55 VOCABULARY Flashcards
Accounting Profit
Accounting profit is the difference between total revenues and measurable or estimable expenses paid to outsiders to acquire and use all necessary factors of production. Accounting profit does not include those implicit costs that are not measurable, such as opportunity costs and return to the owner for use of owner’s capital and entrepreneurial skills (the normal profit). It is the profit in excess of actual costs of production. The residual accrues to the owners.
Gross revenue from sales XXX
Less:
Direct materials xx
Direct labor xx
Factory overhead xx
Cost of goods sold XX
Equals Gross Profit XXX
Less: Nonmanufacturing costs XX
Equals ACCOUNTING PROFIT
(before income taxes) XX
Less: Income tax X
Equals ACCOUNTING PROFIT after tax XX
Less: NORMAL PROFIT (imputed
return to owner for
the use of capital and
for risk-taking) X
Equals ECONOMIC PROFITS X
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As a general rule, accounting profit is greater than normal profit, and normal profit is greater than economic profit because implicit costs are considered in the determination of normal and economic profits. (Income tax is basically applied to accounting profit that has been adjusted to taxable income per tax rules and regulations.)
Accounting profit is the basis for the financial statements of individual firms and is often extrapolated to the industry. It is not used when referring to the entire market.
Accounts Receivable
Accounts receivable are amounts the entity is entitled to receive that arise in the normal course of business (e.g., from the credit sales of goods or services). Receivables are claims against others for money, goods, or services, usually on “open” accounts after credit approval is granted. There is no formal written agreement, and they are usually classified as current assets. Normally, accounts receivable are expected to be received within 30 to 90 days. Accounts receivable are contrasted with notes receivable, which are of a longer term (e.g., 3 to 24 months) and accrue interest at a stated rate. Nontrade receivables are those that arise outside of the normal course of business (e.g., loans to employees or receivables from affiliated entities) and may be recorded net or gross. They are reported at net realizable value (i.e., the amount expected to be collected) and are offset by a valuation allowance account (a contra asset account).
Factors responsible for a net realizable value less than the amount billed are cash discounts, sales returns, and uncollectible amounts.
Accrued
If an item has been accrued, it has been entered in the accounting records by an adjusting journal entry. Accrual accounting requires that the effect of a future cash transaction be reflected in the current period’s financial statements, not in the following period or periods when the cash transaction will occur if its occurrence is certain (contractual) or the result of the passage of time.
From the income statement point of view, the adjusting journal entry is recorded because either the revenue is earned (e.g., interest earned but not received) and should be recognized in the current period—even if payment has not yet been received, or the expense (e.g., interest owed but not paid) should be matched against the current period’s revenue—even if payment for the expense has not yet been made. From the balance sheet perspective, either an asset (e.g., interest receivable) or a liability (e.g., interest payable) should be reported on the balance sheet, but the item has not yet been recorded.
Additional Paid-in Capital
Additional paid-in capital (APIC) is an increase in equity (net assets) in excess of par or stated value arising from transactions involving the enterprise’s own stock. Usually, it is reported for each class of stock or each type of transaction (e.g., APIC from common, from preferred, from treasury stock (both par and cost methods), from conversion of convertible shares, from retirement of callable or redeemable shares from payment of a liquidating dividend, and from quasi-reorganization).
Additional paid-in capital is sometimes called “paid-in capital in excess of par” or “contributed capital in excess of par.”
Assets
Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. They describe levels or amounts of resources at a moment in time.
SFAC 6.25–.34 and .172–.191
Essential characteristics, all three of which must be present, are as follows:
- 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
- A particular entity can obtain the benefit and control others’ access to it.
- The transaction or other event giving rise to the entity’s right to or control of the benefit has already occurred.
Economic benefits derive from the ability of assets to be exchanged for cash or other goods or services, by being used to produce goods or services to increase the value of other assets, or by being used to settle liabilities.
Services provided by other entities cannot be stored and are received and used simultaneously. Rights to receive services for specified or determinable future periods can be assets.
Assets are changed by transactions, activities, and events that happen to the entity, both those directly controlled by the entity (receipt and transfer of cash and other assets or adding value to noncash assets through operations by using, combining, and transforming goods into other goods) and those beyond its control (changes in prices, interest rates, and technology; impositions of taxes and regulations; discovery; growth or accretion; shrinkage; vandalism; theft; expropriations; and natural disasters).
“Valuation accounts” that increase or decrease the carrying value of assets are part of the related asset and are not assets, or liabilities, in their own right. These valuation accounts are either adjunct accounts (increase the related asset) or contra accounts (decrease the related asset).
In governmental accounting: Assets are defined as resources with present service capacity that the government presently controls. (GASB Concepts Statement 4.8)
Balance Sheet
Also called a statement of financial position, a balance sheet is a summary of assets, liabilities, and owner’s equity for a company as of a specific date. It is considered to be a snapshot of the organization’s financial position at a point in time.
Billings
A billing is a periodic interim invoicing for progress payments on long-term contracts. It is a contra asset (construction in process) account, netted against the construction in process asset account and recorded as either an asset (construction costs in excess of billings) or as a liability (billings in excess of construction costs).
Bond
A bond is a type of debt instrument or debt security in the name of the issuing party (a government or corporation) usually issued in denominations of $1,000. It is a legal document representing a long-term obligation to pay interest at a specified rate at specified intervals and to repay a specified amount (the principal) on a specified future date (at maturity). A bond represents a liability or debt to the issuer and is senior to (paid before) capital stock. A bond carries less risk than capital stock. The holder is the creditor, and the maker or issuer is the borrower or debtor. A bond is usually negotiable and can be sold or transferred, with the transferee becoming the holder in due course.
Bonds are classified in the following ways:
- Character of the issuer: Federal, municipal (the interest received from which is tax-exempt), or corporate (industrial)
- Character of the security: Secured, unsecured (debenture), or guaranty
- Payment of interest: Ordinary, income, participating, registered, bearer, or coupon
- Maturity of principal: Ordinary, callable, redeemable, convertible, or serial
In the United States, new corporate bond issues must be registered for tax reporting purposes, so bearer or coupon bonds are no longer issued by U.S. corporations.
Cash Dividend
A cash dividend is the distribution of cash to stockholders in proportion to the number of outstanding shares held. Accounting for dividends involves a disbursement (credit) from the cash account and a reduction (debit) to Retained Earnings.
The entry to record would be:
- When declared:
DR Retained Earnings xx
CR Dividends Payable xx
or
DR Dividends Declared xx
CR Dividends Payable xx
- When paid:
DR Dividends Payable xx
CR Cash xx
If a corporation uses the temporary account Dividends Declared, it is closed to Retained Earnings at the end of the accounting year.
A cash dividend represents a return on investment to shareholders.
Cash Equivalents
Cash equivalents are short-term, highly liquid investments that have both of the following characteristics: they are readily convertible to known amounts of cash AND are so near their maturity that they present insignificant risk of changes in value because of changes in interest rates. Generally, only investments with original maturities of three months or less qualify under that definition. Original maturity means original maturity to the entity holding the investment. For example, both a three-month U.S. Treasury bill and a three-year U.S. Treasury note purchased three months from maturity qualify as cash equivalents. However, a Treasury note purchased three years ago does not become a cash equivalent when its remaining maturity is three months.
Examples of items commonly considered to be cash equivalents are Treasury bills, commercial paper, money market funds, and federal funds sold (for an entity with banking operations).
FASB ASC Glossary
Comparative Financial Statements
Comparative financial statements are financial statements presented together for one or more prior periods as well as the current period. Notes, explanations, and auditor qualifications should be retained to the extent that they continue to be of significance. Any change which affects comparability should be disclosed.
Statements for a series of periods are far more significant than those for a single period. They enhance the usefulness of financial reports and show more clearly the nature and trends of current changes affecting the enterprise.
FASB ASC 205-10-45-1
Contra
An item that is contra is one that is offset or the opposite of another item. In accounting, a contra account is one whose balance is offset against its related account.
Example: The Allowance for Doubtful Accounts is contra to the account Accounts Receivable and the account Bond Discount is contra to the account Bonds Payable.
Assets, liabilities, revenues, and expenses can have contra accounts. Asset contra accounts include Allowance for Uncollectible Accounts Receivable, Allowance for Uncollectible Property Taxes Receivable, Accumulated Depreciation, and Accumulated Depletion. The most common liability contra accounts are discount accounts that adjust the carrying value of the liability such as Discount on Bonds Payable. The common revenue contra accounts are Sales Discounts and Sales Returns and Allowances. The common expense contra accounts are Purchase Discounts and Purchase Returns and Allowances.
Contributed Capital
Contributed capital is increases in net assets received from outside the corporation, from transactions related to capital stock or donated assets, from financing provided in exchange for ownership interest, and from paid-in capital.
Sources of contributed capital:
- Capital stock at par
* Common stock
* Preferred stock
2.Contributed capital in excess of par (CCEP) - Contributed capital from treasury stock
- Contributed capital from donation of assets
Current Assets
Current assets are cash and other assets that can be expected to be used, sold, or converted to cash during the current business cycle, generally one year.
Examples of current assets include cash, raw materials, trade accounts receivable, and marketable securities.
Current Liability
A current liability is payable within one year, or the operating cycle if longer. It is likely to be paid with current assets or require the incurrence of another current liability.
Date of Declaration
The date of declaration is the date on which the corporation’s board of directors formally announces that a dividend will be paid. The formal declaration of a cash, property, or script dividend constitutes a legally enforceable contract between the corporation and the shareholders; thus, the debit to retained earnings should be recorded on this date—the credit can be to Dividends Payable until the date of payment. Stock dividends are not legally enforceable until paid; therefore, no entry is made on the date of declaration.
Dividend Declared
The dividend declared is the per share amount set by a corporation’s board of directors to be paid to stockholders. The sum of these per share amounts (dividends declared) is recorded in a nominal (temporary) retained earnings account, Dividends Declared, on the date (date of declaration) that the corporation’s board of directors decides to pay the dividend because at that point in time it becomes a legal liability of the corporation. The dividend can be cash, other assets, or the corporation’s own preferred or common stock.
Dividends
Dividends are the distributions of cash, other corporate assets or property, or the corporation’s own stock to stockholders in proportion to the number of outstanding shares held. Accounting for dividends represents a debit to retained earnings and the establishment of a liability at the date of declaration. Dividends must meet the preferences of preferred stock first and then may be extended to common stock.
There are two types of dividends:
- Common, such as cash, stock (treasury or newly issued shares), and property
-
Special, such as scrip and liquidating
Four dates are relevant to dividends: date of declaration, record, ex-dividend, and distribution (payment).
Date of declaration is the date whereby the dividend amount is decided by the board of directors for those shareholders owning stock on the date of record (usually 1 month later) and to be paid on the date of distribution. Ex-dividend date is a date prior to the date of record (see ex-dividend date).
Earnings
Earnings are a measure of the performance of the enterprise during the period. Earnings measure the extent to which asset inflows (revenues and gains) associated with cash-to-cash cycles substantially completed during the period exceed (or are less than) asset outflows associated, directly or indirectly, with the same cycles. (SFAC 5.33–.38)
Similar to net income (earnings do not include the cumulative effect of certain accounting adjustments of earlier periods that are recognized in the current period), earnings are a measure of the performance for the current period and to the extent feasible excludes items that belong primarily to other periods. It is narrower, or less than, comprehensive income.
Earnings are also called “net income” (loss) or “profits” in common practice. “Earnings” are not strictly the same as “net income.”
Equity
Equity is ownership interest. It is the residual interest in the business entity that remains after deducting its liabilities. Equity is affected by all events that increase or decrease total assets by a different amount than they increase or decrease total liabilities.
SFAC 6.49–.65 and 6.212–.214
Distinctions within equity (common, preferred, etc.) are matters of presentation and display, not of definition.
Equity stems from ownership rights and involves a relation between the enterprise and its owners as owners rather than as employees, lenders, suppliers, customers, or other nonowner roles. Stockholders, partners, proprietors, investors, and participants are also terms used in defining owners.
The distinction between liability and equity depends on the nature of the claim, not the identity of the claimant—equity ranks after liabilities as a claim to or interest in the assets of the enterprise (the residual interest). Generally, the enterprise is not obligated to transfer interest to owners except under liquidation. Distributions to owners are at the discretion of the owners or their representatives.
The distinguishing characteristic of the equity of a business (compared to the equity of not-for-profit entities, termed “net assets”) is that it may be increased through investments by owners and decreased by distributions to owners.
See SFAC 6.64–.65 for details regarding changes in equity.
Pension
A pension is an agreement whereby the employer undertakes to provide to retired employees benefits that can be estimated or determined in advance, based on the provisions of the plan and established company practice. A pension is a form of deferred compensation in which the employee receives a portion of earned compensation after retirement. A pension involves three parties: the employer, the employee, and the trustee. Pensions are accounted for under accrual accounting.
FASB ASC 715-10
Stockholders’ Equity
Stockholders’ equity is total residual ownership interest in the corporation: net assets and total assets in excess of total liabilities. The source of equity should be specified and segregated:
Contributed capital (paid-in capital):
Capital stock, at par:
Common
Preferred
Less: Treasury stock (under the par value method)
Other contributed capital:
Contributed capital in excess of par (CCEP) (also called Additional paid-in capital (APIC)) on both common and preferred
Contributed capital from treasury stock (under the par value method or cost method)
Donated capital
Retained earnings (earned capital):
Appropriated
Unappropriated
Unrealized capital
Less: Treasury stock (under the cost method)
SFAC 6.60
Stockholders’ Equity
SFAC 6.60
