CHAPTER 13.doc

653 CHAPTER 13 LEARNING TO LEARN Discussion Questions D13-1. The statement of cash flows reports the components of and the net cash flow from operations (usually a net inflow), the components of and the net cash flow from investment activities, and the components of and the net cash flow from financing activities. D13-2. An income statement reports resource inflows from sales of goods and services on an accrual basis. A statement of cash flows reports cash inflows from operations (resource inflows from sales are a component of inflows from operations) and two other cash inflows, investment and financing. Financing inflows are not likely to appear in any income statement. Only the gains and losses from investing activities appear in the income statement. An income statement also reports accrual basis expenses, the outflows of resources used to produce the sales of goods and services. A statement of cash flows reports cash outflows for investing and financing activities. Most outflows for investment will eventually appear as expenses on income statements, but financing outflows do not appear on income statements. D13-3. The three categories are: Operations: cash inflows from selling activities less the cash consumed this period to produce these revenues. Investing: cash inflows from sales of long-lived assets and investments less cash outflows for purchases of long-lived assets and investments. Financing: cash inflows from the sale of debt or stock less principal payments on debt, purchases of treasury stock, and payment of cash dividends. D13-4. The largest component of cash flow from operations using the direct method is cash collected from customers. The Copyright © 1996 by McGraw-Hill, Inc. 653

654 largest components of cash flow from operations using the indirect method are net income and the addition to income of depreciation, depletion, and amortization (expenses that do not consume cash). D13-5. When the indirect method is used, depreciation, depletion, and amortization are added to net income because these three expense items do not consume cash when incurred. Cash was consumed when the assets being depreciated, depleted, or amortized were acquired. D13-6. The most common financing sources are: Sale of equity Sale of bonds Sale of notes The most common investment sources are: Sale of operating assets Sale of investments D13-7. The most common outflows are: Purchases of operating assets and investments Repayment of debt Payment of dividends D13-8. Direct exchanges are included as supplementary information because (1) they represent resource inflows and outflows, and (2) they significantly affect the ability of the firm to secure cash from financing sources in the future. D13-9. The majority of cash inflows should come from operations. Cash secured from operations is more controllable and less expensive than is cash that is secured from investing activities or from financing. In addition, cash inflows from operations do not require future outflows that are required with financing (dividends, interest or principal payments). D13-10. Cash for investment in operating assets should come from long-term sources because operating assets are a long-term investment. Short-term sources are likely to require repayment Copyright © 1996 by McGraw-Hill, Inc. 654

655 before the use of operating assets will provide cash flows that could be used for payments to suppliers of capital. D13-11. When a firm incurs a loss, revenues are less than expenses. The components of net cash flows from operations are revenues and expenses adjusted from the accrual basis to cash flows. Therefore, it is likely that revenues adjusted to cash inflows from selling activities will also be less than the expenses adjusted to cash outflows. D13-12. Such a firm would most likely issue bonds or stock. These inflows would appear as increases in the common or preferred stock accounts and in the long-term and short-term debt accounts on the balance sheet. You might also see decreases in some asset accounts as assets are sold to provide resources. D13-13. The changes in retained earnings are net income or net loss and dividends. Net income appears as a positive amount in the cash flows from operations section of the statement using the indirect method. In the direct method the cash components of net income appear as positive amounts in the cash flows from operations section. (A net loss would be a negative amount in the cash flows from operations section.) Dividends appear in the financing section of the statement as an outflow of cash. D13-14. No. The change in cash and cash equivalents is affected by inflows and outflows for investment and financing as well as operations. Net cash flows for investment and/or financing are frequently negative. If the amount of the cash outflows for investment and/or financing exceeds the inflow from operations, then overall cash and cash equivalents will decline. Analytical Opportunities A13-15. DETERMINING CASH FLOWS INVOLVING EQUIPMENT 1. Ending accumulated depreciation............................... $115,000 Add: Accumulated depreciation of equipment sold. . 30,000 145,000 Copyright © 1996 by McGraw-Hill, Inc. 655

656 Less: Beginning accumulated depreciation.............. 92,000 Depreciation expense................................................... $ 53,000 2. Ending equipment......................................................... $260,000 Add: Cost of equipment sold...................................... 35,000 295,000 Less: Beginning equipment........................................ 225,000 Cash paid for equipment.............................................. $ 70,000 3. For the statement of cash flows, the amount of the cash inflow from the sale of the equipment is $9,400. Copyright © 1996 by McGraw-Hill, Inc. 656

657 A13-16. DETERMINING CASH FLOWS FOR INVESTMENT 1. Ending accumulated depreciation................... $11,900,000 Less: Beginning accumulated depreciation... 10,100,000 Depreciation expense........................................ $1,800,000 Ending aircraft .................................................. $28,500,000 Less: Beginning aircraft................................... 21,750,000 Cash paid for aircraft purchased...................... $6,750,000 2. Ending accumulated depreciation................... $11,900,000 Plus: Accumulated depreciation aircraft sold 3,500,000 .................................................. 15,400,000 Less: Beginning accumulated depreciation... 10,100,000 Depreciation expense........................................ $5,300,000 Ending aircraft .................................................. $28,500,000 Plus: Cost of aircraft sold................................ 4,100,000 .................................................. 32,600,000 Less: Beginning aircraft................................... 21,750,000 Cash paid for aircraft purchased...................... $10,850,000 3. Book value of aircraft sold*.............................. $600,000 Add: Gain on sale............................................. 300,000 Cash inflow from sale of aircraft...................... $900,000 *($4,100,000 - $3,500,000) Copyright © 1996 by McGraw-Hill, Inc. 657

658 A13-17. PREPARING A PROSPECTIVE STATEMENT OF CASH FLOWS 1. Fitness Outfitters Prospective Statement of Cash Flows For the Year Ended December 31, 19x3 Cash flows from operating activities: Cash collected from customers1................... $ 629,000 Cash paid to suppliers2.................................. (307,000) Cash payments for operating expenses3..... (340,000) Net cash used by operating activities $(18,000) Cash flows from investing activities: Equipment purchase...................................... (97,000) Net cash used by investing activities...... (97,000) Cash flows from financing activities: Cash received from stock issue................... 100,000 Net cash provided by financing activities 100,000 Net prospective cash outflow.......................... (15,000) Cash at beginning of year................................ 0 Prospective cash balance at end of year....... (15,000) Desired cash balance at end of year............... 5,000 Shortfall of cash................................................ $ 20,000 1Cash collected from customers is assumed to be equal to sales revenue because there are no accounts receivable at year-end. 2Cash paid to suppliers is cost of goods sold plus the increase in inventory less the increase in accounts payable ($291,000 + $53,000 – $37,000). 3Cash paid for operating expenses is assumed to be equal to operating expenses less the amount of depreciation expense ($355,000 - $15,000). Recall that depreciation expense does not require a cash outflow. 2. At this point, the prospective year-end cash balance falls short of the desired year-end balance by $20,000. Jane and Harvey could sell additional stock or borrow. Copyright © 1996 by McGraw-Hill, Inc. 658

659 A13-17. (continued) 3. Yes. You can anticipate future cash shortages and respond by securing additional cash or reducing cash outflows. Cash planning is a particularly important activity for a new business. You can also anticipate cash surpluses that might develop and plan to invest excess cash wisely. A13-18. PROFITABILITY DECLINES AND THE STATEMENT OF CASH FLOWS 1. Cash provided by operations will always decrease as net income declines in response to decreased sales volume. Of course, the exact amount of the decrease in cash provided by operations will depend on the simultaneous changes in the various factors that explain the difference between net income and cash provided by operations. Thus, we lack sufficient information to calculate the effect of the anticipated further decline. 2. As depreciation decreases, net income will always increase; however, cash flow provided by operations will be unaffected by changes in depreciation because the full amount of depreciation is added back to net income in the calculation of cash flow provided by operations. In other words, the recording of depreciation expense does not affect cash flow from operations. 3. Businesses experiencing declining sales volume do not always consume cash. As long as cash collected from customers is larger than cash paid for merchandise and for various operating expenses, cash from operations will be positive. Of course, if sales volume declines sufficiently far, cash collected from customers can fall short of cash paid for merchandise and for various other expenses, many of which do not decline with sales volume. Copyright © 1996 by McGraw-Hill, Inc. 659

660 A13-18. (continued) 4. Current assets and current liabilities may buffer operating cash flow against the impact of a sales volume decline. Drawing down receivables and inventories and increasing current liabilities will increase cash provided by operations. Although a company may be able to make such changes in receivables, inventories, and current liabilities in the short run, it will be unable to sustain them in the long term. Thus, although current assets and the availability for short-term credit provide a buffer against the consumption of cash in the short run, the operations of a declining business will eventually begin to consume cash. A13-19. ACCRUED LIABILITY CHANGES AND THE STATEMENT OF CASH FLOWS 1. No, because there are cash outflows during the year that are made to satisfy warranty claims. 2. On the income statement would be a $52,000 warranty expense, which reduces net income. In the adjustments to income would be a $9,000 addition. The net effect of both items is to reduce cash flow from operations by $43,000 ($52,000 - $9,000) for the warranty expense, partially offset by the increase in estimated warranty liability. Copyright © 1996 by McGraw-Hill, Inc. 660

661 A13-20. DISSENTING VIEWS AND THE CASH FLOW STATEMENT 1. Dissenting members of the FASB believed that interest and dividends received should have been classified as cash inflows from investing activities and that interest paid should have been classified as a cash outflow for financing activities. The FASB justified classifying both as cash flows from operations on three main bases: (1) virtually all companies classified such items as cash flows from operations under APB Opinion No. 19, the predecessor to Statement No. 95; (2) banks and financial institutions classify such items as cash flows from operations, and it would be hard to argue otherwise; and (3) such items are included in determining net income, and to remove them from the operating category on the cash flow statement would make it more difficult to understand the relationship between net income and cash flow from operations. 2. Dissenters believed that, by permitting continued use of the indirect method, the FASB allowed companies to withhold important cash flow information from users of financial statements. In their view, “Reporting information about cash received from customers, cash paid to suppliers and employees, income taxes paid, and other operating receipts and payments (the direct method) provides a description of operating activities of an entity that is both more informative and more consistent with the primary purpose of a statement of cash flows. . . .” The FASB justified permitting continued use of the indirect method on three main bases: (1) the indirect method concentrates on the relationship between net cash flow from operating activities and net income, providing useful information for investors and creditors who estimate future net cash flows from operations by first estimating future income and then adjusting future income for estimated differences between net income and the cash flow from operations; (2) many companies told the FASB that the direct method would be more costly to apply than the indirect method; (3) for many companies, questions remain as to the best classification of operating cash flows and the best methods by which to compute them. Copyright © 1996 by McGraw-Hill, Inc. 661

662 A13-20. (continued) It should be noted that companies using the indirect method are required to disclose in a footnote the amounts of interest paid and income taxes paid (see last sentence of paragraph 29 in Statement No. 95), which is a step in the direction of requiring the direct method. A13-21. INTERPRETING STATEMENTS OF CASH FLOWS Notes to Instructor 1. Although the authors believe that a useful classroom discussion can be conducted on the basis of a variety of cash flow statements and their various idiosyncrasies, some instructors may prefer to limit discussion to one or several comparative cash flow statements distributed by the instructor. 2. Most comparative schedules will show operations to be the chief source of cash; however, some will show financing to be the largest source of cash, particularly in times of major expansion or growth. The cash flows of distressed companies will also exhibit unusual source patterns. Companies strive to achieve a balance between the three sources of cash that is appropriate for their operations and their long-term plans. 3. The acquisition of property, plant, and equipment and the repayment of long-term debt represent the largest uses of cash for most companies. Consideration should be given to the effect of growth, expansion, and distress on the cash-use patterns in the financing and investing categories. 4. The timing and amounts of future cash inflows and outflows must be planned to avoid temporary shortages and shortfalls. The sequence of cash flow statements may give information about the nature of these plans and the degree to which the company is successful in carrying them out. For example, long-term debt may outlive the income-producing life of the plant assets it funded. Copyright © 1996 by McGraw-Hill, Inc. 662

663 A13-21. (continued) 5. Although the cash flow statement indicates the ability of a company to pay interest out of operating funds and the extent to which external capital sources have been used in recent years, the availability of debt and equity for a company is difficult to assess by reference to the cash flow statement alone. The extent to which the company is leveraged, the profitability and riskiness of the company, and the current economic outlook are also important factors. 6. Students might be asked to draw rough graphs on the chalkboard to indicate trends in important components of cash flow. 7. This question provides an opportunity to consider the form and limitations of various methods and heuristics used to forecast future cash flows. Copyright © 1996 by McGraw-Hill, Inc. 663

664 A13-22. INCOME, CASH FLOW, AND FUTURE LOSSES 1. Schedule of annual cash flows: 19x1 19x2 19x3 19x4 Loans made $(5,000,000) $(5,000,000) Principal collected 5,000,000 $ 200,000 Interest received 800,000 1,000,000 $(5,000,000) $800,000 $ 0 $1,200,000 2. Schedule of effect on annual net income: 19x1 19x2 19x3 19x4 Interest $400,000 $400,000 $500,000 $500,000 revenue Uncollectible notes expense (1,500,000) (2,000,000) (1,300,000)1 $ 400,000 $(1,100,000) $(1,500,000) $(800,000) 1 Calculation of 19x4 uncollectible notes expense: Maturity amount ....................................................... $6,000,000 Amount recovered.................................................... 1,200,000 ....................................................... 4,800,000 Additions to allowance ($1,500,000 + $2,000,000) 3,500,000 Uncollectible note expense..................................... $1,300,000 3. When the allowance procedure is properly used, the sequence of net income figures gives earlier signals of the impending loss than does the sequence of cash flow figures. The income sequence signals an estimated loss of $1,500,000 in 19x2 and $2,000,000 in 19x3. 4. Cash flows have no capacity to signal future losses that are unusual or nonrecurring. Thus, when conditions change and the frequency or amount of losses changes, current cash flows are a poor basis for predicting future cash flows. EXERCISES Copyright © 1996 by McGraw-Hill, Inc. 664

665 E13-23. CLASSIFICATION OF CASH FLOWS 1. Net cash provided by operating activities: Cash collected from customers $794,000 Cash paid to suppliers of merchandise (388,000) Cash paid to employees and other suppliers of goods and services (215,000) Cash paid for interest (22,100) Income taxes paid (58,300) Net cash provided by operating activities $110,600 2. Net cash used by investing activities: Cash received from sale of equipment $44,000 Purchase of equipment (120,000) Cash received from sale of long-term investments 71,400 Purchase of long-term investments (83,000) Net cash used by investing activities $ (87,600) 3. Net cash provided by financing activities: Cash received from issuance of short-term debt $12,700 Principal payments on short-term debt (15,000) Principal payments on mortgage payable (50,000) Proceeds from issuance of common stock 85,000 Payment of dividends (24,000) Net cash provided by financing activities $8,700 Copyright © 1996 by McGraw-Hill, Inc. 665

666 E13-24.STATEMENTS FROM STOCKS AND FLOWS Wayne Sales, Inc. Income Statement For the Year Ended December 31, 19x2 Sales revenue.................................................. $22,500 Less: Cost of goods sold................................ 15,600 Gross margin................................................... 6,900 Less: Operating expenses: Depreciation................................................... $1,800 Other............................................................... 2,600 4,400 Net income....................................................... $2,500 Wayne Sales, Inc. Statement of Changes in Retained Earnings For the Year Ended December 31, 19x2 Retained earnings, 12/31/x1.......................... $6,100 Add: Net income............................................. 2,500 . 8,600 Less: Dividends.............................................. 1,100 Retained earnings, 12/31/x2.......................... $7,500 Copyright © 1996 by McGraw-Hill, Inc. 666

667 E13-24. (continued) Wayne Sales, Inc. Statement of Cash Flows For the Year Ended December 31, 19x2 Cash flows from operating activities: Cash collected from customers................... $21,940 Cash paid to suppliers on account.............. (14,910) Cash payments for other expenses............. (2,600) Net cash provided by operating activities 4,430 Cash flows from investing activities: Equipment purchase..................................... $(5,000) Net cash used by investing activities....... (5,000) Cash flows from financing activities: Cash received from borrowing.................... 1,500 Cash received from stock issue.................. 2,000 Repayment of note........................................ (1,400) Payment of dividends................................... (1,100) Net cash provided by financing activities... 1,000 Net increase in cash........................................ 430 Cash at beginning of year............................... 190 Cash at end of year......................................... $ 620 Copyright © 1996 by McGraw-Hill, Inc. 667

669 E13-25. (continued) Summit Sales, Inc. Statement of Cash Flows For the Year Ended December 31, 19x7 Cash flows from operating activities: Cash collected from customers.................. $47,000 Cash paid to suppliers on account............ (22,600) Cash payments to employees..................... (9,200) Cash payment for insurance....................... (1,850) Paid interest expense.................................. (2,400) Net cash provided by operating activities. 10,950 Cash flows from investing activities: Sold old equipment...................................... $3,900 Equipment purchase.................................... (14,300) Net cash used by investing activities...... (10,400) Cash flows from financing activities: Cash received from stock issue................. 20,000 Repayment of long-term liabilities............. (12,600) Payment of dividends.................................. (5,000) Net cash used by financing activities...... 2,400 Net increase in cash....................................... $2,950 Copyright © 1996 by McGraw-Hill, Inc. 669

670 E13-26. CASH FLOW FROM OPERATIONS, INDIRECT METHOD Service Company Net Cash Flow from Operations Cash flows from operating activities: Net income..................................................... $111,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense*............................. $54,000 Increase in accounts receivable.............. (20,000) Increase in inventory................................ (25,000) Decrease in accounts payable................ (16,000) Increase in interest payable..................... 9,000 Total adjustments................................... 2,000 Net cash provided by operating activities $113,000 *Depreciation expense is the sum of the two increases in accumulated depreciation plus the accumulated depreciation of the equipment sold ($27,000 + $12,000 + $15,000). E13-27.INDIRECT DETERMINATION OF CASH FLOWS FROM OPERATIONS Cornelius, Inc. Net Cash Flow from Operations Cash flows from operating activities: Net income........................................................ $38,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense.................................... $11,000 Increase in accounts receivable................... (6,000) Decrease in inventory.................................... 4,000 Increase in accounts payable....................... 8,000 Total adjustments....................................... 17,000 Net cash provided by operating activities $55,000 Copyright © 1996 by McGraw-Hill, Inc. 670

671 E13-28.CASH FLOWS FROM OPERATIONS, INDIRECT METHOD Bernard Corporation Net Cash Flow from Operations Cash flows from operating activities: Net income........................................................... $206,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense.................................... $42,000 Amortization of goodwill............................... 5,000 Decrease in accounts receivable.................. 4,900 Increase in inventory..................................... (15,300) Decrease in prepaid rent............................... 2,100 Increase in salaries payable.......................... 14,400 Increase in income taxes payable................ 11,200 Total adjustments........................................ 64,300 Net cash provided by operating activities $270,300 Copyright © 1996 by McGraw-Hill, Inc. 671

672 E13-29.DIRECT DETERMINATION OF CASH FLOWS FROM OPERATIONS a) The journal entries to record this transaction are: Accounts receivable 600,000 Sales revenue 600,000 Cost of goods sold 410,000 Inventory 410,000 As the journal entries indicate, this transaction does not affect cash flows. b) The journal entry to record this transaction is: Cash 580,000 Accounts receivable 580,000 As the journal entry indicates, this transaction produces a cash inflow and, therefore, increases cash flow from operations by $580,000. c) The journal entry to record this transaction is: Inventory 425,000 Accounts payable 425,000 As the journal entry indicates, this transaction does not affect cash flows. d) The journal entry to record this transaction is: Accounts payable 392,000 Cash 392,000 As the journal entry indicates, this transaction involves a cash outflow and, therefore, decreases cash flow from operations by $392,000. Copyright © 1996 by McGraw-Hill, Inc. 672

673 E13-30.CASH FLOWS FROM OPERATIONS, DIRECT METHOD Colassard Industries Net Cash Flow from Operations Cash flows from operating activities: Cash collected from customers1...................... $359,300 Cash paid to suppliers2..................................... (180,600) Cash payments to employees3......................... (39,800) Cash payments for insurance4......................... (18,100) Cash payments for interest5............................. (15,800) Cash payments for income taxes6.................... (20,800) Net cash provided by operating activities. . $84,200 1Cash collected from customers is sales revenue plus the decrease in accounts receivable ($345,000 + $14,300). 2Cash paid to suppliers is cost of goods sold plus the increase in inventory less the increase in accounts payable ($182,500 + $9,700 – $11,600). 3Cash payments to employees is wages expense plus the decrease in wages payable ($34,400 + $5,400). 4Cash payments for insurance is insurance expense plus the increase in prepaid insurance ($12,000 + $6,100). 5Cash payments for interest is interest expense less the increase in interest payable ($20,800 – $5,000). 6Cash payments for income taxes is the amount of income taxes expense since there was no change reported in income taxes payable. Copyright © 1996 by McGraw-Hill, Inc. 673

674 E13-31.REFORMATTING A STATEMENT OF CASH FLOWS Rolling Meadows Country Club, Inc. Statement of Cash Flows For the Year Ended November 30, 19x6 Cash flows from operating activities: Net income....................................................... $106,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense, buildings............... $49,000 Depreciation expense, golf carts............... 23,000 Decrease in accounts receivable, dues.... 4,000 Increase in accounts payable.................... 11,400 Increase in income taxes payable............. 7,500 Increase in pro shop inventory.................. (28,600) Increase in prepaid insurance................... (15,800) Decrease in wages payable....................... (11,400) Total adjustments..................................... 39,100 Net cash provided by operating activities......... 145,100 Cash flows from investing activities: Sale of old golf carts....................................... 7,000 Purchase of new golf carts............................. (123,000) Net cash used by investing activities................ (116,000) Cash flows from financing activities: Cash received from short-term notes............ 35,000 Cash received from stock issue..................... 40,000 Repayment of mortgage................................. (45,000) Payment of dividends..................................... (40,000) Net cash used by financing activities................ (10,000) Net increase in cash............................................ $19,100 Copyright © 1996 by McGraw-Hill, Inc. 674

675 E13-32.REFORMATTING A STATEMENT OF CASH FLOWS Boeke Company Statement of Cash Flows For the Year Ended December 31, 19x7 Cash flows from operating activities: Cash collected from customers..................... $511,400 Cash payments to suppliers........................... (302,000) Cash payments for operating expenses....... (83,400) Cash payment for interest.............................. (13,100) Paid income taxes........................................... (22,300) Net cash provided by operating activities........ $ 90,600 Cash flows from investing activities: Cash proceeds from sale of equipment........ 6,100 Equipment purchase....................................... (136,100) Net cash used by investing activities............... (130,000) Cash flows from financing activities: Cash received from short-term notes............ 30,000 Repayment of mortgage................................. (15,000) Cash received from stock issue..................... 50,000 Payment of dividends..................................... (20,000) Net cash provided by financing activities....... 45,000 Net increase in cash.......................................... $5,600 Copyright © 1996 by McGraw-Hill, Inc. 675

676 E13-33.PREPARATION OF A STATEMENT OF CASH FLOWS Beckwith Products Company Statement of Cash Flows For the Year Ended December 31, 19x2 Cash flows from operating activities: Cash collected from customers1.................... $496,000 Cash paid to suppliers 2................................... (336,200) Cash payments to employees and for other services3.............................................. (75,900) Cash payment for interest 4............................. (6,500) Paid income taxes 5.......................................... (17,000) Net cash provided by operating activities........ $60,400 Cash flows from investing activities: Equipment purchase....................................... (58,000) Net cash used by investing activities............... (58,000) Cash flows from financing activities: Cash received from short-term notes............ 20,000 Repayment of long-term liabilities................. (35,000) Cash received from stock issue..................... 40,000 Payment of dividends..................................... (16,000) Net cash provided by financing activities..... 9,000 Net increase in cash........................................... $11,400 1Cash collected from customers is sales revenue plus the decrease in accounts receivable ($481,000 + $15,000). 2Cash paid to suppliers is cost of goods sold plus the increase in inventory less the increase in accounts payable ($329,000 + $9,300 – $2,100). 3Cash paid to employees and for other services is expenses (wages and services) plus the decrease in wages payable ($71,000 + $4,900). 4Cash payments for interest is interest expense less the increase in interest payable ($12,000 – $5,500). 5Cash payments for income taxes is the amount of income taxes expense since there was no change reported in income taxes payable. Copyright © 1996 by McGraw-Hill, Inc. 676

677 E13-34.PREPARING A STATEMENT OF CASH FLOWS Cincinnati Health Club, Inc. Statement of Cash Flows For the Year Ended December 31, 19x9 Cash flows from operating activities: Net loss........................................................... $(7,300) Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense.............................. $28,000 Increase in accounts receivable, dues... (1,600) Increase in inventory................................ (1,200) Increase in accounts payable.................. 19,200 Decrease in wages payable..................... (2,200) Decrease in income taxes payable......... (8,800) Total adjustments................ 33,400 Net cash provided by operating activities....... 26,100 Cash flows from investing activities: Equipment purchase..................................... (10,000) Net cash used by investing activities.............. (10,000) Cash flows from financing activities: Repayment of mortgage............................... (50,000) Cash received from stock issue.................. 30,000 Net cash used by financing activities.............. (20,000) Net decrease in cash......................................... (3,900) Cash at 12/31/x8................................................. 9,200 Cash at 12/31/x9................................................. $5,300 Copyright © 1996 by McGraw-Hill, Inc. 677

678 E13-35.PREPARING A STATEMENT OF CASH FLOWS Rowe Publishing Company Statement of Cash Flows For the Year Ended December 31, 19x5 Cash flows from operating activities: Cash collected from customers1.................. $1,042,000 Cash paid to suppliers2................................. (586,000) Cash payments to employees 3..................... (347,000) Cash payment for interest 4........................... (16,000) Paid income taxes 5........................................ (29,000) Net cash provided by operating activities...... $64,000 Cash flows from investing activities: Equipment purchase..................................... (25,000) Net cash used by investing activities............. (25,000) Cash flows from financing activities: Repayment of short-term notes................... (35,000) Cash received from mortgage...................... 50,000 Payment of dividends................................... (35,000) Net cash used by financing activities............. (20,000) Net increase in cash......................................... 19,000 Cash at 12/31/x4................................................ 66,000 Cash at 12/31/x5................................................ $85,000 1Cash collected from customers is sales revenue less the increase in accounts receivable ($1,051,000 – $9,000). 2Cash paid to suppliers is cost of goods sold plus the increase in inventory less the increase in accounts payable ($578,000 + $20,000 – $12,000). 3Cash paid to employees is salary expense less the increase in salaries payable ($351,000 – $4,000). 4Cash payments for interest is interest expense since there was no change in interest payable (zero at both year-ends). 5Cash payments for income taxes is the amount of income taxes expense plus the decrease in income taxes payable ($22,000 + $7,000). Copyright © 1996 by McGraw-Hill, Inc. 678

679 PROBLEMS P13-36.NET INCOME, CASH FLOWS, AND DIVIDENDS 1. Approximate amount of cash provided by operations: 19x9 19x8 Net income............................................... $608,000 $528,000 Decrease (increase) in accounts receivable.............................................. (900,000) 1,600,000 Depreciation expense............................. 610,000 597,000 Approximate cash provided (used) by operations............................................. $318,000 $2,725,000 2. Although dividends should be viewed as distributions of income to stockholders, they must be paid in cash. Further, as the company’s experience indicates, cash flow and net income do not always move together. In particular, the company is short of cash as a result of the retirement of long-term debt and the increase in accounts receivable. Stockholders’ attention should be directed to the cash flow statement. This statement shows the effect of the increase in accounts receivable on cash flow from operations and also the effect on cash of the outflow for the retirement of debt. Copyright © 1996 by McGraw-Hill, Inc. 679

680 P13-37. DIRECT DEVELOPMENT OF A STATEMENT OF CASH FLOWS Transworld Export Statement of Cash Flows Cash flows from operating activities: Cash collected from customers1.................. $ 978,000 Cash paid to suppliers2................................. (657,000) Cash payments for operating and financial expenses...................................... (307,000) Net cash provided by operating activities.... $14,000 Cash flows from investing activities: Equipment purchase..................................... (37,000) Net cash used by investing activities............ (37,000) Cash flows from financing activities: Repaid long-term note.................................. (10,000) Cash received from stock issue.................. 25,000 Paid cash dividends...................................... (7,000) Net cash provided by financing activities...... 8,000 Net decrease in cash........................................ $(15,000) 1Cash collected from customers is the amount of the collections of accounts receivable. 2Cash paid to suppliers is the amount of the payments on accounts payable. Copyright © 1996 by McGraw-Hill, Inc. 680

681 P13-38. PREPARATION OF A STATEMENT OF CASH FLOWS FROM BALANCE SHEET DATA Endicott & Thurston Associates Statement of Cash Flows For the Year Ended December 31, 19x4 Cash flows from operating activities: Net income............................................................. $ 70,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense..................................... $42,000 Loss on sale of computing equipment 1......... 15,000 Loss on sale of investments 2......................... 2,000 Decrease in accounts receivable................... 141,000 Decrease in prepaid rent................................. 75,000 Decrease in accounts payable....................... (2,000) Decrease in salaries payable.......................... (16,000) Total adjustments....................... 257,000 Net cash provided by operating activities 327,000 Cash flows from investing activities: Purchase of office furniture................................... (35,000) Proceeds, sale of computing equipment............. 5,000 Computing equipment purchase.......................... (376,000) Proceeds, sale of investments.............................. 18,000 Purchase of investments....................................... (31,000) Net cash used by investing activities..................... (419,000) Cash flows from financing activities: Repayment of long-term note................................ (25,000) Cash raised from equipment mortgage................ 140,000 Payment of dividends............................................ (38,000) Net cash provided by financing activities 77,000 Net decrease in cash (15,000) Cash at 12/31/x3 17,000 Cash at 12/31/x4 $ 2,000 Footnote explanations on next page. Copyright © 1996 by McGraw-Hill, Inc. 681

682 P13-38. (continued) 1The computing equipment sold had a book value of $20,000 ($250,000 – $230,000). The proceeds from the sale were $5,000. Therefore, there was a loss of $15,000 ($5,000 - $20,000). Losses are added to net income because they do not consume cash. 2The loss on the sale of the investments is added to net income because it does not consume cash. P13-39. PREPARATION OF A STATEMENT OF CASH FLOWS Yogurt Plus Statement of Cash Flows For the Year Ended December 31, 19x9 Cash flows from operating activities: Cash collected from customers.................... $ 379,000 Cash paid to suppliers................................... (203,000) Cash payments for operating expenses...... (125,000) Cash payments for interest........................... (22,000) Cash payments for income taxes................. (8,000) Net cash provided by operating activities....... $21,000 Cash flows from investing activities: Proceeds from sale of fixtures...................... 13,000 Restaurant fixture purchase.......................... (105,000) Net cash used by investing activities.............. (92,000) Cash flows from financing activities: Proceeds from stock issue............................ 50,000 Proceeds from issue of long-term notes...... 40,000 Proceeds from issue of short-term notes.... 35,000 Principal payment on mortgage.................... (35,000) Paid cash dividends....................................... (6,000) Net cash provided by financing activities....... 84,000 Net increase in cash.......................................... $13,000 In addition, a supplementary schedule should report the $30,000 acquisition of kitchen equipment in exchange for notes. P13-40. USING FINANCIAL STATEMENTS AND TRANSACTIONS Copyright © 1996 by McGraw-Hill, Inc. 682

683 DATA TO PREPARE A STATEMENT OF CASH FLOWS Erie Company Statement of Cash Flows For the Year Ended December 31, 19x7 Cash flows from operating activities: Net income........................................................... $20,500 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense................................... $18,900 Gain on sale of equipment 1.......................... (2,300) Gain on sale of investments 2....................... (4,100) Increase in accounts receivable.................. (8,000) Increase in inventory.................................... (2,000) Decrease in prepaid rent.............................. 4,000 Decrease in accounts payable..................... (1,100) Increase in salaries payable......................... 2,500 Decrease in interest payable........................ (1,300) Increase in income taxes payable............... 1,900 Total adjustments.................................... 8,500 Net cash provided by operating activities 29,000 Cash flows from investing activities: Proceeds, sale of equipment.............................. 3,800 Purchase of equipment....................................... (27,000) Proceeds from sale of investments.................... 39,100 Purchase of investments..................................... (20,800) Net cash used by investing activities (4,900) Cash flows from financing activities: Repayment of long-term note............................. (25,000) Proceeds from stock issue................................. 30,000 Payment of dividends.......................................... (7,900) Net cash used by financing activities (2,900) Net increase in cash $21,200 Footnote explanations on next page. Copyright © 1996 by McGraw-Hill, Inc. 683

684 P13-40. (continued) 1The equipment sold had a book value of $1,500 ($15,000 – $13,500). The gain on the sale was $2,300 ($3,800 - $1,500). Gains are subtracted from net income because they do not provide a cash inflow in excess of the proceeds which are included in the investments portion of the statement. 2The gain from the sale of the investments is subtracted from net income. Copyright © 1996 by McGraw-Hill, Inc. 684

685 P13-41.PREPARATION AND ANALYSIS OF A STATEMENT OF CASH FLOWS 1.SDPS, Inc. Statement of Cash Flows For the Year Ended December 31, 19x6 Cash flows from operating activities: Cash collected from customers1................... $920,000 Cash paid for wages2..................................... (285,000) Cash paid for rent3......................................... (188,000) Cash paid for fuel4.......................................... (24,000) Cash paid for maintenance5.......................... (131,000) Cash payments for interest6.......................... (14,000) Net cash provided by operating activities....... $278,000 Cash flows from investing activities: Proceeds from sale of vehicles..................... 130,000 Vehicles purchased........................................ (425,000) Net cash used by investing activities.............. (295,000) Cash flows from financing activities: Principal payment on long-term note .......... (25,000) Net cash used by financing activities.............. (25,000) Net decrease in cash......................................... (42,000) Cash, 12/31/x5.................................................... 82,000 Cash, 12/31/x6.................................................... $ 40,000 1Cash collected from customers is service revenue less the increase in accounts receivable ($937,000 – $17,000). 2Cash paid to employees is the amount of wages expense plus the decrease in wages payable ($278,000 + $7,000). 3Cash paid for rent is the amount of rent expense less the increase in rent payable ($229,000 - $41,000). 4Cash paid for fuel is the amount of fuel expense less the decrease in fuel inventory less the increase in accounts payable ($83,000 - $14,000 - $45,000). 5Cash paid for maintenance is the amount of maintenance expense less the increase in maintenance services payable ($138,000 - $7,000). 6Cash paid for interest is interest expense since there was no change in interest payable (zero at both year-ends). Copyright © 1996 by McGraw-Hill, Inc. 685

686 P13-41. (continued) 2. Cash decreased primarily because of the large purchase of vehicles. A smaller factor was the cash paid to decrease the mortgage. 3. It would appear that SDPS has partially financed its increase in net property by allowing its current liabilities to increase. P13-42. REORGANIZING A STATEMENT OF CASH FLOWS Befuddled Corporation Statement of Cash Flows For the Year Ended December 31, 19x2 Cash flows from operating activities: Cash collected from customers................... $941,500 Cash paid to suppliers.................................. (523,900) Cash payments for operating expenses..... (173,200) Cash payments for interest.......................... (38,600) Cash payments for income taxes................ (41,300) Net cash provided by operating activities...... $164,500 Cash flows from investing activities: Proceeds from sale of equipment................ 7,000 Vehicles purchased...................................... (209,000) Net cash used by investing activities............. (202,000) Cash flows from financing activities: Proceeds from issue of notes...................... 50,000 Repayment of short-term notes................... (15,000) Payment of dividends .................................. (48,000) Net cash used by financing activities............. (13,000) Net decrease in cash........................................ $(50,500) Copyright © 1996 by McGraw-Hill, Inc. 686

687 P13-43. PREPARING A STATEMENT OF CASH FLOWS Monon Cable Television Company Statement of Cash Flows For the Year Ended December 31, 19x9 Cash flows from operating activities: Cash collected from customers1..................... $518,700 Cash payments for wages, utilities, and supplies2.................................................. (123,000) Cash payments for royalties3.......................... (239,800) Cash payments for pole rental4....................... (16,700) Cash payments for building rental5................ (71,000) Cash payments for interest6............................ (1,800) Cash payments for income taxes6.................. (9,000) Net cash provided by operating activities........ $57,400 Cash flows from investing activities: Proceeds from sale of antenna....................... 1,800 Antenna purchased.......................................... (60,000) Equipment purchased...................................... (20,000) Wiring purchased............................................. (6,000) Net cash used by investing activities................ (84,200) Cash flows from financing activities: Proceeds from issue of long-term note.......... 40,000 Payment of dividends ...................................... (14,200) Net cash provided by financing activities.......... 25,800 Net decrease in cash........................................... $(1,000) 1Cash collected from customers is service revenue less the $300 ($11,300 – $11,000) increase in accounts receivable. 2Cash payments for wages, utilities, and supplies is wages expense plus utility expense plus supplies expense plus the decrease in accounts payable less the decrease in supplies inventory ($26,000 + $83,000 + $13,000 + $1,500 - $500). 3Cash payments for royalties is the amount of royalty expense less the increase in royalties payable ($240,000 - $200). 4Cash payments for pole rentals is the amount of pole rental expense less the increase in pole rent payable ($17,000 - $300). Copyright © 1996 by McGraw-Hill, Inc. 687

688 P13-43. (continued) 5Cash payments for building rent is the amount of building rental expense plus the decrease in building rent payable ($62,000 + $9,000). 6Cash paid for interest and income taxes is interest expense and income taxes expense since there was no change in interest or taxes payable (zero at both year-ends). P13-44. THE STATEMENT OF CASH FLOWS AND CREDIT ANALYSIS 1. No. Depreciation expense just about equals the investment in new equipment for the 2 years. Depreciation Investment 19x8 $37,000 $40,000 19x9 41,000 45,000 Total $78,000 $85,000 2. June should be able to secure the loan. Cash provided by operations is stable and is providing more resources than are needed to pay dividends, repay current debt, and replace operating assets being consumed. 3. If the second store is as profitable as the current store, then $25,000 to $30,000 in additional resources ought to be available from that store each year to add to the $25,000 to $30,000 being generated from the current store. If resources provided by operations from both stores are used to repay the loan, 3 to 4 years would be required to repay the loan plus interest. Copyright © 1996 by McGraw-Hill, Inc. 688

689 P13-45. FIRST-YEAR STATEMENT OF CASH FLOWS 1. Fleet Limousine Service, Inc. Statement of Cash Flows For the Accounting Period (10 months) Ended December 31, 19x6 Cash flows from operating activities: Net loss.................................................................. $(32,200) Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense....................................... $35,500 Increase in accounts receivable...................... (15,900) Increase in supplies inventory ....................... (3,100) Increase in accounts payable.......................... 12,700 Increase in unearned revenue......................... 21,800 Increase in wages payable............................... 4,600 Increase in rent payable................................... 8,200 Total adjustments........................................... 63,800 Net cash provided by operating activities............. 31,600 Cash flows from investing activities: Purchase of land................................................... (11,000) Purchase of building............................................. (175,000) Purchase of equipment......................................... (233,400) Net cash used by investing activities.................... (419,400) Cash flows from financing activities: Proceeds from long-term note.............................. 100,000 Proceeds from stock issue.................................... 300,000 Partial repayment of long-term note................ (5,000) Net cash used by financing activities.............. 395,000 Net increase in cash.......................................... $ 7,200 2. These newly acquired assets are expected to provide operating cash flows over a long period of time. Fleet secured the resources for that investment from creditors and stockholders who expect returns on their cash over a long period of time. Therefore, one may conclude that Fleet has matched the timing of its prospective inflows of cash (generated by long-lived assets) and its future outflows of cash (required to repay its bondholders and stockholders). Copyright © 1996 by McGraw-Hill, Inc. 689

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