Chapter 12, Problem 6AP

a.

To determine

Calculate the change in cash occurred during 2016.

Explanation of Solution

Calculate the change in cash during 2016.

Cash balance as of 31^st December 2015 is $8,000

Cash balance as of 31^st December 2016 is $52,000

$\begin{array}{c}\text{Change in cash }=\text{Cash balance in 2016}-\text{Cash balance in 2015}\\ =\$52,000-\$8,000\\ =\$44,000\end{array}$

Hence, the change in cash during 2016 is $44,000.

b.

To determine

Prepare a statement of cash flow using the direct method.

Explanation of Solution

Statement of cash flows: Statement of cash flows reports all the cash transactions which are responsible for inflow and outflow of cash and result of these transactions is reported as ending balance of cash at the end of reported period. Statement of cash flows includes the changes in cash balance due to operating, investing, and financing activities.

Prepare a statement of cash flow using the direct method.

Schedule in the Change of Current Assets and Liabilities
Company W
Statement of Cash Flows - Direct method
For the year ended December 31, 2016
Details	Amount ($)	Amount ($)
Cash flows from operating activities:
Cash receipts:
From customer (1)	636,000
Total cash receipts		636,000
Cash payments:
To supplier  (2)	(463,000)
To employees  (3)	(83,000)
For interest  (4)	(12,000)
For insurance  (5)	(10,000)
For income tax  (6)	(30,000)
Total cash payments		(598,000)
Net cash provided by operating activities		38,000
Cash flows from investing activities:
Acquisition of plant asset (7)	(24,000)
Net cash used for investing activities		(24,000)
Cash flows from financing activities:
Issuance of bonds payable (8)	66,000
Cash payment of dividends	(36,000)
Net cash provided by financing activities		30,000
Net increase (decrease) in Cash		44,000
Cash balance, December 31, 2015		8,000
Cash balance, December 31, 2016		52,000

Table (1)

Working note:

Prepare the schedule in the change of current assets and liabilities.

Schedule in the Change of Current Assets and Liabilities
Details	Amount ($)			Effect on Operating Activities
	2016 ($)	2015 ($)	Increase/ (Decrease) ($)
Accounts receivable	41,000	32,000	9,000	Less
Inventory	90,000	60,000	30,000	Less
Prepaid insurance	5,000	7,000	(2,000)	Add
Accounts payable	7,000	10,000	(3,000)	Less
Wages payable	9,000	6,000	3,000	Add
Income tax payable	6,000	7,000	(1,000)	Less

Table (2)

1. Calculate the amount of cash receipts from customers.

Calculate the amount of increase or decrease in accounts receivable:

Amount of accounts receivable during 2016 is $41,000

Amount of accounts receivable during 2015 is $32,000

$\begin{array}{c}\text{Increase in accounts receivable}=\left(\begin{array}{l}\text{Accounts receivable in 2016}-\\ \text{Accounts receivable in 2015}\end{array}\right)\\ =\text{\$}41,000-\$32,000\\ =\$9,000\end{array}$

Amount of cash receipts from customers:

$\begin{array}{c}\text{Cash received from suppliers}=\text{Sales revenue}-\text{Increase in accounts receivable}\\ =\$645,000-\$9,000\\ =\$636,000\end{array}$

2. Calculate the cash payments to suppliers.

Cost of Goods Sold is $430,000

Decrease in Accounts payable is $3,000

Increase in inventory is $30,000

$\begin{array}{c}\text{Cash Payments to Suppliers}=\left(\begin{array}{c}\text{Cost of goods sold }\\ +\text{Decrease in} \text{Accounts Payable }\\ +\text{ Increase in Merchandised Inventory}\end{array}\right)\\ =\$430,000+\$3,000+\$30,000\\ =\$463,000\end{array}$

3. Calculate the cash payments for Wages expenses.

$\left(\begin{array}{l}\text{Cash payments }\\ \text{for Wages}\end{array}\right)=\text{Wages expense}\left(\begin{array}{l}+\text{Decrease in wages payable}\\ \text{OR}\\ -\text{Increase in wages payable}\end{array}\right)$

Calculate the amount of cash payment made to employees.

Wages expense is $86,000

Increase in wages payable is $3,000

$\begin{array}{c}\left(\begin{array}{l}\text{Cash payments }\\ \text{for Wages}\end{array}\right)=\text{Wages expense}\left(\begin{array}{l}+\text{Decrease in wages payable}\\ \text{OR}\\ -\text{Increase in wages payable}\end{array}\right)\\ =\$86,000-\$3,000\\ =\$83,000\end{array}$

4. Calculate the cash payments for income taxes.

$\left(\begin{array}{l}\text{Cash payments }\\ \text{for Income taxes}\end{array}\right)=\text{Income tax expense}\left(\begin{array}{l}+\text{Decrease in income tax payable}\\ \text{OR}\\ -\text{Increase in income tax payable}\end{array}\right)$

Calculate the amount of cash payment made for income tax.

Income tax expense is $29,000

Decrease in income tax payable is $1,000

$\begin{array}{c}\begin{array}{l}\text{Cash payments }\\ \text{for income taxes}\end{array}\}=\left(\begin{array}{c}\text{Income tax expense}\\ +\text{Decrease in income tax payable}\end{array}\right)\\ =\$29,000+\$1,000\\ =\$30,000\end{array}$

5. Calculate the cash payments for Interest expense.

$\left(\begin{array}{l}\text{Cash payments }\\ \text{for Interest}\end{array}\right)=\text{Interest expense}\left(\begin{array}{l}+\text{Decrease in interest payable}\\ \text{OR}\\ -\text{Increase in interest payable}\end{array}\right)$

Calculate the amount of cash payment made for interest.

Interest expense is $12,000

Increase/Decrease in Interest payable $0

$\begin{array}{c}\begin{array}{l}\text{Cash payments }\\ \text{for interest}\end{array}\}=\left(\begin{array}{c}\text{interest expense}\\ +\text{Decrease in interest payable}\end{array}\right)\\ =\$12,000+\$0\\ =\$12,000\end{array}$

6. Calculate the cash payments for Insurance expense.

It represents the total amount of cash paid for the insurance.

$\left(\begin{array}{l}\text{Cash payments }\\ \text{for Insurance}\end{array}\right)=\text{Insurance expense}\left(\begin{array}{l}+\text{Incresae in prepaid insurance}\\ \text{OR}\\ -\text{Decrease in prepaid insurance}\end{array}\right)$

Calculate the amount of cash payment made for insurance.

Insurance expense is $12,000

Decrease in prepaid insurance is $2,000

$\begin{array}{c}\begin{array}{l}\text{Cash payment}\\ \text{for insurance}\end{array}\}=\left(\begin{array}{c}\text{Insurance expense}\\ -\text{Decrease in prepaid insurance}\end{array}\right)\\ =\$12,000-\$2,000\\ =\$10,000\end{array}$

7. Calculate the acquisition of plant:

8. Calculate the issue of bonds payable for cash:

Bonds payable in 2016 = $141,000

Bonds payable in 2015 = $75,000

$\begin{array}{c}\text{Issunace of bonds payable for cash }=\$141,000-\$75,000\\ =\$66,000\end{array}$

c.

To determine

Compute the free cash flow for Company W.

Explanation of Solution

Free cash flow:

Free cash flow signifies cash that is provided by the operations of the Company after making capital expenditures for acquiring or expanding its assets.

Formula to calculate free cash flow:

$\text{Free cash flow}=\left(\begin{array}{l}\text{Net cash flows from operating activities}\\ -\text{ Dividends }-\text{ Net capital expenditures}\end{array}\right)$

Compute free cash flow:

Amount of net cash flow from operating activities is $38,000

Amount of Net capital expenditure is $24,000

Amount of dividend is $36,000

$\begin{array}{c}\text{Free cash flow}=\left(\begin{array}{l}\text{Net cash flows from operating activities}\\ -\text{ Dividends }-\text{ Net capital expenditures}\end{array}\right)\\ =\$38,000-\$36,000-\$24,000\\ =\left(\$22,000\right)\end{array}$

Thus, the free cash flow of Company W is (22,000).

d.

To determine

Compute the operating cash flow to current liabilities ratio for Company W.

Explanation of Solution

Operating cash flow to current liabilities ratio measures the capability of the company to pay it current liabilities. In this, higher the ratio shows that the company has sufficient cash flow to pay its debts.

Formula to calculate the operating cash flow to current liabilities ratio is:

$\begin{array}{l}\text{Operating cash flows}\\ \text{ to current liabilities ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Average current liabilities}}$

Compute the Operating cash flow to current liabilities ratio.

Amount of cash flow from operating activities is $38,000

Amount of average current liabilities is $22,500

$\begin{array}{c}\begin{array}{l}\text{Operating cash flows}\\ \text{ to current liabilities ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Average current liabilities}}\\ =\frac{\$38,000}{\$22,500}\\ =1.68\end{array}$

Working note:

Calculate the average current liabilities:

$\begin{array}{c}\text{Average current liabilities }=\frac{\left(\begin{array}{l}\text{Current liabilities, 2016 }\\ +\text{ Current liabilities, 2015}\end{array}\right)}{2}\\ =\frac{\left(\begin{array}{l}\$10,000+\$6,000\\ +\$7,000\end{array}\right)+\left(\begin{array}{l}\$7,000+\$9,000\\ +\$6,000\end{array}\right)}{2}\\ =\$22,500\end{array}$

Thus, the operating cash flow to current liabilities ratio of Company W is 1.68.

e.

To determine

Compute the operating cash flow to capital expenditure ratio for Company W.

Explanation of Solution

Operating cash flow to capital expenditure ratio measures the capability of the company to finance its capital investments from the operating cash flow.

Formula to calculate cash flow to capital expenditure ratio is:

$\begin{array}{l}\text{Operating cash flows}\\ \text{ to capital expenditure ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Annual net capital expenditure}}$

Compute the operating cash flow to capital expenditure ratio.

Cash flow from operating activities is $38,000

Amount of capital expenditure is $24,000

$\begin{array}{c}\begin{array}{l}\text{Operating cash flows}\\ \text{ to capital expenditure ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Annual net capital expenditure}}\\ =\frac{\$38,000}{\$24,000}\\ =1.58\end{array}$

Thus, the operating cash flow to expenditure ratio of Company W is 1.58.