Calculate the change that occurred in cash during the month. You may assume that

Question

Calculate the change that occurred in cash during the month. You may assume that the change in each balance sheet amount is due to a single event (for example, the change in the amount of production equipment is not the result of both a purchase and sale of equipment). (Hints: What is the purpose of the statement of cash flows? How is this purpose accomplished?) Because the retained earnings section of the balance sheet is, in and of itself, an analysis of the change in the retained earnings account for the month, the row for net income and dividends should be entered as the February amount and not the change. Use the space to the right of the January 31 data to enter the difference between the February 28 and January 31 amounts of each balance sheet item Retained earnings: Beginning balance $ 64,000 $ 43,000 Net income for month 36,000 29,000 ? Dividends (10,000 ) (8,000 ) ? Ending Balance $90,000 $64,000 -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- Ending balance $ 90,000 $ 64,000

Explanation / Answer

Statement of Cash Flows: Operations: Net Income $29,000 Additions: Decrease in Accounts Receivable $11,000 Increase in Accounts Payable $4,000 Increase in Other Liabilities $3,000 Subtractions: Increase in Merchandise Inventories ($13,000) Cash Flow from Operations $34,000 Investing: Proceeds From Sale of Plant and Equipment $11,000 Financing: Dividends Paid ($8,000) Proceeds from Long Term Debt Issued $13,000 Stock Buyback ($55,000) Cash Flow from Financing ($50,000) Change in Cash for Month ($5,000) = [$34,000 + $11,000 - $50,000] I calculated the Proceeds From Sale of Plant and Equipment by noting that the cash received plus the associated decrease in accumulated depreciation must equal the value of the change in the cost basis of the Plant and Equipment unless a gain or loss is recorded on the Income Statement. Since the problem does not refer to any such gain or loss, nor does it give any information regarding monthly depreciation expense incurred, I assumed the Plant and Equipment was sold at book value. (Page 343) Since the result of my assumption resulted in the correct end of month cash position, I presume it was correct. The cost of the Stock Buyback is calculated by combining the change in Common stock outstanding with the difference between the Retained Earnings ending balance for the previous month and the current month's beginning balance. The direct method lists "... all revenues providing cash, followed by all expenses using cash." The indirect method "...begins with net income, subtracts revenues not providing cash, and adds expenses not using cash." "Because the indirect method adds depreciation expense to net income to calculate cash provided by operations, readers of financial statements might incorrectly conclude that depreciation expense provides cash." (Page 186) "However, ...the recording of depreciation expense does not affect cash." (Page 187) The Statement of Cash Flows provides information about where earnings are coming from and where cash is generated by a business. The Operations section indicates how the ongoing business is performing: is the company able to collect from its customers, are inventories rising or falling, and is net cash being generated from the ongoing activities of the business. The Investing section reports on whether or not property and equipment is being bought or sold and in what amounts. The Financing section indicates whether the firm is generating cash from sales of stock or bonds or is using cash to pay off bonds or repurchase stock. A firm whose cash position is largely dependent upon obtaining cash from financing and investing is likely to be much riskier than a firm that is able to generate significant cash from operations.

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