Chapter 16, Problem 19QS

Requirement 1

To determine

To prepare:

Statement of cash flows for the year ended December 31, 2016.

Answer to Problem 19QS

Solution:

MONTGOMERY INC.
Statement of Cash Flow
For the year ended December 31, 2016
Cash flow from operating activities
Net income		10,500
Adjustments to reconcile net income with operating assets
Add: Depreciation	7,200
Add: Decrease in Accounts Receivables	2100
Less: Increase in Inventory	-19950
Less: Decrease in Accounts Payable	-1500
Less: Decrease in Salaries Payable	-100
Total adjustments	-12,250
Cash flow used from operating activities (A)		-1,750
Cash flow from Investing activities
Purchase of Equipment	-8,400
Cash flow used in Investing activities (B)		-8,400
Cash flow from financing activities
Issue of Common stock	10,000
Cash flow used in Investing activities ( C)		10,000
Changes in Cash (A + B + C)		-150
Add: Cash in the beginning of the year		30,550
Cash at the end of the year		30,400

Explanation of Solution

The above statement of cash flows is prepared as under −
The statement of cash flows is divided into three parts −

1. Cash flow from operating activities
2. Cash flow from investing activities
3. Cash flow from financing activities

The calculations and working for all the activities are explained as under −

1. Cash flow from operating activities
Given,
• Net income = $ 10,500
• Depreciation expense = $ 7,200 (non-cash expense)
• Current assets, 2016 −
• Accounts receivables = $ 10,050
• Inventory = $ 90,100
• Current liabilities 2016 −
• Accounts Payable = $ 23,900
• Salaries Payable = $ 500
• Current assets, 2015 −
• Accounts receivables = $ 30,550
• Inventory = $ 70,150
• Current liabilities 2015 −
• Accounts Payable = $ 25,400
• Salaries Payable = $ 600

	2016	2015	Increase or Decrease	Amounts
Current Assets
Accounts receivables	10,050	12,150	Decrease	2,100
Inventory	90,100	70,150	Increase	19,950
Current Liabilities
Accounts Payable	23,900	25,400	Decrease	1,500
Salaries Payable	500	600	Decrease	100

The cash flow from operating activities is prepared on the basis of −

Add: Decrease in Current Assets, Increase in Current Liabilities

Less: Increase in Current Assets, Decrease in Current Assets.
The adjustments are added to net income −

  $Cashflowfromoperatingactivities=NetIncome+Adjustmentstoreconcilenetincome$

The adjustment to reconcile net income is calculated as under − $$


  $\begin{array}{l}\begin{array}{l}\begin{array}{l}Adjustmentstonetincome=Depreciation+Decreaseinaccountsreceivables\\ +\text{ Increase in wages payable }+\text{Decrease in inventory}\\ –DecreaseinIncometaxespayable-\text{Increase in prepaid expenses}\\ –D\text{ecreases in Accounts Payable}\end{array}\hfill \\ Adjustmentstonetincome=\$37,600+\$\text{ 10},000+\$\text{ 10},000\text{ + }\$\text{ 4},000-\$1,200-\$6,000-\$\text{ 1,200}\hfill \end{array}\\ Adjustmentstonetincome=\$\text{ 53},200\end{array}$ Cash flow from operating activities is −

  $\begin{array}{l}Cashflowfromoperatingactivities=NetIncome+Adjustmentstoreconcilenetincome\\ Cashflowfromoperatingactivities=\$\text{ 10},500-\$\text{ 12},250\\ Cashflowfromoperatingactivities=-\$\text{ 1},750\end{array}$

The cash flow from operating activities = - $ 1,750.


2. Cash flow from or used Investing Activities −
The cash flow from or used from investing activities can be calculated as under −
The sale and purchase of fixed assets are covered in the investing activities.

Given,


• Equipment for 2016 = $ 41,500
• Equipment for 2015 = $ 49,900
Purchases during the year will be calculated as −

  $\begin{array}{l}Purchaseofequipment=Equipmentfor2016-Equipmentfor2015\hfill \\ Purchaseofequipment=\$49,900-\$41,500\hfill \\ Purchaseofequipment=\$8,400\hfill \end{array}$

The cash used in investing activities = - $ 8,400.


3. Cash flow from financing activities −
The cash flow from financing activities is calculated as under −
Given,
• Common stock for 2016 = $ 110,000
• Common stock for 2015 = $ 100,000
  $\begin{array}{l}Issueofcommonstock=Commonstockfor2016-Commonstockfor2015\hfill \\ Issueofcommonstock=\$110,000-\$100,000\hfill \\ Issueofcommonstock=\$10,000\hfill \end{array}$

The cash flow from financing activities = Issue of common stock = $ 10,000
After calculating the cash flow from or used from the three activities, the change in cash will be calculated.

  $\begin{array}{l}\begin{array}{l}Changeincash=Cashflowusedinoperatingactivities+Cashflowusedininvestingactivities\\ +Cashflowfromfinancingactivities\end{array}\hfill \\ Changeincash=\left(-\$1,750\right)+\left(-\$8,400\right)+\$10,000\hfill \\ Changeincash=-\$150\hfill \end{array}$

Now, the ending cash balance will be calculated −

  $\begin{array}{l}Endingcashbalance=BeginningCashbalance+ChangesinCash\hfill \\ Endingcashbalance=\$30,550+\left(-\$150\right)\hfill \\ Endingcashbalance=\$30,400.\hfill \end{array}$

The statement of cash flow has been prepared.

Conclusion

Thus, the statement of cash flows for the year ended December 31, 2016 has been prepared.

Requirement 2

To determine

To analyse and discuss:

1. Statement prepared in requirement 1
2. Operating activities section

Answer to Problem 19QS

Solution:

1. Statement of cash prepared in requirement 1 explains about the cash used in operating and investing activities and cash flow from financing activities.
2. Operating activities section shows that the cash is used for operating activities, but that does not mean that cash there is loss from the operating activities.

Explanation of Solution

1. Statement of cash flow is divided into three parts −
• Operating activities
• Investing activities
• Financing activities
Operating activities − The cash flow is used in case of operating activities, that means, cash payments for operating activities was more than the cash receipts from operating activities. But that does not mean that the company had a loss during the year, cash flow from or used from operating activities and net income or loss have different basis for their computations.
Investing activities − The only investing activity that appeared in statement of cash flows is purchase of equipment. Since, it is a purchase that it is a cash outflow and shown with a negative sign.
Financing activities − The only financing activity in the statement of cash flows is issue of common stock. It is an inflow of the cash.

2. The operating section as discussed above, shows that the cash flow is used in case of operating activities, that means, cash payments for operating activities was more than the cash receipts from operating activities. But that does not mean that the company had a loss during the year, cash flow from or used from operating activities and net income or loss have different basis for their computations

Conclusion

Thus, the cash flow statement is analysed and operating section is discussed.