What is accounting?

Accounting Definition

Technical definitions of accounting have been published by different accounting bodies. The American Institute of Certified Public Accountants (AICPA) defines accounting as:

the art of recording, classifying, and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least of financial character, and interpreting the results thereof.

What is an expense?

An expense is a cost that occurs as part of a company's operating activities during a specified accounting period. A retailer will likely incur the following expenses: the cost of goods sold, commissions earned by the sales staff, rent for the retail space, the cost of the electricity used, advertising that took place, wages and salaries that were incurred, etc.

Under the accrual method of accounting, an expense is reported on the income statement for the period when 1) the cost best matches the related revenues, 2) the cost is used up or expires, or 3) there is uncertainty or difficulty in measuring the future benefit.

For instance a retailer's income statement for the month of August should report the cost of the goods that were sold in August. (The date that the retailer had paid for the goods is not pertinent.) The commissions earned by the sales staff for having sold the goods in August is to be reported as an expense on the August income statement (even if the commissions are paid in September). The cost of the electricity used in August must also be included as an expense in the August income statement (even if the bill is received in September and is paid in October). These examples indicate that an expense can occur in an accounting period that is different from the period when the company pays for the item. Hence the word expense has a meaning that is different from payment.

Expenses are often divided into two major classifications: operating and nonoperating. Operating expenses involve a company's main activities. For example, a retailer's operating expenses include 1) the cost of goods sold, and 2) the selling, general and administrative (SG&A) expenses. The company may further sort these expenses by department, product line, and so on. A retailer's nonoperating expenses pertain to its incidental activities. A common nonoperating expense for a retailer is interest expense.

What is a fiscal year?

A fiscal year usually refers to an accounting year that does not end on December 31. (The accounting year of January 1 thrugh December 31 is usually referred to as a calendar year.) Some examples of the fiscal years used by U.S. corporations include:

• the 12 months of February 1 through January 31
• the 12 months of October 1 through September 30
• the 12 months of June 1 through May 31
• the 52 weeks (four 13-week quarters) ending on the Saturday closest to January 31 (This will require an occasional fiscal year of 53 weeks since 52 weeks X 7 days = 364 days vs. 365 days per year.)

One reason a business or other organization will have its accounting year end on a date other than December 31 is to fit its natural business year. For example, school districts will use fiscal years of July 1 through June 30. Retailers often end their fiscal years near the end of January.

A corporation or other organization needing audited financial statements will likely save auditing fees by having its accounting year different from the calendar year end of December 31.

What is the profit and loss statement?

The profit and loss statement, or P&L, is a name that is often used for what today is the income statement, statement of income, statement of operations, or statement of earnings. In other words, the profit and loss statement reports a company's revenues, expenses, and most of the gains and losses which occurred during the period of time specified in its heading.

The profit and loss statement's period of time could be a year, a year-to-date period such as nine months, a quarter of a year, one month, four weeks, 52 weeks, etc. (A few gains and losses will not be reported on the profit and loss statement and will instead be reported on the company's statement of comprehensive income.)

Under the accrual basis (or method) of accounting the revenues and expenses reported on the profit and loss statement should be:

• the revenues (sales, service fees) that were earned during the accounting period, and
• the expenses (cost of goods sold, salaries, rent, advertising, etc.) that match the revenues being reported or have expired during the accounting period

Today, the bottom line of this financial statement will appear as net income, which is the net amount of the revenues, expenses, gains, and losses being reported.

What is bad debts expense?

Bad debts expense often refers to the loss that a company experiences because it sold goods or provided services and did not require immediate payment. The loss occurs when the customer does not pay the amount owed. In other words, bad debts expense is related to a company's current asset accounts receivable.

It is common to see two methods for computing the amount of bad debts expense:

1. direct write-off method
2. allowance method

The direct write-off method requires that a customer's uncollectible account be first identified and then removed from the account Accounts Receivable. This method is required for U.S. income taxes and results in a debit to Bad Debts Expense and a credit to Accounts Receivable for the amount that is written off.

The allowance method anticipates that some of the accounts receivable will not be collected. In other words, prior to knowing exactly which customers or clients will not be paying, the company will debit Bad Debts Expense and will credit Allowance for Doubtful Accounts for an estimated, anticipated amount. (The Allowance for Doubtful Accounts is a contra asset account that when combined with Accounts Receivable indicates a more realistic amount that will be turning to cash.)

Many believe that the allowance method is the better method since 1) the balance sheet will be reporting a more realistic amount that will be collected from the company's accounts receivable, and 2) the bad debts expense will be reported on the income statement closer to the time of the related credit sales.

What is the difference between FIFO and LIFO?

The difference between FIFO and LIFO results from the order in which changing unit costs are removed from inventory and become the cost of goods sold. When the unit costs have increased, LIFO will result in a larger cost of goods sold and a smaller ending inventory compared with FIFO. If the unit costs are stable, there will be little or no difference between FIFO and LIFO. Also note that the order in which the costs are removed from inventory is independent of the order in which the physical units are removed from inventory.

To illustrate the difference between FIFO and LIFO, let's assume that a retail store carried only one product during its first year of business. It purchased 30 units in January at a cost of $40 each, 30 units in June at $43 each, and 30 units in November at $46 each. Thus, for the year the retailer purchased 90 units with a total actual cost of $3,870 [30X$40 + 30X$43 + 30X$46]. Let's also assume that 70 units were sold and that 20 units remain in inventory at the end of the year.

FIFO assumes that the first costs (the oldest costs) for 70 of the units will be removed from inventory and will be expensed on the income statement as the cost of goods sold. Hence, the FIFO cost flow assumption is that the 70 units sold had a cost of $2,950 [30X$40 + 30X$43 + 10X$46]. FIFO also assumes that the 20 units remaining in inventory had the most recent cost of $46 each for a total of $920.

LIFO assumes that the last costs (the most recent actual costs) for 70 units will be removed from inventory and will be expensed on the income statement as the cost of goods sold regardless of which units were actually shipped to customers. Therefore, the LIFO cost flow assumption is that the 70 units sold had a cost of $3,070 [30X$46 + 30X$43 + 10X$40]. LIFO also assumes that the 20 units remaining in inventory had the oldest cost of $40 each for a total of $800.

In our example, LIFO results in $120 less of ending inventory and $120 less of gross profit (because the cost of goods sold was larger). The lower gross profit and the associated lower taxable income for a U.S. company can mean less income tax payments if the company is profitable and has significant and increasing levels of inventory.

What is comprehensive income?

Comprehensive income for a corporation is the combination of the following amounts which occurred during a specified period of time such as a year, quarter, month, etc.:

1. Net income or net loss (which is reported on the income statement), plus
2. Other comprehensive income (if this is present, a statement of comprehensive income must be prepared)

Examples of other comprehensive income include:

• Unrealized gains/losses on available-for-sale investments
• Unrealized gains/losses on hedge/derivative financial instruments
• Foreign currency translation adjustments
• Unrealized gains/losses on postretirement benefit plans

Basically, comprehensive income consists of all of the revenues, gains, expenses, and losses that caused stockholders' equity to change during the accounting period. (The corporation's sale or purchase of its capital stock and its declaration of dividends are not a component of comprehensive income. The stock transactions and dividends are reported as separate items in the statement of stockholders' equity.)

The amount of other comprehensive income for the period will be added to the accumulated other comprehensive income, which is a separate line within stockholders' equity on the end-of-the-period balance sheet. (The net income or net loss reported on the income statement will be added to retained earnings as usual.)

What is the difference between income and profit?

Some people intend for the terms income and profit to have the same meaning. For example, the income statement was commonly referred to as the profit and loss (P&L) statement. When a company is profitable, we mean that the company has a positive net income.

To aid in understanding these terms, the word "net" is often added. Hence, we often see the terms net income and net profit. This communicates that the amounts are the remainder after expenses have been deducted. For example, a company's profit margin is often listed as the net profit margin (which is defined as the company's net income divided by its net sales). The word "net" also helps to distinguish a company's net profit from its gross profit, and its net profit margin from its gross profit margin.

Some people use the term income to mean revenues. For example, a bank or an individual will often refer to the interest they earn on bond investments as interest income or investment income. A retailer will refer to the sales of merchandise as revenues, but the revenues from secondary activities will be reported as other income or nonoperating income.

It is wise to keep in mind that different meanings are not unusual among people, businesses and countries.

What is a lease?

A lease is usually a written agreement between an owner of property (land, building, equipment, vehicle, etc.) and a person or business that will use the property for a stated period of time at a specified series of payments.

The owner of the property is known as the lessor and the person using the property is the lessee.

Some leases are for short periods of time and there is no intention of transferring ownership of the asset in exchange for the rent payments. Two examples of this type of lease are 1) the lease for a one-bedroom apartment covering a 12-month period and rent payments of $1,100 per month, and 2) the lease of a new automobile for 24 months with payments of $300 per month.

Other leases may be for longer periods and ownership of the asset will transfer to the lessee for a small additional payment. An example is a noncancellable lease requiring 60 monthly payments of $600 per month for a forklift truck. At the end of the lease period (after the 60th payment) the lessee may take ownership of the forklift truck for an additional payment of $500.

Since leases are contracts requiring a series of payments, there is a question of how the lease and the related payments should be accounted for by the lessee and the lessor. As of September 2015, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) were close to issuing a common financial accounting reporting standard that will replace the present U.S. accounting rules.

What is inflation accounting?

In the U.S., inflation accounting has resulted in optional supplementary disclosures on the effects of 1) general inflation, and 2) changes in the prices of specific types of assets. In other words, the main financial statements continue to report only the traditional, historical cost amounts without any adjustment for changing prices. [During the years 1979 to 1985, some supplementary disclosures on the effects of changing prices had to be included in the notes to the financial statements of the very large U.S. corporations. From 1986 until today, the supplementary disclosures are optional. Hence, the disclosures are not likely to be made.]

One reason that inflation accounting is now optional for U.S. corporations is that the U.S. inflation rate has been modest or low since 1983. Another reason is the belief that the cost of computing the disclosure amounts will be greater than the benefit to the readers of the financial statements.

To illustrate the logic of inflation accounting, let's assume that the general inflation rate and the changes in the costs of specific assets are increasing at a constant rate of 10% each year. This means that a power plant built for a cost of $1 billion will cost $10 billion at the end of a useful life of 25 years. By computing straight-line depreciation based on the historical cost, the income statement will report depreciation expense of $40 million per year ($1 billion/25 years). Obviously this is much lower than the current cost of the productive capacity being used up each year.

Similarly, if a retailer's cost of items in inventory is increasing at an annual rate of 10%, the cost of goods sold reported on the income statement (based on historical costs) will be less than the cost the company will spend in order to replace the units sold.

The use of historical costs during periods of increasing prices means that companies with large amounts of plant assets and inventory will be reporting net income that is greater than the true economic profit. As a result, the reported net income during inflationary periods is said to include illusory profit.

Expenses and Losses

B. Expenses and Losses

1. Expenses involved in primary activities are expenses that are incurred in order to earn normal operating revenues. Under the accrual basis of accounting sales commissions expense should appear on the income statement in the same period that the related sales are reported, regardless of when the commission is actually paid. In the same way, the cost of goods sold is matched with the related sales on the income statement, regardless of when the supplier of the merchandise is paid.
Costs used up (or expiring) in the accounting period shown in the heading of the income statement are also considered to be expenses of that period. For example, the utilities used in a retail store in December should appear on the December income statement, even if the utility's meters are not read until January 1 and the bill is paid on February 1.
The above examples reflect the matching principle and show that under the accrual basis of accounting, expenses on the income statement are likely to be reported at different times than the cash expenditures/disbursements.
It is common for expenses to occur before the company pays for them (e.g., wages earned by employees, employee bonuses and vacations, utilities, and sales commissions). However, some expenses occur after the company has paid for them. For example, let's say a company buys a building on December 31, 2013 for $300,000 (excluding the cost of land). The building is assumed to have a useful life of 30 years. The company paid cash for the building on December 31, 2013 but it will record depreciation expense of $10,000 in each of the years 2014 through 2043.
Cash payments do not always mean that an expense has occurred. For example, a company might pay $20,000 to the bank to reduce its bank loan. This payment will reduce the company's cash and its liability to the bank, but it is not an expense.
Some expenses are matched against sales on the income statement because there is a cause and effect linkage—the sale of the merchandise caused the cost of goods sold and the sales commission expense. Other expenses are not directly linked to sales and as a result they are matched to the accounting period when they are consumed or used—examples include utilities expense, office salaries expense, and depreciation expense. Some expenses such as advertising expense and research and development expense can neither be linked with sales nor a specific accounting period and as a result, they are reported as expenses as soon as they occur.

Here's a Tip

Under the accrual basis of accounting, the cost of goods sold and expenses are matched to sales and/or the accounting period when they are used, not the period in which they are paid.

The income statements or profit and loss statements of merchandisers and manufacturers will use a separate line for the cost of goods sold. The other expenses involved in their primary activities will either be grouped together as operating expenses or subdivided into the categories "selling" and "administrative."
2. Expenses from secondary activities are referred to as nonoperating expenses. For example, interest expense is a nonoperating expense because it involves the finance function of the business, rather than the primary activities of buying/producing and selling.
3. Losses such as the loss from the sale of long-term assets, or the loss on lawsuits result from a transaction that is outside of a business's primary activities. A loss is reported as the net of two amounts: the amount listed for the item on the company's books (book value) minus the proceeds received from the sale. A loss occurs when the proceeds are less than the book value.
Let's assume that a clothing retailer decides to dispose of the company's car. The proceeds from the disposal are $2,800. This is less than the $3,500 amount shown in the company's accounting records. Since this retailer is not in the business of buying and selling cars (the sale of the car is outside of the operating activities of buying and selling clothing), the money received for the car will not be included in sales revenues, and the loss experienced on the sale of the car ($700) will not be included in operating expenses. Instead, the $700 loss will appear in a section on the income statement labeled "nonoperating gains or losses" or "other income or losses". The loss is reported in the time period when the disposal occurs.

Here's a Tip

The income statement or profit and loss statement shows revenues, expenses, gains, and losses.

The income statement does not show cash receipts and cash disbursements.

Additional Considerations

Then vs. Now. The income statement covers a past period of time, and the past may or may not be indicative of the future. For example, a company supplying a high-demand fad item for the recent holiday season may have had a great year financially, but if it does not produce a similarly successful item for the next holiday season, it may experience a poor year financially.
Expenses Do Not Equal Economic Reality. Because of the cost principle and inflation, the expenses shown on the income statement reflect old costs. For example, assume that a company is operating a forty-year-old manufacturing plant that had a cost of $400,000. The depreciation expense for this plant may be zero on the current income statement because the plant was depreciated over 30 years. The cost of a new plant might be $4,000,000 today and the depreciation expense on the new plant might be $130,000 per year. The cost principle, however, prohibits showing the depreciation based on the cost of a new plant.
Using Estimates. An accountant is not allowed the luxury of waiting until things are known with certainty. In order to recognize revenues when they are earned, recognize expenses when they are incurred, or match expenses with revenues, accountants must often use estimates.

Introduction to Income Statement

Introduction to Income Statement

The income statement is one of the major financial statements used by accountants and business owners. (The other major financial statements are the balance sheet, statement of cash flows, and the statement of stockholders' equity.) The income statement is sometimes referred to as the profit and loss statement (P&L), statement of operations, or statement of income. We will use income statement and profit and loss statement throughout this explanation.
The income statement is important because it shows the profitability of a company during the time interval specified in its heading. The period of time that the statement covers is chosen by the business and will vary. For example, the heading may state:
"For the Three Months Ended December 31, 2014" (The period of October 1 through December 31, 2014.)
"The Four Weeks Ended December 27, 2014" (The period of November 29 through December 27, 2014.)
"The Fiscal Year Ended June 30, 2014" (The period of July 1, 2013 through June 30, 2014.)
Keep in mind that the income statement shows revenues, expenses, gains, and losses; it does not show cash receipts (money you receive) nor cash disbursements (money you pay out).
People pay attention to the profitability of a company for many reasons. For example, if a company was not able to operate profitably—the bottom line of the income statement indicates a net loss—a banker/lender/creditor may be hesitant to extend additional credit to the company. On the other hand, a company that has operated profitably—the bottom line of the income statement indicates a net income—demonstrated its ability to use borrowed and invested funds in a successful manner. A company's ability to operate profitably is important to current lenders and investors, potential lenders and investors, company management, competitors, government agencies, labor unions, and others.
The format of the income statement or the profit and loss statement will vary according to the complexity of the business activities. However, most companies will have the following elements in their income statements:
A. Revenues and Gains
1. Revenues from primary activities
2. Revenues or income from secondary activities
3. Gains (e.g., gain on the sale of long-term assets, gain on lawsuits)
B. Expenses and Losses
1. Expenses involved in primary activities
2. Expenses from secondary activities
3. Losses (e.g., loss on the sale of long-term assets, loss on lawsuits)
If the net amount of revenues and gains minus expenses and losses is positive, the bottom line of the profit and loss statement is labeled as net income. If the net amount (or bottom line) is negative, there is a net loss.
Note: We provide business forms for preparing income statements plus a visual tutorial and exam questions pertaining to the income statement for members of AccountingCoach PRO.

A. Revenues and Gains

1. Revenues from primary activities are often referred to as operating revenues. The primary activities of a retailer are purchasing merchandise and selling the merchandise. The primary activities of a manufacturer are producing the products and selling them. For retailers, manufacturers, wholesalers, and distributors the revenues resulting from their primary activities are referred to as sales revenues or sales. The primary activities of a company that provides services involve acquiring expertise and selling that expertise to clients. For companies providing services, the revenues from their primary services are referred to as service revenues or fees earned. (Some people use the word income interchangeably with revenues.)
It's critical that you don't confuse revenues with receipts. Under the accrual basis of accounting, service revenues and sales revenues are shown at the top of the income statement in the period they are earned or delivered, not in the period when the cash is collected. Put simply, revenues occur when money is earned, receipts occur when cash is received.
For example, if a retailer gives customers 30 days to pay, revenues occur (and are reported) when the merchandise is sold to the buyer, not when the cash is received 30 days later. If merchandise is sold in December, the sale is reported on the December income statement. When the retailer receives the check in January for the December sale, the retailer has a January receipt—not January revenues.
Similarly, if a consulting company asks clients to pay within 30 days of receiving their service, revenues occur (and are reported) when the service is performed (earned), not 30 days later when the consulting company receives the cash from the client.
If an attorney requires a client to prepay $1,000 before beginning to research the client's case, the attorney has a receipt, but does not have revenues until some of the research is done.
If a company sells an item to a buyer who immediately pays for it with cash, the company has both a receipt and revenues for that day—it has a cash receipt because it received cash; it has sales revenues because it sold merchandise.
By knowing the difference between receipts and revenues, we make certain that revenues from a transaction are reported only once—when the primary activities have been completed (and not necessarily when the cash is collected).
Let's reinforce the distinction between revenues and receipts with a few more examples. (Keep in mind that all of the examples below assume the accrual basis of accounting.)

• A company borrows $10,000 from its bank by signing a promissory note due in 90 days. The company will have a receipt of $10,000 at the time of the loan, but it does not have revenues because it did not earn the money from performing a service or from a sale of merchandise.
• If a company provided a $1,000 service on January 31 and gave the customer until March 10 to pay for the service, the company's January income statement will show revenues of $1,000. When the money is actually received in March, the March income statement will not show revenues for this transaction. (In March the company will report a receipt of cash and a reduction/collection of an accounts receivable.)
• A company performs a $400 service on December 31 and receives the $400 on the very same day (December 31). This company will report $400 in revenues on December 31—not because the company had a cash receipt on December 31, but because the service was performed (earned) on that day.
• On December 10, a new client asks your consulting company to provide a $2,500 service in January. You are uncertain as to whether or not this client is credit worthy, so to be on the safe side you ask for an immediate partial payment of $1,000 before you agree to schedule the work for January. Although your consulting company has a receipt of $1,000 in December, it does not have revenues in December. (In December your company will record a liability of $1,000.) Your consulting company will report the $1,000 of revenues when it performs $1,000 of services in January.

2. Revenues from secondary activities are often referred to as nonoperating revenues. These are the amounts a business earns outside of purchasing and selling goods and services. For example, when a retail business earns interest on some of its idle cash, or earns rent from some vacant space, these revenues result from an activity outside of buying and selling merchandise. As a result the revenues are reported on the income statement separate from its primary activity of sales or service revenues.
As is true with operating revenues, nonoperating revenues are reported on the profit and loss statement during the period when they are earned, not when the cash is collected.

Here's a Tip

Don't confuse revenues with receipts—

Revenues (operating and nonoperating) occur when a sale is made or when they are earned. Revenues are frequently earned and reported on the income statement prior to receiving the cash.

Receipts occur when cash is received/collected.

3. Gains such as the gain on the sale of long-term assets, or lawsuits result from a transaction that is outside of the primary activities of most businesses. A gain is reported on the income statement as the net of two amounts: the proceeds received from the sale of a long-term asset minus the amount listed for that item on the company's books (book value). A gain occurs when the proceeds are more than the book value.
Consider this example: Assume that a clothing retailer decides to dispose of the company's car and sells it for $6,000. The $6,000 received for the car (the proceeds from the disposal of the car) will not be included with sales revenues since the account Sales is used only for the sale of merchandise. Since this retailer is not in the business of buying and selling cars, the sale of the car is outside of the retailer's primary activities. Over the years, the cost of the car was being depreciated on the company's accounting records and as a result, the money received for the car ($6,000) was greater than the net amount shown for the car on the accounting records ($3,500). This means that the company must report a gain equal to the amount of the difference—in this case, the gain is reported as $2,500. This gain should not be reported as sales revenues, nor should it be shown as part of the merchandiser's primary activities. Instead, the gain will appear in a section on the income statement labeled as "nonoperating gains" or "other income". The gain is reported in the period when the disposal occurred.

What are sales discounts?

Sales discounts (if offered by sellers) reduce the amounts owed to the sellers of products, when the buyers pay within the stated discount periods.

To illustrate a sales discount let's assume that a manufacturer sells $900 of products and its credit terms are 1/10, n/30. This means that the buyer can satisfy the $900 obligation if it pays $891 ($900 minus $9 of sales discount) within 10 days. The alternative is for the buyer to pay $900 within 30 days. If the buyer pays within 10 days, the seller will record a debit to Cash for $891, a debit to Sales Discounts for $9, and a credit to Accounts Receivable for $900.

The account Sales Discounts is referred to as a contra revenue account. Hence, its debit balance will be one of the deductions from sales (gross sales) in order to report the amount of net sales.

Sales discounts are also known as cash discounts and early payment discounts.

What is a capital account?

In accounting and bookkeeping, a capital account is one of the general ledger accounts used to record 1) the amounts that were paid in to the company by an investor, and 2) the cumulative amount of the company's earnings minus the cumulative distributions to the owners. The balances of the capital accounts are reported in the owner's equity, partners' equity, or stockholders' equity section of the balance sheet.

In a corporation the capital accounts include:

• Paid-in capital accounts such as Common Stock, Preferred Stock, Paid-in Capital in Excess of Par. These accounts report the amounts received by the corporation when the shares of its capital stock were originally issued to investors.
• Retained earnings accounts which typically contain the amount of the corporation's cumulative earnings since the corporation was formed minus the cumulative dividends distributed to the stockholders.
• Treasury stock account (a contra account because it has a debit balance) usually reporting the amount paid by the corporation to repurchase its own shares of stock that have not been retired.

In a sole proprietorship (such as one owned by Amy Fox) the capital accounts include:

• Amy Fox, Capital. This account begins with Amy's original investment and is increased for each year's earnings minus each year's withdrawals by Amy.
• Amy Fox, Drawing. This account is a contra account because it will have a debit balance equal to the amount of business assets that Amy has withdrawn during the current accounting year for her personal use. At the end of each accounting year, Amy's drawing account is closed by transferring its debit balance to the account Amy Fox, Capital.

The total of the balances in the capital accounts must be equal to the reported total of the company's assets minus its liabilities. Because of the historical cost principle and other accounting principles the total amount reported in the capital accounts will not indicate the company's market value or net worth.

Introduction to Accounting Principles

Introduction to Accounting Principles

There are general rules and concepts that govern the field of accounting. These general rules–referred to as basic accounting principles and guidelines–form the groundwork on which more detailed, complicated, and legalistic accounting rules are based. For example, the Financial Accounting Standards Board (FASB) uses the basic accounting principles and guidelines as a basis for their own detailed and comprehensive set of accounting rules and standards.
The phrase "generally accepted accounting principles" (or "GAAP") consists of three important sets of rules: (1) the basic accounting principles and guidelines, (2) the detailed rules and standards issued by FASB and its predecessor the Accounting Principles Board (APB), and (3) the generally accepted industry practices.
If a company distributes its financial statements to the public, it is required to follow generally accepted accounting principles in the preparation of those statements. Further, if a company's stock is publicly traded, federal law requires the company's financial statements be audited by independent public accountants. Both the company's management and the independent accountants must certify that the financial statements and the related notes to the financial statements have been prepared in accordance with GAAP.
GAAP is exceedingly useful because it attempts to standardize and regulate accounting definitions, assumptions, and methods. Because of generally accepted accounting principles we are able to assume that there is consistency from year to year in the methods used to prepare a company's financial statements. And although variations may exist, we can make reasonably confident conclusions when comparing one company to another, or comparing one company's financial statistics to the statistics for its industry. Over the years the generally accepted accounting principles have become more complex because financial transactions have become more complex.

Basic Accounting Principles and Guidelines

Since GAAP is founded on the basic accounting principles and guidelines, we can better understand GAAP if we understand those accounting principles. The following is a list of the ten main accounting principles and guidelines together with a highly condensed explanation of each.
1. Economic Entity Assumption
The accountant keeps all of the business transactions of a sole proprietorship separate from the business owner's personal transactions. For legal purposes, a sole proprietorship and its owner are considered to be one entity, but for accounting purposes they are considered to be two separate entities.
2. Monetary Unit Assumption
Economic activity is measured in U.S. dollars, and only transactions that can be expressed in U.S. dollars are recorded.
Because of this basic accounting principle, it is assumed that the dollar's purchasing power has not changed over time. As a result accountants ignore the effect of inflation on recorded amounts. For example, dollars from a 1960 transaction are combined (or shown) with dollars from a 2014 transaction.
3. Time Period Assumption
This accounting principle assumes that it is possible to report the complex and ongoing activities of a business in relatively short, distinct time intervals such as the five months ended May 31, 2014, or the 5 weeks ended May 1, 2014. The shorter the time interval, the more likely the need for the accountant to estimate amounts relevant to that period. For example, the property tax bill is received on December 15 of each year. On the income statement for the year ended December 31, 2013, the amount is known; but for the income statement for the three months ended March 31, 2014, the amount was not known and an estimate had to be used.
It is imperative that the time interval (or period of time) be shown in the heading of each income statement, statement of stockholders' equity, and statement of cash flows. Labeling one of these financial statements with "December 31" is not good enough–the reader needs to know if the statement covers the one week ended December 31, 2014 the month ended December 31, 2014 the three months ended December 31, 2014 or the year ended December 31, 2014.
4. Cost Principle
From an accountant's point of view, the term "cost" refers to the amount spent (cash or the cash equivalent) when an item was originally obtained, whether that purchase happened last year or thirty years ago. For this reason, the amounts shown on financial statements are referred to as historical cost amounts.
Because of this accounting principle asset amounts are not adjusted upward for inflation. In fact, as a general rule, asset amounts are not adjusted to reflect any type of increase in value. Hence, an asset amount does not reflect the amount of money a company would receive if it were to sell the asset at today's market value. (An exception is certain investments in stocks and bonds that are actively traded on a stock exchange.) If you want to know the current value of a company's long-term assets, you will not get this information from a company's financial statements–you need to look elsewhere, perhaps to a third-party appraiser.
5. Full Disclosure Principle
If certain information is important to an investor or lender using the financial statements, that information should be disclosed within the statement or in the notes to the statement. It is because of this basic accounting principle that numerous pages of "footnotes" are often attached to financial statements.
As an example, let's say a company is named in a lawsuit that demands a significant amount of money. When the financial statements are prepared it is not clear whether the company will be able to defend itself or whether it might lose the lawsuit. As a result of these conditions and because of the full disclosure principle the lawsuit will be described in the notes to the financial statements.
A company usually lists its significant accounting policies as the first note to its financial statements.
6. Going Concern Principle
This accounting principle assumes that a company will continue to exist long enough to carry out its objectives and commitments and will not liquidate in the foreseeable future. If the company's financial situation is such that the accountant believes the company will not be able to continue on, the accountant is required to disclose this assessment.
The going concern principle allows the company to defer some of its prepaid expenses until future accounting periods.
7. Matching Principle
This accounting principle requires companies to use the accrual basis of accounting. The matching principle requires that expenses be matched with revenues. For example, sales commissions expense should be reported in the period when the sales were made (and not reported in the period when the commissions were paid). Wages to employees are reported as an expense in the week when the employees worked and not in the week when the employees are paid. If a company agrees to give its employees 1% of its 2014 revenues as a bonus on January 15, 2015, the company should report the bonus as an expense in 2014 and the amount unpaid at December 31, 2014 as a liability. (The expense is occurring as the sales are occurring.)
Because we cannot measure the future economic benefit of things such as advertisements (and thereby we cannot match the ad expense with related future revenues), the accountant charges the ad amount to expense in the period that the ad is run.
(To learn more about adjusting entries go to Explanation of Adjusting Entries and Quiz for Adjusting Entries.)
8. Revenue Recognition Principle
Under the accrual basis of accounting (as opposed to the cash basis of accounting), revenues are recognized as soon as a product has been sold or a service has been performed, regardless of when the money is actually received. Under this basic accounting principle, a company could earn and report $20,000 of revenue in its first month of operation but receive $0 in actual cash in that month.
For example, if ABC Consulting completes its service at an agreed price of $1,000, ABC should recognize $1,000 of revenue as soon as its work is done—it does not matter whether the client pays the $1,000 immediately or in 30 days. Do not confuse revenue with a cash receipt.
9. Materiality
Because of this basic accounting principle or guideline, an accountant might be allowed to violate another accounting principle if an amount is insignificant. Professional judgement is needed to decide whether an amount is insignificant or immaterial.
An example of an obviously immaterial item is the purchase of a $150 printer by a highly profitable multi-million dollar company. Because the printer will be used for five years, the matching principle directs the accountant to expense the cost over the five-year period. The materiality guideline allows this company to violate the matching principle and to expense the entire cost of $150 in the year it is purchased. The justification is that no one would consider it misleading if $150 is expensed in the first year instead of $30 being expensed in each of the five years that it is used.
Because of materiality, financial statements usually show amounts rounded to the nearest dollar, to the nearest thousand, or to the nearest million dollars depending on the size of the company.
10. Conservatism
If a situation arises where there are two acceptable alternatives for reporting an item, conservatism directs the accountant to choose the alternative that will result in less net income and/or less asset amount. Conservatism helps the accountant to "break a tie." It does not direct accountants to be conservative. Accountants are expected to be unbiased and objective.
The basic accounting principle of conservatism leads accountants to anticipate or disclose losses, but it does not allow a similar action for gains. For example, potential losses from lawsuits will be reported on the financial statements or in the notes, but potential gains will not be reported. Also, an accountant may write inventory down to an amount that is lower than the original cost, but will not write inventory up to an amount higher than the original cost.

ACCOUNTING BOOK

EasyPC Training
Accounting Basics
Accounting Basics Page 2
Business & Administration
Contents
Accounting Basics.............................................................................................................. 3
The Accounting Equation ................................................................................................. 3
Assets................................................................................................................................. 3
Liabilities............................................................................................................................ 3
Owner’s Equity................................................................................................................... 3
The Balance Sheet.............................................................................................................. 5
Double Entry Bookkeeping............................................................................................... 6
Ledger Accounts................................................................................................................ 6
Trial Balance ...................................................................................................................... 7
Profit and Loss account.................................................................................................... 8
Sales................................................................................................................................... 8
Cost of Sales ...................................................................................................................... 9
Expenses ............................................................................................................................ 9
Reporting Period & Conversion Period.......................................................................10
Conversion partway through year.................................................................................10
Other conversion issues.................................................................................................10
Glossary ..............................................................................................................................12
Accounting Basics Page 3
Business & Administration
Accounting Basics
This booklet is designed to give the reader an overview of general bookkeeping
practices and accounting terminology, in preparation for EasyPC Training’s MYOB
accounting or manual bookkeeping courses.
As you read through, please note that words or phrases underlined appear in a
glossary at the back of the booklet
The Accounting Equation
All accounting entries in the books of account for an organisation have a relationship
based on the ‘accounting equation’:
Assets = Liabilities + Owner’s equity
Assets
Assets are tangible and intangible items of value which the business owns. Examples
of assets are:
· Cash
· Cars
· Buildings
· Machinery
· Furniture
· Debtors (money owed from customers)
· Stock / Inventory
Liabilities
Liabilities are those items which are owed by the business to bodies outside of the
business. Examples of liabilities are:
· Loans to banks
· Creditors (money owed to suppliers)
· Bank overdrafts
Owner’s Equity
The simplest way to understand the accounting equation is to understand what makes
up ‘owner’s equity’.
Accounting Basics Page 4
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By rearranging the accounting equation you can see that Owner’s Equity is made up
of Assets and Liabilities.
Owner’s Equity = Total Assets less Total Liabilities
Owner’s Equity can also be expressed as:
Owner’s Equity = Capital invested by owner + Profits (Losses) to date
(also known as ‘Retained Earnings ’)
Rearranging the equation again, therefore:
Total Assets - Total Liabilities = Capital + Retained Earnings
Accounting Basics Page 5
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The Balance Sheet
The balance sheet shows a snapshot of the business’s net worth at a given point in
time. Below is a basic balance sheet. Have a look at how it displays the elements of
the accounting equation:
Balance Sheet
Assets $
Current Assets
Stock X
Debtors X
Bank X
Cash X
Fixed Assets
Buildings X
Vehicles X
Total Assets XX
Liabilities
Current Liabilities
Overdraft X
Creditors X
Long-term Liabilities
Bank Loan X
Total Liabilities XX
Total Assets less Total Liabilities ZZ
Owner’s Capital Y
Retained Earnings Y
Owner’s Equity ZZ
The accounting equation establishes the basis of Double Entry Bookkeeping.
Accounting Basics Page 6
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Double Entry Bookkeeping
All accounting transactions are made up of 2 entries in the accounts: a debit and a
credit.
For example, if you purchased a book, your value of books would increase, but your
value of cash would decrease by the same value, at the same time. This is double
entry bookkeeping.
Ledger Accounts
A ledger account is an item in either the Profit & Loss account (which we’ll discuss
shortly) or the balance sheet. A Ledger account is either a:
· Asset
· Liability
· Equity
· Income
· Expense
The example of purchasing a book, mentioned above, can be shown in the form of
ledger “T” accounts as follows:
Purchases – Books
Dr Cr
Cash $20
Cash
Dr Cr
Books $20
If all transactions are entered into the books in this way, then the sum of all of the
debits would equal the sum of all of the credits.
“Dr” is short for Debit “Cr” is short for Credit
Accounting Basics Page 7
Business & Administration
Trial Balance
A trial balance is a list of all of the ledger accounts of a business and the balance of
each. Debits are shown as positive numbers and credits as negative numbers. The
trial balance should therefore always equal zero.
Following on from the previous example, if we were to sell a CD for $25 cash then the
ledger accounts and trial balance would look like this:
Purchases - Books
Dr Cr
Cash $20
Sales - CDs
Dr Cr
Cash $25
Cash
Dr Cr
Sales - CDs $25 Books $20
Trial Balance
$
Purchases - Books 20
Sales - CDs (25)
Cash ($25 - $20) 5
Total 0
Accounting Basics Page 8
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Profit and Loss account
Whereas the balance sheet shows a snapshot at a point in time of the net worth of the
business, the profit and loss account shows the current financial year’s net operating
profits, broken down into various sales, cost of sales and expenses ledger accounts.
Profit and Loss account
Sales $
Books X
CD’s X
Magazines X
Total Sales XX
Cost of Sales
Purchases of Books X
Purchases of CDs X
Purchases of Magazines X
Total Cost of Sales XX
Gross Profit (Sales – Cost of Sales) YY
Expenses
Advertising X
Marketing X
Salaries & Wages X
Electricity X
Total Expenses XX
Net Profit (Gross profit – Expenses) ZZ
Sales
Sales accounts show all sales made in the period, regardless of whether or not money
has been received yet, and are shown as a credit in the Profit and Loss accounts.
Where money has not yet been received, the debit is not to cash (as per the CD
example above), but to a Debtors account (money owed from customer account).
Accounting Basics Page 9
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Cost of Sales
Cost of Sales are expenses that can be directly attributed to sales items, such as
purchases of stocks.
Expenses
These are all other expenses (other than purchases of assets) which cannot be
attributed directly to sales items, such as rent, electricity or advertising.
Accounting Basics Page 10
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Reporting Period & Conversion Period
The reporting period is usually a 12 month period ending 30 June each year. At the
end of each financial year the profit and loss account balance is transferred to the
Retained Earnings account in the Balance Sheet (under Equity). A new profit and loss
account is started for the new financial year
The Balance sheet is continuous, the Profit and Loss account is just for the
current financial year
The conversion period is the month in which you transfer over to a new accounting
system. If you are transferring to a new accounting system at the beginning of a
financial year, the final balance in the profit and loss account would be transferred to
the new system (retained earnings account) along with all of the current balance sheet
account balances.
Conversion partway through year
If you are transferring your accounts partway through a year, all of the individual Profit
and Loss account balances must be individually transferred to the new system as
opening balances so that all of the current year’s financial data is stored. The
individual balances on the balance sheet are transferred as normal.
Other conversion issues
Only the balances of accounts will usually be transferred to the new system. Generally
a business would not re-input all of their individual transactions, such as invoices,
receipts, payments etc. This means that there are likely to be cut-over issues.
For example you may have written a cheque to a supplier but as at the cut-over date
the supplier has not cashed the cheque. Even though the bank would have been
credited and the supplier’s account would be correct, this cheque would be
outstanding, and the new accounting system e.g. MYOB, would not have a record of
the outstanding cheque to enable a reconciliation of the bank account. This issue is
covered in the course “Getting started with MYOB accounting software”.
Accounting Basics Page 11
Business & Administration
Other similar cut-over issues would include:
· Monies received but not yet cleared through the bank
· Supplier invoices not yet paid
· Customer receipts not yet received
We hope you have found this brief introduction useful. If you would like more information on EasyPC
Training’s range of courses or consultancy services, please contact us at:
PO Box 154, Northgate, QLD 4013 web: www.easypctraining.com.au
e-mail: info@easypctraining.com.au
Accounting Basics Page 12
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Glossary
· Accounting Equation All accounting entries made in the books of account of a
business have a relationship based on the accounting
equation: Assets = Liabilities + Owner’s Equity
· Asset Tangible or intangible items of value owned by a
business e.g. cash, stock, buildings & vehicles
· Balance Sheet Shows a snapshot at a given point in time of the net
worth of the business. It details the assets, liabilities and
owner’s equity
· Capital Amount invested in the business (usually at start up, but
may include additional funds raised)
· Conversion Period The period (month) in which the accounts are being
converted, or transferred over, from one system to
another
· Cost of Sales Expenses in the financial year which can be directly
attributed to sales of those goods or services
· Credit Revenue in the Profit and Loss or Liability in the
Balance sheet
· Creditor Amount owed to a supplier from the business
· Current Asset Short-term asset (items or amounts to be used or
received within 12 months) e.g. stock or cash
· Current Liability Short-term liability (items or amounts to be paid within
12 months) e.g. supplier or bank overdraft
· Debit Expenses in the Profit and Loss or Asset in the Balance
sheet
· Debtor Amount owed to the business from a customer
· Double Entry
Bookkeeping
System of bookkeeping where all transaction have 2
entries, a debit and a credit, which net to zero.
· Expense Amount relating to expenditure for the financial year
(excluding purchases of assets or cost of sales)
regardless of whether cash has been paid or not
· Fixed Asset Long-term asset (items or amounts to be used or
Accounting Basics Page 13
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received after 12 months) e.g. building or vehicle
· Gross Profit Sales less Cost of Sales
· Income Amount of sales made in the current financial year,
regardless of whether cash has been received or not
· Ledger Account An account containing transaction data relating to a
specific type of item, whether in the Profit and Loss or
Balance sheet. The full list of ledger accounts for a
business is called the business’s Chart of Accounts
· Liability Amounts owed to entities outside of the business e.g.
bank loan, supplier payments & overdrafts
· Long-term Liability Long-term liability (items or amounts to be paid after 12
months) e.g. bank loan
· Net Profit Gross Profit less Expenses. Amount to be carried over
to retained earnings at the end of each financial year
· Owner’s Equity Net worth of the business to the owner
· Reporting Period The 12 month period which the business runs / reports
to in a normal year (period may be shorter in start and
end years). Normally 1July to 30 June
· Retained Earnings Total profits and/or losses from start of business, to date
· Trial Balance A list of all the business’s account balances which
should net to zero i.e. should ‘balance’

Debt Instruments

DEBT INSTRUMENTS:

         NRIs are permitted to invest in corporate deposits, non-convertible debentures, government securities and PSU bonds issued in India, both on repatriable and non-repatriable basis.

            However, in practice, companies or issuers need to specifically enable the 'NRI window' in an offer (with permission from the RBI). Among offers in the last 1year, Housing and Urban Development Corporation kept its bond door open to NRI investors, but not Dredging Corporation. Reading through the application form for each bond will tell you if the offer is open to NRIs.

EQUITY:

          

            Regulations allow NRIs to invest in the primary (initial public offers) and the secondary market.

            However, for investments in equity in the secondary market (as also convertible debentures), a non-resident is required to open a Portfolio Investment Scheme account (also called PINS account) with a bank.

            The RBI monitors all transactions of NRIs in the secondary market through PINS account. Individual Banks report on transactions in this account on the RBI

            The RBI website states that an NRI investor can purchase shares up to 5% of the paid-up capital of a company, however, cannot exceed 10% (this limit can, however, be raised by the companies by passing a special resolution)

            A PINS account is basically an NRE/NRO account. Transfers to/from NRE/NRO accounts, foreign inward remittances, and debit/credit from the stock broker are the only transactions allowed in a PINS account.

            A PINS account is in addition to opening an NRO demat and a trading account with an Indian broker, says B.Gopkumar, Head of Broking, Kotak Securities.

            NRI investors, however, need to know that broker may have internal restrictions on the clients to whom they may offer broking services, based on geography or other considerations. Check before you plan your investments.

REAL ESTATE PROPERTY:

       

            Investment by NRIs in immovable property in India is permitted provided it does not fall under the definition of agricultural land.

            NRIs can acquire any immovable property in India, other than agricultural property or plantation or a farm house under FEMA regulations.

            Now that you can parcel residential real estate through funds designated as real estate funds, can NRIs invest in them? Expert say: "While the RBI had expressed its concerns that investment by NRIs and FIIs could be tantamount to indirect foreign investment in the real estate sector, the Finance Ministry held that there was no specific restriction imposed upon NRIs o invest in real estate funds."

SORRY, NO ENTRY:

  

           There are certain investment classes that are completely shut for NRIs. These include investments in Public Provident Fund and post-office saving schemes. From the RBI's document on 'Facilities available to NRI for investment in India, it becomes clear that even on a non-repatriation basis investments are not allowed in bearer securities.

            The document, however, states that investments in National savings Certificates are permitted on a non-repatriation basis through an NRO account where the source of income is from India.

            A resident investor who subsequently becomes an NRI can, however, hold the above instruments till maturity.

CAN  YOU TAKE IT HOME?

  

            Apart from knowing what investment avenues are open to you as non-resident Indians, you may also want to know which of these carry repatriation benefits.

            According to the RBI, all investments in the equity market, including that in mutual funds, non-convertible debentures of a company incorporated in India and PSU bonds, are allowed on repatriation as well as non-repatriation basis for NRIs.

            The two things that however determine repatriation benefit on any investment are the source of funds for that investment and the discharge of tax liability. Tax experts explain: "Foreign capital appreciation if any, after the payment of applicable taxes and provided the investment was on a repatriable basis."

            So, it goes without saying that funds for the investments that you intend to repatriate should be drawn from only your NRE account.

            Investments made from an NRO account are non-repatriable.

            For the income that arises from investments in India, non-residents have to pay taxes in India, wherever applicable.

CAPITAL MARKETS

Capital Markets

Capital Market: Capital Market is the market it deals with the long term investment funds. It consists of two markets. 1. Primary Market 2.Secondary Market.

Primary Market: Those companies which are issuing new shares in this market. It is also called new issue market.
Secondary Market: Secondary Market is the market where shares buying and selling. In India secondary market is called stock exchange.
Hedging: Hedging means minimize the risk.

Arbitrage: It means purchase and sale of securities in different markets in order to profit from price discrepancies. In other words arbitrage is a way of reducing risk of loss caused by price fluctuations of securities held in a portfolio.

Derivative: Derivative is product whose value is derived from the value of one or more basic variables of underlying asset.

Forwards: A forward contract is customized contracts between two entities were settlement takes place on a specific date in the future at today’s pre agreed price.

Futures: A future contract is an agreement between two parties to buy or sell an asset at a certain time in the future at a certain price. Future contracts are standardized exchange traded contracts.

Options: An option gives the holder of the option the right to do some thing. The option holder option may exercise or not.

Call Option: A call option gives the holder the right but not the obligation to buy an asset by a certain date for a certain price.

Put Option: A put option gives the holder the right but not obligation to sell an asset by a certain date for a certain price.

Option Price: Option price is the price which the option buyer pays to the option seller. It is also referred to as the option premium.

Expiration Date: The date which is specified in the option contract is called expiration date.

European Option: It is the option at exercised only on expiration date it self.

Basis: Basis means future price minus spot price.

Cost of carry: The relation between future prices and spot prices can be summarized in terms of what is known as cost of carr

Put Option:

An option contract giving the owner the right, but not the obligation, to sell a specified amount of an underlying security at a specified price within a specified time. This is the opposite of a call option, which gives the holder the right to buy shares.

A put becomes more valuable as the price of the underlying stock depreciates relative to the strike price. For example, if you have one Mar 07 Taser 10 put, you have the right to sell 100 shares of Taser at $10 until March 2007 (usually the third Friday of the month). If shares of Taser fall to $5 and you exercise the option, you can purchase 100 shares of Taser for $5 in the market and sell the shares to the option's writer for $10 each, which means you make $500 (100 x $10-$5) on the put option.

Call Option:

An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument at a specified price within a specific time period.

It may help you to remember that a call option gives you the right to "call in" (buy) an asset. You profit on a call when the underlying asset increases in price.

Forward contract: Its an agreement between two parties to buy or sell an asset at a pre-agreed future point in time.

Futures contract : It’s a standardized contract traded on a futures exchange, to buy or sell a certain underlying instrument at a certain date in the future, at a specified price. The future date is called the delivery date or final settlement date

Options: are financial instruments that convey the right, but not the obligation, to engage in a future transaction on some underlying security.

The primary Market : It is that part of the capital markets that deals with the issuance of new securities.

The secondary market: is the financial market for trading of securities that have already been issued in an initial private or public offering.

Stock split increases the number of shares in a public company. The price of adjusted such that the before and after market capitalization of the company remains the same and dilution does not occur. Options and warrants are included. Also known as a Stock Divide.

Initial Public Offering (IPO): Its is the first sale of stock by a private company to the public. IPO’s are often issued by smaller, younger companies seeking capital to expand, but can also be done by large privately-owned companies looking to become publicly traded

The BSE Sensex or Bombay Stock Exchange Sensitive Index is a value-weighted index composed of 30 stocks with the base April 1979 = 100. It consists of the 30 largest and most actively traded stocks, representative of various sectors, on the Bombay Stock Exchange

Rights issue:

Issuing rights to a company's existing shareholders to buy a proportional number of additional securities at a given price (usually at a discount) within a fixed period.

Rights are often transferable, allowing the holder to sell them on the open market.

Rights:

A security giving stockholders entitlement to purchase new shares issued by the corporation at a predetermined price (normally less than the current market price) in proportion to the number of shares already owned. Rights are issued only for a short period of time, after which they expire.

This also known as "subscription rights" or "share purchase rights".

Employee Stock Option:

The payment of stock in lieu of cash for services provided .This is a common method used by corporations to compensate executives. The theory is that executives will work harder since they want their own stock to rise in value and, therefore, have the best interests of shareholders in mind.

Insider Trading:

Insider trading is the trading of acorporation's stock or othersecurities (e.g. bonds or stock options) by corporate insiders such as officers, directors, or holders of more than ten percent of the firm's shares. Insider trading may be perfectly legal, but the term is frequently used to refer to a practice, illegal in many jurisdictions, in which an insider or a related party trades based on material non-public information obtained during the performance of the insider's duties at the corporation, or otherwise misappropriated.^[1]

All insider trades must be reported in the United States. Many investors follow the summaries of insider trades, published by the United States Securities and Exchange Commission (SEC), in the hope that mimicking these trades will be profitable. Legal "insider trading" may not be based on material non-public information. Illegal insider trading in the US requires the participation (perhaps indirectly) of a corporate insider or other person who is violating his fiduciary duty or misappropriating private information, and trading on it or secretly relaying it.  Insider trading is believed to raise the cost of capital for securities issuers, thus decreasing overall economic growth.^[2]

Venture Capital:

Financing for new businesses. In other words, money provided by investors to startup firms and small businesses with perceived, long-term growth potential. This is a very important source of funding for startups that do not have access to capital markets. It typically entails high risk for the investor, but it has the potential for above-average returns.

Venture capital can also include managerial and technical expertise. Most venture capital comes from a group of wealthy investors, investment banks and other financial institutions that pool such investments or partnerships. This form of raising capital is popular among new companies, or ventures, with limited operating history, who cannot raise funds through a debt issue. The downside for entrepreneurs is that venture capitalists usually get a say in company decisions, in addition to a portion of the equity.

Seed Capital: The initial equity capital used to start a new venture or business. This initial amount is usually quite small because the venture is still in the idea or conceptual stage. Also, there's a high risk that the venture will fail.

Bridge Financing:   A method of financing, used by companies before their IPO, to obtain necessary cash for the maintenance of operations. These funds are usually supplied by the investment bank underwriting the new issue. As payment, the company acquiring the bridge financing will give a number of shares at a discount of the issue price to the underwriters that equally offsets the loan. This financing is, in essence, a forwarded payment for the future sales of the new issue.

Stock Split:   A type of corporate action where a company's existing shares are divided into multiple shares. Although the amount of shares outstanding increases by a specific multiple, the total dollar value of the shares remains the same compared to pre-split amounts, because no real value has been added as a result of the split.

In the U.K., a stock split is referred to as a "scrip issue", "bonus issue", "capitalization issue" or "free issue".

For example, in a 2-for-1 split, each stockholder receives an additional share for each share he or she holds.

One reason as to why stock splits are performed is that a company's share price has grown so high that to many investors the shares are too expensive to buy in round lots. 

For example, if a XYZ Corp's shares were worth $1,000 each, investors would need to purchase $100,000 in order to own 100 shares. Whereas, if each share was worth $10 each, investors only need to pay $1,000 to own 100 shares.

Reverse Takeover – RTO:

A type of merger used by private companies to become publicly traded without resorting to an initial public offering. Initially, the private company buys enough shares to control a publicly traded company. At this point, the private company's shareholder uses their shares in the private company to exchange for shares in the public company. At this point, the private company has effectively become a publicly traded one.A reverse takeover can also refer to situation where a smaller company acquires a larger company.

With this type of merger, the private company does not need to pay the expensive fees associated with arranging an initial public offering. The problem, however, is the company does not acquired any additional funds through the merger and it must have enough funds to complete the transaction on its own.

Deep-Discounted bonds:

A bond that sells at a significant discount from par value.

A bond that is selling at a discount from par value and has a coupon rate significantly less than the prevailing rates of fixed-income securities with a similar risk profile.

Typically, a deep-discount bond will have a market price of 20% or more below its face value. These bonds are perceived to be riskier than similar bonds and are thus priced accordingly.

These low-coupon bonds are typically long term and issued with call provisions. Investors are attracted to these discounted bonds because of their high return or minimal chance of being called before maturity.

Merger:

                The combining of two or more companies, generally by offering the stockholders of one company securities in the acquiring company in exchange for the surrender of their stock.

Basically, when two companies become one. This decision is usually mutual between both firms.

Factoring:

               Factoring is a financial service designed to help firms to arrange their receivable better. Under a typical factoring arrangement a factor collects the accounts on due dates, effects payments to the firm on these dates and also assumes the credit risks associated with the collection of the accounts.

Sometimes the factor provides an advance against the values of receivable taken over by it. In such cases factoring serves as a source of short-term finance for the firm.

Capital budgeting :  The process of determining whether or not projects such as building a new plant or investing in a long-term venture are worthwhile. Also known as "investment appraisal". Popular methods of capital budgeting include net present value (NPV), internal rate of return (IRR), discounted cash flow (DCF) and payback period.

Bankruptcy:  The state of a person or firm unable to repay debts. If the bankrupt entity is a firm, the ownership of the firm's assets is transferred from the stockholders to the bondholders. Shareholders are the last people to get paid if a company goes bankrupt. Secure creditors always get first grabs at the proceeds from liquidation.

Diversification:   A risk-management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. 

Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.

Market Capitalization:

A measure of a company's total value. It is estimated by determining the cost of buying an entire business in its current state. Often referred to as "market cap", it is the total dollar value of all outstanding shares. It is calculated by multiplying the number of shares outstanding by the current market price of one share.

Derivatives:  In finance, a security whose price is dependent upon or derived from one or more underlying assets. The derivative itself is merely a contract between two or more parties. Its value is determined by fluctuations in the underlying asset. The most common underlying assets include stocks  bonds, commodities, currencies, interest rates and market indexes. Most derivatives are characterized by high leverage

Portfolio management :Involves deciding what assets to include in the portfolio, given the goals of the portfolio owner and changing economic conditions. Selection involves deciding what assets to purchase, how many to purchase, when to purchase them, and what assets to divest. These decisions always involve some sort of performance measurement, most typically expected return on the portfolio, and the risk associated with this return (i.e. the standard deviation of the return). Typically the expected return from portfolios comprised of different asset bundles are compared.