Statement of Cash Flows—Direct Method The income statement for Pluto Inc. for 2010 is as follows:

For the Year Ended December 31, 2010 Sales revenue $350,000 Cost of goods sold 150,000 Gross profi t $200,000 Operating expenses 250,000 Loss before interest and taxes $ (50,000)
Interest expense 10,000 Net loss $ (60,000).

Presented here are comparative balance sheets:

December 31 2010 2009 Cash $ 25,000 $ 10,000 Accounts receivable 30,000 80,000 Inventory 100,000 100,000 Prepayments 36,000 35,000 Total current assets $ 191,000 $225,000 Land $300,000 $200,000 Plant and equipment 500,000 250,000 Accumulated depreciation (90,000) (50,000)
Total long-term assets $ 710,000 $400,000 Total assets $ 901,000 $625,000.

December 31 2010 2009 Accounts payable $ 50,000 $ 10,000 Other accrued liabilities 40,000 20,000 Interest payable 22,000 12,000 Total current liabilities $ 112,000 $ 42,000 Long-term bank loan payable $ 450,000 $ 100,000 Common stock $ 300,000 $ 300,000 Retained earnings 39,000 183,000 Total stockholders’ equity $ 339,000 $ 483,000 Total liabilities and stockholders’ equity $ 901,000 $ 625,000.

Other information is as follows:

a. Dividends of $84,000 were declared and paid during the year.

b. Operating expenses include $40,000 of depreciation.

c. Land and plant and equipment were acquired for cash. Cash was received from additional bank loans.
The president has asked you some questions about the year’s results. He is disturbed with the net loss of $60,000 for the year. He notes, however, that the cash position at the end of the year is improved. He is confused about what appear to be confl icting signals: “How could we have possibly added to our bank accounts during such a terrible year of operations?”
Required 1. Prepare a statement of cash fl ows for 2010 using the direct method in the Operating Activities section.
2. On the basis of your statement in (1), draft a brief memo to the president to explain why cash increased during such an unprofi table year. Include in your memo your recommendations for improving the company’s bottom line.AppendixLO1