Chapter 2 Basic Accounting terms

Contents:-
Important accounting terms as per CBSE syllabus:-
1) Business transactions
2) Events
3) Account
4) Assets
5) Liabilities
6) Expenses
7) losses
8) Revenue
9) Income
10) Profits
11) Gain
12) Capital
13) Drawings
14) Receipts
15) Expenditure
16) Goods
17) Purchase
18) Purchase return
19) Sales
20) Sales Return
21) Cost
22) Voucher
23) Discount
24) Goods and service Tax [GST]
1) Business Transaction:-
 A business transaction is an economic activity of the business that changes its financial position.
 Whenever any business transaction takes place, it results in a change in the values of some of the
assets, liabilities or capital.
Examples:-
1) Introduction of capital by the owner in the business ;
2) Withdrawl of cash from business by the owner for personal use [Drawings]
3) Cash or Credit Purchase of Goods/Assets
4) Cash or Credit Sale of Goods/Assets
5) Payment made to suppliers
6) Cash received from a customer
7) Payment of expenses in the form of salary, rent, etc.
8) Income Received in the form of rent, Interest, commission, etc.

Features/characteristics of a Business Transaction

1) It involves an economic activity. Social activities are not considered as business transaction.
For example:- If Monu purchases a gift for his friend, it will not be considered as a business transaction because
it is a social engagement.

2) Whenever any business transaction takes place, it results in a change in the values of some of the assets,
liabilities or capital.
Examples:-
1) Introduction of capital by the owner in the business ;
2) Withdrawl of cash from business by the owner for personal use [Drawings]
3) Cash or Credit Purchase of Goods/Assets
4) Cash or Credit Sale of Goods/Assets
5) Payment made to suppliers
6) Cash received from a customer
7) Payment of expenses in the form of salary, rent, etc.
8) Income Received in the form of rent, Interest, commission, etc.

Followings are not business transaction:-

 Receipt of order for supply of goods;
 Appointment of an employee;
 Submission of a Tender for a construction work
 Sent a fax message to a supplier
 Received a Quotation from a supplier;
 General Manager resigned from the organisation
 An Efficient manager resigned from the organisation.
 Interview of a prospective employee.
 Strike of employees in a firm.

3) The change in the financial position must be capable of being expressed in terms of money.
For example:-
 When an efficient manager resignes/retires from the firm [Or when employees of a firm go on strike]
then, it may lead to huge loss to the business. But such loss can not be measured in terms of money. So,
it will not be considered a business transaction

 Loss by fire/theft , Bad debts, Loss on sale of fixed asset/investment etc. are business transactions
because these losses can be measured in terms of money.

4) A business transaction has two aspects: a Debit and a Credit of equal amount.

5) A business transaction may be a Cash transaction or a Credit transaction.

6) Business transaction may be divided into two parts:-
Internal Transaction External Transaction
Internal transactions are those economic External transactions are those transactions
activities that take place entirely within which involve economic activities between two
one business entity. independent business entities.
For example:- For example:-
Depreciation charged on Fixed Asset Purchase or sale of goods

2) Events:-
An event is the consequence or result of a business transaction.

illustration:- Identify transactions and events.

Mohan starts business with a Capital of ₹2,50,000. He purchases goods for ₹2,00,000 for cash
and sells 3/4th of these goods for ₹1,90,000 in cash. He also pays ₹10,000 in cash as wages to
workers.
Solution:-
Transactions are:-
1) Investment of ₹2,50,000 in the business
Or
Introduction of Capital of ₹2,50,000 in the business.
2) Goods purchased of ₹200,000 in cash
3) Cash sales of ₹1,90,000
4) Payment of wages to workers of ₹10,000 in cash
Events i.e. Result of above transactions are:-
1) Profit
₹
Sales 1,90,000
(-) Cost of purchase (1,50,000)
(-) Wages (10,000)
Profit 30,000

2) Closing inventory = ₹2,00,000 - ₹1,50,000 = ₹50,000

3) Closing Cash balance = ₹2,50,000 - ₹2,00,000 + ₹1,90,000 - ₹10,000 = ₹2,30,000

[Capital introduced] [Cash purchase] [Cash Sales] [Wages paid]

4) Closing Capital balance = opening Capital + profit = ₹2,50,000 + ₹30,000 = ₹2,80,000

Or
= Assets – Liabilities = [Closing cash + Closing inventory] - 0
= [₹2,30,000 + ₹50,000] - 0
= ₹2,80,000
3) Account:-
 In accounting, we keep a separate record of each individual, asset, liability, expenses or
income. The place where such a record is maintained is termed as an ‘Account’
For example:- All transactions related to cash are recorded at one place, known as Cash
Account.
Or
The individual transactions of similar nature are recorded, added and subtracted at
one place. Such place is known as an ‘Account’.
For example:- All transactions related to cash are recorded at one place, known as
Cash Account
Or
An account is a place where all business transactions relating to a particular person or
item are recorded.
For example:- All transactions related to cash are recorded at one place, known as Cash
Account.

 An account has two sides:-

i) Left side of an account is known as debit side [abbreviated as Dr.]
ii) Right side of an account is known as credit side [abbreviated as Cr.]

 Example:- Format of an account [Cash Account] is given below:-

Dr. Cash Account Cr.
₹ ₹

The above account looks like English capital Letter ‘T’. Therefore, it is also called ‘T’ shape account.

 An Account is abbreviated [written in short] as A/c.

 4) Assets:-
Assets are valuable/economic resources owned by a business enterprise which can be
measured in terms of money.

Current Assets Fictitious Assets or Nominal

Non-Current
[also known as active/ assets
Assets
Short lived/Circulating/Floating These are the assets which cannot be
Non current assets are
assets] realised in cash or no further benefit
those assets which are
can be derived from these assets.
held for long term[or
Current assets include cash and For example:-
continued] use in the
other assets which are expected 1)Accumulated loss [Debit Balance of
business and are not
to be converted into cash with in P&L A/c]
meant for resale.
a short period of time [normally 2) Unamortised expenses i.e.
For example:-
with in one year] Expenditure not written off such as:-
 Advertisement Expense
For example:- OR
1) Cash and Cash equivalents:- Long term Loans Advertisement suspense
 Cash in hand and Advances  Discount on issue of
 Cash at Bank debentures
 Cheques/Bank drafts etc.  Underwriting commission
Long term  Preliminary expenses
2) Stock/Inventories Investments
These assets are not real assets but
3) Trade receivables:- Fixed Assets are shown on the asset side only for
a) Debtors Fixed assets are the purpose of transferring them to
b) Bills receivables those non-current the profit and loss Account gradually
assets which are held over a period of time.
for long term use [or
4) Prepaid/unexpired expenses continued] use in the
For better understanding:-
business and are not There are some expenditures which
5) Accrued/Earned/outstanding meant for resale. are not fully charged/shown/written
Income[Income earned but not off/transferred to the profit and loss
received] account with in the year in which they
actually take place, but are written off
6) Short term Loans and advances gradually in the subsequent years. As
long as those items are not written off
7) Short/current investment completely they are shown as
[For example:-Marketable Fictitious assets in Balance sheet.
securities]

Tangible Fixed assets Intangible Fixed assets

Tangible fixed assets are those fixed assets which Intangible Fixed assets are those fixed assets
have a physical existence i.e. they can be seen or which do not have a physical existence i.e. they
touched. cannot be seen or touched.
For example:- For example:-
 Land and Building  Goodwill
 Plant and Machinery  Patents
 Furniture, Fixtures and Fittings  Copyrights
 Motor Vehicles  Trademarks
 Office Equipments [Computer, Printer,  Computer software etc.
Scanner etc.] Definition of Some Assets
A)Trade receivables:-
It refers to the amount receivables by the business enterprise for sale of goods/services in the
normal course of business.
Trade receivables includes both debtors and Bills receivables
i.e. Trade Receivables = Debtors + Bills receivables

I) Debtors ii) Bills receivables

Debtor is a person or firm to whom goods A bill of exchange becomes bill receivable for
or services have been sold on credit and the person who draws it [i.e. drawer/seller] and
payment has not been received. get it back, after acceptance from the drawee
[buyer].
The amount specified in such a bill is receivable
at a specified future date.

B) Stock or Stock in trade:-

It refers to value of those goods which are purchased for reselling in the ordinary course of
business and which are lying unsold at the beginning or end of an accounting period.
The stock may be of two types:-
I)Opening Stock ii) Closing Stock
It means the value of goods lying unsold at It means the value of goods lying unsold at the
the beginning of the accounting period end of the accounting period.

C) Inventory
In Case of manufacturer, there can be opening and closing inventory of four types:-
Inventory of raw Inventory of work in Inventory of finished Inventory of Stock in
material progress [also known as goods trade
inventory of partly
finished goods]

It includes inventory of It means goods in semi- It includes the inventory It includes the value of
raw materials purchased finished form. Such of those goods which those goods which are
for using them in the goods need further have been completely purchased for reselling.
products manufactured processing for converting processed and are ready
but still lying unused. them into finished for sale but are lying
products. unsold at the end of
accounting period.
5) Liability:-
Liabilities are obligations or debts that an enterprise has to pay at some time in the future i.e.
it is the amount owed by the business.

Liabilities may be classified as:-

External Liabilities Internal Liabilities
All amounts which a business entity has to All amounts which a business entity has to
pay to the outsiders are known as external pay to the owner/proprietor are known as
liabilities for the business entity. external liabilities for the business entity.
For example:- For example:-
 Creditors  Capital
 Bills payable  Accumulated profits
 Bank overdraft [Credit balance of P&L]
 loans/borrowings
 Outstanding expenses

Liabilities may also be classified as:-

I) Current Liabilities ii) Non- current liabilities
Current liabilities refers to those liabilities
which are to be paid in near future [normally Non Current liabilities refers to those
within 1 year] liabilities which fall due for payment in a
For example:- relatively long period [normally after 1 year]
 Creditors For example:-
 Bills payable  Long term loans/borrowings
 Bank overdraft  Debentures
 Outstanding expenses  Bonds
 Unaccured/Unearned/Advance income  Long term provisions
[Income received but not earned]
 Short term loans/borrowings
 Short term provisions

Definition of some liabilities:-

Trade payables:-
It is the amount payable for purchase of goods or services taken in the normal course of
business.
Trade payables include both Creditors and Bills payable
Creditors Bills payable
Creditor is a person or a firm from whom A bill of exchange becomes bill payable for the
goods have been purchased or services person who accepts it [drawer/buyer] and
taken on credit. returns it to the drawer[seller]
The amount specified in such a bill is payable
at a specified future date.

6) Expenses:-
Expense is the cost incurred by a business in the process of earning revenue.
Or
Expense is the cost incurred by a business in producing and selling the goods and services.

For example:-
 Cost of goods sold [Opening stock + Net purchases + Direct expenses – Closing stock]
 Amount paid for:-
 Salaries
 Wages
 Interest on Loan/borrowings
 Electricity charges
 Printing and Stationery
 Commission
 Advertisement
 Depreciation on fixed assets

Note:- Cost of goods sold is charged/debited to Trading Account and all other expenses are
charged/debited to Profit and loss account.

7) Loss:-
This term conveys three different meanings:-
1) Loss is the excess of total expenses over total revenue of a business enterprise for an
accounting period.
Loss = Total expenses – Total revenue
2) It also refers to such activities of the business for which no benefit is received by the firm.
For example:-
 Loss due to fire/theft/accident
 Bad debts
3) Loss also arises from events of non-recurring nature, like loss on sale of fixed asset or
investment.

8) Revenue 9) Income 10) Profit 11) Gain

Revenue is the Excess of revenue over Profit is the It is a monetary
amount received or excess of total
expenses is called income. benefit, profit or
receivable from the revenues over advantage that
sale of goods or Income = Revenue-Expenses total expenses arises from
services [cost] of a transactions or
business events which are
Revenue is the enterprise for incidental to
income of a recurring an accounting business.
[regular] nature.
period.
Gain is a profit of
irregular nature.

For example:- For example:-

1)Amount received 1)Profit on sale of
from sale of goods fixed asset or
2)Rent investment
3)Commission 2)Winning a court
case
3)Winning a lottery
prize

12) Capital
 It refers to the amount invested by the proprietor/owner in a business enterprise.
Amount may be in the form of Cash, Goods or Assets.
 Capital is the excess of assets over external/outside liabilities
Capital = Assets – Liabilities
 Capital is also knowns as:-
 Owner’s Equity
 Proprietor’s Fund
 Net worth/Net assets
 Internal liability of the business towards the owner

 According to ‘Business entity Concept’, business is considered to be separate and distinct

from its owners. So, capital is an internal liability for the business towards the owner.

 Capital increases with additional/fresh capital and the amount of profit earned. On the
other hand, it reduces when the owner makes drawings or loss is incurred by the
business.

13) Drawings:-
 Withdrawl of money or goods by the owner from the business for personal use is known
as drawings.
 Drawings also include any personal expense of the owner paid out of business funds.
For example:- Payment of insurance premium/income tax etc.
 Drawings reduces the investment or Capital of the owners.

14) Receipts:-
Receipts refers to the amount received or receivable by the business organization from selling
assets, goods or services.
Receipts are of two kinds:-
Revenue receipts Capital receipts
Revenue receipts refers to the amount Capital receipts refers to the amount received or
received or receivable in the normal receivable against transactions which are not
course of business. revenue in nature.
Revenue receipts neither reduce assets of Capital receipts either reduce assets of the firm
the firm nor lead to increase in liabilities of or lead to increase in liabilities of the firm.
the firm.
For example:- For example:-
1) Amount received from sale of goods 1) Amount received from the sale of fixed
2) Commission/fees received from sale assets or investments
of services 2) Amount received by way of
3) Interest/Dividend received on loans/borrowings.
investment 3) Capital contributed by proprietors or
4) Rent received by letting out partners [in case of sole proprietorship or
building. partnership]
4) Money obtained from issue of shares and
debentures [in case of company]

Revenue receipts are of recurring/regular Capital receipts are of non-recurring/irregular/

in nature. non- routine in nature.

Revenue receipts are shown on the credit Capital receipts are shown in the Balance sheet
side of Trading and Profit & loss account. either as increase in liabilities or as reduction in
the value of assets.

15) Expenditure
Expenditure refers to the amount spent or liability incurred for acquiring assets, goods or
services.
For example:-Payment of rent, Salary, Purchase of goods, Purchase of Land, Machinery etc.

Expenditure can be further classified as:-

i)Revenue ii) Capital expenditure iii) Deferred revenue
expenditure expenditure
Any expenditure, the Any expenditure which It refers to a revenue expenditure, the
full benefit of which is is incurred in benefit of which is likely to be derived
exhausted/received acquiring/purchasing or by the firm in more than one
during one accounting increasing the value of a accounting period.
period is known as fixed asset is known as For example:-
revenue expenditure. capital expenditure.  Heavy advertisement expense
For example:- For example:-  Preliminary expenses
 Cost of goods sold 1)The amount spent on the  Discount on issue of debentures
 Rent purchase/construction of  Underwriting commission
 Salaries building or furniture etc.
 Electricity charges The benefit of such an expenditure is derived
etc. 2)The amount spent on the by the firm in more than one accounting
 Repairs and purchase/erection of plant, period.
Maintenance machinery etc. Therefore, the whole of such expenditure is
not debited/charged/written off to profit and
loss Account of the current year but are
spread over the years in which benefit will be
derived.
Only a part of such expenditure is
charged/debited/written off to Profit and
loss account every year and the remaining
[unwritten off] portion is shown on the asset
side of Balance sheet as Fictitious asset.
For example:- a firm spent a huge amount of
₹3,00,000 on advertising to introduce a new
product in the market and it is estimated that
it would provide benefit for 3 years.
In this case, ₹1,00,000 will be
charged/debited/written off to Profit and loss
account of each year for 3 consecutive years.
Therefore ₹1,00,000 will be
debited/charged/written off to P&L A/c of
each year and the balance will be treated as
an asset and shown on assets side of Balance
sheet.
Amount to be shown on the asset side of the
balance sheet:-
At the end of 1st year = 2,00,000
At the end of 2nd year = 1,00,000
At the end of 3rd year = 0

Distinction between Capital Expenditure and Revenue Expenditure

I. Capital expenditure is incurred for the acquisition/purchase of a fixed asset, whereas
 revenue expenditure is incurred for the day to day running of the business.
II. Capital expenditure in incurred for the purpose of increasing the earning capacity of
the business, whereas revenue expenditure for maintenance of earning capacity i.e.,
for keeping the assets in as efficient working order.
III. Capital expenditure yields benefit normally over a long period, whereas revenue
expenditure yields benefit for maximum period of one year.
IV. Capital expenditure is written in the balance sheet, whereas revenue expenditure is
written in Trading and Profit & Loss Account.

16) Goods:-
Goods refers to those things in which business firm is dealing.
 In case of Manufacturing concern ‘goods’ include all those things which are used in
producing the finished products in which business deals.
 In case of trading concern, goods are those things which are purchased for resale in the
ordinary course of business.
For example:-
For a furniture dealer, purchase of chairs and tables is termed as goods, while for others, it is treated as an
asset.
Similarly, for a stationery merchant, stationery is goods, whereas, for others, it is an item of expense.

17) Purchase:-
 The term purchase is used only for the purchase of ‘Goods’ i.e. things in which business
deals.
 In case of Manufacturing concern ‘goods’ include all those things which are used in producing
the finished products in which business deals.
 In case of trading concern, goods are those things which are purchased for resale in the
ordinary course of business.
 The term ‘Purchase’ is never used for the Purchase of assets.
For example:-
If a cloth dealer purchases cloth for sale, the cloth purchased will be called ‘goods’. He will open Purchase
Account for it in the books of accounts. However, if the same cloth dealer purchases furniture for seating the
customers, such furniture will not be termed as goods, but it will be an ‘Assets’ and a separate account named
‘Furniture Account’ will be opened for it in the books of account.

 The term ‘Purchase’ include both cash and credit purchase.

18) Purchase return

When purchased goods are returned to the suppliers/seller these are known as purchase
returns. Such returns are also termed as ‘returns outwards’

19) Sales
 Sales means tranfer of ownership of goods or services to customers for a price.
 The term Sale is used only for the sale of ‘Goods’ i.e. things in which business deals.
 The term ‘sales’ is never used for the sale of assets.
For example, if a cloth dealer sells cloth, it will be termed as sales and ‘Sales Account’ will be opened for it in
the books of account, but if the same cloth dealer sells old furniture, it will not be termed as sales and
‘Furniture Account’ will be credited for it in the books of account.
 The term sales include both cash and credit sales.

20) Sales return

Some customers may return the goods sold to them. These are termed as sales returns or
‘returns inwards’.

21) Cost:-
Cost is the total expenditure incurred or chargeable to a specified product or activity.

22) Voucher:-
Voucher is a documentary evidence in support of a business transaction
For example:- Cash Memo, Invoice, Debit note, Credit note

23) Discount:-
Discount is any type of reduction/rebate in the price by the seller to the buyer.
Discount may be of two types:-
i) Trade Discount ii) Cash Discount
When discount is allowed by a seller to When discount is allowed to the customers for
its customers at a fixed percentage on making prompt/immediate payment it is called
the list or catalogue price of the goods cash discount.
it is called trade discount. For example, if a seller allows 2% discount for
payment within a week it will be called cash
It is generally offered by manufacturer discount.
to wholesaler and wholesaler to
retailers. It is always recorded in the books of accounts.

It is not recorded in the books of It is an expense for the person who is allowing the
accounts as it is deducted in the invoice discount and income for the receiving
or cash memo from the gross value of party/person.
goods.

24) Goods and Service Tax[GST]:-

All indirect taxes like Excise Duty, Sales Tax, VAT, Service Tax etc. have been merged into a
single tax which is known as GST.