Guidance Note on
Accrual Basis of Accounting
The Institute of Chartered Accountants of India
(Set up by an Act of Parliament)
New Delhi
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Edition : January, 2021
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Foreword
Financial Statements are the reports that provide the details of the
entity's financial information including assets, liabilities, equities, incomes and
expenses, shareholders' contribution, cash flow, and other related information
during a specific period of time. Financial statements are written records that
convey the business activities and the financial performance of a company.
Accrual basis of accounting is one of the fundamental accounting assumptions
for the preparation and presentation of general-purpose financial statements.
The Institute of Chartered Accountants of India (ICAI) through its Research
Committee has been relentlessly working to ensure that the users of financial
information of world’s fastest growing economy of India are always equipped
with updated and reliable guidance. I am pleased to note that the Research
Committee of the Institute has undertaken the task to revise ‘Guidance Note
on Accrual basis of accounting’. The revised Guidance Note explains the
fundamental concept of Accrual Accounting and also explains the process of
transition from cash basis of accounting to accrual basis.
I would like to take this opportunity to express my gratitude and thanks to CA.
Anuj Goyal, Chairman, Research Committee, CA. Kemisha Soni, Vice-
Chairperson, Research Committee, and all members of the Research
Committee who have made invaluable contribution in the finalisation of this
Guidance Note.
I am confident that this Guidance Note will be extremely useful to the members
of the Institute in discharging their professional duties and others concerned.
New Delhi CA. Atul Kumar Gupta
January 28, 2021 President, ICAI
Preface
Investors and financial analysts rely on financial data to analyze the
performance of a company and make predictions about its future direction of
the company's stock price. One of the most important resources of reliable and
audited financial data is the annual report, which contains the firm's financial
statements. The financial statements are used by investors, market analysts,
and creditors to evaluate a company's financial health and earnings
potential. The three major financial statement reports are the balance sheet,
income statement, and statement of cash flows. Financial statements are
records of the financial activities and position of a business. One of the
fundamental accounting assumption for preparing and presenting the financial
statement is ‘Accrual’. This led to the importance of Accrual basis of
accounting.
Research Committee felt the need for revising ‘Guidance Note on Accrual
basis of Accounting’ which was issued in the year 1988. The revised
guidance note highlights the need for accrual basis of accounting, provides
guidance in respect of transition from cash basis to accrual basis of
accounting, further states the benefits associated with accrual system of
accounting. The revised guidance note covers definition of accrual, accrual
basis of accounting, difference between accrual basis of accounting with cash
basis of accounting, need for the accrual principle, application of accrual basis
of accounting with respect to assets, liabilities with some examples, income
and expenses, transition from cash to accrual accounting along with appendix.
I would like to convey my sincere thanks to CA. Atul Kumar Gupta, President,
ICAI and CA. Nihar N. Jambusaria, Vice-President, ICAI for providing
guidance on various activities of the Committee. I would like to convey my
sincere thanks to CA. Kemisha Soni, Vice-Chairperson, Research Committee
for her constant co-operation.
I wish to place on record my deep appreciation for CA. Babu Abraham
Kallivayalil, Past Chairman, Research Committee, CA. Satish Kumar Gupta,
Past Vice-Chairman, Research Committee, under whose guidance, task was
initiated to revise the Guidance Note in a timely manner for the benefit of all.
I would also like to acknowledge the invaluable contribution made by CA. M.P.
Vijay Kumar, CCM who spared his valuable time for providing significant inputs
and for representing the draft Guidance Note before the Council, CA. Santosh
Maller, Resource Person for preparing the basic draft of the Guidance Note.
My sincere thanks to CA. Sanjay Vasudeva, Co-opted Member, Research
Committee for providing invaluable inputs and other esteemed members of
Research Committee for their guidance and the branches of ICAI and Regional
Councils of ICAI, members at large for their valuable suggestions.
I also appreciate the untiring efforts of Dr. Amit Kumar Agrawal, Secretary,
Research Committee, CA Amit Agarwal, Senior Executive Officer and CA
Sakshi Garg, Project Associate, Research Committee for finalising the
Guidance Note.
I truly believe and trust that this publication would prove useful to the members
of the Institute and others concerned.
New Delhi CA. Anuj Goyal
January 27, 2021 Chairman, Research Committee
Table of Content
1. Introduction....................................................................................... 1
2. Accrual Basis of Accounting ............................................................. 3
3. Preparation of Financial Statements on Accrual Basis of
Accounting ....................................................................................... 7
4 Application of Accrual Basis of Accounting ........................................ 9
5. Change in the Basis of Accounting .................................................. 17
Appendix I ................................................................................................ 23
Appendix II ............................................................................................... 31
Appendix III .............................................................................................. 34
Appendix IV .............................................................................................. 40
Guidance Note on
Accrual Basis of Accounting
(The following is the text of the ‘Guidance Note on Accrual Basis of
Accounting’, issued by the Council of the Institute of Chartered Accountants of
India. With the issuance of this Guidance Note, the Guidance Note on Accrual
Basis of Accounting issued in 1988 stands withdrawn.)
1. Introduction
1.1 Certain fundamental accounting assumptions underlie the preparation
and presentation of financial statements. “Accrual” is one of the
fundamental accounting assumptions. Framework for the Preparation
and Presentation of Financial Statements under Accounting Standards
(AS) considers the ‘Accrual Basis’ as a fundamental accounting
assumption for the preparation and presentation of general-purpose
financial statements. Section 128 of Companies Act, 2013 prescribes
maintenance of books of account by Companies on accrual basis and
according to the double entry system of accounting. For all other
entities, the concept of accrual is prescribed in ‘Preface to the
Statements of Accounting Standards’ issued by ICAI and requires
Accounting Standards to be applied in respect of commercial, industrial
or business activities of any enterprise. According to Accounting
Standard 1, Disclosure of Accounting Policies, ‘accrual’ is one of the
fundamental accounting assumptions, and if not followed, the fact
should be disclosed. This Guidance Note does not apply to corporate
enterprises which apply Accounting Standards under Companies
(Accounting Standards) Rules, 2006 or Indian Accounting Standards
under Companies (Indian Accounting Standards) Rules, 2015.
1.2 Paragraphs 9 and 10 of AS-1 Disclosure of Accounting Policies states
as under:
“9. Certain fundamental accounting assumptions underlie the
preparation and presentation of financial statements. They are usually
not specifically stated because their acceptance and use are assumed.
Disclosure is necessary if they are not followed.
10. The following have been generally accepted as fundamental
Guidance Notes on Accrual Basis of Accounting
accounting assumptions:
a. Going Concern
The enterprise is normally viewed as a going concern, that is, as
continuing in operation for the foreseeable future. It is assumed
that the enterprise has neither the intention nor the necessity of
liquidation or of curtailing materially the scale of the operations.
b. Consistency
It is assumed that accounting policies are consistent from one
period to another.
c. Accrual
Revenues and costs are accrued, that is, recognised as they are
earned or incurred (and not as money is received or paid) and
recorded in the financial statements of the periods to which they
relate. The considerations affecting the process of matching
costs with revenues under the accrual assumption are not dealt
with in this standard’’.
1.3 Accrual Basis of accounting is a Fundamental Accounting Assumption
as per AS-1 and forms the basis for the principles in various accounting
standards. Wherever the financial statements have been prepared on a
basis other than ‘accrual’ the audit report should describe the basis of
accounting followed, without necessarily making it a subject matter of a
qualification.
Objective
1.4 This Guidance Note highlights the need for accrual basis of accounting,
provides guidance in respect thereof and provides guidance in respect
of transition from cash basis to accrual basis of accounting. In addition,
this Guidance Note states the benefits associated with while following
accrual system instead of cash system.
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Guidance Notes on Accrual Basis of Accounting
2. Accrual Basis of Accounting
2.1 Definitions
The Glossary of Terms used in Financial Statements (issued 2019) by
Research Committee, ICAI also provides definitions as under:
‘Accrual’:
“Recognition of revenues and costs as they are earned or incurred (and
not as money is received or paid). It includes recognition of transactions
relating to assets and liabilities as they occur irrespective of the actual
receipts or payments.”
‘Accrual Basis of Accounting’:
“The method of recording transactions by which revenues, costs, assets
and liabilities are reflected in the accounts pertaining to the period in
which they accrue. The ‘Accrual Basis of Accounting’ includes
considerations relating to deferrals, allocations, depreciation and
amortisation. This basis is also referred to as ‘Mercantile Basis of
Accounting’.”
2.2 What exactly is an “accrual”?
If entities received cash payments for all revenues at the same time
when they were earned and made cash payments for all expenses at
the time when they were incurred, there wouldn’t be a need for accruals.
However, most entities have some revenues in the period that were
earned but for which consideration was not received. This needs to be
accounted for as revenue. Similarly, if the entities incurred expenses but
did not pay for them at the time of incurrence of expenses, then these
expenses also need to be accounted for in the relevant accounting
period.
2.3 Under the Accrual basis of accounting, the enterprise records the
financial effects of the transactions, events, and circumstances in the
period in which they occur rather than in the period(s) in which cash is
received or paid by the enterprise. It recognises that the buying,
producing, selling and other economic events that affect enterprise’s
performance often do not coincide with the cash receipts and payments
of the period. The goal of accrual basis of accounting is to relate the
accomplishments (measured in the form of revenue or income) and the
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Guidance Notes on Accrual Basis of Accounting
efforts (measured in terms of cost/expense) so that reported net income
measures an enterprise’s performance during a period instead of merely
listing its cash receipts and payments. Accrual basis of accounting
recognises assets, liabilities or components of incomes and expenses
for amounts received or paid in cash in past, and amounts expected to
be received or paid in cash in the future. It may be noted that even under
accrual basis of accounting, recognition criteria must be met for
recognition of an element of financial statements.
Accrual Basis of Accounting vs. Cash Basis of Accounting
2.4 The major difference between accrual accounting and cash-based
accounting, is in timing of recognition of assets, liabilities, income,
expenses, gains and losses. Cash receipts in a particular period may to
some extent reflect the effects of activities of the enterprise in the earlier
periods, while many of the cash outlays may relate to activities and
efforts expected in future periods. Thus, an account showing cash
receipts and cash outlays of an enterprise for a short period cannot
solely indicate how much of the cash received is return of investment
and how much is return on investment and, therefore, cannot provide
the correct information in terms of profitability and financial position,
although cash receipts and cash outlays is also useful in assessing the
financial operations on an enterprise.
Appendix I illustrates how the choice of accounting method determines
the timing of when revenue and expenses are recognised.
2.5 An entity following the accrual basis of accounting will record a sale as
soon as it meets the recognition requirements of applicable Accounting
Standards e.g. under AS 9, revenue is recognised when an entity has
transferred to the buyer the property in the goods for a price with all
significant risks and rewards of ownership having been transferred,
while an entity following cash basis would instead wait to receive the
consideration for recording the sale. Similarly, an entity following
accrual basis of accounting will record an expense as incurred, while an
entity following cash basis would instead wait to pay its vendor before
recording the expense.
2.6 Accrual accounting measures the performance and position of an entity
recording the economic events regardless of completion of
corresponding payment or receipt of consideration. The economic
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Guidance Notes on Accrual Basis of Accounting
events are recognised by recording the assets, liabilities, income and
expenses at the time when the transactions occur rather than when
consideration is paid or received.
2.7 The business transactions may occur over a longer period of several
months or years i.e., several accounting periods. Accrual accounting
reflects that income earned and expenses incurred in one accounting
period can be carried over in the books of account as receivable and
payable respectively to the succeeding accounting periods till the
receipt or payment of consideration in cash is completed.
Therefore, the accrual basis of accounting provides a more accurate
picture of an entity's (a) performance in terms of income and expense,
during an accounting period (b) assets and liabilities at the end of an
accounting period. This method is more appropriate in assessing the
health of the organisation in financial terms.
Table 1- Table 3 of Appendix I illustrates why accrual accounting
provides a more complete picture of a company’s financial performance
as compared with cash basis of accounting.
2.8 Accrual basis of accounting provide more appropriate recognition of
revenues and expenses over time, and so is considered by users of
financial statements to be the most acceptable accounting system for
ascertaining the results of operations and financial position of a
business. The accrual basis requires the use of allowances for sales
returns, bad debts and inventory obsolescence etc. and at the end of
each reporting period, entities pass adjusting journal entries to record
any accruals.
Accrual basis of accounting recognises income, expenses, gains and
losses along with corresponding increase or decrease in assets and
liabilities in the period during which the event occurs irrespective of the
cash movement. This results into accurate reporting of net income,
assets, liabilities and retained earnings which improves analysis of the
entity’s financial performance and financial position over different
periods.
2.9 The Need for the Accrual Principle:
The complexity of business transactions
The accrual method of accounting came into use as a response to the
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Guidance Notes on Accrual Basis of Accounting
practice of deferred collection and payment. Entities that sell goods on
credit may continue to collect the consideration over a long period of
time from goods that were sold earlier. Recording such transactions
when the sale proceeds are actually received would reflect an
inaccurate picture of the entity’s financial position, whereas the users of
financial statements require timely and accurate reporting of an entity’s
financial position. With the accrual accounting method, entities can
present the most accurate picture of the financial position of the entity.
Measuring the performance of a business in a
particular period
When an entity wants to examine its actual performance during a
specific period of time, such as a quarter or half year or fiscal year, the
financial statements prepared on accrual method of accounting provides
a complete picture. The financial information recorded under accrual
accounting enables the business to make meaningful comparisons
across different periods by way of key financial metrics or ratios
e.g. gross profit margin, operating profit margin, and net profit margin
and various capital ratios, etc.
Paragraph 14 of the Conceptual Framework under Accounting
Standards (AS) “Framework for the Preparation and Presentation of
Financial Statements (Framework 2000)” states the following as one of
the objectives of financial statements.
“14. Financial statements also show the results of the stewardship of
management, or the accountability of management for the resources
entrusted to it. Those users who wish to assess the stewardship or
accountability of management do so in order that they may make
economic decisions; these decisions may include, for example, whether
to hold or sell their investment in the enterprise or whether to reappoint
or replace the management.”
Given the investment and stewardship objectives of general purpose
financial reports, there are presumed to be informational advantages
that make accrual accounting a ‘better’ basis for assessing past and
future performance than cash-based information.
Accrual method of accounting is central to the process of accounting.
Measurement requirements are necessary for accrual accounting. In
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Guidance Notes on Accrual Basis of Accounting
order to give greater practical clarity and foundation to the overarching
objective of financial reporting, it is therefore necessary to reconcile it
with the underlying mechanics of accrual-based double entry.
Over the life of an enterprise the cash flows and accruals will be
identical. Similarly, the earnings and cash realisation are equivalent
over the life of the enterprise. Yet the distinctive informational content
of accounting is periodic, and it is these limited time frames with which
the users of financial statements are concerned. Accounting data
provide information relevant to the forecasting of future cash flows.
Accrual method allocates the transaction price to one or more financial
reporting periods. For example, revenue is recognised when it is earned
by the enterprise rather than when it is realised. Depreciation on
Property, Plant and Equipment is accrued over the period of putting the
asset to use rather than when the payment to the vendor is made.
Limitations of the Accrual Principle
2.10 While accrual accounting is known to help increase operational
efficiency in practice, the significant limitation of the accrual principle of
accounting is that accounts prepared on the basis of accrual accounting
may indicate that a business generated profits during a specific
accounting period while the resultant cash flows are yet to be received.
The business under such situation may appear as profitable even when
it lacks sufficient cash flow to finance its operations.
3. Preparation of Financial Statements on
Accrual Basis of Accounting
3.1 Conceptual Framework under Accounting Standards (AS)
“Framework for the Preparation and Presentation of Financial
Statements (Framework 2000)”
Paragraph 22 of the above referred Conceptual Framework describes
the accrual basis as follows:
“22. In order to meet their objectives, financial statements are prepared
on the accrual basis of accounting. Under this basis, the effects of
transactions and other events are recognised when they occur (and not
as cash or a cash equivalent is received or paid) and they are recorded
in the accounting records and reported in the financial statements of the
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Guidance Notes on Accrual Basis of Accounting
periods to which they relate. Financial statements prepared on the
accrual basis inform users not only of past events involving the payment
and receipt of cash but also of obligations to pay cash in the future and
of resources that represent cash to be received in the future. Hence,
they provide the type of information about past transactions and other
events that is most useful to users in making economic decisions.”
3.2 As per Paragraphs 27 & 28 of Ind AS1 “Presentation of Financial
Statements”, an entity shall prepare its financial statements, except for
cash flow information, using the accrual basis of accounting. When the
accrual basis of accounting is used, an entity recognises items as
assets, liabilities, equity, income and expenses (the elements of
financial statements) when they satisfy the definitions and recognition
criteria for those elements in the Framework.
3.3 Further, section 128 of the Companies Act, 2013 requires every
company to prepare books of accounts following accrual system of
accounting.
3.4 As per the Master Circular of Reserve Bank of India on “Disclosure in
Financial Statements”1, Banks are also required to comply with AS-1.
Therefore, banks also have to follow accrual basis in preparation of
financial statements. Further, accrual being a fundamental accounting
assumption, the auditor would need to consider modification or
reference in the report, wherever cash basis of accounting is followed,
unless permitted by any law or statute.
3.5 The Insurance Regulatory and Development Authority (Preparation of
Financial Statements and of Insurance Companies) Regulations, 20002
states that “Every Balance Sheet, Revenue Account [Policyholders’
Account], Receipts and Payments Account [Cash Flow statement] and
Profit and Loss Account [Shareholders’ Account] of an insurer shall be
in conformity with the Accounting Standards (AS) issued by the ICAI, to
the extent applicable to insurers carrying on life insurance business,
except AS 3 and AS 17”
1 Circular No.- DBOD.BP. BC No.14 /21.04.018/2012-13 dated 2nd July 2012.
2 Notification No.- F. No. IRDA/ Reg/ 8/ 2000 under The Insurance Regulatory and Development
Authority (Preparation of Financial Statements and of Insurance Companies) Regulations,
2000.
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Guidance Notes on Accrual Basis of Accounting
It further states the recognition of income, expenses and other items of
financial statements on accrual basis, unless otherwise permitted by
any law or statute.
4. Application of Accrual Basis of Accounting
In the following paragraphs, the application of accrual basis of
accounting with reference to key elements of financial statements is
explained.
4.1 Assets and Liabilities
It is important to understand the definition and recognition criteria of
assets and liabilities under the conceptual framework.
Framework for the Preparation and Presentation of Financial
Statements under Accounting Standards
An asset is a resource controlled by the enterprise as a result of past
events from which future economic benefits are expected to flow to the
enterprise.
A liability is a present obligation of the enterprise arising from past
events, the settlement of which is expected to result in an outflow from
the enterprise of resources embodying economic benefits.
An asset is recognised in the balance sheet when it is probable that the
future economic benefits associated with it will flow to the enterprise and
the asset has a cost or value that can be measured reliably.
A liability is recognised in the balance sheet when it is probable that an
outflow of resources embodying economic benefits will result from the
settlement of a present obligation and the amount at which the
settlement will take place can be measured reliably.
4.2 The essential features of accrual basis of accounting:
(i) Asset and Liabilities are recognised when those meet the
definition and recognition criteria of Conceptual Framework and
relevant accounting standards, if any.
(ii) Changes in carrying amount of assets and liabilities are
recognised as income and expenses, except where changes
relate to transactions with owners of the entity.
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Guidance Notes on Accrual Basis of Accounting
It may be noted from the above definitions and recognition criteria that
receipt and payment of cash is not the criteria for recognition of assets
and liabilities, rather the existence of resource or obligation which
results in inflow or outflow of economic benefits.
The application of above principles can be further demonstrated with
four examples as follows.
Example 1: Property, Plant and Equipment (PPE)
Paragraph 7 of AS 10, Property, Plant and Equipment (Revised 2016)
The cost of an item of property, plant and equipment should be
recognised as an asset if, and only if:
(a) it is probable that future economic benefits associated with
the item will flow to the enterprise; and
(b) the cost of the item can be measured reliably.
Similar principles are stated in Ind AS 16 Property, Plant and
Equipment.
Based on the recognition criteria, an entity has to recognise an item of
PPE if it meets the above criteria regardless of when the cash payment
is made for the above assets. e.g. if an entity has purchased a plant and
machinery or building say for ` 100,000 but the payment will be made
after a month. In this scenario, under accrual basis of accounting the
entity has to recognise the PPE of ` 100,000 when it is acquired and
recognise a liability for the amounts to be paid.
Example 2: Employee Benefits
Paragraph 10 of AS 15 Employee Benefits (Revised 2005)
When an employee has rendered service to an enterprise during an
accounting period, the enterprise should recognise the
undiscounted amount of short-term employee benefits expected to
be paid in exchange for that service:
(a) as a liability (accrued expense), after deducting any amount
already paid. If the amount already paid exceeds the
undiscounted amount of the benefits, an enterprise should
recognise that excess as an asset (prepaid expense) to the
extent that the prepayment will lead to, for example, a
reduction in future payments or a cash refund; and
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Guidance Notes on Accrual Basis of Accounting
(b) as an expense, unless another Accounting Standard requires
or permits the inclusion of the benefits in the cost of an
asset.
Similar principles are stated in Para 11 of Ind AS 19 Employee Benefits.
Based on the recognition criteria, an entity has to recognise an item of
a liability for salaries, wages, bonus, leave encashment and other short-
term benefits as and when the employee renders the service regardless
of when the actual payments are made.
Example 3: Provisions, Contingent Liabilities and Contingent
Assets
Paragraph 14 of AS 29, Provisions, Contingent Liabilities and
Contingent Assets lays down the following recognition criteria for a
provision
A provision should be recognised when:
(a) an enterprise has a present obligation as a result of a past
event;
(b) it is probable that an outflow of resources embodying
economic benefits will be required to settle the obligation;
and
(c) a reliable estimate can be made of the amount of the
obligation.
If these conditions are not met, no provision should be recognised.
Similar principles are stated under Para 14 of Ind AS 37 Provisions,
Contingent Liabilities and Contingent Assets.
Based on the recognition criteria, an entity has to recognise an item of
an obligation as a liability if it meets the above criteria regardless of
when the cash expenditure is incurred for the above. E.g. if an entity
has sold goods with a warranty for 3 years, then the entity has to
recognise a provision for warranty expenses on estimated basis when
the goods are sold and not when the actual warranty claims are settled.
Example 4: Gratuity
Accounting standard, AS 15, requires an actuarial valuation to be done
for certain types of employee benefits schemes, including gratuity
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Guidance Notes on Accrual Basis of Accounting
benefit. Actuarial valuations are required by AS 15 and Ind AS 19, to
recognise liability when an employee has provided service in exchange
for employee benefits to be paid in future and to recognise an expense
when the enterprise consumes the economic benefit arising from
service provided by an employee in an exchange for employee benefits.
Accounting Standard (AS) 15, “Employee Benefits” requires provision
for defined employee benefit plans such as Gratuity benefits on accrual
basis except where the relaxations have been granted under the
standard to certain entities fulfilling the exemption criteria mentioned
therein. This means that the accounting treatment for the employee
benefits must be recognised in the balance sheet of the enterprise and
there must be a provision for gratuity every year in the financial
statements of employers.
4.3 Income and Expenses
Similar to assets and liabilities, the Framework for Preparation &
Presentation of Financial Statements under AS lays down recognition
criteria for income and expenses. Accrual is co-terminus with
recognition criteria prescribed under Accounting Standards. It is
highlighted below.
Income is recognised in the statement of profit and loss when an
increase in future economic benefits related to an increase in an asset
or a decrease of a liability has arisen that can be measured reliably.
This means, in effect, that recognition of income occurs simultaneously
with the recognition of increases in assets or decreases in liabilities (for
example, the net increase in assets arising on a sale of goods or
services or the decrease in liabilities arising from the waiver of a debt
payable).
The procedures normally adopted in practice for recognising income, for
example, the requirement that revenue should be earned, are
applications of the recognition criteria in this Framework. Such
procedures are generally directed at restricting the recognition as
income to those items that can be measured reliably and have a
sufficient degree of certainty.
Expenses are recognised in the statement of profit and loss when
decrease in future economic benefits related to a decrease in an asset
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Guidance Notes on Accrual Basis of Accounting
or an increase of a liability has arisen that can be measured reliably.
This means, in effect, that recognition of expenses occurs
simultaneously with the recognition of an increase of liabilities or a
decrease in assets (for example, the accrual of employees’ salaries or
the depreciation of plant and machinery).
Many expenses are recognised in the statement of profit and loss on the
basis of a direct association between the costs incurred and the earning
of specific items of income. This process, commonly referred to as the
matching of costs with revenues, involves the simultaneous or combined
recognition of revenues and expenses that result directly and jointly
from the same transactions or other events; for example, the various
components of expense making up the cost of goods sold are
recognised at the same time as the income derived from the sale of the
goods. However, the application of the matching concept under the
Framework for the Preparation and Presentation of Financial
Statements under AS does not allow the recognition of items in the
balance sheet which do not meet the definition of assets or liabilities.
When economic benefits are expected to arise over several accounting
periods and the association with income can only be broadly or indirectly
determined, expenses are recognised in the statement of profit and loss
on the basis of systematic and rational allocation procedures. This is
often necessary in recognising the expenses associated with the using
up of assets such as property, plant & equipment, patents and
trademarks; in such cases the expense is referred to as depreciation or
amortisation. These allocation procedures are intended to recognise
expenses in the accounting periods in which the economic benefits
associated with these items are consumed or expire.
An expense is recognised immediately in the statement of profit and loss
when expenditure produces no future economic benefits or when, and
to the extent that future economic benefits do not qualify, or cease to
qualify, for recognition in the balance sheet as an asset.
An expense is also recognised in the statement of profit and loss in
those cases when a liability is incurred without the recognition of an
asset, as when a liability under a product warranty arises.
It may be noted from the above definitions and recognition criteria that
receipt and payment of cash is not the criteria for recognition of income
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Guidance Notes on Accrual Basis of Accounting
and expenses, rather the increase and decrease in assets and liabilities
and the criteria of reliability measurement. The application of above
principles can be further demonstrated with following examples.
Revenue Recognition Principle
4.4 The Accounting Standard on “Revenue Recognition” (AS-9) also
assumes that the three fundamental accounting assumption of accruals
is followed in the preparation and presentation of financial statements.
It deals with the bases for recognition of revenue in the statement of
profit and loss of an enterprise. This standard lays down principles for
recognition of revenue arising in the course of the ordinary activities of
the enterprise from
(i) Sale of goods,
(ii) Rendering of services, and
(iii) Use of resources of the enterprise by others yielding interest,
royalties and dividends.
4.5 Recognition of revenue requires that revenue is measurable and that at
the time of sale or the rendering of service or the use of resources of
the enterprise by others it would not be unreasonable to expect ultimate
collection.
4.6 The accrual basis of accounting necessitates adjustments for income
received in advance as well as for outstanding income at the end of the
period of accounting since the receipts during the period may not
coincide with what is properly recognisable as income for the period.
4.7 Accounting Standard (AS)-12 - Accounting for Government Grants
states that it is fundamental to the ‘income approach’ that Government
grants be recognised in the profit and loss statement on a systematic
and rational basis over the periods necessary to match them with the
related costs. Income recognition of Government grants on a receipts
basis is not in accordance with the accrual accounting assumption.
Expense Recognition Principle
a) The Glossary of Terms used in Financial Statements (Issued 2019) by
Research Committee, ICAI, explains the term ‘Expense’ as “a cost
relating to the operations of an accounting period or to the revenue
14
Guidance Notes on Accrual Basis of Accounting
earned during the period or the benefits of which do not extend beyond
that period”.
b) In the accrual basis of accounting, costs are matched either against
revenues or against the relevant time period to determine periodic
income. Further, costs which are not charged against income of the
period are carried forward. If any particular item of cost has lost its utility
or its power to generate future revenue the same is written off as an
expense or a loss.
c) Under accrual basis of accounting, expenses are recognised by the
following approaches:
(i) Identification with revenue transactions
Costs directly associated with the revenue recognised during the
relevant period (in respect of which whether money has been paid
or not) are considered as expenses and are charged to income
for the period.
Examples of application of above concepts are as follows.
• Contracts costs recognition under percentage of
completion method of AS 7 Construction Contracts or
amortisation of incremental costs of obtaining a contract
as per Ind AS 115 Revenue from Contracts with
Customers.
• Accounting for transaction costs of financial asset
(classified under Amortised Cost) as part of Effective
Interest Method of Ind AS 109 Financial Instruments.
(ii) Identification with a period of time
In many cases, although some costs may have connection with
the revenue for the period, the relationship is so indirect that it is
impracticable to attempt to establish it. However, there is a clear
identification with a period of time. Such costs are regarded as
‘period costs’ and are expensed in the relevant period, e.g.,
salaries, telephone, travelling, depreciation on office building etc.
Similarly, the costs the benefits of which do not clearly extend
beyond the accounting period are also charged as expenses.
15
Guidance Notes on Accrual Basis of Accounting
Examples of application of above concepts are as follows.
• Depreciation of Property, Plant and Equipment over its
useful life as per AS 10 Property, Plant and Equipment and
Ind AS 16 Property, Plant and Equipment.
• Recognition of employee benefits costs as per AS 15
Employee Benefits and Ind AS 19 Employee Benefits.
• Recognition of Share-based payments expense under Ind
AS 102 Share-based payments and Guidance Note on
Share Based Payments.
d) Expenses relating to a future period are accounted for as prepaid
expenses even though they are paid for in the current accounting period.
Similarly, expenses of the current year, for which payment has not yet
been made (outstanding expenses) are charged to the profit and loss
account for the current accounting period.
e) The amount of a contingent loss should be provided for by a charge in
the statement of profit and loss if:
(i) It is probable that at the date of the financial statements events
subsequent thereto will confirm that (after taking into account any
related probable recovery) an asset has been impaired or a liability has
been incurred as at that date, and
(ii) a reasonable estimate of the amount of the resulting loss can be
made.
f) The existence of a contingent loss should be disclosed in the financial
statements if either of the conditions in point(e) is not met, unless the
possibility of a loss is remote.
g) Recognition of deferred tax assets and liabilities under AS 22-
Accounting for Taxes on Income arising on accounting of timing
differences between accounting income and tax income is another
example of application of accrual concept of accounting. The objective
of recognising deferred tax assets and liabilities is to link the overall tax
expense with the profits as per books of account, rather than profit
computed in terms of provisions of various tax laws.
16
Guidance Notes on Accrual Basis of Accounting
5. Change in the Basis of Accounting
5.1 When an enterprise which was earlier following cash basis of accounting
for all or any of its transactions, changes over to the accrual basis of
accounting, the effect of the change should be ascertained with
reference to the transactions of the previous accounting periods also, to
the extent such transactions have an impact on the current financial
position of the enterprise. The fact of such change should be disclosed
in the financial statements. The impact of, and the adjustments resulting
from, such change, if material, should be shown in the financial
statements of the period in which such change is made to reflect the
effect of such change. Where the effect of the change is not
ascertainable, wholly or in part, the fact should be indicated. If the
change has no material effect on the financial statements for the current
period but is reasonably expected to have a material effect in later
periods, the fact of such change should be appropriately disclosed in
the period in which the change is adopted.
5.2 Conversion of books of accounts from cash basis to accrual, requires a
series of adjustments with journal entries in the financial accounting
system so that the financial statements (Balance Sheet, Profit & Loss
A/c, etc.) present organisation’s assets, liabilities, revenues and
expenses in the proper period. These adjustments are known as
“adjusting journal entries” and they fall into two categories:
1. Accruals:
Accruals involve recording a transaction in the current period’s
financial statements in which the underlying economic event (i.e.
the trigger for the transaction) has occurred, although cash
related to the transaction has not yet changed hands in the
current period.
2. Deferrals:
Deferrals are the result of cash flows occurring before they are
allowed to be recognised under accrual accounting. Posting
deferrals in the accounting system involves transactions where
the cash impact has taken place during the current period
although the economic event has not yet taken place. Such
transactions should not be recorded in the current period’s
17
Guidance Notes on Accrual Basis of Accounting
statement of Profit & loss A/c forming part of financial statements
as these shall be recognised in a later accounting period.
The Glossary of Terms used in Financial Statements (Issued
2019) by Research Committee, ICAI defines Deferral as
“Postponement of recognition of a revenue or expense after its
related receipt or payment (or incurrence of a liability) to a
subsequent period to which it applies. Common examples of
deferrals include prepaid rent and taxes, unearned subscriptions
received in advance by newspapers and magazine selling
companies, etc.”
5.3 The accrual transactions would include the followings primarily:
1. Accrued Expenses
An accrued expense refers to an expense that is recognised in
the books before it has been paid; the expense is recorded in the
accounting period in which it is incurred, as it represents an
entity's obligation to make future cash payments. These are
shown on an entity's balance sheet as current liabilities; accrued
expenses are also known as accrued liabilities or outstanding
expenses. Virtually all expenses should be accounted for
irrespective of the payments made, such as direct
materials received, office supplies received, expenses incurred,
salary and wages earned by employees etc. even if these have
not yet been paid. An accrued expense can also be an estimate
and may differ from the supplier’s invoice which is yet to be
received.
The Glossary of Terms used in Financial Statements (Issued
2019) by Research Committee, ICAI defines Accrued Expense as
“an expense which has been incurred in an accounting period but
for which no enforceable claim has become due in that period
against the enterprise. It may arise from the purchase of services
(including the use of money) which at the date of accounting have
been only partly performed and are not yet billable”.
2. Prepaid Expenses
Prepaid expenses are future expenses that have been paid in
advance. In other words, prepaid expenses are expenses that
18
Guidance Notes on Accrual Basis of Accounting
have been paid but are not used in the relevant financial year by
the entity or have not yet expired.
Such cash payments may relate to assets that have not been
consumed in the accounting period in which cash is paid, e.g.
insurance policies, memberships, rent deposits etc. The
expenditure made during the accounting period need to be
checked to see if there are any prepaid expenses, and then the
unused portion of these items need to be transferred to an asset
account. Generally, the amounts of prepaid expenses that will be
used up within one year are reported on an entity's balance
sheet as a current asset. As the amount expires, the current asset
is reduced, and the amount of the reduction is reported as
an expense on the income statement.
The Glossary of Terms used in Financial Statements (Issued
2019) by Research Committee, ICAI defines Pre-paid Expense
as “Payment for expense in an accounting period, the benefit for
which will accrue in the subsequent accounting period(s).”
3. Accounts Receivable
When an entity provides goods or services and invoices the
customers, it recognises account receivable. The invoice amount
remains a receivable until the customer pays the entity. The
accounts receivables are not accounted for in cash-basis of
accounting. While switching to accrual, all unpaid customer
invoices are to be accounted for in the books.
The Glossary of Terms used in Financial Statements (Issued
2019) by Research Committee, ICAI defines Sundry Debtors or
Accounts Receivable as “Person from whom amounts are due for
goods sold or services rendered or in respect of contractual
obligations. Also termed as debtor, trade debtor, account
receivable.”
4. Grants Receivable
Grants and contributions that were formally committed to the
entity as of the balance sheet date but not yet been received by
the entity would need to be worked out and accounted for as
Grants Receivable.
19
Guidance Notes on Accrual Basis of Accounting
5. Customer Prepayments or Advances Received
Advances received from the customers against their orders or
contracts would have been recorded as sales under the cash
basis of accounting even though the goods or the services had
not been delivered. Whereas under the accrual basis of
accounting, revenues received in advance of being earned are
reported as a liability. These advances should instead be
recorded as short-term liabilities until such time as the entity has
delivered the related goods or provided the related services and
raised sale invoices there against.
5.4 Issues to be addressed- Transition from Cash to Accrual
Accounting
The following issues may be addressed at the time of transition to
accrual accounting:
• Decide the type of transactions to be transitioned from cash
basis to accrual basis
An entity may choose to undertake a phased approach to transition. In
order to decide what transition plan to undertake, entities will need to
decide which transaction types to transition and when and how this
might occur.
Appendix II details some of the considerations and scenarios which
may influence a transition plan.
• Opening balance sheet
The systematic identification and measurement of assets and liabilities
as at the date from which accrual accounting is to commence is an
essential step in the move to accrual basis accounting. The concept of
materiality may be used to make judgments about assets and liabilities
that should receive the most attention during this exercise. Similarly, as
discussed below, the phasing of the implementation process may also
assist in prioritising this task appropriately.
Opening balance sheet is to be prepared at the beginning of the financial
period in which the enterprise transitions to accrual basis accounting.
This means that in the first financial period in which an enterprise
transitions to accrual basis accounting, the comparative information for
20
Guidance Notes on Accrual Basis of Accounting
previous period shall continue to be presented on cash basis, thereby
causing, lack of comparability within the same set of financial statement.
Although, ideally, comparability within the financial statements is
essential feature of financial statements, restatement of previous
financial statements would be cumbersome and the efforts for restating
comparable information may outweigh the benefits associated. Lack of
comparability can be overcome by providing adequate disclosures in the
financial statements in the financial period in which the enterprise
transitions to accrual basis accounting.
In the financial period in which an enterprise transitions to accrual basis
accounting, it shall explain how the transition from cash basis
accounting to accrual basis accounting affected its reported Balance
sheet and financial performance. This can be done by providing a
reconciliation of equity reported in accordance with the previous cash
basis accounting to its equity in accordance with accrual basis
accounting for both of the following dates:
─ Opening balance sheet (as explained above), and
─ The end of the latest period presented in the enterprise’s most
recent annual financial statements prepared on cash basis
accounting
Similarly, a reconciliation between the net profit/ loss reported in latest
period presented in the enterprise’s most recent annual financial
statements prepared on cash basis accounting and the net profit that
would have been there had the enterprise followed accrual basis
accounting shall be provided.
Preparation of the first financial statements under accrual basis
accounting: The decision on the format of financial statements on
migration to accrual basis accounting and generation of first set of
financial statements is of key importance in transition. The format has to
facilitate transparent, accurate and complete depiction of financial
position.
Appendix III & IV provide guidance to assess what liabilities and assets
should be included in the Opening Balance Sheet.
Checks and balances have to be in place to ensure appropriate
measurement and recording of accounting data.
21
Guidance Notes on Accrual Basis of Accounting
Issues like preparation of Assets register and measurement of assets ,
depreciation, inventory recognition and valuation have to be addressed.
The role of the accountant as well as the auditor is significant in ensuring
a smooth transition to accrual basis of accounting. Auditors may be
helpful in framing the accounting policies on assets and liabilities,
recognition of revenues and expenses, reporting period, measurement
basis and other criteria.
22
Guidance Notes on Accrual Basis of Accounting
Appendix I
Cash vs. Accrual Basis of Accounting
To illustrate how the choice of accounting method determines the timing of
when revenue and expenses are recognised, two different scenarios are
presented.
In each scenario, a subscriber purchases a two-year subscription for online
new content. In the first scenario, the subscriber pays in the first year. In the
second scenario, the subscriber pays in the second year. Under both
scenarios, information communicated and conclusions drawn about the
financial condition of the company differ depending on whether the cash or
accrual basis of accounting is used.
First, a narrative discussion that only focuses on the income statement is
provided for each scenario. A more detailed explanation is then provided that
incorporates an income statement, and a balance sheet.
Table 1 shows the opening balances at the beginning of the year. The set of
financial statements in Table 2-Table 3, report transactions if the payment was
received in the first year for a two-year subscription.
Table 2-Table 3 provide a better illustration of why accrual accounting
provides a more complete picture of a company’s financial performance as
compared with cash basis of accounting, when the payment is received before
the service is provided.
In the examples below, a fictitious small company provides online subscription-
only news service. The company is called XYZ and has a single subscriber
during the two-year business cycle.
A subscription requires a two-year commitment and costs ` 2,400 (total),
which must be paid in full at either the beginning of the first or second year.
The ` 2,400 cost of the subscription for the client is revenue for XYZ. Assume
that XYZ incurs service expenses (costs) of ` 600 each year, or ` 1,200 total.
On April 1, 2020, XYZ had ` 600 cash on hand, same as the owners’ interest
(or ownership equity).
23
Guidance Notes on Accrual Basis of Accounting
Scenario: Payment Received in the First Year
Cash Basis
XYZ receives a one-time payment of ` 2,400 in April 2020 for two-year
subscription. At the end of 2020-21, XYZ has recognised ` 2,400 in revenue
and ` 600 in expenses for an income (profit) of ` 1,800.
In 2021-22, no revenue is recognised by XYZ because the subscriber’s full
payment was recognised as revenue in 2020-21. XYZ incurs ` 600 in
expenses to provide the service in 2021-22, resulting in a loss for the year.
Accrual Basis
XYZ receives a payment of ` 2,400 in April 2020. Because XYZ is following
the matching principle of accrual accounting, it only recognises revenue for
which it has incurred expenses and services have been rendered.
XYZ recognises ` 1,200 in revenue and ` 600 in expenses for an income of
` 600 in 2020-21.
Similar to 2020-21, under accrual basis of accounting XYZ only recognises
revenue for which it has incurred expenses in 2021-22. Thus in 2021-22, XYZ
recognizes ` 1,200 in revenue and ` 600 in expenses for an income of ` 600.
A more comprehensive treatment of which basis of accounting a company
uses and how it affects the company’s income statement and balance sheet
appear in Table 2- Table 3. The figures also provide a detailed explanation by
line item.
Payment Received in the First Year—Income Statement
and Balance Sheet
Perspective for Tables 1-3
As previously discussed, the following examples (Table 2-Table 3) illustrate
how revenue, expenses, and earnings can be exaggerated and give a
misleading impression of a company’s performance under cash basis of
accounting.
Table 1 shows the beginning balance for XYZ. No transactions are recorded
other than beginning cash balance and owners’ equity. Transaction
descriptions by line item for cash and accrual basis are provided below the
financial statements.
24
Guidance Notes on Accrual Basis of Accounting
Table 1. XYZ’s Beginning Financial Statements, April 1, 2020
Cash Basis Accrual Basis -
Income Statement Income Statement -
Revenue — Revenue _______
Expenses — Expenses -
_______ _______
Income — Income
_______
Balance Sheet Balance Sheet
ASSETS ASSETS
Cash 600 Cash 600
Receivables not recognised - Receivables not recognised -
LIABILITIES LIABILITIES
Payables not recognised
- Payables not recognised -
EQUITY _____ EQUITY _____
Owner’s equity 600 Owner’s equity 600
25
Guidance Notes on Accrual Basis of Accounting
Cash Basis Accrual Basis
1. Revenue: None recorded 1. Revenue: None recorded
because it is the beginning because it is the beginning
balance. balance.
2. Expenses: None recorded 2. Expenses: None recorded
because it is the beginning because it is the beginning
balance. balance.
3. Income: There is no beginning 3. Income: There is no beginning
balance income to record balance income to record
without revenue or expenses. without revenue or expenses.
4. Cash: ` 600 cash on hand at 4. Cash: ` 600 cash on hand at
the beginning of the year. the beginning of the year.
5. Receivables: No receivables 5. Receivables: No receivables
at inception. Cash basis would at inception
not normally recognise 6. Payables: No payables at
receivables.
inception.
6. Payables: No payables at 7. Owners’ Equity: ` 600 in
inception. Cash basis would
owners’ equity at the
not normally recognise
beginning of the year.
payables.
7. Owners’ Equity: ` 600 in
owners’ equity at the
beginning of the year.
Table 2 shows year-end financial statement for XYZ for the first year. XYZ
provided the first years’ service and incurred related expenses. It received the
full payment for the two-year subscription from the client in April 2020.
Transaction descriptions by line item for cash and accrual basis are provided
below the financial statements.
26
Guidance Notes on Accrual Basis of Accounting
Table 2. XYZ’s Year-End Financial Statements, March 31, 2021
Cash Basis Accrual Basis
Income Statement Income Statement
1. Revenue 2,400 1. Revenue 1,200
2. Expenses (600) 2. Expenses (600)
Income 1,800 Income 600
Balance Sheet Balance Sheet
ASSETS ASSETS
Cash 2,400 Cash 2,400
Receivables not recognised — Receivables not recognised -
LIABILITIES LIABILITIES
Payables not recognised — Unearned Income (1,200)
EQUITY EQUITY
Owner’s equity 2,400 Owner’s equity 1,200
Cash Basis Accrual Basis
1. Revenue: ` 2400 payment is 1. Revenue: ` 1,200 in revenue is
recognised as revenue in 2020 recognised even though `
because the payment was 2,400 was received as
received in April 2020. payment. Under accrual basis
of accounting, only the first
2. Expenses: ` 600 is recognised year’s revenue is recognised.
as expense in the first year 2. Expenses: ` 600 is recognised
even though the revenue for as expense in the current year.
both years has been
recognised. 3. Income: ` 600 in income is
recognized under accrual
3. Income: ` 1,800 in income is basis.
recognised under cash basis.
The amount is higher than
under accrual basis because
the full amount of the revenue
for the two years was
recognised in the first year, but
only the first year’s expense
27
Guidance Notes on Accrual Basis of Accounting
was recognised, resulting in
higher income than under
accrual basis. 4. Cash: ` 2400 cash on hand at
4. Cash: ` 2400 cash on hand at the end of the first year.
the end of the first year. XYZ (Calculation same as cash
began the year with ` 600 cash basis)
on hand and received a one-
time payment of ` 2,400 in
April 2020, resulting in ` 3,000
cash on hand in April of 2020.
During 2020 cash was spent to
pay for business operating
expenses ` 600 resulting in `
2,400 cash on hand at the end
of the year. (600+2,400-600 =
2,400). 5. Receivables: No receivables
5. Receivables: Cash basis of are recorded as the full
accounting generally does not payment for the two years of
recognise receivables. service was received in April
2020.
6. Deferred Revenue: ` 1,200 is
6. Deferred Revenue: Cash basis recorded as deferred revenue,
does not record the liability, which will not be recognized as
deferred revenue. Should the revenue until the service is
client cancel the subscription provided in 2021-22. Deferred
for the last twelve months, a revenue is a liability that will be
refund of ` 1,200 would need reduced by ` 100 for each
to be made to the client. month of service provided,
reduced by ` 1,200 by end of
the second year, 2021-22.
7. Owners’ Equity: ` 1,200 in
7. Owners’ Equity: ` 2,400 in owners’ equity at year-end,
owners’ equity at year-end, as which is less than under cash
the full payment of cash was basis because ` 1,200 as
recognised as revenue in deferred revenue is recorded
2020-21. under accrual basis and not
under cash basis
28
Guidance Notes on Accrual Basis of Accounting
Table 3 shows year-end financial statement for XYZ for the second year, 2021-
22. At this point, XYZ has provided the second years’ service and incurred
related expenses. Under cash basis of accounting, the company has no
revenue and records a loss. The company’s cash on hand and owners’ equity
also decreased as compared with the first year (see Table 2). The
deteriorating financial condition of the company under the cash basis could
give the impression of a company in financial trouble, possibly going out of
business. On an accrual basis, however, the picture looks quite different.
Transaction descriptions by line item for cash and accrual basis are provided
below the financial statements.
Table 3. XYZ’s Year-End Financial Statements, March 31, 2022
Cash Basis Accrual Basis
Income Statement Income Statement
Revenue — Revenue 1,200
Expenses (600) Expenses (600)
____ ____
Income 600 Income 600
Balance Sheet Balance Sheet
ASSETS ASSETS
Cash 1,800 Cash 1,800
Receivables not recognised — Receivables not recognised —
LIABILITIES
Payables not recognised — LIABILITIES
Unearned Income —
EQUITY EQUITY
_____ _____
Owner’s equity 1,800 Owner’s equity 1,800
29
Guidance Notes on Accrual Basis of Accounting
Cash Basis Accrual Basis
1. Revenue: No revenue is 1. Revenue: ` 1,200 is recognised
recognised under cash basis in as revenue in 2021-22 (same as
2021-22 because the full 2020-21).
amount of the payment, `
2,400, was recognised as
revenue in 2020-21.
2. Expenses: ` 600 is recognised 2. Expenses: ` 600 is recognised as
as expense in current year. expense in the current year.
3. Income: ` 600 is recognised as
loss in 2021-22 because the 3. Income: ` 600 is recognised as
full amount of the payment, ` income in the current year.
2,400, was recognised as
revenue in 2020-21.
4. ` 1,800 of cash is available to
the company at the end of two 4. ` 1,800 of cash is available to the
years. company at the end of two years.
5. Receivables/Payables: Cash 5. Receivables: There are no
basis of accounting generally receivables because the full
does not recognise receivables payment was received in 2020-21
or payables. & no liabilities at the end of two
years.
6. Deferred revenue of ` 1,200 that
6. Owners’ Equity: ` 1,800 in was recorded at the end of 2020-
owners’ equity, a decrease of ` 21 has been recognised as
600 as compared with the end revenue in 2021-22.
of 2020-21 due to the loss of ` 7. Owners’ Equity: ` 1,800 in
600 recorded in 2021-22. owners’ equity, an increase of `
1,200 since the beginning of
2020-21.
30
Guidance Notes on Accrual Basis of Accounting
Appendix II
Transition from Cash to Accrual
The following chart illustrates what types of transactions are to be transitioned
and how this will be dealt in the financial statements:
Cash Accounting Accrual Accounting
Rationale Transaction
Type of Rationale Transaction
Liability
1. Creditors No creditor NA A creditor is Dr.
(a) On purchase Expense
Cr. Creditor
is recognised
Dr. Creditor
recognised when the Cr. Cash
in the significant risks
Financial and rewards of
Statements. the underlying
good/ service
are obtained
rather than
when the
creditor is paid.
The expense
will have impact
on the
Statement of
Profit & Loss.
(b) Payment When paid, Dr. Payment When paid,
the Cr. Cash there is no
payment impact on the
will be Statement of
recorded on P&L, instead
the there is a
Statement decrease in
of Cash liability and a
Receipts decrease in
and cash – both the
Payments Balance Sheet
items.
2. Loans (Long Term/ Short Term)
(c) Initial receipt The loan is Dr. Cash The loan is Dr. Cash
recorded Cr. Loan recorded when
when the Received the cash is Cr. Loans
cash is received. Payable
received
The loan is
31
Guidance Notes on Accrual Basis of Accounting
The cash established as
received is a liability in the
included in Balance Sheet.
the
Statement
of Cash
Receipts
and
Payments
(d) Subsequent When paid, Dr. Loan The Dr. Loans
repayments the Payments Payable
repayments Cr. Cash repayments Cr. Cash
will be
recorded in NA reduce the Dr. Interest
the Expense
Statement Dr Interest loans payable Cr. Accrued
of Cash Cr. Cash Interest on
Receipts & liability leaving Loan
Payments Dr. Cash
Cr Receipt a balance Dr. Accrued
Interest on
outstanding in Loan
Cr Cash
the Balance
Dr. Cash
Sheet. Cr Advance
Receipts
3. Interest on Loan Liability
(e) On accrual No interest Accrued
interest on loan
is is shown as an
expense in
recognised Statement of
P&L and shown
in the as liability in
Balance Sheet.
Financial
When paid,
Statements. there is no
impact on the
(f) On payment When paid, Statement of
the P&L, instead
payment there is a
will be decrease in
recorded on liability and a
the decrease in
Statement cash – both the
of Cash Balance Sheet
Receipts items.
and
Payments Revenue is
recorded when
4. Advance Receipts earned
regardless of
(g) On receipt Receipt is
recorded
when cash
received
32
Guidance Notes on Accrual Basis of Accounting
regardless when received
of whether
(h) When earned it has been NA Revenue is Dr Advance
earned NA recorded and Receipts
NA impacts on the Liability
No Statement of Cr Revenue
treatment Dr. Payment P/L Dr Expense
done Cr. Cash Cr Accrued
Expenses
5. Accrued Expenses
Dr Expense
(i) Initial The This arises Cr Provision
establishment concept is
generally when an Dr.
not applied Provision
in cash expense has Cr. Cash
accounting
been incurred
but has not
been paid
6. Provisions
(j) Provision Liabilities Expenses are
are not
recognised “provided for”
in cash
accounting when the
enterprise has
a present
obligation as a
result of the
past event, the
outflow of
economic
resources is
probable, and
the reliable
estimate/
measurement
of the obligation
can be done.
E.g. land
restoration
(k) Utilisation To pay for When the
expenses
incurred liability is to be
settled, the
provision is
utilised
33
Guidance Notes on Accrual Basis of Accounting
Appendix III
Assessment of what liabilities should be included in
Opening Balance Sheet
Once the transition approach as demonstrated in Appendix II has been
decided, the entity can utilise this information to assess what amounts, if any,
need to be included as part of the opening Balance sheet. Entities will need to
base their assessment on the “Transition” date.
For the purposes of this exercise:
Year Definition
Year 2 The second year preceding the Transition year
Year 1 The year immediately prior to the Transition year. The Year 0
opening Balance Sheet will reflect accrual balances at the end
of Year 1.
Year 0 The Transition year. The opening Balance Sheet will reflect
accrual balances at the beginning of the Transition year
Year 1 The year after the Transition year
Year 2 The second year after the Transition year
The general principles for inclusion on the opening balance sheet are:
Principle #1: If a prior period payment (made Year 1 or before) which in
accrual terms relates in some part up to and including Year 0, then ignore
since it is fully realised.
Principle #2: If a prior period payment (made Year 1 or before) which in
accrual terms relates in some part to Year 1, Year 2 or future years, then
account for the remaining amount outstanding at end of Year 1 on the opening
Balance Sheet.
Refer to Table 1 for a pictorial representation of assessing balances which
should be in the Opening Balance Sheet.
To assist in undertaking the calculation to quantify each liability which needs
to form part of the opening Balance Sheet, refer to Table 2. This also gives
the relevant journal entries required to effect the transactions.
34
Guidance Notes on Accrual Basis of Accounting
Analysis of Liability for Opening Balance
Type of Liability Type of Occurrence Treatment
Trade Creditors of If any creditors were paid Ignore (Principle #1)
short duration in Year 1 and relate partly
to Year 0
Creditors of If any creditors were paid Ignore (Principle #1)
medium duration < in Year 1 and relate to a
1 year1 significant part of Year 0
Creditors of long If any creditors were paid Ignore (Principle #1)
duration > 1 year1 in Year 2 and relate to all
of Year 1 and part of Year
0
If any creditors were paid Pick up the balance
in Year 1 and relate to outstanding at the end of
Year 0 and Year 1 and Year 1 in the opening
any future years Balance Sheet (Principle
#2)
If any creditors were paid Pick up the balance
in Year 2 and relate to outstanding at the end of
Year 0, Year 1, Year 2 Year 1 in the opening
and beyond Balance Sheet (Principle
#2)
Short Term Loans Where the loan will be Ignore (Principle #1)
Long Term Loans cleared within 12 months,
and the repayments will
not fall beyond the end of
Year 0
Where the loan will not be Pick up the balance
cleared before the end of outstanding at the end of
Year 0 Year 1 in the opening
Balance Sheet. (Principle
#2)
1 For simplicity, short term period of assets and liabilities has been restricted to 1 year.
However, in Schedule III to The Companies Act, 2013; the meaning can be wider.
35
Guidance Notes on Accrual Basis of Accounting
Advance Receipts Where the revenue Pick up the balance
Accrued Expense received in advance outstanding at the end of
Provisions relates to periods beyond Year 1 in the opening
the end of Year 0 Balance Sheet. (Principle
#2)
Revenue received in Ignore (Principle #1)
advance relates to a
period before the end of
Year 0
By their nature, accrued Ignore (Principle #1)
expenses are, in most
cases, short term and Pick up each in the
therefore it is unlikely that opening Balance Sheet
these should extend with the amount which
beyond Year 0 would be required to
settle the liability at the
These can be provisions end of Year 1. (Principle
for settlement of a legal #2)
case, rehabilitation of
land, etc. AS 29 and Ind
AS 37 prescribe
treatment for Provisions.
It is likely that the liability
for these will extend
beyond Year 0
36
Guidance Notes on Accrual Basis of Accounting
Table 1: Assess transactions which should be in Opening Balance Sheet
Trade creditors of short duration } No impact on Year 1 or future Ignore
Creditors of medium duration Opening Entry*
< 1 year } years Ignore
Creditors of long duration > 1 year Yes
Will transactions impact
Year 1 & beyond No
Short term loans No impact on Year 1 or Ignore
Long term loans
future years
Yes Opening Entry
Will transactions impact
Year 1 & beyond No Ignore
Yes Opening Entry
Advance Receipts Will transactions impact
Year 1 & beyond No Ignore
Accrued Expenses No impact on Year 1 Ignore
or future years
Provisions Will obligation extend Yes Opening Entry
beyond Year 1 No Ignore
*Note: any long term creditors or long term loans which exist at year -1 will necessarily need
to be included because they will affect Year 1 and beyond.
37
Guidance Notes on Accrual Basis of Accounting
Table 2: Impact on Opening Balance Sheet
Types of Calculation Opening Comments
Transactions Balance Sheet
No requirement
Trade creditors N/A Impact as no impact on
of short duration Accounting Year 1 and
– approx. 1 – 3 beyond
months Entries No requirement
Nil as no impact on
Creditors of N/A Year 1 and
medium Nil beyond
duration < 1
year
Creditors of long Calculate Dr. Only required if
duration > 1year current Accumulated the loan impacts
outstanding funds on Year 1 and
Short Term balance of Cr. Creditor beyond
Loans creditor and
pass journal Nil No requirement
Long Term entry as no impact on
Loans N/A Dr. Year 1 and
beyond
Calculate Accumulated Only required if
current funds the transaction
outstanding impacts on Year 1
balance of loan Cr. Loan and beyond
and pass journal
entry Payable
Advance If revenues Dr. Only required if
Receipts received > 1 Accumulated the transaction
38
Guidance Notes on Accrual Basis of Accounting
year in advance, funds impacts on Year 1
calculate the Cr. Advance and beyond
value of the Receipts
Accrued remaining No requirement
Expenses benefit Nil as no impact on
Year 1 and
Provisions N/A Dr. beyond
Accumulated
funds Assess whether
Cr. Provisions
circumstances
are such that
require a
provision.
39
Guidance Notes on Accrual Basis of Accounting
Appendix IV
Assessment of what assets should be included in
Opening Balance Sheet
Once the transition approach as demonstrated in Appendix II has been
decided, the entity can utilise this information to assess what amounts, if any,
need to be included as part of the opening Balance sheet. Entities will need to
base their assessment on the “Transition” date.
For the purposes of this exercise:
Year Definition
Year 2 The second year preceding the Transition year
Year 1 The year immediately prior to the Transition year. The Year 0
opening Balance Sheet will reflect accrual balances at the end
Year 0 of Year 1.
The Transition year. The opening Balance Sheet will reflect
Year 1 accrual balances at the beginning of the Transition year
Year 2 The year after the Transition year
The second year after the Transition year
The general principles for inclusion in the opening balance sheet are:
Principle #1: If a prior period payment (made Year 1 or before) which in
accrual terms relates in some part up to and including Year 0, then ignore
since it is fully realised.
Principle #2: If a prior period payment (made Year 1 or before) which in
accrual terms relates in some part to Year 1, Year 2 or future years, then pick
up the remaining amount outstanding at end of Year 1 on the opening Balance
Sheet.
Refer to Table 1 for a pictorial representation of assessing balances which
should be in the Opening Balance Sheet
To assist in undertaking the calculation to quantify each liability which needs
to form part of the opening Balance Sheet, refer to Table 2. This also gives
the relevant journal entries required to effect the transactions.
40
Guidance Notes on Accrual Basis of Accounting
Analysis of Asset for Opening Balance
Type of Asset Type of Occurrence Treatment
Trade Receivables If any trade receivable were Ignore (Principle #1)
of short duration received in Year 1 and relate
partly to Year 0 Ignore (Principle #1)
Trade Receivables If any trade receivable were
of medium duration received in Year 1 and relate Ignore (Principle #1)
< 1 year1 to a significant part of Year 0
Trade Receivables If any trade receivables were Pick up the balance
of long duration > 1 received in Year 2 and relate outstanding at the
year1 to all of Year 1 and part of Year end of Year 1 in the
0 opening Balance
Short Term Loans If any trade receivables were Sheet (Principle #2)
received in Year 1 and relate Pick up the balance
& Advances to Year 0 and Year 1 and any outstanding at the
future years end of Year 1 in the
(Receivable) opening Balance
If any trade receivables were Sheet (Principle #2)
Long Term Loans received in Year 2 and relate Ignore (Principle #1)
to Year 0, Year 1, Year 2 and
& Advances beyond Pick up the balance
outstanding at the
(Receivable) Where the loan will be realised end of Year 1 in the
within 12 months, and the opening Balance
realisation will not fall beyond Sheet. (Principle
the end of Year 0 #2)
Where the loan will not be
realised before the end of Year
0
1 For simplicity, short term period of assets and liabilities has been restricted to 1 year.
However, in Schedule III to The Companies Act, 2013; the meaning can be wider.
41
Guidance Notes on Accrual Basis of Accounting
Prepaid expenses Where the prepaid expenses Pick up the balance
relate to periods beyond the outstanding at the
Accrued Interest end of Year 0 end of Year 1 in the
receivables opening Balance
Prepaid expenses relate to a Sheet. (Principle
period before the end of Year #2)
0 Ignore (Principle #1)
By their nature, accrued
interest is, in most cases, short Ignore (Principle #1)
term and therefore it is unlikely
that these should extend
beyond Year 0
42
Guidance Notes on Accrual Basis of Accounting
Table 1: Assess transactions which should be in Opening Balance Sheet
Trade receivables of short duration }
Trade receivables of medium duration No impact on Year 1 or Ignore
< 1 year } future years
Yes Opening Entry*
Creditors of long duration > 1 year Will transactions impact
Year 1& beyond No Ignore
Short term loan receivable No impact on Year 1 or Ignore
future years
Yes Opening Entry
Long term loan receivable Will transactions impact
Year 1 & beyond No Ignore
Yes Opening Entry
Prepaid expense Will transactions impact
Year 1 & beyond No Ignore
Accrued Interest income No impact on Year 1 or Ignore
future years
*Note: any long term trade receivables or long term loans and advances which exist
at year 1 will necessarily need to be included because they will affect Year 1 and
beyond.
43
Guidance Notes on Accrual Basis of Accounting
Table 2: Impact on Opening Balance Sheet
Types of Calculation Opening Comments
Transactions Balance Sheet
Impact
Accounting
Entries
Trade N/A Nil No requirement
as no impact on
receivable of Year 1 and
beyond
short duration
approx. 1 – 3
months
Trade N/A Nil No requirement
as no impact on
receivable of Year 1 and
beyond
medium
duration < 1
year
Trade Calculate Dr. Trade Only required if
receivable of current
long duration > outstanding receivable the trade
1year balance of trade
receivable and Cr. receivable
pass journal
entry Accumulated impacts on Year 1
funds and beyond
Short Term N/A Nil No requirement
as no impact on
Loans & Year 1 and
beyond
Advances
Receivable
Long Term Calculate Dr. Loan & Only required if
current Advance the transaction
Loans & outstanding Receivable impacts on Year 1
balance of loan and beyond
Advances and pass journal Cr.
entry Accumulated
receivable funds
Prepaid If expenses are Dr. Prepaid Only required if
expense
paid > 1 year in Expense the transaction
advance, Cr. impacts on Year 1
44
Guidance Notes on Accrual Basis of Accounting
calculate the Accumulated and beyond
value of the funds
remaining No requirement
benefit as no impact on
Year 1 and
Accrued Interest N/A Nil beyond
45
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