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

2. 2 Identify and explain the accounting elements contained in the balance sheet. Learning Objective 1: © 2007 Pearson Custom Publishing

3. 3 The Accounting Elements Every economic event changes one or more accounting elements. Every economic event changes one or more accounting elements. The ten accounting elements are: The ten accounting elements are: AssetsLiabilitiesEquity Investments by Owners Distributions to Owners Comprehensive Income Revenues Expenses Gains Losses

4. 4 © 2007 Pearson Custom Publishing The Accounting Elements Three accounting elements are included on the balance sheet: Three accounting elements are included on the balance sheet: Assets Assets Liabilities Liabilities Owners’ Equity Owners’ Equity

5. 5 © 2007 Pearson Custom Publishing First Tool of the Trade The Balance Sheet: The Balance Sheet: A financial statement that provides information about the financial condition of an entity at any particular point (usually the end of the month or year). A financial statement that provides information about the financial condition of an entity at any particular point (usually the end of the month or year). The balance sheet is more formally known as: The balance sheet is more formally known as: Statement of Financial Position, or Statement of Financial Position, or Statement of Financial Condition Statement of Financial Condition

6. 6 © 2007 Pearson Custom Publishing Assets Things of value a business owns or controls. Things of value a business owns or controls. FASB says: “Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.” FASB says: “Probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events.”

7. 7 © 2007 Pearson Custom Publishing Liabilities Debts, business amounts owed. Debts, business amounts owed. FASB says: “Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.” FASB says: “Probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events.”

8. 8 © 2007 Pearson Custom Publishing Equity The ownership interests in a company. The ownership interests in a company. FASB says: “The residual interest in the assets of an entity that remains after deducting its liabilities.” FASB says: “The residual interest in the assets of an entity that remains after deducting its liabilities.”

9. 9 © 2007 Pearson Custom Publishing Sources of Equity There are two sources of owners’ equity: There are two sources of owners’ equity: 1. Investments by owners: 1. Investments by owners: This is equal to the cash and other assets paid into the company by the various owners. This is equal to the cash and other assets paid into the company by the various owners. 2. Earned Equity: 2. Earned Equity: This is the total profit that a company has earned since it was started, minus any amounts paid out to the owners. This is the total profit that a company has earned since it was started, minus any amounts paid out to the owners.

10. 10 Demonstrate how the balance sheet provides information about the financial position of a business. Learning Objective 2: © 2007 Pearson Custom Publishing

11. 11 © 2007 Pearson Custom Publishing The Accounting Equation ASSETS = LIABILITIES + OWNERS’ EQUITY The equality (or “balance”) must always be maintained. ASSETS = LIABILITIES + OWNERS’ EQUITY The equality (or “balance”) must always be maintained.

12. 12 © 2007 Pearson Custom Publishing The Accounting Equation ASSETS = LIABILITIES + OWNERS’ EQUITY ASSETS = LIABILITIES + OWNERS’ EQUITY Things We Have = What We Owe + What We Own Things We Have = What We Owe + What We Own Example: You “own” a house. It is worth $80,000 (asset value) and you have a $50,000 mortgage (liability) on it. Your “equity” is equal to $30,000. Example: You “own” a house. It is worth $80,000 (asset value) and you have a $50,000 mortgage (liability) on it. Your “equity” is equal to $30,000.

13. 13 Compare and contrast the balance sheets of proprietorships, partnerships, and corporations. Learning Objective 3: © 2007 Pearson Custom Publishing

14. 14 © 2007 Pearson Custom Publishing Balance Sheet - Account Form Account form is a “left side / right side” presentation.

15. 15 © 2007 Pearson Custom Publishing Balance Sheet - Report Form Report form is a “top & bottom” layout.

16. 16 © 2007 Pearson Custom Publishing Starting a Proprietorship You invest $20,000 to start your business. You invest $20,000 to start your business. ASSETS = LIABILITIES + OWNERS’ EQUITY ASSETS = LIABILITIES + OWNERS’ EQUITY $20,000 = $0 + $20,000 $20,000 = $0 + $20,000

17. 17 © 2007 Pearson Custom Publishing Starting a Proprietorship You invest $20,000 to start your business. You invest $20,000 to start your business. ASSETS = LIABILITIES + OWNERS’ EQUITY ASSETS = LIABILITIES + OWNERS’ EQUITY $20,000 = $0 +$20,000 $20,000 = $0 +$20,000

18. 18 © 2007 Pearson Custom Publishing Starting a Partnership You invest $20,000 and Your Buddy invests $10,000 to start a business. You invest $20,000 and Your Buddy invests $10,000 to start a business. ASSETS = LIABILITIES + OWNERS’ EQUITY ASSETS = LIABILITIES + OWNERS’ EQUITY $30,000 = $0 +$30,000 $30,000 = $0 +$30,000

19. 19 © 2007 Pearson Custom Publishing Starting a Partnership You invest $20,000 and Your Buddy invests $10,000 to start a business. You invest $20,000 and Your Buddy invests $10,000 to start a business. ASSETS = LIABILITIES + OWNERS’ EQUITY ASSETS = LIABILITIES + OWNERS’ EQUITY $30,000 =$0 + $30,000 $30,000 =$0 + $30,000

20. 20 © 2007 Pearson Custom Publishing Starting a Corporation When business people decide that they want to incorporate a business, they have to acquire a corporate charter from a state. When business people decide that they want to incorporate a business, they have to acquire a corporate charter from a state. The articles of incorporation typically include: The articles of incorporation typically 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 corporation. (3) names of the individuals responsible for the corporation.

21. 21 Describe the basic organizational structure of a corporation. Learning Objective 4: © 2007 Pearson Custom Publishing

22. 22 © 2007 Pearson Custom Publishing Corporate Organizational Structure Stockholders (or shareholders) Stockholders (or shareholders) The owners of the corporation. The owners of the corporation. Have invested cash or other assets in exchange for shares of stock. Have invested cash or other assets in exchange for shares of stock. Have stock certificates as evidence of their ownership interests. Have stock certificates as evidence of their ownership interests. Typically meet once a year, primarily to elect members to the board of directors. Typically meet once a year, primarily to elect members to the board of directors.

23. 23 © 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 Organizational Structure

24. 24 Typical Corporate Structure © 2007 Pearson Custom Publishing

25. 25 Differentiate between common stock and preferred stock. Learning Objective 5: © 2007 Pearson Custom Publishing

26. 26 © 2007 Pearson Custom Publishing Common Stock All corporations must have common stock, the voting stock of a company. All corporations must have common stock, the voting stock of a company. Common stock may have a par value. Par value is an arbitrary value that is established when the shares are first authorized. Par value has nothing to do with “fair market value.” Common stock may have a par value. Par value is an arbitrary value that is established when the shares are first authorized. Par value has nothing to do with “fair market value.”

27. 27 © 2007 Pearson Custom Publishing Sample of Par Values The following companies had these par values and per share market prices as of June 30, 2006: The following companies had these par values and per share market prices as of June 30, 2006: Company Par Value Market Price GM $1.6700$29.79 GM $1.6700$29.79 IBM $0.0200 $76.82 IBM $0.0200 $76.82 Chevron $0.7000$62.06 Chevron $0.7000$62.06 Boeing $5.0000 $81.91 Boeing $5.0000 $81.91 PepsiCo $0.0167 $60.04 PepsiCo $0.0167 $60.04

28. 28 © 2007 Pearson Custom Publishing Par Value Example Assume Your Company, Inc., sells 1,000 shares of $1 par value common stock for $10 per share. Assume Your Company, Inc., sells 1,000 shares of $1 par value common stock for $10 per share.

29. 29 © 2007 Pearson Custom Publishing No-Par Stock If common stock does not have a par value, it is known as no-par stock. With no-par stock, the full sales price is entered into the common stock account. If common stock does not have a par value, it is known as no-par stock. With no-par stock, the full sales price is entered into the common stock account.

30. 30 © 2007 Pearson Custom Publishing No-Par Stock If common stock does not have a par value, it is known as no-par stock. With no-par stock, the full sales price is entered into the common stock account. If common stock does not have a par value, it is known as no-par stock. With no-par stock, the full sales price is entered into the common stock account.

31. 31 © 2007 Pearson Custom Publishing Preferred Stock Preferred stock does not have voting privileges, but does have certain preferences over common stock: Preferred stock does not have voting privileges, but does have certain preferences over common stock: Dividend preference : preferred dividends must be paid before common dividends. Dividend preference : preferred dividends must be paid before common dividends. Liquidation preference : distribution of company assets must be made to preferred stockholders before common stockholders may receive any assets. Liquidation preference : distribution of company assets must be made to preferred stockholders before common stockholders may receive any assets.

32. 32 © 2007 Pearson Custom Publishing Preferred Stock Example: Recall that Your Company, Inc., sold par value common stock in an earlier example. Assume that Your Company also sells 100 shares of $100 par value preferred stock at the market price of $120 per share. Example: Recall that Your Company, Inc., sold par value common stock in an earlier example. Assume that Your Company also sells 100 shares of $100 par value preferred stock at the market price of $120 per share. What would the stockholders’ equity section of the balance sheet look like with both types of stock included? What would the stockholders’ equity section of the balance sheet look like with both types of stock included?

33. 33 © 2007 Pearson Custom Publishing Common and Preferred Stock NOTE: Additional paid-in capital should be kept separate for the two different types of stock.

34. 34 Describe the components of stockholders’ equity and explain the meaning of treasury stock. Learning Objective 6: © 2007 Pearson Custom Publishing

35. 35 © 2007 Pearson Custom Publishing Corporate Capital Structure For a corporation, there are various terms related to stock that you must be familiar with: For a corporation, there are various terms related to stock that you must be familiar with: Authorized shares: number that could be sold. Authorized shares: number that could be sold. Issued shares: number that have been sold. Issued shares: number that have been sold. Outstanding shares: number currently held by the stockholders. Outstanding shares: number currently held by the stockholders. Treasury stock: shares reacquired by the corporation; issued but not outstanding. Treasury stock: shares reacquired by the corporation; issued but not outstanding.

36. 36 © 2007 Pearson Custom Publishing Stockholders’ Equity Stockholders’ equity is made up of two main components: Stockholders’ equity is made up of two main components: 1) Contributed Capital (or Paid-In Capital) 1) Contributed Capital (or Paid-In Capital) The amount invested by the holders of both common stock and preferred stock. The amount invested by the holders of both common stock and preferred stock. 2) Retained Earnings 2) Retained Earnings The accumulation of corporate net earnings minus any dividends declared. The accumulation of corporate net earnings minus any dividends declared.

37. 37 Identify what information is available on a corporate balance sheet and what information is not available. Learning Objective 7: © 2007 Pearson Custom Publishing

38. 38 Information Provided on a Balance Sheet The corporation’s assets, liabilities, and equity on the day it was prepared. The corporation’s assets, liabilities, and equity on the day it was prepared. The book value of assets. The book value of assets. The amount stockholders have contributed to the company. The amount stockholders have contributed to the company. The amount of authorized, issued, outstanding, and treasury stock. The amount of authorized, issued, outstanding, and treasury stock. © 2007 Pearson Custom Publishing

39. 39 Information Not Provided on a Balance Sheet The corporation’s assets, liabilities, and equity at any other time than the date prepared. The corporation’s assets, liabilities, and equity at any other time than the 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 Publishing

40. 40 Explain the basic process operating in the primary and secondary stock markets. Learning Objective 8: © 2007 Pearson Custom Publishing

41. 41 © 2007 Pearson Custom Publishing Stock Exchanges A stock exchange is a place (either real or in cyberspace) for stock buyers and sellers to get together to conduct their business. A stock exchange is a place (either real or in cyberspace) for stock buyers and sellers to get together to conduct their business.

42. 42 © 2007 Pearson Custom Publishing The Stock Market Actually there are several stock markets, including the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), National Association of Securities Dealers’ Automated Quotations (NASDAQ), and several regional stock exchanges. Actually there are several stock markets, including the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), National Association of Securities Dealers’ Automated Quotations (NASDAQ), and several regional stock exchanges.

43. 43 © 2007 Pearson Custom Publishing Primary and Secondary Markets When a corporation desires to raise money through the sale of stock, it makes a stock offering in the primary stock market. When a corporation desires to raise money through the sale of stock, it makes a stock offering in the primary stock market. Investment bankers and underwriters purchase most or all of the shares being offered by the company and then resell the shares to other investors in the secondary stock market. Investment bankers and underwriters purchase most or all of the shares being offered by the company and then resell the shares to other investors in the secondary stock market.

44. 44 © 2007 Pearson Custom Publishing Government Influence on the Market The Securities and Exchange Commission (SEC) was created in 1934 by Congress to regulate the buying and selling of stocks and bonds in the U.S. The Securities and Exchange Commission (SEC) was created in 1934 by Congress to regulate the buying and selling of stocks and bonds in the U.S. Companies selling stock in any of the markets are required to file detailed reports with the SEC on a regular basis. Companies selling stock in any of the markets are required to file detailed reports with the SEC on a regular basis.

45. 45 End of Chapter F3