Chapter 21, Problem 21.11P

To determine

Statement of cash flows: It is one of the financial statement that shows the cash and cash equivalents of a company for a particular period. It determines the net changes in cash through reporting the sources and uses of cash due to the operating, investing, and financing activities of a company.

Direct method: The direct method uses the cash basis of accounting for the preparation of the statement of cash flows. It takes into account those revenues and expenses for which cash is either received or paid.

Cash flows from operating activities: Cash flows from operating activity represent the net cash flows from the general operation of the business by comparing the cash receipt and cash payments.

Cash Receipts: It encompasses all the cash receipts from sale of goods and on account receivable.

Cash Payments: It encompasses all the cash payments that are made to suppliers of goods and all expenses that are paid.

The below table shows the way of calculation of cash flows from operating activities:

Cash flows from operating activities (Direct method)

Add: Cash receipts.

Cash receipt from customer

Less: Cash payments:

To supplier

For operating expenses

Income tax expenses

Net cash provided from or used by operating activities

Table (1)

Cash flows from investing activities: Cash provided by or used in investing activities is a section of statement of cash flows. It includes the purchase or sale of equipment or land, or marketable securities, which is used for business operations.

The below table shows the way of calculation of cash flows from investing activities:

Cash flows from investing activities

Add: Proceeds from sale of fixed assets

Sale of marketable securities / investments

Deduct: Purchase of fixed assets/long-lived assets

Purchase of marketable securities

Net cash provided from or used by investing activities

Table (2)

Cash flows from financing activities: Cash provided by or used in financing activities is a section of statement of cash flows. It includes raising cash from long-term debt or payment of long-term debt, which is used for business operations.

The below table shows the way of calculation of cash flows from financing activities:

Cash flows from financing activities

Add: Issuance of common stock

Proceeds from borrowings

Proceeds from issuance of debt

Issuance of bonds payable

Deduct: Payment of dividend

Repayment of debt

Interest paid

Redemption of debt

Repurchase of stock

Net cash provided from or used by financing activities

Table (3)

To Prepare: The statement of cash flows from operating activities using direct method for A Company for the year ended December 31, 2016.

Answer to Problem 21.11P

Prepare the statement of cash flow:

Figure (1)

Explanation of Solution

Working notes:

Calculate the amount of cash received from customers:

$\begin{array}{c}\begin{array}{l}\text{Cash received}\\ \text{ from customers}\end{array}\}\text{ = }\left[\text{Sales revenue + }\left(\begin{array}{l}\text{Accounts receivable in 2015}\\ -\text{Accounts receivable in}2016\end{array}\right)\right]\\ =\left[\$410+\left(\$194-\$190\right)\right]\\ =\$410+\$4\\ =\$414\end{array}$

Calculate the amount of investment revenue:

$\begin{array}{c}\text{Investment revenue = }\left[\begin{array}{l}\text{Amount of investment revenue}-\\ \text{A's company share ofnet income}-\\ \left(\begin{array}{l}\text{Investment revenue receivable in 2016}-\\ \text{Investment revenue receivable in}2015\end{array}\right)\end{array}\right]\\ =\left[\$11-\$6-\left(\$6-\$4\right)\right]\\ =\$11-\$6-\$2\\ =\$3\end{array}$

Calculate the amount of cash paid to suppliers:

$\begin{array}{c}\text{Cash paid to suppliers = }\left[\begin{array}{l}\text{Cost of goods sold +}\\ \text{}\left(\text{Inventory in 2016}-\text{Inventory in 2015}\right)\\ +\left(\begin{array}{l}\text{Accounts payable in 2015}\\ -\text{Accounts payable in 201}6\end{array}\right)\end{array}\right]\\ =\left[\$180+\left(\$205-\$200\right)+\left(\$65-\$50\right)\right]\\ =\$180+\$5+\$15\\ =\$200\end{array}$ 

Calculate the amount of cash paid to employees:

$\begin{array}{c}\text{Cash paid to employees = }\left[\begin{array}{l}\text{Salaries expense + }\\ \left(\text{Salary payable in 2015}-\text{Salary payable in 201}6\right)\end{array}\right]\\ \text{=}\left[\text{\$73 + }\left(\$11-\$6\right)\right]\\ \text{=\$73 + \$5}\\ \text{=\$78 }\end{array}$

Calculate the amount of cash paid for insurance:

$\begin{array}{c}\text{Cash paid for insurance =}\left[\begin{array}{l}\text{ Insurance expense}-\\ \left(\begin{array}{l}\text{Prepaid insurance in 2015}-\\ \text{Prepaid insurance in 201}6\end{array}\right)\end{array}\right]\\ =\left[\$7-\left(\$8-\$4\right)\right]\\ =\$7-\$4\\ =\$3\end{array}$

Calculate the amount of cash paid for bond interest:

$\begin{array}{c}\text{Cash paid for bond interest = }\left[\begin{array}{l}\text{Bond interest expense}-\\ \left(\begin{array}{l}\text{Bond interest payable in 2016}-\\ \text{Bond interest payable in 201}5\end{array}\right)-\\ \left(\begin{array}{l}\text{Discount on bonds in 2015}-\\ \text{Discount on bonds in 201}6\end{array}\right)\end{array}\right]\\ =\left[\$28-\left(\$8-\$4\right)-\left(\$25-\$22\right)\right]\\ =\$28-\$4-\$3\\ =\$21\end{array}$

Calculate the amount of cash paid for income taxes:

$\begin{array}{c}\text{Cash paid for income taxes = }\left[\begin{array}{l}\text{Income tax expense}-\\ \left(\begin{array}{l}\text{Deferred income tax liability in 2016}-\\ \text{Deferred income tax liability in 201}5\end{array}\right)+\\ \left(\begin{array}{l}\text{Income tax payable in 2015}\\ -\text{Income tax payable in 201}6\end{array}\right)\end{array}\right]\\ =\left[\$36-\left(\$11-\$8\right)+\left(\$14-\$12\right)\right]\\ =\$36-\$3+\$2\\ =\$35\end{array}$

Calculate the amount of sale of machine components:

$\begin{array}{c}\text{Sale of machine components = }\left[\begin{array}{l}\left(\begin{array}{l}\text{<x-custom-btb-me data-me-id="391" class="microExplainerHighlight">Depreciation</x-custom-btb-me> in 2016}\\ -\text{Depreciation in 2016}\end{array}\right)\\ -\text{Loss on machine damage}\end{array}\right]\\ \text{=}\left(\text{\$315}-\$280\right)-\$18\\ =\$35-\$18\\ =\$17\end{array}$

Calculate the amount of land:

$\begin{array}{c}\text{Land = Cost of the land}-\text{Cash paid for the land}\\ \text{=\$46}-\$23\\ =\$23\left(Noteissued\right)\end{array}$

Calculate the amount of retirement of bonds payable:

$\begin{array}{c}\text{Retirement of bonds payable = }\left(\begin{array}{l}\text{Bonds payable in 2015}-\\ \text{Bonds payable in 2016}\end{array}\right)\\ \text{=\$275}-\$215\\ =\$60\end{array}$

Calculate the amount of dividend:

Step 1: Calculate the amount of cash dividend.

$\begin{array}{c}\text{Retained earning in 2016 = }\left(\begin{array}{l}\text{Retained earning in 2015 +}\\ \text{ Net income}-\text{Dividends}\end{array}\right)\\ \text{\$242=\$227}\text{}+\$67-\text{Dividend}\\ \text{Dividend}=\$227+\$67-\$242\\ =\$294-\$242\\ =\$52\end{array}$

Step 2: Calculate the amount of stock dividend.

$\begin{array}{c}\text{Stock dividend = }\left\{\begin{array}{l}\text{Number of stock dividend shares }\times \\ \text{Par value of share}\end{array}\right\}\\ \text{=4 million shares }\times \$7.5\\ =\$30shares\end{array}$

Step 3: Calculate the amount of dividend paid:

$\begin{array}{c}\text{Dividend paid = Cash dividend}-\text{Stock dividend}\\ \text{=\$52}-\$30\\ =\$22\end{array}$

Notes:

Note 1: Treasury bill was sold during 2016 at a gain of $2 million. Therefore, it is considered as a gain on sale of cash equivalents.

Note 2: purchase of long-term investment is $25 million.

Note 3: Purchase of land of $23 by issuing cash and a 15%, 4-years lease is considered as non cash investing and financing activities.

Note 4: Sale of preferred stock is $75 million.

Note 5: the amount of purchase of treasury stock is $9 million.