Accounting Exam 3 (Chapters 5 and 6)

Accounts Receivable

Expected future cash receipt arising from permitting a customer to buy now and pay later; typically a relatively small balance due within a short time period.

Accrued Interest

Interest revenue or expense that is recognized before cash has been exchanged.

Adjusting Entry

Entry that updates account balances prior to preparing financial statements.

Aging of Accounts Receivable

Classifying each account receivable by the number of days it has been outstanding. The aging schedule is used to develop an estimate of the amount of the allowance for doubtful accounts.

Allowance for Doubtful Accounts

Contra asset account that contains an amount equal to the accounts receivable that are expected to be uncollectible.

Allowance method of accounting for uncollectible accounts

Method of accounting for uncollectible accounts in which uncollectible accounts are estimated and expensed in the same period in which the ­corresponding sales are recognized. The receivables are reported in the ­financial statements at net realizable value (the amount expected to be ­collected in cash).

Bad Debts Expense

An expense resulting from a decrease in the amount of accounts receivable due to the inability to collect balances due from debtors. The term is a synonym for uncollectible accounts expense.

Collateral

Assets pledged as security for a loan

Consistency

The generally accepted accounting principle that a company should, in most circumstances, continually use the same accounting method(s) so that its financial statements are comparable across time.

Contra Asset Account

Account subtracted from another account with which it is associated; has the effect of reducing the asset account with which it is associated.

First-in, first-out (FIFO) cost flow method

Inventory cost flow method that treats the first items purchased as the first items sold for the purpose of computing cost of goods sold.

Full Disclosure

The accounting principle that financial statements should include all information relevant to an entity’s operations and financial condition. Full disclosure frequently requires adding footnotes to the financial statements.

Interest

Fee paid for the use of funds; represents expense to the borrower and revenue to the lender.

Inventory Cost Flow Methods

Methods used to allocate the cost of goods available for sale between cost of goods sold and inventory.

Last-in, first out (LIFO) cost flow method

Inventory cost flow method that treats the last items purchased as the first items sold for the purpose of computing cost of goods sold.

Liquidity

Ability to convert assets to cash quickly and meet short-term obligations.

Maker

The party issuing a note (the borrower).

Matching Concept

Accounting principle of recognizing expenses in the same accounting period as the revenues they produce, using one of three methods: match expenses directly with revenues (e.g., cost of goods sold), match expenses to the period in which they are incurred (e.g., rent expense), and match expenses systematically with revenues (e.g., depreciation expense).

Maturity Date

The date a liability is due to be settled (the date the borrower is expected to repay a debt).

Net Realizable Value (NRV)

Face amount of receivables less an allowance for accounts whose collection is doubtful (amount actually expected to be collected).

Notes Receivable

Notes that evidence rights to receive cash in the future from the maker of a promissory note; usually specify the maturity date, interest rate, and other credit terms.

Payee

The party collecting cash

Percent of Receivables Method

Estimating the amount of the allowance for doubtful accounts as a percentage of the outstanding receivables balance. The percentage is typically based on a combination of factors such as historical experience, economic conditions, and the company’s credit policies.

Percent of Revenue Method

Estimating the amount of uncollectible accounts expense as a percentage of the revenue earned on account during the accounting period. The percentage is typically based on a combination of factors such as historical experience, economic conditions, and the ­company’s credit policies.

Physical Flow of Goods

Physical movement of goods through the business; normally a FIFO flow so that the first goods purchased are the first goods delivered to customers, thereby reducing the likelihood of obsolete inventory.

Principal

Amount of cash actually borrowed

Promissory Note

A legal document representing a credit agreement between a lender and a borrower. The note specifies technical details such as the maker, payee, interest rate, maturity date, payment terms, and any collateral.

Reinstate

Recording an account receivable previously written off back into the accounting records, generally when cash is collected long after the original due date.

Specific Identification

Inventory method that allocates costs between cost of goods sold and ending inventory using the cost of the specific goods sold or retained in the business.

Uncollectible Accounts Expense

Expense associated with uncollectible accounts receivable; the amount recognized may be estimated using the percent of revenue or the percent of receivables method, or actual losses may be recorded using the direct write-off method. In practice, the uncollectible account expense is frequently called bad debts expense.

Weighted-Average Cost Flow Method

Inventory cost flow method in which the cost allocated between inventory and cost of goods sold is based on the average cost per unit, which is determined by dividing total costs of goods available for sale during the accounting period by total units available for sale during the period. If the average is recomputed each time a purchase is made, the result is called a moving average.

Accelerated Depreciation Method

Depreciation method that recognizes depreciation expense more rapidly in the early stages of an asset’s life than in the later stages of its life.

Accumulated Depreciation

Contra asset account that indicates the sum of all depreciation expense recognized for an asset since the date of acquisition.

Amortization

Method of systematically allocating the costs of intangible assets to expense over their useful lives; also term for converting the discount on a note or a bond to interest expense over a designated period.

Basket Purchase

Acquisition of several assets in a single transaction with no specific cost attributed to each asset.

Book Value

Historical (original) cost of an asset minus the accumulated depreciation; alternatively, undepreciated amount to date.

Capital Expenditures (on an existing asset)

Substantial amounts of funds spent to improve an asset’s quality or to extend its life.

Carrying Value

Face amount of a bond liability less any unamortized bond discount or plus any unamortized bond premium.

Contra Asset Account

Account subtracted from another account with which it is associated; has the effect of reducing the asset account with which it is associated.

Copyright

Legal protection of writings, musical compositions, and other intellectual property for the exclusive use of the creator or persons assigned the right by the creator.

Current (short-term) Asset

Asset that will be converted to cash or consumed within one year or an operating cycle, whichever is longer.

Depletion

Method of systematically allocating the costs of natural resources to expense as the resources are removed from the land.

Depreciable Cost

Original cost minus salvage value (of a long-term depreciable asset).

Depreciation

Decline in value of long-term tangible assets such as buildings, furniture, or equipment. It is systematically recognized by accountants as depreciation expense over the useful lives of the affected assets.

Depreciation Expense

Portion of the original cost of a long-term tangible asset systematically allocated to an expense account in a given period.

Double-Declining-Balance Depreciation

Depreciation method that recognizes larger amounts of depreciation in the early stages of an asset’s life and progressively smaller amounts as the asset ages.

Estimated Useful Life

Time for which an asset is expected to be used by a business.

Franchise

Exclusive right to sell products or perform services in certain geographic areas.

Goodwill

Added value of a successful business that is attributable to factors—reputation, location, and superior products—that enable the business to earn above-average profits; stated differently, the excess paid for an existing business over the appraised value of the net assets.

Historical Cost Concept

Accounting practice of reporting assets at the actual price paid for them when purchased regardless of estimated changes in market value.

Intangible Assets

Assets that may be represented by pieces of paper or contracts that appear tangible; however, the true value of an intangible asset lies in the rights and privileges extended to its owners.

Long-term Operational Assets

Assets used by a business to generate revenue; condition of being used distinguishes them from assets that are sold (inventory) and assets that are held (investments).

Maintenance Costs 

Costs incurred for repair or maintenance of long-term operational assets; recorded as expenses and subtracted from revenue in the accounting period in which incurred.

Natural Resources

Mineral deposits, oil and gas reserves, and reserves of timber, mines, and quarries are examples; sometimes called wasting assets because their value wastes away as the resources are removed.

Patent

Legal right granted by the U.S. Patent Office ensuring a company or an individual the exclusive right to a product or process.

Property, Plant, and Equiptment

Category of assets, sometimes called plant assets, used to produce products or to carry on the administrative and selling functions of a business; includes machinery and equipment, buildings, and land.

Relative Fair Market Value Method

Method of assigning value to individual assets acquired in a basket purchase in which each asset is assigned a percentage of the total price paid for all assets. The percentage assigned equals the market value of a particular asset divided by the total of the market values of all assets acquired in the basket purchase.

Salvage Value

Expected selling price of an asset at the end of its useful life.

Straight-Line Depreciation 

Method of computing depreciation that allocates the cost of an asset to expense in equal amounts over its life. The formula for calculating straight line depreciation is (Cost–Salvage)/Useful Life.

Tangible Assets

Assets that can be touched, such as equipment, machinery, natural resources, and land.

Trademark

Name or symbol that identifies a company or an individual product.

Units-of-Production Depreciation

Depreciation method based on a measure of production rather than a measure of time; for example, an automobile may be depreciated based on the expected miles to be driven rather than on a specific number of years.