The Accounting Cycle

A

Absorption Costing

A costing method where products absorb all manufacturing costs—direct materials, direct labor, and fixed overhead. Think of it like a sponge: the product soaks up every factory cost, whether it varies with production or not.

Account

A record that tracks increases and decreases in a specific asset, liability, equity, revenue, or expense. Each account is like a folder in your filing cabinet—one for Cash, one for Rent Expense, one for Sales, etc.

Accounting

The language businesses use to communicate financial results. If you've ever tracked your bank account or budgeted for rent, you've done accounting—just on a smaller scale.

Accounting Cycle

The complete sequence of steps a company takes to record, process, and report financial transactions during one accounting period. It's like the orbit of the Earth: it starts, completes a full rotation, and then starts again.

Accounting Equation

The foundation of all accounting: Assets = Liabilities + Equity. Think of it as a balance scale. The left side (what you own) must always equal the right side (what you owe plus what owners have invested).

Accounting Period

The span of time covered by a set of financial statements—usually a month, quarter, or year. It's the "reporting window" through which we measure performance.

Accounts Payable (A/P)

Money your company owes to suppliers for goods or services already received but not yet paid for. It's like a tab at a coffee shop: you got the coffee (inventory), but you'll pay for it later.

Accounts Receivable (A/R)

Money customers owe you for goods or services you've already delivered. Think of it as an IOU sitting in your wallet—it's yours, but you haven't collected cash yet.

Accounts Receivable Turnover

A ratio measuring how many times per year a company collects its average receivables balance. Formula: Net Credit Sales ÷ Average Accounts Receivable. High turnover = you're collecting cash quickly.

Accrual Accounting

A system that records revenue when it's earned and expenses when they're incurred—regardless of when cash changes hands. It's like using a credit card: the purchase happens today even if you pay the bill next month.

Accrued Expense

An expense you've incurred but haven't paid yet and haven't recorded. Example: employees worked Monday–Friday, but payday isn't until next week. You owe them wages (liability) and have an expense, even though no cash has left.

Accrued Revenue

Revenue you've earned but haven't collected yet and haven't recorded. Example: you finished a consulting project Friday, but the client won't pay until next month. You've earned the revenue; you just don't have the cash yet.

Accumulated Depreciation

A running total of all depreciation expense ever recorded on a long-term asset. It's a contra-asset account—meaning it reduces the asset's value on the balance sheet. Think of it as wear-and-tear mileage that accumulates over the asset's life.

Acid-Test Ratio (Quick Ratio)

A stricter version of the current ratio that measures whether you can pay short-term debts without selling inventory. Formula: (Cash + Marketable Securities + Accounts Receivable) ÷ Current Liabilities. If the ratio is 1.0 or higher, you can cover liabilities with liquid assets alone.

Activity-Based Costing (ABC)

A method of assigning overhead costs based on the activities that actually drive those costs (machine setups, inspections, etc.) instead of a single allocation base like direct labor hours. It's more accurate but also more complex.

Adjusting Entries

Journal entries made at the end of an accounting period to update accounts before preparing financial statements. These ensure revenues are recorded when earned and expenses when incurred. Common examples: accrued wages, prepaid insurance expiring, depreciation.

Aging of Accounts Receivable

A method of estimating bad debts by categorizing receivables by how long they've been outstanding (0–30 days, 31–60 days, etc.). The older the receivable, the less likely you'll collect it.

Allowance for Doubtful Accounts

A contra-asset account that estimates how much of your Accounts Receivable you'll never collect. It's like setting aside a rainy-day fund for customers who ghost you. Appears on the balance sheet as a reduction to A/R.

Allowance Method

The preferred accounting approach for bad debts, where you estimate uncollectible amounts before they actually become uncollectible. More conservative and matches expense with revenue.

Amortization

The process of expensing the cost of an intangible asset (like a patent or trademark) over its useful life. It's depreciation's cousin, but for assets you can't touch.

Asset

Anything of value a company owns or controls that provides future economic benefit. Examples: cash, inventory, buildings, accounts receivable, patents. Assets go on the left side of the balance sheet.

Asset Turnover Ratio

Measures how efficiently a company uses its assets to generate sales. Formula: Net Sales ÷ Average Total Assets. Higher ratio = more efficient. Think of it as "sales per dollar of assets invested."

Audit

An independent examination of a company's financial statements to verify they're accurate and comply with accounting standards. Think of it as a financial health checkup by an outside doctor (the auditor).

Bad Debt Expense

The cost of doing business on credit—recognizing that some customers won't pay what they owe. Appears on the income statement as an operating expense.

Balance Sheet

A snapshot of a company's financial position at a specific point in time. It lists assets (what you own), liabilities (what you owe), and equity (what's left over for owners). Always balances because: Assets = Liabilities + Equity.

Bank Reconciliation

The process of matching your company's cash records to the bank's records and explaining any differences (outstanding checks, deposits in transit, bank fees, etc.). It's detective work to make sure every dollar is accounted for.

Betterment

An expenditure that improves an asset beyond its original condition or extends its useful life. Gets added to the asset's cost (capitalized) rather than expensed immediately. Example: replacing a roof adds years to a building's life.

Bond

A long-term debt instrument where the issuer borrows money and promises to pay it back with interest. Think of it as an IOU that trades on financial markets.

Book Value (Carrying Value)

The value of an asset on the balance sheet after subtracting accumulated depreciation. Formula: Cost − Accumulated Depreciation = Book Value. It's what the asset is "worth" in your accounting records, not its market value.

Break-Even Point

The sales level where total revenue exactly equals total costs—meaning you're not making or losing money. Formula: Fixed Costs ÷ Contribution Margin per Unit. It's the minimum you must sell to keep the lights on.

Budget

A financial plan projecting future revenues, expenses, and cash flows. It's your roadmap: actual results get compared against it to see if you're on track.

Capital Expenditure (CapEx)

Money spent to acquire or improve long-term assets (buildings, equipment). These costs are capitalized (added to the asset's value) rather than expensed immediately.

Capital Budgeting

The process of evaluating long-term investment opportunities (new equipment, factory expansion, etc.) using tools like NPV, IRR, and payback period.

Cash

Currency, coins, checks, money orders, and bank account balances available for immediate use. The most liquid asset.

Cash Basis Accounting

A system that records revenue only when cash is received and expenses only when cash is paid. Simple, but doesn't match revenue with the period it's earned.

Cash Budget

A plan showing expected cash inflows and outflows over a specific period. Helps avoid running out of cash even when profitable on paper.

Cash Conversion Cycle

The number of days between when a company pays for inventory and when it collects cash from selling that inventory. Shorter cycle = better cash flow.

Cash Equivalents

Short-term, highly liquid investments that can be converted to cash within 90 days. Examples: Treasury bills, money market funds. Reported with cash on the balance sheet.

Cash Flow Statement

A financial statement showing cash inflows and outflows from operating, investing, and financing activities during a period. Answers the question: "Where did the cash come from, and where did it go?"

Chart of Accounts

A complete list of every account a company uses, usually organized by account number (assets 100–199, liabilities 200–299, etc.). It's the index for your financial filing system.

Classified Balance Sheet

A balance sheet that groups assets and liabilities into current (short-term) and non-current (long-term) categories. Makes it easier to assess liquidity.

Closing Entries

Journal entries made at the end of an accounting period to reset revenue, expense, and dividend accounts to zero so they're ready for the next period. Permanent accounts (assets, liabilities, equity) are not closed.

Common Stock

Shares representing ownership in a corporation. Stockholders can vote on company matters and may receive dividends.

Conservatism Principle

An accounting guideline that says when in doubt, recognize expenses and liabilities sooner rather than later, and recognize revenues and assets only when certain. Better to understate profit than overstate it.

Consignment

An arrangement where one party (consignor) ships goods to another (consignee) but retains ownership until the goods are sold. The goods stay in the consignor's inventory, not the consignee's.

Contingent Liability

A potential liability that may occur depending on the outcome of a future event (lawsuit, warranty claim). Disclosed in notes to financial statements if probable and estimable.

Contra Account

An account that offsets another account. Examples: Accumulated Depreciation (contra-asset), Sales Discounts (contra-revenue), Allowance for Doubtful Accounts (contra-asset). Appears as a subtraction on financial statements.

Contribution Margin

Sales revenue minus variable costs. It's the amount each unit contributes toward covering fixed costs and generating profit. Formula: Contribution Margin = Sales − Variable Costs.

Contribution Margin Ratio

Contribution margin as a percentage of sales. Formula: Contribution Margin ÷ Sales. Tells you what percentage of each sales dollar is available to cover fixed costs and profit.

Controllable Cost

A cost that a manager can influence or control through their decisions. Used in performance evaluation.

Conversion Costs

Direct labor + manufacturing overhead. These are the costs to convert raw materials into finished products.

Copyright

Legal protection for original creative works (books, music, software). An intangible asset amortized over its useful life (often shorter than the legal life).

Corporation

A legal business entity separate from its owners (shareholders). Offers limited liability but faces double taxation (corporate income tax + dividend tax).

Cost Accounting

A branch of accounting focused on measuring, analyzing, and reporting costs—especially product costs for manufacturers and service providers.

Cost Behavior

How a cost reacts to changes in activity level. Costs can be fixed (stay constant), variable (change proportionally), or mixed (part fixed, part variable).

Cost of Goods Manufactured (COGM)

The total cost to manufacture products completed during a period. It includes direct materials, direct labor, and manufacturing overhead.

Cost of Goods Sold (COGS)

The direct costs of producing goods that were sold during a period. For a retailer, it's beginning inventory + purchases − ending inventory. Appears on the income statement.

Cost Principle

An accounting rule stating that assets should be recorded at their original purchase cost, not current market value.

Credit

An entry on the right side of a T-account. Increases liabilities, equity, and revenues; decreases assets and expenses. Think of it as the "right" thing for those account types.

Credit Terms

Payment terms for a credit purchase or sale. Example: "2/10, n/30" means take a 2% discount if paid within 10 days, otherwise full payment is due in 30 days.

Current Assets

Assets expected to be converted to cash, sold, or used up within one year or the operating cycle, whichever is longer. Examples: cash, accounts receivable, inventory, prepaid insurance.

Current Liabilities

Obligations due within one year or the operating cycle. Examples: accounts payable, short-term notes, unearned revenue, accrued expenses.

Current Ratio

A liquidity ratio measuring whether a company can pay short-term debts with short-term assets. Formula: Current Assets ÷ Current Liabilities. A ratio of 1.5 or higher is generally considered healthy.

Days Sales in Inventory

The average number of days it takes to sell inventory. Formula: 365 ÷ Inventory Turnover. Lower is better—means inventory moves faster.

Days Sales Outstanding (DSO)

The average number of days to collect accounts receivable. Formula: 365 ÷ Accounts Receivable Turnover. Lower is better—means you collect cash faster.

Debit

An entry on the left side of a T-account. Increases assets and expenses; decreases liabilities, equity, and revenues.

Debt Ratio

Measures what percentage of assets are financed by debt. Formula: Total Liabilities ÷ Total Assets. Higher ratio = more financial risk.

Debt-to-Equity Ratio

Compares total liabilities to shareholders' equity. Formula: Total Liabilities ÷ Total Equity. Shows the balance between creditor and owner financing.

Deferral

Postponing the recognition of revenue or expense to a future period. Examples: prepaid insurance (deferral of expense), unearned revenue (deferral of revenue).

Depletion

The process of allocating the cost of natural resources (oil, timber, minerals) over the periods they're extracted. It's depreciation for stuff you pull out of the ground.

Deposit in Transit

A deposit you've recorded in your cash account but that hasn't yet appeared on your bank statement—usually because it was made after the bank's cutoff time.

Depreciation

The systematic allocation of a long-term asset's cost over its useful life. It's not about the asset losing value—it's about matching expense with the revenue the asset helps generate.

Depreciation Methods

Straight-Line: Same expense every year. Declining Balance: Higher expense early, lower later. Units-of-Production: Based on actual usage (miles driven, units produced).

Direct Cost

A cost that can be easily and cost-effectively traced to a specific product, department, or activity. Examples: direct materials, direct labor.

Direct Labor

Wages of employees who work directly on converting raw materials into finished products. A direct cost and part of product cost.

Direct Materials

Raw materials that physically become part of the finished product and can be traced to it. Examples: wood in furniture, fabric in clothing.

Direct Write-Off Method

Recording bad debt expense only when a specific customer account is deemed uncollectible. Simple, but violates matching principle. Not GAAP-compliant for most companies.

Discount Period

The time window during which a buyer can take a cash discount for early payment (e.g., the "10" in "2/10, n/30").

Dividends

Cash or other assets distributed to shareholders as a return on their investment. Reduces retained earnings but is not an expense.

Double-Entry Accounting

The foundation of accounting: every transaction affects at least two accounts, and total debits always equal total credits. It keeps the accounting equation in balance.

DuPont Analysis

A method of breaking down Return on Equity (ROE) into three components: ROE = Profit Margin × Asset Turnover × Equity Multiplier. Helps identify why ROE is high or low.

Earnings Per Share (EPS)

Net income per share of common stock outstanding. Formula: (Net Income − Preferred Dividends) ÷ Weighted-Average Common Shares. A key profitability metric for investors.

Efficiency Ratios

Ratios measuring how well a company uses its assets. Examples: inventory turnover, receivables turnover, asset turnover.

Equity

The owners' claim on a company's assets after liabilities are subtracted. For corporations, equity = common stock + retained earnings.

Equity Multiplier

A leverage ratio showing how much assets are multiplied by equity financing. Formula: Total Assets ÷ Total Equity. Used in DuPont analysis.

Expense

The cost of resources consumed to generate revenue. Decreases equity (via retained earnings) and appears on the income statement. Examples: rent, wages, utilities.

Expense Recognition Principle (Matching Principle)

Expenses should be recorded in the same period as the revenues they help generate. Ensures accurate income measurement.

FIFO (First-In, First-Out)

An inventory costing method assuming the oldest units purchased are sold first. When costs rise, FIFO produces the lowest cost of goods sold and highest profit.

Financial Accounting

The branch of accounting focused on preparing financial statements for external users (investors, creditors, regulators). Governed by GAAP.

Financial Leverage

Using borrowed money to increase potential returns. More debt = more leverage = more risk and reward.

Financial Statements

The four main reports summarizing a company's financial performance and position: (1) Income Statement, (2) Balance Sheet, (3) Statement of Cash Flows, (4) Statement of Retained Earnings.

Financing Activities

Transactions involving creditors and owners—borrowing, repaying debt, issuing stock, paying dividends. Reported on the cash flow statement.

Finished Goods Inventory

Products that are complete and ready to sell. Part of current assets on the balance sheet for manufacturers.

Fiscal Year

A company's 12-month accounting period, which may or may not match the calendar year. Example: October 1–September 30.

Fixed Cost

A cost that stays constant in total regardless of changes in activity level. Examples: rent, insurance, salaries. Per-unit fixed cost decreases as volume increases.

FOB Destination

"Free on Board Destination"—seller pays shipping costs and retains ownership until goods reach the buyer. Buyer records inventory upon arrival.

FOB Shipping Point

"Free on Board Shipping Point"—buyer pays shipping and takes ownership once goods leave the seller's dock. Buyer records inventory immediately.

Fraud Triangle

The three conditions that lead to fraud: Opportunity (weak controls), Pressure (financial stress), and Rationalization (justifying the act). Understanding this helps companies prevent fraud.

Free Cash Flow

Operating cash flow minus capital expenditures. It's the cash available for expansion, dividends, or debt repayment—the true "leftover" cash.

GAAP (Generally Accepted Accounting Principles)

The rules and standards governing financial accounting in the U.S. Ensures consistency and comparability across companies. Set by the FASB.

General Ledger

The complete collection of all accounts used by a company. It's the central repository where every transaction ultimately ends up.

Going Concern Assumption

The assumption that a company will continue operating for the foreseeable future, not liquidate. Allows assets to be recorded at cost rather than liquidation value.

Goodwill

An intangible asset representing the excess paid when acquiring another company over the fair value of its net assets. Represents brand value, customer loyalty, etc. Not amortized but tested annually for impairment.

Gross Profit (Gross Margin)

Sales revenue minus cost of goods sold. It's the profit before operating expenses. Formula: Sales − COGS = Gross Profit.

Gross Margin Ratio

Gross profit as a percentage of sales. Formula: Gross Profit ÷ Net Sales. Higher ratio = better profitability on core products.

Historical Cost

The original purchase price of an asset. Assets are recorded at historical cost, not current market value.

Horizontal Analysis

Comparing financial data across multiple periods to identify trends. Shows dollar and percentage changes year-over-year.

Income Statement (Profit & Loss Statement)

A financial statement showing a company's revenues, expenses, and net income over a specific period. Answers: "Did we make or lose money?"

Income Summary

A temporary account used only during the closing process to collect all revenue and expense balances before transferring the net amount to retained earnings.

Indirect Cost

A cost that cannot be easily traced to a specific product or department. Examples: factory rent, utilities, supervisor salaries.

Indirect Labor

Labor costs that support production but aren't directly traceable to specific products. Examples: maintenance workers, supervisors. Part of manufacturing overhead.

Indirect Materials

Materials used in production but not directly traceable to finished products. Examples: glue, screws, cleaning supplies. Part of manufacturing overhead.

Intangible Assets

Long-term assets without physical form. Examples: patents, copyrights, trademarks, goodwill. Amortized over useful life (except goodwill).

Interest

The cost of borrowing money or the return earned on lending money. Calculated as: Principal × Annual Rate × Time (in years).

Internal Controls

Policies and procedures designed to protect assets, ensure accurate records, promote efficiency, and ensure compliance with laws. Think of it as guardrails preventing fraud and errors.

Internal Rate of Return (IRR)

The discount rate at which the net present value of an investment equals zero. Higher IRR = better investment.

Inventory

Goods held for sale (finished goods), in production (work in process), or awaiting use in production (raw materials). A current asset.

Inventory Shrinkage

Loss of inventory due to theft, damage, or errors. Discovered when physical count is less than recorded amount.

Inventory Turnover

Measures how many times inventory is sold and replaced during a period. Formula: COGS ÷ Average Inventory. Higher turnover = faster-moving inventory.

Investing Activities

Transactions involving long-term assets—buying/selling equipment, buildings, investments. Reported on the cash flow statement.

Invoice

A bill sent by a seller to a buyer detailing items sold, quantities, prices, and payment terms. A key source document.

Job Order Costing

A costing system where costs are assigned to specific jobs or batches. Used when products are customized (construction, printing, law firms).

Journal

The book (or file) where transactions are first recorded chronologically. Each entry includes date, accounts, debits, credits, and explanation.

Journal Entry

The formal recording of a transaction in the accounting system, showing which accounts are debited and credited.

Land

A long-term asset that is not depreciated because land has unlimited useful life. Recorded at cost, including purchase price, clearing, grading, and legal fees.

Ledger

The collection of all individual accounts where journal entries are posted. The general ledger is the complete set; subsidiary ledgers provide detail for specific accounts.

Leverage

Using debt to finance assets. More leverage = higher potential returns but also higher risk.

Liabilities

What a company owes to others—debts and obligations. Examples: accounts payable, notes payable, bonds, unearned revenue.

LIFO (Last-In, First-Out)

An inventory costing method assuming the newest units purchased are sold first. When costs rise, LIFO produces the highest COGS and lowest profit.

Liquid Assets

Assets that can be quickly converted to cash with minimal loss of value. Cash is the most liquid; buildings are not.

Liquidity

A company's ability to meet short-term obligations with short-term assets. High liquidity = healthy cash position.

Liquidity Ratios

Ratios measuring short-term financial health: current ratio, quick ratio, working capital.

Long-Term Assets (Non-Current Assets)

Assets expected to be used for more than one year. Examples: property, equipment, long-term investments, intangibles.

Long-Term Liabilities (Non-Current Liabilities)

Obligations not due within one year. Examples: bonds payable, long-term notes, mortgages.

Lower of Cost or Market (LCM)

A rule requiring inventory to be reported at the lower of its cost or market value. Prevents overstating assets.

Managerial Accounting

The branch of accounting focused on providing information to internal managers for decision-making, planning, and control. Not governed by GAAP.

Manufacturing Costs

The three components of product cost: direct materials, direct labor, and manufacturing overhead.

Manufacturing Overhead (Factory Overhead)

All manufacturing costs except direct materials and direct labor. Includes indirect materials, indirect labor, factory rent, utilities, depreciation on equipment.

Margin of Safety

The amount by which actual sales exceed break-even sales. It's your cushion—how much sales can drop before you start losing money. Formula: Actual Sales − Break-Even Sales.

Market Value

The current price an asset could be sold for in the marketplace. Different from book value (cost minus depreciation).

Matching Principle

Expenses should be recorded in the same period as the revenues they help generate. Ensures accurate income measurement.

Materiality

An accounting principle stating that insignificant amounts don't need strict adherence to GAAP. If an error wouldn't change a user's decision, it's immaterial.

Maturity Date

The date a note or bond becomes due and must be repaid.

Merchandise Inventory

Goods a retailer or wholesaler has purchased for resale. A current asset.

Mixed Cost

A cost with both fixed and variable components. Example: a cell phone bill with a fixed monthly fee plus per-minute charges.

Mortgage

A long-term loan secured by real estate. If the borrower defaults, the lender can take the property.

Multiple-Step Income Statement

An income statement format that shows multiple levels of profit: gross profit, operating income, and net income. Provides more detail than single-step format.

Natural Resources

Assets that are physically consumed through extraction: oil, minerals, timber. Recorded at cost and depleted (expensed) over time.

Net Income (Net Profit, Earnings)

The bottom line of the income statement. Formula: Revenues − Expenses = Net Income. If negative, it's a net loss.

Net Present Value (NPV)

The value of future cash flows discounted to today's dollars. Used in capital budgeting. Positive NPV = accept the project.

Net Realizable Value (NRV)

The estimated selling price of an asset minus costs to sell it. Used in inventory valuation.

Net Sales

Gross sales minus returns, allowances, and discounts. It's the "real" revenue earned.

Note Payable

A written promise to pay a specific amount at a future date, usually with interest. A liability.

Note Receivable

A written promise from a customer or borrower to pay a specific amount at a future date, usually with interest. An asset.

NSF Check (Non-Sufficient Funds)

A customer's check that bounced due to insufficient funds in their account. You must reverse the cash receipt and re-establish the receivable.

Operating Activities

Day-to-day business activities that generate revenue and incur expenses. Reported on the cash flow statement.

Operating Cycle

The time it takes to go from cash → inventory → sale → accounts receivable → cash. Longer cycle = more working capital needed.

Operating Expenses

Costs of running the business that aren't directly tied to producing goods. Examples: rent, salaries, advertising, utilities. Appear on the income statement below gross profit.

Operating Leverage

The degree to which a company uses fixed costs. High operating leverage = small sales changes cause big profit changes.

Opportunity Cost

The benefit you give up by choosing one option over another. Not recorded in accounting but important for decision-making.

Outstanding Check

A check you've written and recorded but that hasn't yet cleared the bank. Appears on bank reconciliation.

Overhead Rate

A rate used to apply overhead costs to products. Calculated before the period begins: Predetermined Overhead Rate = Estimated Total Overhead ÷ Estimated Allocation Base.

Overapplied Overhead

When more overhead is applied to products than was actually incurred. The difference is typically closed to cost of goods sold.

Par Value

The face value of a stock or bond stated in the corporate charter. For stock, it's often a nominal amount (like $0.01). Has little economic significance today.

Partnership

An unincorporated business owned by two or more people. Partners share profits, losses, and unlimited liability.

Patent

Legal protection for an invention, giving the owner exclusive rights for a period (typically 20 years). An intangible asset that's amortized.

Payback Period

The time it takes for an investment to generate enough cash flow to recover its initial cost. Formula: Initial Investment ÷ Annual Cash Inflow. Shorter payback = faster cost recovery.

Periodic Inventory System

An inventory system where you only update inventory counts at the end of the period (via physical count). COGS is calculated, not tracked transaction-by-transaction.

Permanent Accounts (Real Accounts)

Accounts that carry balances forward to the next accounting period: assets, liabilities, equity. They're not closed at period-end.

Perpetual Inventory System

An inventory system that updates inventory records after every purchase and sale in real time. Provides continuous tracking of inventory levels and COGS.

Petty Cash

A small amount of cash kept on hand for minor expenses (coffee, parking, postage). Replenished periodically and controlled via vouchers.

Plant Assets (Property, Plant & Equipment, PP&E)

Long-term tangible assets used in operations: land, buildings, equipment, vehicles. Depreciated over useful life (except land).

Post-Closing Trial Balance

A list of accounts and balances after closing entries are posted. Only permanent accounts (balance sheet accounts) appear. Confirms debits equal credits before starting the next period.

Posting

The process of transferring journal entry amounts to individual ledger accounts. It's like filing documents from your inbox into specific folders.

Preferred Stock

A class of stock that has preference over common stock for dividends and liquidation proceeds but usually doesn't have voting rights.

Prepaid Expense

A payment made in advance for a benefit to be received in the future. Initially recorded as an asset, then expensed over time. Examples: prepaid insurance, prepaid rent.

Price-Earnings Ratio (P/E Ratio)

A valuation metric showing how much investors are willing to pay per dollar of earnings. Formula: Market Price per Share ÷ Earnings per Share. Higher P/E = higher growth expectations.

Prime Costs

Direct materials + direct labor. These are the primary costs directly tied to making a product.

Principal

The original amount of a loan or note, not including interest.

Process Costing

A costing system where costs are accumulated by department or process and then averaged over all units. Used in mass production (chemicals, beverages).

Product Costs

Costs that attach to products and become inventory: direct materials, direct labor, manufacturing overhead. Expensed as COGS when the product is sold.

Profit Margin

Net income as a percentage of sales. Formula: Net Income ÷ Net Sales. Measures how much profit is earned per dollar of sales.

Profitability Ratios

Ratios measuring how well a company generates profit: profit margin, ROA, ROE, gross margin ratio.

Promissory Note

A written promise to pay a specific amount at a future date.

Raw Materials Inventory

Materials purchased but not yet used in production. A current asset for manufacturers.

Receivable

An amount owed to the company.

Relevant Range

The activity level within which fixed costs remain constant and variable costs remain linear. Outside this range, cost behavior can change.

Residual Value (Salvage Value)

The estimated value of an asset at the end of its useful life. Subtracted from cost when calculating depreciation.

Responsibility Accounting

A system that assigns costs and revenues to the managers who can control them. Used for performance evaluation.

Retained Earnings

Cumulative net income that has been kept in the business rather than paid out as dividends. Part of equity on the balance sheet.

Return on Assets (ROA)

Measures how efficiently assets generate profit. Formula: Net Income ÷ Average Total Assets. Higher ROA = better asset productivity.

Return on Equity (ROE)

Measures the return earned on owners' investment. Formula: Net Income ÷ Average Stockholders' Equity. Higher ROE = better return for shareholders.

Revenue

Income earned from selling goods or services. Increases equity (via retained earnings) and appears on the income statement.

Revenue Expenditure

An expenditure that benefits only the current period and is expensed immediately. Examples: repairs, maintenance.

Revenue Recognition Principle

Revenue should be recorded when it's earned (when goods/services are delivered), not necessarily when cash is received.

Sarbanes-Oxley Act (SOX)

A 2002 law requiring public companies to strengthen internal controls and have external auditors test those controls. Passed after major accounting scandals (Enron, WorldCom).

Segment

A distinct part of a business (product line, division, geographic area) that can be evaluated separately.

Single-Step Income Statement

A simplified income statement format with one subtraction: Total Revenues − Total Expenses = Net Income. Less detail than multi-step format.

Solvency

A company's ability to meet long-term obligations and survive over the long haul.

Solvency Ratios

Ratios measuring long-term financial health: debt ratio, debt-to-equity, times interest earned.

Source Document

Original records supporting a transaction: invoices, receipts, checks, timecards. They're the evidence that a transaction occurred.

Specific Identification

An inventory costing method that tracks the actual cost of each specific unit sold. Used for unique, expensive items (cars, jewelry).

Stakeholder

Anyone with an interest in a company's performance: shareholders, creditors, employees, customers, suppliers, regulators.

Standard Cost

A predetermined cost for materials, labor, or overhead used for budgeting and variance analysis. Represents what costs should be.

Statement of Retained Earnings

A financial statement showing changes in retained earnings during a period: Beginning RE + Net Income − Dividends = Ending RE.

Stock

Ownership shares in a corporation.

Stock Dividend

A dividend paid in shares of stock rather than cash. Increases shares outstanding but doesn't change total equity.

Stock Split

An increase in shares outstanding achieved by dividing each existing share into multiple shares. Doesn't change total equity; just makes shares cheaper per unit.

Straight-Line Depreciation

A depreciation method that allocates equal expense each year. Formula: (Cost − Salvage Value) ÷ Useful Life.

Sunk Cost

A cost that has already been incurred and cannot be changed. Irrelevant for future decisions.

T-Account

A visual tool shaped like a "T" used to illustrate debits (left side) and credits (right side) for an account. Helpful for learning double-entry accounting.

Temporary Accounts (Nominal Accounts)

Accounts that reset to zero at the end of each period: revenues, expenses, dividends. They're closed to retained earnings.

Time Period Assumption

The assumption that a company's life can be divided into artificial time periods (months, quarters, years) for reporting purposes.

Times Interest Earned Ratio

Measures how many times a company can cover interest payments with operating income. Formula: Income Before Interest and Taxes ÷ Interest Expense. Higher ratio = safer debt position.

Trademark

Legal protection for a brand name, logo, or symbol. An intangible asset amortized over its useful life.

Transaction

An event that changes a company's financial position and can be reliably measured in monetary terms.

Treasury Stock

A company's own stock that has been issued, bought back, and is held by the company. Reduces equity and is not an asset.

Trial Balance

A list of all accounts and their balances at a specific date. Used to verify that total debits equal total credits before preparing financial statements.

Underapplied Overhead

When less overhead is applied to products than was actually incurred. The difference is typically closed to cost of goods sold.

Unearned Revenue (Deferred Revenue)

Cash received before goods or services are delivered. It's a liability until you fulfill your obligation. Example: subscription payments received in advance.

Units-of-Production Depreciation

A depreciation method based on actual usage (miles, hours, units produced) rather than time. Formula: (Cost − Salvage Value) ÷ Total Estimated Units × Units This Period.

Useful Life

The estimated period an asset will be productive and used by the company. Used to calculate depreciation.

Variable Cost

A cost that changes in total proportionally with activity level. Per-unit variable cost stays constant. Examples: direct materials, sales commissions.

Variable Costing

A costing method where only variable manufacturing costs are assigned to products. Fixed overhead is expensed immediately. Used for internal reporting, not GAAP-compliant.

Variance Analysis

Comparing actual costs to budgeted or standard costs to identify differences (variances) and investigate causes.

Vertical Analysis (Common-Size Analysis)

Expressing each line item on a financial statement as a percentage of a base figure (total assets, total sales). Useful for comparing companies of different sizes.

Voucher

An internal document authorizing a payment, used in voucher systems to control cash disbursements.

Weighted Average

An inventory costing method that calculates a new average cost per unit after each purchase. Results fall between FIFO and LIFO.

Work in Process Inventory (WIP)

Products that are partially completed. Includes direct materials, direct labor, and overhead applied so far. A current asset for manufacturers.

Working Capital

The difference between current assets and current liabilities. Formula: Current Assets − Current Liabilities. Measures short-term financial health. Positive = you can cover short-term obligations.

Accounting Glossary

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