Basic Terminology of Accounting

Introduction to Basic Terminology of Accounting

In this article we will go through the topic Basic Terminology of Accounting. Following are some important terminologies of accounting which are very useful for all those who are going to deal in accounting. For better understanding of this subject the clear meaning of the following terms will be very helpful.

1. Goods

 Goods are the things in which the business deals for examples, if a business deals in furniture, then all the furniture items in which its deals will be considered as its goods.

2. Assets

 Assets are things of value used by the business in its operations. These are economic resources of an enterprise that can be usefully expressed in monetary terms.

Assets = Liabilities + Capital

According to Finny and Miller, “Assets are future economic benefits, the rights, which are owned or controlled by an organization or individual”.

Classification of Assets

i) Fixed Assets

 Fixed assets refer to those assets which are held for the purposes of providing or producing goods or services and those that are not held for resale in the normal course of business. Fixed assets may be classified as under

Tangible Fixed Assets

 It refers to those fixed assets which can be seen and touched. For example, land and building, plant and machinery, furniture and fixture.

Intangible Fixed Assets

 It refers to those fixed assets which cannot be seen and touched. For example, goodwill, patent, trademarks, copyrights.

ii) Current Assets

Current assets are those assets which are held

a) In the form of cash,

b) For their conversion into cash,

c) For their consumption in the production of goods or rendering of services in the course of business.

d) On a short-term basis.

For example, cash in hand, cash at bank, stock of finished goods, debtors, bills receivables, stock of raw materials and stock of work-in-progress.

iii) Fictitious Assets

Fictitious assets are those assets, which do not have physical form. They do not have any real value. Actually, they are not the real assets but they are called assets on legal and technical ground. These assets are the revenue expenditure of capital nature which is also termed as deferred revenue expenditure. The example of these assets is loss on issue of shares, advertising suspense and preliminary expenses etc. Fictitious assets do not have real value, so they are written off in the future.

Basic Terminology of Accounting

3) Liabilities

 Liabilities means the amount which the firm owes to outsiders, that is excepting the proprietors. These are the obligations or debts that the enterprise must pay in money or services at some time in the future.

According to Finny and Miller. “Liabilities are debts, they are amounts owed to creditors.”

Thus, the claims of those who are not owners are called liabilities. This can be expressed as

Liabilities = Assets- Capital

Classification of Liabilities

i) Current Liabilities/Short-term Liabilities

 Current liabilities refer to those liabilities which fall due for payment in a relatively short period, (normally, a period of not more than 12 months from the date of the balance sheet). For example, bills payable, trade creditors, outstanding expenses, bank overdraft, etc.

ii) Long-term liabilities

Long-term liabilities refer to those liabilities which do not fall due for payment in a relatively short period (normally a period of not more than 12 months from the date of balance sheet). For example, long-term loans, debentures, etc.

iii) Contingent Liabilities

 These liabilities are shown as a footnote to the balance sheet. It includes claims again companies not acknowledged as debt, uncalled liability on shares partly paid, arrears of fixed cumulative dividend liabilities for bills discounted, etc.

4) Capital

Capital is the investment made by the owner for use in the firm. For the business, capital is a liability towards the owner. It is also known as Owner’s Equity or Proprietorship or Net Worth. Owner’s equity means owner’s claim against the assets.

5) Proprietor

Proprietor is an individual or groups of persons who undertake the risk of the business are known as proprietor. They invest their funds into the business as capital. Proprietors are adventurous persons who make arrangement of land, labour, capital and organization. Against all such contribution, he gets profit, as a reward.

Basic Terminology of Accounting

6) Drawings

Amount or goods withdrawn by the proprietor for his private or personal use is termed as ‘drawing’. The cost of using business assets for private or domestic use is also drawing. Use of business car for domestic use or use of business premises for residential purpose is also drawing. Certain examples of drawings are as under

i) Amount withdrawn by proprietor for personal use.

ii) Goods taken by the proprietor for domestic use.

iii) Purchasing pocket transistor for proprietor’s son.

iv) Using business vehicles for business use.

v) Using business premises for residential purpose.

Basic Terminology of Accounting

Read Also : Accounting Principles

7)  Revenues

 Revenues are the amounts; a business earns by selling its product or providing services to customers.

8) Expenses

Expenses are the costs incurred by a business in the process of earning revenue.

9) Income

 Income is the difference between revenue and expense.

10) Losses

 Losses are unwanted burden which the business is forced to bear. Loss of goods due to theft or fire, or flood or storm or accidents is termed as ‘loss in accounting’. Losses are different from expenses in the sense that expenses are voluntarily incurred to generate income where losses are forced to bear.

11) Purchases

Purchases are the total amount of goods procured by business on credit and for cash, for use or sale.

12) Purchases Return

Purchases return is the part of the purchases of goods, which is returned to the seller. This return may be due to unnecessary, excessive and defective supply of goods. In order to calculate net purchases, purchase return is deducted from purchases. Purchases returns are also known as Returns Outward, because it is the return of goods outside the business.

13) Sales

Sales are total revenues of goods sold or services provided to customers.

14) Sales Return

Sales return is that part of sales of goods which is actually returned to us by purchasers. This return may also be due to excessive, unnecessary and defective supply of goods or violation of terms of agreement. Sales return, also known as Returns Inward, is deducted from sales, in order to calculate net sales.

Basic Terminology of Accounting

15) Stock Inventory

Stock Inventory is a measure of something on hand-goods, spares and other items in a business.

16) Debtors (Accounts Receivable)

 Debtors are persons and/or other entities that owe to an enterprise an amount for receiving goods and services on credit.

17) Creditors (Accounts Payable)

Creditors are persons and/or other entities that have to be paid by an enterprise goods and services on credit.

18) Solvent

Solvent are those persons and firms who are capable of meeting their liabilities out of their own resources. Solvent firms have sufficient funds and assets to meet proprietors’ and creditors’ claim. Solvency shows the financial soundness of the business.

19) Insolvent

Insolvent are all those business firms who have been suffering losses for the last many years and are not even capable of meeting their liabilities out of their assets are financially unsound. Only the court can declare the business firm as insolvent if it is satisfied that the continuation of the firm will be against the interest of the public or creditors. No firm can declare itself as insolvent.

20) Transactions

 Transactions are those activities of a business, which involve transfer of money or goods or services between two persons or two accounts. For example, purchase of goods, sale of goods, borrowing from bank, lending of money, salaries paid, rent paid, commission received and dividend received.

Transactions are of two types

Cash Transactions

Cash transactions is the one where cash receipt or payment is involved in the transaction. For example, when Ram buys goods from Karan and paying the price of goods by cash immediately, it is a cash transaction.

Credit Transaction

 Credit transaction is the one where cash is not involved immediately but will be paid or received later. In the above example, if Ram, does not pay cash immediately but promises to pay later, it is credit transaction.

21) Vouchers

 Accounting transaction must be supported by documents. These documentary proofs in support of the transactions are termed as vouchers. It may be a receipt, cash memo, invoice, wages bill, salaries bill, deeds or any document as evidence of transaction having taken place.

22) Invoice

 Invoice is a business document which is prepared when one sell goods to another. The statement is prepared by the seller of goods. It contains the information relating to name and address of the seller and the buyer, the date of sale and the clear description of goods with quantity and price.

23) Receipt

 Receipt is an acknowledgement for cash received. It is issued to the party paying cash. Receipts form the basis for entries in cash book.”

Basic Terminology of Accounting

24) Account

 Account is a summary of relevant business transactions at one place relating to a person, asset, expense or revenue named in the heading. An account is a brief history of financial transactions of a particular person or item. An account has two sides called debit side and credit side.

25) Debit Note

 It is created for any purchase return. When a firm returns some goods to its supplier, it prepares a credit note and sends it along with the goods returned. It is a commercial document notifying a person that a debit has been made to his accounts. For example, if goods are sold on credit and a part of that is returned, a debit note might be issued for the value of the goods returned.

26) Credit Note

Credit note is a form or letter sent by a seller to a buyer, stating that a certain amount has been credited to the buyer’s account. A credit note is issued in various situations to correct a mistake, such as when

i) An invoice amount is overstated,

ii) Correct discount rate is not applied,

iii) Goods spoil within guaranty period, or (sales return)

iv) They do not meet the buyer’s specifications and are returned. Also called credit memo.