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Accounting Terms Defined

Susan Honea

Susan Honea – 8 years experience helping businesses with bookkeeping, tax preparation and auditing

Last updated: May 21, 2020

Confused by accounting terminology? Don't be. Here's an explanation of common accounting terms and what they mean.

Accounting Terms Defined

Not everyone has an accounting degree, of course, but many of us need a basic understanding of accounting terms. Whether you’re looking at implementing accounting software in your small business or hoping to communicate better with your accountant, knowing some basic accounting terms can help you interface more effectively with the business world. We have assembled some of the most important accounting terms to provide you a good start in navigating the accounting realm.

Below you will find some of the most common accounting terms divided by these categories: balance sheet, income statement, bookkeeping terms, business structures, people, and general terms. Terms will include commonly-used abbreviations where applicable.

Balance Sheet Terms

Balance Sheet
A balance sheet is a summary report that shows a company’s assets (what it owns), liabilities (what it owes), and equity. The balance sheet reflects the company’s assets, liabilities, and equity at a specific point in time, rather than over a range. The formula used to calculate a balance sheet is assets = liabilities + equity. In other words, the liabilities and equity combined are assets, thus the name balance sheet.

Asset (A)
An asset is anything a company owns. All assets have what is referred to as a convertible value, meaning that they could be sold for cash. On the balance sheet, assets are listed in a specific order based on their liquidity, starting with cash, which is most liquid, and ending with land, which is least liquid. Common assets include vehicles, equipment, and accounts receivable.

Current assets (CA)
Also referred to as current accounts, a current asset is one the company expects to sell or use within a year, such as inventory; cash and cash equivalents; stocks, bonds, and money market accounts; accounts receivable; and prepaid liabilities.

Fixed assets (FA)
Also referred to as long-term assets or capital assets, a fixed asset is one a company cannot easily sell or use within a year, such as equipment, buildings, or land. Some non-tangible assets, such as copyrights, are also considered fixed assets. Fixed assets are typically subject to depreciation

Asset classes
Asset classes are groups of similar investment assets. Typical asset classes include real estate, cash and cash equivalents (or currency), stocks (or equities), bonds (or fixed income), global markets, commodities, and global fixed income.

Liability (L)
A liability is a debt that a company owes to another company or person. There are two types of liabilities: current (CL) and long-term (LTL).

Current liabilities are debts that will be paid within a year. Common current liabilities include payroll, credit cards, and accounts payable.

Long-term liabilities are debts that will be paid over a longer period of time. Common long-term liabilities include long-term financing (loans or mortgages).

Equity (E)
Equity is the net worth of the company. When liabilities (what is owed) are subtracted from assets (what is owned), equity is what is left over. Equity is the part of the company that owners and investors actually own. Equity can be represented as a positive or negative number, depending on whether asset values exceed the liabilities against them or vice versa.

Additional terms include owner’s equity and shareholders’ equity.

Income, Revenue, or Sales (Rev)
Income (also referred to as revenue or sales) is any money earned by a company. Income can be earned through various means, including payment for goods or services, dividends from investments, and interest earned on bank accounts. Income increases assets on the balance sheet. Two types of revenue are gross revenue and net revenue.

Gross revenue is the total amount of money earned by the company before any expenses are deducted.

Net revenue is the amount of money earned by the company after expenses are subtracted; net revenue is also referred to as profit.

Expense or Cost
An expense is any money spent by the business. Expenses can include goods or services that a company purchases from another company or person, cost of goods sold, depreciation, overhead expenses, and taxes. Expenses decrease equity in one of two ways: short-term expenses, or those that are paid immediately, decrease assets, and long-term expenses, or those that are paid over a period of time, increase liabilities. There are several types of expenses: fixed expenses (FE), variable expenses (VE), accrued expenses (AE), and operation (OE).

Fixed expenses are regular expenses that are consistent over time, such as lease, rent, or loan payments.

Variable expenses are regular expenses that can change from one time period to the next, such as labor costs.

Accrued expenses are expenses that have been incurred and are recognized on the books but have not yet been paid, such as payroll, which is earned in one period and paid in a subsequent period.

Operation expenses are expenses that are required for a company to conduct business, such as property taxes or insurance, but are not part of the cost of goods sold.

Accounts Payable (A/P)
Accounts payable refers to money a company owes to its creditors for goods and/or services. On the company balance sheet, it appears under “current liabilities.”

Accounts Receivable (A/R)
Accounts receivable are the payments owed to a company after goods and/or services have been delivered. Accounts receivable are listed as assets on the balance sheet because, in most situations, it is likely that the payments will be made in a short time frame.

Accruals are liabilities and assets for which money has not yet been paid or received. Accruals affect the balance sheet, and they also appear on the income statement for accrual-based accounting businesses because they affect net income. Examples of accruals can include payroll, interest (earned or payable), tax liabilities, and accounts payable and receivable.

Book Value (BV)
Book value (BV)—sometimes referred to as net book value—can refer to either a company’s book value or an asset’s book value.

The company’s book value is calculated as follows:
Book value = total assets – intangible assets – liabilities

The book value of an asset is calculated by subtracting any depreciation or amortization from the asset’s original purchase price. Book value is also affected by impairment costs, which occurs when an asset is no longer worth the same amount as its book value.

Bonds, coupon bonds, and bearer bonds
A bond is an anonymous way for an investor to earn a fixed amount of interest income from a company on an ongoing basis. An investor chooses to invest a set amount of money in a company that, in return, issues coupons reflecting a specific amount of interest to be paid. The investor submits the coupon to the issuing company to claim interest and is paid accordingly. The interest paid each year increases the face value of the bond. Though physical coupons rarely exist because of modern electronic practices, the process remains the same.

Capital refers to a company’s financial assets.

Debt capital refers to capital raised through obtaining a loan.

Working capital refers to the assets available to a company day to day. The formula for working capital is current assets – current liabilities.

Equity capital is acquired through sale of stock or shares in the company.

Over time, assets are depreciated to reflect their loss in value. In most companies, only assets with substantial purchase value, such as vehicles and equipment, are depreciated.

Diversification involves spreading out capital over different investments to lower one’s risk.

Money (typically from profits) a company pays to its shareholders on a regular basis.

Goods available for sale and the raw materials used to produce them are part of a company’s inventory. Inventory is typically divided into three types: finished goods, work-in-progress, and raw materials.

Liquidity refers to how easily an asset can be sold or converted to cash.

In accounting, material can mean a couple of different things. It can refer to the relevancy of information, which information being material if it might impact decision-making. It can also refer to matter used to make finished goods (i.e., raw materials).

Market value
Market value is the value of an asset in the marketplace, or how much a buyer might pay for it.

On Credit/On Account
If something is purchased on account, it is purchased on credit (meaning the business is deferring payment to a later date). When the item is paid off, it is paid on account.

Present Value (PV)
Determining present value (PV) means calculating how much a given amount of money today will be worth some time in the future when inflation and interest are factored in.

Working capital
Working capital refers to the assets available to a company day to day. The formula for working capital is current assets – current liabilities.

Income Statement Terms

Income Statement (also Profit & Loss Statement)
The income statement is a financial statement showing the company’s profit and loss. It is calculated as Net Income = (Total Revenue + Gains) – (Total Expenses + Losses).

Revenue (also Sales)
The income a company brings in through sales of goods or providing services is its revenue.

Cost of Goods Sold (COGS)
Sometimes referred to as cost of sales, the cost of goods sold (COGS) includes the total direct costs of producing goods that a company has sold. COGS is calculated as COGS = beginning inventory + P (purchases during the period) – ending inventory. Direct costs include the costs of running the business (overhead), any materials consumed while manufacturing a product, and labor engaged in producing the goods (direct labor).

Cost of Services
Cost of services is similar to cost of goods sold (COGS) except that it refers to the total direct costs of creating and delivering a service. In some cases, accounting software packages don’t include a cost of services option on the default chart of accounts; however, it can typically be created in just a few steps to ensure that service-related businesses can calculate their cost of services correctly.

Expenses include any money a business spends to bring in revenue. An expense is different from a cost in that expenses are usually paid regularly, while a cost is a one-time expenditure. Costs are investments while expenses are ongoing expenditures. Therefore, a cost can be an expense, but an expense is never considered a cost.

A gain is an increase in a company’s net profit from activities outside of normal day-to-day operations. For example, if the fair market value of an asset increases (appreciates), the company must reflect a gain when the asset is sold.

Gross Margin
The gross margin is the revenue of a company after the costs of producing a good or service are deducted. Gross margin is calculated as gross margin = net sales – cost of goods sold (COGS).

Gross Profit
Sometimes referred to as gross income, gross profit is the total revenue of a company minus the cost of goods sold (COGS). Thus, the formula for calculating gross profit is gross profit = revenue – cost of goods sold (COGS).

A loss is a decrease in a company’s net profit from activities outside of normal day-to-day operations. For example, if the fair market value of an asset decreases (depreciates), the company must reflect a loss when the asset is sold.

Net Income (NI)
Net income (NI) refers to the amount of money left after all other expenses (including taxes and interest) are subtracted.

Net Margin
Also referred to as a company’s bottom line or net profit margin, net margin reflects the company’s percentage of profit on each dollar of revenue. Net margin is calculated by subtracting the cost of goods sold (COGS), expenses, interest, and taxes from revenue, dividing that number by revenue, and then multiplying by 100, resulting in a percentage. Thus, the formula for calculating net margin is net margin = revenue – cost of goods sold (COGS) – expenses – interest – taxes) / revenue * 100.

Bad debts expense
When a company provides goods or services to a customer on credit, and the customer does not pay for the goods or services, the company reports this as a bad debts expense. The company has two options for reporting the bad debts expense: a direct write-off method and an allowance method.

Direct write-off method
The direct write-off method is most frequently used in the United States. In this method, the uncollected account is removed from accounts receivable and reflected as an expense.

Allowance method
The allowance method requires a company to estimate how much bad debt it thinks will occur in a given reporting period and state that on the balance sheet. The allowance is calculated based on historical data in one of two ways: using a statistical model of probability of payment or taking a percentage of net revenue.

Interest may refer to the cost of borrowed funds to a business (a fee for borrowing funds). The lender receives this fee in exchange for the service of lending funds. Interest can also refer to the percentage of ownership a stockholder holds in a company.

Overhead refers to the cost of doing business. These costs can be fixed (mortgage, rent, sometimes property taxes or utilities), variable (supplies, maintenance of equipment, shipping), or semi-variable (commissions, for example).

The amount of money that a business pays to its employees.

Receipts refer to any money taken in by a business during a specific accounting period.

Variable Cost
A variable cost is simply an expense that can change (vary) depending upon other factors, such as increased or decreased production or other activity.

Bookkeeping Terms

Accounting Period
The amount of time covered by financial statements is an accounting period. An accounting period might be a year, a fiscal year, three months (quarterly), a month, or some other specified period.

Accrual-based accounting method
In the accrual-based accounting method, revenues or expenses are recorded when a transaction occurs, as opposed to cash-based accounting, which records transactions when payment is received or made. For tax purposes, income is reported in the year it is earned even if payment is not received in that year.

Used in cost accounting, allocation refers to the process of assigning costs incurred in overhead accounts, such as payroll, to actual product or service accounts, such as cost of goods sold (COGS) or inventory assets.

Billable Expenses
In the process of rendering a service for a customer, a company may incur expenses that are then passed on to the customer in the form of billable expenses on an invoice.

Cash-based accounting method
In the cash-based accounting method, transactions are recorded when payment is received or made, as opposed to accrual-based accounting, in which revenues or expenses are recorded when a transaction occurs. Also, for tax purposes, income is reported in the year it is received.

Chart of accounts
A company’s chart of accounts includes all of the accounts in the general ledger, including the balance sheet accounts and income statement accounts.

Double-entry Accounting
Double-entry accounting is a method of accounting in which every transaction equally affects two different accounts in opposing ways (via debits and credits). The double-entry accounting method facilitates the creation of the balance sheet by increasing one account and decreasing another by the same amount to reflect a company’s current relative health.

General Ledger (GL)
A general ledger (GL) provides the record of all of a company’s financial transactions and data.

An invoice (also called a bill) is documentation that shows the amount due to a vendor for services rendered or goods received.

Journal Entry (JE)
A journal entry is a complete record of an accounting transaction entered into the journal (the record of all the transactions of a business). Typically, accounting journals rely on the double entry system to note credits and debits. Therefore, a journal entry will note debit and credit amounts, along with the date, a reference number, and a description of the transaction.

A payment is an exchange that occurs when a company sells goods or services to an individual or another company. Payments can be monetary or non-monetary, such as in the case of exchanges of goods or services (bartering). Companies can choose to accept monetary payments in a variety of ways, including cash, check, credit card, automated clearing house (ACH), or electronic funds transfer (EFT).

Periodicity, also referred to as time period assumption, refers to the reporting periods that companies use to close, review, and report company data. Companies typically divide their activities and report them monthly, quarterly, semi-annually, or annually.

Reconciliation in accounting is a comparison of financial records from two sources to make sure they are in agreement.

Trial Balance
A trial balance is used to verify the mathematical correctness of a company’s books. Debits and credits are entered into a two-column worksheet that must balance.

Uncategorized Asset
An uncategorized asset is one that has not been assigned in the general ledger to a specific asset account in the chart of accounts. For tax purposes, use of the uncategorized asset account is not recommended; these assets should be categorized correctly before end-of-period reporting occurs.

Uncategorized Expense
An uncategorized expense is one that has not been assigned in the general ledger to a specific expense account in the chart of accounts. For tax purposes, use of the uncategorized expense account is not recommended; these expenses should be categorized correctly before end-of-period reporting occurs.

Undeposited Funds
Undeposited funds are those monies that have been received but have not yet been deposited into a bank account. Accounting software packages typically include an Undeposited funds account in the chart of accounts and use it as a clearing account for funds during the time that elapses between receipt and deposit acknowledgement.

Business Structures

Business Entity (also Legal Entity)
Any organization created to engage in business is a business entity. There are specific structures or types of business entities, including sole proprietorship, a partnership, a limited liability corporation (LLC), and corporations. The type or structure of a business entity determines how it is taxed.

C-Corporation (C-corp)
The most common business structure, a C-corporation is a double taxation entity, meaning that the company is taxed as a business on overall profits and the owners (shareholders) are taxed as individuals on dividends. Shareholders benefit from limited liability because they cannot lose more than they have invested. In addition, shareholders are allowed to reinvest profits at a lower tax rate, thus offsetting at least a portion of the double taxation risk.

Subchapter-S Corporation (S-corp)
Under Subchapter S of the IRS tax code, an S-corp is a business corporation that has limited liability protection and passes income, losses, credits, and deductions to shareholders. The shareholders report this on their own tax forms. This avoids the double taxation of corporate taxes plus individual taxes.

A partnership is a business entity with at least two parties who have agreed to manage the business and share in profits (or losses). There are three types of partnerships: general, limited, and limited liability. General partnerships are set up to allow equal liability sharing. In a limited partnership, partners are not required to materially participate in day-to-day operations; this is also known as silent partnership. Limited liability partnerships protect partners from personal liability against company business.

Limited Liability Company (LLC)
In a limited liability company, owners are not liable for the company’s debts, and the company does not pay taxes. Instead, owners pay personal taxes on income from the company or record losses on their personal taxes, as necessary.

Sole Proprietorship
A sole proprietorship (also called a sole trader) is a business entity with a single owner. The business itself is not taxed; instead, the owner is taxed on the business’s profits on his or her personal tax return.

People and job titles

A professional who maintains financial accounts and financial information.

Certified Public Accountant
Accountants who pass the Certified Public Accountant (CPA) exam for state certification and have met any other state requirements earn this professional certification.

Bookkeepers record financial information for a business (single entry or double entry); they focus on record-keeping activities.

Financial Advisor
Financial advisors provide guidance to clients about financial concerns such as investments, taxes, insurance, and estate planning.

Enrolled Agent (EA)
Enrolled Agents (EAs) are practitioners and specialists licensed by the federal government to represent taxpayers who are facing audits, collections, or appeals before the Internal Revenue Service (IRS).

General Terms

Accounting is the process of keeping financial records through recording a business’s financial transactions in a systematic way.

Burn rate
The rate of spending of cash and capital by a new company per month.

Cash Flow
The total amount of cash coming into and going out of a business is its cash flow.

In accounting, a credit reflects money coming into the business.

In accounting, a debit reflects money going out of a business.

Fiscal year
A period of time for accounting purposes that emcompasses a calendar year, but may start and end in months other than January and February.

Fixed Cost
A fixed cost is an expense that does not change. It does not increase or decrease.

Forecasting is attempting to determine future costs by analyzing past and current costs to make a prediction.

Generally Accepted Accounting Principles (GAAP)
In the United States, the Financial Accounting Standards Board (FASB) determines standards for accounting and financial reporting, which are known as the Generally Accepted Accounting Principles (GAAP).

Insolvency is the inability to pay one’s debts.