solutions to seminar 6 questions by s07 group 2
TRANSCRIPT
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Seminar 6Josephine Toh
Kok May Chew
Man JieNg Yong ChengXu Zhi Sheng
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Purpose of statement of cash flows• Provide information about the cash receipts and
cash payments of an entity.
• Describe how they relate to an entity’s investing,operating and financing activities.
• Allows readers to asses the liquidity of the business and evaluate its ability to generatepositive future cash flows
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Direct and Indirect methodsDirect method
- This shows the specific cash inflows and outflows
comprising of the operating activities of the business.
Indirect method
- The computation begins with the accrual-basedincome and makes adjustments necessary to arriveat the net cash flows from operating activities.
* Both methods eventually result in the same amountof net cash flows from operating activities.
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Direct Method
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Indirect Method
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Question 1
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Question 1 An analysis of the annual financial statements ofConner Corporation reveals (A) to (J):
In the computation of net cash flows fromoperating activities by the indirect method, explain
whether each of the above items should be addedto pre-tax income, deducted from pre-tax incomeor omitted from the computation. Briefly explain your reasons for each answer.
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(A) The Company sustained a $5
million loss as a result of atyphoon that destroyed the factorybuilding.
• Added $5m to pre-tax income because it is anon-operating loss, which is part of investingactivity. This reduces the net income (net
income < net cash flow) so we must add back theloss to determine the net cash flows fromoperating activities.
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(B) Amortization of patent for the
year amounted to $8 million.
• Added $8m to pre-tax income because it is anon-cash expense . This reduces the net income(net income < net cash flow) so we need to add back the expense to determine the net cash flowsfrom operating activities.
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(C) During the year $2 million of cash
was transferred from the company’schecking account to buy treasury bills.
• Omitted from computation of pre-tax income because it is just a transfer of cash to treasury bills (cash equivalent), so it doesn’t affectincome
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(D) Credit sales during the year
amounted to $200 million. Cashreceived from customers during theyear amounted to $188 million.
• Deducted $12m from pre-tax income because thereis an increase in noncash current asset account.Hence Sales revenue = $200m > Cash collected =$188m. Increase in Accounts Receivables means
increase in Sales Revenue which increases netincome (net income > net cash flow) so we mustdeduct increase in account receivables to determinethe net cash flows from operating activities.
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(E) Prepaid expenses decreased by
$1 million over the year
• Added $1m to pre-tax income. Decrease inprepaid expenses (current asset) means increasein operating expense. This reduces the netincome (net income < net cash flow) so we must
add decrease in prepaid expenses to determinethe net cash flows from operating activities.
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(F) Inventories at the beginning of
the year were $5 million and atthe end of the year the physicalcount were $6 million.
• Deducted $1m from pre-tax income because it isan increase in noncash current asset account.Increase in Inventory means purchase > COGS.
When COGS is understated, net income isoverstated (net income > net cash flow) Deduct increase in inventory to determine netcash flow from operating activities.
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(G) Advance deposits from
customers increased by $4 millionover the years.
• Added $4m to pre-tax income because it is anincrease in liabilities. Increase in UnearnedRevenue means Cash collected > Revenue, hence
Net cash flow > Net income
Add increase inliabilities to pre tax income to put net income ona cash basis.
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(H) Cash paid for purchases
amounted during the yearamounted to $60 million.
• Omitted from computation because purchases isalready included in the computation of pre taxincome, so we don’t have to add again.
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(I) Dividends declared during the
year amounted to $7 million;dividend paid during the yearamounted to $5 million.
• Deducted $5 million from pre-tax income because dividends is a special disclosure itemunder FRS7.
• Changes of dividend payable is excluded.• Compute actual dividend paid and reflect as cash
flow.
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(J) The Company accrued $2
million of income taxes for theyear but only paid $1.8 millionduring the year.
• Deducted $1.8 million from pre-tax income because it is a special disclosure item underFRS7.
• No need to add back income tax expense.• Compute actual income tax paid and reflect as
cash flow.
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Question 2
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Question 2
• The accounting staff of Best Company has assembled thefollowing information for the year ended December 31,2011
• (Figure on the next slide)
• Prepare a statement of cash flows in the formatillustrated in Exhibit 13-1. Place brackets aroundamounts representing cash flows. Use the direct methodof reporting cash flows from operating activities.
• Some of the items will be listed in your statement without change. However, you will have to combinecertain given information to compute the amounts of (1)collections from customers (2) Cash paid to suppliersand employees, and (3) proceeds from sales of plantassets.
Cash sales $230 000
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Cash sales $230,000
Credit sales $3,450,000
Collections on accounts receivable $2,810,000
Cash transferred form the money market fund to the general bankaccount
$200,000
Interest and dividends received $40,000
Purchases (all on account) $1,822,000
Payments on accounts payable to merchandise suppliers $1,220,000
Cash payments for operating expenses $930,000
Interest paid $130,000
Income taxes paid $65,000
Loans made to borrowers $690,000
Collections on loans (excluding receipts of interest) $300,000
Cash paid to acquire plant assets $1,700,000Book value of plant assets sold $520,000
Loss on sales of plant assets $30,000
Proceeds from issuing bonds payable $2,000,000
Dividends paid $250,000
Cash and cash equivalents, Jan. 1 $115,000
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Cash received from Customers
Cash received from customers:
Cash sales $230,000
(Add) Collection on Accounts receivable 2,810,000
Cash Received from customers
$3,040,000
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Cash paid to suppliers and employees:
Payments on accounts payable to merchantsuppliers
1,220,000
Cash paid for operating expenses 930,000
Cash paid to suppliers and employees $2,150,000
Cash paid to Suppliers &Employees
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Cash flows from Operating ActivitiesCash flows from operating activities
Cash Received from customers $3,040,000
Interest and Dividends Received
40,000
Cash provided by operating activities $3,080,000
Cash paid to suppliers and employees $(2,150,000)
Interest paid (130,000)
Dividends paid (250,000)
Income taxes paid (65,000)
Cash disbursed for operating activities (2,595,000)
Net cash provided by operating activities
485,000
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Proceeds on sale of plant assets
Proceeds on sale of plant assets
Book value of plant assets sold $520,000
Less: Loss reported on sales of plantassets
(30,000)
Proceeds on sale of plant assets $490,000
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Cash flows from Investing Activities
Cash flows from investingactivities
Loans made to borrowers $(690,000)
Collections on loans 300,000
Cash paid to acquire plantassets
(1,700,000)
Proceeds on sale of plantassets
490,000
Net cash used for investingactivities
$(1,600,000)
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Cash flows from Financing activities
Cash flows from financing
activities
Proceeds from issuing bonds payable $2,000,000
Net cash provided by financingactivities
$2,000,000
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Cash Flow Statement
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Question 3
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(3A) The following selected balance sheet andincome statement data and additional
information for Kings & Co. are presented below.Balance Sheet Data 2010 2009Accounts receivable $120,000 $150,000
Inventories 56,000 50,000
Accounts payable 38,000 70,000
Notes payable 10,000 20,000
Tax payable 3,000 2,000
Retained earnings 76,000 40,000
Income Statement Data 2010
Depreciation 8,000
Net income before tax 62,000
Tax expense 6,000
Gain on sale of equipment ?
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Additional information:
(1) The only items affecting retained earnings in 2010
were net income and dividends declared and paid.(2) Equipment with a cost of $30,000 and an
accumulated depreciation of $12,000 was sold for$22,000 during 2010.
Required(a) Prepare the operating activities section of a
statement of cash flows for Kings & Co. for 2010using the indirect method and in accordance withFRS 7.
(b) Management of Kings & Co. is exploring ways toincrease the cash flows from operations. Describeand explain ways that cash flows from operationscould be increased.
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Gain on sales of equipmentCost $30 000
Accum. Depr. at date of disposal 12 000
Book value at date of disposal (30 000- 12 000)= 18 000
Cash received 22 000
Gain 4 000
Non operating gains must be deducted from pre-taxincome to avoid double counting as sales figure of$22,000 is already reflected in the cash flow forinvesting activities.
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Balance Sheet Data 2010 2009
Accounts receivable $120,000 $150,000
Inventories 56,000 50,000
Accounts payable 38,000 70,000
Notes payable 10,000 20,000Tax payable 3,000 2,000
Retained earnings 76,000 40,000
Income Statement Data 2010
Depreciation 8,000
Net income before tax 62,000
Tax expense 6,000
Gain on sale of equipment ?
Balance Sheet Data 2010 2009
Accounts receivable $120,000 $150,000
Inventories 56,000 50,000
Accounts payable 38,000 70,000
Notes payable 10,000 20,000Tax payable 3,000 2,000
Retained earnings 76,000 40,000
Income Statement Data 2010
Depreciation 8,000
Net income before tax 62,000
Tax expense 6,000
Gain on sale of equipment ?
The following selected balance sheet and incomestatement data and additional information for Kings &Co. are presented below.
(3) Non-Cash Current Assets
(3) Non-Cash CurrentLiabilities
(4) Separate Disclosureitem under FRS7
(2) Non-cash Expenses
Retained Earnings – Net
Income = Dividend Paid[(4) Separate Disclosure
item under FRS7]
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(4) Separate Disclosure item under
FRS7 - Dividend Paid
• Ending Retained Earnings – Beginning Retained
Earnings = Net Income - Dividend Paid
• Dividend Paid =
$40 000 + ($62 000 - $6 000) - $76 000
= $20 000
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Statement of Cash Flow forOperating Activities
Cash flows from Operating Activities
Pre-tax income $ 62 000
Adjustments to reconcile net income to net cash provided byoperating activities
Decrease in Accts Receivable (150k – 120k) 30 000
Increase in Inventory (56k – 50k) (6 000)
Decrease in Accts Payable (70k – 38k) (32 000)
Depreciation Expense 8 000
Gain on sale of equipment (4 000)
Income tax paid (6 000 - 1 000) (5 000)
Dividends paid (20 000)
Net cash provided by operating activities 33 000
Tax Paid =Tax Expenses– Increase intax payable
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(3B) Management of Kings & Co is exploringways to increase the cash flows from
operations. Describe and explain ways thatcash flows from operations could beincreased
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Reducing the size of inventory• Reduces the need for purchasing merchandise,
but only while inventory levels are falling
• Once the company stabilizes the size of itsinventory at the new and lower level, its monthlypurchases must return to approximately thequantity of goods sold during the period
• The increase in cash flow only increases net cashflows of the current period, there will be notmuch effect on future cash flows Notsustainable
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Increase frequency of collection ofAccounts Receivables• Initially: 60-day credit
▫ Credit sales made in January will only be collected in
March Collect 1 month’s amount of credit sales• Now: 30-day credit, from March
▫ In April: collecting 2 month’s amount of credit sales(Feb under the old terms and March under the new
terms)▫ Thus, only significantly increase the cash for the
month of April and does not signal higher cash flowsfor the months ahead Not sustainable, one time.
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Deferring income taxes• Using accelerated depreciation on income tax
return Greater depreciation expense
• Reducing taxable income in current years, inexchange for increased taxable income in future years
• Postpone payment of taxes to the later years ofthe asset’s life
• Reflecting an increase in the value of the asset
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Question 4
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Financial data from three competitors in the sameindustry are listed in the table below. Explain and discuss
which of the three competitors is in the strongestpositions as shown by its statement of cash flows.
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PENGUIN CO.
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WHY PENGUIN? • Based solely on the cash flow statement, Penguin co.
appear to be in the strongest cash flow position• Although all three competitors have the same net
increase in cash - $36,000,000,• Penguin co. provided $80,000,000 by operatingactivities, which was the most among three.
• Unlike Bear co; Penguin co. did not sell assets togenerate cash and it did not further borrow any debts.
• Penguin co. was able to invest $28,000,000 in operatingassets which was the most among three.
• After Penguin co. repaid its debts, it still remained thesame net increase in cash as other two competitors.
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HOWEVER ..• In order to make a fair judgment and conclusion,
we must look at :
1.Income Statement2.Balance Sheet
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PENGUIN CO.• Highest cash flow among the 3, but might have
incurred huge expenses, which will only be
shown in Income Statement• Able to repay debt, but might have more
outstanding debts which will only be shown inBalance Sheet
Hence we need to look at all 3 statements to makea good comparison. Or else, Penguin CO. seems to be in the strongest position.
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FUN TIME!!!
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THANK YOU!