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CHAPTER 16

Shareholders Equity

ASSIGNMENT CLASSIFICATION TABLE


Topics

Brief
Exercises Exercises Problems

*1. Shareholders equity


3
and financial reporting.

4, 6, 12,
14

2, 6, 11,
12

*2. Issuance of shares.

1, 4

1, 3, 5

2, 3, 4, 6

*3. Subscription sales.

2, 4

1, 5, 12

1, 3, 5, 6,
12

3, 4, 5, 13,
14

1, 2, 4, 5,
6, 12

7, 8, 13

7, 8, 12

*4. Noncash share transactions; lump sum


sales.
*5. Reacquisition
transactions.

5, 6,

*6. Dividend preferences.


*7. Cash and stock
dividends; stock splits;
property dividends;
liquidating dividends.

7, 8, 9, 10,
11

6, 9, 10,
2, 3, 7, 9,
11, 13, 14 10, 11, 12

8. Ratio analysis.

15

*9. Par value and treasury 1


shares.

4, 12

*10. Financial reorganization.12

16, 17

Writing
Assignments
3

5
5

*This material is dealt with in an Appendix to the chapter.


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ASSIGNMENT CHARACTERISTICS TABLE


Item
E16-1
E16-2
E16-3
*E16-4
E16-5
E16-6
E16-7
E16-8
E16-9
E16-10
E16-11
*E16-12
E16-13
E16-14
E16-15
*E16-16
*E16-17
P16-1
P16-2
P16-3
P16-4
*P16-5
P16-6
P16-7
P16-8
P16-9
P16-10
P16-11
P16-12
W16-1
W16-5
W16-3
W16-4
*W16-5

Description
Recording the issuance of common and
preferred shares.
Subscribed shares.
Share issuances and repurchase.
Shareholders equity section.
Correcting entries for equity transactions.
Equity items on the balance sheet.
Preferred dividends.
Preferred dividends.
Stock split and stock dividend.
Entries for stock dividends and stock splits.
Dividend entries.
Shareholders equity section.
Participating preferred and stock dividend.
Dividends and shareholders equity section.
Comparison of alternative forms of financing.
Financial reorganization.
Financial reorganization.
Subscription, repurchase and lump-sum
issuance.
Equity transactions and statement preparation.
Share transactionsnoncash and lump sum.
Share repurchases.
Prepare shareholders equity section par
value shares.
Share transactions and equity section
preparation.
Cash dividend entries.
Preferred share dividends, cumulative and
participating.
Effect of dividends and splits on balance sheet
items.
Entries for shareholders equity transactions.
Dividend entries and balance sheet
presentation.
Analysis and classification of equity
transactions.
Subscribed shares and subscription receivable.
Secret reserves.
Conceptual issues equity.
Stock dividends and splits.
Financial reorganization.

Level of
Time
Difficulty (minutes)
Simple

10-15

Simple
Simple
Moderate
Moderate
Simple
Simple
Moderate
Simple
Simple
Simple
Moderate
Moderate
Moderate
Moderate
Simple
Moderate

10-12
10-15
15-20
15-20
15-20
10-15
10-15
10-15
10-12
10-15
20-25
20-30
30-35
20-25
10-15
15-20

Simple

15-25

Moderate
Moderate
Moderate
Moderate

25-30
20-30
20-30
25-35

Moderate

35-40

Moderate
Moderate

15-20
20-25

Moderate

20-25

Moderate
Simple

15-20
25-35

Complex

35-45

Moderate
Moderate
Moderate
Simple
Moderate

15-20
25-35
20-25
25-30
20-30

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SOLUTIONS TO BRIEF EXERCISES

*BRIEF EXERCISE 16-1


(a) Cash....................................................................... 20,400
Common SharesNo Par Value..................
20,400
(b) Cash....................................................................... 20,400
Common Shares (600 X $2)..........................
1,200
Contributed Surplus Excess over Par.....
19,200

BRIEF EXERCISE 16-2


June 1

Subscriptions Receivable......................... 27,500


Common Shares Subscribed............
27,500

Cash (45% X $27,500)................................ 12,375


Subscriptions Receivable.................
12,375

Cash ($27,500 - $12,375)...........................15,125


Subscriptions Receivable.................
15,125

Common Shares Subscribed....................27,500


Common Shares.................................
27,500

Dec.

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BRIEF EXERCISE 16-3


LUFIA CORPORATION
Shareholders Equity
December 31, 2005
Share Capital
Common shares, no par value..................................... $ 310,000
Common shares subscribed........................ $250,000
Less: subscriptions receivable.................... (80,000) 170,000
Total share capital..................................................... 480,000
Contributed surplus...................................................... 320,000
Total paid-in capital.......................................................
800,000
Retained earnings............................................................. 1,340,000
Total shareholders equity......................................... $2,140,000

BRIEF EXERCISE 16-4


Cash ($70,000 $1,500)............................................. 68,500
Common Shares.................................................
68,500

BRIEF EXERCISE 16-5


Common Shares ($20 X 100)................................... 2,000
Retained Earnings ................................................... 2,500
Cash ($45 X 100).............................................

4,500

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BRIEF EXERCISE 16-6


Common Shares ($5 X 500)....................................
Contributed Surplus ($30 X 500)............................
Cash ($35 X 500)............................................

2,500
15,000
17,500

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BRIEF EXERCISE 16-7


Aug. 1 Retained Earnings............................................................
1,000,000
Dividends Payable...................................................
1,000,000
Aug. 15 No entry.
Sep.

9 Dividends Payable............................................................
1,000,000
Cash..........................................................................
1,000,000

BRIEF EXERCISE 16-8


Sep. 21

Trading Securities.............................................................
825,000
Gain on Appreciation of
Securities..............................................................
825,000
($1,400,000 - $575,000)
Retained Earnings............................................................
1,400,000
Property Dividends
Payable..................................................................
1,400,000

Oct. 8

No entry.

Oct. 23

Property Dividends Payable............................................


1,400,000
Trading Securities...................................................
1,400,000

BRIEF EXERCISE 16-9


Apr. 20

Retained Earnings............................................................
300,000
Common Shares*..............................................................
200,000
Dividends Payable...................................................
500,000

June 1

Dividends Payable............................................................
500,000
Cash..........................................................................
500,000

*Any balance in contributed surplus would be debited first.


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BRIEF EXERCISE 16-10


Declaration Date:
Retained Earnings............................................................
1,050,000
Common Stock Dividend
Distributable......................................................... 1,050,000
(500,000 X 6% X $35 = $1,050,000)
Distribution Date:
Common Stock Dividend Distributable..........................
1,050,000
Common Shares...................................................... 1,050,000

BRIEF EXERCISE 16-11


Shares outstanding after split:
400,000 (200,000 X 2)
Carrying value after split:
$5.00 ($10 X 1/2)
Total carrying value after split: $2,000,000 (400,000 X $5)
Journal entry necessary after split: No entry

*BRIEF EXERCISE 16-12


Deficit (Retained Earnings)..............................................
105,000
Plant Assets.............................................................
Common Shares...............................................................
249,000
Deficit (Retained Earnings).....................................
($144,000 + $105,000)

105,000
249,000

Long-term Liability............................................................
2,300,000
Common Shares...................................................... 2,300,000

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SOLUTIONS TO EXERCISES

EXERCISE 16-1 (10-15 minutes)


Jan. 10

Cash (100,000 X $5)........................... 500,000


Common Shares.........................
500,000

Mar.

Cash (5,000 X $103)........................... 515,000


Preferred Shares.........................
515,000

April 1

Land................................................... 60,000
Common Shares.........................
60,000

May

Cash (100,000 X $7)........................... 700,000


Common Shares.........................
700,000

Aug. 1

Organization Costs........................... 50,000


Common Shares.........................
50,000

Sept. 1

Cash (10,000 X $9)............................ 90,000


Common Shares.........................
90,000

Nov.

Cash (1,000 X $112)........................... 112,000


Preferred Shares.........................
112,000

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EXERCISE 16-2 (10-12 minutes)


Original Subscription:
Subscriptions Receivable..................................... 600,000
(30,000 shares X $20 each)
Common Shares Subscribed........................
600,000
Collection of Down Payments:
Cash ($600,000 X .30)............................................ 180,000
Subscriptions Receivable.............................
180,000
Collection of Balance:
Cash ($600,000 $180,000).................................. 420,000
Subscriptions Receivable.............................
420,000
Issuance of Shares:
Common Shares Subscribed............................... 600,000
Common Shares............................................
600,000

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EXERCISE 16-3 (10-15 minutes)


1.

Cash [(5,000 X $35) $3,000].......................... 172,000


Common Shares.......................................
172,000

Land (2,000 X $46)............................................ 92,000


Common Shares.......................................
92,000

2.

Note: The market value of the share ($92,000) is used to


value the exchange because it is a more objective measure
than the appraised value of the land ($150,000).
3.

Common Shares (500 X $40)........................... 20,000


Retained Earnings........................................... 1,500
Cash (500 X $43).......................................
21,500

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*EXERCISE 16-4 (15-20 minutes)


RADLER CORPORATION
Partial Balance Sheet
As of December 31, 2005
Shareholders equity:
Share capital:
Preferred shares, $100 par value,
6% cumulative and nonparticipating,
authorized 300,000 shares, issued
and outstanding 10,000 shares
Common shares, $11 par value,
authorized 1,000,000 shares, issued
and outstanding 290,000 shares
Common shares subscribed,
10,500 shares
Total common shares issued and
to be issued
Total share capital
Contributed surplus
*
Total paid-in capital
Retained earnings
***
Total paid-in capital and retained
earnings
Less: Subscriptions receivable
**
Total shareholders equity

$1,000,000
$3,190,000
115,500
3,305,500
4,305,500
817,500
5,123,000
150,000
5,273,000
117,600
$5,155,400

*Contributed surplus balance is composed of the following:


From issue of preferred shares:
$1,475,000 (10,000 shares X $100 par value) =
$475,000
From sale of common shares:
$3,600,000 (300,000 shares X $11 par value) =
300,000
From sale of common share subscription:
($16 per share - $11 par value) X 10,500 shares
52,500
From repurchase and retirement of common shares:
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$300,000 X (10,000 / 300,000)


)

Intermediate Accounting, Seventh Canadian

(10,000
$817,500

**$16 X 10,500 X (1 30%)

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*EXERCISE 16-4 (Continued)


*** Retained earnings balance
$180,000
Less repurchase and retirement of common shares:
Purchase price
$150,000
Less par value of common shares
($10,000 X $11)
( 110,000 )
Less pro-rata portion of
contributed surplus
( 10,000 ) ( 30,000 )
Adjusted balance of retained earnings
$150,000

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EXERCISE 16-5 (15-20 minutes)


May 2

The entry is correct.

May 10

Cash......................................................... 600,000
Preferred Shares.............................
600,000

The transaction involves the issue of preferred shares rather


than common shares.
May 15

Common Shares..................................... 16,000


Contributed Surplus.......................
1,000
Cash.................................................
15,000

The share account is debited for the average per share amount
in the account ($16 per share based on the May 2nd transaction).
The difference between the average per share amount and the
purchase price is credited to Contributed Surplus.
May 31

Cash.........................................................
Common Shares.............................

8,500
8,500

No gain can be recognized on the issuance of shares. The


common shares are recorded at their issue price.

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EXERCISE 16-6 (15-20 minutes)


Shareholders
Item Assets Liabilities Equity
1.
I
NE
I
2.
NE
I
D
3.
NE
NE
NE
4.
D
NE
D
5.
D
D
NE
6.
NE
I
D
7.
I
NE
I
8.
NE
I
D
9.
D
D
NE
10.
NE
NE
NE
11.
NE
NE
NE

Share
Capital
NE
NE
NE
NE
NE
NE
NE
NE
NE
I
NE

Retained
Earnings
I
D
NE
D
NE
D
I
D
NE
D
NE

Comprehensive
Income
NE
NE
NE
NE
NE
NE
NE
NE
NE
NE
NE

Net
Income
I
NE
NE
D
NE
D
I
NE
NE
NE
NE

I=increase ; NE=no effect ; D=decrease

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EXERCISE 16-7 (10-15 minutes)


Preferred

Common

Total

(a) Preferred share is


non-cumulative,
non-participating

$16,000

$74,000

$90,000

(b) Preferred share is


cumulative, nonparticipating

$48,000

$42,000

$90,000

(c) Preferred share is


cumulative, participating

$57,778

$32,222

$90,000

Dividends in arrears
Current dividend
Pro rata share to
common
($250,000 X 8%)
Balance dividend pro
rata
($200,000 $450,000)
X $22,000
($250,000 $450,000)
X $22,000

Carrying value:
Preferred: $100 X 2,000
Common: $50 X 5,000
Total carrying value

$32,000
16,000

$32,000
16,000
$20,000

9,778
_______
$57,778

20,000

9,778
12,222
$32,222

12,222
$90,000

$200,000
$250,000
$450,000

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EXERCISE 16-8 (10-15 minutes)


(a)

One year in arrears**


Current year
Participating (12.788%*)

$566,000 - $144,000
=
$3,300,000

Preferred Common
$12,000
12,000 $120,000
38,364
383,636
$62,364 $503,636

Total
$ 12,000
132,000
422,000
$566,000

12.788%

** 15,000 X $0.80 = $12,000


(b)

$12,000 $554,000

$566,000

(c)

Current year
$12,000 $120,000
Additional 6%** to common
180,000
Participating (7.697%*)
23,091 230,909
$35,091 $530,909

$132,000
180,000
254,000
$566,000

$566,000 - $312,000
=
$3,300,000

7.697%

**Dividend rate on common shares


Less matching amount ($12,000 / $300,000)
Additional rate to common shares

10%
(4%)
6%

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EXERCISE 16-9 (10-15 minutes)


(a)

No entrysimply a memorandum indicating the number of


shares has increased to 18 million.

(b)

Retained Earnings
Stock Dividend
Distributable
(9,000,000 shares X $143)
Stock Dividend
Distributable
Common Shares

1,287,000,000
1,287,000,000

1,287,000,000
1,287,000,000

Large stock dividends and splits serve the same function with
regard to the securities markets. Both techniques allow the
Board of Directors to increase the quantity of shares and
channel share prices into the popular trading range.
For accounting purposes the 20%-25% rule reasonably views
large stock dividends as substantive stock splits. It is necessary
to capitalize the stated value with a stock dividend because the
number of shares is increased and the stated value per share
remains the same. Earnings are capitalized for purely procedural
reasons.

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EXERCISE 16-10 (10-12 minutes)


(a)

Retained Earnings............................................................
1,995,000
Common Stock Dividend
Distributable..........................................................
1,995,000
(700,000 X 5% X $57)
Common Stock Dividend
Distributable..................................................................
1,995,000
Common Shares......................................................
1,995,000

(b)

Retained Earnings (700,000 X $57)..................................


39,900,000
Common Stock Dividend
Distributable..........................................................
39,900,000
Common Stock Dividend
Distributable..................................................................
39,900,000
Common Shares......................................................
39,900,000
(c)

No entry. The number of shares outstanding increases


to 1,400,000.

Note: Judgement would be applied in determining whether


this is more like a stock split. Normally, large dividends would
be treated as a stock split and therefore the answer would be
the same as part (c). However, if the relevant business
corporations act specifies that new shares must be recorded
at fair value, the debit would be to retained earnings or
contributed surplus. In this case, the amount would wipe out
both balances and take retained earnings into a deficit
position. This might also be prohibited under the business
corporations act, in which case, the dividend would be illegal.

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EXERCISE 16-11 (10-15 minutes)


(a)

Retained Earnings............................................................
975,000
Common Stock Dividend
Distributable..........................................................
975,000
(500,000 shares X 5% X $39 = $975,000)
Common Stock Dividend Distributable..........................
975,000
Common Shares......................................................
975,000

(b)

No entry, memorandum note to indicate that shares


outstanding are now 2,500,000 (500,000 X 5).

(c)

January 5, 2005
Held-to-Maturity Investment in Bonds............................
35,000
Gain on Appreciation of
Investments (Bonds)............................................
35,000
Retained Earnings............................................................
135,000
Property Dividend Payable.....................................
135,000
January 25, 2005
Property Dividend Payable..............................................
135,000
Held-to-Maturity Investment in
Bonds..................................................................
135,000

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*EXERCISE 16-12 (20-25 minutes)


Bruno Corporation
Shareholders Equity
December 31, 2005
Share Capital:
Preferred shares, $5 cumulative, $50
preference in liquidation; authorized 60,000
shares, issued and outstanding 10,000 shares $ 500,000
Common shares, authorized 600,000 shares,
issued 200,000 shares, and outstanding
190,000 shares
200,000
Total share capital
700,000
Contributed surplus
1,460,000
Total paid-in capital
2,160,000
Retained earnings
201,000
($31,000 + $170,000)
Accumulated other comprehensive income
100,000
Total paid-in capital and retained earnings
2,461,000
Less treasury shares, 10,000 common shares
170,000*
Total shareholders equity
$2,291,000
*Note to instructor: The amount for the treasury shares was
assumed since it is not provided in the exercise information.

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EXERCISE 16-13 (20-30 minutes)


(a)
Dividends in arrears (1)
Current year dividend (2)
Participating dividend (3)
Total

Preferred Common
Total
$250,000
$250,000
125,000 $180,000
305,000
25,000
60,000
85,000
$400,000 $240,000 $640,000

(1) Dividends in arrears: 25,000 X $5 X 2 = $250,000


(2) Current year dividend:
Preferred: 25,000 X $5 =
Common: Number of shares issued

$125,000
60,000
X
$3
$ 180,000

(3) Participating dividend:


Since the common shareholders receive a $4 per share
dividend,
$1 per share is in excess of the $3 dividend
per share entitlement.
Excess dividend
$1
Number of common shares outstanding
X
60,000
Excess total dividend
$60,000
Common share capital
$1,800,000
Excess return
3.33%
Apply excess return to preferred
shareholders capital
X $750,000
Participating dividend to preferred
shareholders
$25,000

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EXERCISE 16-13 (Continued)


(b)

Retained Earnings............................................................
945,000
Common Stock Dividend
Distributable..........................................................
945,000
(60,000 X 15% X $105)

(c)

Common Shares...............................................................
315,000
Contributed Surplus.........................................................
787,500
Cash (10,500 X $105)...............................................
1,102,500
($1,800,000 / 60,000 X 10,500
= $315,000)

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EXERCISE 16-14 (30-35 minutes)


(a)

1.

Dividends PayablePreferred
(2,000 X $8).....................................................................
16,000
Dividends PayableCommon
(25,000 X $3)...................................................................
75,000
Cash..........................................................................
91,000

2.

Common Shares...............................................................
14,800
Contributed Surplus.........................................................
114,700
Cash (3,700 X $35)...................................................
129,500
($100,000 / 25,000 X 3,700 = $14,800)

3.

Cash (1,000 X $105)..........................................................


105,000
Preferred Shares......................................................
105,000

4.

Retained Earnings............................................................
95,850
Common Stock Dividend
Distributable.......................................................
95,850
[(25,000 3,700) X 10% = 2,130 X
$45]

5.

Common Stock Dividend


Distributable...............................................................
95,850
Common Shares......................................................
95,850

6.

Retained Earnings............................................................
70,860
Dividends PayablePreferred
(3,000 X $8)............................................................
24,000
Dividends PayableCommon
[(25,000 3,700 + 2,130) X $2].............................
46,860

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EXERCISE 16-14 (Continued)


(b)

Feller Corp.
Shareholders Equity12/31/05

Share capital
Preferred shares, $8, 10,000 shares
authorized, 3,000 shares issued
Common shares, 100,000 shares
authorized, 23,430 shares issued
Total share capital
Contributed surplus
Total paid-in capital
Retained earnings
Total shareholders equity

$ 305,000
181,050
486,050
40,300
526,350
533,290
$1,059,640

Computations:
Preferred shares $200,000 + $105,000 = $305,000
Common shares $100,000 - $14,800 + $95,850 = $181,050
Contributed surplus: $155,000 - $114,700 = $40,300
Retained earnings: $250,000 $95,850 $70,860 + $450,000 =
$533,290

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EXERCISE 16-15 (20-25 minutes)


(a) Benson Corp. is the more profitable in terms of return on
total assets. This may be shown as follows:
Benson Corp.

$660,000
$4,200,000

= 15.71%

Kingston Corp.

$594,000
$4,200,000

= 14.14%

It should be noted that these returns are based on net


income related to total assets, where the ending amount of
total assets is considered representative. If the rate of
return on total assets uses net income before interest but
after taxes in the numerator, the rates of return on total
assets are the same as shown below:
Benson Corp.
Kingston
Corp.

$660,000
$4,200,000

= 15.71%

$594,000 + $120,000 $54,000


$4,200,000

$660,000
$4,200,000

= 15.71%
(b) Kingston Corp. is the more profitable in terms of return on
shareholders equity. This may be shown as follows:
Kingston Corp.

$594,000
$2,700,000

= 22%

Benson Corp.

$660,000
$3,600,000

= 18.33%

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EXERCISE 16-15 (Continued)


Note to instructor: To explain why the difference in rate of return
on assets and rate of return on shareholders equity occurs, the
following schedule might be provided to the student.
Kingston Corp.

Current liabilities
Long-term debt
Common shares
Retained earnings

Funds
Supplied
$ 300,000
1,200,000
2,000,000
700,000
$4,200,000

Rate of Return
Accruing to
on Funds at
Cost of
Common
15.71%*
Funds
Shares
$ 47,130
$
0
$ 47,130
188,520
66,000 **
122,520
314,200
0
314,200
109,970
0
109,970
$659,820
$66,000
$593,820

*Determined in part (a), 15.71%


**The cost of funds is the interest of $120,000 (1,200,000 X 10%).
This interest cost must be reduced by the tax savings (45%)
related to the interest.
The schedule indicates that the income earned on the total
assets (before interest cost) was $659,820. The interest cost (net
of tax) of this income was $66,000, which indicates a net return
to the common equity of $593,820.

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EXERCISE 16-15 (Continued)


(c) The Kingston Corp. earned a net income per share of $5.94
($594,000 100,000) while the Benson Corp. had an income
per share of $4.55 ($660,000 145,000). The Kingston Corp.
has borrowed a substantial portion of its assets at a cost of
10% and has used these assets to earn a return in excess
of 10%. The excess earned on the borrowed assets
represents additional income for the shareholders and has
resulted in the higher income per share. Due to the debt
financing, Kingston has fewer shares outstanding.
(d) Yes, from the point of view of income it is advantageous for
the shareholders of Kingston Corp. to have long-term debt
outstanding. The assets obtained from incurrence of this
debt are earning a higher return than their cost to Kingston
Corp. which is evidence of leverage.
(e) Price earnings ratio.
Kingston Corp.
Benson Corp.

$101
$5.94
$63.50
$4.55

= 17 times earnings.
= 14 times earnings.

(f) Book value per share.


Kingston Corp.

$2,000,000 + $700,000
= $27.00
100,000

Benson Corp.

$2,900,000 + $700,000
= $24.83
145,000

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*EXERCISE 16-16 (10-15 minutes)


Common Shares...............................................................
190,000
Deficit (Retained Earnings)...................................... 190,000
(To record the elimination of the deficit
against share capital)
Plant Assets......................................................................
85,600
Long-term Liabilities.........................................................
250,000
Common Shares........................................................ 335,600
(To record write-up of plant assets
to fair market value and record the
negotiated change in control)

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*EXERCISE 16-17 (15-20 minutes)


Retained Earnings............................................................
450,000
Inventories...............................................................
Plant Assets.............................................................
[$330,000 = $1,700,000
($1,290,000 + $80,000)]

120,000
330,000

Common Shares...............................................................
850,000
Contributed Surplus.........................................................
220,000
Retained Earnings................................................... 1,070,000
($450,000 + $620,000)

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TIME AND PURPOSE OF PROBLEMS


Problem 16-1
minutes)

(Time 15-25

Purposeto provide the student with an opportunity to record five different


journal entries. The entries involve a share subscription, collection of the
receivable, and default on certain of these receivables. In addition, a repurchase
of shares and a lump-sum issuance must be recorded.

Problem 16-2

(Time 25-30 minutes)

Purposeto provide the student with an opportunity to prepare a shareholders


equity section to reflect the changes from five different transactions involving
share issuances, reacquisitions, stock split, and dividend declarations.
Throughout the problem the student needs to keep track of the number of shares
outstanding.

Problem 16-3

(Time 20-30 minutes)

Purposeto provide the student with an understanding of the necessary entries


to properly account for a corporations share transactions. This problem involves
such concepts as lump-sum sales of shares, and a noncash share exchange.

Problem 16-4

(Time 20-30 minutes)

Purposeto provide the student with an understanding of the proper entries to


reflect the reacquisition, and issuance of a corporations shares. The student is
required to prepare the journal entries to reflect these transactions.

*Problem 16-5

(Time 25-35 minutes)

Purposeto provide the student with an opportunity to analyze a set of


transactions affecting shareholders equity and prepare the companys
shareholders equity section. Transactions include issuance of par value shares
to buy machinery, lump-sum sale, collection of subscribed shares, and a
reacquisition of shares.

Problem 16-6

(Time 35-40 minutes)

Purposeto provide the student with an understanding of the necessary entries


to properly account for a corporations share transactions. The problem involves
such concepts as noncash share exchanges, sale of preferred and common
shares, and the reacquisition of both preferred and common shares. The student
is required to prepare the respective journal entries and the shareholders equity
section of the balance sheet so as to reflect these transactions.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED)


Problem 16-7

(Time 15-20 minutes)

Purposeto provide the student with an understanding of the proper accounting


for the declaration and payment of cash dividends on both preferred and
common shares. This problem also involves a dividend arrearage on preferred
shares, which will be satisfied by the issuance of common shares. The student is
required to prepare the necessary journal entries for the dividend declaration and
payment, assuming that they occur simultaneously.

Problem 16-8

(Time 20-25 minutes)

Purposeto provide the student with an understanding of the effect which certain
preferred share provisions, such as cumulative and fully participating, have on
dividend distributions to common and preferred shareholders. The student is
required to allocate the dividends to each type of share under two different
assumptions: (1) the preferred share does possess these two aforementioned
provisions, and (2) the preferred share does not.

Problem 16-9

(Time 20-25 minutes)

Purposeto provide the student with an understanding of the accounting effects


related to the cash, property, stock dividends and stock splits. The student is
required to analyze their effect on total assets, common shares, contributed
surplus, retained earnings, and total shareholders equity.

Problem 16-10

(Time 15-20 minutes)

Purposeto provide the student with an understanding of the respective entries


for a series of transactions involving equity accounts, such as the declaration of
property dividends and stock dividends and the donation of land. The student is
required to prepare the proper journal entries to reflect these transactions.

Problem 16-11

(Time 25-35 minutes)

Purposeto provide the student with an understanding of the proper accounting


for the declaration and payment of both a cash and stock dividend. The student is
required to prepare both the necessary journal entries to record the cash and
stock dividends and the shareholders equity section of the balance sheet.

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TIME AND PURPOSE OF PROBLEMS (CONTINUED)


Problem 16-12

(Time 35-45 minutes)

Purposeto provide the student a comprehensive problem involving all facets of


the shareholders equity section. The student must prepare the shareholders
equity section of the balance sheet, analyzing and classifying different
transactions to come up with proper accounts and amounts.

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SOLUTIONS TO PROBLEMS
PROBLEM 16-1
1.

Cash.................................................................. 160,000
Subscriptions Receivable............................... 220,000
Common Shares Subscribed..................
380,000

2.

Cash (9,000 X $22)........................................... 198,000


Subscriptions Receivable........................
198,000

3.

Common Shares Subscribed (1,000 X $38)... 38,000


Subscriptions Receivable........................
22,000
Cash (1,000 X $16)....................................
16,000
Common Shares Subscribed.......................... 342,000
Common Shares (9,000 X $38)................
342,000

4.

Common Shares (20,000 X $4.97*)................. 99,400


Contributed Surplus........................................ 300,000
Retained Earnings...........................................
600
Cash (20,000 X $20)..................................
400,000
*($200,000 + $342,000) (100,000 + 9,000)
= $4.97 per share

5.

Cash.................................................................. 290,000
Common Shares (3,000 X $27)................
81,000
Preferred Shares*.....................................
209,000
*Total received
Assigned to common share
(3,000 X $27)
Assigned to preferred

$290,000
(81,000)
$209,000

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PROBLEM 16-2
AMADO LIMITED
Shareholders Equity
December 31, 2005
Share Capital
Preferred shares, $6, 1,000,000 shares authorized
325,000 shares issued and outstanding
Common shares, unlimited shares authorized
2,070,000 shares issued and outstanding
Total share capital
Contributed Surplus
Total paid-in capital
Retained earnings
Total shareholders equity
Preferred Shares
Bal. $ 3,000,000
1.
625,000

$ 3,625,000

4.

Common Shares
Bal. $10,000,000
2.
1,000,000
157,200
$10,842,800

$3,625,000
10,842,800
14,467,800
16,907,200
31,375,000
4,615,000
$35,990,000

Number of Pref. Shares


Bal.
300,000
1.
25,000
325,000
Number of Common Shares
Bal.
1,000,000
2.
50,000
Bal.
1,050,000
3.
X
2
Bal.
2,100,000
4.
(30,000)
Bal.
2,070,000

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PROBLEM 16-2 (Continued)


Contributed Surplus Common
Bal. $17,000,000
5.
292,800
$16,707,200

Retained Earnings
Bal. $5,500,000
7. 1,950,000 6.
2,100,000
8. 1,035,000
$4,615,000

Contributed Surplus Pref.


Bal.
$200,000
$200,000
1.
2.
3.
4.

Jan.
Feb.
June
July

5.
6.
7.
8.

July 1
Dec. 31
Dec. 31
Dec. 31

1
1
1
1

25,000 X $25
50,000 X $20
stock split: 1,050,000 shares X 2
30,000 X ($11,000,000 2,100,000 sh.)
= 30,000 X $5.24 = $157,200
30,000 X ($15 - $5.24) = $292,800
Net income
325,000 X $6 = $1,950,000
2,070,000 X 50 = $1,035,000

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PROBLEM 16-3
-1Cash..........................................................................100,000
Discount on Bonds Payable................................... 1,060
Bonds Payable.................................................
100,000
Preferred Shares..............................................
1,060
-2Machinery................................................................. 7,500
Common Shares (500 X $15)...........................
(Assuming the shares are regularly traded, the value
of the shares would be used.)

7,500

-3Retained Earnings...................................................132,000
Cash..................................................................
132,000
Dividend to preferred: $11 X 2,000 shares =
Dividend to common: $11 X 10,000 shares =

$22,000
$110,000
$132,000

-4Cash.......................................................................... 11,300
Preferred Shares..............................................
Common Shares..............................................
Fair market value of common (375 X $14)
Fair market value of preferred (100 X $65)
Aggregate

6,251
5,049
$5,250
6,500
$11,750

Allocated to common:

$5,250
$11,750

X $11,300 =

Allocated to preferred:

$6,500
$11,750

X $11,300 = 6,251

Total allocation

$5,049

$11,300

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PROBLEM 16-3 (Continued)


-5Furniture and Fixtures............................................
Preferred Shares..............................................
Common Shares..............................................

6,200

Fair market value of furniture and equipment


Less: Market value of common shares
Total value assigned to preferred shares

3,000
3,200
$6,200
3,200
$3,000

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PROBLEM 16-4
(a) Common Shares ($30 X 380)........................... 11,400
Contributed Surplus........................................ 3,420
Cash ($39 X 380).......................................
14,820
(b) Common Shares ($30 X 300)...........................
Contributed Surplus........................................
Cash ($43 X 300).......................................

9,000
3,900
12,900

(c) Cash (3,500 X $42)........................................... 147,000


Common Shares.......................................
147,000
(d) Cash (1,200 X $48)........................................... 57,600
Common Shares.......................................
57,600
(e) Common Shares (1,000 X $34.88*)................. 34,880
Contributed Surplus........................................ 1,680**
Retained Earnings .......................................... 23,440
($60,000 $34,880 $1,680)
Cash (1,000 X $60)....................................
60,000

a.
b.

Common Shares
Bal.
$270,000
11,400
9,000
c.
147,000
d.
57,600

$454,200

Number of Common Shares


Bal. ($270,000 / $30) 9,000
a.
(380)
b.
(300)
c.
3,500
d.
1,200
Bal.
13,020

*Average cost = ($454,200 / 13,020 shares) = $34.88

a.
b.

**Contributed Surplus
Bal.
$9,000
3,420
3,900
$1,680

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*PROBLEM 16-5
HEINRICH CORPORATION
Shareholders Equity
December 31, 2005
Preferred shares, 8%, $100 par value,
10,000 shares authorized, 6,100 issued
Common shares, $2 par value,
200,000 shares authorized, 90,100 issued
Contributed surplus*
Total paid-in capital
Retained earnings
Total shareholders equity

$ 610,000
180,200
964,500
1,754,700
1,026,000
$2,780,700

* $24,500 + $940,000 = $964,500

6.

Preferred Shares
Bal.
$400,000
2.
10,000
3.
200,000

$ 610,000

Contributed Surplus Pref.


Bal. $20,000
2.
500
3.
4,000
$ 24,500

Common Shares
Bal.
$160,000
1.
200
2.
2,000
5.
20,000
2,000
$ 180,200

Contributed Surplus Com.


Bal. $940,000
1.
1,000
2.
12,000
6.
13,000
$ 940,000

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*PROBLEM 16-5 (Continued)


Common Shares Subsc.
Bal.
$20,000
5.
20,000
$0

Retained Earnings
Bal. $780,000
7.
246,000
$ 1,026,000

Subscriptions Receivable
Bal. $40,000
4.
40,000
$0

1. Common shares = $2 par value X 100 shares = $200


Cont. surplus common = ($12 - $2 par value) X 100 =
$1,000
2. Common shares = $2 par value X 1,000 shares = $2,000
Cont. surplus common = ($14 $2 par value) X 1,000 shares
= $12,000
Preferred shares = $100 par value X 100 shares = $10,000
Cont. surplus preferred = ($24,500 - $2,000 - $12,000 $10,000) = $500
3. Preferred shares = $100 par value X 2,000 shares = $200,000
Cont. surplus preferred = ($102 - $100 par value) X 2,000
shares = $4,000
6. Common shares = $2 par value X 1,000 shares = $2,000
Cont. surplus common = ($15 $2 par value) X 1,000 shares
= $13,000
Number of Common
shares
Bal.
80,000
1.
100
2.
1,000
5.
10,000
6.

Number of Preferred
shares
Bal.
4,000
2.
100
3.
2,000
6,100
shares

(1,000)
90,100 shares

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PROBLEM 16-6
(a)

-1(no entry necessary)


-2Land............................................................. 210,000
Common Shares..................................
210,000
-3Cash (15,200 shares X $110)...................... 1,672,000
Preferred Shares.................................
1,672,000
-4Preferred Shares ($110 X 3,000 shares).... 330,000
Cash.....................................................
300,000
Contributed SurplusPreferred........
30,000
-5Preferred Shares ($110 X 4,000 shares).... 440,000
Cash.....................................................
392,000
Contributed SurplusPreferred........
48,000
-6Common Shares.........................................
Retained Earnings......................................
Cash.....................................................
($210,000 10,000 = $21.00 per share
X 500 shares = $10,500)

10,500
14,000

24,500

-7Cash............................................................. 198,000
Preferred Shares.................................
198,000

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PROBLEM 16-6 (Continued)


(b) Shareholders equity:
Share capital
Preferred sharesno par value,

authorized 150,000 shares; issued


10,200 shares
Common sharesno par value,

authorized 150,000 shares; issued

9,500 shares
Total share capital
Contributed surplus

$1,100,000
199,500
1,299,500
78,000
1,377,500
1,018,000
$2,395,500

Total paid-in capital


Retained earnings
Total shareholders equity

Schedule of Capital Amounts

Transaction
2
3
4
5
6
7
Totals

Preferred
Shares

Contr.
Surplus
Preferred

Common
Shares

Retained
Earnings

Number of
Shares
Preferred Common

$210,000
$1,672,000
(330,000) $30,000
48,000
)
(440,000

000,000
$78,000
198,000

10,000
15,200
(3,000)
(4,000)

(10,500)

$199,500

$(14,000)
1,032,000
$1,018,000

(500)
2,000
00,000
10,200

9,500

$1,100,000

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PROBLEM 16-7
(a)

For Preferred in arrears:

Retained Earnings............................................................
72,500
Common Shares......................................................

72,500*

* 25,000 20 = 1,250 common shares


issued as dividend
1,250 X $58 = $72,500
For $2 preferred current:
Retained Earnings............................................................
50,000
Cash..........................................................................
*($2 X 25,000 shares)
For $1 per share common:
Retained Earnings............................................................
301,250
Cash..........................................................................

50,000*

301,250*

*Since all preferred dividends must be paid before the


common dividend, outstanding common shares include
As of Dec. 31, 2004
Preferred distribution1 common for
every 20 preferred shares
Common dividend
Amount of common cash dividend

300,000 shares
1,250 shares
301,250 shares
X 1.00 per share
$301,250

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PROBLEM 16-7 (Continued)


(b)

*Preferred in arrears ($2 X 25,000 shares)


Current preferred ($2 X 25,000 shares)
Common dividend ($1.00 X 300,000)
Total cash dividend

$ 50,000
50,000
300,000
$400,000

**Beginning balance
Net income
Available to pay dividends

$355,000
77,000
$432,000

Total dividends would be $400,000, which is adequately covered


by the cash balance. The retained earnings balance, after adding
the 2005 net income (estimated at $77,000), is sufficient to cover
the dividends.

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PROBLEM 16-8
Assumptions
(a)
Preferred,
noncumulative and
nonparticipating
Year
2003
2004
2005
2006

Paid-out Preferred
$13,000
$5.20
$26,000
$7.00
$57,000
$7.00
$176,000
$7.00

$.57 =

Common
-0$ .57a
$2.63b
$10.57c

(b)
Preferred, cumulative
and fully participating
Preferred Common
$ 5.20
-0d
$ 8.80
$ .27e
$14.25f
$1.43f
$44.00g
$4.40g

$26,000 $17,500*
15,000

*($17,500 = $7 X 2,500)
b

$2.63 =

$57,000 $17,500
15,000

$10.57
=

$176,000 $17,500
15,000

$7 + $1.80 (for 2003)

$8.80 =
e

$.27 =

$26,000 $22,000**
15,000

**($22,000 = $8.80 X 2,500)

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PROBLEM 16-8 (Continued)


f

Total
Total amount to be distributed $57,000
Preferred dividend ($7 X 2,500) (17,500)
Available for common and
participation
39,500
Ratable dividend to common
(7%** X $150,000)
(10,500)
Available for participation
29,000
Preferred .0725* X $250,000
2,500
Common .0725* X $150,000
15,000
Totals
*(.0725 =

$29,000
)
$250,000 + $150,000

$ 7.00

$.70
7.25
.73
$14.25

**(7%=

Total
Total amount to be
distributed
$176,000
Preferred dividend ($7 X 2,500) (17,500)
Available for common and
participation
158,500
Ratable dividend to common
(7% X $150,000)
(10,500)
Available for participation
148,000
Preferred .37* X $250,000
2,500
Common .37* X $150,000
15,000
Totals
*(.37 =

Per Share
Preferred Common

$ 1.43

$17,500
$250,000

Per Share
Preferred Common
$ 7.00

$ .70
37.00
3.70
$44.00

$4.40

$148,000
)
$250,000 + $150,000

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PROBLEM 16-9
Transactions:
(a) Assuming Guo Limited declares and pays a $.50 per share
cash dividend.
(1) Total assetsdecrease $5,000
(2) Common sharesno effect
(3) Contributed surplusno effect
(4) Retained earningsdecrease $5,000
(5) Total shareholders equitydecrease $5,000
(b) Guo declares and issues a 10% stock dividend when the
market price of the share is $12.
(1) Total assetsno effect
(2) Common sharesincrease $12,000
(10,000 X 10%) X $12
(3) Contributed surplus no effect
(4) Retained earningsdecrease $12,000 ($12 X 1,000)
(5) Total shareholders equityno effect
(c) Guo declares and issues a 40% stock dividend when the
market price of the share is $17 per share.
(1) Total assetsno effect
(2) Common sharesincrease $68,000 (10,000 X 40%) X
$17
(3) Contributed surplus no effect
(4) Retained earningsdecrease $68,000
(5) Total shareholders equityno effect
(d) Guo declares and distributes a property dividend
(1) Total assetsnet decrease $30,000 (5,000* X $6)
(2) Common sharesno effect
(3) Contributed surplus no effect
(4) Retained earningsdecrease $30,000
(5) Total shareholders equitydecrease $30,000
*10,000 common shares / 2 = 5,000 shares of ABC.
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PROBLEM 16-9 (Continued)


Note:
The journal entries made for the above transaction are:
Investments in ABC shares......................
30,000
...................................................................
...................................................................
...................................................................
Gain in Appreciation of Securities...
30,000
(To record increase in value of securities to be issued)
Retained Earnings.....................................
60,000
....................................................................
....................................................................
....................................................................
Investment in ABC shares................
(To record distribution of property dividend)

60,000

(e) Guo declares a 3-for-1 stock split


(1) Total assetsno effect
(2) Common sharesno effect
(3) Contributed surplus no effect
(4) Retained earningsno effect
(5) Total shareholders equityno effect

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PROBLEM 16-10
(a)
Available-for-Sale Investment..........................................
37,250
Gain on Appreciation of Securities........................
(5,000* shares X $16)
$80,000
Less cost of 5,000 shares =
42,750**
$37,250

37,250

*50,000 shares 10 = 5,000 shares


**[($68,400 8,000 shares) X 5,000 shares]
Retained Earnings............................................................
80,000
Property Dividends Payable...................................

80,000

Note: This transaction is a partial distribution and the entry


represents a revaluation of only the 5,000 shares distributed of
the total of 8,000 on hand. In addition, a portion of the
Accumulated Other Comprehensive Income will be reclassified
at year end to account for the portion of the fair market value
increase that has been realized through the dividend.
(b)
Retained Earnings............................................................
60,000
Common Stock Dividend Distributable.................
(50,000 X 5% = 2,500 shares @ $24 = $60,000)

60,000

Note to instructor: the shareholders equity information


presented in the problem should be dated December 31, 2003.
(c)
Land ...................................................................................
42,000
Contributed Surplus Donated Land....................

42,000

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PROBLEM 16-11
(a)

Retained Earnings
1,200,000
Cash
1,200,000
(Cash dividend of $.60 per share on 2,000,000 shares)

(b)

Retained Earnings
4,200,000
Common Shares
4,200,000
(Stock dividend of 6%, 120,000 shares, at $35 per share)

(c)

SHAREHOLDERS EQUITY
Common shares
Issued 2,120,000 shares
Contributed surplus
Retained earnings
Total shareholders equity

$24,200,000
5,000,000
24,300,000
$53,500,000

Ducat Corporation
Statement of Retained Earnings
For the Year Ended December 31, 2005
Balance, January 1, 2005
Net income for 2005
Deduct dividends on common shares:
Cash dividend
Stock dividend (see note)
Balance December 31, 2005

$24,000,000
5,700,000
29,700,000
$1,200,000
4,200,000

5,400,000
$24,300,000

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PROBLEM 16-11 (Continued)


Note: The 6% stock dividend (120,000 shares) was distributed to
shareholders of record at the close of business on December 31,
2005. For the purposes of the dividend, the share was assigned
an average price of $35 per share based upon the average
quoted market over a short period preceding the dividend date.
Average market has been chosen to eliminate the chance that
any one days market price might have been affected by some
unusual circumstances.
The use of the average market price is a judgment call. The
problem does provide an opportunity to emphasize to students
that some flexibility exists in GAAP rules, and that judgment
often plays an important part in the final answer.

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PROBLEM 16-12
Okanagan Inc.
Shareholders Equity
June 30, 2005
Share Capital:
Preferred shares, $2.00, cumulative
and non-participating, 100,000
shares authorized, 50,000 shares
issuedNote A
Common shares, 300,000 shares
authorized, 116,000 shares issued
Common shares subscribed,
8,000 shares 2
Total share capital
Retained earnings
AppropriatedNote B
Unappropriated 3
Total shareholders equity
Note A:
Note B:

$2,200,000
$3,918,340 1
368,000 4,286,340
6,486,340
50,000
331,660

381,660
$6,868,000

Okanagan Inc. is in arrears on the preferred shares in


the amount of $50,000.
Okanagan Inc. is required to appropriate retained
earnings in an amount that is equal to the sinking
fund deposit of $50,000, that is to be accumulated to
retire a term loan.

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PROBLEM 16-12 (Continued)


1

Common share transactions:


Date
Shares
Price
07/01/02
95,000 $31.00
07/24/02
5,000
--

Common shares
$2,945,000
220,000
a

03/01/03

10,000

42.00

420,000

10/01/04

2,000

46.00

92,000
b

Subtotal
11/30/04

112,000
(2,000) 32.83

3,677,000
65,660
c

Subtotal
12/15/04
06/20/05
Total

110,000
5,500
500
116,000

52.00

3,611,340
286,000
21,000
$3,918,340

a. The 5,000 shares exchanged for a plot of land are recorded


at $220,000 of shares (use the current market value of the
land on July 24 to value the share issuance).
b. The remaining subscriptions for 8,000 shares resulted in
$368,000 of common shares subscribed.
c. $3,677,000 / 112,000 = $32.83 per share. Retained earnings
is also debited for $12,340, since there is no contributed
surplus, the difference between the repurchase price of
$39 per share less the average stated price of $32.83 per
share.
2

The subscriptions receivable at the balance sheet date could


be shown as a contra account to the Common Shares
Subscribed or as a current asset. As the amount is not known,
it has been assumed to be part of current assets.
Retained earnings, June 30, 2004
Add: Net Income
Deduct:

$ 690,000
40,000

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Appropriation for sinking fund


$ 50,000
Excess of cost of reacquired shares
over assigned value
12,340
Preferred dividend
50,000
Stock dividend, common shares
286,000

398,340
$ 331,660

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TIME AND PURPOSE OF WRITING ASSIGNMENTS


Assignment 16-1(Time 15-20 minutes)
Purposeto provide the student with an opportunity to discuss the options for
reporting common shares subscribed and subscriptions receivable.

Assignment 16-2(Time 25-35 minutes)


Purposeto provide the student with an understanding of the factors underlying
the creation of secret reserves. The student is required to discuss the various
ramifications of this condition and describe the general circumstances in which it
can arise.

Assignment 16-3

(Time 20-25 minutes)

Purposeto require the student to define equity items, in part using the CICA
Handbook Section 1000 on Financial Statement Concepts, in part using Section
3860, and to provide examples of transactions and events that change the terms
defined.

Assignment 16-4(Time 25-30 minutes)


Purposeto provide the student with an understanding of the conceptual
framework that underlies a stock dividend and a stock split. The student is
required to explain what a stock dividend is, the amount of retained earnings to
be capitalized in connection with a stock dividend, and how it differs from a stock
split both from a legal standpoint and an accounting standpoint. This case also
requires an explanation of the various reasons why a corporation declares a
stock dividend or a stock split.

*Assignment 16-5(Time 20-30 minutes)


Purposeto provide the student with an understanding of the concepts that
comprise a financial reorganization. The student is required to describe the
characteristics of a financial reorganization and list the conditions under which it
generally is justified.

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SOLUTIONS TO WRITING ASSIGNMENTS


ASSIGNMENT 16-1
(a) The account Common Shares Subscribed indicates the corporations
obligation to issue shares of its common shares upon payment of final
subscription balances by those who have subscribed for shares. This account
signifies a commitment against the unissued common shares. It is reported in
the shareholders equity section below Common Shares.
(b) The account Subscriptions Receivable indicates the amount yet to be
collected before subscribed shares will be issued. Because this is a
receivable similar to accounts receivable, it is argued that this account should
be reported as a current asset. This account represents a claim to cash that is
generally collectible within a year or less, justifying its classification as a
current asset.
(c) Many accountants argue that Subscriptions Receivable should be reported as
a deduction from Common Shares subscribed in the shareholders equity
section because of the risk of collectibility. No deficiency judgment can be
sought for failure of a subscriber to pay the unpaid balance of a subscription
receivable.
(d) Common shares subscribed (50,000 shares)
Less subscriptions receivable

$ 2,000,000
(700,000
)
$1,300,000

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ASSIGNMENT 16-2
A secret reserve is created when shareholders equity is understated. Generally,
such reserves, often called hidden assets, are created or enlarged by practices
that understate assets and/or overstate liabilities. Such practices often result from
the application of the accounting convention or principle of conservatism.
Both of the practices cited tend to cause assets to be stated at lower amounts
than would be the case with other acceptable alternatives. The use of LIFO
during a period of steadily rising prices tends to cause the inventory cost to be
stated in terms of prices that prevailed when the method was adopted. When
such prices are compared to current prices, they are low; hence income and
shareholders equity are correspondingly low. The expensing of all human
resource costs as they are incurred, in effect, denies that such costs have
produced any future benefits. To the extent that such expenditures produce future
benefits, a portion of the costs should be capitalized as an intangible asset.
Secret reserves exist to the extent that assets have been understated by the
immediate expensing of all human resource costs.
It is possible to create a secret reserve by overstating liabilities. This could most
readily occur in recording estimated liabilities such as for product warranties,
contingent liabilities, or pensions at amounts in excess of actuarially determined
amounts, or for the restoration of property at the termination of a lease. Any such
overstatement of the ultimate liability overstates current expenses and thereby
understates shareholders equity. A secret reserve also would exist when a firm
has long-term, fixed interest debt outstanding during periods when interest rates
are increasing and much higher than on the debt. In a sense the concept of
secret reserves also can be extended to include the effects of holding an
excess of monetary liabilities over monetary assets. During a period of inflation
the reserve is in terms of general purchasing power whereas the previously
discussed reserves have been due to differences in money amounts.
There are several objections to the creation of secret reserves. Only insiders
are likely to know of their existence and value. Statement readers who are
unaware of the existence of secret reserves may regard a companys securities
as overvalued when, in fact, they may be undervalued or valued correctly. As a
result, shareholders may be willing to part with their shares for too little
consideration.

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ASSIGNMENT 16-2 (Continued)


The creation of secret reserves also tends to shift income between periods and
usually tends to have a smoothing effect on reported income. If an asset is
understated or a liability is overstated in the current period, it usually means that
some expense is going to be correspondingly overstated with the result that
current income is understated. In some subsequent period the service potential
of the unrecognized or undervalued asset will be consumed. If its cost were
understated or not recognized, expenses of the later period also will be
understated and income of the later period will be overstated. Somewhat the
same effect can be achieved through over accrual of estimated expenses. There
are practical limits as to how large an estimated liability for estimated expenses
can become before it will be discovered and investigated. In the period when the
carrying value of the estimated liability reaches its upper limit, usually no accrual
or an inadequate accrual is recognized.
Involved also is an application of the concept of organization slack. During
expansionary periods overstating expenses or understating revenues
accumulates a cushion. This cushion can be utilized when the environment
becomes unfavourable such as during a period of depressed income caused by
either external or internal factors. Thus secret reserves are a form of
organization slack that gives management squirming room and helps it to
smooth unfavourable reports under the assumption that bad news should be
softened to prevent expectations (aspirations) from fluctuating widely.
The purpose of financial statements is to inform, not to mislead. The existence of
secret reserves makes the statements misleading to the extent that assets are
understated or liabilities are overstated because the extent of the under or
overstatement is not reported.

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ASSIGNMENT 16-3
(a)

Section 1000 of the CICA Handbook defines equity for a profit-seeking


enterprise as the ownership interest in the assets after deducting the
liabilities. HB 3860 defines an equity instrument as any contract that
evidences a residual interest in the assets after deducting all of its liabilities.
Equity is synonymous with net assets and is a residual interest in the assets
of the enterprise. Equity can only be measured as a result of measuring
assets and liabilities.

(b) Transactions or events that change owners equity include revenues and
expenses, gains and losses (realized and unrealized), investments by
owners, distributions to owners, and changes within owners equity.
(c) Some examples of changes within owners equity that do not change the total
amount of owners equity are the retirement of treasury shares accounted
for by the single transaction method, reclassification of a deficit to share
capital in a financial reorganization (not the revaluation of assets),
conversion of preferred shares into common shares, stock dividends, and
retained earnings appropriations.

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ASSIGNMENT 16-4
(a) A stock dividend is the issuance by a corporation of its own shares to its
shareholders on a pro-rata basis without receiving payment for the shares.
The stock dividend results in an increase in the amount of the legal or stated
capital of the enterprise. The dividend is charged to retained earnings and, in
effect, acts to capitalize retained earnings.
From the legal standpoint, a stock split is distinguished from a stock dividend
in that a split results in an increase in the number of shares outstanding and
a corresponding decrease in the stated value per share. A stock dividend,
though it results in an increase in the number of shares outstanding, does
not necessarily result in a decrease in the stated value of the shares.
From an accounting standpoint, the major distinction is that a stock dividend
requires a journal entry to decrease retained earnings and increase paid-in
capital, while there is no entry for a stock split. Also, the distinction between
a stock dividend and a stock split is dependent upon the intent of the Board
of Directors in making the declaration. If the intent is to give to shareholders
some separate evidence of a part of their pro-rata interests in accumulated
corporate earnings, the action results in a stock dividend. If the intent is to
issue enough shares to reduce the market price per share, the action results
in a stock split, regardless of the form it may take. In other words, if the
action takes the form of a stock dividend but reduces the market price
markedly, it should be considered a stock split. Such reduction will seldom
occur unless the number of shares issued is at least 20% to 25% of the
number previously outstanding.
(b) The usual reason for issuing a stock dividend is to give the shareholders
something on a dividend date and yet conserve working capital.
A stock dividend that is charged to retained earnings reduces the total
accumulated earnings, and all stock dividends reduce the per share earnings.
Issuing a stock dividend to achieve these ends would be a public relations
gesture in that the public would be less likely to criticize the corporation for
high profits or undue retention of earnings.
A stock dividend also may be issued for the purpose of obtaining a wider
distribution of the shares. Although this is the main consideration in a stock
split, it may be secondary consideration in the issuance of a stock dividend.
The issuance of a series of stock dividends will accomplish the same
objective as a stock split.
A stock split is intended to obtain wider distribution and improved marketability
of shares by means of a reduction in the market value of the companys
shares.
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ASSIGNMENT 16-4 (Continued)


(c) The amount of retained earnings to be capitalized in connection with a stock
dividend (in the accounting sense) might be (1) the legal minimum (usually
par), (2) the average contributed capital per outstanding share, or (3) the
market value of the shares.
The third basis is generally recommended on the grounds that recipients tend
to regard the market value of the share received as a dividend as the amount
of earnings distributed to them. If the corporation in such cases does not
capitalize an amount equal to the fair value of the shares distributed as a
dividend, there is left in the corporations retained earnings account an
amount of earnings that the shareholders believe has been distributed to
them. This amount would be subject to further stock dividends or to cash
dividends. The recipients might thus be misled into believing that the
companys distributionsand earningsare greater than they actually are.
If the per share market value of the share is materially reduced as a result of
a distribution (usually 20%-25% of shares outstanding or more), no matter
what form the distribution takes, the action is in substance a stock split and
should be so designated.

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* ASSIGNMENT 16-5
(a) The purpose of a financial reorganization is to enable a company that has
gone through financial difficulty to have a fresh start for financial reporting
purposes. Generally, such would be a possibility for a company that has
incurred losses for several periods and, as a result, has a deficit. In such
circumstances, the company may have difficulty meeting interest and
principal payments on debt, and is unable to pay dividends until earnings
are sufficient to offset the deficit. This can result in serious questions
regarding the companys survival. Rather than declaring bankruptcy,
however, various events (e.g. economic conditions, new products
developed, new management team) may signal promise for successful
operations. Therefore, a financial reorganization, and not bankruptcy, may
be in the best interests of all stakeholders in the business. This would result
in elimination of the deficit, comprehensive revaluation of assets and
liabilities, and realignment of equity and non-equity interests (i.e. to enable
the company to continue as if it were a new entity).
(b) The requirements and accounting for a financial reorganization to result in a
fresh start are:
1. There must be a negotiated agreement between all equity and nonequity holders.
2. There is a substantial realignment of the equity and non-equity interests
such that the rights and claims of each change relative to each other.
3. The same party does not control the company both before and after the
reorganization. (This is required before comprehensive asset and liability
revaluation can take place.)
Note that companies are always permitted to write down their assets
when appropriate. It is the recognition of non-recorded assets and
recognition of higher fair values that is the issue here.
4. The assets and liabilities are comprehensively re-valued at amounts
negotiated in the agreement or, if not established in the agreement, at
fair value. The re-valued net assets cannot exceed the fair value of the
enterprise as a whole. The revaluation adjustment (difference between
the prior-to-reorganization carrying values and these new values) is
accounted for as a capital transaction and recorded as share capital,
contributed surplus, or a separately identified account in shareholders
equity.

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* ASSIGNMENT 16-5 (Continued)


5. The retained earnings (deficit) account balance prior to the
reorganization is brought up to the date of the reorganization. This
includes recording any write-downs related to circumstances that existed
prior to the reorganization. Then, the updated balance in retained
earnings (deficit) is reclassified as share capital, contributed surplus, or a
separately identified account within shareholders equity.
(c) Since the evidence indicates that the company has reached a turning point
and that profitable operations can be expected hereafter, a financial
reorganization to eliminate the accumulated deficit would be appropriate if
the shareholders allow it. The purpose of eliminating the deficitand the
purpose of a financial reorganizationis to relieve the company from the
handicap of past losses that result in an unfavourable reporting of current
financial position even after conditions resulting in the losses have changed.

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SUGGESTED CASE SOLUTIONS


See the Case Primer on the Digital Tool, as well as the suggested outline for
case solutions. Note that the first few chapters lay the foundation for financial
reporting decision making.

CA 16-1 Nadir International Inc.


Overview:
- Company profits suffering due to increased competition and higher labour
costs therefore potential to try to make financial statements look better to
counter this.
- Looking to raise funding internationally additional bias to make the
company look better
- Company has attempted to raise capital but has been declined due to
value of assets pressure to increase value of assets as these higher
value reflect current values and are more relevant for users
- GAAP is a constraint given that the company is looking to raise funds
Analysis and recommendations:
Issue: Valuation of the company assets
There is no real basis for revaluing the assets even though this might provide
more meaningful information.
The company may reduce the deficit in retained earnings with shareholder
approval (HB 3250.11); however, the assets may not be written up arbitrarily.
For revaluation of assets, a comprehensive revaluation is allowed as long as
there is a financial reorganization. A financial reorganization involves bargaining
between equity and non-equity owners including a substantial realignment of the
ownership interests in the company. This bargaining helps establish arms length
values for the net assets since this info is needed to determine the realignment of
the ownership interests.
Recommendation:
In this case, there is no change in ownership nor any realignment of interests and
therefore an asset revaluation is not allowed.
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CA 16-2 Centre Corporation


Overview:
-

The company appears to be cash poor and yet is showing retained


earnings concern is that shareholders will look at the retained earnings
and assume the company should pay dividends
Wants to give the shareholders something of value and reduce retained
earnings so that shareholders will not expect dividends in future
Since the financial statements will be audited, assume a GAAP constraint

Analysis and recommendations:


Issue: Financial accounting treatment of a 100% stock dividend
Account for as a dividend
- Legally this is a dividend and
therefore should be accounted
for at FV
- Reduce retained earnings and
increase common shares

Account for as a split


- Economic substance is that this
is more like a stock split
- Due to the large amount of
shares to be issued, capital
markets will see this as a stock
split and the value of each share
will be reduced by 50%
- No new funds are coming into
the company only the number
of shares is increasing
- Retained earnings should
remain the same as should the
value in the common shares
account only the number of
common shares should be
changed

Recommendations:
Treat as a split since the value of the company is unchanged and only the
number of shares would increase. This will not help with the issue of showing
excess retained earnings. Perhaps the company could consider giving a smaller
stock dividend which would be treated as a dividend and accounted for at FV.

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IC 16-1 Sandolin Incorporated


NB these issues should be ranked in order of importance case does not
give sufficient quantitative info to do this but instructors may wish to
discuss in class. Revenues appear to be a key number, and therefore,
issues that affect revenues may be more important.
Overview:
-

Global company with publicly traded shares therefore GAAP constraint


Has recently undergone a restructuring now may be a good time to
ensure assets are not overvalued since the markets expect write offs in a
restructuring situation
Currently has high credit rating and share price due to increasing
revenues and recent restructuring would not want to jeopardize this
Credit rating agencies will be looking to the company to
reassess/substantiate their recent rating
Investors and shareholders will be looking to the company to assess value
Government will look to the financial statements to assess whether toll
road revenues are excessive
Overall - management must be careful to present a fair representation of
the value of the company (high value) without appearing to be charging
excessive revenues for toll roads. Revenues appear to be a key number.

Issue: Restructuring charges


Present separately on I/S
- The markets are taking the restructuring as a positive factor and should
therefore show separately to give more information
- These items are non-recurring and should be segregated so that users
may assess normalized earnings
Issue: Toll road revenue restrictions issue/Asset impairment/Disclosure
Recognize asset impairment
Do nothing
- If the companys ability to raise tolls is - The companys lawyers believe that
restricted by the government, the asset the company has a contractual right to
value changes. This change in
raise revenues and are willing to
condition signals a potential impairment contest this.
which must be measured
- Disclosure of the issue in the financial
- Full recognition of this potential
statements may not be necessary is
impairment may affect share price and the information is available through the
credit ratings
press or if the company feels that the
government claim is unsubstantiated
- reporting this problem will imply that
future revenue streams are impaired
and thus this may affect share prices
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and credit ratings


Recommendation:
Leave the assets as is and do not disclose on the basis that the lawyers feel that
the company is on sold ground.
Issue: Round trip trades
Show gross revenues
- Accounts for 40% of the
increased revenues
- If shown net would potentially
affect credit rating and share
prices
- Their business is buying and
selling energy contracts may
take legal title of the goods
traded (? must establish this
with company lawyers)

Show net
- As traders, economic substance
is that they are earning
commissions on the trades
similar to a real estate agent
- Never take possession of the
goods traded

Recommendations:
Difficult to justify treating these as sales unless legal title is taken to the energy
traded. The company must show that they have the risks and rewards of
ownership of the energy.
Issue: How to account for the purchase of the engineering business
Record notes as assets impairment? Record notes as share reduction or not
at all
- The value of the transaction should be - Alternatively, this represents a
determined at the transaction date
contingency the company really owes
- Currently, the note represents a
the vendor an additional amount if the
benefit to the company that the
engineering firm does well
company has access to
- Recognize the contingency if likely
- As the situation changes, then this
and measurable this is difficult to
would be reassessed
measure at this point since future
- If the notes are no longer repayable,
profits are unknown. Therefore, since
the value might be added to the cost of the shares are already issued and
the investment since it really
currently have fair value, should record
represents additional consideration
the note. Given the tie in to the
paid for the business.
acquisition may consider recording
- Makes the company look better
the notes as a contra account
Recommendation:
Record as an asset since it has future benefit at this point in time.

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RESEARCH AND FINANCIAL ANALYSIS


RA16-1

INTRAWEST CORPORATION

(a) The number of common shares issued and outstanding at June 30, 2003 was
47,560,062. The percentage of authorized which are issued and outstanding cannot
be calculated since an unlimited number of shares are authorized. None of the
50,000 authorized NRP shares are issued and outstanding at June 30, 2003 since
the remaining shares outstanding last year were redeemed during the 2002/2003
fiscal year.
(b) NRP stands for Non-Resort Preferred. These shares came about in 1997 when the
company reorganized its share capital to separate the companys non-resort real
estate assets from the remainder of its business. Each of the existing common
shares was exchanged for one new common share plus one NRP share. The NRP
shares are more like preferred shares than like common since they were subject to
redemption. Depending on the terms of redemption, these shares may be more like
debt than like preferred shares. Not enough information is provided in the notes to
determine this but given that the shares were classified as equity, one can assume
that they did not have enough characteristics of debt to be classified as such.
(c) The average issue price of the common shares during the year was US$8.80. (This
was calculated by dividing the $2,685,000 issue proceeds amount by the 305,000
number of shares issued.)
(d) The purpose of repurchasing the NRP shares was not disclosed. One possible
reason is that the company no longer needed the capital associated with this special
class of shares. The number of shares repurchased was 5,163,436 and the price
was US$1.30 (or CDN $2.02.)

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RA16-2

CANWEST GLOBAL COMMUNICATIONS CORP.

(a) The following chart presents the four classes of shares which existed at 2002.
Series 2
Preference
shares

# Votes per share

Series 1
Preference
shares
19 votes
per share*

Rights in terms of
dividends

Preference

Preference

Name of share class

Multiple
voting
shares
10 votes
per share
Subordinate
to
preference
shares,
rank equally
with other
classes

none

Subordinate
voting
shares
1 vote per
share
Subordinate
to
preference
shares, rank
equally with
other
classes

Non-voting
shares
none**
Subordinate
to
preference
shares,
rank equally
with other
classes

* plus preferential votes pertaining to the election of up to two directors.


** except at meetings where the holders of such shares would be entitled, by law, to vote
separately as a class.
(b) The bulk of the nonvoting, series 1 and series 2 preference shares were issued upon
the amalgamation of subsidiaries of the company, including Canwest Broadcasting
Ltd. The significant decrease in both the non-voting shares and the series 1
preference shares during 2001 resulted from the conversion of these shares into
subordinate voting shares. This has the impact of diluting the proportional ownership
of the subordinate voting shareholders who owned these shares before the
conversion.
(c) The average carrying value per subordinate voting share for the years ended 2000,
2001 and 2002 and the average issue price for 01/02 and 02/03 are calculated
below.
1-Aug-01

1-Aug-02

Number of shares

70,545,434

Carrying value
Average carrying value per
share

$419,583,000 $816,418,000 $815,545,000


$

5.95

98,371,658

1-Aug-03

8.30

98,280,291

8.30

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01/02

02/03

Shares issued:
6,077
9,645
405,000
27,405,513

58,454
13,031

Total number issued

27,826,235

71,485

Issue Proceeds:
$

66,000
43,000
6,156,
000
390,570,000
Total proceeds
Average issue price

$ 369,000
33,000

$396,835,000
$

$ 402,000

14.26

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$ 5.62

RA16-3
BANK OF MONTREAL VERSUS ROYAL BANK OF
CANADA
Bank of Montreal
(a) and (b)
Year-end
Balance
of
common
shares ($ millions)
Number
of
common
shares outstanding
Average carrying value
Market price on
March 16, 2004
(as listed on TSX)
Authorized share capital:
Preferred shares, in
series
Common shares
(c)

10/31/03
$3,662

Royal Bank of
Canada
10/31/03
$7,018

499,632,368

656,021,122

$7.33

$10.70

$52.86

$62.35

Unlimited number

Unlimited number

Unlimited number

Unlimited number

Both companies present their share capital information in a combined


Consolidated Statement of Shareholders Equity, rather than a statement
of retained earnings with additional share capital information in the notes to
the financial statements. For both companies, the statement of
shareholders equity is presented on a comparative basis for three years,
whereas the balance sheet is presented for two years. This is consistent
with the comparative presentation of the income statement, which is also for
three years. The statement of shareholders equity shows beginning
balances, issuances, redemptions and ending balances to the preferred and
common shares. The Bank of Montreal also shows the impact of this
information on the number of shares outstanding for its common shares
only. The impact of the transactions on the number of preferred shares is
disclosed in the notes to the financial statements. For the Royal Bank, the
change in the number of preferred and common shares outstanding is
disclosed in the notes to the financial statements.

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(d) Dollar amounts in millions and numbers of shares in thousands.

2003

Bank of Montreal
2002
2001
# of
# of
Amount shares Amount
shares

Amount

# of
shares

3,459

492,504

3,375

489,084

3,173

522,584

Issued under
shareholder
dividend
reinvestment and
share purchase
plan

4
6

1,10
1

4
4

1,20
5

3
5

903

Issued under
stock option plan

12
9

5,32
6

3
7

1,92
3

11
4

6,177

34
9

29
2

1,135

2
7

63
5

40
0

10,28
5

(22
)

(2
)

(283
)

(332
)

3,662

499,632

3,459

492,504

3,375

Beg. balance

Issued on
exchange of
shares of
subsidiary
corporations

Cancellation of
stock options
granted on
acquisition of an
investment
Repurchased for
cancellation
Ending balance

(52,000)
489,084

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Royal Bank
2002
# of
Amount
shares

2003

Beg. balance
Issued
Issued under
stock option plan
Issued on
acquisition of
Centura Banks
Issued on
acquisition of
Richardson
Greenshields
Purchased for
cancellation
Ending balance

2001

Amount

# of
shares

6,979

665,257

6,94
0

674,021

3,076

576

193

5,303

176

5,211

81

2,819

3,31
7

67,413

1
5

31
8

13

(154)

(14,539)

(152)

(14,293)

(112)

(10,927)

7,01
8

656,021

6,979

665,257

6,940

Amount

# of
shares
602,398
12,305

674,021

Over the past three years, both companies have had issuances of common shares
for the following transactions:

Issued under stock option plans


Issued on the acquisition of other companies
Issued under dividend reinvestment and share purchase plans
Both companies have also repurchased shares for cancellation.
Both companies have maintained the outstanding number of common shares
fairly constant over the last three years by repurchasing shares in numbers
approximating the number of shares issued under the various plans. Most of
the issuances of common shares have been under purchase plans, such as
stock option and dividend reinvestment plans and not as issuances to raise
capital for the companies. The repurchases maintain the number of shares
outstanding at a fairly constant level in order to avoid dilution of earnings per
share and to comply with regulatory capital requirements of the
Superintendent of Financial Institutions Canada.

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(e) The Bank of Montreal Class B preferred shares have the unique feature of
being able to be issued in a foreign currency. The company may have created
a class of shares with this type of feature to make the shares more
attractive
to
foreign investors.
(f) The amount of cash dividends declared per share and the total amount by
which dividends affected shareholders equity are presented below for each
company.
Cash dividends declared in 2003

Bank of Montreal

Preferred cash dividend per share - class B series 3


Preferred cash dividend per share - class B series 4
Preferred cash dividend per share - class B series 5
Preferred cash dividend per share - class B series 6
Preferred cash dividend per share - class B series 10
Preferred cash dividend per share - series J
Preferred cash dividend per share - series K
Preferred cash dividend per share - series N
Preferred cash dividend per share - series O
Preferred cash dividend per share - series P
Preferred cash dividend per share - series S

1.39
1.2
1.33
1.19
US1.49
0.90
US.80
1.18
1.38
US1.44
1.53

Common cash dividend per share


Total impact on shareholder's equity
(in millions of dollars)

Royal Bank

$1.34
$

(748)

$1.72
$

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(1,205)

(g) The rate of return on common shareholders equity for each company is
presented below. Royal Banks return on common shareholders equity is slightly
higher than that of Bank of Montreal.
Bank of
Montreal
Net income (1)
Less: Preferred dividends (2)
Net income available to common shareholders (3) = (1) - (2)
Total shareholders' equity, beginning (4)
Less: Preferred shares (5)
Common shareholders' equity, beginning (6) = (4) - (5)
Total shareholders' equity, ending (7)
Less: Preferred shares (8)
Common Shareholders' equity, ending (9) = (7) - (8)
Average Common shareholders' equity (10) = [(6) + (9)] /(2)
Return on common shareholders' equity (11) = (3) / (10)

$
1,825
(
82)
1,7
43
11,8
94
(1,5
17)
10,3
77
12,4
82
(1,4
46)
11,0
36
10,7
07
16.28%

Royal Bank
$

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3,005
(68
)
2,937
18,783
(1,545
)
17,238
18,375
(832
)
17,543
17,391
16.89%

RA16-4

CANADIAN TIRE CORPORATION LIMITED

(a) As of December 28, 2002, Canadian Tire had the following: Common Shares:
authorized, 3,423,366 shares; issued, 3,423,366. All of the authorized
common shares are issued.
Class A Non-Voting Shares: authorized,
100,000,000 shares; issued, 76,430,998. The number of shares issued
represents 76% of the authorized Class A shares.
(b) The Class A Non-voting shares have a stated dividend of $.01 per share per
annum which is cumulative and also participate fully in dividends with
common shares over and above this stated cumulative dividend. Although
they do not vote, the shareholders may attend most meetings and vote
separately as a class to elect a specified number of directors. These features
which allow some voting privileges and the opportunity to share in earnings
above a stated amount make these preferred shares more similar to common
shares than to traditional preferred shares. The common shares can be
converted at any time into Class A Non-voting shares on a share per share
basis.
(c) Canadian Tire repurchases shares every year because it has a policy of
repurchasing, over the long term, approximately the same number of Class A
non-voting shares as are issued under various stock compensation and
dividend reinvestment programs. The purpose of these repurchases is to
offset the expected dilutive effect on earnings per share of the various stock
programs. The company was less successful in repurchasing as many as
were issued in 2002 than in 2001. In 2001, the net increase in number of
shares was only 26,146 while in 2002 the net increase was 1,275,519.
(d) The excess of the amount paid on re-acquisition, over the average carrying
value of the shares re-acquired, was charged to retained earnings. The
journal entry would have been (in millions of dollars):
DR Retained Earnings

$5.9

DR Class A shares

$2.5

CR

Cash

$8.4

(e) The average price of the shares at the beginning of the year was $8.27
($621.9 million / 75,155,479 shares). The shares were repurchased at $27.05.
The market price of the shares as of March 16, 2004 is $53.50, which is much
higher than the average price at the beginning of the year.
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RA16-5

MDS INC.

The financial reporting issues surrounding the stock dividend include whether the stock
dividend should result in any capitalization of retained earnings and, if so, at what
amount the capitalization should occur.
When a stock split occurs, there is no change in total shareholders equity or in the dollar
amount of retained earnings or share capital. That is, no entry is made to capitalize
retained earnings; the only changes are in the number of shares outstanding and the
book value per share.
Some argue that a stock dividend is essentially the same in substance as a stock split
and should be treated the same way as a stock split, with no entry being made to
capitalize any amount of retained earnings as share capital. US GAAP requires this
approach for large stock dividends where the number of shares issued is more than 20
to 25 % of the number previously outstanding. The argument to support this treatment
is that large stock dividends impact the market much the same way as a stock split.
Since the MDS stock dividend was one for one, it would be considered a large dividend.
Canadian GAAP is silent on this issue but companies incorporated under the Canada
Business Corporations Act are required by this legislation to capitalize the stock dividend
at the market value amount, regardless of the size of the stock dividend. Others argue
that an entry should be made but that the amount capitalized should be the carrying
value per share amount rather than the market value per share amount.
Regardless of which method is chosen, the total amount of shareholders equity is
unchanged. The issue is one of allocation of amounts within shareholders equity.

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RA16-6 NORTEL NETWORKS


(a) Nortel might have declared a stock split to reduce its price per share. Given the
extreme increase in the market value of the shares in 1999, reducing the price by
half might be seen to make it more attractive to potential investors.
(b) The stock split would have zero dollar impact on total shareholders equity and on
total book value. The number of outstanding shares would double since each
outstanding share was split into two shares. Since total book value was unaffected
and the number of shares outstanding doubled, the book value per share would
decrease by fifty percent.
(c) The shares market value would also decrease by fifty percent as a result of the
stock split since each share would now represent one-half of the value of one share
before the split. The market price increased until 2000 when it peaked at over $120,
then dropped drastically and has remained low since then. As of February 20, 2004,
the price was $10.24 per share.

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