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LO3 Compute and interpret ratios 32, 33, 46, 48, 50,
that reflect a companys liquidity and 59
35, 43 52, 55, 56
solvency.
Investing activities
Inflow: Sale of equipment
Outflow: Purchase of stocks and bonds
Financing activities
Inflow: Issuance of common stock
Outflow: Payment of dividends
a. Positive adjustment
b. Negative adjustment
c. Negative adjustment
d. Positive adjustment
e. Positive adjustment
a.
Balance Sheet Income Statement
Trans- Accts.
Cash Inven- Accts. Contrib. Earned Net
+ Receiv- + = + + Revenue - Expenses =
action Asset tories Payable Capital Capital Income
able
(1) + +507,400 + = + + +507,400 +507,400 - = +507,400
(2) +91,500 + + = + + +91,500 +91,500 - = +91,500
(3) + + 320,100 = + + 320,100 - +320,100 = 320,100
(4) + + 63,400 = + + 63,400 - +63,400 = 63,400
(5) + + +351,600 = +351,600 + + - =
(6) -47,700 + + +47,700 = + + - =
(7) +483,400 + 483,400 + = + + - =
(8) 340,200 + + = 340,200 + + - =
(9) -172,300 + + = + + -172,300 - +172,300 = -172,300
Total +14,700 + +24,000 + +15,800 = +11,400 + + +43,100 +598,900 - +555,800 = +43,100
b. Net income was 43,100 (from the net income column), and cash flow from
operating activities was 14,700 (from the cash column).
d. The accounting equation is kept with every entry, so it is kept for the totals over the
period.
Cash flow + change in accounts receivable + change in inventory
= Change in accounts payable + net income.
This relationship can be presented in the following indirect method cash flow from
operating activities.
Net income 43,100
- Change in accounts receivable 24,000
- Change in inventories 15,800
+ Change in accounts payable +11,400
Cash flow from operating activities 14,700
a.
Balance Sheet Income Statement
Trans- Accts.
Cash Prepaid Accum. Wages Contr. Earned Net
+ Receiv- + - = + + Revenue - Expenses =
action Asset Rent Deprec. Payable Capital Capital Income
able
(1) + +769,200 + - = + + +769,200 +769,200 - = +769,200
(2) +46,200 + + - = + + +46,200 +46,200 - = +46,200
(3) + + - = +526,700 + + 526,700 - +526,700 = 526,700
(4) 149,100 + + +149,100 - = + + - =
(5) 521,600 + + - = 521,600 + + - =
(6) + + 117,900 - = + + 117,900 - +117,900 = 117,900
(7) +724,100 + 724,100 + - = + + - =
(8) 122,800 + + - = + + 122,800 - +122,800 = 122,800
(9) + + - +23,000 = + + -23,000 - +23,000 = -23,000
Total 23,200 + +45,100 + +31,200 - +23,000 = +5,100 + + +25,000 +815,400 - +790,400 = +25,000
b. Net income was $25,000 (from the net income column), and cash flow from
operating activities was $23,200 (from the cash column).
d. The accounting equation is kept with every entry, so it is kept for the totals over the
period.
This relationship can be presented in the following indirect method cash flow from
operating activities.
Net income $ 25,000
+ Depreciation expense 23,000
Change in accounts receivable 45,100
Change in prepaid rent 31,200
+ Change in wages payable +5,100
Cash flow from (used in) operating activities ($ 23,200)
Weber Company's 2013 operating activities provided $4,000 cash. The dividend paid to
shareholders affects cash flows from financing activities.
A + indicates that the amount is added and a - indicates that it is subtracted when
preparing the cash flow statement using the indirect method.
NORDSTROM, INC.
Consolidated Statement of Cash Flows Selected Items
1 Increase in accounts receivable Operating -
2 Capital expenditures Investing -
3 Proceeds from long-term borrowings Financing +
4 Increase in deferred income tax net liability Operating +
5 Principal payments on long-term borrowings Financing -
6 Increase in merchandise inventories Operating -
7 Decrease in prepaid expenses and other assets Operating +
8 Proceeds from issuances under stock compensation plans Financing +
9 Increase in accounts payable Operating +
10 Net earnings Operating +
11 Payments for repurchase of common stock Financing -
12 Increase in accrued salaries, wages and related benefits Operating +
13 Cash dividends paid Financing -
14 Depreciation and amortization expenses Operating +
To make the inventory account work properly, X (purchases) must equal $101,000. If
purchases were $101,000, then Y (payments to suppliers) must equal $105,000.
Howell Company received $814,000 in cash from its customers and paid $569,000
in cash to its suppliers.
c. None of the firms has sufficient cash flow to cover their current liabilities although
none of the ratios is of major concern. The industry ratios shown in Chapter 5 on
page 233 show that only Abbott Labs is below median. Pfizer is the largest of these
three companies and has relatively more cash left over after capital expenditures to
consider using on other activities that could strengthen the firms operating or
financial position. But all four have significant free cash flow that could be invested
or returned to shareholders in the form of dividends or stock repurchases. Given
that these firms are of different sizes and have different research program success,
it is difficult to generalize further.
c. All three companies are producing much more cash than needed for capital
expenditures. All of them are returning substantial amounts of cash to shareholders
through dividends and share repurchases (more than $11 billion for Wal-Mart,
almost $9 billion for Coca-Cola and more than $31 billion for ExxonMobil.
ExxonMobil appears to be in the best position with respect to OCFCL, but it is lower
than the industry average reported in Chapter 5 on page 233. Wal-Mart and Coca-
Cola have lower ratios, and are also below the average ratio for their industries.
MASON CORPORATION
Statement of Cash Flows
For Year Ended December 31, 2013
The basic approach here is to use the beginning and ending balances and the
additional information to reconstruct what must have happened during 2013. Begin by
setting up the T-accounts for property, plant and equipment with the beginning and
ending balances.
Property, plant and - - Accumulated
+ +
equipment at cost (A) depreciation (XA)
Beg. balance 1000 350 Beg. balance
At this point in the book, we know four entries that can affect these two accounts (1)
acquisitions using cash, (2) acquisitions without cash (other financing), (3) disposals,
and (4) depreciation expense. The journal entries for these entries are given below,
with amounts given in the problem filled in.
(1) Property, plant and equipment at cost (+A) 300
Cash (-A) 300
To record purchase of property, plant and equipment with cash.
The three unknowns in the journal entries correspond to the three questions in the
problem. We begin by putting the journal entry amounts into the T-accounts.
a. The PPE at cost account will only balance if the value X equals 200. So, the original
cost of the used equipment that was sold is 200. We can put that amount in the T-
account (so it balances) and also in Journal entry (3).
b. Now, looking at journal entry (3), we see that there is only one unknown left the
depreciation that had accumulated on the used equipment. In order for the entry to
balance (with debits equal to credits), the accumulated depreciation must have been
120 (= Y). Cost of 200 and accumulated depreciation of 120 would produce a net
book value of 80, so when Meubles Fischer sold it for 100, they recorded a gain of
20 on the disposal.
c. Back at the Accumulated depreciation T-account, we can fill in the entry for (3),
leaving only the depreciation expense to determine for entry (4). Knowing that the
disposal reduced the contra-asset by 120, and that the contra-asset increased by 40
over the year, we can infer than the depreciation expense must have been 160 (=
Z).
The basic approach here is to use the beginning and ending balances and the
additional information to reconstruct what must have happened during 2013. Begin by
setting up the T-accounts for property, plant and equipment with the beginning and
ending balances.
Property, plant and - - Accumulated
+ +
equipment at cost (A) depreciation (XA)
Beg. balance 175 78 Beg. balance
At this point in the course, we know four entries that can affect these two accounts (1)
acquisitions using cash, (2) acquisitions without cash (other financing), (3) disposals,
and (4) depreciation expense. The journal entries for these entries are given below,
with amounts given in the problem filled in.
(1) Property, plant and equipment at cost (+A) 28
Cash (-A) 28
To record purchase of property, plant and equipment with cash.
The three unknowns in the journal entries correspond to the three questions in the
problem. We begin by putting the journal entry amounts into the T-accounts.
Property, plant and - - Accumulated
+ +
equipment at cost (A) depreciation (XA)
Beg. balance 175 78 Beg. balance
(1) 28
(2) 0
(3) X Y (3)
17 (4)
Ending balance 183 83 Ending balance
a. The PPE at cost account will only balance if the value X equals 20. So, the original
cost of the used equipment that was sold is 20. We can put that amount in the T-
account (so it balances) and also in Journal entry (3).
b. The accumulated depreciation account will only balance if the value Y equals 12.
So, the accumulated depreciation on the used equipment sold must be 12, and that
amount can be entered into transaction (3) above.
c. Now, looking at journal entry (3), we see that there is only one unknown left the
amount of cash received from disposal of the used equipment. In order for the entry to
balance (with debits equal to credits), the cash amount must have been 3 million (= Z).
Cost of 20 and accumulated depreciation of 12 would produce a net book value of 8, so
when Kasznik Ltd. sold it for 3, they recorded a loss of 5 on the disposal.
Net income
Cash flow Change in Change in accounts
+ = + (COGS
(payments) inventory payable
expense)
666 225
X + = + -51,692
(=8,044-7,378) (=4,810-4,585)
The solution to this is that X = -$51,692 666 + 225 = -$52,133. So, the payments to
suppliers reduced cash by $52,133 million in fiscal year 2011.
b. The net property and equipment account increased by $342 million (=$11,526
11,184). Depreciation expense would have decreased this balance by $809 million in
fiscal year 2011, so the net investment must have been $1,151 million (=$342 + 809)
to result in the ending balance of $11,526 million.
c. With the beginning balance of $16,848 million in retained earnings, net earnings of
$2,714 would have increased retained earnings to $19,562 million. But the ending
balance in retained earnings is $18,877 million, so Walgreens must have paid $685
million in dividends (=$19,562 - $18,877).
b. The book value of the property and equipment sold was $17,433 (=$923,806
906,373), and the reported gain on sale of the property and equipment was $79,483.
Therefore, the cash proceeds must have been $96,916 (= $17,433 + 79,483), which is
the amount reported in Golden Enterprises cash flows from investing activities.
c.
Cash (+A) $ 96,916
Accumulated depreciation (-XA, +A) 906,373
Property and equipment, cost (-A) $ 923,806
Gain on sale of property and equipment
79,483
(+R, +SE)
HOSKINS CORPORATION
Statement of Cash Flows
Year ended December 31, 2013
Cash Flows from Operations:
Net income $ 700
Adjustments:
Add back Depreciation 350
Change in Accounts Receivable (900)
Change in Inventory (100)
Change in Prepaid Expenses 250
+ Change in Accounts Payable 400
+ Change in Income Taxes Payable (100)
Cash Flows from Operating Activities $ 600
a.
Sales $750,000
Accounts Receivable Increase (5,000)
= Cash Received from Customers $745,000
1. True ---
2. False $25
3. False $10
4. False $0
WOLFF COMPANY
Statement of Cash Flows
For Year Ended December 31, 2013
a.
Adjustments:
Gains
Subtract (add) 0
non-operating
gains (losses) +Losses
0
Add the
change in +change in +change in +change in
operating accounts wages income tax
liabilities payable payable payable
(operating +(-3,000) +3,000 +(-1,000)
financing)
b. Computing cash flows from operating activities using the direct method provides
additional detail about the specific cash flows that occurred during the period. For
example, the indirect method does not reveal that Wolff paid $463,000 for merchandise
during 2013, or $83,000 for wages. Because this detail is missing, the FASB requires
supplemental disclosure of two specific (and important) cash payments interest and
taxes if the indirect method is used.
a.
Adjustments:
Gains
Subtract (add) 25,000
non-operating
gains (losses) +Losses
0
Subtract the
change in change change change in
operating in accounts in prepaid
assets receivable inventory advertising
(operating -(-8,000) -(-6,000) -(-3,000)
investments)
Add the
change in +change in +change in +change in +change in
operating accounts wages interest income tax
liabilities payable payable payable payable
(operating +(-14,000) +0 +6,000 +0
financing)
b. Computing cash flows from operating activities using the direct method provides
additional detail about the specific cash flows that occurred during the period. For
example, the indirect method does not reveal that Arctic paid $542,000 for
merchandise during 2013, or $28,000 for advertising. Because this detail is missing,
the FASB requires supplemental disclosure of two specific (and important) cash
payments interest and taxes if the indirect method is used.
DAIR COMPANY
Statement of Cash Flows
For Year Ended December 31, 2013
a. Depreciation and amortization are a noncash expenses that are deducted in the
computation of net income. The depreciation and amortization add-back zeros these
expenses out of the income statement to focus on cash profitability. The positive
amount for depreciation and amortization does not mean that the company is
generating cash from depreciation and amortization, a common misconception. It is
merely an adjustment to remove these expenses from the computation of profit.
b. The adjustments must be interpreted relative to the amounts included in net income.
The $(73,670,000) adjustment for receivables means that Staples collected this much
less than it recognized as revenue. The adjustment for accrued expenses implies that
Staples paid $117,389,000 more than the expenses already recognized in net income.
c. Acquisition of property and equipment are less than the depreciation and amortization
recognized for the year. Unless the prices for property and equipment are falling, that
relationship implies that Staples may not be replacing its capacity. A growing company
will have capital expenditures that exceed the depreciation on its existing property and
equipment.
e. Although net cash decreased during the period, Staples presents a healthy cash flow
picture for the year. It generated almost $1.6 billion of operating cash flow. Most of this
amount was returned to lenders and shareholders, rather than being used to grow the
business. Staples returned over $900 million to shareholders in the form of dividends
and share repurchases, plus it reduced its net borrowings by about $500,000.
b.
RAINBOW COMPANY
Statement of Cash Flows
For Year Ended December 31, 2013
b.
RAINBOW COMPANY
Statement of Cash Flows (Direct Method)
For Year Ended December 31, 2013
Cash flows from operating activities
Cash received from customers $740,000
Cash received as dividends .. 15,000 $755,000
Cash paid for merchandise purchased .. 462,000
Cash paid for wages and other operating expenses 134,000
Cash paid for interest .. 12,000
Cash paid for income taxes 46,000 (654,000)
Net cash provided by operating activities .. 101,000
Cash flows from investing activities
Sale of investments .. 60,000
Purchase of land (90,000)
Improvements to building (95,000)
Sale of equipment .. 14,000
Net cash used by investing activities ... (111,000)
Cash flows from financing activities
Issuance of bonds payable . 30,000
Issuance of common stock . 24,000
Payment of dividends (50,000)
Net cash provided by financing activities 4,000
Net decrease in cash and cash equivalents .. (6,000)
Cash and cash equivalents at beginning of year . 25,000
Cash and cash equivalents at end of year . $ 19,000
c. (1) Reconciliation of net income to net cash flow from operating activities
Net income $ 90,000
Add (deduct) items to convert net income to cash basis
Depreciation 39,000
Patent amortization 7,000
Loss on sale of equipment 5,000
Gain on sale of investments (3,000)
Accounts receivable increase (10,000)
Inventory increase (26,000)
Prepaid expenses increase (4,000)
Accounts payable increase 4,000
Interest payable increase 1,000
Income tax payable decrease (2,000)
Net cash provided by operating activities $101,000
b. ($ millions)
- Cost of goods sold . ($64,431)
- Change in inventories .. +275
+ Change in accounts payable 2,515
- Cash paid for purchases of inventories ($61,641)
continued next page
Cambridge Business Publishers, 2014
4-32 Financial Accounting, 4th Edition
P4-54. concluded
c. ($ billions)
Property, plant and equipment, ending balance $7.8
- Purchases of property, plant and equipment (4.3)
+ Book value of PPE assets sold ... none
+ Depreciation of property, plant and equipment 1.6
Property, plant and equipment, beginning balance $5.1
a.
b. The following statement of cash flows from operations combines the effects of the
income tax asset and liability and combines the effects of the deferred tax asset and
liability. In addition, the effects of changes in current and noncurrent salary
continuation plan liabilities have been combined in the operating cash flow.
a. The positive adjustment of $314,872 thousand (say, $315 million) is caused by the
change in the amount that Groupon owes its merchants. When a customer
purchases, Groupon gets the cash quickly and then waits to pay the merchants
(recognizing the accrued merchant payable liability). If we add the fact that Groupon
is growing very quickly, it means that the accrued merchant payable grows over the
period. The adjustment reflects the fact that the merchant share of the amount
collected from customers is $315 million more than the amount that Groupon paid to
the merchants.
Will this continue into the future? Only if Groupon continues to grow and if its
payment terms to merchants remain unchanged. If Groupons growth went to zero,
then the accrued merchant payable would level out and the change would go to
zero. Likewise, if competitors forced Groupon to speed up its payments to
merchants, the accrued merchant payable liability would decrease, and the
companys ability to generate a positive cash flow from operations would be
impaired.
In the risk factors section of the SEC document, Groupon states Our operating cash
flow and results of operations could be adversely impacted if we change our
merchant payment terms or our revenue does not continue to grow.
b. While Groupon used $121 million in cash for investing activities, most of this was for
acquisitions of businesses and investments, rather than for capital expenditures
(only about $30 million). The OCFCX ratio was $129,511 $29,825 = 4.34.
Groupon appears to be growing more by acquisition than by organic growth.
c. Groupon used $353,550 thousand to repurchase its own common stock and another
$35,221 to redeem its own preferred stock, a total of about $389 million. This might
prompt a financial statement reader to look at the related party transactions section
of the companys filing with the SEC prior to its initial public offering. For example, in
December 2010 and January 2011, Groupon issued new preferred stock in
exchange for $942.2 million in cash. Of this amount, $132.4 million was retained in
the company. The remaining $809.8 million was used to redeem shares of common
and preferred stock, mostly from current and former board members and from
entities that they control.
In the use of proceeds section of the SEC document, Groupon states Based on our
current cash and cash equivalents, together with cash generated from operations,
we do not expect that we will utilize any of the net proceeds of this offering to fund
operationsduring the next twelve months.
The required debt to equity ratio allows for total liabilities to be up to $477 million. That is
$477 / ($125+$148) =1.747 < 1.75. This implies total short-term borrowing of $107 million
and an ending cash balance of $70 million.
LAMBERT CO.
Statement of Cash Flows (projected)
Cash from operations
Net income $ 18
Depreciation expense 120
Increase in accounts receivable . (40)
Decrease in inventory 20
Increase accounts payable .. 30
Decrease in income taxes payable . (10)
Cash provided by (used in) operations .. $ 138
Cash from investing
Acquisitions of property, plant and equipment (225)
Disposal proceeds .. 75
Cash provided by (used in) investing . (150)
Cash from financing
Issue long-term debt .. 80
Repay long-term debt .. (100)
Common stock issue .. 25
Shareholder dividends (30)
Increase (decrease) in short-term borrowing 57
Cash provided by (used in) financing .. 32
Net change in cash .. 20
Beginning cash balance . 50
Ending cash balance .. $ 70
a.
1 Accounts receivable (+A) 3,800
Sales revenue (+R,+SE) 3,800
2 Cash (+A) 3,500
Accounts receivable (-A) 3,500
3 Cost of goods sold (+E,-SE) 1,800
Inventory (-A) . 1,800
4 Inventory (+A) 1,200
Accounts payable (+L) .... 1,200
5 Accounts payable (-L) .. 1,100
Cash (-A) ... 1,100
6 Salaries and wages expense (+E,-SE) . 700
Salaries and wages payable (+L) . 700
7 Salaries and wages payable (-L) 730
Cash (-A) .... 730
8 Rent expense (+E,-SE). 200
Prepaid rent (-A) .. 200
9 Prepaid rent (+A) .. 600
Cash (-A) ... 600
10 Depreciation expense (+E,-SE) . 150
Accumulated depreciation (+XA,-A) . 150
11 Cash (+A) . 10
Accumulated depreciation (-XA,+A) 70
Fixtures and equipment (-A) 80
12 Fixtures and equipment (+A) .. 800
Cash (-A) .. 800
13 Interest expense (+E,-SE) .... 16
Cash (-A) .. 16
14 Bank loan payable (-L) ... 1,600
Cash (-A) .. 1,600
15 Cash (+A) .. 2,000
Long-term loan payable (+L) 2,000
b.
+ Cash (A) - - Accounts Payable (L) + - Common Stock (SE) +
600 3,000 4,600
2 3,500 5 1,100 1,200 4 4,600 Bal
1,100 5 3,100 Bal
730 7
600 9 - Retained Earnings (SE)+
11 10 - Salaries and Wages + 1,300
800 12 Payable (L) 17 80 560 18
16 13 100 1,780 Bal
1,600 14 7 730 700 6
15 2,000 70 Bal
80 17 - Revenue (R) +
Bal 1,184 3,800 1
- Taxes Payable (L) + 18 3,800
0 0 Bal
374 16
+ Accounts Rec. (A) - 374 Bal + Cost of Goods Sold (E) -
6,500 3 1,800
1 3,800 3,500 2 - Bank Loan Payable (L) + 1,800 18
Bal 6,800 1,600 Bal 0
14 1,600
0 Bal + Salaries & Wages (E) -
+ Inventory (A) - 6 700
2,400 - Long-term Loan (L) + 700 18
4 1,200 1,800 3 0 Bal 0
Bal 1,800 2,000 15
2,000 Bal
a. Depreciation and amortization are noncash expenses that are deducted in the
computation of net income. The depreciation and amortization add-back zeros these
expenses out of the income statement to focus on operating cash flow. The positive
amount for depreciation and amortization does not mean that the company is
generating cash from depreciation and amortization, a common misconception. It is
merely an adjustment to remove these expenses from net income to convert profit to
cash flow.
b. Gains on disposals of asset are the result of investing activity, not operating activity,
but these gains are recognized in net income. When we start with net income in an
indirect method cash from operations, subtracting the gain removes this investing item
from the determination of cash from operations.
Daimler reports cash proceeds from disposals of PPE and intangible assets of 252
million. If the recognized gain is 102 million, then the book value of the assets
disposed would be 150 million (= 252 million 102 million).
c. It does not. The adjustments can only be interpreted relative to the amounts that are
included in net income. The negative 2,328 million inventory adjustment means that
Daimlers cost to acquire inventory for the year exceeded its cost of goods sold for the
year by 2,328 million.
Daimlers operating cash flow is negative, as is its free cash flow. We did not include
acquisition of intangible assets in the calculation. Doing so would have reduced free
cash flow by another 1.7 billion. Daimler financed its investing activities by additions
to long-term financing.
e. Daimlers cash flow from operating activities is negative, as is its cash flow from
investing activities. It generated a positive cash flow of 5,842 million from financing
activities. As a result, the net decrease in cash was 1,327million. Daimler appears
to be strong enough to withstand a reduction in cash of this magnitude, especially
given that it has a record (in 2010 and 2009) of reporting very positive cash flows
from operations.
To be thorough in analyzing Daimlers liquidity and solvency, one would want to ask
why operating cash flows were negative. A closer look at the companys business
segments reveals that the Industrial Business had cash from operations of 7.3
billion and free cash flow of about 3.4 billion. Daimler Financial Services had cash
from operations of (8.0) billion, resulting from large increases in financial services
receivables and vehicles on operating leases. In its analysis of cash flows, Daimler
reports that The positive effect from the improvement in net profit before income
taxes was reduced in particular by increased new business in leasing and sales
financing as well as by significantly higher allocations to the pension funds.