Key Terms

Financing activities Obtaining resources from (a) owners and providing them with a return
on and a return of their investment and (b) creditors and repaying
amounts borrowed (or otherwise settling the obligation). See
statement of cash flows.
Dividends A distribution of assets generated from earnings to owners of a
corporation. The firm may distribute cash (cash dividend), stock (stock
dividend), property, or other securities (dividend in kind). Dividends,
except stock dividends, become a legal liability of the corporation
when the corporation’s board declares them. Hence, the owner of
stock ordinarily recognizes revenue when the board of the corporation
declares the dividend, except for stock dividends. See also liquidating
dividend and stock dividend.
Investing activities Acquiring and selling securities or productive assets expected to
produce revenue over several periods.
Operating activities For purposes of the statement of cash flows, all transactions and
events that are neither financing activities nor investing activities. See
operations.
Annual report to A report prepared once a year for shareholders and other interested
shareholders parties. It includes a balance sheet, an income statement, a statement
of cash flows, a reconciliation of changes in owners’ equity accounts,
a summary of significant accounting principles, other explanatory
notes, the auditor’s report, and comments from management about
the year’s events. See 10-K and financial statements.
Management A discussion of management’s views of the company’s performance;
Discussion and required by the SEC to be included in the 10-K and in the annual
Analysis report to shareholders. The information typically contains discussion of
such items as liquidity, results of operations, segments, and the effects
of inflation.
Balance sheet Statement of financial position that shows Total Assets = Total
Liabilities + Owners’
Equity The balance sheet usually classifies Total Assets as (1) current assets,
(2) investments, (3) property, plant, and equipment, or (4) intangible
assets. The balance sheet accounts composing Total Liabilities usually
appear under the headings Current Liabilities and Long-term
Liabilities.
Assets SFAC No. 6 defines assets as “probable future economic benefits
obtained or controlled by a particular entity as a result of past
transactions. . . . An asset has three essential characteristics: (a) it
embodies a probable future benefit that involves a capacity, singly or
in combination with other assets, to contribute directly or indirectly to
future net cash inflows, (b) a particular entity can obtain the benefit
and control others’ access to it, and (c) the transaction or other event
giving rise to the entity’s right to or control of the benefit has already
occurred.” A footnote points out that “probable” means that which we
can reasonably expect or believe but that is not certain or proved. You
may understand condition (c) better if you think of it as requiring that a
future benefit cannot be an asset if it arises from an executory
contract, a mere exchange of promises. Receiving a purchase order
from a customer provides a future benefit, but it is an executory
contract, so the order cannot be an asset. An asset may be tangible or
intangible, short-term (current) or long-term (noncurrent).
Liabilities An obligation to pay a definite (or reasonably definite) amount at a
definite (or reasonably definite) time in return for a past or current
benefit (that is, the obligation arises from a transaction that is not an
executory contract); a probable future sacrifice of economic benefits
arising from present obligations of a particular entity to transfer assets
or to provide services to other entities in the future as a result of past
 transactions or events. SFAC No. 6 says that “probable” refers to that
which we can reasonably expect or believe but that is neither certain
nor proved. A liability has three essential characteristics: (1) the
obligation to transfer assets or services has a specified or knowable
date, (2) the entity has little or no discretion to avoid the transfer, and
(3) the event causing the obligation has already happened, that is, it is
not executory.
Shareholders’ equity Proprietorship or owners’ equity of a corporation. Because stock
means inventory in Australia, the UK, and Canada, their writers use
the term “shareholders’ equity” rather than the term “stockholders’
equity.”
Contributed capital Name for the owners’ equity account that represents amounts paid in,
usually in cash, by owners; the sum of the balances in capital stock
accounts plus capital contributed in excess of par (or stated) value
accounts. Contrast with donatedc apital.
Retained earnings Net income over the life of a corporation less all dividends (including
capitalization through stock dividends); owners' equity less contributed
capital.
Historical valuation Showing balance sheet amounts at acquisition cost, sometimes
reduced for accumulated amortization; sometimes reduced to lower of
cost or market.
Income statement The statement of revenues, expenses, gains, and losses for the
period, ending with net income for the period. Accountants usually
show the earnings-per-share amount on the income statement; the
reconciliation of beginning and ending balances of retained earnings
may also appear in a combined statement of income and retained
earnings. See income from continuing operations, income from
discontinued operations, extraordinary items, multiple-step, and
single-step.
Net income, earnings The excess of all revenues and gains for a period over all expenses
and losses of the period. The FASB is proposing to discontinue use of
this term and substitute earnings. See comprehensive income.
Revenues The owners’ equity increase accompanying the net assets increase
caused by selling goods or rendering services; in short, a service
rendered; sales of products, merchandise, and services and earnings
from interest, dividends, rents, and the like. Measure revenue as the
expected net present value of the net assets the firm will receive. Do
not confuse with receipt of funds, which may occur before, when, or
after revenue is recognized. Contrast with gain and income. See also
holding gain. Some writers use the term gross income synonymously
with revenue; avoid such usage.
Expenses As a noun, a decrease in owners’ equity accompanying the decrease
in net assets caused by selling goods or rendering services or by the
passage of time; a “gone” (net) asset; an expired cost. Measure
expense as the cost of the (net) assets used. Do not confuse with
expenditure or disbursement, which may occur before, when, or after
the firm recognizes the related expense. Use the word “cost” to refer
to an item that still has service potential and is an asset. Use the word
“expense” after the firm has used the asset’s service potential. As a
verb, “expense” means to designate an expenditure—past, current, or
future—as a current expense.
Net loss The excess of all expenses and losses for a period over all revenues
and gains of the period; negative net income.
Statement of cash A schedule of cash receipts and payments, classified by investing,
flows financing, and operating activities; required by the FASB for all for-
profit companies. Companies may report operating activities with
either the direct method (which shows only receipts and payments of
cash) or the indirect method (which starts with net income and shows
adjustments for revenues not currently producing cash and for
 expenses not currently using cash). “Cash” includes cash equivalents
such as Treasury bills, commercial paper, and marketable securities
held as current assets. This is sometimes called the “funds statement.”
Before 1987, the FASB required the presentation of a similar
statement called the statement of changes in financial position, which
tended to emphasize working capital, not cash.
Unqualified, qualified See auditor’s report.
opinion
Disclaimer of opinion An auditor’s report stating that the auditor cannot give an opinion on
the financial statements. Usually results from material restrictions on
the scope of the audit or from material uncertainties, which the firm
has been unable to resolve by the time of the audit, about the
accounts.
Adverse opinion An auditor’s report stating that the financial statements are not fair or
are not in accord with GAAP.
Securities and An agency authorized by the U.S. Congress to regulate, among other
Exchange things, the financial reporting practices of most public corporations.
Commission (SEC) The SEC has indicated that it will usually allow the FASB to set
accounting principles, but it often requires more disclosure than the
FASB requires. The SEC states its accounting requirements in its
Accounting Series Releases (ASR), Financial Reporting Releases,
Accounting and Auditing Enforcement Releases, Staff Accounting
Bulletins (these are, strictly speaking, interpretations by the accounting
staff, not rules of the commissioners themselves), and Regulations S-
X. See also registration statement, 10-K, and 20-F.
secret reserve Hidden reserve.
Financial Accounting An independent board responsible, since 1973, for establishing
Standards Board generally accepted accounting principles. Its official pronouncements
(FASB) are Statements of Financial Accounting Concepts (SFAC), Statements
of Financial Accounting Standards (SFAS), and FASB.