MANAGEMENT ACCOUNTING - 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
businesss 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 companys day-to-day operating activities.

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Chapter 6 Cash Flow Analysis

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.
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 shares).
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 shares).
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
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Cash Flow Analysis Chapter 6

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.
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.
16. (1) Operating activities: Transactions that affect current assets, current
liabilities, or net income.

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Chapter 6 Cash Flow Analysis

(2) Investing activities: Transactions that involve the acquisition or

disposition of noncurrent assets.
(3) Financing activities: Transactions (other than the payment of interest)
involving borrowing from creditors, and any transactions (involving
the owners of a company.
17. Interest is included as an operating activity since it is part of net income.
Financing activities are narrowly defined to include only the principal
amount borrowed or repaid.
18. Since the entire proceeds from a sale of an asset (including any gain)
appear as a cash inflow from investing activities, the gain must be
deducted from net income to avoid double counting.
19. The direct method reconstructs the income statement on a cash basis by
restating revenues and expenses in terms of cash inflows and outflows.
The indirect method starts with net income and adjusts it to a cash basis to
determine the cash provided by operating activities.
20. An increase in the Accounts Receivable account must be deducted from
net income under the indirect method because this is an increase in a
noncash asset.
21. A decrease in the Accounts Payable account must be added to cost of
goods sold under the direct method. The cost of goods sold is increased by
the amount of the decrease in accounts payable. Because the cost of goods
sold is increased, the net cash flow provided by operating activities is
decreased. The effect of a decrease in a liability is a decrease in cash.
22. A sale of equipment for cash would be classified as an investing activity.
Any transaction involving the acquisition or disposition of noncurrent
assets is classified as an investing activity.

II. Exercises
Exercise 1
Net income......................................................................................................................
P84,000
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Cash Flow Analysis Chapter 6

Adjustments to convert net income to a cash basis:
Depreciation charges for the year..............................................................................
P50,000
Increase in accounts receivable..................................................................................
(60,000)
Increase in inventory..................................................................................................
(77,000)
Decrease in prepaid expenses....................................................................................
2,000
Increase in accounts payable......................................................................................
30,000
Decrease in accrued liabilities...................................................................................
(4,000)
Increase in deferred income taxes.............................................................................
6,000
(53,000)
Net cash provided by operating activities......................................................................
P31,000

Exercise 2
Sales.................................................................................................
P1,000,000
Adjustments to a cash basis:
60,000
Less increase in accounts receivable..........................................
P940,000
Cost of goods sold.............................................................................
580,000
Adjustments to a cash basis:
+ 77,000
Plus increase in inventory..........................................................
30,000
Less increase in accounts payable.............................................
627,000
Selling and administrative expenses..................................................
300,000
Adjustments to a cash basis:
2,000
Less decrease in prepaid expenses.............................................
+ 4,000
Plus decrease in accrued liabilities............................................
50,000
Less depreciation charges..........................................................
252,000
Income taxes.....................................................................................
36,000
Adjustments to a cash basis:
6,000
Less increase in deferred income taxes......................................

30,000

Net cash provided by operating activities..........................................P31,000

Note that the P31,000 agrees with the cash provided by operating activities
figure under the indirect method in the previous exercise.
Exercise 3
Item
Amount
Accounts Receivable.........................................
P70,000 decrease
Accrued Interest Receivable..............................
P6,000 increase
Inventory..........................................................
P110,000 increase
Prepaid Expenses..............................................
P3,000 decrease
Accounts Payable.............................................
P40,000 decrease
Accrued Liabilities............................................
P9,000 increase
6-5

Add
X

Deduct
X
X

X
X
X

Chapter 6 Cash Flow Analysis

Deferred Income Taxes Liability.......................

P15,000 increase
Sale of equipment.............................................
P8,000 gain
Sale of long-term investments...........................
P12,000 loss

X
X
X

Exercise 4
Requirement (1)
Net income................................................................................................. P75
Adjustments to convert net income to a cash basis:
Depreciation charges..............................................................................
P40
Decrease in accounts receivable..............................................................
10
Increase in inventory...............................................................................
(30)
Decrease in prepaid expenses.................................................................
5
Increase in accounts payable..................................................................
20
Decrease in accrued liabilities.................................................................
(10)
Increase in taxes payable........................................................................
10
Increase in deferred taxes.......................................................................
5
Loss on sale of long-term investments....................................................
5
Gain on sale of land................................................................................
(40)
15
Net cash provided by operating activities................................................... P90

Requirement (2)
Swan Company
Statement of Cash Flows
Operating activities:
P90
Net cash provided by operating activities (see above)..........................................
Investing activities:
P45
Proceeds from sale of long-term investments........................................................
Proceeds from sale of land...................................................................................
70
Additions to long-term investments......................................................................
(20)
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Cash Flow Analysis Chapter 6

Additions to plant & equipment...........................................................................

(150)
Net cash used for investing activities...................................................................
(55)
Financing activities:
Decrease in bonds payable...................................................................................
(20)
Increase in ordinary shares...................................................................................
40
Cash dividends.....................................................................................................
(35)
Net cash used by financing activities....................................................................
(15)
Net increase in cash (net cash flow).....................................................................
20
Cash balance, beginning.......................................................................................
100
Cash balance, ending...........................................................................................
P120
While not a requirement, a worksheet may be helpful.

Change

Assets (except cash and cash equivalents)

Current assets:
Accounts receivable................................................
10
Inventory.................................................................
+30
Prepaid expenses....................................................
5
Noncurrent assets:
Long-term investments............................................
30
Plant and equipment...............................................
+150
Land........................................................................
30
Liabilities, Contra assets, and Shareholders Equity
Contra assets:
Accumulated depreciation.......................................
+40
Current liabilities:
Accounts payable....................................................
+20
Accrued liabilities....................................................
10
Taxes payable.........................................................
+10
Noncurrent liabilities:
Bonds payable........................................................
20
Deferred income taxes............................................+5
Shareholders equity:
Ordinary shares.......................................................
+40
Retained earnings:
Net income.........................................................
+75
Dividends...........................................................
35
Additional entries
Proceeds from sale of investments..............................

6-7

Source Cash
or
Flow AdjustUse? Effect ments

Source +10
Use 30
Source +5

Adjusted
Effect

Classification

+10
30
+5

Operating
Operating
Operating

50

20

Investing

30

150
0

Investing
Investing

Source +40

+40

Operating

Source +20
Use 10
Source +10

+20
10
+10

Operating
Operating
Operating

Use 20
Source +5

20
+5

Financing
Operating

Source +40

+40

Financing

Source +75
Use 35

+75
35

Operating
Financing

+45

Investing

Source +30

Use 150
Source +30

+45

Chapter 6 Cash Flow Analysis

Loss on sale of investments.........................................
Proceeds from sale of land...........................................
Gain on sale of land.....................................................
Total

+20

+5
+70
40
0

+5
+70
40
+20

Operating
Investing
Operating

Exercise 5
Sales...........................................................................................
P600
Adjustments to a cash basis:
Decrease in accounts receivable..........................................+10
Cost of goods sold......................................................................250
Adjustments to a cash basis:
Increase in inventory...........................................................+30
Increase in accounts payable...............................................20
Selling and administrative expenses............................................280
Adjustments to a cash basis:
Decrease in prepaid expenses.............................................. 5
Decrease in accrued liabilities.............................................+10
Depreciation charges...........................................................40
Income taxes............................................................................... 30
Adjustments to a cash basis:
Increase in taxes payable....................................................10
Increase in deferred taxes.................................................... 5
Net cash provided by operating activities...................................
Exercise 6

P610

260

245

15
P90

Requirements (1) and (2)

Stephenie Company
Statement of Cash Flows
For the Year Ended December 31, 2008
Operating activities:
Net income..............................................................................................P56
Adjustments to convert net income to cash basis:
Depreciation charges.......................................................................
25
Increase in accounts receivable........................................................
(80)
Decrease in inventory......................................................................
35
Increase in prepaid expenses............................................................
(2)
Increase in accounts payable...........................................................
75
Decrease in accrued liabilities..........................................................
(10)
Gain on sale of investments.............................................................
(5)
Loss on sale of equipment................................................................
2
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Cash Flow Analysis Chapter 6

Increase in deferred income taxes....................................................

8
48
Net cash provided by operating activities................................................ 104
Investing activities:
Proceeds from sale of long-term investments...........................................
12
Proceeds from sale of equipment.............................................................
18
Additions to plant and equipment............................................................
(110)
Net cash used for investing activities....................................................... (80)
Financing activities:
Increase in bonds payable........................................................................
25
Decrease in ordinary shares.....................................................................
(40)
Cash dividends........................................................................................
(16)
Net cash used for financing activities...................................................... (31)
Net decrease in cash................................................................................ (7)
Cash balance, January 1, 2008................................................................ 11
Cash balance, December 31, 2008..........................................................P4
While not a requirement, a worksheet may be helpful.

Change

Sourc
e or
Use?

Assets (except cash and cash equivalents)

Current assets:
Accounts receivable................................................
+80
Use
Inventory.................................................................
35
Source
Prepaid expenses....................................................
+2
Use
Noncurrent assets:
Plant and equipment...............................................
+80
Use
Long-term investments............................................
7
Source
Liabilities, Contra assets, and Shareholders Equity
Contra assets:
Accumulated depreciation.......................................
+15
Current liabilities:
Accounts payable....................................................
+75
Accrued liabilities....................................................
10
Noncurrent liabilities:
Bonds payable........................................................
+25
Deferred income taxes............................................
+8
Shareholders equity:
Ordinary shares.......................................................
40
Retained earnings:
Net income.........................................................
+56
Dividends...........................................................
16

6-9

Cash
Flow
Effect

Adjust
-ments

80
+35
2

Adjuste
d Effect

Classification

80
+35
2

Operating
Operating
Operating

80
+7

30
7

110
0

Investing
Investing

Source

+15

+10

+25

Operating

Source
Use

+75
10

+75
10

Operating
Operating

Source
Source

+25
+8

+25
+8

Financing
Operating

Use

40

40

Financing

Source
Use

+56
16

+56
16

Operating
Financing

Chapter 6 Cash Flow Analysis

Additional entries
Proceeds from sale of equipment.................................
Loss on sale of equipment............................................
Proceeds from sale of long-term
investments.............................................................
Gain on sale of long-term investments.........................
7

Total

+18
+2

+18
+2

Investing
Operating

+12
5

+12
5

Investing
Operating

II. Problems
Problem 1
1.

2.
3.
4.
5.
6.
7.
8.

Transaction
Operating Investing Financing
Short-term investment
securities were
purchased
X
.....................................
Equipment was
purchased
X
.....................................
Accounts payable
increased
X
.....................................
Deferred taxes
decreased
X
.....................................
Long-term bonds were
issued
X
.....................................
Ordinary shares were
sold
X
.....................................
Interest was paid to
long-term creditors
X
.....................................
A long-term mortgage
was entirely paid off
X
.....................................
6-10

Source

Use
X
X

X
X
X
X
X
X

Cash Flow Analysis Chapter 6

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

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 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.
2. 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.
3. The payment of a cash dividend is a negative cash flow that is presented
in the financing activities section of the statement.
4. The purchase of treasury share is a negative cash flow in the financing
activities section of the statement.
5. The depreciation expense recognized during the year is a noncash expense
in determining cash flows from operating activities.
6. The conversion of convertible bonds into ordinary shares is a noncash
financing activity that requires disclosure in a separate schedule.
7. 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.
8. 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.
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Chapter 6 Cash Flow Analysis

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

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

3. Net cash used in financing activities

Purchase of treasury shares
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
6-12

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

P170,000

Cash Flow Analysis Chapter 6

Depreciation
Amortization
Net cash provided by operating activities

(25,000)
(7,000)

(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:

P5,237,000
P3,150,000
246,000
394,400
65,200
5,000
335,000

4,195,600
P1,041,400

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

(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*
6-13

P8,500

Chapter 6 Cash Flow Analysis

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
Net cash used in financing activities
Net increase in cash
Cash, January 1, 2005
Cash, December 31, 2005

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

Increase in retained earnings (P20,000 P13,000)

Dividends declared
Net income
6-14

P74,000
67,000
P7,000
9,500
15,000
(53,000)
(28,500)
40,000
(8,500)
31,500
P10,000
20,000
P7,000
1,500
P8,500

Cash Flow Analysis Chapter 6

Cash, December 31, 2005

P30,000

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
Decrease in accrued expenses
Net cash provided by operating activities

P15,000
24,500*
1,000
(33,000)
(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 shares:

Increase in ordinary shares amount
*

Net increase during 2005 (P33,600 P27,100)

Accumulated depreciation on assets sold
Depreciation expense for 2005
6-15

P 6,500
18,000
P24,500

Chapter 6 Cash Flow Analysis

(P100,000 P75,000)
Increase in additional paid-in capital account
(P55,000 P40,000)
Cash dividends:
Increase in retained earnings (P21,000 P14,500)
Net income (P107,000 P92,000)

P 25,000
15,000
P 40,000
P

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 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:

Ebony Company
Ivory Company

Range, 2002-2005
Cash Provided
Cash Used
P125,000 P168,000
P115,000 P170,000
P135,000 P160,000
P125,000 P165,000

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:
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Cash Flow Analysis Chapter 6

2002
Ebony Ivory
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
Ebony Ivory Ebony Ivory
77
-16
7
100

21
10
52
17
100

70
--30
100

2005
Ebony Ivory

(38)
44
63
31
100

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 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

6-17

10. B
11. A
12. D