1 E2-2: Identifying Financing, Investing and Operating Transactions? Listed below are eight transactions. In each case, identify whether the transaction is an example of financing, investing or operating activities and which of the financial statements it would affect. 1. Company borrows $50,000 in cash, signing a 10-year note payable. Financing Cash Flow; Balance Sheet (Cash +, LTD +) 2. Twenty units of inventory are purchased from suppliers on account for $12,000. Operating activity but no cash flow; Balance Sheet (Inventory +, AP +) 3. The utility bill is paid at the end of the month, $5,200. Operating Cash Flow; Balance Sheet (Cash - and SE -) and Income Statement (Exp +) 4. Services are performed and customers are billed for $13,000. (No indication of payment) Operating activity but no cash flow; Balance Sheet (AR +, SE +) and Income Statement (Rev +) 5. Five parcels of real estate are purchased for a total of $55,000 in cash. Investing Cash Flow; Balance Sheet (Land +, Cash -) 6. A long-term investment in an equity security is sold for $4, cash. Investing Cash Flow; Balance Sheet (Cash +, Invest -, SE + or -); Income Statement (Other income + or -) 7. Principal payments are made on outstanding debts. Financing Cash Flow; Balance Sheet (Cash -, Notes Payable -) 8. Cash is received from customers for services completed in a previous period. Operating cash flow; Balance Sheet (Cash +, AR -)
2 E2-3: Balance Sheet or Income Statement Account? Listed below are accounts that may appear on either the balance sheet or the income statement. B/S a. Equipment B/S j. Prepaid Expense I/S b. Fees earned I/S k. Gain on Sale of Short-Term Investments B/S c. Retained earnings I/S l. Rent Revenue I/S d. Wage Expense B/S m. Supplies Inventory B/S e. Patent B/S n. Accounts Receivable I/S f. Cost of Goods Sold B/S o. Land B/S g. Common Stock I/S p. Insurance Expense B/S h. Dividends Payable B/S q. Interest Payable B/S i. Accumulated Depreciation B/S r. Deferred Revenue Required: For each account, indicate whether a company would ordinarily disclose the account on the balance sheet (B/S) or income statement (I/S)
3 E2-12: Preparing a Statement of Cash Flows From the following transactions, prepare a statement of cash flows for Emory, Inc. in the proper form. The company began the year with a cash balance of $25,000. Describe and evaluate the company s cash management activities during the year. 1. Borrowed $30,000 from a bank, signing a long-term note. Financing cash flow + $30, Performed services for $45,000, receiving $40,000 in cash and a $5,000 receivable. Operating cash flow + $40, Incurred expenses of $34,000; paid $23,000 in cash and $11,000 is still payable. Operating cash flow - $23, Purchased equipment for $28,000; paid $23,000 in cash a signed a long-term note payable for the remainder. Investing cash flow - $23, Paid the stockholders a dividend in an amount that ensured an ending cash balance of $25,000. Financing cash flow - $24,000 ($70,000 - $46,000)
4 E2-12: Preparing a Statement of Cash Flows (continued) Cash flows from operating activities: Cash collected for services provided Cash paid for expenses Net cash provided by operating activities Cash flows from investing activities: Purchase of equipment Net cash used by investing activities Cash flows from financing activities: Proceeds from bank loan Payment of dividends Net cash provided by financing activities Net increase (decrease) in cash Beginning cash balance Ending cash balance Emory Inc Statement of Cash Flows For the Year Ended $ 40,000 (23,000) (23,000) 30,000 (24,000) $ 17,000 (23,000) 6, ,000 $ 25,000 Based on just one year s SCF, it is difficult to comment on Emory s cash management activities. However, it seems that the company is generating a good portion of its cash flows from operating activities. The company is taking on some loans to finance its asset base, which would be helpful in the future. The company also paid out a substantial dividend to shareholders, which may cause some concern from its creditors.
5 E2-13: Preparing Financial Statements from Simple Transactions George began a business, and after collecting $6,000 from an equity investor and borrowing $5,000 from a bank, he purchased a piece of land for $8,000. During the year, he leased the land to Sheila and received $3,000 in cash. He paid $2, cash for expenses during the year and paid an $800 dividend to the equity investor. Required: Prepare an income statement, a statement of retained earnings, a balance sheet and statement of cash flows for the period. What did George do that may have concerned the bank? Explain. Step 1: Set up the accounting equation and categorize the transactions Assets = Liabilities + Stockholders Equity Capital Beg Net Dividends Cash Land Note Pay Stock R/E Income Declared 1 6,000 6, ,000 5,000 3 (8,000) 8, ,000 (2,) 3,000 (2,) 6 (800) (800) 2, 8,000 = 5, ,000 0 (800)
6 E2-13: Preparing Financial Statements from Simple Transactions (continued) Step 2: Prepare Financial Statements George s Business Income Statement For the Year Ended George s Business Statement of Stockholders Equity For the Year Ended Lease revenue Expenses Net income 3,000 2, Beginning balance Stock issue Net income Cash dividends Ending balance Contributed Capital $ 0 6,000 $ 6,000 Retained Earnings $ 0 (800) $ (300) George s Business Balance Sheet As of Assets Cash Land Total assets 2, 8,000 10, Liabilities and Stockholders Equity Note payable Contributed capital Retained earnings Total liabilities and stockholders equity 5, (300) 10,
7 E2-13: Preparing Financial Statements from Simple Transactions (continued) George s Business Statement of Cash Flows For the Year Ended Cash flow from operating activities: Cash collected from customers Cash paid for expenses Net cash provided by operating activities Cash flows from investing activities: Purchase of land Net cash used by investing activities Cash flows from financing activities: Proceeds from issuing equity Proceeds from borrowings Payment of dividends Net cash provided by financing activities Increase in cash Beginning cash balance Ending cash balance 3,000 (2,) (8,000) (8,000) 6,000 5,000 (800) 10,200 2, 0 2, The bank would be concerned because George s finance statements show a negative retained earnings balance. George paid out more in dividends that the net income be realized during the year. Generally, dividend payments should not exceed the retained earnings balance.
8 P2-1: Classifying Balance Sheet Accounts Required: a. Current assets e. Current liabilities b. Long-term investments f. Long-term liabilities c. Property, plant and equipment g. Contributed capital d. Intangible assets h. Retained earnings Classify the following accounts under the appropriate headings. Prepare a balance sheet in proper form. e. 1. Dividend Payable d. 12. Patents e. 2. Payments Received in Advance c. 13. Property a. 3. Allowance for Doubtful Accounts b. 14. Investment Fund for Plant Expansion a. 4. Inventories e. 15. Wages Payable g. 5. Capital Stock a. 16. Cash c. 6. Accumulated Depreciation - Building c. 17. Accumulated Depreciation - Equipment f. 7. Bonds Payable a. 18. Prepaid Rent c. 8. Machinery and Equipment d. 19. Trademarks a. 9. Accounts Receivable b. 20. Land Held for Investment a. 10. Short-Term Investments e. 21. Current Portion of Long-Term Debt c. 11. Buildings e. 22. Accounts Payable e. 23. Short-Term Notes Payable
9 P2-1: Classifying Balance Sheet Accounts (continued) X Company Balance Sheet (Date) ASSETS Current assets: Cash Short-term investments Accounts receivable, net Inventories Prepaid expenses Total current assets Long-term investments: Land held for investment Investment fund for plant expansion Total long-term investments Property, plant and equipment: Property Buildings Machinery and equipment Property, plant and equipment, at cost Less accumulated depreciation Property, plant and equipment, net Intangible assets: Patents Trademarks Total intangible assets Total assets $ () $
10 P2-1: Classifying Balance Sheet Accounts (continued) X Company Balance Sheet (Date) LIABILITIES AND STOCKHOLDERS EQUITY Current liabilities: Short-term notes payable Accounts payable Wages payable Dividend payable Payments received in advance Current portion of long-term debt Total current liabilities Bonds payable Total liabilities Stockholders equity: Capital stock Retained earnings Total stockholders equity Total liabilities and stockholders equity $ $
11 P2-3 Complete the blanks below to show the relationship among the four statements for Nimmo Brothers Corporation: Balance Sheet 12/31/2010 Cash Other current assets Long-term assets Total assets $ 420 1,300 1, $ 3,120 Statement of Cash Flows Year ending 12/31/2011 Cash Operating $ 275 Cash Investing (200) Cash Financing 330 Change in cash 405 Cash, 12/31/ Cash, 12/31/2011 $ 825 Balance Sheet 12/31/2011 Cash Other current assets Long-term assets Total assets $ 825 1,550 1,600 $ 3,975 Current liabilities Long-term liabilities Contributed capital Retained earnings $ 620 1,000 1,000 $ 3,120 Income Statement Year ending 12/31/2011 Revenues Expenses Net income $ 4,200 4,050 $ 150 Current liabilities Long-term liabilities Contributed capital Retained earnings $ 995 1,200 1, $ 3,975 Statement of Stockholders Equity Year ending 12/31/2011 Contributed Retained Capital Earnings 12/31/2010 Net income Dividends $ 1,000 $ 150 (70) Stock issue 12/31/ $ 1,200 $ 580
12 P2-5: Balance Sheet and Income Statement Relationships across Four Years Required: Compute the missing values for the following chart and analyze the financial performance and position of this company. The first year of operations is Assets: Cash Accounts receivable Inventory Land Property, plant and equipment (net) $ 800 2,800 $ 200 2,200 $ ,100 $ ,800 Liabilities and Stockholders Equity: Accounts payable Bonds payable Contributed capital Retained earnings , , , ,800 Sales Expenses Net income Dividends declared 1,100 (600) 200 (800) (100) 1,100 () 0 1,000 ()
13 P2-5: Balance Sheet and Income Statement Relationships across Four Years (continued) Required: Analyze the financial performance and position of this company. Key Financial Ratios Solvency: Current ratio 1,600 / 900 = ,100 / = ,300 / 300 = ,000 / 200 = 5.00 Debt-to-equity ratio 1,600 / 1,200 = ,300 / 900 = / 1,200 = 0.75 / 1,100 = 0.64 Earnings Power: Profit margin / 1,100 = 45% -100 / = -14% / 1,100 = 36% 600 / 1,000 = 60% Return on equity 1 (Note that I used average SE) / 1,050 1 = 47.6% / 1,150 1 = 34.8% 600 / 1,100 = 54.5% One can safely conclude that the overall financial position of the company has deteriorated since its inception. The current ratio has gone from 5.0 to below 2 and the debt/equity ratio has increased from 0.64 to The company paid dividends even during the year a loss was incurred, indicating a poorly strategized dividend policy. While the company s liabilities have mushroomed its sales have not grown (declined in 2010) and its ability to generate profits has declined (even suffered a loss in 2010).