Accounting for Managers

Course Outline

Class ONE Why we should Accountancy

Teaching contents:

Accounting as a language and Information system History of Accountancy Brief introduction to accounting process

Teaching Objectives:

After the class, Students should be able –

To understand the importance of accountancy in their life. To distinguish different types of financial statements as per their role in day to day life

Class TWO Why Accountancy is an Art and Science

Teaching contents:

Accountancy is an Art and Science Types of Accounts Principles, Concepts and Conventions of Accounting

Teaching Objectives:

After the class, Students should be able –

To distinguish different types of accounts. To identify the concepts, conventions and principles for given a transaction.

Class THREE ACCOUNTAHOLIC

Teaching contents:

Users of accounting information Accounting process – Brief introduction to Vouchers, Journal , Ledgers

Teaching Objectives:

After the class, Students should be able –

To understand the process of accountancy – limited to vouchers, journal and ledgers. To identify various users of accounting information.

Class FOUR Accounting Cycle continues Page | 1

Teaching contents:

Brief discussion on Trial balance, revised trial balance, Income statement and Balance sheet

After the class, Students should be able –

To understand importance of Trial balance, Revised Trial balance, Balance sheet.

Class FIVE Costs and Blood pressure

Teaching contents:

Cost , Costing and Cost Accounting Brief Introduction to Cost reduction and Cost control

Teaching Objectives:

After the class, Students should be able –

To understand the role of cost accounting. To understand the difference between cost reduction and cost control.

Class SIX Road to IFRS

Teaching Contents:

Difference between GAAPs Recent developments in accountancy – convergence to IFRS. Brief introduction to the Software available for accounting information and its role. Basics of Finance – Trading, How Stock prices are decided etc.

Teaching Objectives:

Students would be able to understand the role of GAAP as an accounting information system

Students should be able to understand how stock markets work.

Instructors:

1. Ms. Bansi Patel2. Mr. Tejas Modi

Accounting for ManagersPage | 2

IndexSr. No.

Particulars Page No.

1 Accounting History 32 Meaning of Accounting 43 Accounting Process 54 Branches of Accounting 75 Accounting Principles, Concepts and Conventions 86 Rules of Accounts 167 Financial Statements 188 GAAP (Generally Accepted Accounting Principles) 199 Indian GAAP Vs. US GAAP 19

10 Introduction to Cost Accounting 2511 Introduction to stocks and trading mechanics12 Important Links 32

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Accounting for Managers

A brief accounting history - from 1494 to the present day 1

History of accounting - Pacioli

Accounting history can be traced back to a book called Summa de arithmetica, geometria, proportioni et proportionalita, written by the Italian mathematician, Luca Pacioli, in A.D. 1494.

Today, this book is regarded as an important document in accounting history: it included the first printed work on algebra and also recorded for the very first time the system of the double-entry accounting system that became popular with Italian merchants during the Renaissance.

The book also included illustrations and diagrams drawn by Pacioli's friend, Leonardo Da Vinci.

In this book, Luca Pacioli described the use of journals and ledgers, and warned that a merchant should not rest until the debits equalled the credits! His ledger had accounts for assets, liabilities, capital, income and expenses. He also demonstrated year-end closing entries and proposed a trial balance be used to prove a balanced ledger.

Summa de arithmetica, geometria, proportioni et proportionalita were best-selling books, published across large parts of Europe, and became the basis for bookkeeping as we know it today. Even today, the double-entry accounting method is used today to record entries in both the Profit and Loss register and the Balance Sheet.

Meaning of Accounting 2

The short-but-sweet description of accounting is "the language of business." A more formal definition is offered by The American Accounting Association: "The process of identifying, measuring and communicating economic information to permit informed judgments and decisions by users of the information."

Why Accounting is considered as a Language of Business3

For a business to properly function, effective methods of communication among owners, managers and investors are essential. Accounting fills the need for a common language of business. It records and processes financial information into an easily accessible format that can be understood by any person in the business world.

Basics of AccountingThere are two main branches of accounting that businesses engage in to carry out business functions: managerial and financial. Managerial accounting is used to compile reports on 1 Retrieved from: http://www.investopedia.com/university/accounting/accounting1.asp#ixzz4DoiDEOYx, https://www.sgucto.sk/home/images/history%20of%20accounting.pdf2 http://www.investopedia.com/university/accounting/#ixzz4E4iv4SV53 http://smallbusiness.chron.com/accounting-referred-language-business-63107.html

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company activities within the organization for managers, while financial accounting is used to processes information and prepare it for external parties such as investors and shareholders. In essence, accounting serves to record and organize all the financial transactions of an organization.

Applications of Accounting in BusinessAccounting is critical for the effective management of a business, as it allows the quantification of business processes and transactions. By quantifying this information, businesses are able to set and create goals for the company to achieve. This function is necessary, as without a method of measuring such data, businesses would be unable to determine whether their operations are profitable or whether organizational goals are being met. With such information, managers are able to make decisions based on the financial indicators and adjust business processes to reflect this data.

Accounting as a Means of CommunicationAccounting allows various departments within an organization to effectively communicate among each other, as well as with external parties. By transforming raw financial data into a format that indicates an organization's financial performance in a number of areas, managers are able to determine whether the business is operating properly and develop plans of action if the business is not meeting company goals. Through this language and format, departments are able to coordinate their efforts and cohesively act as an organization.

Accounting and StandardizationAccounting standardizes the means of communication among both internal and external parties within the business world. As all businesses conform to standardized accounting practices, investors, shareholders and other external parties are able to easily evaluate business activities without specialized knowledge of a firm's accounting practices. This simplifies business transactions, as all parties use the same definitions and methods of calculation to determine their financial indicators.

Accounting Process4

As implied earlier, today's electronic accounting systems tend to obscure the traditional forms of the accounting cycle. Nevertheless, the same basic process that bookkeepers and accountants used to perform by hand are present in today's accounting software. Here are the steps in the accounting cycle:

1. Identify the transaction from source documents, like purchase orders, loan agreements, invoices, etc.

2. Record the transaction as a journal entry.

3. Post the entry in the individual accounts in ledgers. Traditionally, the accounts have been represented as T’s, or so-called T-accounts, with debits on the left and credits on the right.

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4. At the end of the reporting period (usually the end of the month), create a preliminary trial balance of all the accounts by (a) netting all the debits and credits in each account to calculate their balances and (b) totaling all the left-side (i.e. debit) balances and right-side (i.e., credit) balances. The two columns should be equal.

5. Make additional adjusting entries that are not generated through specific source documents. For example, depreciation expense is periodically recorded for items like equipment to account for the use of the asset and the loss of its value over time.

6. Create an adjusted trial balance of the accounts. Once again, the left-side and right-side entries - i.e. debits and credits - must total to the same amount.

7. Combine the sums in the various accounts and present them in financial statements created for both internal and external use.

8. Close the books for the current month by recording the necessary reversing entries to start fresh in the new period (usually the next month).

Nearly all companies create end-of-year financial reports, and a new set of books is begun each year. Depending on the nature of the company and its size, financial reports can be prepared at much more frequent (even daily) intervals. The SEC5 requires public companies to file financial reports on both a quarterly and yearly basis.

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Branches of Accounting6

Financial Accounting

Financial accounting is the periodic reporting of a company's financial position and the results of operations to external parties through financial statements, which ordinarily include the balance sheet (statement of financial condition), income statement (the profit and loss statement, or P&L), and statement of cash flows. A statement of changes in owners' equity is also often prepared. Financial statements are relied upon by suppliers of capital - e.g., shareholders, bondholders and banks - as well as customers, suppliers, government agencies and policymakers.

There's little use in issuing financial statements if each company makes up its own rules about what and how to report. When preparing statements, American companies use U.S. Generally Accepted Accounting Principles, or U.S. GAAP. The primary source of GAAP is the rules published by the FASB and its predecessors; but GAAP also derives from the work done by the SEC and the AICPA, as well standard industry practices.

Management Accounting

Where financial accounting focuses on external users, management accounting emphasizes the preparation and analysis of accounting information within the organization. According to the Institute of Management Accountants, it includes "…designing and evaluating business processes, budgeting and forecasting, implementing and monitoring internal controls, and analyzing, synthesizing and aggregating information…to help drive economic value."

A primary concern of management accounting is the allocation of costs; indeed, much of what now is considered management accounting used to be called cost accounting. Although a seemingly mundane pursuit, how to measure cost is critical, difficult and controversial. In recent years, management accountants have developed new approaches like activity-based costing (ABC) and target costing, but they continue to debate how best to provide and use cost information for management decision-making.

Other Branches such as auditing, Tax accounting, Fund accounting, Forensic accounting are not part of this prep. Course. Cost Accounting is generally branched under Management Accounting.

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Accounting Principles, Concepts and Conventions

Accounting Concepts

a. Separate Entity Conceptb. Going Concern Conceptc. Money Measurement Conceptd. Cost Concepte. Dual Aspect Concept (Duality Concept)f. Periodic Matching of Cost and Revenue Concept (Matching concept)g. Realization Concepth. Accrual Concept

Accounting Conventions

a. Convention of Conservatismb. Convention of Full Disclosurec. Convention of Consistencyd. Convention of Materiality.Let us examine one by one the various concept and conventions and see what they mean

Single Economic Entity Concept/ Business Entity Concept

In separate entity concept the business is treated as a separate entity from the owner event though statutes recognise no such distinct entity. In accounting the concept of separate entity is applicable in the case of all organizations. This concept is very much relevant in the case of sole proprietorship entities and partnerships. In the case of a company it is recognised as a separate entity by statutes as well as from the accounting point of view. The separate entity concept helps to keep the affairs of the business separate from the private affairs of the proprietor.

In other words, the business and the owner of the business are two different entities (I and my business are separate).

For example, Mr. A starts a new business in the name and style of M/s Independent Trading Company and introduced a capital of Rs 200,000 in cash. It means the cash balance of M/s Independent Trading Company will increase by a sum of Rs 200,000/-. At the same time, the liability of M/s Independent Trading Company in the form of capital will also increase. It means M/s Independent Trading Company is liable to pay Rs 200,000 to Mr. A.

Going Concern Concept

Our accounting is based on the assumption that a business unit is a going concern. We record all the financial transaction of a business in keeping this point of view in our mind that a

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business unit is a going concern; not a gone concern. Otherwise, the banker will not provide loans, the supplier will not supply goods or services, the employees will not work properly, and the method of recording the transaction will change altogether.

This concept assumes that the business will continue for a fairly long period of time in future. There is no need of forced sale of the assets of the entity. Otherwise every time the annual financial statements are prepared the probable losses on account of the possible sale of assets should be accounted. This would distort the operating result as revealed by the profit and loss account and the financial position depicted in the balance sheet. On the basis of this principle depreciation is charged on fixed assets on the basis of expected life rather than its market value and intangible assets are amortized over a period of time .The annual financial statements are considered to be interrelated series of statements.

For example, a business unit makes investments in the form of fixed assets and we book only depreciation of the assets in our profit & loss account; not the difference of acquisition cost of assets less net realizable value of the assets. The reason is simple; we assume that we will use these assets and earn profit in the future while using them. Similarly, we treat deferred revenue expenditure and prepaid expenditure. The concept of going concern does not work in the following cases:

1. If a unit is declared sick (unused or unusable unit).2. When a company is going to liquidate and a liquidator is appointed for the same.3. When a business unit is passing through severe financial crisis and going to wind up.

For example, a company purchases a plant and machinery of Rs.100000 and its life span is 10 years. According to this concept every year some amount will be shown as expenses and the balance amount as an asset

Money Measurement Concept

Money is the unit in which economic events affecting a business entity are measured. The money measurement concept implies that accounting could measure and report only those transactions and events which could be measured in terms of money. It cannot account for qualitative aspects like employee relations, competitive market, advantages of the entity over others etc. This concept imposes a restriction on the ability of the financial statements to present a correct picture of the entity as those events which are unable to be quantified in money terms are left out. Further the money as a unit of measurement is not stable. The variations in the value of money fail to present a correct picture of the operating results and financial position of the entity. Over a period of time the value of money fluctuates and even when we are employing the same unit of money the values represented by them are not equal. Thus money as a unit of measurement fails.

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According to this concept, “we can book only those transactions in our accounting record which can be measured in monetary terms.”

Here, if we want to book the value of stock in our accounting record, we need the value of coats and jackets in terms of money. Now if we conclude that the values of coats and jackets are Rs 2,000 and Rs 15,000 respectively, then we can easily book the value of stock as Rs 29,500 (as a result of 5000+7500+2000+15000) in our books. We need to keep quantitative records separately.

Cost Concept (Historical cost concept)

It is a very important concept based on the Going Concern Concept. We book (record) the value of assets on the cost basis, not on the net realizable value or market value of the assets based on the assumption that a business unit is a going concern. No doubt, we reduce the value of assets providing depreciation to assets, but we ignore the market value of the assets.

The cost concept stops any kind of manipulation while taking into account the net realizable value or the market value. On the downside, this concept ignores the effect of inflation in the market, which can sometimes be very steep. Still, the cost concept is widely and universally accepted on the basis of which we do the accounting of a business unit.

Paul Grady has observed the cost concept in the following words.

"Value as used in accounts signifies the amount at which an item is stated in accordance with the accounting principles related to that item. Using the word value in this sense, it may be said that balance sheet values generally represent cost to the accounting unit or some modifications there of; but sometimes they are determined in other ways, as for instance on the basis of market values or cost of replacement, in which cases the basis should be indicated in financial statements. The word value should seldom if ever, be used in accounting statement without a qualifying objective."

For example, a machine was purchased by XYZ Limited for Rs.500000, for manufacturing shoes. An amount of Rs. 1,000 was spent on transporting the machine to the factory site. In addition, Rs. 2000 was spent on its installation. The total amount at which the machine will be recorded in the books of accounts would be the sum of all these items i.e. Rs. 503,000. This cost is also known as historical cost. Suppose the market price of the same is now Rs 90000 it will not be shown at this value.

Dual Aspect Concept (Duality / Double entry system)

The basic equation of accounting is

Assets = Equities Or

Assets = Outsiders' Equity + Owners' Equity Or Assets = Liabilities + Capital

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Every transaction affecting an entity has dual aspect on the accounting records. Both aspects are recorded in the books of accounts. Hence accounting is called ' double entry system'. The two aspects are expressed as 'debit' and 'credit '.In other words ' for every debit there is an equivalent credit'.

The term 'assets' denotes the resources owned by a business while equities denote the claims of various parties against the assets. Equities are two types

i) Owners' Equity and

ii) Outsiders' Equity

Owners' equity otherwise called 'capital' denotes the claims of the owners against the assets of the entity whereas outsiders' equity denotes the claims of creditors, debenture holders, lenders etc. against the assets of the entity.

The dual aspect of transaction may result in change in the assets and equities of the organization and make them equal.

Transaction EffectPurchase of Stock for Rs 25,000 Stock will increase by Rs 25,000 (Increase in

debit balance)

Cash will decrease by Rs 25,000 (Decrease in debit balance)

OR

Creditor will increase by Rs 25,000 (Increase in credit balance)

Accounting Period Concept

The life of a business unit is indefinite as per the going concern concept. To determine the profit or loss of a firm, and to ascertain its financial position, profit & loss accounts and balance sheets are prepared at regular intervals of time, usually at the end of each year. This one-year cycle is known as the accounting period. The purpose of having an accounting period is to take corrective measures keeping in view the past performances, to nullify the effect of seasonal changes, to pay taxes, etc.

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Based on this concept, revenue expenditure and capital expenditure are segregated. Revenues expenditure are debited to the profit & loss account to ascertain correct profit or loss during a particular accounting period. Capital expenditure comes in the category of those expenses, the benefit of which will be utilized in the next coming accounting periods as well.

Accounting period helps us ascertain correct position of the firm at regular intervals of time, i.e., at the end of each accounting period.

Year that begins from 1st of January and ends on 31st of December, is known as Calendar Year. The year that begins from 1st of April and ends on 31st of March of the following year, is known as financial year.

Periodic Matching of Cost and Revenue Concepts (Matching concept)

Matching concept is based on the accounting period concept. One of the objectives of maintaining accounts is to prepare the income statement to ascertain the profit/loss of the entity. The expenditures (Expenses / cost) of a firm for a particular accounting period are to be matched with the revenue of the same accounting period to ascertain accurate profit or loss of the firm for the same period. 'Matching' means the appropriate association of related 'revenues' and 'costs'. Let us take an example to understand the Matching Concept clearly.

The following data is received from M/s Globe Enterprises during the period 01-04-2015 to 31-03-2016:

a. Sale of 1,000 Electric Bulbs @ Rs 10 per bulb on cash basis. b. Sale of 200 Electric Bulb @ Rs. 10 per bulb on credit to M/s Atul Traders. c. Sale of 450 Tube light @ Rs.100 per piece on Cash basis.d. Purchases made from XZY Ltd. – Rs. 40,000e. Cash paid to M/s XYZ Ltd. – Rs. 38,000f. Freight Charges paid on purchases – Rs. 1,500g. Electricity Expenses of shop paid – Rs. 5,000h. Bill for March-13 for Electricity still outstanding to be paid next year – Rs. 1,000

Based on the above data, the profit or loss of the firm is calculated as follows:

Particulars Amount TotalRevenue:Sale

Bulb 12,000.00Tube 45,000.00 57,000.00

Less – ExpensesPurchases 40,000.00Freight Charges 5,000.00

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Electricity Expenses 1,500.00Outstanding Expenses 1,000.00 47,500.00

Net Profit 9,500.00

In the above example, to match expenditures and revenues during the same accounting period, we added the credit purchase as well as the outstanding expenses of this accounting year to ascertain the correct profit for the accounting period 01-04-2015 to 31-03-2016.

It means the collection of cash and payment in cash is ignored while calculating the profit or loss of the year.

Accrual concept

As stated above in the matching concept, the revenue generated in the accounting period is considered and the expenditure related to the accounting period is also considered. Based on the accrual concept of accounting, if we sell some items or we rendered some service, then that becomes our point of revenue generation irrespective of whether we received cash or not. The same concept is applicable in case of expenses. All the expenses paid in cash or payable are considered and the advance payment of expenses, if any, is deducted.

Most of the professionals use cash basis of accounting. It means, the cash received in a particular accounting period and the expenses paid cash in the same accounting period is the basis of their accounting. For them, the income of their firm depends upon the collection of revenue in cash. Similar practice is followed for expenditures. It is convenient for them and on the same basis, they pay their Taxes.

Realization Concept

According to the realization concept 'revenue' should be recognised only when the entity is legally entitled to receive payment. The AICPA has defined revenue as "Revenues results from the sale of goods and the rendering of services and is measured by the charge made to customers, clients or tenants of goods and services furnished to them. It also includes gains from the sale or exchange of assets other than stock in trade, interest and dividend earned on investments and other increase in owner's equity except those arising from capital contribution and capital adjustment .Revenue is sometimes described as operating revenue."

Thus revenue is an inflow of assets resulting from the sale of goods and rendering of services to the customers in the ordinary course of business. For the purpose of preparing the annual financial statements business entities have to recognise revenue. What is revenue recognition? It is the process of identifying the items of revenue receipts, which are to be considered for the matching of costs and revenues. When is revenue recognised? Under accrual system of accounting, revenue is recognised at the time of sale or rendering of services whether cash is

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received or not, provided that at the time of performance it is not unreasonable to expect ultimate collection.

The accounting conventions followed in the preparation of accounting statements are -

Conservatism

The rule of the accountant is 'anticipate no profit but provide for all possible losses' at the time of recording the business transactions and preparation of annual financial statements. The accountant wants to be on the safer side by not taking some profits which may be received but which is not yet received and providing for losses which he thinks may happen but which has not yet happened. This is because he thinks the chances of non-receipt of anticipated profit and the incurring of losses anticipated are higher. If he is very optimistic regarding receipt of profits and non –incurring of losses, the financial statements may present a very rosy picture of the state of affairs of the entity which may not subsequently materialize. So he acts conservatively by not taking anticipated profits and but taking anticipated losses in the preparation of the financial statements.

Because of the convention of conservatism inventory is valued at 'lower of cost or market price and provision is made for bad and doubtful debts out of current year's profits. But reckless application of this convention may lead to creation of 'secret reserves' and the financial statements may fail to disclose a true and fair view of the state of affairs of the business.

For example, If A purchases 1000 items @ Rs 80 per item and sells 900 items out of them @ Rs 100 per item when the market value of stock is (i) Rs 90 and in condition (ii) Rs 70 per item, then the profit from the above transactions can be calculated as follows:

Particulars Condition(i) Condition(ii)Sale Value (A) (900x100) 90,000 90,000Less - Cost of Goods Sold

Purchases 80,000 80,000Less - Closing Stock 8,000 7,000Cost of Goods Sold (B) 72,000 73,000Profit(A-B) 18,000 17,000

In the above example, the method for valuation of stock is ‘Cost or market price whichever is lower’.

The prudence however does not permit creation of hidden reserve by understating the profits or by overstating the losses.

Materiality

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The convention of materiality advocates that the accountant should give importance to transactions and events which are material in the preparation of accounts and presentation of financial statements. He should ignore those items in the recording of transactions and preparation of financial statements, items which are immaterial or not having much bearing in giving a true and fair view of the state of affairs of the entity. It is very difficult to fix a threshold limit in deciding materiality or non-materiality of events. It is left to the discretion and best judgment of the accountant to decide upon the materiality and non-materiality of events. Materiality is dependent on the purpose for which reporting is being done. For example at the time of preparing the annual financial statements the accountant may ignore paise altogether, and may even round of the figures to the nearest 10 rupees without affecting the true and fair view of the statement.

According to Kohler “Materiality is the characteristic attaching to a statement, fact or item whereby its disclosure or method of giving it expression would be likely to influence the judgment of a reasonable person."

Accounting is designed by man with a set of objectives. AICPA has observed "The accounting principles cannot therefore be derived from or proven by the laws of nature." They are rather in the category of conventions or rules developed by man from experience to fulfill the essential and useful needs and purposes, in establishing reliable financial and operating information system to control business activities. In this respect they are similar to principles of commercial and other social disciplines.

For better understanding, please refer to General Instruction for preparation of Statement of Profit and Loss in revised scheduled VI to the Companies Act, 1956:

I. A company shall disclose by way of notes additional information regarding any item of income or expenditure which exceeds 1% of the revenue from operations or Rs 100,000 whichever is higher.

II. A Company shall disclose in Notes to Accounts, share in the company held by each shareholder holding more than 5% share specifying the number of share held.

Consistency

According to the convention of consistency the accounting practices employed should be consistent, that is, applied without change in the coming periods also. In other words the practices should not be changed without sufficient reason. For example if stock is valued on the basis of 'cost or market price whichever is lower' the same method should be employed year after year. If depreciation is charged on straight line method, the same method of computing depreciation should be used thereafter. Consistency of the methods employed should be maintained due to various reasons. First of all it will help the users to make comparative study of financial statements by employing methods of intra-firm and inter-firm comparison.

Again consistency increases the acceptability of the financial statements since the users are averse to frequent changes. Consistency should not be maintained at the cost of accounting development. There should be flexibility in the methods and practices employed. Otherwise it will stifle the growth of accounting thought. But full disclosure of the changes effected and its

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effect on the working results and financial statements of the business should be disclosed. This will help the users to ascertain the impact of the changes on the performance of the business.

Full disclosure

The very purpose of accounting is to facilitate the preparation of the income statement and the statement of financial position so that the operating results of the entity and the financial position could be ascertained. This is done at periodic intervals usually on an annual basis. The business enterprise should provide through the financial statements all the relevant information required, so as to enable the external parties to make sound economic and investment decisions. Any information which is relevant and likely to influence the decision making process of the user should not be left out. This is more important in the case of joint stock companies since the members and outsiders have no access to the accounting records of the company and have to depend on the published annual financial statements to dig out information relating to the company. If full disclosure is not made the financial statements may present a distorted picture of the entity. In India the Companies Act 1956 prescribes the form in which the balance sheet should be presented, the items to be disclosed in the profit and loss account and the accounting policies followed by the entity etc. with a view that the principle of full disclosure is followed.

The Companies Act, 1956, prescribed a format in which financial statements must be prepared. Every company that fall under this category has to follow this practice. Various provisions are made by the Companies Act to prepare these financial statements. The purpose of these provisions is to disclose all essential information so that the view of financial statements should be true and fair. However, the term ‘disclosure’ does not mean all information. It means disclosure of information that is significance to the users of these financial statements, such as investors, owner, and creditors.

Three Golden Rules of Accounting with Examples7

Creating journal entries requires some rules, such rule is named as Three Golden Rules of Accounting standards. There are three kinds of account as Personal Account, Real Account and Nominal Account. Let’s see the rules for those different account from scratch and in detail.

1. Personal Account

Personal account relates to persons with whom a business keeps dealings. A person called be a natural person or a legal person. If a person receives anything from the business, he is called receiver and his account is to debited in the books of the business. If person gives anything to business, he is called as a giver and his account is to be credited in the books of the business.

The Golden Rule for Personal Account is,

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Debit the Receiver and Credit the Giver

Example: Goods worth 1000 bucks sold to Mr. Smith from Mr. John. In this transaction, Mr. Smith is the receiver of goods, he is called receiver and his account is to be debited in the books of business. Mr. John is the giver of goods, he is called giver and his account is to be credited in the books of business.

2. Real Account

Real account relates to property which may either come into the business or go from business. If any property or goods comes into the business, account of that property or goods is to be debited in the books of the business. If any property or goods goes out from the business account of that property or goods is to be credited in the books of business.

The Golden Rule for Real Account is,

Debit What Comes in and Credit What Goes out

Example: Goods sold on cash for 1500 bucks. In this transaction cash, an assets for business comes into the business on sales of goods, and therefore cash account is to be debited in the books of business. On the other side, goods, an assets of business goes out of the business on sale and therefore goods account is to be credited in the books of business.

3. Nominal Account

Nominal account is an account that relates to business expenses, loss, income and gains. If business incurs expense to manage and run business, account of that expense is to be debited in the books of business. When a business earns income by rendering services or hiring business assets, an account of that income is to credited in the books of business.

On other hand, if in the case the transaction of sale or purchase of goods or assets, if any loss is incurred by the business, account of that loss is to debited in the books or assets. if in the transaction of sale or purchase of goods or assets any profit is earned by the business, then account of that profit is to be credited in the books of business.

The Golden Rule for Nominal Account is,

Debit all Expenses or Loss and Credit all Income Gains or Profit

Example: (1) Paid 50 bucks as a commission to our agent, here commission which is paid to an agent is business expense and it is to be debited in the books of business. (2) Received 100 bucks as interest on our fixed deposit, here interest which is received is business income and therefore it is to be credited in the books of business.

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Financial Statements 8

Financial Statements represent a formal record of the financial activities of an entity. These are written reports that quantify the financial strength, performance and liquidity of a company. Financial Statements reflect the financial effects of business transactions and events on the entity.

The four main types of financial statements are:

Statement of Financial Position (Balance Sheet)

Statement of Financial Position, also known as the Balance Sheet, presents the financial position of an entity at a given date. It is comprised of the following three elements:

Assets: Something a business owns or controls (e.g. cash, inventory, plant and machinery, etc.)

Liabilities: Something a business owes to someone (e.g. creditors, bank loans, etc.)

Equity: What the business owes to its owners. This represents the amount of capital that remains in the business after its assets are used to pay off its outstanding liabilities. Equity therefore represents the difference between the assets and liabilities.

Income Statement (Profit and Loss Account)

Income Statement, also known as the Profit and Loss Statement, reports the company's financial performance in terms of net profit or loss over a specified period. Income Statement is composed of the following two elements:

Income: What the business has earned over a period (e.g. sales revenue, dividend income, etc.)

Expense: The cost incurred by the business over a period (e.g. salaries and wages, depreciation, rental charges, etc.)

Net profit or loss is arrived by deducting expenses from income.

Cash Flow Statement

Cash Flow Statement, presents the movement in cash and bank balances over a period. The movement in cash flows is classified into the following segments:

Operating Activities: Represents the cash flow from primary activities of a business.

Investing Activities: Represents cash flow from the purchase and sale of assets other than inventories (e.g. purchase of a factory plant)

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Financing Activities: Represents cash flow generated or spent on raising and repaying share capital and debt together with the payments of interest and dividends.

GAAP9

People and organizations make decisions based on financial information prepared by accountants. That is why it is important for people and organizations to understand the ways in which accounting information is measured. To ensure consistency, rules are established that business people can use to make sure they are comparing oranges to oranges.

For example, assume a store sells goods. Should the store's accountant record the sale at the moment the goods are shipped (accrual accounting) or at the time cash for these goods is received (cash accounting)?

Whether the store owner applies accrual or cash accounting is not important to interested parties, as long as the owner follows a rule requiring him to disclose the chosen accounting method for the reporting purposes.

Accounting rules such as these are grouped together and called Generally Accepted Accounting Principles (GAAP).

Indian GAAP vs. U.S. GAAP10

Some of these major differences between US GAAP and Indian GAAP which give rise to differences in profit are highlighted hereunder:

1. Underlying assumptions: Under Indian GAAP, Financial statements are prepared in accordance with the principle of conservatism which basically means “Anticipate no profits and provide for all possible losses”. Under US GAAP conservatism is not considered, if it leads to deliberate and consistent understatements.

2. Prudence vs. rules: The Institute of Chartered Accountants of India (ICAI) has been structuring Accounting Standards based on the International Accounting Standards (IAS), which employ concepts and `prudence' as the principle in contrast to the US GAAP, which are ”rule oriented", detailed and complex. It is quite easy for the US accountants to handle issues that fall within the rules, while the International Accounting Standards provide a general framework of accounting standards, which emphasise "substance over form" for accounting. These rules are less descriptive and their application is based on prudence. US GAAP has thus issued several Industry specific GAAP, like SFAS 51 (Cable TV)11, SFAS 50 (Record and Music Industry), SFAS 53 (Motion Picture Industry) etc.

9 http://simplestudies.com/introduction-to-accounting.html/page/210 http://usgaap.tripod.com/id6.html11 SFAS means statement of financial accounting standards 

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3. Format/ Presentation of financial statements: Under Indian GAAP, financial statements are prepared in accordance with the presentation requirements of Schedule VI to the Companies Act, 1956. On the other hand, financial statements prepared as per US GAAP are not required to be prepared under any specific format as long as they comply with the disclosure requirements of US GAAP. Financial statements to be filed with SEC include

4. Consolidation of subsidiary companies: Under Indian GAAP (AS 21), Consolidation of Accounts of subsidiary companies is not mandatory. AS 21 is mandatory if an enterprise presents consolidated financial statements. In other words, the accounting standard does not mandate an enterprise to present consolidated financial statements but, if the enterprise presents consolidated financial statements for complying with the requirements of any statute or otherwise, it should prepare and present consolidated financial statements in accordance with AS 21.Thus, the financial income of any company taken in isolation neither reveals the quantum of business between the group companies nor does it reveal the true picture of the Group . Savvy promoters hive off their loss making divisions into separate subsidiaries, so that financial statement of their Flagship Company looks attractive .Under US GAAP (SFAS 94), Consolidation of results of Subsidiary Companies is mandatory, hence eliminating material, intercompany transaction and giving a true picture of the operations and Profitability of the various majority owned Business of the Group.

5. Cash flow statement: Under Indian GAAP (AS 3) , inclusion of Cash Flow statement in financial statements is mandatory only for companies whose share are listed on recognized stock exchanges and Certain enterprises whose turnover for the accounting period exceeds Rs. 50 crore. Thus, unlisted companies escape the burden of providing cash flow statements as part of their financial statements. On the other hand, US GAAP (SFAS 95) mandates furnishing of cash flow statements for 3 years – current year and 2 immediate preceding years irrespective of whether the company is listed or not .

6. Investments: Under Indian GAAP (AS 13), Investments are classified as current and long term. These are to be further classified Government or Trust securities, Shares, debentures or bonds Investment properties others-specifying nature. Investments classified as current investments are to be carried in the financial statements at the lower of cost and fair value determined either on an individual investment basis or by category of investment, but not on an overall (or global) basis. Investments classified as long term investments are carried in the financial statements at cost. However, provision for diminution is to be made to recognise a decline, other than temporary, in the value of the investments, such reduction being determined and made for each investment individually. Under US GAAP (SFAS 115), Investments are required to be segregated in 3 categories i.e. held to Maturity Security (Primarily Debt Security), Trading Security and Available for sales Security and should be further segregated as Current or Noncurrent on Individual basis. Debt securities that the enterprise has the positive intent and ability to hold to maturity are classified as held-to-maturity securities and reported at amortized cost. Debt and equity securities that are bought

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and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealised gains and losses included in earnings. All Other securities are classified as available-for-sale securities and reported at fair value, with unrealised gains and losses excluded from earnings and reported in a separate component of shareholders' equity

7. Depreciation: Under the Indian GAAP, depreciation is provided based on rates prescribed by the Companies Act, 1956. Higher depreciation provision based on estimated useful life of the assets is permitted, but must be disclosed in Notes to Accounts. (Guidance note no 49). Depreciation cannot be provided at a rate lower than prescribed in any circumstance. Similarly, there is no compulsion to provide depreciation at a higher rate, even if the actual wear and tear of the equipment’s is higher than the rates provided in Companies Act. Thus, an Indian Company can get away with providing with lesser depreciation, if the same is in compliance to Companies Act 1956. Contrary to this, under the US GAAP , depreciation has to be provided over the estimated useful life of the asset, thus making the Accounting more realistic and providing sufficient funds for replacement when the asset becomes obsolete and fully worn out.

8. Foreign currency transactions: Under Indian GAAP (AS11) Forex transactions (Monetary items) are recorded at the rate prevalent on the transaction date. Year-end foreign currency assets and liabilities (Non-Monetary Items) are re-stated at the closing exchange rates. Exchange rate differences arising on payments or realizations and restatements at closing exchange rates are treated as Profit /loss in the income statement. Exchange fluctuations on liabilities incurred for fixed assets can be capitalized. Under US GAAP (SFAS 52), Gains and losses on foreign currency transactions are generally included in determining net income for the period in which exchange rates change unless the transaction hedges a foreign currency commitment or a net investment in a foreign entity. Capitalization of exchange fluctuation arising from foreign liabilities incurred for acquiring fixed assets does not exist. Translation adjustments are not included in determining net income for the period but are disclosed and accumulated in a separate component of consolidated equity until sale or until complete or substantially complete liquidation of the net investment in the foreign entity takes place. US GAAP also permits use of Average monthly Exchange rate for Translation of Revenue, expenses and Cash flow items, whereas under Indian GAAP, the closing exchange rate for the Transaction date is to be taken for translation purposes.

9. Expenditure during Construction Period: As per the Indian GAAP (Guidance note on ‘Treatment of expenditure during construction period'), all incidental expenditure on Construction of Assets during Project stage are accumulated and allocated to the cost of asset on completion of the project. Contrary to this, under the US GAAP (SFAS 7), such expenditure are divided into two heads – direct and indirect. While, direct expenditure is accumulated and allocated to the cost of asset, indirect expenditure are charged to revenue.

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10. Research and Development expenditure: Indian GAAP (AS 8) requires research and development expenditure to be charged to profit and loss account, except equipment and machinery which are capitalized and depreciated. Under US GAAP (SFAS 2), all R&D costs are expenses except intangible assets purchased from others and Tangible assets that have alternative future uses which are capitalised and depreciated or amortised as R&D Expense. Under US GAAP, R&D expenditure incurred on software development are expensed until technical feasibility is established (SOP 81.1). R&D Cost and software development cost incurred under contractual arrangement are treated as cost of revenue.

11. Revaluation reserve: Under Indian GAAP, if an enterprise needs to revalue its asset due to increase in cost of replacement and provide higher charge to provide for such increased cost of replacement, then the Asset can be revalued upward and the unrealised gain on such revaluation can be credited to Revaluation Reserve (Guidance note no 57). The incremental depreciation arising out of higher book value may be adjusted against the Revaluation Reserve by transfer to P&L Account. However for window dressing some promoters mutualise this facility to hoodwink the shareholders on many occasions. US GAAP does not allow revaluing upward property, plant and equipment or investment.

12. Long term Debts: Under US GAAP, the current portion of long term debt is classified as current liability, whereas under the Indian GAAP, there is no such requirement and hence the interest accrued on such long term debt in not taken as current liability.

13. Extraordinary items, prior period items and changes in accounting policies: Under Indian GAAP (AS 5), extraordinary items, prior period items and changes in accounting policies are disclosed without netting off for tax effects. Under US GAAP (SFAS 16) adjustments for tax effects are required to be made while reporting the Prior period Items.

14. Goodwill: Under the Indian GAAP goodwill is capitalized and charged to earnings over 5 to 10 years period. Under US GAAP (SFAS 142), Goodwill and intangible assets that have indefinite useful lives are not amortized, but they are tested at least annually for impairment using a two-step process that begins with an estimation of the fair value of a reporting unit. The first step is a screen for potential impairment, and the second step measures the amount of impairment, if any. However, if certain criteria are met, the requirement to test goodwill for impairment annually can be satisfied without a measurement of the fair value of a reporting unit.

15. Capital issue expenses: Under the US GAAP, capital issue expenses are required to be written off when incurred against proceeds of capitals, whereas under Indian GAAP, capital issue expense can be amortized or written off against reserves.

16. Proposed dividend: Under Indian GAAP, dividends declared are accounted for in the year to which they relate. For example, if dividend for the FY 1999-2000 is declared in Sep 2000, then the corresponding charge is made in 2000-2001 as below the line item. Contrary to this, under US GAAP dividends are reduced from the reserves in the year they are declared by the

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Board. Hence in this case under US GAAP, it will be charged Profit and loss account of 2000-2001 above the line.

17. Investments in Associated companies: Under the Indian GAAP (AS 23), investment in associate companies is initially recorded at Cost using the Equity method whereby the investment is initially recorded at cost, identifying any goodwill/capital reserve arising at the time of acquisition. The carrying amount of the investment is adjusted thereafter for the post acquisition change in the investor’s share of net assets of the investee. The consolidated statement of profit and loss reflects the investor’s share of the results of operations of the investee is carried at cost. Under US GAAP (SFAS 115) Investments in Associates are accounted under equity method in Group accounts but would be held at cost in the Investor’s own account.

18. Preoperative expenses: Under Indian GAAP, (Guidance Note 34 - Treatment of Expenditure during Construction Period), direct Revenue expenditure during construction period like Preliminary Expenses, Project related expenditure are allowed to be Capitalised. Further, Indirect revenue expenditure incidental and related to Construction are also permitted to be capitalised. Other Indirect revenue expenditure not related to construction, but since they are incurred during Construction period are treated as deferred revenue expenditure and classified as Miscellaneous Expenditure in Balance Sheet and written off over a period of 3 to 5 years. Under US GAAP (SFAS 7), the concept of preoperative expenses itself doesn’t exist. SOP 98.5 also mandates that all Start-up Costs should be expensed. The enterprise has to prepare its balance sheet and Profit and Loss Account as if it were a normal running organization. Expenses have to be charged to revenue and Assets are capitalised as a normal organization. The additional disclosure include reporting of cash flow, cumulative revenues and Expenses since inception. Upon commencement of normal operations, notes to Statement should disclose that the Company was but is no longer is a Development stage enterprise. Thus, due to above accounting anomaly, Accounts prepared under Indian GAAP, contain higher charges to depreciation which are to be adjusted suitably under US GAAP adjustments for indirect preoperative expenses and foreign currencies.

19. Employee benefits: Under Indian GAAP, provision for leave encashment is accounted based n actuarial valuation. Compensation to employees who opt for voluntary retirement scheme can be amortized over 60 months. Under US GAAP, provision for leave encashment is accounted on actual basis. Compensation towards voluntary retirement scheme is to be charged in the year in which the employees accept the offer.

20. Loss on extinguishment of debt: Under Indian GAAP, debt extinguishment premiums are adjusted against Securities Premium Account. Under US GAAP, premiums for early extinguishment of debt are expensed as incurred.

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Proposed New Roadmap for Implementation of Ind AS converged with IFRS (24-03-2014 ) 12

The Council of the ICAI, at its last meeting, held on March 20-22, 2014, has finalized the roadmap. The revised roadmap recommends Ind AS to be implemented for the preparation of Consolidated Financial Statements of listed companies and unlisted companies having net worth in excess of Rupees 500 crore from the accounting year beginning on or after 1st April, 2016, with previous year comparatives in Ind AS for the year 2015-16. The stand-alone financial statements will continue to be prepared as per the existing notified Accounting Standards which would be upgraded over a period of time.

The Ministry of Corporate Affairs (MCA) had earlier notified Ind AS converged with IFRS in 2011, but the Ind AS were not notified, as per the Press Release issued by the MCA, primarily due to tax implications. Since then the Parliament has passed the new Companies Act, 2013, which is in the process of notification by the MCA. The new Act has introduced various new provisions, including requirement to prepare Consolidated Financial Statements, which would facilitate implementation of Ind AS converged with IFRS.

The recommendation of the ICAI to implement Ind AS for preparation of only the Consolidated Financial Statements would have the advantage that Ind AS would have no tax implications as well as implications for computation of managerial remuneration and dividend distribution etc., since, for these purposes, the existing notified Accounting Standards would continue to be used as is the practice in almost all countries that have adopted or converged with IFRS. This approach would enable India also to be become an IFRS-converged country as promised by it as a part of its G-20 commitments.

CA. K Raghu, President ICAI said, "Further, implementation of Ind AS from 1st April, 2016, with previous year Ind AS comparatives for 2015-16, would allow industry ample time to prepare themselves for the Ind AS, with certain subsequent revisions and amendments after 2011, which have been and are being carried out by the ICAI to keep pace with IFRS revisions/amendments. These would be submitted for consideration of the Government for notification as per the provisions of the Act. It is also felt that the aforesaid time is sufficient to implement Ind AS for all listed companies and unlisted companies having net worth in excess of Rupees 500 crore in one go, instead of implementing Ind AS in phases, as was laid down in the previous roadmap".

The roadmap also proposes that the previous year comparatives for the year 2015-16 shall be prepared in accordance with ‘Ind AS’ as against the previous roadmap which required the same to be prepared in accordance with the existing notified Accounting Standards, which was done at that time because the time for implementation of Ind AS was very short. This proposal would also be another step to make Ind AS convergent with IFRS, as without this, Ind AS would not be 12 http://www.icai.org/new_post.html?post_id=10491

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considered to be IFRS-converged. It is felt that for preparation of previous year comparatives also, the time presently proposed is sufficient.

Cost – Costing – Cost Accounting

Cost: Cost is commonly defined as ‘sacrificed resource’ for a particular thing. If we buy a watch for $30, a number of dollars are considered to be the cost of that watch. Here, 30 dollars are sacrificed to obtain a watch. It is the simplest example but cost can be of anything which is measurable in terms of money. For example, the cost of preparing one pizza which in itself include various other costs like cost of flour, other ingredients, labor, electricity and other overheads. Just the same way, cost of production of any product or service can be determined.

Costing: ‘Cost’ is a term whereas ‘Costing’ is a process for determining the cost. It may be called a technique for ascertaining the cost of production of any product or service in the business organization. The real scope of this term can best be understood in the context of big manufacturing concerns who produce hundreds of products and spend a lot of money on material, labor and other overheads. The cost of each product in those organizations requires recording expenses with to each product or process, classifying expenses like direct material, labor, overheads etc., allocating direct expenses and suitable apportionment of overheads to each product for most correct determination of per unit cost of production of each product.

Cost Accounting: This term is of utmost importance for the top management of any business. Cost Accounting is basically the next step to costing. Cost accounting involves analyzing relevant costing data, interpret it and present various management problems to management. The scope of cost accounting involves preparation of various budgets for an organization, determining standard costs based on technical estimates, finding and comparing with actual costs, ascertaining the reasons of by variance analysis etc.

Cost Accountancy: This term is over and above costing and cost accounting. It envisages application of costing and cost accounting in a business setup. Cost Accountancy facilitates management with cost control initiatives, ascertainment of profitability and informed decision making. It also includes determination of selling price for the products, division and unit wise profitability. Forecasting of expenses and future probable incomes is also a part of the practice of Cost Accountancy.

Difference between Cost Control and Cost Reduction13

The two most important functions of cost accounting are cost control and cost reduction. Cost Control is a technique which provides the necessary information to the management that actual costs are aligned with the budgeted costs or not. Cost Reduction is a technique used to save the unit cost of the product without compromising its quality. Now, you can see the

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differences between cost accounting and cost control below:

Definition of Cost Control

Cost Control is a process which focuses on controlling the total cost through competitive

analysis. It is a practice which works to maintain the actual cost in accordance with the

established norms. It ensures that the cost incurred on an operation should not go beyond the

pre-determined cost.

Cost Control involves a chain of functions, which starts from preparation of the budget in

relation to the operation, thereafter evaluating the actual performance, next is to compute the

variances between the actual cost & the budgeted cost and further, to find out the reasons for

the same, finally to implement the necessary actions for correcting discrepancies.

The major techniques used in cost control are standard costing and budgetary control. It is a

continuous process as it helps in analyzing the causes for variances which control wastage of

material, any embezzlement and so on.

Definition of Cost Reduction

Cost Reduction is a process, aims at lowering the unit cost of a product manufactured or service

rendered without affecting its quality by using new and improved methods and techniques. It

ascertains substitute ways to reduce the cost of a unit. It ensures savings in per unit cost and

maximization of profits of the organization.

Cost Reduction aims at cutting off the unnecessary expenses which occur during the

production, storing, selling and distribution of the product. To identify cost reduction, the

following are the major elements:

Savings in per unit cost.

No compromise with the quality of the product.

Savings are non-volatile in nature.

Tools of cost reduction are Quality operation and research, Improvement in product design, Job

evaluation & merit rating, variety reduction etc.

Key Differences between Cost Control and Cost Reduction

The following are the major differences between Cost Control and Cost Reduction:

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1. The activity of maintaining cost as per the established norms is known as cost control. The

activity of decreasing per unit cost by applying new methods of production in such a way that it

does not affect the quality of the product is known as cost reduction.

2. Cost Control focuses on decreasing the total cost while cost reduction focuses on decreasing

per unit cost of a product.

3. Cost Control is temporary in nature. Unlike Cost Reduction which is permanent.

4. The process of cost control is completed when the specified target is achieved. Conversely, the

process of cost reduction has no visible end as it is a continuous process that targets for

eliminating wasteful expenses.

5. Cost Control does not guarantee quality maintenance; however, 100% quality maintenance is

assured in case of cost reduction.

Cost Control is a preventive function as it ascertains the cost before its occurrence. Cost Reduction is a corrective action.

Introduction to stocks and Trading mechanics14

Definitions: Shares and Stocks-

The difference between the two words comes from the context in which they are used.

For example, "stock" is a general term used to describe the ownership certificates of any company, in general, and "shares" refers to a the ownership certificates of a particular company. So, if investors say they own stocks, they are generally referring to their overall ownership in one or more companies. Technically, if someone says that they own shares - the question then becomes - shares in what company?

Bottom line, stocks and shares are the same thing. The minor distinction between stocks and shares is usually overlooked, and it has more to do with syntax than financial or legal accuracy.

Summary:

A “share” refers to the certain amount of ownership certificates that a person has purchased for a particular company. The more shares purchased, the more ownership you take in a company.

14 http://www.investopedia.com/terms/e/exchange.asp, http://www.investopedia.com/articles/basics/04/092404.asp, http://www.investopedia.com/university/stocks/, http://www.investopedia.com/terms/s/stockmarket.asp, http://www.investopedia.com/ask/answers/140.asp#ixzz4ERxCwCp7, http://www.differencebetween.net/business/finance-business-2/difference-between-shares-and-stocks/#ixzz4ERxdVhd0,

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A “stock” refers to the ownership in general of a certain company speaking outside of the number of shares that you specifically own. Stock is used to refer to the investment in multiple companies as well.

The words “stocks” and “shares” are used interchangeably, and there is no real legal or technical difference in the two.

Stock broker: A stockbroker, also called a Registered Representative, investment advisor or simply, broker, is a professional individual who executes buy and sell orders for stocks and other securities through a stock market, or over the counter, for a fee or commission.

Exchange: An exchange is a marketplace in which securities, commodities, derivatives and other financial instruments are traded. The core function of an exchange - such as a stock exchange - is to ensure fair and orderly trading, as well as efficient dissemination of price information for any securities trading on that exchange. Exchanges give companies, governments and other groups a platform to sell securities to the investing public.

An exchange may be a physical location where traders meet to conduct business or an electronic platform.

Bid and Ask

Bid Price - A bid price is the highest price that a buyer (i.e., bidder) is willing to pay for a good/ stocks. It is usually referred to simply as the "bid." In bid and ask, the bid price stands in contrast to the ask price or "offer", and the difference between the two is called the bid–ask spread.

Ask Price - The Ask price is the lowest price a seller of a stock is willing to accept for a of that given stock. For over-the-counter stocks, the asking price is the best quoted price at which a market maker is willing to sell a stock.

Introduction:

As we all know one cannot trade directly on a major stock exchange and we require broker to buy or sell stocks. Generally Individuals put their order to Broker for buying and selling stocks and then broker forwards those orders to Stock Exchange where transactions are executed.

There are five things needs to be specified for the order:

1. Symbol of equity also called Ticker Symbol (e.g., AAPL – Apple Inc., GOOG – Alphabet Inc.)2. Buy or Sell3. Market Order or Limit Order4. No. of shares to be transacted5. Price (if limit order)

Market Order

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Buy or sell at any price prevailing in the market

Limit Order

Buy – Do not want to buy for more than the given price Sell – Do not want to sell for less than the given price.

Examples of orders

1. IBM, Buy, Market order, 100 shares2. IBM, Buy, Limit order, 100 shares, $ 100

Broker takes your order > Makes it available on the exchange > Order executed.

The Order book (IBM stocks)

Bid/ Ask $ # shares

Ask 100.10 Would like to sell for 100Ask 100.05 500Ask 100.00 1000

Bid 99.95 Would like to buy for 100Bid 99.90 50Bid 99.85 50

No Transactions can be executed. The matter of the fact is that minimum price to sell the stock i.e. minimum asks price is $ 100 and Maximum price to buy the stock i.e. maximum bid price is $ 99.85. Unless the Bid/ Ask prices are revised by the buyers and Seller, The order book would remain unchanged.

Min. Ask $ 100.00 Max. Bid $ 99.95Page | 29

YouOrder

Broker Order received

NYSE

Package the order to his computer in

Exchange

Situation 1: In the above example If Mr. X is willing to sell his 100 IBM stock at $ 100.10, show the change in order book.

Now quoted shares at ask price 100.10 have gone up by 100 shares i.e. 200 shares. Order book stays static until any one changes the price for trading because the prices are still not crossing the spread.

The Order book (IBM stocks)

Bid/ Ask $ # shares

Ask 100.10 200Ask 100.05 500Ask 100.00 1000

Bid 99.95 100Bid 99.90 50Bid 99.85 50

Situation 2: Mr. Y thinks that the prices of IBM stocks would go up in the future and wants to change his offer to $ 99.95 for 100 shares to $ 100.00.

As the offer crosses the spread, trade can be executed. 100 shares order for $ 100 can be executed against 1000 shares sell order.

The Order book (IBM stocks) – before trade

Ask $ # shares Bid $ # shares

Ask 100.10 200 Bid 100 100Ask 100.05 500 Bid 99.90 50Ask 100 1000 Bid 99.85 50

The Order book (IBM stocks) – after trade

Ask $ # shares Bid $ # shares

Ask 100.10 200Ask 100.05 500 Bid 99.90 50

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Ask 100 900 Bid 99.85 50

Situation 3: Market order received for 100 shares. (Buy, Market order, 100 shares)

The Order book (IBM stocks) – after trade

Ask $ # shares Bid $ # shares

Ask 100.10 200Ask 100.05 500 Bid 99.90 50Ask 100 800 Bid 99.85 50

Situation 4: Order for 1100 shares received.

All 800 shares at $ 100 and 300 shares at $ 100.05 would be executed

Question 2:

The Order book (IBM stocks)Bid/ Ask $ # sharesAsk 100.10 Would like to sell for 100Ask 100.05 500Ask 100.00 1000

Bid 99.95 Would like to buy for 100Bid 99.90 50Bid 99.85 50

Situation A: Market order to sell 200 shares receivedAnswer A: First 100 shares @ 99.95, 50 shares @ 99.90, and 50 shares @ 99.85

Situation B: Market order to sell 150 sharesAnswer B: 100 @ 99.95, 50 @ 99.90, and the stock Price drops.

It is also noted that the stock prices would go down as there are less buyers than sellers.

Trading Without Exchange:

In some cases the order does not even reach exchange. Page | 31

Let us take one example; one broker has received Buy order for 100 shares @ $ 100. At the same time broker has also received one sell order for 100 shares @ $ 100.

Transaction can be settled at the broker’s place without forwarding it to Exchange.

Why not traded through exchange:

1. Brokers can make profit. (Sell order 99.90 and Buy order 100, 0.10 profit)2. To avoid exchange charges for execution of order (charged by Stock Exchange)

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http://www.open.edu/openlearn/money-management/money/accounting-and-financehttps://www.coursera.org/course/accountinghttp://www.smallbizu.org/a101/http://www.accounting-world.com/http://misscpa.com/https://www.edx.org/https://www.moneyinstructor.com/accounting.asp

Finance Websites:www. studyfinance .com/ http://www.money.cnn.com/http://www.finance.yahoo.com/http://www.money.msn.com/http://www.investopedia.com/http://returnseekers.com/financial_adviser/ www.investopedia.comwww.about.comwww.khanacademy.orghttps://www.khanacademy.org/economics-finance-domain/core-finance

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