Edition 1 of tutor2u s acclaimed Accounts & Finance Glossary "a very good resource...and a useful addition to the world of the accounting student.

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1 Edition 1 of tutor2u s acclaimed Accounts & Finance Glossary "a very good resource...and a useful addition to the world of the accounting student." Duncan Williamson, Times Educational Supplement, December 2004

2 Absorption costing Accounting Accounting concepts Absorption costing is a method of identifying and ascertaining the cost of products or services. This is done by including both fixed and variable costs. The absorption method of costing can be contrasted with variable or marginal costing methods where costs of products or services are calculated using variable costs only. The absorption costing method requires the choice of an absorption basis by which fixed costs can be allocated appropriately. For example, the fixed costs of factory equipment repairs and maintenance may be allocated to the cost of producing specific products on the basis of their use of machine time. In another example, the cost of factory rent and rates may be allocated to products based on the amount of factory space that their production takes up. Accounting is a difficult term to define. However, it is formally defined by the American Accounting Association as The classification and recording of monetary transactions, the presentation and interpretation of the results of those transactions in order to assess performance over a period and the financial position at a given date, and the monetary projection of future activities arising from alternative planned courses of action. Using this definition, accounting can be seen to be about the identification and recording of business transactions as a way of assisting the management and planning of a business. Accounting concepts are the principles that guide the preparation of accounting information. These fundamental accounting concepts are best considered as the building blocks on which historical accounting information. The fundamental accounting concepts are generally taking to include prudence, consistency, accruals and going concern. Accounting policies Accounting standards Accounting Standards Board ( ASB ) Accruals Accruals concept Accounting policies are the specific accounting bases selected and consistently followed by a business. Accounting policies need to be appropriate to the circumstances of a business so that, when applied to accounting transactions, the resulting accounting information presents fairly its results and financial position. Accounting policies are largely governed by the application of accounting standards. However, there remains a large amount of subjectivity that needs to be applied when determining how to apply accounting policies. Accounting standards are authoritative statements of how particular types of transaction and other events should be reflected in financial statements. Accordingly, compliance with accounting standards will normally be necessary for financial statements to give a true and fair view. When preparing accounts in the UK, businesses must take account of statements issued by the Accounting Standards Board. These require the adoption of certain accounting principles and methods. There are currently two forms of Accounting Standards in the UK Financial Reporting Standards (FRSs) and Statements of Standard Accounting Practice (SSAPs). The only difference between these is that SSAPs were issued prior to Since that date, the name has been changed to FRS. Accounting standards apply to all companies, and other kinds of entities that prepare accounts that are intended to provide a true and fair view. The ASB is a UK standard setting body set up in 1990 manage the use of accounting standards. Its declared aims are to establish and improve standards of financial accounting and reporting, for the benefit of users, preparers and auditors of financial information.. Accounting standards developed by the ASB are contained in 'Financial Reporting Standards' (FRS s). The ASB collaborates with accounting standard setters from other countries and the International Accounting Standards Board (IASB) in order to ensure that its standards are developed as far as possible to be consistent from country to country. Accruals are amounts that are owed to third parties for which a business has not yet been invoiced. The total of accruals is shown in the balance sheet as part of creditors due less than one year. For example, where a business has not been invoiced by an advertising agency for its costs for the last three months of the year, it will show in its accounts an accrual for the estimated amount of the invoice. One of the fundamental accounting concepts, the accruals concept is also known as the matching concept. Under the accruals concept, revenue and costs are credited or charged to the profit and loss account for the year in which they are earned or incurred, not when any Page 2 of 21 Tutor2u Limited 2005 All Rights Reserved

3 Acid test ratio Acquisition Activity based costing Aged creditors report Aged debtors report Agency relationship Administration Allotment of shares Alternative Investment Market Amortisation cash is received or paid. For example, if a sale is made on credit this year, but the cash is only received next year, the sale is treated as income in this year. Similarly, if a business incurs a cost during the year (e.g. electricity) but is not invoiced until early in the next year, the accounts will show an estimated liability for the expected amount of the invoice. The acid test ratio (also know as the quick ratio ) is an accounting ratio that is concerned with business liquidity. It is defined as current assets (excluding stocks) divided by creditors falling due within one year. The acid test ratio is designed to test the short term solvency of a business, in a way similar to the current ratio. Stocks are excluded from current assets on the basis that it can often take several months to convert stocks into cash. The term acquisition commonly refers to the take over of one business by another. Sometimes the acquisition will involve the purchase of the entire share capital of a company. In other situations the acquisition is off certain trading assets rather than an actual company. Acquisitions can be financed by paying cash. Often they also involve the issue of shares by the acquiring business given to the shareholders of the business being sold. Acquisitions are subject to regulatory control via the competition authorities. For larger, crossborder acquisitions, regulation by authorities such as the European Competition Commission must also be taken into account. Activity based costing (commonly shortened to ABC ) is a system of costing which recognises that costs are incurred by each activity that takes place within a business and that products (or customers) should bear costs according to the activities they use. The use of ABC requires the identification of cost drivers those activities that take place in a business that cause costs to be incurred. The costs associated with these cost drivers also need to be identified so that they can be appropriately allocated to each activity being costed. Most businesses make use of an aged creditors report to manage the timing of payment to trade creditors. The report lists the amounts payable to trade creditors based on the payment terms agreed with them. It also lists creditors who have been owed money for the longest period. An aged debtors report lists amounts owed to a business by trade debtors and analyses how long the amounts have been due. The report is a crucial piece of information for managing the amount of credit given to customers and for chasing outstanding amounts. The term agency relationship describes the relationship between management and shareholders. It explains how management act as agents for shareholders, using their delegated powers to run the business in the best interests of the shareholders Administration is a term used to describe a situation relating to the possible insolvency of a business. Under an Administration Order, a court supervises the affairs of a company in financial difficulties with to the aim of securing its survival as a going concern or, failing that, to achieving a more favourable realisation of its assets than would be possible on liquidation. While the administration order is in force, the affairs of the company are managed by an administrator. When new shares are issued in a company it may be that there is excess demand for the shares. In such a case, shares are allotted to new subscribers on a fair basis although almost always in lower numbers than were requested. The process of share allotment is a common feature of new share issues on the London Stock Exchange. The Alternative Investment Market (usually shortened to AIM ) is a junior market of the main London Stock Exchange. AIM replaced the Unlisted Securities Market in It provides an opportunity for smaller companies with growth prospects to raise capital and have their shares traded in a market without the expense of a full market listing. Amortisation is a term used to describe the reduction in value of an asset through wear or obsolescence. In relation to tangible fixed assets, amortisation is mode commonly known as depreciation. In the UK, amortisation usually refers to the reduction in value of intangible assets such as acquired goodwill. Page 3 of 21 Tutor2u Limited 2005 All Rights Reserved

4 Annual general meeting Annual report & accounts Annuity Arbitrage Articles of Association Asset Asset turnover Audit Audit report The annual general meeting ( AGM ) is an annual meeting of the shareholders of a company, which must be held every year. The usual business transacted at an AGM is the presentation of the audited accounts, the appointment of directors and auditors, the fixing of their remuneration, and recommendations for the payment of dividends. Other business may be transacted if notice of it has been given to the shareholders. All limited companies are required by UK company law (the Companies Act) to prepare an annual report each year, containing their financial statements, directors report and, for larger companies, the auditor s report. The annual report of a listed business (i.e. a business quoted on a public stock exchange) must also contain a five year summary of results together with a wide range of other financial and operating disclosures). The annual report and accounts must be sent to shareholders and to the Registrar of Companies the government department that maintains the public records of companies. Once sent to the Registrar, the annual report becomes a public document, available for anyone to view. An annuity is a constant annual payment. The guarantee of the maintenance of such annual payments is also known as an annuity, and can usually be purchased from insurance companies. A certain annuity is paid over a specified number of years, whereas a life annuity is paid until the death of the named recipient. An annuity may be bought with a lump sum or through a series of contributions. Arbitrage refers to the exploitation of differences between the prices of financial assets or currency or a commodity within or between markets by buying where prices are low and selling where they are higher. For example, if coffee is cheaper in New York than in London after allowing for transport and dealing costs, it will pay to buy in New York and sell in London. If interest rates are higher on a Euro deposit in London than in Frankfurt, a higher return will be obtained by switching funds from one centre to the other. Unlike speculation, arbitrage does not normally involve significant risks, since the buying and selling operations are carried out more or less simultaneously and the profit made does not depend upon taking a view on future price changes. By eliminating price differentials, arbitrage contributes to the achievement of market equilibrium. The Articles of Association (the Articles ) is the official company document that acts as a contract between a business and its shareholders. The Articles describe the rights and duties of the shareholders with the business and between themselves (see also Memorandum of Association) An asset is defined by Financial Reporting Standard Number 5 as a right or other access to future economic benefits controlled by an entity as a result of past transactions or events. Future economic benefits might simply mean the conversion of the asset into cash (e.g. payment of cash received from a trade debtor). By contrast, a fixed asset describes ownership of an asset that can be used in the long term to create value for a business (see also current assets, fixed assets, intangible assets). Asset turnover is an accounting ratio. It measures the productivity of the assets of a business achieved by comparing asset values with sales revenue. For example, fixed asset turnover could be calculated by dividing the net book value of fixed assets by sales. An audit can be defined as a systematic examination of the activities and status of an entity, based primarily on investigation and analysis of its systems, controls and records. The Accounting Standards Board defines the annual audit that is required by most UK limited companies as an independent examination of, and expression of an opinion on, the financial statements of the enterprise. Not all companies require an audit there are exemptions available for small companies provided that they meet certain criteria. All companies above a certain size are required to have their financial statements audited by a registered auditor. The auditor prepares an audit report (which is presented at the front of the financial statements) stating whether or not the financial statements give a true and fair view of the business s results and financial position. In most cases the audit report given is clean in other words there are no problems reported to shareholders. However, audit reports can also be qualified. In qualifying an audit report, the auditor draws the attention of the Page 4 of 21 Tutor2u Limited 2005 All Rights Reserved

5 Audit trail Auditing Practices Board ( APB ) Auditor Authorised share capital Average cost Bad debt Balance sheet Balanced scorecard Banking covenants Batch costing Bookkeeping user of the financial statements to matters which are material and which should be considered when reading the accounts. For example, the auditor may be concerned about the ability of the company to continue on a going concern in which case the audit report would be qualified on a going concern basis. The audit trail is the range of documents and other evidence which records all the activities and transactions of a business. Such a historic record allows the firm to piece together the chronology of a transaction. It is also required for compliance purposes. The audit trail is of particular importance to the auditor who is required to obtain evidence that transactions are correctly recorded and reported by a business. The Auditing Practices Board ( APB ) (formed in 1991) is responsible for developing and issuing professional standards for auditors in the United Kingdom and the Republic of Ireland. An auditor is a professionally qualified accountant who is appointed by, and reports independently to, the shareholders. The auditor provides an independent opinion to shareholders and other users that the financial statements have been prepared properly and in accordance with legislative and regulatory requirements; that they present the information truthfully and fairly, and that they conform to the best accounting practice in their treatment of the various measurements and valuations (see audit and audit report) The authorised share capital of a company is the maximum amount of share capital that may be issued by a company. This amount can be found by looking in the company's memorandum of association. The authorised share capital must be disclosed on the face of the balance sheet or alternatively in the notes to the accounts. This is also referred to as nominal share capital. Average cost represents the average cost per unit of output. It is calculated by dividing total costs, both fixed costs and variable costs, by the total units of output. For example, if total costs are 250,000 (comprising fixed costs of 150,000 and variable costs of 100,000) and total output units are 10,000; then the average cost is 25 A bad debt is a debt owed to a business that is not expected to be received. This may arise, for example, as a result of the insolvency of a customer who had been buying products on a credit basis. Bad debts are written off either as a charge to the profit and loss account or against an existing doubtful debt provision. The balance sheet provides a statement of a business s financial position at a given point in time. It details the assets of the business and how these assets are being financed. Financing is broken down into two major categories shareholders' funds and liabilities. Due to the way in which the balance sheet is prepared, total assets will always equal total finance, i.e. the balance sheet will balance. The balanced scorecard is a popular approach to the analysis and reporting of management information. It emphasises the need to provide the user with a set of information which addresses all relevant areas of performance in a way that is objective and unbiased. The information contained in the balanced scorecard usually includes both financial and non financial elements, and covers areas such as profitability, customer satisfaction, internal efficiency, innovation and quality. Banking covenants are a crucial part of any bank loan agreement. A loan agreement in the form of a covenant will include a series of undertakings, the breaching of which will make the loan repayable immediately. The breaching of an undertaking will also be an event of default. In this situation, the bank assumes much greater financial control over the business (for example, it can prevent the payment of any dividends). A form of costing in which the unit costs are expressed on the basis of a batch produced Bookkeeping is the process of recording monetary transactions in the financial records of a business. Originally, bookkeeping was a timeconsuming manual process. However, it is now largely mechanised through the wide range of bookkeeping software programmes. (See Page 5 of 21 Tutor2u Limited 2005 All Rights Reserved

6 Breakeven Breakeven chart Budget Budgetary control Business angel Business angel network Business entity concept Enterprise Investment Scheme Business plan Call option Capital allowances Capital employed double entry bookkeeping) Breakeven refers to the quantity of output or value of sales necessary to cover fixed costs. A breakeven chart is a graph on which a business' total costs, analysed into fixed costs and variable costs, are drawn over a given range of activity, together with the sales revenue for the same range of activity. The point at which the sales revenue curve crosses the total cost curve is known as the breakeven point (expressed either as sales revenue or production/sales volume). The breakeven chart, like breakeven analysis, may also be used to determine the profit or loss likely to arise from any given level of production or sales, the impact on profitability of changes in the fixed or variable costs, and the levels of activity required to generate a required profit. A budget is a quantified financial statement that covers a defined period of time. A budget will normally include planned sales costs assets, liabilities and associated cash flows. Budgetary control is the way in which financial control is maintained within a business by using budgets for income and expenditure for each main function of the business. During the course of a financial period, these budgets are compared with actual performance to establish any variances. Individual managers who are responsible for the controllable activities within their budgets are expected to take corrective action on adverse variances (e.g. where costs are greater than budget or where sales or income are less than budget) Business angels are wealthy entrepreneurs who provide capital in return for being part of a growing successful business. For businesses requiring funds of up to 500,000, business angels are important sources of finance. A business angel will usually expect hands on involvement with the businesses into which he or she invests. A Business Angel Network (BAN) is a group of business angels, who are wealthy individuals looking for investment opportunities in businesses, and businesses seeking finance. The concept that financial accounting and reporting relates to the activities of a specific business entity and not to the activities of the owners of that entity. The Enterprise Investment Scheme (EIS) was introduced on 1 January 1994 with the aim of encouraging new equity investment in trading companies by providing generous tax incentives to investors other than those already connected with the company. An investor may qualify for both income tax relief and capital gains tax relief in respect of an EIS investment. The capital gains tax relief in particular can be extremely valuable, as it can mean that the large gain that may potentially be made by investors in high tech companies when they realise their investment, may be exempt from taxation. A detailed plan setting out the objectives of a business over a stated period usually 1 5 years. A business plan is drawn up by many businesses. For new businesses it is an essential document for raising capital or loans. The plan should quantify as many of the objectives as possible, providing monthly cash flows and production figures for at least the first two years. It must also outline its strategy and the tactics it intends to use in achieving its objectives. For a group of companies the business plan is often called a corporate plan. A call option gives the holder of the option the right to buy a share (or other asset) at the exercise price at some future time. (See also put option) A tax allowance for businesses on capital expenditure on particular items. These include machinery and plant, industrial buildings, agricultural buildings, mines and oil wells, and scientific equipment. Capital employed is essentially the underlying asset base a business needs to generate its profits and turnover. It is usually defined as fixed assets plus working capital, although alternative definitions are possible. It can also be calculated by adding together shareholders' funds Page 6 of 21 Tutor2u Limited 2005 All Rights Reserved

7 Capital expenditure Capital Gains Tax ( CGT ) Capital markets Capital rationing Capital structure Cash Cash flow budget Cash flow statement Charge and long term liabilities. Having calculated capital employed, it is possible to assess the level of return that this investment is producing by using an accounting ratio such as return on capital employed. Capital expenditure is that expenditure by a business that results in the acquisition of fixed assets or an improvement in their earning capacity. Capital expenditure is not charged as an expense in the profit and loss account; the expenditure appears as a fixed asset in the balance sheet. The consumption or use of the fixed asset over time is reflected in the profit and loss account by calculating the amount of depreciation that has occurred. (See depreciation) CGT is a tax on capital gains. Most countries have a form of income tax under which they tax the profits from trading and a different tax to tax substantial disposals of assets either by traders for whom the assets are not trading stock (e.g. a trader's factory) or by individuals who do not trade (e.g. sales of shares by an investor). The latter type of tax is a capital gains tax. A market in which long term capital is raised by industry and commerce, the government, and local authorities. The money comes from private investors, insurance companies, pension funds, and banks and is usually arranged by issuing houses and merchant banks. Stock exchanges are also part of the capital market in that they provide a market for the shares and loan stocks that represent the capital once it has been raised Capital rationing describes a situation in which a business has only a limited amount of capital to invest in potential projects. As a result, the different possible investments need to be compared with one another in order to allocate the capital most effectively. This is done by evaluating the potential returns that each investment might achieve, and allocating capital to the projects with the best projected returns. (See also payback, net present value, investment appraisal) The capital structure of a business refers to the way in which it is financed. In most cases the capital structure will comprise a combination of long term capital (e.g. ordinary shares, reserves, preference shares, debentures, long term bank loans etc) and short term liabilities (such as a bank overdraft and trade creditors). It is important that a business is financed by an appropriate capital structure that reflects the nature of the business and its ability to generate profits and cash flow. For example, a business at the start up or growth stage may not be profitable and may also have significant investment requirements. In this example, the appropriate capital structure would mainly comprise equity finance such as ordinary shares rather than bank debt (where the business would need to finance interest charges). Cash is an asset of a business and represents cash in hand, and deposits repayable on demand with any bank or other financial institution. The cash flow budget summarises the expected cash inflows and the expected cash outflows of a business over a budget period. It is usually prepared on a monthly basis, but can be for shorter or longer periods depending on the needs of management. The main purpose of a cash flow budget is to determine when cash surpluses are likely to be available for investment or when cash deficits are likely to arise requiring additional finance. The cash flow budget is also referred to as the cash flow forecast. The cash flow statement is an historical record of the cash flows of a business, distinguishing between different categories of cash receipts and payments. Financial Reporting Standard FRS 1 (Cash flow statements) requires most companies to publish a cash flow statement as part of their annual accounts. The purpose of this statement is to reveal to users how cash was generated and then applied by the company during the period under review. A term used in relation to the insolvency of a business. Charge refers to security which is taken by a creditor over property or classes of property owned by a creditor to protect against non payment of a debt (frequently by a mortgage or other fixed charge). The advantage of a charge is that it places the charge holder ahead of other creditors in the event of the debtor's insolvency. Page 7 of 21 Tutor2u Limited 2005 All Rights Reserved

8 Companies Acts Consistency concept Consolidated accounts Contingent liability Contract costing Contribution Convertible securities Corporate governance Corporation tax Corporation tax rates Cost centre Creative accounting The UK acts of parliament concerned with companies. Much of UK company law is now influenced by European legislation. The consistency concept is one of the fundamental accounting concepts that underpin the preparation of accounts. With the consistency concept, the principle applied is that there is uniformity of accounting treatment of like items within each accounting period and from one period to the next. Consolidated accounts are the financial statements of a group of companies aggregated to show the overall financial results and position of the group. A contingent liability is a possible liability of a business that arises from past events. The reason why the liability is contingent is that its existence (and final amount) can only be by the occurrence of one or more uncertain future events not wholly within the control of the business. For example, a business may be subject to a legal claim of some kind which may result in the business having to pay costs or damages. The outcome of the legal claim may be uncertain as might the possible costs arising. In this case, the business has to take a prudent view as to the likely outcome. Where the amount and outcome of a contingent liability can be predicted with reasonable likelihood, the prudence concept suggests that the business should make provision for the liability in its accounts as soon as possible. (See also provisions, prudence concept) A costing technique applied to long term contracts in which the costs are collected by contract. Contribution is the amount under marginal costing principles of profit that has been earned before taking account of fixed costs or expenses of a business. A convertible security is a security that, at the option of the holder, may be exchanged for another asset, generally a fixed number of shares of common stock. Convertible issues frequently are fixed income securities such as debentures and preferred stock. Corporate governance describes the way companies are directed and controlled. Boards of directors are responsible for the governance of their companies. The shareholders role in governance is to appoint the directors and the auditors and to satisfy themselves that an appropriate governance structure is in place. Corporation tax is the taxation payable by companies on their profits. As with other direct taxes (such as income tax) there are different rates of corporation tax payable (depending on the level of profits achieved). Companies also receive tax allowances which they can use to reduce the amount of corporation tax payable. The main kind of allowance capital allowances provides a tax incentive to invest in fixed assets. Smaller companies also benefit from lower corporation tax rates. The corporation tax rate is the rate at which companies pay corporation tax. The rate varies depending on the size of the business. A small business for tax purposes pays corporation tax, currently 20%. A small business for tax purposes is defined as a business with taxable profits of 300,000 or less. The normal rate of corporation tax is currently 30% and is paid by companies with taxable profits of 1.5 million or more. Companies with profits between these two limits pay corporation tax at a tapering rate between 20% and 30% [check these numbers] A cost centre is a production or service location, function, activity or item of equipment for which costs are accumulated and to which they are charged. Creative accounting is the term used to describe the deliberate manipulation of reported accounting information with the intention to mislead users of the accounts. Creative accounting tries to take advantage of the use of subjective judgement used in preparing accounts. The ability to use creative accounting has been significantly reduced in recent years following the issue of a range of more prescriptive and Page 8 of 21 Tutor2u Limited 2005 All Rights Reserved

9 Creditors Creditor days ratio Current liabilities Current ratio Debenture Debtor days Debtors Deep discount bonds Depreciation Depreciation provision detailed accounting standards. (See accounting standards, window dressing). Creditors form part of a business s liabilities and represent amounts due to third parties. Creditors are analysed in the balance sheet into those due within one year and those due after more than one year. For most businesses, the main creditor is trade creditors amounts owed to providers of goods and services on credit terms to the business. (See current liabilities) The creditor days ratio provides an indicator of the average number of days' credit taken by a business before its trade creditors are paid. It is calculated by the following formula: (Trade creditors 365)/annual purchases on credit. Current liabilities are those short term liabilities which are intended to be constantly replaced in the normal course of trading activity. Current liabilities typically comprise: trade creditors, accruals and bank overdrafts. The current ratio is an accounting ratio. It is usually defined as current assets divided by creditors falling due within one year. The ratio is designed to assess the solvency of a business in the short term. If the current ratio exceeds one, then the value of current assets is greater than the value of the short term creditors, indicating that the business is able to pay its short term debts as they fall due. Note that this interpretation is fairly simplistic and the resulting ratio depends on the nature of the market in which the business operates. For example, supermarkets usually have a current ratio of less than one since they do not sell goods on credit (i.e. minimal trade debtors) yet have large ongoing balances owed to trade creditors. The most important judgement applied to this ratio (and other similar liquidity ratios) is in understanding the reasons for any significant deterioration in the ratio. A debenture is a form of loan. It is a written acknowledgement of a debt by a business that normally containing provisions as to payment of interest and the terms of repayment of principal. A debenture may be secured on some or all of the assets of the business or its subsidiaries. The debtor days ratio is an accounting ratio that provides insight into the effectiveness of working capital management. The calculation of debtor days (average trade debtors divided by average daily sales on credit terms) indicates the average time taken, in calendar days, to receive payment from credit customers. An increase in debtor days would suggest that credit customers are being allowed to take longer to pay amounts due which has adverse effects on business cash flow. (See also creditor days) Debtors represent amounts owed to a business by its customers and other third parties. Debtors are shown as part of current assets in the balance sheet. A deep discount bond is a long term debt security that, because of a low coupon rate of interest compared with current rates of interest, sells at a substantial discount from face value. Bonds of this type, if not original issue discounts, are preferred by some investors because they are unlikely to be called before maturity. Depreciation is the name given to the amount charged to the profit and loss account to reflect the wearing out of a fixed asset over its useful life. The purpose of depreciation is to comply with the accruals concept. Since the benefit of a fixed asset is received over several periods, the cost of acquiring the asset is charged against profits over those periods. There are several methods available to calculate depreciation. The two most popular approaches are the straight line and reducing balance methods. It should be noted that the depreciation charge in the profit and loss account has no effect on the cash flows of a business. It is simply a subjective estimate of the amount by which the value of a fixed asset has fallen below its original purchase cost. Note: not all fixed assets are depreciated. For example, the value of land is rarely depreciated because its value uslaly grows, not falls over time. The depreciation provision is the amount of depreciation that has cumulatively been charged to the profit and loss account, relating to a fixed asset, from the date of its acquisition. Fixed assets are stated in the balance sheet at their net book value (or written down value) which is usually their historical cost less the cumulative amount of depreciation at the balance sheet date. (See also net book value) Page 9 of 21 Tutor2u Limited 2005 All Rights Reserved

10 Direct cost Director Directors report Discounted cash flow Discount rate Dividend cover Dividend policy Dividends Double entry bookkeeping Doubtful debt Due diligence Earnings per share A direct cost is a cost that can be directly related to producing specific goods or performing a specific service. For example, the wages of an employee engaged in producing a product can be attributed directly to the cost of manufacturing that product. A director is a person elected under a company s Articles of Association to be responsible for the overall direction of the company s affairs. Directors usually act collectively as a board and carry out such functions as are specified in the articles of association or the Companies Acts, but they may also act individually in an executive capacity. The Directors Report forms part of a company s annual report and accounts. It is a legal requirement that the directors write a report summarising the company s performance over the financial period covered by the accounts, comment on the company s future prospects, and provide other required disclosures. Discounted cash flow is a method of investment appraisal. It involves the discounting of the projected net cash flows of a project to ascertain its present value. A term used in investment appraisal to refer to the hurdle rate of interest or cost of capital rate applied to the discount factors used in a discounted cash flow appraisal calculation. The discount rate may be based on the cost of capital rate adjusted by a risk factor based on the risk characteristics of the proposed investment in order to create a hurdle rate that the project must earn before being worthy of consideration. Alternatively, the discount rate may be the interest rate that the funds used for the project could earn elsewhere. The dividend cover ratio is an accounting ratio that is concerned with the level of returns that are given to shareholders compared with the ability of the company to deliver profits. The dividend cover ratio is defined as net earnings per share divided by net dividend per share. The purpose of the ratio is to identify how much of a business s profits are being distributed to shareholders and how much is being retained to finance future expansion of the business. Generally a business with a low dividend cover is paying out most of its earnings as dividends and is unlikely to achieve high growth in the future, compared to a business with high dividend cover. Dividend cover is usually only relevant to companies that are quoted on a recognised stock exchange. It is rare that the ratio would be calculated for a private company. Dividend policy refers to the decisions made by a company as to how much profit should be distributed by way of dividends to shareholders as opposed to being reinvested in the business Dividends represent amounts paid to shareholders out of the profits of a business. Dividends are usually paid annually or semi annually, and represent part of return on a shareholders investment in a business. Preference shares receive a fixed dividend while for equity shares the level of dividend depends on the profitability of the business. Dividends are effectively declared and paid net of income tax. (see also dividend cover) A method of recording and processing accounting transactions based upon the concept that each transaction has a dual aspect; a debit entry and a credit entry A doubtful debt is a debtor balance where there is some uncertainty as to whether or not it will be settled, and for which there is a possibility that it may eventually prove to be bad. A doubtful debt provision may be created for such a debt by charging it as an expense to the profit and loss account. (See also bad debts) Due diligence is an investigation normally conducted by an independent accountant or consultant of the current financial and/or market position and future prospects of a business prior to a stock exchange flotation or a major investment of capital. For example, venture capitalist undertake extensive due diligence on potential investments before completing the deal. Earnings per share (usually shortened to eps ) is a measure of shareholder return. It measures a business s profitability from the point of Page 10 of 21 Tutor2u Limited 2005 All Rights Reserved

11 EBITDA Economic order quantity ( EOQ ) Useful economic life Employee share ownership plan ( ESOP ) Environmental reporting Equity shares Exceptional items Export credit insurance Extraordinary items Factoring Finance lease Financial accounting view of equity shareholders. It is defined as earnings attributable to equity shareholders divided by the number of equity shares in issue over the year. EBITDA is an acronym for a calculation of a business profit that excludes financing costs, taxation and depreciation. It is calculated as operating profit before interest, tax, depreciation, and amortisation. The economic order quantity ( EOQ ) represents the optimal ordering quantity for an item of stock which will minimise stock holding costs. The period for which the present owner of an asset will derive economic benefits from its use. A method of providing the employees of a company with shares in the company. The ESOP buys shares in its sponsoring company, usually with assistance from the company concerned. The shares are ultimately made available to the employees, usually directors, who satisfy certain performance targets. Publicly quoted businesses in the UK are required to provide a statement included within their annual report and accounts that sets out the environmental policies of the business and an explanation of its environmental management systems and responsibilities. The environmental report may include reporting on the performance of the business on environmental matters in qualitative terms regarding the extent to which it meets national and international standards. It may also include a quantitative report on the performance of the business on environmental matters against targets, together with an assessment of the financial impact. Also referred to as ordinary shares or (in the USA) common stock. Equity shares represent the right to participate in the residual assets of a business and typically have voting rights. Equity shareholders will usually receive a dividend, the level of which depends on the level of achieved profits and the extent to which the directors wish to reinvest profits back into the business. If the business is wound up, equity shareholders will be entitled to any assets left over after all other investors have been paid off. Equity shareholders have limited liability, which means that their liability to contribute money to the business is limited to the amount they have already invested. Exceptional items are separately reported in a business s profit and loss account. Exceptional items are those which are material, derived from events or transactions within a business s ordinary activities and which need to be disclosed separately to ensure that the business s accounts give a true and fair view. (See also extraordinary items) Export credit insurance is insurance taken out against the risk of non payment by foreign customers for export debts. Extraordinary items are separately disclosed in a business s profit and loss account. Items which are material, possess a high degree of abnormality, are not expected to recur and are derived from events or transactions outside of the ordinary activities of a business. Note that, because the definition of ordinary activities is extremely wide, it is extremely unlikely that a business will show an extraordinary item in its accounts in any one year. (see also exceptional items). Factoring describes an arrangement whereby the debts of a business are collected by a factor business, which advances a proportion of the money it is due to collect. (See also invoice discounting). A finance lease is a lease where the lessor transfers substantially all the risks and rewards of ownership of the asset to the lessee. (See also operating leases) Financial accounting is the function responsible for the reporting required by company legislation for shareholders. It also provides such similar information as required for Government and other interested third parties, such as potential investors, employees, lenders, suppliers, Page 11 of 21 Tutor2u Limited 2005 All Rights Reserved

12 Financial intermediary Financial management Financial Reporting Council Financial Reporting Review Panel Financial Reporting Standards Finished goods First in first out ( FIFO ) Fixed assets Fixed charge Fixed cost Forward currency transaction Gearing Generally accepted accounting principles ( GAAP ) customers, and financial analysts. A financial intermediary is a party that brings together providers and users of finance, either as a broker or as principal. Financial management is the general term that describes the management of all the processes associated with the raising and use of financial resources in a business. The Financial Reporting Council ( FRC ) is the body which provides the strategic direction behind the development of Accounting Standards in the UK. It has two main operations the Accounting Standards Board and the Financial Reporting Review Panel, which issue and enforce Accounting Standards in the UK. <add links> The Financial Reporting Review Panel is the body responsible for ensuring that companies in the UK follow Accounting Standards. <add link> (See also Accounting Standards Board and Financial Reporting Council) Financial Reporting Standards ( FRSs ) are issued by the Accounting Standards Board. The use of FRSs replaced the previous form of accounting standards in the UK which were named Statements of Standard Accounting Practice. (see also Accounting Standards). Products that have completed the manufacturing process and are available for distribution to customers. Compare finished goods with work in progress. First in first out is a method used to calculate the cost if stocks or inventories. It assumes that the oldest items or costs are the first to be used. It is commonly applied to the pricing of issues of materials, based on using first the costs of the oldest materials in stock, irrespective of the sequence in which actual material usage takes place. Closing stocks are therefore valued at relatively current costs. A fixed asset is defined as any asset, tangible or intangible, acquired for retention by an entity for the purpose of providing a service to the business, and not held for resale in the normal course of trading. This includes, for example, equipment, machinery, furniture, fittings, computers (see also depreciation) A fixed charge is held by the charge holder over specific assets (typically a mortgage in respect of property) which prevents a debtor from selling or otherwise dealing with the charged property without payment in settlement of the debt due to the charge holder A fixed cost is one which, within certain output or turnover limits, tends to be unaffected by fluctuations in the levels of activity (output or turnover). A good example would be the rent and rates charge for an office, or the employment costs of staff who provide services not directly related to production or output (e.g. the accounting department). A forward currency transaction is a transaction where a rate of exchange is agreed today but delivery occurs on an agreed date in the future. The rate of exchange is known as the forward exchange rate. Forward exchange rates are mainly used as a way of creating greater certainty about what the actual cost of a transaction will be in the local currency of the business. The use of forward currency transactions is often referred to as currency hedging. Gearing refers to the use of debt as part of the financial structure of a business. The use of debt as a source of finance reduces the amount of equity funding that is required. However, a business partly financed by debt needs to be satisfied that it will be able to meet the interest payment obligations of the debt providers. In the UK the concept of generally accepted accounting principles is taken to mean accounting standards and the requirements of company legislation and the stock exchange. Page 12 of 21 Tutor2u Limited 2005 All Rights Reserved

13 Gearing ratio Going concern Goodwill Gross margin Gross profit Hire purchase Historical cost concept Indirect cost Insolvency Interest cover Internal audit The gearing ratio is an accounting ratio which measures the level of debt finance a business has raised relative to its level of shareholders funds. The gearing ratio is also known as the debt to equity ratio. It is usually defined as total debt divided by shareholders funds, expressed as a percentage. The precise definition will vary, however, from situation to situation. The higher the percentage from the calculation, the more highly geared a business is. It is possible to calculate the net gearing ratio, where cash balances are deducted from debt in the calculation. (See also interest cover and gearing) Going concern is one of the fundamental accounting concepts (the others being prudence, accruals and consistency). Under the going concern concept it is assumed that a business will continue in operational existence for the foreseeable future. This assumption has significant implications for the valuation of assets in the balance sheet which can be stated at their net book value. If there was a doubt about the ability of the business to operate as a going concern, then certain assets would have to be valued at their disposal value (which is likely to be lower than net book value). (See also accounting concepts) Goodwill, in the accounting sense, refers to the difference between the total value of a business and the value of its net assets in its balance sheet. It represents the ability of the business to generate profits and cash in the future. The value of goodwill is often only determined when a business is bought or sold. Acquired goodwill (the difference between the purchase price for a business and its net assets, is amortised through the profit and loss account. Gross margin is a profitability ratio calculated as gross profit divided by sales. The ratio focuses on the ability of the business to maintain trading margins. (See also gross profit). Gross profit is the difference between sales and the total cost of sales. (See also gross margin). Hire purchase is a method of buying goods in which the purchaser takes possession of the goods as soon as an initial instalment of the price (a deposit) has been paid. The purchaser only obtains ownership of the goods when all the agreed number of subsequent instalments are paid. The historical cost concept is a basis of accounting prescribed by the Companies Act for published accounts. Under this system of accounting, all values are based on the historical costs incurred. Indirect costs are those costs that are untraceable to particular units or cost centres. It is expenditure on labour, materials or services which cannot be economically identified with a specific saleable cost unit. In order to determine the total cost of production on a fully absorbed basis) such costs have to be allocated, that is assigned to a single cost unit, cost centre, or cost account or time period. Businesses are placed into insolvency when they are unable to pay creditors debts in full after realisation of all their assets. The decision to place a business into insolvency is normally taken by the creditors of a business usually a bank. There are several different forms of insolvency the main ones being administration, receivership and liquidation. Interest cover is an accounting ratio. It measures the level of a business s profits relative to its interest charge in the profit and loss account. It is usually defined as profits before interest and tax divided by interest charges, but the precise definition will vary depending on the circumstances. The higher the ratio, the less gearing a business has. The interest cover ratio is particularly important for lenders, in that it helps them determine the vulnerability of interest payments to a drop in profit. (See also gearing and gearing ratio) Internal audit is the name given to an independent appraisal function established within a business to examine and evaluate its activities as a service to the business. The objective of internal auditing is to assist members of the business in the effective discharge of their responsibilities. To this end, internal auditing furnishes them with analyses, appraisals, recommendations, counsel and information Page 13 of 21 Tutor2u Limited 2005 All Rights Reserved