Kazaam Company, a merchandiser, recently completed its calendar-year 2005 operations. For the year,
(1) all sales are credit sales, (2) all credits to Accounts Receivable reflect cash receipts from customers,
(3) all purchases of inventory are on credit, (4) all debits to Accounts Payable reflect cash
payments for inventory, and (5) Other Expenses are paid in advance and are initially debited to Prepaid
Expenses. Kazaam’s balance sheets and income statement follow:
KAZAAM COMPANY
Comparative Balance Sheets
December 31, 2005
2005 2004
Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 53,875 $ 76,625
Accounts receivable . . . . . . . . . . . . . . . . . 65,000 49,625
Merchandise inventory . . . . . . . . . . . . . . . 273,750 252,500
Prepaid expenses . . . . . . . . . . . . . . . . . . . 5,375 6,250
Equipment . . . . . . . . . . . . . . . . . . . . . . . . 159,500 110,000
Accum. depreciation—Equipment . . . . . . . . (34,625) (44,000)
Total assets . . . . . . . . . . . . . . . . . . . . . . . $522,875 $451,000
Liabilities and Equity
Accounts payable . . . . . . . . . . . . . . . . . . . $ 88,125 $116,625
Short-term notes payable . . . . . . . . . . . . . 10,000 6,250
Long-term notes payable . . . . . . . . . . . . . 93,750 53,750
Common stock, $5 par value . . . . . . . . . . 168,750 156,250
Contributed capital in excess
of par, common stock . . . . . . . . . . . . . . 32,500 0
Retained earnings . . . . . . . . . . . . . . . . . . . 129,750 118,125
Total liabilities and equity . . . . . . . . . . . . . $522,875 $451,000
KAZAAM COMPANY
Income Statement
For Year Ended December 31, 2005
Sales . . . . . . . . . . . . . . . . . . . . . . . . . $496,250
Cost of goods sold . . . . . . . . . . . . . . 250,000
Gross profit . . . . . . . . . . . . . . . . . . . . 246,250
Operating expenses
Depreciation expense . . . . . . . . . . . $ 18,750
Other expenses . . . . . . . . . . . . . . . 136,500 155,250
Other gains (losses)
Loss on sale of equipment . . . . . . . 5,125
Income before taxes . . . . . . . . . . . . . . $ 85,875
Income taxes expense . . . . . . . . . . . . 12,125
Net income . . . . . . . . . . . . . . . . . . . . $ 73,750

tlee9

Cash flows-Operating activities
Net income $73,750

Adjustments:
Depreciation $18,750

Loss on sale of equipment $5,125

Sub-total $97,625

Increase:
A/R ($15,375)
Inventories ($21,250)
Increase short-term notes payable $3,750
Decrease:
Prepayments $875
A/P ($28,500)


Net cash from operating activities $37,125

Cash flows from investing activities
Proceeds from sale of equipment $13,625
Purchase of equipment ($25,000)

Net cash used in investing activities ($11,375)

Cash flows from financing activities
Proceeds from issue of share capital $45,000
Repayment of long-term notes payable ($31,375)
Dividends paid ($62,125)

Net cash used in financing activities ($48,500)

Net decrease in cash and cash equivalents ($22,750)
CCE at beginning of period $76,625
CCE at end of period $53,875

Note: Equipment costing $71,375 were paid for by the signing of a long-term note payable.

2. Analyze and discuss the statement of cash flows prepared in part 1, giving special attention to the
wisdom of the cash dividend payment.

The company's AR has increased while its AP has decreased. Effectively this means that it's financing its debtors, which is not very clever. In addition, its COGS for a whole year was only $250,000, but it has $273,750 in ending inventory, i.e. it's holding more than a year's sales in inventory. It has tied up much of its funds in inventory. It already does not have sufficient cash, thereby causing it to borrow via short- and long-term notes payable (and incurring interest expense) and yet it saw fit to pay a dividend. Not very clever is an understatement.

tlee9

Cash flows-Operating activities
Net income $73,750

Adjustments:
Depreciation $18,750

Loss on sale of equipment $5,125

Sub-total $97,625

Increase:
A/R ($15,375)
Inventories ($21,250)
Increase short-term notes payable $3,750
Decrease:
Prepayments $875
A/P ($28,500)


Net cash from operating activities $37,125

Cash flows from investing activities
Proceeds from sale of equipment $13,625
Purchase of equipment ($25,000)

Net cash used in investing activities ($11,375)

Cash flows from financing activities
Proceeds from issue of share capital $45,000
Repayment of long-term notes payable ($31,375)
Dividends paid ($62,125)

Net cash used in financing activities ($48,500)

Net decrease in cash and cash equivalents ($22,750)
CCE at beginning of period $76,625
CCE at end of period $53,875

Note: Equipment costing $71,375 were paid for by the signing of a long-term note payable.

2. Analyze and discuss the statement of cash flows prepared in part 1, giving special attention to the
wisdom of the cash dividend payment.

The company's AR has increased while its AP has decreased. Effectively this means that it's financing its debtors, which is not very clever. In addition, its COGS for a whole year was only $250,000, but it has $273,750 in ending inventory, i.e. it's holding more than a year's sales in inventory. It has tied up much of its funds in inventory. It already does not have sufficient cash, thereby causing it to borrow via short- and long-term notes payable (and incurring interest expense) and yet it saw fit to pay a dividend. Not very clever is an understatement.