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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
Accretion of discount (10% × 276.36)

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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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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

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79.64
$376.00

Scott, Financial Accounting Theory, 6th Edition Instructor’s Manual

Chapter 2

Thus, at time 2 shareholders have:
Cash from time 1 dividend

$40.00

Interest period 2 on time 1 dividend: $40 ×0.10

4.00

Value of firm per balance sheet,

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