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Chapter 23: Q6CA (page 1393)

Question: ETHICS (Cash Flow Reporting)

Brockman Guitar Company is in the business of manufacturing top-quality, steelstring folk guitars. In recent years, the company has experienced working capital problems resulting from the procurement of factory equipment, the unanticipated buildup of receivables and inventories, and the payoff of a balloon mortgage on a new manufacturing facility. The founder and president of the company, Barbara Brockman, has attempted to raise cash from various financial institutions, but to no avail because of the company’s poor performance in recent years. In particular, the company’s lead bank, First Financial, is especially concerned about Brockman’s inability to maintain a positive cash position. The commercial loan officer from First Financial told Barbara, “I can’t even consider your request for capital financing unless I see that your company is able to generate positive cash flows from operations.” Thinking about the banker’s comment, Barbara came up with what she believes is a good plan: With a more attractive statement of cash flows, the bank might be willing to provide long-term financing. To “window dress” cash flows, the company can sell its accounts receivables to factors and liquidate its raw materials inventories. These rather costly transactions would generate lots of cash. As the chief accountant for Brockman Guitar, it is your job to tell Barbara what you think of her plan.

Instructions

Answer the following questions.

(a) What are the ethical issues related to Barbara Brockman’s idea?

(b) What would you tell Barbara Brockman?

Short Answer

Expert verified

Answer

  1. Ethical issue relating to Barbara Brockman’s idea ismisrepresenting the cash flow statement.
  2. Barbara Brockman must prepare a separate report reflecting the reasons for the cash shortage and the business’s ability to generate cash.

Step by step solution

01

Definition of Accounting Ethics

The rules and regulations that must be followed by each individual associated with the accounting and financial reporting to prevent the misstatement and misuse of financial information are known as accounting ethics. The governing bodies establish these ethics.

02

Ethical issues

The ethical issue corresponding to Barbara Brockman’s idea is that she wishes to window dress the statement of the cash flow for getting the loan from the bank. She is trying to misrepresent the financial information to mislead the lenders. Such misrepresentation will create a problem if the business entity cannot perform in future periods.

03

Suggestions

Barbara Brockman must prepare a cash flow statement report that includes the reasons that created the problem relating to a cash position. It must include the reduction in cash due to the acquisition of the factory equipment and unnecessary build-up of the receivables and inventory. The report must also include the ability of the company to generate expected cash from the business operations.

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Most popular questions from this chapter

Hendrickson Corporation reported net income of \(50,000 in 2017. Depreciation expense was \)17,000. The following working capital accounts changed.

Accounts receivable $11,000 increase

Available-for-sale debt securities 16,000 increase

Inventory 7,400 increase

Nontrade note payable 15,000 decrease

Accounts payable 12,300 increase

Compute net cash provided by operating activities.

Moxley Corporation had January 1 and December 31 balances as follows.

1/1/17 12/31/17

Inventory \(95,000 \)113,000

Accounts payable 61,000 69,000

For 2017, cost of goods sold was $500,000. Compute Moxley’s 2017 cash payments to suppliers.

Question: Each of the following items must be considered in preparing a statement of cash flows for Blackwell Inc. for the year ended December 31, 2017. State where each item is to be shown in the statement, if at all.

  1. Plant assets that had cost \(18,000 6½ years before and were being depreciated on a straight-line basis over 10 years with no estimated scrap value were sold for \)4,000.
  2. During the year, 10,000 shares of common stock with a stated value of \(20 a share were issued for \)41 a share.
  3. Uncollectible accounts receivable in the amount of \(22,000 were written off against Allowance for Doubtful Accounts.
  4. The company sustained a net loss for the year of \)50,000. Depreciation amounted to \(22,000, and a gain of \)9,000 was realized on the sale of available-for-sale securities for $38,000 cash.


Question: (SCF Theory and Analysis of Transactions) Ashley Company is a young and growing producer of electronic measuring instruments and technical equipment. You have been retained by Ashley to advise it in the preparation of a statement of cash flows using the indirect method. For the fiscal year ended October 31, 2017, you have obtained the following information concerning certain events and transactions of Ashley.

1. The amount of reported earnings for the fiscal year was \(700,000, which included a deduction for a loss of \)110,000 (see item 5 below).

2. Depreciation expense of \(315,000 was included in the income statement.

3. Uncollectible accounts receivable of \)40,000 were written off against the allowance for doubtful accounts. Also, \(51,000 of bad debt expense was included in determining income for the fiscal year, and the same amount was added to the allowance for doubtful accounts.

4. A gain of \)6,000 was realized on the sale of a machine. It originally cost \(75,000, of which \)30,000 was undepreciated on the date of sale.

5. On April 1, 2017, lightning caused an uninsured building loss of \(110,000 (\)180,000 loss, less reduction in income taxes of \(70,000). This loss was included in determining income as indicated in item 1 above.

6. On July 3, 2017, building and land were purchased for \)700,000. Ashley gave in payment \(75,000 cash, \)200,000 market price of its unissued common stock, and signed a \(425,000 mortgage note payable.

7. On August 3, 2017, \)800,000 face value of Ashley’s 10% convertible debentures was converted into $150,000 par value of its common stock. The bonds were originally issued at face value.

Instructions

Explain whether each of the seven numbered items above is a cash inflow or outflow, and explain how it should be disclosed in Ashley’s statement of cash flows for the fiscal year ended October 31, 2017. If any item is neither an inflow nor an outflow of cash, explain why it is not, and indicate the disclosure, if any, that should be made of the item in Ashley’s statement of cash flows for the fiscal year ended October 31, 2017.

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).
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