Week 6 - Suggested solutions to preparation questions Week...

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Unformatted text preview: Suggested solutions to preparation questions Week 6 Discussion Question 5 Examples of reserves: i General reserve is an amount transferred from retained profits. The purpose is often to indicate to shareholders that the amount of the transfer is unlikely to be paid out in dividends. ii Asset revaluation reserve is credited when assets are revalued upwards. iii Foreign currency translation reserve is an account arising as a consequence of the method used to convert foreign operations' accounting figures into Australia dollars for the purpose of combining them with the figures for Australian operations. Discussion Question 6 If a company decides to split its existing shares in half this will have no impact on the balance sheet. The number of shares available is doubled but the balance of each of the shareholders' equity account is unchanged. Discussion Question 7 Liabilities are obligations and estimates of obligations to people outside the enterprise, whereas equity is the residual ownership interest in the enterprise after considering such obligations to have the first claim on the resources (assets). Equity is what would be left after all the bills were paid, assuming that the assets were disposed of at book value and the liabilities were paid off, also at book value. Owners can be creditors too (for example, for dividends or management fees) but such obligations will have been deducted from equity (as dividends or expenses) and so, to the extent that owners are also creditors, they have less equity. Discussion Question 9 9 a. The decision to issue bonus shares is usually taken as recognition of increased earning potential. Existing shareholders benefit from the issue of bonus shares if the annual cash dividend is maintained at the same rate as previously or at least falls less than proportionately to the increase in the nominal value of each shareholder's holding. The result will then be to increase the cash annually paid, as dividends to shareholders and the total market value of the shares will probably increase. In such circumstances shareholders will be in a position to make a profit from the sale of all or part of their increased holdings. However, if total dividends do not change there is no obvious benefit to shareholders. 9b. Future shareholders may benefit if the accumulated profits and reserves converted to additional share capital are employed to good advantage with improved stability and/or profitability. 9c . The company benefits from the issue of bonus shares if the operations have expanded to such an extent that the assets represented by the reserves are permanently required within the business. Also, if the bonus issue is made in place of the normal cash dividend, funds are retained within the enterprise, at least temporarily. Reducing the overall individual share price via the bonus issue may make more investors interested in the company's shares. Problem 11.10 1 2 3 4 5 The number of shares issued multiplied by their issue price. Consolidated includes parent and all subsidiaries that the parent controls. Asset revaluation reserve and foreign currency translation reserve. Most likely a profit for the period. The percentage of subsidiary's equity not owned by the parent company is known as outside equity interest. May have increased because of an increase in the size of the net assets of a subsidiary. Problem 11.12 Capital Reserves created out of capital profits are known as capital reserves. Capital profits arise due to nonoperational activities of the business (e.g. sale of investments). Profits on sale of fixed assets, premium on issue of shareholders/debentures, and revaluation of fixed assets/liabilities are all examples of capital reserves. Since they are not earned, these reserves are not available for distributions among the shareholders as dividends. Note that in this example, Asset Revaluation Reserve is separately disclosed. General Created by the transfer of profits from retained profits. The purpose of this transfer is often to indicate to shareholders that the amount of the transfer is unlikely to be paid out in dividends. Asset revaluation Results from the upward revaluation of assets. Foreign currency translation Results from unrealised foreign currency gains. ...
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