This guide is a compilation of the basic terms and principles in accounting, from everything that is recorded in your balance sheets, such as your assets, liabilities and equity, and the sub-terms, to your statement income which tracks your revenues and expenses.
Accounting is the language of business. Anyone involved in the busines—a business owner, a business manager, or an investor, must have the basic knowledge and comprehension of the terms being used in accounting and bookkeeping to determine the health of the business you’re involved in.
Even if you’re outsourcing accounting services to a reliable BPO company, you need to have the basic accounting knowledge to understand the data recorded into your books so that you, yourself, can tell whether the money is going where it’s supposed to go or not.
- 1. What is a revenue expenditure?
Revenue expenditure is the amount of money used to maintain the business’ daily operations.
It refers to the expenses incurred to maintain or repair a revenue generating asset such as machinery and computers, and costs used to generate revenue, such as rent, sales commissions, and cost of office supplies and utilities.
These expenses are matched against the revenues to yield income statement.
- 2. What is the difference between depreciation expense and accumulated depreciation?
Depreciation expense is the depletion value of an asset during a tax year. Value of asset based on acquisition minus the value of asset retained after total depletion, divided by the useful life of the asset in years measures its annual depreciation expense.
Accumulated depreciation is the “cumulative depreciation of an asset up to a single point in its life.”
- 3. What is the difference between income and profit?
Income is the gross amount of money earned by a business from a transaction while profit is the amount you get when you deduct your expenses from income.
The equation to derive income is gross revenue – expenses = income.
- 4. What is the operating cycle?
Operating cycle refers to the period that you released funds for the business, the funds being the amount of money you have invested on resources and materials to produce a product or service, to the time you collected the amount back after the product or service had been delivered or sold.
The operating cycle is the basis of measurement on how well the acquired funds had been managed.
- 5. What is a general ledger?
A general ledger is a company’s main record of complete financial transactions that includes accounts for assets, liabilities, owner equity, expenses, and revenues.
A company’s general ledger may be in a form of a physical book or a digital spreadsheet where all the credits and debits are recorded.
It is used for preparing financial statements, for identification of errors and as basis for cases of fraud.
- 6. What are gross sales?
The gross sales of a company or entity refers to the total sales made without deduction of expenses.
For example, a book publisher was able to sell 500 books worth Php 1,000 each for the year. Then the gross sales will be Php 1,000 x Php 500 = Php 500,000.
- 7. What is the cash flow statement?
Cash flow statement is a summary of cash activity, both actual and anticipated, for a period whether monthly, quarterly, or annually.
It is presented in three sections including operating activities or sales of goods or services, investing activities such as a sale or purchase of an asset, and financing activities such as borrowing or selling of common stock.
- 8. What are debits and credits?
Debits and credits are classification methods in accounting used to double-record financial information from source documents into your books.
Under debits, you list down the increase in asset and expenses, decrease in liabilities, income, and equity, while you do the exact opposite under the credits column.
The total amount of debit must match the total amount of credits for the same transaction.
- 9. What are accounting principles?
Accounting principles are the generally accepted set of guidelines and underlying principles from cost principles, full disclosure principles, materiality principles, to economic entity principles that every accountant must follow in preparing a company’s financial statements.
These accounting principles are otherwise known as Generally Accepted Accounting Principles or GAAP.
Check out this list of 10 invoicing and accounting tools for businesses that you can use to prepare your financial statements.
- 10. What is the difference between revenues and earnings?
Simply put, revenues mean gross income and earnings mean net profit.
Revenues refer to the total amount of money that the business acquired from selling products or services, without any deduction. You will derive the amount of your earnings when you subtract the expenses from the revenue.
- 11. What is the difference between expenses and payments?
Expenses are the amount spent for the business to earn a profit while payment is simply money disbursed that is not necessarily an expense.
Expenses are deductible from revenue, while payment is not.
For example, laptops and internet connection can be considered expenses for businesses that heavily rely on computer technology and the internet to operate, while business books are simply purchases that do not merit as an expense.
- 12. What is the difference between revenues and receipts?
Revenue is the total income of a business, whether paid or on credit while the receipt is cash accepted for a sales activity for the delivery of a product or service.
Revenue increases the owner’s equity, while receipt, more commonly referred to as cash inflow, increases the business cash.
- 13. What are operating expenses?
Operating expenses are money spent to continue day-to-day operations that does not directly involve production.
There are three types of operating expenses: (1) compensation-related expenses like benefits and pension contributions for non-production employees, sales commissions and salaries of non-production employees, (2) office-related expenses like legal fees, property tax, utilities, repairs, and office supplies, and (3) sales and marketing-related expenses such as advertising and cost of sales materials, entertainment, and travel costs.
- 14. What is the accrual method?
Accrual method in accounting is keeping record of all revenues and expenses, regardless whether cash exchange was involved.
- 15. What is the statement of cash flows?
Statement of cash flows is a financial statement that presents how money was acquired and spent by the company over a specified period.
It classifies the movement of cash under operating or primary income generating activities (e.g. sales revenue receipts), investing (e.g. purchase or sale of assets), and financing activities (e.g. dividends and interest expenses).
- 16. What is a liability account?
A liability account is a record of all the credit and loans for products or services that the business has already received but has not paid for yet.
For example, loans from the banks and services provided by vendors or rendered by employees or contract workers.
- 17. What is net income?
Net income is also known as net profit or net earnings. The formula is: total revenues – expenses incurred = net income.
For example, the company’s total revenue is Php 500, 000. From this amount, you will deduct the amount you used to maintain operation, interests, taxes, and preferred stock dividends. The difference is your net income.
- 18. What is a long-term asset?
Long-term assets are assets that companies hold for more than a year. Current assets are the total opposite of long-term assets, as they are assets that a company holds for less than a year.
Examples of long-term assets are machinery and equipment, plant, and properties.
- 19. What are balance sheet accounts?
The balance sheet is a financial statement that shows a company’s value at a single point in time. It includes three parts: assets, liabilities, and owner’s equity.
The balance sheet reflects a company’s financial standing and the money it owes. It is divided into parts that must have the same balance once the equation, assets = liabilities + shareholder’s equity, is done.
It is a record of all the assets that the company owns through which these assets, current and long-term, are tracked.
Current assets are assets available within a 12-month period while long-term assets are those anticipated to go beyond 12 months.
Prepaid insurances and cash on-hand are considered current assets, while buildings, vehicles, and equipment are listed under long term-assets.
- 20. What is a general ledger account?
A general ledger account is a record of all the transactions, from assets, liabilities, equity, revenue, expense, gain, and loss transactions of a company, business, or entity.
- 21. What is the difference between accounts payable and accounts receivable?
On the company’s balance sheet, accounts receivable is reflected under assets, while accounts payables go into the list of the company’s current liabilities.
Learn more about accounts payable and accounts receivable here.
- 22. What is the difference between the cash basis and the accrual basis of accounting?
Cash basis accounting and accrual basis of accounting are two methods in recording transaction that differ in timing.
Cash basis accounting is recording revenue and expense when a cash exchange has occurred while accrual basis of accounting is recording revenue and expense when cash is earned and product or service had been consumed.
- 23. What are accruals?
Accruals are expected revenues and consumed expenses, still for future reporting. Examples of expected revenues are billable hours for services rendered while the best example of an accrual expense is interest in loans.
- 24. What is the distinction between a debtor and creditor?
A debtor is a company or entity that owes money from a creditor while the creditor is a company or entity from whom monetary credit is or can be due through a lending agreement.
- 25. What is owner's equity?
Total assets of the business or entity – total liabilities = owner’s equity.
In sole proprietorship, owner’s equity would refer to the total of the owner’s original investment in the business, donated capital, subsequent profits, and losses of the business and distributions to the owner.
In corporations, the owner’s equity is also termed as shareholder’s equity that refers to the net assets of the company.
- 26. What are accrued expenses and when are they recorded?
Accrued expenses are expenses that the company has incurred but have not paid yet. It is recorded within the accounting period that the payment had been made and must also be recognized in the same accounting period, instead of when it is paid.
- 27. How do I calculate the amount of sales tax that is included in total receipts?
To calculate for the amount of sales tax, subtract the retail price from the total receipt price.
To know your retail price, divide the total sales tax of goods sold in the receipt by one hundred to convert to a rate, and then add one to the quotient. Afterward, divide the total receipt price to the answer.
Read more about Post Tax Season: What documents to toss and what to keep.
- 28. What is the cost of sales?
The accumulated total of all costs, from the beginning inventory to the purchases during the manufacturing period, to the ending inventory is called cost of sales by retailers or cost of goods sold by manufacturers.
Cost of sales reflects all of the company’s ability to produce, source, and design a product within a budget.
- 29. What is the difference between product costs and period costs?
All costs, such as costs that are classified under direct material, direct labor, and factory overhead that had been included in the cost of goods are called product costs.
On the other hand, period costs refer to the amount of money spent on anything outside the manufacturing of the goods. Advertising and marketing costs, legal fees, research costs, and sales commissions are classified as period costs.
- 30. What is meant by reconciling an account?
Reconciling an account means that you compare two statement records to make sure that they are consistent with each other.
Reconciling an account is necessary for identification of errors in tracking cash inflow and outflow, errors in balances, and possible fraud or theft.
- 31. What is the purpose of control accounts?
A control account is a subsidiary ledger that is kept for the purpose of keeping the general ledger neat and easy to comprehend while containing the right financial statement.
The details that support that balance on the general ledger are put in the control accounts to keep track of all the cash activity you won’t see in the main ledger.
- 32. What is the difference between a general ledger and a general journal?
A general journal is used to record initial cash transactions that don’t occur in volumes sufficient enough to be recorded in the general ledger, such as asset sales and bond sales or interest expense or income.
A general ledger is a more detailed summarization of the transactions, possibly from many different specialized journals, of the company at the account level.
- 33. What is the difference between an implicit cost and an explicit cost?
Explicit cost is the actual cost of something that you paid or are paying for while explicit cost is implied cost. It is the value of what you have given up to obtain another.
- 34. What is the difference between financial accounting and management accounting?
Financial accounting is the financial information of a company provided to stockholders, investors, and creditors through which the business’ past performance is being judged.
Management accounting is the accounting information provided to managers and those in direct control of operations for the purposes of planning, strategizing, and decision-making.
Here’s an article that helps explain management accounting versus financial accounting.
- 35. What is petty cash?
Petty cash is a small amount of money intended to cover costs that require immediate payment and miscellaneous expenses.
- 36. What is the meaning of equity?
Equity is defined three ways. In accounting and finance, it is the difference between the value of the asset and the cost of liabilities that come with it.
Shareholder’s equity is the equity of the company divided among common or preferred stockholders.
Ownership equity is the portion of a business equity which, after all liabilities and credits have been paid off, remains for the owners.
- 37. What is a contra asset account?
Also called a valuation account, contra asset account is a balance sheet account within the financial statement that offsets related account to know net value.
- 38. What is the difference between stocks and bonds?
Stocks are ownership stakes or units of shares of the company. These shares put together to make up the value of the company or market capitalization.
Bonds are debts issued to the company; types of which include loans made to the government, municipal or loans made to local governments, and corporate, which are loans made to companies.
- 39. What is the cost of goods sold?
Cost of goods sold is a manufacturer’s term for cost of sales. (See number 29)
- 40. What is a lease?
A lease is a legal agreement between a lessor and a lessee, wherein the latter is allowed to use the lessor’s property or asset for a given period in exchange for payment.
Two types of leases are finance lease by which the lessee assumes all substantial risks and rewards of an asset, and the operating lease.
- 41. What is straight line depreciation?
A straight line depreciation is the estimated standard useful life of any fixed asset.
To determine an asset’s straight line depreciation, subtract the estimated salvage value of the asset from its initial cost; make an estimation of the useful life of the asset, and then divide it into 1. Finally, multiply the depreciation rate by the less salvage value or asset cost.
- 42. What is comprehensive income?
Comprehensive income is a statement that includes revenue, finance costs, tax expenses, profit shares and losses, and discontinued operations for a given period.
Companies have the option to create a separate report of the comprehensive income from that of the income resulting from owner’s changes in equity or to present everything together in one financial statement.
- 43. What is opportunity cost?
Opportunity cost is the profit that you will be losing when you choose an alternative over another. This provides management basis to make informative business decisions.
- 44. Why do we charge depreciation?
We charge depreciation because the value of an asset is matched against the profit it generates.
Depreciation of an asset is a loss in profit and therefore, considered an expense which needs to be accounted for. Failure to do so may result in miscalculation of company profits that may lead to the management spending the unaccounted expense.
- 45. What is absorption costing?
Absorption costing is the inclusion or absorption of all costs in manufacturing, whether direct or indirect, in the price inventory.
- 46. What is long-term debt?
Long-term debts are bank loans, mortgage bonds, and other financial obligations of a company or entity due beyond one year from the date recorded in the balance sheet.
- 47. What are interim financial statements?
Interim financial statements are financial statements on assets, liabilities, and equity for a specific period, prepared by publicly-held companies on a quarterly interval.
- 48. What is present value?
Present value is the worth today of a future sum of money. For example, insurance companies offer interest percentages depending on how much you plan to pay monthly. The amount of money you plan to invest in the insurance to accomplish your goal in a certain number of years is the present value.
- 49. What is direct labor?
Direct labor refers to the wages of the workers or employees, regular or contractual, working on the production of goods and services.
Examples of direct labor are production supervisors, truck drivers, and construction workers.
- 50. What is the time value of money?
Time value of money is the idea that a sum of money is worth more in the future because of its potential for profit, based on the principle that money can earn interest over time.
- 51. What is a long-term liability?
Long-term liabilities are mortgage loans, bank loans, and debentures that can be paid within or longer than one accounting year.
Types of long-term liabilities include financing and operating liabilities. Long-term liabilities are indicated in the balance sheet as sources of funds and are required to be paid for a period of 12 months or beyond.
- 52. What is insurance expense?
Insurance expense is the amount of money used to pay for insurance for the business during an accounting period.
- 53. What is interest payable?
Interest payable is the unpaid amount of interest on debts and capital releases. For example, the bank loans a small business Php 500,000 with an interest rate of 4% monthly, which the company will pay for on a quarterly basis.
These interests are “payables” regardless of whether they are short-term or long-term debts. They are considered liabilities and are found in the current liabilities section of the balance sheet.
- 54. What is a capital expenditure versus a revenue expenditure?
Capital expenditures are major financial investments made by a company to maintain a business, make expansions, and generate additional profits.
Revenue expenditures are expenses made by businesses on a short-term basis if only to maintain and continue daily operational expenses.
- 55. What is a contingent liability?
Contingent liability is a reasonably estimated probable cost due depending on how a future event will unfold.
A good example of a contingent liability is warrant reserves where a manufacturer offers a one-year warranty for products sold. The cost of contingent liability is based on the number of units sold during the one-year warranty period.
- 56. What is the accrual basis of accounting?
Accrual basis of accounting is an accounting method where income and expense transactions are reported despite the absence of cash exchange.
- 57. How do you calculate accrued vacation pay?
Accrued vacation pay is determined by matching the amount already accrued by the employee against the correct accrual, which is calculated by multiplying the ending number of accrued vacation hours to his hourly wage.
The accrued amount is the amount of vacation time earned from the beginning of accounting period, added to the number of hours earned in a current accounting period, subtracted by the number of vacation hours in the current period.
- 58. What is the matching principle?
Matching principle is a method that ties the revenues to its related expense through a statement within the same period.
An example of a matching principle is the release of bonuses for the year released in the following year. The amount must be recorded in the year prior to its release.
- 59. What is the double declining balance method of depreciation?
The double declining balance method of depreciation is accelerating the depreciation cost of an asset twice more than the straight line depreciation method (see number 7), deemed reasonable when the asset is consumed much more rapidly in its first few years; or when recognizing expenses and shifting profit into the future.
- 60. What are prepaid expenses?
Prepaid expenses are expenses paid for prior to usage of what has been paid for. It must be recorded, not during the accounting period where it had been paid, but in the period that it was incurred.
For example, a small business issues checks on January to cover rent of equipment for the next three months. The amount paid for February must be recorded in February and so on.
- 61. What is capitalized interest?
Capitalized interest is the interest that is added to the balance of a loan for a long-term asset.
Capitalized interest is considered part of the total value of the asset that depreciates based on the asset’s depreciation value, giving you a more accurate estimation of the actual expenses of a project. This allows you to make calculated allotment of the budget while saving up on taxes.
- 62. Is there a difference between an expense and expenditure?
An expense refers to money spent to meet a daily or current need of the business, while an expenditure is spent on an asset that can be converted back to cash, albeit at a much lower value, if and when necessary.
- 63. Why is depreciation on the income statement different from the depreciation on the balance sheet?
The income statement reflects the depreciation value of the asset for the period indicated on the income statement, along with other expenses of the business.
The balance sheet reflects the accumulated depreciation of the asset, reported as an expense, from the time the asset had been acquired up to the date on the balance sheet.