MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 6
CASH FLOW ANALYSIS
I. Questions
1. Purposes of the Statement of Cash Flows
a. To predict future cash flows
b. To evaluate management decisions
c. To determine the ability to pay dividends to shareholders and
interest and principal to creditors
d. To show the relationship of net income to changes in the
businesss cash.
. Comparative balance sheets present the financial position of the enterprise
at two points in time. The income statement for the period between the
two balance sheets describes how the income!producing activities affected
the financial position. "ecause cash flows from operating activities may
differ substantially from net income# and because numerous other
financing and investing activities have an impact on financial position# the
statement of cash flows is necessary. The statement emphasi$es changes
in the cash balances that result from changes in assets# liabilities and
e%uity accounts caused by operating# investing and financing activities.
&. The most important source of cash for many successful companies is from
operating activities. ' large positive operating cash flow is a good sign
because it means funds have been internally generated with no fi(ed
obligations or commitment to return such to anybody.
). It is possible for cash to decrease during a year when income is high
because cash may be used not only for operating activities but also for
investing and financing activities.
*. Transactions involving accounts payable are not considered to be
financing activities because such transactions are used to obtain goods
and services rather than to obtain cash. Furthermore# purchases of goods
and services relate to a companys day!to!day operating activities.
+. The loss is added bac, to net income to avoid double counting since the
entire proceeds from the sale -net boo, value minus loss on sale. will
appear as a cash inflow from investing activities.
/. Three categories of transactions that may result in increases in cash are
6-1
Chapter 6 Cash Flow Analysis
a. 0perating activities
b. Investing activities -e.g.# sale of investments or other assets..
c. Financing activities -e.g.# borrowing or sale of stoc,..
These activities are sources of cash when cash is increased as a result of
the particular activity.
1. Three categories of transactions that may result in decreases in cash are
a. 0perating activities
b. Investing activities -e.g.# purchase of investments or other assets..
c. Financing activities -e.g.# repayment of debt or retirement of stoc,..
These activities are uses of cash when cash is decreased as a result of the
particular activity.
2. 3oncash transactions do not provide or consume cash even though they
may result in significant changes in financial position. 4(amples are the
issuance of share capital for plant assets and the conversion of debt or
preference shares into ordinary shares. Such transactions are not
presented in the body of the statement of cash flows but rather disclosed in
a separate schedule as financing or investing activities.
15. 6hile net loss is usually associated with a decrease in cash# it may be a
source of cash if noncash e(penses are greater than the amount of the net
loss. For e(ample# if a net loss of P155#555 included amorti$ation and
depreciation of P1*#555 and no noncash revenues e(isted# cash provided
by operating activities would be P*#555# computed as follows7
3et loss P-155#555.
'dd7 4(penses not re%uiring cash 8 depreciation
and amorti$ation 1*#555
3et cash provided by operating activities P *#555
11. The change in cash is the difference between cash at the beginning and end
of the accounting period. The net amount of cash provided by or used in
operating# investing and financing activities must e%ual this change in
cash. For e(ample# if cash increased by P1*5#555 during the year# total
sources from operating# investing# and financing activities must e(ceed
total uses by P1*5#555. 'lso# if cash decreased by P*#555 during the
year# total uses of cash must e(ceed total sources by P*#555.
1. -a. The use of cash does not occur until the cash dividend is actually paid
in the ne(t period. The declaration of the dividend does affect
financial position# however# and should be disclosed as a noncash
financing activity in a separate schedule accompanying the statement
of cash flows.
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Cash Flow Analysis Chapter 6
-b. "ecause the dividend was declared and paid in the same accounting
period# it appears in the statement of cash flows as a cash decrease in
the financing activities category.
1&. 9isagree. The refunding of 15: debt by the 1: debt represents a
significant financing activity# even though the net impact of the e(change
on the balance sheet or on the amount of cash is not material. The
issuance of 1: bonds and the retirement of 15: bonds should be reported
as noncash financing transactions in a schedule accompanying the
statement of cash flows.
1). The net income figure includes P1*5#555 as an e(pense. 0nly P11#*55
of this amount resulted in a decrease in cash# because P&/#*55 represents
an increase in the deferred income ta( liability account. In determining
cash provided by operating activities# the amount of income ta( paid is
P11#*55 -direct method.. 'lternatively# under the indirect method#
P&/#*55 must be added to net income to determine cash flows from
operating activities.
1*. The loss is omitted when listing e(penses re%uiring cash payment -direct
approach. or added bac, to net income -indirect approach. in determining
cash provided by operating activities. This eliminates the impact of the
transaction from cash provided by operating activities. Then# the proceeds
from the sale are included as a source of cash in the investing activities
category of the statement of cash flows. 'ny ta( effects of the transaction
are included in the ta( e(pense figure and remain a part of cash flows
from operating activities.
II. Problems
!ro"le# 1
Transaction Operating Investing Financing Source Use
1. Short!term investment
securities were
purchased
.....................................
; ;
. 4%uipment was
purchased ; ;
6-$
Chapter 6 Cash Flow Analysis
.....................................
&. 'ccounts payable
increased
.....................................
; ;
). 9eferred ta(es
decreased
.....................................
; ;
*. <ong!term bonds were
issued
.....................................
; ;
+. 0rdinary shares were
sold
.....................................
; ;
/. Interest was paid to
long!term creditors
.....................................
; ;
1. ' long!term mortgage
was entirely paid off
.....................................
; ;
2. ' cash dividend was
declared and paid
.....................................
; ;
15. Inventories decreased. . . ; ;
11. 'ccounts receivable
increased
......................................
; ;
1. 9epreciation charges
totaled P55#555 for
the year
......................................
; ;
!ro"le# (Anal%sis o& Cash 'lo( Transa)tions)
Requirement (a)
The eight items should be presented in the statement of cash flows as follows7
1. 3et income is the basis for the calculation of cash flows from operating
activities by starting with that number and ad=usting for noncash revenue
and e(pense transactions -indirect method. or by computing by the direct
method the positive cash flows from revenues# less the negative cash flows
from e(penses. The cash flows from the transaction giving rise to the
e(traordinary loss is reclassified as an investing activity.
. The ac%uisition of intangibles is a negative cash flow from investing
activities. The amorti$ation is a noncash e(pense in determining cash
flows from operating activities.
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Cash Flow Analysis Chapter 6
&. The payment of a cash dividend is a negative cash flow that is presented
in the financing activities section of the statement.
). The purchase of treasury stoc, is a negative cash flow in the financing
activities section of the statement.
*. The depreciation e(pense recogni$ed during the year is a noncash e(pense
in determining cash flows from operating activities.
+. The conversion of convertible bonds into ordinary shares is a noncash
financing activity that re%uires disclosure in a separate schedule.
/. The changes in plant asset accounts 8 land# e%uipment# and building 8
represent activities whose cash flow effects are presented in the investing
activities section of the statement.
1. The increase in wor,ing capital also represents the change in cash because
all other current assets and current liabilities remained constant. The net
of all cash flows from operating# investing and financing activities must
reconcile with the change in cash in the statement of cash flows.
Requirement (b)
1. 3et cash provided by operating activities
3et income P1)*#555
3oncash e(pense ad=ustments7
9epreciation e(pense )+#*5
'morti$ation e(pense +#555
>eclassification of e(traordinary loss 1*#555
P1#*5
. 3et cash used in investing activities
Purchase of intangible assets P -&)#555.
Purchase of land -1&5#555.
Purchase of e%uipment -+5#555.
Purchase of building -155#555.
Sale of land 1+*#555
P-1*2#555.
&. 3et cash used in financing activities
Purchase of treasury stoc, P-&1#555.
Payment of dividends -1#*55.
P-)&#*55.
Computations7
9epreciation e(pense
Change in accumulated depreciation account P&*#555
6-+
Chapter 6 Cash Flow Analysis
'ccumulated depreciation on fully depreciated
assets disposed 11#*5
P)+#*5
Purchase of land
Change in land account P -*5#555.
Cost of land sold in condemnation proceedings 115#555
P1&5#555
!ro"le# $ (Cash 'lo( &ro# Operatin, A)ti-ities)
Cash received from customers7
Total revenues P11*#555
<ess7 3ote receivable -1*#555. P1/5#555
Cash disbursed for e(penses7
Total e(penses -P1/&#555 ? P)#55. P1//#55
<ess7 Income ta(es deferred -1#+5.
9epreciation -*#555.
'morti$ation -/#555. -1)&#2)5.
3et cash provided by operating activities P +#5+5
!ro"le# * (Cash 'lo( &ro# Operatin, A)ti-ities)
Cash received from customers
-1.
P*#&/#555
Cash paid for e(penses7
Cost of goods sold P&#1*5#555
Selling )+#555
Salaries and wages
-.
&2)#)55
Interest
-&.
+*#55
@iscellaneous operating *#555
Incomes ta(es
-).
&&*#555 )#12*#+55
3et cash provided by operating activities P1#5)1#)55
Computations7
1. >evenue from sales P*#)&#555
<ess7 3ote receivable -15#555.
<and -/*#555.
P*#&/#555
. Salaries and wages e(pense P )55#555
<ess7 Increase in accrued salaries and wages
-P)*#+55 8 P)5#555. -*#+55.
P &2)#)55
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Cash Flow Analysis Chapter 6
&. Interest e(pense P /#555
<ess7 9iscount amorti$ation -+#155.
P +*#55
). Income ta( e(pense P ))*#555
<ess7 9eferred portion -115#555.
P &&*#555
!ro"le# + (State#ent o& Cash 'lo(s !reparation . In/ire)t)
Areen Tea Company
Statement of Cash Flows
For the Bear 4nded 9ecember &1# 55*
Cash flows from operating activities
3et income
C
P1#*55
'd=ustments to reconcile net income to net
cash flows provided by operating activities7
9epreciation 1#555
'morti$ation of intangibles 1#555
Increase in current assets -+#555.
Increase in current liabilities &#555
3et cash provided by operating activities P/#*55
Cash flows from financing activities
9ividends paid -1#*55.
>etirement of long!term liabilities -1#555.
3et cash used in financing activities -#*55.
3et increase in cash P *#555
Cash# Danuary 1# 55* 15#555
Cash# 9ecember &1# 55* P1*#555
!ro"le# 6 (Cash 'lo( State#ent !reparation . 0ire)t)
Requirement (a)

Eundred 'cre Company
Statement of Cash Flows
C
Increase in retained earnings -P5#555 8 P1&#555. P/#555
9ividends declared 1#*55
3et income P1#*55
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Chapter 6 Cash Flow Analysis
For the Bear 4nded 9ecember &1# 55*
Cash flows from operating activities
Cash received from customers P/)#555
Cash paid for e(pense +/#555
3et cash provided by operating activities P/#555
Cash flow from investing activities
Sale of e%uipment 2#*55
Sale of investments 1*#555
'c%uisition of e%uipment -*&#555.
3et cash used in investing activities -1#*55.
Cash flows from financing activities
Sale of ordinary shares )5#555
Payment of cash dividends -1#*55.
3et cash used in financing activities &1#*55
3et increase in cash P15#555
Cash# Danuary 1# 55* 5#555
Cash# 9ecember &1# 55* P&5#555
>econciliation of net income to net cash provided
by operating activities7
3et income P1*#555
'd=ustments to reconcile net income to net
cash provided by operating activities7
9epreciation e(pense )#*55
C
'morti$ation e(pense 1#555
Increase in accounts receivable -&&#555.
9ecrease in accrued e(penses -*55.
3et cash provided by operating activities P /#555
Computations7
Cash received from customers7
>evenues P15/#555
9educt7 Increase in accounts receivable
-P/1#555 8 P)*#555. &&#555
P /)#555
Cash paid for e(penses7
4(penses P 2#555
'dd7 9ecrease in accrued e(penses
C
3et increase during 55* -P&&#+55 8 P/#155. P +#*55
'ccumulated depreciation on assets sold 11#555
9epreciation e(pense for 55* P)#*55
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Cash Flow Analysis Chapter 6
-P/#*55 8 P/#555. *55
9educt7 9epreciation e(pense
-P&&#+55 8 P/#155 ? P11#555. -)#*55.
'morti$ation -1#555.
P +/#555
Cash from sale of e%uipment7
Cost P /#*55
9educt7 'ccumulated depreciation -11#555.
Cash received on sale at boo, value P 2#*55
Cash paid to ac%uire e%uipment7
Increase in property# plant and e%uipment
-P111#155 8 P2#+55. P *#*55
Cost of machinery sold /#*55
P *&#555
Cash received on sale of stoc,7
Increase in ordinary shares amount
-P155#555 8 P/*#555. P *#555
Increase in additional paid!in capital account
-P**#555 8 P)5#555. 1*#555
P )5#555
Cash dividends7
Increase in retained earnings -P1#555 8 P1)#*55. P +#*55
3et income -P15/#555 8 P2#555. -1*#555.
P 1#*55
Requirement (b)
The reconciliation of net income to net cash provided by or used in operating
activities is re%uired to be disclosed in order to show more clearly the
relationship and emphasi$e the differences between the two. Fsers of financial
statements are often not as aware of the accrual concepts# which determine net
income# as are preparers of those statements. The reconciliation of net income
to net cash flows from operating activities clearly demonstrates that the two
are different and details those events and transactions that account for the
difference.
!ro"le# 1 (Interpretation o& Cash 'lo( State#ent)
Requirement (a)
The two companies are simiar in the following respects7
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Chapter 6 Cash Flow Analysis
1. 0verall si$e.
. Industry in which they operate.
&. Current ratio -.) to 1..
). 0verall peso amounts of cash provided and used7
>ange# 55!55*
Cash Provided Cash Fsed
4bony Company P1*#555 8 P1+1#555 P11*#555 8 P1/5#555
Ivory Company P1&*#555 8 P1+5#555 P1*#555 8 P1+*#555
*. 3et increase in wor,ing capital is identical for each year# 55 8
55*.
Requirement (b)
The two companies are dissimiar in the ma,eup of the sources of cash# as
indicated in the following analysis7
Sources of Cash in Percentages
55 55& 55) 55*
4bony Ivory 4bony Ivory 4bony Ivory 4bony Ivory
Cash provided7
0perations 15 &/ // 1 /5 -&1. /+ /
<ong!term debt 1 *+ !! 15 !! )) 2 !!
Share capital !! !! 1+ * !! +& !! *+
'sset disposition 1 / / 1/ &5 &1 1* &/
155 155 155 155 155 155 155 155
4bony Company has relied much more heavily on operations to provide cash
and to a very limited e(tent on debt and e%uity financing and asset disposition.
0n the other hand# Ivory Company has not been able to provide cash from
operations and has been re%uired to rely on the alternatives of debt and e%uity
financing and asset disposition.
Requirement (c)
4bony Company is in a considerably stronger position -as determined by the
data given. and thus should be considered the better investment and credit ris,.
The following points are significant7
1. 4bony Company has provided /5:!15: of its cash via operating
activities# supplementing with other means to maintain a current ratio
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Cash Flow Analysis Chapter 6
at the industry average. 4bony has not had to rely consistently on any
alternative source of funding.
. Ivory Company has apparently been forced to rely continuously on
debt financing e(cept in 55*# perhaps because of the inability to
obtain such financing. The year 55) is particularly wea, for Ivory#
with operations resulting in a P+5#555 reduction in cash. The ability
of Ivory to sustain its present financial position -i.e.# current ratio#
etc.. is %uestionable in light of its history.
III. Multiple Choice Questions
1. 9 ). 9 /. C 15. "
. C *. " 1. " 11. '
&. 9 +. 9 2. ' 1. 9
6-11