Accounting Chapter 12 Homework The Direct method Determines All Operating Cash Inflows And Outflows And Then subtracts Total

Company Analysis — AA 12-1 (15 minutes)

1. Indirect Method

Explanation: We readily know this because the operating activity section of

the cash flow statement starts with net income, and makes adjustments for

items such as depreciation and changes in current operating assets and

liabilities.

2. Apple’s cash flows from operating activities and cash dividends paid are

shown in the table below.

$ millions

2017

2016

2015

3. Yes, Apple has Sufficient Cash from Operations for Dividends

Explanation: Apple’s cash flows from operating activities markedly

exceeded its cash dividends paid—see part 2 numbers.

4. More Cash Spent toward Repurchase of Common Stock

Comparative Analysis — AA 12-2 (25 minutes)

1. Apple’s cash flow on total assets ratio ($ millions)

Current Year = Operating cash flows/Average total assets

= $63,598 / [($375,319 + $321,686)/2]

= $63,598 / $348,503 = 18.2%

Prior Year = Operating cash flows/Average total assets

= $65,824 / [($321,686 + $290,345)/2]

= $65,824 / $306,016 = 21.5%

Google’s cash flow on total assets ratio ($ millions)

2. Google

Explanation: In the current year, Google has a higher cash flow on total

assets ratio than Apple—see part 1 results.

3. a. Outperform

Explanation: In the current year, Apple has a higher cash flow on total

assets ratio than the industry average—see part 1 results.

Global Analysis — AA 12–3 (35 minutes)

1. Samsung’s cash flow on total assets ratio follows (in KRW millions).

Current Year = Operating cash flows / Average total assets

= ₩62,162,041 / [(₩301,752,090 + ₩262,174,324)/2]

= ₩62,162,041 / ₩281,963,207 = 22.0%

3. a. Better than Apple

Explanation: Samsung’s cash flow on total assets ratio is better than

Apple’s ratio of 18.2%. (Computations in AA 12-2)

Ethics Challenge — BTN 12-1

1. The business actions available include

a. Encourage early collection of receivables to reduce the accounts

receivable balance.

Many other business actions are possible that would accelerate cash

receipts and/or delay cash payments.

2. As a business owner, Katie Murphy certainly can exercise discretion over

business actions. However, the underlying economic realities should

support any proposed actions. It is not ethical to pursue actions that

purposely mislead users of financial statements.

Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 12

Communicating in Practice — BTN 12-2

Here is a sample of what the body of the memorandum might include:

TO: Diana Wood

FROM: (Your Name)

SUBJECT: Statement of Cash Flows

DATE: _________________

I am pleased to hear your business is more profitable this year than last.

However, I have been thinking about what you said regarding the statement of

cash flows and have some thoughts as to why you found it confusing.

inventory, wages, interest, and taxes. It will determine your net operating

cash flow by directly subtracting the total of these operating outflows from the

inflows. You should find this format more understandable.

Note that good cash management is essential to business success and

growth. The statement of cash flows will provide you with a lot more

information regarding your cash than a balance sheet can offer. It will allow

you to see exactly where your cash came from, where it went, and how much

it changed. It organizes these amounts into categories of operating,

financing, and investing. This organization of cash information will allow you

to better project and plan for the future.

Please reconsider the value of the statement of cash flows for your business

decisions. If you wish to discuss this further, please call me.

Taking It to the Net — BTN 12-3

1. Mendocino Brewing Company uses the indirect method to construct the

consolidated statement of cash flows.

3. The following table shows the net income (or net loss) and the cash flows

from operations for Mendocino Brewing for 2014 and 2015. Over this two-

year period, Mendocino has generated consistently positive cash flows

from operations (relative to its net income); indeed, the company reported

a net loss in 2014 and 2015 while at the same time its operating cash flows

were positive.

2014

2015

4. For the recent period, the largest cash outflow for investing was $642,400

for purchases of property, equipment and leasehold improvements.

For the recent period, the largest cash outflow for financing was $534,700

for repayment on long-term debts.

Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 12

Teamwork in Action — BTN 12-4

Part 1

a. The reporting objective of the statement of cash flows is to provide

information about important cash inflows and outflows for business

decision makers. It answers specific questions such as:

• How does a company obtain its cash?

• Where does a company spend its cash?

• What is the change in the cash balance?

b. The statement can be prepared using the direct method or the indirect

method for reporting cash flows from operating activities.

Similarities

• Both methods report the same net cash flow from operating activities.

• Both methods classify cash flows into operating, financing, and

investing categories.

Differences

• Cash flow from operating activities is determined differently. The direct

method determines all operating cash inflows and outflows, and then

subtracts total operating outflows from inflows. The indirect method

starts with net income and applies a series of adjustments to reconcile

Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 12

Teamwork in Action (Continued)

c. Steps to prepare the statement of cash flows:

(i) Compute the net increase or decrease in cash using comparative

balance sheet data. This is the target number or the number the

statement will explain and prove.

(ii) Compute net cash flow in operating activities using the direct or

indirect method.

d. Common analyses made from information in the statement of cash flows

include assessing a company’s:

• Ability to generate future cash flows.

• Ability to pay dividends.

• Ability to meet obligations.

• Ability to expand operations.

• Ability to obtain financing.

• Cash flow on total assets ratio.

• Sources and uses of cash flows.

Part 2

Adjusting Net Income to Cash Flow from Operating Activities

Items to Add

Items to Subtract

Wild and Shaw, Financial & Managerial Accounting, 8e Solutions Manual: Chapter 12

Teamwork in Action (Concluded)

Part 3

a. Cash receipts from customers = Sales – Increase in Accounts Receivable,

or, + Decrease in Accounts Receivable.

Explanation: Sales reflects what is earned during the period. If Accounts

Receivable increases, that increase represents earnings not yet collected,

so we subtract it. If Accounts Receivable decreases, the entity collected

that much more than the period’s sales, so we add it.

b. Cash paid for inventory requires a two-step computation.

(1) Purchases = Cost of goods sold + Increase in inventory, or, – Decrease

c. Cash paid for wages and operating expenses = Wages and other operating

expenses [+ Increase in prepaid expenses, or, – Decrease in prepaid

expenses] and [+ Decrease in accrued liabilities, or, – Increase in accrued

liabilities].

Explanation: If prepaid expenses increase, the entity paid for more than

was incurred, so we add it. If prepaid expenses decrease, the entity paid

for less than was incurred, so we subtract it. Also, if the accrued liabilities

increase, the expense includes an amount not yet paid for, so we subtract

it. If the accrued liabilities decrease, the entity paid for more than the

period’s expenses, so we add it.

Entrepreneurial Decision — BTN 12-5

1. It is common for businesses to pay cash in advance for items such as rent,

advertising, supplies, and facilities expansion. Consequently, those costs are

usually recorded before revenues are earned, and before those revenues are

ultimately collected in cash. If the business does not carefully plan, it is

possible that it could show a positive net income, but not be able to effectively

operate because it has little or no cash to pay its suppliers, creditors, and

others to whom it owes money.

2. It can potentially raise cash financing for expansion by selling shares in the

company or by borrowing money. Moreover, potential lenders will want to

evaluate the future profitability, cash flows, and solvency of the company

before lending money.

Entrepreneurial Decision — BTN 12-6

Memorandum

To: Jenna and Matt Wilder

From: Your name

Subject: Performance evaluation of Mountain High

Date: Current Date

I have completed my evaluation of your company, Mountain High. My conclusion

is that Mountain High is performing well. This is in spite of its reported net loss

and its negative net cash flow, which I explain in this memorandum.

First, with respect to the net loss, please note that it includes an $85,000 unusual

loss. Absent this unusual loss, Mountain High would report a $75,000 net income.

Using year-end total assets, Mountain High’s return on assets would be roughly

9.4% (computed as $75,000 divided by $800,000). This return is reasonable for a

company in its second year of operations.

Hitting the Road — BTN 12-7

1. The Motley Fool’s Website defines cash flow as earnings before interest,

taxes, depreciation, and amortization (EBITDA). The justification for this

definition includes: “Interest income and expense, as well as taxes, are all tossed

aside because cash flow is designed to focus on the operating business and not

secondary costs or profits… As for depreciation and amortization, these are called

non-cash charges, as the company is not actually spending any money on them.

2. Some analysts tend to focus on this particular earnings definition

(earnings before interest and taxes or EBIT) as it purportedly allows a

focus on a company’s real operating situation. For example, taxes can

depend on laws and can fluctuate from year to year. By using the