1
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
2
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:
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
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
4 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
5 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
6 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.”
7 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.”
8 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.”
9 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
10
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.
Learning Objective 2:
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
11 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
12 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
13
Compare and contrast Compare and contrast the balance sheets of the balance sheets of
proprietorships, proprietorships, partnerships, and partnerships, and
corporations.corporations.
Learning Objective 3:
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
14 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
15 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
16 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
17 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
Total assets $20,000 Total L & OE $20,000
18 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
19 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
Assets LiabilitiesCash $30,000 $0
Owners' equityYou, Capital $20,000
Buddy, Capital 10,000 30,000
Total assets $30,000 Total L & OE $30,000
20 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
21
Describe the basic Describe the basic organizational structure organizational structure
of a corporation.of a corporation.
Learning Objective 4:
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
22 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
23 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
24
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
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
25
Differentiate between Differentiate between common stock and common stock and
preferred stock.preferred stock.
Learning Objective 5:
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
26 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.”
27 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
28 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
Assets LiabilitiesCash $10,000 $0
Stockholders' equityCommon stock $1,000
Add'l paid-in capital 9,000 10,000
Total assets $10,000 Total liabilities & S.Equity $10,000
29 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
30 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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
Assets LiabilitiesCash $10,000 $0
Stockholders' equity
Common stock 10,000
Total assets $10,000 Total liabilities & S.Equity $10,000
31 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
32 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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?
33 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
34
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.
Learning Objective 6:
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
35 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
36 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
37
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.
Learning Objective 7:
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
38
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.
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
39
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.
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
40
Explain the basic process Explain the basic process operating in the primary operating in the primary
and secondary stock and secondary stock markets.markets.
Learning Objective 8:
© 2007 Pearson Custom © 2007 Pearson Custom PublishingPublishing
41 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
42 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
43 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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..
44 © 2007 Pearson Custom Publishing© 2007 Pearson Custom Publishing
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.
45
End of Chapter F3