GLOSSARY Accounting Equation: A(ssets) = L(iabilities) + OE (Owner s Equity), The formula depicts the relationships of the various elements

of the Balance Sheet to each other. Accounts Payable: A Short-Term Liability (debt) incurred from the purchase of Inventory. Assets: Items of value that are owned by the company and are represented on the Balance Sheet. In order for an item to be shown on the Balance Sheet, it must meet three tests: 1) the company must control it or own it, 2) the item must have some value to the company, and 3) this value must be measurable. Assets are categorized as short-term or long-term items. Balance Sheet: This financial statement is a listing of the Assets (items owned), Liabilities (items owed), and Owner s Equity (what belongs to the owner(s)). The relationships between all these items are represented by the accounting equation. Creditors: Those individuals or companies to which money or other Assets are owed; for example, the supplier from whom Sam purchased the bicycles and to whom she owes an additional $3,000 is a creditor of the company Equity: See Owner s Equity Historical Cost: The amount paid for an item owned by the business (Assets), or the amount incurred in a debt on the date of the agreement to enter into the obligation (Liabilities). Even though over time the values of these Assets and/or Liabilities may change, they will always be shown on the Balance Sheet at their historical cost. Intangible Assets: Those Assets that are of value to a business and

meet all tests of being an Asset, but do not have tangible qualities; for example, trademarks and patents. Inventory: An Asset held by a business for the purpose of resale. In the case of Solana Beach Bicycle Company, Inventory is the bicycles that the company intends to sell. Liabilities: Debts owed by a business. They can either be short-term or long-term depending upon when they become due. Short-Term Liabilities are to be paid within a year. Examples in the bicycle company are the Accounts Payable, and the current portion of the Mortgage Payable. LongTerm Liabilities extend beyond one year. An example in the bicycle company is the portion of the mortgage which is due to be paid beyond the current year. 42 Accounting for Non-Accountants Long-Term Assets: Those items that will be consumed or converted to cash after a period of one year. Examples of these Assets in the bicycle company are the truck, the building, and the land. Owner s Equity: The difference between what is owned and what is owed; in a company, this amount belongs to the owners. The Owner s Equity is made up of the original and additional investments by the owner, plus any profit that is retained in the business, minus any cash or other Assets that are withdrawn or distributed to the owner(s) Retained Earnings: The amount of profit earned by the business since its inception, minus any money that is taken out or distributed to the owner(s). At Solana Beach, this is whatever the company earns in selling bikes, minus whatever Expenses are incurred; for example, electricity, gas

for the truck, mortgage payments, salaries, etc. Short-Term Assets: Those Assets that are cash or will be converted to cash or consumed within a period of one year or less. Examples of these Assets in the bicycle company are Cash, Accounts Receivable, bicycle Inventory, and Prepaid Insurance. Accounts Receivable: This is a term used to describe money that is to be received in the future for current sales of goods or services. Normally, Accounts Receivable appears on the Balance Sheet as a Short-Term Asset since companies generally give credit to customers for thirty to sixty days. Accrual Basis of Accounting: This accounting method recognizes transactions when Revenue is earned, Expenses are incurred, and purchases take place whether or not cash changes hands at that moment. This is the method of accounting used by virtue of Generally Accepted Accounting Principle, and most businesses use this rather than the alternative, the cash basis of accounting. Bad Debt Expense: This Expense appears on the Income Statement and is increased by the amount of the receivables that will not be collected (that is, debts owed to the company that will not be paid). When this Expense is created, a contra-Asset to Accounts receivable is also created called Allowance for Bad Debts. This contra-Asset reduces the Accounts Receivable account on the Balance Sheet and keeps the two sides of the Balance Sheet in balance. Bottom Line: Another term used for Net Income, it represents all Expenses subtracted from all Revenues. This figure gets it name from the

fact that it appears at the bottom of the Income Statement. Cash Basis of Accounting: This accounting method only recognizes Revenue and Expenses when cash is exchanged. If the sale or Expense takes place in one period without cash changing hands, because of receivables and payables, the Revenue and the Expenses are not recognized until a future period. For this reason, the cash basis of accounting is typically not used for business according to GAAP, but is the method generally used in personal accounting. Cost of Goods Sold: The cost of all the Inventory that was sold during the period stated in the Income Statement. Cost of goods sold is an Expense and is subtracted from Revenue to arrive at Gross Profit. Expenditures: The spending of cash. All Expenses are expenditures; however, all expenditures are not Expenses. Only expenditures that immediately generate Revenue are considered Expenses. When expenditures are made for items that have future benefits, they are classified as Assets and converted to Expenses as they are used up. Expenses: Expenses are expenditures made to generate Revenue. Whether or not cash changes hands, a company incurs an Expense as soon as it makes a commitment to pay for a product or service. Gross Profit: The difference between Revenue and Cost of Goods Sold before operating Expenses, interest, and taxes are subtracted. A good analysis for the owner of a company is to compare Gross Profit from one year to another and determine whether it is increasing or decreasing and why. Income Statement: This financial statement is a listing of all Revenues

and Expenses of the business earned or incurred during a particular period of time. The Income Statement is usually produced by a company monthly, quarterly, or annually. It is one of the three major statements produced by businesses in the United States, the other two being the Balance Sheet and the Statement of Cash Flows. Net Income: The difference between Revenue and Expenses for a designated period of time. In the case of Solana Beach Bicycle Company, we saw three uses of the term Net Income. The first, Net Income from operations, shows all normal Revenue and Expenses that deal with the main operations of this business selling bicycles. The second usage was Net Income before taxes, where Net Income from operations is increased and reduced by other Revenue and Expenses that are outside the normal operations of this business like repairing bicycles. The third usage was Net Income. This is what is referred to as the bottom line since it appears at the bottom of the Income Statement. It is derived by reducing Net Income before taxes, by the amount of Income Taxes for the year. Other Revenues and Expenses: Those items that are derived from transactions that are not the main business of the company and that are listed on the Income Statement under Other Revenues and Expenses. In the case of Solana Beach, sales of bicycles is the main business; repairs are not the shop s main business and are listed under Other Revenues and Expenses. Recognize: This term refers to the recording of the Revenues and Expenses in the records of the company. This occurs at the point in time

when Revenue and Expenses are shown on the Income Statement. Revenues are recognized when services are performed or when title is transferred on goods sold. Expenses are recognized when they are incurred and become an obligation of the company. Revenue: The amount earned by a business by selling goods or performing services is termed Revenue. In the case of the Solana Beach Bicycle Company, Revenue represents the earnings in from the selling of bicycles as well as the repair of bicycles. Since the main business of the company is to sell bicycles, the Revenue that is earned from the repairs is shown as other income.

Revenues Fees earned from providing services and the amounts of merchandise sold. Under the accrual basis of accounting, revenues are recorded at the time of delivering the service or the merchandise, even if cash is not received at the time of delivery. Often the term income is used instead of revenues. Examples of revenue accounts include: Sales, Service Revenues, Fees Earned, Interest Revenue, Interest Income. Revenue accounts are credited when services are performed/billed and therefore will usually have credit balances. At the time that a revenue account is credited, the account debited might be Cash, Accounts Receivable, or Unearned Revenue depending if cash was received at the time of the service, if the customer was billed at the time of the service and will pay later, or if the customer had paid in advance of the service being performed. If the revenues earned are a main activity of the business, they are considered to be operating revenues. If the revenues come from a secondary activity, they are considered to be nonoperating revenues. For example, interest earned by a manufacturer on its investments is a nonoperating revenue. Interest earned by a bank is considered to be part of operating revenues.

expenses Costs that are matched with revenues on the income statement. For example, Cost of Goods Sold is an expense caused by Sales. Insurance Expense, Wages Expense, Advertising Expense, Interest Expense are expenses matched with the period of time in the heading of the income statement. Under the accrual basis of accounting, the matching is NOT based on the date that the expenses are paid. Expenses associated with the main activity of the business are referred to as operating expenses. Expenses associated with a peripheral activity are nonoperating or other expenses. For example, a retailer's interest expense is a nonoperating expense. A bank's interest expense is an operating expense. Generally, expenses are debited to a specific expense account and the normal balance of an expense account is a debit balance. When an expense account is debited, the account credited might be Cash (if cash was paid at the time of the expense), Accounts Payable (if cash will be paid after the expense is recorded), or Prepaid Expense (if cash was paid before the expense was recorded.)
accounts payable This current liability account will show the amount a company owes for items or services purchased on credit and for which there was not a promissory note. This account is often referred to as trade payables (as opposed to notes payable, interest payable, etc , A current asset resulting from selling goods or services on credit (on account). Invoice terms such as (a) net 30 days or (b) 2/10, n/30 signify that a sale was made on account and was not a cash sale.