Solution manual managerial accounting by cabrera 2010 chapter 06 answer

MANAGEMENT ACCOUNTING (VOLUME I) - Solutions Manual

CHAPTER 6
CASH FLOW ANALYSIS
I.

Questions
1. Purposes of the Statement of Cash Flows
a. To predict future cash flows
b. To evaluate management decisions
c. To determine the ability to pay dividends to shareholders and
interest and principal to creditors
d. To show the relationship of net income to changes in the
business’s cash.
2. Comparative balance sheets present the financial position of the
enterprise at two points in time. The income statement for the period
between the two balance sheets describes how the income-producing
activities affected the financial position. Because cash flows from
operating activities may differ substantially from net income, and
because numerous other financing and investing activities have an
impact on financial position, the statement of cash flows is necessary.
The statement emphasizes changes in the cash balances that result from
changes in assets, liabilities and equity accounts caused by operating,
investing and financing activities.
3. The most important source of cash for many successful companies is
from operating activities. A large positive operating cash flow is a
good sign because it means funds have been internally generated with
no fixed obligations or commitment to return such to anybody.
4. It is possible for cash to decrease during a year when income is high
because cash may be used not only for operating activities but also for
investing and financing activities.

5. Transactions involving accounts payable are not considered to be
financing activities because such transactions are used to obtain goods
and services rather than to obtain cash. Furthermore, purchases of
goods and services relate to a company’s day-to-day operating
activities.
6. The loss is added back to net income to avoid double counting since the
entire proceeds from the sale (net book value minus loss on sale) will
appear as a cash inflow from investing activities.
6-1


Chapter 6 Cash Flow Analysis

7. Three categories of transactions that may result in increases in cash are
a. Operating activities
b. Investing activities (e.g., sale of investments or other assets).
c. Financing activities (e.g., borrowing or sale of stock).
These activities are sources of cash when cash is increased as a result
of the particular activity.
8. Three categories of transactions that may result in decreases in cash
are
a. Operating activities
b. Investing activities (e.g., purchase of investments or other assets).
c. Financing activities (e.g., repayment of debt or retirement of stock).
These activities are uses of cash when cash is decreased as a result of
the particular activity.
9. Noncash transactions do not provide or consume cash even though they
may result in significant changes in financial position. Examples are
the issuance of share capital for plant assets and the conversion of debt
or preference shares into ordinary shares. Such transactions are not

presented in the body of the statement of cash flows but rather
disclosed in a separate schedule as financing or investing activities.
10. While net loss is usually associated with a decrease in cash, it may be a
source of cash if noncash expenses are greater than the amount of the
net loss. For example, if a net loss of P100,000 included amortization
and depreciation of P125,000 and no noncash revenues existed, cash
provided by operating activities would be P25,000, computed as
follows:
Net loss
Add: Expenses not requiring cash – depreciation
and amortization
Net cash provided by operating activities

P(100,000)
P

125,000
25,000

11. The change in cash is the difference between cash at the beginning and
end of the accounting period. The net amount of cash provided by or
used in operating, investing and financing activities must equal this
change in cash. For example, if cash increased by P150,000 during the
year, total sources from operating, investing, and financing activities
must exceed total uses by P150,000. Also, if cash decreased by
P25,000 during the year, total uses of cash must exceed total sources by
P25,000.
6-2

Cash Flow Analysis Chapter 6

12. (a) The use of cash does not occur until the cash dividend is actually
paid in the next period. The declaration of the dividend does affect
financial position, however, and should be disclosed as a noncash
financing activity in a separate schedule accompanying the
statement of cash flows.
(b) Because the dividend was declared and paid in the same accounting
period, it appears in the statement of cash flows as a cash decrease
in the financing activities category.
13. Disagree. The refunding of 10% debt by the 8% debt represents a
significant financing activity, even though the net impact of the
exchange on the balance sheet or on the amount of cash is not material.
The issuance of 8% bonds and the retirement of 10% bonds should be
reported as noncash financing transactions in a schedule accompanying
the statement of cash flows.
14. The net income figure includes P150,000 as an expense. Only
P112,500 of this amount resulted in a decrease in cash, because
P37,500 represents an increase in the deferred income tax liability
account. In determining cash provided by operating activities, the
amount of income tax paid is P112,500 (direct method). Alternatively,
under the indirect method, P37,500 must be added to net income to
determine cash flows from operating activities.
15. The loss is omitted when listing expenses requiring cash payment
(direct approach) or added back to net income (indirect approach) in
determining cash provided by operating activities. This eliminates the
impact of the transaction from cash provided by operating activities.
Then, the proceeds from the sale are included as a source of cash in the
investing activities category of the statement of cash flows. Any tax
effects of the transaction are included in the tax expense figure and

remain a part of cash flows from operating activities.

II. Problems
Problem 1
Transaction

Operating Investing Financing
6-3

Source

Use


Chapter 6 Cash Flow Analysis
1.

Short-term investment
securities were
purchased
....................................
2. Equipment was
purchased
....................................
3. Accounts payable
increased
....................................
4. Deferred taxes
decreased
....................................

5. Long-term bonds
were issued
....................................
6. Ordinary shares were
sold
....................................
7. Interest was paid to
long-term creditors
....................................
8. A long-term mortgage
was entirely paid off
....................................
9. A cash dividend was
declared and paid
....................................
10. Inventories decreased. .
11. Accounts receivable
increased
.....................................
12. Depreciation charges
totaled P200,000 for
the year
.....................................

X

X
X

X

X

X

X

X
X

X

X

X

X

X

X

X

X

X

X
X

X

X

X

X

Problem 2 (Analysis of Cash Flow Transactions)
Requirement (a)
The eight items should be presented in the statement of cash flows as
follows:
1. Net income is the basis for the calculation of cash flows from operating
activities by starting with that number and adjusting for noncash
revenue and expense transactions (indirect method) or by computing by
6-4


Cash Flow Analysis Chapter 6

2.

3.
4.
5.
6.
7.

8.

the direct method the positive cash flows from revenues, less the
negative cash flows from expenses. The cash flows from the
transaction giving rise to the extraordinary loss is reclassified as an
investing activity.
The acquisition of intangibles is a negative cash flow from investing
activities. The amortization is a noncash expense in determining cash
flows from operating activities.
The payment of a cash dividend is a negative cash flow that is
presented in the financing activities section of the statement.
The purchase of treasury stock is a negative cash flow in the financing
activities section of the statement.
The depreciation expense recognized during the year is a noncash
expense in determining cash flows from operating activities.
The conversion of convertible bonds into ordinary shares is a noncash
financing activity that requires disclosure in a separate schedule.
The changes in plant asset accounts – land, equipment, and building –
represent activities whose cash flow effects are presented in the
investing activities section of the statement.
The increase in working capital also represents the change in cash
because all other current assets and current liabilities remained
constant. The net of all cash flows from operating, investing and
financing activities must reconcile with the change in cash in the
statement of cash flows.

Requirement (b)
1. Net cash provided by operating activities
Net income
Noncash expense adjustments:
Depreciation expense

Amortization expense
Reclassification of extraordinary loss

P145,000
46,250
6,000
15,000
P212,250

2. Net cash used in investing activities
Purchase of intangible assets
Purchase of land
Purchase of equipment
Purchase of building
Sale of land
6-5

P (34,000)
(130,000)
(60,000)
(100,000)
165,000
P(159,000)


Chapter 6 Cash Flow Analysis

3. Net cash used in financing activities
Purchase of treasury stock
Payment of dividends

P(31,000)
(12,500)
P(43,500)

Computations:
Depreciation expense
Change in accumulated depreciation account
Accumulated depreciation on fully depreciated
assets disposed
Purchase of land
Change in land account
Cost of land sold in condemnation proceedings

P35,000
11,250
P46,250
P (50,000)
180,000
P130,000

Problem 3 (Cash Flow from Operating Activities)
Cash received from customers:
Total revenues
Less: Note receivable
Cash disbursed for expenses:
Total expenses (P173,000 + P4,200)
Less: Income taxes deferred
Depreciation
Amortization

Net cash provided by operating activities

P185,000
(15,000)
P177,200
(1,260)
(25,000)
(7,000)

P170,000

(143,940)
P 26,060

Problem 4 (Cash Flow from Operating Activities)
Cash received from customers (1)
Cash paid for expenses:
Cost of goods sold
Selling
Salaries and wages (2)
Interest (3)
Miscellaneous operating
Incomes taxes (4)
Net cash provided by operating activities
Computations:
6-6

P5,237,000
P3,150,000
246,000

394,400
65,200
5,000
335,000

4,195,600
P1,041,400


Cash Flow Analysis Chapter 6

1. Revenue from sales
Less: Note receivable
Land

P5,432,000
(120,000)
(75,000)
P5,237,000

2. Salaries and wages expense
Less: Increase in accrued salaries and wages
(P45,600 – P40,000)

P 400,000

3. Interest expense
Less: Discount amortization

P

(5,600)
P 394,400

P
4. Income tax expense
Less: Deferred portion

72,000
(6,800)
65,200

P 445,000
(110,000)
P 335,000

Problem 5 (Statement of Cash Flows Preparation – Indirect)
Green Tea Company
Statement of Cash Flows
For the Year Ended December 31, 2005
Cash flows from operating activities
Net income*
Adjustments to reconcile net income to net
cash flows provided by operating
activities:
Depreciation
Amortization of intangibles
Increase in current assets
Increase in current liabilities
Net cash provided by operating

activities
Cash flows from financing activities
Dividends paid
Retirement of long-term liabilities
*

Increase in retained earnings (P20,000 – P13,000)
Dividends declared
Net income
6-7

P8,500

1,000
1,000
(6,000)
3,000
P7,500

(1,500)
(1,000)
P7,000
1,500
P8,500


Chapter 6 Cash Flow Analysis

Net cash used in financing activities
Net increase in cash

Cash, January 1, 2005
Cash, December 31, 2005

(2,500)
P 5,000
10,000
P15,000

Problem 6 (Cash Flow Statement Preparation – Direct)
Requirement (a)
Hundred Acre Company
Statement of Cash Flows
For the Year Ended December 31, 2005
Cash flows from operating activities
Cash received from customers
Cash paid for expense
Net cash provided by operating
activities
Cash flow from investing activities
Sale of equipment
Sale of investments
Acquisition of equipment
Net cash used in investing activities
Cash flows from financing activities
Sale of ordinary shares
Payment of cash dividends
Net cash used in financing activities
Net increase in cash
Cash, January 1, 2005
Cash, December 31, 2005

Reconciliation of net income to net cash
provided by operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense
Amortization expense
Increase in accounts receivable
*

Net increase during 2005 (P33,600 – P27,100)
Accumulated depreciation on assets sold
Depreciation expense for 2005
6-8

P74,000
67,000
P7,000
9,500
15,000
(53,000)
(28,500)
40,000
(8,500)
31,500
P10,000
20,000
P30,000

P15,000

24,500*
1,000
(33,000)
P 6,500
18,000
P24,500


Cash Flow Analysis Chapter 6

Decrease in accrued expenses
Net cash provided by operating activities

(500)
P 7,000

Computations:
Cash received from customers:
Revenues
Deduct: Increase in accounts receivable
(P78,000 – P45,000)
Cash paid for expenses:
Expenses
Add: Decrease in accrued expenses
(P7,500 – P7,000)
Deduct: Depreciation expense
(P33,600 – P27,100 + P18,000)
Amortization
Cash from sale of equipment:
Cost

Deduct: Accumulated depreciation
Cash received on sale at book value
Cash paid to acquire equipment:
Increase in property, plant and equipment
(P118,100 – P92,600)
Cost of machinery sold

P107,000
33,000
P 74,000
P 92,000
500
(24,500)
(1,000)
P 67,000
P 27,500
(18,000)
P 9,500

P 25,500
27,500
P 53,000

Cash received on sale of stock:
Increase in ordinary shares amount
(P100,000 – P75,000)
Increase in additional paid-in capital account
(P55,000 – P40,000)

P 25,000

Cash dividends:
Increase in retained earnings (P21,000 – P14,500)
Net income (P107,000 – P92,000)

P

15,000
P 40,000
6,500
(15,000)
P 8,500

Requirement (b)
The reconciliation of net income to net cash provided by or used in
operating activities is required to be disclosed in order to show more
6-9


Chapter 6 Cash Flow Analysis

clearly the relationship and emphasize the differences between the two.
Users of financial statements are often not as aware of the accrual
concepts, which determine net income, as are preparers of those
statements. The reconciliation of net income to net cash flows from
operating activities clearly demonstrates that the two are different and
details those events and transactions that account for the difference.
Problem 7 (Interpretation of Cash Flow Statement)
Requirement (a)
The two companies are similar in the following respects:

1.
2.
3.
4.

Overall size.
Industry in which they operate.
Current ratio (2.4 to 1).
Overall peso amounts of cash provided and used:
Range, 2002-2005
Cash Provided
Cash Used
P125,000 – P168,000
P115,000 – P170,000
P135,000 – P160,000
P125,000 – P165,000

Ebony Company
Ivory Company

5. Net increase in working capital is identical for each year, 2002 –
2005.
Requirement (b)
The two companies are dissimilar in the makeup of the sources of cash, as
indicated in the following analysis:

2002
Ebon
Ivor
y

y
Cash provided:
Operations
Long-term debt
Share capital
Asset disposition

80
8
-12
100

37
56
-7
100

Sources of Cash in Percentages
2003
2004
Ebon
Ivor
Ebon
Ivor
y
y
y
y
77
-16

7
100

21
10
52
17
100

70
--30
100

(38)
44
63
31
100

2005
Ebon
Ivor
y
y
76
9
-15
100

7

-56
37
100

Ebony Company has relied much more heavily on operations to provide
cash and to a very limited extent on debt and equity financing and asset
6-10


Cash Flow Analysis Chapter 6

disposition. On the other hand, Ivory Company has not been able to
provide cash from operations and has been required to rely on the
alternatives of debt and equity financing and asset disposition.
Requirement (c)
Ebony Company is in a considerably stronger position (as determined by
the data given) and thus should be considered the better investment and
credit risk. The following points are significant:
1. Ebony Company has provided 70%-80% of its cash via operating
activities, supplementing with other means to maintain a current
ratio at the industry average. Ebony has not had to rely
consistently on any alternative source of funding.
2. Ivory Company has apparently been forced to rely continuously on
debt financing except in 2005, perhaps because of the inability to
obtain such financing. The year 2004 is particularly weak for
Ivory, with operations resulting in a P60,000 reduction in cash.
The ability of Ivory to sustain its present financial position (i.e.,
current ratio, etc.) is questionable in light of its history.
III. Multiple Choice Questions
1. D

2. C
3. D

4. D
5. B
6. D

7. C
8. B
9. A

6-11

10. B
11. A
12. D