Basic Accounting Terms
Before understanding the accounting equation and other accounting functions thoroughly, one must have the knowledge of widely used accounting terms:
1. Accounting cycle
The complete sequence beginning with the recording of the transactions and ending with the preparations of the final accounts is called the accounting cycle.
2. Event
An event is an occurrence that affects the resources of an enterprise. An event may be internal or external. e.g. a technological change making a computer model obsolete, thus decreasing its value, is an external event. The decrease in the value of the computer because of wear and tear, due to use is an internal event.
3. Business transaction
An event involving some value between two or more entities. It can be purchase of goods, receipt of money, payment to a creditor, incurring expenses, etc. It can be a cash transaction or a credit transaction.
4. Capital
It is the amount invested in the business by its owner(s)/proprietor(s). It may be in the form of cash, goods or any other asset.
For business, capital is a liability which is to be settled only in the event of closure or transfer of the business. For companies, capital is usually represented as share capital.
5. Net worth
It represents excess of total assets over total outside liabilities of the business. This amount is available to be distributed to the owners in the event of closure of the business. It is also called owner’s equity or capital standing in the event of closure of business.
Net Worth = Capital + Sum of Undistributed Profits – Sum of Unwritten-off Losses
6. Drawings
It represents cash, goods or any other asset which the owner withdraws from business for his personal use. Drawings result in reduction in owner's capital. The concept of drawings is not applicable to companies.
7. Proprietor(s)
The owner(s) of a business is/are called proprietor(s). Money invested by the proprietor is called capital and share capital in case of cooperative society and companies.
8. Assets
It refer to those resources which the business firm owns, the legal rights it purchases, the amount payable by the outsiders to the business firms or anything which derives benefit normally for more than one year. It can be classified as:
(i) Fixed assets
Those assets which are owned for the period of more than one year by the business to produce goods or to provide services and which are not meant for resale like building, plant, machinery, equipment, furniture, etc.
(ii) Current assets
Those assets which are convertible into cash within the time period of one year are known as current assets. These assets are owned by business in form of cash, any asset convertible into cash, convertible into finished goods or services like stock, debtors, bank balance, etc.
(iii) Tangible assets
Those assets can be seen and touched and have their physical existence.
(iv) Intangible assets
These assets refer to those fixed assets which cannot be seen and touched and are acquired by the way of legal rights in form of goodwill, patent rights, trademarks, copyrights, etc.
(v) Wasting assets
Those assets which are in the form of natural resources consumed/depleted during the process of its use.
Mineral mines, oil wells, quarries, extraction of anything from the natural resources are known as wasting assets because in such type of assets, a stage comes when these resources get exhausted and nothing is left.
9. Liabilities
These denote the amount which the business owes to others, other than owner's capital. It refers to the excess of assets over capital. These are in the form of:
(i) Internal liability
It is the amount owed by business to the proprietor of business. It is also called as capital in case of sole proprietorship/ partnership firms and share capital in case of companies and cooperative societies.
(ii) External liability
It is the amount payable by a business to outsiders other than proprietors.
(iii) Long-term liability
The liabilities which are payable after the expiry of twelve months from the closing date of last balance sheet, e.g. long-term loans, fixed deposits accepted, debentures, etc.
(iv) Short-term liability
or current liability The liabilities which are payable within a year from the closing date of last balance sheet,
e.g. creditors, bills payables, etc.
(v) Contingent liability
The liabilities which may or may not arise in future depending on happening of an event. It is shown as a footnote or notes to the balance sheet.
10. Sales
The term sales is associated with the sale of goods that are dealt with by the firm. When goods are sold for cash, they are termed as cash sales and when the goods sold on credit, they termed as credit sales.
11. Sales return
Goods sold whether on cash basis or credit are received bark from the customers are termed as sales return or return inwards.
12. Revenue
These are the amounts of the business, earned by selling its products or providing services to customers, called sales revenue.
Other items of revenue common to many businesses are commission received, interest received, dividends received, royalties received, rent received, etc. Revenue is also called income.
Revenue = Revenue from Operations (Sales) + Other Incomes
13. Expense
The term ‘expense’ denotes the cost of services and things used for generating revenue. An expense should be distinguished from a loss.
An expense is supposed to bring some benefit to the firm whereas, a loss brings no benefit to the firm, e.g. loss by theft, loss by fire, etc.
14. Expenditure
The term incurring a liability disbursement of cases or transfer of property for the purpose of obtaining assets goods or services. It may be of three types:
(i) Capital expenditure
Expenditure incurred for obtaining a long- term advantage for the business. e.g. purchase of fixed assets.
(ii) Revenue expenditure
An expenditure whose benefits expire within a year or which has been incurred merely to maintain the business or keep the assets in good working condition. e.g. salaries, repairs, maintenance, etc.
(iii) Deferred revenue expenditure
An expenditure or liability for which payment has been made or incurred but which is carried forward on the presumption that it will be of benefit over a subsequent period or periods. e.g. amount spent on training, development, advertisement, etc.
15. Receipts
Receipt is the amount received or receivable for selling goods, services or assets. Receipts can be of two types:
(i) Revenue receipts
It is the amount received or receivable in the normal course of business.e.g. amount received or receivable against sale of goods/rendering of services.
(ii) Capital receipts
It is the amount received or receivable against transactions which are not revenue in nature. e.g. amount received or receivable for sale of machinery building, furniture, investment, loan, etc.
16. Profit
The excess of sum of incomes over the sum of expenses is termed as profit. Profit is generally of three types:
(i) Gross profit
It is excess of revenue from operations (net sales) over the cost of goods sold.
(ii) Operating profit
It is the excess of operating incomes over operating cost.
(iii) Net profit
It is the excess of sum of all incomes and gains over sum of all expenses and losses.
17. Loss
The excess of sum of sum of all expenses and losses over the sum of incomes and gains is termed as loss. It is a negative form of profit.
18. Income
It is the profit earned during a period of time. It refers to excess of revenues over expenses. It also refers to increase in value of assets or decrease in value of liabilities or both, thereby increase in the owner's capital.
19. Gain
Gain means the incomes of non-recurring nature which are not earned regularly. e.g. profit on sale of fixed asset is called capital gain.
20. Goods
The term 'goods' means the property in which the business deals i.e. in terms of which, it is buying and selling or producing and selling. The items that are purchased for use in the business are called goods.
21. Purchases
Purchases are the total of goods procured/purchased by a business for use or sale. When the goods are bought for cash, it is termed as cash purchases and when the goods are bought on credit, it is termed as credit purchase. In trading concern, the purchases are made of merchandise for resale with or without processing.
In a manufacturing concern, raw materials are purchased, processed further into finished goods and then sold. For example, for furniture dealer, purchase of chairs and tables is termed as goods, while for other it is furniture and is treated as an asset.
22. Purchase returns
Goods purchased by an organisation returned to the seller due to defect or any other reason is known as purchase return.
23. Stock
Stock (inventory) is a measure of something in hand viz goods, spares and other items in a business. It is called stock in hand.
(i) In a trading concern
the stock in hand is the amount of the goods which are lying unsold as at the end of an accounting period is called closing stock (ending inventory).
(ii) In a manufacturing concern
closing stock comprises raw materials, semi-finished goods and finished goods in hand on the closing date.
Broadly speaking, stock may be classified into three categories:
(i) Stock of raw material The raw material is the stock on the basis of which goods are manufactured.
(ii) Stock of semi-finished goods It is the stock which is in the process of being finished. These goods which are partially finished. Such stock is also known as work-in-progress.
(iii) Stock of finished goods The goods which are ready to be sold in the market is known as finished goods.
24. Trade receivables
Trade receivables include the following:
(i) Debtor
A debtor is a person from whom a business has to recover money on amount of goods sold or services rendered on credit. Debtors are also called sundry debtors or trade debtors or book debts. They may be classified as below:
(a) Good debts The debts which are sure to be realised are called good debts.
(b) Doubtful debts The debts which may not be realised are called doubtful debts.
(c) Bad debts The debts which cannot be realised at all are called bad debts.
(ii) Bills receivables It is an unconditional instrument (document) prepared by business firm on its debtors duly accepted by than, ordering to pay a certain sum of money after a certain period of time for the value of goods sold or services rendered. It is an asset for the business firm drawing bills receivable.
25. Trade payable
It includes creditors and bills payables on account of goods or services acquired in normal course of business.
These are of two types:
(i) Creditors
Creditors are persons or other entities who have to be paid by an enterprise an amount for providing goods and services on credit.
The total amount standing to the favour of such persons or entities on the closing date is shown in the balance sheet as sundry creditors on the liabilities side.
(ii) Bills payable
It is an unconditional document accepted by a business firm drawn by its creditors duly accepted by the former agreeing to pay a certain sum of money after a certain period of time for the value of goods and services received. It is a liability for the business firm accepting bills payable.
26. Books of accounts
It means journal and ledger in which transactions are recorded.
27. Solvent
Solvent is a person or an enterprise which is in a position to pay its debts.
28. Insolvent
Insolvent is a person or an enterprise which is not in a position to pay its debts.
29. Cost of goods
sold It is the sum of direct costs of the goods sold or services rendered.
30. Debit
It is left side of an account. If an account is to be debited, then the entry is posted to the debit side of the account. In such a course, it is said that account is debited.
31. Credit
It is the right side of an account. If an account is to be credited, the entry is posted to the credit side of the account. In such a course , it is said that the account is credited.
32. Depreciation
Depreciation is the permanent, continuing, gradual fall in the value of fixed assets may be due to wear and tear, the passage of time, obsolescence or accident.
Accounting Equation, Accounting Standards and IFRS
Introduction
It is the fundamental aspect of accounting that every business transaction has two aspects. One aspect is debited and another aspect is credited. American accountants have derived the rules of debit and credit through a ‘novel’ medium, i.e., accounting equation. The equation is based on the principle that accounting deals with property and rights to property and the sum of the properties owned are equal to the sum of the rights to the properties. The properties owned by a business are called assets and the rights to properties are known as liabilities or equities of the business. Equities can be sub-divided into equity of the owners which is known as capital and equity of creditors who represent the debts of the business known as liabilities.
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