In this article we’ll talk about some basic accounting & finance terms which are used in a routine by accounting and finance professionals. We’ll explain here in brief and simplicity that what is the meaning of these term and how they are used in different context.
An account is opened for each type of assets, liabilities, income, expenses or capital. So that relevant accounting entries can be booked in that account.
The timeline for which accounts of the entity are prepared is referred to as accounting period.For examples, if an entity prepares its financial statements for 3 months of its operations from 1 Jan to 31 March, then the accounting period would the 3 months ended 31 March 2018.
The accounting system is a comprehensive term and sometimes refer to the accounting software used by the company. Accounting system is also referred to as only ‘system’. For example, if you ask a company which accounting system do you have, they may reply with the name of their accounting software like Oracle, PeachTree, QuickBooks, SAP, etc.
However, accounting system is comprehensive term which also refers collectively to books of accounts, ledgers, trial balance, the way entries are posted and approved.
Recording of expenses in the books for that transactions where supplier has not sent the invoice but expense has been incurred. For example, the accrual is booked for utility payments based on previous months’ bill.
An asset is a property or item owned by a company. For example, the furniture in the office of a company is its asset (unless it is rented from some other company). Other examples include owned buildings, motor vehicles, computers, machines etc.
Books of Accounts
Nowadays, there are no physical books where accounting transactions are recorded. Almost all the businesses are usually (at least in partially, if not full)
Capital is the amount invested by the owner in the business. This amount may be from his own funds (equity) or borrowed from someone (debt). So, capital is equity + debt.
Crediting an account
Crediting an account means that a payable has been recorded in the books. Usually this transaction happens when an invoice or a credit note is received.
“The cumulative revenue for March is xxxx…”. Here, in this sentence the cumulative means the revenue from the beginning the of the year till the end of the March.
Debiting an account
Debiting an accounting means that a receivable from that party/account has been recorded in the books.
When Business A sends an invoice to Business B, this means that Business A has debited account of Business B in books of Business A. Similarly, sending a debit note also means that account of the receiver of debit note has been debited.
External financial statements
External financial statements refer to the financial statements which are prepared primarily for external parties like banks, regulators, tax authorities, stock exchange etc. These financial statements are prepared and are usually audited by an external auditor.
This refers to financial figures or numbers. It’s a broad term in accountancy and may be used to refer any amount, revenue, expense, collection, accrual etc.
The term ‘cumulative’ is contracted with ‘for the month’. For example, “The amount of sales made for the month of March are xxx…”.
Refer toprofitability reported of the entity. Let’s say that a company reported a profit of $ 1 M in a year, then this is the financial performance of that entity.
If a company is preparing its financial statements for a period which is less than 12 months, then that period is referred to as financial period. For example, if a company prepares its financial statements for the period from 1 July to 31 December, then this is the financial period of company. However, a financial year may also be referred to as financial period.
A new term has recently replaced ‘balance sheet’ with ‘statement of financial position’. Financial position refers to assets, liabilities and capital of the organization.
Refer to income statement and other financial statements of the entity. But the term is more used for the profit of the company, earning per share, dividend per share etc. So disclosing financial results of the entity means that company has made public what was the outcome of the financial year in terms of profitability/loss and where does the company stand in terms of its financial position.
Refer to a set of the documents containing financial results of the entity. These documents include profit & loss statement, statement of financial position (or balance sheet), statement of cashflows and statement of changes in equity.
A financial year is a twelve-month period for which a company prepares its financial statements and products its financial results. This usually runs from 1 January to 31 December or from 1 July to 30 June. On a rarer level some companies run their financial year from 1 April to 31 March.
Internal financial statements/management accounts
Internal financial statements/management accounts is also a set of financial statements which would usually contain profit & loss account and balance sheet etc. However, these accounts are not shared with external parties. These are prepared for entity’s own use and usually for management reporting. There is no practice of these internal accounts being audited by external auditors.
A liability is an obligation of an entity to pay money or settle otherwise to someone. For example, if a company has borrowed money from a bank then this bank loan is a liability for the company. Because company has to repay this bank loan.
Monthly closing and Quarterly Closing
Closingof the books of accounts for that month or quarter so that no further entries can be postedin that month or quarter. For example, monthly closing will be done at the end of every month. For example, January’s books will be closed by 31 January. All transactions carried out during January shall be recorded in January’s month. Once January month is closed in accounting software, February month will be opened. From 1 Feb, all transactions shall be recorded in February.
Normally monthly closing is done either last day of the month or in first few days of the next month. For example, January’s books might be closed by second or third of February. This delay is to ensure that all transactions are properly recorded for January and no entry is missed out.
All accounts related toprofit and lossstatement are called nominal accounts i.e., revenue account, material expense account, labour cost account, general expense account, finance cost account etc.
Passing an entry
Whena transaction is recorded in the books of a company, this is done by passing an entry. For example, if a transaction of sale has happened in the entity where 10 units of company’s products are sold for a total consideration of $100. Then an accounting entry shall be passed in the accounting system of the company to record this transaction. The entry is passed by debiting and crediting relevant ledger accounts in the accounting software (assuming that accounting is done in softwares).
Statement of account or account statement
Refers to history of transactions with a particular party. This contains details of all invoices, payments received and the net balance due for a particular period.
This is an important tool for credit control department and for reconciliation of balances between two parties. When Business A wants to know which accounting entries have been passed in books of Business B in the account of Business A, Business A would request Business B to send them a statement of account. This statement of Account which will be generated from the accounting system of Business B and would contain all debits and credits passed in that account.
When the books of accounts are closed after the accounting year, so that annual financial statements can be prepared and reported, this is called year-end closing. Once year has been closed, it means that no further accounting entry can be passed in that year’s books of accounts.
For example, if a company has an accounting year of 1 Jan to 31 Dec. The year-end closing shall be done usually in early days of January of next year. All the transactions shall be booked in December (or in respective months of that year) and the year shall be closed.