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Financial Reporting & Analysis
Chapter 16 Solutions
Statement of Cash Flows
Exercises
Exercises
E16-2. Determining cash flows from operations
(AICPA adapted)
Lino’s net cash from operating activities is calculated below:
Net income $150,000
Increase in accounts receivable1 (5,800)
Decrease in prepaid rent 4,200
Increase in accounts payable 3,000
Cash flow from operations $151,400
1
The increase in accounts receivable is net of the allowance for doubtful accounts:
Beginning accounts receivable $23,000
Less: Beginning allowance for doubtful accounts (800)
Beginning net accounts receivable $22,200
Ending accounts receivable $29,000
Less: Ending allowance for doubtful accounts (1,000)
Ending net accounts receivable $28,000
Increase in net accounts receivable:
Ending net accounts receivable $28,000
Beginning net accounts receivable (22,200)
Increase in net accounts receivable $5,800
E16-3. Cash flows from operations
(AICPA adapted)
Requirement 1:
Calculate accrual basis net income for December:
Sales revenue $350,000
Cost of goods sold (70% of sales) (245,000)
Gross profit (30% of sales) 105,000
Selling, general, and administrative expenses
Fixed portion = $35,000
Variable portion = 15% $350,000 = 52,500 (87,500)
Net income (accrual basis) $17,500
Requirement 2:
Adjust accrual basis income to obtain cash flows from operations:
Accrual basis net income $17,500
- Increase in gross trade accounts receivable (10,500)
- Increase in inventory (5,000)
+ Charge for uncollectible accounts (1%$350,000) 3,500
+ Depreciation expense included in S, G&A 20,000
Cash flows from operating activities $25,500
E16-5. Cash flows from investing and financing activities
(AICPA adapted)
Requirement 1:
Net cash flows from operating activities are computed as follows:
Net income $300,000
+ Depreciation 52,000
- Gain on sale of equipment (5,000)
Cash flows from operating activities $347,000
713
Requirement 2:
Below is the computation for cash flow from investing activities:
Sale of equipment1 $18,000
Purchase of equipment2 (20,000)
Cash outflow from investing activities ($2,000)
1
Computation of cash from sale of equipment:
Cost of equipment $25,000
Accumulated depreciation (12,000)
Book value of equipment sold 13,000
Gain on sale of equipment 5,000
Amount of cash received in exchange for equipment $18,000
2
Computation of cash paid for equipment:
Cost of new equipment $50,000
Less: amount paid with note payable (30,000)
Cash paid for equipment $20,000
714
Financial Reporting & Analysis
Chapter 16 Solutions
Statement of Cash Flows
Problems
Problems
P16-1. Determining cash provided (used) by operating, investing and financing
activities
(AICPA adapted)
Requirement 1:
Cash flows provided by operating activities:
Net Income $690,000
Increase in inventory ($80,000)
Increase in accounts payable 105,000
Gain on sale of investment1 (35,000)
Goodwill amortization2 10,000
Depreciation expense3 250,000
$250,000
Cash flows from operations $940,000
1
Gain on sale of investment is determined as follows:
Proceeds from sale of investments (given) $135,000
Less: Book value of investment sold
($300,000 - $200,000) (100,000)
Gain on sale of investment $35,000
2
Goodwill amortized is equal to change in the goodwill account for the year =
$100,000 - $90,000 = $10,000
3
Depreciation expense recorded in year 2000 is determined from an analysis of the
accumulated depreciation T-account.
Accumulated Depreciation
$450,000 Beginning balance
Accumulated depreciation X Depreciation expense for year
on equipment sold* $250,000
$450,000 Ending balance
*Cost of equipment sold = $400,000
Less: Carrying value (150,000)
Accumulated depreciation $250,000
715
Solving for depreciation expense amount X in T-account
$450,000 + X - $250,000 = $450,000
X = $250,000 = Depreciation expense for year 2000
Requirement 2:
Cash flows used in investing activities:
Sale of equipment $150,000
Sale of long-term investment 135,000
Purchase of plant assets 4 (1,100,000)
Purchase of short-term investments (300,000)
Cash outflows from investing activities ($1,115,000)
4
Cash payments for plant assets is obtained from an analysis of the plant assets
T-account:
Plant Assets
Beginning balance $1,000,000 $400,000 Cost of equipment sold
Purchase of additional assets X
Ending balance $1,700,000
Solve for X:
$1,000,000 + X - $400,000 = $1,700,000
X = $1,100,000 = Purchase of plant assets
Requirement 3:
Cash flows provided by financing activities:
Dividends paid ($240,000)
Sale of common stock5 220,000
Short-term debt 325,000
Cash flows from financing activities $305,000
5
10,000 shares @ $22/sh. = $220,000
Proof: (Not required)
Cash from operating activities $940,000
Cash used for investing activities (1,115,000)
Cash from financing activities 305,000
Net increase in cash $130,000
716
P16-5. Preparation and analysis of cash flow statement
Requirement 1:
Statement of cash flows under indirect method:
Global Trading Company
Statement of Cash Flows
For the Year Ended December 31, 1996
Cash flow from operations
Net loss for the year ($279,500)
+ Depreciation expense 50,000
+ Goodwill written off 70,000
+ Decrease in net accounts receivable 240,000
+ Decrease in inventory 170,000
+ Decrease in prepaid insurance 20,000
+ Increase in accounts payable 78,000
+ Increase in salaries payable 6,000
Cash flow from operations $354,500
Cash flow from financing activities
Repayment of bank loan ($307,500)
Dividends paid1 (35,000)
Cash flow from financing activities ($342,500)
Net increase in cash $12,000
1
Calculation of dividends
Beginning retained earnings $320,000
- Net loss for the year (279,500)
- Ending retained earnings (5,500)
= Dividends paid $35,000
Requirement 2:
Assessment of financial performance of Global:
Net loss for the year is an indication of poor operating performance.
Positive cash flow may be misleading since cash flow does not do a good job
of matching revenues and expenses.
Goodwill written off is from an acquisition made last year indicating that the
potential benefits from the acquisition have been exhausted.
717
Decrease in accounts receivable coupled with a decrease in inventory is an
indication of decreasing demand. A mere change in the collection policy
cannot explain the reduction in inventory.
Increase in accounts payable could indicate that the company is not paying
off its suppliers because of the constraint on bank loan.
The repayment of the bank loan probably is not voluntary but enforced by the
debt covenants.
Payment of dividends when the company is incurring substantial losses is
not a sign of prudent financial management and drains the cash reserves of
the company.
Ratio of accumulated depreciation to property, plant, and equipment of 0.9
(last year was 0.8) implies that, on average, the life of the fixed assets is one
year and the company needs to invest in these assets immediately.
Requirement 3:
Determination of bad debts written off can be obtained from T-account analysis
of the allowance for doubtful accounts:
Allowance for Doubtful Accounts
$30,000 Beginning balance
55,000 Bad debt expense
Accounts written off X
$20,000 Ending balance
Solve for X:
+ $55,000 - X = $20,000
X = $65,000 = accounts written off in 1996.
Determination of credit sales for the year can be obtained from T-account
analysis of accounts receivable:
Accounts Receivable
Beginning balance $300,000
$65,000 Bad debts written off (see preceding page)
Sales on account X 1,250,000 Collections on account
Ending balance $50,000
Solve for X:
$300,000 + X - $65,000 - $1,250,000 = $50,000
X = $1,065,000 = sales on account.
718
Requirement 4:
Effect of omission of inventory purchase:
Income Statement
No effect. (Purchases are understated, and ending inventory is understated by
equal amounts. Thus, net effect on income is zero.)
Statement of Cash Flows
No effect. (Purchase was on account for credit.)
Balance Sheet
The balance sheet balances, but the year-end amounts for both accounts
payable and inventory are understated by $35,000.
719
Financial Reporting & Analysis
Chapter 16 Solutions
Statement of Cash Flows
Cases
Cases
C16-1. Q-Mart Retail Stores, Inc. (KR): Analysis of statement of cash flow
Requirement 1:
Q-Mart Retail Stores, Inc.
Statement of Cash Flows for the Year Ended 12/31/98
Cash Flow from Operating Activities:
Net income $81,250
+ Depreciation expense–building 25,000
+ Depreciation expense–computer 35,000
- Increase in net accounts receivable (361,000)
- Increase in inventory (275,000)
- Increase in prepaid insurance (20,000)
- Decrease in salaries payable (32,000)
- Decrease in accounts payable (5,000)
+ Increase in income tax currently payable 7,000
Cash flow from operations ($544,750)
Cash Flow from Investing Activities:
Additions to building ($250,000)
Purchase of computer equipment (140,000)
Cash flow from investing activities ($390,000)
Cash Flow from Financing Activities:
Borrowing from Upstate Bank $200,000
Proceeds from stock issuance 390,000
Dividends paid (40,000)
Cash flow from financing activities $550,000
Change in cash balance (384,750)
+ Beginning cash balance 504,750
Ending cash balance $120,000
720
Calculation of dividends:
Beginning balance of retained earnings $341,750
Add: Net income 81,250
Less: Ending balance of retained earnings -383,000
Dividends paid $40,000
Requirement 2:
Bad debts written off = beginning balance of allowance for doubtful accounts +
bad debts expense - ending balance of allowance for doubtful accounts
= $11,000 + $50,000 - $50,000
= $11,000
Requirement 3:
Cash collected = beginning balance of accounts receivable + sales - bad debts
written off (from above) - ending balance in accounts receivable
= $100,000 + $1,500,000 - $11,000 - $500,000
= $1,089,000
Requirement 4:
Purchases of inventory = ending balance of inventory + cost of goods sold -
beginning balance of inventory
= $350,000 + $1,050,000 - $75,000
= $1,325,000
Requirement 5:
Cash paid = beginning balance of accounts payable + purchases (from above)
- ending balance of accounts payable
= $17,000 + $1,325,000 - $12,000
= $1,330,000
Requirement 6:
Cash flow from operations is the main reason for the decline. The increase in
accounts receivable is a good signal if it is commensurate with growth in sales.
On the other hand, it could suggest collection problems as well as inadequate
provision for doubtful accounts. There is also an increase in inventory. This
could be positive news if the buildup is in anticipation of demand. Again, this
721
could be negative if the obsolete items have not been written down. The
investment in property, plant, and equipment is financed by loan and equity.
Additional information required:
What is the sales increase over last year?
By how much have the purchases increased over the last year?
Why haven’t the suppliers extended credit with the rise in purchases?
What is the change in net income over last year?
Requirement 7:
If the sales had been stopped, the net income would be lowered, and,
therefore, the cash flow from operations would decline ultimately. What is
necessary is to reduce the average collection period for accounts receivable
and speed up the collection process.
Requirement 8:
Depreciation is a noncash item and is added back to the net income. Therefore,
even if higher depreciation had been provided, the amount that is added to the
net income would have been originally subtracted from revenues to determine
net income and, consequently, would not affect the cash flow.
Requirement 9:
Matching is an important feature of accrual accounting that is lacking in the
cash flow statements. However, accruals are subject to greater managerial
discretion. See answer to reasons for decline as an example of jointly analyzing
the two statements.
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