Accounting is the process of recording, summarizing, and reporting financial transactions. It is a critical tool for businesses of all sizes, as it provides information that can be used to make informed decisions about financial matters.
There are many different accounting terms and definitions that can be confusing for beginners. This article provides a basic overview of some of the most common accounting terms.
Assets are resources that a business owns or controls. They are typically classified as either current assets or long-term assets.
- Current assets are assets that are expected to be converted into cash within one year. Examples of current assets include cash, accounts receivable, inventory, and prepaid expenses.
- Long-term assets are assets that are not expected to be converted into cash within one year. Examples of long-term assets include property, plant, and equipment, intangible assets, and investments.
Liabilities are debts that a business owes to others. They are typically classified as either current liabilities or long-term liabilities.
- Current liabilities are debts that are due within one year. Examples of current liabilities include accounts payable, accrued expenses, and notes payable.
- Long-term liabilities are debts that are not due within one year. Examples of long-term liabilities include bonds payable, mortgages payable, and long-term notes payable.
Equity is the owner’s claim on a business’s assets. It is calculated as the difference between assets and liabilities.
Revenue is the money that a business earns from its sales or services.
Expenses are the costs that a business incurs in order to generate revenue.
Profit is the difference between revenue and expenses.
Loss is the opposite of profit. It occurs when expenses are greater than revenue.
The balance sheet is a financial statement that summarizes a business’s assets, liabilities, and equity at a specific point in time.
The income statement is a financial statement that summarizes a business’s revenue, expenses, and profit or loss over a period of time.
Statement of cash flows
The statement of cash flows is a financial statement that summarizes a business’s cash inflows and outflows over a period of time.
The accounting equation is a basic formula that summarizes the relationship between assets, liabilities, and equity. The equation is:
Assets = Liabilities + Equity
This equation states that the total value of a business’s assets is equal to the total value of its liabilities plus the total value of its equity.
A debit is an entry on the left side of an accounting ledger. Debits typically represent increases in assets or decreases in liabilities or equity.
A credit is an entry on the right side of an accounting ledger. Credits typically represent decreases in assets or increases in liabilities or equity.
Journal entries are the basic unit of recordkeeping in accounting. They record the effects of financial transactions on the accounting equation.
A ledger is a book or computer system that summarizes all of the journal entries for a business.
A trial balance is a list of all of the accounts in a ledger and their balances. It is used to verify that the accounting equation is in balance.
Closing entries are journal entries that are made at the end of an accounting period to transfer the balances of temporary accounts to permanent accounts.
The accounting cycle is the process of recording, summarizing, and reporting financial transactions. It typically consists of the following steps:
- Journalizing – Recording financial transactions in the journal.
- Posting – Transferring the journal entries to the ledger.
- Preparing a trial balance – Verifying that the accounting equation is in balance.
- Adjusting entries – Recording any necessary adjustments to the accounts.
- Preparing financial statements – Summarizing the financial information in the ledger.
- Closing entries – Transferring the balances of temporary accounts to permanent accounts.
Accounting standards are the rules and regulations that govern the preparation and presentation of financial statements. In the United States, the primary accounting standard is generally accepted accounting principles (GAAP).
Accounting is a complex and challenging subject, but it is essential for anyone who wants to understand the financial health of a business. By understanding the basic accounting terms and definitions, you can start to make sense of the financial information