Learning accountancy takes a lot of time. That is why I write these 10 basic accounting terms. These are the most important terms in accounting you need to know.
1.) Accounting Equation in Basic Accounting Terms
Accounting Equation – is the accounting identity. In the accounting equation, the asset should be equal to liabilities and owner’s equity combine. Another term for the asset is the total resources. In the overall resources, part of it is the initial investments or capital. The initial investment can generate income. To generate income, the business firm should do business operations.
Besides the income, to run the operations business firm has to pay for expenses either cash or on account (terms). Once the expenses incurred on account, the company has obligations or liabilities. If the income is on account, then the company has accounts receivable. Asset account, Liability account, Owner’s Equity account, Income account, and Expense account are the expanded accounting equation.
The Financial Statement
The financial statement composes of these five major accounts. Under each major account comprises several account titles. Account titles are classified as either asset account, liability account, owner’s equity account, Income account, and Expense account. Account title has normal balances namely debit balance and credit balance. Debit balance is the left side of the account title and credit balance is the right side of the account title. Account title is the determining factor. It determines whether the debit or credit entry is an addition or subtraction to the account. Asset and Expense account normally is a debit balance.
Liability, Owner’s Equity, and Income account normally is a credit balance. Posting an amount to the left side of the asset and expense account will increase both accounts. Conversely, posting on the right side of the asset and expense account will decrease the value of both accounts. Entry posted to the right side of liability, owner’s equity, and income will increase all accounts. However, entry posted to the left side of these three accounts will decrease the accounts.
2.) Journal Entry
Journal Entry – an accounting process to record identified economic events (transactions). The double-entry accounting method follows in making journal entries. Journal entry composes of debit entry credit entry. Entry/entries made to an account/s should always have a partner entry/entries. Debit entry should be equal to credit entry. See double-entry accounting rules.
Components of recording transactions:
a.) Account titles – account names to an item to identify the type of account.
b.) Amount – a quantity of something. Represents the value of debit and credit.
c.) Date – the day specified by a number. It is when the transaction takes place.
d.) Description – explanation/s why you made the journal entry/ entries.
e.) Debit and Credit – left side and right side of account respectively.
3.) Ledger
Ledger – often called the T-account. It is where we post the journal entries. All account titles recorded in the journal entries should make a ledger for the computation of total balances. A ledger has an account title, beginning balance, debit amount and/or credit amount, and ending balance. Account title is the basis of arithmetical operation. For instance, if the account title Cash has a debit entry it is an addition while credit entry is a subtraction. Another example, if the account title is an income account, a credit entry is an addition while a debit entry is a subtraction.
4.) Trial Balance
Trial Balance – the purpose of the trial balance is to bring both debit amount and credit amount balance or tally. Once balances are both tallies you can prepare financial reports for interested users. Moreover, if there are wrong posting of accounts it should correct by making adjusting journal entries. Adjusting entries are for the same ledgers and reflected trial balances to get adjusted balances.
5.) Matching principle
Matching principle – It is one of the accounting principles you need to remember. One of the bases of the bureau of internal revenue (bir) in computing taxes. The matching principle is the revenue recognition principle. It states that you should record revenue when earned and expense when incurred.
6.) Accruals and Deferrals
Accruals and Deferrals – the purpose of accruals and deferrals is to correct the figures stated in the financial statements. The accrual basis of accounting is in recording transactions. It is the recognition of the occurrence of something.
Example of Accruals in Basic Accounting Terms:
a.) Accrued expense – Interest earned from time deposit. A time deposit is a long-term deposit, interest-bearing with maturity. To follow the matching principle, you should accrue income earned even though the time deposit has not matured.
b.) Accrued expense – taxes and 13th-month pay. Taxes are usually a huge amount of expenses that’s why business firms accrue expenses monthly. The same is true with 13th-month pay it needs accrual because the expense is good for the entire year.
c.) Allowances – impairment loss allowance and allowance for bad debts. Impairment loss allowance is an allowance to degrading the value of the land. There should be an allowance to land so that the declared assets are in fair market value. We set allowance for bad debt to doubtful accounts. Debtors sometimes can’t pay their installment or amortization for 2-3 consecutive months.
When this occurs, you should set an allowance for possible bad debts. You don’t need to wait until the account became bad debt before you recognize and expense. Good thing there is accrual accounting. It prevents the business firm from recording huge expenses for one day. Huge expenses happen gradually it doesn’t happen in one day. In bookkeeping, the bookkeeper should identify the factor/s that may affect the financials in the future to set an allowance.
Example of Deferrals in Basic Accounting Terms:
a.) Airline tickets – Passengers buy tickets ahead of time. It is recorded as deferrals because cash is paid in advance but the service is not yet rendered.
b.) Prepaid rent – rental payment is paid in advance but the rental income is not yet earned. The rental income is recorded as deferred income or liability account.
7.) Cost principle
Cost principle – in this principle the recording of transactions is based on historical cost, not the current fair market value. This applies to land, loans, furniture, fixture, and equipment
8.) Premium and Discount
Premium and Discount – Premium the paid amount is more than or above the stated value of the account. For instance, in bond investment – any amount that exceeds the value of the bond certificate is a premium. However, if the paid amount is less than the value of the exchange, the difference is a discount.
9.) Depreciation and Amortization
Depreciation and Amortization – Depreciation is an expense gradually recorded based on the useful life of a fixed asset. Fixed assets normally cost a huge amount, it can’t be recorded as an expense one time. The depreciation method is used to decrease the value of a fixed asset. Amortization is the schedule of the amount computed periodically until maturity. In the amortization schedule, you can see the value of an asset account over time.
10.) Financial Statements
Financial Statements – these are the records of the financial affairs of a business. Transactions are recorded using double-entry accounting (Journal entry). The journal entries are posted to ledgers to summarize the amounts. The ending balances per ledger are carried over to trial balances. If the trial balance is tally, you can prepare the financial reports or financial statements Need help with bookkeeping services? Contact us.
Pingback: Personal Finance Books – Why No Mention Of MLM Or Internet Marketing? – Site Title