Question

Accounting, Analysis, and Principles The income statement for the year ended December 31, 2017, for Laskowski Manufacturing Company contains the following condensed information.

LASKOWSKI CO. INCOME STATEMENT
Revenues	\(6,583,000
Operating expenses (excluding depreciation) \)4,920,000
Depreciation expense 880,000	5,800,000
Income before income tax	783,000
Income tax expense	353,000
Net income	\( 430,000

Included in operating expenses is a \)24,000 loss resulting from the sale of machinery for \(270,000 cash. The company purchased machinery at the cost of \)750,000.

Laskowski reports the following balances on its comparative balance sheets on December 31.

LASKOWSKI CO. COMPARATIVE BALANCE SHEETS (PARTIAL)
	2017	2016
Cash	\(672,000	\)130,000
Accounts receivable	775,000	610,000
Inventory	834,000	867,000
Accounts payable	521,000	501,000

Income tax expense of \(353,000 represents the amount paid in 2017. Dividends declared and paid in 2017 totalled \)200,000.

Accounting

Prepare the statement of cash flows using the indirect method.

Analysis

Laskowski has an aggressive growth plan, which will require significant investments in plant and equipment over the next several years. Preliminary plans call for an investment of over $500,000 in the next year. Compute Laskowski’s free cash flow (from Chapter 5) and use it to evaluate the investment plans with the use of only internally generated funds.

Principles

How does the statement of cash flows contribute to achieving the objective of financial reporting?

Short answer

1. The net increase in cash and cash equivalents is$542,000
2. Free cash flow is $272,000
3. By employing a statement of cash flows that separates cash streams over the period into working, contributing, and financing exercises

Step-by-step solution

Meaning of Income Statement

The income statement shows the amount of money earned and how much was spent over a given period. It is generally prepared at the year-end.

Evaluating the Accounting part

LASKOWSKI COMPANY Statement of Cash Flows—Indirect Method For the Year Ended December 31, 2011 LASKOWSKI COMPANY Statement of Cash Flows—Indirect Method For the Year Ended December 31, 2011 LASKOWSKI CO Statement of Cash Flows
Cash flow from operating activities
Net income	$430,000
Adjustment to reconcile net income to net cash provided by operating activity:
Depreciation expense $880,000
Loss on sale of machinery 24,000
Increase in accounts receivables (165,000)
Decrease in inventory 33,000
Increase in account payable 20,000	792,000
Net cash provided by operating activities	1,222,000
Cash flowing from investing activities:
Sale of machinery 270,000
Purchase of machinery (750,000)
Net cash used for investing activities	($480,000)
Cash flows from financing activities.
Payments of cash dividends (200,000)
Net cash used for financing activities	(200,000)
Net increase in cash	542,000
Cash at the beginning of the period	130,000
Cash at the end of the period	$672,000

Explaining the analysis component

LASKOWSKI CO. free cash flow:
Net cash provided by operating activities	$1,222,000
Less: Purchase of machinery	750,000
Dividends	200,000
Free cash flow	$272,000

The sum required for expansion the following year ($500,000) is greater than Laskowski's free cash flow for the present year, i.e., 31 December 2017 is ($272,000). Laskowski's free cash flow won't be enough to finance the expansion plan, even if operations continue at a similarly constant level in subsequent quarters. The business might consider lowering the dividend or borrowing money to get more for the expansion.

Explaining the Principal component

IAS 7 states, "Information on the cash flows of a substance is profitable in providing users of financial statements with a premise to evaluate the capacity of the trade to produce cash and cash equivalents and desires of the entity to utilize those cash flows." Users must evaluate an entity's capacity to deliver cash and cash counterparts, as well as the timing and certainty of those productions, to create financial judgments. By employing a statement of cash flows that separates cash streams over the period into working, contributing, and financing exercises, this Standard looks to compel the supply of data on the verifiable changes in cash and financial reciprocals of a company.