Glossary of Accounting Terms A to M
Above the line : This term can be applied to many aspects of accounting. It means transactions, assets etc., that are associated with the everyday running of a business. See below the line.
Account: A section in a ledger devoted to a single aspect of a business (eg. a Bank account, Wages account, Office expenses account).
Accounting cycle: This covers everything from opening the books at the start of the year to closing them at the end. In other words, everything you need to do in one accounting year accounting wise.
Accounts Payable: An account in the nominal ledger which contains the overall balance of the Purchase Ledger.
Accounts Payable Ledger: A subsidiary ledger which holds the accounts of a business's suppliers. A single control account is held in the nominal ledger which shows the total balance of all the accounts in the purchase ledger.
Accounts Receivable: An account in the nominal ledger which contains the overall balance of the Sales Ledger.
Accounts Receivable Ledger: A subsidiary ledger which holds the accounts of a business's customers. A single control account is held in the nominal ledger which shows the total balance of all the accounts in the sales ledger.
Accretive: If a company acquires another and says the deal is 'accretive to earnings', it means that the resulting PE ratio (price/earnings) of the acquired company is less than the acquiring company. Example: Company 'A' has an earnings per share (EPS) of $1. The current share price is $10. This gives a P/E ratio of 10 (current share price is 10 times the EPS). Company 'B' has made a net profit for the year of $20,000. If company 'A' values 'B' at, say, $180,000 (P/E ratio=9 [180,000 valuation/20,000 profit]) then the deal is accretive because company 'A' is effectively increasing its EPS (because it now has more shares and it paid less for them compared with its own share price). (see dilutive)
Accruals: If during the course of a business certain charges are incurred but no invoice is received then these charges are referred to as accruals (they 'accrue' or increase in value). A typical example is interest payable on a loan where you have not yet received a bank statement. These items (or an estimate of their value) should still be included in the profit & loss account. When the real invoice is received, an adjustment can be made to correct the estimate. Accruals can also apply to the income side.
Accrual method of accounting: Most businesses use the accrual method of accounting (because it is usually required by law). When you issue an invoice on credit (ie. regardless of whether it is paid or not), it is treated as a taxable supply on the date it was issued for income tax purposes (or corporation tax for limited companies). The same applies to bills received from suppliers. (This does not mean you pay income tax immediately, just that it must be included in that year's profit and loss account).
Accumulated Depreciation Account: This is an account held in the nominal ledger which holds the depreciation of a fixed asset until the end of the asset's useful life (either because it has been scrapped or sold). It is credited each year with that year's depreciation, hence the balance increases (ie. accumulates) over a period of time. Each fixed asset will have its own accumulated depreciation account.
Advanced Corporation Tax (ACT - UK only - no longer in use): This is corporation tax paid in advance when a limited company issues a dividend. ACT is then deducted from the total corporation tax due when it has been calculated at year end. ACT was abolished in April 1999. See Corporation Tax.
Amortization: The depreciation (or repayment) of an (usually) intangible asset (eg. loan, mortgage) over a fixed period of time. Example: if a loan of 12,000 is amortized over 1 year with no interest, the monthly payments would be 1000 a month.
Annualize: To convert anything into a yearly figure. Eg. if profits are reported as running at £10k a quarter, then they would be £40k if annualized. If a credit card interest rate was quoted as 1% a month, it would be annualized as 12%.
Appropriation Account: An account in the nominal ledger which shows how the net profits of a business (usually a partnership, limited company or corporation) have been used.
Arrears: Bills which should have been paid. For example, if you have forgotten to pay your last 3 months rent, then you are said to be 3 months in arrears on your rent.
Assets: Assets represent what a business owns or is due. Equipment, vehicles, buildings, creditors, money in the bank, cash are all examples of the assets of a business. Typical breakdown includes 'Fixed assets', 'Current assets' and 'non-current assets'. Fixed refers to equipment, buildings, plant, vehicles etc. Current refers to cash, money in the bank, debtors etc. Non-current refers to any assets which do not easily fit into the previous categories (such as Deferred expenditure).
At cost: The 'at cost' price usually refers to the price originally paid for something, as opposed to, say, the retail price.
Audit: The process of checking every entry in a set of books to make sure they agree with the original paperwork (eg. checking a journal's entries against the original purchase and sales invoices).
Audit Trail: A list of transactions in the order they occurred.
Bad Debts Account: An account in the nominal ledger to record the value of un-recoverable debts from customers. Real bad debts or those that are likely to happen can be deducted as expenses against tax liability (provided they refer specifically to a customer).
Bad Debts Reserve Account: An account used to record an estimate of bad debts for the year (usually as a percentage of sales). This cannot be deducted as an expense against tax liability.
Balance Sheet: A summary of all the accounts of a business. Usually prepared at the end of each financial year. The term 'balance sheet' implies that the combined balances of assets exactly equals the liabilities and equity (aka net worth).
Balancing Charge: When a fixed asset is sold or disposed of, any loss or gain on the asset can be reclaimed against (or added to) any profits for income tax purposes. This is called a balancing charge.
Bankrupt: If an individual or unincorporated company has greater liabilities than it has assets, the person or business can petition for, or be declared by its creditors, bankrupt. In the case of a limited company or corporation in the same position, the term used is insolvent.
Below the line: This term is applied to items within a business which would not normally be associated with the everyday running of a business. See above the line.
Bill: A term typically used to describe a purchase invoice (eg. an invoice from a supplier).
Bought Ledger: See Purchase Ledger.
Burn Rate: The rate at which a company spends its money. Example: if a company had cash reserves of $120m and it was currently spending $10m a month, then you could say that at the current 'burn rate' the company will run out of cash in 1 year.
CAGR: (Compound Annual Growth Rate) The year on year growth rate required to show the change in value (of an investment) from its initial value to its final value. If a $1 investment was worth $1.52 over three years, the CAGR would be 15% [(1 x 1.15) x 1.15 x 1.15]
Called-up Share capital: The value of unpaid (but issued shares) which a company has requested payment for. See Paid-up Share capital .
Capital account: A term usually applied to the owners equity in the business.
Capital Allowances (UK specific): The depreciation on a fixed asset is shown in the Profit and Loss account, but is added back again for income tax purposes. In order to be able to claim the depreciation against any profits the Inland Revenue allow a proportion of the value of fixed assets to be claimed before working out the tax bill. These proportions (usually calculated as a percentage of the value of the fixed assets) are called Capital Allowances.
Capital Assets: See Fixed Assets.
Capital Gains Tax: When a fixed asset is sold at a profit, the profit may be liable to a tax called Capital Gains Tax. Calculating the tax can be a complicated affair (capital gains allowances, adjustments for inflation and different computations depending on the age of the asset are all considerations you will need to take on board).
Cash Accounting: This term describes an accounting method whereby only invoices and bills which have been paid are accounted for. However, for most types of business in the UK, as far as the Inland Revenue are concerned as soon as you issue an invoice (paid or not), it is treated as revenue and must be accounted for. An exception is VAT : Customs & Excise normally require you to account for VAT on an accrual basis, however there is an option called 'Cash Accounting' whereby only paid items are included as far as VAT is concerned (eg. if most of your sales are on credit, you may benefit from this scheme - contact your local Customs & Excise office for the current rules and turnover limits).
Cash Book: A journal where a business's cash sales and purchases are entered. A cash book can also be used to record the transactions of a bank account. The side of the cash book which refers to the cash or bank account can be used as a part of the nominal ledger (rather than posting the entries to cash or bank accounts held directly in the nominal ledger - see 'Three column cash book').
Cash Flow: A report which shows the flow of money in and out of the business over a period of time.
Cash Flow Forecast: A report which estimates the cash flow in the future (usually required by a bank before it will lend you money, or take on your account).
Cash in Hand: See Undeposited funds account .
Charge Back: Refers to a credit card order which has been processed and is subsequently cancelled by the cardholder contacting the credit card company directly (rather than through the seller). This results in the amount being 'charged back' to the seller (often incurs a small penalty or administration fee to the seller).
CIF (Cost, Insurance, Freight [c.i.f.]): A contract (international) for the sale of goods where the seller agrees to supply the goods, pay the insurance, and pay the freight charges until the goods reach the destination (usually a port - rather than the actual buyers address). After that point, the responsibility for the goods passes to the buyer.
Circulating assets: The opposite to Fixed assets . Circulating assets describe those assets that turn from cash to goods and back again (hence the term circulating). Typically, you buy some raw materials, start to manufacture a product (the asset is called work in progress at this point), produce a product (it is now stock), sell it (it is now back to cash again).
Closing the books: A term used to describe the journal entries necessary to close the sales and expense accounts of a business at year end by posting their balances to the profit and loss account, and ultimately to close the profit & loss account too by posting its balance to a capital or other account.
Companies House (UK only): The title given to the government department which collects and stores information supplied by limited companies. A limited company must supply Companies House with a statement of its final accounts every year (eg. trading and profit and loss accounts, and balance sheet).
Compensating error: A double-entry term applied to a mistake which has cancelled out another mistake.
Compound interest: Apply interest on the capital plus all interest accrued to date. Eg. A loan with an annually applied rate of 10% for 1000 over two years would yield a gross total of 1210 at the end of the period (year 1 interest=100, year two interest=110). The same loan with simple interest applied would yield 1200 (interest on both years is 100 per year).
Contra account: An account created to offset another account. Eg: a Sales contra account would be Sales Discounts. They are accounts included in the same section of a set of books, which when compared together, give the net balance. Example: Sales=10,000 Sales Discounts=1,000 therefore Net Sales=9,000. This example, affecting the revenue side of a business, is also referred to as Contra revenue . The tell-tale sign of a contra account is that it has the oposite balance to that expected for an account in that section (in the above example, the Sales Discounts balance would be shown in brackets - eg. it has a debit balance where Sales has a credit balance).
Control Account: An account held in a ledger which summarises the balance of all the accounts in the same or another ledger. Typically each subsidiary ledger will have a control account which will be mirrored by another control account in the nominal ledger (see 'Self-balancing ledgers').
Cook the books: Falsify a set of accounts. See also creative accounting.
Corporation Tax (CT - UK only): The tax paid by a limited company on its profits. At present this is calculated at year end and due within 9 months of that date. From April 1999 Advanced Corporation Tax was abolished and large (UK) companies now pay CT in instalments. Small and medium-sized companies are exempted from the instalment plan.
Cost accounting: An area of management accounting which deals with the costs of a business in terms of enabling the management to manage the business more effectively.
Cost-based pricing: Where a company bases its pricing policy solely on the costs of manufacturing rather than current market conditions.
Cost-benefit: Calculating not only the financial costs of a project, but also the cost of the effects it will have from a social point of view. This is not easy to do since it requires valuations of intangible items like the cost of job losses or the effects on the environment. Genetically modified crops are a good example of where cost-benefits would be calculated - and also impossible to answer with any degree of certainty!
Cost centre: Splitting up your expenses by department. Eg. rather than having one account to handle all power costs for a company, a power account would be opened for each depatrment. You can then analyse which department is using the most power, and hopefully find of way of reducing those costs.
Cost of finished goods: The value (at cost) of newly manufactured goods shown in a business's manufacturing account. The valuation is based on the opening raw materials balance, less direct costs involved in manufacturing, less the closing raw materials balance, and less any other overheads. This balance is subsequently transferred to the trading account.
Cost of Goods Sold (COGS): A formula for working out the direct costs of your stock sold over a particular period. The result represents the gross profit. The formula is: Opening stock + purchases - closing stock.
Cost of Sales: A formula for working out the direct costs of your sales (including stock) over a particular period. The result represents the gross profit. The formula is: Opening stock + purchases + direct expenses - closing stock. Also, see Cost of Goods Sold.
Creative accounting: A questionable! means of making a companies figures appear more (or less) appealing to shareholders etc. An example is 'branding' where the 'value' of a brand name is added to intangible assets which increases shareholders funds (and therefore decreases the gearing). Capitalizing expenses is another method (ie. moving them to the assets section rather than declaring them in the Profit & Loss account).
Credit: A column in a journal or ledger to record the 'From' side of a transaction (eg. if you buy some petrol using a cheque then the money is paid from the bank to the petrol account, you would therefore credit the bank when making the journal entry).
Credit Note: A sales invoice in reverse. A typical example is where you issue an invoice for £100, the customer then returns £25 worth of the goods, so you issue the customer with a credit note to say that you owe the customer £25.
Creditors: A list of suppliers to whom the business owes money.
Creditors (control account): An account in the nominal ledger which contains the overall balance of the Purchase Ledger.
Current Assets: These include money in the bank, petty cash, money received but not yet banked (see 'cash in hand'), money owed to the business by its customers, raw materials for manufacturing, and stock bought for re-sale. They are termed 'current' because they are active accounts. Money flows in and out of them each financial year and we will need frequent reports of their balances if the business is to survive (eg. 'do we need more stock and have we got enough money in the bank to buy it?').
Current cost accounting: The valuing of assets, stock, raw materials etc. at current market value as opposed to its historical cost .
Current Liabilities: These include bank overdrafts, short term loans (less than a year), and what the business owes its suppliers. They are termed 'current' for the same reasons outlined under 'current assets' in the previous paragraph.
Customs and Excise: The government department usually responsible for collecting sales tax (eg. VAT in the UK).
Debenture: This is a type of share issued by a limited company. It is the safest type of share in that it is really a loan to the company and is usually tied to some of the company's assets so should the company fail, the debenture holder will have first call on any assets left after the company has been wound up.
Debit: A column in a journal or ledger to record the 'To' side of a transaction (eg. if you are paying money into your bank account you would debit the bank when making the journal entry).
Debtors: A list of customers who owe money to the business.
Debtors (control account): An account in the nominal ledger which contains the overall balance of the Sales Ledger.
Deferred expenditure: Expenses incurred which do not apply to the current accounting period. Instead, they are debited to a 'Deferred expenditure' account in the non-current assets area of your chart of accounts . When they become current, they can then be transferred to the profit and loss account as normal.
Depreciation: The value of assets usually decreases as time goes by. The amount or percentage it decreases by is called depreciation. This is normally calculated at the end of every accounting period (usually a year) at a typical rate of 25% of its last value. It is shown in both the profit & loss account and balance sheet of a business. See straight-line depreciation .
Dilutive: If a company acquires another and says the deal is 'dilutive to earnings', it means that the resulting P/E (price/earnings) ratio of the acquired company is greater than the acquiring company. Example: Company 'A' has an earnings per share (EPS) of $1. The current share price is $10. This gives a P/E ratio of 10 (current share price is 10 times the EPS). Company 'B' has made a net profit for the year of $20,000. If company 'A' values 'B' at, say, $220,000 (P/E ratio=11 [220,000 valuation/20,000 profit]) then the deal is dilutive because company 'A' is effectively decreasing its EPS (because it now has more shares and it paid more for them in comparison with its own share price). (see Accretive)
Dividends: These are payments to the shareholders of a limited company.
Double-entry book-keeping: A system which accounts for every aspect of a transaction - where it came from and where it went to. This from and to aspect of a transaction (called crediting and debiting) is what the term double-entry means. Modern double-entry was first mentioned by G Cotrugli, then expanded upon by L Paccioli in the 15th century.
Drawings: The money taken out of a business by its owner(s) for personal use. This is entirely different to wages paid to a business's employees or the wages or remuneration of a limited company's directors (see 'Wages').
EBIT: Earnings before interest and tax (profit before any interest or taxes have been deducted).
EBITA: Earnings before interest, tax and amortization (profit before any interest, taxes or amortization have been deducted).
Encumbrance: A liability (eg. a mortgage is an encumbrance on a property). Also, any money set aside (ie. reserved) for any purpose.
Entry: Part of a transaction recorded in a journal or posted to a ledger.
Error of Commission: A double-entry term which means that one or both sides of a double-entry has been posted to the wrong account (but is within the same class of account). Example: Petrol expense posted to Vehicle maintenance expense.
Error of Ommission: A double-entry term which means that a transaction has been ommitted from the books entirely.
Error of Original Entry: A double-entry term which means that a transaction has been entered with the wrong amount.
Error of Principle: A double-entry term which means that one or both sides of a double-entry has been posted to the wrong account (which is also a different class of account). Example: Petrol expense posted to Fixtures and Fittings.
Fiscal year: The term used for a business's accounting year. The period is usually twelve months which can begin during any month of the calendar year (eg. 1st April 2001 to 31st March 2002).
Fixed Assets: These consist of anything which a business owns or buys for use within the business and which still retains a value at year end. They usually consist of major items like land, buildings, equipment and vehicles but can include smaller items like tools. (see Depreciation)
Fixtures & Fittings: This is a class of fixed asset which includes office furniture, filing cabinets, display cases, warehouse shelving and the like.
Flash earnings: A news release issued by a company that shows its latest quarterly results.
Flow of Funds: This is a report which shows how a balance sheet has changed from one period to the next.
FOB: An abbreviation of Free On Board. It generally forms part of an export contract where the seller pays all the costs and insurance of sending the goods to the port of shipment. After that, the buyer then takes full responsibility. If the goods are to travel by train, it's called FOR (Free On Rail).
Freight collect: The buyer pays the shipping costs.
Gearing (AKA: leverage): The comparison of a company's long term fixed interest loans compared to its assets. In general two different methods are used: 1. Balance sheet gearing is calculated by dividing long term loans with the equity (or proprietor's net worth). 2. Profit and Loss gearing: Fixed interest payments for the period divided by the profit for the period.
General Ledger: See Nominal Ledger .
Goodwill: This is an extra value placed on a business if the owner of a business decides it is worth more than the value of its assets. It is usually included where the business is to be sold as a going concern.
Gross loss: The balance of the trading account assuming it has a debit balance.
Gross margin: The difference between the selling price of a product or service and the cost of that product or service often shown as a percentage. Eg. if a product sold for 100 and cost 60 to buy or manufacture, the gross margin would be 40%. Gross margin can also be expressed on a the total revenue and costs of producing that revenue as well as on an item by item basis.
Growth and Acquisition (G & A): Describes a way a company can grow. Growth means expanding through its normal operations, Acquisition means growth through buying up other companies.
Historical Cost: Assets, stock, raw materials etc. can be valued at what they originally cost (which is what the term 'historical cost' means), or what they would cost to replace at today's prices (see Price change accounting).
Impersonal Accounts: These are accounts not held in the name of persons (ie. they do not relate directly to a business's customers and suppliers). There are two types, see Real and Nominal .
Imprest System: A method of topping up petty cash. A fixed sum of petty cash is placed in the petty cash box. When the petty cash balance is nearing zero, it is topped up back to its original level again (known as 'restoring the Imprest').
Income: Money received by a business from its commercial activities. See 'Revenue'.
Inland Revenue: The government department usually responsible for collecting your tax.
Insolvent: A company is insolvent if it has insufficient funds (all of its assets) to pay its debts (all of its liabilities). If a company's liabilities are greater than its assets and it continues to trade, it is not only insolvent, but in the UK, is operating illegally (Insolvency act 1986).
Intangible assets: Assets of a non-physical or financial nature. An asset such as a loan or an endowment policy are good examples. See tangible assets.
Integration Account: See Control Account .
Inventory: A subsidiary ledger which is usually used to record the details of individual items of stock. Inventories can also be used to hold the details of other assets of a business. See Perpetual , Periodic.
Journal Proper: A term used to describe the main or general journal where other journals specific to subsidiary ledgers are also used.
Ledger: A book in which entries posted from the journals are re-organised into accounts.
Leverage: See Gearing.
Liabilities: This includes bank overdrafts, loans taken out for the business and money owed by the business to its suppliers. Liabilities are included on the right hand side of the balance sheet and normally consist of accounts which have a credit balance.
LIFO: Last In First Out. A method of valuing stock.
LILO: Last In Last Out. A method of valuing stock.
Loss: See Net loss .
Management accounting: Accounts and reports are tailor made for the use of the managers and directors of a business (in any form they see fit - there are no rules) as opposed to financial accounts which are prepared for the Inland Revenue and any other parties not directly connected with the business. See Cost accounting.
Manufacturing account: An account used to show what it cost to produce the finished goods made by a manufacturing business.
Matching principle: A method of analysing the sales and expenses which make up those sales to a particular period (eg. if a builder sells a house then the builder will tie in all the raw materials and expenses incurred in building and selling the house to one period - usually in order to see how much profit was made).
Maturity value: The (usually projected) value of an intangible asset on the date it becomes due.
MD & A: Management Discussion and Analysis. Usually seen in a financial report. The information disclosed has deen derived from analysis and discussions held by the management (and is presented usually for the benefit of shareholders).
Memo billing (aka memo invoicing): Goods ordered and invoiced on approval. There is no obligation to buy.
Memorandum accounts: A name for the accounts held in a subsidiary ledger. Eg. the accounts in a sales ledger.
Minority interest: A minority interest represents a minority of shares not held by the holding company of a subsidiary. It means that the subsidiary is not wholly owned by the holding company. The minority shareholdings are shown in the holding company accounts as long term liabilities .
Moving average: A way of smoothing out (i.e. removing the highs and lows) of a series of figures (usually shown as a graph). If you have, say, 12 months of sales figures and you decide on a moving average period of 3 months, you would add three months together, divide that by three and end up with an average for each month of the three month period. You would then plot that single figure in place of the original monthly points on your graph. A moving average is useful for displaying trends. See Normalize .
Multiple-step income statement (aka Multi-step): An income statement (aka Profit and Loss) which has had its revenue section split up into sub-sections in order to give a more detailed view of its sales operations. Example: a company sells services and goods. The statement could show revenue from services and associated costs of those revenues at the start of the revenue section, then show goods sold and cost of goods sold underneath. The two sections totals can then be amalgamted at the end to show overall sales (or gross profit). See Single-step income statement .