59 VOCABULARY Flashcards
Accounts Payable
Accounts payable are obligations to suppliers of merchandise or of services purchased on open account, with payment usually due in 30 to 60 days.
Accrual Basis Accounting
Accrual basis accounting is a method of accounting that attempts to record the financial effects (substance) of transactions and other events and circumstances in the periods in which they occur rather than only in periods in which cash is received or paid by the entity. Accrual basis accounting recognizes that the earnings process, which consists of buying, selling, producing, distributing, and other operations, often does not coincide with cash receipts and payments. This method of accounting records credit transactions, barter exchanges, nonreciprocal transfers, changes in prices, changes in form of assets or liabilities, and other transactions, events, and circumstances that have eventual cash consequences for the entity but do not involve the concurrent movement of cash. Revenue is recognized when earned and expenses are recognized when incurred, not when cash is received or paid.
SFAC 4.50 and 6.139
Accrual basis accounting uses accrual, deferral, and allocation to attempt to reflect the entity’s performance during a specific period of time, rather than just the receipts and disbursements of cash—to match the recognition of revenues with the related expenses (and the related increases or decreases in assets or liabilities).
Accrual basis accounting makes it possible to recognize expenses and losses at the time that economic benefits are consumed or the loss of future benefits is discovered rather than when payment is made. Accrual accounting uses three expense-recognition principles as appropriate:
Associated cause-and-effect
Systematic and rational allocation
Immediate recognition
SFAC 5.85–.86
Amortization
Amortization is an accounting process for reducing an asset or liability by periodic payments or writedowns that are distributed across the time the organization gains a value from or has obligation for the item. Specifically, it is the process of reducing a liability recorded as a result of a cash receipt (e.g., unearned revenue) by recognizing revenues or reducing an asset recorded as a result of a cash payment (e.g., prepaid expenses) by recognizing expenses or costs of production.
SFAC 6.142
Amortization is an allocation process to orderly reduce bond premium, bond discount, and bond issue costs by allocating the cost of an intangible asset to expense over time.
Available-for-Sale Debt Securities
Available-for-sale (AFS) debt securities are investments not classified as either trading securities or as held-to-maturity securities.
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.
Carrying Amount (Book Value)
The carrying amount or book value is the net amount at which an item is reported in the financial statements of the enterprise. For a receivable, the FASB ASC Glossary indicates the carrying amount is the “face amount increased or decreased by applicable accrued interest and applicable unamortized premium, discount, finance charges, or issues costs and also an allowance for uncollectible amounts and other valuation accounts.”
For a payable, the FASB ASC Glossary indicates the carrying amount is the “face amount increased or decreased by applicable accrued interest and applicable unamortized premium, discount, finance charges, or issue costs.”
Carrying Amount (Book Value)
The carrying amount or book value is the net amount at which an item is reported in the financial statements of the enterprise. For a receivable, the FASB ASC Glossary indicates the carrying amount is the “face amount increased or decreased by applicable accrued interest and applicable unamortized premium, discount, finance charges, or issues costs and also an allowance for uncollectible amounts and other valuation accounts.”
For a payable, the FASB ASC Glossary indicates the carrying amount is the “face amount increased or decreased by applicable accrued interest and applicable unamortized premium, discount, finance charges, or issue costs.”
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
Cash Flow
Cash flow is the amount of net cash that was generated by an entity during an accounting period. It is the difference between total cash inflows and total cash outflows.
Debt Security
A debt security is any security representing a creditor relationship with an entity. The term debt security includes (1) preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor; (2) a collateralized mortgage obligation (or other instrument) that is issued in equity form but is required to be accounted for as a nonequity instrument regardless of how that instrument is classified (that is, whether equity or debt) in the issuer’s statement of financial position; (3) U.S. Treasury securities; (4) U.S. government agency securities; (5) municipal securities; (6) corporate bonds; (7) convertible debt; (8) commercial paper; (9) all securitized debt instruments; and (10) interest-only and principal-only strips.
The term debt security excludes option contracts, financial futures contracts, forward contracts, lease contracts, and receivables that do not meet the definition of security and so are not debt securities (e.g., trade accounts receivable arising from sales on credit by industrial or commercial entities or loans receivable arising from consumer, commercial, and real estate lending activities of financial institutions).
Direct Method for Statement of Cash Flows
The direct method is one of the two optional methods of presentation of the statement of cash flows, the method preferred by the Financial Accounting Standards Board (FASB). The direct method presents gross cash receipts and payments from operating activities; cash amounts may be derived from accrual based records by adjusting income statement items for changes in the related balance sheet accounts, e.g., cash collected from customers is found by adjusting sales for the change in accounts receivable during the period. (FASB ASC 230-10-45-25)
In governmental accounting, cash flow statements presented for proprietary funds and governmental entities engaged in business-type activities must use the direct method. (GASB 2450)
The direct method presents major classes of cash flows: cash collected from customers, interest and dividends received, interest paid, cash paid to employees and suppliers, income taxes paid, and other cash payments.
If the direct method is used, a reconciliation of net income to net cash provided by operating activities must be presented as a supplemental disclosure. This reconciliation must present all major classes of adjustments: accruals of expected future operating cash receipts and payments (receivables and payable), deferrals of past cash receipts and payments (inventory, prepaid items, deferred income and expenses), noncash income/expenses (depreciation, amortization, provisions for bad debts), and gains and losses from transactions classified as investing or financing activities (sale of productive assets, sale of debt, liquidating dividend, retirement of debt).
Disclosure
The dictionary definition of the term “disclosure” is “revealing or uncovering.” In general, the purpose of financial reporting is to reveal an entity’s financial information. Often, the term “disclosure” relates to stating additional facts or explanations in a financial statement or auditor’s report. In financial statements, disclosure can be achieved by parenthetical or additional reporting of information after a line item by cross-referencing to another item, by footnotes, and by supplementary verbal and scheduled information. An additional explanatory paragraph can also be added to an auditor’s standard opinion for disclosure purposes.
Discount
A discount is the excess of face value over the proceeds (cash paid) for a bond (i.e., the borrower receives proceeds less than the face value), which is contrasted to a premium. A discount results when the stated interest rate is less than the effective (market) rate. It is amortized over the life of the bond with the amount of amortization reported as interest and is the difference between the present value of the bond and its face value (where the face value is higher). The discount is recorded on the balance sheet as a contra account inseparable from the bond which gives rise to it. It must be disclosed as a direct deduction from the face amount of the bond.
Example: A bond at face value is a $1,000, 20-year bond bearing interest at 10% annually, where the stated interest rate is 10% and cash interest paid is $100 per year. (FASB ASC 835-30-55-5)
If the prevailing market rate is 12%, the bond will “sell” for less than $1,000 (proceeds received will equal $851), because the lender could earn 12% on any other investment (so this bond’s market value is less than its face value). The bond sells at a discount.
i=.12, n=20, PVA(100) = (PVA × 100) + (PV × 1,000)
= (7.47 × 100) + (.104 × 1,000)
Selling price = $747 + $104 = $851
Discount = $1,000 − $851 = $149
The measure of the time value of money (present value), the amount deducted in advance of a payment due (as a cash discount on a receivable for early payment) or an amount charged in advance and deducted from the amount due (as a discounted or noninterest-bearing bond), and the process of decreasing a future amount back to the present at a specific discount rate (i) are all examples of ways in which the term “discount” is used.
Equity Security
Definition 1: An equity security is any security representing an ownership interest in an entity (for example, common, preferred, or other capital stock) or the right to acquire (for example, warrants, rights, forward purchase contracts, and call options) or dispose of (for example, put options and forward sale contracts) an ownership interest in an entity at fixed or determinable prices. The term equity security does not include any of the following:
Written equity options (because they represent obligations of the writer, not investments)
Cash-settled options on equity securities or options on equity-based indexes (because those instruments do not represent ownership interests in an entity)
Convertible debt or preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor
Definition 2: An equity security is any security representing an ownership interest in an entity (for example, common, preferred, or other capital stock) or the right to acquire (for example, warrants, rights, forward purchase contracts, and call options) or dispose of (for example, put options and forward sale contracts) an ownership interest in an entity at fixed or determinable prices. However, the term does not include convertible debt or preferred stock that by its terms either must be redeemed by the issuing entity or is redeemable at the option of the investor.
FASB ASC Glossary
Financing Activities
Financing activities is one of the three categories of cash flows on the statement of cash flows. It includes all transactions related to obtaining resources from owners and providing them with a return on, and a return of, their investment and to obtaining and repaying debt, including short-term and long-term debt, mortgages, finance lease obligations, seller-financed debt, and debt incurred to acquire treasury stock. (FASB ASC 230-10-20)
In governmental accounting, there are two categories of financing activities reported on the cash flow statement of proprietary funds or governments engaged in business-type activities: “noncapital financing activities” and “capital and related financing activities.” (GASB 2450.117–.122)
