Chapter 3.

Measuring Performance: Cash Flow and Net Income

Suggested Solutions to Questions, Exercises, Problems, and Corporate Analyses

Difficulty Rating for Exercises and Problems:

Easy: E3.13; E3.14

Medium: E3.15; E3.16; E3.17
P3.22; P3.23; P3.24
Difficult: E3.18; E3.19; E3.20; E3.21
P3.25; P3.26; P3.27; P3.28

QUESTIONS

Q3.1 Building Shareholder Value. The most commonly agreed upon managerial
actions to build shareholder value are the following, which are rank-ordered by
their expected effectiveness:

1. Invest in positive net-present-value projects (e.g., a new plant, an

acquisition).
2. Repurchase stock.
3. Retire debt early.
4. Increase the dividend paid per share.

Since businesses generally have superior investment-opportunity sets, with

higher expected internal rates of return, than do individual investors,
investments in positive net-present-value projects are believed to be the most
effective way to build shareholder value, with share repurchase a close second,
ceterus paribus. It is generally believed that early debt retirement and
increasing the dividend paid per share are the least effective approaches to
building shareholder value.

Q3.2 Litigation, Reported Income, and Share Prices. Since a jury ruled against
the company and established a damage award of $4.5 million, the company
should report the award as a special loss in its income statement and accrue a
liability for future payment on its balance sheet. During 2005, since no adverse
court decision had yet been reached, Merck would merely have disclosed the
existence of the pending lawsuits in its footnotes (i.e., in the Commitments and
Contingent Liabilities footnote). For its 2006 financial statements, similar
disclosure would be expected for the remaining undecided lawsuits (i.e., in the
footnotes only).

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 3 3-1
Q3.3 Basic versus Diluted Earnings per Share. Mercks annual report discloses
that the increase in shares used in the calculation of basic versus diluted EPS
was due entirely to shares issuable primarily under share-based compensation
plans. Although research suggests that diluted EPS is more closely associated
with share price, P/E multiples most commonly rely on basic EPS unless there
is a high expectation of a debt or preferred stock conversion.

Q3.4 Assessing the Quality of Reported Earnings Using Cash Flow Data. At the
first level, it is possible to confirm the quality of a firms reported earnings using
cash flow data by calculating the cash-flow-from-operations-to-net-income ratio.
For Blockbuster, the result for 1987 and 1988 is:

1988 1987
CFFO net income 3.12 2.52

This ratio indicates the amount of operating cash flow generated relative to
reported net income. Thus, in 1988, for every dollar of earnings, Blockbuster
generated over $3 in operating cash flow.

At issue here, according to Mr. Seidler, is whether the cash outlay for
videocassette rental inventory is properly reported as an investing activity on
the statement of cash flow. He believes that it is incorrectly classified, and
instead, should be reflected as a cash outflow under the companys operating
activities. Following Mr. Seidlers line of argument, we can restate Blockbusters
cash flow from operations as follows:

1988 1987

CFFO (as reported) $48.3 $10.3

Less: Videocassette purchases (51.3) (14.3)
CFFO (restated) $(3.0) $(4.0)

And, the restated cash-flow-to-net-income ratio would be:

1988 1987
CFFO net income -0.19 -0.98

The restated ratio suggests that Blockbuster lost $0.19 in operating cash flow in
1988 for every dollar of reported net earnings, a very different result from the
original calculation. This restated ratio calls into question the quality of
Blockbusters reported net income.

Cambridge Business Publishers, 2014

3-2 Financial Accounting for Executives & MBAs, 3 rd Edition
Q3.5 Earnings Announcements and Share Prices. There are two potential factors
to explain the markets negative reaction to the record earnings announcement
of Apple:

1. Prior expectations (i.e., an earnings surprise)

2. Future expectations (i.e., earnings guidance)

First, if the market was negatively surprised by Apples report, this could readily
explain the negative market response. Second, if as part of the announcement,
Apple indicated that the future looked grim, or perhaps not as rosy as the past
has been, this could also explain the downward price movement.

Q3.6 Managing Earnings. It is frequently alleged that the Enron, WorldCom, and
Global Crossing failures were all examples of cases in which executives
managed the companys reported accounting data. The most commonly cited
motivations for earnings management include:

To make executive stock options more valuable.

To avoid violating a debt covenant.
To achieve executive bonuses linked either to earnings or share price.

Two cases where downward earnings management has been alleged include:

Microsoft. Microsoft defers a portion of its software revenue and

expenses its software development costs (even though some could be
capitalized) to manage its earnings downward. According to some
investment professionals, the purpose of this accounting treatment is to
avoid having the company appear monopolistic. Allegedly, this is part of
the companys defense against EU charges of anti-competitiveness in
the EU marketplace.

Heinz & Co. In a lawsuit in the 1970s, shareholders sued Heinz for
inappropriately deducting prepaid advertising expenses, and hence,
depriving shareholders of potential share price appreciation by managing
earnings downward. Heinz took the excess deductions in an effort to
smooth its earnings growth at approximately 15 percent, a growth
percentage that the companys executives believed was what the capital
markets desired to see (i.e., consistent positive earnings growth implies
lower firm risk).

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 3 3-3
Q3.7 Goodwill Impairment and Sustainable Earnings. Bank of Americas and
AT&Ts huge write-downs of its acquisition goodwill will lower their 2011 net
income, and hence, retained earnings, as well as their goodwill asset account.
Assuming the goodwill is not tax-deductible (i.e. acquisition goodwill is often not
tax deductible), the write-down will lower total assets and shareholders equity
(and hence, firm book value) by the full amount of the write-down. The
announcement will also negatively affect market capitalization as analysts lower
their future estimate of the earnings-generating capacity of these acquisitions.
The calculation of current year sustainable earnings is unaffected by the
noncash write-down of goodwill; however, future estimates of sustainable
earnings will be reduced for the lower revenue estimates associated with the
acquisitions assets.

Q3.8 Special Charges. AMRs special charge of $718 million in 2001 and $1,466
million in 2002 are described as nonoperational in the companys footnotes
(see footnote 3 in AMRs 2002 annual report). Since the charges are not
infrequent (i.e., aircraft hijackings have occurred on many prior occasions), the
FASB determined that all write-downs associated with the terrorist attacks of
September 11, 2001, should be treated as unusual or special items. AMR will
disclose the write-down as a special charge, deducted in arriving at operating
income, with a parallel write-down of its assets on the balance sheet. The
special charges will not be included in AMRs sustainable earnings for either
2001 or 2002.

Q3.9 New Accounting Standard. An alternative treatment for AMRs impairment

charge is to treat the $1.4 billion write-off as a special item or special charge,
to be included in operating income. AMRs treatment of the write-off removes
the special charge from operating income and gives it special attention at the
bottom of AMRs income statement. Thus, treatment as the cumulative effect of
accounting method change avoids having any financial statement user
mistakenly include the write-off as part of the firms recurring or sustainable
earnings. Regardless of the approach used to disclose these events, the write-
down should not affect AMRs 2002 sustainable earnings. However, the signal
of the write-down is unambiguous analysts need to lower their future revenue
(and hence, future sustainable earnings) forecasts for this company.

Cambridge Business Publishers, 2014

3-4 Financial Accounting for Executives & MBAs, 3 rd Edition
Q3.10 Market Capitalization, Book Value, and Intrinsic Value.
Market capitalization: the market price per share times the number of
outstanding shares.
Book value: total assets less total liabilities (i.e., the value of
shareholders equity).
Intrinsic value: the fair market value of a business, which in an efficient
market would equal market capitalization.
Procter & Gamble this data was obtained from Yahoo.Finance in
Spring 2013:

Book value $23.99 per share

Market capitalization $79.26 per share
Intrinsic value (i.e., analysts consensus price): $88.48 per share

Q3.11 Accounting Statement Restatements. One possible explanation for the

increase in financial statement restatements is that the full effect of the internal
control standards imposed by the Sarbanes-Oxley Act was finally felt by
companies. The financial penalties (i.e., up to $5 million in fines) and
incarceration (i.e., up to 20 years) that can be imposed on CEOs and CFOs
under the Act was no doubt driving many executives to get it right. The
surprising element to these findings, however, is that there were so many
companies applying GAAP incorrectly, and that these incorrect applications of
GAAP were not being identified by their independent auditors.

As to the markets reaction to financial statement restatement, the response is

usually negative or none at all, depending upon the nature of the restatement.
For example, in 2005, AIG announced the first of three accounting
restatements, and within three months, saw a market capitalization decline of
$55 billion.

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 3 3-5
Q3.12 (Ethics Perspective) Earnings Management to Prevent Technical Defaults.
This question can be approached from several directions. One might argue
that the only responsibility of management is to serve the shareholders. Under
this premise, one can argue that lenders are responsible for their own welfare,
and if they fail to adequately protect themselves through covenants then it is
acceptable for managers to exploit these lenders. This argument implicitly
implies that managers have a responsibility to only one stakeholder, the
shareholders. The fact that a different stakeholder may be harmed is not of
concern under this argument.

The question raises the moral dilemma of whether the ends justify the means.
Ultimately, whether earnings management to avoid a loan covenant is an
ethical breach depends on where one philosophically locates oneself to the
question of, do the ends justify the means? A utilitarian view would argue that
earnings management to avoid technical default is not an ethical breach.
Rather, this view argues that the goodness of not exposing shareholders to the
loss they would experience far outweighs any associated badness associated
with earnings management. In fact, it could be argued that under this approach
it is actually the responsibility of management to do everything legal to prevent
a technical default, and as a consequence, earnings management would be the
correct thing for managers to do.

A counterargument is that the ends should never justify the means. A wrong or
immoral act can never be justified by an ultimate good ending. If one believes
that earnings management is wrong, then it remains wrong even if employing it
achieves a desirable outcome. Someone who follows this thinking would likely
feel that any positive effects to the business associated with avoiding technical
default are irrelevant in comparison to the negative consequences of an
unethical act.

(Note: This answer was based on the writing of Leah Emkin.)

Cambridge Business Publishers, 2014

3-6 Financial Accounting for Executives & MBAs, 3 rd Edition
 EXERCISES

E3.13 Classifying Accounting Events.

1. Financing
2. Operating
3. Investing
4. None-of-the-above (i.e., noncash sale)
5. Financing
6. Financing
7. Operating
8. None-of-the-above (i.e., noncash purchase)
9. Financing
10. Operating

E3.14 Classifying Accounting Transactions.

1. Investing
2. Financing
3. Operating
4. None-of-the-above (i.e., noncash event)
5. Financing
6. Operating
7. Operating
8. Investing
9. None-of-the-above (i.e., noncash event)
10. Financing

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 3 3-7
E3.15 Analyzing Cash Flow Data. The Longo Companys primary source of cash is
its financing activities; that is, Longo is selling stock or borrowing to support its
operating and investing activities. The Davis Company is generating cash both
from the sale of assets (investing) and the sale of stock or borrowing
(financing); these funds are being used to cover its operating cash deficit.

The change in the cash balance for The Davis Company is an increase in cash
of $51, while for the Longo Corporation the change in its cash balance is a
decrease of $1,598.

The Longo Corporation cash flow from operations of $(1,320) is substantially

less than its operating loss of $(6,050), probably due to the add-back of such
noncash expenses as depreciation and amortization.

E3.16 Analyzing Cash Flow Data. Pfizers primary source of cash is operations, and
it uses this cash flow to support its investing program, to reduce its various
sources of financing, and to pay dividends. Despite paying over $5 billion for its
investing activities and over $9 billion to reduce its outside financing, Pfizer still
managed to increase its cash balance by $439 million.

Like Pfizer, Johnson & Johnsons primary source of cash is operations, which it
uses to pay for its investing activities, to reduce its financing, and to pay
dividends. Johnson & Johnson increased its cash balance by $7,077 million.

Pfizers cash flow from operations is significantly higher than its net income
largely due to the add-back of such noncash charges as depreciation and
amortization. Other sources of cash include increases in its accounts payables
and decreases in its accounts receivable and inventory (i.e., its working capital
accounts).

E3.17 Calculating Earnings per Share.

a) Basic EPS.

$3.2 million - $28,500 *

EPS = = $12 .69
250,000 shares

*(Preferred stock dividend = $28,500 = ($100 x 9.5%) x 3,000 shares)

b) Diluted EPS.

$3.2 million
EPS = = $12.36
250,000 + 9,000

Cambridge Business Publishers, 2014

3-8 Financial Accounting for Executives & MBAs, 3 rd Edition
E3.18 Calculating Earnings per Share.
a) Basic EPS

$159,000
EPS = = $2.65
60,000

b) Diluted EPS

$159,000
EPS = = $2.34
(60,000 + 8,000) (See note below.)

The above calculation of diluted EPS does not consider the effect of the
treasury stock buyback as this technical issue is not covered in the chapter.
For instructors desiring to illustrate this point, the treasury stock buyback
would amount to 7,040 shares (8,000 shares x $22.00= $176,000;
$176,000/$25.00=7,040 shares). And, diluted EPS would amount to $2.61
($159,000/(60,000+8,000-7,040).

E3.19 Permanent versus Transitory Earnings.

Year 3 Year 2 Year 1

Net income (as reported) $1,078 $(35,866) $(17,919)

Adjustments:
Impairment of purchased product rights -- +1,134 --
Restructuring charges -- +13,623 -1,079
Loss from equity investments +1,111 +603 +602
Realized loss on investments -- -- +220
Write-down of long-term strategic
investments -- +2,780 +1,238

Permanent earnings $2,189 $(17,726) $(16,938)

Given that Entrusts share price is only $3.80 at year-end Year 3, it doesnt
appear that the market believes that the companys improving earnings and
cash flow from operations are going to be sustained.

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 3 3-9
E3.20 (Appendix 3A) Converting Indirect Method Cash Flows to Direct Method
Cash Flows.
2013
Operating Activities
Cash from sales ($1,430 $150) $1,280
Cash for cost-of-goods sold(-$500+260-15+50) (205)
Cash for selling, general and administrative revenues (200)
Cash flow from operations $875

E3.21 Measuring Sustainable Earnings.

Sustainable earnings for Harnishfeger:

Income before income taxes (as reported) $5,738

Less: Pretax increase in net income due to estimated
useful life change (3,200)
Restated pretax net income 2,538
Effective tax rate ($2,425 $ 5,738) = 0.42
Provision for income taxes (1,066)
Sustainable earnings $1,472

The capital market is likely to consider these two voluntary accounting

policy changes adversely, resulting in a share price decline. Existing
empirical research suggests that these types of accounting policy changes
(i.e. that lead to an increase in reported net income) tend to be associated
with share price declines as the market apparently worries that the policy
change is an attempt to cover up poor future operating results which was
exactly the case for Harnishfeger.

Cambridge Business Publishers, 2014

3-10 Financial Accounting for Executives & MBAs, 3 rd Edition
 PROBLEMS

P3.22 Statement of Cash Flow.

Amphlett Corporation
Statement of Cash Flow
For Year Ended 2013
Cash flow from operations:
Net income $800,000
Add: Depreciation expense 250,000 1
Amortization expense 10,000 2
Less: Gain on sale of investments (70,000)
Accounts receivable (net) (150,000)
Inventory 15,000
Accounts payable 50,000
CFFO 905,000
Cash flow for investing
Marketable securities (200,000)
Long-term investments 150,000 ($80,000 + $ 70,000)
Purchases of property & equipment (1,150,000) ($700,000 + $450,000)
Sales of property & equipment 200,000
CFFI (1,000,000)
Cash flow from financing:
Short-term bank debt 190,000
Common stock + additional
paid-in-capital 180,000
Dividends paid (350,000) ($415,000 + $800,000 - $865,000 = $350,000)
CFFF 20,000
Decrease in cash (75,000)
Cash, beginning 90,000
Cash, end $15,000

1
The net change in accumulated depreciation is zero; hence, the depreciation expense must
equal the amount of accumulated depreciation written off for the sold property.
2
Assumes that the decrease in intangibles is due to amortization.

Amphlett Corporations statement of cash flow reveals the following information

about its financial health:

1. The firms operating performance, whether measured in terms of accrual net

income or in terms of cash flow from operations, appears quite good.

2. The companys dividend payment of $350,000 is covered both in terms of

net income and operating cash flows.

3. The company is making significant capital investments in future revenue-

generating assets like P,P&E and is financing these investments partly with
operating cash flow and partly with debt and equity financing (i.e. the
companys free cash flow is negative $95,000).

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 3 3-11
P3.23 Statement of Cash Flow.

The Mann Corporation

Statement of Cash Flow
For Year Ended 2013
Cash flow from operations
Net income $600,000
Add: Depreciation expense 30,000
Accounts receivable (230,000)
Inventory (310,000)
Prepaid expenses 0
Accounts payable 70,000
Accrued expenses payable (20,000)
CFFO 140,000
Cash flow for investing
Investments in affiliate companies (100,000)
Property & equipment (510,000)
CFFI (610,000)
Cash flow from financing
Notes payable 500,000
Common stock + APIC 140,000
Dividends paid (20,000) ($90,000* $70,000)
CFFF 620,000
Increase in cash 150,000
Cash, beginning 250,000
Cash, end $400,000

* Retained earnings (end) Retained earnings (beg) = (660,000 150,000) = 510,000.

Net income Change in retained earnings = (600,000 510,000) = 90,000.

Mann Corporations statement of cash flow reveals the following:

1. The company is generating both positive net income and operating cash
flow (i.e. CFFO is $140,000).

2. The companys dividend is covered both by its net income and its operating
cash flow.

3. The company is investing in future revenue-producing assets like P,P&E,

and is financing these capital investments using internally generated cash
flow as well as debt and equity financing (i.e. its free cash flow is negative
$470,000).

Cambridge Business Publishers, 2014

3-12 Financial Accounting for Executives & MBAs, 3 rd Edition
P3.24 Statement of Cash Flow.

Casual Clothing, Inc.

Statement of Cash Flow
FYE 12/31/13
Cash flow from operations
Net income $877,497
Add: Amortization expense 2,700
Depreciation expense 123,000
Merchandise inventory (52,108)
Accounts receivable (7,900)
Other current assets (9,710)
Accounts payable (18,738)
Accrued expenses & other liabilities 32,499
Income taxes payable (8,439)
CFFO 938,801
Cash flow for investing
Buildings, furniture & equipment (290,873)
Land (821,114)
Construction-in-process (200,997)
Intangibles (5,780)
CFFI (1,318,764)
Cash flow from financing
Notes payable 603,020
Current maturities of long-term debt (100,000)
Long-term debt 99,291
Dividends paid (220,906)
CFFF 381,405
Increase in cash 1,442
Cash, beginning 7,352
Cash, end $8,794

Casual Clothing Inc.s statement of cash flow reveals that:

1. The company is generating both positive net income and operating cash
flow.
2. The companys cash dividend is well covered by both its net income and its
operating cash flow.
3. The company is making substantial capital investments in new revenue-
producing assets like buildings and equipment, among others. Financing for
these investments is coming from operating cash flow and new debt (i.e.
notes payable and long-term debt). Casuals free cash flow is negative
$379,963, hence the need for external financing.

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 3 3-13
P3.25 Statement of Cash Flow.

Catalina Divers Supply Company

Statement of Cash Flow
FYE 12/31/13
Cash flow from operations
Net income $22,400
Add: Depreciation expense 12,400
Loss on sale of equipment 8,400
Accounts receivable (net) (4,400)
Inventory 1,200
Prepaid rent 1,200
Accounts payable (6,800)
Wages payable 4,400
Interest payable (1,400)
Deferred revenue 3,600
CFFO 41,000
Cash flow for investing
Equipment ($12,000 + $12,400 + $8,400) (32,800)
CFFI (32,800)
Cash flow from financing
Bank loan (800)
Dividends paid (6,200)
CFFF (7,000)
Increase in cash 1,200
Cash, beginning 10,800
Cash, end $12,000

The statement of cash flow for Catalina Divers reveals the following:
1. The companys performance, whether measured in terms of net income or
in terms of operating cash flows, appears solid.
2. The companys cash dividend of $6,200 is easily covered by either net
income or its operating cash flow.
3. The company is investing in future revenue-producing equipment and is
financing these investments principally with operating cash flow (i.e. its free
cash flow is $8,200, or $41,000 - $32,800).

Cambridge Business Publishers, 2014

3-14 Financial Accounting for Executives & MBAs, 3 rd Edition
P3.26 Analyzing and Interpreting Cash Flow Data: A Growing Enterprise.
1. Despite the positive and growing net income, L.A. Gear generated negative
cash flow from operations (CFFO). The negative CFFO appears to be a
direct consequence of the firms rapid growth, as evidenced by the large
and growing investments in accounts receivable and inventories.

2. In Year 1, L.A. Gear financed its operations by selling marketable securities

($5,661) and by increasing its short-term borrowings ($4,566). In Year 2,
financing came again from an increase in short-term borrowing ($50,104). In
Year 3, financing was provided by a sale of stock ($69,925).

In essence, L.A. Gear executed a strategy of financing based on cost and

availability. In Year 1, the company used self-financing by selling marketable
securities and supplemented this with low-cost, short-term debt. In Year 2,
the company used further low-cost, short-term debt since it had exhausted
its internal sources of self-financing. Finally, in Year 3, the firm accessed the
high-cost equity market, no doubt at a point when its share price was at, or
near, its all-time high. An alternative to equity financing in Year 3 was the
sale of convertible debentures.

3. L.A. Gears depreciation expense is very low during this period because the
company probably (a) outsourced most of its manufacturing and (b) leased
(using operating leases) most of its company-owned stores.

P3.27 Analyzing and Interpreting Cash Flow Data: A Failing Enterprise. In 1995,
L.A. Gear lost $51.4 million; in 1996, when the company filed for bankruptcy, it
lost $61.7 million. Due to the continuing operating losses, external financing
opportunities were essentially nonexistent. The only external cash financing in
1995 or 1996 came from a small international line of credit ($622,000 in 1995).
Thus, the company was forced to generate its own financing and it did so from
its working capital accounts, as follows.

(in millions)
Financing Sources 1996 1995
Collections on accounts receivables $20.6 $30.6
Reductions in inventories 18.1 6.1
Reductions in prepaids 1.5 3.3
Increase in accounts payable 16.2 --
$56.4 $40.0

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 3 3-15
P3.28 Statement of Cash Flow: International.

The Hoechst Group

Statement of Cash Flow
FYE 12/31/Year 2
(in millions, Deutsche Marks)
Cash flow from operations
Net income 1,895
Add: Depreciation expense 2,190
Amortization expense 1,000
Less: Gain on sale of investments (300)
Inventories 1,232
Receivables & prepaid items 278
Provisions for pension (27)
Other provisions (725)
Liabilities & deferred income (218)
CFFO 5,325
Cash flow from investing
Intangible assets (123-1,000) (877)
Property & equipment (2,903-2,190) 713
Investments (226+300) 526
CFFI 362
Cash flow from financing
Corporate debt (4,106)
Dividends paid (1,895-587) (1,308)
CFFF (5,414)
Minority interests (517)
Decrease in liquid assets (244)

The companys statement of cash flows reveals that Hoechst is generating both
positive earnings and cash flow. Further, both earnings and cash flow are large
enough to fully cover the companys cash dividend. Of concern is the cash flow
from investing, which suggests that the company may be downsizing.

Cambridge Business Publishers, 2014

3-16 Financial Accounting for Executives & MBAs, 3 rd Edition
 CORPORATE ANALYSIS

CA3.29 The Procter and Gamble Company.

a. Cash conversion ratio = cash sales
accrual sales = $83,887 $83,680 = 100.2%

The cash conversion ratio tells financial statement users how much of each
dollar of sales reported on the income statement was actually collected. For
P & G, the collection rate is over 100 percent. This is good news and it
speaks favorably about the companys credit granting and credit collection
policies.

b. EBITDA, Free Cash Flow, and Discretionary Cash Flow.

2012 2011 2010

EBITDA
EBT $12,785 $14,997 $14,868
+ Interest 769 831 946
Amortization
+ Depreciation1) 3,204 2,838 3,108
$16,758 $18,666 $18,922

1)
See statement of cash flow

Free cash flow 2012 2011 2010

CFFO $13,284 $13,330 $16,131
- Capital expenditures2) (1,071) (3,081) 1
$12,213 $10,249 $16,132
2)
Capital expenditures were calculated on a net basis; that is, the proceeds from asset
sales is subtracted against the outflow for capital expenditures.

Discretionary cash flow 2012 2011 2010

CFFO $13,284 $13,330 $16,131
- Dividends (6,139) (5,767) (5,458)
- Debt3) ( 8,698) (9,981) N/A
$(1,553) $(2,418) NA
3)
Current maturities of debt (i.e., debt due within one year).

Conclusion: Although P & Gs EBITDA and free cash flow are positive each
year, there are no discretionary cash flows available in either 2012 or 2011.
This may be a cause for concern.

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 3 3-17
 c. Sustainable Earnings.

2012 2011 2010

Sustainable earnings
$10,90
Net income 4 $11,927 $12,846
Goodwill & indefinite lived asset
impairment charges 1,576 ---- ----
Nonoperating income (net) (262) (333) (82)
Net earnings from discontinued
operations (1,587) (229) (1,995)
$10,63
1 $11,365 $10,769

Conclusion: Overall, P & Gs earnings appear healthy and fairly persistent.

CA3.30 Internet-based Analysis. No solution is provided as any solution would be

unique to the company selected.

CA3.31 IFRS Financial Statements - LVMH Moet Hennessey-Louis Vuitton S.A.

a. The income statement format under IFRS very closely resembles that under
U.S. GAAP. A few noteworthy differences include:
Under IFRS, the bottom-line is called net profit as contrasted with
net earnings or net income under U.S. GAAP.
This point is not obvious on the LVMH statement, but IFRS does not
disclose extraordinary gains/losses as a separate income statement
category; these items get lumped into Other income and expenses.
Under IFRS, we adjust for income attributable to minority interests,
while under U.S. GAAP it is usually referred to as income attributable
to noncontrolling interest.

b. With respect to the statement of cash flows, Texas Instruments segments its
total cash flow into three categoriesoperating, investing, and financing.
LVMH, on the other hand, segments its total cash flow into five categories-
operating activities and operating investments, financial investments,
transactions relating to equity, financing activities, and effect of exchange
rate changes.
Despite these classification differences, both statements reconcile to the
change in the cash account on the balance sheet, and thus, contain the
exact same information.
LVMH essentially segments its financing activities into two types: (1) equity
financing, and (2) debt financing. With respect to the effect of exchange rate

Cambridge Business Publishers, 2014

3-18 Financial Accounting for Executives & MBAs, 3 rd Edition
 changes, this information is usually reported within the operating and
investing sections of the statement under U.S. GAAP.

Cambridge Business Publishers, 2014

Solutions Manual, Chapter 3 3-19