Basic Accounting Terms

Samir K Mahajan
 Business Entity

A business entity is a commercial (corporate or other) organisation that is formed in order to

engage in business activities, usually for the sale of a product or a service.

 administered as per commercial law of the country.

 different forms such as sole trader, partnership, co-operatives, partnerships, private limited
company, public limited company and so on.

 The motive of every business is profit.

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 Business Transactions

An economic event that relates to a business entity is called business transaction. Business
transactions

 are financial interactions between businesses and other entities

 involve transfer of money or goods or services between two persons or two accounts.

e.g. purchase of goods, receipt of money, payment to a creditor, incurring expenses, etc. It can be
a cash transaction or a credit transaction.

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 Business Transactions
contd.

Some business transactions are external that take place between the business enterprise and an
outsider and . e.g.
 • Sale of a product the customers
 • Rendering services to the customers
 • Purchase of materials from suppliers.
 • Payment of monthly rent to the landlord

And some others are internal that occurs entirely between the internal wings of an enterprise. e.g.

 supply of raw material or components by the stores department to the manufacturing department
 payment of wages to the employees

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 Features of Business Transactions

Every business activity is not an accounting activity. Business activity are financial in nature and
have documentary proof.

 money or money's worth of goods or services

 exchange of goods or services

 change in the financial position

 has dual aspects "receiving "(debit) and "giving "(credit ) of the benefit

 effect on assets, liabilities, capital, revenue and expenses

Non-economic activities concerning emotions of love, patriotism, and respect do not find place in
accounting.

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 Type of Business Transactions

Transactions are of two types such as: cash and credit transactions.

 Cash Transaction is one where cash receipt or payment is involved in the transaction. For
example, purchase of goods by cash immediately or by paying a price

 Credit Transaction is one where cash is not involved immediately but will be paid or
received later. For example, purchase of goods on credit

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 Accounting Year

Books of accounts are closed annually.

 There is no legal restriction about accounting year of the sole proprietor and partnership firm.
They may adopt accounting year of their choice.

 It may be between two diwalis, or 1st January to 31st December of the same year or financial
year .i.e. April 1 of any year to March 31 of next year.

 The only restriction is that it must contain twelve month. Companies must adopt financial
year.

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 PROPRIETOR

A person who owns a business is called its proprietor.

He contributes capital to the business with the intention of earning profit.

In accounting,

 business separate from its proprietor

 distinct identity i.e. existence other than the existence of its proprietor and other business units

 An accountant has to deal with the business entity and not with its proprietor

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 CAPITAL

Capital is the amount (fund or any other form of resources ) invested by the proprietor/s in the
business.

 This amount is increased by the amount of profits earned and the amount of additional capital
introduced. It is decreased by the amount of losses incurred and the amounts withdrawn.

 For example, if Miss X starts business with Rs.5,00,000, her capital would be Rs.5,00,000.

 Or Mr Y may contribute a machines worth value 20 crores

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 Creditor and Debtor
A creditor is a party, say A (e.g. person, organization, company, or government) that has a
claim on the property or services of a second party (e.g. person, organization, company,
or government) .

 first party has provided some value (property or good or service or funds) to the
second party under the assumption that the second party will return an equivalent
value in some future date.

 second party is a debtor or borrower of the property, service or money.

 first party is the creditor which is the lender of property, service or money.

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 PAYABLES

Payables is the total of sundry creditors and bills payables.

Sundry creditors are sellers of goods on credit

Bills Payables are the bills drawn by the certain seller (creditor) to buyer (firm) or promissory
notes drawn by the buyer (firm ) to certain sellers

Payables are shown on the liabilities of the balance sheet

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 RECEIVABLES

Receivables is the total of sundry debtors and bills receivables.

Sundry debtors are buyers of goods on credit (( buyers of goods on credit that have not paid yet
to the firm)

Bills receivables means bills drawn by the seller to certain purchasers/buyers .

Receivables are shown on the assets side of balance sheet.

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 Goods

Goods are commodities in which the business deals in

Goods includes articles purchased for sale at profit or for use in the manufacture certain other
goods as raw materials

Furniture will be goods for firms dealing in furniture but it will be an assets for firm dealing
stationaries.

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 Stock

Stock includes goods unsold on a particular date.

 Stock may be opening and closing stock

 opening stock means goods unsold in the beginning of the accounting period.

 closing stock includes goods unsold at the end of the accounting period.

 For example, if 4,000 units purchased @ Rs. 20 per unit remain unsold, the closing stock is
Rs.80,000. This will be opening stock of the subsequent year.

Stock can be classified as under:

o Stock of raw materials

o Stock of finished and semi-finished goods
o Work in progress
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 ASSETS

Assets are what firm owns.

 economic resources (properties or valuable things ) of an enterprise that can be

usefully expressed in monetary terms.

 items of value used by the business in its operations.

 E.g. cash in hand, plant and machinery, furniture and fittings, bank balance, debtors, bills
receivable, stock of goods, investments, Goodwill

 measured in money terms.

 is classified as fixed asset and current asset.

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 Assets contd.

ASSETS OF A FIRM

FIXED ASSETS
CURRENT ASSETS

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 ASSETS contd.
Fixed Assets
Fixed Assets are assets held on a long-term basis,

 used for the normal operations of the business.

 not meant for business transaction rather are used to produce goods or service

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 ASSETS contd.
Fixed assets includes
o Lands, buildings
o Machines and plants,
o Furniture's, fixtures, fittings,
o Investment in shares and debentures
o Livestock

Note: Fixed stock may be intangible (patient, copy rights, good will).

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Current Assets ASSETS contd.

Current Assets ( floating assets/circulating assets )are assets held on a short-term basis

 are expected to be realised in cash

 sold or consumed during normal operation of business.

 Are most liquid assets meaning that they are either in cash or going to be converted into
cash.

 change their value constantly.

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Current Assets ASSETS contd.

Current assets include

o Cash and bank balances

o Stock of inventories of raw materials, finished and semi-finished goods

o Debtors or accounts receivable or sundry debtors or book debt

o Bill or note receivables

o Prepaid expenses

o Accrued income

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 ASSETS contd.
It should be noted that certain assets which are popularly known as fixed may prove to be goods
by virtue of their use.
Such as:
o Lands will be goods (land developer and property dealers) .
o Buildings (builders and property dealers).
o Machines and plants (manufacturers and dealers of plants and machineries)
o Furniture's, fixtures, fittings (furniture's dealers and furnishers )
o Shares and debentures (the dealers in securities )

It should be taken care that assets meant for regular purchase and sale are goods.

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 ASSETS contd.

 Tangible Assets: These assets are those having physical existence. It can be seen and
touched. For example, plant & machinery, cash, etc.

 Intangible Assets: Intangible assets are those assets having no physical existence but their
possession gives rise to some rights and benefits to the owner. It cannot be seen and touched.
Goodwill, patents, trademarks are some of the examples.

 Liquid Assets: Liquid assets are those assets which can be converted into cash at short notice.
E.g. cash in hand, cash at bank, debtors, bills receivables, etc.

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 Liabilities

Liabilities are the obligations payable by the enterprise/business in future in the form of
money or goods or services.

 Liabilities are what firm owes to others including owners.

 These denote the amounts which a business owes to owners and other parties , e.g., capital
invested by business, loans from banks or other persons, creditors for goods supplied, bills
payable, outstanding expenses, bank overdraft etc.

 Liabilities are and creditors’ claims against the assets of the business.

 Liabilities are measured in monetary terms

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 CLASSIFICATION OF
LIABILITIES OF A
FIRM IN TERMS OF
CLAIM

LIABILITY TO LIABILITY TO
OWNERS CREDITORS CONTINGET
(OWNERS' EQUITY (CREDITORS' LIABILITES
/CLAIM) CLAIM/EQUITY)

CREDITORS FOR
CREDITORS FOR LOANS LIABILITIY FOR
GOODS EXPENSES
(LENDERS)

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 LIABILITIES OF A FIRM IN TERMS OF CLAIM contd.

 Liabilities to Owners /Shareholder’s Funds / Owner’s Equity/owner’s net worth

= Capital + surpluses (retained earnings) & reserves + interest in capital – drawings – expenses –
losses

 Liabilities to Creditors = Creditor's claim against business

o Creditors for Goods = Suppliers of goods on credit to business = Sundry Creditors

o Creditors for loans = Lenders (Banks, financial institutions or other parties) of Funds to Business

o Creditors for Expenses = Outstanding salaries+ rents due + wages unpaid

 Contingent (Doubtful) Liabilities

Contingent liabilities are not real liabilities future events will decide whether it is really a liability
or not e.g. guarantees undertaken, cases pending in the law of court.
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CLASSIFICATION OF LIABILITIES OF A FIRM IN TERMS OF IN DURATION OF TIME

CLASSIFICATION OF
LIABILITIES OF A
FIRM IN DURATION
OF TIME

CURRENT
FIXED LIABILITIES/
LIABILITIES/
LONG-TERM
SHORT-TERM
LIABILITIES
LIABILITIES

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 LIABILITIES IN TERMS OF IN DURATION OF TIME

 Long-Term /Fixed Liabilities

Long-Term liabilities are payable for a after a period of one year and for a long period of time.
Long Term Liabilities includes
o Owners’ capital
o loans
o Debentures/bonds
o mortgages
o Others

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 LIABILITIES IN TERMS OF IN DURATION OF TIME

 Short-Term /Current Liabilities

Short-term Liabilities are payable within one year. Short-term liabilities change their values
continuously. Short-term liabilities includes
o Creditors/sundry creditors
o bills payables (bill drawn by sellers of goods on credit ,and accepted by the enterprise)
o outstanding expenses
Note: Account payables includes creditors/sundry creditors and bills payables

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 Purchases

 Purchases refers to the amount of goods bought by a business for resale or for use in the
production.

 Purchase are intended to mean either purchase of finished goods for sale or purchase of raw
materials for manufacture of the article, being sold by the business.

 Purchase of assets are not the purchase in accounting terminology as these assets are not
meant for sale.

 Goods purchased for cash are called cash purchases.

 If it is purchased on credit, it is called as credit purchases.

 Total purchases include both cash and credit purchases

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 Purchase Return or Return outwards

 Purchase returns are the part of purchase of goods which are returned to the sellers by
the business.
 This return may be due to unnecessary, excessive and defective supply of goods.
 It also may be result of violation of terms and conditions of the orders or agreements
by the sellers.

 To find net purchases, purchases return is deducted from the total purchases.

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 EXPENSE

Expense are the amount spent or cost incurred in order to produce and sell the goods
and services(Costs incurred by a business in the process of earning revenue).
Generally, expenses are measured by the cost of assets consumed or services used during
an accounting period. The usual items of expenses are: depreciation; payment of wages
and salaries , interest, rent ; cost of heater, light and water; telephone bills, purchase of
raw materials etc.

 Outstanding expenses: If expenses relates to the accounting period and remain unpaid they are
called outstanding payment.
 Outstanding salaries, rent unpaid, wages due, repairs due but not paid are certain examples. As
these expenses are still payables, these are liability of business.

 Pre-paid or unexpired expenses: Pre-paid expenses are expenses paid in advance.

 In certain cases, expenses relating to next accounting period may be paid during the current
year. Pre-paid expenses forms part of assets of business.

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 EXPENDITURE

Spending money or incurring a liability for some benefit, service or property received is called
expenditure. Payment of rent, salary, purchase of goods, purchase of machinery, purchase of
furniture, etc. are examples of expenditure.

If the benefit of expenditure is exhausted within a year, it is treated as an expense (also called
revenue expenditure).

On the other hand, the benefit of an expenditure lasts for more than a year, it is treated as an
asset (also called capital expenditure) such as purchase of machinery, furniture, etc.

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 SALES

Sales are total revenues from goods (already bought or manufactured) or services sold or
provided to customers by the business.

 In accounting sales means sale of goods and not sale of assets.

 Sales may be cash sales (sold for cash) or credit sales (sold and payment is not received at the
time of sale).

 Total sales includes both cash and credit sales.

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 SALES RETURN OR RETURNS INWARD

When goods are returned from the customers to the business, it is called sales return or returns
inward.

 It may be due to due to defective quality or not as per the terms of sale.

 To find out net sales, sales return is deducted from total sales.

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 REVENUES

Revenues are the amount the business earned by selling its products or providing services to
customers, called sales revenue.

Accrued revenues ( income )/ income due but not received: Accrued revenue are
revenue earned during the current accounting year but yet to be received.
 These form part of assets.

Income received in advance or unearned income: Income received in advance are the
income received in current accounting year although this relates to the next year.
 These income form part of liability.

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 Profit, Income and Gain

 Profit: Excess of revenues of a period over its related expenses during an

accounting year is profit. Profit increases the investment of the owners.

 Income: Income is positive change in the net worth of the enterprise from business
activities or other activities over a period of time.

 Income is a wider term and includes profit too.

 Income is profit plus income from activities (such as commission, interest, dividends,
royalties, rent received, etc.

 Gain: A profit that arises from events or transactions which are incidental to business such as
sale of fixed assets, winning a court case, appreciation in the value of an asset

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Loss : The excess of expenses of a period over its related revenues its termed as loss. It decreases
in owner’s equity. It also refers to money or money’s worth lost (or cost incurred) without
receiving any benefit in return, e.g., cash or goods lost by theft or a fire accident, etc. It also
includes loss on sale of fixed assets.

 Drawings: Drawings is the amount of cash or value of goods withdrawn from the business by
the proprietor for his personal use.

 It is deducted from the capital.

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 Discount: Discount is the deduction in the price of the goods sold. It is offered in two ways
such as trade discount and cash discount.

 Trade discount are allowed on quantities of goods purchased as a percentage of list price. It
is generally offered by manufactures to wholesalers and by whole sellers to retailers.

 Cash discount arises at the time of payment on the amount payable. After selling the goods
on credit basis the debtors may be given certain deduction in amount due in case if they pay
the amount within the stipulated period or earlier. Cash discount acts as an incentive that
encourages prompt payment by the debtors.

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 Investment: The firm may invest in other firms’ share and equities and earn dividend and
income.

 Insolvent: All business firms who have been suffering from losses for the last many years
and are not even capable of meeting their liabilities out of their asset are financially
unsound. Only court can declare the business firm as insolvent it is satisfied that the
continuation of the firm will be against the public or creditors.

 Solvent: Solvent firms capable of meeting their liabilities out of their own resources.
Solvent firms Solvent have sufficient funds and assets to meet proprietor’s and creditor’s
claim.

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Voucher: The documentary evidence in support of a transaction is known as voucher. For example, if we buy goods for
cash, we get cash memo, if we buy on credit, we get an invoice; when we make a payment we get a receipt and so on.

Voucher is a written document in support of a transaction. It is a proof that a particular transaction has taken place for
the value stated in the voucher. It may be in the form of cash receipt or cash memo, invoice, bank pay-in-slip etc.
Voucher is necessary to audit the accounts.

 Receipt: Receipt is an acknowledgement for cash received. It is issued to the party paying cash. Receipts form the
basis for entries in cash book.

 Invoice/Bill: Invoice is a business document which is prepared when one sell goods to another on credit. The
statement is prepared by the seller of goods. It contains the information relating to name and address of the seller
and the buyer, the date of sale and the clear description of goods with quantity and price.

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 Entry: Any entry is a systematic record of business transaction. While passing entries, the
principle 'every debit has got its corresponding credit’ is adopted. Different accounts are
debited and credited in the entry with the same amount.

 Account: An account is a brief history of financial transactions of a particular person or item

such as asset, capital, liabilities, expense or revenue named in the heading. An account has
two sides called debit side and credit side.

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 Classification of Capital of Corporation (Public Limited Company)

 The company has to show the authorised, subscribed and paid up-capital under capital head.

o Authorised capital/registered capital is the total of the share capital which a limited company is
allowed (authorised) to issue.

Capital Requirement (long run) = Rs. 1,00,000

Authorized Capital = Rs. 1,000,000

o Issued capital is the total of the share capital issued (allocated) to shareholders. This may be
less or equal to the authorised capital.
Current Requirement = Rs. 50,000
Issued Capital = Rs. 50,000 (5000 share @Rs.10 per share)

o Subscribed capital is the portion of the issued capital, which has been subscribed by all the
investors including the public. This may be less than or more than the issued capital.
Subscribed capital= Rs. 40,000 (4000 shares @ Rs. 10 per share)
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 Liabilities contd.
Capital /share capital : An Illustration

o Called up capital is the total amount of subscribed capital for which the shareholders are required to
pay. This may be less than the subscribed capital as the company may ask shareholders to pay by
instalments.
o If 4,0000 shares of Rs. 10 each have been subscribed by the public, and of which Rs. 5 per share has
been called up.

Called up capital= Rs. 20,000

o Paid up capital is the amount of share capital paid by the shareholders. This may be less than the called
up capital as payments may be in instalments ("calls-in-arrears"). Some of the shareholders might have
defaulted in paying the called up money.
If some of the shareholders have defaulted in paying the called up money, say:
Paid Up capital = Rs. 10000 (2000 share @ Rs 5 per share).

o Reserve Capital : It is that part of uncalled capital of a company which can be called only in the event of
its winding up

Hence Reserve capital = Rs 20000

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 Surpluses: Surplus is the credit balance of the profit and loss account after providing for dividends,
bonus, provision for taxation and general reserves etc. Balance of profit is carried forward in next year as
retained earnings.

 Retained Earnings: When a company generates a profit, management has one of two choices: they can
either pay it out to shareholders as a cash dividend, or retain the earnings, and reinvest them in the
business.

 Retained earnings refers to the portion of net income/profit of a corporation that is retained by the
corporation rather than distributing to shareholders or corporate investors or to vendors as part of
continuing financial obligations as dividends. The business lists all retained earnings in the stockholder's
equity portion of the balance sheet. A company may elect to utilize retained earnings in a number of
ways, such as:
o adding capital to the company's existing business investments and purchasing updated
manufacturing equipment.
o maintaining reserves for obsolescence of plant and machinery
o building up a large cash reserve to help mitigate the effects of any risks, including downturns in
consumer spending.

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 Bank Liabilities contd.

Reserve

 Reserve : Reserve means a provision for a specific purpose. There are lots of unknown
expenditures which can occur in current year or in future. To meet such type of expenses the
business firm has to make the reserves. Reserves can be revenue reserve and capital reserve .

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 Reserve and surplus

Revenue Reserve: Revenue Reserve arises out of retained earnings (are the reserves created out
of revenue profit from trading activities. Examples of revenue reserves are General Reserve,
Dividend Equalisation Reserve, Debenture Redemption Reserve. Revenue reserves are maintained

 To meet the financial position or improve (strengthen) overall financial status and health
of an enterprise
 To settle any unknown future contingencies say inflation or deflation
 To increase the working capital
 To issue of bonus shares to shareholders
 To pay dividend to shareholders when profits are insufficient.
 to offset some specific future losses
 To meet litigation etc.

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 Reserve and surplus

 Capital Reserves: Capital reserve arises as a result of capital gains (arising from sale of equity
share at a premium or resulting from upward revaluation of its assets to reflect their current
market value after appreciation). Capital reserves are created by the accumulated capital
surplus (not revenue surplus) of an organization. Allocating such sums to capital reserve means
they are permanently invested such as future capital investment projects and will not be paid
as dividends.

Note: Share premium is the amount received by a company over and above the face value of its
shares. This difference between the selling price and the face value of a share is known as share
premium.

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