# Calculating CFO

Convenience Travel Corp.’s financial information for the year ended December 31, 2004 included the following:

Property Plant & Equipment \$15,000,000
Accumulated Depreciation 9,000,000

The only asset owned by Convenience Travel in 2005 was a corporate jet airplane. The airplane was being depreciated over a 15-year period on a straight-line basis at a rate of \$1,000,000 per year.

On December 31, 2005 Convenience Travel sold the airplane for \$10,000,000 cash. Net income for the year ended December 31, 2005 was \$12,000,000.

Based on the above information, and ignoring taxes, what is cash flow from operations (CFO) for Convenience Travel for the year ended December 31, 2005?

A) \$13,000,000.

B) \$8,000,000.

C) \$11,000,000.

D) \$12,000,000.

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well, shoot, I’ll go with A)

1) Proceeds from the aircraft sale are a CFI inflow, which we can ignore
2) The loss on the aircraft sale can also be ignored, it’s already charged to earnings
3) On a side-note, there must have been some other PP&E, maybe another aircraft, on the books at 12/31/2004, to explain the accumulated depreciation account, because it appears the jet airplane owned in 2005 is being depreciated with no salvage value. In any case, let’s ignore this accumulated depreciation account.

Let’s try an indirect method calculation: net income + non-cash charges
= net income + depreciation
= \$12,000,000 + \$1,000,000
= \$13,000,000

If I missed this one, I’ll blame it on the wee AM hours :)

i have too agree that A is the answer..
i think i only got this b/c i just finished reading 36 & 37

Someone correct me if I’m wrong, but the way I’m reading this question, the plane has already been depreciated by \$9,000,000. Doesn’t this mean that there was actually a gain when it was sold for \$10,000,000? And shouldn’t the gain of \$6,000,000 be subtracted from Net Income to arrive at CFO?

This is not actually related to the question (I would go with A also) but to one of the answers
2) The loss on the aircraft sale can also be ignored, it’s already charged to earnings
Hiredguns1 may be I am missing something here but how you figure there is a loss on the aircraft sale
Sold for \$10MM, book value \$5MM looks like a gain to me

I agree CFO equals:

Net Income + Depreciation, but also -/+ gains or losses.

Was there a gain or loss on the airplane?

At end of 2004, the plane had depreciated \$9,000,000, in 2005 it would have accum depr of 10,000,000 and been worth 5mil on books (I think not really sure). If it was sold for 10mil, I see a gain of 5mil, so that’s a 5mil gain we need to back out of net income.

I vote for B, 8,000,000

Can we get the final answer on this one?

culley Wrote:
——————————————————-
> I agree CFO equals:
>
> Net Income + Depreciation, but also -/+ gains or
> losses.
>
> Was there a gain or loss on the airplane?
>
> At end of 2004, the plane had depreciated
> \$9,000,000, in 2005 it would have accum depr of
> 10,000,000 and been worth 5mil on books (I think
> not really sure). If it was sold for 10mil, I see
> a gain of 5mil, so that’s a 5mil gain we need to
> back out of net income.
>
> I vote for B, 8,000,000
>
> Can we get the final answer on this one?

I agree with you here:

The reason for CFO is to gauge the true everyday Cashflow from operations

The Gain is included in the Net Income and if we assume the answer is A then we are saying that the Company can sustain the 5000 unrealistic Cashflow, which it cannot.

Logically the answer should be B…

A correction to my post above: I intended to say that the gain of \$4,000,000 (instead of \$6,000,000) should be subtracted from Net Income, for CFO of \$8,000,000.

The correct answer is B… 100% sure of this

CFI already includes the sale of PP&E of 10,000

Therefore, if we leave it in for CFO, we would be double counting. Removal of the 5,000 gain on machinery is required to get to the CFO.

Thus:

NI + Dep (for the current year) - Gain on PP&E

12 + 1 - 5 = 8

Nice refresher for me :)

Another vote for B here. BV of plane at beginning of the year is 15 mil -9 mil depr = 6 mil. Another 1 mil of depr in 2005 brings BV to 5 mil. Plane is sold for 10 mil…

Proceeds = 10 mil —- CFI
Gain on sale = 10 mil - 5 mil = 5 mil —- CFO

CFO
Net Income 12,000,000
Less:Gain (5,000,000)
Depr Exp 1,000,000
————
CFO 8,000,000

Ah, my mistake was assuming the accumulated depreciation was related to some other PP&E. Thank you wee AM hours for taking the wrap for this one :)

The hint in the question is that the only asset owned by Convenience Travel in 2005 is a corporate jet airplane. If the airplane is the only asset they own, what other PP&E could the accumulated depreciation be on? Easy mistake to make, but one to be very careful of on the exam…

You have to drill the material in, otherwise mistakes like this will happen. At first glance i said A, but after a second review, I realized it is B…

I saw a lot of questions like that when I took it… You walk out of the exam room and then you start realizing what you got wrong, and stupid mistakes at that. No point in giving up free points like that.

Regards,

gangrel, you’re correct, fortunately I’m done with LI.

I thought there was some other unnamed PP&E the company owned at the close of FY04 that subsequently was disposed-of at the beginning of FY05, and so didn’t associate the accumulated depreciation with the jet airplane. I never was under the false mpression there was more than the jet airplane in play during FY05.

Level II FSA doesn’t deal with any of this at all and so I welcome the refresher, particularly considering I don’t work with these issues on a daily basis in my profession.

Bottom line: I learn at least as much on AF as I help teach. Another lesson refreshed: think before you post. But hey, mistakes are inevitable. Thanks all for cleaning up after my mess.

Cheers to AF.

hg -

No problems. This kind of stuff is my current and past line of work, and still mistakes like this are easy for me to make.

If the company owned other assets in FY04 and disposed of them before FY05, then there would be no AD on the books in 05 because it would have been cleared out with the sale. If there were other assets on the books at the beginning of 05, but not at the end of 05, then they would have had to disclose the sale or disposal in the problem.

I guess this is where 10 years of corporate accounting work will help me get through the exam, eh?  ;)