246524633 friedlan4e sm ch05 solutions

8/20/2019 246524633 Friedlan4e SM Ch05 Solutions

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CHAPTER 5

Cash Flow, Profitability, and the Cash Flow Statement

QUESTI!S

Q5-1.With cash accounting revenue is recognized when cash is collected and expenses are recognizedwhen cash is paid. Under accrual accounting, revenue is recognized when earned and expensesare matched to the related revenue. With accrual accounting a transaction or economic event can be recognized in the accounting system beore, ater, or at the same time as cash is exchanged.

Q5-!. "et income isn#t e$ual to cash rom operations because net income is calculated on an accrual basis whereas cash rom operations is based solely on cash lows. What this means is that accrual based net income captures events beyond simply the exchange o cash. "et income involves thecalculation o two items % revenues and expenses. When calculating revenues, accrual basedaccounting loo&s at when the revenue is earned % the exchange o cash isn#t the determining

actor in the recognition o revenue. 'or expenses accrual based accounting examines when theeconomic sacriice occurs, not when cash is paid. "et income captures all economic events (thatare measurable) and cash rom operations captures cash lows rom daily business activities.

Q5-*.+he cash low statement provides inormation to sta&eholders that isn#t available rom the otherinancial statements about the cash inlows and disbursements. +he statement provides importantinormation or assessing the li$uidity o the entity. +he inormation in the cash low statementhelps sta&eholders understand the sources and uses o cash, which helps them assess the abilityo the company to generate cash to meet the cash re$uirements in the uture. 'or example, i cashrom operations is negative, the company will need to continually borrow or raise more e$uity.

+he inormation is very important or assessing the li$uidity o an entity and can give importantclues about an entity#s ability to survive.

Q5-.a. +he payables deerral period is the interval rom the time goods are received rom a

supplier until the supplier is paid. b. +he inventory sel-inancing period is the interval rom the payment o a supplier or

inventory until the inventory is sold to customers and the cash is collected.c. +he inventory conversion period is the interval rom the time goods are received rom a

supplier until the inventory is sold to a customer.d. +he receivables conversion period is the interval rom the sale o inventory to a customer

until the cash is collected rom the customer.

Q5-5.ash rom operations is the cash an entity generates rom or uses in its regular businessactivities. ash inlows rom operations include cash collected rom customers along with otherreceipts o cash that are related to operations. ash outlows rom operations include cash payments made to generate operating cash inlows and operate the normal business activities othe entity, or example, payments to suppliers and employees. the amount is negative, the

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-1olutions 2anual

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regular business activities o the entity have consumed more cash than it has generated. '9 isuseul to sta&eholders because it provides them with inormation on regarding the cash that theentity is using and generating through its everyday operations.

Q5-:.

;epreciation isn#t a source o cash or the company. +he indirect method calculates cash romoperations by reconciling rom net income to cash rom operations. "et income is ad8i$uidity reers to the availability o cash or the ability to convert assets to cash to meetobligations and is a short-term concept. ash, investments in shares o public companies, andaccounts receivable (usually) are li$uid. 8and, building, e$uipment, and intangible assets aren#tli$uid as they can#t be converted to cash $uic&ly. olvency is an entity#s long-term viability and

its ability to pay its long-term debts. ?n entity would be insolvent i its liabilities are greater thanits assets or i it will be unable to repay loans that are coming due. =oth are important or anentity#s long-term survival. t#s possible or an entity to be li$uid but not solvent. 'or example, acompany may have a large cash balance that will cover its current liabilities, but it could havesigniicant amounts o long-term debt that are larger than its assets. t could also be solvent butnot li$uid, with assets exceeding liabilities but little cash and other li$uid assets to meet currentobligations.

Q5-@t#s important that sta&eholders are aware o an entity#s li$uidity because i an entity isn#t li$uidit will be unable to pay wages, suppliers, or any liabilities that come due. Without cash or theability to raise cash (convert assets to cash, issue e$uity, borrow), an entity can#t survive. t couldta&e out a ban& loan or use a line o credit to bridge gaps in cash shortalls, however this is only atemporary solution. a company doesn#t have enough li$uidity it will be unable to meetinancial obligations as they become due.

Q5-A.=oth income and cash low are important to the shareholder. +he value o the irm is dependenton the expectation o uture proit, but the survival o the irm is dependent on its ability to meetits inancial obligations as they become due. 0roit is intended to provide a broader measure oeconomic perormance than is cash low while cash low is a better indicator o li$uidity. +hetwo interests o the shareholder, ris& and return, are inormed by proit and cash low.

Q5-14.;epreciation is added bac& to net income when calculating cash rom operations using theindirect method because it has been deducted in calculating net income but it doesn#t involvecash.

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Q5-11.ainsBlosses are subtractedBadded bac& to net income when calculating cash rom operationsusing the indirect method because gains and losses don#t represent cash lows. ainsBlosses arethe dierence between the proceeds rom the sale o certain assets and the carrying amount o

those assets. +he cash received rom the sale o the assets is reported in the cash low statementas an investing activity.

Q5-1!.When a company has negative cash rom operations, the cash collected rom customers is lessthan the amounts paid out to suppliers, employees and other operating cash costs. +he reasons or negative cash rom operations can be growth o the business, poor economic conditions, orincreased competition that is slowing business (slowing collection o receivables or increase inthe inventory conversion period). t#s a cause or concern i it#s expected to continue becausecash reserves or inlows rom other sources (new debt or e$uity, sale o assets) must be availableto und operations (simply being in business is consuming cash) as well as to pay or any

investments in capital assets or re$uired repayments o debt. "egative cash rom operations will be a concern because there must be sources o cash available to inance operations and otherre$uirements. Cven an entity with very avourable prospects can be in serious trouble i it doesn#thave access to the cash it needs to operate and meet its short-term obligations as they arise. tmay be diicult to arrange long-term inancing and the irm may ind itsel unable to meet short-term obligations as they arise. +he cause o negative cash low rom operations may be goodnews, such as sales growth or expansion (cash might have to be invested in inventory andBorreceivables), but the conse$uence might not be good or the company.

Q5-1*.=oth cash low and income are important to management. 6owever, the short-term conse$uenceso cash low problems are more serious than those o low proitability. ? company can continueto operate without proitsD it can#t operate i it can#t pay suppliers and employees. ? lac& o cashthreatens the ability o the entity to survive. +hus management can never ignore the cash needso the entity. 6owever, in the longer term an entity must also be proitable.

Q5-1.+he three types o activities that are reported in a cash low statement are (many other exampleso each category are possible)E9perating activitiesE the cash that an entity generates rom and consumes in its ordinary, day-to-day operations. 'or example, buying inventory that is sold to customers or used in themanuacture o the entity#s products. +his is an operating activity because inventory is directlyused in the main business activity o the entity. 9ther examples are sales to customers, salaries paid to employees, utilities, selling and mar&eting costs, and so on.nvesting activitiesE cash an entity spends on buying capital and other long-term assets and thecash it receives rom selling those assets. 'or example, i an entity purchases a building to baseits manuacturing acility, head oice, or retail operations, this is an investing activity becausethe building is a long-term capital asset that will contribute to revenue generation over time.nterest and dividend payments can be classiied as operating or investing activities under '7.

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'inancing activitiesE cash an entity raises and pays to e$uity investors and lenders. 'or example,i an entity sells e$uity to investors, this is a inancing activity because e$uity is a way oinancing an entity. nterest and dividend payments can be classiied as operating or inancingactivities under '7.

Q5-15. "ew businesses re$uire cash outlows to get the business up and running. +his re$uires the purchase o any capital assets (that can#t be partially or ully inanced) and to pay operating costssuch as inventory and supplies, pay employees, rent, utilities, advertising and promotion, andother operating expenses. +hese cash outlows occur beore cash inlows rom customers begin.+he entity must have ade$uate cash or access to cash to inance the start-up period. Cven or awell-planned new business things may not go according to plan (start-up costs may be greaterthan expected or the business may not build as $uic&ly as planned). n these cases, the businessmay be in trouble or may ail i it#s unable to get the cash it needs. +he cash lag poses thegreatest diiculties during the start-up and growth periods because o the need or cash inlowsand the uncertainty when the business will begin to generate ade$uate cash.

Q5-1:.ash rom operations can be calculated and reported by the direct method or the indirect method.+he direct method subtracts cash paid to employees, suppliers and other operating cash lowsrom cash received rom customers. +he indirect method begins with net income and ad


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method to cash lows rom operations is usually more inormative than the indirect method because inormation that isn#t readily available elsewhere in the inancial statements is presented.2ore generally, the cash low statement provides additional inormation by indicating theamount o capital assets bought and sold separately and the amount o long-term debt that wasretired and the amount that was raised in the period, as well as the amount raised issuing shares

or paid out redeeming shares.

Q5-1A.+he cash cycle is the period o time rom when the company starts with cash, purchasesinventory, supplies, andBor other inputs needed to do business, provides goods or services tocustomers, and then collects cash rom the customers. 'or a wine ma&er, assuming that thegrapes are purchased rather than grown, it would begin with the payment or the grapes and other raw materials, payment to employees, ac$uisition o space to operate the winery, pay or utilities,and so on. +he cycle ends when the cash is collected when the wine is sold to customers, potentially many years later because wine is usually aged. the winery grows its own grapes,the cycle is more complex because land must be purchased, vines planted, cared or and

harvested, and so on. What is important to recognize is that or a winery the cash cycle can bevery long, meaning that having a good reserve o cash or access to cash is essential or thewinery to survive.

Q5-!4. "ot only is this possible, but it#s common or a growing company. When a company grows,accounts receivable and inventories increase, which cause cash low rom operations to be lessthan net income. n addition, many operating costs may increase in advance o the growth insales o the business (perhaps more people are hired in anticipation o the growth). ?lso thecompany may inance long-term assets rom operating cash low or rom cash reserves, ratherthan arranging long-term inancing, which would consume cash and reduce net cash low.

Q5-!1.+he company could have positive cash low overall by issuing e$uity or long-term debt, or byselling assets. +he positive operating cash low could occur i the entity has a substantial amounto non-cash expenses such as depreciation, uture income taxes, write downs or write os, orlosses on disposal o assets. ash rom operations could also be positive even i the entityreported a net loss i accounts receivable or inventory decreased or accounts payable increasedduring the period.

Q5-!!.+his change in policy will result in alstoc& collecting cash rom its customers more $uic&ly ithey pay on time. +his policy change will result in alstocs cash rom operations to increase.+his is because the sales alstoc& ma&es towards the end o the year (mid-"ovember to late "ovember) will be collected i customers pay on time. n previous years (!41: and prior),alstoc& gave 5 days to pay. we assume most customers wait to pay until the 5 days is up,that means sales made in mid to late "ovember would not be collected until !41@. 6owever, icustomers only had *4 days to pay, mid to late "ovember sales would be collected by the end othe year. ash rom operations in !41> would increase as a result o the policy change.




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Q5-!*.+he amount expensed or wages during a period isn#t usually the same as the amount paid orwages during a period because accrual accounting expenses employee costs when they#re earned by employees, not simply when they#re paid. What is expensed or wages in a period is the

amount employees earned, regardless o when they get paid. +o illustrateE Cmployees get paid onthe 15th o every month. +he amount earned by employees in the last hal o ;ecember won#t be paid until /anuary 15, but the amount is expensed in ;ecember because the employees earned themoney during the month. ?ccrual accounting see&s to capture that act (the earning o the wages)and expenses these wages so they are relected in the ;ecember *1, !41> year-end. +he idea isthat these employees helped to earn revenue so revenue should be matched to expenses. +hecompany also has a present obligation to pay the wages so a corresponding liability is created.+he dierence between the amount paid in a period and the amount expensed is the dierence between the opening and closing balances in the wages payables account.

Q5-!.

+he term FcashG includes cash in the ban& as well as petty cash and other cash balances such asthe loat maintained to provide change or cashiers. t can also include short-term li$uidinvestments i they are readily convertible to a &nown amount o cash and where there is littleris& that the amount o cash that will be received will change. FashG can also be netted against ban& overdrats (the purpose here is that i the ban& is used as way to manage cash it can beincluded in the entity#s deinition o cash).

Q5-!5.?n increase in accounts receivable means that the entity has provided more credit to customersin the current year than it collected rom customers who owed money at the end o the previousyear. +hese two amounts (beginning and ending accounts receivable) explain the dierence between accrual revenue and cash collected rom customers. When accounts receivable increaseit means that revenue is greater than cash collected and i accounts receivable decrease it meansthat cash collections are greater than revenues.

Q5-!:.nventory decreases when inventory is sold but not replaced. ?s a result, a payment to a supplierisn#t re$uired and cash is conserved. n other words, cost o goods sold is greater than the amountspent on inventory. +his answer assumes that inventory is purchased or cash. 0ayables ma&ethings more complicated but the idea is the sameE using up inventory that was purchased previously (and not replaced) means that cash is conserved. ?s a result, cost o goods sold(which is inventory sold) isn#t ully a cash expense. t includes inventory paid or in previous periods.

Q5-!>.t#s not possible or managers to manipulate actual cash lows that have occurred when preparingthe cash low statement. 2anipulation o cash lows occurs through dierent actions rather thanaccounting or the actions ater they occur. 2anagers can manipulate cash low by timingtransactions and payments. 'or example, managers can delay repairs and maintenance,advertising, promotions, research, and so on, or even cancel these programs. +hese choices will

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'irms that cut research spending now may have no new products to replace the existing productswhen they are obsolete. +his is crucial or high-tech, biotechnology, and many other &nowledge- based industries.

Q5-*1.

+he low earnings could be the result o many things including expensing as many items as possible as opposed to capitalizing and depreciating these items, or by depreciating assets more$uic&ly. ?s the boo& has indicated, accrual accounting is lexible and the inormation can be presented in a way that serves the ob


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(costs may be greater than expected or the growth may not occur as $uic&ly as planned). n thesecases, the business may get into trouble or ail i it#s unable to get the cash it needs. +he cash lag poses the greatest diiculties during the growth period because o the need to expend cash andthe uncertainty as to when the business will begin to produce ade$uate cash low.

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E"ERCISES

C5-1.a. 0ayables deerral period (goods received - suppliers paid) *4 days

b. nventory sel-inancing period (supplier paid - cash collected)?verage time abric held in inventory (> x *4) !14 days?verage time rom irst appointment to delivery 5 days?verage time rom delivery to customer payment !4 days8essE 0ayables deerral period (rom part a) (*4 days)

!5 daysc. nventory conversion period (goods received % inventory sold)E

?verage time abric held in inventory !14 days?verage time rom irst appointment to delivery 5 days

!55 days

d. 7eceivables conversion period (inventory sold % cash collected) !4 days

e. "umber o days between receiving inventory rom suppliers and receiving cash romcustomersEnventory conversion period !55 days7eceivables conversion period !4 days

!>5 days




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purchased in /anuary !41@ as in !41@ they only had *4 days to pay the supplier. 'ebruary#s cash outlay or 2c0herson was higher by J1!4,444 under the new credit policy due to2c0herson having to pay ;ecember and /anuary purchases in 'ebruary.

d.

0rior Iear 1st Quarter !nd Quarter *rd Quarter th Quarter

0urchases J*:4,444.44 J4!,444.44 J!5,444.44

0er 2onth J1!4,444.44 J1!4,444.44 J1!4,444.44 J1*,444.44 J1*,444.44 J1*,444.44 J11,:::.:> J11,:::.:> J11,:::.:> J1:1,:::.:> J1:1,:::.:

9pening ?B0 1:1,:::.:>

0ayments J1:1,:::.:> J1!4,444.44 J1!4,444.44 J1!4,444.44 J1*,444.44 J1*,444.44 J1*,444.44 J11,:::.:> J11,:::.:> J11,:::.:> J1:1,:::.:

ash 0aid 0erQuarter J41,:::.:> J*@@,444.44 J1>,***.*

Kollections on opening ?B0 L !4,444B!months L J14!,444 per month in Q1

+he amount in !41A is lower than the amount paid in !41@. +he reason is that 2c0herson had another payment to ma&e in !41@ due to the change in credit policy in !41@ ('ebruaryinvolved payment o ;ecember and /anuary purchases. +he beginning ?B0 balance was higher in !41A but by an amount less than the extra payments made in 'ebruary.

6ere is a brea&down o the dierenceE

!41@ - J1,>1,***.*5!41A - J1,:>!,444.44;i. J !,***.*5

+he extra J!,***.*5 cash outlay in !41@ compared to !41A can be explained by two itemsE

Cxtra payment in !41@ J14!,444.448essE ;ierence in irst ?B0 payment (J1:1,:::.:> % J14!,444) 5A,:::.:> J!,***.**

+he irst payment in !41A was higher than the one in !41@D however it was still lower than the extra payment that had to be made in !41@ due to the change in credit policy (:4 days to*4 days).

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-1!olutions 2anual opyright 3 !41* 2craw-6ill 7yerson 8td.


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C5-*.a.

7eported net income J!44,444?ddE depreciation expense *4,444ash rom operations J!*4,444

b.9riginal reported net income J!44,444?ddE original depreciation expense *4,444;eductE new depreciation expense (,444 ) "ew reported net income J1@:,444?ddE new depreciation expense ,444 "ew cash rom operations J!*4,444

+he only dierence between the two scenarios is accrual net income, which is J1,444 lower because the depreciation expense is increased by J1,444 (rom J*4,444 to J,444). ince

depreciation is a non-cash item, and all other revenues and expenses in both scenarios were incash, cash rom operations is the same under both scenarios.

C5-.a.;r. 8oss due to write-o o assets (income statement -, 7C -) !,444,444

r. ?sset accounts (assets -) !,444,444

b. "et income J>,44,444?ddE depreciation expense 55:,444

asset write-o !,444,444;eductE increase in accounts receivable (!44,444)

increase in inventory (*54,444) decrease in accounts payable (*4,444)

ash rom operations JA,*>:,444

c.i. 9riginal net income J>,44,444

?ddE asset-write o !,444,444 "ew net income JA,44,444

ii. "ew net income JA,44,444?ddE ;epreciation expense 55:,444;eductE ncrease in accounts receivable (!44,444)

ncrease in inventory (*54,444) ;ecrease in accounts payable (*4,444)

"ew cash rom operations JA,*>:,444

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d. +he only dierence between net income as originally reported by 6exham and c (i) is theJ!,444,444 asset write-o. =y delaying the asset write-o in c(i), management increasedaccrual net income by J!,444,444.

e. +here is no dierence between cash rom operations under b and c(ii). +he reason is that

the only dierence between the two scenarios is the J!,444,444 asset write-o, which is anon-cash item and has no eect on cash low. n b. the asset write-o was added bac& tonet income while in c(ii) it was not included in net income at all.

C5-5.Item Classifi#ation In#rease$%e#rease

a nvesting ;ecrease

b "o eect

c 'inancing9perating orinancing

;ecrease;ecrease

?0C'7

d 9perating9perating orinancing

;ecrease;ecrease

?0C'7

e 9perating ncrease

"o eect

g 'inancing ncrease

h 'inancing ;ecrease

i 9perating ;ecrease

< "o eect

& "o eect ;ue to the extremely short maturity period, this would beconsidered a cash e$uivalent

l 'inancing ncrease

m "o eect

n 9perating ncrease

o 9perating ncrease

p "o eect

C5-:.a. +his is an operating cash low. ince ?shley is in the movie theatre business which

includes concession sales, collecting payment or selling goods alls within normaloperations or this entity. ince it#s a cash receipt, the item is an inlow. +he amount o

the inlow is the amount o the cash sales, J154,444.

b. 7epayment o a ban& loan is considered a inancing cash low. ince it#s a payment, thisis an outlow. +he amount o the outlow is the repayment amount o J!5,444.

c. +he payment o wages is an operating cash low as it#s within the normal operatingactivities o the entity. ?s it#s a payment, this item is a cash outlow. +he amount o theoutlow is J144,444.




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d. +his is an operating cash low as it relates to normal operations. ?shley is in the businesso selling movie tic&ets and giving reunds is a part o that process. +his item represents acash outlow as she is ma&ing payments to customers. +he amount o the outlow isJ5,444.

e. ;epreciation isn#t a cash low. ;epreciation is an accrual concept intended to match thecost o capital assets to the revenues they generate over their useul lie. t has no eecton cashD it only aects accrual net income. When using the indirect method, it should beadded bac& to net income when determining cash rom operations.

. +he old e$uipment sold by ?shley is capital assetsD thereore, the cash received should beclassiied as an investing cash low. ince it#s a cash receipt, the item is an inlow. +heamount o the inlow is the amount received, J1@,444.

n addition, when using the indirect method, the J5,444 loss should be added bac& to net

income when determining cash rom operations. +he reason is that the cash eect o thesale is included in investing activities on the cash low statement. +his isn#t a cash low. the loss isn#t removed rom net income when determining cash rom operations, aJ5,444 understatement will result. +he loss is the amount the payment received or theasset is less than the carrying amountE it doesn#t relect the actual cash low arising romthe transaction.

g. +he new pro


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C5->.a. 7ent collected by =asanti represents an operating cash low as it#s within its normal

operations. =asanti is in the business o providing housing and other services or seniors.+he item would represent a cash inlow o JA44,444 as =asanti has received money or

the housing services provided.

b. +he renovations to the dining room would li&ely be treated as a capital asset (betterment).?s such, this would appear as an investing activity on the cash low statement(renovations will contribute to =asanti#s revenue generating process or many years).+his is a cash outlow as cash was paid to the contractor or his services in the amount oJ@,444.

c. ;ividends represent a inancing cash low as they are payments made to individuals whoinvested in the company. Under '7 dividends can also be classiied as an operatingcash low. +he payment is an outlow o J!5,444.

d. +he borrowing o J144,444 rom the ban& is a inancing activity as this money will helpinance =asanti#s operations. t represents a cash inlow since the ban& has lent money to=asanti in the amount o J144,444

e. +he sale o old urniture is an investing cash low as urniture would be considered acapital asset. ?s =asanti has collected money on the sale, there would be a cash inlow oJ!!,444. n addition, when using the indirect method, the J*,444 loss should be added bac& to net income when determining cash rom operations.

. arpet cleaning is an activity done in the regular course o business. 2aintenance perormed on the building isn#t a capital asset as these types o activities are done

regularly so they are operating activities. +his is a cash outlow as money lowed romthe entity to the carpet cleaner in the amount o J!,544.

g. +he payment o wages is an operating cash low as it an activity that alls within=asanti#s normal course o operations. +his payment o employee wages is a cashoutlow in the amount o J1>5,444.

h. +his purchase o new mattresses on credit has no eect on cash low because no cash haschanged hands at this point in time.

i. 2aintenance wor& represents an activity that is done in the regular course o business and

would be classiied as an operating activity. +he amount would be or the amount purchased in the prior year. +his would be a cash outlow as cash is paid to the businessthat perormed the maintenance services.

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-1:olutions 2anual



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[email protected] rom (used by) Com&any ' Com&any ( Com&any ) Com&any * Com&any 5

9perations J*4,444 J(*:,444) J:,544 J@,444 J(15,444)

nvesting activities (1*,544) (!,444) 1,544 (*4,444) (15,444)

'inancing activities (1*,544) 5,444 (*4,444) (1@,444) :,444

"et increase(decrease) incash *,444 (15,444) 1@,444 - (!,444)

C5-A.

ncreaseB(decrease) "et income J*>,544 J*>,544

?ccounts receivable on /anuary 1, !41@ 1,*>5,444

?ccounts receivable on ;ecember *1, !41@ 1,5:!,544 1@>,544

nventory on /anuary 1, !41@ 1,>54,444

nventory on ;ecember *1, !41@ 1,5!5,444 (!!5,444)

?ccounts payable on /anuary 1, !41@ 1,1@>,544?ccounts payable on ;ecember *1, !41@ 1,*>,544 !54,444

;epreciation expense !:!,544 !:!,544

Clar+e In#

Cash From &erations - Indire#t .ethod

For the /ear Ended %e# )', (0'1

ash 'rom 9perationsE

"et ncome J*>,544

?d,544) nventory !!5,444

?ccounts payable !54,444 !@>,544

ash 'rom 9perations JA@>,544

ash rom operations is larger than net income by J554,444 because o the depreciation expenseand because non-cash current operating accounts provided cash low (inventory decreased andaccounts receivable and payable increased).

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-1>olutions 2anual



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C5-14.

ncreaseB(decrease) "et income J@>>,544 J@>>,544

?ccounts receivable on /uly 1, !41: !A!,544?ccounts receivable on /une *4, !41> *>5,444 @!,544nventory on /uly 1, !41: 1,1:!,544nventory on /une *4, !41> 1,*!,544 !>4,444?ccounts payable on /uly 1, !41: :>5,444?ccounts payable on /une *4, !41> >*5,444 :4,444Unearned revenue on /uly 1, !41: 1,544,444Unearned revenue on /une *4, !41> *>5,444 (1,1!5,444);epreciation expense or !41> *44,444 *44,444

2roo+s 3td

Cash From &erations - Indire#t .ethodFor the /ear Ended 4ne )0, (0'6

ash 'rom 9perationsE

"et ncome J@>>,544

?d4,444)

?ccounts payable :4,444

Unearned revenue (1,1!5,444) (1,1>,544)

ash 'rom 9perations J(!4,444)

ash rom operations is lower than net income by J1,11>,544 mainly because o the decrease inunearned revenue. ncreases in accounts receivable and inventory also contributed to thedierence. +he depreciation expense and the decrease in accounts payable oset the othereects.

C5-11.

?sset ?ccounts?ccounts receivableE ;ecrease

nventoriesE ncrease9ther current assetsE ncrease

8iability ?ccounts?ccounts payable and accrued liabilitiesE ncreaseWages payableE ;ecrease

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-1@olutions 2anual



19/57

C5-1!.

Qesnel 3td

Cash Flow Statement

For the /ear Ended %e#ember )', (0'6

Cash From &erations7

"et ncome (A*,454)

?d5,A44)

;ecrease in prepaids :,A44

;ecrease in accounts payable (!@,444)

ncrease in wages payable 14,*54 (1!@,454)

Cash From &erations7 111,144 In8estin9 A#ti8ities7

0roceeds rom sale o land !54,444

0urchase o common shares (115,444)

0urchase o 00MC (:*!,544)

Cash from In8estin9 A#ti8ities (A>,544)

Finan#in9 A#ti8ities7

"ew ban& loans 5>5,444

ssuance o common shares 1@,444

ssuance o long-term debt !@>,544

7etirement o long-term debt (*>A,544) ;ividends (54,:44)

Cash from Finan#in9 :1:,44

Cash flow for the year :Chan9e in #ash; !*4,444

ash and cash e$uivalents, beginning o year 1!4,444

ncrease in cash or the year !*4,444

ash and cash e$uivalents, end o year *54,444

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-1Aolutions 2anual



20/57

C5-1*.

Add$%ed#t$!ot Rele8ant

a. ?dd

b. "ot 7elevant

c. "ot 7elevant

d. ?dd

e. ?dd

. "ot 7elevant

g. ;educt

h. "ot 7elevant

i. ;educt


21/57

C5-15.

a.!41> !41: Chan9e !41> !41: #

?ccounts receivable J:4,444 J>,544 J1!,544 ?ccounts payable J1*4,444 J11>,544

nventory 1@>,544 !1>,544 (*4,444) Wages payable !!,544 *4,444

0repaids !5,444 !4,444 5,444 +axes payable 4,444 !5,444

nterest payable !*,>54 *!,544

+otal current operatingassets !>!,544 !@5,444 (1!,544)

+otal current operatingliabilities !1:,!54 !45,444

/ah+ 3td

Cash From &erations - Indire#t .ethodFor the /ear Ended %e#ember )', (0'6


"et ncome J1@4,444

?d5,444

hanges in non-cash wor&ingcapital

ncrease in accounts receivable (1!,544)

;ecrease in inventory *4,444

ncrease in prepaids (5,444) ncrease in accounts payable 1!,544

;ecrease in wages payable (>,544)

ncrease in taxes payable 15,444

;ecrease in nterest payable (@,>54) !*,>54

Cash From &erations7 J!>@,>54

b. +here are three reasons why cash rom operations isn#t the same as net income or !41>.+he irst is the depreciation expense, which decreases accrual net income, but has noeect on cash. econd, the loss on the sale o the e$uipment, which relects the dierence between carrying amount and the price received or the assets, but not the actual casheect o the transaction (the cash low eect will be reported in the investing section).

+he third reason is the changes in the non-cash wor&ing capital on the balance sheet. +heassociated revenues and expenses on the income statement, which determine accrual netincome, relect economic lows but not necessarily the actual cash lows resulting romthe underlying transactions. +he actual cash lows can be determined rom the changes inthe corresponding balance sheet accounts.

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-!1olutions 2anual



22/57

C5-1:.a. ash collectionsash collections L =eginning ?B7 O ales % Cnding ?B7

L J>,544 O @15,444 % :4,444

L J@4!,544 b. ?mounts paid to employeesWages paid L =eg. Wages 0ayable O Wages expense % Cnding Wages 0ayable L J*4,444 O 154,444 % !!,544 L J15>,544c. ?mount paid in interestnterest paid L =eg. nterest 0ayable O nterest expense % Cnding nterest 0ayable L J*!,544 O *5,444 % !*,>54 L J*,>54d. ?mount paid in taxes+axes paid L =eg. +axes 0ayable O +ax Cxpense % Cnding +axes 0ayable

L J!5,444 O :4,444 % 4,444 L J5,444e. ?mount paid or other expensesE 9ther expenses paid L J:5,444 (?B0 only pertains toinventory purchases so it#s assumed other expenses are paid as they are incurred)

C5-1>.+he ollowing solution assumes that all sales are on account.

(1) (!) (*) ()

Cnding

balance inthe

account

L=eginning balance inthe account

O

+ransactionsand economic

events thatincrease the

balance in theaccount

-


events thatdecrease the


J5:,444 L J*:*,444 O J,:!:,444 - N

ash collections L J,5**,444

A##onts Re#ei8able

Cash

End

:<

; be9innin9 :=;

Credit

Sales :-;

Colle#te

d

5:,444 *:*,444 ,:!:,444 N

,5**,444

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-!!olutions 2anual



23/57

C5-1@.

(1) (!) (*) ()

Cnding

balancein the

account

L=eginning balance inthe account

O


events thatincrease the


-


events thatdecrease the


In8entory

End :S

'?@,000 '65,000 ',((0,000

',(*',000

A##onts Payable

Credit Cash Paid

End

:<

; be9innin9 :=;

Pr#hase

s :-;

to

S&&liers

1!!,444 14,444 1,!1,444 N

1,!!*,444

C5-1A.

Ba9es Payable

Ba9es Ba9es

End

:<

; be9innin9 :=; E&ense :-; Paid

11!,544 @>,544 1,1>*,444 N

1,1@,444

Ba9es &ayments < D','*1,000

C5-!4.ash collections L redit ales OB- ;ierence in ?B7 OB- ;ierence in Unearned 7ev. L J*!,@54,444 O (,>54,444 % ,A@,444) O (55,444 % *15,444)

L J*!,@54,444 O !5!,444 O 14,444 L J**,!!,444

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-!*olutions 2anual



24/57

C5-!1.a. +he loss on the sale o land is J!5,444 (J144,444 % >5,444) b. Willems# cash increases by J54,444 at the point o sale as the buyer paid only J54,444 uprontand will pay the remaining J!5,444 in 1 months.

c.i) Willems# used the indirect method o calculating '9, the loss would be added bac& to netincome to calculate '9. +he money derived rom the actual sale o the asset would show up asa cash inlow in the investing section.ii) Willems# used the direct method o calculating '9, this transaction would not even appear as a line item in '9 (not an add bac& li&e when calculating '9 indirectly). +he money romthe actual sale would show up as a cash inlow in the investing section.d. +he loss has no eect on '9. t#s a non-cash item that must be ad


25/57

PR23E.S

05-1.

05-1a. Ba9es Payable

End :


26/57

05-!.a. Ba9es

End :54,444 *,*:4,44

b. In8entory

End :S

!,4,444 A>5,444 !,5,444 A@4,44

c. In8entory

End :S

:44,444 >54,444 !,>44,444 !,@54,44

A##onts PayablePaymen

End :44,444 !,>A:,44

d. A##onts Re#ei8able

Credit

End :


27/57

Cash from finan#in97 ash rom inancing has li&ely increased by a small amount. 0asadenahad to repay a ban& loan (outlow)D however, a new e$uity investor was ound who provided themoney to repay the ban& loan (inlow). +he net eect o these two events is zero on the cashrom inancing section o the cash low statement. +he reason cash rom inancing would li&elyhave increased is that the e$uity investor not only contributed the cash to cover the ban& loan but

also provided some Fadditional wor&ing capitalG. "o dividends were paid during the year so thiswould not be a actor in calculating cash rom inancing activities.

05-.Cash from o&erations7 ash rom operations would deinitely be negative given the act 2P7hasn#t had a product released to the mar&et and won#t until at least !4!4. 2oney is being used upto provide operating unds or wages, rent, utilities, etc. "o sales are being made but 2P7 stillhas operating expenses. +his cash low pattern or '9 is typical or a company in the researchand development phase.

Cash from in8estin97 ash rom investing would be negative because 2P7 ,544 and this means the company isgenerating cash rom its daily. ash rom inancing is positive which means that 9noway iseither issuing shares or borrowing. 9perating cash low was enough to cover the cash re$uiredor investing activities and yet the company still obtained additional inancing. ?s a result cashincreased by J,:>4,544. +his may suggest the company has plans or expansion or will re$uiresigniicant amounts o cash to replace existing capital assets. 9noway#s cash low patternsuggests a healthy company that is generating cash rom operations and is continuing to invest initsel. ash is being built up in the company on an overall basis.

05-:.+he pattern in the cash low statement where '9 and cash rom inancing activities are

negative and cash rom investing activities is positive suggests a company that is experiencingdiiculty in generating cash in its daily operations and has decided to divest. '9 is negative,suggesting the company is struggling (perhaps decreasing sales, increasing operating costs).ash rom investing activities is nearly a J,444,444 inlow, meaning 0eachland is selling ocapital assets or perhaps even shutting down a line o operations that is no longer proitable. +he positive cash rom investing activities is helping to cover the cash consumed in '9 and cashrom inancing activities. +he negative cash rom inancing activities is li&ely used to pay odebt. 9verall, cash low is negative (being consumed), meaning cash reserves are being depleted.

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-!>olutions 2anual



28/57

+he situation isn#t sustainable because a company can#t &eep selling capital assets year ater year to cover its cash shortall and it will eventually run out o cash. ("oteE the negative '9 doesn#tsuggest expansion since that would go along with negative investing cash lows and possibly positive inancing cash lows.)

05->.+he pattern in the cash low statement, where '9 is negative (cash outlow) and cash rominvesting and inancing is positive suggests a company that has had a diicult year. +he negative'9 could suggest growth but the inlow rom investing activities isn#t consistent with that. +oma&e up or the shortall caused by the negative '9, it#s generating cash rom inancing andinvesting. +he positive cash rom investing (cash inlow) meaning the company is selling capitalassetsD perhaps divesting a part o their business that is no longer proitable. +he company hasobtained inancingHissuing shares or borrowing to help ma&e up or the shortall in '9. +heinancing inlow may be rom shareholders who believe in the company and are willing to investor lenders who still have conidence or have received personal guarantees rom the owners. ashhas increased slightly during the year.

[email protected] 1 ash ollectionsE/anuaryE JA>5,444 B * L J*!5,444'ebruaryE JA>5,444 B * L J*!5,4442archE J1,4>5,444 B * L J*5@,***

D',001,)))

Quarter ! ash ollectionsE?prilE J1,4>5,444 B * L J*5@,***2ayE J1,4>5,444 B * L J*5@,***/uneE J1,*@5,444 B * L J:1,::>

D','61,)))

Quarter * ash ollectionsE/ulyE J1,*@5,444 B * L J:1,::>?ugustE J1,*@5,444 B * L J:1,::>eptemberE J!,144,444 B * L J>44,444

D',@(),))*

Quarter ash ollectionsE9ctoberE J!,144,444 B * L J>44,444 "ovemberE J!,144,444 B * L J>44,444;ecemberE J1,!15,444 B * L J45,444

D',105,000

?ccounts receivable on ;ec. *1, !41> L "ov. O ;ec. sales L J1,!15,444K!B* L J@14,444 b.Quarter 1 ash ollectionsE/anuaryE JA>5,444 B * L J*!5,444

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-!@olutions 2anual



29/57

'ebruaryE (JA>5,444 B *) O (1,4>5,444 B *) L J:@*,***2archE J1,4>5,444 B * L J*5@,***

D',)@@,@@@

Quarter ! ash ollectionsE

?prilE J1,4>5,444 B * L J*5@,***2ayE J1,*@5,444 B * L J:1,::>/uneE J1,*@5,444 B * L J:1,::>

D',(1',@@6

Quarter * ash ollectionsE/ulyE J1,*@5,444 B * L J:1,::>?ugustE J!,144,444 B * L J>44,444eptemberE J!,144,444 B * L J>44,444

D',1@',@@6

Quarter ash ollectionsE

9ctoberE J!,144,444 B * L J>44,444 "ovemberE J1,!15,444 B * L J45,444;ecemberE J1,!15,444 B * L J45,444

D',5'0,000

?ccounts receivable on ;ec. *1, !41> L ;ec. sales L J1,!15,444B* L J45,444

c.+he impact o the change in collection period is that cash inlows increases during !41>. n'ebruary o !41>, ;ionne eectively collects sales rom ;ecember (when customers had :4days to pay) and they also collect /anuary sales (as customers now have only *4 days to pay in!41>). n eect, an extra month#s sales are collected in !41> as a result o the change to thecollection period. +he impact is that cash inlow or the year is J45,444 higher than under theold policy. ?ccounts receivable would decrease by hal to J45,444. +his occurs because ;ionneis lending money to customers or a shorter period o time, *4 days instead o :4 days.

d.Quarter 1 ash ollectionsE/anuaryE J1,!15,444 B* L J45,444'ebruaryE J1,4>5,444 B * L J*5@,***2archE J1,4>5,444 B * L J*5@,***

D','(',@@@

Quarter ! ash ollectionsE?prilE J1,4>5,444 B * L J*5@,***2ayE J1,*@5,444 B * L J:1,::>/uneE J1,*@5,444 B * L J:1,::>

D',(1',@@6

Quarter * ash ollectionsE/ulyE J1,*@5,444 B * L J:1,::>

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-!Aolutions 2anual



30/57

?ugustE J!,144,444 B * L J>44,444eptemberE J!,144,444 B * L J>44,444

D',1@',@@6

Quarter ash ollectionsE9ctoberE J!,144,444 B * L J>44,444

"ovemberE J1,!15,444 B * L J45,444;ecemberE J1,!15,444 B * L J45,444D',5'0,000

+he long-term eect o changing the cash collection period to *4 days isn#t as signiicant as inthe year when the cash collection period is changed. sales stay stagnant, there really is noimpact on overall cash low in the long-term. 6owever, i sales start to climb each year, having acollection period o *4 days rather than :4 days will result in higher cash lows (assuming a period o constant rising sales). Cssentially, the collection period represents a permanent loan tocustomers. +he longer the collection period the longer that permanent loan is and the larger theamount o receivables at the end o the period.

e.+he answer to this $uestion is tric&y as there a lot o un&nowns. 'irst o all, the change incollection period will result in signiicantly more cash inlows in !41>. ;ionne was indingitsel with low amounts o cash on hand and a large amount o current liabilities, this strategymight ma&e sense. 6owever, ;ionne must consider the eect o this policy change on itscustomers. n the case it did mention that some competitors were already oering those terms.+he $uestion is how many o their competitors are oering those termsN +he suppliers that oerthose terms may price their products slightly more competitively to get away with oering asmaller collection period. +his decision isn#t as simple as it being a sure way to generate morecash low in !41>. ;ionne would need a good understanding o their customers and how theymay react to such a policy change. were the chie inancial oicer, would re$uest moreinormation and weigh all the pros and cons beore ma&ing such an important decision. t mightnot be worth a decrease in sales in exchange or aster collection o cash.

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-*4olutions 2anual



31/57

05-A.a.i. !414 !44A "et cash provided by operations J1,>5 1,>5A

(includes dividends and interest paid and received) "et cash used in investing activities (1,:>5) (1,*:5) "et cash used in inancing activities (*1@) (1)

ii.!414 !44A

"et cash provided by operations J*,41 *,4@* "et cash used in investing activities (1,::@) (1,*5>)(includes interest received) "et cash used in inancing activities (1,:1!) (1,>:)(includes dividends and interest paid)

iii.!414 !44A

"et cash provided by operations J!,:55 !,:::(includes interest paid and received) "et cash used in investing activities (1,:>5) (1,*:5) "et cash used in inancing activities (1,!1A) (1,451)(includes dividends paid)

b.n part a, we saw the dierent ways o accounting or interest and dividends on the cash lowstatement. 9verall cash low is unaected, but the split between the dierent types o cash lowactivities is aected. ash rom operations was highest under the second scenario wheredividends and interest paid were treated as inancing cash lows and interest received as aninvesting cash low. ash rom operations was the lowest under the irst scenario wheredividends, interest received and paid were treated as operating cash lows. ? company may have preerences where to classiy these cash payments and receivables. a company desired to present strong cash low rom operations, they would li&ely be inclined to present dividends andinterest paid as inancing cash lows since this would give them the highest cash rom operations.+he perceptions o sta&eholders could be aected by the dierent classiications.

c.+here really is no economic impact regarding how the cash lows are presented. 'inancialstatements simply try to present the most representationally aithul picture o how the company perormed in the past. ;ecisions regarding the classiication o cash lows only aect how theinormation is reported % it doesn#t change the actual underlying economic activity o the business. ?ccounting can have conse$uences % such as share price or investors# perceptions ohow the company is perorming % but it still can#t change the actual underlying economicactivities.




32/57

d.t is hard to gauge which treatment would be the most useul to sta&eholders in general. ?company oten has many sta&eholders and their ob


33/57

05-14.

impson1st

Quarter !nd

Quarter *rd

Quarter th

Quarter +otal

ales J!A4,444 J*!4,444 J*@4,444 J54,444 J1,4,444nventory purchases J*44,444 J14,444 J1A5,444 J!54,444 J@@5,4449ther operatingcosts 1*5,444 1*5,444 1*5,444 1*5,444 J54,444

a. ales J!A4,444 J*!4,444 J*@4,444 J54,444 J1,4,444

ogs 15,444 1:4,444 1A4,444 !!5,444 >!4,444

9ther 1*5,444 1*5,444 1*5,444 1*5,444 54,444

"et income J14,444 J!5,444 J55,444 JA4,444 J1@4,444

=eg inventory J4 J155,444 J1*5,444 J14,444 J40urchase *44,444 14,444 1A5,444 !54,444 @@5,444

old 15,444 1:4,444 1A4,444 !!5,444 >!4,444

end inventory 155,444 1*5,444 14,444 1:5,444 1:5,444

=eg ?7 J4 J1A*,*** J!1*,*** J!5*,*** J4

ales !A4,444 *!4,444 *@4,444 54,444 1,4,444

ollections A:,::> *44,444 *4,444 4*,*** 1,14,444

Cnding ?7 1A*,*** !1*,*** !5*,*** *44,444 *44,444

=eg ?0 J4 144,444 J:,::> J:5,444 J40urchases *44,444 14,444 1A5,444 !54,444 @@5,444

0ayments !44,444 1A*,*** 1>:,::> !*1,::> @41,::>

Cnding ?0 144,444 :,::> :5,444 @*,*** @*,***

=eginning cash J!*5,444 (J*,***) (J*1,::>) (J*,***) J!*5,444

ollections A:,::> *44,444 *4,444 4*,*** 1,14,444

0ayments **5,444 *!@,*** *11,::> *::,::> 1,*1,::>

Cnding cash (*,***) (*1,::>) (*,***) **,*** **,***

hange in cash (!*@,***) (!@,***) !@,*** *:,::> (!41,::>)

. "et income and net cash low are dierent because net income includes non-cash amounts suchas gainsBlosses on the sale o assets, accruals, and depreciation. 'or impson the dierence is dueto the initial expenditure o cash needed to get the business going (buildup o inventory) and theact that impson gives its customers :4 to pay while it has only *4 days to pay its suppliers.

9ver the year impson#s cash position has been a challenge. +he company has been in a negativecash position or most o the year, meaning that the company has overdrat protection or a line o

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-**olutions 2anual



34/57


35/57

competitors are oering. ;o all their competitors oer :4 days to pay or moreN +his could besigniicant as impson#s customers could leave and ta&e their business to another supplier ithese credit terms were not generous enough or them. ?lso, the suppliers that oer *4 day payment terms (i any) may price their products slightly more competitively in order to get awaywith oering a smaller collection period. +his decision isn#t necessarily a sure way o generating

more cash low in !41@. impson would need a good understanding o their customers and howthey may react to such a policy change. were the chie inancial oicer, would re$uest moreinormation and weigh all the pros and cons beore ma&ing such an important decision.

05-11

Bin+ler 3td

Cash Flow Statement

For the /ear Ended 4ly )', (0'@


"et ncome J>54,444

?d54,444)

Cash from In8estin9 A#ti8ities :(,@?*,000;

Finan#in9 A#ti8ities7

7epayment o ban& loans (A55,444)

ssuance o common shares 1,444,444 ssuance o long-term debt *,444,444

7etirement o long-term debt (1,>54,444)

;ividends (>54,444)

Cash from Finan#in9 A#ti8ities 5*5,000

Cash flow for the year :Chan9e in #ash; :)1@,000;

ash rom =eginning (!415) 54,544




36/57

Cnding ash balance (!41:) :,544

05-1!.

a. !41@ !41> Chan9e

?ccounts receivable !@,444 !4!,444 :,444

nventory 554,444 :*4,444 (@4,444)

?ccounts payable *@,444 *,444 (54,444)

?ccrued liabilities A@,444 :,444 *,444

Ri8let In#


For the /ear Ended %e#ember )', (0'1


"et ncome (J1>@,444)

?d54,444 1,>@,444

Cash From &erations7 *!4,444

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-*:olutions 2anual



37/57

?mounts to be solved

i; A##onts Re#ei8able Note I

Cash

End

:<

; be9innin9 :=; Credit Sales :-; Colle#ted

!@,444 !4!,444 !,154,444 !,14,444

ii; In8entory Note 2

Credit

Pr#hasesEnd

:<

; be9innin9 :=; :-; C>S

554,444 :*4,444 A@,444 1,4:,444

A##onts Payable

Credit

Pr#hases

Cash Paid

to S&&liersEnd

:<

; be9innin9 :=; :-;

*@,444 *,444 A@,444 1,4*,444

iii; A##red liabilities Note 3

ther

E&enses

ther

PaidEnd

:<

; be9innin9 :=; :-;

A@,444 :,444 >@,444 >54,444

c.+he method that is most inormative depends on the inormation needs o the sta&eholder usingthe statement. +he direct method provides inormation about operating cash inlows andoutlows. 'or a sta&eholder interested in seeing how cash moved in and out o an entity oroperating purposes the direct method would be best. +he direct method inorms the sta&eholdero the amount o cash that was expended or particular purposesD the indirect method doesn#t provide that inormation. +he direct method ocuses on cash low, independent o accrualaccounting. +he indirect method shows why net income and cash rom operations are dierent.+his approach is useul i the sta&eholder is interested in net income but wants to understand howcash low compares with net income. +he indirect method lin&s together the two perormance

measures.

d. "et income is an abstract economic concept used to measure perormance under accrualaccounting. t#s intended to measure the change in wealth o the owners o a proit oriented entity by recognizing revenue when it#s earned and matching expenses to the revenue. ash lows canoccur beore, ater, or at the same time that revenues and expenses are recognized. ash receipts

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-*>olutions 2anual



38/57

are recorded when they are received and disbursements when cash is paid. 7ather than measurelows o wealth, cash low is captures cash inlows and outlows.

+here are three reasons why 7ivulet had a loss on its income statement but a positive cash lowrom operations. +he irst is that the expenses on the income statement included a large

(J*4,444) depreciation expense. ;epreciation is an accrual expense that matches the cost o acapital asset to the revenues it generates over the asset#s useul lie. 6owever, the depreciationexpense doesn#t involve an actual cash low. ash lows associated with capital assets usuallyonly occur when an asset is purchased or sold.

? second reason or the dierence is that the income statement also included a loss o J54,444due to the sale o a capital asset. ?gain, this is due to depreciation. +he loss occurred because thecarrying amount o the asset sold was higher than the price it was sold or. +he carrying amounto an asset is usually not its mar&et value. +hus, the loss doesn#t relect a cash low, but is anattempt to measure a loss o wealth.

? third reason or the dierence is that many cash lows related to operations don#t occur at thesame time as when the related economic low is recognized on the income statement. 'orexample, inventory may be bought and paid or in a dierent period than when it#s expensed.imilarly, revenue might be recognized in one period and the cash collected in another. +hesenon-income statement cash lows are relected on the balance sheet by changes in the non-cashwor&ing capital accounts. n particular, the reduction in the amount o inventory and the increasein accrued liabilities contributed to the positive cash rom operations (these eects were oset bythe increase in accounts receivable and the decrease in accounts payable).

e.+he implication o having a loss on the income statement but positive cash rom operations isthat an entity can#t be


39/57

05-1*.

a.- atrime 3td


For the /ear Ended .ay )', (0'6


"et ncome J>5,444

?d,544 >4,444

hanges in non-cash wor&ing capital

ncrease in accounts receivable (1A,444)

ncrease in inventory (!5!,444)

ncrease in 0repaid insurance (*>,444)

ncrease in accounts payable >>,444 ;ecrease in accrued liabilities (1*,444) (*>,444)

Cash From &erations7 (!!A,444)

b. ee parts i-iv) below the cash low statementR

atrime 3td

Cash From &erations - %ire#t .ethod

For the /ear Ended .ay )', (0'6

Cash From &erations7ash inlowsE (note 1) J1,!*!,444

ash outlowsE

ash payments to suppliers (note !) A14,544

ash paid or wages (note *) *:,444

ash paid or insurance (note ) :>,444

ash paid or other expenses 1*>,544 1,:1,444

Cash From &erations7 (!!A,444)

i; A##onts Re#ei8able Note I

Cash

End

:<

; 2e9innin9 :=;

Credit

Sales :-; Colle#ted

!>,444 !>@,444 1,*@1,444 1,!*!,444

ii; In8entory Note 2

Credit

End :< 2e9innin9 :=; Pr#hase :-; C>S

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-*Aolutions 2anual



40/57

; s

@1@,444 5::,444 A@>,544 >*5,544

A##onts Payable

Credit

Cash

Paid

End

:<

; 2e9innin9 :=;

Pr#hase

s :-;

to

S&&liers

*A!,444 *15,444 A@>,544 A14,544

iii; Ba9es Payable Note 3

Ba9es Ba9es

End

:<

; be9innin9 :=; E&ense :-; Paid

>!,444 @5,444 ***,444 *:,444

i8; Pre&aid insran#e Note 4

Cash

Insran#

e

End

:<

; 2e9innin9 :=;

Payment

s :-; E&ense

>!,444 *5,444 :>,444 *4,444

c.+he method that is most inormative depends on the inormation needs o the sta&eholder using

the statement. +he direct method provides inormation about operating cash inlows andoutlows. 'or a sta&eholder interested in seeing how cash moved in and out o an entity oroperating purposes the direct method would be best. +he direct method inorms the sta&eholdero the amount o cash that was expended or particular purposesD the indirect method doesn#t provide that inormation. +he direct method ocuses on cash low, independent o accrualaccounting. +he indirect method shows why net income and cash rom operations are dierent.+his approach is useul i the sta&eholder is interested in net income but wants to understand howcash low compares with net income. +he indirect method lin&s together the two perormancemeasures.

d.

"et income is an abstract economic concept used to measure perormance under accrualaccounting. t#s intended to measure the change in wealth o the owners o a proit-orientedentity by recognizing revenue when it#s earned and matching expenses to the revenue. ashlows can occur beore, ater, or at the same time that revenues and expenses are recognized.ash receipts are recorded when they are received and disbursements when cash is paid. 7atherthan measure lows o wealth, cash captures the low o cash in and out o the entity. nevitably,dierences arise between the net income and cash lows.




41/57

+he main reason that Satrime 8td. had a proit on its income statement but a negative cash lowrom operations is that the accounts receivable, inventory and prepaid insurance increased by acombined J*@,444. +he increase in current assets must be inanced and is thereore a use ocash. +his pattern suggests a growing company but more inormation is needed to conirm this.+he situation could also be indicative o a struggling company that bought too much inventory

and relaxed its credit terms.

e.+he implication o having a proit on the income statement but negative cash rom operations isthat we can#t assess the ability o a company to meet its short-term obligations as they becomedue simply by examining the income statement. n this case, the company has built up itsinventory and accounts receivable, which cost a signiicant amount o cash. n general, negativecash rom operations isn#t sustainable unless an entity has ongoing non-operating sources ocash. 9therwise it will eventually run out o cash, at which time it will be unable to meet itsobligations. Satrime has reached a plateau whereby it doesn#t have to invest more in inventoryand receivables then operating cash lows should improve. urther investment in these areas is

planned the negative cash low rom operations might continue, which may lead to inancialdiiculties. "egative '9 and a proitable business send a mixed message. +he proit suggests asuccessul operation but the negative '9 may mean short-term problems or even uncertaintyabout whether the entity can survive.

05-1.7eport to 2anagement o 2an&ota 8td.

+o the management o 2an&ota 8td.

2an&ota 8td. (2an&ota) is suering the conse$uences o its success. While don#t have acomplete set o inancial statements to evaluate recent perormance, rom the inormation provided net income has increased dramatically, as has, assume, revenue. +hese are good thingsor a business, but such success comes with the types o challenges that you are having.

2y examination o 2an&ota#s cash low statement shows that the company has positive cashrom operations, meaning that the business is generating cash lows rom its normal businessactivities, which can be used or other purposes, such as purchasing additional plant, property,and e$uipment. 6owever, urther examination o the cash low statement shows that as a resulto the company#s growth inventory and accounts receivable have increased. +hese are necessaryconse$uences o growth but they consume cash. ?ccounts receivable and inventory must beinanced and that uses up some o 2an&ota#s cash. n addition, 2an&ota has investedJ1!,!44,444 over the last two years in plant, property, and e$uipment. Undoubtedly thisspending has been necessary to meet the demand or the company#s products but there has to bea source o this cash. =ased on the inormation provided it seems that additional spending on plant, property, and e$uipment is desired because the company sees itsel losing sales tocompetitors and additional spending would allow it to capture some o this demand.

2an&ota has been able to obtain cash through the issuance o debt and rom ban& loans. +heserepresent appropriate ways o raising needed cash. +he company has also paid bac& J>54,444 in




42/57

long-term debt and paid J>54,444 in dividends over the last two years. 6owever, the overall cashrom inancing activities alls well short o the cash used up in investing activities. 2an&otawants to continue to expand, it will li&ely need to raise more cash rom investors (inancingactivities) to inance their planned expansion activities.

?s o now 2an&ota does not have a lot o cash. t is not clear whether this is enough to operateon. 'urthermore, i the company is to &eep up its expansion plans or at least avoid a cash crisissome steps are re$uired. 'irst, the company should stop paying dividends. +hat cash could be better used internally. the shareholders need cash they should borrow on their own. "ext thecompany could try to secure additional long-term inancing. 8ong-term inancing is theappropriate way to inance long-term capital assets. "ew long-term debt or e$uity inusionseither rom the existing shareholder or rom new e$uity investors are the possible alternatives.?nother way o approaching the situation is to slow down the expansion. +his may not bedesirable because sales will be lost but it would be a way o slowing down the need or cash.ash generated rom operations could then be saved and used as available to inance theexpansion internally.

'rom an operational standpoint 2an&ota could try to collect its receivables more $uic&ly andassess whether it could manage with less inventory. =oth these steps would ree up cash.6owever, whether these steps are possible will re$uire urther investigation o the company#soperations.

hope you ind the inormation in this report useul.

05-15.

7eport to the hareholders o $aluit Water ompany 8td.

+o the hareholders o $aluit Water ompany 8td.,

+han& you or the opportunity to prepare this report. 2y comments are limited to the cash lowstatement and any inerences can draw rom it because that is the only inormation that has been provided to me. ? more thorough analysis would re$uire additional inormation.

2y analysis o the cash low indicates that the $aluit Water ompany 8td. ($aluit) is in trouble.+he company has suered large losses over the last two years as it is acing increasedcompetition and high mar&eting costs. ash resources increased in the past year and as o /uly*1, !41> there was J:@,544 on hand.

ash rom operations in !41> was negative, which isn#t a good sign. 6owever, the cash used up by operating activities was not as signiicant as the net loss or the year. +his was due largely tothe act that net income included the write-down o assets and the loss on disposal o assets and'9 ignores these activities as they don#t include cash.

+he investing section o the cash low statement also supports that $aluit is in trouble. +hecompany has sold o a signiicant amount o plant, property, and e$uipment and hasn#t replaced

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-!olutions 2anual



43/57

it (only small amounts o plant, property, and e$uipment were purchased during the last twoyears). nterestingly, the company also sold a piece o land that it held as an investment in !41>.+his land was not used to support $aluit#s bottling operations, but was a speculative investment. $aluit had not sold this piece o land, they would only have had J!*,544 in cash resources leton hand at /uly *1, !41>. +hese sales o plant, property, and e$uipment and investments are a

cause or concern. +he company cannot continue to sell o its capital assets to ma&e up or theshortall in cash rom operations as it will eventually run out o assets to sell as well as theresources it needs to operate.

$aluit#s inancing section raises additional concerns. 'irst and oremost the company is payingout J1,444,444 a year in dividends. +his isn#t appropriate under the circumstances. +he companyneeds cash to sustain operations and signiicant short-term loans have been ta&en. +hese loanscould have been avoided i the dividends were not paid (as well i the cash invested in long-terminvestments had been used). +he company also has a signiicant amount o short-term debt and ban& loans. +he company has replaced long-term debt with short-term debt. +his is a ris&ystrategy because short-term loans have to be repaid in the near uture. t#s possible that lenders

aren#t willing to commit to inancing long-term. ?nother possibility is that better interest rateswere obtainable on the short-term loans.

9verall, the cash low statement indicates that $aluit is in some inancial duress. t is diicult to prescribe solutions to the problems because they seem to be operational and there isn#t enoughinormation to evaluate the business and its environment. +o the extent that things can be turnaround suggest that dividend payments be stopped immediately. While you as shareholders mayind this very undesirable, it is a necessary step or the company. also suggest that theshareholders consider additional e$uity investments to help any survival strategy the companydevelops.

hope this report has been helpul.

05-1:.+o the management o +oino 8td,

+han& you or giving me the opportunity to examine your inancial situation. 2y report will aidyou in analyzing your inancial statements and assessing your current inancial situation. n particular, my ocus will be on discussing and interpreting your deteriorating perormance andcash low problems.

+o begin, want to discuss cash low and net income rom a high-level standpoint so the rest omy analysis is clear. ash low and net income are not the same and that is evident rom yourinancial statements. ?s you can see, net income in !41> was J5,>:,444 while you suered adecrease in overall cash o J1,!:,444. Within that decrease in overall cash, you suered adecrease in cash rom operations o J*A,A*!,444, which is extremely signiicant. While you posted a proit or the year, you suered nearly a J4 million decrease in cash rom operations.+he largest contributing actor or this dierence is the increase in accounts receivable. nexpanding outside o "orth ?merica, you oered new credit terms, giving companies two tothree years to pay. 9n the income statement, these new sales were recorded as sales despite theact no cash was collected. 6owever, these sales do not aect the cash low statement since you

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-*olutions 2anual



44/57

have not been paid yet. o eectively, that J:,554,444 increase in accounts receivable isrepresented on the income statement (through sales) but is relected nowhere on the cash lowstatement. ?s an aside consideration should be given to the collectability o these receivables.'urther inormation should be obtained about the allowance provided or uncollectables.

want to turn to the income statement and provide an analysis. "et income declined sharplyrom JA,@55,444 in !41: to J5,>:,444 in !41>. "otably, gross margin declined signiicantly. n!41:, sales were o J1@!,554,444 and gross margin J4,1:1,444. n !41>, sales grew byJ:,554,444 yet the gross margin increased by only J*,*:@,444. n !41:, the gross margin percentage was !! T, which means that or every dollar o sales, there is !! cents let over tocover other expenses besides the cost o sales and provide a proit to the owners. n !41>, thegross margin percentage declined to 1AT. ? 1T decline in gross margin percentage can have ahuge eect on net income. the gross margin percentage in !41> was !4T instead o 1AT,gross margin would have increased to J5,@!4,444 J!!A,144,444 K !4TR rom J*,5!A,444.+his would be an increase in net income o J!,!A1,444 J5,@!4,444 % *,5!A,444R grossmargin stayed level at !!T, net income would have increased by J:,@>*,444 (J!,!A1,444,444

K*T). ?lso, the interest expense increased dramatically, more than doubling to JA,1:,444.

+urning to the cash low statement, it is clear to see why cash low has declined signiicantly.9verall cash decreased by J1,!:,444. ash rom operations decreased by J*A,A*!,444 and asexplained above, because o the increase in accounts receivable due to the generous credit termsoered to non-"orth ?merican customers. n examining this cash low statement, there is a lot o ris& pertaining to the increase in accounts receivable. What happens i some customers can#t payin ! to * years when payment comes dueN +here is still J*1,1@@,444 in cash let. 6owever, cashlow problems will remain until you collect rom the irst round o "orth ?merican customers in!41A or !4!4. +he increase in cash rom inancing activities basically covers the cash outlow incash rom investing activities. n order to balance your cash situation, cash rom operations needsto improve $uic&ly by ensuring payment rom "orth ?merican customers.

hope this report proved useul and please contact me i you have any urther $uestions.

05-1>.

+o the tadler 'amilyE

+han& you or approaching me concerning the inancial situation o your amily. +his report willassess your current situation and provide suggestions or improvement.

you loo& at your cash rom operations, there is a negative balance o J*,5>5 which is a bit o acause or concern. +his means that you spend more cash in your day to day activities than cashyou get rom your


45/57

+urning to your inancing activities, you had an overall cash inlow o J!!,@54. +his came romloans rom the ban&, borrowings rom parents, and a second mortgage ta&en out. Iou are relyingheavily on borrowing to survive. Unortunately, there a limits to borrowing. ?t some point borrowers will not lend to you (you will be too ris&y), the cost o borrowing will increase (asyour debt load increases lenders will want to charge a higher interest rate to compensate or the

increased ris&), and ultimately you will be unable to pay or the cost o your borrowing.

'inally, your investing activities had a net cash outlow o J!!,4>5 and this amount is almoste$uivalent to the cash inlow rom inancing activities. Iour investing activities included the purchase o a car (which assume is what the ban& loan was or), renovations made to yourhome, and J544 put to savings.

?s a whole, you saw your cash balance decline J!,@44 leaving you with only JA4 cash on hand.+his is not a lot. you lose your ,4440repaid ?sset !54 nterest payable :44

Total #rrent assets 1>,*44 Total 3iabilities A,A44

!on-#rrent assets7 Shareholders EGity

apital ?ssets 15,444 9wner#s C$uity 1@,:54

?ccumulated depreciation (*,>54)




46/57

Total Assets J!@,554 Total 3iabilities and EGity J!@,554

"otesE1. ;epreciation L J15,444B L J*,>54!. 8icense expense L J544B! L J!54

*. ouvenirs purchased % souvenirs on hand at the end o the year L 9L J1!,!44 % J!,!44 L J14,444

So8enirs-n-the->o

In#ome Statement

For the year Ended A9st )' (0""

ales J!!,44

CxpensesE

ost o ales 14,444 2aintenance 1,454

nterest :44

9ther *,144

;epreciation *,>54

8icence !54

+otal Cxpenses 1@,>54

!et In#ome J*,:54

=eginning owner#s e$uity 15,444

"et ncome *,:54Cnding owner#s e$uity 1@,:54

So8enirs-n-the->o

Cash Flow Statement

As of A9st )', (0""

ash rom operationsE

ash collected rom customers J!!,44

ash expended or operations

nventory (J14,44)2aintenance and repairs (1,454)

2iscellaneous (!,:44) (1,454)

ash rom operations @,*54

ash rom investing activities

0urchase o capital assets (15,444)

8icense (544) (15,544)

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-:olutions 2anual



47/57

ash rom inancing activities

8oan rom parents >,444ssuance o commonshares 15,444 !!,444

ash low or the year 1,@54

ash at the beginning o the year 4ash at the end o the year J1,@54

;ear CvanEouvenirs-9n-+he-o (9+) appears to be a successul venture. t has generated good cashrom operations and a reasonable net income. +he cash rom operations may be a bit misleading because o the amounts owed to suppliers. Iou don#t really have J@,*54 available because youowe your suppliers J!,*44, not to mention the amount you owe your parents. Iou assume theinventory o souvenirs on hand at the end o the summer will be saleable next summer. +here isno problem i that is the case, but i these souvenirs aren#t saleable (perhaps because they are

uni$ue in some way (they speciy a date or event or customers# tastes change), then the economic perormance o 9+ as measured by net income is reduced (there would be no eect on cashlow). 0erhaps the most important $uestion or you is whether operating this business is the bestway to spend your summers. 9n a strictly economic basis, you must consider whether you would be better o ta&ing a olutions 2anual



48/57

When examining your cash low statements or the last our years, they are slightly erratic. 9neyear cash on hand increases, the next year it decreases. 9perating cash lows has also been veryerratic over the our years. iven the cyclical nature o the industry, this is not a surprise. commodity prices or your product were to decline in the next year, cash supplies could beimpacted very negatively. +here is also the matter o expansion. new mining opportunities

arise, you want to be able to ta&e advantage o these opportunities. +hese new miningopportunities may be able to create great share value, which is obviously something investorsloo& or. ?lso, your chie inancial oicer is correct in saying share prices will be negativelyaected when dividends are stopped. =ased on the actors outlined in this paragraph, believe itwould be prudent to delay the payment o a dividend. ompanies that pay dividends are thosethat have had a good, strong, and stable history o earnings growth and strong cash romoperations. would li&e to see another year or two o strong cash rom operations and growth inyour cash reserves beore you pay a dividend. +hat way, it is not as much o a ris& and yourdecision would be based on strong undamentals.

+han&s or considering my report and i you have any $uestions on my suggestions, please give

me a call to discuss urther.

05-!4.a.Chan9e to !et In#ome

7eported "et ncome J!15,4448essE 2a


49/57

shareholders. ta&eholders need to be aware o the potential biases that preparers could have inthe preparation o inancial statements.

05-!1.a.

t can be argued that subscriber recruitment and maintenance costs can be capitalized becausethey will provide uture beneits. 7ecruitment costs are incurred in the process o ac$uiring newsubscribers, which will provide uture revenue or 0hidias 0ublications. 2aintenance costs areincurred to retain subscribers, which decreases the probability o uture decreases in thecompany#s revenue due to loss o subscribers. =oth are uture beneits, and according to thematching principle the costs should be charged to income in the period that the revenue theygenerate is recognized.

9n the other hand, it#s diicult to determine the duration over which the costs will generaterevenue. ?s a result it gives management additional lexibility to manage earnings. ?lso, it may be diicult to measure the amount o revenue that the costs will generate. 2aintenance could be

loo&ed at the same way as car maintenanceHincurred to have the asset operate as intended. 'orthese reasons, it can be argued that subscriber recruitment and maintenance costs should not becapitalized. +his is mainly a conservatism argument.

b.+he income statement will show dierent results depending on which treatment is used orsubscriber recruitment and maintenance costs. the costs are expensed as incurred then accrualnet income or the company will be reduced, or accrual net loss will be increased, by the amounto the expense (J5,444). in act the costs do provide uture beneits, the accrual net incomewon#t relect the true low o net economic beneits that occurred during the reporting period.

the costs are capitalized and amortized, then a greater accrual net income (or lesser accrual netloss) will result relative to expensing the costs as incurred (although the eect will be mitigated by the amount amortized in a given year). in act the costs don#t provide uture beneits, thenaccrual net income won#t relect the true low o net economic beneits that occurred during thereporting period. 9 course, over the lie o the entity net income will be the same, so what is being aected is the timing o expenses and income, not the amount.

"ote that in any given year income could be higher (or lower) under either o the methods. +hisis the case because over the lie o the entity the same amount o expense will be incurred. ?slong as the investment in subscribers increases income will be higher under the deer andamortize method.R

c.

Phidias Pbli#ations 3td

Cash Flow Statement

For the year ended %e#ember )', (0'6

Cash from operations:

ash collected rom customers JA*@,44

ash paid to employees (J54,444)

/ohn 'riedlan, Financial Accounting: A Critical Approach, th edition 0age 5-Aolutions 2anual



50/57

ash paid to suppliers (*:!,444)

ash paid in interest (!4,@44)

ash paid on recruiting M maintaining subscribers (5,444) (@@:,@44)

ash rom operations 51,:44

Cash from investing activities:

0roceeds rom sale o capital assets ,444

0urchase o capital assets (1!4,444)

ash rom investing activities (>:,444)

Cash from financing activities:

;ividends paid (*4,444)

7epayment o ban& loan (>4,444)

0roceeds o long-term debt 1*4,444

ash rom inancing activities *4,444

ash generated during the year 5,:44

ash on hand on ;ecember *1, !41: 1@,544

ash on hand on ;ecember *1, !41> J!,144

d.

Phidias Pbli#ations 3td

Cash Flow Statement

For the year ended %e#ember )', (0'6

Cash from operations:

ash collected rom customers JA*@,44

ash paid to employees (J54,444)

ash paid to suppliers (*:!,444)

ash paid in interest (!4,@44) (@*!,@44)

ash rom operations 145,:44

Cash from investing activities:

0roceeds rom sale o capital assets ,444

apitalized subscriber recruitment costs (1!4,444)

0urchase o capital assets (5,444)

ash rom investing activities (1*4,444)

Cash from financing activities:

;ividends paid (*4,444)

7epayment o ban& loan (>4,444)

0roceeds o long-term debt 1*4,444

ash rom inancing activities *4,444

ash gen

246524633 friedlan4e sm ch05 solutions

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