Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CHAPTER 13 STATEMENT OF CASH FLOWS LEARNING OBJECTIVES Describe the content and format of the statement of cash flows Prepare the operating activities section of a statement of cash flows using the indirect method Prepare the investing and financing activities sections and complete the statement of cash flows Use the statement of cash flows to evaluate a company Prepare the operating activities section of a statement of cash flows using the direct method (Appendix 13A) SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Ite m LO BT Item LO BT Item LO BT Item LO BT Item LO BT Questions 1 1 C C C C K 10 1 2 K C C C K 11 12 13 14 15 1 K C C C 3 AP AN AP AN 10 11 12 1 C C C 2,3 2,3 AP C AN 2 3 C C C AP C 16 17 18 19 20 4 4 C C C C C 21 22 5 C C AP AN AN AP 13 14 15 16 5 5 AP AP AP AP AP AN AN 10 11 12 4 AN AN C 13 14 15 5 3,5 AP AP AP Brief Exercises 4 Exercises 2,3 2,3,4 2,3,4 Problems: Set A and B 3,4 C AP AN 3,4 2,3 2,3 AN AN AN 1,4 1,4 AN AN 4 E AN 2,3 4 AN AN AN 10 11 12 2,5 5 AN AN AN C AN E Cases Solutions Manual 13-1 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Legend: The following abbreviations will appear throughout the solutions manual file LO Learning objective BT Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation Level of difficulty S Simple M Moderate C Complex Estimated time to prepare in minutes Difficulty: Time: AACSB CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006 Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech Diversity Diversity Reflective Thinking Reflec Thinking CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm Communication Self-Mgt Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat & Gov Strategy and Governance Mgt Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation Solutions Manual 13-2 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition ANSWERS TO QUESTIONS The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from the operating, investing, and financing activities of a company during a period, in a format that reconciles the beginning and ending cash balances The statement of cash flows is useful to all readers because it allows them to assess the following aspects of a company’s financial position: • • • the reasons for the difference between net income and cash provided (used) by operating activities the cash generated by (used in) investing and financing transactions during a period the company’s ability to generate future cash flows Creditors in particular, are concerned about the borrower’s ability to generate cash to repay loans and service debt The cash flow statement helps creditors assess risk LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash Generally, only debt investments with original maturities of three months or less qualify under this definition Bank overdrafts that are repayable on demand are also included in (deducted from) cash equivalents The statement of cash flows may be prepared using cash, or cash and cash equivalents as its base If the latter, cash equivalents must be clearly defined LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 13-3 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Operating activities include the cash flow activities arising from a company’s principal revenue-producing activities and all other activities that are not investing or financing activities Investing activities are those arising from the acquisition and disposal of non-current assets Financing activities include those resulting in changes in the size and composition of the equity and borrowings of a company LO BT: C Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting Companies following ASPE classify interest paid, interest revenue, and dividend revenue, as part of operating activities because they are disclosed on the income statement as part of net income Dividend payments are classified as financing activities This is the most common practice for both publicly traded and private companies Companies following IFRS may classify interest and dividend revenue as either investing activities or operating activities, and interest and dividend payments as either financing activities or operating activities Companies select where these payments and receipts will be presented and must apply the presentation consistently LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Examples of noncash transactions include the issue of shares or a mortgage to purchase property, plant, and equipment In both cases, cash is not involved Noncash transactions should be reported in the notes to the financial statements and crossreferenced to the statement of cash flows, but not reported as investing and financing activities in the body of the statement of cash flows LO BT: K Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 13-4 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Although the approaches and format are different, both the direct and indirect methods will produce the same net cash provided by operating activities LO BT: Difficulty: S Time: AACSB: None CPA CM: Reporting (a) and (b) (1) The adjusted trial balance is not required to prepare the statement of cash flows because it does not provide necessary data (2) A comparative statement of financial position is required to obtain the changes in individual asset, liability, and equity balances Changes in the noncash working capital (current) accounts may affect the operating activities, changes in shortterm investment and long-lived asset accounts may affect the investing activities, and changes in non-current liability and equity accounts may affect the financing activities reported in the statement of cash flows (3) The income statement is required to obtain the elements of operating activities, which will be converted from the accrual basis to the cash basis The income statement is also required to identify noncash revenues and expenses such as depreciation and amortization expenses and accounting gains and losses (4) The statement of comprehensive income is needed to reconcile certain fair-valued assets (e.g., revaluation of the fair value of land) and equity (e.g., accumulated other comprehensive income) accounts appearing in the statement of financial position However, changes in comprehensive income not affect cash and are not reported on the statement of cash flows Solutions Manual 13-5 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition (continued) (5) The statement of changes in equity will provide details of the changes in the share capital and retained earnings accounts From these, the cash effects of financing transactions with shareholders, such as the issue or reacquisition of shares and/or payment of dividends, can be determined and reported as financing activities on the statement of cash flows LO BT: C Difficulty: M Time: 15 AACSB: None CPA: cpa-t001 CM: Reporting The indirect method involves converting accrual-based net income to net cash provided by operating activities This is done by starting with accrual-based net income from the income statement and adding or subtracting noncash items included in net income Examples of adjustments include adding back noncash expenses, such as depreciation, and removing any noncash gains or losses from net income Then, changes in the balances of noncash current asset and current liability accounts from one period to the next are added or subtracted LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting A number of factors could have caused a positive amount of net cash provided by operating activities in spite of the fact that Clearwater reported a net loss These include (1) a high amount of collection of unearned revenue; (2) large amounts of depreciation or amortization; and (3) accounting losses or impairments The increase in unearned revenue is added as an inflow under operating activities Items (2) and (3) are non-cash items deducted in arriving at net income (in this case a net loss) so they are now added back to net loss when determining net cash flow provided by operating activities, thereby making it positive LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 13-6 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 10 Financial Accounting, Seventh Canadian Edition Under the indirect method, depreciation and amortization expense is added back to net income to reconcile net income to net cash provided by operating activities because depreciation and amortization are expenses that have reduced net income, but not result in the use of cash Adding them back cancels the expenses reported in the income statement, as accrual net income is the starting point under the indirect method Example: Income before depreciation $5,000 Less: Depreciation expense (1,000) Income 4,000 Add: Depreciation expense 1,000 Cash provided by operating activities $5,000 LO BT: K Difficulty: S Time: AACSB: None CPA: cpa-t001 CM: Reporting 11 Under the indirect method, a gain on disposal of equipment is deducted from net income to reconcile net income to net cash provided by operating activities A gain is the difference between the cash proceeds received when the asset is sold and the carrying amount of the asset This gain is not a cash receipt or payment Therefore, the noncash gain, which was included in net income, must be deducted from net income on the statement of cash flows to convert net income to net cash provided by operating activities The total cash proceeds received when the asset is disposed of would be reported in the statement of cash flows as an investing activity LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 12 When a business invests money, it does so outside of its main revenue-generating operations It might have excess cash, which it wants to put to use in producing some interest or dividend revenue Since the intention is to earn a return on its investment, the buying and selling of investments is generally reported as investing activities in the statement of cash flows The exception occurs when the investments are held for trading purposes, in which case they are treated similarly to inventory acquired for resale These types of investments are reported as operating activities LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 13-7 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 13 Financial Accounting, Seventh Canadian Edition The principal amount advanced by the bank and later repaid involves borrowing and repayment transactions that need to be reported under financing activities in the statement of cash flows The timing of the loan principal repayments will lead to a portion of the loan principal being classified as current liabilities This classification does not change the nature of the cash activity with the bank Both the current and non-current principal portions are treated together for cash flow reporting purposes LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 14 Dividends declared reduce retained earnings once the declaration is made by the board of directors For the cash flow statement, only dividends paid are reported in the financing activities section of the statement Similar to the adjustments made for the changes in working capital accounts in the indirect format of the statement of cash flows, any increase or decrease in the Dividends Payable account will adjust dividends declared (accrual basis) to dividends paid (cash basis) For this example, the amount of the increase of $2,000 ($10,000 - $8,000) in dividends payable will be deducted from the amount of dividends declared of $40,000 to arrive at cash paid for dividends of $38,000 LO BT: AP Difficulty: M Time: AACSB: Analytic CPA: cpa-t001 CM: Reporting 15 The statement of cash flows is prepared from detailed information about the changes in account balances that occurred between two periods of time, as shown on the other financial statements Unlike the other financial statements, it is not prepared from an adjusted trial balance In particular, the information to prepare the statement of cash flows comes from a comparative statement of financial position, the income statement, the statement of changes in equity, and additional information concerning specific transactions such as disposals of property, plant, and equipment LO BT: C Difficulty: M Time: AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual 13-8 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 16 (a) (b) Financial Accounting, Seventh Canadian Edition The corporate life cycle consists of four phases: introductory, growth, maturity, and decline In the introductory and growth phases, we don’t usually expect to see a company generate positive cash from its operating activities until part way through the growth phase Because the company is making significant investments in its long-lived assets, cash will be used by investing activities During the first two phases, cash generated by financing activities is usually positive as debt and equity are issued to pay for the investments and cover the operating activities shortfall These patterns reverse in the maturity and decline phases of the cycle In the decline phase, cash from operating activities decreases Cash from investing activities is positive as the company sells off its excess assets, before starting to decline Cash is used for financing activities as the company continues to pay off its debt LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting 17 A company that just commenced its operations would be expected to report low or negative cash flows from operating activities Later, when the company is growing and healthy, the cash from operating activities will become positive The company would also usually show cash used in investing activities as it invests in its productive capacity At this stage, the company will also usually show cash inflows in financing activities to finance the purchase of productive assets not covered from operating activities LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 13-9 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley 18 Financial Accounting, Seventh Canadian Edition Creditors may be concerned about the company’s ability to repay its obligations over the long-term The lack of cash flows from operating activities may be of concern to investors for several reasons First, the decrease in cash flows may have an adverse effect on the company’s share price In addition, some investors may be concerned that the company will not generate enough cash to pay dividends in the future This concern is supported by the declining free cash flow, which also indicates the company is generating less cash from operating activities to pay future dividends and to expand the business LO BT: C Difficulty: M Time: AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance 19 If net capital expenditures and dividends paid exceed cash provided by operating activities, then free cash flow will be negative LO BT: C Difficulty: M Time: AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance *20 Net cash provided by operating activities under the direct method is the difference between cash revenues and cash expenses The direct method adjusts the accrual-based revenues and expenses directly to reflect the cash-based revenues and expenses, which combine to equal "net cash provided by operating activities." LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting *21 Depreciation and amortization expenses are not listed in the operating activities section under the direct method because they are not cash flow items—they not affect cash Recall the journal entry to record depreciation: debit Depreciation Expense and credit Accumulated Depreciation The entry to record amortization is similar As you can see, there is no cash involved in this journal entry This is different from the indirect method, which uses net income as its starting point and must add back depreciation and amortization as noncash items included in the determination of net income LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 13-10 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition *PROBLEM 13-12B (a) NACKAWIC INC Statement of Cash Flows—Direct Method Year Ended December 31, 2018 Operating activities Cash receipts from customers (1) Cash payments To suppliers (2) $(114,290) For operating expenses (3) (38,900) For interest (12,940) For income tax (27,670) Net cash provided by operating activities Investing activities Sale of long-term investments Disposal of equipment Purchase of equipment Net cash used by investing activities $273,700 (193,800) 79,900 $ 5,000 15,550 (71,000) (50,450) Financing activities Issue of common shares ($240,000 – $200,000) $40,000 Payment of cash dividends ($121,790 + $87,810 – $175,600) (34,000) Net cash provided by financing activities Net increase in cash Cash, January Cash, December 31 6,000 35,450 47,250 $ 82,700 Note X to the Statement of Cash Flows: Equipment costing $141,000 was purchased by paying $71,000 cash and issuing a bank loan payable for $70,000 Note: Calculations follow below Solutions Manual 13-96 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition *PROBLEM 13-12B (CONTINUED) (a) (continued) Calculations (1) (2) (3) (b) Cash receipts from customers Revenues Deduct: Increase in accounts receivable Cash receipts from customers $317,500 (43,800) $273,700 Cash payments to suppliers Cost of goods sold Add: Increase in inventory Cost of purchases Deduct: Increase in accounts payable Cash payments to suppliers $ 99,460 29,250 128,710 (14,420) $114,290 Cash payments for operating expenses Operating expenses Add: Decrease in accrued liabilities Gain on disposal Deduct: Depreciation expense Cash payments for operating expenses $82,120 6,730 8,750 (58,700) $38,900 Nackawic’s cash position has increased primarily because of the amount of cash generated from its operating activities Cash from operating activities increased the company’s cash account by $79,900 Some of this cash was used to purchase equipment and pay dividends with additional cash generated from selling common shares Sufficient cash remained at the end of the year to increase its cash position by $35,450 LO BT: AN Difficulty: M Time: 40 AACSB: Analytic CPA: cpa-t001 CM: Reporting Solutions Manual 13-97 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT13-1 Financial Accounting, Seventh Canadian Edition FINANCIAL REPORTING CASE (a) The North West Company Inc uses the indirect method of calculating operating activities (b) North West generated cash from operating activities in the amount of $132,987,000 for the year ended January 31, 2016 and $115,086,000 for the year ended January 31, 2015 (c) The most significant investing activity for North West is cash used for the purchase of property and equipment, in the amount of $63,179,000 The largest use of cash from financing activities was from the payment of dividends, in the amount of $58,210,000 (d) Cash increased by $8,114,000 for the year ended January 31, 2016, and by $6,776,000 for the year ended January 31, 2015 (e) North West increased its spending for property and equipment for the year ended January 31, 2016 by approximately $14 million compared to the previous year Dividends increased by about $2 million These increases were made possible by an increase of about $18 million in the amount of cash generated by operating activities (f) North West used the cash generated from operating activities to increase capital expenditures and dividends paid, as mentioned in (e) above An increase in long-term debt was closely offset by intangible asset additions of $12,804,000 Besides these three differences, other cash trends were similar when comparing the two years LO 1,4 BT: AN Difficulty: M Time: 25 AACSB: Analytic and Communication CPA: cpa-t001 CM: Reporting Solutions Manual 13-98 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT13-2 Financial Accounting, Seventh Canadian Edition FINANCIAL ANALYSIS CASE (a) Companies following ASPE classify interest paid, interest revenue, and dividend revenue, as part of operating activities because they are disclosed on the income statement as part of net income Dividend payments are classified as financing activities This is the most common practice for both publicly traded and private companies Companies following IFRS may classify interest and dividend revenue as either investing activities or operating activities; and interest and dividend payments as either financing activities or operating activities In order to present the strongest (largest) performance for cash obtained from operating activities, Discount Ltd.’s management probably chose to classify interest and dividend revenue as operating activities as these can only be positive cash flows and likely would have chosen to classify interest and dividend payments under financing activities as these can only be negative cash flows (b) Increasing the cash flows from operating activities by using the classification choices described in part (a) will provide for a larger (better) free cash flow as the amount of cash flow from operating activities will be larger, leaving more cash remaining after covering capital expenditures and dividend payments LO 1,4 BT: AN Difficulty: M Time: 20 AACSB: Analytic and Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 13-99 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT13-3 Financial Accounting, Seventh Canadian Edition PROFESSIONAL JUDGEMENT CASE Note to instructors: All of the material supplementing this group activity, including a suggested solution, can be found in the Collaborative Learning section of the Instructor Resource site accompanying this textbook as well as in the Prepare and Present section of WileyPLUS (a) During 2017, the purchase of property, plant, and equipment in the amount of $2 billion dollars was financed differently by the three companies While some of the financing came from using cash generated from operations, A Limited chose to finance the balance needed with a blend of debt and equity financing that was similar in amount B Limited chose to use only equity and C Limited financed with mostly debt For 2018, expansion continued at an even greater pace for A Limited, which spent $2,350 million on property, plant, and equipment, while B and C acquired far fewer of these assets A Limited financed this higher level of expenditures by using net cash from operating activities and by issuing more common shares Because the majority of the investments in 2017 made by C Limited were financed with debt, even though C Limited was able to pay down some of this debt in 2018 and reduce it to a lower amount than the debt held by A Limited, relative to its assets, of the three companies, C Limited still has the greatest percentage of its assets financed with debt as the other two companies have used equity more extensively than C Limited (b) C Limited is the only company that had a decrease in the net cash from its operating activities in 2018 This happened because too much cash was tied up in accounts receivable and inventory The increases in these current assets, particularly during 2018, caused a large reduction of cash that could have been used instead to reduce the high levels of debt (c) C Limited likely did not have a choice to pay down its bank loans in 2018 It was forced to so by the bank C Limited had poor performance in managing accounts receivable and inventory that in turn caused a shortage of cash needed to satisfy the bank’s concerns with regard to its liquidity and solvency C Limited resorted to the desperate measure of selling off some its non-current assets at a loss of $70 million to raise the cash needed to pay down the bank loans Solutions Manual 13-100 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT13-3 (CONTINUED) (d) As a shareholder interested in dividends and not in growth in the value of my investment, I would consider investing in B Limited The amount of dividends paid by B Limited in 2018 was $120 million, which is 10% of the total value of shares issued This percentage is lower for the other two companies so shareholders in B Limited are receiving the largest dividend relative to the amount invested (e) A Limited is the company most committed to growth as demonstrated by the large investment in property, plant, and equipment that continued into 2018 So long as shareholders feel that the cash spent provides for growth in the market value of the common shares issued, the pace of expansion is not excessive since it was financed with equity, which will not cause a reduction in cash flow due to interest payments (f) C Limited has the highest free cash flow Net cash provided by operating activities Purchases of property, plant, and equipment Dividends paid Free cash flow (g) A Limited $1,030 (2,350) (100) $(1,420) B Limited $980 (830) (120) $30 C Limited $820 (430) (5) $385 If I was interested in owning the shares of one of these companies, I would likely not invest in C Limited due to the build up of inventory and accounts receivable shown in the operating activities section of the statement of cash flows I would also be concerned about a management team that raised funds in 2017 to buy non-current assets, and then sold some of them in 2018 at a loss As an investor, I would like the fact that A Limited is growing, but I would like to know at what point the expansion occurred in 2018 If it occurred early in the year, one would expect, given the larger asset base of this company, that net income would be higher However, if the expansion occurred very late in 2018, the extra asset base could trigger much higher amounts of net income next year compared to 2018 On the other hand, B Limited seems to be conservatively financed with little debt, so it has the potential to expand very easily in the future So before making a decision, I would need more information about the success of A Limited’s 2018 expansion before buying their shares Solutions Manual 13-101 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT13-3 (CONTINUED) (g) (continued) It should be noted that B Limited is probably the safest company to lend money to, given its low level of debt and its reasonably high operating cash flows LO BT: E Difficulty: C Time: 45 AACSB: Analytic and Communication CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 13-102 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT13-4 Financial Accounting, Seventh Canadian Edition FINANCIAL ANALYSIS CASE (a) Based on the changes in cash flows in the 10-year period, Apple was in its introductory phase of its operating cycle in 2005 and by 2010 through to 2015 continued to be in the growth phase of its operating cycle In 2005 no dividends were paid, to assist in financing investments that exceeded cash generated from operations In 2010, there were no dividends paid but Apple could likely have made such a payment and was under pressure from some shareholders to so Investors were satisfied with increases in stock prices and most shareholders bought the stock for price appreciation potential By 2015 Apple was still growing but the stock price declined or increased more modestly, which likely did not satisfy shareholders Dividends had to be paid to provide shareholders with a return on their investment (b) Free cash flow in millions of US dollars: Cash provided by operating cash flows 2015 $81,266 2010 $18,595 2005 $2,535 Capital expenditures paid during the year Dividends paid during the year Free cash flow As a % of cash from operating cash flows 11,831 11,561 $57,874 71.2% 2,759 $15,836 85.2% 281 _ $2,254 88.9% The free cash flow as a percentage of operating cash flows is declining but not at the same rate as the rate of increase in the cash provided by operating cash flows We can conclude that the amount of investments and distributions are in line with the performance of the business and its ability to generate cash from operations Apple is reacting to the needs of its shareholders, which is consistent with the responses in part (a) above LO BT: AN Difficulty: M Time: 20 AACSB: Analytic CPA: cpa-t001, cpa-t005 CM: Reporting and Finance Solutions Manual 13-103 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT13-5 (a) ETHICS CASE A company’s dividend policy should be based on several factors other than the requirement to pay the “usual” dividend Some of these factors include: • • • (b) Financial Accounting, Seventh Canadian Edition Legal requirements such as the Business Corporations Acts for the jurisdiction in which the company is incorporated For example, the Canada Business Corporations Act specifies certain requirements that must be met in order for companies to be able to pay dividends; these requirements include solvency and a positive (credit) balance in Retained Earnings Creditor or other contractual requirements: some creditor loan agreements can specify financial ratios that must be maintained or limit the amounts of dividends that can be paid out to shareholders The company’s short-term and long-term budgets and goals The payment of dividends uses the company’s cash, and management has to ensure that sufficient cash remains to operate the business and meet its short-term and long-term goals, such as property, plant, and equipment purchases, expansion, and debt repayment The stakeholders in this situation are: Phil Monat, president and CEO of Onwards and Upwards Corporation Leland Yee, controller The board of directors The shareholders of Onwards and Upwards Corporation (c) The president’s statement, “We must get that amount above $1 million,” puts undue pressure on the controller This statement along with his statement, “I know you won’t let me down, Leland,” encourages Leland to something unethical Controller Leland Yee’s reclassification (intentional misclassification) of cash payments from interest as an operating activity to a financing activity is inappropriate and unethical Although companies reporting under IFRS have the choice to show interest payments under either operating or financing activities, the presentation must be consistent from year to year Solutions Manual 13-104 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT13-5 (CONTINUED) (d) Yes Under IFRS, it is permissible to show interest paid as a financing rather than an operating cash payment but such a change should be consistent from year to year Companies reporting under ASPE must classify interest paid as part of operating activities and not have the choice to show these payments as part of financing activities LO BT: C Difficulty: M Time: 30 AACSB: Ethics and Communication CPA: cpa-t001, cpa-e001 CM: Reporting and Ethics Solutions Manual 13-105 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley CT13-6 (a) Financial Accounting, Seventh Canadian Edition STUDENT VIEW CASE Statement of Cash Flows—Direct Method Year Ended (date) Operating activities Cash receipts from salary Cash payments For rent and utilities For interest For car expenses For food, entertainment, and recreation Net cash provided by operating activities $45,000 $(16,600) (1,400) (4,800) (6,000) Investing activities Purchase of car Purchase of investments Purchase of computer Disposal of computer Disposal of motorcycle Net cash used in investing activities $(20,000 ) (5,500) (1,500) 100 1,000 Financing activities Increase in credit card debt ($2,500 – $1,000) Decrease in line of credit ($2,500 – $1,200) Car loan obtained Repayment of student loan ($15,000 – $10,000) Net cash provided by financing activities $ 1,500 (1,300) 15,000 (5,000) Net increase in cash Cash, beginning of year Cash, end of year (28,800 ) 16,200 (25,900) 10,200 500 500 $ 1,000 Solutions Manual 13-106 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT13-6 (CONTINUED) (b) Depending on the level of security for the large investment made during the year, your friend should likely consider the benefits of eliminating some interest expenses by reducing debt that carries a higher interest rate than the yield obtained from the investment LO BT: AN Difficulty: M Time: 20 AACSB: Analytic CPA: cpa-t001, cpa-e003 CM: Reporting and Comm Solutions Manual 13-107 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT13-7 SERIAL CASE ABC Ltd $225,279 – $54,000 – $80,000 = $91,279 Software Solutions Inc $6,821,000 – $3,414,000 – $580,000 = $2,827,000 (a) Free cash flow (b) Compuhelp Limited $159,400 – $144,800 – $0 = $14,600 ABC is able to generate a significant amount of cash from its operating activities—in excess of its net income It uses cash for both its investing activities and financing activities The use of cash in investing activities indicates that ABC is investing in its property and equipment, which is a good sign for future growth Its use of cash in financing activities indicates that it is either repaying more debt than it is raising (through debt or equity) or using cash for dividends From the additional information, we can determine that an $80,000 dividend was paid Software Solutions is also generating a significant amount of cash from its operating activities—far in excess of its net income It is also using cash in both its investing and financing activities From this, it appears to be in the maturity stage of its corporate life cycle Compuhelp’s cash flows tell a bit of a different story Although it is also generating a significant amount of cash from its operating activities in excess of its net income, it is insufficient to cover the investing and financing activities It does not pay a dividend so most of its cash used for financing activities is likely repaying debt on its capital expenditures All of this has resulted in a net decrease in cash during the year, leaving the company with a low ending cash balance and an inability to declare dividends Solutions Manual 13-108 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition CT13-7 (CONTINUED) (c) As we saw above, ABC is generating positive cash from its operating activities While its free cash flow is reduced (because of its investment in capital expenditures and relatively large dividend), it has little debt and is able to pay a generous dividend Overall, the company appears to report strong net income and cash flow, which are likely two of the financial reasons Software Solutions and Compuhelp are interested in acquiring ABC, in addition to strategic reasons discussed earlier (d) The Anthonys will likely favour Software Solutions over Compuhelp Software Solutions appears to have a stronger financial position It has more cash available to pay for its investment in ABC Compuhelp does not pay a dividend and has decreased its overall cash position during 2019 Compuhelp’s free cash flow is significantly less than that of Software Solutions Other issues the Anthony family should consider before finalizing their decision could include: • • • • Determining what percentage of ownership Emily and Daniel will have going forward How will Emily and Daniel feel about the change in control? Will they be paid in cash for the purchase of their shares or will they be asked to take back a note or preferred shares in partial payment? What are the income tax consequences of this sale? LO BT: E Difficulty: M Time: 45 AACSB: Analytic and Communication CPA: cpa-t001, cpa-t005, cpa-e003 CM: Reporting, Finance, and Comm Solutions Manual 13-109 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley Financial Accounting, Seventh Canadian Edition Legal Notice Copyright © 2017 by John Wiley & Sons Canada, Ltd or related companies All rights reserved The data contained in these files are protected by copyright This manual is furnished under licence and may be used only in accordance with the terms of such licence The material provided herein may not be downloaded, reproduced, stored in a retrieval system, modified, made available on a network, used to create derivative works, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise without the prior written permission of John Wiley & Sons Canada, Ltd (MMXVII VI F2) Solutions Manual 13-110 Chapter 13 Copyright © 2017 John Wiley & Sons Canada, Ltd Unauthorized copying, distribution, or transmission of this page is strictly prohibited ... and Decision- Making Comm Communication Self-Mgt Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat & Gov Strategy and Governance Mgt Accounting Management Accounting. .. the statement of financial position However, changes in comprehensive income not affect cash and are not reported on the statement of cash flows Solutions Manual 13- 5 Chapter 13 Copyright © 2017... provided by operating activities, thereby making it positive LO BT: C Difficulty: M Time: AACSB: None CPA: cpa-t001 CM: Reporting Solutions Manual 13- 6 Chapter 13 Copyright © 2017 John Wiley & Sons