group that sets accounting standards. It gets its authority from the SEC.
Financial leverage is the use of bonowed funds to increase eamlngs.
Financial services companies deal in services related to money.
First-in, first-out (FIFO) is the inventory cost flow method that assumes the first items purchased are the first items sold.
A fiscal year is a year in the life of a business. It may or may not coincide with the calendar year.
FOB (free on board) destination means that the vendor (selling firm) pays the shipping costs, so the buyer has no freight-in cost.
FOB (free on board) shipping point means the buying firm pays the shipping costs. The amount is called freighrin and is included in the cost of the inventory.
A for-profit firm has the goal of making a profit for its owners.
A franchise is an agreement that authorizes someone to sell or distribute a company's goods or services in a certain area.
Free cash flow is equal to cash from operating activities mi- nus dividends and minus capital expenditures.
The full-disclosure principle means that the firm must dis- close any circumstances and events that would make a dif- ference to the users ofthe financial statements.
G
Generally accepted accounting principles (GAAP) are the guidelines for financial reporting.
The going-concern assumption means that, unless there is obvious evidence to the contrary a firm is expected to con- tinue operating in the foreseeable future.
Goodwill is the excess of cost over market value of the net as- sets when one company purchases another company.
Gross profit ratio is equal to the gross profit (sales minus cost of goods sold) divided by sales. It is a ratio for evaluating firm performance.
H
Held-to-maturity securities Investments in debt securities that the company plans to hold until they mature.
The historical-cost principle means that transactions are recorded at actual cost.
Horizontal analysis A technique for evaluating hnancial statement amounts across time.
I
The income statement shows all revenues minus all expenses for an accounting period a month, a quarter, or a year.
Impairment is a permanent decline in the fair market value of an asset such that its book value exceeds its fair mar- ket value.
The indirect method starts with net income and makes adjust- ments for items that are not cash to prepare the statement of cash flows.
Intangible assets are rights, privileges, or benefits that result from owning long-lived assets that do not have physical sub- stance.
The interest is the cost of using someone else's money.
Interest payable is a liability. It is the amount a company owes for borrowing money (after the time period to which the interest applies has passed).
Internal controls are a company's policies and procedures to protect the assets of the firm and to ensure the accuracy and reliability of the accounting records.
The Internal Revenue Service (IRS) is the federal agency responsible for federal income tax collection.
The inventory turnover ratio is defined as cost of goods sold divided by average inventory. It is a measure of how quickly a firm sells its inventory.
Issued shares are shares of stock that have been offered and sold to shareholders.
L
Last-in, first-out (LIFO) is the inventory cost flow method that assumes the last items purchased are the first items sold.
Liabilities are obligations the company has incurred to obtain the assets it has acquired.
Liquidity is a measure ofhow easily an asset can be converted to cash. The more liquid an asset is, the more easily it can be turned into cash.
Liquidity ratios measure the company's ability to pay its cur- rent bills and operating costs.
The lower-of-cost-or-market (LCM) rule is the rule that re- quires firms to use the lower of either the cost or the market value (replacement cost) of its inventory on the date of the balance sheet.
M
The maker of a note is the person or frrm making the promise to pay.
A manufacturing company makes the goods it sells.
Market indicators ratios relate the current market price of the company's stock to eamings or dividends.
The market rate of interest is the interest rate that an investor could earn in an equally risky investment.
GLOSSARY 623 The matching principle says that expenses should be recog-
nized shown on the income statement in the same period as the revenue they helped generate.
A merchandising company sells a product to its customers.
The monetary-unit assumption means that the items on the financial statements are measured in monetary units (dollar in the U.S.).
A multistep income statement starts with sales and subtracts cost of goods sold to get a subtotal called gross profit on sales, also known as gross margin. Then, other operating rev- enues are added and other operating expenses are deducted.
A subtotal for operating income is shown before deductions related to nonoperating items and taxes are deducted. Then, income taxes are subtracted, leaving net income.
N
Net income equals all revenues minus all expenses for a spe- cific period of time.
Noncurrent assets, or long-term assets, are assets that will Iast for more than a year.
Noncurrent liabilities, or long-term liabilities, are liabil- ities that will take longer than a year to settle.
Notes to the financial statements are information provided with the four basic statements that describes the company's major accounting policies and provide other disclosures to help external users better understand the financial statements.
A not-for-profit firm has the goal ofproviding goods or ser- vices to its clients.
o
On account means on credit.The expression applies to either buying or selling on credit.
Ordinary annuities An annuity whose payments are made at the end of each interval or period.
An outstanding check is a check the firm has written but has not yet cleared the bank. That is, the check has not been pre- sented to the bank for payment.
Outstanding shares are shares of stock that are owned by stockholders.
P
Paid-in capital is the amount of the owner's contributions to the frrm; also known as shareholders' equity or stockholders' equity.
Par value is the monetary amount assigned to a share of stock in the corporate charter. It has little meaning in today's busi- ness environment.
A partnership is a company owned by two or more individuals.
A patent is a property right that the U.S. government grants to an inventor "to exclude others from making, using, offering for sale, or selling the invention throughout the United States or importing the invention into the United States for a specihed period of time."
The payee of a note is the person or firm receiving the money.
The periodic inventory system is a method of record keep- ing that involves updating the accounting records only at the end of the accounting period.
The perpetual inventory system is a method ofrecord keep- ing that involves updating the accounting records at the time of every purchase, sale, and return.
Preferred stock are shares of stock that represent a special kind of ownership in a corporation. Preferred shareholders do not get a vote but they do receive dividends before the coffImon shareholders.
624 GLOSSARY
Premium on bonds payable is an adjunct-liability that is added to bonds payable on the balance sheet; it is the differ- ence between the face value ofthe bond and its selling price, when the selling price is more than the face (par) value.
Prepaid insurance is the name for insurance a business has purchased but not yet used. It is an-a3set.
Prepaid rent is an asset. It represents amounts paid for rent not yet used. The rent expense is deferred until the rented as- set has actually been used when the time related to the rent has passed.
The present value is the value today of a given amount of money to be invested or received in the future, assuming compound interest.
Price-earnings (P/E) ratio The market price of a share of stock divided by that stock's earnings per share.
The principal of a loan is the amount of money borrowed.
Profrtability ratios measure the operating or income perfor- mance of a company.
A promissory note is a written promise to pay a specifred amount of money at a specified time.
The Public Company Accounting Oversight Board (PCAOB) is a group formed to oversee the auditing profes- sion and the audits of public companies. Its creation was mandated by the Sarbanes-Oxley Act of 2002.
A purchase discount is a reduction in the price of an inven- tory purchase for prompt payment according to terms spec- ified by the vendor.
A purchase order is a record of the company's request to a vendor for goods or services. It may be referred to as a P.O.
Purchase returns and allowances are amounts that decrease the cost of inventory purchases due to returned or damaged merchandise.
a
Quality of earnings Refers to how well a reported earnings number communicates the firm's true performance.
R
Realized means the cash is collected. Sometimes revenue is recognizedbefore it is realized.
Recognized revenue is revenue that has been recorded so that it will show up on the income statement.
Relative fair market value method is a way to allocate the total cost for several assets purchased together to each ofthe individual assets. This method is based on the assets' indi- vidual market values.
Replacement cost is the cost to buy similar items in inventory from the supplier to replace the inventory.
Residual value, also known as salvage value,is the estimated value of an asset at the end of its useful life. With most de- preciation methods, residual value is deducted before the calculation of depreciation expense.
Retained earnings is the total of all net income amounts mi- nus all dividends paid in the life of the company. It is de- scriptively named it is the earnings that have been kept (retained) in the company. The amount of retained earnings represents the part of the owner's claims that the company has earned (i.e., not contributed). Retained earnings is zol the same as cash.
Revenue is the amount the company has earned from provid- ing goods or services to customers.
The revenue-recognition principle says that revenue should be recognized when it is earned and collection is reasonably assured.
A risk is a danger something that exposes a business to a po- tential injury or loss.
s
A sales discount is a reduction in the sales price of a product offered to customers for prompt payment.
Sales returns and allowances is an account that holds amounts that reduce sales due to customer returns or al- lowances for damaged merchandise.
Salvage value (also known as residual value) is the estimated value of an asset at the end of its useful life.
The Securities and Exchange Commission (SEC) is the governmental agency that monitors the stock market and the financial reporting of the hrms that trade in the market.
Segregation of duties means that the person who has physi- cal custody of an asset is not the same person who has record-keeping responsibilities for that asset.
The separate-entity assumption means that the firm's finan- cial records and financial statements are completely sepa- rate from those of the firm's owners.
A service company does something for its customers;
Shareholders' equity is the name for owners'claims to the assets of the firm. It includes both contributed capital and re- tained earnings.
Shares of common stock are the units of ownership in a cor- poration.
A single-step income statement groups all revenues together and shows all expenses deducted from total revenue.
A sole proprietorship is a company with a single owner.
Solvency ratios measure the company's ability to meet its longterm obligations and to survive over a long period of time.
The specific identification method is the inventory cost flow method in which the actual cost of the specific goods sold is recorded as cost of goods sold.
The statement of cash flows shows all the cash collected and all the cash disbursed during the period. Each cash amount is classified as one of three types:
The statement of changes in shareholder's equity starts with the beginning amount of contributed capital and shows all changes during the accounting period. Then the state- ment shows the beginning balance in retained earnings with its changes. The usual changes to retained earnings are the increase from net income and the decrease from dividends paid to shareholders.
Stock dividends are new shares of stock that are distributed to the company's current shareholders.
A stock exchange also called the stock market is a market- place where buyers and sellers exchange their shares of stock. Buying and selling shares of stock can also be done on the Internet.
A stock split is the division of the current shares of stock by a specifrc number to increase the number of shares.
Stockholders or shareholders are the owners ofthe corpora- tion.
StraightJine depreciation is a depreciation method in which the depreciation expense is the same each period.
T
Tangible assets are assets with physical substance; they can be seen and touched.
The time-period assumption means that the life of a busi- ness can be divided into meaningful time periods for finan- cial reporting.
Timing differences arise when revenues are eamed and col- lected in different accounting periods. They also arise when expenses are incurred in one accounting period and paid for in another.
A trademark is a symbol, word, phrase, or logo that legally distinguishes one company's product from any others.
Tfading securities Investments in debt and equity securities that the company has purchased to make a short-term profrt.
Tfeasury stock are shares of stock that have been repurchased by the issuing frrm.
U
Unearned revenue is a liability. It represents the amount of goods or services that a company owes its customers. The cash has been collected, but the action of earning the rev- enue has not taken place.
Unrealized gain or loss An increase or decrease in the mar- ket value of a company's investments in securities is recog-
GLOSSARY 625 nized either on the income statement for trading securities or in other comprehensive income in the equity section of the balance sheet for available-for-sale securities when the f,rnancial statements are prepared, even though the securities have not been sold.
V
Vertical analysis A technique for comparing items on a finan- cial statement in which all items are expressed as a percent of a common amount.
W
Working capital equals current assets minus current liabili- ties.
Weighted average cost is the inventory cost flow method in which the weighted average cost of the goods available for sale is used to calculate the cost of eoods sold and the end- ing inventory.
Index
A
Abercrombie & Fitch. 242.395 Accelerated depreciation, 164-165 Accounting assumptions
going-concern assumption, 53 monetary-unit assumption, 52 separate-entity assumption, 52 time-period assumption, 53 Accounting constraints, 53 Accounting cycle
defined,580 example, 592-600
step 1 (recording journal entries), 580-583
step 2 (posting journal entries to general ledger), 583
step 3 (trial balance), 583 step 4 (adjusting journal entries),
583-586
step 5 (adjusted trial balance), 586-587 step 6 (financial statements), 587-588 step 7 (closing entries), 589-591 step 8 (postclosing trial balance), 591 steps, listed, 580
Accounting equation, 14, 18,59 Accounting information
comparability, 51-52 consistency, 52 relevance,5l reliability, 51 users, 66-67 Accounting jobs, 534 Accounting periods, 65-66 Accounting principles
full-disclosure principle, 58 historical-cost principle, 53 matching princrple,62
revenue-recognition principle, 62 Accounting scandals, 2, 28, 53U531 Accounting software, 125
Accounts payable, 54, 120 Accounts receivable, 56, 101,, 286
accounts receivable method. 288190. 293 aging schedule, 288, 289
allowance method, 288-294 balance sheet presentation, 290 controls, 303-304
defined, 286
direct write-off method, 293-294 estimating bad debt expense, 288-293 example (Tom's Wear), 29'l-300 extending credit,286
managing,287
percentage of sales method, 288, 293 ratio analysis, 301-302
recording uncollectible accounts, 286-287
writing off specific account, 290-291
Accounts reqeivable method, 288-290, 293 Accounts receivable turnover ratio,
482,487
Accounts receivable (AR) turnover ratio, 301-302
Accrual accounting information, 66-67 Accrual basis accountin g, 63-65 Accruals, 578
adjustments to accounting records, 1 1 3 - 1 1 8
defined, 99 example, 120-122
financial statements. and. 113-118 interest expense/revenue, 100-102 other revenues/expenses, 102-104 Accrued expenses, 101 , 122,584-585 Accrued liabilities, 101
Accrued revenue, 584 Accumulated amorttzatlon, | 67
Accumulated depreciation, 1,1I, ll2, 120, t22
Acid-test ratio, 123, 482, 487
Acquiring merchandise for sale, 210-215 Acquisition cost, 159
Activity method depreciation, 162-163 Additional paid-in capital, 386 Adelphia, 2,28,98
Adjunct liability, 344
Adjusted trial balance, 586-587 Adjusting journal entries, 583-586 Adjusting the books, 56
Aging method, 288 Aging schedule, 288, 289 Akst. Daniel. 154
Allowance for obsolescence, 238 Allowance for uncollectible accounts,
286-291
Allowance method. 286. 288-29 4 Amazon.com,481
Amortization bonds, 344-348 defined, 158
intangible assets, 167-169 Amortization schedule, 346, 347 Analysis of business transactions, 54-59,
67-70
Analysis of transactions, 54-59, 67 -7 0 Annuity, 378
Apple Computers, 223 AR turnover ratio, 3Ol-302 Arthur Andersen, 28 AsYou Sow, 122
Asset impairment, 169-17 0 Asset turnover ratio, 179-180, 483 Assets. 14. 59
Assumptions. See Accounting assumptions Audit opinion, 25
Auditors, 533
Authorized shares, 384 Attto Zone,438,439
Automatic Data Processing (ADP), 334 Available-for-sale securities. 524
B
BAAN,593
Bad debts expense, 286 See a/so Accounts receivable
Balance sheet, 14-18 accounts recel able, 290 analysis of transactions, 16, 17 classified, 61
comparative, 16 elements, 57-61
income statement, contrasted, 19 liabilities, 333
long-term assets, 173-174 sample, 60, 73, 333
shareholders' equity, 385, 395 Bank One, 490
Bank reconciliatton, 27 9-284 Bank statement. 27 9. 284 Bames & Noble,223,247 Basic earnings per share, 402 Basket purchase, 156-158 Beginning inventory enorc, 27 4-27 5 Berenson, Alex,526
Berstein. Richard.482 Best Buy, 106, ll2,173,207,222 Black & Decker, 332
Bloomingdale's, 210 Board of directors, 533 Bond, 339-348
amortization, 344-348 defined. 339
getting the money (issuing bonds), 341-344
issued at discount, 342-343 issued at par, 342
issued at premium, 343-344 paying the bondholders, 344 types, 341
why used, 339-340 Bond certificate, 339 Bond covenants, 340
Bonds issued at a discount, 340,342-343 Bonds issued at a premium, 340,343-344 Bonds issued at par, 340, 342
Book value. 112.159 Bookkeeping, 576 Books, 18 Borders Group, 51 Bottom line, 66
Brocade Communications Systems, 384 Budgeted cash flows, 428
Business. how it works. 9 Business description, 5
627
6 2 8 I N D E X
Business failures, 530-531 See also Accounting scandals Business plan, 5, 485 Business risk,27
Business scandals, 2,28, 530-53I Business transactions, 9, 54-59, 67 1 0
c
Callable bond, 341
Callable preferred stock, 388 Capital,2, 6l
Capital expenditure, 170 Capital lease, 157 Capital stock, 386 Capital structure, 352 Capitalize, 158 Capitalized leases, 157
Capitalizing retained earnings, 395 Car loan, 335
Carnival Corp.,473474 Canying value, 1 12, 159,343 Cash.77.428
Cash and cash equivalents, 285 Cash basis accounting, 65 Cash budget, 428 Cash budgeting, 71 Cash conversion cycle, 440 Cash dividends, 388-391 Cash equivalents, 285 Cash flow projection, 71
Cash flow statement. ,See Statement of cash flows
Cash from financing activities, 21 Cash from investing activities, 21 Cash from operating activities, 21 Cash inflows/outflows, 22 Cash management,2TS
bank reconciliation, 27 9 -284 bank statement . 279. 284 cash equivalents, 285
cash flow statement. See Statement of cash flows
controls. 27 8-27 9. 303-304 crediVdebit memos, 284 physical controls, 2'7 8-27 9, 303 reporting cash, 285
Caterpillar,223
Certified public accountant (CPA), 13 Charles Schwab, 7
Chico's, 222,241,242 Circuit City, 120, l2l Classified balance sheet, 6l
Clear assignment of responsibility, 303 Cleveland-Cliffs, 166
Closed, 589
Closing entries, 589-591 Closely held corporation, 7 Common stock, 385-387 Comparability, 51-52
Comparative balance sheets, 16 Compound interest, 37 6, 37 7 Comprehensive income, 521-522 Computer Associates, 28, 50, 76 Computerized accounting systems, 125 Computron, T5
Conservatism, 53 Consistency, 52 Constraints, 53
Contingent liabilities, 332 Contra-asset, 111
Contraliabilitv account. 343
Contra-revenue, 217 Contributed caprtal, 9, 61, 384 Contribution,9
Controls
clear assignment of responsibility, 303 defrned,29
documentation procedures, 303 errors in recording transactions, 124-125 financial statements, 75-76
independent internal verification of data, 304
invento_1y confols, 242-243 long-tbrm assets, 1 80 long-term debt, 354 Ioss/destruction of data, 125 monitoring, 180
physical controls, 180 stock ownership, 489490 stockholders' equity, 402-403 unauthorized access, 125 Convertible bond, 341
Cooking the books, 2,528. See also Earnings manipulation Cooper, Cynthia,526 Copyright, 167-168, 180 Copyright of infringement, 180 Corporate bonds, 347 Corporate filings, 24
Corporate governance, 47 6, 530-536
"Corporate Social and Financial Performance Meta-Analysis," 122 Corporate social performance, 122 Corrective controls, 76
Cost of goods available for sale, 215,274 Costofgoods sold,274
Costco, 210 C P A , 1 3 Credit, 578 Crediting, 579 Credit card sales, 294 Credit memo, 284 Credit policies, 287 Credit terms, 214
Cumulative prefened stock, 390 Current assets, 59
Current ratio, 7 4, 482, 487 Curves, 168
Cutoff issues, 65-66
D
Darden Restaurants.'7 4. 152 Date of record, 389-390 Debenture, 341 Debit, 578
Debit-credit rules, 579-580 Debit memo, 284
Debiting, 579 Debt. .lee Liabilities
Debrto-equity ratio,352, 482, 487 Declining balance depreciation, 164-165 Deferrals, 104-113, 57 8
adjustments to accounting records, 1 1 3 - 1 1 8
defined, 99
depreciation, 1 I 1-1 13 equipment, 110 example, 120-122 expenses, 107-lI3
financial statements, and, I 1 3-1 I 8 gift certificates, 105-106 insurance, 1 07- 1 08
magazine subscriptions, 105 rent, 108-109
revenue,105-106 supplies, 109-1 10 unearned revenue, 105 Deferred expenses, 586 Deferred revenue. 105. 585-586 Defrnitely determinable liabilities, 332 Dell,7,24)6,393
DelI. Michael. T Department, 12 Depletion, 158, 166-167 Deposit in transit, 280,282 Depreciable base, 159 Depreciating an asset, 111 Depreciation
accelerated, 164-165 activity method, 162-1 63 declining balance, 164-165 defined, 158
double-declining balance, 165 MACRS,208
straight-line, 159 -162 taxes, and, 208 terminology, 159
Depreciation expense, 1 I 1-l 13 Destruction of accounting data, 125 Detective controls, T6
Diluted earnings per share, 402 Direct method, 429430, 432434, 437 Direct write-off method, 293-29 4
Disclosure. ,lee Notes to financial statements Discount
purchase, 214-215 sales,217-21.8
Discount on bonds payable, 343 Discount rate, 336
Discounting, 336 Disney Corporation, 48 Diversification, 403, 489 490 Dividend.9. 582
cash, 388-391 defined, 388 stock, 394-395
Dividend declaration date, 389 Dividend payment date, 390 Dividend yield ratio, 481, 483, 488 Documentation procedures, 303 Dollar Tree Stores, 402
Double-declining balance depreciation, 165 DVD sales,241
E
Earned capital, 396 Earnings, 476 Earnings manipulation
big bath charges, 528 cookie jar reserves, 528-529 revenue recognition, 529-530 Earnings per share (EPS), 401-402, 483,
487,526 Earnings restatement, 476 Ebbers, Bemard, 2, 28, 154 EBITDA,489
Effective interest method ,344-347 Eichenwald, Kurt,332
Employee theft, 2IO, 219 Ending inventory enorc, 27 4 Enron,2, 28, 354, 441, 526
Enterprise resource planning (ERP) system, 576,593