friedlan4e sm ch10

8/10/2019 Friedlan4e SM Ch10

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CHAPTER 10

Owners Equity

QUESTIONS

Q10-1.Common shares represent the residual ownership of the entity, and the owners have a claim tothe earnings and assets of the entity after the claims of the creditors and preferred shareholdershave been satisfied. Preferred shares rank in claim ahead of common shares. Preferred shareshave rights that must be satisfied before common shareholders rights. !hese preferred rightspertain to the payment of dividends and"or to the distribution of assets in the event of li#uidation.$ividends on preferred shares must be paid before dividends can be paid to commonshareholders. %f the corporation is li#uidated, preferred shareholders claims to assets must besatisfied before the common shareholders claims. !herefore it&s riskier for an investor to owncommon shares than preferred shares because preferred shares have priority to dividends andresidual claim of a li#uidated company.

Q10-'.(everage is the use of debt to attempt to increase the return earned on the e#uity investment ofthe owners. (everage is attractive because any profits earned from investing borrowed money,above the cost of borrowing, go to the owners. )ut leverage is risky because the cost ofborrowing must be paid, regardless of how well or poorly the entity is performing. *notheradvantage of leverage is that interest on debt is ta+ deductible and so part of the cost ofborrowing is financed by the government"ta+payers..

Q10-.inancing a new business with a high proportion of debt is difficult because lenders might be

reluctant to lend. !he higher the debt to e#uity ratio the higher the risk therefore if debt wasapproved it would be at a much higher interest rate and income made has to be allocated toservice the debt first. *s primary concern of a lender is the repayment of the loan. hen lendingto a corporation the owners of the company don&t have an obligation to payback any outstandingdebt should the company go bankrupt. *s a result, lenders will often ask lenders to personallysecure loans to mitigate the risk of default. * company with a high proportion of debt /meaningthe owners have invested relatively little may be problematic to lenders because with little tolose the owners may be prepared to take more risk than if they had a larger stake in the company.%f a new entity was financed with 02 debt the lender would be absorbing a lot of risk and moreimportantly the borrower would have relatively little risk because he would have little at stake inthe business /only a 102 interest in the total investment.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-15olutions 6anual

Copyright 7 '01 6c8raw-9ill :yerson (td.


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Q10-4.* corporation is a separate legal entity from its owners, whereas proprietorships and partnershipsare simply e+tensions of the owner/s. Corporations pay ta+es whereas partnerships andproprietorships don&t /the partners or proprietor pay the ta+. !he corporation continues tooperate when the owners die or no longer wish to own the business. !he income of the

proprietorship or partnership is income in the hands of the owners when it&s earned, but in thehands of shareholders of a corporation only when it&s distributed as dividends. !he liability ofowners of a corporation is limited /unless the owners provide personal guarantees to creditors,but the liability of proprietors and partners is unlimited e+cept in the case of ((Ps.

Q10-;.Common shares represent the residual interest in an entity because the common shareholdersreceive what is left over after all other claims are satisfied. !his means that in the event ofli#uidation, the common shareholders receive the remaining assets after all liabilities and claimsof creditors and other /preferred shareholders have been settled. Common shareholders areentitled to all profits of a corporation once interest and dividends to preferred shareholders have

been paid.

Q10-


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Q10->.?ot-for-profit organi@ations /?PA are economic entities whose obBective is to provide servicesand not to make a profit. ?PAs don&t have owners or ownership shares that can be traded orsold. *ny income earned by the ?PA is reinvested in the organi@ation. *n ?PA may beformed to pursue environmental issues, or fund cancer research or to build homes for those who

otherwise may not be able to afford them. %n many cases, the beneficiaries of the organi@ation&sactivities may be different from those who contributed the funds. 5uccess for ?PAs isn&tmeasured by the ability to earn a profit, but by whether the organi@ation has been effective inpursuing its mission. *s a result, the traditional income statement isn&t appropriate because theDbottom lineE doesn&t represent the residual gain or loss of the owners. %t&s simply the e+cess ofrevenues over e+penses.

Q10-F.!here are no owners of ?PAs that have a residual claim on the e#uity of the [email protected] owners, there can&t be a representation of the owners& interest in the entity. 9owever, toprepare a balance sheet, the difference between assets and liabilities must be represented.

%nstead, there is a statement of resources or net assets that shows the e+cess of assets overliabilities. !his section of the balance sheet represents contributions /often classified by anyrestrictions on the contributions to the ?PA and the e+tent to which the inflows of the entitydiffer from the costs of operations.

Q10-.%n limited liability partnerships, some of the partners have limited liability protection. (imitedliability partners aren&t liable personally for the debts of the limited liability partnership and areless involved in management of the entity. 8eneral partners manage the organi@ation and areliable for debts Bust as in the case of proprietorships. !he nature of a partnership is that thepartners aren&t protected from the risks of the partnership&s activities. !he general partnermaintains the e+istence of the residual party that bears risk while providing protection to theother partners. %f there wasn&t at least one general partner, creditors would be much less willingto lend to the entity, since the owners would have a minimal commitment to ensuring that theobligations of the entity are met.

Q10-10.$ividends are distributions of the earnings of a corporation to the owners and are discretionary.%nterest is a payment on debt to lenders. %nterest isn&t discretionary and isn&t dependent on theearning of profits. !his treatment is consistent with the view that net income reflects changes inthe wealth of the shareholders. %n this view, dividends aren&t a cost of doing business but adistribution to the shareholders. %n this sense, dividends don&t represent a change in the wealth ofthe shareholders but a change in the form of the wealth /the wealth is cash in the hands of theshareholders instead of an increased value of the shares. %nterest payments are e+pensed becauseinterest is a cost that the corporation must incur to borrow money.




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Q10-11.Par value is an amount assigned to a share of stock in the articles of incorporation. ithout par,the full amount invested by investors is credited to common stock. ith par value shares, the parvalue is credited to common stock and the amount in e+cess of par is credited to contributedsurplus.

Q10-1'.i.!he company would pay G100,000 to the bondholders each year, and the amount would be ane+pense on the income statement, reducing before-ta+ income by G100,000 and after-ta+ incomeby G>0,000.

!he net cash cost would be G>0,000 per year.

ii.!he company would pay G


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Q10-1.Property dividends are paid with property instead of cash. !he dividend is recorded at the marketvalue of the property at the date the dividend is declared. %f the market value of the property isn&te#ual to its carrying amount on the date the dividend is declared, a gain or loss is reported on theincome statement for the difference.

Q10-1F

*ccumulated other comprehensive income is an accumulation of revenues, e+penses, gains andlosses that aren&t included in net income. !hese represent transactions with non-owners thataren&t included in the calculation of net income and include certain unreali@ed gains and losses.!his is only re#uired for companies reporting under %:5 /*5P= doesn&t re#uire calculation ofcomprehensive income. %t appears in the e#uity section of the balance sheet and is theaccumulation of other comprehensive income. %t&s analogous to retained earnings is that itaccumulates an amount reported on the income statement"statement of comprehensive income.

Q10-1.!he idea is appealing from the perspective that it creates an incentive for the e+ecutives to takeactions to increase the value of the firm, which is in the interest of shareholders. %t&s also a meansof providing compensation to the e+ecutives without using up cash. or a small and growingcompany, it can be difficult and costly to raise cash by issuing additional stock. 9owever, it alsocreates incentives for management to prop up the share price by means, such as accountingmanipulations that don&t increase the economic value of the firm.

Q10-'0.=mployee stock options impose a cost on shareholders because they allow the employees toobtain a claim on the wealth of the firm for an amount less than the market value of that wealth.!hus the options dilute the value of the shareholders& investment.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-;5olutions 6anual



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Q10-'1.Ane would only pay G;00 to lock in the price of a car if there was an e+pectation that theincrease in car prices would e+ceed G;00 by an amount sufficient to compensate for the timevalue of money, the risk that prices would not increase, and the risk that for some reason, thestudent was unable to purchase a new car after graduation. %f the price guarantee could be sold, it

would increase in value as car prices increased and decrease as car prices fell. !he guaranteeonly has value if it provides benefits which are savings from the price that would otherwise bepaid.

Q10-''.*n action or event has economic conse#uences if it causes a change in someone&s wealth.*ccounting has the potential for many economic conse#uences. * decision by a company todisclose unfavorable information earlier than was previously intended will probably result in adecrease in the share price. *ny shareholder who was planning to sell shares in the firm a fewdays later will receive less for the shares than if the announcement had been delayed. 5imilarly,delaying revenue recognition will reduce net income and the management&s bonuses if it is

directly related to income. *ccounting has economic conse#uences because decisions are basedon accounting information and economic outcomes can be based on accounting numbers.

Q10-'.=ven though the accounting choices don&t change the underlying economic activity of the firm,many numbers on the financial statements do change and accordingly, many individuals may beaffected. %n general, any economic outcome that depends on an accounting measurement /such asthe current ratio can be affected by accounting choices. =mployees with a profit-sharing planmay receive more or less after a change. !he customers of a telephone company will pay more orless for the same rate-regulated services if the rates are based on some target return on e#uity forthe shareholders of the utility. %n other words, while the underlying economic activity may notchange the representation of that activity will change and these changes may affect economicdecisions and economic outcomes.

Q10-'4.!he book value of the e#uity of the firm is simply the total of the assets less the total of liabilitiesas determined by the accounting policies selected by management. !he market value of the firmis the amount that the investors are willing to pay for the shares of the firm. !he market valuefluctuates daily with changes in e+pectations of the future profitability and risk of the firm alongwith variations in stock prices generally. *n important reason the values differ is that the bookvalue reflects only past transactions while market value includes e+pected future profits. 6arketvalue will also reflect assets ignored in the book valueHfor e+ample, research, brand names, andhuman capital. )ook value per share e#uals shareholders& e#uity I number of common sharesoutstanding.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-$r. :etained earnings /e#uity L ';0,000

Cr. $ividends payable /liabilities K ';0,000

ebruary 11, '01F$r. $ividends payable /liabilities L ';0,000

Cr. Cash /assets L ';0,000

d.$r. Cash /assets K ,000

e.$r. :etained earnings /e#uity L ,4>,;00

Cr. Common shares /e#uity K ,4>,;00Msing the market value of the shares on *pril '1, '01> /';,000,000 + ;2 + G'.>;.

A:

$r. :etained earnings /e#uity L 1,000,000Cr. Common shares /e#uity K 1,000,000

Msing the average price paid for the shares by investors /G'0,000,000 + ;2.

f.$ecember 4, '01>$r. %nventory /assets K 00,000

Cr. 8ain on disposal of inventory 00,000/e#uity K

!o recogni@e the gain on disposal of inventory.

$ecember 4, '01>$r. :etained earnings /e#uity L ',100,000

Cr. Property dividend payable ',100,000/liabilities K




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!o record the property dividend.

$ecember '1, '01>$r. Property dividend payable /liabilities L',100,000

Cr. %nventory /assets L ',100,000

!o distribute the property dividend.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-1'5olutions 6anual



13/81

=10-.a.i.$r. :etained =arnings /e#uity L '00,000

Cr. $ividend payable /liability K '00,000

$r. $ividend payable /liability L '00,000Cr. Cash /asset L '00,000

ii.$r. Cash /asset K ,000,000

Cr. Common shares /e#uity K ,000,000

iii.$r. Cash /asset K 1,000,000

Cr. Preferred shares /e#uity K 1,000,000

iv.$r. Patent /asset K F0,000

Cr. Common shares /e#uity K F0,000

v.$r. :etained =arnings /e#uity L '00,000

Cr. $ividend payable - preferred '00,000/liability K

/


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b.Owners' Equity

Date Asset Liai!ity Pre"erre# St$%& C$''$n St$%& Retaine# Earnin(s

)eginning 1-$ec-1> G1,;00,000 G1,'00,000 G,110,000

?et %ncome 1-$ec-1F 1,';0,000

i $uring /G'00,000 /'00,000

ii $uring ,000,000 ,000,000iii $uring 1,000,000 1,000,000

iv $uring F0,000 F0,000

v $uring /'00,000 /'00,000

vi $uring 1,;',000


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=10-4.

Owners' Equity

Date Asset Liai!ity

Pre"erre#

s/ares

C$''$n

s/ares

A%%u'u!ate#

OCI

Retaine#

earnin(s

)eginning 1-$ec-1< 40,000,000 4';,000,000 /1,>;0,000 1;,;00,000?et

%ncome 1-$ec-1> '00,000 1,000,000

i $uring />;,000,000 />;,000,000

ii $uring '4,000,000 '4,000,000

iii $uring >,;00,000 >,;00,000

iv $uring ';,000,000 ';,000,000

v $uring /',>;0,000 /',>;0,000

vi $uring '0,;0,000 11,000,000 ',;0,000 4>,;00,000Common 5tock /*uthori@ed, 400,000,000O Autstanding,1,


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=10-;.$r. (and /asset K ';0,000

Cr. :etained earnings /e#uity K ';0,000

!he land had been e+pensed for G';0,000. *fter the correction, retained earnings would be

G,;00,000. 5ince the adBustment is for correcting an error, beginning retained earnings isadBusted and prior years& comparative income statements restated. !he adBustment has no bearingon the current year and the error results in prior years& statements being misstated so retroactiveadBustment makes sense.

=10-


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=10-.

a. Number of Shares - Issued

-

7ei(/te#

A.era(e

C$''$nPre"erre# St$%& C$''$n St$%&

12

8$nt/s

';,000 ;00,000 1' 1002 ;00,000

;0,000 11 '2 4;,F

>;,000 ; 4'2 1,';0

';,000


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*1+De%+1,

?et income G1,;0,000Preferred dividend 100,000

Common shareholders& e#uity /'01> F,


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=10-11.

a.

i.$r. Cash /asset K 1,000,000Cr. Common shares /e#uity K 1,000,000

ii.$r. Cash /asset K 1,';0,000

Cr. Preferred shares /e#uity K 1,';0,000

iii.$r. :etained earnings /e#uity L 1'0,000

Cr. Cash /asset L 1'0,0001,'00,000 shares + G0.10 per share

iv.?o entry is re#uired.

v.$r. :etained earnings /e#uity L 100,000

Cr. Cash /asset L 100,000;0,000 preferred shares + G'.00 per share

vi.$r. :etained earnings /e#uity L ;,000

?et %ncome 1-$ec-1> 1,1;0,000

i '-3an-1> 1,000,000 1,000,000

ii 'F-eb-1> 1,';0,000 1,';0,000

iii 0-3un-1> /1'0,000 /1'0,000

iv 0-5ep-1>

v 1-$ec-1> /100,000 /100,000

vi 1-$ec-1> /0,000 - 1,';0,000 ;,000,000 ,'4;,000

1-$ec-1> T$ta! C$''$n F,'4;,000

T$ta! O)E ,4;,000

1-$ec-1< T$ta! C$''$n ;,000

T$ta! O)E ;,000




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Number of Shares - Issued 7ei(/te#

12 A.era(e

Pre"erre# St$%& C$''$n St$%& 8$nt/s - C$''$n

- 1,000,000 1' 1002 1,000,000-

'00,000 1' 1002 '00,000

;0,000 -

1,'00,000 1,'00,000

;,000!otal shareholders& e#uity G;,000

!he shareholders& e#uity section of the $ecember 1, '01< balance sheet indicates that1,000,000 common shares were outstanding while the comparative information at $ecember 1,'01> shows that ;00,000 shares were outstanding. !he reason is the effect of the reverse splitduring '01>.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-'05olutions 6anual



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d.)asic =arnings per share N ?et income L Preferred dividends

eighted average number of common shares outstanding

*1+De%+16

?et %ncome 1,1;0,000

Preferred dividends. 100,000eighted average numberof common shares F,'4;,000

ROE 13*5-

5ince the number of shares from the previous year was halved as a result of the reverse stocksplit, =P5 for '01< would be reported as G.;0 in the '01> annual report.

e.!here is no reason to e+pect that the reverse stock split affected the operating results of the

company. !he motivations for stock splits usually relate to financing considerations, notoperating benefits. !he reverse split would affect reported =P5 but the change in themeasurement doesn&t affect the actual performance.




22/81

=10-1'.

a.

i.$r. Cash 1,000,000

Cr. Common stock 1,000,000/100,000 shares G10 per share

ii.$r. =+clusive distribution rights /*K 400,000

Cr. Common stock 400,000

iii.$r. Cash 1;0,000

Cr. Preferred stock 1;0,000/1,;00 shares G100 per share

b.

Owners' Equity # of Shares - Issued

Pre"erre# C$''$n Retaine# Pre"erre# C$''$n

Date Asset Liai!ity S/ares S/ares Earnin(s S/ares S/ares

?et %ncome 0-3un-1F /;0,000

i 1-3ul-1> 1,000,000 1,000,000 100,000

ii $uring 400,000 400,000 ;0,000

iii $uring 1;0,000 1;0,000 1,;00

=nding 0-3un-1F 1,;;0,000 - 1;0,000 1,400,000 /;0,000 1,;00 1;0,000

0-3un-1F T$ta! %$''$n s/are/$!#ers equity G1,;0,000

T$ta! s/are/$!#ers equity 1,;00,000

*0+@un+1, Net In%$'e /;0,000

@une *0> 201,

Preferred shares, no par value, non-cumulative, non-participating,redeemable R G1;0 per share by '0'' /outstanding 1,;00 G 1;0,000

Common shares /outstanding 1;0,000 1,400,000:etained earnings /;0,000!otal shareholders& e#uity G1,;00,000

c.Ses, Tamsack could pay dividends on 3une 0, '01F. Positive retained earnings isn&t are#uirement for the payment of dividends. %f it did pay dividends, then the dividend could beconsidered a partial return of the common shareholders& original investment or it would reducenegative /or deficit retained earnings even more *s long as Tamsack can meet its currentliabilities, they have no restrictive covenants preventing the payment of dividends and they havethe means to pay the dividends, then they can pay dividends.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-''5olutions 6anual



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=10-1.

a.$: C:

i Cash 11,000,000

Common shares 11,000,000

ii Cash 4,000,000

Preferred shares 4,000,000

iii :etained earnings 1,1';,000

Cash 1,1';,000

iv ?o entry is re#uired

v Patent ',000,000 F,000,000 F;,000 11,00,000

?et %ncome 0-3un-1F 100,000 4,;00,00

i 1-*ug-1> 11,000,000 11,000,000

ii 0-?ov-1> 4,000,000 4,000,000iii 1-$ec-1> /1,1';,000 /1,1';,000

iv 0-*pr-1F

v '-3un-1F


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12 A.era(e

Pre"erre# St$%& C$''$n St$%& 8$nt/s - C$''$n

';,000 1,000,000 1' 1002 1,000,000

-

;00,000 11 '2 4;F,;0,000 -

1,;00,000 1,4;F,

4,;00,000 4,>;,000

;,000 4,;;,000

S/are/$!#ers equity

'01F '01>

Preferred 5tock /Autstanding, >;,000, ';,000

Preferred 5tock /Autstanding, ';,000 ',000,000Common 5tock /Autstanding,1,000,000 F,000,000

*ccumulated AC% F;,000

:etained =arnings 11,00,000

!otal '1,F;,000

!he shareholders& e#uity section of the 3une 0, '01> balance sheet indicates that 1,000,000common shares were outstanding while the comparative information for '01> in the 3une 0,'01F financial statements shows that ,000,000 shares were outstanding. !he reason is the effectof the split during '01F.

d.

*0+@un+1,

?et %ncome 4,;00,000

Preferred $iv. 11',;00eighted average number of common shares 4,>;,000

9asi% EPS 100

%f =P5 was reported in the '01> annual report as G1.F0, it would be reported as G0.


25/81

*0+@un+1,

?et income 4,;00,000

Preferred $ividends 11',;00Common shareholders e#uity/'01> 1,F;,000Common shareholders e#uity/'01F >,41,;00

ROE 1606-

e.!here is no reason to e+pect that the stock split would affect the operating results of thecompany. !he motivations for stock splits usually relate to financing considerations, notoperating benefits. !he reported =P5 of the company would be #uite different as a result of thesplit but there is no change in performance as a result of the split. !he company&s income is Bustbeing allocated to twice as many shares.

=10-14.

a.


12 A.era(e Nu'er

Pre"erre# St$%& C$''$n St$%& 8$nt/s - $" C$''$n S/ares

;0,000 400,000 1' 1002 400,000

40,000 > ;F2 ',

;0,000 ';2 1',;00

;0,000 40,000 4;,F

*1+De%+16

?et %ncome G>;0,000

Preferred $ividend ';0,000

eighted average common stock 4;,F

9asi% EPS 114

b.%t&s difficult to estimate future dividends from the information provided. ?et income doesn&t givea strong clue about the amount of dividends investors should e+pect. ?et income isn&t cash andthe company may have a policy of reinvesting income. %n '01>, no common dividends were paidand this might be the best indicator. !he ability to pay dividends depends on the availability ofcash and the ability to generate cash. !he willingness to pay dividends depends on theinvestment opportunities available and the need for cash by the entity. *t times management will

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-';5olutions 6anual



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pay dividends to show a sign of strength despite poor earnings however it&s ultimately up to theboard of directors.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-';,000,000

-

/;,000,000 < ;02 /',;00,000

1,000,000 >0,000,000 >',;00,000

*1+De%+16

?et %ncome 11,>00,000

Preferred $ividend ',;00,000

eighted average common stock >',;00,000

9asi% EPS 0126

b.%t&s difficult to estimate future dividends from the information provided. ?et income doesn&t givea strong clue about the amount of dividends investors should e+pect. ?et income isn&t cash and

the company may have a policy of reinvesting income. %n '01>, no common dividends were paidand this might be the best indicator. !he ability to pay dividends depends on the availability ofcash and the ability to generate cash. !he willingness to pay dividends depends on theinvestment opportunities available and the need for cash by the entity. *t times management willpay dividends to show a sign of strength despite poor earnings however it&s ultimately up to theboard of directors.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-'>5olutions 6anual



28/81

=10-1


29/81

=10-1>.a.$r. Cash /asset K >;0,000

Cr. Common stock /e#uity K >;0,000

b.$r. Cash /assetK >;0,000

Cr. Common stock ',;00Contributed surplus /e#uity K >4>,;00

c.$r. Cash /asset K >;0,000

Cr. Common stock /e#uity K ';,000Contributed surplus /e#uity K >';,000

d.

!he effect of par value on the financial statements is only one of presentation and classification.!here is no economic or legal significance to the use of par value. %nstead of the full proceeds ofthe shares going to the common stock account, the par value of the shares goes to the commonstock account and the remainder to contributed surplus.




30/81

=10-1F.a.i.

$r. :etained =arnings /e#uity L ',;00,000Cr. Cash"$ividend Payable /asset L ',;00,000

ii.$r. %nvestment in 3udson /asset K 1,;00,000

Cr. 8ain on disposal of investments 1,;00,000/net income K, e#uity K

/G'.;0 - G1.00 + /;00,000 shares + ' shares per common share

$r. :etained earnings /e#uity L ',;00,000Cr. %nvestment in 3udson"Property dividend payable ',;00,000

/asset L

iii.$r. :etained =arnings ',;00,000

Cr. Common stock ',;00,000/;00,000 shares + ;2 + G100!his entry assumes the company uses the market value method. %f the cost method was used theamount of the entry would be G>;,000.

b.

Owners' Equity

# of Shares -

Issued

C$''$n Retaine# C$''$n 7ei(/te# a.era(e nu'erDate Asset St$%& Earnin(s St$%& $" %$''$n s/ares

*1+De%+16 6>400>000 12>400>000 400>000 40>>000

i /',;00,000 /',;00,000

=nding >,;00,000 10,000,000 ;00,000 ;00,000

ii 1,;00,000 1,;00,000

/',;00,000 /',;00,000

=nding >,;00,000 11,;00,000 ;00,000 ;00,000

iii ',;00,000 /',;00,000 ';,000

=nding 10,000,000 10,000,000 ;';,000 ;00,000

*ssuming dividends paid $ecember 1, '01>Cas/ Pr$erty St$%&

Di.i#en# Di.i#en# Di.i#en#i Common stock >,;00,000 >,;00,000 10,000,000ii :etained

earnings 10,000,000 11,;00,000 10,000,000

iii 5hareholders&e#uity 1>,;00,000 1,000,000 '0,000,000

c.i T$ta! O)E 1>,;00,000 ii T$ta! O)E 1,000,000 iii T$ta! O)E '0,000,000

?et %ncome 1,>;0,000 ?et %ncome ,';0,000 ?et %ncome 1,>;0,000




31/81

eighted average?umber of

common shares ;00,000





9asi% EPS *40 9asi% EPS 540 9asi% EPS *40

%f the stock dividend was declared at a time other than $ecember 1 the weighted averagenumber of shares would be different.

d.!here are significant differences among the alternatives. !he property and stock dividendsconserve cash, although issuing the property dividend probably will bring the gain into incomeand trigger an additional cash outflow for income ta+es. %f cash is scarce, the company may wishto avoid the cash dividend. !he property dividend sacrifices an asset that could be valuable to thecompany that may result in a loss of future cash flows from the investment. * stock dividend hasbookkeeping implications only.

e.$r. Cash ',;00,000

Cr. 8ain on disposal of investments 1,;00,000Cr. %nvestment in 3udson 1,000,000

$r. :etained =arnings ',;00,000Cr. Cash ',;00,000

=conomically there is no difference to the issuing company. !here is a difference to theindividual shareholders since they will incur transaction costs to sell the shares if they choose notto hold them. !his may be burdensome particularly to small shareholders.




32/81

=10-1a.

orJ '01;N 0.0

$ividend payout ratio represents what ratio of net income is paid out to shareholders for a givenperiod. $ividend yield is the per share return based of the market price per share.

b.!he dividend payout ratio decreased because despite making more net income the company didnot increase the total amount of dividends paid out to its shareholders. $ividend yield decreasedbecause the market value of the shares increased but the amount of dividend per share didn&tchange.

c.




33/81

=P5 is the income earned per common share while dividends are paid at the discretion ofmanagement. 6anagement may have chosen to retain its earning and not payout to itsshareholders to help finance other business opportunities or because it was unsure it couldsustain a higher dividend.

d.9igh ratios aren&t always attractive. !he dividend payout ratio increases as net income falls andthe dividend yield increases as share price falls, holding the dividend constant. (ower net incomeand lower share price may imply poorer performance in future and therefore the inability of theentity to maintain the level of dividends. %n other words, if the dividend payout and yield areincreasing because of deteriorating performance, dividends may have to be cut in the future.*lso, companies with attractive investment opportunities would be better off investing cash thanpaying dividends so for a growing company high ratios might be economically disadvantageousto investors.




34/81

=10-'0a.'01.10N 0.0;'

$ividend Payout :atio represents what ratio of net income is paid out to shareholders for a given

period. $ividend yield is the return based of the market price per share.

b.!he dividend yield changed because the market price of the company&s shares increased eventhough dividends per share staying the same /stock prices rise for a variety of reasons. !hepayout ratio stayed the same because there was no change in the net income and total amount ofdividends paid to shareholders in each year.




35/81

c.!his will depend on the individual investor and their preference. 9igh dividend payout ratios anddividend yield maybe more desirable for investors looking for cash flow, for e+ample retirees

relying on dividends as a source of income. *n investor not looking for an immediate return mayrather the company hold the funds to re-invest in the business hence reducing the need to borrowor issuing new shares. !here are also different ta+ implications depending on earnings fromdividends versus capital gains"loss from the sale of the shares in the future.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-;5olutions 6anual



36/81

=10-'1a.

$ividend Payout :atioN

Common *nnual Cash $ividends

?et %ncome

$ividend SieldCommon *nnual Cash $ividends per share

Current 5hare Price

=P5?et %ncome - Preferred dividends

eighted average. number of common shares

:eturn on =#uity?et %ncome - Preferred $ividends

*verage. Common 5hareholders =#uity

*vg. common shareholders e#uity N /Current common e#uity K Previous common e#uity"'

*ssumptionJ *bney doesn&t have any preferred shares.

*mounts are in thousands of dollars, e+cept forper share amountsJ '01> '01< '01; '014

Common dividends declared G1,10,000 G1,01;,000 GF,000

Cash dividends declared per common share 1.,000 1,>4,000 1,440,000

Common shareholders e#uity 1;,;0,000 1;,''0,000 1',FF,000 ,>F;,000

6arket price per share on $ecember 1 >.

eighted average number of shares outstanding F G '.11 G '.;

:A= 0.0F0 0.0F 0.1'>

b. !he company is increasing its dividend per share year over year despite a reduction in netincome over the same periods. !his may be a result of management trying to demonstratestrength by increasing payouts to draw attention away from the reduction in earnings. !he resultis an increasing dividend payout ratio year over year. !he company may believe that it&s capableof sustaining the amount of dividend despite the decrease in net income. 9owever, this may be a

concern as the payout ratio approaches 1, which means it is paying out almost all of its income individends.

$ividend yield has decreased slightly because the increase in dividends paid per share isincreasing at a slower rate than the increase in market price per share resulting in a loweringratio. !he rising share price suggests the markets aren&t too concerned about the decreasing netincome.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10- 2016

Ir.in( Rut/ T$ta! :evenues G1F4,000

9e(innin( Caita! G40,000 G100,000 G140,000 =+penses 100,000

- s/are $" in%$'e 'F.;>2 >1.42 1002 ?et income GF4,000

S/are $" in%$'e '4,000 2016 ;4,000 14


40/81

=10-'4.a.$r. (oader '>;,000

Cr. Cash '>;,000!o record the purchase of a loader ?ov. 1', '01

b.Ariginal depreciation estimate N /'>;,000-';,000"10 N G';,000"year

Ariginal cost G'>;,000*ccumulated depreciation >;,000 /';,000 + Carrying value '00,0005alvage value ;,000$epreciable base 1. ?o adBustment is made to DcorrectEthe initial estimate. Changes in estimates are done prospectively.




41/81

c.$r. $epreciation e+pense ';,000

Cr. *ccumulated depreciation ';,000!o record the depreciation e+pense for fiscal '014.

!his is the entry that would have originally been recorded. 5ince this is a change in anaccounting estimate, changes are made prospectively and therefore no Bournal entries arere#uired to adBust previously recorded transactions.

d.$r. $epreciation e+pense ,000

Cr. *ccumulated depreciation ,000!o record the depreciation e+pense for fiscal '01F.

e.

Strai(/t !ine

*ccumulated Carrying $epreciation

ear En# $epreciation *mount =+pense

O%t *1 C$st =AD? =CA? =DE?

Purchase G'>;,000 G0 G'>;,000 G0

1-Act-14 '>;,000 ';,000 ';0,000 ';,000

1-Act-1; '>;,000 ;0,000 '';,000 ';,000

1-Act-1< '>;,000 >;,000 '00,000 ';,000

1-Act-1> '>;,000 10F,000 1,000 ,000

1-Act-1F '>;,000 141,000 14,000 ,000

1-Act-1 '>;,000 1>4,000 101,000 ,000

1-3an-'0 '>;,000 1F',';0 ',>;0 F,';0

T$ta! 1,2>240

Proceeds G4',000 1-3an-'0

Carrying *mount ',>;0

(oss /;0,>;0

$r. $epreciation e+pense F,';0Cr. *ccumulated depreciation F,';0

!o record depreciation e+pense for three months /?ov, $ec, U 3an - fiscal '0'0

$r. Cash 4',000$r. *ccumulated depreciation 1F',';0$r. (oss on disposal of loader ;0,>;0

Cr. (oader '>;,000!o record the sale of the loader 3an. 1, '0'0




42/81

=10-';.

a.

5tamping 6achine G0,000

!a+es ',100

$elivery U installation 1,000

!otal G,100

$r. 6achinery ,100Cr. Cash ,100

!o record the purchase of the stamping machine

$epreciation per unit N /,100 L ',000 N 1,100"';0,000 N 0.1'44 per unit.

b.

Units $" r$#u%ti$n

*ccumulated$epreciation

Carrying*mount

$epreciation=+pense

2 units ofproduction

number of unitsproduced

ear

En#

De% *1 C$st =AD? =CA? =DE? -

Purchase ,100 0 ,100 0

'01; ,100 ,>' ',' 1'.002 0,000

'01< ,100 '',' 10,>0F 1F,100 100- 240>000

?umber of unitsover life ';0,000 estimate

Cost ,100 purchase price K associated costs

:V ',000 residual value

DE=nu'er units in eri$#)t$ta! nu'er $" units?=C$st < resi#ua! .a!ue?

DE =- $" t$ta! r$#u%ti$n?= C$st < resi#ua! .a!ue?

AD Current DE F re.i$us years AD

CA C$st + AD

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43/81

c.W5ince management changed the estimated useful life during fiscal '01>, the effect of the changein estimate begins in '01> and is applied prospectively from then forward.X

$epreciation per unit N /10,>0F L 1,000 N ,>0F"1' ',' 1'.002 0,000

'01< ,100 '',' 10,>0F 1F,


44/81

=10-';,000

Det t$ Equity T$ta! Liai!ities 10*

T$ta! Equity

!otal liabilities G1F;,000

!otal =#uity 1>,000

Pri%e t$ 9$$& 8ar&et Ga!ue 20;

9$$& Ga!ue

market value per share G1;.00

$ec. 1, '01> Lcommon shares outstanding ';,000

6arket value >;,000

!otal =#uity - book value 1>,000

Di.i#en# Pay$ut Rati$ C$''$n Annua! Cas/ Di.i#en#s 02;

Net In%$'e

Common annual dividends G10,000

?et %ncome ;,000

Di.i#en# ie!# C$''$n Annua! Di.i#en#s er s/are 00*

Current S/are Pri%e

Common annual dividends per share G0.40

Current share price 1;.00

Return $n Assets Net In%$'e F interest eense =1+ ta rate?

100-A.era(e t$ta! assets01*

?et %ncome ;,000

%nterest e+pense 11,000

ta+ rate 1F2

!otal *ssets /'01>


45/81

preferred dividends ;,000

2016 2015

Common stock >0,000 ;0,000

*AC% ;,000 -4,000

:etained earnings >,000 ;,000

common share e#uity 1;4,000 10;,000

9asi% EPS Net in%$'e + re"erre# #i.i#en#s

7ei(/te# a.era(e %$''$n s/ares:140

?et %ncome G;,000

preferred dividends ;,000

weighted average number of

'0,000common shares outstanding

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-4;5olutions 6anual



46/81

PRO9LE8S

P10-1.

$ebt-to-e#uity ratio N(iabilities I Awners& e#uity:eturn on =#uity N /?et income L preferred dividends I *verage common share e#uityO$ividend payout ratio N Common annual cash dividends I ?et incomePrice to )ook ratio N 6arket value /6V I Carrying amount /)VO6V N /Price per share /number of outstanding common sharesO )V N *ssets L (iabilitiesO/*ssumption that market price isn&t affected by decisions made

Det+t$+equity

rati$

Return

$n equity

Di.i#en#

ay$ut

rati$

Pri%e+t$+

$$& rati$

121 1230- 24- 21

1 5tock dividend ?o effect ?o effect ?o effect ?o effect

'

Payment of a cash dividendthe was declared in a previousperiod

$ecrease ?o effect ?o effect ?o effect

%ssue common shares for land $ecrease $ecrease ?o effect $ecrease

4Purchase by the company ofits own shares for cash

%ncrease %ncrease ?o effect %ncrease

;

$eclaration and payment of acash dividend. $ividend washigher than last year and netincome is unchanged.

%ncrease %ncrease %ncrease %ncrease

1.$r. :"= /A=-

Cr. Common 5tock /A=K

'.$r. $ividend Payable /(-

Cr. Cash /*-

.$r. (and /*K


4.$r. Common stock /A=-

Cr. Cash /*-

;.$r. :etained earnings /A=-

Cr. Cash /*-




48/81

P10-Current ratio N Current assets I Current liabilitiesO$ividend Sield N Common dividend per share I Current market share price)asic =P5 N /?et income L preferred dividends I eighted average common shares outstanding

:eturn on assets N /?et income K interest e+pense /1 L ta+ rate I *verage total assetsO/assumption that market price isn&t affect by decisions made

Return $n

assets

9asi%

earnin(s

er s/are

Current rati$ Di.i#en# yie!#

5;0- :162 12* *10-

1 $eclaration of a stock dividend ?o effect $ecrease ?o =ffect %ncrease

'

Payment of a cash dividend thewas declared in a previousperiod

%ncrease ?o =ffect %ncrease ?o effect

%ssue common shares for land $ecrease $ecrease ?o =ffect ?o effect

4Purchase by the company of itsown shares for cash

%ncrease %ncrease $ecrease ?o effect

;

$eclaration and payment of acash dividend. $ividend washigher than last year and shareprice is unchaged.

?o effect ?o =ffect $ecrease %ncrease

1.$r. :etained earnings /A=-

Cr. Common shares /A=K5ince there are more common shares the price per share decreases as a result of the stockdividend. *ssume dividend per share doesn&t change.

'.$r. $ividend payable /(-

Cr. Cash /*-!he numerator and denominator of the current ratio decrease by the same amount so the ratioincreases.

.$r. (and /*K

Cr. Common shares /A=K

4.$r. Common shares /A=-

Cr. Cash /*-

;.$r. :etained earnings /A=-

Cr. Cash /*-P10-4

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-4F5olutions 6anual



49/81

$ebt-to- e#uity ratio N(iabilities I Awners& e#uity:eturn on =#uity N /?et income L preferred dividends I *verage common share e#uityO$ividend payout ratio N Common annual cash dividends I ?et incomePrice to )ook ratio N 6arket value /6V I Carrying amount /)VO6V N /Price per share /number of outstanding common sharesO )V N *ssets L (iabilitiesO

/*ssumption that market price isn&t affect by decisions made

Det+t$+

equity rati$

Return $n

equity

Di.i#en#

ay$ut rati$

Pri%e+t$+$$&

rati$

121 1230- 24- 21

1 %ssue common shares for cash $ecrease $ecrease %ncrease $ecrease

'

Convert long-term debt tocommon shares

$ecrease $ecrease %ncrease $ecrease

!wo-for-one stock split ?o =ffect ?o effect %ncrease ?o effect

4 $eclaration of a cash dividend %ncrease %ncrease %ncrease ?o effect

;

%ncrease in the market value of

common shares

?o =ffect ?o effect ?o effect %ncrease

1.$r. Cash /*K

Cr. Common 5tock /A=K*ssume that more shares means more dividends if dividend per share doesn&t change. *ssumesale of shares has no impact on stock price so P) ratio decreases.

'.$r. (ongLterm (iabilities /(L


*ssume that more shares means more dividends if dividend per share doesn&t change. *ssumesale of shares has no impact on stock price so P) ratio decreases.

.!here is an increase in the number of common shares outstanding. 6ore shares means moreoverall dividends if dividend per share doesn&t change /different reasonable assumptions arepossible.

4.$r. :etained earnings /A=L

Cr. $ividends payable /(K

;.?o Bournal entry re#uired.




50/81

P10-;.Assu'e t/at t/e #et $r equity is issue# at t/e e(innin( $" t/e year

a., b.

New equity $r #et require# G1;,000,000 G1;,000,000 G1;,000,000 G1;,000,000%nterest rate F2 F2

ta+ rate 1


51/81

a.New equity $r #et require#

,000,000 ,000,000 ,000,000 ,000,000%nterest rate 2 2

ta+ rate 1;2 1;2 1;2 1;2J$$# Out%$'e P$$r Out%$'e

Equity Det Equity Det

Aperating income 1,1';,000 1,1';,000 ';0,000 ';0,000%nterest e+pense /after ta+ of 1;2

'',;00 '',;00

?et income 1,1';,000 F;,;00 ';0,000 '0,;00

5hareholders& e#uity - Sear Ane

,>;0 .142 ';.>2 4.0F2 0.


52/81

P10->./?oteJ ta+ effects from e+pensing stock options are ignored for ease of computationa.

Aptions note+pensed

Aptions e+pensed

:evenues G>,4;,000 G>,4;,000

=+pensesJ Cost of sales 1F,;';,000 1F,;';,000 58U* e+penses 4,;,000,000

1-$ec-1< '1,;00,000 1F,;0,000 >,000,000 1' 1002 >,000,000 9asi% EPS 04*

$ividend $uring />00,000 -

?et %ncome 1-$ec-1> ,,000,000 *1+De%+16

=nding 1-$ec-1> '1,;00,000 '1,;,000

?et income ,T$ta!

Equity 4,4;,000 C"5 e#uity /'01> 4,4;,000

1-$ec-1; per share

ear En#

De% *1

Owners' Equity Number of Shares - Issued

7ei(/te#

A.era(e Nu'er

$" C$''$n S/aresDate

C$''$n

S/ares

Retaine#

Earnin(s

C$''$n

S/ares Ti'e -

)eginning 1-$ec-1< G ;,>;0,000 G 1',4;0,000 1,000,000 1' 1002 1,000,0005tock

dividend 1 6ar-1> ;>;,000 /;>;,000 100,000 >;2 >;,000

Cashdividends 1;-*pr-1> /1,100,000 1,0>;,000

5tock 5plit 0-3un-1> ','00,000 *fter 5plit ,'';,000

Cashdividends 1;-Act-1> /1,F0,000

?et %ncome 1-$ec-1> ,;00,000

=nding 1-$ec-1>


59/81

9asi% EPS *4

c.* typical shareholder who owned 1,000 shares in fiscal '01< and held on to them throughoutfiscal '01> would have received the following payments in dividends.

?umber ofshares $ividend Cash received

1-$ec-1< 1,000 G'.;0 G',;00

A:

1-*pr-1> 1,100 G1.00 G1,100

1;-6ay-10 ,00 G0. G,0F0

* sophisticated shareholder should be happy even though the dividend has decreased on a pershare basis because the total amount of dividend received is greater after the share dividend andsplit.

d. !his assumes market price was stable other than the stock dividend and stock split. %t alsoassumes that the market response to the dividend is e+actly proportional to the change in thenumber of shares.

Date C/an(e Pri%e er s/are K $" s/ares 8ar&et .a!ue

1-$ec-1> G1F.'0 ,00,000 G -common 1,000,000

6arket value G


60/81


61/81

P10-10.*verage amount paid by common shareholders for the shares already outstanding is used to determine the amount that will betransferred from retained earnings to common stock for the accounting for the stock dividend.G1F,;00,000"',000,000 N G.'; per share

ear En#

N$. *0

Owners' Equity

Number of Shares -

Issued

7ei(/te# A.era(e

Nu'er

$" C$''$n S/aresDate

Pre"erre#

St$%&

C$''$n

St$%&

Retaine#

Earnin(s

Pre"erre#

St$%&

C$''$n

St$%& Ti'e -

)eginning 0-?ov-1< G 4,000,000 G 1F,;00,000 G ',4;0,000 '00,000 ',000,000 1' 1002 ',000,000

5tock dividend 1;-6ar-1> 1,F;0,000 /1,F;0,000 '00,000 F.; >12 141, /00,000 '00,000 F,F00,000 F,;

Preferred shares /authori@ed, issued, and outstandingJ '00,000 G4,000,000Common stock /Mnlimited number of shares authori@ed, outstanding F,F00,000 '0,;0,000:etained earnings 1F,>00,000!otal shareholders& e#uity G4,0;0,000

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10-


62/81

b.

*0+N$.+16

?et %ncome


63/81

would be different. 9owever, a change in dividend would probably mean the share pricewouldn&t be proportional. !he calculation below assumes the same amount of dividend.

Pri%e t$ 9$$& 8ar&et Ga!ue

*0+N$.+16 9$$& Ga!ue

market value per share G1'0.00

?ov. 0, '01> Lnumber of commons shares F,F00,000

6arket value 1,0;


64/81

P10-11.a.Tugluktuk&s bonds have a commitment to repay the principal at a definite maturity date and aregular interest payment that must be made, both of which are characteristics of debt. !he bonds

rank ahead of e#uity in the case of li#uidation. !he bondholders have no influence on decisionsof the company. 9owever, since it&s highly likely that the bonds will be converted to e#uity, wecould view the issue as really an e#uity issue, which is e+pressed for a short time in a form that isless risky to the investors. !he fact that the company, not the investors, will decide whether toconvert the bonds makes it difficult to assess the appropriate treatment. /!he principalcomponent of the bond should be considered e#uity if the company has the option to repay thebond through the issuance of common shares at a fi+ed or predetermined price. %f the conversionis at a price that is e#uivalent or greater than the fair market value of the shares then it&sconsidered a financial liability. %t appears in this case that the principal will be recovered becauseit&s highly likely the bonds will be converted before maturity, which implies that the bondholderwill get an e+change e#ual to the market value.

b.$r. Cash '00,000

Cr. (ong-term debt '00,000

!he debt to e#uity ratio will be 1,'00,000"1,400,000 N 0.F


65/81

full disclosure, users& perceptions of the leverage and profitability should be the same either way.9owever, managers of public companies might not always behave in this way and may be moreconcerned about the measurements in the financial statements.

g.

Potentially there are many conse#uences of classifying the bonds as e#uity or debt. !here may becovenants attached to e+isting debt that would be violated if more debt were issued. 6anagementbonuses based on income would be higher if the interest payments were treated as dividends. !heperceptions that investors and lenders have of the company&s profitability and leverage dependon the time the users take to e+amine carefully the financial statements and the notes. 9owever,the underlying economic activity of the entity and its actual underlying risk and capital structurearen&t affected by how the securities are accounted for with the e+ception of ta+ effects.



66/81

P10-1'.

a. !he preferred shares have a commitment to repay the principal before a definite maturity date,which is a characteristic of debt. !he annual dividend payment is specified, which is acharacteristic of debt, but the dividend payments don&t have to be made if management elects not

to. !he dividend is cumulative, but it&s conceivable that the company could choose not to payany dividends to common shareholders until the preferred shares are redeemed. *ssuming thatthe dividends are paid, the definite schedule of redemption makes this issue very much like debt.

b. $r. Cash ;00,000Cr.(ong-term debt ;00,000

!he debt to e#uity ratio will be ',;00,000"',400,000 N 1.04.

c. $r. Cash ;00,000Cr.Preferred shares ;00,000

!he debt to e#uity ratio will be ',000,000"',00,000 N 0.


67/81

P10-1.a., b.

C$''$n Pre"erre#

S/ares S/ares 9$n#s

:evenue G ;,;0

?et %ncome F;0,000 F;0,000 4FF,>;0

(ess preferred dividends 00,000

eighted average common sharesoutstanding 1,';0,000 1,000,000 1,000,000

)asic =P5 05, 044 03;

Preferred stock G ;,000,000

Common stock 1,;00,000 F,;00,000 F,;00,000

:etained earnings ;0

Common shareholders& e#uity - '01F '0,41',;00 1;,00,000 1;,'F,>;0

Common shareholders& e#uity - '01> 1;,;00,000 1;,;00,000 1;,;00,000

*verage common shareholdersO e#uity 1>,;


68/81

c.!o the managementJ

!he financing alternatives have significant implications for the future of your firm. %f morecommon shares are issued, the percentage of the voting shares owned by the current shareholders

will be significantly diluted, although they will still control the firm. $epending on thedistribution of the e+isting ownership, the new shareholders may represent a very significantvoting bloc. * very important cash flow advantage of common shares is that there is nocommitment to make payments of dividends or redeem the shares. !he probability that the firmwill fail should the investment not pay off as #uickly as e+pected is much lower. %f preferredshares are issued, there will be no dilution of control, but the investors in those shares will e+pectdividends. !he G00,000 each year in dividends could create cash flow problems if the firme+periences financial difficulty. hile the dividends on the preferred don&t have to be paid,failure to do so will make it necessary to not pay dividends on common shares until the preferreddividends are paid up in full. *lso, the preferred shares are redeemable after eight years, althoughthere is no indication that this is a mandatory redemption. * benefit of preferred shares, however,

is that it&s a way to raise e#uity temporarily without sharing fully in the success of the business.!he debt alternative has the benefit of ta+ deductibility but there is an obligation to pay theannual interest payments and the need to repay or refinance the debt in 1' years.

8iven the e+pectation that the firm will continue to e+pand over the ne+t few years, the long-term plan must include some mi+ of debt and e#uity. !he #uestion then becomes one of theoptimal se#uence of issuing each. !he debt option raises the risk of violating the 1J1 limit of thedebt-to-e#uity ratio, although if profitability is e+pected in the near future, retained earnings willgrow and shareholders& e#uity will increase over time. %t will likely be advantageous to wait toissue common shares until there is more evidence to support management&s predictions of futureprofits. %n that case, fewer shares will need to be issued to raise a given amount of cash and lessdilution of control will result. $ebt is desirable if future profits and cash flows are fairly certainso that the company can meet its obligations. $ebt is preferred since with debt there is no need toshare profits. 9owever, the greater the uncertainty about future profits and cash flows /both intiming and amount the less attractive debt becomes.



69/81

P10-14.

a. and b.

Tra#iti$na! 6easure * 8easure 9 8easure C:evenue G',4;0,000 G',4;0,000 G',4;0,000 G',4;0,000

=+penses 1,400,000 1,400,000 1,400,000 1,400,000

%nterest e+pense 1>0,000 1>0,000 1>0,000

%ncome ta+es 11;,000 11;,000 11;,000

Preferred $ividends >;,000 >;,000

Common $ividends 1;0,000

?et income G>


70/81

P10-1;.:eport to the board of directorsJ

!he idea that the firm would implement an annual common share dividend seems rather#uestionable. Cash from operations has increased over the last two years after being negativeduring '014 and '01; when the company was implementing its growth strategy. 9owever, cashfrom operations, even if e+pected to remain steady or grow from the G;


71/81

P10-1. !he amount of debt has decreased since '01 by about '> percent. hile thecompany is still financed more by debt than e#uity, the proportion of debt has decreasedsignificantly since '01. %n '01 erland&s debt-to-e#uity ratio was '.1F and in '01> it had fallento 1.1'. !his is a positive sign as the company has become less dependent on debt. !his indicatesa stronger balance sheet because of the lower debt load and its presumed ability to pay down thedebt. e can also consider the amount of non-operating debt erland has /long-term debt/including the current portion divided by e#uity. !he amount of this type of debt financing as aproportion of e#uity has also decreased significantly /see the e+hibit below

Aver the five year period retained earnings has more than doubled, indicating a profitableoperation. !he company has also been able to raise almost G'.F million in e#uity from the sale ofcommon stock.

%t must be noted that erland still has a significant amount of debt and this represents risk sinceinterest must be paid. !he airline industry often faces significant challenges so ongoingprofitability is not assured.

%n conclusion, erland&s balance sheet has shown significant improvement over the last fiveyears and an additional loan of G' million would result in slightly less debt than the company hadin '01F,;0 G>,1>1,'; F,>40,0'; >,< 10,0>;,F

*verage =#uity 1F,',4; 11,04,0;>

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10->15olutions 6anual



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$ebt to e#uity ratio 1.1' 1.' 1.>1 1.' '.1F

P10-1>

!o 6r. )indlossJ

!here are benefits and shortcomings to each financing alternative. )indloss& balance sheetappears to be in a good shape. !he debt to e#uity ratio is 0.>0, meaning there is G0.>0 ofliabilities for every dollar of e#uity. Considering only financing liabilities provides a debt-to-e#uity ratio of 0.4'; /bank loans plus long-term debt, including the current portion. !heG4';,000 of debt the company has seems higher for a company in the oil and gas industry whereresource prices can be #uite volatile.

)orrowing the G>;0,000 would bring your debt-to e#uity ratio up to 1.4;J1 and increase theamount of debt to G1,1>;,000. !his will add risk to the company since the debt comes with fi+edinterest and, in the case of the new loan, principal repayments. Sou should make sure that anynew financing arrangements are consistent with the terms of the e+isting loans. Sou should make

sure that e+isting covenants aren&t in violation and double check if there are any new ones withthis loan. !here is also a matter of servicing the principal and interest payments. %n '01> yearyou paid G1;,000 in dividends to yourself, which is half your earnings for the year. !he newloan would re#uire principal repayments of G1;0,000 along with new interest payments ofG,;00 in the first year. *s a result, how #uickly the proBect generates positive cash flows andthe amount of the cash flows may affect your future payout when going with the debt option.

!here are pros to using debt to finance your company. irst, interest payments are ta+ deductibleand if an increase in income e+ceeds the interest charged you as 1002 e#uity owner will enBoyall benefits in e+cess of the interest cost. !his would mean in the first year you would need tomake an additional G,;00 in net income before interest to breakeven /ignoring ta+es. 9owever

since you are in a cyclical industry you will also bear all the risk should the company not do aswell.

inancing the proBect using e#uity would mean a dilution in ownership. hile you still maintaincontrol with a >;2 ownership, your future earning will have to be shared with the newshareholders. or e+ample the current year&s dividends of G0.'< per share would mean anadditional payout of G'5olutions 6anual



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isn&t e+pected to generate income over the ne+t few years the e#uity financing option maybe thesafer bet.

P10-1F.a.

Strai(/t !ine

ear En#

*ccumulated$epreciation

Carrying*mount

$epreciation=+pense

Set *0 C$st =AD? =CA? =DE?

Purchase 4,100,000 0 4,100,000 0

0-5ep-1; 4,100,000 >>0,000 ,0,000 >>0,000

0-5ep-1< 4,100,000 1,;40,000 ',;>0,000

0-5ep-1> 4,100,000 ',01>,000 ',0F,000 4>>,000

0-5ep-1F 4,100,000 ',44,000 1,,000

0-5ep-1 4,100,000 ',>1,000 1,1',000 4>>,000

0-5ep-'0 4,100,000 ,44F,000 ;,000

M( ; M( :emaining ;

A'$rtiati$n eense MDE

=ur%/ase ri%e MC$st + resi#ua! .a!ueMRG?

use"u! !i"e MUL

DE 660>000 DE 366>000

*nnual depreciation e+pense /'01; and '01 forward will be N /G',;;,000"; N G4>>,000.!he carrying amount on 5eptember 0, '01> would be G',0F,000 after adBusting for the changein estimate.

d.!he change has no immediate real economic impact, but it will have conse#uences because itmeans the company will be able to get benefits from the asset for two more years. *s a result the




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DcostE per year of using the machine decreases and net income decreases. or financial reportingpurposes the company has depreciated too much in the earlier years resulting in change in thereturn on asset ratio. !he debt to e#uity ratio will also be affected as with the higher depreciatione+pense taken in the earlier years would have resulted in a higher debt to e#uity ratio had theestimate been correct. !he users of the financial statements will see a reduction in income from

the increased depreciation e+pense as well as lower carrying amounts of the asset over theremaining useful life prior to the change in estimate. !here may be some information on therevised useful life because it says something about the need for capital e+penditures later thane+pected. hether a user could infer this from the change would depend on if and how theinformation was disclosed. %n any case, there will be a decrease in the amount of depreciation inthe remaining years.

e.!he change in estimate may be obBective under some circumstances although in most cases therewill be a fair bit of discretion as to the amount and timing of the change in estimate. !he way thatthis change is described indicates that management intends to replace the machine at the end of

fiscal '0'1. * change of estimate that reflects a clear intent can probably be consideredobBective. 9owever, management doesn&t always have to be completely forthright with itsintentions. !here are alternative motivations for the same change, such as increasing income toachieve some benefit /higher bonuses, more satisfied investors, higher returns on assets or e#uity,etc.. ?ote that income ta+ effects would not be a consideration as depreciation for ta+ purposeswould be calculated using CC* and therefore the estimates that management makes for financialreporting would not be relevant.




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P10-1.

Nis&u Jri'sy

?et %ncome G4;1,; ,>;,>

Common shareholders e#uity /'01> 4,000,000 4,000,000

ROE 0.1' 0.1'

Common shareholders e#uity /'01 ?et income 4;1,;;,> G,>;,>

?isku and 8rimsby are identical in every respect e+cept for the number of shares outstanding.?isku has 1,000,000 shares outstanding and 8rimsby has 4,000,000. *s a result, =P5 for ?iskuis higher.

%n most instances, an investor would be indifferent in choosing between these two companies.!he only factor that may be a consideration is that the shares in 8rimsby are likely lesse+pensive and if an investor only had a small amount to invest, it may be a more affordableoption. or e+ample, if shares of ?isku were G1,000 and shares of 8rimsby were G';0/maintaining the 4J1 ratio and % only had G;00 to invest, % would have to choose 8rimsby. %nmost instances however, investors would be indifferent. !he fact that =P5 is higher for ?iskuwould have no bearing on a decision.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10->;5olutions 6anual



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P10+20

a.een&e%& Oe$n($

?et %ncome G',>;0,000 G',>;0,000

Preferred $ividends - -eighted average common sharesoutstanding ;0,000,000 100,000,000

9asi% EPS :03, :023

Common annual cash dividends GF,000,000 GF,000,000

Common shares outstanding ;0,000,000 100,000,000

Di.i#en#s Per S/are :015 :00,

Common annual cash dividends GF,000,000 GF,000,000

?et %ncome ',>;0,000 ',>;0,000

Di.i#en# Pay$ut Rati$ 0*3 0*3

Common dividends per share G0.1< G0.0F

Current share price 1;.00 >.;0

Di.i#en# Pay$ut Rati$ 001 001

b.Tepenkeck and Apeongo are identical in every respect e+cept for the number of sharesoutstanding and the market price per share. Tepenkeck has ;0,000,000 shares outstanding andApeongo has 100,000,000 which are proportional to the market price per share at G1;.00 andG>.;0. )oth companies have the same market value of e#uity. !herefore the performancemeasures are effectively the same. Tepenkeck&s earnings per share and dividends per share aretwo times that of Apeongo&s, but Apeongo has twice as many shares outstanding. ?et income

and total dividends are the same for the two companies. !he payout ratio and dividend yield arethe same for the two companies.

3ohn riedlan,Financial Accounting: A Critical Approach, 4thedition Page 10->,000?et earnings for the year ended 6arch 1, '004 N G1,0'4,000

f. ?et assets on 6arch 1, '00; N G1F;,F>1,000/NG,;; - GF>>,>4

=P5 '004 NG1,0'4,000

N G0.'F,;04

:A= '00;N G','0>,000

N1.1,000 K G1;;,101,000 I '

:A= '004 N G1,0'4,000 N 1.>2/G1;;,101,000 K G1',40G1F;,F>1,000

$ebt-to-e#uityratio '004

NGF


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=P5 and :A= are very stable over the two years e+amined. =P5 increased by G0.11 per share, anincrease of about 1


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510-4

!he multiple voting shares represent 4.42 of total number of common shares outstanding

/1,';,.2 of the votes whilerepresenting only 4.42 of the total number of shares W/1,';, N G',


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d. $uring '00; 11,10 options were e+ercised for cash at an average price of G


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10-F

a. An $ecember 1;, '004, the Company completed a ' for 1 stock split effected in the form

of a stock dividend. !his means that for each share owned a shareholder received asecond share and the total number of shares outstanding doubled.b. *mounts on the financial statements aren&t affected by a stock split. Anly per share

amounts, such as earnings per share, are affected.c. ?o Bournal entry is necessary to record a stock split.d. !here would be half as many shares of each class reported in '004 since as a result of the

stock split the number of shares outstanding would double. !hus,

of shares outstanding on6arch 1, '004 as reportedin the '00; annual report

of shares outstanding on6arch 1, '004 as reportedin the '004 annual report

5ubordinate Voting 5hares 'F,1>4,0< 14,0F>,01F6ultiple Voting 5hares 1,';,

friedlan4e sm ch10

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