Chapter 13 Homework Solutions.docx

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Department
Business Administration - Accounting & Financial Planning
Course
Business Administration - Accounting & Financial Planning ACC220
Professor
Ramonagirdauskas
Semester
Winter

Description
Chapter 13 Homework Solutions 3. A corporation provides several advantages over proprietorships and partnerships. The separate legal existence of the corporation from its owners, as well as the limited liability protection offered to shareholders, allow the corporation to acquire capital more easily and in larger amounts than the other two forms of business. The corporate form of business also provides a continuous life beyond the life of the individuals who own it. Corporations also have more easily transferable ownerships rights and enjoy certain forms of income tax advantages. The disadvantages of corporations include increased administrative burden and cost due to additional government regulations and the potential for additional income taxes. Small, privately held corporations are riskier than large publicly held ones and frequently do not enjoy the same advantages as larger corporations. Lenders will often require the owners to sign personal guarantees, thus eliminating the limited liability normally associated with corporations. Because the shares are not offered for sale to the general public, it is more difficult to raise capital. Small corporations may be run by the shareholders, rather than professional managers. This also means that if one of these shareholders sells his or her ownership interest, the corporation may be significantly affected. 4. The ownership rights of shareholders are the rights to: • Vote on the election of the board of directors with each shareholder normally having one vote for each common share • Receive dividends on a pro-rata basis with other shareholders, and • Receive assets upon liquidation on a pro-rata basis with other shareholders. Shareholders manage the corporation indirectly through the board of directors that they have elected. The board of directors can then select and hire officers of the corporation to conduct business on a day-to-day basis. The board of directors decides on the corporation’s operating policies and the officers of the corporation execute the policies. 5. The total number of shares a company is allowed to sell is called its authorized shares—it may be an unlimited amount or a specified amount. No journal entry is recorded when the number of authorized shares is set. The number of authorized shares fixes the upper limit of how many shares can be sold by the corporation. This provides shareholders with an indication of the potential dilution of their ownership share. Issued shares are shares that have been sold. A journal entry will be prepared when shares are issued. The number of issued shares can never exceed the number of authorized shares. The number of shares issued allows users of financial statements to determine how many additional shares can be sold (up to the number authorized) and determine any future dilution of their ownership percentage. That said, under ASPE it is not necessary to show the number of shares authorized, just the number issued. QUESTIONS (Continued) 6. When Paul purchases the original shares as part of TechTop’s initial public offering, he is purchasing from the company. The $1,200 (100 × $12) he spends to buy the shares goes directly to TechTop and increases the company’s assets and shareholders’ equity. In the subsequent purchase, Paul is buying in the secondary market from another investor. The proceeds from this sale go to the seller and not to TechTop. Therefore there is no impact on TechTop’s financial statements as a result of the second purchase. 7. The transaction would be recorded by debiting the equipment and crediting common shares. If the company follows IFRS, the transaction will be valued at the fair value of the equipment received. If this value cannot be determined, then the transaction is recorded at the fair value of the shares given in exchange. If the company follows ASPE, the transaction is valued at whichever amount can be more reliably determined; either the fair value of the equipment or the fair value of the shares given in exchange. 8. The basic ownership rights of preferred shareholders are the rights to receive: • dividends ahead of the common shareholder, and • assets upon liquidation ahead of the common shareholder. They may also have priority for reacquisition if they are redeemable or retractable. In exchange for these preferences, preferred shareholders normally are not entitled to vote. In the absence of restrictive provisions, the basic ownership rights of common shareholders are the rights to: • vote in the election of the board of directors and in corporate actions that require shareholders' approval, • share in corporate profit by receiving dividends, and • share in assets upon liquidation. QUESTIONS (Continued) 9. Cumulative preferred shares are those that require preferred shareholders be paid both current year dividends and unpaid prior year dividends before common shareholders receive any dividends. In contrast, dividends not declared for noncumulative preferred shares are lost forever. Redeemable preferred shares can be purchased from the shareholders, by the issuing corporation, at the option of the corporation. If the shares are retractable they can be sold by the shareholder, to the issuing corporation, at the option of the shareholder. Convertible preferred shares are preferred shares that can be converted into common shares, at the option of the shareholder, at a specified ratio. 12. The unique feature of corporation income statements is a separate section that shows income tax expense. The presentation is as follows: Profit before income tax...........................................$500,000.......... Income tax expense*................................................0150,000......... Profit.............................................................$350,000...................... * This is usually subdivided, to show the portion which is currently due and the portion which is due in future periods. Proprietorship and partnership income statements do not show a section for income taxes since income is taxed personally in the hands of the proprietor or partner. QUESTIONS (Continued) 13. Pro rata means proportional. If you own 5% of the shares, you are entitled to 5% of the dividends that are declared. 14. A cash dividend becomes a liability on the declaration date. This is the date the board of directors formally declares the cash dividend and announces it to shareholders. This commits the corporation to a binding legal obligation that cannot be rescinded. On the declaration date, the company debits Cash Dividends and credits Dividends Payable. On the record date, there is no entry; the company simply determines ownership of the shares. On the payment date, the Dividends Payable is debited and Cash is credited as the dividend is paid out. 15. The requirement to have a positive (or credit) balance in retained earnings is usually a legal requirement set out in the incorporating act of most jurisdictions. Dividends are paid out of retained earnings and most incorporating acts restrict the payment of dividends if it creates or increases a deficit. These restrictions are for the protection of creditors and to ensure that the company can honour its obligations. 18. The main components of shareholders' equity are: Contributed capital, Retained earnings, and Accumulated other comprehensive income (loss) for companies that follow IFRS. Contributed capital represents the amounts contributed by the shareholders. Share capital and additional contributed surplus (e.g., from reacquisition of shares) are components of contributed capital. Retained earnings represent the cumulative profit (or loss) since incorporation that has been retained in the company and not distributed to shareholders as dividends. Accumulated other comprehensive income (loss) represents gains and losses not resulting from share transactions, that bypass profit. The most common example is unrealized gains and losses on certain types of investments. 19. Company 1 would be a better investment since it can generate the same amount of profit using a smaller investment of capital by the shareholders. This can be shown by comparing the return on shareholders’ equity for each company. Company 1: $100,000 ÷ $300,000 = 33.3% and Company 2: $100,000 ÷ $350,000 = 28.6%. BRIEF EXERCISE 13-2 (a) Aug. 5 Cash (2,000 × $12).....................24,000 Common Shares........................ 24,000 Sep. 10 Cash (500 × $13)........................6,500 Common Shares........................ 6,500 (b) Average cost per share: ($24,000 + $6,500) ÷ (2,000 + 500) = $12.20 BRIEF EXERCISE 13-3 (a) Sep. 10 Equipment...............................9,500... Common Shares........................ 9,500 The fair value of the equipment received has been used to value the transaction. Since Juke Joint Ltd. Is a private company, the shares are not widely traded and the $20 per share price from March 12 this likely not a reliable indicator of fair value on September 10 . th (b) The answer would not change since IFRS requires that the fair value of the goods received is used. BRIEF EXERCISE 13-4 (a) Jan. 13 Cash (3,000 × $90)....................270,000 Preferred Shares...................... 270,000 (b) Total dividend: $4 per share × 3,000 shares = $12,000 BRIEF EXERCISE 13-5 (a) Dividends are in arrears by $225,000 ([45,000 × $2.50] × 2). If the shares are noncumulative, there are no dividends in arrears. (b) Dividends in arrears should be reported in the notes to the financial statements. BRIEF EXERCISE 13-6 (a) May 10 Cash (25,000 × $35)...................875,000 Preferred Shares...................... 875,000 (b) Nov. 21 Preferred Shares (5,000 × $35)..... 175,000 Common Shares....................... 175,000 (5,000 x 2 = 10,000 common shares) BRIEF EXERCISE 13-7 (a) June 30 Income Tax Expense ..................... 33,750 Income Tax Payable.................... 33,750 ($800,000 − $575,000) × 15% (b) VICERON INC. Income Statement Year Ended June 30, 2014 Revenues...............................................$800,000........... Expenses...............................................0575,000........... Profit before income tax................................225,000.. Income tax expense........................................33,750.. Profit.................................................$191,250................ BRIEF EXERCISE 13-8 Oct. 14 Cash Dividends—Preferred............... 131,250 Dividends Payable (25,000 × $5.25) 131,250 Nov. 1 No journal entry. Nov. 21 Dividends Payable.............................. 131,250 Cash..........................................131,250 BRIEF EXERCISE 13-9 GRAYFAIR INC. Statement of Retained Earnings Year Ended December 31, 2014 Retained earnings, January 1.......................................... $248,000 Add: Profit....................................................................... 0175,000 423,000 Less: Cash dividends.......................................120,000........ Retained earnings, December 31.................................... $303,000 BRIEF EXERCISE 13-10 (a) Dec. 31 Sales................................745,000........ Income Summary...................... 745,000 31 Income Summary.......................620,000 Cost of Goods Sold.................. 450,000 Operating Expenses................. 135,000 Income Tax Expense................ 35,000 31 Income Summary.......................125,000 Retained Earnings.................... 125,000 31 Retained Earnings.....................50,000 Cash Dividends—Common ($25,000 × 2) 50,000 (b) Income Summary Retained Earnings Clos Clos . 620,000 . 745,000 Bal. 382,000 Bal. 125,000 Clos. 50,000 Clos. 125,000 Clos . 125,000 Bal. 457,000 Bal. - BRIEF EXERCISE 13-12 (a) Return on equity $51,951 ($638,995 + $663,602) ÷ 2 = 7.98% (b) It would be the same because the company does not have any preferred shares. EXERCISE 13-4 (a) Shares issued to Mah........................1,000.. Shares issued to Manji and MacDonald. 9,000 Total number of shares issued..............10,000 Ownership percentage to Mah = 1,000 / 10,000 = 10% Alternatively, total number of shares issued = 9,000 / (1 – 10%) = 10,000 shares (b) Jan. 1 Legal Fees Expense.................5,000 Common Shares.................. 5,000 Issued 1,000 common shares in payment of legal services. (c) By issuing shares to Mah, Mah becomes one of the common shareholders of Southwest Corporation. Manji and MacDonald may not want to issue shares because this allows Mah to share in future dividend payments and future profits. This could increase the cost of Mah’s legal services. This would also mean that Mah would share in the decision-making. EXERCISE 13-6 (a) 150,000 × $4.50 = $675,000 (b) Year 1 Year 2 Regular dividend $675,000 $675,000 Arrears from Year 1 225,000 900,000 Dividend paid 450,000 900,000 Arrears $225,000 $ 0 (c) Dividends in arrears should be disclosed in the notes to the financial statements. They are not recorded in the general ledger accounts. (d) The likely amount is $4.50 per share, for a total of $675,000. EXERCISE 13-7 SHRUNK INC. Income Statement Year Ended July 31, 2014 Sales.......................................................$665,000.................. Cost of goods sold............................................310,000....... Gross profit..................................................355,000............. Operating expenses: Salaries expense........................................... 140,000 Supplies expense.......................................... 150,000 Profit from operations........................................205,000...... Other expenses: Interest expense.............................................5,000........ Profit before income tax......................................200,000..... Income tax expense ($200,000 × 20%)........................... 40,000 Profit......................................................$160,000................... July 31 Income Tax Expense................ 10,000 Income Tax Payable............. 10,000 ($200,000 × 20%) – $30,000 = $10,000 EXERCISE 13-9 (a) SHRUNK INC. Statement of Retained Earnings Year Ended July 31, 2014 Balance, August 1, 2013................................................... $352,000 Add: Profit....................................................160,000............ 512,000 Less: Cash dividends............................................60,000.... Balance, July 31................................................................ $452,000 (b) July 31 Sales.................................................... 665,000 Income Summary........................... 665,000 31 Income Summary................................ 505,000 Cost of Goods Sold........................ 310,000 Supplies Expense.......................... 10,000 Salaries Expense............................ 140,000 Interest Expense............................ 5,000 Income Tax Expense...................... 40,000 31 Income Summary........................
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