BU8101 Seminar 07 Group 3 Week 6 Seminar 5 solutions 1

BU8101 Week 6 Seminar 5

1. Problem 9.5B
During the current year, Omega Products Corporation incurred the following expenditures
which should be recorded either as operating expenses or as intangible assets. Explain.
If you view the expenditure as an intangible asset, indicate the number of years over which
the asset should be amortized. Explain your reasoning.
Intangible assets : Rights, privileges and competitive advantages that result from ownership
of long-lived assets that do not possess physical substance.
Examples : Software, patents, goodwill , trademarks, copyrights, licenses/franchise
Amortization : Systematic write-off to expense off the cost of intangible assets over their
useful life or legal life, whichever is shorter.
a. Expenditures were made for the training of new employees. The average employee
remains with the company for five years, but is trained for a new position every two
years.
Answer : Operating expenses
Although training expenditures do offer some prospects of economic benefits in subsequent
years, the existence and life span of these benefits are uncertain.
b. Omega purchased a controlling interest in a wallpaper company. The expenditure
resulted in recording a significant amount of goodwill. Omega expects to earn aboveaverage returns on this investment indefinitely.
Answer : Intangible asset
Goodwill is an intangible asset.
It represents the present value of future earnings in excess of what is considered normal.
It cannot be amortized as it has indefinite life. Rather, it is tested annually for impairment.
c. Omega incurred large amounts of research and development costs in developing a
superior product. The company expects that it will be patented and that sales of the
resulting products will contribute to revenue for at least 40 years. The legal life of
the patent, however, will be only 20 years.
Answer : Operating expenses
Research and development costs are included as an expense.
Refer to Lecture note 5, slide 6.

BU8101 Seminar 07 Group 3 Week 6 Seminar 5 solutions 2

d. Omega made an expenditure to acquire the patent on a whatsa. The patent had a
remaining legal life of 10 years, but Omega expects to produce and sell the product
for only four more years.
Answer : Intangible asset
Patent is an intangible asset.
The number of years to be amortized: 4 years
e. Omega spent a large amount to sponsor the televising of the World Series. Omega's
intent was to make television viewers more aware of the company's name and
product lines.
Answer : Operating expense
Sponsorship is kind of an advertisement expense.
Why are advertising costs regarded as an operating expense?
Advertising costs are recorded as an expense and not an asset due to the problem of
measuring the future value of an advertisement. The future economic value necessary for
reporting it as an asset is hard to quantify.
2. From Problem 10.8B
a. Define liabilities. Identify several characteristics that distinguish liabilities from
owners equity.
Liabilities are debts that represent negative future cash flows for an entity.
It is also defined as an obligation of the entity arising from past transactions or events, the
settlement of which is expected to result in an outflow of resources.
Examples : Accounts payable, notes payable, accrued liabilities/accrued expenses, deferred
revenues/unearned revenues
Liabilities

Owners Equity

Has a maturity date.

No maturity date.

There is contractual, legal obligation to pay

regular interest and repay principal sum
when due.

There is no legal obligation to pay dividend

unless it is declared by the Board of
Directors.

Creditors of business.

Owners of business.

BU8101 Seminar 07 Group 3 Week 6 Seminar 5 solutions 3

Involves outflow of cash through repayment

of principal and regular interest.

Involves inflow of cash through share

issue.

Risk of default or creditors forcing company

into bankruptcy.

No risk of bankruptcy.

No excess funds.

Excess funds can be reinvested.

Interests paid to creditors are deductible

from income taxes.

Dividends paid to shareholders are not

deductible from income taxes.

b. Prepare a listing of the companys current and long-term liabilites as they should be
presented in the companys December 31 balance sheet.
Current liabilities
: Maturity = 1 year or less
Long-term liabilities : Maturity > 1 year
In installment cases, the principal amount due within one year is regarded as a current
liability, and the remainder of the obligation is classified as a long-term liability.
OCBC Bank 5-year, 10 percent note payable. 5 equal yearly installments.
$1,000,000 matures in the first year. => Current liabilities, under Note Payable
$4,000,000 is the remaining portion. => Long-term liabilities, under Note Payable
DBS Bank note payable due within 3 months. However, the company has confirmed
arrangements with the bank. Assuming all office paperwork has been done,
$500,000 => Long-term liabilities, under Note Payable
Refer Lecture note 6, slide 24
For income taxes,
$100,000 are currently payable => Current liabilities, under Income taxes Payable
$100,000 is the remainder deferred indefinitely => Long-term liabilities
Current liabilities :
Notes Payable

$1,000,000

Accounts Payable

160,000

Interest Payable

250,000

Income taxes Payable

100,000

Unearned Revenue

200,000

Total current liabilities

$1,710,000

BU8101 Seminar 07 Group 3 Week 6 Seminar 5 solutions 4

Long-term liabilities :
Bonds Payable

5,000,000

Notes Payable

4,500,000

Income taxes Payable

Total long-term liabilities

Total

100,000
$9,600,000

$11,310,000

c. Briefly explain why you have excluded any of the listed items in your listing of
current and long-term liabilities.
5. Interest expense arising from note payable to OCBC Bank over the next 12 months.
Not included as it is not accrued. Interest on the principal is due semi-annually on December
31st and June 30th respectively.
6. Ace has been sued for $300,000 in a product damage case, Legal counsel can make no
reasonable estimate of the companys ultimate liability at the date of the balance sheet.
Since no reasonable estimate of the ultimate liability can be made, contingent liability
cannot be accounted for. Instead, a note can be disclosed in the financial statement under
Contingent Loss.
7. Signed a 3-year commitment to Mr. John Ho as Chief Operating Officer at a salary of
$200,000 per year.
Not included as the salary expense is not accrued. It relates to future events and,
therefore, is not a liability at the present time.
3. Shareholders Equity
RM Companys ordinary shares is currently selling on SGX at $20 per share, and its balance
sheet as its fiscal year-end, 31 December 2012 shows the following shareholders equity
section.
Preference shares 5% cumulative
1,000,000 shares issued and outstanding

$ 000
10,000

Ordinary shares
4,000,000 shares issued and outstanding

8,000

BU8101 Seminar 07 Group 3 Week 6 Seminar 5 solutions 5

Retained earnings
Total shareholders equity

81,000
$99,000

a. What is the current market value of RMs ordinary shares?

Current market value of ordinary shares = $20 X 4,000,000
= $80,000,000
b. RMs last dividend payment was for the year ended 31 December 2010. What is the
book value per share of ordinary shares as at 31 December 2012?
Book value per share =

Total shareholders equity*______

Number of ordinary shares outstanding

*Preference shares and preferred dividends in arrears are deducted from the total
shareholders equity.
Dividends in arrears = 5% X $10,000,000
= $500,000
Total shareholders equity = $99,000,000 $10,000,000 2($500,000)
= $88,000,000
Number of ordinary shares outstanding = 4,000,000
Book value per share = $88,000,000/4,000,000
= $22
*2 years = Year 2011 and current year (Year 2012)
c. Is book value per share the amount ordinary shareholders should expect to receive if
RM were to cease operations and liquidate? Explain.
No. The book value per share amount may not be what is received if RM were to cease
operations and liquidate.
What the shareholders may receive is the assets liquidation value, which can be lower than
the book value per share amount.
d. If the board of directors declares cash dividends of $4,000,000 for the year ended 31
December 2012, what total amount will be paid to the preference shareholders and

BU8101 Seminar 07 Group 3 Week 6 Seminar 5 solutions 6

to the ordinary shareholders? What is the amount of dividends per share for the
ordinary shares?

December 31, 2012

Preference

Ordinary

$4,000,000 dividends declared

Dividends in arrears (for Year 2011)

500,000

Current preferred dividend

500,000

Remainder to ordinary shareholders

Totals

1,000,000

3,000,000

3,000,000

Total amount paid to ordinary shareholders/outstanding ordinary shares in the market =

dividends per share for the ordinary shares
Amount of dividends per share for ordinary shares = $3,000,000/4,000,000 = $0.75
e. Assuming in December 2012, the company reported a net loss of $3,000,000 and
paid no dividend.
(i)

Draft a note to accompany the financial statements disclosing any dividend in

arrears at end of 2012.

Note to Financial Statement:

As of December 31, 2013, dividends on the 5%, $10 par value cumulative preferred stock
were in arrears to the extent of $0.5 per share, amounting in total to $ 500,000.
*In part (d), the board of directors declares cash dividends of $4,000,000 for the year ended
31 December 2012.
(ii)

Do the dividends in arrears appear as a liability of the corporation as of the end

of 2013? Explain.

Dividends in arrears do not appear as a liability unless it is declared.

f. Identify two reasons a corporation may choose to issue cumulative preference
shares rather than finance operations with long term debt.
Heavy burden with long-term liabilities.
There is a contractual obligation to repay principal amount when due as well as to pay
regular interest. However, there is no obligation to pay dividends unless it is declared by the
Board of Directors.
Interest payable vs Dividends

BU8101 Seminar 07 Group 3 Week 6 Seminar 5 solutions 7

Company growth may be restricted.

Company with larger liabilities are considered to be more risky by banks and creditors.