Chapter 13
Statement of Cash Flows
ANSWERS TO QUESTIONS
1.
The income statement reports revenues earned and expenses incurred during a
period of time. It is prepared on an accrual basis. The balance sheet reports the
assets, liabilities, and equity of a business at a point in time. The statement of cash
flows reports cash receipts and cash payments of a business, from three broad
categories of business activities: operating, investing, and financing.
2.
The statement of cash flows reports cash receipts and cash payments from three
broad categories of business activities: operating, investing, and financing. While
the income statement reports operating activities, it reports them on the accrual
basis: revenues when earned, and expenses when incurred, regardless of the
timing of the cash received or paid. The statement of cash flows reports the cash
flows arising from operating activities. The balance sheet reports assets, liabilities,
and equity at a point in time. The statement of cash flows and related schedules
indirectly report changes in the balance sheet by reporting operating, investing, and
financing activities during a period of time, which caused changes in the balance
sheet from one period to the next. In this way, the statement of cash flows reports
information to link together the financial statements from one period to the next, by
explaining the changes in cash and other balance sheet accounts, while
summarizing the information into operating, investing, and financing activities.
3.
Cash equivalents are short-term, highly liquid investments that are purchased
within three months of the maturity date. The statement of cash flows does not
separately report the details of purchases and sales of cash equivalents because
these transactions affect only the composition of total cash and cash equivalents,
not the total amount. The statement of cash flows reports the change in total cash
and cash equivalents from one period to the next.
4.
The major categories of business activities reported on the statement of cash flows
are operating, investing, and financing activities. Operating activities of a business
arise from the production and sale of goods and/or services. Investing activities
arise from acquiring and disposing of property, plant, and equipment and
investments. Financing activities arise from transactions with investors and
creditors.
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13-1
5.
Cash inflows from operating activities include cash sales, collections on accounts,
and notes receivable arising from sales, dividends on investments, and interest on
loans to others and investments. Cash outflows from operating activities include
payments to suppliers and employees, and payments for operating expenses,
taxes, and interest.
6.
Depreciation expense is added to net income to adjust for the effects of a noncash
expense that was deducted in determining net income. It does not involve an inflow
of cash.
7.
Cash expenditures for purchases and salaries are not reported on the statement of
cash flows, indirect method, because that method does not report cash inflows and
outflows for each operating activity. Rather, it reports only net income, changes in
accounts payable and wages payable, and net cash flow from operating activities.
8.
The $50,000 increase in inventory must be used in the statement of cash flows
calculations because it increases the outflow of cash all other things equal. It is
used as follows:
Direct method—added to cost of goods sold, accrual basis (the other adjustment
would involve accounts payable) to compute cost of goods sold, cash basis.
Indirect method—subtracted from net income as a reconciling item to obtain cash
flows from operating activities.
9.
The two methods of reporting cash flows from operating activities are the direct
method and the indirect method. The direct method reports the gross amounts of
cash receipts and cash payments arising from the revenues and expenses
reported on the income statement. The indirect method reports the net amount of
cash provided or used by operating activities, by reporting the adjustments to net
income for the net effects of noncash revenues and expenses, and changes in
accruals and deferrals. The two approaches differ in the way they report cash flows
from operating activities, but are similar in that the final result, net cash provided by
operating activities, is the same amount.
10. Cash inflows from investing activities include cash received from sale of
operational assets, sale of investments, maturity value of bond investments, and
principal collections on notes receivable. Cash outflows from investing activities
include cash payments to purchase property, plant, and equipment and
investments, and to make loans.
11. Cash inflows from financing activities include cash received from issuing stock, the
sale of treasury stock, and borrowings. Cash outflows from financing activities
include cash payments for dividends, the purchase of treasury stock, and principal
payments on borrowing.
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Solutions Manual
12. Noncash investing and financing activities are activities that would normally be
classified as investing or financing activities, except no cash was received or paid.
Examples of noncash investing and financing include the purchase of assets by
issuing stock or bonds, the repayment of loans using noncash assets, and the
conversion of bonds into stock. Noncash investing and financing activities are not
reported in the statement of cash flows, because there was no cash received or
cash paid; however, the activities are disclosed in a separate schedule.
13. When equipment is sold, it is considered an investing activity, and any cash
received is reported as a cash inflow from investing activities. When using the
direct method, the cash received from the sale of equipment is reported as an
investing cash inflow. When using the indirect method, the gain on sale of
equipment must be reported as a deduction from net income, because the gain
was included in net income, but did not provide any cash from operating activities.
The cash received is reported in the investing activities section of the statement of
cash flows.
If the equipment was sold at a loss, the cash received is reported as a cash inflow
from investing activities when using the direct method. When using the indirect
method, the loss on sale of equipment is added to net income because the loss
was included in net income but did not require an operating cash outflow. The cash
received is reported as an investing cash inflow.
ANSWERS TO MULTIPLE CHOICE
1. b)
6. b)
McGraw-Hill /Irwin
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2. d)
7. d)
3. d)
8. a)
4. a)
9. d)
5. a)
10. c)
© The McGraw-Hill Companies, Inc., 2007
13-3
Authors' Recommended Solution Time
(Time in minutes)
Mini-exercises
No.
Time
1
5
2
5
3
5
4
5
5
5
6
5
7
5
Exercises
No.
Time
1
10
2
10
3
15
4
15
5
15
6
15
7
20
8
20
9
10
10
15
11
15
12
20
13
20
14
25
15
20
16
25
17
15
18
10
19
20
20
40
Problems
No.
Time
1
35
2
45
3
35
4
40
5
55
Alternate
Problems
No.
Time
1
35
2
35
Cases and
Projects
No.
Time
1
20
2
15
3
25
4
35
5
35
6
*
* Due to the nature of these cases and projects, it is very difficult to estimate the
amount of time students will need to complete the assignment. As with any open-ended
project, it is possible for students to devote a large amount of time to these
assignments. While students often benefit from the extra effort, we find that some
become frustrated by the perceived difficulty of the task. You can reduce student
frustration and anxiety by making your expectations clear. For example, when our goal
is to sharpen research skills, we devote class time discussing research strategies.
When we want the students to focus on a real accounting issue, we offer suggestions
about possible companies or industries.
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Solutions Manual
MINI–EXERCISES
M13–1.
I
F
O
O
O
F
1.
2.
3.
4.
5.
6.
Proceeds from sale of properties.
Purchase of stock. (This involves repurchase of its own stock.)
Depreciation, depletion, and amortization.
Accounts payable (decrease).
Inventories (decrease).
Principal payment on long-term debt.
+
–
–
+
+
1.
2.
3.
4.
5.
Depreciation, depletion, and amortization.
Inventories (increase).
Accounts payable (decrease).
Accounts receivable (decrease).
Accrued expenses (increase).
F
F
I
O
O
F
1.
2.
3.
4.
5.
6.
Repayments of borrowings (bank debt).
Dividends paid.
Proceeds from sale of property, plant and equipment.
Net interest paid.
Receipts from customers.
Payment for share buy-back.
M13–2.
M13–3.
M13–4.
Quality of income ratio = Cash flow from operations = $60,000
Net income
$80,000
= 0.75 (75%)
The quality of income ratio measures the portion of income that was generated
in cash. The low ratio indicates a likely need for external financing.
M13–5.
Investing Activities
Sale of used equipment
Purchase of short-term investments
Cash used in investing activities
$ 250
(300)
$ (50)
M13–6.
Financing Activities
Additional short-term borrowing from bank
Dividends paid
Cash provided by financing activities
McGraw-Hill /Irwin
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$1,000
(800)
$ 200
© The McGraw-Hill Companies, Inc., 2007
13-5
M13–7.
Yes
No
Yes
No
Purchase of equipment with short-term investments
Dividends paid in cash
Purchase of building with mortgage payable
Additional short-term borrowing from bank
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Solutions Manual
EXERCISES
E13–1.
O
NA
F
O
I
F
O
F
F
O
1. Depreciation and amortization
2. Cash collections from customers
3. Dividends paid
4. [Change in] Inventory
5. Payments to acquire property and equipment
6. Repayments of long-term debt
7. Net income
8. Proceeds from issuance of common stock to employees
9. Net repayments of notes payable to banks
10. [Change in] Accounts payable and accrued expenses
E13–2.
F
O
O
NA
I
O
F
I
O
F
1. Dividends paid
2. Income taxes paid
3. Interest received
4. Net income
5. Payments for property, plant and equipment
6. Payments in the course of operations
7. Proceeds from ordinary share [stock] issues
8. Proceeds from sale of property, plant and equipment
9. Receipts from customers
10. Repayments of loans
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13-7
E13–3.
1.
– NCFI
2.
NE
3.
+ NCFO
Plant and equipment
Cash
Inventory
Accounts payable
Cash
Accounts receivable
4.
NE
5.
– NCFO
Interest expense
Cash
6.
– NCFF
Short-term debt
Cash
7.
– NCFO
Prepaid expenses (rent)
Cash
8.
+ NCFI
Cash
Accumulated depreciation
Plant and equipment
9.
– NCFO
Accounts payable
Cash
10.
– NCFF
Retained earnings
Cash
McGraw-Hill/Irwin
13-8
Salaries expense
Accrued salaries payable
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E13–4.
1.
– NCFO
Income tax expense
Cash
2.
+ NCFI
Cash
Plant and equipment (net)
3.
+ NCFF
Cash
Long-term Debt
4.
+ NCFO
Cash
Accounts receivable
5.
NE
Inventory
Accounts payable
6.
– NCFI
Investment securities
Cash
7.
NE
Plant and equipment
Note payable
8.
+ NCFF
Cash
Common stock
Additional paid-in capital
9.
– NCFO
Prepaid expenses (rent)
Cash
10.
NE
Expense
Prepaid expense
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13-9
E13–5.
Comparison of Statement of Cash Flows direct and indirect reporting
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
Cash flows
(and related changes)
Accounts payable increase or decrease
Payments to employees
Cash collections from customers
Accounts receivable increase or decrease
Payments to suppliers
Inventory increase or decrease
Wages payable, increase or decrease
Depreciation expense
Net income
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Net increase or decrease in cash during the period
Statement of Cash Flows
Method
Direct
Indirect
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
The direct method reports cash flows from operating activities individually for each
major revenue and expense. In contrast, the indirect method reports a reconciliation of
net income to cash flow from operating activities. The two methods report the investing
and financing activities in exactly the same way.
McGraw-Hill/Irwin
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Solutions Manual
E13–6.
Cash flows from operating activities—indirect method
Net income ..............................................................................................
Depreciation expense ..............................................................................
Accounts receivable increase (14,000 – 10,000) ....................................
Inventory decrease (7,000 – 15,000) ......................................................
Salaries payable increase (1,500 – 1,000) .............................................
Net cash provided by operating activities ...........................................
$12,000
7,000
(4,000)
8,000
500
$23,500
E13–7.
Req. 1
Cash flows from operating activities—indirect method
Net loss ....................................................................................................
Depreciation expense ..............................................................................
Amortization of copyrights .......................................................................
Accounts receivable decrease (8,000 – 20,000) ....................................
Salaries payable increase (12,000 – 3,000) ...........................................
Other accrued liabilities decrease (1,000 – 5,000) ..................................
Net cash provided by operating activities ...........................................
($6,000)
7,000
300
12,000
9,000
(4,000)
$18,300
Req. 2
The first reason for the net loss was the depreciation expense. This is a non-cash
expense. Depreciation expense, along with decreased working capital requirements
(current assets - current liabilities), turned the net loss into positive operating cash flow
from operations. The reasons for the difference between net income and cash flow are
important because they help the financial analyst to determine if the trends are
sustainable or whether they represent one-time events.
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13-11
E13–8.
Req. 1
Cash flows from operating activities—indirect method
Net loss ...................................................................................................
Depreciation and amortization ................................................................
Increase in receivables ...........................................................................
Decrease in inventories ..........................................................................
Increase in prepaid expenses .................................................................
Decrease in accounts payable ................................................................
Decrease in accrued liabilities ................................................................
Increase in income taxes payable ..........................................................
Cash flows from operating activities ..................................................
($9,482)
33,305
(170)
643
(664)
(2,282)
(719)
1,861
$22,492
Note: The reduction of long-term debt and additions to equipment do not affect cash
flows from operating activities.
Req. 2
The primary reason for the net loss was the depreciation and amortization expense.
These represent non-cash expenses. Large depreciation and amortization expense,
offset partially by increased working capital requirements, turned Sizzler’s net loss into
positive operating cash flow. The reasons for the difference between net income and
cash flow from operations are important because they help the financial analyst to
determine if the trends are sustainable or whether they represent one-time events.
McGraw-Hill/Irwin
13-12
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Solutions Manual
E13–9.
Account
Receivables
Inventories
Other current assets
Payables
Change
Increase
Decrease
Decrease
Decrease
E13–10.
Account
Accounts receivable
Inventories
Other current assets
Accounts payable
Income taxes payable
Other current liabilities
Change
Increase
Decrease
Decrease
Increase
Increase
Increase
E13–11.
Cash flows from operating activities—direct method
Cash collected from customers1
Cash payments to suppliers of inventory2
Cash payments to employees 3
Net cash provided by operating activities ...........................................
$76,000
(42,000)
(10,500)
$23,500
1. Cash collected from customers = Sales revenue – Increase in Accounts receivable
$80,000 – 4,000 = 76,000
2. Cash payments to suppliers of inventory = Cost of goods sold – Decrease in Inventory
$50,000 – 8,000 = 42,000
3. Cash payments to employees = Salaries expense – Increase in Salaries payable
$11,000 – 500= 10,500
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13-13
E13–12.
Req. 1
Cash flows from operating activities—direct method
Cash collected from customers1
Cash payments to employees2
Cash paid for other expenses3
Net cash provided by operating activities ...........................................
$64,000
(33,000)
(12,700)
$18,300
1. Cash collected from customers = Sales revenue + Decrease in Accounts receivable
$52,000 + 12,000 = 64,000
2. Cash payments to employees = Salaries expense – Increase in Salaries payable
$42,000 – 9,000 = 33,000
3. Cash paid for other expenses = Other expenses + Decrease in Other accrued liabilities
$8,700 + 4,000= 12,700
Req. 2
The first reason for the net loss was the depreciation expense. This is a non-cash
expense. Depreciation expense, along with decreased working capital requirements
(current assets - current liabilities), turned the net loss into positive operating cash flow.
The reasons for the difference between net income and cash flow are important
because they help the financial analyst to determine if the trends are sustainable or
whether they represent one-time events.
McGraw-Hill/Irwin
13-14
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Solutions Manual
E13–13.
Req. 1
Cash flows from operating activities—direct method
Cash collected from customers1
Cash payments to employees
Cash payments to suppliers2
Cash payments for other expenses3
Cash payments for income tax4
Net cash provided by operating activities
$136,330
(56,835)
(47,139)
(9,164)
(700)
$22,492
1. Cash collected from customers = Revenues – Increase in Accounts receivable
$136,500 – 170 = 136,330
2. Cash payments to suppliers: Cost of sales – Decrease in Inventories
+ Decrease in Accounts payable
$45,500 – 643 + 2,282 = 47,139
3. Cash payments for other expenses = Other expense + Increase in Prepaid expenses
+ Decrease in Accrued liabilities
$7,781 + 664 + 719 = 9,164
4. Cash payments for income tax = Income tax expense – Increase in income taxes
payable
$2,561 – 1,861 = 700
Req. 2
The primary reason for the net loss was the depreciation and amortization expense.
These represent non-cash expenses. Large depreciation and amortization expense,
offset partially by increased working capital requirements, turned Sizzler’s net loss into
positive operating cash flow. The reasons for the difference between net income and
cash flow from operations are important because they help the financial analyst to
determine if the trends are sustainable or whether they represent one-time events.
McGraw-Hill /Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
13-15
E13–14.
Req. 1
Cash flows from operating activities—indirect method
Net income ..............................................................................................
Depreciation and amortization .................................................................
Increase in accounts receivable ..............................................................
Increase in inventory................................................................................
Decrease in prepaid expense ..................................................................
Increase in accounts payable ..................................................................
Decrease in taxes payable ......................................................................
Decrease in other current liabilities ..........................................................
Cash flows from operating activities ..................................................
$1,587.9
1,444.2
(161.0)
(89.5)
3.3
143.2
(125.1)
(96.7)
$2,706.3
Note: The cash dividends paid and treasury stock purchased are not related to
operating activities and do not affect cash flows from operating activities. The decrease
in other current liabilities was not explained in the PepsiCo annual report, so its proper
inclusion in this computation is a judgment call. If it was not related to operations, it
should not be included in the previous computation. In reality, PepsiCo included the
decrease on its statement of cash flows.
Req. 2
Quality of income ratio = Cash flow from operations = $2,706.3
Net income
$1,587.9
= 1.70
Req. 3
The reason the quality of income ratio was significantly greater than one was because
of large non-cash depreciation charges, offset by modest increases in working capital.
E13–15.
The investing and financing sections of the statement of cash flows for Rowe Furniture:
Cash flows from investing activities:
Purchase of property, plant & equipment ...........................
Sale of marketable securities ...............................................
Proceeds from sale of property & equipment ....................
Net cash flows from investing activities ........................
$(871)
134
6,594
Cash flows from financing activities:
Borrowings under line of credit ............................................
Proceeds from issuance of common stock ........................
Payments on long term debt ................................................
Payment of dividends ............................................................
Purchase of treasury stock ...................................................
Net cash flows from financing activities ........................
1,417
11
(46)
(277)
(1,583)
McGraw-Hill/Irwin
13-16
$5,857
(478)
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
E13–16.
Req. 1
The investing and financing sections of the statement of cash flows for Gibraltar
Industries:
Cash flows from investing activities:
Acquisitions (investments in other companies)
(84,243)
Purchases of other equity investments
(7,797)
Purchases of property, plant and equipment
(22,571)
Net proceeds from sale of property and equipment
436
Net cash used in investing activities
(114,175)
Cash flows from financing activities:
Long-term debt reduction
Proceeds from long-term debt
Net proceeds from issuance of common stock
Payment of dividends
Net cash provided by (used in) financing activities
(118,100)
122,144
73,558
(2,733)
74,869
Req. 2
Capital acquisitions ratio = Cash flow from operations = $64,663
Cash Paid for Plant &
$22,571
Equipment
= 2.86
The capital acquisitions ratio measures the company's ability to finance plant and
equipment purchases from operations. Since this amount was more than 1 (2.86), the
company has generated more than enough to finance plant and equipment purchases
from operations.
Req. 3
Gibraltar’s management is using the cash proceeds from the stock offering, along with
the excess cash generated by operations (see Req. 2) mainly to invest in other
companies. Note that most of the new long-term debt issuances are being used to pay
off existing long-term debt.
McGraw-Hill /Irwin
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13-17
E13–17.
Req. 1
Both of these transactions are considered noncash investing and financing activities,
and are not reported on the statement of cash flows. The transactions must be
disclosed in a separate schedule or in the footnotes. The information disclosed in the
separate schedule would state:
a. Equipment valued at $26,000 was acquired by giving a $15,000, 12%, two-year
note, and common stock with a market value of $11,000.
b. A machine valued at $8,700 was acquired by exchanging land with a book value of
$8,700.
Req. 2
The capital acquisitions ratio measures the company's ability to finance plant and
equipment purchases from operations. Since neither of these transactions enters the
numerator or denominator of the ratio, they would have no effect. Many analysts
believe that these transactions represent important capital acquisitions, and thus should
be included in the denominator of the ratio to indicate what portion of all (not just cash)
acquisitions are being financed from operations.
McGraw-Hill/Irwin
13-18
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Solutions Manual
E13–18.
Req. 1
Cash flows from investing activities
Year 3
Year 2
Year 1
Proceeds from sale of equipment .......
$14,768
$11,623
$1,797
The amount reported in the cash flow from investing activities section of the statement
of cash flows is the total cash proceeds from the sale of the equipment, regardless of
the amount of any gain or loss.
Req. 2
Plant and equipment (at cost)
Accumulated depreciation
Net book value
Cash Proceeds – Net book value =
Gain (Loss) on sale
Year 3
$54,000
29,594
24,406
Year 2
$8,000
3,691
4,309
Year 1
$11,000
9,203
1,797
(9,638)
7,314
0
Any gain on the sale of the equipment is subtracted from net income to avoid double
counting of the gain. Any loss on the sale of the equipment is added to avoid double
counting of the loss.
Cash flows from operating activities
Year 3
Year 2
Year 1
Loss (Gain) on sale of equipment ........
$9,638
$(7,314)
--
E13–19.
Beg. Bal.
End. Bal.
Equipment
12,500
4,500*Sold
8,000
Sold
Accumulated Depreciation
2,000 Beg. Bal.
300*
700 Dep. Exp.
2,400 End. Bal.
*plug figures
Cost of equipment sold = $4,500
Accumulated depreciation on sold equipment = $300
Book value of sold equipment ...............
Less: Loss on sale (given) ....................
Cash received from sale ......................
McGraw-Hill /Irwin
Financial Accounting, 5/e
$4,200
(3,000)
$1,200
© The McGraw-Hill Companies, Inc., 2007
13-19
E13–20.
Item
Cash
Noncash accounts:
Accounts receivable (net) ............
Merchandise inventory ................
Investments, long-term ................
Equipment ...................................
Total ...........................................
Accumulated depreciation ...........
Accounts payable ........................
Wages payable ...........................
Income taxes payable .................
Bonds payable ............................
Balances
12/31/2003
20,500
Debit
22,000
68,000 h
d
114,500 b
225,000
32,000 i
17,000 e
2,500 f
3,000
54,000
Common stock, no par ................
100,000
Retained earnings .......................
Total ...........................................
16,500 k
225,000
Statement of Cash Flows
Conversion of net income to cash flow
from operating activities:
Net income
Depreciation expense
Accounts payable decrease
Wages payable decrease
Income taxes payable increase
Inventory increase
Cash flows from investing activities:
Long-term investment purchased
Sale of equipment
Cash flows from financing activities:
Sale of capital stock
Dividends paid
Net increase (decrease) in cash
Totals
McGraw-Hill/Irwin
13-20
Analysis
Credit
l
1,300
7,000
15,000
20,000
15,000
3,000
1,000
12,000
i
21,000
c
3,000
g
1,500
j
b
6,000
20,000
a
20,200
Inflows
a
c
g
22,000
75,000
15,000
113,500
244,700
20,000
14,000
1,500
4,500
54,000
126,000
24,700
244,700
Outflows
20,200
3,000
e
f
3,000
1,000
h
7,000
d
15,000
1,500
i
6,000
j
6,000
1,300
111,000
13,700
(9,000)
k
l
Balances
12/31/2004
19,200
12,000
(6,000)
111,000
(1,300)
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
PROBLEMS
P13–1.
Req.1
Related Cash
Flow Section
Δ in Cash
O
O
I
O
Balance sheet at December 31
2004
Cash
$68,000
Accounts receivable
15,000
Merchandise inventory
22,000
Property and equipment 210,000
Less: Accumulated
(60,000)
depreciation
$255,000
O
Accounts payable
O
Wages payable
Note payable, long-term
Contributed capital
F
F
O,F
Retained earnings
2003
$65,000
22,000
18,000
150,000
Change
+3,000
-7,000
+4,000
+60,000
(45,000)
-15,000
2
-11,000
5
10
3
4
7
Net increase in cash
Add to net income the decrease in A/R
Subtract from net income the increase in Inventory
Payment in cash for equipment
Add to NI because depreciation expense does not
affect cash
$210,000
$8,000 $19,000
2,000
60,000
100,000
1,000
70,000
75,000
+1,000
-10,000
+25,000
6
85,000
45,000
+40,000
1
8
9
Subtract from net income the decrease in Accounts
Payable
Add to net income the increase in Wages payable
Cash used for repayment of note principal
Issuance of stock for cash
Increased for net income amount of $45,000
Decreased for dividends declared & paid $5,000
$255,000 $210,000
Income statement for 2004
Sales
$195,000
Cost of goods sold
90,000
Depreciation expense
15,000
Other expenses
45,000
Net Income
$45,000
McGraw-Hill /Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
13-21
P13-1 (continued)
MetroVideo Inc.
Statement of Cash Flows
For the Year Ended December 31, 2004
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense
Decrease in accounts receivable
$15,000
7,000
Increase in merchandise inventory
Decrease in accounts payable
Increase in wages payable
(4,000)
(11,000)
1,000
$45,000
2
3
4
5
6
Net cash provided by operating activities
Cash flows from investing activities:
Cash payments to purchase fixed assets
Cash flows from financing activities:
Cash payments on long-term note
Cash payments for dividends
Cash receipts from issuing stock
Net cash provided by financing activities
Net increase in cash during the year
Cash balance, January 1, 2004
Cash balance, December 31, 2004
1
8,000
53,000
(60,000)
(10,000)
(5,000)
25,000
7
8
1
9
10,000
3,000 10
65,000
$68,000
Req. 2
An overall increase in cash of $3,000 came from inflows of $53,000 from operating
activities and a stock issuance of $25,000. A large percentage of the cash inflows were
invested in equipment ($60,000), with $15,000 used to pay down long-term financing
and $5,000 for dividends.
McGraw-Hill/Irwin
13-22
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P13–2.
ROCKY MOUNTAIN CHOCOLATE FACTORY, INC.
Statement of Cash Flows
For the Quarter Ended May 31
Cash flows from operating activities:
Net income ......................................................................
Add (deduct) to reconcile net income to net cash flow:
Depreciation expense ...........................................................
Amortization expense ...........................................................
Accounts receivable increase .............................................
Inventories increase..............................................................
Other current assets increase .............................................
Accounts payable increase .................................................
Accrued liabilities increase ..................................................
Income taxes payable decrease .........................................
Long-term A/R decrease ......................................................
Net cash inflow from operating activities ....................
$ 163,837
276,304
5,901
(138,681)
(243,880)
(357,507)
280,935
164,087
(43,031)
11,382
$ 119,347
Cash flows from investing activities:
Fixed assets purchased ................................................. (1,081,121)
Other assets decrease .........................................................
50,055
Net cash inflow from operating activities
(1,031,066)
Cash flows from financing activities:
Repayment of short-term debt ....................................... (1,000,000)
Repayment of long-term debt ............................................. (2,355,029)
Issuance of long-term debt ............................................ 4,659,466
Net cash inflow from financing activities .....................
Net increase in cash during the quarter ................................
Cash, February 29 ................................................................
Cash, May 31 ........................................................................
1,304,437
392,718
528,787
$ 921,505
McGraw-Hill /Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
13-23
P13–3.
Req.1
O
Balance sheet at December 31
2004
Cash
$68,000
Accounts receivable
15,000
Merchandise inventory
22,000
Property and equipment 210,000
Less: Accumulated
(60,000)
depreciation
$255,000
Accounts payable
$8,000
O
Wages payable
F
F
Note payable, long-term
Contributed capital
Related Cash
Flow Section
Δ in Cash
O
O
I
O
O,F
Retained earnings
2003
$65,000
22,000
18,000
150,000
Change
+3,000
-7,000
+4,000
+60,000
(45,000)
-15,000
2
Depreciation expense does not affect cash
$210,000
$19,000
-11,000
5
2,000
1,000
+1,000
6
60,000
100,000
70,000
75,000
-10,000
+25,000
8
85,000
45,000
+40,000
1
Add to CGS to compute payments to suppliers
Subtract from Other expenses to compute Payments
for wages
Cash used for repayment of note principal
Issuance of stock for cash
Increased for net income amount of $45,000
Decreased for dividends declared & paid $5,000
10
3
4
7
9
Net increase in cash
Add to sales to compute collections from customers
Add to CGS to compute payments to suppliers
Payment in cash for equipment
$255,000 $210,000
Income statement for 2004
Sales
$195,000
Cost of goods sold
90,000
Depreciation expense
15,000
Other expenses
45,000
Net Income
$45,000
McGraw-Hill/Irwin
13-24
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P13-3 (continued)
MetroVideo Inc.
Statement of Cash Flows
For the Year Ended December 31, 2004
Cash flows from operating activities:
Collections from customers ($195,000 +
7,000)
Payments to suppliers ($90,000 + 4,000
+ 11,000)
Payments for wages ($45,000 – 1,000)
$202,000
3
(105,000)
4, 5
(44,000)
6
Net cash provided by operating activities
Cash flows from investing activities:
Cash payments to purchase fixed assets
Cash flows from financing activities:
Cash payments on long-term note
Cash payments for dividends
Cash receipts from issuing stock
Net cash provided by financing activities
Net increase in cash during the year
Cash balance, January 1, 2004
Cash balance, December 31, 2004
53,000
(60,000)
(10,000)
(5,000)
25,000
7
8
1
9
10,000
3,00010
65,000
$68,000
Req. 2
An overall increase in cash of $3,000 came from a positive inflow of $53,000 from
operating activities and a stock issuance of $25,000. A large percentage of the cash
inflow was invested in equipment ($60,000), with $15,000 used to pay down long-term
financing and $5,000 for dividends.
McGraw-Hill /Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
13-25
P13–4.
Req. 1
BETA COMPANY
Cash Flows from Operating Activities
Direct Method
Cash flows from operating activities:
Cash receipts from customers ................................................................
Cash payments to suppliers ...................................................................
Cash payments for salaries ....................................................................
Cash payments for rent ..........................................................................
Cash payments for insurance .................................................................
Cash payments for utilities ......................................................................
Cash payments for bond interest ............................................................
Net cash provided by operating activities .........................................
$20,670
(8,992)
(4,991)
(2,499)
(809)
(700)
(600)
$ 2,079
Req. 2
BETA COMPANY
Cash Flows from Operating Activities
Indirect Method
Cash flows from operating activities:
Net loss ...........................................................................
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation expense ....................................................
Loss on sale of investments ..........................................
Decrease in accounts receivable ...................................
Increase in merchandise inventory ................................
Increase in accounts payable ........................................
Increase in salaries payable ..........................................
Decrease in rent payable ...............................................
Decrease in prepaid rent ...............................................
Increase in prepaid insurance ........................................
Total adjustments .........................................................
Net cash provided by operating activities ..................
McGraw-Hill/Irwin
13-26
$ (400)
$2,000
400
70
(22)
30
9
(4)
5
(9)
2,479
$2,079
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P13–5.
Req.1
Statement of Cash Flows Spreadsheet
Hunter Company
For the Year Ended December 31, 2004
12-31-2003
BALANCE SHEET
Cash
Accounts receivable
Merchandise inventory
Fixed assets-net
Total
Accounts payable
Wages payable
Notes payable, long-term
Common stock-no par
Retained earnings
Total
McGraw-Hill /Irwin
Financial Accounting, 5/e
18,000
29,000
36,000
72,000
155,000
22,000
1,000
48,000
60,000
24,000
155,000
DR
CR
26,000 (k)
9,000 (g)
2,000 (b)
6,000 (c)
6,000 (e)
3,000 (d)
200 (f)
10,000 (h)
3,800 (j)
49,000
20,000 (i)
12,000 (a)
49,000
12-31-2004
44,000
27,000
30,000
75,000
176,000
25,000
800
38,000
80,000
32,200
176,000
© The McGraw-Hill Companies, Inc., 2007
13-27
P13–5. (continued)
STATEMENT OF CASH FLOWS-INDIRECT METHOD
Inflow
Cash flows from operating activities:
Net income
Adjustment to net income
Decrease in accounts receivable
Decrease in merchandise inventory
Increase in accounts payable
Depreciation expense
Decrease in wages payable
Outflow
12,000 (a)
2,000
6,000
3,000
6,000
(b)
(c)
(d)
(e)
Cash flows from investing activities:
Cash payment to purchase fixed assets
Cash flows from financing activities:
Cash payments on long-term note
Cash receipts from issuing stock
Cash payments for dividends
Increase (decrease) in cash during the year
Totals
Cash balance, Jan. 1
Cash balance, Dec. 31
McGraw-Hill/Irwin
13-28
200 (f)
28,800
9,000 (g)
(9,000)
10,000 (h)
20,000 (i)
49,000
3,800 (j)
6,200
26,000 (k)
49,000
26,000
18,000
44,000
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
P3–5. (continued)
Req. 2
HUNTER COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2004
Cash flows from operating activities:
Net income .....................................................................
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense ....................................................
Decrease in accounts receivable ...................................
Decrease in merchandise inventory...............................
Increase in accounts payable ........................................
Decrease in wages payable ...........................................
Total adjustments ...........................................................
Net cash provided by operating activities ..................
Cash flows from investing activities:
Cash payments to purchase fixed assets .......................
Cash flows from financing activities:
Cash payments on long-term note ..................................
Cash receipts from issuing stock ....................................
Cash payments for dividends .........................................
Net cash provided by financing activities ...................
Net increase in cash during the year .....................................
Cash balance, January 1, 2004 ............................................
Cash balance, December 31, 2004.......................................
$12,000
6,000
$ 2,000
6,000
3,000
(200)
16,800
28,800
(9,000)
(10,000)
20,000
(3,800)
6,200
26,000
18,000
$44,000
Req. 3
There were no noncash investing and financing activities during 2004.
McGraw-Hill /Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
13-29
ALTERNATE PROBLEMS
AP13–1.
Req. 1
Related
Cash
Flow
Section
Δ in Cash
O
O
I
O
Balance sheet at December 31
Cash
Accounts receivable
Merchandise inventory
Property and equipment
Less: Accumulated
depreciation
2004
$34,000
45,000
31,000
121,000
2003
Change
$29,000
+5,000
28,000 +17,000
38,000
-7,000
100,000 +21,000
(30,000)
(25,000)
-5,000
2
$201,000 $170,000
$36,000 $27,000
+9,000
5
-200
6
10
3
4
7
O
Accounts payable
O
Wages payable
F
F
Note payable, long-term
Contributed capital
38,000
88,600
44,000
-6,000
72,600 +16,000
8
Retained earnings
37,200
25,000 +12,200
1
O,F
1,200
1,400
9
Net increase in cash
Subtract from net income the increase in A/R
Add to net income the increase in Inventory
Payment in cash for equipment
Add back to NI because depreciation expense does not
affect cash
Add to net income the increase in Accounts Payable
Subtract from net income the decrease in Wages
payable
Cash used for repayment of note principal
Issuance of stock for cash
Increased for net income of $22,200 and decreased
for dividends declared and paid of $10,000
$201,000 $170,000
Income statement for 2004
Sales
$130,000
Cost of goods sold
70,000
Other expenses
37,800
Net Income
$22,200
McGraw-Hill/Irwin
13-30
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP13–1 (continued)
McPherson Construction Supply Company
Statement of Cash Flows
For the Year Ended December 31, 2004
Cash flows from operating activities:
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense
Increase in accounts receivable
Increase in merchandise inventory
Increase in accounts payable
Decrease in wages payable
$22,200
$ 5,000
(17,000)
2
7,000
9,000
(200)
4
3
5
6
Net cash provided by operating activities
Cash flows from investing activities:
Cash payments to purchase fixed assets
Cash flows from financing activities:
Cash payments for dividends
Cash payments on long-term note
Cash receipts from issuing stock
Net cash provided by financing activities
Net increase in cash during the year
Cash balance, January 1, 2004
Cash balance, December 31, 2004
1
3,800
26,000
(21,000) 7
(10,000)
(6,000)
16,000
8
9
-5,00010
29,000
$34,000
Req. 2
There was an increase in cash for McPherson Construction Supply Company this year
of $5,000. Operating activities provided a positive cash flow of $26,000. This inflow of
cash from operating activities, combined with the stock issuance for $16,000 cash,
allowed the company to invest $21,000 in fixed assets, pay down a long-term note by
$6,000, and pay dividends of $10,000.
McGraw-Hill /Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
13-31
AP13–2.
Req. 1
Related
Cash
Flow
Section
Δ in Cash
Balance sheet at December 31
Cash
O
Accounts receivable
O
I
Merchandise inventory
Property and equipment
Less: Accumulated
depreciation
O
O
O
F
F
O,F
Accounts payable
Wages payable
Note payable, long-term
Contributed capital
Retained earnings
2004
$34,000
2003
Change
$29,000
+5,000
45,000
28,000 +17,000
3
31,000
121,000
38,000
-7,000
100,000 +21,000
4
(30,000)
(25,000)
2
Depreciation expense does not affect cash
5
Subtract from CGS to compute payments to suppliers
Add to Wage expense to compute payments for wages
Cash used for repayment of note principal
Issuance of stock for cash
Increased for net income of $22,200 and decreased
for dividends declared and paid of $10,000
-5,000
$201,000 $170,000
$36,000 $27,000
+9,000
1,200
1,400
-200
38,000
44,000
-6,000
88,600
72,600 +16,000
37,200
25,000 +12,200
10
7
6
8
9
1
Net increase in cash
Subtract from sales to compute collections from
customers
Subtract from CGS to compute payments to suppliers
Payment in cash for equipment
$201,000 $170,000
Income statement for 2004
Sales
$130,000
Cost of goods sold
70,000
Other expenses
37,800
Net Income
$22,200
McGraw-Hill/Irwin
13-32
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
AP13–2 (continued)
McPherson Construction Supply Company
Statement of Cash Flows
For the Year Ended December 31, 2004
Cash flows from operating activities:
Collections from customers ($130,000 –
17,000)
Payments to suppliers ($70,000 – 7,000 –
9,000)
Payments for wages ($20,000 + 200)
Payments for other
Payments for taxes
113,000
3
(54,000)
4,5
(20,200)
(6,800)
6
(6,000)
Net cash provided by operating activities
Cash flows from investing activities:
Cash payments to purchase fixed assets
Cash flows from financing activities:
Cash payments for dividends
Cash payments on long-term note
Cash receipts from issuing stock
Net cash provided by financing activities
Net increase in cash during the year
Cash balance, January 1, 2004
Cash balance, December 31, 2004
26,000
(21,000) 7
(10,000)
(6,000)
16,000
1
8
9
-5,00010
29,000
$34,000
Req. 2
There was an increase in cash for McPherson Construction Supply Company this year
of $5,000. Operating activities provided a positive cash flow of $26,000. This inflow of
cash from operating activities, combined with the stock issuance for $16,000 cash,
allowed the company to invest $21,000 in fixed assets, pay down a long-term note by
$6,000, and pay dividends of $10,000.
McGraw-Hill /Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
13-33
CASES AND PROJECTS
FINANCIAL REPORTING AND ANALYSIS CASES
CP13–1.
Req. 1 The two largest “Adjustments to reconcile net income to net cash provided by
operating activities” were:
(a) Depreciation and amortization: the $51,685 expense was added to net income
in the reconciliation because it is a noncurrent deferred expense which does
not cause a cash outflow when it is recorded.
(b) Increase in inventories: the increase of $27,330 was subtracted from net
income in the reconciliation because purchases of inventories were greater
than the amount of inventory sold. The increase (the extra purchases) must be
subtracted from net income to convert to cash flow from operating activities.
Req. 2 Pacific Sunwear of California’s three largest investing and financing uses of
cash over the past three years have been purchasing available-for-sale shortterm investments, purchases of property and equipment, repurchases and
retirement of common stock . The two major sources of cash for these
activities has been cash flow provided by operating activities and maturity of its
available-for-sale short-term investments.
Req. 3 Free Cash Flow was $61,020 thousand, calculated as (in thousands):
Cash Flows from Operating Activities
less Dividends
less Capital Expenditures (purchase of PPE)
Free Cash Flow
$143,012
0
81,992
$61,020
This implies that the company has the financial flexibility to consider additional
capital expenditures or other means of expansion without increasing its debt.
CP13–2.
Req. 1 The company uses the indirect method.
Req. 2 Tax payments of $121,138 thousand were made (Note 2, Supplemental
Disclosures of Cash Flow Information).
Req. 3 “Stock compensation” is an expense paid with common stock rather than cash.
Since it does not use cash, it is added back to net income to determine cash
flows from operations. Depreciation and amortization are also expenses that
do not involve a cash outflow as they are incurred. Thus, both of these
expenses are added back to net income to determine the cash flow from
operations.
McGraw-Hill/Irwin
13-34
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
CP13–2 (continued)
Req. 4 The company has paid cash dividends during the last three years. During the
year ended January 29, 2005, they paid $8,841 thousand in dividends. The
dividend payments are listed under the financing section of the statement of
cash flows.
Req. 5 Free Cash Flow was $262,554 thousand, calculated as (in thousands):
Cash Flows from Operating Activities
less Dividends
less Capital Expenditures
Free Cash Flow
$368,683
8,841
97,288
$262,554
CP13–3.
Req. 1
Quality of
= Cash flow from operations
income ratio
Net income
Pacific Sunwear of
California
American Eagle
Outfitters
$143,012 = 1.34
106,904
$368,683 = 1.73
213,343
American Eagle Outfitters has a higher, and therefore better, quality of income ratio
than does Pacific Sunwear of California.
Req. 2
Quality of Income =
Industry
Average
2.28
Pacific Sunwear
of California
1.34
American Eagle
Outfitters
1.73
Pacific Sunwear of California’s and American Eagle Outfitters’ quality of income ratios
are below the industry average. Two things affect this ratio: the fact that these two
companies are growing rapidly (see below), and the effect of operating leases on the
cash flow statement. Because these companies rely primarily on operating leases for
their stores, all of rent payments are included in operating cash flows. Other companies
in the industry that own their stores have no rent payments and add back depreciation
in computation of CFO.
Sales Growth =
Industry
Average
16.32%
Pacific Sunwear
of California
18.1%*
American Eagle
Outfitters
31.1%**
* ($1,229,762 – 1,041,456) / 1,041,456
** ($1,881,241 – 1,435,436) / 1,435,436
McGraw-Hill /Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
13-35
CP13–3 (continued)
Sales growth helps explain some of the difference in the quality of income ratio. Both of
these companies are in high growth mode, and are spending cash to advertise and
build inventories in anticipation of higher sales in the future.
Req. 3
Capital
= Cash flow from operations
acquisitions
Cash Paid for Plant &
ratio
Equipment
Pacific Sunwear of
California
American Eagle
Outfitters
$143,012 = 1.74
81,992
$368,683 = 3.79
97,288
American Eagle Outfitters has a higher capital acquisitions ratio than does Pacific
Sunwear of California. This implies that American Eagle Outfitters has a greater ability
to fund additional capital expenditures from the cash flow provided by its operating
activities.
Req. 4
Capital Acquisitions =
Industry
Average
2.72
Pacific Sunwear
of California
1.74
American Eagle
Outfitters
3.79
American Eagle Outfitters’ capital acquisitions ratio is higher and Pacific Sunwear of
California’s is lower than the industry average. This implies their relative ability to fund
additional capital expenditures from the cash flow provided by their operating activities
compared to the average company in the industry.
McGraw-Hill/Irwin
13-36
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
FINANCIAL REPORTING AND ANALYSIS CASES
CP13–4.
Date:
To:
From:
Re:
(today’s date)
Supervising Analyst
(your name)
Evaluation of Carlyle Golf, Inc.’s Planned Expansion
While many companies experience losses and negative cash flows during the early
years of their operations, the cash situation for Carlyle Golf is a major concern. The
company has announced plans to increase inventory by $2.2 million but there is no
obvious source to finance the acquisition of this inventory. The statement of cash flows
shows that the company has to make cash deposits with its suppliers. It is unlikely that
these suppliers will be a major source of financing for Carlyle's inventory. The company
obviously does not have enough cash on hand to finance its expansion of inventory.
The planned expansion of inventory has additional implications. The company must
have plans to expand its sales volume. There is no information in the company's report
concerning whether this expansion will require additional expenditures, such as
increased advertising or hiring new sales people. In any case, the expansion will most
likely require an increase in accounts receivable. Most companies underestimate the
amount of resources that must be tied up in inventory and accounts receivable when
they expand sales volume.
Carlyle should seek additional capital to support an increased level of operations.
Without this extra capital, it is unlikely that Carlyle can continue in business.
Instructor's note: Subsequent to September 1992, Carlyle sought new financing through
an initial public offering. At the time of this writing, the company is still trying to develop
a niche in a very competitive market.
McGraw-Hill /Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
13-37
CRITICAL THINKING CASES
CP13–5.
Req. 1
The payment from Merrill Lynch to Enron does not automatically make the Nigerian
barge transaction a sale. When a loan is established between a lender and borrower, a
similar cash payment is made between the two parties. Two other features of the
Nigerian barge transaction resemble a loan. First, the requirement that Enron arrange
for Merrill Lynch to be paid only six months after the “sale” is similar to a possible
requirement that a borrower repay a lender six months after a borrower receives cash in
conjunction with signing a promissory note. Second, the “hefty fee” paid by Enron for
temporarily obtaining the use of Merrill Lynch’s funds is similar to interest that is paid by
a borrower for temporarily obtaining the use of a lender’s funds.
The four revenue recognition criteria discussed in Chapter 3 are:
1) delivery has occurred or services have been rendered,
2) there is persuasive evidence of an arrangement for customer payment,
3) the price is fixed or determinable, and
4) collection is reasonably assured.
Without knowing about the secret side-deal, it’s not obvious which of the four criteria
have not been fulfilled. Knowing about the side-deal, however, makes it clear that the
first criterion has not been fulfilled. At the time of the initial transaction (and receipt of
cash from Merrill Lynch) Enron had a continuing obligation to ensure that Merrill Lynch
was repaid six months later. In other words, Enron had not performed all of the acts
promised to Merrill Lynch.
Req. 2
By recording the transaction as a regular sale, Enron reports the cash received as a
cash inflow from an operating activity. Had the transaction been recorded as a loan,
Enron would have reported the cash received as a cash inflow from a financing activity.
Req. 3
Most financial statement users view cash flows from operating activities as recurring
sources of cash into the future. If $100,000 of cash is generated from operations this
year, it’s often reasonable to expect that a similar amount will be generated next year
and the year after that and the year after that. Financing activities, on the other hand,
are not as readily recurring in the future, particularly as a company takes on more and
more debt. Eventually, lenders will stop lending if a company’s liabilities grow too large.
Given these different perceptions, financial statement users attach more value to cash
generated from operating activities than from financing activities. Thus, when the
transaction is recorded as a sale, financial statement users will perceive the company’s
value as greater than when the transaction is recorded as a loan.
McGraw-Hill/Irwin
13-38
© The McGraw-Hill Companies, Inc., 2007
Solutions Manual
FINANCIAL REPORTING AND ANALYSIS PROJECTS
CP13–6.
The solutions to this case will depend on the company and/or accounting period
selected for analysis.
McGraw-Hill /Irwin
Financial Accounting, 5/e
© The McGraw-Hill Companies, Inc., 2007
13-39