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Derivative instruments acquired to hedge exposure to changes in the fair value of an asset or liability
are fair value hedges. Fair value hedges are of two general types (1) hedges of a recognized asset or
Derivative instruments acquired to hedge exposure to variability in expected future cash flows are cash
flow hedges. Cash flow hedges are of two general types: (1) hedges of cash flows of an existing asset
5. Many firms use derivative instruments to hedge exposure to changes in the fair value of an asset or
liability, or to hedge exposure to variability in expected future cash flows. As an analyst examining the
financial reports of a company that uses derivative instruments to hedge, what questions should you
ask when thinking about derivatives and accounting quality?
ANS:
Items that should be considered are:
1. Of what quality are the market values that are being used to mark derivatives to market at the
PROBLEM
1. In the chart below, assign the directional effect (I = increase, D = decrease, or NE = no effect) of each
of the following six transactions on the components of the book value of common shareholders’
equity.
a. Issuance of $1 par value common stock at par value.
b. Stock repurchased and placed in the treasury
c. Cash dividend declared.
d. Shareholders identified for dividend distribution on the date of record
e. Property dividend declared and paid.
f. Large stock dividend declared and issued.
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Item Common Stock Additional Paid-In Capital Deferred Compensation Retained
Earnings Treasury Stock at Cost Total Common Shareholders’ Equity
a.
b.
c.
d.
e.
f.
ANS:
Item Common Stock Additional Paid-In Capital Deferred Compensation Retained
Earnings Treasury Stock at Cost Total Common Shareholders’ Equity
PTS: 1
2. In the chart below, assign the directional effect (I = increase, D = decrease, or NE = no effect) of each
of the following six transactions on the components of the book value of common shareholders’
equity.
a. Small stock dividend declared and issued.
b. 2-for-1 stock split announced and issued.
c. Stock options granted.
d. Recognition of compensation expense on stock options.
e. Stock options exercised.
f. Stock options expired.
Item Common Stock Additional Paid-In Capital Deferred Compensation Retained
Earnings Treasury Stock at Cost Total Common Shareholders’ Equity
a.
b.
c.
d.
e.
f.
ANS:
Item Common Stock Additional Paid-In Capital Deferred Compensation Retained
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
3. In the chart below, assign the directional effect (I = increase, D = decrease, or NE = no effect) of each
of the following four transactions on the components of the book value of common shareholders’
equity.
a. Treasury stock acquired (company uses the cost method).
b. Treasury stock in transaction a. reissued at an amount greater than original acquisition
price.
c. Treasury stock in transaction a. reissued at an amount less than the original acquisition
price.
d. Restricted stock issued (grant date).
Item Common Stock Additional Paid-In Capital Deferred Compensation Retained
Earnings Treasury Stock at Cost Total Common Shareholders’ Equity
a.
b.
c.
d.
ANS:
4. In the chart below, assign the directional effect (I = increase, D = decrease, or NE = no effect) of each
of the following four transactions on the components of the book value of common shareholders’
equity.
a. Recognition of compensation expense related to restricted stock.
b. Granting of stock appreciation rights to be settled with cash.
c. Recognition of compensation expense on stock appreciation rights.
d. Reacquisition and retirement of common stock at an amount greater than original issue price.
Item Common Stock Additional Paid-In Capital Deferred Compensation Retained
Earnings Treasury Stock at Cost Total Common Shareholders’ Equity
a.
b.
c.
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d.
ANS:
5. Assume that a start-up manufacturing company raises capital through a series of equity issues.
Required:
a. Using the financial statement template below, summarize the financial statement effects of the
following transactions.
(1) Issues 85,000 shares of $1 par value common stock for $15.00 per share.
(2) Receives land in exchange for 8,500 shares of $1 par common stock when the common stock is
trading in the market at $25 per share. The land has no readily determinable market value.
(3) (a) Receives subscriptions for the issue of 28,000 shares of $1 par value common. The share issue
price is $15 of which 30 percent is received as a down payment.
(3) (b) Subsequently, the remaining 70 percent is received from the transaction in 3(a).
Shareholders’ Equity
Entry
Assets
=
Liabilities
+
CC
+
AOCI
+
RE
1
2
3(a)
3(b)
Journal entry (optional):
b. In each case, how does the company measure the transaction? What measurement
attribute is used?
ANS:
Shareholders’ Equity
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Assets
3b. Cash …………………………………………………………….. 294,000
b. In each transaction, the company uses the attribute “fair value” as the measurement
basis for the transaction. The net increase in shareholders’ equity always equals the
© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
6. Following is the shareholders’ equity section of Morgan Supplies on a day its common stock is trading
at $77 per share.
Common stock ($2 par value, 30,000 shares issued and outstanding) $ 60,000
Additional paid-in capital on common stock 1,200,000
Retained earnings 3,000,000
Required:
a. Use the financial statement template below to show the financial statement effects of
the following dividend events. (Assume that the events are independent.)
(1) Cash dividend declaration and payment of $1 per share
(2) Property dividend declaration and payment of shares representing a short-term
investment in Screen Products, Ltd., with a fair value of $15,000
(3) 10 percent stock dividend
(4) 100 percent stock dividend
(5) 3-for-1 stock split
(6) 1-for-2 reverse stock split
Shareholders’ Equity
Entry
Assets
=
Liabilities
+
CC
+
AOCI
+
RE
1
2
3
4
5
6
Journal entry (optional):
b. Which events changed the book value of common equity?
c. Under what conditions will these events lead to future increases and decreases in ROE?
ANS:
(a)
Shareholders’ Equity
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© 2018 Cengage. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Liabilities
+
CC
+
AOCI
+
RE
1 Cash (30,000) Retained Earnings (30,000)
2 Investments (15,000) Retained Earnings (15,000)
3 Common Stock +6,000
APIC +225,000 Retained Earnings (231,000)
4 Common Stock +60,000 Retained Earnings (60,000)
5 N/A – Memorandum
Entry
6 N/A – Memorandum Entry
(b) Journal entries
Transaction 3: 30,000 shares outstanding x 10% dividend = 3,000 shares distributed;
Transaction 4: 30,000 shares outstanding x 100% dividend = 30,000 shares
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c. The book value of common equity (that is, total shareholders’ equity) decreases only
when assets are disbursed (Transactions 1 and 2). The remainder of the transactions
7. NOTE: This problem requires present value information.
Charter Corp. manufactures office equipment and supplies throughout the U.S. The company owns
property, plant, and equipment and also enters into operating leases for certain facilities. The
company’s tax rate is 35%. Listed below is selected financial data for Charter and the company’s
operating lease disclosure.
2012 2011 2010
Property, Plant, & Equipment (net) $178,454 $162,369 $155,388
Total Assets 515,685 424,545 410,256
Common Shareholders’ Equity 302,754 298,564 289,455
Sales $986,258 $888,965
Cost of Goods Sold 693,857 588,920
Depreciation Expense
Interest Expense 84,253 75,689
Net Income 124,581 91,025
Charter Corp.
Operating Lease Disclosure
(amounts in thousands)
Operating Lease Commitments
at the end of 2012
Year Reported Lease Commitments
2013 $ 25,239
2014 $ 52,800
2015 $ 78,924
2016 $ 48,760
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2017 $ 45,678
Beyond 2017 $212,000
As an analyst you wish to restate Charter’s operating leases into capital leases.
Required:
a. Using the information in the operating lease disclosure, and assuming that Charter has an
incremental borrowing rate for secured debt of 8%, restate the operating leases into capital leases.
b. Estimate the average life of the operating leases.
c. Calculate Charter’s fixed asset turnover ratio as reported.
d. Would Charter’s fixed asset turnover ratio increase or decrease, assuming that the operating
leases were capitalized?
ANS:
Present Value
Year Reported Lease Commitments Factor at 8% Present Value
c. Calculate Charter’s fixed asset turnover ratio as reported.
2012 2011
d. Would Charter’s fixed asset turnover ratio increase or decrease assuming that the operating
8. NOTE: The following problem requires present value information.
On January 1, 2012, Porter Corporation signed a five-year non-cancelable lease for certain machinery.
The terms of the lease called for:
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A) Porter to make annual payments of $60,000 at the end of each year (starting on Dec. 31, 2012)
for five years. Porter must return the equipment to the lessor end of this period.
B) The machinery has an estimated useful life of 6 years and no expected salvage value.
C) Porter uses the straight-line method of depreciation for all of its fixed assets.
D) Porter’s incremental borrowing rate is 8%.
E) The fair value of the asset at January 1, 2012 is $275,000.
Required:
1. Discuss whether Porter should account for the lease as an operating or capital lease and why.
2. Using the above information determine how the lease would affect Porter’s financial statements
in 2013. Use the balance sheet equation below to show the effects.
C + N$A = L + CC + AOCI + RE
ANS:
1. The lease should be accounted for as a capital lease given that it meets the 75% criteria. The
9. Summarize how the following information about Crank Corp.’s restructuring would affect the balance
sheet and income statement summary chart below. Crank Corp.’s restructuring will take approximately
18 months and was announced on March 15, 2010:
(1) On March 15, 2010 Crank Corp. announced its restructuring and recognized a restructuring
charge of $845,000.
(2) The tax effect of the restructuring charge was estimated to be $230,000.
(3) Crank determined that the cost of disposing and removing facilities and equipment during
2010 $312,000.
(4) The tax effect associated with the disposal and removal of facilities and equipment are
$95,000.
(5) Crank Corp. made cash payments to severed employees and lessors for lease terminations in
2010 equal to $78,000.
(6) The tax effect of the severance payments and lease cancellations was $19,000.
Shareholders’ Equity
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+
CC
+
AOCI
+
RE
1
2
3
4
5
6
ANS:
Shareholders’ Equity