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# CHAPTER 12

## The Statement of Cash Flows

OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Learning Outcomes

Exercises

Estimated
Time in
Minutes

Level

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

15*

60

Diff

2. Explain what cash equivalents are and how they are treated on
the statement of cash flows.

1
12*

5
10

Easy
Easy

## 3. Describe operating, investing, and financing activities, and give

examples of each.

2
3
12*
13*
14*

10
10
10
10
25

Easy
Mod
Easy
Easy
Diff

## 5. Use T accounts to prepare a statement of cash flows, using the

direct method to determine cash flow from operating activities.

4
5
6
7
8
13*
15*

5
10
20
20
10
10
60

Mod
Mod
Mod
Mod
Mod
Easy
Diff

## 6. Use T accounts to prepare a statement of cash flows, using

the indirect method to determine cash flow from operating
activities.

9
10
14*

10
15
25

Easy
Mod
Diff

11

15

Mod

## 4. Describe the difference between the direct and the indirect

methods of computing cash flow from operating activities.

## 8. Use a work sheet to prepare a statement of cash flows, using

the indirect method to determine cash flow from operating
activities. (Appendix)
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

12-1

12-2

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

Learning Outcomes

Problems
and
Alternates

Estimated
Time in
Minutes

Level

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

2. Explain what cash equivalents are and how they are treated on
the statement of cash flows.

13*

30

Diff

## 4. Describe the difference between the direct and the indirect

methods of computing cash flow from operating activities.

11*
12*

30
30

Mod
Mod

## 5. Use T accounts to prepare a statement of cash flows, using the

direct method to determine cash flow from operating activities.

3
6
11*
13*

45
30
30
30

Mod
Mod
Mod
Diff

## 6. Use T accounts to prepare a statement of cash flows, using

the indirect method to determine cash flow from operating
activities.

1
4
7
9
12*

30
45
30
45
30

Mod
Mod
Mod
Diff
Mod

2
5
8
10

60
60
60
60

Mod
Mod
Mod
Diff

## 3. Describe operating, investing, and financing activities, and give

examples of each.

## 7. Use cash flow information to help analyze a company.

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

## CHAPTER 12 THE STATEMENT OF CASH FLOWS

Learning Outcomes

Cases

Estimated
Time in
Minutes

12-3

Level

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

4*
5*
6*

60
25
25

Diff
Mod
Mod

2. Explain what cash equivalents are and how they are treated on
the statement of cash flows.

1*
7*

30
20

Mod
Mod

## 3. Describe operating, investing, and financing activities, and give

examples of each.

1*
2
7*

30
20
20

Mod
Mod
Mod

## 5. Use T accounts to prepare a statement of cash flows, using the

direct method to determine cash flow from operating activities.

4*

60

Diff

## 6. Use T accounts to prepare a statement of cash flows, using

the indirect method to determine cash flow from operating
activities.

5*
6*

25
25

Mod
Mod

20

Mod

## 4. Describe the difference between the direct and the indirect

methods of computing cash flow from operating activities.

## 8. Use a work sheet to prepare a statement of cash flows, using

the indirect method to determine cash flow from operating
activities. (Appendix)
*Exercise, problem, or case covers two or more learning outcomes
Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

12-4

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

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

## CHAPTER 12 THE STATEMENT OF CASH FLOWS

12-5

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

12-6

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

14. The requirement to separately disclose income taxes paid and interest paid when
the indirect method is used is a compromise. Accounting standards strongly
encourage companies to use the direct method because each major operating cash
receipt and payment is reported in the Operating Activities section of the statement.
However, if a company chooses to use the indirect approach, they are still required
to report separately how much cash was actually paid to the government in taxes
and to creditors in interest.
15. An argument can be made that it is inconsistent to report interest paid in the
operating section and dividends paid in the financing section. Both represent returns
to providers of capital: interest to creditors and dividends to stockholders.
Furthermore, the cash raised from each of these sourcesthe amounts borrowed
from creditors and the amounts contributed by stockholdersis classified as an
inflow in the financing section of the statement. The rationale normally given for this
treatment is that interest enters into the determination of net income, and thus the
cash expended in interest should appear in the operating section. Many believe that
this is illogical and that both interest paid and dividends paid belong in the financing
section.
16. An analysis of the Prepaid Rent account can be used to find the amount of cash paid
for rent:
Beginning Prepaid Rent
+ Cash payments
Rent Expense
= Ending Prepaid Rent

\$ 9,600
X
45,900
\$ 7,300

## \$9,600 + X \$45,900 = \$7,300

X = \$43,600
17. The purchase of 2,000 shares of treasury stock at \$20 per share would be reflected
on the statement of cash flows as a cash outflow of \$40,000 in the financing
activities section of the statement.
18. The entry to record the sale of the truck is:
Cash
Accumulated Depreciation
Loss on Sale
Delivery Truck
To record sale of truck at a loss.

9,000
14,000*
2,000**
25,000

*\$25,000 \$11,000
**\$11,000 \$9,000
Assets
+9,000
+14,000
25,000

Liabilities

Owners Equity
2,000

## CHAPTER 12 THE STATEMENT OF CASH FLOWS

12-7

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

EXERCISES
LO 2

## EXERCISE 12-1 CASH EQUIVALENTS

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

\$ 35,000
105,000
75,000
\$215,000

12-8

LO 3

## EXERCISE 12-2 CLASSIFICATION OF ACTIVITIES

1. F

8. F

2. S

9. S

3. F

10. I

4. F

11. I or O*

5. O

12. O

6. O

13. O

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

LO 3

## EXERCISE 12-3 RETIREMENT OF BONDS PAYABLE ON THE STATEMENT OF

CASH FLOWSINDIRECT METHOD

1. Journal entry:
2007
Dec. 31

Bonds Payable
Loss on Retirement of Bonds
Discount on Bonds Payable
Cash
To record retirement of bonds:
\$510,000 \$460,000.
Assets
510,000

Liabilities
500,000
+40,000

500,000
50,000
40,000
510,000

Owners Equity
50,000

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

LO 5

12-9

## Cash collections to be reported in the operating activities section of Stanleys 2007

statement of cash flows (direct method):
Accounts receivable, December 31, 2006
Plus sales during 2007
Less cash collections during 2007
Accounts receivable, December 31, 2007

\$ 80,800
1,450,000
(X)
\$ 101,100

X = \$1,429,700

LO 5

## EXERCISE 12-5 CASH PAYMENTSDIRECT METHOD

Cash payments for inventory to be reported in the operating activities section of Lester
Enterprises 2007 statement of cash flows (direct method):
Inventory, December 31, 2006
Plus purchases during 2007
Less cost of goods sold during 2007
Inventory, December 31, 2007

\$ 90,200
X
(770,900)
\$ 70,600

## \$90,200 + X \$770,900 = \$70,600

X = \$751,300
Accounts payable, December 31, 2006
Plus purchases during 2007
Less cash payments during 2007
Accounts payable, December 31, 2007
\$57,700 + \$751,300 X = \$39,200
X=\$769,800

\$ 57,700
751,300
(X)
\$ 39,200

12-10

LO 5

## 1. Operating activities section of the statement of cash flows:

PARTIAL STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
Cash Flows from Operating Activities
Cash collected from customers
Cash payments for:
Inventory
Interest
Taxes
Total Cash Payments
Net Cash Provided by Operating Activities

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

Footnotes:
1

Sales revenue
Cash collections

\$ 100,000
2,000
\$ 102,000

## Payments for inventory:

Cost of goods sold
Less: Increase in accounts payable
Cash payments

\$ 75,000
7,000
(3,000)
\$ 79,000

## For general and administrative expenses:

Less: Decrease in office supplies
Add: Decrease in salaries and wages payable
Cash payments
For interest:
Interest expense
Cash payments
For taxes:
Income tax expense
Less: Increase in income taxes payable
Cash payments

\$
\$
\$
\$
\$
\$

8,000
(3,000)
1,000
6,000
3,000
500
3,500
5,000
(1,500)
3,500

## CHAPTER 12 THE STATEMENT OF CASH FLOWS

12-11

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

## EXERCISE 12-7 DETERMINATION OF MISSING AMOUNTSCASH FLOW FROM

OPERATING ACTIVITIES

LO 5
Case 1:

Accounts Receivable
Beginning balance
Credit sales

150,000
175,000

Ending balance

100,000

35,000
X = Cash collections

Write-offs

## \$150,000 + \$175,000 \$35,000 X = \$100,000

X = \$190,000
\$190,000 + \$60,000 (Cash sales) = \$250,000
Case 2:
Inventory
Beginning balance
X = Purchases

80,000

Ending balance

55,000

175,000

Cost of goods
sold expense

## \$80,000 + X \$175,000 = \$55,000

X = \$150,000
Accounts Payable
25,000
X = Cash payments

X = \$160,000

150,000
15,000

Beginning
balance
Purchases
Ending
balance

12-12

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

Case 3:
Prepaid Insurance
Beginning balance
X = Cash payments

17,000

Ending balance

20,000

15,000

Insurance
expense

## \$17,000 + X \$15,000 = \$20,000

X = \$18,000
Case 4:
Income Taxes Payable
95,000
X = Cash payments

300,000
115,000

Beginning
balance
Tax expense
Ending
balance

X = \$280,000

LO 5

## 1. First, determine the amount of dividends declared:

Retained Earnings
250,000
Stock dividend
X = Dividends declared

50,000
285,000
375,000

X = \$110,000

Beginning
balance
Net income
Ending
balance

12-13

## Then, solve for the amount of dividends paid:

Dividends Payable
20,000
X = Dividends paid

110,000
30,000

Beginning
balance
Dividends
declared
Ending
balance

## \$20,000 + \$110,000 X = \$30,000

X = \$100,000
2. Because a stock dividend does not involve cash, it is not reported on the statement
of cash flows. It is questionable whether or not a stock dividend is a significant
noncash activity that should be reported on a supplemental schedule.

LO 6

1. A

6. A

2. D

7. D

3. A

8. A

4. A

9. NR

5. NR

10. A

12-14

LO 6

## 1. Operating activities section of the statement of cash flows:

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

\$40,000
20,000
(8,000)
10,000
(2,000)
7,000
(4,000)
3,000
\$66,000

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

LO 7

## 1. Cash flow adequacy ratio:

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

## CHAPTER 12 THE STATEMENT OF CASH FLOWS

12-15

MULTI-CONCEPT EXERCISES
LO 2,3

1. OI

6. CE

2. CE

7. II

3. IF

8. OI

4. OI

9. IF

5. OF

10. OF

LO 3,5

1. IO

7. OO

2. OO

8. OI

3. NR

9. OF

4. IF

10. NR

5. IO

11. OF

6. NR

12. II

LO 3,6

## EXERCISE 12-14 LONG-TERM ASSETS ON THE STATEMENT OF CASH FLOWS

INDIRECT METHOD

First, determine the accumulated depreciation on the assets sold so that the book value
of those sold can be found:
Accumulated Depreciation
200,000
X = Accumulated
depreciation on assets sold

50,000
160,000

X = \$90,000

Beginning
balance
Depreciation
expense
Ending
balance

12-16

## Thus, the entry to record the sale would be

Cash
Accumulated Depreciation
Plant and Equipment
Gain on Sale
To record sale of plant and equipment at a gain.
Assets
+64,000
+90,000
150,000

64,000
90,000
150,000
4,000

Liabilities

Owners Equity
+4,000

## Plant and Equipment

Beginning balance
X = Acquisitions

500,000

Ending balance

750,000

150,000

Sale of plant
and equipment

## \$500,000 + X \$150,000 = \$750,000

X = \$400,000
Similarly, acquisitions of new patents can be determined:
Patents
Beginning balance
X = Acquisitions

80,000

Ending balance

92,000

8,000

X = \$20,000

Amortization
expense

12-17

## These items would appear on the statement of cash flows as follows:

Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
Amortization expense
Gain on sale of plant and equipment

\$ 200,000
50,000
8,000
(4,000)

## Cash Flows from Investing Activities

Sale of plant and equipment
Acquisition of plant and equipment
Acquisition of patents

LO 1,5

64,000
(400,000)
(20,000)

## EXERCISE 12-15 INCOME STATEMENT, STATEMENT OF CASH FLOWS

(DIRECT METHOD), AND BALANCE SHEET

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

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

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

80,000
\$ 70,000

12-18

## 2. Statement of cash flows:

HANDSOME HOUNDS GROOMING COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED XX/XX/XX
Cash Flows from Operating Activities
Cash receipts from:
Cash sales
Collections on account
Total cash receipts
Cash payments for:
Rent
Security deposit
Other operating expenses
Total cash payments
Net cash provided by operating activities

\$ 110,0001
30,0002
\$ 140,000
\$ (12,000)
(2,000)
(58,000)3
\$ (72,000)
\$ 68,000

## Cash Flows from Investing Activities

Down payment on patent

\$ (20,000)4

## Cash Flows from Financing Activities

Issuance of common stock
Cash dividends paid
Net cash provided by financing activities
Net increase in cash
Cash balance, beginning of year
Cash balance, end of year

\$ 50,000
(20,000)
\$ 30,000
\$ 78,000
0
\$ 78,000

## Supplemental Schedule of Noncash Activities

Acquisition of patent in exchange for four-year note
1
2

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

3
4

\$100,000 20%

\$ 80,000

## CHAPTER 12 THE STATEMENT OF CASH FLOWS

12-19

3. The company generated slightly less cash flow from operations, \$68,000, than it
earned in net income, \$70,000. The differences between the two can be reconciled
as follows:
Net income
Amortization of patent
Deduct:
Security deposit (not yet an expense)
Uncollected accounts receivable
Net cash flow from operating activities

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

4. Balance sheet:
HANDSOME HOUNDS GROOMING COMPANY
BALANCE SHEET
AS OF XX/XX/XX
Assets
Current Assets:
Cash (from Part 2.)
Accounts receivable
Security deposit
Total current assets
Long-term Assets:
Patent
Total Assets
Liabilities and Stockholders Equity
Long-term liabilities:
Notes payable
Stockholders Equity:
Common stock
Retained earnings
Total stockholders equity
Total liabilities and stockholders equity
1
2

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

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

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

12-20

PROBLEMS
LO 6

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepaid rent
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Income taxes payable
Short-term notes payable
Bonds payable
Common stock
Retained earnings
Total

(2)
5
(10)
3
0
100
(35)
(2)
2
(10)
25
(50)
(26)
0

Explanation

Purchase
Depreciation expense
Issuance
Retirement
Issuance
Net income

12-21

## Statement of cash flows:

CHRISMAN COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense
Increase in accounts receivable
Decrease in inventory
Increase in prepaid rent
Increase in accounts payable
Decrease in income taxes payable
Net cash provided by operating activities

\$ 26
35
(5)
10
(3)
2
(2)
\$ 63

## Cash Flows from Investing Activities

Acquisition of plant and equipment

\$(100)

## Cash Flows from Financing Activities

Retirement of bonds payable
Issuance of short-term notes payable
Issuance of common stock
Net cash provided by financing activities
Net increase (decrease) in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ (25)
10
50
\$ 35
\$ (2)
10
\$ 8

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

12-22

LO 8

## PROBLEM 12-2 STATEMENT OF CASH FLOWS USING A WORK SHEETINDIRECT

METHOD (Appendix)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts

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

Balances
12/31/07
12/31/06

Changes

8
20
15
9
75
400

10
15
25
6
75
300

(2)
5
(10)
3

1001

(65)
(12)
(3)

(30)
(10)
(5)

(35)2
(2)
2

(35)
(75)
(200)
(137)
0

(25)
(100)
(150)
(111)
0

(10)3
254
(50)5
(26)6
0

Purchase of equipment.
2
Depreciation expense.
3
Proceeds from note.

## Cash Inflows (Outflows)

Operating Investing Financing

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

(100)

(2)
4

Retirement of bonds.
Issuance of common stock.
6
Net income.
5

35

12-23

## 2. Statement of cash flows:

CHRISMAN COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense
Increase in accounts receivable
Decrease in inventory
Increase in prepaid rent
Increase in accounts payable
Decrease in income taxes payable
Net cash provided by operating activities

\$ 26
35
(5)
10
(3)
2
(2)
\$ 63

## Cash Flows from Investing Activities

Acquisition of plant and equipment

\$(100)

## Cash Flows from Financing Activities

Retirement of bonds payable
Issuance of short-term notes payable
Issuance of common stock
Net cash provided by financing activities
Net increase (decrease) in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ (25)
10
50
\$ 35
\$ (2)
10
\$
8

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

12-24

LO 5

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepayments
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Income tax payable
Long-term bank loan
payable
Common stock
Retained earnings

(38)
50
30
(10)
150
200
(50)
18
(5)
20
(50)
(150)
(165)

Total

Explanation

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

## Proceeds from bank loan (c)

Issuance of common stock (c)
60 Dividends (a)
(225) Net income

Income Statement
Sales revenue

Amount
\$1,250

## Cost of goods sold

700

Operating expenses

150

Interest expense
Income tax expense
Net income

25
150
\$ 225

Cash Flows
\$1,250
Increase in accounts receivable
(50)
Cash collected
\$1,200
\$ 700
+ Increase in inventory
30
+ Decrease in accounts payable
18
Cash payments
\$ 748
\$ 150
Decrease in prepayments
(10)
Depreciation expense
(50)
Increase in accrued liabilities
(5)
Cash payments
\$ 85
\$ 25
No interest payable
0
Cash payments
\$ 25
\$ 150
+ Decrease in income tax payable
20
Cash paid for taxes
\$ 170
Net cash flow from operations
\$ 172

12-25

## Statement of cash flows:

PEORIA CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections from customers
Cash payments for:
Inventory
Operating expenses
Interest
Income taxes
Total cash payments
Net cash provided by operating activities

\$ (748)
(85)
(25)
(170)
\$(1,028)
\$ 172

## Cash Flows from Investing Activities

Acquisition of land
Acquisition of plant and equipment
Net cash used by investing activities

\$ (150)
(200)
\$ (350)

## Cash Flows from Financing Activities

Issuance of common stock
Cash dividends paid
Net cash provided by financing activities
Net decrease in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 1,200

\$
\$
\$
\$

50
150
(60)
140
(38)
90
52

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

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

12-26

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

Although net income on an accrual basis was \$225,000, net cash flow from
operating activities was only \$172,000. One of the reasons is that cash collections
were only \$1,200,000 even though sales were \$1,250,000. Also, inventory was
increased by \$30,000 during the period, and accounts payable was reduced by
\$18,000. Similarly, taxes payable was reduced by \$20,000, resulting in a further
drain on cash. Finally, two major acquisitions were made during the year: \$200,000
was spent on new plant and equipment and another \$150,000 to acquire new land.
These were only partially offset by the sale of additional stock for \$150,000 and the
issuance of additional notes in the amount of \$50,000. Finally, cash dividends
amounted to \$60,000, a further drain on cash.
Our cash flow should improve in future years without the need to invest so
heavily in new property, plant, and equipment. We can also improve our operating
cash flow by accelerating the collection of receivables as much as possible.
Similarly, we should be able to reduce the amount of inventory on hand at any one
time and over the long run reduce the cash paid for inventory purchases.
LO 6

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepayments
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Income tax payable
Long-term bank loan payable
Common stock
Retained earnings
Total

(38)
50
30
(10)
150
200
(50)
18
(5)
20
(50)
(150)
(165)
0

Explanation

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

## Proceeds from bank loan (c)

Issuance of common stock (c)
60 Dividends (a)
(225) Net income

12-27

## Statement of cash flows:

PEORIA CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense
Increase in accounts receivable
Increase in inventories
Decrease in prepayments
Decrease in accounts payable
Increase in other accrued liabilities
Decrease in income taxes payable
Net cash provided by operating activities

\$ 225
50
(50)
(30)
10
(18)
5
(20)
\$ 172

## Cash Flows from Investing Activities

Acquisition of land
Acquisition of plant and equipment
Net cash used by investing activities

\$(150)
(200)
\$(350)

## Cash Flows from Financing Activities

Issuance of common stock
Cash dividends paid
Net cash provided by financing activities
Net decrease in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 50
150
(60)
\$ 140
\$ (38)
90
\$ 52

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

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

12-28

## Although net income on an accrual basis was \$225,000, changes in various

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

LO 8

## PROBLEM 12-5 STATEMENT OF CASH FLOWS USING A WORK SHEETINDIRECT

METHOD (Appendix)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts

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

Balances
12/31/07
12/31/06

Changes

52
180
230
15
750
700

90
130
200
25
600
500

(38)
50
30
(10)
1501
2002

(250)
(130)
(68)
(90)

(200)
(148)
(63)
(110)

(50)3
18
(5)
20

(350)
(550)
(489)

(300)
(400)
(324)

(50)4
(150)5
606
(225)7
0

Purchase of land.
2
Purchase of plant and equipment.
3
Depreciation expense.
4
Proceeds from bank loan.

## Cash Inflows (Outflows)

Operating Investing Financing

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

(350)

(38)
5

Dividends.
7
Net income.
6

140

12-29

## 2. Statement of cash flows:

PEORIA CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense
Increase in accounts receivable
Increase in inventories
Decrease in prepayments
Decrease in accounts payable
Increase in other accrued liabilities
Decrease in income taxes payable
Net cash provided by operating activities

\$ 225
50
(50)
(30)
10
(18)
5
(20)
\$ 172

## Cash Flows from Investing Activities

Acquisition of land
Acquisition of plant and equipment
Net cash used by investing activities

\$(150)
(200)
\$(350)

## Cash Flows from Financing Activities

Issuance of common stock
Cash dividends paid
Net cash provided by financing activities
Net decrease in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 50
150
(60)
\$ 140
\$ (38)
90
\$ 52

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

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

12-30

## Although net income on an accrual basis was \$225,000, changes in various

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

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepayments
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Interest payable
Long-term bank loan payable
Common stock
Retained earnings
Total

15
(25)
(50)
10
75
70
(70)
(25)
10
(5)
(90)
(50)
135
0

Explanation

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

## Proceeds from bank loan (c)

Issuance of common stock (c)
35 Dividends (a)
100 Net loss

12-31

Income Statement
Sales revenue

Amount
\$ 500

## Cost of goods sold

400

Operating expenses

180

Interest expense
Net income (loss)

20
\$(100)

Cash Flows
\$500
+ Decrease in accounts receivable
25
Cash collected
\$525
\$400
Decrease in inventory
(50)
Increase in accounts payable
(25)
Cash payments
\$325
\$180
+ Increase in prepayments
10
Depreciation expense
(70)
+ Decrease in accrued liabilities
10
Cash payments
\$130
\$ 20
Increase in interest payable
(5)
Cash payments
\$ 15
Net cash flow from operations
\$ 55

## Statement of cash flows:

ASTRO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections on account
Cash payments for:
Inventory
Operating expenses
Interest
Total cash payments
Net cash provided by operating activities

\$(325)
(130)
(15)
\$(470)
\$ 55

## Cash Flows from Investing Activities

Acquisition of land
Acquisition of plant and equipment
Net cash used by investing activities

\$ (75)
(70)
\$(145)

## Cash Flows from Financing Activities

Issuance of common stock
Cash dividends paid
Net cash provided by financing activities
Net increase in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 90
50
(35)
\$ 105
\$ 15
80
\$ 95

\$ 525

12-32

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

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

LO 6

12-33

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepayments
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Interest payable
Long-term bank loan payable
Common stock
Retained earnings
Total

15
(25)
(50)
10
75
70
(70)
(25)
10
(5)
(90)
(50)
135
0

Explanation

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

## Proceeds from bank loan (c)

Issuance of common stock (c)
35 Dividends (a)
100 Net loss

12-34

## Statement of cash flows:

ASTRO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(AMOUNTS IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net loss
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense
Decrease in accounts receivable
Decrease in inventories
Increase in prepayments
Increase in accounts payable
Decrease in other accrued liabilities
Increase in interest payable
Net cash provided by operating activities

\$(100)
70
25
50
(10)
25
(10)
5
\$ 55

## Cash Flows from Investing Activities

Acquisition of land
Acquisition of plant and equipment
Net cash used by investing activities

\$ (75)
(70)
\$(145)

## Cash Flows from Financing Activities

Issuance of common stock
Cash dividends paid
Net cash provided by financing activities
Net increase in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 90
50
(35)
\$ 105
\$ 15
80
\$ 95

12-35

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

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

12-36

LO 8

## PROBLEM 12-8 STATEMENT OF CASH FLOWS USING A WORK SHEETINDIRECT

METHOD (APPENDIX)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts

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

Balances
12/31/07
12/31/06

## Cash Inflows (Outflows)

Operating Investing Financing

95
50
100
55
475
870

80
75
150
45
400
800

15
(25)
(50)
10
751
702

(370)
(125)

(300)
(100)

(70)3
(25)

70
25

(35)
(15)

(45)
(10)

10
(5)

(10)
5

(340)
(450)
(310)

(250)
(400)
(445)

(90)4
(50)5
1006
357
0

Purchase of land.
Purchase of plant and equipment.
3
Depreciation expense.
4
Proceeds from borrowings.
5
Issuance of common stock.
6
Net loss.
7
Cash dividends paid.
2

Changes

25
50
(10)
(75)
(70)

90
50
(100)
55
15

(145)

(35)
105

12-37

## 2. Statement of cash flows:

ASTRO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(AMOUNTS IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net loss
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense
Decrease in accounts receivable
Decrease in inventories
Increase in prepayments
Increase in accounts payable
Decrease in other accrued liabilities
Increase in interest payable
Net cash provided by operating activities

\$(100)
70
25
50
(10)
25
(10)
5
\$ 55

## Cash Flows from Investing Activities

Acquisition of land
Acquisition of plant and equipment
Net cash used by investing activities

\$ (75)
(70)
\$(145)

## Cash Flows from Financing Activities

Issuance of common stock
Cash dividends paid
Net cash provided by financing activities
Net increase in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 90
50
(35)
\$ 105
\$ 15
80
\$ 95

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

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

12-38

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

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

LO 6

INDIRECT METHOD

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Land
Plant and equipment
Accumulated depreciation
Investments
Current liabilities
Bonds payable
Common stock
Retained earnings
Total without cash

?
10
100
200
(20)
0
0
(250)
50
(45)

Explanation
h. sales exceeded cash
collections
g. bonds were exchanged
for landa noncash
activity
f. purchase
b. depreciation expense
no change given
i. no change
d. 150 issued for cash and
g. 100 issued for land
e. common stock retired
c. dividends of 25
a. net income of (70)

45 dr.

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

12-39

## Statement of Cash Flows:

TERRIER COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
Increase in accounts receivable
Net cash provided by operating activities

\$ 70
20
(10)
\$ 80

## Cash Flows from Investing Activities

Acquisitions of plant and equipment

\$(200)

## Cash Flows from Financing Activities

Payment of cash dividends
Acquisition and retirement of stock
Net cash provided by financing activities
Net increase (decrease) in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ (25)
150
(50)
\$ 75
\$ (45)
140
\$ 95

## Schedule of Noncash Investing and Financing Activities

Acquisition of land in exchange for bonds

\$ 100

12-40

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

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

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

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

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

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

LO 8

12-41

## PROBLEM 12-10 STATEMENT OF CASH FLOWS USING A WORK SHEET

INDIRECT METHOD (Appendix)

1. Balance sheet:
TERRIER COMPANY
BALANCE SHEET
DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
951
1652
\$ 260
\$ 4003
7004
(170)5
100
\$1,030
\$1,290
\$ 205
\$ 5506
\$ 3507
1858
\$ 535
\$1,290

Cash
Accounts receivable
Total current assets
Land
Plant and equipment
Accumulated depreciation
Investments
Total long-term assets
Total assets
Current liabilities
Bonds payable
Common stock
Retained earnings
Total stockholders equity
Total liabilities and stockholders equity
1

\$140 \$45
2
\$155 + \$10
3
\$300 + \$100
4
\$500 + \$200

\$150 + \$20
\$300 + \$250
7
\$400 \$50
8
\$140 + \$45
6

12-42

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts

Balances
12/31/07
12/31/06

Changes

Cash
Accounts receivable
Land
Plant and equipment
Accumulated
depreciation
Investments
Current liabilities
Bonds payable

95
165
400
700

140
155
300
500

(45)
10
1001
2002

(170)
100
(205)
(550)

(150)
100
(205)
(300)

Common stock
Retained earnings

(350)
(185)

(400)
(140)

(20)3
0
0
(100)1
(150)4
505
(70)6
257
0

Totals
Net increase
(decrease) in cash
1

## Cash Inflows (Outflows)

Operating Investing Financing

(10)
(200)
20

150
(50)
70
80
(45)

## Acquisition of land in exchange for bonds (noncash transaction).

Purchase of plant and equipment.
3
Depreciation expense.
4
Proceeds from issuance of additional bonds.
5
Acquisition and retirement of common stock.
6
Net income.
7
Cash dividends paid.
2

(200)

(25)
75

12-43

## 3. Statement of cash flows:

TERRIER COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
Increase in accounts receivable
Net cash provided by operating activities

\$ 70
20
(10)
\$ 80

## Cash Flows from Investing Activities

Acquisitions of plant and equipment

\$(200)

## Cash Flows from Financing Activities

Payment of cash dividends
Acquisition and retirement of stock
Net cash provided by financing activities
Net increase (decrease) in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ (25)
150
(50)
\$ 75
\$ (45)
140
\$ 95

## Schedule of Noncash Investing and Financing Activities

Acquisition of land in exchange for bonds

\$ 100

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

12-44

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

MULTI-CONCEPT PROBLEMS
LO 4,5

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepaid rent
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Income tax payable
Long-term bank loan payable
Common stock
Retained earnings
Total

(9)
15
(15)
(4)
80
150
(60)
(7)
(6)
2
30
(150)
(26)
0

Explanation

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

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

12-45

## Conversion of income statement items to a cash basis (in thousands of dollars):

Income Statement
Sales revenue
Cost of goods sold

General and

Amount
\$550
350

Cash Flows
\$550
Increase in accounts receivable
(15)
Cash collected
\$535
\$350
Decrease in inventory
(15)
Increase in accounts payable
(7)
Cash payments
\$328

55

Depreciation expense
Loss on sale of
plant assets
Interest expense

75

17

Net income

5
15

\$ 33

## Decrease in prepaid rent

Increase in accrued liabilities
Cash payments
No cash flow effect
Not an operating activity
No interest payable
Cash payments
+ Decrease in income
taxes payable
Cash payments
Net cash flow from operations

\$ 55
(4)
(6)
\$ 45
\$ 0
\$ 0
\$ 15
\$ 17
2
\$ 19
\$128

12-46

## Statement of cash flows:

GLENDIVE CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flow from Operating Activities
Cash collections from customers
Cash payments for:
Inventory
Interest
Income taxes
Total cash payments
Net cash provided by operating activities

\$(328)
(45)
(15)
(19)
\$(407)
\$ 128

## Cash Flow from Investing Activities

Sale of plant assets
Acquisition of land
Acquisition of new plant assets
Net cash used by investing activities

\$ 25
(80)
(195)
\$(250)

## Cash Flow from Financing Activities

Repayment of long-term loan
Payment of cash dividends
Net cash provided by financing activities
Net decrease in cash
Cash balance, June 30, 2006
Cash balance, June 30, 2007

\$ 535

\$ (30)
150
(7)
\$ 113
\$ (9)
40
\$ 31

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

LO 4,6

12-47

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepaid rent
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Income tax payable
Long-term bank loan payable
Common stock
Retained earnings
Total

(9)
15
(15)
(4)
80
150
(60)
(7)
(6)
2
30
(150)
(26)
0

Explanation

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

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

12-48

## Statement of cash flows:

GLENDIVE CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flow from Operating Activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
Loss on sale of plant assets
Increase in accounts receivable
Decrease in inventory
Decrease in prepaid rent
Increase in accounts payable
Increase in other accrued liabilities
Decrease in income taxes payable
Net cash provided by operating activities

\$ 33
75
5*
(15)
15
4
7
6
(2)
\$ 128

## *Book value \$30 proceeds \$25

Cash Flow from Investing Activities
Sale of plant assets
Acquisition of land
Acquisition of new plant assets
Net cash used by investing activities
Cash Flow from Financing Activities
Repayment of long-term loan
Payment of cash dividends
Net cash provided by financing activities
Net decrease in cash
Cash balance, June 30, 2006
Cash balance, June 30, 2007

\$ 25
(80)
(195)
\$(250)
\$ (30)
150
(7)
\$ 113
\$ (9)
40
\$ 31

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

LO 2,5

12-49

## PROBLEM 12-13 STATEMENT OF CASH FLOWSDIRECT METHOD

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

(40)
(50)
110
120
10
110
(60)
(25)
(60)
(5)
0
0
(130)
20
0

Explanation
Sale
Purchase
Purchase
Depreciation expense
Amortization

## (130) Stock dividend

(110) Net income
130 Stock dividend

12-50

## Conversion of income statement items to a cash basis (in thousands of dollars):

Income Statement
Sales revenue
Cost of goods sold

Amount
\$2,408
1,100

## Salaries & benefits

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

\$ 110

Cash Flows
\$2,408
Increase in accounts receivable
(110)
Cash collected
\$2,298
\$1,100
+ Increase in inventory
120
Increase in accounts payable
(60)
Cash payments
\$1,160
No payable
\$ 850
No payable
\$ 75
No cash flow effect
No payable*
\$ 18
No cash flow effect
No payable
\$ 10
No payable
\$ 55
\$ 105
Increase in income tax payable*
(5)
Cash payments
\$ 100
Net cash flow from operations
\$ 30

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

12-51

## Statement of cash flows:

LANG COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections from customers
Cash payments for:
Inventory
(1,160)
Salaries and benefits
Heat, light, and power
Property taxes
Miscellaneous activities
Interest
Income taxes
Total cash payments
Net cash provided by operating activities
Cash Flows from Investing Activities
Sale of U.S. Treasury bills
Acquisition of land
Acquisition of buildings and equipment
Net cash used by investing activities
Net decrease in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 2,298
\$
(850)
(75)
(18)
(10)
(55)
(100)
\$(2,268)
\$
30
\$

50
(10)
(110)
\$ (70)
\$ (40)
100
\$
60

## Note: It is questionable whether or not the stock dividend is a significant noncash

activity. If it is determined to be significant, it should be shown on a supplemental
schedule of noncash activities.

12-52

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

A L T E R N AT E P R O B L E M S
LO 6

## 1. Account changes Dr (Cr) and Explanations:

Cash
Accounts receivable
Inventory
Prepaid rent
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Income taxes payable
Short-term notes payable
Bonds payable
Common stock
Retained earnings
Total

2,000
(2,000)
1,000
200
0
50,000
(50,000)
0
(500)
2,500
(25,000)
0
21,800
0

Purchase
Depreciation expense
Repayment
Issuance
Net loss

12-53

## Statement of cash flows:

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

\$(21,800)
50,000
2,000
(1,000)
(200)
500
\$ 29,500
\$(50,000)
\$ 25,000
(2,500)
\$ 22,500
\$ 2,000
10,000
\$ 12,000

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

12-54

LO 8

## PROBLEM 12-2A STATEMENT OF CASH FLOWS USING A WORK SHEET

INDIRECT METHOD (Appendix)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars)
Accounts

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

Purchase of equipment.
Depreciation expense.
3
Retirement of note.
4
Issuance of bonds.
5
Net loss.
2

Balances
12/31/07
12/31/06

Changes

12.0
10.0
8.0
1.2
75.0
200.0

10.0
12.0
7.0
1.0
75.0
150.0

2.0
(2.0)
1.0
0.2
0.0
50.01

(75.0)
(15.0)
(2.5)

(25.0)
(15.0)
(2.0)

(50.0)2
0.0
(0.5)

(20.0)
(75.0)
(100.0)
(18.7)
0.0

(22.5)
(50.0)
(100.0)
(40.5)
0.0

2.53
(25.0)4
0.0
21.85
0.0

## Cash Inflows (Outflows)

Operating Investing Financing

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

(50)

22.5

12-55

## 2. Statement of cash flows:

STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
Cash Flows from Operating Activities
Net loss
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
Decrease in accounts receivable
Increase in inventory
Increase in prepaid rent
Increase in income taxes payable
Net cash provided by operating activities
Cash Flows from Investing Activities
Acquisition of plant and equipment
(50,000)
Cash Flows from Financing Activities
Issuance of bonds payable
Repayment of short-term notes payable
Net cash provided by financing activities
Net increase (decrease) in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$(21,800)
50,000
2,000
(1,000)
(200)
500
\$ 29,500
\$

\$ 25,000
(2,500)
\$ 22,500
\$ 2,000
10,000
\$ 12,000

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

12-56

LO 5

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepayments
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Income tax payable
Long-term bank loan payable
Common stock
Retained earnings
Total

(70)
(85)
20
(10)
(100)
250
(25)
(20)
5
35
50
(50)
(0)

Explanation

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

## Retirement of bank loan (d)

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

## Conversion of income statement items to a cash basis (in thousands of dollars):

Income Statement
Sales revenue
Cost of goods sold

Amount
\$2,460
1,400

Operating expenses

460

Interest expense

100

## Income tax expense

150

Net income

\$ 350

Cash Flows
\$2,460
+ Decrease in accounts receivable
85
Cash collected
\$2,545
\$1,400
+ Increase in inventory
20
Increase in accounts payable
(20)
Cash payments
\$1,400
\$ 460
Decrease in prepayments
(10)
Depreciation expense
(25)
+ Decrease in accrued liabilities
5
Cash payments
\$ 430
\$ 100
No interest payable
0
Cash payments
\$ 100
\$ 150
+ Decrease in income tax payable
35
Cash paid for taxes
\$ 185
Net cash flow from operations
\$ 430

12-57

## Statement of cash flows:

WABASH CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections from customers
Cash payments for:
Inventory
Operating expenses
Interest
Income taxes
Total cash payments
Net cash provided by operating activities
Cash Flows from Investing Activities
Sale of land
Acquisition of plant and equipment
Net cash used by investing activities
Cash Flows from Financing Activities
Repayment of long-term borrowings
Issuance of common stock
Cash dividends paid
Net cash used by financing activities
Net decrease in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 2,545
\$(1,400)
(430)
(100)
(185)
\$(2,115)
\$ 430
\$

100
(250)
\$ (150)
\$

(50)
50
(350)
\$ (350)
\$ (70)
210
\$ 140

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

You recently expressed concern to me regarding the decrease in cash during 2007
in spite of the profitable year shown on the income statement. Furthermore, there
was a concern regarding the decline in our cash balance during the year, given that
existing loan covenants require a \$100,000 minimum balance at all times. My
thoughts and a copy of the 2007 statement of cash flows follow.
Although net income on an accrual basis was \$350,000, net cash flow from
operating activities was even higher, \$430,000. However, the favorable cash flow
during the year was used for various purposes. First, significant additions were
made to plant and equipment, \$250,000, and this drain on cash was only partially
offset by the sale of land for \$100,000. Additional stock was sold for \$50,000, which

12-58

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

was the amount needed to repay an existing bank loan. The major reason, however,
for the drain on cash is the size of our dividend payments. Dividends of \$350,000
were paid during the year, which is equal to the income of the period.
Our cash flow should improve in future years without the need to invest so
heavily in new property, plant, and equipment. At the same time, I recommend that
we limit the amount paid in any one year for dividends as a way to keep our cash
balance at a sufficient level to satisfy the bank.

LO 6

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepayments
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Income tax payable
Long-term bank loan payable
Common stock
Retained earnings
Total

(70)
(85)
20
(10)
(100)
250
(25)
(20)
5
35
50
(50)
(0)
0

Explanation

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

## Retirement of bank loan (d)

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

12-59

## Statement of cash flows:

WABASH CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
Decrease in accounts receivable
Increase in inventories
Decrease in prepayments
Increase in accounts payable
Decrease in other accrued liabilities
Decrease in income taxes payable
Net cash provided by operating activities

\$ 350
25
85
(20)
10
20
(5)
(35)
\$ 430

## Cash Flows from Investing Activities

Sale of land
Acquisition of plant and equipment
Net cash used by investing activities

\$ 100
(250)
\$(150)

## Cash Flows from Financing Activities

Repayment of long-term borrowings
Issuance of common stock
Cash dividends paid
Net cash used by financing activities
Net decrease in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ (50)
50
(350)
\$(350)
\$ (70)
210
\$ 140

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

You recently expressed concern to me regarding the decrease in cash during 2007
in spite of the profitable year shown on the income statement. Furthermore, there
was a concern regarding the decline in our cash balance during the year, given that
existing loan covenants require a \$100,000 minimum balance at all times. My
thoughts and a copy of the 2007 statement of cash flows follow.
Although net income on an accrual basis was \$350,000, net cash flow from
operating activities was even higher, \$430,000. However, the favorable cash flow

12-60

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

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

LO 8

## PROBLEM 12-5A STATEMENT OF CASH FLOWS USING A WORK SHEET

INDIRECT METHOD (Appendix)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts

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

Balances
12/31/07
12/31/06

Changes

140
60
200
15
600
850

210
145
180
25
700
600

(70)
(85)
20
(10)
(100)1
2502

(225)
(140)
(50)
(80)

(200)
(120)
(55)
(115)

(25)3
(20)
5
35

(200)
(450)
(720)

(250)
(400)
(720)

504
(50)5
3506
(350)7
0

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

(150)

(70)

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

## Cash Inflows (Outflows)

Operating Investing Financing

Dividends.
7
Net income.

(350)

12-61

## 2. Statement of cash flows:

WABASH CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense
Decrease in accounts receivable
Increase in inventories
Decrease in prepayments
Increase in accounts payable
Decrease in other accrued liabilities
Decrease in income taxes payable
Net cash provided by operating activities

\$ 350
25
85
(20)
10
20
(5)
(35)
\$ 430

## Cash Flows from Investing Activities

Sale of land
Acquisition of plant and equipment
Net cash used by investing activities

\$ 100
(250)
\$(150)

## Cash Flows from Financing Activities

Repayment of long-term borrowings
Issuance of common stock
Cash dividends paid
Net cash used by financing activities
Net decrease in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ (50)
50
(350)
\$(350)
\$ (70)
210
\$ 140

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

You recently expressed concern to me regarding the decrease in cash during 2007
in spite of the profitable year shown on the income statement. Furthermore, there
was a concern regarding the decline in our cash balance during the year, given that
existing loan covenants require a \$100,000 minimum balance at all times. My
thoughts and a copy of the 2007 statement of cash flows follow.
Although net income on an accrual basis was \$350,000, net cash flow from
operating activities was even higher, \$430,000. However, the favorable cash flow

12-62

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

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

LO 5

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepayments
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Interest payable
Long-term bank loan payable
Common stock
Retained earnings
Total

15
(50)
0
1
100
250
(40)
(40)
(20)
(10)
(350)
0
144
0

Explanation

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

84 Dividends (a)
60 Net loss

12-63

Income Statement
Sales revenue

Amount
\$350

## Cost of goods sold

150

Operating expenses

250

Interest expense
Net income (loss)

10
\$(60)

Cash Flows
\$350
+ Decrease in accounts receivable
50
Cash collected
\$400
\$150
No change in inventory
Increase in accounts payable
(40)
Cash payments
\$110
\$250
+ Increase in prepayments
1
Depreciation expense
(40)
Increase in accrued liabilities
(20)
Cash payments
\$191
\$ 10
Increase in interest payable
(10)
Cash payments
\$ 0
Net cash flow from operations
\$ 99

## Statement of cash flows:

PLUTO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections on account
Cash payments for:
Inventory
Operating expenses
Total cash payments
(301)
Net cash provided by operating activities

\$ 400
\$(110)
(191)
\$
\$ 99

## Cash Flows from Investing Activities

Acquisition of land
Acquisition of plant and equipment
Net cash used by investing activities

\$(100)
(250)
\$(350)

## Cash Flows from Financing Activities

Cash dividends paid
Net cash provided by financing activities
Net increase in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 350
(84)
\$ 266
\$ 15
10
\$ 25

12-64

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

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

LO 6

12-65

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepayments
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Interest payable
Long-term bank loan payable
Common stock
Retained earnings
Total

15
(50)
0
1
100
250
(40)
(40)
(20)
(10)
(350)
0
144
0

Explanation

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

84 Dividends (a)
60 Net loss

12-66

## Statement of cash flows:

PLUTO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net loss
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense
Decrease in accounts receivable
Increase in prepayments
Increase in accounts payable
Increase in other accrued liabilities
Increase in interest payable
Net cash provided by operating activities

\$ (60)
40
50
(1)
40
20
10
\$ 99

## Cash Flows from Investing Activities

Acquisition of land
Acquisition of plant and equipment
Net cash used by investing activities

\$(100)
(250)
\$(350)

## Cash Flows from Financing Activities

Cash dividends paid
Net cash provided by financing activities
Net increase in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 350
(84)
\$ 266
\$ 15
10
\$ 25

12-67

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

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

12-68

LO 8

## PROBLEM 12-8A STATEMENT OF CASH FLOWS USING A WORK SHEET

INDIRECT METHOD (Appendix)

1. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts

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

Balances
12/31/07
12/31/06

Changes

## Cash Inflows (Outflows)

Operating Investing Financing

25
30
100
36
300
500

10
80
100
35
200
250

15
(50)
0
1
1001
2502

(90)
(50)

(50)
(10)

(40)3
(40)

40
40

(40)
(22)

(20)
(12)

(20)
(10)

20
10

(450)
(300)
(39)

(100)
(300)
(183)

(350)4
0
605
846
0

(1)
(100)
(250)

350
(60)
99

(350)

15

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

50

## Proceeds from borrowings.

Net loss.
6
Cash dividends paid.

(84)
266

12-69

## 2. Statement of cash flows:

PLUTO INC.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net loss
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense
Decrease in accounts receivable
Increase in prepayments
Increase in accounts payable
Increase in other accrued liabilities
Increase in interest payable
Net cash provided by operating activities

\$ (60)
40
50
(1)
40
20
10
\$ 99

## Cash Flows from Investing Activities

Acquisition of land
Acquisition of plant and equipment
Net cash used by investing activities

\$(100)
(250)
\$(350)

## Cash Flows from Financing Activities

Cash dividends paid
Net cash provided by financing activities
Net increase in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 350
(84)
\$ 266
\$ 15
10
\$ 25

TO:

FROM:

Students name

DATE:

## SUBJECT: Cash flows

You recently expressed concern to me regarding the large loss we sustained during
2007 in spite of the net increase in cash during the year. Following are my thoughts,
along with a copy of the 2007 statement of cash flows for your reference.
Pluto was able to generate a significant amount of cash from operations even
though we incurred a net loss of \$60,000. One reason for the difference between
cash generated from operations and the net loss was the \$40,000 of depreciation
expense on the income statement. This noncash expense reduced reported net
income without a corresponding effect on cash flow. Furthermore, the large
decrease in accounts receivable of \$50,000 indicates that we collected more cash

12-70

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

from our customers during the year than the amount of sales to them. Finally, the
large buildup of our accounts payable by \$40,000 had the effect of improving our
cash flow for the year.
The gross profit percentage of 57% is very strong. However, operating expenses
need to be decreased relative to gross profit if we are to improve our bottom line in
the future. A portion of the operating expenses is the depreciation of \$40,000.
Because this represents the write-off of a sunk cost (the cost of plant and equipment
acquired already), we cannot reduce the amount of this expense unless we decide
to sell fixed assets. In fact, during 2007 we actually added \$350,000 to our base of
long-term assets, in the form of land and plant and equipment acquisitions. You will
note on the statement of cash flows that these acquisitions were entirely financed
with the issuance of a long-term bank loan.
I recommend two immediate courses of action. First, we must find ways to
reduce our operating expenses. Second, until we see an improvement in the bottom
line, it is imperative that we cut back, if not eliminate entirely, our dividends. A
dividend payment of \$84,000 in a year in which we sustained a net loss of \$60,000
is not prudent. I look forward to hearing from you before moving forward with any
actions.

LO 6

## PROBLEM 12-9A YEAR-END BALANCE SHEET AND STATEMENT OF CASH

FLOWSINDIRECT METHOD

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Land
Plant and equipment
Accumulated depreciation
Investments
Current liabilities
Long-term note payable

?
15
200
60
(25)
0
20
(200)

Bonds payable
Common stock
Retained earnings

100
(50)
(10)

## Total without cash

110 dr.

Explanation
h. sales exceeded cash
collections
g. note was exchanged for land,
a noncash activity
f. purchase
b. depreciation expense
no change given
i. decrease
g. note was exchanged for land,
a noncash activity
e bonds retired
d. common stock issued
c. dividends of 40
a. income of (50)

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

12-71

## Statement of cash flows:

POODLE COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense
Increase in accounts receivable
Decrease in current liabilities
Net cash provided by operating activities

\$ 50
25
(15)
(20)
\$ 40

## Cash Flows from Investing Activities

Acquisitions of plant and equipment

\$ (60)

## Cash Flows from Financing Activities

Payment of cash dividends
Retirement of bonds
Issuance of common stock
Net cash used by financing activities
Net increase (decrease) in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ (40)
(100)
50
\$ (90)
\$(110)
155
\$ 45

## Schedule of Noncash Investing and Financing Activities

Acquisition of land in exchange for note

\$ 200

12-72

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

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

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

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

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

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

LO 8

12-73

## PROBLEM 12-10A STATEMENT OF CASH FLOWS USING A WORK SHEET

INDIRECT METHOD (Appendix)

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

\$155 \$110
2
\$140 + \$15
3
\$100 + \$200
4
\$700 + \$60

\$175 + \$25
\$325 \$20
7
\$500 + \$50
8
\$120 + \$10
6

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

12-74

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

2. Statement of cash flows work sheet (all amounts are in thousands of dollars):
Accounts

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

Balances
12/31/07
12/31/06

Changes

45
155
300
760

155
140
100
700

(200)
125
(305)

(175)
125
(325)

(25)3
0
20

(200)
0
(550)
(130)

0
(100)
(500)
(120)

(200)1
1004
(50)5
(50)6
407
0

(110)
15
2001
602

## Cash Inflows (Outflows)

Operating Investing Financing

(15)
(60)
25
(20)
(100)
50
50
40
(110)

## Acquisition of land in exchange for note (noncash transaction).

Purchase of plant and equipment.
3
Depreciation expense.
4
Retirement of bonds payable.
5
Issuance of common stock.
6
Net income.
7
Cash dividends paid.
2

(60)

(40)
(90)

12-75

## 3. Statement of cash flows:

POODLE COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Net income
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense
Increase in accounts receivable
Decrease in current liabilities
Net cash provided by operating activities

\$ 50
25
(15)
(20)
\$ 40

## Cash Flows from Investing Activities

Acquisitions of plant and equipment

\$ (60)

## Cash Flows from Financing Activities

Payment of cash dividends
Retirement of bonds
Issuance of common stock
Net cash used by financing activities
Net increase (decrease) in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ (40)
(100)
50
\$ (90)
\$(110)
155
\$ 45

## Schedule of Noncash Investing and Financing Activities

Acquisition of land in exchange for note

\$ 200

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

12-76

LO 4,5

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepaid rent
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Income tax payable
Long-term bank loan payable
Common stock
Retained earnings
Total

(15)
11
25
(16)
(90)
75
(60)
(5)
(5)
10
75
0
(5)
0

Explanation

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

Repayment
5 Dividends
(10) Net income

12-77

## Conversion of income statement items to a cash basis (in thousands of dollars):

Income Statement
Sales revenue
Cost of goods sold

General and

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

Amount
\$400
240

Cash Flows
\$400
Increase in accounts receivable
(11)
Cash collected
\$389
\$240
+ Increase in inventory
25
Increase in accounts payable
(5)
Cash payments
\$260

40

80
10
15

## Decrease in prepaid rent

Increase in accrued liabilities
Cash payments
(No cash flow effect)
Not an operating activity
No interest payable
Cash payments

5
\$ 10

## + Decrease in income taxes payable

Cash payments
Net cash flow from operations

\$ 40
(16)
(5)
\$ 19
\$ 0
\$

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

12-78

## Statement of cash flows:

BANNACK CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections from customers
Cash payments for:
Inventory
Interest
Income taxes
Total cash payments
Net cash provided by operating activities

\$(260)
(19)
(15)
(15)
\$(309)
\$ 80

## Cash Flows from Investing Activities

Sale of land
Purchase of plant and equipment
Sale of plant and equipment
Net cash used by investing activities

\$ 90
(125)
20
\$ (15)

## Cash Flows from Financing Activities

Repayment of long-term loan
Payment of cash dividends
Net cash used by financing activities
Net decrease in cash
Cash balance, June 30, 2006
Cash balance, June 30, 2007

\$ (75)
(5)
\$ (80)
\$ (15)
40
\$ 25

\$ 389

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

LO 4,6

12-79

## 1.Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepaid rent
Land
Plant and equipment
Accumulated depreciation
Accounts payable
Other accrued liabilities
Income tax payable
Long-term bank loan payable
Common stock
Retained earnings
Total

(15)
11
25
(16)
(90)
75
(60)
(5)
(5)
10
75
0
(5)
0

Explanation

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

Repayment
5 Dividends
(10) Net income

12-80

## Statement of cash flows:

BANNACK CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED JUNE 30, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flow from Operating Activities
Net income
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation expense
Loss on sale of plant assets
Increase in accounts receivable
Increase in inventory
Decrease in prepaid rent
Increase in accounts payable
Increase in other accrued liabilities
Decrease in income taxes payable
Net cash provided by operating activities
Cash Flow from Investing Activities
Sale of land
Purchase of plant and equipment
Sale of plant and equipment
Net cash used by investing activities
(15)
Cash Flow from Financing Activities
Repayment of long-term loan
Payment of cash dividends
Net cash used by financing activities
Net decrease in cash
(15)
Cash balance, June 30, 2006
Cash balance, June 30, 2007

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

\$(75)
(5)
\$(80)
\$
40
\$ 25

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

LO 2,5

12-81

## PROBLEM 12-13A STATEMENT OF CASH FLOWSDIRECT METHOD

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

(25)
25
(75)
25
20
60
(40)
(20)
(40)
10
100
0
(20)
(20)
0

Explanation

Purchase
Purchase
Depreciation expense
Amortization
Retirement of note
(20) Stock dividend
(40) Net income
20 Stock dividend

12-82

Income Statement
Sales revenue

Amount
\$1,416

990

## Salaries and benefits

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

195
70
40
2
20
2
45
12

Net income

40

Cash Flows
\$1,416
+ Decrease in accounts receivable
75
Cash collected
\$1,491
\$ 990
+ Increase in inventory
25
Increase in accounts payable
(40)
Cash payments
\$ 975
No payable
\$ 195
No payable
\$ 70
No cash flow effect
No payable*
\$
2
No cash flow effect
No payable
\$
2
No payable
\$ 45
\$ 12
+ Decrease in income tax payable*
10
Cash payments
\$ 22
Net cash flow from operations
\$ 180

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

12-83

## Statement of cash flows:

SHEPARD COMPANY
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collections from customers
Cash payments for:
Inventory
Salaries and benefits
Heat, light, and power
Property taxes
Miscellaneous activities
Interest
Income taxes
Total cash payments
Net cash provided by operating activities

\$ 1,491
\$ (975)
(195)
(70)
(2)
(2)
(45)
(22)
\$(1,311)
\$ 180

## Cash Flows from Investing Activities

Purchase of U.S. Treasury bills
Acquisition of land
Acquisition of buildings and equipment
Net cash used by investing activities

\$ (25)
(20)
(60)
\$ (105)

## Cash Flows from Financing Activities

Retirement of notes payable
Net decrease in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ (100)
\$ (25)
75
\$
50

## Note: It is questionable whether or not the stock dividend is a significant noncash

activity. If it is determined to be significant, it should be shown on a supplemental
schedule of noncash activities.

12-84

## FINANCIAL ACCOUNTING SOLUTIONS MANUAL

D E C IS ION C AS E S

LO 2,3

## DECISION CASE 12-1 READING AND INTERPRETING LIFE TIME FITNESSS

STATEMENT OF CASH FLOWS: OPERATING ACTIVITIES

1. The second note in the report includes a section titled Cash and Cash Equivalents.
Cash equivalents include unrestricted cash accounts and highly liquid debt
instruments purchased with original maturities of three months or less.
2. Life Time Fitness uses the indirect method to prepare the operating activities section
of its statement of cash flows. The first item on the statement is net income and then
various adjustments are made to reconcile this amount to the net cash provided by
operating activities.
3. Net income amounts to \$28,908,000 and net cash provided by operating activities is
\$80,431,000, resulting in a difference of \$51,523,000. The largest adjustment to
reconcile net income to net cash provided by operating activities is depreciation and
amortization of \$29,655,000. Depreciation and amortization are expenses that have
been deducted in the determination of net income. However, they do not decrease
the amount of cash and therefore they must be added back in reconciling net income
to net cash provided by operating activities.
4. A loss on disposing of property is added back for the same reason that depreciation
and amortization are added back. The loss is deducted to arrive at net income but
because it does not use any cash it is added back.
5. Changes in operating assets and liabilities is the last adjustment to reconcile net
income to net cash provided by operating activities. The various current assets and
liabilities, such as accounts receivable, inventory, and accounts payable have a
different effect on net income than they do on cash. For example, a decrease in
accounts receivable for the period is an indication that a company collected more in
cash from its customers than in sales to them. Thus, a decrease in accounts
receivable requires an addition to net income to arrive at net cash provided by
operating activities. Life Time Fitness chooses to net all of these items in one
adjustment on its statement of cash flows.

LO 3

12-85

## DECISION CASE 12-2 READING AND INTERPRETING LIFE TIME FITNESSS

STATEMENT OF CASH FLOWS: INVESTING AND FINANCING ACTIVITIES

1. Purchases of property and equipment are the companys largest use of cash in the
investing activities section of the statement. Purchases increased by \$156,674,000
\$41,315,000, or \$115,359,000, from the prior year. Purchases of additional land,
construction of new fitness centers and the addition of more fitness equipment are
all crucial to the companys strategy to grow its business.
2. Repayments on long-term borrowings are the largest use of cash in the financing
activities section of Life Time Fitnesss statement of cash flows. Repayments
increased by \$68,986,000 \$18,119,000, or \$50,867,000, from the prior year.
3. Proceeds from borrowings and proceeds from an initial public offering are the two
largest sources of cash from financing activities. The former increased by
\$44,853,000 \$1,925,000, or \$42,928,000. Because the initial public offering was in
2004, this amount increased by \$80,398,000 \$0, or \$80,398,000. Purchases of
property and equipment require large amounts of cash and it can be seen that much
of the cash needed to grow the business came from borrowing and the initial public
offering of stock.
LO 7

## DECISION CASE 12-3 COMPUTING AND INTERPRETING LIFE TIME FITNESSS

1. Cash flow adequacy ratio: (Net cash provided by operations Capital expenditures)/
Average annual debt maturing over next five years
= (\$80,431,000 \$156,674,000)/(\$35,949,000 + \$6,040,000 + \$13,327,000 +
\$6,251,000 + \$8,853,000)/5)
= (\$76,243)/\$14,084
= (5.4)
2. The cash flow adequacy ratio gives the user an indication of whether or not the
company is generating sufficient cash from its operations to repay its debts, after
taking into consideration the need to make necessary expenditures on new plant
and equipment. The companys ratio is negative in 2004 because it invested large
amounts in property and equipment to open new fitness centers. These large
purchases are balanced by the stock issued to the public for the first time and longterm borrowings which were significantly larger than in the prior year. In both of the
two prior years the net cash provided by operating activities was larger than
purchases of property and equipment, resulting in positive cash flow adequacy ratios
in those years.

12-86

LO 1,5

## DECISION CASE 12-4 DIVIDEND DECISION AND THE STATEMENT OF CASH

FLOWSDIRECT METHOD

## 1. Changes in account balances and explanations (in thousands of dollars):

Net Change
Dr. (Cr.)
Cash
Accounts receivable
Inventory
Prepayments
Land
Plant and Equipment
Accumulated depreciation
Long-term investments
Patents
Accounts payable
Other accrued liabilities
Taxes payable
Dividends payable
Short-term Notes payable
Long-term Notes payable
Bonds payable
Common stock
Retained earnings
Total

30
50
150
(15)
1,055
1,700
(250)
(400)
(100)
(70)
(60)
(70)
200
(200)
200
(700)
(500)
(1,020)
0

Explanation

## Issued bonds to acquire 700 and

cash for 355
Purchase
Depreciation expense
Sale
Amortization

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

12-87

Income Statement
Sales revenue

Amount
\$8,000

## Cost of goods sold

4,500

Operating expenses

1,450

Interest expense
Income tax expense

350
680

Net income

\$1,020

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

12-88

## 2. Statement of cash flows:

BAILEY CORP.
STATEMENT OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 31, 2007
(IN THOUSANDS OF DOLLARS)
Cash Flows from Operating Activities
Cash collected from customers
Cash payments:
For inventory
(4,580)
For operating expenses
For interest
For income taxes
Total cash payments
Net cash provided by operating activities
Cash Flows from Investing Activities
Sale of long-term investments
Acquisition of land
Acquisition of plant and equipment
Net cash used by investing activities
Cash Flows from Financing Activities
Payment of 2006 cash dividend
Net cash provided by financing activities
Net increase in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007
Supplemental Schedule of Noncash Investing and
Financing Activities
Acquisition of land by issuance of bonds
Reclassification of long-term notes due within next year

\$ 7,950
\$
(1,025)
(350)
(610)
\$ 6,565
\$ 1,385
\$

400
(355)
(1,700)
\$(1,655)
\$

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

\$
\$

700
200

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

LO 1,6

12-89

FROM OPERATIONS

## 1. Cash flow from operations

Net income (loss)
Depreciation expense
Increase in accounts receivable
Increase in inventories
Increase in prepayments
Increase in accounts payable
Decrease in accounts payable
Net cash flow from operations

Year 1

Year 2

Year 3

Year 4

\$(10)

\$ (2)

\$15

\$20

30
(32)
(26)
0
15

25
(5)
(8)
0
3

15
(12)
(5)
(10)

14
(20)
(9)
(5)

(5)
\$ (2)

(4)
\$ (4)

\$(23)

\$13

TO:

President

FROM:

Students name

DATE:

XX/XX/XX

## SUBJECT: Cash flow

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

12-90

## ETHICAL DECISION MAKING

LO 1,6

DECISION CASE 12-6 LOAN DECISION AND THE STATEMENT OF CASH FLOWS
INDIRECT METHOD

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

\$ 65
(150)
56
(19)
27
(42)
18
\$ (45)

## Cash Flows from Investing Activities

Acquisitions of plant and equipment
Net cash provided by investing activities

\$(234)
(125)
450
\$ 91

## Cash Flows from Financing Activities

Repayments of borrowings
Cash dividends paid
Net cash used by financing activities
Net decrease in cash
Cash balance, December 31, 2006
Cash balance, December 31, 2007

\$ 150
(180)
(50)
\$ (80)
\$ (34)
42
\$ 8

## CHAPTER 12 THE STATEMENT OF CASH FLOWS

12-91

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

LO 2,3

FLOWS

## 1. According to current accounting standards, only those investments in highly liquid

securities with an original maturity to the investor of three months or less should be
classified as cash equivalents. Because the Treasury notes do not mature until ten
months after they are purchased, their purchase should be classified as an investing
activity for purposes of preparing a statement of cash flows. (Note: The notes would
be classified as held to maturity securities because Rangers expects to hold them
until maturity.)
2. As controller, you need to explain to the treasurer that accounting standards do not
allow the company to classify the treasury notes as cash equivalents. You are
sympathetic to his desire to minimize the net cash outflow for investing activities, but
the company does not have a choice in its presentation of the notes, nor does the
decision on classification rest with you as controller. Rangers must report the
purchase on the statement of cash flows as a cash outflow from investing activities.
REAL WORLD PRACTICE 12.1
Best Buy uses the indirect method in the operating activities section of the statement of
cash flows. The first line on the statement is net income and the necessary adjustments
are made to reconcile net income to net cash provided by operating activities.

## REAL WORLD PRACTICE 12.2

Best Buys receivables increased during the year that ended February 26, 2005. An
increase in receivables means that the company sold more than it collected in cash
during the year, and therefore the difference must be deducted from net income in the
operating activities section of the statement.

12-92

## REAL WORLD PRACTICE 12.3

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