Glossary—Chapter 24
accounting policiesThe specific accounting principles and methods a company currently uses and considers most appropriate to present fairly its financial statements. (p. 1516).
adverse opinionAn auditor’s report in which the exceptions to fair presentation are so material that in the independent auditor’s judgment, the financial statements taken as a whole are not in accordance with GAAP. Adverse opinions are rare; the SEC will not permit a company listed on an exchange to file statements with an adverse opinion. (p. 1536).
auditorAn accounting professional who conducts an independent examination of a company’s accounting data. (p. 1533).
auditor’s reportThe results of an independent examination of a company’s accounting data, including whether the financial statements are in accordance with GAAP. (p. 1533).
common costsThose incurred for the benefit of more than one segment and whose interrelated nature prevents a completely objective division of costs among segments. (p. 1526).
differential disclosureThe FASB, in recognizing that certain disclosure requirements are costly and unnecessary for certain companies, has eliminated reporting requirements for nonpublic enterprises in such areas as fair values of financial instruments and segment reporting. (p. 1515).
disclaimer of an opinionAppropriate when the auditor has gathered so little information on the financial statements that no opinion can be expressed. (p. 1536).
discrete approachThe belief that companies should treat each interim period as a separate accounting period. (p. 1528).
errors Unintentional accounting mistakes. (p. 1520).
financial forecastA set of prospective financial statements that present to the best of the responsible party’s knowledge and belief, a company’s expected financial position, results of operations, and cash flows. (p. 1539).
financial projectionProspective financial statements that present to the best of the responsible party’s knowledge and belief, given one or more hypothetical assumptions, an entity’s expected financial position, result of operations, and cash flows. (p. 1539).
fraud Intentional distortions of financial statements. (p. 1520).
fraudulent financial reporting Defined as “intentional or reckless conduct, whether act or omission, that results in materially misleading financial statements.” (p. 1543).
full disclosure principleAccounting principle that dictates that in deciding what information to report, companies follow the general practice of providing information that is of sufficient importance to influence the judgment and decisions of an informed user. It recognizes that the nature and amount of information included in financial reports reflects a series of judgmental trade-offs between sufficient detail that makes a difference to users, sufficient condensation to make the information understandable, and the costs and benefits of providing the information. (p. 1514).
illegal actsViolations of laws and regulations, such as illegal political contributions, bribes, and kickbacks. If a company derives revenue from an illegal act that is considered material in relation to the financial statements, this information should be disclosed. (p. 1520).
integral approachThe belief that the interim report is an integral part of the annual report and that deferrals and accruals should take into consideration what will happen for the entire year. (p. 1528).
interim reports Financial reports that cover periods of less than one year, such as a quarterly reports on Form 10-Q. (p. 1528).
management approachHow a company can meet the segmented reporting objective, by providing financial statements segmented based on how the company’s operations are managed. (p. 1524).
management’s discussion and analysis (MD&A)Mandated by the SEC, this section of the annual report covers three financial aspects of an enterprise’s business: liquidity, capital resources, and results of operations. In it, management highlights favorable or unfavorable trends and identifies significant events and uncertainties that affect these three factors. (p. 1536).
nonrecognized subsequent event An event that provides evidence about conditions that did not exist at the balance sheet date but arose subsequent to that date; adjustment of the financial statements is not necessary. (p. 1521).
notes to financial statementsA set of disclosuresin a company’s financial statements that further explain the items presented in the main body of the statements. The additional information provided in the notes does not have to be quantifiable, nor does it need to qualify as an accounting element. Notes to the financial statements are considered an integral part of the statements. (p. 1517).
operating segment A component of an enterprise (1) that engages in business activities from which it earns revenues and incurs expenses, (2) whose operating results are regularly reviewed by the company’s chief operating decision maker to assess segment performance and to allocate resources to the segment; and (3) for which discrete financial information is available that is generated by or based on the internal financial reporting system. (p. 1524).
post-balance-sheet eventsSignificant financial events that took place after the formal balance sheet date but before final issuance and that may materially affect the company’s financial position. Also referred to as subsequent events. Some post–balance-sheet events require adjustments to the accounts. Notes to the financial statements should explain post–balance-sheet events. (p. 1521).
qualified opinion An auditor’s report that contains an exception to the standard opinion, but usually not of sufficient magnitude to invalidate the statements as a whole. (p. 1535).
recognized subsequent eventAn event that provides additional evidence about conditions that existed at the balance sheet date, including the estimates inherent in the process of preparing financial statements. Recognized subsequent events require adjustments to the financial statements. (p. 1521).
related-party transactions When a company engages in transactions in which one of the parties has the ability to significantly influence the policies of the other.Related-party transactions may also occur when a nontransacting party has the ability to influence the policies of the two transacting parties. (p. 1519).
safe harbor rule The SEC-provided protection to a company that presents an erroneous forecast, as long as that company prepared the forecast on a reasonable basis and disclosed it in good faith. (p. 1540).
seasonalityWhen most of a company’s sales occur in one short period of the year, while certain costs are spread more equally throughout the year, for example, retailers for which much of their sales occur in the holiday season. (p. 1531).
subsequent eventsSignificant financial events that took place after the formal balance sheet date but before issuance and that may materially affect the company’s financial position. Also referred to as post–balance-sheet events. Some subsequent events require adjustments to the accounts. Notes to the financial statements should explain subsequent events. (p. 1521).
unqualified or clean opinionThe auditor’s opinion that the financial statement present fairly, in all material respects, the financial position, results of operations, and cash flows of the entity in conformity with GAAP. (p. 1535).
XBRL Extensible business reporting language, a computer language adapted from the code of the Internet that “tags” accounting data to correspond to financial reporting items that are reported in the balance sheet, income statement, and cash flow statement. (p. 1541).
Appendix 24A:
acid-test ratioLiquidity ratio that measures the ability of a company to meet its maturing obligations with its available assets and to meet unexpected needs for cash. Computed as cash plus short-term investments plus net receivables divided by current liabilities.A variation of the current ratio, the acid-test ratio eliminates inventories and prepaid expenses from the amount of current assets, to provide better information for short-term creditors. (p. 1549).
activity ratiosMeasures of how effectively a company is using its assets. Common activity ratios are: receivables turnover, inventory turnover, and asset turnover. (p. 1548).
asset turnoverActivity ratio that measures how efficiently a company uses its assets to generate sales. Computed as net sales divided by average total assets for the period. The resulting number is the dollars of sales produced by each dollar invested in assets. (p. 1549).
book value per shareThe amount each share of stock would receive if a company were liquidated, based on the amounts reported on the balance sheet. Computed as common stockholders’ equity divided by the number of outstanding shares of stock. If the valuations on the balance sheet do not approximate fair value, the book value per share figure loses its relevance. (p. 1549).
cash debt coverage ratioMeasure of solvency that indicates a company’s ability to repay its liabilities from cash generated from operations (without having to liquidate productive assets). Computed as the ratio of cash provided by operating activities to total debt, as represented by average total liabilities. (p. 1549).
common-size analysis Also called vertical analysis, the proportional expression of each financial statement item in a given period to a base figure, with the result that all of the elements within each statement are expressed in percentages of some common number and always add up to 100 percent. (p. 1552).
comparative analysisThe use of the same information for two or more different dates or periods, so that like items may be compared. (p. 1551).
coverage ratiosMeasures of the degree of protection for long-term creditors and investors. Common coverage ratios are: debt to total assets, times interest earned, the cash debt coverage ratio, and book value per share. (p. 1548).
current cash debt coverage ratioMeasure of liquidity that indicates a company’s ability to pay its short-term debts. Computed as cash provided by operating activities divided by average current liabilities. (p. 1549).
current ratioLiquidity ratio that measures the ability of a company to meet its maturing obligations with its available assets and to meet unexpected needs for cash. Computed as total current assets divided by total current liabilities. (p. 1549).
debt to total assets ratioCoverage ratio that measures the percentage of the total assets provided by creditors. Computed as total debt divided by total assets. The higher the percentage of debt to total assets, the greater the risk that the company may be unable to meet its maturing obligations. (p. 1549).
earnings per share (EPS)A distilled and important income figure, calculated as net income minus preferred dividends (income available to common stockholders), divided by the weighted average of common shares outstanding. Companies must disclose earnings per share on the face of the income statement. (p. 1549).
horizontal analysis The proportionate change over a period of time. (p. 1552).
inventory turnoverThe number of times on average a company sells its inventory during the period. Computed as the cost of goods sold divided by the average inventory on hand during the period. Analysts compute average inventory from beginning and ending inventory balances. (p. 1549).
liquidity ratiosMeasures of a company’s short-run ability to pay its maturing obligations. Common liquidity ratios are: the current ratio, the quick or acid-test ratio, and the current cash debt coverage ratio. (p. 1548).
payout ratioProfitability ratio that measures the percentage of earnings a company distributes to common stockholders in the form of cash dividends. Computed as cash dividends paid to common stockholders divided by net income available to common stockholders (net income minus preferred dividends). (p. 1549).
percentage analysisReducing a series of related amounts to a series of percentages of a given base, e.g., expressing all items in an income statement as a percentage of sales. (p. 1552).
profit margin on salesProfitability ratio that measures the company’s use of its assets to produce net income. Also called rate of return on sales. Computed as net income divided by net sales. This measure indicates the percentage of each dollar of sales that results in net income. By relating the profit margin on sales to the asset turnover for the period, we can find out how profitably the company used assets during that period of time. (p. 1549).
profitability ratiosMeasures of the degree of success or failure of a given company or division for a given period of time. Common profitability ratios are: profit margin on sales, rate of return on assets, rate of return on common stock equity, earnings per share, the price-earnings ratio, and the payout ratio. (p. 1548).
quick ratioLiquidity ratio that measures the ability of a company to meet its maturing obligations with its available assets and to meet unexpected needs for cash. Computed as cash plus short-term investments plus net receivables divided by current liabilities. A variation of the current ratio, the quick ratio (also referred to as the acid-test ratio) eliminates inventories and prepaid expenses from the amount of current assets, to provide better information for short-term creditors. (p. 1549).
rate of return on assets (ROA)The rate of return a company achieves through use of its assets. Computed as net income divided by average total assets. ROA indicates the amount of net income generated by each dollar invested in assets. By relating the profit margin on sales to the asset turnover for the period, analysts can find out how profitably the company used assets during that period of time. (p. 1549).
rate of return on common stock equityProfitability ratio that indicates how many dollars of net income the company earned for each dollar invested by the common stockholders. Also called return on equity (ROE). Computed as net income less preferred dividends divided by average common stockholders’ equity. (p. 1549).
receivables turnoverAn activity ratio that measures the number of times, on average, a company collects receivables during a period. Computed by dividing net sales by average (net) accounts receivable outstanding during the year. Barring significant seasonal factors, average receivables outstanding can be computed from the beginning and ending balances of net trade receivables. (p. 1549).
times interest earnedSolvency ratio that indicates the company’s ability to meet interest payments as they come due. Computed as income before income taxes and interest expense divided by interest expense. (p. 1549).
vertical analysisThe proportional expression of each financial statement item in a given period to a base figure. (p. 1552).