Chapter 21, Problem 21.11P

Prepare a statement of cash flows; direct method

• LO21–3, LO21–8

The comparative balance sheets for 2018 and 2017 and the income statement for 2018 are given below for Arduous Company. Additional information from Arduous’s accounting records is provided also.

Additional information from the accounting records:

a. Investment revenue includes Arduous Company’s $6 million share of the net income of Demur Company, an equity method investee.

b. Treasury bills were sold during 2018 at a gain of $2 million. Arduous Company classifies its investments in Treasury bills as cash equivalents.

c. A machine originally costing $70 million that was one-half depreciated was rendered unusable by a flood. Most major components of the machine were unharmed and were sold for $17 million.

d. Temporary differences between pretax accounting income and taxable income caused the deferred income tax liability to increase by $3 million.

e. The preferred stock of Tory Corporation was purchased for $25 million as a long-term investment.

f. Land costing $46 million was acquired by issuing $23 million cash and a 15%, four-year, $23 million note payable to the seller.

g. The right to use a building was acquired with a 15-year lease agreement; present value of lease payments, $82 million. Annual lease payments of $7 million are paid at the beginning of each year starting January 1, 2018.

h. $60 million of bonds were retired at maturity.

i. In February, Arduous issued a 4% stock dividend (4 million shares). The market price of the $5 par value common stock was $7.50 per share at that time.

j. In April, 1 million shares of common stock were repurchased as treasury stock at a cost of $9 million.

Required:

Prepare the statement of cash flows of Arduous Company for the year ended December 31, 2018. Present cash flows from operating activities by the direct method. (A reconciliation schedule is not required.)

To determine

Statement of cash flows: This statement reports all the cash transactions which are responsible for inflow and outflow of cash and result of these transactions is reported as ending balance of cash at the end of reported period.

To Prepare: The statement of cash flows of Company A.

Explanation of Solution

Spreadsheet: The spreadsheet is a supplementary device which helps to prepare the adjusting entries and the statement of cash flows easier.  The spreadsheet is a working tool of the accountant but it is not a permanent accounting record.

The spreadsheet, for the statement of cash flow analysis, is shown below.

Company A
Spreadsheet for the Statement of Cash Flows
Amount in Millions
Particulars	December 31,2017 Amount ($)	Changes		December 31,2018 Amount ($)
		Debit ($)	Credit ($)
Assets
Current Assets
Cash	$81	(21) $28		$109
Accounts receivable	$194		(1) $4	$190
Investment revenue receivable	$4	(2) $2		$6
Inventory	$200	(4) $5		$205
Prepaid insurance	$8		(8) $4	$4
Long-term investment	$125	(2) $6 (13)  $25		$156
Land	$150	(14) $46*		$196
Buildings and equipment	$400	(15) $82*	(10) $70	$412
Less: Depreciation	($120)	(10) $35	(6) $12	($97)
Patent	$32		(7) $2	$30
Total current assets	$1,074			$1,211
Liabilities and Stockholders’ Equity
Liabilities
Accounts payable	$65	(4) $15		$50
Salaries payable	$11	(5) $5		$6
Bond interest payable	$4		(9) $4	$8
Income tax payable	$14	(11) $2		$12
Deferred tax liability	$8		(11) $3	$11
Notes payable	$0		(14) $23*	$23
Lease liability	$0	(15) $7	(15) $82*	$75
Bonds payable	$275	(16) $60		$215
Less: Discount	($25)		(9)  $3	($22)
Stockholders’ equity
Common Stock	$410		(17) $20	$430
Paid-in capital—excess of par	$85		(17) $10	$95
Preferred stock	$0		(18) $75	$75
Retained Earnings	$227	(17) $30/ (19)  $22	(12) $67	$242
Less: Treasury Stock	$0	(20)  $9		($9)
Total liabilities and stockholders’ equity	$1,074			$1,211
Income Statement
Revenues
Sales revenue			(1) $410	$410
Investment revenue			(2) $11	$11
Gain on sale of treasury bills			(3) $2	$2
Expenses
Cost of goods sold		(4)  $180		($180)
Salaries expense		(5)  $73		($73)
Depreciation expense		(6)  $12		($12)
Patent amortization expense		(7)  $2		($2)
Insurance expense		(8)  $7		($7)
Bond interest expense		(9)  $28		($28)
Loss on machine damage		(10)  $18		($18)
Income tax expense		(11)  $36		($36)
Net income		(12) $67		$67
Statement of Cash Flows
Operating activities:
Cash Inflows:
From customers		(1) $414
From investment revenue		(2) $3
From sale of cash equivalents		(3) $2
Cash Outflows:
To suppliers of goods			(4)  $200
To employees			(5)  $78
For insurance			(8)  $3
For bond interest			(9)  $21
For income taxes			(11)  $35
Net cash flows				$82
Investing activities:
Sale of machine components		(10)  $17
Purchase of Long Term investment			(13) $25
Purchase of land			(14) $23
Net cash flows				($31)
Financing activities:
Payment on lease liability			(15) $7
Retirement of bonds payable			(16) $60
Sale of preferred stock		(18) $75
Payment of cash dividends			(19) $22
Purchase of treasury stock			(20) $9
Net cash flows				($23)
Net decrease in cash		(21)  $28		$28
Total		$1,313	$1,313

Table (1)

Operating activities: Operating activities refer to the normal activities of a company to carry out the business. The examples for operating activities are purchase of inventory, payment of salary, sales, and others.

Investing activities: Investing activities refer to the activities carried out by a company for acquisition of long term assets. The examples for investing activities are purchase of equipment, long term investment, sale of land, and others.

Financing activities: Financing activities refer to the activities carried out by a company to mobilize funds to carry out the business activities. The examples for financing activities are purchase of bonds, issuance of common shares, and others.

The spreadsheet of Company A shows the analysis of cash flows in the reporting year 2018.

Company A
Statement of Cash Flows
For year ended December 31, 2018
Amount in Millions
Particulars	Amount ($)	Amount ($)
Operating activities:
Cash Inflows:
From customers	$414
From investment revenue	$3
From sale of cash equivalents	$2
Cash Outflows:
To suppliers of goods	($200)
To employees	($78)
For insurance	($3)
For bond interest	($21)
For income taxes	($35)
Net cash flows from operating activities		$82
Investing activities:
Sale of machine components	$17
Purchase of Long Term investment	($25)
Purchase of land	($23)
Net cash flows from investing activities		($31)
Financing activities:
Payment on lease liability	($7)
Retirement of bonds payable	($60)
Sale of preferred stock	$75
Payment of cash dividends	($22)
Purchase of treasury stock	($9)
Net cash flows from financing activities		($23)
Net decrease in cash		$28
Cash balance, January 1, 2018		$81
Cash balance, December 31, 2018		$109

Table (2)

The statement of cash flows of Company A, shows opening balance of cash flows for the reporting year 2018 as $81 million and the closing balance of cash as $109 million.

Note:

*Non Cash investing activity and financing activity:

• Company A acquired a building on 15 year lease for $82 million.
• Company A acquired a land for $46 million, by:
  • Paying Cash of $23 million;
  • Issuing 4-year note for $23 million.