Chapter 14, Problem 48P

1.

To determine

Compute the cash flows from operations with the use of indirect method.

Explanation of Solution

Cash Flows from Operating Activities:

This category of a cash flow statement shows the operational and profit generating activities in a firm. The operating cash flows increase or decrease the current assets and current liabilities of a firm.

The cash flows from operations for B Company for 20X2 using indirect method is shown below:

Particulars	Amount ($)
Cash flows from operating activities:
Net income	450,000
Add/ Less:
Decrease in accounts receivable1	68,750
Decrease in accounts payable2	(62,500)
Increase in inventories3	(25,000)
Depreciation expense4	125,000
Gain on sale of equipment5	(50,000)
Net cash from operating activities	506,250

Table (1)

Therefore, the net cash from operating activities is $506,250.

Working Note:

1.

Calculation of difference in accounts receivable:

$\begin{array}{c}\left(\begin{array}{l}\text{Difference}\text{in}\\ \text{Accounts}\text{Receivable}\end{array}\right)=\left(\begin{array}{l}\text{Amount}\text{of}\text{Accounts}\text{Receivable}\text{of}20\text{X}2\\ -\text{Amount}\text{of}\text{Accounts}\text{Receivable}\text{of}20\text{X1}\end{array}\right)\\ =\left(\$281,250-\$350,000\right)\\ =-\$68,750\end{array}$

2.

Calculation of difference in accounts payable:

$\begin{array}{c}\left(\begin{array}{l}\text{Difference}\text{in}\\ \text{Accounts}\text{Payable}\end{array}\right)=\left(\begin{array}{l}\text{Amount}\text{of}\text{Accounts}\text{Payable}\text{of}20\text{X}2\\ -\text{Amount}\text{of}\text{Accounts}\text{Payable}\text{of}20\text{X1}\end{array}\right)\\ =\left(\$237,500-\$300,000\right)\\ =-\$62,500\end{array}$

3.

Calculation of difference in inventories:

$\begin{array}{c}\left(\begin{array}{l}\text{Difference}\text{in}\\ \text{Inventories}\end{array}\right)=\left(\begin{array}{l}\text{Amount}\text{of}\text{Inventories}\text{of}20\text{X}2\\ -\text{Amount}\text{of}\text{Inventories}\text{of}20\text{X1}\end{array}\right)\\ =\left(\$150,000-\$125,000\right)\\ =\$25,000\end{array}$

4.

Calculation of depreciation expense:

$\begin{array}{c}\text{Depreciation}\text{Expense}=\left(\begin{array}{l}EndingValueof\text{Accumulated}\text{Depreciation}\\ -BeginningValueof\text{Accumulated}\text{Depreciation}\\ +\text{Accumulated}\text{Depreciation}\text{for}\text{Asset}\text{Sold}\end{array}\right)\\ =\left(\$525,000-\$500,000+\$100,000\right)\\ =\$125,000\end{array}$

5.

Calculation of gain on value of equipment:

$\begin{array}{c}\text{Gain}\text{on}ValueofEquipment=\left(\begin{array}{l}\text{Original}\text{Value}ofEquipment\\ -SalesValueofEquipment\end{array}\right)\\ =\left(\$225,000-\$175,000\right)\\ =\$50,000\end{array}$

2.

To determine

Chart the statement of cash flows.

Explanation of Solution

Cash Flow Statement:

Cash flow statement is a financial statement prepared to provide information about the sources and uses of cash in a firm. In this statement, the activities increasing cash are referred as cash inflows and the activities that decrease cash are referred as cash outflows.

The statement of cash flows for the B Manufacturing for year ending 20X2 is as shown below:

B Company
Cash Flows from Operations
For the year ended December31, 20X2
Particulars	Amount ($)	Amount ($)
Cash flows from operating activities:
Net income	450,000
Add/ Less:
Decrease in accounts receivable1	68,750
Decrease in accounts payable2	(62,500)
Increase in inventories3	(25,000)
Depreciation expense4	125,000
Gain on sale of equipment5	(50,000)
Net cash from operating activities		506,250
Cash flows from investing activities:
Sale of equipment	175,000
Purchase of equipment6	(250,000)
Purchase of land7	(218,750)
Net cash from investing activities		(293,750)
Cash flows from financing activities:
Mortgage received	250,000
Payment of dividends	(225,000)
Net cash from financing activities		25,000
Net increase in cash		237,500

Table (2)

Therefore, there is a net increase in cash of $237,500.

Working Note:

1.

Calculation of difference in accounts receivable:

$\begin{array}{c}\left(\begin{array}{l}\text{Difference}\text{in}\\ \text{Accounts}\text{Receivable}\end{array}\right)=\left(\begin{array}{l}\text{Amount}\text{of}\text{Accounts}\text{Receivable}\text{of}20\text{X}2\\ -\text{Amount}\text{of}\text{Accounts}\text{Receivable}\text{of}20\text{X1}\end{array}\right)\\ =\left(\$281,250-\$350,000\right)\\ =-\$68,750\end{array}$

2.

Calculation of difference in accounts payable:

$\begin{array}{c}\left(\begin{array}{l}\text{Difference}\text{in}\\ \text{Accounts}\text{Payable}\end{array}\right)=\left(\begin{array}{l}\text{Amount}\text{of}\text{Accounts}\text{Payable}\text{of}20\text{X}2\\ -\text{Amount}\text{of}\text{Accounts}\text{Payable}\text{of}20\text{X1}\end{array}\right)\\ =\left(\$237,500-\$300,000\right)\\ =-\$62,500\end{array}$

3.

Calculation of difference in inventories:

$\begin{array}{c}\left(\begin{array}{l}\text{Difference}\text{in}\\ \text{Inventories}\end{array}\right)=\left(\begin{array}{l}\text{Amount}\text{of}\text{Inventories}\text{of}20\text{X}2\\ -\text{Amount}\text{of}\text{Inventories}\text{of}20\text{X1}\end{array}\right)\\ =\left(\$150,000-\$125,000\right)\\ =\$25,000\end{array}$

4.

Calculation of depreciation expense:

$\begin{array}{c}\text{Depreciation}\text{Expense}=\left(\begin{array}{l}EndingValueof\text{Accumulated}\text{Depreciation}\\ -BeginningValueof\text{Accumulated}\text{Depreciation}\\ +\text{Accumulated}\text{Depreciation}\text{for}\text{Asset}\text{Sold}\end{array}\right)\\ =\left(\$525,000-\$500,000+\$100,000\right)\\ =\$125,000\end{array}$

5.

Calculation of gain on value of equipment:

$\begin{array}{c}\text{Gain}\text{on}ValueofEquipment=\left(\begin{array}{l}\text{Original}\text{Value}ofEquipment\\ -SalesValueofEquipment\end{array}\right)\\ =\left(\$225,000-\$175,000\right)\\ =\$50,000\end{array}$

6.

Calculation of purchase value of equipment:

$\begin{array}{c}PurchaseValueofEquipment=\left(\begin{array}{l}EndingValueofEquipment\\ -BeginningValueofEquipment\\ +SalesValue\end{array}\right)\\ =\left(\$1,025,000-\$100,000+\$225,000\right)\\ =\$250,000\end{array}$

7.

Calculation of purchase value of land:

$\begin{array}{c}PurchaseValueofLand=\left(\begin{array}{l}Valueof\text{Land}\text{in}\text{20X2}\\ -Valueof\text{Land}\text{in}\text{20X1}\end{array}\right)\\ =\left(\$718,750-\$500,000\right)\\ =\$218,750\end{array}$

3.

To determine

Identify the method used in preparing the statement of cash flows of a company. Also, explain the manner in which the net income is compared with the operating cash flows and to the change in cash flows.

Explanation of Solution

Generally, companies use indirect method to prepare the statement of cash flows. The net income after making all the adjustments of the noncash and non-operating expenses is equal to the operating cash flows. The net income changes with respect to the increase and decrease in cash flows.