Whether you are a bookkeeper or a business owner, knowing common accounting terms helps you manage your financial strategy. While there are hundreds of terms to know about accounting, here are ten accounting definitions that you may hear (or need to use) in day-to-day operations.
Top 10 Accounting Definitions
1. Accounting Equation
The accounting equation is the key to understanding the rest of the list of accounting definitions: Liabilities + Equity = Assets. This equation should be your north star when dealing with financial matters. It should always be balanced. While we’ll discuss this concept more in definition number ten, every financial transaction should equal zero when you record it in your books based on this equation.
2. Assets
The accounting definition of assets differs from what you typically think of. In accounting, assets are what provide value to a business. They’ll be things you own or the values of specific accounts that are controlled by the business. Some examples of assets are bank accounts, property, and equipment.
However, you cannot count an intangible item as an asset if it doesn’t have value to it. For example, while your staff is a competitive asset to your business, it is not an accounting asset. It’s the same for intellectual property. Unless you’ve acquired at a measurable certain rate, you cannot count it as an asset in your financial statements.
3. Equity
Equity is the value owners have in the business. This can be listed as owners’ equity or shareholders’ equity, depending on the business structure.
4. Liability
A liability is a debts owed or payment outstanding. Essentially, any amount or value you owe to another party is a liability. Loans, accounts payable, and unpaid payroll are all liabilities within the accounting equation. A good rule of thumb is if you owe it and have not paid it, count it as a liability, regardless of to whom it is owed.
5. Debits
You are probably most familiar with the term debits in regards to debit cards–but that’s not what it means in an accounting sense. A debit increases assets or decreases liabilities. For example, if you pay off a loan, that transaction is a debit. Similarly, if you take payment for a service already rendered, that’s a debit as well.
6. Credits
Credits are the opposite of debits. They decrease assets or increase liabilities. Let’s take the two examples we shared in debits, but flip them this time. Taking out a loan increases our liability, making it a credit. However, if we make a cash payment for a service, that decreases our cash balance–an asset–making it a credit.
7. Cash-based accounting
In cash-based accounting, you record revenue when you receive or spend cash, regardless of when the service was rendered or received. Cash-based accounting is more common in small businesses, especially those in the service industry which do not have inventory.
8. Accrual-based accounting
By contrast, in accrual-based accounting you record revenue when you deliver services. So, in our example about taking payment for a service that has not yet been provided, the amount of that payment is a liability until the service is rendered. Businesses with revenues over $5 million or inventories over $1 million must use accrual-based accounting in the US.
9. Journal entries
This doesn’t mean bullet journaling. In accounting, journal entries just mean that you are recording business transactions in your books. After recording your transactions, an accountant takes that information and build numerous financial reports.
10. Double-entry accounting
The first eight definitions build upon each other in a process known as double-entry accounting. In double-entry accounting, you record two book entries for every transaction. In other words, every debit must balance with a credit. Then, those debits and credits should equal $0 to meet the accounting equation’s requirements. This may sound a bit complicated, so here’s an example:
For example, let’s say that you have a taco truck and need to purchase a new tire. The tire costs $500 and you pay for the tire with cash out of your general fund. You’ll record a $500 debit from accounts payable (a liability) for paying for the tire and a $500 credit in your general fund (an asset) to reconcile the cash expenditure. Here’s what that looks like:
By understanding accounting terminology, you’ll have a clearer picture of what the numbers in your business mean. And, if you want an even deeper understanding of your revenue metrics, connect your Xero account directly to Stripe with Bankfeeds.