Accounting test 1

Monetary unit assumption

Accounting assumption that money is the common denominator of economic activity and provides an appropriate basis for accounting measurement and analysis.

Materiality

A company-specific aspect of relevance, an item is said to be material if its inclusion or omission would influence or change the judgment of a reasonable person; it is immaterial, and therefore irrelevant, if it would have no impact on a decision-maker. The point involved is one of relative size and importance; that is, both quantitative and qualitative factors should be considered.

Event

A happening of consequence, which generally is the source or cause of changes in assets, liabilities, and equity. May be external or internal.

Modified cash basis

A mixture of the accrual basis and cash basis, with modifications that have substantial support, such as capitalizing and depreciating plant assets or recording inventory.

Account

A systematic arrangement that shows the effect of transactions and other events on a specific element (asset, liability, and so on). Companies keep a separate account for each asset, liability, revenue, and expense, and for capital (stockholders' equity).

Adjusted trail balance

A trial balance prepared from a company's ledger accounts after journalizing and posting all adjusting entries. It shows the effects of all financial events that occurred during the accounting period.

Accrual-basis accounting

Accounting approach, in which a company records events that change its financial statements in the periods in which the events occur, rather than only in the periods in which it receives or pays cash. Thus, a company recognizes revenue when it satisfies a performance obligation rather than when it receives cash, and it recognizes expenses when it incurs them rather than when it pays them.

Going concern assumption

Accounting assumption that a company will continue in operation for the foreseeable future. Only in situations in which liquidation appears imminent is the assumption inapplicable.

Periodicity assumption

Accounting assumption that implies that a company can divide its economic activities into artificial time periods. These time periods vary, but the most common are monthly, quarterly, and yearly.

Matching principle

Accounting principle that dictates that efforts (expenses) be matched with accomplishment (revenues) whenever it is reasonable and practicable to do so. This linking of expense recognition to revenue recognition is popularly expressed as, "Let the expense follow the revenues."

Full disclosure principle

Accounting principle that dictates that in deciding what information to report, companies follow the general practice of providing information that is of sufficient importance to influence the judgment and decisions of an informed user. It recognizes that the nature and amount of information included in financial reports reflects a series of judgmental trade-offs between sufficient detail that makes a difference to users, sufficient condensation to make the information understandable, and the costs and benefits of providing the information.

Expense recognition principle

Accounting principle that dictates that the recognition of expenses is related to net changes in assets and earning revenues, that is, "let the expense follow the revenues."

Adjusting entry

Adjustments made at the end of the accounting period to ensure that a company has recorded revenues in the period in which it satisfies the performance obligation and recognized expenses in the period in which it incurs them—in other words, that it has followed the revenue recognition and expense recognition principles. Companies often prepare adjustments after the balance sheet date but date the entries as of the balance sheet date.

International financial reporting standards

All the accounting rules accepted for international use, issued by the International Accounting Standards Board.

Historical cost principle

An accepted accounting principle that companies account for and report most assets and liabilities on the basis of acquisition price. To the extent that historical cost is free from error and neutral, it contributes to faithful representation.

Cost constraint

An accounting constraint that requires that the costs of providing financial information be weighed against the benefits that can be derived from using it. The constraint applies to informational requirements established by standard-setting bodies and governmental agencies as well as to companies reporting financial information.

Consistency

An aspect of comparable information, which indicates that a company applied the same accounting treatment to similar events from period to period. A company can change methods, but it must first demonstrate that the newly adopted method is preferable to the old and then must disclose in the financial statements the nature and effect of the accounting change.

Economic entity assumption

An assumption that economic activity can be identified with a particular unit of accountability, by keeping an enterprise's economic activity separate and distinct from that of its owners and any other business unit. The entity assumption refers to economic, rather than legal, entities.

Understandability

An enhancing qualitative characteristic of accounting information that lets reasonably informed users see its significance.

Timeliness

An enhancing qualitative characteristic of accounting information, indicating that information should be available to decision-makers before it loses its capacity to influence their decisions.

Verifiability

An enhancing qualitative characteristic of accounting information, indicating that similar results will occur when independent third parties (e.g., auditors) measure using the same methods.

Comparability

An enhancing qualitative characteristic of accounting information, which describes information that is measured and reported in a similar manner for different companies. Comparability enables users to identify the real similarities and differences in economic activities between companies.

Transaction

An external event involving a transfer or exchange between two or more entities.

Decision-usefulness

Approach that requires that financial reporting be useful to investors by helping them assess (1) the company's ability to generate net cash inflows and (2) management's ability to protect and enhance the capital providers' investments.

Real accounts

Asset, liability, and equity accounts; these accounts appear on the balance sheet. Companies do not close real accounts, also called permanent accounts.

Prepaid expenses

Assets paid for and recorded before a company uses them. Prepaid expenses expire either with the passage of time (e.g., rent and insurance) or through use and consumption (e.g., supplies). Companies typically recognize prepaid expenses by making adjusting entries to record the expenses that apply to the current accounting period and to show the unexpired costs in the asset accounts.

T-account

Basic account form, shaped like the letter T, which shows the effect of transactions on particular asset, liability, stockholders' equity, revenue, and expense accounts.

Comprehensive income

Change in equity of an entity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.

Committee on Accounting procedure

Committee established by the AICPA in 1939 at the urging of the SEC to deal with accounting Problems. The CAP issued 51 Accounting Research Bulletins and was replaced by the Accounting Principles Board in 1959.

Strict cash basis

Companies record only when they receive cash, and they record expenses only when they disburse cash.

Accrued expenses

Expenses incurred but not yet paid or recorded at the statement date. Examples are interest, rent, taxes, and salaries. An accrued expense on the books of one company is often an accrued revenue to another company.

Securities and exchange commission

Federal agency established to help develop and standardize financial information presented to stockholders. It administers the Securities Exchange Act of 1934 and several other acts. Most companies that issue securities to the public are required to file audited financial statements with the SEC. The SEC also has broad powers to prescribe the auditing practices and standards to be employed by companies that fall within its jurisdiction.

Income Statement

Financial statement that measures the results of operations during a particular period and presents those results in terms of net income or net loss.

Statement of retained earnings

Financial statement that reconciles the balance of the retained earnings account from the beginning to the end of the period.

Statement of cash flows

Financial statement that reports the cash provided and used by operating, investing, and financing activities during the period.

Balance sheet

Financial statement that shows the financial condition of a company at the end of a period by reporting its assets, liabilities, and owners' equity.

Conceptual framework

For the accounting profession, a coherent system of objectives and fundamentals established by the FASB, which determine the nature, function, and limits of financial accounting and which lead to consistent accounting standards.

Fair value principle

GAAP-based principle that calls for the use of fair value measurements in the financial statements.

Emerging issues task force

Group created in 1984 by the FASB to reach a consensus on how to account for new and unusual financial transactions that might create differing financial reporting practices. The FASB reviews and approves all EITF consensuses, and the SEC views consensus solutions as preferred accounting.

FASB staff positions

Issued by the FASB, these provide interpretive guidance and also minor amendments to standards and interpretations.

Closing entries

Journal entries made at the end of a company's annual accounting period to transfer the balances of temporary accounts to a permanent owners' equity account (retained earnings or a capital account, depending on the company's form of organization).

Reversing entries

Journal entries, made at the beginning of the next accounting period, that are the exact opposite of the adjusting entries made in the previous period. Making reversing entries is an optional step in the accounting cycle.

Sarbanes-oxley act

Legislation, enacted by the U.S. Congress, intended to combat accounting fraud, curb poor reporting practices, and make sweeping changes to the institutional structure of the accounting profession.

Predictive value

One characteristic of relevant information, indicating that information must help users predict the ultimate outcome of past, present, and future events.

Revenue recognition principle

One of the basic principles of accounting, which dictates that companies recognize revenue in the accounting period in which the performance obligation is satisfied. Generally, recognition at the time of sale provides a uniform and reasonable test.

Neutrality

One of the ingredients of the fundamental quality of faithful representation, neutrality indicates that a company cannot select information to favor one set of interested parties over another. Unbiased information must be the overriding consideration.

Completeness

One of the ingredients of the fundamental quality of faithful representation. Completeness means that all the information necessary for faithful representation is provided.

Confirmatory value

One of the ingredients of the fundamental quality of relevance, it helps to confirm or correct prior expectations based on previous evaluations of financial reporting information.

Assumption

One of the parts in the third level of the conceptual framework; a concept that the accounting profession assumes as foundational for the financial accounting structure. There are four basic assumptions: (1) economic entity, (2) going concern, (3) monetary unit, and (4) periodicity.

Relevance

One of the qualitative characteristics of accounting information, which describes information capable of making a difference in a decision. Information with no bearing on a decision is irrelevant. To be relevant, information needs have predictive or feedback value and is material.

Faithful representation

One of the qualitative characteristics of accounting information. To be a faithful representation, information must be complete, free from error, and neutral.

Public company accounting oversight board

Organization established by the Sarbanes-Oxley Act that has oversight and enforcement authority for accounting practices and that establishes auditing, quality control, and independence standards and rules.

Qualitative characteristics

Part of the second level of the conceptual framework of accounting; the characteristics of accounting information that distinguish better (more useful) information from inferior (less useful) information for decision-making purposes. The primary qualitative characteristics are relevance and faithful representation.

Accounting principles board

Private standard-setting organization from 1959 to 1973, whose mission was to develop an overall conceptual framework. Its official pronouncements, called APB Opinions, were to be based mainly on research studies and be supported by reasons and analysis. The APB issued 31 opinions in its lifetime.

Nominal accounts

Revenue, expense, and dividend accounts; except for dividends, these accounts appear on the income statement. Companies close nominal accounts, also called temporary accounts, at the end of the accounting period.

Unearned revenues

Revenues received in cash and recorded as liabilities before a company satisfies its performance obligation. Examples are rent, magazine subscriptions, and customer deposits for future service. Unearned revenues are the opposite of prepaid expenses.

Accrued revenues

Revenues recognized but not yet received in cash or recorded at the statement date. Accrued revenues result from the passing of time (e.g., interest revenue and rent revenue) or from unbilled or uncollected services that a company performed (e.g., commissions and fees).

Accounting cycle

Standard set of accounting procedures to record transactions and prepare financial statements.

Journal

The "book of original entry" where the company initially records transactions and selected other events. The company transfers that information from the journal to the ledger.

Wheat committee

The Study Group on Establishment of Accounting Principles, chaired by Francis Wheat, that examined the organization and operation of the Accounting Principles Board and determined the changes needed to attain better productivity and more timely correction of accounting abuses. The Study Group submitted its recommendations to the AICPA Council in the spring of 1972, which adopted the recommendations in total and implemented them by early 1973.

Auditing standards board

The arm of the AICPA that had been responsible for developing auditing standards. The Public Company Accounting Oversight Board, established by the Sarbanes-Oxley Act, now oversees the development of auditing standards.

Ledger

The book (or computer printouts) containing the accounts. A general ledger is a collection of all of the asset, liability, owners' (stockholders') equity, revenue, and expense accounts. A subsidiary ledger contains the details related to a given general ledger account.

Generally accepted accounting principles

The common set of accounting standards and procedures, for which either an authoritative accounting rule-making body has established a principle of reporting in a given area, or over time, a given practice has been accepted as appropriate because of its universal application.

Prudence

The convention in accounting that dictates that when in doubt, choose the solution that will be least likely to overstate assets and income. The conceptual framework indicates that prudence or conservatism is generally in conflict with quality of neutrality, because being prudent or conservative can lead to bias in the reported financial position and financial performance.

Posting

The process of transferring the essential facts and figures from the book of original entry (the journal) to the ledger accounts, using debits and credits made to accounts.

Conservatism

The convention in accounting that dictates that when in doubt, choose the solution that will be least likely to overstate assets and income. The conceptual framework indicates that prudence or conservatism is generally in conflict with the quality of neutrality, because being prudent or conservative can lead to bias in the reported financial position and financial performance.

Book value

The difference between a depreciable asset's cost and its related accumulated depreciation. Book value of an asset generally differs from its fair value because depreciation is a means of cost allocation, not of valuation.

Expectations gap

The difference between what the public thinks accountants should do and what accountants think they can do.

Trial balance

The list of all open accounts, in the sequence in which they appear in the ledger, and their balances. Companies may prepare a trial balance at any time, though they usually do so at the end of an accounting period. The trial balance proves the mathematical equality of debits and credits after posting and also uncovers errors in journalizing and posting.

Financial accounting standards board

The major organization of the standard-setting structure for financial accounting. Its mission is to establish and improve standards of financial accounting and reporting for the guidance and education of the public. The FASB consists of seven members, appointed for five-year terms by the Financial Accounting Foundation. Accounting guidance issued by the FASB is considered generally accepted accounting principles (GAAP).

American institute of certified public accountants

The national professional organization of practicing Certified Public Accountants (CPAs), whose various committees and boards have been an important contributor to the development of GAAP.

APB opinions

The official pronouncements of the Accounting Principles Board, intended to be based mainly on research studies and be supported by reasons and analysis. Between its inception in 1959 and its dissolution in 1973, the APB issued 31 opinions.

International accounting standards board

The organization, based in London, that sets accounting standards accepted for international use. Although many of these international standards are similar to U.S. GAAP, the FASB and the IASB are currently working on a convergence project to result in one set of high-quality standards.

Fair value

The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Depreciation

The process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner.

Financial statements

The structured means of communicating financial information, through the balance sheet, income statement, statement of cash flows, and statement of owners' equity.

Post closing trial balance

The trial balance after closing entries are made; consists only of asset, liability, and owners' equity accounts (the real accounts).

Double-entry accounting

The universally used accounting system in which a company records the dual (two-sided) effect of each transaction in appropriate accounts. If a company records every transaction with equal debits and credits, then the sum of all the debits to the accounts must equal the sum of all the credits.

Entity perspective

The view that companies are distinct and separate from their owners (present shareholders).

Free from error

View that information that is accurate will be more representationally faithful.