Reference no: EM132986397 , Length: word count:3000
HI5020 Corporate Accounting - Holmes Institute
Assessment - Cash flows statements
This assignment aims at developing an understanding of students on different aspects of a cash flows statement as well as what information can be derived from the cash flows statement. Students will learn how to prepare the statement of cash flows using direct and indirect method, understand why a company may have reported profit but negative cash flows, and form the ability to look into the profit figure in conjunction with the cash flows information so as to get a complete picture. Hence this assignment helps students to learn how to prepare, present, analyse and synthesise cash flow related data and information for a company or for a corporate group.
Question 1
Aggressive Corporation approaches Matt Taylor, a loan officer for Oklahoma State Bank, seeking to increase the company's borrowings with the bank from $100,000 to $150,000. Matt has an uneasy feeling as he examines the loan application from Aggressive Corporation, which just completed its first year of operations. The application included the following financial statements.
AGGRESSIVE CORPORATION
Income Statement
For the year ended December 31, 2018
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Net sales
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$200,000
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Expenses:
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Cost of goods sold
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$110,000
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Operating expenses
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50,000
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Depreciation expense
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10,000
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Total expenses
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170,000
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Net income
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$ 30,000
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AGGRESSIVE CORPORATION
Balance Sheets
For the year ended December 31, 2018/December 31, 2018
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2018
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2017
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Assets
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Current assets:
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Cash
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$ 10,000
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$0
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Accounts receivable
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60,000
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0
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Inventory
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40,000
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0
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Long-term assets:
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Equipment
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100,000
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0
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Accumulated depreciation
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(10,000)
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0
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Total assets
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$200,000
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$0
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Liabilities and Stockholders' Equity
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|
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Current liabilities:
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Accounts payable
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$ 20,000
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$0
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Interest payable
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10,000
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0
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Long-term liabilities:
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Note payable
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100,000
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0
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Stockholders' equity:
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Common stock
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40,000
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0
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Retained earnings
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30,000
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0
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Total liabilities and stockholders' equity
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$200,000
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$0
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The income statement submitted with the application shows a net income of $30,000 in the first year of operations. Referring to the balance sheet, this net income represents a more-than-acceptable 15% rate of return on assets of $200,000.
Matt's concern stems from his recollection that the $100,000 note payable reported on the balance sheet is a three-year loan from his bank, approved earlier this year. He recalls another promising new company that, just recently, defaulted on its loan due to its inability to generate sufficient cash flows to meet its loan obligations.
Seeing Matt's hesitation, Larry Bling, the CEO of Aggressive Corporation, closes the door to the conference room and shares with Matt that he owns several other businesses. He says he will be looking for a new CFO in another year to run Aggressive Corporation along with his other businesses, and Matt is just the kind of guy he is looking for. Larry mentions that as CFO, Matt would receive a significant salary. Matt is flattered and says he will look over the loan application and get back to Larry concerning the $50,000 loan increase by the end of the week.
Required:
(a) Prepare a statement of cash flows for Aggressive Corporation.
(b) Explain how Aggressive Corporation can have positive net income but negative operating cash flows.
(c) How does the finding of negative operating cash flows affect your confidence in the reliability of the net income amount?
(d) Why do you think Larry mentioned the potential employment position? Should the potential employment position with Aggressive Corporation have any influence on the loan decision?
Question 2
"Why can't we pay our shareholders a dividend?" shouts your new boss at Polar Opposites. "This income statement you prepared for me says we earned $5 million in our first year!" You recently prepared the financial statements below.
POLAR OPPOSITES
Income Statement
For the year ended December 31, 2018
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($ in millions)
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Net sales
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$65
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Cost of goods sold
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(35)
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Depreciation expense
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(4)
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Operating expenses
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(21)
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Net income
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$ 5
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POLAR OPPOSITES
Balance Sheet December 31, 2018
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($ in millions)
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Cash
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$1
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Accounts receivable (net)
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16
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Merchandise inventory
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14
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Machinery (net)
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44
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Total assets
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$75
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Accounts payable
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$7
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Accrued expenses payable
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9
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Notes payable
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29
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Common stock
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25
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Retained earnings
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5
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Total liabilities and stockholders' equity
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$75
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Although net income was $5 million, cash flow from operating activities was a negative $5 million. This just didn't make any sense to your boss.
Required:
Prepare a memo explaining how net income could be positive and operating cash flows is negative. Include in your report the calculation of operating cash flows of negative $5 million using the indirect method.
Question 3
Bryan Eubank began his accounting career as an auditor for a Big 4 CPA firm. He focused on clients in the high-technology sector, becoming an expert on topics such as inventory write-downs, stock options, and business acquisitions. Impressed with his technical skills and experience, General Electronics, a large consumer electronics chain, hired Bryan as the company controller responsible for all of the accounting functions within the corporation. Bryan was excited about his new position- for about a week until he took the first careful look at General Electronics' financial statements.
The cause of Bryan's change in attitude is the set of financial statements he's been staring at for the past few hours. For some time prior to his recruitment, he had been aware that his new employer had experienced a long trend of moderate profitability. The reports on his desk confirm the slight but steady improvements in net income in recent years. The disturbing trend Bryan is now noticing, though, is a decline in cash flows from operations. Bryan has sketched out the following comparison ($ in millions):
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2018
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2017
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2016
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2015
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Operating income
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$1,400
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$1,320
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$1,275
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$1,270
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Net income
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385
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350
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345
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295
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Cash flows from operations
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16
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110
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120
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155
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Profits? Yes. Increasing profits? Yes. So what is the cause of his distress? The trend in cash flows from operations, which is going to the opposite direction of net income. Upon closer review, Bryan noticed a couple events that, unfortunately, seem related:
(i) The company's credit policy has been loosened, credit terms relaxed, and payment periods extended. This has resulted in a large increase in accounts receivable.
(ii) The salaries of the CEO and CFO, are calculated based on reported net income.
Required:
(a) What is likely causing the increase in accounts receivable? How does an increase in accounts receivable affect net income differently than operating cash flows?
(b). Explain why executive compensations for officers, such as the CEO and CFO, might increase the risk of earnings management.
(c) Why is the trend of cash flows from operations, combined with the additional events, such a concern for Bryan?
(d) What course of action, if any, should Bryan take?
Attachment:- Cash flows statements.rar