Accounting sometimes is referred to as the language of business. However, when you are first learning accounting, the language is quite foreign. Understanding some of the basic terminology used in accounting can help you better grasp generally accepted accounting principles to which your company is expected to adhere and improve the quality of financial reporting.
Closing entries are used in accounting to transfer the results of business operations, originally accounted for in temporary revenue and expense accounts, into permanent equity accounts. Processing of closing entries occurs after the end of the company's accounting period. First, the revenue accounts are closed to the income summary account. Second, the expense accounts are closed to the income summary account. At this point, the income summary account will equal the profit or loss for the period. Third, the income summary account is closed to the owners' equity account or retained earnings. Lastly, any distributions to owners are closed into the equity account.
Sales are purchases of the company's goods or services by customers. For companies using accrual accounting, this includes both cash payments and payments made on account. The sales account, otherwise known as the revenue account, is found at the top of the company's income statement. However, at the end of every account period the sales account is closed to equity as part of the closing process. Therefore, the aggregation of sales over the company's history is found in the equity accounts.
Sales returns are reductions in the company's sales for returns the company is expecting or has received. Generally accepted accounting principles require that if a company experiences material returns over the course of the year, the company must make a reasonable estimate of sales returns and reduce the sales balance by this amount. To make this estimate, company accountants usually will examine historical sales and return trends. For many retailers, sales returns is a significant management estimate.
Allowances are reductions in assets based upon uncertainties in the sales process. While there are many types of allowances, the allowance for doubtful accounts is the most common. A company that sells on credit must record an allowance for doubtful accounts. This allowance is an estimate of the company's accounts receivable balance that it expects will ultimately remain uncollectible. Management determines this estimate by examining historical collection rates and trends in the general economy and industry.
