3 - 3 - 11© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Organizing a Business: Organizing a Business:
Equity and Debt Equity and Debt
FinancingFinancing
Chapter 3Chapter 3
3 - 3 - 22© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Learning Objective 1Learning Objective 1
Identify the steps toIdentify the steps to
organizing a business.organizing a business.
3 - 3 - 33© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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.
3 - 3 - 44© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
The Four Functions of the The Four Functions of the FirmFirm
FinancingFinancing
Decision makingDecision making
OperatingOperating
InvestingInvesting
3 - 3 - 55© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Learning Objective 2Learning Objective 2
Describe a corporateDescribe a corporate
organization structureorganization structure
and define the equityand define the equity
structure of a corporation.structure of a corporation.
3 - 3 - 66© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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.
3 - 3 - 77© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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.
3 - 3 - 88© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Corporate Organizational Corporate Organizational StructureStructure
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
3 - 3 - 99© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Corporate Organizational Corporate Organizational StructureStructure
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
3 - 3 - 1010© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Learning Objective 3Learning Objective 3
Compare and contrast theCompare and contrast the
characteristics of commoncharacteristics of common
stock and preferred stock.stock and preferred stock.
3 - 3 - 1111© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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.
3 - 3 - 1212© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Corporate Capital StructureCorporate Capital Structure
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.
3 - 3 - 1313© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Corporate Capital StructureCorporate Capital Structure
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.
3 - 3 - 1414© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Corporate Capital StructureCorporate Capital Structure
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..
3 - 3 - 1515© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Learning Objective 4Learning Objective 4
Research an industry for itsResearch an industry for its
particular characteristics particular characteristics
andand
identify its major identify its major
competitors.competitors.
3 - 3 - 1616© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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.
3 - 3 - 1717© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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
3 - 3 - 1818© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Learning Objective 5Learning Objective 5
Prepare a strategic planPrepare a strategic plan
for a business.for a business.
3 - 3 - 1919© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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.
achieve the stated goals by allocating financialachieve the stated goals by allocating financialresources and directing human resources.resources and directing human resources.
3 - 3 - 2020© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Developing a Strategic PlanDeveloping a Strategic Plan
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.
3 - 3 - 2121© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Developing a Strategic PlanDeveloping a Strategic Plan
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.
3 - 3 - 2222© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Learning Objective 6Learning Objective 6
Outline internal controlsOutline internal controls
for operations.for operations.
3 - 3 - 2323© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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.
3 - 3 - 2424© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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
3 - 3 - 2525© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Learning Objective 7Learning Objective 7
Define borrowing terms andDefine borrowing terms and
compute the cost of compute the cost of
borrowing.borrowing.
3 - 3 - 2626© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Securing FinancingSecuring Financing
FinancingFinancing
Equity financingEquity financing Debt financingDebt financing
3 - 3 - 2727© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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.
3 - 3 - 2828© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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
3 - 3 - 2929© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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?
3 - 3 - 3030© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
The Cost of BorrowingThe Cost of Borrowing
$ $ 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
3 - 3 - 3131© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
The Cost of BorrowingThe Cost of Borrowing
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
3 - 3 - 3232© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
The Cost of BorrowingThe Cost of Borrowing
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
3 - 3 - 3333© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
The Cost of BorrowingThe Cost of Borrowing
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
3 - 3 - 3434© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Learning Objective 8Learning Objective 8
Compute and distinguishCompute and distinguish
between nominal andbetween nominal and
effective interest rates.effective interest rates.
3 - 3 - 3535© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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
3 - 3 - 3636© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Effective Interest RateEffective Interest Rate
3 - 3 - 3737© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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.
3 - 3 - 3838© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Borrowing ThroughBorrowing Throughthe Financial Marketsthe Financial Markets
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
3 - 3 - 3939© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Borrowing ThroughBorrowing Throughthe Financial Marketsthe Financial Markets
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.
3 - 3 - 4040© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Borrowing ThroughBorrowing Throughthe Financial Marketsthe Financial Markets
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.
3 - 3 - 4141© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
Learning Objective 9Learning Objective 9
Compute the selling price Compute the selling price
ofof
bonds with a calculator.bonds with a calculator.
3 - 3 - 4242© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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
3 - 3 - 4343© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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?
3 - 3 - 4444© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
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.
3 - 3 - 4545© 2005 © 2005 Accounting 1/eAccounting 1/e, Terrell/Terrell, Terrell/Terrell
End of Chapter 3End of Chapter 3