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CHAPTER 12

PROFIT AND CHANGES


IN RETAINED EARNINGS
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Brief Learning
Exercises Topic Objectives Skills
B. Ex. 12.1 Extraordinary loss 1 Analysis
B. Ex. 12.2 Extraordinary gain 1 Analysis
B. Ex. 12.3 Discontinued operations 1 Analysis
B. Ex. 12.4 Cash and stock dividends 6 Analysis
B. Ex. 12.5 Statement of changes in equity 5 Analysis
B. Ex. 12.6 Statement of changes in equity 7,8 Analysis
B. Ex. 12.7 Cash dividend journal entries 6 Analysis
B. Ex. 12.8 stock dividend journal entries 6 Analysis
B. Ex. 12.9 Shareholders' equity section of
balance sheet 6,8 Analysis
B. Ex. 12.10 Comprehensive income 4 Analysis
Learning
Exercises Topic Objectives Skills
12.1 Stock dividends and share splits 6 Analysis, communication
12.2 Terminology 14, 6-8 Analysis
12.3 Discontinued operations 1, 2 Analysis
12.4 Extraordinary items 1, 2 Analysis
12.5 Earnings per share: effect of 2 Analysis
preference share
12.6 Restating earnings per share for 2, 6 Analysis
stock dividends
12.7 Stock dividends and splits 6 Analysis
12.8 Effect of stock dividends on share 6 Communication
price
12.9 Effects of transactions upon 8 Analysis
financial measurements
12.10 Effects of transactions upon 2, 6 Communication
earnings per share
12.11 Identifying source of desired 1, 5, 8 Analysis
financial information
12.12 Comprehensive income 4 Analysis
12.13 Cash and stock dividends 6 Analysis, communication,
judgment

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Overview
12.14 Real World: adidas AG 3, 4 Analysis, communication

EPS and dividends


12.15 Real World: adidas AG 1, 8 Analysis, communication

Analysis of share information

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Overview
Learning
Sets A, B Topic Objectives Skills
12.1 A,B Reporting unusual events 1, 2 Analysis
12.2 A, B Format of statements of income 1, 2, 5, 7 Analysis, communication
and retained earnings
12.3 A, B Reporting unusual events: a 1, 2, 4, 7 Analysis, communication
comprehensive problem
12.4 A, B Share splits, stock dividends, 6 Analysis, communication
treasury share, and book value
12.5 A, B Statement of shareholders equity 6, 8 Analysis, communication

12.6 A, B Dividends and treasury share 6 Analysis


transactions
12.7 A, B Effects of transactions upon 8 Analysis, communication
financial measurements
12.8 A, B Shareholders equity: 6 Analysis
comprehensive
12.9 A, B Format of an income statement 1, 2 Analysis

Critical Thinking Cases


12.1 Real World: Hutchison 1 Analysis, communication
Telecommunications International
Limited, Vodafone plc, Cathay
Pacific, Shiseido Company, limited

Reporting special events


12.2 Forecasting continuing 1 Analysis, communication
operations
12.3 Interpreting earnings per share 13 Analysis, communication
12.4 Analyzing statement of shareholders 8 Analysis, communication
equity
12.5 Classifying unusual items 1, 2, 8 Analysis, communication

12.6 Real World: Vodafone plc 8 Communication, research,


Analyzing shareholders' equity and EPS technology
Technology

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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)
12.1 A,B Greater Asian Airlines/Pacific Airlines 30 Easy
Preparation of a condensed income statement and earnings per
share figures for a company with a discontinued segment and an
extraordinary loss. Emphasizes format of the income statement
rather than computation of amounts. Students also are asked to
forecast future operating results.

12.2 A,B Slick Software Limited/Beach Limited 30 Medium


A comprehensive problem on reporting the results of operations.
Stresses the format of an income statement and statement of
changes in equity, with disclosure of unusual items. EPS
computation involves ordinary and preference shares outstanding.

12.3 A,B Phoenix Limited/Dexter Limited 35 Strong


Given an incorrectly prepared income statement, student is asked
to draft a revised income statement and a statement of changes in
equity. Includes discontinued operations, an extraordinary item, an
accounting change, and a prior period adjustment.

12.4 A,B Albers Limited/Jessel Limited 20 Easy


Demonstrates the effect of various transactions upon total
shareholders equity, number of shares outstanding, and book
value per share. Includes share splits, stock dividends, and treasury
share transactions.

12.5 A,B Strait Corporation/ Dry Wall Limited 20 Medium


Preparation of a statement of shareholders equity. Stresses an
understanding of the effects of various transactions upon the
elements of shareholders equity.

12.6 A,B Thompson Service/Greene Limited 40 Strong


A comprehensive problem on cash dividends, stock dividends, and
treasury share transactions. Requires journal entries and
preparation of shareholders equity section of the balance sheet.
Student is asked to compute maximum amount available for
dividends.

12.7 A,B Tech Process Limited/Hot Water Limited 30 Strong


Explanation of the effects of equity transactions on various
financial measures.

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Description Problems
Problems (cont'd)
12.8 A,B Mandella Corporation/Adams Corporation 50 Strong
Preparation of the shareholders equity section of a balance sheet in two
successive years. Transactions affecting shareholders equity include
issuance of ordinary share, a stock dividend, purchase and sale of
treasury share, cash dividends, and a share split.

12.9 A,B Esper Corporation/Blue Jay Manufacturing Corp. 25 Strong


Preparation of a partial income statement for Esper Corp., including
discontinued operations, an extraordinary loss, and an accounting
change. Emphasizes format of the income statement rather than
computation of amounts. Students also are asked to compute earnings
per share.

Critical Thinking Cases

12.1 What's This? 20 Easy


Four unusual events taken from the published financial statements of
well-known corporations. Students are asked to indicate whether each
event qualifies as an extraordinary item, a discontinued operation, or an
accounting change.

12.2 Is There Life Without Baseball? 20 Medium


Student is presented with an income statement containing discontinued
operations and an extraordinary item and is asked to forecast future
earnings. Requires an understanding of recurring versus nonrecurring
events. Good practice for interpreting annual reports.

12.3 Using Earnings Per Share Statistics 30 Strong


Student is given six earnings per share figures, including earnings from
continuing operations, earnings before extraordinary items, and net
earnings, computed on both a basic and diluted basis. From this
information, student is asked to determine the amount of the
extraordinary loss, to use a p/e ratio to estimate share price, and to
forecast future performance.

12.4 Interpreting a Statement of Shareholders' Equity 35 Strong


Student is asked to answer specific questions requiring analysis and
understanding of items reported in the statement of shareholders' equity.

12.5 Classification of Unusual Items - and the Potential Financial 60 Strong


Impact
Students discuss the classification of unusual items from several
perspectivesaccounting principles, pressures on management, cash
flows, and probable effects on share price. Adapted from an actual case;
illustrates the real world aspects of financial reporting. Good group
assignment.

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Desc. of Cases
Students discuss the classification of unusual items from several
perspectivesaccounting principles, pressures on management, cash
flows, and probable effects on share price. Adapted from an actual case;
illustrates the real world aspects of financial reporting. Good group
assignment.

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Desc. of Cases
Critical Thinking Cases (cont'd).

12.6 Comparing Price-Earnings Ratios 30 Easy


Internet
Students are to obtain information on the Internet about a Fortune 500
company and an emerging company. They are to compare p/e ratios and
speculate on the reasons for the differences.

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Desc. of Cases (p.2)
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

1. The purpose of presenting subtotals such as Profit from Continuing Operations and Profit from
Discontinued Operations is to assist users of the income statement in making forecasts of future
earnings. By excluding the operating results of discontinued operations and the effects of unusual
and nonrecurring transactions, these subtotals indicate the amount of income derived from the
companys ongoing, normal operations.

2. The discontinued operations classification is used in the income statement only when a business
discontinues an entire segment of its activities. Franks has two business segmentspizza parlors
and the baseball team. Only if one of these segments is discontinued in its entirety will the
company report discontinued operations. The sale or closure of a few parlors does not represent the
disposal of the pizza parlor segment of the companys business activities.

3. Extraordinary items are defined as 'income or expenses that arise from events or transactions that
are clearly distinct from the ordinary activities of the enterprise and therefore are not expected to
recur frequently or regularly'.

According IAS 1 paragraph 85, "An entity shall not present any items of income and expense as
extraordinary items, either on the face of the income statement or in the notes." It is because items
treated as extraordinary result from the normal business risks faced by an entity and do not warrant
presentation in a separate component of the income statement. The nature or function of a
transaction rather than frequency, should determine its presentation within the income statement.
Items currently classified as 'extraordinary' are only a subset of the items of income and expense
that may warrant disclosure to assist users in predicting an entity's future performance.

4. The restructuring charges should be combined and presented as a line item in the companys
income statement in determining operating income.

In predicting future earnings for the company, the charges generally should not be considered to be
costs that will be incurred in the future. In fact, if the program of downsizing is successful,
operating results in the future could be expected to improve as a result of having incurred the
restructuring charges.

5. A material error represents a correction of an error in the amount of income reported in a prior
period. A material error are shown in the statement of changes in equity (or statement of
shareholders equity) as an adjustment to the balance of retained earnings at the beginning of the
period in which the error is identified.

6. Irregular income items, such as discontinued operations, and material error, are legitimate parts of
the earnings history of a company. On the other hand, they are non-recurring and should not carry
the same weight in evaluating future profitability as normal, recurring operating revenues and
expenses.

7. a. The current-year preference share dividend is deducted from profit to determine the earnings
allocable to the ordinary shareholders. (the preference share dividend is deducted only if
declared.)

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Q1-7
b. The par value of all preference share outstanding and the amount of all dividends in arrears
on preference share are deducted from total shareholders equity to determine the aggregate
book value allocable to the ordinary shareholders.

8. No, the number of ordinary shares used in computing earnings per share may be different from
that used to determine book value per share. In computing earnings per share, earnings
allocable to the ordinary shareholders is divided by the weighted-average number of ordinary
shares outstanding throughout the period. In computing book value per share at a specified date,
shareholders' equity allocable to the ordinary shareholders is divided by the number of ordinary
shares actually outstanding on that date. If the number of ordinary shares outstanding has not
changed during the period, the weighted-average number of ordinary shares outstanding during
the period will be equal to the number of ordinary shares outstanding on a particular date.

9. a. The price-earnings ratio is computed by dividing the market price of a share of ordinary
share by the annual earnings per share.

b. The amount of basic earnings per share is computed by dividing the profit available for
ordinary share by the weighted-average number of ordinary shares outstanding during the
year.

c. The amount of diluted earnings per share is computed by dividing profit by the maximum
potential number of shares outstanding after convertible securities are assumed to have been
converted.

10. a. Shares used in computing basic earnings per share:


Ordinary shares outstanding throughout the year . 3,000,000
b. Shares used in computing diluted earnings per share:
Ordinary shares outstanding throughout the year 3,000,000
Additional ordinary shares that would exist if preference share had
been converted at the beginning of the year (150,000 x 2) 300,000
Total shares used in diluted earnings computation 3,300,000
11. The analyst should recognize the risk that the outstanding convertible securities may be
converted into additional ordinary share, thereby diluting (reducing) basic earnings per share in
future years. If any of the convertible securities are converted, basic earnings per share probably
will increase at a slower rate than profit. In fact, if enough dilution occurs, basic earnings per
share could actually decline while profit continues to increase.

12. Date of declaration is the day the obligation to pay a dividend comes into existence by action
of the board of directors. Date of record is the day on which the particular shareholders who
are entitled to receive a dividend is determined. Persons listed in the corporate records as
owning share on this day will receive the dividend. Date of payment is the day the dividend is
distributed by the corporation. Ex-dividend date (usually three business days prior to the date
of record) is the day on which the right to receive a recently declared dividend no longer
attaches to share. As a result, the market price of the shares usually falls by the
amount of the dividend.

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Q8-13
13. The purpose of a stock dividend is to make a distribution of perceived value to shareholders as
a representation of the profitability of the company while, at the same time, conserving cash.

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Q8-13
14. A share split occurs when there is a relatively large increase in the number of shares issued without
any change in the total amount of stated capital (because the par value per share is reduced
proportionately to the increase in the number of shares).

A stock dividend occurs when there is a relatively small increase in the number of shares issued, with
no change in the net assets of the company but a transfer from retained earnings to the issued and paid
capital section of the balance sheet. The par value of share remains the same.

The distinction in the accounting treatment of a stock dividend and a share split stems directly from
the difference in the effect on stated (legal) capital and retained earnings. There is no difference in the
probable effect on per-share market price of a stock dividend and a share split of equal size, although
share splits are usually much larger than stock dividends.

15. Restructuring charges result when the company incurs costs in the process of reorganization, often
downsizing. The purpose of reorganization is to benefit future operations in terms of more efficient
operations, but the cost is ordinarily charged to current operations. Restructuring charges are not
extraordinary items, and unless they directly related to a discontinued part of the business, are not
presented as discontinued operations. They are often presented as a single line item in the income
statement, before income taxes.

16. Three items that may be shown in a statement of comprehensive income as causing changes in the
balance of retained earnings are:

(1) Profit or loss for the period


(2) Dividends declared (both cash dividends and stock dividends)
(3) Gains or losses arising from the fair value changes of Available For Sale investments
17. If the price of the share declines in proportion to the distribution of shares in a stock dividend, at the
time of that distribution the shareholder does not benefit. He/she holds exactly the same percentage of
the outstanding shares, and the value per share has declined in proportion to the increased number of
shares. Often, however, the value does not drop in proportion to the increased number of shares,
meaning that the recipient of the shares has an immediate benefit. For example, if an investor who
held 2,000 share that had a market value of $10 each received a 10% stock dividend, and the market
price only declined 5%, the following would result:

Market value before stock dividend:


2,000 shares @ $10 . $20,000
Market value after stock dividend:
(2,000 shares x 110%) x ($10 x 95%) . $20,900
The investor has benefited by $900. He/she could sell about 95 shares [$900/($10 x 95%)] at $9.50
and still have a share investment equal to the value before the stock dividend, although the investor
would own a smaller percentage of the company after the sale.

18. A liquidating dividend is a return of the investment made in the company to the investor, in contrast to
a non-liquidating dividend which is a return on the investment in the company. A liquidating dividend
occurs when dividends are distributed in excess of a companys retained earnings.

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Q14-18
19. The student is right in one senseboth share splits and stock dividends are distributions of a companys
shares to existing shareholders with the company receiving no payment in return. The student is
incorrect, however, in stating that the two are exactly the same. The primary difference is one of
magnitude and, thus, the impact on market value. A stock dividend is usually relatively small5% to
20% of the outstanding shares. A share split, on the other hand, is usually some multiple of the number
of outstanding shares, like a 2:1 split (100% increase) or a 3:1 split (200% increase). The market price
reacts strongly to a distribution as large as a share split while stock dividends are often unnoticed in the
share price.

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Q19-20
SOLUTIONS TO BRIEF EXERCISES

B.Ex. 12.1 FELLUPS LIMITED


Partial Income Statement
For year ended _______________

Profit from continuing operations $75,000

Loss from discontinued operations, net of $40,000 income taxes (60,000)


Profit . $15,000

B.Ex. 12.2 WALKER COMPANY


Income Statement
For year ended _______________

Revenues $1,500,000
Expenses 1,200,000
Operating Profit $300,000

Other non-operating profit 149,500


Profit $449,500

IFRS does not allow the presentation of extraordinary item in the financial statements

B.Ex. 12.3 WABASH LIMITED


Income Statement
For year ended _______________
Revenues $480,000
Expenses 430,000
Income from continuing operations $50,000
Discontinued operations:
Operating income from discontinued operations, net of
$10,000 income taxes $15,000
Loss on the sale of discontinued operations, net of
$22,000 income tax benefit 33,000 ($18,000)
Profit $32,000

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BE12.1,2,3,4
B.Ex. 12.4 Number of ordinary shares outstanding after stock dividend:
100,000 shares x 110% = 110,000

Cash required to pay $.50 per stock dividend:


110,000 shares x $.50 = $55,000

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BE12.1,2,3,4
B.Ex. 12.5 MESSER COMPANY
Statement of Comprehensive Income
For year ended _______________

Profit for the year


Other comprehensive income:
Gain on fair value changes of available for sale
investments
Total comprehensive income

B.Ex. 12.6 SALT & PEPPER LIMITED


Statement of Changes in Equity
For year ended _______________

Share capital, beginning of the year


Retained earnings, beginning of year
Corrections of error in prior year's financial statements
Shareholders' Equity, beginning of year, as restated
Add: Profit

Deduct: Preference share dividends $20,000*


Ordinary dividends 100,000**
Shareholders' Equity, end of year

*10,000 shares $1 x 2 years = $20,000


**200,000 shares x $.50 = $100,000

B.Ex. 12.7 Cash dividend on preference share:


100,000 shares x $100 par x 6%
Cash dividend on ordinary share:
750,000 shares x $.75
Total dividends

Journal entries to record declaration and payment of cash dividends:

Retained earnings 1,162,500


Dividends payable..
To record dividends declared on preference and
ordinary shares.

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BE12.5,6,7
Dividends payable. 1,162,500
Cash.
To record payment of dividends.

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BE12.5,6,7
ncome
____

88,000

25,000

$113,000

D
uity
____

$100,000
$460,000
(65,000)
$495,000
250,000
$745,000

120,000
$625,000

$600,000

562,500
$1,162,500

1,162,500

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BE12.5,6,7
1,162,500

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BE12.5,6,7
B.Ex. 12.8 Retained earnings 375,000*
Stock dividend to be distributed. 250,000 **
Share premium 125,000 ***
To record declaration of stock dividend.

*500,000 shares x 5% x $15 = $375,000


**500,000 shares x 5% x $10 = $250,000
***500,000 shares x 5% x ($15 - $10) = $125,000

Stock dividend to be distributed 250,000


Ordinary shares 250,000
To record distribution of stock dividend.

B.Ex. 12.9 ALEXANDER LIMITED


Shareholders' Equity Section of Balance Sheet
(Date)

Ordinary share, 770,000 shares, $5 par value $3,850,000 *


Share premium on ordinary shares 2,590,000 **
$6,440,000
Retained earnings 155,000 ***
Total shareholders' equity $6,595,000

*700,000 shares x 1.10 x $5 = $3,850,000


**700,000 shares x ($8 - $5) + 70,000 shares x ($12 - 5) =
$2,100,000 + $490,000 = $2,590,000
***$995,000 - (70,000 shares x $12) = $155,000

B.Ex. 12.10 CRASHER COMPANY


Statement of Comprehensive Income
For year ended _______________

Profit for the year $500,000


Other comprehensive income:
Gain on the fair value changes of available for sale
investments 20,000
Total comprehensive income $520,000

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BE12.8,9,10
SOLUTIONS TO EXERCISES

Ex. 12.1 a. 1,440 shares = [(200 x 2) x 120%] x 3


$17,280 = 1,440 x $12.

b. Since Smiley is a small and growing corporation, the board of directors probably
decided that cash from operations was needed to finance the companys expanding
operations.

c. You are probably better off because of the boards decision not to declare cash
dividends. Smiley was obviously able to invest the funds to earn a high rate of
return, as evidenced by the value of your investment, which has grown from
$1,000 to $17,280.

Ex. 12.2
a. None (Treasury share is not an asset; it represents shares that have been
reacquired by the company, not shares that have not yet been issued.)
b. Stock dividend
c. Share premium
d. Retrospective restatement
e. P/e ratio (Market price divided by earnings per ordinary share.)
f. Discontinued operations (Showing the discontinued operations in a separate
section of the income statement permits presentation of the subtotal, Income from
Continuing Operations.)
g. Diluted earnings per share
h. Total comprehensive income

Ex. 12.3 a. SPORTS LIMITED


Income Statement
For the Year Ended December 31, 20__
Sales .. $12,500,000
Costs and expenses (including applicable income tax) 8,600,000
Profit from continuing operations $3,900,000
Discontinued operations:
Operating loss from tennis shops (net of income
tax benefit) . $192,000
Loss on sale of tennis shops (net of income tax benefit) 348,000 (540,000)
Profit . $3,360,000
Earnings per share:
Earnings from continuing operations ($3,900,000 182,000 shares) $21.43
Loss from discontinued operations ($540,000 182,000) . (2.97)
Net earnings ($3,360,000 182,000 shares) .. $18.46

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E12.1,2,3
b. The $21.43 earnings per share figure from continuing operations (part a) is probably the most usefu
future operating results for Sports Limited Earnings per share from continuing operations represent
continuing and ordinary business activity, which is expected to continue in the future. Discontinued
extraordinary items are not likely to recur in the future.

Ex. 12.4 a. GLOBAL EXPORTS


Income Statement
For the Year Ended December 31, 20__
Net sales .
Less: Costs and expenses (including income tax) .
Profit from continuing operations .
Gain on disposal of discontinued operations, net of income tax
Profit ..
Earnings per share of ordinary share:

b. The $1.70 earnings per share before continuing operations is the figure used to compute the price-ea
Global Exports. If a company reports a gain or loss resulting from discontinued operations, the price
computed using the per-share earnings before discountinued item.

Ex. 12.5 a. 1.

2.

b. The earnings per share figure computed in part a (2) is a basic EPS figure. Although the company ha
ordinary and preference share, the preference share must be convertible into ordinary share in orde
diluted computation of earnings per share. The potential conversion of preference share into ordinar
necessitates disclosure of diluted EPS. Because the preference share in this exercise is not convertible
computation is basic.

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E12.4,5
The $21.43 earnings per share figure from continuing operations (part a) is probably the most useful one for predicting
future operating results for Sports Limited Earnings per share from continuing operations represents the results of
continuing and ordinary business activity, which is expected to continue in the future. Discontinued operations and
extraordinary items are not likely to recur in the future.

GLOBAL EXPORTS
Income Statement
For the Year Ended December 31, 20__
Net sales .
Less: Costs and expenses (including income tax) .
Profit from continuing operations .
Gain on disposal of discontinued operations, net of income tax
Profit ..
Earnings per share of ordinary share:
Earnings from continuing operations ($1,550,000 910,000 shares) ..
Earnings arising from the disposal of discontinued operations ($420,000 910,000 shares)
Net earnings ($1,970,000 910,000 shares)
The $1.70 earnings per share before continuing operations is the figure used to compute the price-earnings ratio for
Global Exports. If a company reports a gain or loss resulting from discontinued operations, the price-earnings ratio is
computed using the per-share earnings before discountinued item.

Profit (all applicable to ordinary shares)


Ordinary shares outstanding throughout the year ..
Earnings per share ($1,920,000 400,000 shares) ..
Profit ..
Less: Preference share dividend (100,000 x 8% x $100) .
Earnings available for ordinary share .
Ordinary shares outstanding throughout the year ..
Earnings per share ($1,120,000 300,000 shares)

The earnings per share figure computed in part a (2) is a basic EPS figure. Although the company has outstanding both
ordinary and preference share, the preference share must be convertible into ordinary share in order to result in a
diluted computation of earnings per share. The potential conversion of preference share into ordinary share is what
necessitates disclosure of diluted EPS. Because the preference share in this exercise is not convertible, the EPS
computation is basic.

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E12.4,5
ost useful one for predicting
represents the results of
ntinued operations and

$7,750,000
6,200,000
1,550,000
420,000
$1,970,000

$1.70
0.46
$2.16
price-earnings ratio for
the price-earnings ratio is

$1,920,000
400,000
$4.80
$1,920,000
800,000
$1,120,000
300,000
$3.73

mpany has outstanding both


e in order to result in a
o ordinary share is what
nvertible, the EPS

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E12.4,5
Ex. 12.6 a. 2009 2008 2007
Earnings per share $1.88 $1.575 (1) $1.20 (2)
(1) $3.15 originally reported, divided by 2 (twice as many shares)
(2) $2.40 originally reported, divided by 2
b. Following the stock dividend, the earnings per share of earlier periods should be
retroactively restated to reflect the increased number of shares. In this situation, each
"new share (after the 100% stock dividend) is equal to only one-half of a 2008 or 2007
share. If the earnings of each 2008 or 2007 share are allocated between the two new
shares, each new share is viewed as having earned one-half of the original amount ($3.15
2 = $1.575; $2.40 2 = $1.20).

Ex. 12.7 a. Apr. 30 Memorandum: Issued an additional 1,000,000 shares in a 2-for-1 share split.
Par value reduced from $1 per share to $0.50 per share.

June 1 Dividends 1,200,000


Dividends Payable 1,200,000
To record the declaration of a dividend of 60
cents per share on 2 million share outstanding.

July 1 Dividends Payable 1,200,000


Cash 1,200,000
To record payment of the dividend declared on
June 1.

Aug. 1 Retained Earnings 1,900,000


Stock Dividend to Be Distributed . 50,000
Share Premium: Stock Dividends 1,850,000
To record declaration of a 5% stock dividend
consisting of 100,000 shares (2,000,000 shares x
5%) of $0.50 par value ordinary share. Amount of
retained earnings transferred to equity is based
on market price of $19 a share.

Sept. 10 Stock Dividend to Be Distributed 50,000


Ordinary Shares 50,000
To record distribution of a stock dividend of
100,000 shares.

b. 2,100,000 shares
1,000,000 + 1,000,000 + 100,000
c. $0.50 par value per share ($1 par reduced to $0.50 par due to 2-for-1 share split on April
30.)
d. Share splitNo effect
Declaration/payment of cash dividendDecrease retained earnings
Declaration/distribution of stock dividendNo effect

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E12.6,7
Ex. 12.8 The market value of the total Express Limiteds shares outstanding is $5,280,000
(80,000 $66) before the stock dividend. Because the issuance of new shares has no
effect on the net assets of the company, there is no basis of predicting any change in
total market value of the companys share as a result of the stock dividend. The
logical conclusion is, therefore, that the market price per share should fall to $60
($5,280,000 88,000 shares). The fact that this exact result does not always follow in
practice must be attributed to a lack of understanding on the part of the investing
public and to other factors affecting per-share market price at the time of a stock
dividend.

Ex. 12.9 Net Cash


Current Shareholders Flow
(from Any
Event Assets Equity Profit Source)
a D D NE D
b NE NE NE NE
c NE NE NE NE
d D D NE D
e I I NE I

Ex. 12.10 a. After a share split, earnings per share are expressed in terms of the new shares.
Therefore, a 3-for-1 share split will cause earnings per share figures to be
restated at one-third of their former amounts.

b. Realization of a gain from most sources, including discontinued operations,


increases net earnings per share. (As this gain relates to discontinued operations,
however, it would not increase the per-share earnings from continuing
operations.)

c. Dividends declared or paid do not enter into the determination of profit.


Therefore, the declaration and/or payment of a cash dividend on ordinary share
has no effect upon earnings per share.

d. Earnings per share are restated to reflect the increased number of shares
resulting from a stock dividend. Therefore, a stock dividend causes a
proportionate reduction in the earnings per share reported in past periods, as
well as in the current period. (This effect parallels that of a share split, only
smaller.)

e. Acquisition of treasury shares reduces the weighted average number of shares


currently outstanding and, therefore, increases earnings per share.

The McGraw-Hill Companies, Inc., 2010


E12.8,9,10
Ex. 12.11 a. Balance sheet.
b. Statement of Changes in Equity
c. This information is not included in any formal financial statementit is quoted daily in
publications such as The Financial Times.

d. Statement of Changes in Equity


e. Statement of Changes in Equity and/or notes to financial statements.
f. Income statement.
g. This information may be reported in the annual report, but it is not a required disclosure in any
formal financial statement. It is also reported by investors services.

h. This information may be included in the annual report, but it is not a required disclosure in
financial statements. It is reported by investors services and in the financial pages of most
newspapers.

i. Statement of Changes in Equity, and statement of cash flows.

Ex. 12.12 a. Revenues .


Expenses .
Profit before income tax .
Income tax* .
Profit ..

*$290,000 x 35%

b. Profit for the year


Other comprehensive income:
Gains arising from the fair value changes of available-for-sale investments
Total comprehensive income .

* $19,200 $17,500 = $1,700 gain


$1,700 ($1,700 x 35% income tax) = $1,105 gains.

The McGraw-Hill Companies, Inc., 2010


E12.11,12
ance sheet.
ement of Changes in Equity
information is not included in any formal financial statementit is quoted daily in
ications such as The Financial Times.

ement of Changes in Equity


ement of Changes in Equity and/or notes to financial statements.
me statement.
information may be reported in the annual report, but it is not a required disclosure in any
mal financial statement. It is also reported by investors services.

information may be included in the annual report, but it is not a required disclosure in
ncial statements. It is reported by investors services and in the financial pages of most
spapers.

ement of Changes in Equity, and statement of cash flows.

enues . $572,000
enses . 282,000
it before income tax . $290,000
me tax* . 101,500
it .. $188,500

90,000 x 35%

it for the year $188,500


er comprehensive income:
Gains arising from the fair value changes of available-for-sale investments 1,105
l comprehensive income . $189,605

9,200 $17,500 = $1,700 gain


00 ($1,700 x 35% income tax) = $1,105 gains.

The McGraw-Hill Companies, Inc., 2010


E12.11,12
c. Profit is unchanged.
Profit for the year .
Other comprehensive income:
Loss arising from the Fair Value Changes of available-for-sale investments
Comprehensive income

* $17,500 $14,200 = $3,300 loss


$3,300 ($3,300 x 35% income tax benefit) = $2,145 loss

Ex. 12.13 a. 10% stock dividend: 500,000 shares x 1.10 = 550,000 shares
2:1 share split: 550,000 x 2 = 1,100,000 shares

Note: The cash dividends do not affect the number of outstanding shares.

b. $1 cash dividend: 550,000 shares x $1 = $550,000


$.60 cash dividend: 1,100,000 shares x $.60 = $660,000
Total cash paid: $550,000 + $660,000 = $1,210,000

Note: No cash is paid out with a stock dividend or a share split.

c. 220 shares [(100 shares x 1.10) x 2]


Market value of portfolio before the four transactions: 100 shares x $65 = $6,500

Market value of portfolio after the four transactions:


220 shares x $40 = $8,800

Your portfolio after the four transactions is $8,800 compared to $6,500 before the four transactions.
addition, you would have received cash dividends, as follows:

(100 shares x 1.10 x $1) + (110 shares x 2 x $.60) = $110 + $132 = $242

Ex. 12.14 a. adidas AG seems to be an aggressive company. It is constantly acquiring or introducing new brands
and products and making extensive promotion plan, that requires large amounts of capital. The
company retains the majority of its earnings in order to have the capital available to take advantage
its growth opportunities and to constantly introducing new brands and products for its growing
business.

b. Based on information in the Case-in-Point in this chapter, unless you have an extreme need for cash
you should probably be pleased that adidas AG retains its earnings rather than paying them to you
the form of higher dividends. The company is doing well investing its earnings, probably better than
you could do as an individual investor with the additional dividends you would receive if the compa
paid higher dividends.

The McGraw-Hill Companies, Inc., 2010


E12.13,14
fit is unchanged.
fit for the year . $ 188,500
her comprehensive income:
Loss arising from the Fair Value Changes of available-for-sale investments (2,145)
mprehensive income $186,355

17,500 $14,200 = $3,300 loss


300 ($3,300 x 35% income tax benefit) = $2,145 loss

% stock dividend: 500,000 shares x 1.10 = 550,000 shares


share split: 550,000 x 2 = 1,100,000 shares

e: The cash dividends do not affect the number of outstanding shares.

cash dividend: 550,000 shares x $1 = $550,000


0 cash dividend: 1,100,000 shares x $.60 = $660,000
al cash paid: $550,000 + $660,000 = $1,210,000

e: No cash is paid out with a stock dividend or a share split.

shares [(100 shares x 1.10) x 2]


rket value of portfolio before the four transactions: 100 shares x $65 = $6,500

rket value of portfolio after the four transactions:


220 shares x $40 = $8,800

ur portfolio after the four transactions is $8,800 compared to $6,500 before the four transactions. In
dition, you would have received cash dividends, as follows:

100 shares x 1.10 x $1) + (110 shares x 2 x $.60) = $110 + $132 = $242

das AG seems to be an aggressive company. It is constantly acquiring or introducing new brands


d products and making extensive promotion plan, that requires large amounts of capital. The
mpany retains the majority of its earnings in order to have the capital available to take advantage of
growth opportunities and to constantly introducing new brands and products for its growing
iness.

ed on information in the Case-in-Point in this chapter, unless you have an extreme need for cash,
should probably be pleased that adidas AG retains its earnings rather than paying them to you in
form of higher dividends. The company is doing well investing its earnings, probably better than
could do as an individual investor with the additional dividends you would receive if the company
d higher dividends.

The McGraw-Hill Companies, Inc., 2010


E12.13,14
Ex. 12.15 a. adidas AG did not report any irregular items for the year 2008 and 2009.

b. adidas AG seems to have one kind of share in its capital structure. 209 million
share capital had been issued. No information is available for its par value and
authorized capital. Indeed, note 26 of adidas AG (not enclosed) shows adidas'
share having no par value.

c. During the two years presented, adidas AG repurchased shares in 2007 (with a
decrease in share capital of 10 million and capital reserves of 399 million) and
issued share for the conversion of convertiable bond (with an increase in share
capital of 16 million and in capital reserves of 384 million).

The McGraw-Hill Companies, Inc., 2010


E12.15
SOLUTIONS TO PROBLEMS SET A
30 Minutes, Easy PROBLEM 12.1A
GREATER ASIAN AIRLINES
a.
GREATER ASIAN AIRLINES
Income Statement
For the Year Ended December 31, 20__
Sales
Costs and expenses (including income taxes on continuin
operations)
Profit from continuing operations
Discontinued operations:
Operating profit from motels (net of income tax) $ 864,000
Gain on sale of motels (net of income tax) 4,956,000
Profit

Earnings per share of ordinary share:


Earnings from continuing operations ($11,800,000
1,000,000 shares)
Profit from discontinued operations ($5,820,000
1,000,000 shares)
Profit ($17,620,000
1,000,000 shares)

b. Estimated net earnings per share next year:


Earnings per share from continuing operations
Estimated decrease ($11.80 x 5%)
Estimated net earnings per share next year

The profitability of the motels is not relevant, as t


motels are no longer owned by Greater Asian Airlin

The McGraw-Hill Companies, Inc., 2010


P12.1A
The McGraw-Hill Companies, Inc., 2010
P12.1A
O PROBLEMS SET A
PROBLEM 12.1A
ER ASIAN AIRLINES

_
$ 55,120,000

43,320,000
$ 11,800,000

5,820,000
$ 17,620,000

$ 11.80

5.82

$ 17.62

$ 11.80
(0.59)
$ 11.21

The McGraw-Hill Companies, Inc., 2010


P12.1A
The McGraw-Hill Companies, Inc., 2010
P12.1A
30 Minutes, Medium PROBLEM 12.2A
SLICK SOFTWARE LIMITED
a.
SLICK SOFTWARE LIMITED
Condensed Income Statement
For the Year Ended December 31, 2009
Sales $ 19,850,000
Costs and expenses (including applicable income taxes) 16,900,000
Profit from continuing operations $ 2,950,000
Discontinued operations:
Operating profit (net of income tax) $ 140,000
Loss on disposal (net of income tax benefit) (550,000) (410,000)
Profit $ 2,540,000

Earnings per share:


Earnings from continuing operations
[($2,950,000 - $500,000*) 200,000 shares] $ 12.25
Loss from discontinued operations ($410,000 200,000 shares) (2.05)
Net earnings
[($2,540,000 - $500,000 preference share dividends) 200,000 share $ 10.20

Net earnings
[($1,640,000 - $500,000 preference share dividends) $ 5.70
200,000 shares]

*Preference share dividends: 80,000 shares x $6.25 = $500,000

The McGraw-Hill Companies, Inc., 2010


P12.2A
PROBLEM 12.2A
SLICK SOFTWARE LIMITED (concluded)

b.
Total cash dividends declared during 2009 (data given) $ 950,000
Less: Preference share dividend (80,000 shares x $6.25 per share) 500,000
Cash dividends to ordinary shareholders $ 450,000
Number of ordinary shares outstanding through 2009 200,000
Cash dividend per ordinary share ($450,000 200,000 shares) $ 2.25

c. The single 2010 $8.00 figure for EPS is unfavorable in comparison with 2009 performance.
Since 2010 has only one EPS figure, it should be compared to the earnings per share from
continuing operations in 2009, which amounted to $12.25 per share. Slick Software Limiteds
earnings per share from continuing operations fell $4.25 per share (approximately 35%) from
2009 to 2010.

The McGraw-Hill Companies, Inc., 2010


P12.2A (p.2)
35 Minutes, Strong PROBLEM 12.3A
PHOENIX LIMITED
a.
PHOENIX LIMITED
Income Statement
For the Year Ended December 31, 2009
Sales $ 10,836,000
Costs and expenses:
Cost of goods sold $ 6,000,000
Selling expenses 1,104,000
General and administrative expenses 1,896,000
Loss from settlement of litigation 24,000
Income tax on continuing operations 720,000 9,744,000
Profit from continuing operations $ 1,092,000
Discontinued operations:
Operating loss on discontinued operations (net of
income tax benefit) $ (252,000)
Loss on disposal of discontinued operations (net of
income tax benefit) (420,000) (672,000)
Profit $ 420,000

Earnings per share on ordinary share:


Earnings from continuing operations ($1,092,000
180,000 shares) $ 6.07
Loss from discontinued operations ($672,000
180,000 shares) (3.73)
Net earnings ($420,000 180,000 shares) $ 2.34

Note: Selected EPS numbers have been rounded $.01 in order


for EPS schedule to foot.

The McGraw-Hill Companies, Inc., 2010


P12.3A
PROBLEM 12.3A
PHOENIX LIMITED (concluded)

b. The gain on sale of treasury share represents the excess of reissue price received over the
cost Phoenix paid to acquire some of its own share. Although a corporation may reissue
treasury share at prices above or below its cost of acquiring its own share, the difference
between amounts received and the cost of treasury shares does not result in gains or losses
recognized in the income statement. Rather, the amount described as gain on sale of
treasury share is included as part of share premium in the shareholders equity section of
the balance sheet.

The McGraw-Hill Companies, Inc., 2010


P12.3A (p.2)
20 Minutes, Easy PROBLEM 12.4A
ALBERS LIMITED
Total Number Book Value
Shareholders' of Shares per
Equity Outstanding Share
Beginning balance $ 840,000 40,000 $ 21.00
Jan. 10 Declared and distributed 5% share div. 2,000
Balance $ 840,000 42,000 $ 20.00
Mar. 15 Acquired 2,000 treasury share
at cost of $21.00 per share (42,000) (2,000)
Balance $ 798,000 40,000 $ 19.95
May 30 Reissued 2,000 treasury share
at price of $31.50 per share 63,000 2,000
Balance $ 861,000 42,000 $ 20.50
July 31 Share capital split 2-for-1 42,000
Balance $ 861,000 84,000 $ 10.25
Dec. 15 Declared $1.10 per share cash divi (92,400)
Balance 768,600 84,000 $ 9.15
Dec. 31 Profit 525,000
Balance $ 1,293,600 84,000 $ 15.40

Note to instructor: Profit actually increases book value throughout the year, not merely on the date
upon which profit is closed into retained earnings.

The McGraw-Hill Companies, Inc., 2010


P12.4A
20 Minutes, Medium PROBLEM 12.5A
STRAIT CORPORATION
STRAIT CORPORATION
Statement of Shareholders' Equity
For the Year Ended December 31, 20__
a. Share Capital Total
($10 par Share Retained Treasury Shareholders'
value) Premium Earnings Share Equity
Balances, January 1, 20__ $ 1,100,000 $ 1,765,000 $ 950,000 $ - $ 3,815,000
Prior period errors (net of income tax benefit) (80,000) (80,000)
Issuance of ordinary share; 10,000 shares 100,000 240,000 340,000
Declaration and distribution of 5% stock dividend
(6,000 shares at market price of $36 per s 60,000 156,000 (216,000) 0
Purchased 1,000 treasury share @$35 (35,000) (35,000)
Sale of 500 treasury shares @ $36 500 17,500 18,000
Profit 845,000 845,000
Cash dividends (142,700) (142,700)
Balances, December 31, 20__ $ 1,260,000 $
=SUM(f10.f18) 2,161,500 $ 1,356,300 $ (17,500) $ 4,760,300

(part b is on following page)

The McGraw-Hill Companies, Inc., 2010


P12.5A
PROBLEM 12.5A
STRAIT CORPORATION (concluded)

b. Declaration/distribution of a 5% stock dividend has no effect on total shareholders equity.


Declaration of a cash dividend reduces total shareholders equity by the amount of the
dividend.

The two types of dividends do not have the same impact upon shareholders equity. A cash
dividend is a distribution of a corporations assets (cash) to shareholders and, as such,
causes a decrease in shareholders equity. A stock dividend is simply issuing more share
certificates to the existing group of shareholders with no accompanying increase or outflow
of assets; a corporations own share is not an asset of the corporation. With both small and
large share dividends, shareholders equity is adjusted to reflect the increased number of
shares outstanding, but there is no additional equity created and no decrease in equity.

The McGraw-Hill Companies, Inc., 2010


P12.5A(p.2)
40 Minutes, Strong PROBLEM 12.6A
THOMPSON SERVICE
a.
General Journal

2009
Jan 3 Dividends 382,000
Dividends Payable 382,000
To record declaration of $1 per share cash
dividend payable on Feb. 15 to shareholders of
record on Jan. 31

Feb ### Dividends Payable 382,000


Cash 382,000
To record payment of dividend declared Jan. 3.

Apr ### Treasury Share 240,000


Cash 240,000
Purchased 6,000 treasury share at $40
per share.

May 9 Cas 176,000


h Treasury Share 160,000
Share Premium: Treasury Share 16,000
Sold 4,000 treasury share, which cost
$160,000, at a price of $44 per share.

June 1 Retained Earnings 798,000


Stock Dividend to Be Distributed 19,000
Share Premium: Stock Dividends 779,000
Declared a 5% stock dividend (19,000 shares) on
380,000 outstanding shares. Market price $42, par
value $1. To be distributed on June 30 to
shareholders of record.

### Stock Dividend to Be Distributed 19,000


Share Capital 19,000
Issued 19,000 shares of share capital as 5% stock
dividend.

Aug 4 Cash 22,200


Share Premium: Treasury Share 1,800
Treasury Share 24,000
Sold 600 shares of treasury share, which cost $24,000,
at a price of $37 per share.

Dec ### Income Summary 1,928,000


Retained Earnings 1,928,000
To close Income Summary account for the year.

The McGraw-Hill Companies, Inc., 2010


P12.6A
Dec ### Retained Earnings 382,000
Dividends 382,000
To close Dividends account.

The McGraw-Hill Companies, Inc., 2010


P12.6A
PROBLEM 12.6A
THOMPSON SERVICE (concluded)
b.
THOMPSON SERVICE
Partial Balance Sheet
December 31, 2009
Shareholders equity:
Share capital, $1 par value, 500,000 shares authorized,
401,000 shares issued, of which 1,400 are held in the treasury $ 401,000
Share premium:
From issuance of share capital $ 4,202,000
From stock dividend 779,000
From treasury share 14,200 4,995,200
Total issued and fully paid capital 5,396,200
Retained earnings* 3,452,600
$ 8,848,800
Less: Treasury share, 1,400 shares at cost 56,000
Total shareholders equity $ 8,792,800

*Computation of retained earnings at Dec. 31, 2009:


Retained earnings at beginning of year $ 2,704,600
Add: Profit for the year 1,928,000
Subtotal $ 4,632,600
Less: Cash dividend declared Jan. 3 $ 382,000
Stock dividend declared June 1 798,000 1,180,000
Retained earnings, Dec. 31, 2009 $ 3,452,600

c. Computation of maximum legal cash dividend


per share at Dec. 31, 2009:
Retained earnings at Dec. 31, 2009 $ 3,452,600
Less: Restriction of retained earnings for
treasury share owned 56,000
Unrestricted retained earnings $ 3,396,600
Number of shares outstanding
(401,000 shares issued, minus 1,400 shares
held in treasury) 399,600
Maximum legal cash dividend per share ($3,396,600
divided by 399,600 shares) $ 8.50

The McGraw-Hill Companies, Inc., 2010


P12.6A (p.2)
30 Minutes, Strong PROBLEM 12.7A
TECH PROCESS LIMITED

a. Net Cash Flow


Current Shareholders (from Any
Event Assets Equity Profit Source)
1 NE D NE NE
2 D NE NE D
3 D D NE D
4 I I NE I
5 NE NE NE NE
I = Increase
D = Decrease
NE = No effect

b. 1. Declaration of a cash dividend has no immediate effect upon profit or cash


flows. It increases current liabilities (dividends payable), but has no effect on
current assets. Also, retained earnings is decreased, resulting in a decrease in
shareholders equity.

2. Payment of a cash dividend has no effect on revenue or expenses, but it reduces cash. Since it
reduces cash, it also reduces current assets. The transaction has no effect on shareholders
equity, which has already been decreased when the dividend was declared.

3. The purchase of treasury share has no effect on either revenue or expenses and,
therefore, does not affect profit. But cash is used to purchase the treasury
share, and this decreases cash and current assets. Because treasury share is
deducted from shareholders equity in the balance sheet, its purchase decreases
shareholders equity.

4. Reissuance of treasury share at a price less than its original cost results in a loss, but these
losses are not recorded in the income statement. Instead share premium is decreased for the
amount of the loss. Therefore, this transaction does not affect profit. Since the treasury share
account is deducted from shareholders equity, reissuance of the share increases the total
amount of shareholders equity. Also, both cash and current assets are increased as a result of
the cash received from sale of the share.

5. Declaration of a stock dividend results in a reclassification of amounts from Retained


Earnings to the Share Capital and Share Premium accounts. It has no effect on cash, current
assets, shareholders equity, or profit.

The McGraw-Hill Companies, Inc., 2010


P12.7A
50 Minutes, Strong PROBLEM 12.8A
MANDELLA CORPORATION
a.
MANDELLA CORPORATION
Partial Balance Sheet
December 31, 2008
Shareholders equity:
Share Capital:
Ordinary share, $10 par, 500,000 shares authorized,
150,000 shares issued, of which 10,000 are held
in the treasury
Stock dividend to be distributed (1)
Share premium:
From issuance of ordinary share $ 3,000,000
From stock dividend (2) 350,000
Total issued and paid capital
Retained earnings (3)

Less: Treasury share, 10,000 shares at cost of $34 per share


Total shareholders equity

(1) (150,000 shares - 10,000 shares) x 10% = 140,000 shares


@$10 par
(2) Total stock dividend (14,000 shares x $35) $ 490,000
Par value (14,000 shares x $10) (140,000)
Share premium: stock dividend $ 350,000

(3) Profit for 2008 $ 940,000


Less: Stock dividend (14,000 shares x $35) 490,000
Retained earnings at end of 2008 $ 450,000

b.
MANDELLA CORPORATION
Partial Balance Sheet
December 31, 2009
Shareholders equity:
Share capital:
Ordinary share, $5 par, 1,000,000 shares authorized,
328,000 shares issued and outstanding (1)
Share premium:
From issuance of ordinary share $ 3,000,000
From stock dividend 350,000
From treasury share (2) 50,000
Total fully issued and paid capital
Retained earnings (3)
Total shareholders equity

(1) (150,000 shares +14,000 shares) x 2 = 328,000 shares


@ $5 par
(2) 10,000 shares x ($39 reissuance price - $34 cost) = $50,000
(3) Retained earnings at end of 2008 $ 450,000
Profit for 2009 1,080,000
Subtotal $ 1,530,000
Less: Cash dividend (328,000 shares x $2) 656,000

The McGraw-Hill Companies, Inc., 2010


P12.8A
Retained earnings at end of 2009 $ 874,000

The McGraw-Hill Companies, Inc., 2010


P12.8A
PROBLEM 12.8A
LLA CORPORATION

$ 1,500,000
140,000

3,350,000
$ 4,990,000
450,000
$ 5,440,000
340,000
$ 5,100,000

$ 1,640,000

3,400,000
$ 5,040,000
874,000
$ 5,914,000

The McGraw-Hill Companies, Inc., 2010


P12.8A
The McGraw-Hill Companies, Inc., 2010
P12.8A
25 Minutes, Strong PROBLEM 12.9A
ESPER CORP.
a.
ESPER CORP.
Partial Income Statement
For the Year Ended December 31, 20__
(Dollars in
Thousands)
Loss from continuing operations $ (24,516)
Profit from discontinued operations 6,215
Loss $ (18,301)

b.
Loss $ (18,301)
Less: Preference share dividend requirements (2,778)
Net loss applicable to ordinary shareholders (21,079)
Weighted-average number of ordinary share 39,739
Loss per share ($21,079 39,739) $ (0.53)

The McGraw-Hill Companies, Inc., 2010


P12.9A
The McGraw-Hill Companies, Inc., 2010
P12.9A
SOLUTIONS TO PROBLEMS SET B
30 Minutes, Easy PROBLEM 12.1B
PACIFIC AIRLINES
a.
PACIFIC AIRLINES
Income Statement
For the Year Ended December 31, 20__
Sales $ 61,440,000
Costs and expenses (including income taxes on
continuing and other items of operations) 57,100,000
Profit from continuing operations $ 4,340,000
Discontinued operations:
Operating profit from car rental (net of income tax $ 670,000
Gain on sale of car rental business (net of income 4,330,000 5,000,000
Profit $ 9,340,000

Earnings per ordinary share:


Earnings from continuing operations ($4,340,000
4,000,000 shares) $ 1.09
Income from discontinued operations ($5,000,000
4,000,000 shares) 1.25

Net earnings ($9,340,000 4,000,000 shares) $ 2.34

b. Estimated net earnings per share next year:


Earnings per share from continuing operati $ 1.87
Estimated decrease ($1.87 x 10%) 0.19
Estimated net earnings per share next year $ 1.68

The profitability of the rental car operations is


relevant, as these cars are no longer owned by
Pacific Airlines.

The McGraw-Hill Companies, Inc., 2010


P12.1B
The McGraw-Hill Companies, Inc., 2010
P12.1B
30 Minutes, Medium PROBLEM 12.2B
BEACH LIMITED
a.
BEACH LIMITED
Condensed Income Statement
For the Year Ended December 31, 2009
Sales $ 37,400,000
Costs and expenses (including applicable income tax) 21,500,000
Income from continuing operations $ 15,900,000
Discontinued operations:
Operating income (net of income tax) $ 205,000
Loss on disposal (net of income tax benefit) (510,000) (305,000)
Profit $ 15,595,000

Earnings per share:


Earnings from continuing operations
[($15,900,000 - $600,000*) 200,000 shares] $ 76.500
Loss from discontinued operations ($305,000 200,000 shares) (1.525)
Net earnings $ 74.975
[($15,595,000 - $600,000 preference share dividends)
200,000 shares]

*Preference share dividends: 100,000 shares x $6 = $600,000

The McGraw-Hill Companies, Inc., 2010


P12.2B
PROBLEM 12.2B
BEACH LIMITED (concluded)
b.
BEACH LIMITED
Statement of Comprehensive Income
For the Year Ended December 31, 2009

Profit for the year $ 15,595,000


Less: Prior period error (net of income tax) 310,000
As restated $ 15,285,000

Subtotal $ 15,285,000
Other comprehensive income:
Loss on fair value change of available-for-sale securities $ (930,000)
Total comprehensive income, December 31, 2009 $ 14,355,000

c.
Total cash dividends declared during 2009 (data given) $ 2,000,000
Less: Preference stock dividend (100,000 shares x $6 per share) 600,000
Cash dividends to ordinary shareholders $ 1,400,000
Number of ordinary shares outstanding through 2009 200,000
Cash dividend per ordinary share ($1,400,000 200,000 shares) $ 7.00

d. The single 2010 $75.00 figure for EPS is unfavorable in comparison with 2009 performance.
Since 2010 has only one EPS figure, it should be compared to the earnings per share from
continuing operations in 2009, which amounted to $76.50 per share. Beach Limiteds
earnings per share from continuing operations fell $1.50 per share (2%) from 2009 to 2010.

The McGraw-Hill Companies, Inc., 2010


P12.2B (p.2)
35 Minutes, Strong PROBLEM 12.3B
DEXTER LIMITED
a.
DEXTER LIMITED
Income Statement
For the Year Ended December 31, 2009
Sales $ 10,200,000
Costs and expenses:
Cost of goods sold $ 4,000,000
Selling expenses 1,050,000
General and administrative expenses 840,000
Loss from settlement of litigation 10,000
Income tax on continuing operations 612,000 $ 6,512,000
Profit from continuing operations $ 3,688,000
Discontinued operations:
Operating loss on discontinued operations (net of
income tax benefit) $ (180,000)
Loss on disposal of discontinued operations (net of
income tax benefit) (240,000) (420,000)
Profit $ 3,268,000

Earnings per share on ordinary share:


Earnings from continuing operations ($3,688,000
500,000 shares) 7.38
Loss from discontinued operations ($420,000
500,000 shares) (0.84)
Net earnings ($3,268,000 500,000 shares) $ 6.54

The McGraw-Hill Companies, Inc., 2010


P12.3B
PROBLEM 12.3B
DEXTER LIMITED (concluded)
b.
DEXTER LIMITED
Statement of Comprehensive Income
For the Year Ended December 31, 2009

Profit for the year


Add: Prior period error (net of income tax)
As restated

Other comprehensive income:


Gain on fair value changes of available-for-sale financial assets, net of tax

Total comprehensive income, December 31, 2009

c. The gain on sale of treasury share represents the excess of reissue price received over the cost
Dexter paid to acquire some of its own shares. Although a corporation may reissue treasury share at
prices above or below its cost of acquiring its own share, the difference between amounts received and
the cost of treasury shares does not result in gains or losses recognized in the income statement.
Rather, the amount described as gain on sale of treasury share is included as part of share premium
in the shareholders equity section of the balance sheet.

The McGraw-Hill Companies, Inc., 2010


P12.3B (p.2)
PROBLEM 12.3B
LIMITED (concluded)

$ 3,268,000
80,000
$ 3,348,000

$ 110,000

$ 3,458,000

ice received over the cost


may reissue treasury share at
between amounts received and
in the income statement.
luded as part of share premium

The McGraw-Hill Companies, Inc., 2010


P12.3B (p.2)
20 Minutes, Easy PROBLEM 12.4B
JESSEL LIMITED
Total Number Book Value
Shareholders' of Shares per
Equity Outstanding Share (rounded)
Beginning balance $ 600,000 20,000 $ 30.00
Jan. 16 Declared and distributed 5% stock div. 1,000
Balance $ 600,000 21,000 $ 28.57
Feb. 9 Acquired 300 shares of treasury share
at cost of $55.00 per share (16,500) (300)
Balance $ 583,500 20,700 $ 28.19
Mar. 3 Reissued 300 shares of treasury share
at price of $65.00 per share 19,500 300
Balance $ 603,000 21,000 $ 28.71
Jul. 5 Share capital split 2-for-1 21,000
Balance $ 603,000 42,000 $ 14.36
Nov. 22 Declared $6.00 per share cash divi (252,000)
Balance 351,000 42,000 $ 8.36
Dec. 31 Profit 87,000
Balance $ 438,000 42,000 $ 10.43

Note to instructor: Profit actually increases book value throughout the year, not merely on the date
upon which profit is closed into retained earnings.

The McGraw-Hill Companies, Inc., 2010


P12.4B
20 Minutes, Medium PROBLEM 12.5B
DRY WALL LIMITED
DRY WALL LIMITED
Statement of Shareholders' Equity
For the Year Ended December 31, 20__
a. Share Capital Total
($1 par Share Retained Treasury Shareholders'
value) Premium Earnings Share Equity
Balances, January 1, 20__ $ 130,000 $ 1,170,000 $ 1,400,000 $ - $ 2,700,000
Prior period adjustment (net of income tax benefit) (47,000) (47,000)
Issuance of ordinary share; 20,000 shares 20,000 280,000 300,000
Declaration and distribution of 10% stock dividend
(15,000 shares at market price of $17 per 15,000 240,000 (255,000) 0
Purchased 3,000 shares of treasury share @$16 (48,000) (48,000)
Sale of 1,000 treasury shares @ $18 2,000 16,000 18,000
Profit 1,200,000 1,200,000
Cash dividends ($1 per share) (163,000) (163,000)
Balances, December 31, 20__ $ 165,000 $
=SUM(f10.f18) 1,692,000 $ 2,135,000 $ (32,000) $ 3,960,000

(part b is on following page)

The McGraw-Hill Companies, Inc., 2010


P12.5B
PROBLEM 12.5B
DRY WALL LIMITED (concluded)

b. Declaration/distribution of a 10% stock dividend has no effect on total shareholders


equity. Declaration of a cash dividend reduces total shareholders equity by the amount of
the dividend.

The two types of dividends do not have the same impact upon shareholders equity. A cash
dividend is a distribution of a corporations assets (cash) to shareholders and, as such,
causes a decrease in shareholders equity. A stock dividend is simply issuing more share
certificates to the existing group of shareholders with no accompanying increase or outflow
of assets; a corporations own share is not an asset of the corporation. With both small and
large stock dividends, shareholders equity is adjusted to reflect the increased number of
shares outstanding, but there is no additional equity created and no decrease in equity as
occurs when a cash dividend is declared.

The McGraw-Hill Companies, Inc., 2010


P12.5B(p.2)
40 Minutes, Strong PROBLEM 12.6B
GREENE LIMITED
a.
General Journal

2009
Jan 5 Dividends 560,000
Dividends Payable 560,000
To record declaration of $1 per share cash
dividend payable on Feb. 18 to shareholders of
record on Jan. 31.

Feb ### Dividends Payable 560,000


Cash 560,000
To record payment of dividend declared Jan. 5

Apr ### Treasury Share 10,000


Cash 10,000
Purchased 1,000 shares of treasury share at $10
per share.

May ### Cas 6,000


h Treasury Share 5,000
Share Premium: Treasury Share 1,000
Sold 500 shares of treasury share, which cost
$5,000, at a price of $12 per share.

June ### Retained Earnings 307,725


Stock Dividend to Be Distributed 27,975
Share Premium: Stock Dividends 279,750
Declared a 5% stock dividend (27,975 shares) on
559,500 outstanding shares. Market price $11, par
value $1. To be distributed on June 30 to
shareholders of record at June 22.

### Stock Dividend to Be Distributed 27,975


Share capital 27,975
Issued 27,975 shares of share capital as 5% share
dividend declared June 15.

Aug ### Cash 2,925


Share Premium: Treasury Share 75
Treasury Share 3,000
Sold 300 shares of treasury share, which cost $3,000,
at a price of $9.75 per share.

Dec ### Income Summary 1,750,000


Retained Earnings 1,750,000
To close Income summary account for the year.

The McGraw-Hill Companies, Inc., 2010


P12.6B
Dec ### Retained Earnings 560,000
Dividends 560,000
To close Dividends account.

The McGraw-Hill Companies, Inc., 2010


P12.6B
PROBLEM 12.6B
GREENE LIMITED (concluded)
b.
GREENE LIMITED
Partial Balance Sheet
December 31, 2009
Shareholders equity:
Share Capital, $1 par value, 1,000,000 shares authorized,
587,975 shares issued, of which 200 are held in the treasury $ 587,975
Share premium:
From issuance of share capital $ 4,480,000
From stock dividend 279,750
From treasury share 925 4,760,675
Total issued and fully paid capital $ 5,348,650
Retained earnings* 3,882,275
$ 9,230,925
Less: Treasury share, 200 shares at cost 2,000
Total shareholders equity $ 9,228,925

*Computation of retained earnings at Dec. 31, 2009:


Retained earnings at beginning of year $ 3,000,000
Add: Profit for year 1,750,000
Subtotal $ 4,750,000
Less: Cash dividend declared Jan. 3 $ 560,000
Stock dividend declared June 1 307,725 867,725
Retained earnings, Dec. 31, 2009 $ 3,882,275

c. Computation of maximum legal cash dividend


per share at Dec. 31, 2009:
Retained earnings at Dec. 31, 2009 $ 3,882,275
Less: Restriction of retained earnings for
treasury share owned 2,000
Unrestricted retained earnings $ 3,880,275
Number of shares outstanding
(587,975 shares issued, minus 200 shares
held in treasury) 587,775
Maximum legal cash dividend per share ($3,880,275
divided by 587,775 shares) $ 6.60

The McGraw-Hill Companies, Inc., 2010


P12.6B (p.2)
30 Minutes, Strong PROBLEM 12.7B
HOT WATER LIMITED

a. Net Cash Flow


Current Shareholders (from Any
Event Assets Equity Profit Source)
1 NE D NE NE
2 D NE NE D
3 D D NE D
4 I I NE I
5 NE NE NE NE
I = Increase
D = Decrease
NE = No effect

b. 1. Declaration of a cash dividend has no immediate effect upon profit or cash


flows. It increases current liabilities (dividends payable), but has no effect on
current assets. Also, retained earnings is decreased, resulting in a decrease in
shareholders equity.

2. Payment of a cash dividend has no effect on revenue or expenses, but it reduces cash. Since it
reduces cash, it also reduces current assets. The transaction has no effect on shareholders
equity, which has already been decreased when the dividend was declared.

3. The purchase of treasury share has no effect on either revenue or expenses and,
therefore, does not affect profit. But cash is used to purchase the treasury
share, and this decreases cash and current assets. Because treasury share is
deducted from shareholders equity in the balance sheet, its purchase decreases
shareholders equity.

4. Reissuance of treasury share at a price less than its original cost results in a loss, but these
losses are not recorded in the income statement. Instead share premium is decreased for the
amount of the loss. Therefore, this transaction does not affect profit. Since the treasury share
account is deducted from shareholders equity, reissuance of the share increases the total
amount of shareholders equity. Also, both cash and current assets are increased as a result of
the cash received from sale of the share.

5. Declaration of a stock dividend results in a reclassification of amounts from Retained


Earnings to the Share Capital and Share Premium accounts. It has no effect on cash, current
assets, shareholders equity, or profit.

The McGraw-Hill Companies, Inc., 2010


P12.7B
50 Minutes, Strong PROBLEM 12.8B
ADAMS CORPORATION
a.
ADAMS CORPORATION
Partial Balance Sheet
December 31, 2008
Shareholders equity:
Share capital:
Ordinary share, $1 par, 100,000 shares authorized,
20,000 shares issued, 16,000 shares outstanding
Stock dividend to be distributed (1)
Share premium:
From issuance of ordinary share $ 480,000
From stock dividend (2) 48,000
Total issued and fully paid capital
Retained earnings (3)

Less: Treasury share, 4,000 shares at cost of $30 per s


Total shareholders equity

(1) (20,000 shares - 4,000 shares) x 10% = 16,000 share


@$1 par
(2) Total stock dividend (1,600 shares x $31) $ 49,600
Par value (1,600 shares x $1) (1,600)
Share premium: stock dividend $ 48,000

(3) Profit for 2008 $ 850,000


Less: Stock dividend (1,600 shares x $31) 49,600
Retained earnings at end of 2008 $ 800,400

b.
ADAMS CORPORATION
Partial Balance Sheet
December 31, 2009
Shareholders equity:
Share capital:
Ordinary share, $.50 par, 200,000 shares authorized,
43,200 shares issued and outstanding (1)
Share premium:
From issuance of ordinary share $ 480,000
From stock dividend 48,000
From treasury share (2) 20,000
Total issued and fully paid capital
Retained earnings (3)
Total shareholders equity

(1) (20,000 shares + 1,600 shares) x 2 = 43,200 shares


@ $.50 par
(2) 4,000 shares x ($35 reissuance price - $30 cost) = $20
(3) Retained earnings at end of 2008 $ 800,400
Profit for 2009 810,000
Subtotal $ 1,610,400
Less: Cash dividend (43,200 shares x $1) 43,200
Retained earnings at end of 2009 $ 1,567,200

The McGraw-Hill Companies, Inc., 2010


P12.8B
The McGraw-Hill Companies, Inc., 2010
P12.8B
PROBLEM 12.8B
AMS CORPORATION

$ 20,000
1,600

528,000
$ 549,600
800,400
$ 1,350,000
120,000
$ 1,230,000

$ 21,600

548,000
$ 569,600
1,567,200
$ 2,136,800

The McGraw-Hill Companies, Inc., 2010


P12.8B
The McGraw-Hill Companies, Inc., 2010
P12.8B
25 Minutes, Strong PROBLEM 12.9B
BLUE JAY MANUFACTURING
CORP.
a.
BLUE JAY MANUFACTURING CORPORATION
Partial Income Statement
For the Year Ended December 31, 20__
(Dollars in
Thousands)
Loss from continuing operations $ (28,220)
Profit from discontinued operations 12,000
Loss $ (16,220)

b.
Loss $ (16,220)
Less: Preference share dividend requirements (3,100)
Net loss applicable to ordinary shareholders $ (19,320)
Weighted-average number of ordinary share 10,000
Loss per share ($16,220 10,000) $ 1.622

The McGraw-Hill Companies, Inc., 2010


P12.9B
SOLUTIONS TO CRITICAL THINKING CASES
20 Minutes, Easy CASE 12.1
WHAT'S THIS?

a. Both the operating profit from the Indian mobile telecommunications operations and the
disposal gain should be classified in HTILs income statement as discontinued operations and
should be shown separately from the results of HTILs ongoing business operations. These
gains qualify for this separate treatment because the discontinued activities represented an
entire identifiable segment of HTILs business operations.

b. Acquisition of a new entity affect only the current year and future years, and are included in
revenues and expenses from normal operations.

c. The settlement of the court case by Cathay Pacific is classified in normal and recurring
business operations.

d. Liquidation of Shiseido Beautech Co., Ltd. is classified as discontinued operation because


Shiseido Beautech will no longer be able to operate its business.

The McGraw-Hill Companies, Inc., 2010


Case 12.1
20 Minutes, Medium CASE 12.2
IS THERE LIFE WITHOUT BASEBALL?

a. If JPL had not sold the baseball team at the end of 2009, it still would have incurred the teams
$1,300,000 operating loss for the year. However, the company would not have realized the $4,700,000
gain on the sale. Other items in the income statement would not have been affected. Thus, JPLs income
for 2009 would have been $4,700,000 less than was actually reported, or $2,600,000 ($7,300,000
$4,700,000 = $2,600,000).

b. In 2009, JPLs newspaper business earned $3,900,000, as shown by the subtotal, Profit from Continuing
Operations. If the profitability of these operations increased by 7% in 2010, they would earn
approximately $4,173,000 ($3,900,000 x 1.07 = $4,173,000). If the baseball team were still owned and lost
$2,000,000 in 2010, JPL could be expected to earn a profit of about $2,173,000 in that year.

c. Given that the baseball team was sold in 2009, JPL should earn a profit of approximately $4,173,000 in
2010, assuming that the profitability of the continuing newspaper operations increases by 7%
($3,900,000 x 1.07 = $4,173,000).

d. The operating loss incurred by the baseball team in 2009 indicates that the teams expenses (net of tax
effects) exceeded its revenue by $1,300,000. If the expenses were $32,200,000, the revenue must have
amounted to $1,300,000 less, or $30,900,000.

The McGraw-Hill Companies, Inc., 2010


Case 12.2
30 Minutes, Strong CASE 12.3
USING EARNINGS PER SHARE STATISTICS

a. The company reports earnings per share computed on both a basic and a diluted basis because it has
outstanding convertible preference share. The conversion of these
securities into ordinary share would increase the number of ordinary shares outstanding and thereby
dilute (reduce) earnings per share of ordinary share. The primary purpose of a companys disclosing
diluted earnings per share is to warn investors of the dilution in earnings that could occur if the
convertible securities actually were converted.

It is important to recognize that diluted earnings represent a hypothetical case. The convertible
securities have not actually been converted into ordinary shares as of the close of the current year.

b. The total dollar amount of the companys loss from discontinued operations can be computed from
the earnings per share information as follows:

oss from discontinued operations per share ($6.90 $3.60) ..


Total loss from discontinued operations ($3.30 per share x 3 million shares)
c. The approximate market price of the companys ordinary share is $69 per share. When a companys
income statement includes an extraordinary item, the price-earnings ratio shown in newspapers is
based upon basic earnings before extraordinary items ($6.90 x 10 = $69).

d. (1) $7.59 ($6.90 x 110%)


Only the continuing operations will be earning revenue and incurring expenses next year, and
the extraordinary item is not expected to recur. Therefore, the starting point for projecting
future net earnings should be earnings from continuing operations. Since both revenue and
expenses are expected to increase by 10%, earnings per share also should increase 10%.

(2) $6.05 ($5.50 x 110%)


The diluted earnings per share figures show the effect that conversion of all of the convertible
preference share into ordinary shares would have had upon this years earnings. Earnings per
share from continuing operations would have been only $5.50, rather than $6.90. Thus, $5.50
per share becomes the logical starting point for forecasting next years net earnings. As in part
(1), next years earnings are expected to rise by 10% over those of the current year.

The McGraw-Hill Companies, Inc., 2010


Case 12.3
CASE 12.3
HARE STATISTICS

diluted basis because it has

ares outstanding and thereby


se of a companys disclosing
that could occur if the

l case. The convertible


close of the current year.

ons can be computed from

$3.30
$9,900,000
r share. When a companys
o shown in newspapers is

ing expenses next year, and


ting point for projecting
. Since both revenue and
should increase 10%.

ion of all of the convertible


ars earnings. Earnings per
her than $6.90. Thus, $5.50
ars net earnings. As in part
the current year.

The McGraw-Hill Companies, Inc., 2010


Case 12.3
35 Minutes, Strong CASE 12.4
INTERPRETING A STATEMENT OF
CHANGES IN EQUITY

a. Beginning of year: 77,987,500 shares outstanding (82,550,000 issued 4,562,500 held in


treasury)
End of year: 77,353,100 shares outstanding (82,550,000 issued 5,196,900 treasury
shares)
b. $95,700,000 total dividend declared on ordinary share
77,804,878 approximate number of shares entitled to $1.23 per stock dividend ($95,700,000
$1.23 per share)

This answer appears reasonable, since the number of ordinary shares outstanding
ranged from 77,987,500 at the beginning of the year to 77,353,100 at year-end. The
77,804,878 approximate figure for the $1.23 annual dividend appears compatible with the
beginning and ending actual figures because it falls between these numbers.

c. The share issued during the year for the share option plans consisted of treasury shares, not
newly issued shares. The Treasury Share account is used to account for repurchases of a
corporations share, as well as the reissuance of treasury shares. When share is repurchased
and subsequently reissued, the Ordinary Share account is not affected; these transactions do,
however, affect the Treasury Share account, a contra- shareholders equity account.

d. $29.79 average cost per share of treasury share at the beginning of the year
($135,900,000 total cost 4,562,500 treasury shares)
e. The aggregate reissue price for the treasury shares must have been lower than the cost to
acquire those treasury shares, because the Share Premium account was reduced by the
reissuance of the treasury share. The cost of the treasury shares reissued was $16,700,000;
the reissue price for the treasury shares must have been $15,300,000 to cause a $1,400,000
reduction in Share Premium.

f. $63.61 average cost per share for treasury share acquired during the current year
($78,600,000 aggregate cost 1,235,700 shares repurchased)
g. Earnings per share: Divide by the weighted-average number of shares outstanding
throughout the year
Book value per share: Divide by the actual number of shares outstanding as of the specific
date (usually a balance sheet date)

The McGraw-Hill Companies, Inc., 2010


Case 12.4
60 Minutes, Strong CASE 12.5
CLASSIFICATION OF UNUSUAL ITEMS
AND THE POTENTIAL FINANCIAL IMPACT
a. An asset represents something with future economic benefit. But if the amount at which
the asset is presented in the balance sheet (i.e., its book value) cannot be recovered
through future use or sale, any future economic benefit appears to be less than the
assets current book value. In such cases, the asset should be written down to the
recoverable amount.

b. According to IFRS, no extraordinary item should be disclosed in the financial statements.

c. 1. Profit will be reduced since there is no extraordinary loss allowed in IFRS.

2. Income before extraordinary items will be reduced since the losses are classified as ordinary.

3. Income from Continuing Operations will be reduced as the losses are classified as ordinary.

4. Given that these losses do not affect income taxes, they have no cash effects. Therefore, net cash
flow from operating activities will be unaffected.

d. The p/e ratio is based upon income before extraordinary items (stated on a per-share basis). As stated in
c (2), above, income before extraordinary items will be affected since the losses are classified as part of
the ordinary operations. Therefore, the p/e ratio will be higher.

e. Yes. Members of management have a self-interest in seeing share prices increase, which would favorably
affect the value of their share options as well as share they already own. In addition, a rising share price
makes it easier for the company to raise capital, benefits shareholders, and makes management look
good.

The McGraw-Hill Companies, Inc., 2010


Case 12.5
CASE 12.5
CLASSIFICATION (continued)
The classification of these losses may well affect Elliot-Coles share price. Investors
consider income from continuing operations a predictive subtotal. If the losses are
classified as ordinary, this key subtotal will decline, probably below last years level.
(The losses amount to 18% of pre-loss earnings, which exceeds the companys normal
earnings growth of 15%. Thus, these losses may be sufficient to cause a decline in
earnings relative to the preceding year.) This could have an adverse effect on share
price.

In summary, the adverse effects of these losses on the companys share price are likely
to be greater if the losses are classified as ordinary. Therefore, management has a self-interest in seeing
these losses classified as an extraordinary item.

f. These write-offs are likely to increase the earnings reported in future periods, especially if the company
continues to do business in any of the related countries. With the assets having no book value, future
earnings from these operations will not be reduced by charges for depreciation (or, in some cases, for a
cost of goods sold).

g. No ethical dilemma exists because the classification of these losses as extraordinary is not allowed.

Note to instructor: This case is adapted from an incident involving an international pharmaceutical
company. The details of the situation have been altered for the purpose of creating an introductory level
textbook assignment, and the so-called quotations from corporate officers are entirely fictitious.
Nonetheless, we believe that the outcome of the actual event provides insight into the financial reporting
process and also to the importance that investors attach to the various computations of earnings per share.

The McGraw-Hill Companies, Inc., 2010


Case 12.5 (p.2)
CASE 12.5
CLASSIFICATION (concluded)
Management originally classified the losses as extraordinary, and the auditors concurred. The SEC,
however, did not agree. It insisted that the corporation revise and reissue its financial statementwith the
controversial items classified as ordinary operating losses. When the company announced the
reclassification of these losses, its share price fell substantiallydespite the fact that the reported amount of
profit remained unchanged.

Who were the losers? Anyone who bought the share between the release of the original earnings figures and
the announcement that substantial losses would be reclassified.

The McGraw-Hill Companies, Inc., 2010


Case 12.5 (p.3)
30 Minutes, Medium
SHAREHOLDERS' EQUITY AND EPS

The following answers are based on information from March 29, 2010 (part a.) and 2009 annual
financial statements for the remaining parts.

a. On March 29, 2010, Vodafone's share sold for a high of 151.75p and a low of 148.00p. These
amounts will vary for other dates.

b. The number of ordinary shares outstanding on Mar. 31, 2009 was 57,806,283,716. These shares
were originally sold by the company for the total of the par value of the shares plus the share
premium:

Par value 4,153,000,000


Share premium 43,008 million 43,008,000,000
47,161,000,000
The average price at which the shares were sold is computed as follows:

47,161,000,000 / 57,806,283,716 shares = 0.82 per share

c. There is no direct relationship between the amount the share originally sold for (.82) and the
current market price of the share. The original price at which the share was sold is a historical
amount that represents the investment of owners in the company while the current market price
reflects a number of factors, including the long-term performance of the company and many
other factors directly and indirectly related to the company's performance.

d. The three-year trend in basic earnings per share (EPS), including discontinued operations, is
negative 9.7 (2007), 12.56 (2008), and 5.84 (2009). Discontinued operations did not occur in
2009 and 2008, and had the most significant impact on EPS in 2007 when it accounts for a loss of
.76 per share of a net amount of negative 9.7 of earnings per share.

e. The average number of shares used to compute basic EPS in 2009 was 52,737,00,000. This is
different from the 57,806,283,716 because the number of shares outstanding decreased during the
year. The year-end figure is in the balance sheet while a weighted average number is used in
computing EPS.

The McGraw-Hill Companies, Inc., 2010


Case 12.6
The McGraw-Hill Companies, Inc., 2010
Case 12.6
CASE 12.6
OLDERS' EQUITY AND EPS
INTERNET

, 2010 (part a.) and 2009 annual

5p and a low of 148.00p. These

was 57,806,283,716. These shares


e of the shares plus the share

originally sold for (.82) and the


e share was sold is a historical
y while the current market price
ce of the company and many
rformance.

ding discontinued operations, is


ued operations did not occur in
007 when it accounts for a loss of
hare.

009 was 52,737,00,000. This is


outstanding decreased during the
d average number is used in

The McGraw-Hill Companies, Inc., 2010


Case 12.6
The McGraw-Hill Companies, Inc., 2010
Case 12.6