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CHAPTER 11

Investments in Other Companies


QUESTIONS
Q11-1.
Goodwill is the excess of the price paid for all or part of a company over the fair market value of
the identifiable assets less liabilities. Its difficult to be sure what goodwill represents because
its a residual but its often attributed to things such as management ability, location, synergies
created by the acquisition, customer loyalty, reputation, and benefits associated with the
elimination of a competitor. Its only recorded on the financial statements when an entity
purchases control of another entity.
Q11-2.
The extent of influence of one corporation over another determines how the investment is
accounted for. If the influence is sufficient that the entity makes the important decisions for the
investee (control), that company is called a subsidiary and the financial statements of both
entities are aggregated to produce consolidated financial statements. When a company has
significant influence over another company equity accounting is used. When little or no
influence can be exerted, the investment is passive and is accounted for (according to IFRS) at
amortized cost, fair value through other comprehensive income, or fair value through profit or
loss. The classification affects how the investment is valued on the balance sheet and how gains
and loses are accounted for. If the investor can influence decisions but not control them
(significant influence), equity accounting is used.
Q11-3.
a.
When the investing entity controls the other, the investor makes the important decisions
for the investee. When there is control, consolidation accounting is used.
b.
Significant influence means that important decisions can be influenced, but not
determined by the investor. Equity accounting is used when there is significant influence.
c.
When little or no influence can be exerted, the investment is passive and is accounted for
(according to IFRS) at amortized cost, fair value through other comprehensive income, or
fair value through profit or loss. The classification affects how the investment is valued
on the balance sheet and how gains and loses are accounted for.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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Page 11-1
Copyright 2013 McGraw-Hill Ryerson Ltd.

Q11-4.
Consolidated financial statements aggregate the financial statements the parent and all its
subsidiaries into a single set of financial statements that present the financial position and results
of operations for the entire economic entity. The consolidated statements represent the
aggregation of more than one legal entity into statements for a single economic entity. For
example, the assets on the consolidated balance sheets are the sum of the assets of the parent and
those of the subsidiaries, with some adjustments. Consolidated financial statements communicate
to investors in the parent the assets that are at its disposal and the revenues and expenses that the
consolidated entity has generated. This aggregation reduces the time and effort required to learn
about the entity. Without consolidated statements, users would have to examine financial
statements for each of the firms in the consolidated group. This could be very time consuming.
(This approach would, however, be desirable for some users, such as financial analysts.) The
consolidated statements also eliminate the effects of inter-company transactions, which can be
used to manipulate the statements. The disadvantage is that they aggregate information so that
details are lost and the opportunity to compare the performance of parts of the whole to other
companies in their industry is gone. Particularly when a company operates a variety of dissimilar
businesses, there are no comparable companies as a basis for assessing the aggregated results.
Q11-5.
There are a variety of reasons including the pursuit of a reasonable return on surplus cash, a
means of expanding operations more quickly than opening new stores or plants, to ensure
markets for their products or ensure supplies of their needed inputs, or to diversify.
Q11-6.
An inter-company transaction is a sale from one company in the consolidated group to another
company in the consolidated group. If the transactions arent eliminated, consolidated net income
would include the revenue and profit on transactions that arent outside the consolidated entity.
The balance sheet could include accounts receivable and payables that arose on the intercompany
transactions and inventory could be written up in value. The entity concept requires that
transactions be recorded only if an exchange takes place with an external entity. By not
eliminating intercompany transactions, gains would be recognized before they are realized.
Additionally, management would have an opportunity to manipulate income simply by arranging
sales within the economic entity.
Q11-7.
A subsidiary is a corporation that is controlled by another corporation. They are accounted for on
a consolidated basis, which means that the financial statements of the parent and the subsidiary
are aggregated into a single set of consolidated financial statements.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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Page 11-2
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Q11-8.
The non-controlling interest represents the claim on the subsidiary by owners of shares not
owned by the controlling shareholder. Non-controlling interest on the income statement
represents the share of net income that belongs to shareholders other than the controlling
shareholder. Non-controlling interest is necessary because balance sheets report 100% of the
assets and liabilities and income statements represent 100% of the revenues and expenses of the
subsidiaries even if the parent doesnt own 100% of the shares. Non-controlling interest on the
balance sheet represents the equity of non-controlling shareholders.
Q11-9.
There is little information for a non-controlling shareholder in the non-controlling interest
amounts in consolidated balance sheets and income statements. The non-controlling shareholders
will receive the financial statements of the subsidiary itself. The information in the consolidated
statements is aggregated so they dont provide clear information about the non-controlling
shareholders investment.
Q11-10.
Clearly, the available flexibility will provide managers with the opportunity to pursue their
reporting objectives. The preference of management as to the allocation of the purchase price
among the identifiable assets and liabilities would depend on the balance sheet/income strategy.
If management wanted to keep balance sheet values high and delay deprecition of the difference
between purchase price and book values, they would prefer to allocate more to goodwill, which
will not be amortized, and to capital assets with long remaining useful lives, and less to inventory
and other assets that will be sold or amortized over short periods of time. For tax purposes
allocating more of the cost to assets that will be expensed more quickly would be the appropriate
strategy.
Q11-11.
Segment disclosure disaggregates information by type of operations and geographic location.
Segment disclosures are required under IFRS to overcome the problems that arise because of the
aggregation that occurs in consolidated financial statements. It can be useful to users of financial
statements if it facilitates comparison of that business segment to other companies that operate in
the same segment. Without segmented information, its difficult or impossible to assess the
contribution of a business segment to the success of the whole entity. For example, a
manufacturer may have a finance subsidiary to provide financing to purchasers of its product.
Without segmented information, it may be difficult to compare the profitability of the
manufacturing operations to that of another company in the same industry.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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Page 11-3
Copyright 2013 McGraw-Hill Ryerson Ltd.

Q11-12.
a.
The consolidated financial statements are useful for the shareholders of the parent (within
the context of the limitations of consolidated statements in general), since, for example,
the balance sheet indicates the assets that are available to the company (the parent) in
which those shareholders have an interest. Similarly, the income statement provides the
results of operations for the whole entity, which is appropriate for the evaluation of
management.
b.

A major supplier would primarily be interested in the subsidiarys financial statements


since the supplier would have no recourse to the assets of the parent. However, there
might be an interest in the financial health and cash needs of the parent, since the parent
might reduce the liquidity of the subsidiary by transferring cash to the parent. Also the
parents statements might be of interest if the parent guaranteed the subsidiarys debt.

c.

CRA has no interest in the consolidated financial statements. Each legal entity files its
financial statements with CRA with its tax return.

Q11-13
The two methods for accounting of debt investments are as follows:
Amortized Costis used for bonds and other debt instruments. It should be used if (i) the
investment is part of managements plan to hold the investment to receive the cash flows
(interest and principal)not to actively trade it and (ii) if the investment has contractual terms
that give rise to interest and principal payments on specified dates. The investment is reported on
the balance sheet at its cost, including any costs or fees incurred to complete the transaction,
which is the fair value when acquired. Gains and losses are only recognized on the income
statement when an investment is sold. If the investment is impaired the write down is reported on
the income statement.
Fair value through profit and loss (FVTPL): FVTPL is used for in all other circumstances
for debt investments not classified as amortized cost. The investments are valued on the balance
sheet initially at cost excluding fees, which are expensed immediately. Changes in fair value
from one reporting period to the next are reported as gains and losses on the income statement.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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Page 11-4
Copyright 2013 McGraw-Hill Ryerson Ltd.

Q11-14
The two methods for accounting of passive equity investments are as follows:
Fair value through other comprehensive income (FVTOCI): FVTOCI can only be used for
equity securities that are designated as such by management when the investment is acquired.
Once made the classification cant be changed on the balance sheet. Securities classified as
FVTOCI are reported on the balance sheet at fair value. The investment is initially recorded at
cost, including fees, which is fair value when the investment is purchased. Changes in fair
value from one period to the next are reported in other comprehensive income (OCI), not in
net income, as unrealized gains and losses. At the end of each period any fair value changes
reported in OCI are closed to accumulated other comprehensive income in the equity section
of the balance sheet. When an investment is sold the realized gain or loss (the difference
between the proceeds from sale and the original cost) can either be left in accumulated OCI or
be transferred to retained earnings. Dividend income from the shares is reported in net income
in the period its earned (not in OCI).
Fair value through profit and loss (FVTPL): FVTPL is used for equity investments not
classified as FVTOCI. Securities classified as FVTPL are reported on the balance sheet at fair
value. The investment is initially recorded at cost, excluding fees (which are expensed
immediately), which is fair value when the investment is purchased. Changes in fair value
from one period to the next are reported in net income (profit and loss), as are realized gains
and losses. Investment income from dividends is also reported in net income.
Q11-15.
There are intercompany transactions that must be eliminated from the balance sheets and income
statements. Also certain assets and liabilities of the subsidiary will be reported at their fair value
(as of the date they were acquired by the parent) on the consolidated balance but at their
historical cost (as of the date they were acquired by the subsidiary) on the subsidiarys balance
sheet.
Q11-16.
a.
An investor corporation is a corporation that has an investment in another corporation.
b.
An investee corporation is a corporation in which another corporation has invested.
c.
A parent corporation is an investor corporation that controls an investee (subsidiary) corporation.
d.
A subsidiary corporation is an investee corporation that is controlled by another corporation.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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Page 11-5
Copyright 2013 McGraw-Hill Ryerson Ltd.

Q11-17.
When the investor can exert significant influence over the investee, dividends are considered to
be a distribution of the wealth of the entity, not income. With the equity method, the investors
share of the income of the investee is treated as an increase in the amount of the investment on
the investors balance sheet and as income to the investor.Additionally, when an investor has
significant influence it could influence the payment of dividends from the investee and thereby
manipulate its income if the dividends were shown as income.
Q11-18.
The financial statements of the parent alone dont include the revenues and expenses and assets
and liabilities of the subsidiaries; the investment is presented on the balance sheet as one line.
The consolidated financial statements include the revenue, expenses, assets and liabilities of the
parent and the subsidiaries, including the portion of those amounts that are owned by noncontrolling shareholders. The parents financial statements represent the legal financial
statements of the entity. The consolidated financial statements dont represent an entity that
really exists in a formal sense but are a creation of accountants for financial reporting purposes.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-6
Copyright 2013 McGraw-Hill Ryerson Ltd.

EXERCISES
E11-1.
a. The investor has control (owning more than 50%) over the investee corporation. Therefore,
consolidated financial statements should be prepared.
b. The investor has control over the investee corporation because it owns more than 50% of the
votes (its the votes that provides control, not the actual proportion of the number of shares).
Therefore, consolidated financial statements should be prepared.
c. If the 25% ownership of shares represents 25% of the votes, this investment could be
classified as an equity investment because the investor has significant influence on the
decision making of the investee. IFRS suggests that owning between 20% and 50% of the
votes of an investee company is an indication of significant influence. However, more
information is required to provide a definite conclusion because a 25% interest could be a
passive investment if, for example, another shareholder owned the remaining 75% of the
shares.
d. This is passive investment because with 0.05% of the shares it wouldnt be possible to exert
any influence. The investment would be carried at fair value with gains and losses going
through net income or other comprehensive income (as chosen by the company).

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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Page 11-7
Copyright 2013 McGraw-Hill Ryerson Ltd.

E11-2.
a. This is a passive investment that would be classified as amortized cost because it has a
maturity date of three years and management has the intention of holding the investment until
then. It meets both conditions of (i) managements plan to hold and receive cash flows
(Principal and interest) and (ii) contractual terms exist to give rise to interest and principal
payments.
b. This is a passive investment that maybe be classified as FVTOCI management must first
make an irrevocable election for this classification. Here changes to fair value are reported in
OCI. Management may also choose, depending on their objective to classify as FVTPL if
they want profits to be reported in income at which point changes in fair values would be
reported on the income statement.
c. This is a passive investment because IFRS suggests that if an investor corporation owns less
than 20% of the voting shares, it should be treated as a passive investment. Also (and
probably more significant) is that another shareholder has control of the investee corporation,
which suggests the 15% interest wouldnt be able to exert influence (though it could). The
investment doesnt meet the criteria for classification for amortized cost as its an equity
instrument. Therefore it can be classified as either FVOCI or FVTPL depending on
managements decision as to whether or not they want changes in fair value be recorded in
net income. Under both fair value classifications dividends are still reported on the income
statement.
d. This investment in the subsidiary would be accounted for using consolidation because a 52%
investment represents control.
e. The investor has significant influence because of its large shareholding and its representation
on the board of directors. The equity method of accounting is used for this investment.
E11-3.
a. The non-controlling interest would be 25% of the fair value of the net assets or 25% of
$3,600,000 which is $900,000.
b. 100% of the fair value of the assets and liabilities would be reported on the consolidated
balance sheet. 25% of that amount would be allocated to non-controlling interest.
Assets = $6,000,000
Liabilities = $2,400,000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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Page 11-8
Copyright 2013 McGraw-Hill Ryerson Ltd.

E11-4.
a.
Total fair value of assets
Total fair value of liabilities
Total fair value of net assets

$5,850,000
2,900,000
$2,950,000

Non-controlling interest is 40% of the fair value

$1,180,000

b.

Current assets
Tangible capital assets
Patents
Current liabilities
Long term debt

Parent's Share
60% of Fair Value
$750,000
2,160,000
600,000
540,000
1,200,000

Non-controlling Interests Share


40% of Fair Value
$500,000
1,440,000
400,000
360,000
800,000

Total
$1,250,000
3,600,000
1,000,000
900,000
2,000,000

c.
Non-controlling interest on the balance sheet represents the net assets of a subsidiary that are
owned by the shareholders of the subsidiary other than the parent. The need to present the noncontrolling interest arises because 100% of the subsidiarys assets and liabilities are presented on
the consolidated balance sheet (even though the parent owns less than 100%), as required by the
IFRS, to show users that the resources the parent controls. The non-controlling interest represents
little more than a balancing number required as a result of accounting rules, with little
informational value of its own.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-9
Copyright 2013 McGraw-Hill Ryerson Ltd.

E11-5.
a.
Dr. Investment in Inwood Corp.
74,000
Cr.
Cash
74,000
To record the purchase of 2,000 shares of Inwood Corp.
b.
Dr. Cash
10,000
Cr.
Dividend income (income statement +)
10,000
To record receipt of a cash dividend (assuming that the Guthrie investment is not
recorded on the equity basis).
c.
Given that the bonds will mature in 2018, they should be classified at amortized cost. In
this case, the bonds would only be written down to market if the bonds are permanently
impaired. Assuming that this is not a permanent impairment, no adjustment would be required.
d.
In this case since the shares are classified as FVTOCI, they would be valued at fair value and the
loss would be reported in other comprehensive income. The journal would be as follows:
Dr. Unrealized Loss - Other comprehensive income
Cr. Investment in Kynoch shares
To record the investment at fair value at the year end

15,000
15,000

e.
Since the shares are classified as FVTPL changes in fair value are reported through net income.
The journal entry would be as follows:

Dr. Unrealized holding loss


Cr.
Investment in Jobrin Ltd.
To record the investment to market value at the year end.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

9,000
9,000

Page 11-10
Copyright 2013 McGraw-Hill Ryerson Ltd.

E11-6

Current assets
Non-current assets
Investment in Chipman
Goodwill*
Total Assets
Current liabilities
Non-current liabilities
Shareholders' equity
Total liabilities and shareholders' equity

Balance Sheet
of Balmoral
$2,800,000
5,000,000
4,200,000
$12,000,000
$5,000,000
2,000,000
5,000,000
$12,000,000

Fair Value of
Chipman's Assets
and Liabilities
$2,400,000
1,170,000

Consolidated
Balance Sheet
$5,200,000
6,170,000

1,800,000
$5,370,000

1,800,000
$13,170,000

$750,000
420,000
$1,170,000

$5,750,000
2,420,000
5,000,000
$13,170,000

Fair Value of
Hardisty's Assets
and Liabilities
$1,900,000
6,000,000

Consolidated
Balance Sheet
$2,650,000
22,250,000

500,000
$8,400,000

500,000
$25,400,000

$1,350,000
3,550,000

$4,600,000
12,550,000
8,250,000
$25,400,000

Cost of Shares (100%) $4,200,000


Fair value of net assets 2,400,000
*Goodwill
1,800,000

E11-7.

Current assets
Non-current assets
Investment in Chipman
Goodwill*
Total Assets
Current liabilities
Non-current liabilities
Shareholders' equity
Total liabilities and shareholders' equity

Balance Sheet
of Dorchester
$750,000
16,250,000
3,500,000
$20,500,000
$3,250,000
9,000,000
8,250,000
$20,500,000

$4,900,000

Cost of Shares (100%) $3,500,000


Fair value of net assets 3,000,000
*Goodwill
500,000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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Page 11-11
Copyright 2013 McGraw-Hill Ryerson Ltd.

E11-8.
a.

Dr.

Investment in Irvine
10,000,000
Cr.
Cash
10,000,000
To record the purchase of 2,250,000 common shares of Irvine Ltd.

b.

The balance sheet value would be the cost of the shares, plus the share of income less the
dividends received or $10,000,000 plus $390,000 (share of net income) less $30,000
(30% share of dividends) = $10,360,000.
The income statement would report Fletwodes share of the income of Irvine, which is
$390,000.

E11-9.
a.

Dr.

Investment in Griffin
2,000,000
Cr.
Cash
2,000,000
To record the purchase of 1,000,000 common shares of Griffin Ltd.

b.

The income statement would report Wostoks share of the income of Griffin, which is
$440,000.

c.

The balance sheet value would be the cost of the shares, plus the share of income less the
dividends received or $2,000,000 plus $440,000 (share of income) less $500,000
(dividends) = $1,940,000.

E11-10.
a.
b.
c.
d.
e.
f.
g.

Impairment of goodwill will result in a write-down and reduce net income when its
recognized.
Since the fair value adjustments on the land will not be amortized, there will be no effect
on net income in any year.
The fair value of the equipment would be depreciated over five years. In the year after
acquisition there would be a $300,000 depreciation expense.
The fair value of the inventory of $230,000 would be expensed in the year the inventory
is sold.
Consolidated net income will not be affected by dividends paid to the parent because this
is an intercompany transaction.
Intercompany transactions are eliminated on consolidation so intercompany revenues,
expenses, and profits dont affect the consolidated statements.
The 20% of net income that belongs to the shareholders who arent the parent of the
subsidiary. The portion of income belonging to the non-controlling shareholders must be
disclosed separately in the financial statements..

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-12
Copyright 2013 McGraw-Hill Ryerson Ltd.

PROBLEMS
P11-1.
a.
Summarized Income Statements
For the Period Ending May 31
Revenue
Expenses
Unrealized gain(loss) on investment
Net income
Other comprehensive income unrealized gain (loss)
Comprehensive income
Summarized Balance Sheets
As of May 31
Other assets
Investment in Nictaux

2018
2017
Horsefly Jolicare Horsefly Jolicare
225,000
225,000
225,000
225,000
(175,000) (175,000) (175,000) (175,000)
(15,000)
24,000
50,000
35,000
50,000
74,000
(15,000)
35,000

24,000
35,000

74,000

74,000

2018
2017
Horsefly Jolicare Horsefly Jolicare
239,000 239,000 164,000 164,000
45,000
45,000
60,000
60,000

Total assets

284,000

284,000

224,000

224,000

Liabilities
Common shares

75,000
100,000

75,000
100,000

50,000
100,000

50,000
100,000

Retained earnings

100,000

109,000

50,000

74,000

Accumulated other comprehensive


income: unrealized holding gains

9,000

Total liabilities and owners equity

284,000

24,000
284,000

224,000

224,000

b.
Both companies performed equally well in 2017 and 2018. However during times of rising stock
prices Jolicare appears to be performing better on its income statement and worst when prices are
dropping since it reports changes in fair value through net income. The reverse is true with
Horsefly who report through OCI doesnt have any effect on its net income.

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Page 11-13
Copyright 2013 McGraw-Hill Ryerson Ltd.

P11-2.
a.
Lourdes Inc.
Balance Sheet
As of December 31, 2017
Amortized
Cost
Assets
All other assets
Investment in preferred shares
Liabilities and Shareholders' Equity
All liabilities
Shareholders' Equity
Common shares
Retained earnings
Accumulated other comprehensive income
Total liabilities and shareholders' equity

FVTPL

$35,000,000
2,400,000

$35,000,000
1,900,000

$35,000,000
1,900,000

$37,400,000

$36,900,000

$36,900,000

$25,000,000

$25,000,000

$25,000,000

4,000,000
8,400,000

4,000,000
7,900,000

4,000,000
8,400,000
(500,000)

$37,400,000

$36,900,000

$36,900,000

Lourdes Inc.
Income Statement
For the period ending December 31, 2017
Amortized
Cost
FVTPL
Revenue
$8,200,000
$8,200,000
Dividend income
240,000
240,000
Expenses
(6,100,000)
(6,100,000)
Holding loss on preferred shares
(500,000)
Net income

$2,340,000

$1,840,000

Other comprehensive income


Comprehensive income

FVTOCI

FVTOCI
$8,200,000
240,000
(6,100,000)
$2,340,000
(500,000)

$2,340,000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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$1,840,000

$1,840,000

Page 11-14
Copyright 2013 McGraw-Hill Ryerson Ltd.

b.
Lourdes Inc.
Balance Sheet
As of December 31, 2017
Amortized Cost
Assets
All other assets
Investment in preferred shares
Liabilities and Shareholders' Equity
All liabilities
Shareholders' Equity
Common shares
Retained earnings
Other comprehensive income
Total liabilities and shareholders' equity

FVTPL

FVTOCI

36,900,000

36,900,000

36,900,000

36,900,000

36,900,000

36,900,000

25,000,000

25,000,000

25,000,000

4,000,000
7,900,000

4,000,000
7,900,000

4,000,000
8,400,000
(500,000)

36,900,000

36,900,000

36,900,000

Lourdes Inc.
Income Statement
For the period ending December 31, 2017
Amortized Cost
FVTPL
Revenue
8,200,000
8,200,000
Dividend income
240,000
240,000
Expenses
(6,100,000)
(6,100,000)
Realized loss on shares
(500,000)
(500,000)
Net income
Other comprehensive
income

1,840,000

Comprehensive income

1,840,000

1,840,000

FVTOCI
8,200,000
240,000
(6,100,000)
2,340,000
(500,000)

1,840,000

1,840,000

Note: There is an option under FVTOCI to reclassify OCI back into retained earnings.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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Page 11-15
Copyright 2013 McGraw-Hill Ryerson Ltd.

P11-3.
a.
Pacquet Inc.
Balance Sheet
As of August 31, 2017
Current assets
Investment in Schwitzer
Capital assets
Total assets

$1,500,000
2,000,000
3,250,000
$6,750,000

Current liabilities
$1,350,000
Non-current liabilities
1,250,000
Common shares
2,000,000
Retained earnings
2,150,000
Total liabilities and shareholders' equity $6,750,000

b.
Cost: 100% of common shares $2,000,000
FV of net assets
1,900,000
Goodwill
100,000

c, d.
Pacquet Inc.
Balance Sheet
As of August 31, 2017

Current assets
Investment in Schwitzer
Capital assets
Goodwill
Total assets
Current liabilities
Non-current liabilities
Common shares

Schwitzer
(Book Values)
$625,000
1,250,000

Pacquet
$1,500,000
2,000,000
3,250,000

$1,875,000

$6,750,000

$375,000
500,000
250,000

$1,350,000
1,250,000
2,000,000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


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Schwitzer (Fair
values)
$875,000

Consolidated
$2,375,000

1,950,000
100,000

5,200,000
100,000
$7,675,000

$375,000
550,000

$1,725,000
1,800,000
2,000,000

Page 11-16
Copyright 2013 McGraw-Hill Ryerson Ltd.

Retained earnings
Total liabilities and
shareholders' equity
Current ratio
Debt/equity ratio

750,000

2,150,000

2,150,000

$1,875,000

$6,750,000

$7,675,000

1.67
0.88

1.11
0.63

1.38
0.85

*The consolidated financial statements are based on Pacquets own financial statements plus the
fair values of Schwitzers net assets plus goodwill. In addition, the investment in Schwitzer
account on Pacquets balance sheet doesnt appear on the consolidated balance sheet.
The current ratio of Pacquet is lower than the consolidated ratio because it doesnt include the
current assets of Schwitzer, which has a higher current ratio, nor does it include the fair market
value adjustment for Schwitzers current assets.
The consolidated debt to equity ratio is close to Schwitzers. Consolidated equity is the same as
Pacquets but liabilities are higher on the consolidated balance sheet because the liabilities of
Schwitzer are included in the consolidated statements (as well as the fair value adjustment).
e.
Its important to recognize that Pacquets consolidated financial statements apply to the entire
corporate group rather than that of Schwitzer. Therefore, being a lender to Schwitzer would
require the financial statements of Schwitzer alone. Pacquets consolidated financial statements
would assist in making the lending decision because they contain information about the fair
market values of Schwitzers assets. They also provide information about the financial strength
of the consolidated group, which may be relevant in the parent offers to guarantee the loan.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-17
Copyright 2013 McGraw-Hill Ryerson Ltd.

P11-4.
a.
Paju Inc.
Balance Sheet
As of January 31, 2018
Current assets
Investment in Shellmouth
Capital assets
Total assets

$1,250,000
6,250,000
14,687,500
$22,187,500

Current liabilities
$1,500,000
Non-current liabilities
7,500,000
Common shares
9,375,000
Retained earnings
3,812,500
Total liabilities and shareholders' equity $22,187,500

b.
Cost: 100% of common shares $6,250,000
FV of net assets
4,312,500
Goodwill
1,937,500

c, d.
Paju Inc.
Balance Sheet
As of January 31, 2018
Shellmouth (Book
Values)
$5,625,000
1,875,000

Paju
$1,250,000
6,250,000
14,687,500

Total assets

$7,500,000

$22,187,500

Current liabilities
Non-current liabilities
Capital shares
Retained earnings

$1,875,000
625,000
3,750,000
1,250,000

$1,500,000
7,500,000
9,375,000
3,812,500

Current assets
Investment in Shellmouth
Capital assets
Goodwill

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Shellmouth
(Fair values) Consolidated
$4,875,000
$6,125,000
2,375,000
1,937,500

17,062,500
1,937,500
$25,125,000

$2,000,000
937,500

$3,500,000
8,437,500
9,375,000
3,812,500

Page 11-18
Copyright 2013 McGraw-Hill Ryerson Ltd.

Total liabilities and


shareholders' equity
Current ratio
Debt/equity ratio

$7,500,000

$22,187,500

$25,125,000

3.00
0.50

0.83
0.68

1.75
0.91

*The consolidated financial statements are based on Pajus own financial statements plus the fair
values of Shellmouths net assets plus goodwill. In addition, the investment in Shellmouth
account on Pajus balance sheet doesnt appear on the consolidated balance sheet.
The current ratio of Paju is lower than the consolidated ratio because it doesnt include the
current assets of Shellmouth, which has a higher current ratio.
The consolidated debt to equity ratio is much higher than either individual company. This is the
case because the consolidated company has added the debt of the subsidiary but has no
additional equity.
e.
As an equity investor in Shellmouth, you really have little interest in Pajus consolidated
financial statements and would therefore require the financial statements of Shellmouth. You
will share only in the income of Shellmouth but as a minority investor, you will be concerned
that Paju will use their controlling interest to make decisions that adversely affect your position.
Pajus consolidated statements might give you some insight into how it manages and fulfills its
stewardship responsibilities. Pajus consolidated financial statements can be used in making your
investment decision because they contain information about the fair market values of
Shellmouths assets. This information will give you a better understanding of what you are
investing in. This information cannot be found on Shellmouths balance sheet because its based
on historical cost and not fair market value.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-19
Copyright 2013 McGraw-Hill Ryerson Ltd.

P11-5.
a.
Fair value of Saguays net assets = $656,250 + $1,462,500 $281,250 - $412,500 = $1,425,000.
65% of the fair value of the net assets = $926,250.
Goodwill = $1,200,000 - $926,250 = $273,750.
b.
The non-controlling interest of Saguay is reported on the consolidated balance sheet at 35% of
the fair value of the subsidiary, or $498,750. This amount is 35% of the fair value of Saguays
net assets.
c, d.

Popkum Inc.
Balance Sheet
As of March 31, 2018

Current assets
Investment in Shellmouth
Capital assets
Goodwill
Total assets
Current liabilities
Non-current liabilities
Non-controlling interest
Common shares
Retained earnings
Total liabilities and
shareholders' equity
Current ratio
Debt/equity ratio

Saguay
(Book Values)
$468,750
937,500

Popkum
$1,425,000
1,200,000
2,437,500

$1,406,250

$5,062,500

$281,250
375,000

$1,012,500
937,500

187,500
562,500

Saguay
(Fair Values)
$656,250

Consolidated
$2,081,250

1,462,500
273,750

3,900,000
273,750
$6,255,000

$281,250
412,500

1,500,000
1,612,500

$1,293,750
1,350,000
498,750
1,500,000
1,612,500

$1,406,250

$5,062,500

$6,255,000

1.67
0.88

1.41
0.63

1.61
0.73

The current ratio of Popkum is lower than the consolidated ratio because it doesnt include the
current assets of Saguay, which has a higher current ratio. The consolidated debt to equity ratio is
between that of the individual companies. The ratios are affected by the fair value adjustments,
the fact that the equity of the subsidiary is not included in the equity of the consolidated entity,
and that the non-controlling interest is treated as equity.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-20
Copyright 2013 McGraw-Hill Ryerson Ltd.

e.
Non-controlling interest on the consolidated balance sheet represents the portion of the net assets
of the subsidiary that is owned by shareholders other than the parent. To the shareholders of the
Popkum the number is really a reconciling number so that 100% of the assets and liabilities can
be included on the consolidated balance sheet. To the non-controlling shareholders of Saguay,
the number is 35% of the fair value of Saguays net assets. From the prospective of a lender, the
amount is a claim on the net assets of the consolidated entity that arent owned by the Popkum.
The non-controlling interest is of very limited usefulness to stakeholders other than to indicate
the parent doesnt own 100% of subsidiaries.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-21
Copyright 2013 McGraw-Hill Ryerson Ltd.

P11-6.
a.
Dr. Investment in Seebe
Cr. Cash

$1,500,000
$1,500,000

b. There is no journal entry required by Seebe when its purchased.


c.
Fair value of Seebes net assets = $1,950,000 + $950,000 $800,000 - $375,000 = $1,725,000.
75% of the fair value of the net assets = $1,293,750.
Goodwill = $1,500,000 - $1,293,750 = $206,250.
d.
The non-controlling interest of Seebe is reported on the consolidated balance sheet at 25% of the
fair value of the subsidiary (as reported on its own balance sheet), or $431,250 (($1,950,000 +
950,000 800,000 375,000) *25%).

e and f.
Pahonan Inc.
Balance Sheet
As of October 31, 2017

Current assets
Investment in Seebe
Capital assets
Goodwill
Total Assets
Current liabilities
Non-current liabilities
Non-controlling Interest
Common shares
Retained earnings
Total liabilities and S/E
Current ratio
Debt/equity ratio

Pahonan
$500,000
1,500,000
6,875,000
$8,875,000

Seebe
$2,250,000

$600,000
3,000,000

$750,000
250,000

3,750,000
1,525,000
$8,875,000
0.83
0.68

1,500,000
500,000
$3,000,000
3.00
0.50

750,000
$3,000,000

Adjustments
($300,000)
(1,500,000)
200,000
206,250

Consolidated
$2,450,000
7,825,000
206,250
10,481,250

$50,000
125,000
431,250
(1,500,000)
(500,000)

$1,400,000
3,375,000
431,250
3,750,000
1,525,000
$10,481,250
1.75
0.84

After the acquisition, Pahonan has a much lower current ratio than Seebe and is more highly
leveraged. Pahonan after consolidation has an improvement in its current ratio, making it appear
less leveraged and in a better liquidity position. The consolidated debt-to-equity ratio is higher
than either firms separate ratios because only the equity of the parent and non-controlling
interest is included in the consolidated statements but the debt of both firms is included (along
with fair value adjustments to liabilities).
John Friedlan, Financial Accounting: A Critical Approach, 4th edition
Solutions Manual

Page 11-22
Copyright 2013 McGraw-Hill Ryerson Ltd.

g.
Non-controlling interest on the consolidated balance sheet is the portion of the net assets of the
subsidiary that is owned by shareholders of Seebe. To the shareholders of the Pahonan, the
number is really a reconciling number so that 100% of the assets and liabilities can be included
on the consolidated balance sheet. To the non-controlling shareholders, the number is simply
25% of the fair value of Seebes net assets. From the perspective of a lender, the amount is a
claim on the net assets of the consolidated entity that arent owned by Pahonan. The noncontrolling interest is of very limited usefulness to stakeholders other than to indicate the parent
doesnt own 100% of subsidiaries.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-23
Copyright 2013 McGraw-Hill Ryerson Ltd.

P11-7.
a.
Vonda Inc.
Income statement
For the year ended March 31, 2017
Sales
Cost of goods sold
Income

$1,000,000
500,000
$500,000

b.
Vonda would report $1,000,000 in accounts receivable on its March 31, 2017 balance sheet as a
result of the sale to Atik.
c.
Assuming that none of the inventory had been resold or consumed by Atik, Atik would report
$1,000,000 in inventory and $1,000,000 accounts payable on its March 31, 2017 balance sheet as
a result of the purchase from Vonda.
d.
Atik Inc.
Consolidated Income statement
For the year ended March 31, 2017
Sales
Cost of goods sold
Income

$1,000,000
500,000
$500,000

The consolidated entity would report $1,000,000 in accounts receivable, $1,000,000 in accounts
payable and $1,000,000 in inventory on the consolidated balance sheet.
e.
Atik Inc.
Consolidated Income statement
For the year ended March 31, 2017
Sales
Cost of goods sold
Income

$0
0
$0

The consolidated entity would report $0 in accounts receivable, $0 in accounts payable and
$500,000 in inventory on the consolidated balance sheet (which is the original cost of the
inventory to Vonda).

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-24
Copyright 2013 McGraw-Hill Ryerson Ltd.

f.
The information prepared in part e) is much more useful. The consolidated entity hasnt sold any
merchandise and has not earned any profit. The information provided in d) could easily be
manipulated by management to artificially create profits without conducting any real
transactions. By not eliminating the intercompany transactions, gains are being recognized
before they are realized. However, outside of IFRS/ASPE, recognition of intercompany
transactions shows value added within the entity, even if the gains have not been realized.
Information about these gains could be informative to some users, although there is considerable
opportunity for manipulation by management as to the amount of the increases. Also, the
intercompany receivables and payables would likely be confusing or misleading to users if they
were not understood.
P11-8.
a. to e.

Nutak
$$-

Guilds
(a)
$750,000
300,000
$450,000

Unadjusted Consolidated
Income Statement
Nutak (d)
$750,000
300,000
$450,000

Adjusted Consolidated
Income Statement
Nutak (e)
$$-

(c)
Accounts receivable
$Accounts payable
750,000
Inventory
$750,000

(b)
$750,000
-

$750,000
750,000
$750,000

$$300,000

Revenue
Cost of sales
Net income

f.
The information prepared in part e) is much more useful. The consolidated entity hasnt sold any
merchandise and hasnt earned any profit. The information provided in d) could easily be
manipulated by management to artificially create profits without conducting any real
transactions. By not eliminating the intercompany transactions, gains are being recognized
before they are realized. Accounts receivable suggests that there is $750,000 forthcoming to the
company when that isnt the case. In general, the intercompany receivables and payables would
likely be confusing or misleading to users if they were not understood. However, outside of
IFRS/ASPE, recognition of intercompany transactions shows value added within the entity, even
if the gains have not been realized. Information about these gains could be informative to some
users, although there is considerable opportunity for manipulation by management as to the
amount of the increases.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-25
Copyright 2013 McGraw-Hill Ryerson Ltd.

P11-9.
a. to e.

Revenue
Cost of sales
Net income

Yarbo
Dozois (a)
$1,600,000 $1,500,000
1,500,000 1,100,000
$100,000
$400,000

Unadjusted
Consolidated Income
Statement Yarbo (d)
$3,100,000
2,600,000
$500,000

Adjusted
Consolidated Income
Statement Yarbo (e)
$1,600,000
1,100,000
$500,000

$3,100,000
1,500,000

$1,600,000
-

(c)
(b)
Accounts receivable $1,600,000 $1,500,000
Accounts payable
1,500,000
Inventory
-

f.
The information prepared in part e) is much more useful. The consolidated income statement
indicates the same income but revenues and cost of sales are no longer distorted when the
intercompany transactions arent eliminated. The amount of sales is overstated in part d) because
they have been double counted in the sense that the same units have been sold twice, although
one of the sales was an internal transfer. While it could be useful to see the value added as the
inventory moves through the company, double counting the sales doesnt add information to
users. The balance sheet without the eliminations is also misleading because the consolidated
entity doesnt owe any payables and has only $1,600,000 in accounts receivable.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-26
Copyright 2013 McGraw-Hill Ryerson Ltd.

P11-10.
a.
Dr.

Investment in Kola
1,100,000
Cr.
Cash
1,100,000
To record the purchase of 50,000 shares of Kola.

b.

Dr.

Cash
55,000
Cr.
Dividend revenue
55,000
To record dividends received by Kola during 2017.

c.

For financial accounting purposes this investment would be classified as a passive


investment since the size of the investment is too small (0.05% of the outstanding shares)
to represent control of or significant influence over a public company. Therefore, the
investment could be classified as fair value through other comprehensive income
(FVTOCI) or fair value through profit and loss (FVTPL) because the investor corporation
has no influence over the strategic decision making of the investee corporation. Which
classification is appropriate depends on managements intentions towards the investment
and whether or not they want to show changes in fair value in OCI or net income.

d.

If the investment in Kola were classified as fair value through other comprehensive
income, the amount reported on Roddicktons December 31, 2017 balance sheet would
be $1,450,000 because FVTOCI investments are reported at their fair value. The
unrealized gain of $350,000 (($29 - $22) * 50,000) would be reported as other
comprehensive income. There would be no impact on net income.

e.

If the investment in Kola were classified as fair value through profit and loss, the amount
reported on Roddicktons December 31, 2017 balance sheet would be $1,450,000
because FVTPL investments are reported at their fair value. The unrealized gain of
$350,000 would be reported on the income statement, increasing net income for the year.
By recognizing the changing fair value as income when dealing with FVTPL
investments, economic gains and losses are being reflected as they occur, so income is a
better measure of the performance of the entity.

f.

Yes, management cares whether its investments are classified as fair value through other
comprehensive income or fair value through profit and loss because each one of these
passive investments has an effect on the financial statements due to the different
accounting treatments used for each one. Any investments that management designates as
a FVTPL investment will have an impact on the income statement if the fair value of the
investment changes over time. How management decides to classify its investment
depends on their financial reporting objectives and the impact of different measures of
net income has on economic outcomes. However it should be noted that once an
investment is classified as FVTOCI it cannot be reclassified in future periods nor can a
FVTPL be reclassified as FVTOCI. Under IFRS this helps to reduce managements
ability to manipulate the financial statements.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-27
Copyright 2013 McGraw-Hill Ryerson Ltd.

USING FINANCIAL STATEMENTS


Note: Dollar amounts shown are in millions of dollars.
FS11-1.
Amount of non-controlling interests in net assets on December 31, 2011: $18,516
Amount reported as investments on December 31, 2011:$9,401
Amount of equity accounted income for the year ended December 31, 2011:$2,205
Amount of net income attributable to shareholders and non-controlling interests for the year
ended December 31, 2011: $1,957 (Shareholders); $1,717(Non-controlling interest)
FS11-2
An associate is an investment that Brookfield does not control but is able to exercise significant
influence over. Usually this indicates ownership of between 20% and 50%. Associates are
accounted for using the equity method. The companies that Brookfield accounts for as associates
are:
General Growth Properties (23%);
Natural gas pipeline (26%);
Transelec S.A. (28%).
General Growth Properties had the highest carrying value at $4,099 as of December 31, 2011. It
is possible for an associate to have more than 50% ownership if the ownership doesnt provide
50% of the shareholder votes. Therefore an associate can have more than 50% ownership if the
criterion for control isnt met. Equity accounted net income is deducted from net income because
this does not represent a cash inflow to Brookfield; it is an allocation of the income of the
associate and not a payment in cash. Cash flow occurs when the associate pays dividends.
FS11-3
a.

The business segments in which Brookfield operates are:


Property (has the most assets and income);
Renewable power ;
Infrastructure;
Private equity (has the most revenue);
Asset management services, corporate and other.

b.

The geographic segments that Brookfield operates in are:


the United States (has the most revenue and the most assets);
Canada;
Australia;
Brazil
Europe;
Other.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-28
Copyright 2013 McGraw-Hill Ryerson Ltd.

Net income isnt provided because it would likely be very difficult to separate and
allocate expenses by region given the large amounts of overhead the company would
have.
c.

Segment disclosure is required by IFRS because it provides users with important


information that may otherwise be unavailable. Brookfields consolidated financial
statements aggregate information from a number of vastly different industries so without
a breakdown it would be impossible to make sense of its activities. If segment
information isnt provided it would be difficult to properly evaluate management and the
companys strategy. It would also be difficult to understand how the company performs
in each of its areas. Without segmented information, stakeholders would be less equipped
to make informed decisions about the company. For example, if Brookfield didnt
provide segmented information then users couldnt evaluate how the company is
performing in each country and each industry. Without this information, it would be
difficult to know whether Brookfield is investing funds in the best areas or whether past
strategies geared towards a certain area had paid off, or whether Brookfield should even
be operating in a segment (if an investor feels that based on segment information,
Brookfield is pursuing an unprofitable segment too aggressively, they may reconsider
their investment).

d.

The information provided by Brookfield in the segment disclosure isnt complete. Full
financial statements arent provided by segment and instead, only select information is
given. This allows users to only obtain a general understanding of how each segment
operates. Additionally, the segmented statements dont break earnings down by
subsidiary, which could provide valuable information on how individual companies are
performing. Lenders, for example, would likely require additional information (financial
statements of the subsidiary) if they were considering an unguaranteed loan to one of
Brookfields subsidiaries.

FS11-4
a.

Non-Controlling interest represents the non-Brookfield investors in a subsidiary that


Brookfield controls but doesnt own 100%. Non-Controlling interest is reported in the
financial statements because Brookfield doesnt have a 100% claim in the net assets and
income generated by these companies. Accounting standards require that 100% of the
assets and the liabilities of subsidiaries be consolidated (instead of just the share owned
by the parent). The non-controlling interest represents the assets, liabilities, revenues, and
expenses that are reported in the financial statements.

b.

On December 31, 2011, Brookfield reported $18,516 in non-controlling interest on its


balance sheet. This amount represents the equity in Brookfields net assets of the nonwholly owned subsidiaries that is owned by non-Brookfield shareholders.

c.

Brookfield reported $1,717 in non-controlling interest on its statement of operations for


the year ended December 31, 2011. This amount represents the claim to income that nonBrookfield shareholders have on the income of non-wholly owned subsidiaries. This

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-29
Copyright 2013 McGraw-Hill Ryerson Ltd.

amount arises because 100% of consolidated non-wholly owned subsidiaries revenues


and expenses are reported in the consolidated income statement even though not all of
those amounts belong to Brookfields shareholders.
d.

The following companies gave rise to non-controlling interest:


Brookfield Office Properties Inc;
Brookfield Canada Office Properties REIT;
Brookfield Residential Properties Inc.;
Norbord Inc.;

e.

As a non-Brookfield investor in Brookfield Office Properties Inc., the information on


non-controlling interest wouldnt be very useful at all. The information that would be
useful for my purposes isnt found in Brookfields financial statements. I would want to
see the Brookfield Office Properties Inc.s statements.

FS11-5
a.

A subsidiary is an entity that an investor has control over. Control means a majority of
the votes of the company. Subsidiaries are consolidated from the date control is obtained.
The consolidated statements capture 100% of the net assets, revenues, and expenses of
the subsidiary, even if 100% isnt owned. Amounts belonging to the non-controlling
interest are reflected in the financial statements to represents are reflected in the noncontrolling interest in the income statement and balance sheet. The benefit of presenting
the information this way is that it presents the consolidated financial statements of all
entities and resources that Brookfield has access to. However consolidated statements
incorporate balances from numerous companies making it very difficult to measure the
companys performance. For example one subsidiary may be doing very well, while
another may be struggling to survive (and it isnt possible to determine from the
consolidated statements themselves). As the balances from these two companies are
combined, it would be difficult to discern. Additionally, consolidated statements often
combine information from companies in different industries making it difficult to
compare to any one industry. The aggregated information provided in consolidated
statements fails to provide the detail required to make sound judgements. This is why
segment information is important and necessary.

b.

Brookfield has subsidiaries in the following countries: Canada; Bermuda; Australia and
Brazil.

c.

The implications on the financial statements when a company has less than 100% control
of the voting control of the subsidiary is that the financial statements reflect assets,
liabilities, revenues and expenses that dont belong to the parent. In that sense the
consolidated statements overstate these components (although the non-controlling interest
addresses this).

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-30
Copyright 2013 McGraw-Hill Ryerson Ltd.

FS11-6
Because the consolidated statements incorporate balances from numerous companies, the ratios
are of limited usefulness. One subsidiary may be doing very well, while another may be
struggling to survive (and it isnt possible to determine from the consolidated statements
themselves). As the balances from these two companies are combined, it would be difficult to
discern this based on a ratio analysis. Additionally, consolidated statements often combine
information from companies in different industries and ratios may be unrepresentative of any one
industry. The aggregated information provided in consolidated statements fails to provide the
detail required to conduct a thorough analysis using financial ratios. This is why segment
information is important and necessary.

John Friedlan, Financial Accounting: A Critical Approach, 4th edition


Solutions Manual

Page 11-31
Copyright 2013 McGraw-Hill Ryerson Ltd.