It has been discussed that every business concern ascertains profit or loss of the business at the end of the year through Final Accounts. Gross profit or loss of the business is ascertained through Trading A/c and net profit or loss is determined through Profit and Loss Account. There are two systems of ascertaining profit or loss of the business:
1. Cash System.
2. Accrual or Mercantile System.
These two systems are discussed below in details:
1. CASH SYSTEM:
Under this system profit or loss of the business is determined by comparing (matching) only the items of revenue which have been received in cash with the items of expenses which have been paid in cash during an accounting period. The items of revenue which the business has earned (credit sales, interest receivable etc.) but have not been received in cash will not be considered, while determining profit or loss of the business. Similarly, the items of expenses which are incurred but have not been paid in cash (credit purchases, wages payable, salaries payable etc.) will not be considered. Thus, “the system under which the annual result (profit or loss) of the concern is ascertained on the basis of only the items of revenue received in cash and the items of expenses paid in cash whether they relate to the current accounting year or not is called cash system”.
Generally this system is not followed by businessmen. Professional persons or bodies like lawyers, doctors, chartered accountant’s firms etc. maintain accounts under this system.
2. ACCRUAL OR MERCANTILE SYSTEM:
Under this system the profit or loss of a business is ascertained by comparing all items of revenue (whether received in cash or not) with all items of expenses (whether paid in cash or not) relating to the current accounting period. In other words, an item of revenue, whether received in cash or not, and an item of expenditure, whether paid in cash or not, must be taken into consideration, if they relate to the current accounting period. Thus “the system under which all items of revenue and expenses relating to the current accounting period -- whether received / paid in cash or not are taken into consideration while determining the profit or loss of the business, is called Accrual or Mercantile System.” Suppose, if our current accounting year is 2005, then.
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