Chapter 11 Solutions Manual

CHAPTER 11
SHAREHOLDERS' EQUITY:
CAPITAL
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL
THINKING CASES
Brief
Exercises
Topic
Learning
Objective
s
Skills
B. Ex. 11.1
B. Ex. 11.2
B. Ex. 11.3
B. Ex. 11.4
Shareholders' equity
Dividends on preference shares
Dividends on ordinary and
preference shares
4
4
5
5
Analysis
Analysis
Analysis, communication
Analysis
B. Ex. 11.5
Dividends on ordinary and preference

shares
B. Ex. 11.6
B. Ex. 11.7
B. Ex. 11.8
B. Ex. 11.9
B. Ex. 11.10
Book value
Book value
Share split
Treasury shares
Treasury shares
7
7
8
4, 9
4, 9
Analysis
Analysis
Analysis
Exercises
11.1
11.2
11.3
11.4
Topic
Form of organization
Accounting terminology
Prepare equity section
Dividends on preference & ordinary
shares
11.5
11.6
11.7
11.8
11.9
11.10
11.11
11.12
Learning
Objective
s
13
19
4, 5
4, 5
Skills
Analysis
Analyzing equity
Preference shares alternatives
Reporting effects of transactions
Computing book value
Treasury shares transactions
Effects of share splits
Treasury shares presentation
Real World: Star Cruises Limited
47
5, 6
4, 7
47
9
8
9
4
Analysis
Analysis
Analysis
Communication, judgment
11.13
Authorized share capital

Ordinary shares and treasury shares
4, 9
11.14
Treasury shares and share split
8, 9
Analysis
The McGraw-Hill Companies, Inc., 2010

Overview
11.15
Real World: adidas AG
4, 7
Reading an annual report

Overview
Analysis, communication,
research
Problems
Sets A, B
11.1 A,B
11.2 A,B
11.3 A,B
11.4 A,B
11.5 A,B
11.6 A,B
Topic
Reporting shareholders equity
Comprehensive equity problem
Analysis of equity
Comprehensive equity analysis
11.7 A,B
11.8 A,B
Par, book, and market values

Comprehensive equity with
treasury shares transactions
11.9 A,B
Comprehensive equity with

treasury shares transactions and
share splits
Critical Thinking Cases

11.1
Factors affecting market prices
of preference and ordinary shares
11.2
Real World: Japan Airlines

Corporation, HSBC,
GlaxoSmithKline
Learning
Objectives
4, 5, 6
4, 5, 6
4, 5, 6
4, 5
4, 5
17
Skills
Analysis
Analysis
Analytical, communication,
group
4, 7
4, 5, 7, 9
4, 5, 7, 8, 9
Analytical, communication,
judgment
5, 7
Communication
Factors affecting market prices of

ordinary shares
11.3
Selecting a form of business

organization
1, 2, 3
11.4
Securities & Futures

Commission
1, 2, 3
Communication, judgment,
technology
(Ethics, fraud & corporate

governance)

Overview (p.2)
DESCRIPTIONS OF PROBLEMS AND

CRITICAL THINKING CASES
Below are brief descriptions of each problem and case. These descriptions are accompanied by the
estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume
use of the partially filled-in working papers.
Problems (Sets A and B)

11.1 A,B
Robbinsville Press/Septa Limited

A short problem requiring the completion of the shareholders
equity section of a corporate balance sheet. Includes preference
share dividends and conceptual issues pertaining to the market
price of preference shares.
20 Easy
11.2 A,B
Waller Publications/Banner Publications

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

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

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

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

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

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

Description Problems
Problems (continued)
11.8 A,B Feller Corporation/Tin Corporation
A shareholders equity problem involving share capital from treasury
share transactions. Requires the computation of book value per share
and reporting for the statement of cash flows.
11.9 A,B
15 Medium
Herndon Industries/Parker Industries

A comprehensive equity problem involving treasury shares transactions
in two different years, preference and ordinary share transactions, book
value calculations, and an understanding of share splits.
30 Strong
Critical Thinking Cases

11.1
Factors Affecting the Market Prices of Preference and Ordinary

Shares
15 Medium
Students are asked to explain whether the prices of preference shares,

ordinary shares, and convertible preference shares are likely to rise or
fall if profitability increases dramatically and interest rates rise slightly.
A problem that stimulates lively classroom discussion.
11.2
Factors Affecting the Market Prices of Ordinary Shares
25 Strong
Students are to explain the reason for changes in the market prices of
shares of various real companies. A difficult problem that is very
thought-provoking.
11.3
Selecting a Form of Organization

Students are to interview the owners of two small businesses with
different forms of organization and find out why the particular form
was selectedand if they have any misgivings.
11.4
S.F.C. Enforcement Division

Ethics, Fraud & Corporate Governance
Students do an internet search to locate the website of the Securities &
Futures Commission and respond to questions about the S.F.C.

Desc. of Cases
Interview; No
time estimate
20 Easy
*Supplemental Topic, Special Types of Liabilities.

Desc. of Cases
SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

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

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

records of share ownership and transfers.
b.
Shareholders subsidiary ledger. A record kept by a corporation showing the number of

shares owned by each shareholder.
c.
Underwriter. An investment banking company that undertakes to sell new corporate shares
to investors. The underwriter usually guarantees the corporation a specified price, and
plans to make a profit by selling to individual investors at a slightly higher price.
d.
Share registrar. An independent fiscal agent, usually a large bank, retained by a

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

Q6-11
corporation, less the amount assigned to preference shares (par value, or liquidation value if
given, plus dividends in arrears) by the number of ordinary shares outstanding. Book value does
not represent the amount ordinary shareholders would receive in the event of liquidation. If a
corporation were liquidated, many assets would be sold at prices different from their carrying
values in the accounting records. The resulting gains or losses would cause shareholders equity
to change accordingly.

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

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

Q18-20
B.Ex. 11.1
Ordinary shares (10,000 shares @ $10)

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

Share premium:
Preference shares (1,000 shares @ $10)
Retained earnings
$100,000
250,000
B.Ex. 11.3
10,000
20,000
100,000
$480,000
Dividends on arrears on preference shares for three years are calculated as

follows:
100,000 shares x $100 par value x 6% dividend rate x 3 years =
$1,800,000
The amount of dividends in arrears must be disclosed in the financial statements,
but they are not formally included as a liability in the balance sheet until declared
by the Board of Directors of the company.
B.Ex. 11.4
B.Ex. 11.5
Total dividend declared

Dividend requirements for preference shares:
10,000 shares x $100 par x 6% x 2 years
Dividends available for ordinary shares
$200,000
Total dividend declared

Dividend requirements for noncumulative preference shares:
10,000 x $100 par x 8% x 1 year
Dividends available for ordinary shares
Dividends per share on ordinary shares:
$40,000/100,000 shares
$120,000
120,000
$80,000
80,000
$40,000
$0.40
If the preference shares is cumulative, the entire dividend goes to preference shares
and the ordinary shareholders will receive none of the $120,000 dividends
declared. In fact, satisfaction of the full claim of the preference sharesholders in
this case will require $320,000, determined as follows:
10,000 x $100 par x 8% x 4 years = $320,000

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

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

Share premium
(100,000 shares @ $15)
Less: Treasury shares (10,000 shares x $55)
B.Ex. 11.10
Ordinary shares (1,000,000 shares @ $25)

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

BE11.6,7,8,9,10
$1,000,000
1,500,000
$2,500,000
(550,000)
$1,950,000
$25,000,000
5,000,000
350,000
$30,350,000
1,500,000
$28,850,000
SOLUTIONS TO EXERCISES
Ex. 11.1
a.
(1) Organizing the scuba diving school as a sole proprietorship.

Advantages:
(a)
Easy to form
(b)
No double taxation on distributed earnings
Disadvantages:
(a)
Personal liability of owner for debts of the business
(b)
Business ceases with death of owner
(2) Organizing the scuba diving school as a corporation.
Advantages:
(a)
No personal liability of owners for debts of the business
(b)
Readily transferable ownership shares
(c)
Continuous existence
Disadvantages:
(a)
Double taxation on distributed earnings
(b)
Greater regulation
Ex. 11.2
b.
A corporation would probably be the better form of organization because of the

characteristic of limited liability of the owners. Potentially, a scuba diving student
could be seriously injured in the class. With the sole proprietorship form of
organization, your personal assets would be at risk to pay for the persons injuries,
after you exhausted any insurance coverage and assets that the business might
have.
a.
b.
c.
Double taxation
Market value
None (Retained earnings is not an amount of cash; it is an element of owners
equity.)
d.
e.
Ordinary shares
None (Dividends in arrears are prior years dividends owed to holders of
cumulative preference shares.)
f.
g.
h.
i.
Publicly owned corporation

Issued and fully paid capital
Retained earnings
None (Book value is ordinary shareholders equity divided by the number of
ordinary shares outstanding.)
j.
None (The price of preference shares varies inversely with interest rates.)

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

Dividends on 9% noncumulative preference shares:
$376,000
Current years dividend ($50 x .09 x 40,000)

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

Preference shares, 9% noncum. ($180,000 40,000 s
Preference shares, 12% noncum. ($96,000 8,000 share
Ordinary shares ($100,000 400,000 shares)
Ex. 11.5
$ 4.50 per share

$ 12.00 per share
$ 0.25 per share
c.
The shareholders equity section of the balance sheet reports no share premium.
Thus, the preference shares must have been issued at their respective par values
($50 per share for the 9% noncumulative preference shares, and $100 per share for
the noncumulative preference shares).
a.
150,000 shares ($15,000,000 total par value, divided by $100 par value per share)
b.
$1,050,000 ($15,000,000 total par value x 7% or 150,000 x $100 x 7%)
c.
$16 [($20 million par value + $44 million share premium) 4,000,000 shares issued]
d.
$35,000,000 legal capital ($15,000,000 preference, plus $20,000,000 ordinary)

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

E11.3,4,5
$79,000,000 total issued and fully paid capital ($35,000,000 legal capital, plus
$44,000,000 share premium)

E11.3,4,5
Ex. 11.6
e.

$ 143,450,000
Less: Par value of preference shares (150,000 shares x
15,000,000
Equity of ordinary shareholders
$ 128,450,000
Ordinary shares outstanding
4,000,000
$32.11
Book value per share ($128.45 million 4 million shares) ..
f.
No. Changes in the market value of shares do not directly affect a corporations
financial position and are not reflected in the equity section of the balance sheet.
Annual dividends on the preference shares are $14,000 (7,000 $25 8%)
Total dividend
Amount to preference shares
Amount to ordinary shares
Ex. 11.7
Event
a.
b.
c.
Current
Assets
I
NE
D
Shareholders
Equity
I
NE
D
Profit
NE
NE
NE

E11.6,7
$50,000
(14,000)
$36,000
Net Cash Flow

(from Any
Source)
I
NE
D
Ex. 11.8
a. Net assets (shareholders equity):

Preference shares .. $
Ordinary shares, $5 par, 60,000 shares issued
Share premium
$
Less: Deficit
Total net assets (shareholders equity)
$
b. Book value per ordinary share:
Total shareholders equity (from part a)
Less:
Claims of preference sharesholders ($200,000 plus
dividends in arrears, $16,000)
Number of ordinary shares outstanding
Book value per share ($590,000 60,000 shares)
c.
Ex. 11.9
$
$
200,000
300,000
452,800
952,800
146,800
806,000
806,000
216,000
590,000
60,000
9.83
No. The book value per share represents the shareholders share of the net book
value of the corporations assets, not the assets liquidation values. The
shareholders may receive more or less than the book value per share if the
corporation is liquidated, depending primarily on the amounts at which the
corporations assets are sold.
a. Feb. 10
June
Dec. 22
Treasury Shares
425,000
Cash
Purchased 17,000 shares of treasury
shares at $25 per share.
Cash
Treasury Shares
Share premium:
Treasury Shares.
Sold 6,000 shares of treasury shares, cost
$150,000, for $33 per share.
Cash
Share premium: Treasury
Shares
Treasury Shares
Sold 4,000 shares of treasury shares, cost
$100,000, for $22 per share.
425,000
198,000
150,000
48,000
88,000
12,000
100,000
b. Restriction of retained earnings for treasury shares owned at year-end:

$175,000 (7,000 shares still owned x $25 per share cost)
c. No, a restriction on retained earnings does not affect the total amount of retained
earnings reported in the balance sheet. A restriction of retained earnings is
disclosed, but does not reduce the total amount of retained earnings of a company.
The restriction on retained earnings simply limits the amount of dividends the
corporation can pay as long as it holds treasury shares.

E11.8,9
No, a restriction on retained earnings does not affect the total amount of retained
earnings reported in the balance sheet. A restriction of retained earnings is
disclosed, but does not reduce the total amount of retained earnings of a company.
The restriction on retained earnings simply limits the amount of dividends the
corporation can pay as long as it holds treasury shares.

E11.8,9
Ex. 11.10
a. Had the shares been split 2-for-1, it would begin trading at approximately $40
per share immediately after the split ($80 2 = $40).
b. Had the shares been split 4-for-1, it would begin trading at approximately $20
per share immediately after the split ($80 4 = $20).
c. When the market price of a corporations ordinary shares appreciate in value
significantly, as it had in the case of Fido Corporation, it may become too
expensive for many investors. Thus, the decision to split the companys shares
were probably made with the intent of making it more affordable to investors.
Ex. 11.11
a. Companies sometimes purchase their own ordinary shares to help boost the
market price per share. This practice is not generally considered unethical,
given that information pertaining to the purchase is fully disclosed in the
companys financial statements. Furthermore, if the company acquires a
significantly large amount of its outstanding shares, the event would be reported
in the financial press.
b. For a company to classify its treasury shares as a short-term investment is not
appropriate. When treasury shares is purchased, the corporation is actually
reducing its assets (cash), and eliminating part of its shareholders equity. For
this reason, treasury shares should not appear in the balance sheet as a current
asset.
Ex. 11.12
a. Carnival Corporation could sell approximately 1,336 million additional

shares. This figure is determined by subtracting the number of issued shares
from the number of authorized shares 1,960 million 624 million = 1,336
million.
b. Authorized, but unissued, shares do not represent an asset of the company. At
some time in the future they may result in an increase in assets if they are issued
for cash or other assets, but until that time they simply represent the potential
for future increases in assets. They are not included in the companys balance
sheet, other than through disclosure of the numbers of authorized and issued
shares. This permits the reader of the financial statements to calculate the
number of authorized, but unissued shares, as was done above.

E11.10-12
Ex. 11.13
a. Cash (550,000 x $12)

Ordinary shares (550,000 x $10)
Share Premium on ordinary
shares.
6,600,000
5,500,000
1,100,000
Cash (40,000 x $110)

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

Cash
2,400,000
4,000,000
400,000
2,400,000
Note: No entry is required to record the

authorization to issue preference and ordinary
shares.
b. Shareholders' Equity:
Preference shares, 6%, $100 par value, 50,000 shares authorized,
40,000 shares issued and outstanding
Ordinary shares, $10 par value, 1,000,000 shares authorized,
550,000 shares issued
Share premium:
Preference shares
Ordinary shares
$4,000,000
$ 5,500,000
400,000
1,100,000
$11,000,000
Less: Treasury (ordinary) shares at cost, 40,000 shares
(2,400,000)
$8,600,000

E11.13
Ex. 11.14
a. Ordinary Shares, $10 par value, 200,000 shares authorized,

100,000 shares issued
$1,000,000
Share premium on ordinary shares
800,000
Share premium on treasury shares

Transactions
30,000
Total Issued and fully paid capital
$1,830,000
Retained earnings
Total issued and fully paid capital and retained earnings
Less: Treasury shares
120,000
$1,950,000
(300,000)
$1,650,000
Calculations:
Share premium on ordinary shares:
100,000 shares x ($18 - $10) = $800,000
Share premium on treasury shares:
10,000 shares x ($23 - $20) = $30,000
Treasury shares:
15,000 shares x $20 = $300,000
b. After a 2:1 share split is distributed, the par value of the ordinary shares will be
reduced to half ($10 x 1/2 = $5) and all of the share numbers will double. The 2:1
split has no effect on the total figures for ordinary shares, share premium,
retained earnings, treasury shares, or total shareholders' equity.

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

E11.15
20 Minutes, Easy
a.
SOLUTIONS TO PROBLEMS SET A

PROBLEM 11.1A
ROBBINSVILLE PRESS
ROBBINSVILLE PRESS
Partial Balance Sheet
December 31, 2009
Preference shares, $100 par value,
authorized 100,000 shares, issued and outstanding
10,000 shares
Ordinary shares, $1 par value, authorized 500,000 shares
issued and outstanding 170,000 shares
Share premium: Ordinary shares
Retained earnings*
*Computation of retained earnings at December 31, 2009:
Profit for the four-year period 2006-2009
Less: Preference share dividends ($80,000 per year for four yea $
Ordinary share dividends ($0.75 x 170,000 shares x 4 year
Retained earnings, December 31, 2009
b.
$ 1,000,000
170,000
2,380,000
$ 3,550,000
255,000
$ 3,805,000
$ 1,085,000
320,000
510,000
$
830,000
255,000
There are no dividends in arrears at December 31, 2009. We know this because ordinary
dividends were paid in each of the four years that the company was in existence. Ordinary
shareholders could not have received dividends in each year of the companys existence had
any dividends been in arrears on the preference shares.

P11.1A
20 Minutes, Easy
a.
PROBLEM 11.2A
WALLER PUBLICATIONS
WALLER PUBLICATIONS
December 31, 2009
10% cumulative preference shares, $100 par value,
authorized, issued, and outstanding 20,000 shares
Ordinary shares, $1 par value, authorized 1 million shares,
Share premium: ordinary shares
Retained earnings*
Profit for the five-year period 2004-2008
Less: Preference share dividends ($200,000 x 5 years)
$
Ordinary share dividends ($1 x 300,000 shares x 5 yea
Retained earnings, December 2008
Less: Net loss of 2009
b.
2,000,000
$
$
300,000
5,700,000
8,000,000
210,000
8,210,000
4,460,000
1,000,000
1,500,000
$
$
2,500,000
1,960,000
1,750,000
210,000
Note to financial statements:

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

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

Retained earnings at Dec. 31, 2007
Add: Profit for 2008 and 2009
Profit for four-year period
Less: Dividends paid on 8% preference shares:
2008 (8% x $100 x 5,000 shares = $40,000)
2009 (8% x $100 x 5,000 shares = $40,000)
Dividends on $9 preference shares:
2008 ($9 x 5,000 shares)
2009 ($9 x 5,000 shares)
Dividends on ordinary shares:
2008 ($0.50 x 100,000 shares)
2009 ($1.60 x 100,000 shares)
b.
500,000
$
$
200,000
600,000
1,812,000
640,000
2,452,000
170,000
890,000
1,060,000
40,000
40,000
(80,000)
45,000
45,000
(90,000)
50,000
160,000
$
(210,000)
680,000
A corporation might decide to use preference shares rather than debt to finance operations
for any of the following reasons (only 2 required):
1. Dividends do not have to be paid each year and do not become a legal obligation of the
corporation until they are declared. Interest on debt is a legal obligation of the
corporation and must be paid each year.
2. Debt must be repaid at some future date. To be a permanent source of capital, debt must
be periodically refinanced. Preference shares generally does not mature.
3. Increasing the amount of debt on a balance sheet can adversely affect financial ratios.

P11.3A
35 Minutes, Medium
PROBLEM 11.4A
BARNES COMMUNICATIONS LIMITED
a.
General Journal
20__
Jan 6 Cash
280,000
Ordinary Shares
Share Premium: Ordinary Shares
Issued 20,000 shares of $2 par value ordinary
shares
at $14 per share.
7 Organization Costs Expense
Ordinary Shares
Issued 500 shares of ordinary shares to Barnes in
exchange for services relating to formation of the
corporation. Implied issuance price ($7,000 500
shares) = $14 per share.
### Cash
40,000
240,000
7,000
1,000
6,000
250,000
Preference Shares
Issued 2,500 shares of $100 par value, 10%,
preference shares at par value.
June
4 Land
250,000
225,000
Ordinary Shares
Issued 15,000 shares of ordinary shares in
exchange
for land valued at $225,000 (15,000 shares x $15).
Nov
Dec
30,000
195,000
### Dividends (Preference Shares)

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

Cash
To record payment of dividend declared Nov. 15.
25,000
### Income Summary

Retained Earnings
To close the Income Summary account for the
year.
### Retained Earnings
Dividends
To close the Dividends account.

P11.4A
25,000
25,000
147,200
147,200
25,000
25,000

P11.4A
b.
PROBLEM 11.4A
BARNES COMMUNICATIONS LIMITED (concluded)
BARNES COMMUNICATIONS LIMITED
December 31, 20___
Preference shares, $100 par, authorized
50,000 shares, issued and outstanding 2,500 shares
Ordinary shares, $2 par, authorized 400,000 shares,
Retained earnings*
*Computation of retained earnings at December 31, 20__:
Retained earnings at January 1, 20__
Add: Profit in 20__
Less: Preference dividends in 20__
Retained earnings at December 31, 20__.

P11.4A (p.2)
250,000
71,000
441,000
762,000
122,200
884,200
$
$
147,200
(25,000)
122,200

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

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

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

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

Share premium: Ordinary
Total issuance price of all ordinary shares
Number of ordinary shares issued (c)
Average issuance price per ordinary share ($9,225,000 450,000 shares)
900,000
8,325,000
9,225,000
450,000
20.50
Par value of preference shares

Par value of ordinary shares
Total legal capital
Total legal capital (e)

Add: Share premium: Ordinary shares
e.
f.
$
$
2,400,000
900,000
3,300,000
3,300,000
8,325,000
11,625,000
g.
$ 14,220,000
Less: Par value of preference shares [24,000 shares (a) x $100 per shar 2,400,000
$ 11,820,000
450,000
Number of ordinary shares outstanding (c)
$
26.27
Book value per share ($11,820,000 450,000 shares)
h.
Retained earnings, beginning of the year

Add: Profit for the year
Subtotal
Less: Retained earnings, end of the year
Total dividends paid during the year
Less: Dividends on preference shares (part b)
Total dividends on ordinary shares
Dividends per ordinary share ($1,912,500 450,000)

P11.5A
$
$
$
$
$
717,500
3,970,000
4,687,500
2,595,000
2,092,500
180,000
1,912,500
450,000
4.25
35 Minutes, Medium
PROBLEM 11.6A
PARSONS LIMITED CORPORATION
In Thousands
(Except for Per
Share Amounts)
$
6,819
0.50
13,638
a.

Par value per share
Number of shares outstanding ($6,819/$0.50)
b.
Dividend requirement per preference share

Number of preference shares outstanding
Annual dividends paid to preference sharesholders ($17.20 x 345)

Share premium

Less: Preference shares par value = ($250 x 345 shares)
Book value per share ($151,342/13,638 shares)
c.
d.

P11.6A
$
$
17.20
345
5,934
86,250
6,819
87,260
180,329
237,592
86,250
151,342
13,638
11.10
PROBLEM 11.6A
PARSONS LIMITED (concluded)
e.
The basic advantage of being publicly owned is that the corporation has the opportunity to
raise large amounts of equity from many investors. Some publicly owned corporations
have millions of shareholders, including pension funds, mutual funds, and other
corporations. Private corporations are usually unable to raise the large amounts of capital
available to publicly owned corporations.
A major advantage to the shareholders of a publicly owned corporation is that their
equity investments are highly liquid assets, immediately salable at quoted market
prices.
The primary disadvantages of being publicly owned are the increased governmental
regulations and financial reporting requirements.
f.
The term convertible means that at the option of the preference shareholder, each
preference share can be converted into a specified number of ordinary shares. To evaluate
the value of this conversion feature, the shareholder must know into how many shares of
ordinary each preference share can be converted. This information is disclosed in the notes
accompanying the corporations financial statements.
g.
At $248 per share, Parson's preference share has a dividend yield of 6.9% ($17.20 $248).
In comparison, an 8%, $50 par preference selling at $57 has a dividend yield of 7% [(8% x
$50 par) $57].
The dividend yield on preference shares indicates how much investors value certain
features of the shares. The lower the yield, the more investors favor the shares. A
higher yield means that investors demand a higher return to induce them to purchase
the shares.
The two principal factors that cause one preference share to yield less than another are:
(1) the appearance of greater ability to pay the preference dividends each year, and (2)
special features that appeal to investors, such as Parsons conversion feature, cumulative
dividends, or a high call price.

P11.6A(p.2)
15 Minutes, Easy
a.
PROBLEM 11.7A
TECHNO CORPORATION
Par value is the legal capital per sharethe amount by which shareholders equity cannot be
reduced except by losses. Thus, par value may be viewed as a minimum cushion of equity
capital existing for the protection of creditors.
Book value per share is equal to the net assets represented by each ordinary
share. Book value is a historical cost concept, representing the amounts invested by
the shareholders, plus the amounts earned and retained by the corporation. By
comparing book value with current market value, shareholders may gain insight into
whether management has increased or diminished the value of the resources
entrusted to their care.
The market value of a share is established in the marketplace. It represents the per-share
price at which willing sellers can and will sell shares to willing buyers. Market value is
related primarily to investors future expectations of the companys performance, rather
than to historical amounts.
b.
The companys par valueone-tenth of a cent per shareis quite low. However, the
corporation can set par value at any level that it chooses; the amount of par value has
no direct effect upon either book value or market value. It does mean, however, that
the amount of the companys legal capitalserving as a cushion for creditorsis quite
low. Another reason for the small par value is the possibility of share splits in the past.
The fact that book value per share ($6.50) is far above par value indicates either that (1)
the shares initially was issued at a price far above par value, or (2) that the company has
retained substantial amounts of earnings. Even if there had been share splits in prior
years, the total dollar amount of book value would not have been affected.
The market value of $65 is 10 times book value. This implies that investors believe that
management and product lines make the company worth far more than the amounts of
capital historically invested.
The very low par value offers little protection to the companys creditors. On the other
hand, a market value of many times book value implies that little cushion is required for
creditors claims to be secure. If the company performs as its market price implies that it
will, its earnings and cash flows should make the creditors positions quite secure.
Earnings and cash flows are far more relevant to a companys debt-paying ability than is
the cushion provided by par value.

P11.7A
PROBLEM 11.8A
FELLER CORPORATION
15 Minutes, Medium
a.
Ordinary shares, $1 par, 50,000 shares authorized, issu
outstanding

Share premium: Treasury shares
Retained earnings*
*Computation of retained earnings at Dec. 31, 2009:

Profit in 2007
Profit in 2008
Profit in 2009
Retained earnings, Dec. 31, 2009
50,000
350,000
5,000
405,000
185,000
590,000
$
$
82,000
25,000
78,000
185,000
b.
The companys book value per share is $11.80 ($590,000 total shareholders equity 50,000
shares outstanding).
c.
The treasury shares purchase of $35,000 in 2008 was reported as a financing cash outflow in
the statement of cash flows for that year. The reissue of the treasury shares for $40,000 in the
following year was reported as a financing cash inflow in the 2009 statement of cash flows.

P11.8A
PROBLEM 11.9A
HERNDON INDUSTRIES
30 Minutes, Strong
a.
10% preference shares, $100 par, cumulative, authorized,
issued, and outstanding 30,000 shares
Ordinary shares, $10 par, 200,000 shares authorized,
120,000 shares issued, of which 10,000 shares are held in
treasury
Share premium: Treasury shares*
Retained earnings**
Subtotal
Less: Treasury shares (10,000 shares x $20 cost per share)
Total shareholders equity at Dec. 31, 2009
3,000,000
1,200,000
720,000
50,000
4,970,000
1,925,000
6,895,000
200,000
6,695,000
3,700,000
1,775,000
1,925,000
$
$
*Computation of share premium on treasury shares:

Purchase price per share: $400,000 20,000 shares = $20
per share
Reissue price per share: $250,000 10,000 shares = $25
per share
Premium per share reissued: $5 per share ($25 - $20)
Total issued and fully paid capital on treasury shares: $50,000
($5 per share x 10,000 shares reissued)
**Computation of retained earnings at Dec. 31, 2009:
Profit (for years 20052009)
Less: Preference dividend (for years 20052009)
$100 x 10% x 30,000 shares x 5 years
Less: Ordinary dividends
20052006: 120,000 shares outstanding x $0.50 x 2 yrs
2009: 110,000 shares outstanding x $0.50

1,500,000
120,000
100,000
55,000
b.
The companys book value per share is approximately $33.59 ($6,695,000 total shareholders
equity - $3,000,000 of preference shares book value = $3,695,000; $3,695,000 110,000 shares
outstanding = $33.59).
c.
Had the company decided to split its ordinary shares 3-for-1 on December 31, 2009, the market
value would have fallen to approximately $10 per share ($30 3). The par value would have
been reduced to $3.33 ($10 3), and the number of shares outstanding would have increased to
330,000 shares (110,000 x 3).

P11.9A
20 Minutes, Easy
a.
SOLUTIONS TO PROBLEMS SET B

PROBLEM 11.1B
SEPTA LIMITED
SEPTA LIMITED
December 31, 2009
10% noncumulative preference shares, $100 par value, callable
at $110, authorized 1,000 shares, issued and outstanding 500 shares
Ordinary shares, $1 par value, authorized 200,000 shares
Issued and outstanding 80,000 shares
Retained earnings*
Profit for the four-year period 2006-2009
Less: Preference share dividends ($5,000 per year for four years) $ 20,000
128,000
Ordinary share dividends ($0.40 x 80,000 shares x 4 years)
b.
50,000
$
$
80,000
1,120,000
1,250,000
1,652,000
2,902,000
1,800,000
148,000
1,652,000
The market price of preference shares usually decreases as interest rates increase. Thus, at
December 31, 2009, the market price of Septa's preference shares was probably lower than
its call price of $110 (in fact, it may actually have fallen below its original price of $100 per
share.

P11.1B
20 Minutes, Easy
a.
PROBLEM 11.2B
BANNER PUBLICATIONS
BANNER PUBLICATIONS
December 31, 2009
10% noncumulative preference shares, $100 par value,
authorized, issued, and outstanding 10,000 shares
Ordinary shares, $1 par value, authorized 1 million shares,
Share premium: ordinary shares
Retained earnings*
Profit for the five-year period 2004-2008
Less: Preference share dividends ($100,000 x 5 years)
$
Ordinary share dividends ($.80 x 400,000 shares x 5 y
Retained earnings, December 2008
Less: Loss of 2009
b.
1,000,000
400,000
5,600,000
7,000,000
900,000
7,900,000
4,100,000
500,000
1,600,000
$
$
2,100,000
2,000,000
1,100,000
900,000
Note to financial statements:

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

P11.2B
PROBLEM 11.3B
RAY BEAM LIMITED
25 Minutes, Medium
a.
RAY BEAM LIMITED
December 31, 2009
10% noncumulative preference shares, $100 par value, 10,000
shares authorized, issued, and outstanding
$6 noncumulative preference shares, no-par value, 8,000 shares
authorized, 5,000 shares issued and outstanding
Ordinary shares, $1 par, 260,000 shares authorized, 130,000
shares issued and outstanding
Retained earnings*
Retained earnings at Dec. 31, 2007
Add: Profit for 2008 and 2009
Profit for four-year period
Less: Dividends paid on 10% preference shares:
2008 (10% x $100 x 10,000 shares = $100,000)
2009 (10% x $100 x 10,000 shares = $100,000)
Dividends on $6 preference shares:
2008 ($6 x 5,000 shares)
2009 ($6 x 5,000 shares)
Dividends on ordinary shares:
2008 ($0.90 x 130,000 shares)
2009 ($2.00 x 130,000 shares)
b.
100,000
100,000
$
30,000
30,000
117,000
260,000
A corporation might decide to use preference shares rather than debt to finance operations for any of
the following reasons (only 2 required):
1.
Dividends do not have to be paid each year and do not become a legal obligation of the
corporation until they are declared. Interest on debt is a legal obligation of the
corporation and must be paid each year.
2.
Debt must be repaid at some future date. To be a permanent source of capital, debt must
be periodically refinanced. Preference shares generally does not mature.
3.
Increasing the amount of debt on a balance sheet can adversely affect financial ratios.

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

egal obligation of the
nt source of capital, debt must

es not mature.
ersely affect financial ratios.

P11.3B
PROBLEM 11.4B
MARKUP LIMITED
35 Minutes, Medium
a.
General Journal
20__
Jan 7 Cash
300,000
Ordinary Shares
Issued 30,000 shares of $1 par value ordinary
shares
at $10 per share.
### Organization Costs Expense
Ordinary Shares
Issued 1,000 shares of ordinary shares to Deal in
exchange for services relating to formation of the
corporation. Implied issuance price ($12,000
1,000
shares) = $12 per share.
### Cash
30,000
270,000
12,000
1,000
11,000
400,000
5% Preference Shares
Issued 4,000 shares of $100 par value, 5%,
noncumulative preference shares at par value.
July
5 Land
400,000
120,000
Ordinary Shares
Issued 10,000 shares of ordinary shares in
exchange
for land valued at $120,000 (10,000 shares x $12).
Nov
Dec
10,000
110,000
### Dividends (Preference Shares)

Dividends Payable
To record declaration of annual dividends of $5
per share on 4,000 preference shares outstanding.
Payable Dec. 11.
20,000
11 Dividends Payable
Cash
To record payment of dividend declared Nov. 25.
20,000
### Income Summary

Retained Earnings
To close the Income Summary account for the
year.
### Retained Earnings
Dividends (Preference Shares)

P11.4B
20,000
20,000
810,000
810,000
20,000
20,000
To close the Dividends account.

P11.4B
20 Minutes, Easy
b.
PROBLEM 11.4B
RKUP LIMITED (concluded)
MARKUP LIMITED
December 31, 20__
5% cumulative preference shares, $100 par, authorized
100,000 shares, issued and outstanding 4,000 shares
Ordinary shares, $1 par, authorized 100,000 shares,
Retained earnings*
*Computation of retained earnings at December 31, 20__:
Retained earnings at January 1, 20__
Add: Profit in 20__
Less: Preference dividends in 20__
Retained earnings at December 31, 20__.

P11.4B (p.2)
400,000
41,000
391,000
832,000
790,000
1,622,000
$
$
810,000
(20,000)
790,000

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

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

Number of preference shares outstanding (a)
Annual preference shares dividend requirement ($10 x 44,000 shares)
10
44,000
440,000
c.

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

Share premium: Ordinary
Total issuance price of all ordinary shares
Number of ordinary shares issued (c)
Average issuance price per ordinary share ($10,200,000 1,700,000 shares)
3,400,000
6,800,000
10,200,000
1,700,000
6

Total legal capital
Total legal capital (e)

Add: Share premium: Ordinary shares
Donated capital
$
$
e.
f.
4,400,000
3,400,000
7,800,000
7,800,000
6,800,000
400,000
15,000,000
g.
$ 18,160,000
Less: Par value of preference shares [44,000 shares (a) x $100 per shar 4,400,000
$ 13,760,000
1,700,000
Number of ordinary shares outstanding (c)
$
8.09
Book value per share ($13,760,000 1,700,000 shares)
h.
Retained earnings, beginning of the year

Add: Profit for the year
Subtotal
Less: Retained earnings, end of the year
Total dividends paid during the year
Less: Dividends on preference shares (part b)
Total dividends on ordinary shares
Dividends per ordinary share ($2,400,000 1,700,000)

P11.5B
$
$
$
$
$
1,200,000
4,800,000
6,000,000
3,160,000
2,840,000
440,000
2,400,000
1,700,000
1.41

P11.5B
PROBLEM 11.6B
TOASTY CORPORATION
35 Minutes, Medium
In Thousands
(Except for Per
Share Amounts)
$
9,600
$
3
3,200
a.

Par value per share
Number of shares outstanding ($9,600/$3)
b.
Dividend requirement per share of preference shares

Numbers of preference shares outstanding
Annual dividends paid to preference sharesholders ($10 x 250)

Share premium
$
$

Less: Preference shares par value = ($200 x 250 shares)
Book value per share ($137,000 3,200 shares)
c.
d.

P11.6B
$
$
10
250
2,500
50,000
9,600
76,800
136,400
187,000
50,000
137,000
3,200
42.81
PROBLEM 11.6B
TOASTY CORPORATION (concluded)
e.
The basic advantage of being publicly owned is that the corporation has the opportunity to
raise large amounts of equity capital from many investors. Some publicly owned
corporations have millions of shareholders, including pension funds, mutual funds, and
other corporations. Private corporations are usually unable to raise the large amounts of
capital available to publicly owned corporations.
A major advantage to the shareholders of a publicly owned corporation is that their
equity investments are highly liquid assets, immediately salable at quoted market
prices.
The primary disadvantages of being publicly owned are the increased governmental
regulations and financial reporting requirements.
f.
The term convertible means that at the option of the preference sharesholder, each
preference share can be converted into a specified number of ordinary shares. To evaluate
the value of this conversion feature, the shareholder must know into how many shares of
ordinary each preference share can be converted. This information is disclosed in the notes
accompanying the corporations financial statements.
g.
At $190 per share, Toastys preference has a dividend yield of 5.26% ($10 $190). In
comparison, a 6%, $50 par preference selling at $52 has a dividend yield of 5.77% [(6%
$50 par) $52].
The dividend yield on preference shares indicates how much investors value certain
features of the shares. The lower the yield, the more investors favor the shares. A
higher yield means that investors demand a higher return to induce them to purchase
the shares.
The two principal factors that cause one preference to yield less than another are: (1) the
appearance of greater ability to pay the preference dividends each year, and (2) special
features that appeal to investors, such as Toastys conversion feature, cumulative
dividends, or a high call price.

P11.6B(p.2)
15 Minutes, Easy
a.
PROBLEM 11.7B
BRAIN CORPORATION
Par value is the legal capital per sharethe amount by which shareholders equity cannot be
reduced except by losses. Thus, par value may be viewed as a minimum cushion of equity
capital existing for the protection of creditors.
Book value per share is equal to the net assets represented by each ordinary share. Book
value is a historical cost concept, representing the amounts invested by
the shareholders, plus the amounts earned and retained by the corporation. By
comparing book value with current market value, shareholders may gain insight into
whether management has increased or diminished the value of the resources
entrusted to their care.
The market value of a share is established in the marketplace. It represents the per-share
price at which willing sellers can and will sell shares of the share to willing buyers. Market
value is related primarily to investors future expectations of the companys performance,
rather than to historical amounts.
b.
The companys par valuefive cents per shareis quite low. However, the
corporation can set par value at any level that it chooses; the amount of par value has
no direct effect upon either book value or market value. It does mean, however, that
the amount of the companys legal capitalserving as a cushion for creditorsis quite
low. Another reason for the small par value is the possibility of share splits in prior years.
The fact that book value per share ($10.00) is far above par value indicates either that (1)
the share initially was issued at a price far above par value, or (2) that the company has
retained substantial amounts of earnings. Even if there had been share splits in prior
years, the total dollar amount of book value would not have been affected.
The market value of $96 is 9.6 times book value. This implies that investors believe that
management and product lines make the company worth far more than the amounts of
capital historically invested.
The very low par value offers little "cushion" to the companys creditors. On the other
hand, a market value of many times book value implies that little cushion is required for
creditors claims to be secure. If the company performs as its market price implies that it
will, its earnings and cash flows should make the creditors positions quite secure.
Earnings and cash flows are far more relevant to a companys debt-paying ability than is
the cushion provided by par value.

P11.7B
PROBLEM 11.8B
TIN CORPORATION
15 Minutes, Medium
a.
Ordinary shares, $3 par, 50,000 shares authorized, issu
outstanding
Share premium: Treasury shares
Retained earnings*
*Computation of retained earnings at Dec. 31, 2009:

Profit in 2007
Profit in 2008
Profit in 2009
150,000
350,000
10,000
510,000
330,000
840,000
$
$
150,000
80,000
100,000
330,000
b.
The companys book value per share is $16.80 ($840,000 total shareholders equity 50,000
shares outstanding).
c.
The treasury shares purchase of $30,000 in 2008 was reported as a financing cash outflow in
the statement of cash flows for that year. The reissue of the treasury shares for $40,000 in the
following year was reported as a financing cash inflow in the 2009 statement of cash flows.

P11.8B
PROBLEM 11.9B
PARKER INDUSTRIES
30 Minutes, Strong
a.
6% preference shares, $100 par, authorized and
Ordinary shares, $20 par, 100,000 shares authorized,
80,000 shares issued, of which 400 shares are held in
treasury
Share premium: Treasury shares*
Retained earnings**
Subtotal
Less: Treasury shares (400 shares x $40 cost per share)
Total shareholders equity at Dec. 31, 2009
1,000,000
1,600,000
1,200,000
6,000
3,806,000
3,261,440
7,067,440
16,000
7,051,440
3,800,000
*Computation of share premium on treasury shares:

Purchase price per share: $40,000 1,000 shares = $40
per share
Reissue price per share: $30,000 600 shares = $50
per share
Premium per share reissued: $10 per share ($50 - $40)
Total issued and fully paid capital on treasury shares: $6,000

($10 per share x 600 shares reissued)
**Computation of retained earnings at Dec. 31, 2009:
Profit (for years 20052009)
Less: Preference dividend (for years 20052009)
$100 x 6% x 10,000 shares x 5 years
Less: Ordinary dividends
2009: 79,600 shares outstanding x $0.60

300,000
$
96,000
94,800
47,760
$
238,560
3,261,440
b.
The companys book value per share is approximately $76.02 ($7,051,440 total shareholders
equity - $1,000,000 of preference shares book value = $6,051,440; $6,051,440 79,600 shares
outstanding = $76.02).
c.
Had the company decided to split its ordinary share 2-for-1 on December 31, 2009, the market
value would have fallen to approximately $28 per share ($56 2). The par value would have
been reduced to $10.00 ($20 2), and the number of shares outstanding would have increased
to 159,200 shares (79,600 x 2).

P11.9B
SOLUTIONS TO CRITICAL THINKING CASES

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

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

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

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

Case 11.4

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CHAPTER 11

Dividends on ordinary and preference

Authorized share capital

Treasury shares and share split

The McGraw-Hill Companies, Inc., 2010

Real World: adidas AG

Reading an annual report

The McGraw-Hill Companies, Inc., 2010

Par, book, and market values

Comprehensive equity with

Critical Thinking Cases

Real World: Japan Airlines

Factors affecting market prices of

Selecting a form of business

Securities & Futures

(Ethics, fraud & corporate

The McGraw-Hill Companies, Inc., 2010

DESCRIPTIONS OF PROBLEMS AND

Problems (Sets A and B)

Robbinsville Press/Septa Limited

Waller Publications/Banner Publications

Manhattan Transport Company/Ray Beam Limited

Barnes Communications Limited/Markup Limited

Smithfield Products/Manor Limited

Parsons Limited/Toasty Corporation

Techno Corporation/Brain Corporation

The McGraw-Hill Companies, Inc., 2010

Herndon Industries/Parker Industries

Critical Thinking Cases

Factors Affecting the Market Prices of Preference and Ordinary

Students are asked to explain whether the prices of preference shares,

Factors Affecting the Market Prices of Ordinary Shares

Selecting a Form of Organization

S.F.C. Enforcement Division

The McGraw-Hill Companies, Inc., 2010

*Supplemental Topic, Special Types of Liabilities.

The McGraw-Hill Companies, Inc., 2010

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

The McGraw-Hill Companies, Inc., 2010

Share transfer agent. A bank or trust company retained by a corporation to maintain

Shareholders subsidiary ledger. A record kept by a corporation showing the number of

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

The McGraw-Hill Companies, Inc., 2010

The McGraw-Hill Companies, Inc., 2010

The McGraw-Hill Companies, Inc., 2010

The McGraw-Hill Companies, Inc., 2010

Ordinary shares (10,000 shares @ $10)

Preference shares (1,000 shares @ $100)

Dividends on arrears on preference shares for three years are calculated as

Total dividend declared

Total dividend declared

The McGraw-Hill Companies, Inc., 2010

Total shareholders' equity ($4,000,000 + $5,000,000 + $800,000 +

Ordinary shares (100,000 shares @ $10)

Ordinary shares (1,000,000 shares @ $25)

The McGraw-Hill Companies, Inc., 2010

(1) Organizing the scuba diving school as a sole proprietorship.

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

Publicly owned corporation

The McGraw-Hill Companies, Inc., 2010

Total dividends paid in third year

Current years dividend ($50 x .09 x 40,000)

Dividends per share:

Ordinary shares ($100,000 400,000 shares)