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```									                            Financial Reporting & Analysis
Chapter 16 Solutions
Statement of Cash Flows
Exercises

Exercises
E16-2. Determining cash flows from operations

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

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
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

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

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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

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Financial Reporting & Analysis
Chapter 16 Solutions
Statement of Cash Flows
Problems

Problems
P16-1. Determining cash provided (used) by operating, investing and financing
activities

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

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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
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

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P16-5. Preparation and analysis of cash flow statement

Requirement 1:
Statement of cash flows under indirect method:

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.

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 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
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.

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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.

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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:
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

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Calculation of dividends:
Beginning balance of retained earnings               \$341,750
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

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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.

 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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