Finding Income under Mercantile System from income under Cash System.

Income/Profits dependent on basis of accounting

Profits are derived by transferring the ledger account balances in the nominal accounts to the Trading a/c or Profit & Loss a/c as the case may be. The final balance in the Profit & Loss a/c relating to a period gives us the income or profits relating to that accounting period.

The basis of accounting followed i.e. cash basis or mercantile basis would decide whether the transactions relating to outstanding expenses, prepaid expenses, pre received incomes and receivable incomes are recorded or not. Thus, the basis of accounting influences the balance in the ledger accounts representing incomes and expenses which are nominal accounts.

Since the figure of profit is dependent on the incomes/expenses, we can say that the figure of profit would vary depending on the method of accounting being followed by the organisation.

Finding Income under a System given Income under the other

In problem solving, we may be required to identify the income under the Mercantile basis of accounting from the income under cash basis of accounting.

Outstanding expenses, expenses prepaid, pre-received incomes, incomes receivable are to be brought into books in changing the accounting system from Cash to Mercantile or written off from the books in changing from mercantile to cash from a particular point of time.

Information relating to Outstanding expenses, expenses prepaid, pre-received incomes, incomes receivable is to be adjusted in finding the income under one system given the income under the other system of accounting. Such an adjustment would influence the respective income or expense also.

For making the adjustment, we assume that the change is incorporated at the beginning of the period for which the income is being ascertained and is sustained through out the period. Say if we have to find the income under mercantile basis given income under cash basis for an accounting period, we assume that the conversion from cash basis to mercantile basis has to be made at the beginning of the accounting period.

Adjusting Expenditure

  • Opening Outstandings and Prepaids

    Bring the outstanding and prepaid expenses at the beginning of the accounting period into books.
    Journal in the books of M/s ___ for the period from ____ to ____
    Particulars Amount
    (Dr)
    Amount
    (Cr)
    P/L Adjustment a/c
    To Outstanding Expenses a/c
    Dr 18,200
    18,200
    Prepaid Expenses a/c
    To P/L Adjustment a/c
    Dr 15,425
    15,425

    This will result in the Outstanding Expenses a/c and Prepaid Expenses a/c getting created at the beginning of the accounting period.

    Since the outstandings and prepaids relate to the previous accounting periods, any profit or loss on account of bringing them into books should not affect the current period profits. To ensure this the profit or loss on such transactions is credited or debited to Profit and Loss adjustment a/c.

    Outstanding Expenses a/c and Prepaid Expenses a/c though created in the current period relate to the previous accounting periods. They are created anew at the beginning of the accounting period to represent the accounts that would have been created at the end of the previous accounting period and brought forward to the current period.

    Consider the Outstanding expenditure and Prepaid expenditure accounts are used only for the purposes of balance sheet i.e. after bringing down the balances through an opening entry they are closed by transfer to the relevant expenditure account.

    Journal in the books of M/s ___ for the period from ____ to ____
    Particulars Amount
    (Dr)
    Amount
    (Cr)
    Outstanding Expenses a/c
    To Expenses a/c
    Dr 18,200
    18,200
    Expenses a/c
    To Prepaid Expenses a/c
    Dr 15,425
    15,425
  • Closing Outstandings and Prepaids

    Record the closing outstandings and prepaids as would be done normally.

    Since we are assuming the Outstanding Expenses a/c and Prepaid Expenses a/c are being created and maintained only for the purpose of final accounting, the total outstanding and prepaid at the end of the accounting period, irrespective of whether it belongs to the current period or the previous periods, has to be recorded.

    Journal in the books of M/s ___ for the period from ____ to ____
    Particulars Amount
    (Dr)
    Amount
    (Cr)
    Expenses a/c
    To Outstanding Expenses a/c
    Dr 45,300
    45,300
    Prepaid Expenses a/c
    To Expenses a/c
    Dr 23,750
    23,750

The effect of all these transactions on the Expenditure a/c would give an idea of the adjustment to be made.

Expenditure a/c
DrCr
Date Particulars Amount Date Particulars Amount
01/01/_5

31/12/_5
To Prepaid Expenses

To Outstanding Expenses
15,425

45,300
01/01/_5

31/12/_5
By Outstanding Expenses
By P/L a/c
By Prepaid Expenses
18,200

23,750
       

A debit to Expenditure a/c implies increase in expenditure and a credit implies a decrease in expenditure.

Expenditure under Mercantile System from Cash basis expenses
Particulars Amount Amount
Expenditure paid in Cash during the Current Period
+ Opening Prepaid Expenses
Closing Outstanding Expenses

Opening Expenses Outstanding
Closing Expenses Prepaid
Expenditure incurred in the current period

  15,425
45,300

18,200
23,750
2,48,000

60,725
3,08,725

41,950
2,66,775

Logic

  • The cash paid during the current period towards expenses includes payments for previous period outstandings (opening outstanding expenses) as well as the expenses prepaid (closing prepaid expenses) for the subsequent periods.

    These are to be deducted to obtain the cash paid towards the current period expense.

  • Expenditure related to the current accounting period has been paid in the previous period (opening prepaid expenses) and is still outstanding at the end (closing outstanding expenses).

    These have to be added to cash paid towards the current period expense to obtain the total expenditure relatable to the current accounting period.

A debit to Expenditure a/c implies increase in expenditure which will result in a reduction of profit and a credit implies reduction of expenditure which will result in an increase in profit. So, the same adjustment is used in ascertaining the adjusted income also.

Income under Mercantile System from Cash basis income
Particulars Amount Amount
Income under Cash basis of accounting
+ Opening Prepaid Expenses
Closing Outstanding Expenses

Opening Expenses Outstanding
Closing Expenses Prepaid
Income under Mercantile System of accounting

  15,425
45,300

18,200
23,750


60,725


41,950

Adjusting Income

  • Opening Pre-receiveds and Receivables

    Bring the receivable and pre-received incomes at the beginning of the accounting period into books.
    Journal in the books of M/s ___ for the period from ____ to ____
    Particulars Amount
    (Dr)
    Amount
    (Cr)
    P/L Adjustment a/c
    To Pre-received Incomes a/c
    Dr 8,125
    8,125
    Receivable Incomes a/c
    To P/L Adjustment a/c
    Dr 6,850
    6,850

    This will result in the Pre-received Incomes a/c and Receivable Incomes a/c getting created at the beginning of the accounting period.

    Since the pre-receiveds and receivables relate to the previous accounting periods, any profit or loss on account of bringing them into books should not affect the current period profits. To ensure this the profit or loss on such transactions is credited or debited to Profit and Loss adjustment a/c.

    Pre-received Incomes a/c and Receivable Incomes a/c though created in the current period relate to the previous accounting periods. They are created anew at the beginning of the accounting period to represent the accounts that would have been created at the end of the previous accounting period and brought forward to the current period.

    Consider the Pre-received Income and Receivable Income accounts are used only for the purposes of balance sheet i.e. after bringing down the balances through an opening entry they are closed by transfer to the relevant income account.

    Journal in the books of M/s ___ for the period from ____ to ____
    Particulars Amount
    (Dr)
    Amount
    (Cr)
    Pre-received Incomes a/c
    To Incomes a/c
    Dr 8,125
    8,125
    Incomes a/c
    To Receivable Incomes a/c
    Dr 6,850
    6,850
  • Closing Outstandings and Prepaids

    Record the closing pre-receiveds and receivables as would be done normally.

    Since we are assuming the Pre-received Incomes a/c and Receivable Incomes a/c are being created and maintained only for the purpose of final accounting, the total pre-received and receivable at the end of the accounting period, irrespective of whether it belongs to the current period or the previous periods, has to be recorded.

    Journal in the books of M/s ___ for the period from ____ to ____
    Particulars Amount
    (Dr)
    Amount
    (Cr)
    Incomes a/c
    To Pre-received Incomes a/c
    Dr 3,750
    3,750
    Receivable Incomes a/c
    To Incomes a/c
    Dr 5,245
    5,245

The effect of all these transactions on the Income a/c would give an idea of the adjustment to be made.

Income a/c
DrCr
Date Particulars Amount Date Particulars Amount
01/01/_5

31/12/_5
To Receivable Incomes
To P/L a/c
To Pre-received Incomes
6,850

3,750
01/01/_5

31/12/_5
By Pre-received Incomes

By Receivable Incomes
8,125

5,245
       

A credit to Income a/c implies increase in income and a debit implies a decrease in income.

Income under Mercantile System from Cash basis incomes
Particulars Amount Amount
Income received in Cash during the Current Period
+ Opening Pre-received Incomes
Closing Receivable Incomes

Opening Receivable Incomes
Closing Pre-received Incomes
Income incurred in the current period

  8,125
5,245

6,850
3,750
1,32,500

13,370
1,45,870

10,600
1,35,270

Logic

  • The cash received during the current period towards incomes includes receipts for previous period receivables (opening receivable incomes) as well as the incomes pre-received (closing pre-received incomes) for the subsequent periods.

    These are to be deducted to obtain the cash received towards the current period income.

  • Income related to the current accounting period has been received in the previous period (opening pre-received incomes) and is still receivable at the end (closing receivable incomes).

    These have to be added to cash received towards the current period incomes to obtain the total income relatable to the current accounting period.

A credit to Income a/c implies increase in income which will result in an increase of profit and a debit implies reduction of income which will result in a decrease in profit. So, the same adjustment is used in ascertaining the adjusted income also.

Income under Mercantile System from Cash basis income
Particulars Amount Amount
Income under Cash basis of accounting
+ Opening Pre-received Incomes
Closing Receivable Incomes

Opening Receivable Incomes
Closing Pre-received Incomes
Income under Mercantile System of accounting

  8,125
5,245

6,850
3,750


13,370


10,600

Statement for Finding Income under Mercantile System

The adjustment relating to Incomes and expenses together would give the total adjustments needed for deriving the income under mercantile system from income under cash basis.

Income under Mercantile System from income under cash basis
Particulars Amount Amount
Profit/Income under Cash Basis Accounting
+ Opening Expenses Outstanding
Opening Incomes Pre-received
Closing Expenses Prepaid
Closing Incomes Receivable

Opening Expenses Prepaid
Opening Incomes Receivable
Closing Expenses Outstanding
Closing Incomes Pre-received
Profit/Income under Mercantile/Accrual Basis Accounting

18,200
8,125
23,750
5,245

15,425
6,850
45,300
3,750
2,48,000



55,320
3,03,320



49,775
2,53,545

Statement for Finding Income under Cash System

This statement is a converse of the above statement.
Income under cash basis from income under Mercantile System
Particulars Amount Amount
Profit/Income under Mercantile/Accrual Basis Accounting
+ Opening Expenses Prepaid
Opening Incomes Receivable
Closing Expenses Outstanding
Closing Incomes Pre-received

Opening Expenses Outstanding
Opening Incomes Pre-received
Closing Expenses Prepaid
Closing Incomes Receivable
Profit/Income under Cash Basis Accounting

15,425
6,850
45,300
3,750

18,200
8,125
23,750
5,245
2,53,545



49,775
3,03,320



55,320
2,48,000
Author : The Edifier
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