Common Accounting Terms

Accounting may look and sound a little more complicated than it actually is. This is due to the terminology used in accounting; it's far different from the more common terms in the business world. If you know the meaning of the more common terms used in the accounting industry, and you understand them, you'll find it's not quite as complicated as you first thought.

A balance sheet is simply a statement of assets, liabilities, and owner's equity. Another important part of a business is, of course, how much money it makes.

The Basics

Debits: A debit is an entry to an account that results in an addition to an expense or asset account or conversely, a deduction from a revenue, net worth, or liability account. For example, if your business receives a payment for a service, you are increasing your cash account, which is an asset. Therefore, you would debit your cash account.

Credits: In accounting, a credit is an accounting entry that either decreases assets or increases liabilities; it also increases a revenue account. In the example above, you received a payment for a service you provided, so you debited a cash account, you need to credit a revenue account to balance the accounts.

The balance of debits and credits in accounting is known as the double-entry accounting method, which is a system of recording transactions in a way that maintains the equality of the accounting equation; each transaction is recorded with both a credit and a debit. This is one of the most important concepts within accounting.

Accounting Functions

Other common accounting terms to learn to help unravel the world of accounting are:

Accounts Payable: Money which a company owes to vendors for products and services purchased on credit.

Accounts Receivable: Money which owed to a company for services or goods.

Assets: Assets are those things of value that a person or company owns. The cash in a bank account is an asset, as is a home that is owned by an individual or equipment that is owned by a business.

Liabilities: Liabilities are the opposite of assets. These are the obligations of a person or business to another. Accounts payable are liabilities, just as a person's mortgage would be.

Owner's Equity: The difference between assets and liabilities is considered owner's equity and hopefully it's positive. If assets exceed liabilities, we have a positive owners' equity. For example in the case of owning a home it's easy to illustrate:

Asset: The home itself is worth $200,000

Liability Mortgage: You still owe $50,000 on your mortgage

Owner's equity: Your owner's equity in the home is $150,000, the asset value minus the liability of the mortgage.

Balance Sheet: A balance sheet is simply a statement of assets, liabilities, and owner's equity. Another important part of a business is, of course, how much money it makes. The terms below are used within that area of accounting.

Income Accounts: An income account will be established to track how the income is produced. For instance, a company that sells sneakers will have a Sales income account. If they also receive interest from the bank, that's another source of income, and they can have an Interest income account.

Expense Accounts: An account that is used to pay money owed is an expense account. Most companies have a separate account for each type of expense they incur on a regular basis, for example:

  • Wages
  • Rent
  • Utilities

Profit & Loss Statement: Also called a P&L, a profit and loss statement simply takes revenue and subtracts expenses showing the profit or loss for a certain period of time.

These common accounting terms make up the basics for a large portion of the functions of accounting. If you understand the basics, you'll set yourself up for success within the field of accounting.