Basic Accounting Terms (original) (raw)

Last Updated : 20 Feb, 2026

Accounting is often called the language of business because it records, analyses, and communicates financial information about a company. For anyone starting in business, finance, or simply trying to manage personal finances, understanding basic accounting terms is essential. Below is a guide to the most important accounting concepts.

1. Business Transaction

Any activity or event that involves money and has a direct effect on the financial position of a business. These transactions are recorded in the books of accounts because they change the value of assets, liabilities, capital, income, or expenses.

A business transaction typically involves at least two accounts - one account is debited, while another is credited. Recording business transactions accurately and in a timely manner is crucial for the proper functioning of any organization make informed decisions, and comply with legal and regulatory requirements.

Examples of Business Transactions:

• Purchase of goods for cash or on credit
• Sale of goods or services
• Payment of rent, wages, or salary
• Receipt of cash from customers
• Purchase of assets like machinery or furniture

2. **Capital

In accountancy,capital refers to the total amount of money or assets invested in a business by its owners or shareholders. It represents the long-term financial commitment of the owners to the company and is considered a liability of the business.

Capital may introduced as cash or assets , or it can be generated by the business itself through profits or retained earnings. The amount of capital invested determines owners stake in the business and share in the profits and losses. At the end of each accounting period, the net profit is added to the capital account, while a net loss is deducted. This results in an increase or decrease in the owner’s equity.

In the accounting system, capitalis recorded as a separate account in the balance sheet, which shows the financial position of the business . The capital account reflects the total amount of capital invested in the business, including any additional investments made by the owners.

Capital is an essential aspect of any business as it provides funds requires for the daily operations and future growth of company. It also reflects the owner’s commitment and willingness to bear risks for the success of the business.

Examples of Capital:

• Cash invested by the owner at the start of the business
• Machinery or equipment brought in by the owner

3. **Drawings

Drawings refer to the money or assets withdrawn by the owner from the business for personal use. it may be in the form of cash, goods, or other assets taken from the business. Since drawings reduce the owner’s investment in the business, they decrease the capital account. drawings are recorded in a drawings account, which is later deducted from the capital account at the end of the accounting period.

In a partnership, the drawings of each partner are recorded separately to track their personal withdrawals. The total amount of drawings for all partners is then deducted from the partnership's total capital to calculate the remaining capital balance.

4. **Liabilities (Current and Non-current Liability)

Liabilities are the obligations or debts of a business that are payable to outsiders. They represent the amounts the business owes to individuals, firms, or institutions and are settled in the future through cash, goods, or services. Liabilities arise when a business purchases goods or services on credit, borrows money, or incurs expenses that are yet to be paid. They are shown on the liabilities side of the balance sheet. It is important for businesses to manage their liabilities effectively to avoid default or bankruptcy.

Liabilities are of two types:

• **Current liabilities are those that are expected to be paid within one year or the operating cycle of the business, whichever is longer. They include accounts payable, notes payable, wages payable, taxes payable, and other short-term obligations.
• **Non-current liabilities are those that are not due for payment within one year or the operating cycle of the business, whichever is longer. They include long-term debts, such as bonds payable, long-term notes payable, and mortgages payable. .

5. Assets (Current and Non-current Assets)

Assetsare resources that a business owns or controls, which can be used to generate revenue or provide future economic benefits.Assets are recorded on the balance sheet and are categorized as either current assets or non-current assets.

• **Current Assets are those that can be converted into cash or used up within one year or the operating cycle of the business, whichever is longer. They include cash and cash equivalents, accounts receivable, inventory, and prepaid expenses. Current assets are important for the daily operations of the business and are expected to be converted into cash or used up within a short period.
• **Non-current Assets are those that are not expected to be converted into cash or used up within one year or the operating cycle of the business, whichever is longer. They include long-term assets such as property, plant, and equipment, investments, and intangible assets such as patents, trademarks, and goodwill. Non-current assets are essential for the long-term growth and success of the business.

Effective management of assets is critical for the success of a business. This includes monitoring the usage and maintenance of assets, evaluating the return on investment for capital expenditures, and assessing the risk associated with different types of assets.

6. **Fixed Assets (Tangible and Intangible Assets)

Fixed assets are long-term resources that a business owns or controls and that are not expected to be converted into cash within one year or the operating cycle of the business, whichever is longer. Fixed assets include both tangible and intangible assets.

• **Tangible fixed assets are physical assets that can be seen, touched, and felt. They include property, plant, and equipment (PPE) such as land, buildings, machinery, and vehicles. Most tangible fixed assets may depreciate its value due to wear and tear, usage, or obsolescence in long term.
• **Intangible fixed assets are non-physical assets that do not have a physical existence but have value to the business. They include patents, trademarks, copyrights, software, and goodwill. these are recorded at their historical cost or fair value, whichever is more reliable. Intangible fixed assets are not depreciated but are tested annually for impairment, which is a significant decrease in the asset's value.

7****. Expenditure (Capital & Revenue Expenditure)**

It refers to the amount of money spent by a business to acquire goods or services or to incur expenses for its operations. expenditures can be categorized into two types:

• **Capital expenditures are those expenditures that are incurred to acquire or improve a long-term asset that is expected to provide benefits over a period of more than one year. These expenditures are typically large and include the purchase or construction of buildings, machinery, and equipment, as well as the acquisition of land and patents. Capital expenditures are recorded on the balance sheet as fixed assets and are depreciated over their useful lives.
• **Revenue expenditures, are those expenditures that are incurred to maintain or operate a business and are expected to provide benefits within the current accounting period. These expenditures are typically small and recurring and include expenses, such as rent, utilities, salaries, and supplies.Revenue expenditures are recorded on the income statement as expenses and are deducted from revenue to determine net income.

8. Expenses

Expenses are the costs that a business incurs in order to generate revenue. Expenses can be categorized into two types

• **Direct expenses: Expenses that are directly related to the production or sale of a product or service. These expenses can be easily traced to a specific product or service and include items, such as raw materials, direct labour, and manufacturing overhead. Direct expenses are recorded as part of the cost of goods sold on the income statement.
• **Indirect expenses: Expenses that are not directly related to the production or sale of a product or service. These expensescannot be easily traced to a specific product or service and include items, such as rent, utilities, salaries, and advertising. Indirectexpenses are recorded separately on the income statement as operating expenses.

9. Income

Income is the revenue earned by a business through its operations over a specific period of time.Income is an key indicator to financial performance of a business and can be classified into two types:

• **Operating income : Income that is earned from the primary business activities of the company, such as the sale of goods or services.Operating income is calculated by deducting the cost of goods sold and operating expenses from the operating revenue generated by the company. Operating income is a key metric for measuring the profitability of a company's core business operations.

Operating Income=Revenue from Operations−Operating Expenses

• **Non-operating income: income that is earned from sources other than the primary business activities of the company, such as interest income, dividends received, or gains from the sale of investments. Non-operating income is typically reported separately from operating income in the income statement and can have a significant impact on the overall financial performance of the company.

10. **Profit

Profit is the financial gain that a company earns after deducting all expenses from the revenue generated by its operations over a specific period of time. Profit is an important metric for measuring the financial performance of a company, and it is calculated using the income statement. Profit can be classified into two types: Gross Profit and Net Profit.

• Gross profit is the profit earned by a company after deducting the cost of goods sold from its revenue.
• Net profit is the profit earned by a company after deducting all operating expenses, non-operating expenses, and taxes from its revenue.

**11. Gain

Gainrefers to an increase in the value of an asset, or a decrease in the value of a liability, which results in a financial benefit for a company. Income generated apart from the operating activity or incidental transactions that are not part of its core operations.

• **Realized gains are those that have been actually received or realised by a company, usually through the sale of an asset or the settlement of liability. For example, a company that sells a long-term investment at a higher price than its cost basis will realize a gain. This gain will be recognized on the income statement as a realized gain.
• **Unrealized gains, on the other hand, are those that have been earned but not realised by the company till date. Unrealised gains are not recognised on the income statement but instead recorded in the company's balance sheet.

**12. Loss

**Loss refers to a decrease in the value of an asset, or an increase in the value of a liability, which results in a financial loss for a company. Losses can be realised or unrealised and can be classified as operating or non-operating losses.

• **Realised losses are those that have been actually incurred by a company, usually through the sale of an asset or the settlement of liability. For example, a company that sells a long-term investment at a lower price than its cost will realise a loss. This loss will be recognised on the income statement as a realised loss.
• **Unrealised losses, are those that have not actually occurred but exist only on paper. For example, a company that owns a long-term investment that has decreased in value, but has not been sold yet, is an unrealized loss. Unrealised losses are not recognized on the income statement but are instead recorded in the company's balance sheet.
• **Operating losses are losses that are directly related to the primary business activities of the company. For example, a company that sells its products for a lower price than it paid for the raw materials used to make them will realise an operating loss.
• Non-operating losses, on the other hand, are losses that are not related to the primary business activities of the company. For example, a company that incurs a loss on the sale of an office building will realise a non-operating loss.

**13. Purchase

Purchaserefers to the acquisition of goods or services by a company for the purpose of using them in its operations, reselling them, or holding them as an investment. A **purchase can be made for cash or on credit and is typically recorded in a company's books of accounts.

**14. Sales

Salerefers to the transfer of goods or services by a company to a customer in exchange for payment. A sale can be made for cash or on credit and is typically recorded in a company's books of accounts.

**15. Goods

Goods typically refer to tangible products that a company buys or sells as part of its normal operations. Goods are usually classified as assets on a company's balance sheet until they are sold, at which point they become revenue.

Goods can include any tangible item that a company produces or sells, such as inventory, raw materials, finished products, or supplies. In order to account for goods, a company must keep accurate records of all purchases and sales, as well as any changes in the value of its inventory.

**16. Stock

Stock refers to the inventory of products or materials that a company holds for sale or production. This can include raw materials, work-in-progress items, and finished goods. Stockis classified as an asset on a company's balance sheet.

The cost of stockis typically determined using one of several methods, such as First-In-First-Out (FIFO), Last-In-First-Out (LIFO), or Weighted Average Cost (WAC). These methods help a company to determine the value of its stock on hand, as well as the cost of goods sold (COGS) when stock is sold.

**17. Debtor

Debtor is an individual or entity that owes money to the firm. This typically refers to a customer or client who has purchased goods or services on credit but has not yet paid for them. Debtor is classified as an asset on a company's balance sheet.

When a company extends credit to a customer, it records the transaction in its books of accounts by debiting the accounts receivable account and crediting the revenue account. This creates a balance owed by the customer, which is recorded as a debtor on the company's balance sheet.

**18. Creditor

**Creditor refers to an individual or entity to whom the firm owes money. This typically refers to a supplier or vendor from whom a company has purchased goods or services on credit but has not yet paid for them. Creditors are classified as a liability on a company's balance sheet.

When a company purchases goods or services on credit, it records the transaction in its books of accounts by debiting the relevant expense or asset account and crediting the accounts payable account. This creates a balance owed to the supplier or vendor, which is recorded as a creditor on the company's balance sheet.

**19. Voucher

Voucheris a document that serves as evidence of a financial transaction. It serves as evidence that money was paid or received and is used to record transactions accurately in the books of accounts.

Voucher typically contains date of transaction, amount of transaction ,brief description of the transaction and the name and signature of the person who made these transaction.

Types of Vouchers:

• **Payment Voucher: Used when the business makes a payment.
  _Example: Cash payment for electricity bill.
• **Receipt Voucher: Used when the business receives money.
  _Example: Cash received from a customer.
• **Journal Voucher: Used for non-cash transactions or adjustments.
  _Example: Depreciation recorded on machinery.

**20. Discount

Discounts are reductions in the price of goods or services that are offered to customers. There are two main types of discounts: trade discounts and cash discounts.

• A trade discount is a reduction in the list price of goods or services that is offered to customers based on the quantity of the product or the volume of the order. It is usually expressed as a percentage of the list price and is not recorded as a separate transaction. Instead, the discounted price is simply recorded as the new selling price. Trade discounts are used to encourage larger purchases . .
• A cash discount is a reduction in the price of goods or services that is offered to customers who pay their dues within a specified period of time. It is usually expressed as a percentage of the selling price and is recorded as a separate transaction. These are used to encourage instant payment and to reduce the risk of bad debts. They are also used to improve cash flow by accelerating the collection of accounts receivable.

Also Read:

• Rules of Journal Entry
• Basic accounting Concepts
• IFRS & GAAP