Basic Terms used in Accounting
There are two basic financial statements which are prepared by an enterprise:
- Profit & Loss Statement, and
- Balance Sheet
The three components of a balance sheet can be stated in the form of following basic accounting equation
Assets = Liabilities + Capital (owners equity)
This equation tells at a glance that the resources of this enterprise total R50,000 and these assets are financed by two sources — R10,000 by the creditors(liabilities), also known as outsiders claims, and R40,000 by the owner (capital), also known as owner equity.
It is an economic event that relates to a business entity. It can be a purchase of goods, collection of money, payment to creditors for goods and expenses. An event to be a transaction must possess the quality of economic substance, relate to business and affect the economic results. In other words, an event must be capable of being measured in monetary terms and related to business enterprise in terms of economic consequence.
These are economic resources of an enterprise that can be usefully expressed in monetary terms. Assets are things of value used by the business in its operations.
For example, Departmental Store owns a fleet of trucks, which is used by it for delivering food stuff; the trucks, thus, provides economic benefits to the enterprise. This item will be shown of the asset side of the balance sheet of Departmental Store. Assets can be broadly classified into two types: Fixed Assets and Current Assets.
- Fixed Assets are assets held on a long term basis, such as land, buildings, machinery, plant, furniture and fixtures. These assets are used for doing business and not for re-sale in normal course of operation.
- Current Assets are assets held on a short term basis such as debtors (account receivable), bills receivable (notes receivable), stock (inventory), temporary investment in securities, cash and bank balances. Normally the short term refers to an accounting year.
These are the obligations or debts that the enterprise must pay in money or services at sometime in the future.
Therefore, represent creditors, claims against assets of the firms. Both small and big businesses find it necessary to borrow money at some time or the other, and to purchase goods on credit.
For example, Pick N Pay, purchases goods for R10,000 on credit for a month from Fast Foods Products Company on 25 December 2001. If the balance sheet of Departmental stores is prepared as at 31 December 2001, Fast Food Products Company will be shown as creditors (accounts payable) on the liabilities side of the balance sheet. If the departmental store also takes a loan for a period of three years from Absa Bank, this will be shown as a liability in the balance sheet of the Departmental Stores.
- Long term liabilities are those that are usually payable after a period of one year, for example, a term loan from financial institution or debentures (bonds) issued by the company.
- Short term liabilities are obligations that are payable within a period of one year, for example, creditors (accounts payable), bills payable (notes payable), cash credit overdraft from a bank for a short period.
Investment by the owners for the use in the firm is known as capital. From the accounting equation given earlier, it can easily be found that the capital is R40,000. Owner’s equity is the ownership claim on total assets. It is equal to total assets minus total external liabilities: E=A-L this is also called residual interest. Owner’s equity is equal to capital.
Sales are total revenues from goods sold and/or services sold or provided to customers. Sales may be cash sales or credit sales.
These are the amounts the business earns by selling it products or providing services to customers. These are called ‘sales revenues’. Other items and sources of revenues common to many businesses are: sales, fees, commission, interest, dividends, royalties, rent received, etc.
These are costs incurred by a business in the process of earning revenues. Generally, expenses are measured by the cost of assets consumed or services used during an accounting period.
The usual items of expenses are: depreciation, rent, wages, salary, interest, costs of heat, light and water, telephone, etc.
Expenditure is the amount of resources consumed. Usually, it is of long term in nature. Therefore, its benefit is to be derived in future. For example: capital expenditure.
Loss is the gross decreases in the assets or gross increases in the liabilities. It is the excess of expenses over revenues. It represents reduction in owners’ equity due to inability of the firm to recover the assets used in the business.
For example, a firm spends R 70,000 and generates revenue of R 60,000, there is a loss of R 10,000 which represents non-recovery of assets consumed in doing business.
Income is the increase in the net worth of the organization either from business activity or other activities. Income is a comprehensive term, which includes profit also. In accounting income is the positive change in the wealth of the firm over a period of time.
Profit is the excess of revenues over expenses during an accounting year. It increases the owner’s equity.
Gain is the change in the equity (net worth) arising from change in the form and place of goods and holding of assets over a period of time whether realized or unrealized. It may either be of capital nature or revenue nature or both.
It is the amount of cash or other assets withdrawn by the owner for his personal use.
Purchases are total amounts of goods procured by a business on credit and for cash, for use or sale. In a trading concern, purchases are made of merchandise for resale with or without processing. In a manufacturing concern, raw materials are purchased, processed further into finished goods and then sold. Purchases may be cash purchases or credit purchases.
Stock (inventory) is a measure of something on hand-goods, spares and other items-in a business. It is called stock on hand.
In a trading concern, the stock on hand is the amount of goods which have not been sold on the date on which the balance sheet is prepared. This is also called closing stock (ending inventory). In a manufacturing company, closing stock comprises raw materials, semi-finished goods and finished goods on hand on the closing date.
Similarly, opening stock (beginning inventory) is the amount of stock at the beginning of the accounting year.
Debtors (accounts receivable) are persons and/or other entities who owe to an enterprise an amount for receiving goods and services on the credit. The total amount due from such persons and/or entities on the closing date is shown in the balance sheet as the sundry debtors (account receivables) on the asset side.
Creditors (accounts payable) are persons and/or other entities who have to be paid by an enterprise an amount for providing the enterprise goods and/ or services on credit. The total amount standing due to such persons and/or entities on the closing date is shown on the balance sheet as sundry creditors (accounts payable) on the liability side.