PAPER 103
Principles of Basic Accountancy
Comprehensive Study Notes
Term Description
Module I (25 Marks) Accounting Concepts, Conventions & Postulates; Accounting Process
Module II (25 Marks) Preparation of Final Accounts; Accounting Standards
Module III (25 Marks) Analysis & Interpretation of Published Statements
Module IV (25 Marks) Accounting for Non-Profit Organizations; Basics of Company
Accounts
MODULE I — Accounting Concepts, Conventions & Postulates;
Accounting Process
1.1 What is Accounting?
Accounting is the systematic process of recording, classifying, summarizing, interpreting, and
communicating financial information about a business entity to its stakeholders.
1.2 Accounting Concepts
Accounting concepts are the basic assumptions or conditions upon which the science of accounting is
based. These concepts guide how financial transactions are recorded and reported.
(A) Business Entity Concept
The business is treated as a separate entity from its owner(s). All transactions are recorded from the
business's point of view, not the owner's personal perspective.
Example: If the owner invests ₹1,00,000 in the business, it is recorded as a liability of the business
towards the owner (Capital).
(B) Money Measurement Concept
Only those transactions that can be expressed in monetary terms are recorded in the books of
accounts. Non-monetary events like employee morale or management efficiency are not recorded.
Limitation: Inflation distorts money values over time, making comparisons difficult.
(C) Going Concern Concept
It is assumed that a business will continue to operate for the foreseeable future and has no intention
of liquidation. Assets are therefore recorded at cost and not at market value.
Significance: Justifies the use of depreciation and the capitalization of expenses.
(D) Cost Concept (Historical Cost)
Assets are recorded at their original purchase price (cost) and not at their current market value. The
cost is the basis for all subsequent accounting.
Exception: Current assets like stock-in-trade may be valued at cost or net realizable value, whichever is
lower.
(E) Dual Aspect Concept (Double Entry)
Every transaction has two aspects — a debit and a credit of equal amounts. This forms the basis of the
double entry system.
Fundamental Equation: Assets = Liabilities + Capital (Owner's Equity)
(F) Accounting Period Concept
Business life is divided into specific time periods (usually one year) for reporting purposes. This allows
periodic assessment of financial performance.
Types of Accounting Year: Calendar year (Jan–Dec), Financial year (Apr–Mar), or any 12-month period.
(G) Matching Concept
Expenses should be matched against the revenues of the same period in which those revenues were
earned. This ensures accurate profit determination.
Example: Salaries payable for December are charged in December's accounts even if paid in January.
(H) Realization Concept (Revenue Recognition)
Revenue is recognized when it is earned, not necessarily when cash is received. Revenue is earned
when goods are delivered or services are rendered.
Example: Credit sales are recognized as revenue at the point of sale, not when payment is received.
(I) Accrual Concept
Income and expenses are recognized when they are earned or incurred, regardless of when actual
cash is received or paid. This gives a more accurate picture than cash-based accounting.
📌 Key Distinction
Accrual Concept vs. Cash Concept: Under accrual accounting, outstanding expenses and accrued
income are recognized. Under cash accounting, only actual cash transactions are recorded.
1.3 Accounting Conventions
Conventions are customs or traditions that guide accounting practice. They have evolved over time
through common usage.
(A) Convention of Consistency
Once an accounting method is adopted, it should be followed consistently from year to year. Changes
in methods should be disclosed with reasons.
Purpose: Ensures comparability of financial statements over different periods.
(B) Convention of Disclosure
All significant information that is relevant to the users of financial statements must be fully disclosed.
Nothing material should be concealed.
This is partly enforced by legal requirements (Companies Act) and accounting standards.
(C) Convention of Conservatism (Prudence)
Anticipate no profit, but provide for all possible losses. When in doubt, choose the method that results
in a lower profit or a lower asset value.
Examples: Valuing stock at cost or NRV (whichever is lower); creating provisions for bad debts.
(D) Convention of Materiality
Only items that are significant enough to affect decisions of users need to be separately disclosed.
Immaterial items may be combined or aggregated.
What is 'material' depends on judgment — based on amount and nature of the item.
1.4 Accounting Postulates
Postulates are basic assumptions that are widely accepted without proof. They underpin the entire
framework of accounting.
Term Description
Separate Entity Postulate The business is distinct from its owners for accounting purposes.
Continuity Postulate The business will continue indefinitely (Going Concern).
Monetary Unit Postulate All transactions are expressed in a stable monetary unit.
Time Period Postulate Business activity is divided into discrete time periods for reporting.
Objectivity Postulate Accounting records should be based on verifiable, objective
evidence.
1.5 The Accounting Process (Accounting Cycle)
The accounting process is a step-by-step procedure that begins with identifying transactions and ends
with the preparation of financial statements.
Step 1: Identifying and Analyzing Transactions
Only financial transactions that affect the accounting equation are recorded. Source documents
(invoices, receipts, vouchers) serve as evidence.
Step 2: Recording in Journal (Journal Entry)
A journal is the book of original entry. Every transaction is first recorded here in chronological order
with the date, accounts debited and credited, and a brief narration.
Format: Date | Particulars | L.F. | Debit (₹) | Credit (₹)
Step 3: Posting to Ledger
The ledger is the book of final entry. Journal entries are posted (transferred) to individual account
pages (ledger accounts) in the ledger.
The ledger provides a summary of all transactions affecting each account.
Step 4: Preparing the Trial Balance
A trial balance is a list of all ledger account balances at a given date. It is used to check the arithmetical
accuracy of the ledger. Total debits must equal total credits.
Step 5: Adjusting Entries
Adjustments are made for items like outstanding expenses, prepaid expenses, accrued income,
depreciation, and provisions to ensure the matching concept is applied.
Step 6: Preparing Financial Statements
Trading Account (Gross Profit), Profit & Loss Account (Net Profit), and Balance Sheet are prepared
from the adjusted trial balance.
Step 7: Closing Entries
Temporary accounts (revenues, expenses) are closed to the Profit & Loss Account at the end of the
period. Permanent accounts (assets, liabilities, capital) are carried forward.
📌 The Accounting Equation
Assets = Liabilities + Owner's Equity. Every transaction must preserve this equation. This is the
foundation of double-entry bookkeeping.
MODULE II — Preparation of Final Accounts & Accounting
Standards
2.1 Introduction to Final Accounts
Final accounts are prepared at the end of an accounting period to ascertain the profit or loss of a
business and to show its financial position. They include the Trading Account, Profit & Loss Account,
and the Balance Sheet.
2.2 Trading Account
The Trading Account is prepared to find out the Gross Profit or Gross Loss from buying and selling
goods.
Structure of Trading Account
Term Description
Dr. Side (Expenses) Cr. Side (Income)
Opening Stock Sales (Net of Returns)
Purchases (Net of Returns) Closing Stock
Direct Expenses (Carriage,
Wages, Freight)
Gross Profit c/d (if credit Gross Loss c/d (if debit > credit)
side > debit side)
Gross Profit = Net Sales – (Opening Stock + Net Purchases + Direct Expenses) + Closing Stock
Direct vs. Indirect Expenses
Direct Expenses: Costs incurred to bring goods to a saleable condition — carriage inwards, wages,
customs duty, factory power. These go to the Trading Account.
Indirect Expenses: General admin and selling costs — salaries, rent, advertising, depreciation. These go
to the Profit & Loss Account.
2.3 Profit & Loss Account
The P&L Account is prepared to determine the Net Profit or Net Loss of the business after accounting
for all indirect expenses and incomes.
Term Description
Dr. Side (Indirect Expenses) Cr. Side (Indirect Incomes)
Salaries & Wages Gross Profit b/d
Rent, Rates & Taxes Discount Received
Insurance Commission Received
Advertising Rent Received
Depreciation Interest on Investments
Bad Debts & Provisions Miscellaneous Income
Net Profit c/d Net Loss c/d
Net Profit = Gross Profit + Other Incomes – All Indirect Expenses
2.4 Balance Sheet
The Balance Sheet is a statement of financial position showing what the business owns (assets) and
what it owes (liabilities and capital) at a specific date. It is not an account but a statement — it does
not have a debit or credit side.
Term Description
Liabilities Side Assets Side
Capital (Opening + Net Fixed Assets (Land, Building, Plant, Furniture)
Profit – Drawings)
Long-term Loans Investments
Current Liabilities Current Assets (Stock, Debtors, Cash, Bank)
(Creditors, Bills Payable)
Reserves & Provisions Prepaid Expenses, Loans & Advances
📌 Balance Sheet Equation
Total Assets = Total Liabilities + Capital. If the Balance Sheet does not balance, it indicates errors in
the books of accounts.
2.5 Adjustments in Final Accounts
Adjustments are necessary to ensure that accounts reflect the true and fair view of financial
performance.
(A) Closing Stock
Closing stock is shown on the credit side of the Trading Account and on the asset side of the Balance
Sheet (valued at cost or NRV, whichever is lower).
(B) Outstanding (Accrued) Expenses
An outstanding expense is one that is due but not yet paid. It is added to the relevant expense in the
P&L Account and shown as a current liability in the Balance Sheet.
(C) Prepaid Expenses
Expenses paid in advance for the next period. Deducted from the relevant expense in P&L and shown
as a current asset in the Balance Sheet.
(D) Accrued Income
Income earned but not yet received. Added to the relevant income in P&L and shown as a current
asset in the Balance Sheet.
(E) Income Received in Advance (Deferred Income)
Income received but relating to the next period. Deducted from income in P&L and shown as a current
liability.
(F) Depreciation
A portion of the fixed asset's cost written off each year due to wear, tear, and obsolescence. Charged
to P&L Account; deducted from the asset in the Balance Sheet.
Methods: Straight-Line Method (SLM): Fixed amount each year. Written Down Value (WDV): Fixed
percentage on book value.
(G) Bad Debts & Provision for Bad Debts
Bad Debts: Amounts irrecoverable from debtors — charged to P&L. Provision for Bad Debts: An
estimated reserve for future bad debts — reduces debtor values in Balance Sheet.
2.6 Accounting Standards (AS)
Accounting Standards (AS) are authoritative statements issued by the Institute of Chartered
Accountants of India (ICAI) that standardize accounting policies and practices across organizations.
Objectives of Accounting Standards
• Bring uniformity in accounting practices
• Improve the reliability and comparability of financial statements
• Provide guidance on how to account for complex transactions
• Reduce the scope for manipulation in financial reporting
Key Accounting Standards
Term Description
AS 1 Disclosure of Accounting Policies — Requires companies to disclose
significant accounting policies used in preparation of financial
statements.
AS 2 Valuation of Inventories — Inventories to be valued at cost or NRV,
whichever is lower. FIFO and Weighted Average methods permitted.
AS 6 Depreciation Accounting — Provides guidance on methods and rates
of depreciation.
AS 9 Revenue Recognition — Revenue from sale of goods recognized
when significant risks/rewards are transferred.
AS 10 Accounting for Fixed Assets — Fixed assets to be recorded at cost;
guidance on subsequent expenditure.
AS 15 Employee Benefits — Accounting for short-term and post-
employment benefits like gratuity and provident fund.
AS 16 Borrowing Costs — Borrowing costs directly attributable to
acquisition/construction of qualifying assets are capitalized.
AS 22 Accounting for Taxes on Income — Deals with deferred tax
accounting.
AS 26 Intangible Assets — Recognition, measurement, and amortization of
intangible assets.
MODULE III — Analysis and Interpretation of Published
Statements
3.1 Meaning of Financial Statement Analysis
Financial statement analysis involves examining a company's financial reports (Balance Sheet, P&L
Account) to evaluate its performance, profitability, solvency, and efficiency. It helps stakeholders
make informed decisions.
3.2 Objectives of Financial Analysis
• Assessing the profitability of the business
• Evaluating the short-term and long-term solvency (liquidity)
• Analyzing the efficiency of asset utilization
• Comparing performance across time periods or with competitors
• Helping investors, creditors, and management make decisions
3.3 Types of Financial Analysis
Term Description
Horizontal Analysis Comparing financial data across multiple periods to identify trends.
Also called Trend Analysis.
Vertical Analysis Expressing each item as a percentage of a base figure within the
same year (e.g., each P&L item as % of Net Sales).
Ratio Analysis Calculating specific ratios from financial statements to assess
performance and position.
Comparative Statements Side-by-side presentation of statements for two or more years
showing absolute and percentage changes.
Common Size Statements All figures expressed as a % of a common base (Total Assets or Net
Sales).
3.4 Ratio Analysis
A ratio is a mathematical relationship between two related figures from the financial statements.
Ratios are classified into four main categories.
(A) Liquidity Ratios — Short-term Solvency
Term Description
Current Ratio Current Assets / Current Liabilities. Ideal: 2:1. Measures ability to
meet short-term obligations.
Quick Ratio (Acid Test) (Current Assets – Stock – Prepaid) / Current Liabilities. Ideal: 1:1.
Excludes less liquid assets.
Cash Ratio (Cash + Bank + Marketable Securities) / Current Liabilities. Most
stringent liquidity test.
(B) Profitability Ratios
Term Description
Gross Profit Ratio (Gross Profit / Net Sales) × 100. Higher ratio indicates better trading
efficiency.
Net Profit Ratio (Net Profit / Net Sales) × 100. Reflects overall profitability after all
expenses.
Return on Capital Employed (Net Profit + Interest) / Capital Employed × 100. Measures efficiency
(ROCE) of capital use.
Return on Equity (ROE) Net Profit after Tax / Shareholders' Equity × 100.
Earnings Per Share (EPS) Net Profit after Tax / Number of Equity Shares.
(C) Solvency / Leverage Ratios — Long-term Solvency
Term Description
Debt-Equity Ratio Total Debt / Shareholders' Equity. Lower ratio indicates lower
financial risk.
Proprietary Ratio Shareholders' Equity / Total Assets. Higher ratio means more owner
financing.
Interest Coverage Ratio EBIT / Interest Expense. Shows ability to service debt. Higher is
better.
Capital Gearing Ratio Fixed Interest Securities / Equity Shareholders' Funds.
(D) Activity / Efficiency / Turnover Ratios
Term Description
Inventory (Stock) Turnover Cost of Goods Sold / Average Inventory. Higher ratio = faster
inventory movement.
Debtors Turnover Net Credit Sales / Average Debtors. Measures speed of debt
collection.
Debtors Collection Period 365 / Debtors Turnover. Number of days to collect receivables.
Creditors Turnover Net Credit Purchases / Average Creditors.
Fixed Assets Turnover Net Sales / Net Fixed Assets. Measures efficiency of fixed asset
utilization.
Total Assets Turnover Net Sales / Total Assets.
3.5 Comparative Financial Statements
Comparative statements place financial data for two or more periods side by side, showing: absolute
figures for each year, absolute change (current year – previous year), and percentage change.
Purpose: Identifies trends, growth rates, and areas of concern over time.
3.6 Common Size Statements
In common size income statements, every item is expressed as a percentage of Net Sales. In common
size balance sheets, every item is expressed as a percentage of Total Assets.
Purpose: Facilitates inter-firm and intra-firm comparison regardless of the absolute size of the
business.
3.7 Limitations of Financial Statement Analysis
• Based on historical data — may not reflect current conditions
• Ignores non-financial factors like management quality, market conditions
• Different accounting policies make comparisons between firms unreliable
• Window dressing — companies may manipulate figures before year-end
• Inflation distorts the meaning of monetary figures over time
• Ratios alone are insufficient — need to be analyzed in context
MODULE IV — Accounting for Non-Profit Organizations & Basics
of Company Accounts
4.1 Non-Profit Organizations (NPOs)
Non-Profit Organizations (NPOs) are entities formed not to earn profit but to serve social, educational,
cultural, charitable, or religious objectives. Examples: clubs, hospitals, schools, trusts, and societies.
4.2 Key Financial Statements of NPOs
(A) Receipts and Payments Account
This is a summary of all cash and bank transactions during the year, regardless of the period to which
they belong. It is similar to a Cash Book.
Term Description
Receipts Side (Dr.) Payments Side (Cr.)
Opening Cash/Bank Balance Payments for Expenses
Subscriptions Received Purchase of Assets
Donations Received Investments Made
Entrance Fees Closing Cash/Bank Balance
Sale of Assets / Investments
Important: It includes both capital and revenue receipts and payments. It does NOT show the
surplus/deficit.
(B) Income and Expenditure Account
This is equivalent to the Profit & Loss Account of a profit-seeking entity. It is prepared on accrual basis
and shows the surplus (excess of income over expenditure) or deficit for the year.
Term Description
Expenditure Side (Dr.) Income Side (Cr.)
Salaries & Wages Subscriptions (for the current year)
Rent, Rates, Taxes Donations (revenue nature)
Printing & Stationery Entrance Fees (if treated as revenue)
Depreciation on Assets Interest and Dividends Received
Surplus (excess of income) Deficit (excess of expenditure)
(C) Balance Sheet of NPO
The Balance Sheet of an NPO is similar in format to that of a profit-seeking business but uses 'Capital
Fund' or 'General Fund' instead of 'Capital'.
Capital Fund = Opening Balance + Surplus – Deficit + Life Membership Fees + Legacies
4.3 Special Items in NPO Accounting
Subscriptions
Subscriptions are the main source of income for NPOs. Only the amount relating to the current year is
credited to the I&E Account.
Outstanding subscriptions = Current Asset; Advance subscriptions = Current Liability.
Life Membership Fees
Usually treated as a capital receipt and transferred to the Capital Fund in the Balance Sheet (not to I&E
Account).
Legacies and Donations
Legacies (money received through a will) and large specific donations are treated as capital receipts.
Small, general donations may be treated as revenue income in the I&E Account.
Entrance/Admission Fees
If the amount is small and regular, treated as revenue income (I&E Account). If the amount is large,
treated as capital receipt (Capital Fund).
📌 NPO Key Rule
NPOs do NOT prepare a Trading Account or Profit & Loss Account. They prepare a Receipts and
Payments Account and an Income and Expenditure Account.
4.4 Basics of Company Accounts
A company is a legal entity separate from its shareholders. It is governed by the Companies Act, 2013
in India. Companies can be Public Limited or Private Limited.
4.5 Share Capital
Companies raise capital by issuing shares. The share capital structure is as follows:
Term Description
Authorised Capital Maximum capital a company is authorized to raise as per its
Memorandum of Association.
Issued Capital Portion of authorised capital actually offered to the public for
subscription.
Subscribed Capital Portion of issued capital that has been subscribed (applied for) by
investors.
Called-up Capital Portion of subscribed capital that the company has called for
payment.
Paid-up Capital Portion of called-up capital actually received from shareholders.
Types of Shares
Equity Shares: The primary ownership shares. Equity shareholders bear the highest risk but have
residual claim on profits and assets. They have voting rights.
Preference Shares: Carry preferential rights over equity shares regarding dividend payment and return
of capital on winding up. Usually have a fixed dividend rate.
4.6 Issue of Shares
Issue at Par, Premium, and Discount
• At Par: Issued at face (nominal) value.
• At Premium: Issued above face value. The excess is credited to 'Securities Premium Account'
(cannot be used for dividends).
• At Discount: Issued below face value (generally not permitted under Companies Act, 2013 except
for sweat equity).
Accounting Entries for Issue of Shares
Term Description
On Application Bank A/c Dr. / To Share Application A/c
On Allotment Share Application A/c Dr. (transfer) / Share Allotment A/c Dr. / To
Share Capital A/c / To Securities Premium A/c (if at premium)
On Call Money Share Call A/c Dr. / To Share Capital A/c
On Receipt of Calls Bank A/c Dr. / To Share Call A/c
4.7 Forfeiture and Re-issue of Shares
When a shareholder fails to pay calls, the company may forfeit (cancel) those shares after due notice.
The forfeited shares may then be re-issued (sold) to new investors.
Journal Entry for Forfeiture
Share Capital A/c Dr. (with called-up amount) | To Share Allotment/Calls A/c (unpaid) | To Share
Forfeiture A/c (amount received)
Journal Entry for Re-issue
Bank A/c Dr. | Share Forfeiture A/c Dr. (discount if any) | To Share Capital A/c
Any balance remaining in Share Forfeiture Account after re-issue is transferred to Capital Reserve.
4.8 Debentures
Debentures are long-term debt instruments issued by companies to borrow money from the public.
Debenture holders are creditors of the company, not owners.
Term Description
Secured Debentures Backed by charge on company assets.
Unsecured Debentures No security — only a general claim against the company.
Redeemable Debentures Repayable after a specified period.
Irredeemable Debentures Not repayable during the lifetime of the company.
Convertible Debentures Can be converted into equity shares after a period.
Non-Convertible Cannot be converted into equity shares.
Debentures
4.9 Reserves and Provisions
Term Description
Capital Reserve Arises from capital profits (e.g., profit on re-issue of forfeited shares,
profit on revaluation of assets). Cannot be distributed as dividends.
Revenue Reserve Arises from normal business profits. Can be distributed as dividends.
Includes General Reserve and Specific Reserves.
Securities Premium Reserve Premium received on issue of shares; governed by Sec. 52 of
Companies Act, 2013.
Provision Amount set aside for a known liability of uncertain amount (e.g.,
provision for bad debts, provision for taxation).
4.10 Final Accounts of Companies
Companies are required to prepare financial statements under the Companies Act, 2013 and as per
Indian Accounting Standards (Ind AS) or Accounting Standards (AS).
• Statement of Profit & Loss (replaces the old Trading and P&L Account format)
• Balance Sheet (in the prescribed Schedule III format)
• Cash Flow Statement (mandatory for listed and large companies)
• Notes to Accounts (mandatory disclosures supporting the financial statements)
📌 Companies Act, 2013
Under the Companies Act, 2013, the financial statements must give a 'true and fair view' of the state
of affairs of the company and must comply with the accounting standards notified by the Central
Government.
QUICK REVISION SUMMARY
Term Description
Module I Concepts (Entity, Going Concern, Matching, Realization, Accrual,
Dual Aspect, Cost, Money Measurement, Accounting Period).
Conventions (Consistency, Disclosure, Conservatism, Materiality).
Accounting Cycle (Identify → Journal → Ledger → Trial Balance →
Adjustments → Final Accounts → Closing Entries).
Module II Trading Account (Gross Profit). P&L Account (Net Profit). Balance
Sheet (Financial Position). Adjustments (Outstanding, Prepaid,
Accrued, Depreciation, Bad Debts). Accounting Standards (AS 1, 2, 6,
9, 10...).
Module III Financial Analysis Types: Horizontal, Vertical, Ratio, Common-size.
Liquidity Ratios: Current, Quick. Profitability: GP Ratio, NP Ratio,
ROCE, ROE. Solvency: Debt-Equity, Interest Coverage. Activity:
Inventory, Debtors, Creditors Turnover.
Module IV NPOs: Receipts & Payments A/c (cash basis). Income & Expenditure
A/c (accrual basis). Capital Fund. Special items: Subscriptions, Life
Membership, Legacies. Company Accounts: Share Capital types,
Issue at Par/Premium, Forfeiture & Re-issue, Debentures, Reserves &
Provisions.
End of Notes — Paper 103: Principles of Basic Accountancy