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accounting
accounting
124
Accounting
Undergraduate 1
06/14/2011
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Term
Ethics—A Key Concept
 Definition
Ethics are beliefs that distinguish right from wrong or accepted standards of good from bad behavior. Ethics are beliefs that distinguish right from wrong or accepted standards of good from bad behavior.
Term
Generally Accepted Accounting Principles
 Definition
Accounting principles were historically developed through common usage. A principle was deemed acceptable if permitted by most professionals. Eventually the following groups of professionals were given authority to rule on and develop standards:
Term
Setting Accounting Principles
 Definition
The Financial Accounting Standards Board (FASB) is the private group that sets both broad and specific principles
Term
The Securities and Exchange Commission
 Definition
is the government group that establishes reporting requirements for companies that issue stock to the public.
Term
The International Accounting Standards Board (IASB)
 Definition
issues International Financial Reporting Standards (IFRS) that identify preferred accounting practices. The IASB hopes to create more harmony among accounting practices of different countries; however, it does not have the authority to impose its standards on companies.
Term
Cost principle—financial statements
 Definition
are based on actual costs incurred in business transactions. Cost is measured on a cash or equal-to-cash basis.
Term
Objectivity—financial statement information
 Definition
is supported by unbiased evidence, not someone's opinion sold, unless evidence shows that it will not continue.
Term
Going-concern assumption—financial statements
 Definition
are to reflect the assumption that the business will continue operating instead of being closed or sold.
Term
Monetary unit assumption—transactions and events
 Definition
are expressed in monetary, or money, units (generally the currency of the country in which the business operates). Accounting generally assumes a stable monetary unit. This means we do not account for change in the value of currency.
Term
Revenue recognition principle—
 Definition
provides guidance on when a company must recognize revenue; to recognize means to record it.
Term
Matching principle—
 Definition
a company must record its expenses incurred to generate the revenue reported.
Term
Full disclosure principle—
 Definition
a company must report the details behind financial statements that would impact users decisions.
Term
Business entity assumption—
 Definition
a business is accounted for separately and distinctly from its owner(s). A business entity can take one of three legal forms:
Term
Sole proprietorship
 Definition
is a business owned by one person that has unlimited liability. The business is not subject to an income tax but the owner is responsible for personal income tax on the net income of the entity.
Term
Partnership
 Definition
is a business owned by two or more people, called partners, who are subject to unlimited liability. The business is not subject to an income tax, but the owners are responsible for personal income tax on their individual share of the net income of the entity.
Term
Corporation
 Definition
is a business that is a separate legal entity whose owners are called shareholders or stockholders. These owners have limited liability. The entity is responsible for a business income tax.
Term
Sarbanes-Oxley (SOX)
 Definition
Congress passes the Sarbanes-Oxley Act to help curb financialabuses at public companies. SOX requires accounting oversight and stringent internal controls.
Term
Owner’s Equity
 Definition
is the owner’s claim on assets; equity is also called net assets or residual equity (interest).
Term
Contributed capital
 Definition
refers to the amount that stockholders invest in the company—included under the title common stock.
Term
Source documents
 Definition
identify and describe transactions and events. sources of accounting information and can be either hard copy or electronic. Examples are sales tickets, checks, purchase orders, bills from suppliers, employee earnings records, and bank statements. Source documents provide objective and reliable evidence about transactions and events.
Term
An account
 Definition
is a record of increases and decreases in a specific asset, liability, equity, revenue, or expense item
Term
general ledger,
 Definition
is a record containing all accounts used by a company.
Term
Asset Accounts
 Definition
resources owned or controlled by a company that have expected future benefits; examples include Cash, Accounts Receivable, Note Receivable, Prepaid Accounts, Supplies, Equipment, Buildings, and Land.
Term
Liability Accounts—
 Definition
claims by creditors against assets; obligations to transfer assets or provide products or services to others; examples include Accounts Payable, Note Payable, Unearned Revenue, and Accrued Liabilities.
Term
Creditors
 Definition
are individuals or organizations that have rights to receive payments from a company.
Term
Equity Accounts—
 Definition
owner’s residual interest in the assets of the business after deducting liabilities; examples include Common Stock, Dividends, Revenues, and Expenses.
Term
The chart of accounts
 Definition
is a list of all ledger accounts with their identification numbers.
Term
A T-account
 Definition
represents a ledger account and is used to understand the effects of one or more transactions.
Term
A journal
 Definition
gives a complete record of each transaction in one place; it shows the debits and credits for each transaction.
Term
journalizing
 Definition
The process of recording each transaction in a journal is called
Term
The time-period principle
 Definition
assumes that an organization’s activities can be divided into specific time periods such as a month, a three-month quarter, a six-month interval, or a year.
Term
annual financial statements.
 Definition
Reports covering a one-year period
Term
Interim financial statements
 Definition
cover one, three, or six months of activity.
Term
Fiscal year—any twelve consecutive months
 Definition
used to base annual financial reports on.
Term
Natural business year—
 Definition
a fiscal year that ends when a company's sales activities are at their lowest level for the year.
Term
Accrual basis accounting—
 Definition
uses the adjusting process to recognize revenue when earned and to match expenses with revenues. This means the economic effects of revenues and expenses are recorded when earned or incurred, not when cash is received or paid. Accrual basis is consistent with GAAP.
Term
Cash basis accounting—revenues
 Definition
are recognized when cash is received and expenses are recognized when cash is paid. The cash basis is not consistent with GAAP or IFRS.
Term
The revenue recognition principle
 Definition
requires revenue be recorded when earned, not before and not after.
Term
The expense recognition (matching principle)
 Definition
requires expenses be recorded in the same period as the revenues earned as a result of these expenses.
Term
Adjusting Accounts
 Definition
Adjusting accounts is a 3-step process: (1) Determine the current account balance, (2) Determine what the current account balance should be, and (3) Record adjusting entry to get from step 1to step 2.
Term
Framework for Adjustments
 Definition
Adjustments are necessary for transactions and events that extend over more than one period. Adjusting entries are necessary so that revenues, expenses, assets and liabilities are correctly reported. Each adjusting entry affects one or more income statement accounts and one or more balance sheet accounts (but never the cash account).
Term
Prepaid Expenses
 Definition
are items paid for in advance of receiving their benefits. Prepaid expenses are assets. When the assets are used, their costs become expenses.
Term
Plant assets
 Definition
are long-term tangible assets used to produce and sell products and services; they are expected to provide benefits for more than one period.
Term
Depreciation
 Definition
is the process of allocating the cost of plant and equipment assets over their expected useful lives.
Term
Straight-line depreciation
 Definition
allocates equal amounts of the assets’ net cost to depreciation during its useful life.
Term
A contra account
 Definition
is an account linked with another account, and having an opposite normal balance
Term
Book value
 Definition
is a term used to describe the asset’s cost less its contra-asset (accumulated depreciation).
Term
Unearned Revenues
 Definition
are liabilities created by cash received in advance of providing products or services. The company has an obligation to provide the service or product. As they are provided unearned revenues (liabilities) become earned revenues (revenues).
Term
Accrued expenses
 Definition
refer to costs that are incurred in a period but are both unpaid and unrecorded.
Term
Adjusting entries for recording accrued expenses involve
 Definition
increasing (debiting) expenses and increasing (crediting) liabilities. (The liability is a payable.)
Term
Future payment of accrued expenses generally results
 Definition
in cash payments in the next period. Debit the payable for amount accrued and credit cash for the full amount paid. If the amount paid exceeds the amount accrued, the difference is an expense in the current period.
Term
Accrued revenues
 Definition
refer to revenues earned in a period that are both unrecorded and not yet received in cash (or other assets). commonly result from services, products, interest, and rent.
Term
Adjusting entries
 Definition
for recording accrued revenues involve increasing (debit) assets and increasing (credit) revenues. (The asset is a receivable.)
Term
closing process
 Definition
is an important step at the end of the accounting period after financial statements have been completed. It prepares accounts for recording the transactions and the events of the next period.
Term
Steps in closing process:
 Definition
1.Identify accounts for closing. 2.Record and post closing entries. 3.Prepare a post-closing trial balance.
Term
Purpose of closing process:
 Definition
1.Resets revenue, expense, and dividend account balances to zero at the end of each period so that these accounts can properly measure income and dividends for the next period. 2.Helps in summarizing a period's revenues and expenses.
Term
Temporary (or nominal) accounts
 Definition
accumulate data related to one accounting period; they include all income statement accounts, the dividends account, and the Income Summary account. The closing process applies only to temporary accounts.
Term
Permanent (or real) accounts
 Definition
report on activities related to one or more future accounting periods. They carry their ending
Term
post-closing trial balance
 Definition
balance is a list of permanent accounts and their balances from the ledger after all closing entries have been journalized and posted.
Term
accounting cycle
 Definition
refers to the steps in preparing financial statements; it is a cycle because all steps are repeated each reporting period.
Term
The operating cycle
 Definition
is the time span from when cash is used to acquire goods and services until cash is received from their sale. Most operating cycles are less than one year; a few companies have an operating cycle longer than one year.
Term
Current Assets—
 Definition
cash or other assets that are expected to be sold, collected, or used within one year or the company’s operating cycle, whichever is longer. Examples: cash, short term investments, accounts receivable, short-term notes receivable, goods for sale (called merchandise or inventory), and prepaid expenses.
Term
Long-Term Investments—
 Definition
assets that are expected to be held for more than the longer of one year or the operating cycle. Examples: notes receivable, investments in stocks, and land held for future expansion.
Term
Plant Assets—
 Definition
tangible, long lived assets that are both long-lived and used to produce or sell products and services. Examples: equipment, machinery, buildings, and land that are used to produce or sell products and services.
Term
Intangible Assets—
 Definition
long-term resources that benefit business operations. They usually lack physical form and have uncertain benefits. Examples: patents, trademarks, copyrights, franchises, and goodwill.
Term
Current Liabilities—
 Definition
obligations due to be paid or settled within one year or the operating cycle, whichever is longer. Examples: accounts payable, notes payable, wages payable, taxes payable, interest payable, and unearned revenues. Any portion of a long-term liability due to be paid within one year or the operating cycle, whichever is longer, is a current liability.
Term
Long Term Liabilities—
 Definition
obligations not due within one year or the operating cycle, whichever is longer. Examples: notes payable, mortgages payable, bonds payable, and lease obligations.
Term
Equity—owners’ claim on assets; divided into two main subsections:
 Definition
common stock and retained earnings.
Term
Adjusting Accounts and the Closing Process –
 Definition
Both GAAP and IFRS include broad and similar guidance for adjusting accounts. All of the adjustments in this chapter are accounted for identically under the two systems. The closing process is also identical under both systems.
Term
Preparing Financial Statements –
 Definition
Both GAAP and IFRS prepare the same four financial statements following the same process discussed in this chapter. GAAP balance sheets report assets in order of liquidity and liabilities are listed from nearest maturity to furthest. IFRS balance sheets present noncurrent items first and equity before liabilities, but this is not a requirement.
Term
The definition of an asset is similar
 Definition
under both systems and involve three basic criteria: the company owns or controls the right to use the item; the right arises from a past transaction or event; and the item can be reliably measured. Both define the initial asset value as historical cost. After acquisition, one of two asset measurement systems are applied: historical cost or fair value. GAAP defines fair value as the amount to be received in an orderly sale. IFRS defines fair value as exchange value –either replacement cost or selling price.
Term
The definition of a liability is similar
 Definition
under GAAP and IFRS and involves three basic criteria: the item is a present obligation requiring a probably future resource outlay; the obligation arises from a past transaction or event, and the obligation can be reliably measured. Both systems apply one of two measurement systems to specific liabilities: historical cost or fair value.
Term
Profit margin (also called return on sales)
 Definition
is a useful measure of a company’s operating results. It is calculated as net income divided by net sales.
Term
The current ratio
 Definition
is an important measure of a company’s ability to pay its short-term obligations. It is calculated as total current assets divided by total current liabilities.
Term
Reversing entries are optional;
 Definition
they are recorded in response to accrued assets and accrued liabilities that were created by adjusting entries at the end of a reporting period.
Term
Merchandising Activities
 Definition
Products that a company acquires to resell to customers are referred to as merchandise (also called goods). A merchandiser earns net income by buying and selling merchandise. A wholesaler is an intermediary that buys products from manufacturers or other wholesalers and sells them to retailers or other wholesalers.
Term
Revenue (net sales)
 Definition
from selling merchandise minus the cost of goods sold (the expense of buying and preparing the merchandise) to customers is called gross profit (also called gross margin). This amount minus expenses (generally called operating expenses) determines the net income or loss for the period.
Term
A merchandiser's balance sheet
 Definition
is the same as a service business with the exception of one additional current asset, merchandise inventory, or simply inventory.
Term
The cost of Merchandising
 Definition
includes the cost incurred to buy the goods, ship them to the store, and make them ready for sale.
Term
A merchandising company’s operating cycle
 Definition
begins by purchasing merchandise and ends by collecting cash from selling the merchandise. Companies try to keep their operating cycles short because assets tied up in inventory and receivables are not productive.
Term
Merchandise available for sale
 Definition
consists of beginning inventory and what it purchases (net purchases). The merchandise available is either sold (cost of goods sold) or kept for future sales (ending inventory).
Term
Two alternative inventory systems
 Definition
are used to collect information about cost of goods sold and the cost of inventory:
Term
Perpetual inventory system—
 Definition
continually updates accounting records for merchandise transactions, specifically, for those records of inventory available for sale and inventory sold.
Term
Periodic inventory system—
 Definition
updates the accounting records for merchandise transactions only at the end of a period.
Term
hybrid system
 Definition
where the perpetual system is used for tracking units available and the periodic system is used to compute cost of sales.
Term
In catalogs,
 Definition
each item has a list price or catalog price. An item’s intended selling price equals list price minus a given percent called a trade discount.
Term
The buyer and seller must agree
 Definition
on who is responsible for paying any freight costs and who bears the risk of loss during transit for merchandising transactions. The point of transfer is called the FOB (free on board) point.
Term
FOB shipping point—
 Definition
buyer accepts ownership when goods depart sellers’ place of business; buyer pays shipping costs.
Term
Shipping costs
 Definition
increase the cost of merchandise acquired (cost principle).
Term
Entry for buyer to record shipping costs:
 Definition
Debit Merchandise Inventory, credit Cash or Accounts Payable (if to be paid with merchandise later).
Term
FOB destination—
 Definition
ownership of goods transfers to buyer when goods arrive at buyer’s place of business; seller pays shipping costs.
Term
Shipping costs
 Definition
are an operating (selling) expense for seller
Term
Entry for seller to record shipping costs:
 Definition
Debit Delivery Expense (or Transportation-Out or Freight-Out), credit Cash.
Term
Sales returns—merchandise
 Definition
a customer returns to the seller after a sale.
Term
Sales allowances—
 Definition
reductions in the selling price of merchandise sold to customers (usually for damaged or defective merchandise that a customer is willing to keep at a reduced price).
Term
Entry for seller to record sales returns or allowances:
 Definition
debit Sales Returns and Allowances and credit Accounts Receivable; additional entry if returned merchandise is salable: debit Merchandise Inventory, credit Cost of Goods Sold.
Term
Seller prepares a credit memorandum
 Definition
to inform buyer of the seller’s credit to the buyer’s Accounts Receivable (on the seller’s books).
Term
Financial Statement Formats—
 Definition
No specific format is required in practice. Two common income statement formats:
Term
Nonoperating activities—
 Definition
consist of other expenses, revenues, losses, and gains that are unrelated to a company’s operations; reported in two sections:
Term
A single-step income statement
 Definition
includes cost of goods sold as an operating expense and shows only one subtotal for total expenses, one subtraction to arrive at net income.
Term
The merchandiser’s classified balance sheet
 Definition
reports merchandise inventory as a current asset, usually after accounts receivable.
Term
Accounting and Reporting for Merchandising Purchases and Sales –
 Definition
Both GAAP and IFRS include similar guidance in accounting for merchandise purchases and sales. All of the transactions presented in this chapter, including the closing process, are accounted for identically under the two systems.
Term
Income Statement Presentation –
 Definition
IFRS tends to use the term profit more than any other term. GAAP statements use net income the most. Both GAAP and IFRS income statements begin with net sales (or net revenue) followed by cost of goods sold for merchandisers/manufacturers.
Term
Balance Sheet Presentation –
 Definition
GAAP balance sheets report current items first, with assets listed from most liquid to least liquid and liabilities are listed from nearest to maturity to furthest from maturity. IFRS balance sheets present noncurrent items first but this is not a requirement. Notes
Term
The acid-test ratio
 Definition
is used to assess the company's liquidity or ability to pay its current debts; it differs from the current ratio by excluding less liquid current assets.
Term
acid test ratio (2)
 Definition
calculated by dividing quick assets by current liabilities; quick assets are cash, short-term investments, and current receivables.
Term
Rule of thumb is that the acid-test ratio should have a value
 Definition
of at least 1.0 to conclude that a company is unlikely to face near-term liquidity problems.
Term
The gross margin ratio (also called gross profit ratio)
 Definition
is used to assess a company’s profitability before considering operating expenses.
Term
gross margin ratio
 Definition
calculated by dividing gross margin (net sales – cost of goods sold) by net sales.
Term
Periodic Inventory System
 Definition
Records merchandise acquisitions, discounts and returns in temporary accounts (Purchases, Purchase Returns, Purchases Discounts) rather than the merchandise inventory account. Records only the revenue aspect of sales-related events; updates inventory and determines cost of goods sold only at the end or the accounting period. The Merchandise Inventory account can be updated as part of the adjusting or closing process.
Term
Recordkeeping, or bookkeeping
 Definition
, is the recording of transactions and events, either manually or electronically. As technology has changed the way we store, process, and summarize large masses of data, accounting has been freed to expand to include major consulting, planning and other financial areas.
Term
Accounting
 Definition
is an information and measurement system that identifies, records and communicates relevant, reliable, and comparable information about an organization’s business activities.
Term
The four steps necessary to close temporary accounts are:
 Definition
a. Close credit balances in revenue (and gain) accounts to Income Summary; bring accounts with credit balances to zero by debiting them.
b. Close debit balances in expense (and loss) accounts to Income Summary; bring accounts with debit balances to zero by crediting them.
c. Close the Income Summary account to the Retained Earnings account; after the first two steps, the balance of the Income Summary account is equal to the period’s net income. If a net loss occurred, the third entry is reversed: debit Retained Earnings and credit Income Summary.
d. Close the Dividends account to the Retained Earnings account; bring the Dividends account, which has a debit balance, to zero by crediting it.
Term
Steps in accounting cycle:
 Definition
1. Analyze transactions
2. Journalize
3. Post
4. Prepare unadjusted trial balance
5. Adjust
6. Prepare adjusted trial balance
7. Prepare statements
Term
Alternative Accounting for Prepayments (Appendix 3A)
 Definition
A. Recording Prepayment of Expenses in Expense Accounts
Prepaid expenses may originally be recorded with debits to expense accounts (instead of to asset accounts). If so, then adjusting entries must transfer the cost of the unused portions from expense accounts to prepaid expense (asset) accounts.
B. Recording Prepayment of Revenues in Revenue Accounts
Unearned revenues may originally be recorded with credits to revenue accounts (instead of to liability accounts). If so, then adjusting entries must transfer the unearned portions from revenue accounts to unearned revenue (liability) accounts.
C. Note that the financial statements are identical under either procedure, but the adjusting entries are different.
Term
Preparing a work sheet has five important steps:
 Definition
1. Enter the unadjusted trial balance in the first two columns.
2. Enter the adjustments in the third and fourth columns. Total columns to verify debit adjustments equal credit adjustments.
3. Prepare the Adjusted Trial Balance. This is done by combining the unadjusted trial balance and adjustment columns. Total Adjusted Trial Balance columns to verify debits equal credits.
4. Sort the adjusted trial balance amounts to the appropriate financial statement columns.
5. Total statement columns, compute net income or loss, and balance the columns by adding net income or loss.
Term
Credit terms for a purchase
 Definition
include the amounts and timing of payments from a buyer to a seller. The amount of time before full payment is due is called the credit period.
1.Sellers can grant a cash discount to encourage the buyer to pay earlier. A seller views a cash discount as a sales discount and a buyer views a cash discount as a purchase discount. This reduced payment applies only for the discount period.
2.Example: credit terms, 2/10 n/30, offers a 2 % discount if the invoice is paid within 10 days of invoice date.
3.Entry for buyer for purchase of merchandise on credit: debit Merchandise Inventory, credit Accounts Payable.
4.Entry for buyer to record payment within discount period: debit Accounts Payable (full invoice amount), credit Cash (amount paid = invoice – discount), credit Merchandise Inventory (amount of discount).
C.Purchase Returns and Allowances
1.Purchase returns refer to merchandise a buyer acquires but then returns to the seller.
2.A purchase allowance is a reduction in the cost of defective or unacceptable merchandise that a buyer acquires.
3.The buyer issues a debit memorandum to inform the seller of a debit made to the supplier's account.
4.Entry for buyer to record purchase return or allowance: debit Accounts Payable or Cash (if refund given) and credit Merchandise Inventory.
5.When goods are returned, a buyer can take a purchase discount on only the remaining balance of the invoice.
Term
A.Sales of Merchandise
 Definition
Each sales transaction involves two parts and will therefore require two entries:
1.Recognize revenue received —entry for seller to record: debit Accounts Receivable (or cash), credit Sales (for the invoice amount).

2.Recognize cost of merchandise sold— entry for seller to record: debit Cost of Goods Sold, credit Merchandise Inventory (for the cost of the merchandise sold).
Term
Sales Discounts
 Definition
Sales discounts are usually not recorded until a customer actually pays with the discount period.
1.Entry for seller to record collection after discount period—Debit Cash, Credit Accounts Receivable (full invoice amount).
2.Entry for seller to record collection within discount period—debit Cash (invoice amount less discount), debit Sales Discounts (discount amount), credit Accounts Receivable (invoice amount).
3.Sales Discounts is a contra-revenue account; it is subtracted from Sales when computing a company’s net sales.
4.Sales discounts are monitored to assess the effectiveness and cost of its discount policy.
Term
A multiple-step income statement has three main parts:
 Definition
a.Gross profit—net sales minus cost of goods sold),
b.Income from operations—gross profit less operating expenses, and
c.Net income—income from operations adjusted for nonoperating items.
Term
2.Operating expenses are classified into two sections:
 Definition
a.Selling expenses—
b.General and administrative expenses—
Term
Selling expenses—
 Definition
the expenses of promoting sales, making sales, and delivering goods to customers,
Term
General and administrative expenses
 Definition
expenses related to accounting, human resource management, and financial management.
Term
Nonoperating activities
 Definition
a.Other revenues and gains—interest revenue, dividend revenue, rent revenue, and gains from asset disposals.
b. Other expenses and losses—interest expense, losses from asset disposals, and casualty losses.
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