Research 51049 Gnaccba
Research 51049 Gnaccba
Research 51049 Gnaccba
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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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 whi ch
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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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.
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.
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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.
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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).
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LIABILITIES LIABILITIES
Payables not recognised - Payables not recognised -
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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.
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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.
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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
Type of Rationale Transaction Rationale Transaction
Liability
1. Creditors
(a) On purchase No creditor NA A creditor is Dr.
is recognised Expense
recognised when the Cr. Creditor
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, Dr. Creditor
the Cr. Cash there is no Cr. Cash
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 Cr. Loans
when the Received the cash is Payable
cash is received.
received The loan is
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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.
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1For 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.
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*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.
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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
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 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.
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1For 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.
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*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.
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