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Home Introduction to Accounting Important Accounting Terms and Concepts
 
 

Important Accountings Terms and Concepts:

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1. Business Entity:

Profit making organizations are known as businesses. There are three main types of businesses; those selling services (such as dry cleaners, motor workshops, beauty salons, airlines etc.); those selling goods (such as food sellers, automobile dealers etc.); those manufacturing goods (such as automobile manufacturers, fans industries, sugar mills etc.).

A business entity is an economic unit which enters into business transactions that must be recorded, summarized and reported. The entity (organization) is regarded as separate from its owner or owners; the entity owns its own property and has its own debts. The purpose of accounting is to provide useful information about an organization (an entity) to people who need such information but not about the personal affairs of the owner or owners. So it should be remembered that accounting is done for business activities (what is happening in the business organization) and it is not concerned with the personal or private matters of the owner. For example, the owner purchases furniture for business use (this is a business activity and it should be recorded in books of accounts. But if he purchases furniture for his domestic use, it will not be considered as a business activity and will not be recorded in books of accounts. In the same way, the owner may have a personal bank account, a car, a house, and other property, but since these things are not a part of the business, they are not included in the record of the business unit. So, each organization for which accounting is done is an independent entity, separate from its owners, managers, customers, creditors, and all other persons and entities with which it deals.

Forms of Business Organizations

There are three main forms of business organization;

(a) Single or sole proprietorship:

The simplest form of business organization "to organize and operate" is a single or sole proprietorship. This is the most common form of ownership and is found in business such as small retail shops, service stations etc. The owner is the only one in control and makes all management decisions.

(b) Partnership:

In a partnership, ownership is divided between two or more persons who agree to share their property and skills to start and-operate a business. Like the single proprietorship, a partnership business is simple to organize.

(c) Joint Stock Company:

A joint stock company has the legal right to act as person. It may be owned by many people. A company has its own name, in which it can buy, own, and sell property; make contracts; borrow money; and take court action. The persons who have made investment in the company are known as shareholders.

2. Goods or Merchandise

In accounting the word "Goods" has a special meaning. It refers to something which has been purchased by a trader for resale purposes or anything which has been manufactured for selling purposes. For example, if a trader purchases furniture for use in the business, it will not be regarded as "goods", but if it is purchased for resale, it will be regarded as "goods". The same article may be "goods" for one trader but may not be so to another trader. For example, furniture is not "goods" for a book seller; but it will be regarded as "goods" to a furniture-dealer.

Thus,

Cloth will be "goods" to a cloth dealer

Watches will be "goods" to a Watch dealer

Books will be "goods" to a Book - Seller

Stationery will be "goods" to a Stationery dealer.

But watches, books or stationery will not be considered as "goods" to a cloth dealer.

3. Purchases:

In accounting language the word "Purchases" has a special meaning. When saleable goods are bought in a business, it is said that "purchases" have been made. For example, to a cloth dealer, whenever cloth is purchased, it will not be necessary to mention that cloth has been purchased. simply it will be said that purchases have been made. On the other hand, if stationery is purchased, then it will be essential to mention that stationery has been purchased.

4. Cash Purchases:

If goods are purchased from, a supplier and payment is made to him at the same time, such purchases are known as "Cash Purchases". For example, Mr. X purchased goods from a seller, Mr. Y, for $5000 on 1st January, 2005, and payment is made to the seller (Mr. Y) at the same date (1.1.2005), it will be a case of cash purchases.

5. Credit Purchases or "Purchases on Account":

When goods are purchased from a seller and payment is not made to him at the same time, rather the payment is arranged to be made at some future date, such purchases are known as "credit purchases" or "Purchases on account". For example, Mr. A purchased goods from Mr. B for $5000 on 1st January, 2005 and Mr. A agreed to make the payment of goods on 15th January, 2005 (payment has not been made on 1.1.2005), it will be a case of credit purchases. On 15th January Mr. A will pay $5000 to Mr. B.

6. Purchases Returns or Returns Outwards:

Goods once purchased may subsequently be sent back to the seller for certain reasons, i.e. goods are defective, not according to specification, damaged or below standard. Such return of goods to the seller is known as "Purchases returns" or "Returns to suppliers". For example, we purchased 100 radio sets (goods) from Five Star Electronics for $15000. On receiving the delivery of goods, it is found that 10 radio sets are of inferior quality. The return of these 10 radio sets to the seller (Five Star Electronics) will be a case of purchases returns for us.

7. Purchases Discount and Sales Discount:

The Concession given by the supplier to the buyer on purchases of goods is known as "Purchases discount" to the buyer and "Sales discount" to the seller (supplier).

8. Allowances:

Sometimes, the customers (buyers) find that goods purchased have minor defects. In that case, the seller may agree to reduce the price of damaged or defective goods to induce the buyer to keep the goods. Such reduction in price is known as "Purchases allowance" to the buyer and "Sales allowance" to the seller.

9. Sales:

We know that goods are purchased for selling purposes. When these goods are sold to customers at a specific price, it is said that sales have been made. For example, we purchased goods worth $5000 (our purchases). Suppose, these goods have been sold at a price of $6000 - in accounting language it will be said that sales have been made at $6000. So goods sold are called "Sales".

10. Cash Sales:

If goods are sold to customers at a specific price and price of the goods is received from them at the time of sale of goods, such sales are known as "Cash sales". For example, we sold goods to a customer, Mr. A for $2000 on 10th January, 2005 and received the cash from him on the same date, it will be a case of cash sales.

11. Credit Sales:

If goods are sold to a customer and he does not pay the price of goods at the same time but agrees to make payment on some future date, the sales are called "credit sales" or "sales on account." For example, we sold goods to Mr. X for $3000 on 15th January, 2005 and he agreed to make payment on 31st January, 2005, it will be a case of credit sales or sales on account.

12. Sales Returns or Returns Inwards:

If a customer to whom goods have been sold finds that the goods are defective, unsatisfactory, below standard or not according to specification, he may return these goods to the seller. To the seller, such return of goods is known as "sales returns" or "returns inwards" or "returns from customers.

13. Trade Discount:

At the time of selling goods, the manufacturer or wholesaler allows retailers such a discount (concession). It is allowed at a certain percentage of the listed or catalogue price. For example, the list price of the goods is $30,000, and the wholesaler allows a trade discount of 10% on the listed price to the retailer. It means that net price of the goods is 27,000 (30,000 - 3,000). The trade discount enables the retailer to sell goods at the listed price; and the customer can be sure about the fair price of the goods. It may be noted that both the buyer and seller will record $27,000 (not $30,000) in their books of account. In other words trade discount is not recorded in books of account. Thus, discount allowed by manufacturer or wholesaler at the time of selling goods to retailer as a deduction from the listed price or catalogue price, is called trade discount.

14. Debtors or Accounts Receivable:

When goods are sold to the customers on credit basis (credit sales are made to customers), debtors come into existence. Debtors are the persons or customers to whom goods have been sold on credit basis and from whom the business is to receive money in near future. The accounts of such customers are known as "Accounts Receivable". For example, we sold goods to A for $3,000, to B for $2,000 and to C for $4,000 on credit basis. The amount receivable from them (A, B and C) is known as "Debts" and the three customers, A, B and C are our debtors or accounts receivable.

15. Creditors or Accounts Payable:

When goods are purchased from the suppliers (sellers) on credit basis, creditors come into existence. Creditors are the persons or suppliers from whom goods have been purchased on credit basis and to whom the money is to be paid in near future. The accounts of such persons (suppliers) are known as "accounts payable". Accounts payable means, the amount which a business expects to pay to its suppliers for goods purchased or services received from them on credit basis.

The person or business who will receive the money - Creditor.

The person or business who will pay the money -Debtor.

16. Cash Discount:

It is a deduction or allowance given by a creditor to a debtor if the amount due is paid by the debtor before the due date, or it is a reduction in price (usually 2% or less) offered by manufacturers or wholesalers (creditors) to encourage customers (debtors) to pay their debts within a specified discounted period. For example, X sold goods to Y (a customer) for $1,000 on credit basis. It means, X is creditor and Y is debtor. X offers an allowance of 2% to Y, if he will pay his debts within 15 days. It means, if Y pays his debts within 15 days, then he will pay only $980 (1,000 - 20) to X. Such a discount is known as "cash discount".

17. Capital or Owner's Equity:

To understand this term, recall that business is an entity (organization) separate from its owner or owners. Equities mean the sources of funds provided to start or to operate a business entity. Now the question is: who provides funds to a business unit. Mainly there are two sources of funds:

  1. Funds supplied by the owner/owners.
  2. Funds supplied by the external parties like bank etc.

So, the amount of cash or goods invested (supplied) by the owner/owners in a business unit is known as "capital" or owner's equity.

Or

Capital is the money or moneys worth borrowed by a business unit from its owner or owners.

Or

It is the claim or right of the owner/owners against the assets (properties etc. possessed by business) of the business.

Or

It is the source of funds provided by the owner/owners of the business.

Or

It is a part of the total equity which is supplied by the owner/owners.
 

For example, Mr. X started a business with $100,000. Out of $100,000, $70000 have been provided by, the owner, X and $30,000 have been borrowed from a bank. Now, the equity (total funds) of the business is $100,000 but owner's equity (capital) of the business is $70,000 (1,00,000 - 30,000).

18. Assets:

Assets are the economic resources (having certain value) owned by a business on a particular date and which are expected to benefit the future operation of the business.

Or

Assets are the properties and possessions of a business both tangible (have physical existence) and intangible (have no physical existence).

Or

Assets are the things having certain value possessed by a business and receivable by a business on a particular date. For example, cash, furniture, building, land, machinery, stock of goods, Debtors or Accounts receivable, Bank balance, Goodwill etc.

19. Liabilities:

Liabilities are the debts or obligations of a business.

Or

The outsider's (creditors etc.) claims against the assets of the business are known as "Liabilities". There are two main parties who have claims against the assets of a business;

  1. (a) Owner's claim
  2. (b) Outsiders' claims.

The owner's claim against the assets of a business is known as owner's equity and outsider's claims against the assets of the business are known as "liabilities."

Or

Liabilities mean the total amount which a business is legally bound to pay to the outsiders, e.g. creditors, Bills payable, Accounts payable, Bank loan etc.

20. Accounting Period:

It is a span of time for which a business generally prepares its financial statements (the statement prepared to know the profit or loss of a business and to know its financial position). Mostly the financial reports are prepared for one year but they may also be prepared for one month or for one quarter.

21. Revenue:

All business organizations are engaged in providing goods or services to their customers. The amount which a business charges its customers for these goods or services, measures the revenue of the business.

Or

It is the price of goods sold or services provided by a business to its customers.

Or

Revenue is the inflow of assets (cash or debtors) in return for services performed or goods delivered (sold) during an accounting period.

Or

It is inflow of cash and debtors (receivable) in exchange for goods sold or services rendered during an accounting period.
 

For example, we sold goods to a customer for $1,000 and he paid cash to us $1,000. The revenue will be equal to inflow of cash $1,000. But if the customer has paid only $500 and he agreed to pay the remaining amounts  at some future date, again in that case the revenue will be equal to $1,000 (inflow of cash $500 + $500 receivable).

Revenue has the following types.

1. Sales: The total price of goods sold
2. Interest earned
3. Fees earned
4. Rent earned
5. Commission earned

22. Expenses:

Expenses are the costs of the goods and services used up in the process of obtaining revenue.

Or

Expenses are the cost of producing revenue in a particular accounting period.

Or

An expense is a sacrifice, or cost incurred to generate revenue.

For example, salaries for employees, telephone charges, rent of the building, insurance and transportation etc. All these costs are necessary to attract and serve the customers and thereby to obtain revenue. Expenses are sometimes also referred to as the "cost of doing business" or "expired costs".

23. Net Income or Profit:

Net income or net profit is simply the amount by which the "revenue" for a particular period of time exceeds the "expenses" incurred to generate them.

Net income or net profit = Revenue - Expenses

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More study material from this topic:

Need and importance of accounting
Accounting as a business language
Bookkeeping versus accounting
Branches of accounting
Objects of accounting
Important accounting terms and concepts
Accounting principles
Accounting concepts
Accounting conventions
Questions and answers

 

A D V E R T I S E M E N T

 

Financial Accounting Topics


  Introduction to Accounting
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  Transactions and Accounting Equation
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  Analysis of Business Transactions
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  Journal, Ledger and Trial Balance
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  Accounting for Bills of Exchange
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  Special Journals
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  Cash Book
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Bank Reconciliation Statement
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  Final Accounts
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  Work Sheet
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  Capital and Revenue Items
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  Valuation of Inventories
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  Accounts of Non-profit Making Organizations
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  Statement of Cash Flows
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  Accounting Ratios Analysis
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  Depreciation, Provisions and Reserves
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  Accounting Dictionary
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  Financial Calculators
 
 
 
Managerial Accounting Topics

  Financial Statements
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  Cost Volume Profit Relationship
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  Variable Costing System
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  Materials and Inventory Cost Control
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  Activity Based Costing System
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  Standard Costing and Variance Analysis
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  Balanced Scorecard
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  Capital Investment Analysis/Capital Budgeting
 

 

 

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