The field of accounting has its own vocabulary, which can sound like a foreign language at times. By learning the following accounting terms, an individual can figure out how to speak “accounting-ese,” boosting their financial savviness and becoming a smarter entrepreneur in the process.
A trial balance is an accounting report that simply lists the current balances of the accounts in a business’s chart of accounts as of a certain date. It can also be called working trial balance. Another way to look at the trial balance is to view it as an informal version of a balance sheet.
An entity is a “going concern” if it’s expected to continue operations in the near future. For example, the going concern assumption is the prepayment and accrual of expenses. Companies prepay and accrue expenses because they believe they will continue operations in the future.
A double entry bookkeeping system means that when a transaction occurs, two accounts are impacted. For example, when an invoice is generated, entries are made to both the sales revenue account and the accounts receivable account. When a bill is paid, cash is reduced along with accounts payable.
This is probably the toughest concept to understand. Retained earnings is an account in the equity section of the balance sheet. It’s the amount of cumulative earnings of the company after the dividends/distributions are paid out. It’s computed by taking the retained earnings beginning balance, adding income or subtracting loss for the period, and subtracting any dividends/distributions paid to the owners/shareholders.
A transaction is realized and put on the books when there is a contract, a legal obligation, an exchange of products or services, or an exchange of cash. Another way to look at it is to determine if there has been economic performance; ie have benefits or obligations been transferred from one entity to another? There are many complicated principles and rules to help accountants determine this timing. One of the many scandals coming from the Enron debacle was a partnership with Blockbuster Video that clearly violated this concept. Read more about it here: https://www.nytimes.com/2002/01/30/business/enron-s-many-strands-the-accounting-fuzzy-rules-of-accounting-and-enron.html
The cost principle is a foundational accounting principle that means a transaction is at cost and not market or current value. So even though an asset may have gained or lost in value after it’s purchased, the books will still reflect the cost of the item, not the current value. Cost also includes taxes paid on the purchase, installation, testing and shipping.
Expenses are expenditures made in the ordinary course of business. They are not related to a specific job or customer, and they do not have a long life (greater than one year). For example, an oil change to a truck would probably be an expense, but replacing an engine on the same truck would likely be treated differently since a new engine presumably extends the useful life of the truck.
Cost of Sales
Cost of sales are expenditures made with the goal of producting revenue. They relate directly to a job or a customer, but like expenses, they do not have a long life (greater than one year). Labor and materials for a landscaping job or fuel for equipment used on the job are great examples of cost of sales.
To capitalize something means to place it on the balance sheet. For example, a large expenditure purchasing a new machine must be capitalized as a fixed asset, placed on the balance sheet and depreciated over time. Or the previously mentioned new engine in a truck should be capitalized since it significantly extends the useful life of the truck.
Depreciation and Amortization
Depreciation and amortization are accounting terms referring to the allocation of the cost of a tangible asset over its useful life. Businesses depreciate and amortize long-term assets for both tax and accounting purposes. Certain tax laws allow for more immediate depreciation (Section 179 anyone?) but typically an asset is depreciatied or amortized over it’s useful life. Depreciation deals with tangible assets (trucks, equipment, etc.) and amortization refers to intangible items (goodwill, fees, etc).
A client portal is a software application that allows client files to be stored and retrieved securely. Both the accountant and the client have access to the portal.
An engagement letter is the contract that defines the relationship between the client and the accountant. It is typically signed before the work starts and can be renewed once a year. It can also be changed if the scope of the work changes.
The matching principle is another basic accounting principle. It says that for any particular transaction, all aspects should be booked in the same accounting period. For example, let’s say a business owner incurred expenses on an order in November. The order wasn’t delivered or invoiced until December. To meet the matching principle, the expenses should be deferred until December when they can be matched with the revenue that relates to the expenses.
Adjusting Journal Entry
An adjusting journal entry is made when account balances need to be corrected. An example is depreciation expense, which is typically booked with an adjusting entry. Accountants typically make a couple to several adjusting entries like this at year-end to post things like depreciation, amortization or to comply with the other concepts mentioned above, such as revenue recognition or the capitalization of expenditures.
Make sense? Now you’re ready to talk the talk with the Lucrum Consulting team and discuss your accounting needs. Get started by calling 704.927.0462.