2 Glossary. report diluted EPS if the securities in their capital structure are antidilutive; they will report only the basic EPS number.

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1 Glossary accelerated depreciation methods Depreciation methods that allow for higher depreciation charges in the early years and lower charges in later periods. Termed accelerated because these methods allow for higher early depreciation changes than the straight-line method allows. Also called decreasing-charge methods. Generally, companies use one of two decreasing-charge methods: sum-of-the-years -digits or declining-balance. (p. 504). account A systematic arrangement that shows the effect of transactions and other events on a specific element (asset, liability, and so on). Companies keep a separate account for each asset, liability, revenue, and expense, and for capital (stockholders equity). (p. 78). account form Presentation in a classified balance sheet that lists assets by sections on the left side and liabilities and stockholders equity by sections on the right side. (p. 160). accounting cycle Standard set of accounting procedures to record transactions and prepare financial statements. (p. 83). accounting information system A system that collects and processes transaction data and then disseminates the financial information to interested parties. Accounting information systems vary widely from one business to another, depending on the nature of the business and its transactions, the size of the company, the volume of data to be handled, and the informational demands. (p. 78). Accounting Principles Board (APB) Private standard-setting organization from 1959 to 1973 whose mission was to develop an overall conceptual framework. Its official pronouncements, called APB Opinions, were to be based mainly on research studies and be supported by reasons and analysis. The APB issued 31 opinions in its lifetime. (p. 9). Accounting Research Bulletins Fifty-one bulletins from the Committee on Accounting Procedure (CAP) during the years 1939 to 1959, issued to deal with accounting problems as they arose. Subsequently, the AICPA created the Accounting Principles Board to provide a structured body of accounting principles. (p. 9). accounts receivable Oral promises of the purchaser to pay for goods and services sold. They represent short-term extensions of credit, which are normally collected within 30 to 60 days. (p. 363). accounts receivable turnover ratio A liquidity ratio that measures the number of times, on average, a company collects receivables during a period. Computed by dividing net sales by average (net) accounts receivable outstanding during the year. Barring significant seasonal factors, average receivables outstanding can be computed from the beginning and ending balances of net trade receivables. (p. 383). accrual-basis accounting Accounting approach in which a company records events that change its financial statements in the periods in which the events occur, rather than only in the periods in which it receives or pays cash.thus, a company recognizes revenues when it earns them rather than when it receives cash, and it recognizes expenses when it incurs them rather than when it pays them. (p. 6). accrued expenses Expenses incurred but not yet paid or recorded at the statement date. Examples are interest, rent, taxes, and salaries.an accrued expense on the books of one company is often an accrued revenue to another company. (p. 98). accrued revenues Revenues earned but not yet received in cash or recorded at the statement date. Accrued revenues result from the passing of time (e.g., interest revenue and rent revenue) or from unbilled or uncollected services that a company performed (e.g., commissions and fees). (p. 97). accumulated other comprehensive income An entry in the stockholders equity section of the balance sheet that reports the cumulative amounts of Other Comprehensive Income. Other Comprehensive Income measures the amounts of all gains and losses in a period that bypass the income statement but affect stockholders equity. These amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions. (p. 224). accumulated rights Compensation rights that employees can carry forward to future periods if not used in the period in which earned. (p. 845). acid-test (quick) ratio Liquidity ratio that measures the ability of a company to meet its maturing obligations with its available assets and to meet unexpected needs for cash. Computed as cash plus short-term investments plus net receivables divided by current liabilities. A variation of the current ratio, the acid-test ratio eliminates inventories and prepaid expenses from the amount of current assets, to provide better information for short-term creditors. (p. 634). activity method Depreciation method that assumes that depreciation is a function of use or productivity, instead of the passage of time. Using this method, a company considers the life of the asset in terms of either the output it provides (units it produces) or an input measure such as the number of hours it works.also called the variable-charge or units-of-production approach. (p. 502). activity ratios Measures of how effectively a company is using its assets. Common activity ratios are: receivables turnover, inventory turnover, and asset turnover. (p. 277). actual return on the plan assets The increase in pension funds from interest, dividends, and realized and unrealized changes in the fair-market value of the plan assets. If the actual return on the plan assets is positive (a gain) during the period, a company subtracts it when computing pension expense; if the actual return is negative (a loss) during the period, the company adds it when computing pension expense. (p. 858). actuarial present value The additional benefits, predicted by an actuary, that an employer must pay under the plan s benefit formula as a result of the employees current year s service, discounted back to their present value. The actuarial present value is the projected benefit obligation a company recognizes for its pension plan in a given year. (p. 857). additional paid-in capital Any excess over par value paid in by stockholders in return for the shares issued to them. Once paid in, the excess over par becomes a part of the corporation s 1

2 2 Glossary additional paid-in capital. Also called paid-in capital in excess of par. (p. 675). additions Increases or extensions of existing assets. By definition, any addition to plant assets creates a new asset; companies capitalize such expenditures and match them against the revenues that will result in future periods. (p. 497). adjunct account An account that increases either an asset, liability, or owners equity account. An example is Premium on Bonds Payable, which, when added to the Bonds Payable account, describes the total bond liability of the company. (p. 169). adjusted trial balance A trial balance prepared from a company s ledger accounts after journalizing and posting all adjusting entries. It shows the effects of all financial events that occurred during the accounting period. (p. 101). adjusting entry Adjustments made at the end of the accounting period to ensure that a company has recorded revenues in the period in which it earns them and recognized expenses in the period in which it incurs them in other words, that it has followed the revenue recognition and matching principles. Companies often prepare adjustments after the balance sheet date but date the entries as of the balance sheet date. (p. 78, 91). aging schedule A schedule (worksheet or spreadsheet) that shows a company s accounts receivable and estimates uncollectible accounts by applying to the various age categories different percentages estimated to be uncollectible based on past experience. An aging schedule also identifies which accounts require special attention by indicating the extent to which certain accounts are past due. (p. 368). allowance method A method for recording uncollectible accounts receivable by entering the expense on an estimated basis in the accounting period in which the sales on account occur. The allowance method records bad debt expense in the same period as the sale, thus properly matching expenses and revenues and achieving a proper carrying value for accounts receivable. The FASB considers the allowance method appropriate in situations where it is probable that an asset has been impaired and that the amount of the loss can be reasonably estimated. (p. 367). American Institute of Certified Public Accountants (AICPA) The national professional organization of practicing Certified Public Accountants (CPAs), whose various committees and boards have been an important contributor to the development of GAAP. (p. 9). amortization The allocation of the cost of intangible assets in a systematic way. (p. 557). amortized cost The acquisition cost of debt securities adjusted for the amortization of discount or premium, if appropriate. Amortized cost is the valuation amount companies use to account for held-to-maturity debt securities. (p. 733). annuity A series of payments or receipts (called rents) that occur at equal intervals. (p. 1012). annuity due An annuity in which each rent is payable/receivable at the beginning of the period. (p. 1012). antidilutive securities Securities that upon conversion or exercise increase earnings per share (or reduce the loss per share). Companies with complex capital structures will not report diluted EPS if the securities in their capital structure are antidilutive; they will report only the basic EPS number. (p. 965). APB Opinions The official pronouncements of the Accounting Principles Board, intended to be based mainly on research studies and be supported by reasons and analysis. Between its inception in 1959 and its dissolution in 1973, the APB issued 31 opinions. (p. 9). appropriated retained earnings A retained earnings account that is restricted for a specific use, usually to comply with contractual requirements, board of directors policy, or current necessity. (p. 222). asset gains and losses The difference between the expected return and the actual return on a pension plan. Also referred to an unexpected gain or loss. Asset gains occur when actual return exceeds expected return; asset losses occur when the actual return is less than expected return. (p. 861). asset retirement obligation (ARO) An existing legal obligation, whose amount can be reasonably estimated, associated with the retirement of a long-lived asset. Companies should record the ARO at fair value. (p. 627). asset turnover ratio Profitability ratio that measures how efficiently a company uses its assets to generate sales. Computed as net sales divided by average total assets for the period. The resulting number is the dollars of sales produced by each dollar invested in assets. (p. 517). asset-liability method Method of accounting for income taxes. Sometimes referred to as the liability approach. Companies recognize on the current-year return a current tax liability/asset for the estimated taxes payable/refundable, and they recognize a deferred tax liability/asset for estimated future tax effects due to temporary differences and tax carryforwards. The measurement of current/deferred tax liabilities/assets is based on provisions of the tax law. Companies establish a valuation allowance account if it is more likely than not that some/all of the deferred tax asset will not be realized. (p. 809). assumption One of the parts in the third level of the conceptual framework; a concept that the accounting profession assumes as foundational for the financial accounting structure. There are four basic assumptions: (1) economic entity, (2) going-concern, (3) monetary unit, and (4) periodicity. (p. 45). Auditing Standards Board The arm of the AICPA that had been responsible for developing auditing standards. The Public Company Accounting Oversight Board established by the Sarbanes-Oxley Act now oversees the development of auditing standards. (p. 13). available-for-sale securities Debt and equity securities not classified as held-to-maturity or trading securities. Companies report available-for-sale securities at fair value, but do not report changes in fair value as part of net income until after they sell the security. Interest on available-for-sale securities is recorded when earned. Unrealized holding gains and losses on available-for-sale securities are recognized as other comprehensive income and as a separate component of stockholders equity. (p. 150, 732). average days to sell inventory A measure that represents the average number of days sales for which inventory is on

3 Glossary 3 hand. A variant of the inventory turnover ratio, it is computed by dividing the inventory turnover ratio by the number of days in the year (365 or sometimes for simplicity, 360). (p. 449). average tax rate An average of the graduated rates at which the IRS taxes U.S. corporations. The first $50,000 of taxable income is taxed at 15 percent, the next $25,000 at 25 percent, with higher incremental levels of income at rates as high as 39 percent. (p. 795). average-cost method Inventory-costing method that prices items in the inventory on the basis of the average cost of all similar goods available during the period. Companies that use the periodic inventory method use weighted averages and those that use the perpetual method use moving averages. (p. 428). avoidable interest The amount of interest cost in a period that a company could theoretically avoid if it had not made expenditures for an asset. When a company capitalizes interest expense, the amount of interest to capitalize is limited to the lower of actual interest cost incurred during the period or the amount of avoidable interest. (p. 523). balance sheet Financial statement that shows the financial condition of a company at the end of a period by reporting its assets, liabilities, and owners equity. Sometimes referred to as the statement of financial position. (p. 79, 146). bank overdrafts Occur when a company writes a check for more than the amount in its cash account. Companies should report bank overdrafts in the current liabilities section, adding them to the amount reported as accounts payable. If material, companies should disclose these items separately. (p. 360). bank reconciliation A schedule explaining any differences between the bank s and the company s records of cash. If some part of the difference arises from items other than transactions not yet recorded by the bank, either the bank or the company must adjust its records. (p. 391). bargain purchase option An option that allows a lessee to purchase the leased property for a price that is significantly lower than the property s expected fair value at the date the option becomes exercisable. At the inception of the lease, the difference between the option price and the expected fair market value must be large enough to make exercise of the option reasonably assured. A bargain purchase option is one of the criteria for determining if a lease is a capital lease. (p. 898). bargain renewal option An option that allows a lessee to renew the lease for a rental that is lower than the expected fair rental at the date the option becomes exercisable. At the start of the lease, the difference between the renewal rental and the expected fair rental must be great enough to make exercise of the option reasonably assured. A bargain renewal option extends the life of the lease, when determining the lease term. (p. 898). basic EPS The earnings per share for a simple capital structure. A company with a complex capital structure reports both basic EPS and diluted EPS amounts on the face of its income statement. (p. 964). bearer (coupon) bonds Bonds without the name of the owner, which may be transferred from one owner to another by mere delivery. (p. 613). bond discount The difference between the face value of a bond and its selling price when the bond sells for less than face value. (p. 615). bond indenture A contract for a bond that represents a promise to pay a sum of money at a designated maturity rate, plus periodic interest at a specified rate on the maturity amount (face value). (p. 612). bond premium The difference between the face value of a bond and its selling price when the bond sells for more than face value. (p. 615). bonus Compensation in addition to regular salary or wages. Frequently the bonus amount depends on the company s yearly profit. The company shows the bonus expense in the income statement as an operating expense. If the bonus is not paid within the accounting period, the company includes the liability, Bonus Payable, as a current liability in the balance sheet. (p. 846). book value The difference between a depreciable asset s cost and its related accumulated depreciation. Book value of an asset generally differs from its market value because depreciation is a means of cost allocation, not of valuation. (p. 95). book value per share The amount each share of stock would receive if a company were liquidated, based on the amounts reported on the balance sheet. Computed as common stockholders equity divided by the number of outstanding shares of stock. But if the valuations on the balance sheet do not approximate the market value of the shares, the book value per share figure loses its relevance. (p. 700). callable bonds Bonds give the issuer the right to call and retire the bonds prior to maturity. (p. 613). callable preferred stock Preferred stock that permits the corporation, at its option, to call or redeem the outstanding preferred shares at specified future dates and stipulated prices. The callable feature enables the company to use the capital from the issuance of the preferred stock until the need has passed or it is no longer advantageous. (p. 685). capital expenditure Expenditure whose purpose is to create a new asset or to increase an asset s future benefits. Such expenditures are to be capitalized, rather than expensed. (p. 497). capital lease Agreement that allows one party (the lessee) to use the asset of another party (the lessor) and to account for the transaction as a purchase. The lease must be noncancelable and must meet one or more of four capitalization criteria. (p. 897). capital maintenance approach An income measurement approach in which a company determines income for the period based on the change in equity, after adjusting for capital contributions or distributions (dividends). An alternative to the transaction approach to income measurement. (p. 202) (ftn). capitalization criteria Four criteria for deciding if a lease qualifies as a capital lease. In addition to being noncancelable, the lease must meet one or more of the four criteria: (1) transfers ownership of the property to the lessee; (2) contains a bargain purchase option; (3) its lease term equals or exceeds 75 percent of the asset s economic life; (4) the present value

4 4 Glossary of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased asset. If a lease does not meet any of the four criteria, then it is classified and accounted for as an operating lease. (p. 897). capitalization of leases The process of accounting for leases in the same way a company would account for installment purchases. The FASB prescribes a capitalization approach when the lease is similar to an installment purchase, as determined by being noncancelable and by meeting one or more of four capitalization criteria. (p. 895). capitalization period The period of time during which a company must capitalize interest. The period lasts for as long as three conditions are present: expenditures for the asset have been made, activities needed to prepare the asset for its intended use are in progress, and interest cost is being incurred. (p. 523). carrying value The face amount of a bond minus any unamortized discount, or plus any unamortized premium. Synonymous with the term book value. (p. 640). cash Consists of coin, currency, and available funds on deposit at the bank, as well as negotiable instruments such as money orders, certified checks, cashier s checks, personal checks, and bank drafts. Cash, the most liquid of assets, is the standard medium of exchange and the basis for measuring all other items. Companies generally classify cash as a current asset. (p. 358). cash debt coverage ratio Measure of solvency that indicates a company s ability to repay its liabilities from cash generated from operations (without having to liquidate productive assets). Computed as the ratio of cash provided by operating activities to total debt, as represented by average total liabilities. (p. 271). cash discounts Reductions from the sales price, offered by sellers to buyers to induce prompt payment. Also called sales discounts. Cash discounts generally read in terms such as 2/10, n/30 (2 percent if paid within 10 days, gross amount due in 30 days). Companies can account for sales discounts using either the gross or the net method; most use the gross method, in which they record sales and related sales discount transactions by entering the receivable and sale at the gross amount and using a Sales Discount account only when they receive payment within the discount period. (p. 364). cash dividend payable An amount, payable in cash, that a corporation owes to its stockholders as a result of the board of directors dividend authorization. At the date of declaration, the dividend becomes a liability of the corporation, classified as a current liability. (p. 609). cash dividends Pro rata distributions of cash to a company s stockholders as of a certain date (date of declaration), as approved by the company s board of directors. A company may declare dividends either as a certain percent of par or as an amount per share. A declared cash dividend is a current liability of the company between the date of declaration and the payment date. Companies do not declare or pay cash dividends on treasury stock. (p. 689). cash equivalents Short-term, highly liquid investments that are both: (a) readily convertible to known amounts of cash, and (b) so near their maturity that they present insignificant risk of changes in interest rates. Generally, only investments with original maturities of 3 months or less qualify under this definition. Examples are Treasury bills, commercial paper, and money market funds purchased with cash that is in excess of immediate needs. (p. 252, 361). change in accounting estimate A changes that occurs as the result of new events, more experience, or additional information. Companies should not adjust previously reported results for changes in estimates, but should report them prospectively in the period of change if the change affects that period only, or in the period of change and future periods if the change affects both. (p. 942, 952). change in accounting estimate effected by a change in accounting principle Rule applied when it is impossible to determine whether a change in principle or a change in estimate has occurred. In such cases, a company considers the change as a change in estimate. (p. 952). change in accounting principle A change from one generally accepted accounting principle to another. A company reports a change in accounting principle using retrospective application. (p. 942). change in reporting entity A change from reporting as one type of entity to another type of entity. For example, a company might change the subsidiaries for which it prepares consolidated financial statements. (p. 942). changes in estimates Adjustments or changes that companies must make because financial circumstances did not turn out as expected. Companies account for changes in estimates in the period of change if they affect only that period, or in the period of change and future periods if the change affects both. They do not carry back such changes to prior years. Changes in estimate are not considered errors or extraordinary items. (p. 216). closing entries Journal entries made at the end of a company s annual accounting period to transfer the balances of temporary accounts to a permanent owners equity account (retained earnings or a capital account, depending on the company s form of organization). (p. 79, 105). closing process Accounting process at the end of the accounting period that reduces the balance of nominal (temporary) accounts to zero in order to prepare the accounts for the next period s transactions. In the closing process, the company transfers revenue and expense account balances to Income Summary, which matches expenses and revenues. (p. 104). commercial substance In accounting for exchanges of nonmonetary assets, the basis for measuring the gain or loss on an exchange. If the future cash flows change (if the two parties economic positions change) as a result of the transaction, the transaction is said to have commercial substance and the parties to the exchange recognize a gain or loss on the exchange. (p. 511). Committee on Accounting Procedure (CAP) Committee established by the AICPA in 1939 at the urging of the SEC to deal with accounting problems. The CAP issued 51 Accounting Research Bulletins and was replaced by the Accounting Principles Board in (p. 9). commodity-backed bonds Bonds that are redeemable in measures of a commodity (e.g., barrels of oil, tons of coal, or ounces of rare metal). Also called asset-linked bonds. The

5 Glossary 5 accounting problem for such bonds is to project their maturity value in markets where commodity prices fluctuate. (p. 613). common stock The basic ownership interest in a corporation, as evidenced by shares that represent proportional ownership. Holders of common stock bear the ultimate risks of loss (they are guaranteed neither dividends nor assets upon dissolution) and receive the benefits of success through distributions of dividends or sales at a gain. They also generally control the management of the corporation through voting rights. If a corporation has only one authorized issue of capital stock, that issue is by definition common stock. (p. 673) comparability One of the qualitative characteristics of accounting information, which describes information that is measured and reported in a similar manner for different companies. Comparability enables users to identify the real similarities and differences in economic activities between companies. (p. 41). compensated absences Paid absences from employment (e.g., for vacation, illness, and holidays). Companies accrue a liability for the cost of compensation for future absences and recognize the expense and related liability for compensated absences in the year in which the benefits are earned by employees. (p. 844). compensating balances Minimum cash balances in checking or savings accounts, required by some banks and other lending institutions in support for existing borrowing arrangements. Companies must disclose in the financial statements the details of deposits held as compensating balances. (p. 360). completed-contract method Revenue-recognition method in which companies recognize revenue and gross profit only at the point of sale the point at which a contract is deemed completed. Under this method, companies do not record interim charges or credits to income statement accounts for revenues, costs, and gross profit. (p. 314). completion-of-production basis Revenue-recognition method in which companies recognize revenue at the completion of production (e.g., mining of metals or harvesting of crops) even though no sale has been made. (p. 315) complex capital structure A capital structure that includes securities that could have a dilutive effect on earnings per common share. (p. 960). components of pension expense The components that make up a company s pension expense: service cost, interest on the liability, return on plan assets, amortization of prior service cost, and gain or loss. (p. 857). compound interest Interest that accrues on both the principal and the interest earned in past periods (interest not withdrawn or paid out). (p. 1003). comprehensive income Income measure that includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Comprehensive income includes: all revenues and gains, expenses and losses reported in net income, and all gains and losses that bypass net income but affect stockholders equity. These latter amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions. (p. 222). conceptual framework For the accounting profession, a coherent system of objectives and fundamentals established by the FASB, which determine the nature, function, and limits of financial accounting and which lead to consistent accounting standards. (p. 36). conservatism The convention in accounting that dictates that when in doubt, choose the solution that will be least likely to overstate assets and income. Conservatism, properly applied, provides a reasonable guide in difficult situations; if no doubt exists, there is no need to apply this constraint. (p. 56). consigned goods Inventory held by one party (the consignee) who acts as the agent for the owner of the goods (the consignor) in selling the goods. The consignee accepts and holds the consigned goods without any liability, except to exercise due care and reasonable protection from loss or damage until it sells the goods to a third party. When the consignee sells the goods, it remits the revenue to the consignor, less a selling commission and expenses incurred in accomplishing the sale. (p. 423). consistency One of the qualitative characteristics of accounting information, which indicates that a company applied the same accounting treatment to similar events from period to period. A company can change methods, but it must first demonstrate that the newly adopted method is preferable to the old and then must disclose in the financial statements the nature and effect of the accounting change. (p. 41). consolidated financial statements Financial statements that treat the parent and subsidiary corporations as a single economic entity. (p. 748). constraints One of the parts in the third level of the conceptual framework, there are two main overriding factors that limit (constrain) financial reporting: (1) the cost-benefit relationship and (2) materiality. (p. 53). contingency Material event with an uncertain future. The uncertainty can involve a possible gain (gain contingency) or possible loss (loss contingency) that will ultimately be resolved when one or more future events occur or fail to occur. Typical gain contingencies are tax operating loss carryforwards or company litigation against another party. Typical loss contingencies relate to litigation, environmental issues, possible tax assessments, or government investigations. (p. 163, 620). contingent liabilities Liabilities that depend on a contingency on the occurrence of one or more future events to confirm either the amount payable, the payee, the date payable, or its existence. (p. 621). contra account An account that reduces either an asset, liability, or owners equity account. Examples include Accumulated Depreciation and Discount on Bonds Payable. Use of contra accounts enables readers of financial statements to see the original cost of the asset, liability, or owners equity account as well as the changes in the account to date. (p. 169). contra asset account An account that offsets an asset account on the balance sheet. An example is the accumulated depreciation account, which companies use in order to disclose both the original cost of an asset and the total expired cost to date. (p. 95). contributed (paid-in) capital The total amount paid in on capital stock the amount provided by stockholders to the corporation for use in the business. Contributed capital

6 6 Glossary includes the par value of all outstanding stock plus additional paid-in capital (any excess over par value paid in by stockholders). (p. 674). controlling interest A relationship in which one corporation acquires a voting interest of more than 50 percent in another corporation. The investor corporation is referred to as the parent and the investee corporation as the subsidiary. Companies present the investment in the common stock of the subsidiary as a long-term investment on the separate financial statements of the parent. (p. 748). convertible bond Bond that permits its holder to exchange it for ( convert it to ) other corporate securities (typically common stock) for a specified period of time after issuance. The sale of a convertible bond is recorded like a straightdebt issue; upon conversion, the company records the securities exchanged for the bond at the carrying amount (book value) of the bond. The company amortizes, either at its maturity or upon conversion, any discount or premium that results from the issuance of the bond. (p. 613, 705). convertible preferred stock Preferred stock that allows stockholders, at their option, to exchange preferred shares for shares of common stock at a predetermined ratio. The convertible preferred stockholder not only enjoys a preferred claim on dividends but also has the option of converting into a common stockholder with unlimited participation in earnings. (p. 685). copyright A federally granted right that all authors, painters, musicians, sculptors, and other artists have in their creations and expressions. Granted for the life of the creator plus 70 years, it gives the owner, or heirs, the exclusive right to reproduce and sell an artistic or published work. A copyright is an artistic-related intangible asset. Companies may capitalize the costs of acquiring and defending a copyright. (p. 560). correction of an error Change to the financial statements due to an error of any sort (e.g., mathematical mistakes, bad faith changes in estimates, incorrect application of a generally accepted accounting principles, or incorrect classification). Companies must correct errors as soon as they discover them; they record corrections of errors from prior periods as adjustments to the beginning balance of retained earnings in the current period (called prior period adjustments). (p. 943, 954). cost flow assumptions Several systematic assumptions about the flow of inventory, used by companies to value their inventory. The main cost flow assumptions are specific identification, average-cost, FIFO, and LIFO. The actual physical movement of goods need not match the cost flow assumption a company adopts, but the company must use its selected cost flow assumption consistently from one period to the next. The objective should be to choose a cost flow assumption that most clearly reflects periodic income. (p. 426). cost method A method of accounting for treasury stock, in which a company debits a Treasury Stock account for the cost of reacquiring stock to be held in the treasury and reports this account as a deduction from total paid-in capital and retained earnings on the balance sheet. (p. 681). cost-benefit relationship An accounting constraint that requires that one weigh the costs of providing financial information against the benefits that can be derived from using it. The constraint applies to informational requirements established by standard-setting bodies and governmental agencies as well as to companies reporting financial information. (p. 53). cost-recovery method Revenue-recognition method in which companies recognize profit only when cash collections exceed the total cost of the goods sold. Any additional cash collection after the seller has recovered all costs is recorded as income. This method is required under FASB Statements No. 45 (franchises) and No. 66 (real estate) where a high degree of uncertainty exists related to the collection of receivables. (p. 320). cost-to-cost basis Technique that measures the percentage of completion on a contract by comparing costs incurred to date with the most recent estimate of the total costs to complete the contract. (p. 311). coverage ratios Measures of the degree of protection for long-term creditors and investors. Common coverage ratios are: debt to total assets, times interest earned, the cash debt coverage ratio, and book value per share. (p. 277). credit The right side of an account. Commonly abbreviated as Cr. (p. 79). cumulative preferred stock Preferred stock that requires that if a corporation fails to pay a dividend in any year, it must make it up in a later year before paying any dividends to common stockholders. Any passed dividend on cumulative preferred stock constitutes a dividend in arrears. A corporation does not record a dividend in arrears as a liability (because no liability exists until the board of directors declares a dividend), but discloses it in a note to the financial statements. (p. 685). current assets Cash and other assets a company expects to convert into cash, sell, or consume either in one year or in the operating cycle, whichever is longer. Companies present current assets in the balance sheet in order of liquidity. (p. 149). current cash debt coverage ratio Measure of liquidity that indicates a company s ability to pay its short-term debts. Computed as cash provided by operating activities divided by average current liabilities. (p. 270). current liabilities The obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities. This concept includes: payables resulting from the acquisition of goods and services; (2) collections received in advance for the delivery of goods or performance of services; and (3) other liabilities whose liquidation will take place within the operating cycle. Companies usually record and report current liabilities at their full maturity value with no adjustment for the time value of money. The slight overstatement of liabilities that results is accepted as immaterial. (p. 156, 607). current maturities of long-term debt The portion of bonds, mortgage notes, and other long-term indebtedness that will mature within the next fiscal year. However, long-term debts maturing currently as current liabilities are excluded from this category if they are to be: retired by assets accumulated for this purpose that properly have not been shown as current assets; refinanced or retired from the proceeds of a new debt issue; or converted into capital stock. (p. 609). current operating performance approach Income-reporting approach that advocates reporting only regular and recurring revenue and expense elements, but not irregular items, in income. (p. 209).

7 Glossary 7 current ratio Liquidity ratio that measures the ability of a company to meet its maturing obligations with its available assets and to meet unexpected needs for cash. Computed as total current assets divided by total current liabilities. (p. 634). current tax benefit (expense) The amount of income taxes refundable (payable/paid) for a year, as determined by applying the enacted tax rate to the taxable income or excess of deductions over revenues for the year. (p. 785, 799). debenture bonds Unsecured bonds, which are issued against the general credit of the borrower (issuer). (p. 613). debit The left side of an account. Commonly abbreviated as Dr. (p. 79). debt securities Financial securities that represent a creditor relationship with another entity. Examples are U.S. government securities, municipal securities, corporate bonds, convertible debt, and commercial paper. (p. 732). debt to total assets ratio Coverage ratio that measures the percentage of the total assets provided by creditors. Computed as total debt divided by total assets. The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations. (p. 635). decision usefulness Approach that requires that financial information be useful to investor and creditor decisions. (p. 38). declining-balance method Accelerated deprecation method that uses a depreciation rate (expressed as a percentage) that is some multiple of the straight-line method. Companies apply that constant rate to the declining book value of the asset at the beginning of each period. Applying the constant-declining-balance rate to a successively lower book value results in lower depreciation charges each year. This process continues until the book value of the asset equals its estimated salvage value, at which time the company discontinues depreciation. (p. 504). decreasing-charge method Depreciation methods that allow for higher depreciation charges in the early years and lower charges in later periods. Also called accelerated depreciation methods. Generally, companies use one of two decreasing-charge methods: sum-of-the-years -digits or declining-balance. (p. 504). deductible amounts A temporary difference between the tax basis of an asset/liability and its reported (carrying or book) amount in the financial statements that will decrease taxable income in future years. (p. 783). deductible temporary difference Temporary differences that will result in deductible amounts in future years, when the related book liabilities are settled. They give rise to recording deferred tax assets. Examples are: (1) expenses or losses that are deductible after they are recognized in financial income, and (2) revenues or gains that are taxable before they are recognized in financial income. (p. 792). deep-discount (zero-interest) debenture bonds Longterm, unsecured debt securities that do not bear interest. They are sold at a discount that provides the buyer s total interest payoff at maturity. Also called zero-interest debenture bonds. (p. 613). deferred annuity An annuity in which the rents begin after a specified number of periods. (p. 1023). deferred tax asset The increase in taxes refundable (or saved) in future years as a result of deductible temporary differences existing at the end of the current year. (p. 787). deferred tax expense (benefit) The change during the year in a company s deferred tax liabilities and assets. A deferred tax expense results from the increase in the deferred tax liability from the beginning to the end of the accounting period. A deferred tax benefit results from the increase in the deferred tax asset from the beginning to the end of the accounting period; it reduces income tax expense. (p. 785, 788). deferred tax liability The increase in taxes payable in future years as a result of taxable temporary differences existing at the end of the current year. (p. 784). defined-benefit plan A pension plan that outlines the benefits that the employee will receive at the time of retirement. These benefits typically are a function of the employee s years of service and compensation level when he or she nears retirement. (p. 855). defined-contribution plan A pension plan that defines only the employer s contribution. The employer agrees to contribute to a pension trust a certain sum each period, based on a formula that considers factors such as length of employee service, employer s profits, and compensation level. A common form is a 401(k) plan. (p. 854). deposit method Revenue-recognition method used in cases when companies receive cash from the buyer before transfer of the goods or property. Under this method, the seller reports the cash received from the buyer as a deposit on the contract and classifies it on the balance sheet as a liability, while continuing to report the property as an asset.the seller recognizes revenue and income only when the sale is complete. (p. 320). depreciation The process of allocating the cost of a tangible asset to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset. Depreciation is not a matter of valuation but rather a means of cost allocation. (p. 94, 500). depreciation base The cost of a tangible asset that will be allocated to expense through depreciation. The base established for depreciation is a function of two factors: an asset s original cost minus its salvage (disposal) value. (p. 501). designated market value The amount that a company compares to cost, when using the lower-of-cost-or market (LCM) rule. The designated market value is the middle value of three amounts: replacement cost, net realizable value, and net realizable value less a normal profit margin. (p. 443). detachable stock warrants A warrant (long-term option to buy common stock at a fixed price) that can be detached from the related security (a bond) and traded as a separate security for a specified period of time. To account for detachable stock warrants, companies separate debt issued with detachable warrants into debt and equity components, using either the proportional method or the incremental method. (p. 706). development activities Activities that translate research findings or other knowledge into a plan or design for a new product or process or for a significant improvement to an existing product or process, whether intended for sale or use. Companies are required to expense the costs of development activities as incurred. (p. 574).

8 8 Glossary diluted EPS The earnings per share for a complex capital structure. Diluted EPS begins with the basic EPS computation but includes the effect of all potential dilutive common shares outstanding during the period. It is computed as income available to common stockholders divided by weighted average shares outstanding, plus the impact of convertibles, options, warrants, and other dilutive securities. (p. 964). dilutive securities Securities that can be converted to common stock. Upon conversion or exercise by the holder, the dilutive securities reduce (dilute) earnings per share. Companies with dilutive securities report both basic EPS and diluted EPS in their income statements. (p. 964). direct effects of change in accounting principle Changes in assets and liabilities that result directly from making a change in accounting principle. An example is the change in the inventory balance when a company changes from one inventory method to another. Companies report direct effects retrospectively. (p. 948). direct write-off method A method for recording uncollectible accounts receivable by recording the bad debt in the period in which a company determines that it cannot collect a specific receivable. The direct write-off method is used for tax purposes but is otherwise not usually considered appropriate because it usually does not result in the proper carrying value for accounts receivable and it fails to match costs with revenues of the period. (p. 367). direct-financing lease Agreement that is in substance the financing of an asset purchase by the lessee.the lessor records a lease receivable (the present value of the minimum lease payments plus the present value of the unguaranteed residual value) instead of a leased asset. Companies often report the lease receivable in the balance sheet as Net investment in capital leases and classify it either as current or noncurrent, depending on when they recover the net investment. (p. 909). discontinued operation Occurs for a company when two things happen: (1) a company eliminates the results of operations and cash flows of a component from its ongoing operations, and (2) there is no significant continuing involvement in that component after the disposal transaction. Companies report a discontinued operation (in a separate income statement category), indicating the gain or loss from disposal of a business. In addition, companies report separately from continuing operations the results of operations of a component that has been, or will be, disposed of. (p. 210). discounting The process of reducing the amounts or values of cash flows from the future to the present, making the present value less than the future amount. (p. 1007). dividend in arrears A dividend on cumulative preferred stock that a company s board of directors fails to declare at the normal date for dividend action. Such a dividend is said to have been passed. The corporation must make up the passed dividend in a later year before it can pay any dividends to common stockholders. (p. 685). dollar-value LIFO A variation of the LIFO inventory-costing method; it determines and measures any increases and decreases in a pool in terms of total dollar value, not the physical quantity of the goods in the inventory pool. The dollar-value LIFO method overcomes the problems of redefining pools and eroding layers that occur with the regular LIFO method. (p. 434). double-declining-balance method Declining-balance depreciation method in which a company depreciates assets at twice (200 percent) the straight-line rate. (p. 504). double-entry accounting The universally used accounting system in which a company records the dual (two-sided) effect of each transaction in appropriate accounts. If a company records every transaction with equal debits and credits, then the sum of all the debits to the accounts must equal the sum of all the credits. (p. 79). earned (revenue) Revenue is considered earned when the company substantially accomplishes what it must do to be entitled to the benefits represented by the revenues. Generally, an objective test, such as a sale, indicates the point at which a company recognizes revenue and verifies the amount of revenue earned. (p. 48, 305). earned capital The capital that develops from a company s profitable operations. It consists of all undistributed income that remains invested in the company. Earned capital is differentiated from contributed (paid-in) capital that comes from stockholders purchase of capital stock. (p. 674). earnings management The planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings. In most cases, companies use earnings management to increase income in the current year at the expense of income in future years. (p. 201). earnings per share (EPS) A distilled and important income figure, calculated as net income minus preferred dividends (income available to common stockholders), divided by the weighted average of common shares outstanding. Companies must disclose earnings per share on the face of the income statement. (p. 220, 959). economic entity assumption An assumption that economic activity can be identified with a particular unit of accountability, by keeping an enterprise s economic activity separate and distinct from that of its owners and any other business unit. The entity assumption refers to economic, rather than legal, entities. (p. 45). effective tax rate The tax rate a company actually pays, computed as total income tax expense for the period divided by pretax financial income. It differs from the enacted tax rate because of deductions and provisions allowed by the tax code. (p. 795). effective yield The rate of return that takes into account the frequency of compounding. If compounding occurs more than once a year, the effective yield will exceed the stated rate. (p. 1006). effective yield, or market rate (applied to bonds) The rate of interest the bondholders actually earn on a bond. If bonds sell at a discount, the effective yield exceeds the stated rate; if bonds sell at a premium, the effective yield is lower than the stated rate. (p. 615). effective-interest method (applied to investments) Method for computing the amortization of a discount or premium. To compute interest revenue on a bond investment, companies compute the effective-interest rate or yield at the