Chapter 21, Problem 21.32E

To determine

Statement of cash flows: It is one of the financial statement that shows the cash and cash equivalents of a company for a particular period. It determines the net changes in cash through reporting the sources and uses of cash due to the operating, investing, and financing activities of a company.

Direct method: The direct method uses the cash basis of accounting for the preparation of the statement of cash flows. It takes into account those revenues and expenses for which cash is either received or paid.

Cash flows from operating activities: Cash flows from operating activity represent the net cash flows from the general operation of the business by comparing the cash receipt and cash payments.

Cash Receipts: It encompasses all the cash receipts from sale of goods and on account receivable.

Cash Payments: It encompasses all the cash payments that are made to suppliers of goods and all expenses that are paid.

The below table shows the way of calculation of cash flows from operating activities:

Cash flows from operating activities (Direct method)

Add: Cash receipts.

Cash receipt from customer

Less: Cash payments:

To supplier

For operating expenses

Income tax expenses

Net cash provided from or used by operating activities

Table (1)

Cash flows from investing activities: Cash provided by or used in investing activities is a section of statement of cash flows. It includes the purchase or sale of equipment or land, or marketable securities, which is used for business operations.

The below table shows the way of calculation of cash flows from investing activities:

Cash flows from investing activities

Add: Proceeds from sale of fixed assets

Sale of marketable securities / investments

Deduct: Purchase of fixed assets/long-lived assets

Purchase of marketable securities

Net cash provided from or used by investing activities

Table (2)

Cash flows from financing activities: Cash provided by or used in financing activities is a section of statement of cash flows. It includes raising cash from long-term debt or payment of long-term debt, which is used for business operations.

The below table shows the way of calculation of cash flows from financing activities:

Cash flows from financing activities

Add: Issuance of common stock

Proceeds from borrowings

Proceeds from issuance of debt

Issuance of bonds payable

Deduct: Payment of dividend

Repayment of debt

Interest paid

Redemption of debt

Repurchase of stock

Net cash provided from or used by financing activities

Table (3)

T-Account: For all the business transactions, journal entries are passed and are transferred to the respective ledger accounts where it is recorded and summarized in either side of the ‘T’ format.

To Prepare: The Statement of cash flow for Company R, using the T-Accounts.

Explanation of Solution

Cash Account: (all amounts are in millions)

Cash Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Operating activities:			December 31, 2016	Operating activities:
	From customers	1,954			To suppliers	1,523
					For expenses	456
	Investing activities:				Investing activities:
	Sale of equipment	9			Purchase of equipment	230
	Financing activities:				Financing activities:
	Issuance of notes	50			Payment of dividends	50
	Issuance of bonds	160
					Balance	86

Table (4)

Accounts Receivable:

Accounts Receivable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2015	Beginning Balance	132		December 31, 2016	Closing Balance	178
	Balance (Increase)	46

Table (5)

Prepaid Insurance:

Prepaid Insurance Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2015	Beginning balance	3		December 31, 2016	Closing balance	7
	Balance (Increase)	4

Table (6)

Inventory:

Inventory Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2015	Beginning balance	175		December 31, 2016		285
	Balance (Increase)	110

Table (7)

Buildings and Equipment:

Buildings and Equipment Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2015	Beginning balance	350		December 31, 2016	Sold	180
December 31, 2016	Depreciation expense	50		December 31, 2016	Ending balance	400
	Purchase of equipment	230

Table (8)

Accumulated Depreciation:

Accumulated Depreciation Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2015	Beginning balance	240		December 31, 2016	Ending balance	119
December 31, 2016	Accumulated depreciation	121		December 31, 2016	Balance	50
	Depreciation	171

Table (9)

Accounts Payable:

Accounts Payable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Ending balance	87		December 31, 2015	Beginning balance	100
December 31, 2016	Balance (Decrease)	13

Table (10)

Accrued Expenses Payable:

Accrued Expenses Payable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Ending balance	6		December 31, 2015	Beginning balance	11
December 31, 2016	Balance (Decrease)	5

Table (11)

Notes Payable:

Notes Payable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2015	Beginning balance	0
December 31, 2016	Ending balance	50		December 31, 2016	Balance	50

Table (12)

Bonds Payable:

Bonds Payable Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2015	Beginning balance	0
December 31, 2016	Ending balance	160			Balance	160

Table (13)

Retained Earnings:

Retained Earnings Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Dividends	50		December 31, 2016	Balance of retained earnings	53
					Balance	103

Table (14)

Prepare T-account for income statement account of R Incorporation for the year ended December 31, 2016:

Sales:

Sales Account
Date	Details	Debit ($)		Date	Details	Credit ($)
				December 31, 2016	Sales revenue	2,000
					Balance	2,000

Table (15)

Cost of Goods Sold:

Cost of Goods Sold Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Cost of Goods Sold	1,400
	Balance	1,400

Table (16)

Depreciation Expense:

Depreciation Expense Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Depreciation Expense	50
	Balance	50

Table (17)

Operating Expense:

Operating Expense Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Operating Expense	447
	Balance	447

Table (18)

Net income (income summary):

Net Income (Income summary)Account
Date	Details	Debit ($)		Date	Details	Credit ($)
December 31, 2016	Revenue	2,000		December 31, 2016	Cost of goods sold	1,400
December 31, 2016	Balance	103		December 31, 2016	Depreciation expense	50
				December 31, 2016	Operating expense	447

Table (19)

The statement of cash flow of Company R is as follows.

Company R
Statement of Cash Flows
Amount in Millions
Particulars	Amount ($)	Amount ($)
Operating activities:
Cash Inflows:
From customers	$1,954
Cash Outflows:
To suppliers of goods	($1,523)
For operating expenses	($456)
Net cash used from operating activities		($25)
Investing activities:
Sale of equipment	($230)
Purchase of equipment	$9
Net cash used from investing activities		($221)
Financing activities:
Issuance of note payable	$50
Issuance of bonds payable	$160
Payment of cash dividends	($50)
Net cash provided by financing activities		$160
Net decrease in cash		($86)
Cash balance, January 1, 2016		$110
Cash balance, December 31, 2016		$24

Table (20)

Calculate the amount of cash received from customer:

$\begin{array}{c}\begin{array}{l}\text{Cash}\text{receipts}\\ \text{from}\text{Customers}\end{array}]=\text{Sales}\text{revenue }\left(\begin{array}{l}+\text{Decrease in Accounts Receivable}\\ \text{OR}\\ -\text{Increase in Accounts Receivable}\end{array}\right)\\ =\text{Sales revenue }-\text{Increase in accounts receivables}\\ =\$2,000-\$46\\ =\$1,954\end{array}$

Calculate the amount of cash paid to suppliers of goods:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash}\text{paid }\\ \text{to }\text{suppliers}\end{array}\right)=\text{Cost of Goods Sold }\left(\begin{array}{l}+\text{Decrease in Accounts Payable}\\ \text{/}\text{Increase in Inventory}\\ \text{OR}\\ -\text{Increase in Accounts Payable }\\ \text{/}\text{Decrease in Inventory}\end{array}\right)\\ =\left(\begin{array}{l}\text{Cost of goods sold + Decrease in accounts payable}\\ \text{ + Increase in inventory}\end{array}\right)\\ =\$1,400+\$13+\$110\\ =\$1,523\end{array}$

Calculate the amount of cash paid for operating expenses:

$\begin{array}{c}\left(\begin{array}{l}\text{Cash payments for }\\ \text{Operating expenses}\end{array}\right)=\text{Operating expenses}\left(\begin{array}{l}\text{+Increase in prepaid of insurance}\\ \text{+Decrease in other }\\ \text{accrued liabilities}\end{array}\right)\\ =\text{Operating expense +}\left(\begin{array}{l}\text{Increase in prepaid insurance+}\\ \text{Decrease in accrued expense payable}\end{array}\right)\\ =\$447+\$4+5\\ =\$447+\$4+\$5\\ =\$456\end{array}$

Calculate the amount of  proceeds  from sale of equipment:

Step 1: Calculate the amount of depreciation:

$\begin{array}{c}\text{Depreciation = Purchase of equipment}\times \text{95\%}\\ \text{=\$180}\times \text{95\%}\\ \text{=\$171}\end{array}$

Step 2: Calculate the amount of proceeds from sale of equipment:

$\begin{array}{c}\text{Sale of equipment = }\left(\begin{array}{l}\text{Purchase of equipment}-\\ 95\%ofdepreciation\end{array}\right)\\ =\$180-\$171\\ =\$9\end{array}$

Conclusion

The statement of cash flows of Company R shows opening balance of cash flows in the reporting year 2016 as $110 million and the closing balance of cash as $24 million.