Ten Important Accounting Terms
Accounting, known as the language of business, is a system of information intended to reflect the economic activities within an organization. It is concerned with the methods of recording transactions, keeping financial records, performing internal audits, analyzing financial information, and advising taxation matters. Accounting as a profession provides relevant and reliable financial information used in decision making. It can be a difficult profession to understand, so we have compiled the following list of frequently used terms that can help grow your accounting knowledge.
Accrual Accounting: The system in accounting in which transactions are recorded when they occur and in the period in which they relate to rather than when cash is received or paid.
Balance Sheet (or Statement of Financial Position): A balance sheet provides a summary of the total assets owned by an organization and the total amount of debt and equity used to finance the assets at a specific point in time. The total sum of assets is always equal to the sum of debt and equity; hence, the term balance sheet. Like an income statement, a balance sheet is also prepared using the accrual method.
Budget: A detailed plan with information on income and expenses prepared in anticipation of future activities. A budget is usually prepared with agreed objectives and in line with the overall strategy of the organization.
Cash Flow Statement: The cash flow statement provides a summary of the total cash inflow and outflow over a particular time. The cash flow statement is divided into three sections: operating cash flow, investing cash flow, and financing cash flow representing the cash inflow and outflow as a result of each of these activities.
GAAP: GAAP stands for generally accepted accounting principles. These are sets of standards and principles used as the basis for measurement, recognition, and disclosure of financial accounting information. In the United States, the Financial Accounting Standards Board is responsible for setting accounting standards for public companies. The International Accounting Standards Board is responsible for setting International Financial Reporting Standards.
General Ledgers: The general ledger is a central location where all the accounts in a company are listed. Journal entries are posted in a journal which are then transferred (posted) to a general ledger that holds information on all the accounts.
Income Statement: The income statement provides a summary of the income and expenses incurred by an organization over a specified time. The three main parts to the income statement are the income section (sales), the expense section (generally consisting of operating, financial, and tax), and the net profit. The net profit is the difference between the income and expenses. If the expenses exceed income, a net loss is incurred. The income statement is prepared using the accrual method.
Journal Entries: A system of recording accounting transactions. Every accounting transaction has a debit and credit entry (double entry). A debit is an entry that either increases an asset account or decreases a liability or owners’ equity account. A debit entry is shown on the left side of the journal entry. A credit is an entry that either decreases assets or increases liabilities and owners’ equity and is shown on the right side of the journal entry.
Investors: There are generally two kinds of investors: equity and credit investors. Equity investors are investors who invest financial resources in a company in return for an ownership stake. Equity investors receive a share of the profits the company generates and also benefit from appreciation of the value of the organization. Credit investors lend financial resources to an organization for a set period of time. They expect to get a fixed payment (interest) on a regular basis until their investment is paid back.
Total Fixed Costs and Total Variable Costs: Fixed costs are costs within an organization that remain the same even when the volume of activity changes. Variable costs, on the other hand, will fluctuate proportional to the volume of activity.