Tutorial 5 – Chapter 5 Solutions

P5–3
Req. 1
MIKOS INC.
Statement of Cash Flows
For the Year Ended December 31, 2021

Cash flows from operating activities:

Net earnings $105,000
Adjustments to reconcile net earnings to net cash provided
by operating activities:
Depreciation and amortization expense ($33,000 + $4,000) 37,000
Increase in accounts receivable (42,000)
Increase in inventories (14,000)
Decrease in prepaid expenses 2,000
Decrease in accounts payable (23,000)
Increase in income tax payable 5,000
Increase in accrued liabilities 10,000
Net cash flow from operating activities $80,000
Cash flows from investing activities:
Sale of land 25,000
Purchase of equipment. (166,000)
Sale of equipment (note 1) 32,000
Net cash flow used for investing activities (109,000)
Cash flows from financing activities:
Repayment of long-term note (note 2) (10,000)
Issuance of common shares ($140,000 – $30,000) 110,000
Payment of cash dividends ($105,000 + $135,000 – $186,000) (54,000)
Net cash flow from financing activities 46,000
Net increase in cash and short-term investments (note 3) 17,000
Cash and short-term investments, beginning of year 37,000
Cash and short-term investments, end of year $54,000

Note 1:
Increase in building and equipment, net = acquisitions – disposals – depreciation expense
$101,000 = $166,000 – disposals – $33,000
Disposals at book value = $32,000
Note 2:
The conversion of long-term notes to shares is a non-cash transaction that is reported separately in a
note.

Note 3:
Since short-term investments will mature in February 2022, they are considered cash equivalents.
P5–3 (continued)

Req. 2

The statement of cash flows shows that the company generated $80,000 from operations. It
used $166,000 to invest in equipment and disposed of land and old equipment for a total of
$57,000. The cash flow from operations was not sufficient to pay for the net investment in
equipment. To help pay for the new equipment, the company issued shares to investors for a
total $110,000 in cash. The cash inflow helped the company pay $54,000 in dividends.

Mikos Inc. is a profitable business as evidenced by the reported net earnings, and net cash flow
from operations. Given this expansion and the payment of dividends, the company’s free cash
flow is negative (= $80,000 – $109,000 – $54,000 = –$83,000). It seems that the company does
not have financial flexibility. It is unlikely that the company will increase its long-term assets
significantly in the next few years, so it will not require significant amounts of cash for investing
activities. A successful expansion of operations that leads to positive cash flow from operations
will help the company repay any loans.

In addition to analyzing the statement of cash flows, the bank loan officer is likely to consider
the company’s future plans and a projection of future cash flows before deciding on lending the
company the requested amount. The bank officer may also be concerned that the company
paid out just over 50% of its income in dividends.

Req. 3

Both the statement of financial position and statement of earnings provide useful information
about the financial condition and profitability of the company. But neither statement shows
how much cash the company was able to generate from its operations, which is vital if the
company is to continue to operate for the long run. The statement of cash flows shows how the
company manages its inflows and outflows of cash, so that it has enough cash to pay its bills,
finance its growth, and keep borrowing under control. Furthermore, the statement of cash
flows provides information about the financing and investing activities that is not available in
the statement of earnings.
P5–5

Req. 1
LAPORTE INC.
Statement of Cash Flows (Partial)
For the Year Ended December 31, 2020
Cash flows from operating activities:
Net earnings $12
Add (deduct) items not affecting cash:
Depreciation expense 10
Gain on sale of investments (6)
Loss on sale of equipment 2
Increase in accounts receivable (10)
Decrease in merchandise inventory 4
Decrease in accounts payable (14)
Decrease in income taxes payable (1)
Net cash used for operating activities $(3)

P5–5 (continued)

Req. 2
LAPORTE INC.
Statement of Cash Flows (Partial)
For the Year Ended December 31, 2020

Cash flows from investing activities:

Purchase of equipment (notes 1 and 4) $(22)
Sale of equipment (note 2) 10
Sale of long-term investment (note 3) 24
Net cash flow from investing activities $12

Notes:
1. Beg. Balance of Property, Plant and Equipment $154
Cost of equipment sold (40)
Purchase of building 60
Purchase of equipment X → X = $22
Ending balance, Property, Plant and Equipment $196
2. Loss on sale = Cash received – Carrying amount of equipment sold
–2 = X – ($40 – $28) → X = $10
3. Gain on sale = Cash received – Cost of investment
6 = X – ($18 – $0) → X = $24
4. The company purchased a new building in exchange for a five-year note for $60.
Req. 3
a.

Cash flow from operations –$3

Quality of earnings ratio = = = – 0.25
Net earnings $12

The quality of earnings ratio measures the portion of earnings that was generated in cash. This
ratio helps establish whether there are significant differences between net earnings and
operating cash flows. In this case, operating cash flows are negative. The difference between
the two amounts is due primarily to depreciation expense, sales that have not been collected,
and payment to suppliers of goods and services a larger amount than the amount of expenses
recognized during the year.
P5–5 (continued)

b.

Cash flow from operations –$3

Capital expenditures ratio = = = –0.14
Cash paid for capital expenditures $22

The capital expenditures ratio reflects the company's ability to finance the acquisition of
property, plant and equipment from operating cash flows. In this case, cash from operations
was negative and the company financed the acquisition of equipment through long-term
borrowings.

c. Free cash flow = Cash flow from operations – Dividends paid – Capital expenditures
= – $3 – $2* – $22 = – $27.

* Beginning Retained earnings ($38) + Net earnings ($12) – Dividends declared (X)
= Ending Retained earnings ($48) → Dividends declared = $2.

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 company’s operations required the use of cash instead
of generating cash from operations.

Req. 4
Change in Cash = Cash from operating activities
+ Cash from investing activities
+ Cash from financing activities

($90 – $68) = –$3 +$12 + Y = $22; Cash flow from financing activities = $13

Req. 5

(a) Cash collected from customers = Sales revenue – Increase in accounts receivable
= $140 – $10 = $130.

(b) Cash paid to suppliers of merchandise inventory

Purchases = Cost of sales – Decrease in merchandise inventory = $84 – ($32 – $28) = $80

Payments to suppliers = Purchases + Decrease in accounts payable = $80 + ($38 – $24) = $94

(c) Payment for taxes = Income tax expense + Decrease in income taxes payable
= $4 + ($4 – $3) = $5
P5–9

Req.1

Panel A: Changes in Cash Account

Cash (A)
Operating
(1) Net earnings 7,000 3,000 (4) Inventory
(2) Depreciation 4,000
(3) Accounts receivable 2,000
(5) Accounts payable 6,000
(6) Wages payable 500
Net cash flow provided by operating
activities 16,500
Investing
12,000 (7) Purchased property and equipment
12,000 Net cash used in investing activities
Financing
(9) Proceeds from issuance of shares 18,500 6,000 (8) Payment of long-term note
2,000 (10) Payment of dividends
Net cash flow provided by financing
activities 10,500
Net increase in cash and cash equivalents 15,000

Panel B: Changes in Non-cash Accounts

Accounts Receivable (A) Inventory (A)
Beg. bal. 28,000 Beg. bal. 36,000
(3) Decrease 2,000 (4) Increase 3,000
End. bal. 26,000 End. bal. 39,000

Accounts Payable (L) Wages Payable (L)

Beg. bal. 21,000 Beg. bal. 1,000
(5) Increase 6,000 (6) Increase 500
End. bal. 27,000 End. bal. 1,500

Property and Equipment - net (A) Note Payable - Long-Term (L)

Beg. bal. 72,000 Beg. bal. 48,000
(7) Purchases 12,000 (2) Depreciation 4,000 (8) Payments 6,000 Borrowings 0
End. bal. 80,000 End. bal. 42,000

Contributed Capital (SE) Retained Earnings (SE)

Beg. bal. 60,000 Beg. bal. 24,000
Shares repurchased 0 (9) Shares issued 18,500 (10) Dividends 2,000 (1) Net earnings 7,000
End. bal. 78,500 End. bal. 29,000
P5–9 (continued)

Req. 2
HANKS COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2020

Cash flows from operating activities:

Net earnings .............................................................................. $7,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense ............................................................ $ 4,000
Decrease in accounts receivable ............................................ 2,000
Increase in merchandise inventory ........................................ (3,000)
Increase in accounts payable ................................................. 6,000
Increase in wages payable ..................................................... 500
Total adjustments ..................................................................... 9,500
Net cash provided by operating activities .......................... 16,500
Cash flows from investing activities:
Purchase of property and equipment....................................... (12,000)
Cash flows from financing activities:
Payment on long-term note ..................................................... (6,000)
Issuance of shares ..................................................................... 18,500
Payment of dividends ............................................................... (2,000)
Net cash provided by financing activities ........................... 10,500
Net increase in cash during the year ............................................... 15,000
Cash balance, January 1, 2020 ......................................................... 18,000
Cash balance, December 31, 2020 .................................................. $33,000

Req. 3
There were no non-cash investing and financing activities during 2020.
P5–5 (continued)

b.

Cash flow from operations –$3

Capital expenditures ratio = = = –0.14
Cash paid for capital expenditures $22

The capital expenditures ratio reflects the company's ability to finance the acquisition of
property, plant and equipment from operating cash flows. In this case cash from operations
was negative and the company financed the acquisition of equipment through long-term
borrowings.
c. Free cash flow = Cash flow from operations – Dividends paid – Capital expenditures
= – $3 – $2* – $22 = – $27.

* Beginning Retained earnings ($38) + Net earnings ($12) – Dividends declared (X)
= Ending Retained earnings ($48) → Dividends declared = $2.

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 company’s operations required the use of cash instead
of generating cash from operations.

Req. 4

Change in Cash = Cash from operating activities

+ Cash from investing activities
+ Cash from financing activities

($90 – $68) = –$3 +$12 + Y = $22; Cash flow from financing activities = $13

Req. 5

(a) Cash collected from customers = Sales revenue – Increase in accounts receivable
= $140 – $10 = $130.

(b) Cash paid to suppliers of merchandise inventory

Purchases = Cost of sales – Decrease in merchandise inventory = $84 – ($32 – $28) = $80

Payments to suppliers = Purchases + Decrease in accounts payable = $80 + ($38 – $24) = $94

(c) Payment for taxes = Income tax expense + Decrease in income taxes payable
= $4 + ($4 – $3) = $5