Accounting Terms Demystified

Have you ever had a conversation with an accountant that left you scratching your head? Individuals without an accounting degree are often convinced that accountants are speaking a foreign language. The truth is that every industry has its terminology, and the technical accounting jargon can be confusing and hard to understand. Still, it is important to know.

Whether you are an enterprise CEO, a small business owner, or want to pursue an accounting degree, you need a basic understanding of accounting concepts. We have put together a simple glossary, including the most important terms and their standard abbreviations that every business owner in Canada can benefit from.

Assets

Assets represent everything your company owns that has a monetary value. It can be cash, business equipment, inventory, and more. Assets are listed in order of liquidity, starting with cash as the most liquid and usually ending with land as the least liquid. There are two categories of assets — fixed and current.

Audit

An audit pertains to the examination of an organization's books of accounts to verify recorded entries and ensure that financial statements are accurate and complete. It also focuses on discovering discrepancies in the books, such as inadvertent errors either in account classification or data entry.?People often think Audits are meant to find fraudulent activity that the organization's employees may have concealed, but often because of an effort of concealment, detecting fraud or other intentional criminal acts become more difficult, which is why you should have good internal controls over your accounting processes and functions.

Accounts Payable

Accounts payable are the expenses a company owes its creditors, such as suppliers, for delivered services and goods. It is the debt owed by a business and is shown as a current liability on the balance sheet. One example of accounts payable is when a restaurant receives a food order on credit from an outside vendor.?

Accounts Receivable (AR)

Accounts receivable refers to the money customers owe a business for delivered and used goods and services. It includes all the revenue a company has generated but has not yet collected. In most situations, it is listed as a current asset on the balance sheet because it is likely that the payments will be made in the short term (within 1 year).

Accruals

Accruals are a method that recognizes revenues and expenses as soon as they have been incurred but not yet recorded in the company’s accounts. As a rule of thumb, accruals occur before the invoice for the transaction is paid or received. They appear on the income statements as they affect net income. Some examples of accruals include accounts payable and receivable, interest, payroll, and tax liabilities.

Amortization

Amortization typically refers to?the process of writing down the value of either a loan or an intangible asset. Amortization schedules are used by lenders, such as financial institutions, to present a loan repayment schedule based on a specific maturity date.?

Balance Sheet

This financial report keeps track of the company’s liabilities (what it owes), assets (what it owns), and shareholders’ equity (money that the business owner invested in their company and the accumulation of the company’s profits over time). It is also known as the balance sheet equation, which can be recorded monthly, quarterly, or yearly at a particular time. Think of the balance sheet as a snap shot or a picture of the company at a particular date.

Cash Flow (CF)

Cash flow is the movement of cash into and out of the company generated through business activities over a given period. Accountants use the cash flow statement to track its movement. It is more like a motion picture of where the cash went and spilt up into 3 sections – cash generated or used by operations, financing (loans, etc.) and investments (like capital asset purchases).

Credit

Credits are accounting entries representing an increase in liabilities (equity account) or a decrease in assets (expense account). They are the opposite of debits and can be found on the right side of the company’s balance sheet. Credits on the income statement increase revenue.

Cost of Goods Sold

Cost of goods sold (COGS) refers to a business’s direct expenses when it creates a product or provides a service. The formula for calculating COGS depends on what is being made. Additionally, other costs must be considered, such as raw materials (parts) and the amount of employee labour used in production.

Debit

Debits are accounting entries that refer to an increase in assets (expense account) or a decrease in liabilities (equity account). They are the exact opposite of credits and are located on the left side of accounting documentation.??On the income statement, debits increase the expense balances.

Dividends

Dividends represent the money or a portion of the company’s profits regularly paid to its shareholders from after tax profits. Aside from cash, investors can also be paid in real property, liquidation proceeds, or stock, but this is more uncommon. Dividends can be paid monthly, quarterly, or annually, after a resolution from the board declaring a dividend.

Diversification

This risk-management strategy aims to reduce the likelihood of one's capital becoming overexposed to a single market or asset class. People and organizations usually diversify by spreading their capital to different types of financial investments and participating in various economic sectors to lower the risk of loss.

Depreciation (Dep)

Depreciation is a term used to describe a reduction in the value of certain assets over time. It refers to long-term assets, such as vehicles, business equipment, furniture, buildings, etc. Depreciation is listed in the income statement as non-cash expenses.

Expenses

Expenses are the costs of running a business. They are classified as direct (the cost of operating the core business activity, such as production cost, raw material cost, wages, and more) and indirect (general costs for running business operations, such as rent, business permits, bills, and legal fees). Expenses can be classified into four categories — fixed, accrued, operating, and variable.

Fixed Assets

Fixed assets represent tangible and intangible resources a company uses daily to operate its business. Those tangible resources are buildings, furniture, land, machinery, equipment, and more. They are purchased to last longer than a single fiscal year. Intangible assets could be trademarks, customer lists, etc.

Gross Margin (GM)

Gross margin is?the amount of money a company has left after subtracting all direct costs of producing or purchasing the goods or services it sells. This is usually expressed as a percentage of sales.?Gross Profit divided by Gross sales equals Gross Margin. The higher the gross margin, the more money the company is able to contribute to its indirect costs and other expenses like interest.?

Gross Profit (GP)

Gross margin is?the amount of money a company has left after subtracting all direct costs of producing or purchasing the goods or services it sells.?

General Ledger (GL)

Organizations and businesses record their transactions using ledgers. The general ledger is the primary account comprising all ledger accounts with a complete record of all transactions within a specified period. Asset, liability, and equity accounts are all examples of individual accounts in a general ledger.

Generally Accepted Accounting Principles (GAAP)

GAAP is a collection of generally accepted accounting rules and standards for companies to follow when reporting financial data. It includes four principles — cost, revenue, matching, and disclosure. By adhering to GAAP, businesses can ensure that their financial statements are accurate and comparable. In Canada, and across the globe, there are a number of different GAAP that you can follow, depending on your organization’s structure and business, such as ASPE, IFRS, ASNPO, just to name a few.

Income Statement (Profit and Loss Statement)

The income statement forms part of the financial statements and displays the company’s profit and loss at a particular cut-off date. Opposite a balance sheet, it present a motion picture of what happened during a given period, such as a month, quarter or year.?It is calculated using the following formula — (total revenue + gains) - (total expenses + losses) = net income.?

Inventory

Inventory describes assets that a company has purchased or produced to sell to its customers that are still not sold. This also includes goods for sale, those in production, and materials used in production. Inventory will decrease as the company sells these items to customers.

Liabilities

Liability refers to a situation in which an individual or a company owes someone else money. It encompasses all the debts incurred during business operations. There are current (those due within 1 year) and long-term liabilities. Current Liabilities, it is a debt to your suppliers like accounts payable. Long term liabilities are payable over a period longer than a year. This can be a multi-year loan for equipment, as an example.

Liquidity

Liquidity indicates how easily a company can convert an asset for cash for its total value. Cash is the most liquid asset and can quickly be converted to other assets. Accounting liquidity refers to how easily liquid assets can be used to pay for goods or services. On the other hand, market liquidity is the ease with which a market facilitates transparent asset purchases and sales.

Net Income (NI)

When the total value of all products sold during a given accounting period is subtracted from the cost of taxes and goods sold, the amount left is referred to as net income or net profit. A negative net profit is called a net loss. Net income can be expresses as Before or After Tax and would be included in the description on the income statement – for example, Net Income (Loss) Before Tax.

Revenue or Sales

Income is often used interchangeably with revenue to refer to the total amount of sales earned during a given time. Revenue, also known as sales, is the gross income the company makes through its normal business operations. It may come from different sources, such as cash sales, interest income, subscription fees, or credit purchases.

Retained Earnings/Shareholders’ or Owner’s Equity

Retained earnings refer to the company’s cumulative net earnings or profit that is left over after paying all the direct and indirect costs, dividends to shareholders, and income taxes. This term only applies to incorporated businesses. Shareholders’ equity (owners’ equity for privately held companies), represents the amount of money that would be returned to a company's shareholders if all of the assets were liquidated and all of the company's debt was paid off in the case of liquidation.

Trial Balance (TB)

A trial balance is a report that reflects the current balances of all accounts in the general ledger at a particular point in time. Its purpose is to ensure that all accounts and balances add up correctly at the end of a reporting period.

Variable Cost (VC)

Variable costs are corporate expenses that can vary based on the number of goods produced or sold by the organization. For instance, if a company's sales and profits increase, it may also have to pay higher taxes. Variable costs would include temporary labour, packaging costs, etc.?Comparatively, fixed costs remain the same no matter how much production or sales volume increases. Rent would be an example of a fixed cost.

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This blog is not meant to provide specific advice or opinions regarding the topic(s) discussed above. Should you have a question about your specific situation, please discuss it with your GBA advisor.

GBA LLP is a full-service accounting firm in the Greater Toronto Area, but we primarily service all of Ontario as well as the rest of Canada virtually, except Quebec. Our team of over 30, provides Audits and Reviews of financial statements, and Compilations of financial information, as well as corporate tax returns.?We provide specialized corporate tax and succession planning for small and medium businesses, in addition to general advisory services.

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