Finding Material Changes to Debt or Equity
If your audit client has material debt or equity transactions after the balance sheet date, you must disclose the debt or equity in your audit report as well. This type of subsequent event may include the following circumstances:
Borrowing new money, paying off debt, or changing the terms of existing debt: For example, the client issues new bonds or changes the date that a loan needs to be paid off.
Converting debt to equity: Some companies use convertible securities to raise operating capital. These securities start off as debt (bonds) but can be turned into equity (stock) under some circumstances, which are spelled out in the issuance of the bonds.
Declaring dividends: Dividends are income paid to a corporation’s owners based on their proportionate ownership. Stock dividends are extra shares of stock that each shareholder of record gets (the number depends on how many shares each one already owns).
Having significant equity transactions: The company may issue new stock or create a stock split, which involves dividing one share of stock into two or more shares. A company takes this step if it believes that the trading price of its stock is too high. A stock split artificially reduces the price.
For example, if a company’s stock is trading for $100 and the company thinks this high price adversely affects the average investor’s desire to purchase the stock, the company may issue a 4-for-1 split to get the stock price down to $25 per share. Every outstanding share is now equal to four shares.
Material debt or equity changes require disclosure in the financial statements. Here’s an example of a note to the financial statements disclosing bonds that were paid off by issuing preferred stock:
During this period, the Company retired all its callable Series A bonds. The funds used to retire the bonds were obtained from the issuance of Series B preferred stock. Total extraordinary gain from the transaction sale was $200,000, and we recognized a pretax gain of $150,000.
An extraordinary item is an event that’s both unusual and infrequent. For example, you wouldn’t consider hurricane losses in Florida unusual or infrequent, but losses sustained by the Florida fern industry because of a blizzard would be.
Accounting Glossary
accounting equation
The equation Assets = Liabilities + Equity, which demonstrates the two-sided nature of accounting and is useful for explaining the concept of double-entry accounting (or double-entry bookkeeping).
Accounting Glossary
accounting period
The time period for which financial information is being tracked in a business, such as monthly, quarterly, or annually.
Accounting Glossary
accounts receivable
An account that records the amounts that customers owe to a business.
Accounting Glossary
adjusting entry
A correction made to a bookkeeping account that adjusts for accounting errors or other necessary changes at the end of the accounting period.
Accounting Glossary
cash flows
Used to describe the source or sources of cash or how cash is used.
Accounting Glossary
Chart of Accounts
A list of all the accounts used by a business, including what types of transactions go into each account.
Accounting Glossary
debit
An accounting entry that increases an asset or expense account, and decreases a liability or income account.
Accounting Glossary
dividends
A portion of a company’s profits paid by share of common stock on a quarterly or annual basis.
Accounting Glossary
FASB
Financial Accounting Standards Board. FASB is the highest-ranking authority in the private (non-government) sector of the U.S. for making pronouncements on GAAP and for keeping accounting standards up-to-date.
Accounting Glossary
Federal Unemployment Tax
In the U.S., the fund that used to be known simply as Unemployment. Employers contribute to the fund, and states also collect taxes to fill their unemployment fund reserves. (The acronym FUTA means Federal Unemployment Tax Act.)
Accounting Glossary
fidelity bonds
A type of insurance — typically carried by employers for their employees — that helps guard against theft and reduce the risk of loss.
Accounting Glossary
FIFO
First-in, first-out. A method for costs of goods sold in which a business charges out product costs to cost of goods sold expense in the chronological order in which the goods were acquired.
Accounting Glossary
fungible
Describes a product that is interchangeable and virtually indistinguishable from another product.
Accounting Glossary
General Ledger
A summary of all of a business’s accounts and transactions.
Accounting Glossary
IASB
International Accounting Standards Board. The IASB (based in London) is the main authoritative accounting standards setter outside the U.S.
Accounting Glossary
Journals
The location in which bookkeepers keep records (in chronological order) of daily company transactions.
Accounting Glossary
LIFO
Last-in, first-out. A method for costs of goods sold that selects the last item you purchased first, and then works backward until you have the total cost for the total number of units sold during the period.
Accounting Glossary
LLP
Limited liability partnership. A legal structure that state laws offer to qualified professionals in which all the partners have limited liability.
Accounting Glossary
PC
Professional corporation. A legal structure that state laws offer to qualified professionals who otherwise would have to operate as an unlimited partnership liability.
Accounting Glossary
petty cash
A cash account that businesses keep on hand for unexpected expenses.
Accounting Glossary
revenue
Monies that are collected in the process of selling a company’s goods and services.
Accounting Glossary
salvage value
The amount that an asset is worth after it has been fully depreciated.
Accounting Glossary
statement of cash flows
A financial statement that summarizes a business’s cash inflows and outflows during an accounting period.
Accounting Glossary
transactions
Economic exchanges between a business or other entity and the parties with which the entity interacts and makes deals.
Accounting Glossary
worker’s compensation insurance
A type of insurance carried by employers that covers its employees in case they are injured on the job.
