Accounting Terms and Definitions: A Comprehensive Guide
Accounting Terms and Definitions
Bonds
Bond Features and Types
Bonds offer several advantages, including not affecting owner control. Different types of bonds exist, such as:
- Callable bonds: These bonds allow the issuer to retire them before maturity at a predetermined price.
- Serial bonds: These bonds mature on multiple dates, with the principal repaid over several periods.
- Secured bonds: These bonds have specific company assets pledged as collateral, reducing the risk of loss compared to unsecured debt.
Bond Valuation
A bond sells at a discount when its contract rate is below the market rate. Conversely, a bond sells at a premium when its contract rate is above the market rate.
Liabilities
Current vs. Long-Term Liabilities
Liabilities represent obligations a company must fulfill. They are categorized based on their due date:
- Current liabilities: These obligations are due within one year or the company’s operating cycle, whichever is longer. Examples include accounts payable and short-term notes payable.
- Long-term liabilities: These obligations are not due within the longer of one year or the company’s operating cycle. Examples include long-term debt and bonds payable.
Contingent Liabilities
A contingent liability is a potential obligation dependent on a future event arising from a past transaction. Examples include lawsuits and product warranties.
Financial Ratios
Debt-to-Equity Ratio
The debt-to-equity ratio, calculated by dividing total liabilities by total stockholders’ equity, assesses a company’s financial leverage and risk. A higher ratio indicates greater financial risk.
Times Interest Earned Ratio
The times interest earned ratio measures a company’s ability to meet its interest obligations. It is calculated by dividing income before interest expense and income taxes by interest expense. A higher ratio indicates a stronger ability to cover interest payments.
Equity
Stockholders’ Equity
Stockholders’ equity represents the residual interest in a company’s assets after deducting liabilities. It consists of paid-in capital and retained earnings.
Common Stock
Common stock represents ownership in a corporation and entitles holders to voting rights and dividends. The number of shares a corporation can issue is its authorized stock.
Cash Flow
Statement of Cash Flows
The statement of cash flows reports a company’s cash inflows and outflows during an accounting period. It categorizes activities into three sections:
- Operating activities: These activities involve the production, purchase, and sale of goods and services.
- Investing activities: These activities involve the acquisition and disposal of long-term assets.
- Financing activities: These activities involve obtaining and repaying capital.
Cash Equivalents
Cash equivalents are short-term, highly liquid investments readily convertible to known cash amounts.
Internal Controls
Importance of Internal Controls
Internal control systems help safeguard assets, ensure accurate accounting records, and promote operational efficiency. Key principles include segregation of duties, proper authorization, and adequate documentation.
Sarbanes-Oxley Act (SOX)
The Sarbanes-Oxley Act (SOX) mandates that publicly traded companies establish and maintain effective internal control systems.
Other Important Concepts
Depreciation and Amortization
Depreciation allocates the cost of tangible assets, such as buildings and equipment, over their useful lives. Amortization allocates the cost of intangible assets, such as patents and trademarks, over their useful lives.
Prior Period Adjustments
Prior period adjustments correct errors made in previous accounting periods. They are reported in the statement of retained earnings.
Full Disclosure Principle
The full disclosure principle requires companies to report all relevant information that could impact users’ understanding of the financial statements.
Matching Principle
The matching principle requires expenses to be recognized in the same period as the revenues they generate.
Materiality Constraint
The materiality constraint allows for some flexibility in applying accounting principles when the impact on the financial statements is insignificant.
Goodwill
Goodwill represents the excess of a company’s purchase price over the fair value of its identifiable net assets. It arises from factors such as brand reputation and customer relationships.
Payroll
Payroll involves calculating and distributing employee compensation, including wages, salaries, and benefits. Employers are responsible for withholding taxes and other deductions.
Estimated Liabilities
Estimated liabilities are obligations that are uncertain in amount or timing. Examples include warranties and vacation pay.