Glossary: Completing the Accounting Cycle


Accounting cycle Series of steps performed during the accounting period to analyze, record, classify, summarize, and report useful financial information for the purpose of preparing financial statements. The steps include analyzing transactions, journalizing transactions, posting journal entries, taking a trial balance and completing the work sheet, preparing financial statements, journalizing and posting adjusting entries, journalizing and posting closing entries, and taking a post-closing trial balance.

Accounting period A time period normally of one month, one quarter, or one year into which an entity’s life is arbitrarily divided for financial reporting purposes.

Accounting year An accounting period of one year. The accounting year may or may not coincide with the calendar year.

Accounts payable Amounts owed to suppliers for goods or services purchased on credit.

Accounts receivable Amounts due from customers for services performed or merchandise sold on credit.

Accrual basis of accounting Recognizes revenues when sales are made or services are performed, regardless of when cash is received. Recognizes expenses as incurred, whether or not cash has been paid out.

Accrued assets and liabilities Assets and liabilities that exist at the end of an accounting period but have not yet been recorded; they represent rights to receive, or obligations to make, payments that are not legally due at the balance sheet date. Examples are accrued fees receivable and salaries payable.

Accrued items Adjusting entries relating to activity on which no data have been previously recorded in the accounts. Also, see accrued assets and liabilities.

Accrued revenues and expenses Other names for accrued assets and liabilities.

Accumulated depreciation account A contra asset account that shows the total of all depreciation recorded on the asset up through the balance sheet date.

Adjusting entries Journal entries made at the end of an accounting period to bring about a proper matching of revenues and expenses; they reflect economic activity that has taken place but has not yet been recorded. Adjusting entries are made to bring the accounts to their proper balances before financial statements are prepared.

Book value For depreciable assets, book value equals cost less accumulated depreciation.

Calendar year The normal year, which ends on December 31.

Cash Includes deposits in banks available for current operations at the balance sheet date plus cash on hand consisting of currency, undeposited checks, drafts, and money orders.

Cash basis of accounting Recognizes revenues when cash is received and recognizes expenses when cash is paid out.

Classified balance sheet Subdivides the three major balance sheet categories (assets, liabilities, and stockholders’ equity) to provide more information for users of financial statements. Assets may be divided into current assets; long-term investments; property, plant, and equipment; and intangible assets. Liabilities may be divided into current liabilities and long-term liabilities.

Closing process The act of transferring the balances in the revenue and expense accounts to a clearing account called Income Summary and then to the Retained Earnings account. The balance in the Dividends account is also transferred to the Retained Earnings account.

Contra asset account An account shown as a deduction from the asset to which it relates in the balance sheet; used to reduce the original cost of the asset down to its remaining undepreciated cost or book value.

Current assets Cash and other assets that a business can convert into cash or use up in one year or one operating cycle, whichever is longer.

Deferred items Adjusting entries involving data previously recorded in the accounts. Data are transferred from asset and liability accounts to expense and revenue accounts. Examples are prepaid expenses, depreciation, and unearned revenues.

Depreciable amount The difference between an asset’s cost and its estimated residual value.

Depreciable asset A manufactured asset such as a building, machine, vehicle, or equipment on which depreciation expense is recorded.

Depreciation accounting The process of recording depreciation expense.

Depreciation expense The amount of asset cost assigned as an expense to a particular time period.

Depreciation formula (straight-line):

Dividends payable Amounts declared payable to stockholders and that represent a distribution of income.

Estimated residual value (scrap value) The amount that the company can probably sell the asset for at the end of its estimated useful life.

Estimated useful life The estimated time periods that a company can make use of the asset.

Fiscal year An accounting year of any 12 consecutive months that may or may not coincide with the calendar year. For example, a company may have an accounting, or fiscal, year that runs from April 1 of one year to March 31 of the next.

Income Summary account A clearing account used only at the end of an accounting period to summarize revenues and expenses for the period.

Interest payable Interest that has accumulated on debts, such as notes or bonds. This accrued interest has not been paid at the balance sheet date because it is not due until later.

Interest receivable Arises when interest has been earned but not collected at the balance sheet date.

Matching principle An accounting principle requiring that expenses incurred in producing revenues be deducted from the revenues they generated during the accounting period.

Merchandise inventory Goods held for sale.

Notes payable Unconditional written promises by a company to pay a specific sum of money at a certain future date.

Post-closing trial balance A trial balance taken after the closing entries have been posted.

Prepaid expense An asset awaiting assignment to expense. An example is prepaid insurance. Assets such as cash and accounts receivable are not prepaid expenses.

Property, plant, and equipment Assets with useful lives of more than one year that a company acquired for use in a business rather than for resale; also called plant assets or fixed assets.

Retained earnings Shows the cumulative income of the company less the amounts distributed to the owners in the form of dividends.

Salaries payable Amounts owed to employees for services rendered.

Sales taxes payable Are taxes a company has collected from customers but has not remitted to the taxing authority, usually the state.

Service potential The benefits that can be obtained from assets. The future services that assets can render make assets “things of value” to a business.

Stockholdersequity Shows the owners’ interest (equity) in the business.

Trend percentages Calculated by dividing the amount of an item for each year by the amount of that item for the base year.

Unclassified balance sheet A balance sheet showing only three major categories: assets, liabilities, and stockholders’ equity.

Unearned revenues (revenues received in advance) Result when payment is received for goods or services before revenue has been earned.

Work sheet A columnar sheet of paper on which accountants have summarized information needed to make the adjusting and closing entries and to prepare the financial statements.