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18E

Expert-verified
Intermediate Accounting (Kieso)
Found in: Page 247

Short Answer

The comparative balance sheets of Madrasah Corporation at the beginning and end of the year 2017 appear below.

MADRASAH CORPORATION

BALANCE SHEETS

Assets

Dec 31, 2017

Jan 1, 2017

Inc./Dec.

Cash

$20,000

$13,000

$7,000 Inc.

Accounts receivable

106,000

88,000

18,000 Inc.

Equipment

39,000

22,000

17,000 Inc.

Less: Accumulated depreciation – Equipment

17,000

11,000

6,000 Inc.

Total

$148,000

$112,000

Liabilities and Stockholder’s equity

Account payable

$20,000

$15,000

5,000 Inc.

Common stock

100,000

80,000

20,000 Inc.

Retained earnings

28,000

17,000

11,000 Inc.

Total

$148,000

$112,000

Net income of $44,000 was reported, and dividends of $33,000 were paid in 2017. New equipment was purchased and none was sold.

Instructions

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

(b) Compute the current ratio (current assets ÷ current liabilities) as of January 1, 2017, and December 31, 2017, and compute free cash flow for the year 2017.

(c) In light of the analysis in (b), comment on Madrasah’s liquidity and financial flexibility.

The current ratio of the company is 6.3 times.

See the step by step solution

Step by Step Solution

Definition of Current Ratio

The financial metric used to evaluate the financial liquidity of the business entity by using the current assets and current liabilities is known as the current ratio.

Statement of cash flow

Particular

Amount $

Amount $

Cash flow from operations

Net income

$44,000

Add or less: Adjustments to net income

Depreciation expenses

6,000

Increase in accounts receivables

(18,000)

Increase in accounts payable

5,000

Cash flow from operating activities

$37,000

Cash flow from investing activities

Purchase of equipment

(17,000)

Cash flow used in investing activities

(17,000)

Cash flow from financing activities

Cash dividend

(33,000)

Issue of common stock

20,000

Cash flow used in financing activities

(13,000)

Net increase or decrease in cash

7,000

Add: opening cash balance

13,000

Ending cash balance

$20,000

Current ratio and Free Cash Flow

Calculation of free cash flow:

Particular

Amount $

Cash flow from operations

$37,000

Less: Capital expenditure

(17,000)

Less: Cash dividend

(33,000)

Free cash flow

($13,000)

Interpreting Liquidity and Flexibility

Liquidity: The business entity reflects a good liquidity position because the current ratio is 6.3 times. It means that a business entity can easily pay off its current liabilities by using the current assets.

Flexibility: The business entity is not efficient in terms of financial flexibility because free cash flow is negative. The business entity cannot cover its capital expenditure and dividend expenses using the cash generated from the basic functions.

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