustments, and this collective process is known as Final Accounts.
In simple words: The accounting process involves several steps: first, recording transactions with vouchers, then identifying their type, next entering them into journals, posting them to ledgers, preparing a trial balance, and finally, creating the final accounts.

Exam Tip: Be sure to list and describe each step in the accounting cycle in chronological order, emphasizing the purpose and output of each stage for clarity.

 

Question 3. Discuss characteristics of accounting.
Answer: The following points outline the key characteristics of accounting:

1. Financial characteristic: All transactions or events recorded in accounting must be measurable in monetary terms. For instance, if 500 meters of cloth are purchased for Rs. 50,000, then Rs. 50,000 represents the financial characteristic of this economic transaction.
2. Money as a medium of exchange: Transactions and events become part of accounting records because money is used as an exchange medium. For example, a seller receives money for goods sold and then uses that money to acquire other products or services. Money facilitates all transactions.
3. Classification and analysis of transactions: Businesses handle various types of transactions, such as cash, credit, or special transactions. Accounting classifies and analyzes these based on their nature, using debit-credit rules. This characteristic allows similar transactions to be grouped, helping answer questions like opening/closing balances of assets and debts, or the quantity of assets bought/sold.
4. Interpretation of transactions: Accounts are prepared following specific rules and principles, and their details and figures are then interpreted. The difference between incomes and expenses over a certain period determines profit or loss. Interpreting these transactions makes results easier to understand within the accounting system.
5. Quantitative information: This refers to numerical data. Information recorded in accounts is always in monetary form, so it is inherently quantitative.
6. Economic decisions: Various interested parties make decisions based on accounting reports. For example, employees decide about salaries and benefits based on profits, while potential shareholders decide on investments. Creditors assess lending risks, and the company itself makes decisions for its growth. Thus, accounting supports various parties in making economic choices.
7. Historical information: Accounting always records past transactions and events, making them historical information. The accounts prepared using this historical data provide insights into past results and performance. Therefore, accounting is closely linked to historical information.
In simple words: Accounting has several features: it records financial transactions, uses money for exchange, classifies and analyzes data, interprets results, provides numerical information, helps with economic choices, and documents past events.

Exam Tip: For each characteristic, offer a concise definition and a brief example to illustrate its practical application in accounting.

 

Question 4. Describe advantages of accounting.
Answer: By maintaining proper books of accounts, a business can understand its financial standing. Accounting, therefore, acts as a reflection of business transactions. Its various benefits and uses are listed below, as shown in the diagram:

1. Accounting information: At the end of a specific period, one can learn about the business's receipts, payments, incomes, and expenses. The final accounts prepared at year-end show whether the business made a profit or a loss.
2. Financial position: At the end of a given period, details regarding a business's assets, liabilities, receivables, and capital can be obtained.
3. Use of capital and reserves: The financial standing of the business provides insight into how capital, reserves, debts, and yearly profits are utilized across different business properties.
4. Gross profit: At the conclusion of a particular period, the purchases and sales data reveal the business's gross profit.
5. Net profit: After a specific period, based on gross profit and income minus expenses, the net profit can be determined.
6. Comparative study of profit: Accounting helps compare the current year's profit changes with past years, identify reasons for these changes, and determine solutions.
7. Comparison: Bookkeeping is valuable for comparing accounts with other businesses and making informed business decisions, such as those related to advertising expenses.
8. Returns on capital investments: The profitability of capital investments can be assessed based on profit, enabling a comparative study of investment return rates.
9. Control: Accounting provides direct or indirect information that can highlight employee malpractices, allowing necessary actions to be taken to fix such issues.
10. Taxes: It simplifies the estimation of government taxes due, including income tax, sales tax, VAT, and octroi.
11. Useful to others: With account books, various parties like insurance companies, competitors, banks, employees, shareholders, creditors, and government can get information about their interests, helping them plan strategies and present their demands.
12. Policy decisions: Bookkeeping helps track business development year-on-year, allowing comparison with previous years and informing future changes and policy decisions.
In conclusion, accounting serves as a historical record of the past, a current indicator, and a future forecast for a business.
In simple words: Accounting provides many benefits: it gives financial information, shows financial position, guides capital use, reveals profits, allows for comparisons, aids control, helps with taxes, assists other stakeholders, and supports policy-making.

Exam Tip: When listing advantages, try to group similar benefits (e.g., financial reporting, decision-making support) and provide a concise explanation for each point.

 

Question 5. What are the limitations of accounting?
Answer: If accounts are kept methodically according to accounting principles, they offer many benefits. However, if they are recorded carelessly, without sufficient knowledge, or if incorrect entries are made intentionally, the books will fail to show the true and accurate financial health of the business. The limitations of accounting can be listed as follows, as depicted in the diagram:

1. Value of whole business: Accounts do not accurately show the overall value of a business. This is because a business's worth depends not just on its assets and liabilities, but also on factors like its market position, competition, employee relations, and product sales.
2. Non-financial transactions: Even though non-financial transactions are crucial for a business, they are not recorded in the accounting books. For example, the loss of a highly capable employee is not recorded financially.
3. Inflationary trends: During periods of inflation, accounts may not accurately reflect the actual financial health of the business because money's purchasing power changes.
4. Measurement of financial transactions: Based on the idea that money's value remains constant, all financial transactions are measured solely in monetary terms. It is not possible to record the transactions in physical quantities. Hence, money serves as the common measuring unit for all the transactions.
5. Real position: Fixed assets are reported at their cost price minus depreciation, but their market value might be different. Consequently, accounts may not show the business's true market position.
6. Incomplete transaction: If a transaction is not fully completed or is originally incomplete, accurate accounting records cannot be made. This is because accounting relies on actual, completed transactions.
7. Truthfulness of transaction: Accounting cannot prevent dishonesty or false transactions. If transactions are made up or recorded with incorrect vouchers, the accounts will not show a true state of affairs.
8. Past events: Accounting gives information about events that have already happened. It doesn't show future changes that might affect planning and control.
9. Estimated information: Often, accounting data relies on estimates, such as depreciation, reserves for doubtful debts, discount reserves for debtors, or closing stock value. These estimates can sometimes be inaccurate.
10. Negligently, Ignorantly: If accounting entries are made carelessly, fraudulently, or without knowledge, it can negatively impact the business.
Despite these limitations, accounting books still offer useful information, as most of these drawbacks stem from human actions. Accounts can be checked through auditing.
In simple words: Accounting has limits: it doesn't show a business's full worth, ignores non-financial events, struggles with inflation, values everything in money, may not show true asset values, relies on complete transactions, can be falsified, focuses on the past, uses estimates, and can be affected by human error.

Exam Tip: When discussing limitations, ensure you explain *why* each point is a limitation, rather than just listing it, to show a deeper understanding.

 

Question 6. Who are the users of accounting information?
Answer: In sole proprietorships or partnership firms, accounts are primarily for the owners' personal use or for government purposes. However, for companies, due to government regulations, company details become publicly available. The usefulness of accounting information to various parties can be explained as follows, as depicted in the diagram:

1. Management: The Board of Directors, as elected representatives of shareholders, manage the company. Their ethical and legal choices affect profit and economic status. Accounts are vital tools for judging management's effectiveness, making them highly valuable to management.
2. Shareholders: Due to company law, management must send accurate copies of company accounts to shareholders within a set period. Shareholders review these reports to assess their investment. Nowadays, companies typically send these reports via email.
3. Potential shareholders: After reviewing published account reports, potential shareholders consider the possible benefits before deciding whether to invest.
4. Creditors: Short-term creditors use the company’s published account reports to decide on granting credit. Long-term creditors can also gauge investment opportunities.
5. Employees: Employees gain insights into their salaries, increments, bonuses, and other benefits provided by the company. A business unit's growth indicates job security, future salaries, and compensation.
6. Tax authorities: State and Central Governments collect various taxes from companies. Tax authorities use account reports to get information on taxes paid and taxes due based on the budget.
7. Customers: The company's published account reports are very helpful to customers. They gain an understanding of the company’s goods or services. In today's market, consumers hold power because they are considered the king of the market.
8. Foreign entrepreneurs: Improved communication and transportation have globalized the world. Economic restrictions have reduced due to liberalization. Therefore, many foreign companies want to partner with domestic companies to benefit, requiring them to study the detailed accounts of specific companies.
9. Regulatory bodies: To safeguard common people in economic transactions, the Government has established regulatory bodies like SEBI and IRDA. These bodies demand account details for creating guidelines, rules, and regulations.
10. Professional bodies: Those who manage accounts are known as Professional Bodies. Accounting is a profession. Institutes like the Institute of Chartered Accountants, Institute of Company Secretaries, and Institute of Cost Accounts of India offer suggestions for standard and consistent account maintenance.
11. Researchers and Analysts: Researchers and analysts examine a company's progress, profits, growth, and stability by studying its account reports.
12. Government: The Government makes informed decisions by gathering published account details from companies. Such accounting information helps the Government create national economic laws.
In simple words: Many groups use accounting information, including management, shareholders (current and potential), creditors, employees, tax authorities, customers, foreign entrepreneurs, regulatory bodies, professional organizations, researchers, and the government, all for different decision-making purposes.

Exam Tip: Systematically list each user group and briefly explain their specific interest in and use of a company's accounting information.

 

Question 7. Explain the qualitative characteristics of accounting.
Answer: Qualitative characteristics of accounting information are essential attributes that make financial reports useful to users for decision-making. These characteristics ensure that the information is relevant, reliable, comparable, and understandable. Relevant information helps users make informed predictions and confirms their expectations, while reliable information is accurate, unbiased, and free from material error. Comparability allows users to identify similarities and differences across companies or over different periods, and understandability means the information is clear and concise for a reasonable user. These qualities improve the overall utility of financial statements.
In simple words: Good accounting information must be useful. This means it needs to be relevant, trustworthy, easy to compare with other data, and simple to understand so people can make smart decisions.

Exam Tip: Focus on the four main qualitative characteristics (relevance, reliability, comparability, understandability) and briefly explain how each contributes to the usefulness of financial statements for decision-makers.

 

Question 8. Explain the following technical terms :

(1) Capital and Drawings
Answer:
Capital: The money put into a business by its owner to start or operate it is called capital. This contribution can be cash, products, or other valuable items. Simply put, anything an owner gives to their business counts as capital. Since the owner provides this, the amount goes into their capital account. The owner has a right to the business's profits or losses; so, capital goes up with profits and down with losses. Another way to look at it, capital is what remains when liabilities are subtracted from assets. Capital = Assets - Liabilities. The way capital is referred to depends on the business type, as explained below:

• In a sole proprietorship, the owner's contribution is called capital.
• For a partnership, partners use the term 'partners' capital' for their contributions.
• In a company, shareholders' contributions are referred to as 'share capital'.

Drawings: If a business owner takes out cash, goods, assets, or services for personal use, this amount is called drawings. A drawings account is created to track these personal withdrawals throughout the year. A drawings account is considered a personal account. The owner's capital decreases by the amount of these drawings. At year-end, the drawings account is moved to the capital account, meaning the total drawings are subtracted from capital.
In simple words: Capital is money or assets an owner invests in a business. Drawings are money or assets an owner takes out for personal use.

Exam Tip: Remember to differentiate between capital (investment) and drawings (personal withdrawal) as they both affect the owner's equity but in opposite ways.

 

Question 8.
(2) Capital receipts and Revenue receipts
Answer:
Capital receipts: Money obtained from selling assets or from long-term loans is known as capital receipts. Examples include funds from selling old machines or issuing debentures. These types of receipts do not come in often or regularly. Such funds are added to a specific fund or the capital fund.
Revenue receipts: Money gained from normal, everyday business activities is called revenue receipts. For instance, this includes brokerage, interest, or money from selling goods. These receipts usually come in a steady stream. From these funds, the business's yearly profit or loss can be determined. These receipts occur often and consistently. Simply put, the usual, recurring funds a business gets are known as revenue receipts or incomes.
In simple words: Capital receipts are irregular funds from sales of assets or loans. Revenue receipts are regular funds from daily business operations.

Exam Tip: Always classify receipts correctly because capital receipts affect the balance sheet, while revenue receipts impact the income statement.

 

Question 8.
(3) Payables and Receivables
Answer:
Payables: Payables are amounts a business owes to others that must be paid later. This includes things like money owed to suppliers, bills to pay, unpaid costs, or income received in advance. All these items are counted as a business's liabilities. Liabilities come in two main kinds: (1) Current liabilities and (2) Long-term liabilities.
Receivables: Receivables are amounts a business expects to get from others in the future. Examples include money owed by customers, bills to collect, income not yet received, or expenses paid ahead of time. All these items are considered current assets for the business.
In simple words: Payables are debts you owe to others. Receivables are money that others owe to you.

Exam Tip: Understand that payables are liabilities (what you owe), while receivables are assets (what is owed to you).

 

Question 8.
(4) Debit and Credit
Answer: Debit and credit are two important words in accounting:
Debit: In the Double Entry System, the left side of an account is known as the debit side. Recording an amount on this left (debit) side with all the required information is called debiting the account. The name of the corresponding credited account should be noted in the details column.
Credit: In the Double Entry System, the right side of an account is known as the credit side. Putting an amount on this right (credit) side with needed details is called crediting the account. The name of the corresponding debited account should be included in the details column.
In simple words: Debit is an entry on the left side of an account, and credit is an entry on the right side of an account in double-entry bookkeeping.

Exam Tip: Remember that "debit" does not always mean "increase" and "credit" does not always mean "decrease"; their effect depends on the type of account.

 

Question 8.
(5) Account
Answer: An account is a structured accounting record that displays transactions for a set period, covering items like goods, assets, individuals, revenues, and costs. Each transaction's impact, either a debit or a credit, is entered into the account. It also includes figuring out the difference between both sides' totals, which is the account's balance.
For example: If goods worth \( \text{Rs. } 9,000 \) are sold to Manas for cash, two accounts are impacted: (1) Cash account and (2) Goods (Sales) account.
To simplify, a systematic summary created to separate a certain type of business transaction from others is known as an account.
In simple words: An account is a record that shows all the money ins and outs for a specific item, like cash, sales, or a person.

Exam Tip: Visualize an account as a "T" shape, with debits on the left and credits on the right, to help remember its structure.

 

Question 8.
(6) Voucher
Answer: A voucher is a paper or written document that proves a business transaction took place. Because it is written, this proof can be kept safe for a long period. Also, it can be shown as evidence later if needed. Examples of vouchers include bills for cash buys, credit memos for credit buys, credit notes, debit notes, check stubs, bank deposit slips, and receipts given or received. Business dealings are entered into accounting records only when supported by these vouchers. Vouchers also help make certain that an accounting entry is accurate and correct. For example, a seller's invoice serves as the basis for recording a purchase in the Purchase Book. Similarly, a copy of the sales invoice from the office is the basis for recording sales.
In simple words: A voucher is a written document that acts as proof of a business transaction, like a receipt or an invoice.

Exam Tip: Vouchers are essential for auditing, so always ensure that all business transactions are supported by proper documentation.

 

Question 9. Explain the methods of maintaining accounts on Mercantile System and Cash System (Basis).
Answer: To create accounts using the Double Entry System, three distinct approaches are used: 1. Mercantile base, 2. Cash base, and 3. Mixed base.

1. Mercantile base: In this method, accounts are kept based on the financial year. When accounts are prepared this way, these key points should be kept in mind:

• All transactions from that specific year are included.
• Revenues are recorded when they are earned, and costs are recorded when they become due or payable.
• Both cash transactions and credit transactions are recorded.
• Cash revenues and costs from the previous or next year are not included when calculating current profit or loss.
• Last year's transactions are recorded in the previous year, and next year's transactions will be recorded in the next.
• This accounting year's transactions involve receipts, payments, liabilities, and assets.
• Income and expenses for the specific accounting year are considered, including unpaid income, prepaid expenses, outstanding costs, and income received early.

Briefly, this system records items when they are due to be received or paid.

Illustration: Assume that accounts are prepared for the period 1-4-T4 to 31-3-T5, and office rent of \( \text{Rs. } 9,000 \) is paid every month. Further assume that office rent of March T5 is outstanding. It will be recorded as under:
Office rent for 11 months (\( 9,000 \times 11 \)) \( = \text{Rs. } 99,000 \)
\( + \) Office rent o/s of 1 month (March '15) \( = \text{Rs. } 9,000 \)
Total expenses of office rent will \( = \text{Rs. } 1,08,000 \)
These total expenses will be considered in the current accounting year. This method is quite common. In actual practice, except for some specific areas, accounts are kept using the mercantile system. This system is also known as the Accrual basis of accounting.

2. Cash base: Professionals such as doctors, lawyers, and chartered accountants can keep their accounts using this approach. This method is not widely used. When accounts are prepared using this method, these points should be kept in mind:

• Only cash transactions occurring in that particular accounting year are recorded.
• Credit transactions and barter transactions are not recorded.
• Cash transactions for that accounting year cover receipts, payments, liabilities, and assets.
• Cash transactions from the prior year, current year, and next year are also taken into account.
• Every transaction involving cash entering or leaving the business is recorded with its specific reason.

In simple words: The Mercantile System records income when earned and expenses when due, regardless of cash flow. The Cash System records transactions only when cash is actually received or paid.

Exam Tip: Understand that the mercantile (accrual) system gives a more accurate financial picture for most businesses by matching revenues and expenses, while the cash system is simpler but less comprehensive.