Relevance Of Method Of Accounting While Computing Taxable Income

        Generally, there are two main methods of accounting, viz., Cash system of accounting and Mercantile system of accounting.

       Under Mercantile system of accounting, also known as Accrual system, revenue and expenses are recorded on an accrual basis.

        Under Cash system of accounting, revenue and expenses are recorded on cash basis, i.e., revenue or expenses not realised/paid during the year are not recorded.

        As far as income-tax is concerned, the method of accounting followed by the assessee is relevant only for computing income charged to tax under the heads “Profits and gains of business or profession” and “Income from other sources”.

 

        The method of accounting followed by the assessee has no relevance while computing income charged to tax under the heads “Salaries”, “House property” and “Capital gains”.

 

Example

(1)       Mr. Hitesh is running a provision shop. He is following mercantile system of accounting. In this case the income chargeable to tax under the head “Profits and gains of business or profession” will be computed by following mercantile system.

 

(2)       Mr. Mitul is running a provision shop. He is following cash system of accounting. In this case, the income chargeable to tax under the head “Profits and gains of business or profession” will be computed by following cash system.

 

(3)       Mr. Sunil is a salaried employee and he is maintaining proper books of account of his transactions. He is recording his salary income in his books on an accrual basis, i.e., he is following mercantile system of accounting.

 

In this case, it can be observed that Mr. Sunil is following mercantile system of accounting for recording his salary income. However, for the purpose of computing taxable salary income, the method of accounting has no relevance. Hence, salary will be charged to tax on due or receipt basis, whichever is earlier.

 

(4)       Mr. Kapoor owns 3 flats which are rented by him. He is maintaining regular books of account to record his rental income. He maintains books of account on cash basis.

 

In this case rental income will be charged to tax under the head “Income from house property”. It can be observed that Mr. Kapoor is following cash system of accounting for recording his rental income. However, for the purpose of computing income charged to tax under the head “House property”, the method of accounting has no relevance and, hence, income charged to tax under the head “House property” will be charged to tax as per the provisions given in sections 22 to 27.

 
 

 
 
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