Accounting Homework II

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CH 13-Overview

CHAPTER 13
STATEMENT OF CASH FLOWS
OVERVIEW OF BRIEF EXERCISES, EXERCISES, PROBLEMS, AND CRITICAL THINKING CASES
Brief	Learning
Exercises	Topic	Objectives	Skills
B. Ex. 13.1	Cash flows from operations (direct)	13-3	Analysis
B. Ex. 13.2	Cash flows from operations (indirect)	13-7	Analysis
B. Ex. 13.3	Cash flows from operations (direct)	13-3	Analysis
B. Ex. 13.4	Cash flows from operations (indirect)	13-7	Analysis
B. Ex. 13.5	Cash flows from investing activities	13-4	Analysis
B. Ex. 13.6	Cash flows from financing activities	13-4	Analysis
B. Ex. 13.7	Cash payment for merchandise	13-3	Analysis
B. Ex. 13.8	Determining beginning cash balance	13-2	Analysis
B. Ex. 13.9	Reconciling net income to cash from operations	Analysis
13-6
B. Ex. 13.10	Prepare statement of cash flows	13-2	Analysis
Learning Objectives
Topic		Skills
13.1	Using a cash flow statement	13-1, 13-2	Analysis, communication
13.2	Using a cash flow statement	13-1, 13-2, 13-6	Analysis, communication
13.3	Using noncash accounts to compute cash flows	13-4	Analysis

13.4	Relationship between accrual and cash flows	13-3, 13-6	Analysis, communication
13.5	Accrual versus cash flows	13-3	Analysis
13.6	Investing activities and interest revenue	13-3, 13-6	Communication

13.7	Format of a cash flow statement	13-2	Analysis
13.8	Cash effects of business strategies	13-8	Analysis, communication, judgment
13.9	Indirect method	13-6, 13-7	Analysis, communication
13.10	Indirect method	13-7	Analysis
13.11	Classification of cash flows	13-2	Analysis
13.12	Classification of cash flows	13-2	Analysis
13.13	Cash flows from operating activities	13-4	Analysis, communication, judgment
13.14	Cash flows from financing activities	13-4	Analysis, communication, judgment
13.15	Real World: Home Depot, Inc.	13-1, 13-2, 13-4	Analysis, communication, judgment, research

CH 13-Overview (p.2)

Problems	Learning
Sets A, B	Objectives	Skills
13.1 A,B	Preparing a statement of cash flows—direct method (short)	13-2–13-4	Analysis
13.2 A,B	Investing activities	13-4	Analysis
13.3 A,B	Investing activities	13-4	Analysis, communication, judgment
13.4 A,B	Cash flow from operating activities—direct method	13-3, 13-8	Analysis, communication, judgment
13.5 A,B	Cash flow from operating activities—indirect method	13-6, 13-7	Analysis, communication, judgment
13.6 A,B	Preparing a statement of cash flows—direct method; comprehensive	13-2–13-4, 13-6, 13-8	Analysis, communication, judgment
13.7 A,B	Preparing a worksheet and statement of cash flows; evaluate the company’s liquidity-indirect method.	13-1–13-9	Analysis, communication, judgment
13.8 A,B	Preparing a worksheet and statement of cash flows; evaluate the company’s financial position—indirect method.	13-1–13-9	Analysis, communication, judgment
Critical Thinking Cases
13.1	Using a statement of cash flows	13-1	Analytical, communication, judgment
13.2	Budgeting at a personal level	13-1, 13-8	Analytical, communication, judgment
13.3	Window dressing; effects on net income and net cash flow	13-1, 13-4, 13-8	Analytical, communication, judgment
13.4	Peak pricing	13-8	Analytical, communication, judgment
13.5	Improving the Statement of Cash Flows (Ethics, fraud & corporate	13-3	Analytical, communication, judgment
governance)
13.6	Real World: Coca-Cola, Amazon.com Cash Flow Analysis	13-2–13-4	Analytical, communication, judgment, research
(Internet)

Description Problems

DESCRIPTIONS OF PROBLEMS AND CRITICAL THINKING CASES
Below are brief descriptions of each problem and case. These descriptions are accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time estimates assume use of the partially filled-in working papers.
Problems (Sets A and B)
13.1 A,B	Lambert Company/Welch Company	30 Medium
Prepare a statement of cash flows. Emphasis is on format of the statement, with computations held to a minimum. However, sufficient computations are required to assure that students are able to distinguish between cash flows and accrual basis measurements. Uses the direct method.
13.2 A,B	Hampton Inc./Mary's Fashions	25 Easy
Prepare the investing activities section of a statement of cash flows by analyzing changes in balance sheet accounts and gains and losses reported in the income statement.
13.3 A,B	Holmes Export Co./RPZ Imports	25 Easy
Prepare the investing activities section of a statement of cash flows. Problem demonstrates how this section of the financial statement can be prepared by analyzing income statement amounts and changes in balance sheet accounts.
13.4 A,B	Treece, Inc./Royce Interiors, Inc.	30 Medium
Prepare the operating activities section of a statement of cash flows from accounting records maintained using the accrual basis of accounting. Students also are to explain how more efficient asset management could increase cash flow provided by operating activities. Uses the direct method. (Problem 13–5 uses the same data but requires use of the indirect method.)
13.5 A,B	Treece, Inc. (Indirect)/Royce Interiors, Inc. (Indirect)	25 Medium
Using the data provided in Problem 13.4 A,B, prepare the operating activities section of a statement of cash flows using the indirect method.
13.6 A,B	21st Century Technologies/Foxboro Technologies	45 Strong
A comprehensive problem covering conversion from the accrual basis to the cash basis and preparation of a statement of cash flows. Uses the direct method.

*

Description Problems (p.2)

Problems (cont'd)
13.7 A,B	Satellite World/LGIN	60 Strong (P13.7A)
A comprehensive problem covering all learning objectives. P13.7A includes a worksheet, the indirect method, and analysis of the company’s financial position. P13.7B does not include a worksheet and uses the indirect method. We assign this to groups and let them deal with the worksheet mechanics on their own.	40 Strong (P13.7B)
13.8 A,B	Miracle Tool, Inc./Purcells, Inc.	60 Strong
A comprehensive problem covering all learning objectives. Includes a worksheet, the indirect method, and analysis of the company’s financial position. We assign this to groups and let them deal with the worksheet mechanics on their own.

*

Desc. of Cases

Critical Thinking Cases
13.1	Another Look at Allison Corporation	25 Strong
Students are asked to review the cash flow statement of Allison Corporation (the company used as an example throughout the chapter) and to evaluate the company’s ability to maintain its present level of dividends.
13.2	Cash Budgeting for You as a Student	15 Easy
A simple case that illustrates the usefulness of cash budgeting in the environment of a college student.
13.3	Lookin' Good?	45 Medium
An automobile manufacturer is in serious financial difficulty, and management is considering several proposals to increase reported net income and net cash flow. Students are asked to evaluate the probable effects of each proposal. This case can lead into an open-ended discussion of “window dressing” in annual statements.
13.4	Peak Pricing	15 Easy
Students are to discuss various aspects of peak pricing and discuss how it might be applied in specific situations. Also, they are to describe situations in which peak pricing might be considered unethical.
13.5	Improving the Statement of Cash Flows	20 Medium
Ethics, Fraud & Corporate Governance
Students explore the website of the Securities & Exchange Commission and locate a speech by an S.E.C. official in which suggestions for improving the statement of cash flows are discussed.
13.6	Comparing Cash Flow Information from Two Companies	30 Medium
Internet
Visit a website that actually provides assistance in preparing cash budgets and statements of cash flows.

Q1-5

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS
1.	The primary purpose of a statement of cash flows is to provide information about the cash receipts and cash payments of a business. A related purpose is to provide information about the investing and financing activities of the business.
2.	The income statement provides the better measurement of profitability, especially when the business
business is financially sound and short-run survival is not the critical issue. The statement of cash flows is designed for measuring solvency, not profitability. An income statement, on the other hand, is specifically designed to measure profitability but gives little indication of solvency.
3.	Examples of cash receipts and of cash payments in the three major classifications of a cash flow statement are shown below (two receipts and two payments required):
a.	Operating activities:
Receipts:
(1)	Cash received from customers.
(2)	Dividends and interest received.
Payments:
(1)	Cash paid to suppliers and employees.
(2)	Interest paid.
(3)	Income taxes paid.
b.	Investing activities:	c.	Financing activities:
Receipts:	Receipts:
(1)	Sales of investments.	(1)	Short-term or long-term borrowing.
(2)	Collecting loans.	(2)	Issuance of capital stock.
(3)	Sales of plant assets.	(3)	Sales of treasury stock.
Payments:	Payments:
(1)	Purchases of investments.	(1)	Repayment of debt.
(2)	Lending cash.	(2)	Purchase of treasury stock or retirement of outstanding shares.
(3)	Purchases of plant assets.
(3)	Payment of dividends.
4.	Net cash flow from operating activities generally reflects the cash effects of transactions entering into the determination of net income. Because interest revenue and interest expense enter into the determination of net income, these items are classified as operating activities.
5.	In the long run, it is most important for a business to have positive cash flows from operating activities. To a large extent, the ability of a business to generate positive cash flows from financing activities is dependent upon its ability to generate cash from operations. Investors are reluctant to invest money in a business that does not have an operating cash flow sufficient to assure interest and dividend payments.
Also, a business cannot sustain a positive cash flow from investing activities over the long run. A company can only sell productive assets for a limited period of time. In fact, a successful and growing company will often show a negative cash flow from investing activities, as the company is increasing its investment in plant assets.
7

Q6-10

6.	Among the classifications shown in the cash flow statement, a successful and growing company is least likely to report a positive cash flow from investing activities. A growing company is usually increasing its investment in plant assets, which generally leads to a negative cash flow from investing activities. In fact, negative cash flows from investing activities may be a very favorable sign for a growing business. If the company is successful and growing, however, the cash flows from operating activities and from financing activities usually are positive.
7.	Net income may differ from the net cash flows from operating activities as a result of such factors as:
(1)	Depreciation and other noncash expenses that enter into the determination of net income.
(2)	Short-term timing differences between the cash basis and accrual basis of accounting. These include changes in the amounts of accounts receivable, inventories, prepaid expenses, accounts payable, and accrued liabilities.
(3)	Nonoperating gains and losses that, although included in the measurement of net income, are attributable to investing or financing activities rather than to operating activities.
8.	The direct method identifies the major operating sources and uses of cash, using such captions as “Cash received from customers.” The indirect method, on the other hand, reconciles net income to the net cash flows from operating activities by showing a series of adjustments to the net income figure.
Both methods result in exactly the same net cash flows from operating activities.
9.	One purpose of a statement of cash flows is to provide information about all the investing and financing activities of a business. Although the acquisition of land by issuing capital stock does not involve a receipt or payment of cash, the transaction involves both investing and financing activities. Therefore, these activities are disclosed in a supplementary schedule that accompanies the statement of cash flows.
10.	The credit to the Land account indicates a sale of land and, therefore, a cash receipt. However, the $263,000 credit represents only the cost (book value) of the land that was sold. This amount must be adjusted by any gain or loss recognized on the sale in order to reflect the amount of cash received.

Q11-15

11.	Credits to paid-in capital accounts usually indicate the issuance of additional shares of capital stock. Assuming that these shares were issued for cash, the transaction would be presented in the financing activities section of a statement of cash flows as follows:
Proceeds from issuance of capital stock ($15,000,000 + $27,500,000) ……………	$ 42,500,000
12.	The amount of cash dividends paid during the current year may be determined as follows:
Dividends declared during the year …………………………………………….	$ 4,500,000
Add: Decrease during the year in the liability for dividends payable
($1,600,000 − $970,000) ……………………………………………………….	630,000
Dividends paid during the year …………………………………………………	$ 5,130,000
13.	Free cash flow is that portion of the net cash flow from operating activities that is available for discretionary purposes after the basic obligations of the business have been met.
From a short-term creditor’s point of view, free cash flow is a “buffer,” indicating that the business brings in more cash than it must have to meet recurring commitments. Long-term creditors view free cash flow as evidence of the company’s ability to meet interest payments and to accumulate funds for the eventual retirement of long-term debt.
From the stockholders’ viewpoint, free cash flow indicates a likelihood of future dividend increases or, perhaps, expansion of the business, which will increase future profitability.
Management views free cash flow positively because it is available for discretionary purposes rather than already committed to basic operations.
In summary, everyone associated with the business views free cash flow favorably—and the more, the better.
14.	Peak pricing means charging higher prices in periods in which customer demand exceeds the company’s capacity, and lower prices in “off-peak” periods. This serves the dual purposes of increasing revenue during peak periods, and allowing the business to serve more customers by shifting excess demand to off-peak periods.
Common examples include restaurants, which charge higher prices at dinner time, and movie theaters, which offer low matinee prices during the daytime.
15.	Speeding up the collection of accounts receivable does not increase the total amount collected. Rather, it merely shifts collections to an earlier time period. The only period(s) in which cash receipts actually increase are those in which collections under both the older and newer credit periods overlap.

BE13.1,2,3,4,5

SOLUTIONS TO BRIEF EXERCISES
B.Ex. 13.1
Cash flows from operating activities:
Cash received from customers	$270,000
Cash received for interest and dividends	50,000
Cash paid to suppliers and employees	(127,000)
Net cash provided by operating activities	$193,000
B.Ex. 13.2	Net income	$470,000
Adjustments to reconcile net income to net cash from operations:
Depreciation expense	$67,000
Increase in accounts receivable	(35,000)
Increase in accounts payable	56,000	88,000
Net cash provided by operating activities	$558,000
B.Ex. 13.3
Cash flows from operating activities:
Cash received from customers	$750,000
Cash paid to purchase inventory	(345,000)
Cash paid to employees	(230,000)
Net cash provided by operating activities	$175,000
B.Ex. 13.4	Net income	$722,000
Adjustments to reconcile net income to net cash from operations:
Increase in accounts receivable	$(50,000)
Decrease in inventory	23,000
Decrease in accounts payable	(55,000)
Increase in accrued expenses payable	14,000	(68,000)
Net cash provided by operating activities	$654,000
B.Ex. 13.5
Cash used for investing activities:
Cash paid for investments	$(55,000)
Cash paid for plant assets	(147,000)
Cash received for plant assets	66,000
Net cash used for investing activities	$(136,000)

BE13.6,7,8,9,10

B.Ex. 13.6
Cash received from sale of common stock	$560,000
Cash received from sale of preferred stock	56,000
Cash paid to purchase treasury stock	(47,000)
Cash paid for dividends	(24,000)
Net cash provided by financing activities	$545,000
B.Ex. 13.7	Cash payments for purchases:
Cost of goods sold	$100,800
Add: Increase in merchandise inventory
($43,000 – $35,000)	8,000
Deduct: Increase in accounts payable
($32,000 – $23,000)	(9,000)
Net cash provided by financing activities	$99,800
B.Ex. 13.8
Cash balance at the beginning of the year:
Ending balance	$155,000
Add: Cash used in investing activities	67,000
Deduct: Cash provided by operating activities	(145,000)
Cash provided by financing activities	(10,000)
$67,000
B.Ex. 13.9
Net income	$68,000
Adjustments to reconcile net income to net cash from operations:
Depreciation expense	$15,000
Increase in accounts receivable	(4,000)
Decrease in inventory	6,000
Increase in accounts payable	3,000
Decrease in accrued expenses payable	(2,000)
Net cash provided by operating activities	$86,000
B.Ex. 13.10	Maines, Inc.
Statement of Cash Flows
For year ended _____________
Cash flows provided by operating activities	$136,000
Cash flows used in investing activities	(56,000)
Cash flows used in financing activities	(34,000)
Change in cash	$46,000
Cash, beginning of year	72,000
Cash, end of year	$118,000

E13.1,2

SOLUTIONS TO EXERCISES
Ex. 13.1	a.	The operating activities section generally includes the cash provided by and used for those transactions that are normal, ongoing operations and that included in the determination of net income. The investing activities section includes cash provided by and used for the purchase and disposal of assets that are not held for resale, primarily investments, and plant and intangible assets. Financing activities generally include cash provided by and used for debt and equity financing transactions.
b.	Wallace Company's cash increased significantly during the year, going from $75,000 to $255,000. Operations were strong, providing $275,000 of positive cash flow. Based on the limited information provided, interpreting the use of $140,000 for investing activities is difficult, but one possible positive interpretation is that the company is preparing for the future by acquiring additional plant and other assets that will be required. The increase in cash of $45,000 from financing activities indicates that the company is expanding its financing in some ways, probably some combination of selling bonds or other debt securities and selling common, preferred, or treasury stock. While the limited information presented makes substantive interpretation of the overall cash picture highly speculative, it is clear that the company has a much larger cash balance at the end than at the beginning of the year and that the increase is tied directly to its success in generating cash from its ongoing, normal operations.
Ex. 13.2
a.	Cash from operations …………………………………………………………………	$ 280,000
Expenditures for property and equipment …………………………………………..	(30,000)
Dividends paid …………………………………………………………………………	(140,000)
Free cash flow ………………………………………………………………………….	$ 110,000
b.	The major sources and uses of cash from financing activities during 2018 were:
Source: ……………………………………………………………………………………	none
Use: Dividend paid ………………………………………………………………	$ 140,000
Use: Retirement of Debt ……………………………………………………………	$ 150,000
Financing activities resulted in a decline in cash of $290,000.
c.	Cash and cash equivalents decreased by $5,000, moving the cash balance from $50,000 to $45,000. The company paid dividends of $140,000, and appears to be in a relatively strong cash position should it decide to pay dividends in the future.
d.	(1)	The gain on the sale of marketable securities represents a reclassification of this item from the operating activities section of the statement of cash flows to the investing activities section of the statement of cash flows. If a gain is present, as in 2018, it is deducted to effectively remove the item from net income; if a loss has been present, it would have been added to effectively remove it from net income.

E13.2,3,4,5,6

(2)	The increase in accounts receivable represents credit sales which were not collected in 2018. In the indirect method calculation, this item is a decrease in the amount of cash provided by net income because the sale was recognized in determining net income, but the cash was not received in 2018.
Ex. 13.3	a.	Purchases of marketable securities ……………………………………………..	$125,000
b.	Proceeds from sales of marketable securities ($140,000 book
value less $25,000 loss) ………………………………………………………………	$115,000
Ex. 13.4	a.	(1)	Net sales:
Cash sales ………………………………………………………………	$289,000
Credit sales ………………………………………………………………	472,000
Net sales reported as revenue in the income statement	$761,000
(2)	Cash received from collecting accounts receivable:
Credit sales ……………………………………………………………	$472,000
Add: Decrease in accounts receivable ……………………………….	32,000
Collections of accounts receivable ……………………………………	$504,000
(3)	Cash received from customers:
Net sales (includes cash sales and credit sales) …………	$761,000
Add: Decrease in accounts receivable …………………………………	32,000
Cash received from customers ……………………………………….	$793,000
b.	Cash received from customers has two elements: (1) cash sales and (2) collections of accounts receivable. For cash sales, the amounts of sales and cash receipts are the same. However, collections on accounts receivable differ from the amount of credit sales. If accounts receivable increased, credit sales for the period exceeded cash collections on these accounts. If, however, accounts receivable decreased, cash collections of accounts receivable exceeded credit sales. In other words, cash received from customers may be greater or less than the amount of net sales.
Ex. 13.5	Cash payments to suppliers of merchandise:
Cost of goods sold …………………………………………………………..	$ 2,882,000
Add:	Increase in inventory ($820,000 − $780,000) ……………..	$40,000
Decrease in accounts payable ($500,000 − $430,000)	70,000	110,000
Cash payments to suppliers of merchandise ………………….	$ 2,992,000
Ex. 13.6	The new loans made ($17 million) will appear among the financing activities of the company as a positive cash flow. The $2 million of loans paid off will be a negative cash flow in the financing activities section. The interest paid, $1.5 million, will appear as a negative cash flow from operating activities.

E13.7,8

Ex. 13.7	WYOMING OUTFITTERS, INC.
Statement of Cash Flows
For the Year Ended December 31, Current Year
Cash flows from operating activities:
Cash received from customers ……………………………………	$ 795,000
Interest and dividends received ………………………………….	27,000
Cash provided by operating activities ………………………..	$ 822,000
Cash paid to suppliers and employees …………………………..	(635,000)
Interest paid ……………………………………………………….	(19,000)
Income taxes paid …………………………………………………..	(71,000)
Cash disbursed for operating activities ……………………….	(725,000)
Net cash flow from operating activities	$ 97,000
Cash flows from investing activities:
Loans made to borrowers …………………………………………	$ (5,000)
Collections on loans ……………………………………………….	4,000
Cash paid to acquire plant assets ………………………………..	(21,000)
Proceeds from sales of plant assets ………………………………	9,000
Net cash used for investing activities …………………………………	(13,000)
Cash flows from financing activities:
Proceeds from short-term borrowing …………………………….	$ 10,000
Dividends paid ……………………………………………………..	(55,000)
Net cash used for financing activities ………………………………………………..	(45,000)
Net increase in cash and cash equivalents …………………………….	$ 39,000
Cash and cash equivalents, January 1, 20__ …………………….	35,800
Cash and cash equivalents, December 31, 20__ ………………………………	$ 74,800
Ex. 13.8	a.	(1)	Expenditures for R&D are an operating activity. In the short term, reducing these expenditures will increase the net cash flow from operating activities.
(2)	In the long run, reducing expenditures for R&D may reduce cash flows from operations by reducing the number of new products the company brings to market.
b.	Selling to customers using bank credit cards taps a new market of potential customers. This should increase sales and cash receipts in both the short and long term.
c.	(1)	Reducing inventory will lessen expenditures for inventory purchases during the time that inventory levels decline. This will improve the net cash flow from operating activities in the near term.
(2)	Once inventory has stabilized at the new and lower level, monthly expenditures will become approximately equal to the inventory used. This strategy will not affect cash flows once inventory has stabilized.
d.	(1)	Deferring taxes can postpone taxes each year. For a growing business, this can reduce annual cash outlays year after year. It can increase net cash flows over both the short and long terms.
(2)	At some point in the future, the early deferrals will require payment, causing the cash paid to stabilize, much like c. (2) above.

E13.9

	e.	Dividends are a financing activity, not an operating activity. Therefore, discontinuing dividends has no direct effect upon the net cash flow from operating activities. Over the long term, however, the business may increase its cash flows by investing the cash that it retains.
Ex. 13.9	a.	Added to net income. In a statement of cash flows, the uninsured loss from fire is classified as an investing activity, not an operating activity. The loss reduces the amount of cash provided by net income reported in the income statement. Therefore, this loss is added back to net income as a step in determining the net cash flows from operating activities.
b.	Added to net income. Depreciation is a noncash expense. Although it reduces the net income for the period, no cash outlay is required. Thus, to the extent of noncash expenses recorded during the period, net income is less than the amount of net cash flow.
c.	Omitted from the computation. The transfer of cash from a bank account to a money market fund has no effect on net income. Also, as a money market fund is a cash equivalent, this transfer is not regarded as a cash transaction.
d.	Deducted from net income. An increase over the year in the amount of accounts receivable indicates that revenue recognized in the income statement (credit sales) exceeds the collections of cash from credit customers. Therefore, net income is reduced by the increase in receivables which has not yet been collected.
e.	Omitted from the computation. Cash received from customers is a cash inflow shown in the direct method of computing net cash flow from operating activities. However, this cash inflow does not appear separately when the indirect method is used.
f.	Added to net income. A reduction in prepaid expenses indicates that the amounts expiring (and, therefore, being recognized as expense) exceed cash outlays for these items during the period. Net income measured on the accrual basis is lower than net cash flow.
g.	Omitted from the computation. Declarations and payments of dividends do not enter into the determination of either net income or net cash flows from operating activities. Therefore, these transactions do not cause a difference between these figures. Dividends paid are reported in the financing activities section as a disbursement.
h.	Added to net income. An increase in accounts payable means that purchases of merchandise, measured on the accrual basis, exceed the payments during the period made to suppliers. Costs and expenses measured on the accrual basis were greater than the actual cash payments during the period.
i.	Deducted from net income. The $2 million reduction in accrued income taxes payable means that cash payments to tax authorities exceeded by $2 million the income tax expense of the current year. Therefore, cash outlays exceeded the expenses shown in the income statement, and net cash flow from operating activities is smaller than net income.

E13.10, 11

Ex. 13.10	FREEMAN MACHINERY, INC.
Partial Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Net income ……………………………………………………………………………….	$ 385,000
Add:	Depreciation expense ……………………………………………………..	$135,000
Amortization of intangible assets …………………………………………	40,000
Nonoperating loss on sale of investments …….	35,000
Decrease in accounts receivable ………………………………………….	45,000
Decrease in inventory ……………………………………………………..	72,000
Increase in accrued expenses payable …………………………………..	25,000	352,000
Subtotal ……………………………………………………………………………..	$ 737,000
Less:	Nonoperating gain on sale of plant assets…….	$90,000
Increase in prepaid expenses ……………………………………………….	$9,000
Decrease in accounts payable ……………………………………………..	31,000	130,000
Net cash flow from operating activities …………………………………………….	$ 607,000
Ex. 13.11
a.	Operating activity
b.	Financing activity
c.	Operating activity
d.	Financing activity
e.	Operating activity
f.	Operating activity
g.	Not included in the statement of cash flows. A money market fund is viewed as a cash equivalent. Therefore, transfers between bank accounts and money market funds are not viewed as cash receipts or cash payments.
h.	Investing activity
i.	Not included in a statement of cash flows prepared by the direct method. Depreciation is a noncash expense; recording depreciation does not require any cash outlay within the accounting period.
j.	Operating activity
k.	Financing activity
l.	Operating activity
m.	Operating activity
n.	Investing activity
o.	Not included in the statement of cash flows. Transfers between cash equivalents and other forms of cash are not regarded as cash receipts or cash payments.

E13.12

Ex. 13.12
1.	Operating activity
2.	Financing activity
3.	Operating activity
4.	Financing activity
5.	Operating activity
6.	Operating activity
7.	Not included in the statement of cash flows. A money market fund is viewed as a cash equivalent. Therefore, transfers between bank accounts and money market funds are not viewed as cash receipts or cash payments.
8.	Investing activity
9.	Not included in a statement of cash flows prepared by the direct method. Amortization is a noncash expense; recording amortization does not require any cash outlay within the accounting period.
10.	Operating activity
11.	Financing activity
12.	Operating activity
13.	Operating activity
14.	Investing activity
15.	Not included in the statement of cash flows. Transfers between cash equivalents and other forms of cash are not regarded as cash receipts or cash payments.

E13.13

Ex. 13.13	a.	Cash provided by investing activities:
$156,000
Sale of land	$160,000
Purchase of equipment	(178,000)
$138,000
b.	The amount of gain or loss is reflected in the cash receipts figure. For example, equipment that was sold for $156,000 at a $34,000 loss had a book value (cost, less accumulated depreciation) at the time of sale of $190,000:
Cost, less accumulated depreciation	$190,000
Cash received from sale	(156,000)
Loss on sale	$34,000
Similarly, land that was sold for $160,000 at a $50,000 gain had a cost of $110,000:
Cash received from sale	$160,000
Cost	(110,000)
Gain on sale	$50,000
Using the amount of cash received in the calculation of cash provided by investing activities automatically incorporates the gain or loss on the sale.
c.	The following items were excluded because they are financing activities, not investing activities:
●	Cash receipts from sale of common stock
●	Cash payments to purchase treasury stock, retire debt, and pay dividends on preferred and common stock

E13.14

Ex. 13.14	a.	Cash
Sale of bonds	$420,000
Sale of treasury stock	52,000
Dividends on common stock	(60,000)
Purchase of treasury stock	(20,000)
Net cash provided by financing activities	$392,000
b.	The following items were excluded from the above calculations because they are classified as indicated below in the statement of cash flows:
Classified as operating activities:
●	Cash received from customers
●	Cash received from interest and dividends received
●	Cash paid to employees
●	Cash paid to purchase inventory
●	Cash paid for interest expense
Classified as investing activities:
●	Cash received from sale of equipment
c.	While an argument could be made that interest expense should be classified as a financing activity in the statement of cash flows, the Financial Accounting Standards Board has ruled that interest expense should be in the operating activities category. The primary justification for this classification is that interest expense is an ordinary cost of doing business and is included in the determination of net income.

E13.15

Ex. 13.15
a.	Net earnings for 2015 (year ending January 31, 2016) were $7,009 million, compared with $9,373 million cash provided by operations. The primary cause of the difference is depreciation and amortization, which accounts for $1,683 million of the difference. The majority of the remaining difference is attributed to changes in current assets and current liabilities, including receivables, merchandise inventory, accounts payable, accrued liabilities, deferred revenues, and income taxes payable.
b.	The major uses of cash, other than operations, are as follows:

From investing activities: capital expenditures (i.e., purchases of property, plant and equipment), and business acquisitions.
From financing activities: repurchase of (common) treasury stock and payment of dividends to stockholders.

c.	Negative cash flows from investing and financing activities do not necessarily lead to a negative interpretation of a company's cash position. In Home Depot's case in 2013-2015, strong positive operating cash flows have been invested in capital expenditures (which represent growth and future strength), as well as reacquisition of outstanding common stock and the payment of dividends to stockholders. In fact, the company's cash position appears quite strong. Rather than the negative cash flow amounts from investing and financing activities being viewed as negative, they should be considered positive in terms of the company’s future.
d.	Free cash flow for the three years is determined as follows (in millions):
2015	2014	2013
Net cash from operations	$ 9,373	$ 8,242	$ 7,628
Cash invested in property,
plant, and equipment	(1,503)	(1,442)	(1,389)
Cash paid for dividends	(3,031)	(2,530)	(2,243)
$ 4,839	$ 4,270		$ 3,996
The general trend in free cash flow is positive-steady cash provided by operations, strong investment in new assets and steady dividends to stockholders. In general, the company appears to be in a strong cash position.

P13.1A

SOLUTIONS TO PROBLEM SET A
30 Minutes, Medium	PROBLEM 13.1A
	LAMBERT COMPANY
a.
LAMBERT COMPANY
Statement of Cash Flows
For the Year Ended December 31, Current Year
Cash flows from operating activities:
Cash received from customers (1)	$ 3,025,000
Interest and dividends received	100,000
Cash provided by operating activities	$ 3,125,000
Cash paid to suppliers and employees (2)	$ (2,550,000)
Interest paid	(180,000)
Income taxes paid	(95,000)
Cash disbursed for operating activities	(2,825,000)
Net cash flow from operating activities	$ 300,000

Cash flows from investing activities:
Loans made to borrowers	(500,000)
Collections on loans	260,000
Cash paid to acquire plant assets	(3,100,000)
Proceeds from sales of plant assets (3)	580,000
Net cash used in investing activities:	(2,760,000)

Cash flows from financing activities:
Proceeds from issuing bonds payable	$ 2,500,000
Dividends paid	(120,000)
Net cash provided by financing activities		2,380,000

Net increase (decrease) in cash and cash equivalents	(80,000)
Cash and cash equivalents, beginning of year	512,000
Cash and cash equivalents, end of year	$ 432,000

Supporting computations:
(1)	Cash received from customers:
Cash sales	$ 825,000
Collections on accounts receivable	2,200,000
Cash received from customers	$ 3,025,000
(2)	Cash paid to suppliers and employees:
Payments on accounts payable to merchandise suppliers
merchandise suppliers	$ 1,500,000
Cash payments for operating expenses	1,050,000
Cash paid to suppliers and employees	$ 2,550,000
(3)	Proceeds from sales of plant assets:
Book value of plant assets sold	$ 660,000
Less: Loss on sales of plant assets	80,000
Proceeds from sales of plant assets	$ 580,000
Note to instructor: The transfer from the money market fund to the general bank account is not considered a cash receipt because a money market fund is a cash equivalent.

P13.2A

25 Minutes, Easy	PROBLEM 13.2A
	HAMPTON, INC.
a.
HAMPTON, INC.
Partial Statement of Cash Flows
For the Year Ended December 31, Current Year
Cash flows from investing activities:
Purchases of marketable securities	$ (75,000)
Proceeds from sales of marketable securities (1)	132,000
Loans made to borrowers	(210,000)
Collections on loans	162,000
Cash paid to acquire plant assets (see part b)	(60,000)
Proceeds from sales of plant assets (2)	12,000
Net cash used for investing activities	$ (39,000)
Supporting computations:
(1)	Proceeds from sales of marketable securities:
Cost of securities sold (credit entries to
Marketable Securities account)	$ 90,000
Add: Gain on sales of marketable securities	42,000
Proceeds from sales of marketable securities	$ 132,000

(2)	Proceeds from sales of plant assets:
Cost of plant assets sold or retired	$ 120,000
Less: Accumulated depreciation on plant assets
sold or retired	75,000
Book value of plant assets sold or retired	$ 45,000
Less: Loss on sales of plant assets	33,000
Proceeds from sales of plant assets	$ 12,000
b.
Schedule of noncash investing and financing activities:
Purchases of plant assets	$ 196,000
Less: Portion financed through issuance of long-term debt	136,000
Cash paid to acquire plant assets	60,000

c.	Cash must be generated to cover the company’s investment needs through operating or financing activities. Ideally, cash to support investing activities should come from normal operations. If this places undue strain on the company’s operations, however, financing via borrowing and/or sale of capital stock are alternatives the company should consider.

P13.3A

25 Minutes, Easy	PROBLEM 13.3A
	HOLMES EXPORT CO.
a.
HOLMES EXPORT CO.
Partial Statement of Cash Flows
For the Year Ended December 31, Current Year
Cash flows from investing activities:
Purchases of marketable securities	$ (78,000)
Proceeds from sales of marketable securities (1)	46,000
Loans made to borrowers	(55,000)
Collections on loans	62,000
Cash paid to acquire plant assets (see part b)	(60,000)
Proceeds from sales of plant assets (2)	52,000
Net cash used in investing activities	$ (33,000)
Supporting computations:
(1)	Proceeds from sales of marketable securities:
Cost of securities sold (credit entries to
Marketable Securities account)	$ 62,000
Less: Loss on sales of marketable securities	16,000
Proceeds from sales of marketable securities	$ 46,000

(2)	Proceeds from sales of plant assets:
Cost of plant assets sold or retired	$ 140,000
Less: Accumulated depreciation on plant assets
sold or retired	100,000
Book value of plant assets sold or retired	$ 40,000
Add: Gain on sales of plant assets	12,000
Proceeds from sales of plant assets	$ 52,000
b.
Schedule of noncash investing and financing activities:
Purchases of plant assets	$ 170,000
Less: Portion financed through issuance of long-term debt	110,000
Cash paid to acquire plant assets	$ 60,000

c.	Management has more control over the timing and amount of outlays for investing activities than for operating activities. Many of the outlays for operating activities are contractual, reflecting payroll agreements, purchase invoices, taxes, and monthly bills. Most investing activities, in contrast, are discretionary—both as to timing and dollar amount.

P13.4A

30 Minutes, Medium	PROBLEM 13.4A
	TREECE, INC.
a.
TREECE, INC.
Partial Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Cash received from customers (1)	$ 2,920,000
Interest and dividends received (2)	171,000
Cash provided by operating activities		$ 3,091,000
Cash paid to suppliers and employees (3)	$ (2,476,000)
Interest paid (4)	(176,000)
Income taxes paid (5)	(103,000)
Cash disbursed for operating activities		(2,755,000)
Net cash flow from operating activities		$ 336,000

(1)	Cash received from customers:
Net sales		$ 2,850,000
Add: Decrease in accounts receivable		70,000
Cash received from customers		$ 2,920,000
(2)	Interest and dividends received:
Dividend income (cash basis)	$ 104,000
Interest income	70,000
Subtotal	$ 174,000
Less: Increase in accrued interest receivable	3,000
Interest and dividends received	$ 171,000
(3)	Cash paid to suppliers and employees:
Cash paid to suppliers of merchandise:
Cost of goods sold	$ 1,550,000
Add: Increase in inventories	35,000
Net purchases	$ 1,585,000
Less: Increase in accounts payable to suppliers	8,000
Cash paid to suppliers of merchandise	$ 1,577,000
Cash paid for operating expenses:
Operating expenses	$ 980,000
Less: Depreciation expense	115,000
Subtotal	$ 865,000
Add: Increase in short-term prepayments	5,000
Add: Decrease in accrued operating expenses payable	29,000
	899,000
Cash paid to suppliers and employees	$ 2,476,000
(4)	Interest paid:
Interest expense	$ 185,000
Less: Increase in accrued interest payable	9,000
Interest paid	$ 176,000
(5)	Income taxes paid:
Income tax expense	$ 90,000
Add: Decrease in accrued income taxes payable		13,000
Income taxes paid		$ 103,000

P13.4A (p.2)

	PROBLEM 13.4A
	TREECE, INC. (concluded)
b.	In addition to more aggressive collection of accounts receivable, management could increase cash flows from operations by (only two required):
· Reducing the amount of inventories being held.
· Reducing the amount of short-term prepayments of expenses.
· Taking greater advantage of accounts payable as a short-term means of financing purchases of goods and services.

P13.5A

25 Minutes, Medium	PROBLEM 13.5A
	TREECE, INC. (INDIRECT)

TREECE, INC.
Partial Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Net income		$ 223,000
Add:	Depreciation expense	$ 115,000
Decrease in accounts receivable	70,000
Increase in accounts payable to suppliers	8,000
Increase in accrued interest payable	9,000	202,000
Subtotal	$ 425,000
Less:	Increase in accrued interest receivable	$ 3,000
Increase in inventories	35,000
Increase in short-term prepayments	5,000
Decrease in accrued operating expenses payable	29,000
Decrease in accrued income taxes payable	13,000
Gain on sales of marketable securities	4,000	89,000
Net cash flow from operating activities	$ 336,000


Credit sales cause receivables to increase, while collections cause them to decline. If receivables decline over the year, collections during the year must have exceeded credit sales for the year. Thus, cash receipts exceed revenue measured on the accrual basis.

P13.6A

45 Minutes, Strong	PROBLEM 13.6A
	21st CENTURY TECHNOLOGIES
a.
21st CENTURY TECHNOLOGIES
Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Cash received from customers (1)	$ 3,140,000
Interest received (2)	42,000
Cash provided by operating activities	3,182,000
Cash paid to suppliers and employees (3)	$ (2,680,000)
Interest paid (4)	(38,000)
Income taxes paid (5)	(114,000)
Cash disbursed for operating activities	(2,832,000)
Net cash flow from operating activities	$ 350,000

Cash flows from investing activities:
Purchases of marketable securities	$ (60,000)
Proceeds from sales of marketable securities (6)	72,000
Loans made to borrowers	(44,000)
Collections on loans	28,000
Cash paid to acquire plant assets	(500,000)
Proceeds from sales of plant assets (7)	24,000
Net cash used in investing activities:		(480,000)

Cash flows from financing activities:
Proceeds from short-term borrowing	$ 82,000
Payments to settle short-term debts	(92,000)
Proceeds from issuing common stock (8)	180,000
Dividends paid	(120,000)
Net cash provided for financing activities		50,000

Net increase (decrease) in cash and cash equivalents	$ (80,000)
Cash and cash equivalents, January 1, 2018	244,000
Cash and cash equivalents, December 31, 2018	$ 164,000


Supporting computations:
(1)	Cash received from customers:
Net sales	$ 3,200,000
Less: increase in accounts receivable	60,000
Cash received from customers	$ 3,140,000
(2)	Interest received:
Interest revenue	$ 40,000
Add: Decrease in accrued interest receivable	2,000
Interest received	$ 42,000

P13.6A (p.2)

	PROBLEM 13.6A
	21st CENTURY TECHNOLOGIES
a.	(continued)



(3)	Cash paid to suppliers and employees:
Cash paid for purchases of merchandise:
Cost of goods sold		$ 1,620,000
Less: Decrease in inventory		60,000
Net purchases		1,560,000
Add: Decrease in accounts payable to suppliers		16,000
Cash paid for purchases of merchandise		$ 1,576,000
Cash paid for operating expenses:
Operating expenses	$ 1,240,000
Less: Depreciation (a noncash expense)	150,000
Subtotal	1,090,000
Add: Increase in prepayments	6,000
Add: Decrease in accrued liab. for operating expenses	8,000
Cash paid for operating expenses		1,104,000
Cash paid to suppliers and employees
($1,576,000 + $1,104,000)		$ 2,680,000
(4)	Interest paid:
Interest expense		$ 42,000
Less: Increase in accrued interest payable		4,000
Interest paid		$ 38,000

(5)	Income taxes paid:
Income tax expense		$ 100,000
Add: Decrease in income taxes payable		14,000
Income taxes paid		$ 114,000

(6)	Proceeds from sales of marketable securities:
Cost of marketable securities sold (credit entries
to the Marketable Securities account)		$ 38,000
Add: Gain reported on sales of marketable securities		34,000
Proceeds from sales of marketable securities		$ 72,000

(7)	Proceeds from sales of plant assets:
Book value of plant assets sold (paragraph 8)		$ 36,000
Less: Loss reported on sales of plant assets		12,000
Proceeds from sales of plant assets		$ 24,000

(8)	Proceeds from issuing capital stock:
Amounts credited to Capital Stock account		$ 20,000
Add: Amounts credited to Additional Paid-in
Capital account	160,000
Proceeds from issuing capital stock	$ 180,000

P13.6A (p.3)

	PROBLEM 13.6A
	21st CENTURY TECHNOLOGIES (concluded)
b.	(1)	The primary reason why cash provided by operating activities substantially exceeded net income was the company’s $150,000 in depreciation expense. Depreciation reduces net income, but does not affect the cash flows from operating activities.
(2)	The primary reason for the net decrease in cash was the large cash outlays for investing activities—specifically, the cash paid to acquire plant assets.
c.	To the extent that receivables increase, the company has not yet collected cash from its customers. If the growth in receivables had been limited to $10,000, instead of $60,000, the company would have collected an additional $50,000 from its customers. Thus, the net decrease in cash (and cash equivalents) would have been $30,000, instead of $80,000.

P13.7A

60 Minutes, Strong	PROBLEM 13.7A
	SATELLITE WORLD
a.
SATELLITE WORLD
Worksheet for a Statement of Cash Flows
For the Year Ended December 31, 2018
Balance sheet effects:	Effect of Transactions
	Beginning	Debit	Credit	Ending
	Balance	Changes	Changes	Balance
Assets
Cash and cash equivalents	80,000		(x)	43,000	37,000
Accounts receivable	100,000	(3)	750,000		850,000
Plant and equipment (net of
accumulated depreciation)	600,000	(6)	2,200,000	(2)	147,000	2,653,000
Totals	780,000					3,540,000

Liabilities & Owners' Equity
Notes payable (short-term)	0	(7)	1,450,000	1,450,000
Accounts payable	30,000	(4)	33,000	63,000
Accrued expenses payable	45,000	(5)	13,000	32,000
Notes payable (long-term)	390,000			(6)	350,000	740,000
Capital stock (no par)	200,000	(8)	500,000	700,000
Retained earnings	115,000	(1)	440,000	555,000
Totals	=SUM(f10.f18)	780,000	2,963,000	2,963,000	3,540,000
Cash effects:	Sources	Uses
Operating activities:
Net income	(1)	440,000
Depreciation expense	(2)	147,000
Increase in accounts receivable	(3)	750,000
Increase in accounts payable	(4)	33,000
Decrease in accrued
expenses payable	(5)	13,000
Investing activities:
Cash paid for plant assets	(6)	1,850,000
Financing activities:
Short-term borrowing	(7)	1,450,000
Issuance of capital stock	(8)	500,000
Subtotals	2,570,000	2,613,000
Net decrease in cash	(x)	43,000
Totals	2,613,000	2,613,000

P13.7A (p.2)

	PROBLEM 13.7A
	SATELLITE WORLD (continued)
b.
SATELLITE WORLD
Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Net income		$ 440,000
Add:	Depreciation expense		147,000
Increase in accounts payable		33,000
Subtotal	$ 620,000
Less:	Increase in accounts receivable	$ 750,000
Decrease in accrued expenses payable	13,000	763,000
Net cash provided by (used in) operating activities	$ (143,000)
Cash flows from investing activities:
Cash paid to acquire plants assets (see schedule)	$ 1,850,000
Net cash used for investing activities	(1,850,000)
Cash flows from financing activities:
Short-term borrowing from bank	$ 1,450,000
Issuance of capital stock	500,000
Net cash provided by financing activities	1,950,000
Net increase (decrease) in cash	$ (43,000)
Cash and cash equivalents, January 1, 2018	80,000
Cash and cash equivalents, Dec. 31, 2018	$ 37,000
Supplementary Schedule: Noncash Investing and Financing Activities
Purchase of plant assets	$ 2,200,000
Less: Portion financed by issuing long-term notes payable	350,000
Cash paid to acquire plant assets	$ 1,850,000

P13.7A(p.3)

	PROBLEM 13.7A
	SATELLITE WORLD (concluded)

c.	Satellite World's credit sales resulted in $750,000 in new receivables, which were uncollected as of year-end. These credit sales all were included in the computation of net income, but those that remained uncollected at year-end do not represent cash receipts. Therefore, the cash flow from operating activities was substantially below the amount of net income measured on the accrual basis.
Note to instructor: It is not uncommon for cash flows to lag behind a rising net income figure in a growing business. This is why many rapidly growing businesses find themselves “strapped for cash” to finance their growth even if they are profitable.
d.	Satellite World does not appear headed for insolvency. First, the company has a $5.5 million line of credit, against which it has drawn only $1,450,000. This gives the company considerable debt-paying ability. Next, if Satellite World’s rapid growth continues, the company should not have difficulty issuing additional capital stock to investors as a means of raising cash. If a company is obviously successful, it usually is able to raise the cash necessary to finance expanding operations.

P13.8A

60 Minutes, Strong	PROBLEM 13.8A
	MIRACLE TOOL, INC.
a.
MIRACLE TOOL, INC.
Worksheet for a Statement of Cash Flows
For the Year Ended December 31, 2018
Balance sheet effects:
	Beginning	Debit	Credit	Ending
	Balance	Changes	Changes	Balance
Assets
Cash and cash equivalents	10,000	(x)	50,000			60,000
Marketable securities	20,000	(8)	15,000	5,000
Accounts receivable	40,000	(4)	17,000	23,000
Inventories	120,000	(5)	2,000	122,000
Plant and equipment (net of
accumulated depreciation)	300,000	(9)	20,000	(3)	35,000	285,000
Totals	490,000					495,000

Liabilities & Owners' Equity
Accounts payable	50,000	(6)	23,000	73,000
Accrued expenses payable	17,000	(7)	3,000	14,000
Notes payable	245,000	(10)	10,000	(9)	18,000	253,000
Capital stock	120,000	(11)	15,000	135,000
Retained earnings	58,000	(1)	34,000	20,000
		(2)	4,000
Totals		490,000	123,000	123,000	495,000
Cash effects:	Sources	Uses
Operating activities:
Net loss			(1)	34,000
Depreciation expense	(3)	35,000
Decrease in accounts receivable	(4)	17,000
Increase in inventory	(5)	2,000
Increase in accounts payable	(6)	23,000
Decrease in accrued	(7)	3,000
expenses payable
Loss on sale of marketable
securities	(8)	1,000
Investing activities:
Proceeds from sale of
marketable securities	(8)	14,000
Cash paid for plant assets	(9)	2,000
Financing activities
Dividends paid	(2)	4,000
Payment of note payable			(10)	10,000
Issuance of capital stock	(11)	15,000
Subtotals	105,000	55,000
Net increase in cash			(x)	50,000
Totals	105,000	105,000

P13.8A (p.2)

	PROBLEM 13.8A
	MIRACLE TOOL, INC. (continued)
b.
MIRACLE TOOL, INC.
Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Net loss		$ (34,000)
Add:	Depreciation expense		35,000
Decrease in accounts receivable	17,000
Increase in accounts payable	23,000
Loss on sale of marketable securities		1,000
Subtotal	$ 42,000
Less:	Increase in inventory	$ 2,000
Decrease in accrued expenses	3,000	5,000
Net cash provided by operating activities	$ 37,000
Cash flows from investing activities:
Proceeds from sale of marketable securities	$ 14,000
Cash paid to acquire plants assets (see supplementary schedule)	(2,000)
Net cash used in investing activities	12,000
Cash flows from financing activities:
Dividends paid	$ (4,000)
Payment of note payable	(10,000)
Issuance of capital stock	15,000
Net cash provided for financing activities	1,000

Net increase (decrease) in cash	$ 50,000
Cash and cash equivalents, January 1, 2018	10,000
Cash and cash equivalents, Dec. 31, 2018	$ 60,000
Supplementary Schedule: Noncash Investing and Financing Activities
Purchase of plant assets	$ 20,000
Less: Portion financed through issuance of long-term debt	18,000
Cash paid to acquire plant assets	$ 2,000

P13.8A(p.3)

	PROBLEM 13.8A
	MIRACLE TOOL, INC. (continued)

c.	Miracle Tool, Inc. achieved its positive cash flow from operating activities basically by liquidating assets and by not paying its bills. It has converted most of its accounts receivable into cash, which probably means that credit sales have declined substantially over the past several months. A decrease in sales shows up in the income statement immediately, but may take months before its effects appear in a statement of cash flows.
Miracle Tool, Inc. is not replacing plant assets as quickly as these assets are being depreciated. In any given year, this may not be significant. But on the other hand, this relationship certainly indicates that the business is not expanding, and it may indicate that the company is deferring replacements of plant assets in an effort to conserve cash.
Miracle Tool, Inc. is allowing its accounts payable to rise much more quickly than it is increasing inventory. This indicates that the company is not paying its bills as quickly as it used to. While this conserves cash, the “savings” are temporary. Also, if the company’s credit rating is damaged, this strategy may reduce both earnings and cash flows in the near future.
d.	Miracle Tool, Inc. has substantially more cash than it did a year ago. Nonetheless, the company’s financial position appears to be deteriorating. Its marketable securities—a highly liquid asset—are almost gone. Its accounts payable are rising rapidly, and substantially exceed the amount of cash on hand. Most importantly, sales and accounts receivable both are falling, which impairs the company’s ability to generate cash from operating activities in the future. Also, the liquidity of the company’s inventory is questionable in light of the declining sales.
e.	This company is contracting its operations. Its investment in marketable securities, receivables, and plant assets all are declining. Further, the income statement shows that operations are eroding the owners’ equity in the business. The decline in sales—already apparent in the income statement—soon will reduce the cash collected from customers, which is the principal factor contributing to a positive cash flow from operating activities.
In summary, this company appears to be in financial trouble.
f.	The company’s principal revenue source—sales of tools—is declining. If nothing is done, it is likely that the annual net losses will increase, and that operating cash flows will turn negative. Thus, management’s first decision is whether to attempt to revive the company, or liquidate it.
If the company is to be liquidated, this should be done quickly to avoid future operating losses. Information should be gathered to determine whether it would be best to sell the company as a going concern or whether management should sell the assets individually. In either event, management should stop purchasing tools. Assuming that sales continue to decline, the company’s current inventory appears to be approximately a one-year supply.

P13.8A(p.4)

	PROBLEM 13.8A
	MIRACLE TOOL, INC. (concluded)
If management decides to continue business operations, it should consider taking the following actions:
•	Expand the company’s product lines! The combination tool alone can no longer support profitable operations. Also, dependency upon a single product—especially a faddish product with a limited market potential—is not a sound long-term strategy.
•	Stop buying the combination tool—at least until the current inventory is sold. This will not improve profitability, but will help cash flows. (As explained above, the company’s current inventory appears about equal to next year’s potential sales.)
•	Look for ways to reduce operating expenses. In 2018, sales declined by 30%, but the company was able to reduce operating expenses by only about 6.5% ($17,000 decline from a level of $260,000).
•	Stop paying dividends. The company has no cash to spare. As sales continue to fall, the net cash flow from operating activities is likely to turn negative. Collecting existing receivables and letting payables go unpaid can only bolster net cash flow for a limited period of time.
•	Develop forecasts of future operations and cash flows. If a turnaround does not appear realistic, management should reconsider the option of liquidating the company.

P13.1B

SOLUTIONS TO PROBLEM SET B
30 Minutes, Medium	PROBLEM 13.1B
	WELCH COMPANY
a.
WELCH COMPANY
Statement of Cash Flows
For the Year Ended December 31, Current Year
Cash flows from operating activities:
Cash received from customers (1)	$ 3,040,000
Interest and dividends received	40,000
Cash provided by operating activities	$ 3,080,000
Cash paid to suppliers and employees (2)	$ (2,150,000)
Interest paid	(130,000)
Income taxes paid	(65,000)
Cash disbursed for operating activities	(2,345,000)
Net cash flow from operating activities	$ 735,000

Cash flows from investing activities:
Loans made to borrowers	$ (690,000)
Collections on loans	300,000
Cash paid to acquire plant assets	(1,700,000)
Proceeds from sales of plant assets (3)	490,000
Net cash used for investing activities:	(1,600,000)

Cash flows from financing activities:
Proceeds from issuing bonds payable	$ 2,000,000
Dividends paid	(250,000)
Net cash provided by financing activities		1,750,000

Net increase (decrease) in cash and cash equivalents	$ 885,000
Cash and cash equivalents, January 1, 2018	278,000
Cash and cash equivalents, December 31, 2018	$ 1,163,000


Supporting computations:
(1)	Cash received from customers:
Cash sales	$ 230,000
Collections on accounts receivable	2,810,000
Cash received from customers	$ 3,040,000
(2)	Cash paid to suppliers and employees:
Payments on accounts payable to merchandise suppliers
merchandise suppliers	$ 1,220,000
Cash payments for operating expenses	930,000
Cash paid to suppliers and employees	$ 2,150,000
(3)	Proceeds from sales of plant assets:
Book value of plant assets sold	$ 520,000
Less: Loss on sales of plant assets	30,000
Proceeds from sales of plant assets	$ 490,000
Note to instructor: The transfer from the money market fund to the general bank account is not considered a cash receipt because a money market fund is a cash equivalent.

P13.2B

25 Minutes, Easy	PROBLEM 13.2B
	MARY'S FASHIONS
a.
MARY'S FASHIONS
Partial Statement of Cash Flows
For the Year Ended December 31, Current Year
Cash flows from investing activities:
Purchases of marketable securities	$ (65,000)
Proceeds from sales of marketable securities (1)	89,000
Loans made to borrowers	(175,000)
Collections on loans	50,000
Cash paid to acquire plant assets (see part b)	(85,000)
Proceeds from sales of plant assets (2)	80,000
Net cash used for investing activities	$ (106,000)
Supporting computations:
(1)	Proceeds from sales of marketable securities:
Cost of securities sold (credit entries to
Marketable Securities account)	$ 74,000
Add: Gain on sales of marketable securities	15,000
Proceeds from sales of marketable securities	$ 89,000

(2)	Proceeds from sales of plant assets:
Cost of plant assets sold or retired	$ 150,000
Less: Accumulated depreciation on plant assets
sold or retired	$ 60,000
Book value of plant assets sold or retired	$ 90,000
Less: Loss on sales of plant assets	10,000
Proceeds from sales of plant assets	$ 80,000
b.
Schedule of noncash investing and financing activities:
Purchases of plant assets	$ 245,000
Less: Portion financed through issuance of long-term debt	160,000
Cash paid to acquire plant assets	$ 85,000


c.	Cash must be generated to cover the company’s investment needs through operating or financing activities. Ideally, cash to support investing activities should come from normal operations. If this places undue strain on the company’s operations, however, financing via borrowing and/or sale of capital stock are alternatives the company should consider.

P13.3B

25 Minutes, Easy	PROBLEM 13.3B
	RPZ IMPORTS
a.
RPZ IMPORTS
Partial Statement of Cash Flows
For the Year Ended December 31, Current Year
Cash flows from investing activities:
Purchases of marketable securities	$ (59,000)
Proceeds from sales of marketable securities (1)	52,000
Loans made to borrowers	(40,000)
Collections on loans	31,000
Cash paid to acquire plant assets (see part b)	(50,000)
Proceeds from sales of plant assets (2)	34,000
Net cash (used) for investing activities	$ (32,000)
Supporting computations:
(1)	Proceeds from sales of marketable securities:
Cost of securities sold (credit entries to
Marketable Securities account)	$ 60,000
Less: Loss on sales of marketable securities	8,000
Proceeds from sales of marketable securities	$ 52,000

(2)	Proceeds from sales of plant assets:
Cost of plant assets sold or retired	$ 100,000
Less: Accumulated depreciation on plant assets
sold or retired	$ 75,000
Book value of plant assets sold or retired	$ 25,000
Plus: Gain on sales of plant assets	9,000
Proceeds from sales of plant assets	$ 34,000
b.
Schedule of noncash investing and financing activities:
Purchases of plant assets	$ 140,000
Less: Portion financed through issuance of long-term debt	90,000
Cash paid to acquire plant assets	$ 50,000


c.	Management has more control over the timing and amount of outlays for investing activities than for operating activities. Many of the outlays for operating activities are contractual, reflecting payroll agreements, purchase invoices, taxes, and monthly bills. Most investing activities, in contrast, are discretionary—both as to timing and dollar amount.

P13.4B

30 Minutes, Medium	PROBLEM 13.4B
	ROYCE INTERIORS, INC.
a.
ROYCE INTERIORS, INC.
Partial Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Cash received from customers (1)	$ 2,590,000
Interest and dividends received (2)	91,000
Cash provided by operating activities		$ 2,681,000
Cash paid to suppliers and employees (3)	(1,576,000)
Interest paid (4)	(58,000)
Income taxes paid (5)	(112,000)
Cash disbursed for operating activities		(1,746,000)
Net cash flow from operating activities		$ 935,000

(1)	Cash received from customers:
Net sales		$ 2,600,000
Less: Increase in accounts receivable		10,000
Cash received from customers		$ 2,590,000
(2)	Interest and dividends received:
Dividend income	$ 55,000
Interest income	40,000
Subtotal	$ 95,000
Less: Increase in accrued interest receivable	4,000
Interest and dividends received	$ 91,000
(3)	Cash paid to suppliers and employees:
Cash paid to suppliers of merchandise:
Cost of goods sold	$ 1,300,000
Add: Increase in inventories	25,000
Net purchases	$ 1,325,000
Less: Increase in accounts payable to suppliers	5,000
Cash paid to suppliers of merchandise	$ 1,320,000
Cash paid for operating expenses:
Operating expenses	$ 300,000
Less: Depreciation expense	49,000
Subtotal	$ 251,000
Add: Increase in short-term prepayments	1,000
Add: Decrease in accrued operating expenses payable	4,000
	256,000
Cash paid to suppliers and employees	$ 1,576,000
(4)	Interest paid:
Interest expense	$ 60,000
Less: Increase in accrued interest payable	2,000
Interest paid	$ 58,000
(5)	Income taxes paid:
Income tax expense	$ 110,000
Add: Decrease in accrued income taxes payable		2,000
Income taxes paid		$ 112,000

P13.4B (p.2)

	PROBLEM 13.4B
	ROYCE INTERIORS, INC. (concluded)
b.	Management could increase cash flows from operations by (only two required):
·	Reducing the amount of inventories being held.
·	Reducing the amount of short-term prepayments of expenses.
·	Taking greater advantage of accounts payable as a short-term means of financing purchases of goods and services.
·	More aggressive collection of accounts receivable.

P13.5B

25 Minutes, Medium	PROBLEM 13.5B
	ROYCE INTERIORS, INC.
(INDIRECT)
a.
ROYCE INTERIORS, INC.
Partial Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Net income		$ 928,000
Add:	Depreciation expense	$ 49,000
Increase in accounts payable to suppliers	5,000
Increase in accrued interest payable	2,000	56,000
Subtotal	$ 984,000
Less:	Increase in accounts receivable	$ 10,000
	Increase in accrued interest receivable	4,000
Increase in inventories	25,000
Increase in short-term prepayments	1,000
Decrease in accrued operating expenses payable	4,000
Decrease in accrued income taxes payable	2,000
Gain on sales of marketable securities	3,000	49,000
Net cash flow from operating activities	$ 935,000


Credit sales cause receivables to increase, while collections cause them to decline. If receivables increase over the year, collections during the year must have been less than credit sales for the year. Thus, cash receipts were less than revenue measured on the accrual basis.

P13.6B

45 Minutes, Strong	PROBLEM 13.6B
	FOXBORO TECHNOLOGIES
a.
FOXBORO TECHNOLOGIES
Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Cash received from customers (1)	$ 3,340,000
Interest received (2)	65,000
Cash provided by operating activities	3,405,000
Cash paid to suppliers and employees (3)	$ (2,334,000)
Interest paid (4)	(23,000)
Income taxes paid (5)	(125,000)
Cash disbursed for operating activities	(2,482,000)
Net cash flow from operating activities	$ 923,000

Cash flows from investing activities:
Purchases of marketable securities	$ (50,000)
Proceeds from sales of marketable securities (6)	65,000
Loans made to borrowers	(30,000)
Collections on loans	27,000
Cash paid to acquire plant assets	(350,000)
Proceeds from sales of plant assets (7)	22,000
Net cash used for investing activities:		(316,000)

Cash flows from financing activities:
Proceeds from short-term borrowing	$ 56,000
Payments to settle short-term debts	(70,000)
Proceeds from issuing common stock (8)	160,000
Dividends paid	(300,000)
Net cash provided by financing activities		(154,000)

Net increase (decrease) in cash and cash equivalents	$ 453,000
Cash and cash equivalents, January 1, 2018	20,000
Cash and cash equivalents, December 31, 2018	$ 473,000


Supporting computations:
(1)	Cash received from customers:
Net sales	$ 3,400,000
Less: increase in accounts receivable	60,000
Cash received from customers	$ 3,340,000
(2)	Interest received:
Interest income	$ 60,000
Add: Decrease in accrued interest receivable	5,000
Interest received	$ 65,000

P13.6B (p.2)

	PROBLEM 13.6B
	FOXBORO TECHNOLOGIES
(continued)



(3)	Cash paid to suppliers and employees:
Cash paid for purchases of merchandise:
Cost of goods sold		$ 1,500,000
Less: Decrease in inventory		30,000
Net purchases		$ 1,470,000
Add: Decrease in accounts payable to suppliers		22,000
Cash paid for purchases of merchandise		$ 1,492,000
Cash paid for operating expenses:
Operating expenses	$ 900,000
Less: Depreciation (a noncash expense)	75,000
Subtotal	$ 825,000
Add: Increase in prepayments	8,000
Add: Decrease in accrued liab. for operating expenses	9,000
Cash paid for operating expenses		842,000
Cash paid to suppliers and employees		$ 2,334,000

(4)	Interest paid:
Interest expense		$ 27,000
Less: Increase in accrued interest payable		4,000
Interest paid		$ 23,000

(5)	Income taxes paid:
Income tax expense		$ 115,000
Add: Decrease in income taxes payable		10,000
Income taxes paid		$ 125,000

(6)	Proceeds from sales of marketable securities:
Cost of marketable securities sold (credit entries
to the Marketable Securities account)		$ 40,000
Add: Gain reported on sales of marketable securities		25,000
Proceeds from sales of marketable securities		$ 65,000

(7)	Proceeds from sales of plant assets:
Book value of plant assets sold (paragraph 8)		$ 30,000
Less: Loss reported on sales of plant assets		8,000
Proceeds from sales of plant assets		$ 22,000

(8)	Proceeds from issuing capital stock:
Amounts credited to Capital Stock account		$ 60,000
Add: Amounts credited to Additional Paid-in
Capital account	100,000
Proceeds from issuing capital stock	$ 160,000

P13.6B (p.3)

	PROBLEM 13.6B
	FOXBORO TECHNOLOGIES (concluded)
b.	Cash paid to suppliers, presented in the operating activities section of the statement of cash flows, totaled $2,334,000. Cost of goods sold, presented in the income statement, was only $1,500,000. The primary reasons for the difference are as follows:
●	In addition to cost of goods sold, operating expenses required the payment of a significant amount of cash which accounts for much of the difference.
●	Adjustments to the amount of cost of goods sold plus the amount of operating expenses were required as a result of the following:
--Decrease in inventory
--Decrease in accounts payable
--Depreciation expenses (which did not require cash payment)
--Increase in prepaid operating expenses
--Decrease in accrued liabilities for operating expenses
c.	On the contrary, the fact that cash flows from investing and financing activities are negative attests to the strength of the cash position of the company. The amount of cash increased significantly during the year, going from a beginning balance of $20,000 to $473,000. Cash flows from operating activities were a significant positive amount, $923,000. In addition, the company was able to purchase marketable securities and plant assets and make loans to borrowers (all investing activities) and retire debt and pay dividends (financing activities).

P13.7B

40 Minutes, Strong	PROBLEM 13.7B
	LGIN
a.
LGIN
Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Net income		$ 562,000
Add:	Depreciation expense		125,000
Increase in accounts payable		37,000
Subtotal	$ 724,000
Less:	Increase in accounts receivable	$ 865,000
Decrease in accrued expenses payable	17,000	882,000
Net cash provided by (used in) operating activities	$ (158,000)
Cash flows from investing activities:
Cash paid to acquire plants assets (see schedule)	$ (2,000,000)
Net cash used for investing activities		(2,000,000)
Cash flows from financing activities:
Short-term borrowing from bank	$ 1,490,000
Issuance of capital stock	665,000
Net cash provided by financing activities	2,155,000

Net increase (decrease) in cash	$ (3,000)
Cash and cash equivalents, January 1, 2018	45,000
Cash and cash equivalents, Dec. 31, 2018	$ 42,000
Supplementary Schedule: Noncash Investing and Financing Activities
Purchase of plant assets	$ 2,585,000
Less: Portion financed by issuing long-term notes payable	585,000
Cash paid to acquire plant assets	$ 2,000,000

P13.7B(p.2)

	PROBLEM 13.7B
	LGIN (concluded)

b.	LGIN’s credit sales resulted in $865,000 in new receivables, which were uncollected as of year-end. These credit sales all were included in the computation of net income, but those that remained uncollected at year-end do not represent cash receipts. Therefore, the cash flow from operating activities was substantially below the amount of net income measured on the accrual basis.
Note to instructor: It is not uncommon for cash flows to lag behind a rising net income figure in a growing business. This is why many rapidly growing businesses find themselves “strapped for cash” to finance their growth.
c.	LGIN does not appear headed for insolvency. First, the company has a $4.5 million line of credit, against which it has drawn only $1,490,000. This gives the company considerable debt-paying ability. Next, if LGIN’s rapid growth continues, the company should not have difficulty issuing additional capital stock to investors as a means of raising cash. If a company is obviously successful, it usually is able to raise the cash necessary to finance expanding operations.

P13.8B

60 Minutes, Strong	PROBLEM 13.8B
	PURCELLS, INC.
a.
PURCELLS, INC.
Worksheet for a Statement of Cash Flows
For the Year Ended December 31, 2018
Balance sheet effects:
	Beginning	Debit	Credit	Ending
	Balance	Changes	Changes	Balance
Assets
Cash and cash equivalents	22,000	(x)	38,000			60,000
Marketable securities	27,000	(8)	15,000	12,000
Accounts receivable	40,000	(4)	5,000	35,000
Inventory	120,000	(5)	8,000	128,000
Plant and equipment (net of
accumulated depreciation)	250,000	(9)	20,000	(3)	29,000	241,000
459,000	476,000

Liabilities & Owners' Equity
Accounts payable	50,000	(6)	20,000	70,000
Accrued expenses payable	16,000	(7)	2,000	14,000
Notes payable	235,000	(10)	10,000	(9)	12,000	237,000
Capital stock (no par value)	108,000	(11)	35,000	143,000
Retained Earnings	50,000	(1)	34,000	12,000
(2)	4,000
Totals	459,000	116,000	116,000	476,000
Cash effects:		Sources	Uses
Operating activities:
Net loss				(1)	34,000
Depreciation expense		(3)	29,000
Decrease in accounts rec.	(4)	5,000
Increase in inventory	(5)	8,000
Increase in accounts pay.	(6)	20,000
Decrease in accrued
expenses payable			(7)	2,000
Loss on sale of marketable
securities	(8)	4,000
Investing activities:
Proceeds from sale of
marketable securities	(8)	11,000
Cash paid for plant assets	(9)	8,000
Financing activities
Dividends paid	(2)	4,000
Payment of notes payable	(10)	10,000
Sale of capital stock	(11)	35,000
Net increase in cash		(x)	38,000
Totals	104,000	104,000

P13.8B(p.2)

PROBLEM 13.8B
		PURCELLS, INC.
(continued)
b.
PURCELLS, INC.
Statement of Cash Flows
For the Year Ended December 31, 2018
Cash flows from operating activities:
Net loss		$ (34,000)
Add:	Depreciation expense		29,000
Decrease in accounts receivable	5,000
Increase in accounts payable	20,000
Loss on sales of marketable securities		4,000
Subtotal	$ 24,000
Less:	Increase in inventory	$ 8,000
Decrease in accrued expenses	2,000	10,000
Net cash provided by operating activities	$ 14,000
Cash flows from investing activities:
Proceeds from sales of marketable securities	$ 11,000
Cash paid to acquire plants assets (see supplementary schedule)	(8,000)
Net cash provided by investing activities	3,000
Cash flows from financing activities:
Dividends paid	$ (4,000)
Payment of note payable	(10,000)
issuance of capital stock	35,000
Net cash provided by financing activities	21,000

Net increase (decrease) in cash	$ 38,000
Cash and cash equivalents, January 1, 2018	22,000
Cash and cash equivalents, Dec. 31, 2018	$ 60,000
Supplementary Schedule: Noncash Investing and Financing Activities
Purchase of plant assets	$ 20,000
Less: Portion financed through issuance of long-term debt	12,000
Cash paid to acquire plant assets	$ 8,000

P13.8B(p.3)

	PROBLEM 13.8B
	PURCELLS, INC. (continued)
c.	Purcells, Inc. achieved its positive cash flow from operating activities basically by liquidating assets and by not paying its bills. It has converted most of its accounts receivable into cash, which probably means that credit sales have declined substantially over the past several months. A decrease in sales shows up in the income statement immediately, but may take months before its effects appear in a statement of cash flows.
Purcells, Inc. is not replacing plant assets as quickly as these assets are being depreciated. In any given year, this may not be significant. But on the other hand, this relationship certainly indicates that the business is not expanding, and it may indicate that the company is deferring replacements of plant assets in an effort to conserve cash.
Purcells, Inc. is allowing its accounts payable to rise much more quickly than it is increasing inventory. This indicates that the company is not paying its bills as quickly as it used to. While this conserves cash, the “savings” are temporary. Also, if the company’s credit rating is damaged, this strategy may reduce both earnings and cash flows in the near future.
d.	Purcells, Inc. has substantially more cash than it did a year ago. Nonetheless, the company’s financial position appears to be deteriorating. Its marketable securities—a highly liquid asset—are almost gone. Its accounts payable are rising rapidly, and substantially exceed the amount of cash on hand. Most importantly, sales and accounts receivable both are falling, which impairs the company’s ability to generate cash from operating activities in the future. Also, the liquidity of the company’s inventory is questionable in light of the declining sales.
e.	This company is contracting its operations (or collapsing). Its investment in marketable securities, receivables, and plant assets all are declining. Further, the income statement shows that operations are eroding the owners’ equity in the business. The decline in sales—already apparent in the income statement—soon will reduce the cash collected from customers, which is the principal factor contributing to a positive cash flow from operating activities.
In summary, this company appears to be in real trouble.
f.	The company’s principal revenue source—sales of Pulsas—is declining. If nothing is done, it is likely that the annual net losses will increase, and that operating cash flows soon will turn negative. Thus, management’s first decision is whether to attempt to revive the company, or liquidate it.
If the company is to be liquidated, this should be done quickly to avoid future operating losses. Information should be gathered to determine whether it would be best to sell the company as a going concern or whether management should sell the assets individually. In either event, management should stop purchasing Pulsas. Assuming that sales continue to decline, the company’s current inventory appears to be approximately a one-year supply.

P13.8B(p.4)

	PROBLEM 13.8B
	PURCELLS, INC. (concluded)

If management decides to continue business operations, it should take the following actions:
•	Expand the company’s product lines! The Pulsas alone can no longer support profitable operations. Also, dependency upon a single product—especially a faddish product with a limited market potential—is not a sound long-term strategy.
•	Stop buying Pulsas—at least until the current inventory is sold. This will not improve profitability, but will help cash flows. (As explained above, the company’s current inventory appears about equal to next year’s potential sales.)
•	Look for ways to reduce operating expenses. In 2018, sales declined by 36%, but the company was able to reduce operating expenses by only about 3.8% ($10,000 decline from a level of $260,000).
•	Stop paying dividends. The company has no cash to spare. As sales continue to fall, the net cash flow from operating activities is likely to turn negative. Collecting existing receivables and letting payables go unpaid can only bolster net cash flow for a limited period of time.
•	Develop forecasts of future operations and cash flows. If a turnaround does not appear realistic, management should reconsider the option of liquidating the company.

Case 13.1

SOLUTIONS TO CASES

25 Minutes, Strong	CASE 13.1
ANOTHER LOOK AT ALLISON CORPORATION

a.	Based on past performance, it does not appear that Allison Corporation can continue to pay annual dividends of $40,000 without straining the cash position of the company. In a typical year, Allison generates a positive cash flow from operating activities of approximately $50,000. However, about $45,000 is required in a normal year to replace the plant assets retired. This leaves only about $5,000 per year of the net operating cash flow available for dividends and other purposes. If Allison is to continue paying cash dividends of $40,000 per year, the company must raise about $35,000 from investing and financing activities.
Over the long run, it is quite difficult for a company to continually finance its cash dividends through increased borrowing (financing activity) or through sales of assets (investing activity). Therefore, Allison Corporation may have to reduce its cash dividends in future years.
b.	Two of the unusual factors appearing in the current statement of cash flows should be considered in assessing the company’s ability to pay future dividends. First, the company spent an unusually large amount ($160,000) to purchase plant assets during the year. This expenditure for plant assets may increase net operating cash flow above the levels of prior years. Second, the company issued $100,000 of bonds payable and an additional 1,000 shares of capital stock. The interest on the new bonds payable will reduce future cash flows from operations. Also, the additional shares of capital stock mean that total dividend payments must be increased if the company is to maintain the current level of dividends per share.
In summary, the unusual investing and financing activities will improve the company’s ability to continue its dividends only if the new plant assets generate more cash than is needed to meet the increased interest and dividend requirements.

Case 13.2

15 Minutes, Easy	CASE 13.2
	CASH BUDGETING FOR YOU AS A STUDENT
a.	Ending cash balances:
Week 2: $20 [$(20) + $100 − $30 − $20 − $10]
Week 3: $60 ($20 + $100 − $30 − $20 − $10)
Week 4: $100 ($60 + $100 − $30 − $20 − $10)
b.	In Week 1 you have two problems. The first is that you do not have enough cash to pay your rent on Wednesday. But you will by Friday, so your payment may be a couple of days late. (But what’s going to happen next month? Is there some “handwriting on the wall”?)
Your second problem is that if you spend in your normal pattern, you will overdraw your bank account by $20 (which may trigger a service charge of another $10 or more). This problem can be solved by your foregoing any expenditures on entertainment this week—annoying, but hardly a cash crisis.
You have a bigger problem coming up in February. You will have more difficulty paying February’s rent than you did January’s. The sad fact is that you cannot afford rent of $200 per month. You are earning $400 per month and spending $240 on things other than rent. Thus, you can afford only about $160 per month for rent unless you reduce other expenses.
To solve this problem, you might find another roommate to share the rent, move into less expensive housing, or somehow increase your monthly cash receipts. (It does not appear practical to trim $40 per month from your other expenses.)

Case 13.3

45 Minutes, Medium	CASE 13.3
		LOOKIN' GOOD?

a.	Net Cash Flows from
Proposals	Net Income	Operating Activities	Cash
(1)	Increase	No effect	No effect
(2)	Increase	No effect	No effect
(3)	Increase	Increase	Increase
(4)	No effect	Increase	Increase
(or decrease)*	(or decrease)*	(or decrease)*
(5)	Decrease	Increase	Increase
(6)	Increase	Increase	Increase
(7)	No effect	No effect	Increase
*Either “no effect” or “decrease” is an acceptable answer to the probable effect of this proposal upon net income; see discussion in paragraph (4), part b.
b.	(1)	If the costs of producing inventory are rising, use of the FIFO (first-in, first-out) method assigns older and lower costs to the cost of goods sold. FIFO results in higher reported profits (but also in higher income taxes) than does the LIFO method. The inventory method used by a company does not affect the price that it pays to suppliers to purchase inventory. Other than for possible tax consequences, the choice of inventory method does not affect cash flows. (The case stated that the additional taxes stemming from use of the FIFO method would not be paid until the following year.)
(2)	Changing from an accelerated method to the straight-line method of depreciation will (generally) reduce the amount of depreciation expense included in the income statement, increasing reported net income. Lengthening estimates of useful lives has a similar effect. Depreciation is a noncash expense; therefore, cash flows are not affected by the choice of depreciation method or the estimate of useful lives, except to the extent that these choices may affect income tax payments. The problem stated, however, that no changes would be made in the depreciation claimed for tax purposes.
(3)	Pressuring dealers (customers) to increase their inventories will increase General Wheels’ sales for the year. This should increase net income and cash flows from operating activities (collections from customers).
(4)	Requiring dealers to pay more quickly will speed up cash collections from customers, increasing operating cash flows and total cash. The timing of these collections has no direct effect upon net income. However, offering shorter credit terms may have the indirect effect of reducing net sales. Thus, one might argue that this proposal could decrease both net income and future collections from customers.

Case 13.3 (p.2)

	CASE 13.3
	LOOKIN' GOOD? (concluded)
(5)	Passing up cash discounts will delay many cash outlays by about 20 days. In the long run, the amount paid will be about 2% greater, but in the short run, the delay should more than offset these increased costs. (A 20-day delay in cash outlays usually amounts to over 5% of total cash outlays for the year: 20 days/365 days = 5.5%.) While operating cash flows will increase, net income will decline; the higher purchase costs will be reflected in the cost of goods sold.
(6)	Incurring short-term interest charges of 10% to replace long-term interest charges of 13% will reduce interest expense and cash payments of interest. Therefore, net income, cash flows from operating activities, and total cash flow will improve. Management’s primary risk in pursuing this proposal is that short-term rates may rise or that the company may be unable to renew the short-term loans as they mature.
(7)	Dividend payments do not enter into the determination of net income or net cash flow from operating activities. Therefore, these two amounts will not be affected by the proposal. Cash dividends are classified as financing activities and do not affect total cash flows from operating activities. Therefore, replacing cash dividends with stock dividends (which require no cash payment) will increase net cash flow from all sources. However, management should be aware that discontinuing cash dividends may adversely affect the company’s ability to raise capital through the issuance of additional shares of capital stock.

Case 13.4

15 Minutes, Easy	CASE 13.4
PEAK PRICING

a.	The statement is not valid because it addresses only the peak-period aspect of a peak-pricing strategy. It is true that during the peak period, some customers will be priced out of the market (or at least encouraged to purchase in an off-peak period). But in off-peak periods, prices tend to be lower than they would under a single-price strategy. Peak pricing may actually allow some customers to purchase goods or services that they otherwise could not afford.
b.	The alternative to peak pricing is a single all-the-time price. In this case, excess demand is handled on a first-come, first-served basis.
c.	(1)	Hotels in Palm Springs charge their highest daily rates during the sunny but comfortable winter months. The uncomfortably hot summers are their off-season, and they offer their rooms at greatly reduced rates.
(2)	Movie theaters charge peak prices in the evenings. Daytime is the off-peak period, and they normally offer substantially discounted matinee prices. Also, they often lower prices on Monday and/or Tuesday evenings, which are periods of little customer demand.
d.	In the opinion of the authors, peak pricing normally is an ethical business practice. But there are exceptions, and management should think carefully about its responsibilities.
Peak pricing may be unethical if the services are funded in whole or in part by taxpayers—but not in every case. For example, we would consider it unethical for public schools to provide a more convenient class schedule to students willing to pay an extra fee. But we would not object to a museum or national park varying admission prices between peak and off-peak periods.
Also, an ethical distinction may be drawn between peak pricing and a concept called “profiteering.” Profiteering means exploiting customers in an emergency situation. For example, we would view raising the price of medical supplies during a local disaster, such as the September 11, 2001 terrorist attacks on the World Trade Center and the Pentagon, as profiteering. (To our knowledge, this did not occur. In fact, many health-care organizations provided goods and services at no charge during this emergency.) Other examples are increased prices of salt and shovels in preparation for a blizzard and increased prices of generators, pumps, bottled water, and batteries at the time of a hurricane.
But what represents an emergency situation? For example, we would not view it as unethical for hotels to raise their room rates because the Superbowl is being played in town.

Case 13.5

20 Minutes, Medium	CASE 13.5
IMPROVING THE STATEMENT OF CASH FLOWS
ETHICS, FRAUD & CORPORATE GOVERNANCE
The first four parts of this case have no written requirements. Part (d) requires students to write a synopsis, based on their research in the Securities & Exchange Commission's (SEC) web site, of a speech given by SEC staff member Scott Taub, in which he makes a specific reference to the statement of cash flows.
Following are several points that are appropriate for inclusion in the student's response to this case:
•	It is difficult for one person or a few people to make improvements in financial reporting.
•	Improvement can come by looking at reporting as a communications exercise rather than a compliance exercise.
•	Preparers of financial statements should make choices that provide more information rather than those that minimally comply with the rules.
•	Regarding the statement of cash flows, any company can improve its reporting by voluntarily presenting cash flows by the direct rather than the indirect method.
•	Users of financial statements indicate that they prefer the direct method information, and FASB Statement #95 (now FASB Accounting Standards Codification, Section 230) provides a framework in which to provide this information.

Case 13.6

30 Minutes, Medium
CASE 13.6	CASE 13.7
COMPARING CASH FLOW INFORMATION
FROM TWO COMPANIES
INTERNET	FROM TWO COMPANIES
INTERNET
a.	(no solution)
b.	(no solution)
c.	Based on the following information from the 2015 financial statements of the two companies, Amazon’s positive cash flow from operations in 2015 exceeded that of Coca-Cola: $11,920 million (almost $12 billion) compare to $10,528 million (approximately $10.5 billion). However, the trend in operating cash flows is quite different. Coca-Cola’s cash from operations is relatively constant over the three years of 2013 – 2015--$10,542 million in 2013, $10,615 million in 2014, and $10,528 million in 2015. Amazon, on the other hand, has experienced significant growth in cash flows in the 2013 – 1015 period--$5,475 million in 2013, $6,842 million in 2014, and $11,920 million in 2015. The dramatic grown in operating cash flows for Amazon is a result of its significant increase in net income, which grew from $8,084 million to $14,557 million in 2015, an increase of over 80% in the three-year period. During that same three years, Coca-Cola’s net income actually declined from $8,626 million in 2013 to $7,366 million in 2015, a decrease of almost 15% over the three-year period. Note to Instructor: The above example is a good opportunity to demonstrate to students the close association between net income and cash provided by operating activities.
d.	Companies that may have negative cash flows from operations are companies that are in the early stage of development or companies competing in new industries. High start-up costs and marketing costs to develop the company’s business have adverse effects on cash flows. Companies with net operating losses will often have negative cash flows from operations.
e.	Companies with established products or services in established industries will often have large positive cash flows from operations, which result from positive operations that result in large net income amounts.

Coca-Cola


THE COCA-COLA COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS

Year ended December 31
(in millions)
2015	2014	2013
OPERATING ACTIVITIES
Consolidated net income	$ 7,366	$ 7,124	$ 8,626
Depreciation and amortization	1,970	1,976	1,977
Stock-based compensation expense	236	209	227
Deferred income taxes	73	(40)	648
Equity (income) loss — net of dividends	(122)	(371)	(201)
Foreign currency adjustments	(137)	415	168
Significant (gains) losses on sales of assets — net	(374)	831	(670)
Other operating charges	929	761	465
Other items	744	149	234
Net change in operating assets and liabilities	(157)	(439)	(932)
Net cash provided by operating activities	10,528	10,615	10,542

Amazon.com


AMAZON.COM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
	(in millions)
Year ended December 31
(in millions)
2015	2014	2013
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD	$ 14,557	$ 8,658	$ 8,084
OPERATING ACTIVITIES:
Net income (loss)	596	$ (241)	$ 274
Adjustments to reconcile net income (loss) to net cash from operating activities:
Depreciation of property and equipment, including internal-use software and website development, and other amortization, including capitalized content costs	6,281	4,746	3,253
Stock-based compensation	2,119	1,497	1,134
Other operating expense (income), net	155	129	114
Losses (gains) on sales of marketable securities, net	5	(3)	1
Other expense (income), net	245	62	166
Deferred income taxes	81	(316)	(156)
Excess tax benefits from stock-based compensation	(119)	(6)	(78)

Changes in operating assets and liabilities:
Inventories	(2,187)	(1,193)	(1,410)
Accounts receivable, net and other	(1,755)	(1,039)	(846)
Accounts payable	4,294	1,759	1,888
Accrued expenses and other	913	706	736
Additions to unearned revenue	7,401	4,433	2,691
Amortization of previously unearned revenue	(6,109)	(3,692)	(2,292)
Net cash provided by (used in) operating activities	11,920	6,842	5,475