Accounting reform is change to accounting rules that goes beyond the enforcement of standard accounting practices and the elimination of “creative accounting”. It is advocated by those who consider the present standards and practices of the profession wholly inadequate to the task of measuring and reporting the activity, success, and failure of modern enterprise, including government. “Accounting”, says Baruch Lev, a notable proponent of such reform, “is about accountability”. He notes that the present regime of accounting rules dates back about 500 years to Renaissance Italian practices.
Accounting software is computer software that records and processes accounting transactions such as accounts payable, accounts receivable, payroll and trial balance. It may be developed in-house by the company or organisation using it, may be purchased from a third party, or may be a combination of a third-party application software package with local modifications. It varies greatly in its complexity and cost.
Accounts payable is one of a series of accounting transactions dealing with the paying of suppliers to which one owes money for goods and services. The average household performs this task by writing checks each month to such suppliers as the electric company, telephone company, cable TV or satellite dish service, the local newspaper, and so on.
Accounts receivable is one of a series of accounting transactions dealing with the billing of customers which owe money to a person, company or organisation for goods and services that have been provided to the customer. This is typically done in a one person organisation by writing an invoice and mailing or delivering it to each customer.
Accrual basis accounting
Accrual-basis accounting records financial events based on events that change your net worth (the amount owed to you less the amount you owe others). Standard practice is to record expenses with the incomes they are associated with. For example, your landlord would record an income event on the day your rent comes due (you owe it to him). He records an expense event when the fee owed to the rental agent comes due for your apartment that month (he owes it to the agent). The details of the actual cash flows and their timing are tracked by bookkeeping.
Amortisation is the spreading of expenses over future time periods of an intangible balance sheet item such as a Leasing (mortgage) or goodwill.
In finance, an annuity is a series of fixed payments, which might be over a fixed number of years, over the lifetime of an individual, or both. The most common use of annuities is to provide a pension for people in retirement.
In business and accounting an asset is anything owned, whether in possession or by right to take possession, by a person or a group acting together, e.g. a company, the value of which can be expressed in monetary terms. Asset is listed on the balance sheet. It has a normal balance of debit. Assets may be classified in many ways. The principal distinction normally made for business purposes is between: fixed assets and current assets. Other business subdivisions include intangible assets, that is, those assets which, though not visible, add to the earning power of the business, e.g. goodwill, patents, copyrights, etc. (also called invisible assets); liquid assets, which are a subdivision of current assets and also categories labelled trade investments, quoted investments, etc.
Assurance has been defined by the American Institute of Certified Public Accountants (AICPA) as ‘Independent Professional Services that improve information quality or it context’. Such services are very broad and could include assessments of internet security and quality of health facilities.
Audit is the examination of records and reports of a company, in order to check that what is provided is relevant, and closest to the reality. That is to say, all assets and liabilities are properly recorded in the balance sheet, and, all profits and losses are properly assessed. This assessment is done through 2 methods, by assessing internal control procedures and by checking the consistency of items in the books.
In formal bookkeeping and accounting, a balance sheet is a statement of the financial value (or “worth”) of a business or other organisation (or person) at a particular date, usually at the end of its “fiscal year,” as distinct from a profit and loss statement (or “P&L;”), which records income and expenditures over some period. Therefore a balance sheet is often described as a “snapshot” of the company’s financial condition at that time. The balance sheet has two parts: assets on the left-hand (“debit”) side or at the top and liabilities on the right-hand (“credit”) side or at the bottom. The assets of the company — money (“in hand” or owed to it), investments (including securities and real estate), and other property — are equal to the claims for payments of the persons or organisations owed — the creditors, lenders, and shareholders. This standard format for balance sheets is derived from the principle of double-entry book keeping.
In finance and economics, a bond or debenture is a debt instrument that obligates the issuer to pay to the bondholder the principal (the original amount of the loan) plus interest. Thus, a bond is essentially an I.O.U. (I owe you contract) issued by a private or governmental corporation. The corporation “borrows” the face amount of the bond from its buyer, pays interest on that debt while it is outstanding, and then “redeems” the bond by paying back the debt. A mortgage is a bond secured by real estate.
The book value of an asset or group of assets is the price at which they were originally acquired, in many cases equal to purchase price. Book value is therefore relevant insofar as it forms the basis of various calculations e.g. of nominal capital gains (current value divided by book value), of amortised value (book value adjusted for depreciation) and of several financial ratios (e.g. price to book value [P/BV]).
Cash-basis accounting records financial events based on cash flows. For example, when you pay your rent your landlord would record an income event when you make the payment. The landlord records an expense event when he pays the rental agent their fee for your apartment. It is the accounting method used by most individuals, and by some businesses that have limited payables or receivables or whose income and expense cash flows are closely associated with each other in time.
Cash flow statement
A cash flow statement is a financial report that shows incoming and outgoing money during a particular period (often monthly or quarterly). It does not include non-cash items such as depreciation. This makes it useful for determining the short-term viability of a company, particularly its ability to pay bills.
Certified Public Accountant
Certified Public Accountants (CPAs) are accounting professionals of the United States who have passed the Uniform CPA exam, which was developed and is maintained by the American Institute of Certified Public Accountants (AICPA), and have subsequently met additional state requirements for licensure as a CPA. Only CPAs are professionally licensed to provide to the public, attestation (including auditing) opinions on publicly disseminated financial statements.
Common Stock, also referred to as Common shares, are, as the name implies, the most usual and commonly held form of Stock in a corporation. The other type of shares that the public can hold in a corporation is known as Preferred Stock. Common stock that has been re-purchased by the corporation is known as Treasury stock and is available for a variety of corporate uses.
The process of tracking, recording and analysing costs associated with the activity of an organisation, where cost is defined as ‘required time or resources’. Costs are by convention measured in units of currency.
Cost of goods sold
In accounting, the cost of goods sold describes the direct expenses incurred in producing a particular good for sale, including the actual cost of materials that comprise the good, and direct labour expense in putting the good in saleable condition. Cost of goods sold does not include indirect expenses such as office expenses, accounting, shipping department, advertising, and other expenses that cannot be attributed to a particular item for sale.
Creative accounting refers to accounting practices that deviate from standard accounting practices. They are characterised by excessive complication and the use of novel ways of characterising income, assets or liabilities.
Refers to that part of double entry bookkeeping that mirrors debits.
A current asset is an asset on the balance sheet usually lasting less than one year such as accounts receivable, prepaids, cash, etc.
Current liabilities are considered debts of the business that are due within the fiscal year.
Debit is an accounting and bookkeeping term that comes from the Latin word debere which means “to owe.” The opposite of a debit is a credit. Debit is abbreviated Dr while credit is abbreviated Cr. A debit can be either a positive or negative entry to an account depending on what type of account is being debited. Asset and expense accounts increase in value when debited, whereas liability, capital, and revenue accounts decrease in value when debited.
Debt is that which is owed. People or organisations often enter into agreements to borrow something. Both parties must agree on some standard of deferred payment, most usually a sum of money denominated as units of a currency, but sometimes a like good. For instance, one may borrow shares, in which case, one may pay for them later with the shares, plus a premium for the borrowing privilege, or the sum of money required to buy them in the market at that time. There are numerous types of debt obligations. They include loans, bonds, mortgages, promissory notes, and debentures.
A budget deficit occurs when an entity (often a government) spends more money than it takes in. The opposite is a budget surplus.
Depreciation is a decrease in the value of an asset, caused by wear and tear or by obsolescence. In accounting, the act of depreciating an asset is also supposed to create a reserve for the replacement of the asset. The use of depreciation affects a company’s (or an individual’s) financial statements, and, more importantly to them, their taxes.
A dividend is the distribution of profits to a company’s shareholders. The primary purpose of any business is to create profit for its owners, and the dividend is the most important way the business fulfils this mission. When a company earns a profit, some of this money is typically reinvested in the business and called retained earnings, and some of it can be paid to its shareholders as a dividend. Paying dividends reduces the amount of cash available to the business, but the distribution of profit to the owners is, after all, the purpose of the business.
Double-entry book keeping is the standard accounting practice for recording financial transactions. It was invented by Luca Pacioli, a close friend of Leonardo da Vinci, in a 1494 footnote to a scientific paper. The system is based on the concept that a business can be described by a number of different variables or accounts, each describing an aspect of the business in monetary terms. Every transaction has a ‘dual effect’—increasing one aspect and decreasing another, in such a way that all of the different variables always sum to zero.
In accounting, EBITDA stands for “Earnings before Interest, Taxes, Depreciation, and Amortisation”. When companies publish their financial statements, the most important metric for investors is the company’s income, which is calculated as the company’s revenue minus all its expenses. Some companies also publish their EBITDA, which, these companies usually claim, provides a more true picture of the company’s profitability than the “income” number.
In accounting, an expense is a general term for an outgoing payment made by a business or individual. One specific use of the term in accounting is whether a particular expenditure is classified as an expense, which is reported immediately to the investing public in the business’s income statement; or whether it is classified as a capital expenditure or an expenditure subject to depreciation, which are not. These latter types of expenditures are reported eventually, but not immediately, by business that use accrual-basis accounting, meaning all large businesses.
Financial Accountancy (or Financial Accounting) is the branch of accounting concerned with the preparation of financial statements for outsider use. The accounting equation (Assets = Liabilities + Owners’ Equity) and financial statements are the main topics of financial accounting.
In the modern capitalist system, most governments require publicly-traded companies to issue a set of documents each year called financial statements or financial reports. This set most often consists of the “balance sheet”, the “income statement”, the “statement of retained earnings”, and the “statement of cash flows”, in addition to supplementary notes and management discussion. In the United States, publicly-traded companies are required to prepare based on generally accepted accounting principles.
Forensic accounting is the specialty practice area of accounting that describes engagements which result from real or anticipated litigation. Broadly speaking, these engagements fall into one of four categories: economic damages, family law, fraud and other forms of economic crime, and business valuation.
Free cash flow
Free cash flow measures a firm’s cash flow remaining after all expenditures required to maintain or expand the business, including interest payments as well as investments in assets used to maintain or expand the business (including but not limited to those described as “property, plant and equipment” or “PP&E;”).
Refers to accounts of a business and is divided into two sections : balance sheet section, and nominal section.
Goodwill is an accounting concept that describes the value of a business entity not directly attributable to its physical assets and liabilities.
Income OR Earnings
Income, generally defined, is the money that is received as a result of the normal business activities of an individual or a business. For example, most individuals’ income is the money they receive from their regular pay cheques. In business and accounting, income (also known as profit or earnings) is, more specifically, the amount of money that a company earns after paying for all its costs. To calculate a company’s income, it starts with its amount of revenue, deducts all costs, including such things as employees’ salaries and depreciation, and the number that results is its income, which may be a negative number. At least part of this money is typically reinvested in the business, and some of the money might be used to pay the owners (the shareholders) a dividend.
Income per share OR Earnings per share
Income per share is the bottom line net income divided by the number of shares outstanding. It is more often referred to and reported as earnings per share.
Statement of revenue of a company less expenses incurred.
Intangible assets are defined as assets that are not physical in nature. For example the building that a business owns is a tangible asset because it can be valued and sold for a specific sum of money. The most common form of intangible asset is called Goodwill. This is the customer base that the business has built up and is the principal reason that a business might sell for more than the value of the tangible assets.
Interest is a surcharge on the repayment of debt (borrowed money).
Organisations in the U.S. define inventory to suit their needs within Generally Accepted Accounting Practices (GAAP), the rules defined by the Financial Accounting Standards Board (FASB) and enforced by the Securities and Exchange Commission (SEC) and other federal and state agencies. Inventory management affects organisations’ internal operations through their cost accounting methods. The bar codes printed on nearly all goods are called Stock Keeping Units, or SKU’s for their role in managing inventory.
Investment is a term with several closely related meanings in finance and economics. It refers to the accumulation of some kind of asset in hopes of getting a future return from it.
The term “journal” is used, in business, for a book in which an account of transactions is kept previous to a transfer to the ledger.
In accounting, a financial liability is something that is owed to another party. This is typically contrasted with an asset which is something of value that you own. The basic accounting equation relates assets, liability, and capital (or equity) thus: liabilities + equity = assets
Long-term assets are those assets usually in service over one year such as buildings, equipment, etc. These often receive favourable tax treatment over short-term assets.
Liabilities with a future benefit over one year, such as notes payable that mature greater than one year.
Luca Bartolomes Pacioli, Italian mathematician, (1445-1517), is credited with the first publication of the ‘Venetian method’ of keeping accounts, now known as ‘double-entry bookkeeping’. For this reason, some regard him as the founder of the field of accountancy. His publications include the Summa de arithmetica, geometria, proportioni et proportionalita an encylopaedic work on the state of the art in arithmetic, mathematics, and bookkeeping at the time.
Management accounting is concerned with the provision and use of accounting information to managers within organisations, to facilitate the managers in their decision-making and management control functions. Unlike financial accountancy information (which, for the most part, is made publicly available), management accounting information is used within an organisation and is usually confidential.
A mortgage is a device used to create a lien on real estate by contract. The mortgage is an instrument that the borrower (called the mortgagor) uses to pledge real property to the lender (called the mortgagee) as security for a debt, also called hypothecation.
Refers to the profits of a company after expenses and is calculated as gross profit less operating expenditure.
The initials OBERAC stand for: ‘operating balance excluding revaluations and accounting changes’.
In throughput accounting, the cost accounting aspect of Theory of Constraints (TOC), operating expense is the money spent turning inventory into throughput. In TOC, operating expense is limited to costs that vary strictly with the quantity produced, like raw materials and purchased components. Everything else is a fixed cost, including labour unless there is a regular and significant chance that workers will not work a full-time week when they report on its first day.
Owners equity, commonly known simply as equity, also risk or liable capital, is a financial term for the difference between a company’s assets and liabilities — that is, the value that accrues to the owners (sole proprietor, partners, or shareholders). In a corporation, it is called shareholders’ equity. In bankruptcy, ownership equity is the last or residual claim against assets, paid only after all other creditors are paid.
Payroll is one of a series of accounting transactions dealing with the process of paying employees for services rendered, after processing of the various requirements for withholding of money from the employee for payment of payroll taxes, insurance premiums, employee benefits, garnishments and other deductions.
Businesses often need small amounts of cash known as petty cash for expenditures where it is not practical to make the disbursement by check. The most common way of accounting for these expenditures is to use the imprest method. The initial fund would be created by issuing a check for the desired amount. Usually $100 would be sufficient for most small business needs. The entry for this initial fund would be to debit Petty Cash and credit cash.
Preferred stock, also known as Preferred shares, are shares of stock that carry additional rights above and beyond those conferred by common stock. eg a dividend amount that never changes, if the dividend is paid at all. The dividend is usually specified as a percentage of the initial investment and/or a stock symbol letter, such as Pacific Gas & Electric 6% Preferred A.
Price earnings ratio
Calculated as price per share divided by earnings per share. The price per share (numerator) is the market price of a single share of the stock. The Earnings per share (denominator) is the Net Income of the company for the most recent 12-month period, divided by number of shares outstanding.
Many companies report pro forma earnings, in addition to normal earnings calculated under the Generally Accepted Accounting Principles (“GAAP”), in their quarterly and yearly financial reports. The pro forma accounting is a statement of the company’s financial activities while excluding “unusual and nonrecurring transactions” when stating how much money the company actually made. Expenses often excluded from pro forma results include company-restructuring costs, a decline in the value of the company’s investments, or other accounting charges, such as adjusting the current balance sheet to fix faulty accounting practices in previous years.
Retained earnings are profits that were not paid to a firm’s shareholders. They are reported in the ownership equity section of the firm’s balance sheet. Dividing profits between dividends and retained earnings depends on at least two things: the firm’s judgement of its own investment opportunities relative to those available in the market and any difference in tax treatment of dividends paid now and capital gains expected to result from investing retained earnings.
In business, revenue is the amount of money that a company actually receives from its activities, mostly from sales to customers. To investors, revenue is less important than profit, or income, which is the amount of money the business has earned after deducting all the business’s expenses.
Securities are tradeable interests representing financial value. They are often represented by a certificate. They include shares of corporate stock or mutual funds, bonds issued by corporations or governmental agencies, stock options or other options, other derivative securities, limited partnership units, and various other formal “investment instruments.” Banknotes, checks, and some bills of exchange do not fall into this category.
A spreadsheet is a rectangular table (or grid) of information, often financial information. (It is, therefore, a kind of matrix.) The word came from “spread” in its sense of a newspaper or magazine item (text and/or graphics) that covers two facing pages, extending across the centre fold and treating the two pages as one large one.
A stock option is a specific type of option with a stock as the underlying instrument, (the security that the value of the option is based on). Thus it is a contract to buy (known as a “call” contract) or sell (known as a “put” contract) shares of stock, at a predetermined or calculable (from a formula in the contract) price.
A stock split is a type of corporate action that replaces shares in a public company with more shares in the same company at a lower price. Although this leaves the market capitalisation of the company the same, an increase in the number of shares leads to greater liquidity, and therefore a greater volume of trades. This often leads to a higher stock price in the short term. The lower price per share also makes the company more accessible to some smaller investors.
A stock, also referred to as a share, is commonly a share of ownership in a joint stock company. The owners and financial backers of a company may desire additional capital to invest in new projects within the company. If they were to sell the company it would represent a loss of control over the company.
A shareholder or stockholder is an individual or company (including a corporation), that legally owns one or more shares of stock in a joint stock company. Companies listed at the stock market strive to enhance shareholder value. Stockholders are granted special privileges depending on the class of stock, including the right to vote (usually one vote per share owned) on matters such as elections to the board of directors, the right to share in distributions of the company’s income, the right to purchase new shares issued by the company, and the right to a company’s assets during a liquidation of the company.
In business and accounting, shareholder equity is everything of the company that is owned by the shareholders.
In economics and in business decision-making, sunk costs are costs that have already been incurred and which cannot be recovered to any significant degree. Sunk costs are sometimes contrasted with incremental costs, which are the costs that will change due to the proposed course of action. In microeconomic theory, only incremental costs are relevant to a decision. If we let sunk costs influence our decisions, we will not be assessing a proposal exclusively on its own merits.
Throughput in theory of constraints is the rate at which a system produces money, in contrast to output, which may be sold or stored in a warehouse. The signal provided by throughput is received (or not) at the point of sale — exactly the right time. Output that becomes part of the inventory in a warehouse may mislead investors or others about the organisation’s condition by inflating the apparent value of its assets. The theory of constraints and throughput accounting explicitly avoid that trap.
Throughput accounting is an alternative to cost accounting based on Standard or Activity Based Costing (ABC) proposed by Eliyahu M. Goldratt. Throughput accounting claims to improve management decisions by using measurements that more closely reflect the effect of decisions on three critical monetary variables (Throughput, Inventory, and Operating Expense — defined below).
Trade credit exists when one provides goods or services to a customer with an agreement to bill them later, or receive a shipment or service from a supplier under an agreement to pay them later. It can be viewed as an essential element of capitalisation in an operating business because it can reduce the required capital investment to operate the business if it is managed properly.
In finance, a treasury stock (a.k.a. reacquired stock) is stock, which is bought back by the issuing company. It reduces the amount of outstanding stocks on the open market. On the balance sheet, treasury stock is listed under Shareholder Equity.
Merchandise held by the business for sale to customers.
A statement of general ledger accounts that enables an accountant to confirm whether amounts debited equal amounts credited.
UK generally accepted accounting principles
The Generally Accepted Accounting Principles in the UK, or UK GAAP, are the overall body of regulation establishing how company accounts must be prepared in the United Kingdom. This includes not only accounting standards, but also UK company law. Accounting standards derive from a number of sources. The chief standard-setter is the Accounting Standards Board (ASB), which issues standards called Financial Reporting Standards (FRSs). The ASB is a private-sector organisation, funded by the accounting firms, and it replaced the Accounting Standards Committee (ASC), which was disbanded in 1990 following a number of criticisms of its work. To the extent that the ASC’s pronouncements, known as Statements of Standard Accounting Practice (SSAPs), have not been replaced by FRSs, they remain in force.
US generally accepted accounting principles
Generally accepted accounting principles (GAAP) are the accounting rules used to prepare financial statements for publicly traded companies and many private companies in the United States. In the United States, as well as other countries practicing English common law system, the government does not set accounting standards, in the belief that the private sector has better knowledge and resources. The GAAP is not written in law, although the SEC requires that it be followed in financial reporting by publicly traded companies.
In accounting, writing off is the expensing of a balance sheet asset that has no future benefits. An example would be the writing off of goodwill. That is, the worthless asset will be recorded as an expense on the current period’s income statement rather than keeping it on the balance sheet as an asset. Similar to a write off is a write down. This is a partial write off. Only part of the value of the asset is removed from the balance sheet.