What are Balance Sheet and Profit and Loss Account? What are the fundamental accounting principles?

Balance Sheet

The Balance Sheet adheres to the basic accounting equation: Assets = Liabilities + Equity. It’s a statement of financial position as of a specific date.

• Assets: Resources owned by the company (e.g., cash, accounts receivable, inventory, property, plant, and equipment).
• Liabilities: Obligations of the company to outsiders (e.g., accounts payable, loans, deferred revenue).
• Equity: The owners’ stake in the company (e.g., common stock, retained earnings).

Profit and Loss Account

The Profit & Loss Account, also known as the Income Statement, reports a company’s financial performance over a period. It calculates net income by subtracting total expenses from total revenues.

• Revenue: Income generated from the company’s primary business activities.
• Cost of Goods Sold (COGS): Direct costs associated with producing goods or services.
• Gross Profit: Revenue - COGS
• Operating Expenses: Costs incurred in running the business (e.g., salaries, rent, utilities).
• Net Profit: Gross Profit - Operating Expenses - Interest - Taxes

Fundamental Accounting Principles

These principles ensure consistency, comparability, and reliability in financial reporting.

1. Accrual Principle

Recognizes revenues when earned and expenses when incurred, regardless of when cash changes hands. Example: If a service is provided in December but billed in January, the revenue is recognized in December.

2. Going Concern Principle

Assumes the business will continue operating indefinitely. This justifies valuing assets at cost rather than liquidation value.

3. Matching Principle

Expenses should be matched with the revenues they help generate in the same accounting period. Example: Sales commission expense is recognized in the same period as the related sales revenue.

4. Cost Principle

Assets are recorded at their original cost. This provides objectivity and verifiability.

5. Conservatism Principle

When faced with uncertainty, choose the accounting treatment that is least likely to overstate assets or income and understate liabilities or expenses.

6. Materiality Principle

Only information that is significant enough to influence decisions needs to be disclosed. Example: A small office supply expense might not be individually reported.

7. Full Disclosure Principle

All relevant information that could affect a user’s understanding of the financial statements should be disclosed, either in the statements themselves or in the accompanying notes.

Principle	Description	Example
Accrual	Revenue/Expense recognition based on earning/incurrence	Service provided Dec, billed Jan - revenue in Dec
Cost	Assets recorded at original cost	Land purchased for ₹10 lakh - recorded at ₹10 lakh
Materiality	Only significant information disclosed	Small office supplies expense not individually reported