1. Introduction to Financial Statements and Capital vs Revenue

Financial statements are formal records of the financial transactions and position of a business, entity, or person. For a sole proprietorship, the primary statements are the Trading and Profit and Loss Account and the Balance Sheet. Understanding the distinction between capital items (expenditures that benefit the business over multiple periods, like asset purchases) and revenue items (expenditures or incomes relating to the current operating period) is crucial for correct financial reporting.

2. Trading and Profit and Loss Account (Sole Proprietorship)

The Trading Account is prepared to ascertain the gross profit or gross loss of a business from its trading activities. It includes opening stock, purchases, direct expenses on debit side, and sales and closing stock on credit side. The Profit and Loss Account is then prepared to determine the net profit or net loss by considering all indirect incomes and expenses. These statements are essential for a sole proprietorship to understand its operational performance.

3. Balance Sheet (Sole Proprietorship)

The Balance Sheet is a statement that presents the financial position of a business at a specific point in time. For a sole proprietorship, it lists all assets (what the business owns) and all liabilities and capital (what the business owes to external parties and the owner). The Balance Sheet must always balance, reflecting the fundamental accounting equation: Assets = Liabilities + Capital.

4. Adjustments for Financial Statements (Sole Proprietorship)

Before finalizing financial statements, certain adjustments are necessary to reflect the true financial position and performance. Common adjustments include accounting for outstanding expenses, prepaid expenses, accrued income, unearned income, depreciation, bad debts, provision for doubtful debts, and closing stock. These adjustments ensure that the Trading and Profit and Loss Account and the Balance Sheet are accurate.

5. Accounting Cycle and Opening Entry

The accounting cycle is the complete process of identifying, analyzing, recording, summarizing, and reporting a business's financial transactions over an accounting period. It begins with the opening entry, which records the opening balances of assets, liabilities, and capital from the previous period's closing balance sheet into the new accounting period's ledger accounts.