In this article, we shall give an introduction to accounting basics, its definition, and 25 basic accounting terms for beginners who want to start learning accounts. So you can easily learn practical accounting. Once you become familiar with some of these terms and concepts, you will feel comfortable navigating through the explanations. I suggest you read and understand it carefully.
Accounting is the process of identifying, recording, classifying and reporting information on financial transactions in a systematic manner for the purpose of providing financial information for decision making. Accounting helps to arrive at the financial position of an organization at any given point in time.
- Capital- In accounts capital is the amount of money or assets invested by the owner in the business.
- Drawings- The withdrawal of cash or goods by the owner for his personal use is known as drawings. Drawings always reduce capital.
In other words, the payment of personal expenses through business is considered as drawings. Such as payment of life insurance premium, payment of income tax, etc.
- Assets- The entire tangible or intangible rights owned by a business defined as assets. Following are the various types of assets:
- Tangible: The assets which have no physical existence and can be seen or touched are known as tangible assets such as building, plant and machinery, furniture, motor car, computers, etc.
- Intangible: The assets which have no physical existence, can neither be seen nor touched are known as intangible assets. Such as goodwill, trademarks, patent, copyright, etc.
- Floating: The assets which can be converted into cash within one accounting period are known as floating assets such as cash balance, debtors, bills receivable, etc. These assets are also known as Current Assets.
- Fixed Assets: The assets which are purchased to increase the profit earning capacity of the business for future production and providing services are known as fixed assets e.g. building, machinery, furniture, etc. These assets are not sold in the normal course of business.
- Liquid Assets: All such assets that can be converted into cash promptly are called liquid assets such as cash in hand, bank balance, debtors, bills receivable, etc.
- Wasting Assets: The assets which are exhausted with or which lose themselves physically in during the course of production are known as wasting assets. The examples of wasting assets are mines and quarries, oil wells, etc.
- Fictitious Assets: As a matter of fact these are neither the assets nor used nor have resalable value but because of their debit balance and due to legal and technical reasons are included in assets side of balance sheet. Example of fictitious assets is preliminary expenses, discount on issue of shares and debentures, underwriting commission, etc. The fictitious Assets refer to heavy expenditures in the current year but the benefit of these expenses is derived in the following years also. So such expenses partially charged to P& L A/c and rest shown on the assets side of balance sheet.
- Liabilities: Claims of owners and external parties against the assets of the business are known as liabilities such as creditors, bills payable, bank overdraft, bank loans, outstanding expenses, capital, secured loans, unsecured loans, etc. The liabilities can be classified as follows:
- External: No business can be carried out without credit whether it is purchases of goods or assets. Sometimes a loan is also raised from various institutions. All these are categorized user external liabilities.
- Internal: Investment made by the owner, current year’s profit, various reserves and balance of undistributed profits are kept under the category of internal liabilities.
- Short term: The obligations payable within a short period, generally, one year is known as short term liabilities or current liabilities.
- Long Term: The loans raised from different institutions for the requirement of business and payable in the long term that is after one year are known as long term liabilities.
- Balance Sheet: It is the final statement prepared to know the financial position of a business. This statement has two sides- liabilities and assets.
- Working Capital: The liquid funds available for conduction day-to-day operations of a business are known as working capital. The sum of all current assets is known as gross working capital while the sum of current assets less current liabilities are known as net working capital.
- Sundry Debtors: Debtors means all the persons or firms whose amount is due for goods sold on credit.
- Sundry Creditors: The persons or firms whose amount is due on account of goods purchased on credit are known as creditors.
- Revenue: Revenue refers to the inflow of cash through business activities. Revenue can be in the form of sale of goods, commission or brokerage received, rent received, etc. There are two types of Revenue Receipts:-
- Revenue Income: The income received or receivable by the normal activities of business or profession is known as revenue income.
- Capital Income: Any income other than income from the normal activity of business consider as capital income such as profit on the sale of fixed assets.
- Expenses: It is the cost related to the operation of an accounting period. There are three types of expenses:
- Revenue Expenses: This type of expenses incurred in performing normal business activities such as rent, wages, etc.
- Capital Expenses: Fixed nature expenses which benefit the business for a longer period are known as capital expenses. Such as the purchase of fixed assets, installation expenses, etc.
- Deferred Revenue Expenses: A heavy amount of expenses of revenue nature incurred in a financial year and its benefit avail in a number of years are known as deferred revenue expenses.
- Purchase: The buying of any goods or services for the purpose of the sale is called purchases.
- Purchase Return: When the party returns a part of purchased goods to the seller due to some reasons then it is known as purchase return.
- Sales: The goods purchased for the purpose of sales, when transferred to other parties after adding some profit are known as sales.
- Sales Return: The goods returned by the purchaser to the seller due to some reasons are known as sales return.
- Stock: The goods available in business at a particular time are known as stock or inventory. The stock is calculated in the following two forms:-
- Opening Stock: The quantity and cost of the stock present in the business on the 1st day of the accounting year is known as opening stock. In the case of an existing business, the closing stock of preceding year automatically becomes the opening stock of the current year while in the case of a new business there is no opening stock.
- Closing Stock: The unsold goods in the business at the end of the year are called closing stock.
- Investment: When business funds are invested outside the business, such as in shares, government securities, fixed deposits are known as investment. The investment can be short term as well as long term.
- Gross Profit: Excess of the net sales proceeds over the cost of goods sold is known as gross profit. It can be calculated with the help of the following formula:
Gross profit=Net Sale Proceeds- Cost of Goods Sold
- Net Profit: The excess of income during a particular accounting period over the expenses of that period is known as net profit. Net Profit can be calculated using the following formula:-
Net Profit= Gross Profit+ Indirect Incomes-Office and selling Expenses (Indirect Expense)
- Transaction: Business activities involving the transfer of money or goods or services between two parties are known as a transaction. It can be cash or credit transactions.
- Account: A specific format in which transaction relating to a person, goods or incomes and expenses are recorded is called Account. Debit and Credit are the two sides of an account.
- Goods: The items purchased by a businessman for the purpose of sale are called goods.
- Entry: Recording monetary transaction of business in the books of accounts.
- Journal: The book of account in which each business transaction recorded chronologically is known as Journal.
- Provisions: To Protect Our Business from future losses we can create funds known as Provisions.
- Reserve: William Pickles has defined the reserve as follows-“Amount set aside out of Profit and other surpluses which are not designed to meet any liability, contingency, commitment or diminution in value of assets”.
Some of the basic accounting terms that you will learn in the above article help you to clear your accounting concepts. In our next article, you will learn about the accounting debits and credits, as we show you how to record transactions. You will also see why two basic accounting principles, the revenue recognition principle and the matching principle, assure that a company's income statement reports a company's profitability. Thank you so much for your valuable time and effort to learn accounting. You can also join our tally gst course at our Udaipur,Rajasthan center.