Social Science
Economics
Finance
Financial Accounting Terms
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Terms in this set (100)
Assets=Liabilities+Owners' Equity
Equality of Assets= Claims of Creditors+Claims of
Owners
Accounting Equation
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
Example-Interest Expense, Wages (or Salaries)
Accrual
Expense, Uncollected Revenue.
To grow or accumulate overtime.
Financial Accounting Terms
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.
Accrual Accounting
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
A schedule indicating the balances in ledger
accounts after end-of-period adjusting entries
have been posted. The amounts shown in this are
Adjusted Trial Balance
carried directly into financial statements.
Step 5 of Accounting Cycle; comes after end-ofperiod adjustments
Financial Accounting Terms
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)
Adjusting Entry
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.
The financial statement showing the financial
position of an enterprise by summarizing its
assets, liabilities, and owners' equity at a point in
Balance Sheet
time or specific date. Sometimes described as a
snapshot of the business in financial or dollar
terms. Also called the statement of financial
position.
Financial Accounting Terms
An economic event that initiates the accounting
process of recording it in a company's accounting
Business Transactions
system. They are the interactions between
businesses and their customers, vendors and
others with whom they do business.
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
Consistency
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.
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.
Cost Principle
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.
Financial Accounting Terms
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
Deferral
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.
Debit=Credit
A system of recording every business transaction
with equal dollar amounts of both debit and credit
Double-entry accounting
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.
Providing information about the financial
resources, obligations, and activities of an
Financial Accounting
economic entity that is intended for use primarily
by external decision makers-investors and
creditors.
Financial Accounting Terms
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)
Financing Activities
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)
Any 12-month accounting period adopted by a
Fiscal Year
business.
Doesn't have to end on December 31(Calendar
Year).
Cash flows relating to this present the cash effects
Investing Activities
of transactions (purchases and sales) involving
plant assets, intangible assets, and investments.
Providing information that is intended primarily for
use by internal management in decision making
Management Accounting
required to run the business. Used to help set
company's overall goals, evaluating departments
and individuals, and many other kinds of decisions.
Financial Accounting Terms
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
Materiality
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.
Revenue, expense, and dividend accounts are
Nominal Account
called temporary accounts because they
accumulate the transactions of only one
accounting period.
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.
Normal Balance
It is a part of double-entry accounting principles.
An account has either a debit or a credit normal
balance
Asset valuations that are factual, not personal
Objectivity Principle
opinion, and can be verified by independent
experts. Asset was actually measured at the cost
incurred in acquiring it.
A category in the statement of cash flows that
Operating Activities
includes the cash effects of all revenues and
expenses included in the income statement.
Financial Accounting Terms
Real Account
Permanent accounts that continue to exist beyond
the current accounting period.
The generally accepted accounting principle that
determines when revenue should be recorded in
the accounting records.
Realization Principle
Revenue is realized when services are rendered to
customers or when goods soldier delivered to
customers.
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
Retained Earnings
business, less all of the dividends to its
stockholders.
RE+NI-Dividends=Final RE
Increased by Net income;Decreased by Net Loss
and Dividends
A landmark piece of securities law, designed to
improve the effectiveness of corporate financial
reporting through enhanced accountability of
auditors, audit committees, and management.
Sarbanes-Oxley Act (SOX)
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.
Financial Accounting Terms
A governmental organization that has the legal
power to establish accounting principles and
financial reporting requirements for publicly held
companies in the US.
Securities and Exchange
Commission (SEC)
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.
An unincorporated business owned by a single
individual.
Most common form of business organization in
our economy.
Sole Proprietorship
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.
The proof of equality of debit and credit balances.
A two-column schedule listing the names and the
Trial Balance
debit or credit balances of all accounts in the
ledger. Gives you a feel for how the business
stands.
Financial Accounting Terms
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
Accounting Cycle
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
Created whenever units are acquired at a different
per-unit cost.
Units of merchandise acquired at the same unit
Cost Layer
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.
The cost to a merchandising company of the
goods it has sold to its customers during the
Cost of Goods Sold
period.
An expense so important to merchandising
companies it is shown seperately from other
expenses on the income statement.
A term meaning the seller bears the cost of
F.O.B.-Destination
shipping goods to the buyer's location. Title to the
goods remains with the seller while the goods are
in transit.
Financial Accounting Terms
The buyer of goods bears the cost of
transportation from the seller's location to the
F.O.B.-Shipping Point
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.
Net Sales Revenue-Cost of Goods Sold
Gross Profit
Measures profitability of sales transactions, but
not overall profitability of the business.
Gross Profit/Net Sales
Also called Gross Profit Rate. Gross Profit
Gross Profit Margin
expressed as a percentage of Net Sales.
Can be computed for business as a whole,
specific sales departments, and for individual
products.
Balance of this account will be Net Income or Net
Loss for the period
Income Summary Account
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.
Total sales revenue-sales returns and allowancessales discounts
Net Sales
The most widely used measure of dollar sales
volume; usually the first figure shown in an income
statement.
Financial Accounting Terms
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.
Accumulated Depreciation
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
The systematic write-off to expense of the cost of
an intangible asset over the periods of its
economic usefulness.
Amortization
This of an intangible asset is the same as
depreciation for a tangible asset(usually straightline).
Example: Shelves put into company for storage.
(Talked about in class)
Expenditures for the purchase or expansion of
Capital Expenditure
plant assets that are recorded in asset accounts.
Cost incurred to acquire a long-lived asset.
Expenditures that will benefit several accounting
periods.
Financial Accounting Terms
Another name for book value that describes the
net valuation of an asset in a company's
accounting records.
Carrying Value
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.
Allocating the cost of a natural resource to the
Depletion
units removed as the resource is mined, pumped,
cut, or otherwise consumed. Treating natural
resources as inventory.
How much has been taken off of the original cost.
Depreciable Cost
Cost-Residual Value
The systematic allocation of the cost of an asset to
expense over the years of its estimated useful life.
Depreciation
Causes are Physical Deterioration and
Obsolescence
The write-down of a long-lived asset for the
difference between it carrying amount less its fair
value.
Impairment Loss
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.
The only plant asset not subject to depreciation,
Land
which has an unlimited term of existence and
whose usefulness does not decline over time.
Financial Accounting Terms
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
Natural Resources
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
The repeating sequence of transactions by which
a business generates its revenue and cash receipts
from customers.
Operating Cycle
1)Purchases of Merchandise
2)Sales of Merchandise
3)Collection of Accounts Receivable
The amounts of inventory and the cost of goods
Periodic Inventory System
sold are not known until a complete physical
inventory is taken at year-end.
A system of accounting for merchandising
Perpetual Inventory System
transactions in which the Inventory and Cost of
Goods Sold accounts are kept up-to-date.
Represent a bundle of future services and, thus,
can be thought of as long-term prepaid expenses.
Plant Assets
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.
Also known as salvage value, is a portion of an
Residual Value
asset's cost expected to be recovered through
sale or trade-in of the asset at the end of it's useful
life.
Financial Accounting Terms
Examples: Ordinary repairs, maintenance, fuel, and
other items necessary to the ownership and use of
Revenue Expenditure
plant and equipment.
Expenditures that will benefit only the current
accounting period. Charged to expense account.
A method of depreciation that allocates the cost
of an asset (minus any residual value) equally to
each year of its useful life.
Straight-line Depreciation
(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.
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
Additional Paid-in-Capital
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.
In the US, a corporation is brought into existence
under laws of a particular state. First step in
Articles of Incorporation
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.
Financial Accounting Terms
The number of stock units that a publicly traded
Authorized Shares
company can issue as stated in its articles of
incorporation, or as agreed upon by shareholder
vote.
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
Bond Issue Costs
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.
A corporation has the right to redeem bonds in
advance the maturity date by paying this. To
Call Price
compensate bondholders for giving up their
investments, this is usually somewhat higher than
the face value of bonds.
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;
Capital Lease
the lessee records an asset and a liability equal to
the present value of the future lease payments.
Also called a financing lease.
Financial Accounting Terms
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
Commitment
statements.
Paying for services to be rendered in the future,
but having no obligation to pay until the services
are received.
A bond that may be exchanged (at the
Convertible Bonds
bondholder's option) for a specified number of
shares of the company's capital stock.
(pg. 442)
When a stock is this, the money per share dividend
is carried forward to future years if it is not paid all
Cumulative Preferred Stock
before any dividend is paid on common stock. The
dividend preference carried by most preferred
stocks. The dividend on this is always deducted.
An unsecured bond thats value rests on the
general credit of the corporation rather than the
Debenture
value of a specific asset. May have a higher
investment rating than a secured bond issued by a
corporation in less satisfactory financial condition.
Underwriters buy bonds at a price less than their
face value with the intention of selling in future.
Underwriters usually purchase these bonds from
Discount
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)
Financial Accounting Terms
Example: Recording Warranty Expense and
Liability for Warranty Claims.
Estimated Liability
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.
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
Indenture
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.
The number of authorized shares that is sold to
and held by the shareholders of a company,
Issued Shares
regardless of whether they are insiders,
institutional investors or the general public. Also
known as Issued Stock.
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
Legal Capital
corporation and cannot be removed without
special legal action. Of course, it may be eroded
by losses.
(pg.491)
Financial Accounting Terms
The use of borrowed money to finance business
operations.
Leverage
Involves ROA and ROE
(pg. 455,463,647)
Similar to estimated liabilities but may involve
even more uncertainty. It is a possible loss,
stemming from past events, that is expected to be
Loss Contingency
resolved in the future. Disclosed in notes to
financial statements.
Example:
The effective interest rate required by investors at
any given time.
If market conditions support an effective interest
Market Rate of 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.
Mortgage Bond
Bonds secured by the pledge of specific assets.
The interest rate before taking inflation into
account.
Nominal Interest Rate
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.
Financial Accounting Terms
Example: Contract leasing office space in an
office building.
Sometimes termed as off-balance sheet financing,
Operating Lease
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.
Shares that have been issued and are in the hands
Outstanding Shares
of the stockholders. At any time these shares
represent 100 percent of the stockholder's
investment in the corporation.
Represents the minimum amount per share
invested in the corporation by its owners and
cannot be withdrawn except by special legal
action.
Par Value
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.
Price above face value.
The difference between the higher price paid for a
fixed-income security and the security's face
Premium
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.
Financial Accounting Terms
Shares of a corporation's own capital stock that
Treasury Stock
have been issued and later reacquired by issuing
company but that have not been cancelled or
permanently retired.
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
Change in Accounting
Estimate
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.
Financial Accounting Terms
Example:Change from LIFO to FIFO
Change from FOB-Shipping Point to FOBDestination
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
Change in Accounting
Principle
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.
The net operating results (revenues and expenses)
Discontinued Operations
of a segment of a company that has been or is
being sold, as well as the gain or loss on disposal.
Distributions of assets(usually cash) by a
corporation to its stockholders.
Normally viewed as a distribution of profits, these
Dividends
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.
Financial Accounting Terms
The use of accounting techniques to produce
financial reports that may paint an overly positive
Earnings Management
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.
Net income applicable to the common stock
Earnings per Share
divided by the weighted average number of
common shares outstanding during the year.
Example: Most large earthquake losses; such
items are shown separately in the income
statement after the determination of income
Extraordinary Item
before extraordinary items
Transactions and events that are unusual in nature
and occur infrequently.
This subtotal measures the profitability of the
Income from Continuing
ongoing operations. This subtotal should be
Operations
helpful in making predictions of the company's
future earnings.
The allocation of one year's income tax expense
to the various sections of the income statement.
Intra-period Tax Allocation
For example, extraordinary items must be
reported after income tax on the income
statement, while operating revenues are reported
before income tax.
An increase in owner's equity resulting from
profitable operations
Net Income
The excess of revenue earned over the related
expenses for a given period.
Financial Accounting Terms
Operating Income
Represents the income resulting from the
company's principal business activities.
A correction of a material error in the earnings
reported in the financial statements of a previous
year.
Prior-period Adjustment
Recorded directly in the Retained Earnings
account and are not included in the income
statement of the current period.
The amount of earnings attributable to higher
Quality of Earnings
sales or lower costs rather than artificial profits
created by accounting anomalies such as inflation
of inventory.
Costs related to reorganizing and downsizing the
company to make the company more efficient.
Restructuring Charges
These costs are presented in the income
statement as a single line item determining
operating income.
Past, present, or future reductions in cash required
Expenses
to generate revenues; the cost of goods and
services used up in the process of obtaining
revenue.
The classification of investments in marketable
Available for Sales Securities
securities that are listed on the balance sheet right
after cash.
Financial Accounting Terms
Example: Money market funds, U.S treasury bills,
certificates of deposit, commercial paper. These
investments must mature within 90 days of
Cash Equivalent
acquisition.
Very short term investments that are so liquid that
they are considered equivalent to cash.
A minimum average balance that a bank may
require a borrower to leave on deposit in a noninterest bearing account.
Compensating Balance
Company must quickly replenish bank account.
Somewhat of a down payment.
Leftover cash from operating activities that
Free Cash Flow
remains available for discretionary purposes after
the basic obligations of the business have been
met.
Such collections that when a receivable has been
Recoveries of Bad Debts
written off as worthless it will later be collected in
full or in part.
A stockholders' equity account representing the
difference between the cost of investments
Unrealized Holding Gain or
owned and their market value at the balance sheet
Loss
date. In short, gains or losses on these
investments that have not been "realized" through
the sale of the securities.