Key Terms Financing activities Obtaining resources from (a) owners and providing them with a return on and a return of their investment and (b) creditors and repaying amounts borrowed (or otherwise settling the obligation). See statement of cash flows. Dividends A distribution of assets generated from earnings to owners of a corporation. The firm may distribute cash (cash dividend), stock (stock dividend), property, or other securities (dividend in kind). Dividends, except stock dividends, become a legal liability of the corporation when the corporation’s board declares them. Hence, the owner of stock ordinarily recognizes revenue when the board of the corporation declares the dividend, except for stock dividends. See also liquidating dividend and stock dividend. Investing activities Acquiring and selling securities or productive assets expected to produce revenue over several periods. Operating activities For purposes of the statement of cash flows, all transactions and events that are neither financing activities nor investing activities. See operations. Annual report to shareholders A report prepared once a year for shareholders and other interested parties. It includes a balance sheet, an income statement, a statement of cash flows, a reconciliation of changes in owners’ equity accounts, a summary of significant accounting principles, other explanatory notes, the auditor’s report, and comments from management about the year’s events. See 10-K and financial statements. Management Discussion and Analysis A discussion of management’s views of the company’s performance; required by the SEC to be included in the 10-K and in the annual report to shareholders. The information typically contains discussion of such items as liquidity, results of operations, segments, and the effects of inflation. Balance sheet Statement of financial position that shows Total Assets = Total Liabilities + Owners’ Equity The balance sheet usually classifies Total Assets as (1) current assets, (2) investments, (3) property, plant, and equipment, or (4) intangible assets. The balance sheet accounts composing Total Liabilities usually appear under the headings Current Liabilities and Long-term Liabilities. Assets SFAC No. 6 defines assets as “probable future economic benefits obtained or controlled by a particular entity as a result of past transactions. . . . An asset has three essential characteristics: (a) it embodies a probable future benefit that involves a capacity, singly or in combination with other assets, to contribute directly or indirectly to future net cash inflows, (b) a particular entity can obtain the benefit and control others’ access to it, and (c) the transaction or other event giving rise to the entity’s right to or control of the benefit has already occurred.” A footnote points out that “probable” means that which we can reasonably expect or believe but that is not certain or proved. You may understand condition (c) better if you think of it as requiring that a future benefit cannot be an asset if it arises from an executory contract, a mere exchange of promises. Receiving a purchase order from a customer provides a future benefit, but it is an executory contract, so the order cannot be an asset. An asset may be tangible or intangible, short-term (current) or long-term (noncurrent). Liabilities An obligation to pay a definite (or reasonably definite) amount at a definite (or reasonably definite) time in return for a past or current benefit (that is, the obligation arises from a transaction that is not an executory contract); a probable future sacrifice of economic benefits arising from present obligations of a particular entity to transfer assets or to provide services to other entities in the future as a result of past transactions or events. SFAC No. 6 says that “probable” refers to that which we can reasonably expect or believe but that is neither certain nor proved. A liability has three essential characteristics: (1) the obligation to transfer assets or services has a specified or knowable date, (2) the entity has little or no discretion to avoid the transfer, and (3) the event causing the obligation has already happened, that is, it is not executory. Shareholders’ equity Proprietorship or owners’ equity of a corporation. Because stock means inventory in Australia, the UK, and Canada, their writers use the term “shareholders’ equity” rather than the term “stockholders’ equity.” Contributed capital Name for the owners’ equity account that represents amounts paid in, usually in cash, by owners; the sum of the balances in capital stock accounts plus capital contributed in excess of par (or stated) value accounts. Contrast with donatedc apital. Retained earnings Net income over the life of a corporation less all dividends (including capitalization through stock dividends); owners' equity less contributed capital. Historical valuation Showing balance sheet amounts at acquisition cost, sometimes reduced for accumulated amortization; sometimes reduced to lower of cost or market. Income statement The statement of revenues, expenses, gains, and losses for the period, ending with net income for the period. Accountants usually show the earnings-per-share amount on the income statement; the reconciliation of beginning and ending balances of retained earnings may also appear in a combined statement of income and retained earnings. See income from continuing operations, income from discontinued operations, extraordinary items, multiple-step, and single-step. Net income, earnings The excess of all revenues and gains for a period over all expenses and losses of the period. The FASB is proposing to discontinue use of this term and substitute earnings. See comprehensive income. Revenues The owners’ equity increase accompanying the net assets increase caused by selling goods or rendering services; in short, a service rendered; sales of products, merchandise, and services and earnings from interest, dividends, rents, and the like. Measure revenue as the expected net present value of the net assets the firm will receive. Do not confuse with receipt of funds, which may occur before, when, or after revenue is recognized. Contrast with gain and income. See also holding gain. Some writers use the term gross income synonymously with revenue; avoid such usage. Expenses As a noun, a decrease in owners’ equity accompanying the decrease in net assets caused by selling goods or rendering services or by the passage of time; a “gone” (net) asset; an expired cost. Measure expense as the cost of the (net) assets used. Do not confuse with expenditure or disbursement, which may occur before, when, or after the firm recognizes the related expense. Use the word “cost” to refer to an item that still has service potential and is an asset. Use the word “expense” after the firm has used the asset’s service potential. As a verb, “expense” means to designate an expenditure—past, current, or future—as a current expense. Net loss The excess of all expenses and losses for a period over all revenues and gains of the period; negative net income. Statement of cash flows A schedule of cash receipts and payments, classified by investing, financing, and operating activities; required by the FASB for all forprofit companies. Companies may report operating activities with either the direct method (which shows only receipts and payments of cash) or the indirect method (which starts with net income and shows adjustments for revenues not currently producing cash and for expenses not currently using cash). “Cash” includes cash equivalents such as Treasury bills, commercial paper, and marketable securities held as current assets. This is sometimes called the “funds statement.” Before 1987, the FASB required the presentation of a similar statement called the statement of changes in financial position, which tended to emphasize working capital, not cash. Unqualified, qualified opinion See auditor’s report. Disclaimer of opinion An auditor’s report stating that the auditor cannot give an opinion on the financial statements. Usually results from material restrictions on the scope of the audit or from material uncertainties, which the firm has been unable to resolve by the time of the audit, about the accounts. Adverse opinion An auditor’s report stating that the financial statements are not fair or are not in accord with GAAP. Securities and Exchange Commission (SEC) An agency authorized by the U.S. Congress to regulate, among other things, the financial reporting practices of most public corporations. The SEC has indicated that it will usually allow the FASB to set accounting principles, but it often requires more disclosure than the FASB requires. The SEC states its accounting requirements in its Accounting Series Releases (ASR), Financial Reporting Releases, Accounting and Auditing Enforcement Releases, Staff Accounting Bulletins (these are, strictly speaking, interpretations by the accounting staff, not rules of the commissioners themselves), and Regulations S-X. See also registration statement, 10-K, and 20-F. secret reserve Hidden reserve. Financial Accounting Standards Board (FASB) An independent board responsible, since 1973, for establishing generally accepted accounting principles. Its official pronouncements are Statements of Financial Accounting Concepts (SFAC), Statements of Financial Accounting Standards (SFAS), and FASB.
