Work -13

20 The Statement of Cash Flows

Chapter Twenty

After completing this chapter, you should be able to:

1 Briefly describe the evolution of the statement of cash flows.

2 State the purposes of the statement of cash flows.

3 Describe the types of cash flows shown in each of the statement’s three sections.

4 Prepare a statement of cash flows using the indirect method, the direct method, and the T-account approach.

5 Prepare a schedule disclosing direct exchange transactions.

6 Describe how the statement of cash flows is used by an enterprise’s managers and by interested parties outside the organization.

Coulterton, CO—The Coulter- ton Transit Company got a big boost this week as Alpine Trails Ski Resort made a major pur- chase of the small bus line’s stock. Lance Martin, a spokes- man for Alpine Trails, made the announcement yesterday and emphasized that the resort’s management felt the invest- ment was a wise one. Alpine Trails, one of the area’s most popular ski resorts, depends on the Coulterton Transit Company to ferry skiers from Coulterton out to the resort’s slopes. Martin stated that Alpine Trails’ management was very happy with the service provided by the bus line, and stressed that Alpine would not seek any changes in the bus service’s operations or man- agement personnel. “Alpine Trails has felt for some time that we are in a sort of part-

nership with Coulterton Transit Company,” said Martin. “Alpine depends on the bus line to get our skiers to the mountain, and Coulterton depends on Alpine for the bulk of its business. Alpine’s management just felt that investing in the bus line made good business sense.” When asked how Alpine Trails would finance the Coulterton Transit stock purchase, Martin cited Alpine Trails’ recent strong cash flow. “Our cash flow from operations has been very solid the past couple of years. Skiing in the western slopes of the Rockies is growing by leaps and bounds, and we’re getting our share of the growth. Alpine Trails’ man- agement wants to reinvest that cash flow from operations in ways that will strengthen our business in the future. This year we made two major

investments. One was the stock in Coulterton Transit, and the other was new snow- making equipment. We get a lot of snow out here, but occa- sionally we get a mild spell. Then we need to help out Mother Nature with a little extra white stuff. You never can predict. Take the Winter Olympics in Nagano, Japan, for example. In the weeks leading up to the games, they were worried about having enough snow. Then when the games got underway, they were inundated with snow. Several of the alpine events had to be postponed. We feel fortunate at Alpine Trails that we’ve got the cash flow to make the investments we need to in order to keep our business strong.”

ALPINE TRAILS PURCHASES COULTERTON TRANSIT STOCK

How was Chrysler Corporation able to acquire American Motors Corporation for $1.646 billion? How was USAirways able to purchase Piedmont Airlines for $1.28 billion? What type of financing did Marriott use when it introduced its new Courtyard Hotels? How did the top managers in each of these companies make the decision to go forward with such huge investments? The essential question in each example is, How did a company generate cash, and how was the cash used? How much cash did McDonald’s Corporation generate last year through its operations, which involve the provision of food service to millions of people worldwide? How much cash did the company obtain through the issuance of debt or capital stock? How did McDonald’s use the cash it generated?

These are the kinds of questions addressed by the statement of cash flows. In this chapter, we discuss how this important financial statement is prepared and used.

Evolution of the Statement of Cash Flows Nowadays most managers, investors, and financial analysts consider the statement of cash flows to be as important as an organization’s balance sheet or income statement. However, the statement of cash flows is a newcomer compared to the other major financial statements. Prior to 1961, accountants

sometimes prepared a simple analysis of the changes in the firm’s balance sheet accounts, which often was referred to as a “Where Got and Where Gone Statement.” However, no formal statement of cash flows was required for external reporting pur- poses. In 1961, the American Institute of Certified Public Accountants (AICPA) spon- sored research in the area of cash flow analysis. The resulting report recommended that some type of cash flow analysis be provided as part of a company’s annual report. In 1971 the AICPA’s Accounting Principles Board began requiring a statement of changes of financial position as part of a company’s financial statements. Throughout the next two decades, this statement evolved in its form, content, and importance to financial statement users. In 1987, the Financial Accounting Standards Board (FASB) issued its Standard No. 95, which requires that the statement of cash flows be prepared in the manner described in this chapter.

Purpose of the Statement of Cash Flows The primary purpose of the statement of cash flows is to provide infor- mation about the sources and uses of an enterprise’s cash during a particular time period. This information provides financial statement users with insight about the enterprise’s operating, investing, and financing activities as they

relate to the provision and use of cash. According to the FASB’s Statement of Financial Accounting Standards No. 95,1 the statement of cash flows should provide financial statement users with insight about:

1. The organization’s ability to generate positive future net cash flows. 2. The organization’s ability to meet its financial obligations and pay dividends. 3. The future needs of the organization for external financing. 4. The reasons for the difference between net income and the net cash flows related

to operating activities. 5. The effects of the organization’s cash and noncash investing and financing

activities.

4 Chapter 20 The Statement of Cash Flows

LO 1 Briefly describe the evolution of the statement of cash flows.

LO 2 State the purposes of the statement of cash flows.

The statement of cash flows provides information about the sources and uses of an enterprise’s cash during a particular time period.

1 “Statement of Cash Flows,” Statement of Financial Accounting Standards No. 95 (Stamford, CT: FASB, 1987).

Evolution of the Statement of Cash Flows

Cash and Cash Equivalents Any enterprise needs to have cash available to pay its bills, compensate employees, purchase equipment, and so forth. At the same time, organizations try to manage their cash to avoid having more cash on hand than is necessary. As part of a cash- management program, most organizations invest some of their cash in short-term, highly liquid investments. Examples of such investments include money market accounts and U.S. Treasury bills. Such investments enable the organization to earn a return on the invested funds, yet at the same time keep the money readily available if it is needed. Because these highly liquid investments are turned into cash easily, they are, in a sense, cash equivalents. Cash equivalents are defined as highly liquid investments that may be converted easily into a known amount of cash and are near to their maturity dates.

Since cash equivalents are readily available when needed, the statement of cash flows focuses not only on cash but also on the total of an enterprise’s cash and cash equivalents. The statement of cash flows is designed to show financial statement users the reasons behind the change in an enterprise’s total cash and cash equivalents during a particular period of time.

Content and Organization of the Statement The FASB has specified that the cash flow statement be organized into three sections. Each section details the cash flows that have arisen during the accounting period from a particular type of activity. The statement’s three sections disclose the cash flows arising from operating activities, investing activities, and financing activities. Descriptions of each of these types of activities follow.

Operating Activities Operating activities are defined as all events and transactions that are not investing or financing activities. The cash flow from operating activities represents cash flows resulting from the normal, recurring operations of an enterprise in producing and selling its primary product or service. Any transactions that enter into the determination of net income generally are classified as operating activities. The operations of an enterprise include all activities related to the provision of goods or services. Thus, cash receipts from the sale of goods or services are included in the operating activities portion of the cash flow statement. The cash disbursements included in this section of the statement include all disbursements for the purpose of producing goods or services.

Also included in the operating portion of the cash flow statement are cash receipts from any interest-bearing securities or stock the company owns. In addition, cash dis- bursements to pay taxes or to pay interest on the company’s debt are included in the operating portion of the statement. Exhibit 20–1 summarizes the types of cash flows included in the operating activities portion of the cash flow statement.

Investing Activities Investing activities are defined as extending or collecting loans, acquiring or disposing of investments (such as other companies’ bonds or stock), and buying or selling pro- ductive, long-lived assets. Notice that investment activity is defined to include changes in the principal amount of loans, but does not include the interest earned on such loans. As explained previously, cash receipts for interest are included in the operating portion of the cash flow statement. Exhibit 20–1 summarizes the cash flows included in the statement’s investing activities section.

Chapter 20 The Statement of Cash Flows 5

Cash equivalents are highly liquid investments that may be converted easily into a known amount of cash and are near to their maturity dates.

Operating activities are all events and transactions that are not investing or financing activities.

Investing activities are extending or collecting loans, acquiring or disposing of investments, and buying or selling productive, long-lived assets.

LO 3 Describe the types of cash flows shown in each of the statement’s three sections.

Financing Activities Financing activities are defined as transactions involving the company’s debt or equity capital. Included in this section of the cash flow statement are cash receipts from the issuance of debt or the sale of the firm’s own capital stock. Cash disbursements included in this section of the statement include repurchase of the company’s own stock, payment of dividends to stockholders, and issuance of debt. Exhibit 20–1 sum- marizes the cash flows included in the financing section of the cash flow statement.

Notice that the financing section of the cash flow statement does not include cash disbursements to pay interest on the firm’s debt. As previously noted, cash outflows for interest payments are included in the operating portion of the statement.

Preparation of the Statement The process of preparing the statement of cash flows draws upon data from the fol- lowing three sources:

1. Income statement. Determination of the cash provided by operations involves many of the accounts involved in the calculation of income.

2. Comparative balance sheets. This information shows the changes in the company’s asset, liability, and owners’ equity accounts during the year.

6 Chapter 20 The Statement of Cash Flows

Operating activities (transactions that enter into the determination of net income): Cash inflows from:

• Sale of goods or services

• Returns on interest-bearing securities or stock

• Miscellaneous revenue (for example, renting excess space)

Cash outflows from:

• Production of goods or services (includes disbursements such as employee compensation, payments to suppliers of materials or services, and payments for utilities, rent, insurance, and so forth)

• Payment of taxes to the government

• Payment of interest on debt

Investing activities (transactions involved in the acquisition or disposition of long-lived assets): Cash inflows from:

• Sale of productive, long-lived assets

• Collection of loans

• Sale of other companies’ interest-bearing securities or stock owned as an investment

Cash outflows for:

• Purchase of productive, long-lived assets

• Issuance of loans (for example, to another company)

• Purchase of other companies’ interest-bearing securities or stock as an investment

Financing activities (transactions involving the company’s debt or equity capital, excluding stock splits and stock dividends): Cash inflows from:

• Issuing debt such as bonds, notes, or mortgages

• Sale of the company’s own capital stock

Cash outflows for:

• Payment of dividends to stockholders

• Reacquisition of the company’s own stock

• Retirement of debt principal such as by paying off a loan

Exhibit 20–1

Operating, Investing, and Financing Activities

Financing activities are transactions involving the company’s debt or equity capital.

LO 4 Prepare a statement of cash flows using the indirect method, the

direct method, and the T-account approach.

Preparation of the Statement

3. Selected transactions. In most cases other transaction data are needed to determine the sources and uses of cash during the accounting period.

Direct and Indirect Methods Two alternative methods may be used to determine the cash flow from operating activ- ities. Under the direct method, the statement preparer focuses on the firm’s cash receipts and disbursements to determine which cash flows were related to operating activities. Then a cash-basis income statement is constructed, in which operating cash disbursements are subtracted from operating cash receipts. The net result is the cash provided by (or consumed by) operating activities. For example, instead of the sales revenue amount, which appears at the top of an income statement, the cash flow statement would start with cash receipts from customers.

The indirect method of preparing the operating activities section of the cash flow statement begins with the income statement, which already has been prepared on an accrual-accounting basis. The net income figure then is adjusted from an accrual basis to a cash basis. The resulting amount is the cash provided by (or consumed by) opera- tions. The indirect method is also called the reconciliation method.

Both the direct method and the indirect method are illustrated in the remaining sec- tions of this chapter. We begin with the indirect method.

Using the Indirect Method of… To illustrate the statement of cash flows, we focus on a service industry firm. Alpine Trails Ski Resort operates a small winter resort on the western slopes of the Rocky Mountains. The firm owns a ski complex and several condo- miniums. The resort’s primary sources of revenue are fees for use of the ski facilities and weekly rental of the condos. In addition, Alpine Trails receives rental revenue from an independent restaurant firm that operates a food con- cession in the ski lodge. Alpine Trails also operates a small ski shop, in which it sells ski equipment, sports clothing, and souvenirs. The company’s most recent comparative balance sheets, income statement, and statement of retained earnings are displayed in Exhibits 20–2 and 20–3.

The format for the statement of cash flows, under the indirect method of prepa- ration, is shown in Exhibit 20–4, which appears on page 10. Notice that the operating activities section of the statement begins with net income, and then adjustments are made to determine the net cash flow from operating activities. Beginning with the net income figure is the primary feature of the indirect method.

Operating Activities Now let’s begin preparing Alpine Trails’ statement of cash flows. We start with net income from the firm’s 20x1 income statement (Exhibit 20–3).

We must make seven adjustments to determine the cash flow from operating activities, as follows:

Adjustment for Depreciation This is perhaps the easiest adjustment to understand. On Alpine Trails’ income statement, depreciation of $40,000 is recorded as an operating

Starting point Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . $110,000

Chapter 20 The Statement of Cash Flows 7

With the direct method, the statement preparer focuses on the firm’s cash receipts and disbursements to determine which cash flows were related to operating activities.

With the indirect method of preparing the operating activities section of the cash flow statement, the preparer begins with the income statement already prepared on an accrual-accounting basis. Also called the reconciliation method.

LO 4 Prepare a statement of cash flows using the indirect method, the direct method, and the T-account approach.

Using the Indirect Method of Statement Preparation

expense that reduced the company’s net income for 20x1 by $40,000. Did this $40,000 expense represent a cash flow during the year? The answer is no. Depreciation is a noncash expense. Therefore, we must adjust Alpine Trails’ net income by adding back its depreciation expense.

This is a step that confuses some users of a statement of cash flows. Remember, adding back depreciation expense to net income does not imply that depreciation is a source of cash. Depreciation expense has nothing to do with cash. We add back depre- ciation expense as an adjustment to net income because depreciation expense was sub- tracted in the process of determining net income. Since depreciation was not a use of cash, however, we must now add it back to cancel out its earlier subtraction. Thus,

Adjustment 1: Add back depreciation expense . . . . . . . . . . . . �$40,000

8 Chapter 20 The Statement of Cash Flows

Alpine Trails Ski Resort Comparative Balance Sheets December 31, 20x1 and 20x0

(in thousands)

Assets 20x1 20x0 Change Current assets:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 17 $ 20 $ 3 Decrease

Marketable securities . . . . . . . . . . . . . . . . . . . . . 10 10 –0–

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . 130 140 10 Decrease

Merchandise inventory . . . . . . . . . . . . . . . . . . . . 60 25 35 Increase

Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . 8 5 3 Increase

Total current assets . . . . . . . . . . . . . . . . . . . . 225 200 25 Increase

Investment in Coulterton Transit Company Stock . . . 45 –0– 45 Increase

Facilities and equipment . . . . . . . . . . . . . . . . . . . . . 470 400 70 Increase

Less: Accumulated depreciation . . . . . . . . . . . . . . . (140) (100) 40 Increase

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 350 400 50 Decrease

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $950 $900 $ 50 Increase

Liabilities and Stockholders’ Equity Current liabilities:

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . $ 85 $ 70 $ 15 Increase

Accrued salaries payable . . . . . . . . . . . . . . . . . . 20 30 10 Decrease

Total current liabilities . . . . . . . . . . . . . . . . . . . 105 100 5 Increase

Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . 10 15 5 Decrease

Bonds payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190 250 60 Decrease

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . 305 365 60 Decrease

Stockholders’ equity:

Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . 255 235 20 Increase

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . 390 300 90 Increase

Total stockholders’ equity . . . . . . . . . . . . . . . . 645 535 110 Increase

Total liabilities and stockholders’ equity . . . . . . . . . . $950 $900 $ 50 Increase

Exhibit 20–2

Comparative Balance Sheets

depreciation expense is not a source of cash. We are merely making an adjustment for a noncash expense that had previously been subtracted in determining net income.

Alpine Trails’ income statement does not show any depletion or amortization expenses. However, like depreciation, depletion and amortization are noncash expenses. If such expenses appear on an income statement, they must be added back to net income as an adjustment in determining the cash flow from operating activities.

Adjustment for Changes in Prepaid Expenses Alpine Trails must pay for its insurance and property taxes at the beginning of the time period to which these expenditures apply. The company paid for its 20x1 insurance and property taxes in January of 20x1. When a firm makes such a prepayment, an asset is created called Prepaid Expenses. Notice that on Alpine Trails’ comparative balance sheets (Exhibit 20–2), the asset Prepaid Expenses increased during the year by $3,000 (from $5,000 on December 31, 20x0, to $8,000 on December 31, 20x1). This means that Alpine Trails paid $3,000 more in cash for its 20x1 insurance and property taxes than the actual 20x1 expense for

Chapter 20 The Statement of Cash Flows 9

Alpine Trails Ski Resort Income Statement

For the Year Ended December 31, 20x1 (in thousands)

Revenue:

Slope fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300

Condominium rentals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 635

Sales of merchandise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

Total revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $980

Less: Cost of merchandise sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 950

Less: Operating expenses:

Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $270

Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 155

Interest on bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 790

Income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

Income-tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $110

Alpine Trails Ski Resort Statement of Retained Earnings

For the Year Ended December 31, 20x1 (in thousands)

Retained earnings, December 31, 20x0 . . . . . . . . . . . . . . . . . . . . . . . . $300

Add: Net income for 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 410

Deduct: Dividends declared in 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Retained earnings, December 31, 20x1 . . . . . . . . . . . . . . . . . . . . . . . . $390

Exhibit 20–3

Income Statement and Statement of Retained Earnings

these items. From the company’s 20x1 income statement we note that the total of the insurance and property-tax expenses for 20x1 amounted to $115,000 ($80,000 � $35,000). Using these facts, we conclude that Alpine Trails’ cash payment for insurance and property taxes in 20x1 was $118,000, as shown below.

Total of insurance and property-tax expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $115,000

Increase in the asset, Prepaid Expenses, during 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000

Cash payment in 20x1 for insurance and property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $118,000

Since Alpine Trails’ actual cash payment in 20x1 for insurance and property taxes was $118,000, but the income statement shows a total expense for insurance and property taxes of only $115,000, the following adjustment is required:

Adjustment 2: Subtract the increase in Prepaid Expenses . . . �$3,000

10 Chapter 20 The Statement of Cash Flows

Alpine Trails Ski Resort Statement of Cash Flows

For the Year Ended December 31, 20x1

Cash flows from operating activities:

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Adjustments to net income to determine cash provided by operations

List of individual adjustments

• . . . . . . . . . . . . . . . . . . . . . . . XX

• . . . . . . . . . . . . . . . . . . . . . . . XX

• . . . . . . . . . . . . . . . . . . . . . . . XX

• . . . . . . . . . . . . . . . . . . . . . . . XX

Total adjustments . . . . . . . . . . . . . . . . . . . . . . . XX

Net cash flow from operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Cash flows from investing activities:

List of individual cash inflows

. . . . . . . . . . . . . . . . . . . . . . . XX

. . . . . . . . . . . . . . . . . . . . . . . XX

. . . . . . . . . . . . . . . . . . . . . . . XX

Net cash provided by (or used by) investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Cash flows from financing activities:

List of individual cash inflows

. . . . . . . . . . . . . . . . . . . . . . . XX

. . . . . . . . . . . . . . . . . . . . . . . XX

. . . . . . . . . . . . . . . . . . . . . . . XX

Net cash provided by (or used by) financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Net increase (or decrease) in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . XXX

Cash balance, beginning of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Cash balance, end of period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XXX

Exhibit 20–4

Format for Statement of Cash Flows under the Indirect Method

List of individual adjustments

•

•

•

•

Total adjustments

List of individual cash inflows and outflows

•

•

•

List of individual cash inflows and outflows

•

•

•

By subtracting $3,000 from Alpine Trails’ reported net income, we reflect that the firm’s 20x1 cash disbursement for insurance and property taxes exceeded the expense shown on the income statement.

What adjustment would be made if instead Alpine Trails’ Prepaid Expenses had declined during 20x1 by $2,000? Try to answer this question in your mind before referring to footnote 2.

Adjustment for Changes in Accrued Liability Alpine Trails pays its employees at the end of the time period for which the salary expense is recorded. The company’s income statement shows that the 20x1 salary expense was $270,000. However, a glance at the comparative balance sheet shows that the firm’s Accrued Salaries Payable account declined during 20x1 by $10,000 (from $30,000 on December 31, 20x0, to $20,000 on December 31, 20x1). Thus, Alpine Trails’ actual cash payments to its employees in 20x1 must have been $280,000.

Salary expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $270,000

Decrease in Accrued Salaries Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Cash payment in 20x1 for salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $280,000

The company’s 20x1 cash payments to employees were sufficient to cover its 20x1 expense and reduce its Accrued Salaries Payable liability from $30,000 at the beginning of the year to $20,000 at year-end. Thus, we must make the following adjustment.

By subtracting $10,000 from Alpine Trails’ reported net income, we reflect the fact that the firm’s 20x1 cash disbursement for salaries exceeded the expense shown on the income statement.

Suppose instead that Alpine Trails’ Accrued Salaries Payable account had increased by $7,500 during 20x1. Then what adjustment would be necessary? Think about this question before looking at footnote 3.

Adjustment for Changes in Inventory Alpine Trails purchases inventory for sale in its small ski shop. The income statement shows an expense of $30,000 for cost of mer- chandise sold. However, the company’s merchandise purchases during 20x1 were greater than $30,000, because the balance sheet reveals that the asset Merchandise Inventory increased during 20x1. Since Merchandise Inventory increased by $35,000 (from $25,000 to $60,000), Alpine must have purchased a total of $65,000 in mer- chandise:

Cost of merchandise sold (expense) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $30,000

Increase in Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,000

Total merchandise purchases in 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $65,000

Since Alpine Trails’ 20x1 merchandise purchases exceeded its expense for Cost of Merchandise Sold, the following adjustment is necessary.

Adjustment 3: Subtract the decrease in accrued liabilities . . . �$10,000

Chapter 20 The Statement of Cash Flows 11

2In this case, the opposite adjustment would be made. We would add $2,000 to the company’s net income to reflect the fact that the cash payment for insurance and property taxes was less than the expense reported on the income statement.

3 In this situation, the opposite adjustment would be made. We would add $7,500 to the company’s net income to reflect the fact that the cash payment for salaries was less than the expense reported on the income statement.

By subtracting $35,000 from Alpine Trails’ income, we reflect the fact that the company’s purchases of inventory were greater than the expense for Cost of Merchandise Sold shown on the income statement.

Suppose the balance in Merchandise Inventory had declined during the year by $9,000. What adjustment would be appropriate in this case?4

Adjustment for Changes in Accounts Payable We are not finished with the adjustments related to Alpine Trails’ merchandising operations. As we noted above, the company’s 20x1 merchandise purchases amounted to $65,000. However, this does not mean that the firm actually paid $65,000 in cash for those purchases in 20x1. As is true of most retail firms, Alpine Trails buys its merchandise on account. Therefore, in order to determine the company’s cash payments for merchandise during 20x1, we need to take into account the change in the Accounts Payable balance. As the balance sheet shows, Alpine Trails’ Accounts Payable increased by $15,000 during 20x1. What does this change imply about the company’s cash payments for merchandise purchases? As the following analysis shows, the firm’s cash payments must have been $50,000.

Merchandise purchases (as derived in the preceding section) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $65,000

Increase in Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000

Cash payments for merchandise purchases in 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $50,000

Since Alpine Trails’ cash payments for merchandise were less than its purchases, the following adjustment is required.

By adding $15,000 to Alpine Trails’ income, we reflect the fact that the company’s cash payments for merchandise inventory were less than the firm’s purchases.

Suppose instead that Alpine Trails’Accounts Payable balance had declined during the year by $12,000. Then what adjustment would be appropriate?5

Adjustment for Changes in Accounts Receivable Some of Alpine Trails’ patrons do not pay their bills in cash immediately, but prefer to put their charges on their accounts. Thus, Alpine Trails may actually collect a cash amount from customers during the year that differs from the revenue amount shown on the income statement. Alpine Trails’ income statement discloses total revenue for 20x1 of $980,000. However, the company’s Accounts Receivable balance declined during 20x1 by $10,000, as shown on the comparative balance sheets. Putting these two facts together, we conclude that Alpine Trails’ 20x1 cash receipts from customers amounted to $990,000.

Total revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $980,000

Decrease in Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Total cash receipts from customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $990,000

Adjustment 5: Add the increase in Accounts Payable . . . . . . �$15,000

Adjustment 4: Subtract the increase in Merchandise Inventory . . . . . . . . . . . . . . . . �$35,000

12 Chapter 20 The Statement of Cash Flows

4 The opposite adjustment would be made. We would add $9,000 to income. 5 The opposite adjustment would be made. We would subtract $12,000 from income.

Because Alpine Trails’ 20x1 cash receipts from customers exceeded its total revenue, the following adjustment is needed.

The addition of $10,000 to Alpine Trails’ income reflects the fact that the firm’s cash receipts from customers exceeded the total revenue reported on the income statement.

Suppose instead that Alpine Trails’Accounts Receivable balance had increased by $1,000 during the year. What adjustment would be made then?6

Adjustment for Deferred Taxes One final adjustment remains in determining Alpine Trails’ cash provided by operations. Taxes paid to the government are considered oper- ating cash flows. As the income statement shows, the company’s 20x1 income-tax expense was $50,000. However, the comparative balance sheets show that Alpine Trails also has a balance in its Deferred Income Taxes account. The decline in this account of $5,000 during 20x1 means that the company paid $5,000 in income taxes during 20x1 that had already been reported as an expense in some previous year. Thus, Alpine Trails’ cash disbursements for taxes in 20x1 amounted to $55,000, as the fol- lowing calculation shows.

Income-tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $50,000

Decrease in Deferred Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000

Total cash payments for income taxes in 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $55,000

Since Alpine Trails’ cash disbursements for income taxes exceeded its income-tax expense, the following adjustment is required.

The subtraction of $5,000 from Alpine Trails’ income reflects the fact that the company’s cash payments for income taxes exceeded the income-tax expense reported on the income statement.

What adjustment would be made if instead Alpine Trails’ Deferred Income Taxes had increased during the year by $4,000?7

Completing the Operating Activities Section of the Statement Now we have discussed all of the adjustments to income needed to determine Alpine Trails’ cash provided by operations. Exhibit 20–5 summarizes these adjustments and shows the relationship between net income determined under accrual accounting and the cash provided by operating activities. The operating activities section of the statement is shown in Exhibit 20–6. As Exhibit 20–6 shows, Alpine Trails’ operations provided $122,000 in cash during 20x1.

Before we can complete Alpine Trails’ entire statement of cash flows, we must prepare the financing and investing portions of the statement.

Adjustment 7: Subtract the decrease in Deferred Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . �$5,000

Adjustment 6: Add the decrease in Accounts Receivable . . . �$10,000

Chapter 20 The Statement of Cash Flows 13

6 The opposite adjustment would be required. We would subtract $1,000 from income. 7 The opposite adjustment would be required, so $4,000 would be added to Alpine Trails’ income. A $4,000

increase in Deferred Income Taxes would mean that the company’s cash payment for income taxes was exceeded by the income-tax expense reported on the income statement.

Investing Activities The second section of the statement of cash flows focuses on Alpine Trails’ investing activities. The company completed three major investment transactions during 20x1. These transactions, which are apparent upon examining the firm’s comparative balance sheets, are discussed next.

Investment in Stock Coulterton Transit Company is a small bus line which operates in the vicinity of nearby Coulterton, Colorado. The firm provides transportation between Alpine Trails Ski Resort and the city of Coulterton. Since Alpine Trails Ski Resort depends on Coulterton Transit’s services, Alpine’s board of directors recently approved a plan to invest in the bus company’s stock. In 20x1 Alpine Trails purchased 9,000

14 Chapter 20 The Statement of Cash Flows

Cash Flows from Income Statement Operating Activities

(accrual basis of accounting) (cash basis of accounting)

Revenue � Decrease in accounts receivable Cash receipts from customers

Less: Cost of goods sold � Increase in merchandise inventory Less: Cash disbursements for merchandise purchases

Less: Operating expenses � Depreciation expense Less: Cash disbursements for operating expenses

� Increase in prepaid expenses

� Decrease in accrued liabilities

Net income Cash provided by operations

Exhibit 20–5

Summary of Adjustments to Net Income: Alpine Trails Ski Resort

� Decrease in accounts receivable

� Increase in merchandise inventory

� Increase in accounts payable

� Depreciation expense

� Increase in prepaid expenses

� Decrease in accrued liabilities

� Decrease in deferred income taxes

Alpine Trails Ski Resort (in thousands)

Cash flows from operating activities:

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $110

Adjustments to net income to determine cash provided by operations:

1* Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $40

2 Increase in prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3)

3 Decrease in accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10)

4 Increase in merchandise inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (35)

5 Increase in accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

6 Decrease in accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

7 Decrease in deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5)

Total adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Net cash flow from operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $122

*This is the number of the adjustment as explained in the preceding pages.

Exhibit 20–6

Operating Activities Section of Statement of Cash Flows: Indirect Method

shares of Coulterton Transit Company stock for $45,000. Thus, the following entry will appear in the investing activities section of Alpine Trails’ statement.

Notice that the stock purchase also is apparent in Alpine Trails’ comparative balance sheets, in which the balance in the Investment-in-Stock account increased by $45,000 during 20x1.

Purchase of Equipment Another look at Alpine Trails’ comparative balance sheets shows that during 20x1 the company purchased facilities and equipment costing $70,000. Referral to the firm’s long-lived assets records reveals that the company pur- chased new snowmaking equipment. The following entry will appear on the statement of cash flows.

Sale of Land Early in 20x1 Alpine Trails sold several acres of land to a restaurant company which plans to build a restaurant near Alpine Trails Ski Resort. The land was sold at no gain or loss to Alpine Trails. The land sale is apparent on Alpine Trails’ com- parative balance sheets, where the balance in the land account declined from $400,000 to $350,000 during 20x1. The following entry will appear on Alpine Trails’ statement of cash flows.

Financing Activities The final section of Alpine Trails’ statement of cash flows focuses on the company’s financing activities. The three financing transactions completed in 20x1 are discussed next.

Redemption of Bonds On December 31, 20x1, Alpine Trails Ski Resort redeemed bonds with a face value of $60,000. The $60,000 decrease in Bonds Payable is apparent on the comparative balance sheets. The following entry on the statement of cash flows highlights this important transaction.

Sale of Capital Stock Examination of Alpine Trails’ comparative balance sheets shows that the company issued $20,000 of capital stock during 20x1. The following entry highlights this transaction on the statement of cash flows.

Cash flows from financing activities: Redemption of bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(60,000)

Cash flows from investing activities: Sale of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $50,000

Cash flows from investing activities: Purchase of snowmaking equipment . . . . . . . . . . . . . . . . . . . . . . . $(70,000)

Cash flows from investing activities: Purchase of Coulterton Transit Company Stock . . . . . . . . . . . . . . $(45,000)

Chapter 20 The Statement of Cash Flows 15

The sale of Alpine Trails Ski Resort’s own capital stock is a financing transaction. The stock was sold to raise funds to expand and conduct operations. In contrast, Alpine Trails’ purchase of Coulterton Transit Company’s stock is an investment activity, and it was properly included in the investing activities section of the statement.

Payment of Dividends One final financing transaction occurred during 20x1. Alpine Trails’ board of directors declared a $20,000 dividend on the company’s stock, and the dividend was paid in cash in December. This transaction, which is disclosed on the statement of retained earnings, is highlighted on the statement of cash flows by the fol- lowing entry.

Completed Statement of Cash Flows Now we can combine all three sections of Alpine Trails’ statement of cash flows. Exhibit 20–7 displays the completed statement. Alpine Trails had a $3,000 decrease in its cash and cash equivalents during 20x1.

The statement of cash flows explains how this change occurred and summarizes how the company obtained and used cash. Much of the information included on the statement of cash flows also is disclosed in the other major financial statements. For example, the sale of land is disclosed on the balance sheet. The purpose of the statement of cash flows is to pull together all of the company’s cash flow information and present it on one convenient statement.

Use of T-Accounts as an Aid in Preparing the Statement of Cash Flows

Some accountants find that T-accounts help them to organize their infor- mation when preparing a statement of cash flows. To illustrate this approach, let’s prepare Alpine Trails’ 20x1 statement using T-accounts.

Step One: Prepare T-Accounts The first step is to prepare a T-account for each account on Alpine Trails’ balance sheet. These T-accounts are shown in Exhibit 20–8; we analyze them in steps three, four, and five.

Step Two: Enter Account Balances Next we enter the beginning and ending balances in each of the accounts, except for Cash and Cash Equivalents. We can skip this account, since the change in this account is the amount we are attempting to explain.

Cash flows from financing activities: Payment of dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(20,000)

Cash flows from financing activities: Sale of capital stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $20,000

16 Chapter 20 The Statement of Cash Flows

LO 4 Prepare a statement of cash flows using the indirect method, the

direct method, and the T-account approach.

Use of T-Accounts as an Aid in Preparing the Statement of Cash Flows

Step Three: Analyze the Cash Flows from Operating Activities Now we are ready to analyze the changes in Cash and Cash Equivalents for 20x1, as they relate to changes in Alpine Trails’ other accounts during that period. For each account change, we make an entry in the Cash and Cash Equivalents account and in the related noncash account. When we are finished, we will have the basics of Alpine Trails’ statement of cash flows represented by the entries in the Cash and Cash Equivalents account.

Net Income Since we are using the indirect method of statement preparation, we begin by entering Alpine Trails’ 20x1 net income in the Cash and Cash Equivalents account and in the Retained Earnings account. Entries and adjustments that represent increases in cash are entered on the left (debit) side of the Cash and Cash Equivalents account. Since Alpine Trails’ net income of $110,000 increased the firm’s retained earnings we also enter $110,000 on the right (credit) side of the Retained Earnings account. To sum- marize, the following entry is made.

Adjustment 1: Depreciation Alpine Trails’ 20x1 depreciation was $40,000, so the fol- lowing entry is made.

Cash and Cash Equivalents (increase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110,000

Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110,000

Chapter 20 The Statement of Cash Flows 17

Alpine Trails Ski Resort Statement of Cash Flows

For the Year Ended December 31, 20x1 (in thousands)

Cash flows from operating activities:

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $110

Adjustments to net income to determine cash provided by operations:

Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40

Increase in prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3)

Decrease in accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10)

Increase in merchandise inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (35)

Increase in accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Decrease in accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Decrease in deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5)

Total adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Net cash flow from operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122

Cash flows from investing activities:

Purchase of Coulterton Transit Company stock . . . . . . . . . . . . . . . . . . . . . . . . . $(45)

Purchase of snowmaking equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (70)

Sale of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Net cash used by investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (65)

Cash flows from financing activities:

Redemption of bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(60)

Sale of capital stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Payment of dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (20)

Net cash used by financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (60)

Net decrease in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3)

Balance in cash and cash equivalents, beginning of year . . . . . . . . . . . . . . . . . . . 20

Balance in cash and cash equivalents, end of year . . . . . . . . . . . . . . . . . . . . . . . . $ 17

Exhibit 20–7

Statement of Cash Flows: Indirect Method

18 Chapter 20 The Statement of Cash Flows

Cash and Cash Equivalents

Entries and Adjustments Entries and Adjustments That Increase Cash That Decrease Cash

Operating activities:

Net income 110 3 Increase in prepaid expenses 2

1* Depreciation 40 10 Decrease in accrued liabilities 3

5 Increase in accounts payable 15 35 Increase in merchandise inventory 4

6 Decrease in accounts receivable 10 5 Decrease in deferred income taxes 7

Net cash flow from operating activities 122

Investing activities:

10 Sale of land 50 45 Purchase of Coulterton Transit Company stock 8

70 Purchase of snowmaking equipment 9

Financing activities:

12 Issuance of capital stock 20 60 Redemption of bonds 11

20 Payment of dividends 13

3 Decrease in cash and cash equivalents

Accounts Receivable Merchandise Inventory Prepaid Expenses

Beg. bal. 140 Beg. bal. 25 Beg. bal. 5

10 6 4 35 2 3

End. bal. 130 End. bal. 60 End. bal. 8

Investment in Coulterton Transit Company Stock Facilities and Equipment Accumulated Depreciation

Beg. bal. 0 Beg. bal. 400 100 Beg. bal.

8 45 9 70 40 1

End. bal. 45 End. bal. 470 140 End. bal.

Land Accounts Payable Accrued Salaries Payable

Beg. bal. 400 70 Beg. bal. 30 Beg. bal.

50 10 15 5 3 10

End. bal. 350 85 End. bal. 20 End. bal.

Deferred Income Taxes Bonds Payable Common Stock

15 Beg. bal. 250 Beg. bal. 235 Beg. bal.

7 5 11 60 20 12

10 End. bal. 190 End. bal. 255 End. bal.

Retained Earnings

300 Beg. bal.

13 20 110 Net income for 20x1

390 End. bal.

Exhibit 20–8

T-accounts Used in Preparing Statement of Cash Flows (all amounts in thousands)

*Boldface numbers reference the number of the adjustment in the surrounding pages.

As previously noted, the adjustment for depreciation reflects the fact that depreciation expense was deducted previously in computing Alpine Trails’ net income. Now it must be added back, since depreciation is a noncash expense.

Adjustment 2: Prepaid Expenses Since Alpine Trails’ balance in Prepaid Expenses increased by $3,000 during 20x1, the following entry is required.

The company paid $3,000 more in cash for insurance and property taxes in 20x1 than it incurred for those expenses.

Adjustment 3: Accrued Liabilities The following entry is required to record the $10,000 decrease in Alpine Trails’Accrued Salaries Payable account.

The company paid $10,000 more in cash to its employees than it incurred in salary expense for 20x1.

Adjustment 4: Merchandise Inventory A $35,000 increase in Merchandise Inventory means that Alpine Trails purchased more inventory than it sold in 20x1. The following entry reflects this fact.

Adjustment 5: Accounts Payable Alpine Trails’ cash payments to its merchandise sup- pliers amounted to $15,000 less than the firm’s merchandise purchases. The following entry reflects this fact.

Adjustment 6: Accounts Receivable The following entry is needed to show that Alpine Trails’ cash collections from its customers exceeded the company’s 20x1 revenue.

Adjustment 7: Deferred Taxes Alpine Trails’ cash payments for income taxes in 20x1 exceeded the firm’s income-tax expense. The following entry is required.

The seven adjustments complete the operating activities portion of the statement of cash flows. By calculating the balance in the Cash and Cash Equivalents account of Exhibit 20–8, we conclude that the cash provided by the operation in 20x1 amounted to $122,000. This balance reflects only operating activities; Alpine Trails’ financing and investing activities are analyzed in steps 4 and 5.

Deferred Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000

Cash and Cash Equivalents (decrease) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000

Cash and Cash Equivalents (increase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Cash and Cash Equivalents (increase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000

Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15,000

Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,000

Cash and Cash Equivalents (decrease) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,000

Accrued Salaries Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Cash and Cash Equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Prepaid Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000

Cash and Cash Equivalents (decrease) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,000

Cash and Cash Equivalents (increase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000

Accumulated Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40,000

Chapter 20 The Statement of Cash Flows 19

Step Four: Analyze the Cash Flows from Investing Activities Alpine Trails had three major investing transactions in 20x1. The following three entries will record the effects of these transactions on the company’s cash and cash equivalents.

Entry 8: Purchase of Coulterton Transit Company Stock Alpine Trails’ purchase of stock as an investment is recorded as follows:

Entry 9: Purchase of Snowmaking Equipment The following entry records this major use of cash.

Entry 10: Sale of Land Alpine Trails’ land sale generated $50,000 in cash as shown by the following entry.

Step Five: Analyze the Cash Flows from Financing Activities Alpine Trails’ three major financing activities are recorded by the following entries:

Entry 11: Redemption of Bonds The use of $60,000 in cash to redeem bonds requires this entry:

Entry 12: Issuance of Capital Stock Alpine Trails generated $20,000 in cash through the issuance of capital stock, as the following entry shows.

Entry 13: Payment of Dividends The following entry reflects the $20,000 cash outflow resulting from Alpine Trails’ payment of dividends. Dividend payments reduce a firm’s Retained Earnings account.

This completes the entries needed to record Alpine Trails’ investing and financing activities. Now we compute the final balance in the Cash and Cash Equivalents account. This shows that Alpine Trails’ cash and cash equivalents decreased by $3,000 during 20x1. Carefully examine the Cash and Cash Equivalents account in Exhibit 20–8. Compare the account with Alpine Trails’ statement of cash flows in Exhibit 20–7. Notice that all of the information needed to prepare the statement is summarized in the Cash and Cash Equivalents account.

Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000

Cash and Cash Equivalents (decrease) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000

Cash and Cash Equivalents (increase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000

Common Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000

Bonds Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000

Cash and Cash Equivalents (decrease) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60,000

Cash and Cash Equivalents (increase) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000

Facilities and Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70,000

Cash and Cash Equivalents (decrease) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70,000

Investment in Coulterton Transit Company Stock . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,000

Cash and Cash Equivalents (decrease) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,000

20 Chapter 20 The Statement of Cash Flows

Using the Direct Method of Statement… When the direct method is used, the operating activities section of the statement of cash flows is approached differently than when the indirect method is used. Instead of beginning with net income and making adjust- ments, we will list each income statement item on the statement of cash flows. However, we still will make adjustments to reflect the difference between accrual accounting, which is used on the income statement, and cash-basis accounting, which is used on the statement of cash flows.

To illustrate the direct method of statement preparation, we will focus on the activ- ities of Alpine Trails Ski Resort during 20x2. The company’s comparative balance sheets, income statement, and statement of retained earnings are given in Exhibits 20–9 and 20–10.

Alpine Trails’ completed statement of cash flows for 20x2 is displayed in Exhibit 20–11 which appears on page 23. The number next to each item on the statement is keyed to the following discussion, in which each statement item is explained.

Chapter 20 The Statement of Cash Flows 21

Using the Direct Method of Statement Preparation LO 4 Prepare a statement of cash flows using the indirect method, the direct method, and the T-account approach.

Alpine Trails Ski Resort Comparative Balance Sheets December 31, 20x2 and 20x1

(in thousands)

Assets 20x2 20x1 Change Current assets:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 22 $ 17 $ 5 Increase

Marketable securities . . . . . . . . . . . . . . . . . . . 10 10 –0–

Accounts receivable . . . . . . . . . . . . . . . . . . . . 140 130 10 Increase

Merchandise inventory . . . . . . . . . . . . . . . . . . 35 60 25 Decrease

Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . 3 8 5 Decrease

Total current assets . . . . . . . . . . . . . . . . . . . 210 225 15 Decrease

Investment in Coulterton Transit Company Stock . . 45 45 –0–

Facilities and equipment . . . . . . . . . . . . . . . . . . . 450 470 20 Decrease

Less: Accumulated depreciation . . . . . . . . . . . . . . (175) (140) 35 Increase

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 540 350 190 Increase

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,070 $950 $120 Increase

Liabilities and Stockholders’ Equity Current liabilities:

Accounts payable . . . . . . . . . . . . . . . . . . . . . . $ 75 $ 85 $ 10 Decrease

Accrued salaries payable . . . . . . . . . . . . . . . . . 25 20 5 Increase

Deferred revenue . . . . . . . . . . . . . . . . . . . . . . 5 –0– 5 Increase

Total current liabilities . . . . . . . . . . . . . . . . . 105 105 –0–

Deferred income taxes . . . . . . . . . . . . . . . . . . . . 15 10 5 Increase

Bonds payable . . . . . . . . . . . . . . . . . . . . . . . . . . 190 190 –0–

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . 310 305 5 Increase

Stockholders’ equity:

Common stock . . . . . . . . . . . . . . . . . . . . . . . . 270 255 15 Increase

Retained earnings . . . . . . . . . . . . . . . . . . . . . . 490 390 100 Increase

Total stockholders’ equity . . . . . . . . . . . . . . 760 645 115 Increase

Total liabilities and stockholders’ equity . . . . . . . . $1,070 $950 $120 Increase

Exhibit 20–9

Comparative Balance Sheets

Operating Activities The operating activities section of the statement shows that Alpine Trails’ operations provided $195,000 in cash during 20x2. Explanations of the various items in this section of the statement follow.

1. Cash receipts from customers. Alpine Trails’ income statement in Exhibit 20–10 shows that total sales revenue amounted to $1,060,000 in 20x2. However, this is not the amount of cash collected from customers, for two reasons. First, the com- parative balance sheets in Exhibit 20–9 show that Accounts Receivable increased in 20x2 by $10,000. Therefore, $10,000 of the firm’s 20x2 sales were not paid for in cash during 20x2. Second, the current liabilities section of Alpine Trails’ com- parative balance sheets shows a $5,000 increase in Deferred Revenue during 20x2. Deferred Revenue is a liability that results when the company receives cash from customers for services not yet rendered. In Alpine Trails’ case, the $5,000 in Deferred Revenue resulted when customers made advance deposits during 20x2 to hold condo reservations for the following year.

22 Chapter 20 The Statement of Cash Flows

Alpine Trails Ski Resort Income Statement

For the Year Ended December 31, 20x2 (in thousands)

Revenue:

Slope fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $330

Condominium rentals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 650

Sales of merchandise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

Total revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,060

Less: Cost of merchandise sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,005

Less: Operating expenses:

Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300

Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166

Interest on bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 825

Income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 180

Income-tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 125

Alpine Trails Ski Resort Statement of Retained Earnings

For the Year Ended December 31, 20x2 (in thousands)

Retained earnings, December 31, 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $390

Add: Net income for 20x2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515

Deduct: Dividends declared in 20x2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Retained earnings, December 31, 20x2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $490

Exhibit 20–10

Income Statement and Statement of Retained Earnings

The following calculations show that Alpine Trails collected a total of $1,055,000 from its customers in 20x2.

Total revenue (from income statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,060,000

Subtract: Increase in Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,000)

Add: Increase in Deferred Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000

Cash collected from customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,055,000

2. Cash payments to suppliers of merchandise. Alpine Trails’ 20x2 income statement includes an expense for cost of merchandise sold of $55,000, but the statement of cash flows shows cash payments to suppliers of $40,000. The fol- lowing calculations reconcile this difference.

Cost of Merchandise Sold (from income statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $55,000

Subtract: Decrease in Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (25,000)

Add: Decrease in Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Cash payments to suppliers of merchandise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $40,000

3. Cash payments to employees. Salary expense of $300,000 is included on Alpine Trails’ income statement. However, the firm’s cash payments to employees amounted to $295,000 in 20x2, as the following analysis shows.

Chapter 20 The Statement of Cash Flows 23

Statement of Cash Flows: Direct Method Alpine Trails Ski Resort

For the Year Ended December 31, 20x2 (in thousands)

Cash flows from operating activities:

1 Cash receipts from customers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,055

Cash payments:

2 To suppliers of merchandise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40

3 To employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295

4 For interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

5 For income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

For other operating expenses:

6 Insurance and property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

7 Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95

7 Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

7 Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

7 Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166

Total cash payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 860

Net cash flow from operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 195

Cash flows from investing activities:

Sale of equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 10

Purchase of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (190)

Net cash used by investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (180)

Cash flows from financing activities:

Issuance of capital stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 15

Payment of dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (25)

Net cash used by financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10)

Net increase in cash and cash equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Balance in cash and cash equivalents, beginning of year . . . . . . . . . . . . . . . . . . . . . 17

Balance in cash and cash equivalents, end of year . . . . . . . . . . . . . . . . . . . . . . . . . $ 22

Exhibit 20–11

Statement of Cash Flows: Direct Method

Salary expense (from income statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $300,000

Less: Increase in Accrued Salaries Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,000)

Cash payments to employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $295,000

4. Cash payments for interest. Alpine Trails’ $19,000 interest payment is shown on the income statement.

5. Cash payment for income taxes. Income-tax expense on Alpine Trails’ income statement is $55,000. However, the two balance sheets show that the company’s liability for Deferred Income Taxes increased by $5,000 during 20x2. This means that Alpine Trails’ cash payments for income taxes amounted to $5,000 less than the firm’s actual income-tax expense.

Income-tax expense (from income statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $55,000

Less: Increase in Deferred Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,000)

Cash payments for income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $50,000

6. Cash payments for insurance and property taxes. These two expenses total $125,000 on Alpine Trails’ income statement. However, the comparative balance sheets show that the firm’s prepaid expenses declined by $5,000 during 20x2. This means that Alpine’s 20x2 cash payments for insurance and property taxes amounted to $5,000 less than its expenses.

Insurance and property tax expenses (from income statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125,000

Less: Decrease in Prepaid Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (5,000)

Cash payments for insurance and property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $120,000

7. Cash payments for utilities, maintenance, advertising, and administration. These cash payments are the same as the expense items listed on the income statement.

Depreciation Notice that there is no entry on the statement of cash flows for depreci- ation. Under the direct method of statement preparation, we list only the cash receipts and disbursements. Since depreciation is a noncash expense, no entry is necessary.

Investing Activities Alpine Trails’ 20x2 statement of cash flows lists two cash flows from investing activities.

Equipment Sale The company sold a truck with a book value of $10,000 for $10,000 in cash. The truck’s original cost was $20,000, and its accumulated depreciation at the time of the sale was $10,000. Notice that the comparative balance sheets show a $20,000 decline in Facilities and Equipment during 20x2. The balance sheets also show a $35,000 increase in Accumulated Depreciation during 20x2, which is explained as follows:

Accumulated Depreciation, December 31, 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $140,000

Add: Deprecation expense for 20x2 (from income statement) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,000

Subtract: Accumulated depreciation on truck sold in 20x2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10,000)

Accumulated Depreciation, December 31, 20x2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $175,000

Land Purchase As the comparative balance sheets show, Alpine Trails purchased land for $190,000 during 20x2. The company’s management purchased the land for planned future construction of additional condominiums.

24 Chapter 20 The Statement of Cash Flows

Financing Activities Two financing transactions are disclosed on Alpine Trails’ 20x2 statement of cash flows.

Issuance of Capital Stock The company issued $15,000 in capital stock during 20x2, as the comparative balance sheets show.

Payment of Dividends Alpine Trails paid $25,000 in cash dividends during 20x2, as the statement of retained earnings shows.

Completed Statement of Cash Flows Exhibit 20–11 shows Alpine Trails’ 20x2 statement of cash flows. As the statement shows, cash and cash equivalents increased by $5,000 during 20x2.

Reconciliation Between Net Income and Net Cash Flow from Operating Activities When the direct method is used, a separate schedule must be provided to reconcile net income with the cash provided by operating activities. This schedule takes the same form as the operating activities section of the statement when it is prepared using the indirect method. The required schedule to accompany Alpine Trails’ 20x2 statement is dis- played in Exhibit 20–12.

Other Issues in Preparing the Statement of… Two other issues concerning preparation of the statement of cash flows merit dis- cussion: (1) gross versus net cash flows and (2) direct exchange transactions.

Gross versus Net Cash Flows Suppose that in 20x3 Alpine Trails Ski Resort purchases one parcel of land for $80,000 and sells another property for $25,000. In preparing the statement of cash flows, Alpine Trails should report both investing transactions at their gross amounts, rather than reporting a net land purchase of $55,000 ($80,000 purchase minus $25,000 sale).

Chapter 20 The Statement of Cash Flows 25

Alpine Trails Ski Resort Reconciliation of Net Income to the Net Cash Flow from Operating Activities

For the Year Ended December 31, 20x2

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125

Adjustments to reconcile net income to the net cash flow from operating activities:

Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $45

Decrease in prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Increase in accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Decrease in merchandise inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Decrease in accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10)

Increase in accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (10)

Increase in deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Increase in deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

Total adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

Net cash flows from operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $195

Exhibit 20–12

Reconciliation of Net Income to the Net Cash Flow from Operating Activities

Other Issues in Preparing the Statement of Cash Flows

Correct Presentation (gross amounts) Cash flows from investing activities:

Purchase of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(80,000)

Sale of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,000

Cash used for investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(55,000)

Incorrect Presentation (net amount) Cash flows from investing activities

Net purchase of land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(55,000)

The practice of reporting gross transaction amounts extends to all items in the investing and financing portions of the statement. However, net amounts are used in the operating activities section. For example, when Alpine Trails has several transac- tions during the year involving Accounts Payable, only the net change in Accounts Payable would be used in calculating the cash flow from operating activities.

Direct Exchange or Noncash Transactions The statement of cash flows focuses on transactions involving cash inflows or outflows. Sometimes, however, an enterprise experiences a substantive investing or financing transaction that does not involve a cash flow. An example of such a transaction is the purchase of a productive, long-lived

asset through the issuance of debt or stock. Suppose, for example, that in 20x3 Alpine Trails Ski Resort purchases a parcel of land valued at $100,000 by giving the seller a $100,000 note payable. The journal entry to record this transaction is shown below.

No cash was exchanged in this transaction; yet the event involved a significant investing transaction (the purchase of land) and a significant financing transaction (the issuance of a note payable). Such a transaction, which does not involve cash, is called a direct exchange (or noncash) transaction.

Significant direct exchange transactions are not included in the body of the statement of cash flows. However, such transactions should be disclosed in a separate schedule accompanying the statement. In this manner, users of the company’s financial statements will be alerted to these significant events. Alpine Trails’ 20x3 statement of cash flows should be accompanied by the following schedule.

Schedule of direct exchange (noncash) transactions involving significant investing and financing activities: Purchase of land valued at $100,000 through the issuance of a note payable in the amount of $100,000.

Using the Statement of Cash Flows The statement of cash flows provides useful information for both the man- agers of an enterprise and interested parties outside the organization. For both groups, the statement provides a convenient way of reconciling a company’s income with its net cash flow. Many managers find the cash flow concept to be a more intuitively appealing measure of an organization’s per- formance than income based on accrual accounting. In addition, the

statement helps managers in determining the firm’s dividend policy and needs for bor- rowing. Perhaps most important is the information provided by the statement about the ability of the enterprise to invest in facilities, equipment, or expanded operations. In short, the statement of cash flows provides managers with insight about what the enterprise can afford.

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000

Note Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000

26 Chapter 20 The Statement of Cash Flows

LO 5 Prepare a schedule disclosing direct exchange transactions.

LO 6 Describe how the statement of cash flows is used by an enterprise’s

managers and by interested parties outside the organization.

A direct exchange (or noncash) transaction is a transaction in which no cash is involved.

Using the Statement of Cash Flows

Investors, creditors, and financial analysts use the information in the statement of cash flows to help in predicting an enterprise’s future performance. Is the company in a strong position to grow or to take advantage of opportunities? Or, at the other extreme, is the firm in danger of insolvency? What sort of dividend stream is likely in the future? Outside parties find the information in the statement of cash flows important in answering these and many other questions about an enterprise’s future performance.

Illustration of the Statement of Cash Flows McDonald’s Corporation’s comparative statements of cash flows for three recent years are displayed in Exhibit 20–13. Notice that the company’s cash provided by operations

Chapter 20 The Statement of Cash Flows 27

McDonald’s Corporation Consolidated Statement of Cash Flows

Year 3 Year 2 Year 1 Operating activities:

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 1,572.6 $ 1,427.3 $ 1,224.4

Adjustments to reconcile to cash provided by operations:

Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 742.9 709.0 628.6

Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32.9 (4.2) (5.6)

Changes in operating working capital items:

Accounts receivable increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (77.5) (49.5) (51.6)

Inventories, prepaid expenses and other current assets increase . . . (18.7) (20.4) (15.0)

Accounts payable increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44.5 52.6 105.4

Accrued interest increase (decrease) . . . . . . . . . . . . . . . . . . . . . . . 5.0 13.0 (25.5)

Taxes and other liabilities increase . . . . . . . . . . . . . . . . . . . . . . . . . 116.4 158.3 95.2

Other—net . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42.9 10.1 (29.7)

Cash provided by operations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,461.0 2,296.2 1,926.2

Investing activities:

Property and equipment expenditures . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,375.3) (2,063.7) (1,538.6)

Purchases of restaurant businesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . (137.7) (110.1) (133.8)

Sales of restaurant businesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198.8 151.6 151.5

Property sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35.5 66.2 66.0

Notes receivable additions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (36.4) (33.4) (15.1)

Notes receivable reductions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59.2 31.5 56.7

Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (314.4) (151.1) (92.6)

Cash used for investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2,570.3) (2,109.0) (1,505.9)

Financing activities:

Net short-term borrowings (repayments) . . . . . . . . . . . . . . . . . . . . . . . . . 228.8 (272.9) 521.7

Long-term financing issuances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,391.8 1,250.2 260.9

Long-term financing repayments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (841.3) (532.2) (536.9)

Treasury stock purchases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (599.9) (314.5) (495.6)

Common and preferred stock dividends . . . . . . . . . . . . . . . . . . . . . . . . . (232.0) (226.5) (215.7)

Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157.0 63.6 39.4

Cash provided by (used for) financing activities . . . . . . . . . . . . . . . . . . . . 104.4 (32.3) (426.2)

Cash and equivalents increase (decrease) . . . . . . . . . . . . . . . . . . . . . . . . (4.9) 154.9 (5.9)

Cash and equivalents at beginning of year . . . . . . . . . . . . . . . . . . . . . . . 334.8 179.9 185.8

Cash and equivalents at end of year . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 329.9 $ 334.8 $ 179.9

Supplemental cash flow disclosures:

Interest paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 369.0 $ 331.0 $ 323.9

Income taxes paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 558.1 $ 667.6 $ 621.8

Exhibit 20–13

Comparative Statements of Cash Flows: McDonald’s Corporation for Three Recent Years (in millions)

28 Chapter 20 The Statement of Cash Flows

has increased steadily over the three-year period. The investing activities section shows that McDonald’s has invested heavily in property and equipment. Apparent from the statement’s financing activities section is McDonald’s steadily increasing dividend payment. All in all, the statement provides a picture of a vibrant, growing company that is in a strong financial position.

Summary The statement of cash flows has evolved over a period of 30 years from an informal cash flow analysis into a major financial statement. The statement is required by the FASB for external reporting, and it is considered to be of equal importance to the balance sheet and income statement. The purpose of the statement of cash flows is to provide financial statement users with insight about: (1) the organization’s ability to generate positive future cash flows, (2) the organization’s ability to meet its obligations and pay dividends, (3) the needs of the organization for external financing, (4) the reasons for the differences between net income and the net cash flow from operations, and (5) the effects of cash and noncash investing and financing activities.

The statement has three sections, which describe the organization’s cash flows from operating activ- ities, investing activities, and financing activities. The operating activities section of the statement may be prepared using the direct method, under which a cash-basis income statement is prepared by ana- lyzing each of the firm’s cash flows, the income statement accounts, and the changes in the balance sheet accounts. Alternatively, the indirect method may be used, in which the analyst begins with the firm’s net income determined under accrual accounting. Then net income is adjusted to reflect the differences between operating cash flows and the revenues and expenses reported on an accrual basis. T-accounts may also be used as an aid in preparing the statement.

Chapter Summary

Review Questions

cash equivalents, pg. 5

direct exchange (or noncash) transaction, pg. 26

direct method, pg. 7

financing activities, pg. 6

indirect method (or reconciliation method), pg. 7

investing activities, pg. 5

operating activities, pg. 5

statement of cash flows, pg. 4

Key Terms For each term’s definition refer to the indicated page, or turn to the glossary at the end of the text.

20–1. List five purposes for the statement of cash flows.

20–2. What is meant by the term cash equivalent?

20–3. Describe the organization of the statement of cash flows.

20–4. Define each of the following terms: operating activ- ities, investing activities, and financing activities.

20–5. For each of the following transactions, indicate whether it belongs in the operating, investing, or financing section of the statement of cash flows.

a. Purchase of land.

b. Sale of the firm’s own capital stock.

c. Sale of stock owned in another company.

d. Payment of a utility bill.

e. Collection of accounts receivable.

f. Collection of a loan made to another company.

20–6. Explain the difference between the direct and indirect methods of preparing the operating activities section of the statement of cash flows.

20–7. Explain the treatment of depreciation under the indirect method.

20–8. Describe the implications of an increase in accounts receivable when the indirect method is used.

20–9. Is depreciation a source of cash? Explain your answer.

20–10. Describe the adjustment made to net income under the indirect method when accounts payable is increased by $2,000 and inventory is decreased by $800.

20–11. Explain the difference between gross and net cash flows. Which of these types of cash flow is used in the statement of cash flows? Why?

20–12. Define the term direct exchange transaction. Give two examples.

20–13. What are the sources of information from which the statement of cash flows is prepared?

20–14. Last year Robinson Corporation reported a net loss of $200,000, but the company’s net cash provided by operations amounted to $50,000. Moreover, the firm’s cash balance did not change during the year. Explain how these events could occur.

20–15. How might the management of a company use the statement of cash flows? Of what use is the statement to outside parties?

Chapter 20 The Statement of Cash Flows 29

Exercises Celeste Furniture Stores had $9,000 in prepaid expenses on December 31, 20x0. This account relates to a prepaid insurance bill. During 20x1, the company’s insurance expense was $76,000. At the end of 20x1, the balance in prepaid expenses was $7,000.

Required:

1. What was Celeste’s total cash payment for insurance during 20x1? Show your calculations.

2. What adjustment will be needed for prepaid expenses if the indirect method is used in preparing Celeste’s statement of cash flows? Explain your answer.

Frost Wholesalers sells produce to the grocery stores in southern Florida. The beginning and ending bal- ances in the company’s Inventory and Accounts Payable accounts during the most recent year were as follows:

January 1 December 31 Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $25,000 . . . . . . . . . . . . . . . . . . . . . . . . . $20,000

Accounts Payable . . . . . . . . . . . . . . . . . . . . . . 15,000 . . . . . . . . . . . . . . . . . . . . . . . . . 13,000

Frost’s cost of goods sold for the year was reported at $280,000 on its income statement.

Required:

In completing the following requirements, assume that Frost Wholesalers uses the indirect method in preparing the statement of cash flows.

1. What adjustment is required for the change in the inventory balance? Explain your answer. How much produce inventory was purchased during the year?

2. Prepare a schedule that computes Frost’s total cash payments to its produce suppliers during the year.

3. What adjustment is necessary for the change in the accounts payable balance on the statement of cash flows for the year? Explain your answer.

On December 31, 20x0, Sandburg Plastics Company showed $760,000 in Accumulated Depreciation on its balance sheet. During 20x1, the company sold a building with accumulated depreciation of $120,000. At year-end, the balance in the Accumulated Depreciation account was $695,000.

Required:

1. What adjustment is required for depreciation on Sandburg’s 20x1 statement of cash flows:

a. If the indirect method is used?

b. If the direct method is used?

2. Explain why your answers differ in (a) and (b) above.

Thurber Advertising Agency’s balance in Accounts Receivable increased by $45,000 during the year just ended. The firm’s service revenue during the year amounted to $640,000.

20–16. Of what use is the statement of cash flows, given that most of the information can be deduced from an income statement and comparative balance sheet?

20–17. Assuming the indirect method of preparing the statement of cash flows, describe the effects of the fol- lowing items on the cash provided by operations.

a. Increase in deferred income taxes.

b. Decrease in deferred revenue.

c. Increase in prepaid expenses.

20–18. Suppose a company sold a factory building to its former president in exchange for a $600,000, five-year note. Would this transaction be reported in the company’s statement of cash flows? If it would be dis- closed, explain how.

20–19. Would the sale of land be considered an investing activity or a financing activity? Explain.

20–20. Suppose an airline sold three aircraft for $6,000,000 and purchased seven others for $22,000,000. How would these transactions be reported on the statement of cash flows?

Exercise 20–21 Adjustment for Prepaid Expenses (LO 3, LO 4)

Exercise 20–22 Adjustments for Inventory and Accounts Payable (LO 3, LO 4)

Exercise 20–23 Adjustment for Depreciation (LO 3, LO 4)

Exercise 20–24 Adjustment for Changes in Accounts Receivable (LO 3, LO 4)

Required:

1. If Thurber uses the indirect method, what adjustment will be necessary on its statement of cash flows for the year? Explain your answer.

2. If Thurber uses the direct method, what amount will be shown for cash received from clients on the statement of cash flows? Explain your answer.

3. Can you determine the amount of cash received from clients during the year which stemmed from services provided during the year? If yes, what is the amount? If no, what additional information would you need to determine the amount?

Irving Company operates a tour bus line in St. Louis. On December 31, 20x0, the company’s balance in the Deferred Income Taxes account was $48,000. On December 31, 20x1, the Deferred Income Taxes balance was $57,000. The firm’s income-tax expense for 20x1 was $128,000.

Required:

1. If Irving Company uses the indirect method, what adjustment will be required for deferred income taxes? Explain your answer.

2. If Irving Company uses the direct method, what amount will be shown on the statement of cash flows for cash payments for income taxes?

3. In what section of the statement of cash flows will the items referred to above appear?

Steinbeck Broadcasting Company operates several radio stations in the Midwest. The operating activities section of the company’s statement of cash flows for the year just ended is as follows:

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,480,000

Adjustments to net income to determine cash provided by operations:

Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $410,000

Decrease in prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14,000

Decrease in accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (12,000)

Decrease in supplies inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000

Decrease in accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (14,000)

Increase in accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (27,000)

Increase in deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Total adjustments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 390,000

Net cash flow from operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,870,000

Required:

A good friend of yours is perplexed by the preceding information. In particular, he is puzzled as to why the changes in account balances result in the indicated adjustments. Write a note to your friend explaining the adjustments on Steinbeck’s statement of cash flows.

Whittier Publishing Company had received $25,000 in advance subscriptions from its magazine cus- tomers as of December 31, 20x0. This amount was shown as deferred revenue on the company’s balance sheet. The balance in the Deferred Revenue account on December 31, 20x1, was $10,000.

Required:

What adjustment will be necessary when Whittier’s controller prepares the company’s 20x1 statement of cash flows using the indirect method? Explain your answer.

Poe Nurseries grows and sells trees and shrubs for landscaping. In May of the most recent year, the company acquired 200 acres of land appraised at $410,000 from Clemens Orchards, Inc. In exchange for the land, Clemens Orchards, Inc. received a five-year note from Poe Nurseries in the amount of $410,000.

Required:

Show how this transaction will be disclosed in the statement of cash flows prepared by (1) Poe Nurseries and (2) Clemens Orchards, Inc.

30 Chapter 20 The Statement of Cash Flows

Exercise 20–25 Adjustment for Deferred Taxes (LO 3, LO 4)

Exercise 20–26 Understanding the Operating Activities Section of the Statement of Cash Flows (LO 4, LO 6)

Exercise 20–27 Adjustment for Deferred Revenue (LO 3, LO 4)

Exercise 20–28 Direct Exchange Transactions (LO 5)

Chapter 20 The Statement of Cash Flows 31

Alcott Theater Supplies Company engaged in the following transactions during the year just ended.

a. Acquired land for $300,000.

b. Purchased an office building for $200,000.

c. Sold a warehouse for $400,000. The accumulated depreciation on the warehouse was $170,000, and its original cost to Alcott Theater Supplies was $570,000.

Required:

Prepare the investing activities section of Alcott Theater Supplies’ cash flow statement.

Problems Diamond Electronics Company’s most recent financial statements are as follows. The firm did not dispose of any long-lived assets.

Diamond Electronics Company Comparative Balance Sheets December 31, 20x1 and 20x0

Assets 20x1 20x0 Current assets:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 50,000 $ 60,000

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,000 40,000

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000 100,000

Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,000 10,000

Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $228,000 $210,000

Long-lived assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162,000 100,000

Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (30,000) (20,000)

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $360,000 $290,000

Liabilities and Stockholders’ Equity Current liabilities:

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 55,000 $ 50,000

Salaries payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,000 45,000

Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 90,000 $ 95,000

Stockholders’ equity:

Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100,000 $100,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170,000 95,000

Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $360,000 $290,000

Diamond Electronics Company Income Statement December 31, 20x1

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $645,000

Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400,000

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $245,000

Less: Selling and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120,000

Income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125,000

Income-tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 75,000

Required:

1. Prepare the operating cash flows section of Diamond Electronics’ statement of cash flows for 20x1. Use the indirect method.

2. Did Diamond Electronics declare a cash dividend during 20x1? If so, how much was it?

Exercise 20–29 Gross versus Net Cash Flows (LO 4)

Problem 20–30 Operating Cash Flows; Indirect Method (LO 4, LO 6)

The following changes occurred in Baltimore Delivery Service’s balance sheet accounts during the most recent year.

a. Accounts Payable, increase of $39,000.

b. Accounts Receivable, decrease of $23,000.

c. Prepaid Expenses, decrease of $30,000.

d. Accumulated Depreciation on Vehicles, increase of $100,000.

e. Buildings, increase of $120,000.

f. Bonds Payable, increase of $250,000.

g. Deferred Income Taxes, increase of $20,000.

h. Salaries Payable, decrease of $12,000.

i. Supplies Inventory, increase of $9,000.

Required:

For each of the balance sheet account changes listed, indicate how the item will be handled on the company’s statement of cash flows. Assume that the indirect method will be used. Be sure to state which section of the statement will be affected by each item.

The following transactions relate to Metro Daily, Inc., a large newspaper company serving several cities on the east coast.

a. Purchased new presses for $840,000 in cash.

b. Declared and paid cash dividends of $41,000.

c. Sold stock in a radio broadcasting company. The stock was sold for $115,000 in cash, the same amount that had been paid for the stock.

d. Issued Metro Daily common stock in exchange for a piece of land appraised at $310,000.

e. Paid off an income-tax liability from the prior year, $80,000.

f. Sold fully depreciated equipment costing $200,000 for $15,000.

g. Paid deferred income taxes of $18,000.

h. Purchased newsprint costing $95,000 on account.

i. Recorded depreciation expense of $81,000.

Required:

Prepare a table with the following headings, and classify each of the transactions described above. Metro Daily, Inc. uses the direct method.

Increase, On the Decrease, StatementType of Activity

or No Effect of Cash Flows Transaction Operating Investing Financing on Cash Yes or No

Mind Challenge, Inc. is a manufacturer of unique educational toys for preschoolers. The company’s founder and president is considering the acquisition of another small company that manufactures kites. As an aid in making his decision, the president has asked for a set of financial statements for Mind Challenge, Inc. The controller has prepared the comparative balance sheets and income statement shown on the next page.

Depreciation expense of $20,000 is included in operating expenses. The company constructed a prefabricated storage building for $50,000. Long-term debt of $10,000 was retired. The company incurred no income tax expense in 20x1, and no dividends were paid.

Required:

1. The controller has asked you, the assistant controller, to prepare Mind Challenge’s statement of cash flows for 20x1. The controller has a preference for the indirect method.

2. Prepare a memo to the company’s president explaining why the cash balance increased during the year.

32 Chapter 20 The Statement of Cash Flows

Problem 20–31 Changes in Balance Sheet Accounts; Effect on the Statement of Cash Flows; Indirect Method (LO 4, LO 6)

Problem 20–32 Determining the Effect of Transactions on the Statement of Cash Flows (LO 4, LO 6)

Problem 20–33 Statement of Cash Flows; Indirect Method (LO 4, LO 6)

Mind Challenge, Inc. Comparative Balance Sheets December 31, 20x1 and 20x0

Assets 20x1 20x0 Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 64,000 $ 27,000

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90,000 132,000

Marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,000 17,000

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000 129,000

Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000 10,000

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140,000 85,000

Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 750,000 700,000

Less: Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (170,000) (150,000)

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,000,000 $950,000

Liabilities and Stockholders’ Equity 20x1 20x0 Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $125,000 $100,000

Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,000 40,000

Income tax payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,000 13,000

Interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7,000 4,000

Short-term notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12,000 15,000

Long-term notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170,000 180,000

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 362,000 352,000

Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 560,000 520,000

Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45,000 40,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33,000 38,000

Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 638,000 598,000

Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,000,000 $950,000

Mind Challenge, Inc. Income Statement

For the Year Ended December 31, 20x1 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 600,000

Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 345,000

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 255,000

Operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 250,000

Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5,000

Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,000

Net loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (5,000)

Refer to the information given in the preceding problem for Mind Challenge, Inc.

Required:

Using T-accounts, prepare the firm’s 20x1 statement of cash flows using this approach.

Refer to the information given in Problem 20–33 for Mind Challenge, Inc.

Required:

Prepare the company’s 20x1 statement of cash flows using the direct method.

In Shape, Inc. is a retailer of home fitness equipment such as stationary bicycles and treadmills. The firm’s recent comparative balance sheets and income statement are as follows:

Chapter 20 The Statement of Cash Flows 33

Problem 20–34 Statement of Cash Flows; Use of T-Accounts (LO 4, LO 6)

Problem 20–35 Statement of Cash Flows; Direct Method (LO 4, LO 6)

Problem 20–36 Statement of Cash Flows; Direct and Indirect Methods (LO 4, LO 6)

In Shape, Inc. Comparative Balance Sheets December 31, 20x1 and 20x0

Assets 20x1 20x0 Current assets:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 43,250 $ 20,000

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70,000 50,000

Merchandise inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210,000 250,000

Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,000 7,000

Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 332,250 327,000

Buildings and furnishings:

Buildings and furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600,000 510,000

Less: Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (150,000) (125,000)

Net buildings and furnishings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450,000 385,000

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $782,250 $712,000

Liabilities and Stockholders’ Equity Current liabilities:

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $123,000 $115,000

Salaries payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47,250 72,000

Interest payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27,000 25,000

Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197,250 212,000

Long-term debt:

Bonds payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70,000 100,000

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267,250 312,000

Stockholders’ equity:

Common stock ($10 par) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 370,000 280,000

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145,000 120,000

Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515,000 400,000

Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $782,250 $712,000

In Shape, Inc. Income Statement

For the Year Ended December 31, 20x1 Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,255,250

Cost of merchandise sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 712,000

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 543,250

Expenses:

Salary expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252,100

Interest expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75,000

Other expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8,150

Depreciation expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25,000

Total expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 360,250

Operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 183,000

Income-tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43,000

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 140,000

The following additional information concerns the firm’s transactions during 20x1.

� All sales during the year were made on account. � All merchandise was purchased on account, comprising the total Accounts Payable account. � Buildings and furnishings costing $90,000 were purchased by paying $40,000 in cash, and issuing

5,000 shares of stock.

34 Chapter 20 The Statement of Cash Flows

� The “other expenses” are related to prepaid items. � All income taxes incurred during the year were paid during the year. � In order to supplement its cash, In Shape, Inc. issued 4,000 shares of common stock at par value. � Cash dividends of $115,000 were declared and paid at the end of the year.

Required:

1. Compare and contrast the direct method and the indirect method for reporting cash flows from operating activities.

2. Prepare a Statement of Cash Flows for In Shape, Inc. for 20x1, using the direct method. Be sure to support the statement with appropriate calculations.

3. Using the indirect method, calculate the net cash flow from operating activities only for In Shape, Inc. for 20x1.

(CMA, adapted)

The Cookery Corner, Inc., is a distributor of kitchen utensils, pots and pans, and culinary items in Sacramento. The following financial statements are the company’s most recent comparative balance sheets, income statement, and statement of retained earnings.

The Cookery Corner, Inc. Comparative Balance Sheets December 31, 20x1 and 20x0

(in thousands) Assets 20x1 20x0

Current assets:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 33 $ 30

U.S. Treasury bills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 12

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122 113

Merchandise inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 70

Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 5

Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $248 $230

Investment in stock of Jasper Corporation . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90 70

Buildings and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 480 400

Less: Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (255) (210)

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227 200

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $790 $690

Liabilities and Stockholders’ Equity 20x1 20x0 Current liabilities:

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 63 $ 56

Accrued salaries payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32 34

Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 95 $ 90

Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 30

Bonds payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 210 250

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $330 $370

Stockholders’ equity:

Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $130 $100

Additional paid-in capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100 90

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230 130

Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $460 $320

Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $790 $690

Chapter 20 The Statement of Cash Flows 35

Problem 20–37 Statement of Cash Flows; Indirect Method (LO 4, LO 6)

The Cookery Corner, Inc. Income Statement

For the Year Ended December 31, 20x1 (in thousands)

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,100

Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 500

Less: Selling and administrative expenses:

Selling expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $100

Administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200

Total selling and administrative expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 300

Income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 200

Income-tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 120

The Cookery Corner, Inc. Statement of Retained Earnings

For the Year Ended December 31, 20x1 (in thousands)

Retained earnings, December 31, 20x0 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $130

Add: Net income for 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $250

Deduct: Dividends declared and paid in 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Retained earnings, December 31, 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $230

The Cookery Corner purchased two buildings in 20x1. For one building, the company paid $40,000 in cash. In exchange for the other building, the firm issued common stock. The building was appraised at $40,000, and the common stock had a par value of $30,000. No other stock was issued during 20x1.

Required:

1. Use the indirect method to prepare The Cookery Corner’s statement of cash flows for 20x1. (Hint: Treasury bills are cash equivalents.)

2. Write a memo to the company’s new president explaining the change in cash and cash equivalents.

Refer to the information given in the preceding problem for The Cookery Corner, Inc.

Required:

Set up T-accounts, and use this approach to prepare the company’s 20x1 statement of cash flows.

Refer to the information given in Problem 20–37 for The Cookery Corner, Inc.

Required:

Use the direct method to prepare the firm’s statement of cash flows for 20x1.

The following financial statements relate to Alpine Trails Ski Resort: comparative balance sheets as of December 31, 20x3 and 20x2; income statement for 20x3; and statement of retained earnings for 20x3.

Alpine Trails Ski Resort Comparative Balance Sheets December 31, 20x3 and 20x2

(in thousands) Assets 20x3 20x2

Current assets:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 25 $ 22

Marketable securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 10

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130 140

36 Chapter 20 The Statement of Cash Flows

Problem 20–38 Statement of Cash Flows; Use of T-Accounts (LO 4, LO 6)

Problem 20–39 Statement of Cash Flows; Direct Method (LO 4, LO 6)

Problem 20–40 Straightforward Development of Statement of Cash Flows; Indirect Method (LO 4, LO 6)

Assets (continued) 20x3 20x2 Merchandise inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 40 $ 35

Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 3

Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215 210

Investment in Coulterton Transit Company stock . . . . . . . . . . . . . . . . . . . . . . . . . 55 45

Facilities and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 450 450

Less: Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (225) (175)

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 653 540

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,148 $1,070

Liabilities and Stockholders’ Equity 20x3 20x2 Current liabilities:

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 80 $ 75

Accrued salaries payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 25

Deferred revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 5

Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 105

Deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 15

Bonds payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 190 190

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 308 310

Stockholders equity:

Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 270 270

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 570 490

Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 840 760

Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,148 $1,070

Alpine Trails Ski Resort Income Statement

For the Year Ended December 31, 20x3 (in thousands)

Revenue:

Slope fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $340

Condominium rentals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 625

Sales of merchandise . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Total revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,040

Less: Cost of merchandise sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 990

Less: Operating expenses:

Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $310

Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Advertising . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170

Interest on bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

Total operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 830

Income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

Income-tax expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 110

Chapter 20 The Statement of Cash Flows 37

38 Chapter 20 The Statement of Cash Flows

Alpine Trails Ski Resort Statement of Retained Earnings

For the Year Ended December 31, 20x3 (in thousands)

Retained earnings, December 31, 20x2 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $490

Add: Net income for 20x3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 600

Deduct: Dividends declared in 20x3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

Retained earnings, December 31, 20x3 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $570

Alpine Trails did not buy or sell any facilities or equipment during 20x3.

Required:

Using the indirect method, prepare the company’s statement of cash flows for 20x3.

Refer to the financial statements given in the preceding problem for Alpine Trails Ski Resort.

Required:

Set up T-accounts to use as an aid in preparing the company’s statement of cash flows. Prepare the statement for 20x3.

Refer to the financial statements given in Problem 20–40 for Alpine Trails Ski Resort.

Required:

Using the direct method, prepare the company’s statement of cash flows for 20x3.

Case Eight years ago Emily Regis invented a unique fiber optic coupling device used in the telecommunica- tions industry. She began her own firm called OptiComm, and the business expanded rapidly. After three years, Regis took her company public and now is the majority stockholder. Regis is a hands-on company president who gets involved in every phase of the business. It has become increasingly apparent to Regis that a plant expansion will be necessary to keep up with the company’s sales orders. She approached the Great Lakes National Bank about a loan. The bank requested a statement of cash flows.

OptiComm’s comparative balance sheets as of December 31, 20x1 and 20x0, and a statement of income and retained earnings for the year ended December 31, 20x1, are as follows:

OptiComm, Inc. Comparative Balance Sheets December 31, 20x1 and 20x0

(in thousands) Assets 20x1 20x0

Current assets:

Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 60 $ 100

U.S. treasury bills . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 50

Accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 610 500

Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 720 600

Total current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,390 1,250

Long-lived assets:

Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 70

Buildings and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 710 600

Less: Accumulated depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (180) (120)

Patents (less amortization) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105 130

Total long-lived assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 715 680

Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,105 $1,930

Problem 20–41 Straightforward Develop- ment of Statement of Cash Flows; Using T-Accounts (LO 4, LO 6)

Problem 20–42 Straightforward Develop- ment of Statement of Cash Flows; Direct Method (LO 4, LO 6)

Case 20–43 Statement of Cash Flows; Loan Application; Ethics (LO 2, LO 4, LO 6)

Case

Liabilities and Stockholders’ Equity 20x1 20x0 Current liabilities:

Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 360 $ 300

Income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 20

Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 400 400

Total current liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 785 720

Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200 200

Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 985 920

Stockholders’ equity:

Common stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 830 700

Retained earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290 310

Total stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,120 1,010

Total liabilities and stockholders’ equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,105 $1,930

OptiComm, Inc. Income and Retained Earnings Statement

For the Year Ended December 31, 20x1 (in thousands)

Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,408

Less: Expenses:

Cost of goods sold . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,100

Salaries and benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 850

Heat, light, and power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60

Property taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Patent amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25

Miscellaneous expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10

Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 2,193

Net income before income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 215

Income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105

Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 110

Retained earnings, January 1, 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 310

420

Stock dividend* . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130

Retained earnings, December 31, 20x1 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 290

*The stock dividend shown on the statement of income and retained earnings had no effect on the company’s cash flows. The $130,000 stock dividend reduced the Retained Earnings account by $130,000 and increased the Common Stock account by $130,000.

Required:

1. As OptiComm’s new controller, Dave Peterson was asked to prepare a statement of cash flows for 20x1 to submit to the bank. Peterson delegated the task to you, his assistant. Use the direct method. (Hint: Treasury bills are cash equivalents.)

2. When Dave Peterson presented the statement of cash flows to Emily Regis, he expressed several concerns:

Peterson: I’m worried about the bank’s likely reaction to this statement. Although our profit for 20x1 wasn’t too bad, our cash flow from operations was pretty low. When you combine that fact with the increases in inventory and accounts receivable, Great Lakes may say no to our loan request.

Regis: We can explain the increases in inventory and accounts receivable, Dave. The inventory was produced for a government program that got canceled, and the accounts receivable are due to Avantronics not paying us the $100,000 yet on their contract.

Peterson: I know, but the bank’s not going to be impressed.

Chapter 20 The Statement of Cash Flows 39

Regis: Dave, we need this loan badly. I’m no accounting whiz, but I remember enough to know that there’s such a thing as creative accounting. Here’s an idea. I just signed a contract with General Communications for $250,000. It’s only January 3, and we’ll be delivering later this month. Let’s just book the sale and cash receipt in 20x1. I know General Communications’ president, and I’m sure he’ll agree to pay cash on the barrelhead. That will bump up sales, income, and cash flow for 20x1.

Peterson: But Emily, it didn’t happen in 20x1. Regis: We need the loan, Dave.

Comment on the ethical issues in this scenario.

(CMA, adapted)

40 Chapter 20 The Statement of Cash Flows