Twenty-One Common Accounting Terms

A tablet showing the dictionary definition of a word, symbolic of our list of 21 common accounting terms.

If you’re new to accounting one of the first things you need to do is learn some basic accounting vocabulary. We’ve put together this list of twenty-one common accounting terms for that very purpose. Whether you’re a new business owner, student, or just interested in business, this list should get you going. So, strap yourself in and check out our list of common bookkeeping terminology.

Accounts Receivable (AR): invoices that a company has already sent that have yet to be paid. AR is considered an asset on a company’s balance sheet.

Accounts Payable (AP): bills to a company which have yet to be paid. AP is considered a liability on a company’s balance sheet.

Accrual Accounting: an accounting method where revenues and expenses are recognized when sales or services occur rather than when cash exchanges hands. Accrual accounting is required to fully comply with the rules of G.A.A.P. and is used by most large companies.

Asset: something that has current or future value that a company owns. Common examples include vehicles, machinery, patents, land, equipment, or computers. Assets are found on a company’s balance sheet.

Balance Sheet: one of the primary financial statements, the balance sheet shows the balances in a company’s asset, liability, and equity accounts at a particular moment in time. It always satisfies the fundamental accounting equation which states that assets equal liabilities plus equity. (Click here to learn even more about balance sheets.)

Capitalization: the recording an asset on the balance sheet rather than expensing it. Capitalized assets are expensed through time through depreciation.

Cash Accounting: an accounting method where revenues and expenses are recognized when cash exchanges hands, rather than when billing occurs. Many small businesses use cash accounting.

Two pages in a dictionary, symbolic of our list of common accounting terms.
Don’t go searching through a dictionary to learn what accounting terms mean. Use are handy dandy guide to twenty-one common accounting terms!

Contra Account: a balance sheet account used to offset the amount in another account which it is paired with, resulting in a net value. An example is depreciation, which paired with an asset’s original value the current net value of the asset on the books.

Credit: an accounting entry that increases the value of a liability or equity account or decreases the value of an asset account. The amounts of credits in any entry must be matched by an equal amount of debits.

Current Assets: either cash or assets which are expected to be used up or converted to cash within the next twelve months or next operating cycle. Common examples include accounts receivable, inventory, and prepaid expenses. Current assets are found on a company’s balance sheet.

Current Liabilities: liabilities which are expected to be repaid over the next twelve months or next operating cycle. Common examples include accounts payable, short term debt, and accrued expenses. Current liabilities are found on a company’s balance sheet.

Debit: an accounting entry that increases the value of an account or decreases the value of a liability of equity account. The amount of debits in any entry must be matched by an equal number of credits.

Depreciation: the process by which assets on the balance sheet lose value and are expensed over time. The amount of the total depreciation is deducted from the asset value to calculate the current value on the balance sheet. There are several ways to calculate depreciation. Common methods include straight line, declining balance, and double declining balance.

Equity: the value of ownership of a company, calculated by deducting the value of a company’s liabilities from the value of its assets. Equity can be found on a company’s balance sheet.

Fixed Assets: an asset whose useful life is longer than twelve months or an operating cycle. Common examples include Property, Plant, & Equipment (PP&E), land, vehicles, and machinery.

Generally Accepted Accounting Principles (GAAP): a set of standards established by the Financial Standards Accounting Board describing how to engage in GAAP conforming accounting. GAAP is often used in audits and is required for publicly traded companies in the United States.

Income Statement: one of the primary financial statements, the income statement, (also known as the profit and loss statement), displays a company’s sources of income and expenditures through a period of time and its net profit after accounting for both.

Liability: obligations that a company owes to other companies or an individual. Common examples include loans, accounts payable, and unpaid interest. Liabilities are found on a company’s balance sheet.

Long Term Liabilities: liabilities not expected to be repaid over the next twelve months or operating cycle. Common examples include long term loans, mortgages, and bonds payable. Long term liabilities are found on a company’s balance sheet.

Statement of Cash Flows: one of the primary financial statements, the statement of cash flows displays the sources of cash in and out of a company through a period of time. The cash flows are broken down into operating, investing, and financing activities, and can be displayed user either the direct of indirect method.

Statement of Changes in Equity: a financial statement which breaks down the changes in a company’s equity account over a period of time. Examples of sources of changes in equity income net income, dividends, and proceeds from the sale of stock.

There you have it. Twenty-one common accounting terms defined. We hope this list has been informative for you and helps a bit in your business journey. Who are we? We’re My SD Bookkeeper – San Diego’s best bookkeeping and business consulting firm. We provide bookkeeping services to great companies all over the San Diego in industries ranging from eCommerce to real estate. If you need help with your bookkeeping, give us a call today and let’s chat!

Want to learn more about bookkeeping and business? Check out our great blog made with the San Diego businessperson in mind. Recent posts include a list of 5 ways outside bookkeepers can help San Diego businesses and an introduction to bank reconciliations.

Want to learn even more great accounting vocabulary? Try the NYS Society of CPA’s website for an extensive list.

Go Padres!

What are Bank Reconciliations?

Scrabble squares spelling 'Reconcile', symbolic of our intro to bank reconciliations.

Bank reconciliations – a lot of business owners have heard of the concept but aren’t entirely sure what they are or how they are done. If that includes you, don’t worry, we’re here today to answer the age-old question: what is a bank reconciliation, anyway?

So, read on for an introduction to bank reconciliations that will leave you a little wiser and ready to conquer a crucial corner of the bookkeeping world. (Or at least understand it.)

What is a Bank Reconciliation?

Let’s get right to it. A bank reconciliation – also called a ‘bank rec’ by the cool crowd – is a way to check the accuracy of your bookkeeping data. More specifically, it is the process by which you determine if there are any differences between your bookkeeping records and your bank’s records, and if so, why.

Why Are Bank Reconciliations Important?

Excellent question. Bank recs are important because your bookkeeping must be accurate in order for it to properly describe what is happening at your company, and the recs help make that happen. If your bookkeeping isn’t accurate, it can cause a whole host of problems: you might misrepresent your profits, you may pay the wrong amount in taxes, or you might have an inaccurate idea of how your company is functioning. None of these things are good, and they all decrease the value you get out of your books.

How Do You Do a Bank Reconciliation?

Let’s get down to the nitty gritty. To do a bank rec you need your monthly bank statement and access to the reconciliation portal in your bookkeeping software. (QuickBooks, Xero, and Sage are all common examples.) Imagine you just opened your bank account, so this is your first statement. Your software will ask you to enter the opening balance at the beginning of the month, (which in this case is $0), the closing balance, and the closing date. After you enter that information, you will be directly to the reconciliation window.

Here you will see a list of all of the transactions recorded in your books for the bank account in question during the time frame in question. Next you select each transaction on the statement that you find in the books and add any transactions which are missing. By doing so, you should create a scenario whereby the opening balance + the selected debits + the selected credits = the closing balance.

Once the equation above is satisfied, the account is technically reconciled, but your work isn’t done. You also need to review any unselected (unreconciled) transactions that are in your books and decide whether they are there in error and should be eliminated, or perhaps should remain for now, but in an ‘uncreconciled’ state. If you don’t eliminate them, they will stay in the reconciliation portal and be displayed when you do next month’s reconciliation – at which point you can decide once again if they should stay or if they should go. (Possibly a reference to the Clash.)

Close up of a check and pen tip, indicative of checks often messing up bank reconciliations.
Checks are notorious for remaining un-reconciled. Don’t let them mess up your bank reconciliation – arm yourself with knowledge and get your bank recs right!

What Are Examples of Unreconciled Transactions?

The most common type of unreconciled transaction is a check. Often a check won’t be cashed until weeks after it was written. This means that if you input a check in the books when you write it, but it hasn’t been cashed by the end of the month, it will be in the books but not on the bank statement. (A check that has been sitting in the reconciliation window for a long time, by the way, is often called a ‘stale check’.)

When that happens, you will be left with an unreconciled check that should be investigated. If you are confident that it was indeed written, you should give it a couple of months to clear. If a few months go by and it still hasn’t cleared then it’s probably a good idea to confirm that it was written, and if so, you may wish to call your bank and cancel it. Once that is done you can eliminate it from your books and be free of it once and for all. (If it was never written, then of course you can eliminate it right away, or go ahead and write it.)

The other most common kind of unreconciled transaction is simply a transaction that was entered in error. If a transaction that isn’t a check is in the books but not on the bank statement it was likely entered accidentally, the date on it is wrong (sometimes people input the wrong year, for example), or if it is at the end of the month it might not show up until the next statement. If you find transactions like this, investigate them and correct them, delete them, or wait until next month, as needed.

Are Bank Accounts the Only Accounts that Get Reconciled?

Bookkeepers and accountants do all kinds of reconciliations, but bank reconciliations and their closely related cousins – credit card reconciliations – are the most common examples. (Credit card reconciliations are basically the same as bank reconciliations, although there generally aren’t checks involved.) 

Your bookkeeper also likely reconciles any liabilities which you may have on your books, for example a loan or a mortgage. In those cases they compare the balance of the debt in the books at the end of each month to the bank statement, and ensure that the proper amount of interest has been recorded.

So there you have it, our handy dandy introduction to bank reconciliations. We hope this helps you in your business journey, or at the very least the next time you are at a cocktail party, and someone says, “what is a bank reconciliation?”, you can pop up and wow the entire crowd with your bookkeeping prowess. (To be honest, we’re not sure that’s ever happened, but hope springs eternal…)

Want to learn some other basic bookkeeping? Check out this post with everything you need to know about balance sheets. Or, if you’d prefer to learn about payroll, try this great article on the best payroll providers for San Diego businesses. (It’s applicable all over, but we really love San Diego, so it was written with the people of America’s Finest City in mind – much like the classic movie Anchorman…)

Who are we? We’re My SD Bookkeeper. San Diego’s premier bookkeeping and business consulting firm. We work with businesses all over San Diego County in a wide range of industries – from real estate to dentistry. So, if you need help with anything related to your books or your back office, we’re here to help. Give us a call today!

By the by, if you’re more of a visual learner, try the video introduction to bank recs below.

Introduction to Balance Sheets

Rocks balancing on top of each other, symbolic of our introduction to balance sheets.

If you have a company in San Diego (or work at one), having a basic understanding of balance sheets is an important skill. The balance sheet provides crucial information about a business and is one of the key ways of communicating it’s financial circumstance and performance. Unless you are an accountant or analyst you may not need to understand all of the finer points, but knowing the basics is key if you want to understand how businesses function. Because we love the San Diego business community, we decided to put together this introduction to balance sheets for your convenience. So strap on your thinking cap and get ready for balance sheet basics.

What is a Balance Sheet?

The balance sheet is one of the three core financial statements of a company. It gives an overview of a company’s assets, liabilities and shareholders’ equity at a given point in time. The balance sheet is based on the fundamental accounting equation which states that the sum of assets and liabilities equals shareholders’ equity. The logic behind this can be explained in many different ways, but one of the more intuitive explanations is that all assets must have been acquired either through taking on debt (liabilities), or investing capital directly (equity). Hence A = L + E.

A man walks along rope across a cliff, symbolic of balance and therefore balance sheets.
If you want you balance sheet to balance as well as this guy be sure to read our entire introduction to balance sheets. (We really hope this guy didn’t fall. That looks high…)

The Components of a Balance Sheet

In this section we’ll break a balance sheet into its major parts and give examples of the kinds of things you will see there. Read on!

Assets

1. Current assets

The fancy definition of an asset is a resource that an entity owns from which future economic benefits are expected to flow. Put more simply, an asset is something of value that a company owns. (See below for some examples.) They can be divided into two major categories: Current Assets and Fixed Assets.

Current assets are assets that a company expects to use or sell within a year. Common examples of current assets include inventory, cash & cash equivalents, and accounts receivable.

Inventory

Raw materials or supplies used in the production of goods for sale, work-in-progress, and the final finished products that a business holds may all be considered inventory.

Cash and Cash Equivalents

The term cash and cash equivalents is used to describe the value of a company’s items that are cash or can be readily converted to cash. For most small and medium-sized businesses this basically just means cash. Some companies; however, may also own highly liquid assets such as T-bills that can easily be exchanged for cash and are thus considered an ‘equivalent’.

Accounts Receivable

Accounts receivable, also known as AR, represent the amount an entity is owed by its customers for goods and services.

2. Fixed Assets

Unlike current assets, fixed assets (or long-term assets) are assets that a company plans to own and utilize for a longer time frame, often many years.

Property, Plant, and Equipment (PP&E)

PPE are tangible fixed assets such as its equipment, land and buildings. If a business owns a factory, for example, that would be an example of PP&E. All PPE, except for land, is depreciable.

What is depreciation? Depreciation is the way that fixed assets both decrease in face value over time, and the way in which they are expensed. Most items that a business buys are immediately expensed. If you buy paper clips, they are expensed, deducted from revenues, and decrease profit. But when a fixed asset is purchased it isn’t expensed at all. Instead, it is just put on the balance sheet. Then, each year it is depreciated which both decreases it’s value (naturally, as a piece of machinery gets older it loses value) and creates an expense. So, if you buy a very expensive piece of machinery, instead of a massive expense in year one, it will slowly be expensed over a long period, for example fifteen years.

Liabilities

The fancy definition of liabilities are obligations to transfer economic resources as a result of past events. Put more simply, liabilities are things that a business owes to others. Like assets, they can be broken into current and non-current forms.

1. Current Liabilities

Current liabilities are obligations which an entity must settle within a year. Basically, the liability version of a current asset. Examples of current liabilities include accounts payable, dividends payable, and the current portion of long-term debt.

Accounts Payable (AP)

Accounts payable, also referred to as AP, represents the amount an entity owes its creditors and suppliers in return for goods and services.

Dividends Payable

Dividends Payable represent the amount of dividends that an entity has announced to investors but not yet paid. This is more relevant to public companies than your typical small to medium sized San Diego business.

Current Portion of Long Term Debt

The current portion of long-term debt means exactly what it sounds like. That is, the portion of a long-term debt obligation that will be paid in the short term. So, if your business owes a million dollars, but will pay off $50,000 this year, that would be the current portion.

A stressed woman grabs her hair, like you might if you have too many liabilities on your balance sheet.
Too many liabilities on your balance sheet may leave you as stressed as this chic. Don’t be like her. Finish our introduction to balance sheets so you are armed with knowledge.

2. Long Term Liabilities

Non-current liabilities are obligations which will be settled by an entity over a period longer than a year. Examples include bonds payable, debentures, long-term loans and long-term lease obligations.

Bonds Payable

Bonds payable are the amount owed by an entity to lenders to whom it has issued bonds. (Again, not particularly common among local SD businesses, but a common liability nevertheless.)

Debentures

Debentures sound really fancy but are just a type of unsecured bond which often has a longer maturity. In spite of the name, they have nothing to do with dentistry.

Long Term Loans / Long Term Lease Obligations

As you might expect, amounts in these categories represent loans or leases that are expected to be held longer than a year, or the portion of them which is expected to be held longer than a year. (As noted above, the portion expected to be paid would be the ‘current portion’ of the obligation.)

Equity

Equity represents the value of a company after all of the liabilities are deducted, also known as the book value of the company. If we use some basic algebra to move around the variables in the fundamental accounting equation, we can get Equity = Assets – Liabilities.

Common examples of equity include owner’s contributions and retained earnings.

Owner’s Contributions

Smaller businesses often use this category which represents funds invested into the company by the owner.

Retained Earnings

Retained earnings are an ongoing tally of your profit after all direct and indirect costs, taxes and dividends have been paid off. After each year is completed, the profits are added to the retained earnings account, where they will stay until they are used or distributed to the owners.

Balance Sheet Ratios

Creating ratios using data from the balance sheet can be a good way to gain insights into the health of a business. Banks, for example, may consider various balance sheet ratios when deciding whether to give a business a loan, and in some cases a lender will require a business to maintain minimum amounts for certain ratios. Likewise, investors often check balance sheet ratios when deciding whether to invest, and owner’s use them to review the health of their company.

Current Ratio

The current ratio is assets divided by liabilities.

The current ratio is the ratio of current assets to current liabilities. A current ratio is indicative of a company’s ability to pay off its current liabilities using its current assets and is a way of measuring liquidity and solvency. If there are a lot more current liabilities than current assets, you may worry whether the company will be able to meet its debt obligations. Hence, a higher ratio is often considered desirable. (Believe it or not, an unnaturally high ratio is also sometimes considered undesirable because it may imply an inefficient use of resources, but don’t worry if that doesn’t make sense, it’s a bit of an advanced concept.)

Quick Ratio

The Quick Ratio is current assets - inventory divided by current liabilities.

The quick ratio is very similar to the current ratio; however, inventory is deducted from the current assets. Because inventory is deleted, this is considered a more stringent determination of liquidity and the ability to pay your obligations. Why? Because it may be difficult to sell off your inventory at face value in order to pay off debt, so in this case it isn’t included as an indication of how solvent you are.

Gearing Ratio

The Gearing Ratio is debt divided by debt plus equity.

The gearing ratio is the ratio of the entity’s debt to its equity. A high gearing ratio often indicates that the financial risk of a business is high because it is holding a relatively high debt load.

Receivables Collection Period

The receivables collection period equals accounts receivable divided by net credit sales times 365 days.

The receivables collection period indicates the average number of days for which a receivable is outstanding. For liquidity purposes, a shorter receivables collection period is generally considered better because it means you get paid faster.

Average Payment Period

The Average Payment Period equals average accounts payable divided by credit purchases divided by the number of days.

The payables payment period indicates the average time it takes for an entity to pay its suppliers. While a longer payment period may be considered better for liquidity purposes, taking too long to pay may damage an entity’s relationships with its suppliers.

Inventory Holding Period

The Inventory Holding Period equals average inventory divided by cost of goods sold times 365.

The inventory holding period indicates the average time the entity is holding its inventory before it is sold or used. A shorter inventory holding period is considered better for liquidity purposes. Furthermore, a shorter inventory period reduces the chance of inventory getting damaged or obsolete. However, the entity should draw a balance between inventory held and sold. There should be appropriate levels of inventory in the storage to ensure there are no production stoppages or delayed deliveries to customers.

Balance Sheet Conclusions

So there you have it – My SD Bookkeeper’s (more about us in a bit) introduction to balance sheets. We hope you have a basic understanding of the balance sheet at this point. At it’s essence, the balance sheet is a snapshot of a company in time that describes it’s financial position at a given moment, and in doing so helps to provide insights into its functioning. It is rooted in a central concept in accounting, that is: assets are equal to liabilities to equity – always. Like, always always.

If you really want to understand a company than a balance sheet is only the beginning. There are two more extremely important financial statements – the income statement (also known as the profit and loss statement), and the statement of cash flows. When you combine all three of these you can get a remarkably strong understanding of a company.

Need a great general reference? Try Investopedia. They’ve got a lot of great resources on business and finance.

Want to read some more cool stuff? Check out this article on the 3 best payroll services for San Diego businesses? Or, if you love San Diego as much as we do, check out this one on 5 great things about running a SD business.

Who are we? We’re My SD Bookkeeper. We’re a bookkeeping, accounting, and business advisory firm that serves the greater San Diego community. If you’re in San Diego county and need help with any kind of back office operations then give us a call because we’d love to help. We work with companies across industries, including real estate and medical offices, to name a few – so we can help no matter what you do. Give us a call today, and best of luck with whatever your business ambitions may be!

More of a visual learner? Check out the great video introduction to balance sheets below.