Accounting Study Guide



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Beginning your Journey into Accounting


A career in accounting encompasses much more than reviewing and preparing financial information. Becoming an accounting professional means that you will be responsible for ensuring organizations of all sizes are meeting the requirements and standards set by the government, whether it be in the United States or another international locale, and their industries. Accuracy in accounting systems are integral to making business decisions, compiling financial data like financial statements, bookkeeping for small businesses, keeping track of cash flow, putting together balance sheets, completing tax returns, and so much more. When an organization follows a country’s generally accepted accounting principles, they are ensuring they are remaining in compliance with accounting standards and maintaining their integrity with the IRS and in their business community.

One of the most popular accounting careers that has consistently remained in-demand in the job market is the Certified Public Accountant profession. Becoming a Certified Public accountant, more commonly known as a CPA, means you will be joining the ranks of some of the most well-respected accounting professionals in the industry. By obtaining your CPA license, you will not only have the opportunity to ensure an organization’s financials are accurate and abide by government and industry guidelines, but the dedication that getting your CPA license takes also indicates your tenacity and strong work ethic to future employers.

For those of you who are ready to embark on a career in certified public accounting, or for those who are looking for more information on getting the CPA credential, we created this comprehensive study guide to aid you on your journey. In this study guide, you’ll find the following sections:




Study for the CPA Exam



There are a number of details to consider when embarking on your CPA Exam study journey. Studying for the CPA Exam can be a daunting task – but it doesn’t have to be. Our proprietary software, paired with all the additional resources we’ve compiled will help get you started on your journey toward becoming a CPA.

First and foremost, it’s very important to figure out when you’re going to sit for your first exam section. This will impact the amount of time you will be able to set aside for study time amidst the rest of your responsibilities. With Surgent CPA Review, you can input your anticipated exam date, then our software adjusts your study plan to this date ensuring you’re studying your weakest knowledge points to an ample degree during that timeframe.

While our software does the legwork in adapting your study plan based on your knowledge gaps, you will still need to create a study strategy for yourself to stay on track. Once you have that rough estimate for when you’re going to take your exam, creating a study strategy will help you ensure you’re setting aside the proper amount of study time for each CPA Exam section before you have to sit for the exam.

Finally, we break down the details of each CPA Exam section so you can gain a better understanding of what exactly to expect from your CPA Exam. Establishing an Exam date, plus knowledge of each CPA Exam section, along with our CPA Review software which includes the most up-to-date study materials out there, will help set you up for success throughout your study journey as a CPA candidate.




Study Plan Tips


1. FAR Study Tips

FAR is often regarding as one of the harder CPA Exams (although it does depend on who you ask), but by following these 3 tips, you can make your FAR section experience much easier.

Tip 1: Take FAR As Soon As Possible – Most of the information on the FAR CPA Exam you learned in your Sophomore and Junior year during your Intermediate Financial Accounting courses. To maximize on your memory, you should consider taking FAR as soon as possible after you graduate. You’ll likely still remember most of the concepts you learned during your Intermediate Accounting courses, and you’ll be able to easily recall this information as you study. FAR also intersects all three other sections, so learning material from FAR will translate as you start to study for any of the other three exams.

Tip 2: Become an Excel Expert – The spreadsheet tool on the CPA exam isn’t like Microsoft Excel, it is Microsoft Excel. By learning a few simple tricks, like how to create and execute functions and how to navigate easily within the spreadsheet, you can use the tool to your advantage on both multiple choice and task-based simulation questions. Want a helping hand? Surgent offers an Excel course specifically for the CPA Exam.

Tip 3: Spend More Time on Governmental, NGO and Non-Profit Accounting – Not everyone will have taken a specific governmental or non-profit accounting class in college; it’s usually just lumped in with intermediate accounting. If you didn’t take a specific class in college on governmental, NGO and Non-Profit accounting, spend some significant time going over these topics. They make up a larger portion of the exam now than they did in the past, and having a firm understanding of how they function and how they differ from For-Profit companies will help you ace any questions you come across.



Read our full FAR Section Study Guide here!




2. AUD Study Tips

The AUD Exam covers a lot of information regarding auditing and attestation engagements. If you’re considering sitting for AUD in the near future, use these 3 tips to make your experience smoother.

Tip 1: Consider Taking AUD – The content in AUD and FAR build off each other, and there is considerable overlap in the material. You may get questions on AUD that relate to FAR material, and there is a possibility the simulations will ask similar questions to those on FAR. By taking AUD right after FAR, you may reduce your study time since some of the material may be familiar from studying FAR.

Tip 2: Know Your Reconciliations and Journal Entries – Like we said, AUD has material overlap with FAR. Part of an auditor’s job is to reconcile accounts and make sure they add up. Another part of his or her job is to suggest adjusting journal entries to fix any misstatements. Expect to see both topics on the exam, and make sure you’re prepared to think critically to answer the questions.

Tip 3: Take AUD After Some Experience (If Possible) – AUD candidates have likely taken an auditing class in college, but especially with the AUD Exam, most of the learning happens with actual experience. If you’re planning on going into the auditing profession, consider taking the AUD Exam after you’ve worked in the field for a few months. Even better, wait until you’ve had a busy season and then take the exam. This might mean saving the AUD Exam for last, but the content is much easier to grasp after some experience.

If you’re not going into an auditing position or want to pass the exam before working, no worries; Surgent’s exam materials are comprehensive and will help you learn everything you need to know to pass the exam.



Read our full AUD Study Guide here!




3. BEC Study Tips

Many of the concepts on BEC you’ll see on other exams, and vice versa, but it does dig much more into the business side of the profession. If you’re looking to take BEC soon, check out these 3 tips to help you pass with flying colors.

Tip 1: Brush Up on Your Writing Skills – Since 15% of your score is directly related to the written communication tasks, you need to be able to write well. This means correct spelling, grammar, and punctuation, as well as the ability to set a business tone and articulate a point. Spend some time on written communication tasks and have friends, family or co-workers look through them and give you feedback.

Tip 2: Allocate Your Time Based on Your Writing Skills – Some people can jot down essays as quickly as they can think, and some people like to take a little more time. Consider what kind of writer you are and take some time to see how long it will take you to answer three written communication tasks. Since they are at the end of the exam, you want to leave plenty of time to finish them.

Tip 3: Use BEC As a Bookend Exam – BEC covers material from all other exams. To make the most of this, you can take BEC at the beginning and know some material going into the other exams, or you can take it last and study less since you’ll have a grasp of a variety of BEC concepts presented on other exams.



Read our full BEC Study Guide here!




4. REG Study Tips

REG is very tax heavy, which can sometimes be difficult for candidates who struggle with taxation. To help you put your best foot forward on REG, follow these 4 REG CPA Exam tips.

Tip 1: Take REG Based on Your Strengths – Your 18-month window for passing the CPA Exam starts when you take your first exam. The study time before that first exam doesn’t count toward your 18 months. Therefore, to maximize your chances of passing all four parts of the CPA Exam in 18 months, it makes sense to take the exam you expect to study the most on first. If you’re strong in tax, or work as a tax accountant, it would be a good idea to save REG for your last exam, because it won’t require as much studying. If you aren’t great at tax, it might be a good idea to take REG after FAR, since there is a fair amount of overlap in concepts.

Tip 2: Become an Excel Expert – The spreadsheet tool on the CPA Exam isn’t like Microsoft Excel, it is Microsoft Excel. By learning a few simple tricks, like how to create and execute functions and how to navigate easily within the spreadsheet, you can use the tool to your advantage on both multiple-choice and task-based simulation questions. Want a helping hand? Surgent offers an Excel course specifically for the CPA Exam.

Tip 3: Get Familiar with REG Sims – Take your time going through Regulation simulations and practice exams, and really get a feel for what tax questions are asking. If you don’t have any tax experience or took only one tax class in college, it’s really importation you are both familiar with the concepts and can apply them in a simulation setting. It’s a great place to get partial points also, so make sure you’re at least guessing at an answer.

Tip 4: Spend More Time on Federal Taxation Procedures – Between 55% and 85% of your exam is going to be based on Federal Tax Procedures of property transactions, individuals and entities. You want to make sure you’re taking this into account while you’re studying. These are the areas you should take the time to dig into and understand. Make sure you also have a good understanding of Business Law and Ethics, Professional Responsibilities and Federal Tax Procedures, but spend most of your time on Federal Tax Procedures.



Read the full REG Study Guide here




3 Tips for All CPA Exam Sections:3 Tips for All CPA Exam Sections:

  1. Make Sure Your Study Materials are Up to Date – With constant updates relative to new tax laws; each exam section is periodically updated to reflect new laws and changing federal mandates. If you’re planning on sitting for any of the exam sections in the future, you need to make sure your materials reflect these changes. At Surgent, we provide free updates to exam content and unlimited access until you pass; you won’t have to buy new materials or study with old materials.
  2. Take Practice Exams – Taking practice exams helps you to learn to allocate your time as you familiarize yourself with the styles of questions you see, figure out the amount of work needed per question, and become accustomed to the type of work necessary to answer each question. It’s integral for you to know when it’s time to move on from questions, when you need to guess, and where you need to spend more time.
  3. Find Study Materials that Help You Study More Efficiently – Candidates are often told there is a certain hour threshold that must be met before an exam can be passed. However, not everyone learns the same, and candidates often waste time trying to attain a certain number of study hours even if they’re completely ready to sit for the exam. To study more efficiently, look for a CPA Review course that is adaptive and can help you efficiently learn difficult topics. Surgent’s learning materials feature A.S.A.P. Technology, which helps students pass in half the time, and ReadySCORE which helps candidates objectively know when they’re ready to sit for the CPA Exam.




Interested in an all-encompassing study guide that covers each CPA Exam section? Download our comprehensive, exclusive study plan here.




Frequently Asked Questions



  1. How can I pass the CPA exam while working full time?
    • It seems like it’s impossible, but you can absolutely pass the CPA Exam while working full timeIf you don’t believe us, take it from one of our former Surgent CPA Exam Review students, Bill. Bill McClain works full time, cares for his family, and used Surgent CPA Review to both save time studying and pass on his first try. Watch his video testimonial here.
  2. Can I study for the CPA Exam and pass the first time?
    • You can absolutely pass the CPA Exam on your first try if you study with Surgent CPA Review. National CPA Exam pass rates have averaged around  50% over the past 3 years, but students who have used Surgent consistently passed 88% of the time. Other CPA Exam Review courses take as much as 200 hours to complete one section, while our students are ready to pass with 46 hours of study, on average. Our proprietary A.S.A.P™ Technology software’s real-time algorithm follows your study habits and adapts to your knowledge level, then focuses your study plan on the concepts you’re less familiar with.
  3. What is the best CPA Exam Prep Course and why?
    • We’ve put a ton of time and resources into gathering up all the information regarding exactly how our proprietary software has helped our Surgent CPA Review students successfully pass their CPA Exam sections using our software. Read all about how much time and effort we’ve saved so many by checking out our measurable results page. If you’re wondering how we stack up against our competitors, we’ve covered that, too. Finally, check out some testimonials from our former students to hear what they have to say about how we’ve helped them pass their CPA Exams once and for all.
  4. Why is FAR the hardest, and how can I pass? 
    •  Some people say the FAR section of the CPA Exam is the hardest, but it doesn’t have to be. Many people feel it’s difficult because this exam section covers a wider variety of material than the other CPA Exam sections do. If you study with our CPA Review, you’ll need about 54 hours of study time to be able to pass this section on your first try.
  5. Where can I take the Uniform CPA Examination?
    • You can take the Exam at authorized Prometric test centers throughout the 55 U.S. jurisdictions as well as select international locations.
  6. Is the CPA Exam offered in multiple languages?
    • Currently, the CPA Exam is only being offered in English.
  7. Can I take the Exam on paper?
    • No. This is a computer-based Exam.
  8. How much time will I need to devote to studying for the CPA Exam?
    • Some resources suggest studying 15-20 hours per week, some suggest more – but you can pass an exam section with about 46 hours of studying with Surgent CPA Review. Learn more about our course today.
  9. Will there be breaks during the Exam?
    • There will be a 15-minute break at the midway point of each section (after roughly two hours). You can choose to accept and it will not count against your total four-hour time limit. You will also be offered breaks between the other testlets, but the clock will not stop.
  10. How is the CPA Exam structured?
    • As a CPA candidate, you can expect a variety of exam content (which is why it’s very important to choose a thorough and up-to-date CPA Review course). There are four sections test-takers will see on the Uniform CPA Examination:
      • Auditing and Attestation (AUD)
      • Business Environment and Concepts (BEC)
      • Financial Accounting and Reporting (FAR)
      • Regulation (REG)

You have a maximum of four and a half hours to complete the CPA Exam, which is comprised of the following timeframes:

      • 5 minutes — Welcome/enter launch code
      • 5 minutes — Confidentiality/section information
      • 4 hours — Testing time
      • 15 minutes — Break after third testlet (option to pause Exam timer)
      • 5 minutes — Survey

Each of the four CPA Exam sections is broken down into five smaller sections called testlets. These testlets feature multiple-choice questions (MCQs) and task-based simulations (TBSs). In the case of BEC, you also have to complete three written communication tasks. The number of MCQs and TBSs tested varies depending upon the specific section of the CPA Exam you’re taking.

Certain sections of the exam may take you more time than others; be mindful of the timeframes listed above to make sure you have plenty of time to finish.






Accounting Term Glossary

A   B   C   D   E   F   G   H   I   J   K   L   M  N  O  P  W  123

CPA Exam Terms




Acceptance in accounting is the agreement of the offeree to the proposal (the original offer) of the offeror. It may be either oral or written and must conform to all the terms of the offer (“mirror image rule”) (U.C.C. 2-207). Acceptance provides an exception for nonmaterial contract terms between merchants, sometimes involving many different terms and oftentimes incorporating additional terms sometimes by way of a counteroffer. Terms of acceptance are typically part of the contract rules but may result from new terms or a prior breach of contract.

Any reply to an offer that adds qualifications or conditions or changes the terms of the offer is not an offer and acceptance but is actually a rejection and a counteroffer. Silence rarely constitutes acceptance.

In the common law, on the other hand, if the offeree uses an appropriate mode of communication, an acceptance can be effective on dispatch unless the offeror stipulated the contrary in the offer. This is also known as the common law rule and is a general rule widely accepted within the law of contracts.

Acceptance of an offer is effective on dispatch by a reasonable means of communication—usually the same method used by the offeror—i.e., it is effective as soon as it is put out of the offeree’s possession.

Example: The “mailbox” rule states that the acceptance is effective as soon as it is dropped in the mailbox (the postal service acts as an agent).



also known as: Accord and Satisfaction

An accord is a new agreement, or an original contract, between parties to permit some different performance, adjustment for an amount of the claim, or otherwise to allow full satisfaction of the claim, full payment, or to replace the original promised performance. Accord alone does not discharge (end) the contractual obligation but it does help to prevent a bona fide dispute; accord and satisfaction (carrying out the accord) discharges the obligation. An accord usually refers to the settlement of a disputed contract in contract law.

Regardless of the subject matter of the new contract or agreement, an accord – otherwise known as an accord and satisfaction – is put in place when one cannot rely on good faith alone to revise an old contract or ensure their terms will be met in full satisfaction. When an accord agreement  – or an accord contract – is fulfilled, including all pertinent accompanying written communication and terms of the accord, it provides a conspicuous statement that both parties have a direct responsibility to adhere to the disputed obligation in question within a reasonable time.



Accountability is the obligation to explain one’s actions or to justify what one does. Outside of accounting, the definition of accountability could pertain to a variety of areas including good governance, civil society,  corporate accountability, defining a culture of accountability within an organization, identifying accountability mechanisms based on stakeholder engagements, and much more; levels of accountability are dictated by the context of the respective group or organization.

Within accounting, accountability is one of the primary objectives of financial reporting. It is information about how management discharged its stewardship responsibility to owners or to the citizenry regarding the use of resources entrusted to it. “Accountability requires governments to answer to the citizenry—to justify the raising of public resources and the purposes for which they are used.” (GASBCS 1.56)

In governmental accounting, financial accountability can include accountability of one entity for another, as when a primary government reports for component units for which it is financially accountable because either:

the other entity is fiscally dependent on the reporting government or

the reporting government either:

appointed the voting majority of the governing body or

created and has the power to unilaterally abolish another entity and that it also either:

      • can impose its will upon or
      • has a financial benefit or burden relationship with.


Accounting Method

An item of income or expense is included in the taxable year as determined by a taxpayer’s accounting method. The two primary accounting methods are the cash method and the accrual method. Under the cash method, income is included in the year it is either actually or constructively received and expense is recorded in the year it is paid. Under the accrual method, income and expense are included in the year when the right to the income or the liability for an expense becomes fixed, the amount can be determined with reasonable accuracy, and economic performance has occurred.

IRC Section 172


Accounting Period

A basic assumption of accounting is that measurements are made and reports prepared for a specific time period, FASB Concepts Statement 8 indicates that useful financial information reports an entity’s resources and claims and their changes for a specific time period. For taxation, an accounting period is the time a taxpayer uses to determine income, deductions, and tax liability. The accounting period for a taxpayer is normally a calendar year (ends December 31), a fiscal year (ends the last day of any month except December), or a 52–53 week year (ends on the same day of the week each year).

IRC Sections 441 and 443


Accounts Receivable

also known as: Trade Receivables

Accounts receivable are amounts the entity is entitled to receive that arise in the normal course of business (e.g., from the credit sales of goods or services). Receivables are claims against others for money, goods, or services, usually on “open” accounts after credit approval is granted. There is no formal written agreement, and they are usually classified as current assets. Normally, accounts receivable are expected to be received within 30 to 90 days. Accounts receivable are contrasted with notes receivable, which are of a longer term (e.g., 3 to 24 months) and accrue interest at a stated rate. Nontrade receivables are those that arise outside of the normal course of business (e.g., loans to employees or receivables from affiliated entities) and may be recorded net or gross. They are reported at net realizable value (i.e., the amount expected to be collected) and are offset by a valuation allowance account (a contra asset account).

Factors responsible for a net realizable value less than the amount billed are cash discounts, sales returns, and uncollectible amounts.



Accrual is the accounting process that recognizes the value of assets or liabilities and related revenues, expenses, gains, and losses, whether received or paid in cash or by credit, barter, or other means (SFAC 6.141). Accrual involves future cash receipts and payments and may involve the use of an estimate as to the value of a transaction.Example: Examples include purchases and sales of goods or services on account, other expenses such as interest, rent, wages and salaries, and taxes that have not yet been paid in cash.IRC Section 451


Accrual Based Accounting

also known as: Accrual Accounting
Accrual Basis of Accounting
Accrual Method
Accrual Method of Accounting

Accrual basis accounting is a method of accounting that attempts to record the financial effects (substance) of financial transactions and other events and circumstances in the period of time in which they occur rather than only in time periods in which cash is received or paid by the entity. Accrual basis accounting recognizes that the earnings process, which consists of buying, selling, producing, distributing, and other operations, often does not coincide with cash flow – including cash receipts and payments. This accounting method records credit card transactions, barter exchanges, nonreciprocal transfers (ex. to and from bank accounts), changes in prices, changes in form of assets or liabilities, and other transactions, events, and circumstances that have eventual cash consequences for the entity but do not involve the concurrent movement of cash. Revenue is recognized when earned and expenses are recognized when incurred, not when cash is received or paid.

Many small businesses and bookkeeping professionals favor the accrual method of accounting as this type of accounting method helps keep an accurate picture of how cash flows throughout the business within an accounting period. In any period of time, business owners can depend on the use of accrual in their accounting method to take account of current assets, accrued expenses, and cash transactions.

SFAC 4.50 and 6.139

Accrual basis accounting uses accrual, deferral, and allocation to attempt to reflect the entity’s performance during a specific period of time or tax year, rather than just the receipts and disbursements of cash—to match the recognition of revenues with the related expenses (and the related increases or decreases in assets or liabilities). Accrual basis accounting makes it possible to recognize expenses and losses at the time that economic benefits are consumed or the loss of future benefits is discovered rather than when payment is made. Accrual accounting uses three expense-recognition principles as appropriate:

      • Associated cause-and-effect
      • Systematic and rational allocation
      • Immediate recognition

SFAC 5.85–.86

An alternative accounting system for recording accounting transactions is cash basis accounting, sometimes referred to as the cash method of accounting, cash method, or cash accounting.


Adjusted Current Earnings (ACE)

Adjusted current earnings (ACE) is an adjustment to the tax base for the alternative minimum tax, applicable only to corporate taxpayers. It is alternative minimum taxable income adjusted in a manner that is intended to reflect the economic income of the corporation. For this reason, it is closely related to earnings and profits. The adjustment is equal to 75% of the excess, if any, of adjusted current earnings over the alternative minimum taxable income of the corporation. If the adjustment is negative, it can reduce alternative minimum taxable income, but only to the extent of prior year positive adjustments.


Adjusted Gross Income (AGI)

Adjusted gross income (AGI) is gross income for individuals minus certain allowed deductions, commonly referred to as adjustments to income “above the line.” These adjustment are listed directly below the gross income section on the tax return; some examples would be contributions to retirement plans (Keogh, IRA), deduction for education-related interest, health savings account deduction, and self-employment tax.



also known as: Agents

An agent has general or specific authority, as determined by the principal, to bind the principal as regards third parties (i.e., an agent works for and under the control of another (the principal) and has the power to impose liability to third parties on the principal). However, a “general agent” is not an independent contractor, trustee, or employee (servant).

Duties of an agent include acting with loyalty and good faith (“fiduciary” relationship); obedience; necessary skill, care, and diligence; not to make delegation or substitution; and duty to account.

An agent is generally not personally liable to third parties unless the agent does any of the following:

      • Acts for a nonexistent, incompetent, or undisclosed principal
      • Signs a negotiable instrument in his own name
      • Misrepresents his authority
      • Personally guarantees certain acts

Agents are liable for their own torts.



Allocation is a formula or plan that disperses an amount and is considered an accounting process.  It includes, but is broader than amortization.

The following are examples of allocation:

  • Assigning manufacturing costs to production departments or cost centers and then to units of product to determine “product cost”
  • Apportioning the cost of a “basket purchase” to individual assets acquired on the basis of relative market values
  • Spreading the cost of an insurance policy or a building to two to more accounting periods


Alternative Minimum Tax

The alternative minimum tax (AMT) is designed to prevent taxpayers from escaping a fair share of tax liability by excessive use of certain tax breaks. A taxpayer is subject to this tax if the taxpayer has certain minimum tax adjustments or tax preference items and the alternative minimum taxable income (including adjustment for any net operating loss) exceeds the exemption allowed for the taxpayer’s filing status and income level. The alternative minimum tax is computed on Form 6251 for individuals and Form 4626 for corporations.



Amortization is an accounting process for reducing an asset or liability by periodic payments or writedowns that are distributed across the time the organization gains a value from or has obligation for the item. Specifically, it is the process of reducing a liability recorded as a result of a cash receipt (e.g., unearned revenue) by recognizing revenues or reducing an asset recorded as a result of a cash payment (e.g., prepaid expenses) by recognizing expenses or costs of production.

SFAC 6.142

Amortization is an allocation process to orderly reduce bond premium, bond discount, and bond issue costs by allocating the cost of an intangible asset to expense over time.



also known as: Annuities

An annuity is a contract sold by life insurance companies that guarantees a fixed or variable payment to the annuitant (beneficiary of contract) at some future time.

fixed annuity will be paid out in regular installments (monthly, quarterly, or annually) varying only with the payout method elected.

variable annuity will pay out a variable amount in regular installments. The amount of payout varies with the value of the account.

All capital and investment proceeds that remain inside the annuity accumulate tax-deferred.

“Annuity” is also used generally in present value calculations to refer to a series of equal cash flows over a period of time. Present value of an annuity tables simplify the process of discounting annuity cash flows.


Allocative Efficiency

Allocative efficiency occurs when there’s an optimal distribution of goods and services, taking into account consumer’s preferences.More specifically, it’s an output level where the price consumers are willing to pay is very close to or equals the marginal cost (MC) of production.This concept represents the degree to which the marginal benefits are almost equal to marginal costs. In a nutshell, this means at the optimal level of efficiency, the marginal cost of the final unit is equal to the marginal benefit a consumer derives from the goods or services.Because the price that the consumers are willing to pay is equivalent to the marginal utility, optimal distribution is achieved – signifying true productive efficiency.Allocative Efficiency Example


Steve wants to buy a new car, but he’s not exactly sure what color, make, or model he should purchase. So, Steve goes to the car dealership and asks for advice.

Many – if not, all – car retailers have very in-demand vehicles, i.e. cars that are the most sought after by consumers and most likely to sell. Steve assumes that white cars sell the most and are in highest demand. If this stands true, then this represents the allocated efficiency, which suggests that the availability of cars is based on the limited resources of car retailers, who know what will sell the most. So, they provide what consumers need to sell more cars and realize a higher profit.

Steve’s marginal benefit is almost equal to the car retailer’s marginal cost, which represents the dollar amount that the car retailer will pay to acquire (produce) extra units of cars. Also, while not all consumers will agree on a red car, if a large group of consumers shows a preference for red cars, car retailers will choose to promote and sell this type of cars.


Appreciated Asset

also known as: Appreciated Property
Gain Assets
Built-in Gains

An appreciated asset is property that has increased in value over its original purchase price or its adjusted basis.Example: Land purchased five years ago for $1,000, which has a fair market value of $3,000 today, is an appreciated asset.For tax purposes, an appreciated asset means any asset that has a fair market value in excess of its adjusted basis.Example: A building purchased five years ago for $50,000 has been depreciated and has a current adjusted basis of $30,000. If the current fair market value of the building is $42,000, it is considered to be an appreciated asset because its fair market value exceeds basis. This is true even though the building has economically lost $8,000 of value since its purchase.


Assets Vs. Liabilities

To put it in the simplest terms possible, your balance sheet includes two essential components: assets and liabilities. Fixed assets, current assets, intangible assets, total assets, non-current assets, current liabilities, long-term liabilities, tax liabilities, and total liabilities, are components that will illustrate your cash flow and help you determine your financial position. Though these two elements are different in nature, the purpose of both of them is to increase the life-span of business.According to accounting standards, assets vs liabilities are two components that can provide future benefits to the business by allowing an organization to determine their financial health and market value. In a nutshell, assets add value to your company and increase your company’s equity, while liabilities decrease your company’s value and equity. Some examples of assets include buildings, cash, inventory, real estate, brand names, accounts receivable, blueprints and patents. Some examples of liabilities include notes payable, accounts payable, customer deposits, income tax payable and other tax liabilities.The main difference between assets vs liabilities is that having more assets that outweigh your liabilities is a good indication that you’re in a good financial position. When liabilities come close to matching or exceeding assets, it’s a pretty strong indicator that the organization is not in a good financial position.


Average Fixed Cost

An average fixed cost, otherwise known as AFC, is found by dividing the total fixed cost of production by the total quantity of output. Fixed cost is divided by an increased output, average fixed cost will decrease. You can also hear AFC referred to as fixed cost per unit of output or per-unit fixed cost. Generally, the term means the AFC is describing the sum of all the expenses and costs that don’t change as output increases or decreases, divided by the number of goods produced.The best examples of fixed costs include rent on facilities, insurance costs, salaries, and utilities.

How do you Calculate an Average Fixed Cost?



Calculating an Average Fixed Cost can be represented by the following formula:




Simply divide the fixed cost (FC) by the unit of output – otherwise known as quanity (Q) and your answer will equal the average fixed cost.Total cost (TC) of a firm are either fixed (FC) or variable (VC). This can be written mathematically as follows:


TC = FC + VC


If we divide both sides of the equation by quantity (Q), we get:


TC  = FC + VC
 Q        Q       Q


This shows that average fixed cost can also be defined as the difference between average total cost and average variable cost:




For example:XYZ Co. is a local mushroom producer. They have 3 employees working on a one-year contract which cannot be canceled. They’re each paid a salary of $25,000 per year. The company also recently rented farming equipment to the tune of $60,000 per year. The farm facility itself charges depreciation on their facilities averaging at $20,000 per year. To care for the farm, they must apply pesticides at $1,000 per kilometer. The business produces 1,200 tons of mushrooms. What would be the farm’s average fixed cost?XYZ Co. total fixed cost in the short-run is $155,000 (i.e. ($25,000 × 3) for labor, $60,000 on account of farming equipment rent and $20,000 on account of depreciation).Since its total production is 1,200 tons, average fixed cost of $129.20 per ton ($155,000/1,200).Note that the cost of pesticides is not a fixed cost because it varies with change in production level.

Average Fixed Cost

As output increases, total fixed cost remains the same but the average fixed cost falls indefinitely. This is why we have a flat total fixed cost curve and constantly declining average fixed cost curve.

Since all inputs can change in the long-run, there is no long-run average fixed cost curve.

Why does an Average Fixed Cost Matter?

One of the biggest reasons calculating an AFC can play a major role in business is its potential to influence production decisions. For example, total costs of production can be calculated by adding fixed costs and variable costs. Fixed costs must be incurred, regardless of the level of output produced. However, AFC declines as the quantity of output increases. This happens because those fixed costs can be spread across more units as output increases. If an organization sees the elasticity of demand in their product during a certain time of year, they may adjust their fixed costs of production, level of production, units of output, and so on.


Average Variable Cost

What is an Average Variable Cost?  The Average Variable Cost – or AVC – is the variable cost per unit. Furthermore, an AVC is the firm’s variable costs divided by the quantity of output produced. Calculating the average variable cost includes factoring in material and labor costs in short-term production – which is calculated by dividing the total variable cost by the total output.

How Can I Calculate the Average Variable Cost?


Average variable cost is calculated by dividing total variable cost VC by output Q – a unit of output.


In the short-run, a firms’ costs can be generally categorized as either fixed or variable:

TC = FC + VC

Convert this to per-unit form by dividing both sides by Q:

TC = FC + VC
 Q       Q        Q

TC/Q equals average total cost (ATC), FC/Q equals average fixed cost (AFC) and VC/Q equals average variable cost (AVC):



This gives us another definition of the short-run average variable cost. AVC equals ATC minus AFC.

Average variable cost can be worked out directly from a firm’s cost function. We need to subtract the fixed cost and then divide by Q. Let’s consider a firm whose total cost function is given as follows:

TC = 0.1Q3 – 2Q+ 60Q + 200

We can convert this total cost function to a function for average variable cost as follows:


If we plot the average variable cost function, we get a U-shaped cost-curve shown below:

Average Variable Cost Curvesource:

Average Variable Cost Curve

In the chart above, you will see the average variable cost curve is U-shaped. As you’ll see, at first it declines then ultimately switches directions to an upward trend. It declines because the marginal product initially rises but then eventually continues rising because at least one input, typically capital, is fixed in the short-run and in the presence of a fixed input, law of diminishing returns governs the marginal product of other factors, such as labor.


Bad Debt
also known as: Uncollectible Account
Doubtful Account

A bad debt is a receivable that is considered to be uncollectible. The loss in the valuation of receivables should be recognized for financial accounting purposes when the original revenue is earned, even if the specific uncollectible receivables cannot be identified. For tax purposes, the loss in valuation of receivables should be recognized when the specific receivable becomes worthless.

For tax purposes, bad debts that a taxpayer incurs, and that did not arise in the course of operating a trade or business by the taxpayer, are nonbusiness bad debts. Furthermore, a bad debt expense cannot be categorized as a write-off; to be deductible – or to write off bad debt, nonbusiness bad debts expenses must be totally worthless. A partly worthless nonbusiness bad debt cannot be deducted. Nonbusiness bad debts are treated as short-term capital losses (IRC Section 166).Accounts receivable and bookkeeping personnel – especially in small businesses – should keep the write-off method in mind when combing through the financial statements, income statements, balance sheets in calculating the amount of bad debt accrued during an accounting period.

Business bad debts that become wholly worthless during the tax year are deductible. Business bad debts that are partially worthless may be partially deductible according to IRC Section 166.


Bad Debt Allowance

The bad debt allowance is the contra asset account used to bring accounts receivable to net realizable value. It is offset by an entry to bad debt expense in an attempt to match uncollectible accounts receivable with the revenue generated by the sales on account. The two methods for estimating a bad debt allowance are as follows:

      1. Income statement estimation approach (as a percentage of sales)
      2. Balance sheet estimation approach based on the aging of accounts receivable (conceptually preferable)

Both methods of estimating an allowance for bad debts are acceptable for reporting of results by publicly held companies. However, for tax accounting purposes, the reserve method may only be used for small banks. Nearly all accrual-basis taxpayers must use the specific charge-off method for receivables that become uncollectible. This difference in acceptable methodology results in book-to-tax differences for bad debt expense. It is sometimes also called Allowance for Uncollectible Accounts.


Bad Debt Expense

Bad Debt Expense is the account used to write off uncollectible accounts receivable. If a firm extends credit, there will be some level of accounts that will not be collected. Bad debt expense is usually estimated for financial statement purposes to match the expense with the revenues generated. Two primary methods can be used to estimate bad debt expense:

      • The expense is offset by an entry to Allowance for Uncollectible Accounts.

These methods are not acceptable for tax purposes. The IRS will accept only actual expenses; that is, write-offs of actual bad debts.


also known as: Bailor

Bailment is a special type of agency, involving delivery of personal property by the owner (bailor) to another party (bailee) for a particular purpose (usually storage or perfection by possession), without transfer of title (ownership) or risk of loss to the bailee, upon the condition that the property will be subsequently returned, safeguarded until reclaimed, or disposed of in accordance with a contractual agreement. The bailor has title but not possession, the bailee has possession but not title, and both have an insurable interest in the property. Transfer may be either by actual delivery of the property itself or by constructive delivery (as, for example, when the key to the storage facility is given to the bailee).



also known as: Reorganization

Bankruptcy is the condition of being judged insolvent by the court and having property distributed to creditors when a debtor is unable to meet debts. The uniform bankruptcy provisions are governed by the Bankruptcy Reform Act of 2005. The purpose of the Act is to provide relief to an insolvent debtor from his or her debts (to provide a “fresh start”) and to give all creditors an equal chance to share in the assets of the debtor in a specified priority and according to their claims.

A person can become bankrupt involuntarily or voluntarily. He or she can also undertake a reorganization or liquidation to pay his or her debts.

Chapter 7 of the Bankruptcy Act concerns liquidation of the business or the assets of the individual. An interim trustee is appointed by the court with broad powers to make management changes, obtain financing, and operate the business.

Chapter 11 concerns corporate reorganization, but may be used by individuals. Unless the court rules differently, the officers of the corporation continue to operate the business and propose plans to pay off the debts. However, the court must approve such plans.

Bankruptcy proceedings involve many parties: the debtor, the bankruptcy court judge, the trustee, secured creditors, general creditors, the creditors committee, and supporting professionals (e.g., accountants and attorneys).



also known as: Heir

A beneficiary is the party for whose benefit a will, trust, insurance policy, or contract is created. The party may be an individual or an organization (e.g., charity, school, club, business). The party may receive title to property by will or by equitable interest in a trust.

The beneficiary may be specified as an income beneficiary (one who receives the income from the assets) or as a principal or remainder beneficiary (one who receives the trust assets after the interest of the income beneficiary terminates—also called the remainderman).

The settlor of a trust can be the beneficiary as long as the settlor is not both the sole beneficiary and the sole trustee.

Other types of beneficiaries include the following:

    • Income beneficiary: Receives the income from trust assets
    • Principal beneficiary: Receives the trust assets (the corpus, principal) after the interests of the income beneficiary expire or terminate—also called the remainder beneficiary or remainderman
    • Beneficiary of a will: Receives property left by a will
    • Creditor beneficiary: Receives property left by a will in payment of a debt
    • Donee beneficiary: A third party to a contract who benefits by the performance of one or more of the principal parties to the contract
    • Incidental beneficiary: One who benefits from the performance of a contract merely incidentally—one not intended to be a contract beneficiary.


Bill of Lading

A bill of lading is a document of title issued by the common carrier to the shipper, evidencing receipt and possession (for transport) of the goods covered. The common carrier (issuer) has possession of the goods but does not have any ownership interest. The holder of the document has 100% ownership of the document and the goods. Waybill or airbill is usually a part of the bill of lading which details the shipment but does not evidence ownership or the contract between the shipper and the common carrier.


Blank Indorsement
also known as: Blank Endorsement
Endorsement in Blank
Indorsement in Blank

A blank indorsement is a transferor’s signature alone. It names no specific payee/indorsee, converts order paper to bearer paper, and is unqualified and nonrestrictive. (Note: The words “pay to the order of” are the magic words for negotiability; they are not required for negotiation.) Example: Signature alone.

Indorsements can be classified by three pairs of indorsement types: blank or special, restrictive or nonrestrictive, and qualified or unqualified.


Breach of Contract
also known as: Breach

Breach of contract is the failure of a party to a contract to perform as intended by the contract. Only a party to a contract (i.e., in privity) can bring suit for breach.

Breach of Contract under Common Law: Repudiation of the contract, impossibility of performance created by one party (either before or in the course of performance), violation of the terms of the contract, failure to perform, and tortious interference with the contract (inducing a party to the contract who violates its terms making the third-party inducer liable to the damaged party) are examples of breach of contract under common law.

Discharge of the right of action arising from breach may be achieved by agreement of the parties, accord and satisfaction, cure, and/or arbitration.

Remedies for breach include suit for damages (compensatory) and specific performance.

Examples of breach of contract under the U.C.C. (Uniform Commercial Code):

    • Failure to deliver, delivery of nonconforming goods without cure, or breach of warranty by the seller
    • Wrongful rejection or revocation of acceptance of conforming goods or failure to make a payment due by the buyer



Bylaws are the rules, regulations, and procedures that define the rights and powers of the board of directors, company officers, and shareholders.


Calendar Year

A calendar year is a year that begins on January 1 and ends on December 31. The alternative is a fiscal year—one that includes 12 consecutive months and ends on a month other than December.



also known as: Competent Party
Legal Capacity

Capacity is the legal ability to contract resulting from the ability to comprehend the nature and effect of a transaction. A contract between two competent parties is valid, because both parties are competent, and a contract in which one or both parties is not competent is voidable or void. For example, married women have full legal competence (i.e., modern statutory repudiation of common law disabilities which claimed that a woman could not contract without her husband’s signature). Parties are considered to be competent unless demonstrated otherwise. Incompetent parties (e.g., parties lacking legal capacity) include the following:

    • Infants (e.g., legal minors less than 18 years old): A contract with an infant is voidable by the minor only (the other party may not avoid the contract).
    • Persons legally insane (with or without adjudication): A contract with persons legally insane is void from inception if adjudication preceded the contract, if adjudication followed, or if the person is shown to be insane without adjudication.
    • Drunkards: A contract is enforceable unless the party was so intoxicated at the time of contracting that any reasonable person would agree that he or she lacked capacity. In such case, the contract is voidable by the sober drunkard.
    • Corporations: Corporations can contract only through agents. The power to contract is limited by charter with respect to the subject matter of contracts (e.g., the contract must reasonably accomplish some object for which the corporation was created). Private corporations are liable for ultra vires contracts.
    • Illegal aliens: A contract with an illegal alien is voidable.
    • Convicts: Legal capacity is limited for felons.


also known as: Real Capital
Economic Capital

Capital is a factor of production, one of the three essential elements of obtaining or producing wealth. Capital is man-made “investment” goods, e.g., tools, machinery, equipment, buildings, and storage, transportation, and distribution facilities. It is considered to be held (owned) primarily by households. Capital is a microeconomic concept.

Note: The economic resource known as capital or real capital refers only to man-made productive assets; money is not included in this definition. To an economist, money is financial capital or money capital.

Capital is the interest of owner(s) in the net assets (total assets minus total liabilities) of an entity. It is the measure of the resources provided to an entity that are considered permanent in nature—long-term debt and owner’s equity.

In an economic sense, capital also means assets that provide productive capacity—a factor of production.

Compare to land and labor.


Capital Account

The capital account is the Balance of Payment account that records transactions related to international movement of capital invested in a foreign country. It is a macroeconomic concept.


Capital Gain or Loss

Capital gain or loss is gain or loss derived from the sale or exchange of capital assets. It may be short term (held for 1 year or less) or long term (held for more than 1 year).

To determine how long a taxpayer has held the investment property, begin counting on the date after the day the property is acquired (trade date, not settlement date, for securities traded on an established market) and include the day the property is disposed. Put another way, a taxpayer cannot count both the acquisition and disposal dates.



Capitalization is the process of recording a cost as an asset and deferring its recognition as an expense to future periods. The asset can be either tangible (e.g., inventory or fixed assets), intangible (e.g., securities, organization, or rearrangement costs), or represent the right to receive services in the future (e.g., a prepaid expense, such as prepaid rent, insurance, subscriptions, or any service paid for in advance of receipt of the service). Assets are subject to an assessment of recoverability by the enterprise, such as the benefits to be derived and the periods benefited.

Accounting issues involve determination of the following:

    • The valuation of the asset, which usually equals the cash outlay at the market price of the asset acquired, plus costs to put the asset into productive use
    • The periods that will be benefited by the asset
    • The appropriate method of amortization of the deferred cost



Carrybacks are deductions or credits that cannot be utilized on the tax return during a year that may be carried back to reduce taxable income or taxes payable in a prior year.


also known as: Carryover

Carryforwards are deductions or credits that cannot be utilized on the tax return during a year that may be carried forward to reduce taxable income or taxes payable in a future year. An operating loss carryforward is an excess of tax deductions over gross income in a year; a tax credit carryforward is the amount by which tax credits available for utilization exceed statutory limitations.


Cash Basis Accounting

Cash basis accounting is a method of recording transactions for revenue and expenses when the corresponding cash amount is received or when payments are made. Therefore, you only record revenue when a customer pays for a billed service or product and you record a payment only when paid by the company. Small business owners might use the cash basis method in their bookkeeping process if they record business transactions, primarily with a checkbook.Cash basis accounting – not to be confused with accrual basis accounting or accrual accounting – is allowed for tax purposes only for smaller entities, and is not acceptable under generally accepted accounting principles (GAAS) or international financial reporting standards. The cash basis is useful under the following circumstances:For simpler accounting systems with accounting personnel who are not familiar with the more intricate accounting methods or accrual basis of accounting:

    • Where there is no inventory to be tracked or valued
    • Where there is no need for an audit, as may be required by a lender
    • When the company is in the services business (which implies that there is no inventory)

The cash basis can yield inaccurate results, because revenues and/or cash flows may be recognized in a different period by accounts receivable than the period in which related expenses are recognized. The result can be incorrectly high or low reported profits, leading to an impression on the IRS that the profits of a business vary by large amounts from month to month when that is not necessarily the case.


Certificate of Deposit (CD)

A certificate of deposit (CD) is a type of commercial paper. It is an acknowledgment by a bank of the receipt of money and the engagement (promise, obligation) to repay that money. A CD must be negotiable to be commercial paper (some CDs are not negotiable).U.C.C. 3-104Characteristics of CDs include the following:

    • Two-party—the maker (bank) and payee (depositor)
    • A promise by the bank to pay
    • Bank is primarily liable
    • The endorser(s) are secondarily liable
    • Normally pays a fixed rate of interest

Simple diagram of a CD:

                      Promise to Pay
Bank --------------------> Depositor

Charitable Contributions

Charitable contributions are deductible gifts or donations for tax purposes. Both individuals and corporations are allowed charitable contribution deductions.To qualify as deductible from federal income tax, a charitable contribution must meet certain requirements of the Internal Revenue Code as described by IRC Section 170. Contributions may be to such organizations as churches, educational institutions, hospitals and other medical care and research organizations, certain nonprofit service organizations (approved as such under IRC Section 501(c)(3)), certain governmental units, or certain private foundations.



Collateral is the property that a person can give and in which another can take a security interest or property subject to a security interest. Many of the rules regarding collateral depend on the type of property involved. There are three categories and 10 classes of collateral:Tangible

    1. Consumer goods are goods purchased primarily for personal, household, or family use or consumption (e.g., a home refrigerator).
    2. Equipment is considered goods used or purchased primarily for a business (including farming and professional), goods used by a debtor that is a nonprofit organization or a governmental unit, or goods not included in the definitions of inventory, farm products, or consumer goods (e.g., a refrigerator used by a restaurant).
    3. Farm products are considered goods, such as crops, livestock, or supplies, used or produced in a farming operation (e.g., a refrigerator used by a dairy farmer).
    4. Inventory is considered finished goods held for sale or lease in the ordinary course of business, raw materials, work in process, or materials used or consumed in a business (e.g., a refrigerator held for sale by an appliance store).

U.C.C. 9-109


    1. Accounts are any rights to payment for goods sold or leased or for services rendered that are not evidenced by an instrument or chattel paper (e.g., accounts receivable). (The U.C.C. also governs the sale of accounts in Article 2.)
    2. Contract rights are any rights to payment under a contract not yet earned by performance or evidenced by an instrument or chattel paper. An example of a contract right is an assignment of royalties under patents or copyrights.
    3. General intangibles are any personal property (including things in action) other than goods, accounts, instruments, documents, chattel paper, or money. Patents, copyrights, right to performance from someone else, and trademarks would be considered under a residual definition. (The U.C.C. does not cover the sale of general intangibles, only their use as collateral for a loan.)

U.C.C. 9-106

Documentary (quasi-intangible personal property represented by paper)

    1. Instrument: A negotiable instrument is as defined in Article 3 (commercial paper), a security (e.g., stocks, bonds, certificates of deposit, and notes), or a signed, unconditional promise or order to pay a sum certain, at a definite time, to the order of or to the bearer (U.C.C. 3-104).
    2. Documents are documents of title (bill of lading, dock warrant, warehouse receipt, etc.) issued by or addressed to a bailee (keeper of goods) and giving instructions concerning the goods in the bailee’s possession (U.C.C. 1-201).
    3. Chattel paper is writing that evidences both a promise to pay and a security interest in, or a lease of, specific goods. For example, a security agreement is considered chattel paper (U.C.C. 9-105).

Classes of collateral are mutually exclusive. A given item cannot be in more than one class at the same time with respect to the same debtor, but the same item can be in different classes to different debtors or at different times to the same debtor. Classification is based on the principal use to which the item is put by the owner or debtor.


Common Law

Common law is the body of rules developed from custom, usage, and previous court decisions rather than from written legislation. It has been subsequently used as a basis for later court decisions (judge-made law or case law as opposed to legislated law).

Common law liability for accountants relies on the common law theory of negligence—the accountant is obligated to exercise the ordinary reasonable care, skill, and competence of other members of the profession (i.e., the generally accepted standards of the profession).


Compensatory Damages

Compensatory damages are money awarded to the injured party to make amends for the injury or loss sustained as a result of the tort. It is a legal remedy for torts including breach of contract.For breach of contract, compensatory damages include any expense that is reasonably foreseeable as the natural result of the breach (usually either the contract price or the fair market price of the goods or services involved in the contract).


Compliance with Standards
also known as: Compliance with Standards Rule
Accounting Principles Rule

The AICPA’s Compliance with Standards Rule and Accounting Principles Rule (in the Code of Professional Conduct) refer to compliance with standards promulgated by authorized bodies.

Compliance with Standards Rule (ET 1.310.001): “A member who performs auditing, review, compilation, management consulting, tax, or other professional services shall comply with standards promulgated by bodies designated by Council.”

Accounting Principles Rule (ET 1.320.001): “A member shall not (1) express an opinion or state affirmatively that financial statements or other financial data of any entity are presented in conformity with generally accepted accounting principles or (2) state that he or she is not aware of any material modifications that should be made to such statements or data in order for them to be in conformity with generally accepted accounting principles, if such statements or data contain any departure from an accounting principle, promulgated by the bodies designated by Council to establish such principles, that has a material effect on the statements or data taken as a whole. If, however, the statements or data contain such a departure and the member can demonstrate that due to unusual circumstances the financial statements or data would otherwise have been misleading, the member can comply with the rule by describing the departure, its approximate effects, if practicable, and the reasons why compliance with the principle would result in a misleading statement.”

Simply stated, the Compliance with Standards Rule requires all CPAs, regardless of their functional area of service (audit, tax, etc.), to comply with the technical standards issued by those bodies designated by the AICPA to promulgate the technical standards. Any departure from these standards must be justified.

A CPA must not allow his or her name, or his or her firm’s name, to be associated with the financial statements as if he or she were acting as an independent CPA unless he or she, or his or her firm, has complied with the Compliance with Standards Rule.

When a CPA’s name is associated with the financial statements, the degree of responsibility he or she is taking with regard to those statements must be clearly indicated so as not to be misleading to the readers.

Departures from GAAP are acceptable as long as they are justified. This should not be interpreted loosely. Departures should be made only under unusual circumstances. The only acceptable justification is that, if GAAP were to be followed, the financial statements would be misleading to the readers. Thus, a departure is allowed but must be disclosed and justified.


Consolidated Omnibus Budget Reconciliation Act (COBRA)

The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) gives workers and their families the right to choose to continue group health benefits for limited periods of time under certain circumstances. The circumstances would include involuntary job loss, reduction in hours worked, transition between jobs, divorce, death, and other life events.


Constructive Ownership
also known as: Attribution Rules

Constructive ownership is the method of allocation of stock ownership based on attribution rules between the following groups:

    • Family members (brothers, sisters, half-brothers, half-sisters, spouses, ancestors, and lineal descendants)
    • To and from partners and partnerships
    • To and from trusts and estates and beneficiaries
    • To and from corporations and shareholders

Example: The stock owned by a partnership is deemed as being owned by the partners in relation to their partnership interest.



A contract is an agreement between two or more persons that establishes an enforceable legal relationship between the parties. The essential elements of a contract are:

    • an agreement (offer and acceptance),
    • consideration,
    • valid subject matter, and
    • legal capacity.

void contract never had any legal status. A voidable contract is valid only until one party exercises a right to void the contract. An unenforceable contract is valid when made but is made unenforceable by some later event, such as the statute of limitations, discharge of the contract in bankruptcy, or involuntary destruction of the subject matter.


Control Person

also known as: Controlling Person

A control person is a person or party who possesses the power, actual or implied, to direct or control the direction of an entity’s management and policies of the entity. The identity of a control person is a question of the facts and circumstances. Factors to be considered include:

    • stock ownership (e.g., more than 5%),
    • actual or practical control (e.g., member of the board of directors),
    • officer or director, and
    • possession of the ability to control, whether or not exercised.

Standards and liabilities related to control persons are specified by the federal securities laws. (This term is used and defined in the federal securities laws. Similar terms include “insider,” “affiliate,” and “related party.” A control person is usually both an insider and a related party.)

Senior officers, directors, certain large shareholders, and family members who live in a control person’s house are also considered control persons. In addition, corporations, partnerships, estates, and trusts in which a control person has an interest, and estates and trusts for which a control person is executor, trustee, or a similar role are considered control persons.



A copyright is an exclusive right granted by law for a specific period of time to make and dispose of copies of a literary, artistic, or musical work. It is also an intangible asset that is identifiable and separable, may be purchased or developed internally, and has a legal life equal to the life of the author (or artist or composer) plus 70 years.

The useful life of an intangible asset is defined in FASB ASC 350-30-35-02 as “the period over which the asset is expected to contribute directly or indirectly to the future cash flows of that entity.” All relevant information should be considered when estimating the useful life of an intangible asset. FASB ASC 350-30-35-03 lists the following as specific items that should be considered:

    1. “The expected use of the asset by the entity.
    2. “The expected useful life of another asset or group of assets to which the useful life of the intangible asset may relate.
    3. “Any legal, regulatory, or contractual provisions that may limit the useful life. The cash flows and useful lives of intangible assets that are based on legal rights are constrained by the duration of those legal rights. Thus, the useful lives of such intangible assets cannot extend beyond the length of their legal rights and may be shorter.
    4. “The entity’s own historical experience in renewing or extending similar arrangements, consistent with the intended use of the asset by the entity, regardless of whether those arrangements have explicit renewal or extension provisions. In the absence of that experience, the entity shall consider the assumptions that market participants would use about renewal or extension consistent with the highest and best use of the asset by market participants, adjusted for entity-specific factors in this paragraph.
    5. “The effects of obsolescence, demand, competition, and other economic factors (such as the stability of the industry, known technological advances, legislative action that results in an uncertain or changing regulatory environment, and expected changes in distribution channels)
    6. “The level of maintenance expenditures required to obtain the expected future cash flows from the asset (for example, a material level of required maintenance in relation to the carrying amount of the asset may suggest a very limited useful life). As in determining the useful life of depreciable tangible assets, regular maintenance may be assumed but enhancements may not.”

An intangible asset with a finite useful life should be amortized over its useful life to the reporting entity. There is no arbitrary maximum amortization period. (The 40-year maximum amortization period previously prescribed by APB Opinion 17 was deleted by SFAS 142.) Although SFAS 142 (FASB ASC 350-30-35) may allow an amortization period longer than 40 years, many accountants and managers would question the value of a copyright after 40 years plus the impracticality of delaying the recovery of the investment far into the future. Forty years would still be an allowable period for recovery.



A counteroffer is a reply to an offer that adds qualifications, conditions, or new terms. In contract law, it is a rejection of the offer by the offeree combined with a new offer to the original offeror.The U.C.C. modified this definition considerably but specifically stated that an acceptance which includes terms additional to or different from those in the original offer does constitute an acceptance and the contract is formed and the new terms are considered as proposals for inclusion in the contract. Between merchants, the terms become part of the contract unless:

    • the offer expressly limits acceptance to the terms of the offer,
    • the new terms materially alter the offer, or
    • notification of objection is timely given.

U.C.C. 2-207

Coverdell Education Savings Account

After 1997, individuals may establish Coverdell education savings accounts (ESAs, previously called education IRAs) and, subject to an adjusted gross income (AGI)-based phaseout, may make annual nondeductible cash contributions to the ESA for a designated beneficiary who is under the age of 18 or a special-needs beneficiary when the ESA is established. Contributions to these accounts accumulate earnings free of income tax, and distributions are tax-free up to the amount paid for qualified higher education expenses during that year. The proceeds from a Coverdell ESA may fund expenses of elementary, secondary (K–12), undergraduate, and graduate education.


also known as: Tax Credits

Tax credits are amounts deducted from tentative tax to compute income tax payable. Available tax credits include the credit for the elderly or disabled, the credit for child and dependent care, the foreign tax credit, the general business credits, the earned income credit, the adoption credit, the child credit, and the lifetime learning credit. (One must be careful not to confuse this term with the recording process of a transaction in financial accounting, i.e., debits and credits).

Credits are significant in that they directly reduce the tax liability. Deductions decrease the taxable income.


CVP Graph

A CVP Graph – otherwise known as a cost volume profit graph – shows the relationship between costs of production and sales. In other words, a CVP graph provides a graphic representation of the cost-volume-profit analysis. This graph shows the cost of units produced and and volume of units produced by analyzing the relationship between fixed costs, total costs, and total sales.

CVP Graph or Break-even Chart


The above example chart illustrates:

    • Fixed production costs are the solid grey line, which always remain the same – no matter the level of production.
      • For example, if 1 unit or 100 units are produced, the fixed cost stays the same.
    • The dark, thin green line represents the total cost of production, including fixed and variable costs.
      • In this chart, when there is 0 production, costs are at $10,000.  Costs rise as production increases.
    • The light green line signifies the total sales of the organization.
      • For example, at 100 units of production – when total costs are at $50,000 – the company has hit its break-even point and will start increasing total revenue as sales gradually increase.

What does a CVP Graph mean?

CVP Graphs exist to help organizations determine the impact that a change in sales volumes has on costs and profits, including all data accounting for total variable costs, variable expenses, unit sales, unit variable costs, and operating profit.. Sometimes managers cause use this graph to forecast budget estimates and plan for future production.  Generally, managerial accounting personnel can conduct a CVP analysis on a graph like this to predict future sales revenue, conduct a break-even analysis, help aid in adjusted the total costs line, and any future losses if projected sales are not met.

Make your own CVP Graph in Excel®:

    1. Highlight the information you want to include in the graph on your spreadsheet.
    2. Click “Insert” on the top menu.
    3. Scroll over to “Recommended Charts” and click the Line Graph option, then select 2D line graph.

You can learn so much more about Excel by taking our Excel® for Accounting and Finance Professionals certificate course!



A debenture is an unsecured promissory note (bond) to pay a specified amount on a specified date.


also known as: Liability

A debt is an obligation to pay money, goods, or services due in the future to another entity (creditor). The debt may be payable on demand or at some fixed or determinable future date. The debt is often evidenced by a legal document (debt security or instrument) but may arise from a stated or implied contract. The debt may bear interest if it extends over time.

Debts are claims against the assets of an entity, mortgages to which an asset is subject, or financial obligations for which an owner is liable. The indebtedness can be secured or unsecured, recourse or nonrecourse. To the extent that a partner is liable for the indebtedness, that partner’s basis is increased. If the indebtedness is later reduced, that partner’s basis is reduced.

In governmental accounting, debt is referred to as an obligation, encumbrance, or commitment.



also known as: Payor

A debtor is an entity who owes either money, goods, or services to another entity (creditor) that is due in the future. The debt may be payable on demand or at some fixed or determinable future date. The debt is often evidenced by a legal document but may arise from a stated or implied contract. The debt may bear interest if it extends over time.


Debtor in Possession

A debtor in possession is a person who continues to operate his business after entry of an order for relief has been granted under the bankruptcy law. The bankruptcy court usually allows this situation unless gross mismanagement by the person is shown or the best interests of the estate require the appointment of a trustee to operate the business.



A decedent is the deceased individual whose estate is being administered.



A deduction is an amount that may be subtracted to arrive at taxable income.



The term “dependent” means:

    • qualifying child or
    • qualifying relative.

Special test for qualifying child of more than one person—A child can only be claimed as a dependent by one taxpayer. If a child is a qualifying child for more than one taxpayer, the taxpayers can apply a series of tie-breaker tests to determine which taxpayer will prevail. Subject to these tiebreaker rules, the taxpayers may be able to choose which of them claims the disputed child as their qualifying child. The tiebreaker rules are explained in IRS Publication 501.

Qualifying Child:

    1. Pass the relationship test:
      1. Child or descendant of a child
      2. Brother, sister, stepbrother, or stepsister
      3. Father, mother, or ancestor of either
      4. Stepfather or stepmother
      5. Niece or nephew
      6. Aunt or uncle
      7. Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister in law
      8. An individual who at no time during the year was the taxpayer’s spouse, who has the same principal place of abode as the taxpayer, and is a member of the taxpayer’s household
    2. Has the same principal place of abode as the taxpayer for more than one-half of the year
      1. has not attained the age of 19 as of the close of the year,
      2. is a student who has not attained the age of 24 as of the close of the year, or
      3. is permanently and totally disabled
    3. Meets the age requirement; is younger than the taxpayer and:
    4. Has not provided over one-half of their own support for the year
    5. Has not filed a joint return (other than to claim a refund) with their spouse

Qualifying Relative:

    1. Passes the relationship test of qualifying child
    2. Gross income is less than the exemption amount
    3. The taxpayer has provided over one-half of the individual’s support for the year.
    4. Is not a qualifying child of the taxpayer or any other taxpayer

IRC Section 152; IRS Publication 501



Depreciation is the process of systematic, rational allocation of the cost of operational assets to the accounting periods benefited. Depreciation is not a process of valuation (FASB ASC 360-10-35-4), does not represent a reserve to replace the asset, and does not mean that cash will be available to replace the asset. Depreciation allowed for tax purposes often differs from depreciation allowed for accounting.

Accounting depreciation attempts to match the cost of the asset to the revenues generated over the life of the asset. It represents accrual accounting and has no effect on cash flows (a noncash expense). Depreciation expense must be added back to accounting income when reconciling to cash from operations using the indirect method.

Computation of depreciation requires the following:

    • Acquisition cost
    • Estimated useful life
    • Estimated residual (salvage) value
    • Depreciation method (four GAAP alternatives):
      1. Straight-line
      2. Sum-of-the-years’-digits
      3. Double-declining balance
      4. Units of production—units of product and machine hours

Factors which cause the need for depreciation include the following:

    • Physical factors:
      • Wear and tear
      • Effects of time and other elements
      • Deterioration and decay
    • Functional factors:
      • Inadequacy of capacity
      • Obsolescence

In the macroeconomic sense, depreciation is the part of business earnings/gross profit that is considered the replacement of capital stock used or worn out during the period. It is not included in net profit and is not a factor payment. (It is not a claim on the value of output by a factor of production.) Depreciation represents replacement investment, the amount that must be reinvested to maintain the existing level of capital stock, and the amount by which capital contributes to current production. It is a component of GNP (approximately 10%) and is computed by the income approach to national income accounting. Depreciation is the difference between gross and net investment.

In the foreign exchange sense, depreciation is the decline in the value of one currency against or in relation to another, in the sense that it now takes more of a particular currency to buy a unit of a foreign currency. Devaluation is the official change in the value of a country’s currency.

Example: Country A has an inflation rate of 5% and Country B has an inflation rate of 10%. The goods of Country A become relatively cheaper because the relative prices have changed, thus:

    • increasing the demand in Country B for Country A’s goods,
    • increasing the demand for Country A’s currency (to be able to import Country A’s goods), and
    • decreasing the demand for (i.e., depreciating) Country B’s currency by approximately 5% (10%–5%).


Direct Finacial Interest

Direct financial interest is ownership in the entity/client, i.e., common stock, preferred stock, or convertible debt. Direct financial interest is prohibited by the AICPA Conceptual Framework for Independence (ET 1.210.010): the independence of an accountant who holds a direct financial interest in a client or in a nonclient investee of a client is deemed to be impaired. There is no exception to this rule (e.g., even securities held in a blind trust are considered to be a direct financial interest). (ET 1.245.020)

Materiality is irrelevant; any direct financial interest, even one share, is considered to impair independence.


Direct Labor

Direct labor is labor costs that can be traced economically and directly to units of finished product. Direct labor is a part of product cost and is included in both prime cost (direct labor plus direct materials) and conversion cost (direct labor plus manufacturing overhead).Note: Payroll costs for production workers are usually treated as direct labor costs. Fringe benefits such as employer payroll taxes and contributions to health insurance, pension, and other benefits may be included in direct labor costs or treated as indirect overhead costs of production, depending on the company’s data systems.


Disclaimer of Opinion
also known as: Disclaimer

A disclaimer of opinion is an expression of no opinion. (AU-C 700.03)

A disclaimer of opinion is warranted when restrictions on the scope of the audit are so severe, whether client imposed or due to other reasons, that the auditors are unable to obtain sufficient appropriate audit evidence to enable them to form an opinion.

Example: Instances of limitations on scope include the client’s refusal to allow the confirmation of receivables or the lack of a beginning inventory physical count (i.e., when the auditor is hired after the beginning of the fiscal year).

It is only when the auditors are unable to overcome these limitations by other audit procedures that a disclaimer of opinion is warranted.

A disclaimer of opinion because of a scope limitation requires modification of the standard auditor’s responsibility paragraph and, in all cases, the substantive reasons for the disclaimer should be explained in a separate emphasis-of-matter or other-matter paragraph.


also known as: Full Disclosure

The dictionary definition of the term “disclosure” is “revealing or uncovering.” In general, the purpose of financial reporting is to reveal an entity’s financial information. Often, the term “disclosure” relates to stating additional facts or explanations in a financial statement or auditor’s report. In financial statements, disclosure can be achieved by parenthetical or additional reporting of information after a line item by cross-referencing to another item, by footnotes, and by supplementary verbal and scheduled information. An additional explanatory paragraph can also be added to an auditor’s standard opinion for disclosure purposes.



In general, to discriminate is to make a judgment sometimes on the basis of prejudice, specifically judgment for or against someone on the basis of race, sex, age, or religion, or general beliefs or attitudes.

With respect to discrimination under the Americans with Disabilities Act (ADA), the general rule is as follows: No covered entity shall discriminate against a qualified individual with a disability because of the disability of such individual in regard to job application procedures, the hiring, advancement, or discharge of employees, employee compensation, job training, and other terms, conditions and privileges of employment.

The following are included among the forms of discrimination explicitly proscribed by the ADA:

    • Limiting, segregating, or classifying a job applicant or employee in any way that adversely affects the opportunities or status of such applicant or employee because of the disability of such applicant or employee.
    • Participating in a contractual or other arrangement or relationship that has the effect of subjecting a covered entity’s qualified applicant or employee with a disability to the discrimination prohibited in the ADA. This includes a relationship with an employment or referral agency, labor union, an organization providing fringe benefits to an employee of the covered entity, or an organization providing training and apprenticeship programs.
    • Utilizing standards, criteria, or methods of administration that have the effect of discriminating on the basis of disability or that perpetuate the discrimination of others who are subject to common administration control.
    • Excluding or otherwise denying equal jobs or benefits to a qualified individual because of the known disability of an individual with whom the qualified individual is known to have a relationship or association.

Under the ADA, employers are legally allowed to discriminate on a number of grounds when hiring, promoting, or terminating employment. For example, a law firm hiring an associate lawyer is justified in requiring the individual to have a law degree and have passed the bar as prerequisites. However, under the ADA, there are several forms of discrimination that are expressly prohibited.



Dividends are the distributions of cash, other corporate assets or property, or the corporation’s own stock to stockholders in proportion to the number of outstanding shares held. Accounting for dividends represents a debit to retained earnings and the establishment of a liability at the date of declaration. Dividends must meet the preferences of preferred stock first and then may be extended to common stock.There are two types of dividends:

    1. Common, such as cash, stock (treasury or newly issued shares), and property
    2. Special, such as scrip and liquidating

Four dates are relevant to dividends: date of declaration, record, ex-dividend, and distribution (payment).

Date of declaration is the date whereby the dividend amount is decided by the board of directors for those shareholders owning stock on the date of record (usually 1 month later) and to be paid on the date of distribution. Ex-dividend date is a date prior to the date of record (see ex-dividend date).


Dividends Received Deduction (DRD)

also known as: DRD
Special Deduction

A corporation may deduct, within certain limits, 50% of the dividends received if the corporation receiving the dividend owns less than 20% of the distributing domestic corporation. In other circumstances, a corporation may deduct (within certain limits) 65% of the dividends received if it owns 20% or more, but less than 80%, of the paying domestic corporation. This corporation is referred to as a 20%-owned corporation. A small business investment company can deduct 100% of its dividends received. Ownership is determined, for these rules, by the amount of voting power and value of stock (other than certain preferred stock) the corporation owns.

Members of an affiliated group of corporations (at least 80% owned by the parent) may deduct 100% of the dividends received from a member of the same affiliated group if they meet certain conditions. See IRC Section 243 for the definition of an affiliated group of corporations.

When a corporation receives a dividend from a domestic corporation in the form of property other than cash, it includes the dividend in income. The amount included is the lesser of the property’s fair market value or the adjusted basis of the property in the hands of the distributing corporation, increased by any gain recognized by the distributing corporation on the distribution.

In addition to dividends received from domestic corporations, the above rules apply to dividends received from a foreign corporation that are paid out of the earnings and profits of a taxable domestic predecessor corporation.

Corporations cannot take a deduction for dividends received from the following:

    1. A real estate investment trust or regulated investment company (mutual fund)
    2. A corporation exempt from tax either for the tax year of the distribution or the preceding tax year
    3. A corporation whose stock has been held by the taxpayer corporation for 45 days or less
    4. A corporation whose stock has been held by the taxpayer corporation for 90 days or less, if the stock has preference as to dividends and the dividends received on it are for a period or periods totaling more than 366 days
    5. Any corporation, if the taxpayer corporation is under an obligation (pursuant to a short sale or otherwise) to make related payments for positions in substantially similar or related property

Other specific limitations to the deduction may also apply.

The Taxpayer Relief Act of 1997 (TRA ’97) added the requirement that all dividends received during the tax year must meet the requirements of items 3 or 4 for all of the dividends of a specific corporation to qualify for the dividends-received deduction.

The dividends-received deduction helps reduce the potential for triple taxation, where earnings would be taxed by the corporation that originally earns them, by the corporation that receives them as dividends, and by the stockholder who receives them as dividends from the second corporation.


Document of Title

also known as: Documents of Title

Documents of title are instruments (often negotiable) that represent ownership of goods and the contract with a warehouseman or common carrier (who, by giving the document, acknowledges receipt and possession of the goods). The holder of the document (drawn, issued, indorsed to him or to his order, or in blank or to bearer) is entitled to receive, hold, and dispose of the document and the goods it covers. For example:

    • Bill of lading—issued by a common carrier for the shipment of goods. (Note: A waybill or airbill is not necessarily a bill of lading; it may merely document the details of the shipment without representing a contract or document of title. It is usually a part of the bill of lading.)
    • Warehouse receipt—issued by a warehouse for the storage of goods.

Documents of title are made negotiable by meeting the five requisites of negotiability (SWUPS). Provisions for negotiation are the same as for commercial paper, are negotiable to facilitate and expedite commerce (i.e., to transfer ownership without physical transfer of the goods), and flow from ordinary course of business. A document is “payable” in goods rather than in money. It is an intangible personal property representing tangible goods and is governed by Articles 7 and 8 of the Uniform Commercial Code (U.C.C.).

Risk of loss transfers with/follows from the document. The holder in due negotiation (HDN) is similar to HDC.

    • The holder/bailor of the document of title has 100% title to both the document and the goods it represents.
    • The bailee (giver of the document, e.g., the warehouseman or common carrier) has possession of the goods but no title (i.e., ownership interest) in them.

Documents of title are transferred (negotiated) by due negotiation.

Contrast to commercial paper (payable in money) and security interests (intangible representing intangible asset).


Due Diligence

The dictionary meaning of the word “due” as used here is “sufficient” or “adequate.” The meaning of “diligence” is an act performed with great effort and care. In regard to taxation, the IRS states: “In general. A practitioner must exercise due diligence—

    1. “In preparing or assisting in the preparation of, approving, and filing tax returns, documents, affidavits, and other papers relating to Internal Revenue Service matters;
    2. “In determining the correctness of oral or written representations made by the practitioner to the Department of the Treasury; and
    3. “In determining the correctness of oral or written representations made by the practitioner to clients with reference to any matter administered by the Internal Revenue Service.”

Treasury Circular 230, Section 10.22(a)

In the context of mergers and acquisitions, due diligence is the process of examining the books and records of the parties to the transaction.


Earned Income Tax Credit (EIC)
also known as: Refundable Earned Income Credit
Earned Income Credit

The earned income tax credit (EIC) is a refundable credit available to qualifying low-income taxpayers. The amount of the EIC is based on a percentage of earned income and the number of qualifying children the taxpayer supports (0, 1, 2, or 3 or more), with the income limits changing depending on how many qualifying children a taxpayer has.

When determining whether a child is a qualifying child for purposes of computing the EIC, the support test is not included, and the relationship, residency, and age tests are modified (see dependent). The refund decreases as earned income rises after reaching a given amount.

In order to be eligible for the earned income credit, a taxpayer must have an AGI below a certain level, a valid Social Security number, a filing status other than married filing separately, a U.S. citizen or resident alien designation, no foreign income, and limited investment income.



Earnings are a measure of the performance of the enterprise during the period. Earnings measure the extent to which asset inflows (revenues and gains) associated with cash-to-cash cycles substantially completed during the period exceed (or are less than) asset outflows associated, directly or indirectly, with the same cycles. (SFAC 5.33–.38)Similar to net income (earnings do not include the cumulative effect of certain accounting adjustments of earlier periods that are recognized in the current period), earnings are a measure of the performance for the current period and to the extent feasible excludes items that belong primarily to other periods. It is narrower, or less than, comprehensive income.Earnings are also called “net income” (loss) or “profits” in common practice. “Earnings” are not strictly the same as “net income.”


Earnings per Share (EPS)

Earnings per share (EPS) is, generally, the allocation of a pro rata share of income to each share of common stock (EPS is not computed on preferred stock). It is a comparison of net income of an enterprise with the average number of common shares outstanding during the year.The Financial Accounting Standards Board (FASB) has established this definition in FASB ASC 260-10-45. The required reporting for public companies is basic EPS and diluted EPS.The standard is required for all interim and annual reports ending after September 15, 2009.FASB ASC 260-10 applies to all entities that have issued common stock or potential common stock that trades in a public market. Potential common stock consists of other securities and contractual arrangements that may result in the issuance of common stock in the future, such as options, warrants, convertible securities, and contingent stock agreements.Corporations with simple capital structures are required to report only basic earnings per share. Corporations with complex capital structures are required to report basic earnings per share and diluted earnings per share.A simple capital structure is one that consists of capital stock and includes no potential for dilution via conversions, exercise of options, or other arrangements. A complex capital structure would include convertible bonds or preferred stock, outstanding options or warrants, and any contractual arrangement that would include the issuance of new shares.Basic EPS measures the performance of an entity over the reporting period based on its outstanding common stock. The calculation is to divide the income attributable to common stock by the weighted-average number of common shares outstanding.Diluted EPS measures the performance of an entity over the reporting period based on its outstanding common stock while giving effect to all dilutive potential shares that were outstanding. The calculation includes income attributable to common stock plus adjustments resulting from the issuance of dilutive potential common shares. This adjusted income figure is divided by the weighted-average number of common shares outstanding increased by the dilutive potential common shares.


also known as: Easements

Easement is the right to use the land of another or to have the land of another used in a particular way. It may be a title defect.



For income tax purposes, an employee is to be distinguished from an independent contractor. This is important, for the withholding of income taxes on wages applies only to employees. Also, employee status will affect the manner and extent of some deductions and credits. The regulations state that an employee is one who is subject to the will and control of the employer not only as to what shall be done but also as to how it shall be done.

Employee Retirement Income Security Act (ERISA)

also known as: ERISA

The Employee Retirement Income Security Act (ERISA) was enacted by Congress in 1974 to protect employees’ retirement benefits by setting forth rules for employer-provided retirement plans to make them equitable and secure.

Participation rules ensure that certain employee groups cannot be unfairly excluded—by age, income, hours worked, etc. Vesting rules set restrictions and minimum standards. Funding requirements provide a measure of financial safety for a plan and its participants. Tax-free rollover protection allows participants to transfer their vested retirement accounts to other qualified retirement plans. Minimum contributions, maximum benefits, termination insurance, fiduciary responsibilities, and other rules are also defined by ERISA for all qualified benefit plans.

After debating the issue of pension reform for more than seven years, Congress enacted ERISA in 1974. While ERISA did not require employers to establish employee pension plans, this law mandated rules for the management and reporting of those plans that are established (administered and enforced by the Department of Labor and the IRS). Provisions of ERISA are as follows:

    • Specify structure of plans
    • Establish minimum standards for participation, vesting, and funding
    • Impose rigorous standards of fiduciary conduct on plan managers
    • Expand reporting and disclosure requirements by requiring all employee benefit plans (EBPs) to issue annual financial statements
    • Create a program of plan termination insurance

ERISA is a very complex and comprehensive law. The complexity is caused by the breadth of its coverage and the confusion created by the overlapping jurisdiction of federal departments or agencies. Because ERISA amended both the Internal Revenue Code (IRC) and federal laws administered by the Department of Labor (DOL), there is a duplication of many provisions. The labor provisions of ERISA generally affect employee benefit plans maintained by employers engaged in interstate commerce. The tax provisions amended the requirements for qualification under the IRC and thereby extended ERISA’s coverage to plans sponsored by employers not engaged in interstate commerce.



also known as: Entities

An entity is any person or group of people that owns economic resources, incurs economic obligations, and enters into economic transactions. It is a particular unit of accountability. An economic unit is an entity that is considered to be separate and distinct from its owners or the providers of resources. An entity may or may not be a legal entity.

An entity may have profit-making as its primary objective (an enterprise or business enterprise such as a sole proprietorship, partnership, corporation, consolidated entity, or joint venture) or it may not (an individual, family, trust, estate, nonbusiness organization such as a not-for-profit hospital, voluntary health and welfare organization, other not-for-profit entity, or governmental unit).



An error is an unintentional misstatement or omission of amounts or disclosures in financial statements. AU-C 240.02

Errors may involve the following:

    • Mistakes in gathering or processing accounting data
    • Incorrect accounting estimates arising from oversight or misinterpretation of facts
    • Mistakes in the application of accounting principles relating to amount, classification, manner of presentation, or disclosure (compare to fraud)

The primary factor that distinguishes errors from fraud is whether the underlying cause of the misstatement in the financial statements is intentional. Intent is often difficult to determine and must involve the auditor’s professional judgment and professional skepticism.

The independent auditor has the responsibility to design the audit to provide reasonable assurance of detecting errors and fraud that are material to the financial statements.

An assessment of the likelihood of errors and fraud is an element of the auditor’s assessment of audit risk in the planning stage.

In statistics, the error refers to the difference of one observation in a sample from the unobservable, theoretical value that would be derived from the entire population. Statistics assumes that the errors from individual observations are uniformly dispersed from the theoretical value.


also known as: Estates

An estate is a taxable, organizational entity used to wind up the affairs and distribute the property of a deceased person. It comes into existence only upon a person’s death, holds title to the property of the deceased, and exists for a limited time. An estate succeeds to the title of property of the deceased and is liable for debts. It must pay federal estate tax, applicable state inheritance tax, federal income tax, and any other tax that becomes due on the real and personal property of the estate. (Contrast to Trust.)

Administration of the estate is handled by an executor or executrix (if so named in the will and empowered by the court) or a court-appointed administrator (if executor or executrix is not named in the will).

Estate property does not include the following:

    • Life insurance on the deceased paid to the named beneficiary
    • Property placed in an inter vivos trust
    • Property that was given away when the deceased was living

The assets of a bankrupt debtor are also called an estate.

With respect to property held in joint tenancy:

    • If an interest in property created after 1976 is held by a decedent and his spouse as tenants by the entireties or as joint tenants with right of survivorship (if the decedent and his spouse are the only joint tenants), one-half of the value of the jointly owned interest will be included in the estate of the decedent spouse regardless of which spouse furnished the original consideration (IRC Section 2040(b)). The unlimited marital deduction may apply if the surviving tenant is the surviving spouse.
    • Joint ownership created by co-owners: Except for husband-wife tenancies, the entire value of the property is included in the co-owner’s gross estate except the part, if any, attributable to the consideration in money or money’s worth furnished by the other joint owner(s).
    • Tenancy in common: Only the value of decedent’s undivided share of the property is included in his or her gross estate.


Estate Tax

Estate taxes are excise taxes levied on the transfer of a person’s property on that person’s death. There are federal estate taxes and state estate taxes. The amount of the federal estate tax is determined by applying the relevant tax rates to the taxable estate.

Most property in the estate is valued at fair market value for computing the estate tax.

The estate tax is computed by finding the gross estate and taking deductions from gross estate to find the taxable estate. The resulting tax liability can be further reduced by credits.


Estimated Taxes

Individuals, corporations, estates, and trusts must make payments of estimated taxes in order to avoid a penalty for underpayment of estimated taxes. Most often, self-employed people need to pay quarterly installments of estimated tax. Similarly, investors, retirees, and others—a substantial portion of whose income is not subject to withholding—often need to make these payments as well. Besides self-employment income, other income generally not subject to withholding includes interest, dividends, capital gains, alimony, and rental income.

Because the U.S. tax system operates on a pay-as-you-go basis, taxpayers are required, by law, to pay most of their tax liability during the year. This means that an estimated tax penalty will normally apply to anyone who pays too little tax, usually less than 90%, during the year through withholding, estimated tax payments, or a combination of the two.

Exceptions to the penalty and special rules apply to some groups of taxpayers, such as farmers, fishermen, casualty and disaster victims, those who recently became disabled, recent retirees, and those who receive income unevenly during the year. In addition, there is an exception to the penalty for those who base their payments of estimated tax on last year’s tax. Generally, taxpayers will not have an estimated tax penalty if they make payments equal to the lesser of 90% of the tax to be shown on their current-year return or 100% of the tax shown on their prior-year return (110% if their income was more than $150,000). See IRS Form 2210 and its instructions for more information.



also known as: Code of Professional Conduct
Code of Ethics
Ethics Code

Ethics are the basic tenets that guide performance of professional responsibilities. The Code of Ethics was established by the AICPA to “express the profession’s recognition of its responsibilities to the public, to clients, and to colleagues.” They are “principles for honorable behavior, even at the sacrifice of personal advantage” and apply to all members of AICPA. Departures from the Rules must be justified. The Code of Ethics provides the basis for the self-regulation of the accounting profession and guides the behavior of all CPAs, regardless of the area of practice, in the performance of professional services.

The Principles are broad guidelines that provide the framework for the Rules. The Principles do not represent rules that must be followed and for which disciplinary action can be taken, but are the spirit behind the rules. They set the tone, the aspirations, and the ideals.

The Rules establish the fundamental behavior of a CPA professional. They are the minimum acceptable level of conduct. They form the basis for disciplinary action.

The Interpretations of Rules of Conduct are useful as guidelines on the scope of the rules. They answer many applicability questions. They are not enforceable, but deviations must be justified.

The Ethics Rulings are formal rulings made by the Professional Ethics Division’s Executive Committee. They are presented as factual questions and answers. Departures in similar circumstances need to be justified.

Note: Justice Potter Stewart defined ethics as “knowing the difference between what you have the right to do and what is right to do.



An expense is the outflow or other using up of assets or incurring of liabilities (or a combination of both) from delivering or producing goods, rendering services, or carrying out other activities that constitute the entity’s ongoing major or central operations (SFAC 6.80–.81). Expenses are recorded under the accrual method of accounting, in government called the “economic resources measurement focus.”GASB 1600


Face Amount
also known as: Face Value

The face amount (or face value) is specified (printed, stamped, or marked) on the note or bond that will be collected or paid at maturity. Face value equals the principal amount of an interest-bearing note or the face amount of a bond. It is more than the principal in a noninterest-bearing note.


Fair Labor Standards Act (FLSA)
also known as: FLSA

Also known as the Federal Wage and Hour Law, the Fair Labor Standards Act (FLSA) was enacted into law in 1938 to set standards for workers involved in interstate commerce. It also applies to employees in foreign commerce and employees of state and local governments. The Act addresses working conditions, minimum wages and hours, child labor rules, and issues of fair and equitable treatment of employees (e.g., equal pay for equal work).


Fair Market Value (FMV)
also known as: Market Value
Fair Value

The fair value of an investment is the amount that the asset could reasonably expect to receive for it in a current sale between a willing buyer and a willing seller, that is, other than in a forced or liquidation sale. Fair value shall be measured by the market price if there is an active market for the investment. If there is no active market for the investment but there is a market for similar investments, selling prices in that market may be helpful in estimating fair value. If a market price is not available, a forecast of expected cash flows, discounted at a rate commensurate with the risk involved, may be used to estimate fair value. The fair value of an investment shall be reported net of the brokerage commissions and other costs normally incurred in a sale.


Fair Value

also known as: Fair Market Value
Market Value

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants at the measurement date.


Federal Insurance Contributions Act (FICA)
also known as: Federal Old-Age, Survivor’s Disability Insurance
Social Security
Federal Insurance Contributions Act

The Federal Insurance Contributions Act (FICA) is:

    • legislation that provides for and administers social insurance (retirement, survivor’s, and disability insurance) and elderly medical assistance (Medicare),
    • a payroll tax, and
    • financed by employee and employer contributions based on a prescribed percentage of income up to a specified amount.

The federal government responded to the need for old-age support by creating Federal Old-Age, Survivors, and Disability Insurance (OASDI), a national program of social insurance provided for in the Social Security Act of 1935. The program’s objective was to cover all gainfully employed persons, including the self-employed, and excluding certain groups, such as persons employed by the U.S. government. Recent legislation has added all new employees of the U.S. government to FICA coverage.


Federal Unemployment Tax Cut (FUTA)

also known as: Unemployment Compensation

The Federal Unemployment Tax Act (FUTA) is federal legislation that:

    • provides temporary economic security for workers who lose their jobs by being laid off (quitting is not covered immediately) and who meet minimum requirements,
    • is a form of insurance,
    • is organized and administered by all states at federal instigation, and
    • is financed by employer contributions. This is paid by the employer only. It applies to the first $7,000 of earned income per employee, per year.

FUTA’s purpose is to compensate unemployed workers for the period of time that is needed to find a new job. The fund accumulates in periods of economic prosperity and is depleted in periods of economic recession, and is designed to act as a stabilizer of consumer consumption by supporting consumption during recessions.

Each state administers the program within its borders. The state programs are structured to follow the unemployment program described in FUTA.

FUTA stands for the Federal Unemployment Tax Act, while SUTA stands for state unemployment tax acts (a generic term used to apply to the provisions of the unemployment tax acts of the various states). For more information on this issue, see IRS Publication 15, (Circular E), Employer’s Tax Guide.


Financial Accounting Standards Board (FASB)

The Financial Accounting Standards Board (FASB) is an independent authoritative body, created in 1973 to replace the AICPA Accounting Principles Board, and authorized by the AICPA Code of Professional Conduct as a promulgator of generally accepted accounting principles (GAAP). The FASB’s main purpose is to establish accounting and reporting standards for large, publicly-owned corporations whose shares of stock are traded and registered in the United States.


First In, First Out (FIFO)

First in, first out (FIFO) is a cost flow assumption that matches the oldest costs to current sales revenues. It is based on the assumption that the oldest units are sold before units subsequently received (or produced) and thus are the first units used to determine cost of goods sold. As a result, the units left in ending inventory are the newest, or most recently received (produced), units.FIFO produces an inventory value that approximates current cost. The flow of costs approximates the usual physical flow of units (cash outflow is recognized in the same order as cash inflows). The criticism of this method is that it does not match current costs against current revenue—as costs are rising, reported income will be higher than under LIFO or average cost.


Financial Statements

Financial statements are the principal means of communicating financial information to those users external to the entity. They are a formal tabulation of names and amounts of items derived from the accounting records by simplifying, condensing, and aggregating. The financial statements are a fundamentally related set of tabulations that articulate with each other and derive from the same underlying data. SFAC 5.5

The full set of financial statements for an accounting period should show the following:

    • Financial position at the end of the period (balance sheet)
    • Earnings (loss) for the period (income statement)
    • Comprehensive income or loss for the period (income statement)
    • Cash flows during the period (statement of cash flows)
    • Investments by and distributions to owners during the period (statement of changes in owners’ equity and the statement of retained earnings)

Financial statements are representations of the assertions of management. The fairness of their presentation in accordance with accounting standards generally accepted in the United States of America or an applicable financial reporting framework is management’s responsibility. Their accuracy is essential to reporting accurate accounting information within a specific period and to illustrate the company’s financial health.

Audited financial statements are statements that have been subjected to an examination by a CPA according to the generally accepted auditing standards (GAAS) (i.e., the accountant has applied auditing procedures to the statements sufficient to permit the issuance of a report on them). Unaudited financial statements have not been the subject of such an examination. An accountant can still be “associated” with unaudited financial statements, however, if the accountant has prepared, assisted in preparing (compiling), or reviewed them.

In summation, this statement shows business owners, company’s management, and internal and external stakeholders’ financing activities in an accounting period, operating expenses, company’s assets, investing activities, gross profit, and provides a general portrait of an organization’s financial condition and bottom line.

These basic financial statements provide a snapshot of a period of time for a company, whether it be a large scale organization or a small business, and  insight into a company’s financial position in a specific period.


Fixed Costs vs. Variable Costs

Average fixed costs, otherwise known as AFC, is the fixed cost of production divided by the quantity of output. Meaning, these costs don’t vary with output and include rent, insurance, depreciation, and set-up costs. Average variable costs, or AFC, are costs that do vary with output – also known as direct costs. Examples of these include fuel for machinery, production materials, and various labor costs. For example: Consider the following hypothetical example of XYZ Co. The total fixed costs, TFC, include premises, machinery and equipment needed to construct boats, and are $100,000, irrespective of how many tons of mushrooms are produced. Total variable costs (TVC) will increase as output increases.

1 100 50 150
2 100 80 180
3 100 100 200
4 100 110 210
5 100 150 250
6 100 220 320
7 100 350 450
8 100 640 740


Plotting these figures shows us the total costs, total variable costs, and total fixed costs.


Total costssource:


Total fixed costs
Given that total fixed costs (TFC) are constant as output increases, the curve is a horizontal line on the cost graph.

Total variable costs
The total variable cost (TVC) curve slopes up at an accelerating rate, reflecting the law of diminishing marginal returns.

Total costs
The total cost (TC) curve is found by adding total fixed and total variable costs. Its position reflects the amount of fixed costs, and its gradient reflects variable costs.


Average fixed costs

Average fixed costs are found by dividing total fixed costs by output. As fixed cost is divided by an increasing output, average fixed costs will continue to fall.

1 100 100
2 100 50
3 100 33.3
4 100 25
5 100 20
6 100 16.6
7 100 14.3
8 100 12.5


Average fixed costs


The average fixed cost (AFC) curve will slope down continuously, from left to right.

Average variable costs

Average variable costs are found by dividing total fixed variable costs by output.


1 50 50
2 80 40
3 100 33.3
4 110 27.5
5 150 30
6 220 36.7
7 350 50
8 640 80

Average variable costs


The average variable cost (AVC) curve will at first slope down from left to right, then reach a minimum point, and rise again.

Calculating both average variable costs and average fixed costs can help influence businesses in a variety of ways. First, these figures can play a major role in adjusting costs of production (if needed), changing the number of units produced and total output, forecasting marginal returns, calculating any additional costs for the future, figuring out any possible marginal revenue, learning about the types of costs that can either be adjusted, determining whether output levels need to be tweaked, determining whether production costs need to be increased or reduced for following quarters or years, and generally identifying possible areas of cost decreases and cost functions.

Essentially, nailing down your knowledge of average variable costs and average fixed costs then determining the economies of scale relevant to your company can make you the perfect competition in your industry.


Form of Practice

also known as: Name of Practice
Firm Name
Form of Organization and Name Rule
Practice Name

The permissible form and name of accounting practice is the subject of the “Form of Organization and Name Rule” of the AICPA Code of Professional Conduct:

“A member may practice public accounting only in a form of organization permitted by law or regulation whose characteristics conform to resolutions of Council.

“A member shall not practice public accounting under a firm name that is misleading. Names of one or more past owners may be included in the firm name of a successor organization.

“A firm may not designate itself as ‘Members of the American Institute of Certified Public Accountants’ unless all of its CPA owners are members of the AICPA.”

ET 1.800.001

This rule specifies the restrictions on the form of organization and name of a public accounting practice. The concern of AICPA is to avoid misleading the public while permitting firms to better serve clients in non-attest areas. The Council Resolution Concerning the Form of Organization and Name (ET Appendix B) is the Institute’s attempt at this balance. Significant changes were made to the form of organization (and ownership):

“Resolved: …the characteristics of such a firm or organization under the ‘Form of Organization Name Rule’ (AICPA, Professional Standards, ET sec. 1.800.001) of the Code of Professional Conduct are as set forth below:

    1. “A majority of the ownership of the member’s firm in terms of financial interests and voting rights must belong to CPAs. Any non-CPA owner would have to be actively engaged as a member of the firm or its affiliates. Ownership by investors or commercial enterprises not actively engaged as members of the firm or its affiliates is against the public interest and continues to be prohibited.
    2. “There must be a CPA who has ultimate responsibility for all the services described in A above, compilation services and other engagements governed by Statements on Auditing Standards or Statements on Standards for Accounting and Review Services, and non-CPA owners could not assume ultimate responsibility for any such services or engagements.
    3. “Non-CPA owners would be permitted to use the title ‘principal,’ ‘owner,’ ‘officer,’ ‘member’ or ‘shareholder’ or any other title permitted by state law, but not hold themselves out to be CPAs.
    4. “A member shall not knowingly permit a person, whom the member has the authority or capacity to control, to carry out on his or her behalf, either with or without compensation, acts which, if carried out by the member, would place the member in violation of the rules. Further, a member may be held responsible for the acts of all persons associated with him or her in the public practice whom the member has the authority or capacity to control.
    5. “Owners shall at all times own their equity in their own right and shall be the beneficial owners of the equity capital ascribed to them. Provision would have to be made for the ownership to be transferred, within a reasonable period of time, to the firm or to other qualified owners if the owner ceases to be actively engaged in the firm or its affiliates.
    6. “Non-CPA owners would not be eligible for regular membership in the AICPA….”

ET Appendix B(A)

Application of Rules of Conduct to Members Who Own a Separate Business: This interpretation extends the Code to any business operated by a CPA which is of a type performed by CPAs. The CPA in public accounting:

“May own an interest in a separate business that performs for clients accounting, tax, personal financial planning, or litigation support services or other services, for which standards are promulgated by bodies designated by Council….If the member, either individually or collectively with the member’s firm or others in the firm, controls the separate business, then the separate business, its owners (including the member), and its professional employees must comply with the code.”

ET 1.810.010.01–.02



Fraud is the intentional misrepresentation or failure to disclose a material fact or facts that results in injury or loss to someone relying on it.

Elements necessary to prove fraud include the following:

    • A material (significant) misrepresentation or omission of fact
    • Knowledge of the falsity (scienter)
    • Intent that the misrepresentation be relied on
    • Actual reliance by another party
    • Resultant damage suffered as a result of reliance

Research shows that there are usually three conditions present when fraud occurs:

    1. A situational pressure (a nonshareable financial need)
    2. A perceived opportunity to commit and conceal the dishonest act (viewed as a way to secretly resolve the nonshareable pressure)
    3. Some aspect of the individual’s personal integrity that allows him to rationalize his dishonest behavior


Fraud in the Inducement

Fraud in the inducement is false representation or failure to disclose of a material fact knowingly made or omitted, justifiably relied upon in the making of the contract, and resulting in injury. It is antecedent fraud that occurs during the negotiation, precedes the making of the contract, and induced the other party to enter into the contract, and may be in the form of an act, an omission, a concealment, or a nondisclosure. A contract signed under fraud in the inducement is voidable at the option of the defrauded party. It is less serious than fraud in the execution and applies to common law and commercial paper only. (It does not apply to securities fraud.)


Fringe Benefits

Fringe benefits are compensation or other benefits received by an employee that are not in the form of cash. Some fringe benefits (e.g., accident and health plans and de minimis benefits) may be excluded from the employee’s gross income and, therefore, are not subject to federal income tax. Other fringe benefits (e.g., group term life insurance) may be totally or partially excluded from the employee’s gross income. If a fringe benefit is not specifically excluded from gross income by law, the benefit is taxable and must be included in the recipient’s pay.


Full-Time Student

A full-time student is an individual who is enrolled at and attends an educational institution during each of five calendar months of the taxable year of the taxpayer for the number of course hours which is considered to be a full-time course of study. The enrollment for five calendar months need not be consecutive. School attendance at night does not constitute a full-time course of study; however, a full-time course of study may include some attendance at night. Full-time status is determined by the number of hours at each particular college or university that is considered a full-time class load.

Regulation Section 1.151-3(b)


Gambling Losses

Gambling losses are a miscellaneous itemized deduction for money used for wagering. This deduction may only be claimed up to the amount of gambling income claimed in gross income. Gambling losses may only be claimed when a taxpayer itemizes deductions. No loss may be deducted when the taxpayer uses the standard deduction.


General Partner

also known as: General Partners

A general partner is a party who is publicly known and who actively engages in the management of the business and participates to the fullest extent in the profits and losses of the partnership. A general partner has apparent and actual authority to bind the partnership and has joint and several liabilities. A general partner has unlimited liability for partnership debts.


General Partnership

A general partnership is an association of two or more persons or entities to carry on as co-owners a business for profit. A general partnership is formed when two or more persons or entities enter into an agreement to carry on a trade or business with a sharing of the profits and losses between the partners. All partners in a general partnership are referred to as general partners. All of the general partners are jointly and severally personally liable for the debts and obligations of the partnership, unlike a limited partnership, where not all partners are personally liable.


Generally Accepted Accounting Principles (GAAP)

Generally accepted accounting principles (GAAP) are basic accounting principles and standards and specific conventions, rules, and regulations that define accepted accounting practice at a particular time by incorporation of consensus and substantial authoritative support.

The Financial Accounting Standards Board (FASB) Accounting Standards Codification (Codification) is the source of authoritative generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. In addition to the SEC’s rules and interpretive releases, the SEC staff issues Staff Accounting Bulletins that represent practices followed by the staff in administering SEC disclosure requirements, and it utilizes SEC Staff Announcements and Observer comments made at Emerging Issues Task Force (EITF) meetings to publicly announce its views on certain accounting issues for SEC registrants. (FASB ASC 105-10-05-1)

Accounting and financial reporting practices not included in the Codification are nonauthoritative. Sources of nonauthoritative accounting guidance and literature include, for example, the following:

    • Practices that are widely recognized and prevalent either generally or in the industry
    • FASB Concepts Statements
    • American Institute of Certified Public Accountants (AICPA) Issues Papers
    • International Financial Reporting Standards (IFRS) of the International Accounting Standards Board
    • Pronouncements of professional associations or regulatory agencies
    • Technical Information Service Inquiries and Replies included in AICPA Technical Practice Aids
    • Accounting textbooks, handbooks, and articles

The appropriateness of other sources of accounting guidance depends on its relevance to particular circumstances, the specificity of the guidance, the general recognition of the issuer or author as an authority, and the extent of its use in practice. (FASB ASC 105-10-05-3)


Generally Accepted Auditing Standards (GAAS)

Generally accepted auditing standards (GAAS) are the Statements on Auditing Standards issued by the Auditing Standards Board (ASB), the senior committee of the AICPA designated to issue pronouncements on auditing matter for nonissuers. The Compliance with Standards Rule (ET 1.310.001) of the AICPA Code of Professional Conduct requires any AICPA member who performs an audit of a nonissuer to comply with the standards promulgated by the ASB.



A gift is a transfer of property from one person or entity to another without consideration or compensation. For income tax purposes, the words “gift” and “contribution” usually have separate meanings. The word “contribution” is used in connection with contributions to charitable, religious, and similar organizations. The word “gift” refers to transfers of money or property to private individuals, friends, relatives, etc.The recipient of a gift is not required to include it in gross income, and the maker of the gift is not entitled to deduct it (except for business gifts to customers of $25 or less). The donor may be required to file a gift tax return and pay gift taxes.In the case of gifts given in the course of a taxpayer’s trade or business, the taxpayer is able to deduct all or part of the cost. The maximum deductible amount is $25 per donee per year plus any incidental costs. Pursuant to IRS Publication 463, incidental costs include, but are not limited to, engraving on jewelry, packaging, insuring, and mailing.


Gift Tax

The federal gift tax is a graduated tax paid by the donor when assets are transferred between individuals as gifts. Any transfer without adequate compensation could be considered a gift, whether or not it is intended as a gift. Many states have similar taxes.Generally, a gift tax liability will not be triggered by small gifts due to the annual exclusion and the unified credit. The annual exclusion allows anyone to make gifts, up to a certain amount, to any individual in any year on a tax-free basis. The exclusion applies for gifts to each donee, so that a donor could give gifts to multiple donees during a tax year and not pay any gift tax. Payments made directly to an educational institution, a medical care provider for the expenses of another individual, a charitable organization, a political organization for its use, or a spouse are also free of gift tax. Gifts that exceed the annual exclusion and are not for the reasons just mentioned are subject to gift tax. Each taxpayer is entitled to an applicable credit amount.


Good Faith

also known as: Subjective Test for Good Faith

Good faith has several meanings, depending on the situation.

For financial instruments: Did the particular person asserting the status of “holder in due course” take the instrument honestly and without notice? (The objective test would be to ask, would a reasonable person have known?)

For bankruptcy law: The debtor proposing reorganization under Chapter 13 is required to demonstrate good faith by two elements:

    1. Honesty of purpose
    2. Full disclosure of financial facts

For commercial law: Factual honesty in conduct and transactions. For merchants, it is observance of reasonable commercial standards of fair dealing in addition to factual honesty.


The Government Accounting Standards Board (GASB)

The Government Accounting Standards Board (GASB) is the body authorized to promulgate standards of financial accounting and reporting for governmental units. It was created by the Financial Accounting Foundation (FAF) in 1984 as successor to NCGA and is recognized by the AICPA Code of Professional Conduct as an authorized body whose pronouncements must be followed in order to conform to the Compliance with Standards Rule and Accounting Principles Rule (ET 1.310.001 and 1.320.001).

The GASB’s authority derives from Appendix A of the AICPA Code of Professional Conduct.

The GASB is an independent authoritative body created in 1984, under the oversight of FASB and the Governmental Advisory Council of the Financial Accounting Foundation (FAF) and is authorized by the AICPA Code of Professional Conduct as a promulgator of generally accepted accounting principles (GAAP).


Gross Income

Gross income is all revenues from whatever source derived minus certain exclusions, which are specifically provided by law. It includes both earned income (salary, wages, tips, professional fees, business or farm income, and other compensations received for personal services performed) and unearned income (interest, dividends, rents, royalties, capital gains, unemployment, and some Social Security benefits).

Some sources of income are not included in gross income, such as welfare, Veterans Administration (VA) disability, workers’ compensation, insurance benefits, damages for injury or illness, child support, gifts, inheritance, life insurance proceeds received because of a person’s death, and some scholarships.

IRC Section 61


Gross Income Test
also known as: Income Test

The gross income test is a test for dependent status: the amount of gross income that may be earned by a potential dependent to maintain status as a dependent under the qualifying relative rules. This limit is usually equal to the personal exemption, which is indexed for inflation. The qualifying relative must not provide over one-half of such individual’s own support. Nontaxable income (e.g., welfare or some Social Security benefits, or income earned by totally and permanently disabled individuals for services performed in a sheltered school or workshop) is not included in gross income for purposes of determining whether someone is a qualifying relative. (See dependent.)

IRC Section 152


Guaranteed Payment

also known as: Fee
Guaranteed Minimum

Guaranteed payments are payments made by a partnership to a partner for services rendered or for the use of capital, to the extent that such payments are determined without regard to the income of the partnership. Such payments are treated as though they were made to a nonpartner and are either deductible or capitalized by the partnership depending upon the nature of the transfer. This treatment is for purposes of determining gross income and deductible business expenses only. For other tax purposes, guaranteed payments are treated as a partner’s distributive share of ordinary income. Guaranteed payments are not subject to tax withholding as are payments to partnership employees.

The payments are generally deductible by the partnership on IRS Form 1065 as a business expense. They are included in Schedules K and K-1 of the partnership return and are reported by the individual partner on Form 1040, Schedule E, as ordinary income, in addition to the appropriate distributive share of the other ordinary income from the partnership.

Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenditures and are generally not deductible by the partnership. However, these payments generally must be included in the partners’ Schedule K-1 as guaranteed payments.

A partner includes the guaranteed payments in income in the partner’s tax year in which the partnership’s tax year ends.

Sometimes guaranteed payments can come in the form of “guaranteed minimums.” This payment is the amount that the minimum payment exceeds the partner’s distributive share of taxable income of the partnership before taking into account the minimum payment.


Head of Household

Head of household is a special filing status between married filing jointly and single. Head of household is the filing status of a taxpayer who is unmarried or considered unmarried on the last day of the tax year, who is not a surviving spouse, who maintains a home (i.e., provides over 50% of the cost of keeping up a home), and who had a qualifying person live in his or her home for more than half the year (not including temporary absences like school). A taxpayer can determine whether someone is considered a qualifying person for purposes of the Head of Household filing status by using Table 2-1 in IRS Publication 17, Your Federal Income Tax for Individuals.

Exception: A dependent parent need not live with the taxpayer as long as the taxpayer maintains the household that the parent lives in (provides over 50% of the support for the household).



A hedge is a protection against loss, specifically against a foreign exchange loss. It is the act of buying (or selling) a foreign currency for future delivery on the same date that the entity enters into a foreign currency transaction in order to eliminate the risk of (“exposure to”) fluctuations in the exchange rate, i.e., the gain or loss that results from the foreign currency transaction—the purchase or sale of goods denominated in a foreign currency—is exactly offset by a loss or gain on the hedging transaction because the exchange rate for both (opposing) transactions are the same on both the date the transactions were entered into and the date they were settled.FASB ASC 815-10Hedges may also be speculative, i.e., a forward contract that does not cover an open receivable or payable—a forward contract designated as an economic hedge of a net investment (the ownership interest) in a foreign entity or purely speculating that the exchange rates will move in an expected direction. Any gain or loss resulting from such hedges is recognized as a separate component of equity (similar to the recognition of translation gain or loss).FASB ASC 815-10-30-5



A holder is a party that has possession of a negotiable instrument that is drawn, issued, or indorsed to that party or was issued to bearer or indorsed in blank. The holder has the right to transfer (negotiate) the instrument, to discharge it, or to take payment. Both personal and real defenses are good against a holder. (Personal defenses are not good against a holder in due course.)

A holder has the right to (1) seek payment, (2) seek redress from secondary parties if the instrument is not paid (dishonored), or (3) negotiate the instrument to someone else (as payee or indorser).


Holder in Due Course (HDC)

also known as: HDC

The holder in due course (HDC) is the party who (1) holds (is a holder of) an instrument and takes the instrument (2) for value, (3) in good faith (according to the subjective test) and (4) without notice (knowledge) of any claim, dishonor, or defense against it (U.C.C. 3-302):

HDC = H + V + GF(s) + w/o N (c,d,d)

(The subjective test for good faith is “pure heart, empty head,” i.e., did the particular person asserting HDC status take the instrument honestly and without notice? The objective test would ask would a reasonable person have known?)

HDC rights are greater than those of the transferor.

Rights of HDC: HDC takes the instrument free from all title claims to it by any party and free from all personal defenses; only real defenses are good against HDC (e.g., instrument is void due to incapacity, illegality of subject, duress, etc.; is voidable due to infancy, fraud in the execution; unauthorized signatures; fictitious payees and wrongdoing agents; material alteration; discharge in bankruptcy). (U.C.C. 3-305)

Only HDC is entitled to the distinct benefits of negotiability. Following are the steps to attain the status of holder in due course:

    • The instrument must be negotiable.
    • The party asserting the rights must be a holder, i.e., he must take by negotiation.
    • The holder must satisfy the requirements for holding in due course.
    • Any defense asserted must be a personal defense (as contrasted with a real defense) (i.e., HDC is immune to personal defense).

Requirements for holding in due course:

    • Must be a holder, i.e., the payee or a transferee who takes via negotiation of a negotiable instrument
    • Must take the instrument for value (U.C.C. 3-303):
      • by paying or performing the agreed consideration (Note: an executory promise does not qualify as value unless it is irrevocable, i.e., contractual.)
      • by acquiring a security interest
      • by taking the instrument in payment of, or as security for, an antecedent debt
      • by giving one’s own negotiable instrument in exchange
      • by giving an irrevocable commitment to a third person
      • by withdrawing the value of the instrument from the bank account (e.g., “cashing in” a certificate of deposit)
    • Must take the instrument in good faith (honestly) and without notice (knowledge) that the instrument is overdue, has been dishonored, or that any party has a defense against or claim on it.


Holding Period

A holding period is the period of time property has been owned for income tax purposes. The holding period determines if gain or loss from the sale or exchange of a capital asset is long term or short term. Generally, when the basis of the asset carries over in a tax-deferred transaction, the holding period of the transferee tacks onto the holding period for the transferor. All assets that are received from an estate are long-term assets in the hands of the beneficiary regardless of the actual time of ownership.

Hope Credit (American Opportunity Tax Credit)

also known as: American Opportunity Tax Credit
Hope Credit

The American opportunity tax credit (AOTC) is a credit for qualified education expenses paid for an eligible student for the first four years of higher education. A taxpayer can get a maximum annual credit of $2,500 per eligible student. If the credit brings the amount of tax owed to zero, the taxpayer can have 40% of any remaining amount of the credit (up to $1,000) refunded.

The amount of the credit is 100% of the first $2,000 of qualified education expenses paid for each eligible student and 25% of the next $2,000 of qualified education expenses paid for that student. However, if the credit pays the tax down to zero, the taxpayer can have 40% of the remaining amount of the credit (up to $1,000) refunded.


House Ways and Means Committee

The House Ways and Means Committee is a permanent committee of the U.S. House of Representatives that makes recommendations to the full House for raising revenue for the government.


IDC Preference

When calculating regular taxable income, a taxpayer can capitalize or expense intangible drilling and development costs (IDC). IDC has no salvage value. Examples of IDC include costs paid for labor, fuel, repairs, hauling, and supplies used:

    • in drilling, shooting, and cleaning wells;
    • to prepare for drilling of wells such as cleaning of ground, draining, road-making, surveying, and geological work; and
    • to construct derricks, tanks, pipelines, etc.

The intangible drilling and development costs (IDC) tax preference for alternative minimum tax is the excess of the “excess IDC” for the year over 65% of the taxpayer’s net income from oil, gas, and geothermal property.


Implied Warranty

also known as: Implied Warranties

Implied warranty is one of the three types of warranties (implied, express, and warranty of title) provided by the U.C.C. (Uniform Commercial Code) on the sale of goods. It is a guarantee that rests so clearly on a common factual situation or set of conditions that it is automatically imposed on the goods by operation of law without any agreement or consent of the parties. It can be excluded or modified only by specified procedures.

Types of implied warranties:

    • Merchantability—Goods shall be fit for the purpose for which they are sold; applies only to merchants who deal in the type of goods being sold. To be merchantable, goods must:
      • pass without objection in the trade under the contract description.
      • be of fair average quality as described (applies to fungible goods only).
      • be fit for the ordinary purpose for which such goods are used.
      • be within the variation of an even kind, quality, and quantity within each unit and among all units.
      • be adequately contained, packaged, and labeled as required by the agreement.
      • conform to the promises or affirmations of fact made on the container or label (if any).
    • Fitness for a Particular Purpose is imposed on the seller if:
      • the seller has actual or constructive knowledge of the particular purpose for which the buyer needs the goods.
      • the seller must furnish or select the goods.
      • the buyer must rely on the seller’s skill or judgment to select or furnish the goods.

Can be disclaimed if in writing and conspicuous; must mention “merchantability”; terms such as “as is” or “with all faults” act as an exclusion; can be excluded by course of dealing, course of performance, or usage of the trade.

The U.C.C. has reduced or eliminated the requirement of privity.

Contrast warranty to common law negligence and strict liability.


Imputed Interest

also known as: Interest Free Loan

Interest must be imputed or charged on debt obligations issued where no interest is provided for or if the rate of interest is less than the interest rate that would be reasonable to charge the debtor under the circumstances; that is, a market interest rate. If the face amount of the note does not represent the present value of the exchange, then interest is imputed. These debt obligations include:

    • noninterest bearing notes or
    • notes with unrealistic low interest rates.


Inactive Partner

An inactive partner is a partner who does not actively work in the partnership nor the management of the partnership.


Income in Respect of a Decedent (IRD)

also known as: IRD

Income in respect of a decedent (IRD) for a cash-basis taxpayer consists of taxable income that the deceased earned or otherwise was entitled to but failed to receive before their death.


Income Tax

Income tax is a federal, state, or local tax based on income (domestic or foreign).



also known as: Indemnity


To indemnify is to provide compensation for loss or damage sustained or protection or security from future loss or damage. It is the duty of the principal to the agent, to protect the agent from loss and liability for acts that are not illegal or known to be wrong, performed at the direction of the principal. Corporations often indemnify members of the board of directors. Insurance is a form of indemnity.

Indemnity involves a two-party contract; the indemnitor (principal, insurance company, corporation) assumes the risk of loss. There is no default on the part of the party indemnified (agent, insured party, board member). (Contrast to suretyship).



also known as: Independent
Independence Rule

To be independent is to be free from conflicts of interest and bias, self-governing, impartial, not subject to control by others, not requiring or relying on something else, not contingent, and acting with integrity and objectivity (i.e., with judgment that is unimpaired and without bias or prejudice).

Independence Rule (ET 1.200.001): “A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council.” (ET

Independence is the cornerstone on which the audit, or attest, function of the accounting profession is based. It is the independence of the auditor that assures the public of the fair presentation of the audited financial statements. The audit opinion is the “Independent Auditor’s Report” (AU-C 600.A98 requires that the word “independent” appear in the title of the report).

The auditor’s independence recognizes the need for fairness—fairness to the owners and managers of the company and also to creditors and those who may rely wholly or in part on the auditor’s report.

Independence is the ability to act with integrity and objectivity and not to compromise one’s judgment or conceal or modify an honest opinion. Auditors (both external and internal) must be capable of acting in an honest, unbiased fashion, maintaining the ability to use judgment free from influence by or subordination to the will, opinion, and judgment of others.

The CPA must be independent not only in fact but also in appearance. This means both that a true conflict must not exist (the fact of independence) and that the appearance, or impression, of conflict must not exist (the appearance of independence). Hence, there must not be a compromise to the perception of the independence of the CPA in the mind of a reasonable observer, no matter how innocent the questionable circumstances may truly be. Any appearance of the lack of independence would erode the public’s confidence in the profession as quickly as the fact of a lack of independence.

The “reasonable person” concept is applicable, i.e., whether or not a reasonable person, having all the facts and the normal strength of character, concludes that a specific relationship is lacking in independence, represents a conflict of interest, or is a threat to a CPA’s integrity or objectivity.


Independent Contractor
also known as: Independent Contractors

An independent contractor is a party who is not subject to control and supervision by the party who employs the contractor. The employer seeks results only—the contractor controls the methods. No agency relationship exists and the employer is not liable for the torts of the contractor. Control is the key element. Attorneys and CPAs are usually independent contractors. The IRS also uses a 20-factor test to help determine whether an individual is an employee or an independent contractor. An independent contractor’s earnings are subject to self-employment tax.


Indirect Costs

An indirect cost is a cost that is not directly traceable to the manufactured product, is associated with the manufacture of two or more units of finished product, or is an immaterial cost that cannot be economically traced to a single unit of finished product.


Individual Retirement Account (IRA)

Qualified taxpayers may annually set aside limited amounts of earned income for a retirement fund. The amount set aside may be deductible, partially deductible, or nondeductible depending on whether the taxpayer is an active participant in an employer-maintained retirement plan, the amount of AGI, and the amount of the contribution. Money earned by an IRA is tax-deferred until withdrawn. Specific requirements cover the withdrawal of funds from IRAs, and there are penalties for noncompliance.The Roth IRA is similar to a traditional IRA with a few exceptions. Contributions to a Roth IRA are always nondeductible, do not depend on whether the taxpayer or spouse is an active participant in a company-sponsored qualified retirement plan, and may be made after the taxpayer attains the age of 70-1/2. In addition, qualified distributions, including earnings on contributions, are nontaxable.



also known as: Endorsee

The indorsee (or endorsee) is the party to whom/which indorsement is made on a negotiable instrument. The indorsee becomes the payee on the instrument. (The spelling beginning with an “i” instead of an “e” is the common legal spelling.)


also known as: Indorsements

An indorsement is a signature usually put on the reverse side of an instrument, with or without other words, for the purpose of transferring ownership in the instrument. It is the critical element of negotiation. Indorsement has no effect on negotiability; indorsement cannot make a nonnegotiable instrument negotiable. Negotiability is determined by the face of the instrument.

Indorsements can be classified by three pairs of indorsement types: blank or special, restrictive or nonrestrictive, and qualified or unqualified.

Types of indorsements include the following:

    • Blank: transferor’s signature alone; names no specific payee/indorsee; converts order paper to bearer paper; unqualified, nonrestrictive. (The words “pay to the order of” are the magic words for negotiability, but they are not required for negotiation.) Example: Signature alone. Unqualified, nonrestrictive: Example: Pay X, signature; or Pay to the order of X, signature.
    • Special: includes reference to a specific person as the indorsee to whom or to whose order the instrument becomes payable; converts bearer paper to order paper; subsequent negotiation requires additional indorsement (by the indorsee). Unqualified, nonrestrictive: Example: Pay X, signature; or Pay to the order of X, signature.
    • Restrictive: includes additional words that add qualifications.
      • Conditional: adds a condition precedent to payment. Example: Pay if and only if…., signature or Pay upon completion of (name task), signature
      • Restrictive: limits the payment on the instrument. Example: For deposit only, signature.
    • Qualified: transferor disclaims contract liability on the instrument (i.e., he does not promise to pay upon dishonor). Example: Without recourse, signature.

Indorsements may be combined:

    • Blank, qualified, restrictive—Without recourse, for deposit only, signature.
    • Special, qualified, restrictive—Pay to X Bank, for deposit only, without recourse, signature.
    • Special, restricted—Pay X upon completion of Y project, signature.
    • Special, qualified—Pay X, without recourse, signature.

U.C.C. 3-417


also known as: Endorser

The indorser (endorser) is the party that puts signature on a negotiable instrument for the purpose of transferring ownership in the instrument. The indorser has secondary liability on the instrument. (The spelling beginning with an “i” instead of an “e” is the common legal spelling.)


In-Kind Distribution

also known as: Barter
Goods for Service

In-kind distributions are goods or services that are received as a result of performing or exchanging work. For instance, if Joe Smith works for the Amalgamated Widget Factory and is paid in widgets rather than cash, this constitutes an in-kind distribution. The amount received from this type of transaction is includible in income at the fair market value of the goods received. This is often referred to as “bartering.”


Inside Basis
also known as: Adjusted Basis

Inside basis is the adjusted basis of contributed property in the hands of the partnership kept on a tax basis. The inside basis for a partnership is governed by IRC Section 723 that employs the aggregate theory to give the partnership a carryover basis in the assets contributed. The inside basis should be contrasted to the “outside basis,” which is the partner’s adjusted basis in his or her partnership interest.



With respect to federal securities regulations, an insider is any person or party in a position or deemed to be in a position to obtain information not available to the general investing public, specifically: officers and directors, any holder of more than 10% of the registered stock, any controlling party, any party with a “special relationship” with the issuing entity (e.g., bankers, brokers, underwriters, employees of the entity who are in “audit sensitive” positions and who are in a position to know specific financial information), and anyone who receives information from such parties. Trading by insiders is strictly controlled by federal securities laws. The term is used and defined in the federal securities laws; similar terms include “related party” and “controlling person”—an insider need not be a controlling person or a related party.With respect to bankruptcy, an insider is any person or party in a position to receive preferential treatment from a debtor, specifically: relatives or general partners of the individual debtor, directors, officers or “controlling persons” (see above) of a corporate debtor, or any elected official or relative of an elected official of a governmental debtor. Preferential transfers made to insiders by the debtor within one year of filing for bankruptcy may be set aside (avoided) by the trustee (see preference).



also known as: Insolvency

In the general equity sense (financial accounting), insolvency is a financial condition whereby an entity is unable to meet its obligations as they become due. It may be simply a cash flow problem (e.g., insufficient funds to cover checks). This is a more general definition than that used in voluntary bankruptcy. It is used in cases of involuntary petitioning under Chapter 7. It is simpler, less demanding, and more easily proven than insolvency in the bankruptcy sense.

In bankruptcy, insolvent is the financial condition in which debts exceed the fair value of nonexempt assets. It is the definition used in the Bankruptcy Act in all cases except involuntary petitioning under Chapter 7. Insolvent is a stricter, more demanding definition than in the equity sense.


Installment Method

The installment method is a method of accounting enabling a taxpayer to spread the recognition of gain on the sale of property over the payment period. Under this procedure, the seller computes the gross profit percentage from the sale (i.e., the gain divided by the contract price) and applies it to each payment received to arrive at the gain to be recognized.


Installment Sales

Installment sales is a sale method that allows the buyer to make regular payments, or installments, on a periodic basis.Taxpayers may account for installment sales by using the installment method, which spreads the recognition of gains ratably over the years of receipt. Taxpayers are allowed to opt out of the installment method by using the deferred payment method and report the entire gain in the year of sale.IRC Section 453


Insurable Interest

Insurable interest is any legally recognized or substantial economic interest in the safety and preservation of the insured property; the right to collect on insurance; the existence of an insurable interest is the difference between a legal insurance contract and wagering; the party with an insurable interest will suffer some kind of loss or pecuniary damage if the specified property is damaged or destroyed; may reside with both buyer and seller (mortgagor/mortgagee, bailor/bailee, etc.) of the property at the same time.For property insurance, insurable interest must exist at the time of the loss. As a general rule, the Uniform Commercial Code (in Article 2) correlates the risk of loss (and hence the existence of an insurable interest) not only with title, but also with possession irrespective of title and the breach (i.e., the party who breaches a contract assumes the risk of loss). It also attempts to establish the buyer’s insurable interest in the goods at the earliest possible moment (without impairing any insurable interest of any other party recognized through other statutes):

The buyer obtains a “special property and insurable interest” in goods by identification of existing goods to the contract (even if the goods are nonconforming and the buyer has the right of return).

The seller retains an insurable interest so long as any title to, or security interest in, the goods remains.



Insurance is a contract under which, for a stipulated consideration (premium), one party (the insurer) will indemnify (compensate) the other party to the contract (the insured) or a third-party beneficiary for loss from specified causes.

Among other possible uses, insurance:

    • is a method of spreading risk among a large group;
    • covers loss of property interest due to fire, theft, etc. and from the negligence of the insured and the torts of employees of the insured (e.g., arson); and
    • compensates for loss of earning power (accidental injury, health, disability, business interruption, unemployment, retirement, and life insurance) and for liability for loss to a third party caused by the insured (auto, personal injury, and property damage).


Intangible Asset

also known as: Intangibles
Intangible Property

Intangible assets are nonphysical and nonfinancial assets (lacking physical substance) whose value derives from the rights that their ownership confers (e.g., goodwill). The evidence of existence of an intangible asset is elusive, value is often difficult to estimate, and useful life is often indeterminable. It may confer operating, financial, or other income-producing benefits; is recorded at cost (acquisition cost if purchased, cost to develop, maintain, and defend if generated internally); and is amortized in a systematic and rational way (straight-line) over the periods that are estimated to benefit (except goodwill, which is evaluated periodically for impairment).

Classification is based on several characteristics:

    • Identifiability: separately identifiable or lacking separate identification (only goodwill is unidentifiable)
    • Manner of acquisition: purchased or developed internally
    • Expected period of benefit: limited by law or contract, related to human or economic factors, or of indefinite or indeterminate duration
    • Separability from entire enterprise: rights transferable without title, salable, or inseparable from the enterprise

Assets usually included in this term are the long-lived intangible assets usually acquired as operational assets, patents (legal life = 17 years), copyrights (legal life = author’s life plus 70 years; accounting life = 40 years), trademarks, franchise rights, and goodwill.

Internally generated intangible assets (e.g., patents) are capitalized according to FASB ASC 730-10-05. Development costs are expensed, and only costs associated with registration, maintenance, and legal defense are capitalizable (e.g., legal fees, registration fees, costs of models and drawings, and costs of successful court defenses).

For tax purposes, acquired intangible assets that are defined as IRC Section 197 intangibles can be amortized over 15 years.


Intellectual Property Rights

also known as: Intellectual Property

The U.S. recognizes four kinds of intellectual property protection:

    1. Patents
    2. Trademarks
    3. Copyrights
    4. Trade secrets

Patents give owners exclusive rights for 17 years from the date of patent to manufacture, use and sell the patented product within the United States.

Trademarks (e.g., marks, logos, insignias) associated with a company’s goods can be registered and thereby protected in the United States from duplication by another company for 10 years. Unlike patents, trademark registrations can be renewed.

Copyrights grant an author (or holder of a copyright) the exclusive right to publication of written or artistic work. Such publication rights can be granted to other parties at the discretion of the copyright holder.

Trade secrets are those processes (tools, plans, methods of operation, etc.) that are closely held by a given company to provide a business advantage. The regulation of trade secret rights in the United States is within the jurisdiction of state rather than federal laws.

Intellectual property right protection varies greatly by country. International companies are therefore advised to thoroughly research intellectual property rights and enforcement standards prior to conducting business in a foreign country.



Interest is the charge for the use of money over time. It is the time value of money. Interest is the amount paid (or received) in excess of the amount borrowed (loaned). Interest is a financing expense (income) and is dependent on the interest rate, the principal amount, and the number of interest periods.

    • Interest = Principal × Interest rate × Time periods
    • Interest = Amount to be repaid – Amount received (loaned)

Simple interest: Interest is computed on the same principal amount each time period, regardless of the amount of interest accrued to date.

Compound interest: Interest is charged on the principal plus all interest previously accrued (interest computed on interest).

In macroeconomics, interest is a factor payment or factor income. It is a component of gross national product (GNP) (approximately 10%) and is used in the income approach to national income accounting. Interest includes payments received from banks on savings, from firms on loans, and other miscellaneous income.

Interest is analogous to wages, rent, and profit as a component of factor payments or factor income.


Internal Audit
also known as: Internal Auditing

An internal audit is an examination of accounting records and other evidence to establish compliance with the entity’s policies and procedures. An internal audit is performed by an employee of the entity. (See “audit” for the definition of an external audit.)


Internal Control Questionnaire (ICQ)

An internal control questionnaire (ICQ) is a series of questions about specific internal controls. The questions are generally designed to be answered “yes,” “no,” and “not applicable.” The answers to the questions are obtained by inquiry (asking questions of employees), observations by the auditor, or tests of records and transactions by the auditor.


Internal Controls

also known as: Internal Control

Internal controls are the policies and procedures established by management to provide reasonable assurance that its objectives will be achieved. These policies and procedures are categorized several ways:

    • Accounting controls
    • Administrative controls (management controls)
      • Formal policies and directives such as board of director’s resolutions, office manuals, and written instructions
      • Informal policies and procedures such as oral directions from a supervisor
      • Implicit policies and procedures such as unwritten and unspoken operating habits and standards


Interperiod Tax Allocation

also known as: Interperiod Allocation

Interperiod tax allocation is apportionment of the income tax expense for the current year between the tax payable in the current year and a deferred tax liability that may or may not become payable in future years. It is apportionment among accounting periods and is necessitated by differences in the treatment of certain items under GAAP for financial reporting and under the tax law for income tax purposes.

Basic principles of interperiod allocation are as follows:

    • A current or deferred tax liability or asset is recognized for the current or deferred tax consequences of all events that have been recognized in the financial statements.
    • The current or deferred tax consequences of an event are measured based on provisions of the enacted tax law to determine the amount of taxes payable or refundable currently or in future years.
    • The tax consequences of earning income or incurring losses or expenses in future years or the future enactment of a change in tax laws or rates are not anticipated for purposes of recognition and measurement of a deferred tax liability or asset.

Deferred tax liability/asset is recognized by the liability method (not the deferral method).

Basic features of interperiod tax allocation are as follows:

    • All temporary differences are related to differences in the timing of accounting recognition compared to tax recognition.
    • All temporary differences originate, and then reverse, with a net effect of zero.
    • Income tax expense is recognized (i.e., matched) in the period in which the tax effect is incurred rather than when it is reported on the tax return.
    • A deferred tax liability (credit balance) represents a future tax liability; a deferred tax asset is a future tax benefit to be realized.

FASB ASC 740-10-30-5


Intraperiod Tax Allocation

Intraperiod tax allocation is apportionment of the income tax expense for the current accounting period (as determined by application of the liability method to achieve interperiod tax allocation) among the components of the income statement: operating income, income from discontinued operations, accounting changes, prior-period adjustments, and other direct adjustments to capital accounts. Intraperiod tax allocation affects only the reporting, not the recording, of income tax expense. The tax effect is reported along with the particular item which gives rise to the effect.

FASB ASC 740-20-05-1



The aggregate of items of tangible personal property owned by the business (to which the firm has legal title) intended either for internal consumption in the production of goods for sale or for sale is considered inventory. The balance of costs applicable to goods on hand, including raw materials (for use in the production process), intermediate products and parts still in the production process (work-in-process), and finished goods is also considered inventory.

The major objective of accounting for inventories is to facilitate the determination of income. This is achieved through the proper valuation of inventories—the measurement of the value of the current assets and inventories, and the measurement of the related expense and cost of goods sold.

The basis of inventory accounting is cost. Inventories are valued at acquisition or production cost, which is generally held to be the sum of the purchase price plus indirect acquisition costs (freight, insurance, and handling) for purchased goods and the sum of direct materials, direct labor, and allocated factory overhead (i.e., the appropriate general and administrative costs that are clearly related to production) for manufactured goods. Selling, general, and administrative costs not directly related to production should be expensed rather than included in the valuation of inventory, which involves the use of judgment.

Standard costs may be used for inventory pricing so long as they are adjusted at reasonable intervals to reflect current conditions.

Valuation (pricing) of inventories involves:

    • determination of physical quantity (number of units) and
    • unit cost (in dollars).

Unit cost depends on the choice from among various alternative pricing (cost flow) assumptions:

    • last-in, first-out (LIFO),
    • first-in, first-out (FIFO),
    • weighted average, and
    • specific identification.

Consideration must also be given to the cost principle (i.e., the lower-of-cost-or-market rule (LCM)).

Inventories must be compiled periodically (physical count) and valued and compared to the amounts recorded in the accounts. Accounting records can be maintained under a periodic or perpetual system.

FASB ASC 330-10


IRS Section 1244 Stock

also known as: Section 1244 Stock

IRC Section 1244 stock is corporate stock (either common or preferred) that qualifies under IRC Section 1244. If an individual taxpayer generates a loss by sale, exchange, or the stock becoming worthless, such loss can be treated as an ordinary loss rather than a capital loss. Section 1244 stock is also known as small business stock.

To qualify as small business stock, the stock must be issued by a domestic C corporation that was a small business corporation that invests 80% of its assets in the active conduct of a trade or business and that had assets of $50 million or less when the stock was issued. The stock must have been issued for money or property. To remain qualified as Section 1244 stock, the corporation must generate more than 50% of its gross receipts from nonpassive sources during the 5 years ending before the date the stock sustains its loss.


IRS Section 1245 Recapture

also known as: Section 1245 Recapture

IRC Section 1245 assets are assets, primarily consisting of equipment used in a trade or business, and some specified real property, subject to the provisions of Section 1245 of the tax law. Section 1245 denies the long-term capital gains treatment accorded to noncapital assets by Section 1231 because the gain is considered to be a recovery of some or all of the depreciation of ACRS-MACRS allowances (i.e., accelerated depreciation) that were previously deducted. Any gain on Section 1245 property will be treated as ordinary income to the extent of all depreciation or ACRS or MACRS deductions taken previously. Any gain that is not recaptured as ordinary income is treated as Section 1231 gain.

Section 1245 assets include tangible and intangible personal property, including equipment used in trade and business and all ACRS or MACRS property other than real property for which a straight-line recovery election was made, and many types of real property.


IRS Section 179

IRC Section 179 is a provision of the tax law that allows the taxpayer to elect to expense up to a certain amount of tangible depreciable personal property placed in service during the year.

The basis of the asset(s) is reduced by the amount of the IRC Section 179 property expensed. The amount expensed cannot exceed the taxpayer’s aggregate taxable income from trade or business activities.

The maximum amount that can be deducted for most Section 179 property placed in service in tax years beginning in 2018 is $1,000,000. This limit is reduced by the amount by which the cost of Section 179 property placed in service during the tax year exceeds $2,500,000. For property placed in service in tax years beginning after December 31, 2017, Section 179 qualified real property is qualified improvement property (as defined in IRC Section 168(e)(6)), and certain specified improvements to nonresidential real property placed in service after the nonresidential real property was first placed in service. Computers and related peripheral equipment placed in service after December 31, 2017, in tax years ending after December 31, 2017, are not listed property.


IRS Section 444 Election

also known as: Non-Calendar Tax Year
Section 444 Election

An IRC Section 444 election is an election by some business types—partnerships, personal service corporations, S corporations, and electing S corporations—to have a taxable year that ends on a date other than the organization’s required tax year. This election is made on IRS Form 8716, Election to Have a Tax Year Other than a Required Tax Year.

Partnerships and S corporations making a Section 444 election must make required tax payments for the amount they would have owed had they used the required tax year, if these payments exceed $500. Personal service corporations making a Section 444 election must make minimum distributions to employee-owners by the end of a calendar year falling within a tax year in order to avoid certain deduction deferrals for amounts paid to employee-owners.

Generally, a partnership’s required tax year is the tax year of its owners, unless it can establish a business purpose for having a different tax year. An S corporation or personal service corporation must generally use the calendar year unless they can establish a business purpose for having a different tax year.

According to IRS Publication 538, a partnership, S corporation, or personal service corporation can make a Section 444 election if it meets all of the following requirements:

    • It is not a member of a tiered structure (as defined in Regulation Section 1.444-2T).
    • It has not previously had a Section 444 election in effect.
    • It elects a tax year that meets the deferral period requirement.


Itemized Deductions

also known as: Itemized Deduction

Itemized deductions are deductions from adjusted gross income (AGI) that must be listed separately (on Schedule A of IRS Form 1040) and must meet certain specified limitations, usually a percentage of AGI that must be exceeded before an amount is allowable. They are an alternative to the standard deduction and are not necessarily dollar-for-dollar deductions.

For tax years beginning in 2018, the major categories of itemized deductions are as follows:

    • Medical expenses
    • Taxes (specified types of taxes, never federal income tax)
    • Interest expense (primarily mortgage)
    • Charitable contributions (within limits)


Joint and Several

“Joint and several” is a legal phrase used in definitions of liability, meaning that an obligation (to pay or to perform) may be enforced against all liable parties jointly or against any one of them separately.


Joint Conference Committee

The Joint Conference Committee is comprised of members from both the House and Senate. The purpose of this committee is to craft a compromise bill that both legislative groups can agree on, or in other words, to resolve their differences.


Joint Liability

also known as: Jointly Liable

Joint liability is the legal theory that holds that two or more persons promise to perform one obligation or that two or more persons may be held liable for the action of one (“together we promise”).

Said of partners: All partners may be sued for the actions of one partner or of the partnership. All partners are jointly (and severally) liable for the debts and other obligations of the partnership (e.g., breach of contract).

A release on one joint obligor releases all. If one dies, the others are still liable.

Contrast with several liability—obligor may be jointly liable or both jointly and severally liable.


Joint Return

A joint return is an income tax return combining the income, exemptions, credits, and deductions of a husband and wife. Marital status is determined on the last day of the year.


Joint Tenancy

Joint tenancy is concurrent or multiple ownership of real property, created when equal interests to the same property are conveyed to two or more persons in an instrument expressly stating the joint tenancy (a will can create a joint tenancy). Joint tenancy requires four unities: time (all tenants take their interest at the same time), title (all tenants take their interest from the same source, such as a deed or will), interest (every tenant has an identical interest in the property), and possession (every tenant owns the undivided whole and does not own a fractional interest). Joint tenancy conveys the right of survivorship.


Key-Person Life Insurance

Key-person life insurance (also called key-man life) is purchased by a business on the lives of its top executive(s). The business is the beneficiary. The intention is that the proceeds will allow the business to survive the death of a top executive. It is an ordinary business expense. For tax purposes, the premium is not deductible to the business.



Labor is a factor of production, one of the three essential elements of obtaining or producing wealth. It is human effort—both mental (e.g., entrepreneurial/managerial ability) and physical—and is considered to be held (owned) primarily by households. It is a microeconomic concept.



Land is a factor of production, one of the three essential elements of obtaining or producing wealth. Land is all natural/free gifts of nature (minerals, water, land, forests, “raw materials,” and the resultant products) and is considered to be held (owned) primarily by households. It is a microeconomic concept.In accounting, land is a long-term asset that is used for operations and is not for resale. It is long term in nature, and unlike plant and equipment, it is not subject to depreciation. Land possesses physical substance and is thus differentiated from intangible property, but unlike inventory, it does not become part of the product that is held for resale.All of the costs necessary to acquire land and prepare it for use are considered part of the historical cost of the land. This would typically include the purchase price; legal and closing fees; costs such as grading, draining, removal of old buildings, etc. necessary to prepare the land for its intended use; and assumption of past liens, encumbrances, or mortgages. Costs for improvements such as parking lots, fences, and sidewalks that have limited lives should be recorded separately from land as land improvements and depreciated over the life of the specific improvement.


Last In, First Out (LIFO)

LIFO is a cost flow assumption that matches the latest (most recent) costs to current sales revenues. It is based on the assumption that the newest units with the most current acquisition costs are sold first and thus current costs are used to determine cost of goods sold. As a result, the units left in ending inventory are the oldest units. LIFO requires identification of inventory layers at different unit costs and can be used with either the periodic or perpetual inventory system, with slightly different results. It matches current costs against current revenue—as costs are rising, reported income will be lower than under FIFO or average cost. It recognizes the flow of costs versus the usual physical flow of units (cash outflow is recognized in the reverse order as cash inflows). The criticism of this method is that it produces an inventory value that is not at current cost.

If LIFO is used for income tax purposes, it must also be used for reporting purposes. A change from LIFO to any other cost flow method is considered a special change in accounting principle that is given retroactive treatment.

LIFO is not recognized for IFRS (International Financial Reporting Standards).



Liabilities are probable future sacrifices of economic benefits arising from present obligations of the entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. (SFAC 6.35–.42 and .192–.211)

Essential characteristics, all three of which must be present, are as follows:

    1. A present duty or responsibility to one or more other entities entails settlement by probable future transfer or use of assets at a specified determinable date, on occurrence of a specified event, or on demand.
    2. The duty or responsibility obligates the entity, leaving it little or no discretion to avoid the future sacrifice.
    3. The transaction or event obligating the entity has already occurred.

Most liabilities stem from human inventions—financial instruments, contracts, laws—that are commonly embodied in legal obligations and rights with no existence apart from them. Liabilities permit delay—delay in payment, delay in delivery, etc.

Liabilities are changed both by the entity’s transactions and activities and by events that happen to it.

“Valuation accounts,” which increase or decrease the carrying value of assets, are part of the related asset and are not liabilities, or assets, in their own right.

In governmental accounting: Liabilities are defined as present obligations to sacrifice resources that the government has little or no discretion to avoid. (GASB Concepts Statement 4.17)



lien is a creditor’s legal right to have a debtor’s specified property as security for a debt and to take possession of the property, following prescribed legal procedures if the debt is not paid. Property taxes become a lien under statute against the property that is being taxed.

An artisan’s lien is a common-law security device whereby a creditor can recover for work done on personal property of the debtor. If the debtor fails to pay for the work performed, the creditor can retain possession of the property and sell it in satisfaction of the lien. (This is a “possessory” lien.)

mechanic’s lien arises from the making of improvements to real property. This is a statutory lien controlled by state law whereby the lienholder (creditor) generally is required to file a written notice of the lien within a specific time period.

mortgage lien is a lien securing a note payable that has as collateral real assets.


Lifetime Learning Tax Credit

Individual taxpayers are allowed to claim a nonrefundable Lifetime Learning credit against federal income taxes equal to a specified amount of qualified tuition and fees incurred during the taxable year on behalf of the taxpayer, the taxpayer’s spouse, or any dependents.The credit is available in the taxable year the expenses are paid, provided the education commences or continues during the first three months of the next year.The Lifetime Learning credit apples to undergraduate or graduate-level (and professional degree) courses as well as any course of instruction at an eligible educational institution (whether the student is enrolled on a full-time, half-time, or less-than-half-time basis) to acquire or improve job skills of the student.The Lifetime Learning credit may not be claimed by a taxpayer for expenses of a student for any tax year which an American Opportunity tax credit is “allowed” for the same student or if a tax-free distribution from an Education IRA is made for a student for the same tax year.The Lifetime Learning credit begins to phase out once a taxpayer’s modified adjusted gross income (MAGI) exceeds a specified amount.


Limited Liability

“Limited liability” is said of an individual who cannot be held legally responsible for the debts or other liabilities of another party. This is usually said of corporate shareholders. Corporate shareholders are liable only to the extent of their investment in the corporation; they are not liable either for the debts of the corporation or the acts of the officers, directors, or employees of the corporation. Limited partners also have limited liability.


Limited Liability Company 

A limited liability company is a legal business form that offers limited liability to the owners. It possesses characteristics of both a corporation (limited liability of owners) and a partnership (pass-through income taxation).


Limited Liability Partnership (LLP)
also known as: Registered Limited Liability Partnership

The limited liability partnership or LLP is an existing partnership that registers according to the applicable statute. It remains a legal partnership entity but protects a partner from personal liability for the debts and obligations arising out of the negligence or malpractice of other partners or employees of the partnership after registering as an LLP. Other than such limited protection, the partner remains personally liable for the other debts and obligations of the partnership, including liability for the partner’s own negligence or malpractice.

The primary use of an LLP is generally for professional general partnerships (such as accounting, medicine or law) when converting to a PLLC (professional limited liability company) may not be practical. Except in a few states, however, the use of an LLP is not restricted to professional partnerships. The protection from personal liability is not as complete as with a PLLC.


Limited Partnership

also known as: Limited Partnerships

A limited partnership is a partnership created by statute (not common law) consisting of at least one general partner and one or more special or limited partners. It is regulated by the Uniform Limited Partnership Act (ULPA) in most states. In most states the limited partnership must be registered with the state in order to operate and sell limited partnership interests in the state.


Liquidated Debt

A liquidated debt is a debt for an amount to which both parties agree. Payment of a lesser amount does not discharge the balance; additional consideration from the debtor (such as payment of the lesser amount before the due date) is required in exchange for the promise by the creditor to forgive the balance.


Liquidated Distributions

A liquidating distribution is a return of capital received because of a partial or complete liquidation (going out of business) of a corporation. The basis of the stock on which liquidating distributions are paid is reduced by the amount of the distributions. Any amount received in excess of basis in the stock is a taxable capital gain. In a liquidation that results in cancellation of the stock, a capital loss can be claimed in the year the final distribution is received if total distributions are less than the taxpayer’s basis. Reporting liquidating distributions is done on Schedule D of IRS Form 1040.

Liquidating dividends are distributions to shareholders from other contributed capital accounts rather than retained earnings. A liquidating dividend represents a return of the shareholders’ investment, rather than a return on the investment.


also known as: Chapter 7
Straight Bankruptcy

Liquidation is a form of relief granted under the uniform bankruptcy laws (Chapter 7) that results in the distribution of the debtor’s nonexempt, unsecured assets to creditors and a final discharge of the individual debtor from its obligations. Liquidation is the ultimate remedy, the remedy that embodies finality, providing the debtor with a “fresh start.” All entities, except governmental units, family farms, railroads, insurance companies, and financial institutions, may use Chapter 7. An entity can liquidate voluntarily or involuntarily, and Chapter 7 can be converted to a Chapter 11, 12, or 13 proceeding.


Long-Terms Contracts

also known as: Long-Term Construction Contracts
Long-Term Construction Type Contracts

A long-term contract is a contract for the construction of a specific project over an extended period of time (more than one accounting period), such as ships, airplanes, bridges, roads, and buildings. Accounting issues include revenue/profit recognition and valuation of construction-in-process. There are two alternative GAAP methods available: completed-contract and percentage-of-completion.

FASB ASC 605-35-05-5


Management Advisory Services (MAS)

also known as: Management Advisory Services
MAS Engagement
MAS Engagements

Management advisory services (MAS) are a consulting function of providing advice and technical assistance to help the client improve the use of capabilities and resources to achieve its objectives.

Accountants on MAS engagements need not maintain independence but must comply with ET 1.300.001 regarding professional competence, due professional care, planning and supervision, and sufficient relevant data.

MAS engagements are subject to AICPA Statements on Standards for Management Advisory Services (SSMAS).


Marketable Securities

Marketable securities are securities that have readily determinable fair values and are considered marketable when a day-to-day market exists and when they can be sold on short notice. The volume of trading in securities should be sufficient to absorb a company’s holdings without materially altering the market price. Fair value is considered readily determinable if sale prices or bid-and-asked quotations are currently available from a stock exchange such as the NYSE or the over-the-counter (OTC) market. Marketable securities are accounted for per FASB ASC 320-10.

Example: Financial instruments considered to be marketable securities include preferred or common stock, government or corporate bonds, certificates of deposit, Treasury bills, and commercial paper.

Restricted stock is not considered marketable.


Material Indirect Finacial Interest

Material indirect financial interest is involvement, other than direct ownership (i.e., ownership of common or preferred stock or convertible debt), that exceeds 5% of the member’s net worth. Independence is deemed to be impaired. The concept of materiality is relevant to the consideration of indirect financial interests. A “member” is considered to include the member, his firm, and family members.

Immaterial indirect financial interests are allowed, e.g., ownership of mutual fund shares that hold investments in the entity and limited business transactions with the entity-client. Examples of limited business transactions include having a checking account at the client financial institution that is fully insured by a state or federal government deposit insurance agency. There is no exception to this rule. (ET 1.200.001 and 1.240.010)

Examples of indirect financial interest include the following:

    • Member is a trustee of any trust or executor or administrator of any estate that has or is committed to acquire any direct or material indirect financial interest in the entity/client
    • Member has any joint, closely held business investment with the entity or with any officer, director, or principal stockholder thereof
    • Member holds stock in a bank that holds loans to the client
    • Ownership of shares of a mutual fund that hold shares of the client
    • Member has lessor relationship with the client. (ET 1.260.040)
    • Litigation between the member and the client
    • Member is owed fees by the client

ET 1.240.010



Information is material if omitting it or misstating it could influence decisions that users make on the basis of the financial information of a specific reporting entity. In other words, materiality is an entity-specific aspect of relevance based on the nature or magnitude or both of the items to which the information relates in the context of an individual entity’s financial report. Consequently, the FASB cannot specify a uniform quantitative threshold for materiality or predetermine what could be material in a particular situation.

SFAC 8.3, QC11

Materiality judgments are concerned with thresholds.

Example: You would ask the following questions:

    • Is an item of information, an omission, misstatement, or error large enough, considering its nature and the attendant circumstances, that it is probable that the judgment of a reasonable person relying on the information would have been changed or influenced?
    • Is the item important enough to matter?

The relative, rather than absolute, size of the item determines whether or not it is material in a given situation. The auditor’s consideration of materiality is affected by the interaction of quantitative and qualitative factors.

The concept of materiality is pervasive. It is related to the relevance and faithful representation of information and is critical to audit judgments regarding audit risk and disclosure.


Membership Rights

Ownership of an interest in an entity or business organization, whether as a shareholder, partner, limited liability company (LLC) member, or otherwise, contains a membership right, separate and distinct from the economic right attached to such interest. The membership right entitles the holder to participate in management, to vote, and to inspect the books and records of the entity. Generally, a transfer of the membership rights entitles the transferee or assignee to become a “substituted” owner, which may trigger consent requirements for the transfer in entities such as partnerships and LLCs.



A merger is when one company (A) acquires another (B) with the latter (B) ceasing to exist: A + B = A. It is a fusion. It is when two or more companies physically combine operations with all but one ceasing to exist as a legally recognized entity. A merger is accounted for as a purchase. Before 2002, the FASB (Financial Accounting Standards Board) allowed for some mergers to be recorded under a pooling of interests method.


Modified Accelerated Cost Recovery System (MACRS)

The modified accelerated cost recovery system (MACRS) is a depreciation method specified in the tax law applied to assets acquired after 1986. MACRS replaced ACRS (accelerated cost recovery system) and prescribes asset lives and rates of depreciation for classes of assets.

Under MACRS, the cost of business tangible property is recovered over a 3-, 5-, 7-, or 10-year period. The cost of this property is recovered by means of 200% declining balance with a switchover to the straight-line method to provide the maximum depreciation deduction and also uses the half-year convention. Farmers are required to use 150% declining balance. The cost of business real property is recovered over a 27.5- or 39-year period by means of the straight-line method and also uses the half-month convention.



A mortgage is a pledge or security of particular property for the payment of a debt, usually the unpaid purchase price of the real property. A nonpossessory lien on real property, a contractual obligation in the form of a promissory note, and a purchase-money mortgage are examples of a mortgage. A mortgage must be in writing and must be properly executed and recorded to meet the requirements of the statute of frauds.The mortgagor (the debtor) has possession of and title to the property; the mortgagee (creditor) has a security interest in the property, which is dormant as long as timely payments are made. Upon default on the note, the security interest rises above and becomes superior to any lien. A mortgagee has the right to foreclose on and sell the property (state statutes usually allow the mortgagor a specified time during which back payments can be made and the foreclosed property may be reclaimed).



National Association of State Boards of Accountancy – NASBA serves as a forum for the nation’s 55 State Boards of Accountancy, which administer the Uniform CPA Examination, license more than 750,000 Certified Public Accountants and regulate the practice of public accountancy in the United States.



Negligence is the failure to exercise the ordinary reasonable care required under the circumstances. In a civil tort, no knowledge of error or falsity or reckless disregard need be proven (ordinary or simple negligence as distinguished from gross negligence).

When applied to accountants, negligence involves the following:

    • Failure to follow GAAP/GAAS
    • Failure to do what duty requires to be done (e.g., failure to investigate further missing or suspicious data)
    • Disregard of warnings or suspicious comments, behavior, or documents



also known as: Negotiability

Negotiable means freely transferable for value by indorsement or delivery from one party to another. It is the legal right of the transferor to transfer better rights than he or she has (i.e., the subsequent holder acquires greater rights because he or she takes free of most defenses; the critical concept of the law of commercial paper).

U.C.C. 3-104(1) and 112

N = SWUPPPS: The five requisites of negotiability (if any requisite is lacking, the instrument is nonnegotiable) are:

    1. must be signed (S) by the maker or drawer (the signature can be a stamp that is intended as a signature),
    2. must appear on the face (“within the four corners”) of the writing (W) (the instrument); adding “Pay to the order of X” to the reverse side does not cure the defect (if these words are lacking on the face),
    3. must contain an unconditional (U) promise or order to pay (P) a sum certain (S) in money (and no other promise, order, power, or obligation is given by the maker or drawer),
    4. must be payable (P) on demand or at a definite time, and
    5. must be “payable (P) to order of or to bearer” (these are the magic words of negotiability; must be present as shown: “Pay X” or “Pay to X” does not meet this requirement and does not convey negotiability).

Commercial paper contains no other promise except the payment of money. Instruments that are payable in goods (e.g., bill of lading) can also be negotiable if they meet the listed requisites.

Once a writing is negotiable, it is always negotiable. An indorsement can limit (qualify or restrict) the transferability of the instrument but cannot eliminate it.



also known as: Negotiations

A negotiation is a subsequent transfer of an instrument in such a way (by proper means) that the transferee becomes the holder. It can be achieved in two ways:

    1. By delivery alone (for bearer paper)
    2. By indorsement and delivery (order paper)—the party to whose order the instrument is payable must “sign” the back of the instrument.

U.C.C. 3-202

The transferee who takes a negotiable instrument by negotiation becomes a holder, and provisions of Article 3 of the Uniform Commercial Code (U.C.C.) govern. The transferee who takes a non-negotiable instrument or who takes a negotiable instrument (order paper) without proper indorsement takes by assignment and is an assignee, not a holder, and contract law governs.


Net Income

Net income is the total amount of money a person earns in a given period from combined taxable income, tips, and investment income like dividends and interest. This amount is calculated after subtracting income taxes, Social Security taxes, including any Medicare and Medicaid – also known as the Federal Insurance Contributions Act (FICA) tax, health insurance premiums, contributions to a retirement plan such as a 401(k), and any legal obligations that may affect personal finances such as wage garnishments, loan payments, or child support.For an individual, net income is calculated using the following equation:Total Amount Earned (Gross Income) – Paycheck Deductions = Net Income.


Net Investment Income

Net investment income is investment income minus deductible investment expenses (other than investment interest).

IRC Section 163(d)(4)


Net Operating Loss (NOL)

Under the Tax Cuts and Jobs Act (TCJA) for tax years beginning in 2018, the net operating loss (NOL) deduction for a tax year is equal to the lesser of (1) the aggregate of the NOL carryovers to such year, plus the NOL carrybacks to such year, or (2) 80% of taxable income (determined without regard to the deduction) (IRC Section 172(a)). Generally, NOLs cannot be carried back but are allowed to be carried forward indefinitely. The special extended carryback provisions are generally repealed, except for certain farming and insurance company losses.IRC Section 172


Noncompliance with Laws and Regulations by Client

also known as: Illegal Act

Noncompliance with laws and regulations by a client describes violations of laws or governmental regulations perpetrated by the entity or by the management or employees acting on behalf of the entity. Noncompliance by clients does not include personal misconduct by entity personnel unrelated to business activities.

Determination as to whether a particular act is noncompliant is usually beyond the auditor’s professional competence and is generally based on the advice of counsel.

Auditors consider noncompliance with laws and regulations from the perspective of the relation to or effect of the noncompliance on the audit objectives rather than from a per se legal perspective. The auditor is most likely to be familiar with and to detect noncompliance with laws and regulations that has a direct and material effect on the determination of financial statement amounts (e.g., manipulation of tax laws or regulations regarding revenue accrued under government contracts).

The responsibility of the auditor to detect and report noncompliance is the same as for errors and fraud—the independent auditor has the responsibility to design the audit to provide reasonable assurance of detecting noncompliance by the client that is material to the financial statements.

When the auditor concludes, based on information obtained and, if necessary, on consultation with legal counsel, that noncompliance with laws and regulations has or is likely to have occurred, the auditor should consider the effect on the financial statements as well as the implications for other aspects of the audit.

Examples of noncompliance with laws and regulations include lapping and kiting of checks between bank accounts.


Non-interest Bearing
also known as: Noninterest Bearing

A non-interest-bearing note includes the interest in the face amount of the note, i.e., the face value equals the principal plus interest as a single amount to be paid back at maturity. It is a discounted (present value) note, i.e., interest is charged in advance and deducted from the amount of the loan. The borrower receives some amount (the principal) less than the face amount (principal plus interest) that will be repaid at maturity. (Contrast to interest-bearing.)



In the context of external auditing, objectivity is remaining impartial in judgments in order to get more quality information. To be objective is to be intellectually honest and free of conflicts of interest. Objectivity is the ability to maintain an impartial attitude in both fact and appearance based on one’s actions and relationships.

The quality of objectivity is required of all CPAs, not just those in public practice. It is a state of mind that is essential to the maintenance of the public’s trust:

“A member should maintain objectivity and be free of conflicts of interest in discharging professional responsibilities. A member in public practice should be independent in fact and appearance when providing auditing and other attestation services.” (ET 0.300.050.01)

“In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.” (ET


Occupational Saftey and Health Act

also known as: Occupational Safety and Health Administration

The Occupational Safety and Health Act (OSHA) legislation created the Occupational Safety and Health Administration (also OSHA), which develops standards for job health and safety designed to protect employees from occupational injury or illness. OSHA is an example of social regulation.

Primary criticism of OSHA is the use of the “feasibility standard” (workers should be protected from injury or illness “to the extent feasible,”), meaning if it is technologically and economically possible, without regard to the cost-benefit standard.



An offer is a proposal made by the offeror, stated in reasonably specific terms, which manifests intent to be bound. It is distinguished from invitations to bid or preliminary negotiations. An offer may be either oral or written.An offer must be reasonably definite and certain as to what is agreed upon. The essential terms are parties, price, subject matter (quantity and type), and time for performance. The standard used to judge an offer is an objective one—would a reasonable person believe that an offer was made? (U.C.C. “gap fillers” (U.C.C. 2-204) will provide terms for elements which are absent, except quantity. The contract will not fail for indefiniteness.)Ads, price lists, quotes, bids, and inquiries such as “What will you give me…?” or “Would you take $___?” are not an offer but an invitation to trade or a proposal to negotiate.An offer may terminate due to revocation by the offeror before acceptance, rejection by the offeree, lapse of time, or by operation of law.



Officers are the highest-ranking employees in a corporation, such as the chief executive officer (CEO), chief financial officer (CFO), and chief operating officer (COO).



An order is a direction to pay (as related to commercial paper) that is more than an authorization or request, addressed to one or more parties (drawee) identifiable with reasonable certainty. It must be unconditional. Contrast to promise.

U.C.C. 3-102


Order for Relief

also known as: Automatic Stay

An order for relief (or automatic stay) is a court order that freezes all litigation and collection efforts on the part of the creditors or any other party against the debtor. It is the essence of bankruptcy laws, to allow for the reorganization or liquidation of the debtor and equal treatment of all creditors.


Ordinary Income and Expense
also known as: Operating Income
Trade or Business Income
Results From Operations

The computations of net difference between the income earned and expenses incurred in operating a trade or business are called ordinary income and expense items because they are taxed at ordinary income rates. Ordinary income includes salary, wages, interest, dividends, and other income sources.

In contrast to ordinary income and expense items, the Internal Revenue Code recognizes everything else that is not ordinary as a capital gain or loss under IRC Section 1221.


Organizational Costs
also known as: Organizational Cost
Organizational Expense

Organizational costs include any cost incurred in the formation of a business entity. These costs include legal fees, accounting fees, registration fees, and the costs associated with the issuance of shares of a corporation, such as promotion costs, prospectus costs, and SEC registration fees. Expenditures by a corporation related to issuing or selling shares of stock or other securities are capitalized and are not deductible organizational costs.

Taxpayers may deduct up to a specified amount in the taxable year in which the business begins. The amount is reduced by the amount by which the cumulative cost of organizational expenditures exceeds a certain amount; any remaining organizational expenditures not deducted are amortized over a 15-year period (180 months) beginning with the month operations begin.

IRC Section 248

Similar rules apply to organization costs incurred in the formation of a partnership. (IRC Section 709)

Par Value

also known as: Par
Stated Value

Par value is the per-share value of capital stock fixed by the articles of incorporation or legal capital. Par value is the amount of capital that must be retained in the corporation. It is the value at which each share of stock is recorded in the capital stock section of stockholders’ equity. Par value is changed by a stock split.


Parol Evidence

also known as: Parol Evidence Rule

Parol evidence is a legal rule of contract interpretation that states that extrinsic (oral or written) evidence (i.e., outside the contract) is not admissible to add to, alter, or vary the terms of a written contract. All preliminary negotiation should have been merged into the writing.

Despite the parol evidence rule, oral evidence may be admitted as proof:

    • of fraud, misrepresentation, duress, undue influence, lack of consideration, or illegality of the subject matter (constitutes proof, which destroys the contract).
    • of an oral condition precedent to the written contract: proof that the parties agreed orally to a condition that had to be fulfilled before the contract became effective.
    • to explain an ambiguity or omission: evidence cannot contradict the terms of the contract but can explain them.
    • of a subsequent modification (oral or written) made to the contract. (Oral modification is acceptable if it is supported by consideration and does not violate the statute of frauds.)



also known as: Owner
Joint Venture
Pooling of Interest

A partner is an individual, estate, trust, corporation, or other entity that owns a capital or profits interest in a partnership. A partner’s taxable income for a tax year includes his distributive share of certain partnership items for the partnership’s tax year ending with or within the partner’s tax year. A partner must report his distributive share of partnership items on his tax return whether or not it is actually distributed. These items are furnished to the partner on Schedule K-1 (IRS Form 1065). See the instructions for Form 1065 for more information. A partner is not considered an employee.

To determine the allowable amount of any deduction or exclusion that is limited, a partner must combine any separate deductions or exclusions on his or her income tax return with the distributive share of partnership deductions or exclusions before applying the limit.

In general, a partner cannot deduct partnership expenses paid out of his or her personal funds unless required to do so by the partnership agreement. These expenses are usually considered incurred in and deductible by the partnership. If a partner is required by the partnership agreement to pay, out of his or her personal funds, an employee who performs part of the partner’s duties, the partner can deduct that payment as a business expense.

Partners must treat partnership items on their individual tax returns as they are treated on the partnership return. If a partner treats an item differently on his or her individual return, the IRS can automatically assess and collect any tax and penalties that result from adjusting the item to make it consistent with the partnership return. However, this does not apply if a partner who is not part of an existing large partnership files IRS Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request, with his or her return identifying the different treatment.


Partner’s Basis

A partner’s basis in a partnership interest is commonly referred to as the “outside basis.” The adjusted basis of a partner’s partnership interest is ordinarily figured at the end of a partnership’s tax year. However, if there has been a sale or exchange of all or part of the partner’s interest, or a liquidation of his or her entire interest in a partnership, the adjusted basis is figured on the date of the sale, exchange, or liquidation.

A partner’s original basis is increased by:

    • additional contributions to the partnership,
    • an increased share or assumption of partnership debt,
    • the partner’s distributive share of both taxable and nontaxable partnership income, and
    • the partner’s distributive share of the excess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to the partners.

The original basis is decreased (but never below zero) by:

    • the amount of money and the adjusted basis of property distributed to the partner by the partnership,
    • the partner’s distributive share of the partnership losses (including capital losses),
    • the partner’s distributive share of nondeductible partnership expenses that are not capital expenditures,
    • the amount of the partner’s deduction for depletion for any partnership oil and gas wells, up to the proportionate share of the adjusted basis of the wells allocated to the partner, and
    • the partner’s share of any Section 179 expenses, even if the partner cannot deduct the entire amount on his or her individual income tax return.


Partner’s Interest

A partner’s interest in a partnership is generally a profits interest or a capital interest. A profits interest only entitles the partner to share in the income or loss from the partnership each year. A capital interest allows the partner to exercise a claim against the assets of the partnership in the event of a liquidation. A partner can acquire an interest in partnership capital or profits as compensation for services performed or to be performed.

The fair market value of a capital interest must generally be included in the partner’s gross income in the first tax year in which the partner’s interest can be transferred or is not subject to a substantial risk of forfeiture.

A partner’s interest (capital) in the partnership is often confused with a partner’s basis in the partnership. These two concepts are not the same. The adjusted basis of a partner’s interest is determined without considering any amount shown in the partnership books as a capital, equity, or similar account.

Example: Enzo contributes property that has an adjusted basis of $400 and a value of $1,000 to the partnership. His partner contributes $1,000 cash. While under the partnership agreement each has a capital account in the partnership of $1,000, which will be reflected in the partnership books, the adjusted basis of Enzo’s interest is only $400 and the adjusted basis of his partner’s interest (capital in this case) is $1,000.



also known as: Partnerships

A partnership is an association of two or more persons to carry on as co-owners of a business for profit. Partnerships are governed in the various states of the United States by the Uniform Partnership Act (UPA). A partnership may be general, limited, or joint venture.

Characteristics of a partnership include the following:

    • Voluntary association of persons as individuals (the partnership has no separate legal identity under common law, but under the UPA it is now an entity for most purposes)
    • Simple agreement without governmental sanction
    • A fiduciary relationship (mutual agency—each partner is an agent for the others and for the partnership)
    • Co-ownership
    • Mutual agency of partners
    • Joint and several liability

A partnership does not pay income tax. It is a pass-through entity, so profits and losses of the partnership pass through to its partners. A partnership does file an informational tax return using IRS Form 1065, U.S. Return of Partnership Income.


Passive Activity

For taxable years after 1986, the Tax Reform Act of 1986 divided all income and losses into three categories: passive, active, and portfolio. Active and passive income and losses both relate to a trade or business. These two types of income differ in the following ways.

If a taxpayer materially participates in a trade or business on a regular, continuous, and substantial basis, the income or loss resulting is active. To be considered materially participating in an activity, a taxpayer generally must qualify under one of seven tests provided by the IRS.

If the taxpayer does not materially participate in trade or business, the income or loss resulting is passive. All rental activities are generally considered passive activities, whether or not the taxpayer materially participates in the activity, although there are exceptions for certain real estate rental activities.

The passive loss rules limit the amount of losses from passive activities that can reduce income from nonpassive (active and portfolio) sources. Generally, losses from passive activities in excess of passive income may not reduce nonpassive income. Passive losses that cannot offset other types of income are suspended losses and must be carried forward.


Payable at a Definite Time

“Payable at a definite time” is terminology of commercial paper: payable on or before a stated date, or at a fixed period after a stated date, or at a fixed period after sight, or at a definite time subject to acceleration (allowing the payee to demand full payment immediately) or extension (allowing the payment date to be at some later specified time). (U.C.C. 3-109)

The instrument is not payable at a definite time if it is payable only upon the occurrence of an act or event that is uncertain as to the time of occurrence (e.g., upon the death of an individual or upon consummation of a sale).


Payable to the Order of or to Bearer

also known as: Pay to the Order Of

Pay to Bearer

Payable to Bearer

“Payable to order of or to bearer” is the specific terminology of negotiability of commercial paper: payable to any person identified with certainty or to his assigns, or to the person who possesses the paper (“bearer”). The distinction between “to order of” and “to bearer” is important for negotiation. If the instrument does not bear these words (either “payable to order of …” or “payable to bearer” or “payable to cash”) the instrument is not negotiable and this defect is not cured by indorsement using these words. (U.C.C. 3-110 and 111)



also known as: Perfection

Perfection is an additional act (after attachment) that may be required to make a security interest effective against third parties. It is a security interest that cannot be defeated in insolvency proceedings or in general by other creditors. The requirements of perfection depend on (1) the nature of the collateral, (2) the use of the collateral, and (3) the relationship between the debtor and the secured party.

There are three methods of perfection, each used under different circumstances:

    1. Perfection by Attachment Alone—A purchase-money security interest (PMSI) in consumer goods is perfected by attachment alone, with no further steps necessary. The goods must be other than fixtures or a motor vehicle (car, boat, or airplane). It is good against the debtor, against creditors of the debtor, and against the trustee in bankruptcy. It is not good against a bona fide purchaser for value of the collateral from the debtor. (Filing would be required.)
    2. Perfection by Possession—(from common law, preserved by the Uniform Commercial Code (U.C.C.)) filing is not required if the creditor has possession of the collateral; always used when financial instruments (stocks, bonds, chattel paper, other documents) are used as collateral. (The creditor must take possession of negotiable instruments because if the instrument is negotiated the holder in due course would prevail over the secured creditor!) Possession of goods also perfects the security interest in the goods; however, possession impairs the use of the goods by the debtor and is usually not practical.
    3. Perfection by Filing a Financing Statement—giving public notice to third parties of the creditor’s security interest in the collateral by written notice (financing statement) filed in public records. Filing must be in accordance with state law; filing is ineffective if improper or filed in the wrong place. Filing is effective for five years.

U.C.C. 9-302


Personal Holding Company (PHC)
also known as: PHC
Incorporated Pocketbook

“Personal holding company” is a term used in relation to federal income tax to denote a corporation that is majority-owned by a small group of natural persons. It is commonly called an “incorporated pocketbook.”

A personal holding company is defined by IRC Section 542 as a corporation that is as follows:

    • Derives at least 60% of its gross income (after certain adjustments) from investments (dividends, interest, rents, royalties) and from certain personal service contracts
    • With stock that is more than 50% owned by five or fewer individuals


Personal Service Corporation (PSC)

A personal service corporation (PSC) is a corporation that has as its principal business the performance of personal services that are substantially performed by employee-owners. (IRC Section 269A(b)(1))

Personal services means services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, and consulting.

There are several tax implications if a corporation is considered a personal service corporation, including the following:

    • Restrictions on tax years available (IRC Section 441(i))
    • Taxed at a flat 21% rate (IRC Section 11(b)(2))

It is interesting to note that the definition of a personal service corporation is different for these two purposes:

    1. For the flat 21% tax rate, a corporation is a PSC if “substantially all” of the activities of the corporation are performing personal services and the corporate stock is owned by employees who perform these services. “Substantially all” means 95% of the employees’ time. (IRC Section 448(d)(2))
    2. For restrictions on the taxable year allowed, a corporation is a PSC if the “principal activity” is personal services and they are “substantially” performed by owner-employees. Personal services are considered the “principal activity” if more than 50% of the total employee compensation is for these activities. They are “substantially” performed by owner-employees if related compensation is at least 20% of total employee compensation. (IRC Section 441(i)(2); Regulation Section 1.441-3)


Power of Attorney

Power of attorney is a legal instrument that authorizes one party to act for (as the agent of) another. It is a form of express agency. Under such an instrument, the principal cannot delegate to another (the agent) that which the principal is not legally permitted to do. (The principal may delegate that which the principal is not physically able to do, such as in the case of a principal who is a handicapped individual.)

To have someone else represent the taxpayer before the IRS in connection with a federal tax matter, the taxpayer can file IRS Form 2848, Power of Attorney and Declaration of Representative, with the IRS office where the taxpayer is appearing.


Preferred Stock

Preferred stock is ownership interest (class of stock) that carries preferences or specified priorities when compared to common stock; it is usually nonvoting and senior to common stock in dividend and liquidation preference and participation rights (to specified limits). It has characteristics of both debt and equity and may have other features, such as convertibility to other securities, call features, and redemption. Preferred stock is a “security.”

While preferred stockholders generally must be paid before common stockholders, preferred stockholders are paid after creditors.

Dividend preference is usually expressed as a percentage of the par value of the preferred stock but may also be expressed as a specific dollar amount per share. Preference may be cumulative or noncumulative, as well as participating, nonparticipating, or partially participating (where it is participating along with common stock in the receipt of dividends in excess of the stated preferred dividend).



A principal is one with the legal capacity to contract who agrees with another (the agent) that the agent should act on the principal’s behalf. A principal is the person with control over an agent in an agency relationship. A principal may be an individual, corporation, or partnership.The principal is liable for torts of the agent committed within the scope of employment or authority and during the course of duties (see the rule of respondeat superior—a form of strict liability).The duties of principal to agent include to compensate, reimburse, and indemnify.A principal may be “disclosed” (i.e., identity is known to the third party) or “undisclosed.”


Accounting profit is the difference between revenue and costs in a business enterprise related to the product or service provided by the organization. Economic profit is the increase in wealth for the investor related to an investment.



A promise is an engagement (undertaking) to pay (as related to commercial paper) that is more than acknowledgment of an obligation (e.g., an IOU is merely an acknowledgment, hence not negotiable). A promise must be unconditional. Contrast to order. (U.C.C. 3-102)


Promissory Estoppel

Promissory estoppel is an equitable legal doctrine applied to contracts designed to prevent injury to a party resulting from reliance on a promise made. It holds the promisor liable on a promise, even if no consideration was given by the other party. Recovery is based on one party’s reliance on the promises of another even though no contract actually exists. It prevents (“estops”) the promisor from denying the existence of the contract, from denying the promise he has expressly or implicitly made and which was relied on to the detriment of the promisee. Consideration from the promisee is not required (acts in lieu of consideration). The contract is enforceable against the promisor.Conditions required for a finding of promissory estoppel:

  • The promisor knew or should have known that the promise alone was likely to induce a specific action on the part of the promisee.
  • The promisee, after the promise is made, does take the expected action.
  • The action taken by the promisee was definite and substantial in nature (i.e., detrimental to the promised).



In the strict legal sense, property is all rights relating to ownership and the resultant control of things tangible and intangible, guaranteed and protected by law, which may include the following:

  • Realty (real property)—land and anything erected, growing on, or permanently attached to the land (immovables)
  • Personalty (personal property)—everything that is the subject of ownership that is not real property (movable)


Property Dividend

Property dividends are distributions of noncash assets (e.g., investments in the securities of other enterprises, real estate, merchandise) to stockholders in proportion to the number of outstanding shares held. Accounting for property dividends involves a disbursement (credit) from the asset account (at the current market price) and a reduction (debit) to retained earnings and any resultant gain or loss (in conformity with the accounting for nonmonetary transactions in FASB ASC 845-10).A property dividend represents return to shareholders on investment.


Property Payment (Partnerships)

also known as: Property Distribution
Liquidating Distribution
Return of Capital

All payments to a partner in exchange for his partnership interest are classified as property payments except for unrealized receivables and goodwill. As a general rule, property payments under IRC Section 736(b) are treated as liquidating distributions subject to the provisions of IRC Sections 731 through 735. Under the aggregate theory, the distributee partner takes a substituted basis in any property received. Gain is only recognized to the retiring partner to the extent that property payments (cash) exceed the partner’s basis in the partnership interest.

Property payments should be contrasted to retirement payments, which are generally treated as ordinary income for tax purposes and are not considered a return of a partner’s equity interest in a partnership.


Property Tax

Property tax is an imposed nonexchange revenue levied against real or personal property by a governmental entity. Enabling legislation sometimes places restrictions on the use of property tax revenues and/or may specify when the resources are to be used.In the context of state and local governments, property taxes are taxes levied by a legislative body against agricultural, commercial, residential, or personal property pursuant to law and in proportion to the assessed value of the property, or another appropriate basis. Ad valorem (based on value) property taxes are a major source of revenue for many local governments.GASB N50.104


Public Company Accounting Oversight Board (PCAOB)

The Public Company Accounting Oversight Board (PCAOB) was established by Congress to oversee public company audits. Congress formed the group to protect the interests of investors and further the public interest in the preparation of audit reports. The PCAOB also oversees the audits of broker-dealers.


Qualified Business Income (QBI)

also known as: QBI

Qualified business income (QBI) is best thought of as the ordinary, non-investment income of the business; in other words, the revenue the business was designed to generate through operations, less the applicable expenses. Interest or dividend income and capital gains from the sale of property are therefore not included in QBI. Also excluded from QBI are the salary or wages paid to the taxpayer either as W-2 wages from an S corporation or guaranteed payments from a partnership.


Qualified Indorsements
also known as: Qualified Endorsement

A qualified indorsement is a notation and signature on the reverse side of a negotiable instrument by which the transferor disclaims contract liability on the instrument, i.e., he does not promise to pay upon dishonor. (Example: Without recourse, signature)

Indorsements can be classified by three pairs of indorsement types: blank or special, restrictive or nonrestrictive, and qualified or unqualified.


Qualified Small Business

A qualified small business is a small trade or business other than one involving the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, or any trade or business in which the principal asset of the trade or business is the reputation or skill of one or more of its employees.

qualified small business is a C corporation that generally cannot own real property exceeding a value of 10% of its total assets or portfolio stock or securities exceeding in value 10% of the total assets over liabilities.

During substantially all of the taxpayer’s holding period of the stock, at least 80% by value of the corporation’s gross assets (including intangible assets) must be used by the corporation in the active conduct of one or more qualified trades or businesses.

The following corporations are not qualified small businesses:

    • A domestic international sales corporation (DISC) or former DISC
    • A corporation with respect to which an election under IRC Section 939 is in effect
    • A regulated investment company
    • A real estate investment trust
    • A real estate mortgage investment conduit
    • A cooperative

The qualified trade or business term excludes any banking, insurance, leasing, financing, investing, or similar business, any farming business (including the business of raising or harvesting trees), and business involving the production or extraction of products of a character for which percentage depletion is allowable, or any business of operating a hotel, motel, restaurant, or similar business.

As of the date of the issuance of its stock, the corporation’s aggregate gross assets cannot exceed $50 million valued at the amount of cash and the aggregate adjusted basis of the other property held by the corporation.

Noncorporate investors are allowed to exclude 50% of the gain on the sale of qualified small business stock held more than five years. The balance of the gain is taxed at 28% for an effective rate of 14%.

IRC Section 1202


Qualified Tuition and Fees

The Lifetime Learning credit is available for qualified tuition and fees required for the enrollment or attendance at an eligible institution. Charges and fees associated with meals, lodging, student activities, athletics, insurance, transportation, and similar personal, living, or family expenses are not included. It is not available for the purchase of books.

Expenses of education involving sports, games, or hobbies are not qualified tuition expenses unless this education is part of the student’s degree program.


Qualifying Small Business Organization

A corporation issuing IRC Section 1244 stock must qualify as a domestic small business corporation, which generally means that it must be a domestic corporation and that its aggregate capital must not exceed $1 million at the time the stock is issued to its shareholders.

The corporation must also satisfy a gross receipts test as an active business. This test requires that the corporation, during the period of its five most recent years ending before the date the loss on its stock was sustained, derive more than 50% of its gross receipts from sources other than passive investment income.

The benefits of IRC Section 1244 are only available to individuals who acquire the stock by issuance from a domestic small business corporation, and are not available to a subsequent transferee of the stock.



Information, records, or events that occur without discernible pattern or order are said to be random.In sampling, a plan to select items in random order is used to ensure that no bias exists in the sample. If every 10 records in a payroll file was a supervisor who was exempt from overtime, a random sample would ensure that both exempt (the 10th record) and nonexempt records (records 1–9) would all have an equal chance of being drawn. If the sample was pattern (e.g., every 5th record), the sample would include 50% exempt records and 50% nonexempt or all nonexempt, depending on the starting point. In either case, it would not be representative of the total population.


also known as: Ratify a Contract

To ratify is to affirm or sanction a contract (1) by accepting the benefit of the act retroactively, with full knowledge of the facts and the right to avoid the contract (express ratification) or (2) by failure to repudiate or disaffirm the contract (by silence or by retention of goods received; implied ratification). Ratify is the opposite of repudiate.


Real Defense

Real defenses are defenses that are good against a holder in due course. They are defenses that exist because the instrument itself lacked legal validity at its inception, such as due to the following:

  1. Incapacity due to insanity, illegality of subject, duress, etc. (instrument is void)
  2. Infancy, fraud in the execution (instrument is voidable)
  3. Unauthorized signatures
  4. Forgery (Exceptions to the real defense of forgery include fictitious payees and wrongdoing agents (see also impostor rule, fictitious payee rule and wrongdoing agent or employee rule).)
  5. Material alteration
  6. Discharge in bankruptcy


Reasonable Accommodation

Under the Americans with Disabilities Act (ADA), covered entities are required, once knowledge of an individual’s disability is acquired, to take affirmative steps to accommodate for the person’s disability, unless the accommodation will impose an undue hardship on the covered entity. Congress chose to not define the term directly, but rather set forth loose parameters to permit judicial interpretation and application. Those parameters are:

    • making existing facilities used by employees readily accessible to and usable by individuals with disabilities and
    • job restructuring, part-time or modified work schedules, reassignment to a vacant position, acquisition or modifications of examinations, training materials or policies, the provisions of qualified readers or interpreters, and other similar accommodations for individuals with disabilities.

Despite the guidance provided by these Congressional guidelines, the issue of what constitutes a reasonable accommodation has been the primary source of ADA-based litigation.


Recourse Debt

recourse debt is any liability to the extent that any person, or related person, has an economic risk of loss for that liability.

In a partnership, a partner’s share of a recourse debt equals that partner’s share of the economic risk of loss. A limited partner generally has no obligation to contribute additional capital to the partnership and, therefore, does not have an economic risk of loss in partnership liabilities and has no recourse debt in the partnership.

A partner’s basis in a partnership includes a partnership recourse debt only if, and to the extent that, the debt:

    • creates or increases the partnership’s basis in any of its assets,
    • gives rise to a current deduction to the partnership, or
    • is a nondeductible partnership expense that is not a capital expenditure.

The term “assets” includes capitalized items allocable to future periods, such as organizational expenses. The adjusted basis of a partner’s interest in a partnership does not include accrued but unpaid expenses or accounts payable from a cash basis partnership.

If a partner’s share of partnership liabilities increases, or a partner’s individual liabilities increase because the partner assumes partnership recourse debt, this increase is treated as a contribution of money by the partner to the partnership. If a partner’s share of partnership liabilities decreases, or a partner’s individual liabilities decrease because the partnership assumes the partner’s individual liabilities, this decrease is treated as a distribution of money to the partner by the partnership.



Registration is a process specified by federal securities laws (Securities Act of 1933 and Securities Exchange Act of 1934) to provide information to investors about securities to be offered for sale. The objective is to provide investors with material financial and other information concerning securities offered for public sale in order to enable the potential investor to evaluate the security and make informed and discriminating decisions. Securities may not be sold until the registration becomes effective. The process is overseen by the SEC. Some securities and specific transactions are exempt from registration (Regulation D).Registration does not insure investors against loss nor pass judgment on the merits of the issue. The only standard that must be met is adequate and accurate disclosure of all material facts concerning the company and the securities it proposes to sell.


Regular Tax Liability

By definition, the alternative minimum tax (AMT) is an extra tax imposed in addition to the regular tax liability. The regular tax for this purpose is the regular tax liability (as defined in IRC Section 26(b)) reduced by only the foreign tax credit. It does not include investment tax credit recapture.

IRC Section 55(c)

The regular tax liability is computed without regard to the AMT, the environmental tax, corporate penalty taxes including the accumulated earnings tax, the personal holding company tax, the built-in gain tax on S corporations, and the tax imposed on the passive income of S corporations.

IRC Sections 55, 59A, 532, 541, 1374, and 1375



In government accounting, reimbursement is an interfund transaction which repays one fund (Fund 1) for expenditures (or expenses) initially recorded in that fund but properly attributable to another fund (Fund 2). Reimbursement is not an interfund transfer. Reimbursements should not be displayed in the financial statements. The transaction increases expenditures (or expenses) in the reimbursing (paying) fund (Fund 2) and decreases expenditures (or expenses) in the reimbursed (receiving) fund (Fund 1).

GASB 1800.102


Related Parties (RIC)

also known as: Related Parties
Related Party

A “related party” is defined in Internal Revenue Code (IRC) Section 267 as including family members, a taxpayer and a corporation controlled directly or indirectly (through attribution from other family member stock holdings) by the taxpayer (more than 50% of the value of the stock), and a partner and a controlled (directly or indirectly) partnership. IRC Section 267 also specifies other related parties, including a trust and its grantor, a trust and its beneficiary, and a personal services company and any shareholder-employee.

Family members defined as related parties include brothers and sisters, spouse, ancestors, and lineal descendants. In-laws and step relationships are not related parties, and losses on sale or exchanges with these parties may be deducted unless the in-law or step relationship is merely acting as a nominee for a related party. Half-brothers and half-sisters are related parties.



Relevance is one of the qualities of accounting information. It is a fundamental decision-specific quality of decision usefulness and the capacity of information to “make a difference.”Relevant financial information is capable of making a difference in the decisions made by users. Information may be capable of making a difference in a decision even if some users choose not to take advantage of it or already are aware of it from other sources.Financial information is capable of making a difference in decisions if it has predictive value, confirmatory value, or both.SFAC 8.3, QC6–7


Reporting Period

also known as: Fiscal Year

A reporting period is the time period between two balance sheet dates that is covered by the financial statements being audited. It is usually the calendar year; however, it may be any designated period (normally 12 continuous months).


Research and Development

also known as: Research and Development Costs

Research and development (R&D) includes costs incurred in a planned search or critical investigation aimed at the discovery of new knowledge with the hope that such knowledge will be useful in developing a new product or service, developing a new process or technique, bringing about a significant improvement to an existing product (“research”), or translating research findings or other knowledge into a plan or design for a new product or process (“development”). R&D is expensed as incurred. (FASB ASC 730-10-25-1)

R&D includes materials, equipment, and facilities with no alternative use, personnel, intangibles purchased from others, contract services, and an allocation of indirect costs.

R&D acquired as part of a business acquisition may be capitalized. Capitalized R&D should be reviewed periodically for impairment.


Responsibility of Confidentiality

also known as: Confidentiality
Confidential Client Information
Client Confidentiality
Confidential Client Information Rule

One of the ethical responsibilities to clients is the obligation not to reveal client information obtained during the client-accountant relationship. Section 1.700 of the AICPA Code of Professional Conduct addresses this issue:

Confidential Client Information Rule:

“A member in public practice shall not disclose any confidential client information without the specific consent of the client.

“This rule shall not be construed (1) to relieve a member of his or her professional obligations of the ‘Compliance With Standards Rule’ [1.310.001] or the ‘Accounting Principles Rule’ [1.320.001], (2) to affect in any way the member’s obligation to comply with a validly issued and enforceable subpoena or summons, or to prohibit a member’s compliance with applicable laws and government regulations, (3) to prohibit review of a member’s professional practice under AICPA or state CPA society or Board of Accountancy authorization, or (4) to preclude a member from initiating a complaint with, or responding to any inquiry made by, the professional ethics division or trial board of the Institute or a duly constituted investigative or disciplinary body of a state CPA society or Board of Accountancy. Members of any of the bodies identified in (4) above and members involved with professional practice reviews identified in (3) above shall not use to their own advantage or disclose any member’s confidential client information that comes to their attention in carrying out those activities. This prohibition shall not restrict members’ exchange of information in connection with the investigative or disciplinary proceedings described in (4) above or the professional practice reviews described in (3) above.”

ET 1.700.001

There are certain times when confidential client information must be disclosed, which are:

    • compliance with a validly issued and enforceable subpoena or summons,
    • review of CPA’s professional practice under the AICPA or state CPA society authorization review,
    • responding from inquiry by a recognized investigative or disciplinary body, and
    • compliance with the Compliance with Standards Rule and Accounting Principles Rule.

The important time to remember this rule is during the planning stage of rendering professional services. Here, for example, the auditor usually discusses with the prior auditors all information relevant to the audit. However, the client must give full consent before such a discussion can occur.

ET 1.700.050 (“Disclosing Client Information in Connection with a Review of the Member’s Practice”) declares that “a review of a member’s professional practice includes a review performed in conjunction with a prospective purchase, sale, or merger of all or part of a member’s practice.” However, the interpretation also imposes on prospective purchasers the obligation not to disclose or use to their advantage any such confidential client information that comes to their attention during such a review.


Retained Earnings

Retained earnings are an increase in net assets from results of operations, retained by the corporation for use in the enterprise. They are internally generated financing or the corporation’s undistributed earnings. They are accumulated earnings, less accumulated losses and dividends paid, from inception. Retained earnings are a major source of owners’ equity and can be viewed as additional investments by the owners as foregone dividends.Negative balance is called a deficit.Retained earnings may also be decreased by purchase of treasury stock at a price higher than the amount originally received for the stock.Retained earnings may be appropriated (i.e., restricted as to use) by:

    • contractual specification (e.g., bond covenants),
    • legal requirement (e.g., by state law), or
    • management discretion (e.g., for future expansion).

Retained earnings are increased by net income, prior-period adjustments, and quasi-reorganization. Retained earnings are decreased by net loss, prior-period adjustments, cash, property, scrip, stock dividends, and treasury stock and stock retirement transactions.


Roth IRA

The Roth IRA (individual retirement account) is similar to a traditional IRA, with a few exceptions. Contributions to a Roth IRA are always nondeductible, do not depend on whether the taxpayer or spouse is an active participant in a company-sponsored qualified retirement plan, and may be made after the taxpayer attains the age of 70-1/2. There are no required minimum distributions after age 70-1/2 as with traditional IRAs. In addition, qualified distributions, including earnings on contributions, are nontaxable. (Funds must be held in the IRA for 5 years prior to the initial distribution for the funds to be nontaxable.) Accounts may be passed to beneficiaries at death and remain nontaxable for income tax purposes.The Tax Relief Act of 2001 allows an additional catch-up contribution to be made by taxpayers aged 50 and older. A participant who will attain age 50 before the end of a tax year is deemed eligible to make a catch-up contribution during that tax year. The catch-up contribution can be made on any day of that year.The maximum annual contribution that can be made to a Roth IRA is phased out for taxpayers with MAGI over certain levels for the tax year.


Safe Harbor Rule

also known as: Safe Harbor
Presumption of Correctness

Safe harbor rules are rules or regulations that outline conditions under which the Internal Revenue Service (IRS) will not challenge the position taken by the taxpayer in reporting certain types of transactions.

Example: In the Regulations under Section 704(b), the IRS has outlined conditions under which it will accept a special allocation of income, deductions, or credits. If a taxpayer satisfies each of the conditions, he or she can be satisfied that the IRS will not challenge that special allocation in the event of an audit. These conditions are referred to as safe harbor rules for special allocations.



A sale is the transfer of title from one party to another for a price. Sales of goods are governed by U.C.C. Article 2. A sale may be a present sale (consummated by the making of the contract for sale) or an agreement for a future sale (a contract to sell). (U.C.C. 2-106)

The general obligations of the parties to a sale are that the seller is to transfer and deliver the goods and the buyer is to accept the goods and pay in accordance with the contract. (U.C.C. 2-301)

Elements of a sale include the following:

      • Parties must have legal capacity to contract
      • Price
      • Valid subject matter (i.e., the goods to be sold) have the following:
        • Validity—i.e., goods are not illegal or against public policy
        • Actual existence and identity—i.e., existing goods are identified to the contract for present sale, and goods are not existing, identified to the contract, and represent a contract to sell for sale of future goods
      • Subjective good faith (honesty in fact)—merchants must also meet the objective standard of good faith.


Scope of Authority
also known as: Authority

The scope of authority is determined and conferred on an agent by consent of the principal. Authorities have the legal power to act, commit, or change the legal status of another. It may be express (stated in words), implied (unstated, as is customary or usual in the circumstance to fill the gaps in express authority needed to conduct the purpose of the agency), actual (express plus implied authority), or apparent (the appearance of authority).


Section 10(b)

Section 10(b) of the Securities Exchange Act of 1934 contains the principal antifraud provisions of the federal securities laws. It seeks to curb manipulation of the market and the use of deceitful and/or fraudulent acts and practices, and to maintain equal and fair access to information. Section 10(b) was enacted to protect the investing public from misleading and inaccurate information by any party having a role in their creation. It forbids use of insider information and is a very broad and sweeping antifraud provision (plaintiff must prove scienter).


Section 11

Section 11 of the Securities Act of 1933 provides that any person who acquired securities and was injured by false financial statements or misleading omissions from registration statements may sue any party associated with the statement, including the accountant. It relieves the plaintiff of burden of proof; it includes investors who are not clients of the accountant and who are not in privity with the accountant. Section 11 rejects the privity defense of the Ultramares rule. Proof of “due diligence” is the only defense. The plaintiff need prove only that the statements contained material false disclosures or omissions and that the preparer was negligent. The plaintiff does not need to prove fraud, scienter, intent, reliance, or privity.(Contrast to requirements of common law fraud.)


Secured Transactions

A secured transaction is a transaction in which the debtor gives to the creditor an interest in tangible or intangible personal property or fixtures (collateral) to secure payment of the debt. Secured transactions arise from the need of the creditor to have more security than just the promise of the debtor to repay the debt. In the event of default, the creditor may sell the personal property and apply the proceeds to the payment of the debt. A secured transaction gives the creditor priority over other creditors in the property (governed by Uniform Commercial Code (U.C.C.) Article 9).The property can include goods, documents, instruments, general intangibles (e.g., accounts receivable), and chattel paper. However, it does not include real property mortgages or liens.


Securities Act of 1933

The Securities Act of 1933 is a federal statute regulating the initial public offering (IPO) and private placement of securities. It creates liability of the seller (the company and all officers, directors, etc. and experts, including accountants, associated with the financial statements and the offering) to all third-party purchasers of the securities. It creates third-party beneficiary liability, eliminates the privity defense, and regulates the initial public offerings of securities through the mails or in interstate commerce by requiring registration of securities and full public disclosure of all material information about the securities and the company. It is designed to protect the unsophisticated investing public.

The basis for a claim against an accountant under this statute is a false statement or omission of a material fact in the audited financial statements. There is no need to prove negligence, fraud, reliance, or even proximate cause. The burden of proof shifts to the accused (i.e., the accountant). Defenses include proof of reasonable investigation (due care) or that the misstatement is not material.


Securities and Exchange Commission (SEC)

The Securities and Exchange Commission (SEC) is a federal government agency charged with the responsibility of writing rules consistent with federal security laws, investigation of violations, maintenance of financial disclosure documentation, and initiation of action against violators of federal securities acts. The SEC’s main office is in Washington, D.C., but it has “enforcement” and field offices all over the country.The SEC is charged with the oversight of the Federal Securities Act of 1933, the Federal Securities Exchange Act of 1934, and the Foreign Corrupt Practices Act. The agency serves to govern the registration, offering, sale, etc. of stocks, bonds, notes, convertible debentures, warrants, or other financial documents involving investments and purchases. In addition to writing regulations, the SEC reviews registration statements for compliance with disclosure requirements. The SEC does not determine whether the information provided to investors is accurate or truthful, nor does the SEC determine whether the terms of the offering are fair or reasonable to investors. The mission of the SEC is to protect the integrity of capital markets through enforcement of financial disclosure laws that apply when a business entity attempts to raise capital by selling ownership to investors. The SEC defines what information prospective investors must receive from offerors and what information the entities must continue to report to their shareholders if the entity has a certain number of owners.


Securities Exchange Act of 1934

The Securities Exchange Act of 1934 (SEA ’34) is a federal statute that regulates the trading of securities that are already issued and outstanding. The Act created the Securities Exchange Commission (SEC) and established requirements and provisions relating to the registration and operation of stock exchanges and brokers. The Act requires companies whose stock is publicly traded to register with, and report periodically to, the SEC. It supervises market activities, such as proxy solicitations, tender offers, insider trading, and short-swing profits, and strengthens and enforces antifraud provisions (SEA ’34 Section 10(b) and SEC Rule 10b-5).



A security, generally, is the evidence of a debt or ownership or related right. Securities can include stock options and warrants in addition to debt (bonds, notes, loans, mortgages) and stock. A security is a share, participation, or other interest in property or in an enterprise of the issuer that:

    • either is represented by an instrument issued in bearer or registered form or, if not represented by an instrument, is registered in books maintained to record transfers by, or on behalf of, the issuer;
    • is of a type commonly dealt in on securities exchanges or markets or, when represented by an instrument, is commonly recognized in any area in which it is issued or dealt in as a medium for investment; and
    • either is one of a class or series or by its terms is divisible into a class or series of shares, participations, interests, or obligations.


Security Interest

A security interest is an interest in tangible or intangible personal property or fixtures that secures payment or performance of an obligation. It may be possessory or nonpossessory (i.e., the creditor may or may not hold the property that serves as collateral). Three requisites are (1) agreement between the parties, (2) value has been given, and (3) the debtor has rights in the collateral. (U.C.C. 9-203)


Selling Costs

also known as: Selling Expenses
Selling Cost
Selling Expense

Selling costs are the expenses of promoting, marketing, selling, and distributing goods and services. Such expenses include sales personnel’s salaries, sales commissions, traveling expenses of sales personnel, advertising, sample costs, and product shipping costs. These expenses may be combined with administrative expenses and reported as a single line item: selling and administrative expenses.


Several Liability

also known as: Severally Liable

Several liability is the legal theory which holds that one party may be held individually liable for the action of others—“each of us promises.” Said of partners, one partner may be forced to pay the entire claim against the partnership. This one partner then has the right to sue the other partners for his share.

Release of one of several obligees does not release all. If one dies, the estate is liable. (Contrast with joint liability.) The obligee may be severally liable or both jointly and severally liable.


Small Tax Case Appeals of the Tax Court

The Small Tax Case Appeals is a simplified and informal option that is available to a taxpayer within the structure of the Tax Court. The taxpayer can request and, with the Tax Court’s approval, have the case conducted under the simplified small tax case procedures. To qualify for this appeal procedure, the tax dispute cannot exceed $50,000 for any one tax year.In general, a speedier disposition of a case results because the case is heard by a special trial judge and the rules of evidence are relaxed (any evidence the court deems to have probative value is admissible in small tax cases). Thus, the taxpayer might be better able to argue his or her own case if attorney fees would be a constraint on requesting judicial review of a tax dispute (taxpayers usually represent themselves in small tax cases). One disadvantage to the small case procedure is there is no appeal from the decision reached in such a case. See IRS Publication 556 for additional information.


Standard Cost

also known as: Standard Costing
Budgeted Cost

Standard cost is a predetermined quantity or cost of inputs (direct material, direct labor, and manufacturing overhead) that should be required to produce one unit of output. It is the per-unit planned amount; the target, quantity, or cost that should be needed. Standard cost is used with both job order costing and process costing. It serves as the basis for budgeting and control (feedback) and serves as the plan against which actual results are compared.

The objective of a standard cost system is to help the enterprise operate in the most effective and efficient manner, to achieve the organizational objectives by obtaining the optimum and desired outputs from the inputs available.

Standards should be attainable, i.e., standards are set at levels which recognize that labor will not be 100% efficient at all times, that materials will not be used with 100% efficiency (there will be some waste or spoilage), and that operations will not function at 100% capacity at all times.


Standard Deduction

The standard deduction is an amount specified by federal income tax law to be deducted from AGI when it exceeds the allowable itemized deductions of the taxpayer. The amount is indexed for inflation and is dependent on the taxpayer’s filing status. According to IRS Publication 501, the standard deduction is higher for taxpayers who are age 65 or older and/or blind.

In addition, the standard deduction for an individual who can be claimed as a dependent on another person’s tax return is generally limited to the greater of:

    • $1,000 or
    • the individual’s earned income for the year plus $350 (but not more than the regular standard deduction amount).

In addition, certain taxpayers are prohibited from declaring the standard deduction (e.g., a married couple electing to file separately and where one spouse elects to itemize).


Statements on Auditing Standards (SAS)
also known as: SAS

The 10 generally accepted auditing standards (GAAS) are interpreted and expanded upon in Statements on Auditing Standards (SAS), issued periodically by the Auditing Standards Board of the AICPA. They provide the detail and guidance needed to meet the 10 GAAS standards.

The 10 standards have changed to AU-C 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Generally Accepted Auditing Standards. The Auditing Standards Board (ASB) believes that if an auditor fulfills the overall objective of the auditor and meets applicable ethical requirements, the auditor will have fulfilled the requirements currently stated in the 10 standards.


Statements on Standards for Tax Services (SSTSs)
also known as: SSTS

Statements on Standards for Tax Services (SSTSs) are issued by the AICPA and are enforceable tax practice standards for members of the AICPA. The SSTSs and interpretations contain members’ responsibilities to clients, the public, the government, and the profession. These standards are to assist tax practitioners in their dual role of serving their clients and the public.



Tangible means having physical substance. Tangible things are capable of being seen, held, or used (e.g., inventories, land, buildings, equipment, and furniture) and are in contrast to intangible assets.Cash and deposits, accounts receivable, investments in equity securities, and prepaid expenses are intangible assets in the strictest sense of the term. Due to the short-term nature and easily determined value of these assets, however, accounting treatments are fairly straightforward and well defined. These assets are usually included in discussions of tangible assets and are not considered “intangible assets” on the balance sheet.


Tax Position

A tax position is a position in a previously filed tax return or a position expected to be taken in a future tax return that is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods.FASB ASC 740-10-20


Tax Rate
also known as: Tax Rates

A tax rate is the percentage applied to taxable income to compute tentative income tax payable.


Tax Return

also known as: Tax Filing
Income Tax Return

A tax return is a statement of information, usually on a prescribed form, required by governments from individuals, businesses, and other entities.

The most common U.S. tax return form is federal IRS Form 1040, U.S. Individual Income Tax Return, which is used by an individual to report income to the Internal Revenue Service. The complete tax return will include this form, or a similar one, plus any related schedules and other attachments that may be required with this form. The amount of tax to be paid with the return, or the amount of tax to be refunded to the taxpayer, is reported on the tax return.

Corporations usually file an income tax return on Form 1120, U.S. Corporation Income Tax Return, with accompanying schedules and other attachments.

Nonprofit organizations usually file Form 990, Return of Organization Exempt From Income Tax, which is an “information only” type of tax return. Even if a nonprofit organization is tax-exempt, it is still required to report its financial status and activities to the Internal Revenue Service.

Among other tax return forms is Form 1065, U.S. Return of Partnership Income, which is generally used as an information-only return by partnerships.


Taxable Income

Taxable income is the amount of income on which the taxpayer owes tax under current tax law. For individuals, it is adjusted gross income minus all allowable deductions (usually the larger of the standard deduction or itemized deductions). For a business, it is the excess of taxable revenues over tax-deductible business expenses for the period.


Taxable Termination

A taxable termination will trigger the federal generation-skipping transfer tax. A taxable termination is any termination (by death, time, release or otherwise) of an interest in trust property if, immediately after the termination, only skip persons have an interest in the property.

A taxable termination will not result, however, if, after the termination, a distribution cannot be made to a skip person. Taxable terminations only occur with respect to property held in a trust (which includes trust arrangements).


Tentative Minimum Max (TMT)

The tentative minimum tax (TMT) is the second-to-last concept in determining the alternative minimum tax (AMT). The taxpayer pays AMT on the excess of his or her TMT over his or her regular tax liability.

The calculation begins with the regular taxable income. The sum of the AMT tax preference items, which require identification and separate computations, is added to the regular taxable income. To arrive at the alternative minimum taxable income (AMTI), the “AMT adjustments” must be added or subtracted depending on the specific adjustment and the associated facts and circumstances for the year of preparation. The tax rate is then imposed on the AMTI in excess of an exemption amount, producing the “gross AMT.”


Third-Party (Primary) Beneficiary Rule
also known as: Primary Beneficiary Rule
Third-Party Beneficiary Rule

The third-party (primary) beneficiary rule is a modern modification of the Ultramares ruling. An accountant may be liable for simple negligence to third parties, despite lack of privity, when the accountant knows that the services performed for the client were primarily for the benefit of the third party (e.g., when the client needs audited financial statements to obtain funds or credit from a bank, investor or creditor). Under this rule, the third party is treated as if it were a party to the contract between the accountant and the client.


Treasury Regulations

also known as: Final Regulations
Proposed Regulations

The IRS commissioner, under authority granted by the U.S. Congress, publishes interpretations of the tax law in the form of Treasury Department Regulations. These regulations carry significant authority because they are the Treasury Department’s official interpretation of tax statutes. Although courts often do refer to the regulations’ interpretation of the tax code, the regulations do not have the full force and effect of law, except in those cases in which the law on a particular subject calls for rules on that subject to be expounded through regulations, which are called legislative regulations.

Specifically, a legislative regulation is a Treasury Regulation that is issued under a specific directive by Congress. In a sense, Congress gives the Treasury Department the authority to write the law. Thus, it is not possible to claim that the regulation is not in line with Congressional intent. For example, the regulations for filing consolidated returns are legislative, and therefore provide the majority of the law applicable to such tax filings. Legislative regulations are less common than interpretive regulations, which are explained below.

An interpretive regulation is a Treasury Regulation that is issued under the general authority provided to the Treasury Department. It interprets the statutory law. Interpretive regulations generally have the force of law, but it may be possible to demonstrate to a court that the regulation goes beyond the intent of Congress.

In addition, regulations can be proposed, temporary, or final. Many regulations are first issued in proposed form, with a designated time period in which practitioners and other interested parties can provide written or oral comments. Interested parties do not have the ability to comment on other sources of Treasury Department tax guidance, such as Revenue Rulings and Revenue Procedures. Because proposed regulations are simply “invitations to comment,” courts have consistently held that they lack any authoritative weight. Taxpayers must be careful when taking a tax-filing position that contradicts a proposed regulation, however, because the regulation could be issued in temporary or final form without material changes.

A temporary regulation has the same authority as a final regulation, but a temporary regulation has the force of law immediately upon issuance—it is never a proposed regulation with a comment period. A temporary regulation does not have an initial comment period because it is meant for matters where immediate tax guidance is warranted. A temporary regulation is also issued as a proposed regulation, and it can be later superseded by a final regulation. A temporary regulation expires within 3 years of issuance.

A final regulation is the final stage in the process of issuance of regulations after the comments have been received and considered. After release as a final regulation, the regulation has the force of law, subject to the right to challenge an interpretive regulation.

Proposed, temporary, and final regulations are published in the Federal Register and Internal Revenue Bulletin, as well as by major tax services.


Ultramares Rule

also known as: Ultramares

The Ultramares rule is a precedent from a 1931 court case (Ultramares v. Touche) that developed the concept of gross negligence (constructive fraud).

Prior to Ultramares, an accountant was liable for negligence to a client but not to a third party: the third party was not a party to the contract between the accountant and the client (i.e., was not in privity with the accountant) and, therefore, had no standing to bring suit. The Ultramares decision upheld the privity defense for negligence: the accountant is not liable to an unidentified third party for simple negligence. However, the decision also held that when the degree of negligence is so gross as to amount to the inference of fraud (constructive fraud), the auditor could then be liable to third parties.

Some modern courts are modifying the Ultramares ruling by holding that the auditor may be liable for simple negligence to third parties who can reasonably be foreseen, e.g., bankers, creditors, and investors (third-party beneficiary rule).


Uniform Inventory Capitalization (UNICAP)
also known as: UNICAP

UNICAP rules require certain taxpayers to capitalize direct costs and an allocable portion of most indirect costs that are related to production of property or acquisition of property for resale activities. Costs attributable to production and costs attributable to inventory generally must be capitalized.

IRC Section 263A


Uniform Limited Partnership Act (ULPA)

The Uniform Limited Partnership Act (ULPA) consists of uniform rules adopted by various states governing all aspects of limited partnership operation in the absence of agreement to the contrary. The National Conference of Commissioners on Uniform State Laws (NCCUSL) promulgated the original ULPA in 1916 and the most recent revision in 2001.

The 1976 revision of the ULPA is referred to as the Revised Uniform Limited Partnership Act (RULPA).


Uniform Partnership Act

also known as: UPA

The Uniform Partnership Act (UPA) consists of uniform rules adopted by the various states (all except Louisiana, Georgia, and Michigan) governing all aspects of partnership operation in the absence of agreement to the contrary. The UPA provides “presumptions” regarding profits and losses, rights, duties, liabilities, operations and liquidation, all of which may be altered by written contract between or among the partners (partnership agreement). In the absence of such an agreement, UPA presumptions prevail.

Revisions to the UPA are sometimes referred to as the Revised Uniform Partnership Act (RUPA).


United States Government Accountability Office (GAO)
also known as: General Accounting Office (GAO)

The Government Accountability Office (GAO, formerly the General Accounting Office) is the body authorized to promulgate standards that must be followed in the audits of recipients of federal financial assistance. These standards are for the audit of governmental organizations, programs, activities, and functions.

The GAO’s authority derives from its position as a federal agency so charged. The GAO reports directly to Congress (legislative branch) and not to the executive branch of the government.


Unrealized Receivables

also known as: Hot Assets
Ordinary Income Assets

Unrealized receivables are any rights to payment not already included in income for:

    • goods delivered or to be delivered to the extent that the payment would be treated as received for property other than a capital asset, or
    • services rendered or to be rendered.

These rights must have arisen under contracts or agreements that existed at the time of sale or distribution, even though the partnership may not be able to enforce payment until a later date. For example, unrealized receivables include trade accounts receivable of a cash method partnership and rights to payment for work or goods begun but incomplete at the time of the sale or distribution of the partner’s share.

The basis for any unrealized receivables includes all costs or expenses for the receivables that were paid or accrued but not previously taken into account under the partnership’s method of accounting.

Unrealized receivables include the gain that would be treated as ordinary income if the partnership had sold certain depreciable property at its fair market value at the time that any of the following partnership transactions occurs:

    • A distribution by a partnership to a partner
    • A payment made in liquidation of an interest of a retiring or deceased partner
    • A sale or exchange of an interest in a partnership by a partner

Unrealized receivables also include the amount of potential gain that would be ordinary income. The partnership property referenced above that, when sold at fair market value, can yield a gain that is included in unrealized receivables includes the following:

    • Mining property for which exploration expenses were deducted
    • Stock in an Interest Charge Domestic International Sales Corporation (IC-DISC)
    • Certain farmland for which expenses for soil and water conservation or land clearing were deducted
    • Franchises, trademarks, or trade names
    • Oil, gas, or geothermal property for which intangible drilling and development costs were deducted
    • Stock of certain controlled foreign corporations
    • Market discount bonds and short-term obligations
    • Property subject to depreciation recapture under IRC Sections 1245 and 1250

Generally, any arms’-length agreement between the buyer and the seller (or between the partnership and the partner receiving the distribution) will establish the amount or value of:

    • the sales price of unrealized receivables or
    • the value of the receivables received in a distribution that is treated as a sale or exchange.

If no agreement exists, an allowance must be made for the estimated cost to complete performance of the contract or agreement, and for the amount of time between the sale or distribution and the time of the payment.

Example: A is a partner in the ABC Partnership. The adjusted basis of his partnership interest at the end of the current year is zero. His share of potential ordinary income in partnership depreciable property is $5,000. The partnership has no other unrealized receivables or substantially appreciated inventory items. A sells his interest in the partnership for $10,000 in cash. The amount A realizes from the sale of his partnership interest is $10,000. Since the adjusted basis of his interest in the partnership is zero, he reports the entire $10,000 as a gain. He reports the $5,000 as ordinary income. This amount represents his share of potential ordinary income in partnership depreciable property. A reports the remaining $5,000 gain as a capital gain.


Unrelated Business Income
also known as: Tax-Exempt Entity

In a nonprofit organization, unrelated business income refers to income derived from an unrelated activity. It must be received from an activity that is an ongoing trade or business and is not substantially related to the organization’s tax-exempt purpose. Unrelated business income is usually subject to tax for most exempt organizations.

IRC Section 511


Value-Added Tax (VAT)

also known as: VAT

A value-added tax is a tax levied on the value a firm adds to a good or service measured as the difference between the value of a firm’s sales and the value of its purchases from other firms.



also known as: Void Contract

A void contract is one that never had any legal status.



also known as: Voidable Contract

A voidable contract is valid only until one party exercises a right to avoid the contract. Voidable contracts can be made valid by (1) ratification or (2) silence by the party with the right to avoid the contract. The party affirms or sanctions the contract by accepting the benefit of the act retroactively, with full knowledge of the facts and the right to avoid the contract (express ratification) or by failure to repudiate or disaffirm the contract (by silence or by retention of goods received; implied ratification).


Voluntary Bankruptcy

Voluntary bankruptcy is a bankruptcy proceeding that is initiated by the debtor. The debtor files a petition seeking an order for relief. Voluntary bankruptcy can be under Chapter 7, 9, 11, or 13. Insolvency is not required.Debtors ineligible for filing a voluntary petition include railroads, banks, insurance companies, and savings and loan institutions.



also known as: Compensation
Compensation to Labor
Compensation to Employees
Compensation to Workers

Economic Theory: Wages are the factor price/factor payment for labor; the price paid per time period for the use of the services of labor. Wages are the part of the value of production that is due to labor or labor’s claim to the value of production. The pricing of labor is dependent upon many complicating factors other than demand and supply. Nonprice considerations (e.g., the worker’s feelings about the kind of work done, where and with whom it is done, the conditions under which it is done, and the social status accorded that kind of work), discrimination, labor unions, and government intervention (e.g., minimum wage) influence the level of wages and of employment in many industries. Wages are both a microeconomic and macroeconomic concept.

In microeconomics, the extreme conditions of the labor market correspond to the market structure continuum. One extreme is competitive conditions (there are so many employers that no one firm can influence the wage level (price-taker)) and the other extreme, where there is only one “buyer” of labor, is monopsony (meaning one buyer, the analog of monopoly, which means one seller).

Labor is extremely mobile in terms of location, occupation, and specific job. However, since labor requires the physical presence of the owner (the worker), nonprice considerations are often very important in the allocation/location of labor. The need for talent and training can limit the mobility of certain groups of labor (e.g., a clerk cannot easily become a physicist or professional athlete). However, the mobility of the labor force as a whole is much greater than the mobility of individual members (i.e., children of the clerk can choose to become a physicist or athlete).

In macroeconomics, wages include taxes withheld, Social Security payments, pension fund contributions, and other nonmonetary benefits (such as employer contributions to Social Security, health contributions, and unemployment insurance) in addition to “take-home” pay. Wages are a factor payment/factor income that is a major component of GNP (approximately 60%) in the income approach to national income accounting.

Wage information for tax purposes is shown on a taxpayer’s Form W-2, Wage and Tax Statement.


Warehouse Receipt

A warehouse receipt is a document of title issued by warehouseman (a party engaged in the business of storing goods for hire) evidencing receipt and possession (for storage) of the goods covered. The warehouseman (issuer) has possession of the goods but does not have any ownership interest. The holder of the document has 100% ownership of the document and the goods.



A warranty is a statement regarding the quality or quantity of the goods that are the subject of a sales contract. The objective is to protect the consumer. The Uniform Commercial Code (U.C.C.) makes express some warranties that were implied under common law. A warranty may be express or implied.

U.C.C. 2-312–318

Warranty of title is a warranty provided by the seller that the:

  • title is good,
  • transfer is rightful, and
  • goods are delivered free of any security interest or lien.

Express warranty is a warranty that the goods shall conform, which rests on the “bargained for” aspects of the individual agreement and goes so clearly to the essence of the bargain that words of disclaimer are repugnant. It is created by the following (may be oral or written):

  • Any affirmation of fact (of existing conditions) or promise (of future performance of the goods) made by the seller to the buyer that relates to the goods and becomes a basis of the agreement; expressions of value or opinion and “puffing” do not create a warranty.
  • Any description of the goods in words, pictures, drawings, or specifications (e.g., in contract, in catalog, on box containing the goods)
  • Any sample or model

Implied warranty is a guarantee that rests so clearly on a common factual situation or set of conditions that it is automatically imposed on the goods by operation of law without any agreement or consent of the parties and can be excluded or modified only by specified procedures.

  • Merchantability is that goods shall be fit for the purpose for which they are sold. It applies only to merchants who deal in the type of goods being sold. To be merchantable, goods must:
    • pass without objection in the trade under the contract description,
    • be of fair average quality as described (applies to fungible goods only),
    • be fit for the ordinary purpose for which such goods are used,
    • be within the variation of an even kind, quality, and quantity within each unit and among all units,
    • be adequately contained, packaged, and labeled as required by the agreement, and
    • conform to the promises or affirmations of fact made on the container or label (if any).
  • Fitness for a particular purpose is imposed on the seller if:
      • the seller has actual or constructive knowledge of the particular purpose for which the buyer needs the goods,
      • the seller must furnish or select the goods, and
      • the buyer must rely on the seller’s skill or judgment to select or furnish the goods.


Warranty of Merchantability
also known as: Merchantability

A warranty of merchantability is an implied warranty that goods shall be fit for the purpose for which they are sold. It applies only to merchants who deal in the type of goods being sold. To be merchantable, goods must:

    • pass without objection in the trade under the contract description.
    • be of fair average quality as described (applies to fungible goods only).
    • be fit for the ordinary purpose for which such goods are used.
    • be within the variation of an even kind, quality, and quantity within each unit and among all units.
    • be adequately contained, packaged, and labeled as required by the agreement.
    • conform to the promises or affirmations of fact made on the container or label (if any).

A warranty of merchantability can be disclaimed orally or in writing. If in writing, it must be conspicuous. Terms such as “as is” or “with all faults” act as an exclusion. The warranty can be excluded by course of dealing, course of performance, or usage of the trade.


Warranty of Title

Warranty of title is one of the three types of warranties provided by the Uniform Commercial Code (U.C.C.) on the sale of goods. It is a warranty provided by the seller that title is good, transfer is rightful, and goods are delivered free of any security interest or lien. This warranty is neither an express nor an implied warranty but rather one that is always in existence unless expressly disclaimed.


Wash Sale

Wash sale rules limit the ability of the taxpayer to currently deduct losses by effectively looking at the economic substance of the transaction rather than merely the transaction form. The loss deduction is disallowed only if the wash sale occurs within a 60-day period. (The related acquisition occurs within 30 days before or 30 days after the sale transaction.) This is a temporary disallowance of the loss. The disallowed loss is added to the basis of the replacement stock.IRC Sections 1091(a) and (d)



A will is a legal declaration of an individual’s intent as to the disposition of property after death. A person who dies with a will is said to die testate; a person who dies without a will is said to die intestate. A will becomes effective only upon the death of the individual (maker). It is ambulatory (i.e., may be changed by completely rewriting or by codicil or revoked by the maker during his lifetime). A will does not affect the rights of joint tenants (right of survivorship). A will may specify a general (“I leave to (named charity) the sum of $10,000”) or specific (“I leave to my brother our father’s gold watch”) legacy (disposition of property under a will). The will is used to “devise” the testator’s property (i.e., stipulate the recipient of property by will).


With and Without Recourse

“With recourse” is the condition under which the transferor of the accounts receivable agrees to reimburse the transferee for specified collection losses on pledged, factored, or assigned agreements due to (1) failure of debtors to pay when due, (2) estimated effects of prepayments, or (3) adjustments resulting from defects in the eligibility of the transferred receivables. The risk of default remains with the transferor. The transferor must include an allowance for uncollectible pledged, factored, or assigned accounts and incur a liability for estimated losses on these accounts.“Without recourse” is the condition under which the transferor of the accounts receivable is not obligated to reimburse the transferee for specified collection losses on pledged, factored, or assigned agreements due to (1) failure of debtors to pay when due, (2) estimated effects of prepayments, or (3) adjustments resulting from defects in the eligibility of the transferred receivables. The risk of default is assumed by the transferee. The transferor does not need an allowance for uncollectible pledged, factored, or assigned accounts and does not incur a liability for estimated losses on these accounts. Any difference between the total amount of accounts transferred and cash received is treated as interest expense or loss on the sale.


Workers’ Compensation

also known as: Workers’ Compensation
Workman’s Comp

Workers’ compensation is state-administered legislation requiring employers to obtain strict liability (no-fault) coverage for accidental injuries and sickness to employees sustained while on the job (during the course of or within the scope of employment). It is financed by employer payment of premiums. The purpose is to provide employees or their families with benefits in the event of being injured, disabled, or killed as a result of occupational accidents with the benefits to be obtained with little difficulty—the employee does not have to prove that the employer was negligent. It is a “no fault” system—the employer need not be negligent to be strictly liable, and the employee collects even if the employee is negligent.

Employers who accept the strict liability under workers’ compensation coverage cannot be sued by the employee for damages. Most employers are required to provide workers’ compensation. Exceptions to this general requirement vary state by state, and can include farm laborers, domestic servants, and casual workers. In addition, most states require employers to offer workers’ compensation. In the few states that do not require this, employers who do not accept workers’ compensation coverage can be sued, and they lose the three common law defenses:

    1. Contributory (or comparative) negligence (the employee’s own negligence contributed to the injury)
    2. The fellow servant doctrine (another employee caused the injury)
    3. Assumption of risk by the employee (employee knew and understood that the danger was present and voluntarily assumed that risk)

According to IRS Publication 525, workers’ compensation benefits are nontaxable if paid under a workers’ compensation act or a statute in the nature of a workers’ compensation act. This tax exemption applies to the taxpayer’s survivors as well.



also known as: 401(k) Plan

A 401(k) plan (or a cash or deferred arrangement plan) is a retirement plan created by the employer and contributed to by the employee alone or with matching contributions from the employer.

Under a 401(k) plan, an eligible employee may make a cash or deferred election with respect to contributions to, or accruals or other benefits under, a profit-sharing or stock bonus plan, a pre–Employee Retirement Income Security Act of 1974 (ERISA) money purchase plan, or a rural cooperative plan.

Contributions to the plan are made pre-tax (tax-deferred) for income tax—not for Social Security, Medicare, or federal unemployment. Earnings, gains, or losses within the account are tax-deferred. Distributions from the account are fully taxable.

Annual contributions are limited to an indexed amount. The act also allows an additional catch-up contribution to be made by taxpayers aged 50 and older.