Question

1. What are the advantages and disadvantages of the following:
2. Raising capital through the issuance of stock
3. Raising capital through the issuance of bonds
4. Corporate form of business versus sole proprietorship
5. Know the impact of stock splits on par value and market value. Be able to compute the new par value and market value given stock splits
6. What does bond discount do to interest expense over the life of the bond and why?

1. Complete the following chart:

Account	Type (asset, liability, equity, revenue, expense, or contra to any of the above)	Financial Statement and which section (Income statement or Balance sheet and which section)	Normal Balance (Debit or credit)
Common stock
Equipment
Accumulated Depreciation
Cost of Goods Sold
Paid in capital in excess of par value-common stock
Paid in capital in excess of par value-preferred stock
Bonds Payable
Premium on bonds payable
Discount on bonds payable

1. What does bond premium do to interest expense over the life of the bond and why?

Answer 1

1. Advantages of issuing or raising capital through stocks:

• Avoid liability of debt
• Liquidity
• Attract Investors
• Drawbacks to selling stock
• Diluted Ownership

Disadvantages of issuing or raising capital through the issuance of stocks:

• Relinquishing part of the company's equity either by selling capital stock to investors, the company is giving up some of its ownership.
• Dilution of Share value. The more capital stock the company issues, the more diluted the value of each share becomes.
• As a company continues to raise capital through the issuance of stocks, the owners and founders may, at some point, no longer have majority control.
• The number of shares that can be sold is finite. Eventually, there will be no more ownership in the company to offer to investors.

2. Advantages to raising capital through issuance of bonds

• Retained earnings: Issuing bonds allows a company to access capital much faster than if it first had to earn and save profits. As the saying goes, you have to spend money to make money.
• Selling assets: To sell assets, a company needs to have assets it's willing to sell. Growing companies might decide to borrow money rather than selling assets because they're, well, growing and in the process of acquiring -- not selling -- assets. In down markets, on the other hand, a company may be reluctant to sell assets if it can't find a buyer willing to pay an acceptable price.
• Issuing shares: Issuing bonds is much cheaper than issuing shares. When a company sells new shares, the value of its existing shares is diluted. Since shareholders take on more risk than bondholders (in the event of a bankruptcy they're further back in line to receive compensation), shareholders require a higher rate of return than do bond investors.

Disadvantages to raising capital through issuance of bonds:

• Borrowing money can also be riskier than the alternatives. If a company borrows too much money, or if its fortunes change and it is no longer able to pay back its lenders, it might have to raise even more capital on painful terms or go bankrupt.

3. Advantages of corporate business:

• Owner have limited liability, means no personal assets are involved
• Easier to raise capital
• Easy to transfer ownership
• Corporations have perpetual lifetime

Disadvantages of corporate business:

• Double taxation of corporation profits
• Forming a corporation costs more
• States have higher fees
• More state and federal regulations and oversight.

Advantages of sole proprietorship:

• Beginning a sole proprietorship is easy.
• It is cheap to start as compared to partnership or companies
• There are some tax benefits for sole proprietorship
• It can employ others and grow their business

Disadvantages of sole proprietorship:

• Owners are fully liable
• Self employment taxes apply to sole proprietorships
• Business continuity can ends with the death of owner
• Raising capital is difficult.

4. A stock split is a corporate action in which a company increases the number of its outstanding shares by issuing more shares to current shareholders. When a company's stock splits, the change in the par value is offset by a corresponding change in the number of shares so that total par value remains the same. The total stockholders' equity is unaffected by the stock split. The impact of stock split on the market value of the stock of the companies, through a split it will result in the number of shareholders as more investors would buy at lower price and market value will improve whereas market cap will remain same.

5. Bond discount is given on the bond value and the interest expense is amortized over the life of the bond. The amortization casues interest expense in each accounting period to be higher than the amount of interest paid during the year of the bond's life.

6. Complete the chart:

• Common stock: Asset, Debit balance
• Equipment: Asset, Debit Balance
• Accumulated depreciation: Contra asset, credit balance
• Cost of goods sold: expense, debit balance
• Paid-in capital in excess of par value- common stock: Liability, credit
• Paid-in capital in excess of par value- preferred stock: Liability, credit
• Bonds payable: Liability, credit
• The premium on bonds payable: expense, debit
• Discounts on bonds payable: Contra liability, debit balance.

7. Bond premium is recorded in a separate bond-reality liability account. Over the life of the bonds the premium accounts will be systematically moved to the income statement as a reduction of Bond interest expense.