Basic Accounting Terminology

1. Event: An event is an occurrence, happening, change or incident, Accounting can be applied to an event
provided it has some financial element in it.

2. Entity: An entity means an economic unit which is formed for earning income by providing service or
selling goods.

3. Business Transaction: A business transaction is an economic activity of the business that changes its
financial position.

4. Voucher: A voucher is a document which provides the authorization to pay and on the basis of which the
business transactions are recorded in the books of accounts.

5. Entry: When a transaction or event is recorded in the books of accounts, it is called as Entry.

6. Capital: It is the amount invested by the proprietor in the business.

7. Asset: Assets are those resources that the business owns or anything which will enable the firm to get cash
or an economic benefit in the future is an asset.
(i) Non-Current Assets: Non-Current Assets refer to those assets which are held for continued use in the
business for the purpose of producing goods or services and are not meant for sale. Example- Land and
Building.
Non-Current Assets may be classified into:
(a) Tangible Assets – Tangible assets are those assets that can be seen and touched.
(b) Intangible Assets – Intangible assets are those assets which do not have a physical existence and thus
cannot be seen or felt. Example- Goodwill, Patents.
(ii) Current Assets: Current Assets are those assets which are meant for sale or which can be converted into
cash within a year.
(iii) Liquid Assets: Liquid assets are those which are either in the form of cash or can be quickly converted
into cash. Example – Cash, Bills Receivable, Debtors.
(iv) Wasting Assets: Wasting Assets are those assets which are consumed through being worked or used,
such as mines. As soon as all the minerals have been extracted, the mine becomes valueless.
(v) Fictitious Assets:

8. Liabilities: It refers to the financial obligations of an enterprise. Liability can be further classified into:
(i) Internal Liabilities – All amounts which a business entity has to pay to the owner are internal liabilities such
as capital and accumulated profits.
(ii) External Liabilities – All amounts which a business entity has to pay to outsiders are known as External
Liabilities such as creditors, bank overdraft.
(a) Non-current liability: it is that liability which is payable after a period of more than a year. Example- long
term loan, debentures etc.
(b) Current liability: It is that liability which is payable within a year. Example- creditors, bills payable short
term loan.
(c) Contingent Liability – These are not actual liabilities on the date of Balance Sheet but may become payable
only on the happening of some specific event.

9. Trade Receivables: Trade Receivables refer to the amount receivable on the account of sale of goods and
services rendered by the company in the normal course of business.
Trade Receivables include both Debtors and Bills Receivables.
(i) Debtor: Debtor is a person or a firm from whom the firm has to recover money against credit sales of
goods.
(ii) Bills receivables: It means a bill of exchange accepted by a debtor, the amount of which will be received on
the specified date.

10. Trade Payables: Trade Payables refer to the amount payable on the account of purchase of goods and
services by the company in the normal course of business.
Trade Payables include both Creditors and Bills Payables.
(i) Creditor: Creditor is a person or a firm to whom an enterprise owes amount against credit purchase of
goods.
(ii) Bills Payable: It means a bill of exchange accepted, the amount of which will be payable on the specified
date.

11. Purchase: The term purchase is used only for the purchase of “goods” in which the business deals. It
does not include purchase of an Asset.

12. Purchase Returns: When purchased goods are returned to the suppliers these are known as Purchase
Returns. Such returns as also known as Returns Outwards.

13. Sale: Sale means transfer of ownership of goods to the customers for a price.
The term sales is used only for the sales of those goods which are purchased for resale purpose. It does not
include sale of an asset.

14. Sales Returns: Some customers might return the goods sold to them. These are termed as Sales
Returns. Such returns as also known as Returns Inwards.

15. Goods: Goods include all those things which are purchased for resale or which are used for producing
the finished products which are also meant to be sold. Thus, for a furniture dealer purchase of chairs and
tables is termed as goods, while for other businesses it is furniture and is termed as an asset.

16. Stock: The term stock includes the value of those goods which are purchased for reselling and which are
lying unsold at the end of accounting period.
The Stock may be of two types:
1. Opening Stock: It is the value of goods lying unsold at the beginning of the accounting period.
2. Closing Stock: It is the value of goods lying unsold at the end of the accounting period.

17. Inventory: In case of a manufacturer inventory can be of four types:

(i) Inventory of Raw Material : It includes inventory of raw materials purchased for using them in products
manufactured but still lying unused. Example- the value of cotton in case of cloth mills is the inventory of raw
material.
(ii) Inventory of Work-in-progress: It is also called as inventory of partly finished goods. Such goods need
further processing for converting into finished products.
(iii) Inventory of Finished Goods: It includes the stock of those goods which have been completely processed
and are ready for sale but are lying unsold at the end of the accounting period.
(iv) Inventory of Stock: It includes the value of those goods which are purchased for reselling.

18. Profit: It is the excess of total revenues over total expenses of a business enterprise for an accounting
period.

19. Loss: This term conveys two meanings:

1. It conveys the result of the business for a period when total expenses exceed the total revenues. Example-
If revenue is 2,00,000 and expenses are 2,40,000 , the loss will be 40,000.
2. It refers to some activity against which firm receives no benefit. Example- Loss due to fire, theft, accident.

20. Revenue: Revenue may be defined as the inflow of cash resulting from the sale of goods and services in
the ordinary course of business. Other types of revenue are Interest received on investments, commission
received, rent received. It denotes income of a recurring nature. An amount of capital introduced by the
proprietor or borrowing loan is not revenue.

21. Expenses: Expense is cost incurred in producing and selling the goods and services. Following are
included in the term Expense: Amount paid for rent, commission, salary, advertisement

22. Income: Income is different from Revenue. Amount received from sale of goods is called Revenue and
the cost of goods is called Expenses. Surplus of revenue over expenses is called Income.

23. Drawings: Any cash or value of goods withdrawn by the owner for personal use or any private
payments made out of business funds are called drawings.

Accounting Equation: An accounting equation is a mathematical expression which shows that the assets of
a firm are equal to the sum of its liabilities and capital contributed by the owner.
Thus, Assets = Liabilities + Capital
An accounting equation is based on the 'Dual Aspect Concept' of accounting which says that every business
transaction has two aspects, a debit and a credit. In other words, for every debit there is a credit of equal
amount and vice versa.

Usefulness of Accounting Equation:

1. Basis for Double Entry System of Accounting: Accounting Equation is the basis for double entry system of
accounting which states that every transaction affects at least two accounts. If one account is debited, any
other account must be credited with equal amount.
2. Basis for Balance Sheet: It is because of accounting equation that the two sides of the Balance Sheet are
always equal and at any point of time total assets of a firm are equal to its total liabilities.
3. Ensures the Accuracy of Accounting Work: By the use of accounting equation the accuracy of accounting
can be established because accounting equation always holds true with every change that occurs due to a
transaction entered into because it is based on Dual Aspect Concept of Accounting.

Book Keeping: It is a part of accounting and is concerned with record keeping or maintenance of books of
accounting.
Accounting: Accounting is the process of collecting, recording, classifying, summarising and communicating
financial information to the users.
Accountancy: It refers to a systematic knowledge of accounting concerned with the principles and
techniques which are applied in accounting.

Distinction between Book Keeping, Accounting and Accountancy

Basis of Distinction Book Keeping Accounting

1.Scope Book-Keeping includes: Accounting in addition to Book-Keeping
(a) Identifying the transactions of includes:
financial nature, (a) Summarising the classified
(b) Measuring the identified transactions,
transactions in terms of money, (b) Analyzing and interpreting the
( c) Recording the measured summarized results and
transactions ( c) Communicating the results to parties
interested in them.
2. Stage Book- Keeping is primary stage Accounting is the secondary stage.
Accounting starts where Book-Keeping
ends.
3. Objective The main objective of Book-Keeping Its main objective is to ascertain the net
is to maintain systematic records of results and financial position of the
transactions of financial nature. business and to communicate them to
interested parties.
4. Nature of Job The Book-Keeping function is routine The Accounting function is analytical in
and clerical in nature. nature.
5. Who perform The Book-Keeping function is The Accounting function is performed by
performed by junior staff. senior staff.

6. Knowledge Level It can be performed by persons It is performed by persons having higher

having limited level of knowledge. level of knowledge than that of Book-
Keeper.
7. Analytical Skill The Book-Keeper is not required to The Accountant is required to possess
possess analytical skill. analytical skill.

Basis of Distinction Accounting Accountancy

1. Meaning It is concerned with recording, It is a body of knowledge
classifying and summarizing of prescribing certain rules or
transactions. principles to be observed while
recording, classifying and
summarizing of transactions.
2. Scope It is narrow in scope. Accounting It is much wider in scope and
starts where Book-Keeping ends. includes Book- Keeping as well as
Accounting.
3. Relation It depends on Book – Keeping. It depends both on Book-Keeping
and Accounting.
4. Function Its main function is to ascertain It includes the decision making
the net results and the financial function also on the basis of
position of the business and to information provided by Book-
communicate them to interested Keeping and Accounting.
parties.

Users of Accounting Information

1. Owners – The owners of a firm need accounting information to know the success of the business. In the
case of a company, the owners are interested in evaluating the efficiency of management in the use and
protection of the resources under its control. With this information, the owners can make a decision either to
increase, decrease, or maintain their present investment in the firm.
2. Potential Owners – The potential owners are interested to know how effectively the management has
exercised the leadership function in the past. They are also concerned with the portion of ownership they may
acquire and the expected return on their investment.
3. Creditors – Accounting information is important to both prospective and present creditors. Their decisions
concern the extension of credit as well as the terms of credit arrangement. They must evaluate the likelihood
that the firm will pay its debts when they become due.
4. Managers – The management of a firm makes use of accounting information in assessing the results of
operations, determining the need for capital, evaluating the potential for paying dividends and making
decisions relative to expanding or reducing the size and nature of the business.
5. Employees and Trade Unions – The employees and trade unions use accounting information for wage
expectations and negotiations.
6. Customers – The customers of a firm have a significant interest in whether the business can be expected
to continue operations. An unfavorable financial condition may induce them to look elsewhere for a source of
supply.
7. Governmental units – There are numerous governmental units which make use of accounting
information. The correct assessment of income tax, goods and service tax requires close scrutiny of the
financial statements of a firm especially to detect tax evasion, if any. In order to protect public interest, the
government must also keep a close watch over different business firms to detect profiteering and creation of
monopolies.
8. Others – There are many other users of accounting information. Among these are researchers, financial
analysts and lawyers.

Branches of Accounting
(i) Financial Accounting- Financial Accounting is concerning with recording, classifying and summarizing
financial transactions and preparing statements relating to a business. It shows the amount of profit earned or
loss incurred during a period. It also shows the financial position of a business on a particular date.
(ii) Cost Accounting – Cost Accounting is concerned with classification, analysis and presentation of costs on
the basis of functions, processes, products, centres etc.
It also deals with cost computation, cost saving, cost reduction.
(iii) Management Accounting – Management Accounting is concerned with accounting information that is
useful to management in the discharge of its functions. It helps management at all levels, in policy making,
planning, and controlling the execution of plans, appraising performances and decision- making.

Accounting Cycle
Identification of Financial Transactions and events: This step involves identifying transactions that are
of financial nature. Accounting records only those transactions and events which are of financial nature as they
bring change in the resources of a firm.

Recording: It is the process of writing business transactions of financial nature in the book of original entry,
i.e., Journal. This book is further sub-divided into subsidiary books such as Cash Book (for recording cash
transactions), Purchases Book (for recording credit purchases), and Sales Book (for recording credit sales)

Classifying: It is the process of collecting similar transactions at one place by opening accounts in the ledger
Book. Ledger contains individual account heads under which all financial transactions of similar nature are
collected.

Summarizing: This involves presenting the classified data in a manner which is understandable and useful to
internal as well as external users of accounting statements. This process leads to the preparation of the
following statements:
Trial Balance
Trading and profit and Loss Account
Balance Sheet

Analysis and Interpretation: Financial data is analyzed and interpreted so that the users of financial data
can make a meaningful judgment of the financial performance and financial position of the business.

Communicating: Accounting function involves communicating the financial data, i.e, financial statements to
its users. The accounting information must be provided in time and presented to the users so that decisions
are taken at the appropriate time.