Common Accounting Terms Basic 101 Guide

Common Accounting Terms Basic 101 Guide | Accounting Smarts
Craig Fry

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Craig Fry

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May 28, 2021

Accounting refers to recording, processing, analyzing, summarizing financial data, and reporting it. However, you must know the basic accounting terms.

Accounting refers to recording, processing, analyzing, summarizing financial data, and reporting it. However, you must know the basic accounting terms.

There are basic terminologies for writing a financial report, recording data such as assets, liability, accounts payable, accounts receivable, balance sheet, equity, inventory, etc. Other business domains use accounting terms such as revenue, net margin, net income, income statement, and cash flow.

All the above-mentioned terms are just the tip of the iceberg. There are a plethora of basic terms in accounting that every professional accountant must know by heart. For each process, the experts in the area use these technical jargons on a daily basis. While a layman only knows a couple of basic terms like cash, balance sheet, profit, and loss, there are actually over 40 basic accounting terms that you must familiarize yourself with. In this article, you are going to learn about the most commonly and frequently used terms with simple examples for your understanding.

According to NYS Society of Certified Public Accountants NYSSCPA, there are over 1000 basic accounting terms. After thorough research we have compiled some of the most common accounting terms you will come across on a daily basis as an accountant.  

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Common Accounting Terms Basic 101 Guide

The glossary of accounting contains over a thousand terminologies referring to in-depth procedures. However, here are the major common and essential terms that you must know as a student of the subject area.

While you will learn about some of the technical terms used in accounting methods and processes, later, certain terms do not pertain to any specific financial report. These are the basic terminologies used as general accounting lingo.

Accounting Period

An accounting period for a company refers to a designated time frame mentioned in all financial statements, including balance sheets, income statements, and cash flow statements. This period refers to the time span for which the financial data refers to in the statements.

For example, the accounting period can be monthly, quarterly, half-yearly, or yearly. So, you can create financial reports or statements for a month with data referring to that month alone. Similarly, you can do that same for each quarter, every bi-yearly, or annual financial statements as well.

Allocation

This generic accounting terminology refers to the procedure where your company assigns funds to various periods or accounts.

For example, your company can allocate a cost and spread it over several months. One such instance is mortgage payment or payment of insurances etc.

You can even allocate the cost over several departments within the company. Typically, this practice is very common with the administrative expenses for a company that operates with multiple divisions.

Business Entity

A business entity, also known as a legal entity, refers to the legal structure. In accounting, the common form of the business includes partnerships, proprietorship, C-Corp, S-Corp, Limited Liability Corp (LLC).

The accountants keep a close check on the ever-changing rules and regulations of each of these business entities. This is important because each of them has a unique structure of laws, requirements, and tax implications.

So, if your business has to stay out of trouble, it is highly critical that your accountants are well-versed in the laws pertaining to all legal entities.

Cash Flow

In accounting, Cash Flow or (CF) refers to the influx and outgoing of cash from your company. You can calculate the net Cash Flow of your company for a specific period of time. First, you take the Cash Balance at the beginning of the time period and subtract the Cash Balance you have at the end of the time period.

If you get a remainder amount in a positive number, it means that more cash came into the business than what went out. On the other hand, the negative remainder implies that you have spent more than the amount that came into the company.

However, you must remember that these positive and negative remainder sums of the cash flow do not define the profit and loss of your company. There are more complex and integral components of the financial statements that will come into play when you wish to calculate the profit and loss during a specific time period.

Certified Public Accountant (CPA)

Certified Public Accountant is a professional qualification that an accounting student can earn after passing a CPA examination. Plus, you will also have to fulfill the two pre-requisites for work experience and previous educational background. These requirements may vary by each state, so confirm with your local CPA body to determine their eligibility criteria.

Credit

The term credit refers to an increase in your company's equity or liability account. On the other hand, it can also refer to a decrease in your company's expense or asset account. When writing down the credit in the financial statement or balance sheet, you will always mention the credit to the right side.

Debit

In accounting, the term debit identifies an increase in your company's expense or asset account. Alternatively, it may also reflect a decrease in your company's equity or liability account. When recording debit in a financial statement or balance sheet, you will always mention the debit towards the left side in the account details.

Diversification

Diversification in accounting refers to a process of reducing risk. The ultimate purpose of this method is to allocate business capital across multiple assets. This way, the performance of the entire business does not depend on the performance of one asset.

Enroll Agent or EA

This terminology defines a professional designation in the field of accounting. This professional working on this designation has successfully passed the tests showcasing his/her expertise in personal and business taxes.

If your company wants to ensure that you are always in compliance with the rules and regulations by the IRS and file business taxes adequately, then an Enrolled Agent (EA) is who you need to hire.

Fixed Cost (FC)

As the name suggests, Fixed Cost in Accounting indicates the cost that does not change irrespective of your sales volume. For example, the employees' salaries, rent, monthly mortgage payment, and other fixed costs of the company will stay the same regardless of how many products you manufacture and sell.

On the other hand, there is a Variable Cost (VC), which means the cost has the tendency to fluctuate with time. For example, the utility bills of the company may fluctuate depending on how many hours you have been working or how much energy you are using on the production floor, etc.

Interests on business loans are also prone to variation; however, this does not happen overnight. You receive some sort of a prior warning or notification from the bank or lending institution.

General Ledger

A general ledger in accounting shows the complete record of all financial transactions. The GL is the main book that an accountant refers to when the time comes to prepare all financial statements.

GAAP

GAAP is an abbreviation of "Generally Accepted Accounting Principles." These are the set of rules every accountant must abide by when performing their accounting duties.

These general rules have the primary purpose of keeping standard practices in all companies. This way, it is convenient to run an apple to apple comparison in a business's financial statements or reports.

Interest

Interest is the excess amount you pay on top of the principal balance as a repayment for a line of credit or a business.

Insolvency

This is a state in which a company or an individual can no longer meet their financial obligations with the lenders when the debts become due for payment.

Journal Entry

Journal Entry or JE is how you update or make changes in a company's financial books. Each JE must have a unique identifier, a debit/credit, an amount, an account code, and a date. All these factors help determine when you altered the account.

Liquidity

Liquidity is how quickly your company can convert its assets into cash. For example, your stock or cars are more liquid than your office. You can quickly sell stocks and cars to turn them into money, whereas selling the office will take a bit longer for you to gain access to cash.

Material

The material in financial accounting refers to the impact of a misstatement or omission of information on your business's financial reports. Even if the material is half a cent, you will still have to report it. GAAP obligates companies to disclose all material considerations, no matter how big or small.

Overhead

In accounting, overhead refers to business expenses pertaining to running your daily business operations. However, they do not include any costs related to making or delivering your products and services. The most common overheads include employees' wages, rent, and utility bills.

Payroll

Payroll in accounts reflects the payments you make to your workforce as their wages, salaries, bonuses, benefits, and deductions. The payroll usually appears as a liability in your company's balance sheet. This is because it is the sum of money that your company owes to the employees.

Moreover, any accrued vacations and unpaid wages are also a part of your business's liabilities.

Present Value

Present Value or PV indicates the value of your company's assets today. Usually, you calculate it in comparison to a different time period. There is a fundamental principle behind this theory, i.e., due to the inflation rate, the cash your company has today is always more valuable than the cash your company will have tomorrow.

Receipts

Any documentation that is proof of payment made is known as receipts. As a business, you must produce receipts when you make a sale. Similarly, you must ask for receipts when you buy inventory and supplies for your vendors.

You must keep these receipts saved for audits to prove the accurate record of incurred expenses.

Return on Investment

Return on Investment or ROI refers to profits your company makes divided by the initial investment it made for manufacturing the product or creating the service.

For example, you spent 10,000 on creating a product and marketing it, and then you sold the product for $20,000. In this case, your company can say that your ROI on overall marketing spend is 50%.

Trial Balance

Your company's Trial Balance or TB comprises of the list of all the accounts present in the GL or General Ledger. All these accounts must have their balance amounts, i.e., debit or credit mentioned in the GL. The total amount of debits must always be equal to the total amount of credits. This is what you call a balanced General ledger.

So in simpler terms, monies that go out must always be equal to funds coming in. However, the incoming monies can be in other forms such as inventory, products, raw material, and assets.

Basic Terms in Balance Sheets and Accounting Records

The balance sheet, cash, profit, loss, credit, and debit are some of the most common financial terms you will find in any financial report produced by the accountant. However, this section will represent some of the most basic but confusing accounting terms that common people do not understand.

Accounts Payable

Accounts Payable or AP refers to all your business expenses that have been incurred by your company during a financial transaction, but you have not paid them as of yet. Your accountant or accounts department will record these business transactions as a liability.

Therefore, if you want to check out your accounts payable on the balance sheet, you can look for the section that will show the debt your company owes to any stakeholders.

For example, your company belongs to the textile industry, and you buy yarn from various suppliers on credit. This means you get the stock of yarn to continue smooth production of the fabric, but you make the payment later. Ideally, when you receive the payment after delivering the final product to the company that places the order.

So, when you purchase the yarn, the supplier will send you an invoice for this transaction. Your accounts department will receive the invoice and record the due amount along with other relevant details in the accounts payable (AP) ledger. This means you owe this money to the supplier of the yarn.

Accounts Payable plays a vital role for the company's financial analysts to know the most current and accurate financial condition of the company.

Accounts Receivable

Accounts receivable or (AR) refers to all of your business's revenue generated from sales. However, this is the number of sales your company made but did not receive the payment for them yet. In this case, your accountant or accounts department will enter this kind of business transactional amount as accounts receivable.

This is the amount you have not received yet; you will still mention it as an asset on your balance sheet. Why?  This is because you are certainly going to receive the amount at some point in the future. Yes, it is not in liquid or cash form, but you have the money in the pipeline.

For example, you are the supplier of yarn to a textile company. You have delivered an order worth $10,000 to the company, but they will make the payment upon completion of their order and/or receiving their payment.

In this case, your account department will generate an invoice and add an amount of $10,000 into the accounts receivable section of your company's financial balance sheet. So, in simpler terms, if you want to see the current figures of your company's Accounts Receivable (AR), you can check the balance sheet for how much other companies owe you.

Accrued Expenses

Accrued expenses refer to any or all expenses that your company incurs but has not made the payment against them yet.  Therefore, you can also say that accrued expenses are the amount that your company owes to others for whatever reason.

This can be pending invoices, utility bills, credit card bills, pending mortgage payments, insurance, taxes, and other liabilities.

For example, your company has to pay monthly or yearly insurance premiums. However, you do not make payments straight away, and they become a part of your accrued expense for a while. How? Because even if there is an interval of a single day in which you receive a bill and make the payment, the invoice still goes into your accrued statement section of the balance sheet.

So, once your accounts department receives an invoice or bill that your company has incurred, they will enter it into the accrued expense section of the balance sheet. This means you owe this money to a lending party or utility company etc.

Asset (A)

Assets on the balance sheet and in general terms in the business refer to anything that your company owns. However, the owned asset must have a monetary value to be known as an asset. The accounting lists the assets in various categories according to their liquidity.

In this case, the cash held by your company is the most liquid form of assets, whereas land is the least liquid in the category.  If you wish to learn about what other things may count as an asset, here are some examples.

The asset may include cash or cash equivalent such as savings or checking accounts, certificates of deposits, physical money or cash in hand, money market accounts, stocks, treasury bills, etc. The land refers to any area of land or property or structure attached or associated with your company permanently.

Remember, you have to own the property for its classification as an asset. A rented property, no matter how long the duration of the lease, is still an expense. Other assets include the company's furniture, a fleet of vehicles or other transportation, equipment, stock or inventory, etc. However, remember that they are assets only if you own these items.

Balance Sheet (BS)

A balance sheet is a financial statement or report containing every piece of information of your company's monetary activities. No matter how big or small, every financial transaction must go on this balance sheet.

This financial report does not only contain information about the money your business owns but also maintains details of the company's equity, liabilities, and assets. As you can guess by the name "balance sheet," the report's primary purpose is to equalize or balance the financial equation i.e.

Your Company's assets = business liabilities + business equity

Another way to look at it in monetary terms is to see balancing that outgoing money from the company but be equal to incoming goods, services, assets, etc. means if you spend $1000 in a month, there should be an equal amount of services or goods received by your company to balance the sheet.

Think of it as running your home finances; if you go shopping, you balance your receipt. How? You come home and go through the shopping list to ensure that you have each item in the bag you paid for at the store.

Similarly, your accountant will look at all your outgoing money and check the company's record to ensure that the company received the relevant goods, service, or asset you paid the money for. However, a balance sheet also shows other aspects such as money you owe or the money owed to your business by vendors, business partners, and consumers.

Book Value (BV)

As an asset of your company depreciates, it starts to lose its monetary value. In this case, the book value is the term that refers to the original monetary value of the asset minus any monetary depreciation in the value over time.

This term derives from the practice in the field of accounting where the experts record the value of an asset at its historical original cost in the balance sheet. You can say it refers to the value of the item at the time of purchase.

For example, you purchased a vehicle or a truck to deliver your goods to the consumers and paid $ 20,000 for it. As years go by, the value of the truck's original cost will decrease over time, and the book value (BV) tells you the current value of the truck now if you sell it. The depreciation of the cost is another affair looked after by other aspects of accounting.

Equity

The term equity in accounting indicates the value of the item or asset leftover once you remove all the liabilities from the cost. Here you can remember the equation we used earlier i.e.

Business Assets = Business Equity + Business' liabilities

If you take all your company's assets and subtract all of your liabilities, the remainder of the amount is known as the equity of your company. This is also the financial portion of the company, which also refers to the stake owned by all the owners, stakeholders, or shareholders in the company.

In simpler terms, if you dissolve your company or sell it, equity refers to the amount available for division amongst all the stakeholders, partners, and owners. However, the division will happen according to their pre-agreed percentage.

For example, your company may be worth a million-dollar business on the book. That does not mean it has the equity of a million dollars. In order to calculate the equity, first, you will have to deduct all the liabilities, expenses, employee expenses, owned invoices, losses, etc.  

Once you have taken out all the liabilities, you will have the assets and cash known as the equity of your company.

Inventory

In business accounting, the term inventory refers to the classification of all company's assets in stock for selling. This means the asset your company bought to sell them to the customers, but they remained unsold.

Now, as you start selling these items, your inventory system will show the volumes going down. In simpler terms, any products, raw material, or items waiting in your warehouse to sell will automatically become a part of your company's inventory.

So, whether you are a manufacturer of a product or a third-party supplier of raw material, any items in your stock available for selling will fall under the classification of inventory. There is no limitation on size, shape, or type of material. If it is up for sale, it is an inventory.

Liability

The term liability referred to as (L) on the balance sheet identifies all the debts that your company owes to other parties. This means any small or significant amounts that you have yet to pay are the liabilities of your company.

Some of the most common liabilities of a business include pending invoices, employees' payroll, monthly utility bills, daily operations expenses, insurances, business loans, credit card bills, fuel expenses, mortgages, tolls, and taxes, etc.

Not just that, if you have to pay back any dividends to the stakeholders, they will also fall in the category of liabilities.

Basic Accounting Terms in Your Company's Income Statement

Accounting is all about knowing exactly how your business is performing. Therefore, the income statement that is also known as the profit and loss statement, is one of the most basic but important financial statements in accounting.

However, there is a wide range of accounting terms used for reporting your company's income statement.

Costs of Goods Sold

The Costs of Goods Sold is a term also known as COGS. This term refers to the expenses of your company related directly to the manufacturing or creation of a service or a product. However, certain costs will not be a part of COGS. These include the costs or expenses your business requires to run your daily operations.

In order to understand the Costs of Goods Sold, let us consider this scenario. If you are a manufacturer of t-shirts, you will require different raw materials. In this case, the raw material will become part of the COGS. Other expenses that fall in the classification of COGS include Direct Labor cost that will be responsible for producing your t-shirts.

However, the cost of electricity, administration and other management operations will never be a part of COGS because those are the operations that you require anyway to run your business smoothly.

Depreciation

The term depreciation in financial accounting refers to a process that accounts for any loss of monetary value in your company's assets over a period of time. Typically, the assets of your company have to have substantial monetary value in order to fall under the category valid for depreciation.

Some of the most common assets that fall under the category of items valid for depreciation are your company's equipment, tools, and transportation vehicles. Another important aspect you must remember is that the depreciation in the value of any asset will appear as an expense in our company's financial income statement.

However, this particular expense will only appear as the 'non-cash expense.' Why? This is because the depreciation of any or all assets does not directly impact your company's cash position (good or bad).

Expense

Just like any other aspect of your daily life where an expense is something you pay or have to pay, the same principle applies in financial accounting. Here the term expense for a company refers to any cost your company incurs.

Whether it is the utility bills, you have to pay, purchase raw material, repaying a mortgage or business loans, clearing credit cards, or paying employees payroll or vendor's pending payments, all of these are your company's expenses.

Gross Margin

In financial accounting, Gross Margin (GM) refers to a percentage that an accountant calculates by taking your company's Gross Profit and dividing it by the revenue generated during the same period, i.e., of the profit.

The Gross Margin of your company will also represent how profitable your business has been in a specific period of time. However, your accountant will first deduct the Costs of Goods Sold from the money you made after selling the product. The remaining amount will fall under what you call the Gross Margin.

You can either find out the Gross Margin of an entire batch or each product. It depends on how you wish to analyze the productivity and/or profitability of your company.

Gross Profit

Gross profit or GP is an accounting term that identifies the total profitability of your business in the currency you deal in, i.e., Dollars. However, the accountants do not take out any of the overhead expenses in the calculation.

This means the Gross Profit is the outcome when the accountant subtracts the Costs of Goods Sold (COGS) sold from the total revenue your company made during the same period.

For example, your company sold 100 cars for 2 million dollars. On the other hand, the total cost of goods sold accounts for 1.4 million dollars. In this case, your accountant will first subtract the COGS amount of the revenue you generated, i.e., 2 million dollars i.e.

Gross Profit = Revenue – COGS = 2 million dollars – 1.4 million dollars = 0.6 million dollars.

The remainder sum, i.e., 0.6 million dollars, will be your company's gross profit for that period of time when you sold the 100 cars.

The Profit and Loss Statement

The profit and loss statement (P&L) is also known and commonly referred to as an income statement (IS). This is a report that contains your company's financial statement with full details of revenues generated, expenses paid, and profits gained over a specific time.

There is a certain standard format for a Profit and Loss or Income Statement. The revenue that your company earns over a given period of time appears at the very top of the financial report. Then various business expenses and costs appear, and you subtract from the total revenue generated.

For example, your business generated revenue of $500,000 from January to March this year. Your accountant will mention that on the top and then subtract any or all expenses incurred by your business during January to March. The final result will be the net income of your company during the first quarter of the year.

Net Income

According to the basics of financial accounting, the net income or (NI) of your company refers to the monetary amount in dollars that you have earned as profits. The accounting department calculated your business's net income by taking all your revenues and subtracting them from the expenses incurred by the company during a specific period of time.

These expenses include the depreciation value of the assets, overhead costs, Costs of Goods Sold, taxes, and any other costs. You can calculate the overall net income of the company.

On the other hand, you can also narrow it down and find out the net income based on the profitability of a certain project. Moreover, you can also find out the net income of the company during a specific time frame.

Net Margin

The term net margin in accounting refers to the percentage amount of your company that illustrates all profit your company made in relation to the revenue generated. In order to calculate the net income, your accountant will take the net income of the company and divide it by the total revenue.

Now, this can be for the entire year or a specific project, or during a particular period of time.

Revenue

This is a no-brainer; revenue is any money that your company earns upon selling products or services. The revenue is the incoming monies without any consideration of expenses, liabilities, etc.

Craig Fry

Craig Fry

Craig has spent 25 plus years in the world of accounting and business. His experience includes working as a CPA/Auditor for the international accounting firm of KPMG. He has worked as a controller and as a COO for small to medium sized companies. All of his experience has given him a vast knowledge of both book accounting and practical accounting experience which he has applied in all sizes of business.

Learn more about Craig Fry