Below are some simple accounting terminology or basic terms every small business owner, bookkeeper, and the auditor should have a thorough understanding of…even if you have a certified public accountant CPA that takes care of all that “stuff”…
Accounting Basic Definition:
Accounting is the process of documenting the financial transactions of your business entity in a way that you or other interested parties can analyze and make sound financial decisions regarding your business.
Paying your office’s utility bill affects your small business’s financial condition because it would then have less cash on hand. Such an economic event or condition that directly changes your business’s financial condition is a financial (business) transaction. The accuracy of these transactions is a key element to any successful business.
All business transactions can be stated in terms of changes in the three elements of this accounting basic equation which is to the base of all guidelines such as the Generally Accepted Accounting Principles GAAP:
Assets = Liabilities + Owner’s Equity
Learn more about the above accounting basic equation and debits/credits. A trial balance should have the same debit and credit balances at the end of the calendar year or fiscal year.
Accounting systems are designed to show the increases and decreases in each part of the above accounting basic equation in a separate record. This record is called an account.
For example, since cash appears on the balance sheets, a separate record is kept of the increases and decreases in cash.
Likewise, a separate record is kept of the increases and decreases for supplies, equipment, notes payable, and other balance sheet items.
Similar records would be kept for income statement items, such as revenue, wage expenses or employee salaries, cost of goods cogs such as labor, rent expenses, etc., that will result in the net income or total earnings of a company.
A group of accounts that contains all of the balance sheet and income statement or profit & loss statement accounts is called a general accounting ledger. An entry in the ledger is known as a journal entry. A list of the accounts in the general ledger is called a chart of accounts.
The accounts are usually listed in the order in which they appear in the financial statements. The balance sheet accounts are usually listed first, in the order of assets, liabilities, and owner’s equity. The income statement accounts are then listed in the order of revenues and expenses.
Each of these major classifications is briefly described below:
Assets are resources you own and add value to your business. Examples of a company’s assets include cash, accounts receivable (money owed by customers (individuals or corporations) to another entity in exchange for goods or services that have been delivered or used but not yet paid for), supplies, inventory, prepaid expenses (such as prepaid rent or insurance) buildings, equipment, and land. There are even assets that do not exist in a physical sense or are intangible items such as trademarks, copyrights, and patents. Depreciation or deductions is the loss of value over a certain period of time.
Current Assets are resources that you can expect to turn into cash or be used up within a year’s time.
Noncurrent Assets are resources that are NOT expected to turn into cash or be used up within a year’s time, such as property, equipment, and long-term investments. Noncurrent assets also included fixed assets.
Fixed Assets are assets that your business owns that are used to operate your business, such as land, buildings, equipment, and office furniture. Assets not intended to sell to your customers.
Liabilities are debts owed by your business. Liabilities are often identified on your balance sheet by titles that include the word payable. Examples of liabilities include: accounts payable (money owed to vendors for products and services purchased on credit), notes payable, and wages payable.
Current Liabilities are debts due within a year of your balance statement’s date.
Long Term Liabilities are debts that are not payable within a year of your balance statement’s date, such as a long-term bank loan.
Equity is the owner’s, shareholder equity, or investor’s right to the assets or working capital of their business. These are usually paid out in dividends.
Revenues are increases in the owner’s equity. Examples of revenue include sales and commissions.
Expenses are assets used up or services consumed in the process of operating your business. Examples of typical operating expenses include wage expense, rent expense, utilities expense, supplies expense, and miscellaneous expense.