Systems, bases and standards

There are two systems of keeping books.

• Double entry system: both sides of every transaction are recorded: every debit has an equal credit. It is complete and reliable, and its accuracy can be checked with a trial balance. This is the system your book teaches.
• Single entry system: only cash and the accounts of people (debtors and creditors) are kept. It is incomplete and less reliable, used by some small shops.

There are also two bases for deciding when to record something.

• Cash basis: record only when cash is actually received or paid. A small trader with no trained staff may do this.
• Accrual basis: record when revenue is earned or an expense is incurred, whether or not cash has moved. A credit sale in January is January's revenue even if the money comes in April. December's rent paid in January is December's expense.

The accrual basis is better because it matches each year's revenue with that year's expenses. The cash basis cannot do that, which is why it does not fit the matching principle. Outstanding expenses and income earned but not yet received exist only under the accrual basis.

Accounting standards are written rules on how to recognise, measure, present and disclose transactions in the statements. In India they are issued by the ICAI (the Institute of Chartered Accountants of India, the body that makes CAs). For example, one standard covers how to value stock, another how to show cash flows.

Their benefits: fewer differences in how firms treat the same thing, extra useful disclosure, and statements that can be compared. Their limitations: less freedom to choose a method, some rigidity, and they cannot override the law: where a standard and the law differ, the law wins.