Chapter 2: Accounting Statements and Cash Flow

2.1 Following the example in Table 2.1:

Assets

Current assets
Cash $4,000
Accounts receivable 8,000
Total current assets $12,000

Fixed assets
Machinery $34,000
Patents 82,000
Total fixed assets $116,000
Total assets $128,000

Liabilities and equity

Current liabilities
Accounts payable $6,000
Taxes payable 2,000
Total current liabilities $8,000

Long-term liabilities
Bonds payable $7,000
Stockholders equity
Common stock* $88,000
Capital surplus 19,000
Retained earnings 6,000
Total stockholders equity $113,000

Total liabilities and equity $128,000

* You can back this out knowing that Total Assets = Total Liabilities + Equity

2.2
One year ago Changes Today
Long-term debt $50,000,000 none $50,000,000
Preferred stock 30,000,000 none 30,000,000
Common stock 100,000,000 10 million new issue 110,000,000
Retained earnings 20,000,000 5 million net income less 3 22,000,000
million paid out dvds
Total $200,000,000 $212,000,000

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2.3 Following the example in Table 2.2:

Income Statement
Total operating revenues 500000
Cost of goods sold (200000)
Administrative expenses (100000) (300000)
Earnings before interest and taxes (EBIT) 200000
Interest expense (50000)
Earnings before Taxes 150000
Taxes (51000) (Taxes = 150,000 x .34)
Net income 99000

2.4 a.
Income Statement
The Flying Lion Corporation
20X1 20X2
Net sales $800,000 $500,000
Cost of goods sold (560,000) (320,000)
Operating expenses (75,000) (56,000)
Depreciation (300,000) (200,000)
Earnings before taxes (EBT) $(135,000) $(76,000)
Taxes* 40,500 22,800
Net income $(94,500) $(53,200)

*The problem states that Flying Lion has other profitable operations. Assume those
operations generate at least $135,000 EBT in 20X1 and $76,000 in 20X2. Then,
Flying Lion can take advantage of tax losses by deducting these tax liabilities from
the other operations that have taxable profits. If Flying Lion did not have sufficient
other operations or tax losses could not be carried forward or backward, then tax
benefit in each of these years would have been less or zero.

b. Operating Cash Flow is earnings before interest and depreciation, less taxes. So,
since we already have net income from part a, it can be found as
net income + depreciation + interest expense

So for Flying Lion, we have :

Operating cash flow for 20X2 = -$94,500 + $300,000 + $0 = $205,500

Operating cash flow for 20X1 = -$53,200 + $200,000 + $0 = $146,800

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2.5 The main difference between accounting profit and cash flow is that non-cash costs,
such as depreciation expense, are included in accounting profits. Cash flows do not
consider costs that do not represent actual expenditures. Cash flows deduct the entire
cost of an investment at the time the cash flow occurs, rather than amortizing over
some period, as is done with accounting profit. Look back at the previous problem
and notice the differing effects of depreciation, with and without "other operations".
Since depreciation is a non-cash expense, it only effects cash flow in that it effects
Taxes.

2.6 Note that parts a, b and c are simply asking for sequential pieces of the Income
Statement:

a. Net operating income = Sales - COGS - Selling expenses - Depreciation

= $1,000,000 - $300,000 - $200,000 - $100,000
= $400,000

b. Earnings before taxes = Net operating income - Interest expense

= Net operating income - (Notes Payable x Interest Rate)
= $400,000 - ($1,000,000)(0.1 )
= $300,000

c. Net income = Earnings before taxes - Taxes

= Earnings before taxes - (EBT x TaxRate)
= $300,000 - ($300,000)(0.35)
= $195,000

d. Operating Cash flow = Net income + Depreciation + Interest expense

= $195,000 + $100,000 + $100,000
= $395,000

2.7 Following the example in Table 2.3:

Total Cash Flow of the Stancil Company

Cash flows from the firm

Operating Cash Flow 0
Capital spending (purchase of fixed assets) (1000)
Additions to working capital (purchase of (4000)
inventory)
Total (5000)

Cash flows to investors of the firm

Short-term debt (6000)
Long-term debt (20000)
Equity (Dividends paid out less sale of common) 21000
Total (5000)

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2.8 a. The difference in cash flow is the sum of the differences in cash flows from
operations investing activities, and financing activities.

b. The changes in net working capital can be computed from:

Sources of net working

capital
Net income $100
Depreciation 50
Increases in long-term 75
debt
Total sources $225

Uses of net working capital

Dividends $50
Increases in fixed 150
assets*
Total uses $200
Additions to net working $25
capital
*Includes $50 of depreciation.

c.
Cash flow from the firm
Operating cash flow $150
Capital spending (150)
Additions to net working (25)
capital
Total $(25)
Cash flow to the investors
Debt $(75)
Equity 50
Total $(25)

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