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Chapter 5: Q5CA. (page 254)

The partner in charge of the Kappeler Corporation audit comes by your desk and leaves a letter he has started to the CEO and a copy of the cash flow statement for the year ended December 31, 2017. Because he must leave on an emergency, he asks you to finish the letter by explaining: (1) the disparity between net income and cash flow, (2) the importance of operating cash flow, (3) the renewable source(s) of cash flow, and (4) possible suggestions to improve the cash position.

Date

President Kappeler, CEO

Kappeler Corporation

125 Wall Street

Middleton, Kansas 67458

Dear Mr. Kappeler:

I have good news and bad news about the financial statements for the year ended December 31, 2017. The good news is that net income of $100,000 is close to what we predicted in the strategic plan last year, indicating strong performance this year. The bad news is that the cash balance is seriously low. Enclosed is the Statement of Cash Flows, which best illustrates how both of these situations occurred simultaneously . . .

Instructions

Complete the letter to the CEO, including the four components requested by your boss.

Short Answer

Expert verified

Date

President Kappeler, CEO

Kappeler Corporation

125 Wall Street

Middleton, Kansas 67458

Dear Mr Kappeler:

I have good news and bad news about the financial statements for the year ended December 31, 2017. The good news is that net income of $100,000 is close to what we predicted last year's strategic plan, indicating strong performance this year. The bad news is that the cash balance is seriously low. Enclosed is the Statement of Cash Flows, which best illustrates how these situations occurred simultaneously.

  • There exists a difference between the net income and cash flow because of the accrual concept of accounting.
  • Operating cash determines the financial performance of the business entity, and it is considered a renewable source of cash flow.
  • Cash recovery must be fastened, and cash payment must be slowed down.

Regards,

Step by step solution

01

Definition of Cash from Operations

Any cash generated by the business entity from daily activities or recurring activities is known as cash from the operation.

02

The Disparity in Net Income and Cash Flow

There is a difference between the amount reported as cash flow and the amount of net income because the net income is calculated using the accrual accounting that includes all income and expenses incurred or earned even if the payment and receipts are due. While under cash flow, only those income and expenses are recorded, including cash payment and receipts.

03

The Importance of Operating Cash Flow

Operating cash flow proves to be important because the financial success of the business entity can be determined using the operating cash flow. Operating cash flow provides information regarding the cash generated through the normal course of business.

04

The Renewable Sources of Cash Flow

Renewable sources of the cash flow include the sources of cash flow that provide recurring cash flow. It includes all operating activities because these activities are recurring in nature. At the same time, the activities such as financing and investing activities that do not occur frequently are not included in the renewable sources.

05

Suggestions to Improve Cash Flow

Following are some suggestions to improve the cash flow of the business entity:

1. Recovery of payment from receivables must be quicker.

2. The business entity must take more time to make accounts payable payments.

3. Purchase of fixed assets must be reduced, and repayment of bonds must be made partially.

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Most popular questions from this chapter

Each of the following items must be considered in preparing a statement of cash flows. Indicate where each item is to be reported in the statement, if at all. Assume that net income is reported as \(90,000.

(a) Accounts receivable increased from \)34,000 to \(39,000 from the beginning to the end of the year.

(b) During the year, 10,000 shares of preferred stock with a par value of \)100 per share were issued at \(115 per share.

(c) Depreciation expense amounted to \)14,000, and bond premium amortization amounted to \(5,000.

(d) Land increased from \)10,000 to $30,000.

Case 2: Sherwin-Williams Company Sherwin-Williams, based in Cleveland, Ohio, manufactures a wide variety of paint and other coatings, which are marketed through its specialty stores and in other retail outlets. The company also manufactures paint for automobiles. The Automotive Division has had financial difficulty. During a recent year, five branch locations of the Automotive Division were closed, and new management was put in place for the remaining branches.

The following titles were shown on Sherwin-Williams’s balance sheet for that year.

Account payable

Machinery and Equipment

Accounts receivable, less allowance

Other accruals

Accrued taxes

Other capital

Building

Other current assets

Cash and Cash equivalents

Other long term liabilities

Common stock

Postretirement obligation other than pension

Employee compensation payable

Retained earnings

Finished good inventories

Short-term investment

Intangible and other assets

Taxes payable

Land

Work in process and raw material inventories.

Long-term debt

Instructions

(a) Organize the accounts in the general order in which they would have been presented in a classified balance sheet.

(b) When several of the branch locations of the Automotive Division were closed, what balance sheet accounts were most likely affected? Did the balance in those accounts decrease or increase?

How does information from the balance sheet help users of the financial statements?

A comparative balance sheet for Shabbona Corporation is presented below.

Particular

December 31

2017

2016

Assets

Cash

\(73,000

\)22,000

Accounts receivable

82,000

66,000

Inventory

180,000

189,000

Land

71,000

110,000

Equipment

260,000

200,000

Accumulated depreciation – Equipment

(69,000)

(42,000)

Total

\(597,000

\)545,000

Liabilities and stockholder’s equity

Account payable

\(34,000

\)47,000

Bonds payable

150,000

200,000

Common stock (\(1 par)

214,000

164,000

Retained earnings

199,000

134,000

Total

\)597,000

\(545,000

Additional information:

1. Net income for 2017 was \)125,000. No gains or losses were recorded in 2017.

2. Cash dividends of \(60,000 were declared and paid.

3. Bonds payable amounting to \)50,000 were retired through issuance of common stock.

Instructions

(a) Prepare a statement of cash flows for 2017 for Shabbona Corporation.

(b) Determine Shabbona Corporation’s current cash debt coverage, cash debt coverage, and free cash flow. Comment on its liquidity and financial flexibility.

E5-9 (L02,3) (Current Assets and Current Liabilities) The current assets and current liabilities sections of the balance sheet of Allessandro Scarlatti Company appear as follows.

ALLESSANDRO SCARLATTI COMPANY

BALANCE SHEET PARTIAL

December 31, 2017

Cash

\(40,000

Account payable

\)61,000

Accounts receivables

\(89,000

Note payable

67,000

Less: Allowance for doubtful accounts

(7,000)

82,000

\)128,000

Inventory

171,000

Prepaid expenses

9,000

\(302,000

The following errors in the corporation’s accounting have been discovered:

1. January 2018 cash disbursements entered as of December 2017 included payments of accounts payable in the amount of \)39,000, on which a cash discount of 2% was taken.

2. The inventory included \(27,000 of merchandise that had been received at December 31 but for which no purchase invoices had been received or entered. Of this amount, \)12,000 had been received on consignment; the remainder was purchased f.o.b. destination, terms 2/10, n/30.

3. Sales for the first four days in January 2018 in the amount of \(30,000 were entered in the sales journal as of December 31, 2017. Of these, \)21,500 were sales on account and the remainder were cash sales.

4. Cash, not including cash sales, collected in January 2018 and entered as of December 31, 2017, totaled \(35,324. Of this amount, \)23,324 was received on account after cash discounts of 2% had been deducted; the remainder represented the proceeds of a bank loan.

Instructions

(a) Restate the current assets and current liabilities sections of the balance sheet in accordance with good accounting practice. (Assume that both accounts receivable and accounts payable are recorded gross.)

(b) State the net effect of your adjustments on Allessandro Scarlatti Company’s retained earnings balance.
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