Financial Accounting Terms
Loss Contingency
Similar to estimated liabilities but may involve even more uncertainty. It is a possible loss, stemming from past events, that is expected to be resolved in the future. Disclosed in notes to financial statements. Example:
Amortization
The systematic write-off to expense of the cost of an intangible asset over the periods of its economic usefulness. This of an intangible asset is the same as depreciation for a tangible asset(usually straight-line).
Earnings Management
The use of accounting techniques to produce financial reports that may paint an overly positive picture of a company's business activities and financial position. Companies use this to smooth out fluctuations in earnings and/or to meet stock analysts' earnings projections.
Leverage
The use of borrowed money to finance business operations. Involves ROA and ROE (pg. 455,463,647)
Impairment Loss
The write-down of a long-lived asset for the difference between it carrying amount less its fair value. If the carrying amount of an asset cannot be recovered through future use or sale, the asset should be written down to its fair value.
Income from Continuing Operations
This subtotal measures the profitability of the ongoing operations. This subtotal should be helpful in making predictions of the company's future earnings.
Net Sales
Total sales revenue-sales returns and allowances-sales discounts The most widely used measure of dollar sales volume; usually the first figure shown in an income statement.
Premium
Price above face value. The difference between the higher price paid for a fixed-income security and the security's face amount at issue. When bonds are issued at a ..... the borrower repays less than the amount originally received at the date of the issuance. It represents a reduction in the overall cost of borrowing.
Expenses
Past, present, or future reductions in cash required to generate revenues; the cost of goods and services used up in the process of obtaining revenue.
Real Account
Permanent accounts that continue to exist beyond the current accounting period.
Financial Accounting
Providing information about the financial resources, obligations, and activities of an economic entity that is intended for use primarily by external decision makers-investors and creditors.
Management Accounting
Providing information that is intended primarily for use by internal management in decision making required to run the business. Used to help set company's overall goals, evaluating departments and individuals, and many other kinds of decisions.
Plant Assets
Represent a bundle of future services and, thus, can be thought of as long-term prepaid expenses. Long-lived assets that are acquired for use in business operations rather than for resale to customers. Can be categorized as Tangible, Intangible, or Natural Resources.
Operating Income
Represents the income resulting from the company's principal business activities.
Par Value
Represents the minimum amount per share invested in the corporation by its owners and cannot be withdrawn except by special legal action. Also known as stated value, the legal capital of a corporation. May be regarded as a cushion of equity capital existing for the protection of creditors.
Nominal Account
Revenue, expense, and dividend accounts are called temporary accounts because they accumulate the transactions of only one accounting period.
Treasury Stock
Shares of a corporation's own capital stock that have been issued and later reacquired by issuing company but that have not been cancelled or permanently retired.
Outstanding Shares
Shares that have been issued and are in the hands of the stockholders. At any time these shares represent 100 percent of the stockholder's investment in the corporation.
Dividends
Distributions of assets(usually cash) by a corporation to its stockholders. Normally viewed as a distribution of profits, these cannot exceed the amount of retained earnings. Must be formally declared by the board of directors and distributed on a per-share basis. Note: Stockholders cannot simply withdraw assets from a corporation at will.
Legal Capital
Equal to the par value or stated value of capital stock issued. This amount represents a permanent commitment of capital by the owners of a corporation and cannot be removed without special legal action. Of course, it may be eroded by losses. (pg.491)
Accrual
Example-Interest Expense, Wages (or Salaries) Expense, Uncollected Revenue. To grow or accumulate overtime.
Earnings per Share
Net income applicable to the common stock divided by the weighted average number of common shares outstanding during the year.
Capital Lease
A lease contract that finances the eventual purchase by the lessee of the leased property. The lessor accounts for this as a sale of property; the lessee records an asset and a liability equal to the present value of the future lease payments. Also called a financing lease.
Convertible Bonds
A bond that may be exchanged (at the bondholder's option) for a specified number of shares of the company's capital stock. (pg. 442)
Operating Activities
A category in the statement of cash flows that includes the cash effects of all revenues and expenses included in the income statement.
Call Price
A corporation has the right to redeem bonds in advance the maturity date by paying this. To compensate bondholders for giving up their investments, this is usually somewhat higher than the face value of bonds.
Prior-period Adjustment
A correction of a material error in the earnings reported in the financial statements of a previous year. Recorded directly in the Retained Earnings account and are not included in the income statement of the current period.
Securities and Exchange Commission (SEC)
A governmental organization that has the legal power to establish accounting principles and financial reporting requirements for publicly held companies in the US. One of three organizations that do this. Works closely with FASB. Reviews publicly owned corporations and can initiate legal action against the company and individuals.
Sarbanes-Oxley Act (SOX)
A landmark piece of securities law, designed to improve the effectiveness of corporate financial reporting through enhanced accountability of auditors, audit committees, and management. Result of large financial frauds at Enron and WorldCom. Passed in 2002 (Bush). One of most far-reaching securities law since the 1930's. Section 404-Financial Reporting.
Restructuring Charges
Costs related to reorganizing and downsizing the company to make the company more efficient. These costs are presented in the income statement as a single line item determining operating income.
Indenture
A legal and binding contract between a bond issuer and the bondholders. Also contains all the terms and conditions applicable to the bond issue. May impose some restrictions as limits on managers salaries and on dividends, and may require the creditor's approval for additional borrowing or for large capital expenditures. Specifies all the important features of a bond, such as its maturity date, timing of interest payments, method of interest calculation, callable/convertible features if applicable and so on.
Straight-line Depreciation
A method of depreciation that allocates the cost of an asset (minus any residual value) equally to each year of its useful life. (Cost-Residual Value)/Years of Useful Life=Amount depreciating per year Usually used for assets such as vehicles, aircraft, and construction equipment. Assets that have residual values material in amount.
Compensating Balance
A minimum average balance that a bank may require a borrower to leave on deposit in a non-interest bearing account. Company must quickly replenish bank account. Somewhat of a down payment.
Adjusted Trial Balance
A schedule indicating the balances in ledger accounts after end-of-period adjusting entries have been posted. The amounts shown in this are carried directly into financial statements. Step 5 of Accounting Cycle; comes after end-of-period adjustments
Natural Resources
A site acquired for the purpose of extracting or removing some valuable resource such as oil, minerals, timber is classified as this, not land. As this is extracted from the site it is converted into inventory. As this is extracted from the site it is converted into inventory. Depletes not depreciates
Unrealized Holding Gain or Loss
A stockholders' equity account representing the difference between the cost of investments owned and their market value at the balance sheet date. In short, gains or losses on these investments that have not been "realized" through the sale of the securities.
Perpetual Inventory System
A system of accounting for merchandising transactions in which the Inventory and Cost of Goods Sold accounts are kept up-to-date.
F.O.B.-Destination
A term meaning the seller bears the cost of shipping goods to the buyer's location. Title to the goods remains with the seller while the goods are in transit.
Debenture
An unsecured bond thats value rests on the general credit of the corporation rather than the value of a specific asset. May have a higher investment rating than a secured bond issued by a corporation in less satisfactory financial condition.
Commitment
Agreements to carry out future transactions. Although they are not a liability (because the transaction has not yet been performed), they may be disclosed in notes to the financial statements. Paying for services to be rendered in the future, but having no obligation to pay until the services are received.
Sole Proprietorship
An unincorporated business owned by a single individual. Most common form of business organization in our economy. Business entity separate from the other financial activities of the owner. Owner, legally, is personally liable for the debts of the business. Common for small retail stores, farms, service businesses, and professional practices in law, medicine, and accounting.
Depletion
Allocating the cost of a natural resource to the units removed as the resource is mined, pumped, cut, or otherwise consumed. Treating natural resources as inventory.
Residual Value
Also known as salvage value, is a portion of an asset's cost expected to be recovered through sale or trade-in of the asset at the end of it's useful life.
Business Transactions
An economic event that initiates the accounting process of recording it in a company's accounting system. They are the interactions between businesses and their customers, vendors and others with whom they do business.
Net Income
An increase in owner's equity resulting from profitable operations The excess of revenue earned over the related expenses for a given period.
Carrying Value
Another name for book value that describes the net valuation of an asset in a company's accounting records. For depreciable assets such as buildings and equipment, book value is equal to the cost of the asset, less the related amount of accumulated depreciation.
Fiscal Year
Any 12-month accounting period adopted by a business. Doesn't have to end on December 31(Calendar Year).
Objectivity Principle
Asset valuations that are factual, not personal opinion, and can be verified by independent experts. Asset was actually measured at the cost incurred in acquiring it.
Accounting Equation
Assets=Liabilities+Owners' Equity Equality of Assets= Claims of Creditors+Claims of Owners Reason why we call it a "Balance" Sheet. Always equal because they represent two views of the same business. Everything a business owns has been supplied to it either by the creditors or the owners
Cost Layer
Created whenever units are acquired at a different per-unit cost. Units of merchandise acquired at the same unit cost. An inventory comprised of several cost layers is a characteristic of all inventory valuation methods except average cost. Unlikely that a business is to have more than 3 or 4 of these at any given time.
Income Summary Account
Balance of this account will be Net Income or Net Loss for the period The summary account in the ledger to which revenue and expense accounts are closed at the end of the period. The balance (credit balance for a net income, debit balance for a net loss) is transferred to the retained earnings account.
Mortgage Bond
Bonds secured by the pledge of specific assets.
Accrual Accounting
Calls for recording revenue in the period in which it is earned and recording expenses in which they are incurred. The effect of events on the business is recognized as services are rendered or consumed rather than cash is received or paid. The policy of recognizing in the accounting records when it is earned and recognizing expenses when the related goods or services are used. The purpose for this is to measure the profitability of economic activities conducted during the accounting period. Matching Principle-most important concept, Revenue is offset with all of the expenses incurred in generating that revenue, measuring overall profitability of the economic activity. Alternate is Cash Basis Accounting
Investing Activities
Cash flows relating to this present the cash effects of transactions (purchases and sales) involving plant assets, intangible assets, and investments.
Double-entry accounting
Debit=Credit A system of recording every business transaction with equal dollar amounts of both debit and credit entries. As a result of this system, the accounting equation always remains in balance; in addition, the system makes possible the measurement of net income and also the use of error-detecting devices such as trial balance.
Cost Principle
Example: Business buys land for $100,000. Entered in accounting as asset of $100,000. In 10 years if market value rises to $250,000, amount on balance sheet is still $100,000. The widely used principle of accounting for assets at their original cost to the current owner. Whatever the asset was originally purchased for (historical cost), is what is on the balance sheet, no matter the current market value.
Consistency
Example: Choosing FIFO or LIFO. Example: Choosing Accelerated Method for ALL Vehicles and Equipment. (in inventory valuation) Basic concept underlying reliable financial statements that calls for the use of the same method of inventory pricing from year to year, with full disclosure of the effects of any change in method. Intended to make financial statements comparable. (in Depreciation) The company does not change from year to year the method used in computing the depreciation expense for a given plant asset. Choosing Straight-Line or Accelerated Method.
Operating Lease
Example: Contract leasing office space in an office building. Sometimes termed as off-balance sheet financing, a lease contract which is in essence a rental agreement. The lessee has the use of the leased property, but the lessor retains the usual risks and rewards of ownership. The periodic lease payments are accounted for as rent expense by the lessee and as rental revenue by the lessor.
Cash Equivalent
Example: Money market funds, U.S treasury bills, certificates of deposit, commercial paper. These investments must mature within 90 days of acquisition. Very short term investments that are so liquid that they are considered equivalent to cash.
Extraordinary Item
Example: Most large earthquake losses; such items are shown separately in the income statement after the determination of income before extraordinary items Transactions and events that are unusual in nature and occur infrequently.
Estimated Liability
Example: Recording Warranty Expense and Liability for Warranty Claims. The liability is known to exist, but the precise dollar amount cannot be determined until a later date. Because it extends years into the future, this liability and expense must be estimated. Involves matching principle.
Capital Expenditure
Example: Shelves put into company for storage. (Talked about in class) Expenditures for the purchase or expansion of plant assets that are recorded in asset accounts. Cost incurred to acquire a long-lived asset. Expenditures that will benefit several accounting periods.
Change in Accounting Principle
Example:Change from LIFO to FIFO Change from FOB-Shipping Point to FOB-Destination An accounting principle is a general guideline to follow when recording and reporting financial transactions. There is a change in accounting principle when: There are two or more generally accepted accounting principles that apply to a particular situation, and you shift to the other principle; or When the accounting principle that former applied to the situation is no longer generally accepted; or You change the method of applying the principle. A direct effect of a change in principle. For example, if you change from the FIFO to the specific identification method of inventory evaluation, the resulting change in the recorded inventory cost is a direct effect of a change in accounting principle.
Adjusting Entry
Example:Shop purchases supplies that will be used for several months. You need this to record the expense associated with the shop supplies used each month. Example 2: Two or Three year magazine subscriptions Needed at the end of each accounting period to make certain that appropriate amounts of revenue and expense are reported in the company's income statement. Four Types of Adjusting Entries (pg. 142) 1)Converting Assets to Expenses 2)Converting Liabilities to Revenue 3)Accruing Unpaid Expenses 4)Accruing Uncollected Revenue These entries assign revenues to the period in which they are earned, and expenses to the periods in which related goods or services are used. Certain transactions affect the revenue or expenses of two or more accounting periods. The purpose of adjusting entires is to assign to each accounting period appropriate amounts of revenue and expense.
Deferral
Examples Converting Asset to an Expense-Cost that will benefit more than one accounting period usually recorded by debiting asset account (supplies, unexpired insurance, etc.) and crediting cash. Converting liabilities to revenue-collecting cash in advance for future services rendered. Debiting cash and crediting liability account (unearned revenue, customer deposits, etc.) The liability account created represents this. Postponement of an expense or revenue in the asset account.
Revenue Expenditure
Examples: Ordinary repairs, maintenance, fuel, and other items necessary to the ownership and use of plant and equipment. Expenditures that will benefit only the current accounting period. Charged to expense account.
Gross Profit Margin
Gross Profit/Net Sales Also called Gross Profit Rate. Gross Profit expressed as a percentage of Net Sales. Can be computed for business as a whole, specific sales departments, and for individual products.
Depreciable Cost
How much has been taken off of the original cost. Cost-Residual Value
Accumulated Depreciation
How much has depreciated already A contra-asset account shown as a deduction from the related asset account in the balance sheet. Depreciation taken through the useful life of an asset is accumulated in this account. Actually called Depreciable Cost, but listed in Balance sheet as this. 1)Has a credit account 2)is offset against an asset account to produce the book value for the asset
Bond Issue Costs
How much the loan is and how much the corporation decides to break it up. A noncurrent (or long-term) asset reported on the balance sheet under the classification of "other asset". Bond Issue Costs include the professional fees and registration fees associated with the issuance of bonds. The amount in the account Bond Issue Costs will be amortized (systematically written off) to expense on the income statement over the life of the bonds.
Articles of Incorporation
In the US, a corporation is brought into existence under laws of a particular state. First step in forming a corporation is to obtain a corporate charter from the state of incorporation. To obtain this charter, the organizers of the corporation must submit an application called this.
Free Cash Flow
Leftover cash from operating activities that remains available for discretionary purposes after the basic obligations of the business have been met.
Gross Profit
Net Sales Revenue-Cost of Goods Sold Measures profitability of sales transactions, but not overall profitability of the business.
Recoveries of Bad Debts
Such collections that when a receivable has been written off as worthless it will later be collected in full or in part.
Intra-period Tax Allocation
The allocation of one year's income tax expense to the various sections of the income statement. For example, extraordinary items must be reported after income tax on the income statement, while operating revenues are reported before income tax.
Quality of Earnings
The amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory.
Periodic Inventory System
The amounts of inventory and the cost of goods sold are not known until a complete physical inventory is taken at year-end.
F.O.B.-Shipping Point
The buyer of goods bears the cost of transportation from the seller's location to the buyer's location. Title to the goods passes at the point of shipment, and the goods are the property of the buyer while in transit.
Available for Sales Securities
The classification of investments in marketable securities that are listed on the balance sheet right after cash.
Cost of Goods Sold
The cost to a merchandising company of the goods it has sold to its customers during the period. An expense so important to merchandising companies it is shown seperately from other expenses on the income statement.
Market Rate of Interest
The effective interest rate required by investors at any given time. If market conditions support an effective interest rate of less than the contract rate, the bonds will sell at a premium(price above their face value). Since market rates fluctuate constantly, it is reasonable to expect that the contract rate of interest will sometimes vary from the market rate at the date bonds are issued.
Normal Balance
The expectation that a particular type of account will have either a debit or a credit balance based on its classification within the chart of accounts. It is a part of double-entry accounting principles. An account has either a debit or a credit normal balance
Balance Sheet
The financial statement showing the financial position of an enterprise by summarizing its assets, liabilities, and owners' equity at a point in time or specific date. Sometimes described as a snapshot of the business in financial or dollar terms. Also called the statement of financial position.
Realization Principle
The generally accepted accounting principle that determines when revenue should be recorded in the accounting records. Revenue is realized when services are rendered to customers or when goods soldier delivered to customers.
Nominal Interest Rate
The interest rate before taking inflation into account. The nominal interest rate is the rate quoted in loan and deposit agreements. It can be approximated as nominal rate = real interest rate + inflation rate.
Discontinued Operations
The net operating results (revenues and expenses) of a segment of a company that has been or is being sold, as well as the gain or loss on disposal.
Issued Shares
The number of authorized shares that is sold to and held by the shareholders of a company, regardless of whether they are insiders, institutional investors or the general public. Also known as Issued Stock.
Authorized Shares
The number of stock units that a publicly traded company can issue as stated in its articles of incorporation, or as agreed upon by shareholder vote.
Land
The only plant asset not subject to depreciation, which has an unlimited term of existence and whose usefulness does not decline over time.
Retained Earnings
The portion of stockholders' (owners' ) equity that has accumulated as a result of profitable operations and was retained in the business. Represents the total net income of the corporation over the entire lifetime of the business, less all of the dividends to its stockholders. RE+NI-Dividends=Final RE Increased by Net income;Decreased by Net Loss and Dividends
Trial Balance
The proof of equality of debit and credit balances. A two-column schedule listing the names and the debit or credit balances of all accounts in the ledger. Gives you a feel for how the business stands.
Materiality
The relative importance of an item or amount. Items significant enough to influence decisions are said to be material. Items lacking this importance are said to be immaterial. The accounting treatment accorded to immaterial items may be guided by convenience rather than by theoretical principles. Enables accountants to shorten and simplify the process of making adjusting entries in several ways. A matter of professional judgement.
Operating Cycle
The repeating sequence of transactions by which a business generates its revenue and cash receipts from customers. 1)Purchases of Merchandise 2)Sales of Merchandise 3)Collection of Accounts Receivable
Accounting Cycle
The sequence of accounting procedures used to record, classify, and summarize information in financial reports at regular intervals. 1)Journalize (record) transactions 2)Post each journal entry to the appropriate ledger accounts 3)Prepare a trial balance 4)Making end-of-period adjustments 5)Preparing an adjusted trial balance 6)Preparing Financial Statements 7)Journalizing and posting closing entries 8)Preparing an after-closing trial balance
Depreciation
The systematic allocation of the cost of an asset to expense over the years of its estimated useful life. Causes are Physical Deterioration and Obsolescence
Financing Activities
Transactions such as borrowing, repaying borrowed amounts, raising equity capital, or making distributions to owners. Non cash aspects of these transactions are disclosed in a supplementary schedule.(pg. 566) A category in the statement of cash flows that reflects the results of debt and equity financing transactions. The cash effects of the owners investing in the company and creditors loaning money to the company and the repayment of either or both.(pg. 53 and 64)
Discount
Underwriters buy bonds at a price less than their face value with the intention of selling in future. Underwriters usually purchase these bonds from the issuing corporation at a price lower than face value. This percentage is 1 to 2% of the bonds face value. In terms of interest, this is the rate that will cause a given present value to grow to a given future amount. (pg. 451)
Cumulative Preferred Stock
When a stock is this, the money per share dividend is carried forward to future years if it is not paid all before any dividend is paid on common stock. The dividend preference carried by most preferred stocks. The dividend on this is always deducted.
Change in Accounting Estimate
When accounting for business transactions, there will be times when an estimate must be used. In some cases, those estimates prove to be incorrect, in which case a change in accounting estimate is warranted. A change in estimate is needed when there is a change that: Affects the carrying amount of an existing asset or liability, or Alters the subsequent accounting for existing or future assets or liabilities. A change in estimate arises from the appearance of new information that alters the existing situation. Situations where a change in estimate may be needed: Allowance for doubtful accounts, Reserve for obsolete inventory, Changes in the useful life of depreciable assets, Changes in the salvage values of depreciable assets, Changes in the amount of expected warranty obligations.
Additional Paid-in-Capital
When stock is sold for more than par value The Capital stock account is credited with the par value of the shares issued, and this separate account is credited for the excess of selling price over par. An account showing the amounts invested in a corporation by stockholders in excess of par value or stated value. In short, this account shows paid-in capital in excess of legal capital.
