Per Shri B. V. Venkataramiah, Accountant Member - This appeal is by the revenue. The assessee is a transport operator. The ITO observed in his order as follows : "It is seen from the note for the year ending 30-6-1979 forming part of the directors report that the freight earnings have been accounted for on cash basis as against actual basis as in earlier years. As seen from the records, the company was following mercantile system of accounting.
This year it has changed to mixed system. The reason given is to avoid disputes. As the explanation is not convincing and also taking into account that the assessee was following mercantile system of accounting and it cannot change the system of accounting once followed, I add back a sum of Rs. 1,48,491 being freight charges not yet realised and allow the following expenses which are not provided for : The assessee went in appeal. Before the Commissioner (Appeals), it was represented that the facts have not been properly appreciated by the ITO and the IAC. It was stated before him that the method of accounting adopted by the assessee-company had always been cash in respect of most of the customers. Only in respect of a class of reputed customers credit system had been adopted. Bills were made on customers even before delivery of goods at the respective destinations. It was the assessees case that he final settlement made with these reputed customers resulted in receipts which were less than the billed amount due to differences in rates, short delivery, damages, etc. In some cases, the assesse had entered into lengthy correspondence to find out the reasons for short payments. A stage was reached when the system of accounting adopted by the assessee led to assessment of notional income which was never realised by the assessee. For the above reasoning, the assessee decided to change to the cash system of accounting in respect of this class of reputed customers also. The assessee started implementing this from the accounting year relevant to the assessment year 1980-81. As this system had been regularly followed in subsequent years also the assessee pleaded that the same should be accepted and no addition should be made to the trading account. Reliance was also placed on the acceptance of a similar change in the method of accounting in respect of Prakash Roadlines (P.) Ltd. The assessee representative also cited certain decisions of the High Court to support his contention.
2. The Commissioner (Appeals) noticed that the amount of Rs. 1,48,491 related to 22 customers which included parties like Dunlop India, Kirloskar Systems Ltd., Voltas Ltd., etc. He then went on to observe that the revenue cannot attribute mala fide intentions to the assessee or collusion between the assessee and parties in the matter of accounting of freight receipts. He observed that the other transport operators were also adopting similar system of accounting for freight receipts. In order to avoid the confusion caused by frequent adjustment of entries in the books of account regarding short payments the companies switched over to accounting receipts on cash basis. He then adverted to the theory of real income. He finally concluded that the assessee-company had for genuine and bona fide reasons effected a change in the system of accounting and while doing so had not violated any provisions of law and further, the system being recognised by law and having been regularly followed could not be rejected by the ITO. He also observed that the adverse comments of the Advocate General in the case of public sector undertakings had nothing to do with the system of accounting adopted by the assessee. He, accordingly, deleted the addition made by the ITO. The revenue is in appeal.
3. The learned departmental representative firstly contented that the assessee is not entitled to follow the system of accounting which is neither cash nor mercantile. Further, he argued that in effect the assessee was following the mercantile system of accounting. Although he had not extended credit facilities to certain customers, it did not mean that he was following the cash system in those cases. By efficient management he had collected bills in the very year in which they were raised. The fact that there were no outstandings regarding certain class of customers did not mean that the system followed by the assessee was cash. He further contended that during the hearing, the assessees counsel had submitted that the expenditure was being accounted for on the mercantile basis while the receipts were sought to be accounted for on the cash basis. This was truly an irrational system which did not indicate the true profits made by the assessee and was, therefore, liable for rejection by virtue of proviso to section 145(1) of the Income-tax Act, 1961 (the Act). He then referred to footnote No.8 at page 3435 of the commentary on Law of Income-tax by Sampath Iyengar, 7th end., Vol. 4 and submitted that an assessee cannot account for liabilities on mercantile basis and receipts on cash basis.
Reliance was also placed on then decision of the Allahabad High Court in the case of CIT v. Cosmopolitan Trading Co.  116 ITR 728. Law and Practice of Income-tax, Vol. I, p. 883 where it is observed that the true gains are to be ascertained as nearly as it can be done.
4. The learned counsel for the assessee referred to the commentary on Income-tax Law by Chaturvedi and Pithisaria, 3rd end., pp. 2863, 2871 and 2872. It was argued that the assessee was following the hybrid system of accounting. The recognition of the hybrid system as an acceptable method of accounting had been adverted to in various decision, the notable one amongst them being the Supreme Courts decision in CIT v. A. Krishnaswami Mudaliar  53 ITR 122. He then adverted to the various reasons which promoted the assessee to change the system of accounting in the case of class of customers from whom the amounts receivable were being accounted for in the trading account to actual receipt. He also drew our attention to an order of the Commissioner (Appeals) from which it could be seen that the assessee had no mala fide intentions in changing the method of accounting.
Hence, he submitted that the order of the Commissioner (Appeals) should be upheld.5. We have heard the rival submissions. At page 265 of Accountancy by William Pickles, 3rd end., mention is made of the hybrid system. It is stated as follows : "Receipts and Expenditure Account - An account of this nature confines the income earned to the cash received and at the same time includes all expenses, whether paid or not. This method is usually adopted in preparing the accounts of a business of a professional nature (e.g., doctors and solicitors) on the ground that the debtors are of a very uncertain nature, so that a fee may not be considered as earned until the cash is received." At page 2863 of the Commentary on Income-tax Law by Chaturvedi and Pithisaria, 3rd, end., it is stated that there are innumerable other systems of accounting which are called hybrid or heterogeneous in which certain elements and incidents of cash and mercantile systems are combined A. Krishnaswami Mudaliars case (supra). It is not incumbent upon an assessee to follow a purely cash method of accounting or a purely mercantile method of accounting. It may be a mixture of both.
Thus, it appears that there is nothing wrong in the assessee adopting the hybrid system of accounting. The type of system adopted by the assessee conforms to what is stated at page 265 of Pickles Accountancy.
There is of course nothing in the Act prohibiting adoption of this system of accounting by assessees. There is no law that only professionals can follow the hybrid system of accounting for receipts on cash basis and liabilities on mercantile basis. But the system has to be tested in the light of the proviso to section 145(1).
From a theoretical point of view it can be argued that the cash system does not give a correct picture of the profits of an assessee. So also the mercantile system. In cash system, the assessee may account for less profits than what is actually due to him. In another year he may account for more profits because he receives moneys for work done or transactions effected in earlier years. The mercantile system, on the other hand, may account for profits not actually received. A part of the dues may becomes bad and in later years he may write off those amounts. Therefore, it can be said that no system will give true profits earned by an assessee. In the case of banks, etc., mercantile system is not followed in respect of certain transactions, particularly, regarding what are known as sticky loans. This is on the basis that what a person does not hope to realise in the near future cannot be treated as his income. Therefore, it appears that the law permits changes to be made in the method of accounting in order to arrive at the true income. In that case, the question to be faced is whether cash system and hybrid systems are to be totally rejected because, in the opinion of the ITO, true profits cannot be ascertained when books of account are maintained on such basis. If some sanctity is to be attached to the method of accounting regularly adopted by the assessee, we have to examine how the proviso to section 145(1) is to be reconciled with the substantive portion of that section.
6. In our opinion, while ascertaining the true profits the ITO has to make such adjustment to the trading account of the assessee which is in conformity with that system. For example, if profits are being ascertained on cash basis, the ITO has to first give a finding that even according to the cash system adopted by the assessee true profits are not being reflected in the account. He has then to rope in those items which could really be taken as the receipts according to the cash system although the assessee might says that they are not his receipts at all. Similar changes have to be made with regard to the liabilities also. In our opinion, in the guise of applying the proviso to section 145(1) the ITO cannot throw overboard the entire system of accountancy followed by the assessee. Some guidance can be had from the decision of the Supreme Court in the case of A. Krishnaswami Mudaliar (supra) where it is clearly stated that even where cash system of accounting is adopted stock has to be valued. The assessee cannot say that stock valuation has no place in the cash system. Then the ITO can say that the system of accounting adopted by the assessee is not giving a true picture of the profits made by him and then proceed to add the valuation of stock. He cannot say that the cash system of accounting is not correct and, therefore, profits have to be ascertained only accounting is not correct and, therefore, profits have to be ascertained only according to the mercantile system. We reproduce the observations of the learned authors Chaturvedi and Pithisarias commentary on Income-tax Law, 3rd edn.
"An assessee may be choose the mercantile system for certain transactions and the cash basis for other transactions [Shiv Prasad Ram Sahai v. CIT  61 ITR 124, 130 (All.)].
An assessee may employ one method of accounting for one part of business or one class of customers, and a different method for another part of his business or another class of customers. He may also keep accounts in respect of different parts of the same business on different basis. If such different methods are employed regularly and consistently the profits have to be computed in accordance with the respective methods, provided it results in a proper determination of true profits [CIT v. E. A. E. T. Sundararaj  99 ITR 226, 231 (Mad); Bhagwandas Jagdishprasad & Co. v. CIT  28 CTR (MP) 33, 34; Snow White Food Products Co. Ltd. v. CIT  141 ITR 847, 859 (Cal.)." (p. 2863) 6.1 The case cited by the learned departmental representative, viz., Cosmopolitan Trading Co.s case (supra) is distinguishable on facts.
7. We have, therefore, to examine whether the assessee has been regularly employing a particular method of accounting, whether there has been a change in that method of accounting, whether the change is bona fide and in being uniformly followed in the subsequent years. This is necessary because the Courts have now held that the change in the method of accounting for bona fide reason is permissible provided it is properly followed in future.
8. In the assessees case it was already adopting the hybrid system of accounting in the sense that though expenditure was being accounted for on the accrual basis, it was collecting bills on cash and carry method in respect of quite of few customers. Credit facility had been allowed to other customers. Even now it cannot be said that the credit facility is denied to the said customers. The only difference is, in the manner of accounting, the assessee has changed from accrual to cash and carry basis. The reasons given for the change in the method have been adverted to by the Commissioner (Appeals) in detail and we do not repeat them. In any case, annexure to the appellate order shows that for the year ended 30-6-1978 out of the billed amount of Rs. 55,196.35, Rs. 42,688.40 was not i collected.
Out of this, Rs. 40,462 was collected in the next year. In the next year, there was a balance of Rs. 1,48,490 to be collected. This increased to Rs. 2,32,495 but it is seen that for the year ended 30-6-1980 the assessee collected Rs. 6,57,680 out of Rs. 8,37,240 billed. For the year ending 30-6-1982 the outstanding was Rs. 2,97,000 but during the year ended 30-6-1982 it decreased to Rs. 2,22,776. It is also noteworthy that out of Rs. 18,05,004 billed on 30-6-1982 as much as Rs. 16,72,826 was collected during the same year. On the whole, it does not appear that the change in the method of accounting is to defraud the revenue. As a matter of fact, the facts leading to such an inference have not been noticed by the ITO in his order. We, therefore, do not see any reason to interfere with the order of the Commissioner (Appeals). The appeal filed by the revenue is dismissed.