Accounting – Text and Cases 13th Edition Anthony, Hawkins, Merchant Solution Manual

Accounting – Text and Cases 13th Edition Anthony, Hawkins, Merchant Solution Manual

Chapter 11

THE STATEMENT OF CASH FLOWS

Changes from Twelfth Edition

Updated from the Twelfth Edition. Great Valu Variety Stores has been dropped.

Approach

This is a topic that has always been difficult for students. The indirect method of developing the amount of cash flow from operating activities is particularly difficult. The hearings prior to FASB 95 indicated that the investment analyst community would press companies to continue using the indirect (reconciliation) method; the primary supporters of the direct method were bankers. Thus, it appears that students will not be well served in this subject area unless they gain an understanding of the indirect method.

Since students were introduced to the difference between cash flows and accrual accounting’s revenues and expenses way back in Chapter 3, this should be reinforcement at this point, but it usually seems to be a new revelation to at least a subset of the class. For those who never succeed in fully understanding the rationale for the adjustments, Illustration 11-4 now gives them a rote approach to which they can revert.

Cases

Medieval Adventures Company is an armchair case intended to dramatize the difference between operating cash flow and income.

Amerbran Company (A) illustrates preparation of the cash flow statement from the other two statements and supplemental information.

Problems

Problem 11-1

2010 sales................................................................................................................................................................	$8,337,000
Less: Change in accounts receivable..........................................................................................................................	(130,000)
Cash generated from sales during 2003......................................................................................................................	$8,207,000

Problem 11-2

a.      Use of $2 million cash to purchase equipment is an investment use of cash.

b.      Cash proceeds from the issuance of common stock is a financing source of cash. The use of cash to retire mortgage bonds is a financing use of cash.

c.      No cash effect.

d.      No cash effect.

e.      Cash proceeds from the sale of machinery is an investment source of cash.

The above responses assume the direct method is used to present its cash flow of statement.

 

 

 

Problem 11-3

Kids’n Caboodle Statement of Cash Flows
Cash received from customers..........................................................................................................................................	$155,000
Cash used in operations....................................................................................................................................................	(146,900)
Cash from operations....................................................................................................................................................	$8,100
Equipment.......................................................................................................................................................................	(10,500)
Cash used for investments.............................................................................................................................................	(10,500)
Loan................................................................................................................................................................................	21,000
Cash from financing.....................................................................................................................................................	21,000
Increase in cash............................................................................................................................................................	$ 18,600

Problem 11-4

Net loss.......................................................................................................................................................................	$(11,000)
Depreciation................................................................................................................................................................	26,400
	15,400
Accounts receivable (reduced)......................................................................................................................................	17,600
Accounts payable (increased).......................................................................................................................................	8,800
Accrued salaries (increased).........................................................................................................................................	3,300
Other accruals (increased)............................................................................................................................................	2,200
Cash flow from operations...........................................................................................................................................	47,300
Investments................................................................................................................................................................	0
Long-term debt (reduced)............................................................................................................................................	(29,700)
Change in cash.........................................................................................................................................................	17,600
Beginning cash.........................................................................................................................................................	4,400
Ending cash.............................................................................................................................................................	$22,000

Problem 11-5

Operating Activities
Cash received from customers...............................................................................................................................	$62,100
Interest received....................................................................................................................................................	345
Operating cash payments.......................................................................................................................................	(54,165)
Interest payment...................................................................................................................................................	(1,035)
Net cash provided by operations.............................................................................................................................	7,245
Investing Activities
Sale of old machine...............................................................................................................................................	3,105
Down payment on new truck.................................................................................................................................	(3,450)
Net cash used in investing activities......................................................................................................................	(345)
Financing Activities
Payment of debt....................................................................................................................................................	(3,450)
Net cash used in financing activities......................................................................................................................	(3,450)
Increase in cash.....................................................................................................................................................	3,450
Beginning cash.....................................................................................................................................................	3,450
Ending cash..........................................................................................................................................................	$ 6,900

Cases

Case 11-1 Medieval Adventures Company*

Note: This case is unchanged from the Twelfth Edition.

Approach

This (obviously) is an armchair case, intended to show dramatically the difference between profit and cash flow from operations. The case has mechanistic patterns built into it to help students see what is going on: relatively rapid growth is causing cash to be tied up in receivables and inventories faster than it is regenerated from collections. Although the case may seem trivial (at least after the calculations have been made) because of these mechanistic patterns, in fact many businesses have had severe (sometimes fatal) financial crises because management did not anticipate the basic phenomenon that this case develops. The graph included herein can be used in class to help illustrate this phenomenon.

Question 1

The required monthly statements are shown on the following pages. The peak need comes by the end of July, when a $40,000 loan would be needed to maintain a zero cash balance. In August, cash generated by operations finally turns positive, enabling partial repayments of the loan. October’s $27,500 cash generated by operations enables making the final $15,000 loan repayment and ending the month with a $12,500 cash balance.

Question 2

This question is the key one in terms of student insight from this case. The company has been paying its costs currently, but allowing customers two months to pay. This, coupled with constant growth, causes large net operating outflows for several months, which collectively eat up the firm’s initial capital. It is important for students to understand why it is that this situation eventually turns around: the unit margin is $20 and the monthly nonproduction costs are fixed at $10,000; thus, the continued unit sales growth eventually (in August) causes the current inflows (from sales two months ago) to exceed the current outflows (production costs for next month’s sales plus $10,000). In other words, as the income statement shows, the firm is profitable, and eventually those profits get realized in cash.

This need could have been avoided by projecting the cash flow figures that the students have developed after the fact. Then the company could have arranged the necessary line of credit. Banks are happy to provide such funds for companies that anticipate the need because that anticipation reflects good financial management. On the other hand, banks are hesitant to lend to a firm that has been taken by surprise by a cash shortage. Of course, a no-cost method to avoid the problem was also probably feasible. The company could have arranged credit with vendors to help finance the inventory, and could have been more aggressive in collecting from its customers in accord with the stated 30-day terms. If the company delayed its payments by 30 days and accelerated receivable collections from 60 to 30 days (thus shortening its “cash cycle” by 60 days), the operating cash flow would have turned positive in March and no cash crisis would have occurred.

Question 3

The purpose of this question is to give students practice in deriving a cash flow statement from the income statement and balance sheets. Because of the work done in question 1, where cash flows were dealt with directly, students can gain some confidence in these derivation procedures before they apply the procedures in more complex and realistic cases. The statements are as follows (in somewhat simplified format, befitting this introductory problem):

									March				May				July
	Net income...........................................................................................................................................................................................................................								$30,000				$50,000				$70,000
	Increase in accounts receivable........................................................................................................................................................................................								(55,000)				(55,000)				(55,000)
	Increase in inventory..........................................................................................................................................................................................................								(17,500)				(17,500)				(17,500)
	Cash from operations.........................................................................................................................................................................................................								(42,500)				(22,500)				(2,500)
	Proceeds of debt..................................................................................................................................................................................................................								-0-				22,500				2,500
	Cash increase (decrease)...................................................................................................................................................................................................								(42,500)				0				0
	Beginning of month cash balance....................................................................................................................................................................................								72,500				0				0
	End of month cash balance...............................................................................................................................................................................................								$30,000				$ 0				$ 0
	OPERATING BUDGET
		Jan.		Feb.			Mar.				Apr.				May				June				July			Aug.			Sept.			Oct.
	Sales....................................................................................................................................................................................................................................	$55,000		$82,500			$110,000				$137,500				$165,000				$192,500				$220,000			$247,500			$275,000			$302,500
	Cost of Sales......................................................................................................................................................................................................................	35,000		52,500			70,000				87,500				105,000				122,500				140,000			157,500			175,000			192,500
	Gross Margin.....................................................................................................................................................................................................................	20,000		30,000			40,000				50,000				60,000				70,000				80,000			90,000			100,000			110,000
	Other Expenses................................................................................................................................................................................................................. .............................................................................................................................................................................................................................................	10,000		10,000			10,000				10,000				10,000				10,000				10,000			10,000			10,000			10,000
	Net Income.........................................................................................................................................................................................................................	10,000		20,000			30,000				40,000				50,000				60,000				70,000			80,000			90,000			100,000
	CASH BUDGET
	Cash lnflows:
	Cash forwarded.................................................................................................................................................................................................................	$146,250		$111,250			$ 72,500				$ 30,000				$-0-				$-0-				$-0-			$-0-			$-0-			$-0-
	Collections.........................................................................................................................................................................................................................	27,500		41,250			55,000				82,500				110,000				137,500				165,000			192,500			220,000			247,500
	Loan from bank.............................................................................................................................................................................................................	---		---			---				2,500				22,500				12,500				2,500			---			---			---
	Total............................................................................................................................................................................................................................	$173,750		$152,500			$127,500				$115,000				$132,500				$150,000				$167,500			$192,500			$220,000			$247,500
	Cash Outflows:
	Costs & expenses..............................................................................................................................................................................................................	$ 62,500		$ 80,000			$ 97,500				$115,000				$132,500				$150,000				$167,500			$185,000			$202,500			$220,000
	Loan payback................................................................................................................................................................................................................	---		---			---				---				---				---				---			7,500			17,500			15,000
	Cash balance..............................................................................................................................................................................................................	$111,250		$ 72,500			$ 30,000				$ 0				$ 0				$ 0				$ 0			$ 0			$ 0			$ 12,500
	Memo:
	Net operating cash flow...................................................................................................................................................................................................	$(35,000)			$(38,750)			$(42,500)				$(32,500)				$(22,500)				$(12,500)				$(2,500)			$ 7,500		$ 17,500			$ 27,500
	Cash balance w/o loan.....................................................................................................................................................................................................	$111,250		$ 72,500			$ 30,000				$ (2,500)					$(25,000)				$(37,500)				$(40,000)			$(32,500)			$(15,000)			$ 12,500
BALANCE SHEET
		Dec. 31st	Jan. 31st			Feb. 28th				Mar 31st				Apr. 30th				May 31st				June 30th			July 31st			Aug. 31st			Sept. 30th			0ct. 31st
Assets:
Cash.................................................................................................................................................................................................................................		$146,250	$111,250			$ 72,500				$ 30,000				$ 0				$ 0				$ 0			$ 0			$ 0			$ 0			$ 12,500
Accounts Receivable....................................................................................................................................................................................................		68,750	96,250			137,500				192,500				247,500				302,500				357,500			412,500			467,500			522,500			577,500
Inventory........................................................................................................................................................................................................................		35,000	52,500			70,000				87,500				105,000				122,500				140,000			157,500			175,000			192,500			210,000
Total.............................................................................................................................................................................................................................		$250,000	$260,000			$280,000				$310,000				$352,500				$425,000				$497,500			$570,000			$642,500			$715,000			$800,000
Liabilities and Equity:
Note Payable..................................................................................................................................................................................................................		$ ---	$ ---			$ ---				$ ---				$ 2,500				$ 25,000				$ 37,500			$ 40,000			$ 32,500			$ 15,000			$ ---
Common Stock...............................................................................................................................................................................................................		250,000	250,000			250,000				250,000				250,000				250,000				250,000			250,000			250,000			250,000			250,000
Retained Earnings.........................................................................................................................................................................................................		_______	10,000			30,000				60,000				100,000				150,000				210,000			280,000			360,000			450,000			550,000
Total................................................................................................................................................................................................................................		$250,000	$260,000			$280,000				$310,000				$352,500				$425,000				$497,500			$570,000			$642,500			$715,000			$800,000

Case 11-2 Amerbran Company (A)*

Note: This case is unchanged from the Twelfth Edition.

Approach

This case is based on actual financial statements of American Brands, Inc. Although the numbers have been changed from those reported, the magnitudes and relationships have been preserved. This case provides additional practice in preparing a statement of cash flows. Since specific information is not given on cash collections and operating disbursements, it is expected that students will use the indirect approach in developing the cash generated by operations amount. The statements in Exhibit I also provide the raw data for the (B) case, which is a ratio analysis case that appears in Chapter 13.

Answer to Question

The required cash flow statement appears below. The explanatory notes to the statement are as follows:

Note 1  This is the net of the following components:

Increase in accounts receivable ...........................................................................................................	$(68,827)
Increase in inventories ........................................................................................................................	(19,510)
Decrease in prepaid expenses ..............................................................................................................	1,027
Increase in accounts payable ...............................................................................................................	33,075
Increase in accrued expenses payable ..................................................................................................	194,728
	$ 140,493

Note 2. The two components of this acquisition, as given in the case, could be shown separately.

Note 3. The decrease in long-term debt is less than the decrease in long-term liabilities because the latter also includes deferred taxes.

Note 4. Lacking specific information to the contrary, it is assumed that reissuance of treasury stock for bonuses generated no cash. The stock dividend was, in effect, a 2-for-1 stock split. The only difference is that if it were a stock split, the total shown for common stock at par would have remained $161,417 rather than doubling to $322,834.

Note 5. The three major categories of cash flows generated a net of $11,785 of cash. Since the increase to be explained is only $4,960, “miscellaneous activities” must have used $6,825 of cash. Some students may include this line in operating activities, rather than as a fourth category; if they do, the net cash flow from operations becomes $567,303.

AMERBRAN COMPANY Statement of Cash Flows For the year ended December 31, 20x1 (in thousands)
Net cash flow from operating activities:
Net income............................................................................................................................................................	$328,773
Noncash items included in income:
Depreciation and amortization.............................................................................................................................	115,974
Deferred taxes.....................................................................................................................................................	(17,548)
Net change in receivables, inventories, and payables (Note 1)...............................................................................	140,493
Write-off of obsolete equipment..........................................................................................................................	66,046
Income from subsidiary.......................................................................................................................................	(59,610)
Net cash flow from operating activities...................................................................................................................	(574,128)
Cash flows from investing activities:
Acquisitions of property, plant, and equipment.......................................................................................................	(260,075)
Proceeds from disposals..........................................................................................................................................	33,162
Acquisition of Company X (Note 2)........................................................................................................................	(133,721)
Net cash used by investing activities....................................................................................................................	(360,634)
Cash flows from financing activities:
Increase in short-term debt.....................................................................................................................................	79,664
Decrease in long-term debt (Note 3)........................................................................................................................	(34,606)
Dividends paid.......................................................................................................................................................	(216,158)
Purchase of treasury stock (Note 4).........................................................................................................................	(30,609)
Net cash used by financing activities...................................................................................................................	(201,709)
Cash flows from miscellaneous activities (Note 5)......................................................................................................	(6,825)
Net increase in cash..................................................................................................................................................	4,960
Cash at beginning of year..........................................................................................................................................	23,952
Cash at end of year....................................................................................................................................................	$ 28,912

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*This teaching note was prepared by Robert N. Anthony. Copyright © Robert N. Anthony.

*This teaching note was prepared by Robert N. Anthony. Copyright © Robert N. Anthony.