Question

Preparing a Statement of Cash Flows (Indirect Method)

Rainbow Company’s income statement and comparative balance sheets follow.

RAINBOW COMPANY Income Statement For Year Ended December 31, 2016
	Sales		$750,000
	Dividend Income		15,000
	Total Revenue		765,000
	Cost of Goods Sold	$440,000
	Wages and Other Operating Expenses	130,000
	Depreciation Expense	39,000
	Patent Amortization Expense	7,000
	Interest Expense	13,000
	Income Tax Expense	44,000
	Loss on Sale of Equipment	5,000
	Gain on Sale of Investments	(3,000)	675,000
	Net Income		$90,000

RAINBOW COMPANY Balance Sheets
		December 31, 2016	December 31, 2015
	Assets
	Cash and Cash Equivalents	$19,000	$25,000
	Accounts Receivable	40,000	30,000
	Inventory	103,000	77,000
	Prepaid Expenses	10,000	6,000
	Long-Term Investments	-	57,000
	Land	190,000	100,000
	Buildings	445,000	350,000
	Accumulated Depreciation—Buildings	(91,000)	(75,000)
	Equipment	179,000	225,000
	Accumulated depreciation—Equipment	(42,000)	(46,000)
	Patents	50,000	32,000
	Total Assets	$903,000	$781,000
	Liabilities and Stockholders’ Equity
	Accounts Payable	$20,000	$16,000
	Interest Payable	6,000	5,000
	Income Tax Payable	8,000	10,000
	Bonds Payable	155,000	125,000
	Preferred Stock ($100 par value)	100,000	75,000
	Common Stock ($5 par value)	379,000	364,000
	Paid-in capital in excess of par value—Common	133,000	124,000
	Retained Earnings	102,000	62,000
	Total Liabilities and Stockholders’ Equity	$903,000	$781,000

During 2016, the following transactions and events occurred:

1		Sold long-term investments costing $57,000 for $60,000 cash.
2		Purchased land for cash.
3		Capitalized an expenditure made to improve the building.
4		Sold equipment for $14,000 cash that originally cost $46,000 and had $27,000 accumulated depreciation.
5		Issued bonds payable at face value for cash.
6		Acquired a patent with a fair value of $25,000 by issuing 250 shares of preferred stock at par value.
7		Declared and paid a $50,000 cash dividend.
8		Issued 3,000 shares of common stock for cash at $8 per share.
9		Recorded depreciation of $16,000 on buildings and $23,000 on equipment.

Required

a. Compute the change in cash and cash equivalents that occurred during 2016.
$Answer

b. Prepare a 2016 statement of cash flows using the indirect method.

RAINBOW COMPANY STATEMENT OF CASH FLOWS FOR YEAR ENDED DECEMBER 31, 2016
Cash flows from operating activities
AnswerPatent amortizationIssuance of preferred stock to acquire patentIssuance of bonds payableNet incomeNet change in cashPurchase of landBeginning cash balance	$Answer
Add (deduct) items to convert net income to cash basis
Depreciation	Answer
AnswerPatent amortizationIssuance of preferred stock to acquire patentIssuance of bonds payableNet incomeNet change in cashPurchase of landBeginning cash balance	Answer
Loss on sale of equipment	Answer
Gain on sale of investments	Answer
Accounts receivable increase	Answer
Inventory increase	Answer
Prepaid expenses increase	Answer
Accounts payable increase	Answer
Interest payable increase	Answer
Income tax payable decrease	Answer
Net cash provided by operating activities		Answer
Cash flows from investing activities
Sale of investments	Answer
AnswerPatent amortizationIssuance of preferred stock to acquire patentIssuance of bonds payableNet incomeNet change in cashPurchase of landBeginning cash balance	Answer
Improvements to building	Answer
Sale of equipment	Answer
Net cash used by investing activities		Answer
Cash flows from financing activities
AnswerPatent amortizationIssuance of preferred stock to acquire patentIssuance of bonds payableNet incomeNet change in cashPurchase of landBeginning cash balance	Answer
Issuance of common stock	Answer
Payment of dividends	Answer
Net cash provided by financing activities		Answer
AnswerPatent amortizationIssuance of preferred stock to acquire patentIssuance of bonds payableNet incomeNet change in cashPurchase of landBeginning cash balance		Answer
AnswerPatent amortizationIssuance of preferred stock to acquire patentIssuance of bonds payableNet incomeNet change in cashPurchase of landCash and cash equivalents at beginning of year		Answer
Cash and cash equivalents at end of year		Answer

c. Prepare separate schedules showing (1) cash paid for interest and for income taxes and (2) noncash investing and financing transactions.

(1) Supplemental Cash Flow Disclosures
Cash paid for interest	$Answer
Cash paid for income taxes	$Answer
(2) Schedule of noncash investing and financing activities:
AnswerPatent amortizationIssuance of preferred stock to acquire patentIssuance of bonds payableNet incomeNet change in cashPurchase of landBeginning cash balance	$Answer

d. Compute its (1) operating cash flow to current liabilities ratio, (2) operating cash flow to capital expenditures ratio, and (3) free cash flow.
Round your answers to (1) and (2) to two decimal places.

(1)	Operating cash flow to current liabilities ratio	Answer
(2)	Operating cash flow to capital expenditures ratio	Answer
(3)	Free cash flow	$Answer

Answer 1

a. Change in cash and cash equivalents that occurred during 2016 = $ 19,000 - $ 25,000 = $ ( 6,000) Decrease

b.

Rainbow Company
Statement of Cash Flows
For the year ended December 31, 2016
Cash Flows from Operating Activities
Net Income		$ 90,000
Adjustments to reconcile net income with net cash flows from operating activities
Depreciation Expense	$ 39,000
Patent Amortization	7,000
Loss on Sale of Equipment	5,000
Gain on Sale of Investments	(3,000)
Dividend Income	( 15,000)
Increase in Accounts Receivable	(10,000)
Increase in Inventory	( 26,000)
Increase in Prepaid Expenses	(4,000)
Increase in Accounts Payable	4,000
Increase in Interest Payable	1,000
Decrease in Income Tax Payable	(2,000)	(4,000)
Net cash provided by Operating Activities		86,000
Cash Flows from Investing Activities
Proceeds from Sale of Long Term Investments	60,000
Proceeds from Sale of Equipment	14,000
Dividend Income	15,000
Cash paid for purchase of Land	(90,000)
Cash paid for improvement of Building	(95,000)
Net cash used in Investing Activities		(96,000)
Cash Flows from Financing Activities
Proceeds from issuance of Common Stock	24,000
Proceeds from issuance of Bonds Payable	30,000
Dividends paid	(50,000)
Net cash flows fro Financing Activities		4,000
Decrease in Cash and Cash Equivalents		(6,000)
Cash and Cash Equivalents, Beginning		25,000
Cash and Cash Equivalents, Ending		19,000

c.

1.	Supplemental Cash Flow Disclosures
	Cash paid for interest	$ 12,000
	Cash paid for income taxes	46,000
2.	Schedule of non-cash investing and financing activities
	Issuance of preferred stock to acquire patent	$ 25,000

d.

Operating cash flow to current liabilities ratio	2.65 times
Operating cash flow to capital expenditures ratio	0.46 times
Free cash flow	$ ( 10,000)