Investments in Equity Securities: Solutions Manual, Chapter 2

Chapter 2
Investments in Equity Securities

Copyright 2013 McGraw-Hill Ryerson Limited. All rights resered.
Solutions Manual, Chapter 2 1
A !rie" description o" the ma#or points coered in each case and pro!lem.
CA$%$
Case 2-1
A company increases its e&'ity inestment "rom 10( to 2)(. Management wants to compare
the e&'ity method and "air al'e method in order to 'nderstand the a""ect on the acco'nting and
wants to *now which method !etter re"lects management+s per"ormance.
Case 2-2
A company has ac&'ired an inestment in shares o" another company and mem!ers o" its
acco'nting department hae di""ering iews a!o't how to acco'nt "or it.
Case 2-3
,his case "oc'ses on the acco'nting "or a long-term inestment when the inestee is hostile and
re"'ses to co-operate with the inestor.
Case 2-4
,his case- adapted "rom a past ./%- inoles a parent company that is in "inancial di""ic'lty. An
inestment in an associate has !een written o"" and a s'!sidiary has !een s'ed. ,he st'dent
m'st assess whether the company can contin'e to report on a going concern !asis and
determine what sho'ld !e disclosed in the notes to the "inancial statements.
Case 2-5
,his case- adapted "rom a past ./%- gies an ill'stration o" a company that has raised money
"or its operations in seeral ways 0i.e. other than raising common e&'ity1 and as*s the st'dent to
analy2e the acco'nting iss'es "or the ario's types o" inestments.
Case 2-6
,his case- adapted "rom a past ./%- inoles a company that is considering the p'rchase o" a
34.5( interest in another company in the scrap metal !'siness. ,he st'dent m'st write a memo
to disc'ss 11 all releant !'siness considerations pertaining to the p'rchase and 21 how the
p'rchaser sho'ld report its inestment i" it were to proceed with the p'rchase.
2 Modern Advanced Accounting in Canada, Seventh %dition
6R78L%M$
Problem 2-1 020 min.1
,his pro!lem inoles the calc'lation o" the !alance in the inestment acco'nt "or an inestment
carried 'nder the e&'ity method oer a two-year period. ,hen- #o'rnal entries are re&'ired to
reclassi"y and acco'nt "or the inestment as /9,6L "or the third year.
,his pro!lem inoles the preparation o" #o'rnal entries "or a /9,6L inestment "or one year. :n
year 2- #o'rnal entries are re&'ired to reclassi"y and acco'nt "or the inestment as a held-"or-
signi"icant-in"l'ence inestment.
,his pro!lem inoles the preparation o" #o'rnal entries oer a two-year period "or an inestment
'nder two ass'mptions; 0a1 that it is a signi"icant in"l'ence inestment and 0!1 that it is
acco'nted "or 'sing the cost method.
Problem 2-4 030 min1
,his pro!lem re&'ires #o'rnal entries- the calc'lation o" the !alance in the inestment acco'nt
and the preparation o" the inestor+s income statement 'nder !oth the e&'ity method and cost
method. ,he inestee reports a loss "rom discontin'ed operations "or the year.
,his pro!lem compares the inestment acco'nt !alance- the income per year- and the
c'm'latie income "or a three-year period "or a 20( inestment i" it was classi"ied as /9,6L-
inestment in associate and /9,7C:.
,his pro!lem re&'ires the preparation o" slides "or a presentation to descri!e GAA6 "or p'!licly
acco'nta!le enterprises "or "inancial instr'ments as they relate to /9,6L- /9,7C:- held-"or-
signi"icant-in"l'ence and held-"or-control inestments.
Problem 2- 030 min1
,his pro!lem re&'ires the preparation o" slides "or a presentation to descri!e GAA6 "or priate
enterprises "or "inancial instr'ments as they relate to /9,6L- /9,7C:- held-"or-signi"icant-
in"l'ence and held-"or-control inestments.
<%8-8A$%= 6R78L%M$
!eb Problem 2-1
,he st'dent answers a series o" &'estions !ased on the 2011 "inancial statements o" Rogers
Comm'nications :nc.- a Canadian company. ,he &'estions deal with ratio analysis and
inestments reported 'sing cost method- e&'ity method and "air-al'e method.
!eb Problem 2-2
,he st'dent answers a series o" &'estions !ased on the 2011 "inancial statements o" Goldcorp
:nc.- a Canadian company. ,he &'estions deal with ratio analysis and inestments reported
'sing cost method- e&'ity method and "air-al'e method.
S"#$%I"&S %" 'E(IE! )$ES%I"&S
1* A !'siness com!ination is a transaction or other eent in which an ac&'irer o!tains control
o" one or more !'sinesses. ,ransactions sometimes re"erred to as >tr'e mergers+ or
>mergers o" e&'als+ are also !'siness com!inations as that term is 'sed in this :/R$. A
parent?s'!sidiary relationship e@ists when- thro'gh an inestment in shares or other means-
the parent company has control oer the s'!sidiary company. ,he *ey common element is
the concept o" control.
2* A /9,6L inestment is reported at "air al'e with the "air al'e ad#'stment reported in net
income whereas an inestment in an associate is reported 'sing the e&'ity method.
3* A control inestment e@ists i" one entity has the power to determine another entity+s *ey
strategic policies and actiities. Aoint control e@ists when two or more companies hae an
agreement that esta!lishes #oint control s'ch that no one o" them can 'nilaterally determine
the other entity+s *ey strategic policies and actiities.
4* ,he p'rpose o" the IFRS 8; Operating Segments is to improe the in"ormation aaila!le to
shareholders and inestors a!o't the lines o" !'siness and geographic areas in which the
company does !'siness. $ome o" this in"ormation is lost in the aggregation process o"
consolidation- and the disaggregation o" segment reporting is al'a!le "or detailed analysis.
5* ,he e&'ity method sho'ld normally !e 'sed to report an inestment when the inestor has
signi"icant in"l'ence oer or has #oint control o" the inestee. ,he a!ility to e@ercise
signi"icant in"l'ence or #oint control may !e indicated !y- "or e@ample- representation on the
!oard o" directors- participation in policy-ma*ing processes- material intercompany
transactions- interchange o" managerial personnel or proision o" technical in"ormation.
6* ,he e&'ity method records the inestor+s share o" changes in the inestee+s e&'ity. ,he
inestee+s e&'ity is increased !y income and decreased !y diidends. ,here"ore the inestor
records an increase in its e&'ity acco'nt !alance when the inestee earns income- and
records a decrease when the inestee pays diidends.
* ,he Ralston Company co'ld determine that it was inappropriate to 'se the e&'ity method to
report a 3)( inestment in 6'rina in two separate types o" circ'mstances. /or e@ample- i"
another shareholder gro'p owned 'p to 4)( o" 6'rina+s oting shares- Ralston co'ld arg'e
that its ownership did not proide signi"icant in"l'ence oer 6'rina. :n this case- Ralston
wo'ld li*ely classi"y the inestment as a /9,6L inestment and report it at "air al'e.
Alternatiely- Ralston might arg'e that its 3)( ownership esta!lished control oer 6'rina.
,his wo'ld occ'r i"- "or e@ample- Ralston also owned conerti!le pre"erred shares that- i"
conerted- wo'ld increase its oting share ownership to greater than )0(. :n this case-
Ralston wo'ld arg'e that it sho'ld consolidate 6'rina.
+* ,he /9,6L wo'ld hae !een reported at "air al'e. ,he preio's inestment sho'ld !e
ad#'sted to "air al'e on the date o" the change. ,he cost o" the new shares is added to the
"air al'e o" the preio'sly held shares. ,he s'm o" the two al'es !ecomes the total cost
o" shares when calc'lating the ac&'isition di""erential.
,* An inestor sho'ld report its share o" an inestee+s other comprehensie income in the
same manner that it wo'ld report its own other comprehensie income. ,h's- the inestor+s
percentage o" the inestee+s 7C: sho'ld !e reported on a separate line !elow operating
pro"it- net o" ta@- and "'ll disclos're sho'ld !e proided. Howeer- the inestor+s meas're o"
Solutions Manual, Chapter 2 )
materiality sho'ld !e 'sed to determine whether or not the item is s'""iciently material to
warrant separate presentation.
1-* :n this case- Ashton+s share o" the loss o" 9illa 0B2C0-0001 e@ceeds the cost o" its inestment
in 9illa 0B200-0001. ,he e@tent o" loss recogni2ed !y Ashton depends on whether it has
legal or constr'ctie o!ligations or made payments on !ehal" o" 9illa.
a1 Ass'me that Ashton has constr'ctie o!ligations on !ehal" o" 9illa !eca'se it may hae
g'aranteed the lia!ilities o" 9illa s'ch that i" not paid !y 9illa Ashton wo'ld hae to pay on
their !ehal". :n this case- Ashton wo'ld record 30( @ B500-000 or B2C0-000 as a red'ction
o" the inestment acco'nt and as a recogni2ed loss on the statement o" operations. ,he
inestment acco'nt will now hae an BC0-000 credit !alance- and sho'ld !e reported as a
lia!ility.
!1 Howeer- i" Ashton does not hae constr'ctie o!ligations with respect to the lia!ilities o"
9illa- losses wo'ld only !e recogni2ed to the e@tent o" the inestment acco'nt !alance. ,hat
is- a B200-000 loss wo'ld !e recogni2ed and the inestment acco'nt !alance wo'ld !e
red'ced to 2ero. Ashton wo'ld res'me recogni2ing its share o" the pro"its o" 9illa only a"ter
its share o" the pro"its e&'al the share o" losses not recogni2ed 0BC0-000 in this case1.
11* A!le wo'ld red'ce its inestment acco'nt !y the percentage that was sold- and record a
gain or loss on disposition. :t wo'ld then reeal'ate its reporting method "or the inestment.
:" signi"icant in"l'ence still e@ists- it sho'ld report 'sing the e&'ity method. :" it no longer
e@ists- A!le sho'ld report 'sing the "air al'e method and wo'ld meas're any remaining
interest in the inestee at "air al'e.
12* ,he disclos're re&'irements "or an inestment in an associate are stated in :/R$ 12. An
entity shall disclose;
0a1 "or each associate that is material to the reporting entity;
0i1 the name o" the associate.
0ii1 the nat're o" the entityDs relationship with the associate 0!y- "or e@ample- descri!ing
the nat're o" the actiities o" the associate and whether they are strategic to the
entityDs actiities1.
0iii1 the principal place o" !'siness 0and co'ntry o" incorporation- i" applica!le and
di""erent "rom the principal place o" !'siness1 o" the associate.
0i1 the proportion o" ownership interest or participating share held !y the entity and- i"
di""erent- the proportion o" oting rights held 0i" applica!le1.
0!1 "or each associate that is material to the reporting entity;
0i1 whether the inestment in the associate is meas'red 'sing the e&'ity method or
at "air al'e.
0ii1 s'mmarised "inancial in"ormation a!o't the associate.
0iii1 i" the associate is acco'nted "or 'sing the e&'ity method- the "air al'e o" its
inestment in the associate- i" there is a &'oted mar*et price "or the inestment.
0c1 "inancial in"ormation a!o't the entityDs inestments in associates that are not indiid'ally
material
0d1 the nat're and e@tent o" any signi"icant restrictions 0eg res'lting "rom !orrowing
arrangements- reg'latory re&'irements or contract'al arrangements !etween inestors with
signi"icant in"l'ence oer an associate1 on the a!ility o" associates to trans"er "'nds to the
entity in the "orm o" cash diidends- or to repay loans or adances made !y the entity.
0e1 when the "inancial statements o" an associate 'sed in applying the e&'ity method are as
o" a date or "or a period that is di""erent "rom that o" the entity;
0i1 the date o" the end o" the reporting period o" the "inancial statements o" that
associateE and
0ii1 the reason "or 'sing a di""erent date or period.
0c1 the 'nrecognised share o" losses o" an associate- !oth "or the reporting period and
c'm'latiely- i" the entity has stopped recognising its share o" losses o" the associate when
applying the e&'ity method.
13* ,he /9,6L reporting method wo'ld typically show the highest c'rrent ratio !eca'se a
/9,6L inestment is a short term trading inestment- which m'st !e shown as a c'rrent
asset. /or the other reporting methods- the inestment co'ld !e classi"ied as a non-c'rrent
asset depending on management+s intention "or the inestment.
14* 6riate enterprises may elect to acco'nt "or inestments in associates 'sing either the
e&'ity method or the cost method. ,he method chosen m'st !e applied consistently to all
similar inestments. <hen the shares o" the associate are traded in an actie mar*et- the
inestor cannot 'se the cost methodE it m'st 'se either the e&'ity method or the "air al'e
method.
15* :/R$ F re&'ires that all nonstrategic e&'ity inestments !e meas'red at "air al'e incl'ding
inestments in priate companies. Howeer- an entity can elect on initial recognition to
present the "air al'e changes on an e&'ity inestment that is not held "or short-term trading
in other comprehensie income 07C:1. ,he gains or losses are cleared o't o" acc'm'lated
7C: and trans"erred directly to retained earnings and are neer recycled thro'gh net
income. .nder :A$ 3F- inestments that did not hae a &'oted mar*et price in an actie
mar*et and whose "air al'e co'ld not !e relia!ly meas'red were reported at cost. ,his
proision no longer e@ists 'nder :/R$ F.
S"#$%I"&S %" C.SES
Case 2-1
,he inestment in ,on was appropriately classi"ied as /9,6L in Gear 3 on the ass'mption that
Hil did not hae signi"icant in"l'ence with a 10( interest.
,he reporting o" the inestment at the end o" Gear ) depends on whether Hil has signi"icant
in"l'ence. IAS 28 states that the a!ility to e@ercise signi"icant in"l'ence may !e indicated !y- "or
e@ample- representation on the !oard o" directors- participation in policy-ma*ing processes-
material intercompany transactions- interchange o" managerial personnel or proision o"
technical in"ormation. :" the inestor holds less than 20 percent o" the oting interest in the
inestee- it is pres'med that the inestor does not hae the a!ility to e@ercise signi"icant
in"l'ence- 'nless s'ch in"l'ence is clearly demonstrated. 7n the other hand- the holding o" 20
percent or more o" the oting interest in the inestee does not in itsel" con"irm the a!ility to
e@ercise signi"icant in"l'ence. A s'!stantial or ma#ority ownership !y another inestor may- !'t
wo'ld not a'tomatically- precl'de an inestor "rom e@ercising signi"icant in"l'ence.
:" Hil does hae signi"icant in"l'ence as a res'lt o" owning greater than 20( o" the oting
shares- it wo'ld adopt the e&'ity method as o" Aan'ary 1- Gear ). ,he change "rom the "air
al'e method to the e&'ity method wo'ld !e acco'nted "or prospectiely d'e to the change in
circ'mstance. ,he "air al'e method was appropriate in Gear 3 when Hil did not hae signi"icant
in"l'ence. ,he e&'ity method is appropriate starting at the time o" the additional inestment.
,he additional cost o" the 1)-000 shares will !e added to the carrying amo'nt o" the inestment
as at Aan'ary 1- Gear ) to arrie at the total cost o" the inestment 'nder the e&'ity method.
,he "ollowing s'mmari2es the "inancial presentation o" the inestment-related in"ormation in the
"inancial statements "or Gear ). :n the "irst scenario- the "air al'e method is 'sed ass'ming that
the inestment is classi"ied as /9,6L. :n the second scenario- the e&'ity method is 'sed
ass'ming that the inestment is classi"ied as signi"icant in"l'ence 0$:1;
/(%P# SI
7n !alance sheet
:nestment in ,on BF2)-000
1
BCC)-000
2
C Modern Advanced Accounting in Canada, Seventh %dition
7n comprehensie income statement
:n net income
=iidend income B120-000
3
%&'ity income B130-000
3
.nreali2ed gains )0-000
)

,otal B150-000 B130-000
&otes0
11 2)-000shares @ 35 H F2)-000
21 10-000shares @ 3) I )2)-000 I e&'ity income "or Gear ) o" 130-000
3
? diidends
receied in Gear ) o" 120-000
3
H CC)-000
31 2)( @ 3C0-000 H 120-000
31 2)( @ )20-000 H 130-000
)1 2)-000shares @ 035 ? 3)1 H )0-000
Cost o" inestment 010-000shares @ 3) I )2)-0001 BC5)-000
Hil+s share o" net carrying amo'nt o" ,on+s shareholders+ e&'ity
02)( @ J2-400-000I)00-000-3C0-000K1 4))-000
Land B220-000
Lo amorti2ation o" ac&'isition di""erential pertaining to land
,he "air al'e method pro!a!ly proides the !est means o" eal'ating the ret'rn on the
inestment. ,he diidend income and the 'nreali2ed gains are reported in net income. ,he
present !on's scheme considers net income. As s'ch- the 'nreali2ed gains are considered
when eal'ating management+s per"ormance. ,his is appropriate since they represent part
o" the ret'rn earned !y Hil d'ring the year. .nder the e&'ity method- e&'ity income wo'ld
!e reported in net income and wo'ld !e considered when eal'ating management. ,he
'nreali2ed gains are not reported in net income and wo'ld o!io'sly not !e considered in
eal'ating management+s per"ormance 'nder the e&'ity method.
Case 2-2
In this case, students are asked to, in effect, assume the role of a consultant and advise
Cornall Auto!od" Inc# $CAI% ho it should report its investment representing &&' of the
common shares of Flo"d(s Specialt" Foods Inc# $FSFI%#
Acco'ntant M1 s'ggests that the cost method is appropriate !eca'se it is really #'st a loan. ,his
Solutions Manual, Chapter 2 F
might hae some alidity !eca'se /loyd+s "riend Connelly certainly seems to hae come to his
resc'e. Howeer Connelly+s company did !'y shares- and there is no eidence that they can or
will !e redeemed !y /$/: at some "'t're date. An inestment in shares is not a loan- which
wo'ld hae to !e reported as some sort o" receia!le. <hile *nowledge o" the !'siness or the
a!ility to manage it s'ch as might !e seen in the e@change o" management personnel or
technology- might !e indicators that signi"icant in"l'ence e@ists and can !e asserted- the
a!sence o" *nowledge o" the !'siness and a!ility to manage do not necessarily mean that there
cannot !e signi"icant in"l'ence. ,hey are not re&'irements "or the 'se o" an alternatie s'ch as
the cost method.
Acco'ntant M2 "eels that the e&'ity method is the one to 'se simply !eca'se the ownership
percentage is oer 20(. ,his n'm!er is a &'antitatie g'ideline only and whether an inestment
proides the inestee with signi"icant in"l'ence oer the inestee or not depends on "acts other
than the ownership percentage. /or signi"icant in"l'ence- the a!ility to in"l'ence the strategic
operating and inesting policies has to !e present. Representation on the !oard o" directors
wo'ld !e eidence o" s'ch a!ility. ,here is no eidence o" !oard mem!ership.
Acco'ntant M 3 also s'ggests the e&'ity method saying that 33( ownership gies them the
a!ility to e@ert signi"icant in"l'ence. <hether they e@ert it or not doesn+t matter. ,his part is
correctE yo' do not hae to act'ally e@ert it. Howeer- owning 33( does not necessarily mean
that yo' possess this a!ility. Mr. /loyd was the sole shareholder o" /$/: !e"ore CA:+s
inestment- and we hae no *nowledge that he has relin&'ished some o" this control to
Connelly in ret'rn "or his !ail o't.
,he circ'mstances wo'ld seem to r'le o't the three possi!ilities presented !y the acco'ntants.
,he inestment sho'ld !e reported at "air al'e. ,he only choice 0and it is a choice1 is whether
to report the 'nreali2ed gains in net income or other comprehensie income. More in"ormation
is needed to determine whether CA: has other similar inestments and what its pre"erence is
with respect to the reporting o" this type o" inestment.
Case 2-3
(a) ,his 2C( inestment has the possi!ility o" !eing only a signi"icant in"l'ence inestment
'nder :A$ 2C 0to !e acco'nted "or 'sing the e&'ity method1 or a "air-al'e inestment 'nder
:/R$ F. <hile the ownership is greater than 20(- the a!ility to in"l'ence the strategic
operating and inesting policies does not seem to !e present. ,here is no !oard
mem!ership or signi"icant intercompany transactions !etween the two companies. :n "act
Magno cannot een receie in"ormation other than that which is aaila!le to the mar*et as a
whole. ,here"ore it seems eident that this inestment sho'ld !e reported at "air al'e.
(b) Management wo'ld li*e to 'se the e&'ity method !eca'se it wo'ld res'lt in Magno reporting
2C( o" Grille -,o - 8'mper+s yearly earnings. .nder the "air-al'e method- Magno wo'ld
report its inestment at "air al'e at each reporting date with 'nreali2ed gains reported either
in net income or other comprehensie income. ,he "air-al'e method wo'ld !e ery
e@pensie to apply !eca'se Grille -,o - 8'mper+s shares are not traded in an actie mar*et.
$ome sort o" !'siness al'ation wo'ld hae to !e per"ormed eery year to estimate the "air
al'e o" Grille -,o - 8'mper+s shares. ,he cost inoled may not #'sti"y the e""ort.
(c) :" Magno had representation on the !oard o" directors- the inestment wo'ld !e considered
to !e a signi"icant in"l'ence inestment. <ith s'ch mem!ership Magno might !e a!le to
in"l'ence diidend policy. 7n the date that it !ecame a signi"icant in"l'ence inestment-
Magno wo'ld change to 'sing the e&'ity method on a prospectie !asis.
Case 2-4
Memo to; 6artner
/rom; CA
$'!#ect; Going concern stat's o" Canadian Comp'ter $ystems Limited 0CC$1
,here are seeral "actors that s'ggest that CC$ may not !e a going concern. Howeer- many
are limited to the impact o" the inestment in $andra :nestments Limited 0$:L1 on the cash
"lows and "inancial statements o" CC$. $'!se&'ent eents regarding $:L s'ggest that CC$ may
!e a!le to contin'e operations. 7'r concl'sion on the going concern stat's o" CC$ will hae
implications with regard to disclos're and the content o" o'r a'dit report.
.nalysis o1 2oin2 concern status
3eneral consi4erations
Among other things- it will !e important to consider the c'rrent enironmental "actors when
assessing the "'t're o" CC$. ,hese incl'de in"lation pro#ections- "l'ct'ations in interest rates-
.$ c'rrency rates- economic recessions- competition in the ind'stry- and inentory
o!solescence. ,hese "actors may a""ect the prospects o" CC$.
Impact o1 SI# on the 1inancial results o1 CCS
,he poor "inancial res'lts o" CC$ are "or the most part a direct res'lt o" its acco'nting treatment
"or its inestment in $:L. $:L was de-listed !y a .$ stoc* e@change- !eca'se o" perceied
"inancial di""ic'lties. As a res'lt o" $:LDs contin'ed losses- CC$ decided to write o"" its inestment
in $:L. :n addition- $:L lia!ilities that were g'aranteed !y CC$ were also recorded in the
acco'nts o" CC$. ,he write-o"" and ass'mption o" $:LDs lia!ilities adersely a""ected CC$Ds
income statement- while the increase in lia!ilities adersely a""ected CC$Ds wor*ing capital
position.
Howeer- a"ter CC$Ds year-end- $:L was a!le to raise .$B30 million thro'gh a pre"erred share
iss'e. $:L 'sed the .$B30 million to pay o"" the lia!ilities g'aranteed !y CC$. :n addition- $:L
was relisted !y the stoc* e@change. ,hese eents do m'ch to allay any concerns that CC$ may
not !e a going concern.
%he cash 1lo5s o1 CCS
7er the past two years- CC$ has inc'rred s'!stantial operating losses. :n Gear 11- losses
totaled B3.)C million 0Gear 10 - B).CC million1. Howeer- net income a"ter discontin'ed
operations was B1.F3 million in Gear 11 and- more importantly- net cash o't"lows "rom
operations were B1.1C million. ,here"ore- net cash o't"lows "rom operations are s'!stantially
less than reported operating losses. Cash "lows "rom operations are an important consideration
in deciding whether CC$ is a going concern.
,he new e&'ity iss'e !eing considered "or the Gear 12 "iscal year wo'ld help improe cash
"lows in the coming year- especially i" any o" the loans are called.
,he management o" CC$ has partially lost control oer the companyDs cash "lows. C'rrently- the
!an* has "'ll control oer the cash "lows o" CC$- as it collects cash receipts and releases "'nds
!ased on operating !'dgets. ,his practice is an indication that CC$ is haing di""ic'lty in
o!taining "inancing "or its operations. 7n the other hand- interest rates charged are at 1( oer
prime- s'ggesting that the !an* !eliees the sec'rity "or the loan 0acco'nts receia!le and the
"loating charge de!ent're on all assets1 is ade&'ate. :n any case- the !an*Ds control oer cash
"lows does ens're that ade&'ate cash "lows "or operations will !e maintained thro'gh these
demand loans.
.ssessment o1 the balance sheet o1 CCS
/or the year ended $eptem!er 30- Gear 11- CC$ has a negatie shareholdersD e&'ity !alance o"
B53.4 million 0Gear 10 - B54.5 million1. Howeer- this de"icit was created largely !y the write-o""
o" the $:L loan g'arantee o" B)).32 million in Gear 10. :n Gear 11- a "'rther B2.C3 million in
interest charges was e@pensed. <itho't these e@penses- shareholdersD e&'ity wo'ld hae a
de"icit !alance o" only B14.3) million.
:n hindsight- the write-o""s were not re&'ired. ,he s'ccess o" $:LDs pre"erred share iss'e does
s'ggest that inestors hae con"idence in the company and- more importantly- CC$ no longer
has any o!ligation "or the loan- since it has now !een paid o"".
:A$ 34 re&'ires that an entity shall assess at the end o" each reporting period whether there is
any indication that an impairment loss recogni2ed in prior periods "or an asset other than
goodwill may no longer e@ist or may hae decreased. :" any s'ch indication e@ists- the entity
shall estimate the recoera!le amo'nt o" that asset. An impairment loss recogni2ed in prior
periods "or an inestment in an associate shall !e reersed i"- and only i"- there has !een a
change in the estimates 'sed to determine the assetDs recoera!le amo'nt since the last
impairment loss was recogni2ed. :" this is the case- the carrying amo'nt o" the asset shall !e
increased to its recoera!le amo'nt. ,hat increase is a reersal o" an impairment loss.
,he increased carrying amo'nt o" the inestment attri!'ta!le to a reersal o" an impairment loss
shall not e@ceed the carrying amo'nt that wo'ld hae !een determined had no impairment loss
!een recogni2ed "or the asset in prior years. ,he reersal o" the impairment loss "or the
inestment is recogni2ed immediately in net income.
CC$Ds wor*ing capital de"iciency o" BC3.51 million 0Gear 10 - BF2.25 million1 also points to a
going concern pro!lem. Howeer- a"ter the lia!ilities are red'ced !y the $:L loan and related
interest accr'ed- the de"iciency shrin*s to B22.2 million 0Gear 10 - B24.35 million1. A comparison
o" Gear 10 to Gear 11 res'lts s'ggests that the wor*ing capital position o" CC$ is improing.
,he mortgages paya!le !alance o" B21.4 million co'ld also red'ce the wor*ing capital
de"iciency. ,his !alance had !een reclassi"ied as a c'rrent lia!ility !eca'se o" the "ail're o" CC$
to comply with de!t serice re&'irements and operating coenants. :" the mortgage holder
agrees to not demand payment o" the mortgage and to p't the mortgage loan !ac* in good
standing- then the amo'nt sho'ld !e classi"ied as a long-term lia!ility. ,he iolation o" the
coenants co'ld !e the res'lt o" the method that was 'sed to acco'nt "or losses in $:L.
A"ter all these ded'ctions are made- the wor*ing capital de"iciency in Gear 11 wo'ld then !e #'st
B400-000 0Gear 10 - B3.55 million1.
,he growing acco'nts paya!le o" CC$ 0B300-0001 may indicate an ina!ility on CC$Ds part to pay
its creditors on time. ,he B140-000 proceeds "rom the common shares iss'ed d'ring the year
were 'sed to satis"y lia!ilities owing to the companyDs directors and o""icers.
Management intends to sell property that is carried on the !alance sheet at B1.C) million. ,he
proceeds "rom this sale co'ld help improe cash "lows and may also indicate that management
is trying to rid CC$ o" 'npro"ita!le and ine""icient assets.
:n addition- no diidends hae !een paid on the common shares or the pre"erred shares in the
last two years. ,he non-payment o" diidends is pro!a!ly d'e to the "act that CC$ is not
permitted to pay diidends witho't the !an*Ds approal.
Another "actor that sho'ld !e considered in the going concern analysis is CC$Ds long-term loan
o" B1) million- which has !een in de"a'lt since $eptem!er 30- Gear 11. ,his loan sho'ld !e
classi"ied as a c'rrent lia!ility 'nless the lender "ormally agrees to "orgie the iolation and not
call the loan. :n addition- any long-term de!t that is paya!le on demand sho'ld !e classi"ied as a
c'rrent lia!ility since it can !e called at any time. ,o aoid the classi"ication as c'rrent lia!ilities-
the lenders m'st "ormally agree to change the terms o" the loans so that the loans are not
calla!le on demand. ,he reclassi"ication o" any loans "rom long term to c'rrent will ma*e the
wor*ing capital sit'ation worse and co'ld negatiely a""ect the CC$+s a!ility to contin'e as a
going concern.
.ssessment o1 income statement
,here are signs that the company is controlling its costs. 7perating e@penses hae decreased
!y 32( in Gear 11 "rom the Gear 10 amo'nts. :n addition- it appears that CC$ is discontin'ing
certain operations that had !een contri!'ting to its losses in prior yearsE these operations may
also hae adersely a""ected cash "lows.
$ales "ell 3)( in Gear 11 compared to Gear 10. :n addition- there is a large increase in CC$Ds
acco'nts receia!le !alance "rom Gear 10- which may indicate a pro!lem with collections.
CC$ has completed a new so"tware deelopment program that may help sales in the "'t're. ,he
act'al impact o" this new prod'ct on cash "lows sho'ld !e determined.
CC$ may !e a!le to !orrow "'nds 'sing its plant assets as collateral. ,hese assets may hae a
m'ch higher mar*et al'e than those re"lected on the !alance sheet. ,here are also other !ases
o" meas'rement that co'ld !e 'sed to al'e the assets- s'ch as replacement cost or "air al'e.
,hese meas'rements proide a !etter re"lection o" the 'nderlying al'e o" the assets.

,he pending laws'it may res'lt in #'dgments or cash awards. Howeer- management !eliees
that this claim is witho't merit- an opinion that needs to !e con"irmed !y CC$Ds lawyers. /'rther-
any amo'nt that may !e awarded p'rs'ant to an action is recoera!le 'nder the companyDs
ins'rance policies.
"ther steps CCS coul4 ta6e
My analysis o" the "inancial position o" CC$ 'ncoered a n'm!er o" cash planning opport'nities
that may ena!le CC$ to improe its pro"ita!ility. C'rrently- CC$ has a large amo'nt o" de!t
o'tstanding- with interest paya!le at high interest rates. Management sho'ld disc'ss with the
!an* opport'nities that may !e aaila!le to restr'ct're the de!t. 8y proiding cash "low
statements and !'dgets- management may !e a!le to conince the !an* that the ris* o" lending
CC$ "'nds is lower than originally perceied. /'rther- a greater e""ort co'ld !e made to sell the
property held "or resale. $elling $:L wo'ld also generate cash "lows. :n addition- CC$ co'ld
increase its e""orts to collect the o'tstanding receia!lesE one alternatie is to sell the
receia!les to a credit agency.
Implications o1 4isclosin2 a 2oin2 concern problem in the 1inancial statements
:" it is concl'ded that a going concern pro!lem e@ists- then we m'st determine the appropriate
type o" disclos're. ,he most conseratie treatment that co'ld !e adopted is to 'se an
alternatie !asis o" meas'rement 0e.g.- li&'idation al'e1. :n this case- not only will !alance
sheet al'es !e changed- !'t the classi"ication o" assets and lia!ilities in the "inancial
statements may also need to !e ad#'sted.
<e m'st consider whether there is ade&'ate disclos're in the "inancial statements and whether
disclos're e@plicitly draws attention to the going concern pro!lem. :n eal'ating the ade&'acy o"
disclos're- we wo'ld consider the content o" "inancial statements- incl'ding the terminology
Solutions Manual, Chapter 2 1)
'sed- the amo'nt o" detail gien- the location o" the disclos're- and its prominence in the
"inancial statements.
:" it is decided that the going concern pro!lem is to !e disclosed in a note- and the "ig'res 'sed
in the "inancial statements will not !e ad#'sted- then certain in"ormation sho'ld !e incl'ded in
the note. /irst- the note sho'ld state that there are aderse conditions and eents- which
indicate that the acco'nting principles 'sed- are not applica!le. ,he note sho'ld also proide
details o" managementDs plans- i" any- "or dealing with the aderse conditions and eents and
managementDs eal'ation o" their signi"icance "or operations- as well as any mitigating "actors
that may !e present. ,he possi!le e""ects on operations sho'ld !e e@plained i" the pro!lem is
not resoled. /inally- the note sho'ld state the anticipated timing o" the resol'tion o" s'rro'nding
'ncertainties.
=isclos're does not hae to !e limited to the "inancial statements. Going concern pro!lems
co'ld !e comm'nicated in media anno'ncements or in the management disc'ssion and
analysis in the ann'al report- or co'ld !e incl'ded with doc'ments "iled with the proincial
sec'rities commissions.
At a minim'm- going concern matters sho'ld !e disclosed in notes to the "inancial statements.
,here are legal implications i" a going concern pro!lem is not disclosed properly to a'ditors-
directors- o""icers- and any company administrators.

Case 2-5
0a1
7emoran4um
%o0 6artner
/rom0 CA
Sub8ect0 6eng'ins in 6aradise 06:61
Many 'sers will !e relying on the "inancial statements. Most signi"icantly- e&'ity inestors will
!e relying on the "inancial statements to calc'late their participation payment. ,hey will want
acco'nting policies that ma@imi2e pro"it. :n addition- they will want to ens're that 6:6+s
operations- partic'larly its costs- are !eing e""iciently controlled. ,he !an* will also !e relying
on the "inancial statements to ens're that the operations are 'nder control. ,hey will li*ely want
to see statements that ma@imi2e income 0minimi2e losses1 and show positie cash "lows. ,he
promoter will !e relying on the "inancial statements in calc'lating his participation payment.
Li*e all the other inestors- he will want pro"it to !e high in order to ma@imi2e his own income.
:n setting the acco'nting policies- the client m'st !ear in mind that in this sit'ation they will hae
a direct impact on 6:6+s cash "lows. Cash "lows will !e ery important in the "irst stages o" the
li"e o" the play- a period in which e@penses will e@ceed reen'es. %arly recognition o" e@penses
will decrease pro"it- and the participation payments that are !ased on operating pro"its. :
recommend that the acco'nting policies !e set in accordance with acco'nting standards "or
priate enterprises 0A$6%1. /'t're pro"its are 'ncertain. ,o !e conseratie- items sho'ld !e
e@pensed now and reen'es sho'ld !e recogni2ed once prod'ction o" the play commences.
)imited partners
,he inestor contri!'tions to the limited partnership sho'ld !e shown as Npartners+ capitalO in the
shareholders+ e&'ity section o" the !alance sheet. ,he inestors are entitled to the resid'al
interest o" the entity a"ter all de!t holders hae receied the interest.
Ro"alt" rights
Acco'nting "or the royalty right payments to 6:6 is ery important !eca'se o" the impact this
amo'nt will hae on the participation payments to inestors.
/irst- it m'st !e determined whether the amo'nt paid to 6:6 "or the royalty rights is an income
item or a capital item. A royalty payment is ery similar to a diidend. ,he inestors will receie
a royalty 0or participation1 payment that is !ased on their initial contri!'tion. ,he payment that
they receie co'ld also !e considered a ret'rn o" their inestment. 8oth o" these "acts imply
that the payments to 6:6 !y the inestors are on acco'nt o" capital.
7n the other hand- in order "or the inestors to earn a royalty- the critical eent that m'st ta*e
place is the prod'ction o" the play. ,he cost o" prod'cing the play is the cost o" earning the
income. :n addition- the original contri!'tions will not !e re"'nded to the inestor.
:" the amo'nt paid to 6:6 !y the inestors is considered to !e on acco'nt o" income- it is
important to determine the period in which the amo'nt sho'ld !e recogni2ed. ,he critical eent
here is the signing o" the contract. Also- no "'t're serices hae to !e proided. ,hese "acts
s'ggest that the amo'nt sho'ld !e recogni2ed as income immediately.
Howeer- i" pro"it is earned and a royalty payment is made !y 6:6- it will !e !ased on "'t're
pro"it. %@penses will !e inc'rred in the "'t're and there"ore- the amo'nt paid to 6:6 !y inestors
sho'ld !e matched to the period in which the e@pense is inc'rred. :n addition- !y recogni2ing
the inestors+ payments to 6:6 as income in "'t're periods- we wo'ld o!tain a !etter matching
o" e@penses since the prod'ction is in a "'t're period. : recommend that the inestor payments
to 6:6 !e treated as income and recogni2ed in "'t're years.
,o help aoid interpretation pro!lems in the "'t're- Ntr'e operating e@pensesO m'st !e de"ined.
,he de"inition will help clari"y what types o" e@penses are ded'cti!le and what types o" reen'es
m'st !e incl'ded in income.
Sale of reservation rights
,he timing o" recognition o" the "ees earned "rom selling reseration rights m'st !e determined.
,he amo'nt relates to the "'t're per"ormance o" the play- that !eing in Gear 2. :" the play is
cancelled- the theatregoers will as* "or a re"'nd o" their reseration "ee. ,here"ore- there is a
case "or "'t're recognition. Arg'ments "aoring recognition in Gear 1 incl'de the "act that the
critical eent is selling the reseration rights- and that the amo'nt is non-re"'nda!le. :n addition-
the amo'nt paid cannot !e applied against "'t're tic*et prices and no "'t're serices are to !e
rendered.
$ince the play m'st r'n in a "'t're year to aoid haing to repay the reseration "ee- the
reseration "ee sho'ld !e recogni2ed as reen'e in Gear 2. =oing so will red'ce income "or the
c'rrent year and red'ce the participation payment in the c'rrent year.
Sales of movie rights
,he payment receied "or the sale o" the moie rights can !e ta*en into income in the c'rrent
year !eca'se there is no direct tie to "'t're e@penses or eents. Alternatiely- the amo'nt that
was paid is !ased on the s'ccess o" the play- and sho'ld !e ta*en into income in "'t're periods.
*overnment grant
<e m'st determine whether the goernment grant is attri!'ta!le to income or capital. ,he
treatment o" this amo'nt will a""ect the royalty payment. :" the amo'nt is ta*en into income
immediately- the participation payments will increase. :" the amo'nt is o""set against an asset
1C Modern Advanced Accounting in Canada, Seventh %dition
that is depreciated- then the participation payments deried "rom the grant will !e paid oer
time. :" the grant is tied to hiring Canadians to per"orm in the play- then the amo'nt sho'ld !e
credited against the related e@pense.
:" the grant has to !e spent on cost'mes and sets made in Canada- then the amo'nt sho'ld !e
netted against the related assets. ,he grant sho'ld !e recogni2ed when it !ecomes paya!le-
not when it is collected.
:n order to decide how this amo'nt sho'ld !e recogni2ed- we m'st determine what the )0(
content r'le pertains to ? against what p'rchase sho'ld it !e o""setP <e m'st also determine
the length o" time that the r'les apply in case the amo'nt has to !e repaid at a later date.
+ank )oan
<e m'st determine how to record the payment to the !an* that is !ased on the play+s s'ccess.
,he )( that is paya!le as well as an accr'al !ased on e@pected "'t're pro"its co'ld !e
e@pensed. Alternatiely- #'st the )( amo'nt co'ld !e e@pensed !eca'se the remaining !alance
that wo'ld hae to !e paid is 'ncertain and di""ic'lt to determine.
Salaries and miscellaneous costs
Gien that these costs are inc'rred in the start-'p o" the operations- the amo'nts can !e
e@pensed in either the c'rrent year or "'t're years. Arg'ments can !e made "or either
treatment. ,here is no certainty o" the play s'cceeding and so- to !e conseratie- the amo'nt
sho'ld !e e@pensed in the c'rrent period. 7n the other hand- the amo'nts do relate to
prod'ction in "'t're years- and in order to match e@penses with reen'es- the amo'nts sho'ld
!e e@pensed in "'t're periods.
Costumes and sets
,he cost'mes and sets can !e e@pensed either in Gear 1 or in "'t're periods. 6r'dence wo'ld
dictate that the amo'nt sho'ld !e e@pensed immediately !eca'se there is no certainty the play
will s'cceed. Howeer- the cost'mes and sets do relate to prod'ction in "'t're years.
Capitali2ing the amo'nt and recording depreciation in "'t're years will proide a !etter matching
o" reen'es and e@penses.
Insurance
Solutions Manual, Chapter 2 1F
,he ins'rance premi'ms that are c'rrently !eing paid can !e either capitali2ed or e@pensed.
,he term ins'rance has no "'t're al'e or any impact on reen'es- and it sho'ld !e e@pensed
in the period inc'rred. An arg'ment "or capitali2ing the costs is that the cost was inc'rred to
sec're "inancing which will !ene"it "'t're prod'ction. Gien the inestors+ o!#ectie o"
ma@imi2ing their initial losses- and ma@imi2ing "'t're years+ income- the amo'nt sho'ld !e
e@pensed in the c'rrent period.
,romoter(s fees
<e m'st determine what amo'nt- i" any- sho'ld !e accr'ed "or the promoter+s "ees. At present-
the payment is too 'ncertainE th's- the amo'nt sho'ld !e acco'nted "or in the year that an
amo'nt !ecomes paya!le.
0!1
0i1 inestor in Limited 6artnership 'nits
,he limited partnership 'nits represent an e&'ity interest in the !'siness. :n order to determine
the appropriate acco'nting "or the 'nits- it is necessary to determine how the inestment wo'ld
!e classi"ied. ,he potential classi"ications are /9,6L- /9,7C: - signi"icant in"l'ence- #oint
control- or control. :n order to "'rther determine the appropriate classi"ication- it is necessary to
determine the e@tent to which control or signi"icant in"l'ence might e@ist oer the strategic
operating and "inancing policies o" the partnership.
:n a limited partnership- the general partner 's'ally ma*es the *ey operating and "inancing
decisionE the other inestors 's'ally hae has ery little say in the operating and "inancing
policies o" the entity. As s'ch- the limited partners wo'ld not li*ely hae control- #oint control or
signi"icant in"l'ence. $ince the 'nits are not actiely traded- determining the "air al'e will !e
di""ic'lt. ,he inestor may pre"er to report the inestment as "air-al'e-thro'gh 7C: so that pro"it
is not a""ected !y the s'!#ectie assessment o" the "air al'e.
0ii1 inestor in royalties
,he inestments in royalties gie the inestors the right to participate in the operating pro"its o"
the plays. ,hey wo'ld not ena!le the inestor to hae any in"l'ence or control oer the
operating and inesting policies o" the partnership and generally do not hae any characteristics
o" e&'ity. 7n this !asis- they wo'ld L7, !e classi"ied as held "or trading- aaila!le "or sale or
signi"icant in"l'ence- control- or #oint control inestments. ,he inestment has the
characteristics o" an intangi!le asset. :t is a right that ena!les participation in "'t're pro"its.
/'rther- the plays li*ely hae a de"inite timeline oer which they will !e o""ered. Ass'ming that
the amo'nt paid "or these royalties can reasona!ly recoered- they wo'ld !e capitali2ed as
"inite li"e intangi!le assets and amorti2ed oer the li"e o" the play. ,hey wo'ld also !e analy2ed
"or impairment on an ann'al !asis.
0iii1 inestor in moie rights
,he inestments in moie rights gie the inestors the right to receie pro"its "rom the creation o"
motion pict'res "rom the content o" the plays. ,hey wo'ld not ena!le the inestor to hae any
in"l'ence or control oer the operating and inesting policies o" the partnership and generally do
not hae any characteristics o" e&'ity. 7n this !asis- they wo'ld L7, !e classi"ied as held "or
trading- aaila!le "or sale or signi"icant in"l'ence- control- or #oint control inestments. ,he
inestment has the characteristics o" an intangi!le asset. :t is a right that ena!les the holder to
earn pro"it "rom the content o" the plays at a "'t're date. /'rther- the timeline oer which the
pro"its will !e earned is not *nown since the moie m'st !e prod'ced and released !e"ore pro"it
can !e earned. 7n this !asis the moie rights wo'ld generally !e acco'nted "or as an inde"inite
li"e intangi!le. :t is important also to consider that the inestment m'st !e analy2ed "or
impairment on an ann'al !asis. ,his wo'ld !e complicated !y the di""ic'lty in determining the
e@tent and li*elihood o" potential "'t're pro"its "rom the rights.
Case 2-6
7emo
,o; A'les 8o'chard
/rom; CA
$'!#ect; L:L+s 6roposed Ac&'isition o" MML
Attached are my comments regarding MML and its potential ac&'isition !y L:L. 7erall- :
thin* that MML wo'ld !e a ris*y inestment "or L:L- and : thin* that care m'st !e e@ercised in
'nderta*ing it. Howeer- gien the right price and satis"actory terms- it co'ld !e worthwhile "or
L:L to inest.
"vervie5
MML is a ris*y inestment 'nder the proposed terms o" the agreement o'tlined in the
in"ormation : receied. .nder these terms- L:L wo'ld ac&'ire 34.45( immediately and the
remainder oer "ie years. As a res'lt- the "o'r co'sins who c'rrently own and manage MML
wo'ld !e the ma#ority owners d'ring the "irst year. ,he co'sins co'ld 'se this period to ma*e
deals that sere their own interests and not the interests o" MML and L:L. :" MMLDs c'rrent
management 'ndertoo* s'ch actiities- L:L wo'ld !e loc*ed into a deal to p'rchase the shares
o" a company with red'ced al'e. ,his sit'ation is especially o" concern !eca'se there are
&'estions- disc'ssed !elow- a!o't the integrity o" MMLDs management. ,he c'rrent owners
wo'ld also !e in a position to control the acco'nting policies 'sed in the "inancial statements-
which are to !e 'sed to set the selling price o" the remaining shares.
L:L co'ld ta*e steps to mitigate these pro!lems. ,he p'rchase agreement co'ld !e
reised so that L:L gets control o" MML immediately. Coenants co'ld !e written into the
agreement- to restrict !on'ses to the e@isting owners andQor to re&'ire L:LDs approal "or certain
types o" transactions.
Another pro!lem is that MML re&'ires an in"'sion o" cash to pay "or the needed
inestment in e&'ipment- renoation o" the !'ildings- and p'rchase o" a competitor. MML is at
the limit o" its !an* line o" credit so the !an* is not a ia!le so'rce o" "inancing. Howeer- i" L:L
decides to inest in MML- MML itsel" will receie the proceeds o" the sale o" the sharesE th's-
the inestment !y L:L will meet some or all o" MML+s cash needs. :" the inestment !y L:L does
not meet all the needs- then additional so'rces o" cash will hae to !e "o'nd.
L:L sho'ld also consider what will happen to the !'siness when the e@isting owners sell
all their shares. :s the !'siness dependent on the co'sinsD personal contacts "or s'ccess- and i"
so will the co'sins !e a!le to compete with MML !y setting 'p a new scrap !'sinessP :" the
answer is yes- a non-compete cla'se sho'ld !e incl'ded in the agreement o" p'rchase and
sale. Alternatiely- L:L might consider hiring some or all o" the e@isting owners to manage the
!'siness.
/inally- L:L sho'ld !e made aware that historical cost "inancial statements are o" limited
'se "or a p'rchase decision. <hile they may proide some !enchmar* in"ormation- "'t're-
oriented in"ormation and "air al'es o" assets are more releant. Many o" the pro!lems
disc'ssed !elow demonstrate the limitations o" the historical cost statements.
8an* loan
MML is heaily inde!ted. :ts !an* loan wo'ld typically !e aro'nd B13.3F million as it tends to
operate at its ma@im'm line o" credit. ,his amo'nt is signi"icant !eca'se MMLDs sales are a!o't
B1).45) million and MML co'ld !e in serio's di""ic'lty i" the !an* called the loan. ,he !an*
c'rrently re&'ires MMLDs shareholders to gie personal g'arantees "or the loans. :" L:L
!ecomes a shareholder- the !an* co'ld re&'est g'arantees "rom it- which wo'ld increase its
ris*. MML may already !e oer its !an* loan i"- as disc'ssed !elow- inentory andQor acco'nts
receia!le are oerstated. :n these circ'mstances the !an* may demand the di""erence "rom
MML- which wo'ld create additional press're "or MML to raise cash. :" L:L inests- howeer-
some o" its cash needs may !e red'ced !eca'se MML wo'ld receie the proceeds "rom the
initial p'rchase o" shares.
$'spicio's !'siness practices
,he a'ditorsD s'spicions that MML red'ces the weight o" scrap p'rchased !e"ore it
calc'lates acco'nts paya!le s'ggest that MMLDs owners engage in 'nscr'p'lo's !'siness
practices. ,he acco'nting implication o" red'cing the weight is to 'nderstate cost o" goods sold.
:" MML were to pay the correct amo'nt- the pro"it margin wo'ld !e red'ced and net income
wo'ld !e lower than is c'rrently reported. :n addition- MMLDs rep'tation co'ld !e damaged i"
s'ch !'siness practices came to light. :" MML+s s'ppliers discoered these practices- they co'ld
decide to sell their scrap elsewhere- which co'ld hae a disastro's e""ect on the per"ormance o"
MML. ,hese s'ppliers are cr'cial to the !'siness since they proide the inp'ts. 7n the other
hand- i" the n'm!er o" scrap dealers in the area is limited- or the !'siness practices apparently
'sed !y MML are widespread- then the e@tent o" the damage res'lting "rom s'ppliers
discoering these practices may !e limited.
Aoint ent're with G%L
,he #oint ent're with G%L is 30( owned !y MML and 40( owned !y the spo'ses o"
the e@isting owners o" MML. ,he close relationship poses some potential pro!lems with regard
to ta@ and "inancial-statement interpretation. ,ransactions !etween G%L and MML may !e
arranged to trans"er "'nds to the spo'ses or to manip'late the "inancial statements o" MML. :"
trans"er pricing is not done at "air al'e- a ta@ lia!ility may e@ist since the :ncome ,a@ Act
re&'ires that transactions !etween related parties ta*e place at "air al'e. :" MML pays a!oe
"air al'e "or G%LDs serices- e@penses "or waste disposal are oerstated and net income is
'nderstated. :" MML pays G%L !elow "air al'e- then net income is oerstated.
,he e@istence o" non-armDs length transactions ma*es the "inancial statements di""ic'lt to
interpret !eca'se the economic o!#ecties o" the owners will !e achieed oer the two entities
rather than #'st MML. <e need to determine the !asis o" transactions !etween MML and G%L
so that we can ma*e pro#ections a!o't the per"ormance o" MML i" L:L p'rchases MML. <e also
need to "ind o't whether there is a long-term contract !etween MML and G%L regarding the
pricing o" transactions !etween them since the terms will hae an e""ect on the "'t're
per"ormance o" MML.
Ad#'stments on sales inoices
/i"teen percent o" MML+s sales inoices hae to !e ad#'sted. 7n aerage the
ad#'stments are downward !y 20(. ,he direction o" the pricing errors s'ggests that
management attempts to oerstate the amo'nt o" metal that is shipped to c'stomers rather than
that the errors are random. ,his "inding casts additional do'!t on managementDs integrity.
8eca'se the inoices hae to !e ad#'sted- acco'nts receia!le and sales are pro!a!ly
oerstated. ,he ma@im'm !alance-sheet ad#'stment is B151-000 02)M I 32M1Q21 @ 0.20 @ 0.20
@ 0.1)1. ,he oerall ma@im'm income statement e""ect o" the red'ctions is B350-2)0 0aerage
sales H 01.)I3 t'rnoer1 Q 21 @ ).5 million o" aerage acco'nts receia!le H B1).45) million- so
the total ad#'stment H B1).45) million @ 0.1) @ 0.2 H B350-2)01. $ome portion o" the B350-2)0
sho'ld !e accr'ed at year end as sales ret'rns and allowances !eca'se- witho't ad#'stment-
acco'nts receia!le and sales will !oth !e oerstated. ,his sit'ation also raises concerns that
there may !e additional 'nrecorded ad#'stments to receia!les that hae not come to light. ,his
amo'nt is clearly material to L:L. :" acco'nts receia!le and sales are misstated- the p'rchase
price "or MML is a""ected and sho'ld !e reised.
:nentory
<ith a al'e o" a!o't B1F million- inentory is the most important item on the !alance
sheet. Control oer inentory is ery wea*- th's- the amo'nt on the !alance sheet cannot !e
relied on. %@amples o" the control wea*nesses incl'de perpet'al records that are estimates o"
amo'nts rather than act'als- the a!sence o" costing records "or inentory pricing- lac* o"
n'merical se&'ence "or weight tic*ets and the need "or ad#'stments a"ter inentory co'nts.
<itho't relia!le records- it is not possi!le to determine the &'antity and &'ality o" the inentory
on hand and there"ore the inentoryDs c'rrent al'e. ,he al'e is an important determinant o"
the price that L:L sho'ld pay "or MML.
,here are some &'estions a!o't the practices o" !orrowing and lending inentory. :s the
practice 'sed "or legitimate !'siness p'rposes or to increase inentory leels at year endP
:ncreasing year-end inentory leels wo'ld help MML *eep the !an* loan at a high leel- which
is important gien its wea* cash position. Also- it is 'nclear how the !orrowed inentory is
acco'nted "or. :s it incl'ded in inentory and co'nted 0perhaps re&'iring an ad#'stment !etween
the records and the co'nt1P :s it treated as a p'rchase and incl'ded in inentoryP Gien the
poor record-*eeping- the "inancial statements co'ld !e misstated as a res'lt o" these
transactions.
$imilarly- in"ormation is re&'ired a!o't how MML acco'nts "or the inentory p'rchased
conditionally. :" a signi"icant &'antity o" inentory has !een receied on a conditional !asis !'t
not yet graded- its incl'sion in inentory !e"ore it has !een accepted wo'ld res'lt in inentory
!eing oeral'ed. Also- since the amo'nt d'e to the endor is not determined 'ntil the inentory
is graded- year-end paya!les co'ld !e 'nderstated.
7erall- the in"ormation a!o't inentory is highly s'spect. :nentory represents a!o't
two-thirds o" total assets. :" it is materially misstated- the entire "inancial statements are
materially misstated. :" the inentory is materially misstated- the p'rchase price is a""ected
!eca'se the price is !ased on the statements.
7ther iss'es
,he nat're o" the !'siness s'ggests that MML may !e lia!le "or any enironmental
damage ca'sed !y storage o" scrap and !y the !'siness actiities o" G%L 0a waste disposal
company1. ,his possi!ility imposes an additional- 'n*nown ris* on L:L i" it decides to !'y MML.
MMLDs record-*eeping system is wea*- indicating a lac* o" controls. <eight tic*ets "or
sales are not n'm!ered se&'entially- so sales co'ld !e 'nderstated- in which case reported net
income co'ld !e 'nderstated. :" so- the 'nderstatement co'ld lead to a ta@ lia!ility "or
'nreported income.
,he terms 'nder which MML does !'siness with the Aapanese trading company sho'ld
!e inestigated. A s'!stantial &'antity o" MML+s metal p'rchases is made "rom the Aapanese
company- and we sho'ld con"irm that the so'rce will contin'e to s'pply MML i" it is p'rchased
!y L:L. 8eca'se o" the attractie terms that the Aapanese company o""ers MML 0no payments
"or "ie to si@ months1- we sho'ld "ind o't whether there is a special relationship 0perhaps non-
armDs length1 !etween the e@isting owners o" MML and the Aapanese company.
,he e@istence 0or non-e@istence1 o" 'nrecorded lia!ilities sho'ld !e inestigated. /or
e@ample- i" MML red'ces the recorded weights o" scrap it has p'rchased or i" p'rchase tic*ets
are missing 0!eca'se the tic*ets are not n'm!ered1- acco'nts paya!le may !e 'nderstated.
Concl'sion on p'rchase decision
: concl'de "rom my analysis that- MMLDs "inancial statements are li*ely materially
misstated !eca'se o" the pro!lems with inentory and cost o" goods sold. As a res'lt- L:L may
!e misled i" it relies on the "inancial statements "or its assessment o" MML. ,he material
misstatement may a""ect the !an*Ds restrictie coenant and the amo'nts paid to the managers
in !on'ses- and may render the statements 'seless to L:L "or its p'rchase decision.
,here are a n'm!er o" pro!lems with MML that ma*e the decision to p'rchase it ery
ris*y. Certainly L:LDs management sho'ld hae concerns a!o't the integrity o" MML+s managers
as it appears that they are dishonest with their c'stomers and s'ppliers. L:L might want to
&'estion whether it wants to !e in !'siness with the c'rrent owners. Many o" the other
pro!lems identi"ied earlier co'ld !e mitigated !y altering the terms o" the p'rchase and sale
agreement to gie control to L:L initially andQor to restrict the actions o" the c'rrent owners.
Gien all the pro!lems with MML- : do not thin* that it sho'ld !e p'rchased !y L:L. : wo'ld not
dismiss completely the idea o" p'rchasing MML- since at some price the ac&'isition wo'ld !e
attractie. Howeer- : do adise L:L to proceed with e@treme ca'tion and to care"'lly consider
the iss'es disc'ssed in this memo.
Acco'nting "or :nestment in MML
:" L:L decides to proceed with its inestment in MML- then it needs to determine how to
report its interest in MML. :t really depends on whether it has control- signi"icant in"l'ence or
neither. ,his depends on the terms o" the p'rchase and sale agreement and how closely *nit
are the "o'r other shareholders. A 34.45( interest wo'ld normally imply signi"icant in"l'ence
!eca'se L:L wo'ld !ecome the !iggest indiid'al shareholder. Altho'gh it does not hae a
ma#ority interest- it only re&'ires s'pport "rom one o" the other shareholders to control the
ma#ority o" the otes. :t li*ely will get some representation on the !oard o" directors d'e to its
large holding. :t co'ld een o!tain control !y insisting on control thro'gh the p'rchase and sale
agreement. At the other e@treme- it co'ld hae neither control nor signi"icant in"l'ence i" the
co'sins wor* together as a 'nit and do not agree to representation on the !oard or any loss o"
control thro'gh the p'rchase and sale agreement.
:" L:L has control- it wo'ld report its interest in MML !y consolidating MML in its
consolidated "inancial statements. :" it has signi"icant in"l'ence- it wo'ld 'se the e&'ity method
to report its inestment. :" it has neither control nor signi"icant in"l'ence- it wo'ld report its
inestment at "air al'e and choose to report the 'nreali2ed gains in net income or 7C:.
S"#$%I"&S %" P'"9#E7S
Problem 2-1
6art A
Investment .ccount
Aan'ary 1- Gear ) B4)0-000
6l's;
Carter+s Gear ) pro"it BF)-000
Anderson+s percentage ownership 20( 1F-000
Less;
=iidends B40-000
20( 012-0001
=ecem!er 31- Gear ) 4)5-000
6l's;
Carter+s Gear 4 pro"it B10)-000
Anderson+s percentage ownership 20( 21-000
Less;
=iidends B40-000
20( 012-0001
=ecem!er 31- Gear 4 B444-000
6art 8
0a1 :nestment in Carter 33-000
.nreali2ed gain on /9,6L inestment 33-000
020-000 shares @ 3) ? 444-0001
0!1 Cash 0)0-000 @ 20(1 10-000
=iidend income 10-000
Record dividend revenue for Anderson(s share of dividends declared !" Carter
Cash 020-000 shares @ 351 530-000
:nestment in Carter 500-000
Gain on sale 30-000
Sale of investment in Carter
Problem 2-2
Gear )
:nestment in Ro!!in 25)-000
Cash 25)-000
Cash 030-000 @ 20(1 C-000
=iidend income C-000
:nestment in Ro!!in 020-000 shares @ 14 ? 25)-0001 3)-000
.nreali2ed gain on /9,6L inestment 3)-000
Gear 4
:nestment in Ro!!in 0F0-000 @ 20(1 1C-000
:nestment income 1C-000
Share of Ro!!in(s income
Cash 030-000 @ 20(1 C-000
:nestment in Ro!!in C-000
+askin(s share of dividends declared !" Ro!!in
Cash 020-000 @ 151 330-000
:nestment in Ro!!in 025)-000 I 3)-000 I 1C-000 - C-0001 330-000
Gain on sale 10-000
Sale of investment in Ro!!in
Problem 2-3
0a1
Aan'ary 1- Gear )
:nestment in $tergis 1-)00-000
Cash 1-)00-000
,o record p'rchase o" 30( o" $tergis.
=ecem!er 31- Gear )
:nestment in $tergis 12-400
:nestment :ncome 12-400
,o record 30( o" $tergis+s Gear ) net income.
30( @ 32-000 H 12-400
7C: - :nestment income 3-000
,o record 30( o" $tergis+s Gear ) 7C:
30( @ 10-000 H 3-000
Cash 1C-000
:nestment in $tergis 1C-000
,o record 30( o" $tergis+s Gear ) diidends.
30( @ 40-000 H 1C-000
=ecem!er 31- Gear 4
:nestment income 34-000
,o record 30( o" $tergis+s Gear 4 net income.
30( @ 120-000 H 34-000
:nestment in $tergis 5-)00
7C: - :nestment income 5-)00
,o record 30( o" $tergis+s Gear 4 7C:
30( @ 2)-000 H 5-)00
Cash 1C-000
:nestment in $tergis 1C-000
,o record 30( o" $tergis+s Gear 4 diidends.
30( @ 40-000 H 1C-000
8la*e sho'ld disclose the "ollowing with respect to its inestment in $tergis;
,he name and principal place o" !'siness o" the associate
,he method 'sed to report the inestment in the associate
:nestment income "rom 8la*e+s inestment in $tergis sho'ld !e reported separately on the
income statement and the carrying amo'nt o" this inestment sho'ld !e reported separately
on the !alance sheet
,he nat're o" its relationship with $tergis and its percentage ownership
s'mmari2ed "inancial in"ormation "or $tergis- incl'ding the aggregated amo'nts o" assets-
lia!ilities- reen'es- and net income
nat're and e@tent o" any signi"icant restrictions on the a!ility o" $tergis to trans"er "'nds to
8la*e in the "orm o" cash diidends- or to repay loans or adances made !y the entityE and
contingent lia!ilities inc'rred relating to its interests in associates
0!1
Aan'ary 1- Gear )
:nestment in $tergis 1-)00-000
Cash 1-)00-000
-o record purchase of &.' of Stergis#
=ecem!er 31- Gear )
Cash 1C-000R
=iidend reen'eRR 1C-000
,o record 30( o" $tergis+s Gear ) diidendsR
R30( @ 40-000 H 1C-000
=ecem!er 31- Gear 4
Cash 1C-000
=iidend income 1C-000
,o record 30( o" $tergis+s Gear 4 diidends.
RR Lote that 'nder the g'idance o" the $ection 30)1- when applying the cost method- all
diidends are recorded as reen'e when receied or receia!le regardless o" whether they
represent li&'idating diidends.
0c1
8la*e wo'ld pre"er to 'se the e&'ity method. $ince $tergis+ comprehensie income "or Gears )
and 4 is greater than diidends paid "or Gear ) and 4- 8la*e+s comprehensie income wo'ld !e
higher 'nder the e&'ity method. :n t'rn- shareholders+ e&'ity will !e higher and total de!t will
remain the same. ,here"ore- the de!t-to-e&'ity ratio will !e lowest 'nder the e&'ity method.
Problem 2-4
6art a %&'ity method
0i1 :nestment in $altspring 233-000
Cash 233-000
-o record &.' investment in Saltspring
Cash 030( @ 100-0001 30-000
:nestment in $altspring 30-000
/ividends received
:nestment in $altspring 030( @ 2)C-0001 55-300
:nestment loss ? discontin'ed operations 030( @ 30-0001 F-000
:nestment income 030( @ 2CC-0001 C4-300
-o record &.' of Saltspring(s profit and discontinued operations

0ii1 :nestment cost Aan. 1- Gear 4 B233-000
=iidends receied 030-0001
$hare o" income 55-300
:nestment acco'nt =ec. 31- Gear 4 B2C1-300
0iii1
6ender Corp
$tatement o" 7perations
Gear ended =ecem!er 31- Gear 4

$ales BF00-000
:nestment income C4-300
FC4-300
7perating e@penses 0300-0001
:ncome !e"ore income ta@ )C4-300
:ncome ta@ e@pense 0200-0001
Let income !e"ore discontin'ed operations 3C4-300
=isc. 7perations - :nestment loss 0F-0001
6ro"it B355-300
6art ! Cost method
0i1 :nestment in $altspring 233-000
Cash 233-000
-o record &.' investment in Saltspring
Cash 30-000
=iidend income 30-000
/ividends received
0ii1 :nestment acco'nt !alance =ecem!er 31- Gear 4 233-000
0iii1 6ender Corp
$tatement o" 7perations
Gear ended =ecem!er 31- Gear 4

$ales BF00-000
:nestment income 30-000
F30-000
7perating e@penses 0400-0001
6ro"it B330-000
6art !
6ender wo'ld want to 'se the e&'ity method i" its !ias were to show the highest ret'rn on
inestment since the e&'ity method ta*es into acco'nt the "'ll increase in al'e o" the inestee
0i.e. recogni2es proportion o" income earned "or the year1 whereas the cost method only
recogni2es income to the e@tent o" diidends receied.
Cost method ret'rn on inestment H 30-000 Q 233-000 H 12.C(
%&'ity method ret'rn on inestment H 02C1-300 - 233-000 I 30-0001Q233-000 H 33.1(
Problem 2-5
0a1
0i1 20-000 shares @ 20 B300-000
0ii1 7riginal cost B330-000
share o" income 020( @ 0200-000 I 22)-00011 C)-000
less; share o" diidends 020( @ 01)0-000 I 140-00011 042-0001
B343-000
0iii1 20-000 shares @ 20 B300-000
0!1
0i1 :ear 4 :ear 5 :ear 6 %otal
=iidend income 011 B30-000 B32-000 B3)-000 BF5-000
.nreali2ed gains 021 20-000 30-000 0 40-000
Gain on sale 021 0 0 40-000 40-000
Let income B)0-000 B52-000 BF)-000 B215-000
,otal 7C: 0 0 0 0
0ii1 :ear 4 :ear 5 :ear 6 %otal
%&'ity income 031 B30-000 B3)-000 B3C-000 B133-000
Gain on sale 031 0 0 C3-000 C3-000
Let income B30-000 B3)-000 B132-000 B215-000
,otal 7C: 031 0 0 0 0
0iii1 :ear 4 :ear 5 :ear 6 %otal
=iidend income 011 B30-000 B32-000 B3)-000 BF5-000
Gain on sale 0)1 0 0 40-000 40-000
Let income B30-000 B32-000 BF)-000 B1)5-000
7ther comprehensie income
.nreali2ed gain 021 B20-000 B30-000 0 B40-000
Comprehensie income B)0-000 B52-000 BF)-000 B215-000
&otes0
1. 20( @ diidends paid d'ring year
2. 20-000 shares @ change in share price d'ring year
3. 20( @ net income "or the year
3. 340-000 ? J330-000 I 030-000 I 3)-000 I3C-0001 ? 030-000 I 32-000 I 3)-0001K H
C3-000
). 20-000 shares @ 23 ? 20-000 shares @ 20 H 40-000
0c1 ,he total comprehensie income oer the three-year period in total is the same "or all three
sit'ations. Howeer- the split !etween net income and 7C: is not the same in total "or the three
sit'ations. ,his is not 'n's'al in acco'nting. Altho'gh the di""erent methods report di""erent
income each year- in the long r'n- the total income is the same 'nder all methods. ,he total
income is 's'ally e&'al to the di""erence !etween cash receied and cash paid oer the li"e o"
the inestment which is B215-000 calc'lated as "ollows;
Cash receied
6roceeds "rom sale B340-000
=iidends receied 030-000 I 32-000 I 3)-0001 F5-000
,otal proceeds ))5-000
Cash dis!'rsed
Cost o" inestment 330-000
Change in cash B215-000
Problem 2-6
,he "ollowing slides are presented as a sample answer "or this &'estion.
$lide M1
&e5 Carryin2 amounts
-"pe Measurement 0nreali1ed *ains
/9,6L /air al'e Let income
/9,7C: /air al'e 7ther comprehensie income
- %ither method can !e 'sed
$lide M2
'ationale 1or /air (alue
/air al'e is more releant to most 'sers;
S 6roides clearer pict're o" "inancial sit'ation
S :mproes acco'nta!ility to 'sers
S Red'ces opport'nities to manage earnings
$lide M3
;eterminin2 Classi1ication o1 Investment
S Management chooses the classi"ication !ased on;
- whether the inestment is held "or short-term trading or not
- how the manager and entity sho'ld !e eal'ated
$lide M3
'ationale 1or 'eportin2 $nreali<e4 3ains
S Report in net income
- <hen trading in inestments is part o" short-term operating strategy o" "irm
- Management sho'ld !e eal'ated on per"ormance
S Report in other comprehensie income
- ,o aoid short-term "l'ct'ations in net income
- Management sho'ld not !e eal'ated on inestments- which are not actiely traded
$lide M)
"ther Investments
%ype 'eportin2 7etho4
:nestment in associate %&'ity method
:nestment in s'!sidiary Consolidation
,he cost method is 'sed "or internal p'rposes. :nestments sho'ld not !e reported at cost "or
e@ternal reporting p'rposes.
Problem 2-
,he "ollowing slides are presented as a sample answer "or this &'estion.
$lide M1
Strate2ic Investments
%ype "ptions
:nestment in s'!sidiary Consolidation- cost method or e&'ity method
Held "or signi"icant in"l'ence %&'ity method or cost method
R M'st 'se same method "or all inestments in the class
R <hen shares traded in actie mar*et
- m'st report at "air al'e i" planned to 'se cost method
- 'nreali2ed gains reported in net income
$lide M2
'ationale 1or /le=ibility
Cost ? !ene"it considerations
S 'sers may not re&'ire or 'nderstand the more comple@ reporting
S cost inoled in generating the in"ormation may !e e@cessie
S when shares are actiely traded- cost o" o!taining "air al'e in"ormation is minimal
$lide M3
'ationale 1or /air (alue In1ormation
/air al'e is more releant to most 'sers;
S 6roides clearer pict're o" "inancial sit'ation
S :mproes acco'nta!ility to 'sers
S Red'ces opport'nities to manage earnings
$lide M3
&ot-strate2ic Investments
S Report at cost when shares not actiely traded
S Report at "air al'e when shares are actiely traded
- 'nreali2ed gains reported in net income
$lide M)
'ationale 1or 'eportin2 $nreali<e4 3ains
S Teep it simple
S $ame as rationale a!oe "or "air al'e in"ormation
S 7C: does not e@ist 'nder A$6%
S"#$%I"&S %" !E9-9.SE; P'"9#E7S
!eb Problem 2-1
0a1 :nestments in associates and #oint ent'res as a percentage o" total assets 2011 H
221 Q 1C-342 H 1*2>* :nestments in associates and #oint ent'res is "o'nd in note 13 to
the "inancial statements and total assets is "o'nd on the consolidated statement o"
"inancial position.
0!1 Rate o" ret'rn on inestments in associates and #oint ent'res H 5 Q 221 H 3*2>. ,his is
calc'lated !y ta*ing the company+s share o" res'lts in associates and #oint ent'res
0"o'nd on consolidated statement o" income1 diided !y the inestments in associates
and #oint ent'res 0"o'nd in note 13 to the "inancial statements1.
0c1 0i1 c'rrent ratio H 1-F12 Q 2-)3F H .501. :" the company had 'sed the cost method- it
wo'ld not hae had an impact on the c'rrent ratio as neither c'rrent assets nor c'rrent
lia!ilities wo'ld !e a""ected.
0ii1 de!t-to-e&'ity ratio H 013-5F0 Q 3-)52 H 4*1401. :" the company had 'sed the cost
method- total e&'ity wo'ld decrease gien that the c'm'latie addition to net income
wo'ld only !e 5)( o" what it wo'ld !e 'nder the e&'ity method gien that diidends are
only 5)( o" the net income earned !y the associates and #oint ent'res. =e!t wo'ld !e
'nchanged- and there"ore the de!t-to-e&'ity ratio wo'ld increase i" the cost method
were 'sed.
0iii1 ret'rn on e&'ity H 1-)43 Q 03-)52 I 3-5401Q2 H 42*6>. :" the company had 'sed the
cost method- !oth the n'merator and denominator o" this e&'ation wo'ld decrease !y
the e@cess o" net income oer diidends o" the associates and #oint ent'res 0the
company+s share o" them1. ,he e&'ity n'm!er wo'ld decrease !y more as it incl'des
the c'm'latie amo'nt o" income recogni2ed to date. ,h's- the ret'rn on e&'ity wo'ld
decrease i" the cost method were 'sed.
0d1 :n 2011- earned income "rom aaila!le-"or-sale inestments was B153 !e"ore ta@ 0B1)2
a"ter ta@1 as per the consolidated statements o" comprehensie income.
0e1 .nreali2ed gains on aaila!le-"or-sale inestments represents 333 Q 3-)52 H 12.1> o"
total e&'ity as per the statements o" changes in shareholders+ e&'ity.
0"1 :" aaila!le-"or-sale inestments had !een acco'nted "or as /9,6L since the !eginning-
there wo'ld !e no change to the inestment acco'nt !alances as- in !oth cases-
inestments are ad#'sted to "air al'e at each reporting date. Certain e&'ity acco'nts
wo'ld change !'t the total amo'nt o" shareholders+ e&'ity wo'ld not change. ,he
c'm'latie 'nreali2ed gains "or the aaila!le-"or-sale inestments are reported in a
resere acco'nt within shareholders+ e&'ity wheras the c'm'latie 'nreali2ed gains are
incl'ded in retained earnings "or the /9,6L inestments.
!eb Problem 2-2
0a1 :nestments acco'nted "or 'sing the e&'ity method as a percentage o" total assets 2011
H 1-)34 Q 2F-353H 5*2>. ,his in"ormation is "o'nd on consolidated !alance sheets and
note 14 to the "inancial statements.
0!1 Rate o" ret'rn on inestments in associates H -FC Q 1-)34 H -4.3> as per the
consolidated statements o" income and consolidated !alance sheets.
0c1 0i1 c'rrent ratio H 2-F)0 Q 551 H 3*+301. :" the company had 'sed the cost method- it
wo'ld not hae had an impact on the c'rrent ratio as neither c'rrent assets nor c'rrent
lia!ilities wo'ld !e a""ected.
0ii1 de!t-to-e&'ity ratio H 5-CCF Q 21-3C) H 0*301. :" the company had 'sed the cost
method- total e&'ity wo'ld increase compared to that res'lting "rom 'se o" the e&'ity
method gien that there wo'ld !e no c'm'latie red'ction to net income 0and there"ore
e&'ity1 as a res'lt o" the losses generated !y the associates. Also- note that since the
earnings "rom associates are negatie- no diidends wo'ld !e paid. :" the associates+
acc'm'lated income e@ceeded acc'm'lated diidends since the date o" ac&'isition-
total e&'ity wo'ld decrease 'nder the cost method. =e!t wo'ld !e 'nchanged- and
there"ore the de!t-to-Qe&'ity ratio wo'ld increase i" the cost method were 'sed.
0iii1 ret'rn on e&'ity H 1-CC1 Q 01F-544 I 21-3C)1Q2 H ,*1>. :" the company had 'sed the
cost method- the n'merator "or 2011 wo'ld increase !eca'se there wo'ld !e no loss
"rom the inestments in associates. ,he denominator o" this e&'ation wo'ld li*ely
decrease !y the e@cess o" c'm'latie net income oer c'm'latie diidends o" the
associates 0the company+s share o" them1. ,h's- the ret'rn on e&'ity wo'ld li*ely
increase "or 2011. :" the associates are 's'ally generating a positie net income- then
the ret'rn on inestment wo'ld 's'ally decrease i" the cost method were 'sed.
0d1 :n 2011- the company inc'rred an a"ter-ta@ loss o" B315 "rom aaila!le-"or-sale
inestments as per note 24!.
0e1 .nreali2ed gains on aaila!le-"or-sale inestments represents -33 Q 21-3C) H -0.2> o"
total e&'ity as per the statements o" changes in e&'ity.
0"1 :" aaila!le-"or-sale inestments had !een acco'nted "or as /9,6L since the !eginning-
there wo'ld !e no change to the inestment acco'nt !alances as- in !oth cases-
inestments are ad#'sted to "air al'e at each reporting date. Certain e&'ity acco'nts
wo'ld change !'t the total amo'nt o" shareholders+ e&'ity wo'ld not change. ,he
c'm'latie 'nreali2ed gains "or the aaila!le-"or-sale inestments are reported in a
resere acco'nt within shareholders+ e&'ity whereas the c'm'latie 'nreali2ed gains are
incl'ded in retained earnings "or the /9,6L inestments.

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