Solutions to Seminar 6 Questions by S07 Group 2

8/17/2019 Solutions to Seminar 6 Questions by S07 Group 2

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Seminar 6Josephine Toh

Kok May Chew

Man JieNg Yong ChengXu Zhi Sheng


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Purpose of statement of cash flows• Provide information about the cash receipts and

cash payments of an entity.

• Describe how they relate to an entity’s investing,operating and financing activities.

• Allows readers to asses the liquidity of the business and evaluate its ability to generatepositive future cash flows


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Direct and Indirect methodsDirect method

- This shows the specific cash inflows and outflows

comprising of the operating activities of the business.

Indirect method

- The computation begins with the accrual-basedincome and makes adjustments necessary to arriveat the net cash flows from operating activities.

* Both methods eventually result in the same amountof net cash flows from operating activities.


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Direct Method


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Indirect Method


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Question 1


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Question 1 An analysis of the annual financial statements ofConner Corporation reveals (A) to (J):

In the computation of net cash flows fromoperating activities by the indirect method, explain

whether each of the above items should be addedto pre-tax income, deducted from pre-tax incomeor omitted from the computation. Briefly explain your reasons for each answer.


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(A) The Company sustained a $5

million loss as a result of atyphoon that destroyed the factorybuilding.

• Added $5m to pre-tax income because it is anon-operating loss, which is part of investingactivity. This reduces the net income (net

income < net cash flow) so we must add back theloss to determine the net cash flows fromoperating activities.


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(B) Amortization of patent for the

year amounted to $8 million.

• Added $8m to pre-tax income because it is anon-cash expense . This reduces the net income(net income < net cash flow) so we need to add back the expense to determine the net cash flowsfrom operating activities.


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(C) During the year $2 million of cash

was transferred from the company’schecking account to buy treasury bills.

• Omitted from computation of pre-tax income because it is just a transfer of cash to treasury bills (cash equivalent), so it doesn’t affectincome


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(D) Credit sales during the year

amounted to $200 million. Cashreceived from customers during theyear amounted to $188 million.

• Deducted $12m from pre-tax income because thereis an increase in noncash current asset account.Hence Sales revenue = $200m > Cash collected =$188m. Increase in Accounts Receivables means

increase in Sales Revenue which increases netincome (net income > net cash flow) so we mustdeduct increase in account receivables to determinethe net cash flows from operating activities.


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(E) Prepaid expenses decreased by

$1 million over the year

• Added $1m to pre-tax income. Decrease inprepaid expenses (current asset) means increasein operating expense. This reduces the netincome (net income < net cash flow) so we must

add decrease in prepaid expenses to determinethe net cash flows from operating activities.


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(F) Inventories at the beginning of

the year were $5 million and atthe end of the year the physicalcount were $6 million.

• Deducted $1m from pre-tax income because it isan increase in noncash current asset account.Increase in Inventory means purchase > COGS.

When COGS is understated, net income isoverstated (net income > net cash flow) Deduct increase in inventory to determine netcash flow from operating activities.


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(G) Advance deposits from

customers increased by $4 millionover the years.

• Added $4m to pre-tax income because it is anincrease in liabilities. Increase in UnearnedRevenue means Cash collected > Revenue, hence

Net cash flow > Net income

Add increase inliabilities to pre tax income to put net income ona cash basis.


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(H) Cash paid for purchases

amounted during the yearamounted to $60 million.

• Omitted from computation because purchases isalready included in the computation of pre taxincome, so we don’t have to add again.


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(I) Dividends declared during the

year amounted to $7 million;dividend paid during the yearamounted to $5 million.

• Deducted $5 million from pre-tax income because dividends is a special disclosure itemunder FRS7.

• Changes of dividend payable is excluded.• Compute actual dividend paid and reflect as cash

flow.


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(J) The Company accrued $2

million of income taxes for theyear but only paid $1.8 millionduring the year.

• Deducted $1.8 million from pre-tax income because it is a special disclosure item underFRS7.

• No need to add back income tax expense.• Compute actual income tax paid and reflect as

cash flow.


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Question 2


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Question 2

• The accounting staff of Best Company has assembled thefollowing information for the year ended December 31,2011

• (Figure on the next slide)

• Prepare a statement of cash flows in the formatillustrated in Exhibit 13-1. Place brackets aroundamounts representing cash flows. Use the direct methodof reporting cash flows from operating activities.

• Some of the items will be listed in your statement without change. However, you will have to combinecertain given information to compute the amounts of (1)collections from customers (2) Cash paid to suppliersand employees, and (3) proceeds from sales of plantassets.

Cash sales $230 000


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Cash sales $230,000

Credit sales $3,450,000

Collections on accounts receivable $2,810,000

Cash transferred form the money market fund to the general bankaccount

$200,000

Interest and dividends received $40,000

Purchases (all on account) $1,822,000

Payments on accounts payable to merchandise suppliers $1,220,000

Cash payments for operating expenses $930,000

Interest paid $130,000

Income taxes paid $65,000

Loans made to borrowers $690,000

Collections on loans (excluding receipts of interest) $300,000

Cash paid to acquire plant assets $1,700,000Book value of plant assets sold $520,000

Loss on sales of plant assets $30,000

Proceeds from issuing bonds payable $2,000,000

Dividends paid $250,000

Cash and cash equivalents, Jan. 1 $115,000


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Cash received from Customers

Cash received from customers:

Cash sales $230,000

(Add) Collection on Accounts receivable 2,810,000

Cash Received from customers

$3,040,000


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Cash paid to suppliers and employees:

Payments on accounts payable to merchantsuppliers

1,220,000

Cash paid for operating expenses 930,000

Cash paid to suppliers and employees $2,150,000

Cash paid to Suppliers &Employees


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Cash flows from Operating ActivitiesCash flows from operating activities

Cash Received from customers $3,040,000

Interest and Dividends Received

40,000

Cash provided by operating activities $3,080,000

Cash paid to suppliers and employees $(2,150,000)

Interest paid (130,000)

Dividends paid (250,000)

Income taxes paid (65,000)

Cash disbursed for operating activities (2,595,000)

Net cash provided by operating activities

485,000


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Proceeds on sale of plant assets

Proceeds on sale of plant assets

Book value of plant assets sold $520,000

Less: Loss reported on sales of plantassets

(30,000)

Proceeds on sale of plant assets $490,000


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Cash flows from Investing Activities

Cash flows from investingactivities

Loans made to borrowers $(690,000)

Collections on loans 300,000

Cash paid to acquire plantassets

(1,700,000)

Proceeds on sale of plantassets

490,000

Net cash used for investingactivities

$(1,600,000)


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Cash flows from Financing activities

Cash flows from financing

activities

Proceeds from issuing bonds payable $2,000,000

Net cash provided by financingactivities

$2,000,000


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Cash Flow Statement


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Question 3


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(3A) The following selected balance sheet andincome statement data and additional

information for Kings & Co. are presented below.Balance Sheet Data 2010 2009Accounts receivable $120,000 $150,000

Inventories 56,000 50,000

Accounts payable 38,000 70,000

Notes payable 10,000 20,000

Tax payable 3,000 2,000

Retained earnings 76,000 40,000

Income Statement Data 2010

Depreciation 8,000

Net income before tax 62,000

Tax expense 6,000

Gain on sale of equipment ?


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Additional information:

(1) The only items affecting retained earnings in 2010

were net income and dividends declared and paid.(2) Equipment with a cost of $30,000 and an

accumulated depreciation of $12,000 was sold for$22,000 during 2010.

Required(a) Prepare the operating activities section of a

statement of cash flows for Kings & Co. for 2010using the indirect method and in accordance withFRS 7.

(b) Management of Kings & Co. is exploring ways toincrease the cash flows from operations. Describeand explain ways that cash flows from operationscould be increased.


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Gain on sales of equipmentCost $30 000

Accum. Depr. at date of disposal 12 000

Book value at date of disposal (30 000- 12 000)= 18 000

Cash received 22 000

Gain 4 000

Non operating gains must be deducted from pre-taxincome to avoid double counting as sales figure of$22,000 is already reflected in the cash flow forinvesting activities.


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Balance Sheet Data 2010 2009

Accounts receivable $120,000 $150,000



Notes payable 10,000 20,000Tax payable 3,000 2,000



Depreciation 8,000


Tax expense 6,000


Balance Sheet Data 2010 2009

Accounts receivable $120,000 $150,000



Notes payable 10,000 20,000Tax payable 3,000 2,000



Depreciation 8,000


Tax expense 6,000


The following selected balance sheet and incomestatement data and additional information for Kings &Co. are presented below.

(3) Non-Cash Current Assets

(3) Non-Cash CurrentLiabilities

(4) Separate Disclosureitem under FRS7

(2) Non-cash Expenses

Retained Earnings – Net

Income = Dividend Paid[(4) Separate Disclosure

item under FRS7]


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(4) Separate Disclosure item under

FRS7 - Dividend Paid

• Ending Retained Earnings – Beginning Retained

Earnings = Net Income - Dividend Paid

• Dividend Paid =

$40 000 + ($62 000 - $6 000) - $76 000

= $20 000


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Statement of Cash Flow forOperating Activities

Cash flows from Operating Activities

Pre-tax income $ 62 000

Adjustments to reconcile net income to net cash provided byoperating activities

Decrease in Accts Receivable (150k – 120k) 30 000

Increase in Inventory (56k – 50k) (6 000)

Decrease in Accts Payable (70k – 38k) (32 000)

Depreciation Expense 8 000

Gain on sale of equipment (4 000)

Income tax paid (6 000 - 1 000) (5 000)

Dividends paid (20 000)

Net cash provided by operating activities 33 000

Tax Paid =Tax Expenses– Increase intax payable


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(3B) Management of Kings & Co is exploringways to increase the cash flows from

operations. Describe and explain ways thatcash flows from operations could beincreased


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Reducing the size of inventory• Reduces the need for purchasing merchandise,

but only while inventory levels are falling

• Once the company stabilizes the size of itsinventory at the new and lower level, its monthlypurchases must return to approximately thequantity of goods sold during the period

• The increase in cash flow only increases net cashflows of the current period, there will be notmuch effect on future cash flows Notsustainable


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Increase frequency of collection ofAccounts Receivables• Initially: 60-day credit

▫ Credit sales made in January will only be collected in

March Collect 1 month’s amount of credit sales• Now: 30-day credit, from March

▫ In April: collecting 2 month’s amount of credit sales(Feb under the old terms and March under the new

terms)▫ Thus, only significantly increase the cash for the

month of April and does not signal higher cash flowsfor the months ahead Not sustainable, one time.


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Deferring income taxes• Using accelerated depreciation on income tax

return Greater depreciation expense

• Reducing taxable income in current years, inexchange for increased taxable income in future years

• Postpone payment of taxes to the later years ofthe asset’s life

• Reflecting an increase in the value of the asset


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Question 4


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Financial data from three competitors in the sameindustry are listed in the table below. Explain and discuss

which of the three competitors is in the strongestpositions as shown by its statement of cash flows.


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PENGUIN CO.


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WHY PENGUIN? • Based solely on the cash flow statement, Penguin co.

appear to be in the strongest cash flow position• Although all three competitors have the same net

increase in cash - $36,000,000,• Penguin co. provided $80,000,000 by operatingactivities, which was the most among three.

• Unlike Bear co; Penguin co. did not sell assets togenerate cash and it did not further borrow any debts.

• Penguin co. was able to invest $28,000,000 in operatingassets which was the most among three.

• After Penguin co. repaid its debts, it still remained thesame net increase in cash as other two competitors.


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HOWEVER ..• In order to make a fair judgment and conclusion,

we must look at :

1.Income Statement2.Balance Sheet


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PENGUIN CO.• Highest cash flow among the 3, but might have

incurred huge expenses, which will only be

shown in Income Statement• Able to repay debt, but might have more

outstanding debts which will only be shown inBalance Sheet

Hence we need to look at all 3 statements to makea good comparison. Or else, Penguin CO. seems to be in the strongest position.


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FUN TIME!!!


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THANK YOU!

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Solutions to Seminar 6 Questions by S07 Group 2