Glossary

A
methodin which Accelerated depreciation is a depreciation is expense takenin the early yearsof the more depreciation asset's and lessin the later years. life Accounts payable are amountsthat a companyowesits vendors.They areliabilities andareshownon the balancesheet. Accounts receivable is a current assetthat arisesfrom sales owe the firm. on credi| it is alsothe total amountcustomers The accounts receivable (AR) turnover ratio is a ratio that how quickly a firm collects its accountsreceivmeasures accounts dividedby average able.It is definedascredit sales receivable. An accrual is a transactionin which the revenuehas been earnedor the expensehas been incurred but no cash has beenexchanged. Accrual accounting refersto the way we recognizerevenues of Accountantsdo not rely on the exchange and expenses. cashto determinethe timing of revenuerecognition.Firms whenthey and revenue whenit is earned expenses recognize are incurred no matter when the cash is receivedor disfollows the matchingprinciple. bursed.Accrual accounting depreciation is the reductionto the costof the Accumulated deducted is asset. Accumulateddepreciation a contra-asset, for from the cost of the asset the balancesheet. Activity method depreciation is the methodof depreciation in in which usefullife is expressed termsof the total units of and from the asset, the asset activity or productionexpected is written off in proportionto its activity during the accounting period. in Adjusting the books meansto makechanges the accounting records,at the endofthe period,just beforethe financial are statements prepared,to make sure the amountsreflect the financial conditionof the companyat that date' An aging schedule is an analysisof the amountsowed to a firm by the length of time they havebeenoutstanding' acAllowance for uncollectible accounts is a contra-asset the count,the balanceof which represents total amountthe firm believesit will not collect from its total accountsreceivable. for Allowance method is a methodof accounting bad debtsin is which the amountof the uncollectibleaccounts estimated period. at the end of eachaccounting Amortization meansto write off the cost of a long-termasset period. over more than one accounting oven of Annuity A series equalcashreceiptson cashpayments equally spaceintervalsof time. owned or controlledby a Assets are the economicresources resultingfrom pasttransactions. company, of Authorized shares are shares stockthat are availablefor a firm to issueper its corporatecharter. the Available-for-sale securities : Investments companymay hold or sell; the company'sintention is not clear enoughto held to maturity ot trading. useone of the other categories to Bad debts expense is the expense recorduncollectibleaccountsreceivable. The balance sheet is one of the four major financial stateliabilities, ments.It showsthe amountsof a firm's assets, and owners'equity at a specificpoint in time. betweenthe cashbalA bank reconciliation is a comparison on recordsandthe cashbalance ancein the firm's accounting for to thebankstatement identify thereasons anydifferences. A bank statement is a summaryof the activity in a bank account senteachmonth to the accountholder' The book value of an assetis the cost minus the accumulated relatedto the asset. depreciation records. The books are a company'saccounting long-term note payableissued A bond is an interest-bearing, agencies. and governmental universities, by corporations, Bonds issued at a discount are bondsissuedfor an amount when the Iessthanthe facevalue ofthe bond.This happens marketrate of interestis greaterthan the bond's statedrate of interest. Bonds issued at par arebondsissuedfor the facevalueof the whenthe marketrateof interestis equal bond.This happens to the bond's statedrate of interest. Bonds issued at a premium arebondsissuedfor an amount whenthe morethanthe facevalueof thebond.This happens market rate of interestis less than the bond's statedrate of interest.

Capital, as shown on a balancesheet,is the combinedconof capitalretainedearnings a sole tributedcapitalandearned proprietorshipor partnershiP. usedto Capital is a term often usedto describethe resources startand run a business. A capital expenditure is a cost that is recordedas an asset, at not an expense, the time it is incurred.This is also called capitalizing acost. Capital structure is the combinationof debtandequity that a firm usesto frnanceits business. ratherthanto record To capitalize is to recorda costasan asset it as an expense. for Carrying value is anotherexpression book value. of Cash basis accounting is a systembasedon the exchange cash.In this system,revenueis recognizedonly when cash only when cashis is is collected,andan expense recognized method of accounting This is not an acceptable disbursed. underGAAP. with a matuCash equivalents are highly liquid investments rity of 3 monthsor lessthat a flrm can easily convertinto a known amountof cash. who has A certified public accountant (CPA) is someone set and examrequirements up by inmet specifrceducation dividual statesto make surethat only individuals with the 621

622

GLOSSARY

appropriate qualifications performaudits.To sign an aucan dit report, an accountant must be a CPA. A classified balance sheet showsa subtotalfor many items, including currentassets currentliabilities. and Common stock is the most widespread form of ownershipin a corporation; cornmonshareholders havea vote in the election of the firm's boardof directors. Comparative balance sheets are the balance sheetsfrom consecutive fiscal yearsfor a singlecompany. Comprehensive income The total of all items that affect shareholders' equity except transactions with the owners; comprehensive incomehastwo parts:net income and other comprehensive income. Contingent liabilities are potentialliabilities that dependon a future eventrelatedto somepastaction. A contra-asset is an amountthat is deducted from an asset. A contra-revenue is an accountthat is an offset to a revenue accountand thereforededucted from the revenuefor the financialstatements. Contributed capital, sometimes calledpaid-in capital, is the amountthe ownershaveput into the business. Cooking the books A slangixpression that means manipulate to or falsify thefirm's accounting recordsto makethefirm's financial performance positionlook betterthanit actuallyis. or A copyright is a form oflegal protectionfor authorsof "original works of authorship," providedby U.S. law A corporation is a special legalform for a business which the in business a legal entity separate is from the owners. corpoA rationmay havea singleowneror a largenumberof owners. Corporate governance The way a firm governsitself, as executedby the board of directors.Corporategovernance is also described the setofrelationshiosbetweenthe board as of directors,management, shareholders, auditors,and any otherswith a stakein the company. Cost of goods available for sale is the total of beginninginventoryplus the net purchases madeduring the period (plus any freight-in costs). Current assetsare the assets companyplans to tum into the cashor useto generate revenuein the next fiscal year. Current liabilities are liabilities the companywill pay off in the next fiscal year. Current ratio is a liquidity ratio that measures hrm's ability a to meetits short-termoblieations.

The direct write-off method is a method of accountingfor bad debtsin which they arerecorded an expense thepeas in riod in which they areidentifredas uncollectible. Discount on bonds payable is a contra-liabilitythat is deductedfrom bondspayableon the balancesheet;it is the difference between the face value of the bond and its selling price, when the selling price is less than the face (par) value. Discontinued operations Thosepartsof the firm that a company haseliminatedby selling a division. The discount rate is the interestrate usedto comDute orethe sentvalue of future cashflows. Discounting meansto compute the presentvalue of future cashflows. Dividend yield ratio Dividend per sharedivided by the current marketprice per share. Dividends are the distribution of a corporation'searningsto shareholders.

E
Earnings per share (EPS) Net income divided by the weighted averagenumber of outstandingsharesof (common) stock. Estimated liabilities are obligationsthat have some uncertainty in the amount,suchas the cost to honor a warranty. EXpenSeS the costsincurredto generate are revenue. Extraordinary items Events that are unusualin nature and infrequentin occurrence.

F The Financial Accounting Standards Board(FASB) the is

group that sets accountingstandards. gets its authority It from the SEC. Financial leverage is the use of bonowed funds to increase eamlngs. Financial services companiesdeal in services related to money. First-in, first-out (FIFO) is the inventory cost flow methodthat assumes first itemspurchased the first the are items sold. A fiscal year is a year in the life of a business. may or may It not coincidewith the calendaryear. FOB (free on board) destination means that the vendor (selling firm) pays the shipping costs,so the buyer has no freight-in cost. FOB (free on board) shipping point means buying firm the paysthe shippingcosts.The amountis calledfreighrin and is includedin the cost of the inventory. A for-profit firm hasthe goalof makinga profit for its owners. A franchise is an agreement that authorizessomeoneto sell or distributea company'sgoods or servicesin a certain area. Free cash flow is equal to cashfrom operatingactivitiesminus dividendsand minus capital expenditures. The full-disclosure principle meansthat the firm must disclose any circumstances eventsthat would make a difand ferenceto the usersofthe financial statements.

D
Declining balance depreciation is an accelerated depreciation methodin which depreciation expense basedon the is decliningbook value of the asset. A deferral is a transaction which the cashis exchanged in before the revenueis earnedor the expense incurred. is Definitely determinable liabilities are obligationsthat can be measured exactly. Depletion is the amortizationof a naturalresource. A deposit in transit is a bank depositthe frrm hasmadebut is not includedon the month'sbank statement because dethe posit did not reachthe bank'srecord-keeping department in time to be includedon the currentbank statement. Depreciating an asset meansto recognizethe cost of the asset as an expense over more than one period. Depreciation is a systematic rationalallocationprocess and to recognizethe expense long-term assets of over the periods in which the assets used. are The direct method showsevery cashinflow and outflow to preparethe statement cashflows. of

G
Generally accepted accounting principles (GAAP) are the guidelinesfor financial reporting. The going-concern assumption meansthat, unlessthere is obviousevidence the contrary a firm is expected conto to tinue operatingin the foreseeable future.

GLOSSARY

623

Goodwill is the excess cost overmarketvalue of the net asof setswhen one companypurchases anothercompany. minuscost Gross profit ratio is equalto the grossprofit (sales of goods sold) divided by sales.It is a ratio for evaluating firm performance.

H
Held-to-maturity securities Investmentsin debt securities that the companyplansto hold until they mature. The historical-cost principle means that transactionsare recordedat actualcost. Horizontal analysis A technique for evaluating hnancial statement amounts across time.

shouldbe recogThe matching principle saysthat expenses in nized shownon the income statement the sameperiod as the revenuethey helpedgenerate. A merchandising companysellsa productto its customers. The monetary-unit assumption meansthat the items on the in financial statements measured monetaryunits (dollar are in theU.S.). A multistep income statement startswith salesand subtracts cost of goods sold to get a subtotalcalled grossprofit on alsoknown asgrossmargin.Then,otheroperating revsales, enuesare addedand other operatingexpenses deducted. are A subtotalfor operatingincome is shownbefore deductions items and taxesare deducted. Then, relatedto nonoperating leavingnet income. incometaxesare subtracted, N minus all expenses a spefor Net income equalsall revenues cific period of time. that will Noncurrent assets, or long-term assets,areassets Iastfor more than a year. Noncurrent liabilities, or long-term liabilities, are liabilities that will takelonger than a year to settle. Notes to the financial statements are information provided that the with the four basic statements describes company's policies and provide other disclosures to major accounting helpexternal users betterunderstand financialstatements. the A not-for-profit firm hasthe goal ofproviding goodsor servicesto its clients.

I
The income statement showsall revenues minus all expenses period a month, a quarter,or a year. for an accounting Impairment is a permanentdecline in the fair market value of an assetsuchthat its book value exceeds fair marits ket value. The indirect method startswith net incomeandmakesadjustmentsfor itemsthat arenot cashto preparethe statement of cashflows. Intangible assets arerights, privileges,or benefitsthat result from owninglong-livedassets do not havephysicalsubthat stance. The interest is the cost of using someone else'smoney. Interest payable is a liability. It is the amount a company owes for borrowing money (after the time period to which the interestapplieshaspassed). to Internal controls are a company'spoliciesand procedures protectthe assets the firm and to ensure accuracy the and of reliability of the accounting records. The Internal Revenue Service (IRS) is the federal agency responsible federalincometax collection. for The inventory turnover ratio is definedascostof goodssold dividedby average inventory.It is a measure how quickly of a firm sellsits inventory. Issued shares are shares stock that havebeenoffered and of sold to shareholders.

o
appliesto either on On account means credit.The expression buying or selling on credit. are Ordinary annuities An annuitywhosepayments madeat the end of eachinterval or period. An outstanding check is a checkthe firm haswritten but has not yet clearedthe bank.That is, the checkhasnot beenpresented the bank for payment. to Outstanding shares are sharesof stock that are owned by stockholders.

P L
Last-in, first-out (LIFO) is the inventory cost flow method that assumes lastitemspurchased the first items sold. the are Liabilities are obligationsthe companyhasincurredto obtain the assets has acquired. it Liquidity is a measure ofhow easilyan asset be converted can to cash.The more liquid an asset the moreeasilyit canbe is, turnedinto cash. Liquidity ratios measure company'sability to pay its curthe rent bills and operatingcosts. The lower-of-cost-or-market (LCM) rule is the rule that requiresfirms to usethe lower of eitherthe cost or the market value (replacement cost) of its inventoryon the date of the balancesheet. to Paid-in capital is theamountof theowner'scontributions the frrm; alsoknown as shareholders'equity or stockholders' equity. to Par value is the monetaryamountassigned a shareof stock in the corporate charter. haslittle meaningin today'sbusiIt nessenvironment. ownedby two or moreindividuals. A partnership is a company grantsto A patent is a propertyright that the U.S. government an inventor"to excludeothersfrom making,using,offering for sale, or selling the invention throughout the United Statesor importing the inventioninto the United Statesfor a specihedperiod of time." The payee of a note is the personor firm receivingthe money. The periodic inventory system is a methodof recordkeeprecordsonly at the ing that involvesupdatingthe accounting period. end of the accounting The perpetual inventory system is a methodofrecord keeprecordsat the time ing that involvesupdatingthe accounting of everypurchase, sale,andreturn. Preferred stock are sharesof stock that representa special kind of ownershipin a corporation.Preferredshareholders do not get a vote but they do receivedividendsbefore the coffImon shareholders.

M
The maker of a note is the personor frrm making the promise to pay. A manufacturing companymakesthe goodsit sells. Market indicators ratiosrelatethe currentmarketprice of the company'sstockto eamingsor dividends. The market rate of interest is the interestratethat an investor could earnin an equally risky investment.

624

GLOSSARY

Premium on bonds payable is an adjunct-liability that is addedto bondspayableon the balancesheet;it is the differencebetween facevalueofthe bond andits sellingprice, the when the selling price is more than the face (par) value. has Prepaid insurance is the name for insurancea business purchased not yet used.It is an-a3set. but Prepaid rent is an asset.It represents amountspaid for rent not yet used.The rent expense deferred is until therentedassethas actuallybeenusedwhen the time relatedto the rent haspassed. The present value is the value today of a given amount of money to be investedor receivedin the future, assuming compoundinterest. Price-earnings (P/E) ratio The market price of a shareof per stockdivided by that stock'searnings share. The principal of a loan is the amountof moneyborrowed. Profrtability ratios measure operatingor income perforthe manceof a company. A promissory note is a written promise to pay a specifred amountof money at a specifiedtime. The Public Company Accounting Oversight Board (PCAOB) is a groupformedto oversee auditingprofesthe sion and the audits of public companies. creation was Its mandated the Sarbanes-Oxley of 2002. by Act A purchase discount is a reductionin the price of an inventory purchase prompt paymentaccordingto terms specfor ified by the vendor. A purchase order is a record of the company'srequestto a vendorfor goodsor services. may be referredto as a P.O. It Purchase returns and allowances areamounts that decrease the cost of inventorypurchases to returnedor damaged due merchandise.

A risk is a dangersomethingthat exposes business a poa to tential injury or loss.

s
A sales discount is a reductionin the salesprice of a product offeredto customers prompt payment. for Sales returns and allowances is an account that holds amountsthat reduce salesdue to customerreturns or allowances damaged merchandise. for Salvage value (alsoknown as residualvalue)is the estimated value of an assetat the end of its useful life. The Securities and Exchange Commission (SEC) is the governmental that monitorsthe stockmarketandthe agency financial reportingof the hrms that tradein the market. Segregation of duties meansthat the personwho hasphysical custody of an assetis not the same person who has record-keeping responsibilities that asset. for that the firm's finanThe separate-entity assumption means cial recordsand financial statements completelysepaare rate from thoseof the firm's owners. for A service company doessomething its customers; Shareholders' equity is the name for owners'claims to the assets the firm. It includesboth contributed of capitalandretainedearnings. Shares of common stock arethe units of ownershipin a corporation. A single-step income statement groupsall revenues together and showsall expenses deducted from total revenue. A sole proprietorship is a companywith a singleowner. Solvency ratios measurethe company'sability to meet its longterm obligationsand to survive over a long period of time. The specific identification method is the inventorycostflow methodin which the actualcostof the specificgoodssold is recordedas cost of goodssold. The statement of cash flows showsall the cashcollectedand all the cashdisbursed during the period. Each cashamount is classifiedas one of threetypes: The statement of changes in shareholder's equity starts with the beginningamountof contributed capitaland shows all changesduring the accountingperiod. Then the statement showsthe beginningbalancein retainedearnings with its changes. The usual changes retainedearningsare the to increase from net income and the decrease from dividends paid to shareholders. Stock dividends arenew shares stockthat aredistributedto of the company'scurrentshareholders. A stock exchange also calledthe stock market is a marketplace where buyers and sellers exchangetheir sharesof stock.Buying and selling shares stock can also be done of on the Internet. A stock split is the division of the currentshares stockby a of specifrcnumberto increase numberof shares. the Stockholders or shareholders arethe ownersofthe corporation. StraightJine depreciation is a depreciation methodin which the depreciation is expense the sameeachperiod.

Quality of earnings Refersto how well a reportedearnings numbercommunicates firm's true performance. the

a
R

Realized meansthe cash is collected.Sometimes revenueis recognizedbefore is realized. it Recognized revenue is revenue that hasbeenrecordedso that it will showup on the income statement. Relative fair market value method is a way to allocatethe purchased total costfor several togetherto eachofthe assets individual assets. indiThis methodis basedon the assets' vidual marketvalues. Replacement cost is the costto buy similar itemsin inventory from the supplierto replacethe inventory. Residual value, alsoknown assalvagevalue,is the estimated value of an assetat the end of its useful life. With most depreciation methods,residual value is deductedbefore the calculationof depreciation expense. Retained earnings is the total of all net income amountsminus all dividendspaid in the life of the company.It is descriptively named it is the earningsthat have been kept (retained)in the company. The amountof retainedearnings represents part of the owner's claims that the company the has earned(i.e., not contributed).Retainedearningsis zol the sameas cash. Revenue is the amountthe companyhas earnedfrom providing goodsor services customers. to The revenue-recognition principle saysthat revenueshould be recognized when it is earned and collectionis reasonably assured.

T
Tangible assetsare assets with physical substance; they can be seenand touched. The time-period assumption meansthat the life of a businesscan be divided into meaningfultime periodsfor financial reporting.

GLOSSARY

625

Timing differences arisewhen revenues eamedand colare periods.They also arisewhen lectedin differentaccounting period andpaid for expenses incurredin one accounting are in another. A trademark is a symbol, word, phrase,or logo that legally distinguishes company'sproductfrom any others. one Tfading securities Investments debt and equity securities in profrt. that the companyhaspurchased makea short-term to Tfeasury stock areshares stockthat havebeenrepurchased of by the issuingfrrm.

for nized either on the income statement trading securities income in the equity sectionof or in other comprehensive the balancesheetfor available-for-sale securitieswhen the f,rnancialstatements prepared,eventhough the securities are havenot beensold.

V
for Vertical analysis A technique comparingitems on a finanas cial statement which all items are expressed a percent in of a commonamount.

U
the Unearned revenue is a liability. It represents amountof goodsor servicesthat a companyowes its customers. The cashhas been collected,but the action of earning the revenuehasnot takenplace. Unrealized gain or loss An increase decrease the marin or ket value of a company'sinvestments securities recogin is

W
minus current liabiliWorking capital equalscurrent assets ties. Weighted average cost is the inventorycost flow methodin which the weightedaverage cost of the goodsavailablefor saleis usedto calculatethe cost of eoodssold and the ending inventory.