CHAPTER 14 Corporations: Organization and Share Capital Transactions

CHAPTER 14 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. 2. Differentiate between contributed capital and retained earnings. 1, 2, 3, 4, 5 1, 3 1 1 1, 2 6, 7 2 2 2 3. Record the issue of common shares. 8, 9, 10, 11, 12, 13, 14, 15, 16 3, 4, 5, 6 2, 3, 4, 5, 6, 7 2, 3, 4, 5, 8 2, 3, 4, 5 4. Differentiate and journalize preferred and common share transactions. 17, 18 7 5, 6, 7 2, 3, 4, 5 2, 3, 4, 5 5. Prepare the shareholders equity section of the balance sheet. 19 8 7, 8, 9 2, 3, 4, 5, 6, 9 2, 3, 4, 5, 6, 9 6. Calculate return on equity and book value per share. 20, 21 9,10, 11 9, 10 5, 6, 7, 8, 9 4, 5, 6, 7, 8, 9 14-1

ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Determine forms of business organization. Simple 35-45 2A Answer questions about shareholders equity section. Simple 20-30 3A 4A 5A Journalize and post share transactions. Prepare contributed capital section. Journalize and post shareholders equity transactions. Prepare shareholders equity section. Journalize and post share transactions, and prepare a shareholders equity section. Calculate the return on equity and book value. Moderate 25-35 Moderate 30-40 Moderate 20-30 6A Prepare shareholders equity section and calculate book value. Moderate 20-30 7A Show impact of transactions on ratios. Moderate 15-25 8A Calculate book values; compare to amounts paid in. Moderate 15-25 9A Prepare balance sheet; calculate return on equity and book value. Moderate 30-40 1B Determine forms of business organization. Simple 35-45 2B Answer questions about shareholders equity section. Simple 20-30 3B 4B 5B Journalize and post share transactions. Prepare contributed capital section. Journalize and post shareholders equity transactions. Prepare shareholders equity section. Calculate return on equity. Journalize and post share transactions, and prepare a shareholders equity section. Calculate the book value and return on equity. Moderate 25-35 Moderate 30-40 Moderate 20-30 6B Prepare shareholders equity section and calculate book value. Moderate 20-30 7B Show impact of transaction on ratios. Moderate 15-25 8B Calculate return on equity and book value. Moderate 15-25 9B Prepare balance sheet; calculate return on equity and book value. Moderate 30-40 14-2

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. Q14-4 Q14-1 Q14-2 Q14-3 Q14-5 BE14-1 BE14-3 P14-2B E14-1 P14-1A P14-1B 2. Differentiate between contributed capital and retained earnings. Q14-6 Q14-7 BE14-2 P14-2A P14-2B 3. Record the issue of common shares. Q14-9 Q14-10 Q14-11 Q14-15 Q14-16 BE 14-3 Q14-8 Q14-12 Q14-13 Q14-14 BE14-4 BE14-5 BE14-6 E14-2 E14-3 E14-4 E14-5 E14-6 P14-2A P14-3A P14-4A P14-5A P14-2B P14-3B P14-4B P14-5B P14-8B P14-8A E14-7 4. Differentiate and journalize preferred and common share transactions. Q14-17 Q14-18 BE 14-7 E14-5 E14-6 P14-2A P14-3A P14-4A P14-5A P14-2B P14-3B P14-4B P14-5B E14-7 5. Prepare the shareholders equity section of the balance sheet. Q14-19 BE14-8 E14-8 E14-9 P14-2A P14-3A P14-4A P14-5A P14-6A P14-9A P14-2B P14-3B P14-4B P14-5B P16-6B P14-9B E14-7 6. Calculate return on equity and book value per share. Q14-20 Q14-21 BE14-10 BE14-11 BE14-9 E14-9 E14-10 P14-5A P14-6A P14-7A P14-9A P14-4B P14-5B P14-6B P14-7B P14-9B P14-8A P14-8B Broadening Your Perspective BYP14-6 BYP14-1 BYP14-2 BYP14-3 BYP14-4 BYP14-5 BYP14-7 14-3

ANSWERS TO QUESTIONS 01. (a) Separate legal existence. A corporation is separate and distinct from its owners and acts in its own name rather than in the name of its shareholders. In contrast to a partnership, the acts of the owners (shareholders) do not bind the corporation unless the owners are duly appointed agents of the corporation. (b) Limited liability of shareholders. Because of its separate legal existence, creditors of a corporation ordinarily have recourse only to corporate assets to satisfy their claims. Thus, the liability of shareholders is normally limited to their investment in the corporation. (c) Transferable ownership rights. Ownership of a corporation is 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. 02. (a) Taxation is an advantage because corporate tax rates are often lower than personal tax rates. It can be a disadvantage because profits distributed to the shareholders are not a tax deductible expense for the corporation. Therefore profits can be subject to double taxation once at the corporate level and again at the personal rates of the shareholders who receive dividends paid out of these profits (the impact of these taxes is somewhat reduced by the dividend tax credit that shareholders can claim on their personal tax returns). 14-4

Questions Chapter 14 (Continued) 2. (b) Two other disadvantages of a corporation are government regulations and corporate management. A corporation is subject to numerous provincial and federal regulations. For example, laws prescribe the requirements for issuing shares, and govern the sale of shares to the general public. Professional managers often run corporations with ownership being separate from management. Professional managers may act in their own best interests to the detriment of the company and its owners. Two advantages of a corporation are limited liability of shareholders and ability to raising capital. A corporation is a separate legal entity and therefore the shareholders are usually only liable up to their investment in the corporation. A corporation has an easier time raising capital because of features such as limited liability and the ease of transferring shares. 3. (a) (1) A charter is a document that creates a corporation. A charter is also referred to as the articles of incorporation. (2) Organization costs are costs incurred in the formation of a corporation. Organization costs are normally expensed in the year they occur, rather than being capitalized as an intangible asset, because of the difficulty in matching the cost with the future benefits. (b) No, this is not correct. Companies in certain industries which are under federal jurisdiction must incorporate federally. However, most companies in Canada are incorporated provincially, and are free to operate in other provinces although they may be required to register in other provinces in which they operate. 14-5

Questions Chapter 14 (Continued) 4. In the absence of restrictive provisions, the basic ownership rights of common shareholders are the rights to: 04. vote in the election of the board of directors and in corporate actions that require shareholders' approval, share in corporate earnings by receiving dividends, maintain the same percentage ownership when additional shares of common shares are issued (the pre-emptive right), and share in assets upon liquidation. 5. The market value of shares depends on a number of factors, including the company's anticipated future earnings, its expected dividend rate per share, its current financial position, the current state of the economy, and the current state of the stock market. 6. The two principal components of shareholders' equity for a corporation are contributed capital (the investment of cash and other assets in the corporation by shareholders in exchange for share capital) and retained earnings (net income minus dividends). 05. 7. Each of the three basic financial statements for a corporation differs from those for a proprietorship. The income statement for a corporation will have income tax expense. For a corporation, a statement of retained earnings is prepared to show the changes in retained earnings during the period. In the balance sheet, the owner's equity section is called the shareholders' equity section, and consists of share capital (contributed capital if the shares have a stated value) and retained earnings. 8. The maximum number of shares that a corporation is legally allowed to issue is the number authorized. Letterman Corporation is authorized to sell 100,000 common shares. Of these shares, 53,000 common shares (60,000 issued 7,000 reacquired) have been issued. In Canada, shares which are reacquired are usually cancelled and restored to the status of authorized but unissued shares. 14-6

Questions Chapter 14 (Continued) 9. Stated value does not indicate the market value of shares, it is an amount that represents the legal capital per share. Based on the information provided, there is no way to tell which of these common shares is the better investment. 10. The issue of share capital does not have any effect on the issuer's net income. If shares are issued at a price above stated value, the excess is credited to a shareholders' equity account, Contributed Capital in Excess of Stated Value. This excess is part of the company's contributed capital, and is not considered a revenue or a gain. 11. If share prices fall below their par or stated value a company will not be able to use the stock market as a source of financing. Under the law, a share cannot be sold for less than its par or stated value. Also, as market prices increase further away from par or stated value, creditors could have an inadequate equity cushion of protection if the company only retains assets equal to its minimum legal capital. Consequently, many companies in Canada issue no par value shares to avoid these potential problems. 12. 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 shareholder s equity. In the subsequent purchase, Jean Guy is buying in the secondary market from another investor. The proceeds from this sale go to this seller and not to Innovate.com. Therefore there is no impact on Innovate.Com s financial statements as a result of the second purchase. 13. There will be no impact on Chapters financial statements at the time of the share price decline. However, should Chapters decide it would like to raise capital in the stock market, the price decline means they will have to sell more shares to raise the same amount of money. 14-7

Questions Chapter 14 (Continued) 14. When shares are issued for services or noncash assets, the cost should be measured at the fair market value of the consideration given up (in this case, the shares). If that value cannot be reasonably determined, then the fair market value of the consideration received should be used (in this case, the land). In this case, the fair market value of the shares is more objectively determinable than that of the land, since the shares are actively traded in the stock 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 $90,000. 15. A corporation may acquire its own shares (1) to reissue the shares to officers and employees under bonus and stock compensation plans, (2) to increase trading of the company's shares in the stock market, in the hopes of enhancing its market value, (3) to have additional shares available for use in the acquisition of other companies, (4) to reduce the number of shares issued and increase earnings per share, and (5) to comply with percentage share ownership requirements. 16. This transaction (a) decreases total assets, (b) has no effect on total liabilities and, (c) decreases total shareholders' equity. 17. (a) 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. (b) Many preferred share issues are cumulative, which means that preferred shareholders must be paid both current year dividends and unpaid prior year dividends before common shareholders receive any dividends. (c) Dividends in arrears are disclosed in the notes to the financial statements; they are not recorded as liabilities. 14-8

Questions Chapter 14 (Continued) 18. 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. This entry has no effect on (a) total assets, (b) total liabilities, or (c) total shareholders' equity. 19. The answers are summarized in the table below: (a) (b) (c) (d) Account Common Shares Retained Earnings Contributed Capital in Excess of Stated Value Preferred Shares Classification Share capital common shares Retained earnings Additional contributed capital Share capital preferred shares 20. The formula for calculating book value per share when a corporation has only common shares issued is: Total Shareholders' Equity Number of Common Shares Issued represents Book value per share = the equity a common shareholder has in the net assets of the corporation from owning one common share. B V per 21. Book value per share represents the equity a common shareholder has in the net assets of the corporation, from owning one common share. Book value is based on recorded historical costs. Market value is at best only remotely related to book value. A share's market value will reflect many factors, including the company's anticipated future earnings, its expected dividend rate per share, its current financial position, the current state of the economy, and the current state of the stock market. 14-9

SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14-1 The advantages and disadvantages of a corporation are as follows: Advantages Separate legal existence Limited liability of shareholders Ability to acquire capital Continuous life Corporation management professional management Disadvantages Corporation management separation of ownership and management Government regulations Potential for additional income tax Potential for deferred or reduced income tax Transferable ownership rights BRIEF EXERCISE 14-2 Dec. 31 Revenue... 2,000,000 Retained Earnings... 2,000,000 31 Retained Earnings... 1,500,000 Expenses... 1,500,000 14-10

BRIEF EXERCISE 14-3 Open Text may wish to repurchase shares for a number of reasons including: 1. To increase trading of the company s shares in the stock market in hopes of enhancing market value. 2. To reduce the number of common shares issued and thereby increase earnings per share 3. To have additional shares available to reissue to officers and employees under bonus and stock compensation plans. 4. To have additional shares available for use in the acquisition of other companies. 5. To comply with percentage share ownership requirements. The pre-emptive right protects shareholders from dilution of their ownership interest due to the company selling or repurchasing additional shares. If pre-emptive rights exist current shareholders have the first opportunity to buy or sell their shares so that they have the same percentage of ownership both before and after any sales/repurchases by the company. BRIEF EXERCISE 14-4 (a) June 1 Cash (2,000 X $6)... 12,000 Common Shares... 12,000 (b) June 1 Cash (2,000 X $6)... 12,000 Common Shares (2,000 X $1)... 2,000 Contributed Capital in Excess of Stated Value... 10,000 BRIEF EXERCISE 14-5 Dec. 20 Land (5,000 X $14)... 70,000 Common Shares... 70,000 The market price of the shares is a reliable indicator of its value; the advertised price of the land is not. 14-11

BRIEF EXERCISE 14-6 When issuing shares for noncash consideration, the cost is determined to be the fair market value of the consideration given. If the fair market value of the consideration given is not readily determinable, then the fair market value of the consideration received can be used. However, in this case, since the fair market value of the consideration given up (the shares) is known, then the purchase of the assets and issue of the common shares should be recorded at $9.1 million. This accounting treatment is in accordance with the cost principle. BRIEF EXERCISE 14-7 Jan. 28 Cash (5,000 X $110)... 550,000 Preferred Shares... 550,000 BRIEF EXERCISE 14-8 KAPOSI CORPORATION Balance Sheet (Partial) December 31, 2003 Shareholders' equity Contributed capital Share capital 8% preferred shares, cumulative, $25 stated value, 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 Additional contributed capital Contributed capital in excess of stated value preferred shares... 10,000 Total contributed capital... 80,000 Retained earnings... 0 29,000 Total shareholders' equity $109,000 14-12

BRIEF EXERCISE 14-9 Book value per share = $21.50 ($860,000 40,000) BRIEF EXERCISE 14-10 Shareholders were anxious to pay increasing amounts because of their expectations of the future profitability of the company. They expected that the company would be successful in the future and wanted to buy the shares while the price was relatively low. BRIEF EXERCISE 14-11 The impact of this drop on Nortel s financial position is that the company will find it more difficult to raise capital in the stock market. Investors may not be willing to invest in the company given its weak share price. As well, because the price is lower, Nortel will have to issue many more shares to raise the same amount of capital then it would have when the shares were selling for $124.50. 14-13

SOLUTIONS TO EXERCISES EXERCISE 14-1 (a) High $260.00 Low $35.00 (b) 575,000 (c) 1,000 X $164.50 = $164,500 (d) Since this company has not paid any dividends this year but has had significant growth, the person purchasing these shares would most likely be looking for price increases. (e) $164.50 $17.25 = $147.25 (closing price net change) EXERCISE 14-2 (a) Jan. 10 Cash (70,000 X $5)... 350,000 Common Shares... 350,000 July 01 Cash (40,000 X $7)... 280,000 Common Shares (40,000 X $7)... 280,000 (b) Jan. 10 Cash (70,000 X $5)... 350,000 Common Shares (70,000 X $2)... 140,000 Contributed Capital in Excess of Stated Value (70,000 X $3)... 210,000 July 01 Cash (40,000 X $7)... 280,000 Common Shares (40,000 X $2)... 80,000 Contributed Capital in Excess of Stated Value (40,000 X $5)... 200,000 14-14

EXERCISE 14-3 (1) Dec. 5 Land... 115,000 Common Shares... 115,000 (2) June 1 Land (20,000 X $11)... 220,000 Common Shares... 220,000 EXERCISE 14-4 (a) (b) When a federally incorporated company, such as Air Canada, buys back its own shares it is generally required to cancel them. This reduces the number of shares issued and the amount recorded in the Common Shares account. It increases the earnings per share because there are fewer shares issued (earnings are not affected). In an efficient market, the price should not be affected. However, depending on the number of shares purchased, the increase in trading volume may lead to an increase in share prices. The reason for Air Canada s purchase may have been to try to reduce the likelihood of a future takeover bid. EXERCISE 14-5 Mar. 2 Legal Fees Expense (1,600 X $15)... 24,000 Common Shares... 24,000 June 12 Equipment... 360,000 Common Shares... 360,000 July 11 Cash (1,000 X $105)... 105,000 Preferred Shares (1,000 X $105)... 105,000 14-15

EXERCISE 14-6 (a) Nov. 15 Preferred Shares (2,000 X $100)... 200,000 Common Shares (10,000 shares)... 200,000 (b) The entry is the same as in (a) because market values are ignored in accounting for the conversion of preferred shares. (c) Nov. 15 Preferred Shares (2,000 X $100)... 200,000 Common Shares (16,000 shares).. 200,000 Note that, in each case, the conversion is recorded at book value. The amount originally paid for the preferred shares is simply transferred to the common shares account. 14-16

EXERCISE 14-7 MEMORANDUM To: From: Subject: Date: President Shareholders Equity There are two classes of shares issued by Shumway Corporation preferred and common. The preferred shares are cumulative, which means that the preferred shareholders will be paid their annual dividend ($6 per share) for the current and prior years whenever a dividend is declared (up to the amount of the dividend declared). Unpaid dividends from prior years (dividends in arrears) are not recorded because they are not a liability of the company until declared. They are disclosed in the notes to the financial statements. The common shares have a $3 stated value per share ($1,800,000 600,000). Only the stated value is recorded in the Common Shares account. Any excess of the issue price over stated value is recorded in a separate contributed capital account, Contributed Capital in Excess of Stated Value. The common shares were originally sold for $4 per share [($1,800,000 + $600,000) 600,000]. Summary of answers to questions: (a) The stated value of the common shares is $3 per share ($1,800,000 600,000 shares). (b) The average issue price per share of the common shares was $4 per share [($1,800,000 + $600,000) 600,000 shares]. (c) The annual dividend is $6 per share ($36,000 6,000 shares). (d) Dividends in arrears are not recorded until declared. They are, however, disclosed in the notes to the financial statements. 14-17

EXERCISE 14-8 Account Shareholders Equity Contributed Capital Additional Share Contributed Capital Capital Retained Earnings Financial Statement 1. Cash Balance Sheet Other Classification Current Asset 2. Common Shares Common Shares 3. Contributed Capital in Excess of Stated Value Preferred Shares Contributed Capital in Excess of Stated Value Preferred Shares 4. Gain on sale of capital assets Income Statement Other Revenue (Gain) 5. Patents Balance Sheet Capital Asset 6. Preferred Shares Preferred Shares 7. Retained Earnings Retained Earnings 8. Legal Fees Expense Income Statement Operating Expense 14-18

EXERCISE 14-9 (a) FUTURE SHOP LTD. Partial Balance Sheet April 1, 2000 (in thousands) Shareholders' equity Common shares, no par value, unlimited number authorized, 16,189,545 shares issued... $78,783 Retained earnings... 1,450 Total shareholders equity... $80,233 Note to the financial statements: An unlimited number of no par value preferred shares are authorized. None have been issued. (b) Return on Equity = Net Income Average shareholders equity = $23,680 [($80,233 + $56,329) 2] = 34.68% Book Value per Share = Total shareholders equity Number of common shares = $80,233,000 16,189,545 = $4.96 Note: there is no adjustment required for preferred share equity since there are no preferred shares issued. 14-19

EXERCISE 14-10 Total shareholders' equity Less: Preferred shareholders equity Stated value Dividends in arrears ($500,000 X 10%) Common shareholders equity Common shares issued Book value per share (a) $4,000,000 (500,000) 000000000 550$3,500,000 00250,000 $14.00 (b) $4,000,000 (500,000) (50,000) $3,450,000 00250,000 00 $13.80 14-20

SOLUTIONS TO PROBLEMS PROBLEM 14-1A (a) (b) (c) (d) (e) The professors should incorporate their business because of their concerns about the legal liabilities. A corporation is the only form of business that provides limited liability to it owners. Joseph should run his bait shop 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 limited time. Robert and Tom should form a corporation when they combine their operations. This is the best form of business for them to choose because they expect 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. A partnership would be the most likely form of business for Darcy, Ellen and Meg to choose. It is simpler to form than a corporation and less costly. Hervé is most likely to select to operate his business as a proprietorship. He wants to maintain control of the business. Operating as a proprietorship will allow him to do this. He has no savings or personal assets, therefore will not require a corporation to protect his personal assets. 14-21

PROBLEM 14-2A (a) $1,200,000 $60 = 20,000 preferred shares (b) $1,200,000 + $200,000 = $1,400,000 20,000 shares = $70 per share (c) $1,200,000 X 8% = $96,000 (d) It appears that there were no dividends declared in 2003 since there was no decrease for dividends in the retained earnings. (e) Since no dividends were declared in 2003 and the preferred share dividends are cumulative there are $96,000 in dividends in arrears at the end of 2003. 14-22

PROBLEM 14-3A (a) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Jan. 10 Cash (80,000 X $3)... 240,000 Common Shares (80,000 X $2)... 160,000 Contributed Capital in Excess of Stated Value Common Shares (80,000 X $1)... 80,000 Mar. 01 Cash (5,000 X $105)... 525,000 Preferred Shares (5,000 X $105)... 525,000 Apr. 01 Land (24,000 X $3.50)... 84,000 Common Shares (24,000 X $2)... 48,000 Contributed Capital in Excess of Stated Value Common Shares ($84,000 $48,000)... 36,000 June 020 Cash (80,000 X $4)... 320,000 Common Shares (80,000 X $2)... 160,000 Contributed Capital in Excess of Stated Value Common Shares (80,000 X $2)... 160,000 Aug. 01 Legal Fees Expense (10,000 X $5)... 50,000 Common Shares (10,000 X $2)... 20,000 Contributed Capital in Excess of Stated Value Common Shares ($50,000 $20,000)... 30,000 Sept. 01 Cash (10,000 X $5)... 50,000 Common Shares (10,000 X $2)... 20,000 Contributed Capital in Excess of Stated Value Common Shares (10,000 X $3) 30,000 14-23

PROBLEM 14-3A (Continued) (a) (Continued) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Nov. 01 Cash (1,000 X $108)... 108,000 Preferred Shares (1,000 X $108)... 108,000 J2 (b) Preferred Shares Date Explanation Ref. Debit Credit Balance Mar. 1 Nov. 1 J2 525,000 108,000 525,000 633,000 Common Shares Date Explanation Ref. Debit Credit Balance Jan. 10 Apr. 1 June 20 Aug. 1 Sept. 1 160,000 048,000 160,000 020,000 020,000 160,000 208,000 368,000 388,000 408,000 Contributed Capital in Excess of Stated Value Common Shares Date Explanation Ref. Debit Credit Balance Jan. 10 Apr. 1 June 20 Aug. 1 Sept. 1 080,000 036,000 160,000 030,000 030,000 080,000 116,000 276,000 306,000 336,000 14-24

PROBLEM 14-3A (Continued) (c) WETLAND CORPORATION Balance Sheet (Partial) December 31, 2003 Shareholders' equity Contributed capital Share capital 8% preferred shares, no par value, 10,000 shares authorized, 6,000 shares issued... $0,633,000 Common shares, $2 stated value, 500,000 shares authorized, 204,000 shares issued... 00 408,000 Total share capital... 1,041,000 Additional contributed capital Contributed capital in excess of stated value common shares... 336,000 Total contributed capital... $1,377,000 14-25

PROBLEM 14-4A (a) $400,000 + $60,000 = $460,000 4,000 shares = $115 per share (b) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Feb. 1 Land (1,050 x $115)... 120,750 Preferred Shares (1,050 X $100)... 105,000 Contributed Capital in Excess of Stated Value Preferred Shares (1,050 X $15) 15,750 Mar. 1 Cash (1,000 X $120)... 120,000 Preferred Shares (1,000 X $100)... 100,000 Contributed Capital in Excess of Stated Value Preferred Shares (1,000 X $20) 20,000 July 1 Preferred Shares (1,000 X $100)... 100,000 Contributed Capital in Excess of Stated Value Preferred Shares (1,000 X $15)... 15,000 Common Shares... 115,000 Sept. 1 Patent (400 X $125)... 50,000 Preferred Shares (400 X $100)... 40,000 Contributed Capital in Excess of Stated Value Preferred Shares (400 X $25). 10,000 Dec. 1 Preferred Shares (1,000 X $100)... 100,000 Contributed Capital in Excess of Stated Value Preferred Shares (1,000 X $20)... 20,000 Common Shares... 120,000 Note that the conversions are recorded at book values, not market values. 14-26

PROBLEM 14-4A (Continued) (b) (Continued) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Dec. 31 Revenues... 400,000 Retained Earnings... 400,000 31 Retained Earnings... 250,000 Expenses... 250,000 J2 14-27

PROBLEM 14-4A (Continued) (c) Preferred Shares Date Explanation Ref. Debit Credit Balance Jan. 1 Feb. 1 Mar. 1 July 1 Sept. 1 Dec. 1 Balance 100,000 100,000 105,000 100,000 40,000 400,000 505,000 605,000 505,000 545,000 445,000 Contributed Capital in Excess of Stated Value Preferred Shares Date Explanation Ref. Debit Credit Balance Jan. 1 Feb. 1 Mar. 1 July 1 Sept. 1 Dec. 1 Balance 15,000 20,000 0 015,750 20,000 010,000 060,000 75,750 95,750 80,750 90,750 70,750 Common Shares Date Explanation Ref. Debit Credit Balance Jan. 1 July 1 Dec. 1 Balance 115,000 120,000 1,050,000 1,165,000 1,285,000 Retained Earnings Date Explanation Ref. Debit Credit Balance Jan. 1 Dec. 31 31 Balance Closing entry Closing entry J2 J2 250,000 400,000 300,000 700,000 450,000 14-28

PROBLEM 14-4A (Continued) (d) REMMERS CORPORATION Balance Sheet (Partial) December 31, 2003 Shareholders' equity Contributed capital Share capital 10% convertible preferred shares, $100 stated value, 10,000 shares authorized, 4,450 shares issued... $0,445,000 Common shares, no par value, 200,000 shares authorized, 90,000 shares issued... 1,285,000 Total share capital... 1,730,000 Additional contributed capital Contributed capital in excess of stated value preferred shares 70,750 Total contributed capital... 1,800,750 Retained earnings... 450,000* Total shareholders equity... $2,250,750 * Retained earnings: $300,000 Jan. 1 balance + $150,000 net income = $450,000 Dec. 31 balance 14-29

PROBLEM 14-5A GENERAL JOURNAL Date Account Titles and Explanation Debit Credit (a) Feb. 01 Cash... 25,000 Common Shares... 25,000 July 20 Cash... 107,000 Preferred shares... 107,000 Sept. 03 Patent... 13,000 Common Shares... 13,000 (b) Dec. 31 Revenues... 500,000 Retained Earnings... 500,000 31 Retained Earnings... 260,000 Expenses... 260,000 14-30

PROBLEM 14-5A (Continued) (c) Preferred Shares Date Explanation Ref. Debit Credit Balance Jan. 1 July 20 Balance 107,000 0,320,000 427,000 Common Shares Date Explanation Ref. Debit Credit Balance Jan. 1 Feb. 1 Sept. 3 Balance 25,000 13,000 1,425,000 1,450,000 1,463,000 Retained Earnings Date Explanation Ref. Debit Credit Balance Jan. 1 Dec. 31 31 Balance Closing entry Closing entry 260,000 500,000 488,000 988,000 728,000 14-31

PROBLEM 14-5A (Continued) (d) CHUNG CORPORATION Balance Sheet (Partial) December 31, 2003 Shareholders' equity Share capital Preferred shares, no par value, $10 noncumulative, 5,000 shares authorized, 4,000 shares issued... $ 427,000 Common shares, no par value, unlimited number of shares authorized, 206,000 shares issued... 1,463,000 Total share capital... 1,890,000 Retained earnings... 728,000 Total shareholders equity... $2,618,000 (e) Return on equity = Net income Average shareholders equity $240,000 $2,618,000 + $2,233,000 2 = 9.9% (f) Total shareholders' equity... $2,618,000 Less: Preferred shareholders equity... 00,427,000 Common shareholders equity... $2,191,000 Common shares issued... 206,000 Book value per share ($2,191,000 206,000)... $10.64 14-32

PROBLEM 14-6A (a) HUY CORPORATION Balance Sheet (Partial) December 31, 2003 Shareholders' equity Contributed capital Share capital $6 preferred shares, $100 stated value, cumulative, 100,000 shares authorized, 4,000 shares issued... $ 400,000 Common shares, no par value, unlimited number of shares authorized, 150,000 shares issued... 2,400,000 Total share capital... 2,800,000 Additional contributed capital Contributed capital in excess of stated value preferred shares... 300,000 Total contributed capital... 3,100,000 Retained earnings... 1,276,000 Total shareholders' equity... $4,376,000 14-33

PROBLEM 14-6A (Continued) (b) The book value of the common shares is $26.51, calculated as follows: Total shareholders' equity $4,376,000 Less: Preferred shareholders equity Stated value ($100 x 4,000) 400,000 Common shareholders equity $3,976,000 Common shares issued 150,000 Book value per share ($3,976,000 150,000) $26.51 Note: No preferred dividends are assigned to the preferred shareholders equity because there are no dividends in arrears. (c) The book value of the common shares is unchanged at $26.51, calculated as follows: Total shareholders' equity ($2,400,000 + $300,000 + $400,000 + $1,300,000) $4,400,000 Less: Preferred shareholders equity Stated value ($100 X 4,000) 00,400,000 Preferred dividends in arrears ($400,000 X $6) 24,000 Common shareholders equity $3,976,000 Common shares issued 150,000 Book value per share ($3,976,000 150,000) $26.51 14-34

PROBLEM 14-7A Transaction (a) Issue 1,000 no par value common shares for $25 Book Value per Share ($10) Increase Return on Equity (10%) Decrease (b) Issue 100 no par value preferred shares for $50 per share No Effect Decrease (c) Reported net income of $100,000 for the year Increase Increase 14-35

PROBLEM 14-8A (a) The book value of the common shares is $8.18, calculated as follows: Total shareholders' equity... $5,850,000 Less: Preferred shareholders equity... 1,600,000 Dividends in arrears (20,000 x $4 x 2)... 160,000 Common shareholders equity... $4,090,000 Common shares issued... 500,000 Book value per share ($4,090,000 500,000)... $8.18 (b) The book value of the common shares is $7.70, calculated as follows: Total shareholders' equity... $5,850,000 Less: Preferred shareholders equity... 1,600,000 Dividends in arrears (20,000 x $4 x 5)... 400,000 Common shareholders equity... $3,850,000 Common shares issued... 500,000 Book value per share ($3,850,000 500,000)... $7.70 (c) The average amount paid in, or contributed, per common share is $4,000,000 500,000 shares = $8.00 per share. The book value per share is $8.18 in part (a) and $7.70 in part (b). This illustrates that the book value may be higher or lower than the average amount paid in, depending upon factors such as the terms of the preferred shares, the relative value of the preferred shares, and the amount of retained earnings. 14-36

PROBLEM 14-9A (a) REITMANS (CANADA) LIMITED Balance Sheet February 3, 2001 (in thousands) Assets Current assets Cash and short-term deposits... $ 20,008 Accounts receivable... 2,556 Merchandise inventories... 38,481 Prepaid expenses... 8,816 Total current assets... 69,861 Capital assets... $127,172 Less: Accumulated amortization... (41,136) 86,036 Investments... 81,399 Accrued pension asset... 6,903 Total assets... $244,199 Liabilities and Shareholders Equity Current liabilities Accounts payable and accrued items... $ 35,187 Income tax payable... 5,124 Total current liabilities... 40,311 Future income tax payable... 1,381 Total liabilities... 41,692 14-37

PROBLEM 14-9A (Continued) (a) (Continued) REITMANS (CANADA) LIMITED Balance Sheet (Continued) February 3, 2001 (in thousands) Shareholders equity Share capital Class A nonvoting shares, unlimited authorized, 6,709,582 issued... 8,065 Common shares, unlimited authorized, 1,680,000 issued... 482 Total share capital... 8,547 Retained earnings... 193,960* Total shareholders equity... 202,507 Total liabilities and shareholders equity... $244,199 *Retained earnings Balance, January 29, 2000 $185,256 Add: Net income 20,202 Less: Dividends and other deductions (11,498) Balance, February 3, 2001 $193,960 (b) Return on Equity = Net Income Average Shareholders Equity $20,202 $194,121 + $202,507 2 = 10.2% (c) Book Value Per Share = Total shareholders equity available to common shareholders Number of common shares $202,507,000 - $8,065,000 = $194,442,000 1,680,000 = $115.74 14-38

PROBLEM 14-1B (a) Dawn will likely operate her vegetable stand as a proprietorship because she is planning on operating it for a short time period and a proprietorship is the simplest and least costly to form and dissolve. (b) 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 expect to raise significant funds in the coming year. It is easier to raise funds in a corporation. A corporation may also receive more favourable tax treatment. (c) The professors should incorporate their business because of their concerns about the legal liabilities. A corporation is the only form of business that provides limited liability to it owners. (b) (c) Abdur would likely form a corporation because he needs to raise funds to invest in inventories and capital assets. He has no savings or personal assets and it is normally easier to raise funds through a corporation. 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. 14-39

PROBLEM 14-2B (a) Preferred dividends Preferred dividend per share $75,000 $4 = 18,750 preferred shares (b) Preferred share average price = $3,125,000 18,750 shares issued = $166.67 per share (c) Annual preferred dividend = 18,750 shares x $4 = $75,000 (d) Limited liability for preferred shareholders = $3,125,000 14-40

PROBLEM 14-3B (a) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Jan. 10 Cash (100,000 X $3)... 300,000 Common Shares... 300,000 Mar. 01 Cash (10,000 X $52)... 520,000 Preferred Shares... 520,000 Apr. 01 Land (25,000 X $3.50)... 87,500 Common Shares... 87,500 May 01 Cash (75,000 X $4)... 300,000 Common Shares... 300,000 July 24 Legal Fees Expense (10,000 X $4.50)... 45,000 Common Shares... 45,000 Sept. 01 Cash (5,000 X $6)... 30,000 Equipment... 5,000 Common Shares... 35,000 Nov. 01 Cash (2,000 X $54)... 108,000 Preferred Shares... 108,000 14-41

PROBLEM 14-3B (Continued) (b) Preferred Shares Date Explanation Ref. Debit Credit Balance Mar. 1 Nov. 1 520,000 108,000 520,000 628,000 Common Shares Date Explanation Ref. Debit Credit Balance Jan. 10 Apr. 1 May 1 July 24 Sept. 1 (c) HIGHLAND CORPORATION Balance Sheet (Partial) December 31, 2003 300,000 87,500 0300,000 45,000 0035,000 300,000 387,500 687,500 732,500 767,500 Shareholders' equity Share capital $3 preferred shares, no par value, 20,000 shares authorized, 12,000 shares issued... $0,628,000 Common shares, no par value, 500,000 shares authorized, 215,000 shares issued... 00,767,500 Total share capital... $1,395,500 14-42

PROBLEM 14-4B (a) GENERAL JOURNAL Date Account Titles and Explanation Debit Credit Feb. 06 Building (1,000 X $120)... 120,000 Preferred Shares... 120,000 July0 15 Preferred Shares (2,000 X $110)... 220,000 Common Shares... 220,000 Sept. 22 Land (400 X $130)... 52,000 Preferred Shares... 52,000 Dec. 01 Preferred Shares (1,000 X $130)... 130,000 Common Shares... 130,000 31 Revenues... 600,000 Retained Earnings... 600,000 31 Retained Earnings... 340,000 Expenses... 340,000 14-43

PROBLEM 14-4B (Continued) (b) Preferred Shares Date Explanation Ref. Debit Credit Balance Jan. 1 Feb. 1 July 1 Sept. 1 Dec. 1 Balance 220,000 130,000 120,000 052,000 575,000 695,000 475,000 527,000 397,000 Common Shares Date Explanation Ref. Debit Credit Balance Jan. 1 July 1 Dec. 1 Balance 220,000 130,000 1,050,000 1,270,000 1,400,000 Retained Earnings Date Explanation Ref. Debit Credit Balance Jan. 1 Dec. 31 31 Balance Closing entry Closing entry 340,000 600,000 300,000 900,000 560,000 14-44

PROBLEM 14-4B (Continued) (c) DENISON CORPORATION Balance Sheet (Partial) December 31, 2003 Shareholders' equity Share capital Preferred shares, no par value, $10 convertible 10,000 shares authorized, 3,400 shares issued.. $ 397,000 Common shares, no par value, 125,000 shares authorized, 94,000 shares issued..., 1,400,000 Total share capital... 1,797,000 Retained earnings... 560,000 Total shareholders' equity... $2,357,000 (d) Return on equity = Net income Average shareholders equity $260,000 $1,925,000 * + $2,357,000 2 = 12.1% *$575,000 + $1,050,000 + $300,000 = $1,925,000 total shareholders equity on January 1, 2003 14-45

PROBLEM 14-5B GENERAL JOURNAL Date Account Titles and Explanation Debit Credit (a) Feb. 01 Cash... 100,000 Common Shares... 100,000 Sept. 03 Equipment... 25,000 Common Shares... 25,000 (b) Dec. 31 Revenues... 750,000 Retained Earnings... 750,000 31 Retained Earnings... 348,000 Expenses... 348,000 14-46

PROBLEM 14-5B (Continued) (c) Preferred Shares Date Explanation Ref. Debit Credit Balance Jan. 1 Balance 0,500,000 Common Shares Date Explanation Ref. Debit Credit Balance Jan. 1 Feb. 1 Sept. 3 Balance 100,000 025,000 2,450,000 2,550,000 2,575,000 Retained Earnings Date Explanation Ref. Debit Credit Balance Jan. 1 Dec. 31 31 Balance Closing entry Closing entry 348,000 750,000 1,816,000 2,566,000 2,218,000 14-47

PROBLEM 14-5B (Continued) (d) DAOUST CORPORATION Balance Sheet (Partial) December 31, 2003 Shareholders' equity Share capital Preferred shares, $6 cumulative, no par value, 10,000 shares authorized, 8,000 shares issued... $ 500,000 Common shares, no par value, unlimited number of shares authorized, 1,033,000 shares issued... 2,575,000 Total share capital... 3,075,000 Retained earnings (See Note X)... 2,218,000 Total shareholders' equity... $5,293,000 Note X: Dividends on preferred shares totalling $48,000 [8,000 X $6 per share] are in arrears. (e) Total shareholders' equity... $5,293,000 Less: Preferred shareholders equity... $500,000 Dividends in arrears ($6 x 8,000 shares) 48,000 548,000 Common shareholders equity... $4,745,000 Common shares issued... 1,033,000 Book value per share ($4,745,000 1,033,000) $4.59 (f) Return on Equity = Net income Average shareholders equity $402,000 $4,766,000 * + $5,293,000 2 = 8.0% *500,000 + $2,450,000 + $1,816,000 = $4,766,000 14-48

PROBLEM 14-6B DESSERUD CORPORATION Balance Sheet (Partial) August 31, 2003 Shareholders equity Share capital $8 preferred shares, no par value, noncumulative, unlimited number of shares authorized, 4,000 shares issued...... $ 800,000 Common shares, unlimited number of no par value shares authorized, 500,000 shares issued 4,000,000 Total share capital... 4,800,000 Retained earnings... 1,958,000 Total shareholders equity... $6,758,000 (b) The book value of the common shares is $25.16, calculated as follows: Total shareholders' equity $6,758,000 Less: Preferred shareholders equity 800,000 Common shareholders equity $5,958,000 Common shares issued 500,000 Book value per share ($5,958,000 5,000,000) $11.92 14-49

PROBLEM 14-7B Transaction (a) Issue 1,000 no par value common shares for $25 Book Value per Share ($10) Increase Return on Equity (10%) Decrease (b) Reported net income of $200,000 for the year Increase Increase (c) Reacquired and cancelled 4,000 common shares for $100,000 Decrease Increase 14-50

PROBLEM 14-8B (a) Return on Equity ($ in millions) 1999: $199.6 $1,346.3 + $1,164.3 2 2000 : $225.8 $1,549.3 + $1,346.3 2 = 15.9% = 15.6% The return on equity has deteriorated slightly from 1999 to 2000. (b) Sears appears to be doing better than the industry average. (c) Book Value per Share ($ in millions) 1999: $1,346.3 106.2 = $12.67 2000: $1,549.3 106.5 = $14.55 This assumes there are no preferred shares. Book value per share usually does not equal market value. Book value is based on historical cost whereas market value is based on investor perceptions of the company s future potential for earnings and dividends. 14-51

PROBLEM 14-9B (a) LEON S FURNITURE LIMITED Balance Sheet December 31, 2000 (in thousands) Assets Current assets Cash and cash equivalents... $ 24,802 Marketable securities... 78,567 Accounts receivable... 14,605 Inventory... 49,171 Total current assets... 167,145 Fixed assets... $179,335 Less: Accumulated amortization... (70,754) 108,581 Future tax asset... 4,930 Total assets... $280,656 Liabilities and Shareholders Equity Current liabilities Accounts payable and accrued liabilities... $ 68,742 Dividends payable... 2,098 Customers deposits... 6,507 Income tax payable... 885 Total current liabilities... 78,232 Redeemable share liability... 79 Total liabilities... 78,311 Shareholders equity Common shares, unlimited authorized, 20,228,542 issued 9,518 Retained earnings... 192,827* Total shareholders equity... 202,345 Total liabilities and shareholders equity... $280,656 14-52

PROBLEM 14-9B (Continued) (a) (Continued) *Retained earnings ($ in thousands) Balance, January 1, 1999 $170,909 Add: Net income 36,700 Dividends and other deductions ( (14,782) Balance, December 31, 2000 $192,827 (b) Return on equity = Net income Average shareholders equity $36,700,000 $202,345,000 + $178,313,000 2 = 19.3% (c) Book value per share = Total shareholders equity available to common shareholders Number of common shares = $202,345,000 20,228,542 = $10.00 14-53

BYP 14-1 FINANCIAL REPORTING PROBLEM (a) Yes, the Second Cup does have an unlimited number of preferred shares in its authorized share capital. However, none of them have been issued (See Note 8). (b) Average issue price at June 24, 2000 = $62,355,000 9,359,559 shares = $6.66 Average issue price at June 30, 1999 = $61,670,000 9,310,389 shares = $6.62 (c) Per Note 8, the last time shares were repurchased was in 1999. There were 5,035,800 shares repurchased for $33,387,000. (d) 1999 Return on equity $3,791,000 $17,725,000 + $10,950,000 2 = 26.4% This is significantly higher that the return on equity of 9.5% for 2000. (e) Book value per share for Proforma 1999 = $17,725,000 9,347,389 = $1.90 This is higher than the 2000 amount of $0.18 reported in the chapter because of the decrease in the 2000 shareholders equity due to the payment of a special dividend of $2.00 per share see note 8 to the financial statements. Note to instructors: Students may use the year-end balance of common shares of 9,310,389 reported in the notes to the financial statements, rather than the weighted average number of 9,347,389 reported on the statement of earnings. The book value will remain at $1.90 regardless of which number is used in the denominator. 14-54

BYP 14-2 INTERPRETING FINANCIAL STATEMENTS (a) 2000 1999 Return on Equity ($2,977,729) $2,220,967 = (134.1%) ($1,089,966) $979,635 = (111.3%) (b) Investors may be willing to pay an increasing market price for Net Nanny s shares despite the poor operating performance because they believe that the long-term prospects for the company are positive. (c) Net Nanny may be financing through equity rather than debt because they do not want to use available cash for payment of interest charges. 14-55

BYP 14-3 ACCOUNTING ON THE WEB Due to the frequency of change with regard to information available on the world wide web, the Accounting on the Web cases are updated as required. Their suggested solutions are also updated whenever necessary, and can be found on-line in the Instructor Resources section of our homepage [www.wiley.com/canada/weygandt2]. 14-56

BYP 14-4 COLLABORATIVE LEARNING ACTIVITY (a) The cumulative provision means that preferred shareholders must be paid both current year dividends and any unpaid prior year dividends before common shareholders receive any dividends. When preferred shares is cumulative, preferred dividends not declared in a given period are called dividends in arrears. (b) The market price of a share is affected by many factors. Among the factors to be considered are (1) the corporation's anticipated future earnings, (2) its expected dividend rate per share, (3) its current financial position, (4) the current state of the economy, and (5) the current state of the stock market. Stated value is the amount assigned to each share by the Board of Directors. Generally, the amount of stated value is quite low and shares cannot be issued for less than that amount. Stated value is not indicative of the worth or market value of the shares. The significance of stated value is a legal matter. Stated value represents the legal capital per share that must be retained in the business for the protection of corporate creditors. (c) It is important to distinguish between legal capital and total contributed capital. Stated value represents the legal capital per share that must be retained in the business for the protection of corporate creditors. Additional contributed capital is not legal capital, and therefore a distinction between stated value and additional contributed capital (i.e., amounts in excess of stated value) must be maintained. (d) Additional detail such as repurchase information is usually disclosed in the notes to the financial statements. 14-57

BYP 14-5 COLLABORATIVE LEARNING ACTIVITY (a) 1. Generally accepted accounting principles dictate that the cost of an asset acquired as the result of a noncash exchange should be equal to the fair market value of the consideration given up. If this is not clearly determinable, then the fair market value of the consideration received should be used. Since the most recent issue of shares was last year at $20 per share, the $20 value is probably dated and no longer reliable. An advertised price is usually not a reliable indicator of the real value of the property, but in this case, the advertised price is also the appraisal value. This appraised value of up-to-date and independent, and therefore should be objective and reliable. 2. Using the rule stated above, since 8,000 shares were given in exchange for land, and the shares had a $20 per share market value, the land should be recorded at $20 X 8,000 or $160,000, regardless of its advertised selling price or assessed value. (b) 1. Land... 125,000 Building... 375,000 Common Shares... 500,000 2. Land... 160,000 Common Shares... 160,000 14-58