Basic Accounting Terminology and Concepts

Accounting involves recording, classifying, organizing, and documenting financial transactions and data for internal tracking
and reporting purposes. Businesses of all sizes use accounting to remain legally compliant and measure and assess their
financial health. The professionals who lead these efforts possess deep, detailed technical proficiencies often developed
through a bachelor's degree program in accounting.
Small business owners and individual taxpayers can also benefit from a strong working knowledge of basic accounting
concepts and terms. Accounting advances financial literacy and yields precise, powerful insights into financial health.
This resource introduces and explains basic accounting terms, principles, acronyms, and abbreviations. It was developed for
students, entrepreneurs, and anyone else looking to brush up on essential concepts.
How to Use This Guide to Accounting Terms
Presented in alphabetical order, this glossary of accounting terms covers essential basics and key concepts. You can look up
individual terms, or read the guide from start to finish for a quick crash course in accounting fundamentals.
Accounting Basics for Students
Students sometimes enter accounting programs with little technical knowledge. This guide serves as an easy-to-use
resource for developing the vocabulary used by accounting professionals.
You can also use the guide to:

Gauge interest in a potential accounting career

Build familiarity with basic accounting before starting an academic program

Refresh or build on existing accounting knowledge

Accounting Basics for Business Owners

Accounting is critical to the success of small businesses. However, not all business owners have the time or means to pursue
formal training.

The terms and concepts in this guide were selected in part for their relevance to new entrepreneurs. Glossary entries cover
concepts essential to businesses: Key terms like "accounts payable," "accounts receivable," "cash flow," "revenue," and "equity"
are all fully covered and explained.

Simple Accounting Definitions

Beyond basic accounting terms, this resource also explains alternative word uses and defines related or adjacent concepts.
Importantly, it also covers relevant etymologies and word histories in cases where knowledge of these elements can help
you better understand the term.

Accounting Period: An accounting period defines the length of time covered by a financial statement or operation. Examples
of commonly used accounting periods include fiscal years, calendar years, and quarters, which divide the calendar year into
three-month periods. Some organizations also use monthly periods.
Each accounting period covers one complete accounting cycle. An accounting cycle is an eight-step system accountants use to
track transactions during a particular period.

Accounts Payable: Accounts payable (AP) tracks money owed to creditors. Examples include bank loans, unpaid bills and
invoices, debts to suppliers or vendors, and debts accrued on credit cards or lines of credit. Rarely, the term "trade payables"
is used in place of "accounts payable." Accounts payable belong to a larger class of accounting entries known as liabilities.

Accounts Receivable: Accounts receivable (AR) tracks the money owed to a person or business by its debtors. It is the
functional opposite of accounts payable.
Accounts receivable are sometimes called "trade receivables." In most cases, accounts receivable follow from products or
services supplied on credit or without an upfront payment. Accountants consider the funds associated with accounts
receivable as assets.

Accrual Basis Accounting: Accrual basis accounting (or simply "accrual accounting") records revenue- and expense-related
items when they first occur. For instance, consider a case in which a customer acquires a $1,000 product without
submitting an upfront payment. Accrual accounting considers that $1,000 to be revenue that entered the business on the
purchase date.
By contrast, the alternate method of cash basis accounting would only record that $1,000 as revenue when the customer
actually paid for the purchase. In general, large businesses and publicly traded companies favor accrual accounting. Small
businesses and individuals tend to use cash basis accounting.

Accruals: Revenues and expenses recognized by a company but not yet recorded in their accounts are known as accruals
(ACCR). By definition, accruals occur before an actual exchange of money resolves the transaction.
As an example, consider a company that outsourced work to an external contractor. An accrual would immediately recognize
and record the cost of the contractor's work, regardless of whether the contractor had actually submitted an invoice or
received payment.
Accounts payable and accounts receivable are both accrual types. Other types include accrued costs (costs incurred but not
resolved during a particular accounting period) and accrued expenses (expenses or liabilities incurred but not resolved during
a particular accounting period).

Assets: Assets are items of value or resources that a business owns or controls. More technical definitions also specify two
important technicalities: First, assets result from past business activities. Second, they will or are expected to generate
future economic value.
Assets come in many types and classes. Types include current and noncurrent, operating and nonoperating, physical, and
intangible. Classes include broad categories such as cash and cash equivalents, equities, commodities, real estate, and
intellectual property, among others.

Balance Sheet: A balance sheet (or "statement of financial position") is a standard financial statement. It specifies the
business's current state regarding its assets, liabilities, and owners' equity. Some sources abbreviate the term as "BAL
SH."
Accountants use multiple formats when creating balance sheets including classified, common size, comparative, and vertical
balance sheets. Each format presents information as line items that, when combined, provide a snapshot summary of the
company's financial position.

Capital: In common usage, capital (abbreviated "CAP.") refers to any asset or resource a business can use to
generate revenue. A second definition considers capital the level of owner investment in the business. The latter sense of
the term adjusts these investments for any gains or losses the owner(s) have already realized.
Accountants recognize various subcategories of capital. Working capital defines the sum that remains after subtracting
current liabilities from current assets. Equity capital specifies the money paid into a business by investors in exchange for
stock in the company. Debt capital covers money obtained through credit instruments such as loans.

Cash Basis Accounting: Cash basis accounting records revenues and expenses when the money involved in each transaction
actually changes hands. It differs from accrual basis accounting, which recognizes revenues and expenses when they occur
without regard to the actual exchange of associated funds.

Cash Flow: Cash flow (CF) describes the balance of cash that moves into and out of a company during a
specified accounting period. Accountants track CF on a dedicated document known as a cash flow statement.

Certified Public Accountant: A certified public accountant (CPA) is an accounting professional specially licensed to provide
auditing, taxation, accounting, and consulting services. CPAs work for both businesses and individual clients.
To obtain CPA licensure, a candidate must meet eligibility criteria and pass a demanding four-part exam, which consists of
three core parts plus the examinee's choice of one of three specialized discipline sections. Eligibility standards also include at
least 150 hours of higher education covering related coursework.

Chart of Accounts: Accountants record financial transactions in a bookkeeping system known as a general ledger. A chart of
accounts (COA) is a master list of all accounts in an organization's general ledger. Five main types of accounts appear in a
COA: assets, equity, expenses, liabilities, and revenues.

Closing the Books: The informal phrase "closing the books" describes an accountant's finalization and approval of the
bookkeeping data covering a particular accounting period. When an accountant "closes the books," they endorse the relevant
financial records. These records may then be used in official financial reports such as balance sheets and income statements.

Cost of Goods Sold: Cost of goods sold (COGS) tracks the total costs a company incurred when creating a product or
providing a service. With products, the associated costs fall into three broad categories: materials, labor, and overhead.
With services, costs include expenses related to employee compensation, materials, and equipment. Accountants sometimes
use the alternative term "cost of sales."
Accountants use "initial inventory plus purchases, minus ending inventory" as a basic accounting formula for calculating
COGS over a specific accounting period.
Credit: Credits are accounting entries that increase liabilities or decrease assets. They are the functional opposite of
debits and are positioned to the right-hand side in accounting documents.

Debit: Debits are accounting entries that increase assets or decrease liabilities. They are the functional opposite of credits
and are positioned to the left-hand side in accounting documents.

Depreciation: Depreciation (DEPR) is an expense that applies to a class of assets known as fixed assets. Fixed assets are
long-term owned resources of economic value that an organization uses to generate income or wealth. Real estate,
equipment, and machinery are common examples. Fixed assets can decline in value. Accountants record those declines as
depreciation.

Diversification: Diversification describes a risk-management strategy that avoids overexposure to specific industries
or asset classes. To achieve diversification, people and organizations spread their capital out across multiple types of
financial holdings and/or economic sectors. The same term is also widely used in finance and investing.

Dividends: In corporate accounting, dividends represent portions of the company's profits voluntarily paid out to
shareholders. Shareholders are often paid in cash, but may also be issued stock, real property, or liquidation proceeds. In
most cases, dividends follow a regular monthly, quarterly, or annual payment schedule. However, they can also be offered as
exceptional one-time bonuses.

Double-Entry Bookkeeping: Double-entry systems record each financial transaction twice: once as a credit, and once as
a debit. When the sum total of all recorded debits and credits equals zero, the accounting books are considered "balanced."
The system is also known as double-entry accounting. It is a more complete and accurate alternative to single-entry
accounting, which records transactions only once.
Single-entry systems also account only for revenues and expenses. Double-entry systems add assets, liabilities, and equity to
the financial tracking.

Enrolled Agent: An enrolled agent (EA) is a finance professional legally permitted to represent people and businesses in
Internal Revenue Service (IRS) encounters. EAs must earn licensure from the IRS by passing a three-part exam or
building direct experience as an IRS employee.

Equity: At a basic level, equity describes the amount of money that would remain if a business sold all its assets and paid
off all its debts. It therefore defines the stake in a company collectively held by its owner(s) and any investors.
The term "owner's equity" covers the stake belonging to the owner(s) of a privately held company. Publicly traded
companies are collectively owned by the shareholders who hold their stock. The term "shareholders' equity" describes their
ownership stake.

Fixed Cost: A fixed cost (or fixed expense) is a cost that stays the same regardless of increases or decreases in a company's
output or revenues. Examples include rent, employee compensation, and property taxes.
The term is sometimes used alongside "operating cost" or "operating expense" (OPEX). OPEXs describe costs that arise
from a company's daily operations. However, these costs can be fixed or variable. Variable costs change as output, usage, or
revenues change.

General Ledger: Businesses and organizations use a system of accounts known as ledgers to record their transactions. The
general ledger (GL or G/L) is the master account containing all ledger accounts. It holds a complete record of all
transactions taking place within a specified accounting period.
Major examples of the individual accounts found in a general ledger include asset accounts, liability accounts, and equity
accounts. Each transaction recorded in a general ledger or one of its sub-accounts is known as a journal entry.

Generally Accepted Accounting Principles: Generally accepted accounting principles (GAAP) describe a standard set of
accounting practices. GAAP are endorsed by organizations including the Financial Accounting Standards Board (FASB) and
the U.S. Securities and Exchange Commission (SEC), among others. Other, similar standardized accounting systems also
exist: One well-known alternative is International Financial Reporting Standards (IFRS).
In the United States, privately held companies are not required to follow GAAP, but many elect to do so voluntarily.
However, publicly traded companies whose securities fall under SEC regulations must use GAAP standards.

Gross Profit: Gross profit (or gross income) defines the value of the products and services sold by a business before
factoring in the cost of goods sold. If the gross profit is a negative number, it is instead called a gross loss. It contrasts
with "net profit," which describes the actual profit earned after accounting for associated costs.
Gross margin is a related term: It specifies the value of the organization's net sales, minus the cost of goods sold. Net
sales are calculated by correcting gross sales for adjustments such as discounts and allowances.

Income Statement: An income statement is a financial document used by businesses. It specifies the total revenues earned
by the company in a given accounting period, minus all expenses incurred during the same period. An income statement is also
known by multiple alternative names, including:
Earnings statement
Profit and loss statement
Statement of financial result
Statement of operation
Income statements are one of three standard financial statements issued by businesses. The other two are balance
sheets and cash flow statements.

Inventory: Inventory describes assets that a company intends to liquidate through sales operations. It includes assets
being held for sale, those in the process of being made, and the materials used to make them.

Liability: A liability (LIAB) occurs when an individual or business owes money to another person or organization. Bank loans
and credit card debts are common examples of liabilities.
Accountants also distinguish between current and long-term liabilities. Current liabilities are liabilities due within one year
of a financial statement's date. Long-term liabilities have due dates exceeding one year.
The term also appears in a type of business structure known as a limited liability company (LLC). LLC structures allow
business owners to separate their personal finances from the company's finances. Owners of LLCs cannot be held personally
liable for debts incurred solely by the company.

Liquidity: In accounting, liquidity describes the relative ease with which an asset can be converted to cash. Assets that can
easily be converted into cash are known as liquid assets. Accounts receivable, securities, and money market instruments are
all common examples of liquid assets.

Net Profit: Net profit describes the amount of money left over after subtracting the cost of taxes and goods sold from
the total value of all products or services sold during a given accounting period. It is also known as net income. If the net
profit is a negative number, it is called a net loss. The related term "net margin" refers to describing net profit as a ratio
of a company's total revenues.
Net profit contrasts with gross profit. Gross profit simply describes the total value of sales in a given accounting period
without adjusting for their costs.

On Credit: Accountants track partial payments on debts and liabilities using the term "on credit" (or "on account"). Both
versions of the term describe products or services sold to customers without receiving upfront payment.

Overhead: Overhead (O/H) costs describe expenses that do not directly contribute to a company's products or services, but
are nonetheless necessary to sustain business operations. Examples include rent, marketing and advertising costs, insurance,
and administrative costs.
Businesses must account for overhead carefully, as it has a significant impact on price-point decisions regarding a company's
products and services. Overhead costs must be recouped through revenues for a business to become or remain profitable.

Payroll: Operations that record, administer, and analyze the compensation paid to employees are collectively known as payroll
accounting. Payroll also includes fringe benefits distributed to employees and income taxes withheld from their paychecks.

Present Value: Accountants sometimes make future projections with respect to revenues, expenses, and debts. The concept
of "present value" (PV) describes calculated adjustments that express those future funds in present-day dollars. It is
alternately known as discounted value (DV).
PV offers a method for adjusting future revenues, expenses, and debts for inflation. These adjustments allow others within
the business to understand those projections' potential impacts in relatable terms.

Receipt: A receipt is an official written record of a purchase or financial transaction. Receipts serve as proof that the
transaction took place, allowing those transactions to be processed for tax purposes.

Retained Earnings: Retained earnings (or earnings surplus) specifies the profits that remain after a business has paid for
all costs incurred during a given accounting period. It includes all indirect and direct expenses: the cost of goods
sold, dividend payments, and tax liabilities.
When retained earnings (RE) are positive, they increase the organization's equity. That equity may then be reinvested
back into the business to fuel its future growth.
Return on Investment: Usually expressed as a percentage, return on investment (ROI) describes the level of profit or loss
generated by an investment.
Accountants calculate ROI by dividing the net profit of an investment by its cost, then multiplying by 100 to generate a
percentage. For instance, imagine an investor who purchases $20,000 of a company's stock, then sells the stock for
$25,000. The transaction would generate an ROI of 25% for the investor. When an investor incurs a loss, the ROI is
expressed as a negative number.

Revenue: Revenue (REV) describes the income a business earns by selling products and/or services associated with its main
operations. For example, a clothing store's revenue comes exclusively from the garments and accessories customers
purchase. It does not include additional income sources, such as returns earned by investing the store's profits in bonds or
certificates of deposit.
The terms "revenue" and "sales" can be synonymous. For example, revenue is used to establish the datapoint comprising the
"sales" component of a price-to-sales calculation.

Single-Entry Bookkeeping: Single-entry bookkeeping records all revenues and expenses with a single entry in the company's
books. It is also known as single-entry accounting.
Single-entry systems are simplified financial tracking methods primarily used by small businesses. Transactions are recorded
in a document known as a "cash book." It contrasts with the more precise and accurate double-entry accounting method.
Double-entry accounting records all transactions twice: once as a debit, and once as a credit.

Trial Balance: A trial balance is a report of the balances of all general ledger accounts at a given point in time. Accountants
typically prepare or generate trial balances at the end of a reporting period to ensure all accounts and balances add up
properly. In professional practice, trial balances function like test-runs for an official balance sheet.

Variable Cost: Variable costs are expenses that can change depending on the volume of goods produced or sold by a company.
For example, a manufacturer would incur higher costs if it doubled its product output. Companies may also face higher tax
rates as their sales and profits rise. These are both examples of variable costs.
By comparison, fixed costs remain the same regardless of production output or sales volume. Examples of fixed costs include
rent, wages, and salaries.