Testbook Answers

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Scott, Financial Accounting Theory, 6th Edition Instructor’s Manual Chapter 2 Suggested Solutions to Questions and Problems 1. P.V. Ltd. Income Statement for Year 2 Accretion of discount (10% × 286.36) $28.64 P.V. Ltd. Balance Sheet As at Time 2 Financial Asset Cash Shareholders’ Equity $315.00 Opening balance Net income $286.36 28.64 Capital Asset Present value 0.00 $315.00 $315.00 Note that cash includes interest at 10% on opening cash balance of $150. 2. Suppose that P.V. Ltd. paid a dividend of $10 at the end of year 1 (any portion of year 1 net income would do). Then, its year 2 opening net assets are $276.36, and net income would be: P.V. Ltd. Income Statement For Year 2…show more content…
To illustrate, the present value of the firm at time 0 is $260.33 and expected net income is $26.03 for year 1. Similarly, the present value of the firm at time 1 is $236.36 or $336.36 depending on state realization, and expected net income for year 2 is $23.64 or $33.64. In each case the market expects the firm to earn 10% on opening value. This 10% of opening value is accretion of discount. Copyright © 2012 Pearson Canada Inc 14 Scott, Financial Accounting Theory, 6th Edition Instructor’s Manual 4. Chapter 2 The procedure here is similar to that used in Question 2. Assume that the good economy state is realized for year 1. Assume also that P.V. Ltd. pays a dividend of, say, $40 at time 1. If the good economy state is also realized in year 2, P.V.’s year 2 net income will then be: P.V. Ltd. Income Statement For Year 2 (good economy in year 2) Accretion of discount [(336.36 – 40) ×.10] 29.64 Abnormal earnings, as a result of good state realization in year 2 (200 – 150) 50.00 Net income year 2 $79.64 PV’s balance sheet at the end of year 2 will then be: P.V. Ltd. Balance Sheet As at Time 2 Financial Asset Shareholders’ Equity Cash (200 - 40 + 200 + 16) $376.00 Opening balance $336.36 Less: Dividend end Capital Asset 0.00 of year 1 40.00 $296.36 Add: Net income $376.00 Copyright © 2012 Pearson Canada Inc 15 79.64 $376.00

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