BASIC ACCOUNTING CONCEPTS AND TERMS

What are the Golden Rules of Accounting?

Type Debit Credit

Personal The receiver The giver
Real What comes in What goes out
Nominal All expenses and losses All income and gains (profits)

In the Modern Approach, The accounts are classified into 5 categories:

 Assets Account
 Liabilities Account
 Capital Account
 Revenue Account
 Expense Account

Apart from the Traditional Approach of Accounting, the effect of Increase & Decrease of the
above mentioned accounts also play a vital role in understanding & passing the Journal
entry.

Type of Account Account to be Account to be

Debited credited

Assets A/c INCREASE DECREASE

Liabilities A/c DECREASE INCREASE
Capital A/c DECREASE INCREASE
Revenue A/c DECREASE INCREASE
Expense A/c INCREASE DECREASE

Basic accounting terms to remember

Accounting - process of identifying, measuring, and reporting financial information
of an entity

Accounting Equation - assets = liabilities + equity

Accounts Payable - money owed to creditors, vendors, etc.

Accounts Receivable - money owed to a business, i.e. credit sales

Accrual Accounting - a method in which income is recorded when it is earned and
expenses are recorded when they are incurred, all independent of cash flow

Accruals - a list of expenses that have been incurred and expensed, but not paid or a
list of sales that have been completed, but not yet billed

Amortization - gradual reduction of amounts in an account over time, either assets or

liabilities

Asset - property with a cash value that is owned by a business or individual

Audit Trail - a record of every transaction, when it was done, by whom and where,
used by auditors when validating the financial statement

Auditors - third party accountants who review an entity’s financial statements for
accuracy and provide a statement to that effect.

Balance Sheet - summary of a company's financial status, including assets, liabilities,

and equity

Bookkeeping - recording financial information

Budgeting - the process of assigning forecasted income and expenses to accounts,

which amounts will be compared to actual income and expense for analysis of
variances

Capital Stock - found in the equity portion of the balance sheet describing the
number of shares sold to shareholders at a predetermined value per share, also called
“common stock” or “preferred stock”

Capital Surplus - found in the equity portion of the balance sheet accounting for the
amount shareholders paid that is greater or lesser than the “capital stock” amount

Capitalized Expense - expenses that are accumulated, not expensed as incurred, to be

amortized over a period of time; i.e. the development cost of a new product

Chart of Accounts - a listing of a company's accounts and their corresponding

numbers

Cash-Basis Accounting - a method in which income and expenses are recorded when
they are paid.
Cash Flow - a summary of cash received and disbursed showing the beginning and
ending amounts

Closing the Books/Year End Closing - the process of reversing the income and
expense for a fiscal or calendar year and netting the amount into “retained earnings”

Cost Accounting - a type of accounting that focuses on recording, defining, and

reporting costs associated with specific operating functions

Cost of Goods Sold - expenses incurred in producing inventory; this may include
materials, labors, storage costs, depreciation, and overhead.

Credit - an account entry with a negative value for assets, and positive value for
liabilities and equity.

Debit - an account entry with a positive value for assets, and negative value for
liabilities and equity.

Departmental Accounting - separating operating divisions into their own sub entities
on the income statement, showing individual income, expenses, and net profit by
entity

Depreciation - recognizing the decrease in the value of an asset due to age and use

Dividends - amounts paid to shareholders out of current or retained earnings

Double-Entry Bookkeeping - system of accounting in which every transaction has a

corresponding positive and negative entry (debits and credits)

Equity - money owed to the owner or owners of a company, also known as "owner's
equity"

Financial Accounting - accounting focused on reporting an entity's activities to an

external party; ie: shareholders

Financial Statement - a record containing the balance sheet and the income statement

Fixed Asset - long-term tangible property; building, land, computers, etc.

General Ledger - a record of all financial transactions within an entity

Goodwill - an intangible asset reflecting the value of an entity in excess of its tangible
assets
Income Statement - a summary of income and expenses

nventory - merchandise purchased for resale at a profit

Inventory Valuation - the method to set the book value of unsold inventory: i.e.
“LIFO,” last in, first out; “FIFO,” first in, first out; “average,” an average cost over a
given period, “last cost,” the cost based on the last purchase; “standard,” a “deemed”
amount related to but not tied to a specific purchase, “serialized,” based on a uniquely
identifiable serial number or character of each inventory item

Invoice - the original billing from the seller to the buyer, outlining what was
purchased and the terms of sale, payment, etc.

Job Costing - system of tracking costs associated with a job or project (labor,
equipment, etc) and comparing with forecasted costs

Journal - a record where transactions are recorded, also known as an "account"

Liability - money owed to creditors, vendors, etc

Liquid Asset - cash or other property that can be easily converted to cash

Loan - money borrowed from a lender and usually repaid with interest

Master Account - an account on the general ledger that subtotals the “subsidiary
accounts” assigned to it; i.e. Cash might be the master account for a list of depository
accounts at banks

Net Income - money remaining after all expenses and taxes have been paid

Non Cash Expense - recognizing the decrease in the value of an asset; i.e.
depreciation and amortization

Non-operating Income - income generated from non-recurring transactions; ie: sale

of an old building

Note - a written agreement to repay borrowed money; sometimes used in place of

"loan"

Operating Expense (opex) - money used in the process of selling inventory (as
opposed to developing inventory)

Operating Income - income generated from regular business operations

Other Income - income generated from other than regular business operations, i.e.
interest, rents, etc.

Payroll - a list of employees and their wages

Posting - the process of entering then permanently saving or “archiving” accounting

data

Profit - see "net income"

Profit/Loss Statement - see "income statement"

Reconciliation - the process of matching one set of data to another; i.e. the bank
statement to the check register, the accounts payable journal to the general ledger, etc.

Retained Earnings - the amount of net profit retained and not paid out to
shareholders over the life of the business

Revenue - total income before expenses.

Shareholder Equity - the capital and retained earnings in an entity attributed to the
shareholders

Single-Entry Bookkeeping - system of accounting in which transactions are entered

into one account

Statement of Account - a summary of amounts owed to a vendor, lender, etc.

Subsidiary Accounts - the subaccounts that are totaled on the financial statement
under “master accounts;” i.e. “Cash-ABC Bank” might be one of several subsidiary
accounts that are subtotaled under “Cash”

Supplies - assets purchased to be consumed by the entity

Treasury Stock - shares purchased by the entity from shareholders, reducing

shareholder equity

Write-down/Write-off - an accounting entry that reduces the value of an asset due to

an impairment of that asset; i.e. the account receivable from the bankrupt customer
Basic accounting terms to remember
Check out these basic accounting terms and start to commit them to memory. That way, when you start
your degree journey, you’ll already feel like you’re a step ahead and speaking the language.
1. Accounts receivable (AR)
Definition: The amount of money owed by customers or clients to a business after goods or services have
been delivered and/or used.

2. Accounting (ACCG)
Definition: A systematic way of recording and reporting financial transactions for a business or
organization.

3. Accounts payable (AP)

Definition: The amount of money a company owes creditors (suppliers, etc.) in return for goods and/or
services they have delivered.

4. Assets (fixed and current) (FA, CA)

Definition: Current assets are those that will be converted to cash within one year. Typically, this could be
cash, inventory or accounts receivable. Fixed assets are long-term and will likely provide benefits to a
company for more than one year, such as a real estate, land or major machinery.

5. Asset classes
Definition: An asset class is a group of securities that behaves similarly in the marketplace. The three
main asset classes are equities or stocks, fixed income or bonds, and cash equivalents or money market
instruments.

6. Balance sheet (BS)

Definition: A financial report that summarizes a company's assets (what it owns), liabilities (what it owes)
and owner or shareholder equity at a given time.

7. Capital (CAP)
Definition: A financial asset or the value of a financial asset, such as cash or goods. Working capital is
calculated by taking your current assets subtracted from current liabilities—basically the money or assets
an organization can put to work.

8. Cash flow (CF)

Definition: The revenue or expense expected to be generated through business activities (sales,
manufacturing, etc.) over a period of time.

9. Certified public accountant (CPA)

Definition: A designation given to an accountant who has passed a standardized CPA exam and met
government-mandated work experience and educational requirements to become a CPA.

10. Cost of goods sold (COGS)

Definition: The direct expenses related to producing the goods sold by a business. The formula for
calculating this will depend on what is being produced, but as an example this may include the cost of the
raw materials (parts) and the amount of employee labor used in production.

11. Credit (CR)

Definition: An accounting entry that may either decrease assets or increase liabilities and equity on the
company's balance sheet, depending on the transaction. When using the double-entry accounting
method there will be two recorded entries for every transaction: A credit and a debit.

12. Debit (DR)

Definition: An accounting entry where there is either an increase in assets or a decrease in liabilities on a
company's balance sheet.

13. Diversification
Definition: The process of allocating or spreading capital investments into varied assets to avoid over-
exposure to risk.

14. Enrolled agent (EA)

Definition: A tax professional who represents taxpayers in matters where they are dealing with the
Internal Revenue Service (IRS).

15. Expenses (fixed, variable, accrued, operation) (FE, VE, AE, OE)
Definition: The fixed, variable, accrued or day-to-day costs that a business may incur through its
operations.
 Fixed expenses: payments like rent that will happen in a regularly scheduled cadence.
 Variable expenses: expenses, like labor costs, that may change in a given time period.
 Accrued expense: an incurred expense that hasn’t been paid yet.
 Operation expenses: business expenditures not directly associated with the production of goods or services—
for example, advertising costs, property taxes or insurance expenditures.

16. Equity and owner's equity (OE)

Definition: In the most general sense, equity is assets minus liabilities. An owner’s equity is typically
explained in terms of the percentage of stock a person has ownership interest in the company. The
owners of the stock are known as shareholders.

17. Insolvency
Definition: A state where an individual or organization can no longer meet financial obligations with
lender(s) when their debts come due.

18. Generally accepted accounting principles (GAAP)

Definition: A set of rules and guidelines developed by the accounting industry for companies to follow when
reporting financial data. Following these rules is especially critical for all publicly traded companies.

19. General ledger (GL)

Definition: A complete record of the financial transactions over the life of a company.

20. Trial balance

Definition: A business document in which all ledgers are compiled into debit and credit columns in order
to ensure a company’s bookkeeping system is mathematically correct.

21. Liabilities (current and long-term) (CL, LTL)

Definition: A company's debts or financial obligations incurred during business operations. Current
liabilities are those debts that are payable within a year, such as a debt to suppliers. Long-term liabilities
are typically payable over a period of time greater than one year. An example of a long-term liability would
be a multi-year mortgage for office space.

22. Limited liability company (LLC)

Definition: An LLC is a corporate structure where members cannot be held accountable for the company’s
debts or liabilities. This can shield business owners from losing their entire life savings if, for example,
someone were to sue the company.

23. Net income (NI)

Definition: A company's total earnings, also called net profit. Net income is calculated by subtracting total
expenses from total revenues.

24. Present value (PV)

Definition: The current value of a future sum of money based on a specific rate of return. Present value
helps us understand how receiving $100 now is worth more than receiving $100 a year from now, as
money in hand now has the ability to be invested at a higher rate of return. See an example of the time
value of money here.

25. Profit and loss statement (P&L)

Definition: A financial statement that is used to summarize a company’s performance and financial
position by reviewing revenues, costs and expenses during a specific period of time, such as quarterly or
annually.

26. Return on investment (ROI)

Definition: A measure used to evaluate the financial performance relative to the amount of money that
was invested. The ROI is calculated by dividing the net profit by the cost of the investment. The result is
often expressed as a percentage. See an example here.

27. Individual retirement account (IRA, Roth IRA)

Definition: IRAs are savings vehicles for retirement. A traditional IRA allows individuals to direct pre-tax
dollars toward investments that can grow tax-deferred, meaning no capital gains or dividend income is
taxed until it is withdrawn, and, in most cases, it’s tax deductible. Roth IRAs are not tax-deductible;
however, eligible distributions are tax-free, so as the money grows, it is not subject to taxes upon with-
drawls.

28. 401K & Roth 401K

Definition: A 401K is a savings vehicle that allows an employee to defer some of their compensation into
an investment-based retirement account. The deferred money is usually not subject to tax until it is
withdrawn; however, an employee with a Roth 401K can make contributions after taxes. Additionally,
some employers chose to match the contributions made by their employees up to a certain percentage.

29. Subchapter S corporation (S-CORP)

Definition: A form of corporation (that meets specific IRS requirements) and has the benefit of being taxed
as a partnership versus being subject to the “double taxation” of dividends with public companies.

30. Bonds and coupons (B&C)

Definition: A bond is a form of debt investment and is considered a fixed income security. An investor,
whether an individual, company, municipality or government, loans money to an entity with the promise of
receiving their money back plus interest. The “coupon” is the annual interest rate paid on a bond.

1. Assets
Assets are the wealth that has been accumulated by the business and is owned outright
without lien or loan. It may be items that depreciate over time, or goods that are sold to
customers. This may include cash and investments, buildings and property, accounts
receivable, warehouse inventory, equipment and supplies.

2. Balance sheet
The balance sheet is an important aspect of business. It records the basic accounting
formula of assets = liabilities + stockholder equity / capital at a certain point in time,
either monthly, quarterly or yearly. From the balance sheet the financial health of the
business can be ascertained.

3. General ledger
The general ledger is the side of the bookkeeping ledger that contains the balance
sheet and the income statement accounts. Here all business transactions are recorded,
including sales, credit purchases, office expenses and income losses.

4. Gross margin
Gross margin or profit is the total number of sales that have been made, subtracted by
the associated costs, such as manufacturing costs, wholesales costs, material, and
supplies.

5. Loss
When a service or product sells for less than what it cost to supply or manufacture it, or
when expenses have exceeded revenues of a particular asset, it's called a loss.

6. On credit/On account
On credit or on account means that products or services have been sold with the use of
credit. Payment has not immediately been provided for these items, and there may be
terms on account that may result in interest charges.

7. Receipts
Receipts is the total amount of cash collected in business transactions over the course
of one day. It does not include other revenue collected.

8. Revenue
Income and revenue are interchangeable, compromising the total amount of all income
collected at one point in time. It may include cash sales, credit purchases, subscription
fees and interest income. It differs from receipts, as it can include monies that are not
collected at the delivery time.

9. Trade discount
A trade discount is a percentage discounted from the purchase price, and is based on
the volume of goods ordered at one point in time. Higher discounts may be applicable to
larger orders, with smaller discounts for lesser orders.
10. Trial balance
The trial balance is recorded in the general ledger, and includes both debits and credits
for one particular account. The sheet must balance, with debits equaling credits.

Sales or Revenue
Revenue is the income that flows into an organization, and it is often used almost synonymously with
sales. In government and nonprofit organizations it includes taxes and grants.
Don't confuse revenues with receipts. Under the accrual basis of accounting, revenues are shown
in the period they are earned, not in the period when the cash is collected. Revenues occur when
money is earned; receipts occur when cash is received.

Cost of Goods Sold

This is the purchase cost of the merchandise that was subsequently sold to customers.

Expenses
Refers to the other costs that are not matched with sales as part of the cost of goods sold. They may
be matched with a specific time, usually monthly, quarterly, or annually or they may also be one-off
payments. Expenses include: staff wages, rent, utility bills, insurance, equipment, etc.

Gross Profit
Refers to what is left after you subtract the cost of goods sold from the sales. It is also called gross
margin. For example, if an organization buys in an item for $50 and sells it for $75 (plus sales tax),
then the gross profit will be $25.

Fixed Assets
This refers to all of those things that the business owns which will have a value to the business over
a long period. This is usually understood to be any time longer than one year. It includes freehold
property, plant, machinery, computers, motor vehicles, and so on.
Current Assets
This refers to assets with the value available entirely in the short term. This is usually understood to
be a period of less than a year. This is either because they are what the business sells or because
they are money or can quickly be turned into money. Examples of assets include inventory/stock,
money owing by customers, money in the bank, or other short-term investments.

Current Liabilities
This refers to those things that the business could be called upon to pay in the short term - within the
year. Examples include bank overdrafts and money owing to suppliers.
Working Capital
This is the difference between current assets and current liabilities. An organization without sufficient
working capital cannot pay its debts as they fall due. In this situation it may have to stop trading even
if it is profitable.

Liquidity
This is the ability to meet current obligations with cash or other assets that can be quickly converted
into cash in order to pay bills as they become due. In other words the organization has enough cash
or assets that will become cash so that it is able to write checks without running out of money.

Debtor
A debtor is a person owing money to the business, for example a customer for goods delivered.

Creditor
A creditor is a person to whom the business owes money, for example a supplier, landlord, or utility
organization.

Bad Debt
All reasonable means to collect a debt have been tried and have failed so the amount owed is
written off as a loss and becomes categorized as an expense on an income statement. This results
in net income being reduced.

Depreciation
Assets have a certain length of time in which they operate efficiently, referred to as 'an asset's useful
life.' During this period the value of that asset depreciates due to age, wear and tear, or
obsolescence. The loss in value is recorded in accounts as a non-cash expense, which reduces
earnings whilst raising cash flow.

Accrual Accounting
Accrual accounting relies on two principles, which have already been alluded to:
The revenue recognition principle states that revenues are recognized when they are realized or
realizable, and are earned (usually when goods are transferred or services rendered), no matter
when the payment is received.
The matching principle states that expenses are recognized when goods are transferred or
services rendered, and offset against recognized revenues, which were generated from those
expenses, no matter when the cash is paid out.