CHAPTER F3
Tools of the Trade, Part I
The Balance Sheet:
Initial Financing –
Investments by Owners
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Learning Objective 1:
Identify and explain the
accounting elements
contained in the balance
sheet.
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The Accounting Elements
 Every economic event changes one or
more accounting elements.
 The ten accounting elements are:
Assets
Liabilities
Equity
Investments by Owners
Distributions to Owners
Comprehensive Income Revenues
Expenses Gains
Losses
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The Accounting Elements
 Three accounting elements are
included on the balance sheet:
 Assets
 Liabilities
 Owners’ Equity
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First Tool of the Trade
 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).
 The balance sheet is more formally known
as:
 Statement of Financial Position, or
 Statement of Financial Condition
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Assets
 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.”
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Liabilities
 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.”
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Equity
 The ownership interests in a
company.
 FASB says: “The residual
interest in the assets of an
entity that remains after
deducting its liabilities.”
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Sources of Equity
 There are two sources of owners’
equity:
 1. Investments by owners:

This is equal to the cash and other assets
paid into the company by the various
owners.
 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.
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Learning Objective 2:
Demonstrate how the
balance sheet provides
information about the
financial position of a
business.
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The Accounting Equation
 ASSETS = LIABILITIES + OWNERS’ EQUITY
The equality (or “balance”) must
always be maintained.
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The Accounting Equation
 ASSETS = LIABILITIES + OWNERS’
EQUITY
 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.
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Learning Objective 3:
Compare and contrast the
balance sheets of
proprietorships,
partnerships, and
corporations.
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Balance Sheet - Account Form
Your Company
Balance Sheet
December 31, 2000
Asset #1
Asset #2
Asset #3
Asset #4
Assets
$1,000
500
300
200
Total assets
Liabilities
Liability #1 $1,200
Liability #2
100 $1,300
Owners' equity
Equity #1
$700
$2,000
Total L & OE
$2,000
Account form is a “left side / right side” presentation.
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Balance Sheet - Report Form
Yo ur C o m p an y
B ala n ce S h ee t
D e c em b er 3 1, 1 9 99
Asset
Asset
Asset
Asset
A s s e ts
$1 ,0 0 0
500
300
200
#1
#2
#3
#4
T ota l a s s e ts
$ 2 ,0 0 0
L ia b ilities
$1 ,2 0 0
100
L ia b ility # 1
L ia b ility # 2
Report
form is a
“top &
bottom”
layout.
$ 1 ,3 0 0
Own e rs ' e qu ity
E qu ity # 1
T ota l L & O E
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$7 0 0
$ 2 ,0 0 0
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Starting a Proprietorship
 You invest $20,000 to start your business.
 ASSETS = LIABILITIES + OWNERS’ EQUITY
 $20,000 =
$0
+ $20,000
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Starting a Proprietorship
 You invest $20,000 to start your business.
 ASSETS = LIABILITIES + OWNERS’ EQUITY
 $20,000 =
$0
+
$20,000
Your Company
Balance Sheet
January 1, 2000
Assets
Cash
Liabilities
$20,000
$0
Owners' equity
You, Capital
$20,000
Total assets
$20,000
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Total L & OE
$20,000
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Starting a Partnership
 You invest $20,000 and Your Buddy
invests $10,000 to start a business.
 ASSETS = LIABILITIES + OWNERS’ EQUITY
 $30,000 =
$0
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+
$30,000
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Starting a Partnership
 You invest $20,000 and Your Buddy invests
$10,000 to start a business.
 ASSETS = LIABILITIES + OWNERS’ EQUITY
 $30,000 =
$0
+
$30,000
Our Company
Balance Shee t
Januar y 1 , 20 00
Assets
Cash
To tal assets
L iab ilities
$30,000
$30,000
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$0
Own ers' equ ity
Yo u, Capital
$20,000
Bu dd y, Cap ital
10,000
T otal L & O E
30,000
$30,000
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Starting a Corporation
 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:



(1) basic purpose of the corporation,
(2) details related to the stock to be issued, and
(3) names of the individuals responsible for the
corporation.
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Learning Objective 4:
Describe the basic
organizational structure of
a corporation.
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Corporate Organizational
Structure
 Stockholders (or shareholders)
 The
owners of the corporation.
 Have invested cash or other assets in
exchange for shares of stock.
 Have stock certificates as evidence of their
ownership interests.
 Typically meet once a year, primarily to
elect members to the board of directors.
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Corporate Organizational
Structure
 Board of Directors:
Top level of management responsibility.
 Not usually involved in day-to-day decisions.
 Will act on behalf of stockholders, when needed.
 Corporate Officers:
 Chief Executive Officer (CEO)
 Chief Operating Officer (COO)
 Chief Financial Officer (CFO)

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Typical Corporate Structure
Board of Directors
Stockholders
Chief Executive Officer
Chief Operating Officer
Various Vice Presidents
Chief Financial Officer
Treasurer
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Corporate Secretary
Controller
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Learning Objective 5:
Differentiate between
common stock and
preferred stock.
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Common Stock
 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.”
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Sample of Par Values
The following companies had these par
values and per share market prices as of
June 30, 2006:
Company
 GM
 IBM
 Chevron
 Boeing
 PepsiCo
Par Value
$1.6700
$0.0200
$0.7000
$5.0000
$0.0167
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Market Price
$29.79
$76.82
$62.06
$81.91
$60.04
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Par Value Example
Assume Your Company, Inc., sells 1,000 shares of
$1 par value common stock for $10 per share.
Your Company, Inc.
Balance Sheet
January 1, 2000
Cash
Assets
$10,000
Total assets $10,000
Liabilities
$0
Stockholders' equity
Common stock
$1,000
Add'l paid-in capital 9,000
10,000
Total liabilities & S.Equity $10,000
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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.
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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.
Yo u r Co m p an y, In c.
Balance S h eet
Jan u ary 1, 2000
Assets
Cash
L iab ilities
$10,000
$0
Sto ckho ld er s' equ ity
To tal assets
$10,000
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Co mm on sto ck
10,000
T otal liab ilities & S .Equ ity $10,000
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Preferred 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.
 Liquidation
preference: distribution of
company assets must be made to preferred
stockholders before common stockholders
may receive any assets.
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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.
 What would the stockholders’ equity
section of the balance sheet look like with
both types of stock included?
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Common and Preferred Stock
Stockholders' equity
Preferred stock ($100 par value)
Add'l paid-in capital - Preferred
Common stock ($1 par value)
Add'l paid-in capital - Common
Total stockholders' equity
$10,000
2,000
1,000
9,000
$22,000
NOTE: Additional paid-in capital should be kept
separate for the two different types of stock.
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Learning Objective 6:
Describe the components
of stockholders’ equity and
explain the meaning of
treasury stock.
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Corporate Capital Structure
For a corporation, there are various
terms related to stock that you must be
familiar with:
Authorized shares: number that could be
sold.
 Issued shares: number that have been sold.
 Outstanding shares: number currently held
by the stockholders.
 Treasury stock: shares reacquired by the
corporation; issued but not outstanding.

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Stockholders’ Equity
Stockholders’ equity is made up of two
main components:

1) Contributed
Capital)


2)

Capital (or Paid-In
The amount invested by the holders of both
common stock and preferred stock.
Retained Earnings
The accumulation of corporate net earnings
minus any dividends declared.
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Learning Objective 7:
Identify what information is
available on a corporate
balance sheet and what
information is not available.
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Information Provided on a
Balance Sheet




The corporation’s assets, liabilities, and
equity on the day it was prepared.
The book value of assets.
The amount stockholders have contributed
to the company.
The amount of authorized, issued,
outstanding, and treasury stock.
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Information Not Provided
on a Balance Sheet




The corporation’s assets, liabilities, and
equity at any other time than the date
prepared.
The current value of assets.
The market value of the stock.
The earnings of the corporation.
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Learning Objective 8:
Explain the basic process
operating in the primary and
secondary stock markets.
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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.
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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.
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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.
 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.
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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.
 Companies selling stock in any of the
markets are required to file detailed
reports with the SEC on a regular
basis.
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End of Chapter F3
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