Basic Accounting Terminology

Similar to other subjects, accounting has its own set of terminologies which explains its totality in brief. The accounting terms have their individual meanings and are used for describing its financial nature. Some of its important terminologies are stated here.

1. Accounting Equation

There are 3 important terms which revolve around accounting. These terms are,

• Capital
• Liabilities
• Assets

As three of them are co-related with each other, its combination is termed as accounting equation.

Therefore, the accounting equation stands to be,

Assets = Capital + Liabilities

 

2. Accounting Year

It is also known as a fiscal year and depicts the financial activities for a complete year. For various ledger accounts, different position statements and revenue statements are prepared. Position statement or commonly known as balance sheet resembles a mirror of an accounting book which displays the actual asset and liability value on a specific date. The income or revenue statement displays a company’s net and gross generated income.

If related to any partnership firm or any individual proprietorship about the accounting year, there isn’t any legalized restriction imposed on it. There isn’t any hard and fast rule regarding the beginning of an accounting year to be on the 1^st of every year and completion at 31^st. The decision is entirely dependent on the company. In fact, a company can also make its accounting year from 1^st July to 30^th June of the next year or from 1^st April to 31^st march or between 2 Diwali.

As books of accounts are annually closed, it is essential that the accounting period of a company should definitely be of 12 months.

 

3. Assets

Assets are the things of business value which are owned by any company. It can also be said as business or company properties. These are a company’s economic resources which are conveyed in financial or fiscal term.

There are 7 important assets recognized by a company.

1. Current assets

Known as floating, circulating or fluctuating assets; the values of these assets constantly changes. Current assets include various other resources and cash which are expected to be effectively utilized (bought or sold) during a firm’s normal operating cycle. This is current assets’ definition provided by ICPA (Institute of Certified Public Accountants), USA.

Among the current assets, some of them are prevalent as fixed current asset whose base is solely dependent on its virtue of certain use.

• Building can be counted with property dealers and builders.
• Land will be counted as current assets in the hands of property dealers and land developers.
• Shares and Debentures will be counted with dealers in securities.
• Furniture is counted with furnishers and furniture dealers.
• Plant and Machinery are dependent on dealers of machinery and plant, and their manufacturers.

Current assets can also be stated to those assets whose purchase and sale are meant for regular purpose.

1. Fixed assets

These assets are usually not for sale and are obtained by a company for their long term usage. The best thing about these types of assets is the expenditure on these which are irregular in nature and also helps a company in increasing their capacity of profit earning. Some of the examples of fixed assets are:

• Plant
• Land
• Furniture
• Vehicles
• Building machinery.

1. Fictitious assets

Assets without any physical form are stated as fictitious assets. As these assets do not have a real form, they do not have a real value too. But the presence of these assets and its value are showcased on technical or legal grounds. Also known as deferred revenue expenditure, these assets also disburse income of financial type ina business.

Some of the examples of fictitious assets are:

• Preliminary expenses
• Advertisement Suspense account
• Loss on issue of shares

1. Intangible assets

Apart from being in any specific situation, intangible assets are not bought or sold in open markets. Patents and goodwill are two types of this asset. The purchase of patents is made from noteworthy manufacturers who can be of the same country or of abroad. Patent purchase usually comprises in case of panacea (medicines).

Where patents are for commodities, goodwill is for services. Remuneration of goodwill is made when you buy business of other companies. During certain instances like the retirement or admission of a business partner, goodwill can be raised. Being an intangible asset, it is advised not to record patents and goodwill accounts and refrain it to be put it in balance sheet.

1. Liquid assets

Easy convertibility in cash is referred as liquidity. Those assets which can be converted into cash within a short span of time or during emergencies are known as liquid assets. Some of the examples of liquid assets are:

• Cash at bank
• Cash in hand
• Bills receivable
• Debtors, and much more.

Liquid assets can also be stated as stock less current assets.

Liquid Assets = Current Assets- (Prepaid expenses + Stocks)

1. Tangible assets

Incase of tangible assets, there are 2 views that are followed.

• Traditional view
• Alternate view

Traditional view

Any assets that have a physical presence and can be either touched or seen are called tangible assets. According to this view, types of tangible assets include,

• Building
• Equipment
• Furniture
• Plant
• Stock
• Land

Alternate view

An argument was kept regarding these assets that these should not be classified as assets only on the grounds of physical presence. The argument was kept on the basis that although cash, or its equivalent or any collectibles having monetary value do not have a physical form, still have a value associated with it.

The result of this argument came out as the acceptance of any assets to be a tangible one which can generate income with it. Some of the types of tangible assets through an alternate view are as follows.

• Stock
• Equipment
• Building
• Cash receivable
• Furniture
• Plant
• Items equivalent to cash

These cash equivalent items included commercial papers,treasury bills, money market funds and much more.

1. Wasting assets

There are many assets whose worth degrades as time passes. These types of assets are referred to wasting assets. Some of these assets included in this group are,

• Patents
• Mines
• Assets on lease

 

4. Business transactions

The relation of any economic event with a certain business organization is known as business transactions.

Some of the features of it are as follows:

• Documented proof is a must in these transactions.
• Any financial type of business activity can be efficiently presented in a quantitative form. Quantitative form here describes the monetary factor.
• These transactions affect a company’s equities, assets, expenses and capital revenue.
• One of the foremost features of business transactions that are essential is its financial nature.

A business activity which includes commodities, cash or service exchange between 2 accounts or 2 parties also comes under business transaction. As stated here, a business transaction can be either credit or cash. Income receipts and buying and selling of goods are counted as business transactions.

An accounting activity cannot be related to every business activity, for which reason not every activity details are recorded into the book of accounting. In case of financial accounting, only transactions related to business are recorded there. Recognizing the transaction type is the first step of accounting process.

 

5. Capital

Capital is a section of wealth which a company uses for its further production purposes. It comprises of both fixed assets and current assets. In a business cash at bank, cash in hand, furniture and plant, building and others can be stated as capital.But it is not necessary that capital has to be only in cash.

There are 3 categories in which capital can be divided.

• Floating capital

Assets like investments and stocks when are bought for the purpose of sale is known as floating assets.

• Fixed capital

To obtain a fixed asset, a certain amount is spent. That amount is called fixed capital. The money utilized in these fixed assets is usually unavailable for meeting current equities as these becomes blocked. The amount which is then used to buy those fixed assets is called fixed capital. Some of the common examples of fixed capital are vehicle, furniture, machinery, plant, and building.

• Working capital

The monetary portion available to a company for its everyday financial purpose is termed as working capital.  For day to day business workings, adequate funds are required. In fact, operational expenses of a firm are met with working capital. These funds are utilized for buying commodities, sustaining direct and indirect expenditure and many other aspects of a company.

Working capital constitutes both current equities and current assets.

Assets falling under current equities are,

• Outstanding expenses
• Creditors
• Income received in advance
• Short term loan
• Bills payable

The assets coming under current assets are,

• Stock in hand
• Bills receivable
• Cash in hand
• Debtors
• Cash at bank

It can also be expressed as,

Working Capital = Current Assets – Current Equities

 

6. Creditors

A company has to make credit purchases side by side of cash purchases. Creditors of commodities are those sellers who no doubt are a necessary part of a business and sell their merchandises on credit. Unless a complete payment is not made to them, they continue to be a creditor of a company.The accountability of a creditor gradually decreases when parts of funds are provided to them.

These creditors are also called creditors for expenses. Certain outstanding expenses and services like rent, salaries, and repairs and so on when are not paid throughout the accounting period, will also make these parties creditors.Being current liabilities, a company should have ample assets present to make payment to creditors.

 

7. Cost

Expenses which are involved in obtaining, producing and processing commodities or merchandises so that it could be sellable is known as cost related to commodities.The cost of any merchandise usually includes few factors while obtaining and manufacturing them. Those factors are,

• Direct expenses
• Buying tradable goods
• Raw materials

 

8. Debtors

The parties who buy goods on credit from a company without paying for those commodities are known as debtors. These parties own money to the companies.

If a party buys merchandises worth Rs. 50,000 from a company and pays a certain amount like Rs. 20,000, that party will continue to be a debtor unless it pays the company the full amount. This means that the party will be a debtor of Rs. 30,000.

Apart from being a debt or of commodities, if a company provides service and its payment is not registered, then the beneficiaries or recipients will also be called debtors.

 

9. Drawings

Withdrawn funds or commodities for personal use by proprietors are called drawings. Any amount or assets of a company when used for the domestic purpose can also be stated as drawings. For example, if you use your company car for your personal use, it will also a drawing. In fact, if you buy any private asset with the funds from your company will also be considered as a drawing.

 

10. Equities or Liability

Equities are the debts which are paid by a firm in respect of commodities or money for future purpose. It is basically the claim against assets of a company which owners and debtors have towards it. Creditors or debtors can be categorized based on expenses or goods.

 

 

 

 

 

 

 

To meet current equities, ample current equities are a necessity in a business. In the same way, fixed asset of a decent amount is also required for meeting fixed equity.

The classifications of equities that are depicted are as follows.

1. Owners’ equity

Commonly referred as capital, it is the owners claim against the business assets. If stated in technical term it is also known as shareholder’s funds or liabilities to owners in a general way. It can also be expressed as,

Owner’s or internal equity = capital + reserved earning+ undistributed profit+ gained profit+ shareholders’ funds

Shareholders’ funds= Interest on capital–expenses– drawings.

2. Liability to creditors

It is the claim against assets by the creditors. In here too, the creditors may be for commodities, loans or for expenses.

1. Creditors for expenses

There are some expenditure which remains unpaid in spite of being involved in the accounting period. It is also stated as the current equity or liability of a company. Few of these expenses are,

• Outstanding salaries
• Rents which remains due
• Overdue wages

1. Creditors for loans

Banks, parties, and various other financial organizations are the creditors who come under this category. The equity termed here are,

• World Bank
• Bank loan
• Loan from Industrial Finance Corporation
• Creditors for goods
• Bank overdraft
• Industrial Development Bank of India

3. Creditors for expenses

Goods are required to be purchased by a company on credit. The suppliers who supply these commodities to the companies are known as creditors for commodities.

The division of liabilities can also be categorized into 3 parts.

1. Current liabilities

The liabilities or equities which can be paid within a year are stated as current liabilities.The values of these equities do not remain constant. Some of its examples include outstanding expenses, bills payable,and creditors.

1. Fixed liabilities

The equities that are payable after a long duration are termed as fixed liabilities. Few of it examples include,

• Capital
• Mortgage
• Debentures
• Loans
• Contingent liabilities

Heavily dependent on future events, these liabilities are not considered as real. It is because of their uncertain nature; these equities are termed as contingent liabilities; where contingent means doubtful.

Some of the important examples which come under this category are:

• Values of discounted bills
• Cases unresolved in the court of JAWS
• Guarantees which are promised

You will be unable to find the monetary worth of contingent liabilities at the liabilities section of a company’s balance sheet. This can be found outside or inside of the balance sheet in the form of a note.

Equities are also expressed in the form of long-term and long-term liabilities as well.

1. Short term liabilities

These are the transactions or bonds which are required to be paid within a span of a year. Its type includes overdraft, bills payable, and creditors and so on.

1. Long term liabilities

Equities like debentures and term loans come under long-term liabilities which are payable after a year.

 

11. Expenses

In the process of revenue generation by a company the expenditures or the costing involved in it is known as expenses. Income generation is the main goal of any organization. And to do so, these organizations use their services and their manufactured commodities and sell them. The remittance for these services and merchandises are called expenses.

Finney and Miller defined expenses as the voluntary cost involved on objects and services which help in revenue generation.

According to the accounting terminology, there are also some other fields which come under expenses. Those are:

• Cost of merchandises bought for sale
• Cost of raw material for commodity production
• The amount spent on merchandise distribution and their sales like insurance, rent, advertising and wages.
• Expenses involved in commodity production or obtaining them. Such commodities are like freight, carriage, wages and others.

 

12. Entry

An organized record made for every transaction entry in the book of accounts of a business is called entry. An important principle that is adopted or embraced while recording the entries is “every debit has its own corresponding credit.” According to this principle, with a similar amount in various accounts, the funds are credited and debited.

 

13. Expenditure

Any amount of resources which is of long term nature and is utilized in a business is called expenditure.It is the amount which is used for buying assets whose benefits can be obtained in the future.It is due to expenditure that a company experiences a hike in their profit earning capacity and finally earning a profit in future. A company can obtain assets with the help of correct expenditure. A company can make an expenditure with the help of various methods. The methods include,

• Cash
• Money exchanged for different assets
• Merchandises
• Agreement of payment.

 

14. Final Accounts or Financial Statements

A company composes financial statements to evaluate their assets and income status at the end of their accounting year. These statements are known as final accounts or financial statements. Traditionally known as ‘balance sheet’ and ‘profit and loss account,’these statements are also known as ‘position statement’ and ‘income statement.’

 

15. Goods

Goods are defined as the objects or units which are bought to be sold at a profit or used as raw materials to create other commodities. It can also be stated as the creation of units or commodities in a firm which is an important part of a business. A company who deals with furniture will see it as a commodity, but the same will be seen as an asset by a company who deals with stationary.

16. Gain

Any change in equity (net worth) which can happen because of a commodity’s change in form or place, or due to the assets being held for a long period is known as gain. Gain can be either of revenue nature or of capital nature. Or it can be both. In fact, the record of gain can be either registered or unregistered too.

 

17. Insolvent

Any financially unsound companies who are incapable of meeting their debts or who have been facing losses for many years are termed as insolvent companies. A company cannot itself declare to be insolvent. The authority of declaring a company insolvent lies in the hands of thecourt. If the court finds the running of a firm or an organization to be against public or creditor’s interest, it is that time it declares the firm insolvent.

When a company is finally declared insolvent, for solvency, debts are paid to creditors where money is accumulated by selling the company’s assets. If the required debt mount is found insufficient, then the total amount raised after selling the insolvent company assets are divided proportionately and paid equally amongst the creditors.

 

18. Income

Income is the hike of a company’s net worth which can be due to business activities or because of any other activities. As income is an expansive term, profit also comes under it. It is stated as a company’s positive change in case of wealth over certain time period.

 

19. Losses

The unwelcomed burden forced to be borne by a company is called loss.A certain undesired situation like theft of goods or they getting damaged by fire, storm, accident or flood are counted as aloss as per accounting term. Losses and expenses are different from each other as in case of expenses; the cost is voluntarily involved for income generation whereas losses are forced to be endured by a company.

Losses are classified into 2 types.

• Abnormal losses
• Normal losses

Abnormal losses

These losses highly affect a company’s profit margin. Losses caused due to accidents flood,theft,fire, earthquake, storm, and other unnatural events fallinto this category.Every firm should acquire preventive measures so that they do not have to bear the losses and reduce the loss margin to the lowest level.

Normal losses

These are because of the commodity’s immanent weakness. In this case, the loss is in the form of weight issues, meltage, shortage, leakage, spoilage, evaporation, and wastage when they are transferred. Some of the products are like petrol, coal, ice, oil, clarified butter, etc.

 

20. Purchases

For every company to run their businesses successfully, have to either buy raw materials to produce their units, or they need to invest in finished merchandises which are ready for sale. These attained products are called purchases.

If a certain company buys 2000 pieces of dresses from any firm, it is called purchases. And if a company produces 5000 meters of electrical wires in their own factory and uses in various other electrical appliances, it will also be regarded as purchases.

Buying goods on credit or cash is not an important aspect here as they can be bought either from abroad or may be within the country itself. If taken to the consideration of accounting terminology, purchases of assets are not counted in it. This is because these are not taken into account for sales purpose.
It is very necessary that purchases are made at economical rates. As the cost prices of merchandises are based on it, it is important to make the report in a proper and organized way.

 

21. Purchases return

The portion of purchases of commodities returning to the seller is called purchase returns .It is also known as returns outward because the commodities are returned outside the company or business. Certain criteria like excessive merchandise supply or due to any necessity or because of any defective unit may be the cause of return. Another of the reasons for return excluding commodity issues is because of the suppliers.

Any violation or infringe in case of the order’s terms and condition or its agreement can also effect the return.From chase, purchase return is subtracted so that net purchase can be calculated.

 

22. Profit

Profit is the extra income generated over expenses. It can also be said that when sales of commodities become more than the cost of goods sold,involved in its production is called profit.

Cost of goods sold= net purchases + opening stock (cost of sales) + direct expenses – closing stock

Sales, here, means net sales.

Net sales = sales – sales return

A profit can be only expected by a company if its income is regular and concerns the routine activities.It must associate with the current year of a company as it is the portion of a firm’s revenue receipt. As the profit generation is via business activities, you can see it in the profit and loss account (credit side).

 

23. Proprietor

Risk taking group or any individual in a business is called a proprietor. Also known as investors, the amount spent by them in businesses is called capital. For a successful business, they arrange company capital labor and most important thing, land. Apart from these things, they also pay interest on capital, rent to land, salary to thecompany, and salaries to labor.

After these aspects are seen through, any excess amount left after these investments are considered profit. This profit is the reward for their taken risk in their business. In fact, not just profit, they are responsible for any incurred losses too. They bear the losses if the expenses surpass the income in their business.

It can be simply stated for a proprietor that their capital decreases in case of loss and increases in case profit. In case of a single trade, a proprietor is an individual risk taker. But in a firm, a number of shareholders or partners are called proprietors.

24. Payables

The payments that are required to be paid to outside parties by companies are known as payables. Bill drawn by creditors when are accepted by a company becomes a section of thebillpayables. Parties selling commodities when are bought by a company are called creditors.Displayed at the section of liabilities in the balance sheet, payables are the total of bills payable and creditors.

 

25. Receivables

Bill receivables and debtors in totality are termed as receivables. In simple term, it is what a company receives on their income account from outside parties. Debtors are the purchasers of merchandises which are sold by companies. Some of the debtors become pm of bill receivables when they accept the bill drawn by the companies.Being displayed in the assets section of the balance sheet, receivables are current assets and are discerned within an accounting year.

 

26. Sales Return

The portion of sales of commodities returned to buyers by the purchasers is known as sales returns.For the calculation of net sales,it is subtracted from sales; which is also known as returns inward. Similar to purchases return, the items are returned due to its defectiveness, excessive quantity, or because it was necessary to do so. Breach of terms and conditions of an agreement also causes sales return.

 

27. Solvent

The companies or individuals who are competent of meeting their financial obligations out of their own capital are known as solvents. A solvent company has more than enough assets and funds so that they can fulfill the claims of creditors and proprietors. Solvency ofa company showcases its financial soundness.

 

28. Stock

At a specific date when commodities are available for sale to a company, those commodities are called stocks. As per accounting term, it is also known as opening stocks. Stocks do not have any fixed value. It either increases or decreases or goes on fluctuating. A commodity’s value on its opening day as per the as per the accounting year of a company is known as opening stocks. Similarly, at the end of a company’s accounting year, the stocks are called closing stock.

For instance, there is a certain company who opened their business on 1^st January 2015. They decided to their end of accounting year to be on 31^st December for every year. For them, stocks will not be counted on 1^st January 2015 as they had started their business on that day and hence do not have any stock. At the end of the year, it is seen that they do have stocks worth 1 lac which will be counted as closing stock. The same stock will be counted as opening stock on 1^st January 2016 for the particular year.

The value ofstock is calculated, based on its market price or cost price or whichever is the lowest. The stock of a company in case of production is categorized into 3 parts.

• Stock of raw materials

The essential factor which is required to produce a product in a company is raw materials. This is known as stock of raw materials. In a jute mill, jute is the stock of raw materials.

• Work in progress

The semi-finished part of stock or a commodity which is partly produced is known as work in progress.

• Stock of finished or completed goods

The produced goods which are complete and are ready to be sold is termed as stock of finished or completed goods.

 

29. Sales

Sales termed as a final step for merchandises which is either produced or bought by a firm.Here, both credit sales and cash come under it. When sales are associated with accounting terminology, it usually states sales of commodities and not the sale of assets.

For example, furniture sold by a store dealing with new items of that specific category can refer it as sales. But a stationary store selling old furniture cannot state it as sales.

The sales of an item can be affected either on being exported abroad, or it can also be affected within the country. It is very important to complete the sales record and maintain it properly. This is because a number of sales are related to its profit or loss. Every company should buy commodities at economical rates, selling them at higher rates to make more profit.

30. Vouchers

Vouchers, or in other words can be a receipt, invoice, salaries bill, cash memo, deeds,and wages bill. Being the basis of accounting records, these are the documented proofs which support the accounting transactions of a business. These are the evidence which is considered as valid when brought in front of the court of JAWS. In these vouchers, one can find the date of thetransaction, anamountwhich is paid, payment’s purpose, apayment which is passed by proficient authority, and finally,payment made and canceled in a transaction.

They are considered a major help in accounting as they are utilized for auditing and verifying business records of a company. It is also very useful for uncovering theft and frauds in a company.

 

Links of Previous Main Topic:-

• Book keeping
• Process of book keeping
• Accountancy
• Difference between book keeping and accountancy
• Accounting as science and art
• Objective of book keeping and accountancy
• Advantages of book keeping and accountancy

Links of Next Book-Keeping Topics:-

• Meaning of gaap
• Origin of transaction
• The concept of debit and credit
• Subsidiary books or sub division of journal
• Balancing of ledger accounts
• Meaning of trial balance
• Balance sheet in final accounts without adjustments
• Adjustments additional information in preparation of final accounts
• Meaning of bank reconciliation statements
• Bills of exchange concept of bills of exchange
• Errors affecting or disclosed by trial balance introducing the concept
• Meaning of depreciation