# Chapter 12_ The Statement of Cash Flows

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```					CHAPTER 12 The Statement of Cash Flows
OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Learning Outcomes Exercises Estimated Time in Minutes Level

1. Explain the purpose of a statement of cash flows. 2. Explain what cash equivalents are and how they are treated on the statement of cash flows. 3. Describe operating, investing, and financing activities, and give examples of each.

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Diff Easy Easy Easy Mod Easy Easy Diff

4. Describe the difference between the direct and the indirect methods of computing cash flow from operating activities. 5. Prepare a statement of cash flows, using the direct method to determine cash flow from operating activities. 4 5 6 7 8 13* 15* 9 10 14* 11 5 10 20 20 10 10 60 10 15 25 15 Mod Mod Mod Mod Mod Easy Diff Easy Mod Diff Mod

6. Prepare a statement of cash flows, using the indirect method to determine cash flow from operating activities. 7. Use cash flow information to help analyze a company. 8. Use a work sheet to prepare a statement of cash flows, using the indirect method to determine cash flow from operating activities (Appendix). *Exercise, problem, or case covers two or more learning outcomes Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

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Learning Outcomes

Problems and Alternates

Estimated Time in Minutes

Level

1. Explain the purpose of a statement of cash flows. 2. Explain what cash equivalents are and how they are treated on the statement of cash flows. 3. Describe operating, investing, and financing activities, and give examples of each. 4. Describe the difference between the direct and the indirect methods of computing cash flow from operating activities. 5. Prepare a statement of cash flows, using the direct method to determine cash flow from operating activities. 11* 12* 3 6 11* 13* 1 4 7 9 12* 30 30 45 30 30 30 30 45 30 45 30 Mod Mod Mod Mod Mod Diff Mod Mod Mod Diff Mod 13* 30 Diff

6. Prepare a statement of cash flows, using the indirect method to determine cash flow from operating activities.

7. Use cash flow information to help analyze a company. 8. Use a work sheet to prepare a statement of cash flows, using the indirect method to determine cash flow from operating activities (Appendix). 2 5 8 10 60 60 60 60 Mod Mod Mod Diff

*Exercise, problem, or case covers two or more learning outcomes Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

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Learning Outcomes

Cases

Estimated Time in Minutes

Level

1. Explain the purpose of a statement of cash flows.

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2. Explain what cash equivalents are and how they are treated on the statement of cash flows. 3. Describe operating, investing, and financing activities, and give examples of each. 4. Describe the difference between the direct and the indirect methods of computing cash flow from operating activities. 5. Prepare a statement of cash flows, using the direct method to determine cash flow from operating activities. 6. Prepare a statement of cash flows, using the indirect method to determine cash flow from operating activities. 7. Use cash flow information to help analyze a company. 8. Use a work sheet to prepare a statement of cash flows, using the indirect method to determine cash flow from operating activities (Appendix). *Exercise, problem, or case covers two or more learning outcomes Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

1* 6* 1*

30 20 30

Mod Mod Mod

3*

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4* 5*

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QUESTIONS 1. The purpose of the statement of cash flows is to summarize an entity’s cash flows from operating, investing, and financing activities during a period. Because it is concerned with activity for a specific period of time, the statement is similar to the income statement. However, they differ in two important respects. First, with a few exceptions, the income statement deals only with operating activities. Second, the income statement is on an accrual basis, while the statement of cash flows reports operating activities on a cash basis. 2. A cash equivalent is an item that is readily convertible to a known amount of cash and has an original maturity of three months or less. These items, such as Treasury bills and money market funds, present very little risk to the holder, and therefore they are included with cash for the purpose of preparing the statement of cash flows. That is, purchases and sales of cash equivalents are not considered significant activities to be separately reported on the statement. 3. The down payment of \$20,000 is a cash outflow that would be reported in the investing activities section of the statement of cash flows. The issuance of the promissory note for \$60,000 would appear in a supplemental schedule of noncash investing and financing activities. 4. A 60-day Treasury bill would be classified as a cash equivalent and combined with cash on the balance sheet. Therefore, the purchase of the treasury bill would not be reported as an investing activity. However, the purchase of Motorola stock would appear as a cash outflow in the investing activities section of the statement of cash flows. 5. Companies cannot continue in business if they do not generate positive cash flows from operating activities. Also, over a period of years, a company cannot continue to borrow more than it repays, nor can it issue capital stock indefinitely. Thus, you would not expect a net cash outflow from financing activities over a sustained period of time. However, many companies regularly experience a net cash outflow from investing activities. A company must at a minimum replace existing assets and in many cases acquire additional plant and equipment to remain competitive. At the same time, disposals of long-term assets may be fairly common, but usually they will not generate significant amounts of cash inflow. 6. The student is correct in that it is simple enough to find the net inflow or outflow of cash during the period. But this is only the starting point in preparing the statement of cash flows. First, all of the balance sheet accounts must be analyzed to find the explanations for the increases and decreases in cash during the period. Second, each of these inflows and outflows must be classified as either operating, investing, or financing activities.

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7. The only accurate part of this statement is that depreciation is often one of the largest items in the Operating Activities section of the statement. However, this is merely a result of using the indirect method to prepare this section. In computing net income, depreciation is deducted. Therefore, under the indirect method it must be added back to net income because it is a noncash expense. Depreciation does not in any way generate cash. 8. There is considerable debate over which method is most useful. Many accountants, as well as users of the statements, believe that the direct method, with its emphasis on cash receipts and cash payments, provides the most information. Others believe that the indirect method is better because it focuses attention on the differences between net income and net cash provided by operations. Accounting standards allow the use of either method, but companies are strongly encouraged to use the direct method. 9. Under the indirect method, net income is reported at the top of the Operating Activities section, and adjustments are made to convert income to a cash basis. Sales revenue is included in net income. However, on a cash basis we are interested in cash collections from sales, not the sales on an accrual basis. A decrease in accounts receivable indicates that cash collections exceeded sales revenue. Therefore, the excess is added back to the net income of the period. 10. Inventory is analyzed to determine the purchases of the period. Cost of goods sold decreases the Inventory account, and purchases increase it. After the purchases of the period are found, they are added to the beginning balance in the Accounts Payable account. The difference between the addition of these amounts and the ending balance in Accounts Payable is the amount of cash payments. 11. A profitable year does not guarantee a large cash balance at the end of the year. A large share of the profits may be returned to the stockholders in the form of cash dividends. Investments in new plant and equipment require significant amounts of cash, as does the repayment of various forms of borrowing. 12. Yes, it is possible to report a net loss and still experience a net increase in cash. First, a company could report large noncash charges against net income, such as depreciation and various types of losses. Thus, it is possible that net cash provided by operating activities is positive even though a net loss is reported. Second, the net loss deals only with operating activities. It is possible that a net cash inflow was provided by either investing or financing activities, or both. 13. Regardless of which method is used, a decrease in income taxes payable means that cash paid to the government during the period exceeded income tax expense on the income statement. Under the direct method, the amount of cash paid is reported as a cash outflow in the Operating Activities section of the statement. If the indirect method is used, the decrease in taxes payable is deducted from net income to arrive at net cash flow from operations.

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14. The requirement to separately disclose income taxes paid and interest paid when the indirect method is used is a compromise. Accounting standards strongly encourage companies to use the direct method because each major operating cash receipt and payment is reported in the Operating Activities section of the statement. However, if a company chooses to use the indirect approach, they are still required to report separately how much cash was actually paid to the government in taxes and to creditors in interest. 15. An argument can be made that it is inconsistent to report interest paid in the operating section and dividends paid in the financing section. Both represent returns to providers of capital: interest to creditors and dividends to stockholders. Furthermore, the cash raised from each of these sources—the amounts borrowed from creditors and the amounts contributed by stockholders—is classified as an inflow in the financing section of the statement. The rationale normally given for this treatment is that interest enters into the determination of net income, and thus the cash expended in interest should appear in the operating section. Many believe that this is illogical and that both interest paid and dividends paid belong in the financing section. 16. An analysis of the Prepaid Rent account can be used to find the amount of cash paid for rent: Beginning Prepaid Rent + Cash payments – Rent Expense = Ending Prepaid Rent \$9,600 + X – \$45,900 = \$7,300 X = \$43,600 17. The purchase of 2,000 shares of treasury stock at \$20 per share would be reflected on the statement of cash flows as a cash outflow of \$40,000 in the financing activities section of the statement. 18. The effect on the accounting equation of the sale of the truck is as follows: \$ 9,600 X 45,900 \$ 7,300

BALANCE SHEET
Assets Cash 9,000 = Liabilities +

INCOME STATEMENT

Stockholders’ Equity + Revenues – Expenses Loss on Sale of Asset

(2,000)*

Accumulated Depreciation 14,000** Delivery Truck (25,000)

*\$11,000 – \$9,000 = \$2,000 **\$25,000 – \$11,000 = \$14,000

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Two items would be reported on a statement of cash flows using the indirect method. First, the loss of \$2,000 would be added back to net income in the operating activities section. Second, the cash received of \$9,000 would be reported as a cash inflow in the investing activities section. 19. Since the company neither bought nor sold any patents during the year, the decrease in the balance in the account of \$4,000 represents the amortization of the patent for the year. Amortization is a noncash expense, as is depreciation, and is added back to net income under the indirect method. 20. A stock dividend does not involve the inflow or outflow of cash and therefore is not reported on a statement of cash flows. It is questionable whether it is even a significant noncash activity that should be reported in the supplemental schedule. It could be argued that the issuance of stock in connection with a stock dividend is a financing activity and that it should be included on the schedule. If a 10% stock dividend is included on the schedule, it would be reported at the market value of the shares issued. 21. The information needed to determine a company’s cash flow adequacy comes from two sources. The numbers in the numerator of the ratio, net cash provided by operating activities and capital expenditures, appear on the statement of cash flows. The amount of average annual debt maturing over the next five years in the denominator can be found in a note to the financial statements.

EXERCISES LO 2
EXERCISE 12-1 CASH EQUIVALENTS

Investments made during December 2007 that qualify as cash equivalents at December 31, 2007: Certificate of deposit, due January 31, 2008 Money Market fund 90-day Treasury bills Cash equivalents at December 31, 2007 \$ 35,000 105,000 75,000 \$215,000

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LO 3 1. F 2. S 3. F 4. F 5. O 6. O 7. O

EXERCISE 12-2 CLASSIFICATION OF ACTIVITIES

8. F 9. S 10. I 11. I or O* 12. O 13. O

*Investing activity if stock is classified as an available-for-sale security; operating activity if it is classified as a trading security.

LO 3

EXERCISE 12-3 RETIREMENT OF BONDS PAYABLE ON THE STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. The effect on the accounting equation of the December 31, 2007, bond retirement is as follows:
BALANCE SHEET
Assets Cash (510,000) = Liabilities + Bonds Payable (500,000) Discount on Bonds Payable 40,000
INCOME STATEMENT

Stockholders’ Equity + Revenues – Expenses Loss on Retirement of Bonds (50,000)*

*\$510,000 – \$460,000 = \$50,000 2. The \$510,000 in cash paid to retire the bonds would be reported as a cash outflow in the financing activities section. Assuming the company uses the indirect method, the loss of \$50,000 would be added back in the operating activities section.

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LO 5

EXERCISE 12-4 CASH COLLECTIONS—DIRECT METHOD

Cash collections to be reported in the operating activities section of Stanley’s 2007 statement of cash flows (direct method): Accounts receivable, December 31, 2006 Plus sales during 2007 Less cash collections during 2007 Accounts receivable, December 31, 2007 \$80,800 + \$1,450,000 – X = \$101,100 X = \$1,429,700 \$ 80,800 1,450,000 (X) \$ 101,100

LO 5

EXERCISE 12-5 CASH PAYMENTS—DIRECT METHOD

Cash payments for inventory to be reported in the operating activities section of Lester Enterprise’s 2007 statement of cash flows (direct method): Inventory, December 31, 2006 Plus purchases during 2007 Less cost of goods sold during 2007 Inventory, December 31, 2007 \$90,200 + X – \$770,900 = \$70,600 X = \$751,300 Accounts payable, December 31, 2006 Plus purchases during 2007 Less cash payments during 2007 Accounts payable, December 31, 2007 \$57,700 + \$751,300 – X = \$39,200 X = \$769,800 \$ 57,700 751,300 (X) \$ 39,200 \$ 90,200 X (770,900) \$ 70,600

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LO 5

EXERCISE 12-6 OPERATING ACTIVITIES SECTION—DIRECT METHOD

1. Operating activities section of the statement of cash flows: LABRADOR COMPANY PARTIAL STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 Cash Flows from Operating Activities Cash collected from customers Cash payments for: Inventory General and administrative Interest Taxes Total cash payments Net cash provided by operating activities Footnotes:
1

\$ 102,0001 \$ (79,000)2 (6,000)3 (3,500)4 (3,500)5 \$ (92,000) \$ 10,000

Cash collections from customers: Sales revenue Add: Decrease in accounts receivable Cash collections Payments for inventory: Cost of goods sold Add: Increase in inventory Less: Increase in accounts payable Cash payments For general and administrative expenses: General and administrative expense Less: Decrease in office supplies Add: Decrease in salaries and wages payable Cash payments For interest: Interest expense Add: Decrease in interest payable Cash payments For taxes: Income tax expense Less: Increase in income taxes payable Cash payments

\$ 100,000 2,000 \$ 102,000 \$ 75,000 7,000 (3,000) \$ 79,000 \$ 8,000 (3,000) 1,000 6,000 3,000 500 3,500 5,000 (1,500) 3,500

2

3

\$ \$ \$ \$ \$

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EXERCISE 12–6 (Concluded)

2. The use of the direct method reveals the amounts collected from customers and the amounts paid for inventory, interest, taxes, and other operating purposes. The indirect method simply reconciles the net income of the period to the net cash flow from operations. The direct method shows the reader of the statement the specific amounts collected and paid for operating purposes.

LO 5

EXERCISE 12-7 DETERMINATION OF MISSING AMOUNTS—CASH FLOW FROM OPERATING ACTIVITIES

Case 1: Beginning accounts receivable + Credit sales revenue – Write-offs – Cash collections = Ending accounts receivable \$150,000 + \$175,000 – \$35,000 – X = \$100,000 X = \$190,000 credit sales \$190,000 + \$60,000 (cash sales) = \$250,000 Case 2: Beginning inventory + Purchases – Cost of goods sold = Ending inventory \$80,000 + X – \$175,000 = \$55,000 X = \$150,000 Beginning accounts payable + Purchases – Cash payments = Ending accounts payable \$25,000 + \$150,000 – X = \$15,000 X = \$160,000 Case 3: Beginning prepaid insurance + Cash payments – Insurance expense = Ending prepaid insurance \$17,000 + X – \$15,000 = \$20,000 X = \$18,000

\$ 150,000 175,000 (35,000) (X) \$ 100,000

\$ 80,000 X (175,000) \$ 55,000

\$ 25,000 150,000 (X) \$ 15,000

\$ 17,000 X (15,000) \$ 20,000

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EXERCISE 12-7 (Concluded)

Case 4: Beginning income taxes payable + Income tax expense – Cash payments = Ending income taxes payable \$95,000 + \$300,000 – X = \$115,000 X = \$280,000

\$ 95,000 300,000 (X) \$ 115,000

LO 5

EXERCISE 12-8 DIVIDENDS ON THE STATEMENT OF CASH FLOWS

1. First, determine the amount of dividends declared: Beginning retained earnings + Net income – Stock dividends – Dividends declared = Ending retained earnings \$250,000 + \$285,000 – \$50,000 – X = \$375,000 X = \$110,000 Then, solve for the amount of dividends paid: Beginning dividends payable + Dividends declared – Cash dividends paid = Ending dividends payable \$20,000 + \$110,000 – X = \$30,000 X = \$100,000 2. Because a stock dividend does not involve cash, it is not reported on the statement of cash flows. It is questionable whether or not a stock dividend is a significant noncash activity that should be reported on a supplemental schedule. \$ 20,000 110,000 (X) \$ 30,000 \$ 250,000 285,000 (50,000) (X) \$ 375,000

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LO 6 1. A 2. D 3. A 4. A 5. NR

EXERCISE 12-9 ADJUSTMENTS TO NET INCOME WITH THE INDIRECT METHOD

6. A 7. D 8. A 9. NR 10. A

LO 6

EXERCISE 12-10 OPERATING ACTIVITIES SECTION—INDIRECT METHOD

1. Operating activities section of the statement of cash flows: SUFFOLK COMPANY PARTIAL STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 Cash Provided by Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Decrease in inventory Increase in prepaid rent Increase in accounts payable Decrease in income taxes payable Increase in interest payable Net cash inflow from operating activities \$40,000

20,000 (8,000) 10,000 (2,000) 7,000 (4,000) 3,000 \$66,000

2. The primary reason that net cash inflow from operating activities of \$66,000 is more than net income of \$40,000 is depreciation of \$20,000. It is deducted on the income statement but it does not require the use of cash. Other reasons for the higher amount of net cash inflow from operating activities are the decrease in inventory (the company is not buying as much inventory) and the increase in accounts payable (the company is slowing down payments to its creditors).

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LO 7

EXERCISE 12-11 CASH FLOW ADEQUACY

1. Cash flow adequacy ratio: (Net cash provided by operations – Capital expenditures)/Average annual debt maturing over next five years = (\$12,000,000 – \$2,000,000)/(\$20,000,000/5) = \$10,000,000/\$4,000,000 = 2.5 2. The cash flow adequacy ratio gives the user an indication of whether or not the company is generating sufficient cash from its operations to repay its debts, after taking into consideration the need to make necessary expenditures on new plant and equipment. It would appear that a ratio of 2.5 is reasonable; however, other factors should be considered, including how the ratio compares with prior years as well as with competitors.

MULTI-CONCEPT EXERCISES LO 2,3 1. OI 2. CE 3. IF 4. OI 5. OF LO 3,5 1. IO 2. OO 3. NR 4. IF 5. IO 6. NR
EXERCISE 12-12 CLASSIFICATION OF ACTIVITIES

6. CE 7. II 8. OI 9. IF 10. OF
EXERCISE 12-13 CLASSIFICATION OF ACTIVITIES

7. OO 8. OI 9. OF 10. NR 11. OF 12. II

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LO 3,6

EXERCISE 12-14 LONG-TERM ASSETS ON THE STATEMENT OF CASH FLOWS—INDIRECT METHOD

First, determine the accumulated depreciation on the assets sold so that the book value of those sold can be found: Beginning accumulated depreciation + Depreciation expense – Accumulated depreciation on assets sold = Ending accumulated depreciation \$200,000 + \$50,000 – X = \$160,000 X = \$90,000 Thus, the effect on the accounting equation of the sale would be as follows:
BALANCE SHEET
Assets Cash Accumulated Depreciation Plant and Equipment = 64,000 90,000 (150,000) Liabilities +
INCOME STATEMENT

\$ 200,000 50,000 (X) \$ 160,000

Stockholders' Equity + Revenues – Expenses Gain on Sale 4,000

Beginning plant and equipment + Acquisitions – Sales of plant and equipment = Ending plant and equipment \$500,000 + X – \$150,000 = \$750,000 X = \$400,000

\$ 500,000 X (150,000) \$ 750,000

Similarly, acquisitions of new patents can be determined:

Beginning patents + Acquisitions – Amortization expense = Ending patents \$80,000 + X – \$8,000 = \$92,000 X = \$20,000

\$ 80,000 X (8,000) \$ 92,000

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EXERCISE 12-14 (Concluded)

These items would appear on the statement of cash flows as follows: Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Amortization expense Gain on sale of plant and equipment Cash Flows from Investing Activities Sale of plant and equipment Acquisition of plant and equipment Acquisition of patents \$ 200,000

50,000 8,000 (4,000) 64,000 (400,000) (20,000)

LO 1,5

EXERCISE 12-15 INCOME STATEMENT, STATEMENT OF CASH FLOWS (DIRECT METHOD), AND BALANCE SHEET

1. Income statement: HANDSOME HOUNDS GROOMING COMPANY INCOME STATEMENT FOR THE YEAR ENDED XX/XX/XX Grooming service revenue Expenses: Rent expense Amortization of patent Other operating expenses Net income
1 2

\$150,000 \$12,000 10,0001 58,0002

80,000 \$ 70,000

\$100,000/10 years \$80,000 – \$10,000 – \$12,000

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EXERCISE 12-15 (Continued)

2. Statement of cash flows: HANDSOME HOUNDS GROOMING COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED XX/XX/XX Cash Flows from Operating Activities Cash receipts from: Cash sales Collections on account Total cash receipts Cash payments for: Rent Security deposit Other operating expenses Total cash payments Net cash provided by operating activities Cash Flows from Investing Activities Down payment on patent Cash Flows from Financing Activities Issuance of common stock Cash dividends paid Net cash provided by financing activities Net increase in cash Cash balance, beginning of year Cash balance, end of year Supplemental Schedule of Noncash Activities Acquisition of patent in exchange for four-year note
1 2

\$ 110,0001 30,0002 \$ 140,000 \$ (12,000) (2,000) (58,000)3 \$ (72,000) \$ 68,000 \$ (20,000)4 \$ 50,000 (20,000) \$ 30,000 \$ 78,000 0 \$ 78,000 \$ 80,000

\$150,000 – \$40,000 \$40,000 – \$10,000

3 4

\$80,000 – \$12,000 – \$10,000 \$100,000 × 20%

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EXERCISE 12-15 (Concluded)

3. The company generated slightly less cash flow from operations, \$68,000, than it earned in net income, \$70,000. The differences between the two can be reconciled as follows: Net income Add: Amortization of patent Deduct: Security deposit (not yet an expense) Uncollected accounts receivable Net cash flow from operating activities 4. Balance sheet: HANDSOME HOUNDS GROOMING COMPANY BALANCE SHEET AS OF XX/XX/XX Assets Current assets: Cash (from Part 2.) Accounts receivable Security deposit Total current assets Long-term assets: Patent Total assets Liabilities and Stockholders’ Equity Long-term liabilities: Notes payable Stockholders’ equity: Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity
1 2

\$ 70,000 10,000 (2,000) (10,000) \$ 68,000

\$78,000 10,000 2,000 \$ 90,000 90,0001 \$180,000

\$ 80,000 \$50,000 50,0002 100,000 \$180,000

\$100,000 – \$10,000 Net income of \$70,000 less cash dividends of \$20,000

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PROBLEMS LO 6
PROBLEM 12-1 STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepaid rent Land Plant and equipment Accumulated depreciation Accounts payable Income taxes payable Short-term notes payable Bonds payable Common stock Retained earnings Total (2) 5 (10) 3 0 100 (35) (2) 2 (10) 25 (50) (26) 0

Explanation

Purchase Depreciation expense

Issuance Retirement Issuance Net income

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PROBLEM 12-1 (Concluded)

Statement of cash flows: CHRISMAN COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Decrease in inventory Increase in prepaid rent Increase in accounts payable Decrease in income taxes payable Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of plant and equipment Cash Flows from Financing Activities Retirement of bonds payable Issuance of short-term notes payable Issuance of common stock Net cash provided by financing activities Net increase (decrease) in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$ 26

35 (5) 10 (3) 2 (2) \$ 63 \$(100) \$ (25) 10 50 \$ 35 \$ (2) 10 \$ 8

2. No, Chrisman did not generate enough cash from its operations to pay for its investing activities. Cash flow from operating activities amounted to only \$63,000, while the company spent \$100,000 to acquire plant and equipment. The additional cash needed to finance the acquisition was raised by issuing a note for \$10,000 and issuing common stock for \$50,000.

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LO 8

PROBLEM 12-2 STATEMENT OF CASH FLOWS USING A WORK SHEET— INDIRECT METHOD (Appendix)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts Balances 12/31/07 12/31/06 Changes Cash Inflows (Outflows) Operating Investing Financing

Cash Accounts receivable Inventory Prepaid rent Land Plant and equipment Accumulated depreciation Accounts payable Income tax payable Short-term notes payable Bonds payable Common stock Retained earnings Totals Net increase (decrease) in cash
1 2

8 20 15 9 75 400 (65) (12) (3) (35) (75) (200) (137) 0

10 15 25 6 75 300 (30) (10) (5) (25) (100) (150) (111) 0

(2) 5 (10) 3 – 1001 (35)2 (2) 2 (10)3 254 (50)5 (26)6 0

(5) 10 (3) (100) 35 2 (2) 10 (25) 50 26 63 (2) (100) 35

Purchase of equipment. Depreciation expense. 3 Proceeds from note.

4 5

Retirement of bonds. Issuance of common stock. 6 Net income.

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PROBLEM 12-2 (Concluded)

2. Statement of cash flows: CHRISMAN COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Decrease in inventory Increase in prepaid rent Increase in accounts payable Decrease in income taxes payable Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of plant and equipment Cash Flows from Financing Activities Retirement of bonds payable Issuance of short-term notes payable Issuance of common stock Net cash provided by financing activities Net increase (decrease) in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$ 26

35 (5) 10 (3) 2 (2) \$ 63 \$(100) \$ (25) 10 50 \$ 35 \$ (2) 10 \$ 8

3. No, Chrisman did not generate enough cash from its operations to pay for its investing activities. Cash flow from operating activities amounted to only \$63,000, while the company spent \$100,000 to acquire plant and equipment. The additional cash needed to finance the acquisition was raised by issuing a note for \$10,000 and issuing common stock for \$50,000.

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LO 5

PROBLEM 12-3 STATEMENT OF CASH FLOWS—DIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Other accrued liabilities Income tax payable Long-term bank loan payable Common stock Retained earnings Total (38) 50 30 (10) 150 200 (50) 18 (5) 20 (50) (150) (165) 0

Explanation

Purchase (c) Purchase (c) Depreciation expense (b)

Proceeds from bank loan (c) Issuance of common stock (c) 60 Dividends (a) (225) Net income

Conversion of income statement items to a cash basis (in thousands of dollars): Income Statement Sales revenue Amount \$1,250 Adjustment Cash Flows \$1,250 – Increase in accounts receivable (50) Cash collected \$1,200 \$ 700 + Increase in inventory 30 + Decrease in accounts payable 18 Cash payments \$ 748 \$ 150 – Decrease in prepayments (10) – Depreciation expense (50) – Increase in accrued liabilities (5) Cash payments \$ 85 \$ 25 No interest payable 0 Cash payments \$ 25 \$ 150 + Decrease in income tax payable 20 Cash paid for taxes \$ 170 Net cash flow from operations \$ 172

Cost of goods sold

700

Operating expenses

150

Interest expense

25

Income tax expense

150

Net income

\$ 225

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FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-3 (Continued)

Statement of cash flows: PEORIA CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Cash collections from customers Cash payments for: Inventory Operating expenses Interest Income taxes Total cash payments Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Additional long-term borrowings Issuance of common stock Cash dividends paid Net cash provided by financing activities Net decrease in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 2. Memorandum to the president: TO: FROM: DATE: President of Peoria Corp. Student’s name January 20, 2008 \$ 1,200 \$ (748) (85) (25) (170) \$(1,028) \$ 172 \$ (150) (200) \$ (350) \$ 50 150 (60) 140 (38) 90 52

\$ \$ \$

SUBJECT: Cash flows You recently expressed concern that in spite of the profitable year according to the income statement, cash decreased during 2007. Furthermore, there was a concern about the decrease in the company’s cash balance during 2007 to \$52,000 at yearend, given that existing loan covenants require a \$50,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-25

PROBLEM 12-3 (Concluded)

Although net income on an accrual basis was \$225,000, net cash flow from operating activities was only \$172,000. One of the reasons is that cash collections were only \$1,200,000 even though sales were \$1,250,000. Also, inventory was increased by \$30,000 during the period, and accounts payable was reduced by \$18,000. Similarly, taxes payable was reduced by \$20,000, resulting in a further drain on cash. Finally, two major acquisitions were made during the year: \$200,000 was spent on new plant and equipment and another \$150,000 to acquire new land. These were only partially offset by the sale of additional stock for \$150,000 and the issuance of additional notes in the amount of \$50,000. Finally, cash dividends amounted to \$60,000, a further drain on cash. Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. We can also improve our operating cash flow by accelerating the collection of receivables as much as possible. Similarly, we should be able to reduce the amount of inventory on hand at any one time and over the long run reduce the cash paid for inventory purchases.

LO 6

PROBLEM 12-4 STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Other accrued liabilities Income tax payable Long-term bank loan payable Common stock Retained earnings Total (38) 50 30 (10) 150 200 (50) 18 (5) 20 (50) (150) (165) 0

Explanation

Purchase (c) Purchase (c) Depreciation expense (b)

Proceeds from bank loan (c) Issuance of common stock (c) 60 Dividends (a) (225) Net income

12-26

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-4 (Continued)

Statement of cash flows: PEORIA CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Increase in inventories Decrease in prepayments Decrease in accounts payable Increase in other accrued liabilities Decrease in income taxes payable Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Additional long-term borrowings Issuance of common stock Cash dividends paid Net cash provided by financing activities Net decrease in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 2. Memorandum to the president: TO: FROM: DATE: President of Peoria Corp. Student’s name January 20, 2008 \$ 225

50 (50) (30) 10 (18) 5 (20) \$ 172 \$(150) (200) \$(350) \$ 50 150 (60) \$ 140 \$ (38) 90 \$ 52

SUBJECT: Cash flows You recently expressed concern regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern about the decrease in the company’s cash balance during 2007 to \$52,000 at year-end, given that existing loan covenants require a \$50,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-27

PROBLEM 12-4 (Concluded)

Although net income on an accrual basis was \$225,000, changes in various noncash working capital accounts resulted in net cash flow from operating activities of only \$172,000. For example, \$50,000 less was collected in cash than the sales of the period. Accounts payable was reduced by \$18,000 and taxes payable by \$20,000, both resulting in a drain on cash. Finally, two major acquisitions were made during the year: \$200,000 was spent on new plant and equipment and another \$150,000 to acquire new land. These were only partially offset by the sale of additional stock for \$150,000 and the issuance of additional notes in the amount of \$50,000. Finally, cash dividends amounted to \$60,000, a further drain on cash. Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. We can also improve our operating cash flow by accelerating the collection of receivables as much as possible. Similarly, we should be able to reduce the amount of inventory on hand at any one time and over the long run reduce the cash paid for inventory purchases. LO 8
PROBLEM 12-5 STATEMENT OF CASH FLOWS USING A WORK SHEET— INDIRECT METHOD (Appendix)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts Balances 12/31/07 12/31/06 Changes Cash Inflows (Outflows) Operating Investing Financing

Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Accrued liabilities Income tax payable Long-term loan payable Common stock Retained earnings Totals Net increase (decrease) in cash
1 2

52 180 230 15 750 700 (250) (130) (68) (90) (350) (550) (489) 0

90 130 200 25 600 500 (200) (148) (63) (110) (300) (400) (324) 0

(38) 50 30 (10) 1501 2002 (50)3 18 (5) 20 (50)4 (150)5 606 (225)7 0

(50) (30) 10 (150) (200) 50 (18) 5 (20) 50 150 (60) 225 172 (38) (350) 140

Purchase of land. Purchase of plant and equipment. 3 Depreciation expense. 4 Proceeds from bank loan.

5 6

Issuance of common stock. Dividends. 7 Net income.

12-28

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-5 (Continued)

2. Statement of cash flows: PEORIA CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Increase in inventories Decrease in prepayments Decrease in accounts payable Increase in other accrued liabilities Decrease in income taxes payable Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Additional long-term borrowings Issuance of common stock Cash dividends paid Net cash provided by financing activities Net decrease in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$ 225

50 (50) (30) 10 (18) 5 (20) \$ 172 \$(150) (200) \$(350) \$ 50 150 (60) \$ 140 \$ (38) 90 \$ 52

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-29

PROBLEM 12-5 (Concluded)

3. Memorandum to the president: TO: FROM: DATE: President of Peoria Corp. Student’s name January 20, 2008

SUBJECT: Cash flows You recently expressed concern to me regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern about the decrease in the company’s cash balance during 2007 to \$52,000 at year-end, given that existing loan covenants require a \$50,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow. Although net income on an accrual basis was \$225,000, changes in various noncash working capital accounts resulted in net cash flow from operating activities of only \$172,000. For example, \$50,000 less was collected in cash than the sales of the period. Accounts payable was reduced by \$18,000 and taxes payable by \$20,000, both resulting in a drain on cash. Finally, two major acquisitions were made during the year: \$200,000 was spent on new plant and equipment and another \$150,000 to acquire new land. These were only partially offset by the sale of additional stock for \$150,000 and the issuance of additional notes in the amount of \$50,000. Finally, cash dividends amounted to \$60,000, a further drain on cash. Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. We can also improve our operating cash flow by accelerating the collection of receivables as much as possible. Similarly, we should be able to reduce the amount of inventory on hand at any one time and over the long run reduce the cash paid for inventory purchases.

12-30

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 5

PROBLEM 12-6 STATEMENT OF CASH FLOWS—DIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Other accrued liabilities Interest payable Long-term bank loan payable Common stock Retained earnings Total 15 (25) (50) 10 75 70 (70) (25) 10 (5) (90) (50) 135 0

Explanation

Purchase (c) Purchase (c) Depreciation expense (b)

Proceeds from bank loan (c) Issuance of common stock (c) 35 Dividends (a) 100 Net loss

Conversion of income statement items to a cash basis (in thousands of dollars): Income Statement Sales revenue Amount \$ 500 Cash Flows \$500 + Decrease in accounts receivable 25 Cash collected \$525 \$400 – Decrease in inventory (50) – Increase in accounts payable (25) Cash payments \$325 \$180 + Increase in prepayments 10 – Depreciation expense (70) + Decrease in accrued liabilities 10 Cash payments \$130 \$ 20 – Increase in interest payable (5) Cash payments \$ 15 Net cash flow from operations \$ 55 Adjustment

Cost of goods sold

400

Operating expenses

180

Interest expense

20

Net income (loss)

\$(100)

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-31

PROBLEM 12-6 (Continued)

Statement of cash flows: ASTRO INC. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Cash collections on account Cash payments for: Inventory Operating expenses Interest Total cash payments Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Additional long-term borrowings Issuance of common stock Cash dividends paid Net cash provided by financing activities Net increase in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$ 525 \$(325) (130) (15) \$(470) \$ 55 \$ (75) (70) \$(145) \$ 90 50 (35) \$ 105 \$ 15 80 \$ 95

12-32

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-6 (Concluded)

2. Memorandum to the president: TO: FROM: DATE: President of Astro Inc. Student’s name January 20, 2008

SUBJECT: Cash flows You recently expressed concern to me regarding the large loss we sustained during 2007 in view of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference. Astro was able to generate a significant amount of cash from operations even though we incurred the large net loss of \$100,000. One reason for the difference between cash generated from operations and the net loss was the large amount of depreciation expense on the income statement. This noncash expense reduced net income, but without a corresponding effect on cash flow. Further, the decrease in accounts receivable indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the combined effect of a reduction in inventory and an increase in the amounts owed suppliers (accounts payable) added to the cash generated. Operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. The gross profit percentage of 20% appears reasonable, although this depends on many factors, including how our competitors are doing in this area. A significant portion of the operating expenses is the depreciation of \$70,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added to our base of long-term assets. I would recommend that we explore ways to reduce our other operating expenses. I look forward to hearing from you before moving forward with any actions.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-33

LO 6

PROBLEM 12-7 STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Other accrued liabilities Interest payable Long-term bank loan payable Common stock Retained earnings Total 15 (25) (50) 10 75 70 (70) (25) 10 (5) (90) (50) 135 0

Explanation

Purchase (c) Purchase (c) Depreciation expense (b)

Proceeds from bank loan (c) Issuance of common stock (c) 35 Dividends (a) 100 Net loss

12-34

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-7 (Continued)

Statement of cash flows: ASTRO INC. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (AMOUNTS IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net loss Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Decrease in accounts receivable Decrease in inventories Increase in prepayments Increase in accounts payable Decrease in other accrued liabilities Increase in interest payable Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Additional long-term borrowings Issuance of common stock Cash dividends paid Net cash provided by financing activities Net increase in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$(100)

70 25 50 (10) 25 (10) 5 \$ 55 \$ (75) (70) \$(145) \$ 90 50 (35) \$ 105 \$ 15 80 \$ 95

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-35

PROBLEM 12-7 (Concluded)

2. Memorandum to the president: TO: FROM: DATE: President of Astro Inc. Student’s name January 20, 2008

SUBJECT: Cash flows You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference. Astro was able to generate a significant amount of cash from operations even though we incurred the large net loss of \$100,000. One reason for the difference between cash generated from operations and the net loss was the large amount of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Further, the decrease in accounts receivable indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the combined effect of a reduction in inventory and an increase in the amounts owed suppliers (accounts payable) added to the cash generated. Operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. The gross profit percentage of 20% appears reasonable, although this depends on many factors, including how our competitors are doing in this area. A significant portion of the operating expenses is the depreciation of \$70,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added to our base of long-term assets. I would recommend that we explore ways to reduce our other operating expenses. I look forward to hearing from you before moving forward with any actions.

12-36

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 8

PROBLEM 12-8 STATEMENT OF CASH FLOWS USING A WORK SHEET— INDIRECT METHOD (APPENDIX)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts Balances 12/31/07 12/31/06 Changes Cash Inflows (Outflows) Operating Investing Financing

Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Other accrued liabilities Interest payable Long-term loan payable Common stock Retained earnings Totals Net increase (decrease) in cash
1 2

95 50 100 55 475 870 (370) (125) (35) (15) (340) (450) (310) 0

80 75 150 45 400 800 (300) (100) (45) (10) (250) (400) (445) 0

15 (25) (50) 10 751 702 (70)3 (25) 10 (5) (90)4 (50)5 1006 357 0

25 50 (10) (75) (70) 70 25 (10) 5 90 50 (100) 55 15 (145) (35) 105

Purchase of land. Purchase of plant and equipment. 3 Depreciation expense. 4 Proceeds from borrowings. 5 Issuance of common stock. 6 Net loss. 7 Cash dividends paid.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-37

PROBLEM 12-8 (Continued)

2. Statement of cash flows: ASTRO INC. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (AMOUNTS IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net loss Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Decrease in accounts receivable Decrease in inventories Increase in prepayments Increase in accounts payable Decrease in other accrued liabilities Increase in interest payable Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Additional long-term borrowings Issuance of common stock Cash dividends paid Net cash provided by financing activities Net increase in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 3. Memorandum to the president: TO: FROM: DATE: President of Astro Inc. Student’s name January 20, 2008 \$(100)

70 25 50 (10) 25 (10) 5 \$ 55 \$ (75) (70) \$(145) \$ 90 50 (35) \$ 105 \$ 15 80 \$ 95

SUBJECT: Cash flows You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference.

12-38

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-8 (Concluded)

Astro was able to generate a significant amount of cash from operations even though we incurred the large net loss of \$100,000. One reason for the difference between cash generated from operations and the net loss was the large amount of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Furthermore, the decrease in accounts receivable indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the combined effect of a reduction in inventory and an increase in the amounts owed suppliers (accounts payable) added to the cash generated. Operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. The gross profit percentage of 20% appears reasonable, although this depends on many factors, including how our competitors are doing in this area. A significant portion of the operating expenses is the depreciation of \$70,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added to our base of long-term assets. I recommend that we explore ways to reduce our other operating expenses. I look forward to hearing from you before moving forward with any actions. LO 6
PROBLEM 12-9 YEAR-END BALANCE SHEET AND STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) ? 10 100 Explanation h. sales exceeded cash collections g. bonds were exchanged for land—a noncash activity f. purchase b. depreciation expense no change given i. no change d. 150 issued for cash and g. 100 issued for land e. common stock retired c. dividends of 25 a. net income of (70)

Cash Accounts receivable Land

Plant and equipment Accumulated depreciation Investments Current liabilities Bonds payable Common stock Retained earnings Total without cash

200 (20) 0 0 (250) 50 (45) 45 dr.

Thus, the change in cash must be 45 cr. (decrease) to balance the total changes in the accounts.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-39

PROBLEM 12-9 (Continued)

Statement of Cash Flows: TERRIER COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Net cash provided by operating activities Cash Flows from Investing Activities Acquisitions of plant and equipment Cash Flows from Financing Activities Payment of cash dividends Issuance of additional bonds Acquisition and retirement of stock Net cash provided by financing activities Net increase (decrease) in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 Schedule of Noncash Investing and Financing Activities Acquisition of land in exchange for bonds \$ 70

20 (10) \$ 80 \$(200) \$ (25) 150 (50) \$ 75 \$ (45) 140 \$ 95 \$ 100

12-40

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-9 (Concluded)

2. Balance sheet: TERRIER COMPANY BALANCE SHEET DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Accounts receivable Total current assets Land Plant and equipment Accumulated depreciation Investments Total long-term assets Total assets Current liabilities Bonds payable Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity
1 2

951 1652 \$ 260 \$ 4003 7004 (170)5 100 \$1,030 \$1,290 \$ 205 \$ 5506 \$ 3507 1858 \$ 535 \$1,290 \$

\$140 – \$45 \$155 + \$10 3 \$300 + \$100 4 \$500 + \$200

5 6

\$150 + \$20 \$300 + \$250 7 \$400 – \$50 8 \$140 + \$45

3. In addition to the bonds issued in exchange for land, Terrier issued \$150,000 of bonds for cash. The money raised from this issuance was needed to help finance the addition of \$200,000 in plant and equipment.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-41

LO 8

PROBLEM 12-10 STATEMENT OF CASH FLOWS USING A WORK SHEET— INDIRECT METHOD (Appendix)

1. Balance sheet: TERRIER COMPANY BALANCE SHEET DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Accounts receivable Total current assets Land Plant and equipment Accumulated depreciation Investments Total long-term assets Total assets Current liabilities Bonds payable Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity
1 2

951 1652 \$ 260 \$ 4003 7004 (170)5 100 \$1,030 \$1,290 \$ 205 \$ 5506 \$ 3507 1858 \$ 535 \$1,290 \$

\$140 – \$45 \$155 + \$10 3 \$300 + \$100 4 \$500 + \$200

5 6

\$150 + \$20 \$300 + \$250 7 \$400 – \$50 8 \$140 + \$45

12-42

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-10 (Continued)

2. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts Balances 12/31/07 12/31/06 Changes Cash Inflows (Outflows) Operating Investing Financing

Cash Accounts receivable Land Plant and equipment Accumulated depreciation Investments Current liabilities Bonds payable Common stock Retained earnings Totals Net increase (decrease) in cash
1 2

95 165 400 700 (170) 100 (205) (550) (350) (185) 0

140 155 300 500 (150) 100 (205) (300) (400) (140) 0

(45) 10 1001 2002 (20)3 0 0 (100)1 (150)4 505 (70)6 257 0

(10) (200) 20

150 (50) 70 80 (45) (200) (25) 75

Acquisition of land in exchange for bonds (noncash transaction). Purchase of plant and equipment. 3 Depreciation expense. 4 Proceeds from issuance of additional bonds. 5 Acquisition and retirement of common stock. 6 Net income. 7 Cash dividends paid.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-43

PROBLEM 12-10 (Concluded)

3. Statement of cash flows: TERRIER COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Net cash provided by operating activities Cash Flows from Investing Activities Acquisitions of plant and equipment Cash Flows from Financing Activities Payment of cash dividends Issuance of additional bonds Acquisition and retirement of stock Net cash provided by financing activities Net increase (decrease) in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 Schedule of Noncash Investing and Financing Activities Acquisition of land in exchange for bonds \$ 70

20 (10) \$ 80 \$(200) \$ (25) 150 (50) \$ 75 \$ (45) 140 \$ 95 \$ 100

4. In addition to the bonds issued in exchange for land, Terrier issued \$150,000 of bonds for cash. The money raised from this issuance was needed to help finance the addition of \$200,000 in plant and equipment.

12-44

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

MULTI-CONCEPT PROBLEMS LO 4,5
PROBLEM 12-11 STATEMENT OF CASH FLOWS—DIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepaid rent Land Plant and equipment Accumulated depreciation (9) 15 (15) (4) 80 150 (60)

Explanation

Purchase Purchase of 195 and sale of (45) 15 Sale of asset (cost of 45 less book value of 30) and (75) depreciation

Accounts payable Other accrued liabilities Income tax payable Long-term bank loan payable Common stock Retained earnings Total

(7) (6) 2 30 (150) (26) 0

Repayment Issuance of common stock 7 Dividends (33) Net income

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-45

PROBLEM 12-11 (Continued)

Conversion of income statement items to a cash basis (in thousands of dollars): Income Statement Sales revenue Amount \$550 Cash Flows \$550 – Increase in accounts receivable (15) Cash collected \$535 \$350 – Decrease in inventory (15) – Increase in accounts payable (7) Cash payments \$328 – Decrease in prepaid rent – Increase in accrued liabilities Cash payments No cash flow effect Not an operating activity No interest payable Cash payments + Decrease in income taxes payable Cash payments Net cash flow from operations \$ 55 (4) (6) \$ 45 \$ 0 \$ 0 Adjustment

Cost of goods sold

350

General and administrative

55

Depreciation expense Loss on sale of plant assets Interest expense Income tax expense

75 5 15 17

\$ 15 \$ 17 2 \$ 19 \$128

Net income

\$ 33

12-46

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-11 (Concluded)

Statement of cash flows: GLENDIVE CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED JUNE 30, 2007 (IN THOUSANDS OF DOLLARS) Cash Flow from Operating Activities Cash collections from customers Cash payments for: Inventory General and administrative Interest Income taxes Total cash payments Net cash provided by operating activities Cash Flow from Investing Activities Sale of plant assets Acquisition of land Acquisition of new plant assets Net cash used by investing activities Cash Flow from Financing Activities Repayment of long-term loan Issuance of additional stock Payment of cash dividends Net cash provided by financing activities Net decrease in cash Cash balance, June 30, 2006 Cash balance, June 30, 2007 \$ 535 \$ (328) (45) (15) (19) \$ (407) \$ 128 \$ 25 (80) (195) \$(250) \$ (30) 150 (7) \$ 113 \$ (9) 40 \$ 31

2. It is true that the amount of cash flow from operating activities is the same regardless of which method (direct or indirect) is used. The two methods, however, differ in the information reported to the reader of the statement of cash flows. The direct method shows the actual inflows and outflows of cash, while the indirect method arrives at the same amount by reconciling net income to cash flow from operating activities.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-47

LO 4,6

PROBLEM 12-12 STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepaid rent Land Plant and equipment Accumulated depreciation (9) 15 (15) (4) 80 150 (60)

Explanation

Purchase Purchase of 195 and sale of (45) 15 Sale of asset (cost of 45 less book value of 30) and (75) depreciation

Accounts payable Other accrued liabilities Income tax payable Long-term bank loan payable Common stock Retained earnings Total

(7) (6) 2 30 (150) (26) 0

Repayment Issuance of common stock 7 Dividends (33) Net income

12-48

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-12 (Concluded)

Statement of cash flows: GLENDIVE CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED JUNE 30, 2007 (IN THOUSANDS OF DOLLARS) Cash Flow from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of plant assets Increase in accounts receivable Decrease in inventory Decrease in prepaid rent Increase in accounts payable Increase in other accrued liabilities Decrease in income taxes payable Net cash provided by operating activities *Book value \$30 – proceeds \$25 Cash Flow from Investing Activities Sale of plant assets Acquisition of land Acquisition of new plant assets Net cash used by investing activities Cash Flow from Financing Activities Repayment of long-term loan Issuance of additional stock Payment of cash dividends Net cash provided by financing activities Net decrease in cash Cash balance, June 30, 2006 Cash balance, June 30, 2007 \$ 25 (80) (195) \$(250) \$ (30) 150 (7) \$ 113 \$ (9) 40 \$ 31 \$ 33

75 5* (15) 15 4 7 6 (2) \$ 128

2. It is true that the amount of cash flow from operating activities is the same regardless of which method (direct or indirect) is used. The two methods, however, differ in the information reported to the reader of the statement of cash flows. The direct method shows the actual inflows and outflows of cash, while the indirect method arrives at the same amount by reconciling net income to cash flow from operating activities.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-49

LO 2,5

PROBLEM 12-13 STATEMENT OF CASH FLOWS—DIRECT METHOD

1. No, the U.S. Treasury bills are not cash equivalents, because they have a maturity in excess of three months. Instead, the six-month Treasury bills are properly classified as current assets. 2. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash U.S. Treasury bills Accounts receivable Inventory Land Buildings and equipment Accumulated depreciation Patents Accounts payable Taxes payable Notes payable Term notes payable Common stock Retained earnings Total (40) (50) 110 120 10 110 (60) (25) (60) (5) 0 0 (130) 20 0

Explanation Sale

Purchase Purchase Depreciation expense Amortization

(130) Stock dividend (110) Net income 130 Stock dividend

12-50

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-13 (Continued)

Conversion of income statement items to a cash basis (in thousands of dollars): Income Statement Sales revenue Amount \$2,408 Cash Flows \$2,408 – Increase in accounts receivable (110) Cash collected \$2,298 \$1,100 + Increase in inventory 120 – Increase in accounts payable (60) Cash payments \$1,160 No payable \$ 850 No payable \$ 75 No cash flow effect No payable* \$ 18 No cash flow effect No payable \$ 10 No payable \$ 55 \$ 105 – Increase in income tax payable* (5) Cash payments \$ 100 Net cash flow from operations \$ 30 Adjustment

Cost of goods sold

1,100

Salaries & benefits 850 Heat, light, and power 75 Depreciation 60 Property taxes 18 Patent amortization 25 Miscellaneous expenses 10 Interest expense 55 Income tax expense 105

Net income

\$ 110

*The current liability Taxes Payable is assumed to relate entirely to income taxes rather than property taxes.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-51

PROBLEM 12-13 (Concluded)

Statement of cash flows: LANG COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Cash collections from customers Cash payments for: Inventory Salaries and benefits Heat, light, and power Property taxes Miscellaneous activities Interest Income taxes Total cash payments Net cash provided by operating activities Cash Flows from Investing Activities Sale of U.S. Treasury bills Acquisition of land Acquisition of buildings and equipment Net cash used by investing activities Net decrease in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$ 2,298 \$(1,160) (850) (75) (18) (10) (55) (100) \$(2,268) \$ 30 \$ 50 (10) (110) \$ (70) \$ (40) 100 \$ 60

Note: It is questionable whether or not the stock dividend is a significant noncash activity. If it is determined to be significant, it should be shown on a supplemental schedule of noncash activities.

12-52

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

ALTERNATE PROBLEMS LO 6
PROBLEM 12-1A STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. Account changes Dr (Cr) and Explanations: Cash Accounts receivable Inventory Prepaid rent Land Plant and equipment Accumulated depreciation Accounts payable Income taxes payable Short-term notes payable Bonds payable Common stock Retained earnings Total 2,000 (2,000) 1,000 200 0 50,000 (50,000) 0 (500) 2,500 (25,000) 0 21,800 0

Purchase Depreciation expense

Repayment Issuance Net loss

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-53

PROBLEM 12-1A (Concluded)

Statement of cash flows: MADISON COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 Cash Flows from Operating Activities Net loss Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Decrease in accounts receivable Increase in inventory Increase in prepaid rent Increase in income taxes payable Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of plant and equipment Cash Flows from Financing Activities Issuance of bonds payable Repayment of short-term notes payable Net cash provided by financing activities Net increase in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$(21,800)

50,000 2,000 (1,000) (200) 500 \$ 29,500 \$(50,000) \$ 25,000 (2,500) \$ 22,500 \$ 2,000 10,000 \$ 12,000

2. Madison was able to increase its cash balance even though it incurred a net loss primarily because it had one very large expense that did not require the use of any cash: depreciation of \$50,000. This one adjustment is the major difference between the net loss of \$21,800 and the net cash flow from operating activities of \$29,500.

12-54

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 8

PROBLEM 12-2A STATEMENT OF CASH FLOWS USING A WORK SHEET— INDIRECT METHOD (Appendix)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars)
Accounts Balances 12/31/07 12/31/06 Changes Cash Inflows (Outflows) Operating Investing Financing

Cash Accounts receivable Inventory Prepaid rent Land Plant and equipment Accumulated depreciation Accounts payable Income tax payable Short-term notes payable Bonds payable Common stock Retained earnings Totals Net increase (decrease) in cash
1 2

12.0 10.0 8.0 1.2 75.0 200.0 (75.0) (15.0) (2.5) (20.0) (75.0) (100.0) (18.7) 0.0

10.0 12.0 7.0 1.0 75.0 150.0 (25.0) (15.0) (2.0) (22.5) (50.0) (100.0) (40.5) 0.0

2.0 (2.0) 1.0 0.2 0.0 50.01 (50.0)2 0.0 (0.5) 2.53 (25.0)4 0.0 21.85 0.0

2.0 (1.0) (0.2) (50) 50.0 0.5 (2.5) 25.0 (21.8) 29.5 2.0

(50)

22.5

Purchase of equipment. Depreciation expense. 3 Retirement of note. 4 Issuance of bonds. 5 Net loss.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-55

PROBLEM 12-2A (Concluded)

2. Statement of cash flows: MADISON COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 Cash Flows from Operating Activities Net loss Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Decrease in accounts receivable Increase in inventory Increase in prepaid rent Increase in income taxes payable Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of plant and equipment Cash Flows from Financing Activities Issuance of bonds payable Repayment of short-term notes payable Net cash provided by financing activities Net increase (decrease) in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$(21,800)

50,000 2,000 (1,000) (200) 500 \$ 29,500 \$(50,000) \$ 25,000 (2,500) \$ 22,500 \$ 2,000 10,000 \$ 12,000

3. Madison was able to increase its cash balance even though it incurred a net loss primarily because it had one very large expense that did not require the use of any cash: depreciation of \$50,000. This one adjustment is the major difference between the net loss of \$21,800 and the net cash flow from operating activities of \$29,500.

12-56

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 5

PROBLEM 12-3A STATEMENT OF CASH FLOWS—DIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Other accrued liabilities Income tax payable Long-term bank loan payable Common stock Retained earnings Total (70) (85) 20 (10) (100) 250 (25) (20) 5 35 50 (50) (0) 0

Explanation

Sale (c) Purchase (c) Depreciation expense (b)

Retirement of bank loan (d) Issuance of common stock (d) 350 Dividends (a) (350) Net income

Conversion of income statement items to a cash basis (in thousands of dollars): Income Statement Sales revenue Amount \$2,460 Adjustment Cash Flows \$2,460 + Decrease in accounts receivable 85 Cash collected \$2,545 \$1,400 + Increase in inventory 20 – Increase in accounts payable (20) Cash payments \$1,400 \$ 460 – Decrease in prepayments (10) – Depreciation expense (25) + Decrease in accrued liabilities 5 Cash payments \$ 430 \$ 100 No interest payable 0 Cash payments \$ 100 \$ 150 + Decrease in income tax payable 35 Cash paid for taxes \$ 185 Net cash flow from operations \$ 430

Cost of goods sold

1,400

Operating expenses

460

Interest expense

100

Income tax expense

150

Net income

\$ 350

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-57

PROBLEM 12-3A (Continued)

Statement of cash flows: WABASH CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Cash collections from customers Cash payments for: Inventory Operating expenses Interest Income taxes Total cash payments Net cash provided by operating activities Cash Flows from Investing Activities Sale of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Repayment of long-term borrowings Issuance of common stock Cash dividends paid Net cash used by financing activities Net decrease in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$ 2,545 \$(1,400) (430) (100) (185) \$(2,115) \$ 430 \$ 100 (250) \$ (150) \$ (50) 50 (350) \$ (350) \$ (70) 210 \$ 140

2. Memorandum to the president: TO: FROM: DATE: President of Wabash Corp. Student’s name January 20, 2008

SUBJECT: Cash flows You recently expressed concern to me regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern regarding the decline in our cash balance during the year, given that existing loan covenants require a \$100,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.

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FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-3A (Concluded)

Although net income on an accrual basis was \$350,000, net cash flow from operating activities was even higher, \$430,000. However, the favorable cash flow during the year was used for various purposes. First, significant additions were made to plant and equipment, \$250,000, and this drain on cash was only partially offset by the sale of land for \$100,000. Additional stock was sold for \$50,000, which was the amount needed to repay an existing bank loan. The major reason, however, for the drain on cash is the size of our dividend payments. Dividends of \$350,000 were paid during the year, which is equal to the income of the period. Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. At the same time, I recommend that we limit the amount paid in any one year for dividends as a way to keep our cash balance at a sufficient level to satisfy the bank.

LO 6

PROBLEM 12-4A STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Other accrued liabilities Income tax payable Long-term bank loan payable Common stock Retained earnings Total (70) (85) 20 (10) (100) 250 (25) (20) 5 35 50 (50) (0) 0

Explanation

Sale (c) Purchase (c) Depreciation expense (b)

Retirement of bank loan (d) Issuance of common stock (d) 350 Dividends (a) (350) Net income

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-59

PROBLEM 12-4A (Continued)

Statement of cash flows: WABASH CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Decrease in accounts receivable Increase in inventories Decrease in prepayments Increase in accounts payable Decrease in other accrued liabilities Decrease in income taxes payable Net cash provided by operating activities Cash Flows from Investing Activities Sale of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Repayment of long-term borrowings Issuance of common stock Cash dividends paid Net cash used by financing activities Net decrease in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 2. Memorandum to the president: TO: FROM: DATE: President of Wabash Corp. Student’s name January 20, 2008 \$ 350

25 85 (20) 10 20 (5) (35) \$ 430 \$ 100 (250) \$(150) \$ (50) 50 (350) \$(350) \$ (70) 210 \$ 140

SUBJECT: Cash flows You recently expressed concern to me regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern regarding the decline in our cash balance during the year, given that existing loan covenants require a \$100,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.

12-60

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-4A (Concluded)

Although net income on an accrual basis was \$350,000, net cash flow from operating activities was even higher, \$430,000. However, the favorable cash flow during the year was used for various purposes. First, significant additions were made to plant and equipment, \$250,000, and this drain on cash was only partially offset by the sale of land for \$100,000. Additional stock was sold for \$50,000, which was the amount needed to repay an existing bank loan. The major reason, however, for the drain on cash is the size of our dividend payments. Dividends of \$350,000 were paid during the year, which is equal to the income of the period. Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. At the same time, I recommend that we limit the amount paid in any one year for dividends as a way to keep our cash balance at a sufficient level to satisfy the bank.

LO 8

PROBLEM 12-5A STATEMENT OF CASH FLOWS USING A WORK SHEET— INDIRECT METHOD (Appendix)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts Balances 12/31/07 12/31/06 Changes Cash Inflows (Outflows) Operating Investing Financing

Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Accrued liabilities Income tax payable Long-term loan payable Common stock Retained earnings Totals Net increase (decrease) in cash
1 2

140 60 200 15 600 850 (225) (140) (50) (80) (200) (450) (720) 0

210 145 180 25 700 600 (200) (120) (55) (115) (250) (400) (720) 0

(70) (85) 20 (10) (100)1 2502 (25)3 (20) 5 35 504 (50)5 3506 (350)7 0

85 (20) 10 100 (250) 25 20 (5) (35) (50) 50 (350) 350 430 (70) (150) (350)

Sale of land. Purchase of plant and equipment. 3 Depreciation expense. 4 Retirement of bank loan.

5 6

Issuance of common stock. Dividends. 7 Net income.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-61

PROBLEM 12-5A (Continued)

2. Statement of cash flows: WABASH CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Decrease in accounts receivable Increase in inventories Decrease in prepayments Increase in accounts payable Decrease in other accrued liabilities Decrease in income taxes payable Net cash provided by operating activities Cash Flows from Investing Activities Sale of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Repayment of long-term borrowings Issuance of common stock Cash dividends paid Net cash used by financing activities Net decrease in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 3. Memorandum to the president: TO: FROM: DATE: President of Wabash Corp. Student’s name January 20, 2008 \$ 350

25 85 (20) 10 20 (5) (35) \$ 430 \$ 100 (250) \$(150) \$ (50) 50 (350) \$(350) \$ (70) 210 \$ 140

SUBJECT: Cash flows You recently expressed concern to me regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern regarding the decline in our cash balance during the year, given that existing loan covenants require a \$100,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.

12-62

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-5A (Concluded)

Although net income on an accrual basis was \$350,000, net cash flow from operating activities was even higher, \$430,000. However, the favorable cash flow during the year was used for various purposes. First, significant additions were made to plant and equipment, \$250,000, and this drain on cash was only partially offset by the sale of land for \$100,000. Additional stock was sold for \$50,000, which was the amount needed to repay an existing bank loan. The major reason, however, for the drain on cash is the size of our dividend payments. Dividends of \$350,000 were paid during the year, which is equal to the income of the period. Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. At the same time, I recommend that we limit the amount paid in any one year for dividends as a way to keep our cash balance at a sufficient level to satisfy the bank.

LO 5

PROBLEM 12-6A STATEMENT OF CASH FLOWS—DIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Other accrued liabilities Interest payable Long-term bank loan payable Common stock Retained earnings Total 15 (50) 0 1 100 250 (40) (40) (20) (10) (350) 0 144 0

Explanation

Purchase (c) Purchase (c) Depreciation expense (b)

Proceeds from bank loan (c) 84 Dividends (a) 60 Net loss

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-63

PROBLEM 12-6A (Continued)

Conversion of income statement items to a cash basis (in thousands of dollars): Income Statement Sales revenue Amount \$350 Cash Flows \$350 + Decrease in accounts receivable 50 Cash collected \$400 \$150 No change in inventory – Increase in accounts payable (40) Cash payments \$110 \$250 + Increase in prepayments 1 – Depreciation expense (40) – Increase in accrued liabilities (20) Cash payments \$191 \$ 10 – Increase in interest payable (10) Cash payments \$ 0 Net cash flow from operations \$ 99 Adjustment

Cost of goods sold

150

Operating expenses

250

Interest expense

10

Net income (loss) Statement of cash flows:

\$(60)

PLUTO INC. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Cash collections on account Cash payments for: Inventory Operating expenses Total cash payments Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Additional long-term borrowings Cash dividends paid Net cash provided by financing activities Net increase in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$ 400 \$(110) (191) \$(301) \$ 99 \$(100) (250) \$(350) \$ 350 (84) \$ 266 \$ 15 10 \$ 25

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FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-6A (Concluded)

2. Memorandum to the president: TO: FROM: DATE: President of Pluto Inc. Student’s name January 20, 2008

SUBJECT: Cash flows You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference. Pluto was able to generate a significant amount of cash from operations even though we incurred a net loss of \$60,000. One reason for the difference between cash generated from operations and the net loss was the \$40,000 of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Furthermore, the large decrease in accounts receivable of \$50,000 indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the large buildup of our accounts payable by \$40,000 had the effect of improving our cash flow for the year. The gross profit percentage of 57% is very strong. However, operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. A portion of the operating expenses is the depreciation of \$40,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added \$350,000 to our base of long-term assets, in the form of land and plant and equipment acquisitions. You will note on the statement of cash flows that these acquisitions were entirely financed with the issuance of a long-term bank loan. I recommend two immediate courses of action. First, we must find ways to reduce our operating expenses. Second, until we see an improvement in the bottom line, it is imperative that we cut back, if not eliminate entirely, our dividends. A dividend payment of \$84,000 in a year in which we sustained a net loss of \$60,000 is not prudent. I look forward to hearing from you before moving forward with any actions.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-65

LO 6

PROBLEM 12-7A STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Other accrued liabilities Interest payable Long-term bank loan payable Common stock Retained earnings Total 15 (50) 0 1 100 250 (40) (40) (20) (10) (350) 0 144 0

Explanation

Purchase (c) Purchase (c) Depreciation expense (b)

Proceeds from bank loan (c) 84 Dividends (a) 60 Net loss

12-66

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-7A (Continued)

Statement of cash flows: PLUTO INC. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net loss Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Decrease in accounts receivable Increase in prepayments Increase in accounts payable Increase in other accrued liabilities Increase in interest payable Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Additional long-term borrowings Cash dividends paid Net cash provided by financing activities Net increase in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$ (60)

40 50 (1) 40 20 10 \$ 99 \$(100) (250) \$(350) \$ 350 (84) \$ 266 \$ 15 10 \$ 25

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-67

PROBLEM 12-7A (Concluded)

2. Memorandum to the president: TO: FROM: DATE: President of Pluto, Inc. Student’s name January 20, 2008

SUBJECT: Cash flows You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference. Pluto was able to generate a significant amount of cash from operations even though we incurred a net loss of \$60,000. One reason for the difference between cash generated from operations and the net loss was the \$40,000 of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Furthermore, the large decrease in accounts receivable of \$50,000 indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the large buildup of our accounts payable by \$40,000 had the effect of improving our cash flow for the year. The gross profit percentage of 57% is very strong. However, operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. A portion of the operating expenses is the depreciation of \$40,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added \$350,000 to our base of long-term assets, in the form of land and plant and equipment acquisitions. You will note on the statement of cash flows that these acquisitions were entirely financed with the issuance of a long-term bank loan. I recommend two immediate courses of action. First, we must find ways to reduce our operating expenses. Second, until we see an improvement in the bottom line, it is imperative that we cut back, if not eliminate entirely, our dividends. A dividend payment of \$84,000 in a year in which we sustained a net loss of \$60,000 is not prudent. I look forward to hearing from you before moving forward with any actions.

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FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 8

PROBLEM 12-8A STATEMENT OF CASH FLOWS USING A WORK SHEET— INDIRECT METHOD (Appendix)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts Balances 12/31/07 12/31/06 Changes Cash Inflows (Outflows) Operating Investing Financing

Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Accounts payable Other accrued liabilities Interest payable Long-term loan payable Common stock Retained earnings Totals Net increase (decrease) in cash
1 2

25 30 100 36 300 500 (90) (50) (40) (22) (450) (300) (39) 0

10 80 100 35 200 250 (50) (10) (20) (12) (100) (300) (183) 0

15 (50) 0 1 1001 2502 (40)3 (40) (20) (10) (350)4 0 605 846 0

50 (1) (100) (250) 40 40 20 10 350 (60) 99 15 (350) (84) 266

Purchase of land. Purchase of plant and equipment. 3 Depreciation expense.

4 5

Proceeds from borrowings. Net loss. 6 Cash dividends paid.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-69

PROBLEM 12-8A (Continued)

2. Statement of cash flows: PLUTO INC. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net loss Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Decrease in accounts receivable Increase in prepayments Increase in accounts payable Increase in other accrued liabilities Increase in interest payable Net cash provided by operating activities Cash Flows from Investing Activities Acquisition of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Additional long-term borrowings Cash dividends paid Net cash provided by financing activities Net increase in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 3. Memorandum to the president: TO: FROM: DATE: President of Pluto, Inc. Student’s name January 20, 2008 \$ (60)

40 50 (1) 40 20 10 \$ 99 \$(100) (250) \$(350) \$ 350 (84) \$ 266 \$ 15 10 \$ 25

SUBJECT: Cash flows You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference.

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FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-8A (Concluded)

Pluto was able to generate a significant amount of cash from operations even though we incurred a net loss of \$60,000. One reason for the difference between cash generated from operations and the net loss was the \$40,000 of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Furthermore, the large decrease in accounts receivable of \$50,000 indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the large buildup of our accounts payable by \$40,000 had the effect of improving our cash flow for the year. The gross profit percentage of 57% is very strong. However, operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. A portion of the operating expenses is the depreciation of \$40,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added \$350,000 to our base of long-term assets, in the form of land and plant and equipment acquisitions. You will note on the statement of cash flows that these acquisitions were entirely financed with the issuance of a long-term bank loan. I recommend two immediate courses of action. First, we must find ways to reduce our operating expenses. Second, until we see an improvement in the bottom line, it is imperative that we cut back, if not eliminate entirely, our dividends. A dividend payment of \$84,000 in a year in which we sustained a net loss of \$60,000 is not prudent. I look forward to hearing from you before moving forward with any actions.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-71

LO 6

PROBLEM 12-9A YEAR-END BALANCE SHEET AND STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Land Plant and equipment Accumulated depreciation Investments Current liabilities Long-term note payable Bonds payable Common stock Retained earnings Total without cash ? 15 200 60 (25) 0 20 (200) 100 (50) (10) 110 dr. Explanation h. sales exceeded cash collections g. note was exchanged for land, a noncash activity f. purchase b. depreciation expense no change given i. decrease g. note was exchanged for land, a noncash activity e. bonds retired d. common stock issued c. dividends of 40 a. income of (50)

Thus, the change in cash must be 110 cr. (decrease) to balance the total changes in the accounts.

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FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-9A (Continued)

Statement of cash flows: POODLE COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Decrease in current liabilities Net cash provided by operating activities Cash Flows from Investing Activities Acquisitions of plant and equipment Cash Flows from Financing Activities Payment of cash dividends Retirement of bonds Issuance of common stock Net cash used by financing activities Net increase (decrease) in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 Schedule of Noncash Investing and Financing Activities Acquisition of land in exchange for note \$ 50

25 (15) (20) \$ 40 \$ (60) \$ (40) (100) 50 \$ (90) \$(110) 155 \$ 45 \$ 200

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-73

PROBLEM 12-9A (Concluded)

2. Balance sheet: POODLE COMPANY BALANCE SHEET DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Accounts receivable Total current assets Land Plant and equipment Accumulated depreciation Investments Total long-term assets Total assets Current liabilities Long-term note payable Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity
1 2

451 1552 \$ 200 \$ 3003 7604 (200)5 125 \$ 985 \$1,185 \$ 3056 \$ 200 \$ 5507 1308 \$ 680 \$1,185 \$

\$155 – \$110 \$140 + \$15 3 \$100 + \$200 4 \$700 + \$60

5 6

\$175 + \$25 \$325 – \$20 7 \$500 + \$50 8 \$120 + \$10

3. Poodle’s cash from operations of \$40,000 was insufficient to cover its acquisitions of new plant and equipment of \$60,000 and the payment of cash dividends of \$40,000. Common stock of \$50,000 was issued, but this was more than offset by the \$100,000 needed to retire the bonds. The lack of cash from operations to cover acquisitions, pay dividends, and retire the bonds are all responsible for the large decrease in the company’s cash balance at the end of the year.

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LO 8

PROBLEM 12-10A STATEMENT OF CASH FLOWS USING A WORK SHEET— INDIRECT METHOD (Appendix)

1. Balance sheet: POODLE COMPANY BALANCE SHEET DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Accounts receivable Total current assets Land Plant and equipment Accumulated depreciation Investments Total long-term assets Total assets Current liabilities Long-term note payable Common stock Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity
1 2

451 1552 \$ 200 \$ 3003 7604 (200)5 125 \$ 985 \$ 1,185 \$ 3056 \$ 200 \$ 5507 1308 \$ 680 \$ 1,185 \$

\$155 – \$110 \$140 + \$15 3 \$100 + \$200 4 \$700 + \$60

5 6

\$175 + \$25 \$325 – \$20 7 \$500 + \$50 8 \$120 + \$10

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-75

PROBLEM 12-10A (Continued)

2. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts Balances 12/31/07 12/31/06 Changes Cash Inflows (Outflows) Operating Investing Financing

Cash Accounts receivable Land Plant and equipment Accumulated depreciation Investments Current liabilities Long-term note payable Bonds payable Common stock Retained earnings Totals Net increase (decrease) in cash
1 2

45 155 300 760 (200) 125 (305) (200) 0 (550) (130) 0

155 140 100 700 (175) 125 (325) 0 (100) (500) (120) 0

(110) 15 2001 602 (25)3 0 20 (200)1 1004 (50)5 (50)6 407 0

(15) (60) 25 (20)

(100) 50 50 40 (110) (60) (40) (90)

Acquisition of land in exchange for note (noncash transaction). Purchase of plant and equipment. 3 Depreciation expense. 4 Retirement of bonds payable. 5 Issuance of common stock. 6 Net income. 7 Cash dividends paid.

12-76

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-10A (Concluded)

3. Statement of cash flows: POODLE COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Increase in accounts receivable Decrease in current liabilities Net cash provided by operating activities Cash Flows from Investing Activities Acquisitions of plant and equipment Cash Flows from Financing Activities Payment of cash dividends Retirement of bonds Issuance of common stock Net cash used by financing activities Net increase (decrease) in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 Schedule of Noncash Investing and Financing Activities Acquisition of land in exchange for note \$ 50

25 (15) (20) \$ 40 \$ (60) \$ (40) (100) 50 \$ (90) \$(110) 155 \$ 45 \$ 200

4. Poodle’s cash from operations of \$40,000 was insufficient to cover its acquisitions of new plant and equipment of \$60,000 and the payment of cash dividends of \$40,000. Common stock of \$50,000 was issued, but this was more than offset by the \$100,000 needed to retire the bonds. The lack of cash from operations to cover acquisitions, pay dividends, and retire the bonds are all responsible for the large decrease in the company’s cash balance at the end of the year.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-77

ALTERNATE MULTI-CONCEPT PROBLEMS LO 4,5
PROBLEM 12-11A STATEMENT OF CASH FLOWS—DIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepaid rent Land Plant and equipment Accumulated depreciation (15) 11 25 (16) (90) 75 (60)

Explanation

Sale Purchase of 125 and sale of (50) 20 Sale of asset (cost of 50 less book value of 30) and (80) depreciation

Accounts payable Other accrued liabilities Income tax payable Long-term bank loan payable Common stock Retained earnings Total

(5) (5) 10 75 0 (5) 0

Repayment 5 Dividends (10) Net income

12-78

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-11A (Continued)

Conversion of income statement items to a cash basis (in thousands of dollars): Income Statement Sales revenue Amount \$400 Adjustment Cash Flows \$400 – Increase in accounts receivable (11) Cash collected \$389 \$240 + Increase in inventory 25 – Increase in accounts payable (5) Cash payments \$260 – Decrease in prepaid rent – Increase in accrued liabilities Cash payments (No cash flow effect) Not an operating activity No interest payable Cash payments + Decrease in income taxes payable Cash payments Net cash flow from operations \$ 40 (16) (5) \$ 19 \$ 0 \$ 0

Cost of goods sold

240

General and administrative

40

Depreciation expense Loss on sale of plant assets Interest expense Income tax expense

80 10 15 5

Net income

\$ 10

\$ 15 \$ 5 10 \$ 15 \$ 80

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-79

PROBLEM 12-11A (Concluded)

Statement of cash flows: BANNACK CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED JUNE 30, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Cash collections from customers Cash payments for: Inventory General and administrative Interest Income taxes Total cash payments Net cash provided by operating activities Cash Flows from Investing Activities Sale of land Purchase of plant and equipment Sale of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Repayment of long-term loan Payment of cash dividends Net cash used by financing activities Net decrease in cash Cash balance, June 30, 2006 Cash balance, June 30, 2007 \$ 389 \$(260) (19) (15) (15) \$(309) \$ 80 \$ 90 (125) 20 \$ (15) \$ (75) (5) \$ (80) \$ (15) 40 \$ 25

2. It is true that the amount of cash flow from operating activities is the same regardless of which method (direct or indirect) is used. The two methods, however, differ in the information reported to the reader of the statement of cash flows. The direct method shows the actual inflows and outflows of cash, while the indirect method arrives at the same amount by reconciling net income to cash flow from operating activities.

12-80

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 4,6

PROBLEM 12-12A STATEMENT OF CASH FLOWS—INDIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepaid rent Land Plant and equipment Accumulated depreciation (15) 11 25 (16) (90) 75 (60)

Explanation

Sale Purchase of 125 and sale of (50) 20 Sale of asset (cost of 50 less book value of 30) and (80) depreciation

Accounts payable Other accrued liabilities Income tax payable Long-term bank loan payable Common stock Retained earnings Total

(5) (5) 10 75 0 (5) 0

Repayment 5 Dividends (10) Net income

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-81

PROBLEM 12-12A (Concluded)

Statement of cash flows: BANNACK CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED JUNE 30, 2007 (IN THOUSANDS OF DOLLARS) Cash Flow from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of plant assets Increase in accounts receivable Increase in inventory Decrease in prepaid rent Increase in accounts payable Increase in other accrued liabilities Decrease in income taxes payable Net cash provided by operating activities Cash Flow from Investing Activities Sale of land Purchase of plant and equipment Sale of plant and equipment Net cash used by investing activities Cash Flow from Financing Activities Repayment of long-term loan Payment of cash dividends Net cash used by financing activities Net decrease in cash Cash balance, June 30, 2006 Cash balance, June 30, 2007 \$ 10

80 10 (11) (25) 16 5 5 (10) \$ 80 \$ 90 (125) 20 \$(15) \$(75) (5) \$(80) \$(15) 40 \$ 25

2. It is true that the amount of cash flow from operating activities is the same regardless of which method (direct or indirect) is used. The two methods, however, differ in the information reported to the reader of the statement of cash flows. The direct method shows the actual inflows and outflows of cash, while the indirect method arrives at the same amount by reconciling net income to cash flow from operating activities.

12-82

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 2,5

PROBLEM 12-13A STATEMENT OF CASH FLOWS—DIRECT METHOD

1. No, the U.S. Treasury bills are not cash equivalents, because they have a maturity in excess of three months. Instead, the six-month Treasury bills are properly classified as current assets. 2. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash U.S. Treasury bills Accounts receivable Inventory Land Buildings and equipment Accumulated depreciation Patents Accounts payable Taxes payable Notes payable Term notes payable Common stock Retained earnings Total (25) 25 (75) 25 20 60 (40) (20) (40) 10 100 0 (20) (20) 0

Explanation

Purchase Purchase Depreciation expense Amortization

Retirement of note (20) Stock dividend (40) Net income 20 Stock dividend

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-83

PROBLEM 12-13A (Continued)

Conversion of income statement items to a cash basis (in thousands of dollars): Income Statement Sales revenue Amount \$1,416 Cash Flows \$1,416 + Decrease in accounts receivable 75 Cash collected \$1,491 \$ 990 + Increase in inventory 25 – Increase in accounts payable (40) Cash payments \$ 975 No payable \$ 195 No payable \$ 70 No cash flow effect No payable* \$ 2 No cash flow effect No payable \$ 2 No payable \$ 45 \$ 12 + Decrease in income tax payable* 10 Cash payments \$ 22 Net cash flow from operations \$ 180 Adjustment

Cost of goods sold

990

Salaries and benefits Heat, light, and power Depreciation Property taxes Patent amortization Miscellaneous expense Interest expense Income tax expense

195 70 40 2 20 2 45 12

Net income

\$

40

*The current liability Taxes Payable is assumed to relate entirely to income taxes rather than property taxes.

12-84

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

PROBLEM 12-13A (Concluded)

Statement of cash flows: SHEPARD COMPANY STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Cash collections from customers Cash payments for: Inventory Salaries and benefits Heat, light, and power Property taxes Miscellaneous activities Interest Income taxes Total cash payments Net cash provided by operating activities Cash Flows from Investing Activities Purchase of U.S. Treasury bills Acquisition of land Acquisition of buildings and equipment Net cash used by investing activities Cash Flows from Financing Activities Retirement of notes payable Net decrease in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$ 1,491 \$ (975) (195) (70) (2) (2) (45) (22) \$(1,311) \$ 180 (25) (20) (60) \$ (105) \$ (100) \$ (25) 75 \$ 50 \$

Note: It is questionable whether or not the stock dividend is a significant noncash activity. If it is determined to be significant, it should be shown on a supplemental schedule of noncash activities.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-85

DECISION CASES READING AND INTERPRETING FINANCIAL STATEMENTS

LO 3,4

DECISION CASE 12-1 COMPARING TWO COMPANIES IN THE SAME INDUSTRY: FINISH LINE AND FOOT LOCKER

1. Both companies use the indirect method in preparing the Operating Activities section of their statement of cash flows. Both begin the statement with net income and then make the adjustments to reconcile this number to cash provided by operating activities. 2. Finish Line’s net cash provided by operating activities decreased during the year by \$87,147,000 – \$74,027,000 or \$13,120,000. The largest adjustment to reconcile net income to net cash provided by operating activities was the add back of depreciation and amortization of \$34,633,000. Foot Locker’s net cash provided by operating activities of continuing operations increased during the year by \$354,000,000 -– \$289,000,000 or \$65,000,000. The largest adjustment to reconcile net income to net cash provided by operating activities was the add back of depreciation and amortization of \$171,000,000. 3. Finish Line’s merchandise inventories increased during the year, net of the effects of acquisitions, by \$27,348,000. Foot Locker’s merchandise inventories increased during the year by \$111,000,000. An increase in inventory during the year indicates that the company purchased more than it sold. An increase in inventory would be normal for companies such as Finish Line and Foot Locker that are growing and adding more stores each year. 4. Finish Line spent \$70,126,000 and \$58,172,000 to purchase property and equipment in the years ended February 25, 2006 and February 26, 2005, respectively. Foot Locker spent \$155,000,000 and \$156,000,000 on property and equipment (capital expenditures) in the years ended January 28, 2006 and January 29, 2005, respectively. 5. The primary source of financing for Finish Line during the most recent year was from the issuance of common stock for \$4,105,000. Foot Locker’s largest source of financing was also from the issuance of common stock in the amount of \$12,000,000. Both companies bought back some of their own shares during the year in the form of treasury stock. Finish Line spent \$19,865,000 and Foot Locker spent \$35,000,000 for this purpose. Companies buy back their own stock for a variety of reasons including the need to have stock available to distribute to employees as part of bonus and other benefit plans.

12-86

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 7

DECISION CASE 12-2 COMPUTING AND INTERPRETING FOOT LOCKER’S CASH FLOW ADEQUACY

1. Cash flow adequacy ratio for the year ended January 28, 2006: (Net cash provided by operating activities of continuing operations – Capital expenditures)/Average annual debt maturing over next five years (amounts in millions of dollars): (\$354 – \$155)/[(\$50 + \$0 + \$2 + \$88 + \$0)/5] = \$199/28 = 7.1 2. The cash flow adequacy ratio gives the user an indication of whether or not the company is generating sufficient cash from its operations to repay its debts after taking into consideration the need to make necessary expenditures on new property and equipment. This ratio indicates that Foot Locker’s cash flow was more than sufficient to repay its average debt after allowing for capital expenditures.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-87

MAKING FINANCIAL DECISIONS LO 1,5
DECISION CASE 12-3 DIVIDEND DECISION AND THE STATEMENT OF CASH FLOWS—DIRECT METHOD

1. Changes in account balances and explanations (in thousands of dollars): Net Change Dr. (Cr.) Cash Accounts receivable Inventory Prepayments Land Plant and equipment Accumulated depreciation Long-term investments Patents Accounts payable Other accrued liabilities Taxes payable Dividends payable Short-term notes payable Long-term notes payable Bonds payable Common stock Retained earnings Total 30 50 150 (15) 1,055 1,700 (250) (400) (100) (70) (60) (70) 200 (200) 200 (700) (500) (1,020) 0

Explanation

Issued bonds to acquire 700 and cash for 355 Purchase Depreciation expense Sale Amortization

Paid dividends Reclassification of note Reclassification of note Issued for land Issued stock 1,020 Net income

12-88

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

DECISION CASE 12-3 (Continued)

Conversion of income statement items to a cash basis (in thousands of dollars): Income Statement Sales revenue Amount \$8,000 Adjustment Cash Flows \$8,000 – Increase in accounts receivable (50) Cash collected from customers \$7,950 \$4,500 + Increase in inventory 150 – Increase in accounts payable (70) Cash paid to suppliers \$4,580 \$1,450 – Decrease in prepayments (15) – Increase in accrued liabilities (60) – Depreciation included on income statement (250) – Amortization included on income statement (100) Cash paid for operating expenses \$1,025 No interest payable \$ 350 \$ 680 – Increase in taxes payable (70) Cash paid for taxes \$ 610 Net cash flow from operations \$1,385

Cost of goods sold

4,500

Operating expenses

1,450

Interest expense Income tax expense

350 680

Net income

\$1,020

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-89

DECISION CASE 12-3 (Concluded)

2. Statement of cash flows: BAILEY CORP. STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN THOUSANDS OF DOLLARS) Cash Flows from Operating Activities Cash collected from customers Cash payments: For inventory For operating expenses For interest For income taxes Total cash payments Net cash provided by operating activities Cash Flows from Investing Activities Sale of long-term investments Acquisition of land Acquisition of plant and equipment Net cash used by investing activities Cash Flows from Financing Activities Issuance of additional common stock Payment of 2006 cash dividend Net cash provided by financing activities Net increase in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 Supplemental Schedule of Noncash Investing and Financing Activities Acquisition of land by issuance of bonds Reclassification of long-term notes due within next year \$ 7,950 \$(4,580) (1,025) (350) (610) \$ 6,565 \$ 1,385 \$ 400 (355) (1,700) \$(1,655)

\$

500 (200) \$ 300 \$ 30 450 \$ 480

\$

700 200

3. Bailey Corp. should be able to safely pay a cash dividend in 2008 of \$250,000 (note that there are now 250,000 shares of stock outstanding). The cash provided by operating activities of \$1,385,000 indicates that the company is generating a very significant amount of cash from the business. Because the company invested heavily in new plant and equipment during 2007, it should not need to reserve large amounts of cash for capital expenditures in the near future. The profit margin of 12.75% indicates that management is doing a good job of controlling costs. Bailey will need to pay \$200,000 in 2008 to retire the short-term notes payable. In assessing the company’s cash needs in future years, it would be important to know how soon any of the bonds payable will be due for retirement. Assuming that a large portion of the bonds is not due to be retired in 2008, Bailey should have no problem in paying its tenth annual dividend of \$1 per share.

12-90

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

LO 1,6

DECISION CASE 12-4 EQUIPMENT REPLACEMENT DECISION AND CASH FLOWS FROM OPERATIONS

1. Cash flow from operations Net income (loss) Adjustments: Depreciation expense Increase in accounts receivable Increase in inventories Increase in prepayments Increase in accounts payable Decrease in accounts payable Net cash flow from operations 2. Memo to the president: TO: FROM: DATE: President Student’s name XX/XX/XX

Year 1 \$(10) 30 (32) (26) 0 15 \$(23)

Year 2 \$ (2) 25 (5) (8) 0 3 \$13

Year 3 \$ 15 15 (12) (5) (10) (5) \$ (2)

Year 4 \$20 14 (20) (9) (5) (4) \$ (4)

SUBJECT: Cash flow As you are aware, our company has made significant strides in improving our profitability. Our net losses in the first two years have been replaced with profits of \$15 million and \$20 million, respectively, for the last two years. We are all also aware, however, of the need to generate sufficient cash flow operations to make the necessary capital expenditures to replace existing equipment. I have enclosed for your review a four-year summary of cash flow from operations. The summary shows that in our second year we did a good job of generating cash from operations but that the results have not been as good in the last two years. Specifically, our operations have drained \$2 million and \$4 million of cash from the treasury in these years rather than the desired result of generating cash to help pay for capital expenditures. The buildup of various current assets, such as accounts receivable, inventories, and prepayments, is the main reason for our problems. First, we need to do a better job of collecting our receivables in a timely fashion. Second, we must find ways to limit our purchases of inventory and maintain products on hand at a minimum. Third, whenever possible, we should limit the amount of items we prepay, such as office supplies and rent. Finally, the company needs to take full advantage of the credit terms offered by our suppliers and not pay open accounts any sooner than is necessary. Please call me at your earliest convenience to discuss how we can improve our efforts in this critical area.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-91

ETHICAL DECISION MAKING LO 1,6
DECISION CASE 12-5 LOAN DECISION AND THE STATEMENT OF CASH FLOWS— INDIRECT METHOD

1. Mega reported the sale of the business by netting the gain against the cash proceeds and thus reporting the book value of \$300 million as an investing activity inflow. This is not in accordance with generally accepted accounting principles, which require that the actual amount of cash received from the sale of \$450 million be shown as an investing activity inflow. The gain of \$150 million should have been deducted from net income to arrive at cash flow from operations. The use of the net approach to reporting the transaction, rather than the correct approach under GAAP, does not have an effect on the increase or decrease in cash for the period. The issue involves the appropriate reporting and disclosure of the transaction rather than the net change in cash for the period. 2. Revised statement: MEGA ENTERPRISES STATEMENT OF CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 2007 (IN MILLIONS OF DOLLARS) Cash Flows from Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: Gain on sale of California business Depreciation and amortization Increase in accounts receivable Decrease in inventory Decrease in accounts payable Increase in other accrued liabilities Net cash used by operating activities Cash Flows from Investing Activities Acquisitions of other businesses Acquisitions of plant and equipment Sale of other businesses Net cash provided by investing activities Cash Flows from Financing Activities Additional borrowings Repayments of borrowings Cash dividends paid Net cash used by financing activities Net decrease in cash Cash balance, December 31, 2006 Cash balance, December 31, 2007 \$ 65

(150) 56 (19) 27 (42) 18 \$ (45) \$(234) (125) 450 \$ 91 \$ 150 (180) (50) \$ (80) \$ (34) 42 \$ 8

12-92

FINANCIAL ACCOUNTING SOLUTIONS MANUAL

DECISION CASE 12-5 (Concluded)

3. The controller has not acted ethically in this situation. The officer is aware that the bank intends to rely on cash generated from operations for repayment of the loans. As shown in 2. on the previous page, the netting of the sale transaction grossly overstates the cash flow from operating activities and understates the cash flow from investing activities. It appears that the controller intentionally misreported the transaction on the statement of cash flows to influence the bank’s appraisal of the ability of Mega to generate cash from its ongoing operations.

LO 2,3

DECISION CASE 12-6 CASH EQUIVALENTS AND THE STATEMENT OF CASH FLOWS

1. According to current accounting standards, only those investments in highly liquid securities with an original maturity to the investor of three months or less should be classified as cash equivalents. Because the Treasury notes do not mature until ten months after they are purchased, their purchase should be classified as an investing activity for purposes of preparing a statement of cash flows. (Note: The notes would be classified as held to maturity securities because Rangers expects to hold them until maturity.) 2. If the purchase of the notes is classified as an operating activity rather than an investing activity, the information provided to readers is not free from bias. The company would be attempting to disguise the fact that the purchase of the notes was a significant investing activity that used cash. The decision to classify the notes as cash equivalents would be made to present the company’s cash outflows in the most favorable manner, regardless of the substance of the transaction to acquire the notes.

3. As controller, you need to explain to the treasurer that accounting standards do not allow the company to classify the treasury notes as cash equivalents. You are sympathetic to his desire to minimize the net cash outflow for investing activities, but the company does not have a choice in its presentation of the notes, nor does the decision on classification rest with you as controller. Rangers must report the purchase on the statement of cash flows as a cash outflow from investing activities.

REAL WORLD PRACTICE 12.1 Best Buy uses the indirect method in the Operating Activities section of the statement of cash flows. The first line on the statement is net earnings and the necessary adjustments are made to reconcile net income to total cash provided by operating activities from continuing operations.

CHAPTER 12 • THE STATEMENT OF CASH FLOWS

12-93

REAL WORLD PRACTICE 12.2 Best Buy’s Receivables increased during the year that ended February 26, 2005. An increase in Receivables means that the company sold more than it collected in cash during the year, and therefore the difference must be deducted from net income in the Operating Activities section of the statement.

REAL WORLD PRACTICE 12.3 Best Buy paid \$241,000,000 in income taxes during the year that ended February 26, 2005. This is not necessarily the amount that appears as expense on the income statement for the year. The amount of income tax expense on the income statement is based on accrual accounting concepts. For example, any taxes owed at the end of the year would be included in the tax expense but would not be considered a cash outflow.

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