2.1.

APC

a) Retained earnings is a shareholders´ equity item that represents the accumulated

increase in internal funds due to profitable operations of the firm. Even though in theory
all profit being generated might be distributed back to shareholders in the form of
dividends (except if the law or the by-laws of the firm required the creation of a legal or
statutory reserve), most often growing companies will opt for retaining part of the profit
and transfer it to retained earnings instead of distributing it as a way to reinvest
earnings primarily to support growth without having to rely too heavily on debt and
dilutive equity issuances. The shareholders receive their investment return in the form
of stock price appreciation.
Moreover, it should be clear that retained earnings are not a pile of cash waiting to be
distributed. If the company has minimally effective cash management systems in place,
cash will be far lower than retained earnings, as companies tend to avoid having idle
cash. So, even if the company wanted to pay substantially higher dividends, the firm
would need to convert assets into cash, which would most likely distort the normal
course of operations. In any case, if dividends are to be paid in cash, the company
must first be certain that it has sufficient cash to meet the payment. Such a
determination requires a projection of the operating cash flows of the company.
(Notice the difference between dividends and wages as it comes to this exercise.
Wages are an expense line that intervenes in the determination of profit. Dividends are
not an expense, but one of the potential destinations of profits.

b) Only if assets and liabilities were recorded at liquidation value, the statement would be
true. Given the accounting principles (and in particular, the going concern principle),
this is likely to happen very rarely and if so, only by coincidence.

c) The market value of the shares and the market value of the firm in the stock market
depend on the expectations about the stream of future profits (or to be more precise,
future cash flows) of the firm, as well as on the outcome of the tension between supply
and demand forces in the stock market. Therefore, even though the book value or
theoretical value of a share, that is [(assets – liabilities) / number of shares ] is one of
the items that can be used as a basis to establish the valuation of a share or the
valuation of a firm, such book value on its own is not sufficient to establish any forecast
about prices or range of prices.
2.2. A STORE OF PRINCIPLES

a) Both the purchase price principle and the prudence principle suggest the retail space
should be valued at historical cost. Therefore, the consequences of the real estate boom
and the consequent increase in market value would not be taken into account (unless the
retail space was eventually sold). So, no need to record anything.

IFRS suggest historical cost is the reference treatment for tangible fixed assets. However,
it admits fair value (based for example on appraisal by experts) as an alternative treatment
(not in US GAAP). The local standards of only a rather limited number of IFRS-adopting
countries (e.g. NL, UK) allow the application of the fair value alternative as admitted by
IFRS.

b) Purchase price principle + prudence principle + use of nominal monetary units - coherent
recommendation: record at historical cost. Do not take inflation into account. No need to
record anything (However, some countries with persistent hyperinflation use constant
monetary units and annually adjust financial statement figures to capture changes in
general purchasing power of the currency. See IFRS 29 on financial reporting in
hyperinflationary economies)

c) Because of the purchase price principle, the prudence principle and the going-concern
principle, the unrealized and unacquired goodwill should not be recorded. Unrealized,
unacquired goodwill is not goodwill from the accounting perspective. This applies to both
IFRS and US GAAP.

d) According to the purchase price principle, T-shirts should be valued at 12.000. However,
according to the prudence principle, we need to recognize the loss (i.e. lower of cost or
market rule). Both the prevalence of the prudence principle in traditional accounting
systems and the appropriate balance between qualitative characteristics of information in
IFRS end up suggesting the following adjustment;

……. + Inventory + ……….. = ……. + ……..+ (rev-exp)

- 9.000 -9.000

Regarding the blouses, according to the purchase price=historical cost principle, they
should be valued at 2.750. The prudence principle gives us the same indication.
Therefore, no entry is needed.

e) Because of the entity concept, the withdrawal should be accounted for. The pension plan,
being a personal business, should not.