Definition of Accounting
Accounting
A collection of systems and processes used to record, report and interpret business transactions.
accounting
A broad, all-inclusive term that refers to the methods and procedures
of financial record keeping by a business (or any entity); it also
refers to the main functions and purposes of record keeping, which are
to assist in the operations of the entity, to provide necessary information
to managers for making decisions and exercising control, to measure
profit, to comply with income and other tax laws, and to prepare financial
reports.
Related Terms:
The change in the value of a firm's foreign currency denominated accounts due to a
change in exchange rates.
Earnings of a firm as reported on its income statement.
Total liabilities exceed total assets. A firm with a negative net worth is insolvent on
the books.
The ease and quickness with which assets can be converted to cash.
The average project earnings after taxes and depreciation divided by the average
book value of the investment during its life.
A technical accounting term that encompasses the
conventions, rules, and procedures necessary to define accepted accounting practice at a particular time.
Method of accounting for a merger in which the acquirer is treated as having purchased
the assets and assumed liabilities of the acquiree, which are all written up or down to their respective fair
market values, the difference between the purchase price and the net assets acquired being attributed to goodwill.
accounting principals required by the FHLB that allow S&Ls to elect
annually to defer gains and losses on the sale of assets and amortize these deferrals over the average life of the
asset sold.
This is a currency translation standard previously in
use by U.S. accounting firms. See: Statement of accounting Standards No. 52.
This is the currency translation standard currently
used by U.S. firms. It mandates the use of the current rate method. See: Statement of Financial accounting
Standards No. 8.
The representation of the double-entry system of accounting such that assets are equal to liabilities plus capital.
The period of time for which financial statements are produced – see also financial year.
A method of investment appraisal that measures
the profit generated as a percentage of the
investment – see return on investment.
A set of accounts that summarize the transactions of a business that have been recorded on source documents.
A method of accounting in which profit is calculated as the difference between income when it is earned and expenses when they are incurred.
Cash accounting
A method of accounting in which profit is calculated as the difference between income
when it is received and expenses when they are paid.
Financial accounting
The production of financial statements, primarily for those interested parties who are external to the business.
Management accounting
The production of financial and non-financial information used in planning for the future; making decisions about products, services, prices and what costs to incur; and ensuring that plans are implemented and achieved.
Strategic management accounting
The provision and analysis of management accounting data about a business and its competitors, which is of use in the development and monitoring of strategy (Simmonds).
Accounting equation
The formula Assets = Liabilities + Equity.
accounting equation
An equation that reflects the two-sided nature of a
business entity, assets on the one side and the sources of assets on the
other side (assets = liabilities + owners’ equity). The assets of a business
entity are subject to two types of claims that arise from its two basic
sources of capital—liabilities and owners’ equity. The accounting equation
is the foundation for double-entry bookkeeping, which uses a
scheme for recording changes in these basic types of accounts as either
debits or credits such that the total of accounts with debit balances
equals the total of accounts with credit balances. The accounting equation
also serves as the framework for the statement of financial condition,
or balance sheet, which is one of the three fundamental financial
statements reported by a business.
accrual-basis accounting
Well, frankly, accrual is not a good descriptive
term. Perhaps the best way to begin is to mention that accrual-basis
accounting is much more than cash-basis accounting. Recording only the
cash receipts and cash disbursement of a business would be grossly
inadequate. A business has many assets other than cash, as well as
many liabilities, that must be recorded. Measuring profit for a period as
the difference between cash inflows from sales and cash outflows for
expenses would be wrong, and in fact is not allowed for most businesses
by the income tax law. For management, income tax, and financial
reporting purposes, a business needs a comprehensive record-keeping
system—one that recognizes, records, and reports all the assets and liabilities
of a business. This all-inclusive scope of financial record keeping
is referred to as accrual-basis accounting. Accrual-basis accounting
records sales revenue when sales are made (though cash is received
before or after the sales) and records expenses when costs are incurred
(though cash is paid before or after expenses are recorded). Established
financial reporting standards require that profit for a period
must be recorded using accrual-basis accounting methods. Also, these
authoritative standards require that in reporting its financial condition a
business must use accrual-basis accounting.
double-entry accounting
See accrual-basis accounting.
generally accepted accounting principles (GAAP)
This important term
refers to the body of authoritative rules for measuring profit and preparing
financial statements that are included in financial reports by a business
to its outside shareowners and lenders. The development of these
guidelines has been evolving for more than 70 years. Congress passed a
law in 1934 that bestowed primary jurisdiction over financial reporting
by publicly owned businesses to the Securities and Exchange Commission
(SEC). But the SEC has largely left the development of GAAP to the
private sector. Presently, the Financial accounting Standards Board is
the primary (but not the only) authoritative body that makes pronouncements
on GAAP. One caution: GAAP are like a movable feast. New rules
are issued fairly frequently, old rules are amended from time to time,
and some rules established years ago are discarded on occasion. Professional
accountants have a heck of time keeping up with GAAP, that’s for
sure. Also, new GAAP rules sometimes have the effect of closing the barn
door after the horse has left. accounting abuses occur, and only then,
after the damage has been done, are new rules issued to prevent such
abuses in the future.
internal accounting controls
Refers to forms used and procedures
established by a business—beyond what would be required for the
record-keeping function of accounting—that are designed to prevent
errors and fraud. Two examples of internal controls are (1) requiring a
second signature by someone higher in the organization to approve a
transaction in excess of a certain dollar amount and (2) giving customers
printed receipts as proof of sale. Other examples of internal
control procedures are restricting entry and exit routes of employees,
requiring all employees to take their vacations and assigning another
person to do their jobs while they are away, surveillance cameras, surprise
counts of cash and inventory, and rotation of duties. Internal controls
should be cost-effective; the cost of a control should be less than
the potential loss that is prevented. The guiding principle for designing
internal accounting controls is to deter and detect errors and dishonesty.
The best internal controls in the world cannot prevent most fraud
by high-level managers who take advantage of their positions of trust
and authority.
accounting rate of return (ARR)
the rate of earnings obtained on the average capital investment over the life of a capital project; computed as average annual profits divided by average investment; not based on cash flow
cost accounting
a discipline that focuses on techniques or
methods for determining the cost of a project, process, or
thing through direct measurement, arbitrary assignment, or
systematic and rational allocation
Cost Accounting Standards Board (CASB)
a body established by Congress in 1970 to promulgate cost accounting
standards for defense contractors and federal agencies; disbanded
in 1980 and reestablished in 1988; it previously issued
pronouncements still carry the weight of law for those
organizations within its jurisdiction
financial accounting
a discipline in which historical, monetary
transactions are analyzed and recorded for use in the
preparation of the financial statements (balance sheet, income
statement, statement of owners’/stockholders’ equity,
and statement of cash flows); it focuses primarily on the
needs of external users (stockholders, creditors, and regulatory
agencies)
management accounting
a discipline that includes almost
all manipulations of financial information for use by managers
in performing their organizational functions and in
assuring the proper use and handling of an entity’s resources;
it includes the discipline of cost accounting
Management Accounting Guidelines (MAGs)
pronouncements of the Society of Management Accountants of
Canada that advocate appropriate practices for specific
management accounting situations
responsibility accounting system
an accounting information system for successively higher-level managers about the performance of segments or subunits under the control
of each specific manager
Statement on Management Accounting (SMA)
a pronouncement developed and issued by the Management
accounting Practices Committee of the Institute of Management
Accountants; application of these statements is
through voluntary, not legal, compliance
Accounting change
An alteration in the accounting methodology or estimates used in
the reporting of financial statements, usually requiring discussion in a footnote
attached to the financial statements.
Accounting entity
A business for which a separate set of accounting records is being
maintained.
Accrual accounting
The recording of revenue when earned and expenses when
incurred, irrespective of the dates on which the associated cash flows occur.
Constant dollar accounting
A method for restating financial statements by reducing or
increasing reported revenues and expenses by changes in the consumer price index,
thereby achieving greater comparability between accounting periods.
Generally accepted accounting principles
The rules that accountants follow when processing accounting transactions and creating financial reports. The rules are primarily
derived from regulations promulgated by the various branches of the AICPA Council.
generally accepted accounting principles (GAAP)
Procedures for preparing financial statements.
Accounting Errors
Unintentional mistakes in financial statements. Accounted for by restating
the prior-year financial statements that are in error.
Accounting and Auditing Enforcement Release (AAER)
Administrative proceedings or litigation releases that entail an accounting or auditing-related violation of the securities laws.
Accounting Irregularities
Intentional misstatements or omissions of amounts or disclosures in
financial statements done to deceive financial statement users. The term is used interchangeably with fraudulent financial reporting.
Aggressive Accounting
A forceful and intentional choice and application of accounting principles
done in an effort to achieve desired results, typically higher current earnings, whether the practices followed are in accordance with generally accepted accounting principles or not. Aggressive
accounting practices are not alleged to be fraudulent until an administrative, civil, or criminal proceeding takes that step and alleges, in particular, that an intentional, material misstatement
has taken place in an effort to deceive financial statement readers.
Change in Accounting Estimate
A change in accounting that occurs as the result of new information
or as additional experience is acquired—for example, a change in the residual values
or useful lives of fixed assets. A change in accounting estimate is accounted for prospectively,
over the current and future accounting periods affected by the change.
Change in Accounting Principle
A change from one generally accepted accounting principle to another generally accepted accounting principle—for example, a change from capitalizing expenditures
to expensing them. A change in accounting principle is accounted for in most instances
as a cumulative-effect–type adjustment.
Change in Accounting Estimate
A change in the implementation of an existing accounting
policy. A common example would be extending the useful life or changing the expected residual
value of a fixed asset. Another would be making any necessary adjustments to allowances for
uncollectible accounts, warranty obligations, and reserves for inventory obsolescense.
Contract Accounting
Method of accounting for sales or service agreements where completion
requires an extended period.
Creative Accounting Practices
Any and all steps used to play the financial numbers game, including
the aggressive choice and application of accounting principles, both within and beyond
the boundaries of generally accepted accounting principles, and fraudulent financial reporting.
Also included are steps taken toward earnings management and income smoothing. See Financial
Numbers Game.
Creative Acquisition Accounting
The allocation to expense of a greater portion of the price
paid for another company in an acquisition in an effort to reduce acquisition-year earnings and
boost future-year earnings. Acquisition-year expense charges include purchased in-process research
and development and an overly aggressive accrual of costs required to effect the acquisition.
Cumulative Effect of Accounting Change
The change in earnings of previous years assuming
that the newly adopted accounting principle had previously been in use.
Cumulative Effect of a Change in Accounting Principle
The change in earnings of previous years
based on the assumption that a newly adopted accounting principle had previously been in use.
Gain-on-Sale Accounting
Up-front gain recognized from the securitization and sale of a pool
of loans. Profit is recorded for the excess of the sales price and the present value of the estimated
interest income that is expected to be received on the loans above the amounts funded on the loans
and the present value of the interest agreed to be paid to the buyers of the loan-backed securities.
Generally Accepted Accounting Principles (GAAP)
A common set of standards and procedures
for the preparation of general-purpose financial statements that either have been established
by an authoritative accounting rule-making body, such as the Financial accounting
Standards Board (FASB), or over time have become accepted practice because of their universal
application.
Staff Accounting Bulletin (SAB)
Interpretations and practices followed by the staff of the Office of the Chief Accountant and the Division of Corporation Finance in administering the disclosure
requirements of the federal securities laws.
Accounting Policies
The principles, bases, conventions, rules and procedures adopted by management in preparing and presenting financial statements.
Generally Accepted Accounting Principles (GAAP)
GAAP is the term used to describe the underlying rules basis on which financial statements are normally prepared. This is codified in the Handbook of The Canadian Institute of Chartered Accountants.
Accretion (of a discount)
In portfolio accounting, a straight-line accumulation of capital gains on discount
bond in anticipation of receipt of par at maturity.
Annual fund operating expenses
For investment companies, the management fee and "other expenses,"
including the expenses for maintaining shareholder records, providing shareholders with financial statements,
and providing custodial and accounting services. For 12b-1 funds, selling and marketing costs are included.
Balance sheet exposure
See:accounting exposure.
Book value per share
The ratio of stockholder equity to the average number of common shares. Book value
per share should not be thought of as an indicator of economic worth, since it reflects accounting valuation
(and not necessarily market valuation).
Common-base-year analysis
The representing of accounting information over multiple years as percentages
of amounts in an initial year.
Common-size analysis The representing of balance sheet items as percentages of assets and of income
statement items as percentages of sales.
Controller
The corporate manager responsible for the firm's accounting activities.
Counterpart items
In the balance of payments, counterpart items are analogous to unrequited transfers in the
current account. They arise because the double-entry system in balance of payments accounting and refer to
adjustments in reserves owing to monetization or demonetization of gold, allocation or cancellation of SDRs,
and revaluation of the various components of total reserves.
FASB
Financial accounting Standards Board. Sets accounting standards for U.S. firms.
FASB No. 8
U.S. accounting standard that requires U.S. firms to translate their foreign affiliates' accounts by
the temporal method. Gains and losses from currency fluctuations were reported in current income. It was in
effect between 1975 and 1981 and became the most controversial accounting standard in the U.S. It was
replaced by FASB No. 52 in 1981.
FASB No. 52
The U.S. accounting standard which was replaced by FASB No. 8. U.S. companies are required
to translate foreign accounts by the current rate and report the changes from currency fluctuations in a
cumulative translation adjustment account in the equity section of the balance sheet.
Goodwill
Excess of the purchase price over the fair market value of the net assets acquired under purchase
accounting.
Historical exchange rate
An accounting term that refers to the exchange rate in effect when an asset or
liability was acquired.
Long-term
In accounting information, one year or greater.
Matching concept
The accounting principle that requires the recognition of all costs that are associated with
the generation of the revenue reported in the income statement.
Net book value
The current book value of an asset or liability; that is, its original book value net of any
accounting adjustments such as depreciation.
Net errors and omissions
In balance of payments accounting, net errors and omissions record the statistical
discrepancies that arise in gathering balance of payments data.
Opinion shopping
A practice prohibited by the SEC which involves attempts by a corporation to obtain
reporting objectives by following questionable accounting principles with the help of a pliable auditor willing
to go along with the desired treatment.
Pooling of interests
An accounting method for reporting acquisitions accomplished through the use of equity.
The combined assets of the merged entity are consolidated using book value, as opposed to the purchase
method, which uses market value. The merging entities' financial results are combined as though the two
entities have always been a single entity.
Purchase method
accounting for an acquisition using market value for the consolidation of the two entities'
net assets on the balance sheet. Generally, depreciation/amortization will increase for this method compared
with pooling and will result in lower net income.
Regulatory surplus
The surplus as measured using regulatory accounting principles (RAP) which may allow
the non-market valuation of assets or liabilities and which may be materially different from economic surplus.
Reserve
An accounting entry that properly reflects the contingent liabilities.
Retained earnings
accounting earnings that are retained by the firm for reinvestment in its operations;
earnings that are not paid out as dividends.
Revenue fund
A fund accounting for all revenues from an enterprise financed by a municipal revenue bond.
Settlement rate
The rate suggested in Financial accounting Standard Board (FASB) 87 for discounting the
obligations of a pension plan. The rate at which the pension benefits could be effectively settled off the
pension plan wished to terminate its pension obligation.
Statutory surplus
The surplus of an insurance company determined by the accounting treatment of both
assets and liabilities as established by state statutes.
Stockholder's books
Set of books kept by firm management for its annual report that follows Financial
accounting Standards Board rules. The tax books follow IRS tax rules.
Straight line depreciation
An equal dollar amount of depreciation in each accounting period.
Tax books
Set of books kept by a firm's management for the IRS that follows IRS rules. The stockholder's
books follow Financial accounting Standards Board rules.
Turnover
Mutual Funds: A measure of trading activity during the previous year, expressed as a percentage of
the average total assets of the fund. A turnover ratio of 25% means that the value of trades represented onefourth
of the assets of the fund. Finance: The number of times a given asset, such as inventory, is replaced
during the accounting period, usually a year. Corporate: The ratio of annual sales to net worth, representing
the extent to which a company can growth without outside capital. Markets: The volume of shares traded as a
percent of total shares listed during a specified period, usually a day or a year. Great Britain: total revenue.
Unilateral transfers
Items in the current account of the balance of payments of a country's accounting books
that corresponds to gifts from foreigners or pension payments to foreign residents who once worked in the
country whose balance of payments is being considered.
ACCRUAL
A method of accounting in which you record expenses when you incur them and sales as you make them—not when you pay bills or receive checks in the mail.
INCOME STATEMENT
An accounting statement that summarizes information about a company in the following format:
Net Sales
– Cost of goods sold
--------------------
Gross profit
– Operating expenses
--------------------
Earnings before income tax
– Income tax
--------------------
= Net income or (Net loss)
Formally called a “consolidated earnings statement,” it covers a period of time such as a quarter or a year.
UNITS OF PRODUCTION
A depreciation method that relates a machine’s depreciation to the number of units it makes each
accounting period. The method requires that someone record the machine’s output each year.
Accountability
The process of satisfying stakeholders in the organization that managers have acted in the best interests of the stakeholders, a result of the stewardship function of managers, which takes place through accounting.
Accounts
‘Buckets’ within the ledger, part of the accounting system. Each account contains similar transactions (line items) that are used for the production of financial statements. Or commonly used as an abbreviation for financial statements.
Balance Sheet
A financial statement showing the financial position of a business – its assets, liabilities and
capital – at the end of an accounting period.
Cash Flow statement
A financial report that shows the movement in cash for a business during an accounting period.
Dividend
The payment of after-tax profits to shareholders as their share of the profits of the business for an accounting period.
Economic Value Added (EVA)
Operating profit, adjusted to remove distortions caused by certain accounting rules, less a charge
to cover the cost of capital invested in the business.
Financial year
The accounting period adopted by a business for the production of its financial statements.
Finished goods Inventory that is ready for sale, either having been purchased as such or the result of a conversion from raw materials through a manufacturing process.
Job costing
A method of accounting that accumulates the costs of a product/service that is produced either
customized to meet a customer’s specification or in a batch of identical product/services.
Matching
See accruals accounting.
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