Katikati College
Accounting – Year 13
Booklet Number:
Definitions Booklet
Name:
2/12/2008
Common Accounting Terms and
Definitions
This booklet contains:
 Definitions and applications used in Level Two
Accounting Achievement Standard 2.1.
 Features and/or legal requirements of business
entities used Achievement Standard 2.1
 Characteristics of Accounting used in Achievement
Standard 2.1.
 Purposes and objectives of Financial Statements
used in Achievement Standards 2.1 and 2.5.
Term
Definition
Purpose/Application
Function of
Accounting
To provide information (both
financial and non financial) to
users for decision making.
To provide information for users when
making financial decisions.
To be useful, information
must be relevant to the
decision-making needs of
users. Information has the
quality of relevance when it
influences the economic
decisions of users by helping
them evaluate past, present
or future events (predictive
role) or helping the users to
confirm or correct their past
evaluations (confirmatory
role).
Predictive value - assists in forming,
revising or confirming expectations
about the future
Carrying amount has predictive value
because it provides an indication of the
future economic benefit to flow into the
business from the use of the “delivery
van”
Feedback value confirms or corrects
prior expectations about the past.
QUALITATIVE
CHARACTERISTICS
Relevance
Materiality
The relevance of information
is affected by its size and
nature and materiality
Information is material if its
inclusion or non inclusion
could influence the economic
decisions of users taken.
Materiality depends on the
size of the item or error
judged in the particular
circumstances of its
omissions or misstatement.
Year 12 Accounting – Definition Booklet
Actual expenses incurred has feedback
value because it can be compared to
budgeted figures and changes made.
Example of relevant information
affected by its nature – director fees
The shareholders employ the
directors to earn profit so that
they can receive a dividend.
Therefore, directors’ fees are
shown separately from other
expenses so this amount can be
reviewed and a decision made
on whether or not it is worth
paying directors that amount
based on how much profit the
company makes. (Confirmatory
role)
Example of relevant information
affected by materiality – a reporting
entity purchases $500 worth of furniture.
The amount of $500 for furniture
is insignificant in size compared
with total assets of over $20
million and is not going to
influence users’ decision and
therefore is immaterial. It is not
relevant to record this purchase
as an asset and the amount of
$500 will be recorded as an
expense.
2
Reliability
Information has the quality of
reliability when it is free from
material error and bias and can
be depended upon by users to
represent faithfully that which it
either purports to represent or
could reasonably be expected to
represent.
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Reliability consists of the following
components
Faithful Representation
Information must represent faithfully the
transactions it claims to represent. For
example: A source document provides
faithful representation as it is evidence
that a transaction has occurred.
Substance Over Form
If information is to represent faithfully
the transactions and other events that it
claims to represent, it is necessary that
they are accounted for and presented in
accordance with their substance and
economic reality and not merely their
legal form.
Neutrality
The information contained in financial
statements must be free from bias.
Prudence
A degree of caution is needed in
making judgements about estimates
under uncertain conditions, such that
assets or income are not overstated and
liabilities or expenses are not
understated. Some uncertainties
entities deal with are doubtful debts,
useful life of plant and equipment.
Completeness
The information in financial statements
must be complete within the bounds of
materiality and cost. If information is not
included this can be false or misleading,
therefore unreliable and lacking in terms
of its relevance.
Understandability
The financial statements must The users are assumed to have a
be readily understandable by reasonable knowledge of business and
users.
economic activities and a willingness to
study the information with reasonable
diligence.
Comparability
Users must be able to compare
financial statements through
time in order identify trends in
the entity’s financial position
and performance. They must
be able to compare the
financial statements of
different entities.
Year 12 Accounting – Definition Booklet
Therefore
o the measurement and display of the
financial information and elements must
be consistent.
users be informed of accounting policies
and changes
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Term
Definition
Purpose/Application
An example of the
qualitative
characteristic trade
off between
reliability and
timeliness
•
Constraints on Relevance and
Reliability:
Timeliness
Benefit and Cost
Balance between Qualitative
characteristics (trade-off)
Fair presentation (true and fair view)
Fair Presentation
The financial position,
performance and cash flows
of an entity must be fairly
presented in the financial
statements. This means that
the information presented
must be relevant, reliable,
comparable and
understandable.
Accounting Entity
Notion
Monetary
Measurement
Notion
Accrual Basis
Assumption
•
to provide timely
information, it may be
necessary to estimate
amounts (because all
aspects of a transaction
are not known) therefore
impairing reliability.
To provide reliable
information the delaying of
reporting information may
result in the information
being of little value to
users because it is not
timely
The financial affairs of the
business are separate and
distinct from the affairs of the
owner.
All transactions, i.e. assets,
liabilities, expenses, incomes
and equity in financial
statements are recorded in
NZ dollars/dollar terms.
The effects of transactions and
other events are recognized
when they occur and are
reported in the financial
statements of the period to
which they relate.
When the financial statements of XYZ
are prepared only the assets, liabilities,
income and expenses of XYZ are
included
The equipment has been recorded in
NZ dollars. If we export or import, all our
transactions will be recorded in
equivalent New Zealand dollars.
The wages owing is added to the
wages expense account in the Income
Statement to report the total wages
that relate to the period because the
wages have been incurred (earned by
the employees) in the period
The wages owing is a liability at the
end of the period and has been
reported as accrued expenses because
it represents an obligation to pay the
employees that will result in a future out
flow of cash when the wages are paid
The financial statements are
prepared on the assumption
that the business will
continue its present
operations for the
foreseeable future and there
is no intention or need to
liquidate or cut back on the
business operations.
Year 12 Accounting – Definition Booklet
The Going Concern
Assumption
When a business purchases fixed
assets they are assuming that the
business will continue into the
foreseeable future as some of the
economic benefit from the asset will not
be utilised until some time in the future.
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Term
Definition
Purpose/Application
Period Reporting
Assumption
Entities present financial
statements on an annual
basis (the reporting period) so
as to report profit, assets ,
liabilities, revenue and
expenses and enables
comparisons from one year to
the next.
Assets are recorded at the
amount of cash paid or
consideration given at the
time of purchase/acquisition.
Income Statement for year ended …
Balance Sheet as at……..
Historical Cost
Concept
Financial Statements are comparable
because assets of businesses are
recorded at historical cost
FINANCIAL ELEMENTS
Assets
Asset Recognition
Criteria
Liabilities
An asset is a resource
controlled by the entity as a
result of past events and from
which future economic
benefits are expected to flow
into the entity.
a) it is probable that any
future economic benefit
associated with the asset will
flow to the entity. AND
b) The asset has a cost or
value that can be measured
reliably.
NB. The materiality concept
needs to be taken into
account when deciding if it is
an asset or an expense.
A liability is a present
obligation of the entity arising
from past events, the
settlement of which is
expected to result in an
outflow from the entity of
resources embodying
economic benefits
Liability
a) It is probable that any
Recognition Criteria future economic benefit
associated with the liability
will flow from the entity. AND
b) The settlement has a cost
of value that can be
measured reliably.
Year 12 Accounting – Definition Booklet
The van was purchased/bought in the
past by the business. The business has
exclusive/sole use of the van for
delivery. The van will be used to carry
out deliveries of goods which brings
revenue and so a cash flow to the
business.
The delivery van is recognised in the
Balance sheet because
(1)its cost can be reliably measured by
the source document/ invoice recording
its purchase
(2) the van will be used to make
deliveries of goods so it is most
probable that the future economic
benefit of revenue and so cash will be
received/flow to the business
Accounts payable are a liability
because in the past the business
purchased goods on credit.
The business has a legal
responsibility/ obligation to pay
for the goods.
When the business pays the
account payable is will result in
an outflow of cash (resources)
A mortgage on the building for
Joe's Shoes is a liability (because
it has the three characteristics of
a liability – state these as above).
It is probable that there will be an
outflow of money as there is a
contract to ensure the loan is
repaid. The settlement has a cost
value that can be reliably
measured as the dollar amount
will be shown in the loan contract.
5
Term
Definition
Purpose/Application
Owner’s Equity
Assets – liabilities
The residual interest in assets
after deducting all liabilities
The assets in Paris’s Landscape Design
total $237,000 less total liabilities of
$68,000, giving Owner’s Equity of
$169,000
Income
Income is increases in
economic benefits during the
accounting period in the forms
of increases in assets (or
decreases in liabilities), that
result in an increase in equity,
other than those relating to
contributions from the owner.
Income
Recognition
Criteria
An item that meets the
definition of an element should
be recognised if:
(a)
it is probable that any
future economic benefit
associated with the item will
flow to or from the entity; and
(b)
the item has a cost or
value that can be measured
with reliability.
Expenses
Expenses are decreases in
Advertising is an expense for Paris’s
economic benefits during the
Landscape Design as:
accounting period in the form
of decreases in assets (or
 Advertising decreased profit which
increases in liabilities) that
decreases equity
result in a decrease in equity
 Advertising paid decreases the asset
by decreasing profit, and is not
bank when money is paid
but is not owner’s drawings.
 Is not owners drawings.
Year 12 Accounting – Definition Booklet
Sales are an increase equity by
increasing profit and
Sales of goods result in an inflow that
increases the asset bank when money
is received for the sale (or increases the
asset accounts receivable) and
Is not owners contribution
Fees, commission received and interest
received are all forms of income for
Paris’s Landscape Design because
(increase, increase, increase, Not – as
above)
This income can be reliably measured
because there are receipts to indicate
their dollar value.
6
Recognition
Criteria Expense
An item that meets the
definition of an element should
be recognised if:
(a) it is probable that any
future economic benefit
associated with the item will
flow to or from the entity; and
Advertising is an expense for Paris’s
Landscape Design as (decrease,
decrease, decrease, NOT.. as above)
This expense can be measured reliably
as there will be an invoice to show the
price.
(b) the item has a cost or value
that can be measured with
reliability.
Profit
Income Statement
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Balance Sheet
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Statement of Cash
Flows
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Profit is an increase in the net
Profit is recorded in the Income
assets of a business which is
Statement (as a debit) and the Balance
not attributable to contributions Sheet (as a credit).
by the owners.
Provides information about:
Limitations
Income
 Amounts for depreciation and
doubtful debts are based on
Expenses
estimates and so the net profit may
and shows the
not be accurate.
Net Profit
 Errors may have occurred in
for the period arising from the
inventory valuation resulting in
entities activities
incorrect Gross Profit.
 Non financial information (eg quality
of sales staff is not included)
Provides information about:
Limitations
Assets
 Non financial information is not
disclosed.
Liabilities

Accumulated Depreciation and
Equity
Allowance Doubtful debts are based
and the relationship of these
on estimates
elements at a point in time.
Enables owner to measure
 Assets (except land) are reported at
his/her return on investment.
carrying amount which may not
reflect market value
Provides
information
that
allows users to assess the
ability of the entity to generate
cash and how the entity to
utilise those cash flows.
Show where cash has been
generated from and how it has
been spent in the period and it
impact on the bank account
provides information about an
entity’s activities in generating
cash to repay debt, or expand
operating capacity.
Year 12 Accounting – Definition Booklet
Limitations
 Does not show credit transactions eg
credit purchases or include non cash
items eg depreciation.
 The statement does not reflect the
operating performance (profit) of the
business.
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The cash flow statement is based on
past cash receipts and payments and
does not show future planned cash
receipts / payments you would need
a budget for that.
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Statement of
Accounting
Policies
To show the rules and
valuation methods and
assumptions followed
measuring the financial
elements when preparing the
financial statements.
Cost of Goods
Sold
To show who the statements have been
prepared for and what policies have
been used and makes the reports
comparable.
This shows how much the
business has spent on
purchasing the goods that they
sell for a profit.
Distribution Costs The expenses involved in
achieving the sales of a
business and distributing
goods to customers.
Administrative
These expenses are the
Expenses
general expenses involved in
running a business e.g. office
wages, rent, stationery,
electricity etc.
Finance Costs
These are expenses incurred
in managing finance including
the raising of capital and the
repayment of debt,
Is limited to interest expense
Current Assets
Any of:
(a) it is expected to be
realised in, or is intended for
sale or consumption in, the
entity’s normal operating cycle;
(b) it is held primarily for the
purpose of being traded;
(a) (c)it is expected to be realised
within twelve months after the
balance sheet date; or
(b) (d)it is cash or a cash
equivalent
This item appears in the trading section
of the Income Statement.
Current Liabilities
These liabilities are recorded in the
Balance Sheet. They are subtracted
from Current Assets to gain the
calculation of Working Capital.
Any of:
(a) it is expected to be settled in
the entity’s normal operating
cycle;
(b) it is held primarily for the
purpose of being traded;
(c) it is due to be settled within
twelve months after the balance
sheet date; or
(d) the entity does not have an
unconditional right to defer
settlement of the liability for at
least twelve months after the
balance sheet date.
Year 12 Accounting – Definition Booklet
These expenses are recorded in the
Income Statement. Usually the first
classification.
These expenses are recorded in the
Income Statement. Usually the second
classification.
These expenses are recorded in the
Income Statement. Usually the third
classification.
These assets are recorded in the
Balance Sheet. They are part of the
equation for calculating Working Capital
and are used in the Current Ratio.
8
Term
Definition
Purpose/Application
Non Current
Assets
Assets which are expected to
be retained in the business
beyond the end of the next
accounting period.
Assets with long term use in
the business which will provide
future economic benefit or
service potential to the
business for more than one
year.
These assets are recorded in the
Balance Sheet. They are added onto the
Working Capital figure.
Property Plant and
Equipment
Investment Assets
Intangible Assets
Non Current
Liabilities
Income (Revenue)
Expenditure
Assets such as term deposits
or shares in companies which
are expected to be kept in the
firm for more than one
accounting period. These are
normally more easily
converted into cash than fixed
assets. They produce revenue
for the business such as
interest or dividends, but are
not normally the main revenueproducing assets of the firm.
Assets which do not have a
physical existence. An
example of an intangible asset
is goodwill. Goodwill
represents an amount paid
when purchasing a business
that is over and above the
value of the net assets of the
business. People may pay
goodwill for a business
because the business has a
good name and reputation.
Liabilities which will be paid
over a period of time beyond
the next accounting period.
These liabilities include
mortgages, hire purchase
payments and long term loans.
Expenditure whose benefits
are consumed (used up) in the
current period. They are costs
incurred to earn revenue and
affect the years profit and so
owners equity. EG paid rates,
insurance, car registration.
Year 12 Accounting – Definition Booklet
These assets are recorded in the
Balance Sheet under the heading of
Non-current Assets and recorded at their
carrying amount.. Depreciation and
Accumulated Depreciation is calculated
in the Property Plant and Equipment
Note to the Balance Sheet.
These assets are recorded in the
Balance Sheet under the heading of
Non-current Assets and are usually kept
for more than one accounting period.
These assets are recorded in the
Balance Sheet under the heading of
Non-current assets.
These liabilities are recorded in the
Balance Sheet.
Revenue expenditure are recorded in
the Income Statement as either
Distribution, Administrative or Financial
Expenses
9
Term
Definition
Purpose/Application
Capital
Expenditure
Expenditure on items that will
benefit the business beyond
the current financial period. It
creates an asset and does not
affect Equity. Eg - purchase
of building, costs incurred in
installing new equipment or
improvements made to an
existing asset that extend its
useful life
Depreciation is the systematic
allocation of the depreciable
amount of an asset over its
useful life.
Capital expenditure on assets is
recorded in the Balance Sheet. Consider
materiality.
Straight Line
Depreciation
Assumes the use
(consumption) of economic
benefits the asset can provide
occurs evenly over its useful
life eg A Building’s pattern of
use is consistent each
accounting period.
The same amount of the cost is the
asset is allocated each year.
Can be calculated as a percentage of
historical cost or using a given lifetime.
Eg. A building
Diminishing Value
Depreciation
Assumes the (consumption) of More is depreciated in early years.
economic benefits the asset is
Usually based on a percentage of
greatest in the first years of the carrying amount.
assets useful life. Eg a
computer would become
obsolete over time and/or and
its repairs and maintenance
cost would be greater in later
years.
Units of Use
Depreciation
Assumes the (consumption) of
economic benefits the asset is
related to the amount the asset
is used rather than age. EG a
motor vehicles economic life is
measured in kilometres
travelled or a machine in
operating hours. The assets
economic benefit is limited by
the amount it is used.
Depreciation
Year 12 Accounting – Definition Booklet
Depreciation for the year is shown as an
expense in the income Statement.
Accumulated depreciation is shown in
the Balance Sheet, subtracted from the
asset.
Cost is allocated each year based on
the portion of lifetime (measured in
units) that have been used.
Eg. This may be kilometers traveled for
a motor vehicle, number of copies for a
photocopier.
10
Term
Definition
Purpose/Application
Periodic
Inventory
Measurement
Inventory is given an accurate
value once per year via a
stocktake. - the inventory is
physically counted and given a
value. This is the most common
system among small
businesses.
The inventory figure on hand at the
beginning of an accounting period is
included in the Cost of Goods Sold
section in the Income Statement. This is
thus an expense of that accounting
period.
Perpetual
Inventory
Measurement
The inventory figure on hand at the end
of the accounting period is included as a
Current Asset in the Balance Sheet.
This is thus an asset of that accounting
period.
Inventory records are kept
constantly. As inventory is
purchased and sold, a running
balance of exactly how much
inventory is ‘on hand’ is
maintained – lends itself to
computerisation and automation
and more often used by larger
businesses. This method of
inventory valuation has three
ways to calculate the inventory
value:
 Specific Identification
 First in First Out (FIFO)
 Weighted Average Cost
(WAC)
Specific
Indentification
inventory
measurement
This method is used for large
e.g. Motor Vehicle Dealers
items of inventory. Each specific
item of inventory is identified
with its relevant historical cost.
The closing amount of inventory
is calculated by adding the
historical cost of all individual
items.
Fifo Inventory
Measurement
This method assumes that the
first inventory purchased is the
first to be sold. The value of
closing inventory will consist of
the most recent items
purchased.
Year 12 Accounting – Definition Booklet
11
Terms
Definition
Application/Purpose
Weighted
Average
Inventory
Measurement
This method calculates the
value of closing inventory at the
average price paid during the
accounting period.
Used where different batches are not
identifiable e.g. petrol station.
Cost Versus Net
Realisable Value
Measurement
If inventory becomes out of date
it may be necessary to reduce
the selling price to clear the
inventory. Currently this
inventory is valued at Historical
Cost. The amount shown in the
Balance Sheet would not be
reliable as it does not represent
the future economic benefit of
that asset, i.e. the business is
likely to receive less cash when
the inventory is sold.
In this situation where it is probable that
the selling price of inventory will be less
than cost we apply the rule “lower of
cost or net realisable value”. This avoids
total assets being overstated and is an
application of the Prudence concept.
Accounting
Cycle
The sequence of accounting
procedures for processing
transactions during the
accounting year: Transactions
recorded from Source
documents, Journals, ledgers,
trial balance, Income Statement
and then a Balance Sheet.
Used to ensure that transactions are
recorded in the correct sequence.
Source
Documents
A document evidencing a
business transaction or event.
Examples of source documents
are Bank statements, receipts,
till strips, sales dockets,
invoices, credit notes, cheque
butts.
A journal is a chronological
record (ie in date order), of the
transactions of a business.
Often referred to as the books
of first entry. There are seven
journals, a general journal, two
cash journals and four credit
journals.
The business uses these documents to
record transactions in their journals and
ledgers.
Journal
Year 12 Accounting – Definition Booklet
Transactions of a similar nature are
recorded in each journal, e.g. Cash
Receipts journal.
12
Term
Definition
Application/Purpose
General Ledger
(ledger account)
A ledger is a set of accounts.
Transactions of a like nature are
recorded in the ledger accounts
in order to find out their
balances e.g. wages account,
rent account.
A listing of the accounts in the
ledger and total of their
respective debit and credit
balances. It is important to carry
out this step to check the
accuracy of the ledger accounts
before proceeding further in the
accounting cycle.
The chart of accounts is a list of
all the accounts contained in a
businesses records. They are
all allocated a number for easy
reference. They are usually
grouped together in Assets,
Liabilities, Owners Equity,
Revenue and Expense
accounts.
The ledger accounts record the
transactions and then balanced and the
final balances are used to make up the
trial balance before preparing the
Income Statement and Balance Sheet
Trial Balance
Chart of
Accounts
Year 12 Accounting – Definition Booklet
This is updated using the balance day
adjustments and is then used to prepare
the Income Statement and Balance
Sheet
Is merely used for easy reference for a
business. Is especially useful in
computer account.
13
Term
Definition
Purpose/Application
Balance Day
Adjustment
An adjustment made to
revenue and expenses at
balance day to ensure that all
transactions are recorded in
the correct reporting period in
order to calculate an accurate
profit figure.
Accrued Expense
In order to match all revenue
with expenses for the
accounting period these must
be added on to existing
expenses. These are
expenses which are
owing/due/accrued e.g. wages
owing, but have not yet been
paid at Balance Day.
In order to match all revenue
with expenses for the
accounting period these must
be taken away from existing
expenses. Expenses which
have been paid in that
accounting period but relate to
the following accounting period
(or have not yet been
consumed).
In order to match all revenue
with expenses for the
accounting period these must
be added on to existing
revenues. Revenues which
have been earned in that
accounting period but have not
yet been received.
In order to match all revenue
with expenses for the
accounting period these must
be taken away from existing
revenues. Revenues which
have been received in that
accounting period but have not
yet been earned.
The recognition of assets and liabilities
at the end of the period and to adjust the
revenue and expense balances
accordingly. The expense or revenue is
recorded accurately in the Income
Statement and the adjustment account,
e.g. Prepayments are recorded in the
Balance Sheet.
These are recorded as a Current
Liability in the Balance Sheet.
Prepayments
Accrued Income
Income Received
in Advance
Year 12 Accounting – Definition Booklet
These are recorded as a Current Asset
in the Balance Sheet e.g. Prepayments
(insurance paid in advance).
These are recorded as a Current Asset
in the Balance Sheet e.g. Accrued
Revenue (interest due on term deposit).
These are recorded as a Current
Liability in the Balance Sheet e.g.
Revenue in Advance (Rent Received in
Advance).
14
Term
Definition
Purpose/Application
Accounts
Receivable
These are amounts owing to
the business - customers have
purchased goods on credit.
The business has issued
invoices to customers.
These are accounts owing by
the business - the business
has purchased goods on credit
and have received an invoice.
Accounts Receivable are a Current
Asset and are recorded in the Balance
Sheet.
On receipt of a Bank
Statement it is necessary for a
business to compare their
cash records with those of the
bank. Often there are
transactions in the bank
statement that have not yet
been recorded in the cash
records. Also there are often
items recorded in the cash
records that the bank has not
yet recorded.
An indirect tax imposed on
good and services. A business
must charge GST on revenue,
this is in turn paid to the Inland
Revenue Department.
However they are able to claim
back GST on business
expenses. This reduces the
liability to the Inland Revenue
Department.
EFTPOS stands for ‘Electronic
Funds Transfer at Point of
Sale’. Many businesses sell to
customers using this method.
A major advantage over a
cheque is that if there is
insufficient funds in the
customers bank account the
transaction is declined.
This is necessary in order to ensure that
the cash records are completely up to
date. In other words all bank
transactions have been accounted for,
e.g. interest, direct debits, direct credits
etc.
Accounts Payable
Bank
Reconciliation
GST
EFTPOS
Year 12 Accounting – Definition Booklet
Accounts Payable are a Current Liability
and are recorded in the Balance Sheet.
If the GST account is in debit it means
that it is treated as a Current Asset (the
business is owed GST by the IRD). If it
is in credit then it is treated as a Current
Liability (the business owes GST to the
IRD). The current rate is 12.5%.
Any sales made through EFTPOS will
be recorded as a cash sale.
15