Definitions of Accounting Terms

The following terms are often used by accountants, in accounting software, and in fact throughout our discussion. We've placed their definitions here so that you can print them out, if you want. Definitions are also scattered throughout the text when you see blue or gray underlined text, click on the word to get more information.

Accounting equation: Assets = liabilities + owner's equity. The accounting equation is the basis for the financial statement called the balance sheet.

Accounts payable: Also called A/P, accounts payable are the bills your business owes to suppliers.

Accounts receivable: Also called A/R, accounts receivable are the amounts owed to you by your customers.

Accrual method of accounting: With the accrual method, you record income when the sale occurs, not necessarily when you receive payment. You record an expense when you receive goods or services, even though you may not pay for them until later.

Adjusting entries: Special accounting entries that must be made when you close the books at the end of an accounting period. Adjusting entries are necessary to update your accounts for items that are not recorded in your daily transactions.

Aging report: An aging report is a list of customers' accounts receivable amounts and their due dates. It alerts you to any slow-paying customers. You can also prepare an aging report for your accounts payable, which will help you manage your outstanding bills.

Allowance for bad debts: Also called reserve for bad debts, it is an estimate of uncollectable customer accounts. It is known as a "contra" account because it is listed with the assets, but it will have a credit balance instead of a debit balance. For balance sheet purposes, it is a reduction of accounts receivable.

Assets: Things of value held by the business. Assets are balance sheet accounts. Examples of assets are cash, accounts receivable, and furniture and fixtures.

Balance sheet: Also called a statement of financial position, it is a financial "snapshot" of your business at a given date in time. It lists your assets, your liabilities, and the difference between the two, which is your equity, or net worth.

Capital: Money invested in the business by the owners. Also called equity.

Cash method of accounting: If you use the cash method, you record income only when you receive cash from your customers. You record an expense only when you write the check to the vendor.

Chart of accounts: The list of account titles you use to keep your accounting records.

Closing: Closing the books refers to procedures that take place at the end of an accounting period. Adjusting entries are made, and then the income and expense accounts are "closed." The net profit that results from the closing of the income and expense accounts is transferred to an equity account such as retained earnings.

Corporation: A legal entity, formed by the issuance of a charter from the state. A corporation is owned by one or more stockholders.

Cost of goods sold: Cost of inventory items sold to your customers. It may consist of several cost components, such as merchandise purchase costs, freight, and manufacturing costs.

Credit memo: Writing off all or part of a customer's account balance. A credit memo would be required, for example, when a customer who bought merchandise on account returned some merchandise, or overpaid on their account.

Credits: At least one component of every accounting transaction (journal entry) is a credit. Credits increase liabilities and equity and decrease assets.

Current assets: Assets that are in the form of cash or will generally be converted to cash or used up within one year. Examples are accounts receivable and inventory.

Current liabilities: Liabilities payable within one year. Examples are accounts payable and payroll taxes payable.

Debit memo: Billing a customer again. A debit memo would be required, for example, when a customer has made a payment on their account by check, but the check bounced.

Debits: At least one component of every accounting transaction (journal entry) is a debit. Debits increase assets and decrease liabilities and equity.

Depreciation: An annual write-off of a portion of the cost of fixed assets, such as vehicles and equipment. Depreciation is listed among the expenses on the income statement.

Double-entry accounting: In double-entry accounting, every transaction has two journal entries: a debit and a credit. Debits must always equal credits. Double-entry accounting is the basis of a true accounting system.

Drawing account: A general ledger account used by some sole proprietorships and partnerships to keep track of amounts drawn out of the business by an owner.

Equity: The net worth of your company. Also called owner's equity or capital. Equity comes from investment in the business by the owners, plus accumulated net profits of the business that have not been paid out to the owners. Equity accounts are balance sheet accounts.

Expense accounts: These are the accounts you use to keep track of the costs of doing business: where your money goes. Examples are advertising, payroll taxes, and wages. Expenses are income statement accounts.

Fixed assets: Assets that are generally not converted to cash within one year. Examples are equipment and vehicles.

Foot: To total the amounts in a column, such as a column in a journal or a ledger.

General ledger: A general ledger is the collection of all balance sheet, income, and expense accounts used to keep the accounting records of a business.

Income accounts: These are the accounts you use to keep track of your sources of income. Examples are merchandise sales, consulting revenue, and interest income.

Income statement: Also called a profit and loss statement or a "P&L." It lists your income, expenses, and net profit (or loss). The net profit (or loss) is equal to your income minus your expenses.

Inventory: Goods you hold for sale to customers. Inventory can be merchandise you buy for resale, or it can be merchandise you manufacture or process, selling the end product to the customer.

Journal: The chronological, day-to-day transactions of a business are recorded in sales, cash receipts, and cash disbursements journals. A general journal is used to enter period end adjusting and closing entries and other special transactions not entered in the other journals. In a traditional, manual accounting system, each of these journals is a collection of multi-column spreadsheets usually contained in a hardcover binder.

Liabilities: What your business owes creditors. Liabilities are balance sheet accounts. Examples are accounts payable, payroll taxes payable, and loans payable.

Long-term liabilities: Liabilities that are not due within one year. An example would be a mortgage payable.

Merchandise inventory: Goods held for sale to customers.

Net income: Also called profit or net profit, it is equal to income minus expenses. Net income is the bottom line of the income statement (also called the profit and loss statement).

Partnership: An unincorporated business with two or more owners.

Post: To summarize all journal entries and transfer them to the general ledger accounts. This is done at the end of an accounting period.

Prepaid expenses: Amounts you have paid in advance to a vendor or creditor for goods or services. A prepaid expense is actually an asset of your business because your vendor or supplier owes you the goods or services. An example would be the unexpired portion of an annual insurance premium.

Prepaid income: Also called unearned revenue, it represents money you have received in advance of providing a service to your customer. Prepaid income is actually a liability of your business because you still owe the service to the customer. An example would be an advance payment to you for some consulting services you will be performing in the future.

Profit and loss statement: Also called an income statement or "P&L." It lists your income, expenses, and net profit (or loss). The net profit (or loss) is equal to your income minus your expenses.

Proprietorship: An unincorporated business with only one owner.

Reserve for bad debts: Also called allowance for bad debts, it is an estimate of uncollectable customer accounts. It is known as a "contra" account because it is listed with the assets, but it will have a credit balance instead of a debit balance. For balance sheet purposes, it is a reduction of accounts receivable.

Retained earnings: Profits of the business that have not been paid to the owners; profits that have been "retained" in the business. Retained earnings is an "equity" account that is presented on the balance sheet and on the statement of changes in owners' equity.

Sole proprietorship: An unincorporated business with only one owner.

Trial balance: A trial balance is prepared at the end of an accounting period by adding up all the account balances in your general ledger. The debit balances should equal the credit balances.

Unearned revenue: Also called prepaid income, it represents money you have received in advance of providing a service to your customer. It is actually a liability of your business because you still owe the service to the customer. An example would be an advance payment to you for some consulting services you will be performing in the future.