Jia Inc. applies ASPE and had the following statement of financial position at the end of operations for 2013:
During 2014, the following occurred:
1. Jia Inc. sold some of its fair value-net income investment portfolio for $19,000. This transaction resulted in a gain of $3,400 for the firm. At December 31, 2014, the remaining fair value- net income investments in the portfolio had fair value of$16,400 and original costof$13,000. No investments were purchased in 2014.
2. A tract of land was purchased for $18,000 cash.
3. Long-term notes payable in the amount of $17,000 were retired before maturity by paying $ 17,000 cash.
4. An additional $26,000 in common shares was issued.
5. Dividends totalling $9,200 were declared and paid to shareholders.
6. Net income for 2014 was $32,000 after allowing for depreciation of $ 12,000.
7. Land was purchased through the issuance of $30,000 in bonds.
8. At December 31, 2014, cash was $41,000; accounts receivable was $41,600; and accounts payable remained at $30,000.
Instructions
(a) Prepare a statement of cash flows for the year ended December 31, 2014.
(b) Prepare the statement of financial position as it would appear at December 31, 2014.
(c) How might the statement of cash flows help the user of the financial statements?
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*(d) Calculate the following ratios:
1. Free cash flow
2. Current cash debt coverage ratio
3. Cash debt coverage ratio
(e) What is Jia's cash flow pattern? Discuss any areas of concern.
SOLUTION
(a) Jia Inc.
Statement of Cash Flows
For the Year Ended December 31, 2014
Cash flows from operating activities
Net income
$32,000
$32,000
$32,000
$32,000
$32,000
$32,000
Adjustments to reconcile net income to net cash provided by operating activities
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation expense
$12,000
$12,000
$12,000
Gain on sale of investments
(3,400)
(3,400)
(3,400)
(3,400)
Increase in accounts receivable ($41,600 – $21,200)
(20,400)
(20,400)
(20,400)
(20,400)
(11,800)
(11,800)
(11,800)
(11,800)
(11,800)
(11,800)
(11,800)
(11,800)
Net cash provided by operating activities
20,200
20,200
20,200
20,200
20,200
20,200
Cash flows from investing activities
Proceeds from sale of investments
19,000
19,000
19,000
Purchase of land
(18,000)
(18,000)
(18,000)
(18,000)
Net cash provided by investing activities
Net cash provided by investing activities
Net cash provided by investing activities
1,000
1,000
Cash flows from financing activities
Issuance of common shares
26,000
26,000
26,000
Retirement of notes payable
(17,000)
(17,000)
(17,000)
(17,000)
Payment of cash dividends
(9,200)
(9,200)
(9,200)
(9,200)
Net cash used by financing activities
(200)
(200)
(200)
(200)
(200)
(200)
(200)
Net increase in cash
21,000
21,000
21,000
21,000
Cash at beginning of year
20,000
20,000
20,000
20,000
Cash at end of year
$41,000
$41,000
$41,000
$41,000
(b)
Jia Inc.
Statement of Financial Position
December 31, 2014
Assets
Assets
Assets
Liabilities and Shareholders’ Equity
Liabilities and Shareholders’ Equity
Liabilities and Shareholders’ Equity
Liabilities and Shareholders’ Equity
Cash
$41,000
Accounts payable
Accounts payable
$30,000
Accounts receivable
41,600
Long-term notes payable
Long-term notes payable
24,000
(4)
Investments – FV:NI
16,400
(1)
(1)
Bonds payable
Bonds payable
30,000
(5)
Equipment (net)
69,000
(2)
(2)
Common shares
Common shares
126,000
(6)
Land
88,000
(3)
(3)
Retained earnings
Retained earnings
46,000
(7)
$256,000
$256,000
(c)
The statement of cash flows is useful for assessing the amount, timing, and uncertainty of future cash flows. For example, by showing the specific cash inflows and outflows from operating activities, investing activities, and financing activities, the user has a better understanding of the liquidity and financial flexibility of the enterprise. The statement of cash flows also provides useful information about the flow of enterprise resources, which helps users make more accurate predictions about future cash flows. In addition, some individuals are concerned about the quality of the earnings because the measurement of net income depends on a number of accruals and estimates, which may be somewhat subjective. As a result, the higher the ratio of cash provided by operating activities to net income, the more comfort some users have in the reliability of the earnings. In this problem, the ratio of cash provided by operating activities to net income is 63% ($20,200 $32,000).
*(d)
An analysis of Jia’s free cash flow indicates it is negative as shown below:*(d)
An analysis of Jia’s free cash flow indicates it is negative as shown below:
Free Cash Flow Analysis
Net cash provided by operating activities
$20,200
Less: Purchase of land
(18,000)
(18,000)
(18,000)
Dividends
(9,200)
(9,200)
(9,200)
Free cash flow
$ (7,000)
$ (7,000)
Its current cash debt coverage is .67 to 1 and its cash debt coverage ratio is .26 to 1, which are reasonable. Overall, it appears that its liquidity position is average and overall financial flexibility should be improved.
Jia has managed to more than double its cash balance in the year from cash generated from operating activities. While obtaining external financing for the majority of its investments, it has also had an alarming increase in its accounts receivable. Unless this increase is justified from increased sales or from a conscious change in credit policies, management should investigate the causes for this level of increase.