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Statement of
Cash Flows
1. Explain the need for the
statement of cash flows.
2. Identify the three types of
business activities presented
in a statement of cash flows.
Marc Ravira started Ravira
Restaurant Supply more than
10 years ago in a Chicago suburb.
His company (whose shareholders include Marc, members of his
family, and a small number of other investors) sells glassware, pots
and pans, restaurant equipment, and other miscellaneous items. In
all, the company sells more than 5,000 products. Ravira’s sales have
increased each year, and Marc was especially proud of the 25 percent increase in 2014. But he was extremely dismayed when he met
with his accountant, who advised him to secure a line of credit since
the company’s cash balance was alarmingly low. “What’s up with
this?” Marc wondered.“Sales are great, we’re buying from the same
suppliers and they haven’t increased costs substantially. I can’t imagine why we have a cash problem!”
To understand the impact of business activity on cash flows,
which is essential for good management, Marc needs to understand
the statement of cash flows. And providing an understanding of this
statement is the goal of this chapter. We will start by discussing the
need for the statement of cash flows and its primary components.
Then we will consider the two methods used to prepare the statement: the direct method and the indirect method. Finally, we will discuss how to interpret information in the statement. Armed with this
information, Marc Ravira would have had a solid understanding of
why his cash balance decreased.
3. Prepare a statement of cash
flows using the direct
method.
4. Prepare a statement of cash
flows using the indirect
method.
5. Interpret information in the
statement of cash flows.
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LEARNING
OBJECTIVE 1
Explain the need for
the statement of
cash flows.
LEARNING
OBJECTIVE 2
Identify the three
types of business
activities presented
in a statement of
cash flows.
Illustration 13-1
Financial statements
for Ravira Restaurant
Supply, Inc.
NEED FOR A STATEMENT OF CASH FLOWS
Company stakeholders (managers, employees, suppliers, creditors, and stockholders) all
want to know how the company generates and spends cash. Their focus on cash is relatively obvious—managers, employees, and suppliers want assurance that the company can
generate enough cash to pay wages and bills and make debt payments. And stockholders want to know that the company can generate cash consistent with earning a reasonable return on their investments in the company and perhaps pay cash dividends. They
also want to know that the company can generate enough cash to avoid bankruptcy. This
understanding isn’t possible unless the stakeholders understand how a company generates and spends cash.
You might think that this information could be obtained from the income statement. However, under generally accepted accounting principles, income is calculated
using the accrual method rather than on a cash basis showing cash inflows and outflows.
Thus, the income statement does little to inform managers and other company stakeholders as to the sources and uses of cash. Consider the purchase of equipment costing
$1,000,000 that has a five-year life. If the company uses straight-line depreciation, income
will be reduced by $200,000 in the first year. However, assuming the equipment is not
financed, cash will be reduced by $1,000,000. To provide company managers and other
stakeholders with information on the sources and uses of cash, companies prepare the
statement of cash flows. For purposes of this statement, cash includes both cash and cash
equivalents. Cash equivalents are short-term investments that are highly liquid and can
be readily converted into cash. Examples include 90-day U.S. Treasury Bills and money
market funds.
TYPES OF BUSINESS ACTIVITIES AND THE
CLASSIFICATION OF CASH FLOWS
Illustration 13-1 presents a complete set of financial statements for Ravira Restaurant Supply,
including an income statement for 2014, comparative balance sheets for 2013 and 2014, and
a statement of cash flows for 2014.We will be referring to these statements a number of times
in the following discussion. For now, let’s focus on the statement of cash flows. Note that the
cash flows are classified under three types of business activities: operating activities, investing activities, and financing activities.
Ravira Restaurant Supply, Inc.
Income Statement
For the Year Ended December 31, 2014
Sales
Cost of merchandise sold
Gross profit
Operating expenses:
Insurance
Wages and salaries
Depreciation
Loss on sale of equipment
Income from operations
Other income and expense:
Interest expense
Income before taxes
Income taxes
Net income
$10,548,640
7,911,480
2,637,160
$ 25,685
428,650
108,230
2,000
564,565
2,072,595
10,450
2,062,145
721,751
$ 1,340,394
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Types of Business Activities and the Classification of Cash Flows 503
Ravira Restaurant Supply, Inc.
Balance Sheets
As of December 31
Illustration 13-1
(continued)
Assets:
Current assets:
Cash and cash equivalents
Receivables
Merchandise inventories
Prepaid insurance
Total current assets
Property, building, and equipment
Less accumulated depreciation
Total assets
2014
2013
$ 15,435
1,422,868
1,364,448
14,000
2,816,751
1,058,485
(419,376)
$3,455,860
$
80,568
879,053
988,935
15,000
1,963,556
1,050,485
(315,146)
$2,698,895
$ 659,290
38,979
143,758
842,027
100,000
942,027
$ 575,000
34,272
126,548
735,820
125,000
860,820
1,500,000
1,013,833
2,513,833
$3,455,860
1,500,000
338,075
1,838,075
$2,698,895
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable
Accrued salaries and wages
Income taxes payable
Total current liabilities
Long-term debt
Total liabilities
Stockholders’ equity:
Common stock
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
Ravira Restaurant Supply, Inc.
Statement of Cash Flows—Direct Method
For the Year Ended December 31, 2014
Operating Activities
Cash receipts from customers
Cash payments for inventory
Cash payments for prepaid insurance
Cash payments for wages and salaries
Cash payments for interest expense
Cash payments for income taxes
Net cash provided by operating activities
$10,004,825
(8,202,703)
(24,685)
(423,943)
(10,450)
(704,541)
638,503
(1)
(2)
(3)
(4)
(5)
(6)
1,000
(15,000)
(14,000)
(7)
(8)
(25,000)
(664,636)
(689,636)
(65,133)
80,568
15,435
(9)
(10)
Investing Activities
Proceeds from sale of equipment
Purchase of equipment
Net cash used in investing activities
Financing Activities
Reduce long-term debt
Dividends paid
Net cash used in financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at start of year
Cash and cash equivalents at end of year
$
Note: Numbers (1) to (10) relate to calculations presented in the section on the direct method.
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Operating Activities
The first classification in the statement of cash flows is operating activities, which covers
cash flows related to the production and delivery of goods and services by businesses.In other
words, operating activities reflect the day-to-day profit-oriented activities of a business.
Financial statement users focus a great deal of attention on cash flows related to operating
activities because, over the long run, a business must generate positive cash flows from its
profit-oriented activities to be economically viable. The principal cash inflows from operating activities are cash receipts from customers from both cash sales and collections of
accounts receivable, such as when Ravira Restaurant Supply is paid by customers. It is also
the case that cash received from interest and dividends are classified as operating cash
inflows. This is consistent with reporting requirements of the Financial Accounting Standards
Board (FASB) but is somewhat confusing since it might seem more appropriate to classify these
cash inflows under investing activities.
Major sources of cash outflows from operating activities include payments to suppliers (such as when Ravira Restaurant Supply pays the companies from which it purchases glassware), payments to employees, and payments to taxing authorities.
Investing Activities
The second classification in the statement of cash flows is investing activities, which covers cash flows related to the buying and selling of long-term assets. Examples of investing
activities include collections from long-term loans, collections from the sale of equipment no
longer in use, payments to buy debt or equity securities in other companies when these
investments are not short term, buying equipment, buying a building, and buying a business.
If Ravira Restaurant Supply paid cash related to the purchase of a new computer system, this
would be classified under investing activities.
Financing Activities
The third and final classification in the statement of cash flows is financing activities, which
are cash flows related to issuing and repurchasing stock, issuing long-term debt, paying off
loans to debt holders, and making dividend payments to investors.If Ravira Restaurant Supply
obtained a long-term bank loan, the cash proceeds would be listed as cash inflows under
financing activities. And if it paid cash for dividends to investors, this would be classified as
a cash outflow under financing activities.
Illustration 13-2 presents examples of activities and how they would be classified with
respect to operating, investing, and financing activities in the statement of cash flows.
LEARNING
OBJECTIVE 3
Prepare a statement of
cash flows using the
direct method.
THE STATEMENT OF CASH FLOWS PREPARED
USING THE DIRECT METHOD
There are two acceptable methods of preparing a statement of cash flows: the direct method
and the indirect method. The difference between the two methods reflects the way in which net
cash flow from operating activities is reported. Both methods report the same total operating
cash flows and the same investing and financing cash flow amounts.
The format of a statement of cash flows prepared using the direct method is much
like an income statement prepared on the cash-flow basis in that it lists specific cash inflows
and outflows from operating activities. For example, receipts from customers, payments to
suppliers, and payments to employees are typical line items reported on a statement of cash
flows using the direct method.When the direct method is used, the FASB requires a separate
schedule reconciling cash flows from operating activities and net income.As you will see later,
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The Statement of Cash Flows Prepared Using the Direct Method 505
Illustration 13-2
Examples of cash flows
related to operating,
investing, and financing
activities
Operating Activities
Cash collected on sale of merchandise
Cash received (paid) related to interest income (expense)
Cash received related to dividend income
Cash paid to purchase merchandise
Cash paid for selling and administrative expenses
Cash paid for income taxes
Investing Activities
Cash received on the sale of a machine no longer in use
Cash paid to buy a machine
Cash paid to buy a building
Cash received from selling a building
Cash paid to buy a business
Financing Activities
Cash received from selling bonds
Cash received from using a line of credit
Cash received from issuing common stock
Cash paid to retire long-term debt
Cash dividends paid
the indirect method reconciles net income to cash flow from operations right in the cashflow statement.Thus, more than 90 percent of companies use the indirect method. Illustration
13-1 above shows Ravira Restaurant Supply’s statement of cash flows prepared using the
direct method. Note that the general format is as follows:
Cash flows from operating activities
Cash flows from investing activities
Cash flows from financing activities
Total cash flows for period
Beginning cash balance
Ending cash balance
$638,503
(14,000)
(689,636)
(65,133)
80,568
$ 15,435
That is, we start with cash flows from operating activities. To this we add cash flows
from investing and financing activities to obtain total cash flows for the period. By
adding total cash flows for the period to the beginning cash balance, we obtain the ending cash balance.
To determine cash flows using the direct method, we analyze all balance sheet
accounts, other than cash, to determine how their changes were affected by cash flows.
This analysis will also involve information from the income statement. As an example, we
will show how the statement of cash flows for Ravira Restaurant Supply was prepared
(Illustration 13-1).We will begin our analysis by examining the changes in the current asset
and current liability accounts on the balance sheet.These changes generally relate to cash
flows from operating activities. Then we will examine the changes in long-term asset
accounts, which relate to investing activities. Finally, we will examine changes in long-term
liabilities and stockholders’ equity, which relate to financing activities.
Current Asset and Current Liability Accounts. The first item in the income statement
is sales, and corresponding to this in the statement of cash flows is cash receipts from customers. To determine this cash flow, we will analyze the change in accounts receivable.
The beginning balance is $879,053. We know from the income statement that sales are
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$10,548,640.The ending balance in receivables is $1,422,868. Since the beginning balance
plus sales minus cash collected equals the ending balance in receivables, we can use that
relationship to solve for cash collected from customers as follows:
Beginning balance receivables
Plus sales
Less cash collected
Equals ending balance receivables
$ 879,053
10,548,640
?
$ 1,422,868
Solving for the unknown yields cash receipts from customers of $10,004,825.1
(1)
The next item on the income statement is cost of merchandise sold. Corresponding to
this on the statement of cash flows is cash payments for inventory.To calculate this amount,
we will first have to analyze this account to determine how much inventory was purchased.
Then we will use that information in conjunction with the beginning and ending balance in
accounts payable to determine how much cash was paid to purchase inventory:2
Beginning balance inventory
Plus purchases
Less cost of goods sold
Equals ending balance inventory
$ 988,935
?
7,911,480
$1,364,448
Solving for the unknown yields cash purchases of $8,286,993. This number will be used in
the next calculation:
Beginning balance accounts payable
Plus purchases
Less cost paid for inventory purchases
Equals ending balance accounts payable
$ 575,000
8,286,993
?
$ 659,290
Solving for the unknown yields cash payments for purchases of inventory of $8,202,703.
Let’s turn next to prepaid insurance:
Beginning balance prepaid insurance
Plus cash payments for insurance
Less insurance expense
Equals ending balance prepaid insurance
$15,000
?
25,685
$14,000
Solving for the unknown indicates that cash payments for insurance are $24,685.
The next account we will analyze is accrued wages and salaries:
Beginning balance accrued wages and salaries
Plus wages and salary expense
Less cash payments for wages and salaries
Equals ending balance accrued wages and salaries
(2)
(3)
$ 34,272
428,650
?
$ 38,979
1
Here we are making the simplifying assumption that all sales are on account or, alternatively, there are no
cash sales.
2
Note that we make the simplifying assumption that all accounts payable relate to inventory purchases.
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The Statement of Cash Flows Prepared Using the Direct Method 507
Solving for the unknown indicates that Ravira Restaurant Supply paid $423,943 for wages and
salaries.
(4)
Notice that the balance sheet did not show accrued interest payable, yet the income
statement showed interest expense of $10,450. Since there is no accrued liability, we can conclude that cash payments for interest must have been $10,450, the same amount on the
income statement.
(5)
Recall that earlier we noted that interest payments are presented in the section for operating activities.
The next current liability account is income taxes payable:
Beginning balance income taxes payable
Plus income tax expense
Less cash payments for income taxes
Equals ending balance income taxes payable
$126,548
721,751
?
$143,758
Solving for the unknown indicates that Ravira Restaurant Supply paid $704,541 for income
taxes.
(6)
Long-Term Asset Accounts. We have now analyzed the change in every current asset and
current liability account other than cash. Thus, we can turn our attention to long-term asset
accounts.
The first account we will analyze is property, building, and equipment.We want to determine the cash flows related to buying equipment and selling equipment. To do this, we will
also need to analyze accumulated depreciation.
Note that the income statement indicates that there was a loss on the sale of equipment. Let’s determine the cash flow associated with this sale:
Beginning balance accumulated depreciation
Plus depreciation expense
Less accumulated depreciation related to sale
Equals ending balance accumulated depreciation
$315,146
108,230
?
$419,376
Solving for the unknown indicates that the accumulated depreciation related to the equipment sold was $4,000. Let’s assume that the original cost of the equipment sold was $7,000.
This amount would have to be determined from the company’s financial records since it is
not indicated in the financial statements in Illustration 13-1. We use this information in the
following calculation:
Cash proceeds related to sale of equipment
Less book value of equipment sold
Cost of $7,000 minus accumulated depreciation of $4,000
Equals loss on sale
?
$3,000
($2,000)
Solving for the unknown indicates that Ravira Restaurant Supply received $1,000 for the
equipment.
(7)
Now let’s solve for the amount of equipment purchased:
Beginning balance property, building, and equipment
Plus purchase of equipment
Less cost of equipment sold
Equals ending balance property, building, and equipment
$1,050,485
?
7,000
$1,058,485
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Solving for the unknown indicates that Ravira Restaurant Supply purchased $15,000 of
equipment.
(8)
Note that this is indicated in the investment section of the statement of cash flows.
Long-Term Liabilities and Stockholders’ Equity. Now that we have analyzed Ravira
Restaurant Supply’s long-term asset accounts, we can turn our attention to long-term liabilities and stockholders’ equity.
Let’s start with long-term debt:
Beginning balance long-term debt
Less cash paid to reduce debt
Equals ending balance long-term debt
$125,000
?
$100,000
Solving for the unknown indicates that Ravira Restaurant Supply paid $25,000 to reduce
debt.
(9)
This is indicated in the financing activities section of the statement of cash flows.
The balance sheet indicates no changes for common stock. Thus, our next account to
analyze is retained earnings:
Beginning balance retained earnings
Plus net income
Less cash payments for dividends
Equals ending balance retained earnings
$ 338,075
1,340,394
?
$1,013,833
Solving for the unknown indicates that Ravira Restaurant Supply paid $664,636 for cash
dividends.
(10)
We know the dividends were paid in cash because there is no beginning or ending
balance for dividends payable.
Note that we have now analyzed every balance sheet account except cash and that
the net increase in cash in the statement of cash flows presented in Illustration 13-1
accounts for the change in that account. We have also used information from the income
statement to help us determine the implications of the changes in the balance sheet
accounts for cash flows.
LEARNING
OBJECTIVE 4
Prepare a statement of
cash flows using the
indirect method.
PREPARING THE STATEMENT OF CASH FLOWS
USING THE INDIRECT METHOD
As noted earlier, there are two ways to prepare the statement of cash flows: the direct
method and the much more common indirect method. Statements prepared using these two
methods differ only in terms of the presentation of cash flows related to operating activities,
although the total cash flow is the same. There are no differences for investing activities and
financing activities.
To calculate cash flows from operating activities under the indirect method, we will take
a five-step approach:
Five-Step Approach to Calculating Cash Flows from
Operating Activities under the Indirect Method
Step 1. Start with net income.
Step 2. Add noncash expenses, such as depreciation and amortization, that are
included in net income.
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Preparing the Statement of Cash Flows Using the Indirect Method 509
Step 3. Subtract gains and add back losses that are included in net income.
Step 4. Subtract (add) increases (decreases) in current assets other than cash.
Step 5. Add (subtract) increases (decreases) in current liabilities.
Essentially, the section on cash flows from operating activities under the indirect method
is a reconciliation of net income to cash flows from operating activities. Thus, we start
with net income (Step 1). However, net income includes expenses such as depreciation
and amortization that don’t require a cash outlay. These items must be added back to
reconcile net income to cash flows from operating activities (Step 2). Gains (losses) on
sales of assets must also be subtracted (added back) since they do not reflect the cash
flows related to the asset sales (Step 3). Finally, we have to make adjustments for changes
in current asset balances other than cash (Step 4) and for changes in current liabilities
(Step 5). Specifically, we decrease income for increases in current assets and we increase
income for decreases in current assets. With respect to current liabilities, we increase
income for increases in current liabilities and we decrease income for decreases in current liabilities.
Current assets:
Increases in current assets indicate we must reduce income to convert to cash basis
Decreases in current assets indicate we must increase income to convert to cash
basis
Current liabilities:
Increases in current liabilities indicate we must increase income to convert to cash
basis
Decreases in current liabilities indicate we must reduce income to convert to cash
basis
Let’s see why this is the case for one current asset account (accounts receivable) and one current liability account (accrued salary and wages).
The beginning balance in accounts receivable plus sales minus cash collections equals
the ending balance in accounts receivable. For Ravira Restaurant Supply, these values are:
Beginning balance accounts receivable
Plus sales
Less cash collections from customers
Equals ending balance accounts receivable
$
879,053
10,548,640
10,004,825
$ 1,422,868
According to the discussion above, we must reduce net income by the increase in accounts
receivable.The validity of this can be seen by exploring the relationship underlying accounts
receivable for cash collections:
Beginning balance + Sales - Cash collections = Ending balance
Rearranging terms, we have:
Beginning balance - Ending balance + Sales = Cash collections
$879,053 - $1,422,868 + $10,548,640 = $10,004,825
Note that the left side of the equation is now sales less the increase in accounts receivable.
Sales is obviously a positive component of net income. Thus, we have to reduce net income
by the increase in accounts receivable to adjust income to the cash basis.
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Now we will examine accrued salary and wages:
Beginning balance accrued salary and wages
Plus wage and salary expense
Less cash payments for wages and salary
Equals ending balance accrued salary and wages
$ 34,272
428,650
423,943
$ 38,979
This is equivalent to the following equation:
Beginning balance + Salary and wage expense - Cash payments = Ending balance
Rearranging terms, we have:
Beginning balance - Ending balance + Salary and wage expense = Cash payments
($34,272 - $38,979) + $428,650 = $423,943
The equation shows we must reduce the expense account of salary and wages by the increase
in the current liability account, accrued salary and wages. But since expenses reduce net
income, a reduction in the expense implies an increase to net income. Thus, we can see that
increases in current liabilities mean we must increase income to convert to a cash basis.
Statement of Cash Flows for Ravira Restaurant
Supply—Indirect Method
Now let’s examine the statement of cash flows for Ravira Restaurant Supply (Illustration 13-3)
to see how it is prepared using the indirect method.We’ll focus just on the five-step approach
to the section on cash flows from operating activities since this is the only section that differs
between the indirect and the direct method. Note that the sections on investing and financing activities in Illustration 13-3 (indirect method) are the same as those sections in Illustration
13-1 (direct method).
Step 1. We start with net income, which is $1,340,394 for Ravira Restaurant Supply.
Step 2. We add back depreciation of $108,230 since it is a noncash expense.
(1)
Step 3. We add back the $2,000 loss on the sale of equipment.
(2)
Note that the cash inflow from this sale ($1,000) is shown in the section on investing
activities.
Step 4. After adjusting for noncash items, we make adjustments to net income for
changes in current assets other than cash. Specifically, we subtract (add)
increases (decreases) in current assets other than cash as follows:
Current Assets Other
Than Cash
Receivables
Inventory
Prepaid insurance
2014
2013
$1,422,868
1,364,448
14,000
$879,053
988,935
15,000
$543,815
375,513
(1,000)
increase
increase
decrease
(3)
(4)
(5)
Step 5. Finally, we add (subtract) increases (decreases) in current liabilities, as follows:
Current Liabilities
Accounts payable
Accrued wages
and salaries
Income taxes
payable
2014
2013
$659,290
$575,000
$84,290
increase
(6)
38,979
34,272
4,707
increase
(7)
143,758
126,548
17,210
increase
(8)
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Preparing the Statement of Cash Flows Using the Indirect Method 511
Illustration 13-3
Statement of cash flows for
Ravira Restaurant Supply
using the indirect method
Ravira Restaurant Supply, Inc.
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2014
Operating Activities
Net income
Adjustments of net income to cash basis:
Depreciation
Loss on sale of equipment
Increase in receivables
Increase in merchandise inventory
Decrease in prepaid insurance
Increase in accounts payable
Increase in accrued salaries and wages
Increase in income taxes payable
Net cash provided by operating activities
$1,340,394
108,230
2,000
(543,815)
(375,513)
1,000
84,290
4,707
17,210
638,503
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Investing Activities
Proceeds from sale of equipment
Purchase of equipment
Net cash used in investing activities
1,000
(15,000)
(14,000)
Financing Activities
Reduce long-term debt
Dividends paid
Net cash used in financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at start of year
Cash and cash equivalents at end of year
(25,000)
(664,636)
(689,636)
(65,133)
80,568
$ 15,435
After these adjustments, net cash flow from operating activities is equal to $638,503, which
is the same amount we saw in the statement of cash flows prepared using the direct method
(Illustration 13-1).
As already discussed, there are no differences between the direct and indirect method
for investing and financing activities. These sections will be prepared just as we did when
we used the direct method. Namely, we will analyze the noncurrent asset and liability
accounts in connection with income statement information to determine the cash flows in
these two areas.
TEST YOUR KNOWLEDGE
Using the indirect method, changes in current assets other than cash and current liabilities are used to adjust net income to determine:
a. Income from operations.
b. Net cash from investing activities.
c. Net cash provided by operating activities.
d. None of these answer choices is correct.
Correct answer is c.
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LINK TO P R A C T I C E
Spotting a Cash Cow
A business that generates a steady stream of cash without requiring substantial investments is known as a cash
cow. Such businesses often have strong brand names, and customers make repeated purchases of the company’s
products. Given this situation, the company can be milked for cash that can be used to purchase new businesses
or pay substantial dividends to shareholders.1
Let’s examine the cash flow statement of Procter & Gamble for 2011 and see how it suggests that this company is a cash cow:
Amounts in millions; Years ended June 30
Cash And Cash Equivalents, Beginning Of Year
Operating Activities
Net earnings
Depreciation and amortization
Share-based compensation expense
Deferred income taxes
Gain on sale of businesses
Change in accounts receivable
Change in inventories
Change in accounts payable, accrued and other liabilities
Change in other operating assets and liabilities
Other
2011
$ 2,879
11,797
2,838
414
128
(203)
(426)
(501)
358
(1,190)
16
Total Operating Activities
13,231
Investing Activities
Capital expenditures
Proceeds from asset sales
Acquisitions, net of cash acquired
Change in investments
(3,306)
225
(474)
73
Total Investing Activities
(3,482)
Financing Activities
Dividends to shareholders
Change in short-term debt
Additions to long-term debt
Reductions of long-term debt
Treasury stock purchases
Impact of stock options and other
(5,767)
151
1,536
(206)
(7,039)
1,302
Total Financing Activities
(10,023)
Effect of exchange rate changes on cash and cash equivalents
163
Change in cash and cash equivalents
(111)
Cash and cash equivalents, end of year
$2,768
Note that cash flow from operations is $13.231 billion, which is higher than reported earnings of $11.797
billion. And note that this high level of cash from operations was obtained with only $3.482 billion of capital
expenditures in the current period, as indicated in the investing activities section of the report. Finally, as indicated in the financing activities section, Procter & Gamble was able to pay dividends of $5.767 billion and buy
back stock for $7.039 billion. All in all, it looks as if P&G is indeed a cash cow.
1
Based on Ben McClure, “Spotting Cash Cows,” Investopedia.com, August 26, 2005 (www.investopedia.com/articles/stocks/05/
cashcow.asp).
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Interpreting Information in the Statement of Cash Flows 513
LEARNING
OBJECTIVE 5
Interpret information
in the statement of
cash flows.
You Get What You
Measure
INTERPRETING INFORMATION IN THE STATEMENT
OF CASH FLOWS: THE SITUATION AT RAVIRA
RESTAURANT SUPPLY
Information in the statement of cash flows can provide tremendous insight into the
operations of a company. In general, the most important part of the statement is
the identification of cash flows from operating activities. Unless a company is able to
generate cash from its core operations, it is unlikely to succeed. If cash flows in this section are low, this implies that a company must offset them by changes in investing and
financing decisions. For example, a company with low operating cash flows may need
to cut back on cash used to fund capital investments, and it may need to borrow cash
as indicated in the financing section.
Recall that in the opening scenario, Marc Ravira was wondering why, in spite of a substantial increase in sales and income, his company had to borrow cash. Reviewing the statement of cash flows can help solve Marc’s puzzle. As indicated in Illustration 13-3, receivables
have increased by over $500,000.Thus, while sales may have increased, a substantial amount
of the sales have yet to be collected and turned into cash. Also, inventory has increased by
$375,513, suggesting that the company has used cash to purchase more merchandise.
Overall, there is a $701,891 difference between net income ($1,340,394) and cash flow from
operations (only $638,503). Additionally, as pointed out in the statement of cash flows, the
company paid dividends of $664,636. This certainly had a major effect on the company’s
cash balance. If Marc had read and understood the statement of cash flows, he would have
had a clear understanding of why his company’s cash balance has decreased from $80,568
to only $15,435, despite the fact that sales had increased and net income exceeded
$1.3 million.
You Get What You Measure and Incremental Analysis
Linked to the Statement of Cash Flows
It is extremely important that companies generate the cash they need to pay their
current obligations to suppliers, taxing authorities, and creditors. To drive managers to
focus on this, companies may use the ratio of cash flow from operations to current liabilities as a performance measure. This ratio should be greater than 1 to ensure that
operations generate enough cash to pay current obligations. To be on the safe
side, a company might set the target at 1.10 (10 percent more cash generated than
needed to satisfy current obligations) or even higher if it feels a need to be especially
conservative.
Ravira Restaurant Supply had cash from operations of $638,503 (see Illustration 13-3)
and current liabilities of $842,027 (see Illustration 13-1). Thus, the ratio of cash from operations to current liabilities is:
$638,503
= 0.76
$842,027
Since Ravira Restaurant Supply is not generating cash from operations sufficient to
cover its current liabilities, it would be wise for the company to borrow funds and/or reduce
dividends. The company spent only $15,000 on the purchase of equipment, so reducing
investments in equipment is not going to solve its cash flow problem.
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514 Chapter 13 Statement of Cash Flows
Decision Making /
Incremental Analysis
We know from our study of Chapter 9 that investment decisions (also called capital
budgeting decisions) are made using incremental analysis, and we have already seen how
such decisions affect the statement of cash flows (see the section Long-Term Asset
Accounts). But since analyzing them is complicated, let’s review another example before
finishing the chapter.
Suppose in 2015, Ravira Restaurant Supply purchases equipment with a cost of $80,000.
The company also sells a piece of equipment with an initial cost of $26,000 at a loss of $4,000.
Also in 2015, the company has $110,000 of depreciation expense. The beginning balance in
accumulated depreciation is $419,376 and the ending balance is $511,000. How will these
transactions be reflected in the investment section of the statement of cash flow?
Clearly, the purchase decision will result in a cash outflow of $80,000.
To determine the cash flow related to the sale of equipment, we must first determine
the amount of accumulated depreciation related to the equipment sold:
Beginning balance accumulated depreciation
Plus depreciation expense
Less accumulated depreciation related to sale
Equals ending balance accumulated depreciation
$419,376
110,000
?
$511,000
Solving for the unknown indicates that the accumulated depreciation related to equipment
was $18,376. We can now use this to determine the cash proceeds from the sale:
Cash proceeds related to sale of equipment
Less book value of equipment sold
Cost of $26,000 minus accumulated depreciation of $18,376
Equals loss on sale
?
7,624
($4,000)
Solving for the unknown indicates that Ravira Restaurant Supply received $3,624 for the
equipment. Thus, the sale decision will result in an incremental cash inflow of $3,624.
Decision Making
Insight
In this chapter, we learned about the statement of cash flows.This statement presents the
cash flows related to operating, investing, and financing activities, information crucial to
the management of virtually all businesses. Unless a company is able to generate sufficient cash from operations, it will need to seriously curtail investments in capital assets
(which is indicated under investing activities in the statement) and it may have to borrow
funds or issue stock (which is indicated under financing activities in the statement).
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Summary of Learning Objectives
LEARNING OBJECTIVE 1 Explain the need for the
statement of cash flows.
All company stakeholders (managers, employees, suppliers,
creditors, and stockholders) need to know how a company
generates and spends cash. This information, for example,
can help managers identify the need to borrow funds or
accelerate the collection of receivables if operating cash
flows are low. The needed information is contained in the
statement of cash flows, which is one of the three primary
financial statements in addition to the balance sheet and
the income statement.
LEARNING OBJECTIVE 2 Identify the three types of
business activities presented in a statement of cash
flows.
The three types of business activities presented in a statement of cash flows are operating activities, investing activities, and financing activities. Examples of operating
activities include cash collected on sales,cash received from
interest income, and cash paid for salaries and wages. Cash
received from interest and dividend income is also classified
as operating activities. Cash flows related to capital acquisitions and sales of equipment are prime examples of cash
flows classified under investing activities. Financing activities include cash received from selling bonds or issuing
stock.Cash dividends paid and retirement of long-term debt
are examples of items classified under financing activities.
LEARNING OBJECTIVE 3 Prepare a statement of cash
flows using the direct method.
There are two acceptable methods for preparing the statement of cash flows: the direct method and the indirect
method. With the direct method, the operating cash flow
section looks much like an income statement converted to
the cash basis. To prepare the statement, we must analyze
all balance sheet accounts, except cash, to determine how
cash flows affected the changes in the account balances.
This also requires information from the income statement.
There are no differences between the direct and the indirect method with respect to investing or financing activities.
LEARNING OBJECTIVE 4 Prepare a statement of cash
flows using the indirect method.
The operating activities section of the statement of cash
flows, prepared using the indirect method, is essentially a
reconciliation of net income and cash flows from operations.We start with net income and then make adjustments
for all noncash expenses and gains and losses (e.g., depreciation, amortization, and gain on the sale of equipment).
Then we make adjustments for the changes in all current
asset accounts (other than cash) and for changes in all current liability accounts.
LEARNING OBJECTIVE 5 Interpret information in the
statement of cash flows.
Perhaps the most important section in the statement of
cash flows relates to operating activities.This section summarizes cash from a company’s core activities. Unless a
company can generate positive cash flow from operations,
it is unlikely to succeed. In the short run, problems related
to cash flow from operations can be offset by cutting back
on capital expenditures (as indicated in the investing activities section of the statement) or by borrowing or issuing
stock (as indicated in the financing section).
Review Problem 1
The following information relates to Burke and Johnson Consultants:
Income before taxes
Net income
Loss on sale of equipment
Beginning balance current assets other than cash
Ending balance current assets other than cash
Beginning balance current liabilities
Ending balance current liabilities
Beginning balance in long-term debt
Ending balance in long-term debt
Depreciation
$1,200,000
720,000
25,000
65,000
45,000
60,000
50,000
125,000
75,000
15,000
Required
Using the indirect method,prepare the operating activities section of the statement of cash flows.
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Answer
Operating Activities
Net income
Adjustments of net income to cash basis:
Depreciation
Loss on sale of equipment
Decrease in current assets other than cash
Decrease in current liabilities
Net cash provided by operating activities
$720,000
15,000
25,000
20,000
(10,000)
$770,000
Review Problem 2
Below are the 2015 and 2014 income statements and balance sheets for RG Jewelry. During
2015, the company had depreciation expense of $130,000 and purchased additional equipment costing $10,000. The company paid a dividend of $73,000 in 2015.
RG Jewelry Company
Statements of Earnings
(in thousands)
Net sales
Cost of goods sold
Gross margin
Operating expenses:
Selling expenses
General and administrative expenses
other than depreciation
Depreciation
Total operating expenses
Operating income
Interest expense
Income before taxes
Income taxes
Net income
Year Ended
December 31,
2015
Year Ended
December 31,
2014
$21,217
13,367
7,850
$27,563
16,538
11,025
3,395
3,308
2,488
130
6,013
1,837
1,168
669
234
$ 435
2,377
104
5,789
5,236
1,254
3,982
1,394
$ 2,588
RG Jewelry Company
Balance Sheets
(in thousands)
Assets
Current assets
Cash and cash equivalents
Accounts receivable
Inventory
Prepaid expenses
Total current assets
Building and equipment, net
Total assets
516
December 31,
2015
$
332
2,676
17,714
46
20,768
1,262
$22,030
December 31,
2014
$
446
2,924
18,221
25
21,616
1,382
$22,998
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Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable
Other accrued payables
Total current liabilities
Long-term debt
Total liabilities
Stockholders’ equity
Common stock
Retained earnings
Total stockholders’ equity
Total liabilities and stockholders’ equity
$ 2,917
969
3,886
8,330
12,216
$ 4,012
804
4,816
8,730
13,546
3,850
5,964
9,814
$22,030
3,850
5,602
9,452
$22,998
Required
Using the indirect method, prepare a statement of cash flows for 2015.
Answer
The statement of cash flows is as follows.Note that the number next to each item on the statement refers to the corresponding calculation or explanation.
RG Jewelry Company
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2015
(in thousands)
Operating Activities
Net income
Adjustments of net income to cash basis:
Depreciation
Decrease in receivables
Decrease in inventory
Increase in prepaid expenses
Decrease in accounts payable
Increase in other accrued payables
Net cash provided by operating activities
$ 435
130
248
507
(21)
(1,095)
165
369
(1)
(2)
(2)
(2)
(2)
(10)
(10)
(3)
(400)
(73)
(473)
(114)
446
$ 332
(4)
Investing Activities
Purchase of equipment
Net cash used in investing activities
Financing Activities
Reduce long-term debt
Dividends paid
Net cash used in financing activities
Net decrease in cash and cash equivalents
Cash and cash equivalents at start of year
Cash and cash equivalents at end of year
1. We start by adding back noncash items to net income. The only noncash item is
depreciation expense of $130,000.
2. Next, we add and subtract changes in current assets and current liabilities.
3. $10,000 represents the purchase of equipment, which was given. Note, however, that
depreciation of $130,000 and the purchase of equipment, for $10,000 accounts for
the $120,000 change in the net balance in building and equipment.
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4. $400,000 is the reduction in long-term debt.
5. $73,000 is the dividend paid, which is given. Note, however, that net income of $435,000
less the dividend of $73,000 accounts for the $362,000 increase in retained earnings.
Key Terms
Cash (502)
Direct method (504)
Self-Assessment
Financing activities (504)
Investing activities (504)
(Answers Below)
1. Which of the following is an investing activity?
a. Decrease in inventories.
b. Increase in accounts receivable.
c. Purchase of land.
d. Issuance of stock.
2. Which of the following is a financing activity?
a. Payment of dividends.
b. Decrease in accounts receivable.
c. Purchase of land.
d. Increase in inventories.
3. Which of the following would be a cash outflow
from operating activities?
a. Acquisition of operating equipment.
b. Retirement of bonds.
c. Collection of accounts receivable.
d. Payment for inventory.
4. Obtaining cash by issuing capital stock is an
example of:
a. A noncash transaction.
b. A financing activity.
c. An investing activity.
d. An operating activity.
5. Cash inflows from operating activities come
from
a. Issuing capital stock.
b. Issuing bonds.
c. Collection of accounts receivable.
d. Payment for raw materials.
6. When preparing the operating section of a
statement of cash flows using the indirect method,
various adjustments are needed. Which of the
following adjustments is incorrectly stated?
a. Deduct any increases in inventories from net
income.
b. Add to net income any increases in current
liabilities.
518
Operating activities (504)
c. Add to net income depreciation and amortization
expense.
d. Add gains on sale of equipment.
7. Sources of cash include
a. Issue capital stock.
b. Issue long-term debt.
c. Sell long-term assets.
d. All of the answer choices are correct.
8. Uses of cash include all of the following except:
a. A payment related to the purchase of property.
b. The issuance of a stock dividend.
c. Payments to suppliers.
d. A payment to reduce long-term debt.
9. A decrease in accounts receivable is added to net
income to arrive at operating cash flows because:
a. Cash collections from customers were greater
than the sales generated.
b. Cash collections increased due to an increase in
sales.
c. Cash collections decreased due to a decline in sales.
d. Cash collections from customers were less than
the sales reported.
10. Under the indirect method, an increase in
inventories is deducted from net income to calculate
operating cash flow because:
a. Cash payments to customers were less than the
purchases made during the period.
b. Purchases were larger than the cost of goods sold
by the amount that inventories increased.
c. Cash payments to customers were larger than the
purchases made during the period.
d. Purchases were less than the cost of goods sold
by the amount that inventories increased.
Answers to Self-Assessment
1. c
7. d
2. a
8. b
3. d
9. a
4. b 5. c
10. b
6. d
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Enhance and test your knowledge of Chapter 13 using Wiley’s online resources.
Go to our dynamic Web site for more self-assessment, Web links, and additional
information.
QUESTIONS
1. What is the basis of accounting that underlies the income statement, and what is the
basis of accounting that underlies the statement of cash flows?
2. What are the principal uses of a statement of cash flows from the perspective of
investors and company managers?
3. Define and provide one example of a cash inflow and one example of a cash outflow
for (a) operating cash flows, (b) investing cash flows, and (c) financing cash flows.
4. Some companies collect interest and/or dividend payments. Where are they presented on the statement of cash flows?
5. What parts of the statement of cash flows are the same regardless if one is using the
direct or the indirect method?
6. Which method is more commonly used in preparing the statement of cash flows, the
direct method or the indirect method? Why?
7. What is the starting point for determining a business’s net cash flow from its operating activities under the indirect method? Why is this figure used?
8. Under the indirect method of preparing the operating portion of a statement of cash
flows, why is depreciation expense added to net income when determining cash flow
from operating activities?
9. What can an investor learn from looking at the relationship between operating,
financing and investing cash flows from year to year?
10. Why is a business that has substantial positive cash flows from operating activities
with relatively small cash flows related to investing and financing activities referred to
as a cash cow?
Exercises
EXERCISE 13-1. [LO 4] Explain why, under the indirect method, an increase in inventory is
deducted from net income to arrive at net cash provided by operating activities.
EXERCISE 13-2. [LO 5] Write a paragraph explaining why a company with negative operating
cash flows might be doing well or might be doing poorly.
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EXERCISE 13-3. [LO 5] Go to the Web site for Alaska Air Group’s investor relations and find the
company’s consolidated financial statements for 2010 under financial reports. Using information
in the company’s statement of cash flows, explain why, even though the company had a net income
of $251 million, the net change in cash was a negative $75 million.
EXERCISE 13-4. Relating Events to Financial Statements [LO 1] Consider the following
transactions:
Transactions
Income
Statement
Statement of
Cash Flows
Borrow funds from a bank
Collect funds from a customer who previously
purchased goods/services on credit
Receive a cash deposit from a customer in advance
of making the item ordered
Pay back a portion of borrowed funds (excludes interest)
Required
For each transaction, place a check mark under the statement directly affected by it.
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EXERCISE 13-5. Classifying Cash Flows [LO 2] Neo Watch Company produces pocket watches
and has had the following transactions:
1.
2.
3.
4.
5.
6.
Retired long-term bonds.
Sold a warehouse for $600,000.
Issued a long-term note payable for $350,000.
Purchased a new robotic system to automate manufacturing operations.
Purchased a 40 percent interest in HazelWorks, an electronics manufacturer.
Reported a loss on the sale of old equipment of $6,000. The equipment was sold for
$3,000 in cash.
7. Obtained a long-term bank loan.
8. Paid cash dividends of $200,000.
Required
For purposes of the statement of cash flow, classify each of these transactions as an operating,
investing, or financing activity. Additionally, indicate whether the activity is a inflow of cash or an
outflow of cash.
EXERCISE 13-6. Cash Flow from Investing Activities [LO 3, 4]
had the following transactions:
During 2014, Damon Company
1.
2.
3.
4.
Purchased $200,000 of 10-year bonds issued by Gallant, Inc.
Purchased common stock in Morceau Company, as a long-term investment, for $60,000.
Acquired land valued at $200,000 in exchange for one of Damon’s warehouses.
Sold equipment with original cost of $70,000 for $35,000; accumulated depreciation on
the equipment sold was $40,000.
5. Purchased new equipment for $60,000.
Required
Prepare the investing section of the statement of cash flows.
EXERCISE 13-7. Cash Flows from Financing Activities [LO 3, 4] Molton Company experienced
the following during 2015:
1.
2.
3.
4.
5.
Issued preferred stock for $125,000.
Repurchased $70,000 of its own common stock.
Borrowed $150,000 from a bank issuing a five-year note.
Retired bonds by paying $45,000.
Declared dividends of $135,000 payable on March 1, 2015.
Required
Prepare the financing section of the statement of cash flows.
EXERCISE 13-8. Derive Selected Cash Flows [LO 3] Given the following information, what
amount of cash was collected from customers? Assume all sales are on account.
520
Ending Balance
2014
2015
Accounts receivable
Sales
$ 600,000
3,800,000
$ 480,000
2,850,000
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EXERCISE 13-9. Derive Selected Cash Flows [LO 3] What amount of cash was paid to suppliers of inventory, assuming all accounts payable related to inventory purchases?
Ending Balance
2014
2015
Merchandise inventory
Accounts payable
Cost of goods sold
$ 650,000
104,000
4,115,000
$ 519,000
65,000
3,085,000
EXERCISE 13-10. Adjustments to Net Income (Indirect Method) [LO 4]
ing events/amounts is independent of all others.
1.
2.
3.
4.
5.
6.
7.
8.
9.
Each of the follow-
Decrease in inventory.
Loss on sale of an asset.
Amortization of a patent.
Increase in wages payable.
Increase in accounts receivable.
Increase in accounts payable.
Depreciation expense.
Decrease in prepaid rent.
Bad debt expense.
Required
Indicate whether each of the above items will be added to or deducted from net income to arrive
at net cash provided by operating activities.
EXERCISE 13-11. Operating Cash Flows [LO 4]
Supply is as follows:
The income statement for Weinberg Chemical
Weinberg Chemical Supply
Income Statement
For the Year Ended December 31, 2014
Sales
Less:
Cost of goods sold
Depreciation expense
Amortization of patent
Wages expense
Insurance expense
Income before taxes
Less income taxes
Net income
$1,025,000
(620,000)
(65,000)
(6,500)
(61,000)
(12,000)
260,500
(91,175)
$ 169,325
Other information is as follows:
1. Accounts receivable decreased by $13,000 during the year.
2. Accounts payable increased by $6,500.
3. Wages payable had a balance of $0 at the beginning of the year; at the end of the year,
the balance was $4,300.
4. Prepaid insurance increased by $7,500 during the year.
Required
Prepare a schedule that shows the operating cash flows for the year, using the indirect method.
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EXERCISE 13-12. Operating Cash Flows [LO 4] The section on cash from operating activities
in the statement of cash flows for Marismo Services contained the following information:
Operating Activities
Net income
Depreciation
Changes in current assets and liabilities
Accounts receivable
Inventories
Other current assets
Accounts payable
Short-term notes payable
Income taxes payable
Other current liabilities
Net cash provided by operating activities
$260,000
15,000
16,000
(17,000)
8,200
13,000
(7,000)
8,000
5,000
$301,200
Required
For each of the current asset and liability accounts indicated in the operating portion of the statement of cash flows, determine whether the account increased or decreased during the year.
EXERCISE 13-13. Adjustments to Net Income [LO 4] Assume that a company uses the indirect method to prepare the operating activities section of the statement of cash flows.
Required
For each of the following items, fill in the blank to indicate whether it would be added (A) to net
income, deducted (D) from net income, or not reported (NR) in the operating activities section of
the statement of cash flows prepared using the indirect method.
______a. Purchase of a new computer system
______b. Decrease in accounts payable
______c. Increase in prepaid insurance
______d. Depreciation expense
______e. Increase in inventory
______f. Amortization of patents
______g. Loss on retirement of bonds
______h. Gain on the sale of used delivery truck
______i. Bad debt expense
EXERCISE 13-14. Operating Cash Flows [LO 4] During the year, Fastfax Company earned net
income of $15,000.Beginning and ending balances for the year for selected accounts are as follows:
Account Balance
Cash
Accounts receivable
Inventory
Prepaid rent
Accumulated depreciation
Accounts payable
Wages payable
Beginning
$25,000
18,000
7,000
5,000
20,000
19,000
12,000
Ending
$33,000
20,000
6,000
5,600
23,000
18,000
14,000
There were no financing or investing activities for the year. The above balances reflect all adjustments needed to adjust net income to operating cash flows.
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Required
Prepare a schedule of operating cash flows using the indirect method.
EXERCISE 13-15. Analyzing Accounts to Determine Cash Flows [LO 3, 4] Motta Storage
Company had the following balances in its Equipment and Accumulated Depreciation on
Equipment accounts at the beginning and end of 2015:
Equipment
Accumulated depreciation, equipment
January 1
December 31
$105,000
30,000
$130,000
22,000
During 2015, Motta engaged in the following transaction involving equipment:
Sold equipment that originally cost $25,000 and had a current book value of $9,000 for
$18,500. This was the only sale of equipment.
Net income for 2015 was $380,000.
Required
a. How much equipment-related depreciation expense did Motta Storage Company record
during 2015?
b. What was the cost of equipment purchased during the year?
c. Using this limited information, prepare the operating and investing activities sections of the
statement of cash flows. Here you will assume that there were no changes in current asset and
current liability accounts other than cash.
EXERCISE 13-16. Analysis of Cash Flows [LO 1, 5] The following data were included in a recent
annual report of Warehouse Foods:
Net income
Net cash flow from operating activities
Net cash flow from investing activities
Net cash flow from financing activities
Year 1
Year 2
Year 3
$ 3,800,000
7,500,000
(7,800,000)
15,200,000
$ 3,900,000
12,600,000
(41,600,000)
17,500,000
$ 8,700,000
15,400,000
(32,850,000)
15,000,000
Required
a. Why is a company’s net income typically less than its net cash flow from operating activities?
b. Why do most companies, including Warehouse Foods, typically have negative cash flows
from investing activities?
c. Over the three-year period, what type of activity was the largest source of funds for
Warehouse Foods? For what purpose were these funds used?
EXERCISE 13-17. Miscellaneous Topics [LO 1, 2, 3, 4, 5] Below are a series of statements regarding topics discussed in this chapter. Indicate whether each statement is true (T) or false (F).
1. Increases in noncash current assets are added to net income when computing net cash
flow from operating activities under the indirect method.
2. In the short run, profitable companies that are growing do not necessarily generate sufficient cash from operating activities to finance their day-to-day operations.
3. Financing activities are generally those transactions and events related to the production
and delivery of goods and services by businesses.
4. Decision makers use cash flow to evaluate a business’s ability to sustain future growth.
5. In the long run, decision makers prefer companies to generate most of their cash inflows
from investing and financing activities.
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6. The acquisition and disposition of property, plant, and equipment are examples of operating activities.
7. The indirect method of preparing a statement of cash flows requires certain adjustments
to net income to determine the net cash flow from operating activities.
8. Similar to the income statement, the statement of cash flows is prepared for a specific
period.
9. Cash flows from investing and financing activities are reported in the same manner
under the indirect and direct methods of the statement of cash flows.
EXERCISE 13-18. Analyzing Accounts to Determine Cash Flows [LO 5] The following information relates to Martinez Company for fiscal 2014:
Beginning retained earnings
Ending retained earnings
Net income for 2014
$5,100,000
4,100,000
2,050,000
Required
Calculate the cash used to pay dividends.
Problems
PROBLEM 13-1. Distinguishing between Income and Cash Flow [LO 1] Bill and Jeanne are
new managers at Baluga Corporation and are discussing the future prospects of their company.
Bill insists the company’s future is fantastic since Baluga has an upward trend in net income.Jeanne,
while not disagreeing, adds that the proof of ultimate success is the accumulation of cash, which
therefore requires looking beyond net income to cash flows. Bill’s response:“Income and cash flow
are the same thing, aren’t they?”
Required
Assume the role of Jeanne and explain why it might be wise to evaluate the future prospects of
the company using cash flow information in addition to net income.
PROBLEM 13-2. Need for Detailed Cash Flow Information [LO 1] Bob and Jane, two
coworkers in the sales department of Weston Corporation, are having an informal discussion
about the financial condition of one of their customers who has placed a large order. Bob states
that things are really going well for the company. According to its most recent balance sheet,
cash had increased from $5.4 million at the end of last year to $7.9 million at the end of the
current year.
Required
Jane has studied introductory accounting at Grogan College, which included study of the statement of cash flows. How should she respond to Bob’s comment?
PROBLEM 13-3. Classifying Cash Flows [LO 2] Cash flows can be classified into one of the following categories:
1.
2.
3.
4.
5.
6.
524
Cash inflows from operating activities.
Cash outflows from operating activities.
Cash inflows from investing activities.
Cash outflows from investing activities.
Cash inflows from financing activities.
Cash outflows from financing activities.
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Required
Classify each of the following transactions into one of the above six categories:
a.
b.
c.
d.
e.
f.
g.
h.
i.
j.
Payments to employees for wages.
Payments to acquire stock in another company as a long-term investment.
Receipts from customers.
Receipts from the sale of property, plant, and equipment.
Payments of interest.
Payments made to acquire another firm.
Receipts of interest and dividends.
Payments to retire outstanding bonds.
Receipts from issuing common stock.
Purchases of treasury stock.
PROBLEM 13-4. Classifying Cash Flows [LO 2] The following transactions occurred during the
fiscal year for Boston Corporation:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Issued 10-year bonds.
Purchased a nine-month certificate of deposit.
Repaid a six-month bank note.
Invested $60,000 in common stock of another company as a long-term investment.
Issued 20,000 shares of common stock.
Purchased 10,000 shares of IBM stock as a short-term investment.
Purchased 5,000 shares of its own stock to be held in treasury.
Sold 20,000 shares of Ford stock, which had been held as a short-term investment.
Purchased $6,000,000 of inventory from Granger Corporation.
Collected $90,000 from Major Manufacturing related to a previous sale.
Required
For each transaction, indicate how it would be reported on the statement of cash flows. Use the
following key:
a.
b.
c.
d.
e.
f.
Inflow from investing activities.
Outflow from investing activities.
Inflow from financing activities.
Outflow from financing activities.
Inflow from operating activities.
Outflow from operating activities.
PROBLEM 13-5. Classifying Cash Flows [LO 2] The following are transactions, events, and
changes in balances for Exeter Corporation for the past fiscal year:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Repurchase of common stock.
Interest received.
Refund of income taxes.
Principal payment on long-term notes payable.
Cash paid to suppliers and employees.
Increase in accounts payable.
Purchase of property and equipment.
Proceeds from issuing a long-term note payable.
Cash paid as the result of a fine.
525
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10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
Principal payments under capital lease obligations.
Depreciation expense.
Payment of dividends on preferred stock.
Principal payments on mortgages.
Increase in accounts receivable.
Gain on sale of equipment.
Proceeds from issuing common stock.
Decrease in wages payable.
Declaration of a stock dividend.
Cash paid to suppliers for inventory.
Issuance of treasury stock for cash.
Loans to officers.
Issuance of common stock for land.
Proceeds from the sale of property, plant, and equipment.
Cash received from customers.
Decrease in prepaid insurance.
Required
Classify each of the above using one of the following categories. Assume the operating portion
of the statement of cash flows is prepared on a direct basis.
a.
b.
c.
d.
e.
f.
g.
Cash inflow from operating activities.
Cash outflow from operating activities.
Cash inflow from investing activities.
Cash outflow from investing activities.
Cash inflow from financing activities.
Cash outflow from financing activities.
Does not appear in the operating portion of a statement of cash flows prepared on a direct basis.
PROBLEM 13-6. Statement of Cash Flows, Direct Method [LO 3]
following financial statements:
Octel Corporation
Balance Sheets
As of June 30, 2013, and 2014
2013
Assets
Cash
Accounts receivable
Inventory
Prepaid expenses
Plant and equipment
Accumulated depreciation
Total assets
Liabilities and Equity
Accounts payable (all relate to
inventory purchases)
Accrued wages
Common stock
Retained earnings
Total liabilities and equity
526
Octel Corporation has the
2014
$ 48,000
8,600
14,100
12,600
68,250
(9,600)
$141,950
$ 56,400
8,300
15,200
13,800
68,250
(18,200)
$143,750
$ 12,600
3,100
54,500
71,750
$141,950
$ 12,500
3,300
56,100
71,850
$143,750
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Octel Corporation
Income Statement
For the Year Ended June 30, 2014
Sales
Less: Cost of goods sold
Gross margin
Less operating expenses:
Wage expense
Other operating expenses
Depreciation expense
Net income
$267,000
(73,200)
193,800
$95,900
61,000
8,600
(165,500)
$ 28,300
Dividends of $28,200 were paid during the year. No equipment was purchased or retired during
the year.
Required
Using the direct method for the operating section, prepare a statement of cash flows for
fiscal 2014.
PROBLEM 13-7. Statement of Cash Flows, Direct Method [LO 3] Below is an income statement for Boulder Hill, Inc., for the year ended December 31, 2015, and the company’s balance sheets
as of December 31, 2014, and 2015.
The prepaid expenses and accrued liabilities included in Boulder Hill’s balance sheets involve
selling or general (operating) expenses. All of Boulder Hill’s sales and merchandise purchases are
made on a credit basis.
Boulder Hill, Inc.
Income Statement
For the Year Ended December 31, 2015
Sales
Cost of goods sold
Gross profit
Operating expenses:
Selling & general expenses
Depreciation expense
Operating income
Loss on sale of land
Income before income tax
Income tax expense
Net income
$94,000
(37,000)
$57,000
$14,700
6,300
(21,000)
36,000
(2,400)
33,600
(13,440)
$20,160
527
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Boulder Hill, Inc.
Balance Sheets
December 31, 2014, and 2015
2015
Assets
Cash
Accounts receivable
Inventory
Prepaid expenses
Total current assets
Equipment
$57,200
Less acc. depreciation
(24,200)
Investment in land
Total assets
Liabilities
Accounts payable
Accrued liabilities
Total current liabilities
Stockholder’s Equity
Common stock
Additional paid-in capital
Retained earnings
Total stockholder’s equity
Total liabilities and stockholder’s equity
2014
$ 40,200
13,900
14,300
770
69,170
33,000
—
$102,170
$13,300
11,600
16,100
1,430
42,430
$57,200
(17,900)
39,300
5,600
$87,330
$ 5,700
4,000
9,700
$ 7,800
3,600
11,400
5,300
17,170
70,000
92,470
$102,170
4,800
6,630
64,500
75,930
$87,330
Required
Determine the following amounts:
______a. Cash spent on new equipment
______b. Net amount of investing cash flows
______c. Cash received from issuing stock
______d. Cash paid to suppliers of inventory
______e. Cash paid for selling and general expenses
______f. Cash received from the sale of land
______g. Cash received from the sale of equipment
______h. Cash received from customers
______i. Cash paid for dividends
______j. Net amount of operating cash flows
______k. Net amount of financing cash flows
PROBLEM 13-8. Classifying Cash Flows, Indirect Method [LO 4]
that could be found in a statement of cash flows.
1.
2.
3.
4.
5.
6.
7.
8.
9.
528
Repurchase of common stock.
Interest received.
Refund of income taxes.
Principal payment on long-term notes payable.
Cash paid to suppliers and employees.
Increase in accounts payable.
Purchase of property and equipment.
Proceeds from issuing a long-term note payable.
Cash paid for taxes.
The following are line items
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10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
Principal payments under capital lease obligations.
Depreciation expense.
Payment of dividends on preferred stock.
Principal payments on mortgages.
Increase in accounts receivable.
Gain on sale of equipment.
Proceeds from issuing common stock.
Decrease in wages payable.
Declaration of a stock dividend.
Cash paid to suppliers for inventory.
Issuance of treasury stock for cash.
Long-term loans to officers.
Issuance of common stock for land.
Proceeds from the sale of property, plant, and equipment.
Cash received from customers.
Decrease in prepaid insurance.
Required
Classify each of the items as one of the following, assuming the operating portion of the statement of cash flows is prepared on an indirect basis.
a.
b.
c.
d.
e.
f.
g.
h.
i.
Cash inflow from operating activities.
Cash outflow from operating activities.
Cash inflow from investing activities.
Cash outflow from investing activities.
Cash inflow from financing activities.
Cash outflow from financing activities.
Positive adjustment to net income.
Negative adjustment to net income.
Does not appear in the operating portion of the statement of cash flows prepared on an
indirect basis.
j. Noncash transaction.
PROBLEM 13-9. Determining Net Cash Flow from Operating Activities, Indirect Method [LO 4]
Below is an income statement for Newell Products for the year ended December 31,2014,and a schedule listing the company’s current assets and current liabilities at the end of 2013 and 2014:
Newell Products
Income Statement
For the Year Ended December 31, 2014
Sales
Cost of goods sold
Gross profit
Operating expenses:
Selling and general expenses
Depreciation expense
Operating income
Loss on sale of land
Income before taxes
Income tax expense
Net income
$125,800
52,800
73,000
$11,700
2,600
14,300
58,700
3,600
55,100
19,285
$ 35,815
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Schedule of Current Assets
and Current Liabilities
Cash
Accounts receivable
Inventory
Prepaid expenses
Accounts payable
Accrued liabilities
December 31,
2013
December 31,
2014
$12,300
3,600
5,500
2,800
1,530
2,600
$14,800
4,600
6,100
2,350
2,200
1,950
Required
Prepare the operating activities section of the statement of cash flows using the indirect method.
PROBLEM 13-10. Preparing the Operating Activities Section of the Statement of Cash Flows,
Indirect Method [LO 4] The following are line items included in the 2015 statement of cash flows
prepared by Goodly’s Clothing Company:
Depreciation expense
Increase in accounts receivable
Increase in accounts payable
Increase in accrued salaries payable
Increase in inventories
Gain on disposal of long-term assets
Increase in income taxes payable
Net income
$ 5,500
1,500
13,200
4,300
11,900
150
2,200
17,000
Required
Prepare the operating cash flow section of Goodly’s statement of cash flows using the indirect
method.
PROBLEM 13-11. Classifying and Identifying Cash Flows [LO 2, 4] Below are line items
included in recent statements of cash flows prepared by a national retailer. For some items, the
direction of the change in the account is also indicated.
1. Accounts payable, increase.
2. Accounts receivable, decrease.
3. Accrued expenses payable, decrease.
4. Capital expenditures.
5. Deferred income tax liability (long term), increase.
6. Depreciation and amortization expense.
7. Dividend payouts.
8. Income taxes payable, decrease.
9. Issuance of common stock.
10. Issuance of long-term debt.
11. Issuance of short-term debt.
12. Merchandise inventories, decrease.
13. Other current assets, increase.
14. Proceeds from disposals of property and equipment.
15. Purchase common stock in other companies.
16. Purchase of treasury stock.
17. Repayment of long-term debt.
530
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Required
For each item, indicate in which section of the statement of cash flows it would appear, assuming the operating portion was prepared using the indirect method.
a. Operating activities.
b. Financing activities.
c. Investing activities.
d. Would not appear in the statement.
For those flows you identified as operating, indicate whether the amount would have
been added to or subtracted from net income in the operating portion of the statement of cash
flows knowing it was prepared using the indirect method.
PROBLEM 13-12. Statement of Cash Flows, Direct and Indirect Methods [LO 3, 4]
lowing financial statements were furnished by Patton Company:
Patton Company
Balance Sheets
As of December 31, 2013, and 2014
2013
Assets
Cash
Accounts receivable
Inventory
Prepaid expenses
Plant and equipment
Accumulated depreciation
Total assets
Liabilities and Equity
Accounts payable (all relate to
inventory purchases)
Accrued wages payable
Common stock
Retained earnings
Total liabilities and equity
The fol-
2014
$15,500
5,800
8,700
1,340
42,200
(7,200)
$66,340
$17,000
6,400
10,000
2,500
52,500
(8,200)
$80,200
$ 5,100
1,200
37,000
23,040
$66,340
$ 6,300
1,650
37,000
35,250
$80,200
Patton Company
Income Statement
For the Year Ended December 31, 2014
Sales
Less cost of goods sold
Gross margin
Less wage expense
Less other operating expenses
Less depreciation expense
Net income (loss)
$40,700
(13,200)
27,500
(10,600)
(1,130)
(3,560)
$12,210
In 2014, Patton purchased equipment for $25,000 and sold some equipment for its book value (i.e.,
no gain or loss resulted).
Required
a. Prepare a statement of cash flows using the indirect method.
b. Prepare the operating portion of Patton’s cash flow statement using the direct method.
PROBLEM 13-13. Operating Cash Flows, Indirect and Direct Methods [LO 3, 4] Following is
an income statement for Claims Corporation for the year ended December 31, 2014, and a schedule listing the company’s current assets and current liabilities at the end of 2013 and 2014.
531
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Claims Corporation
Income Statement
For the Year Ended December 31, 2014
Sales
Cost of goods sold
Gross margin
Operating expenses:
Selling and general expenses
$ 9,200
Depreciation expense
2,000
Operating income
Gain on sale of land held as investment
Income before income tax
Income tax expense
Net income
Cash
Accounts receivable
Inventory
Prepaid selling/general expenses
Accounts payable
Accrued liabilities
$80,700
(46,200)
34,500
(11,200)
23,300
5,700
29,000
(11,600)
$17,400
2013
2014
$12,200
4,700
7,000
3,600
3,000
1,670
$ 4,300
10,200
11,800
850
5,800
2,900
Required
a. Prepare a schedule documenting Claims Corporation’s net cash flow from operating activities for the year ended December 31, 2014, using the indirect method.
b. Prepare a schedule documenting Claims Corporation’s net cash flow from operating activities for the year ended December 31, 2014, using the direct method. Assume that selling and
general expenses are related to both prepaid expenses and accrued liabilities.
PROBLEM 13-14. Operating Cash Flows, Direct and Indirect Methods [LO 3, 4]
Pasta, Inc., has the following financial statements:
Sellmer’s Pasta, Inc.
Balance Sheets
As of December 31, 2013, and 2014
2013
Assets
Cash
Accounts receivable
Inventory
Prepaid expenses
Plant and equipment
Accumulated depreciation
Total assets
Liabilities and Equity
Accounts payable
Short-term notes payable
Accrued wages
Long-term notes payable
Common stock
Retained earnings
Total liabilities and equity
532
2014
$263,000
118,000
94,200
183,800
55,700
(12,900)
$701,800
$280,900
120,500
83,800
199,080
80,325
(15,500)
$749,105
$172,700
62,500
29,200
175,400
72,500
189,500
$701,800
$175,900
58,200
32,800
156,405
72,500
253,300
$749,105
Sellmer’s
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Sellmer’s Pasta, Inc.
Income Statement
For the Year Ended December 31, 2014
Sales
Less: Cost of goods sold
Gross margin
Less operating expenses:
Wages and salaries expense
Advertising expense
Misc. operating expenses
Depreciation expense
Net income (loss)
$449,000
(173,000)
276,000
$176,000
16,400
12,200
2,600
(207,200)
$ 68,800
At the end of 2014, Sellmer purchased additional equipment for $24,625. Sellmer paid dividends
of $5,000 during the year.
Required
a. Prepare a statement of cash flows for 2014 using the direct method. Assume that advertising
is paid in cash.
b. Prepare the operating activities section of the statement of cash flows for 2014 using the
indirect method. Note that there is no difference between the two methods for the investing
and financing sections.
PROBLEM 13-15. Interpreting Cash Flow Data [LO 5] In the most recent fiscal year, General
Cereal’s statement of cash flows revealed an increase in the company’s accounts receivable of $129
million.
Required
a. How does an increase in accounts receivable affect a company’s net cash flow from operating activities?
b. If a company’s accounts receivable balance is continually increasing from one year to the
next, does that indicate the firm is doing a poor job of managing or collecting its accounts
receivable? Explain.
CASE
13-1 WELLCOMP COMPUTERS
[LO 5]
Wellcomp Computers is a leader in the PC market with a
45 percent market share and a reputation for efficient
operations. Typically the company has only 10 days’ sales
in inventory and 5 days’ sales in receivables. The company
generally can deliver large corporate orders in less than
two weeks. Wellcomp’s parts suppliers, however, accept
payment in 30 days.
At a recent meeting of key executives, Nadine Hunt,
senior VP of marketing, proposed dropping prices to grab
even more market share. Preston Hunt, the chief operating
officer, objected and said,“Nadine, our margin is only 5 percent. If we drop our price, our margin drops, and a lower
margin means less cash coming into the company. If cash
flow drops, we could have a very significant problem.”
Required
Assume the role of Nadine and explain why cash flow is not
likely to be a problem.
533