Glossary of Terms NEL G-1

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1 Glossary of Terms This glossary provides definitions for many terms in financial accounting 1 and refers readers back to those chapter sections in which the terms are discussed. If a good definition or discussion appears in a chapter section, the reference to that section may be provided without repeating the definition. Terms are cross-referenced to other terms where helpful. For additional help in finding things, consult the index at the end of the book. Technical terms used in any definition are themselves defined in their alphabetical location in the glossary. A Accelerated amortization (depreciation) An amortization method, such as declining balance, that records more amortization in the earlier years of an asset s life, and less in later years, than does the straightline method. See Straight-line amortization, Declining balance amortization, and Section Account A summary record of an asset, liability, owners equity, revenue, or expense, in which the effects of transactions, accruals, and adjustments are indicated in dollars (where dollars are the currency of the country). See General journal, General ledger, Transaction, and Sections 2.3, 2.4, and 2.5. Accountant A person who performs accounting functions. Professional accountants are those who are granted designations by self-regulating bodies on the basis of special training and successful examination. For example: CA or Chartered Accountant (Canada, the United Kingdom); CGA or Certified General Accountant (Canada); CMA or Certified Management Accountant (Canada, the United States); and CPA or Certified Public Accountant (the United States). See Section 1.5. Accounting To account is to provide a record, such as of funds paid or received for something. Being accountable is to be responsible for, as in to account for one s actions. These two ideas together describe the practice of accounting as the recordkeeping and reporting of an enterprise s performance and position in monetary terms. Management is responsible for the decisions made in an enterprise. Accounting provides the reports that summarize the economic results of these decisions for inside use and transmits them to outside, interested parties (such as investors, creditors, and regulatory agencies). See Financial accounting, Management accounting, and Section 1.1. Accounting control The practice of creating accounting records that provide expected quantities of important assets and liabilities and so improve the internal control over those assets. Used by most companies for cash, accounts receivable, sales taxes collected on behalf of governments and employee deductions, and by many companies for investments, inventories, property and equipment, and accounts payable. See Internal control and Section 7.9 for various examples of accounting control. Accounting entity The enterprise for which the accounting is being done. The entity may be a single legal corporation or other organization, an economic unit without legal standing (such as a proprietorship), or a group of corporations with connected ownership for which consolidated financial statements are prepared. See Sections 5.2 and 9.7. Accounting policies The chosen accounting methods used by a company to recognize economic events on an accrual basis, and to report the financial position and results of operations. For examples, see the notes immediately following the financial statements of any company. The first such note is usually a summary of significant accounting policies. See Sections 1.1, 5.5, 6.4, 8.4, and 9.2. Accounting policy choice A decision among acceptable accounting policies is often needed because more than one acceptable policy exists in many areas. See Sections 6.4, 8.1, and Accounting principles See Generally accepted accounting principles and Sections 1.1 and 5.1. Accounting research The practice of studying accounting phenomena to determine their effects on other phenomena, such as share prices and the effects of those on accounting. Introduced in Section 1.5 and mentioned frequently throughout the book. Accounting standards The recommending of particular accounting methods or policies by an authoritative body. In Canada this is done by the Accounting Standards Board of the Canadian Institute of Chartered Accountants, in the United States, by the Financial Accounting Standards Board. See Authoritative standards, Accounting policies, Generally accepted accounting principles, and Section 5.1. G-1

2 G-2 GLOSSARY OF TERMS Accounting Standards Board The committee of the Canadian Institute of Chartered Accountants that is responsible for setting financial accounting standards in Canada. See Section 5.4. Accounts payable Liabilities representing amounts owed to short-term trade creditors. (An account payable for the debtor is an account receivable for the creditor.) See Sections 2.3, 2.4, and 9.2. Accounts receivable Amounts owing by debtors (customers), usually arising from sales of goods or services. See Sections 2.3, 3.3, 6.3, 6.4, and 8.6. Accrual accounting The method of making an economically meaningful and comprehensive measurement of performance and position by recognizing economic events regardless of when cash transactions happen, as opposed to the simpler cash basis of accounting. Under this method, revenues and expenses (and related assets and liabilities) are reflected in the accounts in the period to which they relate. See Sections 1.9, 3.1, and 6.2. Accrual basis The use of accrual accounting in preparing financial statements. See Section 3.7. Accrual income The result of subtracting expenses from revenue(s), when both kinds of accounts are calculated by accrual accounting. See Accrual accounting, Net income, and Sections 1.9, 3.3, 3.7, 4.1, 6.2, and 6.3. Accrue To enter amounts in the accounts to reflect events or estimates that are economically meaningful but that do not (at present) involve the exchange of cash. Examples would be recording interest that is building up on a debt prior to paying it or recording revenue from credit sales prior to receipt of cash from customers. See Sections 1.9, 3.1, and 6.2, and Accrual accounting, Revenue recognition, and Matching; see also Deferral. Accrued expense An expense recognized in the accounts prior to paying for it. See Section Accumulated amortization (depreciation) A balance sheet account that accumulates total amortization (depreciation) expense over a number of years. The account balance is a credit and so is opposite to the debit-balance asset cost account. The difference between cost and accumulated amortization is the book value of the asset. See Book value, Contra accounts, Fixed assets, Amortization and Amortization expense, and Sections 2.1, 2.3, and 7.7. Accumulated foreign currency translation adjustment An account arising as a consequence of the method used to convert foreign operations accounting figures into Canadian dollars for the purpose of combining them with the figures for Canadian operations. Because income statement accounts are generally converted at average foreign exchange rates and balance sheet accounts are generally converted at year-end or historical rates, converted accounts do not quite balance. The difference is put into equity as a separate item because it does not seem to fit anywhere else and it is part of the (converted) residual equity of the owners. See Sections 2.9 and 9.4. Acid test ratio Cash, temporary investments, and accounts receivable divided by current liabilities. Also called the quick ratio. See Ratios and Sections 2.3 and 10.4 (Ratio 19), where the ratio is explained. Acquisition There are two related meanings in accounting. The first is just a purchase. Buying a new asset is often described as an acquisition of that asset, or acquiring it. See Acquisition cost and Historical cost. The second meaning applies to a Business combination in which one company buys enough of the voting shares of another company to get voting control and so become the Parent of that company, which becomes the acquiring company s Subsidiary. See Section 9.7. (A Merger is a business combination in which neither company controls the other. Accounting standards now require virtually all business combinations to be accounted for as acquisitions.) Acquisition cost See Historical cost and Section 8.2. Adjusted trial balance The list of accounts prepared after all the accrual accounting adjustments and corrections have been made and so representing the final account balances used in preparing the financial statements. See Trial balance, Adjusting (journal) entry, and Sections 3.8 and 3.9. Adjusting (journal) entry A journal entry to implement accrual accounting by recognizing in the accounts economic events not yet adequately accounted for by the routine transactional accounting system. (For example, if there is no transaction to reveal the gradual wear and tear of a fixed asset, an adjusting entry must be made to recognize this depreciation.) See Sections 3.8 and 3.9. Adjustment(s) See Adjusting (journal) entry and Section 1.7.

3 GLOSSARY OF TERMS G-3 Adverse opinion A type of Auditor s opinion in which the opinion is that the financial statements are not fairly presented. See Section 5.8. Agent A person who is party to a contract between that person and another, called the principal. The agent s role is to carry out the wishes of the principal as specified in the contract. Some examples of agents are managers, auditors, lawyers, and physicians, who are entrusted with acting on behalf of one or more others (the principals, such as owners, creditors, defendants, and patients). Agents have a stewardship responsibility to the principal. See Contract, Principal, Stewardship, and Section Aggressive accounting Seeking out accounting methods and policy choices to meet management objectives for growth, financing, bonuses, or other purposes that seem to violate principles such as fairness and conservatism. See Section 6.4. Aging of accounts receivable The process of classifying accounts receivable by the time that has passed since the account came into existence. This classification is used as an aid to estimating the required allowance for doubtful accounts for the estimated amount of uncollectible accounts receivable. See Section 8.6. Allocating, allocation Spreading the impact of an event out over time, as in amortization of an asset s cost over its useful life or recognition of revenue for a long-term contract over several periods. See Amortization and Sections 6.5 and See also Interperiod tax allocation and Section 9.3, and Intraperiod tax allocation and Section 3.5. (Allocation is also used, especially in management accounting, to refer to spreading the impact of an event across activities, such as in allocating the cost of repairs to different departments.) Allowance for doubtful accounts The estimated amount of accounts receivable that will not be collected (which are doubtful ). The allowance, which is a contra account to accounts receivable, is used in order to recognize the bad debts expense related to such doubtful accounts but without removing those accounts from the books because the firm will still try to collect the amounts owing. See Section 7.7. American Institute of Certified Public Accountants (AICPA) The national self-regulating body in the United States that sets and monitors the auditing and professional standards by which CPAs practise. Amortization Allocation of the cost of a noncurrent asset to expense over several accounting periods to recognize the consumption of the asset s economic value as it helps to earn revenue over those periods. Amortization expense for a period thus is deducted from revenue in that period, recognizing it as a cost of earning the revenue. The term amortization, and especially the common term depreciation, is used for the allocation of the cost of tangible assets over time; amortization is also used for the allocation of the cost of intangible assets such as patents, franchise rights, and goodwill. See Accumulated amortization, Intangible assets, and Sections 1.10, 7.7, 8.10, and Amortization expense The expense recorded to recognize asset amortization. See Amortization, Accumulated amortization, and Sections 7.7 and Amortize To allocate the cost of noncurrent assets (and sometimes liabilities) to expense over several accounting periods. See Amortization, Allocating, and Sections 8.10 and Analysis, analyze The technique, common in accounting, of comparing information derived from different sources or methods in order to understand what has happened, identify errors, and answer questions about the effects of possible actions or events. See Reconciliation and What if (effects) analysis. Also used to refer to the detailed study of accounting information, such as by using Ratios. See Sections 1.12 and Annual report The document provided annually to the shareholders by the officers of a company. It includes the financial statements, the notes to the financial statements, the auditor s report, supplementary financial information such as multi-year summaries, and reports from the company s board of directors and management. See Sections 1.1, 1.3, and 5.6. Articulate, Articulation Of the income statement, retained earnings statement, and balance sheet; refers to the fact that because these three statements are prepared from one set of balanced accounts, changes in any one of the three normally affect the others. In particular, recognition of revenue and expense relies on the fact that a revenue causes a change in the balance sheet, as does an expense. See Recognition, Revenue recognition, and Sections 3.3, 3.6, 6.3, 6.4, and 8.2. Asset(s) An asset is a resource available to do business in the future, represented by an ownership of or right to expected future economic benefits. Assets have value

4 G-4 GLOSSARY OF TERMS because they are expected to bring benefits as they are used or sold. See Sections 1.1, 2.3, and 8.2, and Cash equivalent assets, Inventory, Accounts receivable, Current assets, Fixed assets, and Intangible assets. Asset valuation Determination of the amounts to be used for assets on the balance sheet. See Balance sheet valuation and Section 8.2. Assumed cost flow The practice in inventory accounting of determining the cost of inventories purchased at varying unit costs by assuming a specific order in which the inventory will be taken to have flowed into and out of the company. See Cost flow assumption and Section 8.7. Assurance A broader word than audit, encompassing auditing and similar procedures to confirm or verify reports or events as fair and proper and assure users of such reports that they may be relied upon. See Audit, Auditor s report, and Fairness and Section 5.8. AT The total assets turnover ratio, defined and explained in Section 10.4, Ratio 12. Used in the Scott formula in Section Audit The examination of accounting records and their supporting documentation with the objective of determining the fairness with which the financial statements present the financial position and performance of the company. See Auditor, Auditor s report, and Section 5.8. Audit committee A committee of a corporation s Board of directors, usually composed largely or entirely of directors not also having management positions, which reviews the company s accounting statements and communicates directly with the External auditor. See Sections 5.9 and 7.3. Auditor The person or firm who performs an audit for the purpose of preparing a report on the credibility of the financial statements, also called the External auditor. See Sections 1.4, 1.5, and 5.8. Compare Internal auditor. Auditor s opinion The portion of the auditor s report in which the auditor expresses a professional opinion that the financial statements are, or are not, fairly presented. Auditor s report (or auditors report) The document accompanying the financial statements that expresses the auditor s opinion on the fairness of the financial statements. The auditor s report explains what the auditor did and states the Auditor s opinion. See Section 5.8. Authoritative standards Written rules and guidance established by official accounting standard-setters such as the CICA in Canada and the FASB in the United States. See CICA Handbook and Sections 5.1, 5.4, and 6.4. Available cost The total dollar amount represented by the sum of beginning inventory and purchases during the period, and thus representing the total dollar cost of inventory available for sale or use during the period. See Sections 8.7 and 8.8. Average cost (AVGE) An inventory cost-flow assumption where the cost of an individual unit of inventory is the weighted average cost of the beginning inventory and subsequent purchases. See Weighted average and Section 8.7. Average interest rate An average calculated by dividing interest expense by total liabilities. Defined and explained in Section 10.4 (Ratio 6). An after-tax version of this is used in the Scott formula in Section 10.6 (see IN(ATI)). AVGE See Average cost and Weighted average. B Bad debts expense An expense account that results from the reduction in carrying value of those accounts receivable that have been projected to be uncollectible or doubtful. See Allowance for doubtful accounts and Section 7.7. Balance (an account total) The net sum of the amounts added to and subtracted from an account since the account began. In financial accounting s double-entry system, the balance is expressed as a net debit (DR) or net credit (CR). See Account, Double-entry accounting, and Sections 2.4 and 2.5. Balance (in the balance sheet or the trial balance) Refers to the double-entry accounting requirement that the sum of the accounts with debit balances and the sum of those with credit balances be equal. In the balance sheet, this means that the sum of the assets equals the sum of the liabilities and equity. See Balance sheet, Balance sheet equation, Trial balance, and Sections 2.3, 2.7, and 3.9.

5 GLOSSARY OF TERMS G-5 Balance sheet The balanced list of assets, liabilities, and owners equity constituting the formal statement of a company s financial position at a specified date, summarizing by category the assets, liabilities, and owners equity. See Balance, Balance sheet equation, Balance sheet valuation, Statement of financial position, and Sections 2.2, 2.7, and Balance sheet equation The double-entry arithmetic by which Assets = Liabilities + Owners Equity. See Sections 2.3, 2.4, 8.2, and 8.7. Balance sheet valuation Assigning numerical values to the balance sheet s assets, liabilities, and owners equity accounts. See Section 8.2. Bank overdraft A negative bank account balance (withdrawals exceeding deposits), which banks may allow as a de facto loan as long as it is temporary. See Line of credit and Sections 2.7 and 4.3. Bank reconciliation An analysis conducted to determine if the bank account balance according to the accounting records corresponds with the balance as reported by the bank. The two balances seldom agree exactly, so the reconciliation is designed to set out the reasons for any disagreement. See Analysis and Sections 1.12 and 7.5. Bankruptcy The usually involuntary termination of an enterprise due to its inability to pay its debts and continue in operation. Bankruptcy usually involves significant losses to both creditors and owners. See Going concern. Betterment An expenditure to improve an asset s value to the business, more than just repairs and maintenance. See Section 8.4. Big Bath A way of manipulating reported income to show even poorer results in a poor year in order to enhance later years results. See Sections 3.10 and 6.4. Board of directors The senior level of management, representing and directly responsible to the owners (shareholders). Normally elected annually by the shareholders, the board is responsible for hiring and supervising the operating management (president, chief executive officer, etc.). See Sections 2.3, 3.3, and 5.3. Bond, bonded debt A certificate of debt issued by an enterprise in return for cash, in which a promise is made to repay the debt (usually at a particular date or on a specified schedule) plus interest. Many bonds may be sold to other people by those who received them in return for the original cash provided to the enterprise. See Sections 2.7 and 9.3. Bond markets Capital markets in which debt instruments (bonds and similar items), rather than shares, are traded. See Capital markets. Bookkeeping The process of recording, classifying, and summarizing transactions in the books of account. See Sections 1.7, 2.2, and 2.4. Books Colloquial term for the accounting records, including computerized records, left over from the time when the records were written in bound books. See Sections 1.7 and 7.2. Books of original entry The journals in which transactions are first recorded. See Section 7.2. Book value The amount shown in the accounts for any individual asset, liability, or owners equity item after deducting any related contra account (for example, the book value of a truck is the recorded cost minus accumulated amortization). The term is also commonly used for the whole enterprise, to refer to the net amount of total assets less total liabilities (the recorded value of the owners residual interest, which equals total equity: Assets = Liabilities + Equity). See Sections 7.7 and 8.11 for the book value of individual assets and Sections 2.3, 9.4, and 9.7 for the book value of the whole enterprise. See also Book value per share. Book value per share Total shareholders equity divided by the number of shares issued. It is defined and explained in Section 10.4, Ratio 9. Bottom line A colloquialism referring to the net income (the bottom line on the income statement). See Net income. Business combination A merger of separate corporations or an acquisition of control of one corporation by another, in which the corporations become a single economic entity. See Accounting entity, Consolidation, and Section 9.7. C CA Chartered accountant. See Canadian Institute of Chartered Accountants. See Sections 5.8 and 5.9.

6 G-6 GLOSSARY OF TERMS Callable debt Debt, such as bonds, that might have to be repaid ahead of schedule at the option of the creditor. Most bank loans are callable, in that the bank can ask for repayment within a few days even if the original repayment plan extended over a longer period. See Section 9.2. Canada Business Corporations Act (CBCA) The federal corporations act that provides the authority for the incorporation of federally incorporated companies in Canada and generally sets the requirements for their activities. It requires any such company to prepare annual financial statements. Canadian Certified General Accountants Association (CGA-Canada) An association whose members (CGAs) have had training in accounting, taxation, auditing, and other areas of business and have passed qualifying exams. CGA-Canada and provincial associations of CGAs set and monitor standards by which CGAs practise. CGA-Canada is one of the three national professional accounting bodies. See Accountant and Sections 1.5, 5.8, and 5.9. Canadian Institute of Chartered Accountants (CICA) A national, self-regulating association of chartered accountants in which the accountants have met education and examination standards in Canada. The CICA and provincial institutes of CAs set and monitor the standards by which CAs practise. One of the three national professional accounting bodies. See Accountant and Sections 1.5, 5.8, and 5.9. Capital The owner s contribution to or interest in a business (the equity). Often used specifically to refer to the equity of unincorporated businesses (proprietorships and partnerships). See Equity and Sections 2.9 and 9.4. Capital cost allowance The Canadian Income Tax Act s version of amortization (depreciation), used in calculating taxable income for assessment of income tax. See Section 9.3. Capitalization, capitalize The recognition of an expenditure that may benefit a future period as an asset rather than as an expense of the period of its occurrence. Expenditures are capitalized if they are likely to lead to future benefits, and, thus, meet the criterion to be an asset. See Sections 3.8 and 8.4. Capitalized costs Costs that have been included with an asset on the balance sheet instead of being deducted as expenses on the income statement. See Sections 7.7, 8.4, and Capital lease A lease having the economic character of asset ownership. See Sections 8.14 and 9.3. Capital markets Markets in which financial instruments such as shares and bonds are traded. See Sections 3.2 and 5.10, Financial instruments, and Stock exchange. Cash Currency and coin on hand, balances in bank accounts, and other highly liquid assets. See Cash and equivalents and Sections 4.3, 7.5, and 8.5. Cash and equivalents Cash and near-cash assets minus near-cash liabilities: cash equivalent assets minus cash equivalent liabilities. Changes in cash and equivalents are explained by the cash flow statement (SCFP). See Cash flow statement, Cash, and Sections 4.3 and 8.5. Cash disbursements Cash payouts, by cheque, currency, or direct deductions from the bank account. See Cash payments, Cash disbursements journal, Cash receipts, Cash income, and Section 4.4. Cash disbursements journal The record of cheques and other cash payments made. See Books of original entry and Section 7.2. Cash equivalent assets A term used to describe cash plus very liquid bank deposits and similar assets that can be converted into cash on demand. See Sections 4.3 and 8.5. Cash equivalent liabilities Liabilities that are payable on demand and so represent a reduction in the liquidity otherwise apparent from the amount of cash. Under current accounting standards, temporary bank overdrafts are the only common cash equivalent liabilities. See Bank overdraft and Section 4.3. Cash flow The inflows of cash (cash receipts) and outflows of cash (cash disbursements) over a period. Information about cash flow is presented in the Cash flow statement. See also Sections 4.2 and 4.3. Cash flow analysis A method of accounting Analysis directed at understanding the enterprise s cash inflows, outflows, and resulting balances. This analysis lies behind the Cash flow statement. See Section 4.2. Cash flow statement A statement that explains the changes in cash (and equivalent) balances during a fiscal period. Also referred to as Statement of changes in financial position (SCFP), Funds statement, or Statement of cash flows. See Direct method of cash flow analysis, Indirect

7 GLOSSARY OF TERMS G-7 method of cash flow analysis, and Sections 1.1, 4.2, 4.3, and Cash flow to total assets The ratio of cash from operations divided by total assets. It is defined and explained in Section 10.4, Ratio 7. See Cash from operations. Cash from operations Cash generated by day-to-day business activities and highlighted as the first section in the Cash flow statement. See Sections 4.2, 4.3, 4.9, and Cash income Cash receipts minus cash disbursements, or that subset of both that relates to day-to-day operations. The operating subset is roughly equivalent to the Cash flow statement s Cash from operations figure. See Cash receipts, Cash disbursements, Direct method of cash flow analysis, and Sections 1.10 and 4.4. Cash payments Payments by currency, cheque, or other bank withdrawal. See Cash transaction, Cash disbursements journal, and Section 4.4. Cash receipts Cash inflows, by currency, others cheques, or direct bank deposits. See Cash transaction, Cash receipts journal, and Section 4.4. Cash receipts journal The record of customers cheques and other cash received. See Books of original entry and Section 7.2. Cash received basis Recognition of revenue only when the cash comes in. See Revenue recognition, Conservatism, and Section 6.7. Cash transaction The simplest kind of economic exchange routinely recorded by financial accounting, and an important starting point for the financial statements. See Sections 1.7 and 4.4. CCA See Capital cost allowance. CGA Certified general accountant. See Canadian Certified General Accountants Association (CGA-Canada) and Sections 5.8 and 5.9. Change effects analysis Analysis of the effects on financial statements of economic or accounting policy changes. See Sections 1.12 and 10.8 and What if (effects) analysis. Change in cash Demonstrating why cash changed as it did is the objective of the Cash flow statement s analysis. Cash income is part of this change. See Sections 1.10 and Chart of accounts An organized list of the accounts used in the accounting system. This can be contrasted with the trial balance, which displays all the accounts and their debit or credit balances. See Section 7.2. Cheque A request by one party that the party s bank pay a specified amount to another party. See Section 7.2. CICA Handbook The authoritative source of financial accounting standards in Canada. See Section 5.4. Classification Choice of where in the financial statements to place an account, such as whether an investment asset should be shown as a current asset or a noncurrent asset. See Sections 2.7, 3.5, and 3.8. Classification policies Accounting policies covering where within a financial statement an account or description is to appear. See Sections 2.7, 3.5, 3.8, and 6.4 and Accounting policies. Classified financial statements Financial statement with accounts organized under headings that clarify the accounts meaning, done to increase the information value of the statements. See Sections 2.3, 2.7, 3.5, and 4.3. Clean opinion An external auditor s report which states the auditor s opinion that the financial statements are fairly presented. This is the kind of auditor s report that most companies receive because it indicates the auditor found no problems. See Auditor s report, Qualified opinion, and Section 5.8. Close, closing Transfer(ring) the temporary accounts (revenues, expenses, and dividends declared) to retained earnings at the end of the fiscal period. See Closing entry and Sections 3.6 and 3.7. Closing entry or entries Journal entries recorded at year-end to transfer the balances in temporary accounts (revenues, expenses, and dividends) to the balance sheet account retained earnings and set those balances to zero in preparation for entering the next year s transactions. See Sections

8 G-8 GLOSSARY OF TERMS CMA Certified management accountant. See Society of Management Accountants of Canada and Sections 5.8 and 5.9. COGS See Cost of goods sold and Sections 7.9 and 8.7. COGS expense See Cost of goods sold expense and Sections 7.9 and 8.7. Collection ratio The ratio of accounts receivable to the daily sales, expressed in number of days sales represented by accounts receivable. Also called Days sales in receivables. It is defined and explained in Section 10.4, Ratio 14. Common shares The basic voting ownership interests in a corporation. See Corporation and Sections 2.9 and 9.4. Common size financial statements A technique of analyzing financial statements in which income statement figures are expressed in percentages of revenue and balance sheet accounts are expressed in percentages of total asset. It is defined and explained in Section 10.4, Ratio 4. Company See Corporation. Comparability Information that enables users to identify similarities in and differences between two sets of economic phenomena, such as two different years of a company s financial statements. Comparability between companies and consistency of one company over time are major objectives of financial accounting. See Fairness, Consistency, and Sections 5.2, 5.3, and 6.4. Compilation A service performed by accountants practising public accounting, whereby they prepare financial statements for enterprises without taking responsibility for the quality of the accounting information used to prepare them and without auditing them. See Section 5.8. Completed contract A method of revenue recognition for long-term contracts in which the revenue is not reported on the income statement until the contract has been completed. See Revenue recognition, Conservatism, and Section 6.7. Compound, compounded, compounding These refer to the frequency with which interest calculated on a loan or other debt is periodically added to the principal and so attracts future interest itself. Annual compounding, for example, means that interest built up on a loan starts to bear interest itself on each annual anniversary of the loan. See Present value and Section Conditional sale contract A form of borrowing whereby the title to an asset purchased on credit does not pass to the buyer until all the payments, usually plus interest, are made. See Section 9.3. Conservatism, conservative A prudent reaction to uncertainty to ensure that risks inherent in business situations are adequately considered often phrased as anticipate possible losses but not possible gains. In situations where the accountant cannot decide on the superiority of one of two accounting treatments on the basis of accounting principles alone, being conservative means choosing the treatment that has the least favourable impact on the income of the current period. See Historical cost, Cash received basis, Completed contract method, and Lower of cost or market for examples of conservatism, and see also Sections 5.2, 5.3, 6.4, 6.7, and 8.2. Consistency Treatment of like transactions in the same way in consecutive periods so that financial statements will be comparable. The reporting policy implying that procedures, once adopted, should be followed from period to period by a company. See Accounting policies and Sections 5.2, 5.3, and 6.4. Consolidated financial statements, consolidation Consolidation is a method of preparing financial statements for a group of corporations linked by ownership as if they were a single corporation. Consolidated financial statements recognize that the separate legal entities are components of one economic unit. They are distinguishable from the separate parent and subsidiary corporations statements, and from combined statements of affiliated corporations. See Pooling of interests method, Purchase method, and Sections 1.1, 2.9, 9.6, and 9.7. Consolidated goodwill A form of Goodwill arising only when companies financial statements are combined in Purchase method consolidation. See Sections 2.9 and 9.7. Contingency, contingent asset, contingent liability An economic event (especially a negative one) that is in the process of occurring and so is not yet resolved. Contingencies would include but are not limited to pending or threatened litigation, threat of expropriation of assets, guarantees of the indebtedness of others, and

9 GLOSSARY OF TERMS G-9 possible liabilities arising from discounted bills of exchange or promissory notes. See Conservatism and Section 9.3. Contra accounts Accounts established to accumulate certain deductions from an asset, liability, or owners equity item. See Book value, Amortization, Depreciation, Allowance for doubtful accounts, and Sections 7.7 and 9.3. Contract A contract is an oral or written agreement between or among parties, setting out each party s responsibilities and specifying actions agreed to and resulting payments or other settlements. See Agent and Principal regarding one type of contract important in accounting, and Section Contributed surplus The difference between the legal Par value (or Stated value) of a share and the cash or other consideration received by the company when the share was issued. Also referred to with terms like capital in excess of par value. Does not apply to No-par shares, which are the usual kind in Canada. See Sections 2.9, 2.10, and 9.4. Control account An account used to contain the aggregate amounts of many detailed transactions and so help to prevent or detect errors in the detailed records. The accounts receivable control account, for example, should have the same total as the sum of all the individual customers accounts receivable. Control accounts with detailed backup include cash, accounts receivable, inventory, accumulated amortization, accounts payable, sales tax due, employee deductions due, and share capital. See Internal control, Accounting control, and Sections 7.2, 7.6, and 7.7. Convertible A bond or share that can be changed into another kind of Security, usually a Preferred share that can be converted into a Common share. See Section 9.5. Corporate governance The arrangements by which the board of directors and top management operate the corporation on behalf of its shareholders. See Section 7.3. Corporate group A group of corporations linked by common or mutual ownership. See Consolidation and Sections 2.8, 9.6, and 9.7. Corporation A legal entity with or without share capital, legally separate from those who own it or work as a part of it. It enjoys most of the rights and responsibilities of a person except for those that only an actual person can enjoy. Its main feature is limited liability; in other words, only the assets of the company can be claimed by creditors, not the assets of owners. See Partnership, Proprietorship, and Sections 1.4, 2.9, 3.2, and 9.4. Cost The value of an asset when it is acquired by the business. See Historical cost and Sections 1.7, 8.2, and 8.4. Cost allocation Spreading the cost of an asset out over the periods in which it is useful. See Allocating, Amortization, and Sections 8.8 and 8.9. (Cost allocation is also used in managerial accounting to refer to spreading the cost of an activity out across various products or services affected by that activity.) Cost basis Usually used to account for a noncurrent intercorporate investment when a corporation owns less than 20% of another corporation. The investment is carried at cost, and any receipt of dividends or interest is recorded as other income. See Equity basis, Intercorporate investments, and Section 9.6. Cost-benefit The idea of comparing the benefits of a particular action with its costs, and taking action only if the benefits exceed the costs. See Sections 1.5 and 5.2. Cost flow assumption An assumption made about the order in which units of inventory move into and out of an enterprise, used to compute inventory asset value and cost of goods sold expense in cases where the order of flow is not or cannot be identified. Possible assumptions include FIFO, LIFO, and weighted average. See Cost of goods sold, FIFO, AVGE, Weighted average, and LIFO for specific examples. See also Section 8.7. Cost of capital The cost of raising debt or equity funds (e.g., the cost of borrowed funds is mostly the interest to be paid to the lender). See Section Cost of goods sold (COGS) expense An expense account that reflects the cost of goods that generated the revenue (also called cost of sales). The method of calculating COGS depends on the method of inventory costing. See Cost flow assumption, Inventory costing, and Sections 3.3, 3.4, 7.9, and 8.7. Cost principle The use of the historical cost of assets to value them on the balance sheet. See Historical cost, Balance sheet valuation, and Sections 5.2 and 8.2. CPA Certified public accountant (a designation used especially in the United States). See American Institute of Certified Public Accountants and Sections 5.8 and 5.9.

10 G-10 GLOSSARY OF TERMS Credit (CR or Cr) The right-hand side of double-entry accounting. The term credit can be used as a noun to refer to the righthand side of a journal entry or account, or as a verb referring to the action of making an entry to the righthand side of an account. Most accounts on the righthand side of the balance sheets have credit balances (in other words, the credits to them exceed the debits to them). The term credit also refers to the right to buy or borrow on the promise of future payment. A credit journal entry to the liabilities and equity side of the balance sheet causes an increase in the account, while a credit to the assets side of the balance sheet causes a decrease. See Double-entry accounting, Debit, and Sections Creditor One who extends credit (that is, gives someone the right to buy or borrow now in consideration of a promise to pay at a later date). See Sections 1.5 and 2.3. Credit transaction An economic exchange in which at least one party makes a promise to pay cash or other consideration later. This kind of transaction is recognized by most financial accounting systems, especially if it is a routine way of doing business. See Accounts receivable, Accounts payable, and Section 1.7. Critical event A point in the revenue generation and collection process chosen to represent the earning of the revenue, and so the point at which the revenue is recognized in the accounts. This is a simplification: a common critical event is the point at which the customer takes delivery of the goods sold. Not all revenue is accounted for this way: some is allocated over more than one point in the process: long-term construction projects and franchise revenue are examples where the critical event simplification is generally not used. See Revenue recognition and Section 6.6. Current assets Cash and other assets such as temporary investments, inventory, receivables, and current prepayments that are realizable or will be consumed within the normal operating cycle of an enterprise (usually one year). See such current asset categories as Cash equivalent assets, Inventory, and Accounts receivable. See also Sections 2.3, 2.10, 2.11, and 8.2. Current liabilities Debts or estimated claims on the resources of a firm that are expected to be paid within the normal operating cycle of an enterprise (usually one year). See Cash equivalent liabilities, Accounts payable, and Sections 2.3, 2.10, and 9.2. Current or market value The estimated sale value of an asset, settlement value of a debt, or trading value of an equity share. See Sections 8.2, 8.5, and 8.9. Current portion of income tax expense The part of the year s income tax expense that has been paid or is due to be paid within the next year. The rest of the income tax expense is the Future portion of income tax expense. See Section 9.3. Current ratio Also called Working capital ratio, equalling current assets divided by current liabilities. It is defined and explained in Section 10.4, Ratio 18. See also Section 2.3. Current value accounting A proposed accounting method that would use current or market values to value assets and liabilities and to calculate income. See Sections 2.9 and 8.2. Cut off The end of a fiscal period and the procedures used to ensure accuracy in measuring phenomena up to that date. See Section 6.5. D Days sales in receivables The ratio of accounts receivable to the daily sales, expressed in number of days sales represented by accounts receivable. Also called Collection ratio. Defined and explained in Section 10.4, Ratio 14. DCF See Discounted cash flows, another phrase for present value analysis of future cash flows. See Present value and Section Debenture A form of Security taken by a creditor on a loan or bond, in which the creditor has a general ability to influence or direct management decisions if the debt payments are not made on schedule; not a claim on a specific asset as a Mortgage has. See Sections 2.7 and 9.3. Debit (DR or Dr) The left-hand side of double-entry accounting. The term debit can be used as a noun to refer to the left-hand side of a journal entry or account or as a verb referring to the action of making an entry on the left-hand side of an account. Most accounts (except contra accounts) on the left-hand side of the balance sheet have debit balances, which means the debits to them exceed the credits to them. A debit will increase the amounts on the asset side of the balance sheet, but decrease the amounts on the liabilities and equity side. See Double-entry accounting, Credit, and Sections

11 GLOSSARY OF TERMS G-11 Debt An obligation to make a future payment in return for a benefit already received. See Sections 2.3, 9.2, and 9.3. Debt-equity ratio Total liabilities divided by total equity. It is defined and explained in Section 10.4, Ratio 15. See also Section 2.3, and used in the Scott formula in Section Debt to assets ratio Total liabilities divided by total assets. It is defined and explained in Section 10.4, Ratio 17. Decelerated amortization The opposite of accelerated amortization or depreciation. Not acceptable for most enterprises. See Accelerated amortization and Section Decision relevance An accounting objective: information should be available to the user at a time and in a form that is useful to the user s decision making. See Relevance and Sections 5.2, 5.3, and 6.6. Declining balance amortization An accelerated amortization (depreciation) method in which the annual amortization (depreciation) expense is calculated as a fixed percentage of the book value of the asset, which declines over time as amortization is deducted. See Accelerated amortization, Amortization, and Section Deferral Part of accrual accounting but often used as the opposite to an accrual. A deferral involves keeping a past cash receipt or payment on the balance sheet in other words, putting it on the income statement as revenue or expense at a later time. An example is recognizing a deferred revenue liability resulting from a recent cash receipt, such as for a magazine subscription to be delivered later. (In contrast, accruals involve recording a revenue or expense before the cash receipt or payment occurs.) See Sections 6.2 and 6.3. Deferral method A way of accounting for future income tax expenses incurred by present activities, now largely replaced by future income tax liability estimates. See Deferred income tax. Deferred charge A noncurrent Prepaid expense, in which the costs of issuing bonds, incorporation costs, or other expenditures benefiting several future periods are shown as noncurrent assets and usually amortized to expense over several periods or otherwise charged to expenses in some future period. See Sections 2.10 and Deferred income tax (expense and liability) An expense account and corresponding liability intended to recognize the future tax consequences of income reported on the current income statement but not to be reported on the tax return until a future period. Now largely replaced by future income tax liability estimates. See Future income tax and Section 9.3. Deferred revenue A liability account used for customer deposits or other cash receipts prior to the completion of the sale (for example, before delivery). See Section 9.3. Deficit Negative retained earnings, and sometimes also used to refer to negative earnings. See Retained earnings, Net loss, and Sections 2.3 and 3.3. Delivery The most common basis of recognizing revenue. Revenue is said to be earned when the product or service has been delivered to the customer. See Revenue recognition and Sections 6.6 and 6.7. Demand loans Loans that are repayable whenever the creditor wants. These are a form of Callable debt. See Section 9.2. Denial of opinion A form of Auditor s opinion in which the auditor reports that no opinion may be given about the financial statements fairness. See Section 5.8. Depletion An amortization (depreciation) method used for physically wasting assets such as natural resources. See Section Depreciation The recognition of the expense due to use of the economic value of fixed tangible assets (for example, trucks, building, or plant). Usage, at least in Canada, appears to be changing to replace the term depreciation with the more general term amortization. See Amortization, Declining balance amortization, Straightline amortization, Book value, and Accumulated amortization (depreciation). See also Sections 1.10, 7.7, 8.10, and Diminishing balance Another name for Declining balance amortization. See Section Direct method of cash flow analysis A method of preparing the Cash flow statement, especially the Cash from operations section, using records of cash receipts and disbursements instead of the adjustments to net income used in the more traditional Indirect method of cash flow analysis. See Sections 4.3 and 4.4.

12 G-12 GLOSSARY OF TERMS Direct write-off Transferring the cost of an asset to an expense or Loss account by removing the amount entirely from the asset account. Used in cases where there is no prior allowance for the expense or loss, so used when there is no Contra account such as Accumulated amortization or Allowance for doubtful accounts. See Section 7.7. Disbursements See Cash disbursements and Section 4.3. Disclosure Provision of information about economic events beyond that included in the financial statement figures. Usually given in the notes to the financial statements, but also provided outside the financial statements in press releases, speeches, and other announcements. See Notes to the financial statements, Management of corporate financial disclosure, and Sections 1.10, 4.7, 5.2, 5.3, and 6.4. Discontinued operations Portions of the business that the enterprise has decided not to keep going and/or to sell to others. It is good practice to separate the effects of discontinued operations from continuing operations when measuring income and cash flow. See Section 3.5. Discount (on bonds) Arises when bonds are issued at a price below their legal face value, such as a $100 bond being issued for $95 cash, indicating a $5 discount. See Section 9.3. Discounted cash flows Present value analysis of future cash flows by removing their presumed interest components. See Present value and Section Discretionary expenses Expenses that depend on management s discretion rather than on the necessities of producing, selling, or shipping goods and services. Examples might be donations, political contributions, some maintenance and warranty costs, and bonuses not specifically called for in employment contracts. See Section 6.6. DIT See Deferred income tax. Dividend payout ratio The ratio of dividends declared to net income. It is defined and explained in Section 10.4, Ratio 11. Dividends Distributions of a portion of net income to shareholders in the company. Since this type of payment does not relate to the operating performance of the company, it is placed on the statement of retained earnings and not the income statement. See Statement of retained earnings, Stock dividend, and Sections 2.3, 3.3, 3.4, and 9.4. Double declining balance See Declining balance amortization, Accelerated amortization, Amortization and Section Double-entry accounting The practice of recording two aspects of each transaction or event: the resource effect and the source or story of that effect. Though much expanded since its invention several hundred years ago, it is still the basis of bookkeeping and financial accounting. See Sections 2.2 and 2.3. Double-entry bookkeeping See Double-entry accounting. E Earnings A common synonym for net income. See Net income and Sections 2.3 and 3.3. Earnings management Choosing accounting methods and/or making business deals with the specific objective of altering the size, trend, or interpretation of the company s earnings (net income). Usually frowned on as a form of Manipulation of accounting information. See Sections 3.10, 6.5, and 9.5. Earnings per share (EPS) The ratio of net income to the average number of common (voting) shares outstanding, used to allow the owner of the shares to relate the corporation s earning power to the size of his or her investment. The calculation of EPS can be quite complex, so most public companies calculate it for the users (as required by generally accepted accounting principles for such corporations) and report it on their income statements. See Ratios, Section 3.4, and Section 10.4, Ratio 8, where EPS is defined and explained. Earnings-price ratio The inverse of the Price-earnings ratio. Earnings per share divided by the market price of one share of a corporation. See PE ratio, Ratios, and Section 10.4, Ratio 10, where the ratio is defined and explained. EBITDA Earnings before interest, tax, depreciation and amortization. A more positive measure of net income for a company because it includes all revenues but not all expenses. See Section 3.10.