The accounting process involves recording the financial transactions of an individual or a business. This process includes summarizing, analyzing, and reporting financial transactions.
Accounting can be challenging especially for beginners, you should let an accounting professional handle the process to ensure the accuracy of your financial data, records, and analysis.
Still, there is no harm in trying to understand and learn the process.
Basic Accounting Terms That You Should Know
There are some universal terms in accounting that you will encounter in any given situation. Understanding their definition and their meaning within the context of accounting will help you know what to do when you come across them.
- Generally Accepted Accounting Principles (GAAP) – refers to the standard guidelines for accounting and financial reports.
- Fiscal Year – refers to the accounting period.
- Accounts Payable – refers to the money you owe to other people.
- Accounts Receivable – refers to the money people owe you.
- Assets – refers to your tangible or intangible properties.
- Tangible Assets – this type of asset includes cash and property
- Intangible Assets – this type of asset includes patents, trademarks, and copyrights.
- Expenses – refers to the cost of doing business.
- Accrued – recorded expenses that are not yet paid. Considered as accounts payable.
- Fixed – salaries, utilities, rent, and other expenses that you regularly need to pay.
- Operating – necessary expenses for operating the business.
- Variable – expenses that constantly change such as expenses for raw materials for products.
- Liabilities – refers to anything you owe like debts and loans.
- Accruals – refers to expenses that you have incurred but have not paid or sales that you have delivered but have not received payment for yet.
- Burn Rate – refers to the rate at which a business spends money.
- Cost of Goods Sold (COGS) – refers to the cost of production for your products and services.
- Equity – refers to the money owners or shareholders invest in the business.
- Profit – refers to the remaining amount after you have deducted expenses and COGS from the business income.
- Revenue – refers to the amount of money you have earned before removing any expenses that you have incurred.
Three Basic Rules of Accounting
Accounting uses the double-entry system in which each transaction affects two accounts. One account is debited and the other is credited.
You need to understand these different account types and apply these three basic rules.
Debit the receiver and credit the giver.
This rule is straightforward. If you are doing bookkeeping for your accounts, you need to credit someone who gave something to the business and debit the receiver.
Debit what comes in, credit what goes out.
This rule applies to all real accounts related to the business assets including tangible and intangible accounts.
By default, real accounts have a debit balance– which means you add any debited amount to the current account balance. Inversely, you need to deduct or reduce the account balance as your credit goes out.
Debit expenses and losses and credit all incomes and gains.
This rule applies to fictitious or nominal accounts. These accounts are associated with gains, revenues, expenses, and losses. These accounts include traveling expenses, interest paid, and rent and rates accounts.
The business capital is a liability which means that it has a default credit balance. You need to add the gains and incomes that you credit to the capital. Inversely, you need to decrease the capital as you debit losses and expenses.
The Accounting Equation
As mentioned previously, accounting uses the double-entry system. The accounting equation is based on the balance sheet, which, as the name suggests, ensures your records are balanced.
Each entry encoded on the debit side should have a corresponding entry on the credit side as well.
The accounting equation is made up of three factors: Assets, Liabilities, and Equity. These three factors also measure the company’s financial position.
The accounting equation is:
Assets = Liabilities + Owner/Shareholder’s Equity
How to Use the Accounting Equation
Follow these four steps to calculate the equation:
- Determine the business’ total assets during the given period.
- Get the total of all the declared liabilities.
- Determine the total amount of the owner or shareholder’s equity, then add it to the total liabilities.
- You will get the total assets of a business by adding the sum of the liabilities and equity.
These basic accounting terms, rules, and equations make up the fundamentals of accounting. Understanding these will make it easier for you to navigate the process.
However, accounting is a broad subject that branches out into different branches. This guide to its basics is barely scratching the surface.
Get in touch with a certified public accountant for immediate accounting needs.