3 - 1 © 2005 Accounting 1/e, Terrell/Terrell Organizing a Business: Equity and Debt Financing...

Organizing a Business: Organizing a Business:

Equity and Debt Equity and Debt

FinancingFinancing

Chapter 3Chapter 3

Learning Objective 1Learning Objective 1

Identify the steps toIdentify the steps to

organizing a business.organizing a business.

Checklist BeforeChecklist BeforeBeginning OperationsBeginning Operations

International Accounting Associates LLPInternational Accounting Associates LLPClient Checklist Before Beginning OperationsClient Checklist Before Beginning Operations

1. Find competent people to be responsible for the four1. Find competent people to be responsible for the fourfunctions of the firm.functions of the firm.

2. Decide upon the organizational form for the business.2. Decide upon the organizational form for the business.3. Research the industry and the product.3. Research the industry and the product.4. Prepare a strategic plan.4. Prepare a strategic plan.5. Design internal controls for operations and information.5. Design internal controls for operations and information.6. Secure financing.6. Secure financing.7. Prepare initial capital and operating budgets.7. Prepare initial capital and operating budgets.

The Four Functions of the The Four Functions of the FirmFirm

FinancingFinancing

Decision makingDecision making

OperatingOperating

InvestingInvesting

Describe a corporateDescribe a corporate

organization structureorganization structure

and define the equityand define the equity

structure of a corporation.structure of a corporation.

Forming a CorporationForming a Corporation

1. Basic information about the corporation1. Basic information about the corporation2. Name of the incorporators2. Name of the incorporators3. Details concerning the types and3. Details concerning the types and amounts of stock authorizedamounts of stock authorized

Incorporators are the persons who submitIncorporators are the persons who submita formal application to create a corporationa formal application to create a corporationand file it with the appropriate state agency.and file it with the appropriate state agency.

Articles of incorporation is anArticles of incorporation is anapplication for incorporation.application for incorporation.

Corporate Organizational Corporate Organizational StructureStructure

Stockholders own the corporation.Stockholders own the corporation.

A stock certificate is a legal document providingA stock certificate is a legal document providingevidence of ownership and containing theevidence of ownership and containing the

provisions of the stock ownership agreement.provisions of the stock ownership agreement.

Chief Operating OfficerChief Operating Officer

TreasurerTreasurer

The board of directors has ultimate responsibilityThe board of directors has ultimate responsibility for managing the corporation.for managing the corporation.

Chief Executive OfficerChief Executive Officer

Corporate SecretaryCorporate Secretary

Vice PresidentsVice Presidents

Board of DirectorsBoard of Directors

Chief Financial OfficerChief Financial Officer

StockholdersStockholders

Chief Executive OfficerChief Executive Officer

Chief Operating OfficerChief Operating OfficerChief Operating OfficerChief Operating Officer Corporate SecretaryCorporate SecretaryCorporate SecretaryCorporate Secretary

TreasurerTreasurer ControllerController

Compare and contrast theCompare and contrast the

characteristics of commoncharacteristics of common

stock and preferred stock.stock and preferred stock.

Corporate Capital StructureCorporate Capital Structure

Outstanding sharesOutstanding shares are the number of are the number ofshares currently held by stockholdersshares currently held by stockholders

Treasury stockTreasury stock are shares are sharesreacquired by the corporation.reacquired by the corporation.

Authorized sharesAuthorized shares are the maximum number of are the maximum number ofshares the charter allows the corporation to issue.shares the charter allows the corporation to issue.

Issued sharesIssued shares are shares of are shares ofstock sold to stockholders.stock sold to stockholders.

Par valuePar value is an arbitrary dollar amount is an arbitrary dollar amountplaced on the stock by the incorporators.placed on the stock by the incorporators.

No-par stockNo-par stock is stock authorized is stock authorizedwithout a par value.without a par value.

Common stockCommon stock is the voting is the votingstock of the corporation.stock of the corporation.

Common stockholdersCommon stockholders are the are theresidual owners of the corporation.residual owners of the corporation.

LiquidationLiquidation is the process is the processof going out of business.of going out of business.

Preferred stockPreferred stock offers certain offers certainpreferential treatment to its ownerspreferential treatment to its owners

over common stockholders. over common stockholders.

Owners of preferred stock must receiveOwners of preferred stock must receivea dividend before any dividend isa dividend before any dividend ispaid to owners of common stock.paid to owners of common stock.

Additional paid-in capitalAdditional paid-in capitalis the amount paid to ais the amount paid to acorporation for stock incorporation for stock inexcess of its par valueexcess of its par value..

Research an industry for itsResearch an industry for its

particular characteristics particular characteristics

andand

identify its major identify its major

competitors.competitors.

Researching the IndustryResearching the Industry

An An industryindustry is a group of companies is a group of companiesthat form a sector of the economy.that form a sector of the economy.

Researching the IndustryResearching the Industry

Trade organizationsTrade organizations Market research firmsMarket research firms

How does one research an industry?How does one research an industry?

Industry guidesIndustry guides Business periodicalsBusiness periodicals

Prepare a strategic planPrepare a strategic plan

for a business.for a business.

Developing a Strategic PlanDeveloping a Strategic Plan

A A strategic planstrategic plan describes the organizational describes the organizationalapproach the senior managementapproach the senior management

of a company will employ...of a company will employ...

to fulfill the corporate mission and vision andto fulfill the corporate mission and vision and

achieve the stated goals by allocating financialachieve the stated goals by allocating financialresources and directing human resources.resources and directing human resources.

Develop a clearly articulatedDevelop a clearly articulatedmission and vision.mission and vision.

Set measurable goals and objectives.Set measurable goals and objectives.

Scan the internal environment andScan the internal environment andassess the external environment.assess the external environment.

Formulate alternative strategies.Formulate alternative strategies.

Develop the strategic plan by selectingDevelop the strategic plan by selectingthe best alternatives and determiningthe best alternatives and determiningthe activities needed to accomplishthe activities needed to accomplish

the stated goals.the stated goals.

Implement the plan.Implement the plan.

Evaluate the results of theEvaluate the results of theimplementation and return to step 1.implementation and return to step 1.

Outline internal controlsOutline internal controls

for operations.for operations.

Designing Internal Controls Designing Internal Controls for Operations and for Operations and

InformationInformation

The internal control structure helps toThe internal control structure helps toprotect the business against preventableprotect the business against preventablelosses and to promote efficient operationslosses and to promote efficient operations

by creating checks and balances withinby creating checks and balances withinthe accounting and operating processes.the accounting and operating processes.

Designing Internal Controls Designing Internal Controls for Operations and for Operations and

InformationInformation

Protecting physical assetsProtecting physical assets

Protecting proprietary informationProtecting proprietary information

Creating an environment thatCreating an environment thatrespects internal controlsrespects internal controls

Define borrowing terms andDefine borrowing terms and

compute the cost of compute the cost of

borrowing.borrowing.

Securing FinancingSecuring Financing

FinancingFinancing

Equity financingEquity financing Debt financingDebt financing

Securing FinancingSecuring Financing

Interest is the cost of borrowing.Interest is the cost of borrowing.

Short-term financing is any borrowingShort-term financing is any borrowingthat must be repaid within five years.that must be repaid within five years.

Long-term financing has a repaymentLong-term financing has a repaymentperiod that extends past five years.period that extends past five years.

Borrowing with Notes Borrowing with Notes PayablePayable

DefaultDefaultCollateralCollateral

A note payable is a written agreementA note payable is a written agreementor debt instrument between a lenderor debt instrument between a lender

and a borrower that creates aand a borrower that creates aliability for the borrower toliability for the borrower to

repay both principal and interest.repay both principal and interest.

Promissory notePromissory note

The Cost of BorrowingThe Cost of Borrowing

Kenfield Inc. borrowed $5,000Kenfield Inc. borrowed $5,000on March 2, 2002, by signingon March 2, 2002, by signing

an 8%, three-year note.an 8%, three-year note.

The lender requires annual interestThe lender requires annual interestpayments to be made on thepayments to be made on the

anniversary of the note.anniversary of the note.

What is the important information?What is the important information?

$ $ 5,0005,000 Pleasanton, California Pleasanton, California March 2, 2002March 2, 2002

Three years form date of issueThree years form date of issue wewe promise to paypromise to pay

to the order ofto the order of Slippery CompanySlippery Company

Five-Thousand and 00/100Five-Thousand and 00/100 Dollars Dollars

Payable at:Payable at: National BankNational Bank

Interest:Interest: 8% ($400) to be paid annually at anniversary date8% ($400) to be paid annually at anniversary date

No.No. 115115 Principal is Due:Principal is Due: March 2, 2005March 2, 2005

Kenfield, Inc.Kenfield, Inc.

Paul Mack, TreasurerPaul Mack, Treasurer

PrincipalPrincipal Date of issueDate of issue

InterestInterestraterate

Loan lengthLoan length

InterestInterestpayments duepayments due

What is the formula to determineWhat is the formula to determinethe annual interest?the annual interest?

$5,000 x .08 = $400$5,000 x .08 = $400

Amount repaidAmount repaid $6,200$6,200Amount received from the loanAmount received from the loan 5,000 5,000Cost of borrowing or interestCost of borrowing or interest $1,200$1,200

What is the interest if the fundsWhat is the interest if the fundsare held for three months?are held for three months?

$5,000 x .08 x 3/12 = $100$5,000 x .08 x 3/12 = $100

What would be the interest if the noteWhat would be the interest if the notereads “$5,000, 8%, 90 day note?”reads “$5,000, 8%, 90 day note?”

$5,000 x .08 x 90/365 = $98.63$5,000 x .08 x 90/365 = $98.63

Compute and distinguishCompute and distinguish

between nominal andbetween nominal and

effective interest rates.effective interest rates.

Effective Interest RateEffective Interest Rate

Kenfield Inc. deposited $9,000 as theKenfield Inc. deposited $9,000 as theloan proceeds of a $10,000 discountedloan proceeds of a $10,000 discounted

note due one year from today.note due one year from today.

Amount repaidAmount repaid $10,000$10,000Amount received from the loanAmount received from the loan 9,000 9,000Cost of borrowing (interest)Cost of borrowing (interest) $ 1,000$ 1,000

Effective Interest RateEffective Interest Rate

Borrowing ThroughBorrowing Throughthe Financial Marketsthe Financial Markets

Bond indentureBond indenture is an agreement. is an agreement.

The The nominal interest ratenominal interest rate is the rate that the issuing is the rate that the issuing corporation agreed to pay in the bond indenture. corporation agreed to pay in the bond indenture.

Commercial paperCommercial paper is a corporate promissory note is a corporate promissory note that investors buy from the corporation.that investors buy from the corporation.

BondBond is a type of long-term note payable. is a type of long-term note payable.

The effective interest rate of a bondThe effective interest rate of a bonddenotes the actual interest ratedenotes the actual interest ratethat the bondholder will earn.that the bondholder will earn.

Yield rateYield rate Market interest rateMarket interest rate

The selling price of a bond isThe selling price of a bond isalso called the market price.also called the market price.

Discount occurs when a bondDiscount occurs when a bondsells for less than par value.sells for less than par value.

Premium occurs when a bondPremium occurs when a bondsells for more than par value.sells for more than par value.

The primary securities market involvesThe primary securities market involvessales of newly issued stocks and bondssales of newly issued stocks and bonds

between the issuing corporation and investors.between the issuing corporation and investors.

Compute the selling price Compute the selling price

bonds with a calculator.bonds with a calculator.

Computing the SellingComputing the SellingPrice of BondsPrice of Bonds

nn Number of interest payment periodsNumber of interest payment periods

ii Effective interest rate per periodEffective interest rate per period

FVFV Maturity valueMaturity value

pp Cash interest paid each periodCash interest paid each period

PVPV Selling price of the bondsSelling price of the bondscptcpt

Computing the SellingComputing the SellingPrice of BondsPrice of Bonds

If Jupiter Corporation desired to sellIf Jupiter Corporation desired to sell$1,000,000 of 20-year bonds with a$1,000,000 of 20-year bonds with a

nominal rate of 11% when thenominal rate of 11% when themarket expects to receive 10.5 interest...market expects to receive 10.5 interest...

what would be the bonds’ selling price?what would be the bonds’ selling price?

Amortization TableAmortization Table

Lenders frequently provideLenders frequently providean amortization that detailsan amortization that detailsthe payments of principalthe payments of principal

and interest on loans.and interest on loans.

End of Chapter 3End of Chapter 3

3 - 1 © 2005 Accounting 1/e, Terrell/Terrell Organizing a Business: Equity and Debt Financing...

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