55

Chapter 16
Reporting the Statement of Cash Flows
QUESTIONS
1. The purpose of the cash flow statement is to report all major cash receipts (inflows)
and cash payments (outflows) during a period. It helps users to answer questions
such as:
How does a company obtain its cash?
Where does a company spend its cash?
What explains the change in the cash balance?
2. The direct method of reporting cash flows from operating activities itemizes the
major classes of cash receipts such as sales to customers, and also itemizes the
major classes of cash payments such as for merchandise, interest, taxes, and other
operating expenses.
3. On a statement of cash flows prepared according to the direct method, operating
activities generally include cash receipts from the sale of goods and services, cash
dividends received from stock investments in other entities, and interest on loans to
others. Operating activities also include cash outflows such as payments for
merchandise, salaries, rent, income taxes, utilities, and other operating expense
items.
4. The indirect method of reporting cash flows from operating activities begins with net
income and then adjusts it for items that are necessary to reconcile net income to
the net cash provided or used by operating activities.
5. On a statement of cash flows, investing activities include cash outflows from
purchases of long-term investments such as stocks and bonds, from purchases of
plant assets such as land, buildings, and machinery, and from purchases of other
noncurrent assets such as natural resources and intangible assets. When these
types of assets are sold, the cash inflows from the sales are also reported as
investing activities.
6. On a statement of cash flows, financing activities include cash inflows such as those
that result from issuing preferred or common stock, and from borrowing by issuing
bonds or signing long-term or short-term notes payable. Financing activities also
include cash outflows such as dividend payments to stockholders, purchases of
treasury stock, and repayments of debt.
7. Payments of cash dividends should be reported on the statement of cash flows as
financing activities.
McGraw-Hill Companies, 2009

Solutions Manual, Chapter 16 91
8. The amount of the land purchase that was paid for in cash ($20,000) should be
reported on the statement of cash flows as an investing activity. Also, a schedule of
noncash investing and financing activities or the notes to the statement should
show the $100,000 land investment, the $80,000 financing in the form of a long-term
note payable, and the net $20,000 cash outflow.
9. Since this cash inflow results from borrowing money, it is reported on the statement
of cash flows as a financing activity.
10. Yes; even though a company reports positive net income for the year, it may still
show a net cash outflow from operating activities. When net income is reconciled to
the net cash flow from operating activities, the net effect of all the adjustment items
may be a subtraction from net income (examples of such adjustments are accrued
revenues, prepaid expenses, and other gains). If the amount of this net subtraction
is larger than the net income, the result is net cash used by operating activities.
11. Depreciation is not a source or a use of cash, even though it must be added to net
income when the net cash flow from operating activities is calculated by the indirect
method. (Note: When depreciation is deducted on the tax return of a corporation, the
effect is to reduce taxable income and reduce the cash outflow for income taxes.)
12 (a) Indirect method. (b) The increase in receivables represents an amount by which
sales for the period were more than cash receipts from customers. Since sales are a
positive number in the calculation of net income, an increase in the amounts not yet
received from customers (the increase in receivables) must be deducted from sales
to determine the net amount of cash provided by operations. [Instructor note: There
is a $99 million increase in receivables but only $70 million is subtracted in
computing operating cash flows; the difference is due to acquired receivables during
the period.)
13. Circuit Citys statement of cash flows shows five major financing activities for the
year ended February 28, 2007 ($ thousands):
Proceeds from short-term borrowings................................................. $ 35,657
Principal payments on short-term borrowings.................................... (56,912)
Proceeds from long-term debt.............................................................. 1,216
Principal payments of long-term debt.................................................. (6,724)
Changes in overdraft balances............................................................. 19,347
Repurchases of common stock............................................................ (237,203)
................................................................................................................
Issuances of common stock................................................................. 89,662
Dividends paid....................................................................................... (20,126)
Excess tax benefit from stock-based payments.................................. 15,729
Other financing activities...................................................................... (1,424)
Net cash used for financing activities.................................................. $(160,778)
14. RadioShacks net cash provided by operating activities is $314.8 million; its net cash
used in investing activities is $79.3 million, and its net cash provided by financing
activities is $12.5 million.
15. Apples four investing activities yielding cash outflows for the year ended September
30, 2006, are ($ millions):
Purchases of short-term investments................................................... $7,255
Purchases of long-term investments.................................................... 25
Purchases of property, plant, and equipment....................................... 657
Other........................................................................................................ 58

92 Fundamental Accounting Principles, 19th Edition
QUICK STUDIES
Quick Study 16-1 (20 minutes)
1. The statement of cash flows reports the cash (and cash equivalent)
activities of a business for a specific accounting period. The cash flows
are classified into operating, investing, and financing activities. The net
change in cash as well as the beginning and ending cash balances are
also reported on the statement.
2. Examples of transactions classified as investing activities

Plant asset purchases
Plant asset sales
Investment in debt and equity securities (except trading securities)
Intangible asset acquisitions and disposals
Purchases and sales of natural resources
3. Examples of transactions classified as financing activities

Bond retirement and issuance
Issuance and settlement of notes payable
Common stock issuance
Cash paid for dividends
Treasury stock acquisitions
Owner contributions and withdrawals
4. Examples of significant noncash financing and investing activities

Exchange of stock or debt securities for noncash assets
Conversion of bonds into stock
Purchase of long-term assets by issuing notes payable to seller
Settle debt with noncash assets (such as giving equipment to pay off loan)
1. Investing 6. Financing
2. Operating 7. Operating
3. Operating 8. Operating
4. Operating 9. Investing*
5. Financing 10. Operating
* For the indirect method, the loss is reported as an adjustment (add-

back) to net income in the operating section.

Cash flows from operating activities

Net income................................................................................... $ 36,400
Adjustments to reconcile net income to operating cash flow
Depreciation..............................................................................
$72,000
Accounts receivable decrease................................................14,000
Inventory increase....................................................................(11,800
)
Accounts payable increase..................................................... 9,400
Income taxes payable decrease............................................. 83,300
(300)
Net cash provided from operating activities............................ $119,700
Computation of cash inflow from sale of furniture

Cost of furniture sold (given).................................................. $105,000
Accumulated depreciation at beginning of year (given)...... $221,400
Increase from depreciation expense (given)......................... 36,000
Total expected accumulated depreciation......................... 257,400
Actual accumulated depreciation at end of year (given)......(174,400)
Accumulated depreciation on sold furniture......................... 83,000
Cash received from sale of furniture at book value.............. $ 22,000
Part 1
Computation of cash received from the sale of common stock
Increase in Common stock ($210,000 - $200,000)..................................... $ 10,000
Increase in Paid-in capital in excess of par value
($1,134,000 - $684,000)..............................................................................
450,000
Cash received from the sale of common stock......................................... $460,000
Part 2
Computation of cash paid for dividends
Beginning retained earnings....................................................................... $575,000
Net income....................................................................................................96,000
Total expected retained earnings............................................................ 671,000
Actual ending retained earnings................................................................. (627,000)
Cash paid for dividends............................................................................... $ 44,000

Net income................................................................................... $ 60,000
Adjustments to reconcile net income to operating cash flow
Depreciation..............................................................................
$75,200
Accounts receivable decrease................................................20,000
Inventory decrease...................................................................20,000
Prepaid expense increase....................................................... (2,400)
Accounts payable decrease....................................................(12,000)
Wages payable increase.......................................................... 8,000
Income taxes payable decrease............................................. (2,400) 106,400
Computation of cash inflow from sale of furniture

Cost of furniture sold (given).................................................. $110,000
Accumulated depreciation at beginning of year (given)...... $18,000
Increase from depreciation expense (given)......................... 75,200
Total expected accumulated depreciation......................... 93,200
Actual accumulated depreciation at end of year (given)...... (34,000)
Accumulated depreciation on sold furniture......................... 59,200
Cash received from sale of furniture at book value.............. $ 50,800
1. Computation of cash paid for dividends

Beginning retained earnings................................................. $ 16,800
Net income............................................................................... 60,000
Total expected retained earnings....................................... 76,800
Actual ending retained earnings........................................... (71,200)
Decrease from (cash paid for) dividends............................. $ 5,600
2. Computation of cash payments for notes

Beginning notes payable........................................................ $138,000
Increases to notes (given)...................................................... 0
Total expected notes payable............................................. 138,000
Actual ending notes payable................................................. (58,000)
Decrease from (cash) payments toward notes.................... $ 80,000

Quick Study 16-9B (10 minutes)
1. Cash received from customers = Sales + Accounts receivable decrease

= $976,000 + ($102,000 - $82,000)
= $996,000
2. Net increase in cash = $189,600 - $48,000 = $141,600
1. Cash paid for merchandise

= Cost of goods sold - Inventory decrease + Accounts payable decrease
= $628,000 - ($191,600 - $171,600) + ($42,000 - $30,000)
= $620,000
2. Cash paid for operating expenses

= Operating expenses (excluding depreciation)
+ Prepaid expenses increase - Wages payable increase
= $178,200 + ($10,800 - $8,400) - ($18,000 - $10,000)
= $172,600

Receipts from sales to customersa...................................... $996,000
Payments for merchandise inventoryb................................ (620,000)
Payments for other expensesc............................................. (172,600)
Payments for taxesd............................................................... (37,000)
Net cash provided by operating activities............................. $166,400
a
From QS 16-9B
b
From QS 16-10B
c
From QS 16-10B
d
$34,600 (income tax expense) + $2,400 (decrease in income taxes payable)

1. Pena is probably in the strongest position of the three competing

companies on the basis of the statement of cash flows. Penas cash
flows from operations are able to finance reinvestment in operating
assets as well as help in paying down some debt. Garcia is in the
second strongest position as it is able to reinvest 57% of its operating
cash flows into new productive assets. Piniella is the weakest as it
experienced negative cash flows from operations and generates cash by
selling productive assets and by taking on new debt.
2. Garcias cash flow on total assets ratio is slightly stronger than that for
Pena. Garcia has a 9.6% ratio ($120,000/$1,250,000) compared to Penas
8.9% ratio ($140,000/$1,580,000).
Quick Study 16-13A (10 minutes)
The balance sheet equation can be arranged so that the algebraic total of
all noncash items is equal to cash (see Exhibit 16.8). It follows that when
all changes in noncash balance sheet items are explained, the
corresponding change in cash is also explained. On the spreadsheet,
when the changes in all noncash balance sheet items have been accounted
for, we can be confident that the change in cash also has been fully
accounted for.
Cash Flows from Operating Activities (Indirect)

Case A Case B Case C
Net Income............................................................$ 8,000 $200,000 $144,000
Adjustments to reconcile net income to net
cash provided by operations
Depreciation..........................................................
60,000 16,000 48,000
Changes in assets and liabilities
Accounts receivable............................................ (80,000) (40,000) 8,000
Inventories............................................................
40,000 20,000 (21,000)
Accounts payable................................................. 48,000 (44,000) 28,000
Accrued liabilities.................................................
(88,000) 24,000 (16,000)
Cash provided by (used for) operations............$(12,000) $176,000 $191,000

Investing Activities
Purchase of used equipment......................................................................
$(10,000)
Sale of short-term investments...................................................................
12,000
Cash provided by investing activities........................................................
$ 2,000
Financing Activities
Additional short-term borrowings..............................................................
$ 40,000
Cash dividends paid....................................................................................
(32,000)
Cash provided by financing activities........................................................
$ 8,000

EXERCISES
Exercise 16-1 (10 minutes)

Net income................................................................................ $530,000
Adjustments to reconcile net income to operating
cash flow
Depreciation...........................................................................
$95,400
Accounts receivable increase.............................................. (42,400)
Prepaid expense decrease.................................................... 11,660
Accounts payable increase.................................................. 21,730
Wages payable decrease...................................................... (16,430)
Gain on sale of machinery.................................................... (4,000) 65,960
Statement of Cash Flows Noncash

Investing & Not Reported
Operating Investing Financing Financing on Statement
Activities Activities Activities Activities or in Notes
a. Paid cash to
X
purchase inventory
b. Purchased land by
X
issuing common stock
c. Accounts receivable
X
decreased in the year
d. Sold equipment for
X X
cash, yielding a loss
e. Recorded
X
depreciation expense
f. Income taxes payable
X
increased in the year
g. Declared and paid a
X
cash dividend
h. Accounts payable
X
decreased in the year
i. Paid cash to settle
X
notes payable
j. Prepaid expenses X

increased in the year

Exercise 16-3B (15 minutes)
Statement of Cash Flows Noncash

Investing & Not Reported
Operating Investing Financing Financing on Statement
Activities Activities Activities Activities or in Notes
a. Retired long-term notes
payable by issuing stock X
b. Recorded depreciation
expense X
c. Paid cash dividend that
was declared in a prior X
period
d. Sold inventory for cash X
e. Borrowed cash from bank
by signing a 9-month note X
payable
f. Paid cash to purchase a
patent X
g. Accepted six-month note
receivable in exchange for X
plant assets
h. Paid cash toward
accounts payable X
i. Collected cash from sales X
j. Paid cash to acquire
treasury stock X

Net income.............................................................................. $395,000
Adjustments to reconcile net income to net cash
provided by operating activities
Decrease in accounts receivable....................................... 7,600
Decrease in merchandise inventory.................................. 22,040
Increase in prepaid expenses............................................ (2,000)
Decrease in accounts payable........................................... (5,000)
Increase in other payables................................................. 760
Depreciation expense......................................................... 48,980
Amortization expense......................................................... 9,875
Gain on sale of plant assets............................................... (4,900)
Net cash provided by operating activities............................. $472,355

Case A: Sales revenue........................................................... $590,000

Accounts receivable, Dec. 31, 2009........................ $ 38,000
Accounts receivable, Dec. 31, 2010........................ (52,440)
Less increase in accounts receivable.................... (14,440)
Cash received from customers............................... $575,560
Case B: Rent expense............................................................ $117,400

Rent payable, Dec. 31, 2009.................................... $ 6,700
Rent payable, Dec. 31, 2010.................................... (5,561)
Plus decrease in rent payable................................. 1,139
Cash paid for rent..................................................... $118,539
Case C: Cost of goods sold................................................... $651,000

Merchandise inventory, Dec. 31, 2009.................... $201,810
Merchandise inventory, Dec. 31, 2010.................... (165,484)
Less decrease in merch. inventory........................ (36,326)
Cost of goods purchased........................................ 614,674
Accounts payable, Dec. 31, 2009............................ 84,760
Accounts payable, Dec. 31, 2010............................ (105,102)
Less increase in accounts payable........................ (20,342)
Cash paid for merchandise..................................... $594,332

Net income.............................................................................. $ 678,600
Increase in accounts receivable........................................ (45,300)
Increase in merchandise inventory................................... (35,150)
Decrease in accounts payable........................................... (10,075)
Decrease in salaries payable............................................. (4,750)
Depreciation expense......................................................... 52,200
Amortization expensePatents........................................ 6,525
Gain on sale of equipment................................................. (8,700)
Net cash provided by operating activities............................. $ 633,350


Receipts from customers (see note a)............................................ $2,129,700
Payments for merchandise (see note b)......................................... (1,110,975)
Payments for salaries (see note c).................................................. (302,725)
Payments for rent............................................................................ (58,725)
Payments for utilities...................................................................... (23,925)
Net cash provided by operating activities....................................... $ 633,350
Note a: Sales Increase in receivables

$2,175,000 - $45,300 = $2,129,700
Note b: Cost of goods sold + Increase in inventory + Decrease in payables

$1,065,750 + $35,150 + $10,075 = $1,110,975
Note c: Salaries expense + Decrease in salaries payable

$297,975 + $4,750 = $302,725
Cash flows from investing activities

Cash received from the sale of equipment*......................................$ 50,500
Cash paid for new truck...................................................................... (95,000)
Cash received from the sale of land.................................................. 400,000
Cash received from the sale of long-term investments................... 94,700
Net cash provided by investing activities.........................................$450,200
* Cash received from sale of equipment = Book value - loss = $72,500 - $22,000 = $50,500
Cash flows from financing activities

Sale of common stock.................................................................................
$ 75,000
Paid cash dividend.......................................................................................
(13,000)
Paid maturity amount on note payable...................................................... (90,000)
Purchased treasury stock...........................................................................(18,000)
Net cash used by financing activities........................................................ $ (46,000)

Part 1
BOULWARE, INC.
Statement of Cash Flows (Indirect Method)
For Year Ended June 30, 2009
Net income.....................................................................
$107,465
Increase in accounts receivable..................................(8,768)
Decrease in merchandise inventory............................43,487
Decrease in prepaid expenses..................................... 803
Decrease in accounts payable..................................... (10,766)
Decrease in wages payable (11,118)
Decrease in income taxes payables............................(1,898)
Depreciation expense...................................................88,753
Gain on sale of plant assets.........................................(3,125)
Net cash provided by operating activities.................. $204,833

Cash received from sale of equip. (Note 1)...... 28,019
Cash paid for equipment (Note 1)...................... (85,000)
Net cash used in investing activities................ (56,981)

Cash received from stock issuance (Note 2).... 50,000
Cash paid to retire notes (given)....................... (45,000)
Cash paid for dividends (Note 3)....................... (117,683)
Net cash used in financing activities................ (112,683)
Net increase in cash............................................... $ 35,169
Cash balance at prior year-end............................. 49,494
Cash balance at current year-end........................ $ 84,663
(See Notes on next page.)

Exercise 16-10 (Part 1 continued)
(1) Cost of equipment sold.................................................................................. $ 98,145

Accumulated depreciation of equipment sold.............................................. (73,251)
Book value of equipment sold....................................................................... 24,894
Gain on sale of equipment............................................................................. 3,125
Cash receipt from sale of equipment............................................................ $ 28,019
Cost of equipment sold.................................................................................. $ 98,145

Less decrease in the equipment account balance....................................... (13,145)
Cash paid for new equipment (given)........................................................... $ 85,000
Equipment Accumulated Depreciation, Equipment

Bal., 131,532 Bal., 6/30/2008 10,848
6/30/2008
Purchase 85,000 Sale 98,145 Sale Depr. expense 88,753
73,251
Bal., 6/30/2009 118,387 Bal., 6/30/2009 26,350
(2) Ending balance of common stock................................................................. $ 208,000

Less beginning balance of common stock................................................... (158,000)
Cash received from the sale of common stock............................................ $ 50,000
(3) Beginning retained earnings.......................................................................... $ 47,095

Plus net income.............................................................................................. 107,465
Expected value in retained earnings............................................................. 154,560
Less ending balance in retained earnings.................................................... (36,877)
Dividends paid................................................................................................ $ 117,683
Part 2
Cash flow on total assets ratio = Operating cash flows / Average total assets
= $204,833 / [($310,000 + $339,000)/2]
= $204,833 / $324,500
= 63.1%
Interpretation: A 63.1% result on the cash flow on total assets ratio is

indicative of very good performance. Also, this favorably compares to its
return on assets figure of 33.1% (high quality earnings).

BOULWARE, INC.
Statement of Cash Flows (Direct Method)
For Year Ended June 30, 2009
Cash received from customers (Note 1)........... $967,832
Cash paid for merchandise (Note 2).................. (592,303)
Cash paid for operating expenses (Note 3)...... (112,194)
Cash paid for income taxes (Note 4)................. (58,502)
Net cash provided by operating activities........ $204,833

Cash received from sale of equip. (Note 5)...... 28,019
Cash paid for equipment (Note 5)...................... (85,000)
Net cash used in investing activities................ (56,981)

Cash received from stock issuance (Note 6).... 50,000
Cash paid to retire notes (given)....................... (45,000)
Cash paid for dividends (Note 7)....................... (117,683)
Net cash used in financing activities................ (112,683)
Net increase in cash............................................... $ 35,169

Cash balance at prior year-end............................. 49,494
Cash balance at current year-end........................ $ 84,663
(See notes on next page)

Exercise 16-11B (continued)
Notes
(1) Sales................................................................................................................ $976,600
Less increase in accounts receivable........................................................... (8,768)
Cash received from customers...................................................................... $967,832
(2) Cost of goods sold......................................................................................... $625,024

Less decrease in merchandise inventory..................................................... (43,487)
Purchases....................................................................................................... 581,537
Plus decrease in accounts payable............................................................... 10,766
Cash paid for merchandise............................................................................ $592,303
(3) Other operating expenses.............................................................................. $101,879

Plus decrease in wages payable................................................................... 11,118
Less decrease in prepaid expenses.............................................................. (803)
Cash paid for other operating expenses....................................................... $112,194
(4) Income taxes expense.................................................................................... $ 56,604

Plus decrease in income taxes payable........................................................ 1,898
Cash paid for income taxes........................................................................... $ 58,502
(5) Cost of equipment sold.................................................................................. $ 98,145

Accumulated depreciation of equipment sold.............................................. (73,251)
Book value of equipment sold....................................................................... 24,894
Gain on sale of equipment............................................................................. 3,125
Cash receipt from sale of equipment............................................................ $ 28,019
Cost of equipment sold.................................................................................. $ 98,145

Less decrease in the equipment account balance....................................... (13,145)
Cash paid for new equipment (given)........................................................... $ 85,000
Equipment Accumulated Depreciation, Equipment

Bal., 131,532 Bal., 6/30/2008 10,848
6/30/2008
Purchase 85,000 Sale 98,145 Sale 73,251 Depr. expense 88,753
Bal., 6/30/2009 118,387 Bal., 6/30/2009 26,350
(6) Ending balance of common stock................................................................. $208,000

Less beginning balance of common stock................................................... (158,000)
Cash received from sale of common stock.................................................. $ 50,000
(7) Beginning retained earnings.......................................................................... $ 47,095

Plus net income.............................................................................................. 107,465
Expected balance in retained earnings......................................................... 154,560
Less ending balance in retained earnings.................................................... (36,877)
Dividends paid................................................................................................ $117,683

VALENCIA COMPANY
Statement of Cash Flows
For Year Ended December 31, 2009
Receipts from customers........................................... $ 834,200
Receipts of interest..................................................... 4,300
Payments for merchandise........................................ (433,784)
Payments for salaries................................................. (124,700)
Payments for other expenses.................................... (68,800)
Net cash provided by operating activities................ $211,216
Receipt from sale of equipment................................ 105,350
Payment for store equipment.................................... (40,850)
Net cash provided by investing activities................ 64,500
Payment to retire long-term notes payable.............. (215,000)
Receipt from borrowing on six-month note............. 43,000
Payment of cash dividends........................................ (25,800)
Net cash used in financing activities........................ (197,800)
Net increase in cash and cash equivalents................. $ 77,916
Cash and cash equivalents at prior year-end............. 43,000
Cash and cash equivalents at current year-end......... $120,916
Note No. ___

Noncash investing and financing activities
(1) Issued common stock to retire $180,000 of bonds payable.
(2) Purchased land financed with a $104,400 long-term note payable.

1.
CLARETT CORPORATION
Cash received from customers............................ $7,074,800
Cash received from dividends.............................. 876,180
Cash paid for merchandise................................... (2,934,822)
Cash paid for wages.............................................. (1,018,882)
Cash paid for rent.................................................. (586,964)
Cash paid for interest............................................ (398,693)
Cash paid for taxes................................................ (830,610)
Net cash provided by operating activities........... $2,181,009
Cash paid for purchases of machinery............... (3,130,900)
Cash paid for purchases of long-term
investments......................................................... (2,295,200)
Cash received from sale of land........................... 397,676
Cash received from sale of machinery................ 606,826
Net cash used in investing activities................... (4,421,598)
Cash received from issuing stock....................... 2,846,224
Cash received from borrowing............................. 1,795,388
Cash paid for note payable................................... (905,787)
Cash paid for dividends........................................ (519,208)
Cash paid for treasury stock purchases............. (398,693)
Net cash provided by financing activities........... 2,817,924
Net increase in cash................................................ $ 577,335
Cash at prior year-end............................................. 251,700
Cash at current year-end........................................ $ 829,035
2. a. (i) Financing section reported the largest cash inflow of $2,817,924.

(ii) Investing section reported the largest cash outflow of $4,421,598.
b. The largest individual item among the investing cash outflows is the
purchase of machinery at $3,130,900.
c. Proceeds for issuing stock equity are larger at $2,846,224 than for
issuing notes at $1,795,388 (see financing section).
d. The company has a net cash inflow from borrowing. This is
computed from the borrowing proceeds of $1,795,388 less the note
payment of $905,787 (see financing section).

Cash flows from operating activitiesindirect method

Net income....................................................................................................
$ 12,000
Depreciation expense.................................................................................. 6,000
Accounts receivable increase .................................................................... (5,000)
Inventory decrease....................................................................................... 8,000
Salaries payable increase............................................................................ 500
Net cash provided by operating activities.................................................
$ 21,500
1. Cash flows from operating activitiesindirect method

Net income (loss).........................................................................................
$(32,000)
Depreciation expense..................................................................................
29,200
Accounts receivable decrease ...................................................................
48,000
Salaries payable increase............................................................................
36,000
Accrued liabilities decrease........................................................................
(16,000)
Net cash provided by operating activities.................................................
$ 65,200
2. One reason for the net loss was depreciation expense. Depreciation
expense is added to net income to adjust for the effects of a noncash
expense that was deducted in determining net income. It does not
involve an inflow of cash. Depreciation expense, along with a decrease
in accounts receivable and an increase in salaries payable, turned the
net loss into positive operating cash flow.
3. Differences between cash flow from operations and net income can be
caused by various items. The most important causes for investors are
differences arising from: (1) changes in management of operating
activities and (2) changes in revenue and expense recognition.

PROBLEM SET A
Problem 16-1A (50 minutes)
Part 1
GEORGIA COMPANY
Net income..............................................................................
$120,575
cash provided by operating activities:
Increase in accounts receivable ($65,840 - $56,000)...............(9,840)
Increase in inventory ($277,000 - $252,000)...............................
(25,000)
Decrease in prepaid expenses ($1,500 - $1,000)..................... 500
Decrease in accounts payable ($113,000 - $42,965)................ (70,035)
Depreciation expense..........................................................20,000
Loss on disposal of equipment............................................ 5,875
Net cash provided by operating activities................................ $ 42,075

Cash received from sale of equipment....................................11,625
Cash paid for equipment.........................................................
(35,000)
Net cash used in investing activities....................................... (23,375)

Cash borrowed on short-term note......................................... 3,000
Cash paid on long-term note................................................... (40,500)
Cash received from issuing stock (2,350 x $20)........................47,000
Cash paid for dividends...........................................................(51,900)
Net cash used in financing activities....................................... (42,400)
Net decrease in cash.................................................................. $(23,700)
Cash balance at December 31, 2008........................................... 73,500
Cash balance at December 31, 2009........................................... $ 49,800

Purchased equipment for $97,500 by signing a $62,500 long-term note
payable and paying $35,000 in cash.

Problem 16-1A (Concluded)
Part 2
The company's operations provide a positive net cash inflow of $42,075a

good result. At the same time, the cash balance decreased by $23,700
(32%) during the year. Two major cash outflows are the retirement of
debt ($40,500) and the dividend payment ($51,900), which together
represent 77% of net income. Also, the $35,000 cash investment in
equipment is presumably necessary to replace the older equipment
sold.
Helping fund these cash outflows is $47,000 cash from issuance of stock.
Moreover, the company took on additional debt; namely, $62,500 in
long-term notes. The company must recognize that that the debt must
eventually be repaid with interest.
In summary, perhaps the company should review the wisdom of paying
cash dividends that are considerably larger than cash provided from
operations, especially when the payment also results in a deteriorating
cash position and when the company is taking on additional debt.

Problem 16-2AA (60 minutes)
GEORGIA COMPANY
Spreadsheet for Statement of Cash Flows
December Analysis of Changes December
31, 2008 Debit Credit 31, 2009
Balance sheetdebits
Cash.................................................$ 73,500 $ 49,800
Accounts receivable.......................... 56,000 (b) $ 9,840 65,840
Merchandise inventory...................... 252,000 (c) 25,000 277,000
Prepaid expenses............................. 1,500 (d) $ 500 1,000
Equipment........................................ 107,500 (h) 97,500 (g) 46,500 158,500
$490,500 $552,140
Balance sheet--credits
Accum. depreciationEquip.............$ 52,000 (g) 29,000 (f) 20,000 $ 43,000
Accounts payable............................. 113,000 (e) 70,035 42,965
Short-term notes payable.................. 7,000 (j) 3,000 10,000
Long-term notes payable................... 48,000 (k) 40,500 (i) 62,500 70,000
Common stock, $5 par value............. 151,000 (l) 11,750 162,750
Paid-in capital in excess of
par value, common stock................ 0 (l) 35,250 35,250
Retained earnings............................. 119,500 (m) 51,900 (a) 120,575 188,175
$490,500 $552,140
Statement of cash flows
Operating activities
Net income........................................ (a) 120,575
Increase in accts. receivable.............. (b) 9,840
Increase in merch. inventory............. (c) 25,000
Decrease in prepaid expenses........... (d) 500
Decrease in accounts payable........... (e) 70,035
Depreciation expense........................ (f) 20,000
Loss on sale of equipment................ (g) 5,875
Investing activities
Receipt from sale of equipment......... (g) 11,625
Payment to purchase equipment....... (h) 35,000
Financing activities
Borrowed on short-term note............ (j) 3,000
Payment on long-term note............... (k) 40,500
Issued common stock for cash.......... (l) 47,000
Payments of cash dividends.............. (m) 51,900
Noncash investing and
financing activities
Purchase of equip. financed
by long-term note payable.......... (i) 62,500 (h) 62,500
$594,850 $594,850

Problem 16-2AA (Continued)
GEORGIA COMPANY
Net income..............................................................................
$120,575
cash provided by operating activities:
Increase in accounts receivable........................................... (9,840)
Increase in inventory.................................................................(25,000)
Decrease in prepaid expenses............................................. 500
Decrease in accounts payable.............................................(70,035)

Cash paid for equipment.........................................................(35,000)

Cash paid on long-term note...................................................(40,500)
Cash received from issuing stock...........................................47,000
Net decrease in cash.................................................................. $(23,700)


Problem 16-3AB (40 minutes)
GEORGIA COMPANY
Cash received from customers (Note 1).................... $574,660
Cash paid for merchandise (Note 2)........................... (376,035)
Cash paid for other expenses (Note 3)...................... (132,300)
Cash paid for income taxes........................................ (24,250)
Net cash provided by operating activities................ $ 42,075

Cash received from sale of equipment..................... 11,625
Cash paid for equipment............................................ (35,000)
Net cash used in investing activities........................ (23,375)

Cash borrowed on short-term note........................... 3,000
Cash paid on long-term note...................................... (40,500)
Cash received from issuing stock (2,350 x $20)........ 47,000
Cash paid for dividends.............................................. (51,900)
Net cash used in financing activities........................ (42,400)
Net decrease in cash...................................................... $(23,700)
Cash balance at December 31, 2008............................ 73,500
Cash balance at December 31, 2009............................ $ 49,800

Supporting calculations
(1) Sales - Increase in receivables = $584,500 - ($65,840 - $56,000) = $574,660
(2) Cost of + Increase in Decrease in

goods sold inventory + payables =
$281,000 + ($277,000 - $252,000) + ($113,000 - $42,965) = $376,035
(3) Other expenses - Decrease in prepaid expenses = $132,800 - ($1,500 - $1,000)

= $132,300

MEMPHIS CORPORATION
Net income........................................................................$127,000
cash provided by operating activities
Increase in accounts receivable ($82,000 - $74,000).......... (8,000)
Increase in inventory ($620,000 - $525,000)....................... (95,000)
Increase in accounts payable ($160,000 - $96,000)............ 64,000
Increase in taxes payable ($22,000 - $19,000).................... 3,000
Depreciation expense..................................................... 57,000
Net cash provided by operating activities......................... $148,000

Cash paid for equipment................................................... (105,000)

Cash received from issuing stock (14,000 x $5).................. 70,000
Cash paid for cash dividends............................................ (85,000)
Net cash used in financing activities.................................. (15,000)
Net increase in cash............................................................. $ 28,000
Cash balance at December 31, 2008.................................... 137,000
Cash balance at December 31, 2009.................................... $165,000

Problem 16-5AA (50 minutes)
MEMPHIS CORPORATION
31, 2008 Debit Credit 31, 2009
Balance sheet--debits
Cash.................................................$ 137,000 $ 165,000
Equipment........................................ 240,000 (g) 105,000 345,000
$ 976,000 $1,212,000
Accum. depreciationEquip.............$ 102,000 (f) $ 57,000 $ 159,000
Accounts payable............................. 96,000 (d) 64,000 160,000
Income taxes payable........................ 19,000 (e) 3,000 22,000
Common stock, $2 par value............. 560,000 (h) 28,000 588,000
par value, common stock................ 159,000 (h) 42,000 201,000
Retained earnings............................. 40,000 (i) 85,000 (a) 127,000 82,000
$ 976,000 $1,212,000
Net income........................................ (a) 127,000
Increase in accounts receivable........ (b) 8,000
Increase in accounts payable............ (d) 64,000
Increase in income tax payable.......... (e) 3,000
Payment for equipment..................... (g) 105,000
Issued common stock for cash.......... (h) 70,000
Paid cash dividends.......................... _______ (i) 85,000
$614,000 $614,000

Problem 16-5A (Continued)
MEMPHIS CORPORATION
Net income........................................................................$127,000
Increase in accounts receivable..................................... (8,000)
Increase in inventory...................................................... (95,000)
Increase in accounts payable......................................... 64,000
Increase in taxes payable............................................... 3,000
Depreciation expense..................................................... 57,000
Net cash provided by operating activities......................... $148,000

Cash paid for equipment................................................... (105,000)

Cash received from issuing stock..................................... 70,000
Cash paid for cash dividends............................................ (85,000)
Net cash used in financing activities.................................. (15,000)
Net increase in cash............................................................. $ 28,000
Cash balance at December 31, 2008.................................... 137,000
Cash balance at December 31, 2009.................................... $165,000

MEMPHIS CORPORATION
Cash received from customers (Note 1).................... $1,786,000
Cash paid for merchandise (Note 2) .......................... (1,119,000)
Cash paid for other operating expenses .................. (500,000)
Cash paid for income taxes (Note 3) ......................... (19,000)
Net cash provided by operating activities ............... $148,000

Cash paid for equipment............................................ (105,000)

Cash from issuing stock (14,000 x $5)........................ 70,000
Cash paid for cash dividends ................................... (85,000)
Net cash used in financing activities ....................... (15,000)
Net increase in cash....................................................... $ 28,000
Cash balance at December 31, 2008............................. 137,000
Cash balance at December 31, 2009............................. $165,000
(1) Sales - Increase in receivables = $1,794,000 - ($82,000 - $74,000) = $1,786,000
(2) Cost of Increase in Increase in

+ -
goods sold inventory payables =
$1,088,000 + ($620,000 - $525,000) - ($160,000 - $96,000) = $1,119,000
(3) Income taxes expense - Increase in income taxes payable

= $22,000 - ($22,000 - $19,000) = $19,000

RAWLING COMPANY
Cash Flows from Operating ActivitiesIndirect Method

Net income............................................................................... $ 3,000
Depreciation expense............................................................
$ 6,000
Decrease in accounts receivable.......................................... 10
Increase in merchandise inventory...................................... (22)
Decrease in accounts payable.............................................. (10)
Increase in salaries payable.................................................. 9
Increase in utilities payable................................................... 3
Decrease in prepaid insurance............................................. 1
Increase in prepaid rent......................................................... (2) 5,989
Net cash provided by operating activities............................ $ 8,989

RAWLING COMPANY
Cash Flows from Operating ActivitiesDirect Method

Cash receipts from customers (1).............................................................
$48,610
Cash payments to suppliers (2)................................................................
(21,032)
Cash payments for salaries (3)..................................................................
(8,991)
Cash payments for rent (4)........................................................................
(4,502)
Cash payments for insurance (5)..............................................................
(1,899)
Cash payments for utilities (6)..................................................................
(1,397)
Cash payments for interest.......................................................................
(1,800)
Net cash provided by operating activities................................................
$ 8,989
(1) Sales + Decrease in receivables = $48,600 + ($290 - $280) = $48,610
(2) Cost of + Increase in + Decrease in

$21,000 + ($99 - $77) + ($230 - $220) = $21,032
(3) Salaries expense - Increase in salaries payable = $9,000 - ($44 - $35) = $8,991
(4) Rent expense + Increase in prepaid rent = $4,500 + ($11 - $9) = $4,502
(5) Insurance expense - Decrease in prepaid insurance = $1,900 - ($14 - $13) = $1,899
(6) Utilities expense - Increase in utilities payable = $1,400 - ($11 - $8) = $1,397

PROBLEM SET B
Problem 16-1B (40 minutes)
Part 1
WILSON CORPORATION
Net income..............................................................................
$116,125
Increase in accounts receivable ($65,830 - $55,000)...............(10,830)
Increase in inventory ($277,000 - $252,000).......................(25,000)
Decrease in prepaid expenses ($1,600 - $1,250)..................... 350
Decrease in accounts payable ($112,000 - $55,380)................(56,620)

Cash paid for equipment.........................................................(25,000)

Cash paid on long-term note...................................................(50,750)
Cash received from issuing stock (2,350 x $20)........................47,000
Net decrease in cash.................................................................. $ (24,600)


Problem 16-1B (Continued)
Part 2
The corporation's dividend payments of $59,000 represent 51% of the

$116,125 net income for the year, and 119% of cash inflow provided by
operations of $49,650.
Further analysis reveals that investing activities used a modest $13,500
and, including the dividends, financing activities used $60,750. This
resulted in a $24,600 decrease in the company's cash balance for the year,
a 33% decrease.
In summary, perhaps the company should review the wisdom of paying
cash dividends that are considerably larger than cash provided from
operations, especially when the payment also results in a deteriorating
cash position and when the company is taking on additional debt.

Problem 16-2BA (60 minutes)
WILSON CORPORATION
31, 2008 Debit Credit 31, 2009
Cash................................................. $ 74,000 $ 49,400
Accounts receivable.......................... $
55,000 (b) 10,830 65,830
Prepaid expenses............................. 1,600 (d) $ 350 1,250
Equipment........................................ 107,500 (h) $97,500 (g) 46,500 158,500
$490,100 $551,980
Accum. depreciationEquip............. $ 46,000 (g) 29,375 (f) 20,000 $ 36,625
Accounts payable............................. 112,000 (e) 56,620 55,380
Short-term notes payable.................. 7,000 (j) 2,000 9,000
Long-term notes payable................... 48,250 (k) 50,750 (i) 72,500 70,000
Common stock, $5 par value............. 150,750 (l) 11,750 162,500
par value, common stock................ 0 (l) 35,250 35,250
Retained earnings............................. 126,100 (m) 59,000 (a) 116,125 183,225
$490,100 $551,980
Net income........................................ (a) 116,125
Increase in accounts receivable......... (b) 10,830
Decrease in merch. inventory............ (c) 25,000
Decrease in prepaid expenses........... (d) 350
Decrease in accounts payable........... (e) 56,620
Loss on sale of equipment................ (g) 5,625
Receipt from sale of equipment......... (g) 11,500
Payment to purchase equipment....... (h) 25,000
Borrowed on short-term note............ (j) 2,000
Payment on long-term note............... (k) 50,750
Issued common stock for cash.......... (l) 47,000
Payments of cash dividends.............. (m) 59,000
Noncash investing and financing

activities
Purchase of equip. financed
by long-term note payable.......... (i) 72,500 (h) 72,500
$604,175 $604,175

Problem 16-2BA (Continued)
WILSON CORPORATION
Net income..............................................................................
$116,125
Increase in accounts receivable........................................... (10,830)
Increase in inventory.........................................................
(25,000)
Decrease in prepaid expenses............................................. 350
Decrease in accounts payable............................................. (56,620)
Depreciation expense..........................................................
20,000
Loss on disposal of equipment............................................5,625

Cash received from sale of equipment.................................... 11,500
Cash paid for equipment.........................................................
(25,000)

Cash borrowed on short-term note.........................................2,000
Cash paid on long-term note................................................... (50,750)
Cash received from issuing stock........................................... 47,000
Net decrease in cash.................................................................. $ (24,600)


Problem 16-3BB (40 minutes)
WILSON CORPORATION
Cash received from customers (Note 1).....................$ 574,170
Cash paid for merchandise (Note 2)............................ (366,620)
Cash paid for other expenses (Note 3)....................... (133,650)
Cash paid for income taxes........................................ (24,250)
Net cash provided by operating activities................. $ 49,650

Cash received from sale of equipment...................... 11,500
Cash paid for equipment............................................. (25,000)
Net cash used in investing activities......................... (13,500)

Cash borrowed on short-term note............................ 2,000
Cash paid on long-term note...................................... (50,750)
Cash received from issuing stock (2,350 x $20)......... 47,000
Cash paid for dividends.............................................. (59,000)
Net cash used in financing activities......................... (60,750)
Net decrease in cash...................................................... $ (24,600)
Cash balance at December 31, 2008............................. 74,000
Cash balance at December 31, 2009............................. $ 49,400

Purchased equipment for $97,500 by signing a $72,500 long-term note payable
and paying $25,000 in cash.
(1) Sales - Increase in receivables = $585,000 - ($65,830 - $55,000) = $574,170
(2) Cost of + Increase in Decrease in

goods sold inventory + payables =
$285,000 + ($277,000 $252,000) + ($112,000 - $55,380) = $366,620
(3) Other expenses - Decrease in prepaid expenses = $134,000 - ($1,600 - $1,250)

= $133,650

PRIUS COMPANY
Net income..................................................................... $132,000
Increase in accounts receivable ($82,000 - $70,000)....... (12,000)
Increase in inventory ($605,000 - $515,000)..................... (90,000)
Increase in accounts payable ($173,000 - $119,000)........ 54,000
Increase in taxes payable ($20,000 - $17,000)................. 3,000
Depreciation expense.................................................. 55,000
Net cash provided by operating activities...................... $ 142,000

Cash paid for equipment............................................... (74,000)

Cash received from issuing stock (10,000 x $5).............. 50,000
Cash paid for dividends................................................. (85,000)
Net cash used by financing activities............................. (35,000)
Net increase in cash......................................................... $ 33,000
Cash balance at December 31, 2008................................. 131,000
Cash balance at December 31, 2009................................. $ 164,000

Problem 16-5BA (50 minutes)
PRIUS COMPANY
31, 2008 Debit Credit 31, 2009
Cash................................................. $ 131,000 $ 164,000
Equipment........................................ 276,000 (g) 74,000 350,000
$ 992,000 $1,201,000
Accum. depreciationEquip............. $ 102,000 (f) $ 55,000 $ 157,000
Accounts payable............................. 119,000 (d) 54,000 173,000
Income taxes payable........................ 17,000 (e) 3,000 20,000
Common stock, $2 par value............. 560,000 (h) 20,000 580,000
par value, common stock................ 163,000 (h) 30,000 193,000
Retained earnings............................. 31,000 (i) 85,000 (a) 132,000 78,000
$ 992,000 $1,201,000

Net income........................................ (a) 132,000
Increase in accounts receivable........ (b) 12,000
Increase in accounts payable............ (d) 54,000
Decrease in income taxes payable..... (e) 3,000
Payment for equipment..................... (g) 74,000
Issued common stock for cash.......... (h) 50,000
Paid cash dividends.......................... ________ (i) 85,000
$555,000 $555,000

Problem 16-5BA (Continued)
PRIUS COMPANY
Net income..................................................................... $132,000
Increase in accounts receivable................................... (12,000)
Increase in inventory.................................................... (90,000)
Increase in accounts payable....................................... 54,000
Increase in taxes payable............................................. 3,000
Depreciation expense.................................................. 55,000
Net cash provided by operating activities...................... $ 142,000

Cash paid for equipment............................................... (74,000)

Cash received from issuing stock................................. 50,000
Cash paid for dividends................................................. (85,000)
Net cash used by financing activities............................. (35,000)
Net increase in cash......................................................... $ 33,000
Cash balance at December 31, 2008................................. 131,000
Cash balance at December 31, 2009................................. $ 164,000

PRIUS COMPANY
Cash received from customers (Note 1) .................. $1,780,000
Cash paid for merchandise (Note 2) ......................... (1,123,000)
Cash paid for other operating expenses ................. (494,000)
Cash paid for income taxes (Note 3) ........................ (21,000)
Net cash provided by operating activities ............... $142,000

Cash paid for equipment ........................................... (74,000)

Cash received from issuing stock (10,000 x $5)...... 50,000
Cash paid for cash dividends ................................... (85,000)
Net cash used by financing activities ...................... (35,000)
Net increase in cash....................................................... $ 33,000
Cash balance at December 31, 2008............................ 131,000
Cash balance at December 31, 2009............................ $164,000
(1) Sales - Increase in receivables = $1,792,000 - ($82,000 - $70,000) = $1,780,000
(2) Cost of Increase in

+ - Increase in
$1,087,000 + ($605,000 - $515,000) ($173,000 - $119,000) = $1,123,000
(3) Income taxes expense - Increase in income taxes payable

= $24,000 - ($20,000 - $17,000) = $21,000

KODAK COMPANY
Cash Flows from Operating ActivitiesIndirect Method

Net income............................................................................... $ 40,000
Depreciation expense............................................................
$64,000
Increase in accounts receivable........................................... (120)
Decrease in merchandise inventory..................................... 24
Decrease in accounts payable.............................................. (40)
Increase in salaries payable.................................................. 60
Increase in utilities payable................................................... 40
Decrease in prepaid insurance............................................. 8
Decrease in prepaid rent....................................................... 20 63,992
Net cash provided by operating activities............................ $103,992

KODAK COMPANY
Cash Flows from Operating ActivitiesDirect Method

Cash receipts from customers (1).............................................................
$ 311,880
Cash payments to suppliers (2).................................................................
(144,016)
Cash payments for salaries (3)..................................................................
(39,940)
Cash payments for rent (4).........................................................................(9,980)
Cash payments for insurance (5)...............................................................(5,192)
Cash payments for utilities (6)...................................................................(3,960)
Cash payments for interest........................................................................(4,800)
Net cash provided by operating activities................................................
$ 103,992
(1) Sales - Increase in receivables = $312,000 - ($720 - $600) = $311,880
(2) Cost of
- Decrease in + Decrease in
$144,000 - ($196 - $172) + ($520 - $480) = $144,016
(3) Salaries expense - Increase in salaries payable

= $40,000 - ($180- $120) = $39,940
(4) Rent expense - Decrease in prepaid rent

= $10,000 - ($40- $20) = $9,980
(5) Insurance expense - Decrease in prepaid insurance

= $5,200 - ($36- $28) = $5,192
(6) Utilities expense - Increase in utilities payable

= $4,000 - ($40- $0) = $3,960

SERIAL PROBLEM SP 16
Serial Problem SP 16, Success Systems (45 minutes)
SUCCESS SYSTEMS
Statement of Cash Flows (Indirect)
For Quarter Ended March 31, 2010
Net income..............................................................................
$ 18,686
Increase in accounts receivable ($22,720 - $5,668).................(17,052)
Increase in inventory ($704 - $0)............................................ (704)
Increase in computer supplies ($2,005 - $580) ......................(1,425)
Decrease in prepaid insurance ($1,665 - $1,110)..................... 555
Decrease in accounts payable ($1,100 - $0)...........................(1,100)
Increase in wages payable ($875 - $500) ............................... 375
Decrease in unearned computer service revenue................(1,500)
Depreciation expenseOffice Equipment............................. 400
Depreciation expenseComputer Equipment...................... 1,250
Net cash used by operating activities...................................... $ (515)

Net cash used in investing activities....................................... 0

Cash received from stock issuance.........................................25,000
Cash paid for dividends........................................................... (4,800)
Net cash provided by financing activities................................ 20,200
Net increase in cash................................................................... $ 19,685
Cash balance at March 31, 2010................................................. $ 77,845

Reporting in Action BTN 16-1
1. Best Buy uses the indirect method of reporting operating cash flows. We
know this because the operating activity section of the cash flow
statement starts with net income, and makes adjustments for items such
as depreciation and changes in current assets and liabilities.
2. In all three years, Best Buys cash flows from operating activities
exceeded the amount of cash dividends paid, as can be seen from the
table below:
($ millions) 2007 2006 2005
Cash provided by operating activities...... $1,762 $1,740 $1,981
Cash dividends paid................................... (174) (151) (137)
3. In 2007, the largest item in reconciling the difference between net

income and cash flow from operations was the increase in merchandise
inventories of $550 million.
In 2006, the largest item in reconciling the difference between net
income and cash flow from operations was the increase in merchandise
inventories of $457 million.
In 2005, the largest item in reconciling the difference between net
income and cash flow from operations was the depreciation of $459.
4. In 2007, the largest cash inflow of cash from investing activities was
$4,886 million from the sale of available-for-sale securities. The largest
cash outflow from investing activities was the purchase of available-for-
sale securities in the amount of $4,541 million.
In 2007, the largest cash inflow of cash from financing activities was
$217 million from the issuance of common stock under employee stock
option plans and the exercise of stock options. The largest cash outflow
from financing activities was $599 million for repurchase of stock.
In 2006, the largest cash inflow from investing activities was $4,187
million from the sale of available-for-sale securities. The largest cash
outflow from investing activities was $4,319 million from the purchase of
available-for-sale securities.
In 2006, the largest cash inflow from financing activities was $292
million from the issuance of common stock under employee stock
option plans and the exercise of stock options. The largest cash outflow
from financing activities was $772 million for repurchase of stock.
5. Answer depends on the financial statement information obtained.

Comparative Analysis BTN 16-2
1. Best Buys cash flow on total assets ratio ($ millions)

Current Year = Operating cash flows/Average total assets
= $1,762 / [($13,570 + $11,864)/2]
= $1,762 / $12,717 = 13.9%
Prior Year = Operating cash flows/Average total assets

= $1,740 / [($11,864 + $10,294)/2]
= $1,740 / $11,079 = 15.7%
Circuit Citys cash flow on total assets ratio ($ millions)

= $316 / [($4,007 + $4,069)/2]
= $316 / $4,038 = 7.8%

= $365 / ($4,069 + $3,840)/2]
= $365 / $3,954.5 = 9.2%
RadioShacks cash flow on total assets ratio ($ millions)

= $315 / [($2,070 + $2,205)/2]
= $315 / $2,137.5 = 14.7%

= $363 / ($2,205 + $2,517)/2]
= $363 / $2,361 = 15.4%
2. The cash flow on total assets ratio reflects the return on average assets
by using actual operating cash flows instead of net income. This return
calculation is not affected by the accounting constraints of recognition
and measurement of revenues and expenses. Instead, it is based solely
on operating cash flows (which has its own strengths and weaknesses).
3. RadioShack appears to be successful at earning a cash return on its

assets. Specifically, RadioShacks cash flow on total assets ratios for
the past 2 years (14.7% and 15.4%) are comparable with those of Best
Buys (13.9% and 15.7%), but stronger than those of Circuit Citys (7.8%
and 9.2%).

4. Many business decision makers (such as analysts) feel that the cash
flow on total assets ratio is one indicator of earnings quality in that it is
a measure of the ability of the company to realize its net income in the
form of cash for the period under analysis.

Ethics Challenge BTN 16-3
1. The business actions available include

a. Encourage early collection of receivables to reduce the accounts
receivable balance.
b. Defer payments to vendors due as of year-end to increase the
accounts payable balance.
c. Defer any other payments of operating expenses due near the year-
end to improve the level of cash flow from operations.
Many other business actions are possible that would accelerate cash
receipts and/or delay cash payments.
2. As a business owner, Kaelyn Gish certainly can exercise discretion over

business actions. However, the underlying economic realities should
support any proposed actions. It is not ethical to pursue actions that
purposely mislead users of financial statements.
In addition, Kaelyn Gishs actions may be transparent to the banker
when s/he reviews the financial records of the business. If so, her
reputation may suffer in the eyes of her banker and she may jeopardize
her ability to obtain bank financing in the future or increase the cost of
that financing.

Communicating in Practice BTN 16-4
Here is a sample of what the body of the memorandum might include:
TO: Hanna Willard

FROM: (Your Name)
SUBJECT: Statement of Cash Flows
DATE: _________________
I am pleased to hear your business is more profitable this year than last.
However, I have been thinking about what you said regarding the statement
of cash flows and have some thoughts as to why you found it confusing.
The statement of cash flows (operating section) can be prepared using

either of two methodsthe direct or the indirect method. From what you
describe, your statement is probably prepared using the indirect method.
This method shows a determination of net cash flows in the operating
(first) section by listing the net income number and applying a series of
accounting adjustments. These adjustments often do not make sense to
those that do not have an accounting or finance background.
I recommend that you request your accountant to provide you with a

statement of cash flows that is prepared using the direct method. This will
identify exactly how much cash came in from operating activities like sales.
It will also identify exactly how much cash went out for operating expenses
like merchandise, wages, interest, and taxes. It will determine your net
operating cash flow by directly subtracting the total of these operating
outflows from the inflows. You should find this format more
understandable.
Note that good cash management is essential to business success and

growth. The statement of cash flows will provide you with a lot more
information regarding your cash than a balance sheet can offer. It will
allow you to see exactly where your cash came from, where it went, and
how much it changed. It organizes these amounts into categories of
operating, financing, and investing. This organization of cash information
will allow you to better project and plan for the future.
Please reconsider the value of the statement of cash flows for your
business decisions. If you wish to discuss this further, please call me.

Taking It to the Net BTN 16-5
1. J. Crew Group uses the indirect method to construct the consolidated

statement of cash flows.
2. The largest reconciling item is for Depreciation and amortization of

property and equipment for $33,525,000.
3. The following table shows the net income (net loss) and the cash flows
from operations for J. Crew from 2005 through 2007. Over this three-
year period, J. Crew has generated more positive cash flows from
operations (relative to its net income and losses); indeed, its operating
cash flows have been consistently positive over the past three years.
($ thousands) 2007 2006 2005

$ 77,782
Net income (loss).................................. $ 3,794 $(100,309)
120,977
Cash flows from operations................. 56,835 58,763
4. The largest cash outflow for investing was $45,931,000 for capital
expenditures.
The largest cash outflow for financing was $358,271,000 for redemption
of preferred stock.
5. For supplementary cash flow information, J. Crew reports cash flows

related to: Income taxes paid, and for Interest paid.
6. Yes; for fiscal year-end 2007, J. Crew reports:

Dividends on preferred stock charged directly to stockholders equity
Conversion of principal amount plus accrued and unpaid interest of
5% notes payable into 6,729,186 shares of common stock
Liquidation value of Series A preferred stock converted into 3,673,729
shares of common stock

Teamwork in Action BTN 16-6
Part 1
a. The reporting objective of the statement of cash flows is to provide
information about important cash inflows and outflows for business
decision makers. It answers specific questions such as:
How does a company obtain its cash?
Where does a company spend its cash?
What is the change in the cash balance?
b. The statement can be prepared using the direct method or the indirect
method for reporting cash flows from operating activities.
Similarities
Both methods report the same net cash flow from operating
activities.
Both methods classify cash flows into operating, financing, and
investing categories.
Both methods provide exactly the same information in the financing
and investing categories.
Both identify the change in cash, beginning cash, and ending cash.
Both are acceptable methods for financial reporting.
Differences
Cash flow from operating activities is determined differently. The
direct method determines all operating cash inflows and outflows,
and then subtracts total operating outflows from inflows. The
indirect method starts with net income and applies a series of
adjustments to reconcile this accrual basis number to a cash basis
number.
The direct method requires an extra section reconciling net income to
cash flows from operating activities.
The direct method is recommended by the FASB.
The indirect method is more widely used.

Teamwork in Action (Continued)
c. Steps to prepare the statement of cash flows:

(i) Compute the net increase or decrease in cash using comparative
balance sheet data. This is the target number or the number the
statement will explain and prove.
(ii) Compute net cash flow in operating activities using the direct or
indirect method.
(iii) Compute net cash flows from investing activities.
(iv) Compute net cash flows from financing activities.
(v) Prove that the net cash flow from the three categories combined
equals the net change in cash. List the beginning and ending cash
balances to prove this.
Also, identify and list noncash financing and investing activities in a
separate schedule or note.
d. Common analyses made from information in the statement of cash flows

include assessing a companys:
Ability to generate future cash flows.
Ability to pay dividends.
Ability to meet obligations.
Ability to expand operations.
Ability to obtain financing.
Cash flow on total assets ratio.
Sources and uses of cash flows.
Part 2
Adjusting Net Income to Cash Flow from Operating Activities

Items to Add Items to Subtract
a. Noncash expenses Noncash revenues
b. Losses Gains
c. Decreases in current assets Increases in current assets
d. Increases in current liabilities Decreases in current liabilities

Teamwork in Action (Concluded)
Part 3
a. Cash receipts from customers = Sales - Increase in Accounts
Receivable, or, + Decrease in Accounts Receivable.
Explanation: Sales reflects what is earned during the period. If Accounts

Receivable increases, that increase represents earnings not yet
collected, so we subtract it. If Accounts Receivable decreases, the
entity collected that much more than the periods sales, so we add it.
b. Cash paid for merchandise requires a two-step computation.

(1) Purchases = Cost of goods sold + Increase in inventory, or,
Decrease in inventory.
(2) Cash paid for merchandise = Purchases + Decrease in Accounts
Payable, or, Increase in Accounts Payable.
Explanation for (1): If inventory increases, the entity bought more than
was sold, so we add it. If inventory decreases, the entity bought less
than was sold, so we subtract it.
Explanation for (2): If Accounts Payable decreases, the entity paid for
more than the periods purchases, so we add it. If Accounts Payable
increases, the entity paid for less than the periods purchases, so we
subtract it.
c. Cash paid for wages and operating expenses = Wages and other
operating expenses [+ Increase in prepaid expenses, or, Decrease in
prepaid expenses] and [+ Decrease in accrued liabilities, or, Increase
in accrued liabilities].
Explanation: If prepaid expenses increase, the entity paid for more than
was incurred, so we add it. If prepaid expenses decrease, the entity paid
for less than was incurred, so we subtract it. Also, if the accrued
liabilities increase, the expense includes an amount not yet paid for, so
we subtract it. If the accrued liabilities decrease, the entity paid for
more than the periods expenses, so we add it.
d. Cash paid for interest and taxes = Interest and tax expense + Decrease
in related payable, or, Increase in related payable.
Explanation: If the related payable decreases, the entity paid for more
than was incurred, so we add it. If the related payable increases, the
entity paid for less than was incurred, so we subtract it.

Entrepreneurial Decision BTN 16-7
1. It is common that small businesses must pay cash in advance for items
such as rent, advertising, supplies, and facilities expansion.
Consequently, those costs are usually recorded before revenues are
earned, and before those revenues are ultimately collected in cash. If
the business does not carefully plan, it is possible that it could show a
positive net income, but not be able to effectively operate because it has
little or no cash to pay its suppliers, creditors, and others to whom it
owes money.
2. As a closely held corporation, Jungle Jims can potentially raise cash

financing for expansion by selling shares in the company or by
borrowing the monies. Jungle Jims is not a publicly traded company,
so the potential to raise capital by selling stock is somewhat restricted.
Moreover, potential lenders will want to evaluate the future profitability,
cash flows, and solvency of the company before lending money.

Entrepreneurial Decision BTN 16-8
Memorandum
To: Jenna and Matt Wilder

From: Your name
Subject: Performance evaluation of Mountain High
Date: Current Date
I have completed my evaluation of your company, Mountain High. My

conclusion is that Mountain High is performing well. This is in spite of its
reported net loss and its negative net cash flow, which I explain in this
memorandum.
First, with respect to the net loss, please note that it includes an $85,000
extraordinary loss. Absent this extraordinary loss, Mountain High would
report a $75,000 net income. Using year-end total assets, Mountain Highs
return on assets would be roughly 9.4% (computed as $75,000 divided by
$800,000). This return is reasonable for a company in its second year of
operations.
Second, with respect to its net cash outflow of $(5,000), please note that
this is mainly due to Mountain Highs renovation and expansion activities.
This is reflected in its summarized statement of cash flows. Specifically, its
cash flows provided by operating activities are an impressive $295,000.
Again, using year-end total assets of $800,000, Mountain Highs operating
cash flow on total assets ratio is roughly 36.9%. This return is especially
good for a companys second year of operations.
Consequently, my evaluation is positive. Operating cash flows are very
good and attention should be directed at maintaining or increasing these
amounts. Also, income from continuing operations is a reasonable $75,000.
Still, given the high operating cash flows relative to income from
continuing operations, special scrutiny should be directed at identifying
and assessing differences between cash flow and accrual amounts for
important individual operating activities.

Hitting the Road BTN 16-9
1. The Motley Fools Website defines cash flow as earnings before

interest, taxes, depreciation, and amortization (EBITDA). The schools
justification for this definition includes: Interest income and expense, as
well as taxes, are all tossed aside because cash flow is designed to focus on the
operating business and not secondary costs or profits. As for depreciation and
amortization, these are called non-cash charges, as the company is not actually
spending any money on them. Rather, depreciation is an accounting convention for
tax purposes that allows companies to get a break on capital expenditures as plant
and equipment ages and becomes less useful. Amortization normally comes in when
a company acquires another company at a premium to its shareholder's equity -- a
number that it accounts for on its balance sheet as goodwill and is forced to
amortize over a set period of time, according to generally accepted accounting
principles (GAAP). When looking at a company's operating cash flow, it makes
sense to toss aside accounting conventions that might mask cash strength.
2. Some analysts tend to focus on this particular earnings definition

(earnings before interest and taxes or EBIT) as it purportedly allows a
focus on a companys real operating situation. For example, taxes can
depend on laws and can fluctuate from year to year. By using the
earnings before interest and taxes, the noise caused by such
fluctuations is minimized.
3. Answer depends on the links visited and chosen for the report.
Global Decision BTN 16-10
1. DSGs cash flow on total assets ratio ( millions) follows:

= 207 / [(3,977 + 4,120)/2]
= 207 / 4,048.5 = 5.1%

= 338 / [(4,120+ 4,104)/2]
= 338 / 4,112 = 8.2%
2. In the current year, DSGs ratio (5.1%) is lower than Best Buys (13.9%),
Circuit Citys (7.8%), and RadioShacks (14.7%) ratio. In the prior year
DSGs ratio (8.2%) is again lower than Best Buys (15.7%), Circuit Citys
(9.2%) and RadioShacks (15.4%) ratio.


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Chapter 16

Reporting the Statement of Cash Flows

McGraw-Hill Companies, 2009

McGraw-Hill Companies, 2009

2. Examples of transactions classified as investing activities

3. Examples of transactions classified as financing activities

4. Examples of significant noncash financing and investing activities

Quick Study 16-2 (10 minutes)

* For the indirect method, the loss is reported as an adjustment (add-

McGraw-Hill Companies, 2009

Cash flows from operating activities

Quick Study 16-4 (10 minutes)

Computation of cash inflow from sale of furniture

Quick Study 16-5 (10 minutes)

Cash flows from operating activities

Quick Study 16-7 (15 minutes)

Computation of cash inflow from sale of furniture

Quick Study 16-8 (15 minutes)

1. Computation of cash paid for dividends

2. Computation of cash payments for notes

McGraw-Hill Companies, 2009

1. Cash received from customers = Sales + Accounts receivable decrease

2. Net increase in cash = $189,600 - $48,000 = $141,600

Quick Study 16-10B (10 minutes)

1. Cash paid for merchandise

2. Cash paid for operating expenses

Quick Study 16-11B (10 minutes)

Cash flows from operating activities

McGraw-Hill Companies, 2009

1. Pena is probably in the strongest position of the three competing

Quick Study 16-13A (10 minutes)

Quick Study 16-14 (20 minutes)

Cash Flows from Operating Activities (Indirect)

McGraw-Hill Companies, 2009

Quick Study 16-16 (15 minutes)

McGraw-Hill Companies, 2009

Cash flows from operating activities

Exercise 16-2 (25 minutes)

Statement of Cash Flows Noncash

McGraw-Hill Companies, 2009

McGraw-Hill Companies, 2009

Statement of Cash Flows Noncash

Exercise 16-4 (20 minutes)

Cash flows from operating activities

McGraw-Hill Companies, 2009

Case A: Sales revenue........................................................... $590,000

Case B: Rent expense............................................................ $117,400

Case C: Cost of goods sold................................................... $651,000

Exercise 16-6 (30 minutes)

Cash flows from operating activities

McGraw-Hill Companies, 2009

Cash flows from operating activities

Note a: Sales Increase in receivables

Note b: Cost of goods sold + Increase in inventory + Decrease in payables

Note c: Salaries expense + Decrease in salaries payable

Exercise 16-8 (10 minutes)

Cash flows from investing activities

Exercise 16-9 (10 minutes)

Cash flows from financing activities

McGraw-Hill Companies, 2009

Cash flows from investing activities

Cash flows from financing activities

(See Notes on next page.)