Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
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Abnormal earnings
Actual cash flow, 2005 $5,000,00
Expected cash flow, 2005
c.
XYZ Ltd.
Balance Sheet
As at December 31, 2005
Financial Asset Liabilities
Cash (note 1) $3,288.02 Bonds payable $3,000.00
Capital Asset, Shareholders’ Equity
Notes:
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2. Retained earnings = net income (2,823.95) – dividends (1,411.98)
e. Investors are indifferent across dividend policies under ideal conditions
2A-2. a. First, calculate the cost of the specialized machinery at 1 Jan., 2005:
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Relevant Ltd.
Balance Sheet
As at 31 December, 2005
Assets Liabilities and Shareholders’ Equity
Cash (6,000–120) $5,880.00 Bank Loan $2,000.00
Relevant Ltd.
Income Statement
For the Year Ended 31 December, 2005
Expected Net Income [6,107.89 – 2,000 × .06] $246.46
Abnormal earnings
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c. The financial statements are completely relevant because they are based
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2A–3. a. The discounted PV of the future income tax liability:
At the end of year 1
168,3
112,5
520,2
800,1 −−−=PA
At the end of year 2
)17.580,8($
12.1
168,3
12.1
112,5
12
.1
520,2
32
2
=
−−−=PA
At the end of year 3
)80.089,7($
12.1
168,3
12.1
112,5
2
3
=
−−=PA
At the end of year 4
)57.828,2($
12.1
168,3
4
=
−=PA
At the end of year 5
b. It is because the balances calculated in part a are discounted to reflect
the PV of the future repayments of tax. This reduces their amounts.
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c. i) Repayment of the future income tax liability is triggered when capital
cost allowance falls below book amortization. Depending on the rate and time
2A–4. a. PV of future net cash flows, January 1, 2005 $1,500,000
GAZ Ltd.
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Income Statement
For the Year Ended December 31, 2005
b.
GAZ Ltd.
Balance Sheet
As at December 31, 2005
Financial Asset Shareholders’ Equity
c. Weaknesses of RRA:
• The mandated discount rate of 10% might not reflect the actual risk and
return for GAZ Ltd. This reduces relevance.
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d. Use of a single 10% rate was mandated in SFAS 69 to improve
comparability across firms and over time for the same firm. The effect is to
2A.5 a. Expected present value of asset on January 1, 2010 and 2011:
( ) ( )
00.26768.1887.000.80138.6603.0
06.1
300
06.1
200
7.0
06.1
900
06.1
700
3.0 22
0
+++=
++
+=PA
83.452
11.19872.254
=
+=
Rainy Ltd.
Balance sheet
As at December 31, 2010
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Rainy Ltd.
Income Statement
For the year ended December 31, 2010
b. The main reason why the present value calculations may become
unreliable is that objective state probabilities are not available. Consequently,
Scott, Financial Accounting Theory, 7th Edition Instructor’s Solutions Manual Chapter 2
c. A main reason is incomplete markets. Then, income cannot be measured
by the change in the market values of the firm’s assets and liabilities.