Glossary of CPA Terms

ACCELERATED DEPRECIATION: A depreciation method which allows faster write-offs than the straight line method. These methods provide a greater tax shield effect than straight line depreciation, so companies with large tax burdens might use accelerated depreciation methods, even if it reduces the income shown on the financial statement. Accelerated depreciation methods are popular for writing off equipment that might be replaced before the end of its useful life, having become obsolete (e.g., computers).

ACCRUAL BASIS ACCOUNTING: The most commonly used accounting method, which reports income when earned and expenses when incurred, as opposed to cash basis accounting which reports income when received and expenses when paid. Under the accrual method. companies do have some discretion as to when income and expenses are recognized, but there are rules governing the recognition. Additionally, companies are required to make prudent estimates against revenues that are recorded but may not be received, called a bad debt expense.

ACCUMULATED DEPRECIATION: The depreciation that has taken place on a particular asset up to the present time.

ADJUSTED BOOK VALUE: The book value on a company’s balance sheet after assets and liabilities are adjusted to market value. Also called modified book value.

AMORTIZATION: Definition 1: The gradual elimination of a liability, such as a mortgage, in regular payments over a specified period of time. Such payments must be sufficient to cover both principal and interest.

Definition 2: Writing off an intangible asset investment over the projected life of the assets.

AUDITED FINANCIAL STATEMENTS: A company’s financial statements which have been prepared and certified by a CPA (the auditor). In the U.S., the auditor certifies that the financial statements meet the requirements of the U.S. G.A.A.P. (see definition under G.A.A.P.). An auditor can have an unqualified opinion in which he agrees with how the company prepared the statements, or a qualified opinion in which he states which aspects of the company’s statements he does not agree with. In extreme cases, the auditor may express no opinion on financial statements at all, in the event that the scope of the audit was insufficient.

AUDITOR’S REPORT: A section of an annual report containing an accountant’s opinion regarding the accuracy of its financial statements.

BOOK INVENTORY: What stock on hand should be according to the accounting records. There might be small discrepancies between book inventory and actual stock on hand, especially in larger companies when it is difficult to keep a very precise record of stock on hand.

BURN RATE: For a company with negative cash flow, the rate of that negative cash flow, usually per month. Often used by venture capitalists to measure how much time a startup company has to reach positive cash flow before they run out of money or require additional funding.

COMPILATION: Presentation of financial statement information by the entity without the accountant’s assurance as to conformity with G.A.A.P. (see definition). The accountant should understand the client’s accounting records, form and content of financial statements as well as personnel qualifications. The accountant is not gathering evidence and does not verify client information provided. Rather, the CPA reads the compiled statements to assure that they are in appropriate form and without obvious material errors. The accountant does not express an opinion on the financial statements, nor does he or she give any other form of assurance on them. In the case where management omits needed disclosures, the CPA should state so in the report.

COMPOUND ANNUAL GROWTH RATE CAGR: The year over year growth rate applied to an investment or other part of a company’s activities over a multiple-year period.

COST ACCOUNTING: The process of identifying and evaluating production costs.

DEFERRED REVENUE: Revenue that is considered a liability until it becomes relevant to the business at hand, such as payment received for work that has not yet been performed. The opposite of deferred charge.

DEFERRED TAX: A liability that results from income that has already been earned for accounting purposes, but not for tax purposes.

EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION AND AMORTIZATION: EBITDA. An approximate measure of a company’s operating cash flow based on data from the company’s income statements. Calculated by looking at earnings before the deduction of interest, expenses, taxes, depreciation and amortization. This earnings measure is of particular interest in cases where companies have large amounts of fixed assets which are subject to heavy depreciation charges (such as manufacturing companies) or where a company has a large amount of acquired intangible assets on its books and is thus subject to large amortization charges (such as a company that has purchased a brand or a company that has recently made a large acquisition). Since the distortionary accounting and financing effects on company earnings do not factor into EBITDA, it is a good way of comparing companies within and across industries. This measure is also of interest to a company’s creditors, since EBITDA is essentially the income that a company has free for interest payments. In general EBITDA is a useful measure only for large companies with significant assets and/or for companies with a significant amount of debt financing. It is rarely a useful measure for evaluating a small company with no significant loans. Sometimes also called operational cash flow.

FINANCIAL ACCOUNTING STANDARDS BOARD: FASB. Independent agency which establishes GAAP (see definition).

FIXED ASSET: A long-term, tangible asset held for business use and not expected to be converted to cash in the current or upcoming fiscal year, such as manufacturing equipment, real estate and furniture. Also called plant.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES. GAAP. A widely accepted set of rules, conventions, standards and procedures for reporting financial information, as established by the Financial Accounting Standards Board (see definition – FASB).

NET WORTH: Definition 1. For a company, total assets minus total liabilities. Net worth is an important determinant of the value of a company, considering it is composed primarily of all the money that has been invested since its inception, as well as the retained earnings for the duration of its operation. Net worth can be used to determine creditworthiness because it gives a snapshot of the company’s investment history. Also called owner’s equity, shareholders’ equity, or net assets.

Definition 2. For an individual, the value of a person’s assets, including cash minus all liabilities. The amount by which the individual’s assets exceed their liabilities is considered the net worth of that person.

PROFIT AND LOSS STATEMENT: An official quarterly or annual financial document published by a public company, showing earnings, expenses and net profit. Net income is determined from this financial report by subtracting total expenses from total revenue. The profit and loss statements and the balance sheet are the two major financial reports that every public company publishes. The difference between this statement and the balance sheet deals with the periods of time that each one represents. The profit and loss statement shows transactions over a given period of time (usually quarterly or annually), whereas the balance sheet gives a snapshot of holdings on a specific date. Also called income statement or earnings report.

RETURN ON ASSETS (ROA): A measure of a company’s profitability, equal to a fiscal year’s earnings, divided by its total assets, expressed as a percentage.

RETURN ON CAPITAL (ROC): A measure of how effectively a company uses the money (borrowed or owned) invested in its operations. Return on Invested Capital is equal to the following: net operating income after taxes/[total assets minus cash and investments (except in strategic alliances) minus non-interest-bearing liabilities]. If the Return on Invested Capital of a company exceeds its WACC [Weighted Average Cost of Capital], then the company created value. If the Return on Invested Capital is less than the WACC, then the company destroyed value.

RETURN ON EQUITY (ROE): A measure of how well a company used reinvested earnings to generate additional earnings, equal to a fiscal year’s after-tax income (after preferred stock dividends, but before common stock dividends) divided by book value, expressed as a percentage. It is used as a general indication of the company’s efficiency. In other words, how much profit it is able to generate given the resources provided by its stockholders. Investors usually look for companies with returns on equity that are high and growing.

REVIEW: Accounting service providing some assurance to the Board of Directors and interested parties, as to the reliability of financial data without the CPA conducting an examination in accordance with generally accepted auditing standards. A limited review consists primarily of inquiry and ANALYTICAL REVIEW. It is not an audit, nor does it furnish a basis for an opinion since there is no appraisal of internal control nor gathering of audit evidence.

SEC FILING: A document, usually containing financial data that a company delivers to the SEC and, thereby, to the public.