Chapter 12: The Statement of Cash Flows
CHAPTER 12
THE STATEMENT OF CASH FLOWS
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Estimated
Time in
Learning Outcomes Exercises Minutes Level
1. Explain the purpose of a statement of cash flows. 15* 60 Diff
2. Explain what cash equivalents are and how they are treated on 1 5 Easy
the statement of cash flows. 12* 10 Easy
3. Describe operating, investing, and financing activities, and give 2 10 Easy
examples of each. 3 10 Mod
12* 10 Easy
13* 10 Easy
14* 25 Diff
4. Describe the difference between the direct and the indirect
methods of computing cash flow from operating activities.
5. Prepare a statement of cash flows, using the 4 5 Mod
direct method to determine cash flow from operating activities. 5 10 Mod
6 20 Mod
7 20 Mod
8 10 Mod
13* 10 Easy
15* 60 Diff
6. Prepare a statement of cash flows, using 9 10 Easy
the indirect method to determine cash flow from operating 10 15 Mod
activities. 14* 25 Diff
7. Use cash flow information to help analyze a company. 11 15 Mod
8. Use a work sheet to prepare a statement of cash flows, using
the indirect method to determine cash flow from operating
activities (Appendix).
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
Problems Estimated
and Time in
Learning Outcomes Alternates Minutes Level
1. Explain the purpose of a statement of cash flows.
2. Explain what cash equivalents are and how they are treated on 13* 30 Diff
the statement of cash flows.
3. Describe operating, investing, and financing activities, and give
examples of each.
4. Describe the difference between the direct and the indirect 11* 30 Mod
methods of computing cash flow from operating activities. 12* 30 Mod
5. Prepare a statement of cash flows, using the 3 45 Mod
direct method to determine cash flow from operating activities. 6 30 Mod
11* 30 Mod
13* 30 Diff
6. Prepare a statement of cash flows, using 1 30 Mod
the indirect method to determine cash flow from operating 4 45 Mod
activities. 7 30 Mod
9 45 Diff
12* 30 Mod
7. Use cash flow information to help analyze a company.
8. Use a work sheet to prepare a statement of cash flows, using 2 60 Mod
the indirect method to determine cash flow from operating 5 60 Mod
activities (Appendix). 8 60 Mod
10 60 Diff
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
Estimated
Time in
Learning Outcomes Cases Minutes Level
1. Explain the purpose of a statement of cash flows. 3* 60 Diff
4* 25 Mod
5* 25 Mod
2. Explain what cash equivalents are and how they are treated on 6* 20 Mod
the statement of cash flows.
3. Describe operating, investing, and financing activities, and give 1* 30 Mod examples of each. 6* 20 Mod
4. Describe the difference between the direct and the indirect 1* 30 Mod methods of computing cash flow from operating activities.
5. Prepare a statement of cash flows, using the 3* 60 Diff
direct method to determine cash flow from operating activities.
6. Prepare a statement of cash flows, using 4* 25 Mod
the indirect method to determine cash flow from operating 5* 25 Mod
activities.
7. Use cash flow information to help analyze a company. 2 20 Mod
8. Use a work sheet to prepare a statement of cash flows, using
the indirect method to determine cash flow from operating
activities (Appendix).
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)
questions
1. The purpose of the statement of cash flows is to summarize an entity’s cash flows from operating, investing, and financing activities during a period. Because it is concerned with activity for a specific period of time, the statement is similar to the
income statement. However, they differ in two important respects. First, with a few exceptions, the income statement deals only with operating activities. Second, the income statement is on an accrual basis, while the statement of cash flows reports operating activities on a cash basis.
2. A cash equivalent is an item that is readily convertible to a known amount of cash and has an original maturity of three months or less. These items, such as Treasury bills and money market funds, present very little risk to the holder, and therefore they are included with cash for the purpose of preparing the statement of cash flows. That is, purchases and sales of cash equivalents are not considered significant activities to be separately reported on the statement.
3. The down payment of $20,000 is a cash outflow that would be reported in the investing activities section of the statement of cash flows. The issuance of the promissory note for $60,000 would appear in a supplemental schedule of noncash investing and financing activities.
4. A 60-day Treasury bill would be classified as a cash equivalent and combined with cash on the balance sheet. Therefore, the purchase of the treasury bill would not be reported as an investing activity. However, the purchase of Motorola stock would appear as a cash outflow in the investing activities section of the statement of cash flows.
5. Companies cannot continue in business if they do not generate positive cash flows from operating activities. Also, over a period of years, a company cannot continue to borrow more than it repays, nor can it issue capital stock indefinitely. Thus, you would not expect a net cash outflow from financing activities over a sustained period of time. However, many companies regularly experience a net cash outflow from investing activities. A company must at a minimum replace existing assets and in many cases acquire additional plant and equipment to remain competitive. At the same time, disposals of long-term assets may be fairly common, but usually they will not generate significant amounts of cash inflow.
6. The student is correct in that it is simple enough to find the net inflow or outflow of cash during the period. But this is only the starting point in preparing the statement of cash flows. First, all of the balance sheet accounts must be analyzed to find the explanations for the increases and decreases in cash during the period. Second, each of these inflows and outflows must be classified as either operating, investing, or financing activities.
7. The only accurate part of this statement is that depreciation is often one of the largest items in the Operating Activities section of the statement. However, this is merely a result of using the indirect method to prepare this section. In computing net income, depreciation is deducted. Therefore, under the indirect method it must be added back to net income because it is a noncash expense. Depreciation does not in any way generate cash.
8. There is considerable debate over which method is most useful. Many accountants, as well as users of the statements, believe that the direct method, with its emphasis on cash receipts and cash payments, provides the most information. Others believe that the indirect method is better because it focuses attention on the differences between net income and net cash provided by operations. Accounting standards allow the use of either method, but companies are strongly encouraged to use the direct method.
9. Under the indirect method, net income is reported at the top of the Operating Activities section, and adjustments are made to convert income to a cash basis. Sales revenue is included in net income. However, on a cash basis we are interested in cash collections from sales, not the sales on an accrual basis. A decrease in accounts receivable indicates that cash collections exceeded sales revenue. Therefore, the excess is added back to the net income of the period.
10. Inventory is analyzed to determine the purchases of the period. Cost of goods sold decreases the Inventory account, and purchases increase it. After the purchases of the period are found, they are added to the beginning balance in the Accounts Payable account. The difference between the addition of these amounts and the ending balance in Accounts Payable is the amount of cash payments.
11. A profitable year does not guarantee a large cash balance at the end of the year. A large share of the profits may be returned to the stockholders in the form of cash dividends. Investments in new plant and equipment require significant amounts of cash, as does the repayment of various forms of borrowing.
12. Yes, it is possible to report a net loss and still experience a net increase in cash. First, a company could report large noncash charges against net income, such as depreciation and various types of losses. Thus, it is possible that net cash provided by operating activities is positive even though a net loss is reported. Second, the net loss deals only with operating activities. It is possible that a net cash inflow was provided by either investing or financing activities, or both.
13. Regardless of which method is used, a decrease in income taxes payable means that cash paid to the government during the period exceeded income tax expense on the income statement. Under the direct method, the amount of cash paid is reported as a cash outflow in the Operating Activities section of the statement. If the indirect method is used, the decrease in taxes payable is deducted from net income to arrive at net cash flow from operations.
14. The requirement to separately disclose income taxes paid and interest paid when the indirect method is used is a compromise. Accounting standards strongly encourage companies to use the direct method because each major operating cash receipt and payment is reported in the Operating Activities section of the statement. However, if a company chooses to use the indirect approach, they are still required to report separately how much cash was actually paid to the government in taxes and to creditors in interest.
15. An argument can be made that it is inconsistent to report interest paid in the operating section and dividends paid in the financing section. Both represent returns to providers of capital: interest to creditors and dividends to stockholders. Furthermore, the cash raised from each of these sources—the amounts borrowed from creditors and the amounts contributed by stockholders—is classified as an inflow in the financing section of the statement. The rationale normally given for this treatment is that interest enters into the determination of net income, and thus the cash expended in interest should appear in the operating section. Many believe that this is illogical and that both interest paid and dividends paid belong in the financing section.
16. An analysis of the Prepaid Rent account can be used to find the amount of cash paid for rent:
Beginning Prepaid Rent $ 9,600
+ Cash payments X
– Rent Expense 45,900
= Ending Prepaid Rent $ 7,300
$9,600 + X – $45,900 = $7,300
X = $43,600
17. The purchase of 2,000 shares of treasury stock at $20 per share would be reflected on the statement of cash flows as a cash outflow of $40,000 in the financing activities section of the statement.
18. The effect on the accounting equation of the sale of the truck is as follows:
BALANCE SHEET INCOME STATEMENT
ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY + REVENUES – EXPENSES
Cash 9,000
Loss on Sale
of Asset (2,000)*
Accumulated
Depreciation 14,000**
Delivery Truck (25,000)
*$11,000 – $9,000 = $2,000
**$25,000 – $11,000 = $14,000
Two items would be reported on a statement of cash flows using the indirect method. First, the loss of $2,000 would be added back to net income in the operating activities section. Second, the cash received of $9,000 would be reported as a cash inflow in the investing activities section.
19. Since the company neither bought nor sold any patents during the year, the decrease in the balance in the account of $4,000 represents the amortization of the patent for the year. Amortization is a noncash expense, as is depreciation, and is added back to net income under the indirect method.
20. A stock dividend does not involve the inflow or outflow of cash and therefore is not reported on a statement of cash flows. It is questionable whether it is even a significant noncash activity that should be reported in the supplemental schedule. It could be argued that the issuance of stock in connection with a stock dividend is a financing activity and that it should be included on the schedule. If a 10% stock dividend is included on the schedule, it would be reported at the market value of the shares issued.
21. The information needed to determine a company’s cash flow adequacy comes from two sources. The numbers in the numerator of the ratio, net cash provided by operating activities and capital expenditures, appear on the statement of cash flows. The amount of average annual debt maturing over the next five years in the denominator can be found in a note to the financial statements.
exercises
|LO 2 | |EXERCISE 12-1 CASH EQUIVALENTS |
Investments made during December 2007 that qualify as cash equivalents at December 31, 2007:
Certificate of deposit, due January 31, 2008 $ 35,000
Money Market fund 105,000
90-day Treasury bills 75,000
Cash equivalents at December 31, 2007 $215,000
|LO 3 | |EXERCISE 12-2 CLASSIFICATION OF ACTIVITIES |
1. F 8. F
2. S 9. S
3. F 10. I
4. F 11. I or O*
5. O 12. O
6. O 13. O
7. O
*Investing activity if stock is classified as an available-for-sale security; operating activity if it is classified as a trading security.
|LO 3 | |EXERCISE 12-3 RETIREMENT OF BONDS PAYABLE ON THE STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. The effect on the accounting equation of the December 31, 2007, bond retirement is as follows:
BALANCE SHEET INCOME STATEMENT
ASSETS = LIABILITIES + STOCKHOLDERS’ EQUITY + REVENUES – EXPENSES
Cash (510,000) Bonds Payable (500,000) Loss on Retire-
Discount on ment of Bonds (50,000)*
Bonds Payable 40,000
*$510,000 – $460,000 = $50,000
2. The $510,000 in cash paid to retire the bonds would be reported as a cash outflow in the financing activities section. Assuming the company uses the indirect method, the loss of $50,000 would be added back in the operating activities section.
|LO 5 | |EXERCISE 12-4 CASH COLLECTIONS—DIRECT METHOD |
Cash collections to be reported in the operating activities section of Stanley’s 2007 statement of cash flows (direct method):
Accounts receivable, December 31, 2006 $ 80,800
Plus sales during 2007 1,450,000
Less cash collections during 2007 (X)
Accounts receivable, December 31, 2007 $ 101,100
$80,800 + $1,450,000 – X = $101,100
X = $1,429,700
|LO 5 | |EXERCISE 12-5 CASH PAYMENTS—DIRECT METHOD |
Cash payments for inventory to be reported in the operating activities section of Lester Enterprise’s 2007 statement of cash flows (direct method):
Inventory, December 31, 2006 $ 90,200
Plus purchases during 2007 X
Less cost of goods sold during 2007 (770,900)
Inventory, December 31, 2007 $ 70,600
$90,200 + X – $770,900 = $70,600
X = $751,300
Accounts payable, December 31, 2006 $ 57,700
Plus purchases during 2007 751,300
Less cash payments during 2007 (X)
Accounts payable, December 31, 2007 $ 39,200
$57,700 + $751,300 – X = $39,200
X = $769,800
|LO 5 | |EXERCISE 12-6 OPERATING ACTIVITIES SECTION—DIRECT METHOD |
1. Operating activities section of the statement of cash flows:
LABRADOR COMPANY
PARTIAL STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
Cash Flows from Operating Activities
Cash collected from customers $ 102,0001
Cash payments for:
Inventory $ (79,000)2
General and administrative (6,000)3
Interest (3,500)4
Taxes (3,500)5
Total cash payments $ (92,000)
Net cash provided by operating activities $ 10,000
Footnotes:
1Cash collections from customers:
Sales revenue $ 100,000
Add: Decrease in accounts receivable 2,000
Cash collections $ 102,000
2Payments for inventory:
Cost of goods sold $ 75,000
Add: Increase in inventory 7,000
Less: Increase in accounts payable (3,000)
Cash payments $ 79,000
3For general and administrative expenses:
General and administrative expense $ 8,000
Less: Decrease in office supplies (3,000)
Add: Decrease in salaries and wages payable 1,000
Cash payments $ 6,000
4For interest:
Interest expense $ 3,000
Add: Decrease in interest payable 500
Cash payments $ 3,500
5For taxes:
Income tax expense $ 5,000
Less: Increase in income taxes payable (1,500)
Cash payments $ 3,500
EXERCISE 12–6 (Concluded)
2. The use of the direct method reveals the amounts collected from customers and the amounts paid for inventory, interest, taxes, and other operating purposes. The indirect method simply reconciles the net income of the period to the net cash flow from operations. The direct method shows the reader of the statement the specific amounts collected and paid for operating purposes.
|LO 5 | |EXERCISE 12-7 DETERMINATION OF MISSING AMOUNTS—CASH FLOW FROM OPERATING ACTIVITIES |
Case 1:
Beginning accounts receivable $ 150,000
+ Credit sales revenue 175,000
– Write-offs (35,000)
– Cash collections (X)
= Ending accounts receivable $ 100,000
$150,000 + $175,000 – $35,000 – X = $100,000
X = $190,000 credit sales
$190,000 + $60,000 (cash sales) = $250,000
Case 2:
Beginning inventory $ 80,000
+ Purchases X
– Cost of goods sold (175,000)
= Ending inventory $ 55,000
$80,000 + X – $175,000 = $55,000
X = $150,000
Beginning accounts payable $ 25,000
+ Purchases 150,000
– Cash payments (X)
= Ending accounts payable $ 15,000
$25,000 + $150,000 – X = $15,000
X = $160,000
Case 3:
Beginning prepaid insurance $ 17,000
+ Cash payments X
– Insurance expense (15,000)
= Ending prepaid insurance $ 20,000
$17,000 + X – $15,000 = $20,000
X = $18,000
EXERCISE 12-7 (Concluded)
Case 4:
Beginning income taxes payable $ 95,000
+ Income tax expense 300,000
– Cash payments (X)
= Ending income taxes payable $ 115,000
$95,000 + $300,000 – X = $115,000
X = $280,000
|LO 5 | |EXERCISE 12-8 DIVIDENDS ON THE STATEMENT OF CASH FLOWS |
1. First, determine the amount of dividends declared:
Beginning retained earnings $ 250,000
+ Net income 285,000
– Stock dividends (50,000)
– Dividends declared (X)
= Ending retained earnings $ 375,000
$250,000 + $285,000 – $50,000 – X = $375,000
X = $110,000
Then, solve for the amount of dividends paid:
Beginning dividends payable $ 20,000
+ Dividends declared 110,000
– Cash dividends paid (X)
= Ending dividends payable $ 30,000
$20,000 + $110,000 – X = $30,000
X = $100,000
2. Because a stock dividend does not involve cash, it is not reported on the statement of cash flows. It is questionable whether or not a stock dividend is a significant noncash activity that should be reported on a supplemental schedule.
|LO 6 | |EXERCISE 12-9 ADJUSTMENTS TO NET INCOME WITH THE INDIRECT METHOD |
1. A 6. A
2. D 7. D
3. A 8. A
4. A 9. NR
5. NR 10. A
|LO 6 | |EXERCISE 12-10 OPERATING ACTIVITIES SECTION—INDIRECT METHOD |
1. Operating activities section of the statement of cash flows:
SUFFOLK COMPANY
PARTIAL STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
Cash Provided by Operating Activities
Net income $40,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 20,000
Increase in accounts receivable (8,000)
Decrease in inventory 10,000
Increase in prepaid rent (2,000)
Increase in accounts payable 7,000
Decrease in income taxes payable (4,000)
Increase in interest payable 3,000
Net cash inflow from operating activities $66,000
2. The primary reason that net cash inflow from operating activities of $66,000 is more than net income of $40,000 is depreciation of $20,000. It is deducted on the income statement but it does not require the use of cash. Other reasons for the higher amount of net cash inflow from operating activities are the decrease in inventory (the company is not buying as much inventory) and the increase in accounts payable (the company is slowing down payments to its creditors).
|LO 7 | |EXERCISE 12-11 CASH FLOW ADEQUACY |
1. Cash flow adequacy ratio:
(Net cash provided by operations – Capital expenditures)/Average annual debt
maturing over next five years
= ($12,000,000 – $2,000,000)/($20,000,000/5)
= $10,000,000/$4,000,000
= 2.5
2. The cash flow adequacy ratio gives the user an indication of whether or not the company is generating sufficient cash from its operations to repay its debts, after taking into consideration the need to make necessary expenditures on new plant and equipment. It would appear that a ratio of 2.5 is reasonable; however, other factors should be considered, including how the ratio compares with prior years as well as with competitors.
MULTI-CONCEPT exercises
|LO 2,3 | |EXERCISE 12-12 CLASSIFICATION OF ACTIVITIES |
1. OI 6. CE
2. CE 7. II
3. IF 8. OI
4. OI 9. IF
5. OF 10. OF
|LO 3,5 | |EXERCISE 12-13 CLASSIFICATION OF ACTIVITIES |
1. IO 7. OO
2. OO 8. OI
3. NR 9. OF
4. IF 10. NR
5. IO 11. OF
6. NR 12. II
|LO 3,6 | |EXERCISE 12-14 LONG-TERM ASSETS ON THE STATEMENT OF CASH FLOWS—INDIRECT METHOD |
First, determine the accumulated depreciation on the assets sold so that the book value of those sold can be found:
Beginning accumulated depreciation $ 200,000
+ Depreciation expense 50,000
– Accumulated depreciation on assets sold (X)
= Ending accumulated depreciation $ 160,000
$200,000 + $50,000 – X = $160,000
X = $90,000
Thus, the effect on the accounting equation of the sale would be as follows:
BALANCE SHEET INCOME STATEMENT
ASSETS = LIABILITIES + STOCKHOLDERS' EQUITY + REVENUES – EXPENSES
Cash 64,000 Gain on Sale 4,000
Accumulated
Depreciation 90,000
Plant and
Equipment (150,000)
Beginning plant and equipment $ 500,000
+ Acquisitions X
– Sales of plant and equipment (150,000)
= Ending plant and equipment $ 750,000
$500,000 + X – $150,000 = $750,000
X = $400,000
Similarly, acquisitions of new patents can be determined:
Beginning patents $ 80,000
+ Acquisitions X
– Amortization expense (8,000)
= Ending patents $ 92,000
$80,000 + X – $8,000 = $92,000
X = $20,000
EXERCISE 12-14 (Concluded)
These items would appear on the statement of cash flows as follows:
Cash Flows from Operating Activities
Net income $ 200,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 50,000
Amortization expense 8,000
Gain on sale of plant and equipment (4,000)
Cash Flows from Investing Activities
Sale of plant and equipment 64,000
Acquisition of plant and equipment (400,000)
Acquisition of patents (20,000)
|LO 1,5 | |EXERCISE 12-15 INCOME STATEMENT, STATEMENT OF CASH FLOWS |
| | |(DIRECT METHOD), AND BALANCE SHEET |
1. Income statement:
HANDSOME HOUNDS GROOMING COMPANY
INCOME STATEMENT
FOR THE YEAR ENDED XX/XX/XX
Grooming service revenue $150,000
Expenses:
Rent expense $12,000
Amortization of patent 10,0001
Other operating expenses 58,0002 80,000
Net income $ 70,000
1$100,000/10 years
2$80,000 – $10,000 – $12,000
EXERCISE 12-15 (Continued)
2. Statement of cash flows:
HANDSOME HOUNDS GROOMING COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED XX/XX/XX
Cash Flows from Operating Activities
Cash receipts from:
Cash sales $ 110,0001
Collections on account 30,0002
Total cash receipts $ 140,000
Cash payments for:
Rent $ (12,000)
Security deposit (2,000)
Other operating expenses (58,000)3
Total cash payments $ (72,000)
Net cash provided by operating activities $ 68,000
Cash Flows from Investing Activities
Down payment on patent $ (20,000)4
Cash Flows from Financing Activities
Issuance of common stock $ 50,000
Cash dividends paid (20,000)
Net cash provided by financing activities $ 30,000
Net increase in cash $ 78,000
Cash balance, beginning of year 0
Cash balance, end of year $ 78,000
Supplemental Schedule of Noncash Activities
Acquisition of patent in exchange for four-year note $ 80,000
1$150,000 – $40,000 3$80,000 – $12,000 – $10,000
2$40,000 – $10,000 4$100,000 × 20%
EXERCISE 12-15 (Concluded)
3. The company generated slightly less cash flow from operations, $68,000, than it earned in net income, $70,000. The differences between the two can be reconciled as follows:
Net income $ 70,000
Add:
Amortization of patent 10,000
Deduct:
Security deposit (not yet an expense) (2,000)
Uncollected accounts receivable (10,000)
Net cash flow from operating activities $ 68,000
4. Balance sheet:
HANDSOME HOUNDS GROOMING COMPANY
BALANCE SHEET
AS OF XX/XX/XX
Assets
Current assets:
Cash (from Part 2.) $78,000
Accounts receivable 10,000
Security deposit 2,000
Total current assets $ 90,000
Long-term assets:
Patent 90,0001
Total assets $180,000
Liabilities and Stockholders’ Equity
Long-term liabilities:
Notes payable $ 80,000
Stockholders’ equity:
Common stock $ 50,000
Retained earnings 50,0002
Total stockholders’ equity 100,000
Total liabilities and stockholders’ equity $180,000
1$100,000 – $10,000
2Net income of $70,000 less cash dividends of $20,000
problems
|LO 6 | |PROBLEM 12-1 STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (2)
Accounts receivable 5
Inventory (10)
Prepaid rent 3
Land 0
Plant and equipment 100 Purchase
Accumulated depreciation (35) Depreciation expense
Accounts payable (2)
Income taxes payable 2
Short-term notes payable (10) Issuance
Bonds payable 25 Retirement
Common stock (50) Issuance
Retained earnings (26) Net income
Total 0
PROBLEM 12-1 (Concluded)
Statement of cash flows:
CHRISMAN COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 26
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense 35
Increase in accounts receivable (5)
Decrease in inventory 10
Increase in prepaid rent (3)
Increase in accounts payable 2
Decrease in income taxes payable (2)
Net cash provided by operating activities $ 63
Cash Flows from Investing Activities
Acquisition of plant and equipment $(100)
Cash Flows from Financing Activities
Retirement of bonds payable $ (25)
Issuance of short-term notes payable 10
Issuance of common stock 50
Net cash provided by financing activities $ 35
Net increase (decrease) in cash $ (2)
Cash balance, December 31, 2006 10
Cash balance, December 31, 2007 $ 8
2. No, Chrisman did not generate enough cash from its operations to pay for its investing activities. Cash flow from operating activities amounted to only $63,000, while the company spent $100,000 to acquire plant and equipment. The additional cash needed to finance the acquisition was raised by issuing a note for $10,000 and issuing common stock for $50,000.
|LO 8 | |PROBLEM 12-2 STATEMENT OF CASH FLOWS USING A WORK SHEET—INDIRECT METHOD (Appendix) |
1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Balances Cash Inflows (Outflows)
Accounts 12/31/07 12/31/06 Changes Operating Investing Financing
Cash 8 10 (2)
Accounts receivable 20 15 5 (5)
Inventory 15 25 (10) 10
Prepaid rent 9 6 3 (3)
Land 75 75 –
Plant and equipment 400 300 1001 (100)
Accumulated
depreciation (65) (30) (35)2 35
Accounts payable (12) (10) (2) 2
Income tax payable (3) (5) 2 (2)
Short-term notes
payable (35) (25) (10)3 10
Bonds payable (75) (100) 254 (25)
Common stock (200) (150) (50)5 50
Retained earnings (137) (111) (26)6 26
Totals 0 0 0 63 (100) 35
Net increase
(decrease) in cash (2)
1Purchase of equipment. 4Retirement of bonds.
2Depreciation expense. 5Issuance of common stock.
3Proceeds from note. 6Net income.
PROBLEM 12-2 (Concluded)
2. Statement of cash flows:
CHRISMAN COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 26
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense 35
Increase in accounts receivable (5)
Decrease in inventory 10
Increase in prepaid rent (3)
Increase in accounts payable 2
Decrease in income taxes payable (2)
Net cash provided by operating activities $ 63
Cash Flows from Investing Activities
Acquisition of plant and equipment $(100)
Cash Flows from Financing Activities
Retirement of bonds payable $ (25)
Issuance of short-term notes payable 10
Issuance of common stock 50
Net cash provided by financing activities $ 35
Net increase (decrease) in cash $ (2)
Cash balance, December 31, 2006 10
Cash balance, December 31, 2007 $ 8
3. No, Chrisman did not generate enough cash from its operations to pay for its investing activities. Cash flow from operating activities amounted to only $63,000, while the company spent $100,000 to acquire plant and equipment. The additional cash needed to finance the acquisition was raised by issuing a note for $10,000 and issuing common stock for $50,000.
|LO 5 | |PROBLEM 12-3 STATEMENT OF CASH FLOWS—DIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (38)
Accounts receivable 50
Inventory 30
Prepayments (10)
Land 150 Purchase (c)
Plant and equipment 200 Purchase (c)
Accumulated depreciation (50) Depreciation expense (b)
Accounts payable 18
Other accrued liabilities (5)
Income tax payable 20
Long-term bank loan
payable (50) Proceeds from bank loan (c)
Common stock (150) Issuance of common stock (c)
Retained earnings (165) 60 Dividends (a)
(225) Net income
Total 0
Conversion of income statement items to a cash basis (in thousands of dollars):
Income Statement Amount Adjustment Cash Flows
Sales revenue $1,250 $1,250
– Increase in accounts receivable (50)
Cash collected $1,200
Cost of goods sold 700 $ 700
+ Increase in inventory 30
+ Decrease in accounts payable 18
Cash payments $ 748
Operating expenses 150 $ 150
– Decrease in prepayments (10)
– Depreciation expense (50)
– Increase in accrued liabilities (5)
Cash payments $ 85
Interest expense 25 $ 25
No interest payable 0
Cash payments $ 25
Income tax expense 150 $ 150
+ Decrease in income tax payable 20
Cash paid for taxes $ 170
Net income $ 225 Net cash flow from operations $ 172
PROBLEM 12-3 (Continued)
Statement of cash flows:
PEORIA CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections from customers $ 1,200
Cash payments for:
Inventory $ (748)
Operating expenses (85)
Interest (25)
Income taxes (170)
Total cash payments $(1,028)
Net cash provided by operating activities $ 172
Cash Flows from Investing Activities
Acquisition of land $ (150)
Acquisition of plant and equipment (200)
Net cash used by investing activities $ (350)
Cash Flows from Financing Activities
Additional long-term borrowings $ 50
Issuance of common stock 150
Cash dividends paid (60)
Net cash provided by financing activities $ 140
Net decrease in cash $ (38)
Cash balance, December 31, 2006 90
Cash balance, December 31, 2007 $ 52
2. Memorandum to the president:
TO: President of Peoria Corp.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern that in spite of the profitable year according to the income statement, cash decreased during 2007. Furthermore, there was a concern about the decrease in the company’s cash balance during 2007 to $52,000 at year-end, given that existing loan covenants require a $50,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.
PROBLEM 12-3 (Concluded)
Although net income on an accrual basis was $225,000, net cash flow from operating activities was only $172,000. One of the reasons is that cash collections were only $1,200,000 even though sales were $1,250,000. Also, inventory was increased by $30,000 during the period, and accounts payable was reduced by $18,000. Similarly, taxes payable was reduced by $20,000, resulting in a further drain on cash. Finally, two major acquisitions were made during the year: $200,000 was spent on new plant and equipment and another $150,000 to acquire new land. These were only partially offset by the sale of additional stock for $150,000 and the issuance of additional notes in the amount of $50,000. Finally, cash dividends amounted to $60,000, a further drain on cash.
Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. We can also improve our operating cash flow by accelerating the collection of receivables as much as possible. Similarly, we should be able to reduce the amount of inventory on hand at any one time and over the long run reduce the cash paid for inventory purchases.
|LO 6 | |PROBLEM 12-4 STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (38)
Accounts receivable 50
Inventory 30
Prepayments (10)
Land 150 Purchase (c)
Plant and equipment 200 Purchase (c)
Accumulated depreciation (50) Depreciation expense (b)
Accounts payable 18
Other accrued liabilities (5)
Income tax payable 20
Long-term bank loan payable (50) Proceeds from bank loan (c)
Common stock (150) Issuance of common stock (c)
Retained earnings (165) 60 Dividends (a)
(225) Net income
Total 0
PROBLEM 12-4 (Continued)
Statement of cash flows:
PEORIA CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 225
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense 50
Increase in accounts receivable (50)
Increase in inventories (30)
Decrease in prepayments 10
Decrease in accounts payable (18)
Increase in other accrued liabilities 5
Decrease in income taxes payable (20)
Net cash provided by operating activities $ 172
Cash Flows from Investing Activities
Acquisition of land $(150)
Acquisition of plant and equipment (200)
Net cash used by investing activities $(350)
Cash Flows from Financing Activities
Additional long-term borrowings $ 50
Issuance of common stock 150
Cash dividends paid (60)
Net cash provided by financing activities $ 140
Net decrease in cash $ (38)
Cash balance, December 31, 2006 90
Cash balance, December 31, 2007 $ 52
2. Memorandum to the president:
TO: President of Peoria Corp.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern about the decrease in the company’s cash balance during 2007 to $52,000 at year-end, given that existing loan covenants require a $50,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.
PROBLEM 12-4 (Concluded)
Although net income on an accrual basis was $225,000, changes in various noncash working capital accounts resulted in net cash flow from operating activities of only $172,000. For example, $50,000 less was collected in cash than the sales of the period. Accounts payable was reduced by $18,000 and taxes payable by $20,000, both resulting in a drain on cash. Finally, two major acquisitions were made during the year: $200,000 was spent on new plant and equipment and another $150,000 to acquire new land. These were only partially offset by the sale of additional stock for $150,000 and the issuance of additional notes in the amount of $50,000. Finally, cash dividends amounted to $60,000, a further drain on cash.
Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. We can also improve our operating cash flow by accelerating the collection of receivables as much as possible. Similarly, we should be able to reduce the amount of inventory on hand at any one time and over the long run reduce the cash paid for inventory purchases.
|LO 8 | |PROBLEM 12-5 STATEMENT OF CASH FLOWS USING A WORK SHEET—INDIRECT METHOD (Appendix) |
1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Balances Cash Inflows (Outflows)
Accounts 12/31/07 12/31/06 Changes Operating Investing Financing
Cash 52 90 (38)
Accounts receivable 180 130 50 (50)
Inventory 230 200 30 (30)
Prepayments 15 25 (10) 10
Land 750 600 1501 (150)
Plant and equipment 700 500 2002 (200)
Accumulated
depreciation (250) (200) (50)3 50
Accounts payable (130) (148) 18 (18)
Accrued liabilities (68) (63) (5) 5
Income tax payable (90) (110) 20 (20)
Long-term loan
payable (350) (300) (50)4 50
Common stock (550) (400) (150)5 150
Retained earnings (489) (324) 606 (60)
(225)7 225
Totals 0 0 0 172 (350) 140
Net increase
(decrease) in cash (38)
1Purchase of land. 5Issuance of common stock.
2Purchase of plant and equipment. 6Dividends.
3Depreciation expense. 7Net income.
4Proceeds from bank loan.
PROBLEM 12-5 (Continued)
2. Statement of cash flows:
PEORIA CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 225
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense 50
Increase in accounts receivable (50)
Increase in inventories (30)
Decrease in prepayments 10
Decrease in accounts payable (18)
Increase in other accrued liabilities 5
Decrease in income taxes payable (20)
Net cash provided by operating activities $ 172
Cash Flows from Investing Activities
Acquisition of land $(150)
Acquisition of plant and equipment (200)
Net cash used by investing activities $(350)
Cash Flows from Financing Activities
Additional long-term borrowings $ 50
Issuance of common stock 150
Cash dividends paid (60)
Net cash provided by financing activities $ 140
Net decrease in cash $ (38)
Cash balance, December 31, 2006 90
Cash balance, December 31, 2007 $ 52
PROBLEM 12-5 (Concluded)
3. Memorandum to the president:
TO: President of Peoria Corp.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern to me regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern about the decrease in the company’s cash balance during 2007 to $52,000 at year-end, given that existing loan covenants require a $50,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.
Although net income on an accrual basis was $225,000, changes in various noncash working capital accounts resulted in net cash flow from operating activities of only $172,000. For example, $50,000 less was collected in cash than the sales of the period. Accounts payable was reduced by $18,000 and taxes payable by $20,000, both resulting in a drain on cash. Finally, two major acquisitions were made during the year: $200,000 was spent on new plant and equipment and another $150,000 to acquire new land. These were only partially offset by the sale of additional stock for $150,000 and the issuance of additional notes in the amount of $50,000. Finally, cash dividends amounted to $60,000, a further drain on cash.
Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. We can also improve our operating cash flow by accelerating the collection of receivables as much as possible. Similarly, we should be able to reduce the amount of inventory on hand at any one time and over the long run reduce the cash paid for inventory purchases.
|LO 5 | |PROBLEM 12-6 STATEMENT OF CASH FLOWS—DIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash 15
Accounts receivable (25)
Inventory (50)
Prepayments 10
Land 75 Purchase (c)
Plant and equipment 70 Purchase (c)
Accumulated depreciation (70) Depreciation expense (b)
Accounts payable (25)
Other accrued liabilities 10
Interest payable (5)
Long-term bank loan payable (90) Proceeds from bank loan (c)
Common stock (50) Issuance of common stock (c)
Retained earnings 135 35 Dividends (a)
100 Net loss
Total 0
Conversion of income statement items to a cash basis (in thousands of dollars):
Income Statement Amount Adjustment Cash Flows
Sales revenue $ 500 $500
+ Decrease in accounts receivable 25
Cash collected $525
Cost of goods sold 400 $400
– Decrease in inventory (50)
– Increase in accounts payable (25)
Cash payments $325
Operating expenses 180 $180
+ Increase in prepayments 10
– Depreciation expense (70)
+ Decrease in accrued liabilities 10
Cash payments $130
Interest expense 20 $ 20
– Increase in interest payable (5)
Cash payments $ 15
Net income (loss) $(100) Net cash flow from operations $ 55
PROBLEM 12-6 (Continued)
Statement of cash flows:
ASTRO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections on account $ 525
Cash payments for:
Inventory $(325)
Operating expenses (130)
Interest (15)
Total cash payments $(470)
Net cash provided by operating activities $ 55
Cash Flows from Investing Activities
Acquisition of land $ (75)
Acquisition of plant and equipment (70)
Net cash used by investing activities $(145)
Cash Flows from Financing Activities
Additional long-term borrowings $ 90
Issuance of common stock 50
Cash dividends paid (35)
Net cash provided by financing activities $ 105
Net increase in cash $ 15
Cash balance, December 31, 2006 80
Cash balance, December 31, 2007 $ 95
PROBLEM 12-6 (Concluded)
2. Memorandum to the president:
TO: President of Astro Inc.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern to me regarding the large loss we sustained during 2007 in view of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference.
Astro was able to generate a significant amount of cash from operations even though we incurred the large net loss of $100,000. One reason for the difference between cash generated from operations and the net loss was the large amount of depreciation expense on the income statement. This noncash expense reduced net
income, but without a corresponding effect on cash flow. Further, the decrease in accounts receivable indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the combined effect of a
reduction in inventory and an increase in the amounts owed suppliers (accounts payable) added to the cash generated.
Operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. The gross profit percentage of 20% appears reasonable, although this depends on many factors, including how our competitors are doing in this area. A significant portion of the operating expenses is the depreciation of $70,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added to our base of long-term assets. I would recommend that we explore ways to reduce our other operating expenses. I look forward to hearing from you before moving forward with any actions.
|LO 6 | |PROBLEM 12-7 STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash 15
Accounts receivable (25)
Inventory (50)
Prepayments 10
Land 75 Purchase (c)
Plant and equipment 70 Purchase (c)
Accumulated depreciation (70) Depreciation expense (b)
Accounts payable (25)
Other accrued liabilities 10
Interest payable (5)
Long-term bank loan payable (90) Proceeds from bank loan (c)
Common stock (50) Issuance of common stock (c)
Retained earnings 135 35 Dividends (a)
100 Net loss
Total 0
PROBLEM 12-7 (Continued)
Statement of cash flows:
ASTRO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(AMOUNTS IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net loss $(100)
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense 70
Decrease in accounts receivable 25
Decrease in inventories 50
Increase in prepayments (10)
Increase in accounts payable 25
Decrease in other accrued liabilities (10)
Increase in interest payable 5
Net cash provided by operating activities $ 55
Cash Flows from Investing Activities
Acquisition of land $ (75)
Acquisition of plant and equipment (70)
Net cash used by investing activities $(145)
Cash Flows from Financing Activities
Additional long-term borrowings $ 90
Issuance of common stock 50
Cash dividends paid (35)
Net cash provided by financing activities $ 105
Net increase in cash $ 15
Cash balance, December 31, 2006 80
Cash balance, December 31, 2007 $ 95
PROBLEM 12-7 (Concluded)
2. Memorandum to the president:
TO: President of Astro Inc.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference.
Astro was able to generate a significant amount of cash from operations even though we incurred the large net loss of $100,000. One reason for the difference between cash generated from operations and the net loss was the large amount of depreciation expense on the income statement. This noncash expense reduced
reported net income without a corresponding effect on cash flow. Further, the decrease in accounts receivable indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the combined
effect of a reduction in inventory and an increase in the amounts owed suppliers (accounts payable) added to the cash generated.
Operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. The gross profit percentage of 20% appears reasonable, although this depends on many factors, including how our competitors are doing in this area. A significant portion of the operating expenses is the depreciation of $70,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added to our base of long-term assets. I would recommend that we explore ways to reduce our other operating expenses. I look forward to hearing from you before moving forward with any actions.
|LO 8 | |PROBLEM 12-8 STATEMENT OF CASH FLOWS USING A WORK SHEET—INDIRECT METHOD (APPENDIX) |
1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Balances Cash Inflows (Outflows)
Accounts 12/31/07 12/31/06 Changes Operating Investing Financing
Cash 95 80 15
Accounts receivable 50 75 (25) 25
Inventory 100 150 (50) 50
Prepayments 55 45 10 (10)
Land 475 400 751 (75)
Plant and equipment 870 800 702 (70)
Accumulated
depreciation (370) (300) (70)3 70
Accounts payable (125) (100) (25) 25
Other accrued
liabilities (35) (45) 10 (10)
Interest payable (15) (10) (5) 5
Long-term loan
payable (340) (250) (90)4 90
Common stock (450) (400) (50)5 50
Retained earnings (310) (445) 1006 (100)
357 (35)
Totals 0 0 0 55 (145) 105
Net increase
(decrease) in cash 15
1Purchase of land.
2Purchase of plant and equipment.
3Depreciation expense.
4Proceeds from borrowings.
5Issuance of common stock.
6Net loss.
7Cash dividends paid.
PROBLEM 12-8 (Continued)
2. Statement of cash flows:
ASTRO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(AMOUNTS IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net loss $(100)
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense 70
Decrease in accounts receivable 25
Decrease in inventories 50
Increase in prepayments (10)
Increase in accounts payable 25
Decrease in other accrued liabilities (10)
Increase in interest payable 5
Net cash provided by operating activities $ 55
Cash Flows from Investing Activities
Acquisition of land $ (75)
Acquisition of plant and equipment (70)
Net cash used by investing activities $(145)
Cash Flows from Financing Activities
Additional long-term borrowings $ 90
Issuance of common stock 50
Cash dividends paid (35)
Net cash provided by financing activities $ 105
Net increase in cash $ 15
Cash balance, December 31, 2006 80
Cash balance, December 31, 2007 $ 95
3. Memorandum to the president:
TO: President of Astro Inc.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference.
PROBLEM 12-8 (Concluded)
Astro was able to generate a significant amount of cash from operations even though we incurred the large net loss of $100,000. One reason for the difference between cash generated from operations and the net loss was the large amount of depreciation expense on the income statement. This noncash expense reduced
reported net income without a corresponding effect on cash flow. Furthermore, the decrease in accounts receivable indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the combined
effect of a reduction in inventory and an increase in the amounts owed suppliers (accounts payable) added to the cash generated.
Operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. The gross profit percentage of 20% appears reasonable, although this depends on many factors, including how our competitors are doing in this area. A significant portion of the operating expenses is the depreciation of $70,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added to our base of long-term assets. I recommend that we explore ways to reduce our other operating expenses. I look forward to hearing from you before moving forward with any actions.
|LO 6 | |PROBLEM 12-9 YEAR-END BALANCE SHEET AND STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash ?
Accounts receivable 10 h. sales exceeded cash
collections
Land 100 g. bonds were exchanged
for land—a noncash
activity
Plant and equipment 200 f. purchase
Accumulated depreciation (20) b. depreciation expense
Investments 0 no change given
Current liabilities 0 i. no change
Bonds payable (250) d. 150 issued for cash and
g. 100 issued for land
Common stock 50 e. common stock retired
Retained earnings (45) c. dividends of 25
a. net income of (70)
Total without cash 45 dr.
Thus, the change in cash must be 45 cr. (decrease) to balance the total changes in the accounts.
PROBLEM 12-9 (Continued)
Statement of Cash Flows:
TERRIER COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 70
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 20
Increase in accounts receivable (10)
Net cash provided by operating activities $ 80
Cash Flows from Investing Activities
Acquisitions of plant and equipment $(200)
Cash Flows from Financing Activities
Payment of cash dividends $ (25)
Issuance of additional bonds 150
Acquisition and retirement of stock (50)
Net cash provided by financing activities $ 75
Net increase (decrease) in cash $ (45)
Cash balance, December 31, 2006 140
Cash balance, December 31, 2007 $ 95
Schedule of Noncash Investing and Financing Activities
Acquisition of land in exchange for bonds $ 100
PROBLEM 12-9 (Concluded)
2. Balance sheet:
TERRIER COMPANY
BALANCE SHEET
DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash $ 951
Accounts receivable 1652
Total current assets $ 260
Land $ 4003
Plant and equipment 7004
Accumulated depreciation (170)5
Investments 100
Total long-term assets $1,030
Total assets $1,290
Current liabilities $ 205
Bonds payable $ 5506
Common stock $ 3507
Retained earnings 1858
Total stockholders’ equity $ 535
Total liabilities and stockholders’ equity $1,290
1$140 – $45 5$150 + $20
2$155 + $10 6$300 + $250
3$300 + $100 7$400 – $50
4$500 + $200 8$140 + $45
3. In addition to the bonds issued in exchange for land, Terrier issued $150,000 of bonds for cash. The money raised from this issuance was needed to help finance the addition of $200,000 in plant and equipment.
|LO 8 | |PROBLEM 12-10 STATEMENT OF CASH FLOWS USING A WORK SHEET—INDIRECT METHOD (Appendix) |
1. Balance sheet:
TERRIER COMPANY
BALANCE SHEET
DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash $ 951
Accounts receivable 1652
Total current assets $ 260
Land $ 4003
Plant and equipment 7004
Accumulated depreciation (170)5
Investments 100
Total long-term assets $1,030
Total assets $1,290
Current liabilities $ 205
Bonds payable $ 5506
Common stock $ 3507
Retained earnings 1858
Total stockholders’ equity $ 535
Total liabilities and stockholders’ equity $1,290
1$140 – $45 5$150 + $20
2$155 + $10 6$300 + $250
3$300 + $100 7$400 – $50
4$500 + $200 8$140 + $45
PROBLEM 12-10 (Continued)
2. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Balances Cash Inflows (Outflows)
Accounts 12/31/07 12/31/06 Changes Operating Investing Financing
Cash 95 140 (45)
Accounts receivable 165 155 10 (10)
Land 400 300 1001
Plant and equipment 700 500 2002 (200)
Accumulated
depreciation (170) (150) (20)3 20
Investments 100 100 0
Current liabilities (205) (205) 0
Bonds payable (550) (300) (100)1
(150)4 150
Common stock (350) (400) 505 (50)
Retained earnings (185) (140) (70)6 70
257 (25)
Totals 0 0 0 80 (200) 75
Net increase
(decrease) in cash (45)
1Acquisition of land in exchange for bonds (noncash transaction).
2Purchase of plant and equipment.
3Depreciation expense.
4Proceeds from issuance of additional bonds.
5Acquisition and retirement of common stock.
6Net income.
7Cash dividends paid.
PROBLEM 12-10 (Concluded)
3. Statement of cash flows:
TERRIER COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 70
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 20
Increase in accounts receivable (10)
Net cash provided by operating activities $ 80
Cash Flows from Investing Activities
Acquisitions of plant and equipment $(200)
Cash Flows from Financing Activities
Payment of cash dividends $ (25)
Issuance of additional bonds 150
Acquisition and retirement of stock (50)
Net cash provided by financing activities $ 75
Net increase (decrease) in cash $ (45)
Cash balance, December 31, 2006 140
Cash balance, December 31, 2007 $ 95
Schedule of Noncash Investing and Financing Activities
Acquisition of land in exchange for bonds $ 100
4. In addition to the bonds issued in exchange for land, Terrier issued $150,000 of bonds for cash. The money raised from this issuance was needed to help finance the addition of $200,000 in plant and equipment.
MULTI-CONCEPT PROBLEMS
|LO 4,5 | |PROBLEM 12-11 STATEMENT OF CASH FLOWS—DIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (9)
Accounts receivable 15
Inventory (15)
Prepaid rent (4)
Land 80 Purchase
Plant and equipment 150 Purchase of 195 and sale of (45)
Accumulated depreciation (60) 15 Sale of asset (cost of 45 less
book value of 30) and (75)
depreciation
Accounts payable (7)
Other accrued liabilities (6)
Income tax payable 2
Long-term bank loan payable 30 Repayment
Common stock (150) Issuance of common stock
Retained earnings (26) 7 Dividends
(33) Net income
Total 0
PROBLEM 12-11 (Continued)
Conversion of income statement items to a cash basis (in thousands of dollars):
Income Statement Amount Adjustment Cash Flows
Sales revenue $550 $550
– Increase in accounts receivable (15)
Cash collected $535
Cost of goods sold 350 $350
– Decrease in inventory (15)
– Increase in accounts payable (7)
Cash payments $328
General and
administrative 55 $ 55
– Decrease in prepaid rent (4)
– Increase in accrued liabilities (6)
Cash payments $ 45
Depreciation expense 75 No cash flow effect $ 0
Loss on sale of Not an operating activity $ 0
plant assets 5
Interest expense 15 No interest payable
Cash payments $ 15
Income tax expense 17 $ 17
+ Decrease in income
taxes payable 2
Cash payments $ 19
Net income $ 33 Net cash flow from operations $128
PROBLEM 12-11 (Concluded)
Statement of cash flows:
GLENDIVE CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flow from Operating Activities
Cash collections from customers $ 535
Cash payments for:
Inventory $ (328)
General and administrative (45)
Interest (15)
Income taxes (19)
Total cash payments $ (407)
Net cash provided by operating activities $ 128
Cash Flow from Investing Activities
Sale of plant assets $ 25
Acquisition of land (80)
Acquisition of new plant assets (195)
Net cash used by investing activities $(250)
Cash Flow from Financing Activities
Repayment of long-term loan $ (30)
Issuance of additional stock 150
Payment of cash dividends (7)
Net cash provided by financing activities $ 113
Net decrease in cash $ (9)
Cash balance, June 30, 2006 40
Cash balance, June 30, 2007 $ 31
2. It is true that the amount of cash flow from operating activities is the same regardless of which method (direct or indirect) is used. The two methods, however, differ in the information reported to the reader of the statement of cash flows. The direct method shows the actual inflows and outflows of cash, while the indirect method arrives at the same amount by reconciling net income to cash flow from operating activities.
|LO 4,6 | |PROBLEM 12-12 STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (9)
Accounts receivable 15
Inventory (15)
Prepaid rent (4)
Land 80 Purchase
Plant and equipment 150 Purchase of 195 and sale of (45)
Accumulated depreciation (60) 15 Sale of asset (cost of 45 less
book value of 30) and (75)
depreciation
Accounts payable (7)
Other accrued liabilities (6)
Income tax payable 2
Long-term bank loan payable 30 Repayment
Common stock (150) Issuance of common stock
Retained earnings (26) 7 Dividends
(33) Net income
Total 0
PROBLEM 12-12 (Concluded)
Statement of cash flows:
GLENDIVE CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flow from Operating Activities
Net income $ 33
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 75
Loss on sale of plant assets 5*
Increase in accounts receivable (15)
Decrease in inventory 15
Decrease in prepaid rent 4
Increase in accounts payable 7
Increase in other accrued liabilities 6
Decrease in income taxes payable (2)
Net cash provided by operating activities $ 128
*Book value $30 – proceeds $25
Cash Flow from Investing Activities
Sale of plant assets $ 25
Acquisition of land (80)
Acquisition of new plant assets (195)
Net cash used by investing activities $(250)
Cash Flow from Financing Activities
Repayment of long-term loan $ (30)
Issuance of additional stock 150
Payment of cash dividends (7)
Net cash provided by financing activities $ 113
Net decrease in cash $ (9)
Cash balance, June 30, 2006 40
Cash balance, June 30, 2007 $ 31
2. It is true that the amount of cash flow from operating activities is the same regardless of which method (direct or indirect) is used. The two methods, however, differ in the information reported to the reader of the statement of cash flows. The direct method shows the actual inflows and outflows of cash, while the indirect method arrives at the same amount by reconciling net income to cash flow from operating activities.
|LO 2,5 | |PROBLEM 12-13 STATEMENT OF CASH FLOWS—DIRECT METHOD |
1. No, the U.S. Treasury bills are not cash equivalents, because they have a maturity in excess of three months. Instead, the six-month Treasury bills are properly classified as current assets.
2. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (40)
U.S. Treasury bills (50) Sale
Accounts receivable 110
Inventory 120
Land 10 Purchase
Buildings and equipment 110 Purchase
Accumulated depreciation (60) Depreciation expense
Patents (25) Amortization
Accounts payable (60)
Taxes payable (5)
Notes payable 0
Term notes payable 0
Common stock (130) (130) Stock dividend
Retained earnings 20 (110) Net income
130 Stock dividend
Total 0
PROBLEM 12-13 (Continued)
Conversion of income statement items to a cash basis (in thousands of dollars):
Income Statement Amount Adjustment Cash Flows
Sales revenue $2,408 $2,408
– Increase in accounts receivable (110)
Cash collected $2,298
Cost of goods sold 1,100 $1,100
+ Increase in inventory 120
– Increase in accounts payable (60)
Cash payments $1,160
Salaries & benefits 850 No payable $ 850
Heat, light, and power 75 No payable $ 75
Depreciation 60 No cash flow effect
Property taxes 18 No payable* $ 18
Patent amortization 25 No cash flow effect
Miscellaneous expenses 10 No payable $ 10
Interest expense 55 No payable $ 55
Income tax expense 105 $ 105
– Increase in income tax payable* (5)
Cash payments $ 100
Net income $ 110 Net cash flow from operations $ 30
*The current liability Taxes Payable is assumed to relate entirely to income taxes rather than property taxes.
PROBLEM 12-13 (Concluded)
Statement of cash flows:
LANG COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections from customers $ 2,298
Cash payments for:
Inventory $ (1,160)
Salaries and benefits (850)
Heat, light, and power (75)
Property taxes (18)
Miscellaneous activities (10)
Interest (55)
Income taxes (100)
Total cash payments $(2,268)
Net cash provided by operating activities $ 30
Cash Flows from Investing Activities
Sale of U.S. Treasury bills $ 50
Acquisition of land (10)
Acquisition of buildings and equipment (110)
Net cash used by investing activities $ (70)
Net decrease in cash $ (40)
Cash balance, December 31, 2006 100
Cash balance, December 31, 2007 $ 60
Note: It is questionable whether or not the stock dividend is a significant noncash activity. If it is determined to be significant, it should be shown on a supplemental schedule of noncash activities.
alternate problems
|LO 6 | |PROBLEM 12-1A STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Account changes Dr (Cr) and Explanations:
Cash 2,000
Accounts receivable (2,000)
Inventory 1,000
Prepaid rent 200
Land 0
Plant and equipment 50,000 Purchase
Accumulated depreciation (50,000) Depreciation expense
Accounts payable 0
Income taxes payable (500)
Short-term notes payable 2,500 Repayment
Bonds payable (25,000) Issuance
Common stock 0
Retained earnings 21,800 Net loss
Total 0
PROBLEM 12-1A (Concluded)
Statement of cash flows:
MADISON COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
Cash Flows from Operating Activities
Net loss $(21,800)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 50,000
Decrease in accounts receivable 2,000
Increase in inventory (1,000)
Increase in prepaid rent (200)
Increase in income taxes payable 500
Net cash provided by operating activities $ 29,500
Cash Flows from Investing Activities
Acquisition of plant and equipment $(50,000)
Cash Flows from Financing Activities
Issuance of bonds payable $ 25,000
Repayment of short-term notes payable (2,500)
Net cash provided by financing activities $ 22,500
Net increase in cash $ 2,000
Cash balance, December 31, 2006 10,000
Cash balance, December 31, 2007 $ 12,000
2. Madison was able to increase its cash balance even though it incurred a net loss primarily because it had one very large expense that did not require the use of any cash: depreciation of $50,000. This one adjustment is the major difference between the net loss of $21,800 and the net cash flow from operating activities of $29,500.
|LO 8 | |PROBLEM 12-2A STATEMENT OF CASH FLOWS USING A WORK SHEET—INDIRECT METHOD (Appendix) |
1. Statement of cash flows work sheet (all amounts are in thousands of dollars)
Balances Cash Inflows (Outflows)
Accounts 12/31/07 12/31/06 Changes Operating Investing Financing
Cash 12.0 10.0 2.0
Accounts receivable 10.0 12.0 (2.0) 2.0
Inventory 8.0 7.0 1.0 (1.0)
Prepaid rent 1.2 1.0 0.2 (0.2)
Land 75.0 75.0 0.0
Plant and equipment 200.0 150.0 50.01 (50)
Accumulated
depreciation (75.0) (25.0) (50.0)2 50.0
Accounts payable (15.0) (15.0) 0.0
Income tax payable (2.5) (2.0) (0.5) 0.5
Short-term notes
payable (20.0) (22.5) 2.53 (2.5)
Bonds payable (75.0) (50.0) (25.0)4 25.0
Common stock (100.0) (100.0) 0.0
Retained earnings (18.7) (40.5) 21.85 (21.8)
Totals 0.0 0.0 0.0 29.5 (50) 22.5
Net increase
(decrease) in cash 2.0
1Purchase of equipment.
2Depreciation expense.
3Retirement of note.
4Issuance of bonds.
5Net loss.
PROBLEM 12-2A (Concluded)
2. Statement of cash flows:
MADISON COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
Cash Flows from Operating Activities
Net loss $(21,800)
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 50,000
Decrease in accounts receivable 2,000
Increase in inventory (1,000)
Increase in prepaid rent (200)
Increase in income taxes payable 500
Net cash provided by operating activities $ 29,500
Cash Flows from Investing Activities
Acquisition of plant and equipment $ (50,000)
Cash Flows from Financing Activities
Issuance of bonds payable $ 25,000
Repayment of short-term notes payable (2,500)
Net cash provided by financing activities $ 22,500
Net increase (decrease) in cash $ 2,000
Cash balance, December 31, 2006 10,000
Cash balance, December 31, 2007 $ 12,000
3. Madison was able to increase its cash balance even though it incurred a net loss primarily because it had one very large expense that did not require the use of any cash: depreciation of $50,000. This one adjustment is the major difference between the net loss of $21,800 and the net cash flow from operating activities of $29,500.
|LO 5 | |PROBLEM 12-3A STATEMENT OF CASH FLOWS—DIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (70)
Accounts receivable (85)
Inventory 20
Prepayments (10)
Land (100) Sale (c)
Plant and equipment 250 Purchase (c)
Accumulated depreciation (25) Depreciation expense (b)
Accounts payable (20)
Other accrued liabilities 5
Income tax payable 35
Long-term bank loan payable 50 Retirement of bank loan (d)
Common stock (50) Issuance of common stock (d)
Retained earnings (0) 350 Dividends (a)
(350) Net income
Total 0
Conversion of income statement items to a cash basis (in thousands of dollars):
Income Statement Amount Adjustment Cash Flows
Sales revenue $2,460 $2,460
+ Decrease in accounts receivable 85
Cash collected $2,545
Cost of goods sold 1,400 $1,400
+ Increase in inventory 20
– Increase in accounts payable (20)
Cash payments $1,400
Operating expenses 460 $ 460
– Decrease in prepayments (10)
– Depreciation expense (25)
+ Decrease in accrued liabilities 5
Cash payments $ 430
Interest expense 100 $ 100
No interest payable 0
Cash payments $ 100
Income tax expense 150 $ 150
+ Decrease in income tax payable 35
Cash paid for taxes $ 185
Net income $ 350 Net cash flow from operations $ 430
PROBLEM 12-3A (Continued)
Statement of cash flows:
WABASH CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections from customers $ 2,545
Cash payments for:
Inventory $(1,400)
Operating expenses (430)
Interest (100)
Income taxes (185)
Total cash payments $(2,115)
Net cash provided by operating activities $ 430
Cash Flows from Investing Activities
Sale of land $ 100
Acquisition of plant and equipment (250)
Net cash used by investing activities $ (150)
Cash Flows from Financing Activities
Repayment of long-term borrowings $ (50)
Issuance of common stock 50
Cash dividends paid (350)
Net cash used by financing activities $ (350)
Net decrease in cash $ (70)
Cash balance, December 31, 2006 210
Cash balance, December 31, 2007 $ 140
2. Memorandum to the president:
TO: President of Wabash Corp.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern to me regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern regarding the decline in our cash balance during the year, given that existing loan covenants require a $100,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.
PROBLEM 12-3A (Concluded)
Although net income on an accrual basis was $350,000, net cash flow from operating activities was even higher, $430,000. However, the favorable cash flow during the year was used for various purposes. First, significant additions were made to plant and equipment, $250,000, and this drain on cash was only partially offset by the sale of land for $100,000. Additional stock was sold for $50,000, which was the amount needed to repay an existing bank loan. The major reason, however, for the drain on cash is the size of our dividend payments. Dividends of $350,000 were paid during the year, which is equal to the income of the period.
Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. At the same time, I recommend that we limit the amount paid in any one year for dividends as a way to keep our cash balance at a sufficient level to satisfy the bank.
|LO 6 | |PROBLEM 12-4A STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (70)
Accounts receivable (85)
Inventory 20
Prepayments (10)
Land (100) Sale (c)
Plant and equipment 250 Purchase (c)
Accumulated depreciation (25) Depreciation expense (b)
Accounts payable (20)
Other accrued liabilities 5
Income tax payable 35
Long-term bank loan payable 50 Retirement of bank loan (d)
Common stock (50) Issuance of common stock (d)
Retained earnings (0) 350 Dividends (a)
(350) Net income
Total 0
PROBLEM 12-4A (Continued)
Statement of cash flows:
WABASH CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 350
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 25
Decrease in accounts receivable 85
Increase in inventories (20)
Decrease in prepayments 10
Increase in accounts payable 20
Decrease in other accrued liabilities (5)
Decrease in income taxes payable (35)
Net cash provided by operating activities $ 430
Cash Flows from Investing Activities
Sale of land $ 100
Acquisition of plant and equipment (250)
Net cash used by investing activities $(150)
Cash Flows from Financing Activities
Repayment of long-term borrowings $ (50)
Issuance of common stock 50
Cash dividends paid (350)
Net cash used by financing activities $(350)
Net decrease in cash $ (70)
Cash balance, December 31, 2006 210
Cash balance, December 31, 2007 $ 140
2. Memorandum to the president:
TO: President of Wabash Corp.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern to me regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern regarding the decline in our cash balance during the year, given that existing loan covenants require a $100,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.
PROBLEM 12-4A (Concluded)
Although net income on an accrual basis was $350,000, net cash flow from
operating activities was even higher, $430,000. However, the favorable cash flow during the year was used for various purposes. First, significant additions were made to plant and equipment, $250,000, and this drain on cash was only partially offset by the sale of land for $100,000. Additional stock was sold for $50,000, which was the amount needed to repay an existing bank loan. The major reason, however, for the drain on cash is the size of our dividend payments. Dividends of $350,000 were paid during the year, which is equal to the income of the period.
Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. At the same time, I recommend that we limit the amount paid in any one year for dividends as a way to keep our cash balance at a sufficient level to satisfy the bank.
|LO 8 | |PROBLEM 12-5A STATEMENT OF CASH FLOWS USING A WORK SHEET—INDIRECT METHOD (Appendix) |
1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Balances Cash Inflows (Outflows)
Accounts 12/31/07 12/31/06 Changes Operating Investing Financing
Cash 140 210 (70)
Accounts receivable 60 145 (85) 85
Inventory 200 180 20 (20)
Prepayments 15 25 (10) 10
Land 600 700 (100)1 100
Plant and equipment 850 600 2502 (250)
Accumulated
depreciation (225) (200) (25)3 25
Accounts payable (140) (120) (20) 20
Accrued liabilities (50) (55) 5 (5)
Income tax payable (80) (115) 35 (35)
Long-term loan
payable (200) (250) 504 (50)
Common stock (450) (400) (50)5 50
Retained earnings (720) (720) 3506 (350)
(350)7 350
Totals 0 0 0 430 (150) (350)
Net increase
(decrease) in cash (70)
1Sale of land. 5Issuance of common stock.
2Purchase of plant and equipment. 6Dividends.
3Depreciation expense. 7Net income.
4Retirement of bank loan.
PROBLEM 12-5A (Continued)
2. Statement of cash flows:
WABASH CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 350
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense 25
Decrease in accounts receivable 85
Increase in inventories (20)
Decrease in prepayments 10
Increase in accounts payable 20
Decrease in other accrued liabilities (5)
Decrease in income taxes payable (35)
Net cash provided by operating activities $ 430
Cash Flows from Investing Activities
Sale of land $ 100
Acquisition of plant and equipment (250)
Net cash used by investing activities $(150)
Cash Flows from Financing Activities
Repayment of long-term borrowings $ (50)
Issuance of common stock 50
Cash dividends paid (350)
Net cash used by financing activities $(350)
Net decrease in cash $ (70)
Cash balance, December 31, 2006 210
Cash balance, December 31, 2007 $ 140
3. Memorandum to the president:
TO: President of Wabash Corp.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern to me regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern regarding the decline in our cash balance during the year, given that existing loan covenants require a $100,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.
PROBLEM 12-5A (Concluded)
Although net income on an accrual basis was $350,000, net cash flow from
operating activities was even higher, $430,000. However, the favorable cash flow during the year was used for various purposes. First, significant additions were made to plant and equipment, $250,000, and this drain on cash was only partially offset by the sale of land for $100,000. Additional stock was sold for $50,000, which was the amount needed to repay an existing bank loan. The major reason, however, for the drain on cash is the size of our dividend payments. Dividends of $350,000 were paid during the year, which is equal to the income of the period.
Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. At the same time, I recommend that we limit the amount paid in any one year for dividends as a way to keep our cash balance at a sufficient level to satisfy the bank.
|LO 5 | |PROBLEM 12-6A STATEMENT OF CASH FLOWS—DIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash 15
Accounts receivable (50)
Inventory 0
Prepayments 1
Land 100 Purchase (c)
Plant and equipment 250 Purchase (c)
Accumulated depreciation (40) Depreciation expense (b)
Accounts payable (40)
Other accrued liabilities (20)
Interest payable (10)
Long-term bank loan payable (350) Proceeds from bank loan (c)
Common stock 0
Retained earnings 144 84 Dividends (a)
60 Net loss
Total 0
PROBLEM 12-6A (Continued)
Conversion of income statement items to a cash basis (in thousands of dollars):
Income Statement Amount Adjustment Cash Flows
Sales revenue $350 $350
+ Decrease in accounts receivable 50
Cash collected $400
Cost of goods sold 150 $150
No change in inventory
– Increase in accounts payable (40)
Cash payments $110
Operating expenses 250 $250
+ Increase in prepayments 1
– Depreciation expense (40)
– Increase in accrued liabilities (20)
Cash payments $191
Interest expense 10 $ 10
– Increase in interest payable (10)
Cash payments $ 0
Net income (loss) $ (60) Net cash flow from operations $ 99
Statement of cash flows:
PLUTO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections on account $ 400
Cash payments for:
Inventory $(110)
Operating expenses (191)
Total cash payments $ (301)
Net cash provided by operating activities $ 99
Cash Flows from Investing Activities
Acquisition of land $(100)
Acquisition of plant and equipment (250)
Net cash used by investing activities $(350)
Cash Flows from Financing Activities
Additional long-term borrowings $ 350
Cash dividends paid (84)
Net cash provided by financing activities $ 266
Net increase in cash $ 15
Cash balance, December 31, 2006 10
Cash balance, December 31, 2007 $ 25
PROBLEM 12-6A (Concluded)
2. Memorandum to the president:
TO: President of Pluto Inc.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference.
Pluto was able to generate a significant amount of cash from operations even though we incurred a net loss of $60,000. One reason for the difference between cash generated from operations and the net loss was the $40,000 of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Furthermore, the large decrease in accounts receivable of $50,000 indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the large buildup of our accounts payable by $40,000 had the effect of improving our cash flow for the year.
The gross profit percentage of 57% is very strong. However, operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. A portion of the operating expenses is the depreciation of $40,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added $350,000 to our base of long-term assets, in the form of land and plant and equipment acquisitions. You will note on the statement of cash flows that these acquisitions were entirely financed with the issuance of a long-term bank loan.
I recommend two immediate courses of action. First, we must find ways to reduce our operating expenses. Second, until we see an improvement in the bottom line, it is imperative that we cut back, if not eliminate entirely, our dividends. A dividend payment of $84,000 in a year in which we sustained a net loss of $60,000 is not prudent. I look forward to hearing from you before moving forward with any actions.
|LO 6 | |PROBLEM 12-7A STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash 15
Accounts receivable (50)
Inventory 0
Prepayments 1
Land 100 Purchase (c)
Plant and equipment 250 Purchase (c)
Accumulated depreciation (40) Depreciation expense (b)
Accounts payable (40)
Other accrued liabilities (20)
Interest payable (10)
Long-term bank loan payable (350) Proceeds from bank loan (c)
Common stock 0
Retained earnings 144 84 Dividends (a)
60 Net loss
Total 0
PROBLEM 12-7A (Continued)
Statement of cash flows:
PLUTO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net loss $ (60)
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense 40
Decrease in accounts receivable 50
Increase in prepayments (1)
Increase in accounts payable 40
Increase in other accrued liabilities 20
Increase in interest payable 10
Net cash provided by operating activities $ 99
Cash Flows from Investing Activities
Acquisition of land $(100)
Acquisition of plant and equipment (250)
Net cash used by investing activities $(350)
Cash Flows from Financing Activities
Additional long-term borrowings $ 350
Cash dividends paid (84)
Net cash provided by financing activities $ 266
Net increase in cash $ 15
Cash balance, December 31, 2006 10
Cash balance, December 31, 2007 $ 25
PROBLEM 12-7A (Concluded)
2. Memorandum to the president:
TO: President of Pluto, Inc.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference.
Pluto was able to generate a significant amount of cash from operations even though we incurred a net loss of $60,000. One reason for the difference between cash generated from operations and the net loss was the $40,000 of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Furthermore, the large decrease in accounts receivable of $50,000 indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the large buildup of our accounts payable by $40,000 had the effect of improving our cash flow for the year.
The gross profit percentage of 57% is very strong. However, operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. A portion of the operating expenses is the depreciation of $40,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added $350,000 to our base of long-term assets, in the form of land and plant and equipment acquisitions. You will note on the statement of cash flows that these acquisitions were entirely financed with the issuance of a long-term bank loan.
I recommend two immediate courses of action. First, we must find ways to reduce our operating expenses. Second, until we see an improvement in the bottom line, it is imperative that we cut back, if not eliminate entirely, our dividends. A dividend payment of $84,000 in a year in which we sustained a net loss of $60,000 is not prudent. I look forward to hearing from you before moving forward with any actions.
|LO 8 | |PROBLEM 12-8A STATEMENT OF CASH FLOWS USING A WORK SHEET—INDIRECT METHOD (Appendix) |
1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Balances Cash Inflows (Outflows)
Accounts 12/31/07 12/31/06 Changes Operating Investing Financing
Cash 25 10 15
Accounts receivable 30 80 (50) 50
Inventory 100 100 0
Prepayments 36 35 1 (1)
Land 300 200 1001 (100)
Plant and equipment 500 250 2502 (250)
Accumulated
depreciation (90) (50) (40)3 40
Accounts payable (50) (10) (40) 40
Other accrued
liabilities (40) (20) (20) 20
Interest payable (22) (12) (10) 10
Long-term loan
payable (450) (100) (350)4 350
Common stock (300) (300) 0
Retained earnings (39) (183) 605 (60)
846 (84)
Totals 0 0 0 99 (350) 266
Net increase
(decrease) in cash 15
1Purchase of land. 4Proceeds from borrowings.
2Purchase of plant and equipment. 5Net loss.
3Depreciation expense. 6Cash dividends paid.
PROBLEM 12-8A (Continued)
2. Statement of cash flows:
PLUTO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net loss $ (60)
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense 40
Decrease in accounts receivable 50
Increase in prepayments (1)
Increase in accounts payable 40
Increase in other accrued liabilities 20
Increase in interest payable 10
Net cash provided by operating activities $ 99
Cash Flows from Investing Activities
Acquisition of land $(100)
Acquisition of plant and equipment (250)
Net cash used by investing activities $(350)
Cash Flows from Financing Activities
Additional long-term borrowings $ 350
Cash dividends paid (84)
Net cash provided by financing activities $ 266
Net increase in cash $ 15
Cash balance, December 31, 2006 10
Cash balance, December 31, 2007 $ 25
3. Memorandum to the president:
TO: President of Pluto, Inc.
FROM: Student’s name
DATE: January 20, 2008
SUBJECT: Cash flows
You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference.
PROBLEM 12-8A (Concluded)
Pluto was able to generate a significant amount of cash from operations even though we incurred a net loss of $60,000. One reason for the difference between cash generated from operations and the net loss was the $40,000 of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Furthermore, the large decrease in accounts receivable of $50,000 indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the large buildup of our accounts payable by $40,000 had the effect of improving our cash flow for the year.
The gross profit percentage of 57% is very strong. However, operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. A portion of the operating expenses is the depreciation of $40,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added $350,000 to our base of long-term assets, in the form of land and plant and equipment acquisitions. You will note on the statement of cash flows that these acquisitions were entirely financed with the issuance of a long-term bank loan.
I recommend two immediate courses of action. First, we must find ways to reduce our operating expenses. Second, until we see an improvement in the bottom line, it is imperative that we cut back, if not eliminate entirely, our dividends. A dividend payment of $84,000 in a year in which we sustained a net loss of $60,000 is not prudent. I look forward to hearing from you before moving forward with any actions.
|LO 6 | |PROBLEM 12-9A YEAR-END BALANCE SHEET AND STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash ?
Accounts receivable 15 h. sales exceeded cash
collections
Land 200 g. note was exchanged for land,
a noncash activity
Plant and equipment 60 f. purchase
Accumulated depreciation (25) b. depreciation expense
Investments 0 no change given
Current liabilities 20 i. decrease
Long-term note payable (200) g. note was exchanged for land,
a noncash activity
Bonds payable 100 e. bonds retired
Common stock (50) d. common stock issued
Retained earnings (10) c. dividends of 40
a. income of (50)
Total without cash 110 dr.
Thus, the change in cash must be 110 cr. (decrease) to balance the total changes in the accounts.
PROBLEM 12-9A (Continued)
Statement of cash flows:
POODLE COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 50
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense 25
Increase in accounts receivable (15)
Decrease in current liabilities (20)
Net cash provided by operating activities $ 40
Cash Flows from Investing Activities
Acquisitions of plant and equipment $ (60)
Cash Flows from Financing Activities
Payment of cash dividends $ (40)
Retirement of bonds (100)
Issuance of common stock 50
Net cash used by financing activities $ (90)
Net increase (decrease) in cash $(110)
Cash balance, December 31, 2006 155
Cash balance, December 31, 2007 $ 45
Schedule of Noncash Investing and Financing Activities
Acquisition of land in exchange for note $ 200
PROBLEM 12-9A (Concluded)
2. Balance sheet:
POODLE COMPANY
BALANCE SHEET
DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash $ 451
Accounts receivable 1552
Total current assets $ 200
Land $ 3003
Plant and equipment 7604
Accumulated depreciation (200)5
Investments 125
Total long-term assets $ 985
Total assets $1,185
Current liabilities $ 3056
Long-term note payable $ 200
Common stock $ 5507
Retained earnings 1308
Total stockholders’ equity $ 680
Total liabilities and stockholders’ equity $1,185
1$155 – $110 5$175 + $25
2$140 + $15 6$325 – $20
3$100 + $200 7$500 + $50
4$700 + $60 8$120 + $10
3. Poodle’s cash from operations of $40,000 was insufficient to cover its acquisitions of new plant and equipment of $60,000 and the payment of cash dividends of $40,000. Common stock of $50,000 was issued, but this was more than offset by the $100,000 needed to retire the bonds. The lack of cash from operations to cover acquisitions, pay dividends, and retire the bonds are all responsible for the large decrease in the company’s cash balance at the end of the year.
|LO 8 | |PROBLEM 12-10A STATEMENT OF CASH FLOWS USING A WORK SHEET—INDIRECT METHOD (Appendix) |
1. Balance sheet:
POODLE COMPANY
BALANCE SHEET
DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash $ 451
Accounts receivable 1552
Total current assets $ 200
Land $ 3003
Plant and equipment 7604
Accumulated depreciation (200)5
Investments 125
Total long-term assets $ 985
Total assets $ 1,185
Current liabilities $ 3056
Long-term note payable $ 200
Common stock $ 5507
Retained earnings 1308
Total stockholders’ equity $ 680
Total liabilities and stockholders’ equity $ 1,185
1$155 – $110 5$175 + $25
2$140 + $15 6$325 – $20
3$100 + $200 7$500 + $50
4$700 + $60 8$120 + $10
PROBLEM 12-10A (Continued)
2. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Balances Cash Inflows (Outflows)
Accounts 12/31/07 12/31/06 Changes Operating Investing Financing
Cash 45 155 (110)
Accounts receivable 155 140 15 (15)
Land 300 100 2001
Plant and equipment 760 700 602 (60)
Accumulated
depreciation (200) (175) (25)3 25
Investments 125 125 0
Current liabilities (305) (325) 20 (20)
Long-term note
payable (200) 0 (200)1
Bonds payable 0 (100) 1004 (100)
Common stock (550) (500) (50)5 50
Retained earnings (130) (120) (50)6 50
407 (40)
Totals 0 0 0 40 (60) (90)
Net increase
(decrease) in cash (110)
1Acquisition of land in exchange for note (noncash transaction).
2Purchase of plant and equipment.
3Depreciation expense.
4Retirement of bonds payable.
5Issuance of common stock.
6Net income.
7Cash dividends paid.
PROBLEM 12-10A (Concluded)
3. Statement of cash flows:
POODLE COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 50
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense 25
Increase in accounts receivable (15)
Decrease in current liabilities (20)
Net cash provided by operating activities $ 40
Cash Flows from Investing Activities
Acquisitions of plant and equipment $ (60)
Cash Flows from Financing Activities
Payment of cash dividends $ (40)
Retirement of bonds (100)
Issuance of common stock 50
Net cash used by financing activities $ (90)
Net increase (decrease) in cash $(110)
Cash balance, December 31, 2006 155
Cash balance, December 31, 2007 $ 45
Schedule of Noncash Investing and Financing Activities
Acquisition of land in exchange for note $ 200
4. Poodle’s cash from operations of $40,000 was insufficient to cover its acquisitions of new plant and equipment of $60,000 and the payment of cash dividends of $40,000. Common stock of $50,000 was issued, but this was more than offset by the $100,000 needed to retire the bonds. The lack of cash from operations to cover acquisitions, pay dividends, and retire the bonds are all responsible for the large decrease in the company’s cash balance at the end of the year.
ALTERNATE MULTI-CONCEPT PROBLEMS
|LO 4,5 | |PROBLEM 12-11A STATEMENT OF CASH FLOWS—DIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (15)
Accounts receivable 11
Inventory 25
Prepaid rent (16)
Land (90) Sale
Plant and equipment 75 Purchase of 125 and sale of (50)
Accumulated depreciation (60) 20 Sale of asset (cost of 50 less
book value of 30) and
(80) depreciation
Accounts payable (5)
Other accrued liabilities (5)
Income tax payable 10
Long-term bank loan payable 75 Repayment
Common stock 0
Retained earnings (5) 5 Dividends
(10) Net income
Total 0
PROBLEM 12-11A (Continued)
Conversion of income statement items to a cash basis (in thousands of dollars):
Income Statement Amount Adjustment Cash Flows
Sales revenue $400 $400
– Increase in accounts receivable (11)
Cash collected $389
Cost of goods sold 240 $240
+ Increase in inventory 25
– Increase in accounts payable (5)
Cash payments $260
General and
administrative 40 $ 40
– Decrease in prepaid rent (16)
– Increase in accrued liabilities (5)
Cash payments $ 19
Depreciation expense 80 (No cash flow effect) $ 0
Loss on sale of
plant assets 10 Not an operating activity $ 0
Interest expense 15 No interest payable
Cash payments $ 15
Income tax expense 5 $ 5
+ Decrease in income taxes payable 10
Cash payments $ 15
Net income $ 10 Net cash flow from operations $ 80
PROBLEM 12-11A (Concluded)
Statement of cash flows:
BANNACK CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections from customers $ 389
Cash payments for:
Inventory $(260)
General and administrative (19)
Interest (15)
Income taxes (15)
Total cash payments $(309)
Net cash provided by operating activities $ 80
Cash Flows from Investing Activities
Sale of land $ 90
Purchase of plant and equipment (125)
Sale of plant and equipment 20
Net cash used by investing activities $ (15)
Cash Flows from Financing Activities
Repayment of long-term loan $ (75)
Payment of cash dividends (5)
Net cash used by financing activities $ (80)
Net decrease in cash $ (15)
Cash balance, June 30, 2006 40
Cash balance, June 30, 2007 $ 25
2. It is true that the amount of cash flow from operating activities is the same regardless of which method (direct or indirect) is used. The two methods, however, differ in the information reported to the reader of the statement of cash flows. The direct method shows the actual inflows and outflows of cash, while the indirect method arrives at the same amount by reconciling net income to cash flow from operating activities.
|LO 4,6 | |PROBLEM 12-12A STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (15)
Accounts receivable 11
Inventory 25
Prepaid rent (16)
Land (90) Sale
Plant and equipment 75 Purchase of 125 and sale of (50)
Accumulated depreciation (60) 20 Sale of asset (cost of 50 less
book value of 30) and (80)
depreciation
Accounts payable (5)
Other accrued liabilities (5)
Income tax payable 10
Long-term bank loan payable 75 Repayment
Common stock 0
Retained earnings (5) 5 Dividends
(10) Net income
Total 0
PROBLEM 12-12A (Concluded)
Statement of cash flows:
BANNACK CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flow from Operating Activities
Net income $ 10
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense 80
Loss on sale of plant assets 10
Increase in accounts receivable (11)
Increase in inventory (25)
Decrease in prepaid rent 16
Increase in accounts payable 5
Increase in other accrued liabilities 5
Decrease in income taxes payable (10)
Net cash provided by operating activities $ 80
Cash Flow from Investing Activities
Sale of land $ 90
Purchase of plant and equipment (125)
Sale of plant and equipment 20
Net cash used by investing activities $ (15)
Cash Flow from Financing Activities
Repayment of long-term loan $(75)
Payment of cash dividends (5)
Net cash used by financing activities $(80)
Net decrease in cash $ (15)
Cash balance, June 30, 2006 40
Cash balance, June 30, 2007 $ 25
2. It is true that the amount of cash flow from operating activities is the same regardless of which method (direct or indirect) is used. The two methods, however, differ in the information reported to the reader of the statement of cash flows. The direct method shows the actual inflows and outflows of cash, while the indirect method arrives at the same amount by reconciling net income to cash flow from operating activities.
|LO 2,5 | |PROBLEM 12-13A STATEMENT OF CASH FLOWS—DIRECT METHOD |
1. No, the U.S. Treasury bills are not cash equivalents, because they have a maturity in excess of three months. Instead, the six-month Treasury bills are properly classified as current assets.
2. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash (25)
U.S. Treasury bills 25
Accounts receivable (75)
Inventory 25
Land 20 Purchase
Buildings and equipment 60 Purchase
Accumulated depreciation (40) Depreciation expense
Patents (20) Amortization
Accounts payable (40)
Taxes payable 10
Notes payable 100 Retirement of note
Term notes payable 0
Common stock (20) (20) Stock dividend
Retained earnings (20) (40) Net income
20 Stock dividend
Total 0
PROBLEM 12-13A (Continued)
Conversion of income statement items to a cash basis (in thousands of dollars):
Income Statement Amount Adjustment Cash Flows
Sales revenue $1,416 $1,416
+ Decrease in accounts receivable 75
Cash collected $1,491
Cost of goods sold 990 $ 990
+ Increase in inventory 25
– Increase in accounts payable (40)
Cash payments $ 975
Salaries and benefits 195 No payable $ 195
Heat, light, and power 70 No payable $ 70
Depreciation 40 No cash flow effect
Property taxes 2 No payable* $ 2
Patent amortization 20 No cash flow effect
Miscellaneous expense 2 No payable $ 2
Interest expense 45 No payable $ 45
Income tax expense 12 $ 12
+ Decrease in income tax payable* 10
Cash payments $ 22
Net income $ 40 Net cash flow from operations $ 180
*The current liability Taxes Payable is assumed to relate entirely to income taxes rather than property taxes.
PROBLEM 12-13A (Concluded)
Statement of cash flows:
SHEPARD COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections from customers $ 1,491
Cash payments for:
Inventory $ (975)
Salaries and benefits (195)
Heat, light, and power (70)
Property taxes (2)
Miscellaneous activities (2)
Interest (45)
Income taxes (22)
Total cash payments $(1,311)
Net cash provided by operating activities $ 180
Cash Flows from Investing Activities
Purchase of U.S. Treasury bills $ (25)
Acquisition of land (20)
Acquisition of buildings and equipment (60)
Net cash used by investing activities $ (105)
Cash Flows from Financing Activities
Retirement of notes payable $ (100)
Net decrease in cash $ (25)
Cash balance, December 31, 2006 75
Cash balance, December 31, 2007 $ 50
Note: It is questionable whether or not the stock dividend is a significant noncash activity. If it is determined to be significant, it should be shown on a supplemental schedule of noncash activities.
DECISION CASES
READING AND INTERPRETING FINANCIAL STATEMENTS
|LO 3,4 | |DECISION CASE 12-1 COMPARING TWO COMPANIES IN THE SAME INDUSTRY: FINISH LINE AND FOOT LOCKER |
1. Both companies use the indirect method in preparing the Operating Activities section of their statement of cash flows. Both begin the statement with net income and then make the adjustments to reconcile this number to cash provided by operating activities.
2. Finish Line’s net cash provided by operating activities decreased during the year by $87,147,000 – $74,027,000 or $13,120,000. The largest adjustment to reconcile net income to net cash provided by operating activities was the add back of depreciation and amortization of $34,633,000. Foot Locker’s net cash provided by operating activities of continuing operations increased during the year by $354,000,000 -–$289,000,000 or $65,000,000. The largest adjustment to reconcile net income to net cash provided by operating activities was the add back of depreciation and amortization of $171,000,000.
3. Finish Line’s merchandise inventories increased during the year, net of the effects of acquisitions, by $27,348,000. Foot Locker’s merchandise inventories increased during the year by $111,000,000. An increase in inventory during the year indicates that the company purchased more than it sold. An increase in inventory would be normal for companies such as Finish Line and Foot Locker that are growing and adding more stores each year.
4. Finish Line spent $70,126,000 and $58,172,000 to purchase property and equipment in the years ended February 25, 2006 and February 26, 2005, respectively. Foot Locker spent $155,000,000 and $156,000,000 on property and equipment (capital expenditures) in the years ended January 28, 2006 and January 29, 2005, respectively.
5. The primary source of financing for Finish Line during the most recent year was from the issuance of common stock for $4,105,000. Foot Locker’s largest source of financing was also from the issuance of common stock in the amount of $12,000,000. Both companies bought back some of their own shares during the year in the form of treasury stock. Finish Line spent $19,865,000 and Foot Locker spent $35,000,000 for this purpose. Companies buy back their own stock for a variety of reasons including the need to have stock available to distribute to employees as part of bonus and other benefit plans.
|LO 7 | |DECISION CASE 12-2 COMPUTING AND INTERPRETING FOOT LOCKER’S CASH FLOW ADEQUACY |
1. Cash flow adequacy ratio for the year ended January 28, 2006: (Net cash provided by operating activities of continuing operations – Capital expenditures)/Average annual debt maturing over next five years (amounts in millions of dollars):
($354 – $155)/[($50 + $0 + $2 + $88 + $0)/5] = $199/28 = 7.1
2. The cash flow adequacy ratio gives the user an indication of whether or not the company is generating sufficient cash from its operations to repay its debts after taking into consideration the need to make necessary expenditures on new property and equipment. This ratio indicates that Foot Locker’s cash flow was more than sufficient to repay its average debt after allowing for capital expenditures.
MAKING FINANCIAL DECISIONS
|LO 1,5 | |DECISION CASE 12-3 DIVIDEND DECISION AND THE STATEMENT OF CASH FLOWS—DIRECT METHOD |
1. Changes in account balances and explanations (in thousands of dollars):
Net Change
Dr. (Cr.) Explanation
Cash 30
Accounts receivable 50
Inventory 150
Prepayments (15)
Land 1,055 Issued bonds to acquire 700 and
cash for 355
Plant and equipment 1,700 Purchase
Accumulated depreciation (250) Depreciation expense
Long-term investments (400) Sale
Patents (100) Amortization
Accounts payable (70)
Other accrued liabilities (60)
Taxes payable (70)
Dividends payable 200 Paid dividends
Short-term notes payable (200) Reclassification of note
Long-term notes payable 200 Reclassification of note
Bonds payable (700) Issued for land
Common stock (500) Issued stock
Retained earnings (1,020) 1,020 Net income
Total 0
DECISION CASE 12-3 (Continued)
Conversion of income statement items to a cash basis (in thousands of dollars):
Income Statement Amount Adjustment Cash Flows
Sales revenue $8,000 $8,000
– Increase in accounts receivable (50)
Cash collected from customers $7,950
Cost of goods sold 4,500 $4,500
+ Increase in inventory 150
– Increase in accounts payable (70)
Cash paid to suppliers $4,580
Operating expenses 1,450 $1,450
– Decrease in prepayments (15)
– Increase in accrued liabilities (60)
– Depreciation included on
income statement (250)
– Amortization included on
income statement (100)
Cash paid for operating expenses $1,025
Interest expense 350 No interest payable $ 350
Income tax expense 680 $ 680
– Increase in taxes payable (70)
Cash paid for taxes $ 610
Net income $ 1,020 Net cash flow from operations $1,385
DECISION CASE 12-3 (Concluded)
2. Statement of cash flows:
BAILEY CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collected from customers $ 7,950
Cash payments:
For inventory $ (4,580)
For operating expenses (1,025)
For interest (350)
For income taxes (610)
Total cash payments $ 6,565
Net cash provided by operating activities $ 1,385
Cash Flows from Investing Activities
Sale of long-term investments $ 400
Acquisition of land (355)
Acquisition of plant and equipment (1,700)
Net cash used by investing activities $(1,655)
Cash Flows from Financing Activities
Issuance of additional common stock $ 500
Payment of 2006 cash dividend (200)
Net cash provided by financing activities $ 300
Net increase in cash $ 30
Cash balance, December 31, 2006 450
Cash balance, December 31, 2007 $ 480
Supplemental Schedule of Noncash Investing and
Financing Activities
Acquisition of land by issuance of bonds $ 700
Reclassification of long-term notes due within next year 200
3. Bailey Corp. should be able to safely pay a cash dividend in 2008 of $250,000 (note that there are now 250,000 shares of stock outstanding). The cash provided by operating activities of $1,385,000 indicates that the company is generating a very significant amount of cash from the business. Because the company invested heavily in new plant and equipment during 2007, it should not need to reserve large amounts of cash for capital expenditures in the near future. The profit margin of 12.75% indicates that management is doing a good job of controlling costs.
Bailey will need to pay $200,000 in 2008 to retire the short-term notes payable. In assessing the company’s cash needs in future years, it would be important to know how soon any of the bonds payable will be due for retirement. Assuming that a large portion of the bonds is not due to be retired in 2008, Bailey should have no problem in paying its tenth annual dividend of $1 per share.
|LO 1,6 | |DECISION CASE 12-4 EQUIPMENT REPLACEMENT DECISION AND CASH FLOWS FROM OPERATIONS |
1. Cash flow from operations Year 1 Year 2 Year 3 Year 4
Net income (loss) $(10) $ (2) $ 15 $ 20
Adjustments:
Depreciation expense 30 25 15 14
Increase in accounts receivable (32) (5) (12) (20)
Increase in inventories (26) (8) (5) (9)
Increase in prepayments 0 0 (10) (5)
Increase in accounts payable 15 3
Decrease in accounts payable (5) (4)
Net cash flow from operations $(23) $13 $ (2) $ (4)
2. Memo to the president:
TO: President
FROM: Student’s name
DATE: XX/XX/XX
SUBJECT: Cash flow
As you are aware, our company has made significant strides in improving our profitability. Our net losses in the first two years have been replaced with profits of $15 million and $20 million, respectively, for the last two years. We are all also aware, however, of the need to generate sufficient cash flow operations to make the necessary capital expenditures to replace existing equipment.
I have enclosed for your review a four-year summary of cash flow from operations. The summary shows that in our second year we did a good job of generating cash from operations but that the results have not been as good in the last two years. Specifically, our operations have drained $2 million and $4 million of cash from the treasury in these years rather than the desired result of generating cash to help pay for capital expenditures.
The buildup of various current assets, such as accounts receivable, inventories, and prepayments, is the main reason for our problems. First, we need to do a better job of collecting our receivables in a timely fashion. Second, we must find ways to limit our purchases of inventory and maintain products on hand at a minimum. Third, whenever possible, we should limit the amount of items we prepay, such as office supplies and rent. Finally, the company needs to take full advantage of the credit terms offered by our suppliers and not pay open accounts any sooner than is necessary.
Please call me at your earliest convenience to discuss how we can improve our efforts in this critical area.
ETHICAL DECISION MAKING
|LO 1,6 | |DECISION CASE 12-5 LOAN DECISION AND THE STATEMENT OF CASH FLOWS—INDIRECT METHOD |
1. Mega reported the sale of the business by netting the gain against the cash proceeds and thus reporting the book value of $300 million as an investing activity inflow. This is not in accordance with generally accepted accounting principles, which require that the actual amount of cash received from the sale of $450 million be shown as an investing activity inflow. The gain of $150 million should have been deducted from net income to arrive at cash flow from operations.
The use of the net approach to reporting the transaction, rather than the correct approach under GAAP, does not have an effect on the increase or decrease in cash for the period. The issue involves the appropriate reporting and disclosure of the transaction rather than the net change in cash for the period.
2. Revised statement:
MEGA ENTERPRISES
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN MILLIONS OF DOLLARS)
Cash Flows from Operating Activities
Net income $ 65
Adjustments to reconcile net income to net cash provided
by operating activities:
Gain on sale of California business (150)
Depreciation and amortization 56
Increase in accounts receivable (19)
Decrease in inventory 27
Decrease in accounts payable (42)
Increase in other accrued liabilities 18
Net cash used by operating activities $ (45)
Cash Flows from Investing Activities
Acquisitions of other businesses $(234)
Acquisitions of plant and equipment (125)
Sale of other businesses 450
Net cash provided by investing activities $ 91
Cash Flows from Financing Activities
Additional borrowings $ 150
Repayments of borrowings (180)
Cash dividends paid (50)
Net cash used by financing activities $ (80)
Net decrease in cash $ (34)
Cash balance, December 31, 2006 42
Cash balance, December 31, 2007 $ 8
DECISION CASE 12-5 (Concluded)
3. The controller has not acted ethically in this situation. The officer is aware that the bank intends to rely on cash generated from operations for repayment of the loans. As shown in 2. on the previous page, the netting of the sale transaction grossly overstates the cash flow from operating activities and understates the cash flow from investing activities. It appears that the controller intentionally misreported the transaction on the statement of cash flows to influence the bank’s appraisal of the ability of Mega to generate cash from its ongoing operations.
|LO 2,3 | |DECISION CASE 12-6 CASH EQUIVALENTS AND THE STATEMENT OF CASH FLOWS |
1. According to current accounting standards, only those investments in highly liquid securities with an original maturity to the investor of three months or less should be classified as cash equivalents. Because the Treasury notes do not mature until ten months after they are purchased, their purchase should be classified as an investing activity for purposes of preparing a statement of cash flows. (Note: The notes would be classified as held to maturity securities because Rangers expects to hold them until maturity.)
2. If the purchase of the notes is classified as an operating activity rather than an investing activity, the information provided to readers is not free from bias. The company would be attempting to disguise the fact that the purchase of the notes was a significant investing activity that used cash. The decision to classify the notes as cash equivalents would be made to present the company’s cash outflows in the most favorable manner, regardless of the substance of the transaction to acquire the notes.
3. As controller, you need to explain to the treasurer that accounting standards do not allow the company to classify the treasury notes as cash equivalents. You are sympathetic to his desire to minimize the net cash outflow for investing activities, but the company does not have a choice in its presentation of the notes, nor does the decision on classification rest with you as controller. Rangers must report the purchase on the statement of cash flows as a cash outflow from investing activities.
|REAL WORLD PRACTICE 12.1 |
Best Buy uses the indirect method in the Operating Activities section of the statement of cash flows. The first line on the statement is net earnings and the necessary adjustments are made to reconcile net income to total cash provided by operating activities from continuing operations.
|REAL WORLD PRACTICE 12.2 |
Best Buy’s Receivables increased during the year that ended February 26, 2005. An increase in Receivables means that the company sold more than it collected in cash during the year, and therefore the difference must be deducted from net income in the
Operating Activities section of the statement.
|REAL WORLD PRACTICE 12.3 |
Best Buy paid $241,000,000 in income taxes during the year that ended February 26, 2005. This is not necessarily the amount that appears as expense on the income statement for the year. The amount of income tax expense on the income statement is based on accrual accounting concepts. For example, any taxes owed at the end of the year would be included in the tax expense but would not be considered a cash outflow.
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