1.

People Face Tradeoffs

o To get one thing, we usually have to give up something else

▪ Ex. Leisure time vs. work

2. The Cost of Something is What You Give Up to Get It

o Opportunity cost is the second best alternative foregone.

▪ Ex. The opportunity cost of going to college is the

money you could have earned if you used that time to

work.

3. Rational People Think at the Margin

o Marginal changes are small, incremental changes to an existing

plan of action

▪ Ex. Deciding to produce one more pencil or not

 o People will only take action of the marginal benefit exceed the

marginal cost

4. People Respond to Incentives

o Incentive is something that causes a person to act. Because people

use cost and benefit analysis, they also respond to incentives

▪ Ex. Higher taxes on cigarettes to prevent smoking

5. Trade Can Make Everyone Better Off

o Trade allows countries to specialize according to their

comparative advantages and to enjoy a greater variety of goods

and services

6. Markets Are Usually a Good Way to Organize Economic Activity

o Adam Smith made the observation that when households and

firms interact in markets guided by the invisible hand, they will

produce the most surpluses for the economy

7. Governments Can Sometimes Improve Economic Outcomes

o Market failures occur when the market fails to allocate resources

efficiently. Governments can step in and intervene in order to

promote efficiency and equity.

8. The Standard of Living Depends on a Country's Production

o The more goods and services produced in a country, the higher the

standard of living. As people consume a larger quantity of goods

and services, their standard of living will increase

9. Prices Rise When the Government Prints Too Much Money

 o When too much money is floating in the economy, there will be

higher demand for goods and services. This will cause firms to

increase their price in the long run causing inflation.

10. Society Faces a Short-Run Tradeoff Between Inflation and

Unemployment

o In the short run, when prices increase, suppliers will want to

increase their production of goods and services. In order to

achieve this, they need to hire more workers to produce those

goods and services. More hiring means lower unemployment

while there is still inflation. However, this is not the case in the

long-run.

Income Statement

Meaning of Income Statement

The income statement is a company’s one of the most important financial statement that
indicates profit and loss for an accounting year. This profit or loss is evaluated by adding all
revenues and then subtracting the expenses from operating and non-operating activities.
Corporate finance and accounting use the income statement as one of the significant financial
statements. This income statement includes gross profit, revenue, costs, taxes paid, net profit,
selling and administrative expenses, other expenses, and income, etc.
This income statement is used as a great base to start a financial report because most of the
information is available in this statement.

Components of an Income Statement

Most of the companies have similar components; however, due to the company’s expense,
income and operation type of operations, there are few variations.
The most basic income statement components are:

• Revenue/Sales – At the top of the statement, every firm’s sales and service revenue
are shown.
• Cost of Goods Sold (COGS) – It is a line-item that sums up the direct costs related to
goods sold to make revenue. If the company is a service business, COGS is also
known as the cost of sales.
• Gross Profit – It is determined by subtracting the cost of goods sold from sales
revenue.
 • Marketing, Promotion, and Advertising Expenses – Most organizations have
expenses associated with selling products and services. Marketing, promotion, and
advertising are often classified in the same cost.
• Depreciation & Amortization Expense – These are non-cash charges. A few
examples are depreciation charged on plant, property, and equipment (PP&E).
• Interest – It is divided into interest income and interest expense line in the income
statement.

Company ABC’s Annual Income Statement

Revenue xxx
Operating Expenses xxx
Salaries xxx
Rent xxx
Amortization xxx
Depreciation xxx

Operating Income xxx

Interest Expense xxx

Tax xxx

Net Income xxx

Income Statement Format

Income Statement Formula

Income Statement Example

Here is an income statement from Amit’s adjusted trial balance for the year-end December
2015.

Amit Keyboard Shop’s Annual Income Statement For the Year-End December 2015

Revenue
Merchandise Sale 20,000
Music Lesson Income 5,000

Total Revenue 25,000

Expenses

Cost of Goods Sold 5,000

Depreciation Expense 2,000
Wage Expense 500
Rent Expense 400
Interest Expense 400
Supplies Expense 400
Utility Expense 300

Total Expense 9,000

Net Income 16,000

Balance Sheet- Meaning, Example

What is a Balance Sheet?

The Balance Sheet is a statement that shows the financial position of the business. It records
the assets and liabilities of the business at the end of the accounting period after the
preparation of trading and profit and loss accounts
‘Not-for-Profit’ Organisations design Balance Sheet for determining the financial position of
the establishment. The preparation of the balance sheet is on the same pattern as of the trade
entities. It depicts liabilities and assets as during the end of the year. Assets are depicted on
the right-hand side, whereas the liabilities are depicted on the left-hand side.
However, there will be a General Fund or Capital Fund in place of the Capital and the surfeit
or deficit as per Income and Expenditure A/c which is either deducted from or added to the
capital fund, as the scenario may be. It is a common practice to add some of the subsidised
items like entrance fees, legacies and life membership fees precisely in the capital fund.

Features of Balance Sheet:

The features of a balance sheet are as follows:

• It is regarded as the last step in final accounts creation

• It is a statement and not an account
 • It consists of transactions recorded under two sides namely, assets and liabilities.
Assets are placed in the left hand side, while the liabilities are placed on the right
hand side
• The total of both side should always be equal
• The balance sheet discloses financial position of the business
• It is prepared after trading and profit and loss account is prepared.
All the above are mentioned balance sheet items are also known as characteristics of the
balance sheet.

Importance of Balance Sheet:

Balance sheet analysis can say many things about a company’s achievement. Few essential
factors of the balance sheet are listed below:

• Creditors, investors, and other stakeholders use this financial tool to know the
financial status of a business.
• It is used to analyse a company’s growth by comparing different years.
• While applying for a business loan, a company has to submit a balance sheet to the
bank.
• Stakeholders can find out the business accomplishment and liquidity position of a
company.
• Company’s balance sheet analysis can detect business expansion and future expenses.

What is the purpose of balance sheet?

The main purpose of the balance sheet is to show a company’s financial status. This sheet
shows a company’s assets and liabilities, along with the money invested in the business. This
statement is required to analyze the financial status information for several consecutive
periods.
Generally, investors and creditors look at the balance sheet of the company to understand
how effectively a company will use its resources and how much it can give in return. Though
the balance sheet can be prepared at any time, it is mostly prepared at the end of the
accounting period. The balance sheet can be created at any time. However, it is often
prepared at the end of the financial year.

How to prepare a Balance Sheet?

Below are the steps mentioned to prepare a balance sheet.

1. Compose a trial balance- It is a regular report included in any accounting

programme. If it is a manual mode, then create a trial balance by transferring every
general ledger account’s ending balance to a spreadsheet.
2. Arrange the trial balance- It is important to arrange the initial trial balance to assure
that the balance sheet similar to the relevant accounting structure. While using
adjusting entries to adjust the trial balance all the entry should be completely recorded
so the auditors can understand why it was made.
3. Discard all expense and revenue accounts- The trial balance includes
expenses, revenue, losses, gains, liabilities, equity, and assets. Delete all from the
 trial balance except equity, liabilities, and assets. However, the deleted accounts are
used to create an income statement.
4. Calculate the remaining accounts- In this stage, sum up all the trial balance account
used to create a balance sheet. The typical line items used in the balance sheet are:
o Cash
o Accounts receivable
o Inventory
o Fixed assets
o Other assets
o Accounts payable
o Accrued liabilities
o Debt
o Other liabilities
o Common stock
o Retained earnings
5. Validate the balance sheet- The total for all assets recorded in the balance sheet
should be similar to the liabilities and stockholders’ equity accounts.
6. Present in the required balance sheet format.

Balance Sheet Format:

The balance sheet of a company will look like the image given below.
What Is the Time Value of Money (TVM)?

The time value of money (TVM) is the concept that a sum of money is worth more now than
the same sum will be at a future date due to its earnings potential in the interim. The time
value of money is a core principle of finance. A sum of money in the hand has greater value
than the same sum to be paid in the future. The time value of money is also referred to as the
present discounted value.

What Is Capital Investment?

Capital investment is the acquisition of physical assets by a company for use in furthering its
long-term business goals and objectives. Real estate, manufacturing plants, and machinery
are among the assets that are purchased as capital investments.

The capital used may come from a wide range of sources from traditional bank loans to
venture capital deals.

Elements of Cost
Again, we can bifurcate these elements of cost into two categories such as Direct Material and
Indirect Material, Direct Labour and Indirect Labour, Direct Expenses and Indirect Expenses.
We need to add all direct material, direct labor, and direct expenses to calculate the prime cost.

Likewise, we add all indirect material, indirect labor, and indirect expenses to calculate the
overhead cost. Again, we can bifurcate the overheads into four categories. They are factory
overhead, administrative overhead, selling overhead and distribution overhead.

1. Direct Material
It represents the raw material or goods necessary to produce or manufacture a product. The cost
of direct material varies according to the level of output. For example, Milk is the direct material
of ghee.

2. Indirect Material
It refers to the material which we require to produce a product but is not directly identifiable. It
does not form a part of a finished product. For example, the use of nails to make a table. The
cost of indirect material does not vary in the direct proportion of product.

Learn more about Meaning of Cost, Costing and Cost Accounting here in detail
3. Direct Labour
It refers to the amount which paid to the workers who are directly engaged in the production of
goods. It varies directly with the level of output.

4. Indirect Labour
It represents the amount paid to workers who are indirectly engaged in the production of goods.
It does not vary directly with the level of output.

5. Direct Expenses
It refers to the expenses that are specifically incurred by the enterprises to produce a product.
The production cannot take place without incurring these expenses. It varies directly with the
level of production.

6. Indirect Expenses
It represents the expenses that are incurred by the organization to produce a product. These
expenses cannot be easily identified accurately. For example, Power expenses for the production
of pens.

Source: freepik.com

7. Overhead
It refers to all indirect materials, indirect labour, or and indirect expenses.

8. Factory Overhead
Factory overhead or Production Overhead or Works Overhead refers to the expenses which a
firm incurs in the production area or within factory premises.

Indirect material, rent, rates and taxes of factory, canteen expenses etc.are example of factory
overhead.
9. Administration Overhead
Administrative or Office Overhead refers to the expenses which are incurred in connection with
the general administration of the organizations.

Salary of administrative staff, postage, telegram and telephone, stationery etc.are examples of
administration overhead.

10. Selling Overhead

All expenses that a firm incurs in connection with sales are selling overheads. Salary of sales
department staff, travelers’ commission, advertisement etc.are example of selling overhead.

11. Distribution Overhead

It represents all expenses incurred in connection with the delivery or distribution of finished
goods and services from the manufacturer to the consumer. F Delivery van expenses. loading
and unloading, customs duty, the salary of deliverymen are examples of distribution overhead.

Meaning of Depreciation
Depreciation can be defined as a continuing, permanent and gradual decrease in the book
value of fixed assets. This type of shrinkage is based on the cost of assets utilised in a firm
and not on its market value.
Features of Depreciation
Following are the 3 principal features of depreciation:

• Depreciation is a decrease in the book value of fixed assets.

• Depreciation involves loss of value of assets due to the passage of time and
obsolescence.
• Depreciation is an ongoing process until the end of the life of assets.

Causes of Depreciation

1. Wear and Tear due to Use or Passage of Time: Wear and tear is nothing but
deterioration and the following decrease in the value of an asset, resulting from its use
in business operations for earning revenue.
2. Expiration of Legal Rights: Some categories of assets lose their value after the
agreement directing their use in business comes to an end after the expiry of the
predetermined period.
3. Obsolescence: Obsolescence is another factor driving to the depreciation of fixed
assets. In common language, obsolescence means being “out-of-date”. Obsolescence
refers to an actual asset becoming outdated on account of the availability of a better
type of asset.
4. Abnormal Factors: Drop in the use of the asset may be caused by abnormal factors.
Namely, accidents due to the earthquake, fire, floods, etc., Accidental loss is
permanent but not continuing.
1. Straight-line basis

Also known as the fixed instalment method, this is the most widely used technique to
calculate depreciation. This applies to assets, such as vehicles, computers, office furniture and
office buildings. Under this method, the depreciation amount is the same for every fixed asset
for each accounting period. Below is the formula to calculate annual depreciation expense
using the straight-line bias technique.

Annual depreciation expense = (Cost of an asset – Salvage value)/Useful life of an asset

Asset cost is the purchase price, salvage value is the value of the asset after its estimated
useful life and asset life is the period during which a business may make use of it.

Related: What Are Profitability Ratios? (With Types And Examples)

2. Declining balance

Also known as the reducing balancing method, this technique applies a fixed percentage of
depreciation to the net balance of the fixed asset in each accounting period. You can subtract
the accumulating depreciation from the net balance to determine the asset's value.

This method imposes a higher amount of depreciation on the asset in its early years. This is
because of the low repair costs encountered in the initial years. During the later stages of an
asset's life, its repair and maintenance costs increase, resulting in a smaller amount of
depreciation being calculated for those years. Follow the formula below for calculating
depreciation using the declining balance method:

Depreciation expense = (Book value of an asset at beginning of the year x Rate of

depreciation)/100

Related: What Is A Tangible Asset? (Guide, Steps And Types)

3. Double declining balance

The double-declining method combines both the straight lines and the declining balance
methods to calculate the depreciation expense. This technique depreciates assets twice as fast
compared to a regular depreciation technique. Companies use this technique for assets which
are more productive in the early years and may lose a significant amount of value in the later
years.

Since companies may earn higher income from this asset in the beginning, they depreciate the
asset heavily in the earlier years, reducing the taxable amount. This allows them to defer the
income tax to the later years. The formula for calculating the depreciation expense using this
method is:

Annual depreciation expense = 2 x Cost of an asset x Depreciation rate

Depreciation rate = 1/Useful life of an asset

Related: What Is A Financial Statement? (With Importance And Types)

4. Units of production

In units of production technique, a business changes the charge amount of depreciation

depending on how many times it uses an asset over time. It considers an asset's practical use
in the production process instead of considering its useful life. This is useful for assets that
are used per unit and experience the greatest amount of wear and tear, such as certain pieces
of machinery. Using this method can enable companies to show a higher depreciation
expense in years with higher production, helping offset other production costs. Below is the
formula for calculating the depreciation expense:

Depreciation expense = (Cost of fixed asset - Residual value / Estimated total

production) x Actual production

Related: Top 20 Finance Interview Questions And Sample Answers

5. Sum-of-the-years' digits

According to the sum of years, the depreciation occurs at a faster rate than the straight-line
method, but at a slower rate than the declining balance method. In the early years,
depreciation expense is higher and in the later years, it declines.

As an asset nears the end of its useful life, its value diminishes. To account for this, you
allocate maximum depreciation in the first year since you have not yet recovered the amount
of capital you invested in the asset. With the increase in years, the asset often recovers most
of its original investment, so the asset is not subject to as much depreciation.

Depreciation expense = Depreciable cost x (Remaining useful life of the asset/Sum of

years' digits)

Depreciable cost = Cost of an asset – Salvage value

Sum of years' digits = (n(n +1))/2 where n is the useful life of an asset

What Is Present Value (PV)?

Present value (PV) is the current value of a future sum of money or stream of cash
flows given a specified rate of return. Future cash flows are discounted at the discount rate,
and the higher the discount rate, the lower the present value of the future cash flows.
Determining the appropriate discount rate is the key to properly valuing future cash flows,
whether they be earnings or debt obligations.