Whether completing undergraduate work or preparing for the CPA exam, accounting students have told us that a glossary of terms is never far from their side. But a simple definition rarely seems to be enough for a real understanding of complex concepts and processes.
Here we provide a comprehensive list of the most frequently searched accounting terms, along with the supporting examples and contextual definitions necessary to not only understand the concepts, but to apply the processes behind them. This resource serves as an essential reference for students pursuing an accounting degree and professionals advancing their careers.
Quick Reference: Top 20 Essential Accounting Terms
Assets
Resources owned by a business that have economic value
GAAP
Generally Accepted Accounting Principles – standardized guidelines
Balance Sheet
Financial statement showing assets, liabilities, and equity
Cash Flow
Movement of money into and out of a business
Depreciation
Allocation of asset cost over its useful life
Accounts Receivable
Money owed to a company by its customers
Accounts Payable
Money a company owes to its suppliers
Revenue
Income generated from business operations
Accounting Concepts
Financial accounting concepts are the fundamental principles used in the preparation of financial statements. These concepts form the foundation of modern accounting practices and are essential for anyone studying accounting programs.
Financial Statements
The concept of the accounting period is crucial for financial statements. An accounting period is the interval of time during which accounting activities are measured. Common accounting periods include monthly, quarterly, and annually.
The four most important financial statements in accounting are:
Financial Accounting Concepts
Core accounting concepts for preparing financial statements include:
- Conservatism (Prudence): When financial results can be reported in multiple ways, choose the least optimistic approach
- Consistency: Organizations should use the same accounting methods over time without changing between periods
- Cost Principle: Accounts show actual cost of assets rather than current market value
- Dual Aspect: Every transaction affects at least two accounts
- Going Concern: Assumption that the organization will continue operating
- Matching: Revenues and related expenses should be recorded in the same period
- Materiality: Only significant information needs detailed disclosure
- Money Measurement: Only transactions quantifiable in monetary terms are recorded
- Realization: Revenue is recognized when goods are delivered or services rendered
- Separate Entity: Business is treated as distinct from its owners
These fundamental concepts ensure that financial information is understandable, timely, relevant, reliable, and complete, serving as an objective representation of an organization’s financial status.
Accounting Cycle
During each accounting period, businesses must perform specific steps to account for business activities. This process is called the accounting cycle and is fundamental knowledge for students in accounting degree programs.
The accounting cycle consists of ten comprehensive steps, with the first three occurring throughout the accounting period and the last seven happening only at the end of each period:
Detailed Accounting Cycle Steps
Step One: Identify and Analyze Transactions involves examining source documents such as bank statements, checks, and purchase orders to determine which accounts are affected and how.
Step Two: Journalize refers to using double-entry accounting to record appropriate debits and credits in the journal.
Step Three: Post transfers debits and credits from the journal to the ledger, which is a collection of all company accounts.
Step Seven: Prepare Financial Statements must follow a specific order: income statement, retained earnings statement, balance sheet, and cash flow statement, as each uses information from the previous statement.
Accounting Ratios
Accounting ratios, also called financial ratios, are essential tools for analyzing financial statements. These ratios help investors, creditors, and management evaluate a company’s financial performance and position. A ratio by itself may have no meaning until compared to ratios from previous years (time series analysis) or ratios of other firms in the same industry (cross-sectional analysis).
Types of Accounting Ratios
Advantages and Limitations of Ratio Analysis
Advantages:
- Provides quick financial statement summary
- Enables trend analysis over time
- Allows comparison between companies of different sizes
- Helps identify financial strengths and weaknesses
Limitations:
- Industry comparisons may not be accurate due to different business models
- Historical data may not predict future performance
- Accounting methods can vary between companies
- Ratios focus on the past rather than present or future
Accounting Records
Accounting records encompass all documentation concerning the financial life of a business or individual. These records include the accounting system used to record and track financial transactions, prepared financial statements, and supporting documents such as checks and invoices.
Basic Record Keeping System
A basic record keeping system for a business generally consists of:
- Basic Journal: For recording transactions such as revenues and expenses
- Accounts Receivable Records: Customer payment tracking
- Accounts Payable Records: Vendor payment tracking
- Inventory Records: Product cost and quantity tracking
- Payroll Records: Employee compensation documentation
- Petty Cash Records: Small cash transaction tracking
- Asset and Liability Records: Long-term financial position tracking
Records and the Accounting Process
Most businesses use double entry accounting, where transactions are first recorded in a general journal by date. Every transaction affects at least two accounts, one with a credit and the other with a debit. Debits and credits are then posted to the chart of accounts in the general ledger.
The importance of good accounting records cannot be overstated. Well-organized and thorough records provide quick access to important information such as cash flow, expenses, money owed, accounts receivable, inventory turnover, and profit. The survival of a business can depend on accurate and timely accounting records.
Accounting Technology
Accounting has evolved from a pencil and paper profession to one that uses the full extent of computer technology. There are over 3,300 accounting software options available, falling within various classification types.
Types of Accounting Software
Accounting in the Cloud
Cloud accounting operates exclusively within the cloud, offering significant benefits:
- Multi-user Access: Multiple people can access and work with information simultaneously
- Data Security: Information is protected from onsite physical hazards such as fire or computer theft
- Automatic Updates: Software updates occur automatically without manual intervention
- Remote Access: Users can access information from anywhere with internet connection
Client Portals
Client portals are secure, password-protected online storage areas that allow accountants and clients to exchange files and information. These portals provide secure exchange of confidential information while allowing real-time access for both parties.
Security and Integration Issues
The primary concerns in accounting technology include:
- IT Environment Security: Protecting systems from cyber threats
- Risk Management: Identifying and mitigating technology risks
- Privacy Protection: Ensuring client data confidentiality
- Fraud Prevention: Implementing controls to prevent financial fraud
Accounting Worksheet
An accounting worksheet is a tool that accountants use to compile, organize, and structure data from ledger accounts onto one page. While worksheets aren’t formal documents, they serve as an optional intermediary step for preparing financial statements.
Structure of an Accounting Worksheet
The traditional accounting worksheet contains a far-left column with all open accounts plus five pairs of debit and credit columns:
Determining Net Income or Loss
After completing the income statement columns, if total credits exceed total debits, there’s net income. The accountant adds net income to the debit column for the income statement and to the credit column for the balance sheet. If total debits exceed credits, there’s a net loss, which is added to the credit column for the income statement and debit column for the balance sheet.
Accounting for Stocks & Bonds on the Balance Sheet
Companies often reinvest excess revenue in stocks and bonds to earn additional income. These investments are reported on the balance sheet using various methods depending on their marketability, management’s intent, and investment type.
Three Reporting Methods
- Market Value Method: Securities recorded at current market price
- Present Value Method: Securities recorded at discounted future value
- Equity Method: Used for significant influence investments
Classifications of Management Intent
Accounting for Bad Debts
Accounting for bad debts is necessary yet complex, affecting both the income statement and balance sheet. On the income statement, bad debt estimates appear as expenses, while on the balance sheet, uncollectible accounts appear as a subtraction from accounts receivable.
Two Primary Aims in Bad Debt Accounting
- Matching: Match bad debt costs to the sales revenue for the same period
- Accurate Valuation: Present correct value of accounts receivable on the balance sheet
Methods for Estimating Bad Debts
Allowance Method: Estimates uncollectible accounts at period end using either:
- Percentage-of-Sales Method: Estimates based on total sales percentage
- Accounts Receivable Aging Method: Estimates based on age of outstanding accounts
Direct Write-Off Method: Writes off accounts when they become worthless, though this method is not GAAP-compliant for most businesses.
Accounting for Discontinued Operations
Discontinued operations must be disclosed on the income statement in the period they occur. When management decides to sell a portion of the business, this creates a contingency because the exact gain or loss amount is usually unknown until the transaction finalizes.
Reporting Discontinued Operations
Gains or losses on discontinued operations are reported on the income statement in the section following income from continuing operations and preceding extraordinary items. Tax consequences must also be disclosed, whether additional taxes from gains or tax savings from losses.
For investors, income from continuing operations becomes the most important figure when predicting future earning capacity, as discontinued operations will no longer contribute to earnings.
Accounting vs. Finance Functions
The board of directors ultimately carries responsibility for financial performance, with the chief executive and senior management providing necessary financial information. Understanding the distinction between accounting and finance functions is crucial for effective governance.
Accounting Functions
Accounting functions include:
- Transaction Identification: Identify and record all valid transactions
- Classification: Classify financial transactions on a timely basis
- Period Identification: Determine the appropriate time period for transaction recording
- Valuation: Value transactions appropriately using GAAP
- Disclosure: Provide adequate disclosure of transactions
Finance Functions
Finance functions analyze accounting data to:
- Collect and Analyze: Gather accounting data and statistics
- Trend Analysis: Identify financial trends for future planning
- Ratio Development: Create ratios to assist in analysis
- Communication: Communicate findings to stakeholders
Accounting for Extraordinary Items
For an item to be considered extraordinary, it must meet specific criteria. The gain or loss must be both unusual (unrelated to normal business operations) and nonrecurring (not expected to happen again).
Recording Extraordinary Items
Extraordinary items are presented on the income statement between discontinued operations and cumulative effect of accounting principle changes. They must be recorded net of tax consequences.
Excluded Items
The following gains or losses cannot be treated as extraordinary items:
- Foreign currency exchange gains or losses
- Write-downs of receivables, inventories, or equipment
- Gains or losses from business segment sales
- Losses from employee strikes
- Gains or losses from property, plant, or equipment sales
Accounting for Bonds
Bonds represent loans given to other companies that bear interest. They serve as short-term investments because they can be easily converted to cash when needed.
Bond Pricing Variations
Bonds can be sold in three ways:
- Bonds at Par: Sold at face value when stated rate equals market rate
- Bonds at Discount: Sold below face value when stated rate is below market rate
- Bonds at Premium: Sold above face value when stated rate exceeds market rate
Types of Bonds
Accurately Tracking Inventory Prevents Profit Loss
Inventory tracking is essential for monitoring current assets and preventing profit loss. The inventory account tracks products purchased for sale, with costs deducted as items are sold.
Inventory Tracking Methods
Periodic Inventory Method: Requires physical counts on a periodic basis (daily, monthly, or yearly) with cost of goods calculated using items-sold numbers.
Perpetual Inventory Method: Calculated based on actual transactions using computerized inventory control systems, often linked to cash register sales.
Periodic physical counts are necessary to compare actual inventory with recorded amounts. Inventory losses due to theft or damage can be written off but require accurate documentation.
Annual Report Notes on Commitments
Investors closely review the notes section of annual reports for detailed information about the company’s financial commitments. These notes reveal the company’s current financial state and future obligations.
Types of Commitments Disclosed
Common commitment types include:
- Outstanding Loan Terms: Details of existing debt obligations
- Long-term Purchase Plans: Commitments to future purchases
- Debt Refinancing Arrangements: Plans to restructure existing debt
- Lines of Credit: Available borrowing capacity
- Employee Pension Plan Details: Future retirement obligations
- Lease Terms: Long-term lease obligations
These disclosures are valuable because they indicate future debt structure and cash requirements. Lease terms particularly affect asset definitions, as some long-term leases are equivalent to purchase and mortgage arrangements.
Asset Controls
Businesses must establish internal controls to minimize errors and protect against fraud or theft. Asset controls institute methods and procedures to control business assets, with different controls applied to each asset category.
Specific Asset Controls
Audit Report Contents in the Annual Report
Publicly traded companies must disclose audit report contents in their annual reports. Each paragraph serves a specific purpose in expanding awareness of audit features and limitations.
Audit Report Structure
Paragraph One: Establishes that management is primarily responsible for financial statements, clarifying auditor responsibilities.
Paragraph Two: Describes the audit process, including the auditor’s objective to test financial statement soundness through careful review of accounting records.
Paragraph Three: Provides the auditor’s opinion, which can be:
- “Clean” Opinion: Fair presentation of financial position and earnings
- “Qualified” Opinion: Specific areas deemed not fairly presented
- “Adverse” Opinion: Financial statements not fairly presented
- “Disclaimer”: No opinion offered
Paragraph Four: Lists accounting principle changes made during the fiscal year.
Paragraph Five: Provides auditor’s assessment of management’s internal control systems.
Books of Account
Before electronic accounting, transactions were recorded in different books. Although no longer manually maintained, this terminology remains important in accounting data storage and processing.
Types of Accounting Books
General Ledger: The master book containing all accounts and statements, with an account for each category of asset, equity, expense, and revenue.
Subsidiary Ledger: Provides detailed data for each general ledger account, with individual balances totaling the corresponding general ledger account balance.
General Journal: The book of original entry where transactions are first recorded before transfer to the general ledger.
Specialized Journals: Additional books for specific transaction types, such as:
- Cash receipts journal
- Sales journal
- Payroll journal
- Purchase journal
- Cash disbursements journal
The Importance of Bank Reconciliation
Bank reconciliation is a crucial procedure for establishing internal control over company cash. The goal is to compute the true cash balance that will appear on the balance sheet as of a particular date.
Common Reconciliation Issues
Reasons why accounts might not balance include:
- Bank Service Charges: Fees charged by the bank, including unexpected overdraft fees
- Note Receivable Collections: Bank collections made before company awareness
- Interest Earned: Interest credited to the account
- Bank Errors: Mistakes made by the bank requiring documentation
- Deposits in Transit: Deposits recorded but not yet cleared
- Outstanding Checks: Checks written but not yet deposited by vendors
- Company Errors: Mistakes in company records
The Bookkeeping Cycle
The bookkeeping cycle represents the natural flow of transactions from initial recording to final financial statements. This cycle typically spans one year and requires careful organization.
Bookkeeping Cycle Process
Daily transactions (purchases, sales, payments, collections) are recorded in the book of original entry. At month-end, debits and credits are totaled by account category and posted to the general ledger.
Adjusting entries are necessary for transactions not recorded in the occurrence period, common with continuous services paid at different intervals. These adjustments account for asset depreciation, liabilities, debt interest, and taxes.
The bookkeeping cycle concludes by closing the books, returning all revenue and expense accounts to zero balance, and transferring net income or loss to ownership equity.
Balanced Scorecards
Balanced scorecards integrate financial and non-financial elements to provide comprehensive organizational performance evaluation. They translate company vision and strategy into coherent performance measures.
Four Balanced Scorecard Quadrants
Developing a Scorecard
Scorecard development steps include:
- Strategy Establishment: Outline key success elements
- Strategy Description: Communicate strategy to key players
- Framework Development: Create objectives and measurements embodying strategic objectives
- Implementation: Monitor effectiveness and adjust as needed
Budget Variances
Budget variances represent differences between budgeted figures and actual results. These variances are analyzed to understand performance deviations and their causes.
Types of Variances
Sales Variances:
- Price Variance: Effect of selling at different prices than budgeted
- Quantity Variance: Effect of selling different quantities than budgeted
- Product Mix Variance: Effect of selling products in different proportions than budgeted
Cost Variances:
- Budget Variances: Differences between actual and budgeted amounts
- Price and Quantity Components: Separate analysis of price and quantity effects
Positive sales variances indicate higher actual revenues than budgeted, while favorable cost variances show lower actual costs than budgeted.
Bill Collection
Bill collection is an essential component of total credit strategy. When bills aren’t collected timely, cash becomes tied up, affecting other business operations.
Total Credit Strategy Components
A comprehensive credit strategy involves:
- Payment Terms: Decide on customer payment terms
- Credit Checks: Perform credit evaluations
- Personnel Assignment: Choose appropriate collection staff
- Receivables Monitoring: Track outstanding balances
- Problem Account Follow-up: Address delinquent accounts
- External Assistance: Determine when to use collection agencies
Effective Collection Practices
Good record keeping is essential for effective collection. Records must be accurate, timely, and complete. Best practices include:
- Next-day billing for shipped products
- Weekly billing for professional services
- Phone reminders before due dates
- Accurate invoice information
- Documentation of all client conversations
Budgeting Procedures
All companies operate under budgets, which can range from simple income estimates to complex departmental budgets. Budgets are typically calculated according to fiscal year and divided into quarterly and monthly periods.
Budget Development Process
The budgeting process typically follows this sequence:
- Sales Budget: Foundation for all other budgets
- Expense Budgets: Selling and administrative expenses
- Capital Expenditure Budget: Equipment and facility purchases
- Cash Budget: Combining operating and capital data
- Budgeted Financial Statements: Projected income and balance sheets
Budget Types
Fixed Budgets (Planning Budgets): Useful for planning and coordinating business activities.
Flexible Budgets: Provide accurate cost comparisons at actual activity levels, better for cost control purposes.
Zero-Based Budgeting: Explains every dollar of predicted cost starting from zero, not relying on pre-authorized funds or past trends.
Consolidated Financial Statements
Consolidated financial statements combine the financial statements of parent companies and their subsidiaries. Accounting principles require incorporation of majority-owned subsidiary assets, liabilities, revenues, and expenses.
Consolidation Process
The consolidation process eliminates transactions between parent and subsidiary companies to prevent overstating combined company figures. A parent/subsidiary relationship exists when the parent owns more than 50% of another company’s common stock.
Minority Interest
Minority interest represents the ownership equity held by other shareholders when the parent doesn’t own 100% of subsidiary voting stock. This can be recorded as:
- Liability: Amount the parent “owes” minority shareholders
- Part of Consolidated Equity: Component of total owners’ equity
Certified Public Accountants
The certified public accountant (CPA) is the most prominent accounting certification. CPAs are considered the most trusted professional group in America, given their extensive education and experience requirements.
CPA Exam Requirements
To become a CPA, candidates must pass a four-part exam administered by the AICPA:
Additional Requirements
Beyond the exam, CPA candidates must:
- Complete 150 credit hours of education
- Gain relevant work experience in public accounting
- Meet continuing education requirements
- Maintain ethical standards
The Big Four Accounting Firms
The largest public accounting firms handling majority of public company audits are:
- PricewaterhouseCoopers: Headquarters in London
- Deloitte & Touche: Headquarters in United States
- Ernst & Young: Headquarters in London
- KPMG: Headquarters in Amsterdam
Contingent Assets and Liabilities
Contingent assets and liabilities represent items whose existence is uncertain. These items are not formally recorded in accounts but are described in financial statement notes.
Contingent Assets
When asset existence is uncertain, it’s considered contingent. These assets are not recorded in formal accounts but are listed in financial statement notes. Assets are part of a business if economic benefits and risks of ownership accrue to that business.
Contingent Liabilities
When liability existence is questionable, it’s considered contingent. If payment is probable, the liability is real. If reasonable doubt exists, it’s classified as contingent. Contingent liabilities are noted in financial statements but not recorded in formal accounts.
When payment is certain but amount is undeterminable, the least probable amount is recorded in accounts with a note explaining the situation and possible liability range.
Capital Lease
A capital lease transfers all benefits and risks of ownership to the lessee. This classification depends on lease agreement terms and significantly affects financial reporting.
Capital Lease Indicators
A lease is classified as capital if it meets any of these criteria:
- Ownership Transfer: Legal ownership transfers to lessee
- Bargain Purchase Option: Lessee can purchase at discounted price
- Lease Term: 75% or more of asset’s economic life
- Present Value: Minimum lease payments equal 90% or more of asset’s fair value
Capital Lease Accounting
Capital leases are treated similarly to depreciable assets with two differences:
- Depreciation Period: Limited to lease term unless ownership transfers
- Expense Type: Expenses are amortized rather than depreciated
GAAP requires detailed capital lease disclosure to demonstrate legitimacy.
Credit vs. Debit
Understanding debits and credits is fundamental to double-entry bookkeeping. The accounting use of these terms differs from banking terminology, which can initially cause confusion.
Accounting Perspective
In double-entry bookkeeping:
- Assets = Debits: Things received in exchanges
- Equities = Credits: Things given in exchanges
- Expenses = Debits: What money bought (labor, supplies)
- Revenues = Credits: Where money came from (sales, services)
The terms originate from “debtor” (someone who owes the business) and “creditor” (someone the business owes).
Banking Perspective
Banks call depositor accounts “credits” because the bank owes these amounts to customers. This creates the apparent contradiction between banking and accounting terminology.
Remember: Every transaction has two sides – things received (debits) and things given (credits). The fundamental equation is Assets + Expenses = Liabilities + Equity + Revenue.
Calculations for Evaluating Investment Opportunities
Capital budgeting requires evaluating investment opportunities to determine profitability. Four common methods help assess potential investments.
Investment Evaluation Methods
Method Selection
Each method provides different perspectives on investment attractiveness. The payback method is simplest but least comprehensive, while net present value and internal rate of return provide more sophisticated analysis considering the time value of money.
Circulars Governing Grant Accounting
The federal Office of Management and Budget (OMB) monitors grant accounting through three circulars governing administration, costing, and auditing of grant money.
OMB Circulars
Circular 2 CFR Part 215: Defines administrative requirements for nonprofit organizations, institutions of higher education, and hospitals to ensure equal treatment.
OMB Circular A-122: Determines cost principles for nonprofit organizations, classifying costs as:
- Reasonable Cost: Cost no higher than others would pay under similar circumstances
- Allocable Cost: Cost incurred specifically for the grant or necessary for operations
- Allowable Cost: Cost reimbursable by federal government according to cost principles
OMB Circular A-133: Addresses audit requirements for grant money, requiring nonprofits to maintain copies of all grant documents.
Components of a Budget
Corporate budget formation involves multiple employees, with the chief executive setting objectives and managers projecting departmental needs based on these goals.
Budget Development Sequence
The budgeting process begins with sales forecasting, as this forms the foundation for all other budgets:
- Sales Budget: Units and pricing for each product and territory
- Expense Budgets: Selling and administrative expenses
- Capital Expenditure Budget: Plant and equipment purchases
- Cash Budget: Combining operating and capital data
- Budgeted Financial Statements: Income and balance sheet projections
Budget Review Process
Large corporations typically use budget committees consisting of:
- Budget director
- President
- Senior production executives
- Sales executives
- Financial executives
Components of the Income Statement
The income statement measures economic performance over a given period by summarizing revenues, expenses, gains, and losses to determine net income.
Income Statement Components
Statement Differences
The income statement represents a period of time, while the balance sheet provides a snapshot at a specific moment. Businesses produce income statements, while charitable organizations use a Statement of Activities showing funding sources versus program and administrative expenses.
Company’s Profitability
Profitability analysis examines a company’s ability to generate profits relative to sales and investment. This analysis typically occurs in two phases.
Profitability in Relation to Sales
Profit equals sales minus expenses, including cost of goods sold, salaries, rent, utilities, depreciation, interest, and taxes. Common-size income statements convert figures to percentages for better analysis.
When sales increase but profits remain stagnant, disproportionate expense increases are typically the cause. Detailed expense analysis helps identify problem areas.
Profitability in Relation to Investment
Return on total assets (ROTA) measures basic earning power by comparing profits to total assets. The debt-to-equity ratio analysis determines whether assets were financed through debt or equity.
Capital investment in assets like equipment, inventory, and research must generate appropriate returns to justify the investment.
Cash Flow Statements
Cash flow statements track money movement into and out of businesses. Continuous cash flow is essential for business survival, as many businesses fail due to cash flow problems despite profitability.
Cash Flow Categories
Cash flow statements typically divide activities into three categories:
- Operating Activities: Cash flows from primary business operations
- Investing Activities: Cash flows from long-term asset transactions
- Financing Activities: Cash flows from borrowing and equity transactions
Cash Flow vs. Income
Cash flows differ from income for two reasons:
- Non-cash Expenses: Depreciation and other non-cash expenses are added back to income
- Credit Transactions: Income is adjusted for changes in current asset and liability accounts
For small businesses, cash flow often equals income when operating on a cash basis, but larger businesses require cash flow statements compiled from income statements and balance sheets.
Combining the Accounts of Foreign Companies
When combining domestic and foreign company accounts, the method depends on whether the foreign company is independent or integrated with its American parent.
Classification Determination
Classification depends on answers to questions such as:
- Where are the foreign company’s products sold?
- Does cash flow freely between American and foreign companies?
- Where does the foreign company purchase goods and services?
Translation Methods
Independent Foreign Company: Accounts translated at current exchange rates, with balance sheet items using period-end rates and income statement items using average annual rates.
Integrated Foreign Company: Accounts handled as if transactions occurred in dollars, with different items using historical, current, or average exchange rates as appropriate.
Different translation rates for different accounts create imbalances requiring exchange gain or loss adjustments.
Common Size Statements
Common size statements represent a variation of ratio analysis where every item is expressed as a percentage of the largest statement item. This method evaluates all financial statement components simultaneously.
Common Size Applications
This analysis is valuable for:
- Time Comparison: Comparing different years of the same company
- Company Comparison: Comparing different-sized companies
- Component Analysis: Focusing on relationships between statement components
Common Size Calculations
Income Statement: All items expressed as percentages of sales (the largest item).
Balance Sheet: All items expressed as percentages of total assets (the largest item).
A variation uses a selected prior year as the base, with future years’ components expressed as percentages of base year amounts.
Declining Balance Methods
Declining balance methods charge more depreciation expense in early asset years than other methods, based on the theory that businesses use more of the asset initially.
Declining Balance Method Types
Double Declining Balance Method: Accelerated depreciation based on declining book value, initially ignoring salvage value. Annual depreciation rate can be calculated by:
- Calculating straight-line expense and doubling it
- Dividing 2 by estimated useful life and multiplying by book value
Sum-of-the-Years’-Digits Method: Uses asset’s expected life years as a fraction, with the numerator being remaining years and denominator being sum of all year digits.
Method Benefits
These methods align with asset usage patterns, where assets typically require more repairs in later years. Higher early depreciation offsets lower early repair costs, creating more consistent total annual expenses.
Deferred Income Taxes
Deferred income taxes arise from differences between accounting income and taxable income timing. Most companies use straight-line depreciation for accounting but declining balance for tax purposes.
Tax Timing Differences
Companies typically experience:
- Early Years: Higher depreciation and lower taxable income
- Later Years: Lower depreciation and higher taxable income
Additional differences include fines and interest on unpaid taxes, which aren’t deductible for tax purposes.
Financial Statement Impact
Deferred taxes appear as long-term liabilities on balance sheets, often in substantial amounts that may be overstated compared to present value. Public companies must provide reconciliation of tax expense to actual tax liability, explaining the differences.
Depreciation and Amortization Transactions
Depreciation (tangible assets) and amortization (intangible assets) account for asset value decrease over time. Both are recorded as expenses representing asset wear and tear.
Purpose and Benefits
Depreciation and amortization:
- Match Expenses: Spread major purchase costs over useful life
- Accurate Reporting: Avoid understating current year profits
- Tax Benefits: Provide deductions against loss in asset value
Recording Process
When recording depreciation or amortization:
- Credit: Contra-asset account (Accumulated Depreciation)
- Debit: Expense account (Depreciation/Amortization Expense)
Companies may maintain separate asset accounts showing accumulated depreciation or single accounts with reduced balances after depreciation posting.
Double Entry Accounting
Double entry accounting requires recording every transaction in at least two accounts, providing built-in verification and comprehensive tracking compared to single entry (cash) accounting.
Single vs. Double Entry Comparison
Chart of Accounts
Double entry systems use five basic account types:
- Assets: Cash, Accounts Receivable, Equipment
- Liabilities: Accounts Payable, Wages Payable, Notes Payable
- Equity: Retained Earnings, Common Stock, Owner’s Capital
- Revenue: Sales Revenue, Service Revenue, Interest Revenue
- Expenses: Wages Expense, Rent Expense, Utilities Expense
Fundamental Equation
The basis of double entry accounting is:
Assets + Expenses = Liabilities + Equity + Revenue
Increases in assets and expenses are debits (left side), while increases in liabilities, equity, and revenue are credits (right side). The left side must always equal the right side.
Escrow Funds
Escrow funds management applies mainly to attorneys and realtors under strict state regulations. These funds belong to clients but are collected from third parties on the client’s behalf.
Escrow Fund Requirements
Professional requirements include:
- Separate Bank Account: Maintain escrow funds separately from business funds
- Proper Classification: Record as liabilities in “Funds Held in Trust” account
- Balance Reconciliation: Total liability account must equal bank account balance
- Client Tracking: Link every transaction to specific clients
Escrow Fund Tracking
Best practices include:
- Separate Accounts: Consider individual client accounts for accuracy
- Interest Earning: Use money market accounts when possible
- Audit Trail: Track hard costs and soft costs separately
- Check Writing: Use separate checks for different expense types
Earnings Per Share
Earnings per share (EPS) is the most widely used financial ratio, providing a concise way to present company profitability by dividing earnings by outstanding shares.
EPS Calculation
Basic EPS formula:
Earnings Per Share = Net Income ÷ Outstanding Shares
Factors Affecting Share Count
Outstanding shares can change due to:
- Employee Stock Options: Shares issued for employee compensation
- Stock Issuance/Retirement: New shares issued or existing shares retired
- Bond Conversion: Convertible bonds exchanged for shares
- Mergers: Share exchanges with other companies
EPS Complexity
EPS calculations become complex when considering:
- Preferred Dividends: Must be subtracted from earnings before calculating common stock EPS
- Diluted EPS: Considers potential dilution from convertible securities
- Weighted Average Shares: Adjusts for shares outstanding during different periods
Employer’s Quarterly Federal Tax Return
Form 941 must be filed quarterly by all employers who pay wages subject to income tax withholding and Social Security and Medicare taxes. The form is due on the last day of the month following the quarter end.
Form 941 Components
Filing Requirements
Key filing considerations:
- Small Employer Exception: Employers with quarterly tax liability under $2,500 can pay when filing
- Error Corrections: Use Form 941-X for corrections
- Seasonal Employers: Don’t file during quarters with no wages
- Special Situations: Household and farm employees are exempt
The Essential Balance Sheet
The balance sheet provides a snapshot of company financial condition at a specific point in time by comparing assets versus liabilities and stockholders’ equity.
Balance Sheet Structure
The balance sheet contains three main categories:
- Assets: All resources owned by the business
- Liabilities: All debts and obligations
- Stockholders’ Equity: Owner financing and retained earnings
Asset Classification
Liability Classification
Current Liabilities: Obligations due within one year, including accounts payable, wages payable, and short-term debt.
Long-term Liabilities: Obligations due beyond one year, including mortgages, bonds, and deferred taxes.
The balance sheet equation must always balance:
Assets = Liabilities + Stockholders’ Equity
Equity Controls
Equity controls establish procedures to manage business obligations and financing sources. These internal controls monitor various types of business financing and debt management.
Types of Equity Controls
Accounts Payable Controls:
- Regular settlement of payables
- Monthly reconciliation of individual accounts to general ledger
- Comparison of supplier statements to recorded amounts
- Investigation of any differences found
Short-term Debt Controls:
- Authorization limited to senior officers
- Established borrowing limits
- Two-signature requirement for notes payable
Long-term Debt and Equity Controls:
- Board of directors approval required
- Independent agents for large companies
- Trust company registrars and transfer agents
- Independent dividend and interest payment agents
Financial Statements and Notes in an Annual Report
Annual report financial statements represent the core content, providing the true state of company finances beyond polished promotional sections.
Required Annual Report Components
At minimum, annual reports must include:
- Balance Sheet: Financial position at year-end
- Income Statement: Operating results for the year
- Cash Flow Statement: Cash receipts and payments
- Notes: Detailed explanations and disclosures
- Management Report: Management’s responsibility statement
- Auditor’s Opinion:Auditor’s assessment of statement reliability
The Notes Section
Financial statement notes provide crucial information including:
- Accounting Methods: Depreciation methods, inventory valuation, revenue recognition
- Noncurrent Liabilities: Long-term debt details and maturity dates
- Commitments: Future obligations and contingencies
- Inventory Components: Raw materials, work-in-process, finished goods
- Employee Benefits: Pension provisions and post-retirement benefits
- Subsequent Events: Important events after year-end
Additional Report Sections
Management Report: Provides assurance about report accuracy and discusses internal controls used to ensure precision.
Auditor’s Opinion: Independent assessment of financial statements, with unqualified opinions being most favorable and qualified opinions indicating potential issues.
Additional components may include quarterly summaries, divisional reporting, and five-year operational summaries.
GAAP (Generally Accepted Accounting Principles)
Generally Accepted Accounting Principles (GAAP) provide the universal standard for financial accounting and reporting in the United States. Understanding GAAP is essential for students pursuing accounting degrees and critical for CPA exam preparation.
GAAP Framework Structure
GAAP is built on twelve fundamental principles organized into three categories:
GAAP Governance
The Financial Accounting Standards Board (FASB) establishes and maintains GAAP, functioning like the Supreme Court for accounting standards. The FASB must follow Securities and Exchange Commission legal requirements while developing standards.
Other governing bodies include:
- GASB: Governmental Accounting Standards Board for state and local government
- FASAB: Federal Accounting Standards Advisory Board for federal entities
International Standards Comparison
GAAP differs from International Financial Reporting Standards (IFRS) in several areas:
- Inventory Methods: GAAP allows LIFO; IFRS prohibits it
- Asset Revaluation: IFRS permits; GAAP generally prohibits
- Development Costs: IFRS may capitalize; GAAP typically expenses
- Financial Statement Format: Different presentation requirements
The International Accounting Standards Board (IASB) works to align FASB and international standards for global consistency.
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Frequently Asked Questions
What is the difference between accounting and bookkeeping?
Bookkeeping involves recording daily financial transactions, while accounting includes interpreting, analyzing, and reporting financial information. Accounting requires more education and provides strategic financial insights for business decision-making. Bookkeepers typically handle data entry and basic record-keeping, while accountants analyze financial data and provide recommendations.
How long does it take to become a CPA?
Becoming a CPA typically requires 4-6 years of education (150 credit hours), 1-2 years of relevant work experience, and passing the CPA exam. Requirements vary by state, so check your state’s specific CPA requirements. The CPA exam itself can be completed in 6-18 months depending on study time and scheduling.
What is the most important accounting principle?
The matching principle is often considered most important, as it ensures revenues and related expenses are recorded in the same period, providing accurate financial performance measurement. This principle is fundamental to accrual accounting and helps create meaningful financial statements that reflect true business performance.
What are the main types of accounting?
The main types include financial accounting (external reporting), management accounting (internal decision-making), tax accounting (tax compliance), and auditing (verification of financial information). Each type serves different purposes and requires specialized knowledge and skills.
How do I choose the right accounting degree program?
Consider factors such as accreditation, CPA exam pass rates, faculty qualifications, internship opportunities, and career services. Research programs that align with your career goals and offer strong preparation for professional certification. Look for programs with regional accreditation and specialized accounting accreditation from AACSB.
What is the difference between cash and accrual accounting?
Cash accounting records transactions when cash is received or paid, while accrual accounting records transactions when they occur, regardless of cash flow timing. Accrual accounting provides a more accurate picture of financial performance by matching revenues and expenses in the appropriate periods.
What salary can I expect as an accountant?
According to the Bureau of Labor Statistics, accountant and auditor salaries vary significantly by state, experience level, and specialization. Entry-level positions typically start around $45,000-$55,000 annually, while experienced CPAs can earn $75,000-$120,000 or more. Geographic location, industry, and firm size significantly impact compensation levels.
What skills are most important for accounting professionals?
Essential skills include attention to detail, analytical thinking, proficiency with accounting software, understanding of financial regulations, communication skills, and ethical judgment. Technology skills are increasingly important, including knowledge of data analytics, cloud-based accounting systems, and automation tools.
How has technology changed accounting?
Technology has automated many routine tasks, enabled real-time financial reporting, improved accuracy, and allowed accountants to focus on analysis and strategic advisory services. Cloud computing, artificial intelligence, and data analytics are transforming the profession by eliminating manual processes and providing deeper insights.
What are the career opportunities in accounting?
Accounting offers diverse career paths including public accounting, corporate accounting, government accounting, nonprofit accounting, forensic accounting, tax services, consulting, and financial analysis. Many accountants advance to leadership positions such as CFO, controller, or partner in public accounting firms.
What is the difference between assets and liabilities?
Assets are resources owned by a business that have economic value, such as cash, inventory, equipment, and buildings. Liabilities are debts or obligations owed to others, such as accounts payable, loans, and accrued expenses. The difference between assets and liabilities equals owners’ equity.
How do depreciation methods affect financial statements?
Different depreciation methods (straight-line, declining balance, units of production) affect the timing of expense recognition and asset values on financial statements. Accelerated methods like declining balance record higher expenses in early years, while straight-line spreads expenses evenly over the asset’s useful life.
What is the purpose of financial statement analysis?
Financial statement analysis evaluates company performance, financial health, and future prospects using techniques like ratio analysis, trend analysis, and comparative analysis. This analysis helps investors, creditors, and management make informed decisions about investments, lending, and business operations.
How do internal controls protect businesses?
Internal controls are policies and procedures designed to ensure accurate financial reporting, prevent fraud, and promote efficient operations. These controls include segregation of duties, authorization requirements, documentation procedures, and regular monitoring to protect business assets and ensure compliance with regulations.
What is the accounting equation and why is it important?
The fundamental accounting equation is Assets = Liabilities + Owners’ Equity. This equation must always balance and forms the foundation of double-entry bookkeeping. It shows that everything a business owns (assets) is financed by either debt (liabilities) or owner investment (equity).
This comprehensive accounting glossary serves as an essential resource for students, professionals, and anyone seeking to understand accounting principles and practices. The terms and concepts covered here represent the foundation of modern accounting and are crucial for success in accounting education and professional practice.
For those interested in pursuing an accounting career, this glossary provides the conceptual foundation necessary for advanced study and professional certification. Understanding these fundamental terms and principles is essential for success in CPA exam preparation and professional accounting practice.
May 2024 Bureau of Labor Statistics salary data for Accountants and Auditors reflect state and national data, not school-specific information. Conditions in your area may vary. Data accessed June 2025.
