Basic Accounting Terminology and Concepts
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Accounting is the process of tracking and recording financial activity. People and businesses use the principles of accounting to assess their financial health and performance. Accounting also serves as a useful way for people and companies to honor their tax obligations.
The history of accounting dates back to ancient times. In the modern world, it is most closely associated with businesses' financial reporting. However, everyone can benefit from a knowledge of accounting basics.
General accounting knowledge can be important for individual income-earners during tax season. The following guide explains key accounting definitions and terms.
How to Use This Accounting Terms Guide
This is an alphabetized glossary of accounting terms. It was developed for students and entrepreneurs to build their familiarity with accounting vocabulary.
Accounting Basics for Students
Some students enter accounting programs with little technical knowledge — and that is OK. This guide is an easy-to-use resource for developing the vocabulary accounting professionals use.
It can also be used to:
Gauge interest in a potential accounting career before applying to programs Build familiarity with accounting essentials prior to commencing studies Refresh knowledge gained in an accounting program
Consider reading these additional accounting student resources:
Accounting Basics for Business Owners
Accounting is key to the success of small business ventures. But not all small business owners can pursue formal financial training.
The terms and concepts in this guide were curated in part for their relevance to new entrepreneurs. Glossary entries cover concepts essential to businesses. Examples include terms such as "accounts payable," "accounts receivable," "cash flow," "revenue," and "equity."
Consider reading these additional business owner resources:
Simple Accounting Definitions
Our accounting basics dictionary includes dozens of important terms. This guide includes accounting definitions, alternative word uses, explanations of related terms, and the importance of particular words or concepts to the accounting profession as a whole.
We also explain relevant etymologies or histories of some words and include resources further exploring accounting terminology.
An accounting period defines the length of time covered by a financial statement or operation. Examples of commonly used accounting periods include fiscal years, calendar years, and three-month calendar quarters. Some organizations also use monthly periods. Each accounting period covers one complete accounting cycle. An accounting cycle is an eight-step system accountants use to track transactions during a particular period.
Accounts payable (AP) tracks money owed to creditors. Examples include bank loans, unpaid bills and invoices, debts to suppliers or vendors, and credit card or line of credit debts. Rarely, the term "trade payables" is used in place of "accounts payable." Accounts payable belong to a larger class of accounting entries known as liabilities.
Accounts receivable ( AR) tracks the money owed to a person or business by its debtors. It is the functional opposite of accounts payable.
Accounts receivable are sometimes called "trade receivables." In most cases, accounts receivable derive from products or services supplied on credit or without an upfront payment. Accountants track accounts receivable money as assets.
Accrual Basis Accounting
Accrual basis accounting (or simply "accrual accounting") records revenue- and expense-related items when they first occur. For example, a customer purchases a $2,000 product on credit. Accrual accounting recognizes that $2,000 in revenue on the date of the purchase. The method contrasts with cash basis accounting, which would record the $2,000 in revenue only after the money is actually received. In general, large businesses and publicly traded companies favor accrual accounting. Small businesses and individuals tend to use cash basis accounting.
Revenues and expenses recognized by a company but not yet recorded in their accounts are known as accruals (ACCR). By definition, accruals occur before an exchange of money resolves the transaction.
For example, a company that hired an external consultant would recognize the cost of that consultation in an accrual. That cost would be recognized regardless of whether or not the consultant had invoiced the company for their services. Accounts payable and accounts receivable are accrual types. Others include accrued costs (costs incurred but not resolved during a particular accounting period) and accrued expenses (expenses or liabilities incurred but not resolved during a particular accounting period).
Assets are items of value, or resources that a business owns or controls. More technical and precise definitions specify two technicalities: First, assets result from past business activities. Second, they will or are expected to generate future economic value. Assets come in many types and classes. Types include current and noncurrent, operating and nonoperating, physical, and intangible. Classes include broad categories such as cash and equivalents, equities, commodities, real estate, intellectual property, and fixed income, among others.
A balance sheet (or "statement of financial position") is a standard financial statement. It specifies the business' current state regarding its assets, liabilities, and owners' equity. Some sources abbreviate the term as BAL SH.Accountants use multiple formats when creating balance sheets: classified, common size, comparative, and vertical balance sheets. Each format presents information as line items that combine to provide a snapshot summary of the company's financial position.
In common usage, capital (abbreviated "CAP.") refers to any asset or resource a business can use to generate revenue. A second definition considers capital the level of owner investment in the business. The latter sense of the term adjusts these investments for any gains or losses the owner(s) have already realized.Accountants recognize various subcategories of capital. Working capital defines the sum that remains after subtracting current liabilities from current assets. Equity capital specifies the money paid into a business by investors in exchange for stock in the company. Debt capital covers money obtained through credit instruments such as loans.
Cash Basis Accounting
Cash basis accounting records revenues and expenses when the money involved in each transaction officially changes hands. It contrasts with accrual basis accounting. Accrual accounting recognizes revenues and expenses when they occur without regard to whether the associated funds have been exchanged.
Cash flow (CF) describes the balance of cash that moves into and out of a company during a specified accounting period. Accountants track CF on the cash flow statement.
Certified Public Accountant
A certified public accountant (CPA) is an accounting professional specially licensed to provide auditing, taxation, accounting, and consulting services. CPAs work for both businesses and individual clients.
To obtain CPA licensure, a candidate must meet eligibility criteria and pass a demanding four-part standardized exam. Eligibility standards include at least 150 hours of higher education covering related coursework.
Chart of Accounts
Accountants record financial transactions in a bookkeeping system known as a general ledger. A chart of accounts (COA) is a master list of all accounts in an organization's general ledger. Five main types of accounts appear in a COA: assets, equity, expenses, liabilities, and revenues.
Closing the Books
The informal phrase "closing the books" describes an accountant's finalization and approval of the bookkeeping data covering a particular accounting period. When an accountant "closes the books," they endorse the relevant financial records. These records may then be used in official financial reports such as balance sheets and income statements.
Cost of Goods Sold
Cost of goods sold (COGS) describes the total costs a company incurred in creating a product or providing a service. With products, the associated costs fall into three broad categories: materials, labor, and overhead. With services, costs include expenses related to employee compensation, materials, and equipment. Accountants sometimes use the alternative term "cost of sales."Accountants use the following basic formula to calculate COGS over a specific accounting period: Initial Inventory + Purchases - Ending Inventory.
Credits are accounting entries that increase liabilities or decrease assets. They are the functional opposite of debits and are positioned to the right side in accounting documents.
Debits are accounting entries that function to increase assets or decrease liabilities. They are the functional opposite of credits and are positioned to the left side in accounting documents.
Depreciation (DEPR) applies to a class of assets known as fixed assets. Fixed assets are long-term owned resources of economic value that an organization uses to generate income or wealth. Real estate, equipment, and machinery are common examples. Fixed assets can decline in value. Accountants record those declines as depreciation.
Diversification describes a risk-management strategy that avoids overexposure to a specific industry or asset class. To achieve diversification, people and organizations spread their capital out across multiple types of financial holdings and economic areas. The term is also widely used in finance and investing.
In corporate accounting, dividends represent portions of the company's profits voluntarily paid out to investors. Investors are often paid in cash, but may also be issued stock, real property, or liquidation proceeds. In most cases, dividends follow a regular monthly, quarterly, or annual payment schedule. However, they can also be offered as exceptional one-time bonuses.
Double-entry systems record each financial transaction twice: once as a credit, and once as a debit. When the sum total of all recorded debits and credits equals zero, the accounting books are considered "balanced."
The system is also known as double-entry accounting. It is a more complete and accurate alternative to single-entry accounting, which records transactions only once.
Single-entry systems account exclusively for revenues and expenses. Double-entry systems add assets, liabilities, and equity to the organization's financial tracking.
An enrolled agent (EA) is a finance professional legally permitted to represent people and businesses in Internal Revenue Service (IRS) encounters. EAs must earn licensure from the IRS by passing a three-part exam or accruing direct experience as an IRS employee.
At a basic level, equity describes the amount of money that would remain if a business sold all its assets and paid off all its debts. It therefore defines the stake in a company collectively held by its owner(s) and any investors.The term "owner's equity" covers the stake belonging to the owner(s) of a privately held company. Publicly traded companies are collectively owned by the shareholders who hold its stock. The term "shareholder's equity" describes their ownership stake.
A fixed cost (or fixed expense) is a cost that stays the same regardless of increases or decreases in a company's output or revenues. Examples include rent, employee compensation, and property taxes. The term is sometimes used alongside "operating cost" or "operating expense" (OPEX). OPEXs describe costs that arise from a company's daily operations. However, these costs can be fixed or variable. Variable costs change as output or revenues change.
Businesses and organizations use a system of accounts known as ledgers to record their transactions. The general ledger (GL or G/L) is the master account containing all ledger accounts. It holds a complete record of all transactions taking place within a specified accounting period.Major examples of individual accounts in a general ledger include asset accounts, liability accounts, and equity accounts. Each transaction recorded in a general ledger or one of its sub-accounts is known as a journal entry.
Generally Accepted Accounting Principles
Generally accepted accounting principles (GAAP) describe a standard set of accounting practices. GAAP are endorsed by organizations including the Financial Accounting Standards Board and the U.S. Securities and Exchange Commission (SEC), among others. However, GAAP are only one of multiple such standards. One well-known alternative is International Financial Reporting Standards (IFRS).In the United States, privately held companies are not required to follow GAAP, but many do. However, publicly traded companies whose securities fall under SEC regulations must use GAAP standards. The SEC has stated that it may adopt IFRS best practices to replace GAAP in the future.
Gross profit (or gross income) defines the value of the products and services sold by a business before factoring in the cost of goods sold. If the gross profit is a negative number, it is instead called a gross loss. It contrasts with "net profit," which describes the actual profit earned after accounting for those costs.Gross margin is a related term: It specifies the value of the organization's net sales, minus the cost of goods sold. Net sales are calculated by correcting gross sales for adjustments such as discounts and allowances.
An income statement is a type of financial document businesses generate. It specifies the total revenues earned by the company in a given accounting period, minus all expenses incurred during the same period. Other terms used to describe income statements:
- Earnings statement
- Profit and loss statement
- Statement of financial result(s)
- Statement of operation
Income statements are one of three standard financial statements issued by businesses. The other two include the balance sheet and cash flow statement.
As used in accounting, inventory describes assets that a company intends to liquidate through sales operations. It includes assets being held for sale, those in the process of being made, and the materials used to make them.
A liability (LIAB) occurs when an individual or business owes money to another person or organization. Bank loans and credit card debts are common examples of liabilities.
Accountants also distinguish between current and long-term liabilities. Current liabilities are liabilities due within one year of a financial statement's date. Long-term liabilities have due dates of more than one year.The term also appears in a type of business structure known as a limited liability company (LLC). LLC structures allow business owners to separate their personal finances from the company's finances. As such, owners cannot be held personally liable for debts incurred solely by the company.
In accounting, liquidity describes the relative ease with which an asset can be sold for cash. Assets that can easily be converted into cash are known as liquid assets. Accounts receivable, securities, and money market instruments are all common examples of liquid assets.
Net profit describes the amount of money left over after subtracting the cost of taxes and goods sold from the total value of all products or services sold during a given accounting period. It is also known as net income. If the net profit is a negative number, it is called net loss. The related term "net margin" refers to describing net profit as a ratio of a company's total revenues. Net profit contrasts with gross profit. Gross profit simply describes the total value of sales in a given accounting period without adjusting for their costs.
Accountants track partial payments on debts and liabilities using the term "on credit" (or "on account"). Both versions of the term describe products or services sold to customers without receiving upfront payment.
Overhead (O/H) costs describe expenses necessary to sustain business operations that do not directly contribute to a company's products or services. Examples include rent, marketing and advertising costs, insurance, and administrative costs.
Businesses must account for overhead carefully, as it has a significant impact on price-point decisions regarding a company's products and services. Overhead costs must be recouped through revenues.
Tracking operations that record, administrate, and analyze the compensation paid to employees are collectively known as payroll accounting. Payroll also includes fringe benefits distributed to employees and income taxes withheld from their paychecks.
Accountants sometimes make future projections with respect to revenues, expenses, and debts. The concept of "present value" (PV) describes calculated adjustments that express those future funds in present-day dollars.
It is essentially a way of adjusting future revenues, expenses, and debts for inflation. This allows others within the business to understand those projections' potential impacts in relatable terms. Present value is sometimes called discounted value (DV).
A receipt is an official written record of a purchase or financial transaction. Receipts serve as proof that the transaction took place and allow those transactions to be processed for tax purposes.
Retained earnings (or earnings surplus) specifies the profits that remain after the business has paid all costs in a given accounting period. It includes all indirect and direct expenses: the cost of goods sold, dividend payments, and tax liabilities.
When retained earnings (RE) are positive, they increase the organization's equity. That equity may then be reinvested back into the business to fuel its future growth.
Return on Investment
Usually expressed as a percentage, return on investment (ROI) describes the level of profit or loss generated by an investment.
Accountants calculate ROI by dividing the net profit of an investment by its cost, then multiplying by 100 to generate a percentage. For example, consider a person who invests $10,000 in a company's stock, then sells that stock for $12,000. The exchange would generate an ROI of 20%. When an investor incurs a loss, the ROI is expressed as a negative number.
Revenue (REV) describes the income a business earns by selling products and/or services associated with its main operations. For example, a restaurant's revenue covers all food and beverage sales. It would not cover additional sources of income, such as the liquidation of equipment or real estate owned by the business.The terms "revenue" and "sales" can be synonymous. For example, revenue is used to establish the datapoint comprising the "sales" component of a price-to-sales calculation. Single-Entry Bookkeeping: Single-entry bookkeeping records all revenues and expenses with a single entry in the company's books. It is also known as single-entry accounting.Single-entry systems are simplified financial tracking methods often used exclusively by small businesses. Transactions are recorded in a document known as a "cash book." It contrasts with the more precise and accurate double-entry accounting method. Double-entry accounting records all transactions twice: once as a debit, and once as a credit.
A trial balance is a report of the balances of all general ledger accounts at a point in time. Accountants prepare or generate trial balances at the conclusion of a reporting period to ensure all accounts and balances add up properly. In professional practice, trial balances function like test-runs for an official balance sheet.
Variable costs are expenses that can change depending on the volume of goods produced or sold by a company. For example, a manufacturer would incur higher costs if it doubled its product output. Companies may also face higher tax rates as their sales and profits rise. These are both examples of variable costs. By comparison, fixed costs remain the same regardless of production output or sales volume. Examples of fixed costs include rent, wages, and salaries.
Questions About Accounting Terms
What is a simple definition of accounting?
In its most basic sense, accounting describes the process of tracking an individual or company's monetary transactions. Accountants record and analyze these transactions to generate an overall picture of their employer's financial health.
What are the basics of accounting?
Basic accounting concepts used in the business world cover revenues, expenses, assets, and liabilities. These elements are tracked and recorded in documents including balance sheets, income statements, and cash flow statements.
What are some accounting concepts?
Introduction to accounting frequently identifies assets, liabilities, and capital as the field's three fundamental concepts. Assets describe an individual or company's holdings of financial value. Liabilities are debts and unpaid expenses. Capital describes the money the entity has on hand.
What are the different types of accountants?
Certified public accountants and management accountants are two of the profession's most common specializations. Management accountants are also known as cost accountants. Auditors and forensic accountants are another important branch of the field.
Lizzette Matos, CPA
Lizzette Matos is a certified public accountant in New York state. She earned a bachelor of science in finance and accounting from New York University. Matos began her career at Ernst & Young, where she audited a diverse set of companies, primarily in consumer products and media and entertainment. She has worked in private industry as an accountant for law firms and for ITOCHU Corporation, an international conglomerate that manages over 20 subsidiaries and affiliates. Matos stays up to date on changes in the accounting industry through educational courses.
Lizzette Matos is a paid member of the Red Ventures Education freelance review network.
Page last reviewed April 8, 2022.
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