Question: (SCF Theory and Analysis of Improper SCF) Teresa Ramirez and Lenny Traylor are examining the following statement of cash flows for Pacific Clothing Store’s first year of operations.

PACIFIC CLOTHING STORE STATEMENT OF CASH FLOWS FOR THE YEAR ENDED JANUARY 31, 2017
Sources of cash
From sales of merchandise	\(382,000
From sale of common stock	380,000
From sale of investment	120,000
From depreciation	80,000
From issuance of note for truck	30,000
From interest on investments	8,000
Total sources of cash	1,000,000
Uses of cash
For purchase of fixtures and equipment	330,000
For merchandise purchased for resale	253,000
For operating expenses (including depreciation)	170,000
For purchase of investment	95,000
For purchase of truck by issuance of note	30,000
For purchase of treasury stock	10,000
For interest on note	3,000
Total uses of cash	891,000
Net increase in cash	\)109,000

Teresa claims that Pacific’s statement of cash flows is an excellent portrayal of a superb first year, with cash increasing \(109,000. Lenny replies that it was not a superb first year—that the year was an operating failure, the statement was incorrectly presented, and \)109,000 is not the actual increase in cash.

Instructions

(a) With whom do you agree, Teresa or Lenny? Explain your position.

(b) Using the data provided, prepare a statement of cash flows in proper indirect method form. The only noncash items in income are depreciation and the gain from the sale of the investment (purchase and sale are related).

Step by step solution

01

Definition of Statement of Cash Flow

The schedule prepared by the business entity for providing a summary of all the transactions, including cash payments and receipts, is known as the statement of cash flow.

02

Appropriate statement

Lenny’s statement is appropriate that the year was an operating failure because the business entity is generating a net loss of $11,000 despite having positive cash flow. Also, the presentation of the sources and use of cash is not done in a proper format. The business entity must represent each item by classifying it as financing, investing, and operating.

Working note:

Calculation of net income or loss:

Particular	Amount $
Sales	$382,000
Add: gain on sale of investment	25,000
Interest revenue	8,000
Total revenue	$415,000
Less: Expenses
Purchase of merchandise	(253,000)
Operating expenses	(90,000)
Depreciation	(80,000)
Interest expenses	(3,000)
Total expenses	$426,000
Net Loss	($11,000)

03

Statement of cash flow using the indirect method

Particular	Amount $
Cash flow from operating activity:
Net loss	($11,000)
Adjustments to net income:
Depreciation	80,000
Gain from sale of investment	(25,000)
Net cash provided by operating activity	$44,000
Cash flows from investing activity:
Sale of investment	120,000
Purchase of furniture and equipment	(330,000)
Purchase of investment	(95,000)
Cash used in the investing activity	($305,000)
Cash flow from financing activity:
Sale of common stock	380,000
Purchase of treasury stock	(10,000)
Cash flow from financing activity	$370,000
Net change in the cash	$109,000
Additional disclosures:
Interest payment	$3,000
Non-cash significant financing and investing activity:
Issued note for truck	$30,000

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