Chapter 21, Problem 21.20E

To determine

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)

To Prepare: The reconciliation of net income to net cash flows.

Answer to Problem 21.20E

The reconciliation of net income to net cash flows of Company S is shown below.

Company S
Statement of Cash Flows
For the year ended December 31, 2016
Particulars	Amount ($)	Amount ($)
Operating activities:
Net income		$26,000
Adjustments to reconcile net income to net cash from operating activities:
Depreciation expense	$11,000
Depletion expense	$5,000
Loss on sale of land	$8,000
Gain on sale of equipment	($25,000)
Net noncash effects		($1,000)
Changes in operating assets and liabilities:
Add the expenses:
Increase in accounts payable	$13,000
Increase in salaries payable	$4,000
Decrease in prepaid insurance	$6,000
Decrease in bond discount	$1,000
Increase in income tax payable	$12,000
Net cash outflow from operating activities		$36,000
Less the gains:
Increase in accounts receivable	$54,000
Net cash inflow from operating activities		$54,000
Increase in cash balance		($18,000)
Net cash flows from operating activities		$7,000

Table (2)

Explanation of Solution

Working notes:

Calculate the amount of increase in accounts receivable:

$\begin{array}{l}\begin{array}{l}\text{Cash}\text{receipts}\\ \text{from}\text{Customers}\end{array}]=\text{Sales}\text{revenue }\left(\begin{array}{l}+\text{Decrease in Accounts Receivable}\\ \text{OR}\\ -\text{Increase in Accounts Receivable}\end{array}\right)\\ \Rightarrow \begin{array}{l}\text{Increase in Accounts }\\ \text{Receivable}\end{array}]\text{= }\left[\begin{array}{l}\text{Sales}\\ -\text{Cash received from customers}\end{array}\right]\\ \Rightarrow \begin{array}{l}\text{Increase in Accounts }\\ \text{Receivable}\end{array}]\text{=\$312,000}-\$258,000\\ \Rightarrow \begin{array}{l}\text{Increase in Accounts }\\ \text{Receivable}\end{array}]=\$54,000\end{array}$

Calculate the amount of increase in accounts payable:

$\begin{array}{l}\left(\begin{array}{l}\text{Cash}\text{Payment }\\ \text{for }\text{Purchases}\end{array}\right)=\text{Cost of Goods Sold }\left(\begin{array}{l}+\text{Decrease in Accounts Payable}\\ \text{/}\text{Increase in Inventory}\\ \text{OR}\\ -\text{Increase in Accounts Payable }\\ \text{/}\text{Decrease in Inventory}\end{array}\right)\\ \Rightarrow \begin{array}{l}\text{Increase in }\\ \text{accounts payable }\end{array}\}\text{= Cost of goods sold}-\text{Cash paid to suppliers}\\ \Rightarrow \begin{array}{l}\text{Increase in }\\ \text{accounts payable }\end{array}\}=\$188,000-\$175,000\\ \Rightarrow \begin{array}{l}\text{Increase in }\\ \text{accounts payable }\end{array}\}=\$13,000\end{array}$

Calculate the amount of increase in salaries payable:

$\begin{array}{l}\begin{array}{l}\text{Cash payments }\\ \text{for salaries}\end{array}]=\text{Salaries expense}\left(\begin{array}{l}+\text{Decrease in salaries payable}\\ \text{OR}\\ -\text{Increase in salaries payable}\end{array}\right)\\ \Rightarrow \begin{array}{l}\text{Increase in }\\ \text{salaries payable}\end{array}]=\left(\text{Salaries expense}-\text{Cash payment for employees}\right)\\ \Rightarrow \begin{array}{l}\text{Increase in }\\ \text{salaries payable}\end{array}]=\left(\$41,000-\$37,000\right)\\ \Rightarrow \begin{array}{l}\text{Increase in }\\ \text{salaries payable}\end{array}]=\$4,000\end{array}$

Calculate the amount of decrease in prepaid insurance:

$\begin{array}{l}\left(\begin{array}{l}\text{Cash payments }\\ \text{for insurance}\end{array}\right)=\text{Insurance expense}\left(\begin{array}{l}-\text{Decrease in prepaid insurance}\\ \text{OR}\\ +\text{Increase in prepaid insurance}\end{array}\right)\\ \Rightarrow \begin{array}{l}\text{Decrease in }\\ \text{prepaid insurance}\end{array}\}\text{ = }\left(\begin{array}{l}\text{Insurance expense}-\\ \text{Cash payment for insurance}\end{array}\right)\\ \Rightarrow \begin{array}{l}\text{Decrease in }\\ \text{prepaid insurance}\end{array}\}\text{ =}\$22,000-\$16,000\\ \Rightarrow \begin{array}{l}\text{Decrease in }\\ \text{prepaid insurance}\end{array}\}\text{=}\$6,000\end{array}$

Calculate the amount of bond discount:

$\begin{array}{c}\text{Bond discount}=\left(\begin{array}{l}\text{Bond interest expense}\\ -\text{Cash paid for interest}\end{array}\right)\\ =\text{\$10,000}-\$9,000\\ =\$1\end{array}$

Calculate the amount of increase in income tax payable:

$\begin{array}{l}\left(\begin{array}{l}\text{Cash payments }\\ \text{for Income taxes}\end{array}\right)=\text{Income tax expense}\left(\begin{array}{l}+\left(\begin{array}{l}\text{Decrease in}\\ \text{income tax payable}\end{array}\right)\\ \text{OR}\\ -\left(\begin{array}{l}\text{Increase in income}\\ \text{tax payable}\end{array}\right)\end{array}\right)\\ \Rightarrow \begin{array}{l}\text{Increase in income }\\ \text{tax payable}\end{array}\}=\left(\begin{array}{l}\text{Income tax expense}\\ -\text{Cash paid for income taxes}\end{array}\right)\\ \Rightarrow \begin{array}{l}\text{Increase in income }\\ \text{tax payable}\end{array}\}=\$26,000-\$14,000\\ \Rightarrow \begin{array}{l}\text{Increase in income }\\ \text{tax payable}\end{array}\}=\$12,000\end{array}$

Conclusion

The reconciliation of net income to net cash flows of Company S shows the net cash balance from operating activities as $7,000.