Accounting terms

Question 1

Impairment Loss

Answer 1

Definition:
An impairment loss happens when an asset’s fair value drops below its book value, meaning the asset is worth less than what is recorded on the financial statements. This loss must be recognized in the income statement.

Example:
A company buys a building for $500,000 and records it as an asset. Over time, due to economic downturns, the building’s fair value drops to $350,000. Since the asset is now worth $150,000 less, the company must recognize an impairment loss of $150,000 in its financial statements.

Question 2

Discontinued Operation

Answer 2

Definition:
A discontinued operation is a part of a company (a business segment or major line of business) that has been sold or is planned to be closed. The financial results of this operation are reported separately from continuing operations in the income statement to show its impact clearly.

Example:
A company that sells electronics and furniture decides to stop selling furniture and sells that part of the business. The revenue, expenses, and any gains or losses from the furniture segment will be reported separately under “Discontinued Operations” on the income statement.

Question 3

Statement of Comprehensive Income

Answer 3

The Statement of Comprehensive Income is a financial report that shows a company’s total earnings, including net income and other comprehensive income (OCI). It provides a more complete picture of financial performance by including gains and losses that are not part of net income but still affect equity.

Example:
A company reports:

Net Income: $100,000
Unrealized Gain on Foreign Currency Translation: $5,000
Unrealized Loss on Available-for-Sale Securities: -$3,000
The total Comprehensive Income would be $102,000 ($100,000 + $5,000 - $3,000).

This ensures investors see both regular earnings and gains/losses that affect the company’s value but aren’t included in net income.

Question 4

Statement of Comprehensive Income

Answer 4

The Statement of Comprehensive Income is a financial report that shows a company’s net income plus other comprehensive income (OCI), which includes gains and losses that affect equity but are not included in net income, such as foreign currency adjustments or unrealized investment gains.

Example:
A company reports:

Net Income: $100,000
Unrealized Gain on Foreign Currency Translation: $5,000
Unrealized Loss on Available-for-Sale Securities: -$3,000
The total Comprehensive Income would be $102,000 ($100,000 + $5,000 - $3,000), giving a complete picture of the company’s financial performance.

Question 5

Equity

Answer 5

Equity represents the residual value of a company’s assets after all liabilities have been paid. It is essentially the “net worth” of the business.

Example:
A company has $500,000 in assets and $300,000 in liabilities, so its equity is $200,000 ($500,000 - $300,000), which represents the shareholders’ claim on the company’s value.

Two Main Parts of Equity:

Contributed Capital is money invested by shareholders in exchange for ownership (common stock and preferred stock).

Retained Earnings are profits the company has accumulated over time and reinvested into the business instead of paying out as dividends.

Question 6

Pension Adjustments

Answer 6

Pension adjustments are changes in a company’s pension plan obligations that are recorded in other comprehensive income (OCI) until they are recognized in net income, and they include actuarial gains or losses, prior service costs, and changes in plan assumptions.

Example:
A company’s pension plan experiences a $50,000 actuarial loss due to changes in life expectancy assumptions. Instead of affecting net income immediately, this loss is recorded in OCI and gradually amortized into net income over time.

Question 7

Non-Operating Losses

Answer 7

Non-Operating Losses
Non-operating losses are expenses or losses that do not relate to a company’s core business activities, such as losses from asset sales, lawsuits, or foreign currency transactions.

Example:
A company that manufactures cars sells an old factory for $1 million but originally purchased it for $1.5 million, resulting in a $500,000 non-operating loss, since selling factories is not part of its normal business operations.

Question 8

Treasury Stock

Answer 8

Shares Repurchased by the Company

Treasury Stock represents shares that the company has bought back from investors.

Buying back shares reduces the number of shares in circulation, which can increase earnings per share (EPS).

Treasury Stock reduces total equity because the company is using cash to buy its own stock.

🛑 Example:

A company repurchases 100,000 shares of its stock for $2 million. This is recorded as a $2 million reduction in Stockholders’ Equity.

Why do companies buy back stock?
1. To reduce the number of shares available, increasing ownership percentages for remaining investors.
2. To boost the stock price by signaling confidence in the company’s future.

Question 9

Derivative Instruments

Answer 9

Derivative instruments are financial contracts whose value is based on an underlying asset, index, or rate, such as stocks, bonds, interest rates, or commodities, and they are used for hedging or speculation.

Example:
A company signs a futures contract to buy oil at $80 per barrel in six months to protect against price increases, meaning if oil prices rise to $100 per barrel, the company still pays only $80, using the derivative to hedge against risk.

Question 10

FIFO

Answer 10

FIFO is an inventory valuation method where the oldest inventory (first-in) is sold first (first-out), meaning the cost of goods sold (COGS) reflects older costs, while remaining inventory reflects newer costs.

Example:
A company buys 100 units of inventory at $10 each and later buys 100 more units at $12 each. If it sells 100 units, FIFO assumes the company sold the $10 units first, so COGS is 100 × $10 = $1,000, and the remaining inventory includes 100 units at $12 each.

Question 11

LIFO

Answer 11

LIFO is an inventory valuation method where the most recently purchased inventory (last-in) is sold first (first-out), meaning the cost of goods sold (COGS) reflects the newest costs, while remaining inventory reflects older costs.

Example:
A company buys 100 units at $10 each and later buys 100 more units at $12 each. If it sells 100 units, LIFO assumes the company sold the $12 units first, so COGS is 100 × $12 = $1,200, and the remaining inventory includes 100 units at $10 each.

Question 12

Inventory

Answer 12

Inventory consists of goods a company holds for sale or materials used in production, which are classified as a current asset on the balance sheet until sold.

Example:
A bookstore’s inventory includes books on shelves ready for sale, while a car manufacturer’s inventory includes raw materials (steel), work-in-progress (partially assembled cars), and finished goods (completed cars ready for sale).

Question 13

Depreciation

Answer 13

Depreciation is the process of allocating the cost of a fixed asset over its useful life, representing how much of the asset’s value has been used up each period.

Example:
A company buys a delivery truck for $50,000 with a useful life of 5 years and no salvage value. Using straight-line depreciation, the company records $10,000 ($50,000 ÷ 5) in depreciation expense each year to reflect the truck’s decreasing value.

Question 14

Actuarial Loss

Answer 14

Actuarial Loss

An actuarial loss occurs when changes in actuarial assumptions, such as life expectancy or discount rates, increase a company’s pension or post-employment benefit obligations, making the plan more expensive than previously estimated.

Example:
A company’s pension plan assumes employees will retire at age 65, but new data shows they are retiring at age 60, meaning the company must pay benefits five years earlier than expected, resulting in an actuarial loss that is recorded in other comprehensive income (OCI).

Question 15

Solvency

Answer 15

Solvency is a company’s ability to meet its long-term financial obligations, meaning it has enough assets to cover its total liabilities over time.

Example:
A company has $5 million in total assets and $2 million in total liabilities, meaning it is solvent because its assets exceed its liabilities, ensuring it can pay off its debts in the long run.

Question 16

Current Ratio

Answer 16

The current ratio measures a company’s ability to pay short-term liabilities using its short-term assets and is calculated as current assets divided by current liabilities.

Formula:

CurrentRatio= CurrentAssets / CurrentLiabilities

Example:
A company has $500,000 in current assets and $250,000 in current liabilities, so the current ratio is 2.0 ($500,000 ÷ $250,000), meaning it has twice as many short-term assets as short-term liabilities, indicating good liquidity.

Question 17

Debt-to-EquityRatio

Answer 17

The debt-to-equity ratio measures a company’s financial leverage by comparing its total debt to its total equity, showing how much debt is used to finance the business relative to shareholders’ investment.

Formula:

Debt-to-EquityRatio = TotalLiabilities / TotalEquity
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Example:
A company has $1,000,000 in total liabilities and $500,000 in total equity, so the debt-to-equity ratio is 2.0 ($1,000,000 ÷ $500,000), meaning the company has $2 of debt for every $1 of equity, which indicates a higher reliance on borrowed funds

Question 18

Current Assets

Answer 18

*Cash & Cash Equivalents refer to money the company has in the bank or highly liquid investments that can be quickly converted into cash.
*Accounts Receivable represents money that customers owe to the company for goods or services they have already received.
*Inventory includes raw materials, work-in-progress, and finished goods that the company plans to sell.
*Prepaid Expenses are payments made in advance for future expenses, such as rent, insurance, or subscriptions.

Question 19

Cash equivalents

Answer 19

Cash equivalents are highly liquid, short-term investments that can be quickly converted into cash and have an original maturity of three months or less.

Example:
A company holds $50,000 in Treasury bills and $30,000 in money market funds, both of which qualify as cash equivalents because they are low-risk and can be easily turned into cash when needed.

Question 20

Current Liabilities (Short-Term – Due Within a Year)

Answer 20

*Accounts Payable is the money the company owes to suppliers for goods or services it has already received but not yet paid for.

*Short-Term Loans are loans or credit lines that must be repaid within the next 12 months.

*Accrued Expenses are expenses that have been incurred but not yet paid, such as wages owed to employees.

Question 21

Non-Current Assets (Long-Term – Used Over Many Years)

Answer 21

*Property, Plant & Equipment (PP&E) includes physical, tangible assets like buildings, machinery, and land that the company uses to operate its business.

*Intangible Assets are non-physical assets like patents, trademarks, and copyrights that provide competitive advantages.

*Long-Term Investments include stocks, bonds, or real estate that the company owns but does not actively use in operations.

🛑 Real-Life Example:
Imagine you own a coffee shop. Your current assets include the cash in your register, coffee beans (inventory), and money customers owe you for catering orders (accounts receivable). Your non-current assets include your espresso machines and the building you own.

Question 22

Non-Current Liabilities (Long-Term – Paid Over Many Years)

Answer 22

*Long-Term Loans and Bonds Payable are borrowed funds that will be repaid over several years, often used for major investments or expansion.

*Pension Liabilities represent money the company owes to employees for future retirement benefits.

🛑 Real-Life Example:
If you borrow $50,000 from a bank to expand your coffee shop, that is a long-term liability because you will pay it back over several years. However, if you owe your supplier $5,000 for last month’s coffee beans, that is a short-term liability because it must be paid soon.

Question 23

Capital

Answer 23

Capital refers to the financial resources a company uses to fund its operations, invest in assets, or expand its business, which can come from equity (owner investments) or debt (borrowed funds).

Example:
A startup raises $500,000 from investors (equity capital) and takes out a $200,000 loan (debt capital) to fund the launch of its new product line.

Examples of Capital
Equity Capital – Money raised from investors or owners in exchange for ownership in the company.

Example: A startup raises $1 million from venture capitalists in exchange for shares.
Debt Capital – Funds borrowed from banks, bonds, or other lenders that must be repaid with interest.

Example: A company issues corporate bonds worth $5 million to finance a new factory.
Working Capital – The difference between current assets and current liabilities, used for day-to-day operations.

Example: A retail store has $200,000 in cash and accounts receivable and $100,000 in short-term liabilities, leaving it with $100,000 in working capital to cover daily expenses.
Human Capital – The skills, knowledge, and experience of employees that contribute to business success.

Example: A tech company invests $50,000 in employee training programs to improve productivity and innovation.
Physical Capital – Tangible assets like machinery, buildings, and equipment used to produce goods and services.

Example: A manufacturer buys $2 million worth of machinery to increase production capacity.

Question 24

Income Statement

Answer 24

*The Income Statement summarizes a company’s revenue, expenses, and net income (profit or loss) over a specific period, such as a month, quarter, or year.

*It helps investors and analysts evaluate a company’s financial performance, profitability, and operating efficiency.

*Unlike the Balance Sheet, which is a “snapshot” at one moment in time, the Income Statement tells the story of what happened financially over a period

The Structure of the Income Statement (Three main parts):

✅ Revenue (Sales): How much money did the company bring in?
✅ Expenses: What costs did the company have to pay to operate?
✅ Net Income: The final profit or loss after subtracting expenses from revenue.

Question 25

Revenue

Answer 25

How Much the Company Earned Revenue (also called Sales) is the total amount of money a company earns from selling goods or services. It’s recorded when the company delivers products or services, not necessarily when the cash is received. 🛑 Real-Life Example: If a car dealership sells a car for $30,000 today but allows the customer to pay over 12 months, the full $30,000 still counts as revenue today (under accrual accounting), even though the company hasn’t received all the cash yet.

Question 26

Cost of Goods Sold (COGS)

Answer 26

The Direct Costs of Making the Product or Service COGS includes all the costs directly related to producing the goods or services sold. This includes raw materials, labor, and factory costs. It does NOT include things like office rent or marketing costs. 🛑 Real-Life Example: If a bakery sells a loaf of bread for $5, but the flour, eggs, and labor cost $2 per loaf, then the COGS is $2 per loaf. * Formula: Gross Profit = Revenue – COGS

Question 27

Operating Expenses

Answer 27

The Cost of Running the Business Operating Expenses are costs needed to run the business but are NOT directly tied to making the product. These include salaries, rent, utilities, advertising, and office supplies. Operating expenses are split into two categories: - Selling, General & Administrative Expenses (SG&A) – Salaries, rent, office costs, marketing. - Depreciation & Amortization – The gradual reduction in value of assets like machinery and patents. 🛑 Real-Life Example: A restaurant’s rent, utilities, and advertising are operating expenses because they’re needed to run the business but are not part of making the food.

Question 28

Operating Income (Earnings Before Interest & Taxes – EBIT)

Answer 28

Operating Income shows how profitable a company is from its main business operations, before considering interest or taxes. Formula: Operating Income = Gross Profit – Operating Expenses A higher operating income means the company is managing costs well and running efficiently. 🛑 Example: A tech company earns $5 million in gross profit but spends $2 million on rent, salaries, and marketing. Operating Income = $5M - $2M = $3M

Question 29

Net Income

Answer 29

The Final Profit or Loss Net Income (Profit) is the final amount left after all expenses, interest, and taxes are deducted from revenue. If expenses are higher than revenue, the company has a Net Loss. 🛑 Example: If a company has $3 million in operating income, but it pays $500,000 in interest and $400,000 in taxes, then: Net Income = $3M - $500K - $400K = $2.1M This means the company earned $2.1 million in profit after all costs were deducted.

Question 30

Comprehensive Income

Answer 30

What is Comprehensive Income? Comprehensive Income includes Net Income PLUS certain gains or losses that are NOT included in Net Income. Some gains/losses go straight to Equity instead of Net Income. These are called Other Comprehensive Income (OCI). Examples of Other Comprehensive Income (OCI): Foreign currency translation gains/losses – If a U.S. company owns a business in Europe, exchange rate changes could impact value. Unrealized gains/losses on investments – Stocks or bonds owned by the company might increase or decrease in value but haven’t been sold yet. Pension adjustments – Changes in employee retirement fund values. 🛑 Real-Life Example: Imagine a company owns $10 million worth of stocks. If the stock prices rise to $12 million, they have a $2 million unrealized gain. This $2 million is recorded in Other Comprehensive Income, NOT Net Income (because the stocks haven’t been sold yet)

Question 31

Profitability Ratios

Answer 31

Gross Margin = Gross Profit ÷ Revenue → Measures how efficiently the company produces its products. Operating Margin = Operating Income ÷ Revenue → Shows how efficiently the company runs its operations. Net Profit Margin = Net Income ÷ Revenue → Reveals how much of the revenue actually turns into profit. 🛑 Example: If a company has $1 million in revenue and $200,000 in net income, its Net Profit Margin = 20%. This means for every $1 earned, $0.20 is actual profit.

Question 32

Statement of Cash Flows

Answer 32

The Statement of Cash Flows explains why a company's cash balance changed over time by categorizing all cash inflows (money received) and cash outflows (money spent). Unlike the Income Statement, which follows accrual accounting (recording revenue when earned, not when cash is received), the Cash Flow Statement is purely based on actual cash movement. It helps investors and analysts assess a company’s ability to generate cash and meet financial obligations. ________________________________________ Structure of the Cash Flow Statement The Statement of Cash Flows is divided into three sections, each showing different types of cash movements: ✅ Operating Activities – Cash generated from the company’s core business. ✅ Investing Activities – Cash used for buying or selling assets (like equipment or investments). ✅ Financing Activities – Cash from borrowing, repaying debt, or issuing stock. 🛑 Real-Life Example: A grocery store earns $500,000 in sales, but customers mostly pay with credit cards. By the end of the month, the store has only collected $400,000 in actual cash and still owes $100,000 to suppliers. This means its Operating Cash Flow = $400,000 (not $500,000, because some sales are still unpaid).

Question 33

Statement of Stockholders’ Equity

Answer 33

The Statement of Stockholders' Equity explains how a company's equity (ownership value) changes over time due to earnings, stock issuances, buybacks, and dividends. It helps investors understand whether a company is creating value for shareholders or diluting ownership. This statement is important because it connects the Balance Sheet, Income Statement, and Cash Flow Statement.

Question 34

Stockholders’ Equity

Answer 34

Stockholders’ Equity is the portion of a company’s assets that belongs to shareholders after all liabilities (debts) have been paid. It represents the company’s net worth from an investor’s perspective. Stockholders’ Equity is found on the Balance Sheet under the equation: 📌 Formula: Stockholders' Equity = Total Assets – Total Liabilities 🛑 Example: A company has $1 million in assets and $600,000 in liabilities. Stockholders’ Equity = $1,000,000 – $600,000 = $400,000 This means that if the company sold all its assets and paid all its debts, the remaining $400,000 would belong to the shareholders.

Question 35

Common Stock

Answer 35

Shares Issued by the Company Common Stock represents ownership in a company, giving shareholders voting rights and a share of profits When a company issues new shares, it increases Common Stock, which raises equity. 🛑 Example: A company raises $10 million by selling new shares to investors. This increases Common Stock by $10 million on the Statement of Stockholders’ Equity

Question 36

Preferred Stock

Answer 36

Special Class of Ownership Preferred Stock is another type of ownership, but it has different rights than Common Stock. Preferred Stockholders receive fixed dividends before Common Stockholders but usually do not have voting rights. 🛑 Example: A company issues $5 million in Preferred Stock, which guarantees an annual 5% dividend. This means they must pay $250,000 in dividends each year to Preferred Stockholders before paying Common Stockholders.

Question 37

Retained Earnings

Answer 37

Retained Earnings are the portion of Net Income that the company keeps instead of paying out as dividends. If a company earns a profit and does not distribute all of it to shareholders, it adds to Retained Earnings. If a company loses money, Retained Earnings decrease. 📌 Formula: Ending Retained Earnings = Beginning Retained Earnings + Net Income – Dividends 🛑 Example: A company starts with $2 million in Retained Earnings. It earns $500,000 in Net Income and pays $100,000 in Dividends. Ending Retained Earnings = $2M + $500K – $100K = $2.4M This means the company kept $2.4 million of accumulated profit after distributing dividends

Question 38

Additional Paid-In Capital (APIC)

Answer 38

APIC represents the extra amount investors paid for stock beyond the stated value (par value). When companies issue shares at a price higher than their nominal value, the excess amount is recorded as APIC. 🛑 Example: A company issues 1 million shares with a par value of $1 each but sells them at $10 per share. The Common Stock account increases by $1 million (1M shares × $1 par value). The APIC account increases by $9 million (1M shares × $9 excess amount).

Question 39

Spot Rate

Answer 39

The spot rate is the current exchange rate or market price at which a currency, security, or commodity can be immediately bought or sold for settlement. Example: A U.S. company needs to pay a supplier in euros today, and the spot rate is 1 USD = 0.90 EUR, meaning if they exchange $10,000, they receive €9,000 immediately.

Question 40

Differed Income

Answer 40

Deferred income, also known as unearned revenue, is money received in advance for goods or services that have not yet been delivered, and it is recorded as a liability until earned. Example: A gym receives $1,200 for a one-year membership paid upfront. Since the gym has not yet provided the full service, it records the $1,200 as deferred income and gradually recognizes $100 per month as revenue over the next 12 months.

Question 41

Capital Cost

Answer 41

Capital cost is the total expense incurred to acquire, upgrade, or maintain fixed assets such as buildings, machinery, or equipment, which are used for long-term business operations and recorded as assets on the balance sheet rather than expenses on the income statement. Balance Sheet Relation: Since capital costs relate to long-term investments, they appear under Property, Plant, and Equipment (PP&E) or other fixed assets on the balance sheet and are gradually expensed through depreciation or amortization over time. Example: A company buys machinery for $100,000, which is recorded as an asset on the balance sheet under PP&E. Each year, a portion of this cost is recognized as depreciation expense on the income statement, reducing the book value of the asset while matching the cost to the periods benefiting from its use.

Question 42

Matching Principle

Answer 42

The matching principle is an accounting concept that requires expenses to be recorded in the same period as the revenues they help generate, ensuring that financial statements accurately reflect a company’s profitability. Example: A company spends $5,000 on advertising in December to promote a product that will generate sales in January. According to the matching principle, the $5,000 advertising expense should be recognized in January, when the related revenue is earned, rather than in December when the expense was incurred.

Question 43

Amortization

Answer 43

Amortization is the process of gradually expensing the cost of an intangible asset or reducing the balance of a loan over time according to a fixed schedule. Example (Intangible Asset): A company buys a patent for $50,000 with a 10-year useful life and records $5,000 ($50,000 ÷ 10) as amortization expense each year. Example (Loan): A business takes out a $100,000 loan and makes monthly payments, where each payment partly reduces the loan balance (principal) and partly covers interest, gradually paying off the debt.

Question 44

Write-off

Answer 44

A write-off occurs when a company removes an asset or receivable from its books because it is no longer valuable or collectible, typically resulting in an expense. Example: A company has a customer who owes $5,000, but after repeated collection attempts, the customer goes bankrupt. The company writes off the $5,000 as an uncollectible account, recognizing it as a bad debt expense.

Question 45

Adjustment for a Prior-Year Understatement of Amortization Expense

Answer 45

An adjustment for a prior-year understatement of amortization expense occurs when a company discovers it recorded too little amortization in a previous year, requiring correction to accurately reflect financial results. The adjustment for the prior year understatement of amortization expense is a prior period adjustment that will be reflected in beginning retained earnings, not on the income statement. Example: In Year 1, a company recorded $3,000 of amortization for a patent but later realized it should have been $5,000. In Year 2, the company adjusts by increasing amortization expense by $2,000 to correct the previous year’s understatement.

Question 46

Carrying Value

Answer 46

The carrying value is the amount at which an asset or liability is recorded on the company's accounting records, typically representing the original cost minus accumulated depreciation, amortization, or impairment. Example: A machine costing $50,000 with $20,000 of accumulated depreciation has a carrying value of $30,000 ($50,000 – $20,000).

Question 47

Net Realizable Value (NRV)

Answer 47

Net Realizable Value (NRV) is simply the amount of cash you expect to receive from selling something, after subtracting any selling costs. Simple example: Let's say your business has inventory (shirts) that you think you can sell for $1,000 total. But you'll need to pay $100 to advertise and ship them to customers. The Net Realizable Value of your shirts would be: Selling price: $1,000 Minus selling costs (advertising, shipping): $100 Net Realizable Value (NRV) = $900 NRV helps you realistically value what your assets (like inventory) are actually worth to you in cash terms.

Question 48

Fair Value Hedge

Answer 48

A fair value hedge is a strategy used to protect against changes in the fair value of an asset or liability by using a derivative, such as a futures contract or interest rate swap. Example: A company owns $1 million in bonds, but rising interest rates may decrease their value. To hedge this risk, the company enters into an interest rate swap, offsetting potential losses in the bond’s fair value.

Question 48

Marketable securities

Answer 48

Marketable securities are liquid financial assets that can be quickly bought or sold in public markets, such as stocks, bonds, or Treasury bills, and are typically classified as short-term investments. Example: A company invests $100,000 in publicly traded stocks, which can be sold at any time for cash, making them marketable securities that appear under current assets on the balance sheet.

Question 49

Trading Securities

Answer 49

Trading securities are investments in stocks or bonds that a company buys with the intent to sell in the short term for a profit, and they are reported at fair value with unrealized gains or losses recognized in net income. Example: A company buys $50,000 in stocks expecting to sell them soon for a profit. If the stock value increases to $55,000, the $5,000 gain is recorded in net income, even if the stocks are not yet sold.