Chapter 12, Problem 7E

To determine

(a)

Introduction:

Balance sheet is the financial statement of a company. It helps in maintaining the records of assets, liabilities and capital of the company for a point in time.

To calculate:

The change in balance sheet and classify the type of cash flow activity.

Answer to Problem 7E

Particulars	Previous year	Current year	Change	Activity
Cash	$35	$240	$205	Cash
Account Receivable	$75	$175	$100	O
Inventory	$260	$135	($125)	O
Equipment	$500	$560	$60	I
Accumulated Dep-Equipment	($45)	($80)	($35)	O
Total	$825	$1,030	$205
Salaries and wages payable	$10	$50	$40	O
Notes payable(long-term)	$445	$515	$70	F
Common stock	$10	$10	$0	F
Retained earnings	$360	$455	$95	O
Total	$825	$1,030	$205

Explanation of Solution

Formula used to calculate the change:

Change = Current year amount − Previous year amount

Cash flow from operating activities calculates the inflow and outflow of cash from day-to-day activities. It includes operating income and operating expenses for the year. Changes in current assets and current liabilities are recorded as a part of operating activity.

Cash flow from investing activities calculates the inflow and outflow of cash from purchase and sale of fixed asset.

Cash flow from financing activities calculates the inflow and outflow of cash from issue of shares and debentures and long term-borrowings or repayment of loan and redemption of debentures

To determine

(b)

Introduction:

Cash flow statements are the statements that determines the inflow and outflow of cash from three major activities that are carried out in a business i.e. operating activities, investing activities and financing activities.

To prepare:

The cash flow statements using indirect method

Answer to Problem 7E

Cash flow statements for the year ending 31^st Dec. using indirect method

Cash flow from operating activities	$
Net income	$95
Adjustment to reconcile net income to net cash provided by operating activities:
Depreciation	$35
Changes in current assets and current liabilities:
Accounts Receivable	($100)
Inventory	$125
Salaries and wages payable	$40
Net cash provided by or (used) in operating activities	$195
Cash flow from investing activities
Purchase of equipment	($60)
Net cash provided by or (used) in investing activities	($60)
Cash flow from financing activities
Borrowing notes payable	$70
Net cash provided by or (used) in financing activities	$70
Net increase (decrease) in cash and cash equivalents	$205
+ Cash and cash equivalent at the beginning of the period	$35
Cash and Cash equivalent at the end of the period	$240

Explanation of Solution

Cash flow from operating activities calculates the inflow and outflow of cash from day-to-day activities. It includes operating income and operating expenses for the year.

Depreciation does not involve cash. It is considered as a non-cash expense which is deducted from the income statement. To eliminate this effect, depreciation is added back to net income in cash flow statement. Hence, becoming the part of operating activity.

Changes in current assets and current liabilities:

• Decrease in current assets and increase in current liabilities means there is an inflow of cash. Therefore, they will be added to the net income.
• Increase in current assets and decrease in current liabilities means there is an outflow of cash. Therefore, they will be subtracted from the net income.

Cash flow from investing activities calculates the inflow and outflow of cash from purchase and sale of fixed asset. For example: Purchase or sale of equipment.

Cash flow from financing activities calculates the inflow and outflow of cash from issue of shares and debentures and long term-borrowings or repayment of loan and redemption of debentures.

Net increase (decrease) in cash and cash equivalents = Net cash provided by or (used) in operating activities + Net cash provided by or (used) in investing activities + Net cash provided by or (used) in financing activities

Cash and Cash equivalent at the end of the period = Net increase (decrease) in cash and cash equivalents + Cash and cash equivalent at the beginning of the period.

To determine

(c)

Introduction:

Accounts receivable is the balance money which is yet to be received by the firm for goods and services delivered. This is a legally enforceable claim.

To explain:

The reason for deducting decrease in the account receivable.

Explanation of Solution

Account receivable is a part of current assets. Increase in the current assets means company is acquiring current assets which will lead to outflow of cash. Therefore, it will be deducted from the cash flow statement.

To determine

(d)

Introduction:

Inventory is a part of current asset. It is the collection of products that are waiting to be sold. It includes raw materials, partially finished goods and finished goods.

To explain:

The reason for adding decrease in inventory.

Explanation of Solution

Inventory is a part of current asset. Decrease in inventory means the company is selling out its inventory which will bring cash into the business. Therefore, it is added.

To determine

(e)

Introduction:

Salaries and wages payable are a part of current liability. They are yet to be paid to the employees and workers.

To explain:

Why increase in salaries and wages payable is added.

Explanation of Solution

Salary and wages payable are a part of current liability. Increase in current liabilities means there is an inflow of cash. Therefore, it will be added.

To determine

(f)

Introduction:

Cash flow statements are the statements that determines the inflow and outflow of cash from three major activities that are carried out in a business i.e. operating activities, investing activities and financing activities.

To explain:

What does the cash flows suggest about the company being a startup, healthy or troubled company.

Answer to Problem 7E

The cash flow of the company suggest that the company is a start-up company.

Explanation of Solution

The start-up companies have little operating cashflows. They invest more in long-term assets and rely most on financing activities for cash inflows. The above given cash flow statements of the company suggest that the company is a start-up company.