Chapter 21, Problem 21.21P

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.

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.

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.

Cash Receipts: It encompasses all the cash receipts from sale of goods and on account receivable.

Cash Payments: It encompasses all the cash payments that are made to suppliers of goods and all expenses that are paid.

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

Cash flows from operating activities (Direct method)

Add: Cash receipts.

Cash receipt from customer

Less: Cash payments:

To supplier

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.

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

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)

T-Account: For all the business transactions, journal entries are passed and are transferred to the respective ledger accounts where it is recorded and summarized in either side of the ‘T’ format.

To Prepare: T-account for balance sheet account of A Company for the year ended December 31, 2016.

Explanation of Solution

Cash Account: (all amounts are in 000s)

Cash Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Operatingactivities:			December 31, 2016	Operatingactivities:
	From customers	414			To suppliers of goods	200
	From investment revenue	3			To employees	78
	From sale of cash equivalents	2			For insurance	3
					For bond interest	21
					For income taxes	35
	Investing activities:				Investing activities:
	Sale of machine components	17			Purchase of long-term investment	25
					Purchase of land	23
	Financing activities:				Financing activities:
	Sale of preferred stock	75			Retirement of bonds	60
					Payment of dividends	22
					Purchase of treasury stock	9
	Balance	35

Table (4)

Accounts Receivable:

Accounts Receivable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Decrease in accounts receivable	4
					Balance	4

Table (5)

Prepaid Insurance:

Prepaid InsuranceAccount
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Decrease in accounts receivable	4
					Balance	4

Table (6)

Inventory:

Inventory Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Increase in inventory	5
	Balance	5

Table (7)

Investment Revenue Receivable:

Investment Revenue ReceivableAccount
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Increase in investment revenue receivable	2
	Balance	2

Table (8)

Long-Term Investment:

Long-Term Investment Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Increase in long-term investment	31
	Purchase of long-term investment	6
	Balance	25

Table (9)

Land:

Land Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Increase in land	46
	Balance	46

Building and Equipment:

Building and Equipment Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Increase in building and equipment	12
December 31, 2016	Balance	82		December 31, 2016	Machine cost	70

Table (10)

Accumulated Depreciation:

Accumulated Depreciation Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Accumulated depreciation	23
	Depreciation	35		December 31, 2016	Balance	12

Table (11)

Patent:

Patent Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Decrease in patent	2
					Balance	2

Table (12)

Accounts Payable:

Accounts Payable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Decrease in accounts payable	15
	Balance	15

Table (13)

Salaries Payable:

Salaries Payable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Decrease in salary payable	5
	Balance	5

Table (14)

Bond Interest Payable:

Bond Interest Payable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Increase in interest payable	4
					Balance	4

Table (15)

Income Tax Payable:

Income Tax PayableAccount
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Decrease in income tax payable	2
	Balance	2

Table (16)

Deferred Tax Liability:

Deferred Tax Liability Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Increase in income tax payable	3
					Balance	3

Table (17)

Notes Payable:

Notes Payable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Notes payable	23
					Balance	23

Table (18)

Lease Liability:

Lease Liability Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Lease liability	82
					Balance	82

Table (19)

Bonds Payable:

Bonds Payable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Decrease in Bonds payable	60
	Balance	60

Table (20)

Discount on Bonds:

Discount on Bonds Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Discount on bond	3
					Balance	3

Table (21)

Common stock:

Common stock Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Common stock	20
					Balance	20

Table (22)

Paid-in Capital:

Paid-in Capital Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Paid-in capital	10
					Balance	10

Table (23)

Preferred Stock:

Preferred Stock Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Preferred stock	75
					Balance	75

Table (24)

Retained Earnings:

Retained Earnings Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016				December 31, 2016	Balance of retained earnings	15
	Payment of cash dividend	22			Balance	67
	Retained earning	30

Table (25)

Treasury Stock:

Treasury Stock Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Treasury stock	9
	Balance	9

Table (26)

Sales:

Sales Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Sales revenue	410
					Balance	410

Table (27)

Investment Revenue:

Investment Revenue Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Investment revenue	11
					Balance	11

Table (28)

Gain on Sale of Treasury Bills:

Gain on Sale of Treasury Bills Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Gain on sale of treasury bill	2
					Balance	2

Table (29)

Cost of Goods Sold:

Cost of Goods Sold Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Cost of Goods Sold	180
	Balance	180

Table (30)

Salaries Expense:

Salaries Expense Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Salaries Expense	73
	Balance	73

Table (31)

Depreciation Expense:

Depreciation Expense Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Depreciation Expense	12
	Balance	12

Table (32)

Patent Amortization Expense:

Patent Amortization ExpenseAccount
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Patent amortization expense	2
	Balance	2

Table (33)

Insurance Expense:

Insurance Expense Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Insurance expense	7
	Balance	7

Table (34)

Bond Interest Expense:

Bond Interest ExpenseAccount
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Bond Interest Expense	28
	Balance	28

Table (35)

Income Tax Expense:

Income Tax Expense Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Income Tax Expense	36
	Balance	36

Table (36)

Loss on Machine Damage:

Loss on Machine Damage Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Loss on machine damage	18
	Balance	18

Table (37)

Net income (income summary):

Net Income (income summary)Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Net income	67
	Balance	67

Table (38)

To determine

To Prepare: The statement of cash flows from operating activities using direct method for A Company for the year ended December 31, 2016.

Answer to Problem 21.21P

Figure (1)

Explanation of Solution

Working notes:

Calculate the amount of cash received from customers:

$\begin{array}{c}\begin{array}{l}\text{Cash}\text{receipts}\\ \text{from}\text{Customers}\end{array}]=\text{Sales}\text{revenue }\left(\begin{array}{l}+\text{Decrease in Accounts Receivable}\\ \text{OR}\\ -\text{Increase in Accounts Receivable}\end{array}\right)\\ =\text{Sales revenue +Decrease in accounts receivables}\\ =\$410+\$4\\ =\$414\end{array}$

Calculate the amount of investment revenue:

$\begin{array}{c}\begin{array}{l}\text{Cash}\text{receipts}\\ \text{from}\text{investment}\end{array}]=\text{Investment}\text{revenue }\left(\begin{array}{l}\text{A's company share of net income}\\ -\left[\begin{array}{l}+\text{Decrease in investment}\\ \text{ revenue receivable}\\ \text{OR}\\ -\text{Increase in investment }\\ \text{revenue receivable}\end{array}\right]\end{array}\right)\\ =\left(\begin{array}{l}\text{Investment revenue}-\text{A's company share of net income }\\ -\text{Increase in accounts receivables}\end{array}\right)\\ =\$11-\$6-\$2\\ =\$3\end{array}$

Calculate the amount of cash paid to suppliers:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash}\text{paid }\\ \text{to suppliers}\end{array}\right)=\text{Cost of Goods Sold }\left(\begin{array}{l}+\text{Decrease in Accounts Payable}\\ \text{/}\text{Increase in Inventory}\\ \text{OR}\\ -\text{Increase in Accounts Payable }\\ \text{/}\text{Decrease in Inventory}\end{array}\right)\\ =\left(\begin{array}{l}\text{Cost of goods sold + Decrease in accounts payable}\\ \text{ + Increase in inventory}\end{array}\right)\\ =\$180+\$15+\$5\\ =\$200\end{array}$

Calculate the amount of cash paid to employees:

$\begin{array}{c}\begin{array}{l}\text{Cash paid }\\ \text{for salaries}\end{array}]=\text{Salaries expense}\left(\begin{array}{l}\text{+Decrease in salaries payable}\\ \text{OR}\\ -\text{Increase in salaries payable}\end{array}\right)\\ =\text{Salaries expense + Decrease in salaries payable}\\ \text{=73}-\$5\\ =\$78\end{array}$

Calculate the amount of cash paid for insurance:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash paid }\\ \text{for insurance}\end{array}\right)=\text{Insurance expense}\left(\begin{array}{l}-\text{Decrease in prepaid insurance}\\ \text{OR}\\ +\text{Increase in prepaid insurance}\end{array}\right)\\ \text{=Insurance expense}-\text{Decrease in prepaid insurance}\\ \text{=\$7}-\$4\\ =\$3\end{array}$

Calculate the amount of cash paid for bond interest:

$\begin{array}{c}\begin{array}{l}\text{Cash paid for}\\ \text{Bond interest}\end{array}]=\text{Bond interest expense}\left(\begin{array}{l}\text{+Decrease in bonds interest payable}\\ \text{/Increase in discount on bond}\\ \text{OR}\\ -\text{Increase in bonds interest payable}\\ \text{/Decrease in discount on bond}\end{array}\right)\\ =\left(\begin{array}{l}\text{Bond interest expense}-\text{Increase in bonds interest payable}\\ -\text{Decrease in discount on bond}\end{array}\right)\\ =\$28-\$4-\$3\\ =\$21\end{array}$

Calculate the amount of cash paid for income taxes:

$\begin{array}{c}\begin{array}{l}\text{Cash paid for}\\ \text{Income taxes}\end{array}]=\text{Income tax expense}\left(\begin{array}{l}\text{+Decrease in income taxpayable}\\ \text{/Decrease deferred tax liability}\\ \text{OR}\\ -\text{Increase in income tax payable}\\ \text{/Increase in deferred tax liability}\end{array}\right)\\ =\left(\begin{array}{l}\text{Income tax expense +Decrease in income tax payable}\\ -\text{Increse in income tax liability}\end{array}\right)\\ =\$36+\$2-\$3\\ =\$35\end{array}$

Calculate the amount of retirement of bonds payable:

$\begin{array}{c}\text{Retirement of bonds payable = }\left(\begin{array}{l}\text{Bonds payable in 2015}-\\ \text{Bonds payable in 2016}\end{array}\right)\\ \text{=\$275}-\$215\\ =\$60\end{array}$

Calculate the amount of cash dividend:

Step 1: Calculate the amount of totaldividend.

$\begin{array}{c}\text{Retained earning in 2016 = }\left(\begin{array}{l}\text{Retained earning in 2015 +}\\ \text{ Net income}-\text{Dividends}\end{array}\right)\\ \text{\$242=\$227}\text{}+\$67-\text{Dividend}\\ \text{Dividend}=\$227+\$67-\$242\\ =\$294-\$242\\ =\$52\end{array}$

Step 2: Calculate the amount of stock dividend.

$\begin{array}{c}\text{Stock dividend = }\left\{\begin{array}{l}\text{Number of stock dividend shares }\times \\ \text{Par value of share}\end{array}\right\}\\ \text{=4 million shares }\times \$7.5\\ =\$30shares\end{array}$

Step 3: Calculate the amount of cash dividend:

$\begin{array}{c}\text{Dividend paid = Cash dividend}-\text{Stock dividend}\\ \text{=\$52}-\$30\\ =\$22\end{array}$

Conclusion

The statement of cash flows of Company S shows opening balance of cash flows in the year 2015 as $81million and the closing balance of cash in the year 2016 as $116 million.