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Chapter 13

LEARNING OBJECTIVES
1 2 3 4
Explain the purposes of the statement of cash flows and describe its elements. Distinguish among operating, investing, and financing cash flows. Prepare a statement of cash flows by the indirect method. Prepare a statement of cash flows by the direct method.

Special Section
To demonstrate the projects in this chapter, use the Special Section located at the end of this binder. Included in this section are Demo Docs and Textbook Exercises.

13

688

The Statement of Cash Flows


recent commercial for a credit card company asked, Whats in your wallet? Credit cards are a convenient way to buy what you want or need, but it ultimately takes cash to pay the bills. Do you know how much cash you have in your checking and savings accounts? Do you know how much cash you received last year? On what did you spend your cash? You may borrow money for a large purchase, like a car, but if you have to borrow money for everyday living expenses, you are in trouble. Businesses face the same issues that individuals do. They need enough cash flowing in to pay the bills and run their operations. When companies want to purchase land, a building, or equipment, they need to determine the source of the funds they will use to make the investment. If businesses want to finance the investment by borrowing money or issuing stock, they need to show lenders and stockholders that they can manage their cash well.

Look Back
In previous chapters, you examined the accounting for assets, liabilities, and equity of business organizations. You witnessed how these items are reported on the balance sheet, and how the accounting for these balance sheet elements affects the income statement.

Look Ahead
Switching focus, you will discover how cash flows are reported on the statement of cash flows. You will consider the various elements of cash flows, and see how increases and decreases in cash from operations can be presented by two different methods.

Recall from Chapter 1 that liquidity, the ability to pay bills in a timely manner, is one of
the primary goals of businesses, and that business activity is divided among operating, investing, and financing activities. With the importance of this goal in mind, we study cash flows in this chapter because understanding cash flows is vital for making good business decisions. We will see how to prepare the statement of cash flows by categorizing cash receipts and disbursements into the three areas of business activity. We first explain the format for the statement of cash flows used by the vast majority of companies, called the indirect method, then turn our attention to the alternate format, the direct method. Finally, using the statement as the basis for cash flow analysis, we will discuss how to interpret cash flow information.

Basic Concepts: Statement of Cash Flows


1
Explain the purposes of the statement of cash flows and describe its elements.

A balance sheet reports financial position, and balance sheets for two periods show whether cash increased or decreased. For example, Avery Corporations comparative balance sheet reported the following:
Increase 2007 (Decrease) $42,000 $(20,000)

Cash

2008 $22,000

You can see that Averys cash decreased by $20,000 during 2008, but the balance sheet doesnt show why cash decreased. The statement of cash flows introduced in Chapter 1 reports cash flows, cash receipts and cash payments, during the period. It shows where cash came from and where it went. It explains the causes of the change in cash during any given time period and is therefore dated Year Ended December 31, 2008 or Month Ended June 30, 2008. Exhibit 13-1 illustrates the time element of each financial statement.

Exhibit 13-1
December 31, 2007 (a point in time)

Timing of the Financial Statements


For the Year Ended December 31, 2008 (a period of time) December 31, 2008 (a point in time)

Income Statement Statement of Stockholders Equity Statement of Cash Flows

Balance Sheet

Balance Sheet

The Statement of Cash Flows 691

The statement of cash flows serves several purposes: 1. Predicts future cash flows. Past cash receipts and payments are good predictors of future cash flows. 2. Evaluates management decisions. If managers make wise decisions, the business prospers. If they make unwise choices, the business suffers. The statement of cash flows reports cash flows resulting from the operating, investing, and financing decisions the company is making. Stakeholders use cash flow information to evaluate managers decisions. 3. Predicts ability to make debt payments to lenders and to pay dividends to stockholders. Lenders want to collect interest and principal on their loans. Stockholders want dividends on their investments. The statement of cash flows helps predict whether the business can make these payments. On a statement of cash flows, Cash means more than just cash on hand and cash in the bank. Recall from Chapter 6 that it includes cash equivalents, highly liquid short-term investments that can be readily converted into cash. Examples of cash equivalents are money-market funds, certificates of deposit, and investments in U.S. government securities. Businesses invest cash in liquid assets rather than let the cash remain idle. Throughout this chapter, the term cash refers to cash and cash equivalents.

In Class Tip
Cash equivalents must be able to be converted into known amounts of cash and mature within three months of purchase. Stocks and bonds would not be considered cash equivalents because the amount of cash they can be converted into varies from day to day.

Operating, Investing, and Financing Activities


Consider that businesses engage in three types of activities affecting cash flows: Operating activities create revenues, expenses, gains, and losses, and thus include the daily activities of buying and selling products and services. In addition to staying liquid, the other, major goal of businesses is to operate profitably; these operating activities are the business events that affect net income on the income statement as the result of accrual accounting. Because companies use resources and incur debt to run on a daily basis, operating activities also affect the current assets and current liabilities shown on the balance sheet. Operating activities are the most important of the three categories of cash flows. A successful business must generate most of its cash from day-to-day operations. Individuals can only borrow money without repayment or sell assets for a limited amount of time before they find that no one is willing to lend to them any longer or before they run out of items to sell. Accordingly, to survive, businesses need to be able to generate cash from profitable operations. The statement of cash flows reports the cash effects of these operating activities. Investing activities increase and decrease long-term assets, such as land, buildings, and equipment, and even stock investments in other entities. The purchases and sales of these assets are investing activities. Loans to others and collections of loans are also investing activities. Investing activities are less vital to the life of the business than operating activities. Financing activities obtain cash to launch a business and keep it running. Financing includes issuing stock, borrowing money, buying and selling

Distinguish among operating, investing, and financing cash flows.

Pitfalls to Avoid
Transactions that create gains and losses often include the sale of property, plant, and equipment. The proceeds from these activities are investing activities. Losses and gains may appear under the operating activities section to eliminate them from net income as per Exhibit 13-4 (p. 694).

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In Class Tip
Operating activities are similar to the routine inflows and outflows students experience in their personal lives. They need to receive enough cash from their jobs to cover everyday expenditures. When a shortfall occurs, options may include borrowing money or selling some of their assets as a temporary stopgap measure. Because these options are short-lived, it is critical to maintain a positive operating cash inflow.

treasury stock, and paying dividends. Paying off borrowings is another financing activity. Financing cash flows relate to long-term liabilities and owners equity. They are the least important of the three categories of cash flows, which is why they are reported last. Exhibit 13-2 shows the relationship between operating, investing, and financing activities and the various parts of the balance sheet.

Exhibit 13-2
Operating Cash Flows Investing Cash Flows

Operating, Investing, and Financing Cash Flows and the Balance Sheet Accounts
Current Assets Current Liabilities Long-Term Liabilities Long-Term Assets Owners Equity Operating Cash Flows Financing Cash Flows

Pitfalls to Avoid
The purchase of some stocks and bonds would also be reported as an investing activity. But the related dividend and interest received must be included as an operating activity. Operating activities include the cash flow impact of transactions that affect net income, such as dividend and interest revenue.

Two Formats for Operating Activities


Accountants can report operating activities on the statement of cash flows in either or two formats: The indirect method, which reconciles net income to net cash provided by operating activities. The direct method, which reports all cash receipts and cash payments from operating activities. The two methods use different computations but produce the same amount of

Pitfalls to Avoid

Paying off the loan is a cash flows from operations. The indirect and direct methods have no effect on financing activity, but the investing or financing activities. The following table uses assumed dollar amounts interest payment related to the to summarize the differences between these approaches for operating activities: loan is an operating activity. Operating activities include the cash flow impact of Indirect Method Direct Method transactions Net income ................................ $300 Collections from customers ................. $ 900 that affect net Adjustments: Deductions: income, such as interest Depreciation, etc ................... 100 Payments to suppliers, etc. ............. (500) expense.

Net cash provided by operating activities ...............

$400

Net cash provided by operating activities..........................

$ 400

FYI
GAAP requires that the indirect method be shown in a separate schedule if the direct method is chosen to be included in the statement of cash flows.

Noncash Investing and Financing Activities


Companies sometimes make investments that do not require cash. They also finance without exchanging cash. Examples of investing and financing activities that do not require cash include: Acquisition of an asset by issuing common stock

The Statement of Cash Flows 693

Acquisition of an asset by issuing a note payable Payment of note payable by issuing common stock These transactions are not reflected on the statement of cash flows, but they are important business events. Noncash investing and financing activities can be reported in a separate schedule that accompanies the statement of cash flows or disclosed in a note.

Preparing the Statement of Cash Flows by the Indirect Method


To prepare the statement of cash flows, you need data from the income statement and the balance sheet. Imagine Avery Corporation, an office and home furniture retailer. Suppose Exhibit 13-3 shows Averys balance sheet as of December 31, 2007 and 2008. Also suppose that Exhibit 13-4 presents Averys income statement for the year ended December 31, 2008.

Prepare a statement of cash flows by the indirect method.

Exhibit 13-3

Comparative Balance Sheet AVERY CORPORATION Comparative Balance Sheet December 31, 2008 and 2007 Increase 2008 2007 (Decrease)

(In thousands) Assets Current: Cash Accounts receivable Inventory Plant assets, net of depreciation Total assets Liabilities Current: Accounts payable Accrued liabilities Long-term notes payable Stockholders Equity Common stock Retained earnings Total liabilities and stockholders equity

Type of Activity

$ 22 $ 42 96 81 143 145 464 219 $725 $487

$ (20) 15 (2) 245 $238

Changes in current assetsOperating Changes in noncurrent assetsInvesting

$ 91 $ 57 5 9 160 77 359 110 258 86

$ 34 (4) 83 101 24

Changes in current liabilitiesOperating Changes in long-term liabilities and common stockFinancing Change due to net incomeOperating Change due to dividendsFinancing

$725 $487

$238

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Exhibit 13-4

Income Statement AVERY CORPORATION Income Statement Year Ended December 31, 2008

(In thousands) Revenues and gains: Sales revenue Interest revenue Dividend revenue Gain on sale of plant assets Total revenues and gains Expenses: Cost of goods sold Salary and wage expense Depreciation expense Other operating expenses Interest expense Income tax expense Total expenses Net income

$284 12 9 8 $313 $150 56 18 17 16 15 272 $ 41

To prepare the statement of cash flows by the indirect method, use information from preceding financial statements to perform the following steps: STEP 1 Lay out the template as shown in Exhibit 13-5. The exhibit is comprehensive. Steps 2 to 4 will complete the statement of cash flows. STEP 2 Use the comparative balance sheet to determine the increase or decrease in cash. The change in cash is the check figure for the statement of cash flows. Exhibit 13-3 gives the comparative balance sheet of Avery Corporation at December 31, 2008 and 2007, with cash highlighted. Averys cash decreased by $20,000 during 2008. STEP 3 From the income statement, take net income, depreciation, depletion, and amortization expense, and any gains or losses on the sale of assets. Exhibit 13-4 gives the income statement of Avery Corporation for the year ended December 31, 2008, with relevant items highlighted. STEP 4 Use data from the income statement and balance sheet to complete the statement of cash flows. The statement is complete only after the year-to-year changes in all balance sheet accounts have been explained. Lets apply these steps to prepare the operating activities section of Avery Corporations statement of cash flows. Exhibit 13-6 gives the operating activities section of the statement.

FYI
Many transactions affect the Cash account, which makes it difficult to obtain the necessary information from analyzing that one account. Double-entry accounting ensures that if Cash is affected by a transaction, then another balance sheet account is also affected. Its more efficient to analyze the yearto-year changes in the other balance sheet accounts.

The Statement of Cash Flows 695

Exhibit 13-5

Template of the Statement of Cash Flows: Indirect Method AVERY CORPORATION Statement of Cash Flows Year Ended December 31, 2008

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: + Depreciation/amortization/depletion expense + Loss on sale of long-term assets Gain on sale of long-term assets Increases in current assets other than cash + Decreases in current assets other than cash + Increases in current liabilities Decreases in current liabilities Net cash provided by (used for) operating activities Cash flows from investing activities: Proceeds from sale of long-term assets Purchase of long-term assets Net cash provided by (used for) investing activities Cash flows from financing activities: Proceeds from issuance of stock + Proceeds from sale of treasury stock Purchase of treasury stock + Proceeds from issuance of notes or bonds payable Payment of notes or bonds payable Payment of dividends Net cash provided by (used for) financing activities Net increase (decrease) in cash during the year + Cash at December 31, 2007 = Cash at December 31, 2008

Exhibit 13-6

Statement of Cash FlowsOperating Activities: Indirect Method

AVERY CORPORATION Statement of Cash Flows: Operating Activities Only Year Ended December 31, 2008 (In thousands) Cash flows from operating activities: Net income Adjustments to reconcile net income to net Cash provided by operating activities: 1 Depreciation 2 Gain on sale of plant assets 3 Increase in accounts receivable Decrease in inventory Increase in accounts payable Decrease in accrued liabilities Net cash provided by operating activities $41

$18 (8) (15) 2 34 (4)

27 $68

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Cash Flows from Operating Activities


The operating section of the cash flow statement begins with net income, taken from the income statement (Exhibit 13-4). Additions and subtractions, which follow, are labeled Adjustments to reconcile net income to net cash provided by operating activities. Operating activities are related to the transactions that determine net income: Revenues, expenses, gains, and losses. 1. Depreciation, Depletion, and Amortization Expenses These expenses do not affect cash, and are sometimes referred to as noncash expenses. They are added back to net income to reconcile net income to cash flow. To see why, lets examine the journal entry for depreciation. Depreciation, for example, is recorded as follows:
Journal Entry: Date Accounts Dec. 31 Depreciation Expense Accumulated Depreciation Record depreciation. Post Ref. Dr. 18,000 Cr. 18,000

You can see that recording depreciation does not affect cash. However, depreciation, like all other expenses, decreases net income. Therefore, in converting accrual basis net income to net cash provided by operating activities, we add depreciation back to net income. The add-back cancels the earlier deduction of the expense. Lets consider this issue further through an example. Suppose a company had only two transactions during the period, a $1,000 cash sale to a customer and depreciation expense of $300. Net income is $700 ($1,000 $300), but cash flow from operations is $1,000. To reconcile net income of $700 to the cash flow of $1,000, add back depreciation of $300. Similarly, depletion and amortization must also be added back to net income. 2. Gains and Losses on the Sale of Long-Term Assets Sales of long-term assets are investing activities. A gain or loss on a sale is included in net income in the operating activities section and therefore must be adjusted out of net income on the statement of cash flows. Exhibit 13-6 includes an adjustment for a gain. Suppose that, during 2008, Avery sold equipment for $62,000. The equipments book value was $54,000, so Avery realized a gain of $8,000. The $62,000 sale is an investing cash flow, so the $8,000 gain on the sale must be removed from operating cash flow to show the entire proceeds from the sale in one section, as an investing activity cash flow. By making this adjustment, we avoid showing the $8,000 twice, once as part of the net income and again as part of the $62,000 proceeds from the sale. We explain investing activities in the next section. A loss on the sale of plant assets would be added back to net income. The cash received from selling the plant assets is then reported under investing activities. 3. Changes in the Current Asset and Current Liability Accounts Most current assets and current liabilities result from operating activities. For example, accounts receivable result from sales, inventory relates to cost of goods sold, and so on. Changes in the current accounts are reported

In Class Tip
Gains and losses on the sale of assets pertain to investing activities. We must delete them from the operating section.

In Class Tip
Use another example to illustrate the need to reduce a gain. Land with a cost of $54,000 was sold for $62,000 cash. The entry required would be: Cash 62,000 Land 54,000 Gain on Sale 8,000 The entire cash flow effect of $62,000 is shown as an investing activity (Exhibit 13-7, p. 698). An $8,000 reduction (see Exhibit 13-6, p. 695) is needed to eliminate the $8,000 gain (see Exhibit 13-4, p. 694) included in the net income of $41,000.

The Statement of Cash Flows 697

as adjustments to net income on the cash flow statement. The reasoning follows: 1. An increase in a current asset other than cash means a decrease in cash. It takes cash to acquire assets. If Accounts Receivable, Inventory, or Prepaid Expenses increase during the period, subtract the increase from net income to measure cash flow from operations. True, current assets like inventory may be purchased on credit, but this increase in liabilities would be captured separate from the increase in assets. 2. A decrease in a current asset other than cash means an increase in cash. Suppose Averys Accounts Receivable decreased by $4,000. Avery must have collected on the Accounts Receivable. Therefore, add decreases in Accounts Receivable and the other current assets to net income. 3. A decrease in a current liability means a decrease in cash. The payment of a current liability causes cash to decrease. Therefore, subtract decreases in current liabilities from net income. 4. An increase in a current liability means an increase in cash. Averys Accounts Payable increased, which means that cash was not spent to pay this liability, so Avery has more cash on hand. Thus, increases in current liabilities are added to net income. EVALUATING CASH FLOWS FROM OPERATING ACTIVITIES During 2008, Avery Corporations operations provided net cash flow of $68,000. This amount exceeds net income, as it should because of the add-back of depreciation and other adjustments. However, to fully evaluate a companys cash flows, you must also examine its investing and financing activities. Lets see how to report those cash flows, as shown in Exhibit 13-7, which imagines Averys complete statement of cash flows using the indirect method for presenting cash flows from operating activities.

On the Web
Students dont need to memorize these rules if they use T-accounts to determine the required adjustment to net income. Indicate the increase or decrease in the Current Asset and Liability accounts. Using a system of equal debits and credits, the offsetting entry is the adjustment required to reconcile net income to cash from operating activities. For an example of this, visit www.prenhall.com and retrieve Reference Document 13-1.

Cash Flows from Investing Activities


Investing activities affect long-term asset accounts, such as Plant Assets and Investments. Lets see how to compute the investing cash flows. COMPUTING ACQUISITIONS AND SALES OF PLANT ASSETS Companies keep separate accounts for Land, Buildings, Equipment, and other plant assets. But for computing investing cash flows, it is helpful to combine these accounts into a single Plant Assets account. Also, we subtract accumulated depreciation from the assets cost and work with a single net figure for plant assets. This practice simplifies the computations. To understand this concept, observe the following about Avery Corporations financial statements: The comparative balance sheet reports beginning plant assets, net of depreciation, of $219,000 and an ending net amount of $464,000 (Exhibit 13-3). Remember that the beginning balance for the current year is the ending balance for the previous year, 2007. The income statement shows depreciation expense of $18,000 and an $8,000 gain on sale of plant assets (Exhibit 13-4).

Q&A
Q: A company in financial distress might sell off one of its profitable divisions to boost net income. How would the statement of cash flows help an investor to recognize this event as a one-time boost? A: The large cash inflow would be in the investing section rather than the operating section.

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Further, Avery knows the acquisitions of plant assets total $317,000. What we dont know, however, is the amount of the cash proceeds from the sale of plant assets. To determine this, we first find the book value of plant assets sold, as follows: Plant Assets (Net of Depreciation) Beginning Balance $219,000 + + Acquisitions $317,000 Depreciation $18,000 Book Value of Assets Sold x x x = = = = Ending Balance $464,000 $464,000 $219,000 $317,000 + $18,000 $54,000

Now we can compute the sale proceeds: Sale Proceeds Book Value of Assets Sold $54,000 $62,000 + + Gain, or $8,000 Loss $0

= = =

Trace the sale proceeds of $62,000 to the statement of cash flows in Exhibit 13-7. If the sale resulted in a loss of $3,000, the sale proceeds would be $51,000 ($54,000 $3,000), and the statement of cash flows would report $51,000 as a cash receipt from this investing activity. The Plant Assets T-account provides another look at the computation of the book value of the assets sold:
Plant Assets (Net of Depreciation) Beginning balance Acquisitions Ending balance 219,000 317,000 464,000 Depreciation Book value of assets sold 18,000 54,000

Proceeds from the sale of an asset can be computed as follows: Proceeds = Book Value of Assets Sold + Gain, or Loss The information used to find the book value of the assets sold comes from the balance sheet; the gain or loss comes from the income statement. Exhibit 13-8 summarizes the computation of the investing cash flows.

Cash Flows from Financing Activities


Financing activities affect the liability and stockholders equity accounts, such as Long-Term Notes Payable, Bonds Payable, Common Stock, and Retained Earnings. COMPUTING ISSUANCES AND PAYMENTS OF LONG-TERM NOTES PAYABLE In computing the cash flows related to the issuance and payment of long-term debt, the beginning and ending balances of Long-Term Notes Payable or Bonds

The Statement of Cash Flows 699

Exhibit 13-7

Statement of Cash Flows: Indirect Method AVERY CORPORATION Statement of Cash Flows Year Ended December 31, 2008 (In thousands)

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: 1 Depreciation 2 Gain on sale of plant assets 3 Increase in accounts receivable Decrease in inventory Increase in accounts payable Decrease in accrued liabilities Net cash provided by operating activities Cash flows from investing activities: Acquisition of plant assets Proceeds from sale of plant assets Net cash used for investing activities Cash flows from financing activities: Proceeds from issuance of common stock Proceeds from issuance of long-term notes payable Payment of long-term notes payable Payment of dividends Net cash provided by financing activities Net decrease in cash Cash balance, December 31, 2007 Cash balance, December 31, 2008

$41

$18 (8) (15) 2 34 (4)

27 68

$(317) 62 (255) $101 94 (11) (17) 167 $(20) 42 $ 22

Exhibit 13-8
Receipts

Computing Cash Flows from Investing Activities Book Value of Ending Plant Beginning Plant Acquisitions Depreciation Assets Sold Assets (net) Assets (net) Gain on Sale Book Value of Sale proceeds or Assets Sold Loss on Sale

From sale of plant assets

Payments For acquisition of plant assets Book Value of Ending Plant Beginning Plant Acquisitions Depreciation Assets Sold Assets (net) Assets (net)

Payable are taken from the balance sheet. If either the amount of new issuances or the payments is known, the other amount can be calculated. For Avery Corporation, suppose new issuances of notes payable total $94,000. To compute the amount of debt payments, we use the Long-Term Notes Payable account, with amounts from Avery Corporations balance sheet in Exhibit 13-3:

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Long-Term Notes Payable Beginning Balance $77,000 + + Issuance of New Notes Payable $94,000 Payment of Notes Payable x x x Another view:
Long-Term Notes Payable Beginning balance Payment of notes payable 11,000 Issuance of new notes payable Ending balance 77,000

= = = =

Ending Balance $160,000 $160,000 $77,000 $94,000 $11,000

94,000 160,000

COMPUTING ISSUANCES OF STOCK AND PURCHASES OF TREASURY STOCK Cash flows for these financing activities can be determined by analyzing the stock accounts. For example, the amount of a new issuance of common stock is determined from Common Stock. Using data from Exhibits 13-4 and 13-7: Common Stock Beginning Balance $ 258,000 Another view:
Common Stock Beginning balance Issuance of new stock Ending balance 258,000 101,000 359,000

+ +

Issuance of New Stock $101,000

= =

Ending Balance $359,000

Although the Avery Corporation example does not show any treasury stock transactions, cash flows affecting Treasury Stock can be analyzed as follows using amounts assumed just for this illustration: Treasury Stock (Amounts assumed for illustration only) Beginning Balance $16,000 Another view:
Treasury Stock Beginning balance Purchase of treasury stock Ending balance 16,000 3,000 19,000

+ +

Purchase of Treasury Stock $3,000

= =

Ending Balance $19,000

The Statement of Cash Flows 701

COMPUTING DIVIDEND PAYMENTS The amount of dividend payments can be computed by analyzing Retained Earnings.

Retained Earnings Beginning Balance $86,000 + + Net Income $41,000 Dividends x x x = = = = Ending Balance $110,000 $110,000 $86,000 $41,000 $17,000

Pitfalls to Avoid
Students should be reminded that dividends may be declared but unpaid at the financial statement date. Changes in the Dividends Payable account, if any, will need to be analyzed to determine the amount of dividends paid.

The following T-accounts provide another view:


Retained Earnings Dividends 17,000 Beginning balance 86,000 Net income 41,000 Ending balance 110,000

Recall from Chapter 11 that a stock dividend is a distribution of stock shares. Hence, a stock dividend has no effect on Cash and is not reported on the cash flow statement. Exhibit 13-9 summarizes the computation of cash flows from financing activities, highlighted in color.

Exhibit 13-9

Computing Cash Flows from Financing Activities

Receipts From issuance of long-term notes payable From issuance of stock Payments Of long-term notes payable For purchase of treasury stock Of dividends

Beginning Notes Payable Beginning Stock

Issuance of New Notes Payable Issuance of New Stock

Payment of Notes Payable

Ending Notes Payable Ending Stock

Beginning Notes Payable Beginning Treasury Stock

Issuance of New Notes Payable Purchase of Treasury Stock Net Income

Payment of Ending Long-Term Notes Payable Notes Payable Ending Treasury Stock Dividends Ending Retained Earnings

Beginning Retained Earnings

Noncash Investing and Financing Activities


Our examples thus far included transactions that affect cash. Now suppose that Avery Corporation issued common stock of $320,000 to acquire a building. Avery would journalize this transaction as follows:

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Journal Entry: Date Accounts Building Common Stock Record acquisition of a building in exchange for common stock. Post Ref. Dr. 320,000 Cr. 320,000

This transaction would not be reported on the cash flow statement because Avery paid no cash. But the companys exchange of common stock for a building is an important transaction because of the large value of the exchange. Noncash investing and financing activities can be reported in a separate schedule that accompanies the statement of cash flows, as Exhibit 13-10 illustrates using amounts assumed for the purpose of creating an example. This information follows the cash flow statement or can be disclosed in a note that accompanies the financial statements.

Exhibit 13-10

Noncash Investing and Financing Activities (All amounts assumed) (in thousands)

Noncash investing and financing activities: Acquisition of building by issuing common stock Acquisition of land by issuing note payable Payment of note payable by issuing common stock Total noncash investing and financing activities

$320 70 100 $490

Preparing the Statement of Cash Flows by the Direct Method


4
Prepare a statement of cash flows by the direct method.

The Financial Accounting Standards Board (FASB), mentioned in Chapter 1 as the organization that determines how accounting is practiced in the United States, has expressed a preference for the direct method of reporting cash flows from operating activities. Unfortunately, few companies use this method because it takes more computations than the indirect method. A recent survey indicated that almost 80% of managers, investors, and analysts polled preferred the indirect method. However, the direct method provides clearer information about the sources and uses of cash. Remember that investing and financing cash flows are exactly the same regardless of whether the direct or indirect method is used to report operating cash flows. To illustrate the preparation of the statement of cash flows by the direct method, we will assume the same financial statement information for Avery Corporation. We need information from Averys comparative balance sheet (Exhibit 13-3), income statement (Exhibit 13-4), and cash-related transactions summarized in Exhibit 13-11.

The Statement of Cash Flows 703

Exhibit 13-11

Summary of Avery Corporations 2008 Cash-Related Transactions

Operating Activities 1 Collections from customers, $269,000 2 Cash receipt of interest revenue, $12,000 3 Cash receipt of dividend revenue, $9,000 4 Payments to suppliers, $135,000 5 Salary expense and payments, $56,000 6 Interest expense and payments, $16,000 7 Income tax expense and payments, $15,000 Investing Activities 8 Cash payments to acquire plant assets, $317,000 9 Proceeds from sale of plant assets, $62,000, including $8,000 gain Financing Activities 10 Proceeds from issuance of common stock, $101,000 11 Proceeds from issuance of long-term note payable, $94,000 12 Payment of long-term note payable, $11,000 13 Payment of cash dividends, $17,000

To help you see cash inflows and outflows for the direct method, think about the business activities that will increase or decrease the cash balance of a company. Exhibit 13-12 links Averys cash activity to the statement of cash flows. The cash activities are grouped by type of activity, as operating, investing, or financing activities. Each activity groups net cash amount equals its cash inflows minus its cash outflows. For example, net cash used for investing activities is $255. Averys cash outflow related to the acquisition of plant assets exceeded its cash inflow from the sales of plants assets ($317 $62). The net change in cash is the sum of the changes for each activity group. In 2008, Averys net cash flow decreased by $20 because the net cash used for investing activities, $255, exceeded the net cash provided by operating and financing activities, $68 + $167 = $235, by $20. The ending cash balance is the beginning cash balance adjusted for the net change in cash during the year. Averys ending cash balance of $22 equals the beginning cash balance of $42 less $20 for the net decrease in cash resulting from 2008s operating, investing, and financing activities. Now, lets take the following steps to prepare the statement of cash flows using the direct method to report cash flow from operating activities: STEP 1 Lay out the template of the statement of cash flows by the direct method, as shown in Exhibit 13-13. The format for the cash flows from operating activities is different from the format used in the indirect method, as shown in Exhibit 13-5. STEP 2 Use the comparative balance sheet to determine the increase or decrease in cash. The change in cash is the check figure for the statement of cash flows.

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Exhibit 13-12

Linking Avery Corporations Cash Activity to the Statement of Cash Flows: Direct Method Cash Outflows To suppliers To employees For interest For income tax Acquisition of plant assets Format for the Statement of Cash Flows: Direct Method 135 56 16 15 317

Inflows Collections from customers Interest received Dividends received

269 12 9

Net cash provided from operations Net cash used for investing activities Net cash provided by financing activities Net decrease Beginning cash balance Ending cash balance

$ 68

Sale of plant assets

62

(255)

Issued stock Issued notes payable

101 94

Payment of long-term note Payment of dividends

11 17

167 $(20) 42 $ 22

The comparative balance sheet of Avery Corporation at December 31, 2008 and 2007, shows that Averys cash decreased by $20,000 during 2008. See Exhibit 13-3. STEP 3 Use the available data, including the summary of Averys 2008 cash-related transactions as shown in Exhibit 13-11, to prepare the statement of cash flows. The statement of cash flows reports only those transactions with cash effects. Exhibit 13-14 gives Avery Corporations statement of cash flows for 2008 using the direct method to present cash flows from operating activities. Lets compare Exhibit 13-14 to Exhibit 13-7. Investing and financing cash flows are the same, so we do not need to review these two sections again. Instead, lets examine the cash flows from operating activities using the direct method, since this is the only section that differs between the two methods.

Cash Flows from Operating Activities


Again, operating cash flows are listed first because they are the most important source of cash. Exhibit 13-14 shows that Avery is sound; its operating activities were the largest source of cash receipts, $290,000 in total. Depreciation, depletion, and amortization expense are not listed on this version of the statement of cash flows because they do not affect cash. How did we compute the operating cash flows needed for the direct method and shown in Exhibit 13-11? We used the income statement and the changes in the related balance sheet accounts, as diagrammed in Exhibit 13-15. Data for computing Avery Corporations operating cash flows come from the income statement in Exhibit 13-4 and comparative balance sheet in Exhibit 13-3. COMPUTING CASH COLLECTIONS FROM CUSTOMERS Collections from customers can be computed by converting sales revenue, an amount computed according to the accrual basis of accounting, to the cash basis

The Statement of Cash Flows 705

Exhibit 13-13

Template of the Statement of Cash Flows: Direct Method

AVERY CORPORATION Statement of Cash Flows Year Ended December 31, 2008 Cash flows from operating activities: Receipts: Collections from customers Interest received Dividends received Total cash receipts Payments: To suppliers To employees For interest For income tax Total cash payments Net cash provided by (used for) operating activities Cash flows from investing activities: Proceeds from sale of long-term assets Purchase of long-term assets Net cash provided by (used for) investing activities Cash flows from financing activities: Proceeds from issuance of stock + Proceeds from sale of treasury stock Purchase of treasury stock + Proceeds from issuance of notes or bonds payable Payment of notes or bonds payable Payment of dividends Net cash provided by (used for) financing activities Net increase (decrease) in cash during the year + Cash at december 31, 2007 = Cash at december 31, 2008

amount. Avery Corporations income statement in Exhibit 13-4 reports sales of $284,000. But cash collections are different. Exhibit 13-3 shows that Accounts Receivable increased from $81,000 at the beginning of the year to $96,000 at yearend, a $15,000 increase. Based on those amounts, cash collections equal $269,000. Collections from Customers $269,000 Increase in Accounts Receivable $15,000

= =

Sales Revenue $284,000

COMPUTING PAYMENTS TO SUPPLIERS This computation includes two parts: Payments for inventory: Convert cost of goods sold to the cash basis using the amount from the income statement as well as Inventory and Accounts Payable information from the balance sheet. Payments for operating expenses: Convert other operating expenses from the income statement to the cash basis using accrued liabilities from the balance sheet. Throughout, all amounts come from Exhibits 13-3 and 13-4.

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Exhibit 13-14

Statement of Cash Flows: Direct Method AVERY CORPORATION Statement of Cash Flows Year Ended December 31, 2008 (In thousands)

Cash flows from operating activities: Receipts: Collections from customers Interest received Dividends received Total cash receipts Payments: To suppliers To employees For interest For income tax Total cash payments Net cash provided by operating activities Cash flows from investing activities: Acquisition of plant assets Proceeds from sale of plant assets Net cash used for investing activities Cash flows from financing activities: Proceeds from issuance of common stock Proceeds from issuance of long-term notes payable Payment of long-term notes payable Payment of dividends Net cash provided by financing activities Net decrease in cash Cash balance, December 31, 2007 Cash balance, December 31, 2008

$ 269 12 9 $290 $(135) (56) (16) (15) (222) 68 $(317) 62 (255) $ 101 94 (11) (17) 1 67 $ (20) 42 $ 22

Exhibit 13-15
Receipts/Payments Receipts: From customers

Computing Cash Flows from Operating Activities: Direct Method Income Statement Account or Change in Related Balance Sheet Account

Sales Revenue

Decrease in Accounts Receivable Increase in Accounts Receivable

Payments: To suppliers Cost of Goods Sold Increase in Inventory Decrease in Inventory Increase in Prepaids Decrease in Prepaids Decrease in Accounts Payable Increase in Accounts Payable Decrease in Accrued Liabilities Increase in Accrued Liabilities

Operating Expense

The Statement of Cash Flows 707

Payments for Inventory $114,000

= =

Cost of Goods Sold $150,000

Decrease in Inventory $2,000

Increase in Accounts Payable $34,000

Payments for Operating Expenses $21,000 Payments to Suppliers $135,000

= =

Other Operating Expense $17,000

+ +

Decrease in Accrued Liabilities $4,000 Payments for Operating Expenses $21,000

= =

Payments for Inventory + $114,000 +

Keep in mind that Averys Statement of Cash Flows for 2008 shows the same information for cash flows from investing and financing activities when you compare Exhibit 13-7 prepared using the indirect method to Exhibit 13-14 assembled according to the direct method.

Demo Doc
Preparing the Statement of Cash Flows Using the Indirect Method
Learning Objectives 13 Cassidy Inc. has the following information for 2008:
CASSIDY INC. Income Statement Year Ended December 31, 2008 Sales revenue Costs of goods sold Gross profit Operating expenses: Salary expense Depreciation expense Insurance expense Total operating expense Income from operations Other items: Gain on sale of furniture Net income $550,000 320,000 230,000 $165,000 21,000 19,000 205,000 25,000 3,000 $ 28,000

CASSIDY INC. Balance Sheet December 31, 2008 and 2007 Assets Current: Cash Accounts receivable Prepaid insurance Total current assets Furniture, net 2008 2007 Liabilities Current: Accounts payable Salary payable Total current liabilities Notes payable Stockholders equity Common stock (no par) Retained earnings Total liabilities and stockholders equity 2008 $ 20,000 10,000 30,000 40,000 4,000 100,000 $174,000 2007 $23,000 8,000 31,000 50,000 3,500 80,000 $164,500

$ 28,000 $ 33,000 26,000 15,000 30,000 42,000 84,000 90,000 90,000 74,500

Total assets

$174,000 $164,500

During 2008 Cassidy: Sold furniture with a book value of $15,000 for cash. New furniture was purchased for cash. Repaid notes payable with a principal value of $22,000. Issued new notes for cash. Issued new common shares for cash. Paid cash dividends.

Requirement
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Prepare Cassidys statement of cash flows using the indirect method.

Demo Doc Solution


Requirement
Prepare Cassidys statement of cash flows using the indirect method.

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Operating Activities

When answering this question, refer to the template shown in Exhibit 13-5 (p. 695). This guide will help you structure the statement of cash flows. As with income statements and balance sheets, every cash-flow statement needs a proper title. The first line of the title is the company name, next is the name of the statement (statement of cash flows), and last is the date (year ended December 31, 2008). Put all together, the title is:

Distinguish among operating, investing, and financing cash flows. Prepare a statement of cash flows by the indirect method.

CASSIDY INC. Statement of Cash Flows Year Ended December 31, 2008

The first section of the statement of cash flows is operating activities. This section begins with net income. We can find net income on the income statement. According to Cassidys income statement, net income for the year is $28,000. Items are added or subtracted on the statement of cash flows based on their impact to cash. In this case, net income increases cash, so it is added on the statement of cash flows. Next, we must take a quick look through the income statement and look for any noncash items there. Noncash items are not part of cash flow, so any noncash items in net income must be removed. The most frequent noncash item on the income statement is depreciation expense. Depreciation expense is subtracted to calculate net income (if you look at the income statement, you will see a subtraction for depreciation expense), so to remove its impact, the opposite must be done: Depreciation expense of $21,000 must be added back to net income.

The Statement of Cash Flows 709

The other noncash item that you will see on many income statements is gains/losses on sale of assets. In this example, Cassidy has a gain on sale of furniture of $3,000. As you can see on the income statement, this gain was added to calculate net income. To remove its effect, we do the opposite: subtract it. So the gain of $3,000 is subtracted. Now that we have gotten all necessary information from the income statement, we can turn to the balance sheet. Operating activities deal with everyday transactions of the business, the kind of things the company normally does to earn a profit. What kinds of accounts do businesses deal with on a daily basis? Some accounts are Accounts Receivable, Accounts Payable, Inventory, and so forth. In other words, they are the current assets and current liabilities of the company. Other than Cash (which we are trying to analyze in preparing the statement of cash flows), what is the first current asset on the balance sheet? It is Accounts Receivable. What happened to Accounts Receivable during the year? It increased from $15,000 to $26,000. This increase affected Cash, but was it in a positive or negative way? An increase in Accounts Receivable indicates that we did not collect cash, so cash was impacted negatively. So the increase of $11,000 ($26,000 $15,000) to Accounts Receivable is essentially a decrease to Cash, which means that this amount is subtracted on the statement of cash flows. The other current asset is Prepaid Insurance. This account decreased from $42,000 to $30,000. A decrease to Prepaid Insurance indicates that we used something we had prepaidthat is something we had already paid for, so cash is conserved. So the decrease of $12,000 ($42,000 $30,000) will be added on the statement of cash flows. So far, operating activities show the following information:

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Gain on sale of plant assets Increase in accounts receivable Decrease in prepaid insurance

$28,000

$21,000 (3,000) (11,000) 12,000

Now that we have looked at the current assets, we can look at the current liabilities. The first current liability is Accounts Payable. During the

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year, Accounts Payable decreased from $23,000 to $20,000. This amount would be a debit. To balance out with Cash, Cash would be credited, which is a decrease. So $3,000 ($23,000 $20,000) will be subtracted on the statement of cash flows. The other current liability is Salary Payable. During the year, Salary Payable increased from $8,000 to $10,000. The increase in this payable account shows that this amount of salaries were unpaid, an increase to Cash. So $2,000 ($10,000 $8,000) will be added on the statement of cash flows. Now that we have looked at all of the current assets and liabilities, we can total the operating activities section:

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Gain on sale of plant assets Increase in accounts receivable Decrease in prepaid insurance Decrease in accounts payable Increase in salary payable Net cash provided by operating activities

$28,000

$21,000 (3,000) (11,000) 12,000 (3,000) 2,000

18,000 46,000

Investing Activities

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Investing activities deal with long-term assets. The only long-term asset is Furniture. Unfortunately, we cannot just say increase in Furniture or decrease in Furniture and look at the overall change because Furniture is a major account. We must look at each significant transaction affecting the account. From the additional information we were given with the question, we know that Cassidy purchased furniture and sold furniture during the year. Each of these

Distinguish among operating, investing, and financing cash flows. Prepare a statement of cash flows by the indirect method.

The Statement of Cash Flows 711

transactions will be a separate line in investing activities. Looking at Exhibit 13-5 (p. 695), we can set up a framework for the investing activities section:

Cash flows from investing activities: Acquisition of furniture Proceeds from sale of furniture Net cash used for investing activities

??? ??? ???

We do not know these totals, but we can calculate them with the information we already have. First, we should analyze the Furniture, Net T-account. From the balance sheet, we know that in 2008, Furniture, net has a beginning balance of $74,500 and an ending balance of $90,000. During the year, Furniture (Net) increased and decreased.

Furniture, Net Beginning balance Increases Ending balance 74,500 ??? Decreases 90,000 ???

Furniture (Net) increases when new furniture is purchased (acquisitions). Furniture (Net) decreases by the book value of furniture sold and when depreciation expense is recorded. Putting these items into the T-account:

Furniture, Net Beginning balance Acquisitions Ending balance 74,500 Depreciation X Book value of assets sold 90,000 21,000 15,000

Depreciation expense of $21,000 can be obtained from the income statement (or the operating activities section of the statement of cash flows). The book value of $15,000 for the assets sold was given in the problem. We can use this information to calculate the cost of furniture purchased (acquisitions), X.
$74,500 $21,000 $15,000 + X = $90,000 X = $90,000 $74,500 + $21,000 + $15,000 = $51,500

So acquisitions of furniture were $51,500. Purchasing furniture caused Cash to decrease, so the $51,500 will be subtracted on the statement of cash flows.
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We still need to determine the cash received when furniture was sold (proceeds). We can use the gain/loss formula for this calculation:
Proceeds = Book Value of Assets Sold + Gain, or Loss Proceeds = $15,000 Book Value of Assets Sold + Gain of $3,000 = $18,000

So the proceeds from sale of furniture were $18,000. Selling furniture caused Cash to increase, so the $18,000 will be added on the statement of cash flows. Filling this information into the investing activities, we have:

Cash flows from investing activities: Acquisition of furniture Proceeds from sale of furniture Net cash used for investing activities

$(51,500) 18,000 $(33,500)

Financing Activities

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Financing activities deal with long-term liabilities (that is, debt financing) and equity (that is, equity financing). Cassidy only has one long-term liability: Notes Payable. As with furniture, we know that we must report the major transactions in this account separately. From the additional information we were given with the question, we know that Cassidy paid off notes payable and issued new notes payable during the year. Each of these transactions will be a separate line in financing activities. Looking at Exhibit 13-5 (p. 695), we can set up a framework for the beginning of the financing activities section:

Distinguish among operating, investing, and financing cash flows. Prepare a statement of cash flows by the indirect method.

Cash flows from financing activities: Proceeds from issuance of long-term notes payable Payment of long-term notes payable

??? ???

From the additional information given in the problem, we know that $22,000 of notes were paid off. We need to calculate the value of new notes issued. As we did with furniture, we can make this calculation by analyzing the T-account. In 2008, Notes Payable had a beginning balance of $50,000 and an ending balance of $40,000.
The Statement of Cash Flows 713

Notes Payable Decreases Beginning balance ??? Increases Ending balance 50,000 ??? 40,000

Notes Payable is increased when new notes are issued and is decreased when notes are paid off. Putting this information into the T-account, we have:
Notes Payable Payments Beginning balance 22,000 Issuance of new notes payable Ending balance 50,000 X 40,000

We can use this information to calculate the value of new notes issue, $50,000 $22,000 + X = $40,000 X = $40,000 $50,000 + $22,000 = $12,000 So issuance of notes payable was $12,000. Because issuing notes payable increased Cash, $12,000 will be added on the statement of cash flows. Putting this information into the financing activities section, we have:

Cash flows from financing activities: Proceeds from issuance of long-term notes payable $12,000 Payment of long-term notes payable (22,000)

Now that we have examined the long-term liabilities, we only have equity remaining. The first account in equity is Common Stock. From the additional information, we know that new common stock (no par) was issued during the year. Because this is the only transaction affecting Common Stock, we know that the change in the Common Stock account represents the issuance of these shares. Using the T-account:
Common Stock (no par) Beginning balance Issuance of new stock Ending balance 3,500 X 4,000

We use this information to calculate the value of new common stock issued, X.
$3,500 + X = $4,000 X = $4,000 $3,500 = $500

So issuance of common stock (proceeds) was $500. Because issuing common stock increases Cash, $500 will be added on the statement of cash flows. The last account in equity is Retained Earnings. This account changed during 2008. Looking at the T-account:
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Retained Earnings Decreases Beginning balance ??? Increases Ending balance 80,000 ??? 100,000

Retained Earnings is increased when the company earns net income and is decreased when the company pays dividends. Putting this information into the Taccount, we have:

Retained Earnings Dividends Beginning balance X Net income Ending balance 80,000 28,000 100,000

We use this information to calculate the amount of cash dividends paid, X.


$80,000 + $28,000 X = $100,000 X = $80,000 + $28,000 $100,000 = $8,000

So cash dividends paid were $8,000. Because the payment of dividends decreased Cash, $8,000 will be subtracted on the statement of cash flows. Notice that we do not record net income in the financing activities (even though it affects Retained Earnings), because net income was already accounted for in the operating activities section. Putting all of this information into the financing activities section, we have:

Cash flows from financing activities: Proceeds from issuance of long-term notes payable $12,000 Payment of long-term notes payable (22,000) Proceeds from issuance of common stock 500 Payment of dividends (8,000) Net cash used for financing activities $(17,500)

The Statement of Cash Flows 715

Finishing the Statement of Cash Flows

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Distinguish among operating, investing, and financing cash flows. Prepare a statement of cash flows by the indirect method.

Now that we have completed the three main sections of the statement of cash flows, we can add the totals of the three sections together to determine cash flow (the net change in cash).
Net Change in Cash = Cash Provided by Operating Activities + Cash Provided by Investing Activities + Cash Provided by Financing Activities Net Change in Cash = $46,000 $33,500 $17,500 = $(5,000)

Because the change in cash is negative, we know that it means a net decrease in cash. The statement began with net income (from the income statement). Now we tie it to the balance sheet to bring cash flows full circle. We add the decrease of $5,000 in cash to the cash balance at the beginning of the year of $33,000 (from Cassidys balance sheet). This equation gives us the cash balance at the end of the year of $(5,000) + $33,000 = $28,000. Putting this information in statement of cash flows format:

Net decrease in cash Cash balance, December 31, 2007 Cash balance, December 31, 2008

$ (5,000) 33,000 $28,000

This section of the statement is also a nice check to ensure that our calculations are correct. The $28,000 calculated is the number reported for cash on the balance sheet at December 31, 2008. To finish the statement of cash flows, we just put all of these pieces together:

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CASSIDY INC. Statement of Cash Flows Year Ended December 31, 2008 Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Gain on sale of plant assets Increase in accounts receivable Decrease in prepaid insurance Decrease in accounts payable Increase in salary payable Net cash provided by operating activities Cash flows from investing activities: Acquisition of furniture Proceeds from sale of furniture Net cash used for investing activities Cash flows from financing activities: Proceeds from issuance of long-term notes payable Payment of long-term notes payable Proceeds from issuance of common stock Payment of dividends Net cash used for financing activities Net decrease in cash Cash balance, December 31, 2007 Cash balance, December 31, 2008

$28,000

$21,000 (3,000) (11,000) 12,000 (3,000) 2,000

18,000 $46,000

(51,500) 18,000 (33,500) 12,000 (22,000) 500 (8,000) (17,500) $ (5,000) 33,000 $28,000

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The Statement of Cash Flows 717

Accounting in Action
THE STATEMENT OF CASH FLOWS
Imagine that you start your own business, and based on your accounting knowledge, you choose to prepare the financial statements for your company. What decision would you face in preparing and interpreting its statement of cash flows?

Decision
Where is most of the companys cash coming from?

Guidelines
Operating activities: Company is generating positive cash flows from day-to-day operations. Investing activities: Company is producing positive cash flows from selling investments for cash. Financing activities: Company is creating positive cash flows by obtaining cash from long-term creditors or owners. Operating activities must be the main source of cash for long-term success. Cash includes both cash and cash equivalents, highly liquid short-term investments. Statement of cash flows is the financial statement showing inflows and outflows of cash for a period of time. It reconciles the cash balance at the beginning of the period to the cash balance at the end of that period. 2 choices: Indirect method, the more popular choice, reconciles net income as reported on the income statement to net cash provided by operating activities. Direct method shows all cash receipts and cash payments form operating activities.

Which set of activities is most important when considering cash flow? What is cash? What is the statement of cash flows?

How is the operating activities section of the statement prepared?

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Review
The Statement of Cash Flows Word Power
Cash flows Cash receipts and cash payments. Direct method Format of the operating activities section of the statement of cash flows that lists the major categories of operating cash receipts and cash payments. Indirect method Format of the operating activities section of the statement of cash flows that starts with net income and reconciles it to net cash provided by operating activities.

The Statement of Cash Flows 719

Quick Check
1. The three main categories of cash flows are: a. Direct, indirect, and hybrid b. Current, long-term, and fixed c. Operating, investing, and financing d. Short-term, long-term, and equity 2. The purposes of the cash flow statement are to: a. Predict future cash flows b. Evaluate management decisions c. Predict ability to make payments to lenders d. All of the above 3. Financing activities are most closely related to a. Current assets and current liabilities b. Long-term assets c. Long-term liabilities and owners equity d. Net income and dividends 4. Which item does not appear on a statement of cash flows prepared by the indirect method? a. Collections from customers b. Net income c. Depreciation d. Gain on sale of land 5. Artoo Detoo Robotics earned net income of $60,000 after deducting depreciation of $4,000 and all other expenses. Current assets increased by $3,000 and current liabilities decreased by $5,000. Using the indirect method, how much was Artoo Detoos cash flows from operating activities? a. $48,000 b. $50,000 c. $52,000 d. $56,000 6. The Plant Assets account of C. Threepio, Inc., shows the following:
Plant Assets, Net Beginning Balance Purchase Ending Balance 100,000 Depreciation 400,000 Sale 420,000 30,000 ?

C. Threepio sold plant assets at a $10,000 gain. Where on the statement of cash flows should C. Threepio report the sale of plant assets? How much should C. Threepio report for the sale?
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a. Cash flows from investing activities, $40,000 b. Cash flows from investing activities, $50,000 c. Cash flows from investing activities, $60,000 d. Cash flows from financing activities, $60,000 7. Wookie Corporation borrowed $15,000, issued common stock of $10,000, and paid dividends of $25,000. What was Wookies net cash provided or used by financing activities? a. $0 b. $25,000 c. $(25,000) d. $50,000 8. Which item does not appear on a statement of cash flows prepared by the direct method? a. Net income b. Payment to suppliers c. Collections from customers d. Payment of income tax 9. H. Solo Systems Incorporated had accounts receivable of $20,000 at the beginning of the year and $50,000 at year-end. Revenue for the year totaled $100,000. How much cash did H. Solo Systems collect from customers? a. $170,000 b. $150,000 c. $120,000 d. $70,000 10. Skywalker Enterprises had operating expenses of $40,000. At the beginning of the year, Skywalker owed $5,000 on accrued liabilities. At year-end, accrued liabilities were $8,000. How much cash did Skywalker pay for operating expenses? a. $35,000 b. $37,000 c. $43,000 d. $45,000 Answers are given after Apply Your Knowledge (p. 745).

The Statement of Cash Flows 721

Accounting Practice
Short Exercises
1
Explaining the purposes of the statement of cash flows and describing its elements.

S13-1. Describe how the statement of cash flows helps investors and creditors
perform each of the following functions: 1. Predict future cash flows 2. Evaluate management decisions 3. Predict the ability to make debt payments to lenders and pay dividends to stockholders

Distinguishing among operating, investing, and financing cash flows. Preparing a statement of cash flows by the indirect method. Preparing a statement of cash flows by the direct method. Preparing a statement of cash flows by the indirect method.

S13-2. Answer these questions about the statement of cash flows:


1. What is the check figure for the statement of cash flows? Where do you get this check figure? 2. List the categories of cash flows in order of importance. 3. What is the first dollar amount reported using the indirect method? 4. What is the first dollar amount reported using the direct method?

S13-3. Spock Spaceships is preparing its statement of cash flows by the indirect method. Identify each of the following transactions as Operating activity: addition to net income (O+) or subtraction from net income (O) Investing activity (I) Financing activity (F) Activity that is not used to prepare the cash flow statement (N) ____ a. Loss on sale of land ____ b. Depreciation expense ____ c. Increase in inventory ____ d. Decrease in accounts receivable ____ e. Purchase of equipment ____ f. Increase in accounts payable

____ g. Payment of dividends ____ h. Decrease in accrued liabilities ____ ____


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i. Issuance of common stock j. Gain on sale of building

S13-4. C. Kirk Corporation reported this data for 2007:


Income statement: Net income..................................... $50,000 Depreciation .................................. Balance sheet: Increase in accounts receivable.... Decrease in accounts payable....... 8,000 6,000 4,000

Preparing a statement of cash flows by the indirect method.

Compute Kirks net cash provided by operating activities according to the indirect method.

S13-5. Scotty Inc.s accountants assembled the following data for the year
ended June 30, 2008.

Preparing a statement of cash flows by the indirect method.

Net income ....................................................... Proceeds from issuance of common stock....... Payment of dividends ...................................... Increase in current assets other than cash .... Purchase of treasury stock..............................

$60,000 20,000 6,000 30,000 5,000

Purchase of equipment................. Decrease in current liabilities ..... Payment of note payable .............. Proceeds from sale of land ........... Depreciation expense ...................

$40,000 5,000 30,000 60,000 15,000

Prepare the operating activity section of Scottys statement of cash flows for the year ended June 30, 2008. Scotty Inc. uses the indirect method.

S13-6. Use the data in S13-5 to prepare Scottys statement of cash flows for the
year ended June 30, 2008. Scotty Inc. uses the indirect method for presenting its operating activities related to cash flows. Use Exhibit 13-7 as a guide, but stop after determining the net increase or decrease in cash.

Preparing a statement of cash flows by the indirect method.

S13-7. McCoy Medical Company reported the following financial statements


for 2008:

Preparing a statement of cash flows by the indirect method.

MCCOY MEDICAL COMPANY Income Statement Year Ended December 31, 2008 Revenue: Sales revenue Expenses: Cost of goods sold Depreciation expense Other expenses Total expense Net income

$710 $340 60 200 600 $110

continued.....

The Statement of Cash Flows 723

MCCOY MEDICAL COMPANY Comparative Balance Sheet December 31, 2008 and 2007 (in thousands) Assets Current: Cash Accounts receivable Inventory Prepaid expenses Long-term investments Plant assets, net 2008 2007 Liabilities Current: Accounts payable Salary payable Accrued liabilities Long-term notes payable Stockholders Equity Common stock Retained earnings Total liabilities and stockholders equity 2008 2007

$ 19 54 80 3 75 225

$ 16 48 84 2 90 185

$ 47 23 8 66 40 272 $456

$ 42 21 11 68 37 246 $425

Total assets

$456

$425

Use the information in the financial statements to compute the amount of plant assets acquired by McCoy, assuming McCoy sold no plant assets in 2008.

Preparing a statement of cash flows by the indirect method.

S13-8. Use the McCoy Medical Company data in S13-7 to compute the following amounts for 2008: 1. Borrowing or payment of long-term notes payable, assuming McCoy had only one long-term note payable transaction during the year. 2. Issuance of common stock, assuming McCoy had only one common stock transaction during the year. 3. Payment of cash dividends.

Preparing a statement of cash flows by the direct method.

S13-9. Uhura Health Spas began 2008 with cash of $104,000. During the
year, Uhura earned service revenue of $600,000 and collected $590,000 from customers. Expenses for the year totaled $420,000, of which Uhura paid $410,000 in cash to suppliers and employees. Uhura also paid $140,000 to purchase equipment and paid a cash dividend of $50,000 to its stockholders during 2008. Prepare the companys statement of cash flows for the year ended December 31, 2008. Format cash flows from operating activities by the direct method.

Preparing a statement of cash flows by the direct method.

S13-10. Scotty Inc. assembled the following data related to its cash transactions for the year ended June 30, 2008: Payment of dividends ............................. Proceeds from issuance of stock ............. Collections from customers .................... Proceeds from sale of land ..................... Payments to suppliers ............................ Purchase of equipment ........................... Payments to employees .......................... Payment of note payable ........................ $ 6,000 20,000 200,000 60,000 80,000 40,000 70,000 30,000 continued.....

724 Chapter 13

Prepare the operating activities section of Scottys statement of cash flows for the year ended June 30, 2008. Scotty Inc. uses the direct method for cash flows from operating activities.

S13-11. Use the data in S13-10 to prepare Scottys statement of cash flows for
the year ended June 30, 2008. Scotty uses the direct method for cash flows from operating activities. Use Exhibit 13-14 as a guide, but stop after determining the net increase or decrease in cash.

Preparing a statement of cash flows by the direct method.

S13-12. Use the McCoy Medical Company data in S13-7 to compute the following:
1. Collections from customers 2. Payments for inventory

Preparing a statement of cash flows by the direct method.

Exercises
E13-13. S. Cowell, Inc., experienced an unbroken string of 10 years of growth in
net income. Nevertheless, the business is facing bankruptcy. Creditors are calling all of S. Cowells outstanding loans for immediate payment, and Cowell has no cash available to make these payments because managers placed undue emphasis on net income and gave too little attention to cash flows.

Explaining the purposes of the statement of cash flows and describing its elements.

Requirements
Write a brief memo in your own words to explain to the managers of S. Cowell, Inc., the purposes of the statement of cash flows.

E13-14. Identify each of the following transactions as


Operating activity (O) Investing activity (I) Financing activity (F) Noncash investing and financing activity (NIF) For each item, indicate whether it represents an increase (+) or a decrease () in cash. The indirect method is used to report cash flows from operating activities. ____ a. Cash sale of land ____ b. Issuance of long-term note payable in exchange for cash ____ c. Depreciation of equipment ____ d. Purchase of treasury stock continued.....

Preparing a statement of cash flows by the indirect method.

The Statement of Cash Flows 725

____ e. Issuance of common stock for cash ____ f. Increase in accounts payable

____ g. Net income ____ h. Payment of cash dividend ____ ____ i. Decrease in accrued liabilities j. Loss on sale of land

____ k. Acquisition of building by issuance of notes payable ____ l. Payment of long-term debt

____ m. Acquisition of building by issuance of common stock ____ n. Decrease in accounts receivable ____ o. Decrease in inventory ____ p. Increase in prepaid expenses

Preparing a statement of cash flows by the indirect method.

E13-15. Indicate whether each of the following transactions would result in an


operating activity, an investing activity, a financing activity, or a transaction that does affect cash for a statement of cash flows prepared by the indirect method.

Journal Entry: Date a. b. c. d. e. f. g. h. i. j. k. Accounts Equipment Cash Cash Long-Term Investment Bonds Payable Cash Building Notes Payable, Long-Term Loss on Disposal of Equipment Equipment Dividend Payable Cash Cash Common Stock Treasury Stock Cash Cash Sales Revenue Land Cash Depreciation Accumulated Depreciation Post Ref. Dr. 18,000 7,200 7,200 45,000 45,000 164,000 164,000 1,400 1,400 16,500 16,500 81,000 81,000 13,000 13,000 60,000 60,000 87,700 87,700 9,000 9,000 Cr. 18,000

726 Chapter 13

E13-16. The accounting records of P. Abdul Talent Agency reveal the following:

Preparing a statement of cash flows by the indirect method.

Net income ............ Depreciation ......... Sales revenue ........... Decrease in current liabilities ...... Loss on sale of land ........ Increase in current assets other than cash Acquisition of land ..........

$22,000 12,000 9,000 20,000 5,000 27,000 37,000

Requirements
Compute cash flows from operating activities by the indirect method. Use the format of the operating activities section shown in Exhibit 13-7. Also evaluate the operating cash flow of P. Abdul Talent Agency. Give the reason for your evaluation.

E13-17. The March accounting records of R. Jackson Record Company include


these accounts:

Preparing a statement of cash flows by the indirect method.

Cash Mar. 1 Receipts Mar. 31 5,000 447,000 4,000 Inventory Mar. 1 Purchases Mar. 31 19,000 337,000 21,000 Accumulated Depreciation Mar.1 Depreciation Mar. 31 52,000 3,000 55,000 Cost of goods sold Payments 335,000 Payments 448,000 Mar. 1 Sales Mar. 31

Accounts Receivable 18,000 443,000 14,000 Accounts Payable 332,000 Mar. 1 Purchases Mar. 31 14,000 337,000 19,000 Collections 447,000

Retained Earnings Dividends 18,000 Mar. 1 Net income Mar. 31 64,000 69,000 115,000

Compute Jacksons net cash provided by operating activities during March. Use the indirect method.

E13-18. The income statement and additional data of Seacrest Services, Inc.,
follow: continued.....
The Statement of Cash Flows 727

Preparing a statement of cash flows by the indirect method.

SEACREST SERVICES INCORPORATED Income Statement Year Ended June 30, 2008 Sales revenue Cost of goods sold Gross profit Other expenses: Salary expense Depreciation expense Income tax expense Total expenses Net income $237,000 103,000 134,000 $58,000 29,000 9,000 96,000 $ 38,000

Additional data: 1. Acquisition of plant assets totaled $116,000. Of this amount, $101,000 was paid in cash and a $15,000 note payable was signed for the remainder. 2. Proceeds from sale of land totaled $24,000. No gain was recognized on the sale. 3. Proceeds from issuance of common stock totaled $30,000. 4. Payment of long-term note payable was $15,000. 5. Payment of dividends was $11,000. 6. Data from the comparative balance sheet follows:

June 30 Current Assets: Cash ............................................... Accounts Receivable ...................... Inventory ....................................... Current Liabilities: Accounts Payable ........................... Accrued Liabilities ........................

2008 $27,000 43,000 92,000 $35,000 13,000

2007 $20,000 58,000 85,000 $22,000 21,000

Requirements
1. Prepare Seacrests statement of cash flows for the year ended June 30, 2008, using the indirect method. 2. Evaluate Seacrests cash flows for the year. In your evaluation, mention all three categories of cash flows and give the reason for your evaluation.

Preparing a statement of cash flows by the indirect method.

E13-19. Compute the following items for the statement of cash flows:
1. The beginning and ending Retained Earnings balances are $45,000 and $73,000, respectively. Net income for the period is $62,000. How much are cash dividends? continued.....

728 Chapter 13

2. The beginning and ending Plant Assets, net, balances are $103,000 and $107,000, respectively. Depreciation for the period is $16,000, and acquisitions of new plant assets total $27,000. Plant assets were sold at a $1,000 loss. What were the cash proceeds of the sale?

E13-20. Identify each of the following transactions as:


Operating activity (O) Investing activity (I) Financing activity (F) Noncash investing and financing activity (NIF) For each cash item, indicate whether it represents an increase (+) or a decrease () in cash. The direct method is used for cash flows from operating activities. ____ a. Collections from customers ____ b. Issuance of long-term note payable in exchange for cash ____ c. Depreciation of equipment ____ d. Purchase of treasury stock ____ e. Issuance of common stock for cash ____ f. Payment to suppliers

Preparing a statement of cash flows by the direct method.

____ g. Issuance of preferred stock for cash ____ h. Payment of cash dividend ____ ____ i. Sale of land j. Acquisition of building by issuance of note payable

____ k. Payment of long-term debt ____ l. Acquisition of building by issuance of common stock

____ m. Purchase of equipment for cash ____ n. Payment of wages to employees ____ o. Collection of interest revenue ____ p. Sale of building

E13-21. Indicate whether each of the following transactions would result in an


operating activity, an investing activity, a financing activity, or a transaction that does affect cash for a statement of cash flows prepared by the direct method. continued.....
The Statement of Cash Flows 729

Preparing a statement of cash flows by the direct method.

Journal Entry: Date a. b. c. d. e. f. g. h. i. j. k. l. Accounts Equipment Cash Cash Long-Term Investment Bonds Payable Cash Building Notes Payable, Long-Term Cash Accounts Receivable Dividend Payable Cash Salary Expense Cash Cash Common Stock Treasury Stock Cash Cash Interest Revenue Land Cash Accounts Payable Cash Post Ref. Dr. 18,000 7,200 7,200 45,000 45,000 164,000 164,000 1,400 1,400 16,500 16,500 4,300 4,300 81,000 81,000 13,000 13,000 2,000 2,000 87,700 87,700 8,300 8,300 Cr. 18,000

Preparing a statement of cash flows by the direct method.

E13-22. The accounting records of A. Idol, Inc., reveal the following:


Payment of salaries and wages ... $ 34,000 Depreciation.................................. Payment of interest...................... Payment of dividends................... Collections from customers ......... 12,000 16,000 7,000 102,000

Net income ................................... $22,000 Payment of income tax................ Collection of dividend revenue ... Payment to suppliers................... 13,000 7,000 54,000

Requirements
Compute cash flows from operating activities by the direct method. Use the format of the operating activities section shown in Exhibit 13-14. Also evaluate the operating cash flow of A. Idol, Inc. Give the reason for your evaluation.

730 Chapter 13

E13-23. Selected accounts of Auditions, Inc., show the following:


Dividends Receivable Beginning balance Dividend revenue Ending balance 9,000 Cash receipts of dividends 40,000 11,000 Land Beginning balance Acquisition by cash payment Ending balance 90,000 18,000 108,000 Long-Term Notes Payable Payments 69,000 Beginning balance Issuance for cash Ending balance 273,000 83,000 287,000 38,000

Preparing a statement of cash flows by the direct method.

Requirements
For each account, identify the item or items that should appear on a statement of cash flows prepared by the direct method. State in which section the item should be reported.

E13-24. The income statement and additional data of Seacrest Services, Inc.,
follow:

Preparing a statement of cash flows by the direct method.

SEACREST SERVICES INCORPORATED Income Statement Year Ended June 30, 2008 Revenues: Sales revenue Dividend revenue Total revenues Expenses: Cost of goods sold Salary expense Depreciation expense Advertising expense Interest expense Income tax expense Total expenses Net income

$229,000 8,000 $237,000 $103,000 45,000 28,000 12,000 2,000 9,000 199,000 $ 38,000

Additional data: a. Collections from customers are $15,000 more than sales. b. Payments to suppliers are the sum of cost of goods sold plus advertising expense. continued.....
The Statement of Cash Flows 731

c. Payments to employees are $1,000 more than salary expense. d. Dividend revenue, interest expense, and income tax expense equal their cash amounts. e. Acquisition of plant assets for cash is $101,000. f. Proceeds from sale of land total $24,000. g. Proceeds from issuance of common stock for cash total $30,000. h. Payment of long-term note payable is $15,000. i. Payment of dividends is $11,000. j. Cash balance, June 30, 2007, was $20,000. Prepare Seacrests statement of cash flows for the year ended June 30, 2008. Use the direct method.

Preparing a statement of cash flows by the direct method.

E13-25. Compute the following items for the statement of cash flows:
1. The beginning and ending Accounts Receivable balances are $22,000 and $18,000, respectively. Credit sales for the period total $81,000. How much are cash collections? 2. Cost of goods sold is $90,000. Beginning Inventory balance is $25,000, and ending Inventory balance is $21,000. Beginning and ending Accounts Payable are $11,000 and $8,000, respectively. How much are cash payments for inventory?

Preparing a statement of cash flows by the direct method.

E13-26. Top Ten Corporation, a nationwide insurance chain, reported the following selected amounts in its financial statements for the year ended August 31, 2008 (adapted, in millions):

Income Statement 2008 Net Sales Cost of Goods Sold Depreciation Expense Other Expenses Income Tax Expense Net Income $24,623 18,048 269 4,883 537 886 2007 $21,207 15,466 230 4,248 486 777

continued.....
732 Chapter 13

Balance Sheet 2008 Cash and Cash Equivalents Accounts Receivable Inventories Property and Equipment, Net Accounts Payable Accrued Liabilities Long-Term Liabilities Common Stock Retained Earnings $ 17 798 3,482 4,345 1,547 938 478 676 4,531 $ 2007 13 615 2,831 3,428 1,364 848 464 446 3,788

Determine the following for Top Ten Corporation during 2008: a. Collections from customers b. Payments for inventory c. Payments of operating expenses d. Acquisitions of property and equipment. No sales were made during 2008. e. Long-term borrowing, assuming Top Ten made no payments on long-term liabilities f. Proceeds from issuance of common stock g. Payment of cash dividends

Problems (Group A)
P13-27A. Top managers of Greys and Atomy, Inc., are reviewing company performance for 2008. The income statement reports a 20% increase in net income over 2007. However, most of the increase resulted from an extraordinary gain on insurance proceeds from storm damage to a building. The balance sheet shows a large increase in receivables. The cash flow statement, in summarized form, reports the following:

Explaining the purposes of the statement of cash flows and describing its elements. Distinguishing among operating, investing, and financing cash flows.

Net cash used for operating activities ............................... Net cash provided by investing activities .......................... Net cash provided by financing activities.......................... Increase in cash during 2008 .............................................

$(80,000) 40,000 50,000 $ 10,000

continued.....
The Statement of Cash Flows 733

Requirements
Write a memo giving Greys and Atomys managers your assessment of 2008 operations as it relates to cash flows. Also provide your outlook for the future.

Preparing a statement of cash flows by the indirect method.

P13-28A. OMalley Corporation accountants assembled the following data for


the year ended December 31, 2008:

OMalley Corporation December 31 Current assets: Cash and cash equivalents Accounts receivable Inventory Current liabilities: Accounts payable Income tax payable $57,800 14,700 $55,800 16,700 $85,000 69,200 80,000 $22,000 64,200 83,000 2008 2007

Transaction Data for 2008: Net income ................................................................................... Purchase of treasury stock .......................................................... Issuance of common stock for cash ............................................. Loss on sale of equipment ........................................................... Payment of cash dividends.......................................................... Depreciation expense .................................................................. Issuance of long-term note payable in exchange for cash ......... Purchase of building for cash...................................................... Retirement of bonds payable by issuing common stock ............ Sale of equipment for cash .......................................................... $ 57,000 14,000 41,000 11,000 18,000 21,000 34,000 125,000 65,000 58,000

Requirements
Prepare OMalley Corporations statement of cash flows using the indirect method to report operating activities. List noncash investing and financing activities on an accompanying schedule.
734 Chapter 13

P13-29A. Data from the comparative balance sheet of Izzie Company at March 31,
2009, follows: March 31 Current assets: Cash and cash equivalents Accounts receivable Inventory Current liabilities: Accounts payable Accrued liabilities Income tax payable $30,100 10,700 8,000 $27,600 11,100 4,700 $6,200 14,900 63,200 $4,000 21,700 60,600 2009 2008

Preparing a statement of cash flows by the indirect method.

Izzies transactions during the year ended March 31, 2009, included the following: Payment of cash dividend ............................. Purchase of equipment for cash ................... Issuance of long-term note payable in exchange for cash ..................................... $30,000 78,700 50,000 Depreciation expense .................. Purchase of building for cash ..... Net income ................................... Issuance of common stock ........... $ 17,300 47,000 70,000 11,000

Requirements
1. Prepare Izzies statement of cash flows for the year ended March 31, 2009, using the indirect method to report cash flows from operating activities. 2. Evaluate Izzies cash flows for the year. Mention all three categories of cash flows and give the reason for your evaluation.

P13-30A. The 2008 comparative balance sheet and income statement of A. Karev
Medical Supplies follow on the next page. A. Karev had no noncash investing and financing transactions during 2008. During the year, A. Karev made no sales of land or equipment, no issuance of notes payable, no retirement of stock, and no treasury stock transactions.

Preparing a statement of cash flows by the indirect method.

Requirements
1. Prepare the 2008 statement of cash flows, formatting operating activities by the indirect method. 2. How will what you learned in this problem help you evaluate an investment? continued.....
The Statement of Cash Flows 735

A. KAREV MEDICAL SUPPLIES Comparative Balance Sheet December 31, 2008 and 2007 2008 Current assets: Cash and cash equivalents Accounts receivable Inventory Plant assets: Land Equipment, net Total assets Current liabilities: Accounts payable Accrued liabilities Long-term liabilities: Notes payable Stockholders equity: Common stock Retained earnings Total liabilities and stockholders equity $ 2007 Increase (Decrease) $ 1,400 (1,600) 2,000 29,000 4,100 $34,900

6,700 $ 5,300 25,300 26,900 91,800 89,800

89,000 60,000 53,500 49,400 $266,300 $231,400

$ 30,900 $ 35,400 30,600 28,600 75,000 100,000

$ (4,500) 2,000 (25,000) 23,600 38,800 $34,900

88,300 64,700 41,500 2,700 $266,300 $231,400

A. KAREV MEDICAL SUPPLIES Income Statement Year Ended December 31, 2008 Revenues: Sales revenue Interest revenue Total revenues Expenses: Cost of goods sold Salary expense Depreciation expense Other operating expenses Interest expense Income tax expense Total expenses Net income

$213,000 8,600 $221,600 $ 70,600 27,800 4,000 10,500 11,600 29,100 153,600 $ 68,000

Preparing a statement of cash flows by the direct method.

P13-31A. The accounting records for R. Webber Associates, Inc., for the year
ended April 30, 2008, contain the following information: a. Purchase of plant assets for cash, $59,400 b. Proceeds from issuance of common stock, $8,000 continued.....

736 Chapter 13

c. Payment of dividends, $48,400 d. Collection of interest, $4,400 e. Payment of salaries, $93,600 f. Proceeds from sale of plant assets, $22,400 g. Collections from customers, $620,500 h. Cash receipt of dividend revenue, $4,100 i. Payments to suppliers, $368,500 j. Depreciation expense, $59,900 k. Proceeds from issuance of long-term notes, $19,600 l. Payments of long-term notes payable, $50,000 m. Interest expense and payments, $13,300 n. Income tax expense and payments, $37,900 o. Cash balances: April 30, 2007, $39,300; April 30, 2008, $47,200

Requirements
Prepare R. Webber Associates statement of cash flows for the year ended April 30, 2008. Use the direct method for cash flows from operating activities. Follow the format of Exhibit 13-1.

P13-32A. Use the A. Karev Medical Supplies data from P13-30A. The cash
amounts for Interest Revenue, Salary Expense, Interest Expense, and Income Tax Expense are the same as the accrual amounts for these items.

Preparing a statement of cash flows by the direct method.

Requirements
1. Prepare the 2008 statement of cash flows by the direct method. 2. How will what you learned in this problem help you evaluate an investment?

P13-33A. To prepare the statement of cash flows, accountants for C. Yang, Inc.,
summarized 2008 activity in the Cash account as follows:
Cash Beginning balance Receipts of interest Collections from customers Issuance of common stock 53,600 17,100 673,700 47,300 Payment on accounts payable Payment of dividends Payment of salaries and wages Payment of interest Payment for equipment Payment of operating expenses Payment of notes payable Payment of income tax 399,100 27,200 143,800 26,900 10,200 34,300 67,700 18,900

Preparing a statement of cash flows by the direct method.

Ending balance

63,600

continued.....
The Statement of Cash Flows 737

Requirements
Prepare the statement of cash flows of C. Yang, Inc., for the year ended December 31, 2008, using the direct method for operating activities.

Problems (Group B)
1
Explaining the purposes of the statement of cash flows and describing its elements. Distinguishing among operating, investing, and financing cash flows.

P13-34B. Top managers of Super Hair Replacements, Inc., are reviewing company performance for 2008. The income statement reports a 15% increase in net income, the fifth consecutive year with an income increase above 10%. The income statement includes a loss not expected to occur again, without which net income would have increased by 16%. The balance sheet shows modest increases in assets, liabilities, and stockholders equity. The assets posting the largest increases are plant and equipment because the company is halfway through a 5-year expansion program. No other assets and no liabilities are increasing dramatically. A summarized version of the cash flow statement reports the following: Net cash provided by operating activities .......................... Net cash used for investing activities ................................. Net cash provided by financing activities........................... Increase in cash during 2008 .............................................. $310,000 ( 290,000) 70,000 $ 90,000

Requirements
Write a memo giving top managers of Super Hair Replacements your assessment of 2008 operations as it relates to cash flows. Also provide your outlook for the future. Focus on the information content of the cash flow data.

Preparing a statement of cash flows by the indirect method.

P13-35B. Accountants for Gray Lantern, Inc., assembled the following data for
the year ended December 31, 2008: December 31 Current assets: Cash and cash equivalents Accounts receivable Inventory Current liabilities: Accounts payable Income tax payable $71,600 5,900 $67,500 6,800 continued..... $56,000 70,100 90,600 $34,000 73,700 86,600 2008 2007

738 Chapter 13

Transaction Data for 2008: Depreciation expense ............................................................................ Payment of cash dividends.................................................................... Purchase of equipment for cash............................................................ Issuance of note payable in exchange for cash .................................... Acquisition of land by issuing long-term note payable ....................... Net income ............................................................................................. Payment of note payable ....................................................................... Issuance of preferred stock for cash ..................................................... Gain on sale of equipment .................................................................... Proceeds from sale of equipment .......................................................... $ 30,200 48,300 109,000 71,000 118,000 50,500 47,900 36,200 3,500 40,000

Requirements
Prepare Gray Lanterns statement of cash flows using the indirect method to report operating activities. List noncash investing and financing activities on an accompanying schedule.

P13-36B. The comparative balance sheet of Justice League, Inc., at December 31,
2008, reported the following: December 31 Current assets: Cash and cash equivalents Accounts receivable Inventory Current liabilities: Accounts payable Accrued liabilities 2008 $12,500 26,600 54,600 $29,100 14,300 2007 $22,500 29,300 53,000 $28,000 16,800

Preparing a statement of cash flows by the indirect method.

Justice Leagues transactions during 2008 included the following: Payment of cash dividends .......................... $17,000 Purchase of equipment for cash .................. 55,000 Issuance of long-term note payable in exchange for cash ......................................... 32,000 Purchase of building for cash................. $124,000 Net income .............................................. 31,600 Issuance of common stock for cash ........ 105,000 Depreciation expense ............................. 17,700

Requirements
1. Prepare the statement of cash flows of Justice League, Inc., for the year ended December 31, 2008. Use the indirect method to report cash flows from operating activities. 2. Evaluate Justice Leagues cash flows for the year. Mention all three categories of cash flows and give the reason for your evaluation.

P13-37B. The 2008 comparative balance sheet and income statement of


Waterman, Inc., follow on the next page. Waterman had no noncash investing and financing transactions during 2008. During the year, Waterman made no sales of land or equipment, no issuance of notes payable, no retirement of stock, and no treasury stock transactions. continued.....

Preparing a statement of cash flows by the indirect method.

The Statement of Cash Flows 739

WATERMAN, INCORPORATED Comparative Balance Sheet December 31, 2008 and 2007 2008 Current assets: Cash and cash equivalents Accounts receivable Inventory Plant assets: Land Equipment, net Total assets Current liabilities: Accounts payable Accrued liabilities Long-term liabilities: Notes payable Stockholders equity: Common stock Retained earnings Total liabilities and stockholders equity $21,000 46,500 84,300 2007 $18,700 43,100 89,900 Increase (Decrease) $ 2,300 3,400 (5,600) 25,100 7,200 $32,400 $ 1,300 (600) (10,000) 8,800 32,900 $32,400

35,100 10,000 100,900 93,700 $287,800 $255,400 $ 31,100 $ 29,800 18,100 18,700 55,000 65,000

131,100 122,300 52,500 19,600 $287,800 $255,400

WATERMAN, INCORPORATED Income Statement Year Ended December 31, 2008 Revenue: Sales revenue Interest revenue Total revenues Expenses: Cost of goods sold Salary expense Depreciation expense Other operating expenses Interest expense Income tax expense Total expenses Net income

$438,000 11,700 $449,700 $205,200 76,400 15,300 49,700 24,600 16,900 388,100 $ 61,600

Requirements
1. Prepare the 2008 statement of cash flows, formatting operating activities by the indirect method. 2. How will what you learned in this problem help you evaluate an investment?
740 Chapter 13

P13-38B. Blue Vulcan, Inc., has developed the following data from the companys
accounting records for the year ended July 31, 2008: a. Purchase of plant assets for cash, $100,000 b. Proceeds from issuance of long-term notes payable, $44,100 c. Payments of long-term notes payable, $18,800 d. Proceeds from sale of plant assets, $59,700 e. Cash receipt of dividends, $2,700 f. Payments to suppliers, $673,300 g. Interest expense and payments, $37,800 h. Collection of interest revenue, $11,700 i. Payment of salaries, $104,000 j. Income tax expense and payments, $56,400 k. Depreciation expense, $27,700 l. Collections from customers, $827,100 m. Proceeds from issuance of common stock, $116,900 n. Payment of cash dividends, $50,500 o. Cash balances: July 31, 2007, $53,800; July 31, 2008, $75,200

Preparing a statement of cash flows by the direct method.

Requirements
Prepare Blue Vulcans statement of cash flows for the year ended July 31, 2008. Use the direct method for cash flows from operating activities. Follow the format of Exhibit 13-14.

Preparing a statement of cash flows by the direct method.

P13-39B. Use the Waterman, Inc., data from P13-37B. The cash amounts for
Interest Revenue, Salary Expense, Interest Expense, and Income Tax Expense are the same as the accrual amounts for these items.

Requirements
1. Prepare the 2008 statement of cash flows by the direct method. 2. How will what you learned in this problem help you evaluate an investment?
The Statement of Cash Flows 741

Preparing a statement of cash flows by the direct method.

P13-40B. To prepare the statement of cash flows, accountants for Flash


Fireworks Company summarized 2008 activity in the cash account as follows:
Cash Beginning balance Collections from customers Receipts of interest Issuance of common stock 87,100 60,800 14,100 308,100 Payment of operating expenses Payment of notes payable Payment of income taxes Payment on accounts payable Payment of dividends Payment of wages and salaries Payment of interest Payment for equipment 46,100 89,300 8,000 101,600 1,800 67,500 21,800 51,500

Ending balance

82,500

Requirements
Prepare Flash Fireworks statement of cash flows for the year ended December 31, 2008, using the direct method to report operating activities.

for 24/7 practice, visit www.MyAccountingLab.com

742 Chapter 13

Apply Your Knowledge


BE ON GUARD Case 1. Design Incorporated experienced a downturn in December sales. To make matters worse, many of the recent sales were on account and because many customers were not paying on their accounts, the ending balance of Accounts Receivable at December 31 was higher than the beginning balance. Because the business had a dramatic need for cash, a prime piece of land owned by the company was sold for cash in December at a substantial gain. Design had purchased the land 10 years earlier and properly classified it as a long-term investment. The CEO, Slim Shady, was looking over the financial statements and saw the companys weak operating cash flows. He approached the accountant to ask why the December cash flows provided from operations were so weak, given that the land had been sold. The accountant explained that because the indirect method was used in preparing the cash flow statement, certain adjustments to net income were required. To begin with, the increase in accounts receivable was a decreasing adjustment made in arriving at the net cash provided from operating activities. Next, the large gain recognized on the sale of land had to be adjusted by subtracting it from the net income in arriving at the cash provided by operating activities. These large negative adjustments drastically reduced the reported cash provided from that category of cash flows. The accountant then explained that all the cash proceeds from the land sale were included as cash inflows in the investing activities section. Slim became worried because he remembered the bank telling him about the importance of strong operating cash flows, so he told the accountant to redo the statement but not to reduce the net income by the accounts receivable increase or the gain on the land sale. The accountant refused, because these adjustments were necessary in order to properly arrive at the net cash provided from operating activities. If these adjustments were not made, then the net change in cash could not be reconciled. Slim finally agreed but then told the accountant to just include the cash proceeds from the sale of land in the operating activities rather than in the investing activities. The accountant said that would be wrong, and besides, everyone would be able to see that, as proceeds from the sale of land, it should be an investing activity. Slim then suggested listing it as other in the operating section so no one would ever know that it wasnt an operating cash flow. Why didnt Slim want the accountant to decrease the net income by the increase in accounts receivable and the gain on the land sale? Why do you think Slim finally agreed with the accountant? Could the operating cash flows be increased by including the cash proceeds from the sale but listing them as other rather than as land sale proceeds? What ethical concerns are involved? Do you have any other thoughts? Case 2. Kevin Sailors, the CEO of Candle Corporation, was discussing the financial statements with the company accountant. Weak cash flows had resulted in the company borrowing a lot of money. Kevin wanted to know why the money borrowed was included as cash inflows in the financing section of the statement of cash flows but the interest paid on the amounts borrowed was not. The accountant replied that the interest paid on loans was an expense included in the calculation of net income, which was in the operating activities section. Kevin then asked why the dividends Candle Corporation paid to stockholders were included as an outflow of cash in the financing section. The accountant then
The Statement of Cash Flows 743

explained that dividends paid, unlike interest paid, were a return to stockholders and not an expense; therefore it would not be included in net income, nor would it appear in the operating activities section. Kevin replied that he did not care, and instructed the accountant to include both the interest paid and the dividends paid in the financing section. The accountant said that such a move would not be proper. Kevin then said to not provide the statement of cash flows at all because too many people would see the weakening operating cash flows. He further stated that investors and creditors who really analyzed the income statements and balance sheets would be able to understand the company without the need for a statement of cash flows spelling out the net changes in cash flows. Why would Kevin want the interest paid to be included in the financing activities section? Why would the accountant state that interest paid should not be included in the financing activities section? Can the statement of cash flows be omitted? What ethical issues are involved? Do you have any additional thoughts? KNOW YOUR BUSINESS This case focuses on the cash flows of the Target Corporation. Recall that inflows and outflows of cash are classified as operating activities, investing activities, or financing activities. The statement of cash flows presents cash flows from each of these three activities. It is therefore important to understand the information provided in this revealing financial statement. The statement of cash flows and additional related information for Target are disclosed in its annual report. Refer to the Target Corporation financial statements found in Appendix A. Also, consider the following footnote excerpt from the annual report.
Cash Equivalents Cash equivalents represent short-term investments with a maturity of three months or less from the time of purchase and were $1,732 million, $244 million and $357 million in 2004, 2003 and 2002, respectively. The increase of $1,488 in 2004 compared to 2003 is primarily due to investment of the remaining proceeds at year end from the divestitures of Marshall Fields and Mervyns.

Requirements
1. Look at the operating activities section of the statements of cash flows. Compare the net earnings (net income) for each of the three fiscal years presented. Are the net income amounts reported on the cash flow statement the same as on the income statement? How does the total cash flows provided by operations compare to the net income? Why do they differ? Is this difference good or bad? Have the cash flows provided from operations been increasing or decreasing? What is the largest adjustment item in the operating cash flows section? Why is this amount added back each year? 2. Look at the investing activities section of the statements of cash flows. Can you determine whether Target has been spending money to purchase more property and equipment? Are the amounts increasing or decreasing? What is the significance of this item? Did investing activities provide or require cash for the three fiscal years presented?
744 Chapter 13

3. Look at the financing activities section of the statements of cash flows. Did financing activities provide or require cash for the three fiscal years presented? What is the significance of this information? What are the stock repurchase and dividend trends? What was the largest item in the financing section for the most recent year? 4. How do you feel about the overall sufficiency of cash flows? Does the cash provided from operations cover the cash required for investing activities? Does the cash provided from operations cover the cash required for financing activities? 5. What was the net change in cash and cash equivalents for the most recent fiscal year? Does this amount agree with the cash and cash equivalents reported on the balance sheet? What are the cash equivalents? Do you have any other observations about the statement of cash flows?

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Quick Check Answers


1. c 2. d 3. c 4. a 5. d 6. c 7. a 8. a 9. d 10. b

The Statement of Cash Flows 745