Basic Accounting Terms
In this article we will discuss some basic accounting terms which are very important and plays a vital role in learning accountancy.
Business is an economic activity involved in the production, purchase, sales, transfer, and exchange of goods and services on regular basis undertaken with the motive of earning profit with an element of Risk by satisfying human needs in the society. A business should be Lawful. Every business requires some investment in cash or kind or both.
Capital is the amount invested by the proprietors or owner in the business. It may be brought in the form of money or assets having monetary value. * Capital increases with the amount of additional capital introduced and the amount of profit earned.
- It is decreased by the amount of losses incurred by the business and the amount withdrawn by proprietors for his personal use.
- Capital=Assets-Liabilities (Capital is excess of assets over outside liabilities).
- Capital is also known as Owner’s Equity or Proprietors Fund.
- For example, if Mr. X starts a business with ₹6,00,000, his capital would be ₹6,00,000.
- For example, if Mr. X starts business with cash ₹5,00,000, and Goods ₹ 2,00,000 his capital would be ₹5,00,000+₹2,00,000= ₹7,00,000.
- For example, if Mr. X starts business with cash ₹5,00,000, and Goods ₹ 2,00,000 and machinery ₹2,50,000 his capital would be ₹5,00,000+₹2,00,000+₹2,50,000 = ₹9,50,000.
- For example, if Assets ₹15,00,000 and liabilities ₹6,00,000 amount of capital would be: – Capital=Assets-Liabilities Capital=₹15,00,000-₹6,00,000 Capital= ₹9,00,000.
3. Business Transactions-
Business Transaction is an economic activity that affects the financial position (Change in the values of assets, liabilities, and capital) of the business can be measured in terms of money. Business Transactions are those activities of a business, which involve the transfer of money or goods or services between two or more persons. Examples of Business Transactions-
- Purchase of Goods
- Purchase of Furniture
- Sale of goods
- Business started for cash
- Purchase of Machinery
- Borrowing from bank
- The lending of money
- Salaries paid to Employee
- Rent paid to a landlord
- Commission received
- Dividend received
- Cash paid to Mohit
- Cash received from Rachit
- Withdrawn of Cash from the business by the owner for his personal use.
Features of Transaction-
- It involves an economic activity.
- It results in a change in the financial position of the business enterprise.
- Transactions may be classified into two types- a.External Transaction- Transaction between the business entity and another party, like goods sold on credit to Dinesh. b.Internal transaction-Transaction within the same business entity like Depreciation charged on Furniture.
- There are two types of transactions – cash and credit.
- A Transaction has two aspects. (Debit and Credit)
- It involves an exchange of goods and services for money consideration.
There are two types of transactions 1. Cash transactions 2. credit transactions.
1. Cash Transaction
A cash transaction is one where a cash receipt or payment is involved in the transaction. For example, When X buys Furniture ₹80,000. from Neel-Kamal Furniture paying the price of Furniture by cash immediately, it is a cash transaction.
1. Credit Transaction
A credit Transaction is one where cash is not involved immediately but will be paid or received later. In the above example, When X buys Furniture ₹80,000 from Neel-Kamal Furniture if Shubh, does not pay cash immediately but promises to pay later, it is a credit transaction.
The person who invests money, manages, controls, and bears the risk in business with the aim of earning profit is called a proprietor.
In other words, The person who is the owner of the business is called Proprietor.
Basic Accounting Terms
An event is the result of a business transaction. For example, goods purchased ₹20,000 and all the goods sold ₹28,000 the result of the transactions profit ₹8,000 called an event.
Assets are valuable and economic resources of an enterprise useful in its operations.
Assets are valuable and economic resources of an enterprise, which can be expressed in terms of money.
Assets are the properties owned by an enterprise.
Examples of Assets are Land, Building, Factory, Plant & Machinery, Furniture, Fixtures and Fitting, Furniture, Stock, Inventory, Debtors, Bills Receivable, Patents, Copyrights, Goodwill, Investment, Cash, Bank Balance, etc.
Definitions of Assets
According to IFRS (International Financial Reporting Standards), “An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits.”
According to US GAAP (Generally Accepted Accounting Principles used in the United States of America): “Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.”
According to Prof. R.N. Anthony, “Assets are valuable resources owned by a business which are acquired at a measurable money cost”
According to Finney and Miller, “Assets are future economic benefits, the rights of which are owned or controlled by an organization or individual”
Characteristics of Assets
- It should be owned by the business.
- It may be a tangible form or an intangible form.
- It should have some value attached to it.
- It should have been acquired at a measurable money cost.
Liabilities are obligations or debts that an enterprise has to pay after some time in the future.
Liabilities mean the amount owed by the Business.
Liability towards the owners of the business is termed as an internal liability. on the other hand, Liability towards the outsiders,i.e, other than the owners of the business is termed as an external liability.
Types of liabilities/ list of liabilities:
1. Current Liabilities Or Short term Liabilities:
Current Liabilities are obligations or debts that are payable within a period of one year.
These are those Liabilities that are payable within a period of one year.
1. Account Payable (Trade Creditors & Bills Payable),
2. Bank overdraft,
3. Cash credit,
4. Outstanding Expenses,
5. Income received in advance,
6. Interest payable.
7. Income taxes payable etc.
2. Non-Current Liabilities Or Fixed Liabilities Or Long Term Liabilities:
Non-Current Liabilities are those obligations or debts that are payable after a period of one year. Or These are those Liabilities that are not payable within a period of one year.
1. Long-term Bank Loan,
3. Long-term Loan,
5. Bonds etc.
3. Contingent Liabilities:
Those Liabilities that will become payable of an uncertain future event, otherwise not.
Contingent Liabilities are those Liabilities that are not certain at the time of preparing the balance sheet. Contingent Liabilities are not shown in the balance sheet. However, they are disclosed by way of a footnote just below the balance sheet.
1. Bills of exchange discounted but not yet matured,
2. Guarantees were given by the firm,
3. Claim against the company not acknowledged as debt.
Debtor is a person or a firm to whom goods have been sold or services rendered on credit and payment has not been received. The amount due is known as debt and it is shown on the Assets side of the Balance Sheet.
Creditor is a person or a firm from whom goods have been purchased or services have been taken on credit and payment has not been made. The creditors are shown as a liability in the Balance Sheet.
Basic Accounting Terms
Goods refer to the products in which the business unit is dealing, i.e. goods mean all the items which are buying and selling or producing and selling in the normal course of business.
The items that are purchased for use in the business are not called goods. For example, for a furniture dealer purchase of chairs and tables is termed as goods, while for others it is furniture and is treated as an asset.
Similarly, for a stationery merchant, stationery is goods, whereas for others it is an item of expense not purchases.
Purchase refers to the amount of goods bought by a business for resale or for use in production. Goods purchased for cash are called cash purchases. If it is purchased on credit, it is called as credit purchase.
Total purchases include both cash and credit purchases.
Total purchases= Cash purchases+ credit purchases.
Sales refer to the amount of goods sold that are already bought or manufactured by the business. When goods are sold for cash, they are cash sales but if goods are sold and payment is not received at the time of sale, it is credit sales. Total sales include both cash and credit sales.
Total Sales= Cash sales+ credit sales
13. Purchase Return Or Return Outward-
When goods are returned to the suppliers/Creditors due to some reason like defective quality or not as per the terms of purchase, it is called a purchase return.
To find net purchases, purchases return is deducted from the total purchases.
Net purchases = Total purchases – purchases return
14. Sales Return Or Return Inward-
When goods are returned from the customers due to some reason like defective quality or not as per the terms of sale, it is called sales return or returns inward. To find out net sales, sales return is deducted from total sales.
Net sales = Total sales – sales return
Basic Accounting Terms
15. Bad Debts-
When the goods are sold to a customer on credit and if the amount becomes irrecoverable due to his insolvency or for some other reason, the amount not recovered is called bad debts.
In other words, The Amount of Debt that cannot be recovered or collected from a debtor is called bad debt.
16. Bad Debts Recovered-
Sometimes, it so happens that the bad debts previously written off are subsequently recovered. In such a case, the cash account is debited and the bad debts recovered account is credited because the amount so received is a gain to the business.
The cost incurred by a business for earning revenue is known as expenses. For example, purchase of raw materials, Factory expenses, Advertisement expenses, selling and distribution expenses, Rent, Wages, Salaries, Interest, administrative expenses, General expenses, Office Expenses, etc.
Revenue is the total amount received or receivable or realized from the sale of goods or services.
Revenue means the amount of the business earned by selling its products or providing services to customers. Revenue can be operating as well as non-operating. For example-
- Amount received from the sale of goods
- Rent received
- Commission received
- Interest received
- Dividend received
- Royalties received
- Amount received from rendering services
Operating revenue is the revenue that a business enterprise generates from its primary business activities.
Non–operating revenue is the revenue earned by activities other than the primary activities of a business enterprise.
Turnover refers to the total sales made in a particular period.
The excess of revenues over its related expenses during an accounting year is profit.
Profit is the excess of total revenues over total expenses(costs) of a business enterprise for an accounting period.
Profit = Total Revenue – Total Expenses
Loss is the excess of total expenses over the total revenue of a business enterprise for an accounting period.
Loss = Total Expenses – Total Revenue
Basic Accounting Terms
Goodwill is the monetary value of a business reputation. Over a period of time, a business firm develops a good name and reputation among the customers. This helps the business earn some extra profits as compared to a newly set up business, The capacity of any business to earn an extra profit than normal profit is called Goodwill.
In other words, goodwill is the value of the reputation of a firm in respect of the profit earned in the future over and above the normal profit.
23. Trade Receivable-
Trade receivables are the amounts receivable by the business enterprise against goods sold on credit and services rendered in the normal course of business. Trade receivables are the sum total of debtors and bills receivable.
24. Trade Payable-
Trade payables are obligations to pay for goods or services that have been acquired from suppliers in the normal course of business. Trade Payables are the sum total of creditors and bills payable.
25. Stock –
Stock includes goods unsold on a particular date. Stock may be opening and closing stock. The term opening stock means goods unsold at the beginning of the accounting period. Whereas the term closing stock includes goods unsold at the end of the accounting period.
For example, if 4,000 units purchased @ ₹20 per unit and out of these 2500 units sold @ ₹30 per unit. 1,500 units remain unsold, the closing stock is ₹30,000 (1500 X 20). This will be opening stock for the subsequent year.
The act of writing business transactions in the books of account according to date according to principle and in a systematic manner is called entry.
Account refers to a summarized record of relevant transactions of particular head at one place. All accounts are divided into two sides. The left side of an account is called debit side and the right side of an account is called credit side
The concession given by the seller to his customer in the price of the goods is called a discount.
In other words, Discount is the rebate given by the seller to the buyer. There are mainly two types of discount- 1. Trade Discount 2. Cash Discount
29. Trade Discount-
The reduction in the list price with the aim of motivating the customers to buy more goods is called a trade discount. This discount is given on both cash and credit transactions, it is not recorded in the books of account, it is shown by deducting it directly in the invoice.
30. Cash Discount-
The discount given to the customers for the purpose of making quick payments is called a cash discount, this discount is given only on cash deals. This discount is given on the amount paid. This is recorded in the books of account.
31. Direct Expenses-
Those expenses which are incurred on purchasing of goods and for converting raw material into the finished goods e.g. Manufacturing wages, Expenses on purchases (including all duty and tax paid on purchases), Carriage/Freight/Cartage inwards, Production expenses (such as power and fuel, water, etc.), factory expenses (e.g. lighting, rent, and rates), Royalty based on Production, etc.
32. Indirect Expenses-
Those expenses which are not directly related to production or purchase of the goods are called indirect expenses. It includes those expenses which are related to office and administration, selling and distribution of goods and financial expenses, etc. e.g Office & Admin. Expenses Salaries, Rent Rates Taxes, Printing, and Stationery, Salaries & Wages, To Postages and Telephones, Office Lighting, Insurance Premium, Legal Expenses, Audit Fees, Travelling Expenses, Selling & Distribution Exp. Carriage and Freight Outwards, Commission, Brokerage, Advertisement, Publicity Bad Debts Packing Expenses Salaries of Salesman Delivery Van Expenses, Financial Exp. Interest paid on loans, Discounts Allowed Rebate Allowed Bank Charges Miscellaneous Exp. Repairs Depreciation on Fixed Assets Entertainment Expenses Donations & Charity Loss on Sale of Fixed Assets Stable Expenses Loss by Fire Loss by theft, Unproductive Expenses.
33. Revenue Expenditure-
Revenue expenditures consist of those expenditures, which are incurred in the normal course of business. They are incurred in order to maintain the existing earning capacity of the business. It helps in the upkeep of fixed assets. Generally, it is recurring in nature.
34. Capital Expenditure-
Capital expenditure consists of those expenditures, the benefit of which is carried over to several accounting periods. For example, the amount spent on the purchase of plant and machinery, Building, Land, Furniture, Computer, Motor Vehicle, Patents, etc.
35. Deferred Revenue Expenditure –
There are certain expenditures that are revenue in nature but the benefit of which is derived over number of years. For Example Heavy Advertisement Expenditure.
36. Business Entity
A business entity means an economic unit that is formed for earning profit by providing service or selling goods.
37. Source documents-
Business transactions are recorded in the books of accounts on the basis of some written evidence called source documents. Common Source documents are Cash Memo, Invoice or Bill, Receipts, Debit Note, Credit Note, Cheque, Pay-in-slip.