Chapter 13, Problem 6AP

a.

To determine

Prepare a statement of cash flows for the current year using the 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

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)

A statement of cash flow for C technologies for the year ended December 31, 2018.

C Technologies
Statement of Cash Flows Direct Method
For the Year Ended December 31, 2018
Details	Amount ($)	Amount ($)
Cash flows from operating activities:
Cash receipts:
Cash received from customers	3,140,000
Interest received	42,000
Total cash receipts		3,182,000
Cash payments:
Cash paid to suppliers and employees	(2,680,000)
Interest paid	(38,000)
Income taxes paid	(114,000)
Total cash payments		(2,832,000)
Net cash provided operating activities		350,000
Cash flows from investing activities:
Purchase of marketable securities	(60,000)
Proceeds from sales of marketable securities	72,000
Loans made to borrowers	(44,000)
Collections on loan	28,000
Cash paid to acquire plant	(500,000)
Proceeds from sale of plant assets	24,000
Net cash used for investing activities		(480,000)
Cash flows from financing activities:
Proceeds from short-term borrowing	82,000
Payments to settle short-term debt	(92,000)
Proceeds from issuing common stock	180,000
Payment of dividend	(120,000)
Net cash provided by financing activities		50,000
Net increase (decrease) in Cash		(80,000)
Cash and cash equivalents, January 1, 2018		244,000
Cash and cash equivalents, December 31, 2018		$164,000

Table (4)

Working notes:

Calculate the amount of cash receipts from customers.

$\begin{array}{c}\begin{array}{l}\text{Cash}\text{receipts}\text{from}\\ \text{Customers}\end{array}]=\text{Net sales }\left(\begin{array}{l}+\text{Decrease in Accounts Receivable}\\ \text{OR}\\ -\text{Increase in Accounts Receivable}\end{array}\right)\\ =\text{ Net sales }-\text{Increase in Accounts Receivable}\\ =\$3,200,000-\$60,000\\ =\$3,140,000\end{array}$

Calculate the amount of interest received.

$\begin{array}{c}\text{Interest received}]=\left\{\begin{array}{l}\text{Interest income }\\ \left(\begin{array}{l}+\text{Decrease in Interest Receivable}\\ \text{OR}\\ -\text{Increase in Interest Receivable}\end{array}\right)\end{array}\right\}\\ =\left[\begin{array}{l}\left(\text{Interest income }\right)\\ \text{+ Decrease in Accounts Receivable}\end{array}\right]\\ =\left[\$40,000+\text{ \$2,000}\right]\\ =\$42,000\end{array}$

Calculate the cash paid to supplier and employees.

Step 1: Calculate the amount of cash paid to suppliers of merchandise.

$\begin{array}{c}\left(\begin{array}{l}\text{Cash}\text{paid to }\text{suppliers}\\ \text{of merchandise}\end{array}\right)=\text{Cost of Goods Sold }\left(\begin{array}{l}+\text{Decrease in Accounts Payable}\\ \text{/}\text{Increase in Inventory}\\ \text{OR}\\ -\text{Increase in Accounts Payable }\\ \text{/}\text{Decrease in Inventory}\end{array}\right)\\ =\left(\begin{array}{l}\text{Cost of goods sold + Decrease in accounts payable}\\ -\text{ Decrease in inventory}\end{array}\right)\\ =\$1,620,000+\$16,000-\$60,000\\ =\$1,576,000\end{array}$

Step 2: Calculate the amount paid for operating expenses.

$\begin{array}{l}\left(\text{Cash}\text{paid to }\text{operating expenses}\right)=\left\{\begin{array}{l}\text{Operating expenses }-\text{Depreciation expenses }\\ \left(\begin{array}{l}+\text{Decrease in Accrued Operating}\\ \text{ Expenses Payable}\\ \text{/}\text{Increase in Short-Term Prepayment}\\ \text{OR}\\ -\text{Increase inAccrued Operating }\\ \text{Expenses PayablePayable }\\ \text{/}\text{Decrease in Short-Term Prepayment}\end{array}\right)\end{array}\right\}\\ =\left(\begin{array}{l}\text{Operating expenses }-\text{Depreciation expenses }\\ \text{+}\text{Decrease in accrued operating}\\ \text{ expenses payable + }\\ \text{Increase in Short-Term Prepayment}\end{array}\right)\\ =\left(\begin{array}{l}\text{\$1,240,000}-\$150,000\\ \text{+}\text{\$8,000 + \$6,000}\end{array}\right)\\ =\$1,104,000\end{array}$

Step 3: Calculate the amount of cash paid to supplier and employees.

$\begin{array}{c}\text{Cash paid to supplier and employees}=\left(\begin{array}{l}\text{Cash paid to suppliers of merchandise}\\ +\text{ Cash paid for operating expenses}\end{array}\right)\\ =\text{\$1,575,000}+\$1,104,000\\ =\$2,680,000\end{array}$

Calculate the amount of cash paid for interest expenses.

$\begin{array}{c}\left(\begin{array}{l}\text{Cash paid for}\\ \text{interest expenses}\end{array}\right)=\left\{\begin{array}{l}\text{Interest expense}\\ \left(\begin{array}{l}+\text{Decrease in accrued expenses payable}\\ \text{OR}\\ -\text{Increase in accrued expenses payable}\end{array}\right)\end{array}\right\}\\ =\left(\begin{array}{l}\text{Interest expense }-\\ \text{Increase in accrued expenses payable}\end{array}\right)\\ \text{=}\left(\text{\$42,000 }-\$4,000\right)\\ =\$38,000\end{array}$

Calculate the amount of cash paid for income tax expenses:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash paid }\\ \text{for Income taxes}\end{array}\right)=\text{Income tax expense}\left(\begin{array}{l}+\text{Decrease in income tax payable}\\ \text{OR}\\ -\text{Increase in income tax payable}\end{array}\right)\\ =\left(\text{Income tax expense + Decrease in income tax payable}\right)\\ \text{=}\left(\text{\$100,000 + }\$14,000\right)\\ =\$114,000\end{array}$

Calculate the amount of proceeds from sales of marketable securities.

$\begin{array}{c}\begin{array}{l}\text{Proceeds from sales of}\\ \text{marketable securities}\end{array}\}=\left(\begin{array}{l}\text{Cost of the marketable securities sold +}\\ \text{Gain reported on sales of marketable securities}\end{array}\right)\\ =\left(\$38,000+\$34,000\right)\\ =\$72,000\end{array}$

Calculate the amount of proceeds from sales of plant assets.

$\begin{array}{c}\begin{array}{l}\text{Proceeds from sales }\\ \text{of plant assets}\end{array}\}=\left(\begin{array}{l}\text{Book value of the plant assets sold }-\\ \text{Loss reported on sales of plant assets}\end{array}\right)\\ =\left(\$36,000-\$12,000\right)\\ =\$24,000\end{array}$

Calculate the amount of proceeds from issuing capital stock.

$\begin{array}{c}\begin{array}{l}\text{Proceeds from }\\ \text{issuing capital stock}\end{array}\}=\left(\begin{array}{l}\text{Amount credited to capital account+}\\ \text{Amount credited to additional}\\ \text{ paid-in capital account}\end{array}\right)\\ =\left(\$20,000+\$160,000\right)\\ =\$180,000\end{array}$

b.

To determine

1. 1. Explain the primary reason why the amount of cash provided by operating activities was substantially greater than the company’s net income.
2. 2. Explain the primary reason for net decrease in cash over the year, despite the substantial amount of cash provided by operating activities.

Explanation of Solution

The primary reason why the amount of cash provided by operating activities substantially more than the company’s net income is because of the depreciation expenses. Under direct method, depreciation expense amount reduces the net income amount and it does not show any effect on cash flows from operating activities.

The primary reason for decrease in cash is investing activities because, C technologies uses their cash in capital expenditure. Hence, investing activities plays a greater role for the net decrease in cash.

c.

To determine

Compute the effect that limiting the growth in receivables to $10,000 would have had on the company’s net increase or decrease in cash (and cash equivalents) for the year.

Explanation of Solution

Net decrease in cash:

$\begin{array}{c}\text{Net decrease in cash =}\left\{\begin{array}{l}\text{Net decrease in cash}-\\ \left(\begin{array}{l}\text{Increase in accounts receivable}\\ -\text{ Growth in receivable }\end{array}\right)\end{array}\right\}\\ =\left\{\text{\$80,000}-\$50,000\left(\$60,000-\text{ \$10,000 }\right)\right\}\\ =\$30,000\end{array}$

Conclusion

Therefore, the net decrease in cash would be $30,000 instead of $80,000.