Chapter 13, Problem 17E

Statement of cash flows–indirect method

The comparative balance sheet of Olson-Jones Industries Inc. for December 31, 20Y2 and 20Y1, is as follows:

The following additional information is taken from the records:

1. A. Land was sold for $120.
2. B. Equipment was acquired for cash.
3. C. There were no disposals of equipment during the year.
4. D. The common stock was issued for cash.
5. E. There was a $62 credit to Retained Earnings for net income.
6. F.  There was a $24 debit to Retained Earnings for cash dividends declared.
7. A. Prepare a statement of cash flows, using the indirect method of presenting cash flows from operating activities.
8. B. Was Olson-Jones’s net cash flow from operations more or less than net income? What is the source of this difference?

To determine

Prepare a statement of cash flows under indirect method.

Answer to Problem 17E

O Industries
Statement of Cash Flows - Indirect Method
Details	Amount ($)	Amount ($)
Cash flows from operating activities:
Net income		62
Adjustments to reconcile net income to net cash flow from operating activities:
Depreciation expense	26
Gain on sale of land	(40)
Changes in current operating assets and liabilities:
Increase in accounts receivable	(6)
Increase in inventory	(18)
Increase in accounts payable	14	(24)
Net cash provided by operating activities		$38
Cash flows from investing activities:
Cash from sale of land	120
Cash used for purchase of equipment	(30)
Net cash provided by investing activities		$90
Cash flows from financing activities:
Cash from sale of common stock	60
Cash used for dividends	(19)
Net cash provided by financing activities		$41
Increase (decrease) in cash		$169
Cash at the beginning of the year		14
Cash at the end of the year		$183

Table (4)

Explanation of Solution

Statement of cash flows: It is one of the financial statement that shows the cash and cash equivalents of a company for a particular period. It determines the net changes in cash through reporting the sources and uses of cash due to the operating, investing, and financing activities of a company.

Indirect method: Under this method, the following amounts are to be adjusted from the Net Income to calculate the net cash provided from operating activities.

Cash flows from operating activities: These are the cash produced by the normal business operations.

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

Cash flows from operating activities (Indirect method)

Add: Decrease in current assets

Increase in current liability

Depreciation expense and amortization expense

Loss on sale of plant assets

Deduct: Increase in current assets

Decrease in current liabilities

Gain on sale of plant assets

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.

The below table shows the way of calculation of cash flows from investing activities:

Cash flows from investing activities

Add: Proceeds from sale of fixed assets

Sale of marketable securities / investments

Interest received

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.

The below table shows the way of calculation of cash flows from financing activities:

Cash flows from financing activities

Add: Issuance of common stock

Proceeds from borrowings

Proceeds from issuance of debt

Issuance of bonds payable

Deduct: Payment of dividend

Repayment of debt

Interest paid

Redemption of debt

Repurchase of stock

Net cash provided from or used by financing activities

Table (3)

Working note:

Prepare the schedule in the changes of current assets and liabilities.

Schedule in the Change of Current Assets and Liabilities
Details	Amount ($)			Effect on Operating Activities
	Beginning Balance	Ending Balance	Increase/ (Decrease)
Accounts receivable	49	55	6	Deduct
Inventories	99	117	18	Deduct
Accounts payable	37	51	14	Add

Table (3)

Calculate the amount of depreciation expense:

$\begin{array}{c}\text{Amount of depreciation expense =}\left(\begin{array}{l}\text{ Ending balance -}\\ \text{ Beginning balance}\end{array}\right)\\ =\left(\$68-\$42\right)\\ =\$26\end{array}$

Calculate the amount gain on sale of land:

$\begin{array}{c}\text{Amount gain on sale of land}\text{= }\left[\begin{array}{l}\text{Book value of land}\\ \left(\begin{array}{l}\text{ Beginning balance }\\ \text{- Ending balance }\\ \end{array}\right)\\ -\text{Sale value}\end{array}\right]\\ =\left(\begin{array}{l}\$80\left(\$330-\$250\right)\\ -\$120\end{array}\right)\\ =\$40\end{array}$   

Calculate the amount of cash used to purchase of equipment:

$\begin{array}{c}\begin{array}{l}\text{Amount of cash used to }\\ \text{purchase of equipment }\end{array}\}\text{=}\left(\begin{array}{l}\text{ Ending balance -}\\ \text{ Beginning balance}\end{array}\right)\\ =\left(\$205-\$175\right)\\ =\$30\end{array}$

Calculate the amount of cash from common stock:

$\begin{array}{c}\begin{array}{l}\text{Amount of cash from}\\ \text{common stock}\end{array}\}\text{=}\left[\begin{array}{l}\left(\begin{array}{l}\text{ Ending balance -}\\ \text{ Beginning balance}\end{array}\right)+\\ \left(\begin{array}{l}\text{Paid in capital Ending balance }\\ \text{- Beginning balance}\end{array}\right)\end{array}\right]\\ =\left[\begin{array}{l}\left(\$125-\$80\right)\\ +\left(\$85-\$75\right)\end{array}\right]\\ =\$45+10\\ =\$60\end{array}$

Calculate the amount of dividends:

$\begin{array}{c}\text{Amount of dividends =}\left(\begin{array}{l}\text{ Balance of dividends -}\\ \text{ Cash dividends declared}\end{array}\right)\\ =\left(\$5-\$24\right)\\ =\$19\end{array}$

Conclusion

Therefore, the ending cash balance is $183.

To determine

Explain the cash flow from operations more or less than net income.

Explanation of Solution

• Depreciation expense amount of $26 does not show any effect on cash flow from operating activities.
• The gain on sale of land of $40 will be reported in operating activities. The proceeds from sale of $120 will be reported in the investing activities section of the statement of cash flows.
• Moreover, the changes in current operating assets and liabilities are added or deducted based on the effect of below cash flows:
• Increase in accounts receivable $6 (Deducted).
• Increase in inventories $18 (Deducted).
• Increase in accounts payable $14 (Added).