Financial Accounting: Terminology for Sole Proprietorships

Understanding accounting vocabulary is an important first step in learning how accounting really works. So let’s look at some key terms and their meanings. The Journal, sometimes call the Book of Original Entry or more commonly the General Journal, is how transactions are recorded or entered into accounting records. It is a chronological list of a company’s transactions. An account is a basic summary device used in accounting. All of the related transactions to a particular account are recorded in that account. For example, all of the transactions affecting cash would be recorded in the cash account. Accounts are grouped into 5 broad categories which include; assets, liabilities, equity, revenues, and expenses. We will now learn how financial data moves from the journal into the accounts. In academic setting the account is often expressed as a T account. Two additional terms that are very important are debit and credit. Debit, which is sometimes abbreviated DR, means left side. Credit, sometimes abbreviated CR, means right side. And that’s it. Debits and credits are how different accounts are increased or decreased, but they don’t mean increase or decrease because it depends on which account they effect. Each transaction must effect two or more accounts to keep the accounting equation balance. We learned this when we learned about the accounting equation. This is known as double-entry accounting. So every transaction must include must include at least two accounts. One account that is debited and one account that is credited. There can be more than two accounts but there can never be less. And debits must always equal credits or the accounting equation would be out of balance account balances are either debit balances or credit balances. There are no negative balances in accounting. Balances are calculated by totaling the data side an account and totaling the credit side of the account. Then subtract the smaller side from the larger side. This is the balance that goes on the larger side. An account can have only one balance. In this example, debits are 20,000 and credits are 9000. So the balance of this account is an $11,000 debit balance. In this next example, debits are 15,000 and credits are 17,000. So the balance of this account is a $2000 credit balance. The ledger, sometimes known as the general ledger, is a collection of all the company’s accounts. So all of the assets, liability, equity, revenue, and expense accounts are located in the ledger. Before we end this short video on accounting terms, I would like to revisit a few terms we’ve learned earlier and define the accounts a little bit better. Assets are economic resources, that means something of value, that are owned or controlled by a business and they will provide benefits into the future. The key when trying to determine if something is an asset is that assets provide future benefit. Supplies is in assets because we haven’t used them up yet. When we do they will become an expense, supplies expense to be exact, and they will be a past benefit not a future benefit anymore. Accounts receivable is for money that is owed to us from our customers If we perform service on account, we would use accounts receivable in recording that transaction. Prepaid expenses are like supplies. They will become a past benefits but until they do they are assets. Liabilities are claims on our assets from external parties like creditors. Accounts payable is for money that we owe to our vendors or suppliers. Accrued liabilities, sometimes called accrued expenses, are amounts that we own for our bills related to operations. For example, utility bills received but not yet paid is a type of accrued liability. Equity is the claim on assets from internal parties like owners. It is sometimes called net worth or net assets because it’s the value of the assets that remain after the liabilities are paid and settled. You can see that the accounting equation can be manipulated to be assets minus liabilities equal equity or net worth or net assets. Owner’s capital is used for both owner investment in a company and increased when a company has net income. Owner’s withdrawal are the amount of earnings the owner has taken out of the company either as a return on investment or as a salary. Revenues are inflows from operations. They are the benefit companies receive from their business operations. Recall that they increase equity but are not technically equity accounts. Service revenue is earned by performing service. Sales revenue is earned by selling goods. Expenses are outflows from operations they are other costs companies incur from their business operations. The account, costs of goods sold, is not obvious that it is an expense account. For retailers and manufacturers it is often their largest expense account. It is titled exactly what it means – it is the cost of goods sold. And that concludes this short video introducing some foundational accounting terms and a more in depth look at some specific accounts.

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