Key Financial Accounting Terms and Definitions
Part of the Financial Accounting For Dummies Cheat Sheet
In a financial accounting class, and on the job as an accountant, you need to know some jargon. Following is a glossary of words and phrases crucial to the accounting profession.
Users of financial accounting information: The people or businesses that need to see the accounting transactions organized into financial statements to make educated decisions (such as whether to invest in or loan money to a company).
Characteristics of financial information: Financial accounting information has to be
Relevant: The information directly relates to the facts you’re trying to evaluate or understand.
Reliable: You can depend on the information to steer you in the right direction.
Comparable: The quality of the information is such that users can identity differences and similarities between companies they are evaluating.
Consistent: The company uses the same accounting treatment for the same types of accounting transactions.
Generally accepted accounting principles (GAAP): The rules financial accountants have to follow when handling accounting transactions and preparing financial statements. Financial accountants can’t just throw numbers on the income statement, balance sheet, or statement of cash flows; a level playing field must exist between businesses so that the individuals reading the financial statements can compare one company to another.
Just about everything you learn and do in a financial accounting class harkens back to the way GAAP tell accountants how to do their job. For example, GAAP determine how to expense assets, record revenue, and value inventory. The Financial Accounting Standards Board (FASB) is the private-sector body that establishes GAAP for all non-governmental entities.
American Institute of Certified Public Accountants (AICPA): The national professional organization for all certified public accountants (CPAs).
Certified Public Accountant (CPA): The professional license for accountants. To become a CPA, you must first complete a certain number of accounting and business-related courses in college. You then must take and pass the Uniform Certified Public Accountant exam, which is written and scored by the AICPA.
Chart of accounts: A list of all accounts set up to handle a company’s accounting transactions. The accounts are numbered in order, usually starting with 1000 (assets) and continuing through to 9000 (miscellaneous gains and losses).
General ledger: The record of all financial transactions taking place within a business during a particular accounting cycle, ordered by chart of account number.
Depreciation: The method used to systematically move the cost of an asset from the balance sheet to the income statement over the course of the asset’s useful life. Financial accounting uses three methods of depreciation based on time: the straight-line, declining balance, and sum-of-the-years’-digits methods. A fourth method, units-of-production, is based on actual physical usage of the fixed asset.
Stockholders’ equity: The claim that shareholders of the corporation have to the company’s net assets. Stockholders’ equity has three common components:
Paid-in capital: Money the shareholders in the corporation invest in the business
Treasury stock: A company’s own stock, which it buys back from other investors
Retained earnings: The company’s total net income or loss from the first day it’s in business to the date on the balance sheet
Contingency: A liability that exists because of a circumstance (such as a lawsuit) that may cause a business loss in the future depending on other events that have yet to happen (such as the outcome of a trial) and indeed may never happen.
Business combination: The process of combining two or more businesses — also known as mergers and acquisitions (M&A). Business combinations come in two different forms:
Asset acquisition: One company acquires the net assets of another company.
Stock acquisition: The acquiring company purchases an investment in another company (which is now a subsidiary).