Basic Terms of Accounting
Accounting describes and analyzes bulk data of a business through recording, measurement and summarizing to prepare detailed reports and statements which help the management to know the actual financial position of a business. In accounting there are a plenty of technical terms used. It is important to know the meaning of these terms before using accounting system. These basic terms are:
An entity is something that has its own individual existence. It also refers to business organizations which have its own goals, record and process. Business entity has its special identification which is totally different from other enterprises like ABC Ltd., Super Market, Big Bazaar etc. Every entity follows the process of accounting system, record transactions and prepare financial statements at the end of the accounting period.
The meaning of transaction refers to an event between two or more entities and involves some monetary values. These events can be Sale and Purchase of goods, payment made to creditors, receipts of payments from debtors etc. Transaction may be a Cash transaction or a credit transaction which can be recorded in the books of accounts of both the entities.
Assets are the items and resources owned and used in operations by a business enterprise. Assets are purchased and used to generate cash flow in future. Value of assets of a company or business is recorded on the Assets side of Balance sheet. Some examples of assets are Machinery, Investments, Building, Stock and inventories, patents etc. Assets are mainly of 2 types
Current assets are those assets of a business which are used for day-to-day activities and operations to grow the business and are considered as short term assets because they may be consumed or sold to make profits within a short period of time. Some examples of current assets are Cash, Prepaid Expenses, Inventory or stock, accounts receivable etc.
Non Current Assets
Assets which are fixed in nature and can be used for long term (at least for the period of one year) to run a business successfully are known as non- current assets. Machinery, Land and Building, equipments used in day-to-day operations are some examples of non-current assets. Fixed assets may also include assets with long life, computers, long term investments and intangible assets. Intangible assets refers to the items with no physical existence or the items which cannot be seen or touched but still includes in the list of non-current assets like trademark of the company, patents and rights and goodwill.
Liability means the amount of debt that a business has to pay at a certain times in future. When a company purchases any assets or goods from other entities, the entities are known as creditors and liable to receive their payments within the agreed period of time. The company who purchased goods or assets is liable to pay the due amount for their purchases to their creditors. This debt which a company has to pay in future is known as liabilities. Liabilities are classified into three types which are current liabilities and non -current liabilities. Current liabilities are short term which is due and payable within a short period of maximum one year whether non-current liabilities are due after one year or more. Another liability which may be arise or may not be arise in future depending upon the particular event and situation is known as contingent liability.
Amount which is invested by the owner in business in the form of cash or assets is known as capital of a business or firm. Generally capital means the assets or financial resources owned by a business used for development of business and generating income.
Sales are the transactions between two or more business entities in which the buyers can buy goods, services or assets from its seller in exchange of money. These goods, services or assets may be sold within a certain time on cash basis or credit basis.
Revenue is also called income. Revenue is the amount generated by a business by selling products and services to its customers. Revenue can be generated in terms of other businesses are commission, dividends, royalty, rent received, interest received etc.
Expenses in accounting refer to the amount spent in operations by a company to generate revenue. Expenses are recorded in the books of accounts on the basis of the accounting system applied by the company, which is either accrual basis or cash basis. In accrual basis, the expenses for the goods or service are recorded after completion of legal formalities i.e when the goods have been received by the buyer or the service has been provided. The expense is recorded only after the actual cash has been paid for the goods or services. Example, an expense incurred in June and for this the payment has been made in July will be recorded in June as per the accrual basis method but recorded as an expense in July under the cash basis method as the cash is actually paid in July.
Expenditure is the money spent on something for some benefit. It represents payments against liabilities or we can say the expenditure is an amount paid by a company or a firm in exchange of assets and goods. If expenditure is exhausted within the period of one year, it is treated as expense or revenue expenditure. Whether the capital expenditures refers to the expenditures for which the benefit are lasts for more than one year. For example purchase of machinery and equipments, furniture etc.
Profit is the net amount of income of a business or earnings that exceeds over the expenses. The expenses include labour, raw material, interest on creditors and taxes etc. Profit is of three types. Gross profit, Operating profit and Net profit. Gross profit is the amount of sales subtracted from the cost of goods sold and other expenses paid during the production period. Operating profit is the amount which is derived from gross profit. It also refers to the earnings before interest and taxes. Net profit is the net income of a business after calculated as all incomes over all expenditures. Net profit is the aggregate of all financing and operating activities of a business.
A profit arises from incidental events and transactions are called gain. Such as income from sale of an asset, winning a court case, income from a lottery, appreciation in the value of an asset etc. are the incidental incomes from various events which are uncertain. Hence, the gain refers to the income generated through uncertain events in a business.
The increase in expenses over revenues is termed as loss. Loss decreases the owner’s equity. It is the loss of money or money’s worth without any benefits in return. For example goods are lost by fire or cash lost by theft and loss on sale of fixed assets of business.
This is the amount of money deducted from the price of the good sold. It is offered to the customers at the time of selling goods at a fixed agreed percentage. This type of discount is known as Trade Discount and generally offered by the manufacturers to their wholesalers and by wholesalers to their retailers. Another type of discount which is called Cash Discount is refer to the deductions in amount of total sales and is provided to the debtors after the sales made and paid by them within the stipulated period or earlier than the agreed period for payment. This discount is given at the time of payment on the amount payable by the debtors of a business.
Voucher is the supporting document evidence of a transaction between two entities. It is generally used to gather all the supporting documents which accounts department of a company needs to verify and approve various payments. For example if a customer buy goods for cash he get cash memo and if he buy goods on credit he get invoice for the same. When he pay the invoice amount he get the receipt for the payment made by him.
The products or items in which a business unit is dealing are known as goods. In can be the process of producing and selling the goods or buying and selling of goods. The other items which are purchased for use in business like tables, chairs, and computers are not goods. But table, chair and computers are considered as goods for their dealers. Similarly for a stationary merchant stationary is treated as goods but for other buyers or consumers it is the item of expense.
The cost of goods bought by an organization during an accounting period for consumption or resale purposes is called purchases. The result of purchases is increase in inventory. When full payment is paid by the buyer at the time of purchases it is called cash purchases and when a trader buy goods or assets on credit and agreed to pay the amount later within a particular period then it is considered as credit purchases.
Stock is the items bought by a business for reselling to customers and to make profit by reselling them. Items purchased can be sold as it is or can be sold after modification by combining two or more products and produces a new item. In trading business the amount of goods laying unsold in the godown is known as stock in hand and the amount of goods laying unsold at the end of the accounting period is the closing stock of the business. In a manufacturing unit closing stock includes raw material, semi-finished goods and finished goods at the closing date of the accounting year. Opening stock refers to the amount of stock at the beginning of the accounting period.
Debtors are the persons or any business organization who owes an amount to its suppliers or service providers in exchange of goods or services purchased on credit. On the closing date of accounting period the total amount which is not yet received is shown on the asset side of balance sheet as sundry debtors. If any debtor is not able to pay the debts on time in future then they are called bad debts.
A person, a company or a government body that provide goods or services on credit to another entity or in other words creditors are defined as an organization or a person who has a claim on others to whom goods and services has been provided on credit. On the closing date of an accounting period the amount which is standing unpaid to the favour of such organization or person is shown on the liabilities side in balance sheet as Sundry Creditors. Click here to register for online courses
Drawings are the withdrawal made in form of cash or goods for personal use by the owners of business. It reduces the amount of owner’s capital while the profit earned by the business increases the owner’s capital. Drawings made by the owners affects the balance sheet by reduction in assets withdrawn and decrease in owner’s equity or capital.