Question

Orange Ltd., a publicly traded company, has compiled their comparative Statement of Financial Position as follows for their December 31, 20X8 year-end.

  Orange Ltd
Comparative Statement of Financial Position
As at December 31, 20X8

	20X8		20X7
Assets
Current Assets
Cash	42,485		22,000
Accounts receivable	163,794		181,000
Inventory	23,000	229,297	53,000	256,000
Non-current assets
PP&E (net)	759,600		446,000
Patents	80,000	839,600	87,000	295,000
Total Assets		1,068,897		507,000
Liabilities and Equity
Current liabilities
Accounts payable	47,532		31,700
Income tax payable	86,000	133,532	73,200	104,900
Non-current liabilities
Bank loan		698,000		275,000
Total liabilities		831,532		379,900
Equity
Common shares	78,000		78,000
Retained earnings	159,365	237,365	49,100	270,000
Total equity
Total Liabilities and Equity		1,068,897		507,000

Additional information:

·         Net income in 20X8 was $146,400: Sales were 1,552,000; Cost of sales 852,000; Operating expenses of 310,000; interest expense of 14,000; and income tax expense of 238,000.

·         PP&E is presented net of accumulated depreciation of $45,000 in 20X8 and $37,000 in 20X7. There have been no disposals of PPE during the year.

·         Patents are presented net of accumulated amortization of $29,000 in 20X8 and $22,000 in 20X7. There have been no disposals of intangible assets during the year.

Required:

(a)    Prepare the operating section of Orange’s Statement of Cash Flows for 20X8 using the direct method. (8 marks)

Orange Ltd
Statement of Cash Flows
For the year ended December 31, 20X8

Operating activities
Cash from customers ( )
Cash paid to suppliers ( )
Cash paid for other operating expenses ( )
Cash paid for interest
Cash paid for taxes ( )
Cash provided by (used in) operating activities

	20X8	20X7
Liquidity: current ratio	?	?
Solvency: debt to total assets	?	?
Leverage: debt to equity	?	?

(b)   Write a 4-5 sentence memo to the shareholders of Orange Ltd discussing changes in the company’s liquidity, solvency, and leverage year-over-year. (3 marks)

Answer 1

Let’s first do the working notes and compute the following –

I. Amount received from customers

Accounts receivable Account

Particulars	Amount	Particulars	Amount
Balance b/d	1,81,000	Cash received (balancing figure)	1,569,026
Sales	1,552,000	Balance c/d	163,974
	1,733,000		1,773,000

II. Amount paid to suppliers

Inventory Account

Particulars	Amount	Particulars	Amount
Balance b/d	53,000	Cost of Sales	852,000
Purchases (balancing figure)	822,000	Balance c/d	23,000
	875,000		875,000

Accounts Payable Account

Particulars	Amount	Particulars	Amount
Cash paid (Balancing figure)	806,168	Balance b/d	31,700
Balance c/d	47,532	Purchases	822,000
	853,700		853,700

III. Amount paid for other operating expenses

There is no liability in the balance sheet in respect of the above. Hence, the entire operating expense of 310,000 must have been paid during the 20X8.

IV. Amount paid for interest

There is no liability in the balance sheet in respect of the above. Hence, the entire interest expense of 14,000 must have been paid during the 20X8.

V. Amount paid for taxes

Income tax Payable Account

Particulars	Amount	Particulars	Amount
Cash paid (Balancing figure)	225,200	Balance b/d	73,200
Balance c/d	86,000	Expense for the year	238,000
	311,200		311,200

VI. Reconciliation of income statement

Income Statement

Particulars	Amount	Particulars	Amount
Cost of Sales	852,000	Sales	1,552,000
Operating Expenses	310,000	Other income (Balancing figure)	23,400
Interest Expense	14,000
Income tax expense	238,000
Depreciation on PPE (45,000 - 37,000)	8,000
Depreciation on Patent (29,000 - 22,000)	7,000
Net income	146,400
	1,575,400		1,575,400

Computing cash flows from operating section

Amount received from customers                                           -              1,569,026

Other income                                                                                    -              23,400

Amount paid to suppliers                                                             -              (806,168)

Amount paid for other operating expenses                         -              (310,000)

Amount paid for interest                                                              -              (14,000)

Amount paid for taxes                                                                   -              (225,200)

                                                                                                                                237,058

                                                                                                                                                20X8                      20X7

Current Ratio (Current Assets / Current Liabilities)

- 229,297/133,532                                                                                               1.717

- 256,000/104,900                                                                                                                               2.44

Debt to Total assets (Debt/ total assets)

- 698,000/1,068,897                                                                                            0.653

- 275,000/507,000                                                                                                                               0.542

Debt to Equity (Debt/ Equity)

- 698,000/237,365                                                                                               2.941

- 275,000/270,000                                                                                                                               1.019

The current ratio of the company has declined from 2.44 to 1.717. This is because of reduction in current assets and increase in current liabilities. In effect, the company has reduced its investment in the working capital.

The solvency ratio has increased implying increase in debt as compared to increase in assets of the company. During 20X8, company has availed the bank loan, however, the assets have not increased in the same proportion.

Further, the leverage ratio has also worsened on account of increase in debt.

Note: The assets side of the balance sheet of 20X7 is not matching. The aggregated total of current assets and non-current assets is 551,000 (instead of 507,000) and further individual sum of non-current assets is 533,000 (instead of 295,000). Hence, the question is wrong. The above answer would consequentially change.