1 Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investments by Owners CHAPTER F3 © 2007 Pearson Custom Publishing

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Tools of the Trade, Tools of the Trade, Part I The Balance Part I The Balance

Sheet: Sheet: Initial Financing Initial Financing ––Investments by Investments by

OwnersOwners

CHAPTER F3

© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing

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Identify and explain the Identify and explain the accounting elements accounting elements

contained in the balance contained in the balance sheet.sheet.

Learning Objective 1:


3 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing

The Accounting ElementsThe Accounting Elements

Every economic event changes one or Every economic event changes one or more accounting elements.more accounting elements.

The ten accounting elements are:The ten accounting elements are:AssetsAssets LiabilitiesLiabilities EquityEquityInvestments by OwnersInvestments by OwnersDistributions to OwnersDistributions to OwnersComprehensive Income RevenuesComprehensive Income RevenuesExpenses Gains LossesExpenses Gains Losses


The Accounting ElementsThe Accounting Elements

Three accounting elements are Three accounting elements are included on the balance sheet:included on the balance sheet: AssetsAssets LiabilitiesLiabilities Owners’ EquityOwners’ Equity


First Tool of the TradeFirst Tool of the Trade

The The Balance SheetBalance Sheet:: A financial statement that provides A financial statement that provides

information about the financial condition of information about the financial condition of an entity at any particular point (usually the an entity at any particular point (usually the end of the month or year).end of the month or year).

The balance sheet is more formally known The balance sheet is more formally known as:as: Statement of Financial PositionStatement of Financial Position, or, or

Statement of Financial ConditionStatement of Financial Condition


AssetsAssets

Things of value a business owns Things of value a business owns or controls.or controls.

FASB says: FASB says: ““Probable future Probable future economic benefits obtained or economic benefits obtained or controlled by a particular entity as controlled by a particular entity as a result of past transactions or a result of past transactions or events.”events.”


LiabilitiesLiabilities

Debts, business amounts owed.Debts, business amounts owed. FASB says: FASB says: ““Probable future Probable future

sacrifices of economic benefits sacrifices of economic benefits arising from present obligations of arising from present obligations of a particular entity to transfer assets a particular entity to transfer assets or provide services to other entities or provide services to other entities in the future as a result of past in the future as a result of past transactions or events.”transactions or events.”


EquityEquity

The ownership interests in The ownership interests in a company.a company.

FASB says: FASB says: “The residual “The residual interest in the assets of an interest in the assets of an entity that remains after entity that remains after deducting its liabilities.”deducting its liabilities.”


Sources of EquitySources of Equity

There are two sources of owners’ There are two sources of owners’ equity:equity:

1. 1. Investments by owners:Investments by owners: This is equal to the cash and other assets This is equal to the cash and other assets

paid into the company by the various paid into the company by the various owners.owners.

2. 2. Earned Equity:Earned Equity: This is the total profit that a company has This is the total profit that a company has

earned since it was started, minus any earned since it was started, minus any amounts paid out to the owners.amounts paid out to the owners.

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Demonstrate how the Demonstrate how the balance sheet provides balance sheet provides information about the information about the financial position of a financial position of a

business.business.




The Accounting EquationThe Accounting Equation

ASSETS = LIABILITIES + OWNERS’ EQUITYASSETS = LIABILITIES + OWNERS’ EQUITY

The equality (or “balance”) must The equality (or “balance”) must always be maintained.always be maintained.


The Accounting EquationThe Accounting Equation

ASSETS = LIABILITIES + OWNERS’ ASSETS = LIABILITIES + OWNERS’ EQUITYEQUITY

Things We Have = What We Owe + What Things We Have = What We Owe + What We OwnWe Own

Example: You “own” a house. It is Example: You “own” a house. It is worth $80,000 (asset value) and you worth $80,000 (asset value) and you have a $50,000 mortgage (liability) on it. have a $50,000 mortgage (liability) on it. Your “equity” is equal to $30,000.Your “equity” is equal to $30,000.

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Compare and contrast Compare and contrast the balance sheets of the balance sheets of

proprietorships, proprietorships, partnerships, and partnerships, and

corporations.corporations.




Balance Sheet - Account Balance Sheet - Account FormForm

Your CompanyBalance Sheet

December 31, 2000

Assets LiabilitiesAsset #1 $1,000 Liability #1 $1,200Asset #2 500 Liability #2 100 $1,300Asset #3 300 Owners' equityAsset #4 200 Equity #1 $700

Total assets $2,000 Total L & OE $2,000

Account form is a “left side / right side” presentation.


Balance Sheet - Report Balance Sheet - Report FormForm

Reportform is a“top &bottom”layout.

Your CompanyBalance Sheet

December 31, 1999

AssetsAsset #1 $1,000Asset #2 500 Asset #3 300 Asset #4 200

Total assets $2,000

LiabilitiesLiability #1 $1,200Liability #2 100 $1,300

Owners' equityEquity #1 $700

Total L & OE $2,000


Starting a ProprietorshipStarting a Proprietorship

You invest $20,000 to start your business.You invest $20,000 to start your business. ASSETS = LIABILITIES + OWNERS’ EQUITYASSETS = LIABILITIES + OWNERS’ EQUITY $20,000 =$20,000 = $0 + $20,000 $0 + $20,000


Starting a ProprietorshipStarting a Proprietorship You invest $20,000 to start your business.You invest $20,000 to start your business. ASSETS = LIABILITIES + OWNERS’ EQUITYASSETS = LIABILITIES + OWNERS’ EQUITY $20,000 =$20,000 = $0 $0 + + $20,000$20,000

Your CompanyBalance SheetJanuary 1, 2000

Assets LiabilitiesCash $20,000 $0

Owners' equity You, Capital $20,000



Starting a PartnershipStarting a Partnership

You invest $20,000 and Your Buddy You invest $20,000 and Your Buddy invests $10,000 to start a business.invests $10,000 to start a business.

ASSETS = LIABILITIES + OWNERS’ EQUITYASSETS = LIABILITIES + OWNERS’ EQUITY $30,000 =$30,000 = $0 + $0 + $30,000$30,000


Starting a PartnershipStarting a Partnership

You invest $20,000 and Your Buddy invests You invest $20,000 and Your Buddy invests $10,000 to start a business.$10,000 to start a business.

ASSETS = LIABILITIES + OWNERS’ EQUITYASSETS = LIABILITIES + OWNERS’ EQUITY $30,000 =$30,000 = $0$0 + + $30,000 $30,000

Our CompanyBalance Sheet

January 1, 2000


Owners' equityYou, Capital $20,000

Buddy, Capital 10,000 30,000



Starting a Starting a CorporationCorporation

When business people decide that they want When business people decide that they want to incorporate a business, they have to to incorporate a business, they have to acquire a acquire a corporate chartercorporate charter from a state. from a state.

The The articles of incorporationarticles of incorporation typically typically include:include: (1) basic purpose of the corporation,(1) basic purpose of the corporation, (2) details related to the stock to be issued, and (2) details related to the stock to be issued, and (3) names of the individuals responsible for the (3) names of the individuals responsible for the

corporation.corporation.

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Describe the basic Describe the basic organizational structure organizational structure

of a corporation.of a corporation.




Corporate OrganizationalCorporate OrganizationalStructureStructure

Stockholders (or shareholders)Stockholders (or shareholders) The owners of the corporation.The owners of the corporation. Have invested cash or other assets in Have invested cash or other assets in

exchange for shares of stock.exchange for shares of stock. Have stock certificates as evidence of their Have stock certificates as evidence of their

ownership interests.ownership interests. Typically meet once a year, primarily to Typically meet once a year, primarily to

elect members to the board of directors.elect members to the board of directors.


Board of Directors:Board of Directors: Top level of management responsibility.Top level of management responsibility. Not usually involved in day-to-day decisions.Not usually involved in day-to-day decisions. Will act on behalf of stockholders, when needed.Will act on behalf of stockholders, when needed.

Corporate Officers:Corporate Officers: Chief Executive Officer (CEO)Chief Executive Officer (CEO) Chief Operating Officer (COO)Chief Operating Officer (COO) Chief Financial Officer (CFO)Chief Financial Officer (CFO)

Corporate Corporate OrganizationalOrganizational

StructureStructure

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Typical Corporate Typical Corporate StructureStructure

Various V ice Presidents

T reasurer Controller

Chief Financial Officer Corporate Secretary

Chief Operating Officer

Chief Executive Officer

Board of Directors Stockholders


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Differentiate between Differentiate between common stock and common stock and

preferred stock.preferred stock.




Common StockCommon Stock

All corporations must have common All corporations must have common stock, the stock, the votingvoting stock of a stock of a company.company.

Common stock may have a Common stock may have a par par valuevalue. Par value is an arbitrary . Par value is an arbitrary value that is established when the value that is established when the shares are first authorized. Par shares are first authorized. Par value has nothing to do with “fair value has nothing to do with “fair market value.” market value.”


Sample of Par ValuesSample of Par Values

The following companies had these The following companies had these par values and per share market par values and per share market prices as of June 30, 2006:prices as of June 30, 2006:Company Company Par Value Par Value Market Price Market Price GMGM $1.6700 $1.6700 $29.79$29.79 IBMIBM $0.0200 $0.0200 $76.82$76.82 ChevronChevron $0.7000 $0.7000 $62.06$62.06 BoeingBoeing $5.0000 $5.0000 $81.91$81.91 PepsiCoPepsiCo $0.0167 $0.0167 $60.04$60.04


Par Value ExamplePar Value Example

Assume Your Company, Inc., sells 1,000 shares of Assume Your Company, Inc., sells 1,000 shares of $1 par value common stock for $10 per share.$1 par value common stock for $10 per share.

Your Company, Inc.Balance Sheet

January 1, 2000


Stockholders' equityCommon stock $1,000

Add'l paid-in capital 9,000 10,000

Total assets $10,000 Total liabilities & S.Equity $10,000


No-Par StockNo-Par Stock

If common stock does not have a par If common stock does not have a par value, it is known as value, it is known as no-par stockno-par stock. . With no-par stock, the full sales price With no-par stock, the full sales price is entered into the common stock is entered into the common stock account.account.


No-Par StockNo-Par Stock If common stock does not have a par value, it is If common stock does not have a par value, it is

known as known as no-par stockno-par stock. With no-par stock, the . With no-par stock, the full sales price is entered into the common stock full sales price is entered into the common stock account.account.

Your Company, Inc.Balance Sheet

January 1, 2000


Stockholders' equity

Common stock 10,000

Total assets $10,000 Total liabilities & S.Equity $10,000


Preferred StockPreferred Stock

Preferred stock does not have voting Preferred stock does not have voting privileges, but does have certain privileges, but does have certain preferences over common stock:preferences over common stock: Dividend preferenceDividend preference: preferred : preferred

dividends must be paid before common dividends must be paid before common dividends.dividends.

Liquidation preferenceLiquidation preference: distribution of : distribution of company assets must be made to company assets must be made to preferred stockholders before common preferred stockholders before common stockholders may receive any assets.stockholders may receive any assets.


Preferred StockPreferred Stock

Example: Recall that Your Company, Example: Recall that Your Company, Inc., sold par value common stock in Inc., sold par value common stock in an earlier example. Assume that Your an earlier example. Assume that Your Company also sells 100 shares of $100 Company also sells 100 shares of $100 par value preferred stock at the par value preferred stock at the market price of $120 per share. market price of $120 per share.

What would the stockholders’ equity What would the stockholders’ equity section of the balance sheet look like section of the balance sheet look like with both types of stock included?with both types of stock included?


Common and Preferred Common and Preferred StockStock

Stockholders' equity

Preferred stock ($100 par value) $10,000Add'l paid-in capital - Preferred 2,000 Common stock ($1 par value) 1,000 Add'l paid-in capital - Common 9,000

Total stockholders' equity $22,000

NOTE: Additional paid-in capital should be kept separate for the two different types of stock.

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Describe the Describe the components of components of

stockholders’ equity stockholders’ equity and explain the and explain the

meaning of treasury meaning of treasury stock.stock.




Corporate Capital Corporate Capital StructureStructure

For a corporation, there are various For a corporation, there are various terms related to stock that you must be terms related to stock that you must be familiar with:familiar with: Authorized shares:Authorized shares: number that could be number that could be

sold.sold. Issued shares:Issued shares: number that have been sold. number that have been sold. Outstanding shares:Outstanding shares: number currently held number currently held

by the stockholders.by the stockholders. Treasury stock:Treasury stock: shares reacquired by the shares reacquired by the

corporation; issued but not outstanding.corporation; issued but not outstanding.


Stockholders’ EquityStockholders’ Equity

Stockholders’ equity is made up of Stockholders’ equity is made up of two main components:two main components: 1) 1) Contributed CapitalContributed Capital (or Paid-In (or Paid-In

Capital)Capital) The amount invested by the holders of both The amount invested by the holders of both

common stock and preferred stock.common stock and preferred stock.

2) 2) Retained EarningsRetained Earnings The accumulation of corporate net earnings The accumulation of corporate net earnings

minus any dividends declared.minus any dividends declared.

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Identify what information Identify what information is available on a is available on a

corporate balance sheet corporate balance sheet and what information is and what information is

not available.not available.



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Information Provided on a Balance Sheet

The corporation’s assets, liabilities, The corporation’s assets, liabilities, and equity on the day it was prepared.and equity on the day it was prepared.

The book value of assets.The book value of assets. The amount stockholders have The amount stockholders have

contributed to the company.contributed to the company. The amount of authorized, issued, The amount of authorized, issued,

outstanding, and treasury stock.outstanding, and treasury stock.


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Information Not Provided on a Balance Sheet

The corporation’s assets, liabilities, The corporation’s assets, liabilities, and equity at any other time than the and equity at any other time than the date prepared.date prepared.

The current value of assets.The current value of assets. The market value of the stock.The market value of the stock. The earnings of the corporation.The earnings of the corporation.


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Explain the basic process Explain the basic process operating in the primary operating in the primary

and secondary stock and secondary stock markets.markets.




Stock ExchangesStock Exchanges

A stock A stock exchange is a exchange is a place (either place (either real or in real or in cyberspace) for cyberspace) for stock buyers stock buyers and sellers to and sellers to get together to get together to conduct their conduct their business.business.


The Stock MarketThe Stock Market

Actually there are several stock Actually there are several stock markets, including the New York markets, including the New York Stock Exchange (NYSE), Stock Exchange (NYSE), American Stock Exchange American Stock Exchange (AMEX), National Association of (AMEX), National Association of Securities Dealers’ Automated Securities Dealers’ Automated Quotations (NASDAQ), and Quotations (NASDAQ), and several regional stock several regional stock exchanges.exchanges.


Primary and Secondary Primary and Secondary MarketsMarkets

When a corporation desires to raise When a corporation desires to raise money through the sale of stock, it money through the sale of stock, it makes a makes a stock offeringstock offering in the in the primary primary stock marketstock market..

Investment bankersInvestment bankers and and underwritersunderwriters purchase most or all of the shares purchase most or all of the shares being offered by the company and then being offered by the company and then resell the shares to other investors in resell the shares to other investors in the the secondary stock marketsecondary stock market..


Government Influence on Government Influence on the Marketthe Market

The The Securities and Exchange Securities and Exchange Commission (SEC)Commission (SEC) was created in was created in 1934 by Congress to regulate the 1934 by Congress to regulate the buying and selling of stocks and buying and selling of stocks and bonds in the U.S.bonds in the U.S.

Companies selling stock in any of Companies selling stock in any of the markets are required to file the markets are required to file detailed reports with the SEC on detailed reports with the SEC on a regular basis.a regular basis.

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End of Chapter F3

Documents

1 Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investments by Owners CHAPTER F3 © 2007 Pearson Custom Publishing