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Definition of Capitalism

Capitalism Image 1


An economic system in which the marketplace, through the pricing mechanism, determines the allocation and distribution of scarce goods and services, with a minimum of government involvement.

Related Terms:

Accelerated cost recovery system (ACRS)

Schedule of depreciation rates allowed for tax purposes.

Accounting system

A set of accounts that summarize the transactions of a business that have been recorded on source documents.

actual cost system

a valuation method that uses actual direct
material, direct labor, and overhead charges in determining
the cost of Work in Process Inventory

Administrative pricing rules

IRS rules used to allocate income on export sales to a foreign sales corporation.

Agency pass-throughs

Mortgage pass-through securities whose principal and interest payments are
guaranteed by government agencies, such as the government National Mortgage Association ("Ginnie Mae"), Federal Home Loan Mortgage Corporation ("Freddie Mac") and Federal National Mortgage Association ("Fannie Mae").


the systematic assignment of an amount to a recipient
set of categories annuity a series of equal cash flows (either positive or negative) per period


The process of storing costs in one account and shifting them to other
accounts, based on some relevant measure of activity.

Capitalism Image 1

Allocation base A measure of activity or volume such as labour

hours, machine hours or volume of production
used to apportion overheads to products and

approximated net realizable value at split-off allocation

a method of allocating joint cost to joint products using a
simulated net realizable value at the split-off point; approximated
value is computed as final sales price minus
incremental separate costs

Arbitrage-free option-pricing models

Yield curve option-pricing models.

Arbitrage Pricing Theory (APT)

An alternative model to the capital asset pricing model developed by
Stephen Ross and based purely on arbitrage arguments.

Asset allocation decision

The decision regarding how an institution's funds should be distributed among the
major classes of assets in which it may invest.

Asset pricing model

A model for determining the required rate of return on an asset.

Asset pricing model

A model, such as the Capital Asset pricing Model (CAPM), that determines the required
rate of return on a particular asset.

Automated storage/retrieval system

A racking system using automated systems
to load and unload the racks.

Binomial option pricing model

An option pricing model in which the underlying asset can take on only two
possible, discrete values in the next time period for each value that it can take on in the preceding time period.

Capitalism Image 2

Black-Scholes option-pricing model

A model for pricing call options based on arbitrage arguments that uses
the stock price, the exercise price, the risk-free interest rate, the time to expiration, and the standard deviation
of the stock return.

business intelligence (BI) system

a formal process for gathering and analyzing information and producing intelligence to meet decision making needs; requires information about
internal processes as well as knowledge, technologies, and competitors

Capital allocation

decision allocation of invested funds between risk-free assets versus the risky portfolio.

Capital asset pricing model (CAPM)

An economic theory that describes the relationship between risk and
expected return, and serves as a model for the pricing of risky securities. The CAPM asserts that the only risk
that is priced by rational investors is systematic risk, because that risk cannot be eliminated by diversification.
The CAPM says that the expected return of a security or a portfolio is equal to the rate on a risk-free security
plus a risk premium.

Capital Asset Pricing Model (CAPM)

A model for estimating equilibrium rates of return and values of
assets in financial markets; uses beta as a measure of asset risk
relative to market risk

capital asset pricing model (CAPM)

Theory of the relationship between risk and return which states that the expected risk
premium on any security equals its beta times the market risk premium.

charge-back system

a system using transfer prices; see transfer

Classical Macroeconomics

The school of macroeconomic thought prior to the rise of Keynesianism.

Clearing House Automated Payments System (CHAPS)

A computerized clearing system for sterling funds
that began operations in 1984. It includes 14 member banks, nearly 450 participating banks, and is one of the
clearing companies within the structure of the Association for Payment Clearing services (APACS).

Clearing House Interbank Payments System (CHIPS)

An international wire transfer system for high-value
payments operated by a group of major banks.

Concentration services

Movement of cash from different lockbox locations into a single concentration
account from which disbursements and investments are made.

Capitalism Image 3

Conventional pass-throughs

Also called private-label pass-throughs, any mortgage pass-through security not
guaranteed by government agencies. Compare agency pass-throughs.

cost allocation

the assignment, using some reasonable basis,
of any indirect cost to one or more cost objects

cost control system

a logical structure of formal and/or informal
activities designed to analyze and evaluate how well
expenditures are managed during a period

cost management system (CMS)

a set of formal methods
developed for planning and controlling an organization’s
cost-generating activities relative to its goals and objectives
cost object anything to which costs attach or are related

cost of goods manufactured (CGM)

the total cost of the
goods completed and transferred to Finished goods Inventory
during the period

Cost of goods sold

The cost of merchandise that a company sold this year. For manufacturing companies, the cost of raw
materials, components, labor and other things that went into producing an item.

Cost of goods sold

See cost of sales.

Cost of goods sold

The cost of the items that were sold during the current period.

Cost of goods sold

The accumulated total of all costs used to create a product or service,
which is then sold. These costs fall into the general sub-categories of direct
labor, materials, and overhead.

Cost of goods sold

The charge to expense of the direct materials, direct labor, and
allocated overhead costs associated with products sold during a defined accounting

Cost-plus pricing

A method of pricing in which a mark-up is added to the total product/service cost.

Cumulative probability distribution

A function that shows the probability that the random variable will
attain a value less than or equal to each value that the random variable can take on.

Distribution center

A branch warehouse containing finished goods and service
items intended for distribution directly to customers.

distribution cost

a cost incurred to warehouse, transport, or deliver a product or service

Distribution inventory

Inventory intended for shipment to customers, usually
comprised of finished goods and service items.


Payments from fund or corporate cash flow. May include dividends from earnings, capital
gains from sale of portfolio holdings and return of capital. Fund distributions can be made by check or by
investing in additional shares. Funds are required to distribute capital gains (if any) to shareholders at least
once per year. Some Corporations offer Dividend Reinvestment Plans (DRP).

Du Pont system

A breakdown of ROE and ROA into component ratios.

dual pricing arrangement

a transfer pricing system that allows
a selling division to record the transfer of goods or
services at one price (e.g., a market or negotiated market
price) and a buying division to record the transfer at another
price (e.g., a cost-based amount)

Dupont system of financial control

Highlights the fact that return on assets (ROA) can be expressed in terms
of the profit margin and asset turnover.

Dynamic asset allocation

An asset allocation strategy in which the asset mix is mechanistically shifted in
response to -changing market conditions, as in a portfolio insurance strategy, for example.

Economic assumptions

economic environment in which the firm expects to reside over the life of the
financial plan.

economic components model

Abrams’ model for calculating DLOM based on the interaction of discounts from four economic components.
This model consists of four components: the measure of the economic impact of the delay-to-sale, monopsony power to buyers, and incremental transactions costs to both buyers and sellers.

Economic defeasance

See: in-substance defeasance.

Economic dependence

Exists when the costs and/or revenues of one project depend on those of another.

Economic earnings

The real flow of cash that a firm could pay out forever in the absence of any change in
the firm's productive capacity.

Economic exposure

The extent to which the value of the firm will change because of an exchange rate change.

Economic income

Cash flow plus change in present value.

economic integration

the creation of multi-country markets
by developing transnational rules that reduce the fiscal and
physical barriers to trade as well as encourage greater economic
cooperation among countries

Economic life

The period over which a company expects to be able to use an asset.

economic order quantity

Order size that minimizes total inventory costs.

Economic order quantity (EOQ)

The order quantity that minimizes total inventory costs.

economic order quantity (EOQ)

an estimate of the number
of units per order that will be the least costly and provide
the optimal balance between the costs of ordering
and the costs of carrying inventory

economic production run (EPR)

an estimate of the number
of units to produce at one time that minimizes the total
costs of setting up production runs and carrying inventory

Economic rents

Profits in excess of the competitive level.

Economic risk

In project financing, the risk that the project's output will not be salable at a price that will
cover the project's operating and maintenance costs and its debt service requirements.

Economic surplus

For any entity, the difference between the market value of all its assets and the market
value of its liabilities.

Economic union

An agreement between two or more countries that allows the free movement of capital,
labor, all goods and services, and involves the harmonization and unification of social, fiscal, and monetary

Economic Value Added (EVA)

Operating profit, adjusted to remove distortions caused by certain accounting rules, less a charge
to cover the cost of capital invested in the business.

economic value added (EVA)

a measure of the extent to which income exceeds the dollar cost of capital; calculated
as income minus (invested capital times the cost of capital percentage)

economic value added (EVA)

Term used by the consulting firm Stern Stewart for profit remaining after deduction of the cost
of the capital employed.

economically reworked

when the incremental revenue from the sale of reworked defective units is greater than
the incremental cost of the rework


The study of the allocation and distribution of scare resources among competing wants.

Electronic Federal Tax Payment Systems (EFTPS)

An electronic funds transfer system used by businesses to remit taxes to the government.

enterprise resource planning (ERP) system

a packaged software program that allows a company to
(1) automate and integrate the majority of its business processes,
(2) share common data and practices across the entire enterprise, and
(3) produce and access information in a realtime environment

Enterprise resource planning system

A computer system used to manage all company
resources in the receipt, completion, and delivery of customer orders.

European Monetary System (EMS)

An exchange arrangement formed in 1979 that involves the currencies
of European Union member countries.

Exchange Rate Mechanism (ERM)

The methodology by which members of the EMS maintain their
currency exchange rates within an agreed upon range with respect to other member countries.

Federal Reserve System

The central bank of the U.S., established in 1913, and governed by the Federal
Reserve Board located in Washington, D.C. The system includes 12 Federal Reserve Banks and is authorized
to regulate monetary policy in the U.S. as well as to supervise Federal Reserve member banks, bank holding
companies, international operations of U.S.banks, and U.S.operations of foreign banks.

Federal Reserve System

The central banking authority responsible for monetary policy in the United States.

Finished goods inventory

goods that have been completed by the manufacturing
process, or purchased in a complete form, but which have not yet been sold to

Finished goods inventory

Completed inventory items ready for shipment to

flexible manufacturing system (FMS)

a production system in which a single factory manufactures numerous variations
of products through the use of computer-controlled
focused factory arrangement
an arrangement in which a
vendor (which may be an external party or an internal corporate
division) agrees to provide a limited number of
products according to specifications or to perform a limited
number of unique services to a company that is typically
operating on a just-in-time system

Flow-through basis

An account for the investment credit to show all income statement benefits of the credit
in the year of acquisition, rather than spreading them over the life of the asset acquired.

Flow-through method

The practice of reporting to shareholders using straight-line depreciation and
accelerated depreciation for tax purposes and "flowing through" the lower income taxes actually paid to the
financial statement prepared for shareholders.

Frequency distribution

The organization of data to show how often certain values or ranges of values occur.

Fully modified pass-throughs

Agency pass-throughs that guarantee the timely payment of both interest and
principal. Related: modified pass-throughs
Functional currency As defined by FASB No. 52, an affiliate's functional currency is the currency of the
primary economic environment in which the affiliate generates and expends cash.

Garmen-Kohlhagen option pricing model

A widely used model for pricing foreign currency options.

Government bond

See: government securities.

Government National Mortgage Association (Ginnie Mae)

A wholly owned U.S. government corporation
within the Department of Housing & Urban Development. Ginnie Mae guarantees the timely payment of
principal and interest on securities issued by approved servicers that are collateralized by FHA-issued, VAguaranteed,
or Farmers Home Administration (FmHA)-guaranteed mortgages.

Government securities

Negotiable U.S. Treasury securities.

Government sponsored enterprises

Privately owned, publicly chartered entities, such as the Student Loan
Marketing Association, created by Congress to reduce the cost of capital for certain borrowing sectors of the
economy including farmers, homeowners, and students.

hybrid costing system

a costing system combining characteristics
of both job order and process costing systems

Imputation tax system

Arrangement by which investors who receive a dividend also receive a tax credit for
corporate taxes that the firm has paid.

Information services

Organizations that furnish investment and other types of information, such as
information that helps a firm monitor its cash position.

Interac system

Canada's bank machine and electronic debit system. If you use your bank card at a bank machine which displays the Interac symbol (and that bank machine is not your bank's machine), you will be charged a fee.

job order costing system

a system of product costing used
by an entity that provides limited quantities of products or
services unique to a customer’s needs; focus of recordkeeping
is on individual jobs

Just-in-time inventory systems

systems that schedule materials/inventory to arrive exactly as they are
needed in the production process.

just-in-time manufacturing system

a production system that attempts to acquire components and produce inventory only as needed, to minimize product defects, and to
reduce lead/setup times for acquisition and production

Leading economic indicators

economic series that tend to rise or fall in advance of the rest of the economy.

lock-box system

system whereby customers send payments to a post office box and a local bank collects and processes checks.

Lognormal distribution

A distribution where the logarithm of the variable follows a normal distribution.
Lognormal distributions are used to describe returns calculated over periods of a year or more.


The study of the determination of economic aggregates such as total output and the price level.

MACRS (Modified Accelerated Cost Recovery System)

A depreciation method created by the IRS under the Tax Reform Act of 1986. Companies must use it to depreciate all plant and equipment assets installed after December 31, 1986 (for tax purposes).







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