3THE ACCOUNTING CYCLE:CAPTURING ECONOMIC EVENTS

HIGHLIGHTS OF THE CHAPTER

1. The effects of business transactions are recorded in accounting records called journals and ledgers. The recorded data then are used to prepare financial statements and other accounting reports at periodic intervals.

2. Transactions are recorded first in a journal, and the data is later transferred to the ledger. We can best illustrate the nature of these accounting records if we discuss the ledger first.

3. A ledger account may be viewed as the smallest unit of storage in an accounting system. In a manual system, each ledger account is represented by a separate page in a binder. In a computerized system, of course, each unit of storage is maintained electronically using general ledger software. But each general ledger account can still be viewed separately.

4. Each ledger account lists all of the increases and decreases in a particular financial statement account, and also indicates the account’s current “balance.”

5. In its simplest form a ledger account may be viewed as having two sides. The left side of the account is called the debit side; the right side is called the credit side.

6. Information entered on the left side of a ledger account are called debit entries. Information entered on the right side of a ledger account are called credit entries.

7. For all asset accounts, increases are recorded by debit entries, and decreases are recorded by credit entries.

8. For all liability accounts and owners' equity accounts, increases are recorded by credits, and decreases are recorded by debits.

9. The debit and credit rules for recording revenue and expenses are based upon the changes they cause in owners' equity. Revenue increases owners' equity; therefore, revenue is recorded by credit entries. Expenses decrease owners' equity and are recorded debits.

10. The double-entry system of accounting requires that equal dollar amounts of debits and credits be recorded for every transaction.

11. Virtually every business maintains a journal as a record of “original” entry. A journal is a chronological listing of all transactions in the order they occur.

12. The journal shows all information about each transaction: (a) the date of the transaction, (b) the accounts debited and credited, and (c) a brief explanation of the transaction.

13. After a transaction has first been recorded in the journal, each debit and credit is later transferred to the appropriate ledger accounts. This transfer is called posting.

14. Two things can cause changes in owners' equity: (a) owner investments and dividends, and (b) profits or losses resulting from the operation of the business.

15. Profits increase owners' equity, and may either be distributed to the owners or reinvested in the business to help finance expansion and growth. Losses, however, reduce owners' equity, making the owners worse off, economically.

16. Net income is the term most often used to describe increases in owners' equity resulting from profitable operations. Net loss is the term used to describe decreases in owners' equity resulting from unprofitable operations.

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17. Net income is computed by deducting expenses incurred during the accounting period from revenue earned during the period. Net income for each accounting period is reported in a financial statement called an income statement.

18. An income statement covers a span of time, whereas a balance sheet shows a company’s financial position at one particular date. The need to relate net income to a period of time is called the time period principle.

19. Revenue is the price charged to customers for goods sold and services rendered during the accounting period. Revenue is not necessarily “cash” flowing into a business. Rather, it is the amount “earned” during the period. Recognizing revenue as it is “earned” illustrates the realization principle. Cash received from customers may be received by a business before revenue is earned, after revenue is earned, or at the same time that revenue is earned.

20. Expenses are the cost of goods and services incurred in the effort to generate revenue. Expenses are typically recorded as “resources” are used up, regardless of when payment for the resources is made. Thus, cash may be paid before resources are used up, after resources are used up, or at the same time that resources are used up.

21. An income statement shows the revenue earned during the period and the expenses incurred during the period in generating that revenue. This policy of offsetting revenue with related expenses is called the matching principle.

22. Businesses often purchase assets that will be “used up” over two or more accounting periods. The matching principle requires that an effort be made to allocate an appropriate portion of the asset’s cost as an expense in each period that the asset helps the business to earn revenue.

23. At the end of the accounting period, when all entries in the journal have been posted to the ledger, the debit or credit balance of each account is computed. These balances are listed in a trial balance.

24. The trial balance is a two-column schedule listing all of the accounts in the order they appear in the ledger. Debit account balances are shown in the left column and credit account balances are shown in the right column. Since the total of the debit balances should equal the total of the credit balances, the two columns will be equal if the ledger is in balance. However, the amounts shown are not necessarily the correct amounts.

25. The trial balance is not a formal financial statement, but merely a preliminary step to preparing financial statements.

26. The accounting procedures covered in this chapter were part of what is referred to collectively as the accounting cycle. The accounting cycle involves eight steps: (a) journalizing transactions (b) posting journal entries to ledger accounts, (c) preparing a trial balance, (d) making adjusting entries, (e) preparing an adjusted trial balance (f) preparing financial statements from the adjusted trial balance figures, (g) closing appropriate accounts, and (h) preparing an after-closing trial balance. In this chapter we have illustration d steps a-c of the accounting cycle. In Chapters 4 and 5, the remaining steps will be addressed.

TEST YOURSELF ON THE ACCOUNTING CYCLE

True or False

For each of the following statements, circle the T or the F to indicate whether the statement is true or false.

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T F 1. In a prosperous and solvent business the accounts with credit balances will normally exceed in total dollar amount the accounts with debit balances.

T F 2. The term debit may signify either an increase or a decrease; the same is true of the term credit.

T F 3. A business transaction is always recorded in the ledger by entries to two or more different ledger accounts.

T F 4. An entry on the left side of a ledger account is called a debit entry and an entry on the right side is called a credit entry, regardless of whether the account represents an asset, a liability, or owners' equity.

T F 5. Accounts representing items which appear on the left-hand side of the balance sheet usually have credit balances.

T F 6. A trial balance with equal debit and credit totals proves that all transactions have been correctly journalized and posted to the proper ledger accounts.

T F 7. The sequence of the account titles in a trial balance depends upon the size of the account balances.

T F 8. A journal entry may include debits to more than one account and credits to more than one account but the total of the debits must always equal the total of the credits.

T F 9. If a business transaction is recorded correctly, it cannot possibly upset the equality of debits and credits in the ledger.

T F 10. In a journal entry recording the purchase of a desk for $275.80, both the debit and credit were recorded and posted as $257.80. This transposition error would not be disclosed by the preparation of a trial balance.

T F 11. The double-entry accounting system means that transactions are recorded both in the journal and in the ledger.

T F 12. An income statement relates to a specified period time whereas a balance sheet shows the financial position of a business at a particular date.

T F 13. The realization principle states that a business should never record revenue until cash is collected from the customer.

T F 14. Expenses cause a decrease in owners' equity and are recorded by debits.

T F 15. If cash receipts are $10,000 greater than total expenses for a given period, the business will earn a net income of $10,000 or more.

T F 16. The journal entry to recognize a revenue or an expense usually affects an asset or liability account as well.

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T F 17. Under accrual basis accounting, revenue is recognized when cash is received, and expenses are recognized when cash is paid.

T F 18. An expense may be recognized and recorded even though no cash outlay has been made.

T F 19. Buying a building for cash is just exchanging one asset for another and will not result in an expense even in future.

T F 20. Revenue increases owners' equity and is recorded by a credit.

Completion Statements

Fill in the necessary word to complete the following statements:

1. Increases in assets are recorded by ___________, and decreases in assets are recorded by credits; increases in accounts appearing on the right side of a balance sheet are recorded by ___________, while decreases in those accounts are recorded by _____________.

2. In accounting, the term debit refers to the _________ side of a _________ ________, while the term credit refers to the _____________side.

3. Asset accounts appear on the ___________ side of the balance sheet and normally have ____________balances. Liability and owners' equity accounts appear on the ______________ side of the balance sheet and normally have ___________balances.

4. When a company borrows from a bank, two accounts immediately affected are _____________ and ______ ________________. The journal entry to record the transaction requires a ________ to the first account and a ______ to the second one.

5. A ___________ _____________is prepared from the ledger accounts at the end of the month (or other accounting period) in order to prove that the total accounts with _______ _____________ is equal to the total accounts with __________ ___________________.

6. The ______________ principle of accounting states that revenue should be recognized in the period that it is earned. The ________________ principle indicates that expenses should be recognized in the period in which they help produce _________.

7. The principle distinction between expenses and dividends is that expenses are incurred for the purpose of ______________ ______________.

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Multiple Choice

Choose the best answer for each of the following questions and enter the identifying letter in the space provided.

__ 1. A ledger contains a separate “account” for each:a. Business transaction.

b. Business day.

c. Asset, liability, and element of owners' equity.

d. Journal entry.

__ 2. Which of the following statements about the rules for debiting and crediting balance sheet accounts is not true?

a. Liability accounts are reduced by debit entries.

b. Accounts on the left side of the balance sheet are reduced by credit entries.

c. Each transaction is recorded by equal dollar amounts of debits and credits.

d. Owners' equity accounts and asset accounts are increased by the debit entries.

__ 3. The key point of double-entry accounting is that every transaction:a. Is recorded by equal dollar amounts of debit and credit entries.

b. Is recorded in both the journal and the ledger.

c. Affects both sides of the balance sheet.

d. Is both recorded and posted.

__ 4. A journal consists of:a. A listing of the balances of the accounts in the ledger.

b. A storage center of information within a computer-based system.

c. A chronological record of individual business transactions.

d. a separate “account” for each asset, liability, and element of owners' equity.

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__ 5. The purpose of a trial balance is:a. To determine that journal entries are in balance before posting those entries to the

ledger.

b. To indicate the effects of business transactions.

c. To prove the equality of debits and credits in the ledger.

d. To determine that the number of ledger accounts with debit balances is equal to the number of credit balances.

__ 6. Red Hill Vineyards completes a transaction which causes an asset account to decrease. Which of the following related effects may also occur?

a. An increase of equal amount in a liability account.

b. An increase of an equal amount in owners' equity.

c. An increase of an equal amount in another asset account.

d. None of the above.

__ 7. The time-period principle:a. Requires that all companies prepare monthly, quarterly, and annual financial

statements.

b. Involves dividing the life of a business entity into accounting periods of equal length.

c. Requires all companies to use a fiscal year ending December 31.

d. Stems from the Internal Revenue Service requirement that taxable income be reported on an annual basis.

__ 8. The realization principle:a. Indicates that a business should record revenue when services are rendered or

merchandise sold is delivered to customers, even if cash has not yet been received.

b. Indicates that revenue should be recognized in the accounting period when cash is received, even if the business has not yet performed all the required services.

c. Indicates that revenue should be recorded only after two conditions have been met: (1) the earning process is complete, and (2) the cash has been collected.

d. Provides guidelines as to when expenses should be recognized.

__ 9. A produce supplier enters into a contract with a supermarket chain on September 8 to deliver pumpkins in October. The pumpkins are delivered on October 14 at a price of $4,000, $2,000 payable on November 1, and $2,000 December 1. When should the produce supplier record the $4,000 as revenue?

a. September 8.

b. October 14.

c. $2,000 November 1, and $2,000 December 1.

d. When the supermarket sells the pumpkins.

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__ 10. The matching principle implies that expenses:a. Should be deducted from revenue in the period which the suppliers of the goods

or services are paid.

b. For a period should be equal in amount to the revenue recognized during the period.

c. Should be deducted in the period in which use of the related goods or services help to produce revenue.

d. Should be equal to the cash payments made during the period.

__ 11. On April 1, Hudson Company received and paid a $700 bill for advertising done in March. In addition to this bill, the company paid $6,100 during April for expenses incurred in that month. On May 2, Hudson Company paid a $4,600 payroll to employees for work done in April. Based on these facts, total expenses for the month of April were:

a. $ 6,100.

b. $ 6,800.

c. $10,700.

d. $11,400.

__ 12. If a journal entry recognizes an expense, the entry might also:a. Increase an asset account.

b. Decrease the Capital Stock account.

c. Decrease a liability account.

d. Increase a liability account.

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Exercises

1. Listed below are eight technical accounting terms emphasized in this chapter.

Trial Balance Accounting CycleDebit Realization principleRevenue Accrual accountingNet income Credit

Each of the following statements may (or may not) describe one of these technical terms. In the space provided below each statement, indicate the accounting term described, or answer “None” if the statement does not correctly describe any of the terms.

a. An eight-step process by which economic events are initially captured and transformed into financial statements.______________________________________________

b. The price of goods sold and services rendered during the period.______________________________________________

c. Revenue earned less expenses incurred during the period.______________________________________________

d. A two-column schedule listing all of the accounts in the general ledger and their respective balances.______________________________________________

e. The generally accepted accounting principle that expenses are to be recognized in the period that the related expenditure helps to produce revenue.______________________________________________

f. The right-hand side of a ledger account.______________________________________________

g. The technique of recognizing revenue when it is earned and expenses when the related goods and services are used, without regard to when cash is received or paid.______________________________________________

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2. Show the change in total assets, total liabilities, and total owners' equity that will be caused by posting each amount in the following journal entries. In the effect of transaction row, show the total change in assets, liabilities, and owners' equity that has occurred after all parts of the transaction have been posted. Hint: The effect of each transaction should be that the total change on the left side of the balance sheet (change in assets) should equal the change on the right side (change in liabilities + change in owners' equity). Explanations have been omitted from journal entries to conserve space.

Journal Entry Dr Cr Assets = Liabilities +Owners'Equity

Example:Office Equipment................................ 600 +600

Cash ....................................... 150 -150Accounts Payable................... 450 +450

Effect of transaction +450 = +450 + 0a. Cash ................................................ 1,230

Accounts Receivable.............. 1,230Effect of transaction = +b. Cash ................................................ 5,000

Capital Stock.......................... 5,000Effect of transactionc. Cash ................................................ 3,800

Notes Payable......................... 3,800Effect of transaction = +d. Accounts Payable............................ 350

Cash........................................ 350Effect of transaction = +e. Land ................................................ 9,000

Cash........................................ 1,000Notes Payable......................... 8,000

Effect of transaction = +

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3. A list of accounts for Jones Company is given below followed by a series of transactions. Indicate the accounts that would be debited and credited in recording each transaction by placing the appropriate account number(s) in the space provided1. Cash2. Accounts Receivable3. Office Equipment4. Accumulated Depreciation: Office Equipment21. Notes Payable22. Accounts Payable31. Capital Stock35. Retained Earnings41. All Revenue Accounts51. All Expense Accounts99. Dividends

Transactions Accounts(s)Debited

Accounts(s)Credited

Example Purchased office equipment, paying part cash and issuing a note payable for the balance

3 1,21

a. Paid creditor amount due on open account

b. Collected from customer for services performed by Jones Company in previous period

c. Utility bill is received; payment will be made in 10 days

d. Performed services for a customer; $50 cash received and the balance due in 30 days

e. Office equipment purchased giving note payable

f. Made a Cash distribution to the stockholders.

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4. Indicate the effects that each of these transactions will have upon the following six total amounts in the company’s financial statements for the month of May. Use the code letters I for Increase, D for Decrease, and NE for No Effect.

Income Statement Balance Sheet

ErrorTotal

RevenueTotal

ExpensesNet

IncomeTotalAssets

TotalLiabilities

Owners'Equity

Example: Rendered services to a customer and received immediate payment in cash but made no record of the transaction

U NE U U NE U

a. Payment for repairs erroneously debited to Building account

b. Recorded collection of an account receivable by debiting Cash and crediting a revenue account.

c. Recorded twice revenue earned on account.

d. Recorded twice a purchase of offices supplies on credit

e. Recorded the purchase of office equipment for cash as a debit to Office expense and a credit to cash.

f. Recorded cash payment for advertising by debiting Repairs Expense and crediting Accounts Payable.

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SOLUTIONS TO CHAPTER 3 SELF-TEST

True or False

1. F Regardless of whether a business is solvent or profitable, the sum of accounts with credit balances (normally Liabilities and Owners' Equity) will always equal the sum of accounts with debit balances (assets).

2. T The term debit means an entry on the left-hand side of an account, and credit means an entry on the right-hand side of an account. Whether the entry results in an increase or decrease depends upon the type of account affected.

3. T Equal dollar amounts of debit and credit entries are needed to record each transaction. Although more than two accounts may be affected, a transaction would never involve just a single account.

4. T By definition, a debit is an amount recorded on the left-hand side of an account and a credit is an amount recorded on the right-hand side of an account.

5. F Liability and owners' equity accounts normally have credit balances. These accounts appear on the right-hand side of the balance sheets illustrated in your text.

6. F A “balancing” trial balance only gives assurance that (a) equal debits and credits have been recorded, (b) the balance of each account has been computed correctly, and (c) the addition of account balances in the trial balance has been done accurately.

7. F Accounts appear in the trial balance in the order in which they appear in the ledger, which is in financial statement order (assets, followed by liabilities, owners’ equity, revenue, and expenses).

8. T An entry which includes more than one debit or more than one credit is called a compound journal entry.

9. T Every transaction is to be recorded by an equal dollar amount of debits and credits; recording a transaction properly will maintain equality of debits and credits.

10. T Since both debit and credit of the original journal entry were equal, the trial balance would still show equality of debits and credits.

11. F The premise of double-entry accounting means that equal dollar amounts of debits and credits are used to record each business transaction.

12. T Net income cannot be evaluated unless it is associated with a specific time period.

13. F The realization principle states that revenue should be recognized when services are rendered or goods are delivered.

14. T Expenses offset revenue in determining net income and therefore reduce owners’ equity.

15. F Net income equals revenue minus expenses; cash receipts and revenue are not the same.

16. T To record an expense, the expense account is debited and cash or a liability is credited; to record revenue, the asset received is debited and revenue is credited.

17. F Revenue is recognized when earned; expenses are recognized in the period in which the cost helps to produce revenue.

18. T The cash payment for an expense may occur before, after, or in the same period that an expense helps to produce revenue.

19. F A portion of the cost of the building will be recognized as depreciation expense each period over the building’s useful life.

20. T Revenue is the gross increase in owners’ equity resulting from business activities; all increases in owners’ equity are recorded by credits.

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Completion Statements

1. Debits, credits, debits. 2. Left, ledger account, right. 3. Left, debit, right, credit. 4. Cash, Notes Payable, debit, credit. 5. Trial balance, debit balances, credit balances. 6. Realization, matching, revenue. 7. producing revenue.

Multiple Choice

1. Answer c – a separate ledger account is maintained to record the changes in each asset, liability, and element of owners' equity. Answers a, b, and d all relate to the journal, which consists of a chronological record of business transactions.

2. Answer d is false. Owners' equity accounts appear on the right-hand side of the balance sheet and are increase by credit entries.

3. Answer a – double-entry accounting means that equal dollar amounts of debits and credits are needed to record any business transaction.

4. Answer c describes a journal. Answer a describes a trial balance; answer b, a database; and answer d, a ledger.

5. Answer c – a trial balance is a listing of the balances of the accounts in the ledger. Answers a and b are incorrect because they relate to data not yet posted into the ledger. Answer d is incorrect because it is the total dollar amount of debit and credit balances that must be equal, not the number of accounts with each type of balance.

6. Answer c – a decrease in one asset account must be accompanied by an increase in another asset account, or by a decrease in either a liability or an owners' equity account.

7. Answer b – for accounting information to be useful, it must be available on a frequent periodic basis. This requires dividing the overall life of the business entity into equal “accounting periods.” Answer a is incorrect because the principle does not require monthly statements. Answer c is incorrect because a company’s fiscal year need not end on December 31. Answer d is incorrect because generally accepted accounting principles are not governed by income tax laws.

8. Answer a – under the realization principles revenue is recognized when it is earned regardless of when the cash is collected. Answers b and c are incorrect because they tie the recognition of revenue to the collection of cash. Answer d describes the matching principle, not the realization principle.

9. Answer b – the realization principle indicates that revenue should be recognized when it is earned – that is, when services are rendered or when goods sold are delivered to customers.

10. Answer c – expenses should be offset against the revenue produced by these expenditures. Answers a and d are incorrect because the period in which expenses are recognized may differ from the period in which the related cash payments are made. Answer b is incorrect because expenses may differ from revenue by the amount of any net income or net loss.

11. Answer c – $6,100 + $4,600. Answer a excludes the $4,600 in salaries expense for April. Answer b excludes the salaries and improperly includes $700 in advertising expense for the month of March. Answer d improperly includes the $700 in advertising expense applicable to March.

12. Answer d – the debit entry to record an expense is always accompanied by either a credit (decrease) in an asset account, or a credit (increase) in a liability account.

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Solutions to Exercises

1.

a. Accounting Cycle

b. Revenue

c. Net income

d. Trial Balance

e. None (The statement describes the matching principle.)

f. Credit

g. Accrual accounting

2.

Journal Entry Dr Cr Assets = Liabilities +Owners'Equity

a. Cash ................................................ 1,230 +1,230Accounts Receivable 1,230 -1,230

Effect of transaction 0 = 0 + 0b. Cash ................................................ 5,000 +5,000

Capital Stock.......................... 5,000 +5,000Effect of transaction +5,000 = 0 + +5,000c. Cash ................................................ 3,800 +3,800

Notes Payable......................... 3,800 +3,800Effect of transaction +3,800 = +3,800 + 0d. Accounts Payable............................ 350 -350

Cash........................................ 350 -350Effect of transaction -350 = -350 + 0e. Land ................................................ 9,000 +9,000

Cash........................................ 1,000 -1,000Notes Payable......................... 8,000 +8,000

Effect of transaction +8,000 = +8,000 + 0

3. Transactions Accounts(s)Debited

Accounts(s)Credited

a 22 1b 1 2c 51 22d 1,2 41e 3 21f 99 1

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4. Income Statement Balance Sheet

ErrorTotal

RevenueTotal

ExpensesNet

IncomeTotalAssets

TotalLiabilities

Owners'Equity

a NE U O O NE Ob O NE O O NE Oc O NE O O NE Od NE NE NE O O NEe NE O U U N Uf NE NE NE O O NE

GLOSSARY

accrual basis of accounting: Transactions are recorded when they occur regardless of when cash is paid or received. Commissions use a modified form of accrual accounting (see Modified Accrual Basis) for Governmental funds. However, the accrual basis of accounting is used for the preparation of annual government-wide financial statements where governmental activities are reported (governmental activities are defined later).

active investment management: Active management of an investment portfolio implies that the investing official may sell some securities in order to shift assets into other instruments. This may be done simply to rebalance a portfolio that has become overconcentrated in one sector, or it may reflect an effort to enhance total returns by trading or swapping into securities that are expected to outperform the original holding. Active investment management requires expertise and frequent monitoring of financial markets.

administrative costs: Costs incurred for a common or joint purpose that benefits more than one cost objective, supports the general management and administration of a First 5 commission, and/or those costs not readily assignable to a specifically benefited cost objective.

advance payment: Any payment made to a contractor before work has been performed or goods have been delivered.

appropriation: Appropriations represent the maximum expenditures that are authorized by the governing body of the commission. They represent (by budget category) amounts that cannot be legally exceeded. Internal reporting must provide timely information so the Board of the commission can determine that the spending limits authorized have not been exceeded.

assigned fund balance: That portion of the fund balance that reflects a commission's intended use of resources, which is established either by the county First 5 Commission, a body created by the commission, such as a commission finance committee, or an official designated by the commission (e.g., an Executive Director).

balance sheet: The financial statement disclosing the assets, liabilities, and equity of the governmental funds (which includes general funds and special revenue funds). Governments are also required to disclose assets, liabilities and equity on a “government-wide entity” basis, using accrual accounting. This is known as the Statement of Net Assets.

bankers’ acceptance: A time draft drawn on and accepted by a bank to pay a specified amount of money on a specified date. Bankers’ acceptances are short-term, non-interest bearing notes sold at a discount and redeemed at maturity at face value by the accepting bank. Bankers’ acceptances are backed by the issuers’ guarantee to pay, the underlying goods being financed, and the guarantee of the accepting bank.

bidder’s conference: A meeting with potential providers before the proposal submission date.

broker: A person or firm that acts as an intermediary by purchasing and selling securities for others rather than for its own account.

budgetary basis of accounting: The form of accounting used to describe revenues and expenditures in the budget document. The term "basis of accounting" is used to describe the timing of recognition, that is, when the effects of transactions or events should be recognized. The basis of accounting used for purposes of financial reporting in

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accordance with generally accepted accounting principles (GAAP) is not necessarily the same basis used in preparing the budget document. For example, governmental funds are required to use the modified accrual basis of accounting in GAAP financial statements whereas the cash basis of accounting or the "cash plus encumbrances" basis of accounting may be used in those same funds for budgetary purposes. Disparities between GAAP and the budgetary basis of accounting often occur because of regulations that govern budgeting (e.g., laws or ordinances of the state, county, city or some other jurisdiction) which differ from GAAP. There are four basic categories of difference between the budgetary basis of accounting and the basis of accounting that follows generally accepted accounting principles (GAAP) for state and local governments. They are:

basis of accounting – "cash plus encumbrances" and "modified accrual" are two of the different ways to define revenues and expenditures;

timing – the budget period may differ from the accounting reporting period, e.g., lapse periods for encumbrances;

perspective – the budget and accounting reports may have different fund reporting structures, e.g., a budget may account for debt service in the general fund, while GAAP principles require that debt service be recorded in a separate fund;

entity – the government’s financial report may not include all of the same entities and funds as the budget document.

capital assets: Land, improvements to land, easements, buildings, building improvements, vehicles, machinery, equipment, works of art and historical treasures, infrastructure, and all other tangible or intangible assets that are used in operations and that have initial useful lives extending beyond a single reporting period. Capital assets historically were also referred to as fixed assets, but that terminology is no longer used in practice.

cash basis of accounting: Basis of accounting that recognizes transactions or events when related cash amounts are received or disbursed.

certificate of deposit: A time deposit in a financial institution documented by a certificate that bears a specified dollar amount of the deposit, a specified maturity date and a specified interest rate.

collateral: Underlying securities that are pledged to secure deposits of public funds. Also used in conjunction with repurchase agreements to protect the entity from default by the counter party.

collateralization: The process by which a borrower pledges securities, property, or other deposits for the purpose of securing the repayment of a loan and/or security.

CAFR (comprehensive annual financial report: An annual financial report that conforms to the requirements of the Governmental Accounting Standards Board.

commercial paper: An unsecured short-term promissory note issued by corporations, with maturities ranging from 2 to 270 days.

committed fund balance: That portion of fund balance that includes funds whose use is contrained by limits imposed by the government's highest level of decision making (for First 5 county organizations, the County First 5 Commission), and for which the removal or modification of use of funds can be acomplished only by formal action of the same level of decision making that established the constraints.

contract: A legally binding agreement between two parties for the provision of goods or services.

county pooled investment funds: The aggregate of all funds from public agencies placed in the custody of the county treasurer or chief finance officer for investment and reinvestment.

coupon: The annual rate of interest that a bond’s issuer promises to pay the bondholder on the bond’s face value; a certificate attached to a bond evidencing interest due on a payment date.

credit quality: The measurement of the financial strength of a bond issuer. This measurement helps an investor to understand an issuer’s ability to make timely interest payments and repay the loan principal upon maturity. Generally, the higher the credit quality of a bond issuer, the lower the interest rate paid by the issuer because the risk of default is lower. Credit quality ratings are provided by nationally recognized rating agencies.

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custodian: A bank or other financial institution that keeps custody of stock certificates and other assets.

dealer: Someone who acts as a principal in all transactions, including underwriting, buying, and selling securities, including from his/her own account.

derivative: Securities that are based on, or derived from, some underlying asset, reference date, or index.

disbursements: The payment of cash for expenditures. Such payments may precede the expenditures (an advance), coincide with the expenditures (a direct payment), or follow the expenditures (the payment of a liability).

discount securities: Securities that pay no interest. They are issued at a discount from their face value. An investor's return on investment is the difference between the discounted purchase price and the maturity (or sale) price. U.S. Treasury bills are an example of a discount security.

encumbrances: Contractual obligations to make future payments. Encumbrances represent the estimated amount of future expenditures that will result when, for example, purchase orders are placed and contracts are signed. Since the amount of an appropriation cannot be legally exceeded, the placing of purchase orders and the signing of contracts are critical events in controlling the commissions’ funds. The financial resources of a fund are said to be encumbered when a transaction is executed that requires performance on the part of another party before the commission becomes liable to perform its part of the transaction (make payment to the entity). Consistent with the enactment of GASB Statement 54, encumbrances are no longer reported separately in the financial statements. For governments that use encumbrance accounting, significant encumbrances should be disclosed in the notes to the financial statements by major funds and non-major funds in the aggregate in conjunction with required disclosures about other significant commitments.

evaluation costs: Costs incurred by First 5 commissions in the evaluation of funded programs, in accordance with their accountability framework, and data collection and evaluation for required reporting to state and local stakeholders.

expenditures: Take place when a vendor or contractor performs on a contract or a purchase order, as well as when goods or services are received. An expenditure and a corresponding liability or cash disbursement will be recorded at the time goods or services are received or at the time funds are granted to an authorized recipient.

fiduciary funds: Funds used to report assets held in a trustee or agency capacity for others and which therefore cannot be used to support the government's own programs. The fiduciary fund category includes pension (and other employee benefit) trust funds, investment trust funds, private-purpose trust funds, and agency funds.

fund balance: The value of the funds available to the commission. Fund balance is the difference between fund assets and fund liabilities of governmental funds.

GAAP: Abbreviation for "generally accepted accounting principles," which are conventions, rules, and procedures that serve as the norm for the fair presentation of financial statements. The Governmental Accounting Standards Board (GASB) is responsible for setting GAAP for state and local governments.

Governmental Accounting Standards Board (GASB): Ultimate authoritative accounting and financial reporting standard-setting body for state and local governments. The GASB was established in June 1984.

governmental activities: Governmental activities are basically all of the governmental funds reported together on an accrual basis. Also, governmental activities include all related capital assets and long-term liabilities and are reported at the government-wide level of reporting.

governmental funds:Funds generally used to account for tax-supported activities. There are five different types of governmental funds: the general fund, special revenue funds, debt service funds, capital projects funds, and permanent funds.

guaranteed investment contracts (GICs): An agreement acknowledging receipt of funds for deposit, specifying terms for withdrawal, and guaranteeing a rate of interest to be paid.

interest-only strips: The interest cash flow portion of a stripped mortgage-backed security or bond. The holder receives no principal payments. A significant loss in value can occur on interest only strips created from mortgage-backed securities when the underlying mortgage prepayments accelerate, typically in a falling interest-rate environment.

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internal control (framework): Integrated set of policies and procedures designed to assist management to achieve its goals and objectives. To be comprehensive, the framework must: 1) prove a favorable control environment, 2) provide for the continuing assessment of risk, 3) provide for the design, implementation, and maintenance of effective control-related policies and procedures, 4) provide for the effective communication of information, and 5) provide for the ongoing monitoring of the effectiveness of control-related policies and procedures as well as the resolution of potential problems identified by controls.

inverse floaters: A security that reacts inversely to the direction of interest rates. These securities can be very volatile and can lose value in a rising interest-rate environment.

liquidity: The ability to convert securities into cash on a short notice. Liquidity incorporates a security holder’s ability to sell an instrument without significant loss, as well as other factors that might expedite quick exchange for cash. An example of an illiquid asset would be a nonnegotiable bank certificate of deposit, for which the holder must pay an interest penalty for premature redemption.

local agency investment fund: A voluntary investment fund open to government entities and certain non-profit organizations in California that is managed by the State Treasurer’s Office.

local agency investment fund (LAIF): A voluntary investment fund open to government entities and certain non-profit organizations in California that is managed by the State Treasurer's Office.

local agency investment fund: A voluntary investment fund open to government entities and certain non-profit organizations in California that is managed by the State Treasurer’s Office.

local government investment pool (LGIP): Investment pools that range from the State Treasurer's Office Local Agency Investment Fund (LAIF) to county pools, to Joint Powers Authorities (JPAs). These funds are not subject to the same SEC rules applicable to money market mutual funds.

long-term financial plan: A plan that assesses the long-term financial implications of current and proposed policies, programs, and assumptions and develops appropriate strategies to achieve its goals. A financial plan illustrates the likely financial outcomes of particular courses of action or factors affecting the environment in which the government operates. A financial plan is not a forecast of what is certain to happen but rather a device to highlight significant issues or problems that must be addressed if goals are to be achieved.

market value: The price at which a security is trading and presumably could be purchased or sold at a particular point in time.

material: Materiality in auditing and accounting relates to the importance of an amount, transaction or discrepancy. It usually depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. In government, materiality has both a quantitative and a qualitative aspect, where materiality often concerns the nature rather than the size of an amount, such as illegal acts, bribery, corruption and related party transactions. Because of the importance of transparency in the public sector, commissions should discuss with and understand the level of materiality that will be chosen by the auditors of their financial statements.

maturity: The date on which the principal or stated value of an investment becomes due and payable.

medium-term note: Corporate or depository institution debt securities that meets certain minimum quality standards (as specified in the California Government Code) with a remaining maturity of five years or less.

modified accrual basis of accounting: The basis of accounting adapted to government fund accounting where revenues are recognized when received in cash or when resources are considered available (except for material or available revenues which should be accrued to reflect properly the taxes levied and the revenues earned – not applicable to county commissions). Expenditures are recognized when the related fund liability is incurred.

multi-year budgeting: A multi-year budget is a document that authorizes a government’s appropriations (i.e., planned expenditures) and anticipated revenues for two or more consecutive budgetary years. A multi-year budget also may consist of a biennial budget with one or two financial plans that serve as the tentative spending plans for the out-years (i.e., the first year appropriations are formally adopted, whereas the subsequent year “appropriations” are not).

mutual funds: An investment company that pools money and can invest in a variety of securities, including fixed-income securities and money market instruments.

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National Advisory Council on State and Local Budgeting (NACSLB):  A cooperative effort of eight state and local government associations to improve governmental budgeting. To this end, the NACSLB developed a comprehensive set of 59 recommended budgeting practices. These practices address all steps of the budgeting process including:  the analysis and goal setting that occurs before the written budget document is produced, the items that should be included in the budget document, and the monitoring and evaluation that occurs after the document is adopted. The recommended practices are available on the Web.

nonspendable fund balance: Amounts in fund balance that cannot be spent because they are either not in spendable form (e.g., prepaid items and inventories) or legally/contractually required to be maintained intact (e.g., the reinvested principal provided by an endowment).

note: A written promise to pay a specified amount to a certain entity on demand or on a specified date.

object of expenditure: In the context of the classification of expenditures, the article purchased or the service obtained, rather than the purpose for which the article or service was purchased or obtained (e.g. personal services, contractual services, materials and supplies).

outcome: The end result that is sought. A service may have more than one outcome.

par: Face value or principal value of a bond, typically $1,000 per bond.

passive investment management: An investment strategy in which securities are bought with the intention of holding them to maturity or investing in benchmark products designed to yield a market rate of return.

performance contract: A type of contract that specifies the end results desired rather than the specific details of how a product should be manufactured or how a service should be delivered.

performance measure: A particular value or characteristic designated to measure input, output, outcome, efficiency, or effectiveness.

portfolio: Combined holding of more than one stock, bond, commodity, real estate investment, cash equivalent, or other asset. The purpose of a portfolio is to reduce risk by diversification.

principal: The face value or par value of a debt instrument, or the amount of capital invested in a given security.

program costs: Costs incurred by local First 5 commissions readily assignable to a program, grantee, contractee, or service provider (other than post-contract program evaluation activities) and/or in the execution of direct service provision.

progress payments: Partial payments related to steps or phases toward the completion of the required services under a contract.

progress report: A report on contract performance or fiscal compliance made at specific intervals during the term of a contract.

proposal review committee: A committee or panel that convenes to evaluate the qualifications of bidders who respond to a request for proposals (RFP).

proprietary funds:Funds that focus on the determination of operating income, changes in net assets (or cost recovery), financial position, and cash flows. There are two different types of proprietary funds: enterprise funds and internal service funds.

prudent investor standard: A statement, often included in laws and investment policies, that specifies the responsibility of government officials in their investment decisions with public funds. The prudent investor standard holds the investor to a higher standard of care than the average prudent person. The prudent investor standard states: “These persons shall act with care, skill, prudence, and diligence under the circumstances then prevailing when investing, reinvesting, purchasing, acquiring, exchanging, selling, and managing funds.” The “prudent expert rule” holds an investor to an even higher standard and is often cited in contracts with investment advisors.

prudent person rule: A statement, often included in laws and investment policies, that specifies the responsibility of government officials in their investment decisions with public funds. The prudent person rule states: “Investments shall be made with judgment and care, under circumstances then prevailing, which persons of prudence, discretion

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and intelligence exercise in the management of their own affairs, not for speculation, but for investment, considering the probable safety of their capital as well as the probable income to be derived.”

repurchase agreements: An agreement of one party (for example, a financial institution) to sell securities to a second party (such as a local agency) and simultaneous agreement by the first party to repurchase the securities at a specified price from the second party on demand or at a specified date.

request for information (RFI): The document used to obtain information from potential providers before a solicitation document (RFP) is issued.

request for proposals (RFP): The solicitation document that is most appropriate in those situations in which it is necessary and appropriate to evaluate bidders on the basis of their qualifications as well as their price. The RFP describes the qualification requirements, performance specifications, time frames, and other requirements and asks bidders to describe how they would accomplish the services and at what price.

request for qualifications (RFQ): An RFQ is used when a commission has specific requirements as to how services are to be delivered. In an RFQ, the applicant demonstrates their qualifications to provide those services according to the model that the commission has specified. In addition, the commission asks applicants to demonstrate their knowledge of, and commitment to, the specified model.

restricted fund balance: Amounts in fund balance that have constraints imposed externally from creditors, grantors, contributors, laws or regulations of other governments, or imposed constitutionally by enabling legislation.

return on investment: Investors will face a multitude of securities and other instruments with varying quoted interest rates, coupons, prices, yields, and other numbers. The amount of income received from an investment, expressed as a percentage of its price, is the rate of return. A market rate of return is the yield that an investor can expect to receive in the current interest rate environment utilizing a buy-and-hold investment strategy. Total return is interest income plus capital gains (or minus losses) on an investment and is the most important measure of performance as it is the actual return on investment during a specific time interval. Many investors consider the holding period (from purchase until maturity or sale) the easiest interval to measure the return on investment. Others measure the investment return on a security or portfolio according to various time intervals (monthly, quarterly or annually).

reverse repurchase agreements: An agreement of one party (for example, a financial institution) to purchase securities at a specified price from a second party (such as a public agency) and a simultaneous agreement by the first party to resell the securities at a specified price to the second party on demand or at a specified date.

risk-based monitoring: An approach to contract monitoring in which reporting requirements are based on a given provider’s risk profile.

Rule G-37 of the Municipal Securities Rulemaking Board: Federal regulations to sever any connection between the making of political contributions and the awarding of municipal securities business.

safekeeping: A procedure where securities are held by a third party acting as custodian for a fee.

Securities and Exchange Commission (SEC): The federal agency responsible for supervising and regulating the securities industry.

securities lending agreement: An agreement of one party (for example, a local agency) to borrow securities at a specified price from a second party (for example, another local agency) with a simultaneous agreement by the first party to return the security at a specified price to the second party on demand or at a specified date. These agreements generally are collateralized and involve a third-party custodian to hold the securities and collateral. Economically similar to reverse repurchase agreement.

sole source procurement: A noncompetitive procurement in which only a single provider is afforded the opportunity to offer a price for desired goods or services.

secondary market: The market where securities are sold after their initial issuance.

stakeholder: The term "stakeholder" refers to anyone affected by or who has a stake in government. This term includes, but is not limited to: citizens, customers, elected officials, management, employees and their representatives (whether unions or other agents), businesses, other governments, and the media.

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statement of activities: A government-wide presentation of its activities by function or program using the accrual basis of accounting. The statement presents revenues, expenditures, and a reconciliation of net assets.

statement of net assets: The government-wide presentation of assets, liabilities, and equity of governmental activities which includes all funds. It is the government-wide balance sheet. The Statement of Net Assets is presented on an accrual basis.

statement of revenues, expenditures, and changes in fund balances: The governmental fund presentation of the revenues, expenditures, and other finance sources and uses of funds. This statement is presented on a modified accrual basis.

statement of work: A definition of the services to be delivered and/or the outcomes to be achieved.

supplantation: Occurs when new funds are used to fund existing programs. No funds provided by the commission should be used to supplant state or local general fund money for any purpose. In general terms the word supplant means to take the place of, or take the place of something else.

trustee, trust company, or trust department of a bank: A financial institution with powers to act in a fiduciary capacity for the benefit of the bondholders in enforcing the terms of the bond contract.

U.S. Treasury obligations: Debt obligations of the U.S. government sold by the Treasury Department in the forms of bills, notes, and bonds. Bills are short-term obligations that mature in one year or less and are sold at a discount. Notes are obligations that mature between one year and 10 years. Bonds are long-term obligations that generally mature in 10 years or more.

unassigned fund balance: That portion of the fund balance portion that does not meet the requirements of the other classifications (assigned, committed, nonspendable, restricted).

weighted average maturity (WAM): The average maturity of all the securities that comprise a portfolio, typically expressed in days or years.

yield: The percentage return on an investment; also called “return.” There are several yield calculations that can be made, such as “yield to maturity” and “yield to call.” Yield to maturity is the promised return assuming all interest and principal payments are made and reinvested at the same rate taking into account price appreciation (if priced below par) or depreciation (if priced above par). Yield to call is the yield an investor will receive if the security is called prior to maturity.

yield curve: A graphic representation that shows the relationship at a given point in time between yields and maturity for bonds that are identical in every way except maturity.

zero-interest accrual: Zero interest accrual means the security has the potential to realize zero interest depending upon the structure of the security. Zero coupon bonds and similar investments that start at a level below the face value are legal because their value does increase.

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