Must Know Basic Accounting Terms

Basic accounting terms include "Assets," representing resources owned by a business; "Liabilities," which are the company's debts and obligations; "Equity," indicating the owner's interest in the business; "Revenue," the income generated from business activities; and "Expenses," the costs incurred in generating revenue. Understanding these terms is fundamental to grasping a company's financial health and operations. Let's understand!

Do you know which are the first things investors look for when investing in a business? It is their “accounts.” Accounting provides stakeholders with the relevant and required economic information. 

Here we have covered significant concepts and basic accounting terms required to understand accounting completely. Let’s start our discussion with the accounting definition.

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Accounting

Accounting involves identifying, measuring, and communicating economic information so users can make informed decisions.

Now let’s learn some basic accounting terms.

1. Accounting Period

An accounting period defines the time covered by an operation or financial statement. Common accounting periods include calendar years, fiscal years, and three-month calendar quarters. Some companies also use monthly periods. An accounting period encompasses one entire accounting cycle. An accounting cycle is an eight-step system accountants utilise to track transactions during a particular period.

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2. Assets

Assets are economic resources controlled that a business owns or controls. It can be categorized based on duration, i.e., Current Assets and Fixed Assets.

Current assets are short-term resources of the company. Within a tenure of one year, they are anticipated to be converted into cash or cash and equivalent, account receivables, inventory, other prepaid expenses, etc.

Fixed assets or non-current assets are for the long term, such as machinery, plants, land, buildings, etc.

3. Liabilities 

Liabilities refer to the debts owed by businesses to third parties. Debentures (bonds), unpaid expenses, loans, and creditors, are examples of liabilities. They can be current or non-current, and as per their classification, they are grouped into balance sheets and other accounts. 

• For example- A current liability must be paid back within a year,
• An organization might take out a 15-year mortgage as an example of a non-current liability.

4. Account Payable

When a company purchases goods on credit that need to be paid in a short period, refers to Accounts Payable. It is a liability and comes under the head’s current liabilities. Accounts Payable is a short-term debt payment that needs to be paid to avoid default.

5. Account Receivable

The money the business will receive from clients who have used credit to buy its goods and services is known as Accounts Receivable (AR). In rare situations, the credit term is often brief, ranging from a few days to several months or even an entire year.

6. Capital

Capital is the amount invested in the business by the owner in cash, kind, or any other asset. It is also known as owner equity. Change in capital or owners’ equity occurs when: (i) owners either invest in or withdraw cash or other assets from the business and (ii) the business either earns income from a profitable operation or incurs losses from unprofitable operations.

7. Balance Sheet

A balance sheet is a financial statement that lists the company’s assets and liabilities as of a particular date. It resembles a snapshot of a firm’s debts and assets, including any loans or equity it may have. Accountants can create balance sheets in various formats, including classified, common size, comparative, and vertical balance sheets. Each format displays data as a series of line items that, when combined, reveal the company’s financial situation.

8. Debit (Dr)

A debit is an accounting entry in a company’s balance sheet or other accounts that records either an increase in assets or a decrease in liabilities.

9. Credit (Cr)

An accounting entry that, depending on the transaction, could either raise liabilities and equity or decrease assets on the company’s balance sheet. 

10. Working Capital

Working capital is the funding you have to take care of your immediate, short-term requirements. Calculate your present levels, predict your future needs, and think about ways to make sure you always have sufficient cash on hand if you want to ensure your working capital is working for you.

Working Capital = Current Assets- Current Liabilities

11. Retained earnings

After a company has covered all of its expenses for a specific accounting period, the profits are known as retained earnings (or surplus earnings ). It comprises all direct and indirect costs, including tax obligations, dividend payments, and goods sold. Retained earnings (RE), when they are positive, boost the company’s equity. This stock could be invested back into the company to support future expansion.

12. Accruals

Accruals are revenues and expenses that a company recognizes but still needs to record in its financial statements (ACCR). By definition, accruals take place before a currency exchange completes the transaction.

Imagine a business engaged a third-party consultant and recorded the fee in its accruals. The consultant would record this expense regardless of whether it sent an invoice to the company.Accounts payable and receivable are examples of accrual types. Others include accrued and accrued expenses, which are incurred but not yet paid for a specific accounting period.

13. Income Statement:

The company’s revenues, costs, and profit for a given accounting year are displayed on the income statement, also known as the income and expenditure or profit and loss accounts. It thoroughly describes a company’s profitability during that specific accounting year.

Profit or Loss = Revenue – Expenses

14. Cost of Goods Sold

The term “cost of goods sold” (COGS) refers to all expenses a business has to pay when producing an item or to offer a service. Materials, labor, and overhead are the three cost types involved with products. Costs associated with services include equipment, supplies, and staff remuneration. “Cost of sales” is an alternate term occasionally used by accountants. Accountants use the following fundamental formula to determine COGS throughout a specific accounting period: Ending inventory minus initial inventory plus purchases.

15. Generally Accepted Accounting Principles (GAAP)

 GAAP is an accounting principle that has a collection of regulations and best practices created by the accounting profession for businesses to adhere to when reporting financial data. All publicly traded organizations need to abide by these regulations.

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16. Depreciation

Depriciation is the decline in the value of business assets such as plant and machinery over time due to use or obsolescence.

Usually, there are three methods of depreciation that are followed in India.

• Straight line method
• Diminishing value method
• Unit of production method

17. Income Statement (Profit and Loss)

The financial statement that displays the revenues, costs, and profits for a specific period is the income statement (sometimes known as a profit and loss or P&L). The top of the report displays the revenue collected, and various expenditures (expenses) are deducted from it until all costs are included; the outcome is net income.

18. Cash Flow Statement

The word “cash flow” refers to the inflow and outflow of cash in a firm. One can calculate the Net Cash Flow for a certain period by subtracting the Beginning Cash Balance and subtracting the Ending Cash Balance. A positive figure shows that more money flowed into the company than leaving it, while a negative number shows the opposite.

19. Dual Aspect Concept

It states that every transaction or event has two aspects. The impact of a transaction is such that the accounting equation:

Assets= Liabilities + Owners’ Capital always holds.

20. Entity Concept

As a concept, it separates the business affairs of the owners from their personal affairs. It states that the business and owner of the business are two separate entities.  

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Conclusion

You must know the basic accounting terms to understand accounts. Here we have covered almost every basic definition and meaning that a novice interested in accounting must know.