Decent Essays

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

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.

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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