11
Tools of the Trade, Part III
The Statement of Cash Flows:
Bringing the Focus Back to Cash
Discussion Questions
11-1. The criteria for revenue and expense recognition under
accrual accounting focus on the earnings process and the
expenses incurred to generate income, with no regard to the
receipt or payment of cash. The obvious outcome of this
approach is a lack of overt attention to cash.
11-2. NOTE TO INSTRUCTOR: Your students do not yet have the
background to answer Discussion Question 11-2 according
to the classification used by the accounting profession in the
statement of cash flows, but this question serves to preview
the standard classifications of activities presented a little
later in the chapter. You can probably expect your students
to have more difficulty with investing activities than with
either of the other two categories. More important than the
answers is the students= reasoning for why certain activities
should be classified in a certain category. This would be a
good question to revisit as more of the definitions are
provided in the chapter.
Examples of the three activities your students should be able
to identify include:
a. Operating activities. Buying and selling books, paying
wages to employees, paying for janitorial services,
paying building rent (unless the building is owned) and
paying for advertising. These items are classified as
operating activities because they are activities related
to the day-to-day operations of the business.
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-1
b.
c.
Investing activities. The items your students are most
likely to think of as investing activities will be buying and
selling stock in other companies or loaning somebody
money and then being paid back. These are legitimate
examples, of course, but you may want to point out that
for most companies these are peripheral or incidental
activities. The bookstore is not in the business of
investing in other companies.
The examples of investing activities you should
focus on are the buying and selling of bookshelves,
desks, chairs, cash registers, and maybe even the
building in which the bookstore is located. These items
are classified as investing activities because investment
in these things is necessary to create the environment
in which the bookstore can operate.
Financing activities. Borrowing from banks (or others),
owner contributions, paying dividends, and repaying
loans. These items are classified as financing activities
because they are the means by which the investing
activities and operating activities are financed.
11-3. This question can be answered in two correct ways. The
first is very basic and the second is a bit more complex.
a. Look through the inflows (deposits) and outflows
(checks written) recorded in the check register during
the period. Consider only inflows and outflows dealing
with operating activities, ignoring all inflows and
outflows dealing with investing and financing activities.
Once you have determined the operating inflows and
operating outflows, subtract the outflows from the
inflows and you will have determined the net cash flow
from operations.
b. Because of the way the cash basis of accounting
measures revenues (receipt of cash) and expenses
(payment of cash), net cash flow from operations is
F11-2
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
disclosed in the cash basis income statement. This
concept is logical, but not intuitive. If you will take the
time to gently guide your students through the
discussion of this question, their understanding of the
presentation of the operating activities section of the
statement of cash flows later in the chapter will be
greatly enhanced.
11-4. This is an integrating question from material previously
presented (in Chapter 6). Help your students walk through
the cash vs. accrual treatment of various sales, constantly
reinforcing that the trigger for the cash basis is always cash
inflow or outflow and that the trigger for the accrual basis is
the earnings process. This question is important because it
focuses on the process of converting accrual accounting to
cash accounting to arrive at net cash flow from operations.
a. Under the cash basis, the revenue would not be
recognized until the cash was received from the
customer (presumably 30 days after the sale).
b. Under the accrual basis, the revenue would be
recognized at the time the sale was made even though
the cash associated with the sale will not be collected
for at least 30 days following the sale.
11-5. This will likely be a difficult question for your students to
answer. The key here is for students to recognize that
accrual basis income from operations is not cash flow, so
certain items must be Aadjusted@ to arrive at cash flow from
operations. Emphasizing the different measurement criteria
used by cash accounting and accrual accounting in
Discussion Question 11-4 will help your students grasp that
the operating activities section of the statement of cash flows
is essentially a conversion of accrual accounting to cash
accounting.
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-3
Returning to the scenario presented in Discussion
Question 11-4, the credit sale made to the customer was
appropriately included in the income statement for the month
and flowed through to net income. In determining cash flow
from operations for the month, however, that sale must be
removed because it did not generate cash in the current
month. The same process must be repeated for any revenue
or expense item that did not generate or use cash during the
current month.
11-6. This question actually has two purposes. The first is to make
sure your students understand that the ending balance of
any item on the balance sheet is the beginning balance for
the next year. In the case of Pipkin Company, the balance of
accounts receivable on December 31, 2006 was $3,112,000,
which is the beginning balance of accounts receivable on
January 1, 2007.
The second purpose of the question is to help your
students become comfortable with using information from
comparative financial statements. Accounts receivable
decreased by $187,000 during 2007 ($3,112,000 beginning
balance - $2,925,000 ending balance).
11-7. This question actually has two purposes. The first is to make
sure your students understand that the ending balance of
any item on the balance sheet is the beginning balance for
the next year. In the case of Pipkin Company, the balance of
retained earnings on December 31, 2006 was $1,774,000,
which is the beginning balance of retained earnings on
January 1, 2007.
The second purpose of the question is to reinforce your
students= understanding of what causes retained earnings
to change. In the case of Pipkin Company, the increase in
retained earnings to $2,086,000 on December 31, 2007
F11-4
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
resulted from a combination of $449,000 net income for
2007 and paying $137,000 in dividends during 2007.
11-8. Answers to this question should focus on financing activities.
Examples should include borrowing and repaying loans,
investments by owners and distributions by owners. Your
students may want to include buying and selling property,
plant and equipment as cash flows that would not show up in
net income. Remind them that the question centers on cash
basis net income. Buying and selling fixed assets does not
show in accrual basis net income, but does show in cash
basis net income.
11-9. Using the direct method to prepare the cash flow statement
requires the extensive use of the income statement to
determine the cash flows from operations. The major
categories required by this format include cash flows from
customers, cash paid for merchandise, interest and taxes.
However, the figures from the income statement represent
the accrual basis measurement of the items B not
necessarily the cash paid or received. All of the numbers
from the income statement are used to derive the cash flow
statement numbers except for the depreciation amounts.
Because depreciation never involves cash flow, it is not part
of the cash flow from operations prepared with the direct
method. The only numbers that appear on the cash flow
statement are the interest expense and the taxes amount
because they are equal to the cash paid for those items.
11-10. Cash comes into the business and is used for many
activities that are unrelated to net income such as investing
and financing activities. For reasons discussed extensively
over the last several chapters, accrual basis net income for a
particular income statement period is not equal to cash. Net
income is a particular income statements period=s addition
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-5
to retained earnings and dividends declared (whether paid
within the period or not) are deducted from retained
earnings. Therefore the only possible way that retained
earnings could equal cash is by sheer coincidence.
11-11. The cash flows generated from operating activities are the
same regardless of the format used. The indirect method
converts the income statement from the accrual basis to the
cash basis while the direct method analyzes the cash inflows
and cash outflows by major operating activity.
11-12. The direct method cash flow explains the operating sources
and uses of cash, similar to a cash basis income statement.
The indirect method explains the differences between the
accrual basis income statement and the cash derived from
operations. Regardless of method used to prepare the
operating section of the cash flow statement, the total cash
flows generated from operating activities are the same.
Students will frequently select the direct method because it
is the easiest to read and understand. More critical thinking
students will understand the powerful analysis contained in
the indirect method because it helps them to grasp the
reality of the difference between income and cash flow B or
the difference between the reality of performance and the
reality of cash.
Review the Facts
A.
F11-6
The statement of cash flows as it is presented in its present
state has only been in existence since 1988. There were
other prior attempts to present funds statements such as
working capital statements, but the current cash flow
statement presents detailed information about the sources
and uses of cash.
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
B.
The main purpose of the statement of cash flows is to bring
the focus to cash and to report detailed information about the
sources and uses of cash.
C.
The two methods used to prepare the cash flow statement
are the direct method and the indirect method. The indirect
method is the preferred method by companies.
D.
The three major classifications of activities on the cash flow
statement are operating activities, financing activities and
investing activities.
E.
Cash inflows from dividends and interest received and cash
outflows for interest paid are usually classified as operating
activities.
F.
Examples of inflows from operating activities would be cash
from sales or the collection of receivables, whereas outflows
might be the cash paid for salaries or rent or any expenses.
Cash inflows for investing activities would come from the
sale for cash of fixed assets or other investments. Cash
outflows for investing activities might arise from the purchase
for cash of fixed assets or investments in stocks and bonds.
Cash inflows from financing activities would arise from the
sale of the company’s stock or the borrowing of monies.
Financing activities outflows would come from the purchase
of treasury stock or the payment of dividends.
G.
The direct method for preparing the cash flow statement
focuses on the direct effect of cash from customers and the
cash paid for purchases and the expenses necessary to run
the business. The indirect method focuses on the changes in
the balance sheet accounts and how these changes impact
the statement of cash flows.
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-7
H.
The starting point for cash flows from operations using the
indirect method is the accrual basis net income.
I.
The items reported in the operating section of the cash flow
statement are found on the income statement of the entity
and in the current asset and current liability sections of the
balance sheet.
J.
Items included in the investing section of the cash flow
statement are found in the long-term asset section of the
balance sheet.
K.
The items included in the financing section of the cash flow
statement would be found in the long-term liability and
stockholders’ equity sections of the balance sheet.
L.
The section of the cash flow statement used to tell the
reader how much cash was used for the purchase of
depreciable assets is the investing activities section.
M.
The investments made by the company would be reported in
the investing section of the cash flow statement while the
methods of financing used would be reported in the financing
section of the cash flow statement.
F11-8
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
Apply What You Have Learned
11-13.
1.
b
2.
e
3.
j
4.
a
5.
6.
7.
f
h
g
8.
c
9.
d
10. i
Provides a reconciliation of accrual net income to the cash
provided by or used by operating activities
Accounting reports providing information from two or more
consecutive periods at once
Investments in stocks and bonds that management
intends to hold for an indefinite period.
Activities centered around the day-to-day business
transactions of a company
Current assets less current liabilities
Business activities related to long-term assets
Provides detail as to the individual sources and uses of
cash associated with operating activities
An item that reduces reported net income, but does not
require the use of cash
Activities such as the issuance of debt or equity and the
payment of dividends
Investments in stocks and bonds that management
intends to hold for an indefinite period.
11-14.
1.
2.
3.
4.
5.
6.
7.
c
a
a
b
c
c
a
Payment of dividends
Adjustment for depreciation
Purchase of merchandise inventory
Purchase of vehicles
Repayment of 90-day loans
Issuing capital stock
Payment of wages to employees
Chapter 11 – Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-9
8.
9.
10.
11.
a
b
b
a
12.
a
Payment of taxes
Cash from sale of property and equipment
Loans to other companies
Adjustments for changes in current assets and current
liability items
Cash from selling trading securities
11-15.
1. a
2. a
3. a
4. c
5. c
6. c
7. a
8. a
9. c
10. b
11. b
12. a
Amortization Expense
Depreciation Expense
Sale of merchandise inventory
Sale of Treasury Stock
Repayment of 30-day loans
Purchase of one’s own stock
Payment of rent on office space
Payment of insurance on factory equipment
Cash from sale of treasury stock
Purchase of stock in other companies
Cash from the sale of available-for-sale securities
Cash from the collection of accounts receivable
11-16.
1. U
2. N
3. U
4. N
5. S
6. S
7. U
8. N
9. S
10. S
Accounts payable decreased.
Property and equipment increased.
Accounts receivable increased.
Long-term notes payable decreased.
Prepaid expenses decreased.
Short-term notes payable increased.
Taxes payable decreased.
Common stock increased.
Wages payable increased.
Merchandise inventory decreased.
F11-10
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
11-17.
Jackson Company
Partial Statement of Cash Flows
For the Year Ended December 31, 2008
(in thousands)
Cash Flows from Operating Activities:
Net Income
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation Expense
$ 175
Decrease in Accounts Receivable
387
Increase in Merchandise Inventory
(204)
Decrease in Prepaid Expenses
30
Increase in Accounts Payable
581
Net Cash Provided by Operating Activities
$ 406
969
$1,375
11-18.
Scotia Company
Partial Statement of Cash Flows
For the Year Ended December 31, 2007
Cash Flows from Operating Activities:
Net Income
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation Expense
$102,000
Increase in Accounts Receivable
(277,000)
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
$ 86,900
F11-11
Decrease in Merchandise Inventory 126,000
Increase in Prepaid Expense
( 13,000)
Decrease in Accounts Payable
(276,000)
Net Cash Used by Operating Activities
(338,000)
$(251,100)
11-19.
Powers Corporation
Partial Statement of Cash Flows
For the Year Ended December 31
Cash Flows from Operating Activities:
Net Income
$450,000
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Decrease in Accounts Receivable
$ 7,000
Decrease in Uncollectible Accounts
(2,000)
Increase in Merchandise Inventory
(19,000)
Decrease in Prepaid Expenses
12,000
(2,000)
Net Cash Provided by Operating Activities
$448,000
11-20.
Mavis Company
Partial Statement of Cash Flows
For the Year Ended
Cash Flows from Investing Activities:
Proceeds from sale of Machinery
Investment in Bonds
Net Cash Used For Investing Activities
$ 60,000
(80,000)
$(20,000)
11-21.
Nash Company
Partial Statement of Cash Flows
F11-12
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
For the Year Ended
Cash Flows from Investing Activities:
Proceeds from sale of Machinery
Investment in Bonds
Net Cash Used For Investing Activities
$ 40,000
(980,000)
$(940,000)
11-22.
Rambler Corporation
Partial Statement of Cash Flows
For the Year Ended
Cash Flows from Investing Activities:
Proceeds from sale of Equipment
Purchase of Equipment
Net Cash Used For Investing Activities
$ 20,000
(980,000)
$(960,000)
11-23.
Reo Company
Partial Statement of Cash Flows
For the Year Ended
Cash Flows from Financing Activities:
Proceeds from the sale of Common Stock
Proceeds from bank loan
Dividends Paid
Purchase of Treasury Stock
Net Cash Provided by Financing Activities
$ 890,000
200,000
(28,000)
(60,000)
$1,002,000
11-24.
Diamond Company
Partial Statement of Cash Flows
For the Year Ended
Cash Flows from Financing Activities:
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-13
Proceeds from the sale of Preferred Stock
Proceeds from bank loan
Proceeds from sale of Treasury Stock
Dividends Paid
Repayment of bank loan
Net Cash Provided by Financing Activities
$ 200,000
300,000
160,000
(80,000)
(120,000)
$ 460,000
11-25.
Cirrus Company
Partial Statement of Cash Flows
For the Year Ended
Cash Flows from Financing Activities:
Proceeds from the sale of Preferred Stock
Proceeds from bank loan
Proceeds from sale of Common Stock
Dividends Paid
Repayment of bank loan
Net Cash Provided by Financing Activities
$ 100,000
300,000
500,000
(75,000)
(400,000)
$ 425,000
11-26.
a. Investing activities: $1,559,000
b. The statement of cash flows, by itself, cannot tell you
anything with certainty about Rock Company. In the long
run, however, you would expect a company to use the
majority of its cash for investing activities, which may
indicate the company is growing. The statement of cash
flows, however, does not indicate the quality of the
investment – only that the investment was made.
c. Financing activities: $1,000,000
d. In 2008, Rock had to rely on outside financing, which is often
appropriate and necessary when a company is expanding.
Financing activities, however, are not the most appropriate
source of cash in the long run. In the long run, cash must be
generated from operating activities.
F11-14
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
11-27.
a.
b.
c.
d.
Investing activities: $1,200,000
The statement of cash flows, by itself, cannot tell you
anything with certainty about McDougle Company. In the
long run, however, you would expect a company to use the
majority of its cash in investing activities, which may indicate
the company is growing. The statement of cash flows,
however, does not indicate the quality of the investment –
only that the investment was made.
Operating activities: $1,620,000
In the long run, cash must be generated from operating
activities because they are the only renewable source of
cash. Therefore, this is an appropriate source of cash for
McDougle Company.
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-15
11-28.
a.
Hoople Company
Statement of Cash Flows
For the Year Ended December 31, 2008
(in thousands)
Cash Flow from Operating Activities:
Cash received from customers
Cash paid for:
Merchandise
$7,723
Selling and administrative expense 2,706
Interest
168
Income taxes
114
Net Cash Provided by Operating Activities
Cash Flows from Investing Activities:
Purchase of Building
Purchase of Equipment
Net Cash Used By Investing Activities
Cash Flows from Financing Activities:
Proceeds from Long-Term Loan
Proceeds from Sale of Common Stock
Payment of Cash Dividends
Payment on Note Payable
Net Cash Provided By Financing Activities
Net Increase in Cash During 2008
Beginning Cash Balance, January 1, 2008
F11-16
$11,415
(10,711)
$ 704
$(1,526)
( 289)
(1,815)
$
500
1,349
(140)
(200)
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
1,509
$ 398
1,220
Ending Cash Balance, December 31, 2008
$ 1,618
Note to Instructor: The direct method also requires the
preparation of a Reconciliation of Net Income to Cash Provided
by Operations. It should be a supplemental schedule to the Cash
Flow Statement. See problem 11-29 for the indirect method.
11-28. (Continued)
b.
c.
d.
e.
Investing activities: $1,815,000
The statement of cash flows, by itself, cannot tell you
anything with certainty about Hoople Company. In the long
run, however, you would expect a company to use the
majority of its cash for investing activities, which may
indicate the company is growing. However, the statement of
cash flows does not indicate the quality of the investment –
only that the investment was made.
Financing activities: $1,509,000
In 2008, Hoople had to rely on outside financing, which is
often appropriate and necessary when a company is
expanding. Financing activities, however, are not the most
appropriate source of cash in the long run. In the long run,
cash must be generated from operating activities.
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-17
11-29.
a.
Hoople Company
Statement of Cash Flows
For the Year Ended December 31, 2008
(in thousands)
Cash Flow from Operating Activities:
Net Income
$ 426
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation Expense
$ 102
Decrease in Accounts Receivable
187
Increase in Merchandise Inventory
(104)
Increase in Prepaid Expense
( 39)
Increase in Accounts Payable
132
278
Net Cash Provided by Operating Activities
$ 704
Cash Flows from Investing Activities:
Purchase of Building
Purchase of Equipment
Net Cash Used By Investing Activities
Cash Flows from Financing Activities:
Proceeds from Long-Term Loan
Proceeds from Sale of Common Stock
Payment of Cash Dividends
Payment on Note Payable
F11-18
$(1,526)
( 289)
(1,815)
$
500
1,349
(140)
(200)
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
Net Cash Provided By Financing Activities
Net Increase in Cash During 2008
Beginning Cash Balance, January 1, 2008
Ending Cash Balance, December 31, 2008
1,509
$ 398
1,220
$1,618
11-29. (Continued)
Supplemental Schedule:
Amount paid for:
Interest
Income Taxes
b.
c.
d.
e.
$168
$114
Investing activities: $1,815,000
The statement of cash flows, by itself, cannot tell you
anything with certainty about Hoople Company. In the long
run, however, you would expect a company to use the
majority of its cash for investing activities. Hoople certainly
did so in 2008. The investing activity may indicate the
company is growing. However, the statement of cash flows
does not indicate the quality of the investment – only that the
investment was made.
Financing activities: $1,509,000
In 2008, Hoople had to rely on outside financing, which is
often appropriate and necessary when a company is
expanding. Financing activities, however, are not the most
appropriate source of cash in the long run. In the long run,
cash must be generated from operating activities.
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-19
11-30.
a.
Al Muzny Company
Statement of Cash Flows
For the Year Ended December 31, 2007
(in thousands)
Cash Flow from Operating Activities:
Net Loss
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation Expense
Decrease in Accounts Receivable
Decrease in Merchandise Inventory
Decrease in Prepaid Expense
Decrease in Accounts Payable
Net Cash Used by Operating Activities
Cash Flows from Investing Activities:
Purchase of Building
Purchase of Equipment
Net Cash Used By Investing Activities
Cash Flows from Financing Activities:
Proceeds from Loans
Proceeds from Sale of Common Stock
Payment of Cash Dividends
Net Cash Provided By Financing Activities
Net Decrease in Cash During 2007
F11-20
$(339)
$ 45
5
56
24
(83)
47
$(292)
$(319)
(200)
(519)
$ 450
300
(70)
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
680
$(131)
Beginning Cash Balance, January 1, 2007
Ending Cash Balance, December 31, 2007
Supplemental Schedule:
Amount paid for interest
Amount paid for income taxes
660
$ 529
$145
$ -0-
11-30. (Continued)
b.
c.
d.
e.
Investing activities: $519,000
The statement of cash flows, by itself, cannot tell you
anything with certainty about Al Muzny Company. In the long
run, you would expect a company to use the majority of its
cash for investing activities when the company is growing.
However, the statement of cash flows does not indicate the
quality of the investment – only that the investment was
made.
Financing activities: $680,000
In 2007, Muzny had to rely on outside financing, which is
often appropriate and necessary when a company is
expanding. Financing activities, however, are not the most
appropriate source of cash in the long run. In the long run,
cash must be generated from operating activities, the only
renewable source of cash.
f.
Al Muzny Company
Statement of Retained Earnings
For the Year Ended December 31, 2007
(in thousands)
Retained Earnings, January 1, 2007
Less: Net Loss for 2007
Dividends Declared in 2007
Retained Earnings, December 31, 2007
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
$ 659
$339
70
(409)
$(250)
F11-21
11-31.
a.
Al Muzny Company
Statement of Cash Flows
For the Year Ended December 31, 2007
(in thousands)
Cash Provided by Operating Activities:
Cash received from customers
Cash paid for:
Merchandise
Selling and administrative expenses
Interest
Net Cash Used by Operating Activities
Cash Flows from Investing Activities:
Purchase of Building
Purchase of Equipment
Net Cash Used By Investing Activities
Cash Flows from Financing Activities:
Proceeds from Loans
Proceeds from Sale of Common Stock
Payment of Cash Dividends
Net Cash Provided By Financing Activities
Net Decrease In Cash During 2007
Beginning Cash Balance, January 1, 2007
Ending Cash Balance, December 31, 2007
F11-22
$6,396
$4,501
2,042
145 (6,688)
$ (292)
$ (319)
(200)
(519)
$ 450
300
(70)
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
680
$ (131)
660
$ 529
Note to Instructor: The direct method also requires the
preparation of a Reconciliation of Net Income to Cash Provided
by Operations. It should be a supplemental schedule to the Cash
Flow Statement. See problem 11-30 for the indirect method.
11-31. (Continued)
b.
c.
d.
e.
Investing activities: $519,000
The statement of cash flows, by itself, cannot tell you
anything with certainty about Al Muzny Company. In the long
run, however, you would expect a company to use the
majority of its cash for investing activities. Muzny certainly
did so in 2007. The investing activity may indicate the
company is growing. However, the statement of cash flows
does not indicate the quality of the investment – only that the
investment was made.
Financing activities: $680,000
In 2007, Muzny had to rely on outside financing, which is
often appropriate and necessary when a company is
expanding. Financing activities, however, are not the most
appropriate source of cash in the long run. In the long run,
cash must be generated from operating activities.
f.
Al Muzny Company
Statement of Retained Earnings
For the Year Ended December 31, 2007
(in thousands)
Retained Earnings, January 1, 2007
Less: Net Loss for 2007
Dividends Declared in 2007
Retained Earnings, December 31, 2007
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
$ 659
$339
70
(409)
$(250)
F11-23
11-32.
a. In the long run, you expect a company to use the majority of
its cash for investing activities. Healthy companies provide
the majority of cash from operating activities. Job certainly
did both of these things in the year for which this statement
of cash flows was prepared. If this is representative of the
company’s long-term performance, Job and Company is
probably a well-run, healthy company.
b. None of the financial statements should be viewed as
independent of the others. At a very minimum, you would
want to see the income statement and balance sheet from
which the statement of cash flows was created. From the
income statement, it would be important to determine if the
cash from operations resulted from recurring sources.
It would also be helpful to see financial statements for
more than one period. This period may not represent the
company’s long-term performance, in which case it would
not be a good basis for predictions of future performance.
While the totals shown on Job’s statement of cash flows
look very positive, the statement does not address the
quality of the investments made during this period – only that
the investments were made.
c. There is no way to determine from the information provided
in the problem whether Job had a net income or a net loss.
Net income or loss is only a starting point for determining
cash generated by operating activities. It is quite possible for
a company to have a net loss and still generate cash from
operations.
F11-24
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
At a minimum, you would want to see the income
statement and balance sheet from which the statement of
cash flows was created. It would also be helpful to see
income statements for more than one period. A single
period’s information will not provide enough information to
predict the company’s future performance.
11-33.
a. In the long run, you expect a company to use the majority of
its cash for investing activities. Healthy companies provide
the majority of cash from operating activities. For this year,
Coleman did not generate positive cash flow through its
operations. Financing activities provided the cash to support
the company’s operating and investing activities. If this is
representative of the company’s long-term performance,
Coleman and Company may not be a well-run, healthy firm.
b. None of the financial statements should be viewed as
independent of the others. At a very minimum, you would
want to see the income statement and balance sheet from
which the statement of cash flows was created.
It would also be helpful to see financial statements for
more than one period. This period may not represent the
company’s long-term performance, in which case it would
not be a good basis for predictions of future performance.
While Coleman’s statement of cash flows shows the
company used the majority of its cash for investing activities,
the statement does not address the quality of the
investments made during this period – only that the
investments were made.
c. There is no way to determine from the information provided
in the problem whether Coleman had a net income or a net
loss. Net income or loss is only a starting point for
determining cash generated by operating activities. It is quite
possible for a company to have net income and still use cash
from other sources to finance its operations.
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-25
At a minimum, you would want to see the income
statement and balance sheet from which the statement of
cash flows was created. It would also be helpful to see
income statements for more than one period. A single
period’s information will not provide enough information to
predict the company’s future performance.
11-34.
a. During the year covered by this statement of cash flows,
Faulkner and Company generated cash from its investing
activities. Whether this was from selling property, plant, and
equipment or from selling investments it held in other
companies cannot be determined from the information
provided in the problem. The operating activities section
shows a rather large use of cash, which may suggest that
the company was forced to generate cash from its
investments in order to support its operations. Overall,
financing activities used more cash than they generated this
period. If this is representative of the company’s long-term
performance, Faulkner and Company may not be a very
healthy company.
b. At a minimum, you would want to see the income statement
and balance sheet from which the statement of cash flows
was created. It would be important to determine if the fact
that operations used cash instead of generating cash was
the result of a recurring or nonrecurring situation. While
Faulkner’s statement of cash flows shows it generated cash
from investing activities, the balance sheet will tell more
about the company’s financial position after selling assets to
generate cash this period.
It would also be helpful to see financial statements for
more than one period. This period may not be representative
of the company’s recent performance.
F11-26
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
11-35.
a. The use of accrual accounting shifts the focus of financial
statements from cash to earnings. Under accrual-basis
accounting, revenue and expense recognition is unrelated to
when cash is received or paid. For this reason, users of
accrual basis financial statements cannot determine what
caused the change in cash from one period to the next from
the income statement and the balance sheet.
b. The statement of cash flows brings the focus of economic
decision makers back to cash by providing a detailed
analysis of the change in cash from one period to the next.
The operating activities section of the statement is
essentially a conversion of accrual accounting back to cash
accounting. The investing and financing activities sections
describe the cash flowing in and out of the company as a
result of activities other than operations.
11-36.
The two methods for preparing the statement of cash flows,
the direct method and the indirect method relate only to the
operating section of the cash flow statement, and both arrive at
the same amount of cash flow from operations. Cash flows from
investing and financing activities are identical in either method.
The two methods are markedly different in presenting the cash
flows from operations. The direct method of preparing the cash
flows from operations transforms the income statement into a
statement of cash receipts and disbursements. This is
accomplished by reversing the accruals and deferrals used to
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-27
create accrual basis financial statements.
The indirect or reconciliation method receives its name from
its format, which begins with net income and transforms net
income into cash flow from operations. This process is possible
because most items involved in net income, except for
depreciation and amortization, are either already cash or are
expected to eventually become cash.
11-37.
a. Depreciation Expense = $37,500
Cash received + Loss on sale = Book value of asset
$44,000
+
$2,000 = $46,000
Asset Cost – Accumulated Depreciation = Book Value
$49,500 - Accumulated Depreciation = $46,000
Accumulated Depreciation = $3,500
Beginning Accumulated Depreciation
– Accumulated Depreciation from asset sold
+ Depreciation Expense for the Year
= Ending Balance of Accumulated Depreciation
b.
Equipment Purchases = $75,000
–
=
–
=
F11-28
Beginning Machinery Balance
Cost of Machinery Sold
Sub Total
Ending Balance
Purchases
$450,000
49,500
$400,500
475,500
$ 75,000
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
$ 95,000
3,500
37,500
$129,000
11-38.
a. Depreciation Expense = $41,000
Cash received – Gain on sale = Book value of asset
$50,000
–
$2,000 = $48,000
Asset Cost – Accumulated Depreciation = Book Value
$65,000
– Accumulated Depreciation = $48,000
Accumulated Depreciation = $17,000
Beginning Accumulated Depreciation
– Accumulated Depreciation from asset sold
+ Depreciation Expense for the Year
= Ending Balance of Accumulated Depreciation
b.
$65,000
17,000
41,000
$89,000
Equipment Purchases = $95,000
Beginning Machinery Balance
– Less: Cost of Machinery Sold
= Sub Total
– Ending Balance
Purchases
$250,000
65,000
185,000
280,000
$ 95,000
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-29
11-39.
a. Depreciation Expense = $82,000
Cash received – Gain on sale = Book value of asset
$20,000
–
$12,000 = $8,000
Asset Cost – Accumulated Depreciation = Book Value
$40,000
– Accumulated Depreciation = $8,000
Accumulated Depreciation = $32,000
Beginning Accumulated Depreciation
– Accumulated Depreciation from asset sold
+ Depreciation Expense for the Year
= Ending Balance of Accumulated Depreciation
b.
Equipment Purchases = $130,000
–
=
+
=
F11-30
Beginning Machinery Balance
Less: Cost of Machinery Sold
Sub Total
Purchases
Ending Balance
$300,000
40,000)
$260,000
130,000
$390,000
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
$165,000
32,000
82,000
$215,000
11-40.
Foster Company
Partial Statement of Cash Flows
For The Year Ended December 31, XXXX
Cash Flows from Operating Activities:
Cash received:
From customers
Interest on investments
Cash paid for:
Employees wages
Suppliers for merchandise
Interest
Income taxes
$450,000
5,000
$455,000
$ 64,000
150,000
85,000
75,000 374,000
Net Cash Provided by Operating Activities
$ 81,000
11-41.
Galway Company
Partial Statement of Cash Flows
For The Year Ended December 31, XXXX
Cash Flows from Operating Activities:
Cash received:
From customers
Interest on investments
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
$435,000
15,000
$450,000
F11-31
Cash paid for:
Employees wages
Suppliers for merchandise
Interest
Income taxes
Net Cash Used in Operating Activities
$ 95,000
260,000
68,000
45,000 468,000
$ (18,000)
11-42.
Porter Company
Partial Statement of Cash Flows
For The Year Ended December 31, XXXX
Cash Flows from Operating Activities:
Cash received:
From customers
Interest on investments
Cash paid for:
Employees wages
Suppliers for merchandise
Interest
Income taxes
Net Cash Used in Operating Activities
F11-32
$1,255,000
95,000
$1,350,000
$460,000
988,000
35,000
245,000 1,728,000
$ (378,000)
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
11-43.
Wolf Company
Statement of Cash Flows
For The Year Ended December 31, 2007
Cash Flows from Operating Activities:
Cash received:
From customers
Dividends from investments
Cash paid for:
Operating expenses
$ 8,000
Suppliers for merchandise
29,000
Interest
200
Wages to employees
9,500
Net Cash Provided by Operating Activities
Cash Flows from Investing Activities:
Loan to Jones Company
Purchase of equipment
Proceeds of equipment sale
Purchase of Ford Company stock
Net Cash Used in Investing Activities
$95,000
200
$95,200
46,700
$48,500
$( 2,000)
(20,000)
4,000
(5,000)
(23,000)
Cash Flows from Financing Activities:
Sale of Wolf common stock
$10,000
Payment of cash dividend
(2,000)
Borrowing from Friendly National Bank
6,000
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-33
Payment on loan from Friendly Bank
Net Cash Provided by Financing Activities
(2,000)
12,000
Net Change in Cash
$37,500
11-44.
RoJo Company
Statement of Cash Flows
For The Year Ended December 31, 2008
Cash Flows from Operating Activities:
Cash received:
From customers
Dividends from investments
Cash paid for:
Operating expenses
$ 3,000
Suppliers for merchandise
32,000
Interest
100
Wages to employees
4,500
Net Cash Provided by Operating Activities
Cash Flows from Investing Activities:
Loan to Jordan Company
Purchase of equipment
Proceeds of equipment sale
Purchase of Dupont stock
Net Cash Used in Investing Activities
Cash Flows from Financing Activities:
Sale of Treasury Stock
Payment of cash dividend
Borrowing from Peoples Bank
F11-34
$75,000
100
$75,100
39,600
$35,500
$(1,000)
(8,000)
1,000
(2,000)
(10,000)
$6,000
(500)
5,000
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
Payment on loan
Net Cash Provided by Financing Activities
(1,400)
9,100
Net Change in Cash
$34,600
11-45.
Byrd Company
Statement of Cash Flows
For The Year Ended December 31, 2008
Cash Flows from Operating Activities:
Cash received:
From customers
Dividends from investments
Cash paid for:
Operating expenses
$ 2,000
Suppliers for merchandise
24,000
Interest
500
Wages to employees
7,000
Net Cash Provided by Operating Activities
Cash Flows from Investing Activities:
Loan to Pippen Company
Purchase of equipment
Proceeds of equipment sale
Purchase of Lucent stock
Net Cash Used in Investing Activities
Cash Flows from Financing Activities:
Sale of Treasury Stock
Payment of cash dividend
Borrowing from bank
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
$80,000
50
$80,050
33,500
$46,550
$(2,000)
(3,000)
2,000
(1,000)
(4,000)
$ 9,000
(100)
8,000
F11-35
Payment on loan
Net Cash Provided by Financing Activities
(2,500)
14,400
Net Change in Cash
$56,950
11-46.
a.
The Walt Disney Company and Subsidiaries
Cash Flow Information
For the Years Ended September 30
(in millions)
Operating Activities
2005
$ 4,269
2004
$ 4,370
2003
$ 2,901
Financing Activities
$(2,897)
$(2,701) $(1,523)
Investing Activities
$(1,691)
$(1,484) $(1,034)
b.
Walt Disney Company uses the indirect method to report its
operating cash flows.
c.
Operating cash flows have been positive over this three-year
period and have increased overall since 2003.
d.
The cash flow from operations has been sufficient to service
debt in each of the three years.
F11-36
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
11-47.
a.
Target Corporation
Cash Flow Information
For the Fiscal Years Ended
(in millions)
Operating Activities
Financing Activities
Investing Activities
2005
$ 4,451
$ (899)
$(4,149)
2004
2003
$ 3,808 $3,188
$(2,824) $ (313)
$ 1,179 $3,209
b.
Target uses the indirect method to report operating cash
flows.
c.
Operating cash flows have been positive over this three-year
period and have increased from 2003 to 2005.
d.
The financing activities have shown the same types of
transactions over the three-year period. Target has issued
new debt, repaid debt, issued stock, purchased treasury
stock, and paid dividends each of the three years.
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash
F11-37
11-48.
a.
Darden Restaurants
Cash Flow Information
For the Fiscal Years Ended
(in thousands)
Operating Activities
Financing Activities
Investing Activities
5-28-06
5-29-05
5-30-04
$ 717,090
$(392,941)
$(324,616)
$ 583,242
$(263,994)
$(313,141)
$ 525,411
$(194,090)
$(343,257)
b.
Darden uses the indirect method to report operating cash
flows.
c.
Operating cash flows have been positive over this three-year
period and have grown substantially each year.
d.
Darden has similar investing activities each year. The
activities include the purchase of fixed assets, proceeds from
the sale of fixed assets, and purchases of other assets.
F11-38
Chapter 11 - Tools of the Trade, Part III, The Statement of Cash Flows:
Bringing the Focus Back to Cash