Glossary with Financial Accounting by Needles & Powers

This Glossary gives an overview of important terms used in the field of Financial Accounting. The Glossary can also be used while studying the book by Powers and Needles, Chapters 1 to 7 and 11 & 12.

Chapter 1: Uses of Accounting Information and the Financial Statements

Accounting An information system that measures, processes, and communicates financial information about an economic entity.

Business An economic unit that aims to sell goods and services to customers at prices that will provide an adequate return to its owners.

Profitability The ability to earn enough income to attract and hold investment capital.

Liquidity The ability to have enough cash to pay debts when they are due.

Operating activities Include buying, producing, and selling goods and services, hiring managers and other employees; and paying taxes.

Investing activities Involve spending a company’s capital in ways that will help it achieve its goals. Include buying the resources needed to operate the business, such as land, buildings, and equipment, and selling those resources when they are no longer needed.

Financing activities Involve obtaining adequate funds to begin operating the business and to continue operating it. They include obtaining capital from creditors, such as banks and suppliers, and from the company’s owners. They also include repaying creditors and paying a return to the owners.

Financial analysis The use of financial statements to determine that a business is well managed and is achieving its goals. The effectiveness of financial analysis depends on the use of relevant performance measures and financial ratios.

Performance measures Must be well aligned with the two major goals of business – profitability and liquidity. Profitability is commonly measured in terms of net income, and cash flows are a common measure of liquidity.

Financial ratios They show how elements of financial statements relate to each other. They allow for comparisons from one period to another and from one company to another.

Management accounting Providing information about financing, investing, and operating activities to achieve the goals of profitability and liquidity. Managers and employees need information about how they have done and what they can expect in the future.

Financial accounting External decision makers use financial accounting reports to evaluate how well the business had achieved its goals.

Financial statements Reports used within financial accounting

Bookkeeping It is the process, usually through the use of computers, of recording financial transactions and keeping financial records. It is a small, important part of accounting.

Management information systems (MIS) These consist of the interconnected subsystems, including accounting, that provide the information needed to run a business.

Ethics A code of conduct that applies to everyday life. It adresses the question of whether actions are right or wrong.

Fraudulent financial reporting The intentional preparation of misleading financial statements. It can result from the distortion of records, falsified transactions, or the misapplication of various accounting principles.

Sarbanes-Oxley Act (2002) Regulates financial reporting and the accounting profession, among other things.

Management Refers to the people who are responsible for ensuring that a company meet its foals of profitability and liquidity. Managers are internal users of accounting information.

Investors They have invested capital in a company and thus acquired part ownership in it. Investors have a direct financial interest in its success, and they depend on the financial statements to evaluate how the business has performed.

Creditors Those who lend money or deliver goods and services before being paid, are interested mainly in whether a company will have the cash to pay the interest charges and to repay the debt on time.

Securities and Exchange Commission (SEC) Set up by Congress to protect the public, and regulates the issuing, buying and selling stocks in the United States.

Business transactions Economic events that affect a business’ financial position. Businesses can have hundreds of even thousands of transactions every day. These transactions are the raw material of accounting reports.

Money measure Concept of all business transactions recorded in terms of money.

Exchange rate The value of one currency in terms of another. In effect, currencies are goods that can be bought and sold.

Separate entity For accounting purposes, a business is a separate entity, distinct not only from its creditors and customers but also from its owners.

Sole proprietorship One person is the owner, takes all the profits or losses of the business, and is liable for all its obligations.

Partnership Two or more owners. The partners share profits and losses of the business according to a prearranged formula.

Corporation A business unit chartered by the state and that is legally separate from its owners, the stockholders.

Articles of incorporation To form a corporation, most states require individuals, called incorporators, to sign an application and file it with the proper state official. This application contains the articles of incorporation.

Share of stock A unit of ownership in a corporation is called a share of stock.

Common stock Corporations may have more than one kind of stock, but in the first part of this book, we refer only to common stock – the most universal form of stock.

Corporate governance The oversight of a corporation’s management and ethics by its board directors.

Audit committee Independent directors who have financial expertise. The purpose is to ensure that board of directors are objective in evaluating management’s performance.

Income statement Also referred to as the statement of operations, is the most important financial report because it shows whether a business achieved its profitability goal through its operating activities.

Revenues Increases in stockholders’ equity that result from operating a business.

Expenses Decreases in stockholders’ equity that result from operating a business.

Net income When revenues exceed expenses, the difference is called net income.
Net loss When expenses exceed revenues, the difference is called net loss.

Retained earnings The accumulated earnings generated by a business’s income-producing activities less amounts that have been paid out to the stockholders.

Statement of retained earnings Shows the changes in retained earnings over an accounting period. The elements are net income and dividends.

Dividends Distributions of resources, generally in the form of cash or stock, to stockholders, and only the board of directors has the authority to declare them.

Balance sheet The purpose is to show the financial position of a business on a certain date, usually the end of the month or year.

Accounting equation Assets = Liabilities + Stockholders’ Equity. The two sides of equation must always be equal, or be ‘in balance’.

Assets The economic resources of a company that are expected to benefit the company’s future operations.
Liabilities A business’s present obligations to pay cash, transfer assets, or provide services to other entities in the future.

Stockholders’ equity Also called shareholders’ equity, represents the claims of the owners of a corporation to the assets of the business.

Net assets Theoretically, stockholder’s equity is what would be left over if all liabilities were paid, and it is sometimes said to equal net assets, also called net worth.

Contributed capital The amount that stockholders invest in the business.

Par value An amount per share that when multiplied by the number of common shares becomes the corporation’s common stock amount.

Additional paid-in capital When the value received is greater than par value, the amount over par value is called additional paid-in capital, but we assume in early chapters of this book that common stock is listed as par value.

Statement of cash flows Focuses on a company’s liquidity. It is organized according to the three major business activities; operating, investing, and financing activities.

Cash flows The inflows and outflows of cash into and out of a business.

Profit margin Calculated by dividing net income by revenues.

Generally accepted accounting principles (GAAP) To ensure that financial statements are understandable to their users, this has been developed to provide guidelines for financial accounting.

Certified public accountant (CPA) This person is independent and is not an employee of the company being audited and has no financial or other compromising ties with it.

Audit An examination of a company’s financial statements and the accounting systems, controls, and records that produced them.

Financial Accounting Standards Board (FASB) Most important body for developing rules on accounting practice in the United States.

International Accounting Standards Board (IASB) Which issues IFRS, is becoming increasingly important because of the acceptance of its standards in many financial markets throughout the world.

International Financial Reporting Standards (IFRS) Issued by the IASB.

Public Company Accounting Oversight Board (PCAOB) A governmental body created by the Sarbanes-Oxley Act, that regulates the accounting profession and has wide powers to determine the standards that auditors must follow and to discipline them if they do not follow these standards.

American Institute of Certified Public Accountants (AICPA) Professional association of certified public accountants, influences accounting practice through the activities of its senior technical committees.

Securities and Exchange Comission (SEC) An agency of the federal government that has the legal power to set and enforce accounting practices for companies whose securities are offered for sale to the general public.

Governmental Accounting Standards Board (GASB) A seperate but related body to the FASB, and issues accounting standards for state and local governments.

Internal Revenu Service (IRS) Interprets and enforces the tax laws that specify the rules for determining taxable income also influence accounting practice.

Integrity The accountant is honest and candid and subordinates personal gain to service and the public trust.

Objectivity The accountant is impartial and intellectually honest.

Independence The accountant avoids all relationships that impair or even appear to impair his or her objectivity.

Due care Carrying out professional responsibilities with competence and diligence.

Institute of Management Accountants (IMA) The primary professional association of management accountants, and has a code of professional conduct. It emphasizes that management accountants have responsibility, integrity and objectivity. .

Chapter 2: Analyzing Business Transactions

Recognition Refers to the difficulty of deciding when a business transaction should be recorded.

Recognition point The predetermined time at which a transaction should be recorded is the recognition point.

Valuation Focuses on assigning a monetary value to business transactions and the resulting assets and liabilities.

Fair value The exchange price of an actual or potential business transaction between market participants.

Cost principle The practice of recording transactions at exchange price at the point of recognition is reffered to as the cost principle.

Classificiation This issue has to do with assigning all the transactions in which a business engages to appropriate categories, or accounts.

Double-entry system In this system, each transaction must be recorded with at least one debit and one credit, and the total amount of the debits and credits must be equal.

Accounts Basic storage units for accounting data and are used to accumulate amounts from similar transactions.

T-account Such an account has three parts; a title, which identifies the asset, liability, or stockholders’ equity account, and a debit and credit side.

Debit The left side of a balance sheet and T-account.

Credit The right side of a balance sheet and T-account.

Footings The totals of a T-account are simply working totals, or footings.

Balance The difference in dollars between the total debit footing and the total credit footing is called the balance.

Normal balance The normal balance of an account is its usual balance and is the side that increases the account.

Accounting Cycle Is a series of six stepts whose basic purpose is to produce financial statements for decision makers. The steps are as follows: Analyze, Record, Post, Adjust, Prepare, Close.

Source documents Includes invoices, receipts, checks, and contracts and usually provide the details of a transaction.

Journal entry A notation that records a single transaction in the chronological accounting record.

Journal The chronological accounting record is known as a journal.

Compound entry When more than two accounts are involved in a journal entry, it is called a compound entry.

Trial balance Tests that the total of the debits and credits in the accounts are equal.

Chart of accounts To help identify accounts in the ledger and make them easy to find, accountants assign them numbers. A list of these numbers with the corresponding account titles is called a chart of accounts.

General journal Most businesses have more than one kind of journal. The simplest form and most flexible is the general journal, the one we focus on here. The general journal is used to record the details of each transaction.

General ledger The general ledger is used to update each account.

Ledger account form Contains four columns for ollar amounts, and is a somewhat more complicated form of the T-account.

Posting The process of transferring information from the journal to the ledger.

Asset turnover One measure related to liquidity and profitability is the asset turnover ratio, which shows how productice assets are in generating revenues.

Chapter 3: Measuring Business Income

Continuity Choosing the number of accounting periods raises the issues of continuity. Unless there is evidence to the contrary, the accountant assumes that the business will continue to operate indefinitely.

Going concern The majority of companies present annual financial statements on the assumption that the business will continue to operate indefinitely – that is, that the company is going concern.

Periodicity The portion of the cost of the building assigned to each period depends on this estimate and requires an assumption about periodicity. Although the lifetime of a business is uncertain, it is nonetheless useful to estimate the business’s net income in terms of accounting periods.

Fiscal year A 12-month accounting period.

Interim period Accounting periods of less than a year.

Matching rule Revenues must be assigned to the accounting period in which the goods are sold or the services are performed, and expensed must be assigned to the accounting period in which they are used to produce revenu.

Cash basis of accounting The practice of accounting for revenues in the period in which cash is received and for expenses in the period in which cash is paid.

Earnings management The manipulation of revenues and expenses to achieve a specific outcome.

Accrual accounting Encompasses all the techniques accountants use to apply the matching rule. Revenues and expenses are recorded in the periods in which they occur rather than in the periods in which they are received or paid.

Revenue recognition Relates to the process of determining when revenue should be recorded.

Adjusting entries When transactions span more than one accounting period, accrual accounting requires the use of adjusting entries.

Deferral The postponement of the recognition of an expense already paid or of revenu received in advance.

Accrual The recognition of a revenu or expense that has arisen but not been recorded during the accounting period.

Prepaid expenses Companies customarily pay some expenses, including those for rent, supplies, and insurance, in advance. These cost are called prepaid expenses.

Depreciation The amount allocated to any one accounting period.

Accumulated Depreciation accounts Used to accumulate the depreciation on each long-term asset.

Contra account A separate account that is paired with a related account.

Carrying value The balance of the contra account is shown on the financial statement as a deduction from its related account. The net amount is called the carrying value.

Accrued expenses As the expense and the corresponding liability accumulate, they are said to accrue.

Unearned revenues When a company receives revenues in advance, it has an obligation to deliver goods or perform services. Unearned revenues are therefore shown in a liability account.

Accrued revenues Revenues that a company has earned by performing a service or delivering goods but for which no entry has been made in the accounting records.

Adjusted trial balance After adjusting entries have been recorded and posted, an adjusted trial balnce is prepared by listing all accounts and their balances.

Permanent accounts Balance sheet accounts

Temporary accounts Revenue and expense accounts.

Closing entries Journal entries made at the end of an accounting period.

Post-closing trial balance The purpose is to determine that all temporary accounts have zero balances and to double-check that total debits equal total credits.

Cash flow yield Calculated by dividing the cash flows from operating activities by net income.

Chapter 4: Financial Reporting and Analysis

Qualitative characteristics To facilitate interpretation of accounting information, the FASB has established qualitative characteristics, by which to judge the information.

Relevance Information should have a direct bearing on a decision.

Faithful representation Financial information is complete, neutral, and free from material error.

Comparability The quality that enables users to identify similarities and differences between two sets of financial data.

Verifiability The quality that assures users that information as presented can be substantiated.

Timeliness The quality that enables users to receive information in time to influence their decisions.

Understandability The quality that enables users to comprehend the meaning of the infromation they receive.

Accounting conventions These conventions affect how and what information will be presented in financial statements.

Consistency Requires that once company has adopted an accounting procedure, it must use it from one period to the next unless a note to the financial statements informs users of a change in procedure.

Full disclosure Requires that financial statements present all the information relevant to users’ understanding of the statements.

Materiality Refers to the relative importance of an item or event.

Conservatism This convention holds that when faced with choosing between two equally acceptable procedures or estimates, accountants should choose the one that is least likely to overstate assets and income.

Cost-benefit This convention holds that the benefits to be gained from providing accounting information should be greater than the costs of providing it.

Classified financial statements General-purpose external financial statements that are divided into subcategories are called classified financial statements.

Other assets For simplicity, some companies group investments, intangible assets, and other miscellaneous assets into one single category called other assets.

Current assets Include cash and other assets that a company can reasonably expect to convert to cash, sell, or consume within one year or its normal operating cycle, whichever is longer.

Normal operating cycle The average time it needs to go from spending cash to receiving cash.

Investments Assets, usually long term, that are not used in normal business operations and that management does not plan to convert to cash within the next year.

Property, plant and equipment Include tangible long-term assets used in a business’s day-to-day operations.

Intangible assets Long-term assets with no physical substance whose value stems from the rights or privileges accruing to their owners.

Current liabilities Obligations that must be satisfied within one year or within the company’s normal operating cycle, whichever is longer.

Long-term liabilities Debts that fall due more than one year in the future or beyond the normal operating cycle and are thus paid out of non-currents assets.

Contributed capital The amount that stockholders invest in the business.

Multistep income statement Goes through a series of steps, or subtotals, to arrive at net income.

Merchandising company Buys and sells products.

Manufacturing company Makes and sells products.

Net sales Gross sales less sales returns and allowances.

Gross sales Consist of total revenue from cash and credit sales recorded during an accounting period.

Sales returns and allowances Include cash refunds and credits on account. They also include any discounts from selling prices made to customers who have returned defective products or products that are otherwise unsatisfactory.

Cost of goods sold Second major part of a multistep income statement. It is the amount a merchandiser paid for the merchandise it sold during an accounting period.

Gross margins The difference between net sales and the cost of goods sold.

Operating expenses The expenses incurred in running a business other than the cost of goods sold.

Selling expenses Include the costs of storing goods and preparing them for sale.

General and administrative expenses Include expenses for accounting, personnel, credit checking, collections, and any other expenses that apply to overall operations.

Income from operations The income from a company’s main business.

Other revenues and expenses Not relate to a company’s operating activities.

Income before income taxes The amount a company has earned from all activities, before taking into account the amount of income taxes it incurred.

Income taxes Represent the expense for federal, state, and local taxes on income.

Net income Final figure, or bottom line, of an income statement.

Earnings per share The net income earned on each share of common stock.

Singe-step income statement Income before income taxes is derived in a single step by putting the major categories of revenues in the first part of the statement and the major categories of costs and expenses in the second part.

Profit margin Shows the percentage of each sales dollar that results in net income.

Cash flow yield Measures how much cash a company’s operations generate in relation into net income.

Debt to equity ratio Reflects a company’s strategy for financing its operations.

Return on assets Overcomes deficiencies by relating net income from the income statement to average total assets form the balance sheet.

Cash return on assets It relates cash flows from operating activities from the statement of cash flows to average total assets from the balance sheet.

Return on equity Ratio of net income to average total equity. It indicates whether a company has earned a favorable return for stockholders.

Chapter 5: The Operating Cycle and Merchandising Operations

Merchandising business Earns income by buying and selling goods, which are called merchandise inventory.

Working capital Which uses two elements of the classified balance sheet, is the amount by which current assets exceed current liabilities. It is an important measure of liquidity.

Current ratio Calculated by dividing the current assets by the current liabilities.

Operating cycle Merchandising businesses engage in a series of transactions called the operating cycle.

Financing period The amount of time from the purchase of inventory until it is sold and payment is collected, less the amount of time creditors give the company to pay for the inventory.

Perpetual inventory system Continuous records are kept of the quantity and the cost of individual items as they are brought and sold.

Periodic inventory system The inventory not yet sold, or on hand, is counted periodically. This physical count is usually taken ate the end of the accounting period.

Exhange gain or loss If the exchange rate between two currencies changes between the date of sale and the date of payment.

Internal controls Management’s responsibility is to establish an environment, accounting systems, and control procedures that will protect the company’s assets. These systems and procedures are called internal controls,

Physical inventory Taking a physical inventory facilitates control over merchandise inventory. This process involves an actual count of all merchandise on hand.

Trade discount Particularly manufacturers and wholesalers quote prices as percentages off their list of cataogue prices. Such a reduction is called a trade discount.

Sales discount An invoice that offers a sales discount might be labeled ‘2/10, n/30’, which means that the buyer either can pay the invoice within ten days of the invoice date and take a 2 percent discount, or can wait 30 days and pay the full amount of the invoice.

Purchase discounts Discounts that buyers take for early payment of merchandise.

FOB shipping point The seller places the merchandise ‘free on board’ at the point of origin and the buyer bears the shipping costs.

FOB destination The seller bears the transportation costs to the place where the merchandise is delivered.

Freight-in When the buyer pays the transportation charge.

Delivery expense When the seller pays the transportation charge.

Sales Returns and Allowances account Gives management a readily available measure of unsatisfactory products and dissatisfied customers.

Cost of goods available for sale The total cost of merchandise that could be sold in the accounting period. Cost of goods sold is the cost of merchandise actually sold.

Net purchases Consist of total purchases plus any freight-in less any deductions such as purchases returns and allowances and discounts from suppliers for early payment.

Purchases account Under the periodic inventory system, the cost of merchandise is recorded in the purchases account at the time of purchase. This account is a temporary one used only with the periodic inventory system.

Purchases Returns and Allowances account Under the periodic inventoy system, the amount of a return or an allowance is recorded in this account.

Control environment Created by the management’s overall attitude, awareness, and actions. It encompasses a company’s ethics, philosophy and operating style, organizational structure, method of assigning authority and responsibility, and personal policies and practices.

Risk assessment This component involes identifying areas in which risks of loss of assets or inaccuracies in accounting records are high so that adequate controls can be implemented for risk management.

Information and communication Pertains to the accounting system established by management – to the way the system gathers and treats information about the company’s transactions and how it communicates individual responsibilities within the system.

Control activities The policies and procedures management puts in place to see that its directives are carried out, are called control activities.

Monitoring Management’s regular assesment of the quality of internal control, including periodic review of compliance with all policies and procedures, is part of monitoring.

Authorization The approval of certain transactions and activities.

Physical controls Controls that limit access to assets.

Periodic independent verification It states that someone other than the persons responsible for the accounting records and assets should periodically check the records against the assets.

Separation of duties No one person should authorize transactions, handle assets, or keep records of assets.

Bonding The process of carefully checking an employee’s background and insuring the company against theft by that person.

Purchase requisition A formal request for a purchase.

Purchase order The people in the purchasing department prepare a purchase order. The purchase order indicates that a company will not pay any bill that does not include a purchase order number.

Invoice An invoice shows the quantity of goods deliverd, describes what they are, and lists the price and terms of the payment.

Receiving report When the purchased goods reach the company, an employee notes the quantity, type of goods, and their condition on a receiving report.

Check authorization If everything is correct regarding to the purchased goods, the accounting department completes a check authorization and attaches it to the three supporting documents.

Check The treasurer examines all the documents. If the treasurer approves them, he or she signs or authorize an electronic check, which is an authoriation for the bank to pay the vendor in the amount of the invoice less any applicable account.

Bank statement The vendor deposits the check in its bank, and the canceled check appears in the company’s monthly bank statement.

Chapter 6: Inventories

Inventory turnover The average number of times a company sells an amount equal to its average level of inventory during an accounting period. It is computed by dividing the cost of goods sold by average inventory.

Days’ inventory on hand The average number of days it takes a company to sell an amount equal to is average inventory.

Supply chain management To reduce their levels of inventory, many merchandisers and manufacturers use supply chain management in conjuction with a just-in-time operating environment.

Just-in-time (JIT) operating environment Goods arrive just at the time needed.

Inventory cost The price paid to acquire an asset.

Goods flow Refers to the actual physical movement of goods in the operations of a company.

Cost flow Refers to the association of costs with their assumed flow in the operations of a company.

Consignment Merchandise that its owner places on the premises of another company with the understanding that payment is expected only when the merchandise is sold and that unsold items may be returned to the consignor.

Lower-of-cost-or-market (LCM) rule Requires that inventory is written down to the lower value and that a loss is recorded.

Specific identification method Identifies the cost of each item in ending inventory.

Average-cost method Inventory is priced at the average cost of the goods available for sale during the accounting period.

First-in, first-out (FIFO) method Assumes that costs of the first items acquired should be assigned to the first items sold.

Last-in, first-out (LIFO) method Assumes that costs of the last items purchased should be assigned to the first items sold.

LIFO liquidation When sales have reduced inventories below the levels set in prior years, it is called LIFO liquidation – that is, units sold exceed units purchased for the period.

Retail method This method estimates the cost of ending inventory by using the ratio of cost to retail price.

Gross profit method Assumes that the ratio of gross margin for a business remains relatively stable from year to year.

Chapter 7: Cash and Receivables

Cash Consists usually of currency and coins on hand, checks and money orders from customers, and deposits in checking and saving accounts.

Compensating balance A minimum amount that a bank requires a company to keep in its bank account as part of a credit-granting arrangement.

Short-term financial assets Accounts receivable and notes receivable are major types of short-term financial assets.

Trade credit Accounts receivable are short-term financial assets that arise from credit sales made in the ordinary course of business. This type of credit is called trade credit.

Receivable turnover Shows how many times, on average, a company turned its receivables into cash during an accounting period.

Days’ sales uncollected Shows how long it takes to collect accounts receivable.

Factoring The sale or transfer of accounts receivable, to an entity called a factor.

Contingent liability Potential liability that can develop into a real liability if a particular event occurs.

Securitization A process in which a company groups its receivables in batches and sells them at a discount to other companies or investors.

Discounting A method of financing receivables by selling promissory notes held as notes receivable to a financial lender, usually a bank.

Uncollectible accounts Company’s know they will always have some credit customers who cannot or will not pay. The accounts of such customers are uncollectible accounts.

Cash equivalents If investments have a term of 90 days or less when they are purchased, they are called cash equivalents because the funds revert to cash so quickly that they are treated as cash on the balance sheet.

Imprest system One way to control a cash fund and cash advances is by using an imprest system.

Electronic funds transfer (EFT) A method of conducting business transactions that does not involve the actual transfer of cash.

Bank reconciliation The process of accounting for the difference between the balance on a company’s bank statement and the balance in its Cash account.

Direct charge-off method Federal regulations require companies to use a method of recognizing a loss – called direct charge-off method – in computing taxable income.

Allowance method Losses from bad debts are matched against the sales they help to produce.

Allowance for Uncollectible Accounts Appears on the balance sheet as a contra account that is deducted from accounts receivable.

Percentage of net sales method Asks how much of this year’s net sales will not be collected. The answer then determines the amount of uncollectible accounts expense for the year.

Accounts receivable aging method Asks how much of the ending balance of accounts receivable will not be collected.

Aging of accounts receivable The process of listing each customer’s receivable account according to the due date of the account.

Promissory note Unconditional promise to pay a definite sum of money on demand or at a future date.

Notes receivable A payee includes all the promissory notes it holds that are due less than one year in notes receivable in the current assets section of its balance sheet.

Notes payable A maker includes all the notes in the current liabilities section of its balance sheet.

Maturity date The date on which a promissory note must be paid.

Duration of a note This refers to the time between a promissory note’s issue date and its maturity date.

Interest The cost of borrowing money or the return on lending money, depending on whether one is the borrower or the lender.

Maturity value The total proceeds of a promissory note – face value plus interest – at the maturity date.

Dishonored note A note not paid at maturity is called a dishonored note.

Chapter 8: Current Liabilities and Fair Value Accounting

Current liabilities Debts and obligations that a company expects to satisfy within one year of within its normal operating cycle, whichever is longer.

Payables turnover The number of times that a company pays it accounts payable in an accounting period.

Days’ payable Show how long a company takes to pay its accounts payable. It is computed by dividing the number of days in a year by the payables turnover.

Long-term liabilities These are liabilities due beyond one year or beyond the normal operating cycle.

Definitely determinable liabilities Current liabilities that are set by contract or stature and that can be measured exactly are called definitely determinable liabilities.

Line of credit Management often establishes a line of credit with a bank. This arrangement allows the company to borrow funds when they need to finance current operations.

Commercial paper Refers to unsecured loans that are sold to the public.

Wages Compenstation of employees at an hourly rate.
Salaries Compensation of employees at a monthly or yearly rate. (p. 370)

Employee A person who is paid a wage or salary by the organization and is under its direct supervision and control.

Independent contractor A person who is not an employee of the organization and so is not accounted for under the payroll system.

Estimated liabilities Definite debts or obligations whose exact dollar amount cannot be known until a later date.

Contingent liability Potential liability because it depends on a future event arising out of a past transaction.

Commitment A legal obligation that does not meet the technical requirements for recognition as a liability and so is not recorded.

Time value of money Refers to the costs or benefits of holding or not holding money over time.

Interest The cost of using money for a specific period.

Future value Amount of principle plus interest after one or more periods.

Simple interest The interest cost for one or more periods when the principal sum stays the same from period to period.

Compound interest The interest cost for two or more periods when, after each period, the interest earned in that period is added to the amount on which interest is computed in future periods.

Present value The amount that must be invested today at a given rate of interest to produce a given future value.

Ordinary annuity It is often necessary to compute the present value of a series of receipts or payments equally spaced overtime, with compound interest – in other words, the present value of an ordinary annuity.

Chapter 9. Long-Term Assets

Long-term assets They have a useful life of more than one year, are used in oeration of a business and are not intended for resale to customers.

Tangible assets Include buildings, equipment, and land. Most tangible assets are accounted for through depreciation.

Depreciation The periodic allocation of the cost of tangible long-lived asset over its estimated useful life.

Natural resources Assets that are extracted from the land and purchased for their economic value. Although they are tangible assets, they are accounted for through depletion.

Depletion Refers to the proportional allocation of the cost of a natural resource to the units extracted.

Intangible assets Assets such as copyrights and trademarks, that have no physical substance. Most intangible assets are accounted for through amortization.

Amortization Refers to the periodic allocation of the cost of the asset to the period its benefits.

Carrying value The unexpired part of an asset’s cost.

Asset impairment Occurs when the carrying value of a long-term asset exceeds its fair value.

Free cash flow An important and commonly cited measure of a company’s financial strength.

Expenditure A payment or an obligation to make a future payment for an asset.

Capital expenditure Expenditure for the purchase/expansion of a long-term asset.

Revenue expenditure Expenditure made for ordinary repairs and maintenance needed to keep a long-term asset in good operating condition.

Additions Enlargements of a plant asset’s physical layout.

Betterments Refers to improvements to a plant asset that do not add to a plant’s physical layout.

Extraordinary repairs Repairs that significantly enhance a plant asset’s estimate useful life or residual value.

Leasehold improvements Improvements to leased property that become the property of the lessor at the end of the lease are called leasehold improvements.

Physical deterioration Refers to the result of use or exposure to the elements, such as the wind and the sun.

Obsolescence The process of going out of date.

Residual value The portion of an asset’s acquisition cost that a company expects ro recover when it disposes of the asset.

Depreciable cost An asset’s cost less its residual value.

Estimated useful life Total number of service units expected from long-term assets.

Straight-line method Used to calculate depreciation, the asset’s depreciable cost is spread evenly over the estimated useful life of the asset.

Production method Based on the assumption that depreciation is solely the result of use and that the passage of time plays no role in the process.

Accelerated method Results in relatively large amounts of depreciation in the early years of an asset’s life and smaller amounts in later years.

Declining-balance method Most common accelerated method of depreciation. Depreciation is computed by applying a fixed rate to the carrying value.

Double-declining-balance method When twice the straight-line rate is used, the method is usually called the double-declining-balance method.

Group depreciation Large companies group similar assets to calcute depreciation.

Economic Stimulus Act (2008) A change in the federal income tax law allows a small company to expense the first $250,000 of equipment expenditures rather than recording them as assets and depreciating them over their useful lifes.

Successful efforts accounting Under this method, the cost of a succesful exploration is a cost of the resource.

Full-costing method All costs, including the cost of dry wells, are recorded as assets and depleted over the estimated life of the resources.

Copyright Exclusive right to reproduce and sell literary, musical, and other artistic materials and computer programs for a period of the author’s life plus 7 years.

Patent Exclusive right to make a particular product or use a process for 20 years.

Leasehold Right to occupy land or buildings under a long-term rental contract.

Software Capitalized costs of computer programs that are developed for sale, lease, or internal use.

Noncompete covenant Contract limiting the rights of others to compete in a specific industry or line of business for a specified period.

Customer list A list of customers or subscribers.

Goodwill The excess of the amount paid for a business over the fair market value of the business’s net assets.

Trademark (Brand name) Registered symbol or name that can be used only by its owner to identify a product or service.

Franchise (License) A right to an exclusive territory or market or the right to use a formula, technique, process or design.

Chapter 10: Long-Term Liabilities

Financial leverage If a corporation earns more from the funds it raises by incurring long-term debt than it pays in interest on the debt, the excess will increase its earnings for the stockholders.

Debt to equity ratio Shows the amount of debt a company carries in relation to its stockholder’s equity. The higher this ratio, the greater the company’s financial risk.

Off-balance-sheet financing McDonald’s has long-term leases on property at more than 13,850 locations, but it structures these leases in such a way that they do not appear as liabilities on its balance sheet.

Interest coverage ratio Measures the degree of protection a company has from default on interest payments. The lower this ratio, the greater the financial risk.

Mortgage A long-term debt secured by real property.

Operating lease When a company leases, the risks of ownerships of the asset remain with the lessor, and the lease is shorter than the asset’s useful life.

Capital lease When the lease cannot be canceled, the duration is about the same as the useful life of the asset and the lease stipulates that the lessee has the option to buy the asset at a nominal price at the end of the lease.

Pension plan Contract that requires a company to pay benefits to its employees after they retire.

Pension fund Contributions from employer and employees are usually paid into a pension pund, which is invested on behalf of the employees and from which benefits are paid to retirees.

Other postretirements benefits Many companies provide retired employees not only with pensions, but also with health care and other benefits.

Deferred Income Taxes Result of using different accounting methods to calculate income taxes on the income statement and income tax liability on the income tax return.

Bond A security, usually long term, representing money that a corporation borrows from the investing public.

Bond indenture Contract that defines the rights, privileges, and limitations of the bondholders.
Bond certificate As evidence of its debt to the bondholders, the corporation provides each of them with a bond certificate.

Bond issue The total value of bonds issued at one time.

Face interest rate The fixed rate of interest paid to bondholders based on the face value of the bonds. The rate and amount are fixed over the life of the bond.

Market interest rate The rate of interest paid in the market on bonds of similar risk.

Discount A discount equals the excess of the face value over the issue price. The issue price will be less than the face value when the market interest rate is higher than the face interest rate.
Premium A premium equals the excess of the issue price over the face value. The issue price will be more than the face value when the market interest rate is lower than the face interest rate.

Unsecured bonds Are issued on the basis of a corporation’s general credit.

Secured bonds Carry a pledge of certain corporate assets as a guarantee of repayment. A pledged asset can be a truck, or a property, plant, or equipment.

Term bonds When all the bonds of an issue mature at the same time.

Serial bonds Wen the bonds of an issue mature on different dates.

Early extinguishment of debt When a company retires a bond issue before its maturity date, is is called early extinguishment of debt.

Callable bonds These give the issuer the right to buy back and retire the bonds begore maturity at a specified call price.

Call price Usually above the face value.

Convertible bonds Allows the bondholder to exchange a bond for a specified number of shares of common stock.

Registered bonds Issued in the names of the bondholders. The issuing organization keeps a record of the bondholders’ names and addresses and pays them interest by check on the interest payment date.

Coupon bonds Not registered with the organization. Instead, they bear coupons stating the amount of interest due and the payment date.

Zero coupon bonds Some bonds do not require periodic interest payments. These bonds are simply a promise to pay a fixed amount at the maturity date.

Straight-line method Equalizes amortization of a bond discount for each interest period in the life of the bonds.

Effective interest method Is used to compute the interest and amortization of a bond discount, a constant interest rate is applied to the carrying value of the bonds at the beginning of each interest period.

Chapter 11: Stockholders Equity

Share of stock A unit of ownership in a corporation. Easily transferable.

Double taxation A major disadvantage of the corporate form of business.

Legal capital Number of shares issued times the par value.

Start-up and organization costs Costs of forming a corporation.

Dividend Distribution among stockholders if the assets that a corporation’s earnings have generated.

Liquidating dividend When a company declares a dividend that exceeds retained earnings, it is returning to the stockholders part of their contributed capital. Usually happens when a corporation is going out of business or when reducing its operations.

Declaration date The date on which the board of directors formally declares that the corporation is going to pay a dividend.

Record date The date on which ownership of stock is determined.

Ex-dividend Between the record date and date of payment, the stock is said to be called ex-dividend.

Payment date The date on which the dividend is paid to the stockholders of record.

Dividends yield Computed by dividing the dividends per share by the market price.

Return on equity Most important financial ratio associated with stockholders’ equity.

Price/earnings ratio (P/E) Measure of investors’ confidence in a company’s future. It is calculated by dividing the marktet price per share by the earnings per share.

Stock option plans Such plans give employees the right to purchase stock in the future at a fixed price.

Contributed capital The stockholdes’ investments in the corporation.

Treasury stock Share of corporation’s own stock that is has bought back on the open market.

Other comprehensive income/loss Include a variety items such as the effect of foreign exchange adjustment and unrealized gains and losses, that do not appear on the income statement but go directly to stockholders’ equity.

Residual equity Common stock is also called residual equity, which means that if the corporation is liquidated, the claims of all creditors and usually those of preferred stockholders rank ahead of the claims of common stockholders.

Preferred stock Stock that a corporation may issue to atract investors whose goals differ from those of common stockholders.

Authorized shares The maximum number of shares that a corporation’s state charter allows it to issue.

Issued shares Those that a corporation sells or otherwise transfers to stockholders.

Outstanding shares These are shares that a corporation has issued and that are still in circulation.

Noncumulative preferred stock If the stock is noncumulative preferred stock and the board of directors fails to declare a dividend on it in any given year, the company is under no obligation to make up the missed dividend in future years.

Cumulative preferred stock If the stock is cumulative preferred stock, the dividend amount per share accumulates from year to year, and the company must pay the whole amount before it pays any dividends on common stock.

Dividends in arrears Dividends not paid on cumulative preferred stock in the year they are due, are called dividends in arrears.

Convertible preferred stock Owners of convertible preferred stock are more likely than common stockholders to receive regular dividends.

Callable preferred stock Most preferred stock. The issuing corporation can redeem it at a price stated in the preferred stock contract.

No-par stock Does not have a par value.

Stated value State laws often require corporations to place a stated value on each share of stock that they issue, but even when this is not required, a corporation’s board of directors may do so as a matter of convenience.

Stock dividend This is a proportional distribution of shares among a corporation’s stockholders.

Stock split Occurs when a corporation increases the number of shares of stock issued and outstanding and reduces the par or stated value proportionally.

Statement of stockholders’ equity Summarizes changes in the components of the stockholders’ equity section of the balance sheet.

Book value Represents a company’s total assets less its liabilities.

Book value per share The equity of the owner of one share of stock in the net assets of the company.

Chapter 12: The Statement of Cash Flows

Statement of cash flows Shows how a company’s operating, investing, and financing activities have affected cash during an accounting period.

Cash Is defined as including both cash and cash equivalents.

Cash equivalents Investments that can be quickly converted to cash; they have a maturity of 90 days or less when they are purchased.

Operating activities Involve the cash inflows and outflows from activities that enter into the determination of net income.

Trading securities A type of marketable security that a company buys and sells for the purpose of making a profit in the near term as opposed to holding them indefinitely for investment purposes.

Investing activities Involve the purchase and sale of property, plant, and equipment and other long-term assets, including long-term investments.

Financing activities Involve obtaining resources from stockholders and providing them with a return on their investments and obtaining resources from creditors and repaying the amounts borrowed or otherwise settling the obligation.

Noncash investing and financing transactions These transactions involve only long-term assets, long-term liabilities, or stockholders’ equity.

Cash flow yield The ratio of net cash flows from operating activities to net income.

Cash flows to sales The ratio of net cash flows from operating activities to net sales.

Cash flows to assets The ratio of net cash flows from operating activities to average total assets.

Free cash flow The amount of cash that remains after deducting the funds a company must commit to continue operating at its planned level.

Direct method Adjusts each item on the income statement from the accrual basis to the cash basis.

Indirect method Does not require the adjustment of each item on the income statement. It lists only the adjustments that are necessary to convert net income to cash flows from operations.