Chapter 11

CHAPTER 11
SHAREHOLDERS' EQUITY:
CAPITAL
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Brief Learning
Exercises Topic Objectives Skills
B. Ex. 11.1 Shareholders' equity 4 Analysis

B. Ex. 11.2 Shareholders' equity 4 Analysis
B. Ex. 11.3 Dividends on preference shares 5 Analysis, communication
B. Ex. 11.4 Dividends on ordinary and 5 Analysis
preference shares
B. Ex. 11.5 Dividends on ordinary and preference 5 Analysis, communication
shares
B. Ex. 11.6 Book value 7 Analysis, communication
B. Ex. 11.7 Book value 7 Analysis
B. Ex. 11.8 Share split 8 Analysis, communication
B. Ex. 11.9 Treasury shares 4, 9 Analysis
B. Ex. 11.10 Treasury shares 4, 9 Analysis
Learning
Exercises Topic Objectives Skills
11.1 Form of organization 1–3 Analysis, communication
11.2 Accounting terminology 1–9 Analysis
11.3 Prepare equity section 4, 5 Analysis, communication
11.4 Dividends on preference & ordinary 4, 5 Analysis, communication
shares
11.5 Analyzing equity 4–7 Analysis
11.6 Preference shares alternatives 5, 6 Analysis
11.7 Reporting effects of transactions 4, 7 Analysis
11.8 Computing book value 4–7 Analysis, communication
11.9 Treasury shares transactions 9 Analysis, communication
11.10 Effects of share splits 8 Communication, judgment
11.11 Treasury shares presentation 9 Communication, judgment
11.12 Real World: Star Cruises Limited 4 Analysis, communication
Authorized share capital

11.13 Ordinary shares and treasury shares 4, 9 Analysis, communication
11.14 Treasury shares and share split 8, 9 Analysis
11.15 Real World: adidas AG 4, 7 Analysis, communication,
research
Reading an annual report
© The McGraw-Hill Companies, Inc., 2010

Overview
Reading an annual report

Overview
Problems Learning
Sets A, B Topic Objectives Skills
11.1 A,B Reporting shareholders’ equity 4, 5, 6 Analysis, communication
11.4 A,B Comprehensive equity problem 4, 5 Analysis
11.5 A,B Analysis of equity 4, 5 Analysis
11.6 A,B Comprehensive equity analysis 1–7 Analytical, communication,
group
11.7 A,B Par, book, and market values 4, 7 Communication, judgment
11.8 A,B Comprehensive equity with 4, 5, 7, 9 Analysis, communication
treasury shares transactions
11.9 A,B Comprehensive equity with 4, 5, 7, 8, 9 Analytical, communication,
treasury shares transactions and judgment
share splits
Critical Thinking Cases

11.1 Factors affecting market prices 5, 7 Communication, judgment
of preference and ordinary shares
11.2 Real World: Japan Airlines 7 Communication

Corporation, HSBC,
GlaxoSmithKline
Factors affecting market prices of
ordinary shares
11.3 Selecting a form of business 1, 2, 3 Communication, judgment
organization
11.4 Securities & Futures Commission 1, 2, 3 Communication, judgment,
technology
(Ethics, fraud & corporate
governance)

Overview (p.2)
DESCRIPTIONS OF PROBLEMS AND
CRITICAL THINKING CASES
Below are brief descriptions of each problem and case. These descriptions are accompanied by the
estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume
use of the partially filled-in working papers.
Problems (Sets A and B)
11.1 A,B Robbinsville Press/Septa Limited 20 Easy
A short problem requiring the completion of the shareholders’
equity section of a corporate balance sheet. Includes preference
share dividends and conceptual issues pertaining to the market
price of preference shares.
11.2 A,B Waller Publications/Banner Publications 20 Easy

A second short problem requiring the completion of the
shareholders’ equity section of a corporate balance sheet. Includes
preference share dividends and conceptual issues pertaining to
dividends in arrears.
11.3 A,B Manhattan Transport Company/Ray Beam Limited 25 Medium

A more difficult problem requiring the completion of the
shareholders’ equity section of a corporate balance sheet. Includes
preference share dividends and conceptual issues pertaining to
equity versus debt financing.
11.4 A,B Barnes Communications Limited/Markup Limited 35 Medium

A short but comprehensive problem on corporations. Includes
journal entries for issuance of ordinary shares and preference
shares. Also includes dividends on preference shares, closing
entries, and the preparation of the shareholders’ equity section of
a corporate balance sheet.
11.5 A,B Smithfield Products/Manor Limited 35 Strong

A more difficult problem involving distinction among par values,
book values, and market values.
11.6 A,B Parsons Limited/Toasty Corporation 35 Medium

Analysis of the shareholders’ equity of a publicly owned
corporation. Includes a discussion of why a business may opt to
become publicly owned and the reasons why the dividend yields
on preference shares vary.
11.7 A,B Techno Corporation/Brain Corporation 15 Easy

A straightforward discussion of the relationships (if any) among
par value, book value, and market value per share. A company has
a book value 6,500 times greater than its par value, and a market
value 65,000 times as high. Fun problem that makes a point.

Description Problems
Problems (continued)
11.8 A,B Feller Corporation/Tin Corporation
A shareholders’ equity problem involving share capital from treasury 15 Medium
share transactions. Requires the computation of book value per share
and reporting for the statement of cash flows.
11.9 A,B Herndon
A Industries/Parker
comprehensive Industries
equity problem involving treasury shares
transactions in two different years, preference and ordinary share 30 Strong
transactions, book value calculations, and an understanding of share
splits.
Critical Thinking Cases
11.1 Factors Affecting the Market Prices of Preference and Ordinary 15 Medium
Shares
Students are asked to explain whether the prices of preference shares,
ordinary shares, and convertible preference shares are likely to rise or
fall if profitability increases dramatically and interest rates rise
slightly. A problem that stimulates lively classroom discussion.
11.2 Factors Affecting the Market Prices of Ordinary Shares 25 Strong
Students are to explain the reason for changes in the market prices of
shares of various real companies. A difficult problem that is very
thought-provoking.
11.3 Selecting a Form of Organization Interview; No
Students are to interview the owners of two small businesses with time estimate
different forms of organization and find out why the particular form
was selected—and if they have any misgivings.
11.4 S.F.C. Enforcement Division 20 Easy
Ethics, Fraud & Corporate Governance
Students do an internet search to locate the website of the Securities &
Futures Commission and respond to questions about the S.F.C.
*Supplemental Topic, “Special Types of Liabilities.”

Desc. of Cases
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1. Large corporations are often said to be publicly owned because they are literally owned by the
general public. The shares of many large corporations is actively traded on organized stock
exchanges, such as the Singapore Exchange. Anyone may purchase an ownership interest in such
corporations, even if that interest is but a single share. Many large corporations have hundreds of
thousands, even millions, of individual shareholders.
2. a. Owners’ liability for debts of the business. Sole proprietors are personally liable for the debts
of the business. A corporation, however, is responsible for its own debts; the shareholders of
a corporation are not personally liable for the debts of the business entity. Thus, the amount
of money that a shareholder might lose by investing in a corporation is limited to the amount
of his or her investment.
b. Transferability of ownership interest. A sole proprietor generally must sell his or her entire
interest in the business. This creates a new business owned by a new sole proprietor. Shares in
a corporation are freely transferable.
c. Continuity of existence. A sole proprietorship is terminated upon sale or abandonment by the
owner and upon that person’s death or incapacitation. Corporations continue in existence
regardless of changes in ownership.
d. Federal taxation on income. A corporation is subject to federal income tax on its income, and
shareholders are also subject to a personal income tax on any amounts they receive as
dividends. A sole proprietorship is not a taxable entity, but the owner must pay personal taxes
on the income earned by the business, whether or not it is actually withdrawn by the owner.
3. There are three basic rights: (1) the right to vote, (2) the right to share in dividends when declared,
and (3) the right to share in assets upon liquidation.
A preference share is typically entitled to cumulative preference to a limited amount of dividends
and to a prior claim against assets in case of liquidation; in return, it usually has no voting power.
4. The term double taxation refers to the fact that the profit of a corporation may be taxed on two
separate occasions. First, the profit of a corporation is subject to corporate income taxes, which
must be paid by the corporation. Second, if the corporation distributes its earnings as dividends to
shareholders, the shareholders must pay personal income taxes on the amounts they receive. This
double taxation of profit is one of the principal disadvantages of the corporate form of business
organization.
5. Capital of a corporation represents the amount invested by shareholders and is generally not
available for dividends. Retained earnings represents the cumulative amount of profit not
distributed to shareholders as dividends. The distinction between share capital and retained
earnings is useful because it shows how much of the total shareholders’ equity represents
investments by the owners and how much has been accumulated through profitable operations
since the company started in business.

Q1-5
6. Par value represents the legal capital per share, that is, the amount below which shareholders’
equity cannot be reduced except by losses. The primary significance of par value is that a
corporation cannot declare a dividend if this action would reduce total shareholders’ equity
below the par value of the outstanding shares.
Par value is not an indication of a fair market price for an ordinary share. The market price of
the share is determined by such factors as the profitability and solvency of the issuing company,
interest rates, the amount of dividends paid by the share, and general market conditions. The
market price of a share may be above or below its par value.
7. a. Cumulative means that unpaid dividends on preference shares are carried forward and
must be fully paid before any dividends can be paid on ordinary shares.
b. Convertible means that each preference share may be returned to the corporation in
exchange for a given number of ordinary share under specified conditions.
8. Noncumulative preference share is entitled to dividends only if and when they are declared. If
noncumulative preference dividends had not been declared for several years, it would be
possible to declare only the current year’s dividends on preference share and then declare a
dividend on ordinary shares. Noncumulative preference shares does not have the protection
afforded by the cumulative requirements that any dividends in arrears must be paid before
dividends can be paid on ordinary shares. This means a weak form of dividend preference, and
as a result the noncumulative feature is not attractive to most investors.
9. (a) Cash is classified as an asset; (b) Organization Costs typically are classified as an expense;
(c) Preference Shares, (d) Retained Earnings, and (e) Share premium are all classified as
shareholders’ equity accounts; (f) Income Taxes Payable is classified as a liability.
10. a. Share transfer agent. A bank or trust company retained by a corporation to maintain
records of share ownership and transfers.
b. Shareholders subsidiary ledger. A record kept by a corporation showing the number of
shares owned by each shareholder.
c. Underwriter. An investment banking company that undertakes to sell new corporate
shares to investors. The underwriter usually guarantees the corporation a specified price,
and plans to make a profit by selling to individual investors at a slightly higher price.
d. Share registrar. An independent fiscal agent, usually a large bank, retained by a

corporation to control the issuance of share certificates and provide assurance against
overissuance.
11. Book value per share represents the amount of net assets (or shareholders’ equity) associated
with each ordinary share. It is determined by dividing the total shareholders’ equity in the
corporation, less the amount assigned to preference shares (par value, or liquidation value if
given, plus dividends in arrears) by the number of ordinary shares outstanding. Book value
does not represent the amount ordinary shareholders would receive in the event of liquidation.
If a corporation were liquidated, many assets would be sold at prices different from their
carrying values in the accounting records. The resulting gains or losses would cause
shareholders’ equity to change accordingly.

Q6-11
12. To compute book value per ordinary share for a company with both preference shares and ordinary
shares outstanding, the starting point is total shareholders’ equity, including both preference and
ordinary shares and all other elements of share capital. Deduct from this total the preference shares at
its assigned amount (par value or liquidation value, if given) and any dividends in arrears. The
remainder is the equity of the ordinary shareholders. Divide this amount by the number of ordinary
shares outstanding to arrive at book value (or net assets) per ordinary share.
13. a. When a corporation obtains a bank loan there is no effect upon book value per ordinary share.
Assets and liabilities both increase by the amount of the loan. Net assets, therefore, are unchanged.
b. Declaration of a dividend reduces book value per share. Total assets are not affected by the
declaration of a dividend, but liabilities are increased. Net assets (shareholders’ equity), therefore,
are decreased.
14. A change in the market price of IBM’s outstanding shares has no effect upon IBM’s balance sheet.
These shares belong to IBM’s shareholders, not to IBM. Therefore, a change in the market value of
these shares has no effect upon the recorded amounts of IBM’s assets, liabilities, or shareholders’
equity. IBM’s share capital accounts will continue to show the amount received by IBM at the time
the ordinary share was issued. This historical amount is not affected by subsequent changes in market
price.
15. When you ask a sharebroker to purchase shares for you, the shares is purchased on a secondary
market—in this case the Singapore Exchange, because that is where Singapore Airlines shares are
traded. On a secondary market, you are purchasing the shares from another investor. The transaction
will have no effect on the financial statements of Singapore Airlines.
16. The purpose of a share split is to reduce the per-share market price of the company’s shares down to a
more appropriate “trading range”—that is, a price that is appealing to a greater number of potential
investors.
17. Treasury shares are corporate shares that has been issued and then reacquired by the issuing
company.
One reason for acquiring treasury shares is to have shares available to issue to officers and employees
under profit-sharing agreements, shares options, or bonus plans. Purchases of treasury shares may
also be intended to support the market price of the shares or to increase earnings per share.
Treasury shares are not asset; it represents a reduction in the amount of shareholders’ investment in
the corporation. For this reason the cost of the treasury shares are reported in the balance sheet as a
reduction of the shareholders’ equity.

Q12-17
18. The purpose of this rule is to protect corporate creditors, for whom shareholders’ equity represents the
margin of safety against loss from a shrinkage of asset values. The restriction of retained earnings for
dividend purposes to the extent of the cost of treasury shares assures creditors that the shareholders’
equity of a corporation will not, as a result of the purchase of treasury shares, be reduced below the
amount of share capital. If this restriction were not imposed, a corporation might distribute assets equal to
the entire amount of its retained earnings as dividends, and then distribute additional assets in payment for
its own shares, thereby reducing the net assets of the corporation below the amount of the share capital or
even below the amount of stated (legal) capital.
19. The major types of transactions and activities that change the amount of issued and fully paid capital and
the direction of that change are as follows:
Transaction/activity Direction of change
Sale of share capital Increase
Purchase of treasury shares Decrease
Sale of treasury shares Increase
Share split None*
*A share split increases the number of shares and lowers the market price of that share, but does not
affect the total amount of share capital.
20. No definitive answer can be given to this question because a case can be made for having preference
shares and for not having preference shares. Similarly, if preference shares are included in the capital
structure, a case can be made for different features, primarily whether the dividend is cumulative or not.
Following are comments under different assumptions about the desirability of preference shares.
Include preference shares—Preference shares offer investors an opportunity to invest on what may be a
more predictable and secure basis than ordinary share. While dividends are not guaranteed, they are more
predictable than on ordinary share, particularly for a new company. Some investors may be willing to
invest in preference shares while they would not be willing to accept the greater uncertainty and risk of
ordinary share. This may be a factor in designing the company’s capital structure in light of the capital
requirements of the new company.
Do not include preference shares—The presence of preference shares may make ordinary shares less
attractive in light of the dividend preference of preference shares. Once the company is up and running,
preference shares may be undesirable in terms of the long-term capital structure of the company.
Features of preference shares—Assuming preference shares are included in the capital structure, the most
important decision is whether the dividend is cumulative. If the dividend is cumulative, the preference
shares are more attractive to investors, but it detracts from the attractiveness of the ordinary shares. The
lack of the cumulative feature may make preference shares a relatively weak investment alternative and
effectively defeat the purpose of including preference shares in the capital structure.

Q18-20
B.Ex. 11.1 Ordinary shares (10,000 shares @ $10) $100,000
Share premium (10,000 shares @ $3) 30,000
Retained earnings 75,000
Total shareholders' equity $205,000
B.Ex. 11.2 Preference shares (1,000 shares @ $100) $100,000

Ordinary shares (10,000 shares @ $25) 250,000
Share premium:
Preference shares (1,000 shares @ $10) 10,000
Ordinary shares (10,000 shares @ $2) 20,000
Total shareholders' equity $480,000
B.Ex. 11.3 Dividends on arrears on preference shares for three years are calculated as
follows:
100,000 shares x $100 par value x 6% dividend rate x 3 years =
$1,800,000
The amount of dividends in arrears must be disclosed in the financial statements,

but they are not formally included as a liability in the balance sheet until declared
by the Board of Directors of the company.
B.Ex. 11.4 Total dividend declared $200,000

Dividend requirements for preference shares:
10,000 shares x $100 par x 6% x 2 years 120,000
Dividends available for ordinary shares $80,000
B.Ex. 11.5 Total dividend declared $120,000

Dividend requirements for noncumulative preference shares:
10,000 x $100 par x 8% x 1 year 80,000
Dividends available for ordinary shares $40,000
Dividends per share on ordinary shares:
$40,000/100,000 shares $0.40
If the preference shares is cumulative, the entire dividend goes to preference

shares and the ordinary shareholders will receive none of the $120,000 dividends
declared. In fact, satisfaction of the full claim of the preference sharesholders in
this case will require $320,000, determined as follows:
10,000 x $100 par x 8% x 4 years = $320,000

BE11.1,2,3,4
B.Ex. 11.6 The book value on ordinary shares are calculated by adding all shareholders'
equity accounts together and dividing by the number of ordinary shares
outstanding:
($1,000,000 + $750,000 + $600,000)/100,000 shares =
$23.50
This amount does not reflect the current market value of the shares. Instead, it
reflects a per-share amount of the assets, less liabilities, included in the company's
balance sheet.
B.Ex. 11.7 Total shareholders' equity ($4,000,000 + $5,000,000 + $800,000 +

$1,750,000) $11,550,000
Less: Preference shares at par value $4,000,000
Dividends in arrears (40,000 shares x $5) 200,000 4,200,000
Amount attributable to ordinary shares $7,350,000
Book value per ordinary share:
$7,350,000/500,000 shares $14.70
B.Ex. 11.8 The share split will double the number of shares outstanding from 100,000 to
200,000. It will reduce the market price of the shares to approximately half of its
current price: $50 x 1/2 = $25. The split will have no impact on the total
shareholders' equity attributable to ordinary shares. While the number of shares
will double, the par value will be reduced to half, or $5 per share, leaving the total
shareholders' equity attributable to ordinary shares unchanged.
B.Ex. 11.9 Ordinary shares (100,000 shares @ $10) $1,000,000

Share premium
(100,000 shares @ $15) 1,500,000
$2,500,000
Less: Treasury shares (10,000 shares x $55) (550,000)
Total shareholders' equity $1,950,000
B.Ex. 11.10 Ordinary shares (1,000,000 shares @ $25) $25,000,000

Share premium on ordinary shares
(1,000,000 shares @ $5) 5,000,000
Share premium on treasury shares
[70,000 shares x ($55 - $50)] 350,000
$30,350,000
Less: Treasury shares (30,000 shares x $50) 1,500,000

BE11.6,7,8,9,10
SOLUTIONS TO EXERCISES
Ex. 11.1 a. (1) Organizing the scuba diving school as a sole proprietorship.
Advantages:
(a) Easy to form
(b) No double taxation on distributed earnings
Disadvantages:
(a) Personal liability of owner for debts of the business
(b) Business ceases with death of owner
(2) Organizing the scuba diving school as a corporation.

Advantages:
(a) No personal liability of owners for debts of the business
(b) Readily transferable ownership shares
(c) Continuous existence
Disadvantages:
(a) Double taxation on distributed earnings
(b) Greater regulation
b. A corporation would probably be the better form of organization because of the

characteristic of limited liability of the owners. Potentially, a scuba diving student
could be seriously injured in the class. With the sole proprietorship form of
organization, your personal assets would be at risk to pay for the person’s
injuries, after you exhausted any insurance coverage and assets that the business
might have.
Ex. 11.2 a. Double taxation

b. Market value
c. None (Retained earnings is not an amount of cash; it is an element of owners’
equity.)
d. Ordinary shares
e. None (Dividends in arrears are prior years’ dividends owed to holders of
cumulative preference shares.)
f. Publicly owned corporation
g. Issued and fully paid capital
h. Retained earnings
i. None (Book value is ordinary shareholders’ equity divided by the number of
ordinary shares outstanding.)
j. None (The price of preference shares varies inversely with interest rates.)

E11.1,2
Ex. 11.3 a. Shareholders’ equity:
Preference shares, $100 par value,
5,000 shares authorized, 2,500 shares issued and outstanding ……………………………………
$ 250,000
Ordinary shares, $2 stated value, 100,000 shares authorized,
70,000 shares issued and outstanding……………………………………………………………………… 140,000
Share premium:
Preference shares …………………………………………………………………… 7,500
Ordinary shares ……………………………………………………………… 770,000
Total issued and fully paid capital …………………………………………………………………… $ 1,167,500
Retained earnings ………………………………………………………………. 382,000
Total shareholders’ equity ……………………………………………………. $ 1,549,500
b. No. The market value of a corporation’s shares have no effect on the amount in
the financial statements. Share capital is recorded at the amount for which it was
originally issued.
Ex. 11.4 a. Total dividends paid in third year ……………………………………………………..

$376,000
Dividends on 9% noncumulative preference shares:
Current year’s dividend ($50 x .09 x 40,000) ………………. 180,000

Total paid on 9% noncumulative preference shares ……………………
$180,000
Dividends on 12% noncumulative preference shares:
Current year’s dividend ($100 x .12 x 8,000) …………………………….96,000 276,000
Dividends on ordinary shares in third year ……………………………………….$100,000
b. Dividends per share:

Preference shares, 9% noncum. ($180,000 ¸ 40,000 shares) ……………..
$ 4.50 per share
Preference shares, 12% noncum. ($96,000 ¸ 8,000 shares) …….. $ 12.00 per share
Ordinary shares ($100,000 ¸ 400,000 shares) …… $ 0.25 per share
c. The shareholders’ equity section of the balance sheet reports no share premium.
Thus, the preference shares must have been issued at their respective par values
($50 per share for the 9% noncumulative preference shares, and $100 per share
for the noncumulative preference shares).
Ex. 11.5 a. 150,000 shares ($15,000,000 total par value, divided by $100 par value per share)
b. $1,050,000 ($15,000,000 total par value x 7% or 150,000 x $100 x 7%)

c. $16 [($20 million par value + $44 million share premium) ¸ 4,000,000 shares issued]
d. $35,000,000 legal capital ($15,000,000 preference, plus $20,000,000 ordinary)

$79,000,000 total issued and fully paid capital ($35,000,000 legal capital, plus
$44,000,000 share premium)

E11.3,4,5
e. Total shareholders’ equity …………………………………………………………………… $ 143,450,000
Less: Par value of preference shares (150,000 shares x $100) ………………………………
15,000,000
Equity of ordinary shareholders ………………………………………………….. $ 128,450,000
Ordinary shares outstanding ………………………………………………………….. 4,000,000
Book value per share ($128.45 million  4 million shares) ………………………….. $32.11
f. No. Changes in the market value of shares do not directly affect a corporation’s
financial position and are not reflected in the equity section of the balance sheet.
Ex. 11.6 Annual dividends on the preference shares are $14,000 (7,000 × $25 × 8%)
Total dividend ……………………………………………………………………………. $50,000

Amount to preference shares ……………………………………………………………
(14,000)
Amount to ordinary shares ……………………………………………………………..
$36,000
Ex. 11.7 Net Cash Flow

Current Shareholders’ (from Any
Event Assets Equity Profit Source)
a. I I NE I
b. NE NE NE NE
c. D D NE D

E11.6,7
Ex. 11.8 a. Net assets (shareholders’ equity):
Preference shares ……………………………………………………….. $ 200,000
Ordinary shares, $5 par, 60,000 shares issued ……………………………………..
300,000
Share premium ………………………………………………………………… 452,800
Total issued and fully paid capital ……………………………………………………………..
$ 952,800
Less: Deficit ……………………………………………………………………………… 146,800
Total net assets (shareholders’ equity) …………………………………………..
$ 806,000
b. Book value per ordinary share:

Total shareholders’ equity (from part a) …………………………………………………..
$ 806,000
Less: Claims of preference sharesholders ($200,000 plus
dividends in arrears, $16,000) ………………………………………………… 216,000
Equity of ordinary shareholders ……………………………………………………………… $ 590,000
Number of ordinary shares outstanding ………………………………………….. 60,000
Book value per share ($590,000  60,000 shares) $ 9.83
c. No. The book value per share represents the shareholders’ share of the net book
value of the corporation’s assets, not the assets’ liquidation values. The
shareholders may receive more or less than the book value per share if the
corporation is liquidated, depending primarily on the amounts at which the
corporation’s assets are sold.
Ex. 11.9 a. Feb. 10 Treasury Shares ………………………………………………. 425,000

Cash ………………………………………………… 425,000
Purchased 17,000 shares of treasury
shares at $25 per share.
June 4 Cash ……………………………………… 198,000
Treasury Shares ………………………………… 150,000
Share premium: ……………………….
Treasury Shares…………………….. 48,000
Sold 6,000 shares of treasury shares,
cost $150,000, for $33 per share.
Dec. 22 Cash ……………………………………………………………. 88,000
Share premium: Treasury
Shares …………………………………………… 12,000
Treasury Shares ………………………………………. 100,000
Sold 4,000 shares of treasury shares,
cost $100,000, for $22 per share.
b. Restriction of retained earnings for treasury shares owned at year-end:
$175,000 (7,000 shares still owned x $25 per share cost)
c. No, a restriction on retained earnings does not affect the total amount of retained
earnings reported in the balance sheet. A restriction of retained earnings is
disclosed, but does not reduce the total amount of retained earnings of a company.
The restriction on retained earnings simply limits the amount of dividends the
corporation can pay as long as it holds treasury shares.

E11.8,9
Ex. 11.10 a. Had the shares been split 2-for-1, it would begin trading at approximately $40
per share immediately after the split ($80 ¸ 2 = $40).
b. Had the shares been split 4-for-1, it would begin trading at approximately $20
per share immediately after the split ($80 ¸ 4 = $20).
c. When the market price of a corporation’s ordinary shares appreciate in value
significantly, as it had in the case of Fido Corporation, it may become too
expensive for many investors. Thus, the decision to split the company’s shares
were probably made with the intent of making it more affordable to investors.
Ex. 11.11 a. Companies sometimes purchase their own ordinary shares to help boost the
market price per share. This practice is not generally considered unethical,
given that information pertaining to the purchase is fully disclosed in the
company’s financial statements. Furthermore, if the company acquires a
significantly large amount of its outstanding shares, the event would be reported
in the financial press.
b. For a company to classify its treasury shares as a short-term investment is not

appropriate. When treasury shares is purchased, the corporation is actually
reducing its assets (cash), and eliminating part of its shareholders’ equity. For
this reason, treasury shares should not appear in the balance sheet as a current
asset.
Ex. 11.12 a. Carnival Corporation could sell approximately 1,336 million additional
shares. This figure is determined by subtracting the number of issued shares
from the number of authorized shares 1,960 million – 624 million = 1,336
million.
b. Authorized, but unissued, shares do not represent an asset of the company. At

some time in the future they may result in an increase in assets if they are issued
for cash or other assets, but until that time they simply represent the potential
for future increases in assets. They are not included in the company’s balance
sheet, other than through disclosure of the numbers of authorized and issued
shares. This permits the reader of the financial statements to calculate the
number of authorized, but unissued shares, as was done above.

E11.10-12
Ex. 11.13 a. Cash (550,000 x $12)……………………………… 6,600,000
Ordinary shares (550,000 x $10)…………… 5,500,000
Share Premium on ordinary
shares…………………………………………. 1,100,000
Cash (40,000 x $110)……………………………… 4,400,000

Preference Shares (40,000 x $100)…………… 4,000,000
Share Premium on Preference
Shares………………………………………….. 400,000
Treasury Stock/Ordinary (40,000 x $60)…………. 2,400,000

Cash…………………………………………… 2,400,000
Note: No entry is required to record the

authorization to issue preference and ordinary
shares.
b. Shareholders' Equity:
Preference shares, 6%, $100 par value, 50,000 shares authorized,
40,000 shares issued and outstanding $4,000,000
Ordinary shares, $10 par value, 1,000,000 shares authorized,

550,000 shares issued $ 5,500,000
Share premium:
Preference shares 400,000
Ordinary shares 1,100,000
Total issued and fully paid capital $11,000,000
Less: Treasury (ordinary) shares at cost, 40,000 shares (2,400,000)

E11.13
Ex. 11.14 a. Ordinary Shares, $10 par value, 200,000 shares authorized, $1,000,000
100,000 shares issued
Share premium on ordinary shares 800,000
Share premium on treasury shares

Transactions 30,000
Total Issued and fully paid capital $1,830,000
Total issued and fully paid capital and retained earnings $1,950,000
Less: Treasury shares (300,000)
Calculations:
Share premium on ordinary shares:
100,000 shares x ($18 - $10) = $800,000
Share premium on treasury shares:
10,000 shares x ($23 - $20) = $30,000
Treasury shares:
15,000 shares x $20 = $300,000
b. After a 2:1 share split is distributed, the par value of the ordinary shares will be
reduced to half ($10 x 1/2 = $5) and all of the share numbers will double. The 2:1
split has no effect on the total figures for ordinary shares, share premium,
retained earnings, treasury shares, or total shareholders' equity.

E11.14
Ex. 11.15
a. The number of issued and fully paid up ordinary shares can be read in the note
26 to adidas' financial statements but it is not enclosed. The share capital in the
balance sheet cannot indicate the par value of the share capital. adidas in fact
issued about 209 million no-par-value bearer shares. Issued and fully paid up
shares represents the number of shares that the company has issued and bought
by its shareholders.
b. The amount of authorized share capital can be be read in the note 26 to adidas'
financial statement but it is not enclosed. adidas' authorized share capital is
about €304 million. Authorized shares or authroized share capital are the
number of shares or the amount of share capital specified in the company’s
articles of incorporation. It represents the maximum number of shares that the
company is authorized to issue by its state of incorporation.
c. €3,771 million. This amount is not how much the outstanding shares is actually
worth. The total shareholders’ equity figure represents the amount invested in
the company by owners over time, plus the amount of earnings retained in the
company. The amount reported is an historical concept that may or may not
bear a close relationship to the shares's current market value.

E11.15
SOLUTIONS TO PROBLEMS SET A
20 Minutes, Easy PROBLEM 11.1A
ROBBINSVILLE PRESS
a.
ROBBINSVILLE PRESS
Partial Balance Sheet
December 31, 2009
Shareholders' equity
Preference shares, $100 par value,
authorized 100,000 shares, issued and outstanding $ 1,000,000
10,000 shares
Ordinary shares, $1 par value, authorized 500,000 shares
issued and outstanding 170,000 shares 170,000
Share premium: Ordinary shares 2,380,000
Total issued and fully paid capital $ 3,550,000
Retained earnings* 255,000
Total shareholders' equity $ 3,805,000
*Computation of retained earnings at December 31, 2009:

Profit for the four-year period 2006-2009 $ 1,085,000
Less: Preference share dividends ($80,000 per year for four years)$ 320,000
Ordinary share dividends ($0.75 x 170,000 shares x 4 years) 510,000 830,000
Retained earnings, December 31, 2009 $ 255,000
b. There are no dividends in arrears at December 31, 2009. We know this because ordinary
dividends were paid in each of the four years that the company was in existence. Ordinary
shareholders could not have received dividends in each year of the company’s existence had
any dividends been in arrears on the preference shares.

P11.1A
WALLER PUBLICATIONS
a.
WALLER PUBLICATIONS
December 31, 2009
10% cumulative preference shares, $100 par value,
authorized, issued, and outstanding 20,000 shares $ 2,000,000
Ordinary shares, $1 par value, authorized 1 million shares,
Share premium: ordinary shares 5,700,000

Profit for the five-year period 2004-2008 $ 4,460,000
Less: Preference share dividends ($200,000 x 5 years) $ 1,000,000
Ordinary share dividends ($1 x 300,000 shares x 5 years) 1,500,000 2,500,000
Retained earnings, December 2008 $ 1,960,000
Less: Net loss of 2009 1,750,000
b. Note to financial statements:

Since the corporation sustained a loss of $1,750,000 the directors recommended that no
dividends shall be paid for the year 2009.

P11.2A
25 Minutes, Medium PROBLEM 11.3A
MANHATTAN TRANSPORT COMPANY
a.
MANHATTAN TRANSPORT COMPANY
December 31, 2009
8% noncumulative preference shares, $100 par, 5,000
shares authorized, issued, and outstanding $ 500,000
$9 noncumulative preference shares, no-par value, 10,000 shares
authorized, 5,000 shares issued and outstanding 512,000
Ordinary shares, $2 par, 200,000 shares authorized, 100,000
shares issued and outstanding 200,000
Share premium: Ordinary shares 600,000

Retained earnings at Dec. 31, 2007 $ 170,000
Add: Profit for 2008 and 2009 890,000
Profit for four-year period $ 1,060,000
Less: Dividends paid on 8% preference shares:
2008 (8% x $100 x 5,000 shares = $40,000) $ 40,000

2009 (8% x $100 x 5,000 shares = $40,000) 40,000 (80,000)
Dividends on $9 preference shares:
2008 ($9 x 5,000 shares) $ 45,000
2009 ($9 x 5,000 shares) 45,000 (90,000)
Dividends on ordinary shares:
2008 ($0.50 x 100,000 shares) $ 50,000
2009 ($1.60 x 100,000 shares) 160,000 (210,000)
b. A corporation might decide to use preference shares rather than debt to finance operations
for any of the following reasons (only 2 required):
1. Dividends do not have to be paid each year and do not become a legal obligation of the
corporation until they are declared. Interest on debt is a legal obligation of the
corporation and must be paid each year.
2. Debt must be repaid at some future date. To be a permanent source of capital, debt must
be periodically refinanced. Preference shares generally does not mature.
3. Increasing the amount of debt on a balance sheet can adversely affect financial ratios.

P11.3A
BARNES COMMUNICATIONS LIMITED
a.
General Journal
20__
Jan 6 Cash 280,000
Ordinary Shares 40,000
Share Premium: Ordinary Shares 240,000
Issued 20,000 shares of $2 par value ordinary
shares
at $14 per share.
7 Organization Costs Expense 7,000

Issued 500 shares of ordinary shares to Barnes in
exchange for services relating to formation of the
corporation. Implied issuance price ($7,000 ÷ 500
shares) = $14 per share.
## Cash 250,000
Preference Shares 250,000
Issued 2,500 shares of $100 par value, 10%,
preference shares at par value.
June 4 Land 225,000

Issued 15,000 shares of ordinary shares in
for land valued at $225,000 (15,000 shares x $15).
Nov ## Dividends (Preference Shares) 25,000

Dividends Payable 25,000
To record declaration of annual dividends of $10
per share on 2,500 preference shares outstanding.
Payable Dec. 20.
Dec ## Dividends Payable 25,000

Cash 25,000
To record payment of dividend declared Nov. 15.
## Income Summary
Retained Earnings 147,200
To close the Income Summary account for the 147,200
year.
## Retained Earnings 25,000

Dividends 25,000
To close the Dividends account.

P11.4A
P11.4A
PROBLEM 11.4A
BARNES COMMUNICATIONS LIMITED (concluded)
b.
BARNES COMMUNICATIONS LIMITED
December 31, 20___
Preference shares, $100 par, authorized
50,000 shares, issued and outstanding 2,500 shares $ 250,000
Ordinary shares, $2 par, authorized 400,000 shares,
Total issued and fully paid capital $ 762,000
Total shareholders' equity $ 884,200
*Computation of retained earnings at December 31, 20__:

Retained earnings at January 1, 20__ $ -
Add: Profit in 20__ 147,200
Less: Preference dividends in 20__ (25,000)
Retained earnings at December 31, 20__. $ 122,200

P11.4A (p.2)
35 Minutes, Strong PROBLEM 11.5A
SMITHFIELD PRODUCTS
a. Par value of all preference shares outstanding $ 2,400,000

Par value per share of preference shares $ 100
Number of preference shares outstanding ($2,400,000 ÷ $100) 24,000
b. Dividend requirement per preference share (7 1/2% x $100) $ 7.50

Number of preference shares outstanding (a) 24,000
Annual preference shares dividend requirement ($7.50 x 24,000 shares) $ 180,000
c. Par value of all ordinary shares outstanding $ 900,000

Par value per ordinary share $ 2
Number of ordinary shares outstanding ($900,000 ÷ $2 per share) 450,000
d. Par value of all ordinary shares issued $ 900,000

Share premium: Ordinary 8,325,000
Total issuance price of all ordinary shares $ 9,225,000
Number of ordinary shares issued (c) 450,000
Average issuance price per ordinary share ($9,225,000 ÷ 450,000 shares) $ 20.50
e. Par value of preference shares $ 2,400,000

Par value of ordinary shares 900,000
Total legal capital $ 3,300,000
f. Total legal capital (e) $ 3,300,000

Add: Share premium: Ordinary shares 8,325,000
g. Total shareholders’ equity $ 14,220,000

Less: Par value of preference shares [24,000 shares (a) x $100 per share] 2,400,000
Equity of ordinary shareholders $ 11,820,000
Number of ordinary shares outstanding (c) 450,000
Book value per share ($11,820,000  450,000 shares) $ 26.27
h. Retained earnings, beginning of the year $ 717,500

Add: Profit for the year 3,970,000
Subtotal $ 4,687,500
Less: Retained earnings, end of the year 2,595,000
Total dividends paid during the year $ 2,092,500
Less: Dividends on preference shares (part b) 180,000
Total dividends on ordinary shares $ 1,912,500
Number of ordinary shares outstanding 450,000
Dividends per ordinary share ($1,912,500 ¸ 450,000) $ 4.25

P11.5A
PARSONS LIMITED CORPORATION
In Thousands
(Except for Per
Share Amounts)
a. Par value of all ordinary shares outstanding $ 6,819
Par value per share 0.50
Number of shares outstanding ($6,819/$0.50) 13,638
b. Dividend requirement per preference share $ 17.20

Number of preference shares outstanding 345
Annual dividends paid to preference sharesholders ($17.20 x 345) $ 5,934
c. Par value of preference shares $ 86,250

Par value of ordinary shares 6,819
Share premium 87,260
d. Total shareholders’ equity $ 237,592

Less: Preference shares par value = ($250 x 345 shares) 86,250
Equity of ordinary shareholders $ 151,342
Book value per share ($151,342/13,638 shares) $ 11.10

P11.6A
PROBLEM 11.6A
PARSONS LIMITED (concluded)
e. The basic advantage of being publicly owned is that the corporation has the opportunity
to raise large amounts of equity from many investors. Some publicly owned corporations
have millions of shareholders, including pension funds, mutual funds, and other
corporations. Private corporations are usually unable to raise the large amounts of capital
available to publicly owned corporations.
A major advantage to the shareholders of a publicly owned corporation is that their

equity investments are highly liquid assets, immediately salable at quoted market
prices.
The primary disadvantages of being publicly owned are the increased governmental
regulations and financial reporting requirements.
f. The term convertible means that at the option of the preference shareholder, each
preference share can be converted into a specified number of ordinary shares. To evaluate
the value of this conversion feature, the shareholder must know into how many shares of
ordinary each preference share can be converted. This information is disclosed in the
notes accompanying the corporation’s financial statements.
g. At $248 per share, Parson's preference share has a dividend yield of 6.9% ($17.20 ¸ $248).
In comparison, an 8%, $50 par preference selling at $57 has a dividend yield of 7% [(8% x
$50 par) ¸ $57].
The dividend yield on preference shares indicates how much investors value certain
features of the shares. The lower the yield, the more investors favor the shares. A
higher yield means that investors demand a higher return to induce them to purchase
the shares.
The two principal factors that cause one preference share to yield less than another are:
(1) the appearance of greater ability to pay the preference dividends each year, and (2)
special features that appeal to investors, such as Parson’s conversion feature, cumulative
dividends, or a high call price.

P11.6A(p.2)
TECHNO CORPORATION
a. Par value is the legal capital per share—the amount by which shareholders’ equity cannot
be reduced except by losses. Thus, par value may be viewed as a minimum cushion of equity
capital existing for the protection of creditors.
Book value per share is equal to the net assets represented by each ordinary
share. Book value is a historical cost concept, representing the amounts invested by
the shareholders, plus the amounts earned and retained by the corporation. By
comparing book value with current market value, shareholders may gain insight into
whether management has increased or diminished the value of the resources
entrusted to their care.
The market value of a share is established in the marketplace. It represents the per-share
price at which willing sellers can and will sell shares to willing buyers. Market value is
related primarily to investors’ future expectations of the company’s performance, rather
than to historical amounts.
b. The company’s par value—one-tenth of a cent per share—is quite low. However, the
corporation can set par value at any level that it chooses; the amount of par value has
no direct effect upon either book value or market value. It does mean, however, that
the amount of the company’s legal capital—serving as a cushion for creditors—is quite
low. Another reason for the small par value is the possibility of share splits in the past.
The fact that book value per share ($6.50) is far above par value indicates either that (1)
the shares initially was issued at a price far above par value, or (2) that the company has
retained substantial amounts of earnings. Even if there had been share splits in prior
years, the total dollar amount of book value would not have been affected.
The market value of $65 is 10 times book value. This implies that investors believe that
management and product lines make the company worth far more than the amounts of
capital historically invested.
The very low par value offers little protection to the company’s creditors. On the other
hand, a market value of many times book value implies that little cushion is required for
creditors’ claims to be secure. If the company performs as its market price implies that it
will, its earnings and cash flows should make the creditors’ positions quite secure.
Earnings and cash flows are far more relevant to a company’s debt-paying ability than is
the cushion provided by par value.

P11.7A
FELLER CORPORATION
a.
Shareholders’ equity:
Ordinary shares, $1 par, 50,000 shares authorized, issued, and $ 50,000
outstanding
Share premium: Treasury shares 5,000
Total shareholders’ equity $ 590,000
*Computation of retained earnings at Dec. 31, 2009:

Profit in 2007 $ 82,000
Profit in 2008 25,000
Profit in 2009 78,000
Retained earnings, Dec. 31, 2009 $ 185,000
b. The company’s book value per share is $11.80 ($590,000 total shareholders’ equity ¸ 50,000
shares outstanding).
c. The treasury shares purchase of $35,000 in 2008 was reported as a financing cash outflow in
the statement of cash flows for that year. The reissue of the treasury shares for $40,000 in
the following year was reported as a financing cash inflow in the 2009 statement of cash
flows.

P11.8A
30 Minutes, Strong PROBLEM 11.9A
HERNDON INDUSTRIES
a.
10% preference shares, $100 par, cumulative, authorized,
issued, and outstanding 30,000 shares $ 3,000,000
Ordinary shares, $10 par, 200,000 shares authorized,
120,000 shares issued, of which 10,000 shares are held in
treasury 1,200,000
Share premium: Treasury shares* 50,000
Retained earnings** 1,925,000
Less: Treasury shares (10,000 shares x $20 cost per share) 200,000
Total shareholders’ equity at Dec. 31, 2009 $ 6,695,000
*Computation of share premium on treasury shares:

Purchase price per share: $400,000 ÷ 20,000 shares = $20
per share
Reissue price per share: $250,000 ÷ 10,000 shares = $25
per share
Premium per share reissued: $5 per share ($25 - $20)
Total issued and fully paid capital on treasury shares: $50,000
($5 per share x 10,000 shares reissued)
**Computation of retained earnings at Dec. 31, 2009:

Profit (for years 2005–2009) $ 3,700,000
Less: Preference dividend (for years 2005–2009)
$100 x 10% x 30,000 shares x 5 years $ 1,500,000
Less: Ordinary dividends
2005–2006: 120,000 shares outstanding x $0.50 x 2 yrs 120,000
2009: 110,000 shares outstanding x $0.50 55,000 1,775,000
Retained earnings, Dec. 31, 2009 $ 1,925,000
b. The company’s book value per share is approximately $33.59 ($6,695,000 total shareholders’
equity - $3,000,000 of preference shares book value = $3,695,000; $3,695,000 ¸ 110,000 shares
outstanding = $33.59).
c. Had the company decided to split its ordinary shares 3-for-1 on December 31, 2009, the market
value would have fallen to approximately $10 per share ($30 ¸ 3). The par value would have
been reduced to $3.33 ($10 ÷ 3), and the number of shares outstanding would have increased to
330,000 shares (110,000 x 3).

P11.9A
SOLUTIONS TO PROBLEMS SET B
20 Minutes, Easy PROBLEM 11.1B
SEPTA LIMITED
a.
SEPTA LIMITED
December 31, 2009
10% noncumulative preference shares, $100 par value, callable
at $110, authorized 1,000 shares, issued and out- $ 50,000
standing 500 shares
Ordinary shares, $1 par value, authorized 200,000 shares
Issued and outstanding 80,000 shares 80,000
Share premium: Ordinary shares 1,120,000
Retained earnings* 1,652,000

Profit for the four-year period 2006-2009 $ 1,800,000
Less: Preference share dividends ($5,000 per year for four years) $ 20,000
Ordinary share dividends ($0.40 x 80,000 shares x 4 years) 128,000 148,000
Retained earnings, December 31, 2009 $ 1,652,000
b. The market price of preference shares usually decreases as interest rates increase. Thus, at
December 31, 2009, the market price of Septa's preference shares was probably lower than
its call price of $110 (in fact, it may actually have fallen below its original price of $100 per
share.

P11.1B
BANNER PUBLICATIONS
a.
BANNER PUBLICATIONS
December 31, 2009
10% noncumulative preference shares, $100 par value,
authorized, issued, and outstanding 10,000 shares $ 1,000,000
Ordinary shares, $1 par value, authorized 1 million shares,
Share premium: ordinary shares $ 5,600,000
Total issued and fully paid capital 7,000,000

Profit for the five-year period 2004-2008 $ 4,100,000
Less: Preference share dividends ($100,000 x 5 years) $ 500,000
Ordinary share dividends ($.80 x 400,000 shares x 5 years) 1,600,000 2,100,000
Retained earnings, December 2008 $ 2,000,000
Less: Loss of 2009 1,100,000
b. Note to financial statements:

Since the company sustained a loss in 2009, the directors recommended that no dividends
shall be paid.

P11.2B
25 Minutes, Medium PROBLEM 11.3B
RAY BEAM LIMITED
a.
RAY BEAM LIMITED
December 31, 2009
10% noncumulative preference shares, $100 par value, 10,000
shares authorized, issued, and outstanding
$6 noncumulative preference shares, no-par value, 8,000 shares
authorized, 5,000 shares issued and outstanding
Ordinary shares, $1 par, 260,000 shares authorized, 130,000
shares issued and outstanding
Share premium: Ordinary shares
Total issued and fully paid capital
Retained earnings*
Total shareholders' equity

Retained earnings at Dec. 31, 2007
Add: Profit for 2008 and 2009
Profit for four-year period
Less: Dividends paid on 10% preference shares:
2008 (10% x $100 x 10,000 shares = $100,000) 100,000

2009 (10% x $100 x 10,000 shares = $100,000) 100,000
Dividends on $6 preference shares:
2008 ($6 x 5,000 shares) $ 30,000
2009 ($6 x 5,000 shares) 30,000
Dividends on ordinary shares:
2008 ($0.90 x 130,000 shares) $ 117,000
2009 ($2.00 x 130,000 shares) 260,000
Retained earnings, December 31, 2009
b. A corporation might decide to use preference shares rather than debt to finance operations for any of
the following reasons (only 2 required):
1. Dividends do not have to be paid each year and do not become a legal obligation of the
corporation until they are declared. Interest on debt is a legal obligation of the
corporation and must be paid each year.
2. Debt must be repaid at some future date. To be a permanent source of capital, debt must
be periodically refinanced. Preference shares generally does not mature.
3. Increasing the amount of debt on a balance sheet can adversely affect financial ratios.

P11.3B
PROBLEM 11.3B
RAY BEAM LIMITED
$ 1,000,000
320,000
130,000
1,820,000
$ 3,270,000
1,193,000
$ 4,463,000
$ 530,000
1,400,000
$ 1,930,000
(200,000)
(60,000)
(377,000)
$ 1,293,000
finance operations for any of
ome a legal obligation of the

egal obligation of the
ent source of capital, debt must

es not mature.
ersely affect financial ratios.

P11.3B
MARKUP LIMITED
a.
General Journal
20__
Jan 7 Cash 300,000
Issued 30,000 shares of $1 par value ordinary
shares
at $10 per share.
## Organization Costs Expense 12,000

Issued 1,000 shares of ordinary shares to Deal in
exchange for services relating to formation of the
corporation. Implied issuance price ($12,000 ÷ 1,000
shares) = $12 per share.
## Cash 400,000
5% Preference Shares 400,000
Issued 4,000 shares of $100 par value, 5%,
noncumulative preference shares at par value.
July 5 Land 120,000

Issued 10,000 shares of ordinary shares in
for land valued at $120,000 (10,000 shares x $12).
Nov ## Dividends (Preference Shares) 20,000

Dividends Payable 20,000
To record declaration of annual dividends of $5
per share on 4,000 preference shares outstanding.
Payable Dec. 11.
Dec ## Dividends Payable 20,000

Cash 20,000
To record payment of dividend declared Nov. 25.
## Income Summary
Retained Earnings 810,000
To close the Income Summary account for the 810,000
year.
## Retained Earnings 20,000

Dividends (Preference Shares) 20,000
To close the Dividends account.

P11.4B
P11.4B
MARKUP LIMITED (concluded)
b.
MARKUP LIMITED
December 31, 20__
5% cumulative preference shares, $100 par, authorized
100,000 shares, issued and outstanding 4,000 shares $ 400,000
Ordinary shares, $1 par, authorized 100,000 shares,
*Computation of retained earnings at December 31, 20__:

Retained earnings at January 1, 20__ $ -
Add: Profit in 20__ 810,000
Less: Preference dividends in 20__ (20,000)
Retained earnings at December 31, 20__. $ 790,000

P11.4B (p.2)
35 Minutes, Strong PROBLEM 11.5B
MANOR LIMITED
a. Par value of all preference shares outstanding $ 4,400,000

Par value per share of preference shares $ 100
Number of preference shares outstanding ($4,400,000 ÷ $100) 44,000
b. Dividend requirement per share of preference shares (10% x $100) $ 10

Number of preference shares outstanding (a) 44,000
Annual preference shares dividend requirement ($10 x 44,000 shares) $ 440,000
c. Par value of all ordinary shares outstanding $ 3,400,000

Par value per ordinary share $ 2
Number of ordinary share outstanding ($3,400,000 ÷ $2 per share) 1,700,000
d. Par value of all ordinary shares issued $ 3,400,000

Share premium: Ordinary 6,800,000
Total issuance price of all ordinary shares $ 10,200,000
Number of ordinary shares issued (c) 1,700,000
Average issuance price per ordinary share ($10,200,000 ÷ 1,700,000 shares) $ 6
e. Par value of preference shares $ 4,400,000

Par value of ordinary shares 3,400,000
Total legal capital $ 7,800,000
f. Total legal capital (e) $ 7,800,000

Add: Share premium: Ordinary shares $ 6,800,000
Donated capital 400,000
g. Total shareholders’ equity $ 18,160,000

Less: Par value of preference shares [44,000 shares (a) x $100 per share] 4,400,000
Equity of ordinary shareholders $ 13,760,000
Number of ordinary shares outstanding (c) 1,700,000
Book value per share ($13,760,000  1,700,000 shares) $ 8.09
h. Retained earnings, beginning of the year $ 1,200,000

Add: Profit for the year 4,800,000
Less: Retained earnings, end of the year 3,160,000
Total dividends paid during the year $ 2,840,000
Less: Dividends on preference shares (part b) 440,000
Total dividends on ordinary shares $ 2,400,000
Number of ordinary shares outstanding 1,700,000
Dividends per ordinary share ($2,400,000 ¸ 1,700,000) $ 1.41

P11.5B
TOASTY CORPORATION
In Thousands
(Except for Per
Share Amounts)
a. Par value of all ordinary shares outstanding $ 9,600
Par value per share $ 3
Number of shares outstanding ($9,600/$3) 3,200
b. Dividend requirement per share of preference shares $ 10

Numbers of preference shares outstanding 250
Annual dividends paid to preference sharesholders ($10 x 250) $ 2,500
c. Par value of preference shares $ 50,000

Par value of ordinary shares $ 9,600
Share premium 76,800
d. Total shareholders’ equity $ 187,000

Less: Preference shares par value = ($200 x 250 shares) 50,000
Equity of ordinary shareholders $ 137,000
Book value per share ($137,000 ÷ 3,200 shares) $ 42.81

P11.6B
PROBLEM 11.6B
TOASTY CORPORATION (concluded)
e. The basic advantage of being publicly owned is that the corporation has the opportunity
to raise large amounts of equity capital from many investors. Some publicly owned
corporations have millions of shareholders, including pension funds, mutual funds, and
other corporations. Private corporations are usually unable to raise the large amounts of
capital available to publicly owned corporations.
A major advantage to the shareholders of a publicly owned corporation is that their

equity investments are highly liquid assets, immediately salable at quoted market
prices.
The primary disadvantages of being publicly owned are the increased governmental
regulations and financial reporting requirements.
f. The term convertible means that at the option of the preference sharesholder, each
preference share can be converted into a specified number of ordinary shares. To evaluate
the value of this conversion feature, the shareholder must know into how many shares of
ordinary each preference share can be converted. This information is disclosed in the
notes accompanying the corporation’s financial statements.
g. At $190 per share, Toasty’s preference has a dividend yield of 5.26% ($10 ¸ $190). In
comparison, a 6%, $50 par preference selling at $52 has a dividend yield of 5.77% [(6% ´
$50 par) ¸ $52].
The dividend yield on preference shares indicates how much investors value certain
features of the shares. The lower the yield, the more investors favor the shares. A
higher yield means that investors demand a higher return to induce them to purchase
the shares.
The two principal factors that cause one preference to yield less than another are: (1) the
appearance of greater ability to pay the preference dividends each year, and (2) special
features that appeal to investors, such as Toasty’s conversion feature, cumulative
dividends, or a high call price.

P11.6B(p.2)
BRAIN CORPORATION
a. Par value is the legal capital per share—the amount by which shareholders’ equity cannot
be reduced except by losses. Thus, par value may be viewed as a minimum cushion of equity
capital existing for the protection of creditors.
Book value per share is equal to the net assets represented by each ordinary share. Book
value is a historical cost concept, representing the amounts invested by
the shareholders, plus the amounts earned and retained by the corporation. By
comparing book value with current market value, shareholders may gain insight into
whether management has increased or diminished the value of the resources
entrusted to their care.
The market value of a share is established in the marketplace. It represents the per-share
price at which willing sellers can and will sell shares of the share to willing buyers.
Market value is related primarily to investors’ future expectations of the company’s
performance, rather than to historical amounts.
b. The company’s par value—five cents per share—is quite low. However, the
corporation can set par value at any level that it chooses; the amount of par value has
no direct effect upon either book value or market value. It does mean, however, that
the amount of the company’s legal capital—serving as a cushion for creditors—is quite
low. Another reason for the small par value is the possibility of share splits in prior years.
The fact that book value per share ($10.00) is far above par value indicates either that (1)
the share initially was issued at a price far above par value, or (2) that the company has
retained substantial amounts of earnings. Even if there had been share splits in prior
years, the total dollar amount of book value would not have been affected.
The market value of $96 is 9.6 times book value. This implies that investors believe that
management and product lines make the company worth far more than the amounts of
capital historically invested.
The very low par value offers little "cushion" to the company’s creditors. On the other
hand, a market value of many times book value implies that little cushion is required for
creditors’ claims to be secure. If the company performs as its market price implies that it
will, its earnings and cash flows should make the creditors’ positions quite secure.
Earnings and cash flows are far more relevant to a company’s debt-paying ability than is
the cushion provided by par value.

P11.7B
TIN CORPORATION
a.
Ordinary shares, $3 par, 50,000 shares authorized, issued, and $ 150,000
outstanding
Share premium: Treasury shares 10,000
Total shareholders’ equity $ 840,000
*Computation of retained earnings at Dec. 31, 2009:

Profit in 2007 $ 150,000
Profit in 2008 80,000
Profit in 2009 100,000
Retained earnings, Dec. 31, 2009 $ 330,000
b. The company’s book value per share is $16.80 ($840,000 total shareholders’ equity ¸ 50,000
shares outstanding).
c. The treasury shares purchase of $30,000 in 2008 was reported as a financing cash outflow in
the statement of cash flows for that year. The reissue of the treasury shares for $40,000 in
the following year was reported as a financing cash inflow in the 2009 statement of cash
flows.

P11.8B
30 Minutes, Strong PROBLEM 11.9B
PARKER INDUSTRIES
a.
6% preference shares, $100 par, authorized and
issued and outstanding 10,000 shares
Ordinary shares, $20 par, 100,000 shares authorized,
80,000 shares issued, of which 400 shares are held in
treasury
Share premium: Ordinary shares
Share premium: Treasury shares*
Total issued and fully paid capital
Retained earnings**
Subtotal
Less: Treasury shares (400 shares x $40 cost per share)
Total shareholders’ equity at Dec. 31, 2009
*Computation of share premium on treasury shares:

Purchase price per share: $40,000 ÷ 1,000 shares = $40
per share
Reissue price per share: $30,000 ÷ 600 shares = $50
per share
Premium per share reissued: $10 per share ($50 - $40)
Total issued and fully paid capital on treasury shares: $6,000
($10 per share x 600 shares reissued)
**Computation of retained earnings at Dec. 31, 2009:

Profit (for years 2005–2009)
Less: Preference dividend (for years 2005–2009)
$100 x 6% x 10,000 shares x 5 years
Less: Ordinary dividends
2005–2006: 80,000 shares outstanding x $0.60 x 2 yrs $ 96,000
2009: 79,600 shares outstanding x $0.60 47,760
Retained earnings, Dec. 31, 2009
b. The company’s book value per share is approximately $76.02 ($7,051,440 total shareholders’
equity - $1,000,000 of preference shares book value = $6,051,440; $6,051,440 ¸ 79,600 shares
outstanding = $76.02).
c. Had the company decided to split its ordinary share 2-for-1 on December 31, 2009, the
market value would have fallen to approximately $28 per share ($56 ÷ 2). The par value
would have been reduced to $10.00 ($20 ÷ 2), and the number of shares outstanding would
have increased to 159,200 shares (79,600 x 2).

P11.9B
PROBLEM 11.9B
ARKER INDUSTRIES
$ 1,000,000
1,600,000
1,200,000
6,000
$ 3,806,000
3,261,440
7,067,440
16,000
$ 7,051,440
$ 3,800,000
300,000
238,560
$ 3,261,440
($7,051,440 total shareholders’

40; $6,051,440 ¸ 79,600 shares
n December 31, 2009, the

e ($56 ÷ 2). The par value
of shares outstanding would

P11.9B
SOLUTIONS TO CRITICAL THINKING CASES
15 Minutes, Medium CASE 11.1
FACTORS AFFECTING THE MARKET PRICES
OF PREFERENCE AND ORDINARY SHARES
a. The market price of the 10%, $100 par value preference shares may be expected to decline
gradually as long-term interest rates rise. The market price of preference shares tends to
vary inversely with the level of interest rates.
b. If ADM’s profitability increases dramatically, the market price of its ordinary share
probably will rise significantly. The improved profitability of the company may lead to
larger increases in the dividends paid to ordinary shareholders than the 5 and 10 cent
increases of prior years. The market price of ordinary share is strongly affected by such
factors as the company’s expected future earnings and the probable rate of future
ordinary share dividends.
c. The market price of the 7%, $100 par value convertible preference shares should rise
approximately in proportion to the increase in the market value of the ordinary share. This
issue of preference shares is already deriving much of its market value from its conversion
feature, as indicated by the fact that its market price ($125) exceeds the market price of
ADM’s 10% preference shares ($90), which pays a higher dividend.
The current market price of the convertible preference shares is too high to be explained by
its $7 per year dividend, and it is approximately three times the current market price of the
ordinary share. Therefore, each share of this preference shares probably is convertible into
about three shares of ordinary share. As the market price of the ordinary share increases, the
market price of the convertible preference should also increase to remain approximately
equal in value to three shares of ordinary share.

Case 11.1
25 Minutes, Strong CASE 11.2
FACTORS AFFECTING THE MARKET PRICES
OF ORDINARY
SHARES
a. The value of an ordinary share is based on investors’ expectations about future earnings and cash
flows of the business. Thus, the increase in the price of the shares of Japan Airlines Corporation
resulted from an decrease in investors’ expectations about future earnings of the company based on
bankruptcy rumors.
b. The fall in the price of HSBC’s ordinary shares probably is based on two factors. The increase in the
default risk signals a general increase in interest rates which will affect the required yield on all
investments. Since investors will demand a higher yield on their investments, share and bond prices
may suffer an overall decline.
As a financial institution, this increase in the defaults has additional significance to HSBC. The
increase in the discount rate increases HSBC’s financial strength, which will reduce its profit, at least
in the short run. This reduction in expectations about future earnings will further reduce the bank’s
share price.
c. The close down of research center signaled to the market that GlaxoSmithKline may be having
problems with its investment in research and development. Therefore, investors are reducing their
expectations of the company’s future earnings and increasing their assessments of the risk of the
business. This caused the share price to drop.

Case 11.2
Group assignment: CASE 11.3
No time estimate SELECTING A FORM OF ORGANIZATION
We do not provide comprehensive solutions for group problems that involve interviews. But the
following items normally come to light in our classes.
• Students may find that many people entered a business without giving much thought to the
form of entity.
• Among the “unforeseen complications” that often come to light are the problems when
partners do not see eye to eye, and the costs and complications resulting from the
corporation being a taxable entity.
• The normal reason why a business may change its form of entity is to attract more
capital.
• Some students may encounter professional corporations, which often are used by one or
more members of a partnership. These professional corporations are intended to limit the
individuals’ personal liability—although they require the individual to carry “malpractice”
insurance and do not exonerate them from liability for some types of professional
misconduct. They may also encounter S corporations, which, for tax purposes, are treated as
unincorporated organizations.

Case 11.3
20 Minutes, Medium CASE 11.4
S.F.C. ENFORCEMENT DIVISION
ETHICS, FRAUD & CORPORATE GOVERNANCE
(a)
The six divisions and two departments of the Securities and Futures Commission are:
Corporate Finance
Enforcement
Policy, China & Investment Products
Supervision of Markets
Corporate Affairs
Legal Services
Licensing
Intermediaries Supervision
(b) The Enforcement Division inquires possible irregularities of stock and derivative markets,
recommends disciplinary action when appropriate and prevent unlawful or improper
activities.
(c) The publication is "Does price information tell all?" under monthly focus on February 2010.
(d) Investor has to pay attention to the timeliness of market data and cross check different
financial ratios through the latest financial reports and announcements. In addition to price
information, investors should also look at other corporate actions that also affect the price
movements of stocks.
The recent market manipulation verdicts have sent the a clear message to all market
participants that market manipulation is a serious offence and that perpetrators could be
prosecuted and sent to jail for such actions. It is imperative that all market participants
operate with fairness and integrity on the markets.

Case 11.4

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CHAPTER 11

B. Ex. 11.1 Shareholders' equity 4 Analysis

Authorized share capital

© The McGraw-Hill Companies, Inc., 2010

© The McGraw-Hill Companies, Inc., 2010

Critical Thinking Cases

11.2 Real World: Japan Airlines 7 Communication

© The McGraw-Hill Companies, Inc., 2010

11.2 A,B Waller Publications/Banner Publications 20 Easy

11.3 A,B Manhattan Transport Company/Ray Beam Limited 25 Medium

11.4 A,B Barnes Communications Limited/Markup Limited 35 Medium

11.5 A,B Smithfield Products/Manor Limited 35 Strong

11.6 A,B Parsons Limited/Toasty Corporation 35 Medium

11.7 A,B Techno Corporation/Brain Corporation 15 Easy

© The McGraw-Hill Companies, Inc., 2010

*Supplemental Topic, “Special Types of Liabilities.”

© The McGraw-Hill Companies, Inc., 2010

© The McGraw-Hill Companies, Inc., 2010

d. Share registrar. An independent fiscal agent, usually a large bank, retained by a

© The McGraw-Hill Companies, Inc., 2010

© The McGraw-Hill Companies, Inc., 2010

© The McGraw-Hill Companies, Inc., 2010

B.Ex. 11.2 Preference shares (1,000 shares @ $100) $100,000

The amount of dividends in arrears must be disclosed in the financial statements,

B.Ex. 11.4 Total dividend declared $200,000

B.Ex. 11.5 Total dividend declared $120,000

If the preference shares is cumulative, the entire dividend goes to preference

10,000 x $100 par x 8% x 4 years = $320,000

© The McGraw-Hill Companies, Inc., 2010

B.Ex. 11.7 Total shareholders' equity ($4,000,000 + $5,000,000 + $800,000 +

B.Ex. 11.9 Ordinary shares (100,000 shares @ $10) $1,000,000

B.Ex. 11.10 Ordinary shares (1,000,000 shares @ $25) $25,000,000

© The McGraw-Hill Companies, Inc., 2010

(2) Organizing the scuba diving school as a corporation.

b. A corporation would probably be the better form of organization because of the

Ex. 11.2 a. Double taxation

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Ex. 11.4 a. Total dividends paid in third year ……………………………………………………..

Current year’s dividend ($50 x .09 x 40,000) ………………. 180,000

b. Dividends per share:

b. $1,050,000 ($15,000,000 total par value x 7% or 150,000 x $100 x 7%)

d. $35,000,000 legal capital ($15,000,000 preference, plus $20,000,000 ordinary)

© The McGraw-Hill Companies, Inc., 2010

Total dividend ……………………………………………………………………………. $50,000

Ex. 11.7 Net Cash Flow

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b. Book value per ordinary share:

Ex. 11.9 a. Feb. 10 Treasury Shares ………………………………………………. 425,000

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b. For a company to classify its treasury shares as a short-term investment is not

b. Authorized, but unissued, shares do not represent an asset of the company. At

© The McGraw-Hill Companies, Inc., 2010

Cash (40,000 x $110)……………………………… 4,400,000

Treasury Stock/Ordinary (40,000 x $60)…………. 2,400,000

Note: No entry is required to record the

Ordinary shares, $10 par value, 1,000,000 shares authorized,

Total issued and fully paid capital $11,000,000

Less: Treasury (ordinary) shares at cost, 40,000 shares (2,400,000)

Total shareholders' equity $8,600,000

© The McGraw-Hill Companies, Inc., 2010

Share premium on ordinary shares 800,000

Share premium on treasury shares

Total Issued and fully paid capital $1,830,000

Retained earnings 120,000