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Understanding Financial Statements 11th Edition Fraser Ormiston Test Bank

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Chapter 4

True-False

1. The analyst of financial statements should consider cash flows over a period of
time, looking at patterns of performance and exploring underlying causes of
strength and weakness.

2. The statement of cash flows shows the changes in the balance sheet accounts
between periods.

3. Cash flow from operations represents the “cash” income from the company’s
business operations.

4. Cash from sales of property, plant and equipment is considered an operating


activity on the cash flow statement.

5. Proceeds from borrowing are a financing cash outflow.

6. Repurchase of a firm’s own shares is an investing cash outflow.

7. Cash outflows result from increases in asset accounts and decreases in liability
and equity accounts.

8. Analyzing the statement of cash flows helps determine the future external
financing needs of a business firm.
9. An analysis of the statement of cash flows should, at a minimum, cover the
following areas: analysis of cash inflows, analysis of cash outflows, and an
analysis of the structure of asset and liabilities.

10. The amounts on a cash flow statement cannot be manipulated.

Fill in the Blank

1. Cash flows are segregated on a statement of cash flows by


activities, activities, and activities.

2. A change in the retained earnings account is the result of the


for the period and the payment of .

3. Per FASB rules, firms may use the method or the


method to calculate and present cash flow from operating activities.

4. The is one way to common size the cash flow


statement.

For questions 5 through 10, insert the word “added” or “subtracted” in the blank.

5. An increase in inventory should be to convert net income to cash


flow from operating activities.

6. An increase in accounts payable should be to convert net


income to cash flow from operating activities.

7. A decrease in accrued liabilities should be to convert net


income to cash flow from operating activities.

8. A decrease in accounts receivable should be to convert net


income to cash flow from operating activities.

9. Depreciation and amortization should be to convert net income to


cash flow from operating activities.

10. A gain on sale of asset should be to convert net income to cash


flow from operating activities.
Multiple Choice

1. All of the following are reasons that the statement of cash flows is useful to the
analyst except:
a. The statement of cash flows shows how cash is generated during an
accounting period and how it has been used.
b. A positive net income figure on the income statement is ultimately
insignificant unless a company can translate its earnings into cash, and the
only source in financial statements for learning about cash generation is the
statement of cash flows.
c. The statement of cash flows shows the adjustments made to net income in
order to calculate cash flow from operations; those should be examined to
determine why cash flow from operations is negative or positive.
d. The statement of cash flows is the only financial statement that cannot be
manipulated.

2. How is the statement of cash flows connected to the balance sheet?


a. The statement of cash flows shows changes in the asset and liability
accounts to explain cash from operating activities.
b. The changes in all revenue and expense accounts are calculated and then
listed as cash inflows or outflows.
c. The changes in all of the balance sheet accounts are calculated and then
listed as inflows or outflows, except for cash.
d. Changes in asset accounts are recorded as operating activities, changes in
liability accounts are recorded as financing activities and changes in equity
accounts are recorded as investing activities.

3. The following item would be classified as an operating activity on the statement


of cash flows:
a. Payments for inventory.
b. Acquisitions of equipment.
c. Proceeds from borrowing.
d. Payments on loans.

4. The following item would be classified as an investing activity on the statement


of cash flows:
a. Proceeds from borrowing.
b. Sale of goods.
c. Sale of property.
d. Payment to lenders.
5. The following item would be classified as a financing activity on the statement
of cash flows:
a. Payments for inventory.
b. Payment of dividends.
c. Acquisition of land.
d. Sales of goods.

6. Which item is a noncash item that would be added to net income to convert it to
cash flow from operating activities?
a. Accounts receivable.
b. Depreciation.
c. Accounts payable.
d. Inventory.

Use the indirect method to answer questions 7-10. The following information is
available for Armstrong Company:

Net income $450 Increase in plant and equip. $170


Depreciation expense 80 Payment of dividends 10
Decrease in accts. receiv. 20 Increase in long-term debt 100
Increase in inventories 15 Decrease in accounts payable 30

7. What is cash flow from operating activities for Armstrong Company?


a. $505
b. $495
c. $335
d. $55

8. What is cash from investing activities for Armstrong Company?


a. ($160)
b. $160
c. $170
d. ($170)

9. What is cash from financing activities for Armstrong Company?


a. $70
b. $60
c. $90
d. ($110)
10. What is the change in cash for Armstrong Company?
a. $315
b. $565
c. $425
d. $215

Use the indirect method to answer questions 11-14. The following information is
available for Felix Company:

Net income $300 Decrease in plant and equip. $40


Depreciation expense 20 Increase in deferred tax asset 5
Gain on sale of assets 35 Decrease in long-term debt 50
Increase in inventories 25 Decrease in accounts payable 15

11. What is cash flow from operating activities for Felix Company?
a. $240
b. $70
c. $320
d. $250

12. What is cash from investing activities for Felix Company?


a. $5
b. $40
c. $75
d. $10

13. What is cash from financing activities for Felix Company?


a. $50
b. $65
c. ($50)
d. $60

14. What is the change in cash for Felix Company?


a. $310
b. $205
c. $330
d. $230

15. What is implied if the inventory account has increased?


a. Cash flow from financing activities has decreased relative to net income.
b. Cash flow from operating activities has increased relative to net income.
c. Cash flow from operating activities has decreased relative to net income.
d. Cash flow from financing activities has increased relative to net income.

16. Why are gains and losses from asset sales removed from net income when
calculating the cash flows from operating activities?
a. Selling assets is a noncash item.
b. Gains and losses from asset sales are a financing activity.
c. Gains and losses are not removed from net income when calculating the
cash flows from operating activities
d. The entire proceeds from sales of long-lived assets are included in
investing activities.
17. What is the preferred method to generate cash in a firm?
a. Operating activities.
b. Investing activities.
c. Financing activities.
d. Investing and financing activities.

18. Which item may be of concern when analyzing cash flow from financing
activities?
a. Increasing inventories.
b. Borrowing each year to repay debt from prior years.
c. Repayment of debt.
d. Payments of dividends.

19. Which of the following would increase cash from operating activities?
a. Increasing accounts receivable.
b. Increasing inventories.
c. Decreasing accounts payable.
d. Decreasing accounts receivable.

20. Which of the following items would be a way to manipulate the cash flow from
operating activities amount on the statement of cash flows?
a. Adding depreciation back to net income to determine cash flow from
operating activities.
b. Including interest expense and tax expense in the calculation of cash flow
from operating activities.
c. Recording an item that should be recorded as an operating activity as an
investing activity.
d. The cash flow statement cannot be manipulated.

Short Answer/Problem

1. What can be learned from a statement of cash flows?

2. Discuss the format of a statement of cash flows prepared using the indirect
method.

3. What are the three areas of a cash flow statement that an analyst should cover at
a minimum? Discuss each area by explaining items an analyst should be concerned
with when reviewing the cash flow statement.

4. Identify the following as operating (O), financing (F), or investing (I) activities:
a. Proceeds from borrowing
b. Purchases of property, plant and equipment
c. Cash from sale of a business segment
d. Interest payments to lenders
e. Cash from sales of goods and services
f. Payment of dividends
g. Payments for purchase of inventory
h. Payments for taxes
i. Repurchase of a firm’s own shares
j. Cash collections from loans to others

5. Indicate which of the following current asset and current liability accounts are
operating (O), investing (I), or financing (F) accounts.
a. Current portion of long-term debt
b. Accounts receivable
c. Prepaid expenses
d. Marketable securities
e. Accrued expenses
f. Notes payable to bank

6. Indicate whether each of the following items would result in net cash flow from
operating activities being higher (H) or lower (L) than net income.
a. Increase in inventory
b. Increase in accounts payable
c. Amortization expense
d. Decrease in accrued liabilities
e. Loss on sale of assets
f. Decrease in accounts receivable
g. Decrease in deferred tax assets
h. Increase in deferred revenue
i. Decrease in income taxes payable
j. Decrease in prepaid expenses

7. Jesse Corporation reported the following information for the current year:
(1) Net income is $205 million.
(2) Acquisitions were $32 million.
(3) Customer accounts receivable increased by $12 million.
(4) Dividends paid to common shareholders were $8 million.
(5) Depreciation expense was $41 million.
(6) Income tax payable decreased by $11 million.
(7) Long-term debt increased by $28 million.
(8) Accounts payable decreased by $6 million.
(9) Inventories increased by $17 million.

Required: Based on the above information, calculate the following items:

a. Cash flow from operating activities.


b. Cash flow from investing activities.
c. Cash flow from financing activities.
d. The increase or decrease in the cash balance.

8. N&M Corporation reported the following information for the current year:
(1) Net income is $560 million.
(2) Sales of assets $26 million.
(3) Customer accounts receivable decreased by $14 million.
(4) Repurchases of common stock were $20 million.
(5) Depreciation expense was $38 million.
(6) Income tax payable increased by $4 million.
(7) Long-term debt decreased by $13 million.
(8) Accounts payable increased by $9 million.
(9) Inventories increased by $24 million.

Required: Based on the above information, calculate the following items:

a. Cash flow from operating activities.


b. Cash flow from investing activities.
c. Cash flow from financing activities.
d. The increase or decrease in the cash balance.
9. Prepare the statement of cash flows for Franklin Company using the indirect
method.

Franklin Company
Income Statement
For the Year Ended December 31, 2015

Revenues $9,000
Depreciation expense $ 650
Other operating expenses 7,100 7,750
Income before income taxes $1,250
Interest expense 440
Income tax expense 270
Net income $ 540

Franklin Company
Balance Sheet
December 31, 2015 and 2014

2015 2014 2015 2014


Assets: Liab. & SE:
Cash $ 230 $ 480 A/P $ 370 $ 550
A/R 510 590 Inc.Taxes/Pay. 120 280
Inventories 980 960 LT debt 910 830
Plant & Equip. 3,140 2,150 Common Stock 1,100 1,350
Less: Acc. Depr. (1,520) (870) Retained Earnings 840 300
Total Assets $3,340 $3,310 Total Liab. & SE $3,340 $3,310
10. Prepare the statement of cash flows for Benji Company using the indirect
method.

Benji Company
Income Statement
For the Year Ended December 31, 2015

Revenues $8,200
Depreciation expense $ 400
Other operating expenses 6,800 7,200
Income before income taxes $1,000
Income tax expense 340
Net income $ 660

Benji Company
Balance Sheet
December 31, 2015 and 2014

2015 2014 2015 2014


Assets: Liab. & SE:
Cash $ 380 $ 120 A/P $ 770 $ 600
A/R 640 580 Inc.Taxes/Pay. 90 160
Inventories 950 840 LT debt 1,080 1,630
Plant & Equip. 2,870 2,990 Common Stock 1,000 1,000
Less: Acc. Depr. (1,120) (720) Retained Earnings 780 420
Total Assets $3,720 $3,810 Total Liab. & SE $3,720 $3,810
11. Using the excerpt from the Ralston Company statement of cash flows analyze
thoroughly the cash flow from operating activities. Be sure to offer possible
reasons for the changes identified.

Operating Activities 2015 2014


Net income $175,000 $137,000
Depreciation and amortization 28,500 23,200
Deferred income taxes 7,600 4,100
Equity in gains of investees 3,300 1,100
Increase (decrease) in cash resulting from changes in:
Accounts receivable (6,500) (66,700)
Inventories 35,600 (53,900)
Accounts payable and accrued expenses 43,400 (5,000)
Net cash provided (used) by operating activities $286,900 $(39,800)

12. Using the excerpt from the Animal World Company statement of cash flows
analyze thoroughly the cash flow from operating activities. Be sure to offer
possible reasons for the changes identified.

Operating Activities 2015 2014


Net income $(2,800) $(9,800)
Depreciation and amortization 21,800 21,700
Loss on disposal of property and equipment 11,000 3,100
Increase (decrease) in cash resulting from changes in:
Accounts receivable (10,100) (9,200)
Inventories (35,500) (56,500)
Accounts payable and accrued expenses 54,700 24,200
Net cash provided (used) by operating activities $39,100 $(26,500)
13. Using the summary analysis for eApparel, Inc. analyze the cash inflows and
cash outflows for 2015 and 2014.

Inflows (in percent of total) 2015 2014


Sales and maturities of marketable securities 20.1 22.9
Proceeds from issuance of common stock 54.5 23.5
Proceeds from long-term debt 25.4 53.6
Total Inflows 100.0 100.0
Outflows (in percent of total)
Operations 18.4 22.4
Purchases of marketable securities 19.8 21.7
Purchases of fixed assets 26.5 23.1
Repayment of long-term debt 35.3 32.8
Total Outflows 100.0 100.0
14. Use the following statement of cash flows for Star Pharmaceuticals to:
a. prepare a summary analysis of the statement of cash flows,
b. analyze cash flow from operating activities, and
c. analyze the cash inflows and cash outflows.

Star Pharmaceuticals
Statement of Cash Flows
For the Years Ended December 31, 2015 and 2014

(in millions) 2015 2014


Cash flows from operating activities (CFO):
Net income $5,800 $3,300
Adjustments to reconcile net income to CFO:
Depreciation and amortization 550 360
Deferred income taxes 10 (580)
Stock-based compensation 590 170
(Increase) decrease in operating assets and liabilities:
Accounts receivable (490) (380)
Inventories (6,900) (1,960)
Other current assets 410 (480)
Accounts payable 700 690
Income taxes payable 250 140
Accrued liabilities 170 (290)
Net CFO 1,090 970
Cash flows from investing activities:
Purchases of property and equipment (740) (750)
Acquisitions 0 (350)
Net cash used by investing activities (740) (1,100)
Cash flows from financing activities:
Proceeds from common stock sales 2,000 580
Repayment of short-term line of credit 0 (140)
Repayment of long-term debt (70) (70)
Net cash provided by financing activities 1,930 370
Net increase in cash 2,280 240
Beginning cash balance 980 740
Ending cash balance $3,260 $980
15. Using the statements of cash flows for JAJ Enterprises:
a. prepare a summary analysis of the statement of cash flows,
b. analyze cash flow from operating activities, and
c. analyze the cash inflows and cash outflows.

JAJ Enterprises
Statement of Cash Flows
For the Years Ended December 31, 2015 and 2014

(in thousands) 2015 2014


Cash flows from operating activities (CFO):
Net income $8,100 $6,800
Adjustments to reconcile net income to CFO:
Depreciation and amortization 3,100 1,600
Deferred income taxes 900 700
Other non-cash items (600) (700)
(Increase) decrease in operating assets and liabilities:
Accounts receivable (7,800) (2,300)
Inventories (2,100) 1,700
Other current assets (900) 2,000
Accounts payable (1,300) 4,100
Income taxes payable 400 (800)
Accrued liabilities 1,700 700
Net CFO 1,500 13,800
Cash flows from investing activities:
Purchases of property and equipment (800) (1,200)
Net cash used by investing activities (800) (1,200)
Cash flows from financing activities:
Proceeds from common stock sales 4,700 4,600
Proceeds (repayments) of short-term debt 100 (1,100)
Repayment of long-term debt (200) (3,300)
Net cash provided by financing activities 4,600 200
Net increase in cash 5,300 12,800
Beginning cash balance 30,600 17,800
Ending cash balance $35,900 $30,600
Solutions - Chapter 4

True-False

1. T 6. F
2. T 7. T
3. T 8. T
4. F 9. F
5. F 10. F

Fill in the Blank

1. operating, investing, financing


2. net income, dividends
3. direct, indirect
4. summary analysis
5. subtracted
6. added
7. subtracted
8. added
9. added
10. subtracted

Multiple Choice

1. d 6. b 11. a 16. d
2. c 7. a 12. b 17. a
3. a 8. d 13. c 18. b
4. c 9. c 14. d 19. d
5. b 10. c 15. c 20. c

Short Answer/Problem

1. The statement of cash flows shows how cash has been generated during a year
or a quarter, and how it has been used. The statement of cash flows is an important
analytical tool for creditors, investors, and other users of financial statement data
that helps determine the following about a business firm:
• Its ability to generate cash flows in the future
• Its capacity to meet obligations for cash
• Its future external financing needs
• Its success in productively managing investing activities
• Its effectiveness in implementing financing and investing strategies

2. Regardless of format used the statement of cash flows shows changes over time
rather than the absolute dollar amount of the accounts at a point in time. Because
a balance sheet balances, the changes in all of the balance sheet accounts balance,
and the changes that reflect cash inflows less the changes that result from cash
outflows will equal the changes in the cash account. The statement of cash flows
is prepared in exactly that way: by calculating the changes in all of the balance
sheet accounts, including cash; then listing the changes in all of the accounts
except cash as inflows or outflows; and categorizing the flows by operating,
financing, or investing activities. The inflows less the outflows balance to and
explain the change in cash. FASB allows firms to calculate cash from operating
activities using either the direct or the indirect format. The indirect method starts
with net income and adjusts for deferrals; accruals; noncash items, such as
depreciation and amortization; and nonoperating items, such as gains and losses
on asset sales. The net income number is converted from an accrual-based amount
to a cash-basis amount called cash from operating activities.

3. An analysis of the statement of cash flows should, at a minimum, cover the


analysis of cash flow from operating activities, analysis of cash inflows and
analysis of cash outflows. When analyzing the cash flow from operating
activities, the analyst should be concerned with the success or failure of the firm
in generating cash from operations, the underlying causes of the positive or
negative operating cash flow, the magnitude of positive or negative operating
cash flow and the fluctuations in cash flow from operations over time.
Analyzing cash inflows is important to determine if the firm is generating cash
from operations, the preferred method, or if the firm must rely on external
sources. Using external sources to generate the majority of cash year after year
should be investigated further. When analyzing the cash outflows, the analyst
should consider the necessity of the outflow and how the outflow was financed.

4. a. F f. F
b. I g. O
c. I h. O
d. O i. F
e. O j. I
5. a. F d. I
b. O e. O
c. O f. F

6. a. L f. H
b. H g. H
c. H h. H
d. L i. L
e. H j. H

7. a. Net income $205 million


Increased A/R (12)
Depreciation 41
Decreased tax payable (11)
Decreased A/P (6)
Increased inventories (17)
$200 million

b. Acquisitions ($32) million

c. Dividends paid ($8) million


Increase of long-term debt 28
$20 million

d. $200 + (32) + 20 = $188 million

8. a. Net income $560 million


Decreased A/R 14
Depreciation 38
Increased tax payable 4
Increased A/P 9
Increased inventories (24)
$601 million

b. Sales of assets $26 million

c. Repurchases of common stock ($20) million


Decrease of long-term debt ($13)
($33) million
d. $601 + 26 - 33 = $594 million

9.
Franklin Company
Statement of Cash Flows
For the Year Ended December 31, 2015

Net income $540


Adjustments to reconcile net income
to net cash provided by (used for)
operating activities:
Depreciation 650
Changes in assets and liabilities:
Accounts receivable 80
Inventory (20)
Accounts payable (180)
Income taxes payable (160)
Net cash provided by operating activities $910
Cash flows from investing activities:
Capital expenditures (990)
Net cash used by investing activities ($990)
Cash flows from financing activities:
Proceeds from long-term debt 80
Repurchase of common stock (250)
Net cash used by financing activities ($170)
Net increase (decrease) in cash ($250)
Cash at beginning of period 480
Cash at end of period $230
10.
Benji Company
Statement of Cash Flows
For the Year Ended December 31, 2015

Net income $660


Adjustments to reconcile net income
to net cash provided by (used for)
operating activities:
Depreciation 400
Changes in assets and liabilities:
Accounts receivable (60)
Inventory (110)
Accounts payable 170
Income taxes payable (70)
Net cash provided by operating activities $990
Cash flows from investing activities:
Sales of plant and equipment 120
Net cash provided by investing activities $120
Cash flows from financing activities:
Repayment of long-term debt (550)
Dividends paid (300)
Net cash used by financing activities ($850)
Net increase (decrease) in cash $260
Cash at beginning of period 120
Cash at end of period $380

11. Ralston Company generated negative cash flows from operations (CFO)
despite a positive net income in 2014. In 2015 the firm was able to increase its net
income from 2014 and cash from operations increased to a positive amount greater
than net income for the year. Accounts receivable increased both years but
especially in 2014, causing CFO to be lower. Inventories increased significantly in
2014, but declined in 2015. Accounts payable and accrued expenses were paid
down in 2014, but increased significantly in 2015 which contributed to the larger
CFO. The large increases in accounts receivable and inventory in 2014 combined
with increased net income, a smaller increase in accounts receivable and a large
decrease in inventories suggest the firm may be expanding.
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