Financial Accounting: An Integrated Approach, Sixth Edith
Chapter 4
Measuring and Evaluating Cash Flow
Solution Outline for Problem 4.1
a. Investing activities is often the largest use (outflow) of cash especially in expanding businesses.
The investing section of the cash flow statement offers insight into what the company is doing in
this regard.
Financing provide the reader with more readable information on the companies changes in debt
and capital structure than does the balance sheet alone. Both new issues and retirements of debt and
shares are disclosed here.
b. An increase in accounts receivable reduces the cash inflow from earnings from that indicated by
net income.
c. There can be many reasons for this occurrence. Among them:
Increases in current assets such as accounts receivable (cash from sales not collected),
Increases in inventory purchased and paid for but not sold,
Increases in prepaid items such as rent use cash before expense is recognized,
Decreases in current liabilities, the outlay of cash during the period with no expense recognized,
The repayment of long-term debt,
The retirement of shares and the payment of dividends,
The acquisition of long-term assets which will be expensed in future periods.
d. This occurs because cash flows do not normally coincide with expense recognition as in c above.
e. The declaration of a cash dividend has no effect on cash flow. A cash outflow occurs when the
dividend is paid whether this is the period in which the dividend is declared or a subsequent period.
Solution Outline for Problem 4.2
In answering this, students should try to avoid jargon (which often conceals a lack of real understanding)
and speak to the issues in clear English. Points could include the following:
a.
The income statement attempts to measure overall economic performance, which includes
estimates and assumptions about receipts and payments of cash that happened in previous years or
have not yet happened. Management of the company's cash (buying things, paying bills, collecting
from customers, borrowing and lending) is a different sort of problem than earning income, so the
cash flow statement has been developed to show how the company performed in managing its
cash.
b.
There are various kinds of cash, such as cash on hand, cash in bank accounts and cash invested in
short-term investments that could be gotten back for paying bills if need be. There is even
“negative cash”, such as bank overdrafts. Moving cash around among all these is a daily
management task, but it is thought that investors are not really interested in such details so the cash
flow statement lumps them all together as “cash and cash equivalents” and explains what happened
to the total cash and equivalents during the year. (The bottom of the cash flow statement usually
says what the company has included as cash and equivalents.)
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Instructor’s Solution Manual
c.
Income and cash flow usually reflect good or poor management in the same sort of direction. A
company making income should have a positive cash flow (more receipts than payments), and one
making a loss should have a negative cash flow (more payments than receipts). Therefore, the cash
flow statement starts off with the income figure and “corrects” that for items not involving cash
receipts and payments during the year, arriving at a figure showing the net amount of cash inflow
or outflow from day to day operations. This figure tells you how the company has done in
generating (or using up) cash in its routine activities of buying and selling goods, manufacturing,
administering and generally running its normal affairs.
d.
The cash flow statement also tells you about cash received or paid out for four other less routine
kinds of activities, which are not represented in the income statement. The cash flow statement
therefore gives a more complete picture of cash activities than the income statement could, even if
the income statement were done on a receipts and payments basis. These four other activities are:
i.
Cash dividends paid to investors during the year;
ii. Cash paid for, or received by selling, investments such as land, buildings, equipment and
long-term investments such as in other companies;
iii. Cash received from, or paid out to repay, long-term debt financing such as mortgages or
bonds;
iv. Cash received from, or paid out to redeem, equity financing such as new share issues.
(Amounts paid by one investor to another in stock market trades do not get to the company
and so are not included in the cash flow statement or any of the financial statements.)
Solution Outline for Problem 4.3
1. The cash flow information covers at least the following:
a. It tells you what the cash income (cash from operations) is.
b. It tells you why the cash income differs from the accrual net income.
c. If done by the traditional indirect method, it reports whether the company’s noncash working
capital is rising or falling (supplementing the working capital and working capital ratio: if
working capital is growing, that may not be good because receivables are not being collected
or inventories are increasing, and if such is going on, the indirect method cash flow statement
will point out the negative effect of this on cash).
d. It reports several cash activities that the income statement does not include and that can be
determined from the balance sheet only if you know how to do it, such as expenditures on
additional noncurrent assets, proceeds from the sale of such assets, and the raising and
repayment of noncurrent liabilities and share capital.
e. It reports how much cash was used to pay dividends.
2. Net change in cash = $127,976 - $238,040 + $107,000 = -$3,064.
Solution Outline for Problem 4.4
Some points that might be raised:
•
•
•
analysts pay attention to income performance already - it is not ignored in favour of cash flow
information, but rather that information adds to the understanding of performance;
the strong interest in performance is what produces the interest in cash flow - it is not just idle
interest;
monitoring management's performance is an important activity, springing from a belief by
investors and others that managers should not be just left to work on their own - the interest in cash
is a natural part of this;
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Financial Accounting: An Integrated Approach, Sixth Edith
•
•
there's more to managing cash than just daily attention - such important but not usually frequent
activities as making investments in long-term assets, raising long-term financing and issuing share
capital are also involved;
income performance and cash flow performance can be quite different, so it is not satisfactory to
make presumptions about cash management based on income performance.
Solution Outline for Problem 4.5
Some points for discussion:
Spending more money to produce cash flow statements?
• Cash flow statements are not costly to prepare. They are not based on the accounts in the way the
income statement is; they are an analysis of the income statement, balance sheet, and retained
earnings information.
• Users of financial information could reconstruct the cash flow statement using the balance sheet
and income statement information. (Not in quite as much detail as that provided by management.)
Creating a dubious income measure and then uncreating it?
• Accrual accounting measures performance over time by measuring changes in wealth.
• Changes in wealth are unequal to changes in cash.
• The cash flow statement measures another aspect of performance, i.e. the managing of inflows and
outflows of cash, so that the entity has enough cash to pay its bills, finance its growth and keep
borrowing under control.
• Cash situation of the entity can be obscured by accrual accounting.
No need for cash flow statement?
• Cash flow statements report three main kinds of changes in cash, cash from operations, cash from
investing activities and cash from financing activities.
• Cash from operations is basically a cash flow income statement.
• The income statement does not give information about the financing and investing activities of the
entity.
• The cash flow statement provides information about the solvency and liquidity of the entity. The
income statement does not provide this information.
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Instructor’s Solution Manual
Solution Outline for Problem 4.6
Cash Flow Statement
for the Year X
Operating Activities:
Cash receipts ($31,610 + $797,640)
Cash disbursements ($8,920 + $513,600 + $14,920 + $223,610)
Cash generated by operations
Investing Activities:
Noncurrent assets acquired ($81,000 + $49,000)
Proceeds from disposal of noncurrent assets
Cash used in investing activities
Financing Activities:
Bank loan obtained
Repayments on mortgage
Common shares issued
Paid to redeem preferred shares
Dividends paid
Cash obtained from financing activities
Increase in cash for the year
Cash on hand at the beginning of the year
Cash on hand at the end of the year
$ 829,250
761,050
$ 68,200
$(130,000)
7,000
$(123,000)
$ 60,000
(80,500)
140,000
(25,000)
(15,000)
$ 79,500
$ 24,700
68,920
$ 93,620
Solution Outline for Problem 4.7
Ryley's Dog Treats Inc.
Cash Flow Statement for the Year X (Direct Method)
Operations:
Cash receipts (919,160 + 65,580)
Cash disbursements (468,380 + 365,730 +
32,400 + 32,490)
984,740
(899,000)
85,740
Investing:
Noncurrent assets acquired (132,000 + 233,750)
Proceeds from disposal of noncurrent assets
Financing:
Bonds issued
Repayments on mortgage
Common shares issued
Paid to redeem preferred shares
Dividends paid
(365,750)
29,700
(336,050)
90,000
(73,700)
242,000
(44,000)
(33,000)
181,300
Decrease in cash for the year
Cash on hand at the beginning of the year
Cash on hand at the end of the year
(69,010)
108,270
39,260
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Financial Accounting: An Integrated Approach, Sixth Edith
Solution Outline for Problem 4.8
Hannibal's Fine Dining Ltd.
Cash Flow Statement for the Year X (Direct Method)
Operations:
Cash receipts (850,630 + 3,100)
Cash disbursements (168,580 + 229,850 + 149,240 +
63,170)
Investing:
Noncurrent assets acquired (40,000 + 30,000)
Proceeds from disposal of noncurrent assets
$853,730
(610,840)
242,890
(70,000)
6,500
(63,500)
Financing:
Withdrawls on line of credit
Repayments on mortgage
Common shares issued
Paid to redeem preferred shares
Dividends paid
20,000
(97,500)
30,000
(50,000)
(80,000)
(177,500)
Change in cash
Cash on hand at the beginning of the year
Cash on hand at the end of the year
1,890
146,800
$148,690
Solution Outline for Problem 4.9
Operations:
Cash receipts (48,000 + 944,980)
Cash payments
Investing:
Equipment purchased
Building sold
$992,980
(832,630)
160,350
(580,340)
290,000
(290,340)
Financing:
Bonds issued
463,000
Shares issued
90,000
Bonds repaid
(373,000)
Dividends paid (100,000 – 20,000)
(80,000)
100,000
Change in cash
Cash beginning (deduced)
Cash end (43,220-17,530)
(29,990)
55,680
$25,690
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Instructor’s Solution Manual
The following items do not involve cash and are therefore irrelevant:
• Accounts receivable written off
• Amortization expense
• Inventory purchased on credit
• Investment written down
• Shares issued in exchange for land
Solution Outline for Problem 4.10
Northern Star Theatre Company
Cash Flow Statement
for the Period November 5, 2005, to August 26, 2006
Operations:
Partnership income for the period
Add back amortization expense
Increase in interest receivable and inventory
Increase in accounts payable
Cash from operations
Investing activities:
Costumes and props
Financing activities:
Contributions by partners
Cash provided during the period and on hand at its end
$3,420
132
(100)
940
$4,392
(660)
1,450
$5,182
Solution Outline for Problem 4.11
1.
Accrual Basis
Sales
Cost of goods sold
Gross profit
Operating expense
Amortization
$38
Miscellaneous
146
Rent
Wages
________
184___
Cash Basis
Sales
Cost of goods sold
Gross profit
Operating expense
Amortization
Miscellaneous
Rent
Wages
Net income for the
year
$ 322
Net income for the
year
$1,206
700
$ 506
Accrual notes:
Sales: 860 = 346 = 1,206
Cost of goods sold = 185+610+135-230 = 700
Miscellaneous 145+12-5-6 = 146
Wages and rent included in Miscellaneous
Cash basis notes
Cash sales + Acct. rec. collections:
860+85+346-110=311
Wages included in Miscellaneous.
105
1,181
735
$446
$
145
6
_____
151_____
___
$295___
Financial Accounting: An Integrated Approach, Sixth Edith
2.
Micadam Inc
Statement of Cash Flows
For the Year Ended December 31, 2006
Net income
Amortization
$ 322
38
360
Increase in accounts receivable
Increase in inventory
Increase in accounts payable
Increase in wages payable
Increase in prepaid rent
Cash flow from operations
(25)
(45)
10
7
(6)
(59)
$ 301
Solution Outline for Problem 4.12
Saint John Enterprises Inc.
Cash Flow Statement
For the Year 2003
Operations:
Net income
$ 38,400
Add (subtract) non-cash items:
Amortization expense
Noncurrent asset write-off 112,000
Future income taxes
Gain on sale of truck
Change in working capital accounts:
Current assets
Current liabilities
37,700 (2)
8,800
(700)
(40,600)
25,800 (1)
$ 181,400
Investing:
Proceeds from sale of truck 8,400
Acquisition of noncurrent assets
Cash used in investing activities
(191,000) (2)
$(182,600)
Financing:
Payment of noncurrent liabilities
Increase in share capital
Dividends paid
Cash from financing activities
(9,300) (3)
20,000
(8,500) (4)
$ 2,200
Net increase in cash
Cash beginning of the year
Cash end of the year
$ 1,000 (5)
5,200
$ 6,200
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Instructor’s Solution Manual
Solution Outline for Problem 4.12 (Continued)
(1) Change in current liabilities 27,300
Dividends payable
(1,500)
25,800
(2) Reconciliation of noncurrent assets:
Balance 2002
NBV of truck sold
Amortization expense
Acquisition of assets
Written-off
(112,000)
Balance 2003
286,200
(7,700)
(37,700)
191,000
319,800
Note: We see the NBV of truck sold in the cash flow statement as follows:
Investing - proceeds of disposition
8,400
Operating - gain on sale
(700)
NBV of truck sold
7,700
(3) Change in noncurrent liabilities
Increase in future income tax liability
Payment of noncurrent liabilities
(500)
(8,800)
(9,300)
Note: We know that the total noncurrent liabilities changed by (500) and that + 8,800 was due to
future income tax, so by deduction, the company must have repaid 9,300 of some other noncurrent
liabilities.
(4) Dividends declared
Dividends payable
Dividends paid
10,000
(1,500)
8,500
(5) Change in cash equivalent assets
Change in cash equivalent liabilities
Net increase in cash
3,100
(2,100)
1,000
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Financial Accounting: An Integrated Approach, Sixth Edith
Solution Outline for Problem 4.13
Gronsky’s Great Things Ltd.
Cash Flow Statement
For the year Ended August 31, 2007
Operations
Net income
Amortization
Non-cash working capital changes
Accounts receivable
Income tax receivable
Inventory of clothing
Supplies inventory
Prepaid rent
Accounts payable
Credit note liability
35,050
3,750
(4,375)
(950)
(37,775)
(11,250)
(2,500)
28,750
550
Investing
Purchase of furniture and fixtures
Purchase of investment
Incorporation costs
Financing
Loan
Dividends paid (4,000 – 2,000)
(27,550)
11,250
(19,375)
(12,500)
(2,375)
(34,250)
10,000
(2,500)
7,500
Change in cash
Cash, beginning
Cash, ending
(15,500)
18,750
3,250
Solution Outline for Problem 4.14
Wriggle Corp.
Cash Flow Statement
For the Year Ended December 31, 2007
Net income
Amortization
$ 21
9
30
Increase in accounts receivable
Increase in inventory
Increase in accounts payable
Gain on disposal of fixed assets
Loss on disposal of investment
Cash flow operations
(12)
(6)
6
(3)
6
108
(9)
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Instructor’s Solution Manual
Investing activities:
Disposal of investments
Disposal of fixed assets
Purchase of fixed assets
Net Cash outflow investing
Cash used by investing activities
Financing activities:
Issuance of long-term notes payable
Issuance of common shares
Dividends paid
Net cash flow financing
Net increase in cash
$ 15
12
(60)
(33)
$12
15
(9)
18
$6
2.
•
•
•
•
•
Wriggle had a positive cash flow for the year
Proportionately large outflow in investing (purchase of fixed assests)
Operations provided insufficient cash to make fixed asset purchases
Increased both long-term debt and share capital to pay for acquisitions
Company would appear to be expanding capacity in the expectation of increase sales
Solution Outline for Problem 4.15
There is enough information to prepare an indirect cash flow statement, so this is illustrated below.
Net income:
Cash receipts:
Collection of this year’s revenue
Uncollected revenue at the end of this year
347,085
28,116
375,201
Payment of this year’s expenses
Amortization
Unpaid expenses at the end of this year
267,269
42,221
26,417
(335,907)
Proceeds on sale of equipment
Cost of equipment that was sold
Accumulated amort. on equipment that was sold
2,160
(14,400)
10,800
Collection of this year’s revenue
Collection of last year’s revenue
Deposit on next year’s revenue
Noncurrent debt issued
Proceeds on sale of equipment
(1,440)
37,854
347,085
20,516
5,489
67,500
2,160
442,750
Cash disbursements:
Payment of this year’s expenses
Payment of last year’s expenses
Advance payment on next year’s expenses
Repayment of noncurrent debt
Purchase of new equipment
109
267,269
1,701
8,028
27,000
164,178
468,176
Financial Accounting: An Integrated Approach, Sixth Edith
Ending cash:
63,419 + 442,750 - 468,176 = 37,993
If the direct method were used, cash from operations would be shown as:
Cash received from customers: 347,085 + 20,516 + 5,489 =
Cash paid to suppliers: 267,269 + 1,701 + 8,028 =
373,090
(276,998)
96,092
Chatal Inc.
Cash Flow Statement for Year X
Operations
Net income
Amortization
Loss on disposal
$42,060
46,912
1,600
$90,572
Changes in non-cash working capital:
Receivables (22,795 - 31,240)
Prepaids ( 0 - 8,920)
Payables (1,890 - 29,352)
Deferred revenue (0 - 6,099)
$(8,445)
(8,920)
27,462
6,099
16,196
$106,768
Investing
Purchase of new equipment
Proceeds from equipment sale
$(182,420)
2,400
$(180,020)
Financing
Issue of long-term debt
Repayment of long term debt
$ 75,000
(30,000)
$45,000
Decrease in cash for the year
$(28,252)
Cash at beginning of the year
63,419
Cash at end of the year
$35,167
Solution Outline for Problem 4.19
1. If the garage had brought $40,000 instead of $25,000, cash used in investing activities would have gone
down $15,000 for the proceeds, to $212,414. In Operations, income would have been $15,000 higher
because the garage disposal would have produced a $10,000 gain instead of the $5,000 loss shown in
the Problem 4.30* solution. But this would cancel out in calculating cash from operations, because
instead of a $5,000 loss being added back to income of $56,292, there would have been a $10,000 gain
deducted from an income of $71,292. So no effect on cash from operations, and the lower Investing net
outflow would carry down to the bottom cash change, which would be $15,000 higher, and ending
cash would therefore be $15,000 higher at $31,064. This makes sense, as the company would have
$15,000 more cash from the garbage disposal.
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Instructor’s Solution Manual
2. Ignoring part 1, this would have changed the $5,000 loss on sales to a $7,000 gain ($25,000 proceeds
minus $18,000 book value). But that change would mean that the amortization expense deduced in
Problem 4.30* would have been $12,000 higher. So in Operations, the amortization add-back would be
$12,000 higher and instead of a $5,000 loss add-back there would be a $7,000 gain deducted, for a
change of $12,000 in the opposite direction. So no net effect on cash from operations or cash on hand.
This makes sense, because a change in the garage’s accumulated amortization doesn’t involve cash at
all, so cannot have any effect on the cash flow statement.
Solution Outline for Problem 4.16
a. Cash from operations = $11,000 income + $5,000 amortization – $4,000 gain + $3,000 future tax
expense + $13,000 loss – $1,000 change in OCA + $2,000 change in OCL = $29,000.
b. Cash from financing = $2,000 shares + $4,000 debt* – $6,000 dividend = $0.
(*Debt change: NCL begin = $18,000 + $3,000 regular future tax – $8,000 future tax reduction on
special item = $13,000. Present NCL = $17,000, so it seems $4,000 more debt was incurred.)
c. Cash for investing = $34,000 new spending** – $7,000 proceeds = $27,000 net outflow.
(** New spending: NCA begin = $32,000 – $21,000 write-off – $3,000 book value of item sold –
$5,000 amortization = $3,000. Present NCA = $37,000, so it appears that $34,000 of new spending
happened.)
d. From above, $29,000 + $0 – $27,000 = $2,000. Looking at the CEA and CEL categories, the net
cash (CEA – CEL) was $(2,000) at the beginning and $0 at the end, an improvement of $2,000.
Solution Outline for Problem 4.17
Aragon Ltd.
Cash Flow Statement
for the Year X
Operating activities
Net income for the year
$216,350
Add back: Amortization
$ 218,890
Future income tax expense
21,210
240,100
Noncash working capital changes
Increase in accounts receivable
(223,120)
Decrease in inventory
80,200
Decrease in accounts payable
(91,970)
Increase in current income tax payable
6,530
(228,360)
Cash from operating activities
$228,090
Investing activities
Additions to noncurrent assets
$(393,980)
Proceeds from sales of noncurrent assets
11,260
Cash used by investing activities
(382,720)
Financing activities
New noncurrent debt
$ 250,500
Repayments of noncurrent debt
(78,800)
Share capital issued
120,000
Dividends paid
(75,000)
Cash from financing activities
216,700
Change in cash for the year
$ 62,070
Beginning cash
(13,730)1
Ending cash
$ 48,340
1
-The beginning cash figure is deduced from the change in cash for the year and the ending cash
balance, both of which are known from Fred’s draft statement.
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Financial Accounting: An Integrated Approach, Sixth Edith
Solution Outline for Problem 4.18
Effects if the event had occurred during the year:
a. Investing would show an expenditure of $38,950, which would reduce the cash inflow from Investing
activities. The net change in cash would be $38,950 lower.
b. Investing would now show an expenditure of $18,950 ($38,950 – $20,000), which would reduce the
cash inflow from Investing activities. The net change in cash would be $18,950 lower.
c. The change in accounts receivable would have been $6,000 higher in the direction of reducing cash
in the Operating activities section of the statement, because this revenue is reflected in income but
hasn’t yet been collected. Cash from operating activities and the net change in cash would be
$6,000 lower.
d. Dividends would show a cash outflow of $15,000, which would reduce the cash inflow from
Financing activities. The net change in cash would be $15,000 lower.
e. The demand loan would increase the cash inflow from Financing by $25,000, and the change in
cash would also be $25,000 higher.
f. No change. In Operating activities, net income would be $5,000 lower but then the amortization
added back in the Operations section would be $5,000 higher, cancelling out the effect. Therefore,
there is no effect on the net total change in cash. Amortization has no effect on cash or on total cash
from operations.
Solution Outline for Problem 4.20
2004
a) Additions to properties (673.8 + 25.0)
Cash used in investing activities (666.1 + 25.0)
Increase (decrease) in net cash (218.3 - 25.0)
Net cash at end of year (353.0 - 25.0)
(698.8)
(691.11)
193.3
$ 328.0
b) Issuance of Common Shares (2.5 + 14.0)
Cash provided by (used in) financing activities (98.4 + 14.0)
Increase (decrease) in net cash (218.3 + 14.0)
Net cash at end of year (353.0 + 14.0)
16.5
112.4
232.3
$ 367.0
c) Net income (413.0 + 10.0)
Depreciation and amortization (407.1 - 10.0)
Cash provided by operating activities
Increase (decrease) in net cash
Net cash at end of year
$ 423.0
397.1
no change
no change
no change
d) Repayment of long-term debt (16.1 + 130.0)
Cash provided by (used in) financing activities (98.4 - 130.0)
Increase (decrease) in net cash (218.3 – 130.0)
Net cash at end of year (353.0 –130.0)
(146.1)
31.6
88.3
$ 223.0
e) Track dismantling (costs) net of proceeds from
disposal of transportation properties (10.2 + 7.0)
Cash used in investing activities (666.1 + 7.0)
Increase (decrease) in net cash (218.3 – 7.0)
Net cash at end of year (353.0 – 7.0)
(17.2)
(659.1)
225.3
$ 360.0
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Instructor’s Solution Manual
f) Accounts receivable (Note 10) (39.0 - 5.0)
Change in non-cash working capital (Note 10) (33.2 + 5.0)
Change in non-cash working capital balances
Cash provided by operating activities (786.0 + 5.0)
Increase (decrease) in net cash (218.3 + 5.0)
Net cash at end of year (353.0 + 5.0)
$ 34.0
38.2
791.0
223.3
$ 358.0
Solution Outline for Problem 4.21
1.
Two figures in the cash flow statement are incorrect. The change in accounts.payable (in Operations)
includes the dividend payable, so the increase in that payable has the effect of increasing cash from
operations, via an incorrect change in noncash working capital accounts. The dividend figure in the
Financing section is also wrong, by the same amount, because so far, it will have been assumed that
the whole dividend declared had been paid. The declared amount should have been reduced by the
payable (unpaid) amount so that the Financing section showed only the cash paid for dividends. So
cash from Financing is too low, and cash from Operations is too high, by the same amount. The two
cancel out in their effect on the total change in cash.
2.
a. Let x be the acquisitions during the year. Then x - $159,400 amortization expense - $790,000 cost
removed when building was sold + $610,000 accumulated amortization removed when building was
sold = $382,500 net change. Solving, x = $721,900. Going the other way, $721,900 - $790,000 $159,400 + $610,000 = $382,500,
b. The book value of the building was $790,000 - $610,000 = $180,000. The $190,000 proceeds $180,000 book value = $10,000 gain on sale.
c. Add back amortization of $159,400; subtract gain on sale of $10,000.
d. Investing would show $721,900 acquisitions minus $190,000 proceeds, for a net expenditure of
$531,900.
Solution Outline for Problem 4.22
This problem is an example of “what if” or “change effects” analysis, an important skill to be emphasized
in later chapters.
1.
2.
There would be no effect on the cash flow statement as long as the demand bank loan is considered
part of the total cash and cash equivalents explained by the cash flow statement. It's just a
rearrangement within CCE: the CCE figures at the bottom would show cash going up by $250,000
and bank loan going up by the same. The two changes would cancel out in calculating total CCE
change. (If there had been a long-term loan, CCE would have gone up by $250,000 due to the
increased cash and that increase would be explained by a cash inflow under the cash flow statement's
financing activities category.)
Cash generated from operations would go up because the change in accounts receivable would be
reduced by $75,000, which would look the same as if the money had been collected from customers.
Cash used by investing activities would also go up, as if the company had gone out and made a
$75,000 long-term investment. The net effect on CCE would be zero: quite properly, as no cash
actually was affected by the reclassification.
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Financial Accounting: An Integrated Approach, Sixth Edith
3.
4.
5.
6.
Cash used by investing activities would go up by $710,000, as would cash received from financing
activities. There would be no net effect on CCE as cash position is really unaffected by a 100%
financed acquisition. (The cash flow statement “grosses up” the transaction as if the $710,000 was
deposited from the borrowing and then expended purchasing the land. Indeed, this may well have
happened, or instead a lawyer or trustee may have handled all the cash. No matter: the cash flow
statement tells us about it anyway.) If the financing had been by equity instead of debt, there would be
little effect: instead of the “debt” line under financing activities showing the $710,000 cash receipt,
the “equity” line would.
Income would go down by $82,000 and the amortization added back to income at the top of the cash
flow statement would go up by $82,000. There would therefore be no effect on cash from operations
or any other part of the cash flow statement, including on the CCE figure. This is as it should be:
there was no cash involved in the increase of depreciation expense.
CCE would go down by $50,000 when the cash was paid, and the reason would be shown under the
dividends paid category of the cash flow statement. Until the dividend is paid, the cash flow statement
would not reflect the dividend declaration because no cash has yet been paid out.
Income would go down by $35,000, as would CCE due to the disbursement of the cash. Thus the
CCE figure would be $35,000 lower and would be explained by reduced cash generated from
operations.
Solution Outline for Problem 4.23
•
•
•
•
•
•
Cash began and ended negative in spite of much activity, but the change in cash was positive so the
situation improved.
Cash from opeartions was more than twice net income so that is good, but increased accounts
receivable (possible collection problems) and inventories (possible selling problems), combined
with increased payables (possible problems keeping up with bills), suggest difficulty with managing
the day-to-day cash and with working capital management.
Investing activities were almost twice the cash from operations, and given the lack of cash on hand,
the company had to get substantial financing to support the asset acquisitions. Not much cash was
obtained by selling noncurrent assets, so management seems to be building up the company’s plant
and equipment.
Amortization expense was twice the income and almost equal to cash from operations, but only half
the new long-term investment. This supports the idea that the company’s productive capacity is
growing and being kept up to date.
Financing activities seemed to be complicated by substantial debt repayments—another demand on
cash (we don’t know if the debts had come due or if the company chose to repay them, perhaps to
refinance and get lower interest rates); therefore, almost $550,000 of new financing was required.
This was raised mostly through debt, but also additional shares were issued (perhaps to keep the
debt-equity mix from becoming too much weighted to debt).
The company chose to pay out almost 40% of net income as dividends. If that had not been done,
there would have been almost no cash deficit at the end of the year.
Solution Outline for Problem 4.24
•
•
Cash from operations was nearly five times as large as net income.
Accounts receivable increased while inventories decreased. This suggests that management has
allowed collections to slip a bit, however the increase in receivables may result from an increase in
sales. The decrease in inventories may signal more effective management of stock on hand.
Definitive analyses would require examination of both balance sheet movements and income
statement amounts. Accounts payable has increased and this may signify difficulty with paying
bills timely.
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Instructor’s Solution Manual
•
•
•
•
Investing activities were about 60% of cash from operations and approximately 20% amortization
expense. Wemakem does not appear to be growing but simply maintaining its productive capacity.
Wemakem made significant debt repayments. There was no need to issue additional debt, as more
than enough cash was generated to support what little investing was done.
Dividends in excess of net income were paid out to shareholders. This high dividend payout ratio,
combined with minimal investing activity seems to suggest that Wemakem is a “cash cow”.
There has been an overall decline in cash but that is not a bad thing if the money in the bank is not
earning much in the way of interest and can be put to better use.
Solution Outline for Problem 4.25
•
•
•
•
•
Cash flow Provided by Operating Activities declined significantly, 58%,((877.4 – 368.5/877.4))
in 2003. This is mostly due to changes in operating assets and liabilities. Note 19 shows that the
major changes were the increases in inventory and accounts receivable. The accounts receivable
collection period rose from 99.9 days in 2002 (817.5/(2987.7/365)) to 136.6 days
(1,120.7/(3061.7/365)) in 2003. This may have been the result of accounts receivable acquired
with subsidiaries purchases or the collections may have slowed. Not 1 states that inventories are
valued at the OEB approved price. Thus the increase in inventory value reported may have
arisen from any combination of price increase and volume of gas in storage.
The proceeds of disposition of non-current assets provided about three-quarters of the funds
requires to support acquisitions, long-term investments and additions to property plant and
equipment in 2002
Investments in new long-term assets was so much lower in 2003 that the sale of other assets and
collections of loans from affiliates generated surplus funds.
2004 showed a return to increased investment in long-term assets with investing activities using
more funds than were generated from operating activities.
Net debt reduction was significant in both 2002 and 2003. 2004 showed a return to net
borrowings largely to finance the return to increased investment activities.
Solution Outline for Problem 4.26
1. The story of how there can be a profit but no cash on hand is clearly set out in the cash flow
statement:
Cash income for 2007 was
$12,000
The bank loan provided more cash
7,000
$19,000
There was cash on hand at the beginning
1,000
Total cash available
$20,000
Bikes and shed were purchased
20,000
So no cash left
$
0
Natasha spent all the cash from the profit, and more, on the new bikes and the shed.
2. The loan from Natasha’s parents would increase 2007 cash by $5,000 and would be shown under
Financing in the cash flow statement, as the 2006 loan was. The bank loan is a little trickier:
• If the extra bank loan were treated as the 2007 loan was then it would increase cash by $2,000
and would be shown under Financing just to keep the direct financing sources separate;
• If the cash flow statement’s definition of cash were broadened to include cash and equivalents
(as in most cash flow statements), and if this loan were considered part of CCE because of its
demand nature, then this loan would have no effect on the cash flow statement. Cash would go
up by $2,000 but the loan (part of CCE) would go up the same, so there would be no net effect
on CCE even though plain cash went up.
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Financial Accounting: An Integrated Approach, Sixth Edith
3. If Natasha continues the business, she will not have to pay for a shed or bicycles next year. She should
therefore have a great deal of extra cash. She could potentially borrow against the bicycles on a longterm loan as the bicycles should be able to generate revenues for many years.
Solution Outline for Problem 4.27
Operations: $100,000 + $200,000 – $150,000 – $25,000 = $125,000 cash generated
Investing: $600,000 – $30,000 proceeds = $570,000 cash used
Financing: $90,000 + $250,000 + $100,000 – $40,000 = $400,000 cash obtained
Change in cash overall = $125,000 – $570,000 + $400,000 = negative $45,000
Comments:
• Yes, the comfortable $50,000 cash on hand from last year end has been reduced to a marginal
$5,000 this year end.
• Collection problems and increased inventory took a very large bite out of cash from operations. The
receivables increase alone is three times the year’s cash decline.
• Cash from operations would have been almost enough to complete the company’s financing needs,
if dividends had not been paid.
• It can be argued that dividends are the least necessary payment to make if cash is short: if they had
not been paid, there would have been only a small decline in cash, or else much less need for the
bank loan.
• The company did not provide enough financing to pay for the new assets (given the collection
problems): investing activities cost $570,000 but financing amounted to a net of only $400,000, and
that included the $90,000 bank loan.
• The company spent three times as much on new assets as amortization expense, suggesting that the
company is keeping assets up to date; indeed, the spending on new assets is so much above the cash
from operations that the company appears to be growing rapidly. Cash strains often accompany
growth.
Solution Outline for Problem 4.28
1.
•
The narrator was likely referring to the net income figure which has shown an increasing trend
with the exception of 2000 and 1994.
2.
•
•
•
•
Total net income ten years - $28.2 million.
Total cash flow from operation for ten years - $28.7 million.
Net income is very smooth and generally increasing.
Is there a possibility of net income manipulation given how variable the business is supposed to
be?
Cash from operations is not smooth at all (time variability?).
In recent years, cash from operation is not generally larger than net income, therefore the company
must be piling up accounts receivables and inventory minus accounts payable in the same amounts
as depreciation.
Assets have grown $21.3 million over ten years and bank loans have grown $10.2 million, so this
is an example of the need to borrow, due to lack of internally generated funds.
Bank loans used to be 34% of total assets, now they are 40% of total assets.
Not covered in text yet but NI/Assets = 8.6% in 1994 and 7.4% in 2003, so the company's relative
performance is slipping a bit (perhaps because of higher interest charges on its borrowing.)
•
•
•
•
•
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Instructor’s Solution Manual
3.
•
•
•
Existing research has found only small market reactions to cash flow statement information,
perhaps because net income and cash flow are quite highly correlated.
Although in some years cash and income are very similar for this company, for other years they
are quite dissimilar. May observe a price reaction in years in which results are quite dissimilar
(e.g. 2003).
Might also note that stock market reaction to earnings is quite strong, and this may outweigh the
effects of added cash flow statement information.
Solution Outline for Problem 4.29
Lambic Beverages Inc.
Cash Flow Statement
for This Year
Operating activities
Net loss
Add back: Amortization expense
Future income tax expense
Noncash working capital changes:
Accounts receivable
Inventory
Accounts payable
Income tax payable
Cash from operating activities
Investing activities
Increase in noncurrent assets
Financing activities
Repayment of bank loan
Repayment of debt
Share capital issued
Dividends paid
Cash used by financing activities
Change in cash
Cash, beginning of year
Cash, ending of year
$ (210)
$ 2,630
250
$(1,150)
470
1,020
(330)
2,880
10
$2,680
(1,850)
$(1,100)
(540)
300
(50)
(1,390)
$ (560)
1,120
$ 560
Comments on the statement:
• Cash flow is quite positive in spite of negative income.
• The increase in accounts receivable suggests that there may be a problem with collections.
• The increase in accounts payable is inconsistent with the reduction in inventory.
• Less has been spent on new assets than amortization, so the book value of noncurrent assets is
lower (are they being kept up to date?).
• Financing had a negative net effect because debt repayments and the large repayment on the bank
loan exceeded proceeds from new share capital.
• Overall, the company’s entire financing came from operating activities because all other cash flows
were negative. Cash remained positive, however, so reductions in the company’s bank loan and
debt were probably sensible, saving interest and reducing risk.
This Year
Last Year
Working capital ratio 8,210 / 7,640 = 1.075
8,090 / 8,050 = 1.005
Debt-equity ratio
(7,640 + 14,060) / 5,420 = 4.00 (8,050 + 14,350) / 5,380 = 4.16
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Financial Accounting: An Integrated Approach, Sixth Edith
Comments on ratios:
• The decline in cash is countered by a slight improvement in the working capital ratio, but the
current position is not strong because the working capital remains only slightly positive.
• The debt-equity ratio has also improved: the company paid off debt and raised share capital greater
than the sum of the loss and dividends.
Solution Outline for Problem 4.30
Tamarack Systems Inc.
Cash Flow Statement
for the Year 2007
Operating activities
Net income
$ 56,292
Noncash expenses ($139,904 amortization* +
$5,000 garage loss + $35,000 land write-off +
$4,075 warranty provision** + $4,516 future tax expense)
188,495
Noncash working capital changes ( – $76,706 accounts receivable +
$10,815 inventories + $5,317 prepaids
+ $35,987 accounts payable + $1,138 taxes payable)
(23,449)
Cash from operating activities
$ 221,338
Investing activities
Additions ($37,500 land*** + $279,914 building****)
$(317,414)
Proceeds from disposal (garage)
25,000
Cash used by investing activities
$(292,414)
Financing activities
Bank loan obtained
$ 21,700
Repayment of bonds ($22,000 – $2,000 current)
(20,000)
Warranty payments**
(7,000)
Shares issued ($50,000 – $5,000 non-cash exchange for land***)
45,000
Dividends paid ($24,000 declared + $6,000 from year before)
(30,000)
Cash from financing activities
$ 9,700
Decrease in cash and short-term investments for the year
$ (61,376)
Cash and short-term investments on hand at the beginning of the year
77,440
Cash and short-term investments on hand at the end of the year
$ 16,064
* Change in accumulated amortization = $69,904, but the garage’s $70,000 amortization
would have been removed when it was sold, so there must have been an addition, due to expense,
of $139,904.
** Warranty change = $2,925 down, but that was after paying out $7,000, so a further noncash
expense provision of $4,075 must have been made.
*** Land change = $7,500. This was after a $35,000 write-off, so there must have been
additions to land of $42,500. But $5,000 of that was a noncash exchange for shares, so the cash
spent on land was $37,500.
**** Building cost change = $179,914, but the garage’s $100,000 cost would have been removed
when it was sold, so the additions to building must have cost $279,914.
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Instructor’s Solution Manual
Comments:
• Tamarack generated about all the cash it needed to finance its investing from operations, so it
needed little noncurrent financing and still managed a small increase in cash.
• Cash from operations was four times net income. This demonstrates that accrual income can be a
poor guide to cash flow.
• Cash was maintained partly by cashing in the temporary investments on hand last year. So you
could say that near-cash resources actually went down this year: there are no temporary investments
left to use if there are cash needs next year.
• The rise in accounts receivable was the only negative in the otherwise cash-increasing management
of noncash working capital accounts. If the receivables had not risen so much, the company would
not have had to liquidate its temporary investments.
Solution Outline for Problem 4.31
1.
Cash and cash equivalents could be defined in various ways. Defining CCE as "cash plus 30-days
term deposits" produces the following cash flow statement:
Greenplace Restaurants Inc.
Cash Flow Statement for 2006
Operations:
Net income
Add back non-cash expenses (amortization)
Changes in non-cash working capital:
Receivables
Inventories
Prepaid expenses
Trade payables
Taxes payable
Cash generated by operations
$ 61,140
47,110
$108,250
$ 24,489
(37,241)
(8,778)
37,970
(9,498)
Investing activities:
Cash used to acquire buildings and equipment
Financing activities:
Cash obtained through mortgage
Cash obtained through bank loan
Cash obtained from shares issued
Dividends paid
6,942
$115,192
(206,942)
$ 45,500
24,780
35,000
(21,000)
Decrease in cash and equivalents
84,280
$(7,470)
Reconciliation of change in cash and equivalents:
Increase in cash
Decrease in term deposits
$ 3,030
(10,500)
$(7,470)
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Financial Accounting: An Integrated Approach, Sixth Edith
2.
What the cash flow statement reveals about the company's 2006 cash management:
•
cash (CCE) declined during the year;
•
cash from operations was positive but was used up in investing activities;
•
most of the cash from operations arose from income - there were many changes in noncash working capital accounts, but they all netted out close to zero, so the company
appeared to be keeping its working capital under control;
•
dividends caused a fairly minor drain on cash;
•
acquisition of buildings and equipment caused a very large drain on cash, larger than cash
from operations and from financing put together - this indicates the company is keeping its
operating assets up to date;
•
cash from financing was divided between debt and equity, with twice as much coming
from debt as from equity;
•
all in all, cash management seems to have been all right, with most of the cash
from income used to acquire operating assets and not much used to pay dividends or
increase current assets - however, more information about the policies and actions behind
the figures is needed to make a proper evaluation of the cash management.
Solution Outline for Problem 4.32
1.
Fuzzy Wuzzy Wines Ltd.
Cash Flow Statement
For the Year Ended August 31, 2006
Operations:
Net income
Non-cash items:
Amortization
Write-off on building
Changes in non-cash working capital:
Receivables (went up, tied up cash)
Inventories (went up, tied up cash
Payables (went up, saved cash)
$ 235
$210
45
$(170)
(90)
225
Investing:
Increased factory investment (used cash)
Decreased term deposit (produced cash)
Financing:
Long-term loans reduced (used cash)
Share capital issued (produced cash)
Bank loan received (produced cash)
Dividend paid: as given (used cash)
Net decrease in cash for the year
120
$(655)
150
$(175)
200
40
(110)
255
(35)
$455
(505)
(45)
$(95)
Instructor’s Solution Manual
2.
Degree of happiness with management's performance depends on the story behind what the cash
flow statement reveals. There is one main good thing: substantial cash was generated by
operations. However, that is clouded by large increases in receivables and inventories, tying up
cash. Apparent difficulties in paying bills are shown by the large rise in payables. The company
put a great deal of money into its factory: if this improved products or competitiveness, the
company may be well fixed for the future, but it probably cannot stand another year with a cash
decrease. Perhaps strangely, the company repaid a lot of long-term debt in the year it was
acquiring new factory assets. As that was offset by new share capital issued, perhaps the company
was trying to reduce its debt risk. (Even with the increases in payables and bank loan, the
debt/equity ratio improved from 0.88 in 2005 [$700/$800] to 0.70 in 2006 [$790/$1,125].)
We can see that this cash flow statement tells us a lot about what happened to the company during
the year. Some of the results are fairly clear, others (such as the factory expenditures and the
financing changes) require more investigation or data.
Solution Outline for Problem 4.33
Prairie Products Inc.
Balance Sheet as at November 30, 2007
(With 2006 Figures for Comparison)
(in thousands of dollars)
ASSETS
2007
Current assets:
Cash
Marketable sec.
Accounts rec.
Inventories
Prepaid expenses
Noncurrent assets:
Land cost
Buildings cost
Equipment cost
Accum. amort.
Investments, cost
TOTAL
$ 31
100
281
321
12
$745
2006 Change
$ 38
200
315
239
18
$810
(7)
(100)
(34)
82
(6)
(65)
$182
$ 70
761
493
643
510
$1,586 $1,073
112
268
133
513
631
$ 955
365
$1,320
(62)
451
(73)
378
569
$ 504
438
$ 942
$2,065 $1,752
313
LIABILITIES AND EQUITY
2007
2006 Change
Current liabilities:
Bank loan
$ 25
$ 30
(5)
Accounts payable
195
284
(89)
Taxes payable
34
20
14
Dividends payable
20
30
(10)
$274
$364
(90)
Noncurrent liabilities:
Mortgage payable
Bonds payable
Future income tax
Warranty liability
Shareholders' equity:
Share capital
Retained earnings
TOTAL
121
$240
200
138
126
$704
$280
0
111
118
$509
(40)
200
27
8
195
600
487
$1,087
450
429
$ 879
150
58
208
$2,065
$1,752
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Financial Accounting: An Integrated Approach, Sixth Edith
Prairie Products Inc.
Cash Flow Statement
For the Year Ended November 30, 2007
Operations:
Net income
Add (subtract) items not affecting cash:
Amortization expense
Loss on sale of building
Future income tax
Warranty expense
Gain on sale of investments (29)
Change in working capital accounts:
Accounts receivable
Inventories
(82)
Prepaid expenses
Accounts payable
Taxes payable
Cash flow from operations
Investing:
Sale of marketable securities
Proceeds on sale of investment
Acquisition of land
Proceeds on sale of building
Acquisition of building
Acquisition of equipment
Cash used in investing activities $(379)
Financing:
Payment of bank loan
Payment in warranty liability
Payment of mortgage
Bond issue
200
Sale of shares
Dividends paid
Cash flow from financing activities
Change in cash
(7)
Cash, beginning of the year
Cash, end of the year
$ 98
118 (1)
12 (1)
27
23 (4)
(2)
34
6
(89)
14
$ 132
100
102 (2)
(112)
42 (1)
(378) (1)
(133)
(5)
(15) (4)
(40)
150
(50) (3)
$ 240
38
$ 31
122
Instructor’s Solution Manual
(1) Reconciliation of building account and accumulated amortization:
Building:
2002 balance
Cost of building sold
Acquisition of building (plug)
2003 balance
Accumulated amortization:
2002 balance
Accumulated amortization - building sold
Amortization expense
2003 balance
Loss on sale of building:
Proceeds
NBV 110 - 56
Loss
(2) Gain on sale of investment
Proceeds
Cost
Gain
(3) Dividends paid
Dividends declared
Change in dividend payable
Dividends paid
(4) Reconciliation of warranty liability:
2002 balance
Current year expense
Current year payment
2003 balance
493
(110)
383
378
761
569
(56)
118
631
42
(54)
(12)
102
(73)
29
40
10
50
118
23
(15)
126
Some comments on cash management for 2007:
• Not much change in cash. They company seems to be behind on accounts payable payments, but
accounts receivable collections seem okay.
• Large use of cash for investing in capital assets, financed 1/3 by operations and 2/3 by debt and equity.
Capital assets are being kept up to date, acquisitions more than exceed amortization.
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Financial Accounting: An Integrated Approach, Sixth Edith
Solution Outline for Problem 4.34
1. Cash receipts: 46,665 + 848,911 + 20,000
= 915,576
Cash payments: 78,640 + 649,925 + 14,610
= 743,175
Cash income: 915,676 – 743,175
= 172,401
2. Revenue: 848,911 + (73,007 – 53,116 + 46,665)
= 915,467
Expense: 649,925 + (115,304 – 78,640 + 78,640)
= (765,229)
Gain on land (135,000 – 80,000)
= 55,000
Amortization
= (114,618)
Accrual net income
90,620
3. Net income + non-cash (90,620 – 55,000 + 114,618)
= 150,238
Accounts receivable change (73,007 – 53,116)
= (19,891)
Accounts payable change (115,304 – 78,640)
= 36,664
Customer deposits
20,000
Prepaid expenses
(14,610)
Cash from operating activities
172,401
4. Cash from operating activities: 915,576 – 743,175 (all in Part 1) = 172,401
Solution Outline for Problem 4.35
1.
2.
3.
784,000 – 645,000 – (12,750,000 – 6,000,000) – 4,800,000 - 495,000 + 3,310,000
= (8,596,000)
No change, still (442,000)
Not okay if new president just trying to look good. But okay if these were really economically
valid. Effects should be clean from income.
Solution Outline for Problem 4.36
TGIF Industries Ltd.
Balance Sheet as at December 31, 2007
(thousands of dollars)
2006
Current assets:
Cash on hand
Cash in bank
Term deposits
Accounts receivable
Inventories
Prepaid expenses
Noncurrent assets:
Land cost
Automotive equipment cost
Building cost
Equipment cost
Accumulated amortization
Investments cost
Total
124
Change
2007
19
238
0
2,868
2,916
184
6,225
+6
-17
+100
-1,134
-647
-37
25
221
100
1,734
2,269
147
4,496
416
892
2,411
1,020
4,739
863
3,876
740
4,616
10,841
-80
0
-890+1,670
+643
336
892
3,191
1,663
6,082
740
5,342
180
5,522
10,018
+291 -4141
-560
Instructor’s Solution Manual
1
Calculation of accumulated amortization on building sold.
Proceeds - gain on sale = NBV 514 - 38 = 476
Cost-accumulated depreciation = NBV
890 - x = 476 x = 890 - 476 x = 414
Accumulated amortization on building sold = 414
Liabilities and Equity
Current liabilities:
Demand bank loan
Other bank indebtedness
Accounts payable, accruals
Income other taxes payable
Dividends payable
Noncurrent liabilities:
Mortgage payable
Loans from shareholders
Debenture debt
Other long-term loans
Future income tax
Estimated pension liability
Shareholders' equity:
Share capital
Retained earnings
2006
Change
2,205
840
1,948
213
0
5,206
-1,137
-360
-587
-14
+60
1,068
480
1,361
199
60
3,168
516
600
0
318
248
163
1,845
-103
+250
+300
-74
+68
+53 -43
413
850
300
244
316
173
2,296
1,000
2,790
3,790
10,841
+250
+614 -100
1,250
3,304
4,554
10,018
2007
Total
Comments on management strategy:
• Investing activities indicate selling off of significant long-term assets, even at a loss.
• Strong reduction of accounts receivable and inventory. Cash used partly to reduce accounts payable.
• Increase in long-term borrowing and decrease in short-term borrowing.
• Large reduction in demand loan and other bank indebtedness.
• Contributions by shareholders (500 = ½ loan, ½ shares)
Ratios
Working capital:
2006
2007
Current assets
6,225 = 1.20
4,496 = 1.42
Current liabilities
5,206
3,168
Debt/Equity:
Liabilities
7,051 = 1.86
5,464 = 1.20
Equity
3,790
4,554
All of this indicates that management's strategy has left the company in a much stronger position.
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Solution Outline for Problem 4.37
1.
These statements should be fairly straightforward from the information given, but reasonable
assumptions leading to some differences may be made (e.g. about where to place service revenue). A
full set of statements should also contain notes, but there is insufficient information in this problem to
prepare notes.
For ease, we begin with the income statements.
Grandin Ltd.
Income Statement for the Year 2007
(With 2006 Figures for Comparison)
2007
$163,290
103,190
$ 60,100
32,600
$133,800
Product sales revenue
Cost of goods sold
Gross profit from product sales
Service revenue 73,700
Total gross profit
General expenses:
Administration
Amortization
Interest
Packaging and shipping
Service wages 69,500
Utilities
Total general expenses
Income before income tax
Income tax expense:
Current portion
Future portion
250
Total income tax expense
Net income for the year
2006
$116,250
71,650
$ 44,600
$ 77,200
$ 14,600
4,000
4,800
8,100
28,200
9,200
$110,200
$ 23,600
6,200
$ 63,500
$ 13,700
$
$
5,200
500
5,450
$ 18,150
$ 11,900
5,800
3,900
7,500
3,000
3,500
$ 10,200
Grandin Ltd.
Statement of Retained Earnings for the Year 2007
(With 2006 Figures for Comparison)
2007
$37,500
18,150
$55,650
4,000
$37,500
Beginning balance
Net income for the year
Dividends declared and paid
Ending balance $51,650
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2006
$33,300
10,200
$43,500
6,000
Instructor’s Solution Manual
Grandin Ltd.
Balance Sheet as at the End of 2007
(With 2006 Figures for Comparison)
2007
Current assets:
Cash
Receivables
Inventory
Prepaids
Current assets
Noncurrent assets:
Equipment
Acc. amort.
Noncurr.assets
TOTALS
2006
$ 4,700
44,200
42,500
2,100
$93,500
$ 5,400
21,300
37,000
800
$ 64,500
$87,000
36,000
$51,000
$ 87,000
32,000
$ 55,000
$144,500 $119,500
Current liabilities:
Bank loan
Payables
Inc. tax pay.
Current liabilities
Noncurrent liabilities:
Eq. financing
Future inc. tax
Noncurrent liab.
Shareholders' equity:
Share capital
Retained earnings
Equity
TOTALS
2007
2006
$ 29,000
12,300
2,200
$ 43,500
$ 19,000
8,900
1,000
$ 28,900
$ 20,000
4,350
$ 24,350
$ 24,000
4,100
$ 28,100
$ 25,000 $ 25,000
51,650
37,500
$ 76,650 $ 62,500
$144,500 $119,500
2.
Grandin Ltd.
Cash Flow Statement
For the Year 2007
Operations:
Net income for the year
Add back expenses not involving cash
(amortization $4,000 plus future
income tax $250)
$ 18,150
4,250
$ 22,400
Changes in non-cash working capital*
Cash used in operations
Investing activities
Financing activities
Equip. financing paid
(4,000)
Bank loan
10,000
Dividends paid
(4,000)
Decrease in cash for the year
Cash, beginning
Cash, ending
*
Receivables
Inventory
Prepaids
Payables
Inc. tax payable
Net total changes
(25,100)
$ (2,700)
0
2,000
$(700)
5,400
$ 4,700
$(22,900)
(5,500)
(1,300)
3,400
1,200
$(25,100)
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Financial Accounting: An Integrated Approach, Sixth Edith
Solution Outline for Problem 4.38
There are many ways cash flow can be manipulated. The following are three possibilities.
1.
Operating Cash Flows
• Defer inventory purchases, i.e. allow inventory levels to run down.
• This increases cash flow from operations.
• May be necessary because of cash shortages or decreases in demand.
• On the other hand, if there is no cash shortage and demand has not decreased this can hurt the
company. The company may not be able to supply customers, thus alienating the customers and
causing a decrease in sales.
• Unethical if the manager just does it to make himself look good.
2.
Investing Cash Flows
• Defer acquisition of new assets.
• May be necessary because of cash flow problems.
• May hurt the company if existing equipment is wearing out.
• May hurt the company if there is an opportunity for expansion, thus increased sales, that the
manager is not taking advantage of.
• Unethical if the manager does it just to make himself look good.
3.
Financing Cash Flows
• Defer redemption of bonds when interest rates are falling.
• May be necessary because of cash flow problems.
• May result in the company making higher interest payments in the long run than they otherwise
would have had to.
• Unethical if cash is available for redemption and manager fails to redeem bonds in order to make
himself look good.
Solution Outline for Case 4A
This case is intended to be based on any set of financial statements the instructor or students select, so
there is no particular set of solution points. Instead, a few observations are made below to assist in
organizing the case discussion.
1. In discussing the usefulness of the cash flow statement, it might be helpful to work through its main
parts and prompt some discussion of any difficulties students have with each:
a. The statement starts with net income and so requires reconciling items that would not appear if
the statement just started with cash income or with receipts and disbursements (direct method).
b. The non-cash revenues and expenses reconciliation may seem counter-intuitive because noncash revenues are deducted and non-cash expenses are added (leading to some people thinking
that amortization is a source of cash, for example).
c. The non-cash working capital reconciliation provides information about whether cash is tied up
in or released via changes in receivables, payables, etc.
d. Cash from operations specifies the cash generated from day-to-day operations.
e. Cash for investing relates to the cash used or obtained via non-current asset changes.
f. Cash from financing relates to the cash obtained via or used in non-current liability or equity
changes (other than from income).
g. The reconciliation of cash changes to the balance sheet demonstrates that the cash flow
statement’s summary is correct.
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Instructor’s Solution Manual
2. Discussing these points might be done under such headings as:
a. Ways in which the income and cash flow measures correlate, or support each other.
b. Ways in which the two measures differ – and if these differences add information to the overall
set of statements or else indicate some problems with the two measures, as the case implies.
c. Aspects of performance that might not be well measured by either income or cash flow.
3. This is a specific application of the points in part 2.
4. This is a specific application of the points in part 1.
5. This applies to the cash flow statement’s overall interpretation. The instructor might get some help
with this discussion from section 10.5 in addition to the material in Chapter 4.
Solution Outline for Case 4B
The points below are only guides to the discussion. They start with the 14 comments and end with some
overall observations.
1. Depends how performance is defined. Cash performance does show a reduction. Other questions
indicate the company did not issue significant new shares during the year, so the per-share figures
can be compared to the past year.
2. Cash flow should be higher than accrual income because of the presence of significant non-cash
expenses like depreciation and amortization.
3. It can easily be that both figures are correct. Other questions show some of the reasons. But the
concern may be valid – the two should not be in opposite directions for any length of time. This
particular pattern is not a good one, prompting the worries about earnings quality that other
questions express.
4. A rise in accounts receivable could indicate aggressive recording of revenues, as the questioner
worried. But it could also indicate lax collection efforts or a change in sales patterns to lowerquality or slower-paying customers (governments are slow to pay). A rise in inventories probably is
not earnings management but rather indicates difficulty selling or poor purchasing policies in which
inventories pile up.
5. Depreciation and amortization do not bring in cash. This is a common misunderstanding resulting
from the cash flow statement’s format.
6. Yes, it means the restructuring charge has not been paid yet, and probably is just an estimate of a
future cash flow. Note the presence of this charge indicates that the gap between accrual income
and cash income should have been larger than last year, not smaller. It adds to the growing feeling
that the company is not generating cash from operations as it should.
7. Good question. Since cash did not go up much in spite of borrowing, cash must have been used for
investments, dividends or other non-operating uses.
8. Yes, good point.
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Financial Accounting: An Integrated Approach, Sixth Edith
9. This is a serious point. It appears both that the company is not replacing its property and plant as
they wear out and that the increases in receivables and inventories were quite large. Neither of these
conclusions indicates a healthy operation.
10. Yes. It seems that cash from operations was not very large. The per-share numbers for cash flow
and EPS might have led us to think both were solid, but the evidence is building up that both were
not very healthy.
11. Also true. Good idea to link cash uses and sources according to short or long-term. Issuing more
share capital would have accomplished this linkage without the risk of the borrowing.
12. Yes, this is an indication of financial trouble.
13. Again yes. The stock market is usually sensitive to cash flow, and in a case like this with falling
cash flow and rising earnings, the stock price quite likely would reflect the cash decline rather than
the earnings increase.
14. Good summary comment. The next year looks quite challenging, which also could have influenced
forward-looking investors and so share prices.
Overall, the questions give us a pretty good idea of the cash flow statement’s contents and the
company’s financial situation. These are just some ideas:
• Earnings and operating cash flows are not strong;
• Non-cash working capital (receivables and inventories) are getting too large, draining cash;
• The company is not keeping up with its property and plant investments (perhaps due to lack of
cash);
• The company is borrowing to finance investments because it is not generating enough cash
internally to do this;
• The company’s cash situation, both as to generating it and as to how much is available, seems
to be deteriorating steadily.
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