accounts receivable: dollar amount due from customers from sales made on open account.

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1 GLOSSARY 1 above-the-line: income items related to core operations. Typically assumed to have high predictive power for future earnings. accrual accounting: system of accounting that purports to measure income in the period it is earned rather than the period in which cash transactions occur. Revenues that are recognized prior to the receipt of cash give rise to a balance sheet asset called accounts receivable. Expenses that are recognized prior to the disbursement of cash give rise to balance sheet liabilities (for example, wages, interest, or taxes payable). Cash receipts that precede revenue recognition give rise to a balance sheet liability called deferred income. Cash disbursements that precede expense recognition give rise to balance sheet assets (prepaid rent, prepaid insurance, etc.) Revenue recognition and the matching principle are important components of accrual accounting. accounts payable: dollar amounts owed to others for goods, supplies, and services purchased on open account (usually related to the purchase of inventory, but not exclusively) accounts receivable: dollar amount due from customers from sales made on open account. activity based costing: method of assigning overhead costs to products or services characterized by the use of multiple cost drivers (activities). additional paid in capital: an owners equity account representing capital contributed by shareholders in stock issuances. allocation rate: the rate at which costs in an indirect cost pool are allocated to individual cost objects. Expressed as a dollar of overhead per unit of cost driver (activity). Also called burden rate. amortization: the process of allocating the cost of a long-lived intangible asset to its useful life for the purposes of measuring periodic income. Very similar conceptually to depreciation. asset (economic): resource a corporation owns or controls with the expectation that it will provide future benefit. asset (accounting): economic asset whose benefits can be measured with a reasonable degree of precision, allowing recognition on the balance sheet. asset impairment: the reduction in the balance sheet amount of an asset that occurs when the value of the asset is judged to be permanently below the book value. Similar to writedown or writeoff, depending on size. asset recognition: rules governing the recognition of an asset. In the US, it must 1) be the result of a past transaction and 2) have a benefit that is reasonably precisely measurable. avoidable fixed cost: a fixed cost that can be avoided if the firm discontinues an activity. balance sheet: a financial statement that summarizes a company's assets, liabilities and shareholders' equity at a specific point in time. 1 References include Pratt, Financial Accounting in an Economic Context, 6 th edition, and Maher, Stickney and Weil, Managerial Accounting, 9 th Edition.

2 below-the-line: income items related to peripheral or support activities. Typically assumed to have low predictive power for future earnings. book rate of return: total cash inflows from an investment divided by the initial investment. It is considered to be an inferior capital budgeting rule because it ignores the time value of money. book value: total assets less total liabilities. bottom-line: net income including all sources of revenues, gains, expenses and losses; net income. breakeven point: sales volume at which the firm covers the fixed costs. burden rate: the rate at which costs in an indirect cost pool are allocated to individual cost objects. Expressed as a dollar of overhead per unit of cost driver (activity). Also called allocation rate. capitalize: recognize a cost on the balance sheet as an asset, to be expensed over time, rather than immediately. Inventory and PPE are capitalized; R&D, advertising, and other internally generated intangibles are not. capital budgeting: process of choosing long-term investment projects capital lease: lease contracts whose terms trigger recognition of both an asset (the right to use the asset) and the liability (the obligation to make the payments). capital structure: the relative proportion of debt and equity in a corporation s financing. change in net assets: the equivalent of net income for a nonprofit. Nonprofit entities report change in net assets for restricted and unrestricted funds. common-size balance sheet: balance sheet in which all the numbers are expressed as a % of total assets. Facilitates intercompany and intertemporal comparisons. common-size income statement: income statement in which all the numbers are expressed as a % of sales revenue. Facilitates intercompany and intertermporal comparisons. common stock: an owners equity account representing capital contributed by shareholders in stock issuances. consolidated financial statements: include the balance sheet and income statement of the parent, or controlling corporation, as well as those of the majority-owned subsidiaries. Intracompany transactions, such as the sale of an intermediate product from one subsidiary to another, are eliminated, that is, are not double counted. contributed capital: money invested directly by investors during primary issuances of a firm s stock. contribution margin: the difference between the price and variable cost of one unit of output. contribution margin income statement: income statement that decomposes costs into variable costs, fixed costs specific to a product or service, and costs that are fixed at the corporate level. The product-specific fixed costs are avoidable. The corporate fixed costs are not. Used in product line decisions. cookie-jar reserves: earnings management technique in which a firm overestimates an accrued expense with the purpose of reversing the overestimate in a future period when income is lower than desired. This effectively 2

3 shifts income from the current period to a future period. Companies do this to smooth earnings growth. Illegal in the US, though other countries allow and even encourage it. core operations: main or central operations of a business. cost: outflow of resources; cost driver: a factor that causes an activity s costs cost object: an activity for which management desires a separate measurement of costs. Can refer to products, divisions, departments, customers, etc. cost of capital: the opportunity cost of funds invested in a business. This is often measured as a weighted average of the costs of equity and debt financing. cost of sales (often called cost of goods sold): the cost of inventory sold during the period. cost pool: aggregations of indirect costs, usually for allocation purposes. cost-volume profit analysis: a study of the sensitivity of profits to changes in costs and volume. current: occurring within the next fiscal period. deferred income: cash received by a firm prior to provision of goods or services. Also known as unearned revenue, customer advances, deferred revenue. deferred taxes: book tax obligation relating to the differences between tax and financial accounting. depreciation: the process of allocating the cost of a long-lived tangible asset to its useful life for the purposes of measuring periodic income. direct cost: cost of labor and materials in producing a product or providing a service. Sometimes used synonymously with variable cost. discount rate: interest rate used to convert future cash flows into the equivalent in today s dollars divestment: the sale of a division or subsidiary by the parent corporation. earnings management: altering the choice of accounting method, or making incorrect assumptions and estimates, with the purpose of altering reported income. EBIT: earnings before interest and taxes. Different companies may have different capital structures and be subject to different tax rates. EBIT purportedly neutralizes these differences and allows more meaningful analysis of profitability. EBITDA: earnings before interest, taxes, depreciation, and amortization. EBIT less depreciation and amortization, both of which are non-cash expenses. Approximates cash flow, and is sometimes used instead of GAAP earnings for valuation purposes. EPS: earnings per share, or earnings divided by the number of shares of stock outstanding. 3

4 equity method investments: balance sheet account representing a stake in another company large enough to provide some influence over management, but small enough not to be a controlling interest. expense: outflow of assets or creation of liabilities in an effort to generate current-period revenues; may or may not involve current-period cash outflows. financing activity: activity related to financing transactions such as borrowing money, repaying debt, issuing stock, paying dividends, repurchasing shares, etc. fiscal year: most firms use the calendar year. Others use a 365 day-cycle ending on different days. fixed cost: a cost that does not vary with the volume of activity. footnotes: additional information related to individual balance sheet accounts included in the 10-K. free cash flow: cash flow from operations less cash used to purchase PPE. Indicates the amount of cash available to pursue other business ventures. full-cost accounting: an estimate of a product or service s cost that includes allocation of all overhead costs as well as direct costs to individual products or services. The fully allocated cost is typically used for determining long-term profitability and strategy, but can be misleading for short-term decisions because it includes unavoidable fixed costs. GAAP: generally accepted accounting principles, or the measurement rules underlying financial reports. gain: difference between book value and cash received (if higher than book value) in the sale of a nonoperating asset. geared: levered. Goodwill: balance sheet asset related to the premium companies typically pay when acquiring other companies (the market value of the acquired firm usually exceeds its accounting book value). gross profit: revenues less cost of sales. hurdle rate: required rate of return in a discounted cash flow analysis. income statement: summary of revenues, expenses, gains and losses during a given time period. indirect cost: cost of producing a product or providing a service not easily traceable to an individual unit of output. Often referred to as overhead. intangible assets: resources lacking physical substance, for example intellectual capital, brand name, copyright, patent, etc. Internally generated intangibles cannot be capitalized under US GAAP. internal rate of return: the discount rate that equates the net present value of a stream of cash inflows and outflow to 0. Used in capital budgeting. interest payable: cash owed to creditors related to an expense already recognized on the income statement. inventory: items or products that are available for sale to customers. 4

5 investing activity: activity related to the acquisition and divestment of long-term productive assets, such as buying a patent, acquiring another company, selling a division, acquiring PPE, etc. IRR: internal rate of return left-hand side of the balance sheet: assets leverage: the ratio of liabilities to owners equity. liability: a corporation s legal debts or obligations; settled over time through the transfer of economic benefits including money, goods or services. liquidity: the ability to convert to cash quickly. long-term debt: debt whose repayment is more than one accounting period in the future. loss: negative net income; also, deficit between book value and cash received in the sale of a non-operating asset. Management s Discussion and Analysis: text in the 10-k immediately preceding the financial statements which provides a description of the year s results and also provides qualitative and forward-looking information not included in the financial statements proper. marketable securities: debt or equity securities held by corporations in small amounts usually for cash management purposes. market capitalization: market value. market value: total number of shares outstanding multiplied by the market price per share. matching principle: measurement principle requiring the matching of expense recognition to the period in which the related revenues are recognized or benefits realized. For example, matching requires the firm to carry inventory costs as assets on the balance sheet until the firms sells it, at which time cost of goods sold is recognized. net assets: the equivalent of Shareholders Equity on a nonprofit entity s balance sheet. net income: the amount remaining after all expenses and losses have been deducted from all revenues and gains. net present value: discounted net value of all cash flows from an investment. It is considered to be the optimal investment decision rule. noncurrent: occurring more than one year in the future. non-recurring: an economic event or transaction that is unique, for example, the sale of a subsidiary. NPV: net present value 5

6 operating activity: activity related to the daily provision of goods and services related to the firm s central business, such as paying suppliers, paying employees, collecting cash from customers, etc. operating department: a department producing goods or services sold to customers. Also called production department. Contrast with support or service department. operating expenses: costs to generate revenues associated with the normal activities of a company. operating income: revenue less operating expenses operating lease: lease contract whose terms do not trigger recognition on the balance sheet of either the related asset or the related liability. opportunity cost: the present value of the cash inflows (outflows) that the firm could earn (or save) by using the asset in its best alternative use to the one under consideration. overhead cost: a cost not directly associated with an identifiable unit of output (good or service). Also called indirect cost. payback period: number of periods until the firm recoups its investment in a long-term asset. It is considered to be an inferior capital budgeting rule because it ignores the time value of money. pension obligation: unfunded liability (that is, net of pension assets) of a corporation related to its defined benefit pension plan. P-E ratio: price to earnings ration. Computed as price per share divided by earnings per share. Often used as a shorthand tool for valuing a stock. peripheral activities: activities a firm engages in to support the core business, such as buying and selling securities to manage cash, or buying and selling property related to retail outlets. preferred stock: form of stock typically having a fixed dividend payment and having preference to common shares in the liquidation of the firm. Usually counted as owners equity despite its debt-like properties. prepaid expenses: asset representing cash paid for a resource (rent, for example) prior to its actual use. present value: the equivalent value in today s dollars of a future stream of cash flows production department: a department producing goods or services sold to customers. Also called operating department. Contrast with support or service department. pro forma earnings: non-gaap version of earnings sometimes disclosed by firms in addition to GAAP earnings. No standard definition. Typically, non-cash expenses have been eliminated. Similar to EBITDA in this sense. profit: net income. property, plant, and equipment: long-term productive assets 6

7 reciprocal method: method for allocation service department costs to production departments that, unlike the step method, explicitly accounts for interactions among service departments. Requires the solution of systems of simultaneous equations. recognize: record on financial statements. For example, firms recognize an expense related to inventory costs only when it sells the inventory. Prior to the sale of the inventory, the firm recognizes the inventory costs as assets. relevant cost: costs that are relevant to a decision. Typically refers to avoidable fixed costs and variable costs. relevant range: the range of volume for which characterizations of a firm s cost structure remain valid. restricted funds: contributions of funds to nonprofit organizations whose use has been restricted by the donor, i.e., to be used only to endow a chaired professorship, or for capital expenditures. restructuring charges: a preemptive expense taken by firms in anticipation of major changes in the firm s organizational and operational structure. retained earnings: the cumulative reinvested profits of the firm. revenue: asset inflows related to the sale or provision of the firm s product or service. revenue recognition: the rules governing when a firm may recognize revenue related to a sales transaction. Under US GAAP, the firm must have provided all, or most, of the services or goods and recognized something of measurable value in return. right-hand side of the balance sheet: liabilities and owners equity ROA: return on assets. Measures the return on assets independent of the method of financing those assets (equity or debt). Computed as net income + interest expense all divided by total assets. ROE: return on equity. Measures the return to shareholders. Computed as net income divided by total owners equity. semi-fixed cost: cost that increases with activity in discrete jumps. Also called step-function cost. semi-variable cost: cost that increases with activity but are positive even if volume is 0. service department: a department that provides services to production and other service departments. Also called support department. Contrast with production or operating department. shareholders equity: the residual claim of the owners against the assets of the firm; also equivalent to book value. statement of activities: the equivalent of an income statement for a nonprofit statement of cash flows: financial report that disaggregates cash flows in a period into operating, investing, and financing activities. statement of revenues and expenses: the equivalent of an income statement for a nonprofit 7

8 step-function cost: cost that increases with activity in discrete jumps. Also called semi-fixed cost. step method: method for allocating service department costs to production departments in a stepwise manner. sunk cost: a cost that has already been incurred. Irrelevant for decision-making because not reversible. support department: a department that provides services to production and other support departments. Also called service department. Contrast with production or operating department. treasury stock: owners equity account representing the value of the shares the firm has repurchased. Firms repurchase shares for a variety of reasons to boost earnings per share, to return capital to shareholders, to benefit from perceived undervaluation of the stock price. unavoidable fixed cost: a fixed cost that will be incurred regardless of the action chosen. unrestricted funds: contributions of funds to nonprofit organization whose donor has placed no restriction on its use. variable cost: a cost that varies with the volume of an activity. wages payable: wages that have already been recorded as an expense but which have not been paid in cash yet. writedown: reduction in the value of a long-lived asset in response to evidence that the market value is substantially lower than the book value; gives rise to an expense. writeoff: similar to writedown except that the long-lived asset is judged to have no value. 8

Index. Cambridge University Press Short Introduction to Accounting Richard Barker Index More information

Index. Cambridge University Press Short Introduction to Accounting Richard Barker Index More information accountants, roles, 4 5 accounting applications, 11 12 approaches, 8 9 building blocks, 64 coverage, 9 divisiveness of, 3 foundations of, 11, 65 83 importance of, 1 3 incompleteness, 7 knowledge of, 1