COMMERCE KEY TERMS

COMMERCE
Important Terms
CONTENTS
1. Financial Accounting
2. Cost and Management Accounting
3. Financial Management
4. Auditing
5. Economics
6. Commerce
7. Money, Banking & Finance
Financial Accounting Important Questions
FIANCIAL ACCOUNTING
Accounting:
Accounting is an art of recording, classifying & summarizing the business transactions and
interpreting the results of financial statements.
• Financial Accounting: The objective of financial accounting is to ascertain the financial
performance as well as financial position of the business by preparing financial statements.
• Cost Accounting: The objective of cost accounting is to determine the cost of goods
manufactured by the business.
• Management Accounting: The objective of management accounting is to make effective
decisions for the business by using accounting information.
Qualitative Characteristics of Accounting Information System:

Accounting information should be reliable, relevant, easily understandable and comparable.
• Reliability: Accounting information is said to be reliable if it is accurate, unbiased, complete and
faithfully presented.
• Relevance: Accounting information is said to be relevant if it influences the decision making.
• Understandability: Accounting information is understandable if it enables the users to
understand the content and significance of financial reports.
• Comparability: Accounting information is comparable if is capable of being compared either
over a period of time or between two or more entities.
Concepts in Accounting:
Following are the concepts in accounting;
• Separate Entity Concept: According to this concept business is treated as a separate entity from
its owners.
• Money Measurement Concept: According to this concept accounting records only those
transactions or events, which can be measured in terms of money.
• Dual Aspect Concept: According to this concept, “for every debit, there is an equivalent credit.”
• Going Concern Concept: According to this concept it is assumed that the business will continue
to operate for an indefinite time period, there is no intention to close the business in near future.
• Cost Concept: According to this concept an asset is normally recorded in the books of accounts
at its original acquisition cost.
• Accounting Period Concept: According this concept, “life of the business is divided into a series
of relatively short accounting periods of equal lengths for studying the results shown by the
business.
• Matching Concept: The matching concept requires that revenue earned is matched with the
expenses incurred in earning that revenue.
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• Realization Concept: According to this concept, revenue should be recognized at the time when
goods are sold or services are rendered.
• Conservatism / Prudence Concept: Prudence concept states that profits should not be
recognized until realized, but a loss should be recognized as soon as it is foreseen. In other words
‘anticipate no profit but provide for all possible losses.’
• Materiality Concept: According to this concept all material items should be disclosed in the
financial statements. Information about an item is material if its omission or misstatement could
influence the financial decision of users taken on the basis of that information.
Generally Accepted Accounting Principles (GAAP):

Accounting principles are basically rules and procedures adopted by accountants universally while
recording the business transactions in books of accounts.
International Accounting Standards (IAS)

Accounting standards are issued by IASC; these standards guide how to prepare books of accounts
and how to present financial statements to bring uniformity in presentation of accounting results all
over the world. Till now 41 IAS are issued by IASC.
International Financial Reporting Standards (IFRS)

The accounting standards which are developed and issued by IASB are called IFRS; these standards
guide how to prepare books of accounts and how to present financial statements to bring uniformity in
presentation of accounting results. Till now 13 IFRS are issued by IASB.
Types of Accounting System:

Following are two types of accounting system;
• Cash System of Accounting: It is a system in which accounting entries are recorded only when
cash is received or paid.
• Accrual System of Accounting: It is a system in which accounting entries are recorded on the
basis of amount having become due for payment or receipt.
Five Pillars of Financial Accounting:

Assets, liabilities, capital, expenses and revenue are considered five pillars of accounting.
• Assets: Assets are the economic resources from whom the business is expected to get benefit in
near future.
• Liabilities: Liabilities are the debts or obligations of a business which are repayable in future.
• Capital: Capital is the amount or economic resources invested by owner in the business.
• Expenses: Expenses are the costs incurred to generate revenue.
• Revenue: Revenue is the price of goods sold or service rendered by a business to its customers.
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Difference between Expense & Expenditure:

Expenses and Expenditure: Expenses are the costs incurred to generate revenue while expenditures
are the costs incurred to purchase non-current assets to benefit for long term.
Drawings:
The amount of cash or goods taken away by the owner from the business for his personal use is
known as drawings.
Difference between Trade Discount & Cash Discount:

• Trade Discount: Discount allowed by the manufacturer or wholesaler at the time of selling goods
as a deduction from the list price is called trade discount.
• Cash Discount: Cash discount is an allowance given by a creditor to a debtor if the amount is
paid by the debtor within the specified discount period.
Transaction:
A business event which can be measured in terms of money and which must be recorded in books of
accounts is known as transaction.
Monetary Event:
Events which can be measured in terms of money and change the financial position of business are
known as monetary events.
Accounting Equation:
The expression of the equality of an organization’s assets with the claims against them is referred as
accounting equation. Assets = Liabilities + Capital
Systems of Accounting:
Double Entry System: A system in which both aspects of a transaction are recorded, one is debited
and the other is credited is known as double entry system.
Single Entry System: A system in which sometimes both aspects of a transaction are recorded,
sometimes only one aspect of a transaction is recorded and sometimes no aspect of a transaction is
recorded called single entry system.
What is an Account?
Account is an individual record of an asset, liability, revenue, expense and capital in a summarized
manner.
• Nominal Accounts: Accounts which are related with expenses and revenue are known as
nominal accounts e.g. rent account.
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• Real Accounts: Accounts which are related with non-current assets of an organization are known
as real accounts e.g. machinery account.
• Personal Accounts: Accounts which are related with persons or institutions are known as
personal accounts e.g. bank account.
Journal and Journalizing:

The book in which transactions are first of all recorded chronologically together with its short
description is called journal. It is also called as ‘book of original entry’ or ‘prime entry’. While
recording of a transaction in journal is called journalizing.
Entry:
Recording a transaction in appropriate place of the concerned book of account is called entry.
• Simple Entry: An entry in which one account is debited and another account is credited is called
simple entry.
• Compound Entry: An entry in which more than one account is debited or more than one account
is credited is known as compound entry.
Narration:
A short explanation of each transaction which is written under each entry is called narration.
Ledger:
The book in which all the transactions of a business concern are finally recorded in the concerned
accounts in a summarized and classified form is called ledger.
Posting:
The process of transferring information from journal to ledger is known as posting.
Trial Balance:
Trial balance is a list of balances of all ledger accounts with any disagreement in total.
Debit Note & Credit Note:

• Debit None: If goods bought on credit are returned to the supplier for any solid reason e.g.
defective of goods, the buyer debits the supplier account and informs the supplier through a note.
This note is called debit note.
• Credit Note: If goods sold on credit are returned by the customer for any solid reason e.g.
defective of goods, the seller credits the customer account and informs the supplier through a
note. This note is called credit note.
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Voucher:
Any written evidence in support of a business transaction is known as voucher.
Types of Cash Book:

• Single Column Cash Book: A book in which only cash transactions are recorded is called single
column cash book.
• Double Column Cash Book: A book in which both cash and bank transactions are recorded is
called double column cash book.
• Treble Column Cash Book: A book in which cash, bank and discount transactions are recorded
is called treble column cash book.
Contra Entry:
An entry in which cash account and bank account is involved and is recorded on both sided of cash
book is called contra entry.
Petty Cash Book:

A book in which petty expenses e.g. postage and stationery are recorded is called petty cash book.
Imprest System:
A system in which a fixed sum of money is given to the cashier to cover all the petty expenses for the
month is called imprest system.
Bank Reconciliation Statement:

If there is any difference between the balances of cash book and pass book, the depositor prepares a
statement to explain the causes of difference and to reconcile the both balances. The statement of
explanation is called bank reconciliation statement.
Opening Entries:
The entries passed at the start of the year for bringing forward balances of assets and liabilities of the
previous period to the current period are called opening entries.
Closing Entries:
At the end of every accounting period, all accounts relating to expenses and revenues are closed by
transferring their balances to trading and profit and loss account. Entries necessary to transfer these
balances are called closing entries.
Adjusting Entries:
Adjusting entries are journal entries made at the end of the accounting period to allocate revenue and
expenses to the period in which they actually occurred
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Rectifying Entries:
Entries necessary to correct the errors in books of accounts are called rectifying entries.
Accounting Cycle:
Accounting cycle includes the following stages:
Transaction Journal Ledger Trial Balance Financial Statements
Trading Account:
The account which shows the gross result i.e. gross profit or gross loss of the business is known as
trading account.
Profit & Loss Account:

The account which shows the net result i.e. net profit or net loss of the business is known as profit &
loss account.
Financial Statements
Financial statements are the statements which show the financial performance as well as financial
position of the business. Financial statements include income statement, balance sheet, statement of
changes in equity, cash flow statement and notes to the accounts.
• Income Statement: The statement which shows the financial performance of the business during
a particular period is called income statement.
• Balance Sheet: Balance sheet is the statement which shows the financial position of the business
on a specific date.
• Cash Flow Statement: The statement which shows total cash inflows and cash outflows of
operating, investing and financing activities.
Real & Fictitious Assets:

• Real Assets: Assets which have some market value are called real assets e.g. machinery.
• Fictitious Assets: Assets which have no market value are called fictitious assets e.g. preliminary
expenses.
Wasting Assets:
Assets whose value gradually reduce on account of use and finally exhausted completely are called
wasting assets e.g. mines, forest.
Contingent Liabilities:
Contingent liability is not a liability at present but may or may not become liability in future. It
depends upon certain future events.
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Deferred Liabilities:
Debts which are repayable in the course of less than one year but more than one month are known as
deferred liabilities.
Marshalling
An arrangement in which assets and liabilities are shown in the balance sheet is known as
marshalling.
Differentiate reserve and reserve fund.

• Reserve: Undistributed portion of profits to meet any liability or contingency of the business is
called reserve.
• Reserve Fund: If the amount of reserve is invested outside the business is known as reserve fund.
Revenue Reserves & Capital Reserves

• Revenue Reserves: The portion of profit which is not paid to shareholders and created out of the
revenue profit earned in the normal course of the business is called revenue reserves.
• Capital Reserves: The reserve which is created out of the capital profit is called capital reserve.
Provision:
Provision means providing for possible loss or liability, the amount of which cannot be determined
exactly e.g. provision for taxation.
Prepaid Expenses & Outstanding Expenses:

• Prepaid Expenses: The expenses which have been paid in advance during the current year but
the benefits against them have not been received till the end of current year are called prepaid
expenses.
• Outstanding Expenses: The expenses which have been incurred during the current year but have
not been paid till the end of current year are known as outstanding expenses.
Accrued Revenue & Unearned Revenue:

• Accrued Revenue: The revenue which have been earned in the current year but not yet received
in the form of cash within the current year is called accrued revenue.
• Unearned Revenue: Unearned revenue is the cash received in advance against goods or services
not yet delivered to the customer. It is also known as deferred revenue.
Operating Expenses:
The expenses which incurred to generate revenues from the sales of goods are called operating
expenses.
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Cost of Goods Sold:

Cost of Goods Sold (CGS) represents the sum of the cost of all goods, which have been sold during
the accounting period. CGS = opening stock + purchases + direct expenses– closing stock
Difference between Bad Debts and Bad Debts Recovered:

• Bad Debts: The debts which are irrecoverable form the debtors are called bad debts.
• Bad Debts Recovered: The debts which are written off as bad debts, if recovered in future are
called bad debts recovered.
Loss:
Loss is the excess of expenses over revenues for an accounting period.
• Normal Loss: Loss which arises due to handling of goods, breakage, and shrinkage is known as
normal loss. Normal loss is not recorded in books of accounts.
• Abnormal Loss: Loss which arises due to abnormal reason i.e. fire, flood is known as abnormal
loss. It is recorded in books of accounts.
Work Sheet:
Work sheet is not a permanent record but it is a working paper of accountant. Work sheet consists of
account titles, trial balance, adjustments, adjusted trial balance, income statement and balance sheet.
Capital & Revenue Expenditure

• Capital Expenditure: An expenditure which results in the acquisition of non-current assets or
adding value to non-current assets which increases the earning capacity of the business is called
capital expenditure.
• Revenue Expenditure: Expenditure incurred in the day-to-day conduct of a business and the
effect of which is completely exhausted within the current accounting period is called revenue
expenditure.
Deferred Revenue Expenditure:

The expenditure which is charged to the profit and loss account of more than one year is called
deferred revenue expenditure.
Amortization:
Decrease in the value of intangible assets such as patents, copy rights is called amortization.
Depletion:
Decrease in the value of wasting assets such as mines, oil well, forests is called depletion.
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Depreciation:
Depreciation is the systematic allocation of cost of asset over its useful life.
Straight Line / Fixed Installment Method:

Depreciation is calculated on the cost of an asset and depreciation remains constant throughout the life
of an asset. (original cost – scrap value) ÷ estimated useful life
Declining/Diminishing Balance Method:

Under diminishing balance method depreciation is calculated on the book value of an asset.
Annuity Method:
Under annuity method, depreciation is charged on original cost of an asset keeping the factor of
interest at fixed rate. Amount of depreciation remains constant.
Sinking Fund Method:

Under this method, a fund is created with the amount of annual depreciation to provide for the
replacement of asset at the end of its useful life.
Machine Hour Rate Method:

Depreciation under machine hour rate method is calculated with the help of following formula
(original cost – scrap value) ÷ life of asset in hours.
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Cost & Management Accounting Important Questions
COST & MANAGEMENT ACCOUNTING
Accounting:
Accounting is an art of recording, classifying & summarizing the business transactions and
interpreting the results of financial statements.
• Cost Accounting: The objective of cost accounting is to determine the cost of goods
manufactured by the business.
• Management Accounting: The objective of management accounting is to make effective
decisions for the business by using accounting information.
Cost:
Cost is the value of money utilized to obtain a particular product or service.
Cost Object:
Cost object is anything in respect of which a separate measurement of cost is desirable.
• Cost Unit: Cost unit is a quantitative unit of product or service in relation to which costs are
ascertained.
• Cost Centre: Cost centre is a function or location for which costs are ascertained.
• Profit Centre: Profit centre is a section of an organization that is responsible for producing profit.
Prime Cost:
Prime cost is the combination of all the direct expenses.
prime cost = direct material + direct labour + other direct expenses
Overheads (FOH):
FOH is the combination of all the indirect expenses.
FOH = indirect material + indirect labour + other indirect expenses
Conversion Cost:
Conversion cost is the cost incurred in the factory to convert the raw material into finished goods.
conversion cost = direct labour + FOH
Manufacturing Cost:
Manufacturing cost is the combination of direct material, direct labour and FOH.
manufacturing cost = prime cost (dir. material + dir. labour) + FOH
Standard Cost:
Standard cost means what the cost should be. It is predetermined cost of a unit of output.
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Difference between Product and Period Cost

• Product Cost: Product cost is a cost that is incurred in producing goods & services and included
in the value of inventory (direct material, direct labour, manufacturing overheads).
• Period Cost: A cost that relates to a time period and are not affected by changes in the level of
activity are called period costs e.g. selling and admin expenses.
Difference between Fixed & Variable Cost:

• Fixed Cost: Fixed costs are the cost that does not vary with the change in production, if
production increases or decrease fixed cost remains constant.
• Variable Cost: Variable costs are the costs that vary with the change in production e.g. if
production increases variable cost increases, if production decreases variable cost decrease.
• Step Cost:
Sunk Cost, Opportunity Cost & Avoidable Cost:

• Sunk Costs: Sunk cost is unrecoverable past outlay that is irrelevant to future decision making.
• Opportunity Cost: Opportunity cost is the value of the benefit sacrificed when one course of
action is chosen, in preference to another. It is also called imputed cost in economics.
• Avoidable cost: A cost that can be avoided (in whole or in part) by taking a particular decision is
known as avoidable cost.
Costing Methods:
The methods used for the calculation of cost per unit of output are known as costing methods.
• Job Costing (Job Order Costing): Job costing applies where work is undertaken according to
specific order and individual customer requirements that can be completed in a single accounting
period e.g. shipbuilding.
• Process Costing: Process costing is used by the companies that are producing large quantities of
identical products through continuous operations.
Unit cost = total manufacturing cost ÷ total units produced
Costing Techniques:
• Absorption (Full) Costing: Absorption costing includes variable manufacturing costs e.g. direct
material, direct labour and variable manufacturing overheads along with fixed manufacturing
overhead costs to each unit of product.
• Marginal (Variable) Costing: A costing technique that includes only variable manufacturing
costs (direct material, direct labor and variable manufacturing overheads) in unit product costs.
• Standard Costing: A costing that uses standards for costs and revenues for the purpose of control
through variance analysis.
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High-Low method:
High-low is a method of separating a mixed cost into its fixed and variable elements by analyzing the
change in cost between the high and low activity levels.
Cost-volume-profit (CVP) graph:

CVP graph is s graphical representation of the relationships between an organization’s costs, and
profits on y-axis and its sales volume on x-axis.
Profit = (sales – variable expenses) – fixed expenses
Contribution Approach:
According to contribution approach an income statement format that organizes costs by their
behavior. Costs are separated into variable and fixed categories.
• Contribution Margin: contribution margin = sales revenues – all variable expenses
Break-Even (CVP) Analysis:

Break-even analysis is a technique for studying the relationship among variable and fixed costs, sales
volume, and profits of the firm. It is also called Cost Volume Profit (CVP) Analysis.
• Break-Even Point: A point where total revenues are total cost are equal e.g. no profit no loss is
called break-even point.
Margin of Safety:
The margin of safety is the excess of budgeted or actual sales over the breakeven volume of sales.
Margin of safety in Rs. = total budgeted (or actual) sales – break-even sales
Target Profit Analysis:

Target profit analysis estimates “what sales volume is needed to achieve a specific target profit.”
Bill of Material:
Bill of materials is a document that shows the quantity of each type of direct material required to
make a product
Material Requisition Form:

Material requisition form is a document that specifies the type and quantity of materials to be issued
from the storeroom.
Activity-based Costing (ABC):

ABC is a costing method that focuses on the costs of various activities which are performed to
produce the product. It is designed to provide managers with cost information for strategic and
internal decisions making.
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Activity-based management (ABM):

ABM is a management approach that focuses on managing activities as a way of eliminating waste
and reducing delays and defects.
Benchmarking:
Benchmarking is a standard for comparing the performance in an organization with the performance
of other organization.
Budget:
Budget is an estimation of revenue and expenditure for some future period.
• Deficit Budget: Excess of expenditure over revenue is called deficit budget.
• Surplus Budget: Excess of revenue over expenditure is called surplus budget.
Types of Budget:
• Cash budget: A detailed plan showing estimated cash inflows and cash outflows.
• Master Budget: A master budget comprises the budgeted cash flow, budgeted income statement
and budgeted balance sheet.
• Fixed Budget: Fixed budget is a budget for single level of activity. It remains constant regardless
of the change in production. Fixed budget is also called static budget.
• Flexible Budget: A budget designed to change as the volume of activity changes (vary with
production) is called flexible budget.
• Incremental Budget: A budget which is prepared using a previous period's budget as a basis with
incremental amounts added for the new budget period.
• Zero-based Budget (ZBB): A budget in which all expenses must be justified for each new period
as it starts from a zero base.
• Financial Budget: A financial budget presents a company's strategy for managing its assets, cash
flow, income, and expenses.
• Operating Budget: Operating budget is a forecast and analysis of projected income and expenses
for a specific time period.
• Mini Budget: An interim budget which revises or supplements fiscal policy, especially in
response to a deteriorating economic situation.
• Performance Budget: A budget which reflects the input of resources and the output of services
for each unit of an organization.
Budget Slack:
The deliberate overestimation of costs and underestimation of revenues in a budget is called budget
slack.
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Budget variance:
The difference between the actual fixed overhead and the budgeted fixed overhead in the flexible
budget is called budget variance.
Management by Exception:
A management system in which standards are set for various activities, with actual results compared
to these standards. Significant deviations from standards are flagged as exceptions.
Common fixed cost:

A fixed cost that supports more than one business segment, but is not traceable in any one of the
business segments is called common fixed cost e.g. salary of CEO.
Net Operating Income (NOI):

Net operating income is the same thing as earnings before interest and tax.
Margin:
Margin = net operating income ÷ sales
Turnover:
Turnover = sales ÷ average operating assets
• Operating Assets: Cash, accounts receivable, inventory, plant and equipment, and all other assets
held for operating purposes are known as operating assets.
Target Costing:
Target costing involves setting a price for the product and then getting the production costs in line
with the target price to earn profit.
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Financial Management Important Questions
FIANCIAL MANAGEMENT
Finance:
Finance is the science of money management.
• Corporate Finance: Corporate finance is the branch of financial economics concerned with
business funding, decision making, and mergers & acquisitions.
• Financial Management: Financial management is concerned with the acquisition, financing, and
management of assets with some overall goal in mind.
Decision Function of Financial Management:

• Investment: The investment decision involves a determination of the total amount of assets
needed, the composition of the assets, and whether any assets need to be reduced, eliminated, or
replaced.
• Financing: The financing decision involves determining the appropriate make-up of the right-
hand side of the balance sheet.
• Asset Management: The asset management decision involves efficiently managing the assets on
day-to-day basis, especially current assets.
Goal of the Firm:

The most appropriate goal of the firm is the creation of value for shareholders e.g. to maximize the
value of the firm’s common stock.
1. Shareholder wealth maximization is concerned with the maximization of a firm’s stock price.
2. Profit maximization is concerned with the maximization of a firm’s earnings after taxes.
Agency Theory:
Agency theory is concerned with the branch of economics relating the behavior of principals and their
agents.
• Agent: An individual authorized by another person e.g. principal to perform a task on his behalf.
In agency theory, shareholder would be an example of principal while manager would be an
example of an agent.
Stakeholders:
Stakeholders mean a person or group of persons who are interested in the financial reports of the
company and make decisions on the basis of these financial reports.
• Internal Stakeholders: employees and management
• Connected Stakeholders: shareholders, customers, suppliers and bankers
• External Stakeholders: government and pressure groups e.g. PEMRA
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Corporate Social Responsibility:

A concept that implies that the firm should consider issues such as protecting the consumer, paying
fair wages, and considering environmental issues is known as corporate social responsibility.
Corporate Governance:
Corporate governance is the system by which corporations are managed and controlled by senior
management. Three key groups in corporate governance are board of directors, executive officer and
common shareholders.
Financial Markets:
A market in which people trade financial securities such as stock and bonds is known as financial
markets.
• Primary Market: A market where new securities are bought and sold for the first time.
• Secondary Market: A market where existing securities are bought and sold.
• Money Market: A market where short-term government and corporate debt securities are traded.
• Capital Market: A market for relatively long-term financial instruments e.g. KSE
Financial Intermediary:
An institution that holds funds borrowed from lenders in order to make investment and to make loans
to borrowers e.g. commercial banks.
Time Value of Money:

Time value of money concept says that rupee in hand today is worth more than the rupee you are
going to get tomorrow.
Simple and Compound Interest:

• Simple Interest: Interest paid on only the original principal borrowed is often referred to as
simple interest.
• Compound Interest: Interest paid on both the original principal borrowed as well as on unpaid
interest is often referred to as compound interest.
Discount Rate:
Interest rate used to convert future values to present value is called discount rate and the process is
called discounting.
Compounding and Discounting:

Compounding is a way to determine current value of an investment to its future value while
discounting is a way to determine future value of an investment to its current value.
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Annuity:
A series of equal payments or receipts over a specified period of time is called annuity.
• Ordinary Annuity: An annuity whose payments occur at the end of each period.
• Annuity Due: An annuity whose payments occur at the start of each period.
• Perpetuity: Perpetuity is a type of annuity in which no time span is involved.
Liquidation Value verses Going-Concern Value:

• Liquidation Value: The amount of money that could be realized if an asset or a group of assets is
sold separately from its operating organization.
• Going-Concern Value: The value of share when it is sold as a continuing operating business.
Book Value verses Market Value:

• Book Value: The accounting value of an asset is called book value of an asset.
• Market Value: The value at which buyers and sellers are willing to buy and sell any asset.
Intrinsic Value verses Par Value:

• Intrinsic Value: Intrinsic value is the value of a security, which we expect the security “ought to
have.” It is also known as fair value of security.
• Par Value: The price which is mentioned on the security e.g. face value of share is Rs. 10. It is
also called face value or nominal value.
Difference between Bond, Share and Debenture:

• Bond: Bond is a long-term debt instrument issued by a corporation or company.
• Share: The total capital is divided into small individual units, each individual unit is called share.
• Debenture: Debenture is a long term unsecured debt instrument.
Difference between Bond Yield and Yield to Maturity:

• Bond Yield: Bond yield is calculated as annual interest divided by current price of bond.
• Yield to Maturity: The expected rate of return earned on a bond if it is held until maturity.
Common Stock and Preferred Stock:

• Common Stock: A type of stock that represents the ultimate ownership position in a company.
• Preferred Stock: A type of stock that has preference over common stock in the payment of
dividends and claims on assets.
Dividend Discount Model:

A model designed to compute the intrinsic value of common stock under specific assumptions (e.g.
growth rate is always higher than discount rate) is called dividend discount model.
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Risk:
Risk is the occurrence of unfavorable events. Following are two types of risk
• Systematic Risk: Systematic risk is the variability of return on stocks or portfolios associated
with changes in return on the market as a whole, also called undiversifiable risk or market risk.
• Unsystematic Risk: Unsystematic risk is the variability of return on stocks or portfolios not
explained by general market movements. It is avoidable through diversification therefore called
diversifiable risk or company specific risk.
Capital Asset Pricing Model (CAMP):

CAPM is a model that describes the relationship between risk and expected return.
Characteristic Line:
The characteristic line describes the relationship between an individual security's returns and returns
on the market portfolio.
Beta:
Beta is an index measure of systematic risk and slope of characteristic line.
Financial Statements:
Financial statements are the statements which show the financial performance as well as financial
position of the business. Financial statements include income statement, balance sheet, statement of
changes in equity and cash flow statement.
• Income Statement: The statement which shows the financial performance of the business during
a particular period is called income statement.
• Balance Sheet: The statement which shows the financial position of the business on a specific
date is known as balance sheet.
• Cash Flow Statement: The statement which shows the liquidity position i.e. changes in cash and
cash equivalents of operating, investing and financing activities of company.
• Statement of Changes in Equity: The statement which reports on the changes in equity of the
company during the stated period
• Notes to the Accounts: Notes to the accounts give additional information stated in financial
statements.
Financial Analysis:
Financial analysis is the process to analyze the financial statements of the company.
Financial Ratios
Financial ratio is an index that relates two accounting numbers and is obtained by dividing one
number by the other.
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Liquidity Ratios:
Ratios which measure a firm’s ability to meet short-term debt obligations are called liquidity ratios.
• Current Ratio: Current assets divided by current liabilities. Current ratio shows a firm’s ability
to cover the current liabilities with its current assets. Rule of thumb 2:1
• Quick (Acid Test) Ratio: Quick assets divided by current liabilities. Quick ratio shows a firm’s
ability to cover the current liabilities with its liquid assets. Rule of thumb 1:1
Quick Assets = Current Assets – (Inventory + Prepaid Exp)
• Absolute Liquid Ratio: Absolute liquid assets divided by current liabilities. It shows a firm’s
ability to cover the current liabilities with its most liquid assets. Rule of thumb 0.5:1
Absolute Liquid Assets = Cash + Bank + Marketable Securities
• Liquidity Index: Liquidity index is used to estimate the ability of a business to generate the cash
through accounts receivable and inventory to meet current liabilities.
Financial Leverage (Debt) Ratios:

Debt ratios state the extent to which the firm is financed with debt.
• Debt-to-Equity Ratio: Total debt divided by shareholders’ equity. It shows the extent to which
the firm is financed by debt.
• Debt-to-Total-Assets Ratio: Total debt divided by total assets. It shows the percentage of a
company's assets that are provided via debt.
• Times Interest earned: EBIT divided by interest expense. It shows the firm’s ability to pay
annual interest expense, also known as interest coverage ratio.
• Debt-Service Burden: The cash required during a specific period to meet interest expenses as
well as principal payments.
Debt Capacity: The maximum amount of debt a company can adequately service.
Activity Ratios:
Ratios measure how effectively the firm is using its assets are known as activity ratios.
• Inventory Turnover Ratio: cost of goods sold divided by average inventory. It measures the
number of times inventory is sold or used in one accounting period.
• Receivable Turnover Ratio: Net credit sales divided by average accounts receivable. It measures
how effectively a company is in extending credit as well as collecting debts.
• Payable Turnover Ratio: Net credit purchases divided by average accounts payable. It indicates
the speed with which payments are made to the trade creditors.
Operating Cycle and Cash Cycle:

• Operating Cycle: A firm's operating cycle is equal to its inventory turnover in days plus its
receivable turnover in days.
• Cash Cycle: A firm’s cash cycle is equal to operating cycle less payable turnover in days.
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Profitability Ratios:
Profitability ratios relate profits to sales and investments. These ratios indicate the firm’s overall
effectiveness of operations.
• Return on Equity (ROE): Earning after tax divided by shareholders equity. ROE ratio shows
that for each dollar in equity how much profit is generated by the company.
• Return on Investment (ROI): Earning after tax divided by shareholders fund or investment. ROI
ratio measures the efficiency of an investment.
• Return on Capital Employed: Earnings before interest and tax (EBIT) divided by average
capital employed. Capital employed = total assets – current liabilities (or)
Capital employed = equity + long term debt
Market Ratios:
Market value ratios relate the firm’s stock price to its earnings & book value per share.
• Dividend Payout Ratio: Dividend per share divided by earning per share.
• Earnings per share: Earnings after tax divided by no. of common shares outstanding.
• Dividend Yield: Dividend per share divided by market price per share.
• Price Earnings (P/E) Ratio: Market price per share divided by earnings per share.
Common-Size Analysis:
Common-size analysis is an analysis of percentage financial statements where all balance sheet items
are divided by total assets and all income statement items are divided by net sales or revenue is known
as common-size analysis.
Index Analysis:
Index analysis is an analysis of percentage financial statements where all balance sheet or income
statement figures for a base year equal 100 and subsequent financial statement items are expressed as
percentages of their values in the base year.
Funds Flow Statement:

Statement of sources and uses of funds is called funds flow statement. It shows the changes in
financial position of the firm.
Sources of funds = decrease in assets & increase in equity and liabilities
Uses of funds = increase in assets & decrease in equity and liabilities
Cash Flow Statement:

The statement which shows the liquidity position i.e. changes in cash and cash equivalents of
operating, investing and financing activities of company.
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Cash Budget:
Cash budget is a forecast of a firm’s future cash flows arising from collections and disbursements.
Sustainable Growth Rate (SGR):

The maximum annual percentage increase in sales that can be achieved based on dividend-payout
ratios is called SGR.
SGR = return of equity * (1 – dividend payout ratio)
Working Capital:
In finance ‘working capital’ is the same thing as current assets. In accounting working capital is
current assets less current liabilities.
Net Working Capital:

Net working capital refers to current assets less current liabilities.
Working Capital Management:

Working capital management means the management of current assets and financing needed to
support current assets.
Approaches to Financing:
• Conservative Approach: Conservative approach states that short term needs should be finance
with long-term debt.
• Hedging (Maturity Matching) Approach: Hedging approach states that short term needs should
be financed with short term funds and long-term minimum needs should be finance with long-
term funds.
• Aggressive Approach: Aggressive approach states that long-term needs should be financed with
short-term funds.
Motives for Holding Cash:

• Transactions Motive: to meet routine payments e.g. purchases
• Speculative Motive: to take advantage of temporary opportunities
• Precautionary Motive: to meet unexpected cash needs.
Outsourcing:
Outsourcing is the subcontracting a certain business operation to an outside firm instead of doing it
“in-house.”
• Business Process Outsourcing (BPO): BPO is a form of outsourcing in which an entire business
process is handed over to a third party service provider.
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Money Market Instruments:

Money market instruments are all government securities and short-term corporate obligation.
• T-bills: T-bills are short term debt issued by the federal government.
• Commercial Paper: Commercial paper is essentially a short-term unsecured corporate IOU.
Credit Standard:
The minimum quality of credit-worthiness of a credit applicant that is acceptable to the firm to make
credit sales.
Economic Order Quantity (EOQ):

EOQ is the order quantity that minimizes total inventory costs over the firm’s planning period.
Just-in-Time (JIT):
JIT is an inventory management approach in which material is purchased and inserted in production
only as needed to meet actual customer demand.
Capital Budgeting:
Capital budgeting is the process of identifying, analyzing and selecting the investment projects whose
cash flows are expected to extend beyond one year.
• Capital Budgeting Process:
Capital budgeting process includes the following steps;
1. Generate project proposals
2. Estimate after tax operating cash flows
3. Evaluate projects
4. Select value-maximizing projects
5. Perform a post-audit for completed projects
Capital Budgeting Techniques:

If a company intends to start a new project, capital budgeting technique are employed to assess the
financial viability of the project.
• Payback Period: Payback period is the time period required to recover the amount spent for
capital investment.
• Internal Rate of Return: IRR is the discount rate that equates the present value of the future net
cash flows from an investment with the project’s initial investment. If IRR is higher than cost of
capital (required rate of return), the project is acceptable.
• Net Present Value: NPV is the present value of project’s future net cash flows less the project’s
initial investment. If NPV is 0 or greater than 0 the project is acceptable.
• Profitability Index: PI is the ratio of the present value of a project’s future net cash flows to the
project’s initial investment. If PI is 1 or greater than 1 the project is acceptable.
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Difference between Sunk Cost and Opportunity Cost:

• Sunk Costs: Sunk costs are unrecoverable past outlays that are irrelevant to future decision
making.
• Opportunity Cost: The value of the benefit sacrificed when one course of action is chosen, in
preference to another.
Hurdle Rate:
The minimum required rate of return on an investment in a discounted cash flow analysis. Hurdle rate
is the rate at which a project is acceptable.
Capital Rationing:
Capital rationing selects the combination of investment proposals that will provide the greatest
increase in the value of the firm within the budget ceiling constraint.
Fisher’s Rate of Intersection:

The discount rate at which two projects have identical net present value is referred to as Fisher's rate
of intersection.
Types of Project:
Following are the three types of project;
• Independent Project: A project whose acceptance does not prevent or require the acceptance of
one or more alternative projects.
• Dependent Project: A project whose acceptance requires the acceptance of one or more
alternative projects.
• Mutually Exclusive Project: A project whose acceptance prevent the acceptance of one or more
alternative projects.
Post-Completion Audit:
A formal comparison of the actual costs and benefits of a project with original estimates is known as
post-completion audit.
Cost of Equity, Debt and Overall Capital:

• Cost of Equity Capital: It is the required rate of return on investment of the common
shareholders of the company.
• Cost of debt: It is the required rate of return on investment of the lenders of the company. Cost of
debt is represented by Kd.
• Overall Cost of Capital: It is the weighted average of cost of common equity, cost of preferred
stock, and cost of debt.
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Cost of Equity Approaches

• Dividend Discount Model: A model designed to compute the intrinsic value of common stock
through discount rate that equates the present value of all expected future dividends.
• Capital-Asset Pricing Model: CAPM is a model that describes the relationship between risk and
expected return. Ke = Rf + Bi (Rm – Rf)
• Before-Tax Cost of Debt plus Risk Premium: Ke is the sum of the before-tax cost of debt and a
risk premium in expected return for common stock over debt.
Economic Valued Added (EVA):

EVA is a measure of business performance. EVA is equal to after-tax net operating profit less cost of
financing the firm's capital.
Tax Shield:
Tax shield is basically the tax savings of the firm derived from the deductibility of interest expense.
Leverage:
Leverage is the use of fixed costs to increase the profitability of the firm.
• Operating Leverage: Operating leverage states how best fixed operating costs are being utilized
by the firm. Higher operating leverage increases risk due to higher percentage of fixed costs.
Operating Leverage = fixed costs ÷ total costs.
Degree of operating leverage = % change in EBIT ÷ % change is sales (1% change in sales will
lead to __% change in EBIT).
• Financial Leverage: Financial leverage states how best fixed financing costs are being utilized
by the firm. Higher financial leverage increases financial risk due to higher percentage of
financing costs. Financial Leverage = long term debt ÷ total assets
Degree of financial leverage = % change in EAT ÷ % change in EBIT (1% change in EBIT will
lead to __% change in EAT).
Total Firm Risk:

Total firm risk is the sum of business risk plus financial risk.
• Business Risk: Business risk refers to inherent uncertainty in the business operations
(without debt). It includes both company-specific and Market Risks.
• Financial Risk: It refers to risk faced by equity holders when debt is used by the firm.
Break-Even Analysis:
Break-even analysis is a technique for studying the relationship among variable and fixed costs, sales
volume, and profits of the firm. It is also called Cost Volume Profit (CVP) Analysis.
• Break-Even Point: A point where total revenues are total cost are equal is called break-even
point.
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EBIT-EPS Indifference Point:

EBIT-EPS indifference point is the level of EBIT that produces the same level of EPS for two or more
alternative capital structure.
Capital Structure:
Capital structure refers to the proportion of firm’s long permanent long-term financing. It includes
long-term debt, preferred stock, and common stock equity.
Capitalization Rate:
The discount rate used to determine the present value of cash flows is called capitalization rate.
Theories of Capital Structure:

• Net Operating Income Approach: A theory of capital structure in which weighted average cost
of capital and total value of firm remain constant as financial leverage is changed.
• Traditional Approach: A theory of capital structure in which there exists an optimal capital
structure therefore value of firm can be increased through proper use of financial leverage.
Optimal Capital Structure: The capital structure that minimizes the firm’s cost of capital and
maximizes total value of firm. (Combination of the net tax effect with bankruptcy and agency
costs will result in an optimal capital structure.)
Arbitrage:
Arbitrage is the process of buying the asset at lower price and selling the same at higher price in
another market.
Financial Signaling:
Financial signaling occurs when the manager of a firm uses capital structure changes to convey
information about the profitability and risk of the firm.
Dilution:
Dilution is decrease in EPS of existing shareholders because of the issuance of additional common
stock.
Stock Split:
An increase in the number of outstanding shares by reducing the par value of stock is known as stock
split.
Stock dividend:
Stock dividend is a payment of additional shares to shareholders in lieu of cash.
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Dividend Reinvestment Plan (DRIP):

An optional plan allowing shareholders to automatically reinvest dividend payments in additional
shares of the company’s stock is called dividend reinvestment plan.
Public Issue:
Sale of bonds or stock to the general public is called public issue.
Initial Public Offering (IPO):

A company’s first offering of common stock directly to general public is called IPO.
Lease:
Lease is a contract giving the right to lessee (user) to use the asset for specific time period, in return
for payment to lessor (owner).
• Operating Lease: Operating lease refers to a short-term lease that is often cancelable.
• Financial Lease: Financial lease is a long-term lease that is not cancelable and its life often
matches the useful life of the asset
Underwriting:
Underwriting occurs when the investment banker bears the risk of not being able to sell a new security
at the established price.
Fair Market Value:

The price at which an asset can be sold at arm’s length transaction is called fair market value.
Difference between Convertibles, Exchangeable and Warrants:

• Convertible Bond: Convertible bond is a bond that may be exchanged for common stock of the
same company.
• Exchangeable Bond: Exchangeable bond allows the holder to exchange the bond for
common stock of another company.
• Warrants: A warrant is a relatively long-term option to purchase common stock at a specified
exercise price over a specified period of time.
Derivative:
A financial asset which derives its value from some underlying asset is called derivative.
• Put Option: A contract that gives the holder the right to sell a specified quantity of the
underlying assets at a predetermined price on or before a fixed expiration date.
• Call Option: A contract that gives the holder the right to purchase a specified quantity of the
underlying assets at a predetermined price on or before a fixed expiration date.
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Hedging:
Hedging is a strategy that reduces the risk of future price fluctuation.
Restructuring:
Any change in a company’s capital structure, operations or ownership to make it more profitable is
known as corporate restructuring.
Merger:
The combination of two or more companies in which only one firm survives as a legal entity is known
as merger.
Consolidation:
The combination of two or more firms into an entirely new firm is called consolidation.
Acquisition:
When one company acquires all the assets or shares of another company is called acquisition.
• Strategic Acquisition: A firm that acquires another firm as part of its overall business strategy.
• Financial Acquisition: A firm that acquires another firm as part of its strategy to sell off assets,
cut costs, and operates the remaining assets more efficiently.
Strategic Alliance:
An agreement between two or more independent firm to cooperate in order to achieve some specific
commercial objective is called strategic alliance.
• Joint Venture: A business venture jointly owned and controlled by two or more independent
firm.
• Outsourcing: Outsourcing is the subcontracting a certain business operation to an outside firm
instead of doing it “in-house.”
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Auditing Important Questions
AUDITING
Audit:
Audit is an independent examination of books of accounts by professional accountants with a view to
express an opinion on financial statements.
Objectives of Audit:
• Primary Objective: Primary objective is to express an opinion on financial statements (through
audit report).
• Secondary Objective: Secondary objective is to detect and prevent errors and frauds.
Types of Errors:
• Error of Omission: When a transaction has been completely omitted to record in the book of
accounts is called error of omission.
• Error of Commission: When an account or amount is recorded incorrectly on the wrong side of
the same account is called error of commission.
• Compensatory Error: An error which is committed to compensate the effect of first error is
called compensatory error.
• Principle Error: Errors committed due to non-compliance of accounting rules & regulations are
called principle errors.
a. Incorrect Allocation: These errors occur when there is an incorrect distinction between the
capital and revenue expenditure.
b. Incorrect Valuation: These errors occur when assets and liabilities are not valued according
to Generally Accepted Accounting Principles.
Error & Fraud:

• Error: Unintentional mistake in the books of accounts is known as error.
• Fraud: An intentional mistake committed by management in the books of accounts is known as
fraud.
Internal Control:
All policies and procedures established to achieve the objective of management is known as internal
control. Components of internal control are internal audit and internal check.
• Internal Audit: Internal audit is the audit which is undertaken by employees of the organization
to check financial irregularities. Internal Auditor is more likely to be concerned with operational
auditing.
• Internal Check: Checking the work of one person by another automatically. Objective of internal
check is to prevent errors and frauds.
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Types of Audit (in terms of timing):

Following are three types of audit in terms of timing;
• Final Audit: Audit of accounts which is conducted after the end of the financial year is called
final audit. It is also known as balance sheet audit.
• Continuous Audit: The audit which remains continue throughout the financial year is called
continuous audit. It is also called detailed audit.
• Interim Audit: Audit which is conducted between two final audits to find out and check interim
profits of a company is called interim audit.
Types of Audit:
• Compliance Audit: Audit which is conducted to determine whether the company is following
specific procedures e.g. rules and regulations set by higher authority is called compliance audit.
• Operational Audit: Audit which is conducted to determine the operational efficiency and
effectiveness of company is called operational audit. It is also known as management audit.
• Special Audit: Special audit is conducted to find out the fraud or misuse of public funds is an
organization.
Audit Engagement Letter:

Audit engagement letter defines the legal relationship between auditor and his client. The letter is
written by the auditor in response to appointment letter before the commencement of audit work.
Audit Plan:
Audit plan is a specific guideline to be followed when conducting an audit. It helps the auditor to
obtain appropriate audit evidence.
Audit Programme:
Audit programme is a written plan which includes audit procedures to be carried out during the course
of audit.
Audit Working Papers (Audit File):

Audit working papers are the documents which record all the audit evidence obtained during the
course of audit.
• Permanent Audit File: Permanent audit file consist of matters which are long-term in nature e.g.
copy of memorandum and articles of association.
• Current Audit File: Current audit file consists of matters relating to the year of audit e.g. audit
planning.
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Tests of Control (Compliance Tests):

Tests of control are performed to obtain audit evidences of both effectiveness of the design of
accounting system and internal control system.
Substantive Procedures:
Substantive tests are performed to obtain audit evidence to detect material misstatements in financial
statements. Substantive tests are of two types; tests of details and analytical procedures.
• Analytical Procedures: Analytical Procedures include comparison of financial information with
prior period information, budgets, forecasts, similar industries and so on.
• Inspection: Visual examination of accounting records & schedules to identify unusual items or
inconsistencies is called inspection.
• Observation: Observation means looking at certain procedures performed by others to obtain
audit evidence such as observing the stock taking.
• Inquiry: Inquiry is the process of obtaining information directly from the client’s staff who is
familiar with the subject matter.
Management Representations Letter:

Management representation letter is issued by the management of the company that they are
responsible for the information stated in financial statement, it is considered as audit evidence.
Management Letter:
The letter issued by the auditor to his client describing the weaknesses in the system observed during
the course of audit work is referred to as management letter.
Test Checking:
Test checking refers to intensive checking of selected number of transactions.
Vouching:
Vouching is the process of examining the vouchers to check the authenticity of accounting records.
Voucher:
Written evidence in support of a business transaction is called voucher.
Verification:
Verification is the process of examining the physical existence, accuracy and ownership of asset as
well as valuation of assets.
Investigation:
Examination of accounting records undertaken for a special purpose is called investigation.
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Types of Audit Reports:

1. Annual Report: Annual report states fairness about Profit & Loss A/C and Balance Sheet.
2. Prospectus Report: Prospectus report is about performance of company.
3. Statutory Report: Statutory report is about shares allotment and receipts & payments.
Types of Annual Reports:

Following are the four types of annual reports;
1. Unqualified Audit Report: Unqualified audit report is issued when financial statements are
prepared in accordance with the Companies Ordinance 1984 and Generally Accepted Accounting
Principles.
2. Qualified Audit Report: Qualified report is issued when auditor is able to form an opinion but
there is limitation on scope of auditor’s work and auditor’s is in disagreement with management
on certain issues.
3. Disclaimer of Opinion Report: Disclaimer of Opinion report is issued when auditor is unable to
form and express an opinion due to limitation on scope of auditor’s work which is considered to
be of fundamental importance.
4. Adverse Opinion Report: Adverse opinion report is issued when financial statements of a
company are materially misstated and not prepared in accordance with Companies Ordinance
1984 and GAAP.
Auditors’ Liability:
1. Liability for Negligence: If the auditor does not perform his duties with reasonable care and skill
e.g. fails to examine the books of accounts, he may be held liable for negligence.
2. Liability for Misfeasance: If auditor fails to disclose the material items in financial statements,
he may be held liable for misfeasance.
3. Liability to Third Party: If third party suffer loss by relying on the financial statements certified
by the auditor, the auditor may be liable for liability to third party.
4. Criminal Liability: If an auditor intentionally and willfully certifies wrong books of accounts
and financial statements to deceive shareholders, he may be held liable for criminal liability.
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Economics Important Questions
ECONOMICS
Economics:
Economics is a social science which studies how to use scarce resources to satisfy human needs and
wants. (In economics scarcity means limited resources.)
• Micro Economics: Micro economics is the study of individual units of economy e.g. consumer
behaviour.
• Macro Economics: Macro economics is the study of economy as whole or in aggregate form
such as GDP.
Inductive & Deductive Method:

• Inductive Method: Inductive method is the process of reasoning from particular facts to general
principle.
• Deductive Method: Deductive method is the process of reasoning from general to particular.
Economics is Science or Art:

Economics is both science and art. Economics is science because it uses scientific methods and
economics is an art because it presents solution of economic problems.
Opportunity Cost:
The value of the benefit sacrificed when one course of action is chosen; in preference to another is
called opportunity cost.
Utility:
Utility is the power of a good or service by which a human want is satisfied e.g. bread satisfies
hunger.
• Marginal Utility: Marginal Utility is the change in total utility due to one unit change in quantity
consumed.
Consumer Surplus:
Consumer surplus is the difference between the price that a consumer is willing to pay and the price
that he actually does pays for a commodity.
Marginal Rate of Substitution (MRS):

MRS is the rate of exchange between two commodities which are equally preferred by the consumer.
Budget Line (Price Line):

Budget line shows different combinations of two commodities which can be purchased with a given
money income and prices of two commodities.
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Indifference Curve:
A curve which shows different combinations of two commodities that give the same level of
satisfaction to a consumer is called indifference curve.
• Indifference Map: Indifference map is a set of indifference curves showing lower and higher
level of satisfaction.
Demand:
Demand is the combination of two components; desire to purchase the product and power to purchase
the product.
• Law of Demand: Law of demand states increase in price will lead to decrease in quantity
demanded and decrease in price will lead to increase in quantity demanded.
Slope of demand curve is negative due to inverse relationship between price and quantity
demanded.
Elasticity of Demand (Ed):

Ed is the ratio of percentage change in quantity demanded due to percentage change in price.
Difference between Reserve Price & Floor Price:

• Reserve Price: Reserve price is the minimum price below which a seller is not willing to sell the
commodity.
• Floor Price: Floor price is the minimum price which is determined by the government.
Normal Goods:
Normal goods are those goods for which income elasticity of demand is positive i.e. if income
increases then demand for normal goods increases while price remains constant.
• Luxury Goods: Luxury goods are those goods whose elasticity is more (income increases
demand increases and vice versa) than one in responsiveness to income changes.
• Necessary Goods: Necessary goods are those goods whose elasticity is less than one in
responsiveness to income changes.
Difference between Giffen Goods & Inferior Goods:

• Giffen Goods: Giffen goods are the type of inferior goods for which demand increases as the
price increases and demand decreases as the price decreases.
• Inferior Goods: Inferior goods are those goods for which the income elasticity of demand is
negative i.e. if income increases then demand for inferior goods decreases.
Complementary Goods:
Complementary goods are those goods whose use is interrelated with the use of paired goods. Ink is
complement for pen.
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Supply:
Supply is that part of stock which a supplier is willing to offer for sale at a given price.
• Law of Supply: Law of supply states that increase in price increase in quantity supplied and
decreases in price decrease in quantity supplied.
Market:
Market is a place where goods are bought and sold between buyers and sellers.
• Free Market: Free market is a market in which the price is determined by the market forces i.e.
demand and supply.
Market Equilibrium:
Market equilibrium is a point where market forces such as demand and supply are balanced.
Market Price or Equilibrium Price:

The price which is determined by the market forces such as demand and supply is called market price.
Equilibrium price = price at which quantity demand is equal to quantity supplied.
Factors of Production:
Land, labour, capital and organization are four factors of production (inputs).
Forms of Market:
• Monopoly: Monopoly is a form of market in which there is only single seller in the market.
• Duopoly: Duopoly is a form of market in which there are two firms having a complete control
over the market.
• Oligopoly: Oligopoly is a form of market in which few firms have control over the market.
• Competition: Competition is a form of market in which there are large number buyers and
sellers.
Monopolistic Competition:
Monopolistic competition is that market situation in which both monopoly and competition co-exist.
Profit:
Profit is the difference between total revenue and total cost.
• Normal Profit: AR = AC (or) TR = TC
• Abnormal Profit: AR > AC (or) TR > TC
Price Discrimination:
If producer or seller charges different price from different consumers of the same product is known as
price discrimination.
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Dumping:
A sale of goods to a foreign market at a price much lower than the current market price is called
dumping. This is done to capture the foreign market.
National Income:
National income is the total amount of money earned within a country.
Gross Domestic Product (GDP):

GDP is the monetary value of all the goods and service produced in a country within a year.
Gross National Product (GNP):

GNP is the total monetary value of all final goods and services produced in the country within a year.
GNP = GDP + Income from abroad – income of foreigners
Net National Product (NNP):

NNP = GNP - Depreciation
Net National Income:

NNI = NNP + Subsidies – indirect taxes
Personal Income:
Personal income is the total income received by a person from all sources.
Disposable Personal Income (DPI):

DPI = Personal income – direct taxes
Per Capita Income:

Average income of the people of a country during a particular year is called per capital income.
Per capital income = National income ÷ total population
Difference between Nominal GDP & Real GDP:

• Nominal GDP: When all the components of GDP are valued at the current market price, is called
nominal GDP.
• Real GDP: When all the components of GDP are valued at constant prices, is called real GDP.
Real GDP consider the effect of inflation.
Black Money:
Money earned through illegal and underground activities (e.g. income from smuggling) which is not
declared for taxation purpose is called black money.
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Public Finance:
Public finance is the management of income and expenditure of the government.
Fiscal Policy:
Government policy on taxation, public borrowing and public spending is called fiscal policy.
Monetary Policy:
Monetary policy is mainly concerned with dealing how much money the community should have or
perhaps more correctly deciding whether to increase or decrease the volume of purchase power.
Tax:
Tax is a compulsory payment to the government for which no direct benefit is given.
• Direct Tax: A tax which is paid by the person on whom it is levied e.g. income tax is called
direct tax.
• Indirect Tax: A tax whose burden can be shifted to another person e.g. sales tax is called indirect
tax.
• Proportional Tax: Proportional tax is the tax in which tax is charged with the same rate of tax
from each taxpayer, irrespective of income e.g. sales tax.
• Regressive Tax: A tax is a tax which takes a higher proportion of tax as income decreases and
vice versa is regressive tax (income increase tax rate decrease and income decrease tax rate
increase).
• Progressive Tax: A tax is a tax which takes a higher proportion of tax as income increases and
vice versa is progressive (income increase tax rate increase and income decrease tax rate
decrease).
Balance of Payments (BoP):

BoP is the systematic record of all receipts and payments for both visible and invisible items of a
country with the rest of the world (visible items computer hardware while invisible items are
computer software). Final BoP should always be balanced.
• Current Account: Current account is that part of BoP in which receipts and payments of imports
and exports of goods and services are recorded.
• Capital Account: Capital account is that part of BoP in which foreign investment in Pakistan and
Pakistan’s investment in foreign countries are recorded.
Balance of Trade:
BoT is a systematic record of visible items (import & export of physical goods) of a country with the
rest of the world.
• Balance of trade will be negative when exports are less than imports.
• Balance of trade will be positive when exports are more than imports.
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Foreign Exchange Rate:

Exchange rate is the rate at which currency of one country can be exchanged for currency of another
country (price of one country’s currency in terms of another country’s currency).
• Flexible Exchange Rate: The exchange rate for currencies which is determined by the market
forces i.e. supply and demand. It is also called floating exchange rate.
• Fixed Exchange Rate: The rate which remains constant against the value of another currency.
Difference between Capitalism & Socialism:

• Capitalism: Capitalism refers to the private ownership of capital goods. In capitalism prices are
determined by market forces i.e. demand and supply.
• Socialism: Socialism refers to an economic system in which there is little private ownership and
state owns virtually all the factors of production.
• Communism: Communism refers to an economic system in which government owns all the
factors of production. In communism economic system prices are set by govt.
Tariff:
Tariff is the duty paid by the importer on imports of goods.
Imports Quotas:
Import quota is a limit on the quantity of goods that can be produced imported.
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38 | P a g e
Commerce Important Questions
COMMERCE
Business:
Any legal activity which is done for the purpose of earning profit is called business.
• Commerce: Commerce includes all those activities which are related with buying and selling of
goods and services.
• Industry: Industry includes all those activities which are related with manufacturing (converting
raw material into finished goods) or production of goods and services.
o Extractive Industry: The industry which is related with extraction of hidden resources from
the surface of earth e.g. mining.
o Genetic Industry: The industry which is related with growing of plants and animals e.g. fish
farm.
o Constructive Industry: The industry which is related with construction of roads, dams and
building etc.
o Manufacturing Industry: The industry which is related with converting raw material into
finished goods e.g. textile mill.
Entrepot Trade:
When goods are imported from one country with a view to re-export them to other country is known
as entrepot trade.
Partnership:
Partnership is relation between persons who have agreed to share profits of business carried on by all
or any one of them acting for all.
Rules Applicable in the Absence of Partnership Agreement:

1. Partners shall share equal profit & loss.
2. Partner shall be entitled to interest @ 6% per annum on loan advanced by him to the firm.
3. Partner is not entitled to any salary for taking part in conduct of business.
4. No partner is entitled to interest on capital.
5. No interest on drawing is to be charged by firm.
Unlimited Liability:
Unlimited liability means if business is unable to pay debts then personal property of owner can be
sold to pay off business debt.
Nominal Partner:
Nominal Partner: The person whose name is used in business due to his goodwill. He does not invest
capital but receives profit for the usage of his name.
39 | P a g e
Company:
Company is an artificial person created by law with perpetual succession and common seal.
• Perpetual Succession: It means that the life of company is infinite.
• Common Seal: Common seal is company’s stamp which is used in agreement for signatures.
Types of Company:
• Chartered Company: A company which is formed by the order of Queen or King e.g. East India
Company.
• Statutory Company: A company which is formed by special act of parliament or by the order of
head of state e.g. State Bank of Pakistan.
• Registered Company: A company which is formed and registered under Co. Ordinance 1984 e.g.
Pakistan Petroleum Ltd.
• Company Limited by Shares: A company in which the liability of members is limited up to the
face value of their shares e.g. SNGPL.
• Company Limited by Guarantee: A company in which members give a guarantee to contribute
a specific amount to the assets of the company on its winding up e.g. KSE.
• Unlimited Company: A company in which the liability of members is unlimited.
Basic Legal Document of Co:

The documents which are required for the registration of company are three basic legal documents.
• Memorandum of Association: Memorandum of association is most important legal document of
company which includes object of formation. It is the contract between the company and its
shareholders.
• Articles of Association: Articles of association includes the internal rules and regulations for
internal management to govern the company.
• Prospectus: Prospectus is an advertisement to general public for the sale of share to raise capital.
Difference between Holding Co & Subsidiary Co:

• Holding Company: A company which holds more than 50% shares of another company
(subsidiary company) e.g. PSO is the holding PICIC.
• Subsidiary Company: A company whose more than 50% shares are held by another (holding)
company e.g. PICIC is the subsidiary of PSO.
Promoters:
The promoters is a person who initially takes all necessary steps to form a company.
Formation of Company:
Formation of company includes three steps; promotion stage, incorporation stage and certificate of
commencement.
40 | P a g e
Meetings of Company:
A meeting in which directors and shareholders decide the company’s matter is called meeting of
company;
• BOD Meeting: A meeting in which board of directors decide the company’s matter.
• Shareholders Meeting: shareholders meeting is called to discuss the company’s affairs with
shareholders.
o Statutory Meeting: The first meeting of shareholders of company.
o Annual General Meeting (AGM): AGM is the annually meeting of shareholders in which
annual performance of company is discussed.
o Extra-ordinary General Meeting: The meeting which is conducted for particular and urgent
nature of work which cannot be postponed till next AGM.
Resolution:
The formal expression of opinion obtained by the majority votes of members is known as resolution.
• Ordinary Resolution: A resolution which is passed by the simple majority of members.
• Special Resolution: A resolution which is passed by three fourth (3/4) majority of members.
• Extra-ordinary Resolution: A resolution which is passed by three fourth (3/4) majority of
members on special notice of 14 days.
Co-operative Society:
Co-operative society is an association of persons who voluntarily pool their resources for mutual
welfare of members.
Business Combination:
Business combination is the joining of two or more companies to form a single company for better
business activities.
• Horizontal Combination: When two or more similar nature of business units are combined
under one management is called horizontal combination.
• Vertical Combination: When two or more different nature of business units are combined under
one management is vertical combination.
Difference between Amalgamation & Merger:

Amalgamation: When two or more existing companies lose their separate entity to form a new
company is called amalgamation.
Merger:
When a company purchases the business of another company in which acquiring company retains its
identity is called merger.
41 | P a g e
Difference between Pool and Cartel:

• Pool: Pool is the combination of companies dealing in similar products to regulate the demand
and supply without losing their separate entities.
• Cartel (Syndicate): Cartel or Syndicate is a group of similar nature of companies formed to
regulate the price.
Bill of Lading:
If goods are to be dispatched by ship from one place to another the receipt issued by shipping
company is called bill of lading.
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42 | P a g e
Money, Banking & Finance Important Questions
MONEY, BANKING & FINANCE
Barter System:
Barter system is direct exchange of goods and services without use of money.
Money:
Money is anything which is commonly used & generally accepted as a medium of exchange or as a
standard of value.
Metallic Money:
The money which is made of any material such as gold, silver etc. is called metallic money.
• Full Bodied Coins: Money whose face value is equal to the value of metal used in money.
• Token Money: Coins whose face value is greater than the value of metal used in money.
Paper Money:
Paper money means the currency notes issued by the central bank on behalf of the government.
• Representative Paper Money: Representative Paper money is that money which is fully backed
by gold or metallic reserves.
• Convertible Paper Money: The money which can be converted into gold or silver reserves is
known as convertible paper money.
• Inconvertible Paper Money: The money which is not convertible into gold or silver is called
inconvertible paper money.
• Fiat Money: Fiat money is inconvertible money having face value more than its real value. It is
accepted as the order of govt. as it is used as a medium of exchange and standard of value.
Legal Tender Money:

Anything declared by the state as money is legal tender money.
• Limited Legal Tender: The money that can only be used up to a certain limit is limited legal
tender e.g. coins in Pakistan.
• Unlimited Legal Tender: The money that can be used up to any limit is unlimited legal tender
e.g. currency notes in Pakistan.
Plastic Money:
Plastic money means credit cards and other plastic cards that serve as the purpose of money.
Near Money:
Near money is that money which can be converted into actual money for making payments e.g.
cheque
43 | P a g e
Principles of Note Issue:

1. Currency Principle: According to currency principle, central bank must keep 100% gold
reserves against each and every note issued. These notes are convertible into gold on demand.
2. Banking Principle: In banking principle, there is no need of reserve requirement of gold and
silver for note issue. Only a percentage of notes in circulation should be covered by gold.
Methods of Note Issue:

1. Fixed Fiduciary System: In fixed fiduciary method, central bank issues a fixed amount of notes
without keeping any metallic reserves. Fixed amount is called fiduciary limit. But all notes issued
above this limit must be covered by 100% gold reserves.
2. Proportional Reserve System: In proportional reserve method, central bank is required to keep a
certain percentage of gold or silver reserve generally from 25% to 40% to issue the notes and
remaining notes are covered by securities. This system was followed in Pakistan till 1965.
3. Minimum Reserve System: In minimum reserve system, central bank keeps only a minimum
amount of reserves against all the notes issued. The reserve may be in the form of gold, silver or
foreign exchange. This system is followed in Pakistan since 1965.
Quantity Theory of Money (QTM):

QTM states that price is the function of quantity of money in circulation P = f(q). If quantity of money
in circulation increases, the price level also increases and vice versa.
Trade Cycle (Business Cycle):

Business cycle is the fluctuation in the economic activities i.e. production and sales etc.
• Boom: Boom is the best economic situation with rapid increase in overall business activities.
• Recession: During recession, business activities start declining i.e. slow down of business.
• Depression: Depression means business slump which is the worse economic situation with rapid
decrease in overall business activities.
• Recovery: Recovery is the revival of business activities. In recovery, business activities flourish
and profits begin to reappear.
Inflation:
Inflation is the persistent increase in general price level.
Difference between Demand-pull and Cost Push Inflation:

• Demand-Pull Inflation: When the demand for goods is more than the supply then there will be
increase in the price level, it is called demand-pull inflation.
• Cost Push Inflation: When there is an increase in the cost of production, there will be an increase
in the price level, it is called cost push inflation.
44 | P a g e
Difference between Creeping & Hyper Inflation:

• Creeping Inflation: When the increase in price level is very slow i.e. up to 2%.
• Hyper Inflation: When the general price level increases rapidly i.e. above 50%.
Difference between Monetary & Budgetary Inflation:

• Monetary Inflation: When there is expansion in currency notes in circulation there will be
monetary inflation.
• Budgetary Inflation: When the govt. covers the budget deficit by borrowing then there will be
budgetary inflation.
Deflation:
Deflation is a general decrease in price level and increase in the purchasing value of money.
Devaluation:
Devaluation means decrease in the value of currency.
Foreign Exchange Rate:

Exchange rate is the rate at which currency of one country can be exchanged for currency of another
(price of one country’s currency in terms of another country’s currency).
• Flexible Exchange Rate: The exchange rate for currencies which is determined by the market
forces i.e. supply and demand. It is also called floating exchange rate.
• Fixed Exchange Rate: The rate which remains constant against the value of another currency.
Difference between Spot Rate & Forward Rate:

• Spot Rate: Spot rate means the exchange rate at the spot or at the moment i.e. market price.
• Forward Rate: The rate at which foreign currency will be purchased and sold for future
transactions.
Inter-Bank Rate:
The rate at which central bank and commercial banks sell and buy foreign exchange is called inter-
bank rate.
Central Bank:
Central bank is an institution which is charged with the responsibility of managing the expansion and
contraction of the volume of money in the interest of general public welfare.
45 | P a g e
Bank:
Bank is an institution which receives deposits and advances loans.
• Schedule Bank: The bank with is registered with State Bank and have a minimum paid up capital
reserve of Rs. 6 billion.
• Non-Schedule Bank: The bank which is not included in the second schedule of SBP Act 1956 is
known as non-schedule bank.
Mortgage Bank:
The bank which provides loans against immovable property e.g. loan against land and building.
Relationship between Bank and Customer:

• Mortgager & Mortgagee: If bank provides loans against immovable property e.g. loan against
land and building, then customer is mortgager and bank is mortgagee.
• Pledger & Pledgee: If bank provides loans against movable property e.g. loan against goods,
then customer is pledger and bank is pledgee.
• Bailer & Bailee: When the customer keeps his valuable goods with the bank for safe custody
then customer is bailer and bank is bailee.
• Lessor & Lessee: When the bank provides an asset to customer on the basis of lease financing
then bank is lessor and customer is lessee.
Overdraft:
Bank overdraft means excess of withdrawal over deposits. O/D facility is provided to only current
account holder.
Credit Creation:
Credit creation is an increase in quantity of money through new deposits in the name of borrowers by
the bank.
• Required Reserve Ratio: Required reserve ratio means that each bank is required to keep 20% of
its liabilities as cash.
Cheque:
Cheque is a bill of exchange drawn on a specified banker and not expressed to be paid otherwise than
on demand.
• Crossing of Cheque: A cheque is said to be crossed when two transverse parallel lines are drawn
on its face with or without some words.
Guarantee:
Guarantee is a contract to perform the promise, or to discharge the liability of a third person in case of
his default.
46 | P a g e
Lien:
Lien is the right of a person to retain the property in possession till all the dues are cleared.
Nationalization of Banks:
Nationalization is the process of converting a privately owned business into government ownership.
In 1974, 13 commercial banks were merged to form 5 nationalized banks i.e. HBL, UBL, ABL, MCB
& NBP.
Privatization of Bank:
Privatization is the process of converting a business from public to private ownership. In 1991,
commercial banks were privatized.
Letter of Credit (L/C):

Letter of Credit is a written instrument issued by the import’s bank that the importer’s bank will make
payment to exporter if importer does not make the payment.
Monetary Policy:
Monetary policy is mainly concerned with dealing how much money the community should have or
perhaps more correctly deciding whether to increase or decrease the volume of purchase power.
Quantitative Tools of Monetary Policy:

1. Open Market Operation: Sale and purchase of securities in open market by the central bank is
called open market operation. Bank of Sweden used this method for the 1st time.
• In inflation, central bank sells the securities to reduce the money supply
• In deflation, central bank purchases the securities to increase the money supply.
2. Credit Rationing (Credit Ceiling): Central bank puts limit for the grant of credit. Bank of
England used this method for the 1st time.
• In inflation, central bank decreases the credit limit
• In deflation, central bank increases the credit limit.
3. Bank Rate / Discount Rate Policy: Bank rate means the rate of interest at which commercial
banks get loans from the central bank. Discount rate means the rate of rediscount at which the
commercial banks rediscounts their bills of exchange from the central bank. Bank of Sweden used
this method for the 1st time.
• In inflation, central bank increases the bank rate & discount rate to reduce the credit volume.
• In deflation, central bank decreases bank rate & discount rate to increase money supply.
4. Change in Reserve Ratio: All the scheduled commercial banks are required to keep a certain
percentage (20%) of their deposits with the central bank, it is known as reserve ratio.
• In inflation, central bank increases the cash reserve ratio to reduce the credit volume.
• In deflation, central bank decrease the cash reserve ratio to increase the credit volume.
47 | P a g e
ISLAM MODES OF FINANCING:

Services Charge Loans:
Under this system the bank advances loans with full guarantee of repayment of principal sum.
However at the time of returning principal sum a service charge is paid by the borrower to the bank.
In this way interest is replaced by services charges.
Mark Up Financing:
If a seller agrees with his purchase to provide him a specific commodity on a certain profit added to
his cost, is called mark up financing or murabahah. This system is based on “cost plus profit concept.”
Buy Back Agreement (Mark Down):

In this system the seller will sell his property to bank with the promise that he will purchase back in
future. The bank makes whole payment in cash. Afterwards the client buys back the same property at
some higher price in future.
Leasing:
In simple words leasing is a contract whereby the lessee uses an asset which is owned by the lessor.
The lessee pays monthly or annual rent for the uses of the asset and ownership remains with the
lessor.
Hire Purchase:
Under this system, the bank purchases the required asset at the request of the client. After that the
bank hires the asset to the client and client makes payment in installments. The asset remains in
bank’s ownership till al the payments are made by the hirer.
Musharakah:
Musharakah is a system in which partners joins their hands on the basis of profit and loss sharing. The
partners can contribute their money, skills and efforts of these items.
Modaraba:
Under this system, a bank invests money in the business and client invests his knowledge and
services. The investor is called “rab-ul-mall” and the client becomes “modarib”. The profit will be
shared by both while the loss will bear by the “rab-ul-mall”.
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48 | P a g e

COMMERCE KEY TERMS

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Qualitative Characteristics of Accounting Information System:

Generally Accepted Accounting Principles (GAAP):

International Accounting Standards (IAS)

International Financial Reporting Standards (IFRS)

Types of Accounting System:

Five Pillars of Financial Accounting:

Difference between Expense & Expenditure:

Difference between Trade Discount & Cash Discount:

Journal and Journalizing:

Debit Note & Credit Note:

Types of Cash Book:

Petty Cash Book:

Bank Reconciliation Statement:

Profit & Loss Account:

Real & Fictitious Assets:

Differentiate reserve and reserve fund.

Revenue Reserves & Capital Reserves

Prepaid Expenses & Outstanding Expenses:

Accrued Revenue & Unearned Revenue:

Cost of Goods Sold:

Difference between Bad Debts and Bad Debts Recovered:

Capital & Revenue Expenditure

Deferred Revenue Expenditure:

Straight Line / Fixed Installment Method:

Declining/Diminishing Balance Method:

Sinking Fund Method:

Machine Hour Rate Method:

COST & MANAGEMENT ACCOUNTING

Difference between Product and Period Cost

Difference between Fixed & Variable Cost:

Sunk Cost, Opportunity Cost & Avoidable Cost:

Cost-volume-profit (CVP) graph:

Break-Even (CVP) Analysis:

Target Profit Analysis:

Material Requisition Form:

Activity-based Costing (ABC):

Activity-based management (ABM):

Common fixed cost:

Net Operating Income (NOI):

Decision Function of Financial Management:

Goal of the Firm:

Corporate Social Responsibility:

Time Value of Money:

Simple and Compound Interest:

Compounding and Discounting:

Liquidation Value verses Going-Concern Value:

Book Value verses Market Value:

Intrinsic Value verses Par Value:

Difference between Bond, Share and Debenture:

Difference between Bond Yield and Yield to Maturity:

Common Stock and Preferred Stock:

Dividend Discount Model:

Capital Asset Pricing Model (CAMP):

Financial Leverage (Debt) Ratios:

Operating Cycle and Cash Cycle:

Funds Flow Statement:

Cash Flow Statement:

Sustainable Growth Rate (SGR):

Net Working Capital:

Working Capital Management:

Motives for Holding Cash: