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3. 3. EXERCISES E4- 1 The data for this exercise are identical to that in Problem 3- 5. The cash t-ac- count for that problem is: Cash BB 0 a 3,000 1,000 c b 20,00 20,00 d 0 0 20,50 3,000 f g 0 50 h 1,800 i EB 17,65 0 Analyzing this t-account, we find that: Operating items: d is payments to suppliers of magazines f is collections from customers g is payment of a salary i is payment of interest Investing item: c is purchase of a bicycle Financing items: a is issuance of common stock b is taking out a loan from a bank h is a dividend payment (Note: Items e and j are required to do proper accrual accounting, but do not affect cash flows.)
4. 4. The direct method cash flow statement is: Miloslav’s Magazines Statement of Cash Flows for the Year Ended Dec. 31, 2004 Cash flows from operations: Collections from customers \$20,500 Payments to suppliers (20,000 ) Payment of salary (3,000 ) Payment of interest (1,800 ) Total cash flow from (used by) operations \$ (4,300 ) Cash flows used for investing: Purchase of equipment (bicycle) \$ (1,000 ) Cash flows from financing: Issuance of common stock \$ 3,000 Loan from bank 20,000 Payment of dividends (50 ) Cash flow from financing \$22,950 Change in cash \$ 17,650
5. 5. Statement of Cash Flows: Operating, Investing, and Financing Activities 112 E4- 2 The data for this exercise are identical to that in Problem 3- 6. The cash t-ac- count for that problem is (amounts in thousands): Cash BB 0.0 a 100.0 10.0 b c 50.0 100.0 e i 30.0 20.0 f j 84.0 15.0 g 19.0 h EB 100.0 Analyzing this t-account, we find that: Operating items: b is a payment for inventory items c is a receipt of cash for services e is payment of wages f is payment of rent g is partly the payment of interest i is a receipt of cash from customers j is a receipt of cash from customers Total collections from customers: \$50.0 + \$30.0 + \$84.0 = \$164.0 Payment (g): From the answer to Problem 3- 6, the entry for g is: g. Interest Expense 9,000 Notes Payable 6,000 Cash 15,000 Note: The holder would first take any interest owed off the note, then reduce the principal. The interest owed at December 31, 2004 is: 8% × \$150,000 × (9/12) = 9,000. Investing items: None 04-bookdoc729.doc
6. 6. Financing items: a is issuance of common stock g is partly a repayment of debt h is a dividend payment Noncash transactions: b is partly a noncash transaction (Note: Item d is not used.) The direct method cash flow statement is: Ofer’s Office Designs Statement of Cash Flows for the Year Ended Dec. 31, 2004 (amounts in thousands) Cash flows from operations: Collections from customers \$164.0 Payments to suppliers (10.0) Payment of salary (100.0) Payment of rent (20.0) Payment of interest (9.0 ) Total cash flow from (used by) operations \$ 25.0 Cash flows used for investing: None \$ 0.0 Cash flows from financing: Issuance of common stock \$100.0 Repayment of debt (6.0) Payment of dividends (19.0 ) Cash flow from financing \$ 75.0 Change in cash \$100.0
7. 7. Statement of Cash Flows: Operating, Investing, and Financing Activities 114 E4- 3 The data for this exercise are identical to that in Problem 3- 7. The cash t-ac- count for that problem is (amounts in thousands): Cash B 0 B a 100,00 60,00 b 0 0 f 20,000 4,000 c i 30,000 25,00 e 0 j 50 15,00 h 0 6,000 k 40,050 Analyzing this t-account, we find that: Operating items: c is payment of rent h is a payment to suppliers i is collections from customers j is another collection from a customer k is payment of salaries and wages Investing items: b is purchase of equipment e is purchase of a short- term investment Financing items: a is issuance of common stock f is issuance of a bond (Note: Items d, g, l and m are required to do proper accrual accounting, but do not affect cash flows.) 04-bookdoc729.doc
8. 8. The direct method cash flow statement is: Ralphy’s Business Cash Flow Statement for Nine Months Ended 12/31/04 Operations: Collections from customers \$ 30,050.0 Payments to suppliers (15,000.0) Payments for salaries (6,000.0) Payments for rent (4,000.0 ) Cash Flows from Operations \$ 5,050.0 Investing: Investments \$(25,000.0) Purchased equipment (60,000.0 ) Cash Flows for Investing \$(85,000.0 ) Financing: Issued Common Stock \$100,000.0 Issued Bonds 20,000.0 Cash Flows from Financing \$120,000.0 Change in Cash \$ 40,050.0 Although it is not called for in the problem, you may want to either have the class do the indirect method worksheet and prepare an indirect method statement or do it in class to introduce the indirect method. What follows is the worksheet and indirect method cash flow statement.
9. 9. Statement of Cash Flows: Operating, Investing, and Financing Activities 116 Indirect Method Work- sheet Explanation dr cr ref dr cr ref dr cr Accounts – AR 9,800.0 9,800.0 Rec. Inventories – INV 5,000.0 5,000.0 Prepaid Rent – PREPR 1,000.0 1,000.0 Investments – INVEST 25,000.0 25,000.0 Equipment – EQUIP 60,000.0 60,000.0 Acc. Depr. – 7,500.0 DEPR 7,500.0 Accounts 15,000. – 15,000.0 AP Pay. 0 Salaries Pay. – 1,000.0 SALP 1,000.0 Interest Pay. – 1,500.0 INTP 1,500.0 20,000. Bonds Pay. – 20,000.0 BP 0 100,000. 100,000 Common St. – CS 0 .0 Ret. Earn - – NI 4,150.0 4,150.0 ings 104,950. 145,000 – – 0 .0 Beg Cash – Cash End Cash 40,050.0 145,000. – BB – 0 Operations 4,150.0 NI DEPR 7,500.0 9,800.0 AR AP 15,000.0 5,000.0 INV SALP 1,000.0 1,000.0 PREPR INTP 1,500.0 CFO 5,050.0 – Investing 60,000.0 EQUIP 25,000.0 INVEST – 85,000.0 CFI Financing BP 20,000.0 Issued - 100,000. CS 0 120,000. CFF – 0 EB 40,050.0 04-bookdoc729.doc
10. 10. Ralphy’s Business Cash Flow Statement for Nine Months Ended 12/31/04 Operations: Net Loss \$ (4,150.00) Depreciation 7,500.00 Increase in accounts receivable (9,800.00) Increase in inventory (5,000.00) Increase in prepaid expenses (1,000.00) Increase in accounts payable 15,000.00 Increase in salaries payable 1,000.00 Increase in interest payable 1,500.00 Cash Flow from Operations \$ 5,050.00 Investing: Investments \$(25,000.00) Purchased equipment (60,000.00 ) Cash Flow for Investing \$(85,000.00 ) Financing: Issued Common Stock \$100,000.00 Issued Bonds 20,000.00 Cash Flow from Financing \$120,000.00 Change in Cash \$ 40,050.00 E4- 4 The data for this exercise are identical to that in Problem 3- 8. The cash T- account for that problem is (amounts in thousands): Cash BB – a 110.0 60.0 b e 20.0 3.0 c h 36.0 31.0 g 16.0 i 56.0 Analyzing this t-account, we find that: Operating items: c is payment of rent g is a payment to suppliers h is collections from customers i is payment of salaries and wages
11. 11. Statement of Cash Flows: Operating, Investing, and Financing Activities 118 Investing item: b is purchase of equipment Financing items: a is issuance of common stock e is taking a loan (Note: Items d, f, j and k are required to do proper accrual accounting, but do not affect cash flows.) Rick and Stan’s Business Cash Flow Statement for Three Months Ended 12/31/05 (in thousands) Operations: Collections from customers \$ 36.0 Payments to suppliers (31.0) Payments for salaries (16.0) Payments for rent (3.0 ) Cash Flows from Operations \$ (14.0 ) Investing: Purchased equipment \$ (60.0 ) Cash Flows for Investing \$ (60.0 ) Financing: Issued Common Stock \$110.0 Took out a loan 20.0 Cash Flows from Financing \$130.0 Change in Cash \$ 56.0 Although it is not called for in the problem, you may want to either have the class do the indirect method worksheet and prepare an indirect method statement or do it in class to introduce the indirect method. What follows is the worksheet and indirect method cash flow statement. 04-bookdoc729.doc
12. 12. Indirect Method Worksheet Explanation dr cr ref dr cr ref dr cr 9 9 Accounts Rec. – AR .0 .0 10. 10. Inventories – INV 0 0 Prepaid Insur- 2.2 2.2 – PREPINS ance 5 5 60. 60. Equipment – EQUIP 0 0 Acc. Depr.— 3 3 – DEPR Equip. .0 .0 4 4 Accounts Pay. – AP .0 .0 2 2 Wages Pay. – WP .0 .0 0 0 Interest Pay. – IntP .6 .6 20. 20 Note Payable – NOTE 0 .0 110. 110. Common St. – CS 0 0 2.3 2.3 Ret. Earnings – 5 5 – – 83.6 139.6 Beg Cash – Cash End Cash 56.0 – BB – 139.6 Operations 2.3 NI 5 DEPR 3 9 AR .0 .0 AP 4 10. INV .0 0 WP 2 2.2 PRE - .0 5 PINS IntP 0 .6 14.0 CFO Investing 60.0 EQUIP 60.0 Financing LOAN 20.0 CS 110.0 CFF 130.0 Ch in Cash 56.0 EB 56.0
13. 13. Statement of Cash Flows: Operating, Investing, and Financing Activities 120 Rick and Stan’s Business Cash Flow Statement for Three Months Ended 12/31/05 (in thousands) Operations: Net Loss \$ (2.35) Depreciation 3.00 Increase in accounts receivable (9.00) Increase in inventory (10.00) Increase in prepaid expenses (2.25) Increase in accounts payable 4.00 Increase in wages payable 2.00 Increase in interest payable 0.60 Cash Flow from Operations \$ (14.00 ) Investing: Purchased equipment \$ (60.00 ) Cash Flow for Investing \$ (60.00 ) Financing: Issued common stock \$110.00 Took out a loan 20.00 Cash Flow from Financing \$130.00 Change in Cash \$ 56.00 04-bookdoc729.doc
14. 14. PROBLEMS P4 -1 Note: This problem does not specify whether a direct or indirect method statement should be prepared. Preparation of both is recommended. Journal entries: a1. Inventory 49,000 Cash 49,000 a2. Cash 73,500 Sales 73,500 a3. Inventory 49,000 Cost of goods sold 49,000 b. Prepaid rent 4,000 Cash 4,000 c. Retained earnings 2,000 Cash 2,000 Implied: d. Salaries and wages expense 11,000 Cash 11,000 Adjustments: A1. Interest expense 4,000 Interest payable 4,000 10% of \$40,000 = \$4,000 A2. Wages expense 1,000 Wages payable 1,000 A3. Rent expense 6,000 Prepaid rent 6,000 \$3,000 + (\$4,000/8 months)*6 months = \$6,000.
15. 15. Statement of Cash Flows: Operating, Investing, and Financing Activities 122 (The following closes all revenue and expense accounts to an account called ‘Income Summary.’ The balance in Income Summary should be equal to Net Income as shown on the income statement, below. Income Summary is then closed to Retained Earnings. This is an alternative to closing the revenue and expense accounts directly to retained earnings and provides a conve - nient check on the net income number on the income statement.) C1. Sales Revenue 73,500 Income Summary 73,500 C2. Income Summary 49,000 COGS 49,000 C3. Income Summary 6,000 Rent Expense 6,000 C4. Income Summary 4,000 Interest Expense 4,000 C5. Income Summary 12,000 Salaries Expense 12,000 C6. Income Summary 2,500 Retained Earnings 2,500 04-bookdoc729.doc
16. 16. T- accounts (in thousands) Cash Inventory Prepaid Rent BB 52.0 BB 0.0 BB 3.0 a2 73.5 49.0 a1 a1 49.0 49.0 a3 b 4.0 6.0 A3 4.0 b EB 1.0 2.0 c EB – 11.0 d Land Note Payable BB 5.0 40.0 BB EB 5.0 40.0 EB Interest Wages Payable Payable 0.0 BB 4.0 A1 1.0 A2 EB 59.5 4.0 EB 1.0 EB Retained Common Stock Earnings Sales Revenue 20.0 BB 0.0 BB C1 73.5 73.5 a2 c 2.0 2.5 C6 0.0 EB 20.0 EB 0.5 EB Cost of Salaries Goods Sold Expense Rent Expense a3 49.0 49.0 C2 d 11.0 A3 6.0 6.0 C3 EB 0.0 A2 1.0 12.0 C5 EB 0.0 EB 0.0 Income Interest Ex- pense Summary A1 4.0 4.0 C4 C2 49.0 73.5 C1 C3 6.0 EB 0.0 C4 4.0 C5 12.0 C6 2.5 0.0
17. 17. Statement of Cash Flows: Operating, Investing, and Financing Activities 124 To do a direct method cash flow statement, we analyze the cash T- account. We find that: Operating items: b is payment of rent a1 is a payment to suppliers a2 is collections from customers d is payment of salaries and wages Investing items: none Financing items: c is payment of dividends The direct method cash flow statement is: Sampson, Inc. Cash Flow Statement for Year Ended 12/31/04 (in thousands) Operations: Collections from customers \$ 73 .5 Payments to suppliers (49 .0) Payments for salaries (11 .0) Payments for rent (4 .0 ) Cash Flows from Operations \$ 9 .5 Investing: None Cash Flows for Investing – Financing: Dividends \$ (2 .0 ) Cash Flows for Financing \$ (2 .0 ) Change in Cash \$ 7 .5 04-bookdoc729.doc
18. 18. The indirect method cash flow worksheet is: Indirect Method Worksheet (in thou- sands) Explanation dr cr ref dr cr ref dr cr Decr in Prepaid Rent 3.0 2.0 PreR 1.0 Land 5.0 5.0 Wages Pay. – 1.0 Incr in WP 1.0 Interest Pay. – 4.0 Incr in IP 4.0 Note Payable 40.0 40.0 Common St. 20.0 20.0 Ret. Earnings – DIV 2.0 2.5 NI 0.5 8.0 60.0 6.0 65.5 Beg Cash 52.0 Cash End Cash 59.5 60.0 BB 52.0 65.5 Operations NI 2 .5 Decr PreR 2.0 Incr WP 1.0 Incr IP 4.0 CFO 9.5 Investing – CFI Financing 2.0 DIV 2.0 CFF Ch in Cash 7.5 EB 59.5
19. 19. Statement of Cash Flows: Operating, Investing, and Financing Activities 126 Sampson, Inc. Cash Flow Statement for Year Ended 12/31/04 (in thousands) Operations: Net income \$ 2.5 Decrease in prepaid rent 2.0 Increase in wages payable 1.0 Increase in interest payable 4 .0 Cash Flows from Operations \$ 9 .5 Investing: None Cash Flows for Investing – Financing: Dividends \$ (2 .0 ) Cash Flows for Financing \$ (2 .0 ) Change in Cash \$ 7 .5 P4- 2 Journal entries (amounts in thousands) a. Accounts receivable 3,000.0 Sales 3,000.0 b. Cash 3,100.0 Accounts receivable 3,100.0 c. This is information for the cost of goods sold adjustment. See T- ac- counts. d. Buildings & machinery 50.0 Cash 50.0 e. Cash 1.5 Accumulated depreciation 8.0 Loss on sale of machinery 0.5 Buildings & machinery 10.0 f. This is information for the depreciation adjustment. g. This is information for the interest adjustment. h. This is information for the interest adjustment. i. Cash 14.0 Retained earnings 14.0 j. This is information for the wages adjustment. 04-bookdoc729.doc
20. 20. k. Wages expense 57.0 Wages payable 57.0 l. Miscellaneous expenses 50.0 Cash 50.0 m. Interest payable 7.0 Cash 7.0 n. Inventory 2,820.0 Accounts payable 2,820.0 o. Accounts payable 2,700.0 Cash 2,700.0 p. This is information for the rent adjustment. q. Prepaid rent 25.0 Cash 25.0 r. Other accrued expenses 5.0 Cash 5.0 s. This is information for the accrued liabilities adjustment. t. Tax expense 12.0 Taxes payable 12.0 u. This is information for the taxes adjustment. Adjusting entries—(calculations below) A1. Cost of goods sold 2,800.0 Inventory 2,800.0 A2. Rent expense 27.0 Prepaid rent 27.0 A3. Wages payable 53.0 Cash 53.0 A4. Miscellaneous expenses 9.0 Other accrued liabilities 9.0 A5. Taxes payable 11.0 Cash 11.0 A6. Depreciation expense 14.0 Accumulated depreciation 14.0 A7. Interest expense 6.0 Interest payable 6.0 A8. Interest expense 2.4 Interest payable 2.4 (Closing entries.)
21. 21. Statement of Cash Flows: Operating, Investing, and Financing Activities 128 C1. Sales 3,000.0 Income summary 3,000.0 C2. Income summary 2,800.0 Cost of goods sold 2,800.0 C3. Income summary 57.0 Wages expense 57.0 C4. Income summary 59.0 Miscellaneous expense 59.0 C5. Income summary 27.0 Rent expense 27.0 C6. Income summary 12.0 Tax expense 12.0 C7. Income summary 8.4 Interest expense 8.4 C8. Income summary 0.5 Loss on sale of machinery 0.5 C9. Income summary 14.0 Depreciation expense 14.0 04-bookdoc729.doc
22. 22. (Close the balance in income summary to retained earnings.) C10. Income summary 22.1 Retained earnings 22.1 Calculations for adjusting entries: The inventory, unpaid wages, prepaid rent, other accrued liabilities, and un- paid taxes at the end of the year are given, and are best analyzed in the T- accounts given below. Depreciation: 1 × \$140,000 = \$14,000. 10 Interest: Senior debt: 0.06 × \$100,000 = \$6,000. Subordinated debt: 0.08 × \$30,000 = \$2,400.
23. 23. Statement of Cash Flows: Operating, Investing, and Financing Activities 130 1. T- accounts Cash Accounts Rec. Inventory Prepaid Rent BB 68.0 BB 340.0 BB 75.0 BB 32.0 b 3,100. 50.0 d a 3,000. 3,100. b n 2,820. q 25.0 0 0 0 0 e 1.5 14.0 i 2,800. A1 27.0 A2 0 50.0 l 7.0 m 240.0 c 95.0 p 30.0 2,700.0 o 25.0 q Buildings & Accumulated 5.0 r Machinery Depreciation Land 53.0 A3 BB 100.0 25.0 BB BB 25.0 11.0 A5 d 50.0 10.0 e e 8.0 14.0 A6 140.0 31.0 25.0 Accounts Wages Interest Payable Payable Payable 63.0 BB 13.0 BB 3.0 BB o 2,700. 2,820. n m 7.0 6.0 A7 0 0 A3 53.0 57.0 k 2.4 A8 254.5 183.0 17.0 j 4.4 Other Accrued Subordinat - Taxes Payable Liabilities Senior Debt ed Debt 6.0 BB 5.0 BB 100.0 BB 30.0 BB 12.0 t r 5.0 A5 11.0 9.0 A4 7.0 u 9.0 s 100.0 30.0 Add’l Paid- in Retained Wages Common Stock Capital Earnings Expense 15.0 BB 115.0 BB 265.0 BB k 57.0 57.0 c3 i 14.0 22.1 c10 15.0 115.0 273.1 04-bookdoc729.doc
24. 24. Miscella - Cost of neous Ex- Depreciation Sales Goods Sold pense Expense 3,000. a A 2,800. l 50.0 A6 14.0 0 1 0 2,800. c2 A 9.0 0 4 c1 3,000. 59.0 c4 14.0 c9 0 Interest Income Expense Rent Expense Tax Expense Summary A7 6.0 A 27.0 t 12.0 3,000. c1 2 0 2.4 27.0 c5 12.0 c6 c2 2,800. A8 0 8.4 c7 c3 57.0 c4 59.0 c5 27.0 c6 12.0 Loss on Sale c7 8.4 of Machinery e 0.5 c8 0.5 0.5 c8 c9 14.0 c1 22.1 0 –
25. 25. Statement of Cash Flows: Operating, Investing, and Financing Activities 132 2. REVIEW Co. Balance Sheet as of 12/31/2006 Cash \$254.5 Accounts Payable \$183.0 240 17. Accounts Receivable .0 Wages Payable 0 95 4 Inventory .0 Interest Payable .4 7 Prepaid Rent 30.0 Taxes Payable .0 Total Current Assets \$619.5 Other Accrued Liabilities 9.0 Total Current Liabilities \$220.4 Buildings & Machinery \$140.0 Less: Accumulated Depreciation (31.0 ) Senior Debt \$100.0 Buildings & Machinery, net \$109.0 Subordinated Debt 30.0 Land 25.0 Total Long- term Liabilities \$130.0 Total Non- current Assets \$134.0 Total Liabilities \$350.4 Total Assets \$753.5 Shareholders’ Equity Common Stock \$ 15.0 115. Add’l Paid- in Capital 0 Retained Earnings 273.1 Total Shareholders’ Equity \$403.1 Total Liabilities & Shareholders’ Equity \$753.5 3. REVIEW Co. Income Statement for Year Ended 12/31/2006 Sales \$ 3,000.0 Cost of Goods Sold (2,800.0 ) Gross Margin \$ 200.0 Other Expenses: Wages (57.0) Depreciation (14.0) Interest (8.4) Rent (27.0) Taxes (12.0) Miscellaneous (59.0) Loss on Sale of Machine (0.5 ) Net Income \$ 22.1 04-bookdoc729.doc
26. 26. 4. REVIEW Co. Cash Flow Statement for Year Ended 12/31/2006 Operations: Net Income \$ 22.1 Addbacks: Depreciation 14.0 Loss on Sale of Machinery 0.5 Changes in accounts that require additions: Accounts Receivable 100.0 Prepaid Rent 2.0 Accounts Payable 120.0 Wages Payable 4.0 Interest Payable 1.4 Taxes Payable 1.0 Other Accrued Liabilities 4.0 Changes in accounts that require subtrac - tions: Inventory (20.0 ) Cash flow from operations \$249.0 Investing: Sale of machinery \$ 1.5 Purchase of machinery (50.0 ) Cash flows for investing \$ (48.5 ) Financing: Payment of dividends \$ (14.0) Change in Cash \$186.5 Supplemental disclosure: Cash paid for interest \$ 7.0 Cash paid for taxes \$ 11.0
27. 27. Statement of Cash Flows: Operating, Investing, and Financing Activities 134 Indirect Method Worksheet Explanation dr cr ref dr cr ref dr cr 240. Accounts Receivable 340.0 100.0 AR 0 95. Inventory 75.0 INV 20.0 0 30. Prepaid Rent 32.0 2.0 PREPR 0 140. Buildings & Machinery 100.0 PURCH 50.0 10.0 SALE 0 31. Accumulated Depreciation 25.0 SALE 8.0 14.0 DEPR 0 25. Land 25.0 0 183. Accounts Payable 63.0 120.0 AP 0 17. Wages Payable 13.0 4.0 WP 0 4. Interest Payable 3.0 1.4 IP 4 7. Taxes Payable 6.0 1.0 TP 0 9. Other Accrued Liabilities 5.0 4.0 OAL 0 100. Senior Debt 100.0 0 30. Subordinated Debt 30.0 0 15. Common Stock 15.0 0 115. Add’l Paid- in Capital 115.0 0 Retained Earnings 265.0 DIV 14.0 22.1 NI 273.1 572.0 640.0 530.0 784.5 End- Beg Cash 68.0 Cash Cash 254.5 640.0 BB 68.0 784.5 Operations NI 22.1 DEPR 14.0 LOSS - SALE 0.5 20.0 INV AR 100.0 PREPs 2.0 AP 120.0 WP 4.0 IP 1.4 TP 1.0 OAL 4.0 CFO 249.0 Investing EQUIP - SALE 1.5 50.0 EQPURC H 48.5 04-bookdoc729.doc
28. 28. Financing 14 DIV 14 CFF ChinCash 186.5 EB 254.5
29. 29. Statement of Cash Flows: Operating, Investing, and Financing Activities 136 P4- 3 This problem can be done by working backwards through the indirect method cash flow worksheet. Indirect Method Worksheet Explanation dr cr ref dr cr ref dr cr Accounts Rec. 380 AR 60 440 Inventories 560 INV 80 640 Land 100 20 Land 80 Buildings & 810 Acq B&E 260 70 Sale B&E 1,000 Equipment Other Long- term Sale 280 80 OLTA 200 Assets Accumulated 320 Sale B&E 40 120 Depr 400 Depreciation Accounts 510 50 AP 560 Payable Other Current 260 OCL 90 170 Liabilities Bonds Payable 120 80 IssBonds 200 Common Stock 280 120 IssCS 400 Ret. Earnings 680 Div 400 400 NI 680 2,130 2,170 2,360 2,410 Beg Cash 40 Cash EndCash 50 2,170 BB 40 2,410 Operations NI 400 60 AR Depr 120 80 INV AP 50 90 OCL CFO 340 Investing Land 20 260 Acq B&E Sale B&E 30 Sale OLTA 80 130 CFI Financing IssBonds 80 400 Div IssCS 120 200 CFF ChinCash 10 EB 50 04-bookdoc729.doc
30. 30. ABC Widget Company Balance Sheet at December 31, 2003 Cash \$ 40 Accounts receivable 380 Inventory 560 Total current assets \$ 980 Buildings & equipment \$ 810 Accumulated depreciation (320 ) Buildings & equipment, net \$ 490 Land 100 Other long- term assets 280 Total long- term assets \$ 870 Total assets \$ 1,850 Accounts payable \$ 510 Other current liabilities 260 Total current liabilities \$ 770 Bonds payable \$ 120 Total liabilities \$ 890 Common stock \$ 280 Retained earnings 680 Total stockholders’ equity \$ 960 Total liabilities and stockholders’ equity \$ 1,850
31. 31. Statement of Cash Flows: Operating, Investing, and Financing Activities 138 P4- 4 Indirect Method Worksheet Explanation dr cr ref dr cr ref dr cr Accounts Rec. 93.0 93.0 Inventories 151.0 151.0 Land 30.0 5.0 3 25.0 14. Equipment 690.0 10.0 1 730.0 0 EqPur 44.0 Accumulated 54. 460.0 1 8.0 Depr 506.0 Depreciation 0 10. Patents 100.0 Amort 90.0 0 Accounts 136.0 136.0 Payable Interest 10.0 10.0 Payable Mortgage 120.0 5 10.0 110.0 Payable 10. Common St. 250.0 2 270.0 0 10. 4 0 10. 36. Ret. Earnings 140.0 Div NI 166.0 0 0 1,064. 1,116. 1,089 1,198. 0 0 .0 0 End- Beg Cash 52.0 Cash Cash 109.0 1,116. BB 1,198 0 .0 Operations NI 36. 3 3 0 .0 Depr 54. 1 5 0 .0 Amort 10. 0 1 2. 0 4 10. 0 CFO 108.0 Investing 1 4. 44. EqPur 0 0 3 8 .0 32.0 CFI Financing 10.0 Div 04-bookdoc729.doc
32. 32. 9.0 5 19.0 CFF Chin- Cash 57.0 EB 109.0
33. 33. Statement of Cash Flows: Operating, Investing, and Financing Activities 140 Active Company Statement of Cash Flows (Indirect Method) For the Year Ended December 31, 2004 (in thousands) Operations: Net Income 36 .0 Add: Expenses not requiring cash and losses Depreciation expense 54 .0 Amortization expense 10 .0 Noncash compensation 10 .0 Loss on sale of equipment 2.0 Subtract: Gains Gain on sale of land (3 .0) Gain on repayment of mortgage (1 .0 ) Cash Flow from Operations \$ 108 .0 Investing: Sold equipment \$ 4.0 Sold land 8.0 Purchased equipment (44 .0 ) Cash Flow for Investing \$ (32 .0 ) Financing: Repaid mortgage \$ (9 .0) Dividends (10 .0 ) Total Financing \$ (19 .0 ) Change in cash \$ 57 .0 04-bookdoc729.doc
34. 34. Active Company Statement of Cash Flows (Direct Method) For the Year Ended December 31, 2001 (in thousands) Operations: Collections from customers \$1,200 .0 Payments: Suppliers (788 .0) Wages (270 .0) Interest (12 .0) Taxes (22 .0 ) Cash Flow from Operations \$ 108 .0 Investing: Sold equipment \$ 4.0 Sold land 8.0 Purchased equipment (44 .0 ) Cash Flow for Investing \$ (32 .0 ) Financing: Repaid mortgage \$ (9 .0) Dividends (10 .0 ) Total Financing \$ (19 .0 ) Change in cash \$ 57 .0
36. 36. e. Gains on investments are deducted because the entire cash flow is con- sidered an investing activity. Since the gain is included in net income, it must be deducted so that the cash flows from operations do not “double count” the gain. Losses on investments are added because they are losses that do not represent cash outflows. A loss means that the company sold the securi - ties for less than their balance sheet carrying value. However, the trans - action resulted in a positive cash flow, all of which is reflected in the in- vesting section. The loss is added back because it did not result in the use of cash by the company even though it resulted in a reduction of net income. f. The income statement is prepared on the accrual basis, where revenues are recognized in the period earned and expenses in the period incurred, regardless of the receipt or payment of cash. It is aimed at reflecting economic performance. Therefore, the timing of cash receipts or pay - ments may not be the same as the timing of the expense or revenue recognition. Additionally, some expenses, such as depreciation and amortization, reduce income but do not consume cash. g. 1. The exchange of common stock for land is a significant non- cash ac- tivity. Since it is a non- cash transaction, it will not be part of the cash flows. However, it must be reported separately under the caption “significant non- cash investing and financing activities.” 2. Interest paid is an operating activity. It will be part of net income. Any change in interest payable will be added to or deducted from net in- come to arrive at the cash provided by operating activities. h. The accounting change represented an after- tax adjustment reducing Mi- crosoft’s net income by \$375 million. The adjustments are related to the valuations of derivative investments reported by Microsoft. While the ad- justment resulted in a loss, it did not require the use of cash. Therefore, the adjustment is added back to net income to arrive at cash provided by operating activities. P4- 6 a. The statement of cash flows helps investors and creditors assess the amounts of cash flows from three categories of activities: operating, in- vesting and financing. The cash flow statement describes the changes in an entity’s cash over a period of time by grouping the increases and de - creases to cash into one of the three categories. Investors and creditors can then use the net change in cash for the individual categories and the company as a whole to make investment and credit decisions.
37. 37. Statement of Cash Flows: Operating, Investing, and Financing Activities 144 b. Answers may vary. Among those items that might be of interest to a banker would be: 1. The company had positive cash provided by operations in 2000 and 2001. 2. The company was able to pay off \$90,000,000 of long- term debt over the two years. 3. The total cash position of the company increased in both 2000 and 2001. 4. The company repaid \$1,234,000 of short- term bank borrowings over the two years. 5. Cash provided by operating activities is the company’s primary source of funds. c. Existing creditors would be encouraged by any of the items listed in b. Also, the Management Discussion and Analysis points out that the com- pany was in compliance with all loan covenants as of March 31, 2001. d. The primary source of funds is cash provided by operations. e. THC paid no dividends in 2000 or 2001. MD & A indicates that the com- pany may not pay dividends or make other payments with respect to capi - tal stock that exceed 33 percent of the Company’s cumulative consolidated net income. To avoid violating the loan covenant, it would not be wise for the compa - ny to pay a dividend at this time. P4- 7 Net income: \$910,000 + Amortization expense 40,000 – Increase in Accounts receivable (10,000) – Increase in inventory (2,000) – Decrease in accounts payable (20,000) + Increase in interest payable 2,000 = Cash provided by operations    before depreciation adjustment \$920,000 + Depreciation expense 100,000 = Cash provided by operations \$1,020,000 Note to Instructor: Dividends are a financing activity; the change in divi- dends payable is not relevant to computing the cash provided by operating activities. 04-bookdoc729.doc
38. 38. CASES C4- 1 Edgar Obviously, the instructor will have to adapt to the particular companies cho- sen by the students. The point of the question is to get the students to see how few companies use the indirect method. We sometimes ask for a show of hands as to how many students found a direct method statement. It may be wise to examine the statements that some students believe are direct method, however, as many students make mistakes in this regard. The purpose of the second question is to get the student to think about net income versus cash flows from operations. The Total Toy example in the chapter shows how a growing company can have net income in excess of cash flows from operations. Companies in more of a steady state should have cash flows from operations (plus capital expenditures) close to net in- come. An interesting conversation can ensue if a student has found a compa - ny with cash flow from operations more than net income. This might be be - cause the company suffers a loss (or even takes a “big bath”), or because the company is shrinking. Questions 2b and 2c are aimed at getting the student to think about the in- vesting activities that firms have, and in particular to begin to think about whether investment represents growth or just replacement of assets. Question 2d asks the student to focus on financing activities. Questions e, f and g ask the student to find supplemental disclosures. While the company may not have any noncash transactions, the company must dis- close how much was paid for taxes and interest. These disclosures may, however, be hard to find. C4- 2 Coldwater Creek’s Cash Flows a. At this point, the students have seen, Collections from customers = Sales – Change in Accounts receivable. They should analyze the T- account: Accounts receivable BB 2,342 Sales 246,697 245,020 Collections EB 4,019 If you have a really good class, you could point out that the correct for- mula is: Collections from customers = Sales – Adjustment for Accounts receivable in the cash flow statement.
39. 39. Statement of Cash Flows: Operating, Investing, and Financing Activities 146 Although it is not true in general (see the Appendix in Chapter 15), for Coldwater Creek’s fiscal year ended February 28, 1998, the change in Accounts receivable is equal to the adjustment for receivables listed on the cash flow statement: Adjustment for Accounts receivable in the cash flow statement is for an increase in Accounts receivable of 1,677. The change in Accounts receivable on the balance sheet: Ending Accounts receivable \$4,019 Beginning Accounts receivable (2,342 ) Increase in Accounts receivable \$ 1,677 From Coldwater’s income statement, Net sales were \$246,697; therefore, collections from customers were: Net sales \$246,697 Increase in Accounts receivable (1,677 ) Collections from customers \$ 245,020 b. We analyze the inventory account: Inventory BB 25,279 Purch 147,898 120,126 COGS EB 53,051 c. After determining purchases in part b, cash paid on account can be de- duced from analyzing the Accounts payable 18,061 BB Pa y- 138,684 147,898 Purch ments 27,275 EB Again, you might point out to a really good class that: Payments to suppliers = Cost of goods sold – Adjustment for Inventory in the cash flow statement + Adjustment for Accounts payable in the cash flow statement. In the case of Coldwater Creek, this approach yields a slightly different answer than the above T- account analysis: Payments to suppliers = 120,126 + 27,772 – 9,924 = 137,974. 04-bookdoc729.doc
40. 40. The difference between these two answers is \$710, and might be the re - sult of foreign currency translations, which the students will not en - counter in detail in this book. d. The difference between net income and cash flow from operations is: Net income \$11,688 Less: Cash flow for operations – (5,959 ) Collections from customers \$17,647 The primary cause of the difference between net income and cash flow from operations is the increase in inventories. Of the \$27,772 increase in inventories, only \$9,214 (the increase in accounts payable) was financed by suppliers. The increase in inventories that Coldwater had to pay for was: \$27,772 – \$9,214 = \$18,558. Therefore, only \$18,558 – \$17,647 = \$911 comes from the combination of all other items. C4- 3 Med- Design Corporation 1. Research and development is an expense that is not listed on the bal - ance sheet. One could say that the effects of research and development are felt in Retained earnings. 2. Zero. The change in Retained earnings (Accumulated deficit) is exactly explained by net income: Beginning balance in Accumulated deficit\$(18,967,241 ) Add: net income 882,889 Ending balance in Accumulated deficit \$( 18,084,352 ) 3. Depreciation and amortization (from cash flow statement) \$289,022 Less: amortization (notes) 36,602 Depreciation \$252,420 4. Because it is an expense related to a long term asset. Net income is the starting point in deriving cash flow from operations, but depreciation is not a cash flow and must be added back.
41. 41. Statement of Cash Flows: Operating, Investing, and Financing Activities 148 5. The “issuance of warrants for services” reflects an expense that did not consume cash. Therefore, like depreciation, it is added back in adjusting net income to cash flow from operations. The notes reveal that the warrants were issued to directors who supplied consulting services to Med- Design. On January 14, 1998, warrants worth \$194,000 were issued for consulting services. On September 8, 1998, warrants worth \$186,802 were issued for consulting services. Their total is \$380,802: Value of warrants issued and expense recorded on January 19, 1998 \$194,000 Value of warrants issued and expense recorded on September 8, 1998 186,802 Total consulting expense paid for with warrants instead of cash \$380,802 6. The credit to Additional paid- in capital is deduced from examination of the stockholders’ equity section. (Some students might think the credit should go to Other comprehensive income because they don’t know what that is.) Wage (or Consulting) expense 194,000 Additional paid- in capital 194,000 7. Increase in Prepaid expenses and other current assets \$20,459 Adjustment in the cash flow statement (as if there was a decrease in Prepaid expenses and other current assets 6,545 Total change in account due to warrants \$27,004 8. There is no gain or loss because none is listed on the income statement and there is no adjustment for a gain or loss in the operating section of the cash flow statement. 9. Accrued expenses from income statement \$82,335 Change in Accrued expense (from cash flow statement or balance sheet—there is \$1 rounding error on the balance sheet) 36,346 Cash paid for marketing costs in 1998 \$118,681 04-bookdoc729.doc
42. 42. C4- 4 Blue Zone, Inc. 1. The depreciation is added back because it is an expense that decreased reported net income. But none of the expense was associated with a cash outflow. That is, Depreciation Expense is debited and Accumulated Depreciation is credited. Since net income was the initial estimate of cash from operations,and since depreciation did not involve a cash out - flow, we adjust the initial estimate by adding back depreciation expense —adjusting the estimate (net income) to get what it would have been if depreciation expense was not in it. 2. See the following table. The change number computed from the begin - ning and ending balances in the balance sheet agrees with the cash flow statement numbers. It is not always true. Changes in the entity (acquisi - tion of another company or major division, or disposal,for example) or re- classification of a portion of an item’s balance (for example, reclassifying an A/R as a note receivable) will cause the balance sheet change num- bers to be different from the cash flow statement numbers. Beginning balance Ending bal- Change ance A/R \$97,600 \$221,363 \$123,763 increase Work- in-progress 70,581 0 70,581 decrease Prepaid expenses 93,204 144,767 51,563 increase 3. The prepaid expenses are a current asset that has increased. Therefore, more cash is tied up in this asset at the end of the period than at the be - ginning. This increase is subtracted from net income to arrive at cash flow from operations. Another way of saying this is that the cash outflow to create the prepaid asset exceeds the amount of expense created by prepaids in the income statement by the amount of the increase. 4. It is added to net income to arrive at cash provided by (used by) operat - ing activities for reasons similar to those for the depreciation adjustment. It was an expense that did not consume cash. A plausible journal entry is: Compensation expense…… 359,173 APIC…………………… 359,173 5. The deferred revenue account balance decreased by \$120,123 during the 2000 fiscal year. The decrease can be thought of as the following journal entry: Deferred revenue……….. 120,123 Revenue ………….. 120,123 Although revenue was recognized, the cash flow associated with the rev - enue was already collected in a previous period. In fiscal 1999 it was just the opposite. More cash was collected than revenue recognized. 6. The following excerpt from the statement explains it:
43. 43. Statement of Cash Flows: Operating, Investing, and Financing Activities 150 On August 1, 1997, the Company entered into an agreement to ex - change services with a British Columbia television station. The Com- pany provided website development and monthly maintenance services in exchange for daily television advertising. The Company recognized the revenues and advertising expenses from the barter transaction at the fair value of the advertising received. There was no adjustment shown in the cash flow statement, probably be- cause the revenue was exactly equal to the expense, and neither in- volved a cash flow. Therefore, they cancelled out each. It might have been better to show a subtraction for the revenue and an add- back for the expense in two separate lines of the cash flow from operations sec- tion of the statement. This would make it more transparent to the reader. The company likely would not have reported the transactions in the fiscal 2000 statements because they have no historical track record on which to rely (and the new accounting pronouncement requires it). 7. The company has a net loss in all three years as well as a negative cash flow from operations in the last two years. The loss and the nega - tive cash flow seems to be getting worse. Cash flow from financing is decreasing. Cash flow from investment is negative, indicating that the company still has to make minimal investment to sustain operations. Financing cash flow is posi- tive, but decreasing. Overall, it looks as if the company is experiencing cash flow problems because basic operations are not profitable. 8. See the following: Fixed Assets (Gross) Accumulated Depreciation Beg. Bal. 544,263 118,667 Beg. Bal- ance Increases 610,419 ? Decreases Decreases ? 197,118 Increases End. Bal. 1,146,229 307,332 End. Bal- ance From the cash flow statement: fixed asset purchases were \$610,419, and depreciation expense was \$197,118. Fixed assets………………………… 610,419 Cash ………………………….. 610,419 Depreciation expense…………….. 197,118 Accumulated depreciation... 197,118 After recording these two transactions in the above t-accounts, the “plug” needed to balance both of the accounts is the same, \$8,453 (\$544,263 + \$610,419 – \$1,146,229, or \$118,667 + \$197,118 – \$307,332). Therefore, what must have happened is that fully depreciated assets were taken out of service. The following entry records that: 04-bookdoc729.doc
44. 44. Accumulated depreciation……….. 8,453 Fixed assets…………………. 8,453 You should notice that no asset sales are accounted for in the investing section of the cash flow statement. C4- 5 Bluegreen Corporation This is an interesting case for several reasons. It shows that not every firm has a conventional balance sheet, and that the accounting and presentation is flexible enough to capture the essence of specific company transactions. The large number of supplemental cash flow statement items also shows that many material changes to assets and liabilities arise from transactions that do not go through the cash account. These transactions are important and cannot be ignored. 1. There are no current asset or liability categories likely because of the na- ture of the business. Most of the company’s operating assets and liabili- ties are longer term. For example, the inventory consists of pieces of property and land, which has a longer than one- year useful life. 2. The depreciation is added back because it is an expense that decreased reported net income. But none of the expense was associated with a cash outflow. That is, Depreciation Expense is debited and Accumulated Depreciation is credited. Since net income was the initial estimate of cash from operations, and since depreciation did not involve a cash out- flow, we adjust the initial estimate by adding back depreciation expense —adjusting the estimate (net income) to get what it would have been if depreciation expense was not in it. 3. The notes receivable relate to the basic business of the company. It buys and sells property and finances it for customers. Therefore, the notes relate to operations. “Proceeds from sales of notes receivable” are the actual cash inflow from selling such notes, and “Proceeds from borrowings collater - alized by notes receivable” is the cash raised by pledging the notes to get a loan. Both of these activities relate to basic operations. 4. The cash flow investing section shows proceeds from sale of property and equipment in the amount of \$79. The operating section of the cash flow statement shows there was a loss on the sale included in net income in the amount of \$45. Therefore, the book value must have been \$79 + \$45 = \$124. 5. Some of the notes receivable were sold to a third party. The \$89,786 is the decrease resulting from normal changes in the notes account—issu - ing new notes and collecting on old notes from customers purchasing property from the company. 6. Bluegreen did not pay any cash dividends during the year ended April 1, 2001.