Reporting and Interpreting Cash Flows Problem Sets

QUESTION 1

The following information has been reported by Karou Corp. on its statement of financial positions at December 31, 2011
and 2010, and on its income statement for the year ended December 31, 2011. All amounts are in millions of dollars.
Statement of financial positions
Assets 2011 2010
Cash $ 97 $ 94
Trade receivables (net) 32 26
Merchandise inventory 135 90
Prepayments 40 42
Total current assets 304 252
Property, plant and equipment 420 370
Accumulated depreciation (168) (129)
Total assets $556 $493

Liabilities and Shareholders’ Equity

Trade payables $ 31 35
Interest payable 3 2
Income taxes payable 9 5
Total current liabilities 43 42
Bonds payable, at par 90 120
Total liabilities 133 162
Common shares 200 140
Retained earnings 223 191
Total liabilities and shareholders’ equity $556 $493

Income Statement
Sales $970
Gain on sale of equipment 6
976
Expenses
Cost of goods sold 550
Wages expense 95
Utilities expense 136
Depreciation expense 69
Interest expense 6
Income tax expense 24
Total expenses 880
Profit $ 96

Additional information (dollars in millions)

a. Old equipment with an original cost of $40, and a net book value of $10 was sold for cash.
b. New equipment was purchased for cash.
c. Bonds with a face value (par value) of $20 were converted to common shares in December 2011. There was no
gain or loss on the conversion.
d. Trade payables relate only to transactions with suppliers of merchandise inventory.
Required:

1. Prepare, in good form, a statement of cash flows for Karou Corp. for the year ended December 31, 2011. Use the
indirect method to calculate the cash flow from operating activities. To facilitate your work, non-cash working capital
items (non-cash current assets minus current liabilities) increased by $48 million during the year. You do not have to
show in your statement of cash flows the separate effects of changes in each non-cash current asset and current
liability, i.e., use the $48 million figure. (13 marks)
2. Assume that the statement of cash flows you prepared for requirement 1 above was distributed to the Company’s
board of directors along with the other financial statements and related notes. After glancing at the statement of cash
flows, one of the board members commented: “This statement does not show how much cash was received from
operations and how much cash was paid for operating activities. Could we ask the controller to provide us with these
details?”

Assume the role of the Company controller and calculate the following amounts for 2011:

a) Cash collected from customers,

b) Cash paid to suppliers of merchandise inventory,
c) Cash paid for interest.

QUESTION 2 (22 marks; 40 minutes)

Drapeau Corp. has provided you with financial information for the years 2011 and 2010, respectively. The company’s
fiscal year ends on December 31.

2011 2010
Assets
Cash $ 47,000 $ 12,000
Trade Receivables 110,000 125,000
Merchandise inventory 25,000 36,000
Prepaid rent 0 7,000
Land, at cost 29,000 38,000
Equipment, at cost 690,000 600,000
Less: Accumulated depreciation (224,000) (215,000)
Total Assets $ 677,000 $ 603,000

Liabilities
Trade payables $ 32,000 $ 61,000
Rent payable 4,000 0
Bonds payable, at par, due 2020 45,000 120,000
Shareholders’ Equity
Common shares 201,000 42,000
Retained earnings 395,000 380,000
Total Liabilities and Shareholders’ Equity $ 677,000 $ 603,000

Additional information for 2011:

1. Net Profit for 2011 was $22,000. The calculation of profit includes the following selected items and amounts: Cost of
goods sold, $293,000; Gross profit, $444,000; Depreciation expense, $27,000; Gain on sale of land, $2,000; Loss on
sale of equipment, $4,000; and Rent expense, $16,000.

2. New equipment was purchased for $142,000 cash in 2011. Old equipment was sold for cash in 2011 (the amount can
be derived).

3. Bonds payable with a face value of $75,000 were converted to common shares in 2011.

4. Trade payables relates to transactions with suppliers of merchandise inventory only.

Required
a. How much cash was paid for rent in 2011? (2.5 marks)
b. How much cash was paid to suppliers of merchandise inventory in 2011? (3 marks)
c. How much cash was collected from customers in 2011? (1.5 marks)
d. Prepare in proper form a complete Statement of Cash Flows for 2011 (i.e., all sections).
Use the indirect method for the Operating section. (13 marks)
e. Calculate the quality of earnings ratio for 2011 and give a meaningful definition of
this ratio. (2 marks)
QUESTION 3 (23 marks; 42 minutes)

Mary Wong, the sole shareholder and manager of Kitchenware Inc., has approached you and asked you to prepare a
statement of cash flows for her company. The Company sells kitchen utensils that are used in most households. Mary is
presently worried about the meeting that she has scheduled in two weeks with a lending officer of her bank. It is time for
a review of the Company’s loan from the bank.
Mary provided you with the following condensed financial statements for the fiscal years ended December 31, 2009 and
2010. She assures you that the financial statements are free of any omissions or misstatements, and that they conform to
international financial reporting standards.

KITCHENWARE INC.
Statement of Financial Positions as at December 31
(In thousands of dollars)
2010 2009
Assets
Current assets
Cash …………………………………………………… $ 1,000 $ 3,400
Short-term investments …………………………………. 2,000 8,000
Trade accounts receivable ……………………………… 56,300 10,600
Inventories ……………………………………………… 10,000 30,000
Total current assets ……………………………………… 69,300 52,000
Noncurrent assets
Furniture and fixtures, at cost …………………………. 59,000 26,000
Less: accumulated depreciation ……………………….. (24,000) (12,000)
Investments ……………………………………………... 2,000 3,000
Total non-current assets …………………………………. 37,000 17,000
Total assets ………………………………………………. $106,300 $69,000

Liabilities and Shareholders’ Equity

Current liabilities
Bank loan ……………………………………………… $ 18,000 $ 8,000
Trade accounts payable ………………………………… 17,000 13,100
Dividends payable ……………………………………… -0- 600
Total current liabilities …………………………………… 35,000 21,700
Noncurrent liabilities
Mortgage notes payable ………………………………. 28,000 -0-
Total liabilities …………………………………………… 63,000 21,700
Shareholders’ equity
Share capital …………………………………………… 24,000 22,000
Retained earnings ……………………………………… 19,300 25,300
Total shareholders’ equity ……………………………….. 43,300 47,300
Total liabilities and shareholders’ equity …………………. $106,300 $69,000

KITCHENWARE INC.
Income Statements
For the Years Ended December 31
2010 2009
Sales revenue ……………………………………………. $980,000 $880,000
Cost of sales …………………………………………… (640,000) (560,000)
Gross profit ………………………………………….. 340,000 320,000
Operating expenses:
Depreciation …………………………………………… (15,200) (12,000)
 Selling and general …………………………………….. (298,800) (288,000)
Operating income ……………………………………. 26,000 20,000
Interest expense …………………………………………. (9,600) (3,200)
Loss on sale of furniture …………………………………. (1,200) -0-
Gain on sale of investments ……………………………… 800 -0-
Profit before income taxes …………………………. 16,000 16,800
Income tax expense (@25%) …………………………….. (4,000) (4,200)
Profit …………………………………………… $12,000 $12,600

Additional information:

a. During 2010, the company sold old furniture with an original cost of $5,000 and $3,200 of accumulated depreciation
up to the date of sale.

b. During 2010, the company sold one of the noncurrent investments that had cost $1,000. The gain on this sale is
reported on the income statement.

c. The company considers short-term investments as cash equivalents.

Required:

1. Prepare a partial statement of cash flows for Kitchenware Inc. showing the operating activities section for the year
ended December 31, 2010. The Company uses the indirect method to report cash flows from operations. (5 marks)

2. Compute the following amounts: (5 marks)

a. Cash collected from customers, assuming that 90 percent of the sales are on credit.
b. Cash paid to trade suppliers of merchandise
c. Cash received for sale of old furniture
3. Prepare the investing activities section of the statement of cash flows for Kitchenware Inc. for the year ended
December 31, 2010. (5 marks)

4. Compute and explain each of the following: (a) quality of earnings ratio, and (b) free cash flow. (5 marks)

5. In an effort to improve the company’s financial performance, Mary Wong proposed that the furniture and
fixtures can be depreciated over a longer period. This change will decrease depreciation expense by $2,000 in
2009 and by $4,000 in 2010. As a professional accountant, would this proposed change be acceptable to you?
Explain. (3 marks).