Friedlan4e SM Ch05 Solutions

CHAPTER 5
Cash Flow, Profitability, and the Cash Flow Statement

QUESTIONS
Q5-1.
With cash accounting revenue is recognized when cash is collected and expenses are recognized
when cash is paid. Under accrual accounting, revenue is recognized when earned and expenses
are matched to the related revenue. With accrual accounting a transaction or economic event can
be recognized in the accounting system before, after, or at the same time as cash is exchanged.
Q5-2.
Net income isnt equal to cash from operations because net income is calculated on an accrual
basis whereas cash from operations is based solely on cash flows. What this means is that accrual
based net income captures events beyond simply the exchange of cash. Net income involves the
calculation of two items revenues and expenses. When calculating revenues, accrual based
accounting looks at when the revenue is earned the exchange of cash isnt the determining
factor in the recognition of revenue. For expenses accrual based accounting examines when the
economic sacrifice occurs, not when cash is paid. Net income captures all economic events (that
are measurable) and cash from operations captures cash flows from daily business activities.
Q5-3.
The cash flow statement provides information to stakeholders that isnt available from the other
financial statements about the cash inflows and disbursements. The statement provides important
information for assessing the liquidity of the entity. The information in the cash flow statement
helps stakeholders understand the sources and uses of cash, which helps them assess the ability
of the company to generate cash to meet the cash requirements in the future. For example, if cash
from operations is negative, the company will need to continually borrow or raise more equity.
The information is very important for assessing the liquidity of an entity and can give important
clues about an entitys ability to survive.
Q5-4.
a.
The payables deferral period is the interval from the time goods are received from a
supplier until the supplier is paid.
b.
The inventory self-financing period is the interval from the payment of a supplier for
inventory until the inventory is sold to customers and the cash is collected.
c.
The inventory conversion period is the interval from the time goods are received from a
supplier until the inventory is sold to a customer.
d.
The receivables conversion period is the interval from the sale of inventory to a customer
until the cash is collected from the customer.
Q5-5.
Cash from operations is the cash an entity generates from or uses in its regular business
activities. Cash inflows from operations include cash collected from customers along with other
receipts of cash that are related to operations. Cash outflows from operations include cash
payments made to generate operating cash inflows and operate the normal business activities of
the entity, for example, payments to suppliers and employees. If the amount is negative, the
John Friedlan, Financial Accounting: A Critical Approach, 4th edition
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Copyright 2013 McGraw-Hill Ryerson Ltd.
regular business activities of the entity have consumed more cash than it has generated. CFO is
useful to stakeholders because it provides them with information on regarding the cash that the
entity is using and generating through its everyday operations.
Q5-6.
Depreciation isnt a source of cash for the company. The indirect method calculates cash from
operations by reconciling from net income to cash from operations. Net income is adjusted for
items included in the calculation of net income but that have no effect on cash flow. Because
depreciation is a non-cash expense, its added back in the indirect calculation of cash from
operations.
Q5-7
Liquidity refers to the availability of cash or the ability to convert assets to cash to meet
obligations and is a short-term concept. Cash, investments in shares of public companies, and
accounts receivable (usually) are liquid. Land, building, equipment, and intangible assets arent
liquid as they cant be converted to cash quickly. Solvency is an entitys long-term viability and
its ability to pay its long-term debts. An entity would be insolvent if its liabilities are greater than
its assets or if it will be unable to repay loans that are coming due. Both are important for an
entitys long-term survival. Its possible for an entity to be liquid but not solvent. For example, a
company may have a large cash balance that will cover its current liabilities, but it could have
significant amounts of long-term debt that are larger than its assets. It could also be solvent but
not liquid, with assets exceeding liabilities but little cash and other liquid assets to meet current
obligations.
Q5-8
Its important that stakeholders are aware of an entitys liquidity because if an entity isnt liquid
it will be unable to pay wages, suppliers, or any liabilities that come due. Without cash or the
ability to raise cash (convert assets to cash, issue equity, borrow), an entity cant survive. It could
take out a bank loan or use a line of credit to bridge gaps in cash shortfalls, however this is only a
temporary solution. If a company doesnt have enough liquidity it will be unable to meet
financial obligations as they become due.
Q5-9.
Both income and cash flow are important to the shareholder. The value of the firm is dependent
on the expectation of future profit, but the survival of the firm is dependent on its ability to meet
its financial obligations as they become due. Profit is intended to provide a broader measure of
economic performance than is cash flow while cash flow is a better indicator of liquidity. The
two interests of the shareholder, risk and return, are informed by profit and cash flow.
Q5-10.
Depreciation is added back to net income when calculating cash from operations using the
indirect method because it has been deducted in calculating net income but it doesnt involve
cash.

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Q5-11.
Gains/losses are subtracted/added back to net income when calculating cash from operations
using the indirect method because gains and losses dont represent cash flows. Gains/losses are
the difference between the proceeds from the sale of certain assets and the carrying amount of
those assets. The cash received from the sale of the assets is reported in the cash flow statement
as an investing activity.
Q5-12.
When a company has negative cash from operations, the cash collected from customers is less
than the amounts paid out to suppliers, employees and other operating cash costs. The reasons for
negative cash from operations can be growth of the business, poor economic conditions, or
increased competition that is slowing business (slowing collection of receivables or increase in
the inventory conversion period). Its a cause for concern if its expected to continue because
cash reserves or inflows from other sources (new debt or equity, sale of assets) must be available
to fund operations (simply being in business is consuming cash) as well as to pay for any
investments in capital assets or required repayments of debt. Negative cash from operations will
be a concern because there must be sources of cash available to finance operations and other
requirements. Even an entity with very favourable prospects can be in serious trouble if it doesnt
have access to the cash it needs to operate and meet its short-term obligations as they arise. It
may be difficult to arrange long-term financing and the firm may find itself unable to meet shortterm obligations as they arise. The cause of negative cash flow from operations may be good
news, such as sales growth or expansion (cash might have to be invested in inventory and/or
receivables), but the consequence might not be good for the company.
Q5-13.
Both cash flow and income are important to management. However, the short-term consequences
of cash flow problems are more serious than those of low profitability. A company can continue
to operate without profits; it cant operate if it cant pay suppliers and employees. A lack of cash
threatens the ability of the entity to survive. Thus management can never ignore the cash needs
of the entity. However, in the longer term an entity must also be profitable.
Q5-14.
The three types of activities that are reported in a cash flow statement are (many other examples
of each category are possible):
Operating activities: the cash that an entity generates from and consumes in its ordinary, day-today operations. For example, buying inventory that is sold to customers or used in the
manufacture of the entitys products. This is an operating activity because inventory is directly
used in the main business activity of the entity. Other examples are sales to customers, salaries
paid to employees, utilities, selling and marketing costs, and so on.
Investing activities: cash an entity spends on buying capital and other long-term assets and the
cash it receives from selling those assets. For example, if an entity purchases a building to base
its manufacturing facility, head office, or retail operations, this is an investing activity because
the building is a long-term capital asset that will contribute to revenue generation over time.
Interest and dividend payments can be classified as operating or investing activities under IFRS.

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Financing activities: cash an entity raises and pays to equity investors and lenders. For example,
if an entity sells equity to investors, this is a financing activity because equity is a way of
financing an entity. Interest and dividend payments can be classified as operating or financing
activities under IFRS.
Q5-15.
New businesses require cash outflows to get the business up and running. This requires the
purchase of any capital assets (that cant be partially or fully financed) and to pay operating costs
such as inventory and supplies, pay employees, rent, utilities, advertising and promotion, and
other operating expenses. These cash outflows occur before cash inflows from customers begin.
The entity must have adequate cash or access to cash to finance the start-up period. Even for a
well-planned new business things may not go according to plan (start-up costs may be greater
than expected or the business may not build as quickly as planned). In these cases, the business
may be in trouble or may fail if its unable to get the cash it needs. The cash lag poses the
greatest difficulties during the start-up and growth periods because of the need for cash inflows
and the uncertainty when the business will begin to generate adequate cash.
Q5-16.
Cash from operations can be calculated and reported by the direct method or the indirect method.
The direct method subtracts cash paid to employees, suppliers and other operating cash flows
from cash received from customers. The indirect method begins with net income and adjusts for
non-cash transactions and economic events that are included in the calculation of net income and
adjusts for operating cash flows (through balance sheet accounts) that arent included in the
calculation of net income (off income statement cash flows). The direct method has the
advantage of providing information that would not otherwise be available to the users of the
financial statements and users can see the amount of cash spent for various activities (wages,
advertising, etc.). The indirect method links the cash flows to the income statement and shows
why net income and operating cash flow differ. The preferable method is up to the particular
stakeholder although the direct method is usually more understandable and intuitive, and
provides information that is otherwise not available in the financial statements.
Q5-17.
Under IFRS, managers can classify interest paid as cash from operations or as a financing cash
flow (cost of borrowing). If interest is classified as CFO, it might make the company look
stronger as any interest paid isnt being reflected as an operating cash outflow (thus operations
will seem better able to cover expenses). If classified as a financing cash flow the interest cash
flows will be categorized in the same manner as the cash flows of the principle which the interest
is paid on. Students may express preference for any of the options but explanation of their choice
should be provided. An example of a suitable answer would be: Categorizing interest cash flows
as financing/investing is my preferred alternative as it intuitively matches the categorization of
interest cash flows to the cash flows of the principle amount.
Q5-18.
In its simplest form, the cash flow statement can be constructed from the balance sheet and
income statement. For the statement of cash flow to be useful, it must provide information
beyond what can be obtained elsewhere in the financial statements. That is why the direct
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method to cash flows from operations is usually more informative than the indirect method
because information that isnt readily available elsewhere in the financial statements is presented.
More generally, the cash flow statement provides additional information by indicating the
amount of capital assets bought and sold separately and the amount of long-term debt that was
retired and the amount that was raised in the period, as well as the amount raised issuing shares
or paid out redeeming shares.
Q5-19.
The cash cycle is the period of time from when the company starts with cash, purchases
inventory, supplies, and/or other inputs needed to do business, provides goods or services to
customers, and then collects cash from the customers. For a wine maker, assuming that the
grapes are purchased rather than grown, it would begin with the payment for the grapes and other
raw materials, payment to employees, acquisition of space to operate the winery, pay for utilities,
and so on. The cycle ends when the cash is collected when the wine is sold to customers,
potentially many years later because wine is usually aged. If the winery grows its own grapes,
the cycle is more complex because land must be purchased, vines planted, cared for and
harvested, and so on. What is important to recognize is that for a winery the cash cycle can be
very long, meaning that having a good reserve of cash or access to cash is essential for the
winery to survive.
Q5-20.
Not only is this possible, but its common for a growing company. When a company grows,
accounts receivable and inventories increase, which cause cash flow from operations to be less
than net income. In addition, many operating costs may increase in advance of the growth in
sales of the business (perhaps more people are hired in anticipation of the growth). Also the
company may finance long-term assets from operating cash flow or from cash reserves, rather
than arranging long-term financing, which would consume cash and reduce net cash flow.
Q5-21.
The company could have positive cash flow overall by issuing equity or long-term debt, or by
selling assets. The positive operating cash flow could occur if the entity has a substantial amount
of non-cash expenses such as depreciation, future income taxes, write downs or write offs, or
losses on disposal of assets. Cash from operations could also be positive even if the entity
reported a net loss if accounts receivable or inventory decreased or accounts payable increased
during the period.
Q5-22.
This change in policy will result in Calstock collecting cash from its customers more quickly if
they pay on time. This policy change will result in Calstocks cash from operations to increase.
This is because the sales Calstock makes towards the end of the year (mid-November to late
November) will be collected if customers pay on time. In previous years (2016 and prior),
Calstock gave 45 days to pay. If we assume most customers wait to pay until the 45 days is up,
that means sales made in mid to late November would not be collected until 2018. However, if
customers only had 30 days to pay, mid to late November sales would be collected by the end of
the year. Cash from operations in 2017 would increase as a result of the policy change.

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Q5-23.
The amount expensed for wages during a period isnt usually the same as the amount paid for
wages during a period because accrual accounting expenses employee costs when theyre earned
by employees, not simply when theyre paid. What is expensed for wages in a period is the
amount employees earned, regardless of when they get paid. To illustrate: Employees get paid on
the 15th of every month. The amount earned by employees in the last half of December wont be
paid until January 15, but the amount is expensed in December because the employees earned the
money during the month. Accrual accounting seeks to capture that fact (the earning of the wages)
and expenses these wages so they are reflected in the December 31, 2017 year-end. The idea is
that these employees helped to earn revenue so revenue should be matched to expenses. The
company also has a present obligation to pay the wages so a corresponding liability is created.
The difference between the amount paid in a period and the amount expensed is the difference
between the opening and closing balances in the wages payables account.
Q5-24.
The term cash includes cash in the bank as well as petty cash and other cash balances such as
the float maintained to provide change for cashiers. It can also include short-term liquid
investments if they are readily convertible to a known amount of cash and where there is little
risk that the amount of cash that will be received will change. Cash can also be netted against
bank overdrafts (the purpose here is that if the bank is used as way to manage cash it can be
included in the entitys definition of cash).
Q5-25.
An increase in accounts receivable means that the entity has provided more credit to customers
in the current year than it collected from customers who owed money at the end of the previous
year. These two amounts (beginning and ending accounts receivable) explain the difference
between accrual revenue and cash collected from customers. When accounts receivable increase
it means that revenue is greater than cash collected and if accounts receivable decrease it means
that cash collections are greater than revenues.
Q5-26.
Inventory decreases when inventory is sold but not replaced. As a result, a payment to a supplier
isnt required and cash is conserved. In other words, cost of goods sold is greater than the amount
spent on inventory. This answer assumes that inventory is purchased for cash. Payables make
things more complicated but the idea is the same: using up inventory that was purchased
previously (and not replaced) means that cash is conserved. As a result, cost of goods sold
(which is inventory sold) isnt fully a cash expense. It includes inventory paid for in previous
periods.
Q5-27.
Its not possible for managers to manipulate actual cash flows that have occurred when preparing
the cash flow statement. Manipulation of cash flows occurs through different actions rather than
accounting for the actions after they occur. Managers can manipulate cash flow by timing
transactions and payments. For example, managers can delay repairs and maintenance,
advertising, promotions, research, and so on, or even cancel these programs. These choices will
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have an impact on cash flow. Acquisition of and payments for capital assets could also be timed
to affect CFO. These manipulations could be much more serious than the accounting choices
made under accrual accounting because they actually affect the entitys business activities. The
components of cash (operations, investing, financing) will be affected by the accounting used for
certain expenditures. If expenditures are capitalized, the associated cash flow is classified as an
investing activity and if the expenditure is expensed as incurred, its classified as an operating
cash flow.
These decisions are much different from managements ability to influence accrual financial
statements. Managers can make reporting decisions that will have no bearing on the economic
activities of the business itself (ignoring stock prices, etc.). No matter what depreciation policy
or revenue recognition policy an entity chooses (policies related to accrual accounting), these
policies only change the way an entitys economic activities are reported they dont change the
underlying economic activity. The timing of transactions and payments are actions that can affect
the business activities. For example, if an entity delayed paying a large invoice until after yearend so as not to reduce the current years cash flow figures, late charges and negative reactions
from the supplier could occur.
Q5-28.
Net income is considered to be a better basis for assessing performance because it includes
revenue actually earned and expenses incurred rather than cash flows. In responding, one has to
consider what it is that managers should receive bonuses for. Net income is a broader economic
measure of success whereas cash flow is narrower. Cash flow tends to be more variable than net
income as well, which might make it less attractive as a basis for evaluating performance.
To reward a manager based on cash from operations would create an incentive to delay payments
to suppliers, postpone purchases of inventory, accelerate shipments to customers, delay
maintenance, and push for collections. To some extent, these are all desirable actions but, if taken
to an extreme, there will be detrimental effects on customer and supplier relations. In other
words, these choices could have severe operational consequences for the entity. Accrual
accounting mitigates the need to manage cash flows in this way but does introduce the
opportunity to make accounting choices that affect the amount of bonus.
Q5-29.
The primary objective served by the cash flow statement is cash flow prediction. If a company
consistently reports a positive cash flow from operations, investments in capital assets can be
made without additional debt or equity. The firm is less risky to creditors and shareholders if
cash flow from operations is positive. From this perspective, the information is useful for
assessing liquidity and the ability of an entity to pay dividends, a key concern for some investors.
The cash flow statement also provides stewardship information because it informs stakeholders
about how managers managed cash.
Q5-30.
Except for the cost of capital assets, expenditures made for research are expensed as incurred. By
reducing expenditures on research, net income and cash from operations increase since cash
payments are reduced. However, research is the lifeblood of biotechnology, software, or other
high-technology companies. Research provides new products that generate future revenues.
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Firms that cut research spending now may have no new products to replace the existing products
when they are obsolete. This is crucial for high-tech, biotechnology, and many other knowledgebased industries.
Q5-31.
The low earnings could be the result of many things including expensing as many items as
possible as opposed to capitalizing and depreciating these items, or by depreciating assets more
quickly. As the book has indicated, accrual accounting is flexible and the information can be
presented in a way that serves the objectives of the preparers. Management could have had the
objective of lowering net income to argue against a wage increase for its employees. The union
based its argument on the operating cash flows of the entityarguing that cash flow was a better
representation of the ability of the company to pay the employees more money without
jeopardizing the ability of the firm to continue in business. This position would assume that the
cash flows were reasonably reliable and predictable so that the cash flows would be available for
the duration of the contract. Of course, its important to remember that the union isnt unbiased
in this affair. Union leaders will try to interpret and bargain to maximize their own positions and
the position of the union membership.
The companys ability to pay would likely be suited to its cash from operations. Since employees
get paid in cash, it makes sense to base a companys ability to pay on their ability to generate
cash. If the entity has historically strong cash from operations and no information to refute this
trend from continuing, it might make sense to base decisions on cash from operations.
Management cant manipulate cash from operations to the same degree they can potentially
manipulate net income. If the union had solid evidence that the entitys cash flows would
continue for the duration of the contract, their argument would have validity. However, operating
cash flows arent only surplus. They have to be used to, for example, replace capital assets.
Q5-32.
Golf courses have a lot of upfront costs before the golf season gets going. Maintenance and
repairs have to be done to ready the course for use. If a golf course started the year in a weak
cash flow situation, it could find itself in a difficult situation as they have a lot of upfront costs
(employee wages and materials to beautify the course) and no real income until the weather is
warmer and the course is beautified and ready for play. Also, if a golf course had a particularly
wet and cold season, it could see its sales drop significantly. While this happens, it would have to
continue to spend money on the upkeep and maintenance of the course so it was still in good
shape for when the weather became more appropriate for golf. During increments of bad
weather, cash flow would suffer as maintenance costs would still exist while cash from sales
would suffer significantly.
Q5-33.
A growing business requires cash outflows to finance the growth. This is required for the
purchase of any capital assets (that cant be partially or fully financed) and to purchase inventory
and supplies, pay new employees, rent, utilities, advertising and promotion, other operating
expenses and so on needed to support the anticipated growth. These cash outflows occur before
the increased cash inflows from customers begin. The entity must have adequate cash or access
to cash to finance the growth phase. Even well-planned growth may not go according to plan
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(costs may be greater than expected or the growth may not occur as quickly as planned). In these
cases, the business may get into trouble or fail if its unable to get the cash it needs. The cash lag
poses the greatest difficulties during the growth period because of the need to expend cash and
the uncertainty as to when the business will begin to produce adequate cash flow.

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EXERCISES
E5-1.
a.
Payables deferral period (goods received - suppliers paid)
b.
c.
Inventory self-financing period (supplier paid - cash collected)

Average time fabric held in inventory (7 x 30)
Average time from first appointment to delivery
Average time from delivery to customer payment
Less: Payables deferral period (from part a)
Inventory conversion period (goods received inventory sold):
Average time fabric held in inventory
Average time from first appointment to delivery
30 days
210 days
45 days
20 days
(30 days)
245 days
210 days
45 days
255 days
d.
Receivables conversion period (inventory sold cash collected)
e.
Number of days between receiving inventory from suppliers and receiving cash from
customers:
Inventory conversion period
255 days
Receivables conversion period
20 days
275 days

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E5-2.
a.
Prior Year
Purchases
Per Month
Opening A/P
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
$360,000.00
$402,000.00
$425,000.00
$485,000.00
Total
$1,672,0
$120,000.00
$120,000.00
$120,000.00
$134,000.00
$134,000.00
$134,000.00
$141,666.67
$141,666.67
$141,666.67
$161,666.67
$161,666.67
$161,666.67
$1,672
$102,000.00
$102,000.00
$120,000.00
$120,000.00
$120,000.00
$134,000.00
$134,000.00
$134,000.00
$141,666.67
$141,666.67
$141,666.67
$161,666.67
$1,552
$445,000.01
$1,552
$204,000
Payments
Cash Paid Per
Quarter
$324,000.00
$374,000.00
$409,666.67
*Collections on opening A/P = 204,000/2months = $102,000 per month in Q1
b.
Prior
Year
Purchases
Per Month
Opening A/P
Payments
1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
$120,000.00
$360,000.00
$120,000.00 $120,000.00
$134,000.00
$402,000.00
$134,000.00 $134,000.00
Total
$425,000.00
$485,000.00 $1,672
$141,666.67 $141,666.67 $141,666.67 $161,666.67 $161,666.67 $161,666.67 $1,672
$102,000.00
$222,000.00
$120,000.00
$134,000.00 $134,000.00
$134,000.00 $141,666.67 $141,666.67 $141,666.67 $161,666.67 $161,666.67
$204,000
Cash Paid Per

Quarter
$120,000.00
$444,000.00
$388,000.00
$417,333.34
c.
Under the scenario in part b, McPherson had more of a cash outlay ($1,714,333.35) than they did in scenario a ($1,552,666.68). The reason is that in scenario b the suppliers credit
policy changed in 2018 so that McPherson had only 30 days to pay instead of 60 days. The first quarter of 2018 is why McPhersons payments in 2018 were so much higher. In
February, McPherson had to pay for goods purchased 60 days earlier in fiscal 2017 when the supplier offered 60 days to pay. Also in February, McPherson had to pay for goods

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$465,000.01
$1,714
$1,714
purchased in January 2018 as in 2018 they only had 30 days to pay the supplier. Februarys cash outlay for McPherson was higher by $120,000 under the new credit policy due to
McPherson having to pay December and January purchases in February.
d.
Prior Year
Purchases
Per Month
Opening A/P
Payments
1st Quarter
2nd Quarter
$120,000.00
$360,000.00
$120,000.00 $120,000.00
$134,000.00
$161,666.67
$120,000.00
$120,000.00
3rd Quarter
$134,000.00
$402,000.00
$134,000.00
$141,666.67
$134,000.00
$134,000.00
$134,000.00
4th Quarter
$141,666.67
$425,000.00
$141,666.67
$161,666.67
$161,666.67
$485,000.
$161,666.
$141,666.67
$141,666.67
$141,666.67
$161,666.67
$161,666.
161,666.67
Cash Paid Per

Quarter
$120,000.00
$401,666.67
$388,000.00
$417,333.34
*Collections on opening A/P = 204,000/2months = $102,000 per month in Q1
The amount in 2019 is lower than the amount paid in 2018. The reason is that McPherson had another payment to make in 2018 due to the change in credit policy in 2018 (February
involved payment of December and January purchases. The beginning A/P balance was higher in 2019 but by an amount less than the extra payments made in February.
Here is a breakdown of the difference:
2018 - $1,714,333.35
2019 - $1,672,000.00
Diff. $ 42,333.35
The extra $42,333.35 cash outlay in 2018 compared to 2019 can be explained by two items:
Extra payment in 2018
Less: Difference in first A/P payment ($161,666.67 $102,000)
$102,000.00
59,666.67
$42,333.33
The first payment in 2019 was higher than the one in 2018; however it was still lower than the extra payment that had to be made in 2018 due to the change in credit policy (60 days to
30 days).

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$465,000.
E5-3.
a.
Reported net income
Add: depreciation expense
Cash from operations
$200,000
30,000
$230,000
b.
Original reported net income
Add:
original depreciation expense
Deduct: new depreciation expense
New reported net income
Add:
new depreciation expense
New cash from operations
$200,000
30,000
(44,000)
$186,000
44,000
$230,000
The only difference between the two scenarios is accrual net income, which is $14,000 lower
because the depreciation expense is increased by $14,000 (from $30,000 to $44,000). Since
depreciation is a non-cash item, and all other revenues and expenses in both scenarios were in
cash, cash from operations is the same under both scenarios.
E5-4.
a.
Dr.
Loss due to write-off of assets (income statement -, RE -)
Cr.
Asset accounts (assets -)
b.
Net income
Add: depreciation expense
asset write-off
Deduct: increase in accounts receivable
increase in inventory
decrease in accounts payable
2,000,000
2,000,000
$7,400,000
556,000
2,000,000
(200,000)
(350,000)
(30,000)
$9,376,000
c.
i. Original net income
Add: asset-write off
New net income
ii. New net income
Add: Depreciation expense
Deduct: Increase in accounts receivable
Increase in inventory
Decrease in accounts payable
New cash from operations

Solutions Manual
$7,400,000
2,000,000
$9,400,000
$9,400,000
556,000
(200,000)
(350,000)
(30,000)
$9,376,000
Page 5-13
d.
The only difference between net income as originally reported by Hexham and c (i) is the
$2,000,000 asset write-off. By delaying the asset write-off in c(i), management increased
accrual net income by $2,000,000.
e.
There is no difference between cash from operations under b and c(ii). The reason is that
the only difference between the two scenarios is the $2,000,000 asset write-off, which is a
non-cash item and has no effect on cash flow. In b. the asset write-off was added back to
net income while in c(ii) it was not included in net income at all.
E5-5.
Item
a
b
c
Increase/Decrease
Decrease
e
f
g
h
i
j
k
Classification
Investing
No effect
Financing
Operating or
financing
Operating
Operating or
financing
Operating
No effect
Financing
Financing
Operating
No effect
No effect
l
m
n
o
p
Financing
No effect
Operating
Operating
No effect
Increase
Decrease ASPE
Decrease IFRS
Decrease ASPE
Decrease IFRS
Increase
Increase
Decrease
Decrease
Due to the extremely short maturity period, this would be
considered a cash equivalent
Increase
Increase
E5-6.
a.
This is an operating cash flow. Since Ashley is in the movie theatre business which
includes concession sales, collecting payment for selling goods falls within normal
operations for this entity. Since its a cash receipt, the item is an inflow. The amount of
the inflow is the amount of the cash sales, $150,000.
b.
Repayment of a bank loan is considered a financing cash flow. Since its a payment, this
is an outflow. The amount of the outflow is the repayment amount of $25,000.
c.
The payment of wages is an operating cash flow as its within the normal operating
activities of the entity. As its a payment, this item is a cash outflow. The amount of the
outflow is $100,000.

Solutions Manual
Page 5-14
d.
This is an operating cash flow as it relates to normal operations. Ashley is in the business
of selling movie tickets and giving refunds is a part of that process. This item represents a
cash outflow as she is making payments to customers. The amount of the outflow is
$5,000.
e.
Depreciation isnt a cash flow. Depreciation is an accrual concept intended to match the
cost of capital assets to the revenues they generate over their useful life. It has no effect
on cash; it only affects accrual net income. When using the indirect method, it should be
added back to net income when determining cash from operations.
f.
The old equipment sold by Ashley is capital assets; therefore, the cash received should be
classified as an investing cash flow. Since its a cash receipt, the item is an inflow. The
amount of the inflow is the amount received, $18,000.
In addition, when using the indirect method, the $5,000 loss should be added back to net
income when determining cash from operations. The reason is that the cash effect of the
sale is included in investing activities on the cash flow statement. This isnt a cash flow.
If the loss isnt removed from net income when determining cash from operations, a
$5,000 understatement will result. The loss is the amount the payment received for the
asset is less than the carrying amount: it doesnt reflect the actual cash flow arising from
the transaction.
g.
The new projection equipment is a capital asset and as such would be classified as an
investing activity. It represents a cash outflow since money left the entity to pay for the
assets acquired. The amount of the outflow would only be the amount paid to date,
$10,000.
h.
Advertising is an operating cash flow as it relates to a normal activity within Ashleys

business. Advertising is a cost incurred to sell more tickets. Its an outflow since cash
flowed to the advertising agency for their work performed in the amount of $15,000.
i.
Capital contributions represent a financing cash flow. Since Ashley has provided the
company with cash, this would be an inflow in the amount of the contribution: $20,000.
j.
This item can be classified in different ways depending on which accounting standards an
entity has adopted. ASPE would classify interest paid as an operating activity. However,
IFRS allows classification as either an operating or financing activity. This is a cash
outflow as money flows from the entity to the bank. The amount in this case is $10,000.

Solutions Manual
Page 5-15
E5-7.
a. Rent collected by Basanti represents an operating cash flow as its within its normal
operations. Basanti is in the business of providing housing and other services for seniors.
The item would represent a cash inflow of $900,000 as Basanti has received money for
the housing services provided.
b. The renovations to the dining room would likely be treated as a capital asset (betterment).
As such, this would appear as an investing activity on the cash flow statement
(renovations will contribute to Basantis revenue generating process for many years).
This is a cash outflow as cash was paid to the contractor for his services in the amount of
$48,000.
c. Dividends represent a financing cash flow as they are payments made to individuals who
invested in the company. Under IFRS dividends can also be classified as an operating
cash flow. The payment is an outflow of $25,000.
d. The borrowing of $100,000 from the bank is a financing activity as this money will help
finance Basantis operations. It represents a cash inflow since the bank has lent money to
Basanti in the amount of $100,000
e. The sale of old furniture is an investing cash flow as furniture would be considered a
capital asset. As Basanti has collected money on the sale, there would be a cash inflow of
$22,000. In addition, when using the indirect method, the $3,000 loss should be added
back to net income when determining cash from operations.
f. Carpet cleaning is an activity done in the regular course of business. Maintenance
performed on the building isnt a capital asset as these types of activities are done
regularly so they are operating activities. This is a cash outflow as money flowed from
the entity to the carpet cleaner in the amount of $2,500.
g. The payment of wages is an operating cash flow as it an activity that falls within
Basantis normal course of operations. This payment of employee wages is a cash
outflow in the amount of $175,000.
h. This purchase of new mattresses on credit has no effect on cash flow because no cash has
changed hands at this point in time.
i. Maintenance work represents an activity that is done in the regular course of business and
would be classified as an operating activity. The amount would be for the amount
purchased in the prior year. This would be a cash outflow as cash is paid to the business
that performed the maintenance services.

Solutions Manual
Page 5-16
E5-8.
Cash from (used by)
Operations
Investing activities
Financing activities
Net increase(decrease) in
cash
Company 1
$30,000
(13,500)
(13,500)
Company 2
$(36,000)
(24,000)
45,000
Company 3
$46,500
1,500
(30,000)
Company 4
$48,000
(30,000)
(18,000)
Company 5
$(15,000)
(15,000)
6,000
3,000
(15,000)
18,000
(24,000)
E5-9.
Increase/(decrease)
Net income
Accounts receivable on January 1, 2018
Accounts receivable on December 31, 2018
Inventory on January 1, 2018
Inventory on December 31, 2018
Accounts payable on January 1, 2018
Accounts payable on December 31, 2018
Depreciation expense
$437,500
1,375,000
1,562,500
1,750,000
1,525,000
1,187,500
1,437,500
262,500
Clarke Inc.
Cash From Operations - Indirect Method
For the Year Ended Dec. 31, 2018
Cash From Operations:
Net Income
Adjustments for non-cash items:
Depreciation (add)
$262,500
Changes in non-cash current operating accounts:
Accounts receivable
(187,500)
Inventory
225,000
Accounts payable
250,000
Cash From Operations
$437,500
187,500
(225,000)
250,000
262,500
$437,500
262,500
287,500
$987,500
Cash from operations is larger than net income by $550,000 because of the depreciation expense
and because non-cash current operating accounts provided cash flow (inventory decreased and
accounts receivable and payable increased).

Solutions Manual
Page 5-17
E5-10.
Net income
Accounts receivable on July 1, 2016
Accounts receivable on June 30, 2017
Inventory on July 1, 2016
Inventory on June 30, 2017
Accounts payable on July 1, 2016
Accounts payable on June 30, 2017
Unearned revenue on July 1, 2016
Unearned revenue on June 30, 2017
Depreciation expense for 2017
$877,500
292,500
375,000
1,162,500
1,432,500
675,000
735,000
1,500,000
375,000
300,000
Brooks Ltd.
For the Year Ended June 30, 2017
Net Income
Depreciation (add)
$300,000
Changes in non-cash current operating accounts:
Accounts receivable
(82,500)
Inventory
(270,000)
Accounts payable
60,000
Unearned revenue
(1,125,000)
Cash From Operations
Increase/(decrease)
$877,500
82,500
270,000
60,000
(1,125,000)
300,000
$877,500
300,000
(1,417,500)
$(240,000)
Cash from operations is lower than net income by $1,117,500 mainly because of the decrease in
unearned revenue. Increases in accounts receivable and inventory also contributed to the
difference. The depreciation expense and the decrease in accounts payable offset the other
effects.
E5-11.
Asset Accounts
Accounts receivable: Decrease
Inventories: Increase
Other current assets: Increase
Liability Accounts
Accounts payable and accrued liabilities: Increase
Wages payable: Decrease

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Page 5-18
E5-12.
Quesnel Ltd.
Cash Flow Statement
For the Year Ended December 31, 2017
Net Income
Depreciation (add)
300,000
Loss on sale of land (add)
32,200
Changes in non-cash working capital
Increase in accounts receivable
(41,400)
(75,900)
Decrease in prepaids
6,900
(28,000)
Increase in wages payable
10,350
Investing Activities:
Proceeds from sale of land
Purchase of common shares
Purchase of PP&E
575,000
184,000
287,500
(379,500)
(50,600)
616,400
230,000
Cash flow for the year (Change in cash)
Cash and cash equivalents, end of year
(128,050)
111,100
(497,500)
Cash from Financing
Cash and cash equivalents, beginning of year

Increase in cash for the year
332,200
250,000
(115,000)
(632,500)
Cash from Investing Activities

Financing Activities:
New bank loans
Issuance of common shares
Issuance of long-term debt
Retirement of long-term debt
Dividends
(93,050)
120,000
230,000
350,000

Solutions Manual
Page 5-19
E5-13.
a.
b.
c.
Add/Deduct/Not Relevant
Add
Not Relevant
Not Relevant
d.
e.
f.
g.
h.
i.
j.
k.
Add
Add
Not Relevant
Deduct
Not Relevant
Deduct
Deduct
Add
E5-14.
Despite beginning and ending the year with identical cash balances, Company A and Company B
are very different from one another from an overall cash flow/liquidity perspective. The key is to
examine how the cash was generated/used up during the year. Company B appears to be in the
better cash flow situation as it generated much more cash from operations. Company A had
negative cash from operations, which is a concern for a mature company. What is the reason and
will it continue? Cash from operations is always a figure businesses want to be positive as they
operate to make money. Company A also likely sold off some capital assets as they have positive
cash from investing activities while Company B made investments. The net decrease in investing
cash flows by Company A suggests it needs cash so it sold off assets, or its declining and has
idle assets it doesnt need. Selling assets isnt the ideal way for a company to generate cash as a
company will eventually run out of assets to sell. Company Bs net outflow for investing
activities suggests it needs new assets to replace existing ones. Company B also had negative
cash from financing probably because its repaid some debt (more than they acquired during
the year) while Company A had positive cash from financing (perhaps selling shares or acquiring
a bank loan). Increased borrowing or issuing equity isnt necessarily negative, but it appears for
Company A it was necessary for survival. Company B from the cash flow statement appears to
be in a stronger cash flow and liquidity position.

Solutions Manual
Page 5-20
E5-15.
a.
Accounts receivable
Inventory
Prepaids
2017
$60,000
187,500
25,000
2016
$47,500
217,500
20,000
Change
$12,500
(30,000)
5,000
Total current operating

assets
272,500
285,000
(12,500)
Accounts payable
Wages payable
Taxes payable
Interest payable
Total current operating
liabilities
2017
$130,000
22,500
40,000
23,750
2016
$117,500
30,000
25,000
32,500
change
$12,500
(7,500)
15,000
(8,750)
216,250
205,000
11,250
Yahk Ltd.
Net Income
Depreciation (add)
Loss on sale of equipment (add)
Changes in non-cash working
capital
Decrease in inventory
Increase in prepaids
Increase in accounts payable
Decrease in wages payable
Increase in taxes payable
Decrease in Interest payable
b.
$180,000
$50,000
25,000
(12,500)
30,000
(5,000)
12,500
(7,500)
15,000
(8,750)
75,000
23,750
$278,750
There are three reasons why cash from operations isnt the same as net income for 2017.
The first is the depreciation expense, which decreases accrual net income, but has no
effect on cash. Second, the loss on the sale of the equipment, which reflects the difference
between carrying amount and the price received for the assets, but not the actual cash
effect of the transaction (the cash flow effect will be reported in the investing section).
The third reason is the changes in the non-cash working capital on the balance sheet. The
associated revenues and expenses on the income statement, which determine accrual net
income, reflect economic flows but not necessarily the actual cash flows resulting from
the underlying transactions. The actual cash flows can be determined from the changes in
the corresponding balance sheet accounts.

Solutions Manual
Page 5-21
E5-16.
a. Cash collections
Cash collections = Beginning A/R + Sales Ending A/R
= $47,500 + 815,000 60,000
= $802,500
b. Amounts paid to employees
Wages paid = Beg. Wages Payable + Wages expense Ending Wages Payable
= $30,000 + 150,000 22,500
= $157,500
c. Amount paid in interest
Interest paid = Beg. Interest Payable + Interest expense Ending Interest Payable
= $32,500 + 35,000 23,750
= $43,750
d. Amount paid in taxes
Taxes paid = Beg. Taxes Payable + Tax Expense Ending Taxes Payable
= $25,000 + 60,000 40,000
= $45,000
e. Amount paid for other expenses: Other expenses paid = $65,000 (A/P only pertains to
inventory purchases so its assumed other expenses are paid as they are incurred)
E5-17.
The following solution assumes that all sales are on account.
(1)
(2)
(3)
(4)
Transactions
Transactions
Ending
and economic
and economic
Beginning
balance in
events that
events that
= balance in +
the
increase the
decrease the
the account
account
balance in the
balance in the
account
account
$456,000 = $363,000 + $4,626,000 -
Cash collections = $4,533,000

Accounts Receivable
End
456,000
(=
)
beginning
363,000
(+)
Credit
Sales
4,626,000

Solutions Manual
(-)
Cash
Collecte
d
?
4,533,000
Page 5-22
E5-18.
(1)
(2)
(3)
(4)
Transactions
Transactions
Ending
and economic
and economic
Beginning
balance
events that
events that
= balance in +
in the
increase the
decrease the
the account
account
balance in the
balance in the
account
account
Inventory
End
196,000
(=)
beginning
175,000
(+)
Purchases
?
1,241,000
(-)
COGS
1,220,000
Accounts Payable
(=
)
End
beginning
122,000
(+)
104,000
Credit
Purchase
s
(-)
1,241,000
Cash Paid
to
Suppliers
?
1,223,000
E5-19.
Wages Payable
Wages
End
112,500
(=
)
beginning
87,500
(+)
Expense
1,173,000
Wages
(-)
Paid
?
1,148,000
Wages payments = $1,148,000

E5-20.
Cash collections = Credit Sales +/- Difference in A/R +/- Difference in Unearned Rev.
= $32,850,000 + (4,750,000 4,498,000) + (455,000 315,000)
= $32,850,000 + 252,000 + 140,000
= $33,242,000

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Page 5-23
E5-21.
a. The loss on the sale of land is $25,000 ($100,000 75,000)
b. Willems cash increases by $50,000 at the point of sale as the buyer paid only $50,000 upfront
and will pay the remaining $25,000 in 14 months.
c.
i) If Willems used the indirect method of calculating CFO, the loss would be added back to net
income to calculate CFO. The money derived from the actual sale of the asset would show up as
a cash inflow in the investing section.
ii) If Willems used the direct method of calculating CFO, this transaction would not even appear
as a line item in CFO (not an add back like when calculating CFO indirectly). The money from
the actual sale would show up as a cash inflow in the investing section.
d. The loss has no effect on CFO. Its a non-cash item that must be adjusted for when calculating
CFO using the indirect method.
e. The non-cash part of the sale doesnt appear in the cash flow statement; only the $50,000
actually received appears. An alternative would be to show the gross amount of the sale and
deduct the $50,000 deferred. Another way would be to show the amount the land was sold for
($100,000) as an investing activity and an increase in financing for the amount owing ($50,000).
None of the approaches are perfect. The two alternatives include non-cash activities in the cash
flow statement. The second alternative is especially poor in this regard since it implies the land
was sold for $100,000 cash. The method used (only show cash flows) doesnt reflect the nature
of the transaction. With disclosure the cash approach is fully described.

Solutions Manual
Page 5-24
PROBLEMS
P5-1.
P5-1
a.
End
44,000
b.
Wages Payable
(=)
Beginning
64,000
Wages Expense
(-)
400,000
Wages Paid
420,000
Accounts Receivable
End
(=)
900,000
c.
(+)
Inventory
End
Beginning
(+)
1,000,000
(=)
3,000,000
Beginning
(+)
2,500,000
Cash
Collections
Credit Sales
4,800,000
(-)
Purchases
11,200,000
(-)
Purchases
(-)
Payments to
Suppliers
10,900,000
(-)
COGS
4,900,000
COGS
10,700,000
Accounts Payable
End
(=)
2,200,000
d.
Beginning
(+)
1,900,000
11,200,000
Beginning
Credit
Purchases
1,230,000
Inventory
End
(=)
540,000
e.
(+)
350,000
1,040,000
Development Costs
End
170,000
(=)
Beginning
(+)
150,000

Solutions Manual
Development
Costs
60,000
(-)
Amortization
Expense
40,000
Page 5-25
P5-2.
a.
Wages
(=)
End
456,000
(+)
66,000
b.
Inventory
(=)
End
2,440,000
c.
beginning
beginning
Wages Expense
(-)
Wages Paid
3,750,000
(+)
975,000
3,360,000
Purchases
2,445,000
(-)
COGS
Purchases
2,700,000
(-)
Purchases
(-)
Payments
to Suppliers
2,796,000
(-)
Cash Collections
980,000
Inventory
End
(=)
600,000
beginning
(+)
750,000
COGS
2,850,000
Accounts Payable
End
(=)
309,000
d.
beginning
(+)
405,000
2,700,000
beginning
1,100,000
Credit
Sales
6,610,000
beginning
Development
Costs
Accounts Receivable
End
(=)
1,260,000
e.
(+)
6,450,000
Development Costs
End
485,000
(=)
445,000
(+)
130,000
(-)
Amortization
Expense
90,000
P5-3.
Cash from operations: Cash from operations is likely negative (or at least lower than last year)
as sales have declined significantly and Pasadena has been unable to reduce many of its
operating costs. Also, when there is a slowdown in the economy, there is increased risk
regarding the collectability of receivables.
Cash from investing: Cash from investing is likely positive as the sale of land would generate a
cash inflow and all but essential capital expenditures (outflows) have been delayed. The fact that
there was a loss on the land is irrelevant as the loss represents the excess of carrying amount over
the amount paid for the assetit doesnt impact cash flows. In short, the company is selling off
capital assets while putting a freeze on the purchase of new ones.
Solutions Manual
Page 5-26
Cash from financing: Cash from financing has likely increased by a small amount. Pasadena
had to repay a bank loan (outflow); however, a new equity investor was found who provided the
money to repay the bank loan (inflow). The net effect of these two events is zero on the cash
from financing section of the cash flow statement. The reason cash from financing would likely
have increased is that the equity investor not only contributed the cash to cover the bank loan but
also provided some additional working capital. No dividends were paid during the year so this
would not be a factor in calculating cash from financing activities.
P5-4.
Cash from operations: Cash from operations would definitely be negative given the fact MVR
hasnt had a product released to the market and wont until at least 2020. Money is being used up
to provide operating funds for wages, rent, utilities, etc. No sales are being made but MVR still
has operating expenses. This cash flow pattern for CFO is typical for a company in the research
and development phase.
Cash from investing: Cash from investing would be negative because MVR just recently
completed its state-of-the-art research facility near the university, which would represent
significant investing cash outflows. Its unlikely that MVR would be selling any capital assets in
this time of expansion and development.
Cash from financing: Cash from financing would likely be positive. The reason for this is that
MVR would need to fund its investing activities as well as support its operating costs until MVR
has a product that can be taken to market. To accomplish this, MVR sold shares to venture
capitalists which is a financing cash inflow.
P5-5.
The pattern in the cash flow statement, where CFO and financing activities are positive and cash
from investing activities is negative suggests that the company is reasonably mature but
continues to invest and expand the business. CFO is $4,247,500 and this means the company is
generating cash from its daily. Cash from financing is positive which means that Onoway is
either issuing shares or borrowing. Operating cash flow was enough to cover the cash required
for investing activities and yet the company still obtained additional financing. As a result cash
increased by $4,670,500. This may suggest the company has plans for expansion or will require
significant amounts of cash to replace existing capital assets. Onoways cash flow pattern
suggests a healthy company that is generating cash from operations and is continuing to invest in
itself. Cash is being built up in the company on an overall basis.
P5-6.
The pattern in the cash flow statement where CFO and cash from financing activities are
negative and cash from investing activities is positive suggests a company that is experiencing
difficulty in generating cash in its daily operations and has decided to divest. CFO is negative,
suggesting the company is struggling (perhaps decreasing sales, increasing operating costs).
Cash from investing activities is nearly a $4,000,000 inflow, meaning Peachland is selling off
capital assets or perhaps even shutting down a line of operations that is no longer profitable. The
positive cash from investing activities is helping to cover the cash consumed in CFO and cash
from financing activities. The negative cash from financing activities is likely used to pay off
debt. Overall, cash flow is negative (being consumed), meaning cash reserves are being depleted.
Solutions Manual
Page 5-27
The situation isnt sustainable because a company cant keep selling capital assets year after year
to cover its cash shortfall and it will eventually run out of cash. (Note: the negative CFO doesnt
suggest expansion since that would go along with negative investing cash flows and possibly
positive financing cash flows.)
P5-7.
The pattern in the cash flow statement, where CFO is negative (cash outflow) and cash from
investing and financing is positive suggests a company that has had a difficult year. The negative
CFO could suggest growth but the inflow from investing activities isnt consistent with that. To
make up for the shortfall caused by the negative CFO, its generating cash from financing and
investing. The positive cash from investing (cash inflow) meaning the company is selling capital
assets; perhaps divesting a part of their business that is no longer profitable. The company has
obtained financingissuing shares or borrowing to help make up for the shortfall in CFO. The
financing inflow may be from shareholders who believe in the company and are willing to invest
or lenders who still have confidence or have received personal guarantees from the owners. Cash
has increased slightly during the year.
P5-8.
a.
Quarter 1 Cash Collections:
January: $975,000 / 3
= $325,000
February: $975,000 / 3
= $325,000
March: $1,075,000 / 3
= $358,333
$1,008,333
April: $1,075,000 / 3
= $358,333
May: $1,075,000 / 3
= $358,333
June: $1,385,000 / 3
= $461,667
$1,178,333
July: $1,385,000 / 3
= $461,667
August: $1,385,000 / 3
= $461,667
September: $2,100,000 / 3 = $700,000
$1,623,334
October: $2,100,000 / 3
= $700,000
November: $2,100,000 / 3 = $700,000
December: $1,215,000 / 3
= $405,000
$1,805,000
Accounts receivable on Dec. 31, 2017 = Nov. + Dec. sales = $1,215,000*2/3 = $810,000
b.
January: $975,000 / 3
= $325,000
Solutions Manual
Page 5-28
February: ($975,000 / 3) + (1,075,000 / 3)

March: $1,075,000 / 3
= $683,333
= $358,333
$1,366,666

April: $1,075,000 / 3
= $358,333
May: $1,385,000 / 3
= $461,667
June: $1,385,000 / 3
= $461,667
$1,281,667
July: $1,385,000 / 3
= $461,667
August: $2,100,000 / 3
= $700,000
September: $2,100,000 / 3 = $700,000
$1,861,667
October: $2,100,000 / 3
= $700,000
November: $1,215,000 / 3 = $405,000
December: $1,215,000 / 3
= $405,000
$1,510,000
Accounts receivable on Dec. 31, 2017 = Dec. sales = $1,215,000/3 = $405,000
c.
The impact of the change in collection period is that cash inflows increases during 2017. In
February of 2017, Dionne effectively collects sales from December (when customers had 60
days to pay) and they also collect January sales (as customers now have only 30 days to pay in
2017). In effect, an extra months sales are collected in 2017 as a result of the change to the
collection period. The impact is that cash inflow for the year is $405,000 higher than under the
old policy. Accounts receivable would decrease by half to $405,000. This occurs because Dionne
is lending money to customers for a shorter period of time, 30 days instead of 60 days.
d.
January: $1,215,000 /3
= $405,000
February: $1,075,000 / 3
= $358,333
March: $1,075,000 / 3
= $358,333
$1,121,666
April: $1,075,000 / 3
= $358,333
May: $1,385,000 / 3
= $461,667
June: $1,385,000 / 3
= $461,667
$1,281,667
July: $1,385,000 / 3
= $461,667
Solutions Manual
Page 5-29
August: $2,100,000 / 3
September: $2,100,000 / 3
= $700,000
= $700,000
$1,861,667

October: $2,100,000 / 3
= $700,000
November: $1,215,000 / 3 = $405,000
December: $1,215,000 / 3
= $405,000
$1,510,000
The long-term effect of changing the cash collection period to 30 days isnt as significant as in
the year when the cash collection period is changed. If sales stay stagnant, there really is no
impact on overall cash flow in the long-term. However, if sales start to climb each year, having a
collection period of 30 days rather than 60 days will result in higher cash flows (assuming a
period of constant rising sales). Essentially, the collection period represents a permanent loan to
customers. The longer the collection period the longer that permanent loan is and the larger the
amount of receivables at the end of the period.
e.
The answer to this question is tricky as there a lot of unknowns. First of all, the change in
collection period will result in significantly more cash inflows in 2017. If Dionne was finding
itself with low amounts of cash on hand and a large amount of current liabilities, this strategy
might make sense. However, Dionne must consider the effect of this policy change on its
customers. In the case it did mention that some competitors were already offering those terms.
The question is how many of their competitors are offering those terms? The suppliers that offer
those terms may price their products slightly more competitively to get away with offering a
smaller collection period. This decision isnt as simple as it being a sure way to generate more
cash flow in 2017. Dionne would need a good understanding of their customers and how they
may react to such a policy change. If I were the chief financial officer, I would request more
information and weigh all the pros and cons before making such an important decision. It might
not be worth a decrease in sales in exchange for faster collection of cash.

Solutions Manual
Page 5-30
P5-9.
a.
i.
2010
Net cash provided by operations
$1,754
(includes dividends and interest paid and received)
Net cash used in investing activities
(1,675)
Net cash used in financing activities
(318)
2009
1,759
(1,365)
(144)
ii.
(includes interest received)
(includes dividends and interest paid)
2010
$3,041
(1,668)
2009
3,083
(1,357)
(1,612)
(1,476)
2010
$2,655
2009
2,666
(1,675)
(1,219)
(1,365)
(1,051)
iii.
(includes interest paid and received)
(includes dividends paid)
b.
In part a, we saw the different ways of accounting for interest and dividends on the cash flow
statement. Overall cash flow is unaffected, but the split between the different types of cash flow
activities is affected. Cash from operations was highest under the second scenario where
dividends and interest paid were treated as financing cash flows and interest received as an
investing cash flow. Cash from operations was the lowest under the first scenario where
dividends, interest received and paid were treated as operating cash flows. A company may have
preferences where to classify these cash payments and receivables. If a company desired to
present strong cash flow from operations, they would likely be inclined to present dividends and
interest paid as financing cash flows since this would give them the highest cash from operations.
The perceptions of stakeholders could be affected by the different classifications.
c.
There really is no economic impact regarding how the cash flows are presented. Financial
statements simply try to present the most representationally faithful picture of how the company
performed in the past. Decisions regarding the classification of cash flows only affect how the
information is reported it doesnt change the actual underlying economic activity of the
business. Accounting can have consequences such as share price or investors perceptions of
how the company is performing but it still cant change the actual underlying economic
activities.
Solutions Manual
Page 5-31
d.
It is hard to gauge which treatment would be the most useful to stakeholders in general. A
company often has many stakeholders and their objectives can differ a great deal. Given these
varying objectives, certain stakeholders may desire a certain accounting treatment while other
stakeholders may desire a much different accounting treatment. Regardless, a stakeholder that
has a good knowledge of financial statements would be able to consider the accounting treatment
the company used and perhaps even re-create the cash flow statement using a different treatment
for interest and dividends.
e.
This is very much an opinion question many answers could be deemed acceptable. Thomson
Reuters likely sees the payment of dividends as something that keeps shareholders happy and is
related to Thomson Reuters keeping them as investors in their company. They see a close link
between the payment of dividends and the continuance of investing so they show it as an
outflow from cash for financing activities. Interest on the other hand, they likely perceive it as a
regular (perhaps monthly or quarterly payment) that is closely related to their day-to-day
activities). Without paying interest on bank loans, they would be in danger of default on these
loans and may be required to pay the money back. Because of the regularity and frequency of
these payments, they see it as an operating cash flow. Under old Canadian GAAP this was the
required treatmentinterest in operations and dividends in financing. The company may have
decided to keep on doing the same thing.

Solutions Manual
Page 5-32
P5-10.
Simpson
1st
Quarter
$290,000
2nd
Quarter
$320,000
3rd
Quarter
$380,000
4th
Quarter
$450,000
Total
$1,440,000
$300,000
$140,000
$195,000
$250,000
$885,000
135,000
135,000
135,000
135,000
$540,000
Sales
Cogs
Other
Net income
$290,000
145,000
135,000
$10,000
$320,000
160,000
135,000
$25,000
$380,000
190,000
135,000
$55,000
$450,000 $1,440,000
225,000
720,000
135,000
540,000
$90,000
$180,000
Beg inventory
Purchase
Sold
end inventory
$0
300,000
145,000
155,000
$155,000
$135,000
$140,000
140,000
160,000
135,000
195,000
190,000
140,000
250,000
225,000
165,000
$0
885,000
720,000
165,000
$0
$193,333
$213,333
$253,333
$0
290,000
96,667
193,333
320,000
300,000
213,333
380,000
340,000
253,333
450,000
403,333
300,000
1,440,000
1,140,000
300,000
$0
$46,667
$65,000
$0
195,000
176,667
65,000
250,000
231,667
83,333
885,000
801,667
83,333
($31,667)
340,000
311,667
(3,333)
28,333
($3,333)
403,333
366,667
33,333
36,667
$235,000
1,140,000
1,341,667
33,333
(201,667)
Sales
Inventory
purchases
Other operating
costs
a.
Beg AR
Sales
Collections
Ending AR
Beg AP
Purchases
Payments
Ending AP
300,000
200,000
100,000
100,000
140,000
193,333
46,667
Beginning cash
Collections
Payments
Ending cash
Change in cash
$235,000
96,667
335,000
(3,333)
(238,333)
($3,333)
300,000
328,333
(31,667)
(28,333)
f.
Net income and net cash flow are different because net income includes non-cash amounts such
as gains/losses on the sale of assets, accruals, and depreciation. For Simpson the difference is due
to the initial expenditure of cash needed to get the business going (buildup of inventory) and the
fact that Simpson gives its customers 60 to pay while it has only 30 days to pay its suppliers.
Over the year Simpsons cash position has been a challenge. The company has been in a negative
cash position for most of the year, meaning that the company has overdraft protection or a line of
Solutions Manual
Page 5-33
credit from a bank that has allowed it to continue operations. As of the end of the year it has a
small cash balance of $33,333, which is significantly less than the amount it owes its suppliers.
As long as receivables are collected on time it will be able to meet its obligations. Any decrease
in sales or slowing of collection of receivables could be very challenging for the company to
manage, especially if it doesnt have sources of cash available.
g.
Sales
Inventory purchases
$290,000
$300,000
$320,000
$140,000
$380,000
$195,000
$450,000
$250,000
$1,440,000
$885,000
30 days to pay
sales
cogs
other
net income
$290,000
145,000
135,000
$10,000
$320,000
160,000
135,000
$25,000
$380,000
190,000
135,000
$55,000
$450,000
225,000
135,000
$90,000
$1,440,000
720,000
540,000
$180,000
beg inventory
purchase
sold
end inventory
$0
300,000
145,000
$155,000
$155,000
140,000
160,000
$135,000
$135,000
195,000
190,000
$140,000
$140,000
250,000
225,000
$165,000
$0
885,000
720,000
$165,000
Beg AR
Sales
Collections
Ending AR
$0
290,000
193,333
$96,667
$96,667
320,000
310,000
$106,667
$106,667
380,000
360,000
$126,667
$126,667
450,000
426,667
$150,000
$0
1,440,000
1,290,000
$150,000
Beg AP
Purchases
Payments
Ending AP
$0
300,000
200,000
$100,000
$100,000
140,000
193,333
$46,667
$46,667
195,000
176,667
$65,000
$65,000
250,000
231,667
$83,333
$0
885,000
801,667
$83,333
Beginning cash
Collections
Payments
Ending cash
Change in cash
$235,000
193,333
335,000
93,333
($141,667)
$93,333
310,000
328,333
75,000
($18,333)
$75,000
360,000
311,667
123,333
$48,333
$123,333
426,667
366,667
183,333
$60,000
$235,000
1,290,000
1,341,667
183,333
($51,667)
Allowing customers less time to pay vastly improves Simpsons cash situation, with the ending
cash balance significantly higher. By reducing the period in which customers are allowed to pay
to 30 days, there are 30 days less worth of receivables remains outstanding. Simpson still has 30
days to pay its suppliers, so the cash outflows have not changed. Thus the company has identical
cash outflows but its cash inflows have sped up. This all is good news. However, there are some
business issues to consider before Simpson should adopt such a policy. Simpson must consider
the effect of this policy change on its customers. It should consider the kind of terms their
Solutions Manual
Page 5-34
competitors are offering. Do all their competitors offer 60 days to pay or more? This could be
significant as Simpsons customers could leave and take their business to another supplier if
these credit terms were not generous enough for them. Also, the suppliers that offer 30 day
payment terms (if any) may price their products slightly more competitively in order to get away
with offering a smaller collection period. This decision isnt necessarily a sure way of generating
more cash flow in 2018. Simpson would need a good understanding of their customers and how
they may react to such a policy change. If I were the chief financial officer, I would request more
information and weigh all the pros and cons before making such an important decision.
P5-11
Winkler Ltd.
Cash Flow Statement
For the Year Ended July 31, 2016
Net Income
Depreciation (add)
Gain on the sale of equipment (deduct)
Loss on the sale of land (add)
Write-down of assets (add)
Decrease in accounts receivable
Increase in prepaids
Increase in taxes payable
Investing Activities:
Purchase of long-term investments
Proceeds from the sale of land
Proceeds from the sale of PP&E
Purchase of PP&E
Cash from Investing Activities
Financing Activities:
Repayment of bank loans
Issuance of long-term debt
Retirement of long-term debt
Dividends
Cash from Financing Activities
$750,000
$852,000
(225,000)
100,000
310,000
51,000
(96,000)
(12,000)
(44,000)
77,000
1,037,000
(24,000)
1,763,000
(1,355,000)
55,000
356,000
(1,750,000)
(2,694,000)
(955,000)
1,000,000
3,000,000
(1,750,000)
(750,000)
Cash flow for the year (Change in cash)

Cash from Beginning (2015)
Solutions Manual
545,000
(386,000)
450,500
Page 5-35
Ending Cash balance (2016)
P5-12.
a.
Accounts receivable
Inventory
Accounts payable
Accrued liabilities
64,500
2018
2017
Change
248,000
550,000
384,000
202,000
630,000
434,000
46,000
(80,000)
(50,000)
98,000
64,000
34,000
Rivulet Inc.
Net Income
Depreciation (add)
Loss on sale of CA (add)
Decrease in inventory
Increase in accrued liabilities
($178,000)
430,000
50,000
480,000
(46,000)
80,000
(50,000)
34,000
18,000
320,000
b.
Rivulet Inc.
Cash From Operations - Direct Method
Cash inflows: (note 1)
Cash outflows:
Cash payments to suppliers (note 2)
1,034,000
Other cash expenses (note 3)
750,000

Solutions Manual
$2,104,000
1,784,000
320,000
Page 5-36
Amounts to be solved
i) Accounts Receivable
Note I
Cash
End
(=
)
beginning
248,000
(+)
202,000
(=
)
(-)
2,150,000
ii) Inventory
End
Credit Sales
Collected
2,104,000
Note 2
beginning
550,000
(+)
630,000
Credit
Purchases
(-)
COGS
1,064,000
984,000
Accounts Payable
End
(=
)
beginning
384,000
(+)
434,000
98,000
(=
)
(-)
Cash Paid
to Suppliers
1,034,000
(-)
Other
Paid
750,000
984,000
iii) Accrued liabilities
End
Credit
Purchases
Note 3
beginning
64,000
(+)
Other
Expenses
784,000
c.
The method that is most informative depends on the information needs of the stakeholder using
the statement. The direct method provides information about operating cash inflows and
outflows. For a stakeholder interested in seeing how cash moved in and out of an entity for
operating purposes the direct method would be best. The direct method informs the stakeholder
of the amount of cash that was expended for particular purposes; the indirect method doesnt
provide that information. The direct method focuses on cash flow, independent of accrual
accounting. The indirect method shows why net income and cash from operations are different.
This approach is useful if the stakeholder is interested in net income but wants to understand how
cash flow compares with net income. The indirect method links together the two performance
measures.
d.
Net income is an abstract economic concept used to measure performance under accrual
accounting. Its intended to measure the change in wealth of the owners of a profit oriented entity
by recognizing revenue when its earned and matching expenses to the revenue. Cash flows can
occur before, after, or at the same time that revenues and expenses are recognized. Cash receipts
Solutions Manual
Page 5-37
are recorded when they are received and disbursements when cash is paid. Rather than measure
flows of wealth, cash flow is captures cash inflows and outflows.
There are three reasons why Rivulet had a loss on its income statement but a positive cash flow
from operations. The first is that the expenses on the income statement included a large
($430,000) depreciation expense. Depreciation is an accrual expense that matches the cost of a
capital asset to the revenues it generates over the assets useful life. However, the depreciation
expense doesnt involve an actual cash flow. Cash flows associated with capital assets usually
only occur when an asset is purchased or sold.
A second reason for the difference is that the income statement also included a loss of $50,000
due to the sale of a capital asset. Again, this is due to depreciation. The loss occurred because the
carrying amount of the asset sold was higher than the price it was sold for. The carrying amount
of an asset is usually not its market value. Thus, the loss doesnt reflect a cash flow, but is an
attempt to measure a loss of wealth.
A third reason for the difference is that many cash flows related to operations dont occur at the
same time as when the related economic flow is recognized on the income statement. For
example, inventory may be bought and paid for in a different period than when its expensed.
Similarly, revenue might be recognized in one period and the cash collected in another. These
non-income statement cash flows are reflected on the balance sheet by changes in the non-cash
working capital accounts. In particular, the reduction in the amount of inventory and the increase
in accrued liabilities contributed to the positive cash from operations (these effects were offset by
the increase in accounts receivable and the decrease in accounts payable).
e.
The implication of having a loss on the income statement but positive cash from operations is
that an entity cant be judged on accrual net income alone. A company can withstand several
years of accrual losses, yet remain in operation so long as it has positive cash flow. On the other
hand, just because an entity has positive cash flow does not mean its creating wealth for its
owners. Evaluating an entitys performance isnt a black and white matter, but requires that one
look at all the available information.

Solutions Manual
Page 5-38
P5-13.
a.-
Katrime Ltd.

For the Year Ended May 31, 2017
Net Income
Depreciation (add)
Loss on sale of capital assets (add)
Increase in Prepaid insurance
Increase in accounts payable
Decrease in accrued liabilities
$75,000
42,500
27,500
70,000
(149,000)
(252,000)
(37,000)
77,000
(13,000)
(374,000)
(229,000)
b. [See parts i-iv) below the cash flow statement]

Katrime Ltd.
Cash From Operations - Direct Method
For the Year Ended May 31, 2017
Cash inflows: (note 1)
Cash outflows:
Cash payments to suppliers (note 2)
910,500
Cash paid for wages (note 3)
346,000
Cash paid for insurance (note 4)
67,000
Cash paid for other expenses
137,500
i) Accounts Receivable
$1,232,000
1,461,000
(229,000)
Note I
Cash
End
427,000
(=
)
Beginning
278,000
(+)
ii) Inventory
End
(=
Beginning
(+)
Credit
Sales
1,381,000
Note 2
Credit
Purchase

Solutions Manual
(-)
Collected
1,232,000
(-)
COGS
Page 5-39
)
818,000
566,000
s
987,500
735,500
Credit
Purchase
s
987,500
Cash
Paid
to
Suppliers
910,500
Accounts Payable
End
392,000
(=
)
Beginning
315,000
(+)
iii) Wages Payable

End
72,000
(=
)
beginning
85,000
Note 3
Wages
(+)
iv) Prepaid insurance
End
72,000
(=
)
Beginning
35,000
(-)
Expense
333,000
Wages
(-)
Paid
346,000
Note 4
(+)
Cash
Payment
s
67,000
Insuranc
e
(-)
Expense
30,000
c.
The method that is most informative depends on the information needs of the stakeholder using
the statement. The direct method provides information about operating cash inflows and
outflows. For a stakeholder interested in seeing how cash moved in and out of an entity for
operating purposes the direct method would be best. The direct method informs the stakeholder
of the amount of cash that was expended for particular purposes; the indirect method doesnt
provide that information. The direct method focuses on cash flow, independent of accrual
accounting. The indirect method shows why net income and cash from operations are different.
This approach is useful if the stakeholder is interested in net income but wants to understand how
cash flow compares with net income. The indirect method links together the two performance
measures.
d.
Net income is an abstract economic concept used to measure performance under accrual
accounting. Its intended to measure the change in wealth of the owners of a profit-oriented
entity by recognizing revenue when its earned and matching expenses to the revenue. Cash
flows can occur before, after, or at the same time that revenues and expenses are recognized.
Cash receipts are recorded when they are received and disbursements when cash is paid. Rather
than measure flows of wealth, cash captures the flow of cash in and out of the entity. Inevitably,
differences arise between the net income and cash flows.
Solutions Manual
Page 5-40
The main reason that Katrime Ltd. had a profit on its income statement but a negative cash flow
from operations is that the accounts receivable, inventory and prepaid insurance increased by a
combined $438,000. The increase in current assets must be financed and is therefore a use of
cash. This pattern suggests a growing company but more information is needed to confirm this.
The situation could also be indicative of a struggling company that bought too much inventory
and relaxed its credit terms.
e.
The implication of having a profit on the income statement but negative cash from operations is
that we cant assess the ability of a company to meet its short-term obligations as they become
due simply by examining the income statement. In this case, the company has built up its
inventory and accounts receivable, which cost a significant amount of cash. In general, negative
cash from operations isnt sustainable unless an entity has ongoing non-operating sources of
cash. Otherwise it will eventually run out of cash, at which time it will be unable to meet its
obligations. If Katrime has reached a plateau whereby it doesnt have to invest more in inventory
and receivables then operating cash flows should improve. If further investment in these areas is
planned the negative cash flow from operations might continue, which may lead to financial
difficulties. Negative CFO and a profitable business send a mixed message. The profit suggests a
successful operation but the negative CFO may mean short-term problems or even uncertainty
about whether the entity can survive.
P5-14.
Report to Management of Mankota Ltd.
To the management of Mankota Ltd.
Mankota Ltd. (Mankota) is suffering the consequences of its success. While I dont have a
complete set of financial statements to evaluate recent performance, from the information
provided net income has increased dramatically, as has, I assume, revenue. These are good things
for a business, but such success comes with the types of challenges that you are having.
My examination of Mankotas cash flow statement shows that the company has positive cash
from operations, meaning that the business is generating cash flows from its normal business
activities, which can be used for other purposes, such as purchasing additional plant, property,
and equipment. However, further examination of the cash flow statement shows that as a result
of the companys growth inventory and accounts receivable have increased. These are necessary
consequences of growth but they consume cash. Accounts receivable and inventory must be
financed and that uses up some of Mankotas cash. In addition, Mankota has invested
$12,200,000 over the last two years in plant, property, and equipment. Undoubtedly this
spending has been necessary to meet the demand for the companys products but there has to be
a source of this cash. Based on the information provided it seems that additional spending on
plant, property, and equipment is desired because the company sees itself losing sales to
competitors and additional spending would allow it to capture some of this demand.
Mankota has been able to obtain cash through the issuance of debt and from bank loans. These
represent appropriate ways of raising needed cash. The company has also paid back $750,000 in
Solutions Manual
Page 5-41
long-term debt and paid $750,000 in dividends over the last two years. However, the overall cash
from financing activities falls well short of the cash used up in investing activities. If Mankota
wants to continue to expand, it will likely need to raise more cash from investors (financing
activities) to finance their planned expansion activities.
As of now Mankota does not have a lot of cash. It is not clear whether this is enough to operate
on. Furthermore, if the company is to keep up its expansion plans or at least avoid a cash crisis
some steps are required. First, the company should stop paying dividends. That cash could be
better used internally. If the shareholders need cash they should borrow on their own. Next the
company could try to secure additional long-term financing. Long-term financing is the
appropriate way to finance long-term capital assets. New long-term debt or equity infusions
either from the existing shareholder or from new equity investors are the possible alternatives.
Another way of approaching the situation is to slow down the expansion. This may not be
desirable because sales will be lost but it would be a way of slowing down the need for cash.
Cash generated from operations could then be saved and used as available to finance the
expansion internally.
From an operational standpoint Mankota could try to collect its receivables more quickly and
assess whether it could manage with less inventory. Both these steps would free up cash.
However, whether these steps are possible will require further investigation of the companys
operations.
I hope you find the information in this report useful.
P5-15.
Report to the Shareholders of Iqaluit Water Company Ltd.
To the Shareholders of Iqaluit Water Company Ltd.,
Thank you for the opportunity to prepare this report. My comments are limited to the cash flow
statement and any inferences I can draw from it because that is the only information that has
been provided to me. A more thorough analysis would require additional information.
My analysis of the cash flow indicates that the Iqaluit Water Company Ltd. (Iqaluit) is in trouble.
The company has suffered large losses over the last two years as it is facing increased
competition and high marketing costs. Cash resources increased in the past year and as of July
31, 2017 there was $648,500 on hand.
Cash from operations in 2017 was negative, which isnt a good sign. However, the cash used up
by operating activities was not as significant as the net loss for the year. This was due largely to
the fact that net income included the write-down of assets and the loss on disposal of assets and
CFO ignores these activities as they dont include cash.
The investing section of the cash flow statement also supports that Iqaluit is in trouble. The
company has sold off a significant amount of plant, property, and equipment and hasnt replaced
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it (only small amounts of plant, property, and equipment were purchased during the last two
years). Interestingly, the company also sold a piece of land that it held as an investment in 2017.
This land was not used to support Iqaluits bottling operations, but was a speculative investment.
If Iqaluit had not sold this piece of land, they would only have had $23,500 in cash resources left
on hand at July 31, 2017. These sales of plant, property, and equipment and investments are a
cause for concern. The company cannot continue to sell off its capital assets to make up for the
shortfall in cash from operations as it will eventually run out of assets to sell as well as the
resources it needs to operate.
Iqaluits financing section raises additional concerns. First and foremost the company is paying
out $1,000,000 a year in dividends. This isnt appropriate under the circumstances. The company
needs cash to sustain operations and significant short-term loans have been taken. These loans
could have been avoided if the dividends were not paid (as well if the cash invested in long-term
investments had been used). The company also has a significant amount of short-term debt and
bank loans. The company has replaced long-term debt with short-term debt. This is a risky
strategy because short-term loans have to be repaid in the near future. Its possible that lenders
arent willing to commit to financing long-term. Another possibility is that better interest rates
were obtainable on the short-term loans.
Overall, the cash flow statement indicates that Iqaluit is in some financial duress. It is difficult to
prescribe solutions to the problems because they seem to be operational and there isnt enough
information to evaluate the business and its environment. To the extent that things can be turn
around I suggest that dividend payments be stopped immediately. While you as shareholders may
find this very undesirable, it is a necessary step for the company. I also suggest that the
shareholders consider additional equity investments to help any survival strategy the company
develops.
I hope this report has been helpful.
P5-16.To the management of Tofino Ltd,
Thank you for giving me the opportunity to examine your financial situation. My report will aid
you in analyzing your financial statements and assessing your current financial situation. In
particular, my focus will be on discussing and interpreting your deteriorating performance and
cash flow problems.
To begin, I want to discuss cash flow and net income from a high-level standpoint so the rest of
my analysis is clear. Cash flow and net income are not the same and that is evident from your
financial statements. As you can see, net income in 2017 was $5,764,000 while you suffered a
decrease in overall cash of $41,264,000. Within that decrease in overall cash, you suffered a
decrease in cash from operations of $39,932,000, which is extremely significant. While you
posted a profit for the year, you suffered nearly a $40 million decrease in cash from operations.
The largest contributing factor for this difference is the increase in accounts receivable. In
expanding outside of North America, you offered new credit terms, giving companies two to
three years to pay. On the income statement, these new sales were recorded as sales despite the
fact no cash was collected. However, these sales do not affect the cash flow statement since you
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have not been paid yet. So effectively, that $46,550,000 increase in accounts receivable is
represented on the income statement (through sales) but is reflected nowhere on the cash flow
statement. As an aside consideration should be given to the collectability of these receivables.
Further information should be obtained about the allowance provided for uncollectables.
I want to turn to the income statement and provide an analysis. Net income declined sharply
from $9,855,000 in 2016 to $5,764,000 in 2017. Notably, gross margin declined significantly. In
2016, sales were of $182,550,000 and gross margin $40,161,000. In 2017, sales grew by
$46,550,000 yet the gross margin increased by only $3,368,000. In 2016, the gross margin
percentage was 22 %, which means that for every dollar of sales, there is 22 cents left over to
cover other expenses besides the cost of sales and provide a profit to the owners. In 2017, the
gross margin percentage declined to 19%. A 1% decline in gross margin percentage can have a
huge effect on net income. If the gross margin percentage in 2017 was 20% instead of 19%,
gross margin would have increased to $45,820,000 [$229,100,000 * 20%] from $43,529,000.
This would be an increase in net income of $2,291,000 [$45,820,000 43,529,000]! If gross
margin stayed level at 22%, net income would have increased by $6,873,000 ($2,291,000,000
*3%). Also, the interest expense increased dramatically, more than doubling to $9,164,000.
Turning to the cash flow statement, it is clear to see why cash flow has declined significantly.
Overall cash decreased by $41,264,000. Cash from operations decreased by $39,932,000 and as
explained above, because of the increase in accounts receivable due to the generous credit terms
offered to non-North American customers. In examining this cash flow statement, there is a lot of
risk pertaining to the increase in accounts receivable. What happens if some customers cant pay
in 2 to 3 years when payment comes due? There is still $31,188,000 in cash left. However, cash
flow problems will remain until you collect from the first round of North American customers in
2019 or 2020. The increase in cash from financing activities basically covers the cash outflow in
cash from investing activities. In order to balance your cash situation, cash from operations needs
to improve quickly by ensuring payment from North American customers.
I hope this report proved useful and please contact me if you have any further questions.
P5-17.
To the Stadler Family:
Thank you for approaching me concerning the financial situation of your family. This report will
assess your current situation and provide suggestions for improvement.
If you look at your cash from operations, there is a negative balance of $3,575 which is a bit of a
cause for concern. This means that you spend more cash in your day to day activities than cash
you get from your jobs. Typically, this is an area you want to be positive. Positive cash flow from
operations means your living within your means, saving some money for non-day-to-day
purposes. Negative cash from operations means you need to get cash from other sources to make
ends meet.

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Turning to your financing activities, you had an overall cash inflow of $22,850. This came from
loans from the bank, borrowings from parents, and a second mortgage taken out. You are relying
heavily on borrowing to survive. Unfortunately, there a limits to borrowing. At some point
borrowers will not lend to you (you will be too risky), the cost of borrowing will increase (as
your debt load increases lenders will want to charge a higher interest rate to compensate for the
increased risk), and ultimately you will be unable to pay for the cost of your borrowing.
Finally, your investing activities had a net cash outflow of $22,075 and this amount is almost
equivalent to the cash inflow from financing activities. Your investing activities included the
purchase of a car (which I assume is what the bank loan was for), renovations made to your
home, and $500 put to savings.
As a whole, you saw your cash balance decline $2,800 leaving you with only $490 cash on hand.
This is not a lot. If you lose your job you have absolutely no reserve. You have ongoing
obligations that include your mortgage payments, interest payments on your bank loan, and
payments on the second mortgage. You need to take drastic steps to right your familys financial
situation. First, you need a budget. In building the budget you need to examine your expenditure
to find places to cut. Perhaps you should eat out less or go out less often. Experts say you should
be saving 10 % of your paycheque, which you are not doing. You want to make sure you have a
plan to cover your short-term obligations as this can create a lot of anxiety if you cannot cover
your current liabilities (those coming due in less than one year mortgage payments, bank loan,
etc.). You should look to reducing your debt load by channelling cash savings that your find to
the most costly loans. You should definitely not plan a vacation, home renovations, or major
purchases for the next little while.
Thank you for the opportunity to prepare this report. It was not intended as the time to press the
panic button, but simply a reminder of the need to always live within your means and ensure
unnecessary anxiety concerning finances creep up in your familys life. Please call me for further
suggestions or questions.
P5-18.
Souvenirs-On-the-Go
Balance Sheet
As of August 31 20XX
Assets
Current Assets:
Cash
Inventory
Prepaid Asset
Total current assets
Non-current assets:
Capital Assets
Accumulated depreciation
$14,850
2,200
250
17,300
Liabilities and Equity

Current Liabilities
Accounts payable
Loan payable
Interest payable
Total Liabilities
Shareholders Equity
15,000 Owners Equity
(3,750)

Solutions Manual
$2,300
7,000
600
9,900
18,650
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Total Assets
$28,550 Total Liabilities and Equity
$28,550
Notes:
1. Depreciation = $15,000/4 = $3,750
2. License expense = $500/2 = $250
3. Souvenirs purchased souvenirs on hand at the end of the year = COGS
= $12,200 $2,200 = $10,000
Souvenirs-On-the-Go
Income Statement
For the year Ended August 31 20XX
Sales
Expenses:
Cost of Sales
Maintenance
Interest
Other
Depreciation
Licence
Total Expenses
Net Income
$22,400
10,000
1,050
600
3,100
3,750
250
18,750
$3,650
Beginning owners equity 15,000

Net Income
3,650
Ending owners equity
18,650
Souvenirs-On-the-Go
Cash Flow Statement
As of August 31, 20XX
Cash from operations:
Cash collected from customers
$22,400
Cash expended for operations

Inventory
($10,400)
Maintenance and repairs
(1,050)
Miscellaneous
(2,600)

Cash from investing activities
Purchase of capital assets
License
(14,050)
8,350
(15,000)
(500)
(15,500)

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Cash from financing activities

Loan from parents
7,000
Issuance of common
shares
15,000
Cash flow for the year
Cash at the beginning of the year
22,000
14,850
0
Cash at the end of the year
$14,850
Dear Evan:
Souvenirs-On-The-Go (SOTG) appears to be a successful venture. It has generated good cash
from operations and a reasonable net income. The cash from operations may be a bit misleading
because of the amounts owed to suppliers. You dont really have $8,350 available because you
owe your suppliers $2,300, not to mention the amount you owe your parents. You assume the
inventory of souvenirs on hand at the end of the summer will be saleable next summer. There is
no problem if that is the case, but if these souvenirs arent saleable (perhaps because they are
unique in some way (they specify a date or event or customers tastes change), then the economic
performance of SOTG as measured by net income is reduced (there would be no effect on cash
flow). Perhaps the most important question for you is whether operating this business is the best
way to spend your summers. On a strictly economic basis, you must consider whether you would
be better off taking a job elsewhere or operating a different business. (Of course, other
considerations must come into play in making a decision. Financial and economic criteria arent
the only ones.) Given that SOTG has some cash on hand, you might consider paying back the
loan to your parents. By doing so, you would save future interest costs and would ensure you
would not get to a point when you would be unable to repay the loan. However, after paying the
loan and his suppliers, you would not have a lot of money left to withdraw funds for himself and
leave a cash reserve for next summer (only $4,950 (cash on balance sheet liabilities = $14,850
$9,900) would remain after paying off liabilities). That probably is not enough to pay for your
tuition. It would probably be a good idea for you to do some planning to figure out what your
cash needs would be before taking money out of the business. You will need money for inventory
and perhaps to service the cart.
P5-19.
To the management of Newbrook Ltd.,
Thank you for the opportunity to advise you on the matter of whether or not to declare a
dividend. It is wise for you to labour such a decision as it is a substantial one to make.
I would like to congratulate you on a successful year. As of now, you have $2,008,000 cash on
hand. During 2017, cash increased by $930,000 and the company posted strong cash from
operations of $2,480,000. There are a lot of factors in favour of a dividend given your recent
success and the desire to reward your shareholders. I was told a dividend of $0.10/share was
being considered. With 10 million shares outstanding, that would be a net cash outlay of
$1,000,000, which comprises nearly half of your current cash balance.

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Page 5-47
When examining your cash flow statements for the last four years, they are slightly erratic. One
year cash on hand increases, the next year it decreases. Operating cash flows has also been very
erratic over the four years. Given the cyclical nature of the industry, this is not a surprise. If
commodity prices for your product were to decline in the next year, cash supplies could be
impacted very negatively. There is also the matter of expansion. If new mining opportunities
arise, you want to be able to take advantage of these opportunities. These new mining
opportunities may be able to create great share value, which is obviously something investors
look for. Also, your chief financial officer is correct in saying share prices will be negatively
affected when dividends are stopped. Based on the factors outlined in this paragraph, I believe it
would be prudent to delay the payment of a dividend. Companies that pay dividends are those
that have had a good, strong, and stable history of earnings growth and strong cash from
operations. I would like to see another year or two of strong cash from operations and growth in
your cash reserves before you pay a dividend. That way, it is not as much of a risk and your
decision would be based on strong fundamentals.
Thanks for considering my report and if you have any questions on my suggestions, please give
me a call to discuss further.
P5-20.
a.
Change to Net Income
Reported Net Income
Less: Major Maintenance
Depreciation Adjustment
Adjusted Net Income
$215,000
(125,000)
(30,000)
$60,000
Change to Cash from Operations

Reported Cash from Operations
Less: Major Maintenance
Delay in Cheque Processing
Adjusted Cash from Operations
$300,000
(125,000)
(210,090)
($35,090)
b.
There is a common theme with regard to these three decisions. They all either increase net
income and/or increase cash from operations. There are many possible explanations for why
these changes would be made. The increase in the useful lives of certain assets may actually be
legitimate. Perhaps improvements were made to these assets or maybe management legitimately
underestimated the useful lives previously and corrected things this year. The delaying of the
major maintenance program could have been changed this year to make it easier on employees
during the vacation season to boost workplace morale. The delay in cheque processing may have
been legitimate. Many possibilities exist. However, something that cant be ignored is that
management may have reasons for making these decisions, particular positive economic
consequences resulting from the decisions. Management could have financial bonuses tied to net
income or cash from operations which would have caused them to tweak their depreciation
estimates, delay payments to suppliers and delay maintenance projects until the next fiscal year.
Or management may be trying to window dress the company so as to satisfy external
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shareholders. Stakeholders need to be aware of the potential biases that preparers could have in
the preparation of financial statements.
P5-21.
a.
It can be argued that subscriber recruitment and maintenance costs can be capitalized because
they will provide future benefits. Recruitment costs are incurred in the process of acquiring new
subscribers, which will provide future revenue for Phidias Publications. Maintenance costs are
incurred to retain subscribers, which decreases the probability of future decreases in the
companys revenue due to loss of subscribers. Both are future benefits, and according to the
matching principle the costs should be charged to income in the period that the revenue they
generate is recognized.
On the other hand, its difficult to determine the duration over which the costs will generate
revenue. As a result it gives management additional flexibility to manage earnings. Also, it may
be difficult to measure the amount of revenue that the costs will generate. Maintenance could be
looked at the same way as car maintenanceincurred to have the asset operate as intended. For
these reasons, it can be argued that subscriber recruitment and maintenance costs should not be
capitalized. This is mainly a conservatism argument.
b.
The income statement will show different results depending on which treatment is used for
subscriber recruitment and maintenance costs. If the costs are expensed as incurred then accrual
net income for the company will be reduced, or accrual net loss will be increased, by the amount
of the expense ($54,000). If in fact the costs do provide future benefits, the accrual net income
wont reflect the true flow of net economic benefits that occurred during the reporting period.
If the costs are capitalized and amortized, then a greater accrual net income (or lesser accrual net
loss) will result relative to expensing the costs as incurred (although the effect will be mitigated
by the amount amortized in a given year). If in fact the costs dont provide future benefits, then
accrual net income wont reflect the true flow of net economic benefits that occurred during the
reporting period. Of course, over the life of the entity net income will be the same, so what is
being affected is the timing of expenses and income, not the amount.
[Note that in any given year income could be higher (or lower) under either of the methods. This
is the case because over the life of the entity the same amount of expense will be incurred. As
long as the investment in subscribers increases income will be higher under the defer and
amortize method.]
c.
Phidias Publications Ltd.
Cash Flow Statement
For the year ended December 31, 2017
Cash paid to employees
Solutions Manual
$938,400
($450,000)
Page 5-49
Cash paid to suppliers
(362,000)
Cash paid in interest
(20,800)
Cash paid on recruiting & maintaining subscribers

Cash from investing activities:
Proceeds from sale of capital assets
(54,000)
(886,800)
51,600
44,000

Cash from financing activities:
Dividends paid
Repayment of bank loan
(120,000)
(76,000)
(30,000)
(70,000)
Proceeds of long-term debt
130,000

Cash generated during the year
30,000
5,600
Cash on hand on December 31, 2016
18,500
$24,100
d.
Phidias Publications Ltd.
Cash Flow Statement
For the year ended December 31, 2017
Cash paid to employees
Cash paid to suppliers
Cash paid in interest
Cash from investing activities:
Proceeds from sale of capital assets
Capitalized subscriber recruitment costs
$938,400
($450,000)
(362,000)
(20,800)
(832,800)
105,600
44,000
(120,000)

Cash from financing activities:
Dividends paid
Repayment of bank loan
(54,000)
Proceeds of long-term debt
130,000
(130,000)
(30,000)
(70,000)

Cash generated during the year
30,000
5,600
18,500
$24,100

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e.
Both cash flow statements will arrive at the same cash balance as of December 31, 2017. The
difference between the two is the section within which the subscriber recruitment and
maintenance cash flows are included. Under the expensing treatment, the costs are included in
the cash from operations section. The result is reduced cash from operations compared to the
capitalizing treatment. A stakeholder might interpret this as something unfavourable, as it
indicates a lesser ability of Phidiass ordinary business activities to generate enough cash to
cover operating cash flows.
Under the capitalization treatment, a stakeholder might easily overlook the subscriber costs
included in the cash from investing activities section. Thus a stakeholder might conclude that the
ordinary business activities of the company have a greater ability to generate sufficient cash to
cover operating cash flows than if the expensing treatment were used. Also, the user might
conclude that cash flows will increase in the future as a result of investment in subscriber
recruitment and maintenance, whereas they likely would not arrive at this conclusion if the
expensing treatment were used.
However, this is simply an issue of classification. One might debate the true nature of
recruiting and maintenance costs but the underlying liquidity of the entity isnt affected by the
treatment, although its possible that some users may misinterpret the cash flow of the entity
depending on the classification used.
f.
This issue isnt well explored in the literature. One might think that higher cash from operations
would give rise to a better perception of an entitys liquidity. However, its not clear how
stakeholders use this information. From the income statement perspective, the issue is clearer.
The preference of management will depend on its objectives of reporting. Capitalizing and
amortizing would probably be preferred if managements compensation is based on accrual net
income or the company is public and higher or smoother income flow is desired. Expensing
might be preferred for tax minimization or for accounting simplicity (with expensing its not
necessary to manage amortization and to assess whether the unamortized costs are impaired).
From an efficient market theory standpoint, as long as the amount and classification is
transparent there will be no effect on the stock price of public companies.

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P5-22.
a.
Soldit Properties Ltd.
Income Statement
For the period ended January 31, 2017
Revenue*
Commission expense**
Gross margin
Salaries expense
Rent expense
Utilities expense
Depreciation expense***
Net income
$60,000
(32,000)
28,000
(4,400)
(2,400)
(1,000)
(833)
$ 19,367
Notes:
*$1,200,000 5%
**$800,000 4%
***Its assumed that capital assets (car and office equipment) have useful lives of five years.
Depreciation expense = 50,000/5/12 = $833 per month. Students can make other reasonable
assumptions. (This is an important skill that students should develop. In practice the useful life of
assets must be determined by managers.)
b.
Soldit Properties Ltd.
Cash Flow Statement
For the period ended January 31, 2017
Cash collected from customers*:
Cash paid for:
Commissions
Salaries
Rent
Utilities
Cash flow for the year
Solutions Manual
$44,000
32,000
4,400
2,400
1,000
4,200
(10,000)
40,000
34,200
Page 5-52
Cash at the beginning of the year

Cash at the end of the year
0
$34,200
*$1,200,000 5% - $16,000
**Down payment car + purchase of computer, fax, and copier = $6,000 + $4,000
c.
Soldit performed well in the month of January. The company has positive cash from operations,
meaning that ordinary business activities generate enough cash to cover operating cash flows.
Also, the fact that the income statement shows that the company made an accrual profit indicates
that Soldits generating wealth for its shareholder. Mr. Bedlam is judging the companys
performance solely on cash. This isnt appropriate. If a company is to be evaluated on the basis
of cash flows, then its the operating cash flow that Mr. Bedlam should focus on, as this section
of the cash flow statement shows if operations are generating more cash than is being used.
Ultimately, this will indicate whether Soldit will generate positive cash flows in the future.
However, cash flows do not reveal information about flows of wealth (at least as measured in an
accrual context). To determine if shareholders are better off economically (as opposed to in terms
of cash flow) at the end of a period than at the beginning of the period, one must look to the
income statement. Soldit is in its first month of operations. Assets were acquired that consumed
cash but that wont have to be purchased every month. The car and office equipment will likely
contribute to the business over several years. Thus, its misleading to conclude that the entity is
doing poorly because it depleted some of its initial investment. Its expected that in the early
going a business will use cash as it gets the business going. Indeed Soldit did quite well for the
first month given that it used up only $5,800 of the initial investment. The income statement,
which shows economic gains rather than cash flows, shows that Soldit made almost $20,000 in
income in the first month; not bad for the first month of operations. This means that the company
was able to generate net economic gainsits economic benefits exceeded its economic costs in
January.
P5-23.
a.
The main users of Doggie Duds Inc.s (DDI) financial statements are Anna Malover (she is the
non-managing owner of the company), banks/lenders (they have a significant amount of money
invested in DDI and rely on financial statements for information about the loans), prospective
lenders (if additional borrowing is required), and the manager (his bonus is based on the cash
flow statement).
b.
The manager should definitely not have been fired simply because cash decreased during the
year. Cash from operations was significantly positive, indicating that ordinary business activities
were generating cash which is available for other purposes, such as paying dividends. The reason
cash flow was negative during the year was because the company invested in a computer system
(presumably necessary for effective management of a large chain of stores) and it paid off
$85,000 in loans (thereby strengthening DDIs balance sheet). A dividend was also paid. These

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were all financed by the cash generated by DDIs operations. Overall it seems from the
information provided that the manager did a good job (certainly compared with 2018).
c.
From the information provided DDI didnt perform as well in 2018 as it did in 2017. Net income
for the year was slightly lower (by $17,480). Cash from operations was significantly lowerit
was negative, meaning that being in business consumed operating cash. This is a significant
change from 2017 and not a favourable one. There can be good reasons that CFO would be
negative but there is no information that suggests that these changes were generated by growth.
The only reason that cash increased during the year was because some land was sold for
$200,000. It may have been reasonable to sell the land given that it has been idle since it was
purchased in 2015, but DDI wont be able to generate cash on an ongoing basis from selling land
(it presumably doesnt have a large inventory of land to sell). Also, the company paid dividends
and increased the amount paid (from $50,000 to $90,000). So its quite possible next year is
going to be a disaster when the $200,000 from the sale of land doesnt occur again and CFO is
negative. So overall, the new manager achieved the goal set for him but doesnt seem to have
done a very good job managing DDI.
d.
Increase in cash isnt a good basis for evaluating performance. It would be easy to increase cash
by selling assets and borrowing money without any reasonable underlying business purpose. A
better cash focus for evaluation would be cash from operations since that is cash from the normal
business activities. Even then CFO can be manipulated some by timing transactions and cash
flows.
P5-24.
The direct and indirect methods are different ways of getting to the same placecash from
operations. The direct method provides information about operating cash inflows and outflows.
For a stakeholder interested in seeing how cash moved in and out of an entity for operating
purposes the direct method would be best. The direct method informs the stakeholder of the
amount of cash that was expended for particular purposes; the indirect method doesnt provide
that information. The direct method focuses on cash flow, independent of accrual accounting. On
Stantecs statement we can see the amount of cash received from customers and amounts paid to
suppliers and employees, along with dividends received and interest and taxes paid and received.
The indirect method shows why net income and cash from operations are different. This
approach is useful if the stakeholder is interested in net income but wants to understand how cash
flow compares with net income. The indirect method links together the two performance
measures. Stantecs indirect calculation of CFO is very complicated looking, with a long list of
adjustments. Of course none of the adjustments have anything to do with cash flows. All the
adjustments were ignored when CFO was calculated using the direct method. The changes in
non-cash working capital accounts do represent cash flows. These are reflected in the direct
approach in the calculation of cash receipts and expenditures.

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USING FINANCIAL STATEMENTS

FS5-1.
In thousands of $
Operating activities
Investing activities
Financing activities
2010
$50,356
(36,719)
(14,816)
2011
$3,572
(264,969)
263,923
FS5-2.
Examination of the statement of cash flows shows that High Liner has been able to generate
positive cash flows from operations in both reported years. However, there has been a significant
drop in cash due to the change non-cash working capital in 2011. As a result cash from
operations decreased significantly in 2011. The impact is largely due to significant increase in
inventory in the year (which ties up cash), but the overall effect of the change in non-cash
working capital was over $33 million. In financing High Liner increased the amount of long term
debt resulting in a net cash inflow from financing activities of $263,923,000. This is a significant
increase from 2010 when there was a net cash outflow from financing activities of $14,816,000.
The cash from financing activities appears to have been used to make a significant acquisition of
business in the amount of $257,778,000. In total in 2011 cash expended on investing activities
was $264,969,000. In 2010 High Liner spent $36,719,000 on investing activities. The net result
is an increase in ending cash of $2,662,000. The cash balance on December 31, 2011 was $3,260.
The cash balance at the end of 2010 seems quite low so an increase is a positive event.
FS5-3.
High Liner uses the indirect method for calculating cash from operations. You can tell because it
starts with net earnings and add back non-cash items, and then adjust for changes in non-cash
working capital.
FS5-4.
a. High Liners cash and cash equivalents include cash on hand, demand deposits with
maturity of 3 months or less, and highly liquid investments but does not include restricted
cash. (Note 3).
b. It does make sense to include cash and cash equivalents on the statement of cash flow
because the cash equivalents are highly liquid investments that could easily be converted
to cash. Ignoring these items could paint an inaccurate portrait of the companys liquidity.
For example, if a company invested the majority of its excess cash in treasury bills and
kept very little cash on hand it may seem like the company has a cash shortage, which is
not the case at all. Treasury bills could easily be converted back into cash to meet
obligations as needed.
c. High Liner had $3,260,000 on hand on December 31, 2011, $598,000 on hand on January
1, 2011 and $1,953,000 on January 3, 2010. The amount of cash on hand is a concern
because it seems fairly low. The balance at the end of fiscal 2010 seemed particularly
concerning. In 2011 the cash position increased by over $2.5 million, which is an
improvement.
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d. While having cash is a positive sign for the company having too much cash could be an
indication that the companys cash is not working for the company to earn additional
income. For example short term investments may yield a smaller return than a business
venture. From a lending perspective more cash will make a company appear less risky
while continuous growth in cash without investments could be an indication of stagnant
growth. However, history shows that in the event of a global liquidity crisis too much
cash might be a very large amount.
FS5-5.
In thousands of $
2010
2011
Net income
$19,958 $18,180
Cash from operations $50,356 $3,572
High Liners net income was much lower than cash from operations in 2010 because of
adjustments from non-cash items and adjustments of charges to income not involving activities.
It was a different story in 2011 where net income was much lower than CFO. In 2011 the change
in non-cash working capital reflected a decrease in CFO of $25,142, mainly due to an increase in
inventory. In general, cash from operations and net income are different because cash from
operations is comprised of cash items alone, whereas net income is a combination of cash and
non-cash items (for example, depreciation and gains and losses are non-cash items that impact
net income but are not part of cash from operations).
FS5-6.
a. The amount of cash used to repay long term debt in 2011 and 2010 was $49,649,000 and
$4,511,000 respectively.
b. The amount of cash spent on PP&E in 2011 and 2010 was $6,952,000 and $4,339,000
respectively.
c. The change in cash from 2011 to 2010 was a gain of $2,662,000 and reduction of
d. The amount of dividends paid in common shares in 2011 and 2010 was $5,184,000 and
FS5-7.
High Liner has positive cash from operations and financing activities and negative investing cash
flows. This means that High Liners business activities are generating positive cash flows, the
company is investing money in property, plant, and equipment, and is servicing its debt load.
High Liner is also growing through acquisition but is financing it through debt. This pattern
indicates that High Liner is a mature company that is expanding its operations. The cash flows
show that High Liner is able to generate cash through its business activities and use that cash to
maintain/expand capital investment but does not have enough equity to fund its growth.
FS5-8.
Depreciation is added back to net income when calculating CFO because the indirect method
reconciles net income to CFO by removing all non-cash expenses and making adjustments for
changes in non-cash working capital accounts. High Liners depreciation and amortization
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expense in 2011 was $9,734,000. If depreciation were $11,000,000, net income would be
$16,914,000 ($1,266,000 lower). A larger depreciation expense would not impact CFO because it
has no effect on cash flow. Increasing depreciation would lower net income but the larger amount
of depreciation expense would be added back when calculating CFO.
FS5-9.
High Liners interest expense was $5,983,000 and $5,165,000 in 2011 and 2010, respectively. Its
cash interest payments were $5,194,000 in 2010 and $4,717,000 in 2010. These amounts differ
because interest can be accrued or paid in advance meaning that interest payments can be made
before or after the associated expense is recorded. This results in a timing difference and as a
result interest paid differs from interest expense in the financial statements.
FS5-10.
The impact of the increase in inventories is a reduction is cash flow from operations. Inventory
ties up cash so increasing inventory decreases cash flow. While some of the inventory is financed
by payables, a good portion of the amount is paid for with cash. Therefore cash from operations
would be reduced as a result of funds tied up in inventory resulting in a cash outflow from noncash working capital.
FS5-11.
Free cash flow = CFO capital expenditures
(in thousands of dollars)
2011 free cash flow = $3,572 $264,969 = $(261,397)
2010 free cash flow = $50,356 $36,719 = $13,637
Free cash flow represents the cash available for use after capital expenditures have been made.
This would be cash available for discretionary purposes. Comparing the annual results its
evident that High Liners expansion initiative does not leave any cash free cash flow.
FS5-12.
From the balance sheet, High Liner doesnt seem to have a strong liquidity position. Cash from
operations is quite small and decreased from 2010. The cash position, while improved from
2010, maybe too low to provide an adequate buffer. The current ratio is good (1.51) but on closer
examination we see that inventory makes up 70% all the current assets. Inventory that is food
based is perishable and this could be of concern (if there is a slowdown in sales). There is no
explanation for the doubling of inventory but traditionally High Liner has carried a lot of
inventory relative to other current assets. As an analyst I would wonder if the increase in
inventory is a result of stock piling for a future contract, if its from the acquisition, or if its
excess. Overall excluding inventory High Liner does not have enough cash to service its current
obligations. Even though receivables have increased, bank loans have more than doubled and
accounts payables have more than doubled year over year. Since there was a major acquisition in
2011 this could be the reason for the increase in inventory and current liabilities. Overall the
liquidity position of High Liner is poor even prior to the purchase of the new business with an
ever increasing debt load.

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CHAPTER 5

Cash Flow, Profitability, and the Cash Flow Statement

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Inventory self-financing period (supplier paid - cash collected)

Receivables conversion period (inventory sold cash collected)

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

*Collections on opening A/P = 204,000/2months = $102,000 per month in Q1

$134,000.00 $141,666.67 $141,666.67 $141,666.67 $161,666.67 $161,666.67

Cash Paid Per

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Cash Paid Per

*Collections on opening A/P = 204,000/2months = $102,000 per month in Q1

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Advertising is an operating cash flow as it relates to a normal activity within Ashleys

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Cash flow for the year (Change in cash)

Cash and cash equivalents, end of year

Cash from Financing

Cash and cash equivalents, beginning of year

Cash from Investing Activities

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Total current operating

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

$456,000 = $363,000 + $4,626,000 -

Cash collections = $4,533,000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Wages payments = $1,148,000

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

February: ($975,000 / 3) + (1,075,000 / 3)

Quarter 2 Cash Collections:

Quarter 4 Cash Collections:

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Cash flow for the year (Change in cash)

Ending Cash balance (2016)

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

iii) Accrued liabilities

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Cash From Operations - Indirect Method

Cash From Operations:

b. [See parts i-iv) below the cash flow statement]

Cash paid for insurance (note 4)

Cash paid for other expenses

Cash From Operations:

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

iii) Wages Payable

iv) Prepaid insurance

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

Liabilities and Equity

John Friedlan, Financial Accounting: A Critical Approach, 4th edition

$28,550 Total Liabilities and Equity

Beginning owners equity 15,000

Cash expended for operations