7P - Intermediate Accounting (Kieso)

Question

Aero Inc. had the following balance sheet at December 31, 2016.

LANSBURY INC.
BALANCE SHEET
DECEMBER 31, 2016
Cash	\(20,000	Account payable	\)30,000
Accounts receivables	21,200	Bond payable	41,000
Investment	32,000	Common stock	100,000
Plant assets (net)	81,000	Retained earnings	23,200
Land	40,000
	\(194,200		\)194,200

 

During 2017, the following occurred. 

1. Aero liquidated its available-for-sale debt investment portfolio at a loss of \(5,000.

2. A tract of land was purchased for \)38,000. 

3. An additional \(30,000 in common stock was issued at par. 

4. Dividends totaling \)10,000 were declared and paid to stockholders. 

5. Net income for 2017 was \(35,000, including \)12,000 in depreciation expense. 

6. Land was purchased through the issuance of \(30,000 in additional bonds. 

7. At December 31, 2017, Cash was \)70,200, Accounts Receivable was \(42,000, and Accounts Payable was \)40,000. 

Instructions 

(a) Prepare a statement of cash flows for the year 2017 for Aero. 

(b) Prepare the unclassified balance sheet as it would appear at December 31, 2017.

(c) Compute Aero’s free cash flow and current cash debt coverage for 2017. 

(d) Use the analysis of Aero to illustrate how information in the balance sheet and statement of cash flows helps the user of the financial statements.

Step-by-Step Solution

Answer

The net increase in the cash balance is equal to $50,200.

Definition of Free Cash Flow

A business entity's cash flow after all the outflows regarding the operating activities and capital assets is known as free cash flow.

Statement of Cash Flow

Particular	Amount $	Amount $
Opening Cash balance
Cash flow from operations:
Net income	$35,000
Add: Adjustment for reconciling net income to net cash.
Depreciation expenses	12,000
Increase in accounts payable	10,000
Loss on sale of investment	5,000
Increase in accounts receivables	(20,800)
Net Cash flow from operation		$41,200
Cash flow from investing activities:
Land purchased for cash	(38,000)
Sale of available for sale investment	27,000
Net cash flow from investing		(11,000)
Cash flow from financing activities:
Cash dividend	(10,000)
Issue of common stock	30,000
Net cash flow from finance		20,000
Net increase or decrease in cash		50,200
Add: opening cash balance		20,000
Ending cash balance		$70,200

Unclassified Balance sheet

LANSBURY INC.
BALANCE SHEET
DECEMBER 31, 2016
Cash	$70,200	Account payable	$40,000
Accounts receivables	42,000	Bond payable	71,000
Investment	0	Common stock	130,000
Plant assets (net)	69,000	Retained earnings	48,200
Land	108,000
	$289,200		$289,200

Cash Flow Ratios

Free cash flow

Particular	Amount $
Cash flow from operations	$41,200
Less: Dividend	(10,000)
Less: Capital expenditure	(38,000)
Free Cash Flow	($6,800)

$\begin{array}{rcl}\mathrm{Current} \mathrm{cash} \mathrm{debt} \mathrm{coverage}& =& \frac{\mathrm{Cash} \mathrm{flow} \mathrm{from} \mathrm{operating} \mathrm{activities}}{\mathrm{Average} \mathrm{current} \mathrm{liabilities} }\\ & =& \frac{\$41,200}{{\displaystyle \frac{\$40,000+\$30,000}{2}}}\\ & =& 1.18\end{array}$

Importance of Information Provided by the Balance Sheet and Statement of Cash Flow

The balance sheet and cash flow statement provide information to help the users predict financial flexibility and performance. It helps the users determine all the inflows and outflows of cash. It also helps the business entity in determining liquidity and solvency.