Financial Accounting Glossary

Accounting

The recording of monetary transactions which enables the provision of information to stakeholders. Sometimes referred to as 'the language of business'.

Accounting equation

Assets = Equity + Liabilities

Accruals

Expenses incurred during the accounting period but not paid for until after the accounting period ends are recognized as an expense in the SOPL and as a liability in the SOFP.

Accruals concept

An accounting concept for the preparation of financial statements which requires all income and expenditure earned and incurred in the accounting period is recognized in that accounting period (ie not when received or paid in cash).

Asset

A tangible or intangible resource that is owned or controlled by a business and which is expected to generate future economic benefits. Assets can be current assets or non-current assets.

Business entity concept

The business does not include any transactions that are not related to the business (such as personal transactions of the owner).

Capital

The difference between an entity's assets and liabilities and represents what the owner of the business has invested in the business. Closing capital = opening capital + new capital + profit/-loss - drawings. Also known as equity.

Capital expenditure

Expenditure on non-current assets.

Cash transaction

A transaction in which goods or services are paid for in cash or via bank at the point of delivery or receipt.

Cost of sales

Opening inventory + purchases - closing inventory.

Credit transaction

A transaction in which goods or services are paid for some time after delivery. Typical credit periods are 30-60 days.

Current asset

Short-term assets such as inventory, cash and trade receivables.

Current liability

Short-term liabilities such as trade payables and bank overdraft.

Current ratio

Current assets divided by current liabilities. Assesses the short-term liquidity of a business.

Debt ratio

Total liabilities divided by total assets. Assesses how reliant the business is on external parties to fund its assets.

Depreciation

The allocation of the cost of a non-current asset to the accounting periods benefiting from its use in the business. Can be calculated on a straight line or reducing balance basis.

Discount allowed

A cash discount offered to a credit customer for early settlement of an invoice. Discounts allowed are treated as expenses in the income statement.

Discount received

A cash discount received from a credit supplier for early settlement of an invoice. Discounts received are treated as other income in the income statement.

Dividend

A distribution of profits to shareholders.

Dividend cover

Dividends divided by profit after tax and preference dividends. Assesses the expected continuity of dividend payments (the higher, the better).

Dividend per share

Total dividend divided by number of ordinary shares.

Dividend yield

Dividend per share as a % of current share price.

Double-entry book-keeping

The process of recording transactions into the accounting system of the business (the ledger).

Drawings

Money or goods removed from the business by the owner for their own personal use. Drawings are not treated as an expense but as a reduction in capital.

Dual aspect

Recognising that each accounting transaction has a double effect on the amounts in the financial statements.

Duality concept

Each transaction affects the accounting system in two ways. Every debit entry has an equal and opposite credit entry. Also referred to as double entry or dual aspect.

Earnings per share

Profit after tax and preference dividends divided by the number of ordinary shares in issue.

Economic resource

A right that has the potential to produce economic benefits.

Equity

Capital ie what the owner has invested into the business.

Fair value

The amount at which an asset could be sold or a liability settled in the open market.

Faithful representation

One of the two fundamental qualitative characteristics of financial information. Financial information must be complete, neutral and free from error.

Financial accounting

The recording of monetary transactions and the preparation of the financial statements, which comprise the income statement, statement of financial position and the statement of cash flows. Financial accounting is based on retrospective, historical information.

Gearing

Debt divided by equity x 100%.

Going concern

A business that is able to continue for the foreseeable future (at least 12 months from the end of the accounting period date).

Gross profit

Revenue less cost of sales.

Gross profit percentage

Gross profit divided by sales x 100%.

Historic cost

The original cost of an asset when it was purchased.

IASB

International Accounting Standards Board - an organization which sets International Financial Reporting Standards (guidance for the preparation of financial statements).

Income Statement

Another name for the statement of profit or loss which shows the profit or loss made by the business over the accounting period.

Interest cover

Profit divided by interest. Shows how many times interest can be covered by operating profits.

Inventory

Goods held by a business. Inventory represents a current asset.

Inventory days

Inventory divided by cost of sales x 365 days.

Irrecoverable debts

Trade receivables from whom cash will never be collected because they have gone out of business. Treated as an expense in the SOPL. Also known as bad debts.

Liability

A legal obligation to transfer assets or provide services to another entity which arises from some past transaction or event. Liabilities can be current liabilities or non-current liabilities.

Liquidity

The ability of businesses to meet payments from their suppliers or lenders as they become due.

Non-current asset

An asset owned by the business and held to be used in the business for more than a year eg buildings, vehicles, machinery.

Non-current asset turnover

Revenue divided by non-current assets. Shows how many £ of sales are generated from each £ of non-current assets.

Non-current liability

A liability that is due to be paid over more than a year eg bank loan, mortgage.

Operating profit

Sales revenue - cost of sales - distribution and selling costs - administration expenses.

Operating profit %

Revenue less operating costs x 100%.

Payables

Amounts that the business owes to suppliers and other lenders. Treated as a current liability in the SOFP.

Payable days

Trade payables divided by cost of sales x 365 days. Measures the average time taken to pay trade suppliers.

Prepayments

Amounts that the business has paid in advance for goods or services to be provided in the future. Treated as a current asset in the SOFP.

Price/Earnings ratio

Current market price of a share divided by earnings per share. Provides an indicator of how many years of current period earnings are represented in the share price today.

Profit

The surplus remaining after all expenses are deducted from sales revenue.

Profit after tax

Profit that remains after all expenses have been deducted from sales revenue and any other income.

Profit after tax %

Profit for the year divided by revenue x 100%.

Profit before tax

Sales - cost of sales - distribution and selling costs - administration expenses + finance incomes - finance costs.

Profit before tax %

Profit before tax divided by revenue x 100%.

Prudence concept

An accounting concept that requires accountants to exercise caution when producing the financial statements to avoid overstating assets and income, and avoid understating liabilities and expenses.

Quick ratio

(Current assets - inventory) divided by current liabilities. Used to assess liquidity. Also known as the acid test ratio.

Receivables

Amounts of money owed to the business by customers who paid for goods or services on credit. Treated as a current assets in the SOFP.

Receivables days

Trade receivables divided by sales x 365 days. Measures the average time taken to collect monies from credit customers.

Reducing balance depreciation

A method of calculating depreciation by applying a given % to the net book value or carrying value of a non-current asset each year.

Residual value

The expected sales value of a non-current asset at the end of its useful economic life.

Return on capital employed

Operating profit (profit before interest and tax) divided by (equity + non-current liabilities) x 100%.

Revenue

Another term for sales of goods or services. Also referred to as income.

Revenue expenditure

Expenditure on the day to day running of a business eg wages, rent, electricity etc.

Revenue per employee

Revenue divided by the average number of employees.

Shareholders

Owners of share capital (ordinary shares or preference shares) in a limited company.

Stakeholders

An organisation or individual that is affected by a business eg employees, customers, government etc. Stakeholders are either internal or external.

Statement of Cash Flows

Part of the financial statements of a business, showing the cash inflows and outflows during the accounting period.

Statement of Financial Position

Part of the financial statements of a business, showing the assets and liabilities of a business on the last day of the accounting period. Also known as a balance sheet.

Statement of profit or loss

Part of the financial statements of a business, showing the profit or loss in the accounting period, by showing the income and deducting the expenses. Also known as an income statement.

Straight line depreciation

Calculates depreciation on a non-current asset using (cost - residual value) divided by the useful economic life in years (or multiplied by the useful economic life expressed as a %).

Trade discount

A discount given by one trader to another, which is deducted on the invoice indicating the amount that the buyer is charged for the goods, and sometimes referred to as a bulk discount. Trade discounts are not recorded in the accounting system.

Trade payables

Money owed to a supplier from whom goods were purchased on credit.

Trade receivables

Money owed by a customer who purchased goods on credit.

Useful economic life

The period over which a non-current asset is expected to be used.

Working capital

Current assets less current liabilities.

Working capital cycle

Inventory days + receivables days - payables days. Also known as operating cycle or cash conversion cycle.

Aquisition

Company buying or obtaining ownership of a company, business or asset. Aquiring something valuable