3 Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investments by Owners Discussion Questions 3-1. NOTE TO INSTRUCTOR: Discussion Question 3-1 is a great one to revisit later in the semester. Consider having your students submit their lists of questions and then redistribute the lists later in the semester and have them analyze how their lists would change, based on their increased knowledge of how to use accounting information. If students truly seem stumped on how to approach this question, suggest that they envision a specific company with which they have some experience (e.g., the local bike shop, gas station, fast food restaurant). One object of the question is to help your students understand that the purpose of the balance sheet is to address very logical information needs. The other object is to convey to your students an understanding that not all the information needed by economic decision makers can be found in the financial statements. A good way to approach the discussion is to have the students provide questions from their lists while you record the questions on the board or an overhead. Record the questions under four groups as follows (but don=t title them or explain what they represent): a. Questions about assets. b. Questions about liabilities. Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-1 c. Questions about owners= equity. d. Questions not fitting any of the first three groups. An interesting thing will happen as you record the questions. Most of the questions your students ask will be requesting balance sheet information. For example, they may ask if the company owes anybody anything, but they may not know they are referring to liabilities. They may ask whether the company has any cash, not knowing they are asking about assets. They may ask whether the company has been profitable, not knowing they are asking about retained earnings. They may ask if anybody is suing the company, which you would record under the fourth group. With very little guidance from you, your students will come up with questions regarding the major sections of the balance sheet, plus some questions that do not fit in the balance sheet. When you have enough questions recorded to drive home the point of the exercise, label the four headings. This can be a powerful way for your students to learn why the balance sheet is organized as it is. They will also learn that there are important items of information about a company that cannot be learned from the balance sheet (or any other financial statement, for that matter). F3-2 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners 3-2. The purpose of this question is twofold. First, it is designed to help your students understand that the best way to solve any problem is to locate and use the best tool available. This assumes that the real problem and the most appropriate tool have been identified. Second, it should help your students understand that in order to use any tool effectively, you must understand both what it can do and what it cannot do. How does one decide what kind of tool is needed in the situation described in the question? An expert escape artist would very likely request a different tool than someone who had never been in this situation before because of his or her knowledge of the problem and potential solutions. Some of your students may want a screwdriver to remove the hinges of the door or the doorknob (including the lock mechanism). Some may want an axe and just chop their way out. The specific answers they come up with are not as important as the thought they put into their answers. This analogy is very powerful in helping students think about thinking, and can be revisited as they add more tools to their kits. 3-3. A stock=s market price for a publicly traded company is quoted in business newspapers such as the Wall Street Journal, the business section of most local papers, on-line computer services, and even business programs on television. You could also contact a stockbroker. 3-4. One argument that could be made for issuing par value stock, is to remain Acomparable@ to other corporations already in existence. Certain states= corporate laws require a corporation to have a par value. Another is that by establishing a low par value and then selling the stock for more than the par value, a company will show Additional Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-3 Paid-in Capital on its balance sheet, which sounds impressive (even though, as the text explains, is meaningless). The argument against establishing a par value on common stock is that such data no longer provide relevant information and par value is only an accounting device that clutters the equity section of the balance sheet presentation and confuses readers. The statements could be simplified with no-par stock. 3-5. The balance between investment and speculation involves an awareness of the philosophy of motivating a person=s actions. Investment usually connotes a long-term philosophy of buying into the industry, management and corporate character of the investment, which is more company-driven. Speculation usually connotes a short-term philosophy of buying the investment only as a means to receive quick profits, which is more market-driven. The long-term concern for the U.S. economy is that speculation is encroaching on investment, thereby causing corporate management to run their companies with a very short-term, quick-profit perspective. This appears to have a long-term detrimental effect on the economic health of our country. F3-4 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners Review the Facts A. Assets are the probable future economic benefits obtained or controlled by an entity as a result of past transactions or events; things of value owned by a company. Liabilities are probable future sacrifices of economic benefits arising from present obligations of the entity to transfer assets or provide services in the future as a result of past transactions or events. Equity is the residual interest in the assets of an entity that remains after deducting its liabilities. Equity is also called net assets, owners’ equity, or net worth. B. The two sources of equity are the investments by owners which result from transfers from other entities of something valuable and earned equity which is the total amount the entity has earned since its inception reduced by any distributions to owners. C. Assets = Liabilities + Owners’ Equity D. The balance sheet is also referred to as the Statement of Financial Condition or the Statement of Financial Position. E. The formats applied to the balance sheet are the account form which lists assets in the left column and the liabilities and equity in the right column; and the report form which lists all the elements in one vertical column. F. A proprietorship has one owner and therefore only one capital account and one drawing account. A partnership has multiple owners and each owner is represented with one capital and one drawing account which allow the tracking of each individual partner’s capital. Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-5 G. The ownership of a corporation by a stockholder is evidenced by shares of stock. The stockholder may receive distributions from the corporation in the form of dividends and if the stockholder is involved in the day to day operations of the business he becomes an employee of the corporation. H. Authorized shares of stock are the maximum number of shares that can be legally issued under the corporate charter. Issued shares of stock represent the number of shares already distributed to shareholders. Outstanding shares of stock are the shares being held by stockholders; calculated as the issued shares minus the treasury stock. I. Treasury stock is the stock reacquired by the corporation that have been issued but are no longer outstanding. J. The two major components of stockholders equity are contributed capital and retained earnings. Contributed capital is the total amount of capital invested by the shareholders. Retained earnings are the sum of all earnings of a corporation since inception minus the dividends declared. The retained earnings account is the portion of earnings retained for internal financing. K. The two major classes of stock are the common stock and the preferred stock. Common stock has voting privileges whereas; preferred stock contains certain preferences over common stock but has no voting privileges. The common shareholders elect board members and vote on major corporate issues. The preferred stock is entitled to dividends before the common shareholders and they have a preference in the event of liquidation. F3-6 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners L. Par value is an optional, arbitrary dollar amount placed on the stock by the incorporators when the corporate charter is created. The stock is listed on the balance sheet at a figure that represents the par value per share multiplied by the number of shares issued. The par value of the stock has no relationship to the market value of the stock. M. A stock offering is the offer of stock of a corporation to the public for the first time. A stock exchange is a place which provides the ability for willing buyers and sellers of stock to come together to exchange shares in the secondary market. The most famous stock exchange is the New York Stock Exchange. N. Investment bankers or underwriters serve as intermediaries between a corporation issuing stock and the investors who ultimately purchase the shares. O. The primary stock market is the business activity involved in the initial issue of stock from a corporation. The secondary stock market is the business activity that focuses on the trades of stock among investors subsequent to the initial issue. P. The SEC is a government organization created by Congress in 1933 that regulates the reporting by public companies and the trading of securities in the market. Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-7 Apply What You Have Learned 3-6. a. Assets = Liabilities + Equity b. Assets – Probable future economic benefits controlled by an entity as a result of prior transactions. What a company has. Liabilities – Probable future sacrifices of assets arising from present obligations of an entity as a result of past transactions. What a company owes. Equity – The residual interest in the assets of an entity that remains after deducting liabilities. c. Assets – Cash, Accounts Receivable, Supplies, Inventory Liabilities – Accounts Payable, Notes Payable, Bonds Payable Equity – Capital, Withdrawals, Common Stock, Preferred Stock, Retained Earnings 3-7. 1. b 2. a 3. a 4. c 5. 6. 7. 8. F3-8 b b c c Debts of the company Probable future economic benefits Things of value a company has The residual interest in the assets of an entity that remains after deducting its liabilities Probable future sacrifices of economic benefits What the company owes What the company has less what it owes The owner’s interest in the company Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners 3-8. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. a c b a c c b c c c 3-9. a. 1. 2. 3. 4. 5. Cash Additional Paid-in Capital Bonds Payable Land Common Stock Retained Earnings Notes Payable Withdrawals Partners’ Capital Preferred Stock The date of the balance sheet should not be for the year ended, but as of December 31, 2007. The heading and total for the right side of the balance sheet should be Liabilities and Stockholders’ Equity. Notes Payable is a liability, not an asset. Cash is an asset, not a liability. The balance sheet does not balance. Each item must verified to determine which one is incorrectly stated or if an item is missing. For this scenario, we assumed that Retained Earnings is understated by $20,000. b. Karen Bean Enterprises Balance Sheet December 31, 2007 Assets Liabilities and Stockholders’ Equity Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-9 Cash $ 20,000 Land 120,000 Notes Payable $ 20,000 Common Stock 40,000 Additional Paid-in Capital 50,000 Retained Earnings 30,000 Total Liabilities and Stockholders’ Equity $140,000 Total Assets $140,000 3-10. a. 1. 2. 3. 4. There are only 30 days in November. The heading and total for the right side of the balance sheet should be Stockholders’ Equity instead of Owner’s Equity. Treasury Stock is a reduction in equity, not an asset. Stallworth’s Capital account should be Common Stock because this is a corporation. b. L. Stallworth, Inc. Balance Sheet November 30, 2007 Cash Assets $50,000 Total Assets F3-10 $50,000 Liabilities and Notes Payable Common Stock Retained Earnings Less: Treasury Stock Total Liabilities and Stockholders’ Equity Equity $ 20,000 40,000 10,000 <20,000> $ 50,000 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners 3-11. There are two possible interpretations of this problem. First Interpretation: a. 1. The Balance sheet should not be for the year ended but as of December 31, 2007. 2. Sweet and Barnes Capital accounts should be Common Stock because this is a corporation. Contributed capital is not an asset, but an equity item. 3. Liabilities and Owner’s Equity should be labeled Stockholders’ Equity because this is a corporation. b. Sweet Corporation Balance Sheet December 31, 2007 Assets Cash $120,000 Total Assets $120,000 Liabilities and Stockholders’ Equity Notes Payable $ 30,000 Common Stock 60,000 Retained Earnings 30,000 Total Liabilities and Stockholders’ Equity $120,000 Second Interpretation: 1. 2. 3. The Balance sheet should not be for the year ended but as of December 31, 2007. Sweet is not a corporation, but a partnership. Sweet and Barnes Capital accounts should be equity Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-11 accounts, not asset accounts. 4. Liabilities and Owner’s Equity should be labeled Partners’ Equity because this is a partnership. 5 The Retained Earnings is the net income earned to date. In the absence of additional information, we will split it between the two partners. 3-11. (Continued) b. Sweet Corporation Balance Sheet December 31, 2007 Assets Cash $120,000 Total Assets $120,000 Liabilities and Partners’ Capital Notes Payable $ 30,000 Sweet Capital 35,000 Barnes Capital 55,000 Total Liabilities and Partners’ Capital $120,000 3-12. a. It appears that Gerner contributed assets to the business and borrowed funds from the bank. Gerner may have contributed $100,000 in cash and bought land with money borrowed from the bank, or he may have contributed the Land and borrowed $50,000 from the bank. b. It appears that the business is organized as a sole proprietorship based on the presentation of Gerner’s Capital account on the balance sheet. F3-12 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners 3-13. a. Susan Pate and Associates has assets of $60,000, consisting of Cash (of $40,000) and Land (that cost $20,000).The entity has two partners, Susan Pate and Julie Pham. The partnership owes a note payable to the bank for $10,000 and each partner has a capital balance of $25,000. b. Because there are two Capital accounts, this entity appears to be a partnership. c. Without additional information, it is not possible to determine the profit for the year because we do not know the original capital contributions. d. Without additional information, it is not possible to determine the profit sharing ratio because we do not know the original capital contributions. Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-13 3-14. a. The Balance Sheet reports Total Assets of $120,000. The Liabilities reported indicate that the business owes a note payable of $20,000 to the bank and has 4,000 shares of common stock that were sold above the par value. The company has earned a profit in the first year based on the Retained Earnings balance. b. Vu Enterprises appears to be a corporation. c. Because we do not know if any dividends were paid out, we cannot determine the amount of profit for the first year from this information. d. Based upon the way the word stockholder’s is written, we can assume that there is only one stockholder. e. Quynh Vu Enterprises issued 4,000 shares of common stock at a price of $22.50 per share, using information from the Common Stock account and the Additional Paid-in Capital account as follows: Common Stock Account / Par Value = Number of Shares $40,000 / $10 = 4,000 shares Sales price of stock / Number of shares = Price per share $90,000 / 4,000 shares = $22.50 per share F3-14 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners 3-15. a. Randy Peoples Enterprises Balance Sheet January 2, 2007 Assets Cash $5,000 Total Assets $5,000 Liabilities and Owner’s Equity Liabilities $ -0Owner’s Equity: Randy Peoples, Capital 5,000 Total Liabilities and Owner’s Equity $5,000 b. R & S Enterprises Balance Sheet January 2, 2007 Assets Cash $5,000 Total Assets $5,000 Liabilities and Partners’ Capital Liabilities $ -0Partner’s Capital: Randy Peoples, Capital 2,000 Sandy Peoples, Capital 3,000 Total Liabilities and Partners’ Capital $5,000 Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-15 3-15. (Continued) c. R & S Enterprises, Inc. Balance Sheet January 2, 2007 Assets Cash $5,000 Total Assets $5,000 Liabilities and Stockholders’ Equity Liabilities $ -0Stockholders’ Equity: Common Stock $1,000 Additional Paid-in Capital 4,000 Total Stockholders’ Equity 5,000 Total Liabilities and Stockholders’ Equity $5,000 d. R & S Enterprises Inc. Balance Sheet January 2, 2007 Assets Cash $5,000 Total Assets $5,000 e. F3-16 Liabilities and Stockholders’ Equity Liabilities $ -0No-Par Common Stock 5,000 Total Liabilities and Stockholders’ Equity $5,000 Randy might wish to form a partnership instead of a soleChapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners proprietorship for several reasons. Partnerships provide: 1. Increased management expertise 2. Access to more capital than a sole proprietorship 3. No special income taxes 4. Greater business continuity than the proprietorship. 3-16. a. Arthur Johnson Enterprises Balance Sheet June 2, 2007 Assets Cash Total Assets Liabilities and Owner’s Equity $50,000 Liabilities $ -0Owner’s Equity: Arthur Johnson, Capital 50,000 Total Liabilities and $50,000 Owner’s Equity $50,000 b. A & C Enterprises Balance Sheet June 2, 2007 Assets Cash $80,000 Total Assets $80,000 Liabilities and Partners’ Capital Liabilities $ -0Partner’s Capital: Arthur Johnson, Capital 50,000 Charles Smith, Capital 30,000 Total Liabilities and Partners’ Capital $80,000 Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-17 3-16. (Continued) c. A & C Enterprises, Inc. Balance Sheet June 2, 2007 Assets Cash $80,000 Total Assets $80,000 Liabilities and Stockholders’ Equity Liabilities $ -0Stockholders’ Equity: Common Stock $ 8,000 Additional Paid-in Capital 72,000 Total Stockholders’ Equity 80,000 Total Liabilities and Stockholders’ Equity $80,000 d. A & C Enterprises, Inc. Balance Sheet June 2,2007 Assets Cash $80,000 Total Assets $80,000 e. F3-18 Liabilities and Stockholders’ Equity Liabilities $ -0No-Par Common Stock 80,000 Total Liabilities and Stockholders’ Equity $80,000 The balance sheet is a “financial snapshot “that reports the Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners financial position (assets, liabilities, and equity) of a business as of a point in time. 3-17. a. Fred Berfel Enterprises Balance Sheet July 1, 2007 Assets Cash Total Assets Liabilities and Owner’s Equity $90,000 Liabilities $ -0Owner’s Equity: Fred Berfel, Capital 90,000 Total Liabilities and $90,000 Owner’s Equity $90,000 b. F & D Enterprises Balance Sheet July 1, 2007 Assets Cash $90,000 Total Assets $90,000 Liabilities and Partners’ Capital Liabilities $ -0Partner’s Capital: Fred Berfel, Capital 40,000 Dan Berfel, Capital 50,000 Total Liabilities and Partners’ Capital $90,000 Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-19 3-17. (Continued) c. F & D Enterprises Inc. Balance Sheet July 1, 2007 Assets Cash $90,000 Total Assets $90,000 Liabilities and Stockholders’ Equity Liabilities $ -0Stockholders’ Equity: Common Stock $18,000 Additional Paid-in Capital 72,000 Total Stockholders’ Equity 90,000 Total Liabilities and Stockholders’ Equity $90,000 d. F & D Enterprises Inc. Balance Sheet July 1, 2007 Assets Cash $90,000 Total Assets $90,000 F3-20 Liabilities and Stockholders’ Equity Liabilities $ -0No-Par Common Stock 90,000 Total Liabilities and Stockholders’ Equity $90,000 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners e. Some advantages of the corporate form over a partnership include: 1. Limited liability of the owners 2. Even greater access to capital 3. Ease of transfer of ownership 4. Continuity of life. 3-18. a. Sandy Sanders Enterprises Balance Sheet March 1, 2007 Assets Cash Land Total Assets Liabilities and Owner’s Equity $40,000 Liabilities $ -05,000 Owner’s Equity: Sandy Sanders, Capital 45,000 Total Liabilities and $45,000 Owner’s Equity $45,000 b. S & D Enterprises Balance Sheet March 1, 2007 Assets Cash Land $70,000 10,000 Total Assets $80,000 Liabilities and Partners’ Capital Liabilities $ -0Partner’s Capital: Sandy Sanders, Capital 50,000 Daryl Sanders, Capital 30,000 Total Liabilities and Partners’ Capital $80,000 Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-21 3-18. (Continued) c. S & D Enterprises, Inc. Balance Sheet March 1, 2007 Assets Cash Land $70,000 10,000 Total Assets $80,000 Liabilities and Stockholders’ Equity Liabilities $ -0Stockholders’ Equity: Common Stock $ 8,000 Additional Paid-in Capital 72,000 Total Stockholders’ Equity 80,000 Total Liabilities and Stockholders’ Equity $80,000 d. S & D Enterprises Inc. Balance Sheet March 1, 2007 Assets Cash Land $70,000 10,000 Total Assets $80,000 e. F3-22 Liabilities and Stockholders’ Equity Liabilities $ -0No-Par Common Stock 80,000 Total Liabilities and Stockholders’ Equity $80,000 Some advantages of the corporate form are: Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners 1. 2. 3. 4. Limited liability of the owners Even greater access to capital Ease of transfer of ownership Continuity of life. 3-19. On the asset side, there are no differences among the balance sheets of proprietorships, partnerships, and corporations. Except for bonds payable, which are generally issued by corporations, and income taxes payable, there are no differences in the presentation of liabilities. The differences are found in the equity section of the balance sheet. Neither proprietorships nor partnerships differentiate between amounts invested by their owner or owners and amounts earned by the company. Both owner investments and amounts earned by the company are lumped together as capital. A proprietorship has only one capital account, representing the equity of a single owner. Partnerships have a separate capital account for each of the owners or partners. Corporations are required to report owner investments and amounts the company has earned separately. Stock accounts and Additional Paid-in Capital accounts reflect investments by owners and make up the equity section called “contributed capital”. Retained Earnings reflects amounts earned throughout the life of the corporation, but not distributed to owners. Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-23 3-20. 1. h 2. f 3. 4. d i 5. b 6. g 7. a 8. e 9. c 10. j F3-24 An arbitrary value placed on either common stock or preferred stock at the time a corporation is formed. The group of men and women who have the ultimate responsibility for managing a corporation. The owners of the corporation. Any amount received by a corporation when it issues stock at a price greater than the par value of the stock issued. The formal document that legally allows a corporation to begin operations. The group of men and women who manage the day-today operations of a corporation. The person or persons who submit a formal application with the appropriate government agencies to form a corporation. A legal document providing evidence of ownership in a corporation. Rules established to conduct the business of the corporation. The amount at which common stock sells. Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners 3-21. a. The key officers of the corporation usually consist of the following: 1. Chief Executive Officer: Duties include responsibility for all activities of the corporation. This person is usually the president. 2. Chief Operating Officer: This is the person who directs the daily operations of the corporation. 3. Chief Financial Officer: The person who is responsible for the financial affairs of the corporation. 4. Controller: The person in charge of all accounting functions of the corporation. 5. Treasurer: The person responsible for the management of the cash of a corporation. 6. Corporate Secretary: The person who maintains minutes of meetings of the board of directors and the stockholders. b. Authorized shares of stock are the maximum number of shares a corporation has been given permission to issue under its corporate charter. Issued shares of stock are the shares that have been distributed to the owners of the corporation in exchange for cash or other assets. Outstanding shares are the shares of stock actually held by the shareholders, while Treasury Stock is stock that has been issued and reacquired by the corporation. Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-25 3-22. a. Ramona Rahill, Inc. could issue up to a maximum of 1,000,000 shares of stock as this is the amount of stock authorized. This means that they currently have an additional 200,000 shares that they may sell. b. The average price at which the corporation sold its stock is found by totaling the Common Stock and Additional Paid-in Capital accounts (contributed capital) and dividing the total by the shares issued. $8,800,000/800,000 shares = $11 per share. c. Dividends are paid based on the outstanding shares, therefore the corporation would need: 800,000 shares x $1.25 = $1,000,000 d. If the corporation has distributed $3,500,000 in dividends, it has earned a total of $5,500,000 in profits. 3-23. a. The Juliette Richard Corporation has 1,000,000 shares of authorized stock. The corporation has 200,000 shares of unissued stock and 50,000 shares in the Treasury for a total of 250,000 shares available to sell. b. The average price at which the corporation sold its stock is found by totaling the Common Stock and Additional Paid-in Capital accounts (contributed capital) and dividing the total by the shares issued. $16,000,000 / 800,000 shares = $20 per share. c. Dividends are paid based on the outstanding shares, therefore the corporation would need: F3-26 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners 750,000 shares x $2.00 = $1,500,000. d. If the corporation has distributed $5,500,000 in dividends then the corporation has earned a total of $15,000,000 of net profit. e. $4,100,000 / 50,000 shares = $82 per share. f. $5,000,000 / 250,000 shares = $20 per share. 3-24. a. David Luza Corporation has 1,000,000 shares of authorized stock. The corporation has no shares of unissued stock and 50,000 shares in the Treasury, for a total of 50,000 shares available to sell. b. The average price at which the corporation sold its stock is found by totaling the Common Stock and Additional Paid-in Capital accounts (contributed capital) and dividing the total by the issued shares. $18,000,000 / 1,000,000 shares = $18 per share. c. Dividends are paid based on the outstanding shares, therefore the corporation would need: 950,000 shares x $1.50 = $1,425,000. d. Because the Retained Earnings account contains $9,500,000, the corporation has paid no dividends. e. $2,500,000 / 50,000 shares = $50 per share. f. All of the treasury stock could be sold. 50,000 shares x $60 per share = $3,000,000 3-25. The preferred stockholders will receive a liquidation distribution before the common stockholders. Preferred stockholders have certain preferences over common stockholders. One of the preferences is a priority claim over common shareholders to assets in the event of the company’s liquidation. Because common shareholders are the residual owners of the firm, they receive what is left after all creditors and the preferred shareholders receive their liquidation payout. Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-27 3-26. a. Investors will choose preferred stock as an investment because preferred stock has 1. preference to dividends ahead of Common Stock; 2. less risk than Common Stock; and 3. preference in liquidation over Common Stock. b. Investors will choose common stock as an investment because common stock has 1. voting rights; 2. greater possibility of stock appreciation if the company performs well; and 3. the residual ownership of the corporation. 3-27. 1. B 2. N 3. B 4. P 5. C 6. P 7. P 8. P 9. N 10. C F3-28 Often has a par value. Must have a par value. Can legally pay a dividend. Pays a pre-established dividend amount. Usually has voting rights. Usually does not have voting rights. Has preference in dividends. Has preference in liquidation. Is preferred by all investors. Represents the residual ownership in the corporation. Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners 3-28. a. Investors who choose common stock are willing to take risk and are more interested in the long-term profitability of the entity. Those who invest in common stock frequently look more to stock appreciation than to annual dividends. Although common stocks pay dividends, the return rate on the investment is normally very low in comparison to other investments. b. Investors who select preferred stock are generally risk averse and frequently require regular dividend income. Fixed annual dividends, that often pay higher returns than certificate of deposits, entice many investors to choose preferred stocks to achieve a guaranteed rate of return on the investment. Unlike common stocks, preferred stocks seldom achieve significant market value appreciation. Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-29 3-29. a. The 20,000 shares of stock issued in 1972 and the 50,000 shares issued in 1992 indicate primary stock market transactions. The transactions that have occurred in item #2 describe secondary market transactions. Items #3 and #4 describe results of activity in the secondary stock market, but are not actual transactions. b. The company received: 1972 (20,000 x $5 per share) 1992 (50,000 x $15 per share) Secondary stock transactions Total $100,000 750,000 -0$850,000 c. Common stock will show a total of $850,000 as determined in requirement b above. Balance sheet figures for common stock reflect what the corporation received when the corporation originally issued it, not its current market value. d. The obvious answer is the company must have performed well in 2006 and 2007 because the stock price increased substantially. But, this response may be too simplistic. An increase in the market value of common stock tells us that investors gained confidence in the corporation during this period. This could be explained by new technology developed by the company, new markets announced by the company, or any number of other factors. In addition, the increased market price per share indicates that the investors F3-30 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners believe the company will perform well in the future. 3-30. a. The 35,000 shares of stock issued in 1988 and the 80,000 shares issued in 1992 indicate primary stock market transactions. The transactions that occurred in item #2 describe secondary market transactions. Items #3 and #4 describe results of activity in the secondary stock market, but are not actual transactions. b. The company received: 1988 (35,000 x $10 per share) 1992 (80,000 x $15 per share) Secondary stock transactions Total $ 350,000 1,200,000 -0$1,550,000 c. Common stock will show a total of $1,550,000 as determined in requirement b above. Balance sheet figures for common stock reflect what the corporation received when the corporation originally issued it, not its current market value. d. The obvious answer is the company performed poorly in 2006 because the stock price declined substantially. But, this response may be too simplistic. A decrease in the stock’s market price tells us that investors lost confidence in the corporation during the period. This could be explained by new technology developed by other companies that put Shiner at a disadvantage, the loss of market share, or any number of other factors. The decrease in stock price also indicates that the investment community believes the Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-31 company will not perform better in the future. 3-31. a. The 90,000 shares of common stock and 10,000 shares of preferred stock issued in 1992 and the 50,000 shares of common and 5,000 shares of preferred issued in 1993 indicate primary stock market transactions. The item #2 transactions describe results of secondary market activity. Items #3 and #4 describe results of activity in the secondary stock market, but are not actual transactions. b. The company received: 1992 (90,000 x $25 per share) $2,250,000 1992 (10,000 x $100 per share) 1,000,000 1993 (50,000 x $35 per share) 1,750,000 1993 (5,000 x $150 per share) 750,000 Secondary stock transactions -0Total $5,750,000 c. Common stock will show a total of $4,000,000 ($2,250,000 + $1,750,000) as determined in requirement b above. Preferred stock will show a total of $1,500,000 ($1,000,000 + $500,000) from the par value of $100 for 15,000 shares issued. Additional Paid-in Capital – Preferred Stock will reflect $250,000 ($50 x 5,000) for the shares sold above par in 1993. Balance sheet figures for common stock and preferred stock reflect what the corporation received for it when it was issued, not its current market value. d. Common Stock (90,000 + 50,000) = 140,000 shares Market Value: December 31, 2006 (140,000 shares x $55) = $7,700,000 December 31, 2007 (140,000 shares x $65) = $9,100,000 F3-32 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners Preferred Stock (10,000 + 5,000) = 15,000 shares Market Value: December 31, 2006 (15,000 shares x $135) = $2,025,000 December 31, 2007 (15,000 shares x $150) = $2,250,000 e. It is impossible to determine from the information given. f. It is impossible to determine from the information given. 3-32. a. The 40,000 shares of stock issued in 1979 and the 70,000 shares issued in 1992 indicate primary stock market transactions. The item #2 transactions describe results of activity in the secondary market. Item #3 is a transaction that involves the repurchase by the company of its stock in the secondary market. Items #4 and #5 describe results of activity in the secondary stock market, but are not actual transactions. b. The company received: 1979 (40,000 x $10 per share) $ 400,000 1992 (70,000 x $15 per share) 1,050,000 Secondary stock transactions -0Total $1,450,000 The company paid out $200,000 for treasury stock in 1995. c. Common stock will show a total of $1,450,000 as determined in requirement b above. Balance sheet figures for common stock reflect what the corporation received for it when it was issued, not its current market value. The cost of the Treasury Stock will be shown as a reduction from the total stockholders’ equity. d. The obvious answer is the company must have performed poorly in 2007 because the stock price decreased substantially. But, this response may be too simplistic. A decrease in the market price tells us that investors have lost confidence in the corporation during the period. This could be explained by new technology developed by other companies that puts Bennett at a disadvantage, the loss of Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-33 market share, or any number of other factors. In addition, the decrease in the stock’s price during the year indicates that the investment community believes the company will not perform better in the future. 3-33. Gaylord Corporation Balance Sheet July 10, 2007 Liabilities and Stockholders’ Equity Cash $360,000 Liabilities $ -0Stockholders’ Equity: Preferred Stock $200,000 Common Stock 50,000 Additional Paid-in Capital 110,000 Total Stockholders’ Equity 360,000 Total Liabilities and Total Assets $360,000 Stockholders’ Equity $360,000 Assets 3-34. Sheets Corporation Balance Sheet May 5, 2007 Assets Cash $5,250,000 F3-34 Liabilities and Stockholders’ Equity Liabilities $ -0Stockholders’ Equity: Preferred Stock $2,500,000 Common Stock 300,000 Additional Paid-in Capital 2,450,000 Total Stockholders’ Equity 5,250,000 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners Total Assets $5,250,000 Total Liabilities and Stockholders’ Equity $5,250,000 3-35. Mayes Corporation Balance Sheet April 15, 2007 Liabilities and Stockholders’ Equity $7,500,000 Liabilities $ -0Stockholders’ Equity: Preferred Stock $1,000,000 Common Stock 5,000,000 Additional Paid-in Capital 1,500,000 Total Stockholders’ Equity 7,500,000 Total Total Liabilities and Assets $7,500,000 Stockholders’ Equity $7,500,000 Assets Cash Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-35 3-36. a. As of December 31, 2006, the company had issued 669,847,961 shares of stock. The total amount received for these shares was $4,744,000,000. (Total of Common Stock and Additional Paid-in Capital.) The average amount received for each share was $7.08. $4,744,000,000 / 669,847,961 = $7.08 b. The number of common stock shares outstanding as of December 31, 2007 was 671,242,137. Each share has a par value of $.60. Therefore, the precise amount in the Common Stock account is $402,745,282.20. 671,242,137 x $.60 = $402,745,282.20 c. The number of shares of common stock issued rose from 669,847,961 at the end of 1998 to 671,242,137 at the end of 2007. The difference between these two amounts represents the number of shares issued during 2007 of 1,394,176 shares. d. The company has been authorized to issue up to 900,000,000 shares. With 671,242,137 shares already issued as of the end of 2007, the company could issue the remaining authorized shares. 900,000,000 – 671,242,137 = 228,757,863 F3-36 Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners 3-37. August 27, 2005 a. b. Type of stock outstanding Shares authorized Shares issued Shares outstanding Common 600,000,000 188,871,875 165,262,513 August 28, 2004 Common 600,000,000 187,671,318 167,396,998 Family Dollar does have 500,000 Shares of preferred stock authorized but no shares are issued or outstanding. c. Family Dollar might wish to issue preferred stock to raise additional capital without obligating itself for interest and debt principal payments or to avoid diluting its earnings per share with additional common stock issues. A corporation only has to pay preferred dividends if it declares them. d. Year Ended August 27, 2005: Assets = Liabilities + Stockholders’ Equity $2,409,501 = $981,435 + $1,428,066 Year Ended August 28, 2004: Assets = Liabilities + Stockholders’ Equity $2,229,361 = $887,279 + $1,337,082 Note to Instructor: Depending upon timing, students may find different years listed than are presented here for problems. The answers below are based upon the years available at our publishing date. Chapter 3 – Tools of the Trade, Part I: The Balance Sheet: Initial Financing – Investment by Owners F3-37 3-38. January 28, 2006 a. b. c. d. January 29, 2005 Type of stock outstanding Common Common Shares authorized 500,000,000 500,000,000 Shares issued 68,557,041 68,325,046 Shares outstanding 68,316,590 68,325,046 Treasury shares $240,451 $231,995 Assets = Liabilities + Stockholders’ Equity 1-28-06 $1,821,753,000 = $1,227,188,000 + $594,565,000 1-29-05 $1,867,023,000 = $1,213,567,000 + $653,456,000 3-39. January 28, 2006 a. b. c. d. e. F3-38 January 29, 2005 Type of stock outstanding Common Common Shares authorized 100,000,000 100,000,000 Shares issued 19,339,153 21,685,008 Shares outstanding 19,339,153 21,685,008 Long-term Liabilities` $ 29,342,000 $ 26,879,000 Assets = Liabilities + Stockholders’ Equity 1-28-06 $374,266,000 = $74,473,000 + $299,793.000 1-29-05 $405,543,000 = $72,615,000 + $332,938,000 Each student may select a different article. It is important for the student to develop their opinion and reaction to the information. Chapter 3 – Tools of the Trade, Part I The Balance Sheet: Initial Financing – Investment by Owners