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Basic Accounting Terms You Should Know
Below are some of the common accounting and bookkeeping terms you’ll generally come across as a business owner:
Revenue or income: Money your business earns from the sale of goods or services or other business activities.
Expenses or expenditures: Costs you incur to generate revenue, including rent, labor costs, and office supplies.
Accounts payable: Any money your business owes. This could be an amount you owe to a lender, creditor, vendor, freelancer, etc. Accounts payable are categorized as ‘liabilities’ on your balance sheet because they’re a form of debt owed by your company.
Accounts receivable: Money owed to your business for goods or services by customers, clients, and anyone you do business with. These are recorded as ‘assets’ on a balance sheet.
Assets: Liquid and non-liquid assets owned by your business, like land, equipment, accounts receivable, stocks, and patents.
Liabilities: Debts and obligations owed by your business, like business loans, accounts payable, income taxes, and mortgage payments.
Equity: The value remaining when you subtract liabilities from assets. This amount represents ownership in the business.
General ledger: The complete record of all business transactions, like sales, expenses, and credit. Used to generate financial statements.
Chart of accounts: Lists your different accounts and transaction categories, like income, expenditures, assets, and liabilities.
Journal entry: Accountants and bookkeepers make journal entries to update the general ledger. Each entry has a unique reference number, transaction date, debit or credit amount, and description.
Trial balance: An accounting report that lists the balance for all accounts in the general ledger, labeled as a debit or credit. Used to check for mathematical errors.
What is job order costing?
Job order costing is a costing approach for determining the cost of producing each product. This method of costing is commonly used when a manufacturer creates a number of goods that are distinct from one another and has to calculate the cost of performing a single operation. The direct labor, direct materials, and manufacturing overhead for that particular project are all included in the job costing.
What is process costing?
When there is a large production of comparable products and the costs associated with individual units of output cannot be distinguished from one another, process costing is utilized. To put it another way, each product's cost is presumed to be the same as every other product's cost. Costs are accumulated over a set period of time, summarized, and then uniformly distributed to all units produced during that period. Job costing is used to gather costs and assign them to items when products are manufactured on an individual basis.
What are conversion costs?
The costs of converting raw resources into finished goods are known as conversion costs. In cost accounting, the notion is used to calculate the value of ending inventory, which is then reported in financial statements. It can also be used to figure out how much it costs to make a product incrementally, which can help with pricing. Because conversion procedures need manpower and manufacturing expenses, conversion costs are calculated as follows:
Direct labor + manufacturing overhead = conversion costs
What is the economic entity assumption?
The economic entity assumption is an accounting principle that states that all transactional data associated with a specific entity is assumed to be clearly attributed to the entity, and does not include other transactional data associated with the entity’s owners or business partners. While this assumption applies to all varieties of businesses, it most notably applies to sole proprietorships, for which the transactional records are maintained by the entity’s owners.
What is a monetary unit assumption?
The monetary unit concept assumes that money is used as a unit of measurement and that any transactions or economic events recorded in a business's records can be described and measured in monetary terms.
What is owner’s equity?
Owner’s equity is essentially the owner’s rights to the assets of the business. It’s what’s leftover for the owner after you’ve subtracted all the liabilities from the assets.
If you look at your company’s balance sheet, it follows a basic accounting equation:
Assets – Liabilities = Owner’s Equity
The term “owner’s equity” is typically used for a sole proprietorship. It may also be known as shareholder’s equity or stockholder’s equity if the business is structured as an LLC or a corporation.
Who uses a double-entry accounting system?
Public companies must use the double-entry bookkeeping system by law. The Financial Accounting Standards Board (FASB), a non-governmental body, decides on the generally accepted accounting principles (GAAP). Public companies have to follow any rules and methods outlined by GAAP.
Small businesses with more than one employee or looking to apply for a loan should also use double-entry bookkeeping. This system is a more accurate and complete way to keep track of the financial situation of a company and how fast it’s growing.
What is conservatism?
Accounting conservatism is a set of bookkeeping guidelines that call for a high degree of verification before a company can make a legal claim to any profit. The general concept is to factor in the worst-case scenario of a firm’s financial future. Uncertain liabilities are to be recognized as soon as they are discovered. In contrast, revenues can only be recorded when they are assured of being received.
What is the accounting equation that is the basis for the double entry accounting system?
The accounting equation is a basic principle of accounting and a fundamental element of the balance sheet.
The equation is as follows:
Assets = Liabilities + Shareholder’s Equity
This equation sets the foundation of double-entry accounting and highlights the structure of the balance sheet. Double-entry accounting is a system where every transaction affects both sides of the accounting equation. For every change to an asset account, there must be an equal change to a related liability or shareholder’s equity account. It is important to keep the accounting equation in mind when performing journal entries.
The balance sheet is broken down into three major sections and their various underlying items: Assets, Liabilities, and Shareholder’s Equity.
What does a business general ledger show?
The general ledger is a master accounting document providing a complete record of all the financial transactions of your business. It helps you look at the bigger picture. Accounts include assets (fixed and current), liabilities, revenues, expenses, gains, and losses.
What is the optimal capital structure for a retail bank?
The optimal capital structure is estimated by calculating the mix of debt and equity that minimizes the weighted average cost of capital (WACC) of a company while maximizing its market value. The lower the cost of capital, the greater the present value of the firm’s future cash flows, discounted by the WACC. Thus, the chief goal of any corporate finance department should be to find the optimal capital structure that will result in the lowest WACC and the maximum value of the company (shareholder wealth).
What is the current role of internet banking in society?
The fundamental move toward user involvement in financial service provision through technology, particularly the internet, has enabled financial institutions to lower costs while also allowing clients to use the service at any time and from nearly anywhere with an internet connection. Customer evaluation of electronic services is influenced by attributions of success and failure in interpersonal service scenarios, according to theorists (Walfried et al., 2005).
Electronic banking has eliminated the need for banking professionals to facilitate transactions, placing greater obligations on clients to use the service. Although the usage of E-banking is for the advantage of customers, these developments necessitate more labor or participation on the side of customers. These and other variables may be seen as a lower level of customer service. These assumptions, on the other hand, are incorrect if the client understands the value of using the electronic service.
What is a simple journal entry?
A simple journal entry is an accounting entry in which just one account is debited and one is credited. The use of simple journal entries is encouraged as a best practice since it is easier to understand these entries. The best possible approach to their use is to thoroughly document the reasons for each entry, and store this backup information along with a copy of the entry. Simply journal entries are commonly used for minor transactions, such as to record a purchase, a sale, or a refund.
What is a compound journal entry?
A compound journal entry is an accounting entry in which there is more than one debit, more than one credit, or more than one of both debits and credits. It is essentially a combination of several simple journal entries; they are combined for either of these reasons:
It is more efficient from a bookkeeping perspective to aggregate the underlying business transactions into a single entry.
Examples of aggregation that may involve compound journal entries are:
Depreciation for multiple classes of fixed assets
Accruals for multiple supplier deliveries at month-end for which no invoices have yet been received
Accruals for the unpaid wages of multiple employees at month-end
All of the debits and credits relate to a single accounting event.
Examples of accounting events that frequently involve compound journal entries are:
Record all payments and deductions related to a payroll
Record the account receivable and sales taxes related to a customer invoice
Record multiple line items in a supplier invoice that relate to different expenses
Record all bank deductions related to a bank reconciliation
An example of a compound journal entry is a payroll entry, where there is a debit to salaries expense, another debit to payroll taxes expense, and credits to cash, and a variety of deduction accounts.
What is depreciation expense?
Depreciation is the process of deducting the total cost of something expensive you bought for your business. But instead of doing it all in one tax year, you write off parts of it over time. When you depreciate assets, you can plan how much money is written off each year, giving you more control over your finances.
The number of years over which you depreciate something is determined by its useful life (e.g., a laptop is useful for about five years). For tax depreciation, different assets are sorted into different classes, and each class has its own useful life. If your business uses a different method of depreciation for your financial statements, you can decide on the asset’s useful life based on how long you expect to use the asset in your business.
For example, the IRS might require that a piece of computer equipment be depreciated for five years, but if you know it will be useless in three years, you can depreciate the equipment over a shorter time.
How are prepaid expenses adjusted on the general ledger?
A prepaid expense is a prepayment paid by a company for expenses it will incur overtime in the future. A prepaid expense serves as an asset that a company can use or consume to cover future expenses. Thus, a company records a prepaid expense as an asset at the time of the cash transaction, rather than an expense until actually incurred later. At the end of an accounting period, depending on the amount of prepaid expense that has been consumed, a company records an adjusted debit entry for the expense incurred as of the period end and an adjusted credit entry to reduce the amount of prepaid expense to reflect the net asset amount.
What are the limitations in forensic accounting today?
Forensic accounting is a method in which an auditor develops an objective hypothesis that the company has been the victim of fraud or theft, and then collects evidence to support the hypothesis in such a way that the crime and criminal are proven.
Advantages - When there is no proper eye witness, documentary proof, or property evidence to show the crime and criminal, forensic accounting can assist us in obtaining justice.
Disadvantages - It can be prejudiced, and hence the evidence might be contested if the Forensic Accountant cannot demonstrate "Objectivity and Independence."
Limitation - A term used to describe procedures and controls that are aimed at preventing fraud and misappropriation, as well as proving criminal activity. As a result, the hypothesis must be supported by evidence; otherwise, the exercise would fail.
All taxpayers have a set of fundamental rights they should be aware of when dealing with the IRS. Explore your rights and our obligations to protect them.
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