Chapter 16



Chapter 15 Organization and Operation of Corporations

Questions

1. The board of directors of a corporation is responsible for directing the corporation’s affairs.

2. Organization costs are incurred in creating a corporation. Examples include: legal fees, promoters’ fees, accountants’ fees, costs of printing share certificates, and fees paid to the provincial legal jurisdiction to obtain a corporate charter.

3. Organization costs are intangible assets, if material. If not, can be expensed.

4. The general rights of common shareholders include: (1) the right to vote in shareholders’ meetings, (2) the right to sell or otherwise dispose of shares, (3) the preemptive right, (4) the right to share proportionately in dividends, and (5) the right to share proportionately in assets remaining after the creditors are paid if the corporation is liquidated. In addition, shareholders have the right to receive timely and useful financial reports that describe the corporation’s financial position and the results of its activities.

5. The preemptive right of common shareholders is the right to maintain their relative ownership interests in the corporation by having the first opportunity to purchase their proportionate share of any additional common shares issued by the corporation.

6. The call price is the amount that a corporation must pay if it exercises the option to buy back and retire callable shares.

7. Convertible preferred shares are attractive because they offer the safety of a regular return as well as the opportunity to share in the increased value of the issuer’s common shares.

8. According to Note 7(b), WestJet Airlines had 129,575,099 common and variable shares issued and outstanding at December 31, 2005 for a total of $429,613,000. The average issue price at December 31, 2005 is $429,613,000/129,575,099 = $3.32 per common share.

9. According to the statement of retained earnings, Danier Leather declared and paid dividends of $1,620,000 during the year ended June 25, 2005.

quick study

QUICK STUDY 15-1 (10 MINUTES)

a, d

Quick Study 15-2 (10 minutes)

|2011 | | | |

|Jan. 1 |Organization Costs |56,000 | |

| | Cash | |50,000 |

| | Common Shares | |6,000 |

| | To record payment of organization costs | | |

| |and issuance of shares as part | | |

| |consideration. | | |

| | | | |

|Dec. 31 |Amortization Expense, Organization Costs |11,200 | |

| | Accumulated Amort., Organization Costs | |11,200 |

| | To record accumulated amortization, organization | | |

| |costs; 56,000/5 = 11,200. | | |

Quick Study 15-3 (10 minutes)

|LUDWIG LTD. |

|Income Statement |

|For Year Ended October 31, 2011 |

|Sales | | |$ 982,000 | |

|Cost of goods sold | | | 420,000 | |

|Gross profit | | |$ 562,000 | |

|Operating expenses | | | 162,000 | |

|Income from operations | | |$ 400,000 | |

|Other revenues and expenses: | | | | |

| Gain on sale of capital assets | $ 4,000 | | | |

| Interest expense |(6,200 |) | (2,200 |) |

|Income before tax | | |$ 397,800 | |

|Income tax expense | | | 99,450 | |

|Net income | | |$ 298,350 | |

Quick Study 15-4 (5 minutes)

|X |Cash | |CC |Preferred shares |

|CC |Common shares | |RE |Retained earnings |

|X |Common dividend payable | |X |Preferred dividend payable |

|RE |Deficit | |CC |Preferred shares, |

| | | | |$5 noncumulative |

| | | | | |

Quick Study 15-5 (20 minutes)

| |FORM OF BUSINESS ORGANIZATION |

|Transaction |Sole Proprietorship |Corporation |

|Jan. 1, 2011: |Cash 10,000 |Cash 10,000 |

|The owner(s) invested $10,000 |Ian Smith, Capital 10,000 |Common Shares 10,000 |

|into the new business | | |

|During 2011: |Cash 50,000 |Cash 50,000 |

|Revenues of $50,000 were earned; all cash |Revenues 50,000 |Revenues 50,000 |

|During 2011: |Expenses 30,000 |Expenses 30,000 |

|Expenses of $30,000 were incurred; all cash |Cash 30,000 |Cash 30,000 |

|Dec. 15, 2011: |Ian Smith, Withdrawals 15,000 |Cash Dividends 15,000 |

|$15,000 cash was distributed to the owner(s) |Cash 15,000 |(or R/E) |

| | |Cash 15,000 |

|Dec. 31, 2011, Year End: | | |

|All temporary accounts were closed |Revenues 50,000 |Revenues 50,000 |

|—Close Revenue account |Income Summary 50,000 |Income Summary 50,000 |

|—Close Expense account |Income Summary 30,000 |Income Summary 30,000 |

| |Expenses 30,000 |Expenses 30,000 |

|—Close Income Summary account to appropriate |Income Summary 20,000 |Income Summary 20,000 |

|equity account(s) |Ian Smith, Capital 20,000 |Retained Earnings 20,000 |

|—Close Withdrawal/Cash Dividends Declared |Ian Smith, Capital 15,000 |Retained Earnings 15,000 |

|account |Ian Smith, Withdrawals 15,000 |Cash Dividends 15,000 |

| | |No entry if debit Retained Earnings |

| | |used above. |

|Equity section on the balance sheet at December|Vision Consulting |Vision Consulting Inc. |

|31, 2011 after the first year of operations. |Partial Balance Sheet |Partial Balance Sheet |

| |December 31, 2011 |December 31, 2011 |

| | | |

| |Owner’s Equity |Shareholders’ Equity |

| |Ian Smith, capital………… $15,000 |Common shares………. $ 10,000 |

| | |Retained earnings……. 5,000 |

| | | |

| | |Total shareholders’ equity. 15,000 |

Quick Study 15-6 (10 minutes)

$48,000 + $146,000 – $47,000 – $15,000 = $132,000

OR

|Retained Earnings      |

| | | 48,000 |Bal. Dec. 31/11 |

| | |146,000 |Net income, 2012 |

|Dividends, 2012 |47,000 | | |

|Net loss, 2013 |15,000 | | |

| | |132,000 |Bal. Dec. 31/13 |

Quick Study 15-7 (5 minutes)

1. 300,000 – 120,000 + 50,000 = 230,000

2. Net income

3. Dividends

Quick Study 15-8 (10 minutes)

Feb. 1 Cash 252,440

Common shares 252,440

Issued shares for cash.

Feb. 12 Cash 340,750

Common shares 340,750

Issued shares for cash; 47,000 x $7.25.

The average issue price is $7.02 calculated as:

($252,440 + $340,750) ÷ (37,500 + 47,000).

Quick Study 15-9 (10 minutes)

a. Sold common shares for cash.

b. Issued common shares to pay organization costs.

c. Issued common shares for inventory and machinery, and assumed a note payable.

Quick Study 15-10 (10 minutes)

a.

|2011 | | | |

|Oct. 3 |Cash |60,000 | |

| | Preferred Shares | |60,000 |

| | To record issuance of preferred shares; | | |

| |4,000 × $15 = 60,000. | | |

| | | | |

|Nov. 19 |Land |52,480 | |

| | Preferred Shares | |52,480 |

| | To record issuance of 3,400 preferred | | |

| |shares in exchange for land. | | |

b. (60,000 + 52,480)/(4,000 + 3,400) = $15.20 per preferred share.

Quick Study 15-11 (10 minutes)

Apr. 15 Cash Dividends 48,000.00

Common Dividend Payable 48,000.00

Declared a cash dividend on common shares.

June 30 Common Dividend Payable 48,000.00

Cash 48,000.00

Paid the cash dividend to common shareholders.

Dec. 31 Retained Earnings 48,000.00

Cash Dividends 48,000.00

To close the Cash Dividends account.

OR

Apr. 15 Retained Earnings 48,000.00

Common Dividend Payable 48,000.00

Declared a cash dividend on common shares.

June 30 Common Dividend Payable 48,000.00

Cash 48,000.00

Paid the cash dividend to common shareholders.

Dec. 31 No entry required.

Quick Study 15-12 (10 minutes)

a. Total dividend . 108,000

To preferred shareholders 60,000* 

Remainder to common shareholders $48,000

*75,000 shares × $0.40 × 2 years = $60,000

b. Total dividend . 108,000

To preferred shareholders 30,000* 

Remainder to common shareholders $78,000

*75,000 shares × $0.40 for current year only = $30,000

Quick Study 15-13 (10 minutes)

a. The preferred shares are entitled to receive $0.50 per share when the board of directors declares dividends; if dividends are not declared, the undeclared dividends do not become a liability but go into arrears; arrears mean that the undeclared dividends must be paid to the preferred shareholders in the future along with any current dividends before the common shareholders receive dividends.

b. The total amount contributed, or given to the corporation, as a result of the shareholders’ purchase of shares.

c. The corporation is allowed to issue 20,000 shares based on its articles of incorporation.

d. 150,000 common shares have been ‘sold’ and are held by shareholders.

e. Accumulated net profits less any net losses and dividends.

f. An unlimited number of common shares may be issued by the corporation based on its articles of incorporation.

Quick Study 15-14 (20 minutes)

a.

|2011 | | | |

|May 31 |Revenues |92,000 | |

| | Income Summary | |92,000 |

| | To close revenues to the income summary. | | |

| | | | |

| 31 |Income Summary |58,000 | |

| | Expenses | |58,000 |

| | To close expenses to the income summary. | | |

| | | | |

| 31 |Income Summary |34,000 | |

| | Retained Earnings | |34,000 |

| | To close the income summary to retained earnings. | | |

Quick Study 15-14 (concluded)

|2011 | | | |

|May. 31 |Retained Earnings |3,500 | |

| | Cash Dividends | |3,500 |

| | To close cash dividends to retained earnings. | | |

b.

|PETER PUCK INC. |

|Statement of Retained Earnings |

|For Year Ended May 31, 2011 |

|Retained earnings, June 1 |$ 29,000 |

|Add: Net income | 34,000 |

| Total |$ 63,000 |

|Less: Dividends | 3,500 |

|Retained earnings, May 31 |$ 59,500 |

Quick Study 15-15 (20 minutes)

a.

|2011 | | | |

|Nov. 30 |Revenues |87,000 | |

| | Income Summary | |87,000 |

| | To close revenues to the income summary. | | |

| | | | |

| 30 |Income Summary |96,000 | |

| | Expenses | |96,000 |

| | To close expenses to the income summary. | | |

| | | | |

| 30 |Retained Earnings |9,000 | |

| | Income Summary | |9,000 |

| | To close the income summary to retained | | |

| |earnings regarding the loss. | | |

| | | | |

| 30 |Retained Earnings |14,000 | |

| | Cash Dividends | |14,000 |

| | To close cash dividends to retained | | |

| |earnings. | | |

Quick Study 15-15 (concluded)

b.

|MORRIS INC. |

|Statement of Retained Earnings |

|For Year Ended November 30, 2011 |

|Retained earnings, December 1 |$42,000 |

|Less: |Net loss |9,000 | |

| |Dividends |14,000 | 23,000 |

|Retained earnings, November 30 |$19,000 |

| | |

Quick Study 15-16 (20 minutes)

a.

|2011 | | | |

|Aug. 31 |Revenues |76,000 | |

| | Income Summary | |76,000 |

| | To close revenues to the income summary. | | |

| | | | |

| 31 |Income Summary |94,000 | |

| | Expenses | |94,000 |

| | To close expenses to the income summary. | | |

| | | | |

| 31 |Retained Earnings |18,000 | |

| | Income Summary | |18,000 |

| | To close the income summary to retained | | |

| |earnings regarding the loss. | | |

b.

|VELOR LTD. |

|Statement of Retained Earnings (Deficit) |

|For Year Ended August 31, 2011 |

|Retained earnings, September 1 |$12,000 | |

|Less: Net loss | 18,000 | |

|Retained Earnings (Deficit), August 31 |$ (6,000 |) |

| | | |

*Quick Study 15-17 (20 minutes)

a.

| |Total shareholders’ equity |$920,000 | |

| |Less equity attributable to preferred shares: | | |

| | — paid-in capital | 100,000 | |

| |Equity applicable to common shares |$820,000 | |

| |Book value of common shares ($820,000/75,000) |$ 10.93 | |

b.

| |Total shareholders’ equity |$920,000 | |

| |Less equity attributable to preferred shares: | | |

| | — paid-in capital |100,000 | |

| | — dividends in arrears (10,000 × $5 × 3 years) | 150,000 | |

| |Equity applicable to common shares |$670,000 | |

| |Book value of common shares ($670,000/75,000) |$ 8.93 | |

c.

| |Total shareholders’ equity |$920,000 | |

| |Less equity attributable to preferred shares: | | |

| | — call price (10,000 × $30) | 300,000 | |

| |Equity applicable to common shares |$620,000 | |

| |Book value of common shares ($620,000/75,000) |$ 8.27 | |

EXERCISES

EXERCISE 15-1 (20 MINUTES)

|a) |Partnership | | | |

|Feb. |14 |Cash |250,000.00 | |

| | |  Tom Seabrink, Capital | |125,000.00 |

| | |  Joan Miller, Capital | |125,000.00 |

| | | To record investment into business by partners. | | |

| | | | | |

|Dec. |23 |Tom Seabrink, Withdrawals |24,000.00 | |

| | |Joan Miller, Withdrawals |24,000.00 | |

| | |  Cash | |48,000.00 |

| | |To record withdrawals by owners. | | |

| | | | | |

| |31 |Income Summary |96,000.00 | |

| | |  Tom Seabrink, Capital | |48,000.00 |

| | |  Joan Miller, Capital | |48,000.00 |

| | | To record closing of income summary to capital. | | |

| | | | | |

| |31 |Tom Seabrink, Capital |24,000.00 | |

| | |Joan Miller, Capital |24,000.00 | |

| | |  Tom Seabrink, Withdrawals | |24,000.00 |

| | |  Joan Miller, Withdrawals | |24,000.00 |

| | | To record closing of withdrawals to capital. | | |

| | | | | |

Exercise 15-1 (concluded)

|b) |Corporation | | | |

|Feb. |14 |Cash |250,000.00 | |

| | |  Common Shares | |250,000.00 |

| | | To record issuance of common shares. | | |

| | | | | |

|Dec. |20 |Cash Dividends |48,000.00 | |

| | |  Common Dividend Payable | |48,000.00 |

| | | To record declaration of dividends. | | |

| | | | | |

| |23 |Common Dividend Payable |48,000.00 | |

| | |  Cash | |48,000.00 |

| | | To record payment of dividends. | | |

| | | | | |

| |31 |Income Summary |96,000.00 | |

| | |  Retained Earnings | |96,000.00 |

| | |   To record closing of income summary to | |

| | |   retained earnings. | |

| | | | | |

| |31 |Retained Earnings |48,000.00 | |

| | |  Cash Dividends | |48,000.00 |

| | | To record closing of dividends to | |

| | |   retained earnings. | |

OR

|b) |Corporation | | | |

|Feb. |14 |Cash |250,000.00 | |

| | |  Common Shares | |250,000.00 |

| | | To record issuance of common shares. | | |

| | | | | |

|Dec. |20 |Retained Earnings |48,000.00 | |

| | |  Common Dividend Payable | |48,000.00 |

| | | To record declaration of dividends (directly to | | |

| | |retained earnings). | | |

| | | | | |

| |23 |Common Dividend Payable |48,000.00 | |

| | |  Cash | |48,000.00 |

| | | To record payment of dividends. | | |

| | | | | |

| |31 |Income Summary |96,000.00 | |

| | |  Retained Earnings | |96,000.00 |

| | |   To record closing of income summary to | |

| | |   retained earnings. | |

| | | | | |

Exercise 15-2 (15 minutes)

|2011 | | | |

|Jan. 15 |Organization Costs |22,500 | |

| | Common Shares | |22,500 |

| | Issued common shares to promoters. | | |

| | | | |

|Feb. 21 |Cash |150,000 | |

| | Common Shares | |150,000 |

| | Issued common shares for cash; | | |

| |15,000 shares x $10/share = $150,000. | | |

| | | | |

|Mar. 9 |Cash |79,000 | |

| | Preferred Shares | |79,000 |

| | Issued preferred shares for cash. | | |

| | | | |

|Aug. 15 |Land |225,000 | |

| |Building |300,000 | |

| |Equipment |80,000 | |

| | Common Shares | |605,000 |

| | Issued common shares in exchange for capital | | |

| |assets. | | |

Exercise 15-3 (30 minutes)

|a) | |

|2011 | | | | | |

|Jan. |1 |Cash | |50,000.00 | | |

| | |  Preferred Shares | | | |50,000.00 |

| | | Issued preferred shares. | | | | | |

| | | | | | | | |

|Feb. |5 |Cash | |105,000.00 | | |

| | |  Common Shares | | | |105,000.00 |

| | | Issued common shares. | | | | | |

| | | | | | | | |

|Mar. |20 |Organization Costs | |24,000.00 | | |

| |  |  Common Shares | | | |24,000.00 |

| | | Issued shares to organizers for their work. | | | | | |

| | | | | | | | |

|May |15 |Cash | |292,000.00 | | |

| | |  Preferred Shares | | | |132,000.00 |

| | |  Common Shares | | | |160,000.00 |

| | | Issued preferred and common shares. | | | | | |

| | | | | | | | |

|Dec. |31 |Retained Earnings | |235,000.00 | | |

| | |  Income Summary | | | |235,000.00 |

| | | Closed the net loss to Retained Earnings. | | | | | |

Exercise 15-3 (continued)

|b) | |ABC Inc. | | |

| | |Shareholders’ Equity | | |

| | |December 31, 2011 | | |

| | |Contributed Capital: | | |

| | | Preferred Shares, $2.00; 50,000 shares authorized; | | |

| | |  17,0001 shares issued and outstanding |$182,000.001 |

| | | Common Shares | | |

| | |  300,000 shares authorized; | | |

| | |  38,0002 shares issued and outstanding | 289,000.002 |

| | |  Total contributed capital |$471,000.00 |

| | |Deficit | 235,000.00 |

| | |Total shareholders’ equity |$236,000.00 |

|c) | | |The $2.00 is the dividend entitlement per preferred share or how much each preferred share is supposed to get in dividends |

| | | |each year. |

Calculations:

|1. Preferred Shares: |Shares |Dollars |

|Jan. 1 |Issued 5,000 shares (5,000 x $10.00) |5,000 |$ 50,000 |

|May 15 |12,000 shares issued (12,000 x $11.00) |12,000 | 132,000 |

| |Totals |17,000 |$ 182,000 |

|2. Common Shares: | | |

|Feb. 5 |Issued 15,000 shares |15,000 |$105,000 |

|Mar. 20 |Issued 3,000 shares |3,000 |24,000 |

|May 15 |20,000 shares issued (20,000 x $8.00) |20,000 | 160,000 |

| |Totals |38,000 |$289,000 |

Exercise 15-4 (10 minutes)

|March |1 |Cash Dividends or Retained Earnings |25,000 | |

| | Common Dividends Payable | |25,000 |

| | To record common dividend of $0.50 per share. | | |

| | | | |

| |10 |No entry. | | |

| | | | |

| |31 |Common Dividends Payable |25,000 | |

| | Cash | |25,000 |

| | Paid the dividends declared on March 1. | | |

Exercise 15-5 (15 minutes)

|2011 | | | |

|June 5 |Organization Costs |65,000 | |

| | Common Shares | |65,000 |

| | Issued 4,000 common shares to promoters. | | |

| | | | |

|15 |Cash |1,275,000 | |

| | Common Shares | |1,275,000 |

| | Issued common shares for cash; | | |

| |75,000 shares x $17/share = $1,275,000. | | |

| | | | |

|16 |Cash |300,000 | |

| | Preferred Shares | |300,000 |

| | Issued preferred shares for cash; | | |

| |10,000 shares x $30/share = $300,000. | | |

| | | | |

|17 |Accounts Payable |100,000 | |

| | Common Shares | |100,000 |

| | Issued 8,000 common shares to a creditor. | | |

| | | | |

|18 |Cash Dividends or Retained Earnings |20,000 | |

| | Common Dividends Payable | |5,000 |

| | Preferred Dividends Payable | |15,000 |

| | Declared dividends. | | |

| | | | |

|30 |Machinery |1,980,000 | |

| | Common Shares | |1,980,000 |

| | Issued common shares in exchange for machinery; | | |

| |150,000 shares x $13,20/share = $1,980,000. | | |

| | | | |

|July 1 |Common Dividends Payable |5,000 | |

| |Preferred Dividends Payable |15,000 | |

| | Cash | |20,000 |

| | Paid the dividends declared June 18. | | |

Exercise 15-6 (25 minutes)

|a) | |

|2011 | | | | | |

|Jan. |1 |Organization Costs | |8,000.00 | | |

| | |  Common Shares | | | |8,000.00 |

| | | To record issuance of shares. | | | | | |

| | | | | | | | |

| |5 |Cash | |135,000.00 | | |

| | |  Common Shares | | | |135,000.00 |

| | | To record issuance of shares, 15,000 × $9 | | | | | |

| | | | | | | | |

| |15 |Cash Dividends or Retained Earnings | |8,000.00 | | |

| | |  Common Dividends Payable | | | |8,000.00 |

| | | Declared dividends; $0.50 x 16,000 = $8,000 | | | | | |

| | | | | | | | |

| |20 |Land | |43,000.00 | | |

| | |  Common Shares | | | |43,000.00 |

| | | To record issuance of shares: | | | | | |

| | |4,000 x $10.75. | | | | | |

| | | | | | | | |

| |31 |Income Summary | |110,000.00 | | |

| | |  Retained Earnings | | | |110,000.00 |

| | | To close income summary to retained | | | | | |

| | |earnings. | | | | | |

| | | | | | | | |

| |31 |Common Dividends Payable | |8,000.00 | | |

| | |  Cash | | | |8,000.00 |

| | | Paid dividends. | | | | | |

Exercise 15-6 (concluded)

|b) | | |LINDSAY LTD. | | | |

| | | |Shareholders’ Equity | | | |

| | | |January 31, 2011 | | | |

| | | | | | | |

| | | |Common shares, unlimited shares authorized, | | | |

| | | | 20,0001 shares issued and outstanding | |$186,0001 |

| | | |Retained earnings | | 102,0002 |

| | | |Total shareholders’ equity | |$288,000 |

|c) |Average Issue Price $186,000 ( 20,000 shares = $9.30 per share. | |

Calculations:

|1. | |Shares |Dollars |

|Jan. 1 |Issued 1,000 shares |1,000 |$ 8,000 |

|5 |Issued 15,000 shares (15,000 x $9.00) |15,000 |135,000 |

|20 |Issued 4,000 shares (4,000 x $10.75) | 4,000 | 43,000 |

| |Totals |20,000 |$186,000 |

| | | | |

|2. |$110,000 – $8,000 = $102,000 | | |

Exercise 15-7

1. $4.50 Cumulative Preferred Shares:

$4.50/share × 40,000 shares = $180,000 each year × 3 years = $540,000

$12 Noncumulative Preferred Shares:

$12/share × 8,000 shares = $96,000

Common Shares:

$736,000 – (540,000 + 96,000) = $100,000

2. Dec. 31/10 Retained Earnings Balance + 2011 Net Income of $1,500,000 – 2011 Dividends of $736,000 = Dec. 31/11 Retained Earnings Balance of $890,000

Therefore,

Dec. 31/10 Retained Earnings Balance = $126,000

OR

|Retained Earnings |

| | | |Bal. |

| | |X |Dec. 31/10 |

| | | | |

|2011 dividends |736,000 |1,500,000 |2011 net income |

| | | |Bal. |

| | |890,000 |Dec. 31/11 |

3.

Maritime Inc.

Statement of Retained Earnings

For Year Ended December 31, 2011

Retained earnings, January 1 $ 126,000

Add: Net income 1,500,000

Total $1,626,000

Less: Cash dividends 736,000

Retained earnings, December 31 $ 890,000

Exercise 15-8

BLUE IGUANA INC.

Shareholders’ Equity

December 31, 2011

|Contributed Capital: | |

| Preferred shares, $3.00 noncumulative: | |

|  100,000 shares authorized, |A. |$2,250,000 |

|  75,000 shares issued and outstanding | | |

| Common shares | | | |

|  Unlimited shares authorized, | E. 250,000 shares | |B. |4,000,000 |

|  250,000 shares issued and outstanding | | | | |

| | |

| Total contributed capital |$6,250,000 |

|Retained earnings | |C. |1,150,000 |

| | | | |

|Total shareholders’ equity | |D. |$7,400,000 |

| | | | |

Calculations:

A. $30.00 × 75,000 shares = $2,250,000

B. $6,250,000 – $2,250,000 = $4,000,000

C. $160,000 + $1,440,000 – $450,000 = $1,150,000

OR

|Retained Earnings |

| | |160,000 | |

| |450,000 |1,440,000 | |

| | |1,150,000 | |

D. $6,250,000 + $1,150,000 = $7,400,000

E. $4,000,000 ( $16.00 = 250,000 shares

Exercise 15-9

1. $5/share × 8,000 shares = $40,000

2. Yes. Calculation is $40,000 × 2 years = $80,000

3. a) ($5 × 8,000 shares) = $40,000 × 3 years = $120,000

b) $4 × 45,000 = $180,000

4. 105,000 + 340,000 – 120,000 – 180,000 = 145,000

5. 160,000 + 450,000 = 610,000

6. 610,000 + 145,000 = 755,000

7. 10,000 – 8,000 = 2,000

8. $160,000/8,000 shares = $20/share

Exercise 15-10 (20 minutes)

NOTE: The holders of the cumulative preferred shares are entitled to no more than $376,000 of dividends in any year ($8 × 47,000 shares) plus any dividends in arrears.

Preferred Common

2011 ($0):

Preferred—current $ 0

Common—remainder   $ 0

Total for the year $ 0 $ 0

2012 ($400,000):

Preferred—arrears $ 376,000

Preferred—current (400,000 – 376,000) 24,000

Common—remainder   $ 0

Total for the year $ 400,000 $ 0

2013 ($840,000):

Preferred—arrears (376,000 – 24,000) $ 352,000

Preferred—current 376,000

Common—remainder (840,000 – 728,000)   $112,000

Total for the year $ 728,000 $112,000

2014 ($400,000):

Preferred—current $ 376,000

Common—remainder (400,000 – 376,000)   $ 24,000

Total for the year $ 376,000 $ 24,000

Total for four years $1,504,000 $136,000

Exercise 15-11 (20 minutes)

NOTE: The holders of the noncumulative preferred shares are entitled to no more than $376,000 of dividends in any year ($8 × 47,000 shares).

PREFERRED COMMON

2011 ($0):

Preferred—current $ 0

Common—remainder   $ 0

Total for the year $ 0 $ 0

2012 ($400,000):

Preferred—current $ 376,000

Common—remainder (400,000 – 376,000)   $ 24,000

Total for the year $ 376,000 $ 24,000

2013 ($840,000):

Preferred—current 376,000

Common—remainder (840,000 – 376,000)   $464,000

Total for the year $ 376,000 $464,000

2014 ($400,000):

Preferred—current $ 376,000

Common—remainder (400,000 – 376,000)   $ 24,000

Total for the year $ 376,000 $ 24,000

Total for four years $1,128,000 $512,000

Exercise 15-12 (10 minutes)

1. B

2. A

3. F

4. E

5. D

6. C

Exercise 15-13

1. (15,000 shares × $4.50/share) × 2 years = $135,000

2. $150,000 Total dividends – $135,000 paid to preferred shareholders = $15,000 to common shareholders

Exercise 15-14 (20 minutes)

|2011 | | | |

|Dec. 31 |Revenue |194,000 | |

| | Income Summary | |194,000 |

| | To close the revenue account to the income | | |

| |summary. | | |

| | | | |

|31 |Income Summary |107,000 | |

| | Income Tax Expense | |29,000 |

| | Operating Expenses | |78,000 |

| | To close the expense accounts to the income | | |

| |summary. | | |

| | | | |

|31 |Income Summary |87,000 | |

| | Retained Earnings | |87,000 |

| | To close the income summary to retained earnings. | | |

| | | | |

|31 |Retained Earnings |14,000 | |

| | Cash Dividends | |14,000 |

| | To close the Cash Dividends account to Retained | | |

| |Earnings. | | |

| | | | |

| |Post-Closing Balance in Retained Earnings: | | |

| | Retained Earnings, December 31, 2010 | |$19,800 |

| | Add: Net income for December | |87,000 |

| | Less: Cash Dividends | | 14,000 |

| | Retained Earnings, December 31, 2011 | |$92,800 |

| | | | |

| |OR | | |

| | | | |

| |Retained Earnings | | |

| | | |19,800 |Bal. Dec. 31/10 | | |

| |Cash Dividends | | |2011 | | |

| | |14,000 |87,000 |Net income | | |

| | | |92,800 |Bal. Dec 31/11 | | |

Exercise 15-15 (30 minutes)

|Gildan Corp. |

|Balance Sheet |

|December 31, 2011 |

|Assets | | | |

| Current assets: | | | |

| Cash | |$ 6,000 | |

| Accounts receivable | |28,000 | |

| Total current assets | | |$34,000 |

| Property, plant and equipment: | | | |

| Land | |$84,000 | |

| Warehouse |$92,000 | | |

| Less: Accumulated amortization | 15,200 |76,800 | |

| Equipment |$56,000 | | |

| Less: Accumulated amortization | 7,600 |48,400 | |

| Total property, plant and equipment | | |209,200 |

|Total assets | | |$243,200 |

| | | | |

|Liabilities | | | |

| Current liabilities : | | | |

| Accounts payable | |$ 18,400 | |

| Long-term liabilities: | | | |

| Long term note payable, due in 2014 | |24,000 | |

|Total liabilities | | |$ 42,400 |

| | | | |

|Shareholders’ Equity | | | |

| Contributed Capital: | | | |

| Preferred shares | |$28,000 | |

| Common shares | |80,000 | |

| Total contributed capital | |$108,000 | |

| Retained earnings | | 92,800 | |

|Total shareholders’ equity | | |200,800 |

|Total liabilities and shareholders’ equity | | |$243,200 |

1. 83% (200,800 ÷ 243,200 = 83%)

2. 83% (200,800 ÷ 243,200 = 83%)

3. 17% (42,400 ÷ 243,200 = 17%)

4. 71% [(80,000 + 92,800) ÷ 243,200 = 71%]

5. 12% (28,000 ÷ 243,200 = 12%)

The main advantage to the common shareholders of issuing preferred shares over additional common shares is that the common shareholders will retain ownership, hence, control.

Exercise 15-16

|1. | |

|2011 | | | | | |

|Jan. |3 |Cash | |21,500.00 | | |

| | |  Common Shares | | | |21,500.00 |

| | | Issued common shares for cash. | | | | |

| | | | | | | | |

|Mar . |1 |Cash | |15,000.00 | | |

| | |  Preferred Shares (5,000 x 3) | | | |15,000.00 |

| | | Issued preferred shares for cash. | | | | |

| | | | | | | | |

|June |15 |Equipment | |10,000.00 | | |

| | |  Common Shares | | | |10,000.00 |

| | | Issued common shares in exchange for equipment. | |

| | | | | | | | |

|Dec. |31 |Income Summary | |175,000.00 | | |

| | |  Retained Earnings | | | |175,000.00 |

| | | Closed the income summary to retained earnings. | |

| | | | | | | | |

|2. |TGIF Inc. |

| |Shareholders’ Equity |

| |December 31, 2011 |

| | |

| | |

| | |Contributed Capital: | | | | |

| | | Preferred shares, $0.25 cumulative | | | | |

| | |  80,000 shares authorized, | | | | |

| | |  65,0001 shares issued and outstanding | | | |$165,0001 |

| | | Common shares, | | | | |

| | |  250,000 shares authorized, | | | | |

| | |  147,0002 shares issued and outstanding | | | | 151,5002 |

| | | Total contributed capital | | | |$316,500 |

| | |Retained earnings* | | | | 267,500 |

| | |Total shareholders’ equity | | | |$584,000 |

*$92,500 + $175,000

|3. |15,000 | | | | | | | |

| | | | | | | | | |

|4. |103,000 | | | | | | | |

Exercise 15-16 (concluded)

Calculations:

|1. Preferred Shares: |Shares |Dollars |

|Jan. 1 |Balance brought forward |60,000 |$150,000 |

|Mar. 1 |Issued 5,000 shares (5,000 x $3.00) | 5,000 | 15,000 |

| |Totals |65,000 |$165,000 |

| | | |

|2. Common Shares: |Shares |Dollars |

|Jan. 1 |Balance brought forward |120,000 |$120,000 |

|3 |20,000 shares issued |20,000 |21,500 |

|Jun. 15 |Issued 7,000 shares | 7,000 | 10,000 |

| |Totals |147,000 |$151,500 |

Exercise 15-17

Part A

|2011 | | | |

|Oct. 1 |Cash |4,000 | |

| | Preferred Shares | |4,000 |

| | Issued preferred shares; 1,000 shares × $4.00/share. | |

| | | | |

|10 |Cash |150,000 | |

| | Common Shares | |150,000 |

| | Issued common shares; 50,000 shares × $3.00/share. | |

| | | | |

|12 |Organization Costs |11,250 | |

| | Preferred Shares | |11,250 |

| | Issued preferred shares in exchange for | | |

| |organization efforts; 2,500 shares × $4.50/share. | | |

| | | | |

|15 |Land |155,000 | |

| | Cash | |55,000 |

| | Notes Payable | |100,000 |

| | Purchased land in exchange for cash and a note. | | |

| | | | |

|20 |Cash |70,500 | |

| | Preferred Shares | |70,500 |

| | Issued preferred shares for cash. | | |

| | | | |

|24 |Cash Dividends (or Retained Earnings) |31,650 | |

| | Common Dividends Payable | |22,400 |

| | Preferred Dividends Payable | |9,250 |

| | Declared dividends; 18,500 preferred shares × $0.50 = $9,250. | |

| | | | |

|31 |Cash |750,000 | |

| | Revenues | |750,000 |

| | To record revenues. | | |

| | | | |

|31 |Expenses |250,000 | |

| | Cash | |250,000 |

| | To record expenses. | | |

| | | | |

|31 |Income Summary |500,000 | |

| | Retained Earnings | |500,000 |

| | To record closing of income summary to retained earnings. | |

| | | | |

|31 |Retained Earnings* |31,650 | |

| | Cash Dividends | |31,650 |

| | To record closing of dividends to retained earnings | |

| |(*or no entry if on Oct. 24 it was debited to Retained Earnings). |

Exercise 15-17 (concluded)

Part B

|ABC INC. |

|Balance Sheet |

|October 31, 2011 |

|Assets | | |

| Current assets: | | |

| Cash | |$669,500 |

| Property, plant and equipment: | | |

| Land | |155,000 |

| Intangible assets: | | |

| Organization costs | | 11,250 |

|Total assets | |$835,750 |

| | | |

|Liabilities | | |

| Current liabilities | | |

| Dividends payable |$ 31,650 | |

| Long term liabilities: | | |

| Long term note payable |100,000 | |

|Total liabilities | |$131,650 |

| | | |

|Shareholders’ Equity | | |

|Contributed Capital: | | |

| Preferred shares, $0.50 cumulative, | | |

| 100,000 shares authorized, | | |

| 18,500 shares issued and outstanding: |$ 85,750 | |

| Common shares, | | |

| 500,000 shares authorized, | | |

|  50,000 shares issued and outstanding: |150,000 | |

| Total contributed capital |$235,750 | |

| Retained earnings | 468,350 | |

| Total shareholders’ equity | | 704,100 |

|Total liabilities and shareholders’ equity | |$835,750 |

*Exercise 15-18 (20 minutes)

a.

|Total shareholders’ equity | |$1,585,000 | |

|Less equity applicable to preferred shares: | | | |

| Call price ($60 × 5,000) |$300,000 | | |

| Cumulative dividends in arrears (none) |              0 | (300,000 |) |

|Equity applicable to common shares | |$1,285,000 | |

| | | | |

|Book value of preferred shares ($300,000/5,000) |$ 60.00 | | |

| | | | |

|Book value of common shares ($1,285,000/40,000) | |$ 32.13 | |

b.

|Total shareholders’ equity | |$1,585,000 | |

|Less equity applicable to preferred shares: | | | |

| Call price ($60 × 5,000) |$300,000 | | |

| Cumulative dividends in arrears | | | |

| (3 × $3.00 × 5,000) | 45,000 | (345,000 |) |

|Equity applicable to common shares | |$1,240,000 | |

| | | | |

|Book value of preferred shares ($345,000/5,000) |$ 69.00 | | |

| | | | |

|Book value of common shares ($1,240,000/40,000) | |$ 31.00 | |

PROBLEMS

PROBLEM 15-1A (40 MINUTES)

|SOUTHGATE INC. |

|Balance Sheet |

|March 31, 2011 |

|Assets | | |

| | | |

|Current assets | | |

| | | |

| | | |

| | | |

| | | |

|Cash | | |

| | | |

| | | |

|$ 24,000 | | |

| | | |

|Accounts receivable | | |

| | | |

|$56,000 | | |

| | | |

| | | |

|Less: Allowance for doubtful accounts | | |

| | | |

|3,000 | | |

|53,000 | | |

| | | |

|Prepaid rent | | |

| | | |

| | | |

|46,000 | | |

| | | |

|Total current assets | | |

| | | |

| | | |

|$123,000 | | |

| | | |

|Property, plant and equipment | | |

| | | |

| | | |

| | | |

| | | |

|Vehicles | | |

|$ 68,000 | | |

| | | |

| | | |

| | | |

|Less: Accumulated amortization, vehicles | | |

|52,000 | | |

|$ 16,000 | | |

| | | |

| | | |

|Equipment | | |

|$390,000 | | |

| | | |

| | | |

| | | |

|Less: Accumulated amortization, equipment | | |

|124,000 | | |

|266,000 | | |

| | | |

| | | |

|Total property, plant and equipment | | |

| | | |

| | | |

|282,000 | | |

| | | |

|Intangible assets | | |

| | | |

| | | |

| | | |

| | | |

|Franchise | | |

| | | |

|$ 96,000 | | |

| | | |

| | | |

|Less: Accumulated amortization, franchise | | |

| | | |

|42,000 | | |

|54,000 | | |

| | | |

|Total assets | | |

| | | |

| | | |

|$459,000 | | |

| | | |

|Liabilities | | |

| | | |

|Current liabilities | | |

| | | |

| | | |

| | | |

| | | |

|Accounts payable | | |

| | | |

|$ 17,000 | | |

| | | |

| | | |

|Advertising payable | | |

| | | |

|2,500 | | |

| | | |

| | | |

|Income tax payable | | |

| | | |

|46,000 | | |

| | | |

| | | |

|Unearned revenues | | |

| | | |

|23,000 | | |

| | | |

| | | |

|Current portion of notes payable | | |

| | | |

|50,000 | | |

| | | |

| | | |

|Total current liabilities | | |

| | | |

| | | |

|$ 138,500 | | |

| | | |

|Long-term liabilities | | |

| | | |

| | | |

| | | |

| | | |

|Notes payable, less $50,000 current portion | | |

| | | |

| | | |

|70,000 | | |

| | | |

|Total liabilities | | |

| | | |

| | | |

|208,500 | | |

| | | |

|Shareholders' equity | | |

| | | |

|Contributed capital | | |

| | | |

| | | |

| | | |

| | | |

|Common shares, 100,000 shares authorized, | | |

| | | |

| | | |

| | | |

| | | |

|25,000 shares issued | | |

| | | |

|$200,000 | | |

| | | |

| | | |

|Retained earnings | | |

| | | |

|50,500 | | |

| | | |

| | | |

|Total shareholders' equity | | |

| | | |

| | | |

|250,500 | | |

| | | |

|Total liabilities and shareholders' equity | | |

| | | |

| | | |

|$459,000 | | |

| | | |

| | | |

| | | |

| | | |

|Problem 15-1A (concluded) | | |

|Analysis component: | | |

|45.42% (208,500/459,000 × 100) | | |

|54.58% (100 – 45.42) | | |

|Assuming that 37% of Southgate’s assets were financed by debt at March 31, 2010, the balance sheet has not | | |

|been strengthened over the current year. | | |

| | | |

Problem 15-2A (20 minutes)

|Retained earnings December 31, 2011 | |$1,117,216 |

|Reductions in retained earnings due to transactions: | | |

| Cash dividends declared: | | |

| March 16, on 96,000 shares (96,000 × $0.40) |$ 38,400 | |

| June 25, on 96,000 shares |38,400 | |

| Sept. 25, on 96,000 shares |38,400 | |

| Nov. 22, on 115,200 shares (115,200 × $0.40) | 46,080 |161,280 |

|Less: Retained earnings December 31, 2012 | | 919,200 |

|Net loss | |$ 36,736 |

Problem 15-3A (25 minutes)

|2011 | | | |

|Apr. 1 |Preferred Shares |200,000 | |

| | Common Shares | |200,000 |

| | To record the conversion of 1,000 preferred / | | |

| |shares into 8,000 common shares; | | |

| |$500,000 ÷ 2,500 shares = $200 average issue | | |

| |price per preferred share; $200 x 1,000 = $200,000. | | |

Immediately after the conversion of the preferred shares, the shareholders’ equity section would still show 2,500 preferred shares authorized, but only 1,500 shares issued and outstanding. The amount of preferred shares would change from $500,000 to $300,000. Common shares would still show unlimited shares authorized, and 48,000 shares issued and outstanding. The amount of common shares would be $1,000,000 instead of $800,000. Retained earnings would not be affected. Total shareholders’ equity also would not be affected because $200,000 has simply shifted from the preferred shares section to the common shares section.

Analysis component:

As a result of the conversion, a smaller total dividend would be paid to preferred shares and a larger total dividend would be paid to common shares. However, as a common shareholder, you would not want the conversion of preferred shares to take place before the dividend. The reason is that the conversion increases the number of common shares outstanding by 8,000 and the dividend per share of common would be smaller. Even though there is more cash left over for the common shareholders after the conversion, the dividend per common share is less because there are more common shares dividing the cash. Before the conversion, there are 2,500 shares of $16 preferred. Therefore, $40,000 of the $600,000 paid out in dividends goes to the preferred shareholders. If the remaining $560,000 is divided by 40,000 common shares outstanding, the common dividend per share is $14.00. However, after the conversion, $24,000 ($16 x 1,500) of the $600,000 paid out in dividends goes to the 1,500 shares of $16 preferred, and the remaining $576,000 is divided between the 48,000 common shares outstanding. This reduces the dividend per share to $12.00.

Problem 15-4A (25 minutes)

1. $450,000/$15 per share = 30,000 shares

2. 325,000 shares × $8 per share = $2,600,000

3. 450,000 + 2,600,000 = 3,050,000

4. $3,050,000 – $2,890,000 = $160,000 Deficit

5. 2,890,000 – 3,050,000 = 160,000 Deficit; 320,000 + 160,000 = 480,000 Net Loss

6. a) $2.50/share × 30,000 shares = $75,000 to preferred shareholders

b) $100,000 – $75,000 paid to preferred shareholders = $25,000 to common shareholders

7. a) $75,000/30,000 shares = $2.50/share

b) $25,000/325,000 shares = $.0769/share

8. No, because the preferred shares are non-cumulative.

9. Retained Earnings result when cumulative net earnings are greater than cumulative losses + dividends. A deficit results when cumulative earnings are less than cumulative losses and dividends.

10. Dividends in arrears represent undeclared dividends that must be paid to preferred shareholders before any dividends are given to common shareholders but only if dividends are declared. Dividends payable, in contrast, are dividends that have been declared but not yet paid.

Problem 15-5A (20 minutes)

Part A – Non-cumulative (maximum annual dividend: 45,000 x $5.60 = $252,000)

1.

| | | |Total Dividends |

|Year |Preferred Dividends |Common Dividends | |

|2009 |$200,000 |0 |$200,000 |

|2010 |252,000 |248,000 |500,000 |

|2011 |252,000 |448,000 |700,000 |

|Total for three years |$704,000 |$696,000 |$1,400,000 |

Problem 15-5A (concluded)

2. Preferred Shares: $252,000/45,000 shares = $5.60 per share

Common Shares: $448,000/80,000 shares = $5.60 per share

Part B — Cumulative

1.

| | | |Total Dividends |

|Year |Preferred Dividends |Common Dividends | |

|2009 |$200,000 |0 |$200,000 |

|2010 |252,000 + 52,000 = 304,000 |196,000 |500,000 |

|2011 |252,000 |448,000 |700,000 |

|Total for three years |$756,000 |$644,000 |$1,400,000 |

2. Preferred Shares: $252,000/45,000 shares = $5.60 per share

Common Shares: $448,000/80,000 shares = $5.60 per share

Analysis component:

Cumulative preferred shares would have a greater market value than non-cumulative because undeclared dividends are never lost on cumulative preferred shares whereas undeclared dividends on non-cumulative shares are lost. Therefore, the potential return to the shareholder on cumulative preferred shares would be higher.

Problem 15-6A (60 minutes)

Part 1. Journal entries:

Jan. 5 Cash Dividends or Retained Earnings 80,000

Common Dividend Payable 80,000

Declared dividend on 20,000 outstanding shares.

Feb. 28 Common Dividend Payable 80,000

Cash 80,000

Paid cash dividend.

July 6 Cash (750 × $48) 36,000

Common shares 36,000

Issued common shares.

Aug. 22 Cash (1,250 × $34) 42,500

Common shares 42,500

Issued common shares.

Sept. 5 Cash Dividends or Retained Earnings 88,000

Common Dividend Payable 88,000

Declared dividend on 22,000 outstanding shares.

Oct. 28 Common Dividend Payable 88,000

  Cash 88,000

Paid cash dividend.

Dec. 31 Income Summary 434,000

  Retained Earnings 434,000

Closed the Income Summary account.

31 Retained Earnings 168,000

  Cash Dividends 168,000

Closed the cash dividend account (Note: No entry is required

if Retained Earnings was debited in the Sept. 5 entry and Jan. 5 entry).

Problem 15-6A (concluded)

Part 2

clarke CORPORATION

Statement of Retained Earnings

For Year Ended December 31, 2012

Retained earnings, January 1 $270,000

Add: Net income 434,000

Total $704,000

Less: Cash dividends 168,000

Retained earnings, December 31 $536,000

Part 3

clarke CORPoration

Shareholders’ Equity Section of the Balance Sheet

December 31, 2012

|Contributed capital: | | |

Common shares, unlimited shares

authorized, 22,0001 shares issued

and outstanding $ 538,5001

Retained earnings 536,000

Total shareholders’ equity $1,074,500

Calculations:

|1. Common Shares: |Shares |Dollars |

|Jan. 1 |Balance brought forward |20,000 |$460,000 |

|July 6 |Issued 750 shares (750 x $48.00) |750 |36,000 |

|Aug. 22 |Issued 1,250 shares (1,250 x $34.00) | 1,250 | 42,500 |

| |Totals |22,000 |$538,500 |

Analysis component:

The relationship between assets and retained earnings is that retained earnings represents how much of the assets are financed by the accumulated profits less losses less distributions of dividends. In other words, retained earnings is a component of equity and we know that assets are financed in part by equity. Using the information in Part (3) above for Clarke Corporation, we know that $536,00000 of the assets are financed by retained earnings as at December 31, 2012.

Problem 15-7A (50 minutes)

Part 1

|2011 | | | | |

|Jan. |12 |Cash |160,000 | |

| | | Common Shares | |160,000 |

| | | To record issuance of shares. | | |

| | | | | |

| |20 |Organization Costs |30,000 | |

| | | Common Shares | |30,000 |

| | | To record issuance of shares in exchange for organization efforts. |

| | | | | |

| |31 |Land |300,000 | |

| | |Building |400,000 | |

| | |Equipment |40,000 | |

| | | Common Shares | |740,000 |

| | | To record exchange of shares for capital assets. | | |

| | | | | |

|Mar. |4 |Equipment |6,800 | |

| | | Cash | |6,800 |

| | | To record purchase of equipment. | | |

| | | | | |

|Dec. |31 |Retained Earnings |80,000 | |

| | | Income Summary |80,000 |

| | |To record closing of income summary to retained earnings. | |

| | | | |

|2012 | | | | |

|Jan. |4 |Cash |300,000 | |

| | | Preferred Shares | |300,000 |

| | | To record issuance of preferred shares. | | |

| | | | | |

|Dec. |31 |Income Summary |180,000 | |

| | | Retained Earnings | |180,000 |

| | | To record closing of income summary to retained earnings. | |

|2013 | | | | |

|Dec. |4 |Retained Earnings or Cash Dividends |72,600 | |

| | | Preferred Dividends Payable | |60,000 |

| | | Common Dividends Payable | | 12,600 |

| | | To record declaration of dividends; 126,000 C/S × $0.10 = 12,600; 5,000 P/S × $12 = 60,000. | |

| | | | | |

| |18 |Preferred Dividends Payable |60,000 | |

| | |Common Dividends Payable |12,600 | |

| | | Cash | |72,600 |

| | | To record the payment of dividends. | | |

Problem 15-7A (continued)

| | | | | |

| |31 |Retained Earnings |72,600 | |

| | | Cash Dividends | |72,600 |

| | | To close the cash dividends account (assuming the | | |

| | |Cash Dividends account was debited on December 4). | | |

| | | | | |

| |31 |Income Summary |160,000 | |

| | | Retained Earnings | |160,000 |

| | | To close the income summary account. | | |

Part 2

WRIGHTSON CORP.

Statement of Retained Earnings

For Year Ended December 31, 2013

Retained earnings, January 1 $ 100,000

Add: Net income 160,000

Total $260,000

Less: Cash dividends 72,600

Retained earnings, December 31 $ 187,400

Part 3

|WRIGHTSON CORP. |

|Shareholders’ Equity |

|December 31, 2013 |

|Contributed Capital: | |

|Preferred shares, $12 noncumulative, 100,000 shares | |

| authorized, 5,000 shares issued & outstanding |$ 300,000 |

|Common shares, unlimited shares | |

| authorized, 126,0001 shares issued and outstanding | 930,0001 |

|Total contributed capital |$1,230,000 |

|Retained earnings | 187,400 |

|Total shareholders’ equity |$1,417,400 |

Calculations:

|1. Common Shares: | | |

|2011 | |Shares |Dollars |

|Jan. 12 |Issued 40,000 shares (40,000 x $4.00) |40,000 |$ 160,000 |

|20 |Issued 6,000 shares |6,000 |30,000 |

|31 |Issued 80,000 shares | 80,000 | 740,000 |

| |Totals |126,000 |$930,000 |

Problem 15-7A (concluded)

Analysis component:

| |2011 |2012 |2013 |

|Net assets |$160,000 + $30,000 + $740,000 – |$850,000 + $300,000 + $180,000 = |$1,330,000 –- $72,600 + $160,000 = |

| |$80,000 = $850,000 |$1,330,000 |$1,417,400 |

|Trend |F |

|(F or U) | |

Problem 15-8A (30 minutes)

1.

|2011 | | | |

|Jan. 1 |Cash |228,000 | |

| | Common shares | |228,000 |

| | Issued 30,000 common shares; 30,000 x $7.60. | | |

| 5 |Cash Dividends or Retained Earnings |165,000 | |

| | Preferred Dividend Payable | |90,000 |

| | Common Dividend Payable | |75,000 |

| | Declared dividend on preferred shares | | |

| |(20,000 x $1.50 x 3 years) and common | | |

| |shares (165,000 – 90,000). | | |

|Feb. 28 |Preferred Dividend Payable |90,000 | |

| |Common Dividend Payable |75,000 | |

| | Cash | |165,000 |

| | Paid cash dividends. | | |

|July 1 |Cash |112,000 | |

| | Preferred Shares | |112,000 |

| | Issued 7,000 preferred shares | | |

| |(112,000 ÷ 16.00 = 7,000 shares). | | |

|Dec. 31 |Retained Earnings |165,000 | |

| | Cash Dividends | |165,000 |

| | Closed the dividend account (assuming Retained | | |

| |Earnings was not debited directly on the January | | |

| |5 declaration date). | | |

| | | | |

|31 |Income Summary |412,000 | |

| | Retained Earnings | |412,000 |

| | To close net income to retained earnings. | | |

Problem 15-8A (continued)

|2012 | | | |

|Sept. 5 |Cash Dividends or Retained Earnings |145,500 | |

| | Preferred Dividend Payable | |40,500 |

| | Common Dividend Payable | |105,000 |

| | Declared dividend on preferred shares | | |

| |($1.50 × 27,000 = 40,500) and common shares | | |

| |($1.00 × 105,000 = 105,000). | | |

|Oct. 28 |Preferred Dividend Payable |40,500 | |

| |Common Dividend Payable |105,000 | |

| | Cash | |145,500 |

| | Paid cash dividends declared. | | |

|Dec. 31 |Retained Earnings |145,500 | |

| | Cash Dividends | |145,500 |

| | Closed the dividend account (assuming Retained | | |

| |Earnings was not debited directly on the September | | |

| |5 declaration date). | | |

|31 |Income Summary |388,000 | |

| | Retained Earnings | |388,000 |

| | Closed the Income Summary account. | | |

Problem 15-8A (concluded)

2.

TECHNO Corporation

Statement of Retained Earnings

For Year Ended December 31, 2012

Retained earnings, January 1 $517,000

Add: Net income 388,000

Total $905,000

Less: Cash dividends 145,500

Retained earnings, December 31 $759,500

3.

|TECHNO CORPORATION |

|Shareholders’ Equity |

|December 31, 2012 |

|Contributed Capital: | |

|Preferred shares, $1.50 cumulative, unlimited shares authorized, | |

|27,000 shares issued and outstanding |$ 392,000 |

|Common shares, unlimited shares authorized | |

|105,000 shares issued and outstanding |753,000 |

| Total contributed capital |$1,145,000 |

|Retained earnings | 759,500 |

|Total shareholders’ equity |$1,904,500 |

Calculations:

|1. Preferred Shares: |Shares |Dollars |

|2011 | | | |

|Jan. 1 |Balance brought forward |20,000 |$280,000 |

|July 1 |Issued 7,000 shares | 7,000 | 112,000 |

| |Totals |27,000 |$392,000 |

|2. Common Shares: | | |

|2011 | | | |

|Jan. 1 |Balance brought forward |75,000 |$525,000 |

|Jan. 1 |Issued 30,000 shares (30,000 x $7.60) | 30,000 | 228,000 |

| |Totals |105,000 |$753,000 |

*Problem 15-9A (40 minutes)

1. Market value = $85.00 per share (given) x 4,000 shares = $340,000.

2. $80,000 was contributed by the residual owners (common shareholders).

3. Book values:

Preferred book value per share = $50,000 ( 1,000 = $50

Common shares:

| |Total equity |$ 280,000 | |

| |Less preferred | (50,000 |) |

| |Common shares equity |$ 230,000 | |

| |Number of outstanding shares |4,000 | |

| |Book value per share |$ 57.50 | |

4. Book values with two years’ dividends in arrears:

Preferred shares:

| |Annual dividend ($2.50 × 1,000) |$ 2,500 | |

| |Preferred share value |$ 50,000 | |

| |Plus two years’ dividends in arrears | 5,000 | |

| |Preferred equity |$ 55,000 | |

| |Number of outstanding shares |1,000 | |

| |Book value per share |$ 55.00 | |

Common shares:

| |Total equity |$ 280,000 | |

| |Less preferred | (55,000 |) |

| |Common shares equity |$ 225,000 | |

| |Number of outstanding shares |4,000 | |

| |Book value per share |$ 56.25 | |

5. Book values with call price and two years’ dividends in arrears:

Preferred shares:

| |Annual dividend |$ 2,500 | | | |

| |Preferred shares call price (1,000 × $55) | | |$ 55,000 | |

| |Plus two years’ dividends in arrears | | | 5,000 | |

| |Preferred equity | | |$ 60,000 | |

| |Number of outstanding shares | | |1,000 | |

| |Book value per share | | |$ 60.00 | |

Common shares:

| |Total equity |$ 280,000 | |

| |Less preferred | (60,000 |) |

| |Common shares equity |$ 220,000 | |

| |Number of outstanding shares |4,000 | |

| |Book value per share |$ 55.00 | |

*Problem 15-9A (concluded)

6. Dividend allocation in total

| | |Preferred |Common |

| |2 years’ dividends in arrears |$5,000 |0 |

| |Current year dividends |2,500 | |

| |  Remainder to common | |$2,500 |

Dividends per share for the common shares:

$2,500/4,000 shares = $0.625

7. Equity represents the residual interest of owners in the assets of the business after subtracting claims of creditors. With few exceptions, these assets and liabilities are reported at historical cost, not market value. Therefore, the book value of common shares does not reflect most market value changes. Also the book value of common shares is based on past transactions and events, whereas the market value takes into account expected future earnings, dividends, and factors that may impact the economy.

*Problem 15-10A (25 minutes)

Part 1:

a.

|Book value per common share |Book value per preferred share |

|1,225,000 – [220,000 + ($4 × 10,000 × 2 years)] |220,000 + ($4 × 10,000 × 2 years) |

| 25,000 | 10,000 |

|= $37.00 |= $30.00 |

b.

|Book value per common share |Book value per preferred share |

|1,225,000 – 220,000 |220,000 |

| 25,000 | 10,000 |

|= $40.20 |= $22.00 |

*Problem 15-10A (concluded)

Part 2:

c.

|Book value per common share |Book value per preferred share |

|1,225,000 – 220,000 |220,000 |

| 25,000 | 10,000 |

|= $40.20 |= $22.00 |

d.

|Book value per common share |Book value per preferred share |

|1,225,000 – 220,000 |220,000 |

| 25,000 | 10,000 |

|= $40.20 |= $22.00 |

Part 3:

e.

|Book value per common share |Book value per preferred share |

|1,225,000 – [($30 × 10,000) + ($4 × 10,000 × 2 years)] |($30 × 10,000) + ($4 × 10,000 × 2 years) |

| 25,000 | 10,000 |

|= $33,80 |= $38.00 |

Problem 15-1B (40 minutes)

|JENSTAR INC |

|Balance Sheet |

|October 31, 2011 |

|Assets | | | |

| Current assets: | | | |

| Cash | |$ 355,000 | |

| Accounts receivable | |225,000 | |

| Office supplies | |85,000 | |

| Prepaid insurance | | 17,000 | |

| Total current assets | | |$ 682,000 |

| | | | |

| Property, plant, and equipment: | | | |

| Land | |$1,000,000 | |

| Building |$2,875,000 | | |

| Less: Accumulated amortization | 833,000 |2,042,000 | |

| | | | |

| Machinery |$1,600,000 | | |

| Less: Accumulated amortization | 763,000 | 837,000 | |

| Total property, plant and equipment | | | 3,879,000 |

|Total assets | | |$4,561,000 |

| | | | |

|Liabilities | | | |

| Current liabilities: | | | |

| Accounts payable |$ 158,000  | | |

| Wages payable |130,000  | | |

| Unearned fees | 28,000  | | |

| Total current liabilities | |$ 316,000 | |

| Long-term liabilities: | | | |

| Long term liabilities (due in 2015) | | 550,000 | |

| Total liabilities | | |$ 866,000 |

| | | | |

|Shareholders’ Equity | | | |

|Contributed Capital: | | | |

| Preferred Shares, $1.50 non-cumulative, | | | |

|unlimited shares authorized, | | | |

|30,000 shares issued and outstanding |$1,200,0001 | | |

| Common Shares, unlimited shares authorized, | 1,600,0002 | | |

|50,000 shares issued and outstanding | | | |

| Total contributed capital | |$2,800,000 | |

| Retained earnings | | 895,000 | |

| Total shareholders’ equity | | | 3,695,000 |

|Total liabilities and shareholders’ equity | | |$4,561,000 |

1. 30,000 preferred shares × $40/share = $1,200,000

2. 50,000 common shares × $32/share = $1,600,000

Problem 15-2B (20 minutes)

|Retained earnings December 31, 2011 | |$1,960,720 |

|Reductions in retained earnings due to transactions: | | |

| Cash dividends declared: | | |

| Feb. 11, on 350,000 shares (350,000 × $0.25) |$ 87,500 | |

| May 24, on 350,000 shares |87,500 | |

| Aug. 13, on 365,000 shares (365,000 × $0.25) |91,250 | |

| Dec. 12, on 385,000 shares (385,000 × $0.25) | 96,250 |362,500 |

|Less: Retained earnings December 31, 2012 | | 2,200,500 |

|Net income | |$ 602,280 |

Problem 15-3B (25 minutes)

a.

|2011 | | | |

|Dec. 1 |Preferred Shares |100,000 | |

| | Common Shares | |100,000 |

| | To record the conversion of 1,000 preferred | | |

| |shares into 8,000 common shares; | | |

| |$200,000 ÷ 2,000 shares = $100 average issue | | |

| |price per preferred share; $100 x 1,000 = $100,000. | | |

Immediately after the conversion of preferred shares, the shareholders’ equity section would still show 2,000 shares of preferred shares authorized, but only 1,000 shares issued and outstanding. The amount of preferred shares would change from $200,000 to $100,000. Common shares would still show unlimited shares authorized, and 68,000 shares issued. The amount of common shares would be $700,000 instead of $600,000. Retained earnings would not be affected. Total shareholders’ equity also would not be affected because $100,000 has simply shifted from the preferred share section to the common share section.

b. As a common shareholder, you would not want the conversion of preferred shares to take place. As a result of the conversion, a smaller total dividend would be paid to preferred shares and a larger total dividend would be paid to common shares. However, the dividend per common share is less because there are more common shares dividing the cash. Before the conversion, there are 2,000 shares of $11 preferred. Therefore, $22,000 of the $487,000 paid out in dividends goes to the preferred shareholders. If the remaining $465,000 is divided by 60,000 shares of common shares outstanding, the common dividend per share is $7.75. However, after the conversion, $11,000 of the $487,000 paid out in dividends goes to the 1,000 shares of $11 preferred, and the remaining $476,000 is divided between the 68,000 common shares outstanding. This reduces the dividend per share to $7.00.

Problem 15-4B (25 minutes)

1. A = $20/share × 45,000 shares = $900,000

2. B = $3,800,000/$100 per share = 38,000 shares

3. C = 265,000 shares × $5/share = $1,325,000

4. D = 900,000 + 3,800,000 + 1,325,000 = $6,025,000

5. E = 2,500,000 + 1,750,000 + 1,300,000 – 2,200,000 – 1,200,000 = $2,150,000

6. F = 6,025,000 + 2,150,000 = 8,175,000

7. 3 years (2009, 2010, 2011) × ($8 per share × 45,000 shares) = $1,080,000

Problem 15-5B (20 minutes)

1.

| |Dividends Declared |Preferred |Common |

|Year |and Paid |Dividends |Dividends |

| | | | |

|2010 |600,000 |480,000 |120,000 |

| | | | |

|2011 |100,000 |100,000 |0 |

| | | | |

|2012 |250,000 |250,000 |0 |

| | | | |

|2013 |1,500,000 |1,090,000 |410,000 |

2.

| |Dividends Declared |Preferred |Common |

|Year |and Paid |Dividends |Dividends |

| | | | |

|2010 |600,000 |480,000 |120,000 |

| | | | |

|2011 |100,000 |100,000 |0 |

| | | | |

|2012 |250,000 |250,000 |0 |

| | | | |

|2013 |1,500,000 |480,000 |1,020,000 |

Problem 15-6B (60 minutes)

Part 1. Journal entries:

Mar. 2 Cash Dividends or Retained Earnings 150,000.00

Common Dividend Payable 150,000.00

Declared dividend on 100,000 outstanding shares.

31 Common Dividend Payable 150,000.00

Cash 150,000.00

Paid cash dividend.

Nov. 11 Cash (12,000 × $13) 156,000.00

Common shares, 156,000.00

Issued common shares.

25 Cash (8,000 × $9.50) 76,000.00

Common shares 76,000.00

Issued common shares.

Dec. 1 Cash Dividends or Retained Earnings 300,000.00

Common Dividend Payable 300,000.00

Declared dividend on 120,000 outstanding shares.

31 Income Summary 536,000.00

Retained Earnings 536,000.00

Closed the Income Summary account.

31 Retained Earnings 450,000.00

Cash Dividends 450,000.00

Closed the cash dividend account (assuming that

Cash Dividends was debited on March 2 and December 1).

Part 2

CALDWELL CORP.

Statement of Retained Earnings

For Year Ended December 31, 2012

Retained earnings, January 1 $1,080,000

Add: Net income 536,000

Total $1,616,000

Less: Cash dividends 450,000

Retained earnings, December 31 $1,166,000

Problem 15-6B (concluded)

Part 3

CALDWELL CORP.

Shareholders’ Equity

December 31, 2012

|Contributed capital: | | |

Common shares, unlimited shares

authorized, 120,0001 shares issued

and outstanding $1,032,0001

Retained earnings 1,166,000

Total shareholders’ equity $2,198,000

Calculations:

|1. Common Shares: |Shares |Dollars |

|Jan. 1 |Balance brought forward |100,000 |$800,000 |

|Nov. 11 |Issued 12,000 shares (12,000 x $13.00) |12,000 |156,000 |

|25 |Issued 8,000 shares (8,000 x $9.50) | 8,000 | 76,000 |

| |Totals |120,000 |$1,032,000 |

Analysis component:

$2,198,000 of Caldwell’s assets at December 31, 2012 are financed by common shareholders’ equity ($1,032,000 contributed capital and $1,166,000 retained earnings). Other sources of financing that are available are from debt (liabilities) and from investment by preferred shareholders (preferred shareholders’ contributed capital).

Problem 15-7B (50 minutes)

Part 1

2011

Feb. 5 Cash (70,000 × $10) 700,000.00

Common Shares 700,000.00

Issued common shares.

28 Organization Costs 40,000.00

Common Shares 40,000.00

Issued common shares to corporation’s promoters.

Mar. 3 Land 80,000.00

Buildings 210,000.00

Machinery 155,000.00

Common shares 445,000.00

Issued common shares for

land, buildings, machinery.

Dec. 31 Retained Earnings 27,000.00

Income Summary 27,000.00

Closed the Income Summary account.

Problem 15-7B (continued)

2012

Jan. 28 Cash (4,000 × $100) 400,000.00

Preferred Shares 400,000.00

Issued preferred shares.

Dec. 31 Income Summary 98,000.00

Retained Earnings 98,000.00

Closed the Income Summary account.

2013

Jan. 1 Cash Dividends or Retained Earnings 63,550.00

Preferred Dividend Payable 40,000.00

Common Dividend Payable 23,550.00

Preferred dividend = 4,000 × $10 = 40,000,

No. of common shares = 70,000 + 3,750 +

44,000 = 117,750

Common dividend = $0.20 × 117,750 = $23,550

Feb. 5 Preferred Dividend Payable 40,000.00

Common Dividend Payable 23,550.00

Cash 63,550.00

Paid dividends.

Dec. 31 Retained Earnings 63,550.00

Cash Dividends 63,550.00

Closed dividends (assuming Cash Dividends was debited on the January 1 declaration date).

31 Income Summary 159,000.00

Retained Earnings 159,000.00

Closed the Income Summary account.

Part 2

SOLAR ENERGY COMPANY INC.

Statement of Retained Earnings

For Year Ended December 31, 2013

Retained earnings, January 1 $ 71,000

Add: Net income 159,000

Total $230,000

Less: Cash dividends 63,550

Retained earnings, December 31 $166,450

Problem 15-7B (concluded)

Part 3

SOLAR ENERGY COMPANY INC.

Shareholders’ Equity

December 31, 2013

Contributed capital:

Preferred, $10, noncumulative, unlimited shares

authorized, 4,000 issued and outstanding $ 400,000

Common shares, unlimited shares authorized,

117,750 shares issued and outstanding 1,185,000

Total contributed capital $1,585,000

Retained earnings 166,450

Total shareholders’ equity $1,751,450

Calculations:

|1. Common Shares: |Shares |Dollars |

|2011 | | | |

|Feb. 5 |Issued 70,000 shares |70,000 |$ 700,000 |

|28 |Issued 3,750 shares |3,750 |40,000 |

|Mar. 3 |Issued 44,000 shares | 44,000 | 445,000 |

| |Totals |117,750 |$1,185,000 |

Problem 15-8B (60 minutes)

1.

|2011 | | | |

|Jan. |1 |Cash |617,500 | |

| | | Common shares | |617,500 |

| | | Issued 130,000 common shares; 130,000 x $4.75. | | |

| |5 |Cash Dividends or Retained Earnings |270,000 | |

| | | Preferred Dividend Payable | |75,000 |

| | | Common Dividend Payable | |195,000 |

| | | Declared dividend on preferred shares | | |

| | |(100,000 x $0.75 = 75,000) and common shares | | |

| | |(270,000 – 75,000 = 195,000). | | |

|Feb. |28 |Preferred Dividend Payable |75,000 | |

| | |Common Dividend Payable |195,000 | |

| | | Cash | |270,000 |

| | | Paid cash dividends. | | |

|July |1 |Cash |675,000 | |

| | | Preferred Shares | |675,000 |

| | | Issued 50,000 preferred shares | | |

| | |(675,000 ÷ 13.50 = 50,000 preferred shares). | | |

|Dec. |31 |Retained Earnings |270,000 | |

| | | Cash Dividends | |270,000 |

| | | To close cash dividends (assuming Cash Dividends | | |

| | |was debited on January 5, the declaration date). | | |

| | | | | |

| |31 |Income Summary |320,000 | |

| | | Retained Earnings | |320,000 |

| | | Closed the Income Summary account. | | |

|2012 | | | |

|Sept. |5 |Cash Dividends or Retained Earnings |307,500 | |

| | | Preferred Dividend Payable ($0.75 × 150,000) | |112,500 |

| | | Common Dividend Payable ($0.25 × 780,000) | |195,000 |

| | | Declared dividend on preferred and common shares. | | |

|Oct. |28 |Preferred Dividend Payable |112,500 | |

| | |Common Dividend Payable |195,000 | |

| | | Cash | |307,500 |

| | | Paid cash dividends declared. | | |

Problem 15-8B (concluded)

|Dec. |31 |Retained Earnings |307,500 | |

| | | Cash Dividends | |307,500 |

| | | Closed the dividend account (assuming Cash | | |

| | | Dividends was debited on September 5). | | |

| |31 |Retained Earnings |480,000 | |

| | | Income Summary | |480,000 |

| | | Closed the Income Summary account (net loss). | | |

2.

Francois corp.

Statement of Retained Earnings

For Year Ended December 31, 2012

|Retained earnings, January 1 | |$1,185,000 |

|Less: Net loss |480,000 | |

| Cash dividends | 307,500 | 787,500 |

|Retained earnings, December 31 | |$ 397,500 |

3.

|FRANCOIS CORP. |

|Shareholders’ Equity |

|December 31, 2012 |

|Contributed Capital: | |

|Preferred shares, $0.75 noncumulative, unlimited shares authorized | |

|150,000 shares issued and outstanding |$1,975,000 |

|Common shares, unlimited shares authorized, | |

|780,000 shares issued and outstanding |3,542,500 |

|Total contributed capital |$5,517,500 |

|Retained earnings | 397,500 |

|Total shareholders’ equity |$5,915,000 |

Calculations:

|1. Preferred Shares: |Shares |Dollars |

|Jan. 1 |Balance brought forward |100,000 |$1,300,000 |

|July 1 |Issued 50,000 shares | 50,000 | 675,000 |

| |Totals |150,000 |$1,975,000 |

| | | |

|1. Common Shares: |Shares |Dollars |

|Jan. 1 |Balance brought forward |650,000 |$2,925,000 |

|1 |Issued 130,000 shares (130,000 x $4.75) |130,000 | 617,500 |

| |Totals |780,000 |$3,542,500 |

*Problem 15-9B (25 minutes)

|a. |Book value per share of preferred is call price |$ 106.00 |

| |Total shareholders’ equity |$920,000 |

| |Less total book value of preferred ($106 × 2,000) | 212,000 |

| |Total book value of common |$708,000 |

| |Book value per share of common ($708,000/60,000) |$ 11.80 |

| | | |

|b. |Call price |$ 106.00 |

| |Dividends in arrears | 11.00 |

| |Book value per share of preferred |$ 117.00 |

| |Total shareholders’ equity |$920,000 |

| |Less total book value of preferred ($117 × 2,000) | 234,000 |

| |Total book value of common |$686,000 |

| |Book value per share of common ($686,000/60,000) |$ 11.43 |

| | | |

|c. |Call price |$ 106.00 |

| |Dividends in arrears ($11 × 3) | 33.00 |

| |Book value per share of preferred |$ 139.00 |

| |Total shareholders’ equity |$920,000 |

| |Less total book value of preferred ($139,000 × 2,000) | 278,000 |

| |Total book value of common |$642,000 |

| |Book value per share of common ($642,000/60,000) |$ 10.70 |

*Problem 15-10B (25 minutes)

Part 1:

a.

|Book value per common share |Book value per preferred share |

|1,800,000 – [400,000 + ($0.75 × 50,000 × 2 years)] |400,000 + ($0.75 × 50,000 × 2 years) |

| 125,000 | 50,000 |

|= $10.60 |= $9.50 |

b.

|Book value per common share |Book value per preferred share |

|1,800,000 – 400,000 |400,000 |

| 125,000 | 50,000 |

|= $11.20 |= $8.00 |

Part 2:

c.

|Book value per common share |Book value per preferred share |

|1,800,000 – (400,000 + 25,000*) |400,000 + 25,000 |

| 125,000 | 50,000 |

|= $11.00 |= $8.50 |

|* $0.75 × 50,000 × 2 years = $75,000; | |

|$75,000 – $50,000 dividends paid = $25,000 arrears | |

d.

|Book value per common share |Book value per preferred share |

|1,800,000 – 400,000 |400,000 |

| 125,000 | 50,000 |

|= $11.20 |= $8.00 |

Part 3:

e.

|Book value per common share |Book value per preferred share |

|1,800,000 – ($12 × 50,000) |$12 × 50,000 |

| 125,000 | 50,000 |

|= $9.60 |= $12.00 |

ANALYTICAL & REVIEW PROBLEMS

A&R Problem 15-1

1.

|For the Years Ended December 31 |

| |Dec. 31/12 |Dec. 31/11 |Dec. 31/10 |

|Net sales |$5,000,000 |$4,000,000 |$3,000,000 |

|Cost of goods sold | 3,000,000 | 2,400,000 |1,650,000 |

|Gross profit |$2,000,000 |$1,600,000 |$1,350,000 |

|Operating expenses | 1,400,000 | 1,300,000 | 900,000 |

|Operating income |$ 600,000 |$ 300,000 |$ 450,000 |

|Other revenues (expenses) | (200,000) | (220,000) | 50,000 |

|Income before income tax |$ 400,000 |$80,000 |$ 500,000 |

|Income tax expense | 80,000 | 16,000 | 100,000 |

|Net income |$ 320,000 |$ 64,000 |$ 400,000 |

2, 3, & 4.

| |Dec. 31/12 |Dec. 31/11 |Dec. 31/10 |

|Contributed Capital: | | | |

|Preferred shares, $2 noncumulative, | | | |

|100,000 shares authorized, | | | |

|20,000 issued & outstanding |$ 400,000 |$ 400,000 |$ 400,000 |

|Common shares | | | |

|500,000 shares authorized | | | |

|100,000 issued & outstanding |   550,000 |   550,000 |   550,000 |

|Total contributed capital |$ 950,000 |$ 950,000 |$ 950,000 |

|Retained earnings |     684,000 |     364,000 |     300,000 |

|Total shareholders’ equity |$1,634,000 |$1,314,000 |$1,250,000 |

Analysis component:

| |2012 |2011 |2010 |

|Liabilities |$1,123,200 |$ 936,000 |$ 900,000 |

|Equity |1,634,000 |1,314,000 |1,250,000 |

|Total Assets |$2,757,200 |$2,250,000 |$2,150,000 |

|Liabilities/Total Assets |40.74% |41.60% |41.86% |

Although liabilities are increasing in total they are decreasing slightly as a percentage of total assets (which is the same as total liabilities and shareholders’ equity). This indicates that the balance sheet has been strengthened from 2010 to 2012. A balance sheet is said to be strengthened when liabilities (and therefore the related risk) are decreasing.

EC 15-1 - Ethics Challenge

It appears that Jack may be in violation of copyright laws. This is both a legal issue and an ethical issue. To copy someone else’s work is ethically wrong. To incorporate as a means of protection against normal business risk is a well accepted practice. The obvious intent here, however, is to use the corporate shell as a means of limiting any legitimate claim that Corel might have to Jack and Bill’s assets. Jack is recommending incorporation for deceptive purposes and Bill should hold his moral ground on this issue.

Focus on Financial Statements

FFS 15-1

Part A:

BowTie Fishing Expeditions Corp.

Statement of Retained Earnings

For Month Ended March 31, 2011

|Retained earnings, March 1 |$ -0- |

|Add: Net income |190,000 |

|Less: Dividends declared | 45,000 |

|Retained earnings, March 31 |$145,000 |

FFS 15-1 (continued)

BowTie Fishing Expeditions Corp.

Balance Sheet

March 31, 2011

|Assets | | | |

| Current assets: | | | |

| Cash | |$ 15,000 | |

| Accounts receivable |$36,000 | | |

| Less: Allowance for doubtful accounts | 1,200 |34,800 | |

| Prepaid rent | |9,000 | |

|  Total current assets | | |$ 58,800 |

| Property, plant and equipment: | | | |

| Land | |$105,000 | |

| Building |$148,600 | | |

| Less: Accumulated amortization | 12,000 |136,600 | |

| Equipment |$140,000 | | |

| Less: Accumulated amortization | 2,000 |138,000 | |

| Furniture |$ 75,000 | | |

| Less: Accumulated amortization | 5,000 |70,000 | |

|   Total property, plant and equipment | | |449,600 |

| Intangible assets: | | | |

| Patent |$14,000 | | |

|Less: Accumulated amortization ……………………. |2,000 | |12,000 |

|Total assets | | |$520,400 |

|Liabilities | | | |

| Current liabilities: | | | |

| Accounts payable |$ 17,000 | | |

| Current portion of long-term notes payable |30,000 | | |

| Customer deposits |28,000 | | |

| Dividends payable |45,000 | | |

| Estimated warranty liabilities | 3,400 | | |

|   Total current liabilities | |$123,400 | |

| Long-term liabilities: | | | |

| Notes payable, less $30,000 current portion | | 60,000 | |

| Total liabilities | | |$183,400 |

|Shareholders’ Equity | | | |

| Contributed capital: | | | |

| Preferred shares, $2, cumulative, | | | |

| Authorized: 30,000 shares | | | |

| Issued and outstanding: 10,000 shares |$ 42,000 | | |

| Common shares, | | | |

| Authorized: Unlimited | | | |

| Issued and outstanding: 50,000 shares |150,000 | | |

| Total contributed capital | |$192,000 | |

| Retained earnings | |145,000 | |

| Total shareholders’ equity | | |337,000 |

|Total liabilities and shareholders’ equity | | |$520,400 |

FFS 15-1 (concluded)

Analysis component:

1. 337,000 ÷ 520,400 x 100 = 65%

2. 183,400 ÷ 520,400 x 100 = 35%

3. At March 31, 2011, 35.24% ($183,400/$520,400 × 100) of BowTie’s assets were financed by debt. Therefore, given that 30% of the assets were financed by debt at March 31, 2010, the risk associated with debt financing has increased because of the increase in debt as a percentage of assets (the balance sheet has been weakened as opposed to strengthened).

4. (150,000 + 145,000 = 295,000)/520,400 x 100 = 57%

5. 150,000/520,400 x 100 = 29%

FFS 15-2

1. Note 7 of Danier’s financial statements indicate that 5,321,825 shares were issued as of June 25, 2005.

2. a. The total dividends declared during the year ended June 25, 2005 were $1,620 (thousand).

b. Because there are no dividends payable on the balance sheet, it would appear that all of the dividends declared in 2005 were paid in 2005.

c. Dividends are a distribution of cash* to Danier’s shareholders representing the

shareholders’ share of earnings generated by Danier.

3.

— Danier’s net loss caused equity, specifically retained earnings, to decrease by $185 (thousand).

— Dividends cause equity to decrease because the cash dividends* distributed to the shareholders represent the shareholders’ share of earnings generated by the business.

Critical Thinking Mini Case

CT 15-1

Note to instructor: Student responses will vary therefore the answer here is only suggested and not inclusive of all possibilities; it is presented in point form for brevity.

Problem:

— how to best finance the purchase of new equipment

Goal:*

— from the perspective of the manager of Jones Inc., the financing option with the lowest cost is the best option (the shareholders of Jones Inc. would want the option that not only has the lowest cost but that does not dilute the ownership of the common shareholders)

— another consideration would be to minimize risk to Jones Inc.

Principles:

— must comply with GAAP (disclose method of financing, for example)

Facts:

— as per the mini case study

— also, the following calculations can be derived from the information provided:

| | |Issue $1 cumulative preferred|

| |Borrow |shares |

|Income before interest and tax |$80,000 |$80,000 |

|Interest expense ($100,000 x 6%) | 6,000 | — |

|Income before tax |$74,000 |$80,000 |

|Income tax ($74,000 x 25%; $80,000 x 25%) | 18,500 | 20,000 |

|Net income |$55,500 |$60,000 |

|Less dividends ($100,000 x 6,000 x $1) | — | 6,000 |

|Net earnings applicable to common shareholders | | |

| |$55,500 |$54,000 |

CT 15-1 (concluded)

Conclusions/Consequences:

— Is the primary goal risk minimization (issue shares) or minimize cost (borrow)?

— Common shareholders will want to maximize their earnings which points to borrowing but borrowing increases risk because principal and interest payments must be made; potential future creditors are sensitive to risk.

— Finance manager may be compensated based on performance so will prefer borrowing option.

— Alternatively, the finance manager could make a case to the board of directors to avoid the declaration of dividends in which case issuing preferred shares would generate the highest earnings applicable to common shareholders ($60,000 vs $55,500) but this may have negative implications for future issuance of shares.

*The goal is highly dependent on ”perspective.”

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