Review of Chapter 6

Cost of Property, Plant and Equipment

Capital versus Operating Expenditure
Depreciation – Straight-line, Units of Production
and Diminishing balance
Additional depreciation topics
Intangible Assets
Return on Assets
Liabilities

Chapter 8
Current and Long-Term Liabilities
• liabilities are debts

• borrowing is one way a company finances its

operations

• liabilities are classified as current or long-term

 Learning Objective 1

Explain and account for

current liabilities
 Current Liabilities
Current liabilities are obligations due within one
year or within the company’s normal operating
cycle if it is longer

Examples: accounts payable, short-term notes

payable, taxes payable, current portion of
long-term debt, accrued expenses, unearned
revenue, etc.
 Current Liabilities That
Must Be Estimated

Estimated Warranty Payable

Assume that Black & Decker made sales of
$200,000 subject to product warranties.
Black & Decker estimates that 3% of the products
it sells this year will require repair or replacement.
What is the estimated warranty expense?
 Estimated Warranty Payable

$200,000 × 0.03 = $6,000

Warranty Expense 6,000

Estimated Warranty Payable 6,000
To accrue warranty expense
 Contingent Liabilities
They are a potential liability that depends on a future
event arising out of past events

Examples: Lawsuits in progress,

guarantees of a subsidiary’s debt,
audit by Canada Revenue Agency

These liabilities are disclosed in the notes

to the financial statements (if it is likely that
they will become actual liabilities).
 Question #1
On January 1, a company signs a $200,000, 4% 9-
month note. Interest is due at maturity. What is
the adjusting entry required if the company
prepares financial statements on June 30.

a. Dr Interest expense; Cr Interest payable, $4,000

b. Dr Interest expense; Cr Cash, $4,000
c. Dr Interest expense; Cr Cash, $6,000
d. Dr Interest expense; Cr Interest payable, $6,000
 Bonds: An Introduction

A bond is an interest bearing

long-term note payable.

Bonds are groups of notes payable issued

to multiple lenders called bondholders.

Principal Interest rate Payment dates

 Learning Objective 5

Explain the advantages

and disadvantages
of financing with debt
versus equity
 Financing Operations
With Bonds or Shares
Issuing Shares Issuing Notes or Bonds

Does not dilute share

Creates no liabilities
ownership or control
or interest expense
of the corporation

Results in higher earnings

Less risky to the per share because the earnings
issuing corporation on borrowed money usually
exceeds interest expense
 Financing Operations
With Bonds or Shares

Suppose a corporation needs $500,000 for expansion.

It has net income of $300,000 and 100,000
common shares outstanding.
Management is considering two financing plans:
Plan 1 is to issue $500,000 of 10% bonds payable.
Plan 2 is to issue 50,000 common shares
for $500,000.
 Financing Operations
With Bonds or Shares
Plan 1: Borrow $500,000 at 10%
Net income before expansion $300,000
Project income before interest and taxes $200,000
Less interest expense ($500,000 × 0.10) – 50,000
Project income before income tax $150,000
Less income tax expense (40%) – 60,000
Expected project net income 90,000
Total company net income $390,000
Earnings per share after expansion:
($390,000/100,000 shares) $3.90
 Financing Operations
With Bonds or Shares
Plan 2: Issue 50,000 Common Shares for $500,000
Net income before expansion $300,000
Project income before interest and taxes $200,000
Less interest expense 0
Project income before income tax $200,000
Less income tax expense (40%) – 80,000
Expected project net income 120,000
Total company net income $420,000
Earnings per share after expansion:
($420,000/150,000 shares) $2.80
 Learning Objective 6

Analyze and evaluate a company’s

debt-paying ability

9 - 16
 Using Debt in Decision Making
• liabilities are a popular way to finance operations
• managers use ratios to determine how much credit
risk it is taking
• both creditors and investors worry when a company’s
debt grow
• there is a risk that the company cannot pay its debts
as they become due
 Using Debt in Decision Making
• ratios are used to determine how much credit risk
the company is taking

1) Accounts payable turnover

2) Leverage ratio
3) Times Interest Earned
 Accounts payable turnover
A/P Turnover = Cost of goods sold
Average accounts payable

Measures the number of times a year a company

is able to pay its accounts payable

Days’ payable outstanding = 365/T/O

9 - 19
 Leverage ratio
Leverage ratio = Total assets
Total shareholders’ equity

Shows a company’s total assets per dollar of

shareholders’ equity

9 - 20
 Times Interest Earned

Times Interest Earned = Operating income

Interest expense

It measures the number of times that operating income

can cover interest expense.

A high ratio indicates ease in paying interest expense

Learning Objective 8

Report liabilities on
the balance sheet.
 Reporting Liabilities

Amounts in millions

Bank Loans $ 14
Accounts payable and accrued liabilities 234
Income taxes (current and future) 4
Current installments of long-term debt 21
Total current liabilities $ 273
Long-term debt 99
Other long-term liabilities 8
 Reporting Financing Activities on
the Cash Flow Statement
For the Year Ended
Amounts in millions December 31
Cash Flow used in Financing Activities:
Issue of common shares (net) $140
Repayment of bank loans (118)
Payments of long-term debt (72)
Net cash provided by financing activities $(50)
End of Chapter 8
Shareholders’ Equity

Chapter 9
 Learning Objective 1

Explain the main features

of a corporation.
 What is the Best Way to
Organize a Business?

Proprietorship

Partnership

Corporation
 Corporations
Corporations are legal entities apart from their
owners

Public corporations –

Private corporations –
 Advantages and Disadvantages
of a Corporation
Advantages
1. Can raise more capital than a
proprietorship or partnership can
2. Continuous life
3. Ease of transferring ownership
4. Limited liability of shareholders
Disadvantages
1. Separation of ownership
2. Corporate taxation
3. Government regulation
Authority Structure
of a Corporation

Shareholders

Board of Directors

Chief Executive Officer

Chief Operating Officer

Common Shareholders’ Rights

The right to sell shares

Vote

Dividends

Residual interest
 Shareholders’ Equity
Assets = Liabilities + Shareholders’ Equity

Shareholders’ Equity represents the ownership interest in

the assets of the business
It is divided into 4 components:
1) Share capital
2) Contributed surplus
3) Accumulated other comprehensive income
4) Retained earnings
 Share Capital

Corporate ownership is evidenced

by a share certificate, which may
be for any number of shares.

The total number of shares

authorized is limited by the articles
of incorporation.
 Share Capital

Common Shares Preferred Shares

Voting rights No voting rights

Receive dividends after Fixed dividend
preferred dividend Receive dividends first
Shareholders benefit most Receive assets first in
if corporation succeeds liquidation
 Intrawest Corporation Shareholder
s’ Equity
June 30
(In thousands of U.S. dollars) 2017 2016
Preferred shares - -
Common shares $453,299 $400,262
Retained earnings 241,665 187,922
Foreign currency translation adjust. (31,295) (33,780)
Total shareholders’ equity $ 667,269 $568,362
 Retained Earnings
The amount that the company has earned
through profitable operations

Beginning balance
Add: Net income
Less: Dividends
Losses
= Ending balance
 Learning Objective 2

Account for the issuance

of shares.
 Common Shares

When a company issues shares, it debits

the asset received and credits the share account.

January 8
Cash (700,000 × $10) 7,000,000
Common Shares 7,000,000
To issue common shares
 Shares Issued for Non-Cash Assets
Asset received is recorded at current market value
JOURNAL
Date Accounts and explanation Debit Credit
Equipment 4,000
Building 120,000
Common Shares 124,000
Issued shares in exchange for equipment and building
 Preferred Shares

Accounting for preferred shares follows the

pattern illustrated for common shares.

Shareholders’ equity on the balance sheet

lists preferred shares, common shares,
contributed surplus, accumulated other
Income and retained earnings –
in that order
 Question #2
ABC Company is authorized to issue 50,000
common shares. On Feb. 10, 2017, it issued
10,000 shares at $11 per share. The journal
entry to record these facts include a

a. Credit to Common shares $110,000

b. Credit to Common shares $550,000
c. Debit to Cash for $550,000
d. Debit to Common shares for $110,000
 Learning Objective 3

Explain why a company

repurchases shares
 Share Repurchase Transactions

Repurchased shares are shares that a company

has issued and later reacquired.

Issuing shares grows a company’s assets

and equity.
Repurchasing shares shrinks assets
and equity.
 Ava Smallco Ltd. Before Share
Repurchase Transaction

Shareholders’ Equity
December 31, 2016 ($000s)
Common Shares(10,000 shares) $ 70,000
Retained earnings 193,632
Total equity $263,632
 Ava Smallco Ltd.
Repurchase of Shares

During 2017, Ava Smallco Ltd. paid $12,000 to

repurchase 1,000 shares of its common shares.

November 12, 2017

Common shares 7,000
Retained earnings 5,000
Cash 12,000
Repurchased common shares for cancellation
 Ava Smallco Ltd. After
Repurchase of Shares

Shareholder’s Equity at December 31, 2017

($000s)
Common Shares, 9,000 issued $ 63,000
Retained earnings 188,632
Total equity $251,632
 Learning Objective 4

Account for retained earnings,

dividends and stock splits
 Cash Dividends
Company must have both:
Enough Retained earnings to declare the dividend
Enough Cash to pay the dividend

Board of directors has authority to declare a

dividend
Company not obligated to pay dividend until
declared
 Cash Dividend

Three relevant dates for dividends are:

Declaration date

Date of record Payment date

 Declaration Date
Declaration date, June 19, the board of directors
announces the dividend. Assume a $50,000
dividend.

June 19
Retained earnings 50,000
Dividends payable 50,000
Declared a cash dividend
 Date of Record

Date of record, July 1. This follows the

declaration date by a few weeks. The
shareholders on the record date will receive the
dividend.

There is no journal entry for the date of record

 Payment Date
Payment date, July 10.

Dividends payable 50,000

Cash 50,000
Paid cash dividend
 Dividends on Preferred Shares
When a company has issued both preferred and
common shares, the preferred shareholders receive
their dividends first

Common shareholders receive dividends only if the

total declared dividend is large enough to pay
preferred dividends first
 Dividends on Preferred Shares
Dividend rate – stated as a dollar amount

Cumulative – if dividends are omitted in any given year,

they must be paid before common shareholders
receive their dividend

Non-cumulative – if dividends are not paid in any given

year, they are lost
Example: Preferred Share Dividends

Pinecraft Industries Inc. has 100,000 of

$1.50 cumulative preferred shares and
common shares outstanding.
 Preferred Share Dividends

Preferred dividends are paid at the annual

rate of $1.50 per share.
Assume that in 2016, the company declares
an annual dividend of $1,000,000.
Preferred dividend (100,000 × $1.50 per share) $150,000
Common dividend
(remainder: $1,000,000 – $150,000) 850,000
Total dividend $1,000,000
 Preferred Share Dividends

The preferred shares of Pinecraft are cumulative.

Suppose the company passed the 2016
preferred dividend of $150,000.
In 2017, the company declares a $500,000 dividend.
Retained Earnings 500,000
Dividends Payable, Preferred 300,000*
Dividends Payable, Common
($500,000 – $300,000) 200,000
To declare a cash dividend
*($150,000 × 2 years)
 Question #3
XYZ Corporation has 10,000, $2 cumulative
preferred shares and 110,000 common shares
outstanding. At the beginning of the current
year, preferred dividends were 3 years in
arrears. The Board of Directors wants to pay a
$1.50 cash dividend on each outstanding
common share. To accomplish this, what
TOTAL amount of dividends must they
declare?
a. $225,000 b. $165,000 c. $245,000
Why Issue a Stock Dividend?

To continue dividends,
but conserve cash

To reduce the per-share market price

of its shares
 Stock Dividend Dates
1. Declaration date
JOURNAL
Date Accounts and explanation Debit Credit
Retained Earnings
Stock Dividends Distributable

2. Date of record No entry

3. Payment date
JOURNAL
Date Accounts and explanation Debit Credit
Stock Dividends Distributable
Common Shares
 Stock Dividend
PotPota Corp declared
Potash Corp. declared a 2% stock dividend.
a 2% stock dividend.
Potash Corp had
296 million common shares outstanding.

The shares are trading for $120 per share.

How would this stock dividend be recorded?

 Stock Dividend

Retained Earnings 710,400,000*

Share Dividend Distributable 710,400,000
Declaration of stock dividend

Share Dividend Distributable 710,400,000

Common Shares 710,400,000
Distributed a 2% stock dividend

*(296,000,000 shares × 2% × $120/share)

 Stock Splits

A stock split is an increase in the number of

issued, and outstanding shares, but does not
affect any financial statement balances.

A stock split decreases the market price of shares.

 Stock Splits

The market price of a share of Winpak Ltd.

has been approximately $120.
Assume that the company wants
to decrease it to approximately $60.00.
This 2-for-1 split means that the company
would have twice as many shares outstanding
after the split as is had before the split.
 Effect on Total
Stockholders’
Transaction Assets = Liabilities + Equity
Issuance of shares Increase No effect Increase
Repurchase of
shares Decrease No effect Decrease
Declaration of
cash dividend No effect Increase Decrease
Payment of cash
dividend Decrease Decrease No effect
Stock dividend No effect No effect No effect
Stock split No effect No effect No effect
 Learning Objective 5

Distinguish between fair value

and book value per share
 Share Values
Fair value (or market price) – value a person buy or sells the
shares

Redemption value – value company pays to buy back shares

Liquidation value – amount company pays to preferred

shareholders if a company liquidate

Book value – Total shareholders’ equity – Preferred equity

divided by Number of common shares outstanding
 Book Value

Assume that a company’s balance sheet reports the following:

Shareholders’ Equity

Preferred shares, $6.00, 400 shares issued,

redemption value $130 per share $ 40,000
Common shares, 5,000 shares issued 131,000
Retained earnings 70,000
Total shareholders’ equity $241,000
 Book Value

Suppose that four years’ (including the current year)

cumulative preferred dividends are in arrears
and that preferred shares have a redemption
value of $130 per share.
The book-value-per-share computations
for this company are as follows:
 Book Value

Preferred equity:
Redemption value (400 shares × 130) $ 52,000
Cumulative dividends (400 × $6.00 × 4 years) 9,600
Preferred equity $ 61,600
Common equity:
Total shareholders’ equity $241,000
Less preferred equity – 61,600
Common equity $179,400

Book value per share: $179,400 ÷ 5,000 shares $ 35.88

Learning Objective 6

Evaluate a company’s
return on assets and
return on equity
 Return on Assets

Net income + Interest expense

Average total assets

Indicates how well it has used the assets to

earn money for its creditors and shareholders
Return on Equity

Net income – Preferred dividends

Average common shareholders’ equity

It indicates how much profit it has generated for

each dollar of common shareholders equity it has
 Question #4
Use the following information to calculate Return on
Equity for 2017 (rounded).
2017 2016
Total assets $21,695 $20,757
Common shares 43 388
Retained earnings 8,607 7,216
Operating income 4,021 3,818
Interest expense 219 272
Net income 2,662 2,543

a. 16.4%b. 12.5% c. 24.7% d. 32.8%

 Learning Objective 7

Report equity
transactions and events
in the financial statements
Shareholders’ Equity and the Statement
of Cash Flows
• 3 main financing categories that affect shareholders’
equity are:

1) Issuance of shares
2) Repurchase of shares
3) Payment of dividends
 Reporting Shareholders’
Equity Transactions
During 2017, George Weston Ltd. paid
dividends and retired shares.
Following is their report of cash flows from
financing activities illustrating the effect
on their shareholders’ equity.
Financing activities:
Share capital: retired (59)
Dividends (285)
Shareholders’ Equity on the
Balance Sheet
End of Chapter 9