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The High Court observed:-

"When we reach the position that it was the cash system that the assessee had adopted in this case, and that valuation of the closing stock was not an incident of that system for ascertaining the profits, it should be obvious that the Income-tax Officer had no power under the proviso to s. 13 to force a different system 'on the assessee either the mercantile system or a hybrid system of cash plus valuation of closing stock."
a .system of accounting other than the one adopted by the firm. In the title of the order by the Income-tax Officer it was recited that the, method of accounting adopted by the firm was "mercantile", but that does not amount to saying that he proposed to compute the income on the basis that the accounts should be re-written on the mercantile system. The question referred to the High Court asks for advice on the justification for applying the proviso to s. 13, and computation of the income on the basis of the mercantile, system of accounting. On neither of these two branches there was any argument raised by the firm before the Tribu- nal. But we do not propose to dispose of this appeal on the limited ground that the question as framed did not arise out of the order of the Tribunal and need not be answered. The grounds given by the High Court in support of their answer, to the question referred raise a matter of principle of some importance in the computation of income of an assessee carrying on a trading venture with the aid of a wasting asset, and we have heard elaborate arguments advanced by counsel at the Bar and we deem it necessary, to express our opinion on the questions debated.
Among Indian businessmen, as elsewhere, there are current two principal systems of book-keeping There is, firstly, the cash system in which a record is maintained of actual receipts and actual disbursements, entries being posted when money or money's worth as actually received, collected or disbursed. There is secondly the mercantile system, in which entries are posted in the books of account on the date of the transaction i.e. on the date on which rights accrue or liabilities are incurred, irrespective of the date of payment. For example, when goods are sold on credit, a receipt entry is posted as of the date of sale, although no cash is received immediately in payment of such goods; and a debit entry is similarly posted when a liability is incurred although payment on account of such liability is not made at the time. There may have to be appropriate variations when this system is adopted by an assessee who carries on a profession. Whereas under the cash system no account of what are called the outstandings of the business either at the commencement or at the close of the year is taken; according to the mercan- tile method actual cash receipts during the year and the actual outlays during the year are treated in the same way as under the cash system, but to the balance thus arising, there is added the amount of the outstandings not collected at the end of the year and from this is deducted the liabilities incurred or accrued but not discharged at the end of the year. Both the methods are somewhat rough. In some cases these methods may not give a clear picture of the true profits earned and certainly not of taxable profits. The quantum of allowances permitted to be deducted under diverse heads under s. 10(2) from the income, profits and gains of a business would differ according to the system adopted. This is made clear by defining in sub-s. (5) the word "paid" which is used in several clauses of sub-s (2) as meaning actually paid or incurred according to the method of accounting upon the basis of which the profits or gains are computed under s. 10. Again where the cash system as adopted, there is no question of bad debts or outstandings at all: in the case of mercantile system against the book profits some of the bad debts may have to be set off when they are found to be mercantile system, there are in- numerable other systems of accounting which may be called hybrid or heterogeneous-in which certain elements and inci- dents of the cash and mercantile systems are combined. But whatever method of book-keeping is adopted, in the case of a trading venture, for computing the true profits of the year the stock-in-trade must be taken into account. If the value of stock-in-trade is not taken into account, in the ultimate result the profit or loss resulting from trading is bound to get absorbed or reflected in the stock-in-trade unless the value of the stock-in-trade remains unchanged at the commencement of the year and at the end of the year.It must be remembered that under the Income-tax Act, tax is levied on income, profits and gains, and not on receipts:
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mon ground that the method of accounting was not mercantile. but was wholly or primarily cash. The Income-tax Officer was of the view that in the absence of stock-valuation of the film which was a wasting asset of the partnership and which was exploited for earning profits, the income of the firm could not properly be deduced and with that view the Appellate Assistant Commissioner and the Tribunal have agreed. The High Court, however, held that the maintenance of account on cash basis being a recognised method of accounting, the Income-tax Officer was bound by the choice of the assessee who had adopted that system of accounting, and to compute the income in accordance with that method, unless the Income-tax Officer was satisfied that the assessee had not regularly adopted that system. The High Court also observed that what the Department had done was to make the assessment on the basis that the system of accounting adopted by the assessee was mercantile-a system which the assessee had never adopted, and thereby computed the profits of the assessee, by taking into consideration valuation of the closing stock which was not an incident of the cash system. The Income-tax Officer had in the view of the High Court no power under the proviso to s. 13 "to force a different system on the assessee either the mercantile system or a hybrid system of cash plus valuation of closing stock".