The accounting equation states that assets = liabilities + owner’s equity. Or to put it another way, a company’s economic resources must equal the value of the financial claims against those resources. The accounting equation is a central feature of the double-entry system. We can think of the accounting equation like a scale whose two […]
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The modern economy is highly globalized. Goods, services, and capital can flow between countries in a highly efficient manner. The price of a country’s currency relative to other currencies greatly affects that country’s economy. The currencies of most industrial economies trade freely against one another. The foreign exchange market is the market where currencies are
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With accrual basis accounting, a firm recognizes revenues when a sale occurs regardless of when the firm receives payment for the sale. Likewise, a firm recognizes expenses when it incurs the expense, regardless of when the firm sends payments to its vendors. The accrual method has two advantages over the cash method. First, the accrual
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Cash basis accounting refers to an accounting system where the firm recognizes sales when it receives cash from customers and recognizes expenses when it pays cash to vendors. Thus, with cash basis accounting, income more closely approximates the firm’s operating cash flow. The Internal Revenue Service (IRS) allows firms under a certain size to report
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A firm’s cost of capital represents the cost to the firm of accessing debt and equity capital. Business decision makers use the cost of capital as a minimum “hurdle rate” when determining if a project or investment will yield value to the firm. The cost of capital is also called the weighted-average cost of capital
Double-entry bookkeeping is a process of recording business transactions in which each transaction affects two or more accounts. The double-entry system was popularized by an Italian friar named Luca Pacioli. In 1494, Pacioli published a mathematics book which contained a section describing the double-entry system. This section, titled Particularis de computis et scripturis (details of
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When it comes to allocating capital, most investors have limited resources and, therefore, must choose among competing alternatives. Investors make these choices with reference to their opportunity cost. An investor’s opportunity cost represents the return on the investor’s next best alternative. In other words, the opportunity cost is the return which the investor foregoes by
Money is a commodity like any other and like other commodities, money can be lent by those with a surplus to those with a deficit. The price which those with surplus funds charge for the use of funds is called the interest rate. The Loanable Funds Market The supply of loanable funds ultimately comes from
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In a market economy, prices play a leading role in allocating scarce resources. Prices fulfill this function by conveying information to buyers and sellers about the relative scarcity or abundance of goods and services. With price information, buyers and sellers alter their behavior in ways that bring about equilibrium – the state in which a
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In this post, we discuss monetary policy and the role that central banks play in a modern economy. Although our focus is primarily on the U.S. central bank, the Federal Reserve, the policy tools which we discuss our similar to those used by other central banks, such as the European Central Bank, the Bank of
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