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,
Trang 1CHAPTER 6 CASH FLOW ANALYSIS
I Questions
1 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
2 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
3 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
4 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
5 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
6 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
Trang 27 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
8 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
9 Noncash transactions do 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:
Add: Expenses not requiring cash – depreciation
Net cash provided by operating activities P 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
Trang 312 (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 1
Transaction Operating Investing Financing Source Use
Trang 41 Short-term investment
securities were
purchased
2 Equipment was
purchased
3 Accounts payable
increased
X X
4 Deferred taxes
decreased
5 Long-term bonds
were issued
X X
6 Ordinary shares were
sold
X X
7 Interest was paid to
long-term creditors
8 A long-term mortgage
was entirely paid off
9 A cash dividend was
declared and paid
11 Accounts receivable
increased
12 Depreciation charges
totaled P200,000 for
the year
X X
Problem 2 (Analysis of Cash Flow Transactions)
Requirement (a)
The eight items should be presented in the statement of cash flows as follows:
1 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
Trang 5the 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
2 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
3 The payment of a cash dividend is a negative cash flow that is presented in the financing activities section of the statement
4 The purchase of treasury stock is a negative cash flow in the financing activities section of the statement
5 The depreciation expense recognized during the year is a noncash expense in determining cash flows from operating activities
6 The conversion of convertible bonds into ordinary shares is a noncash financing activity that requires disclosure in a separate schedule
7 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
8 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)
1 Net cash provided by operating activities
Noncash expense adjustments:
Reclassification of extraordinary loss 15,000
P212,250
2 Net cash used in investing activities
Purchase of intangible assets P (34,000)
P(159,000)
Trang 63 Net cash used in financing activities
Purchase of treasury stock P(31,000)
P(43,500)
Computations:
Depreciation expense
Change in accumulated depreciation account P35,000 Accumulated depreciation on fully depreciated
P46,250 Purchase of land
Cost of land sold in condemnation proceedings 180,000
P130,000
Problem 3 (Cash Flow from Operating Activities)
Cash received from customers:
Less: Note receivable (15,000) P170,000 Cash disbursed for expenses:
Total expenses (P173,000 + P4,200) P177,200
Less: Income taxes deferred (1,260)
Amortization (7,000) (143,940) Net cash provided by operating activities P 26,060
Problem 4 (Cash Flow from Operating Activities)
Cash received from customers (1) P5,237,000 Cash paid for expenses:
Salaries and wages (2) 394,400
Incomes taxes (4) 335,000 4,195,600 Net cash provided by operating activities P1,041,400
Computations:
Trang 71 Revenue from sales P5,432,000
P5,237,000
2 Salaries and wages expense P 400,000
Less: Increase in accrued salaries and wages
(P45,600 – P40,000) (5,600)
P 394,400
Less: Discount amortization (6,800)
P 65,200
P 335,000
Problem 5 (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
Adjustments to reconcile net income to net
cash flows provided by operating
activities:
Increase in current assets (6,000)
Increase in current liabilities 3,000
Net cash provided by operating
activities
P7,500
Cash flows from financing activities
Retirement of long-term liabilities (1,000)
* Increase in retained earnings (P20,000 – P13,000) P7,000
Trang 8Net cash used in financing activities (2,500)
Problem 6 (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 P74,000
Net cash provided by operating
Cash flow from investing activities
Net cash used in investing activities (28,500) Cash flows from financing activities
Payment of cash dividends (8,500)
Net cash used in financing activities 31,500
Reconciliation of net income to net cash
provided by operating activities:
Adjustments to reconcile net income to net
cash provided by operating activities:
Increase in accounts receivable (33,000)
* Net increase during 2005 (P33,600 – P27,100) P 6,500
Accumulated depreciation on assets sold 18,000
Depreciation expense for 2005 P24,500
Trang 9Decrease in accrued expenses (500)
Net cash provided by operating activities P 7,000
Computations:
Cash received from customers:
Deduct: Increase in accounts receivable
(P78,000 – P45,000) 33,000
P 74,000 Cash paid for expenses:
Add: Decrease in accrued expenses
Deduct: Depreciation expense
(P33,600 – P27,100 + P18,000) (24,500)
P 67,000 Cash from sale of equipment:
Deduct: Accumulated depreciation (18,000) Cash received on sale at book value P 9,500
Cash paid to acquire equipment:
Increase in property, plant and equipment
P 53,000 Cash received on sale of stock:
Increase in ordinary shares amount
Increase in additional paid-in capital account
P 40,000 Cash dividends:
Increase in retained earnings (P21,000 – P14,500) P 6,500
Net income (P107,000 – P92,000) (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
Trang 10clearly 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 7 (Interpretation of Cash Flow Statement)
Requirement (a)
The two companies are similar in the following respects:
1 Overall size
2 Industry in which they operate
3 Current ratio (2.4 to 1)
4 Overall peso amounts of cash provided and used:
Range, 2002-2005 Cash Provided Cash Used Ebony Company P125,000 – P168,000 P115,000 – P170,000 Ivory Company P135,000 – P160,000 P125,000 – P165,000
5 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:
Sources of Cash in Percentages
Ebon
y Ivory Ebony Ivory Ebony Ivory Ebony Ivory Cash provided:
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
Trang 11disposition 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:
1 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
2 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