Chapter 02: Basic Accounting Term
There are certain basic accounting terms which are daily used in the business world. These basic terms are called accounting terminology.
(1)Entity: Entity means an economic unit,which may be business entity and non-business entity.
- Business Entity:
A business entity is a specific, distinguishable organization or unit that operates with the primary goal of engaging in economic activities, typically to produce and sell goods or services, and often with the aim of generating profit.
Example: Wipro, Maruti Suzukii etc.
- Non-Business Entity:
They often use specialized accounting frameworks that differ from profit accounting, focusing more on fund accounting and reporting on contributions and program expenses rather than just profit and loss.
In essence, a non-business entity serves a public or specific community interest, distinct from the financial interests of private owners. Such entities are also called ‘Not-for-Profit Organisation’
Example: Charitable hospitals,Cultural Societies etc.
(2) Business Transcation: A business transaction is an economic event or activity that affects the financial position of a business entity and can be reliably measured in monetary terms. It’s the core unit of accounting because every transaction has an impact on the assets, liabilities, or equity of the business.
The Chief Characteristics of a Business Transcation are:
- It is concerned with the transfer or exchange of goods & services for money consideration.
- It has dual or two aspects: One is Debit and other is Credit of equal amount
- Economic Event: It involves an exchange of value or a financial activity that has a direct impact on the business’s financial health.
- Business transactions may be classified as External & Internal. External Transactions: Involve an exchange between the business and an outside party, e.g., buying supplies from a vendor, selling goods to a customer, paying employees. Internal Transactions: Occur entirely within the business. e.g using raw materials to produce finished goods, depreciation of an asset.
While they don’t involve an outside party, they still have a financial impact that needs to be recorded.
- Affects Financial Position:A transaction changes the accounting equation (Assets = Liabilities + Equity). It could involve:An increase or decrease in assets (e.g., cash, inventory, equipment).
An increase or decrease in liabilities (e.g., accounts payable, loans).
An increase or decrease in owner’s equity (e.g., capital, retained earnings).
- Measurable in Monetary Terms: The value of the transaction can be expressed in a currency (e.g., dollars, rupees, euros). This is crucial for recording it in accounting books.
(3) Event: An event is the consequence or result of a transcation.
(4) Account: An account is a systematic record of all the transactions relating to a particular item or type of item. It is a dedicated place in the accounting system where similar transactions are grouped and summarized.
Two Sides (Debit and Credit): In double-entry bookkeeping, every account has two sides: a left side called Debit (Dr.) and a right side called Credit (Cr.). This structure helps maintain the accounting equation
(Assets = Liabilities + Equity) in balance.
Debit(Dr.) CASH ACCOUNT Credit(Cr.)
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The above statement resembles English capital letter ‘T’. As such it is often called ‘T’ shape account. An Account is abbreviated as A/c.
(5) Capital: It is the amount invested by the owners into the business, plus any accumulated profits that have been retained in the business, minus any withdrawals made by the owners
Capital = Assets – Liabilities
(6) Drawing: Cash or value of goods/assets withdrawn by the owners from the business for personal use. It reduces capital.
(7) Liability: Financial obligations or debts of the business that must be repaid to outsiders in the future.
- Non-Current Liabilities (Long-term Liabilities): Obligations that are due for repayment after a period of more than one year.
Examples: Long-term Loans (e.g., from banks, financial institutions), Debentures.
- Current Liabilities: Obligations that are due for repayment within one year.
(8) Assets: Economic resources owned by the business that are expected to provide future economic benefits. They have monetary value.
- Non-Current Assets (Fixed Assets): Assets held for long-term use in the business operations and not intended for resale. They help in producing goods/services.
Fixed Assets are further classified as:
Tangible Fixed Assets: Assets that have physical existence and can be seen and touched.
Examples: Land, Building, Machinery, Plant, Furniture, Computers, Vehicles.
Intangible Fixed Assets: Assets that do not have physical existence but have value due to the rights they confer.
Examples: Goodwill, Patents, Copyrights, Trademarks, Computer Software.
- Current Assets: Assets held for the purpose of being converted into cash or consumed within one year.
Examples:Cash in Hand,Cash at Bank, Debtors
- Fictitious Assets: These are the Assests which cannot be realised in Cash or no further benefit can be derived from these assets.
Example: Advertisement Expenses
(9) Capital Receipts & Revenue Receipts
Revenue Receipts: Recurring nature, related to normal business operations e.g., sales revenue, commission received.
Capital Receipts: Non-recurring nature, usually from sale of assets or fresh capital introduction.
e.g., sale of fixed assets, share capital issue, loans received.
Receipts: Amounts received or receivable by the business.
(10) Expenditure: Amount spent or liability incurred for acquiring assets, goods, or services.
Expenditure may be classified into three categories:
- Capital Expenditure: Incurred to acquire or improve a fixed asset, benefiting for more than one accounting period. e.g., purchase of machinery, extension of building.
- Revenue Expenditure: Incurred for the normal running of the business, benefit is consumed within one accounting period. e.g., salaries, rent, purchases of goods for resale.
- Deferred Revenue Expenditure: Revenue expenditure whose benefit extends beyond one year but is not a capital expenditure. e.g., heavy advertising expenditure.
Distinction between Capital & Revenue Expenditure:-
| Basis | Capital Expenditure (CapEx) | Revenue Expenditure (RevEx) |
| Benefit Period | More than one accounting period (long-term) | Within the current accounting period (short-term) |
| Purpose | Acquire/improve assets, increase earning capacity, growth | Maintain existing assets, daily operations, earn current revenue |
| Nature | Non-recurring, usually large amount, creates/enhances assets | Recurring, usually smaller amount, maintains assets |
| Financial Statement Recording | Recorded as an Asset on the Balance Sheet | Recorded as an Expense on the Income Statement |
| Depreciation/Amortization | Yes, depreciated/amortized over asset’s useful life | No, fully expensed in the current period |
| Impact on Profit | Reduces profit indirectly through depreciation over years | Directly reduces current year’s profit |
| Cash Flow Statement Section | Investing Activities | Operating Activities |
| Examples | Purchase of land, new machinery, building extension | Salaries, rent, utilities, routine repairs, advertising |
(11) Expenses: Cost incurred to earn revenue in an accounting period. e.g., rent paid, salaries paid, depreciation charged.
(12) Income: Revenue earned over expenses incurred. ‘Income’ is different from ‘revenue’.
Income = Revenue – Expenses
(13) Profit: Excess of revenues over expenses during an accounting period from regular business operations.
Gross Profit: Sales revenue – Cost of Goods Sold.
Net Profit: Gross Profit – Other Operating Expenses + Other Incomes.
(14) Gain: Profit arising from events or transactions incidental to business. e.g., profit on sale of a fixed asset, winning a lottery.
(15) Loss: Excess of expenses over revenues during an accounting period. Can also arise from abnormal events e.g., loss by fire, loss on sale of fixed asset.
(16)Purchases: Total amount of goods procured by a business for resale or for use in production.
- Cash Purchases: Goods bought for cash.
- Credit Purchases: Goods bought on credit.
- Purchase Returns:- When goods purchased are returned to Also known as ‘Returns Outwards’.
(17) Sales: Total revenue from goods sold or services provided to customers.
- Cash Sales: Goods sold for cash.
- Credit Sales: Goods sold on credit.
- Sales Returns:- Some customers might return the goods sold to them. Also known as ‘Returns Inwards’.
(18) Goods: Items purchased for resale or used as raw materials in production.
(19) Stock or Stock-in-Trade: Unsold goods at the end of an accounting period.
Opening Stock: Goods on hand at the beginning of the accounting period.
Closing Stock: Goods on hand at the end of the accounting period.
(20) Inventory: In accounting, inventory refers to the goods and materials that a business holds for the purpose of sale in the ordinary course of business, or that are in the process of production for such sale, or that are consumed in the production process or in the rendering of services.
Inventory in case of manufacturer,there can be opening & closing inventory of four types:-
- Raw Material: These are basic materials and components that will be used in the production process to create finished goods. Examples: flour for a bakery, steel for an automobile manufacturer.
- Work-in-Progress (WIP): These are partially completed goods that are still undergoing the production process. They have had some labor and overhead costs added to raw materials but are not yet ready for sale. Examples: partially assembled cars on an assembly line, dough being baked into bread.
- Finished Goods: These are products that have completed the manufacturing process and are ready for sale to customers. For a trading or retail business, these are simply the goods purchased for resale.
Examples: packaged cookies ready for sale, electronics in a retail store.
- Stock-in-trade: It includes the value of all those goods which are purchased for reselling.
Distinction between Stock & Inventory:-
| Basis | Stock | Inventory |
| Scope of Goods | Primarily refers to finished goods that are ready for sale to customers. Can also include raw materials if they are sold directly. | A broader term encompassing all goods a business holds, including: Raw Materials, Work-in-Progress (WIP) ,Finished Goods, Stock in trade |
| Purpose | Goods held specifically for resale to generate revenue. | Goods held for sale OR for use in production to create goods for sale. |
| Stage of Production | Typically refers to goods at the final stage ready for sale. | Includes goods at all stages of the production cycle. |
| Relationship | Stock is a subset of Inventory. All stock is inventory, but not all inventory is stock. | Inventory is the overarching term. Stock is one type of inventory specifically, finished goods inventory. |
| Management Focus | Often relates to sales and immediate customer fulfillment. | Focuses on overall supply chain efficiency, production planning, cost control, and financial reporting. |
| Valuation in Accounting | Sometimes considered at market value (selling price) or lower of cost/market for quick business insights. | Valued in accounting typically using methods like FIFO, LIFO, or Weighted Average Cost for financial reporting. |
| Common Usage | More common in retail, trading, and sales contexts . | More common in manufacturing, logistics, and formal accounting/finance contexts. |
(21) Trade Receivables: Persons or entities who owe money to the business for goods sold or services rendered on credit. Also known as Trade Debtors & Bills Receivables.
- Trade Debtors: In accounting, Trade Debtors represent the amounts of money owed to a business by its customers for goods sold or services rendered on credit.
- Bills Receivables: In accounting, Bills Receivable is a specific type of Receivable that arises when a business receives a formal, written promise from a customer (or debtor) to pay a specific sum of money on a definite future date. This promise is typically in the form of a Bill of Exchange or a Promissory Note.
(22) Trade Payables: Persons or entities to whom the business owes money for goods purchased or services received on credit. Also known as Trade Creditors & Bills Payables.
- Trade Creditors: In accounting, Trade Creditors refer to the amounts of money that a business owes to its suppliers for goods or services purchased on credit as part of its normal operating activities.
- Bills Payables: In accounting, Bills Payable refers to a specific type of liability that arises when a business issues a formal, written promise to pay a specific sum of money to a supplier or creditor on a definite future date.
(23) Cost: Cost can be termed as the amount of resources given up in exchange for goods and services. The resources given up are money or money’s equivalent expressed in terms of money.
Example:- A retailer buys 100 shirts at ₹500 each. The cost of these shirts for the retailer is ₹50,000 (100 shirts * ₹500/shirt).If there are additional direct expenses like freight charges to bring the shirts to the shop (e.g., ₹2,000),. So, the total cost might be ₹52,000.
(24)Voucher: Documentary evidence in support of a transaction. e.g., cash memo, invoice, receipt.
(25) Discount: Reduction in the price of goods or amount of a debt.
- Trade Discount: Allowed by a supplier at the time of sale, not recorded in books.
- Cash Discount: Allowed for prompt payment, recorded in books as an expense (discount allowed) or income (discount received).
(26) Rebate: In accounting, a rebate is a partial refund of the purchase price of a product or service that is given back to the buyer after the original payment has been made. It’s a retrospective reduction in the cost. Example: Rebate may be allowed because of poor quality of goods sold or goods being not as per specifications.
(27)Goods & Services Tax(GST): All indirect taxes like Excise Duty, Sales Tax, VAT, Service Tax etc. have been merged into a single tax known GST. It is paid at the time of purchase & GST is collected at the time of sale.
(28) Proprietor: Proprietor is the person who owns the business and who invests the capital in the business and bears all the risks releated to the business.
(29) Entry: In accounting, an “entry” refers to the act of recording a financial transaction in the books of accounts
(30) Bad Debts: Amount that becomes irrecoverable from a debtor. It is a loss for the business.
(31) Insolvent: A person or entity whose liabilities exceed their assets, and they are unable to pay their debts.
(32) Solvent: A person or entity whose assets exceed their liabilities, and they are able to pay their debts.
(33) Stores: In accounting, the term “stores” most commonly refers to materials and supplies held in inventory by a business, particularly in manufacturing or production environments and not for resale. Examples: lubricants, packing materials etc.
(34) Revenue: The gross inflow of cash or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise assets yielding interest, royalties, and dividends.
(35) Revenue from Operations: It is the revenue earned by an enterprise from its operating activities. It includes revenue from sale of goods and revenue from sale of services.
(36)Turnover: It means total sales made in a particular period.
(37) Livestock: Domestic animals, such as cattle or horses are known as Livestock.
(38) Investments: It refers to deployment of funds in the shares or debentures of Companies with the intention of earning a return.
(39) Book Value: It is the value of an assest existing in the books of accounts.