Chapter 11, Problem 11.7APWC

Written Communication

“Why can’t we pay our shareholders a dividend?” shouts your new boss at Polar Opposites. “This income statement you prepared for me says we earned $5 million in our first year!” You recently prepared the financial statements below.

POLAR OPPOSITES Income Statement For the year ended December 31, 2018
	($ in millions)
Net sales	$65
Cost of goods sold	(35)
Depreciation expense	(4)
Operating expenses	(21)
Net income	$ 5

POLAR OPPOSITES Balance Sheet December 31, 2018
	($ in millions)
Cash	$ 1
Accounts receivable (net)	16
Merchandise inventory	14
Machinery (net)	44
Total assets	$75
Accounts payable	$ 7
Accrued expenses payable	9
Notes payable	29
Common stock	25
Retained earnings	5
Total liabilities and stockholders’ equity	$75

  Although net income was $5 million, cash flow from operating activities was a negative $5 million. This just didn’t make any sense to your boss.

Required:

Prepare a memo explaining how net income could be positive and operating cash flows negative. Include in your report a determination of operating cash flows of negative $5 million using the indirect method.