CHAPTER 13. Corporations: Organization and Share Capital Transactions. Brief 3, 4, 5, 6 2, 3, 4, 7, 11 7, 8, 9 3, 4, 5, 6, 7, 11 10, 11, 12, 13

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1 CHAPTER 13 Corporations: Organization and Share Capital Transactions ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises Problems Set A Problems Set B 1. Identify and discuss the major characteristics of a corporation. 1, 2, 3, 4, 5, 6, 7, 8, 9,10 1, 2 1, 7 1, Record common share transactions. 11, 12, 13, 14, 15 3, 4, 5, 6 2, 3, 4, 7, 11 2, 3, 4, 5, 6, 7, 11 2, 3, 4, 5, 6, 7, Record preferred share transactions. 16, 17, 18, 19 7, 8, 9 3, 4, 5, 6, 7, 11 4, 5, 6, 7, 11 4, 5, 6, 7, Prepare the shareholders equity section of the balance sheet and calculate return on equity. 20, 21, 22, 23, 24 10, 11, 12, 13 7, 8, 9, 10, 11 4, 5, 6, 7, 8, 9, 10, 11 4, 5, 6, 7, 8, 9, 10, 11 Solutions Manual 13-1 Chapter 13

2 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Determine form of business organization. Simple A Determine impact of reacquired shares. Moderate A Allocate dividends between preferred and common shares. Simple A Show impact of transactions on accounts. Simple A 6A 7A Record and post transactions. Prepare shareholders equity section. Record and post transactions. Prepare shareholders equity section. Record and post transactions. Prepare shareholders equity section. Moderate Moderate Moderate A Record closing entries and prepare balance sheet. Simple A Prepare balance sheet and calculate return on equity. Simple A Calculate return on equity. Simple A Answer questions about shareholders equity section. Simple B Determine form of business organization. Simple B Determine impact of reacquired shares. Moderate B Allocate dividends between preferred and common shares. Simple B Show impact of transactions on accounts. Simple B 6B 7B Record and post transactions. Prepare shareholders equity section. Record and post transactions. Prepare shareholders equity section. Record and post transactions. Prepare shareholders equity section. Moderate Moderate Moderate Solutions Manual 13-2 Chapter 13

3 ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number Description Difficulty Level Time Allotted (min.) 8B Record closing entries and prepare balance sheet. Simple B Prepare balance sheet and calculate return on equity. Simple B Calculate return on equity. Simple B Answer questions about shareholders equity section. Simple Solutions Manual 13-3 Chapter 13

4 BLOOM S TAXONOMY TABLE Correlation Chart between Bloom s Taxonomy, Study Objectives and End-of- Chapter Material. Study Objectives Knowledge Comprehension Application Analysis Synthesis Evaluation 1. Identify and discuss the major characteristics of a corporation. 2. Record common share transactions. Q13-5 Q13-1 Q13-2 Q13-3 Q13-4 Q13-6 Q13-7 Q13-8 BE13-1 BE13-2 E13-7 Q13-12 Q13-13 Q13-14 Q13-15 E13-7 Q13-9 Q13-10 P13-11A Q13-11 BE13-3 BE13-4 BE13-5 BE13-6 E13-2 E13-3 E13-4 P13-2A P13-3A P13-4A P13-5A P13-6A P13-7A P13-11A P13-2B P13-3B P13-4B P13-5B P13-6B P13-7B P13-11B E13-1 P13-1A P13-1B E Record preferred share transactions. 4. Prepare the shareholders equity section of the balance sheet and calculate return on equity. Broadening Your Perspective Q13-20 Q13-22 Q13-16 Q13-17 Q13-18 Q13-19 E13-7 Q13-21 Q13-23 Q13-24 E13-7 BYP13-1 BYP13-3 BE13-7 BE13-8 BE13-9 E13-3 E13-4 E13-5 E13-6 P13-4A BE13-10 BE13-11 BE13-12 BE13-13 E13-8 E13-9 E13-10 P13-4A P13-5A P13-6A P13-7A P13-5A P13-6A P13-7A P13-11A P13-4B P13-5B P13-6B P13-7B P13-11B P13-8A P13-9A P13-10A P13-11A P13-4B P13-5B P13-6B P13-7B P13-8B P13-9B P13-10B P13-11B BYP13-2 Continuing Cookie Chronicle E13-11 E13-11 BYP13-4 BYP13-5 Solutions Manual 13-4 Chapter 13

5 ANSWERS TO QUESTIONS 1. Classified by Purpose: A business may be incorporated to make a profit, like Tim Hortons. Or, it may be incorporated as a not-for-profit, like the Canadian Cancer Society. Alternately, a business, like the Yellow Pages Group, could be created as an income trust, to invest in income-producing assets. Classified by Ownership: A corporation can be publicly held or privately held. A publicly held corporation, like The Forzani Group Ltd., may have thousands of shareholders, and its shares trade in an organized securities market. A privately held corporation, like McCain Foods Limited, usually only has a few shareholders, and its shares are not offered for sale to the general public. 2. (a) Limited liability of shareholders. Because of its separate legal existence, creditors of a corporation ordinarily have recourse only to corporate assets to satisfy their claims. Thus, the liability of shareholders is normally limited to their investment in the corporation. (b) Transferable ownership rights. Ownership of a corporation is held in capital shares. The shares are transferable units. Shareholders may dispose of part or all of their interest by simply selling their shares. The transfer of ownership to another party is usually entirely at the discretion of the shareholder. (c) Ability to acquire capital. A corporation has an easier time raising capital because of features such as limited liability and the ease of transferring shares. Also, because only small amounts of money need to be invested, many individuals can become shareholders. However, small, privately held corporations can have as much difficulty getting capital as any proprietorship or partnership. 3. (a) Income taxation can be an advantage for a corporation because corporate tax rates are often lower than personal tax rates. Personal income tax can also be deferred until income is distributed to the shareholders as dividends. It can also be a disadvantage because the dividends are subject to double taxation once at the corporate level and again at the personal rates of the shareholders who receive them. The impact of these taxes is somewhat reduced by the dividend tax credit that shareholders can claim on their personal tax returns. (b) Corporations must pay income tax on its taxable income. Income earned by proprietorships, partnerships and income trusts is taxed in the hands the owners. The businesses themselves do not pay income tax. Solutions Manual 13-5 Chapter 13

6 QUESTIONS (Continued) 4. Small, privately held corporations are riskier than large publicly held ones. As a result, lenders will often require the owners to sign personal guarantees, thus eliminating the limited liability normally associated with corporations. Because the shares are not offered for sale to the general public, it is more difficult to raise capital. Small corporations may be run by the shareholders, rather than professional managers. This also means that if one of these shareholders sells his or her ownership interest, the corporation may be significantly affected. 5. In the absence of restrictive provisions, the basic ownership rights of common shareholders are the rights to: vote in the election of the board of directors and in corporate actions that require shareholders' approval, share in corporate income by receiving dividends, and share in assets upon liquidation. The basic ownership rights of preferred shareholders are the rights to receive: dividends ahead of the common shareholder, and assets upon liquidation ahead of the common shareholder. In exchange for these preferences, preferred shareholders normally are not entitled to vote. 6. The total number of shares a company is allowed to sell is called its authorized shares it may be an unlimited amount or a specified amount. No journal entry is recorded when the number of authorized shares is set. Issued shares are shares that have been sold. A journal entry will be prepared when shares are issued. The number of issued shares can never exceed the number of authorized shares. 7. (a) Legal capital is capital that has been contributed by the shareholders that must remain in the corporation, to protect creditors. (b) Legal capital is unavailable for dividends. Retained earnings are available for dividends. Keeping the two amounts separate on the balance sheets enables users to see the amount of creditor protection that exists. The distinction between amounts contributed by the owners and amounts earned and retained by the company is not needed for proprietorships because the proprietor has unlimited personal liability for the debts of the business in any case. Solutions Manual 13-6 Chapter 13

7 QUESTIONS (Continued) 8. Income trusts are established to invest in income producing assets. Unit holders expect regular distributions. As a result, most of the earnings of the trust are distributed, leaving very little retained. On the other hand, corporations often retain a large portion of their earnings to finance their continued operations, expansion plans, or to provide a measure of safety. 9. When Jean-Guy purchases the original shares as part of Innovate.com s initial public offering, he is purchasing from the company. The $1,000 (100 X $10) he spends to buy the shares goes directly to Innovate.com and increases the company s assets and shareholders equity. In the subsequent purchase, Jean Guy is buying in the secondary market from another investor. The proceeds from this sale go to the seller and not to Innovate.com. Therefore there is no impact on Innovate.com s financial statements as a result of the second purchase. 10. There will be no impact on Abitibi s financial statements at the time of the share price decline. However, should Abitibi decide it would like to raise capital in the securities market, the price decline means it will have to sell more shares to raise the same amount of money. 11. When shares are issued for services or noncash assets, the cost should be measured at the fair market value of the consideration given up (the shares). If that value cannot be reasonably determined, then the fair market value of the consideration received should be used (the land). In this case, the fair market value of the shares is more objectively determinable, since the shares are actively traded in the securities market. The appraised value of the land is merely an estimate of the land's value, while the market price of the shares is the amount the shares were actually worth on the date of exchange. Therefore, the land should be recorded at $90, A corporation may acquire its own shares: (1) to increase trading of the company's shares in the securities market in the hope of enhancing its market value, (2) to increase earnings per share by reducing the number of shares issued, (3) to eliminate hostile shareholders by buying them out, (4) to have additional shares available to be reissued to officers and employees under bonus and stock compensation plans, or for use in the acquisition of other companies, and (5) to comply with percentage share ownership requirements. Solutions Manual 13-7 Chapter 13

8 QUESTIONS (Continued) 13. This transaction: (a) decreases total assets, (b) has no effect on total liabilities and, (c) decreases total shareholders' equity. 14. Share repurchases are transactions between the company and its shareholders. Therefore, any resulting gains or losses cannot be reported on the income statement. Such gains and losses are seen as an excess or deficiency belonging to the original shareholders and are reported as an increase or decrease in the shareholders equity section of the balance sheet. 15. If there have been gains from similar transactions in the past, the resulting credit balance of the contributed capital account is available to absorb some or all of the loss on reacquisition. However, the balance of the contributed capital account cannot go below zero. If the loss exceeds the balance in the contributed capital account, the excess amount is debited to retained earnings. 16. Common shares and preferred shares both represent ownership of the corporation. Common shares signify the basic residual ownership; preferred shares represent ownership with certain privileges or preferences. Preferred shareholders typically have a preference as to dividends and as to assets in the event of liquidation. However, preferred shareholders generally do not have voting rights. 17. Cumulative preferred shares are those that require preferred shareholders be paid both current year dividends and unpaid prior year dividends before common shareholders receive any dividends. Dividends not declared for noncumulative preferred shares are lost forever. Redeemable preferred shares can be purchased from the shareholders, by the issuing corporation, at the option of the corporation. If the shares are retractable they can be sold by the shareholder, to the issuing corporation, at the option of the shareholder. 18. (a) Dividends in arrears are dividends on cumulative preferred shares that were not declared in a given period. (b) Dividends in arrears are disclosed in the notes to the financial statements; they are not recorded as liabilities. Solutions Manual 13-8 Chapter 13

9 QUESTIONS (Continued) 19. When convertible preferred shares are converted into common shares, the shareholder simply exchanges preferred shares for common shares, according to a predetermined rate. To record the conversion, the amount originally paid for the preferred shares is transferred into the appropriate common shares account. If multiple share issues have occurred at varying prices, then the average cost for each preferred share is used instead of the original cost. This entry has no effect on (a) total assets, (b) total liabilities, or (c) total shareholders' equity. 20. The three main components of shareholders' equity are: Contributed capital, Retained earnings, and Accumulated other comprehensive income. Contributed capital represents the amounts contributed by the shareholders. Share capital and additional contributed capital (e.g., from reacquisition of shares) are components of contributed capital. Retained earnings represent the cumulative net income (or loss) since incorporation that has been retained in company and not distributed to shareholders as dividends. Accumulated other comprehensive income represents gains and losses not resulting from share transactions, that bypass net income. The most common example is unrealized gains and losses on investments. 21. The answers are summarized in the table below: (a) (b) (c) (d) (e) Account Common Shares Retained Earnings Contributed Capital Reacquired Shares Accumulated Other Comprehensive Income Preferred Shares Classification Share capital common shares Retained earnings Additional contributed capital Accumulated other comprehensive income Share capital preferred shares Solutions Manual 13-9 Chapter 13

10 QUESTIONS (Continued) 22. Comprehensive income includes all changes in shareholders equity during a period except for changes that result from the sale or repurchase of shares or from the payment of dividends. Accumulated other comprehensive income is reported separately from retained earnings to distinguish unrealized gains and losses from realized gains and losses and other sources of earned income that are accumulated in retained earnings. Reporting this information separately insulates income, and consequently retained earnings, from fluctuations in market value while still informing users of the gain or loss that could have occurred had the investment been sold. 23. Return on equity is the return earned by all the shareholders both the preferred and common shareholders. It is calculated by dividing net income by the average shareholders equity. Return on common shareholder s equity is the return earned by the common shareholders. It is calculated by dividing the net income available to the common shareholders by the average common shareholders equity. Preferred dividends are deducted from net income to determine the numerator. The legal capital of the preferred shareholders is deducted from total shareholders equity before calculating the average common shareholders equity. 24. Net income by itself does not provide shareholders with an indication of their return per dollar of investment. Comparing net income to shareholders equity provides investors with a meaningful measure of how many dollars are earned for each dollar of their investment. It also provides shareholders with the information necessary to compare investment opportunities in the marketplace. Solutions Manual Chapter 13

11 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 13-1 Characteristic Proprietorship Partnership Corporation 1. Continuous life X 2. Unlimited liability X X 3. Ease of formation X X 4. Income taxes X 5. Ability to acquire capital X X 6. Shared skills and resources X 7. Fewer government regulations X X 8. Separation of ownership and X management 9. Owners acts are binding X X 10. Ease of transfer of ownership rights X BRIEF EXERCISE 13-2 The increase in share price will have no impact on Body Shop s financial position. The balance sheet will be unchanged since the shares are listed at their issue price, not their current market value. On the other hand, the increased market valuation of the business would enable the Body Shop to raise funds more easily. The shareholders would see the value of their investment increase and could realize gains by selling some or all of their shares. Solutions Manual Chapter 13

12 BRIEF EXERCISE 13-3 (a) June 1 Cash (2,000 X $6)... 12,000 Common Shares... 12,000 Dec. 15 Cash (1,000 X $9)... 9,000 Common Shares... 9,000 (b) Average issue price: ($12,000 + $9,000) (2, ,000) = $7 BRIEF EXERCISE 13-4 (a) Dec. 20 Land (5,000 X $14)... 70,000 Common Shares... 70,000 (b) No, the answer would not change. The market price of the shares is a reliable indicator of its value; the advertised price of the land is not. Solutions Manual Chapter 13

13 BRIEF EXERCISE 13-5 (a) Average Repurchase Price = $10.80 ($2,000,000 + $4,000,000) 555,600 shares (b) Initial Average Issue Price = $3.60 $2,000, ,600 shares (c) Cascades may have repurchased some of its own shares (1) to increase trading of the company's shares in the stock market, in the hopes of enhancing its market value, (2) to reduce the number of shares issued and increase earnings per share, or (3) to comply with percentage share ownership requirements. Some companies have been repurchasing their own shares lately because they have excess cash on hand and no better investments available. BRIEF EXERCISE 13-6 (a) Feb. 15 Common Shares (5,000 X $3.50*)... 17,500 Contributed Capital Reacquired Common Shares... 2,500 Cash... 15,000 (b) Feb. 15 Common Shares (5,000 X $3.50*)... 17,500 Retained Earnings... 2,500 Cash... 20,000 *Average share price = $122,500 35,000 shares = $3.50 Solutions Manual Chapter 13

14 BRIEF EXERCISE 13-7 (a) Jan. 28 Cash (5,000 X $110) ,000 Preferred Shares ,000 June 15 Cash (1,000 X $125) ,000 Preferred Shares ,000 (b) Average issue price: $ ($550,000 + $125,000) (5, ,000) BRIEF EXERCISE 13-8 (a) Mar. 3 Cash (40,000 X $100)... 4,000,000 Preferred Shares... 4,000,000 (b) Oct. 1 Preferred Shares (10,000 X $100) 1,000,000 Common Shares... 1,000,000 (40,000 shares) BRIEF EXERCISE 13-9 (a) Dividends are in arrears by $80,000 (40,000 X $2). (b) If the shares were noncumulative, there would be no dividends in arrears. Solutions Manual Chapter 13

15 BRIEF EXERCISE KAPOSI CORPORATION Balance Sheet (Partial) December 31, 2008 Shareholders' equity Contributed capital Share capital Preferred shares, no par value, $5-noncumulative, unlimited number of shares authorized, 800 shares issued $ 20,000 Common shares, no par value, unlimited number of shares authorized, 5,000 shares issued 50,000 Total share capital 70,000 Contributed capital reacquisition of common shares 5,000 Total contributed capital 75,000 Retained earnings 29,000 Total shareholders' equity $104,000 Solutions Manual Chapter 13

16 BRIEF EXERCISE (a) KAPOSI CORPORATION Balance Sheet (Partial) December 31, 2008 Shareholders' equity Contributed capital Share capital Preferred shares, no par value, $5-noncumulative, unlimited number of shares authorized, 800 shares issued $ 20,000 Common shares, no par value, unlimited number of shares authorized, 5,000 shares issued 50,000 Total share capital 70,000 Contributed capital reacquisition of common shares 5,000 Total contributed capital 75,000 Retained earnings 29,000 Accumulated other comprehensive income 6,000 Total shareholders' equity $110,000 (b) Total shareholders equity would be $98,000 ($104,000 - $6,000) Solutions Manual Chapter 13

17 BRIEF EXERCISE Dec. 31 Revenues... 2,000,000 Income Summary... 2,000, Income Summary... 1,500,000 Expenses... 1,500, Income Summary ,000 Retained Earnings , Retained Earnings... 50,000 Dividends... 50,000 BRIEF EXERCISE (a) Return on equity $8,097 ($132,495 + $121,784) 2 = 6.4% (b) It would be the same. Solutions Manual Chapter 13

18 SOLUTIONS TO EXERCISES EXERCISE 13-1 (a) High $60.85 Low $41.45 (b) $0.75 (c) 1,000 X $60.41 = $60,410 (d) $ $1.24 = $60.49 (closing price + change) (e) 9,837 X 100 = 983,700 shares (f) Since the share price is up $17.80 over the 365-day low ($ $41.45) investors are probably looking primarily for capital appreciation. EXERCISE Dec. 5 Land ,000 Common Shares , June 1 Land (20,000 X $12) ,000 Common Shares ,000 Solutions Manual Chapter 13

19 EXERCISE 13-3 (a) Jan. 10 Cash (75,000 X $5) ,000 Common Shares ,000 Feb. 24 Cash (1,000 X $105) ,000 Preferred Shares ,000 July 1 Cash (50,000 X $6.50) ,000 Common Shares ,000 (b) (1) The average issue price of the preferred shares is $105. (2) The average issue price of the common shares is $5.60 ($375,000 + $325,000) (75, ,000). EXERCISE 13-4 (a) Jan. 6 Cash ,000 Common Shares ,000 (200,000 shares X $1.50) 12 Cash... 87,500 Common Shares... 87,500 (50,000 shares X $1.75) Mar. 17 Cash ,000 Preferred Shares ,000 (1,000 shares X $105) July 18 Cash... 2,000,000 Common Shares... 2,000,000 Solutions Manual Chapter 13

20 EXERCISE 13-4 (Continued) (a) (Continued) Nov. 17 Common Shares * ,000 Retained Earnings... 8,000 Cash (200,000 X $1.95) ,000 Dec. 30 Common Shares * ,500 Contributed Capital Reacquisition of Common Shares 16,500 Cash (150,000 X $1.80) ,000 *Average Cost per Common Share: Transaction Date Number of Common Shares Issued Proceeds of Issue January 6 200,000 $ 300,000 January 12 50,000 87,500 July 18 1,000,000 2,000,000 Total 1,250,000 $2,387,500 $2,387,500 1,250,000 = $ ,000 X $1.91 = $382, ,000 X $1.91 = $286,500 Solutions Manual Chapter 13

21 EXERCISE 13-4 (Continued) (b) There are 900,000 common shares remaining, at an average cost of $1.91**. **Average Cost per Common Share: Transaction Date Number of Common Shares Issued Proceeds of Issue January 6 200,000 $ 300,000 January 12 50,000 87,500 July 18 1,000,000 2,000,000 Nov. 17 (200,000) (382,000) Dec. 30 (150,000) (286,500) Total 900,000 $1,719,000 $1,719, ,000 = $1.91 EXERCISE 13-5 (a) 100,000 X $4 = $400,000 (b) Year 1 Year 2 Regular dividend $400,000 $400,000 Arrears from Year 1 150, ,000 Dividend paid 250, ,000 Arrears $150,000 $ 0 (c) Dividends in arrears should be disclosed in the notes to the financial statements. They are not recorded in the books. (d) The likely amount is $4 per share, for a total of $400,000. Solutions Manual Chapter 13

22 EXERCISE 13-6 (a) Nov. 15 Preferred Shares ,000 Common Shares ,000 Average share price ($1,000,000 + $3,600,000) (10, ,000) = $115 2,000 X $115 = $230,000 (b) 10, ,000 2,000 = 38,000 preferred shares 2,000 X 5 = 10,000 common shares EXERCISE 13-7 (a) 9. Legal capital (b) 1. Publicly held corporation (c) 12. Organization costs (d) 2. Authorized shares (e) 5. Issued shares (f) 8. Initial public offering (g) 7. Secondary market (h) 6. Retained earnings (i) 4. Common shares (j) 11. Comprehensive income (k) 10. Contributed capital (l) 13. Convertible (m) 3. Cumulative Solutions Manual Chapter 13

23 EXERCISE Cash Account Share Capital Shareholders Equity Additional Contributed Capital Retained Earnings 2. Common shares X 3. Contributed capital reacquisition of X common shares 4. Gain on sale of property, plant and equipment 5. Available-forsale security 6. Unrealized gain on available-forsale security 7. Preferred shares X 8. Retained X earnings 9. Legal fees expense 10. Dividends X Accumulated Other Comprehensive Income X Financial Statement Balance Sheet Income Statement Balance Sheet Income Statement Other Classification Current Assets Other Revenue (Gain) Current Assets Operating Expense Solutions Manual Chapter 13

24 EXERCISE 13-9 OZABAL INC. Partial Balance Sheet December 31, 2008 Shareholders' equity Contributed capital Share capital Preferred shares $4-noncumulative, no par value, 100,000 shares authorized, 30,000 issued $ 150,000 Common shares, no par value, unlimited number of shares authorized, 300,000 shares issued 300,000 Total share capital 450,000 Contributed capital reacquisition of common shares 25,000 Total contributed capital 475,000 Retained earnings 900,000 Accumulated other comprehensive income 75,000 Total shareholders equity $1,450,000 Solutions Manual Chapter 13

25 EXERCISE (a) REITMANS (CANADA) LIMITED Partial Balance Sheet January 28, 2006 (in thousands) Shareholders' equity Share capital Class A non-voting (preferred) shares, unlimited number authorized, 56,747 issued... $ 16,892 Common shares, unlimited number authorized, 13,440 shares issued Total share capital... 17,374 Contributed surplus... 2,523 Total contributed capital... 19,897 Retained earnings* ,360 Total shareholders equity... $390,257 *$316,191 + $84,889 - $29,345 - $1,375 = $370,360 (b) ($ in thousands) Return on equity = Net income Average shareholders equity = $84,889 [($390,257 + $331,524) 2] = 23.52% Solutions Manual Chapter 13

26 EXERCISE (a) The average cost of the preferred shares is $60 ($600,000 10,000 = $60). The average cost of the common shares is $3 ($1,800, ,000 = $3). (b) It will be able to sell an additional 150,000 common shares (750,000 authorized - 600,000 issued). (c) The company paid $2 per share, for a total of $200,000. $100, ,000 = $1 per share was credited to contributed capital. The average issue price of $3 per share was debited to the common shares account. The difference, $2 was the price paid per share. Common Shares ,000 Contributed Capital ,000 Cash ,000 (d) $5 X 10,000 = $50,000. (e) The retained earnings balance would be $1,208,000 ($1,158,000 + $50,000 dividends which were not paid nor declared). Dividends in arrears are only disclosed in the notes to the financial statements. Solutions Manual Chapter 13

27 SOLUTIONS TO PROBLEMS PROBLEM 13-1A 1. Kyle should run his beer cart business as a proprietorship because this is the simplest form of business to establish. It is also the least expensive. He is the only person involved in the business and is planning to operate for a short time. 2. Joseph and Sabra should form a corporation when they combine their operations. This is the best form of business for them to choose because they need to raise significant funds in the coming year and it is easier to raise funds in a corporation. A corporation may also receive more favourable income tax treatment. 3. The professors should form a partnership for their business. It is simpler to form than a corporation and less costly. Each professor has contributed a similar amount of money and expertise, and there is no mention of additional funds being required. 4. Abdur should form a corporation. This is the best form of business for him to choose because he will require significant funds to finance the chain of stores and it is easier to raise funds in a corporation. A corporation may also receive more favourable income tax treatment. 5. A partnership would be the most likely form of business for Mary and Richard to choose. It is simpler to form than a corporation and less costly. Solutions Manual Chapter 13

28 PROBLEM 13-2A (a) Shares authorized 100,000 Shares issued 11,000 (b) Common shares $396,000 Contributed capital reacquisition of common shares $2,600 Retained earnings $161,400 Calculations: Common shares (a) Number of shares (b) Average issue price (a) (b) Contributed capital reacquisition of common shares Retained earnings Bal $270,000 9,000 $30.00 $ 9,000 $180, (12,000) (400) (3,600) 258,000 8, , , ,000 3, ,000 12, , , ,800 1, ,800 13, , , (36,000) (1,000) (5,400) (18,600) 442,800 12, , (46,800) (1,300) 2, $396,000 11, $2,600 $161,400 Solutions Manual Chapter 13

29 PROBLEM 13-3A (a) Year Dividend Paid Noncumulative Preferred Common Cumulative Preferred Common 1 $15,000 $15,000 $ 0 $15,000 $ ,000 12, , ,000 15,000 12,000 18,000 9, ,000 15,000 20,000 15,000 20, Regular dividend is $5 X 3,000 = $15,000 2b. Arrears = $15,000 - $12,000 = $3,000 3b. Preferred dividend = $15,000 (regular) + $3,000 (arrears) = $18,000 (b) Solutions Manual Chapter 13

30 PROBLEM 13-4A Assets Liabilities Preferred Shares Common Shares Shareholders' Equity Other Contributed Capital Retained Earnings Accumulated Other Comprehensive Income 1. +$100,000 n/a n/a +$100,000 n/a n/a n/a 2. +5,500 n/a n/a +5,500 n/a n/a n/a 3. n/a n/a -$300, ,000 n/a n/a n/a ,000 n/a +150,000 n/a n/a n/a n/a ,500 n/a -75,000 n/a +$2,500 n/a n/a ,000 n/a n/a n/a n/a -$10,000 n/a 7. -5,000 n/a n/a n/a n/a n/a -$5, $600,000 4,000 = $150 $150 X 2,000 = $300, ($600,000 $300,000 + $150,000) (4,000 2, ,000) = $150 $150 X 500 = $75,000 $75,000 - $72,500 = $2, ,500 X $4 = $10,000 Solutions Manual Chapter 13

31 PROBLEM 13-5A (a) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Jan. 10 Cash (100,000 X $2) ,000 Common Shares ,000 Mar. 1 Cash (10,000 X $42) ,000 Preferred Shares ,000 Apr. 1 Land (25,000 X $2.50)... 62,500 Common Shares... 62,500 May 1 Cash (75,000 X $3) ,000 Common Shares ,000 July 24 Cash... 60,000 Equipment... 7,200 Common Shares (16,800 X $4).. 67,200 Nov. 1 Cash (2,000 X $48)... 96,000 Preferred Shares... 96,000 Dec. 31 Income Summary ,000 Retained Earnings , Dividends... 36,000 Cash... 36, Retained Earnings... 36,000 Dividends... 36,000 Solutions Manual Chapter 13

32 PROBLEM 13-5A (Continued) (b) Preferred Shares Date Explanation Ref. Debit Credit Balance Mar. 1 Nov. 1 Common Shares 420,000 96, , ,000 Date Explanation Ref. Debit Credit Balance Jan. 10 Apr. 1 May 1 July 24 Dividends 200,000 62, ,000 67, , , , ,700 Date Explanation Ref. Debit Credit Balance Dec Closing entry Retained Earnings 36,000 36,000 36,000 0 Date Explanation Ref. Debit Credit Balance Dec Closing entry Closing entry 36, , , ,000 Solutions Manual Chapter 13

33 PROBLEM 13-5A (Continued) (c) HIGHLAND CORPORATION Balance Sheet (Partial) December 31, 2008 Shareholders' equity Share capital Preferred shares, no par value, $3-noncumulative,. unlimited number of shares authorized,12,000* shares issued... $ 516,000 Common shares, no par value, unlimited number of shares authorized, 216,800** shares issued 554,700 Total share capital... 1,070,700 Retained earnings ,000 Total shareholders equity... $1,684,700 * 10, ,000 = 12,000 shares ** 100, , , ,800 = 216,800 shares Solutions Manual Chapter 13

34 PROBLEM 13-6A (a) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Feb. 1 Cash... 75,000 Common Shares... 75,000 Sept. 3 Cash... 16,500 Common Shares... 16,500 Oct. 25 Common Shares (10,000 X $2.75*).. 27,500 Contributed Capital Reacquisition of Common Shares... 1,500 Retained Earnings... 1,000 Cash... 30,000 *Average Cost per Common Share: Number of Common Shares Issued Proceeds of Issue Transaction Date Beginning balance 1,000,000 $2,741,000 February 1 25,000 75,000 September 3 5,000 16,500 Total 1,030,000 $2,832,500 $2,832,500 1,030,000 = $2.75 Nov. 3 Cash ,000 Preferred Shares ,000 Dec. 31 Income Summary ,000 Retained Earnings ,000 Solutions Manual Chapter 13

35 PROBLEM 13-6A (Continued) (a) (Continued) Dec. 31 Dividends... 30,000 Cash... 30,000 (b) 31 Retained Earnings... 30,000 Dividends... 30,000 Preferred Shares Date Explanation Ref. Debit Credit Balance Jan. 1 Nov. 3 Common Shares Balance 130, , ,000 Date Explanation Ref. Debit Credit Balance Jan. 1 Feb. 1 Sept. 3 Oct. 25 Balance 27,500 Contributed Capital Reacquisition of Shares 75,000 16,500 2,741,000 2,816,000 2,832,500 2,805,000 Date Explanation Ref. Debit Credit Balance Jan. 1 Oct. 25 Dividends Balance 1,500 1,500 0 Date Explanation Ref. Debit Credit Balance Dec Closing entry 30,000 30,000 30,000 0 Solutions Manual Chapter 13

36 PROBLEM 13-6A (Continued) (b) (Continued) Retained Earnings Date Explanation Ref. Debit Credit Balance Jan. 1 Balance 1,816,000 Oct. 25 1,000 1,815,000 Dec. 31 Closing entry 275,000 2,090, Closing entry 30,000 2,060,000 (c) MOUNTAINHI CORPORATION Balance Sheet (Partial) December 31, 2008 Shareholders' equity Share capital $4 preferred shares, cumulative, no par value, 50,000 shares authorized, 10,000 shares issued... $ 630,000 Common shares, no par value, unlimited number of shares authorized, 1,020,000* shares issued 2,805,000 Total share capital... 3,435,000 Retained earnings (See Note X)... 2,060,000 Total shareholders' equity... $5,495,000 Note X: Dividends on preferred shares totalling $10,000 [10,000 X $1 per share] are in arrears. *1,000, , ,000 10,000 = 1,020,000 shares Solutions Manual Chapter 13

37 PROBLEM 13-7A (a) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Feb. 06 Building (1,000 X $111) ,000 Preferred Shares ,000 July 15 Preferred Shares (2,000 X $106*) ,000 Common Shares ,000 *($525,000 + $111,000) (5, ,000) = $ Aug. 22 Cash (500 X $124)... 62,000 Preferred Shares... 62,000 Nov. 1 Preferred Shares (1,000 X $108**). 108,000 Common Shares ,000 **($525,000 + $111,000 $212,000 + $62,000) (5, ,000 2, ) = $108 Dec 31 Revenues ,000 Income Summary , Income Summary ,000 Expenses , Income Summary... 60,000 Retained Earnings... 60,000 Solutions Manual Chapter 13

38 PROBLEM 13-7A (Continued) (a) (Continued) Preferred Shares Date Explanation Ref. Debit Credit Balance Jan. 1 Feb. 6 July 15 Aug. 22 Nov. 1 Common Shares Balance 212, , ,000 62, , , , , ,000 Date Explanation Ref. Debit Credit Balance Jan. 1 July 15 Nov. 1 Balance 212, ,000 Contributed Capital Reacquisition of Preferred Shares 1,050,000 1,262,000 1,370,000 Date Explanation Ref. Debit Credit Balance Jan. 1 Balance 18,750 Retained Earnings Date Explanation Ref. Debit Credit Balance Jan. 1 Dec. 31 Balance Closing Entry Accumulated Other Comprehensive Income 60, , ,000 Date Explanation Ref. Debit Credit Balance Jan. 1 Balance 25,000 Solutions Manual Chapter 13

39 PROBLEM 13-7A (Continued) (c) DENISON CORPORATION Balance Sheet (Partial) December 31, 2008 Shareholders' equity Contributed capital Share capital Preferred shares, no par value, $3-noncumulative, convertible, 10,000 shares authorized, 3,500* shares issued... $ 378,000 Common shares, no par value, unlimited number of shares authorized, 94,000** shares issued... 1,370,000 Total share capital... 1,748,000 Additional contributed capital Contributed capital- reacquisition of preferred shares... 18,750 Total contributed capital... 1,766,750 Retained earnings ,000 Accumulated other comprehensive income... 25,000 Total shareholders' equity... $2,151,750 *5, ,000 2, ,000 = 3,500 shares **70, , ,000 = 94,000 shares Solutions Manual Chapter 13

40 PROBLEM 13-8A (a) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Sep. 30 Commission Revenue ,850 Income Summary , Income Summary ,440 Salaries Expense ,400 Rent Expense... 25,000 Amortization Expense... 30,080 Supplies Expense... 4,860 Utilities Expense... 18,200 Interest Expense... 3,900 Income Tax Expense... 25, Income Summary... 69,410 Retained Earnings... 69, Retained Earnings... 2,000 Dividends... 2,000 Solutions Manual Chapter 13

41 PROBLEM 13-8A (Continued) (b) MISCOU CORP. Balance Sheet September 30, 2008 Assets Current assets Cash... $ 32,500 Accounts receivable... 74,705 Supplies... 1,265 Total current assets ,470 Property, plant and equipment Equipment... $150,400 Less: Accumulated amortization... (60,160) 90,240 Franchise ,000 Total assets... $423,710 Liabilities and Shareholders Equity Current liabilities Accounts payable... $ 43,000 Salaries payable... 8,400 Interest payable Income tax payable... 2,000 Unearned commission revenue... 5,500 Current portion of long-term debt... 5,000 Total current liabilities... 64,800 Long-term debt Long-term note payable... 55,000 Total liabilities ,800 Solutions Manual Chapter 13

42 PROBLEM 13-8A (Continued) (b) (Continued) MISCOU CORP. Balance Sheet September 30, 2008 Shareholders equity Contributed capital Share capital $4 noncumulative preferred shares unlimited number of shares authorized, 500 issued... $ 50,000 Common shares, unlimited number of shares authorized, 40,000 issued ,000 Total share capital ,000 Other contributed capital Contributed capital reacquisition of preferred shares... 1,500 Total contributed capital ,500 Retained earnings* ,410 Total shareholders equity ,910 Total liabilities and shareholders equity... $423,710 *Retained earnings Balance, Oct 1, $ 75,000 Add: Net income... 69,410 Less: Dividends... (2,000) Balance, September 30, $142,410 Solutions Manual Chapter 13

43 PROBLEM 13-9A (a) ANDRÉS WINES LTD. Balance Sheet March 31, 2006 (in thousands) Assets Current assets Accounts receivable... $ 18,444 Inventories... 70,528 Income taxes recoverable Prepaid expenses... 2,447 Total current assets... 92,330 Property, plant, and equipment... $134,697 Less: Accumulated amortization... (49,100) 85,597 Goodwill... 35,862 Other long-term assets... 8,298 Total assets... $222,087 Liabilities and Shareholders Equity Current liabilities Bank indebtedness... $ 37,295 Accounts payable and accrued liabilities... 21,613 Dividends payable Current portion of long-term debt... 5,888 Total current liabilities... 65,574 Long-term liabilities Long-term debt... $50,328 Future income tax liability... 12,381 Other long-term liabilities... 4,224 66,933 Total liabilities... $132,507 Solutions Manual Chapter 13

44 PROBLEM 13-9A (Continued) (a) (Continued) ANDRÉS WINES LTD. Balance Sheet March 31, 2006 (in thousands) Shareholders equity Share capital Class A shares, nonvoting, unlimited authorized, 3,963 issued... 6,975 Class B shares, voting, convertible into Class A shares, unlimited authorized, 1,002 issued. 400 Total share capital... 7,375 Retained earnings*... 82,205 Total shareholders equity... 89,580 Total liabilities and shareholders equity... $222,087 *$79,260 + $6,054 $3,109 = $82,205 (b) Return on equity = Net income Average shareholders equity $6,054 $89,580 + $87,168 2 = 6.85% Solutions Manual Chapter 13

45 PROBLEM 13-10A (a) Return on equity = Net income Average shareholders equity 2004 $128.7 $1, $1, = 7.04% 2005 $770.8 $1, $ = 61.11% Sears return on equity has improved significantly during the last year. (b) Sears is performing as well as the industry average in both years. Solutions Manual Chapter 13

46 PROBLEM 13-11A (a) Preferred dividends Preferred dividend per share $150,000 $5 = 30,000 preferred shares (b) Preferred share average price = $3,150,000 30,000 shares issued = $105 per share Common share average price = $1,000, ,000 shares issued = $4 per share (c) The shares were issued for an average selling price of $4 (see (b) above) which means the company would have reduced the Common Shares account by $100,000 (25,000 X $4). Since a reduction to retained earnings is shown relating to this reacquisition for $56,250, this indicates the company had to pay $156,250 ($100,000 + $56,250) to reacquire the 25,000 shares. (d) Limited liability for preferred shareholders = $3,150,000 Limited liability for common shareholders = $4,600,000 - $3,150,000 = $1,450,000 (e) It is a loss that bypasses the income statement because it has not yet been realized. An example is an unrealized loss on investments that are available for sale. Solutions Manual Chapter 13

47 PROBLEM 13-1B 1. A partnership would be the most likely form of business for the students to choose. It is simpler to form than a corporation and less costly. 2. Chris will likely operate his lawn maintenance service as a proprietorship because he is planning on operating it for a short time period and a proprietorship is the simplest and least costly to form and dissolve. 3. Ron would likely form a corporation because he probably needs to raise funds to buy equipment. It is normally easier to raise funds through a corporation. A corporation is also the only form of business that provides limited liability to it owners. There may also be income tax benefits. 4. Hervé would likely form a corporation because he needs to raise funds to invest in inventories and equipment. He has no savings or personal assets and it is normally easier to raise funds through a corporation. 5. A proprietorship would be the most likely form of business for Johnny. It is simpler to form than a corporation and less costly. A corporation is the only form of business that provides limited liability to it owners. However, is unlikely that incorporating the business would shield Johnny from personal liability in the event of an accident. Solutions Manual Chapter 13

48 PROBLEM 13-2B (a) Shares authorized 500,000 Shares issued 200,000 (b) Common shares $830,000 Contributed capital reacquisition of Common shares $10,500 Retained earnings $680,000 Calculations: Common shares (a) Number of shares (b) Average issue price (a) (b) Contributed capital reacquisition of common shares Retained earnings Bal $1,000, ,000 $4.00 $10,000 $680, ,500 25,000 1,127, , , , (20,500) (5,000) 500 1,107, , , , ,000 10,000 1,162, , , , (49,800) (12,000) (10,200) 1,112, , , (282,200) (68,000) 10, $ 830, , $10,500 $680,000 Solutions Manual Chapter 13

49 PROBLEM 13-3B (a) (b) Year Dividend Noncumulative Common Cumulative Common Paid Preferred Preferred 1 $20,000 $20,000 $ 0 $20,000 $ ,000 15, , ,000 20,000 10,000 25,000 5, ,000 20,000 15,000 20,000 15, Regular dividend is $4 X 5,000 = $20,000 2b. Arrears = $20,000 - $15,000 = $5,000 3b. Preferred dividend = $20,000 (regular) + $5,000 (arrears) = $25,000 Solutions Manual Chapter 13

50 PROBLEM 13-4B Assets Liabilities Shareholders' Equity Accumulated Other Preferred Common Retained Other Contributed Shares Shares Earnings Comprehensive Capital Income 1. +$23,550 n/a n/a +$23,550 n/a n/a n/a ,000 n/a n/a -160,500 -$30,000 -$9,500 n/a 3. n/a n/a -$70, ,000 n/a n/a n/a ,000 n/a n/a +25,000 n/a n/a n/a 5. +7,500 n/a +7,500 n/a n/a n/a n/a ,000 n/a n/a n/a n/a -15,000 n/a 7. +2,500 n/a n/a n/a n/a n/a +$2, Average share price = ($2,400,000 + $23,550) (150, ,000) = $ $350,000 5,000 = $70; $70 X 1,000 = $70,000 Solutions Manual Chapter 13

51 PROBLEM 13-5B (a) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Feb. 10 Cash (80,000 X $4) ,000 Common Shares ,000 Mar. 1 Cash (5,000 X $115) ,000 Preferred Shares ,000 Apr. 1 Land (22,000 X $4.25)... 93,500 Common Shares... 93,500 Jun. 20 Cash (78,000 X $4.50) ,000 Common Shares ,000 Aug. 1 Legal Fees Expense (10,000 X $4.75) 47,500 Common Shares... 47,500 Sep. 1 Cash (10,000 X $5)... 50,000 Common Shares... 50,000 Nov. 1 Cash (1,000 X $117) ,000 Preferred Shares ,000 Jan. 31 Income Summary ,000 Retained Earnings , Dividends... 24,000 Cash... 24, Retained Earnings... 24,000 Dividends... 24,000 Solutions Manual Chapter 13

52 PROBLEM 13-5B (Continued) (b) Preferred Shares Date Explanation Ref. Debit Credit Balance Mar. 1 Nov. 1 Common Shares 575, , , ,000 Date Explanation Ref. Debit Credit Balance Feb. 10 Apr. 1 June 20 Aug. 1 Sept. 1 Dividends 320,000 93, ,000 47,500 50, , , , , ,000 Date Explanation Ref. Debit Credit Balance Jan Closing entry Retained Earnings 24,000 24,000 24,000 0 Date Explanation Ref. Debit Credit Balance Jan Closing entry Closing entry 24, , , ,000 Solutions Manual Chapter 13

53 PROBLEM 13-5B (Continued) (c) WETLAND CORPORATION Balance Sheet (Partial) January 31, 2008 Shareholders' equity Share capital $4-noncumulative preferred shares, no par value, unlimited number of shares authorized, 6,000* shares issued... $ 692,000 Common shares, no par value, unlimited number of shares authorized, 200,000** shares issued 862,000 Total share capital... 1,554,000 Retained earnings ,000 Total shareholders equity... $2,030,000 *5, ,000 = 6,000 shares **80, , , , ,000 = 200,000 shares Solutions Manual Chapter 13

54 PROBLEM 13-6B (a) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Feb. 1 Cash... 55,500 Common Shares... 55,500 Sep. 3 Cash ,000 Preferred Shares ,000 Oct. 25 Common Shares (10,000 X $7.10*)... 71,000 Contributed Capital Reacquisition of Common Shares... 2,500 Retained Earnings... 1,500 Cash... 75,000 *Average Cost per Common Share: Number of Common Shares Issued Proceeds of Issue Transaction Date Beginning balance 200,000 $1,400,000 February 1 5,000 55,500 Total 205,000 $1,455,500 $1,455, ,000 = $7.10 Dec. 31 Income Summary... 60,000 Retained Earnings... 60, Dividends... 12,000 Cash... 12,000 Solutions Manual Chapter 13

55 PROBLEM 13-6B (Continued) (a) (Continued) Dec. 31 Retained Earnings... 12,000 Dividends... 12,000 (b) Preferred Shares Date Explanation Ref. Debit Credit Balance Jan. 1 Sep. 3 Common Shares Balance 107, , ,000 Date Explanation Ref. Debit Credit Balance Jan. 1 Feb. 1 Oct. 25 Balance 71,000 Contributed Capital Reacquisition of Shares 55,500 1,400,000 1,455,500 1,384,500 Date Explanation Ref. Debit Credit Balance Jan. 1 Oct. 25 Dividends Balance 2,500 2,500 2,500 0 Date Explanation Ref. Debit Credit Balance Jan Closing entry 12,000 12,000 12,000 0 Solutions Manual Chapter 13

56 PROBLEM 13-6B (Continued) (b) (Continued) Retained Earnings Date Explanation Ref. Debit Credit Balance Jan. 1 Oct. 25 Dec Balance Closing entry Closing etnry 1,500 12,000 60, , , , ,500 (c) CHEUNG CORPORATION Balance Sheet (Partial) December 31, 2008 Shareholders' equity Share capital $5-cumulative preferred shares, no par value, 25,000 shares authorized, 4,000* shares issued $ 427,000 Common shares, no par value, unlimited number of shares authorized, 195,000** shares issued 1,384,500 Total share capital... 1,811,500 Retained earnings ,500 Total shareholders equity... $2,346,000 *3, ,000 = 4,000 preferred shares ** 200, ,000 10,000 = 195,000 common shares Note X: Dividends of $8,000 are in arrears. (4,000 X $5 - $12,000) Solutions Manual Chapter 13

57 PROBLEM 13-7B (a) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Feb. 1 Land (1,000 x $120) ,000 Preferred Shares ,000 Mar. 1 Preferred Shares (500 X $112*)... 56,000 Common Shares... 56,000 *Average cost of preferred shares: ($440,000 + $120,000) (4, ,000) = $112 Jul. 1 Cash (1,500 X $130) ,000 Preferred Shares ,000 Sep. 1 Preferred Shares (1,000 X $116.50**) 116,500 Common Shares ,500 ** Average cost of preferred shares: ($440,000 + $120,000 $56,000 + $195,000) (4, , ,500) = $ Dec. 31 Revenues ,000 Income Summary , Income Summary ,000 Expenses , Income Summary... 50,000 Retained Earnings... 50,000 Solutions Manual Chapter 13

58 PROBLEM 13-7B (Continued) (b) Preferred Shares Date Explanation Ref. Debit Credit Balance Jan. 1 Feb. 1 Mar 1 Jul 1 Sep. 1 Common Shares Balance 56, , , , , , , , ,500 Date Explanation Ref. Debit Credit Balance Jan. 1 Mar 1 Sep. 1 Balance 56, ,500 Contributed Capital Reacquisition of Preferred Shares 1,050,000 1,106,000 1,222,500 Date Explanation Ref. Debit Credit Balance Jan. 1 Balance 25,000 Retained Earnings Date Explanation Ref. Debit Credit Balance Jan. 1 Dec. 31 Balance Closing Entry Accumulated Other Comprehensive Income 50, , ,000 Date Explanation Ref. Debit Credit Balance Jan. 1 Balance 10,000 Solutions Manual Chapter 13

59 PROBLEM 13-7B (Continued) (c) REMMERS CORPORATION Balance Sheet (Partial) December 31, 2008 Shareholders' equity Contributed capital Share capital $5 cumulative preferred shares, no par value, convertible 10,000 shares authorized, 5,000* shares issued... $ 582,500 Common shares, no par value, unlimited shares authorized, 85,000** shares issued... 1,222,500 Total share capital... 1,805,000 Additional contributed capital Contributed capital reacquisition of preferred shares... 25,000 Total contributed capital... 1,830,000 Retained earnings ,000 Accumulated other comprehensive income... 10,000 Total shareholders equity... $2,190,000 * 4, , ,500 1,000 = 5,000 preferred shares ** 70, , ,000 = 85,000 common shares Note X: Dividends of $25,000 (5,000 X $5) are in arrears Solutions Manual Chapter 13