Glossary
accelerated depreciation methods Depreciation methods
that allow for higher depreciation charges in the early years
and lower charges in later periods. Termed accelerated be-
cause these methods allow for higher early depreciation
changes than the straight-line method allows. Also called
decreasing-charge methods. Generally, companies use one of
two decreasing-charge methods: sum-of-the-years’-digits or
declining-balance. (p. 504).
account A systematic arrangement that shows the effect of
transactions and other events on a specific element (asset,
liability, and so on). Companies keep a separate account for
each asset, liability, revenue, and expense, and for capital
(stockholders’ equity). (p. 78).
account form Presentation in a classified balance sheet that
lists assets by sections on the left side and liabilities and
stockholders’ equity by sections on the right side. (p. 160).
accounting cycle Standard set of accounting procedures
to record transactions and prepare financial statements.
(p. 83).
accounting information system A system that collects and
processes transaction data and then disseminates the finan-
cial information to interested parties. Accounting informa-
tion systems vary widely from one business to another,
depending on the nature of the business and its transactions,
the size of the company, the volume of data to be handled,
and the informational demands. (p. 78).
Accounting Principles Board (APB) Private standard-setting
organization from 1959 to 1973 whose mission was to de-
velop an overall conceptual framework. Its official pro-
nouncements, called APB Opinions, were to be based mainly
on research studies and be supported by reasons and analy-
sis. The APB issued 31 opinions in its lifetime. (p. 9).
Accounting Research Bulletins Fifty-one bulletins from the
Committee on Accounting Procedure (CAP) during the
years 1939 to 1959, issued to deal with accounting problems
as they arose. Subsequently, the AICPA created the
Accounting Principles Board to provide a structured body of
accounting principles. (p. 9).
accounts receivable Oral promises of the purchaser to pay
for goods and services sold. They represent short-term
extensions of credit, which are normally collected within 30
to 60 days. (p. 363).
accounts receivable turnover ratio A liquidity ratio that
measures the number of times, on average, a company col-
lects receivables during a period. Computed by dividing net
sales by average (net) accounts receivable outstanding dur-
ing the year. Barring significant seasonal factors, average re-
ceivables outstanding can be computed from the beginning
and ending balances of net trade receivables. (p. 383).
accrual-basis accounting Accounting approach in which a
company records events that change its financial statements
in the periods in which the events occur, rather than only in
the periods in which it receives or pays cash.Thus, a company
recognizes revenues when it earns them rather than when it
receives cash, and it recognizes expenses when it incurs them
rather than when it pays them. (p. 6).
accrued expenses Expenses incurred but not yet paid or re-
corded at the statement date. Examples are interest, rent, taxes,
and salaries.An accrued expense on the books of one company
is often an accrued revenue to another company. (p. 98).
accrued revenues Revenues earned but not yet received in
cash or recorded at the statement date. Accrued revenues re-
sult from the passing of time (e.g., interest revenue and rent
revenue) or from unbilled or uncollected services that a
company performed (e.g., commissions and fees). (p. 97).
accumulated other comprehensive income An entry in the
stockholders’ equity section of the balance sheet that reports
the cumulative amounts of Other Comprehensive Income.
Other Comprehensive Income measures the amounts of all
gains and losses in a period that bypass the income statement
but affect stockholders’ equity. These amounts arise from
such items as unrealized gains or losses on certain invest-
ments and unrealized gains and losses on certain hedging
transactions. (p. 224).
accumulated rights Compensation rights that employees can
carry forward to future periods if not used in the period in
which earned. (p. 845).
acid-test (quick) ratio Liquidity ratio that measures the abil-
ity of a company to meet its maturing obligations with its
available assets and to meet unexpected needs for cash.
Computed as cash plus short-term investments plus net
receivables divided by current liabilities. A variation of the
current ratio, the acid-test ratio eliminates inventories and
prepaid expenses from the amount of current assets, to pro-
vide better information for short-term creditors. (p. 634).
activity method Depreciation method that assumes that de-
preciation is a function of use or productivity, instead of the
passage of time. Using this method, a company considers the
life of the asset in terms of either the output it provides (units
it produces) or an input measure such as the number of hours
it works.Also called the variable-charge or units-of-production
approach. (p. 502).
activity ratios Measures of how effectively a company is
using its assets. Common activity ratios are: receivables
turnover, inventory turnover, and asset turnover. (p. 277).
actual return on the plan assets The increase in pension
funds from interest, dividends, and realized and unrealized
changes in the fair-market value of the plan assets. If the ac-
tual return on the plan assets is positive (a gain) during the
period, a company subtracts it when computing pension
expense; if the actual return is negative (a loss) during the
period, the company adds it when computing pension
expense. (p. 858).
actuarial present value The additional benefits, predicted by
an actuary, that an employer must pay under the plan’s ben-
efit formula as a result of the employees’ current year’s serv-
ice, discounted back to their present value. The actuarial
present value is the projected benefit obligation a company
recognizes for its pension plan in a given year. (p. 857).
additional paid-in capital Any excess over par value paid in
by stockholders in return for the shares issued to them. Once
paid in, the excess over par becomes a part of the corporation’s
1
2 Glossary
additional paid-in capital. Also called paid-in capital in
excess of par. (p. 675).
additions Increases or extensions of existing assets. By defini-
tion, any addition to plant assets creates a new asset; compa-
nies capitalize such expenditures and match them against the
revenues that will result in future periods. (p. 497).
adjunct account An account that increases either an asset,
liability, or owners’ equity account. An example is Premium
on Bonds Payable, which, when added to the Bonds Payable
account, describes the total bond liability of the company.
(p. 169).
adjusted trial balance A trial balance prepared from a com-
pany’s ledger accounts after journalizing and posting all
adjusting entries. It shows the effects of all financial events
that occurred during the accounting period. (p. 101).
adjusting entry Adjustments made at the end of the ac-
counting period to ensure that a company has recorded rev-
enues in the period in which it earns them and recognized
expenses in the period in which it incurs them—in other
words, that it has followed the revenue recognition and
matching principles. Companies often prepare adjustments
after the balance sheet date but date the entries as of the bal-
ance sheet date. (p. 78, 91).
aging schedule A schedule (worksheet or spreadsheet) that
shows a company’s accounts receivable and estimates uncol-
lectible accounts by applying to the various age categories
different percentages estimated to be uncollectible based on
past experience. An aging schedule also identifies which
accounts require special attention by indicating the extent to
which certain accounts are past due. (p. 368).
allowance method A method for recording uncollectible ac-
counts receivable by entering the expense on an estimated
basis in the accounting period in which the sales on account
occur. The allowance method records bad debt expense in
the same period as the sale, thus properly matching expenses
and revenues and achieving a proper carrying value for ac-
counts receivable. The FASB considers the allowance
method appropriate in situations where it is probable that an
asset has been impaired and that the amount of the loss can
be reasonably estimated. (p. 367).
American Institute of Certified Public Accountants (AICPA)
The national professional organization of practicing Certified
Public Accountants (CPAs), whose various committees and
boards have been an important contributor to the develop-
ment of GAAP. (p. 9).
amortization The allocation of the cost of intangible assets in
a systematic way. (p. 557).
amortized cost The acquisition cost of debt securities ad-
justed for the amortization of discount or premium, if appro-
priate. Amortized cost is the valuation amount companies
use to account for held-to-maturity debt securities. (p. 733).
annuity A series of payments or receipts (called rents) that
occur at equal intervals. (p. 1012).
annuity due An annuity in which each rent is payable/receiv-
able at the beginning of the period. (p. 1012).
antidilutive securities Securities that upon conversion or
exercise increase earnings per share (or reduce the loss per
share). Companies with complex capital structures will not
report diluted EPS if the securities in their capital structure
are antidilutive; they will report only the basic EPS number.
(p. 965).
APB Opinions The official pronouncements of the Accounting
Principles Board, intended to be based mainly on research
studies and be supported by reasons and analysis. Between
its inception in 1959 and its dissolution in 1973, the APB
issued 31 opinions. (p. 9).
appropriated retained earnings A retained earnings ac-
count that is restricted for a specific use, usually to comply
with contractual requirements, board of directors’ policy, or
current necessity. (p. 222).
asset gains and losses The difference between the expected
return and the actual return on a pension plan. Also referred
to an unexpected gain or loss. Asset gains occur when actual
return exceeds expected return; asset losses occur when the
actual return is less than expected return. (p. 861).
asset retirement obligation (ARO) An existing legal obliga-
tion, whose amount can be reasonably estimated, associated
with the retirement of a long-lived asset. Companies should
record the ARO at fair value. (p. 627).
asset turnover ratio Profitability ratio that measures how
efficiently a company uses its assets to generate sales.
Computed as net sales divided by average total assets for the
period. The resulting number is the dollars of sales produced
by each dollar invested in assets. (p. 517).
asset-liability method Method of accounting for income
taxes. Sometimes referred to as the liability approach.
Companies recognize on the current-year return a current
tax liability/asset for the estimated taxes payable/refundable,
and they recognize a deferred tax liability/asset for estimated
future tax effects due to temporary differences and tax
carryforwards. The measurement of current/deferred tax
liabilities/assets is based on provisions of the tax law.
Companies establish a valuation allowance account if it is
more likely than not that some/all of the deferred tax asset
will not be realized. (p. 809).
assumption One of the parts in the third level of the con-
ceptual framework; a concept that the accounting profes-
sion assumes as foundational for the financial accounting
structure. There are four basic assumptions: (1) economic
entity, (2) going-concern, (3) monetary unit, and (4) perio-
dicity. (p. 45).
Auditing Standards Board The arm of the AICPA that had
been responsible for developing auditing standards. The
Public Company Accounting Oversight Board established
by the Sarbanes-Oxley Act now oversees the development of
auditing standards. (p. 13).
available-for-sale securities Debt and equity securities not
classified as held-to-maturity or trading securities. Companies
report available-for-sale securities at fair value, but do not
report changes in fair value as part of net income until after
they sell the security. Interest on available-for-sale securities
is recorded when earned. Unrealized holding gains and
losses on available-for-sale securities are recognized as other
comprehensive income and as a separate component of
stockholders’ equity. (p. 150, 732).
average days to sell inventory A measure that represents
the average number of days’ sales for which inventory is on

hand. A variant of the inventory turnover ratio, it is com-
puted by dividing the inventory turnover ratio by the num-
ber of days in the year (365 or sometimes for simplicity, 360).
(p. 449).
average tax rate An average of the graduated rates at which
the IRS taxes U.S. corporations. The first $50,000 of taxable
income is taxed at 15 percent, the next $25,000 at 25 percent,
with higher incremental levels of income at rates as high as
39 percent. (p. 795).
average-cost method Inventory-costing method that prices
items in the inventory on the basis of the average cost of all
similar goods available during the period. Companies that
use the periodic inventory method use weighted averages
and those that use the perpetual method use moving aver-
ages. (p. 428).
avoidable interest The amount of interest cost in a period
that a company could theoretically avoid if it had not made
expenditures for an asset. When a company capitalizes inter-
est expense, the amount of interest to capitalize is limited to
the lower of actual interest cost incurred during the period
or the amount of avoidable interest. (p. 523).
balance sheet Financial statement that shows the financial
condition of a company at the end of a period by reporting
its assets, liabilities, and owners’ equity. Sometimes referred
to as the statement of financial position. (p. 79, 146).
bank overdrafts Occur when a company writes a check for
more than the amount in its cash account. Companies should
report bank overdrafts in the current liabilities section, adding
them to the amount reported as accounts payable. If material,
companies should disclose these items separately. (p. 360).
bank reconciliation A schedule explaining any differences
between the bank’s and the company’s records of cash. If
some part of the difference arises from items other than
transactions not yet recorded by the bank, either the bank or
the company must adjust its records. (p. 391).
bargain purchase option An option that allows a lessee to
purchase the leased property for a price that is significantly
lower than the property’s expected fair value at the date the
option becomes exercisable.At the inception of the lease, the
difference between the option price and the expected fair
market value must be large enough to make exercise of the
option reasonably assured. A bargain purchase option is one
of the criteria for determining if a lease is a capital lease.
(p. 898).
bargain renewal option An option that allows a lessee to re-
new the lease for a rental that is lower than the expected fair
rental at the date the option becomes exercisable. At the
start of the lease, the difference between the renewal rental
and the expected fair rental must be great enough to make
exercise of the option reasonably assured. A bargain renewal
option extends the life of the lease, when determining the
lease term. (p. 898).
basic EPS The earnings per share for a simple capital struc-
ture. A company with a complex capital structure reports
both basic EPS and diluted EPS amounts on the face of its
income statement. (p. 964).
bearer (coupon) bonds Bonds without the name of the
owner, which may be transferred from one owner to another
by mere delivery. (p. 613).
Glossary 3
bond discount The difference between the face value of a
bond and its selling price when the bond sells for less than
face value. (p. 615).
bond indenture A contract for a bond that represents a
promise to pay a sum of money at a designated maturity rate,
plus periodic interest at a specified rate on the maturity
amount (face value). (p. 612).
bond premium The difference between the face value of a
bond and its selling price when the bond sells for more than
face value. (p. 615).
bonus Compensation in addition to regular salary or wages.
Frequently the bonus amount depends on the company’s
yearly profit. The company shows the bonus expense in the
income statement as an operating expense. If the bonus is
not paid within the accounting period, the company includes
the liability, Bonus Payable, as a current liability in the bal-
ance sheet. (p. 846).
book value The difference between a depreciable asset’s
cost and its related accumulated depreciation. Book value
of an asset generally differs from its market value because
depreciation is a means of cost allocation, not of valuation.
(p. 95).
book value per share The amount each share of stock would
receive if a company were liquidated, based on the amounts
reported on the balance sheet. Computed as common stock-
holders’ equity divided by the number of outstanding shares
of stock. But if the valuations on the balance sheet do not
approximate the market value of the shares, the book value
per share figure loses its relevance. (p. 700).
callable bonds Bonds give the issuer the right to call and
retire the bonds prior to maturity. (p. 613).
callable preferred stock Preferred stock that permits the
corporation, at its option, to call or redeem the outstanding
preferred shares at specified future dates and stipulated
prices. The callable feature enables the company to use the
capital from the issuance of the preferred stock until the
need has passed or it is no longer advantageous. (p. 685).
capital expenditure Expenditure whose purpose is to cre-
ate a new asset or to increase an asset’s future benefits. Such
expenditures are to be capitalized, rather than expensed.
(p. 497).
capital lease Agreement that allows one party (the lessee)
to use the asset of another party (the lessor) and to account
for the transaction as a purchase. The lease must be non-
cancelable and must meet one or more of four capitalization
criteria. (p. 897).
capital maintenance approach An income measurement
approach in which a company determines income for the
period based on the change in equity, after adjusting for
capital contributions or distributions (dividends). An alter-
native to the transaction approach to income measurement.
(p. 202) (ftn).
capitalization criteria Four criteria for deciding if a lease
qualifies as a capital lease. In addition to being noncance-
lable, the lease must meet one or more of the four criteria: (1)
transfers ownership of the property to the lessee; (2) contains
a bargain purchase option; (3) its lease term equals or exceeds
75 percent of the asset’s economic life; (4) the present value
4 Glossary
of the minimum lease payments equals or exceeds 90 percent
of the fair value of the leased asset. If a lease does not meet
any of the four criteria, then it is classified and accounted for
as an operating lease. (p. 897).
capitalization of leases The process of accounting for leases
in the same way a company would account for installment
purchases. The FASB prescribes a capitalization approach
when the lease is similar to an installment purchase, as deter-
mined by being noncancelable and by meeting one or more
of four capitalization criteria. (p. 895).
capitalization period The period of time during which a
company must capitalize interest. The period lasts for as long
as three conditions are present: expenditures for the asset
have been made, activities needed to prepare the asset for its
intended use are in progress, and interest cost is being in-
curred. (p. 523).
carrying value The face amount of a bond minus any un-
amortized discount, or plus any unamortized premium.
Synonymous with the term book value. (p. 640).
cash Consists of coin, currency, and available funds on deposit
at the bank, as well as negotiable instruments such as money
orders, certified checks, cashier’s checks, personal checks,
and bank drafts. Cash, the most liquid of assets, is the stan-
dard medium of exchange and the basis for measuring all
other items. Companies generally classify cash as a current
asset. (p. 358).
cash debt coverage ratio Measure of solvency that indicates
a company’s ability to repay its liabilities from cash gener-
ated from operations (without having to liquidate produc-
tive assets). Computed as the ratio of cash provided by oper-
ating activities to total debt, as represented by average total
liabilities. (p. 271).
cash discounts Reductions from the sales price, offered by
sellers to buyers to induce prompt payment. Also called sales
discounts. Cash discounts generally read in terms such as
2/10, n/30 (2 percent if paid within 10 days, gross amount due
in 30 days). Companies can account for sales discounts using
either the gross or the net method; most use the gross
method, in which they record sales and related sales discount
transactions by entering the receivable and sale at the gross
amount and using a Sales Discount account only when they
receive payment within the discount period. (p. 364).
cash dividend payable An amount, payable in cash, that a
corporation owes to its stockholders as a result of the board
of directors’ dividend authorization. At the date of declara-
tion, the dividend becomes a liability of the corporation, clas-
sified as a current liability. (p. 609).
cash dividends Pro rata distributions of cash to a company’s
stockholders as of a certain date (date of declaration), as ap-
proved by the company’s board of directors. A company may
declare dividends either as a certain percent of par or as an
amount per share. A declared cash dividend is a current lia-
bility of the company between the date of declaration and
the payment date. Companies do not declare or pay cash div-
idends on treasury stock. (p. 689).
cash equivalents Short-term, highly liquid investments that
are both: (a) readily convertible to known amounts of cash,
and (b) so near their maturity that they present insignificant
risk of changes in interest rates. Generally, only investments
with original maturities of 3 months or less qualify under this
definition. Examples are Treasury bills, commercial paper,
and money market funds purchased with cash that is in ex-
cess of immediate needs. (p. 252, 361).
change in accounting estimate A changes that occurs as the
result of new events, more experience, or additional informa-
tion. Companies should not adjust previously reported re-
sults for changes in estimates, but should report them
prospectively—in the period of change if the change affects
that period only, or in the period of change and future peri-
ods if the change affects both. (p. 942, 952).
change in accounting estimate effected by a change in
accounting principle Rule applied when it is impossible
to determine whether a change in principle or a change in
estimate has occurred. In such cases, a company considers
the change as a change in estimate. (p. 952).
change in accounting principle A change from one gener-
ally accepted accounting principle to another.A company re-
ports a change in accounting principle using retrospective
application. (p. 942).
change in reporting entity A change from reporting as one
type of entity to another type of entity. For example, a com-
pany might change the subsidiaries for which it prepares
consolidated financial statements. (p. 942).
changes in estimates Adjustments or changes that compa-
nies must make because financial circumstances did not turn
out as expected. Companies account for changes in estimates
in the period of change if they affect only that period, or in
the period of change and future periods if the change affects
both. They do not carry back such changes to prior years.
Changes in estimate are not considered errors or extraordi-
nary items. (p. 216).
closing entries Journal entries made at the end of a com-
pany’s annual accounting period to transfer the balances of
temporary accounts to a permanent owners’ equity account
(retained earnings or a capital account, depending on the
company’s form of organization). (p. 79, 105).
closing process Accounting process at the end of the ac-
counting period that reduces the balance of nominal (tem-
porary) accounts to zero in order to prepare the accounts
for the next period’s transactions. In the closing process, the
company transfers revenue and expense account balances
to Income Summary, which matches expenses and revenues.
(p. 104).
commercial substance In accounting for exchanges of non-
monetary assets, the basis for measuring the gain or loss on
an exchange. If the future cash flows change (if the two par-
ties’ economic positions change) as a result of the transac-
tion, the transaction is said to have commercial substance
and the parties to the exchange recognize a gain or loss on
the exchange. (p. 511).
Committee on Accounting Procedure (CAP) Committee
established by the AICPA in 1939 at the urging of the SEC to
deal with accounting problems. The CAP issued 51
Accounting Research Bulletins and was replaced by the
Accounting Principles Board in 1959. (p. 9).
commodity-backed bonds Bonds that are redeemable in
measures of a commodity (e.g., barrels of oil, tons of coal, or
ounces of rare metal). Also called asset-linked bonds. The

accounting problem for such bonds is to project their maturity
value in markets where commodity prices fluctuate. (p. 613).
common stock The basic ownership interest in a corporation,
as evidenced by shares that represent proportional owner-
ship. Holders of common stock bear the ultimate risks of loss
(they are guaranteed neither dividends nor assets upon dis-
solution) and receive the benefits of success through distri-
butions of dividends or sales at a gain. They also generally
control the management of the corporation through voting
rights. If a corporation has only one authorized issue of cap-
ital stock, that issue is by definition common stock. (p. 673)
comparability One of the qualitative characteristics of ac-
counting information, which describes information that is
measured and reported in a similar manner for different
companies. Comparability enables users to identify the real
similarities and differences in economic activities between
companies. (p. 41).
compensated absences Paid absences from employment
(e.g., for vacation, illness, and holidays). Companies accrue a
liability for the cost of compensation for future absences and
recognize the expense and related liability for compensated
absences in the year in which the benefits are earned by
employees. (p. 844).
compensating balances Minimum cash balances in checking
or savings accounts, required by some banks and other lending
institutions in support for existing borrowing arrangements.
Companies must disclose in the financial statements the de-
tails of deposits held as compensating balances. (p. 360).
completed-contract method Revenue-recognition method
in which companies recognize revenue and gross profit only
at the point of sale—the point at which a contract is deemed
completed. Under this method, companies do not record in-
terim charges or credits to income statement accounts for
revenues, costs, and gross profit. (p. 314).
completion-of-production basis Revenue-recognition method
in which companies recognize revenue at the completion of
production (e.g., mining of metals or harvesting of crops)
even though no sale has been made. (p. 315)
complex capital structure A capital structure that includes
securities that could have a dilutive effect on earnings per
common share. (p. 960).
components of pension expense The components that
make up a company’s pension expense: service cost, interest
on the liability, return on plan assets, amortization of prior
service cost, and gain or loss. (p. 857).
compound interest Interest that accrues on both the princi-
pal and the interest earned in past periods (interest not with-
drawn or paid out). (p. 1003).
comprehensive income Income measure that includes all
changes in equity during a period except those resulting
from investments by owners and distributions to owners.
Comprehensive income includes: all revenues and gains, ex-
penses and losses reported in net income, and all gains and
losses that bypass net income but affect stockholders’ equity.
These latter amounts arise from such items as unrealized
gains or losses on certain investments and unrealized gains
and losses on certain hedging transactions. (p. 222).
conceptual framework For the accounting profession, a co-
herent system of objectives and fundamentals established by
Glossary 5
the FASB, which determine the nature, function, and limits
of financial accounting and which lead to consistent account-
ing standards. (p. 36).
conservatism The convention in accounting that dictates that
when in doubt, choose the solution that will be least likely to
overstate assets and income. Conservatism, properly applied,
provides a reasonable guide in difficult situations; if no doubt
exists, there is no need to apply this constraint. (p. 56).
consigned goods Inventory held by one party (the con-
signee) who acts as the agent for the owner of the goods (the
consignor) in selling the goods. The consignee accepts and
holds the consigned goods without any liability, except to ex-
ercise due care and reasonable protection from loss or dam-
age until it sells the goods to a third party. When the con-
signee sells the goods, it remits the revenue to the consignor,
less a selling commission and expenses incurred in accom-
plishing the sale. (p. 423).
consistency One of the qualitative characteristics of account-
ing information, which indicates that a company applied the
same accounting treatment to similar events from period to
period. A company can change methods, but it must first
demonstrate that the newly adopted method is preferable to
the old and then must disclose in the financial statements the
nature and effect of the accounting change. (p. 41).
consolidated financial statements Financial statements
that treat the parent and subsidiary corporations as a single
economic entity. (p. 748).
constraints One of the parts in the third level of the concep-
tual framework, there are two main overriding factors that
limit (constrain) financial reporting: (1) the cost-benefit rela-
tionship and (2) materiality. (p. 53).
contingency Material event with an uncertain future. The
uncertainty can involve a possible gain (gain contingency) or
possible loss (loss contingency) that will ultimately be re-
solved when one or more future events occur or fail to occur.
Typical gain contingencies are tax operating loss carryfor-
wards or company litigation against another party. Typical
loss contingencies relate to litigation, environmental is-
sues, possible tax assessments, or government investiga-
tions. (p. 163, 620).
contingent liabilities Liabilities that depend on a contingency—
on the occurrence of one or more future events to confirm
either the amount payable, the payee, the date payable, or its
existence. (p. 621).
contra account An account that reduces either an asset, lia-
bility, or owners’ equity account. Examples include
Accumulated Depreciation and Discount on Bonds Payable.
Use of contra accounts enables readers of financial state-
ments to see the original cost of the asset, liability, or owners’
equity account as well as the changes in the account to date.
(p. 169).
contra asset account An account that offsets an asset ac-
count on the balance sheet. An example is the accumulated
depreciation account, which companies use in order to dis-
close both the original cost of an asset and the total expired
cost to date. (p. 95).
contributed (paid-in) capital The total amount paid in on
capital stock—the amount provided by stockholders to the
corporation for use in the business. Contributed capital
6 Glossary
includes the par value of all outstanding stock plus addi-
tional paid-in capital (any excess over par value paid in by
stockholders). (p. 674).
controlling interest A relationship in which one corporation
acquires a voting interest of more than 50 percent in another
corporation. The investor corporation is referred to as the
parent and the investee corporation as the subsidiary.
Companies present the investment in the common stock of
the subsidiary as a long-term investment on the separate
financial statements of the parent. (p. 748).
convertible bond Bond that permits its holder to exchange it
for (“convert it to”) other corporate securities (typically
common stock) for a specified period of time after issuance.
The sale of a convertible bond is recorded like a straight-
debt issue; upon conversion, the company records the securi-
ties exchanged for the bond at the carrying amount (book
value) of the bond. The company amortizes, either at its
maturity or upon conversion, any discount or premium that
results from the issuance of the bond. (p. 613, 705).
convertible preferred stock Preferred stock that allows
stockholders, at their option, to exchange preferred shares
for shares of common stock at a predetermined ratio. The
convertible preferred stockholder not only enjoys a pre-
ferred claim on dividends but also has the option of convert-
ing into a common stockholder with unlimited participation
in earnings. (p. 685).
copyright A federally granted right that all authors, painters,
musicians, sculptors, and other artists have in their creations
and expressions. Granted for the life of the creator plus 70
years, it gives the owner, or heirs, the exclusive right to re-
produce and sell an artistic or published work. A copyright is
an artistic-related intangible asset. Companies may capital-
ize the costs of acquiring and defending a copyright. (p. 560).
correction of an error Change to the financial statements
due to an error of any sort (e.g., mathematical mistakes, bad
faith changes in estimates, incorrect application of a gener-
ally accepted accounting principles, or incorrect classifica-
tion). Companies must correct errors as soon as they dis-
cover them; they record corrections of errors from prior
periods as adjustments to the beginning balance of retained
earnings in the current period (called prior period adjust-
ments). (p. 943, 954).
cost flow assumptions Several systematic assumptions
about the flow of inventory, used by companies to value their
inventory. The main cost flow assumptions are specific iden-
tification, average-cost, FIFO, and LIFO. The actual physical
movement of goods need not match the cost flow assump-
tion a company adopts, but the company must use its
selected cost flow assumption consistently from one period
to the next. The objective should be to choose a cost flow as-
sumption that most clearly reflects periodic income. (p. 426).
cost method A method of accounting for treasury stock, in
which a company debits a Treasury Stock account for the
cost of reacquiring stock to be held in the treasury and re-
ports this account as a deduction from “total paid-in capital
and retained earnings” on the balance sheet. (p. 681).
cost-benefit relationship An accounting constraint that re-
quires that one weigh the costs of providing financial infor-
mation against the benefits that can be derived from using it.
The constraint applies to informational requirements estab-
lished by standard-setting bodies and governmental agencies
as well as to companies reporting financial information. (p. 53).
cost-recovery method Revenue-recognition method in which
companies recognize profit only when cash collections exceed
the total cost of the goods sold. Any additional cash collection
after the seller has recovered all costs is recorded as income.
This method is required under FASB Statements No. 45 (fran-
chises) and No. 66 (real estate) where a high degree of uncer-
tainty exists related to the collection of receivables. (p. 320).
cost-to-cost basis Technique that measures the percentage
of completion on a contract by comparing costs incurred to
date with the most recent estimate of the total costs to com-
plete the contract. (p. 311).
coverage ratios Measures of the degree of protection for
long-term creditors and investors. Common coverage ratios
are: debt to total assets, times interest earned, the cash debt
coverage ratio, and book value per share. (p. 277).
credit The right side of an account. Commonly abbreviated as
Cr. (p. 79).
cumulative preferred stock Preferred stock that requires that
if a corporation fails to pay a dividend in any year, it must
make it up in a later year before paying any dividends to com-
mon stockholders. Any “passed” dividend on cumulative pre-
ferred stock constitutes a dividend in arrears. A corporation
does not record a dividend in arrears as a liability (because no
liability exists until the board of directors declares a dividend),
but discloses it in a note to the financial statements. (p. 685).
current assets Cash and other assets a company expects to
convert into cash, sell, or consume either in one year or in the
operating cycle, whichever is longer. Companies present cur-
rent assets in the balance sheet in order of liquidity. (p. 149).
current cash debt coverage ratio Measure of liquidity that
indicates a company’s ability to pay its short-term debts.
Computed as cash provided by operating activities divided
by average current liabilities. (p. 270).
current liabilities The obligations that a company reasonably
expects to liquidate either through the use of current assets
or the creation of other current liabilities. This concept in-
cludes: payables resulting from the acquisition of goods and
services; (2) collections received in advance for the delivery
of goods or performance of services; and (3) other liabilities
whose liquidation will take place within the operating cycle.
Companies usually record and report current liabilities at
their full maturity value with no adjustment for the time
value of money. The slight overstatement of liabilities that
results is accepted as immaterial. (p. 156, 607).
current maturities of long-term debt The portion of bonds,
mortgage notes, and other long-term indebtedness that will
mature within the next fiscal year. However, long-term debts
maturing currently as current liabilities are excluded from
this category if they are to be: retired by assets accumulated
for this purpose that properly have not been shown as cur-
rent assets; refinanced or retired from the proceeds of a new
debt issue; or converted into capital stock. (p. 609).
current operating performance approach Income-report-
ing approach that advocates reporting only regular and re-
curring revenue and expense elements, but not irregular
items, in income. (p. 209).

current ratio Liquidity ratio that measures the ability of a
company to meet its maturing obligations with its available
assets and to meet unexpected needs for cash. Computed as
total current assets divided by total current liabilities. (p. 634).
current tax benefit (expense) The amount of income taxes
refundable (payable/paid) for a year, as determined by ap-
plying the enacted tax rate to the taxable income or excess of
deductions over revenues for the year. (p. 785, 799).
debenture bonds Unsecured bonds, which are issued against
the general credit of the borrower (issuer). (p. 613).
debit The left side of an account. Commonly abbreviated as
Dr. (p. 79).
debt securities Financial securities that represent a creditor
relationship with another entity. Examples are U.S. govern-
ment securities, municipal securities, corporate bonds, con-
vertible debt, and commercial paper. (p. 732).
debt to total assets ratio Coverage ratio that measures the
percentage of the total assets provided by creditors.
Computed as total debt divided by total assets. The higher
the percentage of debt to total assets, the greater the risk that
the company may be unable to meet its maturing obligations.
(p. 635).
decision usefulness Approach that requires that financial
information be useful to investor and creditor decisions. (p. 38).
declining-balance method Accelerated deprecation method
that uses a depreciation rate (expressed as a percentage)
that is some multiple of the straight-line method.
Companies apply that constant rate to the declining book
value of the asset at the beginning of each period. Applying
the constant-declining-balance rate to a successively lower
book value results in lower depreciation charges each year.
This process continues until the book value of the asset
equals its estimated salvage value, at which time the com-
pany discontinues depreciation. (p. 504).
decreasing-charge method Depreciation methods that al-
low for higher depreciation charges in the early years and
lower charges in later periods. Also called accelerated depre-
ciation methods. Generally, companies use one of two
decreasing-charge methods: sum-of-the-years’-digits or
declining-balance. (p. 504).
deductible amounts A temporary difference between the
tax basis of an asset/liability and its reported (carrying or
book) amount in the financial statements that will decrease
taxable income in future years. (p. 783).
deductible temporary difference Temporary differences
that will result in deductible amounts in future years, when
the related book liabilities are settled. They give rise to
recording deferred tax assets. Examples are: (1) expenses or
losses that are deductible after they are recognized in finan-
cial income, and (2) revenues or gains that are taxable before
they are recognized in financial income. (p. 792).
deep-discount (zero-interest) debenture bonds Long-
term, unsecured debt securities that do not bear interest.
They are sold at a discount that provides the buyer’s total in-
terest payoff at maturity. Also called zero-interest debenture
bonds. (p. 613).
deferred annuity An annuity in which the rents begin after a
specified number of periods. (p. 1023).
Glossary 7
deferred tax asset The increase in taxes refundable (or
saved) in future years as a result of deductible temporary dif-
ferences existing at the end of the current year. (p. 787).
deferred tax expense (benefit) The change during the year
in a company’s deferred tax liabilities and assets. A deferred
tax expense results from the increase in the deferred tax lia-
bility from the beginning to the end of the accounting period.
A deferred tax benefit results from the increase in the
deferred tax asset from the beginning to the end of the
accounting period; it reduces income tax expense. (p. 785, 788).
deferred tax liability The increase in taxes payable in future
years as a result of taxable temporary differences existing at
the end of the current year. (p. 784).
defined-benefit plan A pension plan that outlines the bene-
fits that the employee will receive at the time of retirement.
These benefits typically are a function of the employee’s
years of service and compensation level when he or she
nears retirement. (p. 855).
defined-contribution plan A pension plan that defines only
the employer’s contribution. The employer agrees to con-
tribute to a pension trust a certain sum each period, based on
a formula that considers factors such as length of employee
service, employer’s profits, and compensation level. A com-
mon form is a 401(k) plan. (p. 854).
deposit method Revenue-recognition method used in cases
when companies receive cash from the buyer before transfer
of the goods or property. Under this method, the seller reports
the cash received from the buyer as a deposit on the contract
and classifies it on the balance sheet as a liability, while con-
tinuing to report the property as an asset.The seller recognizes
revenue and income only when the sale is complete. (p. 320).
depreciation The process of allocating the cost of a tangible
asset to expense in a systematic and rational manner to those
periods expected to benefit from the use of the asset.
Depreciation is not a matter of valuation but rather a means
of cost allocation. (p. 94, 500).
depreciation base The cost of a tangible asset that will be al-
located to expense through depreciation. The base estab-
lished for depreciation is a function of two factors: an asset’s
original cost minus its salvage (disposal) value. (p. 501).
designated market value The amount that a company com-
pares to cost, when using the lower-of-cost-or market (LCM)
rule. The designated market value is the middle value of
three amounts: replacement cost, net realizable value, and
net realizable value less a normal profit margin. (p. 443).
detachable stock warrants A warrant (long-term option to
buy common stock at a fixed price) that can be “detached”
from the related security (a bond) and traded as a separate
security for a specified period of time. To account for de-
tachable stock warrants, companies separate debt issued
with detachable warrants into debt and equity components,
using either the proportional method or the incremental
method. (p. 706).
development activities Activities that translate research
findings or other knowledge into a plan or design for a new
product or process or for a significant improvement to an ex-
isting product or process, whether intended for sale or use.
Companies are required to expense the costs of develop-
ment activities as incurred. (p. 574).
8 Glossary
diluted EPS The earnings per share for a complex capital
structure. Diluted EPS begins with the basic EPS computa-
tion but includes the effect of all potential dilutive common
shares outstanding during the period. It is computed as in-
come available to common stockholders divided by
weighted average shares outstanding, plus the impact of con-
vertibles, options, warrants, and other dilutive securities. (p.
964).
dilutive securities Securities that can be converted to com-
mon stock. Upon conversion or exercise by the holder, the
dilutive securities reduce (dilute) earnings per share.
Companies with dilutive securities report both basic EPS
and diluted EPS in their income statements. (p. 964).
direct effects of change in accounting principle Changes
in assets and liabilities that result directly from making a
change in accounting principle. An example is the change in
the inventory balance when a company changes from one in-
ventory method to another. Companies report direct effects
retrospectively. (p. 948).
direct write-off method A method for recording uncol-
lectible accounts receivable by recording the bad debt in the
period in which a company determines that it cannot collect
a specific receivable. The direct write-off method is used for
tax purposes but is otherwise not usually considered appro-
priate because it usually does not result in the proper carry-
ing value for accounts receivable and it fails to match costs
with revenues of the period. (p. 367).
direct-financing lease Agreement that is in substance the
financing of an asset purchase by the lessee.The lessor records
a lease receivable (the present value of the minimum lease
payments plus the present value of the unguaranteed residual
value) instead of a leased asset. Companies often report the
lease receivable in the balance sheet as “Net investment in
capital leases” and classify it either as current or noncurrent,
depending on when they recover the net investment. (p. 909).
discontinued operation Occurs for a company when two
things happen: (1) a company eliminates the results of
operations and cash flows of a component from its ongoing
operations, and (2) there is no significant continuing
involvement in that component after the disposal transac-
tion. Companies report a discontinued operation (in a sep-
arate income statement category), indicating the gain or
loss from disposal of a business. In addition, companies
report separately from continuing operations the results of
operations of a component that has been, or will be, dis-
posed of. (p. 210).
discounting The process of reducing the amounts or values of
cash flows from the future to the present, making the present
value less than the future amount. (p. 1007).
dividend in arrears A dividend on cumulative preferred
stock that a company’s board of directors fails to declare at
the normal date for dividend action. Such a dividend is said
to have been “passed.” The corporation must make up the
passed dividend in a later year before it can pay any divi-
dends to common stockholders. (p. 685).
dollar-value LIFO A variation of the LIFO inventory-costing
method; it determines and measures any increases and
decreases in a pool in terms of total dollar value, not the
physical quantity of the goods in the inventory pool. The
dollar-value LIFO method overcomes the problems of re-
defining pools and eroding layers that occur with the regular
LIFO method. (p. 434).
double-declining-balance method Declining-balance de-
preciation method in which a company depreciates assets at
twice (200 percent) the straight-line rate. (p. 504).
double-entry accounting The universally used accounting
system in which a company records the dual (two-sided) ef-
fect of each transaction in appropriate accounts. If a com-
pany records every transaction with equal debits and credits,
then the sum of all the debits to the accounts must equal the
sum of all the credits. (p. 79).
earned (revenue) Revenue is considered earned when the
company substantially accomplishes what it must do to be
entitled to the benefits represented by the revenues.
Generally, an objective test, such as a sale, indicates the point
at which a company recognizes revenue and verifies the
amount of revenue earned. (p. 48, 305).
earned capital The capital that develops from a company’s
profitable operations. It consists of all undistributed income
that remains invested in the company. Earned capital is dif-
ferentiated from contributed (paid-in) capital that comes
from stockholders’ purchase of capital stock. (p. 674).
earnings management The planned timing of revenues, ex-
penses, gains, and losses to smooth out bumps in earnings. In
most cases, companies use earnings management to increase
income in the current year at the expense of income in future
years. (p. 201).
earnings per share (EPS) A distilled and important income
figure, calculated as net income minus preferred dividends
(income available to common stockholders), divided by the
weighted average of common shares outstanding. Companies
must disclose earnings per share on the face of the income
statement. (p. 220, 959).
economic entity assumption An assumption that economic
activity can be identified with a particular unit of accounta-
bility, by keeping an enterprise’s economic activity separate
and distinct from that of its owners and any other business
unit. The entity assumption refers to economic, rather than
legal, entities. (p. 45).
effective tax rate The tax rate a company actually pays, com-
puted as total income tax expense for the period divided by
pretax financial income. It differs from the enacted tax rate
because of deductions and provisions allowed by the tax
code. (p. 795).
effective yield The rate of return that takes into account the
frequency of compounding. If compounding occurs more
than once a year, the effective yield will exceed the stated
rate. (p. 1006).
effective yield, or market rate (applied to bonds) The
rate of interest the bondholders actually earn on a bond. If
bonds sell at a discount, the effective yield exceeds the stated
rate; if bonds sell at a premium, the effective yield is lower
than the stated rate. (p. 615).
effective-interest method (applied to investments)
Method for computing the amortization of a discount or pre-
mium. To compute interest revenue on a bond investment,
companies compute the effective-interest rate or yield at the

time of investment and apply that rate to the beginning car-
rying amount (book value) for each interest period. The
investment carrying amount is increased by the amortized
discount or decreased by the amortized premium in each
period. (p. 734).
effective-interest method (applied to bonds) The pre-
ferred procedure for computing the amortization of a dis-
count or premium. Under this method, companies compute
bond interest expense (by multiplying the carrying value of
the bonds at the beginning of the period by the effective-
interest rate) and then subtract bond interest paid (calculated
as the face amount of the bonds times the stated interest
rate); the result is the amortization amount. (p. 1026).
effective-interest method (for lease transactions) Method
used by the lessee to allocate each payment under a capital
lease between principal and interest.This method produces a
periodic interest expense equal to a constant percentage of
the carrying value of the lease obligation. The lessee must
use the same discount rate that determines the present value
of the minimum lease payments. (p. 900).
effective-interest method of amortization (applied to
bonds) The preferred procedure for computing the amor-
tization of a discount or premium. Also called present value
amortization. Under this method, companies compute bond
interest expense (by multiplying the carrying value of the
bonds at the beginning of the period by the effective-interest
rate) and then subtract bond interest paid (calculated as the
face amount of the bonds times the stated interest rate); the
result is the amortization amount. (p. 640).
elements, basic Definitions of the items that make up any
theoretical structure. For accounting, the basic elements are
the many terms with distinctive and specific meanings. There
are ten basic accounting elements: assets, liabilities, equity, in-
vestments by owners, distributions to owners, comprehensive
income, revenues, expenses, gains, and losses. These terms
constitute the language of business and accounting. (p. 42).
Emerging Issues Task Force (EITF) Group created in 1984
by the FASB to reach a consensus on how to account for new
and unusual financial transactions that might create differing
financial reporting practices. The FASB reviews and ap-
proves all EITF consensuses, and the SEC views consensus
solutions as preferred accounting. (p. 11).
enacted tax rate The tax rate, passed by Congress, that is ex-
pected to apply to future periods. When determining the tax
rate to apply to existing temporary differences, a company
must consider presently enacted changes in the tax rate that
become effective for a particular future year(s). (p. 795).
equity method Method of accounting for investment hold-
ings of 20 percent or more (investments in which the investor
and the investee acknowledge a substantive economic rela-
tionship). The investor records the investment at cost but
adjusts the amount each period for changes in the investee’s
net assets. That is, the investor’s proportionate share of the
earnings (losses) of the investee periodically increase
(decrease) the investment’s carrying value. All dividends
received by the investor from the investee decrease the
investment’s carrying amount. (p. 746).
equity securities Financial securities that represent owner-
ship interests such as common, preferred, or other capital
Glossary 9
stock. They also include rights to acquire or dispose of own-
ership interests at an agreed-upon or determinable price,
such as in warrants, rights, and call or put options. The cost of
equity securities includes the purchase price of the security
plus broker’s commissions and other fees incidental to the
purchase. (p. 742).
errors in financial statements Errors that result from math-
ematical mistakes, mistakes in applying accounting princi-
ples, or oversight or misuse of facts that existed when
preparing the financial statements. (p. 942).
event A happening of consequence, which generally is the
source or cause of changes in assets, liabilities, and equity.
Events may be external or internal. (p. 78).
exchange for noncash consideration Transaction in which
the medium of exchange is an asset other than cash (e.g.,
property or services). Companies record equity securities
acquired in exchange for noncash consideration at the fair
value of the consideration given or the fair value of the security
received, whichever is more clearly determinable. (p. 743) (ftn).
executory costs Costs for insurance, maintenance, and tax
expenses during the economic life of a leased asset.
Executory costs do not represent payment on or reduction of
the lease obligation. Many lease agreements specify that the
lessee directly pays executory costs to the appropriate third
parties. (p. 899).
expectations gap The difference between what the public
thinks accountants should do and what accountants think
they can do. (p. 17).
expected cash flow approach Method of calculating pres-
ent value that uses a range of cash flows and incorporates the
probability of those cash flows to provide as accurate as pos-
sible measure of expected future cash flows. (p. 1027).
expected rate of return The percentage growth rate that ac-
tuaries expect when they develop a funding pattern to pay
future pension-plan benefits. They multiply the expected
rate of return by a weighted asset value, to determine an
expected return on plan assets, and they use that return to
determine the plan’s funding pattern. (p. 861).
expected return on plan assets A rate of return on plan as-
sets that actuaries calculate to determine the funding pattern
for a pension plan. It is computed as the expected rate of re-
turn multiplied by a market-related asset value of the plan
assets. The market related asset value is either a fair value or
a calculated value that recognizes changes in fair value in a
systematic and rational manner.When determining the fund-
ing pattern for the pension plan (and the pension expense
element related to the return on assets), the company uses
the expected return on plan assets, not the actual return in a
given year. (p. 861).
expense-warranty approach Method of accounting for a
company’s warranty expense, in which a company charges
warranty costs to operating expense in the year of a product’s
sale. Also called the accrual method. It is the generally ac-
cepted method, and companies should use it whenever the
warranty is an integral and inseparable part of the sale and the
company can reasonably estimate the costs involved. (p. 624).
extinguishment of debt The payment of debt. If a company
holds a debt security to maturity, it does not compute any gains
or losses; the carrying amount will equal the maturity (face)
10 Glossary
value of the bond. If a company extinguishes debt prior to ma-
turity, it must calculate any gain or loss from extinguishment
and report such gain or loss in net income. (p. 618).
extraordinary items Nonrecurring material items that differ
significantly from a company’s typical business activities.
They are distinguished by their unusual nature and by the
infrequency of their occurrence. (p. 211).
f.o.b. destination Freight term indicating that shipped goods
are placed free on board (“f.o.b.”) to the buyer’s place of
business and the seller pays the freight costs; the goods be-
long to the seller while in transit and title passes to the buyer
when the buyer receives the goods from the shipping carrier.
(p. 423).
f.o.b. shipping point Freight term indicating that shipped
goods are placed free on board (“f.o.b.”) to the shipping car-
rier by the seller and the buyer pays the freight costs; the
goods belong to the buyer while in transit. (p. 423).
face rate The annual interest rate stated on a financial instru-
ment. Also called nominal or stated rate. 1006
face value, par value, principal amount, or maturity value
On a bond, the amount of capital that must be repaid at ma-
turity. The terms face value, par value, principal amount, or
maturity value are used interchangeably. (p. 615).
factoring receivables Sales of receivables to factors, finance
companies or banks that buy receivables from businesses
for a fee and then collect the remittances directly from the
customers. (p. 378).
fair value (for financial instruments) The amount at which a
company can exchange a financial instrument in a current
transaction between willing parties. Companies account for
trading securities and available-for-sale securities at fair
value. (p. 733).
fair value method (for investments without significance in-
fluence) Method of accounting for investment holdings of
less than 20 percent (investments in which the investor has
little or no influence over the investee), assuming that mar-
ket prices are available subsequent to acquisition. The fair
value method requires that companies classify equity securi-
ties at acquisition as available-for-sale securities or trading
securities. (p. 743).
fair value method (for accounting for stock options)
Method for reporting compensation cost. Under this
method, companies use the fair value of the compensation
paid. For stock options, companies use the fair value of the
options, based on acceptable option-pricing models, to value
the options at the grant date. FASB No. 123(R) requires that
companies use the fair-value method to account for compen-
sation cost, including stock options. (p. 848).
fair value option The choice allowed by the FASB to use fair
value in the financial statements as the basis of measurement
for financial assets and liabilities. Under the fair value option,
the item is recorded at fair value at each reporting date, and
unrealized holding gains or losses are reported as part of net
income. (p. 376).
fair value test (for impairments) The impairment test for an
indefinite-life asset other than goodwill. It compares the fair
value of the intangible asset with the asset’s carrying
amount. If the fair value of the intangible asset is less than
the carrying amount, a company recognizes an impairment.
Companies should test indefinite-life intangibles for impair-
ment at least annually. (p. 570).
feedback value A characteristic of relevant information, in-
dicating that information must help users confirm or correct
prior expectations. (p. 40).
financial accounting The accounting process that culminates
in the preparation of financial reports for use by both inter-
nal and external parties. (p. 4).
Financial Accounting Standards Board (FASB) The major
organization of the standard-setting structure for financial
accounting. Its mission is to establish and improve stan-
dards of financial accounting and reporting for the guid-
ance and education of the public. The FASB consists of
seven members, appointed for five-year terms by the
Financial Accounting Foundation. Standards issued by the
FASB are considered generally accepted accounting princi-
ples (GAAP). (p. 9).
Financial Accounting Standards Board Interpretations
Statements issued by the FASB that modify or extend exist-
ing FASB standards. Interpretations have the same authority
as standards for purposes of determining GAAP. (p. 11).
financial components approach Approach used for sales
of receivables with recourse (in which the seller guarantees
payment to the purchaser in the event the debtor fails to
pay). In this approach, each party to the sale recognizes
only the assets and liabilities that it controls after the sale.
(p. 380).
financial flexibility The ability of a company to take effec-
tive actions to alter the amounts and timing of cash flows so
it can respond to unexpected needs and opportunities. A
company’s liquidity and solvency affect its financial flexibil-
ity. (p. 146).
financial instruments Assets consisting of cash, accounts
receivable, an ownership interest, or a contractual right to
receive or obligation to deliver cash or another financial
instrument. (p. 166).
financial reporting Reporting of financial information other
than in formal financial statements. Examples include the
president’s letter or supplementary schedules in the corpo-
rate annual report, prospectuses, reports filed with govern-
ment agencies, news releases, management’s forecasts, and
social or environmental impact statements. (p. 4).
financial statements The principal means through which a
company communicates its financial information. These
statements reflect the collection, tabulation, and final
summarization of the accounting data. The statements most
frequently provided are (1) the balance sheet, (2) the income
statement, (3) the statement of cash flows, and (4) the
statement of owners’ or stockholders’ equity. Note disclo-
sures are an integral part of a company’s financial state-
ments. (p. 4, 79).
financing activities Cash flow activities that include (1) ob-
taining cash from issuing debt and repaying the amounts
borrowed, and (2) obtaining cash from stockholders and
paying them dividends. (p. 252).
finished goods inventory The costs identified with the com-
pleted but unsold units on hand at the end of the fiscal
period. This category of inventory appears on the balance
sheets of manufacturing companies. (p. 420).

first-in, first-out (FIFO) method Inventory-costing method
that assumes that a company uses goods in the order in
which it purchases them. Thus, the costs of the earliest goods
purchased are the first to be allocated to cost of goods sold.
FIFO often approximates the physical flow of goods, pre-
vents manipulation of income, and prices ending inventory
close to current cost, but it fails to match current costs
against current revenues on the income statement, possibly
distorting gross profit and net income. (p. 429).
fixed assets Assets of a durable nature used in the regular
operations of a business. Also called property, plant, and
equipment and plant assets. (p. 488).
franchise A contractual arrangement under which the fran-
chisor grants the franchisee the right to sell certain products
or services, to use certain trademarks or trade names, or to
perform certain functions, usually within a designated geo-
graphical area. A franchise is a contract-related intangible
asset. Companies amortize the cost of a franchise with a lim-
ited life as operating expense over the life of the franchise,
and they also treat as operating expenses any annual pay-
ments made under the franchise agreement. (p. 560).
free cash flow Measure of the cash remaining from operating
activities after adjusting for capital expenditures and divi-
dends paid. Some analysts prefer free cash flow to the meas-
ure of cash provided by operating activities because free
cash flow takes into account the outflows needed to maintain
current operations. (p. 269).
full disclosure principle Accounting principle that dic-
tates that in deciding what information to report, compa-
nies follow the general practice of providing information
that is of sufficient importance to influence the judgment
and decisions of an informed user. It recognizes that the
nature and amount of information included in financial
reports reflects a series of judgmental tradeoffs between
sufficient detail that makes a difference to users, sufficient
condensation to make the information understandable,
and the costs and benefits of providing the information.
(p. 51).
future value Value at a later date of a single sum that is
invested at compound interest. (p. 1007).
future value of an annuity The accumulated total that re-
sults from a series of equal deposits (rents) invested at com-
pound interest. (p. 1012).
gain contingencies Claims or rights to receive assets (or
have a liability reduced) whose existence is uncertain but
which may become valid eventually. Typical gain contingen-
cies include: possible receipts of monies from gifts, dona-
tions, bonuses; possible refunds from the government in tax
disputes; pending court cases; and tax loss carryforwards.
Companies do not record gain contingencies; they disclose
them in the financial statement notes only when a high prob-
ability of realization exists. (p. 620).
gains trading Method of managing net income by selling
investment “winners” in order to report the gains in in-
come, and holding on to the losers. Also referred to as
“cherry picking,” “snacking,” or “sell the best and keep the
rest.” (p. 740, 757).
general journal A complete record of a company’s transac-
tions or other financial events, listed chronologically and
Glossary 11
expressed in terms of debits and credits made to accounts.
(p. 85).
general ledger A list of all of a company’s asset, liability,
stockholders’ equity, revenue, and expense accounts. (p. 84).
generally accepted accounting principles (GAAP) The
common set of accounting standards and procedures, for
which either an authoritative accounting rule-making body
has established a principle of reporting in a given area, or
over time, a given practice has been accepted as appropriate
because of its universal application. (p. 7).
going-concern assumption Accounting assumption that a
company will continue in operation for the foreseeable fu-
ture. Only in situations in which liquidation appears immi-
nent is the assumption inapplicable. (p. 46).
goodwill The value of all favorable attributes that relate to a
company over and above the cost (purchase price) of the
company’s identifiable tangible and intangible net assets.
Goodwill is often referred to as the most intangible of intan-
gible assets; the only way to sell it is to sell the business.
Companies do not amortize goodwill because it is consid-
ered to have an indefinite life. (p. 564).
Governmental Accounting Standards Board (GASB) The
organization that sets accounting standards for state and lo-
cal government reporting. It has an advisory council called
the Governmental Accounting Standards Advisory Council
(GASAC) and its own technical staff and task forces to assist
its work. (p. 12).
grant date The date at which a company grants stock options
to employees. Public companies estimate the options’ fair
value as of that date, using an option pricing model and any
adjustments needed for unique factors. No adjustments oc-
cur after the grant date in response to subsequent changes
(up or down) in the stock price. (p. 848, 850).
gross profit method Method of determining inventory
amount, often used when it is impossible or impractical to
take a physical inventory. In this method, companies com-
pute the gross profit percentage on selling price, multiply
that percentage times net sales to determine gross profit,
subtract gross profit from net sales to find cost of goods sold,
and subtract cost of goods sold from total goods available for
sale to determine ending inventory. Also called the gross
margin method. (p. 454).
gross profit percentage Measure used in the gross profit
method, it represents the rate (percentage) of profit a com-
pany expects from some convenient measure, usually sales.
This rate is determined by company policy and prior-period
experience. (p. 455).
guaranteed residual value Either the certain or deter-
minable amount that the lessee will pay the lessor at the end
of a lease to purchase the leased asset or the amount the
lessee or third-party guarantees the lessor will realize if the
asset is returned. The amount of guaranteed residual value is
included in determining the amount of minimum lease
payments. (p. 899).
held-to-maturity securities Debt securities that the com-
pany has the positive intent and ability to hold to maturity.
Companies report held-to-maturity securities at amortized
cost, recognize interest when earned, and do not recognize
unrealized holding gains or losses. (p. 150, 732).
12 Glossary
high rate of returns A high ratio of returned merchandise to
sales, which results in companies needing to postpone rev-
enue recognition until the return privilege has substantially
expired. (p. 307).
historical cost The cash or cash equivalent price of obtaining
an asset and bringing it to the location and condition neces-
sary for its intended use. Most companies use historical cost
as the basis for valuing property, plant, and equipment.
Historical cost typically includes the purchase price, freight
costs, sales taxes, installation costs, and any related costs
incurred after the asset’s acquisition (such as additions or
improvements) if they provide future service potential.
Historical cost is allocated to future periods through depre-
ciation. (p. 488).
historical-cost principle An accepted accounting principle
that companies account for and report most assets and lia-
bilities on the basis of acquisition price. Historical cost is
verifiable and neutral and therefore contributes to reliabil-
ity. (p. 47).
holding gain or loss (for securities) The net change in the
fair value of a security from one period to another, exclusive
of dividend or interest revenue recognized but not received.
(p. 740).
if-converted method Method of measuring the dilutive ef-
fects of potential conversion on EPS, for companies with
securities convertible into common stock. For a convertible
bond, this method assumes the conversion of the convertible
securities at the beginning of the period and the elimination
of related interest, net of tax. The additional shares assumed
issued increase the weighted-average number of shares out-
standing (the denominator), and the amount of interest ex-
pense increases net income (the numerator). (p. 966).
impairment (applied to investments) A loss in value that is
other than temporary. Companies should evaluate every
investment, at each reporting date, to determine if it has suf-
fered impairment. If a decline in an investment is judged to
be other than temporary, a company writes down the cost ba-
sis of the individual security to a new cost basis.The company
accounts for the write-down as a realized loss and includes
the amount in net income. (p. 754).
impairment (applied to ling-lived assets) A write-off of
the carrying amount of a long-lived asset (property, plant,
and equipment or intangible asset) that is not recoverable.
Companies use a recoverability test to determine whether
an impairment has occurred and if it has, they then use a
fair value test to measure the amount of the impairment
loss. (p. 568).
implicit interest rate The interest rate used by the lessor in
determining the lease payments; it ensures a desired rate of
return for the lessor in the leasing arrangement. (p. 899).
impracticable (application) (as it relates to changes in
accounting principle) Retrospective application that is
not possible because a company cannot determine the prior-
period effects using every reasonable effort to do so. If it is
deemed impracticable to apply the retrospective approach,
the company prospectively applies the new accounting prin-
ciple. (p. 949).
imprest system for petty cash A method of control for dis-
bursements of petty cash. The company establishes a petty
cash fund, controlled by the petty cash custodian, who pays
out cash from the fund for amounts up to a certain pre-set
limit. When the cash in the fund runs low, the custodian pres-
ents a request for reimbursement of the fund, supported by
receipts as evidence of fund disbursement. Petty cash trans-
actions are recorded in the accounting records when the
fund is established and when it is replenished, but not in the
interim. Companies use the account Cash Over and Short to
record any errors that occur in the petty cash fund. (p. 389).
improvements (betterments) The substitution of a better
asset for the one currently used (say, a concrete floor in a
factory for a wooden floor). If the expenditure for an im-
provement increases future service potential of an asset, the
company capitalizes the cost of the improvement. (p. 498).
imputed interest rate An approximated interest rate, used
when a company cannot determine the interest rate of a note
receivable because it has no ready market. To estimate the
present value of the note, the company approximates an
applicable interest rate, which may differ from the stated
interest rate. (p. 376).
inadequacy The state of an asset in which the asset has
ceased to be useful to a company because the demands of the
firm have changed. Inadequacy is a physical factor that leads
to a company’s decision to retire an asset (end its service
life). An example would be the need for a larger building to
handle increased production. Although the old building may
be still be sound, it may not be adequate for the company’s
purpose. Retired assets are not depreciated and are removed
from the books when disposed of. (p. 501).
income available to common stockholders The numerator
used in a basic earnings per share calculation when a com-
pany has both common and preferred stock outstanding.
Computed as net income minus preferred dividends. (p. 961).
income bonds Bonds that pay no interest unless the issuing
company is profitable. (p. 613).
income statement Financial statement that measures the re-
sults of operations during a particular period and presents
those results in terms of net income or net loss. It is also of-
ten called the statement of income or statement of earnings.
(p. 79, 200).
Income Tax Refund Receivable The account to which a
company records a tax benefit. The company reports this ac-
count on the balance sheet as a current asset and reports it
on the income statement as an income tax benefit. (p. 798).
incremental borrowing rate Discount rate that the lessee
would have incurred to borrow the funds necessary to buy a
leased asset on a secured loan with repayment terms similar to
the payments called for in the lease. This rate is used to deter-
mine whether a lease meets the 90 percent (recovery of invest-
ment) test if the lessor’s implicit rate is not known. (p. 899).
indefinite-life intangibles Intangible assets for which there
is no foreseeable limit on the period of time over which they
are expected to provide cash flows. A company does not
amortize an indefinite-life intangible asset but instead
assesses it for impairment at least annually. (p. 557).
indirect effects of change in accounting principle Any
change to current or future cash flows of a company that
result from making a change in accounting principle that is
applied retrospectively. An example is the change in payments

in a profit-sharing plan arising from a change in accounting
principle. Indirect effects do not change prior-period
amounts. A company includes in the financial statements a
description of the indirect effects and discloses the amounts
recognized in the current period and related per share infor-
mation. (p. 948).
indirect method Method of preparing the cash flow state-
ment that starts with net income and converts it to net cash
provided by operating activities, by adjusting net income for
items that affected reported net income but did not affect
cash. Also called the reconciliation method. (p. 259).
industry practices Peculiarities of some industries and busi-
ness concerns that cause variations from basic accounting
theory or practice. For example, agricultural companies often
report crops at market value because it is costly to develop
accurate cost figures on individual crops. (p. 55).
installment-sales method Revenue-recognition method in
which companies recognize income in the periods of collec-
tion rather than in the period of sale. “Installment sales”
generally describes any type of sale for which payment is
required in periodic installments over an extended period of
time. Theoretically, the installment-sales method is not gen-
erally preferred, except for some sales of real estate; a better
approach generally is for a company to recognize a sale
when completed and keep a bad debts account to estimate
uncollectibles. (p. 317).
intangible assets Assets that lack physical substance and
are not financial instruments. Intangible assets derive their
value from the rights and privileges granted to the company
using them. Examples are patents, copyrights, franchises,
goodwill, trademarks, and trade names. Companies write off
(amortize) limited-life intangible assets over their useful
lives, and they periodically assess indefinite-life intangibles
for impairment. (p. 154, 556).
interest Payment for the use of someone else’s money. It is
the excess cash received/repaid over and above the amount
lent/borrowed. (p. 1002).
interest on the liability/interest expense A component of
pension expense. Because a company defers paying the
pension liability until maturity, it records the liability on a
discounted basis and accrues interest. The interest on the
liability (interest expense) is the interest for the period on
the projected benefit obligation outstanding during the
period, using a settlement rate as the discount rate. (p. 857).
International Accounting Standards Board (IASB) The or-
ganization, based in London, that sets accounting standards
accepted for international use. Those international stan-
dards, many of which are similar to U.S. GAAP, are known as
iGAAP. Currently, the FASB and the IASB are working on
a convergence project to result in one set of high-quality
standards. (p. 18).
intraperiod tax allocation Reporting of irregular items
within an accounting period on the income statement or
statement of retained earnings net of tax. Such allocation
relates the income tax expense of the fiscal period to the spe-
cific items that give rise to the amount of the tax provision. It
helps financial statement users better understand the impact
of income taxes on the various components of net income,
and it discourages statement readers from using pretax
Glossary 13
measures of performance when evaluating financial results.
(p. 218).
intrinsic-value method Method for reporting the granting of
stock options. It measures compensation cost as what the
holder of the stock option would receive today if the option
was immediately exercised. The intrinsic value is the differ-
ence between the market price of the stock and the exercise
price of the options at the grant date. Use of this approach
for most stock-based compensation plans is not allowed
based on FASB No. 123(R), which generally requires the
fair-value method. (p. 848).
inventories Asset items that a company holds for sale in
the ordinary course of business, or goods that it will use or
consume in the production of goods to be sold. The invest-
ment in inventories is frequently the largest current asset
of merchandising (retail) and manufacturing businesses.
(p. 420).
inventory turnover ratio Liquidity ratio that measures the
number of times on average a company sells its inventory
during the period. Computed as the cost of goods sold
divided by the average inventory on hand during the period.
Analysts compute average inventory from beginning and
ending inventory balances. (p. 449).
investee A corporation whose common stock is bought by
another corporation (investor) for investment purposes.
(p. 742).
investing activities Cash flow activities that include (1) pur-
chasing and disposing of investments and productive long-
lived assets using cash, and (2) lending money and collecting
the loans. (p. 252).
investor A corporation that acquires an interest in the com-
mon stock of another corporation (investee) for investment
purposes. The percentage of the investee voting stock that is
held by the investor, which determines the amount of influ-
ence the investor has over the investee, generally determines
the accounting treatment for the investment. (p. 742).
involuntary conversion The termination of an asset’s service
as a result of some type of unwanted or unexpected event,
such as fire, flood, theft, or condemnation. Companies report
the difference between the amount recovered from the
involuntary conversion, if any, and the asset’s book value as
a gain or loss. In rare cases, these gains or losses are reported
as extraordinary items in the income statement. (p. 510).
irregular items Income-statement components for which
the FASB has established special reporting rules. These
items fall into six general categories: (1) discontinued oper-
ations, (2) extraordinary items, (3) unusual gains and losses,
(4) changes in accounting principle, (5) changes in esti-
mates, and (6) corrections of errors. (p. 209).
journal The “book of original entry” where the company ini-
tially records transactions and selected other events. The
company transfers that information from the journal to the
ledger. (p. 79).
large stock dividend A stock dividend (a corporation’s
issuance of its own stock to its stockholders, on a pro rata
basis) of more than 20–25 percent of the number of shares
previously outstanding. The company transfers, from
retained earnings to capital stock, the par value of the stock
issued. Such a distribution (often referred to as a split-up
14 Glossary
effected in the form of a stock dividend) typically reduces
the market price of the stock, making it more marketable.
The effects of large stock dividends thus make them more
like stock splits than like an ordinary stock dividend. (p. 694).
last-in, first-out (LIFO) method Inventory-costing method
that assumes that a company uses the latest goods purchased
before it uses the earlier goods purchased. Thus, the costs of
the latest goods purchased are the first to be allocated to cost
of goods sold. LIFO provides a good matching of recent
costs against current revenues and tax benefits, but generally
reports lower earnings, which some managers see as a disad-
vantage. (p. 430).
lease A contractual agreement that gives a lessee the right to
use specific property, owned by the lessor, for a specified pe-
riod of time in exchange for rental payments over the life of
the lease. For accounting purposes, leases are classified as
either capital leases or operating leases. (p. 892).
lease receivable The present value of the minimum lease
payments plus the present value of the unguaranteed resid-
ual value of a direct-financing lease. Direct-financing leases
require the lessor to substitute a lease receivable for the
leased asset. (p. 909).
lease term The duration of a lease, generally considered to be
the fixed, noncancelable term of a lease. A lease term equal
to 75 percent or more of the estimate life of leased property
is one of the criteria for determining if a lease is a capital
lease. (p. 894, 898).
ledger The book (or computer printouts) containing the
accounts. A general ledger is a collection of all the asset, lia-
bility, owners’ equity, revenue, and expense accounts. A sub-
sidiary ledger contains the details related to a given general
ledger account. (p. 79).
lessee A party that has made a contractual arrangement to
use another party’s asset for a specific period of time by
making periodic payments. (p. 892).
lessor A party that has made a contractual arrangement to let
another party use an asset for a specific period of time in
exchange for periodic payments. (p. 892).
leveraged buyout (LBO) Transaction in which a company
borrows money to finance the repurchase of all of the com-
pany’s outstanding stock, in order to eliminate public (outside)
ownership. (p. 680).
liabilities Present obligations, as a result of past transactions,
that entail settlement by probable future transfer or use of
cash, goods, or services. (p. 606).
liability gains and losses (for pensions) Unexpected gains
or losses from changes in the projected benefit obligation of
a pension. Such changes result from the difference between
actual experience and actuarial predictions about such items
as mortality rate, retirement rate, turnover rate, disability
rate, and salary amounts. Companies defer recognition of
liability gains (resulting from unexpected decreases in the
liability balance) and liability losses (resulting from unex-
pected increases). They combine the liability gains and losses
in the Other Comprehensive Income (G/L) account and
accumulate them from year to year. (p. 862).
license (permit) An agreement by which governmental units or
agencies grant rights to a privately owned company to use pub-
lic property in performing its services. Examples are the use of
public waterways for a ferry service, the use of public land for
telephone or electric lines, and the use of the airwaves for radio
or TV broadcasting. A license or permit is a contract-related
intangible asset. Companies amortize the cost of a license or
permit with a limited life as to operating expense over the life
of the agreement, and they also treat as operating expenses any
annual payments made under the agreement. (p. 561).
LIFO effect The change from one period to the next in the
balance of the account (Allowance to Reduce Inventory to
LIFO, also called the LIFO reserve) that companies use to
record the difference between the non-LIFO inventory
method used for internal-reporting purposes and LIFO used
for tax or external-reporting purposes. (p. 432).
LIFO liquidation Erosion of the LIFO inventory under a spe-
cific-goods (unit LIFO) approach. Such erosion matches
costs from preceding periods against sales revenues reported
in current dollars, which often distorts net income and leads
to substantial tax payments. (p. 433).
LIFO reserve The difference between the inventory amount
reported using LIFO for tax or external-reporting purposes
and the inventory amount using FIFO or some other method
for internal-reporting purposes. (p. 432).
limited-life intangibles Intangible assets judged to have a
limited useful life, which reflects the periods over which
these assets will contribute to cash flows. Companies amor-
tize limited-life intangibles by systematic charges to expense
over their useful lives. (p. 557).
liquidating dividends Dividends based on funds other than
retained earnings, implying that the dividends are a return of
the stockholder’s investment rather than of profits. Any
dividend not based on earnings reduces corporate paid-in
capital. (p. 688, 690).
liquidity The amount of time that is expected for an asset to
be realized or otherwise converted into cash or until a lia-
bility has to be paid. In general, the greater a company’s
liquidity, the lower its risk of failure. (p. 146).
liquidity ratios Measures of a company’s short-run ability to
pay its maturing obligations. Common liquidity ratios are:
the current ratio, the quick or acid-test ratio, and the current
cash debt coverage ratio. (p. 277).
litigation, claims, and assessments Different types of loss
contingencies. Litigation may be pending or threatened;
claims and assessments may be actual or possible. Whether
companies should record litigation, claims, and assessments
depends on such factors as the time period in which the under-
lying cause of action occurred, the probability of an unfavor-
able outcome, and the ability to make a reasonable estimate
of the amount of loss. Loss contingencies usually are dis-
closed in a note to the financial statements; loss contingen-
cies that are probable and can be reasonably estimated are
accrued as liabilities in the financial statements. (p. 622).
long-term debt Probable future sacrifices of economic bene-
fits arising from present obligations that are not payable
within a year or the operating cycle of the company,
whichever is longer. Examples are: bonds payable, long-term
notes payable, mortgages payable, pension liabilities, and
lease liabilities. (p. 612).
long-term investments Investments that companies expect to
hold for many years. Examples are: (1) investments in securities,

such as bonds or common stock; (2) investments in tangible
fixed assets not currently used in operations, such as land held
for speculation (3) investments set aside in special funds such as
a pension fund; and (4) investments in nonconsolidated sub-
sidiaries. Companies usually present long-term investments on
the balance sheet just below current assets. (p. 153).
long-term liabilities Obligations that a company expects to
pay at some date beyond the normal operating cycle.
Examples are: bonds payable, notes payable, some deferred
income tax amounts, lease obligations, and pension obliga-
tions. Also referred to as long-term debt. Companies provide
a great deal of supplementary disclosure for long-term liabil-
ities because they often are subject to covenants and restric-
tions for the protection of lenders. (p. 157).
loss carryback An income-averaging provision in the U.S. tax
code that enables companies to carry a net operating loss
back two years and receive refunds for income taxes paid in
those years. A company must apply the loss to the earlier
year first and then to the second year. (p. 797).
loss carryforward An income-averaging provision in the
U.S. tax code that enables companies to carry forward any
loss remaining after a two-year carryback up to 20 years to
offset future taxable income. Or, a company may forgo the
loss carryback and use only the loss carryforward option, off-
setting future taxable income for up to 20 years. (p. 797).
loss contingencies Possible losses, which may occur as the
result of one or more future events.A liability incurred as a re-
sult of a loss contingency is by definition a contingent liability.
Loss contingencies are judged on likelihood and are rated
probable, reasonably possible, or remote. Companies accrue an
estimated loss from a loss contingency by a charge to expense
and a recorded liability if the loss is probable and its amount
can be reasonably estimated. They also disclose and discuss
the loss contingency in the financial statement notes. (p. 621).
lower (floor) limit In the lower-of-cost-or-market (LCM)
rule, the lowest amount at which inventory can be reported;
computed as the net selling price less a normal profit margin.
This minimum amount measures what the company can re-
ceive for the inventory and still earn a normal profit. (p. 443).
lower-of-cost-or-market (LCM) Rule that dictates that a
company value inventory at the lower-of-cost-or-market,
with “market” limited to an amount that is not more than net
realizable value or less than net realizable value less a
normal profit margin. Thus, companies abandon the histori-
cal cost principle when the revenue-producing ability of an
asset drops below its original cost. (p. 443).
lump-sum price A single amount paid for a group of plant as-
sets. To determine the cost for the individual assets acquired
in a lump-sum purchase, the company allocates the total cost
among the various assets on the basis of their relative fair
values. (p. 492).
lump-sum sales The issuance of two or more classes of secu-
rities for a single payment (lump sum). Companies use one
of two methods of allocating the proceeds among the multi-
ple classes of securities: the proportional method (allocate
among classes on a proportional basis) or the incremental
method (allocate using market value of securities for which
market value is known and allocate the remainder to the
class for which market value is not known). (p. 676).
Glossary 15
major repairs Significant expenditures, such as an overhaul,
whose purpose it to maintain assets in operating condition.
Several periods benefit from major repairs, and companies
should depreciate the cost of such repairs as they would the
costs for an addition, improvement, or replacement. (p. 499).
manufacturer’s or dealer’s profit (or loss) of sales-type
lease Distinguishing feature of a sales-type lease. The les-
sor recognizes a sale of the asset and a gross profit (or loss)
on the sale, a measure based on the difference between the
selling price of the leased asset and its cost. (p. 909).
market (for LCM) The cost to replace an inventory item by
purchase or reproduction. For a merchandiser, “market”
refers to the market in which a company purchases goods,
not the market in which it sells them. For a manufacturer, the
term “market” refers to the cost to reproduce. Thus, lower-
of-cost-or-market means that companies value goods at cost
or cost to replace, whichever is lower. (p. 442).
master valuation approach A procedure for valuing good-
will. It assumes that goodwill is the difference between the
purchase price for a company and the amount that cannot be
specifically identified with any identifiable tangible or intan-
gible assets, less liabilities assumed in the purchase. (p. 566).
matching principle Accounting principle that dictates that
efforts (expenses) be matched with accomplishment (rev-
enues) whenever it is reasonable and practicable to do so.
This linking of expense recognition to revenue recognition
is popularly expressed as, “Let the expense follow the
revenues.” (p. 49).
materiality An accounting constraint that says that if an item
would not make a difference in a user’s decision making, the
company need not disclose the item in its financial reporting.
An item is said to be material if its inclusion or omission
would influence or change the judgment of a reasonable per-
son; it is immaterial, and therefore irrelevant, if it would have
no impact on a decision maker. The point involved is one of
relative size and importance; that is, both quantitative and
qualitative factors should considered. (p. 54).
merchandise inventory For a merchandising business, the
cost assigned to unsold units left on hand, but ready for sale.
Only one inventory account, Merchandise Inventory, appears
in a merchandiser’s financial statements. (p. 420).
minimum lease payments A measure, the present value of
which is determined and used as part of the recovery of in-
vestment (90 percent) test. Minimum lease payments include
minimum rental payments, a guaranteed residual value, a
penalty for failure to renew the lease, and a bargain purchase
option.The lessee does not include executory costs in comput-
ing the present value of the minimum lease payments. (p. 899).
modified all-inclusive concept Approach, adopted by the
accounting profession, that dictates that companies record
just about all items, including irregular ones, as part of net in-
come, and that companies must highlight irregular items in
the financial statements. (p. 209).
monetary unit assumption Accounting assumption that
money is the common denominator of economic activity and
provides an appropriate basis for accounting measurement
and analysis. (p. 46).
more likely than not A level of likelihood of at least slightly
more than 50 percent.This measure is used in connection with
16 Glossary
a deferred tax asset for all deductible temporary differences. If
it is more likely than not that a company will not realize some
portion of the deferred tax asset, the company should reduce
the deferred tax asset by a valuation allowance. (p. 790).
moving-average method Inventory-costing method, used
by companies that use the perpetual inventory method. In
this method, a company computes a new average unit cost (a
“moving average”) each time it makes a purchase. (p. 428).
multiple-step income statement Income statement format
that separates operating transactions from nonoperating
transactions, and matches costs and expenses with related
revenues. It highlights certain intermediate components of
income that analysts use to compute ratios for assessing the
performance of the company. (p. 204).
negative goodwill (badwill) Amount by which the fair value
of assets acquired by a company exceeds the purchase price
of the assets. Also called excess of fair value over the cost ac-
quired, badwill, or bargain purchase. This situation results
from a market imperfection, in which the purchase price is
less than the value of the net identifiable assets. The FASB
requires that negative goodwill be recognized as an extraor-
dinary gain. (p. 567).
net current amount (related to deferred income taxes)
The difference between the amounts of deferred tax assets
and deferred tax liabilities that are classified as current. If the
net result is an asset, report it on the balance sheet as a cur-
rent asset; if a liability, report it as a current liability. (p. 804).
net funded status The overfunded or underfunded status of
a defined-benefit pension plan, measured as the difference
between the fair value of the plan assets and the projected
benefit obligation. Companies recognize on the balance
sheet the net (overfunded or underfunded) status of the pen-
sion plan. (p. 864).
net noncurrent amount (related to deferred income taxes)
The difference between the amounts of deferred tax assets
and deferred tax liabilities that are classified as noncurrent.
If the net result is an asset, report it on the balance sheet as a
noncurrent asset; if a liability, report it as a noncurrent liabil-
ity. (p. 804).
net operating loss (NOL) A loss that occurs for tax purposes
in a year when tax-deductible expenses exceed taxable
revenues. Under certain circumstances, the federal tax laws
permit companies to use the losses of one year to offset the
profits of other years, through use of the carryback and
carryforward of net operating losses. (p. 796).
net realizable value (applied to receivables) The net
amount that companies expect to receive in cash for short-
term receivables. Companies estimate both uncollectible
receivables and any returns or allowances to be granted in
order to determine net realizable value, which they report in
the financial statements. (p. 366).
net realizable value (NRV) (applied to inventories) In the
lower-of-cost-or-market approach, the estimated selling
price in the ordinary course of business, less reasonably pre-
dictable costs of completion and disposal. The NRV repre-
sents the ceiling (upper limit) under LCM. (p. 443).
net realizable value less a normal profit margin In the
lower-of-cost-or-market approach, the floor (lower limit),
calculated as the NRV minus a normal profit margin. (p. 443).
neutrality One characteristic of reliable information, which
indicates that a company cannot select information to favor
one set of interested parties over another. Unbiased infor-
mation must be the overriding consideration. (p. 41).
nominal accounts Revenue, expense, and dividend accounts;
except for dividends, these accounts appear on the income
statement. Companies close nominal accounts, also called tem-
porary accounts, at the end of the accounting period. (p. 78).
nominal rate The annual interest rate stated on a financial
instrument (a note or bond, for example). Also called face or
stated rate. (p. 1006).
noncancelable (for a lease transaction) Terms of a lease
agreement by which the lessee can cancel the lease contract
only upon the outcome of some remote contingency or that
involve cancellation provisions and penalties that are so
costly to the lessee that cancellation probably will not occur.
(p. 896).
nonmonetary assets Fixed assets such as property, plant, and
equipment. Ordinarily companies account for the exchange
of nonmonetary assets by recognizing immediately any gains
or losses on the exchange, using the fair value of the asset
given up or the fair value of the asset received, whichever is
clearly more evident. The accounting for exchanges of non-
monetary assets with a gain involves assessing whether the
transaction has commercial substance. (p. 511).
nonreciprocal transfers Contributions (donations or gifts of
cash, securities, land, buildings, or use of facilities) that trans-
fer assets in only one direction. Companies that receive con-
tributions should record the transferred asset at its fair value.
In general, companies should recognize contributions as rev-
enue in the period received. (p. 494).
nontrade receivables Claims that arise from a variety of
non-sales transactions. Examples include: advances to offi-
cers and employees or to subsidiaries; dividends and interest
receivable; deposits paid to cover potential damages or
losses or as a guarantee of performance or payment; and
claims against insurance companies for casualties sustained,
defendants under suit, governmental bodies for tax refunds,
common carriers for damaged or lost goods, creditors for re-
turned, damaged, or lost goods, and customers for returnable
items. (p. 363).
no-par stock Capital stock that has not been assigned a par
value. No-par stock avoids the contingent liability that might
occur if the corporation issued par value stock at a discount
and avoids the possibility of mistakenly using par value as a
basis for fair value. (p. 675).
notes payable Written promises to pay a certain sum of money
on a specified future date, which may arise from purchases,
financing, or other transactions. Some notes payable (often
referred to as trade notes payable) are part of a sales/purchases
transaction; notes payable to banks generally arise from cash
loans. Notes payable can be short-term or long-term, and they
can be interest-bearing or zero-interest-bearing. (p. 607).
notes receivable Written promises to pay a certain sum of
money on a specified future date. Notes receivable may arise
from sales, financing, or other transactions and may be short-
term or long-term. (p. 363).
notes to financial statements A set of amplifications to a
company’s financial statements that further explain the

items presented in the main body of the statements. The ad-
ditional information provided in the notes does not have to
be quantifiable, nor does it need to qualify as an accounting
element. Notes to the financial statements are considered an
integral part of the statements. (p. 51).
not-sufficient-funds (NSF) checks A charge recorded by a
bank against a depositor’s balance for a check written for more
than the amount of funds in the depositor’s account. (p. 390).
objectives of financial reporting Goals for financial ac-
counting and reporting, established by the accounting pro-
fession, which are to provide information that is (1) useful in
investment and credit decisions, (2) useful in assessing cash
flow prospects, and (3) about company resources, claims to
those resources, and changes in them. (p. 6, 38).
obsolescence The state of an asset in which the asset becomes
out of date before it physically wears out. Obsolescence is an
economic factor that leads to a company’s decision to retire an
asset (end its service life). Retired assets are not depreciated
and are removed from the books when disposed of. (p. 501).
off–balance-sheet financing Borrowing funds in a way that
prevents the recording of obligations and does not add debt
to the balance sheet. Examples of such arrangements are
nonconsolidated subsidiaries, special purpose entities, and
operating leases. Companies engage in off–balance-sheet fi-
nancing as a way to remove debt from the balance sheet or
bypass loan covenants. In response to off–balance-sheet fi-
nancing gone bad (e.g., Enron), the FASB has increased dis-
closure (note) requirements related to this type of financing.
(p. 629, 894).
operating activities Cash flow activities include the cash ef-
fects of transactions that create revenues and expenses, and
thus enter into the determination of net income. (p. 252).
operating cycle The period of time elapsing between the
acquisition of goods and services involved in the manufac-
turing process and the final cash realization resulting from
sales and subsequent collections. Most retail and service es-
tablishments have several operating cycles within a year;
some manufacturers and capital-intensive industries have an
operating cycle of considerably more than one year. (p. 607).
operating lease Lease that does not meet any of the criteria
for a capital lease. An operating lease essentially allows the
lessee to account for the use of the lessor’s asset as a rental,
with payments recorded as rent expense. (p. 897).
ordinary annuity An annuity in which each rent is payable/
receivable at the end of the period. (p. 1012).
ordinary repairs Routine expenditures to maintain plant as-
sets in operating condition. Examples are replacing minor
parts, lubricating and adjusting equipment, repainting, and
cleaning. Companies treat ordinary repairs as operating ex-
penses and charge these amounts to an expense account in
the period incurred, on the basis that it is the primary period
benefited. (p. 499).
originating temporary difference The initial difference
between the book basis and the tax basis of an asset/liability,
regardless of whether the tax basis of the asset/liability
exceeds or is exceeded by the book basis of the asset or lia-
bility. An originating temporary difference may be changed
by a later reversing difference, which results in deferred tax
expense. (p. 793).
Glossary 17
other comprehensive income Measure of the amounts of all
gains and losses in a period that bypass the income statement
but affect stockholders’ equity. These amounts arise from
such items as unrealized gains or losses on certain invest-
ments and unrealized gains and losses on certain hedging
transactions. (p. 222).
Other Comprehensive Income (G/L) Account in which
companies record unexpected gains or losses from changes
in the projected benefit obligation of a pension plan. This ac-
count nets gains and losses from the current year. (p. 862).
Other Comprehensive Income (PSC) Account in which
companies record amortization of prior service cost. When a
company initiates or amends a defined-benefit plan, it often
credits employees for years of service provided before the
start of, or amendment to, the plan. The company records
the PSC as an adjustment to other comprehensive income
and then amortizes that amount over future service periods.
(p. 863).
owners’ (stockholders’) equity The ownership claim on a
company’s total assets. The owners’ equity section of the
corporate balance sheet consists of capital stock, additional
paid-in capital, and retained earnings. The ownership ac-
counts (stockholders’ equity) in a corporation differ con-
siderably from ownership accounts in a partnership or
proprietorship. Partners show separately their permanent
capital accounts and the balance in their temporary
accounts (drawing accounts). Proprietors ordinarily use a
single capital account that handles all of the owner’s equity
transactions. (p. 158).
par-(stated-) value method A method of accounting for
treasury stock, in which a company records all transactions in
treasury shares at their par value and reports the treasury
stock as a deduction from capital stock only. (p. 681).
parent A corporation that has a controlling interest (voting
interest of more than 50 percent) in another corporation (the
subsidiary) Companies present the investment in the sub-
sidiary as a long-term investment on the financial statements
of the parent. (p. 748).
participating preferred stock Preferred stock whose hold-
ers share ratably with the common stockholders in any profit
distributions beyond the prescribed rate. Its holders receive
the prescribed return for preferred stock plus dividends gen-
erally at the same rates as those paid to common stockhold-
ers if the company pays dividends on common stock in
excess of the prescribed preferred rate. (p. 685).
patent An exclusive right, granted by the U.S. Patent and
Trademark Office, to use, manufacture, and sell a product or
process for a period of 20 years without interference or
infringement by others. A patent is a technology-related
intangible asset. The two principal kinds are product patents,
which cover actual physical products, and process patents,
which govern the process of making products. Companies
amortize the cost of the patent, including purchase price and
legal fees needed to obtain or defend a patent, over its legal
life or its useful life, whichever is shorter. Any R&D costs
related to the development of the patented product or
process must be expensed as incurred. (p. 561).
payout ratio Profitability ratio that measures the percentage
of earnings a company distributes to common stockholders
18 Glossary
in the form of cash dividends. Computed as cash dividends
paid to common stockholders divided by net income avail-
able to common stockholders (net income minus preferred
dividends). (p. 699).
pension asset/liability The difference between the projected
benefit obligation and the fair value of the plan assets, which
is shown in the balance sheet. If the projected benefit obliga-
tion is greater than the plan assets, a pension liability occurs;
if the projected benefit obligation is less that the plan assets,
a pension asset occurs. (p. 858).
pension worksheet A multi-column form that companies
use to record pension-related information. It is not a perma-
nent accounting record (neither a journal nor part of the
general ledger), but merely a tool to make it easier to pre-
pare entries and the financial statements. (p. 858).
percentage-of-completion method Revenue-recognition
method in which companies recognize revenues, costs, and
gross profit as progress is made toward completion on a
long-term contract, using a basis or standard (such as the
cost-to-cost basis) to measure the progress toward comple-
tion at interim dates. (p. 311).
percentage-of-receivables approach A method of determin-
ing bad debt expense, by simply reporting receivables in the
balance sheet at net realizable value. Also referred to as the
balance sheet approach. This approach gives a reasonably ac-
curate estimate of the receivables’ realizable value, but it
does not match cost and revenues. Companies may apply this
method using one composite rate that reflects an estimate of
the uncollectible receivables, or they may set up an aging
schedule for particular account categories. (p. 368).
percentage-of-sales approach A method of determining
bad debt expense, in which a company converts the relation-
ship between previous years’ credit sales and bad debts into
a percentage and uses that percentage to determine the cur-
rent year’s bad debt expense. To use this method, there must
be a fairly stable relationship between previous years’ credit
sales and bad debts. Because it relates the charge to the pe-
riod in which a company records the sale, this method
matches costs with revenues. Also referred to as the income
statement approach. (p. 367).
period costs (applied to inventory) Costs that are indi-
rectly related to the acquisition or production of goods.
Examples are selling expenses and, under ordinary circum-
stances, general and administrative expenses. Period costs
are not included as part of inventory cost; instead, they are
matched with revenue of a specific time period and expensed
as incurred. (p. 425).
period costs Costs that attach to a specific accounting pe-
riod. Examples are officers’ salaries and other administrative
expenses. Companies charge off such period costs in the im-
mediate period, even though benefits associated with these
costs may occur in the future. (p. 50).
periodic inventory system Inventory system in which a
company uses a Purchases account to record purchases of in-
ventory during the period. The Inventory account represents
the beginning inventory amount throughout the period; at
the end of the accounting period the company adjusts the in-
ventory account by closing out the beginning inventory
amount and recording the ending inventory amount, which is
determined by a physical count of the items on hand, valued
at cost or at the lower-of-cost-or-market. (p. 110, 421).
periodicity (time period) assumption Accounting assump-
tion that implies that a company can divide its economic activ-
ities into artificial time periods. These time periods vary, but
the most common are monthly, quarterly, and yearly. (p. 46).
permanent difference A difference between taxable income
and pretax financial income that results from items that en-
ter into pretax financial income but never into taxable in-
come, or that enter into taxable income but never into pretax
financial income. (p. 793).
perpetual inventory system An inventory system in which a
company continuously tracks changes in the Inventory ac-
count. The company records all purchases and sales (issues)
of goods directly in the Inventory account as they occur. The
accounting records continuously show the balances in both
the inventory account and the cost of goods sold account. A
computerized recordkeeping system records nearly instan-
taneously any additions to and issuances from inventory.
(p. 110, 421).
plant assets Assets of a durable nature used in the regular
operations of a business. Also called property, plant, and
equipment and fixed assets. (p. 488).
point of sale (delivery) The point at which companies deliver
products or merchandise or render services to customers. For
revenue recognition, the point of sale or delivery is the point
at which companies commonly recognize revenues from
manufacturing and selling activities. (p. 307).
post–balance-sheet events Significant financial events that
took place after the formal balance sheet date but before
final issuance and that may materially affect the company’s
financial position. Also referred to as subsequent events.
Some post–balance-sheet events require adjustments to the
accounts. Notes to the financial statements should explain
post–balance-sheet events. (p. 164).
post-closing trial balance The trial balance after closing
entries are made; consists only of asset, liability, and owners’
equity accounts (the real accounts). (p. 107).
posting The process of transferring the essential facts and
figures from the book of original entry (the journal) to the
ledger accounts, using debits and credits made to accounts.
(p. 79, 85).
predictive value One characteristic of relevant information,
indicating that information must help users predict the ulti-
mate outcome of past, present, and future events. (p. 40).
preemptive right The right of shareholders (unless prohib-
ited in articles of incorporation) to share proportionately in
any new issues of stock of the same class. The preemptive
right protects existing stockholders from involuntary dilution
of ownership interest when a corporation issues additional
stock. Stock warrants (an option to purchase stock) are com-
monly used to satisfy this right. (p. 673).
preferred dividends in arrears Accumulated but undeclared
dividends on cumulative preferred stock. Such dividends are
not a liability until the board of directors authorizes the
distribution of earnings, though companies should disclose
the amount of cumulative dividends unpaid in a note or
show it parenthetically in the capital stock section of the

balance sheet. Dividends in arrears must be paid before any
common stock dividends are paid. (p. 610).
preferred stock A special class of stock that gives its holders
certain special preference or features not possessed by com-
mon stock. Holders typically get preference as to dividends
and to assets in the event of liquidation, and the preferred
stock may be convertible into common stock or callable at the
option of the corporation. The preferred stockholder may sac-
rifice certain rights in return for the other special rights and
privileges; preferred stock may be nonvoting, noncumulative,
and nonparticipating. The accounting for preferred stock is
similar to that for common stock, with preferred stock classi-
fied in a separate category in stockholders’ equity. (p. 673, 684).
prepaid expenses Assets paid for and recorded before a
company uses them. Prepaid expenses expire either with the
passage of time (e.g., rent and insurance) or through use and
consumption (e.g., supplies). Companies typically recognize
prepaid expenses by making adjusting entries to record the
expenses that apply to the current accounting period and to
show the unexpired costs in the asset accounts. (p. 92).
present value The value at an earlier date (usually now) of a
given future sum discounted at compound interest. (p. 1007).
present value of a bond issue The value today of a bond is-
sue that will mature at some date in the future, after taking
into account the interest rate on the issue. (p. 615).
pretax financial income A financial reporting term, deter-
mined according to GAAP and with the purpose of providing
useful information to investors and creditors. Also often re-
ferred to as income before taxes, income for financial reporting
purposes, or income for book purposes. Pretax financial income
is not the same as taxable income, which is income calculated
for tax purposes and determined according to the U.S. tax code.
The main difference is that companies use the accrual method
to report revenues for financial reporting and they use a modi-
fied cash basis to report revenues for tax purposes. (p. 782).
principal The amount borrowed or invested. (p. 1001).
principles of accounting One of the parts in the third level of
the conceptual framework, which details recognition and
measurement concepts. The accounting profession generally
uses four basic principles of accounting to record transac-
tions: (1) historical cost, (2) revenue recognition, (3) match-
ing, and (4) full disclosure. (p. 47).
prior period adjustments Corrections of accounting errors
made in previous accounting periods. Companies correct
such errors by making proper entries in the accounts and re-
porting the corrections in the financial statements (as an ad-
justment to the beginning balance of retained earnings) in
the year in which they are discovered. If a company prepares
comparative financial statements, it should restate the prior
statements for the effects of the error. (p. 216, 954).
prior service costs (PSC) The pension costs related to years
of service credited to employees before the start of a de-
fined-benefit pension plan or at the time of plan amend-
ments. The company records the PSC as an adjustment to
other comprehensive income and then amortizes that
amount over future service periods. (p. 860).
probable (contingency) Evaluation of the likelihood of a
loss contingency; indicates that a future event or events are
likely to occur. (p. 621).
Glossary 19
product costs Costs that “attach” to the inventory and are di-
rectly connected with bringing the goods to the buyer’s place
of business and converting such goods to a salable condition.
Such costs include direct materials, direct labor, and manu-
facturing overhead costs (indirect materials, indirect labor,
and various costs incurred in the manufacturing process such
as depreciation, taxes, insurance, and heat and electricity).
Companies record product costs as part of the inventory
cost. (p. 50, 424).
profit margin on sales ratio Profitability ratio that measures
the company’s use of its assets to produce net income. Also
called rate of return on sales. Computed as net income di-
vided by net sales. This measure indicates the percentage of
each dollar of sales that results in net income. By relating the
profit margin on sales to the asset turnover for the period, we
can find out how profitably the company used assets during
that period of time. (p. 518).
profitability ratios Measures of the degree of success or fail-
ure of a given company or division for a given period of time.
Common profitability ratios are: profit margin on sales, rate
of return on assets, rate of return on common stock equity,
earnings per share, the price-earnings ratio, and the payout
ratio. (p. 277).
projected benefit obligation Pension benefits payable to
employees because of their services rendered during the
current year. Companies use the projected benefit obliga-
tion as an input in determining service cost of a pension
plan. (p. 856).
promissory note A written promise to pay a certain sum of
money at a specific future date, in support of a note receiv-
able. (p. 371).
property dividends Dividends payable in assets of the cor-
poration other than cash. Also called dividends in kind.
Property dividends may be merchandise, real estate, or in-
vestments. The company restates at fair value the property it
will distribute, recognizing any gain or loss on the difference
between the property’s fair value and carrying value, and
records the dividend in either the retained earnings account
or a property dividends account. (p. 690).
property, plant, and equipment Assets of a durable nature
used in the regular operations of the business. Also called
fixed assets and plant assets. These assets consist of physical
property (such as land, buildings, machinery) and wasting re-
sources (timberland, minerals). With the exception of land, a
company either depreciates (e.g., buildings) or depletes (e.g.,
oil reserves) these assets. (p. 153, 488).
Public Company Accounting Oversight Board (PCAOB)
Organization established by the Sarbanes-Oxley Act of 2002
that has oversight and enforcement authority for accounting
practices and that establishes auditing, quality control, and
independence standards and rules. (p. 17).
qualitative characteristics Part of the second level of the
conceptual framework of accounting; the characteristics
of accounting information that distinguish better (more
useful) information from inferior (less useful) informa-
tion for decision-making purposes. The primary qualita-
tive characteristics are relevance and reliability and the
secondary characteristics are comparability and consis-
tency. (p. 39).
20 Glossary
quality of earnings The extent to which earnings is useful to
investors and creditors in making resource allocation deci-
sions, generally in terms of predicting future earnings and
cash flows. Thus, higher quality earnings exhibit higher lev-
els of relevance and reliability. A high quality of earnings
boosts investors’ confidence in the financial statements.
Earnings management negatively affects the quality of earn-
ings when it distorts the information in a way that does not
accurately predict future earnings and cash flows. (p. 201).
rate of return on assets (ROA) The rate of return a com-
pany achieves through use of its assets. Computed as net
income divided by average total assets. ROA indicates the
amount of net income generated by each dollar invested in
assets. By relating the profit margin on sales to the asset
turnover for the period, analysts can find out how prof-
itably the company used assets during that period of time.
(p. 518).
rate of return on common stock equity Profitability ratio
that indicates how many dollars of net income the company
earned for each dollar invested by the common stockholders.
Also called return on equity (ROE). Computed as net in-
come less preferred dividends divided by average common
stockholders’ equity. (p. 699).
ratio analysis An evaluation of the relationship among se-
lected financial statement data, expressed in terms of either
a percentage, a rate, or a simple proportion. (p. 277).
raw materials inventory The cost assigned to goods and ma-
terials on hand but not yet placed into production. Raw ma-
terials can be traced directly to the end product. This cate-
gory of inventory appears on the balance sheets of
manufacturing companies. (p. 420).
real accounts Asset, liability, and equity accounts; these ac-
counts appear on the balance sheet. Companies do not close
real accounts, also called permanent accounts. (p. 78).
realizable (revenue) Part of the first test of the revenue
recognition principle, revenues are realizable when assets re-
ceived or held are readily convertible into cash or claims to
cash—that is, when they are salable or interchangeable in an
active market at readily determinable prices without signifi-
cant additional cost. (p. 48, 305).
realized (revenues) Revenue-recognition criterion indicat-
ing that a company has exchanged goods or services for cash
or claims to cash (receivables). (p. 304).
rearrangement and reinstallation costs The costs of mov-
ing assets from one location to another. Companies incur
such costs to benefit future periods. If a company can de-
termine or estimate the original installation cost and the
accumulated depreciation to date, it handles the rearrange-
ment and reinstallation cost as a replacement. If not, the
company capitalizes the new costs. If these costs are imma-
terial or if they cannot be separated from other operating
expenses, the company should immediately expense them.
(p. 499).
reasonably possible (contingency) Evaluation of the likeli-
hood of a loss contingency; indicates that the chance of a fu-
ture event or events occurring is more than remote but less
than likely. (p. 621).
receivables Claims held against customers and others for
money, goods, or services. Companies classify receivables as
either current (short-term, for which collection is expected
within a year or the current operating cycle), or noncurrent
(long-term). Receivables are further classified in the balance
sheet as either trade or nontrade receivables. (p. 362).
reclassification adjustment Adjustment made when at the
end of a period in which a company sold securities, to en-
sure that gains and losses are not counted twice in compre-
hensive income. Without such an adjustment, a company
might report realized gains or losses as part of net income
but also show the gains or losses as part of other comprehen-
sive income in the current or previous periods. Companies
use reclassification adjustments where they report compre-
hensive income or disclose them in the notes to the financial
statements. (p. 751).
reconciliation (of projected benefit obligation and fair
value of plan assets) A financial statement disclosure of
pension obligations, showing how the projected benefit obli-
gation and the fair value of the plan assets changed from the
beginning to the end of the period. (p. 866).
recoverability test A test to determine whether an impair-
ment of a long-lived asset has occurred. If the sum of the ex-
pected future net cash flows (undiscounted) is less than the
carrying amount of the asset, the asset is considered im-
paired. If the test indicates impairment has occurred, the
company then computes the amount of the impairment loss
to record, based on a fair value test. (p. 568).
redeemable preferred stock Preferred stock that has a
mandatory redemption period or a redemption feature that
the issuer cannot control, making the security more like debt
than like an equity instrument. The FASB requires that these
(and similar) debt-like securities be classified and accounted
for as liabilities. (p. 686).
refunding The replacement of an existing bond issue with a
new one. A company may find it advantageous to acquire its
entire outstanding bond issue and replace it with a new bond
issue bearing a lower rate of interest. The company should
recognize as income the gain from the refunding in the pe-
riod of redemption. (p. 619).
registered bonds Bonds issued in the name of the owner. At
redemption or in a sale of the bond, they require surrender
of the certificate. (p. 613).
relevance One of the qualitative characteristics of accounting
information, which describes information capable of making
a difference in a decision. Information with no bearing on a
decision is irrelevant. To be relevant, information needs pre-
dictive or feedback value and needs to be presented on a
timely basis. (p. 40).
reliability One of the qualitative characteristics of accounting
information, which describes information that is verifiable, is
a faithful representation, and is reasonably free of error and
bias. (p. 40).
remote (contingency) Evaluation of the likelihood of a loss
contingency; indicates that the chance of a future event or
events occurring is slight. (p. 621).
replacements The substitution of a similar asset for an ex-
isting asset (e.g., a new wooden floor for an old wooden
floor). If the expenditure for the replacement increases the
service potential, a company should capitalize the cost of
the replacement. (p. 498).

report form Presentation in a classified balance sheet that
lists liabilities and stockholders’ equity directly below assets
on the same page. (p. 160).
repossessions Merchandise that the seller has taken back
when the purchaser failed to meet payment requirements.
The seller would remove both the account receivable and the
applicable deferred gross profit from the ledger, using a
Repossessed Merchandise (inventory) account. (p. 334).
representational faithfulness A characteristic of reliable
information, indicating that a company’s accounting num-
bers and descriptions match what really existed or hap-
pened. (p. 40).
research activities Activities that involve planned search or
critical investigation aimed at discovery of new knowledge.
Companies are required to expense the costs of research
activities as incurred. (p. 574).
research and development (R&D) costs Costs incurred in
research and development activities. Companies are re-
quired to expense the costs of most R&D activities as
incurred. (p. 574).
reserve An appropriation of retained earnings. Also called
appropriated earnings. (p. 170).
residual interest The difference between the assets and the
liabilities of the company, which represents the owners’ or
stockholders’ interest in the company. The concept of resid-
ual interest means that stockholders’ equity has no existence
apart from the assets and liabilities of the company—that
stockholders’ equity is not a claim to specific assets but a
claim against the assets remaining after financial obligations
have been met. (p. 674).
residual value The estimated fair (market) value of leased
property at the end of the lease term. This value is included
by the lessor in the computation of lease payments. The
residual value is included in the minimum lease payments, if
it is guaranteed. (p. 899).
restatements The process of revising previously issued fi-
nancial statement to reflect the correction of an error. This
distinguishes an error correction from a change in account-
ing principle. (p. 955) (ftn).
restricted cash Material amounts of cash set aside for a par-
ticular purpose. Companies segregate restricted cash from
“regular” cash for reporting purposes, and they classify re-
stricted cash either in the current assets or in the long-term
assets section, depending on the date of availability or
disbursement. (p. 360).
retained earnings The earned capital of the company,
which develops from profitable operations. It consists of all
undistributed income that remains invested in the com-
pany. (p. 674).
retroactive benefits Benefits to a company from its employ-
ees’ prior services. Companies do not recognize retroactive
benefits as pension expense entirely in the year in which a
pension plan is adopted or amended, but instead initially
record the prior service cost as an adjustment to other com-
prehensive income and then recognize that cost as a compo-
nent of pension expense in future years. (p. 860).
retrospective application The application of a different
accounting principle to recast previously issued financial
Glossary 21
statements as if the new principle had always been in use.
Companies treat any part of the effect attributable to years
prior to those presented as an adjustment of the earliest
retained earnings balance presented. (p. 943).
revenue bonds Bonds that pay interest from specified rev-
enue sources (e.g., airports, school districts, counties, toll-
road authorities, and governmental bodies). (p. 613).
revenue expenditure Expenditure whose purpose is to
maintain a given level of services (or revenues generated
from these expenditures). Ordinary repairs are an example.
Revenue expenditures are expensed in the period in which
they take place. (p. 497).
revenue recognition principle One of the basic principles of
accounting, which dictates that companies recognize revenue
when it is realized or realizable and when it is earned–that is,
when assets are salable or interchangeable in an active mar-
ket at readily determinable prices without significant addi-
tional cost (realized or realizable) and when the company
substantially accomplishes what it must do to be entitled to
the benefits represented by the revenues (earned).
Generally, recognition at the time of sale provides a uniform
and reasonable test. (p. 48, 304).
reversing difference The elimination of a temporary differ-
ence that originated in prior periods and removal of the
related tax effect from the deferred tax account. (p. 793).
reversing entries Journal entries, made at the beginning of
the next accounting period, that are the exact opposite of the
adjusting entries made in the previous period. Making revers-
ing entries is an optional step in the accounting cycle. (p. 107).
risk-free rate of return The pure (real) rate of return plus
the expected inflation rate. Typically measured by the return
on a low-risk security (such as a 3-month U.S. Treasury bill.)
(p. 1029).
sales discounts Reductions from the sales price, offered by
sellers to buyers to induce prompt payment. Also called cash
discounts. Cash discounts generally read in terms such as
2/10, n/30 (2 percent if paid within 10 days, gross amount due
in 30 days). Companies can account for sales discounts using
either the gross or the net method; most use the gross
method, in which they record sales and related sales discount
transactions by entering the receivable and sale at the gross
amount and using a Sales Discount account only when they
receive payment within the discount period. (p. 364).
sales-type lease Lease that recognizes interest revenue
like a direct-financing lease but that also recognizes a
manufacturer’s or dealer’s profit. In a sales-type lease, the
lessor records the sale price of the asset, the cost of goods
sold and related inventory reduction, and the lease receiv-
able. (p. 913).
sales-warranty approach Method of accounting for an
extended warranty sold with a product that has a manufac-
turer’s warranty. The seller recognizes separately the sale of
the product with the manufacturer’s warranty and the sale of
the extended warranty. The seller defers revenue on the sale
of the extended warranty and generally recognizes it on a
straight-line basis over the life of the contract. (p. 625).
salvage value The estimated amount that a company will
receive when it sells an asset or removes it from service. It is
22 Glossary
the amount to which a company writes down or depreciates
the asset during its useful life. (p. 501).
Sarbanes-Oxley Act of 2002 Legislation, enacted by the
U.S. Congress, intended to combat accounting fraud, curb
poor reporting practices, and make sweeping changes to the
institutional structure of the accounting profession. (p. 16).
secured bonds Bonds backed by a pledge of some sort of col-
lateral. For example, mortgage bonds are secured by a claim
on real estate; collateral trust bonds are secured by stocks
and bonds of other corporations. (p. 613).
Securities and Exchange Commission (SEC) Federal agency
established to help develop and standardize financial in-
formation presented to stockholders. It administers the
Securities Exchange Act of 1934 and several other acts. Most
companies that issue securities to the public are required to
file audited financial statements with the SEC. The SEC also
has broad powers to prescribe the accounting practices and
standards to be employed by companies that fall within its
jurisdiction. (p. 7).
Securities Fair Value Adjustment account A valuation ac-
count that enables a company to maintain a record of its
amortized cost of available-for-sale securities. (p. 737).
securitization Procedure in the sale (transfer) of receivables
that takes a pool of receivables and sells shares in these pools
of interest and principal payments, in effect creating securi-
ties backed by these pools of assets.Virtually every asset with
a payment stream and a long-term payment history is a can-
didate for securitization. (p. 379).
security A share or other interest in an enterprise or obliga-
tion of the issuer that is: (1) represented by an instrument is-
sued in bearer or registered form or registered in books
maintained by the issuer; (2) is of a type commonly traded on
securities exchanges or markets or commonly recognized as
a medium for investment; and (3) is one of a class or series of
shares, participations, interests, or obligations. (p. 732) (ftn).
self-constructed asset An asset that a company constructs
on its own. Without a purchase price or contract price, the
company must allocate costs and expenses to arrive at the
cost of the self-constructed asset. Materials and direct labor
used in construction come directly from work and material
orders related to the asset. To account for indirect overhead
costs for the constructed asset, the company assigns a portion
of all overhead to the construction process. (p. 490).
self-insurance Risk assumption in lieu of insurance. Self-
insurance is not insurance. A company that assumes its own
risks incurs expenses or losses as they occur. The company
should not establish a liability based on a hypothetical
charge to insurance expense, because the event giving rise to
the obligation has not occurred. (p. 629).
serial bonds Bond issues that mature in installments. School
or sanitary districts, municipalities, or other local taxing bod-
ies that receive money through a special levy frequently use
serially maturing bonds. (p. 613).
service cost A component of pension expense; it reflects the
actuarial present value of new pension benefits earned by
employees’ services during the period. (p. 857).
service period (for stock options) For stock options, the
period in which employees perform services, typically repre-
sented by the time between the grant date and the vesting
date. A company generally determines total compensation
cost of the options at the grant date and allocates it as an ex-
pense in the periods in which employees perform the serv-
ices. (p. 850).
settlement rate The rate at which a pension plan obligation
could be effectively settled if the company sponsoring the
plan wished to terminate its pension obligation (liability). To
estimate this rate, companies determine a rate of return on
high-quality fixed-income investments currently available,
whose cash flows match the timing and amount of expected
benefit payments, that would provide the necessary future
cash flows to pay the pension benefits when due. (p. 858).
significant influence The ability of an investor corporation
to affect the operating and financial policies of an investee
corporation, without possessing legal control of the investee.
Examples include representation on the board of directors,
participation in policy-making processes, material intercom-
pany transactions, interchange of managerial personnel, or
technological dependency. (p. 746).
significant noncash transactions Transactions and events
that are investing or financing activities but that do not in-
volve cash and thus are omitted from the statement of cash
flows. These include: acquisition of assets by assuming liabil-
ities or by issuing equity securities, exchanges of nonmone-
tary assets, refinancing of long-term debt, conversion of debt
or preferred stock to common stock, issuance of equity secu-
rities to retire debt. Companies either disclose these transac-
tions in a separate schedule on the statement of cash flows or
in a separate note to the financial statements. (p. 1059).
simple capital structure Capital structure that consists only
of common stock and preferred stock that is not dilutive. A
company has a simple capital structure if does not include
potential common stock that upon conversion or exercise
could dilute earnings per share. (p. 960).
simple interest Interest on principal only, regardless of in-
terest that may have accrued in past periods (compounded).
(p. 1002).
single-step income statement Income statement format
that consists of just two groupings: revenues and expenses.
Expenses are deducted from revenues to arrive at net in-
come or loss. Companies that use the single-step income
statement in financial reporting typically do so because of its
simplicity. (p. 203).
small (ordinary) stock dividend A stock dividend (a corpo-
ration’s issuance of its own stock to its stockholders, on a pro
rata basis) of less than 20–25 percent of the number of shares
previously outstanding. The company transfers, from re-
tained earnings to capital stock and additional paid-in capi-
tal, the fair market value of the stock issued. Payment of the
stock dividend does not affect any asset or liability, but is a
reclassification of stockholders’ equity. (p. 691).
Social Security tax The combination of the OASDI tax
(FICA) and the federal Hospital Insurance Tax. The com-
bined rate for these taxes changes intermittently by acts of
Congress. Companies report as a current liability the amount
of unremitted employee and employer Social Security tax on
gross wages paid. (p. 842).
solvency The ability of a company to pay its debts as they ma-
ture. A company with a high level of long-term debt relative

to assets has lower solvency than a similar company with a
low level of long-term debt. (p. 146).
special journals Records of transactions possessing a common
characteristic, such as cash receipts, sales, purchases, cash pay-
ments. Using such journals reduces bookkeeping time. (p. 85).
special purpose entity (SPE) A legal entity created to per-
form a special activity (issue securities, complete a project,
perform R&D activities). The company that creates the SPE
guarantees that it or some outside party will eventually per-
form the activity. Use of the SPE enables the company that
created it to avoid reporting any assets or liabilities related
to the activities on its balance sheet. (p. 630).
specific identification Inventory-costing methods in which
companies identify and cost each item sold and each item in
inventory. Retailers use this method only when handling a
relatively small number of costly, easily distinguishable
items, such as fur coats, automobiles, some furniture; man-
ufacturers use it for special orders and many products
manufactured under a job cost system. (p. 427).
specific-goods pooled-LIFO approach A method used to
alleviate LIFO liquidation problems and to simplify LIFO
accounting, by grouping goods into pools of similar items.
Thus, instead of tracking specific inventory units, a company
combines, and accounts for together, a number of similar
units or products, which usually results in fewer LIFO liqui-
dations. (p. 434).
stated rate The annual interest rate stated on a financial
instrument (a note or bond, for example). Also called face or
nominal rate. (p. 1006).
stated value A value below which a company cannot issue
no-par stock, as required by law in some states. Stated-value
stock thus becomes, in effect, stock with a par value. (p. 676).
stated, coupon, or nominal rate The interest rate written in
the terms of the bond indenture (and often printed on the
bond certificate). The issuer of the bonds sets this rate,
expressed as a percentage of the bond’s face value. (p. 615).
stated-value method See Par- (Stated-)value method. (p. 681).
statement of cash flows A basic financial statement that
provides information about cash receipts, cash payments,
and the net change in cash resulting from the operating, in-
vesting, and financing activities of a company during the pe-
riod, in a format that reconciles the beginning and ending
cash balances. (p. 79, 252, 1050).
Statement of Financial Accounting Concepts A series of
statements by the FASB that set forth fundamental objec-
tives and concepts that the Board uses in developing future
standards of financial accounting and reporting. Unlike a
Statement of Financial Accounting Standards, these state-
ments of concepts do not establish GAAP. However, this
cohesive set of interrelated concepts is intended to be a con-
ceptual framework that will serve as tools for solving existing
and emerging problems in a consistent manner. (p. 11).
Statement of Financial Accounting Standards Statements
issued by the FASB that are considered GAAP and thereby
binding in accounting practice. These statements go through
a rigorous due process system (discussion memo, public
hearing, exposure draft). The passage of a new Statement of
Financial Accounting Standards requires the support of four
of the seven FASB members. (p. 10).
Glossary 23
statement of retained earnings Financial statement that
reconciles the balance of the retained earnings account from
the beginning to the end of the period. (p. 79).
statement of stockholders’ equity One of the basic finan-
cial statements, which reports the changes in each stockhold-
ers’ equity account and in total stockholders’ equity during
the year. It typically shows balances at the beginning of the
period, additions and deductions, and balances at the end of
the period. Companies disclose changes in the separate ac-
counts either in separate statements or in the basic financial
statements or notes thereto. (p. 698).
stock compensation plans Plans that offer employees com-
pany stock as a form of compensation, generally if perform-
ance measures (e.g., earnings per share, revenues, stock price,
or market share) meet specified levels. FASB No. 123(R) re-
quires that companies use the fair-value method to account
for the cost of stock compensation. (p. 847).
stock dividend The issuance by a corporation of its own
stock to its stockholders on a pro rata basis, without receiv-
ing any consideration. The company transfers, from retained
earnings to capital stock and additional paid-in capital, the
fair market value of the stock issued. Payment of the stock
dividend does not affect any asset or liability, but is a reclas-
sification of stockholders’ equity. The term stock dividend
usually refers to what are properly classified as small (ordi-
nary) stock dividends. (In contrast, large stock dividends are
more like stock splits because of their effect of the market
price of the stock.) (p. 691).
stock split The issuance of additional shares of stock by di-
viding existing shares into multiple shares for each share
owned; e.g., a 4-for-1 split gives a shareholder 4 shares for
each 1 share owned.The motive is to reduce the market price
of shares to be within range of the majority of potential in-
vestors. Companies record no entry for a stock split, but
make a memorandum note to indicate the changed par value
and the increased number of shares. (p. 693).
stockholders’ (owners’) equity The ownership claim on a
company’s total assets, computed as the difference between a
company’s assets and its liabilities. Stockholders’ equity rep-
resents the cumulative net contributions by stockholders
plus retained earnings. Reported in the owners’ equity sec-
tion of the corporate balance sheet, stockholders’ equity
consists of capital stock, additional paid-in capital, and re-
tained earnings. (p. 674).
straight-line method Depreciation method that considers
depreciation a function of time rather than of usage and thus
charges the same amount for each year of the asset’s service
life. Companies widely use this method because of its sim-
plicity. (p. 503).
straight-line method of amortization Alternative method
for computing bond amortization. Under the straight-line
method, companies amortize a constant amount each year.
Although the FASB recommends the effective-interest
method, companies may use a straight-line method if the re-
sults obtained are not materially different from those pro-
duced by the effective-interest method. (p. 643).
subsequent events Significant financial events that took
place after the formal balance sheet date but before issuance
and that may materially affect the company’s financial
24 Glossary
position. Also referred to as post–balance-sheet events. Some
subsequent events require adjustments to the accounts.
Notes to the financial statements should explain subsequent
events. (p. 164).
subsidiary A corporation in which another corporation (par-
ent) has a controlling interest (voting interest of more than
50 percent). The investment in the subsidiary is presented as
a long-term investment on the financial statements of the
parent. (p. 748).
sum-of-the-years’-digits method Depreciation method
that uses a decreasing fraction of depreciable cost (original
cost less salvage value), using the sum of the years of the
asset’s service life as a denominator and the number of
years of estimated life remaining as of the beginning of the
year as the numerator. The numerator decreases year by
year, and the denominator remains constant, which results
in a decreasing depreciation charge. At the end of the asset’s
service life, the balance remaining should equal the salvage
value. (p. 504).
supersession The replacement of one asset with another
more efficient and economical asset. Supersession results in
a company retiring an asset (ending its service life). Retired
assets are not depreciated and are removed from the books
when disposed of. (p. 501).
supplementary information Information included in the notes
to financial statements, which includes details or amounts that
present a different perspective from that adopted in the finan-
cial statements. It may be quantifiable information that is high
in relevance but low in reliability and may include manage-
ment’s explanation of the financial information and its discus-
sion of the significance of that information. (p. 51).
T-account Basic account form, shaped like the letter T, that
shows the effect of transactions on particular asset, liability,
stockholders’ equity, revenue, and expense accounts. (p. 84).
take-or-pay contract A guarantee offered by the company
that creates a special purpose entity that it or some outside
party will purchase the completed special project or its prod-
ucts at a predetermined price. (p. 630).
tax effect / tax benefit (related to loss carryback) The re-
sult, for accounting as well as tax purposes, of a loss carry-
back. When a company recognizes a tax loss that gives rise to
a tax refund, the company should recognize the associated
tax benefit by reporting it as a current asset on the balance
sheet and as a benefit due to loss carryback on the income
statement. (p. 798).
taxable amounts A temporary difference between the tax ba-
sis of an asset/liability and its reported (carrying or book)
amount in the financial statements that will increase taxable
income in future years. (p. 783).
taxable income Income for tax purposes, determined accord-
ing to the Internal Revenue Code (the tax code). It is meas-
ured as the excess of taxable revenues over tax-deductible
expenses and exemptions for the year. (p. 782)
taxable temporary difference Temporary differences that
will result in taxable amounts in future years. They give rise to
recording deferred tax liabilities. Examples are: (1) revenues
or gains that are taxable after they are recognized in financial
income, and (2) expenses or losses that are deductible before
they are recognized in financial income. (p. 792).
temporary difference The difference between the amounts
reported for tax purposes and the book (carrying) amounts
reported in the financial statements. The temporary differ-
ence will result in taxable amounts or deductible amounts in
future years. Taxable amounts increase taxable income in fu-
ture years; deductible amounts decrease taxable income in
future years. (p. 783).
term bonds Bond issues that mature on a single date. (p. 613).
third-party guarantors Insurers who for a fee assume the
risk of deficiencies in lease asset residual values. (p. 899).
time value of money The relationship between time and
money. A dollar received today is worth more than a dollar
promised at some time in the future, because of the opportu-
nity to invest today’s dollar and receive interest on the in-
vestment. (p. 1000).
timeliness A characteristic of relevant information, indicat-
ing that information should be available to decision makers
before it loses its capacity to influence their decisions. (p. 40).
times interest earned ratio Solvency ratio that indicates the
company’s ability to meet interest payments as they come
due. Computed as income before income taxes and interest
expense divided by interest expense. (p. 635).
trade accounts payable Balances owed to others for goods,
supplies, or services purchased on open account. Also called
simply accounts payable. Accounts payable arise because of
the time lag between the receipt of services or acquisition of
title to assets and the payment for them.The terms of the sale
(e.g., 2/10, n/30 or 1/10, E.O.M.) usually state this period of
extended credit, commonly 30 to 60 days. (p. 607).
trade discounts Reductions in sales prices, which companies
use to avoid frequent changes in catalogs, to alter prices for
different quantities purchased, or to hide the true invoice
price from competitors. Trade discounts are commonly
quoted in percentages. (p. 364).
trade notes payable Written promises to pay a certain sum
of money on a specified future date, required in some indus-
tries as part of the sales/purchases transaction in lieu of the
normal extension of open account credit. (p. 607).
trade receivables Accounts receivable and notes receivable
that result from sales transactions for a company’s goods or
services. Trade receivables are usually the most significant
type of receivable a company possesses. (p. 363).
trademark, trade name A word, phrase, or symbol that dis-
tinguishes or identifies a particular company or product. A
trademark is a marketing-related intangible asset. Under
common law, the right to use a trademark or trade name,
whether registered or not, rests exclusively with the original
user as long as the original user continues to use it.
Registration with the U.S. Patent and Trademark Office pro-
vides legal protection for an indefinite number of renewals
for periods of 10 years each.Thus, a trademark or trade name
is considered to have an indefinite life. Companies do not
amortize intangible assets with indefinite lives. (p. 558).
trading on the equity The practice of using borrowed
money or issuing preferred stock in hope of obtaining a
higher rate of return on the money used. If return on the
assets is higher than the cost of financing these assets, the
excess accrues as a profit to the common stockholders. (p. 699).

trading securities Debt and equity securities bought and
held primarily for sale in the near term to generate income
on short-term price differences. Companies report trading
securities at fair value at each reporting date, with unrealized
holding gains and losses recognized as net income. Interest
and dividends are recorded when earned. (p. 150, 732).
transaction An external event involving a transfer or ex-
change between two or more entities. (p. 78).
transaction approach Method of income measurement that
focuses on the income-related activities—revenue, expense,
gain, and loss transactions—that have occurred during the
period. (p. 202).
treasury stock Shares of stock reacquired by the issuing
company and either retired or held in the treasury for reissue
at a later date. Treasury stock is essentially the same as unis-
sued capital stock; it is not an asset. Companies use two
methods of accounting for treasury stock: the cost method
(which records the purchase in a treasury stock account and
reports that amount as a deduction from “paid-in capital and
retained earnings” on the balance sheet), or the par-value
method (which records all transactions in treasury shares at
their par value and reports the treasury stock as a deduction
from capital stock only). Companies generally use the cost
method to account for treasury stock. (p. 680).
treasury-stock method Method of measuring the dilutive
effects on EPS of stock options and warrants outstanding.
This method assumes that a company exercises the options
or warrants and uses those proceeds to purchase common
stock for the treasury at the average price of common shares
during the period. If such purchases result in dilution (as-
suming the market price of the stock is above the exercise
price), the company reports potential common shares in its
diluted EPS. (p. 968).
trial balance The list of all open accounts, in the sequence in
which they appear in the ledger, and their balances.
Companies may prepare a trial balance at any time, though
they usually do so at the end of an accounting period. The
trial balance proves the mathematical equality of debits and
credits after posting and also uncovers errors in journalizing
and posting. (p. 79, 89).
understandability A qualitative characteristic of accounting
information that lets reasonably informed users see its sig-
nificance. (p. 40).
unearned revenues Revenues received in cash and recorded
as liabilities before a company earns them. The company rec-
ognizes the revenue in the period in which it completes the
earnings process. Examples are rent, magazine subscriptions,
and customer deposits for future service. Unearned revenues
are the opposite of prepaid expenses. (p. 96, 610).
unexpected gain or loss (on plan assets) The difference
between the expected return and the actual return on a
pension plan. The FASB uses the term asset gains and
losses. (p. 861).
unguaranteed residual value The estimated residual value
of a leased asset, exclusive of any portion guaranteed by the
lessee or a third-party guarantor. (p. 899).
upper (ceiling) limit In the lower-of-cost-or-market (LCM)
approach, the highest amount at which inventory can be
reported, which is the inventory’s net realizable value. The
Glossary 25
ceiling prevents overstatement of inventories and under-
statement of the loss in the current period. (p. 443).
useful life The time period over which assets provide a service.
(p. 94).
valuation allowance An amount by which a company should
reduce the valuation of a deferred tax asset if it is more likely
than not that the company will not realize some portion of
the deferred tax asset. (p. 790).
verifiability A characteristic of reliable information, indicat-
ing that similar results will occur when independent third par-
ties (e.g., auditors) measure using the same methods. (p. 40).
vested rights Compensation rights that exist when an em-
ployer has an obligation to make payment to an employee
even after terminating his or her employment. Vested rights
are not contingent on an employee’s future service. (p. 845).
warrants Long-term options, issued with other securities, to
buy common stock at a fixed price for a specified period of
time (generally 5 years, occasionally 10). Companies account
for debt issued with nondetachable warrants as straight debt.
To account for detachable stock warrants, companies sepa-
rate debt issued with detachable warrants into debt and
equity components, using either the proportional method or
the incremental method. (p. 706).
warranty A seller’s promise to a buyer to make good on a
deficiency of quantity, quality, or performance in a product.
Also called a product guarantee. Companies use two meth-
ods of accounting for warranty costs: Under the cash-basis
method, the seller expenses warranty costs in the period in
which they are incurred. Under the accrual method (ex-
pense-warranty approach), the seller charges warranty costs
to operating expense in the year of a product’s sale. (p. 623).
weighted-average accumulated expenditures A measure
used in determining the amount of interest that can be capi-
talized. Computed by weighting construction expenditures
by the amount of time (e.g., fraction of a year) that a com-
pany can incur interest cost on the expenditure. (p. 523).
weighted-average method Inventory-costing method, used
in the periodic inventory method, that prices items in the in-
ventory on the basis of the average cost of all similar goods
available during the period. The method calculates the total
cost of inventories of similar goods, divides the total cost by
the number of inventory units, and applies the weighted-
average cost per unit to the items in ending inventory. (p. 428).
weighted-average number of shares outstanding The de-
nominator used in an earnings per share calculation.
Companies weight the shares of stock issued or purchased
during a period by the fraction of the period they are out-
standing, to determine the equivalent number of whole
shares outstanding for the year. (p. 961).
Wheat Committee The Study Group on Establishment of
Accounting Principles, chaired by Francis Wheat, that exam-
ined the organization and operation of the Accounting
Principles Board and determined the changes needed to
attain better productivity and more timely correction of
accounting abuses. The Study Group submitted its recom-
mendations to the AICPA Council in the spring of 1972,
which adopted the recommendations in total and imple-
mented them by early 1973. (p. 9).
26 Glossary
with recourse A receivables-factoring transaction in which
the seller guarantees payment to the purchaser if the debtor
fails to pay. The seller records this transaction using a finan-
cial components approach, in which each party to the sale
recognizes only the assets and liabilities that it controls after
the sale. (p. 380).
without recourse A receivables-factoring transaction in
which the purchaser assumes the risk of collectibility and ab-
sorbs any credit losses. The transfer of receivables in such a
transaction is an outright sale of the receivables both in form
(transfer of title) and substance (transfer of control). (p. 379).
working capital The excess of total current assets over total cur-
rent liabilities; represents the net amount of a company’s rela-
tively liquid resources. Also called net working capital. (p. 156).
working capital ratio Liquidity ratio that measures the abil-
ity of a company to meet its maturing obligations with its
available assets and to meet unexpected needs for cash. Also
called the current ratio. Computed as total current assets di-
vided by total current liabilities. (p. 634).
work-in-process inventory The cost of partially processed
units in a continuous production process, consisting of the
raw material for these unfinished units, plus the direct labor
cost applied specifically to this material and a ratable share
of manufacturing overhead costs. This category of inventory
appears on the balance sheets of manufacturing companies.
(p. 420).
worksheet An informal device for accumulating and sorting
information needed for the financial statements. The work-
sheet typically provides columns for the first trial balance,
adjustments, adjusted trial balance, income statement, and
balance sheet. Completing the worksheet provides consider-
able assurance that a company properly handled all of the
details related to the end-of-period accounting and state-
ment preparation. (p. 117).
years-of-service method (for prior service costs) Method of
amortizing prior service cost in a pension plan, based on the
average remaining service of employees in the plan. (p. 860).
zero-interest debenture bonds Long-term, unsecured debt
securities that do not bear interest. They are sold at a dis-
count that provides the buyer’s total interest payoff at matu-
rity. Also called deep-discount bonds. (p. 613).
zero-interest-bearing notes A note receivable that includes
interest as part of the face amount. Also called noninterest-
bearing notes. (p. 371).