Basic Accounting Terms

You may often hear accountants and other business professionals throw aroundbasic accounting terms accounting terms that sound like nothing but jargon to most of us. Here is a quick reference guide for some of the often used basic accounting terms.

Accelerated Depreciation – Any method of depreciation other than straight-line depreciation in which more depreciation expense is recorded earlier on in the life of the asset and less depreciation expense in the end of the assets depreciable life.

Account – A record (represented by a general or sub ledger number) that represents a unit of measurement of money, other resources, or claims to the money or other resources.

Account PayableAn account which represents money owed to a vendor or creditor for delivered goods or services. These accounts represent balances the company owes outside parties. 

Account Receivable – An account which represents a claim for uncollected money from the delivery of goods or services. These accounts represent what customers owe the company. 

Accounting – The record keeping and reporting of financial transactions in the form of financial statements. Accounting is often referred to as “the language of business.”

Accounts Receivable Turnover – Calculated by dividing net sales by average net accounts receivable over a specified period of time. This ratio measures the company’s ability to collect payment from credit customers.

AccrualRecording the expense or income for a good or service that has already been received or delivered but not yet been recorded. Accruals are used to match income and expenses in the correct periods in which they are incurred.

Accumulated Depreciation – The total depreciation expense recorded for an asset since it has been placed into service. The asset acquisition value less the accumulated depreciation represents the “book value.”

Allowance for Doubtful Accounts – An account that represents an estimated amount of the accounts receivable balance that will not end up being collected. The accounts receivable balance less the allowance for doubtful accounts balance represents “net accounts receivable.”

Amortization – The deduction of the value of an intangible asset over time. Amortization works similar to depreciation except it is used for intangibles such as patents, copyrights, and bond premiums/discounts.

Asset – An item owned by a person or company that represents a probable future economic benefit. The item can be tangible such as a cash or a building or intangible such as a patent.

Bad Debt – The portion of a receivable or loan balance that is considered “uncollectible.” Bad debt usually arises from an event impacting the borrowing party that indicates they will not make good on their loan such as bankruptcy.

Bank Reconciliation – A process an accountant performs to determine the causes of the difference between a cash bank statement and the cash balance on the general ledger. Differences can arise from items such as “deposits in transit” or “un-cleared checks.”

Bond Discount – The amount below the PAR value that a bond is sold for. The PAR value is usually considered the “face value” of the bond. Example: If a $1,000 bond is sold for $800 due to an increase in interest rates, the bond discount would be $200.

Book Value – The amount of an asset (net of depreciation/amortization) shown on a company’s balance sheet. Companies must report assets at book value on their balance sheets.

Break Even Point – The amount of sales required for revenue to equal total expense. This can be expressed in dollars or units.

Capital Gain – The portion of a gain on the sale or exchange of an asset that is taxed at a lower rate. The lower rate is known as the “capital gains rate.” Assets need to be held for at least one year to qualify for the lower tax rate.  

Capital Stock – Represents the ownership of a company authorized by its “Articles of Incorporation.” On the balance sheet the capital stock account represents the total amount of the par value of all stock issued by the corporation.

Capital Lease – A lease that is treated like a “purchase.” An asset and liability are established on the balance sheet of the lessor and lessee.

Carrying Value – Same as “book value.” See above.

Cash – An asset account on the balance sheet which represents paper currency, coins, negotiable checks, money orders, and short-term government securities.

Certified Public Accountant (CPA) – An accountant who has met the educational requirements of his or her state and passed the uniform four section CPA exam created by the AICPA (American Institution of Certified Public Accountants).

Closing Entry – A journal entry made at the end of a reporting period which clears the balances of the revenue and expense accounts.

Commercial Paper – A way for a company to borrow money using unsecured short-term notes sold to the public through investment banking firms.

Common Stock – Capital stock that has no preferential treatment in terms of dividends or distributions.

Consolidation – Combining the net assets, revenue, and expenses of two or more entities for financial reporting purposes.

Contra Account – An account which represents a reduction or “offset” of another account. A good example of a contra account would be “accumulated depreciation” which would reduce the corresponding asset to arrive at “book value.”

Contribution Margin – Calculated by taking revenue less variable costs.

Costs of Goods Sold – The costs associated with the production of goods or services sold by the company. The amount includes direct material and labor costs as well as indirect overhead expenses.

Credit – An entry in a general ledger accounting system which represents a reduction to an asset or expense account and an increase to a liability or revenue account. 

Current Ratio – A calculation to understand how quickly a company can meet its obligations. It is calculated by dividing the current assets by the current liabilities on the balance sheet.

Debit – An entry in a general ledger accounting system which represents an increase to an asset or expense account and a decrease to a liability or revenue account.

Depreciation – The act of expensing an asset over its economic useful life.

Dividends – A distribution of a portion of a company’s earnings to a class of stock shareholders.

Effective Interest Rate – The rate of interest actually paid or redeemed. The effective interest rate incorporates discounts and premiums.

Effective Tax Rate – The total income tax paid expressed as a percentage of net income.

Equity – Ownership, calculated by taking assets less liabilities.

Expense – The outflow of cash or other valuables from a company for goods or services.  

Fair Market Value – The current “market price” of an asset. Basically what the asset could be exchanged for on the open market.

FASB – Financial Accounting Standards Board. This board establishes and clarifies accounting guidance under US Generally Accepted Accounting Principles.

FIFO – “First-in First-out”, an inventory valuation method under which the costs to acquire the first materials and goods are expensed through costs of goods sold first.

Finished Goods – An inventory balance which represents goods that are ready to be sold to customers.

Fiscal Year – A chosen period of 12 months in which a company chooses to operate. Most companies operate on a calendar year (Jan-Dec) but many choose other periods of 12 consecutive months to operate.

Fixed Asset – Tangible long-lived property not expected to be consumed or converted into cash anytime soon.

FOB Destination – A shipping term which indicates that the receiving party takes legal control of the asset when it arrives to its destination. Until arrival, the shipping party assumes responsibility.  

FOB Shipping Point – A shipping term which indicates that the receiving party takes legal control of the asset when the goods are shipped.

Forecast – Using historical information and other indicators to predict future incomes and expenses for decision making purposes and external reporting.

Form 10-K – A Securities and Exchange annual filing requirement for all public companies. The form 10-K shows the company’s financial statements, footnotes, and provides other relevant information to help investors make decisions.

Fraud – The purposeful misrepresentation or deception intended to produce a personal financial gain.

GAAP – Generally Accepted Accounting Principles. They are considered rules and guidance to define accepted accounting practices. The most authoritative source of US GAAP is set forth by the Financial Accounting Standards Board.

General Ledger – The collection and organization of all asset, liability, equity, revenue, and expense accounts.

Goodwill – The premium or excess amount over the fair market value (using its tangible and intangible assets and liabilities) paid in the acquisition of another company.

Gross MarginCalculated by taking net sales less cost of goods sold.

Income – The total revenue received in a given period of time. Not to be confused with “net income” which represents all revenue minus all expenses in a given period.

Income Statement – A financial statement which summarizes all revenue and expenses over a given period of time.

Interest – Money paid at a certain rate for the use of borrowed money.

Internal Audit – Auditing measures performed internally by a company’s own staff instead of by an external third party. Internal auditors identify risk and help management with decision making.     

Internal Revenue Code – The tax rules set forth by the Internal Revenue Service of the federal government.

Internal Revenue Service – The federal agency that administers the internal revenue code.

Inventory Turnover – A ratio a company uses to indicate how many times its average inventory balance is sold during a specified period of time. It is usually calculated by dividing net sales by inventory.

IPO – “Initial Public Offering.” Represents the first sale of stock when a private company goes public.

Journal Entry – A single transaction recorded in the general journal.

LIFO – “Last-in First-out”, an inventory valuation method under which the costs to acquire the last materials and goods are expensed through costs of goods sold first.

Liability – Obligations owed by a debtor to a creditor payable in cash, goods, or services.

Long-Term Asset – An asset that has an economic useful life longer than one year.

Long-Term Liability – An obligation that is not due to a creditor for more than one year.

Management Accounting – Accounting analysis performed for the use of managers and leaders for internal decision making purposes.

Margin – Selling price of a unit less its unit cost to produce or purchase.

Market Price – Same as “Fair Market Value.” See above.

Materiality – The impact an omission or misstatement on the financial statements would have on the decision making of an external user.

NASBA – “National Association of State Boards of Accountancy.” NASBA serves as the administrator of the uniform CPA exam for all 54 state boards of accountancy.

Net Income – Total revenues and gains less total expenses and losses for a specified accounting period.

Net Present Value (NPV) – A method to evaluate an investment by analyzing the net present value of all cash outflows and inflows using a given discount rate and required rate of return.

Net Sales – Calculated by taking gross sales less adjustments for returns, allowances, and discounts.

Notes Payable – A written promissory note for the repayment of cash due in less than one year.

Notes Receivable – A written promissory note for the receipt of cash loaned due in less than one year.

Operating Lease – A lease which conveys the right to use but not the ownership of an asset. The benefit of an operating lease is that it remains off the balance sheet (no asset or liability is recorded for the lease).

Operating Profit/Loss – Calculated by taking the revenue from business operations less expenses from normal business operations. Income and expenses derived from other sources and events is excluded in operating profit.

Opportunity Cost – The price or rate of return an alternative course of action would provide.

PCAOB“Public Company Accounting Oversight Board.” An entity created by the Sarbanes-Oxley act of 2002 to oversee the audit procedures performed by the accounting firms to protect the public interest.

Periodic Inventory System – An accounting method used for determining inventory on hand by performing a physical count at the end of an accounting period.

Perpetual Inventory System – An accounting method used for determining inventory on hand by utilizing continuous journal entries that impact inventory accounts.

Petty Cash – An insignificant amount of cash on hand used to pay minor business expenses.

Plant – A building or group of buildings where goods are produced.

Preferred Stock – A form of capital stock which carries preferential treatment over common stock to dividends and assets.

Bond Premium – The amount above the PAR value that a bond is sold for. The PAR value is usually considered the “face value” of the bond. Example: If a $1,000 bond is sold for $1200 due to a decrease in interest rates, the bond premium would be $200.

Prepaid Expense – An amount paid for goods or services that have not yet been consumed or realized in the revenue earning cycle.

Pro Forma Financial Statements – Projected future financial statements based on historical data and other variables.

Profit Margin – Calculated by dividing the net profit by revenue.

Property, Plant, and Equipment – Long-term tangible assets used in the operations of the business.

Purchase Order – A written note to a vendor requesting the delivery of specific goods or services.

Raw Material – A material in its original state that will be used in the manufacturing of a product.

Retained Earnings – The accumulated amount of net income retained by the company and not paid out to the shareholders.

Revenue – Arises from both the sale of goods and services and the earnings from interest and dividends.                   

Revenue Recognition – Revenue can be recognized or recorded when it has been earned and is realized or realizable based on the terms of the sale or contract.

SEC – “Securities and Exchange Commission.” The agency authorized by the US Congress to regulate the financial reporting practices of publicly traded companies.

Shareholder – An owner of one or more shares of common stock of a company.

Short-Term Debt – Debt obligations that are due within one year.

Standard Cost – Estimated costs for direct materials, labor, and overhead. Usually based on a per unit basis.  

Statement of Cash Flows – A required financial statement under US GAAP which breaks out net cash provided from operating, investing, and financing activities.

Stockholder’s Equity – The value of the ownership in a company. It is calculated by subtracting total liabilities from total assets.

Straight-Line Depreciation – A depreciation method which expenses depreciation equally over the economic useful life of an asset. Straight-line depreciation is calculated by dividing the total book value of the asset by the number of useful life years.

Subsequent Event – An event which could significantly impact investor decisions that occurs after the end of the accounting period but before the release of the financial statements.

T-Account – A simple form of a general ledger account in which debits can be recorded on the left side and credits on the right side.

Transaction – An event or condition recognized using a journal entry in a general ledger account.

Treasury Stock – Stock that is repurchased by the issuing company.

Unearned RevenueAmounts received in advance of providing goods or services. The amounts are liabilities on the balance sheet until the goods and services have been provided.

Variable CostsThe costs that are dependent on the total productive output.

Work-In-Process – An inventory account which is made up of raw materials, labor, and overhead which is in the process of being converted to finished goods.