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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