Name Date

CHAPTER 12 Business Organizations and

Decision-Making

SECTION 12.1 REVIEW QUESTIONS (page 551)

1. A partnership is a legal agreement where two or more people join together in a business and
share in its profits or losses.
2. A partnership name includes two or more names or one name and a reference to other
partners. Two examples are H. Gregg and Sons, and Lem and Kato Associates.
3. The main difference between the accounts of a partnership and a sole proprietorship is the
number of Capital and Drawings accounts. A sole proprietorship has one Capital and one
Drawings for the owner while a partnership has one Capital and one Drawings for each
partner.
4. A partnership has as many Capital accounts as there are partners.
5. Three advantages of the partnership form of business organization are pooling financial
resources, sharing skills and abilities, and paying a single income tax (rather than double
income tax like with a corporation). Other advantages are a simpler organizational structure
and fewer people to report to when compared to a corporation.
6. Three disadvantages of the partnership form of business organization are that it is
terminated by the death or bankruptcy of a partner, it has unlimited liability, and it is
subject to mutual agency.
7. The purpose of the partnership agreement is to outline the terms and conditions of the
partnership in writing so all partners understand their role and responsibilities in the
organization.
8. Answers will vary. The three most important items contained in a partnership agreement
are the duties of the various partners, the amount of capital to be contributed by each part-
ner, and how net income or net loss will be shared.
9. It is advisable for a partnership to have a formal agreement to ensure that partners get what
they are entitled to if the partnership is dissolved. Partnerships without an agreement are
subject to the Partnership Act, which is very general and does not consider the specifics of
each partnership. For example, it divides profits and losses equally between partners even
when one partner invested more money in the business.
10. The purpose of a shotgun clause is to ensure that partners are not pressured into paying
a low price for their shares if one partner wants to terminate the partnership agreement.
The terminating partner can offer to buy the other partners’ shares. The other partners can
decline but then they must purchase the terminating partner’s shares at the offered price.
This means a low offer will only hurt the partner who initially wanted to terminate the
partnership.

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SECTION 12.1 REVIEW QUESTIONS (continued)

11. There is more to the process of handling net income (or loss) and drawings for a partnership
than for a sole proprietorship because partnerships have a Capital account and a Drawings
account for each partner.
12. The three factors that affect the calculation of the distribution of net income or net loss to
the partners are salaries, interest on the capital account balances, and the income- or loss-
sharing ratio.
13. A partner who puts more time and effort into the business is rewarded with a salary as part
of his share of the earnings.
14. The usual way to reward a partner who has a greater investment in the business is to pay
her interest on the balance in her capital account.
15. Salaries and interest are deducted before apportioning net income or net loss.
16. To determine a partner’s share of net income or net loss, apply the income- or loss-sharing
ratio to the net income or loss.
17. The net income of a partnership is calculated by subtracting operating expenses from
income, as is done for a sole proprietorship.
18. In the absence of a partnership agreement, net income or net loss is apportioned equally
among the partners according to the Partnership Act of the province.
19. The statement of distribution of net income shows the apportionment of net income or
net loss.
20. Salaries and interest are not recorded in the accounts but are used to calculate the
distribution of net income or net loss.
21. The two new financial statements introduced in this chapter are the statement of
distribution of net income and the statement of partners’ capital.
22. The order in which to prepare the financial statements for a partnership is the income
statement, the statement distribution of net income, the statement of partners’ capital,
and the balance sheet.
23. There is a statement of partners’ capital because there is not enough room on the balance
sheet to show the necessary calculations.

SECTION 12.1 EXERCISES (page 552)

Exercise 1, p. 552
A. The partners of a business share in its profits
and losses .
B. There is a separate capital account and
drawings account for each partner.
C. You can usually tell if a business is a partnership from its
name. You can also tell by examining its ledger .
D. The day-by-day accounting for a partnership is no different than for a
sole proprietorship .

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SECTION 12.1 EXERCISES (continued)

Exercise 1, p. 552 (continued)
E. Accounting for the partners’ capital accounts is the principal
new aspect of partnership accounting.
F. The capital accounts of a partnership must be maintained in agreement with the terms
of the partnership agreement .
G. Persons may pool their fi nancial resources when forming a
partnership.
H. Persons may bring together different resources when forming a
partnership.
I. A partnership is simple to organize .
J. A partnership is not subject to double taxation .
K. According to the law, a partnership is terminated by the
death , incapacity , or
insolvency of any partner.
L. There is no limited liability in regards to partnership debts.
M. Mutual agency means that the partners are legally bound by
the actions of any one of them.
N. The partnership agreement should be worked out with the help of a
lawyer .
O. The partnership acts of the various provinces come into play
where there is no partnership agreement and a dispute arises.

Exercise 2, p. 553
A. LI AND AHU
STATEMENT OF DISTRIBUTION OF NET INCOME
YEAR ENDED DECEMBER 31, 20–8

Net Income available for distribution $100 3 2 5 –

Li Ahu Total
Salaries allowed to partners – – –
Interest on Capital accounts at 10%
Li 10% of $116 240 $11 6 2 4 – $20 4 7 6 – $ 32 1 0 0 –
Ahu 10% of $204 760

Balance of net income divided in the ratio of 2:3 27 2 9 0 – 40 9 3 5 – 68 2 2 5 –

Total distributed to partners $38 9 1 4 – $61 4 1 1 – $100 3 2 5 –

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SECTION 12.1 EXERCISES (continued)

Exercise 2, p. 553 (continued)
B. LI AND AHU
STATEMENT OF PARTNERS’ CAPITAL
YEAR ENDED DECEMBER 31, 20–8

Li Ahu Total
Capital Balances January 1 $116 2 4 0 – $204 7 6 0 – $321 0 0 0 –

Add: Shares of Net Income for Year 38 9 1 4 – 61 4 1 1 – 100 3 2 5 –

$155 1 5 4 – $266 1 7 1 – $421 3 2 5 –

Deduct: Drawings for Year 38 5 0 0 – 59 3 0 0 – 97 8 0 0 –

Capital Balances December 31 $116 6 5 4 – $206 8 7 1 – $323 5 2 5 –

Exercise 3, p. 553
A. GENERAL ASSOCIATES
STATEMENT OF DISTRIBUTION OF NET INCOME
YEAR ENDED DECEMBER 31, 20–4

Net Income available for distribution $18 0 0 0 –

Hacio Jaako Saasto Total

Salaries allowed to partners $4 2 0 0 – $4 0 0 0 – $ 8 2 00 –
Interest on Capital accounts at 20% $1 0 0 0 – 6 0 0 – 2 0 0 – 1 8 00 –
Hacio—$5 000 ⫻ 20%
Jaako—$3 000 ⫻ 20%
Saasta—$1 000 ⫻ 20%

Balance of net income divided in

the ratio of 2:1:1 4 0 00 – 2 0 00 – 2 0 0 0 – 8 0 00 –
Total distribution to partners $5 0 0 0 – $6 8 0 0 – $6 2 0 0 – $18 0 0 0 –

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SECTION 12.1 EXERCISES (continued)

Exercise 3, p. 553 (continued)
B. GENERAL ASSOCIATES
STATEMENT OF PARTNERS’ CAPITAL
YEAR ENDED DECEMBER 31, 20–4

Hacio Jaako Saasto Total

Capital Balances January 1 $ 5 0 0 0 – $3 0 0 0 – $1 0 0 0 – $ 9 0 00 –
Add: Shares of Net Income for Year 5 0 0 0 – 6 8 0 0 – 6 2 0 0 – 18 0 0 0 –
$10 0 0 0 – $9 8 0 0 – $7 2 0 0 – $27 0 0 0 –
Deduct: Drawings for Year 8 0 0 0 – 4 0 0 0 – 4 0 0 0 – 16 0 0 0 –
Capital Balances December 31 $ 2 0 0 0 – $5 8 0 0 – $3 2 0 0 – $11 0 0 0 –

C. GENERAL ASSOCIATES
BALANCE SHEET
DECEMBER 31, 20–4

ASSETS
Bank $ 5 0 0 –
Merchandise Inventory 9 0 0 0 –
Equipment 3 5 0 0 –
Total Assets $13 0 0 0 –

LIABILITIES AND PARTNERS’ EQUITY

Accounts Payable $ 2 0 0 0 –
Partners’ Capital
Hacio $ 2 0 0 0 –
Jaako 5 8 0 0 –
Saasto 3 2 0 0 – 11 0 0 0 –
Total Liabilities and Partners’ Equity $13 0 0 0 –

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SECTION 12.1 EXERCISES (continued)

Exercise 4, p. 554
Partnership 1
Give a salary to a partner or partners? Y or N? N
If yes, which one(s)? –
Give interest on capital balances? Y or N? N
Divide balance of net income equally? Y or N? Y
If no, ratio to favour which partner? –

Partnership 2
Give a salary to a partner or partners? Y or N? Y
If yes, which one(s)? B
Give interest on capital balances? Y or N? Y
Divide balance of net income equally? Y or N? Y
If no, ratio to favour which partner? –

Partnership 3
Give a salary to a partner or partners? Y or N? Y
If yes, which one(s)? C
Give interest on capital balances? Y or N? Y
Divide balance of net income equally? Y or N? N
If no, ratio to favour which partner? C

Exercise 5, p. 555
Partnership 1 A B
Interest – –
Salaries – –
Balance of net income (ratio: 3:2 ) 36 000 24 000
Total 36 000 24 000

Partnership 2 A B
Interest – –
Salaries – –
Balance of net income (ratio: 1:6 ) 10 400 62 400
Total 10 400 62 400

Partnership 3 A B
Interest – –
Salaries 10 000 25 000
Balance of net income (ratio: 1:1 ) 27 500 27 500
Total 37 500 52 500

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SECTION 12.1 EXERCISES (continued)

Exercise 5, p. 555 (continued)
Partnership 4 A B C
Interest 1 600 1 600 1 600
Salaries 20 000 – –
Balance of net income (ratio: 4:3:2 ) 48 800 36 600 24 400
Total 70 400 38 200 26 400

Partnership 5 A B C
Interest 1 000 2 000 8 000
Salaries – 12 000 8 000
Balance of net income (ratio: 5:3:1 ) 55 000 33 000 11 000
Total 56 000 47 200 27 000

SECTION 12.2 REVIEW QUESTIONS (page 563)

1. Corporations are the dominant form of business organization in our economy.
2. A corporation is considered a separate legal entity with certain rights and obligations of an
individual.
3. You know a company is a corporation if it has the word Limited, Ltd., Incorporated, Inc., or
Corp. as a part of the company name.
4. The original purpose of a corporation was to raise large amounts of capital for risky and
costly ventures. A benefit to the owners is the ability to participate in the venture without
risking a great deal of personal money.
5. The owner of a corporation receives a share certificate to show that she or he has ownership
in the company.
6. The owners of a corporation are called shareholders or stockholders.
7. Limited liability means that shareholders can only lose the money they have invested in the
company, not their own personal assets.
8. The Canada Business Corporations Act is the federal law governing the actions of
corporations.
9. The board of directors is elected by a vote of shareholders at the annual meeting.
10. The board of directors make the major policy decisions of the company.
11. A director is a shareholder who is elected to serve a special role. An executive is a specialist
hired to participate in running the company.
12. A public corporation is listed on a stock exchange and obtains its capital partly by the sale
of shares to the general public. A private corporation is limited to 50 shareholders and
cannot raise money publicly.

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SECTION 12.2 REVIEW QUESTIONS (continued)

13. The major difference in the accounts for a corporation compared to a sole proprietor is
that corporations do not have a Capital account or a Drawings account. Instead, there is a
Capital Stock account—which may also be called Share Capital or Common Stock—and a
Retained Earnings account.
14. The Capital Stock account represents capital acquired by the sale of shares.
15. The Retained Earnings account represents the claim on assets acquired through the
earnings of the company.
16. The Retained Earnings account is increased by net income or net income after
dividends, if any are issued.
17. The increase in Question 16 is recorded as a credit to the Retained Earnings account.

18. Net losses and the declaration of dividends cause the Retained Earnings account to decrease.

19. The decreases in Question 18 are recorded as debits to the Retained Earnings account.

20. The Capital Stock account has a credit balance.

21. The Retained Earnings account usually has a credit balance.
22. One large loss could cause a negative (debit) balance in the Retained Earnings account.
More commonly, such a balance is caused by a series of losses.
23. A negative balance in the Retained Earnings account is called a deficit.
24. Dividends are distributed to shareholders based on the number of shares they hold.
The amount of the dividend is stated as so much a share; for example, 50 cents per share for
a three month period.
25. The board of directors decides if there is to be a dividend.
26. Two reasons why a dividend might not be declared are that the profits are needed for some
other purpose, such as company expansion, or that the profits and cash position are too low
for the company to afford paying the dividend.
27. The board of directors creates a dividend by making a formal declaration at one of its
meetings.
28. To determine who will receive dividends, the board of directors states a date of record
associated with the declaration of a dividend. Everyone who owns shares on the date of
record will receive the dividend.
29. The payment date is a few weeks after the date of record because time is needed to calculate
the dividends and then prepare and mail the dividend cheques.
30. If a declared dividend is not paid, the shareholders can sue the company for the money they
are owed, since declared dividends are a legal liability to the company.

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SECTION 12.2 REVIEW QUESTIONS (continued)

31. This is the accounting entry to record the declaration of a dividend.
Dr Cr
Retained Earnings $$$$
Dividends Payable $$$$
32. This is the accounting entry to record the payment of a dividend.
Dr Cr
Dividends Payable $$$$
Bank $$$$
33. Common stock is the basic class of stock of a corporation.
34. The usual advantage associated with preferred stock are that preferred shareholders are
paid dividends before common shareholders. If the corporation goes bankrupt they also
recover their assets before common shareholders.

SECTION 12.2 EXERCISES (page 564)

Exercise 1, p. 564

A. private corporation E. share certificate I. date of declaration

B. common shareholders F. board of directors J. date of record

C. corporation G. shareholder K. dividend payable

D. limited liability H. dividend

Exercise 2, p. 565
A.
Year Profits Dividends Retained Earnings
(Losses) Paid at Year-end
1 ($ 45 000) nil $ 45 000 deficit
2 ($ 20 000) nil $ 65 000 deficit
3 $ 25 000 nil $ 40 000 deficit
4 $ 48 000 nil $ 8 000
5 $110 000 $ 50 000 $ 68 000
6 $156 000 $100 000 $ 124 000
7 $227 000 $120 000 $ 231 000
B. No dividends were paid in the first three years because the Retained Earnings account did
not have a positive balance.
C. Yes, a dividend could have been paid in year 4.
D. A dividend was not paid in year 4 because the company was not consistently profitable.
E. All the retained earnings were not paid out in dividends because the corporation needs
money in reserve to finance company operations and to avoid paying interest on loans.

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SECTION 12.2 EXERCISES (continued)

Exercise 3, p. 565
MANDRELL LTD.
BALANCE SHEET
DECEMBER 31, 20–3

ASSETS
Bank $ 5 0 0 25
Accounts Receivable 7 8 5 8 35
Merchandise Inventory 25 3 2 6 –
Supplies 4 5 0 –
Land 50 0 0 0 –
Building 275 0 0 0 –
Equipment 116 1 2 5 40
Total Assets $475 2 6 0 –

LIABILITIES
Accounts Payable $ 23 1 2 5 60
Bank Loan 50 0 0 0 –
Mortgage Payable 212 3 2 5 40
Total Liabilities $285 4 5 1 –

SHAREHOLDERS’ EQUITY
Capital Stock––Common
10 000 Shares, no par value $100 0 0 0 –
Retained Earnings 89 8 0 9 –
Total Shareholders’ Equity 189 8 0 9 –
Total Liabilities and Shareholders’ Equity $475 2 6 0 –

Exercise 4, p. 566
A. A dividend is distributed to the shareholders in proportion to
the number of shares held.
B. Retained Earnings represents the company’s net accumulation
of earnings.
C. Only the board of directors has the power to declare a dividend.
D. When dividends are declared they are declared to shareholders of record
on a certain date.

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SECTION 12.2 EXERCISES (continued)

Exercise 4, p. 566 (continued)
E. A good system is necessary for keeping shareholders’ records up to
date and accurate.
F. Dividends are usually stated at so much a share.
G. Once declared, a dividend becomes a legal liability of the
company.
H. The Retained Earnings account normally has a credit
balance.
I. When a dividend is declared, it is set up in a Dividends Payable
account.
J. When a dividend is declared, the Retained Earnings account is
reduced.
Exercise 5, p. 566

Cumulative
Number Number Dividend Total Retained
of Shares of Shares Income Declared Dividend for Earnings
Year Sold Issued for Year Dec. 15 Year Dec. 31
1 10 000 10 000 $52 500 $1.00 $ 10 000 $42 500
2 12 000 22 000 $50 250 $1.50 $ 33 000 $59 750
3 12 500 34 500 $60 750 $1.60 $ 55 200 $65 300
4 15 000 49 500 $75 200 $1.75 $ 86 625 $53 875
5 20 000 69 500 $95 050 $1.85 $128 575 $20 350

Exercise 6, p. 566
A. 220 000 × $0.25 = $55 000
The total dividend to be paid is $55 000.
B., C.

GENERAL JOURNAL PAGE

DATE PARTICULARS P.R. DEBIT CREDIT

20–
Mar. 1 Retained Earnings 55 0 0 0 –
Dividends Payable 55 0 0 0 –
Declaration of dividend

31 Dividends Payable 55 0 0 0 –
Bank 55 0 0 0 –
Payment of dividend

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SECTION 12.2 EXERCISES (continued)

Exercise 7, p. 567
A. The dividend on the $5 preferred shares is calculated by multiplying the 10 000 shares
issued by $5.

Bank Other Assets Land Buildings

1 20 000 300 000 3 4 88 000 3 100 000 3 200 000
2 500 000

220 000 88 000 100 000 200 000

Dividend Payable Common Stock Preferred Stock Retained Earnings

50 000 5 20 000 1 500 000 2 5 50 000 88 000 4

50 000 20 000 500 000 38 000

B. REGUS CORPORATION
BALANCE SHEET
DECEMBER 31, 20–

ASSETS
Bank $220 0 0 0 –
Other Assets 88 0 0 0 –
Land 100 0 0 0 –
Building 200 0 0 0 –
Total Assets $608 0 0 0 –

LIABILITIES
Dividend Payable $ 50 0 0 0 –

SHAREHOLDERS’ EQUITY
Capital Stock––Common
10 000 Shares, no par value $ 20 0 0 0 –
Capital Stock–$5 Preferred
10 000 Shares, no par value 500 0 0 0 –
Retained Earnings 38 0 0 0 –
Total Shareholders’ Equity 580 0 0 0 –
Total Liabilities and Shareholders’ Equity $608 0 0 0 –

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SECTION 12.3 REVIEW QUESTIONS (page 583)

1. A comparative financial statement is a statement that shows the financial positions of
successive business years side by side.
2. An Increase or Decrease column and a Percent Change column are added to comparative
financial statements to make them more meaningful.
3. To calculate the percentage increase, subtract Year 1 net income from Year 2 net income.
This gives the increase amount. Then divide this figure by Year 1 net income and multiply
by 100 to get the percentage increase.
Percentage Increase: ($15 200 – $13 700) ÷ $13 700 × 100 = 10.9%
The percentage increase for this company’s net income is 10.9%.
4. A common-sized financial statement is a statement that expresses all the figures as
percentages of a chosen number.
5. Common-size statements help accountants communicate the financial numbers more clearly
to their clients and make it easier to compare statements between companies, regardless
of size.
6. The two aspects associated with accounting ratios and percentages are liquidity and
profitability.
7. A liquidity ratio is used to decide how easily a company can pay its debts.
8. A profitability percentage is used to evaluate a company’s ability to earn a profit.
9. Once ratios and percentages have been calculated, the figures should be compared with the
results of other years, other companies, and other investment opportunities.
10. The collection period is calculated by dividing the accounts receivable figure by the average
charge sales per day.
11. The collection period figure gives an indication of how long it usually takes for the company
to collect an account receivable.
12. The inventory turnover is calculated by dividing the cost of goods sold figure by the average
inventory figure.
13. The inventory turnover figure gives an indication of how quickly the company is able to sell
its inventory.
14. The turnover figure for a fruit market would be very high. The merchandise is
perishable and must be sold quickly so the inventory is sold and replaced many times in a
year. The turnover figure for a gift store would be much lower because there is not a weekly
demand for gifts like there is for food.
15. Public corporations are required to make their financial statements available to the public.
Private corporations do not sell shares to the public so they can keep their financial
statements private.

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SECTION 12.3 EXERCISES (page 584)

Exercise 1, p. 584
A., B.

PROFESSIONAL ENGINEERING AND CONSULTING

COMPARATIVE INCOME STATEMENT
YEAR ENDED JUNE 30, 20–2 AND 20–1

Increase or Percent
Revenues 20–2 20–1 Decrease Change
Consulting $ 62 250 $ 60 402 $ 1 848 +3.1%
Construction 202 365 290 201 (87 836) –30.3%
Designing 35 250 36 603 (1 353) –3.7%
Total Revenue $299 865 $387 206 $ (87 341) –22.6%

Operating Expenses
Advertising Expense $ 3 520 $ 3 400 $ 120 +3.5%
Automobiles Expense 25 025 16 350 8 675 +53.1%
Bank Charges Expense 15 850 11 200 4 650 +41.5%
Building Expense 4 200 3 700 500 +13.5%
Equipment Maintenance Expense 1 525 1 750 (225) –12.9%
Insurance Expense 5 014 3 000 2 014 +67.1%
Miscellaneous Expense 312 250 62 +24.8%
Property Taxes Expense 1 215 950 265 +27.9%
Telephone Expense 1 507 904 603 +66.7%
Utilities Expense 3 124 3 107 17 +0.5%
Wages Expense 102 301 78 201 2 100 +30.8%
Total Expenses $163 593 $122 812 $ 40 781 +33.2%

Net Income $136 272 $264 394 $(128 122) –48.5%

C. The four expense accounts that show the greatest dollar change for the year are Wages,
Automobiles, Bank Charges, and Insurance.

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SECTION 12.3 EXERCISES (continued)

Exercise 2, p. 584
A. NEON COMPANY
COMMON-SIZE BALANCE SHEET
DECEMBER 31, 20–

ASSETS Percent
Bank $ 3 0 0 0 – 1.6%
Accounts Receivable 10 0 0 0 – 5.5%
Plant and Equipment 132 0 0 0 – 72.1%
Automobiles 38 0 0 0 – 20.8%
Total Assets $183 0 0 0 – 100.0%

LIABILITIES AND EQUITY

Accounts Payable $ 19 0 0 0 – 10.4%
Mortgage Payable 92 5 0 0 – 50.5%
Owner’s Equity 71 5 0 0 – 39.1%
Total Liabilities and Equity $183 0 0 0 – 100.0%

RADON COMPANY
COMMON-SIZE BALANCE SHEET
DECEMBER 31, 20–

ASSETS Percent
Bank $14 5 0 0 – 14.6%
Accounts Receivable 5 5 0 0 – 5.6%
Plant and Equipment 53 0 0 0 – 53.5%
Automobiles 26 0 0 0 – 26.3%
Total Assets $99 0 0 0 – 100.0%

LIABILITIES AND EQUITY

Accounts Payable $ 2 2 0 0 – 2.2%
Mortgage Payable 18 0 0 0 – 18.2%
Owner’s Equity 78 8 0 0 – 79.6%
Total Liabilities and Equity $99 0 0 0 – 100.0%

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SECTION 12.3 EXERCISES (continued)

Exercise 2, p. 584 (continued)
B. The ability of Neon Company to pay its accounts payable is somewhat uncertain. Bank
and Accounts Receivable are its cash and near-cash assets but these amount to only 7.1%
of Total Assets (1.6% + 5.5%). Accounts Payable are 10.4% of Total Assets. Neon will need
a large inflow of cash in the next month because it presently does not have enough funds to
meet the $19 000 of Accounts Payable that will be due soon.
In contrast, the Accounts Payable percentage (2.2%) for Radon Company is extremely
small when compared to the combined percentage for Bank and Accounts Receivable
(20.2%). Radon is in a good position to pay its Accounts Payable.
C. Neon Company’s overall debt is 60.9% of Total Assets; its equity is 39.1%. The majority of its
long-term assets have been financed with a mortgage, which means there are interest costs to
pay. Nevertheless, equity of nearly 40% is acceptable. Radon’s debt is a tiny 20.4% of Total
Assets. In fact, its entire mortgage is less than its cash and near-cash assets (Bank and
Accounts Receivable) combined.

Exercise 3, p. 585

Description Ratio Opinion

A. current ratio 1.52:1 Fair
B. quick ratio 0.85:1 Fair
C. collection period 35.2 days Fair to good
D. inventory turnover 8.37 times Fair but need more data
E. rate of return on net sales 8.97% Good
F. rate of return on shareholders' equity 15.35% Good
G. debt ratio 35.13% Good
H. equity ratio 64.87% Good
I. times interest earned 3.73 times Fair

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SECTION 12.3 EXERCISES (continued)

Exercise 4, p. 586

CALVINO COMPANY
INCOME STATEMENT
YEAR ENDED DECEMBER 31, 20–8
Revenue
Sales $ 170 000
Cost of Goods Sold
Opening Inventory A. $ 11 000
Purchases 128 500
Goods Available for Sale B. $ 139 500
Closing Inventory C. 10 500
Cost of Goods Sold $ 129 000
Gross Profit D. $ 41 000
Operating Expenses E. $ 19 750
Net Income F. $ 21 250

CALVINO COMPANY
BALANCE SHEET
DECEMBER 31, 20–8
ASSETS
Current Assets
Bank $ 3 700
Accounts Receivable G. 17 000
Merchandise Inventory 10 500
Total Current Assets H. $ 31 200
Plant and Equipment
Land $ 35 000
Buildings and Equipment I. 93 800
Total Plant and Equipment J. $ 128 800
Total Assets K. $ 160 000

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current Liabilities
Bank Loan $ 15 000
Accounts Payable L. 9 000
Total Current Liabilities M. $ 24 000
Shareholders’ Equity
Share Capital $ 30 000
Retained Earnings 106 000
Total Shareholders’ Equity N. $ 136 000
Total Liabilities and Shareholders’ Equity O. $ 160 000

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 A. Students should input the data from Figure 12.19 on student textbook page 582 for the first
Name

sheet. The second sheet should use the formulas shown below (cell references may vary) and
should match Figure 12.20 on student textbook page 583.
Note: The cell references in the image below look complex because they point to cells
in the Statement Data sheet. They are simple to create, however, by pointing and clicking
Exercise 5, p. 587

with the mouse.

Copyright © 2013 Pearson Canada Inc.

SECTION 12.3 EXERCISES (continued)
Date

Chapter 12 Business Organization and Decision-Making

475
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SECTION 12.3 EXERCISES (continued)

Exercise 5, p. 587 (continued)
B. Comparative balance sheets should match Figure 12.16 on student textbook page 570.
The formulas for the comparative balance sheet appear below.

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SECTION 12.3 EXERCISES (continued)

Exercise 5, p. 587 (continued)
B. (continued) Comparative income statements should match Figure 12.17 on student textbook
page 571. The formulas for the comparative income statement appear below.

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SECTION 12.3 EXERCISES (continued)

Exercise 5, p. 587 (continued)
B. (continued) The common-sized income statement should match Figure 12.18 on student
textbook page 572. Partial formulas for the common-size income statement appear to the
right of Column E below.

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SECTION 12.3 EXERCISES (continued)

Exercise 5, p. 587 (continued)
B. (continued) Partial formulas for the common-size balance sheet appear to the right of
Column E below.

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SECTION 12.3 EXERCISES (continued)

Exercise 5, p. 587 (continued)
C. Letters will vary. The reference in the textbook to the large growth in inventory without a
corresponding increase in sales is a major concern. This could be the result of poor inventory
management or it could signal a downturn in the demand for the company’s products. The
company reduced its operating expenses slightly in the past year, which produced more net
income. However, the major reduction in advertising could have adverse long-term effects.
The ratio analysis in the textbook reveals weak liquidity and reinforces the concern
about the high inventory levels. The fair current ratio, weak quick ratio, and declining
Inventory Turnover are important trouble spots.
There are several other items of interest. The percentage increase in Cost of Good Sold
(4.7%) was greater than the percentage increase in Sales (4.0%). Gross Profit lagged behind
as a result (3.2%). It seems that Okada Wireless Ltd. is unable to pass along increases in
inventory costs to its retail customers. Additionally, Wages Expense is only 12.6% of Sales.
Normally, low expenses are a positive feature but perhaps the company needs to hire more
people, especially salespeople, to help move its inventory.
The balance sheet proves that the company is a legitimate company. It owns the land
and buildings used for operations. Also, Retained Earnings amounts to 26.6% of Total
Assets, demonstrating that the company has been able to generate profits for a good length of
time. For future growth, perhaps the company should consider selling the land and
buildings and look at renting facilities. The cash generated by the sale could then be used to
aggressively combat the downward financial trend. Advertising levels could be restored and
more staff could be hired in the hope of making a significant impact in the marketplace.

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SECTION 12.4 REVIEW EXERCISES (page 590)

A. to C.

Graphs should resemble the bar charts on textbook page 592. Students should try to make
the bars more prominent than the title. They can experiment with combinations of clicking,
double-clicking, or CRTL-clicking (Command key on Macs) to select and vary the size and
colour of the chart’s components.

D. Letters will vary. Morris might be displeased with the bonus arrangement. Even though
Graves is more active on a daily basis, Morris’s original capital investment was significant
at $100 000. Grave’s contributed only $40 000 in comparison. Since Morris invested a good
deal of cash, he should expect reasonable participation in the growth of the profits. The bar
chart shows that Morris’s share of net income will increase moderately but Graves’s gains
will grow substantially. Morris should ask Graves to modify her proposal so he gets a larger
share of the profits to reward his contribution of capital.

E. Letters will vary. Graves must be rewarded for her active involvement in the business. The
potential for large gains will boost her motivation and productivity. Morris benefits as a
result. His share of the net income remains substantial and its growth over the five-year
period is projected to be 33.6% ($113 250 – $84 750), which is more than fair when
compared to other investment opportunities. Graves should not change her proposal.

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SECTION 12.5 REVIEW QUESTIONS (page 601)

1. A budget is a financial plan that involves a forecast of financial figures.

2. The type of budget that is most familiar is a budgeted income statement, which is a forecast
of revenues and expenses.

3. In a large organization, a variety of departmental budgets are the components of the master
budget.

4. The four stages of budgeting are as follows. Investigate: Gather financial data. Forecast:
Use the financial data to predict future account outcomes. Feedback: Establish an
information system to provide feedback on the predictions made. Follow-up: Feedback is
reviewed and used by management to make business decisions and adjust previous forecasts.

5. A system of feedback for budgeting helps managers determine if the budgetary predictions
are accurate.

6. Business managers need more detailed information than just profit projections for the
income statement. For example, they must know if there will be enough cash to meet payroll
obligations and if credit is available to finance new equipment purchases. Since this
information involves asset and liability accounts, it is clear that the budgeting process must
be include balance sheet accounts as well as income statement accounts.

7. Budgeted financial statements and a spreadsheet model restored Karissa’s hope in her
business venture because they allowed her to change variables while seeing the effects of
these changes overall. After the final changes, Karissa’s spreadsheet model predicted a
healthier income of $8230 and a sufficiently lower decrease than previously seen to her
Cash account.

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SECTION 12.5 EXERCISES (page 602)

A. The data sheet should match Figure 12.25 on textbook page 594. Formulas for the data sheet
appear below.

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SECTION 12.5 EXERCISES (continued)

B. The budgeted income statement should match Figure 12.27 on textbook page 597. Formulas
for the budgeted income statement appear below.

C. Budgeted cash flow from operations should match Figure 12.28 on textbook page 598.
Formulas for the budgeted cash flow from operations appear below.

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SECTION 12.5 EXERCISES (continued)

D. Statements of financial position should match Figure 12.29 on textbook page 599. Formulas
for the statements of financial position appear below.

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SECTION 12.5 EXERCISES (continued)

E., F. With current versions of Microsoft Excel, you can open a new window of a file by
choosing Window, New Window from the top-line menu. Often, when a new window
opens, gridlines appear, which can be distracting when working with formatted models.
To turn off the gridlines, click the Layout tab and uncheck the Gridlines box.

SECTION 12.5 SPREADSHEET EXTENSIONS (page 603)

A. Spreadsheets will vary. To achieve the goal of a net income of $20 000, Karissa might try
lowering the price per unit while increasing her advertising amount. For example, if the
price per unit is lowered to $1.00 (cell F5) and $12 000 more is spent on advertising (cell
F16, Other Expenses, which is now $18 000), projected unit sales can be reasonably set at
175 000 (cell F4). This changes the projected Net Income to $21 230.
B. Spreadsheets will vary. To achieve a net income of $30 000, Karissa could take the opposite
approach from the strategy outlined in Part A. She could dramatically increase the unit
price, drop the unit sales, and cut expenses. She might do this if she felt that the demand for
lip gloss was not sensitive to price changes.
For example, if Karissa increased the price per unit to $1.50 and lowered the projected
unit sales to 85 000, the projected net income would be $26 230—still below target. To reach
her goal, Karissa could plan to cut the wages because the lower volume of sales would require
less part-time help. If wages are cut to $25 000 in cell F14, the net income would be $31 230.
C. With a unit price of $1.15 and a volume of 50 000 units, Karissa’s business would be in
serious trouble. The Net Loss would be $28 020, the Cash Flow from Operations would be
negative $32 288, and the ending cash would be a credit balance of negative $11 288, which
would force the bank loan and interest costs to increase.
D. Spreadsheets will vary. With the volume decreasing by half to 50 000 units, Karissa will
have to look at decreasing other major expenses by 50%. This action, combined with tight
inventory management, will help keep the business afloat until market conditions improve.
Specifically, the 50% cut in volume will mean the business will have to cut its wages by
50% (down to $15 000 for part-time help). Also, careful inventory management will be
implemented; inventory on hand will be only 10% above the sales level (cell C6). With less
inventory to deal with, Karissa will have to look for better office and storage venues to cut
Rent Expense by half to $12 000. The Other Expenses will be reduced by $1000 to $5000.
With the four changes above entered on the Data Sheet, Karissa’s projected Net Loss will
be $20 instead of $28 020. The Cash Flow from Operations will still be negative $3263. While
this is not sustainable in the long term, Karissa’s opening cash position is strong enough to
hold until sales increase. The bank balance at the end of the year will be a healthy $18 738.

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SECTION 12.5 COMMUNICATE IT (page 603)

Attach your report to the Workbook.
Reports will vary. Reports should include financial statements and relevant graphs generated from
the spreadsheet data. They could also include ratio and percentage analysis. The best reports will
effectively communicate the changes and the rationale for the changes that the students made in
Part D of the Section 12.5 Spreadsheet Extensions.

CHAPTER 12 REVIEW EXERCISES (page 605)

Using Your Knowledge

Exercise 1, p. 605

Shareholders’ Equity
Common Stock, no par value $ 54 2 6 0 –
authorized and issued, 5000 shares
Preferred Stock, 6% cumulative, par value $25
authorized and issued, 20 000 shares 500 0 0 0 –
Retained Earnings 157 2 0 6 –
Total Shareholders’ Equity $711 4 6 6 –

Exercise 2, p. 606
A. The sale of common shares raised $250 000 in equity.
B. Company profits generated $172 490 in equity.
C. If all shares were sold for the same price, the sale price for one share was $10.
D. The company is not in a good position to pay out dividends, even though it has far more
equity than debt. Equity represents the shareholders’ claims on assets and most of those
assets are in the form of Plant and Equipment. There is very little cash so the company
would have to borrow money to pay the dividend. Borrowing is not a good idea given that
the liquidity of the company is already weak. For example, the combined total of cash and
accounts receivable is insufficient to cover accounts payable.

Exercise 3, p. 606
A. Value of preferred shares: 27 500 shares × $10 = $275 000
Dividend on preferred shares: $275 000 × 6% = $16 500
The total dividend on the preferred stock is $16 500.
B. Dividends on common shares: 76 700 shares × $0.26 = $19 942
The total dividend on the common stock is $19 942.

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CHAPTER 12 REVIEW EXERCISES (continued)

Exercise 3, p. 606 (continued)
C., D.

GENERAL JOURNAL PAGE

DATE PARTICULARS P.R. DEBIT CREDIT

20–
Apr. 12 Retained Earnings 36 4 4 2 –
Dividends Payable—Common 19 9 4 2 –
Dividends Payable—Preferred 16 5 0 0 –
Dividends declared

30 Dividends Payable—Common 19 9 4 2 –
Dividends Payable—Preferred 16 5 0 0 –
Bank 36 4 4 2 –
Payment of dividends declared April 12

Exercise 4, p. 606
• A sales figure of $300 000 indicates that this is a medium-sized company.
• A current ratio of less than 2 and a quick ratio of less than 1 indicates that the company’s cash
position is only fair.
• The collection period figure of 63 days is worrying. Unless the company offers its customers
terms of 60 days, the figure of 63 days is poor and suggests that the company is not good at
collecting its accounts receivable.
• The inventory turnover figure is quite low at 2.9 times per year. Unless a low inventory
turnover is normal for this company’s industry, this figure is something to be concerned about.
• The debt ratio is fairly high at 0.56, indicating that the company has financed its assets more
through debt than equity. The size of the debt might not be too large since the company still
manages a healthy value of 11.2 for the times interest earned.
• The 7.6% return on equity is good if other investment opportunities are below this rate. This
means that, despite some concerns from the balance sheet, the company is capable of generating
profits.

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CHAPTER 12 REVIEW EXERCISES (continued)

Exercise 5, p. 607
The $16 000 figure is a more accurate measure of the average inventory than the $12 000
calculated in the usual way. Therefore, 6.3 times gives a more realistic inventory turnover figure.
You must be careful, however, when comparing the 6.3 times results to those of other companies.
Most companies’ inventory turnover figures will be calculated with the average of just two
inventory amounts: the beginning and ending inventory.

Exercise 6, p. 607
A. Answers will vary. Students should research two viable public businesses so EPS and
P/E ratios can be found.

B. The EPS ratio or earnings per share ratio gives a common base for comparing the
profitability of two different companies. The EPS ratio can be easily compared to the market
price of a company’s stock, which is also expressed per share. For example, if a stock is
selling at $50 per share, yet is earning only 25 cents per share, an investor should probably
investigate further before buying the stock.

C. The P/E ratio stands for price/earnings ratio. The ratio is calculated by dividing the
market price per share by the earnings per share.

D. Answers will vary. Students should express caution about judging the merits of a stock
based on the P/E ratio alone. A high P/E ratio means investors are very confident about the
stock. Sometimes this confidence is justified but sometimes it means the stock is overpriced.
A low P/E ratio might be a warning sign that investors are aware of other important factors
that will adversely affect the company or it might mean that the stock is undervalued.

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CHAPTER 12 REVIEW EXERCISES (continued)

Exercise 7, p. 607
A.
Description Pluto Neptune
Current ratio 2.2 1.0
Quick ratio 1.4 0.7
Collection period 31.7 46.1
Inventory turnover 12.1 7.5
Rate of return on net sales 11.9 7.0
Rate of return on equity* 30.6 16.8
Debt ratio 25.4 33.5
Equity ratio 74.6 66.5
Times interest earned 7.3 2.0
* Average equity figure not used.

B. Although Neptune’s performance falls far short of Pluto’s there are no serious danger signs.
The poor current ratio of 1.0 for Neptune is caused by its large bank loan. The $90 000 loan
is a concern because it incurs interest costs. However, since the debt likely takes the form of
a demand loan, it will not be due for payment unless the bank gets nervous about Neptune’s
ability to meet the monthly interest costs. So far, Neptune has been able to meet its
obligations and earn a profit. The large bank loan is also responsible for the other poor
statistic of 2.0 for times interest earned. The collection period for Neptune is too long at
46 days but when the company is purchased Pluto will implement its accounts receivable
policies to correct the situation.

C. Pluto should take a chance and purchase Neptune. Neptune is earning a profit, even while
faced with an annual rent expense of $49 000. Neptune owns its own facilities so the
$49 000 rent expense will be eliminated making the purchase proposal very attractive
indeed. In addition to the impressive credit ranting and collection policies of Pluto,
Neptune’s inventory turnover may also benefit from Pluto’s obvious expertise with inventory
management.

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CHAPTER 12 REVIEW EXERCISES (continued)

Exercise 8, p. 608

Lemaire Kennedy Henning Dudley

Allocation of Salaries $12 5 0 0 – $12 5 0 0 –

Allocation of Balance of Net

Income:
$126 040.28
Less 25 000.00
$101 040.28 (equally) $25 2 6 0 07 $25 2 6 0 07 $25 2 6 0 07 $25 2 6 0 07
Totals to Partners $37 7 6 0 07 $37 7 6 0 07 $25 2 6 0 07 $25 2 6 0 07

Exercise 9, p. 608

BARNES, DOBY, AND FIROZ

STATEMENT OF DISTRIBUTION OF NET INCOME
YEAR ENDED APRIL 30, 20–

Net Income Available for Distribution $87 1 9 9 21

A. Barnes W. Doby [Link] Total

Salaries Allowed $10 0 0 0 – $10 0 0 0 –

Interest at 9% allowed on Capital $ 1 8 0 0 – $ 3 1 5 0 – 4 9 5 – 5 4 4 5 –
A. Barnes—9% of $20 000
= $1800
W. Doby—9% of $35 000
= $3150
S. Firoz—9% of $5500 = $495
Balance of Net Income divided
in 4:4:3 ratio 26 0 9 2 44 26 0 9 2 44 19 5 6 9 33 71 7 5 4 21
Totals $27 8 9 2 44 $29 2 4 2 44 $30 0 6 4 33 $87 1 9 9 21

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CHAPTER 12 REVIEW EXERCISES (continued)

Exercise 10, p. 609
A. FRAME BROTHERS
STATEMENT OF DISTRIBUTION OF NET INCOME
YEAR ENDED DECEMBER 31, 20—

Net Income available for distribution $57 6 4 7 98

S. Frame G. Frame Total

Salaries allowed to partners $20 0 0 0 – $16 0 0 0 – $36 0 0 0 –

Balance of net income divided in the ratio of 2:1 14 4 3 1 99 7 2 1 5 99 21 6 4 7 98
Total distributed to partners $34 4 3 1 99 $23 2 1 5 99 $57 6 4 7 98

B. FRAME BROTHERS
STATEMENT OF PARTNERS’ CAPITAL
YEAR ENDED DECEMBER 31, 20–

S. Frame G. Frame Total

Capital Balances January 1 $40 0 0 0 – $40 0 0 0 – $ 80 0 0 0 –

Add: Share of Net Income for Year 34 4 3 1 99 23 2 1 5 99 57 6 4 7 98
$74 4 3 1 99 $63 2 1 5 99 $137 6 4 7 98
Deduct: Drawings for Year 21 1 6 6 12 21 1 3 3 40 42 2 9 9 52
Capital Balances December 31 $53 2 6 5 87 $42 0 8 2 59 $ 95 3 4 8 46

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CHAPTER 12 REVIEW EXERCISES (continued)

Exercise 10, p. 609 (continued)
C. FRAME BROTHERS
BALANCE SHEET
DECEMBER 31, 20–

ASSETS
Current Assets
Petty Cash $ 1 0 0 00
Bank 6 2 5 40
Accounts Receivable 18 1 8 4 32
Merchandise Inventory 57 1 5 0 00 $76 0 5 9 72

Prepaid Expenses
Supplies $ 6 5 0 00
Prepaid Insurance 2 2 4 00 8 7 4 00

Long-Term Assets
Furniture and Equipment $38 1 4 6 00
Less Accumulated Depreciation 15 4 8 0 72 $22 6 6 5 28

Automobiles $53 2 8 5 80
Less Accumulated Depreciation 31 9 0 8 10 21 3 7 7 70 44 0 4 2 98
Total Assets $120 9 7 6 70

LIABILITIES
Current Liabilities
Bank Loan $10 0 0 0 00
Accounts Payable 13 2 4 0 84
Sales Tax Payable 2 3 8 7 40 $ 25 6 2 8 24

PARTNERS’ EQUITY
Partners’ Capital
S. Frame $53 2 6 5 87
G. Frame 42 0 8 2 59 95 3 4 8 46
Total Liabilities and Partners’ Equity $120 9 7 6 70

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CHAPTER 12 REVIEW EXERCISES (continued)

Exercise 10, p. 609 (continued)
D.
GENERAL JOURNAL PAGE

DATE PARTICULARS P.R. DEBIT CREDIT

Closing Entries
20–
Dec. 31 Merchandise Inventory 57 1 5 0 –
Sales 271 4 0 5 40
Income Summary 328 5 5 5 40

31 Income Summary 270 9 0 7 42

Merchandise Inventory 54 1 1 0 –
Bank Charges 9 0 0 –
Miscellaneous Expense 3 8 4 40
Purchases 96 3 0 7 60
Rent Expense 24 0 0 0 –
Telephone Expense 1 3 1 5 34
Utilities Expense 1 9 4 0 40
Wages Expense 75 8 8 3 50
Supplies Expense 8 3 0 –
Insurance Expense 4 0 8 –
Depreciation Furn. & Equip. 5 6 6 6 32
Depreciation Automobiles 9 1 6 1 86

31 Income Summary 57 6 4 7 98
S. Frame, Capital 34 4 3 1 99
G. Frame, Capital 23 2 1 5 99

31 S. Frame, Capital 21 1 6 6 12
G. Frame, Capital 21 1 3 3 40
S. Frame, Drawings 21 1 6 6 12
G. Frame, Drawings 21 1 3 3 40

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CHAPTER 12 REVIEW EXERCISES (continued)

Cases for Further Thought, page 610
1. John Smith could raise the money he needs without giving up any control in the company by
selling preferred shares. Also, he can issue the remaining common shares of the company and
sell up to 49 999 of them to other people. As long as he owns 50 001 (or 50% plus one), he will
have effective control of the company because he cannot be outvoted.

2. Limited liability could be a disadvantage to someone doing business with a corporation if

the person is injured as a result of negligence by the company. The company may have very
little equity or insurance. Even if the company has few assets for the injured person to claim,
they can only sue the company not its owners.
3. A corporation can be effectively controlled by a person holding less than 50% of the shares
plus one if the shares are widely distributed between many shareholders. Shareholders with
few shares have little stake in the company, rarely attend annual meetings, vote, or organize
into voting blocks. This gives anyone with a comparatively larger share of the company the
power to influence the company’s direction at the annual meeting.

4. The shareholders of the corporation would lose money when their share values dropped as a
result of the expected reduction in company profits due to the compensation settlement and
the negative publicity.
5. False. You will only receive the dividend if you own the shares on the date of record, which
is several days after the date of declaration.
6. A company with a high inventory turnover sells a large volume of items per year. This
company can afford to have a lower per item profit margin because the total overall profit
earned in a year is very large due to the volume. A company with a low inventory turnover
sells a small number of items per year so the profit earned on each item must be large in
order for the total yearly profit to be acceptable.
7. A company with a high debt ratio is operating on borrowed money. Such a company will
have to pay interest on the debt and therefore will likely have a large interest expense figure.

8. A company’s collection period could be gradually increasing because the company has given
its clients longer payment terms or it has become less efficient in collecting its accounts
receivable. A downturn in the economy could also cause cash shortages among the business’s
credit customers resulting in slower payment of the accounts receivable.
9. If the company’s assets are undervalued, the debt ratio will be overstated and the equity
ratio will be understated. When calculating the rate of return on equity, the net income is the
numerator. This amount is not affected by the asset undervaluation. Since the denominator
(equity) shrinks due to the undervaluation, the rate of return actually increases and is
overstated.

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CHAPTER 12 REVIEW EXERCISES (continued)

Cases for Further Thought, page 610 (continued)
10. Answers will vary. To quickly evaluate two companies, I would use the current ratio, the
collection period, the inventory turnover, the debt ratio, and the return on equity figure. The
current ratio shows the company’s ability to pay its short-term debts. The collection period
shows whether the company is efficient in collecting its receivables, which is a good indicator
of the company’s overall efficiency. The inventory turnover indicates the high cost of having
inventory sit on the shelves. The debt ratio shows how much debt the company carries in
relation to total assets. The return on equity figure measures the company’s performance
against other investment opportunities.

11. If the company’s equity ratio is 8%, this means its debt ratio is 92%. This company is
operating almost entirely on credit with very little shareholder investment. This is not a
safe company to sell to on credit because it already has more creditors than it could pay
off with its assets. Also, its interest costs must be quite high. To protect yourself, you might
consider dealing with this company on a cash basis only. Or, if that measure is too drastic,
investigate the company’s profitability and payment record to get a better idea of how well it
handles its debts to its current suppliers.

12. The banker is concerned about your current ratio of 0.64 because it is quite poor. Your bank
balance, $150, and your accounts receivable, $9052, cannot cover the $75 256 accounts
payable you owe your vendors. If you can sell the marketable securities for $125 000, you
improve the current ratio to 0.90. This one-time solution is insufficient. The current ratio
is still very weak and worsens when the acid test is applied because of the large amount of
inventory.
13. The obsolete merchandise inventory must be written off immediately. This will reduce the
current ratio to 1.3, which shows the company’s true liquidity status to be poor.

CASE STUDIES (page 611)

Case 1 Buy the Shares or the Assets? (p. 611)

1. Jane Church understated the inventory on the financial statements in order to understate
the net income by deceptively increasing the cost of goods sold (COGS = Cost of Goods
Available – Ending Inventory). Having a lower net income reduced the amount of corporate
income tax Jane’s company paid last year.

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CASE STUDIES (continued)

Case 1 Buy the Shares or the Assets? (continued)

2. Cynthia is concerned about the misrepresented inventory because if she buys the shares, the
corporation continues to operate. Consequently, the tax that Jane dodged is merely deferred
to the following year. To illustrate, the count of next year’s ending inventory will include the
$250 000 that Jane did not report. The high ending inventory will lower the cost of goods
sold. The lower cost means more net income and more income taxes. Also, since the
corporation is a separate legal entity, it may be liable for fines and penalties connected to tax
evasion while Jane was in charge.

3. It is to Jane’s advantage to sell the shares rather than the company assets because the
corporation will continue to exist and will be responsible for any future tax liability. If the
company is dissolved, Jane can expect a personal investigation from the Canada Revenue
Agency into her conduct when she was the CEO of the company.

4. It is to Cynthia’s advantage to buy the company assets and not the shares because she does
not inherit the inventory problem and the resulting income tax problem.

Case 2 Control of a Corporation (p. 611)

1. There are 500 shares in total.
2. The shareholders who control the corporation are Clarke (65 shares), Brasseur (100 shares),
and Moukas (70 shares), for a total of 235 shares.

3. If you bought Farmer’s shares, you could count on Baker, with 40 shares, for guaranteed
support.
4. You would need an additional 61 shares on your side to get certain control.
5. The chances of getting 61 shares are doubtful. It would be necessary to buy Mrs. Allair and
Mrs. Greig’s shares. They both support the current management so it is unlikely they will
sell to you.
6. To prevent you from acquiring a controlling interest, the controlling shareholders would
purchase 16 shares from Mrs. Greig or Mrs. Allair. Then they would have absolute control
of the company.
7. The controlling shareholders can easily stop you from gaining control of the company so
Farmer’s plan will not work. You are better off asking Farmer for a lower price for his shares
if you can accept the current management or looking for another investment opportunity.

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CASE STUDIES (continued)

Case 3 A Problem of Sudden Termination (p. 612)

1. Partnership law states that upon the death of a partner, the partnership is terminated.

2. Nashimo has $45 248 of equity in the business.

3. The business has an estimated worth of $300 000.
4. Nashimo’s family should get $150 000 out of the business.
5. Iwasko’s problem is that the business does not have $150 000 to pay out Nashimo’s share.

6. The most straightforward solution to the problem in Question 5 is for Iwasko to borrow the
money.
7. An undesirable aspect of borrowing is the interest expense and principal repayment.
A desirable aspect of borrowing is retaining total control of the business.
8. An alternative course of action is that Iwasko forms a new partnership with someone in
Nashimo’s family. An undesirable aspect of the course of action is that the new partner may
not have any skills pertinent to the business and may not get along with Iwasko.
9. If Iwasko cannot borrow the money or make a deal with Nashimo’s family, the business will
have to be liquidated.
10. Liquidating the company would involve the additional hardship of getting much less for the
assets than they are worth since they must be sold quickly.
11. If the partnership took out life insurance on both partners then the deceased partner’s
insurance would cover paying out their share of the business to their family.

Case 4: Challenge The Partner You Know or the Shareholder You Don’t—Choosing between a Partnership
or Corporation (p. 614)
Part A, p. 614
1. The bank manager would pre-approve a loan if the sisters formed a partnership because the
bank would have a legal claim on the sisters’ assets and could recover the loan if
necessary. If the sisters formed a corporation, they would have limited liability and their
personal assets could not be claimed to pay back the loan. The bank manager will not
pre-approve a loan to a newly formed corporation with few assets and no clients because it is
too great a risk.
2. If the sisters form a corporation, the bank manager would ask one or all of the sisters to sign
agreements that guaranteed the loan to the corporation. These personal guarantees would
give the bank access to the sisters’ assets in case the corporation defaulted on the loan.

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CASE STUDIES (continued)

Case 4: Challenge The Partner You Know or the Shareholder You Don’t—Choosing between a Partnership
or Corporation (continued)
Part A, p. 615 (continued)
3. SELL DEM BOARD GAMES
STATEMENT OF DISTRIBUTION OF PROJECTED NET INCOME
YEAR ENDED JUNE 30, 20–1

Net Income available for distribution $66 000

Cheryl Yvonne Beverly Jack Totals
Interest at 5% of
capital account
balance $10 0 0 0 – $10 0 0 0 – $10 0 0 0 – $30 0 0 0 – $60 0 0 0 –

Balance of income
divided 1:1:1:3 1 0 00 – 1 0 00 – 1 0 00 – 3 0 00 – 6 0 00 –
Total share of
net income $11 0 0 0 – $11 0 0 0 – $11 0 0 0 – $33 0 0 0 – $66 0 0 0 –

SELL DEM BOARD GAMES

STATEMENT OF DISTRIBUTION OF PROJECTED NET INCOME
YEAR ENDED JUNE 30, 20–2

Net Income available for distribution $138 000

Cheryl Yvonne Beverly Jack Totals
Interest at 5% of
capital account
balance $9 3 5 0 – $9 3 5 0 – $9 3 5 0 – $29 5 5 0 – $57 6 0 0 –

Balance of income
divided 1:1:1:3 13 4 0 0 – 13 4 0 0 – 13 4 0 0 – 40 2 0 0 – 80 4 0 0 –
Total share of
net income $22 7 5 0 – $22 7 5 0 – $22 7 5 0 – $69 7 5 0 – $138 0 0 0 –

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CASE STUDIES (continued)

Case 4: Challenge The Partner You Know or the Shareholder You Don’t—Choosing between a Partnership
or Corporation (continued)
Part A, p. 615 (continued)
4. SELL DEM BOARD GAMES
STATEMENT OF PARTNERS’ CAPITAL
YEAR ENDED JUNE 30, 20–1

Cheryl Yvonne Beverly Jack Totals

Capital Balances
July 1 $200 0 0 0 – $200 0 0 0 – $200 0 0 0 – $600 0 0 0 – $1200 0 0 0 –
Add: Share of
Net Income 11 0 0 0 – 11 0 0 0 – 11 0 0 0 – 33 0 0 0 – 66 0 0 0 –
$211 0 0 0 – $211 0 0 0 – $211 0 0 0 – $633 0 0 0 – $1266 0 0 0 –
Deduct: Drawings
for year 24 0 0 0 – 24 0 0 0 – 24 0 0 0 – 42 0 0 0 – 114 0 0 0 –
Total Capital $187 0 0 0 – $187 0 0 0 – $187 0 0 0 – $591 0 0 0 – $1152 0 0 0 –

SELL DEM BOARD GAMES

STATEMENT OF PARTNERS’ CAPITAL
YEAR ENDED JUNE 30, 20–2

Cheryl Yvonne Beverly Jack Totals

Capital Balances
July 1 $187 0 0 0 – $187 0 0 0 – $187 0 0 0 – $591 0 0 0 – $1152 0 0 0 –
Add: Share of
Net Income 22 7 5 0 – 22 7 5 0 – 22 7 5 0 – 69 7 5 0 – 138 0 0 0 –
$209 7 5 0 – $209 7 5 0 – $209 7 5 0 – $660 7 5 0 – $1290 0 0 0 –
Deduct: Drawings
for year 24 0 0 0 – 24 0 0 0 – 24 0 0 0 – 42 0 0 0 – 114 0 0 0 –
Total Capital $185 7 5 0 – $185 7 5 0 – $185 7 5 0 – $618 7 5 0 – $1176 0 0 0 –

500 Accounting 1 Teacher’s Key Copyright © 2013 Pearson Canada Inc.

Name Date

CASE STUDIES (continued)

Case 4: Challenge The Partner You Know or the Shareholder You Don’t—Choosing between a Partnership
or a Corporation (continued)
Part A, p. 616 (continued)
5. SELL DEM BOARD GAMES
SUMMARY OF CAPITAL BALANCES
JULY 1, 20–0 TO JUNE 30, 20–2

Cheryl Yvonne Beverly Jack Totals

July 1, 20–0 $200 0 0 0 – $200 0 0 0 – $200 0 0 0 – $600 0 0 0 – $1200 0 0 0 –
Percent 16.7% 16.7% 16.7% 50.0% 100.0%
June 30, 20–1 $187 0 0 0 – $187 0 0 0 – $187 0 0 0 – $591 0 0 0 – $1152 0 0 0 –
Percent 16.2% 16.2% 16.2% 51.3% 100.0%
June 30, 20–2 $185 7 5 0 – $185 7 5 0 – $185 7 5 0 – $618 7 5 0 – $1176 0 0 0 –
Percent 15.8% 15.8% 15.8% 52.6% 100.0%

Part B, p. 617
1.

Net Income (Partnership) $ 66 0 0 0 –

Public Corporation Expenses

Management Salaries $ 72 0 0 0 –
Costs 102 5 0 0 –
Extra Accounting Fees 25 0 0 0 –
Bank Interest @ 9% 13 5 0 0 –
213 0 0 0 –
Net Loss (Corporation) $(147 0 0 0 –)

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CASE STUDIES (continued)

Case 4: Challenge The Partner You Know or the Shareholder You Don’t—Choosing between a Partnership
or Corporation (continued)
Part B, p. 617 (continued)
2. SHAREHOLDERS’ EQUITY
JUNE 30, 20–1

Common Stock $1050 0 0 0 –

Retained Earnings (147 0 0 0 –) $903 0 0 0 –

3.

Net Income (Partnership) $138 0 0 0 –

Public Corporation Expenses

Management Salaries $72 0 0 0 –
Extra Accounting Fees 25 0 0 0 –
Bank Interest 13 5 0 0 –

Net Loss (Corporation) 110 0 0 0 –

$ (19 8 7 5 –)

4. SHAREHOLDERS’ EQUITY
JUNE 30, 20–2

Common Stock $1050 0 0 0 –

Retained Earnings (166 8 7 5 –) $883 1 2 5 –

5. On June 30, 20–2, each sister would have a 19.05% share in the corporation (200 000 shares
divided by the 1 050 000 shares outstanding). Under Jack’s partnership proposal, each
sister would have a 15.80% share in the partnership.

Total Equity Dollar Share Percent Share

Partnership $1176 0 0 0 – $185 7 5 0 – 15.80%
Corporation 883 1 2 5 – 168 2 1 4 – 19.05%
Difference $292 8 7 5 – $ 17 5 3 6 – –3.25%

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CASE STUDIES (continued)

Case 4: Challenge The Partner You Know or the Shareholder You Don’t—Choosing between a Partnership
or Corporation (continued)
Part C, p. 617
Reports will vary. Students should include information gathered from the TSX Venture Exchange
website. A major portion of the report should comment on how much equity each sister would
have under the two proposals.
The table from Part B, Question 5, appears to favour the partnership. However, the costs of
going public were charged as an expense in the first year. If that amount were amortized over a
number of years, each sister’s dollar share of equity would be higher in the corporate model.
In addition, the potential for growth is limited in the partnership model because Jack’s
drawings are twice as much as those of the sisters and he is earning more interest on his large
initial Capital balance. Holding 19.05% of the company’s shares gives each sister the opportunity
to make rapid gains in equity if the company is profitable.
The partnership would also make the sisters subordinate to Jack’s large capital and
aggressive nature. By forming a corporation, no one individual could have more votes than the
combined total of the sisters. Their policy decisions could not be challenged.

CAREER Tammy Drew, CGA/General Manager,

Intergovernmental Secretariat, Miawpukek
First Nation (page 618)
Discussion (p. 618)
1. The education requirements for a CGA normally include six years of post-secondary
education plus applicable work experience. When Tammy achieved her designation, she was
able to accomplish it with a two-year finance diploma, four years of CGA correspondence
courses, and applicable work experience.
2. The CGA correspondence courses were useful to Tammy because she could live at home
on the reserve and raise her children. She could also work full time and contribute to her
community while she studied.
3. Answers will vary. Advantages of taking correspondence courses include not needing
to travel to school, convenient study times, and the ability to work while studying.
Disadvantages include a lack of direct instruction from teachers, the need for a lot of self-
discipline to complete lessons when there is no fixed schedule, and less contact with other
students.

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