7 Basic Accounting Concepts To Know

 

7 Basic Accounting Concepts To Know

By Indeed Editorial Team

February 23, 2022

Learning about accounting concepts such as revenue, expenses and assets can be a great way to introduce yourself to the field of accounting. These principles can help you with your personal finances, starting your own business or teaching others about this discipline.

In this article, we explain some basic accounting concepts and note the difference between accounting concepts and accounting principles.

What are accounting concepts?

Accounting concepts are the ideas, components and terms that make up the world of accounting, finance and economics. These terms help individuals, businesses or organizations record all of their financial information, including transactions. Accountants refer to these concepts to prepare financial reports and other documents for individuals and businesses.

Knowing common accounting concepts and how to work with them is crucial for an accountant to interpret financial situations and properly track money. Learning about these concepts can also help business owners organize their business records, prepare for audits and ensure they are earning enough revenue to maintain operations. Even a regular person can benefit from an understanding of accounting ideas because it can help them save money, avoid debt, maintain proper financial records and make smart financial decisions.

Related: What Is Accounting?

Difference between accounting concepts and accounting principles

Both accounting concepts and accounting principles are critical parts of accounting because they set up a universal framework for discussing particular financial situations, rules, documents and theories. While some people use these phrases interchangeably, you could think of accounting concepts as what accountants do and accounting principles as how they do it. Here are some important differences between the two:

Accounting principles

Accounting principles, often referred to as generally accepted accounting principles (GAAP), are the widely accepted laws or standards of accounting. Organizations like the Financial Accounting Standards Board create these principles for accountants to use throughout the world. Accounting principles are rules and regulations that accountants must follow if they are creating financial documents or doing other accounting work. GAAP are universal conventions that allow everyone to understand and read a business's financial reports easily and efficiently.

It is necessary for a business to adhere to accounting principles if they are seeking investments or applying for loans. External verification groups like investors, banks and auditors want to see clear, accessible financial records before getting involved in a business. By following accounting principles, a business can ensure they are abiding by the law and show external parties evidence of economic growth. Examples of these principles are accrual, conservatism and consistency.

Read more: 12 Widely Accepted Accounting Principles

Accounting concepts

Accounting concepts are the basic elements of accounting. These can be topics, terms or theories that accountants apply to forms of money, transactions and economic functions. Accountants use accounting concepts to understand and explain a business's operations, cash flows and financial performance. Just like most other fields, accounting uses concepts as its own sort of language to communicate.

Basic accounting concepts

There are many different parts of the accounting field. To give you a basic understanding of accounting, review these seven concepts:

Revenue

For a business, revenue is the total amount of money received from customers for services and products. Income is the net profit of a business, or the money that remains after you subtract the expenses and taxes from the revenue.

Expenses

Expenses are the costs a business incurs in order to generate revenue. This can be costs of supplies and materials, rent, advertising, employee salaries, repairs and taxes. For example, a restaurant may purchase ingredients regularly from a supplier to operate their business. A business's expenses should be less than their revenue in order to earn income.

Assets

Assets are resources a business owns that bring it economic benefits. A business can calculate their assets by adding their liabilities to their equity. There are current and non-current assets:

  • Current assets: Resources that are going to be used by the business within a year, such as cash, checks, receivables, inventories for sale and prepaid expenses

  • Non-current or fixed assets: Long-term items that can provide benefits to a company for over a year, such as stocks and bonds, land, buildings, equipment and trademarks

Related: Examples of Assets

Liabilities

Liabilities are economic obligations or what a business owes to other organizations, such as lenders and creditors. Like assets, liabilities can also be:

  • Current liabilities: Payments due within the year and include accounts payable, short-term loans, installments of a long-term loan and tax obligations

  • Non-current liabilities: Payments not due within the year and include long-term bonds and mortgages and deferred tax obligations

Capital

Capital is anything that provides value or benefits for a business owner, including assets, machinery, property, inventory and patents. While cash can be a type of capital, capital usually refers to investments that generate wealth for a business. Here are some types of capital:

  • Working capital: You can calculate working capital by subtracting current liabilities from current assets. Working capital is liquid capital assets, or assets in the form of cash, that a company uses for daily operations. A business uses their working capital for short-term payments, including covering debts and accounts payable due within the year.

  • Equity capital: Equity is an owner's stake or share in a business or any asset they own. If a business liquidated all their assets, or sold them for cash, and paid off all their liabilities or debts, the value that each shareholder would get is their equity. A business's equity capital is the money that shareholders are investing in the company.

  • Debt capital: Businesses can get debt capital through borrowing loans and bonds from banks and private or government organizations. As a sizeable amount of money at one time, debt capital can enable a business to invest in its future and expand.

Read more: What Is Capital?

Accounts

An account is a type of transaction, such as cash or sales. Businesses record accounts in a general ledger, an accounting book that stores and organizes transactions. Accounts receivable is the money owed to a business by customers in exchange for goods and services. Accounts payable is the money owed by a business to creditors and suppliers in exchange for goods and services.

Read more: Accounts Payable vs. Accounts Receivable: What's the Difference?

Financial statements

Financial statements are documents that show the transactions of a business or individual. Here are some different types of financial statements and their definitions:

  • Income statement: Also called a profit-and-loss statement, a document that offers a company's financial performance by reporting revenues, costs and expenses during a particular period

  • Balance sheet: A financial document that reports a business's assets, liabilities and equity

  • Statement of cash flows: A report of the amount of cash earned by a business as well as the amount of cash they spent

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