Capital Market

Document Sample
Capital Market Powered By Docstoc
					By: Sumati Sethia Indian Institute of Finance Capital Markets Question 1: Write a note on Indian Capital market? Answer 1: Capital market is place for raising long-term funds and investments in long tem instruments are available. It’s a market where borrowing and lending of long term funds takes pl ace. However the scope of capital market has grown a lot in th e recent years, now it includes all the financial instruments i.e. Short term and Long term (like shares, debentures, bonds etc.), Commercial/ Industrial (Commercial Bills, Commercial Pa pers, Inter-corporate deposits etc) and Government paper (T-bi lls, Central and State Government securities). With the pace of economic reforms followed in India, the impor tance of Capital markets has grown in the last ten years. Corp orate’s both in public and private sectors raise thousands of crores rupees through this market. The governments through RBI (Reserve Bank of India) as well as FI’s (Financial Institutio ns) raise a lot of money to pay off their Debts and to cope up with their Public expenditure. Following are the major operations being carried in Indian Cap ital Market: 1. The raising of new Capital. (Primary Market) 2. Trading in securities already issued by the companies. (Se condary Market) The 1. 2. 3. 4. 5. 6. 7. 8. important constituents of Indian Capital Markets are: Stock Exchange Banks Investment Trusts/ Companies Development Banks / Specialized Financial Institutions International financial Investors and Institutions Non Banking Financial Institutions (NBFI) Mutual funds Post office Saving Banks

Functions of the Capital Market: 1. The organized and regulated capital market motivates indiv idual to save and invest funds. The availability of safe and p rofitable source of investment is an essential criterion to cr eate propensity to save and invest on the part of the earning public. 2. It provides for the investors safe and productive channels for investment of savings and secures the recurring benefit o f return thereon, as long as the savings are retained. 3. It provides liquidity to the savings of the investors, by

developing a secondary capital market, and thus makes even sho rt term savings, consistently available for long-term users 4. It thus mobilizes savings of large number of individuals, families and associations and makes the same available for mee ting the large capital needs of organised industry, trade and business and for progress and development of the country as a whole and its economy. The Liberalization of Indian economy has opened doors for For eign Direct/Institutions investments to Indian Capital market. These institutions have invested close to $14 billions in Ind ian Markets. As a result of which Indian market is considered as the part of emerging markets across the world. The various liberal developments in the Indian Capital market includes ope ning of mutual funds industry for banks and private players. T his has helped a lot to spread the equity culture. By investin g in Mutual funds one can acquire the shares of different comp anies, without actually buying them. The recent developments in Indian Capital market include SCRIP LESS trading; Over The Counter Exchange of India (OTCEI) and e stablishment of SEBI (Stock and Exchange board of India) as a regulatory authority have taken Indian markets to internationa l standards. They provided improved services to investors. The country's first ringless, scripless, electronic stock exchang e - OTCEI - was created in 1992 by country's premier financial institutions - Unit Trust of India, Industrial Credit and Inv estment Corporation of India, Industrial Development Bank of I ndia, SBI Capital Markets, Industrial Finance Corporation of I ndia, General Insurance Corporation and its subsidiaries and C anBank Financial Services. Biggest achievement in Indian Stock market was establishment o f NSE (National Stock Exchange). It was a turning point by inc orporating best international practices of Capital market. NSE has several advantages over the traditional trading exchanges . They are as follows: • NSE brings an integrated stock market trading network acro ss the nation. • Investors can trade at the same price from anywhere in the country since inter-market operations are streamlined coupled with the countrywide access to the securities. • Delays in communication, late payments and the malpractice ’s prevailing in the traditional trading mechanism can be done away with greater operational efficiency and informational tr ansparency in the stock market operations, with the support of total computerized network. Unless stock markets provide professionalised service, small i nvestors and foreign investors will not be interested in capit al market operations. And capital market being one of the majo r sources for long-term finance for industrial projects, India cannot afford to damage the capital market path. In this rega rd NSE gains vital importance in the Indian capital market sys

tem. Due to vibrant market many Indian companies/projects have rais ed large sums from these markets and investors in these activi ties have got good returns on their investment. Also the GOI ( Government of India) is slowly disinvesting from the Public se ctor companies through these markets For e.g. Two public secto r companies viz. Maruti Udyog Ltd. and BPCL’s shares will be o ffered to public through IPO (Initial public offers). The secondary market in India is also very active and volumes on the 2 premier stock exchanges National stock exchange and B ombay stock exchange have shown marked/healthy growth. In the few years the markets have taken big strides in the Derivative s instruments instead of Badla system. The Indian debt markets has become more vibrant as the RBI has recently allowed parti cipation of individuals in the government securities markets, which was previously dominated by Banks, FI’s and Mutual funds only. This has opened new avenues for investment to individua ls. Question 2: What are Mutual funds? What are the different type s of Mutual Funds? Answer 2: A Mutual Fund is a body corporate that pools the savings of a number of investors and invests the same in a variety of diffe rent financial instruments, or securities. The income earned through these investments and the capital ap preciations realized by the scheme are shared by its unit hold ers in proportion to the number of units owned by them. Mutual funds can thus be considered as financial intermediaries in t he investment business that collect funds from the public and invest on behalf of the investors. The losses and gains accrue to the investors only. The Investment objectives outlined by a Mutual Fund in its prospectus are binding on the Mutual Fund scheme. The investment objectives specify the class of securi ties a Mutual Fund can invest in. Mutual Funds invest in vario us asset classes like equity, bonds, debentures, commercial pa per and government securities. The various Technical terms commonly used in case of Mutual Fun ds: Portfolio is a group of securities/assets that the fund manage r plans to invest. The Portfolio/fund manager invests the mone y in diverse assets with the aim of maximizing return and mini mizing the risk. An Asset Management Company (AMC) is a highly regulated organi zation that pools money from investors and invests the same in a portfolio. They charge a small management fee, which is nor

mally 1.5 per cent of the total funds managed. NAV or Net Asset Value of the fund is the cumulative market va lue of the assets of the fund net of its liabilities. NAV per unit is simply the net value of assets divided by the number o f units outstanding. Buying and selling into funds is done on the basis of NAV-related prices. NAV is calculated as follows: M.V of investments+Receivables+Accr. Income– Liabilities-Accr. Expenses Number of Outstanding u nits

Different types of mutual funds:

(a) On the basis of Objective Equity Funds/ Growth Funds Funds that invest in equity shares are called equity funds. Th ey carry the principal objective of capital appreciation of th e investment over the medium to long-term. The returns in such funds are volatile since they are directly linked to the stoc k markets. They are best suited for investors who are seeking capital appreciation. There are different types of equity fund s such as Diversified funds, Sector specific funds and Index b ased funds. Index funds These funds invest in the same pattern as popular market indic es like S&P 500 and BSE Index. The value of the index fund var ies in proportion to the benchmark index. Tax Saving funds

These funds offer tax benefits to investors under the Income T ax Act. Opportunities provided under this scheme are in the fo rm of tax rebates U/s 88 as well saving in Capital Gains U/s 5 4EA and 54EB. They are best suited for investors seeking tax c oncessions. Debt / Income Funds These Funds invest predominantly in high-rated fixed-income-be aring instruments like bonds, debentures, government securitie s, commercial paper and other money market instruments. They a re best suited for the medium to long-term investors who are a verse to risk and seek capital preservation. They provide regu lar income and safety to the investor. Hedge Funds These funds adopt highly speculative trading strategies. They hedge risks in order to increase the value of the portfolio. (b) On the basis of Flexibility Open-ended Funds These funds do not have a fixed date of redemption. Generally they are open for subscription and redemption throughout the y ear. Their prices are linked to the daily net asset value (NAV ). From the investors' perspective, they are much more liquid than closed-ended funds. Investors are permitted to join or wi thdraw from the fund after an initial lock-in period. Close-ended Funds These funds are open initially for entry during the Initial Pu blic Offering (IPO) and thereafter closed for entry as well as exit. These funds have a fixed date of redemption. One of the characteristics of the close-ended schemes is that they are g enerally traded at a discount to NAV; but the discount narrows as maturity nears. These funds are open for subscription only once and can be redeemed only on the fixed date of redemption . The units of these funds are listed (with certain exceptions ), are tradable and the subscribers to the fund would be able to exit from the fund at any time through the secondary market .

Question 3: Explain the role of Merchant Bankers in the Initia l Public offerings? Answer 3: Merchant Bankers play a significant role in the Ind ian Capital market, especially in placing equity in the primar y market through the Public offers route. Public money or savi ngs constitute thousands of rupees every year, which is raised through equity or debt from market. Merchant bankers help cor porates to raise capital from market. They ought to possess kn owledge and information about the various aspects of capital m arket, trends prevailing and the psychology of the investors. The must have the ability to evaluate and analyze various aspe cts concerning the formulation of Industrial project and affec ting the viability of the project. Merchant Bankers helps corporate to raise money from capital m arket through the issue of shares, debentures, bonds etc. They are designated as managers to the issue. Their main business is to attract public money to capital issue. They also help th e companies to determine the capital structure. The pricing of the issue esp. in the public issue is very important. The pricing has to be such that: Investors will be attracted to invest at that price and get su itable returns. And the Company at the same time should get th e premium they are looking for, as larger the premium lesser i s the requirement for borrowed funds. All issues should be managed by at least one merchant banker f unctioning as the lead merchant banker. Provided that, in an i ssue of offer of rights to the existing members with or withou t the right of renunciation the amount of the issue of the bod y corporate does not exceed rupees fifty lakhs, the appointmen t of a lead merchant banker shall not be essential. No merchan t banker, other than a bank or a public financial institution,

who has been granted a certificate of registration under thes e regulations, shall after June 30th, 1998 carry on any busine ss other than that in the securities market. The Merchant Bankers offers following services and activities during the public issue: Preparing the action plan and Budget for the total expenses for the issue Drafting of prospectus and application for SEBI. Obtaining consent from SEBI. Selection of the Underwriter, Brokers, Bankers to the issue, Advertising agency, Printers etc. Holding the road shows to sell the issue for the analyst, Brokers and institutional investors. Deciding the pattern for advertising Deciding the branches where application money should be Collected. Fixing the Dates for opening and Closing the issue. Obtaining the daily report of application money collected In various branches. Obtaining the subscription of the issue. (Underwriting minimum 5% of the issue price) After the closer of issue, Obtaining the consent of SEBI for Deciding basis of allotment etc. Companies are free to allot one or more agencies as managers t o an issue. SEBI guidelines insist that there should be at lea st one authorized Merchant Banker for an issue less than Rs 10 0 crore and not more than two merchant bankers should be assoc iated as lead managers, advisors and consultants to public iss ues over Rs 100 crore. This number could be up to max 4. The prime responsibilities of the Merchant Bankers in the Mana

gement of public issues are listed below: 1. The merchant bankers should satisfy themselves with the vi ability of the projects (Technical, financial, managerial, mar ket etc) before promoting it to the invertors. Also this helps him to sell the issue with confidence. They should associate themselves with good issues for maintaining high professional standards and reputation in the market. 2. They should act as the custodians of the investor’s money and this puts a lot of responsibility on them. To discharge th is function they need to exercise due diligence independently by verifying the content of prospectus and the reasonableness of the views expressed there in. Though they don’t have to sig n the prospectus, but the have to give a certificate to that e ffect to SEBI. 3. They are responsible to get the securities listed on all t he stock exchanges mentioned in the prospectus. It can be espe cially true of companies who cannot list their shares on eithe r NSE or BSE but promise listing in several regional stock mar kets but actually they list the in one/two exchanges. 4. Non-receipt of the refund orders and allotment advice with in the stipulated period to the investors should be taken care . Introduction of DEMAT accounts the allotment complaints have considerably reduced. But the timely refunds and allotment of securities is the responsibility of lead/merchant bankers. 5. The Merchant bankers have to certify that the have verifie d everything and they believe it to be true. This assures the investing public about the safety of their investment. The pre cautions taken by merchant bankers would ensure that the fake companies, whose intention is to defraud investors, do not acc ess market. 6. Every merchant banker shall keep and maintain the followin g books of accounts, records and documents namely: (a) A copy of balance sheet as at the end of each accounting p eriod; (b) A copy of profit and loss account for that period; (c) A copy of the auditor's report on the accounts for that per iod; and (d) A statement of financial position.

Question 4: Write Notes on: Answer 4: a) Book Building:

Book building is the mechanism where in the price of issue is determined on the basis of actual demand as evident from the o ffers give by the various institutional investors and the unde rwriters. As the companies generally raise the capital through public is sues where they need to decide the size of the issue and also the price at which the shares are to be offered to the investo rs. However in this system the issuer is not able to ascertain the price that the market may be willing to pay forth shares, before launching the issue. This is where book building comes to their aid. Book building is also termed as “Price Discover y Method”. In the usual process investors are not involved in determining the issue/offer price where as in book building pr icing of the issue is determined on the basis of investors’ fe edback only which assures investor demand. Also the issue pric e after the issue marketing is flexible in terms of issue size and the prices of the shares. The issue may have a placement portion and a public portion. T

he public offer is retail marketing of the offer to the public , the placement portion can be offered through the book buildi ng process. For e.g. Bharati Tele has recently made issues in this way. The Book Building process is described below: • The issuer company appoints a LEAD Manager to the issue kn own as “Book Runner”. The book runner forms a syndicate to pro cure subscriptions to the issue. • The syndicate members take steps for demand creation and f or the feedback. Orders are procured from the investors. • Book runner builds the book based on the orders received f rom the various bidders through the syndicate members. The BR determines the Size and the Price of the issue. • Book runner the closes the book in consultation with the I ssuer and finalizes the allocation to the syndicate members wh o in turn enter into procurement agreement. • Final prospectus is filed with the Registrar of companies along with procurement agreements. • The placement portion is to close one day before the openi ng of the public portion.



A depository is an organization where the securities of a shar eholder are held in the electronic format at the request of th e shareholder through the medium of the depository participant s. Basically a depository is a bank of securities. The deposit ory can legally transfer beneficial ownership, which a custodi an cannot. A Depository can be compared to a bank for shares. Just as a Bank holds cash in your account and provides all ser vices related to transaction of cash, a depository holds secur ities in electronic form and provides all services related to transaction of shares / debt instruments. A depository interac ts with clients through a Depository Participant (DP) with who m the client has to maintain a DEMAT Account. Depositories registered with SEBI are: • NSDL – National Securities Depositories Limited is a Depos itory promoted by UTI, IDBI, SBI & NSE who hold the securities in electronic form on behalf of the beneficiary holder. • CDSL – Central Depositories Securities Limited is a Deposi tory promoted by BSE.

The benefits of availing Depository services: • Protection against loss, theft, forgery, mutilation etc. • Safe and convenient way to hold securities. • No stamp duty on transfer of securities as compared to the duty of 0.50% in the physical segment while transferring owne rship. • Transfer of shares is done immediately i.e. Credit and deb t of shares. • Shorter settlement cycles • Protection against bad deliveries • Nomination facility • No Odd lot problem even one share can be sold • Minimum paperwork involved in transfer of securities • Reduction in transaction costs • Change in address recorded with DP gets registered with al l the companies in which the investor holds securities electro nically eliminating the need to correspond with each of them s eparately. • Automatic credit into DEMAT account of shares, arising out -of bonus/split/consolidation/merger etc. c) Rolling statements

Rolling settlement is the one in which trades outstanding (Pay ments made for the purchases or deliveries in case of sale of securities) at the end of the day have to be settled at the en d of the settlement period. For E.g. In a T+5 Rolling settleme nt, a transaction entered into Monday has to be settled on the fifth working day, which will be the subsequent Monday when e ither the pay-in or pay-out transaction takes place. Advantages of Rolling settlement: The Rolling settlement payments are much quicker than weekly s ettlements. Thus, investors benefit increases from the increas ed liquidity as in the Rolling settlement system the investor would receive the payments on the fifth day after the sales. T hus rolling settlement reduces delays. Rolling settlement was introduced in India only after introduc tion of depositories because the Rolling settlements necessari ly require Electronic transfer of funds and DEMAT facilities i n place for trading of securities. This is because of the fact that handling large volume of paper on a daily basis is extre mely difficult for the Clearinghouses of Stock exchanges. Howe ver, still the transfer of funds in India takes two – three da ys, as all the Banks are not yet connected electronically with all their branches, which delays the clearance process. d) Non-Voting Shares:

In equity market Shareholders enjoys basically two types of rig hts: 1. Dividend 2. Voting rights

In case of Non- voting shares one right gets excluded i.e. the shareholder looses the right to vote, even though he is the m ember of the company and may attend the general meeting of the company. They usually are not entitled to rights or bonus iss ues of shares of the concerned company. Non- voting shares therefore require being more attractive tha n the shares, which carry Voting rights. This can be achieved in two ways: 1. By giving discount on the issue price 2. By giving higher dividend on Non- voting shares Advantages of Non- voting shares: To Companies/Issuer: Most commonly the Non- voting shares will be quoted at a disco unted price with respect to normal share price. Due to the rec ent developments in the economy the industries are growing at fast rate. Thus they require resources for modernization, expa nsion, integration and for new projects. But raising funds by the way of equity has an inherent danger of loosing control to others. The ability to raise debts has its own limitations. N on- voting shares provide a way out to companies to garner equ ity without dilution of the promoter’s stake and control. To Investors: Some of the investors are always interested in gaining high re turns from the investment rather than the right to vote. This is quite evident from the fact that very few investors/shareho lders actually turn up in the annual general body meetings of the companies and are really interested in the day-to-day acti vities of the company. Mostly the investors are not really int erested in the affairs of company or wish to participate in th e affairs of the company. Question 5: Write a note on Money Market. What is the Whole sa le Debt Market of NSE? Answer 5: Money market is a place for trading in money and sho rt-term financial assets that are close substitutes for money. It provides an avenue for equilibrating the short-term surplu s funds of the lenders/investors with the short-term requireme nts of borrowers. The number of players in the money market an d their objectives in participating in the market are differen t. The volume and risk perception of each of these players are also different. To fulfill such varied requirements, the mone y market needs a variety of instruments. The objectives of Money Market are: 1. Providing equilibrating mechanism for ironing out short-te rm surpluses and deficits. 2. Provide liquidity and a realistic price. 3. Provide cash-rich corporations/institutions a means for pa

rking their short-term surpluses. (Provident Fund/ Income tax payments/ seasonal surpluses - otherwise would be kept in curr ent a/c) Money Market Instruments: Money market is the most liquid mark et and very short term in nature. Money market instruments are those with maturity less than a year and highly liquid. Overn ight inter bank call money market, commercial paper market, ce rtificate of deposit market and T-bills market come under the purview of money market.

1. Commercial paper is a debt instrument issued by a corporate with a very good credit rating to meet its working capital re quirements. Corporates usually take this route when the rates in the money market are lower than working capital finance rat es of the banks. It's a highly liquid market and these instrum ents have a maximum maturity period of 1 year and it goes as l ow as 1 month and it can be rolled over. The minimum denominat ion for issue of such securities is Rs. 25 lakhs. The issuers are usually highly rated corporates. The issuer has to be comp ulsorily by any of the credit rating agencies. CP was introduc ed in India in 1990 by RBI to enable highly rated corporate bo rrowers diversify their sources of short-term borrowings and a lso to provide an additional instrument to investors. The bigg est advantage is that by issuing CPs, a top-rated corporate ca n raise funds at even below the prime lending rate of banks. 2. Certificate of deposit is a debt instrument issued by a Com mercial Bank to meet its short-term requirement of funds. Thes e instruments have a maximum maturity period of 1 year and in special cases, it can go up to 1 and a half years with special permission of the RBI. The minimum denomination of CD is Rs. 5 lakhs. 3. T-bills are Promissory notes issued by the Government of In dia and constitute a major portion of short-term borrowings by the government. T-Bills are the most liquid paper after cash and call money. They are highly liquid and virtually risk free as the Government of the respective country to tide over the temporary imbalance between receipts and expenditures issues t

hem. Usually, there is a time lag between the receipts and exp enditures of Government and during that time; the Govt. issues the T-bills to make up this imbalance. Presently, in India, w e have 14 day T-bills, 91 day, 182 day and 364 day T-bills. Th e RBI issues securities on behalf of the GOI and the yields ar e determined on the basis of competitive bidding. The auction is conducted on the French auction basis, i.e., all the bidder s above the cutoff price will get the amount of securities iss ued in their name for which they had bid for, while the bidder s at the cutoff price are issued securities on a pro rata basi s. 4. Money Market mutual funds (MMMFs) enable the small investor s to participate in the money market. The collected funds are invested in Money market instruments like T-bills, CPs, CDs, I CDs, Call/Notice money etc. Wholesale debt market (WDM) WDM is a market where pure debt instruments such as government securities, treasury bills, public sector bonds, corporate de bentures, commercial paper, certificate of deposits etc are tr aded. A debt instrument is an obligation undertaken by the issuer of the debt instrument to repay principal with interest at a pre determined future date. The concept of a debt instrument is ba sed on a premise that when a person borrows, he enters into an agreement with the lender that he will repay the principal an d interest at a future date. This arrangement can be converted in the form of an instrument wherein the loans can be made tr adable by converting it into instruments of smaller units with a pro rate allocation of principal and interest. So the basic features of any debt instrument are as follows: • Face value of the instrument is the value that is written on the debt certificate. • Issue price, is the value at which the security is issued. It might be at par or at a premium or discount. • Coupon, the interest rates payable on the instrument. • Terms and conditions like repayment period, pattern and mo de of repayment. Various Characteristics of WDM: • A WDM comprises of very large number of institutional inve stors and a very high volume of trade dominate this segment. • The wholesale debt market is not centrally located anywher e but it is an over the counter market where buyers and seller s conduct business linked by telephones, computers, faxes, tel exes and other means of communications. • Its participants include Banks, Financial Institutions, th e RBI, Primary Dealers, Insurance companies, Provident Funds, MFs, Corporates and FIIs. • Gilt securities are immobilized with the RBI and they main tain a book entry of holders.

• In this market, the player’s give two way quotes, i.e., bo th buy and sell quotes to each other. • Trades in this market are settled on the basis of trade fo r trade i.e. each transaction is settled individually. • Each trade has a settlement date specified upfront at the time of order entry and is used a matching parameter. The actu al settlement of funds and securities are effected directly be tween participants. • The recent development in this type of market is that RBI has allowed individuals to buy and sell government securities.

Question 7: What is meant by Buy back of shares? What are the legal provisions for buy back in India? Answer 7: Buy back of shares is nothing but Buying back of the securitie s issued by the company to the shareholders either from the ma rket or directly from the investors. Objectives of Buy Back: Shares may be bought back by the compan y on account of one or more of the following reasons: 1. To increase promoters holding 2. Increase earning per share 3. Rationalize the capital structure by writing off capital n ot represented by available assets. 4. Support share value 5. To thwart takeover bid 6. To pay surplus cash not required by business In fact the best strategy to maintain the share price in a bea r run is to buy back the shares from the open market at a prem

ium over the prevailing market price. Conditions of Buy Back 1. The buy-back is authorized by the Articles of association of the Company. 2. A special resolution has been passed in the general meetin g of the company authorizing the buy-back. In the case of a li sted company, this approval is required by means of a postal b allot. Also, the shares for buy back should be free from lock in period/non transferability. The buy back can be made by a B oard resolution If the quantity of buyback is or less than ten percent of the paid up capital and free reserves. 3. The buy-back is of less than twenty-five per cent of the t otal paid-up capital and fee reserves of the company and that the buy-back of equity shares in any financial year shall not exceed twenty-five per cent of its total paid-up equity capita l in that financial year. 4. The ratio of the debt owed by the company is not more than twice the capital and its free reserves after such buy-back. 5. There has been no default in any of the following (i) In repayment of deposit or interest payable thereon. (ii) Redemption of debentures, or preference shares. (iii) Payment of dividend, if declared, to all shareholders within the stipulated time of 30 days from the date of declara tion of dividend. (iv) Repayment of any term loan or interest payable thereon to any financial institution or bank. 6. There has been no default in complying with the provisions of filing of Annual Return, Payment of Dividend, and form and contents of Annual Accounts. 7. All the shares or other specified securities for buy-back are fully paid-up. 8. The buy-back of the shares or other specified securities l isted on any recognized stock exchange shall be in accordance with the regulations made by the Securities and Exchange Board of India in this behalf. and 9. The buy-back in respect of shares or other specified secur ities of private and closely held companies is in accordance w ith the guidelines as may be prescribed. Disclosures in the explanatory statement The notice of the meeting at which special resolution is propo sed to be passed shall be accompanied by an explanatory statem ent stating – 1. A full and complete disclosure of all material facts. 2. The necessity for the buy-back. 3. The class of security intended to be purchased under the bu y-back. 4. The amount to be invested under the buy-back. and 5. The time limit for completion of buy-back. Filing of Declaration of solvency

After the passing of resolution but before making buy-back, fi le with the Registrar and the Securities and Exchange Board of India a declaration of solvency in form 4A. The declaration m ust be verified by an affidavit to the effect that the Board h as made a full inquiry into the affairs of the company as a re sult of which they have formed an opinion that it is capable o f meeting its liabilities and will not be rendered insolvent w ithin a period of one year of the date of declaration adopted by the Board, and signed by at least two directors of the comp any, one of whom shall be the managing director, if any: No declaration of solvency shall be filed with the Securities and Exchange Board of India by a company whose shares are not listed on any recognized stock exchange. Register of securities bought back After completion of buyback, a company shall maintain a regist er of the securities/shares so bought and enter therein the fo llowing particulars 1. The consideration paid for the securities bought-back. 2. The date of cancellation of securities. 3. The date of extinguishing and physically destroying of sec urities and 4. Such other particulars as may be prescribed where a compan y buys-back its own securities, it shall extinguish and physic ally destroy the securities so bought-back within seven days o f the last date of completion of buy-back. Procedure for Buy back: 1. Where a company proposes to buy back its shares, it shall, after passing of the special/Board resolution make a public a nnouncement at least one English National Daily, one Hindi Nat ional daily and Regional Language Daily at the place where the registered office of the company is situated. 2. The public announcement shall specify a date, which shall be "specified date" for the purpose of determining the names o f shareholders to whom the letter of offer has to be sent. 3. A public notice shall be given containing disclosures as s pecified in Schedule I of the SEBI regulations. 4. A draft letter of offer shall be filed with SEBI through a merchant Banker. The letter of offer shall then be dispatched to the members of the company. 5. A copy of the Board resolution authorizing the buy back sh all be filed with the SEBI and stock exchanges. 6. The date of opening of the offer shall not be earlier than seven days or later than 30 days after the specified date 7. The buy back offer shall remain open for a period of not l ess than 15 days and not more than 30 days. 8. A company opting for buy-back through the public offer or tender offer shall open an escrow Account.

Question 8: Write a note on Portfolio management. Answer 8: Portfolio Management involves the allocation of assets for ind ividuals and institutions, keeping in mind their previous inve stment experience, their needs and circumstances (such as liqu idity needs, risk appetite, tax considerations), and their inv estment objectives. Every portfolio is tailored to the individ ual client's requirement, and the attempt is to provide person alized financial solutions. Investment requirements are as unique as the individual. An in dividual's investment needs would be driven by his current fin ancial status, future requirements, social and age profile. To comprehensively cover his needs, a person would ideally requi re exposure to equities, debt, insurance, fixed deposits, real

estate, etc. Evaluation and investment in each requires a uni que skill. Factors influencing the Portfolio decisions • Investor’s Characteristics • Liquidity needs • Tax considerations • Investment risk • Interest rate risk • Assurance of income • Safety of principal • Business and market risk Types of Portfolio management 1. Discretionary Portfolio management services (DPMS): In thi s case the client gives his money for investment to fund manag er, who handles the paper work, takes all investment decisions and gives a good return to the investors and charges a fee fo r the service rendered. 2. Non-Discretionary Portfolio management services: The manag er function acts a counselor, but the investor is free to acce pt or reject the managers advice, the managers handles the pap er work and charges some service fees. Manager makes a tailor made portfolio as per the risk taking ability of the investor. Steps in Portfolio management: 1. Specification and qualification of investor’s objectives, constraints and preferences in the form of policy statement. 2. Determination and quantification of capital market expecta tions for the economy, market sectors, industries and individu al securities. 3. Allocation of assets and selection of individual securitie s (Elaborated in the figure below). 4. Performance measurement and evaluation of portfolio to ens ure investors objectives are attained. 5. Monitoring the performance and responding to changes in in vestors’ objective constraints and capital market expectations . 6. Rebalancing the portfolio whenever necessary. Benefits of Portfolio Management: • It can be a complex, risky and time-consuming process for an individual to handle in isolation. That's why it makes good sense to appoint a properly qualified investment manager to i nvest in the stock market on ones behalf. • As a client of Portfolio Management the investment manager will use his market knowledge, experience and contacts to ide ntify those investments, which are likely to offer an appropri ate combination of risk and return in relation to ones objecti ves. • Manage ones investments in a tax efficient manner, ensurin g that the person takes full advantage of the allowances and l

imits available to him. • Assess your risk profile to identify the most suitable typ e of investments. • Takes care of all the day-to-day administrative work ensur ing that ones rights in relation to his investments are protec ted, • Keep the investor informed about changes in his portfolio and will regularly review his financial objectives to ensure h is investment portfolio continues to be relevant to his financ ial goals. • Regularly update him on the performance of his investments and stock markets generally. SEBI Regulation governing Portfolio Management activities: 1. The portfolio manager must register himself with the SEBI. 2. The applicant needs to have necessary infrastructure. 3. He must have in his employment at least 2 employees who ar e experienced in the business of Portfolio Management. 4. The applicant must fulfill the capital adequacy norms laid down from time to time 5. The applicant must not be involved in any litigation conne cted with the securities market. 6. He must have a professional qualification from a recognize d institution in finance, law, and accountancy or business man agement. 7. The applicant must pay registration fees as are in force. 8. Portfolio manager must enter into an agreement clearly def ining the inter relationship and setting out their mutual righ ts, liabilities and obligation relating to the management of p ortfolio of the client. 9. The funds of all the clients’ shall be placed by the portf olio manager in a separate account to be maintained by him in a scheduled commercial bank. 10. The portfolio manager charges agreed fees from the client for rendering portfolio management services. 11. The portfolio manager shall not accept money or securitie s form client for a period of less than one year. 12. The portfolio manager shall sell and purchase securities separately from each client. 13. Renewal of portfolio fund on maturity of the initial peri od shall be deemed as a fresh placement and shall be for minim um period of one year. Question 9: Explain briefly the Derivative trading in stock ex changes. Answer 9: The Securities Contracts (Regulation) Act 1956 defines derivat ive as under: 1. A "Derivative” is a security derived from a debt instrumen t, share, and loan whether secured or unsecured, risk instrume

nt or contract for differences or any other form of security; 2. A "Derivative" is a contract, which derives its value from the prices, or index of prices of underlying securities The above definition conveys: • That derivatives are financial products • Derivative is derived from another financial instrument/co ntract called the underlying. In the case of Nifty futures, Nifty index is the underlying. • A derivative derives its value from the underlying assets. The underlying asset can be securities, commodities, bullion, currency, live stock or anything else. In other words, Derivative means a forward, future, option or any other hybrid contract of pre determined fixed duration, li nked for the purpose of contract fulfillment to the value of a specified real or financial asset or to an index of securitie s. Classification of Derivatives: 1. Forward Contracts (Currencies, Stocks etc): A cash market transaction in which a seller agrees to deliver a specific cash commodity to a buyer at some point in the futu re is called Forward Contracts. Forward contract is different from a spot transaction, where p ayment of price and delivery of commodity concurrently take pl ace immediately the transaction is settled. In a forward contr act the sale/purchase transaction of an asset is settled inclu ding the price payable, not for delivery/settlement at spot, b ut at a specified future date. India has a strong dollar-rupee forward market with contracts being traded for one, two,.. si x month expiration. Daily trading volume on this forward marke t is around $500 million a day. Indian users of hedging servic es are also allowed to buy derivatives involving other currenc ies on foreign markets. Unlike futures contracts (which occur through a clearing firm) , forward contracts are privately negotiated and are not stand ardized. Further, the two parties must bear each other's credi t risk, which is not the case with a futures contract. Also, s ince the contracts are not exchange traded, there is no markin g to market requirement, which allows a buyer to avoid almost all capital outflows initially (though some counter parties mi ght set collateral requirements). Given the lack of standardiz ation in these contracts, there is very little scope for a sec ondary market in forwards. The price is specified in a forward contract for a specific commodity. The forward price makes th e forward contract have no value when the contract is written. However, if the value of the underlying commodity changes, th e value of the forward contract becomes positive or negative, depending on the position held. Forwards are priced in a manne r similar to futures. Like in the case of a futures contract,

the first step in pricing a forward is to add the spot price t o the cost of carry (interest forgone, convenience yield, stor age costs and interest/dividend received on the underlying). U nlike a futures contract though, the price may also include a premium for counter party credit risk, and the fact that there is not daily marking to market process to minimize default ri sk. If there is no allowance for these credit risks, then the forward price will equal the futures price. 2. Futures Contract (Currencies, Stocks, Indexes, Commodities e tc) A future contract is an agreement between a buyer and a seller where the seller agrees to deliver a specified quantity and g rade of a particular asset at a predetermined time in future a t an agreed upon price through a designated market (exchange) under stringent financial safeguards. A futures contract, in o ther words, is a forward contract, which trades on an exchange . S&P CNX Nifty futures are traded on National Stock Exchange. This provides them transparency, liquidity, anonymity of trad es, and also eliminates the counter party risks due to the gua rantee provided by National Securities Clearing Corporation Li mited. 3. Options (Currencies, Stocks, Indexes etc). Options are the standardized financial contracts that allows t he buyer (holder) of the options, i.e. the right at the cost o f option premium, not the obligation, to buy (call options) or sell (put options) a specified asset at a set price on or bef ore a specified date through exchanges under stringent financi al security against default. The underlying assets may be physical commodities like wheat/ rice/ cotton/ gold/ oil or financial instruments like equity s tocks/ stock index/ bonds etc. Various types of options: • Call Option • Put Option • European Option & American Option 4. Swaps (Currency, Interest, Asset etc). An agreement for an exchange of payments between two counter p arties at some point(s) in the future and according to a speci fied formula. Types of swaps: • An Interest Rate Swap (IRS) is a financial contract betwee n two parties exchanging or swapping a stream of interest paym ents for a 'notional principal' amount on multiple occasions d uring a specified period. Such contracts generally involve exc hange of a 'fixed to floating' or 'floating to floating' rates of interest. Accordingly, on each payment date - that occurs during the swap period - cash payments based on fixed/floating and floating rates, are made by the parties to one another.

• A Currency Swap (CS) is a financial contract between two p arties exchanging or swapping a stream of payments for a 'noti onal principal' amount on multiple occasions during a specifie d period. Such contracts generally involve exchange of a 'fixe d to floating' rate or ‘Cross currency'. Accordingly, on each payment date -that occurs during the swap period - the parties make cash payments based on fixed/floating and exchange rates , to one another.

Question 12: Write a note on Credit and Debit cards. Comment o n the future of plastic money in India. Answer 12:

Credit Card A credit card is a payment card issued to a person for purchas ing goods and services and obtaining cash against a line of cr edit established by the issuer. It is a card (usually plastic) that assures a seller that the person using it has a satisfactory credit rating and that the issuer will see to it that the seller receives payment for the merchandise delivered. Some companies are now offering credit cards for those with bad or no credit that do not require a s ecurity deposit. The application fees, annual fees, and intere st rates associated with these unsecured cards are higher than standard cards. These cards should be used only to re-establ ish a good credit history only, and not to run up a big balanc e. Debit cards A Debit card is a payment card (usually plastic) that enables the holder to withdraw money or to have the cost of purchases charged directly to the holder's bank account. They are very similar to credit cards in that they can be used to withdraw cash from ATMs and make purchases at millions of locations worldwide just as with a regular Visa or MasterCard. The major difference is that amounts used for purchases with your debit card are immediately deducted from your checking a ccount. Merchants prefer them to checks because they don't bo unce and the money is transferred quickly. The biggest advantage of debit cards is convenience. Not only one needs to carry cash, one doesn’t run up interest charges like in case of credit card. For this reason, debit cards are a good option for those who have gotten into trouble with cred it cards in the past. They certainly will reign in uncontroll ed spending, since purchase amounts are immediately deduced fr om one's bank account, and one can keep track of spending and expenses. The major disadvantage of using debit cards is in terms of fin ancial protection that a credit card provides in regard of fra uds. If ones credit card is stolen, he will only be required to pay $50.00. However, if your debit card is stolen, a thief can use it at many locations without being required to have ac cess to a PIN number. Money lost from your bank account in th is manner is not refundable. However, both Visa and MasterCar d offer a $50 limit on liability on fraudulent charges made wi th the debit cards they issue.

Various Parties involved in the transaction

Card Issuers are mainly the banks. They are interested in this business because of high margins i.e. they charge up to 3% fe es from member establishments, Charge annual fees from their c ustomers, earn interest on the credit made available to the us ers. The Banks also have to bear the costs Like the cost of marketing the cards, the credit information c ost, membership fees paid to clearing agencies, admin fees and cost of bad debts. Card Holders includes both the individuals and the business or ganization. Member establishments (ME’s) are the establishments enlisted t o the card issuers, who accept payment through cards for goods sold or services rendered. ME’s are enlisted after taking int o account their reputation, integrity, standing, popularity in market and the volume of business generated by them Based on type of business, location turnover etc floor limit for ME’s i s fixed. Clearing agencies: The card issuer affiliates itself with Mast erCard International or Visa International –the two leading in ternational card issuers which act as clearing agencies. The a dvantage of this affiliation is that it enables cardholder of one affiliate to use his/her card at the member of other affil iate also. Future of plastic money in India The prudish Indian psyche will have a tremendous bearing on th e future of plastic money. ``Among potential consumers, percep tion of likelihood of spending beyond means and taking credit while using a credit card is considered as the biggest obstacl e,'' says a Finance market expert. ``Research shows that consu mers still felt threatened by a credit card. The primary reaso n being the fear of overspending''. The credit card is ``looke d upon more as a status symbol and a sign of extravagance than a convenience tool or an alternative mode of payment.'' The debit card may still prove closer to the Indian heart, all owing conservative spenders that ``perfect control on expenses .'' Yet the road ahead for the debit card too is not entirely without its share of prickly gravel. ``The biggest deterrent w ould be that very few merchant establishments in India are equ ipped to accept debit cards and there is no grace period avail able.''

Question 15: Explain the need and concept of Credit Rating? Answer 15: “Credit-rating” and "Credit-rating agency" are defined as under • "Rating" means an opinion regarding securities, expressed in the form of standard symbols or in any other standardized m anner, assigned by a credit rating agency and used by the issu er of such securities, to comply with a requirement specified by these regulations. Credit ratings are expressed as letter g rades such as A-, B, or C+. These ratings are based on various factors such as a borrower's payment history, foreclosures, b ankruptcies and charge-offs. There is no exact science to rati ng a borrower's credit, and different lenders may assign diffe rent grades to the same borrower. • "Credit Rating Agency" is a commercial concern engaged in the business of credit rating of any debt obligation or of any project or programme requiring finance, whether in the form o f debt or otherwise, and includes credit rating of any financi al obligation, instrument of security, which has the purpose o f providing a potential investor or any other person any infor mation pertaining to the relative safety of timely payment of interest or principal. Credit rating is a measure of ones credit-worthiness: his/her reputation for paying back money. A credit rating (or profile) is a picture of how you, as an individual, pay back the compa nies you borrow money from. It is also an accounting of how yo u meet your other financial obligations. A credit rating usual ly requires information in five categories: 1. Identifying information (name, address, date of birth, etc.) 2. 3. 4. 5. Employment information Credit information Public record information Inquiries

Information on ones credit report comes from companies that ha ve loaned money. National credit reporting agencies, also know n as credit bureaus, organize the information and keep credit reports on file. Anyone who has ever used credit to buy anythi ng probably has a credit report. To sum up what exactly Credit Rating is: • It reflects the borrowers’ accountability, expected capabi lity and inclination to pay interest and principal in timely m anner. • It is an isolated function of a credit risk evaluation.

• •

It involves issue specific evaluation. It is useful in differentiating credit quality.

What Credit rating is not: • Rating is not a general-purpose evaluation of the issuer. • It is not a recommendation to buy/sell/hold a security. • It is not an extensive audit of the issuing company. • Rating is not a one-time assessment of the credit worthine ss valid over the future life of the security. The types of instruments rated: Credit rating is used extensively for evaluating debt instrume nts. These include long-term instruments like bonds and debent ures as well as short-term instruments like commercial paper. In addition to these fixed deposits, Certificate of deposits ( CDs), structured obligations including the non-convertible por tion of PCDs (Partially convertible Debentures) and preference shares are rated. BUT the EUITY shares are not rated. The need for credit rating is different for different parties depending on the benefits it offers to the various parties uti lizing these services viz. investors, intermediaries, issuers and the regulatory authority. • Benefits to Investors: 1. Credit Rating will supplement the investors’ credit evalua tion process. 2. It facilitates comparison of relative value between compet ing securities. 3. It helps in recognizing the risk involved in the investment . • Benefits to Financial Intermediaries: 1. The rating helps them in pricing the debt. 2. It shifts the burden of establishing the credit quality fr om intermediary to a rating agency thereby easing the due dili gence requirement. 3. With high credit rated instruments brokers find it easy to convince their clients to select a particular investment prop osal. This saves their time, cost and manpower in the convinci ng activity. • Benefits to Issuer: 1. A company with rating can approach a wider section of inve stors for resource mobilization. 2. Smaller and not so well known companies can access the mark et. 3. A company with high credit rated instruments has the oppor tunity to reduce the cost of borrowing by quoting less interes t rates. 4. Encourages financial discipline as borrowers attempt to ob tain ratings by improving financial structures and reducing op erating risks.

5. Rating encourages the companies to come out with more disc losures about their accounting system, financial reporting and management pattern. 6. Company with rated instruments can use their rating as mar keting tool to create a better image in dealing with customers , lenders and the creditors. • Benefits to Regulatory Authorities: 1. By identifying risks, rating helps in channeling savings i nto more productive investments. 2. Credit rating serves the objective of protecting Customer i nterest.

By Atiq ur Rahman For exclusive use of Students of Mardan Institute of Management Studies

Accounting Terminologies account A record in the general ledger that is used to collect and sto re similar information. For example, a company will have a Cas h account in which every transaction involving cash is recorde d. A company selling merchandise on credit will record these s ales in a Sales account and in an Accounts Receivable account. accelerated depreciation The allocation of the cost of a plant asset to expense in an a ccelerated manner. This means that the amount of depreciation in the earlier years of an asset's life is greater than the st raight-line amount, but will be less in the later years. In to tal the amount of depreciation over the life of the asset will be the same as straight-line depreciation. The difference bet ween accelerated and straight-line is the timing of the deprec iation. For profitable companies, the use of accelerated depre ciation on the income tax return will mean smaller cash paymen ts for income taxes in the earlier years and higher cash payme nts for income taxes in later years. accounting equation Assets = Liabilities + Owner's Equity. For a corporation the e quation is Assets = Liabilities + Stockholders' Equity. Becaus e of double entry accounting this equation should be in balanc e at all times. The accounting equation is expressed in the fi nancial statement known as the balance sheet. accounts payable This current liability account will show the amount a company owes for items or services purchased on credit and for which t here was not a promissory note. This account is often referred to as trade payables (as opposed to notes payable, interest p ayable, etc.) accounts receivable A current asset resulting from selling goods or services on cr edit (on account). accounts receivable turnover ratio The financial ratio which indicates the speed at which a compa ny collects its accounts receivable. If a company's turnover i s 10, this means the company's accounts receivable are turning over 10 times per year. It indicates that the company, on ave rage, is collecting its receivables in 36.5 days (365 days per

year divided by 10). accrual basis of accounting The accounting method under which revenues are recognized on t he income statement when they are earned (rather than when the cash is received). The balance sheet is also affected at the time of the revenues by either an increase in Cash (if the ser vice or sale was for cash), an increase in Accounts Receivable (if the service was performed on credit), or a decrease in Un earned Revenues (if the service was performed after the custom er had paid in advance for the service). Under the accrual basis of accounting, expenses are matched wi th revenues on the income statement when the expenses expire o r title has transferred to the buyer, rather than at the time when expenses are paid. The balance sheet is also affected at the time of the expense by a decrease in Cash (if the expense was paid for when it incurred), an increase in Accounts Payabl e (if the expense will be paid in the future), or a decrease i n Prepaid Expenses (if the expense was paid in advance). accrued expense An expense that has occurred but the transaction has not been entered in the accounting records. Accordingly an adjusting en try is made to debit the appropriate expense account and to cr edit a liability account such as Accrued Expenses Payable or A ccounts Payable.

accumulated depreciation The amount of a long term asset's cost that has been allocated to Depreciation Expense since the time that the asset was acq uired. Accumulated Depreciation is a long-term contra asset ac count (an asset account with a credit balance) that is reporte d on the balance sheet under the heading Property, Plant, and Equipment.

adjusting entries Journal entries usually dated the last day of the accounting p eriod to bring the balance sheet and income statement up to da te on an accrual basis (as required by the matching principle and the revenue recognition principle)

admininstrative expenses Administrative expenses are part of the operating expenses (al

ong with selling expenses). Administrative expenses include ex penses associated with the general administration of the busin ess. Examples include the salaries and fringe benefits of the company president, human resource personnel, accounting, infor mation technology, the depreciation expense for equipment and space used in administration, as well as supplies, utilities, etc. Under the accrual basis of accounting, administrative expenses appear on the income statement for the period in which they o ccurred (not the period in which they were paid). assets Things that are resources owned by a company and which have fu ture economic value that can be measured and can be expressed in dollars. Examples include cash, investments, accounts recei vable, inventory, supplies, land, buildings, equipment, and ve hicles. Assets are reported on the balance sheet usually at cost or lo wer. Assets are also part of the accounting equation: Assets = Liabilities + Owner's (Stockholders') Equity. Some valuable items that cannot be measured and expressed in d ollars include the company's outstanding reputation, its custo mer base, the value of successful consumer brands, and its man agement team. As a result these items are not reported among t he assets appearing on the balance sheet. audited financial statements Financial statements that bear the report of independent audit ors attesting to the financial statements' fairness and compli ance with generally accepted accounting principles.

auditor's report A written opinion of an independent certified public accountan t that a company's financial statements are a fair representat ion of the company's financial performance and financial posit ion. The auditor's report is required for each corporation who se stock is publicly-traded. authorized number of shares of stock The number of shares of stock that a corporation may issue. average accounts receivable The average balance in the account Accounts Receivable during a period of time. Since the amount reported in the Accounts Re

ceivable account is the ending balance on one specific day, it is necessary to compute an average balance when relating this account to Sales (the balance of which reports the sales for a period of time).

balance per bank A phrase used in reconciling the bank statement. It refers to the ending balance shown on the bank statement. balance per books The amount appearing in the general ledger. When reconciling t he bank statement, the balance per books is the balance of the Cash account in the general ledger that pertains to the bank account. balance sheet One of the main financial statements. The balance sheet report s the assets, liabilities, and owner's (stockholders') equity at a specific point in time, such as December 31. The balance sheet is also referred to as the Statement of Financial Positi on. balance sheet account Asset, liability, and owner's equity accounts. Also referred t o as permanent or real accounts. bank errors Errors made by the bank on a company's bank account. These are usually infrequent but could include an incorrect amount of a check or deposit or a check or deposit recorded in the wrong account. bank overdraft A negative balance in the bank's records for the company's che cking account. bank reconciliation The process of comparing the amounts in the Cash account in th e general ledger to the amounts appearing on the bank statemen t. The objective is to be certain that there is consistency be tween the amounts and that the company's amounts are accurate and complete. bank service charge expense This is an administrative expense which reports the fees incur red by a company for the expenses associated with its checking account transactions.

bank statement Usually refers to a statement from the bank showing the activi ty in a company's checking account. The statement includes the deposits received by the bank, checks paid by the bank, bank service charge, and other amounts transferred into and out of the checking account. batch-level activities Activities involving a batch of products--as opposed to indivi dual items. An example of a batch activity is the setting up o f a machine to produce a batch of 1,000 identical items. batch-level cost A cost associated with a batch of items, but not directly trac eable to an individual item within the batch. For example, the cost to set up a machine to run a batch of 5,000 items is a b atch-level cost. This cost must then be allocated to the 5,000 items included in the batch. batch size In activity-based costing, this refers to the number of items that will be produced after a machine has been setup. biweekly Usually means every two weeks. For example, if an employee is paid every other Thursday, the employee is paid biweekly. The person paid biweekly will receive 26 paychecks per year. (Peop le paid two times per month – on the 15th and on the last day of the month – are said to be paid semimonthly and will receiv e 24 paychecks per year.) blue-collar worker A term often used when referring to production workers and oth er workers who are paid with an hourly pay rate. These workers ’ compensation is referred to as "wages" (as opposed to salari es). board of directors Individuals elected by the common stockholders of a corporatio n to represent the stockholders and to establish the policies of the corporation. The board of directors appoints the office rs of the corporation and declares dividends for the common an d preferred stock. book depreciation The depreciation computed for financial reporting purposes--as opposed to income tax depreciation. book of original entry Also known as a journal.

book value The book value of an asset is the amount of cost in its asset account less the accumulated depreciation applicable to the as set. The book value of a company is the amount of owner's or s tockholders' equity. book value of a company The amount of owner's equity or stockholders' equity reported on a company's balance sheet. This is not an indication of the company's fair market value. book value of an asset The book value of an asset is the asset's cost minus the accum ulated depreciation since the asset was acquired. This net amo unt is not an indication of the asset's fair market value. The book value of an asset is also referred to as the asset's car rying value. bookkeeping The recording of a company's transactions into the accounts co ntained in the general ledger. It is usually associated with t he accounting tasks prior to the preparation of the trial bala nce. books A term to mean the company's general ledger or accounting recor ds. budget variance The difference between the actual amount and the budgeted amoun t. buildings Buildings is a noncurrent or long-term asset account which sho ws the cost of a building (excluding the cost of the land). Bu ildings will be depreciated over their useful lives by debitin g the income statement account Depreciation Expense and credit ing the balance sheet account Accumulated Depreciation. byproduct A product that emerges with other products in a common process ; however, this product does not have a significant value. (If it had significant value, it would be a joint product.)

capitalize To include in the cost of an asset. For example, the interest incurred by a company when it constructs its own building is a dded to the cost of the building's components. This is referre

d to as capitalizing the interest, or capitalization of intere st. carrying amount Also referred to as book value; the cost of an asset minus the accumulated depreciation since the asset was acquired. This n et amount is not an indication of the asset's fair market valu e. cash A current asset account which includes currency, coins, checki ng accounts, and undeposited checks received from customers. T he amounts must be unrestricted. (Restricted cash should be re corded in a different account.) cash account The general ledger account Cash that reports currency, coins, undeposited checks, and the checking accounts of a company. (C ould also be a reference to a customer required to pay cash fo r purchases.) cash and cash equivalents A balance sheet heading or grouping that includes both cash an d those marketable assets that are very close to their maturit y dates. cash basis of accounting An accounting method wherein revenues are recognized when cash is received and expenses are recognized when paid. This metho d is inferior to the accrual basis of accounting where revenue s are recognized when they are earned and expenses are matched to revenues or the accounting period when they are incurred ( rather than paid). The cash basis of accounting is usually fol lowed by individuals and small companies, but is not in compli ance with accounting's matching principle. cash receipt The collection of money (currency, coins, checks). Not to be c onfused with revenues. chief executive officer (CEO) Usually the top ranking officer of the corporation who is char ged with executing the policies set by the board of directors. chief financial officer (CFO) The top ranking financial person in the corporation. comparability A quality of accounting information that facilitates the compa rison of financial reporting of one company to the financial r eporting of another company

compound interest Interest on interest. For example, if $1,000 is deposited in a n account earning interest of 6% per year the account will ear n $60 in the first year. In year two the account balance will earn $63.60 (not $60.00) because 6% interest is earned on $1,0 60. Similarly the bank paying the interest will incur interest on interest. compound journal entry A journal entry with more than the minimum of one debit and on e credit. Example: a debit to Cash of $500 and a credit to Sal es of $475 and a credit to Sales Tax Payable of $25. comprehensive income This is the total of the net income plus a few items that affe ct the owner's equity but are not reported on the income state ment. Two examples are unrealized gains and losses on some inv estments, and unrealized gains and losses involving foreign cu rrency. consistency A quality of accounting information that facilitates comparing a company's reporting of one accounting period to another. Fo r example, the reader of a company's financial statements can assume that the company is using the same inventory cost flow assumption this period as it used last period or last year. (I f the company did change, it must be disclosed to the reader.) consolidated financial statements Financial statements that reflect the total economic entity. F or example, on a consolidated income statement a corporation h aving several subsidiaries would report the total of all of it s companies' sales that were made to customers outside of its group. (Sales to companies within its group of related compani es would be excluded as well as the purchases within its group .) A consolidated balance sheet would report the combined asse ts except for claims against companies within its group. Liabi lities would be combined except for amounts owed to companies within its group. contingent liability A potential liability dependent upon some future event occurri ng or not occurring. For example, a company is named as a defe ndent in a $1 million lawsuit. Does that mean the company auto matically has a liability of $1million? What if the lawsuit ha s no merit and can easily be defended? If it is probable that the company will lose and the amount can be estimated, a journ al entry is prepared to debit Loss from Lawsuit and to credit Lawsuit Payable. If it is possible but not probable that the c

ompany will lose, the journal entry is not made but instead th ere will be a footnote disclosure. If the lawsuit is remote (a nuisance suit without any merit), there is no need for a jour nal entry and no need to disclose the lawsuit. Accountants usu ally consider product warranties to be a contingent liability that is both probable and can be estimated and is therefore re corded with a journal entry. control account A general ledger account containing the correct total amount w ithout containing the details. For example, Accounts Receivabl e could be a control account in the general ledger. Each day t he total of the day's credit sales and the day's collections a re posted to this account. However, the details involving spec ific customers' accounts will be found in a subsidiary ledger. copyright An exclusive right granted by the federal government to publis h and sell various works. In accounting a copyright is recorde d at its cost and is reported on the balance sheet as an intan gible asset. corporation A legal entity organized under state laws that is considered s eparate from its owners. Ownership is evidenced by shares of s tock. In Pakistan the common name is Company. correcting entry A journal entry to correct an erroneous amount previously ente red in the general ledger. cost In accounting, cost is defined as the cash amount (or the cash equivalent) given up for an asset. Cost includes all costs ne cessary to get an asset in place and ready for use. For exampl e, the cost of an item in inventory also includes the item's f reight-in cost. The cost of land includes all costs to get the land ready for its use. cost of goods purchased For a merchandiser this is the cost of merchandise purchased a fter deducting purchase returns, purchase allowances, and purc hase discounts but after adding freight-in. cost principle The accounting guideline requiring amounts in the accounts and on the financial statements to be the actual cost rather than the current value. Accountants can show an amount less than c ost due to conservatism, but accountants are generally prohibi ted from showing amounts greater than cost. (Certain investmen ts will be shown at fair value instead of cost.)

credit (as in debit and credit) To enter an amount on the right side of an account. Normal ent ries to revenue accounts are credits. Liabilities normally hav e credit balances. credit (as in debt, not cash) Allowing a person or company to purchase goods or services wit hout paying cash at the time of purchase. credit balances A balance on the right side (credit side) of an account in the general ledger. credit sales Sales made on account. Sales where the customer is allowed to pay at a later date. Noncash sales. credit terms The terms which indicate when payment is due for sales made on account (or credit). For example, the credit terms might be 2 /10, net 30. This means the amount is due in 30 days; however, if the amount is paid in 10 days a discount of 2% will be per mitted. Other terms might be net 10 days, due upon reciept, ne t 60 days, etc. creditor Someone who has granted credit. If a bank lends a company mone y, the bank is a creditor. If a supplier sold merchandise to a company on credit, the supplier is a creditor. current assets Cash and other resources that are expected to turn to cash or to be used up within one year of the balance sheet date. (If a company's operating cycle is longer than one year, an item is a current asset if it will turn to cash or be used up within the operating cycle.) Current assets are presented in the orde r of liquidity, i.e., cash, temporary investments, accounts re ceivable, inventory, supplies, prepaid insurance.

current liabilities Obligations due within one year of the balance sheet date. (If a company's operating cycle is longer than one year, an item is a current liability if it is due within the operating cycle .) Another condition is that the item will use cash or it will create another current liability. (This means that if a bond payable is due within one year of the balance sheet date, but the bond will be retired by a bond sinking fund (a long term r

estricted asset) the bond will not be reported as a current li ability.) current maturity of long-term debt or current portion of long-term debt The principal portion of an obligation that must be paid withi n one year of the balance sheet date. For example, if a compan y has a bank loan of $50,000 that requires monthly interest an d principal payments, the next 12 monthly principal payments i s the current portion of the long-term debt. That amount is re ported as a current liability and the remaining principal amou nt is reported as a long-term liability. current value The present fair market value. customer deposits (Advance from customers) A liability account on the books of a company receiving cash i n advance of delivering goods or services to the customer. The entry on the books of the company at the time the money is re ceived in advance is a debit to Cash and a credit to this acco unt. days' sales in inventory This indicates (on average) how many days of merchandise sales are in inventory. debit The accounting term that means an entry will be made on the le ft side of an account. debit balance A balance on the left side of an account in the general ledger . Typically expenses, losses, and assets have debit balances. debtor The person that owes money. If a bank lent you money, the bank is the creditor and you are the debtor. However generally deb tors or sundry debtors means trade accounts receivebles. deferred expense A cost that has been recorded in the accounting records and re ported on the balance sheet as an asset until matched with rev enues on the income statement in a later accounting period. deferred revenues A balance sheet liability account that reports amounts receive d in advance of being earned. For example, if a company receiv es $10,000 today to perform services in the next accounting pe riod, the $10,000 is unearned in this accounting period. It is

deferred to the next accounting period by crediting a liabili ty account such as Unearned Revenues. Next period (when it is earned) a journal entry will be made to debit the liability ac count and to credit a revenue account. deficit This term is used in place of retained earnings when the balan ce in the retained earnings account is negative (a debit balan ce). delivery expense This account shows the amount of delivery expense incurred (oc curring) during the accounting period shown in the heading of the income statement. The title of this account could also be Freight Out or Transportation Out. demand deposits This term refers to checking account balances. On a bank's bal ance sheet, demand deposits are reported as current liabilitie s. depletion The systematic allocation of the cost of a natural resource fr om the balance sheet to the income statement. depreciable cost The amount of an asset's cost that will be depreciated. It is the cost minus the expected salvage value. For example, if equ ipment has a cost of $30,000 but is expected to have a salvage value of $3,000 then the depreciable cost is $27,000. depreciation The systematic allocation of the cost of an asset from the bal ance sheet to Depreciation Expense on the income statement ove r the useful life of the asset. (The depreciation journal entr y includes a debit to Depreciation Expense and a credit to Acc umulated Depreciation, a contra asset account). The purpose is to allocate the cost to expense in order to comply with the m atching principle. It is not intended to be a valuation proces s. In other words, the amount allocated to expense is not indi cative of the economic value being consumed. Similarly, the am ount not yet allocated is not an indication of its current mar ket value. depreciation expense The income statement account which contains a portion of the c ost of plant and equipment that is being matched to the time i nterval shown in the heading of the income statement. (There i s no depreciation expense for land.) disposal of fixed assets The sale, retirement, or exchange of property, plant and equipm

ent. dividend A distribution of part of a corporation's past profits to its stockholders. A dividend is not an expense on the corporation' s income statement. dividend payment date The date a corporation pays a dividend to its shareholders. On this date the accounting entry will be a debit to Dividends P ayable and a credit to Cash. dividends payable A current liability account that reports the amounts of cash d ividends that have been declared by the board of directors but not yet distributed to the stockholders. double entry accounting The 500 year-old accounting system where every transaction is recorded into at least two accounts. drawing account The contra owner's equity account that reports the amount of w ithdrawals of business cash or other assets by the owner for p ersonal use during the current accounting year. At the end of the accounting year, the balance in the drawing account is tra nsferred (closed) to the owner's capital account. earned Under accrual accounting an item has been "earned" and is repo rted as revenue when a service has been performed or the owner ship to a product has been transferred from the seller to the buyer (not when cash is received). economic entity assumption (separate entity concept) An accounting principle/guideline that allows the accountant t o keep the sole proprietor's business transactions separate fr om the owner's personal transactions even though a sole propri etorship is not legally separate for the owner. economic life Also referred to as the useful life. This differs from the phy sical life of an asset. For example, a computer may have a phy sical life of 50 years, but its economic or useful life might be five years. employee fringe benefits Benefits given to employees that are in addition to wages and salaries. Examples include health, dental, life, vision, and d isability insurances, employer's portion of social security an d Medicare tax, paid absences (sick days, holidays, vacation d

ays), pension or retirement contributions, unemployment tax, w orker compensation insurance, profit sharing, and other benefi ts. equipment Equipment is a noncurrent or long-term asset account which rep orts the cost of the equipment. Equipment will be depreciated over its useful life by debiting the income statement account Depreciation Expense and crediting the balance sheet account A ccumulated Depreciation (a contra asset account). estimates Approximate amounts. Accountants use estimates for depreciatio n expense, warranty expense, bad debt expense, monthly accrual s for utilities, bonuses, income taxes, etc. exdividend The day after the record date for a cash dividend on shares of stock. Theoretically, the market price of the stock should dr op on this day by the amount of the dividend. expenditure A payment. The expenditure might be for a significant long ter m asset (capital expenditure), a short term asset (prepaid ins urance), a reduction in a liability, or for an immediate expen se such as rent.

expenses Costs that are matched with revenues on the income statement. For example, Cost of Goods Sold is an expense caused by Sales. Insurance Expense, Wages Expense, Advertising Expense, Intere st Expense are expenses matched with the period of time in the heading of the income statement. Under the accrual basis of a ccounting, the matching is NOT based on the date that the expe nses are paid. expired Costs that have been used up or consumed. Expired costs are re ported as expenses. (Costs that have not yet expired are repor ted as assets.) fees earned An income statement account that reports the amount of service revenues earned during the time interval indicated in the hea ding of the income statement. (Under the accrual basis of acco unting, fees earned are reported in the time period in which t hey are earned and not in the period in which the company rece ives payment.) financial accounting

Refers to the accounting associated with the preparation of th e main financial statements: income statement, balance sheet, statement of cash flows, statement of retained earnings, state ment of shareholders' equity. financial statements Usually financial statements refer to the balance sheet, incom e statement, statement of cash flows, statement of retained ea rnings, and statement of stockholders' equity. The balance sheet reports information as of a date (a point in time). The income statement, statement of cash flows, stateme nt of retained earnings, and the statement of stockholders' eq uity report information for a period of time (or time interval ) such as a year, quarter, or month. freight-in The shipping cost to be paid by the buyer of merchandise purch ased when the terms are fob shipping point. Freight-in is cons idered to be part of the cost of the merchandise and should be included in inventory if the merchandise has not been sold. freight-out Delivery expense to be paid by the seller when its merchandise is sold with terms of fob destination. This is an operating e xpense and is not included in the cost of merchandise. gain on sale of assets This is a non-operating or "other" item resulting from the sal e of an asset (other than inventory) for more than the amount shown in the company's accounting records. The gain is the dif ference between the proceeds from the sale and the carrying am ount shown on the company's books. general journal A book of original entry that requires that both the account b eing debited and the account being credited be listed along wi th the respective amounts. Because of accounting software and special journals there are relatively few entries made into th e general journal.

general ledger That part of the accounting system which contains the balance sheet and income statement accounts used for recording transac tions. general ledger account An account in the general ledger, such as Cash, Accounts Payab le, Sales, Advertising Expense, etc.

generally accepted accounting principles (GAAP) The general guidelines and principles, standards and detailed rules, plus industry practices that exist for financial report ing. Often referred to by its acronymn GAAP. going concern assumption An accounting guideline which allows the readers of financial statements to assume that the company will continue on long en ough to carry out its objectives and commitments. In other wor ds, the accountants believe that the company will not liquidat e in the near future. This assumption also provides some justi fication for accountants to follow the cost principle. goodwill Goodwill is a long-term asset categorized as an intangible ass et. Goodwill arises when a company acquires another entire bus iness. The amount of goodwill is the cost to purchase the busi ness minus the fair market value of the tangible assets, the i ntangible assets that can be identified, and the liabilities o btained in the purchase. The amount in the Goodwill account wi ll be adjusted to a smaller amount if there is an impairment i n the value of the acquired company as of a balance sheet date . gross The amount before deductions. For example, gross pay is the am ount before withholding deductions. Gross sales is the amount before sales returns and allowances and sales discounts. gross profit Net sales revenues minus the cost of goods sold. historical cost The original cost incurred to acquire an asset. (As opposed to replacement cost, current cost, or cost adjusted by a general price index.) If a company purchased land in 1940 for $1,000 and continues to hold that land, the company's balance sheet i n the year 2004 will report the land at $1,000 (even if the la nd is now worth $1 million). income statement One of the main financial statements (along with the balance s heet, the statement of cash flows, and the statement of stockh olders' equity). The income statement is also referred to as t he profit and loss statement, P&L, statement of income, and th e statement of operations. The income statement reports the re venues, gains, expenses, losses, net income and other totals f or the period of time shown in the heading of the statement. income statement account Revenues, Expenses, Gains, and Losses are the categories or cl assification of income statement accounts.

incurred A word used by accountants to communicate that an expense has occurred and needs to be recognized on the income statement ev en though no payment was made. The second part of the necessar y entry will be a credit to a liability account. insolvent The inability to pay liabilities as they become due. Some cons ider a company to be insolvent when its current liabilities ex ceed its current assets. insurance expense The amount of insurance that was incurred/used up/expired duri ng the period of time appearing in the heading of the income s tatement. The amount of insurance premiums that have not yet e xpired should be reported in the current asset account Prepaid Insurance. intangible assets Some examples of intangible assets include copyrights, patents , goodwill, trade names, trademarks, mail lists, etc. These as sets will be reported at cost (or lower) on the balance sheet after property, plant and equipment. Trade names and trademark s that were developed by a company (as opposed to buying them from another company at a significant cost) may not appear on the balance sheet, even though they might be a company's most valuable asset. interest payable This current liability account reports the amount of interest the company owes as of the date of the balance sheet. (Future interest is not recorded as a liability.) interim financial statement Financial statements issued between the end of year financial statements. For example, quarterly financial statements are in terim financial statements. inventory A current asset whose ending balance should report the cost of a merchandiser's products awaiting to be sold. The inventory of a manufacturer should report the cost of its raw materials, work in process, and finished goods. The cost of inventory sh ould include all costs necessary to acquire the items and to g et them ready for sale. inventory-finished goods (FG) The products in a manufacturer's inventory that are completed and are awaiting to be sold. You might view this account as co

ntaining the cost of the products in the finished goods wareho use. A manufacturer must disclose in its financial statements the amount of finished goods, work in process, and raw materia ls. inventory-work in process (WIP) That part of a manufacturer's inventory that is in the product ion process and has not yet been completed and transferred to the finished goods inventory. This account contains the cost o f the direct material, direct labor, and factory overhead plac ed into the products on the factory floor. A manufacturer must disclose in its financial statements the cost of its work in process as well as the cost of finished goods and materials on hand.

journal The record of journal entries appearing in order by date. Some refer to the journal as the book of original entry, since the entries are first recorded in a journal. From the journal the entries will be posted to the designated accounts in the gene ral ledger. journal entry The entry made in a journal. It will contain the date, the acc ount name and amount to be debited, and the account name and a mount to be credited. Each journal entry must have the dollars of debits equal to the dollars of credits. ledger A "book" containing accounts. For example, there is the genera l ledger that contains the balance sheet and income statement accounts. liabilities Obligations of a company or organization. Amounts owed to lend ers and suppliers. Liabilities often have the word "payable" i n the account title. Liabilities also include amounts received in advance for a future sale or for a future service to be pe rformed. liquidity The ability to generate cash. long term assets Noncurrent assets. Assets that are not intended to be turned i nto cash or be consumed within one year of the balance sheet d ate. Long term assets include long term investments, property, plant, equipment, intangible assets, etc. long term liabilities

Obligations of the enterprise that are not payable within one year of the balance sheet date. Two examples are bonds payable and long term notes payable. loss The result of the sale of an asset for less than its carrying amount; the write-down of assets; the net result of expenses e xceeding revenues. loss on sale of assets This is a non-operating or "other" item resulting from the sal e of an asset (other than inventory) for less than the amount shown in the company's accounting records. Management or managerial accounting The field of study within accounting that is devoted to inform ation needed by the management of the company (as opposed to f inancial accounting to external parties). Topics covered in ma nagerial accounting include cost behavior, product costing for manufacturers, budgeting, amounts needed for decision making, transfer pricing, capital budgeting, etc.

matching principle The principle that requires a company to match expenses with r elated revenues in order to report a company's profitability d uring a specified time interval. Ideally, the matching is base d on a cause and effect relationship: sales causes the cost of goods sold expense and the sales commissions expense. If no c ause and effect relationship exists, accountants will show an expense in the accounting period when a cost is used up or has expired. Lastly, if a cost cannot be linked to revenues or to an accounting period, the expense will be recorded immediatel y. An example of this is Advertising Expense and Research and Development Expense. materiality The accounting guideline that permits the violation of another accounting guideline if the amount is insignificant. For exam ple, a profitable company with several million dollars of sale s is likely to expense immediately a $200 printer instead of d epreciating the printer over its useful life. The justificatio n is that no lender or investor will be misled by a one-time e xpense of $200 instead of say $40 per year for five years. Ano ther example is a large company's reporting of financial state ment amounts in thousands of dollars instead of amounts to the

penny. materials inventory One component of a manufacturer's inventory. Sometimes referre d to as Stores or Raw Materials. (Other components of a manufa cturer's inventory are work in process and finished goods.) merchandise inventory The current asset which reports the cost of a retailer's, whol esaler's, or distributor's goods purchased to be resold, which have not yet been sold as of the balance sheet date. MIS Management information system. miscellaneous expense An income statement account for expense items that are too ins ignificant to have their own separate general ledger accounts. natural resources Long term assets of a company such as minerals, oil reserves, timberland, stone quarries, etc. The term depletion is associa ted with natural resources. net The result of two or more amounts being combined. For example, net sales is equal to gross sales minus sales returns, sales allowances, and sales discounts. The net realizable value of a ccounts receivable is the combination of the debit balance in accounts receivable and the credit balance in the allowance fo r doubtful accounts. The book value of equipment is also a net amount: the cost of the equipment minus the accumulated depre ciation of the equipment. net assets Generally this refers to total amount of assets minus the tota l amount of liabilities; similar to owner's equity or stockhol ders'equity.

net carrying amount This term might be used to express the combined balances of tw o accounts. For example, if Equipment has a debit balance of $ 300,000 and the account Accumulated Depreciation - Equipment h as a credit balance of $130,000, we might say that the equipme nt has a net carrying amount of $170,000. net current assets Current assets minus current liabilities. Also called working

capital. net income This is the bottom line of the income statement. It is the mat hematical result of revenues and gains minus the cost of goods sold and all expenses and losses (including income tax expens e if the company is a regular corporation) provided the result is a positive amount. If the net amount is a negative amount, it is referred to as a net loss. net loss The bottom line of the income statement when revenues and gain s are less than the aggregate amount of cost of goods sold, op erating expenses, losses, and income taxes (if the company is a regular corporation). noncash expense An expense reported on the income statement that did not requi re the use of cash during the period shown in the heading of t he income statement. The typical example is depreciation expen se. Also, the write-down of an asset's carrying amount will re sult in a noncash charge against earnings. normal account balance The debit or credit balance that would be expected in a specif ic account in the general ledger. For example, asset accounts and expense accounts normally have debit balances. Revenues, l iabilities, and stockholders' equity accounts normally have cr edit balances. notes to financial statements Also referred to as footnotes. These provide additional inform ation pertaining to a company's operations and financial posit ion and are considered to be an integral part of the financial statements. The notes are required by the full disclosure pri nciple. objectivity Fair, unbiased, and objective; not subjective. on account On credit; not for cash. operating expenses Operating expenses consist of selling and administrative expen ses. Operating expenses are deducted from gross profit to arri ve at income from operations. operating income A company's profit before nonoperating items such as interest income, interest expense, and gains and losses on sale of asse ts used in the business, loss on lawsuit, etc.

owner's capital account The account in which the owner's investment is recorded plus t he net income earned by the company minus the draws made by th e owner. Current year net income and draws will be in temporar y accounts until the end of the year. owner's drawing account The contra owner's equity account used to record the current y ear's withdrawals of business assets by the sole proprietor fo r personal use. This is a temporary account with a debit balan ce. It will be closed at the end of the year to the owner's ca pital account. owner's ( stockholders' ) equity The book value of a company equal to the recorded amounts of a ssets minus the recorded amounts of liabilities. P & L The abbreviation for profit and loss statement. Also known as the income statement. Pacioli An Italian monk associated with debits, credits, and double-en try accounting approximately 500 years ago. payable In accounting this word is often included in the title of liab ility accounts. It means the amount owed by a company as of th e balance sheet date, even if the company did not yet receive an invoice from the supplier. For example, the electric utilit y furnishes electricity for the month of January, but does not read the meter until February 1 and sends the invoice or bill on February 4. The company pays the bill on March 1. The elec tricity used in January is a payable or obligation on January 31. payee The person or organization to whom a check is written or the a mount given. petty cash A current asset account that represents an amount of cash for making small disbursements such as postage due and reimburseme nts for small amounts of supplies. postdated check A check bearing a date in the future. The company receiving su ch a check should not report the check as cash until the date

of the check. posting Recording an entry in an account in the general ledger or in a subsidiary ledger. prepaid expense A current asset representing amounts paid in advance for futur e expenses. As the expenses are used or expire, expense is inc reased and prepaid expense is decreased.

prepaid insurance A current asset which indicates the cost of the insurance cont ract (premiums) that have been paid in advance. It represents the amount that has been paid but has not yet expired as of th e balance sheet date. A related account is Insurance Expense, which appears on the i ncome statement. The amount in the Insurance Expense account s hould report the amount of insurance expense expiring during t he period indicated in the heading of the income statement. prepaid rent A current asset account that reports the amount of future rent expense that was paid in advance of the rental period. The am ount reported on the balance sheet is the amount that has not yet been used or expired as of the balance sheet date. procurement Another word for purchasing. pro forma financial statement Financial statements based upon various assumptions. proprietor An individual owner of a business that is not incorporated. purchases A temporary account used in the periodic inventory system to r ecord the purchases of merchandise for resale. (Purchases of e quipment or supplies should not get recorded in the purchases account.) This account reports the gross amount of purchases o f merchandise. Net purchases is the amount of purchases minus purchase returns, purchase allowances, and purchase discounts.

receipts Cash received. Receipts is different from revenue. relevance A qualitative characteristic in accounting. Relevance is assoc iated with information that is timely, useful, has predictive value, and is going to make a difference to a decision maker. reliability A qualitative characteristic in accounting. Is achieved when i nformation is verifiable, objective (not subjective) and you c an depend on it. repairs Operating expenses made to return an asset to its previous con dition (rather than to make the asset more than it was origina lly). The amount is charged to an account such as Repairs and Maintenance Expense in the period when the repair is made. repairs and maintenance expense The costs incurred to bring an asset back to an earlier condit ion or to keep the asset operating at its present condition (a s opposed to improving the asset). For example, if a company t ruck is damaged, the cost to repair the damage is immediately debited to repairs and maintenance expense. Routine maintenanc e such as engine tune-ups, oil changes, radiator flushing, etc . is also debited to repairs and maintenance expense. residual value The remainder or difference. In depreciation the residual valu e is the estimated scrap or salvage value at the end of the as set's useful life. In the accounting equation, owner's equity is considered to be the residual of assets minus liabilities. In investment evaluations, the residual value is the profit mi nus the cost of capital. restricted cash Cash that can be used only for the purpose intended. retained earnings A stockholders' equity account that reports the net income of a corporation from its inception until the balance sheet date less the dividends declared from its inception to the date of the balance sheet. retirement of assets Usually means to scrap a long-term plant asset and receive no proceeds from its disposal. returned check

A check that is not paid by the bank on which it is written (d rawn). Often the reason for a check not to be paid is the acco unt on which the check was drawn did not have a sufficient bal ance. In that case the check is returned as "NSF" or not suffi cient funds. A check could also be returned unpaid because the account was closed or due to a stop payment order requested b y the maker of the check. revenues Fees earned from providing services and the amounts of merchan dise sold. Under the accrual basis of accounting, revenues are recorded at the time of delivering the service or the merchan dise, even if cash is not received at the time of delivery. Of ten the term income is used instead of revenues. Examples of revenue accounts include: Sales, Service Revenues, Fees Earned, Interest Revenue, Interest Income. Revenue accou nts are credited when services are performed/billed and theref ore will usually have credit balances. At the time that a reve nue account is credited, the account debited might be Cash, Ac counts Receivable, or Unearned Revenue depending if cash was r eceived at the time of the service, if the customer was billed at the time of the service and will pay later, or if the cust omer had paid in advance of the service being performed. If the revenues earned are a main activity of the business, th ey are considered to be operating revenues. If the revenues co me from a secondary activity, they are considered to be nonope rating revenues. For example, interest earned by a manufacture r on its investments is a nonoperating revenue. Interest earne d by a bank is considered to be part of operating revenues. salaries expense Under the accrual method of accounting, the account Salaries E xpense reports the salaries that employees have earned during the period indicated in the heading of the income statement, w hether or not the company has yet paid the employees. Salaries Expense will usually be an operating expense (as opposed to a nonoperating expense). Depending on the function performed by the salaried employee, Salaries Expense could be classified a s an administrative expense or as a selling expense. If the em ployee was part of the manufacturing process, the salary would end up being part of the cost of the products that were manuf actured. salaries payable The current liability account which reports the amount of sala ries earned by a company's employees, but which have not yet b een paid by the company. salary The compensation usually associated with executives, managers,

professionals, office employees, etc. whose pay is stated on an annual or on a monthly basis. (On the other hand, "wages" i s usually associated with employees whose pay is stated on an hourly basis.) sales A revenue account that reports the sales of merchandise. Sales are reported in the accounting period in which title to the m erchandise was transferred from the seller to the buyer. sales returns Merchandise that was returned to the seller by a customer. Thi s account is a contra sales account. When merchandise sold on credit is returned, this account is debited and Accounts Recei vable is credited. salvage value of fixed assets The estimated scrap value at the end of the useful life of an asset used in the business. It is also referred to as residual value. simple journal entry An accounting entry with only one account being debited and on ly one account being credited. sole proprietorship A simple form of business where there is one owner. Legally th e owner and the sole proprietorship are the same. However, for accounting purposes the economic entity assumption results in the sole proprietorship's business transactions being account ed for separately from the owner's personal transactions. statement of cash flows One of the main financial statements (along with the income st atement and balance sheet). The statement of cash flows report s the sources and uses of cash by operating activities, invest ing activities, financing activities, and certain supplemental information for the period specified in the heading of the st atement. statement of financial position Also called balance sheet stockholder Also referred to as a shareholder. The owner of shares of stoc k in a corporation. Every corporation has common stock and tho se owners are known as common stockholders. Some corporations also issued preferred stock and those corporations will have b oth common stockholders and preferred stockholders. stockholders' equity Also referred to as shareholders' equity. At a corporation it

is the residual or difference of assets minus liabilities. straight-line method of depreciation The depreciation method that results in the same equal amount of depreciation expense for each full year over the life of th e asset. T-account A visual aid used by accountants to illustrate a journal entry 's effect on the general ledger accounts. Debit amounts are en tered on the left side of the "T" and credit amounts are enter ed on the right side. taxes payable A liability account that reports the amount of taxes that a co mpany owes as of the balance sheet date. telephone expense The cost of telephone service that was used during the period shown on the income statement. temporary investments A current asset account which contains the amount of investmen ts that can and will be sold in the near future. time period assumption Also known as the periodicity assumption. The accounting guide line that allows the accountant to divide up the complex, ongo ing activities of a business into periods of a year, quarter, month, week, etc. The precise time period covered is included in the heading of the income statement, statement of cash flow s, and the statement of stockholders' equity. time value of money The recognition that a dollar in the present is more valuable than a dollar in the future. trade accounts receivable Receivables due from customers. trademark An intangible asset that is reported at cost (or lower) on the balance sheet. It might consist of a name or a logo. Trademar ks should be registered with the registrar of trade marks. trade payables Payables arising from the purchase of merchandise inventory. trial balance A listing of the accounts in the general ledger along with eac h account's balance in the appropriate debit or credit column. The total of the amounts in the debit column should equal the

total of the amounts in the credit column. unappropriated retained earnings The regular retained earnings.

unearned revenue(s) A liability account that reports amounts received in advance o f providing goods or services. When the goods or services are provided, this account balance is decreased and a revenue acco unt is increased. unqualified opinion A "clean" auditor's report. That is, the auditor has concluded that the financial statements present fairly the results of t he company's operations and its financial position according t o generally accepted accounting principles. useful life This is the period of time that it will be economically feasib le to use an asset. Useful life is used in computing depreciat ion on an asset, instead of using the physical life. For examp le, a computer might physically last for 100 years; however, t he computer might be useful for only three years due to techno logy enhancements that are occurring. As a consequence, for fi nancial statement purposes the computer will be depreciated ov er three years. valuation To determine what something is worth. vehicles A long-term asset account that reports company's cost of autom obiles, trucks, etc. The account is reported under the balance sheet classification property, plant, and equipment. Vehicles are depreciated over their useful lives. vendors Suppliers. Companies that provide goods or services. wages The compensation earned by employees who are paid on an hourly or daily basis. It is common for production workers to earn w ages, since they are usually paid via an hourly or daily rate. wages expense The compensation earned by hourly-paid employees during the in terval of time indicated in the heading of the income statemen t. Under the accrual basis of accounting, the date that wages are paid does not determine when the wages are reported as an

expense. white-collar worker A term often used when referring to office workers, managers, professionals, and executives. These employees' pay is often s tated as a salary for a month (and not as an hourly pay rate). withdrawals by owner Also referred to as draws. These are a reduction of owner's eq uity, but are not a business expense and they do not appear on the sole proprietorship's income statement. working capital Current assets minus current liabilities.

Shared By: