INTRODUCTION TO BASIC ACCOUNTING TERMS

Every business owner should know basic accounting terms to communicate with online accounting services. In this article you will learn basic acoounting rules and basic accounting entries. There are five most important accounting terms that all business owners should know:

Basic accounting terms finance terminology
  1. Assets
  2. Liabilities
  3. Capital
  4. Expenses
  5. Income/ Revenue

(1) Explanation of accounting terms

ASSETS

These are those valuable things which are purchased by a company from which business gets benefits in the future in generating income. Simply you can say assets are those values which give benefits in the future. Assets are brought in business to increase the level of the business as they are capable of generating future economic value or in generating cash flow in the business.

Example of assets:

  • Building
  • Land

LIABILITIES

Liabilities are the obligations or debt on the company which has to pay to the outsiders from which debt had been taken for the business projects or activities. It is the claim of the outsiders to the total assets of the business. Liability is the value that has to pay to the creditors within a given period. Liabilities are paid from the current assets in the business or from another current liability.

Example of liabilities:

  • Bank loan
  • Credit cards

CAPITAL

Capital is the fund given by the owner to raise the business. It is the claim of the owner in the total assets of the business. Capital is not always the money or cash this may be the building, land or car, etc. It increases the level of the business.

Example of capital:

  • Machine
  • Equipment
  • Furniture

EXPENSES

Expenses are those values from which the benefits have been already taken. Expenses reduce the value of the assets. In accounting expenses are recorded as an expense if the benefit has been already taken, it does not matter whether the payment has been done or not.

Examples of Expenses:

  • Rent expense
  • Employer’s salary
  • Purchased goods

INCOME

In accounting, income is those values for which the services have been rendered & it does not matter whether the payment has been received or not.

Example of income:

  • Sales goods

(2) General accounting terms

  • Accounts payable: It is a debt which is owed by an organization to its creditors.
  • Accounts receivables: It is an amount of money earned from all revenues or sales but the payment has not been received from the customer on delivery. So, you can say that it is money owed to a company from its debtors.
  • Book value: It shows the original assets value against its accumulated depreciation.
  • Inventory: It is an account which includes those assets that a company has purchased to sell their customers but they remain unsold.
  • Cost of goods sold (COGS): It is the cost that is required for the raw material and converted into a final product.
  • Generally accepted accounting principles (GAAP): It involves the rules and the standards for financial statements which must be followed by the company and their accountants.
  • Depreciation: It is the cost or value of the fixed assets which has declined over time.
  • Accounting period: It is a period which is covered by an organization’s financial statements. After this period accounting books are changed and on its basis profit or loss can be calculated. Generally denoted by “A Year”.
  • Cash flow: It indicates the inflow and outflow of cash in a business.
  • Diversification: It is the method used to reduce the risk.
  • Fixed cost: It is the cost that does not change with business activities. It remains the same whether the activity has happened or not and the company has to pay it such as insurance, depreciation, property tax, etc.
  • Variable cost: It is the cost that changes with the business activities.
  • Liquidity: It shows how easily something can convert into cash.
  • Trade: It involves buying and selling goods and services.
  • Payroll: It is the total amount of money paid to the company’s employees.
  • On Credit/ On Account: It is a purchase that happens on credit that will be paid later or a future date.

(3) Branches of accounting

Financial accounting: It is a branch of accounting in which the track of the company’s financial transactions has been kept.

Cost accounting: Accounting which has control over the cost of production and services.

Management accounting: It involves the analysis and reporting all about the company’s financial transactions. It helps in decision making and selecting the best methods in accounting.

Government accounting: It is the field of science in which the financial transactions are recorded for which the government is responsible.

Auditing: It involves the evaluation of financial statements to examine the accuracy, fairness.

(4) Objectives of accounting

  • maintaining accounts to keep the track of inflow and outflow in a business.
  • reduces misappropriation or fraud.
  • helps in determining loss, profit or financial position of the business.

(5) Introduction To Accounts & General Ledger

The system by which transactions are recorded in the accounting business. In accounting, business records are categorized on the T structure & also known as T-accounts. This structure consists of two sides:- Debit side on the left side while Credit side on the right side.

                            T-ACCOUNT

Debit Side Credit Side

(6) Charts Of Accounts

In T structure we use a series or different codes for each T account.

Example:

  ASSETS (1001-1999)

CASH (101)

Debit Side Credit Side

MACHINERY (1201)

Debit Side Credit Side

Similarly, we can make T accounts for the liabilities, capital, expenses, revenue by using different codes for each.

(7) Double Entry Bookkeeping

There are two facts in the accounting business:-

  1. the total transaction has been made.
  2. reasons for making a transaction.

The rule of bookkeeping said that Debit must equal to Credit.

(8) Rules For Recording Transaction

For Assets and Expenses:

  • increases are recorded as a Debit. 
  • decreases are recorded as a credit.

For Liabilities, Revenues:

  • increases are recorded as Credit.
  • decreases are recorded as Debit.

(9) Compile Accounts And Trial Balance

Balance sheet and the trial balance sheet are most important in accounting to compile the record of all financial activities in the business.

Example:

Transactions:

  • Owner inputs 2000$ into a business bank account.
  • The business buys printing machine 100$.
  • The business pay obligation to the bank of 1000$.
  • The business pay salary of about 100$ to an employee from the new credit card.

 TRIAL BALANCE SHEET

ACCOUNT DEBIT CREDIT
Cash 2000$ 1100$
Machinery 100$
Bank loan 1000$
Receivables
Credit cards 100$
Creditors
Capital input 2000$
Retained profit
Other reserves
Marketing exp
Administrative exp
Distributive exp 100$
Sales
Sales return
Interest income
TOTAL 3200$ 3200$

The debit must be equal to the credit.

 PREPARING FINANCIAL STATEMENTS

(10) PROFIT & LOSS STATEMENT AND BALANCE SHEET:

Balance sheets and income statements are important aspects of the accounting business. The balance sheet includes total assets and total liabilities & capitals. It summarizes the statement of the business. The income statement includes total sales and total expenses. It summarizes the performance of the business. Once the trial sheet has been made then it becomes easy to make a balance sheet and income statement.

 

                                                                 TRIAL SHEET

ACCOUNT DR CR
Cash 2000$
Machinery 500$
Receivables 1000$
Bank loan
Credit cards 500$
Creditors
Capital input 1500$
Retained profit
Other reserves
Marketing exp 200$
Administrative exp 300$
Distributive exp
Sales 2000$
Sales return
Interest income
TOTAL 4000$ 4000$

                                                                  BALANCE SHEET

ACCOUNT DR CR
Cash 2000$
Machinery 500$
Receivables 1000$
TOTAL ASSETS 3500$
Bank loan
Credit cards 500$
Creditors
Capital input 1500$
Retained profit 1500$
Other reserves
TOTAL LIABILITIES & CAPITAL   3500$

                                                         INCOME STATEMENT

ACCOUNT DR CR
Sales 2000$
Sales return
Interest income
Marketing exp 200$
Administrative exp 300$
Distributive exp
PROFIT 1500$

 

 Additional Areas Of Accounting

(11) CASH ACCOUNTING & ACCRUAL ACCOUNTING

The main difference lies in cash accounting and accrual accounting is the period when expenses & sales are recorded on bills.

Cash accounting: In cash accounting expenses are recorded when payment has been done & sales are recorded when money has been received.

Accrual Accounting: In accrual, accounting expenses are recorded when it has been incurred & sales are recorded when goods have been offered or transferred.

In large businesses, companies are preferred to maintain their records using accrual accounting while in small business they have both the choices, cash accounting as well as accrual accounting.

Example: Electricity bill

In cash accounting, this will be recorded as an expense only when the bill has been paid.

But in accrual accounting, this will be recorded as an expense because the service has been already consumed. In accrual accounting, it does not matter whether the payment has been done or not.

(12) ACCRUALS & PREPAYMENTS

Prepayments: In prepayments payments paid in advance before consuming the services. In accounting, prepayments are recorded as profit & loss when services have been consumed.

Accrual accounting: In accrual accounting expenses are recorded for which payment has to be paid in the future. So, in accrual accounting expenses are recorded as profit & loss when payment has been made the consumption of the service.

(13) CAPITAL AND REVENUE EXPENDITURE:

Capital expenditure: Capital included these expenses which have the benefit of more than one year. These expenses are recorded as an asset in the income statement and depreciated over their life.

  • Purchase of car
  • registration of land.

Revenue expenditure: These are those expenses which have the benefit of one year or less than one year. These expenses are recorded as profit and loss when they are incurred.

Example-

  • car fuel
  • utility bills.

(14) FIXED ASSET

  • Fixed asset= Debit
  • Cash = Credit

With time the operating ability value of assets decreases. This fall in value is an expense, is known as depreciation.

(15) INTANGIBLE ASSETS & AMORTIZATION

Intangible assets: Intangible assets are those which lack physical substances.

Example-

  • Licenses
  • copyrights, etc.

When an intangible asset is purchased it is capitalized in the balance sheet. This cost is then expressed over the life of an intangible asset, called Amortization.

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