Reporting and Interpreting Cash Flows Answers

QUESTION 1 (19 MARKS)

Karou Corp.
Statement of Cash Flows
For the year ended December 31, 2011

Operating activities
Profit $96
Add (deduct) items not affecting cash :
Depreciation expense 69

Gain on sale of equipment (6)

Increase in non-cash working capital items (48)
Cash from operating activities $111
Investing activities
Purchase of equipment (Note 1) (90) See details below
Sale of equipment (Note 2) 16 See details below
Cash used in investing activities (74)
Financing activities
Repayment of bonds (Note 3) (10) See details below
Issuance of common shares 40
See details below
Payment of dividends (Note 4) (64)
Cash used in financing activities (34)
Increase in cash during 2011 3
Cash balance, December 31, 2010 94
Cash balance, December 31, 2011 $97

Note: Bonds payable of $20 million were converted to common shares during 2011.

Note 1: Increase in PP&E = Purchase of equipment – Cost of equipment sold

$420 – $370 = Purchase – $40 ==> Purchase = $50 + $40 = $90

Or, Beg Equip + Purchase-Sale of Equip = Ending Equip

Note 2: Cash received = Carrying amount + gain = $10 + 6 = $16.

Note 3: Decrease in bonds payable = conversion of bonds to shares + repayment of bonds

$120 – $90 = $20 + repayment ==> Repayment = $30 – $20 = $10

Or, Beg Balance of Bonds Payable +New Issue- Repayment- conversion of bonds to shares=Ending Bonds
Payable

Note 4: Increase in retained earnings = Profit – dividends declared

$223 – $191 = $96 – dividends ==> Dividends = $96 – $32 = $64
Req. 2
a) Cash collected from customers = $970 – ($32 – $26) = $964
Sales + Beg A/C Receivable-Cash Collection from Customers= Ending A/C Receivable

b) Purchases = $135 + $550 – $90 = $595

Beg Inv+ Purchase-Ending Inventory= Costs of Goods Sold
Payments = $35 + $595 – $31 = $599
Beg A/P +Purchase-Cash Paid to suppliers= Ending A/P
c) Cash paid = $6 – ($3 – $2) = $5
Beg Int Payable – cash payment of Interest = End Int Payable

Question 2 (19 marks)

Req. a (2.5 marks)

Cash paid for rent = Rent expense – decrease in Prepaid rent – Increase in Rent payable
= $16,000 – ($7,000 – 0) – ($4,000 – 0) = $5,000.

Req. b (3 marks)

Cash paid to suppliers = Cost of goods sold – decrease in Inventory + decrease in Trade payables
= $293,000 + $25,000 – $36,000 + $61,000 – $32,000 = $311,000.

Req. c (1.5 marks)

Cash collected from customers = Sales revenue + decrease in Trade receivables

= ($444,000 + $293,000) + $125,000 – $110,000 = $752,000.

Req. d

Drapeau Corp.
Statement of Cash Flows
For the Year ended December 31, 2011
Operating activities
Profit $22,000
Add (deduct) items not affecting cash:
Depreciation expense 27,000
Gain on sale of land (2,000)
Loss on sale of equipment 4,000
Decrease in trade receivables 15,000
Decrease in merchandise inventory 11,000
Decrease in prepaid rent 7,000
Decrease in trade payables (29,000)
Increase in rent payable 4,000
Cash from operating activities $59,000
Investing activities
Acquisition of equipment (142,000)
Sale of land (Note 1) 11,000
Sale of equipment (Note 2) 30,000
Cash from (used in) investing activities (101,000)
Financing activities
Issuance of common shares for cash (Note 3) 84,000
Payment of dividends (Note 4) (7,000)
Cash from financing activities 77,000
Increase in cash 35,000
Cash balance, December 31, 2010 12,000
Cash balance, December 31, 2011 $47,000

Notes:
1. Cash received = Cost of land sold + Gain = ($38,000 – $29,000) + $2,000 = $11,000.

2. Cost of equipment sold = Beginning balance + Purchase of equipment – Ending balance

= $600,000 + $142,000 – $690,000 = $52,000.

Accumulated depreciation = Beginning balance + Depreciation expense – Ending Balance

= $215,000 + $27,000 – $224,000 = $18,000.

Proceeds from sale of equipment = Carrying amount – Loss on sale

= ($52,000 – $18,000) – $4,000 = $30,000.
3. Issuance of common shares = Increase of Common shares – Issuance of shares on conversion of
bonds
= ($201,000– $42,000) – $75,000 = $84,000.

4. Dividends declared = Beg. Retained earnings + Profit – End. Retained earnings

= $380,000 + $22,000 – $395,000 = $7,000.
 In the absence of a Dividends Payable account, the dividends declared were paid during the
year.

Note X -- Significant non-cash financing activity

During 2011 common shares were issued in exchange for bonds payable with a face value of
$75,000.

Req. e (2 marks)

Quality of earnings = Cash flow from operations / Profit = $59,000 / $22,000 = 2.68

The quality of earnings ratio measures the portion of earnings that was generated in cash. A ratio that
is higher than 1 indicates higher-quality earnings because each dollar of profit is supported by at least
one dollar of cash from operations.

QUESTION 3 (23 marks):

Req. 1 (5 marks)
KITCHENWARE INC.
Statement of Cash Flows
For the Year Ended December 31, 2010

Cash flows from operating activities:

Profit .....................................................................................................................
$12,000
Add (deduct) items not affecting cash:
Depreciation expense ....................................................................................... 15,200
Loss on sale of furniture .................................................................................... 1,200
Gain on sale of investment ................................................................................ (800)
Increase in trade receivables ............................................................................ (45,700)
Decrease in inventories ..................................................................................... 20,000
Increase in trade payables ................................................................................ 3,900
Net cash flow from operating activities ....................................................... $ 5,800

Req. 2 (5 marks)
a.
Trade receivables, beginning $10,600
+ Sales revenue 980,000
– Cash collections from customers ( X ) [X = $934,300]
= Trade receivables, ending $ 56,300
b. The computation of the cash paid to suppliers is a two-step process.
 Inventories, beginning $ 30,000
+ Merchandise purchases X [X = $620,000]
– Cost of sales (640,000)
= Inventories, ending $ 10,000

Trade payables, beginning $ 13,100

+ Merchandise purchases 620,000
[Y = $616,100]
– Cash payments to suppliers ( Y )
= Trade payables, ending $ 17,000

c. Loss on sale = Cash received – Carrying amount of furniture sold

– $1,200 = X – ($5,000 – $3,200) → Cash received = $600

Req. 3 (5 marks)
Cash flows from investing activities:
Sale of furniture (amount determined in req. 2 above) $ 600
Purchase of furniture (note 1) (38,000))
Sale of investments ($1,000 change in balance + $800 gain) 1,800
Net cash flow used for investing activities $(35,600)
Note 1:
Cost of furniture, January 1, 2011 $26,000
+ Purchases during the year X
– Cost of furniture disposed of (5,000)
= Cost of furniture, December 31, 2011 $59,000
Purchases (X) = $38,000

Req. 4 (5 marks)
a.
Quality of earnings ratio = Cash flow from operations = $5,800 = 0.48
Profit $12,000
The quality of earnings ratio measures the portion of profit that was generated
in cash. This ratio helps establish whether there are significant differences between profit and
operating cash flows. In this case, the large increase in Trade receivables, which reflects sales
on account, reduced the amount of cash from operations. (1 mark)
b. Free cash flow = Cash flow from operations – Dividends paid – Capital expenditures
= $5,800 – ($18,000 + 600)* – $38,000 = –$50,200.
* Beginning RE + Profit – Dividends Declared = Ending RE
$25,300 + 12,000 – X = 19,300 ➔ X = $18,000
The decrease in Dividends Payable should be added to the Dividends declared to get the
amount of dividends paid.
Free cash flow represents the amount of cash that is available for additional capital
expenditures, investments in other companies, and mergers and acquisitions, without the need
for external financing. In this case, the operating activities did not generate sufficient cash to
cover dividends and capital expenditures. (1 mark)

Req. 5 (3 marks)
As a professional accountant, I need to ensure that the proposed change is justified based on
the available evidence. It should be consistent with IFRS. The proposed change would be
acceptable if the original estimate of the useful life of these assets was understated or if regular
maintenance or improvements increased the assets’ useful life. However, if the proposed
change is to improve the company’s financial performance without valid justification, I would
point out to Ms. Wong that such a change is not appropriate. It should be noted that the
proposed change would increase profit but not affect cash flow.

Dividends declared = Beg. Retained earnings + Profit – End. Retained earnings

= $380,000 + $22,000 – $395,000 = $7,000.
In the absence of a Dividends Payable account, the dividends declared were paid during the
year.