Chapter 12, Problem 6BP

a.

To determine

Calculate the change in cash that occurred during 2016.

Explanation of Solution

Calculate the change in cash during 2016.

Cash balance as of 31^st December 2015 is $33,000

Cash balance as of 31^st December 2016 is $41,000

$\begin{array}{c}\text{Change in cash }=\text{Cash balance in 2016}-\text{Cash balance in 2015}\\ =\$41,000-\$33,000\\ =\left(\$8,000\right)\end{array}$

Hence, the change in cash during 2016 is ($8,000).

b.

To determine

Prepare a statement of cash flows using indirect method for Company R.

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.

Indirect method: Under this method, the following amounts are to be adjusted from the Net Income to calculate the net cash provided from operating activities.

Prepare a statement of cash flows using direct method for Company R.

Company R
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)	653,000
Total cash receipts		653,000
Cash payments:
To supplier (2)	(390,000)
To employees (3)	(100,000)
For rent (4)	(32,000)
For income tax (5)	(32,000)
Total cash payments		(554,000)
Net cash provided by operating activities		99,000
Cash flows from investing activities:
Acquisition of plant asset (6)	(120,000)
Net cash used for investing activities		(120,000)
Cash flows from financing activities:
Issuance of common stock (7)	43,000
Paid-in capital on common stock	14,000
Cash payment of dividends	(28,000)
Net cash provided by financing activities		29,000
Net increase (decrease) in Cash		8,000
Cash balance, December 31, 2015		33,000
Cash balance, December 31, 2016		41,000

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	52,000	60,000	(8,000)	Add
Inventory	142,000	116,000	26,000	Less
Prepaid rent	14,000	10,000	4,000	Less
Accounts payable	29,000	17,000	12,000	Add
Wages payable	14,000	7,000	7,000	Add
Income tax payable	7,000	8,000	(1,000)	Less

Table (2)

1. Calculate the amount of cash receipts from customers.

$\left(\begin{array}{l}\text{Cash}\text{receipts}\text{from}\\ \text{Customers}\end{array}\right)=\text{Sales}\text{revenue }\left(\begin{array}{l}+\text{Decrease in Accounts Receivable}\\ \text{OR}\\ -\text{Increase in Accounts Receivable}\end{array}\right)$

Calculate the amount of cash receipts from customers.

Net Sales = $645,000

Decrease in Accounts receivable = $8,000

$\begin{array}{c}\text{Cash}\text{receipts}\text{from}\text{Customers}=\left(\begin{array}{c}\text{Sales}\text{revenue}\\ +\text{Decrease in Accounts Receivable}\end{array}\right)\\ =\text{\$645,000}+\$8,000\\ =\$653,000\end{array}$

2. Calculate the cash payments to suppliers.

Cost of Goods Sold = $376,000

Increase in Accounts payable = $12,000

Increase in inventory = $26,000

$\begin{array}{c}\text{Cash Payments to Suppliers}=\left(\begin{array}{c}\text{Cost of goods sold }\\ -\text{Increase in} \text{Accounts Payable }\\ \text{+ Increase in Merchandised Inventory}\end{array}\right)\\ =\$376,000-\$12,000+\$26,000\\ =\$390,000\end{array}$

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 = $107,000

Increase in wages payable = $7,000

$\begin{array}{c}\left(\begin{array}{l}\text{Cash payments }\\ \text{for Wages}\end{array}\right)=\text{Wages expense}\left(\begin{array}{l}+\text{Decrease in wages payable}\\ \text{OR}\\ -\text{Increase in wages payable}\end{array}\right)\\ =\$107,000-\$7,000\\ =\$100,000\end{array}$

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 = $31,000

Decrease in income tax payable = $1,000

$\begin{array}{c}\begin{array}{l}\text{Cash payments }\\ \text{for income taxes}\end{array}\}=\left(\begin{array}{c}\text{Income tax expense}\\ +\text{Decrease in income tax payable}\end{array}\right)\\ =\$31,000+\$1,000\\ =\$32,000\end{array}$

5. Calculate the cash payments for Rent expense.

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

Calculate the amount of cash payment made for rent.

Rent expense = $28,000

Increase in prepaid rent= $4,000

$\begin{array}{c}\begin{array}{l}\text{Cash payment}\\ \text{for rent}\end{array}\}=\left(\begin{array}{c}\text{Rent expense}\\ +\text{Increase in prepaid rent}\end{array}\right)\\ =\$28,000+\$4,000\\ =\$32,000\end{array}$

6. Calculate the acquisition of plant:

7. Calculate the issue of common stock for cash:

Common stock in 2016 = $295,000

Common stock in 2015 = $252,000

$\begin{array}{c}\text{Issunace of common stock for cash }=\$295,000-\$252,000\\ =\$43,000\end{array}$

c.

To determine

Compute the free cash flow for Company R.

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 $99,000

Amount of Net capital expenditure is $120,000

Amount of dividend is $28,000

$\begin{array}{c}\text{Free cash flow}=\left(\begin{array}{l}\text{Net cash flows from operating activities}\\ -\text{ Dividends }-\text{ Net capital expenditures}\end{array}\right)\\ =\$99,000-\$28,000-\$120,000\\ =\left(\$49,000\right)\end{array}$

Thus, the free cash flow of Company R is (49,000).

d.

To determine

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

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 $99,000

Amount of average current liabilities is $41,000 (3)

$\begin{array}{c}\begin{array}{l}\text{Operating cash flows}\\ \text{ to current liabilities ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Average current liabilities}}\\ =\frac{\$99,000}{\$41,000}\\ =2.41\end{array}$

Working note:

Calculate the average current liabilities:

$\begin{array}{c}\text{Average current liabilities }=\frac{\left(\begin{array}{l}\text{Current liabilities, 2015 }\\ +\text{ Current liabilities, 2016}\end{array}\right)}{2}\\ =\frac{\left(\begin{array}{l}\$17,000+\$7,000\\ +\$8,000\end{array}\right)+\left(\begin{array}{l}\$29,000+\$14,000\\ +\$7,000\end{array}\right)}{2}\\ =\$41,000\end{array}$ (3)

Thus, the operating cash flow to current liabilities ratio of Company R is 2.41.

e.

To determine

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

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 $99,000

Amount of capital expenditure is $120,000

$\begin{array}{c}\begin{array}{l}\text{Operating cash flows}\\ \text{ to capital expenditure ratio}\end{array})=\frac{\text{Cash flows from operating activities}}{\text{Annual net capital expenditure}}\\ =\frac{\$99,000}{\$120,000}\\ =0.83\end{array}$

Thus, the operating cash flow to expenditure ratio of Company R is 0.83.