Financial management for public health and not for profit organizations 5th edition finkler solution

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Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

Chapter 10

REPORTING THE RESULTS OF OPERATIONS— THE ACTIVITY AND CASH FLOW STATEMENTS

QUESTIONS FOR DISCUSSION 10-1. The Activity Statement is often referred to by other names, including the Income Statement, Statement of Changes in Net Assets, the Operating Statement, Profit and Loss (P&L) Statement, Earnings Report, Statement of Revenues and Expenses, and Statement of Revenues and Expenditures.

10-2. All organizations need to measure their net income, surplus, or excess of revenues over expenses. This allows them to determine whether their asset inflows exceed or fall short of their asset outflows. Public service organizations need to have adequate profits to sustain, update, and expand the services provided. Failure to earn a profit, or at least break even, can endanger the organization. However, because their mission is largely one of public service, many organizations do not wish to maximize their profits. The purpose of the income statement is to provide management with information they need to steer the organization as necessary to best accomplish its objectives.

10-3. Revenues and expenses can only be recorded if certain conditions are met. Revenues are recorded if they have been earned and realized. The first requirement, being earned, is met only if the organization has provided goods or services to the customer. If a legal transfer has occurred, raising a legal right to collect payment, then the revenues have been earned. To be realized we must be able to objectively measure the amount of money owed, and there must be a reasonable likelihood of eventual collection.

Support recognition is allowed even though the gift has not been received, and even though no goods or services have actually been provided. In fact, pledges are enforceable contracts. We record pledges as support if there is a specific amount and a reasonable likelihood of collection.

10-4. Some types of expenses are product costs, and other types of costs are period costs. Product costs are those expenses that are directly connected to providing goods and services. They become expenses as they get used up. Period costs are those that relate to the passage of time, rather than the direct provision of services. They become expenses as they expire over time. For example, rent on a machine for a specific month or year expires as time passes.

10-5. It is unlikely that all numbers in the organization’s bookkeeping records are exactly correct. If numbers are reported to the nearest dollar or to the penny, there is an inference of greater accuracy than is likely to actually exist. By rounding off numbers, the financial statements provide a better sense to the user that this is approximately what has occurred, rather than exactly and precisely what has happened.

Chapter 10: Reporting the Results of Operations: The Activity and Cash Flow Statements

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10-6. This is a fairly open-ended question. Although the revenue from telephone is down, there is an equal increase in revenues from mail solicitations. Perhaps management decided it would be less expensive to increase the number of pieces of mail and reduce the number of phone calls. One would wonder whether it did turn out that this form of solicitation was less expensive, per dollar raised. If so, perhaps we should pursue it even more in the future. On the other hand, if we spent just as much on telephone solicitation as in the past, but had lower yields, the organization should be trying to find out why. The point of this exercise is to encourage students to look more critically at the numbers in the statement and to start using them as an effective management tool.

10-7. That would be extremely unlikely. The bad debt expense represents the portion of revenues earned for a period of time that will not be collected. In contrast, the balance sheet looks at a moment in time. Given the amount of receivables owed to us at that moment in time, what portion of those receivables will not be collected? For example, an activity statement for a year would include as bad debts the portion of that year’s revenue that we don’t expect to be able to collect. The balance sheet at the end of the year might have an allowance for uncollectible accounts related to revenues from that year as well as from prior years revenues that we are still trying to collect.

10-8. No. The primary goal of depreciation is not determining the current value of the asset to place on the balance sheet. Depreciation strives to allocate the cost of the asset over the asset’s useful life.

In accord with the matching principle of GAAP, the goal of depreciation is to assign expense for use of the asset into the periods that the asset is used up, generating revenue. Depreciation is based on assigning the cost incurred when we acquired the asset, rather than on some measure of replacement cost if we were to buy the asset now.

10-9. At best, estimates are subjective guesses. We can try to base them on historical experience, but they still introduce the possibility of errors into the financial statements. Another problem is that estimates open the door to manipulating results. If we want to look poor to encourage donations, we might be tempted to overstate bad debt expense or to underestimate the salvage value of a piece of equipment. Both of those actions would tend to lower current net income, making us look poorer now. Estimates increase the chances that the financial statements will not be free of material misstatements.

10-10. No, for organizations using the accrual basis of accounting, the activity and cash flow statements are complementary, rather than being substitutes. Income statements measure profitability, but profitability alone does not assure viability. We must know how much cash was received and used, where it came from, and what it was spent on. An organization can be profitable but run out of cash if payment for its expenses precedes receipt of cash from revenues. An organization can appear to have sufficient cash, but that cash may be from one-time sources that will not repeat, and the future may be worse than the present. We should know if that it is the case. The cash flow statement helps by showing not only the amount of cash flow, but also the specific major categories of sources and uses of cash.

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Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

10-11. The statement shows Cash Flows from Operating Activities, Cash Flows from Investing Activities, and Cash Flows from Financing Activities. Cash from operating activities helps us understand the organization’s ability to continue operations over time. If this number is positive, then the routine operations are self-sustaining. Cash from investing activities allows us to determine if the organization is spending cash to either acquire productive assets or investments in stocks and bonds. Alternatively, we might learn that the organization is selling its fixed assets to raise cash. That would send a warning signal of potential problems. Cash from financing activities shows sources of cash such as loans and issuance of stock. If the organization is taking out long-term loans to finance cash losses from current operations, that would also send a warning signal.

10-12. The balance sheet, activity statement, and cash flow statement are interconnected. The information from each relies to some extent on information from the others. Suppose that we use up inventory as we provide services during the year. Our asset—inventory—goes down on the balance sheet. Our expense related to supply use increases on the activity statements. Just the reverse happens with revenues. When we charge clients for our services, accounts receivable rise, increasing assets and the balance sheet. Revenues also rise, affecting the activity statement.

The net of the revenues and expenses helps account for the change in net assets on the balance sheet from the beginning to the end of the year.

The cash flow statement has linkages to both the activity statement and balance sheet. The first line on the cash flow statement is the change in net assets, taken from the activity statement.

The ending balance of the cash flow statement is the cash balance, which appears at the beginning of the balance sheet.

The balance sheet provides information on the current assets and current liabilities (working capital). The change in each working capital account has an impact on the organization’s cash balances. These changes primarily show in the adjustments that are made in the cash from operations section of the cash flow statement. Changes in fixed assets and investments on the balance sheet are reflected in the cash from investing activities section of the cash flow statement. Similarly, financing activities will appear on the cash flow statement, but also are reflected in changes in long-term liability values on the balance sheet.

10-13. Permanent accounts are those whose balance carries over from the end of one year to the beginning of the next. For example, the amount of cash that the organization has at the end of one year becomes its beginning cash balance at the start of the next year. In contrast, the balance in temporary accounts is emptied out each year. For example, revenue and expense accounts, which are temporary accounts, transfer their balances to net assets at the end of the year. As a result, net assets are adjusted to show the impact of profits on the equity of the organization, and the revenue and expense accounts begin the next accounting period with a zero balance. This is appropriate, because revenue and expense are measurements for a specific period of time, rather than being cumulative balances for the entire existence of the organization.

Chapter 10: Reporting the Results of Operations: The Activity and Cash Flow Statements

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Problems 10-14.

10-15. (Transaction Analysis) 1.

Jan. 12 Assets (A) Cash + $300,000

=

Liabilities (L)

+

Net Assets (NA)

=

No change

+

No change

Pledges receivable – $300,000 Date 1/12

Cash Pledges receivable Collection of pledges

Dr. $300,000

Cr. $300,000

Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

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2.

Feb. 4 No journal entry. There has been no exchange by either party.

3.

Mar. 1 Assets (A) Cash – $50,000 Date 3/1

=

Liabilities (L)

+ –

= Dr. $50,000

Grant Expense Cash

Net Assets (NA) Grant Expense $50,000 Cr. $ 50,000

Pay grant to GARCH

4.

May 29 Assets (A) Deposit + $5,000

=

Liabilities (L)

+

Net Assets (NA)

=

No change

+

No change

Cash – $5,000

Date 5/29

Dr. $5,000

Deposit Cash

Cr. $5,000

Deposit on ordered partitions

5.

Jun. 12 Assets (A) Cash + $80,000 Date 6/12

=

Sept. 1

+

=

Cash Donation revenue Donation revenue.

6.

Liabilities (L)

+ Dr. $80,000

Net Assets (NA) Donation revenue + $80,000 Cr. $80,000

Chapter 10: Reporting the Results of Operations: The Activity and Cash Flow Statements

Assets (A) Inventory + $60,000

= =

Liabilities (L) Accounts payable + $30,000

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+

Net Assets (NA)

+

No change

Cash – $30,000 Date 9/1

Dr. $60,000

Inventory Cash Accounts payable

Cr. $30,000 30,000

Purchase bookstore inventory.

7.

Oct. 15 Assets (A) PPE + $15,000

=

Liabilities (L)

+

Net Assets (NA)

=

No change

+

No change

Deposit – $5,000 Cash – $10,000 Date 10/15

Dr. $15,000

PPE Deposit Cash Received partitions (property, plant, and equipment)

Cr. $ 5,000 10,000

Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

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8.

Nov. 10 Assets (A) Cash + $75,000 Date 11/10

= =

Liabilities (L) Notes payable + $75,000

+

Net Assets (NA) No change

Dr. $75,000

Cash Notes payable

Cr. $75,000

Borrow with note payable.

9.

Dec. 5 Assets (A) Cash – $28,000 Date 12/5

= =

Liabilities (L) Notes payable – $25,000

+ –

Net Assets (NA) Interest expense $3,000

Dr. $ 3,000 25,000

Interest expense Notes payable Cash

Cr.

$28,000

Payment on note and interest expense

10.

Dec. 28 Assets (A) Cash – $75,000

Date 12/28

= =

Liabilities (L) Wages payable +$15,000

+ –

Dr. $90,000

Wage expense Wages payable Cash

Net Assets (NA) Wage expense $90,000

Cr. $ 15,000 75,000

Record wage expense and payment

11.

Dec. 31 Assets (A) Cash + $98,000

= =

Liabilities (L)

+ +

Net Assets (NA) Sales revenue + $110,000

Chapter 10: Reporting the Results of Operations: The Activity and Cash Flow Statements

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Accounts receivable + $12,000 Inventory - $58,000

-

Cash -$30,000 Date 12/31

Cost of goods sold -$58,000

Accounts payable -$30,000 Dr. $68,000 58,000 12,000 30,000

Cash Cost of goods sold Accounts receivable Accounts payable Sales revenue Inventory

Cr.

$110,000 58,000

Record bookstore sales

Note: The cash and accounts payable transaction occur because the balance of the unpaid inventory is paid at the end of the year (see #6).

12.

Dec. 31 Assets (A) Accounts receivable, net – $2,000 Date 12/31

= =

Liabilities (L)

Bad debt expense Accounts receivable, net

+ –

Net Assets (NA) Bad debt expense $2,000

Dr. $2,000

Cr. $2,000

Record estimated uncollectible receivables

OR Assets (A) Allowance for Uncollectible Accounts – $2,000 Date 12/31

= =

Bad debt expense

Liabilities (L)

+ –

Net Assets (NA) Bad debt expense $2,000

Dr. $2,000

Cr.

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Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

Allowance for Uncollectible Accounts

13.

$2,000

Dec. 31 Assets (A) PPE, net – $40,000 Date 12/31

= =

Liabilities (L)

Depreciation expense PPE, net Record depreciation expense

+ –

Dr. $40,000

Net Assets (NA) Deprec. expense $40,000 Cr. $40,000

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Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

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10-17.

This Worksheet page contains just the Activity Statement. The Statement of Financial Position and the Cash Flow Statement are on separate Worksheets within this file.

See tabs at the bottom of this page.

ARCH Activity Statement for the Year Ending December 31, Year 2 Revenues and support Donation revenue

$80,000

Sales revenue

110,000

Total revenues and support

$190,000

Expenses: Grant Expense

$50,000

Cost of goods sold

58,000

Wage expense

90,000

Interest expense Bad debts Depreciation

3,000 2,000 40,000

Total expenses

$243,000

Increase/(Decrease) in net assets

($53,000)

Chapter 10: Reporting the Results of Operations: The Activity and Cash Flow Statements

Assets Current assets Cash Accounts receivable, net of estimated uncollectibles of $2,000 in Year 2 Pledges receivable Inventory Total current assets

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ARCH Statement of Financial Position as of December 31, Year 2 and Year 1 Liabilities & Net Assets Year 2 Year 1 Year 2 Liabilities $335,000 $10,000 Current liabilities 36,000 26,000 Accounts payable $27,000 Wages payable 47,000

50,000

350,000

27,000 $448,000

$25,000 $411,000

Year 1

$27,000 32,000

Total current liab.

$74,000

$59,000

Long-term liabilities Notes payable

$320,000

$270,000

Total long-term liab.

$320,000

$270,000

Total liabilities

$394,000

$329,000

$249,000

$302,000

Temp. restricted

30,000

30,000

Perm. restricted Total net assets

100,000 $379,000

100,000 $432,000

Total equities

$773,000

$761,000

Long-term assets Fixed assets Buildings & Equip., net Total long-term assets

$325,000

$350,000

$325,000

$350,000

Net assets Unrestricted

Total assets

$773,000

$761,000

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Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

ARCH Statement of Cash Flows for the Year Ending December 31, Year 2 Cash flows from operating activities Decrease in unrestricted net assets Add expenses not requiring cash: Depreciation Bad Debts Other adjustments: Subtract the increase in accounts receivables Add the decrease in pledges receivable Subtract the increase in inventory Add the increase in wages payable Net cash from operating activities

($53,000) 40,000 2,000 (12,000) 300,000 (2,000) 15,000 $290,000

Cash flows from investing activities Purchase of PPE Net cash used in investing activities

($15,000) ($15,000)

Cash flows from financing activities Borrowing with notes Net cash from financing activities

$50,000 $50,000

Net increase/(decrease) in cash Cash, beginning of year Cash, end of year

$325,000 10,000 $335,000

1) Strengths:

Strong Cash position, strong cash from operations, low current liabilities

2) Concerns: Operating loss for the year, long-term debt increasing

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10-18.

Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

Chapter 10: Reporting the Results of Operations: The Activity and Cash Flow Statements

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PROBLEM 10-18

Assets Cash Beginning Balance 1

2

40,000 200,000 (3,000) (9,000) (200,000)

3

50,000

4 5

375,000 100,000

Pledges Receivable, Net

Inventory

Prepaid Rent

PP&E, Net

Wages Payable

Accounts Payable

Deferred Revenue

Notes Payable

100,000

10,000

4,000

10,000

75,000

20,000

0

0

50,000 200,000

200,000 (10,000) (5,000) 50,000 (25,000) (100,000) 50,000 60,000 (45,000) (6,000) (4,000)

45,000 6,000 (15,000)

15,000 (15,000) 5,000 300,000 (20,000) (275,000)

(20,000) (275,000) 9

122,000

169,000 (3,000) (9,000)

Interest Expense Interest Expense

(10,000) (5,000)

Depreciation Expense Depreciation Expense

25,000 375,000

Membership Revenue Ticket Revenue

50,000 60,000

Grant Revenue Donations

(4,000)

Bad Debt Expense

(15,000)

Supplies Expense

(300,000) Wages Expense

(10,000) (110,000) (12,000) (50,000)

Unrestricted

5,000

8

10 Ending Balance

Net Assets

Grants Receivable

6

7

The Science Road Show, Transactions Worksheet, FY 2018 Liabilities

(10,000) Rent Expense (110,000) Rent Expense

12,000 (50,000) 50,000

15,000

9,000

12,000

260,000

25,000

5,000

25,000

200,000

213,000

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Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

Chapter 10: Reporting the Results of Operations: The Activity and Cash Flow Statements

The Science Road Show Statement of Activities For the Year Ending August 31, 2018 Revenues and Support Ticket Sales Memberships Grants Donations Total Revenue and Support

$375,000 25,000 50,000 60,000 $510,000

Expenses Wages Rent Supplies Interest Bad Debts Depreciation Total Expenses

$300,000 120,000 15,000 12,000 4,000 15,000 $466,000

Change in Net Assets Net Assets, Beginning Net Assets, Ending

$44,000 $169,000 $213,000

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Instructor’s Manual for Financial Management for Public, Health, and Not-for-Profit Organizations, 5E

The Science Road Show Statement of Cash Flows For the Year Ending December 31, 2018 Cash From Operating Activities Change in Net Assets Adjustment for Non-Cash Expense: Depreciation (Increases)/Decreases in Non-Cash Current Assets: Grants Receivable Pledges Receivable, Net Inventory Prepaid Rent Increases/(Decreases) in Current Liabilities: Wages Payable Accounts Payable Deferred Revenue Net Cash From Operating Activities

5,000 5,000 25,000 $132,000

Cash From Investing Activities Purchase of Equipment Net Cash (Used For) Investing Activities

($200,000) ($200,000)

Cash From Financing Activities Loan Proceeds Principal Repayment Net Cash From/(Used For) Financing Activities

$200,000 (50,000) $150,000

Net Increase/(Decrease) in Cash Cash, Beginning of Year Cash, End of Year

$82,000 40,000 $122,000

$44,000 15,000 50,000 (5,000) (5,000) (2,000)

Chapter 10: Reporting the Results of Operations: The Activity and Cash Flow Statements

10-19.

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