It is not easy to provide a concise definition of accounting since the word has a broad application within businesses and applications.
The American Accounting Association define accounting as follows:
"the process of identifying, measuring and communicating economic information to permit informed judgements and decisions by users of the information!.
This definition is a good place to start. Let's look at the key words in the above definition:
- It suggests that accounting is about providing information to others. Accounting information is economic information - it relates to the financial or economic activities of the business or organisation.
- Accounting information needs to be identified and measured. This is done by way of a "set of accounts", based on a system of accounting known as double-entry bookkeeping. The accounting system identifies and records "accounting transactions".
- The "measurement" of accounting information is not a straight-forward process. it involves making judgements about the value of assets owned by a business or liabilities owed by a business. it is also about accurately measuring how much profit or loss has been made by a business in a particular period. As we will see, the measurement of accounting information often requires subjective judgement to come to a conclusion
- The definition identifies the need for accounting information to be communicated. The way in which this communication is achieved may vary. There are several forms of accounting communication (e.g. annual report and accounts, management accounting reports) each of which serve a slightly different purpose. The communication need is about understanding who needs the accounting information, and what they need to know!
Accounting information is communicated using "financial statements"
What is the purpose of financial statements?
There are two main purposes of financial statements:
(1) To report on the financial position of an entity (e.g. a business, an organisation);
(2) To show how the entity has performed (financially) over a particularly period of time (an "accounting period").
The most common measurement of "performance" is profit.
It is important to understand that financial statements can be historical or relate to the future.
Accountability
Accounting is about ACCOUNTABILTY
Most organisations are externally accountable in some way for their actions and activities. They will produce reports on their activities that will reflect their objectives and the people to whom they are accountable.
The table below provides examples of different types of organisations and how accountability is linked to their differing organisational objectives:
Organisation
Objectives
Accountable to (examples)
Private or public company (e.g. BP, Tesco)
- Making of profit - Creation of wealth
- Shareholders - Other stakeholders (e.g. employees, customers, suppliers)
Charities (e.g. Save the Children)
- Achievement of charitable aims - Maximise spending on activities
- Charity commissioners - Donors
Local Authorities (e.g. Leeds City Council)
- Provision of local services - Optimal allocation of spending budget
- Local electorate - Government departments
Public services (e.g. transport, health) (e.g. National Health Service, Prison Service)
- Provision of public service (often required by law) - High quality and reliability of services
- Government ministers - Consumers
Quasi-governmental agencies (e.g. Data Protection Registrar, Scottish Arts Council)
- Regulation or instigation of some public action - Coordination of public sector investments
- Government ministers - Consumers
All of the above organisations have a significant roles to play in society and have multiple stakeholders to whom they are accountable.
All require systems of financial management to enable them to produce accounting information.
How accounting information helps businesses be accountable
As we have said in our introductory definition, accounting is essentially an "information process" that serves several purposes:
- Providing a record of assets owned, amounts owed to others and monies invested;
- Providing reports showing the financial position of an organisation and the profitability of its operations
- Helps management actually manage the organisation
- Provides a way of measuring an organisation's effectiveness (and that of its separate parts and management)
- Helps stakeholders monitor an organisations activities and performance
- Enables potential investors or funders to evaluate an organisation and make decisions
There are many potential users of accounting Information, including shareholders, lenders, customers, suppliers, government departments (e.g. Inland Revenue), employees and their organisations, and society at large. Anyone with an interest in the performance and activities of an organisation is traditionally called a stakeholder.
For a business or organisation to communicate its results and position to stakeholders, it needs a language that is understood by all in common. Hence, accounting has come to be known as the "language of business"
There are two broad types of accounting information:
(1) Financial Accounts: geared toward external users of accounting information (2) Management Accounts: aimed more at internal users of accounting information
Although there is a difference in the type of information presented in financial and management accounts, the underlying objective is the same - to satisfy the information needs of the user. These needs can be described in terms of the following overall information objectives:
Collection
Collection in money terms of information relating to transactions that have resulted from business operations
Recording and Classifying
Recording and classifying data into a permanent and logical form. This is usually referred to as "Book-keeping"
Summarising
Summarising data to produce statements and reports that will be useful to the various users of accounting information - both external and internal
Interpreting and Communicating
Interpreting and communicating the performance of the business to the management and its owners
Forecasting and Planning
Forecasting and planning for future operation of the business by providing management with evaluations of the viability of proposed operations. The key forecasting and planning tool is the "Budget"
The process by which accounting information is collected, reported, interpreted and actioned is called "Financial Management". Taking a commercial business as the most common organisational structure, the key objectives of financial management would be to:
(1) Create wealth for the business (2) Generate cash, and (3) Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested
In preparing accounting information, care should be taken to ensure that the information presents an accurate and true view of the business performance and position. To impose some order on what is a subjective task, accounting has adopted certain conventions and concepts which should be applied in preparing accounts.
For financial accounts, the regulation or control of what kind of information is prepared and presented goes much further. UK and international companies are required to comply with a wide range of Accounting Standards which define the way in which business transactions are disclosed and reported. These are applied by businesses through their Accounting Policies.
The main financial accounting statements
The purpose of financial accounting statements is mainly to show the financial position of a business at a particular point in time and to show how that business has performed over a specific period.
The three main financial accounting statements that help achieve this aim are:
(1) The profit and loss account for the reporting period
(2) A balance sheet for the business at the end of the reporting period
(3) A cash flow statement for the reporting period
A balance sheet shows at a particular point in time what resources are owned by a business ("assets") and what it owes to other parties ("liabilities"). It also shows how much has been invested in the business and what the sources of that investment finance were.
It is often helpful to think of a balance sheet as a "snap-shot" of the business - a picture of the financial position of the business at a specific point. Whilst this is a useful picture to have, every time an accounting transaction takes place, the "snap-shot" picture will have changed.
By contrast, the profit and loss account provides a perspective on a longer time-period. If the balance sheet is a "digital snap-shot" of the business, then think of the profit and loss account as the "DVD" of the business' activities. The story of what financial transactions took place in a particular period - and (most importantly) what the overall result of those transactions was.
Not surprisingly, the profit and loss account measures "profit".
What is profit?
Profit is the amount by which sales revenue (also known as "turnover" or "income") exceeds "expenses" (or "costs") for the period being measured.
There are two main forms of accounting information:
(1) Financial Accounts, and
(2) Management Accounts
Financial Accounts - A Definition
Financial accounts are concerned with classifying, measuring and recording the transactions of a business. At the end of a period (typically a year), the following financial statements are prepared to show the performance and position of the business:
Profit and Loss Account
Describing the trading performance of the business over the accounting period
Balance Sheet
Statement of assets and liabilities at the end of the accounting period (a "snapshot") of the business
Cash Flow Statement
Describing the cash inflows and outflows during the accounting period
Notes to the Accounts
Additional details that have to be disclosed to comply with Accounting Standards and the Companies Act
Directors' Report
Description by the Directors of the performance of the business during the accounting period + various additional disclosures, particularly in relation to directors' shareholdings, remuneration etc
Financial accounts are geared towards external users of accounting information. To answer their needs, financial accountants draw up the profit and loss account, balance sheet and cash flow statement for the company as a whole in order for users to answer questions such as:
- "Should I invest my money in this company?"
- "Should I lend money to this business?"
- "What are the profits on which this company must pay tax?"
Company Law Requirements for Financial Accounts
Every UK company registered under the Companies Act is required to prepare a set of accounts that give a true and fair view of its profit or loss for the year and of its state of affairs at the year end. Annual accounts for Companies Act purposes generally include:
- A directors’ report - An audit report - A profit and loss account - A balance sheet - A statement of total recognised gains and losses - A cash flow statement - Notes to the accounts
If the company is a "parent company", (in other words, the company also owns other companies - subsidiaries) then "consolidated accounts" must also be prepared. Again there are exceptions to this requirement (see consolidated accounts).
Comparative figures should also be given for almost all items and analysis given in the year end financial statements. Exceptions to this rule are given individually. For example, there is no requirement to give comparative figures for the notes detailing the movements in the year on fixed asset or reserves balances.
In drawing up accounting statements, whether they are external "financial accounts" or internally-focused "management accounts", a clear objective has to be that the accounts fairly reflect the true "substance" of the business and the results of its operation.
The theory of accounting has, therefore, developed the concept of a "true and fair view". The true and fair view is applied in ensuring and assessing whether accounts do indeed portray accurately the business' activities.
To support the application of the "true and fair view", accounting has adopted certain concepts and conventions which help to ensure that accounting information is presented accurately and consistently.
Accounting Conventions
The most commonly encountered convention is the "historical cost convention". This requires transactions to be recorded at the price ruling at the time, and for assets to be valued at their original cost.
Under the "historical cost convention", therefore, no account is taken of changing prices in the economy.
The other conventions you will encounter in a set of accounts can be summarised as follows:
Monetary measurement
Accountants do not account for items unless they can be quantified in monetary terms. Items that are not accounted for (unless someone is prepared to pay something for them) include things like workforce skill, morale, market leadership, brand recognition, quality of management etc.
Separate Entity
This convention seeks to ensure that private transactions and matters relating to the owners of a business are segregated from transactions that relate to the business.
Realisation
With this convention, accounts recognise transactions (and any profits arising from them) at the point of sale or transfer of legal ownership - rather than just when cash actually changes hands. For example, a company that makes a sale to a customer can recognise that sale when the transaction is legal - at the point of contract. The actual payment due from the customer may not arise until several weeks (or months) later - if the customer has been granted some credit terms.
Materiality
An important convention. As we can see from the application of accounting standards and accounting policies, the preparation of accounts involves a high degree of judgement. Where decisions are required about the appropriateness of a particular accounting judgement, the "materiality" convention suggests that this should only be an issue if the judgement is "significant" or "material" to a user of the accounts. The concept of "materiality" is an important issue for auditors of financial accounts.
Accounting Concepts
Four important accounting concepts underpin the preparation of any set of accounts:
Going Concern
Accountants assume, unless there is evidence to the contrary, that a company is not going broke. This has important implications for the valuation of assets and liabilities.
Consistency
Transactions and valuation methods are treated the same way from year to year, or period to period. Users of accounts can, therefore, make more meaningful comparisons of financial performance from year to year. Where accounting policies are changed, companies are required to disclose this fact and explain the impact of any change.
Prudence
Profits are not recognised until a sale has been completed. In addition, a cautious view is taken for future problems and costs of the business (the are "provided for" in the accounts" as soon as their is a reasonable chance that such costs will be incurred in the future.
Matching (or "Accruals")
Income should be properly "matched" with the expenses of a given accounting period.
Key Characteristics of Accounting Information
There is general agreement that, before it can be regarded as useful in satisfying the needs of various user groups, accounting information should satisfy the following criteria:
Criteria
What it means for the preparation of accounting information
Understandability
This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities
Relevance
This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view - usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?)
Consistency
This implies consistent treatment of similar items and application of accounting policies
Comparability
This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability.
Reliability
This implies that the accounting information that is presented is truthful, accurate, complete (nothing significant missed out) and capable of being verified (e.g. by a potential investor).
Objectivity
This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest
There is general agreement that, before it can be regarded as useful in satisfying the needs of various user groups, accounting information should satisfy the following criteria:
Understandability
This implies the expression, with clarity, of accounting information in such a way that it will be understandable to users - who are generally assumed to have a reasonable knowledge of business and economic activities
Relevance
This implies that, to be useful, accounting information must assist a user to form, confirm or maybe revise a view - usually in the context of making a decision (e.g. should I invest, should I lend money to this business? Should I work for this business?)
Consistency
This implies consistent treatment of similar items and application of accounting policies
Comparability
This implies the ability for users to be able to compare similar companies in the same industry group and to make comparisons of performance over time. Much of the work that goes into setting accounting standards is based around the need for comparability.
Reliability
This implies that the accounting information that is presented is truthful, accurate, complete (nothing significant missed out) and capable of being verified (e.g. by a potential investor).
Objectivity
This implies that accounting information is prepared and reported in a "neutral" way. In other words, it is not biased towards a particular user group or vested interest
It is easy to assume that the only users of accounting information are shareholders - since it is a requirement of company law that shareholders must receive periodic accounting statements. However, in reality there are many users of accounts. The table below summarises the main user groups and provides examples of their areas of interest in accounts:
User
Interest in / Use of Accounting Information
Investors
Investors are concerned about risk and return in relation to their investments. They require information to decide whether they should continue to invest in a business. They also need to be able to assess whether a business will be able to pay dividends, and to measure the performance of the business' management overall. The key accounting information for an investor is therefore:
- Information about growth - sales, volumes - Profitability (profit margins, overall level of profit) - Investment (amounts invested, assets owned) - Business value (share price) - Comparative information of competitors
Lenders
Banks and loan stockholders who lend money to a business require information that helps them determined whether loans and interest will be paid when due. The key accounting information for lenders is therefore:
- Cash flow - Security of assets against which the lending may be secured - Investment requirements in the business
Creditors
Suppliers and trade creditors requirement information that helps them understand and assess the short-term liquidity of a business. Is the business able to pay short-term debt when it falls due? Creditors will, therefore, be looking for information on:
- Cash flow - Management of working capital - Payment policy
Debtors
Customers and trade debtors require information about the ability of the business to survive and prosper. As customers of the company's products, they have a long-term interest in the company's range of products and services. They may even be dependent on the business for certain products or services. Customer will be particularly interested in:
- Sales growth - New product development - Investment in the business (e.g. production capacity)
Employees
Employees (and organisations that represent them - e.g. trade unions) require information about the stability and continuing profitability of the business. They are crucially interested in information about employment prospects and the maintenance of pension funding and retirement benefits. They are also likely to interested in the pay and benefits obtained by senior management!. Employees will, therefore look for information on:
- Revenue and profit growth - Levels of investment in the business - Overall employment data (numbers employed, wage and salary costs) - Status and valuation of company pension schemes / levels of company pension contributions
Government
There are many government agencies and departments that are interested in accounting information. For example, the Inland Revenue needs information on business profitability in order to levy and collect Corporation Tax. Customs & Excise need accounting information to verify Value Added Tax ("VAT") returns; local government need similar information to levy local taxes and rates. Various regulatory agencies (e.g. the Competition Commission and the Environment Agency) need information to support decisions about takeovers and grants, for example.
Analysts
Investment analysts are an important user group - specifically for companies quoted on a stock exchange. They require very detailed financial and other information in order to analyse the competitive performance of a business and its sector. Much of this is provided by the detailed accounting disclosures that are required by authorities such the London Stock Exchange. However, additional accounting information is usually provided to analysts via informal company briefings and interviews.
Public at large
Interest groups, formed by various groups of individuals who have a specific interest in the activities and performance of businesses, will also require accounting information.
There are two broad types of accounting information:
• Financial Accounts: geared toward external users of accounting information
• Management Accounts: aimed more at internal users of accounting information
Although there is a difference in the type of information presented in financial and management accounts, the underlying objective is the same - to satisfy the information needs of the user.
Financial Accounts
Management Accounts
Financial accounts describe the performance of a business over a specific period and the state of affairs at the end of that period.� The specific period is often referred to as the "Trading Period" and is usually one year long.� The period-end date as the "Balance Sheet Date"
Management accounts are used to help management record, plan and control the activities of a business and to assist in the decision-making process.� They can be prepared for any period (for example, many retailers prepare daily management information on sales, margins and stock levels).
Companies that are incorporated under the Companies Act 1989 are required by law to prepare and publish financial accounts.� The level of detail required in these accounts reflects the size of the business with smaller companies being required to prepare only brief accounts.
There is no legal requirement to prepare management accounts, although few (if any) well-run businesses can survive without them.
The format of published financial accounts is determined by several different regulatory elements:
� Company Law
� Accounting Standards
� Stock Exchange
There is no pre-determined format for management accounts.� They can be as detailed or brief as management wish.
Financial accounts concentrate on the business as a whole rather than analysing the component parts of the business.� For example, sales are aggregated to provide a figure for total sales rather than publish a detailed analysis of sales by product, market etc.
Management accounts can focus on specific areas of a business' activities.� For example, they can provide insights into performance of:
� Products
� Separate business locations (e.g. shops)
� Departments / divisions
Most financial accounting information is of a monetary nature
Management accounts usually include a wide variety of non-financial information.� For example, management accounts often include analysis of:
- Employees (number, costs, productivity etc.)
- Sales volumes (units sold etc.)
-Customer transactions (e.g. number of calls received into a call centre)
By definition, financial accounts present a historic perspective on the financial performance of the business
Management accounts largely focus on analysing historical performance.� However, they also usually include some forward-looking elements - e.g. a sales budget; cash-flow forecast.
Costing system wherein fixed manufacturing overhead is allocated to (or absorbed by) products being manufactured. This system, which treats fixed manufacturing costs as a product cost, is required for external financial statements.
Accelerated depreciation
The allocation of the cost of a plant asset to expense in an accelerated manner. This means that the amount of depreciation in the earlier years of an asset's life is greater than the straight-line amount, but will be less in the later years. In total the amount of depreciation over the life of the asset will be the same as straight-line depreciation. The difference between accelerated and straight-line is the timing of the depreciation. For profitable companies, the use of accelerated depreciation on the income tax return will mean smaller cash payments for income taxes in the earlier years and higher cash payments for income taxes in later years. To learn more,Explanation of Depreciation.
Account
A record in the general ledger that is used to collect and store similar information. For example, a company will have a Cash account in which every transaction involving cash is recorded. A company selling merchandise on credit will record these sales in a Sales account and in an Accounts Receivable account.
Accounting equation
Assets = Liabilities + Owner's Equity. For a corporation the equation is Assets = Liabilities + Stockholders' Equity. Because of double entry accounting this equation should be in balance at all times. The accounting equation is expressed in the financial statement known as the balance sheet. To learn more, see Explanation of Accounting Equation.
Accounting net income flows
The amounts reported on the income statement. Because of accrual accounting the net income flows will be different from the cash flow.
Accounting principles
The standards, rules, guidelines, and industry-specific requirements for financial reporting. To learn more, see Explanation of Accounting Principles.
Accounting principles board (APB)
This group preceded the current Financial Accounting Standards Board (FASB). The APB members served in a part-time capacity to determine the accounting standards from 1962 to 1973. The accounting rules established by the APB were titled Opinions and remain as part of the generally accepted accounting principles (unless superseded by standards issued by the FASB).
accounting rate of return
An indicator of profitability that is measured by dividing the accounting net income by the amount invested.
Accounting research bulletin (ARB)
These pronouncements were issued by the Committee on Accounting Procedures of the American Institute of Certified Public Accountants during the years 1953 to 1959. They were and are part of the generally accepted accounting principles unless superseded by pronouncements of the APB or FASB.
Accounts payable
This current liability account will show the amount a company owes for items or services purchased on credit and for which there was not a promissory note. This account is often referred to as trade payables (as opposed to notes payable, interest payable, etc.)
Accounts receivable
A current asset resulting from selling goods or services on credit (on account). Invoice terms such as (a) net 30 days or (b) 2/10, n/30 signify that a sale was made on account and was not a cash sale.
Accounts receivable - net
The combined amount of the debit balance in the current asset account Accounts Receivable and the credit balance in the contra asset account Allowance for Doubtful Accounts. The difference between the balances in these two accounts is an approximation of the amount of the accounts receivable that is likely to turn to cash (be collected).
Accounts receivable turnover ratio
The financial ratio which indicates the speed at which a company collects its accounts receivable. If a company's turnover is 10, this means the company's accounts receivable are turning over 10 times per year. It indicates that the company, on average, is collecting its receivables in 36.5 days (365 days per year divided by 10). To learn more, see Explanation of Financial Ratios.
Accrual basis of accounting
The accounting method under which revenues are recognized on the income statement when they are earned (rather than when the cash is received). The balance sheet is also affected at the time of the revenues by either an increase in Cash (if the service or sale was for cash), an increase in Accounts Receivable (if the service was performed on credit), or a decrease in Unearned Revenues (if the service was performed after the customer had paid in advance for the service).
Under the accrual basis of accounting, expenses are matched with revenues on the income statement when the expenses expire or title has transferred to the buyer, rather than at the time when expenses are paid. The balance sheet is also affected at the time of the expense by a decrease in Cash (if the expense was paid for when it incurred), an increase in Accounts Payable (if the expense will be paid in the future), or a decrease in Prepaid Expenses (if the expense was paid in advance).
Accrual method of accounting
See accrual basis of accounting.
Accrual-type adjusting entry
An adjusting entry made at the end of the accounting period in order to report (1) revenues that have been earned but not yet entered into the accounting records, (2) expenses that have been incurred but have not yet been entered into the accounting records, (3) revenues already recorded that involve more than the current accounting period, or (4) expenses already recorded that involve more than the current accounting period. To learn more, see Explanation of Adjusting Entries.
Accruals
See accrual-type adjusting entry.
Accrue
To report a revenue or expense that has occurred, but has not yet been entered in the accounting records as of the end of the accounting period. To learn more, see Explanation of Adjusting Entries.
Accrued expense
An expense that has occurred but the transaction has not been entered in the accounting records. Accordingly an adjusting entry is made to debit the appropriate expense account and to credit a liability account such as Accrued Expenses Payable or Accounts Payable. To learn more, see Explanation of Adjusting Entries.
Accrued expenses payable
A liability account that reflects the estimated amount a company owes for expenses that occurred, but have not yet been paid nor recorded through a routine transaction. To learn more, see Explanation of Adjusting Entries.
Accrued liability
The amount a company owes for expenses or losses incurred that have not yet been paid nor recorded through a routine transaction. To learn more, see Explanation of Adjusting Entries.
Accrued revenue
Revenue that has been earned but yet invoiced to the customer.
Accumulated deficit
The term used in place of retained earnings when a corporation has a negative (debit) balance in its account Retained Earnings.
Accumulated depletion
The cumulative amount of depletion expense pertaining to the natural resources shown on the balance sheet. The account has a credit balance and will be reported on balance sheet as a contra asset.
Accumulated depreciation
The amount of a long term asset's cost that has been allocated to Depreciation Expense since the time that the asset was acquired. Accumulated Depreciation is a long-term contra asset account (an asset account with a credit balance) that is reported on the balance sheet under the heading Property, Plant, and Equipment.
Accumulated depreciation - buildings
This is a contra long-term asset account which is credited for the depreciation associated with Buildings. Since it is a balance sheet account, the accumulated depreciation account balance does not close at the end of each year; therefore, its credit balance will increase each year. However, its balance cannot become greater than the cost of the buildings.
When the credit balance in Accumulated Depreciation - Buildings is netted with the cost in the Buildings account, the result is the book value or carrying value of the buildings.
Depreciation Expense - Buildings is the income statement account that is debited when Accumulated Depreciation - Buildings is credited.
Accumulated depreciation - equipment
The contra asset account which accumulates the amount of Depreciation Expense taken on Equipment since the equipment was acquired. As a contra asset account it will have a credit balance.
Accumulated depreciation - land improvements
This account is a contra long-term asset account which is credited for the depreciation associated with land improvements. As an asset account, the accumulated depreciation account balance does not close at the end of each year; therefore, its credit balance will increase each year. However, its balance cannot become greater than the cost shown in the Land Improvements account.
When the credit balance in Accumulated Depreciation - Land Improvements is netted with the cost of land improvements, the result is the book value or carrying value of the land improvements.
Depreciation Expense - Land Improvements is the income statement account that is debited when Accumulated Depreciation - Land Improvements is credited.
Accumulated other comprehensive income
A separate line within stockholders' equity that reports the corporation's cumulative income that has not been reported as part of net income on the corporation's income statement. The items that would be included in this line involve the income or loss involving foreign currency transactions, hedges, pension liabilities, and the unrealized gains and losses on certain investments. To learn more about this go to www.FASB.org, select Accounting Pronouncements form the left panel, and then select Statement of Financial Accounting Standards No. 130, Reporting Comprehensive Income.
Acid test ratio
See quick ratio.
Activity-based costing (ABC)
A technique for allocating costs to a product, service, customer, etc. The premise is that activities cause an organization to incur costs. Once the cost of the activities has been identified and each activity's cost has been determined, the cost of the activities is then allocated to the product, service, customer, etc. that required the activity. This technique is more logical for allocating overhead than simply allocating costs based on machine hours or direct labor hours. To learn more, see Explanation of Activity Based Costing (ABC).
Activity-based management
Using the information generated in activity-based costing to plan and control activities and processes.
Adjusted trial balance
A listing of the general ledger accounts and their account balances at a point in time after the adjusting entries have been posted. The grand total of the accounts with debit balances should equal the grand total of the accounts with credit balances.
Adjusting entries
Journal entries usually dated the last day of the accounting period to bring the balance sheet and income statement up to date on an accrual basis (as required by the matching principle and the revenue recognition principle). To learn more, see Explanation of Adjusting Entries.
Administrative expenses
Administrative expenses are part of the operating expenses (along with selling expenses). Administrative expenses include expenses associated with the general administration of the business. Examples include the salaries and fringe benefits of the company president, human resource personnel, accounting, information technology, the depreciation expense for equipment and space used in administration, as well as supplies, utilities, etc.
Under the accrual basis of accounting, administrative expenses appear on the income statement for the period in which they occurred (not the period in which they were paid).
Advertising expense
Advertising Expense is the income statement account which reports the dollar amount of ads run during the period shown in the income statement. Advertising Expense will be reported under selling expenses on the income statement.
After-tax
The result after subtracting the income tax associated with a given amount. For example, if a corporation has a gain of $100,000 before tax, and its income tax rate is 30%, its after-tax gain is $70,000. If a corporation has a loss of $30,000 before tax, and its income tax rate is 30%, its after-tax loss is $21,000.
Aging of accounts payable
A sorting of a company's accounts payable by due date.
Aging of accounts receivable
A sorting of a company's accounts receivables by the age of the receivables.
AICPA
See American Institute of Certified Public Accountants.
Allocate
To assign costs to a product, department, customer, etc. on an arbitrary basis. For example, the heating cost might be allocated to the five departments located in the area that is heated. The allocation is often based on each department's square footage.
Allocated
Costs that have been divided up and assigned to periods, departments, products, etc. In depreciation it is the asset's cost that is assigned to each of the years that the asset is in use. In cost accounting it is the assigning of common production costs to various production departments, product lines, individual products, activities.
Allocation
The assigning or dividing up of amounts. For example, depreciation is an allocation process because it assigns an asset's cost to expense in each of the years the asset is expected to be used. There is also an allocation process when the cost of goods available for sale is divided up between ending inventory and cost of goods sold. Manufacturers allocate (or assign) fixed overhead such as factory rent to the units of products produced in the factory.
Allowance for doubtful accounts
Allowance for Doubtful Accounts is a contra current asset account associated with Accounts Receivable. When the credit balance of the Allowance for Doubtful Accounts is subtracted from the debit balance in Accounts Receivable the result is known as the net realizable value of the Accounts Receivable.
The credit balance in this account comes from the entry wherein Bad Debt Expense is debited. The amount in this entry may be a percentage of sales or it might be based on an aging analysis of the accounts receivables (also referred to as a percentage of receivables).
When the allowance account is used, the company is anticipating that some accounts will be uncollectible in advance of knowing the specific account. As a result the bad debt expense is more closely matched to the sale. When a specific account is identified as uncollectible, the Allowance for Doubtful Accounts should be debited and Accounts Receivable should be credited.
Allowance to reduce inventory to LCM
This is a valuation account for the asset Inventory. A credit balance should be reported in the allowance account for the amount that the market value of inventory is less than the cost reported in the Inventory account. The credit entered into the Allowance for Reduction of Cost to Market will mean a debit is entered into the income statement account Loss From Reducing Inventory to LCM. To learn more, see Explanation of Lower of Cost or Market.
Allowance method for bad debt expense
Under this method of recognizing losses on credit sales, a contra asset account Allowance for Doubtful Accounts is reported on the balance sheet. Prior to specifically identifying an account receivable as uncollectible, a company debits Bad Debt Expense and credits Allowance for Doubtful Accounts for an estimated amount. The estimate could be based on a percentage of sales or it could be based on the age of its accounts receivables.
American Institute of Certified Public Accountants (AICPA)
This is a national organization of certified public accountants. For more information go to www.aicpa.org.
Amortization
The systematic allocation of the discount, premium, or issue costs of a bond to expense over the life of the bond; the systematic allocation of an intangible asset to expense over a certain period of time; the systematic reduction of a loan's principal balance through equal payment amounts which cover interest and principal repayment.
Amortization expense
The allocation to expenses of the cost of an intangible asset such as a patent, goodwill, bond issue costs, etc.
Amortization of bond discount
The systematic allocation of the discount on bonds payable (reported as a debit in a contra-liability account) to Bond Interest Expense over the life of the bonds. The journal entry to amortize contains a debit to the income statement account Bond Interest Expense and a credit to the balance sheet account Discount on Bonds Payable.
Amortization of bond issue costs
The systematic allocation of the costs incurred to issue bonds (reported in an asset account) to Bond Issue Cost Expense over the life of the bonds. The journal entry to amortize the issue costs contains a debit to the income statement account Bond Issue Cost Expense and a credit to the long-term asset account Bond Issue Costs.
Amortization of bond premium
The systematic allocation of the premium on bonds payable (reported as a credit in a liability account) to Bond Interest Expense over the life of the bonds. The journal entry to amortize the premium contains a debit to the balance sheet account Premium on Bonds Payable and a credit to the income statement account Bond Interest Expense.
Amortization of intangible assets
The expensing of an intangible asset from the balance sheet to the income statement.
Amortization schedule
A multi-column listing of the amounts needed to eliminate a balance in a systematic manner over the life of the item. For example, an amortization schedule for a 15-year mortgage loan would show the 180 payments. The first column might be the payment number. The second column would show the amount of the payment. Column 3 would show the amount of interest being paid. Column 4 would show the principal amount being paid (total payment minus the interest payment). Column 5 would show the principal balance remaining after the payment (previous principal balance minus the current principal payment).
An amortization schedule for bond discount would show the amounts needed to be journalized over the life of the bonds in order to systematically move the amount from the balance sheet to interest expense on the income statement.
Annuity
A series of equal amounts at equal time intervals. Also see annuity due, annuity in advance, annuity in arrears, and ordinary annuity.
Annuity due
A series of equal amounts occurring at the beginning of each equal time interval. Also known as an annuity in advance. An example would be the monthly rent on an apartment.
Annuity in advance
A series of equal amounts occurring at the beginning of each equal time interval. Also known as an annuity due. An example would be the monthly rent on an apartment.
Annuity in arrears
A series of equal amounts occurring at the end of each equal time interval. Also known as an ordinary annuity. An example would be the monthly payments on a loan. Another example is the semiannual interest on a bond.
APB
See Accounting Principles Board.
Applied overhead
Manufacturing overhead assigned to units of output. Often this is applied via a standard overhead rate. To learn more, see Explanation of Standard Costs & Variances.
Appropriated retained earnings
A second retained earnings account that reports the amount that a company has transferred from the inappropriate or regular retained earnings account.
ARB
See accounting research bulletin.
Arm’s length transaction
A phrase that indicates a transaction was between two independent parties and that the resulting amount is a fair representation of the value.
Arrears
A term meaning behind, such as dividends in arrears, or something occurring at the end of a period, such as the recurring payment in an annuity in arrears.
Articles of incorporation
A document filed when a corporation is formed. Among other things, it lists the number of shares of stock that the corporation is authorized to issue.
Asset turnover ratio
The mathematical result of sales revenues divided by average total assets during the period of the sales.
Assets
Things that are resources owned by a company and which have future economic value that can be measured and can be expressed in dollars. Examples include cash, investments, accounts receivable, inventory, supplies, land, buildings, equipment, and vehicles.
Assets are reported on the balance sheet usually at cost or lower. Assets are also part of the accounting equation: Assets = Liabilities + Owner's (Stockholders') Equity.
Some valuable items that cannot be measured and expressed in dollars include the company's outstanding reputation, its customer base, the value of successful consumer brands, and its management team. As a result these items are not reported among the assets appearing on the balance sheet.
Assigned accounts receivable
Accounts receivable that serve as the collateral for a loan.
Assignee
The lender (bank) that receives an asset as collateral for a loan.
Assignor
The borrower who provides to a lender an asset as collateral for a loan.
Audited financial statements
Financial statements that bear the report of independent auditors attesting to the financial statements' fairness and compliance with generally accepted accounting principles.
Auditor’s report
A written opinion of an independent certified public accountant that a company's financial statements are a fair representation of the company's financial performance and financial position. The auditor's report is required for each corporation whose stock is publicly-traded.
Authorized number of shares of stock
The number of shares of stock that a corporation may issue. The amount is specified in the corporation's articles of incorporation.
Average accounts receivable
The average balance in the account Accounts Receivable during a period of time. Since the amount reported in the Accounts Receivable account is the ending balance on one specific day, it is necessary to compute an average balance when relating this account to Sales (the balance of which reports the sales for a period of time).
Average cost of inventory
See weighted-average cost flow assumption and moving-average cost of inventory.
Average inventory
The average amount of inventory during a period of time. Since the amount reported in the Inventory account is the ending balance on one specific day, it is necessary to compute an average balance when relating this account to the cost of goods sold (which is the costs for a period of time). See Calculating the Average Inventory.
