Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CHAPTER 11 REPORTING AND ANALYZING SHAREHOLDERS’ EQUITY LEARNING OBJECTIVES Identify and discuss the major characteristics of a corporation Record share transactions Prepare the entries for cash dividends, stock dividends, and stock splits, and understand their financial impact Indicate how shareholders’ equity is presented in the financial statements Evaluate dividend and earnings performance SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO BT Item LO BT Item LO BT Questions Item LO BT 1 1 C AP C C 10 2 2 C K K C 13 14 15 16 3 3 K C C AP 19 20 21 22 4 4 C C K C C 11 AP 17 K 23 K C 12 C 18 K 24 AN Item LO BT 25 26 27 28 5 5 C C AN C 17 18 5 AP AP 13 14 15 5 AN AN AN Brief Exercises 2 C AP AN AP 10 AN AN 13 14 5 AN AN AP AP 11 AP 15 AP AP AN 12 AP 16 AP 10 11 12 5 AP AN AP 5 AN AN Exercises 2 AN AP AN 2,3 AN AP AP 2,3,4 2,3,4 2,3,4 AN AN AN 2,3,4 2,3,4 AP AP AN 2,3,4 AP 3,4 1,2,5 C C 2,3,4 4 AN C AP Problems: Set A and B 3,4 5 AP AP AN 10 11 Accounting Cycle Review Cases 2,4 S C 2,3,4 E AP Solutions Manual 11-1 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Legend: The following abbreviations will appear throughout the solutions manual file LO Learning objective BT Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation Level of difficulty S Simple M Moderate C Complex Estimated time to prepare in minutes Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech Diversity Diversity Reflective Thinking Reflec Thinking CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm Communication Self-Mgt Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat & Gov Strategy and Governance Mgt Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation Difficulty: Time: AACSB CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006 Solutions Manual 11-2 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ANSWERS TO QUESTIONS (a) (1) Separate legal existence A corporation is separate and distinct from its shareholders (owners) and acts in its own name rather than in the name of its shareholders In addition, the acts of the shareholders not bind the corporation unless the shareholder is a duly appointed agent of the corporation This is an advantage to the corporate form of organization (2) Limited liability of shareholders Because of its separate legal existence, creditors of a corporation ordinarily have recourse only to corporate assets to satisfy their claims Thus, the liability of shareholders is normally limited to their investment in the corporation This is an advantage to the corporate form of organization (3) Transferable ownership rights Ownership of a corporation is shown in shares, which are transferable Shareholders may dispose of part or all of their interest by simply selling their shares The transfer of ownership to another party is entirely at the discretion of the shareholder This is an advantage to the corporate form of organization (4) Ability to acquire capital Corporations can raise capital quite easily by issuing shares Public corporations have an almost unlimited ability to acquire capital Investors find shares of corporations to be attractive since they need not invest large sums of money to become shareholders In addition, shareholders benefit from limited liability This is an advantage to the corporate form of organization (5) Continuous life Since a corporation is a separate legal entity, its continuance as a going concern is not affected by the withdrawal, death, or incapacity of a shareholder, employee, or officer This is an advantage to the corporate form of organization Solutions Manual 11-3 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition (a) (continued) (6) Separation of management and ownership Although the shareholders of a corporation are its owners, it is the board of directors that decides on the operating policies of the company The shareholders seldom get involved in the company’s day-to-day activities This is normally seen to be an advantage to the corporate form of organization (7) Government regulations Corporations in Canada may incorporate federally or provincially Government regulations usually provide guidelines for issuing shares, distributing net income, and reacquiring shares Provincial securities commissions also govern the sale of share capital to the general public When a corporation’s shares are listed or traded on a stock exchange, it must adhere to the reporting requirements of that exchange This may be a disadvantage to the corporate form of organization because it adds extra cost and complexity to the organization (8) Income tax Corporations must pay federal and provincial income tax as separate legal entities However, corporations usually benefit from more favourable tax rates than the owners of partnerships or proprietorships The shareholders of the corporation not pay tax on the corporation’s net income unless they receive dividends from the corporation This is often seen to be an advantage to the corporate form of organization (b) While public corporations have an almost unlimited ability to acquire capital, this is not the case for private corporations In addition, transferring ownership rights can be much more limited given that private corporation shares are not publicly traded Private companies not have as stringent reporting and disclosure requirements as public companies LO BT: C Difficulty: M Time: 30 AACSB: None CPA: cpa-t001, cpa-t006 CM: Reporting and Tax Solutions Manual 11-4 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition (a) Letson has 60,000 shares issued and is eligible to issue an additional 40,000 shares (100,000 – 60,000) (b) Only issued shares are recorded in the general journal The number of authorized shares is disclosed but not recorded until issued LO BT: AP Difficulty: M Time: AACSB: Analytic CPA: cpa-t001 CM: Reporting When Richard purchased the original shares as part of lululemon’s initial public offering, he purchased these shares directly from the corporation The $1,800 (100 × $18) he spent to buy the shares went directly to lululemon and increased the company’s assets (Cash) and shareholders’ equity (Common Shares) There was no impact on the company’s liabilities In the subsequent purchase, Richard bought shares in the secondary market from another investor or investors The proceeds from this sale went to the seller and not to lululemon Therefore, there was no impact on lululemon’s assets, liabilities, or shareholders’ equity a result of the second purchase LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Market capitalization is the measure of the fair value of a corporation’s equity It is calculated by multiplying the number of shares issued by the share market price at any given date It should not be confused with a corporation’s legal capital which represents the amount paid to the corporation on the initial and any subsequent issue of shares and consequently is the amount that appears on the statement of financial position Solutions Manual 11-5 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition (continued) Dollarama Inc.’s market capitalization decreased in 2015 There are two primary reasons for a decrease in the market capitalization of a company, which may happen separately or in combination First, the number of shares may have decreased because the company repurchased some of its shares If this is the case, assets (Cash) and shareholders’ equity (Common Shares) would decrease as a result of the repurchase Liabilities would be unaffected The second and more likely reason for the decrease in the market capitalization is the decrease in the market price of the shares Decreases in the market price of the shares can result from a number of reasons but are most likely due to the market’s perception of the future ability of the corporation to earn income As a result, investors bid down the price paid for the shares on the market This possible reason for the change in market capitalization does not affect any element on the statement of financial position LO BT: C Difficulty: M Time: 15 AACSB: None CPA: cpa-t001 CM: Reporting Legal capital is the portion of a company’s share capital that cannot be distributed to shareholders Legal capital is created largely for the protection of creditors (b) The proceeds received by the company when issuing shares determine the carrying amount of the shares recorded in the accounts The proceeds are considered to be legal capital that must remain invested in the company for the protection of corporate creditors (c) Par value is very common in the United States and very rare in Canada Federally incorporated companies and most provincially incorporated companies have no par value shares (d) Legal capital is kept separate from retained earnings because retained earnings may be distributed to shareholders in the form of dividends, whereas legal capital may not be distributed to shareholders until the company is liquidated (a) LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 11-6 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition (a) Preferred shareholders have priority over common shareholders with respect to the distribution of dividends and, in the event of liquidation, over the distribution of assets Preferred shareholders not usually have the voting rights that the common shareholders have (b) Companies issue preferred shares for a permanent type of equity financing for the company LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting When shares are issued for a consideration other than cash, such as goods or services, IFRS requires that the transaction be recorded at the fair value of the consideration received If the fair value of the consideration received cannot be reliably determined, then the fair value of the consideration given up (for example, shares) can be used When shares are issued for a noncash consideration in a private company following ASPE, the valuation of the shares can be slightly different than that described above for a publicly traded company following IFRS The shares of a private company should be recorded at the most reliable of the two values—the fair value of the consideration (such as goods or services) received or fair value of the consideration given up (such as shares) Quite often, the fair value of the consideration received is the most reliable value because a private company’s shares seldom trade and therefore not have a ready market value LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 11-7 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition (a) A normal course issuer bid is synonymous with the reacquisition of shares In a normal course issuer bid, a company is allowed to repurchase up to a certain percentage of its shares subject to regulatory approval It can purchase the shares gradually over a period of time, such as one year This repurchasing strategy allows the company to buy when its shares are favourably priced (b) A corporation may acquire its own shares (1) to increase trading of the corporation's shares in the stock market, in the hopes of enhancing its market value, (2) to reduce the number of shares issued and increase basic earnings per share and return on equity ratios, (3) to eliminate hostile shareholders by buying their shares, and (4) to have additional shares to issue if required to compensate employees using stock options, or to acquire other businesses LO BT: K Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting Because companies cannot realize a gain or incur a loss from share transactions with their own shareholders, these amounts are not reported on the income statement They are seen instead as an excess or deficiency that belongs to the remaining shareholders and are recorded directly into the shareholders’ equity accounts such as Contributed Surplus or Retained Earnings LO BT: K Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting 10 When reacquiring shares, if the amount paid by the company is less than the average cost of the shares on hand, the difference is credited to Contributed Surplus, increasing it If the opposite is true (i.e., the amount paid to reacquire the shares is greater than the average cost of the shares on hand), the difference is applied to reduce (debit) Contributed Surplus, but because that account cannot have a negative (debit) balance, if the debit arising from the reacquisition is greater than the balance in the Contributed Surplus account, then the remainder of the debit is applied against the Retained Earnings account, reducing it LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 11-8 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 11 Financial Accounting, Seventh Canadian Edition David should expect to receive a dividend in the amount of $295.00 (1,000 shares ì $1.18 ữ 4) each quarter When the Royal Bank resets the dividend rate, it will be adjusted to more closely reflect market interest rates If David invested in the preferred shares because he hoped to earn a more attractive return from dividends compared to the rate of return he could receive from interest earned on a debt investment, he may be disappointed when the dividend rate is reset at the lower market interest rate On the other hand, because the resetting of the dividend rate occurs only periodically, if David believes that interest rates will fall, he may be very pleased to own these preferred shares (at least until the dividend rate is reset at the same level as the lower interest rates) Furthermore, if David believes that the interest rates will be volatile in the future, the reset feature will make the investment in the preferred shares more appealing because at least until the next reset, David will know what his rate of return will be LO BT: AP Difficulty: C Time: AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance 12 (a) Redeemable (or callable) preferred shares give the issuing corporation the right to purchase these shares from shareholders at specified future dates and prices Retractable preferred shares are similar to redeemable or callable preferred shares, except that it is at the shareholder’s option, rather than the corporation’s option, that the shares are redeemed This usually occurs at an arranged price and date (b) Preferred shares are cumulative or noncumulative with respect to their dividend provisions Cumulative preferred shares entitle the shareholder to any previous years’ dividends that have not yet been paid, as well as their current dividend, before common shareholders can receive any dividends Solutions Manual 11-9 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition 12 (continued) (c) Dividends in arrears can only arise from cumulative preferred shares If a dividend is not declared for a noncumulative preferred share, the dividend entitlement is erased and does not carry forward into the future On the other hand, if a dividend is not declared for a cumulative preferred share, the amount of the dividend shortfall becomes dividends in arrears which must be paid first from any dividend declared in the future LO BT: C Difficulty: M Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting 13 Cash dividends cannot exceed the balance of the Retained Earnings account For a cash dividend to be paid, a corporation must meet a solvency test to ensure that it has sufficient cash to be able to pay its liabilities as they become due after the dividend is declared and paid The test essentially requires the net realizable value of the assets of a company to exceed the total of its liabilities and share capital In addition, a formal dividend declaration by the board of directors is required Also, any required preferred dividends must be paid before common dividends are paid LO BT: K Difficulty: S Time: 10 AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 11-10 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR11-1 (CONTINUED) (e) (3) HAMPTON CORPORATION Statement of Financial Position December 31, 2018 Assets Current assets Cash Accounts receivable Less: Allowance for doubtful accounts Inventory Supplies Total current assets Property, plant and equipment Land Buildings $142,000 Less: Accumulated depreciation 26,400 Total property, plant, and equipment Total assets $ 87,240 $67,800 3,500 64,300 143,560 5,900 301,000 $ 40,000 115,600 155,600 $456,600 Solutions Manual 11-113 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR11-1 (CONTINUED) (e) (3)(continued) Liabilities and Shareholders’ Equity Current liabilities Accounts payable Interest payable Dividends payable Income tax payable Current portion of mortgage payable Total current liabilities Non-current liabilities Mortgage payable Total liabilities Shareholders’ equity Share capital $2.80 Preferred shares, cumulative, 50,000 shares authorized, 500 issued Common shares, unlimited number of shares authorized, 3,500 issued Total share capital Retained earnings Accumulated other comprehensive income Total shareholders’ equity Total liabilities and shareholders’ equity $98,700 350 5,600 6,000 2,500 $113,150 75,500 188,650 $ 50,000 60,000 110,000 148,550 9,400 267,950 $456,600 Solutions Manual 11-114 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ACR11-1 (CONTINUED) (f) Closing Entries: 2018 Dec 31 31 031 31 Sales Income Summary 420,000 Income Summary Cost of Goods Sold Salaries Expense Supplies Expense Depreciation Expense Bad Debts Expense Bank Charges Expense Interest Expense Income Tax Expense 393,250 Income Summary Retained Earnings 26,750 Retained Earnings Dividends Declared 5,600 420,000 250,000 88,200 33,600 4,400 3,700 3,000 4,350 6,000 26,750 5,600 LO 2,3,4 BT: AP Difficulty: M Time: 80 AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual 11-115 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT11-1 (a) Financial Accounting, Seventh Canadian Edition FINANCIAL REPORTING CASE The North West Company Inc reported $1.44 basic earnings per share for the year ended January 31, 2016 and $1.30 for the year ended January 31, 2015 North West reported a weighted average number of common shares of 48,509,000 in 2016, and 48,432,000 in 2015 (b) Number of common shares authorized Number of preferred shares authorized Number of common shares issued Number of preferred shares issued 2016 unlimited N/A 48,523,341 N/A 2015 unlimited N/A 48,497,199 N/A Although very close in amount, the number of common shares issued does not correspond to the weighted average number of common shares because the number of shares issued is the actual number of shares issued as at the end of the fiscal year while the weighted average number of shares weights shares issued and repurchased during each fiscal year for the proportion of the year they have been outstanding (c) The dollar amount showing in Note 15 for the Common Shares account is $167,910,000 and this is the amount received by the company when it issued the 48,523,341 common shares that are currently outstanding The company would have received on average $3.46 per share ($167,910,000 ÷ 48,523,341) North West reported other comprehensive income in the amount of $11,953,000 for the 2016 fiscal year and other comprehensive income of $11,384,000 for the 2015 fiscal year North West declared dividends to common shareholders in the amount of $58,210,000 for the 2016 fiscal year and $56,180,000 for fiscal 2015 LO 3,4 BT: C Difficulty: M Time: 20 AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual 11-116 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT11-2 (a) Financial Accounting, Seventh Canadian Edition FINANCIAL ANALYSIS CASE Companies choose different types of ownership structures for a variety of reasons One of the most common reasons companies choose to go public is to access the funds available through the capital markets However, this access to capital comes with costs Once a company goes public, it must follow the securities regulations, which results in additional costs and requirements such as filing quarterly financial statements, audited annual financial statements, expanded disclosure requirements, and various other reports Also, because public companies must publicly disclose financial information, competitors may have access to useful information Although private companies may have more difficulty accessing large amounts of capital, some choose to remain private in order to retain control over the company Once a company is public, it is answerable to a variety of stakeholders Consequently, some companies choose to remain private in order to avoid revealing information to the general public, in particular to their competitors (b) Public companies should record noncash transactions at the fair value (or current value) of the consideration received (the new restaurant) If that consideration cannot be reliably determined, the fair value of the consideration given up (the shares) should be used instead Since Boston Pizza is a public company, it can easily obtain an objective measure of the fair value of its shares through the TSX (the exchange where it is listed) Private companies should record noncash transactions at the most reliable fair value of what was received or given up When private companies such as Pizza Pizza, whose shares are not publicly traded, need to determine the fair value of their shares, they often hire a business valuation expert to provide them a valuation It is more usual that they find the fair value of the consideration received (that is, of the new restaurant) to be more reliable and relevant to use than the current value of the consideration given up, given the lack of a readily available share price Solutions Manual 11-117 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT11-2 (CONTINUED) (c) When the standard setters developed ASPE, a major focus was on the objectives and needs of the users of the financial statements The users generally fall into two broad groups: lenders and other creditors, and private shareholders The two groups are generally more focused on shorter-term cash flows, liquidity, balance sheet strength, interest coverage, and solvency issues Given these users’ needs, basic earnings per share (EPS) is not usually considered to be relevant In addition, the shares are usually very closely held Therefore, ASPE does not require that private companies report EPS (but if the company thinks EPS is relevant information, it is free to report it) LO 1,2,5 BT: C Difficulty: M Time: 20 AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 11-118 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT11-3 Financial Accounting, Seventh Canadian Edition PROFESSIONAL JUDGEMENT CASE Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS Option All equity At the beginning of the year: Assets Liabilities Shareholders' equity $1,000,000 Option Option All debt Debt and equity 1,000,000 $1,000,000 999,999 $2,000,000 1,000,000 1,000,000 Option All equity Option All debt $1,000,000 850,000 150,000 150,000 $1,000,000 850,000 150,000 60,000 90,000 $2,000,000 1,700,000 300,000 60,000 240,000 37,500 $ 112,500 22,500 $ 67,500 60,000 $ 180,000 (a) Projected income statements: Revenue (= to assets) Operating expenses (85% of revenue) Income from operations Interest expense (6% of liabilities) Income before income tax Income tax expense (25% of income before income tax) Net income Option Debt and equity Solutions Manual 11-119 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT11-3 (CONTINUED) (b) (c) The return on common shareholders’ equity for each option is calculated below Note that because the net income will be paid out as dividends, the retained earnings at the end of the year will be zero so the average common shareholders’ equity at the end of the year will be the same amount that it was at the beginning of the year (d) Net income for the year Common shareholder's equity, beg of year Common shareholder's equity, end of year Average shareholder's equity for the year Return on common shareholders’ equity Option All equity $ 112,500 1,000,000 1,000,000 1,000,000 11.3% Option All debt $67,500 1 6,750,000% Option Debt and equity $ 180,000 1,000,000 1,000,000 1,000,000 18.0% The option with the lowest return is the one with the lowest level of debt relative to equity When no debt is taken out, a company cannot take advantage of leverage, which means that the company does not profit by using the bank’s money As a result, the best return is the one with all debt, Option Because the denominator is so low (only $1 of equity), the return appears to be astronomically high (e) The amount of cash that Depinder would have before income tax is calculated in the table below He will have the most cash under Option if he borrows money from the bank and buys the larger restaurant Option All equity $112,500 Option Option All debt Debt and equity Dividends received by Depinder $ 67,500 $180,000 Interest received by Depinder 60,000 $127,500 (d) If the operating expenses are greater than the revenues, then the company will have a loss The return on common shareholders’ equity will be negative If the company has more debt, additional interest will have to be paid to the bank and this will make the loss greater and the return on common shareholder’s equity lower than it would have been otherwise Solutions Manual 11-120 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT11-3 (CONTINUED) (e) If the bank loan was replaced with preferred shares, there would be no interest expense on the income statement and net income would rise The preferred dividends would be reported on the statement of changes in shareholders’ equity and not on the income statement The net income for the large restaurant would be exactly double what is currently reported on the income statement for Option 1, the purchase of the small restaurant (f) The preferred shares that the uncle would purchase would be considered to be retractable since he has the right to require the company buy back the shares This makes the shares similar to debt because there is a contractual obligation to pay an amount in the future (this is in essence the definition of a liability) Because of this, the preferred shares would be shown as a liability rather an equity item Consequently, the dividends on those shares would be treated as interest on the income statement rather than as dividends on the statement of changes in equity for consistency with its presentation on the statement of financial position (g) If the business was not incorporated, the income statement would still be prepared but income tax expense would not apply and therefore not be shown This is because the net income of the business is taxed at the personal level as the business is not a separate legal entity LO 2,4 BT: S Difficulty: C Time: 50 AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 11-121 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT11-4 (a) Financial Accounting, Seventh Canadian Edition ETHICS CASE The stakeholders in this situation are: Vince Ramsey, president of Flambeau Corporation Janice Rahn, financial vice-president The shareholders of Flambeau Corporation (b) The stock dividend results in a decrease in retained earnings and an increase of the same amount in share capital with no change in total shareholders’ equity There is no change in total assets and no change in total liabilities and shareholders’ equity (c) The 5% stock dividend will likely reduce the value at which the shares are trading by around 5%—at least in the immediate future Since essentially nothing has changed in the company’s financial position, the only effect a 5% stock dividend will have on the market value of the shares is to allocate the equity of the business over 5% more shares (d) There is nothing unethical in declaring and issuing a stock dividend However, the president’s order to write a press release convincing the shareholders that the stock dividend is just as good as a cash dividend is unethical A stock dividend is not a cash dividend and does not necessarily leave the shareholders in the same position A stock dividend is a “paper” dividend—the company issues a certificate, not a cheque (cash) LO BT: C Difficulty: M Time: 20 AACSB: Analytic, Ethics, and Communication CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics Solutions Manual 11-122 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT11-5 Financial Accounting, Seventh Canadian Edition FINANCIAL ANALYSIS CASE Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS (a) Alternative (Borrow $50,000) Alternative (Issue $50,000 common shares) Alternative (Issue $50,000 preferred shares) Debt to total assets $71,980 ÷ $195,280 = 36.9% $31,980 ÷ $207,680 = 15.4% $31,980 ÷ $204,680 = 15.6% Return on common shareholders’ equity $21,600 ÷ [[($50,000 + $51,700) + ($50,000 + $73,300)] ÷ 2)] = 19.2% $24,000 ÷ [[($50,000 + $51,700) + ($100,000 + $75,700)] ÷ 2)] = 17.3% ($24,000 – $3,000) ÷ [[($50,000 + $51,700) + ($50,000 + $72,700)] ÷ 2)] = 18.7% $24,000 ÷ 1,000 = $24.00 ($24,000 - $3,000) ÷ 500 = $42.00 Basic earnings $21,600 ÷ 500 per share = $43.20 (Debt to assets ratio = Total liabilities ÷ Total assets) (Return on common shareholders’ equity = (Net income – preferred dividends) ÷ Average common shareholders’ equity) (Basic earnings per share = (Net income – preferred dividends) ÷ Weighted average number of common shares) (b) Alternatives and provide for the least amount of debt—$31,980 instead of $71,980 reported in Alternative Instead of borrowing, the company has issued shares in Alternatives and Solutions Manual 11-123 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT11-5 (CONTINUED) (c) Alternative 1, borrowing instead of issuing shares, provides for the highest return on equity and the highest basic earnings per share (d) If I were John, I would choose Alternative This alternative would generate a smaller amount of net income because of the amount of aftertax interest expense paid on the loan; however, the return on common shareholder’s equity and basic earnings per share would increase because the distribution of net income is limited to current shareholders LO BT: E Difficulty: C Time: 20 AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 11-124 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT11-6 (a) Financial Accounting, Seventh Canadian Edition SERIAL CASE June 15 Dividends Declared Dividends Payable 60,000 June 30 Dividends Payable Cash 60,000 60,000 60,000 Since the date of record on the declaration of the dividend is June 20, 2018, only shareholders on that date are eligible to receive dividends Bev, Doug, and Emily each receive one-third of the dividend and will each receive $20,000 (b) (c) June 30 Cash 125,000 Common Shares (100 × $1,250) 125,000 ANTHONY BUSINESS COMPANY LTD Statement of Retained Earnings Year Ended June 30, 2018 Retained earnings, July 1, 2017 Add: Net income Less: Dividends declared Retained earnings, June 30, 2018 $177,834 156,069 333,903 60,000 $273,903 (Ending retained earnings = Beginning retained earnings + Net income – Dividends declared) If ABC followed IFRS rather than ASPE, a statement of changes in equity explaining the changes in each component of shareholder’s equity would be required instead of a statement of retained earnings Solutions Manual 11-125 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT11-6 (CONTINUED) (d) ANTHONY BUSINESS COMPANY LTD Statement of Financial Position (Partial) June 30, 2018 Shareholders’ equity Common shares, unlimited number authorized, 400 issued Retained earnings Total shareholders’ equity $125,300 273,903 $399.203 ($300 + $125,000 = $125,300) LO 2,3,4 BT: AP Difficulty: M Time: 30 AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual 11-126 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Legal Notice Copyright © 2017 by John Wiley & Sons Canada, Ltd or related companies All rights reserved The data contained in these files are protected by copyright This manual is furnished under licence and may be used only in accordance with the terms of such licence The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd (MMXVII vi F2) Solutions Manual 11-127 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited ... and Decision- Making Comm Communication Self-Mgt Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat & Gov Strategy and Governance Mgt Accounting Management Accounting. .. shareholder, employee, or officer This is an advantage to the corporate form of organization Solutions Manual 11- 3 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying,... shares and consequently is the amount that appears on the statement of financial position Solutions Manual 11- 5 Chapter 11 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying,