(a)Both the direct method and the indirect method for reporting cash flows from operating activities are acceptable in preparing a statement of cash flows according to SFAS No. 95; however, the FASB encourages the use of the direct method. Under the direct method, the statement of cash flows reports the major classes of cash receipts and cash disburse-ments, and discloses more information; this may be the statement’s principal advantage. Under the indirect method, net income on the accrual basis is adjusted to the cash basis by adding or deducting noncash items included in net income, thereby providing a useful link between the statement of cash flows and the income statement and balance sheet.

(b)The Statement of Cash Flows for George Winston Company, for the year ended May 31, 2008, using the direct method, is presented below.

George Winston Company
STATEMENT OF CASH FLOWS
For the Year Ended May 31, 2008
Cash flows from operating activities
Cash received from customers / $1,233,250
Cash paid
To suppliers / $674,000
To employees / 276,850
For other expenses / 10,150
For interest / 73,000
For income taxes / 43,000 / 1,077,000
Net cash provided by operating activities / 156,250
Cash flows from investing activities
Purchase of plant assets / (48,000)
Cash flows from financing activities
Cash received from common stock issue / $ 40,000
Cash paid
For dividends / (105,000)
To retire bonds payable / (30,000)
Net cash used by financing activities / (95,000)
Net increase in cash / 13,250
Cash, June 1, 2007 / 20,000
Cash, May 31, 2008 / $ 33,250

Note 1:Noncash investing and financing activities:

Issuance of common stock for plant assets $50,000.

Supporting Calculations:

Collections from customers
Sales / $1,255,250
Less:Increase in accounts receivable / 22,000
Cash collected from customers / $1,233,250
Cash paid to suppliers
Cost of merchandise sold / $722,000
Less:Decrease in merchandise inventory / 40,000
Increase in accounts payable / 8,000
Cash paid to suppliers / $674,000
Cash paid to employees
Salary expense / $252,100
Add:Decrease in salaries payable / 24,750
Cash paid to employees / $276,850
Cash paid for other expenses
Other expenses / $ 8,150
Add: Increase in prepaid expenses / 2,000
Cash paid for other expenses / $10,150
Cash paid for interest
Interest expense / $75,000
Less:Increase in interest payable / 2,000
Cash paid for interest / $73,000
Cash paid for income taxes:
Income tax expense (given) / $43,000

(c)The calculation of the cash flow from operating activities for George Winston Company, for the year ended May 31, 2008, using the indirect method, is presented below.

George Winston Company
STATEMENT OF CASH FLOWS
For the Year Ended May 31, 2008
Cash flows from operating activities
Net income / $130,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense / $25,000
Decrease in merchandise inventory / 40,000
Increase in accounts payable / 8,000
Increase in interest payable / 2,000
Increase in accounts receivable / (22,000)
Increase in prepaid expenses / (2,000)
Decrease in salaries payable / (24,750) / 26,250
Net cash provided by operating activities / $156,250

(a)Time diagram (alternative one):

i = ?

PV–OA =

$572,000 R =

$80,000 $80,000 $80,000 $80,000 $80,000

0 1 2 10 11 12

n = 12

Formulas:PV–OA = R (PVF–OAn, i)

$572,000 = $80,000 (PVF–OA12, i)

PVF–OA12, i = $572,000  $80,000

PVF–OA12, i = 7.15

7.15 is present value of an annuity of $1 for 12 years discounted at approximately 9%.

Time diagram (alternative two):

i = ?

PV = $572,000FV = $1,900,000

n = 12

Future value approach / Present value approach
FV = PV (FVFn, i) / PV = FV (PVFn, i)
or
$1,900,000 = $572,000 (FVF12, i) / $572,000 = $1,900,000 (PVF12, i)
FVF12, i / = $1,900,000  $572,000 / PVF12, i / = $572,000  $1,900,000
FVF12, i / = 3.32168 / PVF12, i / = .30105
3.32 is the future value of $1
invested at between 10% and
11% for 12 years. / .301 is the present value of $1
discounted at between 10%
and 11% for 12 years.

Mark Grace, Inc. should choose alternative two since it provides a higher rate of return.

(b)Time diagram:

i = ?

(824,150 – $200,000)

PV–OA = R =

$624,150 $76,952 $76,952 $76,952 $76,952

0 1 8 9 10

n = 10 six-month periods

Formulas:PV–OA = R (PVF–OAn, i)

$624,150 = $76,952 (PVF–OA10, i)

PV–OA10, i = $624,150  $76,952

PV–OA10, i = 8.11090

8.11090 is the present value of a 10-period annuity of $1 discounted at 4%. The interest rate is 4% semiannually, or 8% annually.

(c)Time diagram:

i = 5% per six months

PV = ?

PV–OA = R =

? $24,000 $24,000 $24,000 $24,000 $24,000 ($600,000 X 8% X 6/12)

0 1 2 8 9 10

n = 10 six-month periods [(7 – 2) X 2]

Formulas:

PV–OA = R (PVF–OAn, i)PV = FV (PVFn, i)

PV–OA = $24,000 (PVF–OA10, 5%)PV = $600,000 (PVF10, 5%)

PV–OA = $24,000 (7.72173)PV = $600,000 (.61391)

PV–OA = $185,321.52PV = $368,346

Combined present value (amount received on sale of note):

$185,321.52 + $368,346 = $553,667.52

(d)Time diagram (future value of $300,000 deposit)

i = 2½% per quarter

PV =

$300,000 FV = ?

12/31/01 12/31/03 12/31/10 12/31/11

n = 40 quarters

Formula:FV = PV (FVFn, i)

FV = $300,000 (FVF40, 2½%)

FV = $300,000 (2.68506)

FV = $805,518

Amount to which quarterly deposits must grow:

$1,300,000 – $805,518 = $494,482.

Time diagram (future value of quarterly deposits)

i = 2½% per quarter

R R R R R R R R R

R = ? ? ? ? ? ? ? ? ?

12/31/01 12/31/02 12/31/10 12/31/11

n = 40 quarters

Formulas: FV–OA = R (FVF–OAn, i)

$494,482 = R (FVF–OA40, 2½%i)

$494,482 = R (67.40255)

R = $494,482  67.40255

R = $7,336.25