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Financial Accounting Glossary by Lie Dharma Putra [Part 1]



This accounting glossary is not a general accounting dictionary that you can find any terms and definitions from abaccus system to african tze-tze mosquitoz. But it is just the most used financial accounting term and definitions based on my own understanding on the terms. Tended to be more practical and composed personally by myself. They are not refers to [nor referred by] any official accounting authorities [or literatures] such as IFRS, nor IAS, nor GAAP, nor FASB, nor ICPA,  IASB neither. These are really a “personally-speaking” financial accounting terms and definitiaons by myself. So every term defined here involves my own judgements, opinions and overviews. Consequently, you will find one definition maybe described by 300 or even 500 characters that practically takes a half page. You’re invited to correct or replace any of them by filling the comment form provided on the bottom of every page in this site. Enjoy!



ACCOUNTING – This is a broad, all-inclusive term that refers to the methods and procedures of financial record keeping by a business [or any entity]; 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 for managers for making decisions and exercising control, to measure profit, to comply with income and other tax laws, and to prepare financial statements that are included in financial reports.

ACCOUNTING EQUATION – This equation reflects the two-sided nature of a business entity: assets on one side, 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 primary fundamental financial statements reported by a business. [The other two are the income statement and the statement of cash flows].


ACCRUAL-BASIS ACCOUNTING – Well, accrual is not the best descriptive term in the world. 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 disbursements 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 by the income tax law for most businesses. 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 revenue when sales are made [though cash is received before or after making sales] and records expenses when costs are incurred [though cash is paid before or after expenses are recorded]. Established financial reporting standards are based on accrual-basis accounting. Even though accrual-basis accounting is required, a business also reports a financial statement that summarizes its cash sources and uses for the period.

ACCOUNTS PAYABLE – These are short-term, noninterest-bearing liabilities of a business that arise in the course of its activities and operations from purchases on credit. A business buys many things on credit; the purchase cost of goods and services are not paid for immediately. This liability account records the amounts owed for purchases on credit that will be paid in the short run, which generally means about one month. These are also referred to as operating liabilities.


ACCOUNTS RECEIVABLE – These are short-term, noninterest-bearing debts owed to a business by its customers who bought goods and services from the business on credit. Generally, these debts should be collected within a month or so. In a balance sheet, this asset is listed immediately after cash. [Actually the amount of short-term marketable investments, if the business has any, is listed after cash and before accounts receivable]. Accounts receivable are viewed as a near-cash type of asset that will be turned into cash in the short run. A business may not be able to collect all of its accounts receivable. Uncollectible accounts receivable are called bad debts.

ACCOUNTS RECEIVABLE TURNOVER RATIO – This ratio is computed by dividing annual sales revenue by the year-end balance of accounts receivable. Technically speaking, to calculate this ratio, the amount of annual credit sales should be divided by the average accounts receivable balance; but this information is not readily available from external financial statements. For reporting internally to managers, this ratio should be refined and fine-tuned to be as accurate as possible.


ACCELERATED DEPRECIATION – The term accelerated refers to two things: [1] the estimated useful life of the fixed asset being depreciated is shorter than a realistic forecast of its probable actual service life; and [2] most of the total cost of the fixed asset is allocated to the first half of its useful life and less to the second half [i.e., there is a front-end loading of depreciation expense].

ACCRUED EXPENSES [PAYABLE] – This account records the short-term, noninterest-bearing liabilities of a business that accumulate over time, such as vacation pay owed to employees. This liability is different than accounts payable, which is the liability account for bills that have been received by a business from purchases on credit.


ACCUMULATED DEPRECIATION – This is a contra, or offset, account; it is coupled with the property, plant, and equipment asset account in which the original costs of these long-term operating assets of a business are recorded. By the way, these resources of a business are also called fixed assets. The accumulated depreciation contra account accumulates the amount of depreciation expense that is recorded period by period. So, the balance in this account is the cumulative amount of depreciation that has been recorded since the assets were acquired. The balance in the accumulated depreciation account is deducted from the original cost of the assets recorded in the property, plant, and equipment asset account. The remainder, called the book value of the assets, is the amount included on the asset side of a business.

ACID TEST RATIO [ALSO CALLED THE QUICK RATIO] – The sum of cash, accounts receivable, and short-term marketable investments [if any] is divided by total current liabilities to compute this ratio. Suppose that all short-term creditors decided to stop extending credit to a business and that they all demanded payment when their debts come due. In this rather extreme scenario, the acid test ratio reveals whether the company’s cash and near-cash assets would be enough to pay its shortterm current liabilities—assuming that none of the liabilities could be renewed and rolled over. This ratio is an extreme test, which is not likely to be imposed on a business unless it is in financial straits. This ratio is quite relevant when a business is in a liquidation situation or is in bankruptcy proceedings.


AMORTIZATION – Unfortunately, this term has two quite different meanings. First, the term refers to the allocation to expense each period of the total cost of an intangible asset [such as the cost of a patent purchased from the inventor or the cost of goodwill bought by the business] over the useful economic life of the intangible asset. In this sense, amortization is equivalent to depreciation, which allocates the cost of a tangible long-term operating asset [such as a machine] over its useful economic life. Second, amortization refers to the gradual pay down of the principal amount of a debt. Principal refers to the amount borrowed that has to be paid back to the lender, as opposed to interest that has to be paid on the principal. Each period, a business may pay interest and also make a payment on the principal of the loan, which reduces the principal amount of the loan, of course. In this situation, the loan is amortized, or gradually paid down.

ASSET TURNOVER RATIO – This broad-gauge ratio is computed by dividing annual sales revenue by total assets. It is a rough measure of the salesgenerating power of a business’s assets. The idea is that assets are used to make sales, and sales should lead to profit. The ultimate test is not sales revenue on assets, but the profit earned on assets that is measured by the return on assets [ROA] ratio.


BAD DEBT – This term refers to accounts receivable from credit sales to customers that a business will not be able to collect [or not collect in full]. In hindsight the business shouldn’t have extended credit to these particular customers. The amounts owed to the business that will not be collected are written off and recorded to expense. The accounts receivable asset account is decreased by the estimated amount of uncollectible receivables, and the bad debts expense account is increased this amount. These write-offs can be done by the direct write-off method, which means that no expense is recorded until specific accounts receivable are identified as uncollectible, or by the allowance method, which is based on an estimated percent of bad debts from credit sales during the period. Under the allowance method, a contra asset account is created [called allowance for bad debts], and the balance of this account is deducted from the accounts receivable asset account.

BALANCE SHEET – This is the term often used instead of the more formal and correct term—statement of financial condition. This financial statement summarizes the assets, liabilities, and owners’ equity sources of a business at a moment in time. It is prepared at the end of each profit period and whenever else it is needed. It is one of the three primary financial statements of a business, the other two being the income statement and the statement of cash flows. The values reported in the balance sheet are used to determine book value per share of capital stock. The book value of an asset is the amount, or balance, reported in a business’s most recent balance sheet.


BASIC EARNINGS PER SHARE [EPS] – This important ratio equals the net income for a period [usually one year] divided by the number of capital stock shares issued by a business corporation. Public companies must report EPS, but private companies are not required to report this ratio. EPS is so important for publicly owned business corporations that it is included in the daily stock trading tables published by the Wall Street Journal, the New York Times, and other major newspapers. Despite being a rather straightforward concept, several things complicate the calculation of EPS. As a result, a business may have to report its basic EPS, which uses the actual number of capital shares outstanding at the balance sheet date, and its diluted EPS, which includes additional shares of stock that may be issued when stock options are exercised, as well as any other shares that the business may be obligated to issue in the future. Also, a business may report not one but two net income figures—one before extraordinary gains and losses that were recorded in the period, and a second after deducting these nonrecurring gains and losses. To further complicate matters, some business corporations issue more than one class of capital stock, which makes the calculation of their EPS more technical.

BIG BATH – This street-smart term refers to the practice of many businesses of recording very large lump-sum write-offs of certain assets or recording large amounts for pending liabilities. These unusual entries are triggered by business restructurings, massive employee layoffs, disposals of major segments of the business, and other traumas in the life of a business. Businesses have been known to use these occasions to record every conceivable asset write-off and/or liability write-up that they can think of—in order to clear the decks for the future. In this way, a business avoids recording expenses in the future, and its profits in the coming years will be higher. Investors don’t seem to mind this accounting practice.


BOOK VALUE AND BOOK VALUE PER SHARE – Generally speaking, these terms refer to the balance sheet value of an asset [or less often of a liability] or the balance sheet value of owners’ equity per share. These terms are used to emphasize that the amount recorded in the accounts, or on the books, of a business is the value being used. The total of the accounts reported for owners’ equity in its balance sheet is divided by the number of stock shares of a corporation to determine its book value per share of its capital stock.

BOTTOM LINE – A commonly used term that refers to the net income [profit] reported by a business, which is the last, or bottom, line in its income statement. As you undoubtedly know, the term has taken on a much broader meaning in everyday use, which refers to the ultimate or most important effect or result of something. Not many accountingbased terms have found their way into everyday language, but bottom line is one that has.


BREAK EVEN POINT [BEP]– The annual sales volume level at which total contribution margin equals total annual fixed expenses. The breakeven point is only a point of reference, not the goal of a business of course. It is computed by dividing total fixed expenses by unit margin. The breakeven point is quite useful in analyzing profit behavior. It provides managers a good point of reference for setting sales goals and for understanding the consequences of incurring fixed costs for a period.

Other glossaries:

[Financial Accounting Glossary Part 2 – CAPITAL]
[Financial Accounting Glossary Part 3 – DIVIDEND PAYOUT RATIO]
[Financial Accounting Glossary Part 4 – INVENTORY TURNOVER RATIO]
[Financial Accounting Glossary Part 5 – PROFIT]

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