Answer Outlines for Exam Questions Flashcards
Preparing a Statement of Cash Flows
Before starting the cashflow statement, first work out what the final cashflow answer will be:
Y1 (last year): Cash and cash equivalents - Bank overdrafts = ‘Y1 cash’
Y2 (this year): Cash and cash equivalents - Bank overdrafts = ‘Y2 cash’
Net change in cash and equivalents = Y2 cash - Y1 cash
Cash flows from operating activities
Profit from operations
Adjustments for:
Depreciation see ‘Further information’; add it back, because it’s a non-cash item
(Dividends received) only dividends received goes here; dividends paid goes directly too financing acitivies
(Profit/Loss on disposal of property, plant, and equipment)
Decrease/(increase) in inventories comparing last years and this years figures
Decrease/(increase) in trade receivables
(Decrease)/increase in trade payables
Cash generated by operations
(Tax paid) = last year’s Tax liabiities + Tax paid [income statemtent] - this year’s Tax liabilities ; in other words: what you owe from last year + what you have to pay this year - how much is left to pay / what you owe this year
(Interest paid) if it doesnt mention Finance cost or Interest in the liabilities section in the SOFP, then just take the Finance cost from the income statement. Otherwise: yast year’s Interest liabiities + Finance cost [income statemtent] - this year’s Interest liabilities
Net cash from operating activities
Cash flows from investing activities
Dividends received
Proceeds on disposal of PPE because profit is not cash: carrying amount of assets sold [how much it was worth: see ‘Further Information’] + profit on disposal OR - loss on disposal = proceeds (what you sold it for)
(Purchases of PPE) = last year’s PPE - depreciation - carrying amount of assets sold - this year’s PPE
Net cash used in investing activities
Cash flows from finance activities
(Bank loans repaid) last year’s Bank loans - this year’s Bank loan [SOFP] = positive number
or New bank loans last year’s Bank loans - this year’s Bank loan [SOFP] = negative number
(Dividends paid)
(Proceeds of share issue) add Share Capital and Share premium from each year and find the difference between the years of those two sums; positive figure means you’ve issued shares –> positive cash flow
Net cash from financing activities
Net increase/(decrease) in cash and cash equivalents sum of all 3 activities; should match the cashflow figure calculate at the beginning
Cash and cash equivalents at beginning of year cash and cash equ. - bank overdrafts from last year
Cash and cash equivalents at end of year cash and cash equ. - bank overdrafts from this year
a) Calculate the cash flow and profit for each year
b) Calculate
- Payback
- ARR
- NPV at 10%
- IRR using NPV at 10% and 12%
Don’t forget that at Year 0, the cashflow is negative 300,000
Why is the NPV considered most suitable for evaluating capital expenditure proposals?
Payback period ranks projects on the basis of how quickly the cash inflows pay back the investment and the both ARR and IRR ranks projects on the basis of the ratio of average profits to average investment.
These two methods do not take into account the time value of money. The capital invested is either borrowed where interest becomes payable or capital that could be invested and interest earned. Hence, any method which does not take into account the interest aspect or the time value of money is not suitable.
The NPV and the IRR method through discounting takes into account the time value of money. The NPV method shows the present value of the deficit or surplus at the end of the life of a project. This is more meaningful than the IRR method which only shows the maximum cost of capital that the project could afford.
What are the difficulties companies face when deciding the most appriopriate discount rate to use in the Net Present Value?
The reliability of the NPV depends on the correctness of the discount rate, but risk due to unpredictable future.
The life of projects usually extend over many years. The discount rate reflects the cost of capital which can change frequently over a few years as can be seen in the current “Credit Crunch”.
The cost of capital is linked to interest rates and availability of capital. Most projects involve the production and marketing of products or services and these involve a certain amount of risk. The discount rate chosen must also include a measure for the risk involved. Companies find it difficult to decide on the correct discount rate to reflect the foregoing.
Garry has receivables of £50,000 and writes off a bad debt of £2,000. How would we show this in the final accounts?
From above. Garry’s mate John tells him he should have had aprovision for doubtful debts. So he decides to set one up using 5% of the closing receivables. How would you show this in the final accounts?
Diana has an opening provision for doubtful debts account of £4,000 and debtors of £120,000. She has to write off debts of £3,500 and increases her provision for doubtful debts to 5% of the closing receivables. How you show this in the final accounts?
Jimmy buys a new machine for £24,000 and depreciates it at 10% per annum using the straight-line method. What will be in his Income Statement and Balance Sheet at the end of the first year?
straight-line
Income Statement:
- Mach. depr. 15k
- Fix. depr. 25k
SOFP
- Mach. NBV 55k
- F. NBV 200k
reducing-balance
Income Statement:
- Mach. depr. 5k
- Comp. depr. 26k
SOFP
- Mach. NBV 15k
- C. NBV 104k
Why is the profit is reduced every year by depreciation?
Where does all the money go? Is there a reduction in cash?
The purpose of depreciation is to match the cost of a productive asset (that has a useful life of more than a year) to the revenues earned from using the asset.
Since it is hard to see a direct link to revenues, the asset’s cost is usually allocated to (assigned to, spread over) the years in which the asset is used.
The first thing to understand about depreciation expense is that it is a real expense of doing business. People sometimes refer to depreciation expense as representing a “paper” expense because no cash changes hands when there is a charge for depreciation.
Share Capital vs Share Premium
The key difference between share capital and share premium is that while share capital is the equity generated through the issue of shares at face value, share premium is the value received for shares that exceed the face value.
https://www.differencebetween.com/difference-between-share-capital-and-vs-share-premium/
