Essential Accounting Terms Explained Quiz

Amortisation refers to the gradual reduction or writing off of an asset or a liability over a period of time, typically done in a systematic manner.

Depreciation refers to the systematic allocation of the cost or revalued amount of a tangible non-current asset over its useful life. It accounts for the gradual wear and tear or obsolescence of the asset.

Impairment refers to the reduction in value of an asset below its depreciated cost usually due to factors like damage or obsolescence, not an increase in value or market fluctuations.

An associate is different from a subsidiary, joint venture, or partnership as it refers to an entity where the investor has significant influence but not full control.

A subsidiary is a company that is controlled by another company, known as the parent company. The subsidiary operates independently but is ultimately controlled by the parent company.

Goodwill represents the premium paid during acquisition exceeding the fair value of identifiable assets and liabilities. It includes intangible factors like brand reputation, customer loyalty, or employee expertise. Goodwill is tested for impairment rather than amortised, ensuring accurate reflection of its ongoing value. It’s crucial during mergers and acquisitions as it signifies perceived business advantage beyond tangible worth.

A contingent liability is a potential financial obligation that may occur depending on the outcome of an uncertain event, such as pending litigation or warranty claims. It’s disclosed in financial notes unless the likelihood of payment is high, in which case it becomes a provision. Contingent liabilities enhance transparency, ensuring investors understand possible future risks and their potential financial impact.

Retained earnings represent the cumulative profit a company keeps after paying dividends. They are reinvested to finance expansion, pay debt, or improve operations. This internal source of financing reflects business sustainability and management’s reinvestment strategy. Over time, consistent positive retained earnings indicate profitability, while negative balances may signal losses or over-distribution of dividends.

Financial statements—comprising the income statement, balance sheet, and cash flow statement—summarize a company’s financial performance and position. They reveal profitability, liquidity, and solvency, supporting decision-making by stakeholders. Accurate statements comply with accounting standards (e.g., IFRS or GAAP), ensuring comparability and accountability across reporting periods. They form the foundation of corporate transparency and financial health analysis.

Liquidity measures a company’s ability to meet short-term obligations using its most liquid assets like cash and receivables. High liquidity indicates sound cash management, while low liquidity raises concerns about solvency. Key ratios include the current ratio and quick ratio. Liquidity analysis ensures the company can cover immediate liabilities without disrupting operations, reflecting operational efficiency and financial stability.