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“Why can’t we pay our shareholders a dividend?” shouted your new boss. “This income statement you prepared for me says we earned $5 million in our first half-year!”

You were hired last month as the chief accountant for Enigma Corporation which was organized on July 1 of the year just ended. You recently prepared the financial statements below:

Income Statement
For the Six Months Ended December 31, 2011
($ in millions)

Sales Revenue


Cost of goods sold


Depreciation expense


Remaining expenses


Net income


Balance Sheet
December 31, 2011
($ in millions)



Accounts receivable (net)


Merchandise inventory


Machinery (net)




Accounts Payable


Accrued expenses payable


Notes payable


Common stock


Retained earnings




You have just explained to your boss, Robert James, that although net income was $5 million, operating activities produced a net decrease in cash. Unable to understand your verbal explanation, he has asked you to prepare a written report.


Prepare a 300-500 word report explaining the apparent discrepancy between Engima’s profitability and its cash flows. To increase the chances of your boss’s understanding the situation, include in your report a determination of net cash flows from operating activities by both the direct and indirect methods. Your report should also include a narrative explanation of how it is possible for operating activities to simultaneously produce a positive net income and negative net cash flows.


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