Solution manual managerial accounting by cabrera 2010 chapter 06 answer

MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual CHAPTER CASH FLOW ANALYSIS I Questions Purposes of the Statement of Cash Flows a To predict future cash flows b To evaluate management decisions c To determine the ability to pay dividends to shareholders and interest and principal to creditors d To show the relationship of net income to changes in the business’s cash Comparative balance sheets present the financial position of the enterprise at two points in time The income statement for the period between the two balance sheets describes how the income-producing activities affected the financial position Because cash flows from operating activities may differ substantially from net income, and because numerous other financing and investing activities have an impact on financial position, the statement of cash flows is necessary The statement emphasizes changes in the cash balances that result from changes in assets, liabilities and equity accounts caused by operating, investing and financing activities The most important source of cash for many successful companies is from operating activities A large positive operating cash flow is a good sign because it means funds have been internally generated with no fixed obligations or commitment to return such to anybody It is possible for cash to decrease during a year when income is high because cash may be used not only for operating activities but also for investing and financing activities Transactions involving accounts payable are not considered to be financing activities because such transactions are used to obtain goods and services rather than to obtain cash Furthermore, purchases of goods and services relate to a company’s day-to-day operating activities The loss is added back to net income to avoid double counting since the entire proceeds from the sale (net book value minus loss on sale) will appear as a cash inflow from investing activities 6-1 Chapter Cash Flow Analysis Three categories of transactions that may result in increases in cash are a Operating activities b Investing activities (e.g., sale of investments or other assets) c Financing activities (e.g., borrowing or sale of stock) These activities are sources of cash when cash is increased as a result of the particular activity Three categories of transactions that may result in decreases in cash are a Operating activities b Investing activities (e.g., purchase of investments or other assets) c Financing activities (e.g., repayment of debt or retirement of stock) These activities are uses of cash when cash is decreased as a result of the particular activity Noncash transactions not provide or consume cash even though they may result in significant changes in financial position Examples are the issuance of share capital for plant assets and the conversion of debt or preference shares into ordinary shares Such transactions are not presented in the body of the statement of cash flows but rather disclosed in a separate schedule as financing or investing activities 10 While net loss is usually associated with a decrease in cash, it may be a source of cash if noncash expenses are greater than the amount of the net loss For example, if a net loss of P100,000 included amortization and depreciation of P125,000 and no noncash revenues existed, cash provided by operating activities would be P25,000, computed as follows: Net loss Add: Expenses not requiring cash – depreciation and amortization Net cash provided by operating activities P(100,000) P 125,000 25,000 11 The change in cash is the difference between cash at the beginning and end of the accounting period The net amount of cash provided by or used in operating, investing and financing activities must equal this change in cash For example, if cash increased by P150,000 during the year, total sources from operating, investing, and financing activities must exceed total uses by P150,000 Also, if cash decreased by P25,000 during the year, total uses of cash must exceed total sources by P25,000 6-2 Cash Flow Analysis Chapter 12 (a) The use of cash does not occur until the cash dividend is actually paid in the next period The declaration of the dividend does affect financial position, however, and should be disclosed as a noncash financing activity in a separate schedule accompanying the statement of cash flows (b) Because the dividend was declared and paid in the same accounting period, it appears in the statement of cash flows as a cash decrease in the financing activities category 13 Disagree The refunding of 10% debt by the 8% debt represents a significant financing activity, even though the net impact of the exchange on the balance sheet or on the amount of cash is not material The issuance of 8% bonds and the retirement of 10% bonds should be reported as noncash financing transactions in a schedule accompanying the statement of cash flows 14 The net income figure includes P150,000 as an expense Only P112,500 of this amount resulted in a decrease in cash, because P37,500 represents an increase in the deferred income tax liability account In determining cash provided by operating activities, the amount of income tax paid is P112,500 (direct method) Alternatively, under the indirect method, P37,500 must be added to net income to determine cash flows from operating activities 15 The loss is omitted when listing expenses requiring cash payment (direct approach) or added back to net income (indirect approach) in determining cash provided by operating activities This eliminates the impact of the transaction from cash provided by operating activities Then, the proceeds from the sale are included as a source of cash in the investing activities category of the statement of cash flows Any tax effects of the transaction are included in the tax expense figure and remain a part of cash flows from operating activities II Problems Problem Transaction Operating Investing Financing 6-3 Source Use Chapter Cash Flow Analysis Short-term investment securities were purchased Equipment was purchased Accounts payable increased Deferred taxes decreased Long-term bonds were issued Ordinary shares were sold Interest was paid to long-term creditors A long-term mortgage was entirely paid off A cash dividend was declared and paid 10 Inventories decreased 11 Accounts receivable increased 12 Depreciation charges totaled P200,000 for the year X X X X X X X X X X X X X X X X X X X X X X X X Problem (Analysis of Cash Flow Transactions) Requirement (a) The eight items should be presented in the statement of cash flows as follows: Net income is the basis for the calculation of cash flows from operating activities by starting with that number and adjusting for noncash revenue and expense transactions (indirect method) or by computing by 6-4 Cash Flow Analysis Chapter 6 the direct method the positive cash flows from revenues, less the negative cash flows from expenses The cash flows from the transaction giving rise to the extraordinary loss is reclassified as an investing activity The acquisition of intangibles is a negative cash flow from investing activities The amortization is a noncash expense in determining cash flows from operating activities The payment of a cash dividend is a negative cash flow that is presented in the financing activities section of the statement The purchase of treasury stock is a negative cash flow in the financing activities section of the statement The depreciation expense recognized during the year is a noncash expense in determining cash flows from operating activities The conversion of convertible bonds into ordinary shares is a noncash financing activity that requires disclosure in a separate schedule The changes in plant asset accounts – land, equipment, and building – represent activities whose cash flow effects are presented in the investing activities section of the statement The increase in working capital also represents the change in cash because all other current assets and current liabilities remained constant The net of all cash flows from operating, investing and financing activities must reconcile with the change in cash in the statement of cash flows Requirement (b) Net cash provided by operating activities Net income Noncash expense adjustments: Depreciation expense Amortization expense Reclassification of extraordinary loss P145,000 46,250 6,000 15,000 P212,250 Net cash used in investing activities Purchase of intangible assets Purchase of land Purchase of equipment Purchase of building Sale of land 6-5 P (34,000) (130,000) (60,000) (100,000) 165,000 P(159,000) Chapter Cash Flow Analysis Net cash used in financing activities Purchase of treasury stock Payment of dividends P(31,000) (12,500) P(43,500) Computations: Depreciation expense Change in accumulated depreciation account Accumulated depreciation on fully depreciated assets disposed Purchase of land Change in land account Cost of land sold in condemnation proceedings P35,000 11,250 P46,250 P (50,000) 180,000 P130,000 Problem (Cash Flow from Operating Activities) Cash received from customers: Total revenues Less: Note receivable Cash disbursed for expenses: Total expenses (P173,000 + P4,200) Less: Income taxes deferred Depreciation Amortization Net cash provided by operating activities P185,000 (15,000) P177,200 (1,260) (25,000) (7,000) P170,000 (143,940) P 26,060 Problem (Cash Flow from Operating Activities) Cash received from customers (1) Cash paid for expenses: Cost of goods sold Selling Salaries and wages (2) Interest (3) Miscellaneous operating Incomes taxes (4) Net cash provided by operating activities Computations: 6-6 P5,237,000 P3,150,000 246,000 394,400 65,200 5,000 335,000 4,195,600 P1,041,400 Cash Flow Analysis Chapter Revenue from sales Less: Note receivable Land P5,432,000 (120,000) (75,000) P5,237,000 Salaries and wages expense Less: Increase in accrued salaries and wages (P45,600 – P40,000) P 400,000 Interest expense Less: Discount amortization P (5,600) P 394,400 P Income tax expense Less: Deferred portion 72,000 (6,800) 65,200 P 445,000 (110,000) P 335,000 Problem (Statement of Cash Flows Preparation – Indirect) Green Tea Company Statement of Cash Flows For the Year Ended December 31, 2005 Cash flows from operating activities Net income* Adjustments to reconcile net income to net cash flows provided by operating activities: Depreciation Amortization of intangibles Increase in current assets Increase in current liabilities Net cash provided by operating activities Cash flows from financing activities Dividends paid Retirement of long-term liabilities * Increase in retained earnings (P20,000 – P13,000) Dividends declared Net income 6-7 P8,500 1,000 1,000 (6,000) 3,000 P7,500 (1,500) (1,000) P7,000 1,500 P8,500 Chapter Cash Flow Analysis Net cash used in financing activities Net increase in cash Cash, January 1, 2005 Cash, December 31, 2005 (2,500) P 5,000 10,000 P15,000 Problem (Cash Flow Statement Preparation – Direct) Requirement (a) Hundred Acre Company Statement of Cash Flows For the Year Ended December 31, 2005 Cash flows from operating activities Cash received from customers Cash paid for expense Net cash provided by operating activities Cash flow from investing activities Sale of equipment Sale of investments Acquisition of equipment Net cash used in investing activities Cash flows from financing activities Sale of ordinary shares Payment of cash dividends Net cash used in financing activities Net increase in cash Cash, January 1, 2005 Cash, December 31, 2005 Reconciliation of net income to net cash provided by operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Amortization expense Increase in accounts receivable * Net increase during 2005 (P33,600 – P27,100) Accumulated depreciation on assets sold Depreciation expense for 2005 6-8 P74,000 67,000 P7,000 9,500 15,000 (53,000) (28,500) 40,000 (8,500) 31,500 P10,000 20,000 P30,000 P15,000 24,500* 1,000 (33,000) P 6,500 18,000 P24,500 Cash Flow Analysis Chapter Decrease in accrued expenses Net cash provided by operating activities (500) P 7,000 Computations: Cash received from customers: Revenues Deduct: Increase in accounts receivable (P78,000 – P45,000) Cash paid for expenses: Expenses Add: Decrease in accrued expenses (P7,500 – P7,000) Deduct: Depreciation expense (P33,600 – P27,100 + P18,000) Amortization Cash from sale of equipment: Cost Deduct: Accumulated depreciation Cash received on sale at book value Cash paid to acquire equipment: Increase in property, plant and equipment (P118,100 – P92,600) Cost of machinery sold P107,000 33,000 P 74,000 P 92,000 500 (24,500) (1,000) P 67,000 P 27,500 (18,000) P 9,500 P 25,500 27,500 P 53,000 Cash received on sale of stock: Increase in ordinary shares amount (P100,000 – P75,000) Increase in additional paid-in capital account (P55,000 – P40,000) P 25,000 Cash dividends: Increase in retained earnings (P21,000 – P14,500) Net income (P107,000 – P92,000) P 15,000 P 40,000 6,500 (15,000) P 8,500 Requirement (b) The reconciliation of net income to net cash provided by or used in operating activities is required to be disclosed in order to show more 6-9 Chapter Cash Flow Analysis clearly the relationship and emphasize the differences between the two Users of financial statements are often not as aware of the accrual concepts, which determine net income, as are preparers of those statements The reconciliation of net income to net cash flows from operating activities clearly demonstrates that the two are different and details those events and transactions that account for the difference Problem (Interpretation of Cash Flow Statement) Requirement (a) The two companies are similar in the following respects: Overall size Industry in which they operate Current ratio (2.4 to 1) Overall peso amounts of cash provided and used: Range, 2002-2005 Cash Provided Cash Used P125,000 – P168,000 P115,000 – P170,000 P135,000 – P160,000 P125,000 – P165,000 Ebony Company Ivory Company Net increase in working capital is identical for each year, 2002 – 2005 Requirement (b) The two companies are dissimilar in the makeup of the sources of cash, as indicated in the following analysis: 2002 Ebon Ivor y y Cash provided: Operations Long-term debt Share capital Asset disposition 80 -12 100 37 56 -7 100 Sources of Cash in Percentages 2003 2004 Ebon Ivor Ebon Ivor y y y y 77 -16 100 21 10 52 17 100 70 30 100 (38) 44 63 31 100 2005 Ebon Ivor y y 76 -15 100 -56 37 100 Ebony Company has relied much more heavily on operations to provide cash and to a very limited extent on debt and equity financing and asset 6-10 Cash Flow Analysis Chapter disposition On the other hand, Ivory Company has not been able to provide cash from operations and has been required to rely on the alternatives of debt and equity financing and asset disposition Requirement (c) Ebony Company is in a considerably stronger position (as determined by the data given) and thus should be considered the better investment and credit risk The following points are significant: Ebony Company has provided 70%-80% of its cash via operating activities, supplementing with other means to maintain a current ratio at the industry average Ebony has not had to rely consistently on any alternative source of funding Ivory Company has apparently been forced to rely continuously on debt financing except in 2005, perhaps because of the inability to obtain such financing The year 2004 is particularly weak for Ivory, with operations resulting in a P60,000 reduction in cash The ability of Ivory to sustain its present financial position (i.e., current ratio, etc.) is questionable in light of its history III Multiple Choice Questions D C D D B D C B A 6-11 10 B 11 A 12 D ... activities must exceed total uses by P150,000 Also, if cash decreased by P25,000 during the year, total uses of cash must exceed total sources by P25,000 6-2 Cash Flow Analysis Chapter 12 (a) The use of... operating activities by starting with that number and adjusting for noncash revenue and expense transactions (indirect method) or by computing by 6-4 Cash Flow Analysis Chapter 6 the direct method... end of the accounting period The net amount of cash provided by or used in operating, investing and financing activities must equal this change in cash For example, if cash increased by P150,000