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Chapter: 5 -Problem: 8 >> XYZ Ltd. is a large retail company listed on a major stock exchange, and its reported net income for the year ended December 31, 2019, is $5 million. The earnings were announced to the public on March 31, 2020. Just before the release of the 2019 earnings on March 31, 2020, financial analysts had predicted the company's net income for 2019 to be $7 million. Assumptions• No other news about XYZ Ltd
Answer Preview: a. Yes, a stock price decrease is expected, other things equal, because unexpected earnings were neg…

, Chapter: 7 -Problem: 10 >> Should firms be required to fair-value their long-term debt even in the event of a mismatch? Outline arguments for and against this suggestion. Include arguments based on eliminating or reducing mismatch, as well as arguments based on wealth transfers deriving from the entity and the proprietorship views of financial reporting (See Section 3. 7 .1, including Note 23).
Answer Preview: Arguments against fair valuing long-term debt: Market value of debt falls following a credit downgra…

, Chapter: 7 -Problem: 16 >> Refer to the sensitivity analysis of Husky Energy Inc. reproduced in Table 7.2. The analysis discloses the potential effects of changes in prices of oil and natural gas, and of changes in the CON/U.S. dollar exchange rate, on 2016 cash flows and earnings. Requireda. Evaluate the relevance and re liability of t his method of disclosing risk information.b . The analysis indicates that the sensitivit
Answer Preview: a. If the CAPM and theory of rational decision-making are accepted, the risk information seems largely firm-specific, and hence diversifiable. Then, firm-specific risk information would be low in rele…

, Chapter: 7 -Problem: 13 >> Manulife Financial is a large Canadian-based insurance and financial services company. with operations in Canada. United States. and Asia. Manulife's profits suffered from low interest rates and poor stock market returns following the 2007-2008 market meltdowns. These returns were less than the rates of return assumed by Manulife when setting pre-meltdown premiums for its insurance and other produ
Answer Preview: a. There is some justification to this claim, since core earnings for the quarter removes from GAAP earnings the lingering negative effects of Manulifes failure to hedge against the possibility of low…

, Chapter: 11 -Problem: 6 >> The comparative balance sheet o f JSA Ltd. at June 30, 2018, is as follows: JSA Ltd.'s 2018 income statement is as follows: Requireda. Calculate the various accruals on an item-by-item basis. For each accrual indicate the extent to which t hat accrual may contain a discretionary component and briefly explain why.b . Briefly describe two other ways that researchers have used to estimate discretiona
Answer Preview: a. The various accruals for JSA Ltd. are as follows: Check: Net income $(12) Net income-decreasing accruals 19 Cash flow from operations $7 Students often deduct from net income a $1 accrual for the i…

, Chapter: 2 -Problem: 22 >> The following supplemental RRA information is taken from the 2019 annual report of HL Oil & Gas Ltd. Requireda. Prepare an income statement for 2019 on an RRA basis.b. Use the concepts of relevance and reliability to explain why the standardized measure is not applied to unproved reserves in RRA.c. Explain why present value calculations for oil and gas reserves lay down a mandatory 10 percent disc
Answer Preview: a. HL Oil & Gas Ltd. Income Statement from Proved Oil and Gas Reserves For the Year 2019 Expected ne…

, Chapter: 9 -Problem: 21 >> You are engaged by the owner of a small firm to recommend a one-year compensation contract for the firm's top manager. She is concerned about cash flow and feels that in previous years the manager may have been shirking.You ascertain that if the manager works hard (a1), the firm's ultimate cash flow from current year operations will be one of $338 or $142 (before manager compensation) with probabi
Answer Preview: a. If the manager works hard, his expected utility is: where k is the managers share of net income. If the manager is to accept the contract, his expe…

, Chapter: 2 -Problem: 3 >> Explain why expected net income is also called "accretion of discount."
Answer Preview: Expected net income is also called accretion of discount be…

, Chapter: 3 -Problem: 16 >> Sonja, a rational investor, has $2,500 to invest for one year while she completes her professional accounting designation. She is contemplating investing the full amount in shares of Northeastern Oil & Gas Ltd. (a1) or in a risk-free government bond yielding an annual return of 1.96% (a2).Sonja identifies two states of nature:State H: Northeastern has high future cash flow.State l: Northeastern ha
Answer Preview: a. Sonjas expected utilities based on her prior probabilities: Sonja should take a 1 and buy the Nor…

, Chapter: 2 -Problem: 15 >> Undoubtedly Corp. operates under ideal conditions of certainty. It acquired its sole asset on January 1, 2019. The asset will yield $725 cash at the end of each year from 2019 to 2021, inclusive, after which it will have no market value and no disposal costs. The interest rate in the economy is 5 percent. Purchase of the asset was financed by the issuance of common shares. Undoubtedly Corp. will p
Answer Preview: a. Present value of capital asset 2019, 2020, and 2021 Undoubtedly Corp. Balance Sheet As at December 31, 2019 Cash ($725 - $50) $675 00 Shareholders' …

, Chapter: 7 -Problem: 18 >> Vulture Ltd. is incorporated to invest in risky securities. On January 1, 2019, the company buys Volatile Ltd. bonds with a par value of $10,000. Vulture plans to hold these bonds until they mature in two years, on December 31, 2020. The bonds pay 5 percent interest, paid on December 31 of each year.Volatile Ltd. is in financial distress, and payment of interest and principal on December 3 1, 2020
Answer Preview: a. Under ideal conditions of uncertainty, the amount paid for an asset equals its expected …

, Chapter: 2 -Problem: 16 >> P Ltd. operates under ideal conditions of certainty. It has just bought a capital asset for $2,800, which will generate $1,350 cash flow at the end of one year and $1,443 at the end of the second year. At that time, the asset will be useless in operations and P Ltd. plans to go out of business. The asset will have a known salvage value of $460 at the end of the second year. The interest rate in t
Answer Preview: a. Notes: 1. Cash = $1,350 00 cash flow - 72 60 (605 0 12) interest paid on bonds= $1,277 40 2. Book value of asset = PV end of year 1 = (1,443 + 460)…

, Chapter: 7 -Problem: 14 >> Manulife Financial is a large Canadian-based insurance and financial services company, with operations in Canada, United States, and Asia. The company reports on the basis of IASB standards. However, until 2014, it also reported the amount of its net income under FASB standards (see Theory in Practice 13.1). In 2014, Manu life discontinued reporting U.S. GAAP -based earnings, on the grounds that t
Answer Preview: a. The major difference, according to Manulife, between IASB-based and FASB-based net income of Manulife seems to be different methods of fair value accounting. Reporting core earnings as supplemental …

, Chapter: 9 -Problem: 9 >> Arthur's small business has grown to the point where he plans to hire a full-time manager. Arthur, an architect, has little inclination and ab il ity to manage a medium-sized, fast-growing business himself. He plans to semi-retire, devoting his working hours to consulting on issues of design and project management. Arthur's accounting system is quite simple. There is no R&D or other recognition la
Answer Preview: a. Denote working hard by a1 and shirking by a 2 . Yvonnes expected utility of each act is: Yvon…

, Chapter: 7 -Problem: 2 >> A technology company sells a complex computer program. It promises customers that it will provide updates and virus protection for three years from the date of sale. Upon signing the contract, the company records an account receivable for the full contract amount, and allocates 80 percent of this amount to current revenue, with the 20 percent remainder recorded as deferred revenue on the balance s
Answer Preview: a. Under the current IFRS 15 and ASC 606 standards, the company appears to be prematurely recognizing revenue on the computer program component of the …

, Chapter: 3 -Problem: 13 >> Stephen is a rational, risk-averse investor with $5,000 to invest for one year. He has decided to invest this amount in a high-technology firm and has narrowed his choice down to either AB Ltd. or XY Ltd. AB is a highly speculative firm with good prospects but no established  products. XY is a well-established firm with stable performance. The payoffs (net of amount invested) for each firm depend
Answer Preview: a. Stephen should take a 1 and invest in AB Ltd., the speculative fir…

, Chapter: 3 -Problem: 11 >> Tina has $3,000 that she wishes to invest for one year. She has narrowed her choices down to one of the following two actions:a1: Buy bonds of Risky Mining Ltd. The se pay 14.7% interest unless Risky goes bankrupt, in which case Tina will lose her principal and interest.a2: Buy savings bonds, paying 6.2% interest.Tina assesses her prior probability of Risky Mining Ltd. going bankrupt as 0.40. The
Answer Preview: a. The payoff table for Tinas decision is: Based on her prior probabilities and square root utility function, the expected utility of each act is: The…

, Chapter: 2 -Problem: 23 >> The following RRA information is taken from the December 31, 2019, annual report of AY Energy, Inc. Required a. Prepare an RRA income statement for AY Energy for 2019.b. AY Energy reports elsewhere in its annual report an (historical cost-based) operating loss from exploration and production for 2019 of $5,389. While this amount may exclude certain administrative cost allocations, take this operat
Answer Preview: a. AY Energy, Inc. Income Statement for 2019 Expected net income (accretion of discount) $ 520 Abnormal Earnings: Present value of additional reserves …

, Chapter: 5 -Problem: 18 >> OiiSands Petro Ltd reported its 2019 earnings on March 27,2020. Net income was a record $374 million, up from $191 million for the same quarter of the previous year. Return on equity was 25.7 percent, up from 10.1 percent a year earlier. Earnings for the year included an $80 million gain on sale of a surplus property. Cash flow for the year was $433 million, up from $270 million in the previous ye
Answer Preview: a. Closing OilSands share price, March 27, 2020 $37 35 Decline in share price for the day 1 25 Openi…

, Chapter: 9 -Problem: 14 >> Mr. O'Kay, a risk -neutral investor, is contemp lating a one-year, 8 percent loan of $750 to Firm J. Mr. O'Kay demands at least a 5 percent expected return per annum on loans like this. O'Kay is concerned that the firm may not be able to pay the interest and/or principal at the end of the year. A further concern is that if he makes the loan, Firm J may engage in additional borrowing. If so, O'Kay'
Answer Preview: a. The (net of amount loaned) payoff table is: State Payoff 1 $60 00 2 0 00 3 -750 00 Expected payof…

, Chapter: 7 -Problem: 7 >> Refer to Theory in Practice vignette 1.3, concerning the bankruptcy of New Century Financial. New Century had securitized and transferred to investors (i.e., derecognized) many (but not all) of its subprime mortgages, treating the transfers as sales. However, as the 2007-2008 market meltdowns developed, it was forced to repurchase many of these mortgages. Its provisions for credit losses on repurc
Answer Preview: a. One reason is as a form of credit enhancement. By retaining an interest, hence bearing some risk, the company demonstrated its commitment to the qu…

, Chapter: 12 -Problem: 14 >> Refer to the study by Bozanic, Roulstone, and Van Buskirk (2018) in Section 12.8.2. Requireda. Based on the results of their study concerning standalone future-oriented statements, do these statements constitute a signal? Explain why or why not.b. The authors also found that as firm uncertainty increased, managers made fewer quantitative earnings forecasts but supplied more qualitative future-orie
Answer Preview: a. The executive share purchase conveyed favourable inside information about the future prospects of …

, Chapter: 2 -Problem: 20 >> Contingent Corp. operates under ideal conditions of uncertainty. It has just purchased a new machine, at a cost of $3,575.10, paid for entirely from the proceeds of a stock issue. The interest rate in the economy is 8 percent. The machine is expected to last for two years, after which time it will have zero salvage value.The new machine is an experiment al model, and its suitability for use in Con
Answer Preview: In this problem, state probabilities are not independent ov…

, Chapter: 3 -Problem: 12 >> David has $2,500 that he wishes to invest for one year. He has narrowed his choices down to one of the following two actions:a1: Buy bonds of X Ltd., a company that has a very high debt-equity ratio. These bonds pay 8% interest, unless X defaults, in which case David will receive no interest but will recover his principal.a2: Buy Government Savings Bonds, paying 3% interest.David assesses his prio
Answer Preview: a. The payoff table for Davids decision is: Based on his prior probabilities and square root utility …

, Chapter: 3 -Problem: 9 >> Prudent plans to invest $6,000 in one of the following instruments:• Bonds of J ltd., yielding 12% (a1)• Canada Savings Bonds, yielding 9% (a2)On the basis of his knowledge of current economic conditions and the outlook for the industry of J ltd., Prudent assesses the prior probability that J l td. will go bankrupt as 0.05. If this happens, Prudent will lose both principal and interest and receive
Answer Preview: a. Denote buying the J Ltd. bonds as a 1 , and the Canada Savin…

, Chapter: 6 -Problem: 9 >> The 2018 IASB Conceptual Framework (Section 3. 7) has significant effects on how financial reporting is implemented. Requireda. The Framework drops the word "rational" as a description of investor and creditor decision-making. This description appeared in the original 1978 FASB Statement of Financial Accounting Concepts. Instead, in the 2018 Framework, the objective of financial reporting is to he
Answer Preview: a. The word rational may have been dropped due to the theory and evidence from behavioural finance, which suggests that investors on average are not f…

, Chapter: 12 -Problem: 16 >> XYl Ltd. is an owner-managed retail grocery store that went public on January 1, 2018. Afterward, Tom Jones, the fun-loving owner-manager, held 40 percent of the common stock and remained the chief executive of the company. Requireda. Why is it likely that Tom Jones will shirk more after the firm goes public, relative to the time he was the owner-manager of the company prior to January 1, 2018? Wi
Answer Preview: a. Tom Jones will shirk more as a minority shareholder because prior to going public, he alone bore …

, Chapter: 2 -Problem: 19 >> SC Ltd. operates under ideal conditions of uncertainty. On January 1, 2019, it purchased a capital asset that will last for two full years and then will be retired with no salvage. The purchase price was financed with an issue of common stock. SC Ltd. plans to pay no dividends until after the end of 2020. The interest rate in the economy is 6 percent.SC Ltd. is certain that net cash flow from its
Answer Preview: a. Under ideal conditions, the amount paid for an asset equals its present value: b. SC Ltd. Stateme…

, Chapter: 11 -Problem: 18 >> Valeant Pharmaceuticals International Inc. is a large Canada-based multinational drug company. Its shares are traded on the Toronto and New York stock exchanges. Valeant adopted an aggressive acquisitions strategy, purchasing numerous medical and drug companies and drastically raising the price of t heir products. For example, users of the drug Syprine faced an increase in the cost of a year's sup
Answer Preview: a. Some aspects of this strategy can be argued as good. Valeant was engaged in a vigorous policy of acquiring other drug companies. Numerous low-persistence costs would be incurred in the process, suc…

, Chapter: 7 -Problem: 5 >> Refer to Theory in Practice 7.1 reInco Ltd., discussing the failure of Inco to recognize impairment of its Voisey's Bay nickel mine prior to 2002. Current accounting standards in Canada require an impairment writedown if the book value of a cash -generating unit exceeds the higher of its value in use or net fair value. However, the events described in Theory in Practice 7.1 took place before Canad
Answer Preview: a. Yes, Inco should have recognized an impairment loss. The undiscounted cash flows from the mine were below book value for most of the time prior to …

, Chapter: 5 -Problem: 16 >> Pat, a rational investor, has $5,000 to invest for one year, pending a large purchase. She has narrowed her choice down to two investments. One (a1) is to invest the full amount in shares of Company X. The other (a2) is to buy risk-free government bonds yielding an annual return of 4.5 percent. Company X has little debt and its stock is low-beta.Pat identifies two states of nature:State H: Company
Answer Preview: a. Expected utility of each act, based on Pats prior probabilities: Pat should take a 1 . b. By Bayes theorem: Thus P(L | B) = 1- 0 18 = 0 82 Then, Pa…

, Chapter: 4 -Problem: 9 >> Refer to Theory in Practice 3.1, concerning Home Capital Group (HC), describing the issues faced by HC following public revelation of problems with its high-risk mortgage portfolio and its failure to disclose. Requireda. As noted in the vignette, HC 's share price fell significantly when its mortgage problems were revealed. Share price also fell when HC obtained its $2 billion line of credit from
Answer Preview: a. Prices under an efficient securities market will respond to new information as soon as the information becomes publicly known. The significant pric…

, Chapter: 2 -Problem: 17 >> EZ Sports Ltd. plans to manufacture cross-country skiing equipment. Its cash flows are highly dependent on the winter weather. EZ operates under ideal conditions of uncertainty. On August 1, 2019, the beginning of its first year in business, EZ acquires equipment to be used in its operations. The equipment will last two years, at which time its salvage value will be zero. The company finances the
Answer Preview: a. Expected present value of EZ Sports Ltds asset on August 1, 2019 and July 31, 2020: EZ Sports Ltd. Balance sheet As at July 31, 2020 Financial Asse…

, Chapter: 2 -Problem: 24 >> The following RRA information is taken from the 2019 annual report of Moonglo Energy Inc.Balance of proved reserves: beginning of year........................$ 1,010 Sales, net of production costs.........................................................(477) Sales of reserves in place.....................................................................(6) Accretion of discount.....................
Answer Preview: a. Moonglo Energy Inc. Income Statement for Proved Oil and Gas Operations For the Year 2019 RRA Basis Accretion of discount $135 Present value of additional reserves added during year 162 Unexpected i…

, Chapter: 10 -Problem: 18 >> Say-on-pay votes by shareholders are now quite common. Occasionally, shareholders' non-binding votes do not approve executive compensation. For example, in 2013, share holders of Barrick Gold Corp. rejected a large signing bonus to a new co-chairman (Theory in Practice 10.5). A second rejection followed in 2014 due to falling share price.In 2009, shareholders of Royal Dutch Shell pic voted against
Answer Preview: a. Whether say-on-pay is an advantage or disadvantage depends on which model of executive compensation is most descriptive of reality. If managerial l…

, Chapter: 11 -Problem: 2 >> If a manager "takes a bath" to manage reported earnings downwards, the probability of that manager receiving a bonus in a future year rises. Explain why.
Answer Preview: Taking a bath involves writing off assets against the current years operations, as in low…

, Chapter: 2 -Problem: 18 >> AltCoins Ltd. has just begun operating under ideal conditions of uncertainty. Its cash flows will depend on the state of the economy. On January 1, 2019, the company acquired plant and equipment that will last two years, with a nil salvage value. AltCoins financed the plant and equipment purchase by issuing common shares.In 2019, net cash flows will be $800 if the state of the economy is good and
Answer Preview: a. Under ideal conditions, the amount paid for an asset equals its expected present value. Expected present value of AltCoinss assets on January 1, 20…

, Chapter: 2 -Problem: 21 >> On January 1, 2019, Drill Deep Ltd. started its business by purchasing a productive oil well. The proved oil reserves from the well are expected to generate $8,000 cash flow at the end of 2019, $7,000 at the end of 2020, and $6,000 at the end of 2021. Net sales is gross revenues less production costs. Net sales equals cash flows. On January 1, 2023, the oil well is expected to be dry, with no envi
Answer Preview: a. Present value at January 1, 2019: Present value at December 31, 2019, based on revised estimates: …

, Chapter: 12 -Problem: 24 >> Refer to Theory in Practice 12.2 concerning Mark's Work Wearhouse, Ltd. As noted there, Mark's did not publish an earnings forecast for 1992, a year for which it was expecting a loss. RequiredSuggest two possible reasons why the disclosure principle failed with respect to Mark's 1992 forecast. Theory in Practice 12.2The impact of bad news can be seen in the case of Mark's Work Wearhouse, Ltd., a l
Answer Preview: Suggested reasons why the disclosure principle failed for Marks for 1992: The model of Pae (2005) (Section 12 8 1) applies to non-proprietary informat…

, Chapter: 6 -Problem: 11 >> Refer to Theory in Practice 3.1 concerning Home Capital Group (HC), describing the issues faced by HC following public revelation of fraud problems with its high-risk mortgage portfolio. The vignette refers to the purchase, in June 2014 by Warren Buffett's Berkshire Hathaway Inc., of a 20 percent interest in HC shares for $9.55 per share and the rise of HC's share price to $19.00 the following day
Answer Preview: a. According to prospect theory, investors tend to hold on to loser securities, the reason being that the expected disutility of holding such securiti…

, Chapter: 9 -Problem: 11 >> Edison operates a small, fast-growing electronics business. His workload has expanded to the point where he decides to hire a full-time manager. He will then take one year off to travel, and on his return he will concentrate on the technical aspects of the business. Edison is negotiating with lily for the manager job. He ascertains that Lily is risk-averse, with utility for money equal to the squa
Answer Preview: a. Let the proportion of net income be x. Then, we want: b. To check, this profit share yields: If L…

, Chapter: 7 -Problem: 22 >> Refer to Theory in Practice 7.5, describing how The Blackstone Group proposed to account for the carried interest to be received from future earnings of unconsolidated firms it has invested in. Requireda. As a rational investor in the shares of Blackstone's initial public offering, would you find fair value accounting more or less decision-useful than historical cost accounting for the value of Bl
Answer Preview: a. Relevance is higher under fair value accounting than under historical cost accounting. From an asset perspective, the fair value of Blackstones carried interest option conveys information about the …

, Chapter: 9 -Problem: 10 >> New Horizons Co. is a high-tech firm whose owner does not have the required management expertise to run the firm. The owner wants to hire a manager with the required expertise. The continued success of New Horizons Co. depends crucially on how hard the new manager works.If the manager works hard (a1), firm net income will be $500 with probability 0.7 and $200 with probability 0.3. If the manager s
Answer Preview: The payoff table for New Horizons Co. is as follows: Managers Act a 1 (work hard) a 2 (shirk) Net In…

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