Chapter 12, Problem 8BP

To determine

Prepare a complete statement of cash flows and reports its cash flow from operating activities using direct method.

Explanation of Solution

Statement of cash flows: Statement of cash flows reports all the cash transactions which are responsible for inflow and outflow of cash and result of these transactions is reported as ending balance of cash at the end of reported period. Statement of cash flows includes the changes in cash balance due to operating, investing, and financing activities.

Cash flows from operating activities: Cash flows from operating activity represent the net cash flows from the general operation of the business by comparing the cash receipt and cash payments.

Direct method: The direct method uses the cash basis of accounting for the preparation of the statement of cash flows. It takes into account those revenues and expenses for which cash is either received or paid.

The below table shows the way of calculation of cash flows from operating activities using direct method:

Cash flows from operating activities (Direct method)

Add: Cash receipts.

Cash receipt from customer

Less: Cash payments:

To supplier

Interest expense

For operating expenses

Income tax expenses

Net cash provided from or used by operating activities

Table (1)

Cash flows from investing activities: Cash provided by or used in investing activities is a section of statement of cash flows. It includes the purchase or sale of equipment or land, or marketable securities, which is used for business operations.

Cash flows from investing activities

Add: Proceeds from sale of fixed assets

Sale of marketable securities / investments

Dividend received

Deduct: Purchase of fixed assets/long-lived assets

Purchase of marketable securities

Net cash provided from or used by investing activities

Table (2)

Cash flows from financing activities: Cash provided by or used in financing activities is a section of statement of cash flows. It includes raising cash from long-term debt or payment of long-term debt, which is used for business operations.

Cash flows from financing activities

Add: Issuance of common stock

Proceeds from borrowings

Proceeds from sale of treasury stock

Proceeds from issuance of debt

Deduct: Payment of dividend

Repayment of debt

Interest paid

Redemption of debt

Purchase of treasury stock

Net cash provided from or used by financing activities

Table (3)

The statement of cash flows for the year ended December 31, 2015:

Company S
Statement of Cash Flows – Direct Method
For Year Ended December 31, 2015
Particulars	Amount	Amount
Cash flows from operating activities
Cash received from customers	756,438
Cash paid for inventory	(431,705)
Cash paid for other operating expenses	(173,933)
Cash paid for income taxes	(93,200)
Net cash provided by operating activities		$57,600
Cash flows from investing activities
Cash paid for equipment	($30,250)
Net cash used in investing activities		($30,250)
Cash flows from financing activities
Cash received from issuing stock $\left(3,000\text{ shares }\times \$21\text{ per share}\right)$	$63,000
Less: Cash paid for cash dividends	($60,000)
Net cash used in financing activities		$3,000
Net increase in cash		$30,350
Add: Cash balance at December 31, 2014		$28,400
Cash balance at December 31, 2015		$58,750

Table (4)

Working notes:

The amount of cash receipts from customers.

Step 1: Calculate the change in accounts receivable.

$\begin{array}{c}\text{Change in accounts receivable}=\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$20,222}-\$25,860\\ =\$5,638\left(\text{Decrease}\right)\end{array}$

Step 2: The Calculate the amount of cash receipts from customers.

$\begin{array}{c}\begin{array}{l}\text{Cash}\text{receipts}\text{from}\\ \text{Customers}\end{array}]=\text{Sales}\text{revenue }\left(\begin{array}{l}+\text{Decrease in Accounts Receivable}\\ \text{OR}\\ -\text{Increase in Accounts Receivable}\end{array}\right)\\ =\text{ Sales Revenue + Decrease in Accounts Receivable}\\ =\$750,800+\$5,638\\ =\$756,438\end{array}$

Calculate the cash payments to suppliers.

Step 1: Calculate the change in inventory.

$\begin{array}{c}\text{Change in inventory=}\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$165,667}-\$140,320\\ =\$25,347\left(\text{Increase}\right)\end{array}$

Step 2: Calculate the change in accounts payable.

$\begin{array}{c}\text{Change in accounts payable}=\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$20,372}-\$157,530\\ =\$137,158\left(\text{Decrease}\right)\end{array}$

Step 3: Calculate the amount of cash payments to suppliers.

$\begin{array}{c}\left(\begin{array}{l}\text{Cash}\text{paid }\\ \text{to }\text{suppliers}\end{array}\right)=\text{Cost of Goods Sold }\left(\begin{array}{l}+\text{Decrease in Accounts Payable}\\ \text{/}\text{Increase in Inventory}\\ \text{OR}\\ -\text{Increase in Accounts Payable }\\ \text{/}\text{Decrease in Inventory}\end{array}\right)\\ =\left(\begin{array}{l}\text{Cost of goods sold}+\text{Decrease in accounts payable}\\ \text{ + Increase in inventory}\end{array}\right)\\ =\$269,200+\$137,158+\$25,347\\ =\$431,705\end{array}$

Calculate the amount of cash paid for income tax expenses:

Step 1: Calculate the change in income taxes payable.

$\begin{array}{c}\text{Change in income taxes payable =}\left(\begin{array}{l}\text{Ending balance}\\ -\text{Beginning balance}\end{array}\right)\\ =\text{\$2,100}-\$6,100\\ =\$4,000\left(\text{Decrease}\right)\end{array}$

Step 2: Calculate the amount of cash paid for income taxes.

$\begin{array}{c}\left(\begin{array}{l}\text{Cash paid }\\ \text{for Income taxes}\end{array}\right)=\text{Income tax expense}\left(\begin{array}{l}+\text{Decrease in income tax payable}\\ \text{OR}\\ -\text{Increase in income tax payable}\end{array}\right)\\ =\left(\text{Income tax expense + Decrease in income tax payable}\right)\\ \text{=}\left(\text{\$89,200 + }\$4,000\right)\\ =\$93,200\end{array}$

Compute the amount of issuance of common stock:

$\begin{array}{c}\text{Issuance of common stock =}\left(\begin{array}{l}\text{ Number of issued common shares }\\ \times \text{ Cash per share}\end{array}\right)\\ =\left(3,000\text{ shares}\times \text{\$21}\right)\\ =\$63,000\end{array}$