CHAPTER 11 Reporting and Analysing Shareholders’ Equity ASSIGNMENT CLASSIFICATION TABLE

Kimmel, Weygandt, Kieso, Trenholm Financial Accounting, Second Canadian Edition

CHAPTER 11

Reporting and Analysing Shareholders’ Equity

ASSIGNMENT CLASSIFICATION TABLE

Study Objectives Questions

Brief

Exercises Exercises

A

Problems

B

Problems

1. Identify and discuss the major characteristics of a corporation and its

1, 2, 3, 4,

5, 6, 7, 8, 9

1, 2 shares.

2. Record the issue of common shares.

10 3, 4

11 5 3. Differentiate preferred shares from common shares.

4. Prepare the entries for cash dividends, stock dividends, and stock

12, 13, 14,

15, 16

6, 7, 8, 9,

10 splits, and understand their financial impact.

5. Identify the items that affect retained earnings.

6. Indicate how shareholders’ equity is presented in the financial statements.

7. Evaluate dividend and earnings performance.

17, 18

19, 20 11

1, 2

3, 4, 5, 6 1A, 2A,

3, 4, 6

3A, 4A, 5A

1B, 2B,

3B, 4B

1A, 2A, 3A 1B, 2B, 3B

5, 6, 7, 8, 9 3A, 5A,

5, 10, 11,

12

21, 22, 23 12, 13, 14 13, 14

6A, 7A

6A

1A, 2A,

3A, 6A,

7A, 8A

3A, 7A,

9A, 10A,

11A, 12A

3B, 5B,

6B, 7B

6B

1B, 2B,

3B, 6B,

7B, 8B

3B, 7B,

9B, 10B,

11B, 12B

Solutions Manual 11-1 Chapter 11

Copyright © 2004 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.


ASSIGNMENT CHARACTERISTICS TABLE

Problem

Number Description

Difficulty

Level

1A Journalize share transactions and prepare share capital section. Discuss financing choice.

Simple

2A Journalize transactions, and prepare shareholders’ equity section.

Moderate

3A Journalize transactions and prepare shareholders’ equity section; calculate profitability ratios.

Moderate

4A Evaluate impact of stock option plan. Complex

5A Compare impact of equity transactions. Moderate

6A Reproduce retained earnings account, and prepare shareholders’ equity section.

Moderate

7A Journalize dividend transactions, prepare shareholders’ equity section, and calculate profitability ratios.

Moderate

Moderate 8A Prepare shareholders’ equity section of balance sheet and financing activities section of cash flow statement.

9A Evaluate dividend policy. Moderate

10A Calculate profitability ratios and comment. Moderate

11A Evaluate profitability. Complex

12A Evaluate profitability and solvency. Complex

Simple 1B Journalize share transactions and prepare share capital section. Discuss financing choice.

Moderate 2B Journalize transactions, and prepare shareholders’ equity section.

Time

Allotted (min.)

30-40

40-50

40-50

30-40

30-40

30-40

40-50

40-50

20-30

30-40

20-30

20-30

30-40

40-50




Problem

Number Description

Difficulty

Level

Moderate 3B Journalize transactions and prepare shareholders’ equity section; calculate profitability ratios.

4B Evaluate impact of stock option plan and repurchase of shares.

5B

Compare impact of cash dividend, stock dividend and stock split.

Complex

Moderate

6B Reproduce retained earnings account, and prepare shareholders’ equity section.

Moderate

7B Journalize dividend transactions, prepare shareholders’ equity section, and calculate profitability ratios.

Moderate

Moderate 8B Prepare shareholders’ equity section of balance sheet and financing activities section of cash flow statement.

9B Evaluate dividend policy. Moderate

10B Calculate profitability ratios and comment. Moderate

11B Evaluate profitability. Complex

12B Evaluate profitability and solvency. Complex

Time

Allotted (min.)

40-50

30-40

30-40

30-40

40-50

40-50

20-30

30-40

20-30

20-30




ANSWERS TO QUESTIONS

1. (a) Separate legal existence. A corporation is separate and distinct from its owners and acts in its own name rather than in the name if its shareholders. In addition, the acts of the owners (shareholders) do not bind the corporation unless the owners are duly appointed agents of the corporation.

(b) 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.

(c) 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.

(d) 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.

2. (a) Income tax can be an advantage for a corporation because corporate income tax rates are generally lower than personal tax rates, therefore, a corporation will usually pay less tax than the same business which is not incorporated. Taxation can be a disadvantage for corporations because corporate distributions (dividends), which have been already taxed at the corporate level, are taxed again personally when received by the shareholders. However, most of the effects of this double taxation are eliminated by the use of a special tax provision called the dividend tax credit, which offers shareholders a personal tax credit to approximate a portion of the tax already paid at the corporate level.

(b) Two other advantages of a corporation are:

1. The ability to transfer ownership rights easily through the selling of shares in the business.

2. The ability to separate ownership and management, which allows professional, experienced managers to run the business on behalf of the owners (shareholders).

Two other disadvantages of a corporation are:

1. The owners of the business may not be involved in day-to-day decisionmaking and the professional managers hired to run the business may make decisions that are not in the best interest of the shareholders.

2. The corporate form of business organization requires more government reporting, which can be very costly and time-consuming.




Questions (Continued)

3. In the absence of restrictive provisions, the basic ownership rights of common shareholders are the rights to:

(1) vote for the election of the board of directors and in corporate actions that require shareholders’ approval.

(2) share in corporate earnings.

(3) share in assets upon liquidation.

4. When no par value shares are issued, the value is established by the market. Market value after this time is generally unrelated to the ‘no par value.’ A share’s market value will reflect many factors, including the company’s anticipated future earnings, its expected dividend rate per share, its current financial position, the current state of the economy, and the current state of the securities markets.

5.

The initial share purchase will cause the company’s assets (cash) to increase by $1,000 and the company’s shareholders’ equity (common shares) to increase by the same amount. The second purchase made by Peter was for shares currently being traded on the Toronto Stock Exchange. These shares have already been issued by the company and are being sold by another shareholder. The purchase of the additional shares had no impact on Innova te.com’s assets, liabilities or shareholders’ equity.

6. The effect of the decline in share price will have no impact on Bombardier’s current financial statements. The value of the common shares on the financial statements is recorded at the price for which the shares were originally issued. Any subsequent change in the market price of the issued shares is not reflected in the financial statements. It will, of course, affect the proceeds received on any future share issues planned however.

7. The maximum number of shares that a corporation is legally allowed to issue is the number authorized. Letterman Corporation is authorized to sell 100,000 shares. Letterman has 53,000 shares issued (60,000 issued less 7,000 reacquired and cancelled). They are eligible to issue an additional 47,000 shares (100,000 – 53,000).

8. A corporation may reacquire its own shares (1) to have additional shares available to officers and employees under bonus and share compensation plans, (2) to increase trading of the com pany’s shares in the securities market in the hopes of enhancing its market value, (3) to have additional shares available for use in the acquisition of other companies, (4) to reduce the number of shares issued, thereby increase earnings per share, or

(5) to avoid a takeover of the company by investors that are hostile to management.





9. There is so much controversy about the recording of stock options as executive compensation because over the past several years the use of stock based compensation has increased significantly in both frequency and amount.

In the past couple of years, several public companies have found themselves in financial difficulty. This has cost shareholders millions of dollars in lost investments, while the executives running the companies have earned millions in stock-based compensation.

As a result, accounting standards are being developed which require companies to better disclose executive compensation in the form of stock options, which should improve the ability of investors to make better-informed investment decisions.

[Note to instructor: Effective January 1, 2004, stock options are expensed in Canada.]

10. The land would be recorded at $100,000

—the value of what was given up to acquire the land.

11. (a) Common shares and preferred shares both represent ownership of the corporation. Common shares signify the basic residual ownership; preferred shares signify ownership with certain privileges or preferences. Preferred shareholders typically have a preference as to dividends and as to assets in the event of liquidation.

However, preferred shareholders often do not have voting rights.

(b) Some preferred shares possess the additional feature of being cumulative. Most preferred shares are cumulative

 preferred shareholders must be paid both current year dividends and unpaid prior year dividends before common shareholders receive any dividends.

(c) Dividends in arrears are disclosed in the notes to the financial statements.

12. For a cash dividend to be paid, a corporation must have retained earnings, adequate cash, and a dividend declared by the board of directors.

13. May 1 is the date on which the board of directors formally declares (authorizes) and announces the cash dividend. May 15 is the record date, which marks the time when ownership of shares is determined for dividend purposes from the shareholders’ records. May 31 is the date when the dividend cheques are mailed to shareholders.

Accounting entries are made on May 1 (debit Cash Dividends and credit Dividends

Payable), and on May 31 (debit Dividends Payable and credit Cash). No entry is required on the record date, May 15.





14. (a) For a corporation, a cash dividend decreases cash, total assets, retained earnings, and total shareholders’ equity. A stock dividend decreases retained earnings, increases share capital, and has no effect on total assets and total shareholders’ equity. A stock split results only in an increase in the number of shares authorized and issued.

(b) A cash dividend increases cash for an individual shareholder. A stock dividend and a stock split both increase the number of shares held by an individual shareholder, however, as a result of the dividend or split, the shares’ market value often declines so that the shareholders’ total equity in the company remains unchanged. However, after the stock dividend or stock split, the shareholder does own more shares on which to earn dividend income, or for future potential profitable resale as the share prices climb.

15. A corporation generally issues stock dividends for one of the following reasons:

(1) To satisfy shareholders’ dividend expectations without distributing cash.

(2) To increase the marketability of its shares by increasing the number of shares issued and thereby decreasing the market price per share. Decreasing the market price of the shares makes the shares easier to purchase for smaller investors.

(3)

To emphasize that a portion of shareholders’ equity that had been reported as retained earnings has been permanently reinvested in the business and therefore is unavailable for cash dividends.

16. In a stock split, the number of shares issued is increased. The number of shares authorized is not affected by a stock split. Thus, in the Bella Corporation the number of shares issued will increase to 20,000 (10,000 X 2). The effect of a split on market value is generally inversely proportional to the size of the split. In this case, the market price would fall to approximately $70 per share ($140



2).

17. The debits and credits to retained earnings are:

Debits

1. Net loss

Credits

1. Net earnings

2. Cash dividends

3. Stock dividends





18. (a) The purpose of a retained earnings restriction is to indicate that a portion of retained earnings is currently unavailable for dividends.

(b) Restrictions may result from the following causes: legal, contractual, or voluntary.

19. The answers are summarized in the table below:

Account

(a) Common Shares

(b) Retained Earnings

(c) Stock Dividends Distributable

Classification

Share capital

Retained earnings

Share capital

(d) Preferred Shares Share capital

20. (a) Share and dividend transactions are reported in the financing activities section of the cash flow statement.

(b) Share transactions are reported in the share capital section of the balance sheet.

Dividend transactions indirectly affect the retained earnings section of the balance sheet, through the ending retained earnings balance.

(c) Share and dividend transactions are not reported on the statement of earnings.

21. (a) Favourable

(b) Favourable

(c) Unfavourable

(d) Favourable

22.

The return on assets and the return on common shareholders’ equity would be the same if the company were fully financed through common shareholde rs’ equity. That is, if the company has issued no debt and no preferred shares.

23.

All that changes as a result of this transaction is the composition of the company’s liabilities. Therefore there would be no effect on the debt to total assets or the c ompany’s return on common shareholders’ equity.




SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 11-1

The advantages and disadvantages of a corporation are as follows:

Advantages

Separate legal existence

Limited liability of shareholders

Ability to acquire capital

Continuous life

Organizational structure

 professional management

Deferral or reduction of taxes

Transferable ownership rights

Disadvantages

Organizational structure

 separation of ownership and management

Government regulations

Additional taxes

BRIEF EXERCISE 11-2

The drop in Nortel’s share price has no impact on its current financial position. However, it could have an impact on the company’s future financial position in that Nortel will find it more difficult to raise capital in the stock market. Investors may not be willing to invest in the company given its weak share price. As well, because the price is lower, Nortel will have to issue many more shares to raise the same amount of capital than it would have when the shares were selling for $124.50.

BRIEF EXERCISE 11-3

May 10 Cash (1,000 X $15) ............................................................

Common Shares (1,000 X $15) .................................

15,000

15,000




BRIEF EXERCISE 11-4

The assets and the common shares would have been recorded at $9.1 million, the market value of the shares given up in the acquisition.

BRIEF EXERCISE 11-5

Cash (5,000 X $110) .......................................................................... 550,000

Preferred Shares (5,000 X $110) ...............................................

BRIEF EXERCISE 11-6

550,000

Nov. 1 Cash Dividends (10,000 X $1) .....................................

Dividends Payable ................................................

10,000

Dec. 31 Dividends Payable ......................................................... 10,000

Cash......................................................................

BRIEF EXERCISE 11-7

Dec. 1 Stock Dividends ............................................................. 60,000

Stock Dividends Distributable ...............................

(100,000 x 5% X $12)

31 Stock Dividends Distributable ........................................ 60,000

Common Shares ...................................................

10,000

10,000

60,000

60,000




BRIEF EXERCISE 11-8

(1)

Shareholders’ equity

Common shares

(3) Retained earnings

Total shareholders’ equity

(2) Number of shares

Before

Dividend

$1,000,000

400,000

$1,400,000

100,000

After

Dividend

$1,090,000

310,000

$1,400,000

110,000

Stock dividend 100,000 x 10% = 10,000 X $9 = $90,000

BRIEF EXERCISE 11-9

After the reverse stock split the shareholder would own 5 shares (100 shares/20). The share price should then increase by about 20 times to $10 ($0.50 X 20). A firm generally institutes a reverse split to boost its share's market price and attract investors.

BRIEF EXERCISE 11-10

Transaction

(b) Paid cash dividend declared in (a)

(c) Declared stock dividend

(e) Stock-split three-for-one

Total

Assets

-

N/A

N/A

Total

Liabilities

-

N/A

N/A

Total

Shareholders’

Equity

-

N/A

N/A

N/A

N/A





KAPOSI CORPORATION

Balance Sheet (Partial)

December 31, 2004

Shareholders' equity

Share capital

8% preferred shares, cumulative, no par value, unlimited number of shares authorized,

800 shares issued ..........................................................

Common shares, no par value, unlimited number of shares authorized, 5,000 shares issued .....................

Total share capital ....................................................

Retained earnings .................................................................

Total shareholders' equity ............................................................

$20,000

50,000

70,000

29,000

$99,000


Return on common shareholders’ equity:

$12,321

($73,088



$90,197)



2


= 15.1%

Payout ratio

 last year =

$150,000

$600,000



25%

Dividends paid this year = $2,000,000 X 25% = $500,000 (assuming the same payout ratio)

Maintaining a constant payout ratio may be considered a sign of stability from the shareholders’ perspective. However, maintaining a constant payout ratio may have a negative impact on the company’s cash flow and its ability to grow.





Shareholders were anxious to pay increasing amounts because of their expectations of the future profitability of the company. They expected that the company would be successful in the future and wanted to buy the shares while the price was relatively low.




SOLUTIONS TO EXERCISES

EXERCISE 11-1

(a) High $32.35

Low $13.19

(b) 550,900

(c) 1,000 X $32.35 = $32,350

(d) Since this company has not paid any dividends this year but has had significant growth, the person purchasing these shares would most likely be looking for future price increases.

(e) $32.35 – $0.66 = $31.69 (closing price – net change)




EXERCISE 11-2

(a) The repurchase of the shares will have no impact on the number of shares authorized as this is set in the company’s articles of incorporation and cannot be changed without revising the company’s charter. The number of shares issued will decline because in Canada repurchased shares must be retired and cancelled. The value of the remaining shares should increase with the reduction in the number of shares, all else being equal.

(b)

Wendy’s may have repurchased its shares to:

(1) Reissue the shares to officers and employees under its stock option plan.

(2)

Increase trading of the company’s shares in the securities market in hopes of enhancing its price.

(3) Have additional shares available for use in the acquisition of other companies.

(4) Reduce the number of shares issued and thereby increase earnings per share.

(5) Reduce the possibility of a takeover of the company by investors who are hostile to management.

(c) The effect of not recording the options in the financial statements until they are exercised is that the company’s statement of earnings does not recognize all the expenses associated with compensating employees in the period. Compensation expense is understated causing net earnings and shareholders’ equity to be overstated. Depending on the specific characteristics of the stock option plan, liabilities may also be understated.

[Note to instructors: At the time of writing, stock options are expensed in Canada effective January 1, 2004, but not expected to be expensed in the US and internationally until 2005.]

EXERCISE 11-3

June 12 Cash ................................................................... 375,000

375,000 Common Shares ........................................

July 11 Cash (1,000 X $105) .......................................... 105,000

Preferred Shares (1,000 X $105) ............... 105,000

Oct. 1 Land ...................................................................

Common Shares ........................................

70,000

70,000




EXERCISE 11-4

May 2 Gain on Sale of Shares ...................................... 144,000

Common Shares ........................................

10 Preferred Shares ................................................ 600,000

144,000

Loss on Preferred Shares .......................... 600,000

EXERCISE 11-5

(a)

Apr. 1 Cash ....................................................................... 50,000

Common Shares (5,000 X $10) ..................... 50,000

June 15 Dividends(80,000 X $1) .......................................... 80,000

Dividends Payable ........................................ 80,000

July 10 Dividends Payable .................................................. 80,000

Cash............................................................... 80,000

Dec. 1 Cash ....................................................................... 36,000

Common Shares (3,000 X $12) ..................... 36,000

Dec. 15 Dividends (83,000* X $1.25) ................................... 103,750

Dividends Payable ........................................ 103,750

* 75,000 + 5,000 + 3,000 = 83,000 shares

(b) In the statement of retained earnings, dividends of $183,000 ($80,000 + $103,750) will be deducted. In the balance sheet, Dividends Payable of $103,750 will be reported as a current liability.




EXERCISE 11-6

(a) The average per share selling price of the preferred shares was $6 ($600,000



10,000 = $6).

The average per share selling price of the common shares was $3 ($1,800,000



600,000 = $3).

(b) They will be able to sell an additional 150,000 common shares (750,000 authorized -

600,000 issued).

(c) The annual dividend on the preferred shares in total is $50,000 ($5 X 10,000 shares).

(d) The retained earnings balance is still $1,158,000. Cumulative dividends in arrears are only disclosed in the notes to the financial statements.

EXERCISE 11-7

March 4 Stock Dividends ............................................ 1,846,000

Preferred Stock Dividend Distributable

(16,408,880 X 5% X $2.25)................... 1,846,000

March 28 Preferred Stock Dividend Distributable

(16,408,880 X 5% X $2.25)................... 1,846,000

Preferred Shares ................................. 1,846,000

EXERCISE 11-8

Before

Action

After

Stock

After

Stock

Dividend Split


Share capital

Retained earnings

Total shareholders’ equity

Issued shares

$ 600,000

400,000

$1,000,000

60,000

*60,000 x 10% = 6,000 x $15 = $90,000 + $600,000 = $690,000

$ 690,000* $ 600,000

310,000 400,000

$1,000,000 $1,000,000

66,000 120,000




EXERCISE 11-9

1. Dec. 31 Cash Dividend ................................................

Interest Expense ....................................

2. 31 Stock Dividend ...............................................

Dividends Payable .......................................

Common Stock Dividends Distributable

Retained Earnings .................................

3.

Retained Earnings .................................

25,000

17,000

10,000

31 Common Shares ............................................ 2,000,000

25,000

17,000

10,000

2,000,000




EXERCISE 11-10

1. Cash

Account

Shareholders’ Equity

Share Capital

Retained

Earnings

Financial

Statement

Balance

Sheet

Other

Classification

Current Asset

2. Common Shares

3. Gain on Sale of

Property, Plant and

Equipment

4. Patents

Common

Shares

5. Preferred Shares Preferred

Shares

6. Retained Earnings

7. Organization Costs

8. Dividends

9.Stock Dividends

Distributable

Share Capital

Retained

Earnings

Retained

Earnings

Statement of

Earnings

Other Revenue

Balance

Sheet

Intangible Assets

Statement of

Earnings

Administrative

Expense




EXERCISE 11-11

OZABAL INC.


December 31, 2004


Share capital

$8 preferred shares, no par value,

40,000 shares authorized, 30,000 shares issued ....

Common shares, no par value,

unlimited number of common shares authorized,

300,000 shares issued .............................................

Common stock dividends distributable .......................

Total share capital ..............................................

Retained earnings (Note R) ................................................

Total shareholders’ equity ..................................

Note R: Retained earnings restricted for plant expansion, $100,000.

$300,000

$ 150,000

75,000 375,000

525,000

900,000

$1,425,000




EXERCISE 11-12

INTRAWEST CORPORATION

Statement of Retained Earnings

Year Ended June 30, 2002

(U.S. thousands)

Retained earnings, July 1, 2001 ..................................................

Add: Net earnings ........................................................................

Less: Dividends ...........................................................................

Retained earnings, June 30, 2002 ...............................................

INTRAWEST CORPORATION


June 30, 2002

(thousands)


Share capital

NRP common shares, no par value,

50,000,000 shares authorized,

5,163,436 shares issued ..........................................

Common shares, unlimited number without par

value authorized, 47,255,062 shares issued ..........

Total share capital ..............................................

Retained earnings ..........................................................

Total shareholders’ equity ..........................................................

$187,922

58,480

246,402

4,737

$241,665

$ 13,600

453,299

466,899

241,665

$708,564




EXERCISE 11-13

Payout ratio

Return on common shareholders’ equity

2002

$577

$653



88 .

4 %

$653

($2,868





$161

$2,827)



2



17.3%

2001

$536

$1,686



31.8%

$1,686

($2,827





$121

$2,868)



2



55.0%

Although the company’s earnings declined significantly in 2002, CIBC continued to pay out relatively the same dollar amount of dividends, which caused the dividend payout ratio to increase significantly. However, the return on common shareholders’ equity declined significantly due to the large decline in earnings.

EXERCISE 11-14

(a) Return on common shareholders’ equity

2004

$250,000

$1,100,000



22.7%

2003

$200,000

$700,000



28.6%

(b) The return on common shareholders’ equity decreased even though net earnings increased because the proportionate increase in average common shareholders’ equity is greater than the increase in net earnings.

(c) Debt to total assets $100,000

$1,200,000



8.3%

$500,000

$1,200,000



41.7%

The decrease in the debt to total assets ratio from 41.7% in 2003 to 8.3% in 2004 indicates that the company’s solvency has significantly improved. The company has much less debt financing which decreases the risk that the company would be unable to pay its debts as they become due.




SOLUTIONS TO PROBLEMS

PROBLEM 11-1A

(a) Jan. 10 Cash (80,000 X $3) .............................

Common Shares ..........................

Mar. 1 Cash (5,000 X $102) ...........................

Preferred Shares ..........................

May 1 Cash (80,000 X $4) .............................

Common Shares ..........................

Aug. 2 Equipment (5,000 X $5) .......................

Common Shares ..........................

Sept. 1 Cash (10,000 X $6) .............................

Common Shares ..........................

Nov. 1 Cash (2,000 X $105) ...........................


(b)

Preferred Shares

Mar. 1 510,000

Nov. 1 210,000

Dec. 31 Bal. 720,000

Common Shares

Jan. 10 240,000

May 1 320,000

Aug. 2 25,000

Sept. 1 60,000

Dec. 31 Bal. 645,000

240,000

240,000

510,000

510,000

320,000

320,000

25,000

25,000

60,000

60,000

210,000

210,000




PROBLEM 11-1A (Continued)

(c) WETLAND CORPORATION


December 31, 2004


Share capital

$8 preferred shares, no par value, unlimited number of shares authorized,

7,000 shares issued ................................ $ 720,000

Common shares, no par value, unlimited number of shares authorized,

175,000 shares issued ............................ 645,000

Total share capital ................................................. $1,365,000

(d) Wetland may have chosen to finance with equity rather than debt because they are a new company and may not want to have to make regular interest payments. They may not have been able to obtain debt financing or may have faced a high interest rate.




PROBLEM 11-2A

( a) 1. Cash .............................................................. 150,000

150,000 Preferred Shares (1,200 shares) .............

2. Cash .............................................................. 1,000,000

Common Shares (200,000 shares) ......... 1,000,000

3. Land ...............................................................

Common Shares (5,000 shares) .............

30,000

30,000

4. Cash Dividends - Preferred ............................

Cash (1200 shares X $10) ......................

Retained Earnings ..................................

12,000

12,000

5. Income Summary ........................................... 712,000

712,000

6. Retained Earnings ..........................................

Cash Dividends, Preferred ......................

12,000

12,000

(b)


CATTRALL CORPORATION


December 31, 2004

Share capital

$10 preferred shares, no par value, noncumulative, unlimited number

of shares authorized, 1,200 shares issued ..... $ 150,000

Common shares, unlimited number of no par value shares authorized, 205,000 shares issued ............................................................ 1,030,000

Total share capital ................................................. 1,180,000

Retained earnings ........................................................ 700,000

Total shareholders’ equity ..................................... $1,880,000




PROBLEM 11-3A

(a) Feb. 1 Cash ....................................................

Common Shares (15,000 shares)

June 1 Cash Dividends – Common Shares

(495,000 X $0.30) ...............................

Dividends Payable .......................

June 30 Dividends Payable ...............................

Cash.............................................

Nov. 15 Cash Dividend – Preferred Shares

(4,000 X $10)......................................

Dividends Payable .......................

Dec. 15 Dividends Payable ...............................

Cash.............................................

90,000

90,000

148,500

148,500

148,500

148,500

40,000

40,000

40,000

40,000

31 Income Summary ................................

Retained Earnings ........................

31 Retained Earnings ...............................

Cash Dividends – Preferred Shares

Cash Dividends – Common Shares

408,000

408,000

188,500

40,000

148,500





(b)

Preferred Shares

Jan. 1 Bal. 480,000

Dec. 31 480,000

Retained Earnings

Jan.1 Bal.1,756,000

Dec.31 188,500 Dec. 31 408,000

Dec. 31 1,975,500

Common Shares

Jan. 1 Bal. 2,400,000

Feb.1 90,000

Dec. 31 2,490,000

(c)


Share capital

CAPOZZA CORPORATION


December 31, 2004

Preferred shares ($12, no par value, cumulative, unlimited number of shares authorized,

4,000 shares issued) (Note X).......................... $ 480,000

Common shares (no par value, unlimited number of shares authorized, 495,000 shares, issued) ..... 2,490,000

Total share capital .................................... 2,970,000

Retained earnings ................................................... 1,975,500

Total shareholders’ equity .............................................. $4,945,500

Note X:

At December 31, 2004 the company had preferred share dividends in arrears of $8,000 ($2 X 4,000 shares).





(d) Dividend payout ratio =

$188,500

$408,000

= 46.2%

$408,000 $40,000

(480,000 + 495,000) ÷ 2

= $0.75

Earnings per share =

Price-earnings ratio =

$9

= 12 times

$0.75

Return on common shareholders’ equity ratio=

$408,000 $40,000

($4,156,00 0 a 

$ 4,465,000 b

)



2



8 .54% a $2,400,000 + $1,756,000 = $4,156,000 b $2,490,000 + $1,975,500 = $4,465,500




PROBLEM 11-4A

Under the prior method of accounting for stock based compensation, the intrinsic method of valuation gave rise to very little compensation expense being reported in the financial statements. By adopting the new standards set out by the CICA,

Dofasco will be reporting a much higher amount of compensation expense on its statement of earnings. The company will therefore have a lower net earnings and weaker profitability ratios.

However, financial statement users will be now more informed as to the true financial performance of the company and will be able to make better decisions as a result of having more accurate financial information.




PROBLEM 11-5A

Date

July 1, 2004

(a)

Retained

Earnings

(b)

Shares

Issued

(c)

Mark's

Shares

$350,000 100,000 25,000

(d)

Share Price

$25.00

1. Aug. 31, 2004 238,000 104,000 26,000 28.00

2. Dec.1, 2004

3. March 31, 2005:

238,000 124,000 31,000 30.00

238,000 124,000 31,000 26.00 pre-split

March 31, 2005: post-split

4. June 30, 2005

238,000 248,000 62,000

238,000 248,000 62,000

13.00

10.50

(e)

Value of

Mark's Shares

$625,000

728,000

930,000

806,000

806,000

651,000




(a)

PROBLEM 11-6A

Retained Earnings

Oct. 1 Cash Dividend

Dec. 31 Stock Dividend

240,000 1 Jan. 1 Balance

400,000 2 Dec. 31 Net Earnings

980,000

418,600

Dec. 31 Balance 758,600

(b)


December 31, 2004

Shar eholders’ equity

MAGGIO CORPORATION

Share capital

Preferred shares ($10, no par value, cumulative, an unlimited number of shares authorized, 12,000 shares issued) . $ 850,000

Common shares (no par value, an

unlimited number of shares authorized,

250,000 shares issued) ............................ $3,200,000

Common stock dividends distributable

(20,000 shares) ......................................... 400,000 3,600,000

Total share capital ................................. 4,450,000

Retained earnings (Note X) .................................

Total shareholders’ equity ..........................................

758,600

$5,208,600

Note X: Retained earnings restricted for plant expansion, $200,000.

1 12,000 X $10 = $120,000 (2003 dividend) + $120,000 (2004 dividend).

2 250,000 X 8% = 20,000 X $20 = $400,000




PROBLEM 11-7A

(a) Feb. 1 Cash Dividends (60,000 X $0.50) ........

Dividends Payable ........................

30,000

30,000

Mar. 1 Dividends Payable ...............................

Cash .............................................

July 1 Stock Dividends (3,000* X $28) ...........

Common Stock Dividends

Distributable ..............................

*60,000 shares X 5% = 3,000

30,000

84,000

30,000

84,000

31 Common Stock Dividends Distributable

Common Shares ...........................

84,000

84,000

Dec. 1 Cash Dividends (63,000 X $1) .............


31 Income Summary .................................


63,000

410,000

63,000

410,000

31 Retained Earnings ............................... 177,000

Cash Dividends ............................ 93,000

Stock Dividends ............................ 84,000





(b)

Common Shares Retained Earnings

Jan 1 Bal. 1,400,000 Jan. 1 Bal. 600,000

July 31 84,000 Dec. 31 177,000 Dec. 31 410,000

Dec. 31 Bal. 1,424,000

Common Stock

Dividends Distributable

Jul. 31 84,000 July 1 84,000

Dec. 31 Bal. 0

Dec. 31 Bal. 833,000

(c) STENGEL CORPORATION


December 31, 2004


Common shares, no par value, unlimited number of shares authorized, 63,000 shares issued .......

Retained earnings .................................................

Total shareholders’ equity ..............................

$1,484,000

833,000

$2,317,000



Kimmel, Weygandt, Kieso, Trenholm


Financial Accounting, Second Canadian Edition

(d)

Dividend payout ratio =

($30,000 + $63,000)

= 22.68%

$410,000


$410,000

(60,000 + 63,000) ÷ 2

= $6.67


$35

$6.67



5.25

times

Return on common shareho lders’ equity ratio =

* $1,400,000 + $600,000

** From req. (c)

($2,000,00 0

$410,000

*



$2,317,000 * *)



2



19.0%




(a)

PROBLEM 11-8A


SCHIPPER LTD.


December 31, 2004

Share capital

Preferred shares ($4.50, no par value,

noncumulative, 100,000 shares issued ........ $2,600,000


1,000,000 shares issued .............................. 1,000,000

Total share capital ................................... 3,600,000

Retained earnings ................................................. 1,650,000*

Total shareholders’ equity ............................... $5,250,000

*$700,000 + $2,400,000



$1,000,000



$450,000 = $1,650,000

(b)

SCHIPPER LTD.

Cash Flow Statement (Partial)

Year Ended December 31, 2004

Financing activities

Proceeds from issue of preferred shares ............... $2,600,000

Dividends – common ............................................. (1,000,000)

Dividends – preferred ............................................ (450,000)

Cash provided by financing activities ..................... $1,150,000




PROBLEM 11-9A

(a) Molson’s dividend policy appears to be to maintain a constant dividend regardless of earnings. Because the dividend does not fluctuate with earnings the company has had some significant variation in its payout ratio. However, if the company does not expect their earnings to vary significantly (as it did in 2000) then keeping a constant dividend will keep shareholders happy and will ensure the payout ratio stays relatively constant.

(b) Investors who rely on th e company’s dividends to supplement their income would be happy with Molson’s dividend policy because the dividend remains constant and can be relied upon as a source of income.

(c) As a creditor I might be concerned that, if the company is losing money and maintaining a constant dividend, there may not be sufficient cash available to meet the interest and principal payments on the debt owed by the company.




(a) ($ in millions)


PROBLEM 11-10A

Ratio

Payout ratio

Earnings per share

Price-earnings ratio


2002

$174



$21



45.45%

$429

$429 $21



186.6

$2.19

$29.39



13.42

times

$2.19

$429 $21



11.30%

$3,612

2001

$156



$ 35



33.93%

$563

$563 $35



$2.78

189.9

$24.25



8.72

times

$2.78

$563



$35



15.17%

$3,480

(b) During the year the profitability of the National Bank of Canada decreased.

This is apparent from the lower net earnings, which caused the earnings per share to decline. This decrease in net earnings also lead to a decrease in the return provided to common shareholders as evidenced by the decline in the return on common shareholders’ equity from 15.17% in 2001 to 11.30% in 2002. The company’s payout ratio increased from 33.93% to 45.45% primarily because the company’s net earnings fell when the amount of cash dividends paid to the preferred and common shareholders in total remained relatively unchanged.

Although the company’s profitability has decline in 2002 it is still performing better than most other companies in the industry. The earnings per share is higher than the average firm as is the return on common shareholders’ equity. However, investors do not seem to have as much confidence in the National Bank as indicated by it price-earnings ratio of 13.42 times compared to the industry average of 23.2 times.




PROBLEM 11-11A

(a) Bargain Hunters seems to be the more profitable of the two companies. Its profit margin of 3.8% is slightly higher than Discount Paradise (3.3%) and of the average firm in the industry (2.9%). Bargain Hunters is providing a higher return to its shareholders and turning its assets over more quickly than both Discount Paradise and the industry. Investors seem to have more confidence in the earnings of Bargain Hunters as evidenced by the companies price-earnings ratio of 26.6 times versus 14.8 times for Discount Paradise.

(b) Discount Paradise would probably be the better investment for someone interested in generating a regular income from his or her investment. As indicated by a comparison of Discount Paradise’s ratios to those for the industry, the higher profit margin and return on common shareholders’ equity show that the company performing as well as, or better than most other companies in the industr y. As well, Discount Paradise’s higher payout (23.3% versus

16.6% for Bargain Hunters) indicates that this company has a policy of paying out a much more significant amount of earnings as dividends which is good for an investor who needs a regular income from their investment.

(c) From part (a) we learned that Bargain Hunters is more profitable than both

Discount Paradise and the average company in the industry. However, the company is only paying out 16.6% of its earnings as dividends. This is lower than the amount being paid by Discount Paradise and the average for the industry as a whole. Assuming that Bargain Hunters is reinvesting its earnings in the business rather than paying them out as dividends, the company should have faster growth and its share price should be experiencing more growth in share value. Therefore, an investor interested in experiencing a return in the form of future capital gains would have a better chance of attaining those gains by investing in Bargain Hunters.




(a)

Ratio

Return on assets


PROBLEM 11-12A

2004

$850,000

$5,312,500



16.00%

2003

$1,000,000

$6,250,000



16.00%


Dividend payout

$850,000

$3,312,500



25.66%

$1,000,000

$5,250,000



19.05%

$340,000

$850,000



40.00%

$400,000

$1,000,000



40.00%

Debt to total assets

$2,000,000

$5,000,000



40%

$1,000,000

$5,625,000



17.78%

Times interest earned

$850,000



$ 125,000



$ 100,000

$125,000

$1,000,000



$ 50,000



$ 142,000

$50,000



8.6



23.84

(b) Jiye Corporation’s net earnings decreased $150,000 in 2004 even though its sales remained constant. However, much of this decline was due to the higher interest expense the company incurred as a result of its decision to issue the new debt. Its return on assets of 16% did not change from 2003 to

2004. Its dividend payout also remained unchanged at 40%. Its return on common shareholders’ equity increased almost 35% from 2003 to 2004. An increase of this size indicates improved profitability.

(c) Jiye Corporation acquired more debt in 2004 and became less solvent. Its debt to total assets increased from 17.78% to 40%. In 2003, Jiye’s times interest earned ratio was 23.84 times compared to 8.6 times in 2004. It is clear that Jiye is less solvent in 2004 than 2003.





(d) It appears that the decision to issue bonds and repurchase the common shares was a wise choice. The bonds require payment of 7% interest that is less than Jiye’s 16% return on assets. This positive difference resulted in the significant improvement in return on common shareholders’ equity.

Jiye is less solvent in 2004 than 2003 but it does not appear to have trouble covering its interest payments.




PROBLEM 11-1B

(a) Jan. 10 Cash (100,000 X $3) ............................

Common Shares ...........................

Mar. 1 Cash (12,000 X $52) ............................


May 1 Cash (70,000 X $5) ..............................

Common Shares ...........................

Sept. 1 Cash (5,000 X $6) ................................

Common Shares ...........................

Nov. 1 Cash (2,000 X $63) ..............................


Dec. 12 Patent (400 X $60) ...............................


(b)

Preferred Shares

Mar. 1 624,000

Nov. 1 126,000

Dec. 12 24,000

Dec. 31 Bal. 774,000

Common Shares

Jan. 10 300,000

May 1 350,000

Sept. 1 30,000

Dec. 31 Bal. 680,000

300,000

624,000

350,000

30,000

126,000

24,000

300,000

624,000

350,000

30,000

126,000

24,000




PROBLEM 11-1B (Continued)

(c) REMMERS CORPORATION


December 31, 2004


Share capital

$3 Preferred shares, no par value, noncumulative

200,000 shares authorized, 14,400 shares issued .......................................... $ 774,000

Common shares, no par value, unlimited number of shares authorized, 175,000 shares issued . 680,000

Total share capital ........................................................ $1,454,000

(d) Remmers may have chosen to finance with equity rather than debt because they are a new company and may not want to have to make regular interest payments. They may not have been able to obtain debt financing or may have faced a high interest rate.




PROBLEM 11-2B

(a) 1. Cash ............................................................... 150,000

150,000 Preferred Shares (1,000 shares) .............

2. Cash ............................................................... 3,850,000

Common Shares (400,000 shares) .......... 3,850,000

3. Building .......................................................... 100,000

100,000 Common Shares (10,000 shares) ............

4. Cash Dividend –Preferred Shares ...................

Cash (1,000 X $8) ...................................

8,000

8,000

5. Income Summary ........................................... 582,000

Retained Earnings ................................... 582,000

6. Retained Earnings ..........................................

Cash Dividends –Preferred Shares ..........

8,000

8,000





(b)


LARGENT CORPORATION


December 31, 2004

Share capital

$8 Preferred shares, no par value, cumulative,

200,000 shares authorized, 1,000 shares issued..... $ 150,000

Common shares, unlimited number of no par value shares authorized, 410,000 shares issued ............. 3,950,000

Total share capital .......................................... 4,100,000

Retained earnings* .......................................................... 574,000

Total shareholders’ equity .................................................... $4,674,000

* $582,000 - $8,000




PROBLEM 11-3B

(a) Feb. 1 Cash ....................................................

Common Shares (3,000 shares) ...

Oct. 1 Preferred Cash Dividends (3,000 X $5)


Nov. 1 Dividends Payable ...............................

Cash .............................................

18,000

15,000

15,000

18,000

15,000

15,000

Dec. 1 Common Cash Dividends

([200,000 + 3,000] X $0.50) ..............


31 Income Summary .................................


31 Dividends Payable ...............................

Cash .............................................

31 Retained Earnings ...............................

Preferred Cash Dividends .............

Common Cash Dividends .............

101,500

101,500

280,000

280,000

101,500

101,500

116,500

15,000

101,500






(b)

Preferred Shares

Jan 1. Bal. 320,000

Dec. 31 Bal. 320,000

Common Shares

Jan. 1 Bal. 1,425,000

Feb. 1 18,000

Dec. 31 Bal. 1,443,000

Retained Earnings

Jan. 1 Bal. 488,000

Dec. 31 116,500 Dec. 31 280,000

Dec. 31 Bal. 651,500

(c)

CHUNG CORPORATION


December 31, 2004


Share capital

Preferred shares ($10, no par value, noncumulative

25,000 shares authorized, 3,000 shares issued)

Common shares (unlimited number authorized,

$ 320,000 no par value, 203,000 shares issued) ................. 1,443,000

Total share capital ...................................... 1,763,000

Retained earnings ....................................................... 651,500

Total shareholders’ equity ................................................ $2,414,500

Note that because the preferred shares are not cumulative, there are no dividends in arrears.






(d)

Dividend payout ratio=

$116,500

$280,000

= 41.61%


$280,000 $15,000

(200,000 + 203,000) ÷ 2

= $1.32

Price-earnings ratio=

$10

$1.32



7.58

times

Return on common shareholders’ equity ratio = a b

$280,000

($1,913,00 0 a

+

Ending common shareholders’ equity:

$15,000

$2,094,500 b

) ÷ 2

Beginning common shareholders’ equity:

$1,425,000 + $488,000 = $1,913,000

$1,443,000 + $651,500 = $2,094,500

= 13.23%




PROBLEM 11-4B

(a) Under the prior method of accounting for stock based compensation, the intrinsic method of valuation gave rise to very little compensation expense being reported in the financial statements. By adopting the new standards set out by the CICA, Canadian Tire will not be disclosing the compensation expense on its statement of earnings but will be preparing proforma statements to illustrate to shareholders the effect on earnings had the compensation expense been recognized in the financial statements. The proforma statements will therefore reflect lower net earnings and weaker profitability ratios.

As a result of Canadian Tire adopting the new standards, financial statement users will be now more informed as to the true financial performance of the company and will be able to make better decisions as a result of having more accurate financial information.

(b) The impact of the repurchase of the shares would be to decrease the number of shares issued as the repurchased shares must be retired and cancelled. The number of shares authorized remains unchanged as this is set out in the company’s articles of incorporation. The repurchase should have no effect on the company’s statement of earnings, as transactions in the company’s own shares is not considered to be an operating activity. Any gains or losses on the repurchase are reflected directly on the shareholders’ equity section of the balance sheet.




(a)


PROBLEM 11-5B

Assets

Liabilities

Common

Shares

Retained

Earnings

Cash Dividend

$13,500,000 -

$800,000 a =

$12,700,000

No effect

$1,500,000

No effect

$2,000,000

$10,000,000 -

$800,000 =

$9,200,000

$12,000,000 -

$800,000 =

$11,200,000

No effect

400,000

Stock Dividend

No effect

$13,500,000

No effect

$1,500,000

$ 2,000,000 + $800,000 b =

$ 2,800,000

$10,000,000 - $800,000 =

$9,200,000

Stock Split

No effect

$13,500,000

No effect

$1,500,000

No effect

$2,000,000

No effect

$10,000,000

Total Shareholders’ Equity

Number of shares

No effect

$12,000,000 + $800,000 -

$800,000 = $12,000,000

20,000 increase

20,000 + 400,000 =

No effect

$12,000,000

400,000 increase

400,000 + 400,000

420,000 a b

400,000 X $2 = $800,000

400,000 X 5% = 20,000 x $40 = $800,000

(b) Cash dividend

Cash dividend 1,000 X $2 = $2,000

Market value of shares 1,000 X $40 = $40,000

Stock Dividend

Stock dividend 1,000 x 5% = 50 new shares

= 800,000


Stock Split


The alternative that is most beneficial for each shareholder will depend on the individual preferences of the shareholder. For example, if a shareholder needs cash, they will prefer the cash dividend. If they prefer additional shares for future profitable resale, they will prefer the stock split. If they wish to take advantage of income tax deferral, they may prefer the stock dividend .




(a)


PROBLEM 11-6B

Retained Earnings

Nov. 1 Cash Dividend

Dec. 31 Stock Dividend**

100,000 Jan. 1 Balance

147,000 Dec. 31

2,980,000

880,000 ..................................

Dec. 31 Balance 3,613,000

*420,000 x 5% = 21,000 x $7 = $147,000

(b) ROBICHAUD CORPORATION


December 31, 2004


Share capital

Preferred shares ($10, no par, noncumulative, redeemable at $125, unlimited number of shares authorized,

10,000 shares issued) ................................

Common shares (no par value, unlimited number of shares authorized,

420,000 shares issued ............................... $3,700,000

$1,000,000

Common stock dividends distributable .......... 147,000 3,847,000

Total share capital ...................................... 4,847,000

Retained earnings (See Note A) ........................

Total shareholders’ equity ...................

3,613,000

$8,460,000

Note A: Retained earnings restricted for plant expansion, $100,000.




PROBLEM 11-7B

(a) Jan. 15 Cash Dividends (80,000 X $0.60) ........


48,000

48,000

Feb. 15 Dividends Payable ...............................

Cash .............................................

48,000

48,000

Apr. 15 Stock Dividends (8,000 X $20)............. 160,000

Common Stock Dividends

Distributable...............................

May 15 Common Stock Dividends Distributable 160,000

Common Shares (8,000 X $20) ....

160,000

160,000

Dec. 1 Cash Dividends (88,000 X $0.75) ........


31 Income Summary .................................


66,000

370,000

66,000

370,000

31 Retained Earnings ............................... 274,000

Cash Dividends ............................

Stock Dividends ............................

114,000

160,000





(b)


Common Shares

Jan. 1 Bal. 1,000,000

May 15

Retained Earnings

Jan. 1 Bal.

160,000 Dec. 31 240,000 Dec. 31

540,000

370,000

636,000 Dec. 31 1,160,000

Common Stock

Dividends Distributable

Dec. 31

May 15 160,000 Apr. 15 160,000

Dec. 31 0

(c) WIRTH CORPORATION


December 31, 2004


Common shares (no par value, unlimited number of shares authorized, 88,000 shares issued) ......... $1,160,000

Retained earnings ........................................................ 636,000

Total shareholders’ equity ............................................. $1,796,000






(d)

Payout ratio =


$114,000

$370,000

= 30.81%

$370,000

(80,000 + 88,000) ÷ 2

= $4.40


$25

$4.40

= 5.68

times

Return on common shareholders’ equity ratio =

($1,540,00 0

$370,000

* + $1,796,000 * *) ÷ 2

= 22.18%

* $1,000,000 + $540,000 = $1,540,000

** From req. (c)




PROBLEM 11-8B

CONWAY LTD.


December 31, 2004


Share capital

Preferred shares ($8, no par value,

noncumulative, 100,000 shares issued ........ $11,000,000


1,500,000 shares issued .............................. 16,500,000

Total share capital ................................... 27,500,000

Retained earnings ................................................. 2,200,000*

Total share holders’ equity ....................... $29,700,000

*$900,000 + $3,600,000 - $1,500,000 - $800,000 = $2,200,000

CONWAY LTD.

Cash Flow Statement (Partial)

Year Ended December 31, 2004

Financing activities

Proceeds from issue of preferred shares ............... $11,000,000

Dividends – common ............................................. (1,500,000)

Dividends – preferred ............................................ (800,000)

Cash provided by financing activities ..................... $ 8,700,000




PROBLEM 11-9B

(a) Bombardier Inc.’s dividend policy seems to be to increase amount of dividends per share each year. Up to 2001, this resulted in a fairly constant payout ratio of around 20%, which would indicate that earnings seemed to be growing at a rate fairly constant with the growth in dividends.

(b) Bombardier’s dividend payout ratio may have jumped to 66.7% in 2002 because the company’s earnings did not increase as much as the dividend. If earnings were lower (or remained close to the same) and the company paid out a higher dividend then this would cause the dividend payout ratio to increase.

(c) As an investor seeking dividend income the investor should be happy with Bombar dier’s dividend policy because the company seems to be consistently increasing the size of its annual dividend. This would mean more money for the investor.




(a) ($ in millions)


PROBLEM 11-10B

Ratio

Payout ratio

Earnings per share


2002

$170



$6



30.82%

$571

$571



199

$2.87

$65.27



22.74

times

$2.87

2001

$150



$ 12



22.28%

$727

$727



$3.73

195

$76.70



20.56

times

$3.73


$571



$6



8.7%

$6,494

$727



$12



11.9%

$6,000 amount of cash dividends paid to the preferred and common shareholders increased slightly.

Although the company’s profitability has declined in 2002 it is still performing better than most other companies in the industry. The earnings per share is higher than the avera ge firm and the return on common shareholders’ equity is almost exactly the same as the industry average. However, investors do seem to have more confidence in the earnings of CN as indicated by it price earnings ratio of 22.74 times compared to the industry average of 14.4 times.

(b) During the year the profitability of the Canadian National Railway Company decreased. This is apparent from the lower net earnings, which caused the earnings per share to decline. This decrease in net earnings also led to a decrease in the return provided to common shareholders as evidenced by the decline in the return on common sharehold ers’ equity from 11.9% in

2001 to 8.7% in 2002. The company’s payout ratio increased from 22.28% to 30.82% primarily because the company’s net earnings fell when the




PROBLEM 11-11B

(a) World Oil seems to be the more profitable of the two companies. Its profit margin of 14.5% is significantly higher than PetroBoost’s (7.9%) and of the average firm in the industry (8.5%). World Oil is providing a much higher return to its shareholders and turning its assets over more quickly than both

Petro-Boost and the industry. Investors seem to have more confidence in the earnings of World Oil as evidenced by the companies price-earnings ratio of

26.8 times versus 14.2 for Petro-Boost and 23.5 times for the average firm in the industry.

(b) Petro-Boost would probably be the better investment for someone interested in generating a regular income from his or her investment. As indicated by a comparison of Petro-B oost’s ratios to those for the industry, the profit margin and return on common shareholders’ equity show that the company is performing as well as, or better than most other companies in the industry. As well, PetroBoost’s significantly higher payout ratio (65.3% versus 14.8% for

World Oil) indicates that this company has a policy of paying out a much more significant amount of earnings as dividends which is good for an investor who needs a regular income from their investment.

(c) From part (a) we learned that World Oil is more profitable than both Petro-

Boost and the average company in the industry. However, the company is only paying out 14.8% of its earnings as dividends. This is much lower than the amount being paid by Petro-Boost and the average for the industry as a whole. Assuming that World Oil is reinvesting its earnings in the business rather than paying them out as dividends, the company should have faster growth and its share price should be experiencing higher growth in share value. Therefore, an investor interested in experiencing a return in the form of future capital gains would have a better chance of attaining those gains by investing in World Oil.




(a)

Ratio

Return on assets


PROBLEM 11-12B

2004

$2,550,000

$14,937,50 0



17.07%

2003

$3,000,000

$17,647,00 0



17.00%


Dividend payout

$2,550,000

$9,400,000



27.13%

$3,000,000

$14,100,00 0



21.28%

$1,020,000

$2,550,000



40.00%

$1,200,000

$3,000,000



40.00%


$6,000,000

$14,500,00 0



41.38%

$3,000,000

$16,875,00 0



17.78%

Times interest earned $2,550,000



$ 400,000



$ 700,000

$400,000

$3,000,000



$ 150,000



$ 826,000

$150,000



9.13



26.51

(b) Extralite’s net earnings declined from $3,000,000 to $2,550,000. However, the decline in earnings can be mostly attributed to the increased interest expense that the company is incurring as a result of the bond issue. Its return on assets ratio increased slightly, but its return on common shareholders’ equity ratio increased to 27%. Based on these measures it appears profitability improved.

(c) Extr alite’s debt to total assets ratio increased from 17.78% to 41.38% and its times interest earned ratio decreased from 26.51 to 9.13 times. These changes indicate that Extralite is less solvent in 2004 than 2003.





(d) It appears that the decision to issue debt to purchase common stock was wise. Extralite’s 8% interest rate was less than its return on assets of 17%.

This resulted in the increase in return on common shareholders’ equity. Although the solvency ratios declined, Extralite does not appear to be in trouble covering the extra debt. As indicated by the strong times interest earned ratio of 9.13, the company appears to be generating sufficient income to meet its interest obligations.




BYP 11-1 FINANCIAL REPORTING PROBLEM

(a) An unlimited number of common shares are authorized. The number of common shares issued at the end of 2002 was 276,018,714 and at the end of 2001 was 276,252,714.

(b) Loblaw repurchased 309,000 shares in 2002 at a cost of $17 million and 12,600 in 2001 at a cost of $1 million.

(c) The company paid out $127 million in dividends in 2002 and $110 in 2001.

(d) Loblaws accounts for its stock options under the new standards proposed by the CICA on stock based compensation and other stock-based payments. The company recognizes in operating income a compensation cost related to employee stock option grants which is accounted for using the intrinsic value method.

(e)

2002 2001

Payout ratio

$127

$728



17.45%

$110

$563



19.54%


$728

($4,124



$3,569



2)



18.93%

$563

($3,569



$3,124)



2



16.82%




BYP 11-2 COMPARATIVE ANALYSIS PROBLEM

Loblaw Sobeys (a)

Return on common shareholders’ equity

$728

($4,124



$3,569)



2



18.93%

$179.0

($1,436.8



$1,283.3)



2



13.16%


Return on assets

$6,986

$11,110



62.88%

$728

($11,110



$10,025)



2



6.89%

$1,755.7

$3,192.5



54.99%

($3,192.5

$179.0



$2,875.2)



5 .

90 %



2

(b) Loblaw has a higher debt to total asset ratio, therefore it relies more on debt to boost its return to common shareholders.

(c) Both companies seem to be very healthy. Both companies are generating a reasonable return on the assets invested in the business and both companies are offering shareholders a strong return on their investment.




BYP 11-3 RESEARCH CASE

(a) Tech companies do not usually pay dividends because these companies usually have good reinvestment opportunities. They use the money that would have been paid in dividends to take advantage of these opportunities and to ensure strong growth in the future.

(b) The only disadvantage that could be faced by a firm that does pay out dividends is that it may not have sufficient funds available to take advantage of opportunities for growth as they arise.

(c) By expensing research and development costs, the assets on the balance sheet do not grow, profits are lower which in turn causes reported shareholders’ equity to stay lower.

The lower shareholders’ equity leads to a higher return on common shareholders’ equity.

(d) Currently this practice does not affect the net earnings, however, this is expected to change as new accounting standards have recently been adopted which require companies to recognize the cost of most stock based compensation in the statement of earnings.




BYP 11-4 INTERPRETING FINANCIAL STATEMENTS

(a) Management might repurchase and cancel shares because it feels that its share price is too low. It may believe that by purchasing shares it is signalling to the market that it believes the price is too low. Management might also use excess cash to purchase shares to ward off a hostile takeover. Management might purchase shares in an effort to change its capital structure. If it purchased shares and issued debt (or at least does not retire debt), it will increase the percentage of debt in its capital structure. Finally, management might repurchase shares to achieve earnings per share goals.

(b) Earnings per share

2002

$58,602

44,206



$1.33

2001

$63,529

43,665



$1.45

$58,602 $63,529


Return on assets

$609,037



9.62%

$58,602

$2,061,615



2.84%

$523,876



12.13%

$63,529

$1,836,834



3.46%

The company’s profitability has declined during the year as evidenced by the lower earnings per share and the decline in the return on common shareholders’ equity and return on assets.

(c)

Payout ratio

2002

$4,737

$58,602



8.08%

2001

$4,618

$63,529



7.27%

The company paid out a slightly higher percentage of its earnings as dividends in

2002. Even though earnings dropped, the amount of dividends paid increased slightly. It appears that the company’s dividend policy may be to maintain or slightly increase its dividend annually.




BYP 11-4 (Continued)

(d)

$1,489,648

$2,166,917



68.75% Debt to total assets

Times interest earned

$58,602



$ 43,072



$ 9,549

$43,072



2.58

times


$1,387,950

$1,956,312



70.95%

$63,529



$ 44,490



$ 10,014

$44,490



2.65

times

Cash total debt coverage

$5,706

$1,438,799



0 .39%

$(47,645)

$1,297,017



(3.67%)

Intrawest’s solvency position seems to have improved slightly in 2002. The company’s debt to total asset ratio declined slightly in 2002 and the company had a positive cash total debt coverage ratio in the current year. The times interest earned ratio declined only slightly during the year.

(e)

The increased reliance on debt did not appear to help Intrawest’s return on shareholders’ equity. As can be seen in part (b), the return on shareholders’ equity actually declined during the year. This decline is likely due to the fact that the cost of the additional debt of ap proximately 3% ($43,072÷ $1,438,799) is greater than the return on assets of 2.84%.

The extra cost of the financing not being covered by the return on the assets must be borne by the common shareholders.




BYP 11-5 A GLOBAL FOCUS

(in £ million, except share numbers)

Payout ratio

Earnings per share


Return on common shareholders’ equity ratio

2002

11.4



211.11%

5.4

5.4

195.0



0 .03

0.965



32.17

times

0.03

5.4

122.9



4.39%

2001

10.9



114.74%

9.5

9.5

190.5



0.05

0.735



14.7

0.05

9.5

130.9



7.26%

During 2002, the Body Shop’s profitability declined. The company’s earnings per share dropped as did its return on common shareholders’ equity. However, the closing common share price and price earnings ratio has increased in 2002 despite the decline in earnings which indicates that investors seem to have confiden ce in the company. The company’s payout ratio increased in 2002 despite the decline in profitability.




BYP 11-6 A GLOBAL FOCUS

Due to the frequency of change with regard to information available on the World Wide Web, the

Accounting on the Web cases are updated as required. Their suggested solutions are also updated whenever necessary, and can be found online in the Instructor Resources section of our home page <www.wiley.com/canada/kimmel>.




BYP 11-7 COLLABORATIVE LEARNING ACTIVITY

(a) The cumulative provision means that preferred shareholders must be paid both currentyear dividends and unpaid prior-year dividends before common shareholders receive any dividends. When preferred shares are cumulative, preferred dividends not declared in a given period are called dividends in arrears.

(b) The market price of shares is determined by many factors. Among the factors to be considered are (1) the corporation’s anticipated future earnings, (2) its expected dividend rate per share, (3) its current financial position, (4) the current state of the economy, and

(5) the current state of the securities markets.

The average share price reflects the price paid for shares when they were originally issued by the company. It is not indicative of the worth or market value of the shares.

(c) A corporation may repurchase its shares to:

(1) Reissue the shares to officers and employees under bonus or shares compensation plans.

(2)

Increase trading of the company’s shares in the securities market in hopes of enhancing its price.

(3) Have additional shares available for use in the acquisition of other companies.

(4) Reduce the number of shares issued and thereby increase earnings per share.

(5) Reduce the possibility of a takeover of the company by investors who are hostile to management.

(d) By restricting retained earnings for plant expansion, the company is limiting the amount of dividends that can be paid to shareholders since the payment of dividends required that there be sufficient retained earnings. The $50,000 dollars in cash dividends that will no longer be paid can now be used to finance the plant expansion.




BYP 11-8 COMMUNICATION ACTIVITY

Memorandum

To: Accounting Standards Board

From: Accounting Student

Re: Stock Based Compensation

In response to the board’s recently announced plans to require the reporting of stock based compensation as an expense on the statement of earnings I would like to support the board’s decision.

In light of recent account scandals involving several large public companies, it is apparent that increased transparency in financial reporting is becoming a necessity. In order to make informed decisions, investors must be aware of the true financial performance of an organization.

In recent years there has been a tremendous increase in both the use and value of stock based compensation. By not reporting such compensation as an expense on the statement of earnings, companies are understating their expenses and therefore overstating earnings. This leaves many investors to make decisions unaware that significant compensation costs of the organization are not being recorded in the financial statements.

By requiring companies to record stock based compensation as an expense on the statement of earnings, investors will be able to better assess the true performance of the company in which they are investing.

Note to instructors: Effective January 1, 2004, stock options are now expensed in Canada.




BYP 11-9 ETHICS CASE

(a) The stakeholders in this situation are:

Vince Ramsey, president of Flambeau Corporation.

Janice Rahn, financial vice-president.

The shareholders of Flambeau Corporation.

(b) There is nothing unethical in issuing a stock dividend. However, the presi dent’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 place the shareholder in the same position. A stock dividend is a “paper” dividend

—they issue a certificate, not a cheque (cash).

(c) 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.

As a shareholder, preference for a cash dividend versus shares dividend is dependent upon one’s investment objective—income (cash flow) or growth (reinvestment).




Legal Notice


Copyright

Copyright © 2004 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.



CHAPTER 11 Reporting and Analysing Shareholders’ Equity ASSIGNMENT CLASSIFICATION TABLE

CHAPTER 11

Reporting and Analysing Shareholders’ Equity

ASSIGNMENT CLASSIFICATION TABLE

ASSIGNMENT CHARACTERISTICS TABLE

ANSWERS TO QUESTIONS

SOLUTIONS TO BRIEF EXERCISES

SOLUTIONS TO EXERCISES

SOLUTIONS TO PROBLEMS

PROBLEM 11-1A

PROBLEM 11-2A

PROBLEM 11-3A

PROBLEM 11-4A

PROBLEM 11-5A

PROBLEM 11-6A

PROBLEM 11-8A

PROBLEM 11-9A

PROBLEM 11-10A

PROBLEM 11-11A

PROBLEM 11-12A

PROBLEM 11-1B

PROBLEM 11-2B

PROBLEM 11-3B

PROBLEM 11-4B

PROBLEM 11-7B

PROBLEM 11-8B

PROBLEM 11-9B

PROBLEM 11-10B

PROBLEM 11-11B

PROBLEM 11-12B

BYP 11-1 FINANCIAL REPORTING PROBLEM

BYP 11-2 COMPARATIVE ANALYSIS PROBLEM

BYP 11-3 RESEARCH CASE

BYP 11-4 INTERPRETING FINANCIAL STATEMENTS

BYP 11-5 A GLOBAL FOCUS

BYP 11-6 A GLOBAL FOCUS

BYP 11-7 COLLABORATIVE LEARNING ACTIVITY

BYP 11-8 COMMUNICATION ACTIVITY

BYP 11-9 ETHICS CASE

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