Guided Readings for Financial Accounting, Lesson 1.2-Mastery Level

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SUGGESTION: Read Section 1.2 of Chapter One, “Incorporation and the Trading of Capital Shares.” As you read, keep a short list of 4-5 pieces of information in this section that might be particularly helpful to a working person. Creating this list will help you evaluate what is most important in the section. It will also serve as a rough outline of the material for review purposes.

Mark any of these cards that you feel are important for your later review.

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(1Q7) - What are the three types of legal formats that are most common for business organizations in the United States?

(1A7) – (a) – A business organization can seek and receive official recognition from the state government and be deemed a corporation. (b) – A business organization might not seek official recognition from the state. In that case, if there is more than one owner, it is legally a partnership. (c) – A business organization might not seek official recognition from the state. If there is only one owner, it is a sole proprietorship.

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(1Q8) – For each of the three types of legal recognition for an organization, what is the relationship of the owners to the organization?

(1A8) – In a corporation, the owners and the organization are separate. A corporation is viewed as a separate legal entity. Unless otherwise set up contractually, the owners are not responsible for the debts and losses of a corporation. In both a partnership and a sole proprietorship, there is no separation of the organization and its ownership. Unless otherwise stated, if a partnership or sole proprietorship owes money, the owners are responsible.

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SUGGESTION: Do the first Test Yourself question in Section 1.2 (“Ray Nesbitt owns a…”). Can you use what you have learned in this section to answer the question? Read the explanation carefully and make sure it makes sense to you.

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(1Q9) – A corporation can grow by issuing shares of its ownership in exchange for cash or other assets. What are those shares called?

(1A9) – Shares of the ownership of a corporation are generally known as capital stock. As discussed in a later chapter, more than one type of capital stock exists. Every corporation issues capital shares with general legal rights. These shares are known as common stock. A few corporations also issue capital shares—with specified contractual rights—known as preferred stock.

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(1Q10) – A corporation is getting its business started and issues a total of 1000 shares of its capital (common) stock to several people who want to be stockholders. The corporation then issues another 60 shares of this capital (common) stock to BeLinda Jones for $30 per share. By acquiring these shares, what does Ms. Jones get?

(1A10) – By acquiring capital stock, Ms. Jones has a right to a portion of dividends the corporation might distribute. Ms. Jones also has a right to vote for the members on the board of directors. Ms. Jones has a right to share in any property left over if the corporation ever goes out of business and liquidates. These specific benefits can vary based on (a) the laws of the individual state where incorporation originally took place and (b) the type of capital stock that was issued. For most capital stock, these are the rights obtained.

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(1Q11) – All corporations issue common stock. A few also issue a second type of capital stock known as preferred stock. The rights of the holders of common stock are set by the laws of the state of incorporation. What rights do the owners of the preferred stock receive?

(1A11) – The holders of a corporation’s common stock are entitled to several specific rights established by the state government where the organization was originally incorporated. The holders of a corporation’s preferred stock are entitled to the rights specifically stipulated on the stock contract. For example, preferred stock holders often have a right to a specific dividend payment but that has to be stated in the contract.

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(1Q12) – What is a dividend?

(1A12) – A dividend is the distribution of cash (or very occasionally some other property) from a corporation to its ownership as a sharing of profits. It is a reward for the owners. Younger businesses that want to grow often distribute few (if any) dividends. Older businesses that are well established tend to pay larger dividends as profits and cash balances rise. Fast growth is not as important for older organizations.

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(1Q13) – Ms. Garcia acquires 100 shares of the capital stock of Company X. That is a small percentage of the outstanding ownership so Ms. Garcia is not able to control or apply significant influence over this company. How does she hope to benefit from this investment? In other words, why spend money for this stock?

(1A13) – Owners of a company’s capital stock usually hope to benefit in two ways. First, if a cash dividend is ever distributed, owners will be entitled to receive a portion of that dividend based on the percentage of shares that are owned. Second, if the company grows and prospers, it is likely that the price of the stock will rise and can be sold by the owner for a profit. Most investors buy stock with the hope of possible cash dividends and stock appreciation.

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(1Q14) – Who votes to elect the members of a corporation’s board of directors?

(1A14) - The stockholders vote to elect the members of the board of directors. Normally, each share of capital stock is equal to one vote. Thus, a person who holds 75 shares of capital stock has 75 votes when selecting the board of directors.

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(1Q15) – What is the responsibility of the board of directors within the organization of a corporation?

(1A15) – A board of directors represents the stockholders in overseeing the operations of an organization and its management. The board of directors has the authority to hire and fire members of the management. It also addresses policy decisions. No single individual stockholder can watch over a large corporation so a board of directors is appointed to serve that purpose.

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SUGGESTION: Read Section 1.3 of Chapter One titled, “Using Financial Accounting for Wise Decision Making.” People who succeed in business normally learn how to retrieve and then use available information to make wise decisions. Helping you to learn and understand that process is an important goal of this book.

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(1Q16) – Ms. Haskins is thinking about buying 100 shares of the outstanding capital stock of the Central North Corporation for $50 per share. She studies the financial accounting information provided by this company. What does she hope to anticipate?

(1A16) – When potential investors are studying financial accounting information, they are trying to anticipate the amount of dividends (if any) that will be distributed and the future market price of the capital stock shares. A healthy and prosperous company should be able to pay dividends in the future and still grow (causing the stock price to climb.)

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SUGGESTION: Answer the first Test Yourself question in Section 1.3 of Chapter One (“An investor is currently studying…”). This question and answer will help ensure that you understand the role financial information plays in the acquisition and sale of the ownership shares of a corporation.

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(1Q17) – Ms. Abrams is thinking about loaning money to the Red Corporation. She studies the financial accounting information provided by this company. What does she hope to discover?

(1A17) – A decision maker who is considering giving a loan (or credit) to an organization is interested in looking at the financial accounting information for one reason. The potential creditor wants to be able to anticipate the amount of future cash flows that the organization can generate. This helps the decision maker assess the risk that the debt might not be repaid.

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(1Q18) – Mr. NaTrom buys a share the capital stock of Ace Corporation on the first day of the current year for $50 in cash. Near the end of the year, Ace Corporation distributes a $2 per share cash dividend. On the last day of the year, the stock is selling for $53 per share on a stock market (such as the New York Stock Exchange). What is owner’s annual rate of return on this investment?

(1A18) – The investor paid $50 at the beginning of the year for this capital stock. At the end of the year, the investor holds cash of $2 and a share of capital stock worth $53. The value of the investment started the year at $50 and is now $55 (stock plus cash). That is a growth of $5 ($55 - $50) which is a return on the investment for that year of $5/$50 or 10 percent.

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(1Q19) – Financial accounting conveys financial information. What is financial information?

(1A19) – Financial information provides details that describe an organization and its operations. This financial information is stated in monetary terms and, where possible, is objective (capable of being proven). The information that is included should report the past and present so that decision makers can anticipate the future.

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(1Q20) – What are examples of financial information that might be communicated by a financial accountant?

(1A20) – There could be thousands of examples of financial information including the following. --Merchandise was sold this past year for a total of $333,000. --A piece of land was bought at a total cost of $55,000. --A loan of $200,000 is owed to the bank.--A dividend of $40,000 was distributed to owners of capital stock. The information describes transactions of the organization as a whole.

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(1Q21) – An outside decision maker wants to locate financial information about a particular company. Where can that be found?

(1A21) – Financial accounting information can be found in many different ways. One common method is through an organization’s annual report. Annual reports are often made available on an organization’s website. An annual report contains considerable data including financial accounting information. Pick a company. Look at its website (and review a section such as “Investor Information”) just to see what you can learn about the organization. Take the course information and go look at the real world.

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Within Section 1.3, you will find a subsection titled “The Annual Report.” In that area of the textbook, you will find a link to a short video titled, “How Financial Accounting Can Help You Make Wise Decisions about an Organization.” Write down the two or three most important pieces of information you discover in this video.

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SUGGESTION: After you study Chapter One, make a list of the five things that you think were most important in the chapter. You can learn a lot of accounting by focusing on the important stuff. After you have made your list, go to the end of the chapter and watch the short video titled “The Most Important Elements of Chapter One.” Compare your list to mine. This will help you identify and focus on the key parts of this chapter. Evaluation is an important component of learning.

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