Unit 1: Accounting basics, GAAP & financial statements
Financial Accounting notes · PTU syllabus (BCOM 102-18)
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Unit summary
Financial accounting records business transactions and summarises them into statements that owners, lenders and tax authorities rely on. This unit covers the accounting cycle — journal, ledger and trial balance — Generally Accepted Accounting Principles (GAAP), and the preparation of final accounts of a sole proprietor and a partnership firm.
After this unit you can
- Explain the accounting cycle and record transactions in the journal and ledger
- Prepare a trial balance
- Explain GAAP — concepts and conventions
- Prepare final accounts of a sole proprietor and a partnership firm with adjustments
PTU syllabus topics
- Accounting cycle
- journal
- ledger
- trial balance
- GAAP
- financial statements of sole proprietor and partnership
- 1. Transaction: Source document
- 2. Journal: Record in date order
- 3. Ledger: Post to accounts
- 4. Trial balance: Check arithmetic accuracy
- 5. Final accounts: Trading, P&L, balance sheet
Topic 1
The accounting cycle
Accounting is the art of recording, classifying and summarising in a significant manner and in terms of money, transactions and events which are of a financial character, and interpreting the results (AICPA).
- 1. Identify transactions:
- 2. Journalise: Record in the journal
- 3. Post to ledger:
- 4. Prepare trial balance:
- 5. Pass adjusting entries:
- 6. Prepare final accounts:
- 7. Close the books:
Rules of debit and credit
| Type of account | Debit | Credit |
|---|---|---|
| Personal | The receiver | The giver |
| Real | What comes in | What goes out |
| Nominal | All expenses and losses | All incomes and gains |
Modern (accounting equation) approach: Assets = Liabilities + Capital; increase in assets and expenses is debited; increase in liabilities, capital and income is credited.
Topic 2
Journal, ledger and trial balance
- Journal: book of original entry; transactions recorded chronologically with date, particulars, L.F., debit and credit amounts and narration.
- Ledger: book of final entry; transactions classified account-wise; each account balanced periodically.
- Trial balance: a statement of debit and credit balances of all ledger accounts on a date, prepared to check arithmetical accuracy.
Example
Journal entries: (1) Started business with cash ₹1,00,000 — Cash A/c Dr. To Capital A/c. (2) Bought goods on credit from Ravi ₹20,000 — Purchases A/c Dr. To Ravi. (3) Paid rent ₹5,000 — Rent A/c Dr. To Cash A/c.
Errors not disclosed by a trial balance
- Errors of omission (transaction completely omitted).
- Errors of principle (capital expenditure treated as revenue).
- Compensating errors (one error cancels another).
- Errors of commission of certain types (posting to the wrong account on the correct side).
Exam tip
The trial balance agreeing does not prove the accounts are free from errors — say this in every answer on trial balance.
Topic 3
Generally Accepted Accounting Principles (GAAP)
GAAP are the common set of rules, concepts and conventions used for preparing financial statements so that they are consistent and comparable.
Business entity
Business is separate from the owner
Money measurement
Only transactions measurable in money are recorded
Going concern
Business will continue indefinitely
Accounting period
Life divided into periods (usually one year)
Cost concept
Assets recorded at cost
Dual aspect
Every transaction has two effects
Matching
Expenses matched with revenues of the period
Accrual
Recorded when earned or incurred, not when cash moves
Realisation
Revenue recognised when earned
Conventions
Consistency, full disclosure, conservatism (prudence), materiality
- In India, Accounting Standards (AS) issued by ICAI and Ind AS (converged with IFRS) for specified companies give GAAP a formal shape.
Topic 4
Final accounts of a sole proprietor
- 1Trading account
Gross profit = Net sales − Cost of goods sold
- 2Profit and loss account
Net profit = Gross profit + Other income − Indirect expenses
- 3Balance sheet
Assets = Liabilities + Capital at year end
Common adjustments
| Adjustment | Treatment in P&L / Trading | Treatment in Balance Sheet |
|---|---|---|
| Closing stock | Credit side of trading account | Current asset |
| Outstanding expenses | Add to expense | Current liability |
| Prepaid expenses | Deduct from expense | Current asset |
| Accrued income | Add to income | Current asset |
| Income received in advance | Deduct from income | Current liability |
| Depreciation | Debit P&L | Deduct from asset |
| Bad debts and provision for doubtful debts | Debit P&L | Deduct from debtors |
| Interest on capital | Debit P&L | Add to capital |
| Drawings | — | Deduct from capital |
Example
Opening stock ₹20,000, purchases ₹1,20,000, wages ₹10,000, sales ₹2,00,000, closing stock ₹30,000. Cost of goods sold = 20,000 + 1,20,000 + 10,000 − 30,000 = ₹1,20,000. Gross profit = 2,00,000 − 1,20,000 = ₹80,000.
Topic 5
Final accounts of a partnership firm
- Same Trading and P&L account; then a Profit and Loss Appropriation Account distributes net profit.
- 1
Net profit from P&L
- 2
Add interest on drawings
- 3
Less interest on capital
- 4
Less partners' salary and commission
- 5
Less transfer to reserve
- 6
Balance shared in profit-sharing ratio
- Capital accounts: fixed (capital account shows only capital; current account records interest, salary, drawings, share of profit) or fluctuating (all items in the capital account).
- In the absence of a partnership deed, Section 13 of the Partnership Act, 1932 applies: profits shared equally, no interest on capital, no salary, interest on loans by partners at 6% p.a., no interest on drawings.
Example
Net profit ₹1,20,000; A and B share 3:2; interest on capital A ₹10,000, B ₹6,000; B's salary ₹14,000. Divisible profit = 1,20,000 − 16,000 − 14,000 = ₹90,000. A gets ₹54,000; B gets ₹36,000.
Key terms
- Journal
- Book of original entry in chronological order
- Ledger
- Book of final entry where transactions are classified by account
- Trial balance
- Statement of ledger balances to check arithmetical accuracy
- GAAP
- Generally accepted accounting principles
- Appropriation account
- Shows distribution of a firm's net profit among partners
Quick revision
- Cycle: journal → ledger → trial balance → adjustments → final accounts.
- Golden rules: personal, real, nominal accounts.
- Trial balance does not reveal errors of omission, principle and compensating errors.
- Final accounts: trading → P&L → balance sheet.
- Partnership: P&L appropriation; Section 13 rules apply without a deed.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Define accounting.
- Q2.State the golden rules of debit and credit.
- Q3.What is a trial balance?
- Q4.Explain the matching concept.
- Q5.What is a prepaid expense and how is it treated?
- Q6.State the provisions of Section 13 of the Partnership Act regarding profits and interest.
Long-answer questions
- Q1.Explain the accounting cycle with journal, ledger and trial balance.
- Q2.Explain the accounting concepts and conventions that form GAAP.
- Q3.Explain the preparation of final accounts of a sole proprietor with adjustments.
- Q4.Explain the preparation of the profit and loss appropriation account and partners' capital accounts.
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