Problem 14-14 (45 minutes)
1. Prepare a statement of cash flows.
Operating activities:
Step 1: The following equation can be applied to the Accumulated Depreciation account to compute the depreciation to add back to net income:
Beginning balance – Debits + Credits = Ending balance
Step 2: The guidelines from Exhibit 14-2 can be used to analyze the changes in noncash balance sheet accounts that impact net income as follows:
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Increase in Account Balance |
Decrease in Account Balance |
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Current Assets |
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Accounts receivable…. |
61,000 |
40,000 |
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Inventory………………. |
848,000 |
860,000 |
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Prepaid expenses…….. |
10,000 |
5,000 |
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Current Liabilities |
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Accounts payable…….. |
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Accrued liabilities………. |
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Income taxes payable |
Step 3: The gain on sale of investments ($60,000) is subtracted from net income. The loss on sale of equipment ($20,000) is added to net income.
Problem 14-14 (continued)
The net cash provided by operating activities can now be calculated as follows:
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Net income…………………………………………. |
$170,000 |
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Adjustments to convert net income to cash basis: |
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Depreciation…………………………………….. |
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Increase in accounts receivable……………. |
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Decrease in inventory………………………… |
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Increase in prepaid expenses……………….. |
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Increase in accounts payable………………. |
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Decrease in accrued liabilities……………….. |
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Increase in income taxes payable…………. |
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Loss on sale of equipment…………………… |
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Gain on sale of investments…………………. |
180,000 |
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Net cash provided by operating activities…. |
$350,000 |
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Investing and Financing activities:
The guidelines from Exhibit 14-3 can be used to analyze the changes in noncash balance sheet accounts that impact investing and financing cash flows as follows:
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Increase in Account Balance |
Decrease in Account Balance |
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Noncurrent Assets |
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Property, plant, and equipment………….. |
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Long-term investments…………………….. |
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Long-term loans to subsidiaries…………… |
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Liabilities and Stockholders’ Equity |
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Bonds payable………………………………… |
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Common stock……………………………….. |
The decrease in the long-term investments account ($50,000) equals the cost of the long-term investment sold; therefore, Lomax did not purchase any long-term investments during the year. The proceeds from the sale of the long-term investment ($110,000) should be recorded as a cash inflow in the investing activities section of the statement.
Problem 14-14 (continued)
Lomax’s subsidiaries did not repay any loans during the year, therefore, the amount in the table on the prior page (– 44,000) represents a cash outflow pertaining to a new loan. The company did not repurchase any of its own stock, so the amount on the prior page represents a $90,000 cash inflow related to a stock issuance. Property, plant, and equipment, bonds payable, and retained earnings require further analysis as follows:
Property, plant, and equipment:
Beginning balance + Debits – Credits = Ending balance
The additions to property, plant, and equipment ($700,000) are recorded as a cash outflow and the proceeds from the sale of equipment ($70,000) are recorded as a cash inflow.
Bonds Payable:
Beginning balance – Debits + Credits = Ending balance
Retained earnings:
Beginning balance – Debits + Credits = Ending balance
The dividend payment ($75,000) should be recorded as a cash outflow in the financing activities section of the statement.
Problem 14-14 (continued)
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Lomax Company |
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Statement of Cash Flows |
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Operating activities: |
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Net income………………………………………………… |
$170,000 |
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Adjustments to convert net income to cash basis: |
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Depreciation……………………………………………. |
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Increase in accounts receivable…………………… |
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Decrease in inventory……………………………….. |
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Increase in prepaid expenses………………………. |
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Increase in accounts payable……………………… |
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Decrease in accrued liabilities………………………. |
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Increase in income taxes payable………………… |
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Loss on sale of equipment………………………….. |
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Gain on sale of investments………………………… |
180,000 |
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Net cash provided by operating activities………… |
350,000 |
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Investing activities: |
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Proceeds from sale of long-term investments…… |
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Proceeds from sale of equipment…………………… |
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Loans to subsidiaries……………………………………. |
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Additions to plant and equipment…………………… |
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Net cash used in investing activities………………… |
(564,000) |
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Financing activities: |
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Issuance of bonds payable……………………………. |
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Issuance of common stock…………………………… |
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Retirement of bonds payable………………………… |
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Cash dividends to stockholders……………………… |
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Net cash provided by financing activities…………. |
235,000 |
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Net increase in cash and cash equivalents……….. |
21,000 |
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Beginning cash and cash equivalents………………. |
40,000 |
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Ending cash and cash equivalents………………….. |
$ 61,000 |
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Problem 14-14 (continued)
2. The large amount of cash provided by operating activities is traceable for the most part to the $300,000 increase in accounts payable. If the accounts payable had remained basically unchanged, the same as inventory, then operating activities would have provided very little cash and the company might have experienced serious cash problems.
Note particularly that the cash provided by operating activities was used to purchase plant and equipment. Thus, the company is using cash derived from a short-term source (buildup of accounts payable) to finance long-term asset acquisitions. In short, although the company is generating substantial cash from operating activities, the quality of this source is open to question.
Also, note the substantial increase in accounts receivable. Apparently, the company’s collections from customers are lagging, perhaps because of sales to customers whose credit is weak. This may be the result of trying to increase sales so fast that proper credit checks are not being made. Again, this can lead to serious cash problems if the trend continues.
In the company’s financing activities, it appears that long-term debt sources, rather than equity sources, are being used to provide for expansion. Although companies frequently use debt to finance expansion, the level of debt in this company is increasing rapidly. (See Chapter 15 for a discussion of the Debt-to-Equity ratio and other financial ratios.)
*** You must work the entire problem which includes answering the theory questions. ***
