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ADM1340 Exam Review

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University of Ottawa
Marc Tasse

Chapter  9          Reporting  and  Analyzing  Long -­‐Lived  Assets   Property,  Plant,  and  Equipment   • Long  lived  assets  that:   o Are  controlled  by  the  company   o Have  physical  substance   o Are  used  in  the  operation  of  a  business   o Are  not  intended  for  sale  to  customers   • Provide  benefits  over  many  years   o PPE  are  critical  to  a  company’s  success  because  they  determine  the   company’s  production  capacity,  which  in  turn  affects  customer  satisfaction.   Determining  the  Cost  of  Property,  Plant  and  Equipment   • Record  at  cost,  which  includes:   o Purchase  price,  including  taxes  and  duties,  less  discounts  or  rebates   o Expenditures  necessary  to  bring  asset  to  its  intended  location  and  make  it   ready  for  its  intended  use   Types  of  Expenditures   • Operating  expenditures   o Benefit  only  the  current  period   o Immediately  charged  against  revenue  as  an  expense   • Capital  expenditures   o Capitalized  as  an  asset   o Benefit  future  periods     o Increases  a  company’s  investment  in  productive  activity   Property,  plant,  and  equipment  are  often  subdivided  into  four  classes:   Land   • Cost  of  land  includes   o Purchase  price   o Closing  costs  such  as  title  and  legal  fees   o Additional  costs  to  prepare  land  for  its  intended  use  (less  any  proceeds   from  salvage)   • Land  has  an  unlimited  life,  therefore  it  is  not  depreciated   Land  Improvements   • The  costs  of  structural  additions  made  to  land  (e.g.  paving,  fencing)   • These  decline  in  service  potential  over  time   o They  are  recorded  separately  from  land   o Depreciated  over  their  useful  lives   Buildings     • All  expenditures  related  to  the  purchase-­‐e  or  construction  of  a  building   • When  a  building  is  purchased  such  costs  include:   o Purchase  price   o Closing  costs  (legal  fees,  title,  insurance)   o Costs  required  to  make  building  ready  for  its  intended  use   ADM1340  EXAM  REVIEW   1     CHAPTER  9   • When  a  building  is  constructed,  its  cost  consists  of:     o Contract  price     o Architect's  fees   o Building  permits   o Excavation  cost   o Interest  costs  during  construction   Equipment   • Costs  include:   o Purchase  price   o Freight  charges  and  insurance  during  transit  paid  by  the  purchaser   o Assembling   o Installing  and  testing   Asset  Retirement  Costs   • Cost  of  any  obligation  to  dismantle,  remove  or  restore  a  long-­‐lived  asset   when  it  is  retired   • These  costs  are  estimated  in  advance  and  included  as  part  of  the  cost  of  the   asset   Buy  or  Lease?   • Advantages  of  leasing   o Reduced  risk  of  obsolescence   o 100%  financing   o Income  tax   o “Off-­‐balance  sheet”  financing   • Terminology   o Lessor  —  owner  of  asset  for  lease  (e.g.,  landlord)   o Lessee  —  company  leasing  asset  from  owner  (e.g.,  tenant)   • Operating  lease   o Treated  as  rental  by  lessee   o Periodic  payment  (dr.  rent  expense/cr.  cash)   • Finance  lease   o Treated  as  purchase  by  lessee  (dr.  asset/cr.  liability)   o Periodic  payment  (dr.  liability  and  interest  expense/cr.  cash)   Depreciation   • The  cost  model  records  property,  plant,  and  equipment  at  cost  when  acquired.   • Subsequent  to  acquisition,  depreciation  is  recorded  each  period  and  the   assets  are  carried  at  cost  less  the  accumulated  depreciation.   • Systematic  allocation  of  the  cost  of  property,  plant  and  equipment  over  the   asset’s  useful  life   • Depreciation  is  a  process  of  cost  allocation,  not  a  process  of  determining  an   asset’s  fair  value.     • Does  not  use  or  provide  cash  to  replace  the  asset         2   ADM1340  EXAM  REVIEW     CHAPTER  9   Factors  in  Calculating  Depreciation     Cost:   the  purchase  price  plus  all  necessary  costs  to  make  the  asset  ready  for  its  intended  use.   Useful  life:   an  estimate  of  the  period  over  which  an  asset  is  expected  to  be  available  for  u   Residual  value:   an  estimate  of  the  amount  that  will  be  received  upon  disposal  of  the  asset.   • The  difference  between  a  depreciable  asset’s  cost  and  its  residual  value  is   called  the  depreciation  amount,  which  is  the  total  amount  to  be  depreciated   over  the  useful  life.   Depreciation  Methods   Depreciation  is  generally  calculated  using  one  of  these  three  methods:   1. Straight-­‐line     2. Diminishing-­‐balance   3. Units-­‐of-­‐production   Straight -­‐Line  Method   • Depreciation  is  constant  for  each  year  of  the  asset’s  useful  life.   Diminishing -­‐Balance   Method   • Produces  a  decreasing  annual  depreciation  expense  over  an  asset’s  useful  life   o Depreciation  is  calculated  based  on  the  asset’s  carrying  amount,  which   diminishes  each  year  as  accumulated  depreciation  increases   • Annual  depreciation  expense  is  calculated  by  multiplying  the  carrying   amount  by  the  depreciation  rate   o Residual  value  is  not  included  in  the  calculation   • Can  be  applied  using  different  rates   o Depreciation  rate  =  Straight-­‐line  rate  x  multiplier   Units -­‐of-­‐Production  Method   • Useful  life  is  expressed  in  terms  of  total  units  of  production  or  activity   expected  from  the  asset   o Such  as  units  produced  or  machine-­‐hours  worked     • Useful  for  factory  machinery,  vehicles,  airplanes   Example:   A  delivery  van  was  bought  on  Jan.  1,  2012   Cost:  $33,000   Estimated  residual  val ue:  $3,000   Estimated  useful  life:  5  years/100,000km     Straight -­‐Line  Method                   ADM1340  EXAM  REVIEW   3     CHAPTER  9   Diminishing -­‐Balance  Method   Units -­‐of-­‐Production  Method                         Other  Depreciation  Issues   • Significant  components   o May  be  depreciated  separately   • Income  tax   • Impairments   o When  carrying  amount  of  asset  exceeds  its  recoverable  amount   • Cost  vs.  revaluation  model   o Revaluation  model  allowed  under  IFRS   o Allows  revaluation  to  fair  market  value   Reversing  Periodic  Depreciation   • Revisions  needed  if:   o Capital  expenditures  during  useful  life   o Impairment  losses   o Change  in  estimated  useful  life  or  residual  value   o Change  in  the  pattern  in  which  the  asset’s  economic  benefits  are  consumed   • Accounted  for  as  a  change  in  estimate   o Change  made  in  current  and  future  years,  but  not  to  prior  periods  (prospectively)   Disposal  of  Property,  Plant,  and  Equipment   • Companies  dispose  of  property,  plant,  and  equipment  that  is  no  longer  useful   to  them  using  of  these  three  methods:   Sale:  equipment  is  sold   Retirement:  equipment  is  scrapped  or  discarded   Exchange:  existing  equipment  is  traded  for  new  equipment   4   ADM1340  EXAM  REVIEW     CHAPTER  9   • Whatever  the  disposal  method,  the  company  must  follow  these  four  steps  to   record  the  disposal:   Step  1:  Update  depreciation   • Depreciation  for  the  fraction  of  the  year  to  the  date  of  disposal  must  be  recorded   Step  2:  Calculate  carrying  amount   • Carrying  amount  =  Cost  –  Accumulated  depreciation   Step  3:  Calculate  gain  or  loss   • Proceeds  –  carrying  amount  =  gain  (loss)   Proceeds  >  carrying  amount  =  Gain  (Cr.)   Proceeds  <  carrying  amount  =  Loss  (Dr.)   Step  4:  Record  disposal   • Remove  cost  of  asset  and  accumulated  depreciation.  Record  proceeds  (if  any)   and  gain  or  loss  on  disposition  (if  any)   Cash   xxx     Accumulated  Depreciation   xxx                  Asset     xxx                Gain  on  Disposal   xxx   Intangible  Assets  and  Goodwill   • Do  not  have  physical  substance   • Rights,  privileges  and/or  competitive  advantages   o For  example,  intellectual  property  in  a  production  process   • Must  be  identifiable  –  either:   o Can  be  separated  from  company  and  sold;  or   o Based  on  contractual  or  legal  rights   Accounting  for  Intangible  Assets   • Accounting  for  intangible  assets  parallels  accounting  for  tangible  assets   o Recorded  at  cost  including  all  costs  to  make  asset  ready  for  use   • If  intangible  asset  has  a  finite  (limited)  life,  its  cost  must  be  systematically   allocated  over  its  useful  life   o For  intangible  assets,  this  is  referred  to  as  amortization  rather  than  depreciation   • Intangible  assets  with  an  indefinite  (unlimited)  life  are  not  amortized   Intangibles  with  Finite  Lives   • Patents   o Exclusive  right  to  produce  for  20  years   • Research  and  development  costs   o All  research  costs  are  expensed   o Development  costs  are  capitalized  only  if  associated  with  an  identifiable,   feasible  product   • Copyrights  ©   o Protection  for  the  life  of  the  creator  +  50  years   Intangibles  with  Indefinite  Lives   • Trademarks  and  trade  names  ™®   o Word,  jingle,  symbol  that  distinguishes  business   ADM1340  EXAM  REVIEW   5     CHAPTER  9   • Franchises   o Contractual  agreement  to  sell  products  or  services   • Licenses   o Operating  rights   Goodwill   • Asset  representing  future  economic  benefits  arising  from  the  purchase  of  a   business   o Excess  of  cost  over  fair  market  value  of  net  assets  (assets  less  liabilities)   acquired   o Represents  the  extra  value  relating  to  a  business  when  it  is  purchased   o Only  identified  with  the  business  as  a  whole   • Not  amortized,  but  subject  to  an  annual  test  for  impairment   Statement  Presentation  of  Long-­‐Lived  Assets   Statement  of  Financial  Position   • Reported  as   o Property,  Plant  and  Equipment   o Intangible  Assets   o Goodwill   • Disclose  cost  and  accumulated  depreciation  (amortization)  of  each  major   class  of  assets   o Either  in  statement  or  in  notes   • IFRS  also  requires  additional  disclosures   Income  Statement   • Depreciation  expense,  gains  and  losses  on  disposal  and  impairment  losses   are  included  in  the  operating  section   Statement  of  Cash  Flows   • Cash  flows  from  the  purchase  and  sale  of  long-­‐lived  assets  are  reported  in  the   investing  section   Analyzing  Assets   Return  on  Assets   Asset  Turnover   • Measures  overall  profitability   • Measures  how  efficiently  a     company  uses  its  assets            Profit                  Net  Sales         Return  on  Assets   = Average  Total  Assets   Asset  Turnover   = Average  Total  Assets       HIGHER  IS  BETTER   HIGHER  IS  BETTER       6   ADM1340  EXAM  REVIEW       Chapter  10            Reporting  and  Analyzing  Liabilities   Current  Liabilities   • Expected  to  be  paid:   o From  existing  current  assets  or  through  the  creation  of  other  current   liabilities   o Within  one  year   • Debts  that  do  not  meet  both  criteria  are  classified  as  non-­‐current  (or  long-­‐ term)  liabilities   • Types  of  current  liabilities  include:   o Bank  indebtedness  from  operating  lines  of  credit   o Accounts  payable  and  accrued  liabilities   o Unearned  revenue   o Notes  or  loans  payable   o Sales  taxes   o Property  taxes   o Payroll   o Current  portion  of  non-­‐current  debt   Operating  Line  of  Credit   • Prearranged  agreement  between  a  company  and  a  lender  to  allow  the   company  to  borrow  up  to  an  agreed-­‐upon  amount:   o To  help  manage  temporary  cash  shortfalls   • Interest  is  charged  using  a  floating  (or  variable)  interest  rate   • Security  (collateral)  may  be  required  by  bank   • When  used,  results  in  bank  indebtedness   Sales  Taxes   • Expressed  as  a  percentage  of  the  sales  price   • Federal  Goods  and  Services  Tax  (GST)   • Provincial  Sales  Tax  (PST  or  QST)   • Combines  into  one  harmonized  sales  tax  (HST)  in  some  provinces   • When  a  sale  occurs,  the  retailers  collects  the  sales  tax  from  the  customer  and   periodically  sends  the  sales  tax  to  respective  governments:     o When  paid,  debit  Sales  Tax  Payable  account  and  credit  Cash   Example:  The  March  25  cash  register  readings  for  the  Islander  Corporation  show   sales  of  $10,000,  and  HST  of  $1,300   Mar.   Cash   11,300     25                Sales   10,000                Sales  Tax  Payable  ($10,000  X  13%)   1,300        (To  record  sales  and  sales  x )   ADM1340  EXAM  REVIEW   7     CHAPTER  10   Property  Taxes   • Businesses  that  own  property  pay  property  taxes  for  each  calendar  year  to   municipal  or  provincial  governments   • Property  taxes  are  calculated  at  a  specified  rate  for  every  $100  of  the     assessed  valued  of  the  property   Example:  Tantramar  owns  land  and  a  building  in  the  city  of  Regina.  Tantramar   receives  its  property  tax  bill  of  $6,000  for  the  calendar  year  on  March  1,  payable   May  31.     Upon  receipt  of  the  property  tax  bill,  an  expense  is  recorded  for  the  months  that   have  passed.     Mar  1   Property  Tax  Expense  ($6,000  X  2/12)     1,000                  Property  Tax  Payable   1,000       (To  record  property  tax  expense  for  January  and  February )     In  May,  when  Tantramar  records  the  payment  of  the  liability  recorded  on  March  1,  it   also  records  the  expense  incurred  to  date  for  the  months  of  March-­‐May.     May   Property  Tax  Payable   1,000     31   Property  Tax  Expense  ($6,000  X  3/12)   1,500     Prepaid  Property  Tax  ($6,000  X  7/12)   3,500                  Cash   6,000        (To  record  payment  of  property  tax  for  January  through                                    December) Prepaid  is  cleared  to  expense  at  the  end  of  year.   Dec.   Property  Tax  Expense   11,300     31                Prepaid  Property  Tax   10,000        (To  record  property  tax  expense  for  June  through   1,300                                    December)   Payroll   • Three  types  of  liabilities  related  to  employee  salaries  and  wages:   1. Salary  and  wages  owed  to  employees  (known  as  gross  pay)   2. Payroll  deductions  required  to  be  withheld  from  employees’  gross  pay   o Employees’  gross  pay  less  payroll  deductions  is  known  as  net  pay   (or  take  home  pay)   3. Employer  payroll  obligations   Employee  Payroll  Deductions   Employer  Payroll  Obligations   • Mandatory  payroll  deduction s:   • Employer’s  share  of  CPP  and  EI     o Canada  pension  plan  (CPP)   • Workers’  compensation   o Employment  insurance  (EI)   • Employee  benefits:   o Federal  and  provincial  income  taxes   o Compensated  absences  (vacation,   • Voluntary  payroll  deductions:   statutory  holidays)   o Benefits  such  as  health  and  pension   o Employer-­‐sponsored  health  plans   o Charitable  contributions   and  pensions   o Union  dues   8   ADM1340  EXAM  REVIEW     CHAPTER  10   Short-­‐Term  Notes  Payable   • A  promise  to  pay  a  specified  amount  either  at  a  future  date  or  on  demand   • Often  used  instead  of  accounts  payable   • Provide  written  documentation,  if  needed,  for  legal  remedies   • Normally  has  interest  attached  (at  a  fixed  annual  rate)   • Issued  for  varying  periods:   o If  due  within  one  year  of  financial  statement  date,  they  are  classified  as   current  liabilities     Example:  assume  HSBC  Bank  lends  $100,000  to  Williams  Ltd.  on  March  1,  2012.   The  loan  is  due  in  four  months,  on  July  1,  and  6%  interest.     Williams  makes  the  following  journal  entry  when  it  receives  the  $100,000:   Mar  1   Cash   100,000                  Bank  Loan  Payable   100,000       (To  record  receipt  of  four -­‐month,  6%  bank  loan  from                                 HSBC) If  Williams  has  a  March  31  year-­‐end,  the  adjusting  entry  for  interest  would  be:   Mar   Interest  Expense   500     31                Interest  Payable   500       (To  accrue  interest  for  March  on  HSBC  bank  loan )     At  maturity,  the  following  entries  would  be  made:   July  1   Interest  Expense   1,500                  Interest  Payable   1,500       (To  accrue  interest  for  April -­‐June  on  HSBC  bank  loan)       July  1   Bank  Loan  Payable   100,000     Interest  Payable  ($500  +  $1,500)   2,000                  Cash  ($100,000  +  $2,000)   102,000       (To  record  payment  of  HSBC  bank  loan  and  interest  at                                  maturity)   Current  Maturities  of  Non-­‐Current  Debt   • The  portion  of  non-­‐current  (long-­‐term)  debt  that  is  due  within  the  current   year  or  operating  cycle  should  be  classified  as  a  current  liability   Non-­‐Current  Liabilities:  Installment  Notes  Payable   Non-­‐Current  Liabilities   • Obligations  to  be  paid  after  one  year  or  longer   • Also  known  as  financial  liabilities  (a  type  of  financial  instrument):   o A  contractual  obligation  to  pay  cash  in  the  future   • Includes  long-­‐term  notes,  bonds,  and  lease  obligations   • May  be  secured  or  unsecured:   o Secured  notes  are  also  known  as  mortgages   ADM1340  EXAM  REVIEW   9     CHAPTER  10   Installment  Notes  Payable   • Normally  repayable  in  a  series  of  periodic  payments  called  installments   • Installment  payments  usually  take  one  of  two  forms:   o Fixed  principal  payments  plus  interest  (fixed  or  floating  interest)     o Blended  principal  and  interest  payments   Non-­‐Current  Liabilities:  Bonds  Payable   Bonds  Payable   • A  form  of  interest-­‐bearing  notes  payable   • Large  amount  is  divided  into  smaller  denominations:   o Makes  them  attractive  to  investors     • Most  have  a  fixed  interest  rate  (coupon  rate)   • May  be  secured  or  unsecured  (debenture)   • Payable  at  maturity  (term  bonds)  or  in  installments  (serial  bonds)   • Redeemable  bonds  can  be  retired  before  maturity   Bonds  Trading   • Convertible  bonds  can  be  converted  to  common  shares  at  a  stated  price   • Bonds  can  also  be  traded  on  stock  exchanges:   o Bond  prices  are  quoted  as  a  percentage  of  the  face  value  of  the  bonds   • Market  (or  effective)  interest  rate  (yield):   o Rate  investors  demand  for  loaning  funds   Terminology   • Face  value:   o Amount  of  principal  due  at  maturity   • Present  value:   o Value  today  of:   1. Bond  face  value  to  be  received  at  maturity,  and   2. Interest  payments  to  be  received  periodically   o The  value  today  is  dependent  upon  when  the  amounts  are  to  be  received,   and  the  market  rate  on  interest   Statement  Presentation  and  Analysis   Presentation   Current  liabilities   • Reported  as  the  first  category  of  liabilities   • Can  be  listed  separately  on  statement  of  financial  position  or  detailed  in  the   notes   • Normally  listed  in  order  of  liquidity   Non-­‐current  liabilities   • Report  separately  in  statement  of  financial  position  and  detail  in  notes   • Measured  and  reported  at  amortized  cost   10   ADM1340  EXAM  REVIEW     CHAPTER  10   Uncertain  Liabilities     • Events  with  uncertain  outcomes:   o Who  is  owed   o When  it  is  owed,  and/or   o How  much  is  owed   • Provisions  are  uncertain  as  to  timing  or  amount   • Contingent  liabilities  are  possible  obligations  that  are  dependent  upon  some   future  event:   o Should  be  recognized  if  more  likely  than  not  (IFRS)   o Should  be  recognized  if  likely  (ASPE)   Analysis  of  Debt  Obligations   Liquidity   • Measure  short-­‐term  ability  to  pay  maturing  obligations  and  meet  cash  needs:   o Current  ratio   o Inventory  turnover  ratio   o Receivables  turnover  ratio   Solvency   • Measure  ability  to  meet  long-­‐term  obligations:   o Debt  to  total  assets     o Times  interest  earned   Debt  to  Total  Assets   • Measures  the  percentage  of  assets  that  is  financed  by  lenders  and  other   creditors  rather  than  by  shareholders.              Total  Liabilities           Debt  to  Total  Assets     =     Total  Assets   LOWER  IS  BETTER   Times  Interest  Earned   • Provides  an  indication  of  a  company’s  ability  to  meet  interest  payments  as   they  come  due              Profit + Interest  Expense + Income  Tax  Expense           Times  Interest  Earned     =   Interest  Expense     HIGHER  IS  BETTER   Operating  Leases   • Treated  as  periodic  rentals  –  no  assets  or  liabilities  are  recorded   • Usually  short-­‐term:   o If  longer-­‐term,  considered  to  be  “off-­‐balance-­‐sheet  financing”   • Must  be  disclosed  in  the  notes  to  the  financial  statement. ADM1340  EXAM  REVIEW   11       Chapter  11          Reporting  and  Analyzing  Shareholders’ Equity   The  Corporate  Form  of  Organization   • A  separate  legal  entity:   o Separate  and  distinct  from  its  owners   • Has  most  of  the  rights  and  privileges  of  a  person   • Classified  by  purpose  and  ownership:   o Purpose:  profit  or  not-­‐for-­‐profit   o Ownership:  public  or  private   Characteristics  of  a  Corporation   • Separate  legal  existence   • Continuous  life   • Limited  liability  of   • Corporation  management   shareholders   • Government  regulations   • Transferable  ownership  rights   • Income  tax   • Ability  to  acquire  capital     Advantages  and  Disadvantages  of  a  Corporation   Advantages   Disadvantages   • Corporate  management   • Increased  costs  and  complexity   • Separate  legal  existence   in  order  to  adhere  to   • Limited  liability  of  shareholders   government  regulation   • Deferred  or  reduced  income  tax   • Additional  income  tax   • Transferable  ownership  rights   • Ability  to  acquire  capital   • Continuous  life Share  Issue  Consideration   • To  raise  capital,  the  corporation  sells  ownership  rights  as  shares:   o Other  way  to  raise  capital  is  to  issue  debt   • Shares  can  be  divided  into  different  classes:   o Usually  referred  to  as  common  shares  and  preferred  shares   • Ownership  rights  are  specified  in  articles  of  incorporation  or  in  by-­‐laws:   o Rights  in  voting,  dividends,  liquidation   • Authorized  share  capital:   o Maximum  amount  of  shares  allowed  to  sell   o May  be  limited  or  unlimited   • Not  recorded;  disclosed  only  (IFRS  not  ASPE)     • Legal  capital:   o Share  capital  cannot  be  distributed  to  shareholders  unlike  retained   earnings,  which  can  be  distributed  as  dividends   12   ADM1340  EXAM  REVIEW     CHAPTER  11   Issuing  Shares   • First  issue  normally  through  initial  public  offering  (IPO):   o Share  price  is  set  by  the  company   • Once  issued,  shares  of  publicly  held  companies  trade  on  organized   exchanges:   o At  prices  per  share  established  between  buyers  and  sellers  (no  direct   impact  on  company)   o Fair  value  of  shares  –  share  price  -­‐  is  determined  by  market  forces   Common  Shares   Issuing  Common  Shares   • Contributed  capital:   o The  amount  that  shareholders  have  paid  to  the  corporation  for  their  shares   • Shares  are  usually  issued  for  cash:   Dr.  Cash              Cr.  Common  Shares   • Shares  can  be  issued  in  exchange  for  services  or  noncash  assets:   o IFRS:  Record  at  cash  equivalent  price  (ideally  the  fair  value  of   consideration  received)   o ASPE:  Fair  value  of  shares  given  up  or  fair  value  of  consideration  received   (whichever  is  more  reliable)     Example:  assume  Hydro-­‐Slide,  Inc.  is  authorized  to  issues  1,000  shares  for  $2  per   share  on  January  12.     Jan.   Cash   2,000     12                Common  Shares   2,000       (To  record  issue  of  1,000  common  shares)   Assume  that  5,000  common  share3s  were  issued  by  Hydro-­‐Slide  in  exchange  for  a   parcel  of  land  on  January  27.  The  shares  were  trading  at  $3.50  per  share  and  the   land  was  valued  at  $20,000.     Jan.   Land   20,000     27                Common  Shares   20,000       (To  record  issue  of  5,000  common  shares  in  exchange  for                                    land)   **  The  transaction  is  recorded  using  the  value  of  the  land,  rather  than  the  value  of  the  common  shares**     Preferred  Shares   • Share  capital  can  consist  of  preferred  and  common  shares   • Preferred  shares  have  contractual  provisions  that  give  them  priority  over  common   shares   • Usually  do  not  have  voting  rights   • Accounting  for  preferred  shares  similar  to  common  shares   ADM1340  EXAM  REVIEW   13     CHAPTER  11   Preferred  Share  Preferences   • Dividend  preference:   o Cumulative  (dividends  in  arrears)   • Liquidation  preference   • Other  preferences:   o Convertible     o Redeemable/callable  (company  option)   o Retractable  (shareholder  option)   Retained  Earnings   Dividends   • A  pro  rata  (equal)  distribution  of  a  portion  of  a  corporation’s  retained  earnings  to  its   shareholders     • Cash  dividends  are  most  common:   o A  distribution  of  cash  to  shareholders   • Stock  dividends  may  also  be  issued   Cash  Dividends   • For  a  cash  dividend  to  occur,  a  corporation  must:   1. Meet  a  two-­‐part  solvency  test  ,  and   2. Effect  a  formal  declaration  of  dividends  by  board  of  directors   • Three  important  dates  in  connection  with  dividends:   1. Declaration  date     2. Record  date   3. Payment  date   Declaration  Date   • Date  the  Board  of  Directors  authorizes  the  cash  dividend   • Commits  the  corporation  to  a  binding  legal  obligation     Record  Date   • Date  of  ownership  of  shares  is  determined  for  dividend  purposes   • No  entry  necessary   Payment  Date   • Date  dividend  cheques  are  mailed   Stock  Dividends   • Cash  dividend:  paid  in  cash   • Stock  dividend:  distributed  (paid)  in  shares:   o Fair  value  (on  date  of  declaration)  is  assigned  to  the  stock  dividend  shares     Purposes  and  Benefits  of  Stock  Dividends   • Satisfy  shareholders'  dividend  expectations  without  spending  cash   • Increase  marketability  of  its  shares:   o Increases  number  of  shares  and  decreases  market  price  per  share     • Reinvest  and  restrict  a  portion  of  shareholders'  equity:   o Unavailable  for  future  cash  dividends     14   ADM1340  EXAM  REVIEW     CHAPTER  11   Example:  Assume  that  IBR  Inc.  has  50,000  common  shares  with  a  balance  of  $500,000  in   Common  Shares  and  $300,000  in  Retained  Earnings.  On  June  30,  it  declares  a  10%  stock   dividend  to  shareholders  of  record  at  July  20,  to  be  distributed  to  shareholders  on  August  5.      share  price  on  June  30  is  $15  per  share.   Declaration  Date   June   Stock  Dividends     75,000     30                Common  Stock  Dividends  Distributable   75,000       (To  record  declaration  of  10%  stock  dividend )     Record  Date   No  Entry   Distribution  Date   Aug.   Stock  Dividends  Distributable   75,000     5                Common  Shares   75,000       (To  record  issue  of  5,000  common  shares  in  a  10%                                    stock  dividend)     Effect  of  Stock  Dividends   • Decreases  retained  earnings   • Increases  common  shares   • Total  shareholder’s  equity  remains  the  same   Stock  Splits   • A  stock  split  involves  the  issue  of  additional  shares  to  shareholders  according  to  their   percentage  ownership:   o Like  a  stock  dividend  but  much  larger   • A  stock  split  has  no  effect  on  total  share  capital,  retained  earnings,  or  total  shareholders’   equity   • Market  value  of  the  shares  will  decrease  roughly  proportionately  to  the  split   Retained  Earnings  Restrictions   • Balance  in  Retained  Earnings  is  generally  available  for  dividend  declarations   • Restrictions  make  a  portion  of  the  balance  unavailable  for  dividends:   o May  be  legal,  contractual  or  voluntary  restrictions   • No  journal  entry;  disclosed  in  notes   Presentation  of  Shareholders’  Equity   Statement  of  Financial  Position   Contributed  Capital:   • Share  capital:  preferred  and  common  shares   • Additional  contributed  capital:  amounts  contributed  from  acquiring  and  retiring  shares   Retained  Earnings:   • Cumulative  profits  (losses)  since  incorporation   • Annual  profit  is  added;  losses  and  dividends  declared  are  deducted     ADM1340  EXAM  REVIEW   15     CHAPTER  11   Accumulated  Other  Comprehensive  Income:   • Certain  gains  and  losses  that  bypass  profit   • Recorded  directly  to  shareholders’  equity   • Other  comprehensive  income  reported  only  under  IFRS;  not  required  under  ASPE   • Other  comprehensive  income  (OCI)  includes  certain  gains  and  losses:   o For  example,  revaluations  of  property,  plant,  and  equipment  using  the  revaluation   model   • Accumulated  other  comprehensive  income  is  the  cumulative  change  in  shareholders   equity:     o Starts  with  opening  balance  and  is  increased  (decreased)  by  other  comprehensive   income  (loss)  each  period   • Comprehensive  income  (loss)  includes  profit  and  OCI       Statement  of  Changes  in  Equity  (IFRS)   • Discloses  changes  in  total  shareholders’  equity  for  the  period,  including:   o Contributed  capital   o Retained  earnings   o Accumulated  other  comprehensive  income   • Required  under  IFRS   Measuring  Corporate  Performance   • Dividend  record:   o Payout  ratio   o Dividend  yield   • Earnings  performance:   o Earnings  per  share   o Return  on  common  shareholders’  equity   Payout  Ratio   • Measures  the  percentage  of  profit  distributed  in  the  form  of  cash  dividends  to   common  shareholders   Payout  Ratio     =            Cash  Dividends           Profit   HIGHER  IS  BETTER  if  investor  is  looking  for  income   16   ADM1340  EXAM  REVIEW     CHAPTER  11   Dividend  Yield   • Measures  the  profit  generated  by  each  share,  based  on  the  market  price  of  the  shares            Dividend  per  Share         Dividend  Yield     =   Market  Price  per  Share   HIGHER  IS  BETTER  if  investor  is  looking  for  income   Earnings  Performance   Earnings  per  Share   • Measures  the  profit  earned  by  each  common  share            Profit  available  to  common  Shareholders           Earnings  Per  Share     =   Weighted  averge  number  of  common  shares     NOT  COMPARABLE  BETWEEN  COMPANIES     • Profit  available  to  common  shareholders:   =  Profit  –  preferred  dividends   • Weighted  average  number  of  common  shares:   o Shares  issued  during  the  year  x  the  fraction  of  the  year  they  are  outstanding   o Example:  April  1  =  3/12  months  if  calendar  year  used   Complex  Capital  Structure   • When  a  company  has  securities  that  can  be  converted  into  common  shares   • The  additional  common  shares  will  result  in  a  reduced  (diluted)  EPS  figure   • Two  EPS  amounts  are  calculated:   o Basic  EPS:  calculation  on  preceding  page   o Diluted  EPS:  hypothetical  calculation  as  if  all  securities  were  converted   into,  or  exchanged  for,  common  shares   Return  on  Equity   • Common  shareholders’  equity:   =  Total  shareholders’  equity  –  legal  capital  of  preferred  shares   Return  on  Common  Shareholders’  Equity   • Measures  the  company’s  profitability  from  the  shareholders’  viewpoint          Profit  Available  to  Common  Shareholders         Return  on  Common  Shareholders  Equity   =   Average  Common  Shareholders  Equity ▯     HIGHER  IS  BETTER     ADM1340  EXAM  REVIEW   17       Chapter  13               Statement  of  Cash  Flows   Reporting  of  Cash  Flows   Purpose  of  the  Statement  of  Cash  Flows   • Helps  users  assess:   o A  company’s  ability  to  generate  cash   o A  company’s  needs  in  using  this  cash   • This  is  useful  in  determining:   o Company’s  ability  to  generate  future  cash  flows   o Investing  and  financing  transactions  during  the  period,  and  effect  upon   capital  structure   o And  for  making  comparisons  with  other  companies   Content  of  the  Statement  of  Cash  Flows   Definition  of  Cash   • Cash  may  include  cash  equivalents   o Short-­‐term,  highly  liquid  investments  that  are  readily  converted  to  cash   within  a  short  period  of  time  (usually  within  three  months)   o May  not  be  included  in  future  depending  on  outcome  of  IASB/FASB  joint   project   Classification  of  Cash  Flows   Operating  Activities   • Cash  effects  of  transactions  that  create  revenues  and  expenses  that  enter  into   determination  of  profit   • Includes  relevant  (i.e.,  the  related  account  is  an  income  statement  account)   noncash  current  assets  and  current  liabilities  on  the  statement  of  financial   position   Investing  Activities   • Purchasing  and  disposing  of  long-­‐term  investments  and  productive  long-­‐ lived  assets  using  cash     • Lending  money  and  collecting  the  loans   • Generally  includes  non-­‐current  asset  items  (e.g.,  long-­‐term  investments,   property,  plant,  and  equipment)  on  the  statement  of  financial  position   Financing  Activities   • Obtaining  cash  from  issuing  debt  and  repaying  the  amounts  borrowed       • Obtaining  cash  from  selling  common  and  preferred  shares  and  paying  dividends   • Generally  includes  non-­‐current  liabilities,  and  shareholders’  equity  items  on   the  statement  of  financial  position   Significant  Noncash  Activities   • If  it  does  not  affect  cash,  do  NOT  report  in  statement  of  cash  flows   • Report  in  separate  note  or  supplementary  schedule  to  the  financial  statements   • Examples:   o Issue  of  debt  to  purchase  assets   18   ADM1340  EXAM  REVIEW     CHAPTER  13   o Issue  of  shares
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