Question

The various scenarios below involve issues that may arise for entities that prepare their financial statements
using a special purpose framework (SPF).

Required—Provide the information requested in each scenario.

1. Silver Company is a cash method taxpayer and uses this basis for its financial statements. It has a 20%
tax rate, began fiscal 2019 with retained earnings of $25,000, and has determined pre-tax amounts for
fiscal 2019 as follows—revenues and expenses total $100,000 and $60,000, respectively, with the
former including $10,000 in municipal bond interest. Silver’s accountant is seeking your help in
preparing its “Statement of Revenues, Expenses, and Retained Earnings—Income Tax Basis.”

What guidance should you offer the accountant? Express it by preparing a draft of the statement.

2. Gold Company is a small, privately owned business that uses the pure cash basis. Gold’s accountant
has prepared a draft of its financial statement for your review, as presented below:

Gold Company
Statement of Cash Flows
For the Year Ended December 31, 2019

Net cash flows provided by operating activities      $36,000
Net cash flows used in investing activities               24,000
Net cash flows provided by financing activities       15,000
Increase in cash                                                      27,000
Cash, January 1, 2019                                            13,000
Cash, December 31, 2019                                      $40,000

What observations and suggested revisions, if any, should you share with the accountant?

Answer 1

Assumption: Details of Municipal bond Interest is not depicted clearly, hence it is treated as a Indirect Income.

Statement of SILVER COMPANY
Particulars	Amount
Revenue	1,00,000
Less: Expenses	-    60,000
Contribution From Operations	40,000
Add: Interest on Municipal Bonds	10,000
Profit Before Tax	50,000
Less: Tax Expense @ 20%	-    10,000
Net Profit Transferred to Retained Earnings	40,000
OPENING BALANCE OF RETAINED EARNINGS	25,000
CLOSING BALANCE OF RETAINED EARNINGS	65,000

Cash Flow Statement of GOLD COMPANY
Particulars	Amount
NET CASH INFLOW FROM OPERATION ACTIVITIES	36,000
NET CASH OUTFLOW FROM INVESTING ACTIVITIES	-    24,000
NET CASH INFLOW FROM FINANCING ACTIVITIES	15,000
TOTAL CASH INFLOW	27,000
OPENING CASH BALANCE, JANUARY 01, 2019	13,000
CLOSING CASH BALANCE, DECEMBER 31, 2019	40,000

OBSERVATIONS

1. Company having negative Cash Flows From Investing Activities depict that Company is engaged in Capital Expenditure Cycle or Replacement Cycle.
2. Cash Outflow of Investing Activiy is higher than Cash inflow of Financial Activity, suggesting that Company is using Short Term Funds for Long Term Investing.
3. Funding of Long Term Projects from Operating Funds may result in Short Term Liquidity Crises.
4. Further, Cash Inflows from Operating activities suggests, Operational efficiency & effectiveness of Accounts Management.

SUGGESTIONS:

1. If operation efficiency is high, then use of Debt for investment may lead to higher RETURNS ON EQUITY.
2. To avoid short term liquidity crises, financing is better option to fund investment rather than to use operational activity funds.