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Chapter

Statement of Cash Flows After studying this chapter, you should be able to: 1 Indicate the usefulness of the statement

of cash flows. 2 Distinguish among operating, investing,

and financing activities. 3 Prepare a statement of cash flows using

the indirect method. 4 Analyze the statement of cash flows.

S T U D Y O B J E C T I V E S

Feature Story

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GOT CASH?

In today’s environment, companies must be ready to respond to changes quickly in order to survive and thrive. They need to produce new products and expand into new markets continually. To do this takes cash—lots and lots of cash. Keeping lots of cash available is a real challenge for a young company. It requires careful cash management and attention to cash flow.

One company that managed cash successfully in its early years was Microsoft (www.microsoft.com). During those years the company paid much of its payroll with stock options (rights to purchase company stock in the future at a given price) instead of cash. This strategy conserved cash, and turned more than a thousand of its employees into millionaires during the company’s first 20 years of business.

In recent years Microsoft has had a different kind of cash problem. Now that it has reached a more “mature” stage in life, it generates so much cash— roughly $1 billion per month—that it cannot always figure out what to do with it. By 2004 Microsoft had accumulated $60 billion.

Scan Study Objectives ■

Read Feature Story ■

Read Preview ■

Read text and answer p. 617 ■ p. 625 ■ p. 628 ■ p. 632 ■

Work Comprehensive p. 634 ■

Review Summary of Study Objectives ■

Work Comprehensive p. 648 ■

Answer Self-Study Questions ■

Complete Assignments ■

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Do it!

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The company said it was accumu- lating cash to invest in new oppor- tunities, buy other companies, and pay off pending lawsuits. But for years, the federal government has blocked attempts by Microsoft to buy anything other than small firms because it feared that purchase of a large firm would only increase Microsoft’s monopolistic position. In addition, even the largest esti- mates of Microsoft’s legal obligations related to pending lawsuits would use up only about $6 billion in cash.

Microsoft’s stockholders have complained for years that holding all this cash was putting a drag on the company’s profitability. Why? Because Microsoft had the cash invested in very low-yielding government securities. Stockhold- ers felt that the company either should find new investment projects that would bring higher returns, or return some of the cash to stockholders.

Finally, in July 2004 Microsoft announced a plan to return cash to stockhold- ers, by paying a special one-time $32 billion dividend in December 2004. This special dividend was so large that, according to the U.S. Commerce Department, it caused total personal income in the United States to rise by 3.7% in one month—the largest monthly increase ever recorded by the agency. (It also made the holiday season brighter, especially for retailers in the Seattle area.) Microsoft also doubled its regular annual dividend to $3.50 per share. Further, it announced that it would spend another $30 billion over the next four years buying treasury stock. In addition, in 2008 Microsoft offered to buy Yahoo! for $44.6 billion (Yahoo! declined the offer). These actions will help to deplete some of its massive cash horde, but as you will see in this chapter, for a cash-generating machine like Microsoft, the company will be anything but cash-starved.

Source: “Business: An End to Growth? Microsoft’s Cash Bonanza,” The Economist, July 23, 2005, p. 61.

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Inside Chapter 13…

• Net What? (p. 617)

• Cash Flow Isn’t Always What It Seems (p. 619)

• GM Must Sell More Cars (p. 626)

• All About You: Where Does the Money Go? (p. 633)

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THE STATEMENT OF CASH FLOWS: USEFULNESS AND FORMAT

Preview of Chapter 13

The balance sheet, income statement, and retained earnings statement do not always show the whole picture of the financial condition of a company or institution. In fact, looking at the financial statements of some well-known companies, a thoughtful investor might ask questions like these: How did Eastman Kodak finance cash dividends of $649 million in a year in which it earned only $17 million? How could United Airlines purchase new planes that cost $1.9 billion in a year in which it reported a net loss of over $2 billion? How did the companies that spent a combined fantastic $3.4 trillion on mergers and acquisitions in a recent year finance those deals? Answers to these and similar questions can be found in this chapter, which presents the statement of cash flows.

The content and organization of this chapter are as follows.

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Statement of Cash Flows

The Statement of Cash Flows: Usefulness and Format

• Usefulness • Classifications • Significant noncash activities • Format • Preparation • Indirect and direct methods

Preparing the Statement of Cash Flows—Indirect Method

• Step 1: Operating activities • Step 2: Investing and financing

activities • Step 3: Net change in cash

Using Cash Flows to Evaluate a Company

• Free cash flow

The balance sheet, income statement, and retained earnings statement provide only limited information about a company’s cash flows (cash receipts and cash pay- ments). For example, comparative balance sheets show the increase in property, plant, and equipment during the year. But they do not show how the additions were financed or paid for. The income statement shows net income. But it does not indi- cate the amount of cash generated by operating activities. The retained earnings statement shows cash dividends declared but not the cash dividends paid during the year. None of these statements presents a detailed summary of where cash came from and how it was used.

Usefulness of the Statement of Cash Flows The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from operating, investing, and financing activ- ities during a period. The information in a statement of cash flows should help investors, creditors, and others assess:

1. The entity’s ability to generate future cash flows. By examining relationships between items in the statement of cash flows, investors can make predictions of the amounts, timing, and uncertainty of future cash flows better than they can from accrual basis data.

Indicate the usefulness of the statement of cash flows.

S T U D Y O B J E C T I V E 1

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2. The entity’s ability to pay dividends and meet obligations. If a company does not have adequate cash, it cannot pay employees, settle debts, or pay dividends. Employees, creditors, and stockholders should be particularly interested in this statement, because it alone shows the flows of cash in a business.

3. The reasons for the difference between net income and net cash provided (used) by operating activities. Net income provides information on the success or failure of a business enterprise. However, some financial statement users are critical of accrual-basis net income because it requires many estimates. As a result, users often challenge the reliability of the number. Such is not the case with cash. Many readers of the statement of cash flows want to know the reasons for the difference between net income and net cash provided by operating activities. Then they can assess for themselves the reliability of the income number.

4. The cash investing and financing transactions during the period. By examining a company’s investing and financing transactions, a finan- cial statement reader can better understand why assets and liabilities changed during the period.

Classification of Cash Flows The statement of cash flows classifies cash receipts and cash payments as operating, investing, and financing activities. Transactions and other events characteristic of each kind of activity are as follows.

1. Operating activities include the cash effects of transactions that create revenues and expenses. They thus enter into the determination of net income.

2. Investing activities include (a) acquiring and disposing of investments and property, plant, and equipment, and (b) lending money and collecting the loans.

3. Financing activities include (a) obtaining cash from issuing debt and repaying the amounts borrowed, and (b) obtaining cash from stockholders, repurchasing shares, and paying dividends.

The operating activities category is the most important. It shows the cash pro- vided by company operations. This source of cash is generally considered to be the best measure of a company’s ability to generate sufficient cash to continue as a going concern.

Illustration 13-1 (page 616) lists typical cash receipts and cash payments within each of the three classifications. Study the list carefully. It will prove very useful in solving homework exercises and problems.

Note the following general guidelines:

1. Operating activities involve income statement items. 2. Investing activities involve cash flows resulting from changes in investments

and long-term asset items. 3. Financing activities involve cash flows resulting from changes in long-term lia-

bility and stockholders’ equity items.

Companies classify as operating activities some cash flows related to invest- ing or financing activities. For example, receipts of investment revenue (interest and dividends) are classified as operating activities. So are payments of interest to lenders. Why are these considered operating activities? Because companies report these items in the income statement, where results of operations are shown.

The Statement of Cash Flows: Usefulness and Format 615

E T H I C S N O T E

Though we would discour- age reliance on cash flows to the exclusion of accrual account- ing, comparing cash from opera- tions to net income can reveal important information about the “quality” of reported net income. Such a comparison can reveal the extent to which net income provides a good mea- sure of actual performance.

Distinguish among operating, investing, and financing activities.

S T U D Y O B J E C T I V E 2

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Significant Noncash Activities Not all of a company’s significant activities involve cash. Examples of significant noncash activities are:

1. Direct issuance of common stock to purchase assets. 2. Conversion of bonds into common stock. 3. Direct issuance of debt to purchase assets. 4. Exchanges of plant assets.

Companies do not report in the body of the statement of cash flows significant financing and investing activities that do not affect cash. Instead, they report these activities in either a separate schedule at the bottom of the statement of cash flows or in a separate note or supplemen- tary schedule to the financial statements. The reporting of these noncash activities in a separate schedule satisfies the full disclosure principle.

In solving homework assignments you should present significant non- cash investing and financing activities in a separate schedule at the bottom of the statement of cash flows. (See the last entry in Illustration 13-2, on page 617, for an example.)

616 Chapter 13 Statement of Cash Flows

Operating activities

Investing activities

J AVA TIME

Financing activities

STOCK BOND

TYPES OF CASH INFLOWS AND OUTFLOWS Operating activities—Income statement items

Cash inflows: From sale of goods or services. From interest received and dividends received.

Cash outflows: To suppliers for inventory. To employees for services. To government for taxes. To lenders for interest. To others for expenses.

Investing activities—Changes in investments and long-term assets Cash inflows:

From sale of property, plant, and equipment. From sale of investments in debt or equity securities of other entities. From collection of principal on loans to other entities.

Cash outflows: To purchase property, plant, and equipment. To purchase investments in debt or equity securities of other entities. To make loans to other entities.

Financing activities—Changes in long-term liabilities and stockholders’ equity Cash inflows:

From sale of common stock. From issuance of long-term debt (bonds and notes).

Cash outflows: To stockholders as dividends. To redeem long-term debt or reacquire capital stock (treasury stock).

Illustration 13-1 Typical receipt and payment classifications

INTERNATIONAL NOTE The statement of cash flows

is very similar under GAAP and IFRS. One difference is that, under IFRS, noncash investing and financing activities are not reported in the statement of cash flows but instead are reported in the notes to the financial statements.

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before you go on...

Format of the Statement of Cash Flows The general format of the statement of cash flows presents the results of the three activities discussed previously—operating, investing, and financing—plus the sig- nificant noncash investing and financing activities. Illustration 13-2 shows a widely used form of the statement of cash flows.

The Statement of Cash Flows: Usefulness and Format 617

Net What?

Net income is not the same as net cash provided by operating activities. Below are some results from recent annual reports (dollars in millions). Note the wide

disparity among these companies, all of which engaged in retail merchandising.

Net Cash Provided by Company Net Income Operating Activities

Kohl’s Corporation $ 1,083 $ 1,234 Wal-Mart Stores, Inc. 11,284 20,164 J. C. Penney Company, Inc. 1,153 1,255 Costco Wholesale Corp. 1,082 2,076 Target Corporation 2,849 4,125

ACCOUNTING ACROSS THE ORGANIZATION

In general, why do differences exist between net income and net cash provided by operating activities?

The cash flows from operating activities section always appears first, followed by the investing activities section and then the financing activities section.

COMPANY NAME Statement of Cash Flows

Period Covered

Cash flows from operating activities (List of individual items) XX

Net cash provided (used) by operating activities XXX Cash flows from investing activities

(List of individual inflows and outflows) XX

Net cash provided (used) by investing activities XXX Cash flows from financing activities

(List of individual inflows and outflows) XX

Net cash provided (used) by financing activities XXX

Net increase (decrease) in cash XXX Cash at beginning of period XXX

Cash at end of period XXX

Noncash investing and financing activities (List of individual noncash transactions) XXX

Illustration 13-2 Format of statement of cash flows

Do it! During its first week, Duffy & Stevenson Company had these transactions.

1. Issued 100,000 shares of $5 par value common stock for $800,000 cash.

2. Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest.

Classification of Cash Flows

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Preparing the Statement of Cash Flows Companies prepare the statement of cash flows differently from the three other basic financial statements. First, it is not prepared from an adjusted trial balance. It requires detailed information concerning the changes in account balances that occurred between two points in time. An adjusted trial balance will not provide the necessary data. Second, the statement of cash flows deals with cash receipts and payments. As a result, the company must adjust the effects of the use of accrual accounting to determine cash flows.

The information to prepare this statement usually comes from three sources: • Comparative balance sheets. Information in the comparative balance sheets

indicates the amount of the changes in assets, liabilities, and stockholders’ equi- ties from the beginning to the end of the period.

• Current income statement. Information in this statement helps determine the amount of cash provided or used by operations during the period.

• Additional information. Such information includes transaction data that are needed to determine how cash was provided or used during the period.

Preparing the statement of cash flows from these data sources involves three major steps, as explained in Illustration 13-3 on the next page.

Indirect and Direct Methods In order to perform step 1, a company must convert net income from an accrual basis to a cash basis. This conversion may be done by either of two methods: (1) the indirect method or (2) the direct method. Both methods arrive at the same total amount for “Net cash provided by operating activities.” They differ in how they arrive at the amount.

The indirect method adjusts net income for items that do not affect cash. A great majority of companies (98.8%) use this method, as shown in the nearby chart.1 Companies favor the indirect method for two reasons: (1) It is easier and

618 Chapter 13 Statement of Cash Flows

3. Purchased two semi-trailer trucks for $170,000 cash.

4. Paid employees $12,000 for salaries and wages.

5. Collected $20,000 cash for services provided.

Classify each of these transactions by type of cash flow activity.

Solution

1. Financing activity

2. Financing activity

3. Investing activity

4. Operating activity

5. Operating activity

Related exercise material: BE13-1, BE13-2, BE13-3, E13-1, E13-2, E13-3, and 13-1.Do it!

Action Plan

• Identify the three types of activities used to report all cash inflows and outflows.

• Report as operating activities the cash effects of transactions that create revenues and expenses and enter into the determination of net income.

• Report as investing activities transactions that (a) acquire and dispose of investments and long-term assets and (b) lend money and collect loans.

• Report as financing activities transactions that (a) obtain cash from issuing debt and repay the amounts borrowed and (b) obtain cash from stock- holders and pay them dividends.

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INTERNATIONAL NOTE Companies preparing finan-

cial statements under IFRS must prepare a statement of cash flows as an integral part of the financial statements.

1 Accounting Trends and Techniques—2007 (New York: American Institute of Certified Public

Accountants, 2007).

1% Direct Method

99% Indirect Method

Usage of Methods

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less costly to prepare, and (2) it focuses on the differences between net income and net cash flow from operating activities.

The direct method shows operating cash receipts and payments, making it more consistent with the objective of a statement of cash flows. The FASB has expressed a preference for the direct method, but allows the use of either method.

The next section illustrates the more popular indirect method. Appendix 13B illustrates the direct method.

The Statement of Cash Flows: Usefulness and Format 619

The difference between the beginning and ending cash balances can be easily computed from comparative balance sheets.

+ or –

This step involves analyzing not only the current year's income statement but also comparative balance sheets and selected additional data.

Step 2: Analyze changes in noncurrent asset and liability accounts and record as investing and financing activities, or disclose as noncash transactions.

Step 1: Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis.

Step 3: Compare the net change in cash on the statement of cash flows with the change in the cash account reported on the balance sheet to make sure the amounts agree.

This step involves analyzing comparative balance sheet data and selected additional information for their effects on cash.

Fina ncin

gInvesting

Buying & selling goods

Illustration 13-3 Three major steps in preparing the statement of cash flows

For what reasons might managers at WorldCom and at Dynegy take the actions noted above?

Cash Flow Isn’t Always What It Seems

Some managers have taken actions that artificially increase cash flow from operating activities. They do this by moving negative amounts out of the operating section and into the investing or financing section.

For example, WorldCom, Inc. disclosed that it had improperly capitalized expenses: It had moved $3.8 billion of cash outflows from the “Cash from operating activities” section of the cash flow statement to the “Investing activities” section, thereby greatly enhancing cash provided by operating activities. Similarly, Dynegy, Inc. restated its cash flow statement because it had improp- erly included in operating activities, instead of in financing activities, $300 million from natural gas trading. The restatement resulted in a drop of 37% in cash flow from operating activities.

SSource: Henny Sender, “Sadly, These Days Even Cash Flow Isn’t Always What It Seems to Be,” Wall Street Journal, May 8, 2002.

I N V E S T O R I N S I G H T

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620 Chapter 13 Statement of Cash Flows

PREPARING THE STATEMENT OF CASH FLOWS—INDIRECT METHOD

To explain how to prepare a statement of cash flows using the indirect method, we use financial information from Computer Services Company. Illustration 13-4 presents Computer Services’ current and previous-year balance sheets, its current-year income statement, and related financial in-

formation for the current year.

Prepare a statement of cash flows using the indirect method.

S T U D Y O B J E C T I V E 3

COMPUTER SERVICES COMPANY Comparative Balance Sheets

December 31

Change in Account Balance

Assets 2011 2010 Increase/Decrease

Current assets Cash $ 55,000 $ 33,000 $ 22,000 Increase Accounts receivable 20,000 30,000 10,000 Decrease Merchandise inventory 15,000 10,000 5,000 Increase Prepaid expenses 5,000 1,000 4,000 Increase

Property, plant, and equipment Land 130,000 20,000 110,000 Increase Building 160,000 40,000 120,000 Increase Accumulated depreciation—building (11,000) (5,000) 6,000 Increase Equipment 27,000 10,000 17,000 Increase Accumulated depreciation—equipment (3,000) (1,000) 2,000 Increase

Total assets $398,000 $138,000

Liabilities and Stockholders’ Equity

Current liabilities Accounts payable $ 28,000 $ 12,000 $ 16,000 Increase Income tax payable 6,000 8,000 2,000 Decrease

Long-term liabilities Bonds payable 130,000 20,000 110,000 Increase

Stockholders’ equity Common stock 70,000 50,000 20,000 Increase Retained earnings 164,000 48,000 116,000 Increase

Total liabilities and stockholders’ equity $398,000 $138,000

COMPUTER SERVICES COMPANY Income Statement

For the Year Ended December 31, 2011

Revenues $507,000 Cost of goods sold $150,000 Operating expenses (excluding depreciation) 111,000 Depreciation expense 9,000 Loss on sale of equipment 3,000 Interest expense 42,000 315,000

Income before income tax 192,000 Income tax expense 47,000

Net income $145,000

Illustration 13-4 Comparative balance sheets, income statement, and additional information for Computer Services Company

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We will now apply the three steps to the information provided for Computer Services Company.

Step 1: Operating Activities DETERMINE NET CASH PROVIDED/USED BY OPERATING ACTIVITIES BY CONVERTING NET INCOME FROM AN ACCRUAL BASIS TO A CASH BASIS To determine net cash provided by operating activities under the indirect method, companies adjust net income in numerous ways. A useful starting point is to under- stand why net income must be converted to net cash provided by operating activities.

Under generally accepted accounting principles, most companies use the ac- crual basis of accounting. This basis requires that companies record revenue when earned and record expenses when incurred. Earned revenues may include credit sales for which the company has not yet collected cash. Expenses incurred may in- clude some items that it has not yet paid in cash. Thus, under the accrual basis, net income is not the same as net cash provided by operating activities.

Therefore, under the indirect method, companies must adjust net income to convert certain items to the cash basis. The indirect method (or reconciliation method) starts with net income and converts it to net cash provided by operating activities. Illustration 13-5 lists the three types of adjustments.

Preparing the Statement of Cash Flows—Indirect Method 621

Illustration 13-4 (continued)

Illustration 13-5 Three types of adjustments to convert net income to net cash provided by operating activities

H E L P F U L H I N T Depreciation is similar to any other expense in that it reduces net income. It differs in that it does not involve a current cash outflow; that is why it must be added back to net income to arrive at cash provided by operating activities.

DEPRECIATION EXPENSE Computer Services’ income statement reports depreciation expense of $9,000. Although depreciation expense reduces net income, it does not reduce cash. In other words, depreciation expense is a noncash charge. The company must add it back to net income to arrive at net cash provided by operating activities. Computer Services reports depreciation expense in the statement of cash flows as shown on page 622.

Additional information for 2011: 1. The company declared and paid a $29,000 cash dividend. 2. Issued $110,000 of long-term bonds in direct exchange for land. 3. A building costing $120,000 was purchased for cash. Equipment costing $25,000 was also

purchased for cash. 4. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated

depreciation $1,000) for $4,000 cash. 5. Issued common stock for $20,000 cash. 6. Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.

Net Cash Provided/ Net Income �� Adjustments � Used by Operating

Activities • Add back noncash

expenses, such as depreciation, amortization, or depletion.

• Deduct gains and add losses that resulted from investing and financing activities.

• Analyze changes to noncash current asset and current liability accounts.

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As the first adjustment to net income in the statement of cash flows, companies frequently list depreciation and similar noncash charges such as amortization of intangible assets, depletion expense, and bad debt expense.

LOSS ON SALE OF EQUIPMENT Illustration 13-1 (page 616) states that the investing activities section should report cash received from the sale of plant assets. Because of this, companies must eliminate from net income all gains and losses related to the disposal of plant assets, to arrive at cash provided by operating activities.

In our example, Computer Services’ income statement reports a $3,000 loss on the sale of equipment (book value $7,000, less $4,000 cash received from sale of equipment). The company’s loss of $3,000 should not be included in the operating activities section of the statement of cash flows. Illustration 13-7 shows that the $3,000 loss is eliminated by adding $3,000 back to net income to arrive at net cash provided by operating activities.

622 Chapter 13 Statement of Cash Flows

If a gain on sale occurs, the company deducts the gain from its net income in order to determine net cash provided by operating activities. In the case of either a gain or a loss, companies report as a source of cash in the investing activities section of the statement of cash flows the actual amount of cash received from the sale.

CHANGES TO NONCASH CURRENT ASSET AND CURRENT LIABILITY ACCOUNTS A final adjustment in reconciling net income to net cash provided by operating activities involves examining all changes in current asset and current liability accounts. The accrual accounting process records revenues in the period earned and expenses in the period incurred. For example, companies use Accounts Receivable to record amounts owed to the company for sales that have been made but for which cash collections have not yet been received. They use the Prepaid Insurance account to reflect insurance that has been paid for, but which has not yet expired, and therefore has not been expensed. Similarly, the Salaries Payable account reflects salaries expense that has been incurred by the company but has not been paid.

Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash

provided by operating activities: Depreciation expense 9,000

Net cash provided by operating activities $154,000

Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash

provided by operating activities: Depreciation expense $9,000 Loss on sale of equipment 3,000 12,000

Net cash provided by operating activities $157,000

Illustration 13-6 Adjustment for depreciation

Illustration 13-7 Adjustment for loss on sale of equipment

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As a result, we need to adjust net income for these accruals and prepayments to determine net cash provided by operating activities. Thus we must analyze the change in each current asset and current liability account to determine its impact on net income and cash.

CHANGES IN NONCASH CURRENT ASSETS. The adjustments required for changes in noncash current asset accounts are as follows: Deduct from net income increases in current asset accounts, and add to net income decreases in current asset ac- counts, to arrive at net cash provided by operating activities. We can observe these relationships by analyzing the accounts of Computer Services Company.

Decrease in Accounts Receivable. Computer Services Company’s accounts receivable decreased by $10,000 (from $30,000 to $20,000) during the period. For Computer Services this means that cash receipts were $10,000 higher than rev- enues. The Accounts Receivable account in Illustration 13-8 shows that Computer Services Company had $507,000 in revenues (as reported on the income statement), but it collected $517,000 in cash.

Preparing the Statement of Cash Flows—Indirect Method 623

To adjust net income to net cash provided by operating activities, the company adds to net income the decrease of $10,000 in accounts receivable (see Illustra- tion 13-9, page 624). If the Accounts Receivable balance increases, cash receipts are lower than revenue earned under the accrual basis. Therefore, the company deducts from net income the amount of the increase in accounts receivable, to arrive at net cash provided by operating activities.

Increase in Merchandise Inventory. Computer Services Company’s Merchandise Inventory balance increased $5,000 (from $10,000 to $15,000) during the period. The change in the Merchandise Inventory account reflects the differ- ence between the amount of inventory purchased and the amount sold. For Computer Services this means that the cost of merchandise purchased exceeded the cost of goods sold by $5,000. As a result, cost of goods sold does not reflect $5,000 of cash payments made for merchandise. The company deducts from net income this inventory increase of $5,000 during the period, to arrive at net cash provided by operating activities (see Illustration 13-9, page 624). If inventory de- creases, the company adds to net income the amount of the change, to arrive at net cash provided by operating activities.

Increase in Prepaid Expenses. Computer Services’ prepaid expenses in- creased during the period by $4,000. This means that cash paid for expenses is higher than expenses reported on an accrual basis. In other words, the company has made cash payments in the current period, but will not charge expenses to income until future periods (as charges to the income statement). To adjust net income to net cash provided by operating activities, the company deducts from net income the $4,000 increase in prepaid expenses (see Illustration 13-9, page 624).

If prepaid expenses decrease, reported expenses are higher than the expenses paid. Therefore, the company adds to net income the decrease in prepaid expenses, to arrive at net cash provided by operating activities.

Accounts Receivable

1/1/11 Balance 30,000 Receipts from customers 517,000 Revenues 507,000

12/31/11 Balance 20,000

Illustration 13-8 Analysis of accounts receivable

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CHANGES IN CURRENT LIABILITIES. The adjustments required for changes in current liability accounts are as follows: Add to net income increases in current liability accounts, and deduct from net income decreases in current liability accounts, to arrive at net cash provided by operating activities.

Increase in Accounts Payable. For Computer Services Company, Accounts Payable increased by $16,000 (from $12,000 to $28,000) during the period. That means the company received $16,000 more in goods than it actually paid for. As shown in Illustration 13-10 (below), to adjust net income to determine net cash provided by operating activities, the company adds to net income the $16,000 increase in Accounts Payable.

Decrease in Income Tax Payable. When a company incurs income tax expense but has not yet paid its taxes, it records income tax payable. A change in the Income Tax Payable account reflects the difference between income tax expense incurred and income tax actually paid. Computer Services’ Income Tax Payable account de- creased by $2,000. That means the $47,000 of income tax expense reported on the income statement was $2,000 less than the amount of taxes paid during the period of $49,000. As shown in Illustration 13-10, to adjust net income to a cash basis, the company must reduce net income by $2,000.

624 Chapter 13 Statement of Cash Flows

Illustration 13-10 shows that, after starting with net income of $145,000, the sum of all of the adjustments to net income was $27,000. This resulted in net cash provided by operating activities of $172,000.

Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash

provided by operating activities: Depreciation expense $ 9,000 Loss on sale of equipment 3,000 Decrease in accounts receivable 10,000 Increase in merchandise inventory (5,000) Increase in prepaid expenses (4,000) Increase in accounts payable 16,000 Decrease in income tax payable (2,000) 27,000

Net cash provided by operating activities $172,000

Illustration 13-10 Adjustments for changes in current liability accounts

Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash

Net cash provided by operating activities $158,000

Illustration 13-9 Adjustments for changes in current asset accounts

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before you go on...

Summary of Conversion to Net Cash Provided by Operating Activities—Indirect Method As shown in the previous illustrations, the statement of cash flows prepared by the in- direct method starts with net income. It then adds or deducts items to arrive at net cash provided by operating activities. The required adjustments are of three types:

1. Noncash charges such as depreciation, amortization, and depletion. 2. Gains and losses on the sale of plant assets. 3. Changes in noncash current asset and current liability accounts.

Illustration 13-11 provides a summary of these changes.

Preparing the Statement of Cash Flows—Indirect Method 625

Depreciation expense Patent amortization expense Depletion expense

Loss on sale of plant asset Gain on sale of plant asset

Increase in current asset account Decrease in current asset account Increase in current liability account Decrease in current liability account

Gains and Losses

Noncash Charges

Changes in Current Assets

and Current Liabilities

Adjustment Required to Convert Net Income to Net Cash Provided

by Operating Activities

Add Add Add

Add Deduct

Deduct Add Add

Deduct

⎫ ⎬ ⎭

Illustration 13-11 Adjustments required to convert net income to net cash provided by operating activities

Do it! Josh’s PhotoPlus reported net income of $73,000 for 2011. Included in the in-

come statement were depreciation expense of $7,000 and a gain on sale of equipment of $2,500. Josh’s comparative balance sheets show the following balances.

12/31/10 12/31/11

Accounts receivable $17,000 $21,000 Accounts payable 6,000 2,200

Calculate net cash provided by operating activities for Josh’s PhotoPlus.

Solution

Cash from Operating Activities

Cash flows from operating activities Net income $73,000

Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $7,000 Gain on sale of equipment (2,500) Increase in accounts receivable (4,000) Decrease in accounts payable (3,800) (3,300)

Net cash provided by operating activities $69,700

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Related exercise material: BE13-4, BE13-5, BE13-6, BE13-7, E13-4, E13-5, E13-6, E13-7, E13-8, and 13-2.

Do it!

Action Plan

• Add noncash charges such as depreciation back to net income to compute net cash provided by operating activities.

• Deduct from net income gains on the sale of plant assets, or add losses back to net income, to compute net cash provided by operating activities.

• Use changes in noncash current asset and current liability accounts to compute net cash provided by operating activities.

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Step 2: Investing and Financing Activities ANALYZE CHANGES IN NONCURRENT ASSET AND LIABILITY ACCOUNTS AND RECORD AS INVESTING AND FINANCING ACTIVITIES, OR AS NONCASH INVESTING AND FINANCING ACTIVITIES Increase in Land. As indicated from the change in the Land account and the additional information, the company purchased land of $110,000 through the issuance of long-term bonds. The issuance of bonds payable for land has no effect on cash. But it is a significant noncash investing and financing activity that merits disclosure in a separate schedule. (See Illustration 13-13 on page 628.)

Increase in Building. As the additional data indicate, Computer Services Company acquired an office building for $120,000 cash. This is a cash outflow reported in the investing section. (See Illustration 13-13 on page 628.)

Increase in Equipment. The Equipment account increased $17,000. The addi- tional information explains that this was a net increase that resulted from two

626 Chapter 13 Statement of Cash Flows

GM Must Sell More Cars

Market share matters—and it shows up in the accounting numbers. Just ask General Motors. In recent years GM has seen its market share erode until, at

25.6% of the market, the company reached the point where it actually consumed more cash than it generated. It isn’t time to panic yet—GM has about $20 billion in cash on hand—but it is time to come up with a plan.

To address immediate cash needs, GM management reduced its annual dividend and sold off some assets and businesses. Even these measures were not enough to avoid bankruptcy. GM is now in the process of shrinking its operations to fit its sales figures. The following table shows net income and cash provided by operating activities at various market-share levels.

ACCOUNTING ACROSS THE ORGANIZATION

Why does GM’s cash provided by operating activities drop so precipitously when the company’s sales figures decline?

Source: David Welch and Dan Beucke, “Why GM’s Plan Won’t Work,” Business Week, May 9, 2005, pp. 85–93.

Data: Merrill Lynch & Co. *Net income and cash flow figures in billions of dollars, including GMAC.

$3.0

$1.5

�$1.5

�$3.0

�$4.5

28% 27% 26% 25% 24% 23% 22% 21% 20%

U.S. market share

Cash flow*Net income*

GM'S current U.S. market share = 25.6%

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transactions: (1) a purchase of equipment of $25,000, and (2) the sale for $4,000 of equipment costing $8,000. These transactions are investing activities. The com- pany should report each transaction separately. Thus it reports the purchase of equipment as an outflow of cash for $25,000. It reports the sale as an inflow of cash for $4,000. The T account below shows the reasons for the change in this account during the year.

Preparing the Statement of Cash Flows—Indirect Method 627

Equipment

1/1/11 Balance 10,000 Cost of equipment sold 8,000 Purchase of equipment 25,000

12/31/11 Balance 27,000

The following entry shows the details of the equipment sale transaction.

Cash 4,000 Accumulated Depreciation 1,000 Loss on Sale of Equipment 3,000

Equipment 8,000

Increase in Bonds Payable. The Bonds Payable account increased $110,000. As indicated in the additional information, the company acquired land from the issuance of these bonds. It reports this noncash transaction in a separate schedule at the bottom of the statement.

Increase in Common Stock. The balance sheet reports an increase in Common Stock of $20,000. The additional information section notes that this increase re- sulted from the issuance of new shares of stock. This is a cash inflow reported in the financing section.

Increase in Retained Earnings. Retained earnings increased $116,000 during the year. This increase can be explained by two factors: (1) Net income of $145,000 increased retained earnings. (2) Dividends of $29,000 decreased retained earnings. The company adjusts net income to net cash provided by op- erating activities in the operating activities section. Payment of the dividends (not the declaration) is a cash outflow that the company reports as a financing activity.

STATEMENT OF CASH FLOWS—2011 Using the previous information, we can now prepare a statement of cash flows for 2011 for Computer Services Company as shown in Illustration 13-13 (page 628).

Step 3: Net Change in Cash COMPARE THE NET CHANGE IN CASH ON THE STATEMENT OF CASH FLOWS WITH THE CHANGE IN THE CASH ACCOUNT REPORTED ON THE BALANCE SHEET TO MAKE SURE THE AMOUNTS AGREE Illustration 13-13 indicates that the net change in cash during the period was an increase of $22,000. This agrees with the change in Cash account reported on the balance sheet in Illustration 13-4 (page 620).

Illustration 13-12 Analysis of equipment

Cash Flows �4,000

A SEL� �

�4,000 �1,000

�3,000 Exp �8,000

H E L P F U L H I N T When companies issue stocks or bonds for cash, the actual proceeds will appear in the statement of cash flows as a financing inflow (rather than the par value of the stocks or face value of bonds).

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before you go on...

628 Chapter 13 Statement of Cash Flows

H E L P F U L H I N T Note that in the invest- ing and financing activi- ties sections, positive numbers indicate cash inflows (receipts), and negative numbers indicate cash outflows (payments).

COMPUTER SERVICES COMPANY Statement of Cash Flows—Indirect Method

For the Year Ended December 31, 2011

Cash flows from operating activities Net income $145,000 Adjustments to reconcile net income to net cash

Net cash provided by operating activities 172,000 Cash flows from investing activities

Purchase of building (120,000) Purchase of equipment (25,000) Sale of equipment 4,000

Net cash used by investing activities (141,000) Cash flows from financing activities

Issuance of common stock 20,000 Payment of cash dividends (29,000)

Net cash used by financing activities (9,000)

Net increase in cash 22,000 Cash at beginning of period 33,000

Cash at end of period $ 55,000

Noncash investing and financing activities Issuance of bonds payable to purchase land $110,000

Do it! Use the information below and on the next page to prepare a statement of

cash flows using the indirect method. Indirect Method

Action Plan

• Determine net cash provided/ used by operating activities by adjusting net income for items that did not affect cash.

• Determine net cash provided/used by investing activities and financing activities.

• Determine the net increase/ decrease in cash.

REYNOLDS COMPANY Comparative Balance Sheets

December 31

Change Assets 2011 2010 Increase/Decrease

Cash $ 54,000 $ 37,000 $ 17,000 Increase Accounts receivable 68,000 26,000 42,000 Increase Inventories 54,000 –0– 54,000 Increase Prepaid expenses 4,000 6,000 2,000 Decrease Land 45,000 70,000 25,000 Decrease Buildings 200,000 200,000 –0– Accumulated depreciation—buildings (21,000) (11,000) 10,000 Increase Equipment 193,000 68,000 125,000 Increase Accumulated depreciation—equipment (28,000) (10,000) 18,000 Increase

Totals $569,000 $386,000

Illustration 13-13 Statement of cash flows, 2011—indirect method

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Preparing the Statement of Cash Flows—Indirect Method 629

Liabilities and Stockholders’ Equity

Accounts payable $ 23,000 $ 40,000 $ 17,000 Decrease Accrued expenses payable 10,000 –0– 10,000 Increase Bonds payable 110,000 150,000 40,000 Decrease Common stock ($1 par) 220,000 60,000 160,000 Increase Retained earnings 206,000 136,000 70,000 Increase

Totals $569,000 $386,000

REYNOLDS COMPANY Income Statement

For the Year Ended December 31, 2011

Revenues $890,000 Cost of goods sold $465,000 Operating expenses 221,000 Interest expense 12,000 Loss on sale of equipment 2,000 700,000

Income before income taxes 190,000 Income tax expense 65,000

Net income $125,000

Additional information: 1. Operating expenses include depreciation expense of $33,000 and charges from prepaid

expenses of $2,000. 2. Land was sold at its book value for cash. 3. Cash dividends of $55,000 were declared and paid in 2011. 4. Interest expense of $12,000 was paid in cash. 5. Equipment with a cost of $166,000 was purchased for cash. Equipment with a cost of

$41,000 and a book value of $36,000 was sold for $34,000 cash. 6. Bonds of $10,000 were redeemed at their face value for cash. Bonds of $30,000 were

converted into common stock. 7. Common stock ($1 par) of $130,000 was issued for cash. 8. Accounts payable pertain to merchandise suppliers.

Solution

REYNOLDS COMPANY Statement of Cash Flows—Indirect Method

For the Year Ended December 31, 2011

Cash flows from operating activities Net income $125,000 Adjustments to reconcile net income to net cash

provided by operating activities: Depreciation expense $ 33,000 Loss on sale of equipment 2,000 Increase in accounts receivable (42,000) Increase in inventories (54,000) Decrease in prepaid expenses 2,000 Decrease in accounts payable (17,000) Increase in accrued expenses payable 10,000 (66,000)

Net cash provided by operating activities 59,000

H E L P F U L H I N T 1. Determine net cash

provided/used by operating activities, recognizing that operating activities generally relate to changes in current assets and current liabilities.

2. Determine net cash provided/used by investing activities, recognizing that investing activities generally relate to changes in noncurrent assets.

3. Determine net cash provided/used by financing activities, recognizing that financing activities generally relate to changes in long-term liabilities and stock- holders’ equity accounts.

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630 Chapter 13 Statement of Cash Flows

Cash flows from investing activities Sale of land 25,000 Sale of equipment 34,000 Purchase of equipment (166,000)

Net cash used by investing activities (107,000) Cash flows from financing activities

Redemption of bonds (10,000) Sale of common stock 130,000 Payment of dividends (55,000)

Net cash provided by financing activities 65,000

Net increase in cash 17,000 Cash at beginning of period 37,000

Cash at end of period $ 54,000

Noncash investing and financing activities Conversion of bonds into common stock $ 30,000

Related exercise material: BE13-4, BE13-5, BE13-6, BE13-7, E13-4, E13-5, E13-6, E13-7, E13-8, and E13-9.

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USING CASH FLOWS TO EVALUATE A COMPANY

Traditionally, investors and creditors have most commonly used ratios based on accrual accounting. These days, cash-based ratios are gaining in- creased acceptance among analysts.

Free Cash Flow In the statement of cash flows, cash provided by operating activities is intended to indicate the cash-generating capability of the company. Analysts have noted, however, that cash provided by operating activities fails to take into account that a company must invest in new fixed assets just to maintain its current level of operations. Companies also must at least maintain dividends at current levels to satisfy investors. The measurement of free cash flow provides additional insight regarding a company’s cash-generating ability. Free cash flow describes the cash remaining from operations after adjustment for capital expenditures and dividends.

Consider the following example: Suppose that MPC produced and sold 10,000 personal computers this year. It reported $100,000 cash provided by oper- ating activities. In order to maintain production at 10,000 computers, MPC invested $15,000 in equipment. It chose to pay $5,000 in dividends. Its free cash flow was $80,000 ($100,000 � $15,000 � $5,000). The company could use this $80,000 either to purchase new assets to expand the business or to pay an $80,000 dividend and continue to produce 10,000 computers. In practice, free cash flow is often calculated with the formula in Illustration 13-14. (Alternative definitions also exist.)

Analyze the statement of cash flows.

S T U D Y O B J E C T I V E 4

Free Cash Cash Provided by Capital Cash Flow

� Operating Activities

� Expenditures

� Dividends

Illustration 13-14 Free cash flow

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Illustration 13-15 provides basic information (in millions) excerpted from the 2008 statement of cash flows of Microsoft Corporation.

Using Cash Flows to Evaluate a Company 631

MICROSOFT CORPORATION Statement of Cash Flows (partial)

2008

Cash provided by operating activities $21,612 Cash flows from investing activities

Additions to property and equipment $ (3,182) Purchases of investments (20,954) Sales of investments 25,132 Acquisitions of companies (8,053) Maturities of investments 2,597 Other (127)

Cash used by investing activities (4,587) Cash paid for dividends (4,015)

Microsoft’s free cash flow is calculated as shown in Illustration 13-16.

Cash provided by operating activities $21,612 Less: Expenditures on property and equipment 3,182

Dividends paid 4,015

Free cash flow $14,415

This is a tremendous amount of cash generated in a single year. It is available for the acquisition of new assets, the retirement of stock or debt, or the payment of dividends. As indicated in the Feature Story, for example, Microsoft is attempting to buy Yahoo! for over $44 billion as part of its acquisition strategey.

Oracle Corporation is one of the world’s largest sellers of database software and information management services. Like Microsoft, its success depends on continuing to improve its existing products while developing new products to keep pace with rapid changes in technology. Oracle’s free cash flow for 2008 was $7,159 million. This is impressive, but significantly less than Microsoft’s amazing ability to generate cash.

Illustration 13-15 Microsoft cash flow information ($ in millions)

Illustration 13-16 Calculation of Microsoft’s free cash flow ($ in millions)

Where Does the Money Go? on page 633 for

information on how topics in this chapter apply

to you.

all about Y U* Be sure to read

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before you go on...

632 Chapter 13 Statement of Cash Flows

(a) Free cash flow � $29,300 � $19,000 � $9,000 � $1,300 (b) Cash provided by operating activities fails to take into account that a company must invest

in new plant assets just to maintain the current level of operations. Companies must also maintain dividends at current levels to satisfy investors. The measurement of free cash flow provides additional insight regarding a company’s cash-generating ability.

Solution

Related exercise material: BE13-8, BE13-9, BE13-10, BE13-11, E13-7, E13-9, and 13-3.Do it!

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Action Plan

• Compute free cash flow as: Cash provided by operating activities � Capital expenditures � Cash dividends.

Chicago Corporation issued the following statement of cash flows for 2011.Free Cash Flow Do it!

CHICAGO CORPORATION Statement of Cash Flows—Indirect Method

For the Year Ended December 31, 2011

Cash flows from operating activities Net income $19,000 Adjustments to reconcile net income to net cash

provided by operating activities: Depreciation expense $ 8,100 Loss on sale of equipment 1,300 Decrease in accounts receivable 6,900 Increase in inventory (4,000) Decrease in accounts payable (2,000) 10,300

Net cash provided by operating activities 29,300

Cash flows from investing activities Sale of investments 1,100 Purchase of equipment (19,000)

Net cash used by investing activities (17,900)

Cash flows from financing activities Issuance of stock 10,000 Payment on long-term note payable (5,000) Payment for dividends (9,000)

Net cash used by financing activities (4,000)

Net increase in cash 7,400 Cash at beginning of year 10,000

Cash at end of year $17,400

(a) Compute free cash flow for Chicago Corporation. (b) Explain why free cash flow often provides better information than “Net cash provided by operating activities.”

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all about Y U*all about Y U* Where Does the Money Go?

Some Facts*

About the Numbers*

* College students spend about $200 billion per year on consumer products. Of that amount, $41 billion is “discretionary” in nature.

* More than 70% of college students own a cell phone, and 71% own a car.

* College students spend more than $8 billion per year purchasing DVDs, CDs, music downloads, and video games.

* Annual spending on travel by college students is about $4.6 billion.

* 78% of college students work, earning an average of $821 per month.

College students spend an average of $287 per month on discretionary items (defined as anything other than tuition, room/board, rent, books, and school fees). A large chunk of that—more than $11 billion—is spent on beverages and snack foods. Maybe this would be a good place to start cutting your expenditures.

The authors’ comments on this situation appear on page 672.

WWhen a company’s cash flow from operatingactivities does not cover its cash needs, it must borrow money. In the short term this is OK, but in the long-term it can spell disaster. Sooner or later the company needs to increase its cash from operations or cut back on its expenditures, or it will go broke. Guess what? The same is true for you and me.

Where do you spend your cash? Most of us know how much we spend each month on rent and car payments. But how much do you spend each month on soda, coffee, pizza, video rentals, music downloads, and your cell phone service? Don’t think it matters? Suppose you spend an average of only $4 per day on unneeded “incidentals.” That’s $120 a month, or almost $1,500 per year.

Source: “College Students Spend $200 Billion per Year,” HarrisInteractive, www.harrisinteractive.com/news/allnewsbydate.asp?NewsID�480 (accessed May 2006).

What Do You Think?* Let’s say that you live on campus and own a car. You use the car for pleasure and to drive to a job that is three miles away. Suppose your annual cash flow statement includes the following items.

Cash inflows: Wages $ 9,000 Student loans 5,000 Credit card debt 4,000

Cash outflows: Tuition, books, room, and board 13,000 Vehicle costs 2,000 Vacation 2,000 Cell phone service 500 Snacks and beverages 500

Should you get rid of your car and cell phone, quit eating snacks, and give up the idea of a vacation?

YES: At this rate you will accumulate nearly $40,000 in debts by the time you graduate. It is not fun to spend most of the paycheck of your post- graduation job paying off the debts you accumulated while in school.

NO: Give me a break. A person has to have some fun. Life wouldn’t be worth living if I couldn’t be drinking a Starbucks while cruising down the road talking on my cell phone.

Sources: Becky Ebenkamp, “College Communications 101,” Brandweek, August 22-29, 2005, p. 16.

633

Annual Spending by College Students on Beverages and Snacks

$0 $1,000 $2,000 $3,000 $4,000

Sports drinks

Chip snacks

Coffee

Bottled water

Bottled juice

Soda

Dollars in millions

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634 Chapter 13 Statement of Cash Flows

The income statement for the year ended December 31, 2011, for Kosinski Manufacturing Company contains the following condensed information.

KOSINSKI MANUFACTURING COMPANY Income Statement

For the Year Ended December 31, 2011

Revenues $6,583,000 Operating expenses (excluding depreciation) $4,920,000 Depreciation expense 880,000 5,800,000

Income before income taxes 783,000 Income tax expense 353,000

Net income $ 430,000

Included in operating expenses is a $24,000 loss resulting from the sale of machinery for $270,000 cash. Machinery was purchased at a cost of $750,000.

The following balances are reported on Kosinski’s comparative balance sheets at December 31.

KOSINSKI MANUFACTURING COMPANY Comparative Balance Sheets (partial)

2011 2010

Cash $672,000 $130,000 Accounts receivable 775,000 610,000 Inventories 834,000 867,000 Accounts payable 521,000 501,000

Income tax expense of $353,000 represents the amount paid in 2011. Dividends declared and paid in 2011 totaled $200,000.

Instructions Prepare the statement of cash flows using the indirect method.

Solution to Comprehensive Do it!

Do it!

KOSINSKI MANUFACTURING COMPANY Statement of Cash Flows—Indirect Method

For the Year Ended December 31, 2011 Cash flows from operating activities

Net income $ 430,000 Adjustments to reconcile net income to net cash

provided by operating activities: Depreciation expense $ 880,000 Loss on sale of machinery 24,000 Increase in accounts receivable (165,000) Decrease in inventories 33,000 Increase in accounts payable 20,000 792,000

Net cash provided by operating activities 1,222,000 Cash flows from investing activities

Sale of machinery 270,000 Purchase of machinery (750,000)

Net cash used by investing activities (480,000) Cash flows from financing activities

Payment of cash dividends (200,000)

Net increase in cash 542,000 Cash at beginning of period 130,000

Cash at end of period $ 672,000

The Navigator✓

Action Plan

• Determine net cash from oper- ating activities. Operating activities generally relate to changes in current assets and current liabilities.

• Determine net cash from invest- ing activities. Investing activities generally relate to changes in noncurrent assets.

• Determine net cash from financing activities. Financing activities generally relate to changes in long-term liabilities and stockholders’ equity accounts.

Comprehensive

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Appendix 13A Using a Worksheet to Prepare the Statement of Cash Flows—Indirect Method 635

1 Indicate the usefulness of the statement of cash flows. The statement of cash flows provides information about the cash receipts, cash payments, and net change in cash resulting from the operating, investing, and financing activ- ities of a company during the period.

2 Distinguish among operating, investing, and financing activities. Operating activities include the cash effects of transactions that enter into the determination of net in- come. Investing activities involve cash flows resulting from changes in investments and long-term asset items. Financing activities involve cash flows resulting from changes in long- term liability and stockholders’ equity items.

3 Prepare a statement of cash flows using the indirect method. The preparation of a statement of cash flows involves three major steps: (1) Determine net cash

provided/used by operating activities by converting net income from an accrual basis to a cash basis. (2) Analyze changes in noncurrent asset and liability accounts and record as investing and financing activities, or disclose as noncash transactions. (3) Compare the net change in cash on the statement of cash flows with the change in the cash account reported on the balance sheet to make sure the amounts agree.

4 Analyze the statement of cash flows. Free cash flow indicates the amount of cash a company generated during the current year that is available for the payment of addi- tional dividends or for expansion.

SUMMARY OF STUDY OBJECTIVES

The Navigator✓

Direct method A method of determining net cash provided by operating activities by adjusting each item in the income statement from the accrual basis to the cash basis and which shows operating cash recipts and payments. (p. 619).

Financing activities Cash flow activities that include (a) ob- taining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from stockholders, repur- chasing shares, and paying dividends. (p. 615).

Free cash flow Cash provided by operating activities adjusted for capital expenditures and dividends paid. (p. 630).

Indirect method A method of preparing a statement of cash flows in which net income is adjusted for items that do

not affect cash, to determine net cash provided by operat- ing activities. (pp. 618, 621).

Investing activities Cash flow activities that include (a) purchasing and disposing of investments and property, plant, and equipment using cash and (b) lending money and collecting the loans. (p. 615).

Operating activities Cash flow activities that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income. (p. 615).

Statement of cash flows A basic financial statement that provides information about the cash receipts, cash pay- ments, and net change in cash during a period, resulting from operating, investing, and financing activities. (p. 614).

GLOSSARY

APPENDIX 13A Using a Worksheet to Prepare the Statement of Cash Flows—Indirect Method When preparing a statement of cash flows, companies may need to make numerous adjustments of net income. In such cases, they often use a worksheet to assemble and classify the data that will appear on the state- ment. The worksheet is merely an aid in preparing the statement. Its use is optional. Illustration 13A-1 (page 636) shows the skeleton format of the worksheet for preparation of the statement of cash flows.

The following guidelines are important in preparing a worksheet.

1. In the balance sheet accounts section, list accounts with debit balances separately from those with credit balances. This means, for example, that Accumulated Depreciation appears under credit balances and not as a contra account under debit balances. Enter the beginning and ending balances of each account in the appropriate columns. Enter as reconciling items in the two middle columns the transactions that caused the change in the account balance during the year.

After all reconciling items have been entered, each line pertaining to a balance sheet account should “foot across.” That is, the beginning balance plus

Explain how to use a worksheet to prepare the statement of cash flows using the indirect method.

S T U D Y O B J E C T I V E 5

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636 Chapter 13 Statement of Cash Flows

File Edit View Insert Format Tools Data Window Help

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27

A B C D E

XYZ COMPANY Worksheet

Statement of Cash Flows For the Year Ended . . .

End of Last Year Balances

XX XX

XX XXX

XXX

End of Current Year

Balances

XX XX

XXX XX XX

XXX

Balance Sheet Accounts

Debit balance accounts

Operating activities Net income Adjustments to net income Investing activities Receipts and payments Financing activities Receipts and payments Totals Increase (decrease) in cash Totals

Credit balance accounts Totals

Totals Statement of Cash

Flows Effects

Debit

(XX) XXX

XXX

XX XX

Credit

XX XX

XX XXX

XXX

Reconciling Items

XYZ Company.xlsIllustration 13A-1 Format of worksheet

or minus the reconciling item(s) must equal the ending balance. When this agreement exists for all balance sheet accounts, all changes in account balances have been reconciled.

2. The bottom portion of the worksheet consists of the operating, investing, and financing activities sections. It provides the information necessary to prepare the formal statement of cash flows. Enter inflows of cash as debits in the recon- ciling columns. Enter outflows of cash as credits in the reconciling columns. Thus, in this section, the sale of equipment for cash at book value appears as a debit under investing activities. Similarly, the purchase of land for cash appears as a credit under investing activities.

3. The reconciling items shown in the worksheet are not entered in any journal or posted to any account. They do not represent either adjustments or corrections of the balance sheet accounts. They are used only to facilitate the preparation of the statement of cash flows.

Preparing the Worksheet As in the case of worksheets illustrated in earlier chapters, preparing a worksheet involves a series of prescribed steps. The steps in this case are:

1. Enter in the balance sheet accounts section the balance sheet accounts and their beginning and ending balances.

2. Enter in the reconciling columns of the worksheet the data that explain the changes in the balance sheet accounts other than cash and their effects on the statement of cash flows.

3. Enter on the cash line and at the bottom of the worksheet the increase or decrease in cash. This entry should enable the totals of the reconciling columns to be in agreement.

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To illustrate the preparation of a worksheet, we will use the 2011 data for Computer Services Company. Your familiarity with these data (from the chapter) should help you understand the use of a worksheet. For ease of reference, the comparative balance sheets, income statement, and selected data for 2011 are presented in Illustration 13A-2 (on page 638).

DETERMINING THE RECONCILING ITEMS Companies can use one of several approaches to determine the reconciling items. For example, they can first complete the changes affecting net cash provided by operating activities, and then can determine the effects of financing and investing transactions. Or, they can analyze the balance sheet accounts in the order in which they are listed on the worksheet. We will follow this latter approach for Computer Services, except for cash. As indicated in step 3, cash is handled last.

Accounts Receivable. The decrease of $10,000 in accounts receivable means that cash collections from revenues are higher than the revenues reported in the income statement.To convert net income to net cash provided by operating activities, we add the decrease of $10,000 to net income. The entry in the reconciling columns of the worksheet is:

(a) Operating—Decrease in Accounts Receivable 10,000 Accounts Receivable 10,000

Merchandise Inventory. Computer Services Company’s Merchandise Inventory balance increases $5,000 during the period. The Merchandise Inventory account reflects the difference between the amount of inventory that the company purchased and the amount that it sold. For Computer Services this means that the cost of mer- chandise purchased exceeds the cost of goods sold by $5,000. As a result, cost of goods sold does not reflect $5,000 of cash payments made for merchandise. We deduct this inventory increase of $5,000 during the period from net income to arrive at net cash provided by operating activities. The worksheet entry is:

(b) Merchandise Inventory 5,000 Operating—Increase in Merchandise

Inventory 5,000

Prepaid Expenses. An increase of $4,000 in prepaid expenses means that ex- penses deducted in determining net income are less than expenses that were paid in cash. We deduct the increase of $4,000 from net income in determining net cash provided by operating activities. The worksheet entry is:

Land. The increase in land of $110,000 resulted from a purchase through the issuance of long-term bonds. The company should report this transaction as a sig- nificant noncash investing and financing activity. The worksheet entry is:

(d) Land 110,000 Bonds Payable 110,000

Building. The cash purchase of a building for $120,000 is an investing activity cash outflow. The entry in the reconciling columns of the worksheet is:

(e) Building 120,000 Investing—Purchase of Building 120,000

Equipment. The increase in equipment of $17,000 resulted from a cash purchase of $25,000 and the sale of equipment costing $8,000. The book value of the equipment

Appendix 13A Using a Worksheet to Prepare the Statement of Cash Flows—Indirect Method 637

H E L P F U L H I N T These amounts are asterisked in the worksheet to indicate that they result from a significant noncash transaction.

JWCL165_c13_612-673.qxd 8/13/09 11:15 AM Page 637

638 Chapter 13 Statement of Cash Flows

purchased for cash. 4. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated

depreciation $1,000) for $4,000 cash. 5. Issued common stock for $20,000 cash. 6. Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29

A B C D

$ 22,000 10,000 5,000 4,000

110,000 120,000

6,000 17,000 2,000

$ 16,000 2,000

110,000

20,000 116,000

Change in Account Balance

Increase/Decrease

Increase Decrease Increase Increase

Increase Increase Increase Increase Increase

Increase Decrease

Increase

Increase Increase

Assets Current assets Cash Accounts receivable Merchandise inventory Prepaid expenses Property, plant, and equipment Land Building Accumulated depreciation—building Equipment Accumulated depreciation—equipment Total

Liabilities and Stockholders’ Equity Current liabilities Accounts payable Income tax payable Long-term liabilities Bonds payable Stockholders’ equity Common stock Retained earnings Total liabilities and stockholders’ equity

$ 33,000 30,000 10,000 1,000

20,000 40,000 (5,000) 10,000 (1,000)

$138,000

$ 12,000 8,000

20,000

50,000 48,000

$138,000

20102011

$ 55,000 20,000 15,000 5,000

130,000 160,000 (11,000) 27,000 (3,000)

$398,000

$ 28,000 6,000

130,000

70,000 164,000

$398,000

COMPUTER SERVICES COMPANY Comparative Balance Sheets

December 31

Computer Services Company.xls

Sheet 1 Sheet 2

File Edit View Insert Format Tools Data Window Help

1 2 3 4 5 6 7 8 9 10 11 12 13 14

A B C D

Revenues Cost of goods sold Operating expenses (excluding depreciation) Depreciation expense Loss on sale of equipment Interest expense Income before income tax Income tax expense Net income

COMPUTER SERVICES COMPANY Income Statement

For the Year Ended December 31, 2011

$507,000

315,000 192,000 47,000

$145,000

$150,000 111,000

9,000 3,000

42,000

File Edit View Insert Format Tools Data Window Help

Computer Services Company.xls

Sheet 1 Sheet 2

Illustration 13A-2 Comparative balance sheets, income statement, and additional information for Computer Services Company

JWCL165_c13_612-673.qxd 8/13/09 11:15 AM Page 638

was $7,000, the cash proceeds were $4,000, and a loss of $3,000 was recorded. The worksheet entries are:

(f) Equipment 25,000 Investing—Purchase of Equipment 25,000

(g) Investing—Sale of Equipment 4,000 Operating—Loss on Sale of Equipment 3,000 Accumulated Depreciation—Equipment 1,000

Equipment 8,000

Accounts Payable. We must add the increase of $16,000 in accounts payable to net income to determine net cash provided by operating activities.The worksheet entry is:

(h) Operating—Increase in Accounts Payable 16,000 Accounts Payable 16,000

Income Tax Payable. When a company incurs income tax expense but has not yet paid its taxes, it records income tax payable. A change in the Income Tax Payable account reflects the difference between income tax expense incurred and income tax actually paid. Computer Services’ Income Tax Payable account decreases by $2,000. That means the $47,000 of income tax expense reported on the income statement was $2,000 less than the amount of taxes paid during the period of $49,000. To adjust net income to a cash basis, we must reduce net income by $2,000. The worksheet entry is:

(i) Income Tax Payable 2,000 Operating—Decrease in Income Taxes

Payable 2,000

Bonds Payable. The increase of $110,000 in this account resulted from the is- suance of bonds for land. This is a significant noncash investing and financing activ- ity. Worksheet entry (d) above is the only entry necessary.

Common Stock. The balance sheet reports an increase in Common Stock of $20,000. The additional information section notes that this increase resulted from the issuance of new shares of stock. This is a cash inflow reported in the financing section. The worksheet entry is:

(j) Financing—Issuance of Common Stock 20,000 Common Stock 20,000

Accumulated Depreciation—Building, and Accumulated Depreciation— Equipment. Increases in these accounts of $6,000 and $3,000, respectively, resulted from depreciation expense. Depreciation expense is a noncash charge that we must add to net income to determine net cash provided by operating activities. The worksheet entries are:

(k) Operating—Depreciation Expense—Building 6,000 Accumulated Depreciation—Building 6,000

(l) Operating—Depreciation Expense—Equipment 3,000 Accumulated Depreciation—Equipment 3,000

Retained Earnings. The $116,000 increase in retained earnings resulted from net income of $145,000 and the declaration and payment of a $29,000 cash divi- dend. Net income is included in net cash provided by operating activities, and the dividends are a financing activity cash outflow. The entries in the reconciling columns of the worksheet are:

(m) Operating—Net Income 145,000 Retained Earnings 145,000

(n) Retained Earnings 29,000 Financing—Payment of Dividends 29,000

Appendix 13A Using a Worksheet to Prepare the Statement of Cash Flows—Indirect Method 639

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Disposition of Change in Cash. The firm’s cash increased $22,000 in 2011. The final entry on the worksheet, therefore, is:

(o) Cash 22,000 Increase in Cash 22,000

As shown in the worksheet, we enter the increase in cash in the reconciling credit column as a balancing amount. This entry should complete the reconciliation of the changes in the balance sheet accounts. Also, it should permit the totals of the rec- onciling columns to be in agreement. When all changes have been explained and the reconciling columns are in agreement, the reconciling columns are ruled to complete the worksheet. The completed worksheet for Computer Services Company is shown in Illustration 13A-3.

640 Chapter 13 Statement of Cash Flows

Balance 12/31/10

33,000 30,000 10,000 1,000

20,000 40,000 10,000

144,000

12,000 8,000

20,000 5,000 1,000

50,000 48,000

144,000

55,000 20,000 15,000 5,000

130,000 160,000 27,000

412,000

28,000 6,000

130,000 11,000 3,000

70,000 164,000 412,000

22,000

5,000 4,000

110,000 120,000 25,000

2,000

1,000

29,000

145,000 10,000

16,000

6,000 3,000 3,000

4,000

20,000

525,000

10,000

8,000

16,000

110,000 6,000 3,000

20,000 145,000

5,000 4,000

2,000

120,000 25,000

29,000 503,000 22,000

525,000

Reconciling Items Debit

* Significant noncash investing and financing activity.

Credit

(o)

(b) (c) (d) (e) (f)

(i)

(g)

(n)

(m) (a)

(h)

(k) (l) (g)

(g)

(j)

(a)

(g)

(h)

(d) (k) (l) (j) (m)

(b) (c)

(i)

(e) (f)

(n)

(o)

Balance 12/31/11

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46

A B C D E

Balance Sheet Accounts Debits Cash Accounts receivable Merchandise inventory Prepaid expenses Land Building Equipment Total Accounts payable Income tax payable Bonds payable Accumulated depreciation—building Accumulated depreciation—equipment Common stock Retained earnings Total Statement of Cash Flows Effects Operating activities Net income Decrease in accounts receivable Increase in merchandise inventory Increase in prepaid expenses Increase in accounts payable Decrease in income tax payable Depreciation expense—building Depreciation expense—equipment Loss on sale of equipment Investing activities Purchase of building Purchase of equipment Sale of equipment Financing activities Issuance of common stock Payment of dividends Totals Increase in cash Totals

Credits

COMPUTER SERVICES COMPANY Worksheet

Statement of Cash Flows For the Year Ended December 31, 2011

Computer Services Company.xls

File Edit View Insert Format Tools Data Window Help

Illustration 13A-3 Completed worksheet— indirect method

JWCL165_c13_612-673.qxd 8/13/09 11:15 AM Page 640

Appendix 13B Statement of Cash Flows—Direct Method 641

SUMMARY OF STUDY OBJECTIVE FOR APPENDIX 13A

5 Explain how to use a worksheet to prepare the state- ment of cash flows using the indirect method. When there are numerous adjustments, a worksheet can be a helpful tool in preparing the statement of cash flows. Key guidelines for using a worksheet are: (1) List accounts with debit balances separately from those with credit balances. (2) In the reconciling columns in the bottom portion of the worksheet, show cash inflows as debits and cash outflows as

credits. (3) Do not enter reconciling items in any journal or account, but use them only to help prepare the statement of cash flows.

The steps in preparing the worksheet are: (1) Enter be- ginning and ending balances of balance sheet accounts. (2) Enter debits and credits in reconciling columns. (3) Enter the increase or decrease in cash in two places as a balancing amount.

APPENDIX 13B Statement of Cash Flows—Direct Method To explain and illustrate the direct method, we will use the transactions of Juarez Company for 2011, to prepare a statement of cash flows. Illustration 13B-1 presents information related to 2011 for Juarez Company.

Prepare a statement of cash flows using the direct method.

S T U D Y O B J E C T I V E 6

JUAREZ COMPANY Comparative Balance Sheets

December 31

Change Assets 2011 2010 Increase/Decrease

Cash $191,000 $159,000 $ 32,000 Increase Accounts receivable 12,000 15,000 3,000 Decrease Inventory 170,000 160,000 10,000 Increase Prepaid expenses 6,000 8,000 2,000 Decrease Land 140,000 80,000 60,000 Increase Equipment 160,000 –0– 160,000 Increase Accumulated depreciation—equipment (16,000) –0– 16,000 Increase

Total $663,000 $422,000

Liabilities and Stockholders’ Equity

Accounts payable $ 52,000 $ 60,000 $ 8,000 Decrease Accrued expenses payable 15,000 20,000 5,000 Decrease Income tax payable 12,000 –0– 12,000 Increase Bonds payable 130,000 –0– 130,000 Increase Common stock 360,000 300,000 60,000 Increase Retained earnings 94,000 42,000 52,000 Increase

Total $663,000 $422,000

JUAREZ COMPANY Income Statement

For the Year Ended December 31, 2011

Revenues $975,000 Cost of goods sold $660,000 Operating expenses (excluding depreciation) 176,000 Depreciation expense 18,000 Loss on sale of store equipment 1,000 855,000

Income before income taxes 120,000 Income tax expense 36,000

Net income $ 84,000

Illustration 13B-1 Comparative balance sheets, income statement, and additional information for Juarez Company

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To prepare a statement of cash flows under the direct approach, we will apply the three steps outlined in Illustration 13-3 (page 619).

Step 1: Operating Activities DETERMINE NET CASH PROVIDED/USED BY OPERATING ACTIVITIES BY CONVERTING NET INCOME FROM AN ACCRUAL BASIS TO A CASH BASIS Under the direct method, companies compute net cash provided by operating activi- ties by adjusting each item in the income statement from the accrual basis to the cash basis.To simplify and condense the operating activities section, companies report only major classes of operating cash receipts and cash payments. For these major classes, the difference between cash receipts and cash payments is the net cash provided by operating activities. These relationships are as shown in Illustration 13B-2.

642 Chapter 13 Statement of Cash Flows

Additional information: 1. In 2011, the company declared and paid a $32,000 cash dividend. 2. Bonds were issued at face value for $130,000 in cash. 3. Equipment costing $180,000 was purchased for cash. 4. Equipment costing $20,000 was sold for $17,000 cash when the book value of the equipment

was $18,000. 5. Common stock of $60,000 was issued to acquire land.

From sales of goods and services

to customers

Cash Receipts – Cash Payments = Net Cash Providedby Operating Activities

To suppliers

To employees

For operating expenses

Net cash provided by

operating activities

For interest

For taxes

From receipts of interest and

dividends on loans and investments

Illustration 13B-1 (continued)

An efficient way to apply the direct method is to analyze the items reported in the income statement in the order in which they are listed. We then determine cash receipts and cash payments related to these revenues and expenses. The following pages present the adjustments required to prepare a statement of cash flows for Juarez Company using the direct approach.

Illustration 13B-2 Major classes of cash receipts and payments

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Cash Receipts from Customers. The income statement for Juarez Company re- ported revenues from customers of $975,000. How much of that was cash receipts? To answer that, companies need to consider the change in accounts receivable during the year. When accounts receivable increase during the year, revenues on an accrual basis are higher than cash receipts from customers. Operations led to revenues, but not all of these revenues resulted in cash receipts.

To determine the amount of cash receipts, the company deducts from sales revenues the increase in accounts receivable. On the other hand, there may be a decrease in accounts receivable. That would occur if cash receipts from customers exceeded sales revenues. In that case, the company adds to sales revenues the decrease in accounts receivable.

For Juarez Company, accounts receivable decreased $3,000. Thus, cash receipts from customers were $978,000, computed as shown in Illustration 13B-3.

Appendix 13B Statement of Cash Flows—Direct Method 643

Revenues from sales $975,000 Add: Decrease in accounts receivable 3,000

Cash receipts from customers $978,000

Juarez can also determine cash receipts from customers from an analysis of the Accounts Receivable account, as shown in Illustration 13B-4.

Accounts Receivable

1/1/11 Balance 15,000 Receipts from customers 978,000 Revenues from sales 975,000

12/31/11 Balance 12,000 H E L P F U L H I N T The T account shows that revenue plus decrease in receivables equals cash receipts.

Illustration 13B-5 shows the relationships among cash receipts from customers, revenues from sales, and changes in accounts receivable.

Cash Receipts Revenues � Decrease in Accounts Receivable from � from or

Customers Sales � Increase in Accounts Receivable

⎫⎪ ⎬ ⎪⎭

Cash Payments to Suppliers. Juarez Company reported cost of goods sold of $660,000 on its income statement. How much of that was cash payments to suppliers? To answer that, it is first necessary to find purchases for the year. To find purchases, companies adjust cost of goods sold for the change in inventory. When inventory increases during the year, purchases for the year have exceeded cost of goods sold. As a result, to determine the amount of purchases, the company adds to cost of goods sold the increase in inventory.

In 2011, Juarez Company’s inventory increased $10,000. It computes purchases as follows.

Illustration 13B-3 Computation of cash receipts from customers

Illustration 13B-4 Analysis of accounts receivable

Illustration 13B-5 Formula to compute cash receipts from customers— direct method

Cost of goods sold $660,000 Add: Increase in inventory 10,000

Purchases $670,000

Illustration 13B-6 Computation of purchases

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After computing purchases, a company can determine cash payments to suppliers. This is done by adjusting purchases for the change in accounts payable. When ac- counts payable increase during the year, purchases on an accrual basis are higher than they are on a cash basis. As a result, to determine cash payments to suppliers, a com- pany deducts from purchases the increase in accounts payable. On the other hand, if cash payments to suppliers exceed purchases, there will be a decrease in accounts payable. In that case, a company adds to purchases the decrease in accounts payable.

For Juarez Company, cash payments to suppliers were $678,000, computed as follows.

644 Chapter 13 Statement of Cash Flows

Purchases $670,000 Add: Decrease in accounts payable 8,000 Cash payments to suppliers $678,000

Illustration 13B-7 Computation of cash payments to suppliers

Juarez also can determine cash payments to suppliers from an analysis of the Accounts Payable account, as shown in Illustration 13B-8.

Accounts Payable

Payments to suppliers 678,000 1/1/11 Balance 60,000 Purchases 670,000

12/31/11 Balance 52,000

Illustration 13B-9 shows the relationships among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable.

�

⎫ ⎪ ⎪ ⎬ ⎪ ⎪ ⎭

Cash Payments

to Suppliers

Cost of

Goods Sold

� Increase in Inventory or

� Decrease in Inventory

� Decrease in Accounts Payable

or � Increase in Accounts

Payable

⎫ ⎪ ⎪ ⎬ ⎪ ⎪ ⎭

Cash Payments for Operating Expenses. Juarez reported on its income state- ment operating expenses of $176,000. How much of that amount was cash paid for operating expenses? To answer that, we need to adjust this amount for any changes in prepaid expenses and accrued expenses payable. For example, if prepaid ex- penses increased during the year, cash paid for operating expenses is higher than operating expenses reported on the income statement. To convert operating ex- penses to cash payments for operating expenses, a company adds the increase to operating expenses. On the other hand, if prepaid expenses decrease during the year, it deducts the decrease from operating expenses.

Companies must also adjust operating expenses for changes in accrued ex- penses payable. When accrued expenses payable increase during the year, operat- ing expenses on an accrual basis are higher than they are in a cash basis. As a result, to determine cash payments for operating expenses, a company deducts from oper- ating expenses an increase in accrued expenses payable. On the other hand, a com- pany adds to operating expenses a decrease in accrued expenses payable because cash payments exceed operating expenses.

H E L P F U L H I N T The T account shows that purchases plus decrease in accounts payable equals payments to suppliers.

Illustration 13B-8 Analysis of accounts payable

Illustration 13B-9 Formula to compute cash payments to suppliers— direct method

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Juarez Company’s cash payments for operating expenses were $179,000, computed as follows.

Appendix 13B Statement of Cash Flows—Direct Method 645

Operating expenses $176,000 Deduct: Decrease in prepaid expenses 2,000 Add: Decrease in accrued expenses payable 5,000

Cash payments for operating expenses $179,000

Illustration 13B-11 shows the relationships among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable.

Cash Payments

for Operating Expenses

� Operating Expenses

� Increase in Prepaid Expense

or � Decrease in

Prepaid Expense

� Decrease in Accrued Expenses Payable

or � Increase in Accrued

Expenses Payable

⎫ ⎪ ⎪ ⎬ ⎪ ⎪ ⎭

Depreciation Expense and Loss on Sale of Equipment. Companies show operating expenses exclusive of depreciation. Juarez’s depreciation expense in 2011 was $18,000. Depreciation expense is not shown on a statement of cash flows because it is a noncash charge. If the amount for operating expenses includes depreciation expense, the company must reduce operating expenses by the amount of depreciation to determine cash payments for operating expenses.

The loss on sale of equipment of $1,000 is also a noncash charge. The loss on sale of equipment reduces net income, but it does not reduce cash. Thus, companies do not report on a statement of cash flows the loss on sale of equipment.

Other charges to expense that do not require the use of cash, such as the amor- tization of intangible assets, depletion expense, and bad debt expense, are treated in the same manner as depreciation.

Cash Payments for Income Taxes. Juarez reported income tax expense of $36,000 on the income statement. Income tax payable, however, increased $12,000. This increase means that the company has not yet paid $12,000 of the income taxes. As a result, income taxes paid were less than income taxes reported in the in- come statement. Cash payments for income taxes were, therefore, $24,000 as shown below.

Income tax expense $36,000 Deduct: Increase in income tax payable 12,000

Cash payments for income taxes $24,000

Illustration 13B-13 shows the relationships among cash payments for income taxes, income tax expense, and changes in income tax payable.

Cash Payments for Income Taxes

� Income Tax

Expense � Decrease in Income Tax Payable

or � Increase in Income Tax Payable

⎫⎪ ⎬ ⎪⎭

Illustration 13B-10 Computation of cash payments for operating expenses

Illustration 13B-11 Formula to compute cash payments for operating expenses—direct method

Illustration 13B-12 Computation of cash payments for income taxes

Illustration 13B-13 Formula to compute cash payments for income taxes—direct method

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The operating activities section of the statement of cash flows of Juarez Company is shown in Illustration 13B-14.

646 Chapter 13 Statement of Cash Flows

Cash flows from operating activities Cash receipts from customers $978,000 Less: Cash payments:

To suppliers $678,000 For operating expenses 179,000 For income taxes 24,000 881,000

Net cash provided by operating activities $ 97,000

When a company uses the direct method, it must also provide in a separate schedule (not shown here) the net cash flows from operating activities as computed under the indirect method.

Step 2: Investing and Financing Activities ANALYZE CHANGES IN NONCURRENT ASSET AND LIABILITY ACCOUNTS AND RECORD AS INVESTING AND FINANCING ACTIVITIES, OR AS SIGNIFICANT NONCASH TRANSACTIONS Increase in Land. Juarez’s land increased $60,000. The additional information section indicates that the company issued common stock to purchase the land. The issuance of common stock for land has no effect on cash. But it is a significant noncash investing and financing transaction. This transaction requires disclosure in a separate schedule at the bottom of the statement of cash flows.

Increase in Equipment. The comparative balance sheets show that equipment increased $160,000 in 2011. The additional information in Illustration 13B-1 indicated that the increase resulted from two investing transactions: (1) Juarez purchased for cash equipment costing $180,000. And (2) it sold for $17,000 cash equipment costing $20,000, whose book value was $18,000. The relevant data for the statement of cash flows is the cash paid for the purchase and the cash proceeds from the sale. For Juarez Company, the investing activities section will show the following: The $180,000 purchase of equipment as an outflow of cash, and the $17,000 sale of equipment as an inflow of cash. The company should not net the two amounts. Both individual outflows and inflows of cash should be shown.

The analysis of the changes in equipment should include the related Accumulated Depreciation account. These two accounts for Juarez Company are shown in Illustration 13B-15.

Equipment

1/1/11 Balance –0– Cost of equipment sold 20,000 Cash purchase 180,000

12/31/11 Balance 160,000

Accumulated Depreciation—Equipment

Sale of equipment 2,000 1/1/11 Balance –0– Depreciation expense 18,000

12/31/11 Balance 16,000

Illustration 13B-14 Operating activities section of the statement of cash flows

Illustration 13B-15 Analysis of equipment and related accumulated depreciation

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Increase in Bonds Payable. Bonds Payable increased $130,000. The additional information in Illustration 13B-1 indicated that Juarez issued, for $130,000 cash, bonds with a face value of $130,000. The issuance of bonds is a financing activity. For Juarez Company, there is an inflow of cash of $130,000 from the issuance of bonds.

Increase in Common Stock. The Common Stock account increased $60,000. The additional information indicated that Juarez acquired land from the issuance of common stock. This transaction is a significant noncash investing and financing transaction which the company should report separately at the bottom of the statement.

Increase in Retained Earnings. The $52,000 net increase in Retained Earnings resulted from net income of $84,000 and the declaration and payment of a cash dividend of $32,000. Companies do not report net income in the statement of cash flows under the direct method. Cash dividends paid of $32,000 are reported in the financing activities section as an outflow of cash.

STATEMENT OF CASH FLOWS—2011 Illustration 13B-16 shows the statement of cash flows for Juarez.

Appendix 13B Statement of Cash Flows—Direct Method 647

JUAREZ COMPANY Statement of Cash Flows—Direct Method For the Year Ended December 31, 2011

Cash flows from operating activities Cash receipts from customers $ 978,000 Less: Cash payments:

To suppliers $ 678,000 For operating expenses 179,000 For income taxes 24,000 881,000

Net cash provided by operating activities 97,000 Cash flows from investing activities

Purchase of equipment (180,000) Sale of equipment 17,000

Net cash used by investing activities (163,000) Cash flows from financing activities

Issuance of bonds payable 130,000 Payment of cash dividends (32,000)

Net cash provided by financing activities 98,000

Net increase in cash 32,000 Cash at beginning of period 159,000

Cash at end of period $ 191,000

Noncash investing and financing activities Issuance of common stock to purchase land $ 60,000

Illustration 13B-16 Statement of cash flows, 2011—direct method

Step 3: Net Change in Cash COMPARE THE NET CHANGE IN CASH ON THE STATEMENT OF CASH FLOWS WITH THE CHANGE IN THE CASH ACCOUNT REPORTED ON THE BALANCE SHEET TO MAKE SURE THE AMOUNTS AGREE Illustration 13B-16 indicates that the net change in cash during the period was an increase of $32,000. This agrees with the change in balances in the cash account reported on the balance sheets in Illustration 13B-1 (page 641).

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648 Chapter 13 Statement of Cash Flows

6 Prepare a statement of cash flows using the direct method. The preparation of the statement of cash flows involves three major steps: (1) Determine net cash provided/ used by operating activities by converting net income from an accrual basis to a cash basis. (2) Analyze changes in non- current asset and liability accounts and record as investing and financing activities, or disclose as noncash transactions.

(3) Compare the net change in cash on the statement of cash flows with the change in the cash account reported on the balance sheet to make sure the amounts agree. The direct method reports cash receipts less cash payments to arrive at net cash provided by operating activities.

SUMMARY OF STUDY OBJECTIVE FOR APPENDIX 13B

GLOSSARY FOR APPENDIX 13B

Direct method A method of determining net cash pro- vided by operating activities by adjusting each item in the

income statement from the accrual basis to the cash basis. (pp. 619, 642)

Do it!Comprehensive

The income statement for Kosinski Manufacturing Company contains the following condensed information.

KOSINSKI MANUFACTURING COMPANY Income Statement

For the Year Ended December 31, 2011

Revenues $6,583,000 Operating expenses, excluding depreciation $4,920,000 Depreciation expense 880,000 5,800,000

Income before income taxes 783,000 Income tax expense 353,000

Net income $ 430,000

KOSINSKI MANUFACTURING COMPANY Comparative Balance Sheets (partial)

2011 2010

Cash $672,000 $130,000 Accounts receivable 775,000 610,000 Inventories 834,000 867,000 Accounts payable 521,000 501,000

Included in operating expenses is a $24,000 loss resulting from the sale of machinery for $270,000 cash. Machinery was purchased at a cost of $750,000. The following balances are reported on Kosinski’s comparative balance sheet at December 31.

Income tax expense of $353,000 represents the amount paid in 2011. Dividends declared and paid in 2011 totaled $200,000.

Instructions Prepare the statement of cash flows using the direct method.

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Self-Study Questions 649

Solution to Comprehensive Do it! Action Plan

• Determine net cash from operating activities. Each item in the income statement must be adjusted to the cash basis.

• Determine net cash from investing activities. Investing activities generally relate to changes in noncurrent assets.

• Determine net cash from financing activities. Financing activities generally relate to changes in long-term liabilities and stockholders’ equity accounts.

The Navigator✓

KOSINSKI MANUFACTURING COMPANY Statement of Cash Flows—Direct Method For the Year Ended December 31, 2011

Cash flows from operating activities Cash collections from customers $6,418,000* Cash payments:

For operating expenses $4,843,000** For income taxes 353,000 5,196,000

Net cash provided by operating activities 1,222,000

Cash flows from investing activities Sale of machinery 270,000 Purchase of machinery (750,000)

Net cash used by investing activities (480,000)

Cash flows from financing activities Payment of cash dividends (200,000)

Net cash used by financing activities (200,000) Net increase in cash 542,000 Cash at beginning of period 130,000 Cash at end of period $ 672,000

Direct-Method Computations:

*Computation of cash collections from customers: Revenues per the income statement $6,583,000 Deduct: Increase in accounts receivable (165,000)

Cash collections from customers $6,418,000

**Computation of cash payments for operating expenses: Operating expenses per the income statement $4,920,000 Deduct: Loss from sale of machinery (24,000) Deduct: Decrease in inventories (33,000) Deduct: Increase in accounts payable (20,000)

Cash payments for operating expenses $4,843,000

*Note: All Questions, Exercises, and Problems marked with an asterisk relate to material in the appendices to the chapter.

Answers are at the end of the chapter.

1. Which of the following is incorrect about the statement of cash flows? a. It is a fourth basic financial statement. b. It provides information about cash receipts and cash

payments of an entity during a period. c. It reconciles the ending cash account balance to the

balance per the bank statement. d. It provides information about the operating, investing,

and financing activities of the business. 2. Which of the following will not be reported in the state-

ment of cash flows?

a. The net change in plant assets during the year. b. Cash payments for plant assets during the year. c. Cash receipts from sales of plant assets during the year. d. How acquisitions of plant assets during the year were

financed.

3. The statement of cash flows classifies cash receipts and cash payments by these activities: a. operating and nonoperating. b. investing, financing, and operating. c. financing, operating, and nonoperating. d. investing, financing, and nonoperating.

SELF-STUDY QUESTIONS

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4. Which is an example of a cash flow from an operating activity? a. Payment of cash to lenders for interest. b. Receipt of cash from the sale of capital stock. c. Payment of cash dividends to the company’s stock-

holders. d. None of the above.

5. Which is an example of a cash flow from an investing activity? a. Receipt of cash from the issuance of bonds payable. b. Payment of cash to repurchase outstanding capital

stock. c. Receipt of cash from the sale of equipment. d. Payment of cash to suppliers for inventory.

6. Cash dividends paid to stockholders are classified on the statement of cash flows as: a. operating activities. b. investing activities. c. a combination of (a) and (b). d. financing activities.

7. Which is an example of a cash flow from a financing activity? a. Receipt of cash from sale of land. b. Issuance of debt for cash. c. Purchase of equipment for cash. d. None of the above

8. Which of the following is incorrect about the statement of cash flows? a. The direct method may be used to report cash provided

by operations. b. The statement shows the cash provided (used) for

three categories of activity. c. The operating section is the last section of the statement. d. The indirect method may be used to report cash pro-

vided by operations.

Questions 9 through 11 apply only to the indirect method.

9. Net income is $132,000, accounts payable increased $10,000 during the year, inventory decreased $6,000 dur- ing the year, and accounts receivable increased $12,000 during the year. Under the indirect method, what is net cash provided by operating activities? a. $102,000. b. $112,000. c. $124,000. d. $136,000.

10. Items that are added back to net income in determining cash provided by operating activities under the indirect method do not include: a. depreciation expense. b. an increase in inventory. c. amortization expense. d. loss on sale of equipment.

11. The following data are available for Allen Clapp Corporation.

Net income $200,000 Depreciation expense 40,000 Dividends paid 60,000 Gain on sale of land 10,000 Decrease in accounts receivable 20,000 Decrease in accounts payable 30,000

Net cash provided by operating activities is: a. $160,000. b. $220,000. c. $240,000. d. $280,000.

12. The following data are available for Orange Peels Corporation. Sale of land $100,000 Sale of equipment 50,000 Issuance of common stock 70,000 Purchase of equipment 30,000 Payment of cash dividends 60,000 Net cash provided by investing activities is: a. $120,000. b. $130,000. c. $150,000. d. $190,000.

13. The following data are available for Something Strange! Increase in accounts payable $40,000 Increase in bonds payable 100,000 Sale of investment 50,000 Issuance of common stock 60,000 Payment of cash dividends 30,000 Net cash provided by financing activities is: a. $90,000. b. $130,000. c. $160,000. d. $170,000.

14. The statement of cash flows should not be used to eval- uate an entity’s ability to: a. earn net income. b. generate future cash flows. c. pay dividends. d. meet obligations.

15. Free cash flow provides an indication of a company’s ability to: a. generate net income. b. generate cash to pay dividends. c. generate cash to invest in new capital expenditures. d. Both (b) and (c).

*16. In a worksheet for the statement of cash flows, a decrease in accounts receivable is entered in the reconciling columns as a credit to Accounts Receivable and a debit in the: a. investing activities section. b. operating activities section. c. financing activities section. d. None of the above.

*17. In a worksheet for the statement of cash flows, a work- sheet entry that includes a credit to accumulated de- preciation will also include a: a. credit in the operating section and a debit in

another section. b. debit in the operating section. c. debit in the investing section. d. debit in the financing section.

Questions 18 and 19 apply only to the direct method. *18. The beginning balance in accounts receivable is

$44,000, the ending balance is $42,000, and sales during

(SO 2)

(SO 3)

(SO 4)

(SO 5)

(SO 6)

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Brief Exercises 651

the period are $129,000. What are cash receipts from customers? a. $127,000. b. $129,000. c. $131,000. d. $141,000.

*19. Which of the following items is reported on a cash flow statement prepared by the direct method?

a. Loss on sale of building. b. Increase in accounts receivable. c. Depreciation expense. d. Cash payments to suppliers.

Go to the book’s companion website, www.wiley.com/college/weygandt, for Additional Self-Study Questions. The Navigator✓

QUESTIONS

1. (a) What is a statement of cash flows? (b) John Norris maintains that the statement of cash

flows is an optional financial statement. Do you agree? Explain.

2. What questions about cash are answered by the statement of cash flows?

3. Distinguish among the three types of activities reported in the statement of cash flows.

4. (a) What are the major sources (inflows) of cash in a statement of cash flows?

(b) What are the major uses (outflows) of cash? 5. Why is it important to disclose certain noncash transac-

tions? How should they be disclosed? 6. Wilma Flintstone and Barny Rublestone were discussing

the format of the statement of cash flows of Hart Candy Co. At the bottom of Hart Candy’s statement of cash flows was a separate section entitled “Noncash investing and financing activities.” Give three examples of significant noncash transactions that would be reported in this section.

7. Why is it necessary to use comparative balance sheets, a current income statement, and certain transaction data in preparing a statement of cash flows?

8. Contrast the advantages and disadvantages of the direct and indirect methods of preparing the statement of cash flows. Are both methods acceptable? Which method is preferred by the FASB? Which method is more popular?

9. When the total cash inflows exceed the total cash outflows in the statement of cash flows, how and where is this ex- cess identified?

10. Describe the indirect method for determining net cash provided (used) by operating activities.

11. Why is it necessary to convert accrual-based net income to cash-basis income when preparing a statement of cash flows?

12. The president of Ferneti Company is puzzled. During the last year, the company experienced a net loss of $800,000, yet its cash increased $300,000 during the same period of time. Explain to the president how this could occur.

13. Identify five items that are adjustments to convert net in- come to net cash provided by operating activities under the indirect method.

14. Why and how is depreciation expense reported in a state- ment prepared using the indirect method?

15. Why is the statement of cash flows useful? 16. During 2011 Doubleday Company converted $1,700,000

of its total $2,000,000 of bonds payable into common stock. Indicate how the transaction would be reported on a statement of cash flows, if at all.

*17. Why is it advantageous to use a worksheet when prepar- ing a statement of cash flows? Is a worksheet required to prepare a statement of cash flows?

*18. Describe the direct method for determining net cash provided by operating activities.

*19. Give the formulas under the direct method for computing (a) cash receipts from customers and (b) cash payments to suppliers.

*20. Garcia Inc. reported sales of $2 million for 2011. Accounts receivable decreased $200,000 and accounts payable in- creased $300,000. Compute cash receipts from customers, assuming that the receivable and payable transactions related to operations.

*21. In the direct method, why is depreciation expense not re- ported in the cash flows from operating activities section?

22. In its 2008 statement of cash flows, what amount did PepsiCo report for net cash (a) provided by operating activities, (b) used for investing activities, and (c) used for financing activities?

BE13-1 Each of these items must be considered in preparing a statement of cash flows for Kiner Co. for the year ended December 31, 2011. For each item, state how it should be shown in the statement of cash flows for 2011.

(a) Issued bonds for $200,000 cash. (b) Purchased equipment for $150,000 cash. (c) Sold land costing $20,000 for $20,000 cash. (d) Declared and paid a $50,000 cash dividend.

BRIEF EXERCISES

Indicate statement presentation of selected transactions.

(SO 2)

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BE13-2 Classify each item as an operating, investing, or financing activity. Assume all items involve cash unless there is information to the contrary.

(a) Purchase of equipment. (d) Depreciation. (b) Sale of building. (e) Payment of dividends. (c) Redemption of bonds. (f) Issuance of capital stock.

BE13-3 The following T account is a summary of the cash account of Edmonds Company.

Cash (Summary Form)

Balance, Jan. 1 8,000 Receipts from customers 364,000 Payments for goods 200,000 Dividends on stock investments 6,000 Payments for operating expenses 140,000 Proceeds from sale of equipment 36,000 Interest paid 10,000 Proceeds from issuance of Taxes paid 8,000

bonds payable 300,000 Dividends paid 50,000

Balance, Dec. 31 306,000

What amount of net cash provided (used) by financing activities should be reported in the statement of cash flows?

BE13-4 Martinez, Inc. reported net income of $2.5 million in 2011. Depreciation for the year was $160,000, accounts receivable decreased $350,000, and accounts payable decreased $280,000. Compute net cash provided by operating activities using the indirect method.

BE13-5 The net income for Adcock Co. for 2011 was $280,000. For 2011 depreciation on plant assets was $70,000, and the company incurred a loss on sale of plant assets of $12,000. Compute net cash provided by operating activities under the indirect method.

BE13-6 The comparative balance sheets for Goltra Company show these changes in noncash current asset accounts: accounts receivable decrease $80,000, prepaid expenses increase $28,000, and inventories increase $30,000. Compute net cash provided by operating activities using the indirect method assuming that net income is $200,000.

BE13-7 The T accounts for Equipment and the related Accumulated Depreciation for Pettengill Company at the end of 2011 are shown here.

In addition, Pettengill Company’s income statement reported a loss on the sale of equip- ment of $4,500. What amount was reported on the statement of cash flows as “cash flow from sale of equipment”?

BE13-8 In a recent year, Cypress Semiconductor Corporation reported cash provided by operating activities of $155,793,000, cash used in investing of $207,826,000, and cash used in financing of $33,372,000. In addition, cash spent for fixed assets during the period was $132,280,000. No dividends were paid. Calculate free cash flow.

BE13-9 Lott Corporation reported cash provided by operating activities of $360,000, cash used by investing activities of $250,000, and cash provided by financing activities of $70,000. In addition, cash spent for capital assets during the period was $200,000. No dividends were paid. Calculate free cash flow.

BE13-10 In a recent quarter, Alliance Atlantis Communications Inc. reported cash provided by operating activities of $45,600,000 and revenues of $264,800,000. Cash spent on plant asset ad- ditions during the quarter was $1,600,000. Calculate free cash flow.

BE13-11 The management of Radar Inc. is trying to decide whether it can increase its divi- dend. During the current year it reported net income of $875,000. It had cash provided by oper- ating activities of $734,000, paid cash dividends of $70,000, and had capital expenditures of $280,000. Compute the company’s free cash flow, and discuss whether an increase in the dividend appears warranted. What other factors should be considered?

Equipment Accumulated Depreciation

Beg. bal. 80,000 Disposals 22,000 Disposals 5,500 Beg. bal. 44,500 Acquisitions 41,600 Depr. exp. 12,000

End. bal. 99,600 End. bal. 51,000

Classify items by activities.

(SO 2)

Identify financing activity transactions.

(SO 2)

Compute cash provided by operating activities—indirect method.

(SO 3)

Compute cash provided by operating activities—indirect method.

(SO 3)

Compute net cash provided by operating activities—indirect method.

(SO 3)

Determine cash received from sale of equipment.

(SO 3)

Calculate free cash flow.

(SO 4)

Calculate free cash flow.

(SO 4)

Calculate free cash flow.

(SO 4)

Calculate and analyze free cash flow.

(SO 4)

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Do it! Review 653

*BE13-12 During the year, prepaid expenses decreased $6,600, and accrued expenses increased $2,400. Indicate how the changes in prepaid expenses and accrued expenses payable should be entered in the reconciling columns of a worksheet. Assume that beginning balances were: Prepaid expenses $18,600 and Accrued expenses payable $8,200.

*BE13-13 Columbia Sportswear Company had accounts receivable of $206,024,000 at the be- ginning of a recent year, and $267,653,000 at year-end. Sales revenues were $1,095,307,000 for the year. What is the amount of cash receipts from customers?

*BE13-14 Young Corporation reported income taxes of $340,000,000 on its 2011 income state- ment and income taxes payable of $277,000,000 at December 31, 2010, and $522,000,000 at December 31, 2011. What amount of cash payments were made for income taxes during 2011?

*BE13-15 Flynn Corporation reports operating expenses of $80,000 excluding depreciation expense of $15,000 for 2011. During the year prepaid expenses decreased $6,600 and accrued expenses payable increased $4,400. Compute the cash payments for operating expenses in 2011.

Compute receipts from customers—direct method.

(SO 6)

Indicate entries in worksheet.

(SO 5)

Compute cash payments for income taxes—direct method.

(SO 6)

Compute cash payments for operating expenses—direct method.

(SO 6)

13-1 Rapture Corporation had the following transactions.

1. Issued $200,000 of bonds payable. 2. Paid utilities expense. 3. Issued 500 shares of preferred stock for $45,000. 4. Sold land and a building for $250,000. 5. Lent $30,000 to Dead End Corporation, receiving Dead End’s 1-year, 12% note.

Classify each of these transactions by type of cash flow activity (operating, investing, or financing).

13-2 JMB Photography reported net income of $100,000 for 2011. Included in the income statement were depreciation expense of $6,000, patent amortization expense of $2,000, and a gain on sale of equipment of $3,600. JMB’s comparative balance sheets show the follow- ing balances.

12/31/10 12/31/11

Accounts receivable $27,000 $21,000 Accounts payable 6,000 9,200

Calculate net cash provided by operating activities for JMB Photography

13-3 Grinders Corporation issued the following statement of cash flows for 2011.

GRINDERS CORPORATION Statement of Cash Flows—Indirect Method

For the Year Ended December 31, 2011

Cash flows from operating activities Net income $59,000 Adjustments to reconcile net income to net cash

provided by operating activities: Depreciation expense $9,100 Loss on sale of equipment 3,300 Decrease in accounts receivable 9,500 Increase in inventory (5,000) Decrease in accounts payable (2,200) 14,700

Net cash provided by operating activities 73,700 Cash flows from investing activities

Sale of investments 3,100 Purchase of equipment (27,000)

Net cash used by investing activities (23,900)

Do it!

ReviewDo it! Classify transactions by type of cash flow activity.

(SO 2)

Calculate net cash from operating activities.

(SO 3)

Compute and discuss free cash flow.

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Cash flows from financing activities Issuance of stock 20,000 Payment on long-term note payable (10,000) Payment for dividends (15,000)

Net cash used by financing activities (5,000)

Net increase in cash 44,800 Cash at beginning of year 13,000

Cash at end of year $57,800

(a) Compute free cash flow for Grinders Corporation. (b) Explain why free cash flow often provides better information than “Net cash provided by operating activities.”

E13-1 Pioneer Corporation had these transactions during 2011.

(a) Issued $50,000 par value common stock for cash. (b) Purchased a machine for $30,000, giving a long-term note in exchange. (c) Issued $200,000 par value common stock upon conversion of bonds having a face value of

$200,000. (d) Declared and paid a cash dividend of $18,000. (e) Sold a long-term investment with a cost of $15,000 for $15,000 cash. (f) Collected $16,000 of accounts receivable. (g) Paid $18,000 on accounts payable.

Instructions Analyze the transactions and indicate whether each transaction resulted in a cash flow from operating activities, investing activities, financing activities, or noncash investing and financing activities.

E13-2 An analysis of comparative balance sheets, the current year’s income statement, and the general ledger accounts of Gagliano Corp. uncovered the following items. Assume all items involve cash unless there is information to the contrary.

(a) Payment of interest on notes payable. (b) Exchange of land for patent. (c) Sale of building at book value. (d) Payment of dividends. (e) Depreciation. (f) Receipt of dividends on investment in

stock. (g) Receipt of interest on notes receivable.

EXERCISES

(h) Issuance of capital stock. (i) Amortization of patent. (j) Issuance of bonds for land. (k) Purchase of land. (l) Conversion of bonds into common stock. (m) Loss on sale of land. (n) Retirement of bonds.

Instructions Indicate how each item should be classified in the statement of cash flows using these four major classifications: operating activity (indirect method), investing activity, financing activity, and sig- nificant noncash investing and financing activity.

E13-3 Rachael Ray Corporation had the following transactions.

1. Sold land (cost $12,000) for $15,000. 2. Issued common stock for $20,000. 3. Recorded depreciation of $17,000. 4. Paid salaries of $9,000. 5. Issued 1,000 shares of $1 par value common stock for equipment worth $8,000. 6. Sold equipment (cost $10,000, accumulated depreciation $7,000) for $1,200.

Instructions For each transaction above, (a) prepare the journal entry, and (b) indicate how it would affect the statement of cash flows.

Classify transactions by type of activity.

(SO 2)

Classify transactions by type of activity.

(SO 2)

Prepare journal entry and determine effect on cash flows.

(SO 2)

654 Chapter 13 Statement of Cash Flows

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Exercises 655

E13-4 Villa Company reported net income of $195,000 for 2011. Villa also reported deprecia- tion expense of $45,000 and a loss of $5,000 on the sale of equipment. The comparative balance sheet shows a decrease in accounts receivable of $15,000 for the year, a $17,000 increase in accounts payable, and a $4,000 decrease in prepaid expenses.

Instructions Prepare the operating activities section of the statement of cash flows for 2011. Use the indirect method.

E13-5 The current sections of Bellinham Inc.’s balance sheets at December 31, 2010 and 2011, are presented here.

Bellinham’s net income for 2011 was $153,000. Depreciation expense was $24,000.

Prepare the operating activities section—indirect method.

(SO 3)

Prepare the operating activities section—indirect method.

(SO 3)

Equipment

Date Debit Credit Balance

Jan. 1 Balance 160,000 July 31 Purchase of equipment 70,000 230,000 Sept. 2 Cost of equipment constructed 53,000 283,000 Nov. 10 Cost of equipment sold 49,000 234,000

Accumulated Depreciation—Equipment

Date Debit Credit Balance

Jan. 1 Balance 71,000 Nov. 10 Accumulated depreciation on

equipment sold 30,000 41,000 Dec. 31 Depreciation for year 28,000 69,000

Retained Earnings

Date Debit Credit Balance

Jan. 1 Balance 105,000 Aug. 23 Dividends (cash) 14,000 91,000 Dec. 31 Net income 67,000 158,000

2011 2010

Current assets Cash $105,000 $ 99,000 Accounts receivable 110,000 89,000 Inventory 158,000 172,000 Prepaid expenses 27,000 22,000

Total current assets $400,000 $382,000

Current liabilities Accrued expenses payable $ 15,000 $ 5,000 Accounts payable 85,000 92,000

Total current liabilities $100,000 $ 97,000

Instructions Prepare the net cash provided by operating activities section of the company’s statement of cash flows for the year ended December 31, 2011, using the indirect method.

E13-6 The three accounts shown below appear in the general ledger of Cesar Corp. during 2011.

Instructions From the postings in the accounts, indicate how the information is reported on a statement of cash flows using the indirect method. The loss on sale of equipment was $5,000. (Hint: Cost of equipment constructed is reported in the investing activities section as a decrease in cash of $53,000.)

Prepare partial statement of cash flows—indirect method.

(SO 3)

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E13-7 Scully Corporation’s comparative balance sheets are presented below.Prepare statement of cash flows and compute free cash flow.

(SO 3, 4)

Additional information:

1. Net income was $22,630. Dividends declared and paid were $19,500. 2. All other changes in noncurrent account balances had a direct effect on cash flows, except the

change in accumulated depreciation. The land was sold for $4,900.

Instructions (a) Prepare a statement of cash flows for 2011 using the indirect method. (b) Compute free cash flow.

E13-8 Here are comparative balance sheets for Taguchi Company.

SCULLY CORPORATION Comparative Balance Sheets

December 31

2011 2010

Cash $ 14,300 $ 10,700 Accounts receivable 21,200 23,400 Land 20,000 26,000 Building 70,000 70,000 Accumulated depreciation (15,000) (10,000)

Total $110,500 $120,100

Accounts payable $12,370 $31,100 Common stock 75,000 69,000 Retained earnings 23,130 20,000

Total $110,500 $120,100

TAGUCHI COMPANY Comparative Balance Sheets

December 31

Assets 2011 2010

Cash $ 73,000 $ 22,000 Accounts receivable 85,000 76,000 Inventories 170,000 189,000 Land 75,000 100,000 Equipment 260,000 200,000 Accumulated depreciation (66,000) (32,000)

Total $597,000 $555,000

Liabilities and Stockholders’ Equity

Accounts payable $ 39,000 $ 47,000 Bonds payable 150,000 200,000 Common stock ($1 par) 216,000 174,000 Retained earnings 192,000 134,000

Total $597,000 $555,000

Additional information:

1. Net income for 2011 was $103,000. 2. Cash dividends of $45,000 were declared and paid. 3. Bonds payable amounting to $50,000 were redeemed for cash $50,000. 4. Common stock was issued for $42,000 cash. 5. No equipment was sold during 2011, but land was sold at cost.

Prepare a statement of cash flows—indirect method.

(SO 3)

656 Chapter 13 Statement of Cash Flows

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Exercises 657

Instructions Prepare a statement of cash flows for 2011 using the indirect method.

E13-9 Muldur Corporation’s comparative balance sheets are presented below.

EDDIE MURPHY COMPANY Comparative Balance Sheets

December 31 Assets 2011 2010

Cash $ 63,000 $ 22,000 Accounts receivable 85,000 76,000 Inventories 180,000 189,000 Land 75,000 100,000 Equipment 260,000 200,000 Accumulated depreciation (66,000) (42,000)

Total $597,000 $545,000

Liabilities and Stockholders’ Equity

Accounts payable $ 34,000 $ 47,000 Bonds payable 150,000 200,000 Common stock ($1 par) 214,000 164,000 Retained earnings 199,000 134,000

Total $597,000 $545,000

MULDUR CORPORATION Comparative Balance Sheets

December 31

2011 2010

Cash $ 15,200 $ 17,700 Accounts receivable 25,200 22,300 Investments 20,000 16,000 Equipment 60,000 70,000 Accumulated depreciation (14,000) (10,000)

Total $106,400 $116,000

Accounts payable $ 14,600 $ 11,100 Bonds payable 10,000 30,000 Common stock 50,000 45,000 Retained earnings 31,800 29,900

Total $106,400 $116,000

Additional information:

1. Net income was $18,300. Dividends declared and paid were $16,400. 2. Equipment which cost $10,000 and had accumulated depreciation of $1,200 was sold for

$3,300. 3. All other changes in noncurrent account balances had a direct effect on cash flows, except

the change in accumulated depreciation.

Instructions (a) Prepare a statement of cash flows for 2011 using the indirect method. (b) Compute free cash flow.

*E13-10 Comparative balance sheets for Eddie Murphy Company are presented below.

Additional information:

1. Net income for 2011 was $125,000. 2. Cash dividends of $60,000 were declared and paid.

Prepare statement of cash flows and compute free cash flow.

(SO 3, 4)

Prepare a worksheet.

(SO 5)

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3. Bonds payable amounting to $50,000 were redeemed for cash $50,000. 4. Common stock was issued for $50,000 cash. 5. Depreciation expense was $24,000. 6. Sales for the year were $978,000.

Instructions Prepare a worksheet for a statement of cash flows for 2011 using the indirect method. Enter the reconciling items directly on the worksheet, using letters to cross-reference each entry.

*E13-11 Hairston Company completed its first year of operations on December 31, 2011. Its initial income statement showed that Hairston had revenues of $192,000 and operating expenses of $78,000. Accounts receivable and accounts payable at year-end were $60,000 and $23,000, re- spectively. Assume that accounts payable related to operating expenses. Ignore income taxes.

Instructions Compute net cash provided by operating activities using the direct method.

*E13-12 A recent income statement for McDonald’s Corporation shows cost of goods sold $4,852.7 million and operating expenses (including depreciation expense of $1,201 million) $10,671.5 million. The comparative balance sheet for the year shows that inventory increased $18.1 million, prepaid expenses increased $56.3 million, accounts payable (merchandise suppli- ers) increased $136.9 million, and accrued expenses payable increased $160.9 million.

Instructions Using the direct method, compute (a) cash payments to suppliers and (b) cash payments for operating expenses.

*E13-13 The 2011 accounting records of Verlander Transport reveal these transactions and events.

Payment of interest $ 10,000 Collection of accounts receivable $182,000 Cash sales 48,000 Payment of salaries and wages 53,000 Receipt of dividend revenue 18,000 Depreciation expense 16,000 Payment of income taxes 12,000 Proceeds from sale of vehicles 12,000 Net income 38,000 Purchase of equipment for cash 22,000 Payment of accounts payable Loss on sale of vehicles 3,000

for merchandise 115,000 Payment of dividends 14,000 Payment for land 74,000 Payment of operating expenses 28,000

Instructions Prepare the cash flows from operating activities section using the direct method. (Not all of the items will be used.)

*E13-14 The following information is taken from the 2011 general ledger of Pierzynski Company.

Rent Rent expense $ 40,000 Prepaid rent, January 1 5,900 Prepaid rent, December 31 9,000

Salaries Salaries expense $ 54,000 Salaries payable, January 1 10,000 Salaries payable, December 31 8,000

Sales Revenue from sales $170,000 Accounts receivable, January 1 16,000 Accounts receivable, December 31 7,000

Instructions In each case, compute the amount that should be reported in the operating activities section of the statement of cash flows under the direct method.

Compute cash provided by operating activities—direct method.

(SO 6)

Visit the book’s companion website at www.wiley.com/college/weygandt, and choose the Student Companion site, to access Exercise Set B and a set of Challenge Exercises.

EXERCISES: SET B AND CHALLENGE EXERCISES ww w

.wiley.com

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Calculate cash flows—direct method.

(SO 6)

Compute cash payments— direct method.

(SO 6)

Compute cash flow from oper- ating activities—direct method.

(SO 6)

658 Chapter 13 Statement of Cash Flows

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Problems: Set A 659

Instructions Complete the table indicating whether each item (1) should be reported as an operating (O) ac- tivity, investing (I) activity, financing (F) activity, or as a noncash (NC) transaction reported in a separate schedule; and (2) represents a cash inflow or cash outflow or has no cash flow effect. Assume use of the indirect approach.

P13-2A The following account balances relate to the stockholders’ equity accounts of Gore Corp. at year-end.

Cash Inflow, Where Reported Outflow, or

Transaction on Statement No Effect?

(a) Recorded depreciation expense on the plant assets.

(b) Recorded and paid interest expense. (c) Recorded cash proceeds from a sale of

plant assets. (d) Acquired land by issuing common stock. (e) Paid a cash dividend to preferred

stockholders. (f) Distributed a stock dividend to common

stockholders. (g) Recorded cash sales. (h) Recorded sales on account. (i) Purchased inventory for cash. (j) Purchased inventory on account.

P13-1A You are provided with the following transactions that took place during a recent fiscal year.

PROBLEMS: SET A

A small stock dividend was declared and issued in 2011. The market value of the shares was $10,500. Cash dividends were $15,000 in both 2011 and 2010. The common stock has no par or stated value.

Instructions (a) What was the amount of net income reported by Gore Corp. in 2011? (b) Determine the amounts of any cash inflows or outflows related to the common stock and

dividend accounts in 2011. (c) Indicate where each of the cash inflows or outflows identified in (b) would be classified on

the statement of cash flows.

P13-3A The income statement of Elbert Company is presented here.

(a) Net income $65,500

2011 2010

Common stock, 10,500 and 10,000 shares, respectively, for 2011 and 2010 $160,000 $140,000

Preferred stock, 5,000 shares 125,000 125,000 Retained earnings 300,000 260,000

ELBERT COMPANY Income Statement

For the Year Ended November 30, 2011

Sales $7,700,000 Cost of goods sold

Beginning inventory $1,900,000 Purchases 4,400,000

Goods available for sale 6,300,000 Ending inventory 1,400,000

Distinguish among operating, investing, and financing activities.

(SO 2)

Determine cash flow effects of changes in equity accounts.

(SO 3)

Prepare the operating activities section—indirect method.

(SO 3)

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Additional information:

1. Accounts receivable increased $250,000 during the year, and inventory decreased $500,000. 2. Prepaid expenses increased $150,000 during the year. 3. Accounts payable to suppliers of merchandise decreased $340,000 during the year. 4. Accrued expenses payable decreased $100,000 during the year. 5. Operating expenses include depreciation expense of $90,000.

Instructions Prepare the operating activities section of the statement of cash flows for the year ended November 30, 2011, for Elbert Company, using the indirect method.

*P13-4A Data for Elbert Company are presented in P13-3A.

Instructions Prepare the operating activities section of the statement of cash flows using the direct method.

P13-5A Grania Company’s income statement contained the condensed information below.

Cash from operations $1,400,000

Cash from operations $308,000

Grania’s balance sheet contained the comparative data at December 31, shown below.

GRANIA COMPANY Income Statement

For the Year Ended December 31, 2011

Revenues $970,000 Operating expenses, excluding depreciation $624,000 Depreciation expense 60,000 Loss on sale of equipment 16,000 700,000

Income before income taxes 270,000 Income tax expense 40,000

Net income $230,000

2011 2010

Accounts receivable $75,000 $60,000 Accounts payable 41,000 28,000 Income taxes payable 11,000 7,000

Cost of goods sold 4,900,000

Gross profit 2,800,000 Operating expenses 1,150,000

Net income $1,650,000

Accounts payable pertain to operating expenses.

Instructions Prepare the operating activities section of the statement of cash flows using the indirect method.

*P13-6A Data for Grania Company are presented in P13-5A.

Instructions Prepare the operating activities section of the statement of cash flows using the direct method.

Prepare the operating activities section—direct method.

(SO 6)

Prepare the operating activities section—indirect method.

(SO 3)

Prepare the operating activities section—direct method.

(SO 6)

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Problems: Set A 661

Additional data:

1. Dividends declared and paid were $25,000. 2. During the year equipment was sold for $8,500 cash. This equipment cost $18,000 originally

and had a book value of $8,500 at the time of sale. 3. All depreciation expense, $14,500, is in the operating expenses. 4. All sales and purchases are on account.

Instructions (a) Prepare a statement of cash flows using the indirect method. (b) Compute free cash flow.

P13-8A Data for Weller Company are presented in P13-7A. Further analysis reveals the following.

1. Accounts payable pertain to merchandise suppliers. 2. All operating expenses except for depreciation were paid in cash.

Instructions (a) Prepare a statement of cash flows for Weller Company using the direct method. (b) Compute free cash flow.

WELLER COMPANY Income Statement

For the Year Ended December 31, 2011

Sales $242,000 Cost of goods sold 175,000

Gross profit 67,000 Operating expenses 24,000

Income from operations 43,000 Interest expense 3,000

Income before income taxes 40,000 Income tax expense 8,000

Net income $ 32,000

WELLER COMPANY Comparative Balance Sheets

December 31

Assets 2011 2010

Cash $ 35,000 $ 20,000 Accounts receivable 33,000 14,000 Merchandise inventory 27,000 20,000 Property, plant, and equipment 60,000 78,000 Accumulated depreciation (29,000) (24,000)

Total $126,000 $108,000

Liabilities and Stockholders’ Equity

Accounts payable $ 29,000 $ 15,000 Income taxes payable 7,000 8,000 Bonds payable 27,000 33,000 Common stock 18,000 14,000 Retained earnings 45,000 38,000

Total $126,000 $108,000

(a) Cash from operations $33,500

Prepare a statement of cash flows—indirect method, and compute free cash flow.

(SO 3, 4)

Prepare a statement of cash flows—direct method, and compute free cash flow.

(SO 4, 6)

P13-7A Presented below are the financial statements of Weller Company.

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P13-9A Condensed financial data of Arma Inc. follow.

ARMA INC. Income Statement

For the Year Ended December 31, 2011

Sales $392,780 Less:

Cost of goods sold $135,460 Operating expenses, excluding

depreciation 12,410 Depreciation expense 46,500 Income taxes 27,280 Interest expense 4,730 Loss on sale of plant assets 7,500 233,880

Net income $158,900

ARMA INC. Comparative Balance Sheets

December 31

Assets 2011 2010

Cash $ 90,800 $ 48,400 Accounts receivable 92,800 33,000 Inventories 112,500 102,850 Prepaid expenses 28,400 26,000 Investments 138,000 114,000 Plant assets 270,000 242,500 Accumulated depreciation (50,000) (52,000)

Total $682,500 $514,750

Liabilities and Stockholders’ Equity

Accounts payable $112,000 $ 67,300 Accrued expenses payable 16,500 17,000 Bonds payable 110,000 150,000 Common stock 220,000 175,000 Retained earnings 224,000 105,450

Total $682,500 $514,750

Additional information:

1. New plant assets costing $85,000 were purchased for cash during the year. 2. Old plant assets having an original cost of $57,500 were sold for $1,500 cash. 3. Bonds matured and were paid off at face value for cash. 4. A cash dividend of $40,350 was declared and paid during the year.

Instructions Prepare a statement of cash flows using the indirect method.

*P13-10A Data for Arma Inc. are presented in P13-9A. Further analysis reveals that accounts payable pertain to merchandise creditors.

Instructions Prepare a statement of cash flows for Arma Inc. using the direct method.

P13-11A The comparative balance sheets for Ramirez Company as of December 31 are presented on the next page.

Cash from operations $185,250

Prepare a statement of cash flows—indirect method.

(SO 3)

Prepare a statement of cash flows—direct method.

(SO 6)

Prepare a statement of cash flows—indirect method.

(SO 3)

662 Chapter 13 Statement of Cash Flows

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Problems: Set A 663

Additional information:

1. Operating expenses include depreciation expense of $42,000 and charges from prepaid ex- penses of $5,720.

2. Land was sold for cash at book value. 3. Cash dividends of $15,000 were paid. 4. Net income for 2011 was $37,000. 5. Equipment was purchased for $95,000 cash. In addition, equipment costing $22,000 with a

book value of $10,000 was sold for $6,000 cash. 6. Bonds were converted at face value by issuing 40,000 shares of $1 par value common stock.

Instructions Prepare a statement of cash flows for the year ended December 31, 2011, using the indirect method.

*P13-12A Condensed financial data of Oprah Company appear below.

OPRAH COMPANY Comparative Balance Sheets

December 31

Assets 2011 2010

Cash $ 92,700 $ 47,250 Accounts receivable 90,800 57,000 Inventories 121,900 102,650 Investments 84,500 87,000 Plant assets 250,000 205,000 Accumulated depreciation (49,500) (40,000)

$590,400 $458,900

Liabilities and Stockholders’ Equity

Accounts payable $ 57,700 $ 48,280 Accrued expenses payable 12,100 18,830 Bonds payable 100,000 70,000 Common stock 250,000 200,000 Retained earnings 170,600 121,790

$590,400 $458,900

RAMIREZ COMPANY Comparative Balance Sheets

December 31

Assets 2011 2010

Cash $ 71,000 $ 45,000 Accounts receivable 44,000 62,000 Inventory 151,450 142,000 Prepaid expenses 15,280 21,000 Land 105,000 130,000 Equipment 228,000 155,000 Accumulated depreciation—equipment (45,000) (35,000) Building 200,000 200,000 Accumulated depreciation—building (60,000) (40,000)

Total $709,730 $680,000

Liabilities and Stockholders’ Equity

Accounts payable $ 47,730 $ 40,000 Bonds payable 260,000 300,000 Common stock, $1 par 200,000 160,000 Retained earnings 202,000 180,000

Total $709,730 $680,000

Cash from operations $105,000

Prepare a worksheet—indirect method.

(SO 5)

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Additional information:

1. New plant assets costing $92,000 were purchased for cash during the year. 2. Investments were sold at cost. 3. Plant assets costing $47,000 were sold for $15,550, resulting in gain of $8,750. 4. A cash dividend of $83,400 was declared and paid during the year.

Instructions Prepare a worksheet for the statement of cash flows using the indirect method. Enter the recon- ciling items directly in the worksheet columns, using letters to cross-reference each entry.

OPRAH COMPANY Income Statement

For the Year Ended December 31, 2011

Sales $297,500 Gain on sale of plant assets 8,750

306,250 Less:

Cost of goods sold $99,460 Operating expenses (excluding

depreciation expense) 14,670 Depreciation expense 49,700 Income taxes 7,270 Interest expense 2,940 174,040

Net income $132,210

Cash Inflow, Where Reported Outflow, or

Transaction on Statement No Effect?

(a) Recorded depreciation expense on the plant assets.

(b) Incurred a loss on disposal of plant assets. (c) Acquired a building by paying cash. (d) Made principal repayments on a

mortgage. (e) Issued common stock. (f) Purchased shares of another company

to be held as a long-term equity investment.

(g) Paid dividends to common stockholders. (h) Sold inventory on credit. The company

uses a perpetual inventory system. (i) Purchased inventory on credit. (j) Paid wages to employees.

Reconciling items total $610,210

P13-1B You are provided with the following transactions that took place during a recent fiscal year.

PROBLEMS: SET B

Distinguish among operating, investing, and financing activities.

(SO 2)

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Problems: Set B 665

P13-2B The following selected account balances relate to the plant asset accounts of Wegent Inc. at year-end.

2011 2010

Accumulated depreciation—buildings $337,500 $300,000 Accumulated depreciation—equipment 144,000 96,000 Buildings 750,000 750,000 Depreciation expense 101,500 85,500 Equipment 300,000 240,000 Land 100,000 70,000 Loss on sale of equipment 8,000 0

ROSENTHAL COMPANY Income Statement

For the Year Ended December 31, 2011

Sales $5,400,000 Cost of goods sold

Beginning inventory $1,780,000 Purchases 3,430,000

Goods available for sale 5,210,000 Ending inventory 1,900,000

Cost of goods sold 3,310,000

Gross profit 2,090,000 Operating expenses

Depreciation expense 105,000 Amortization expense 20,000 Other expenses 945,000 1,070,000

Net income $1,020,000

Additional information:

1. Wegent purchased $95,000 of equipment and $30,000 of land for cash in 2011. 2. Wegent also sold equipment in 2011. 3. Depreciation expense in 2011 was $37,500 on building and $64,000 on equipment.

Instructions (a) Determine the amounts of any cash inflows or outflows related to the plant asset accounts in

2011. (b) Indicate where each of the cash inflows or outflows identified in (a) would be classified on

the statement of cash flows.

P13-3B The income statement of Rosenthal Company is presented below.

Additional information:

1. Accounts receivable decreased $320,000 during the year, and inventory increased $120,000. 2. Prepaid expenses increased $175,000 during the year. 3. Accounts payable to merchandise suppliers increased $50,000 during the year. 4. Accrued expenses payable increased $155,000 during the year.

(a) Cash proceeds $11,000

Instructions Prepare the operating activities section of the statement of cash flows for the year ended December 31, 2011, for Rosenthal Company, using the indirect method.

*P13-4B Data for Rosenthal Company are presented in P13-3B.

Instructions Prepare the operating activities section of the statement of cash flows using the direct method.

Cash from operations $1,375,000

Determine cash flow effects of changes in plant asset accounts.

(SO 3)

Prepare the operating activities section—indirect method.

(SO 3)

Prepare the operating activities section—direct method.

(SO 6)

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P13-5B The income statement of Brislin Inc. reported the following condensed information.

BRISLIN INC. Income Statement

For the Year Ended December 31, 2011

Revenues $545,000 Operating expenses 400,000

Income from operations 145,000 Income tax expense 36,000

Net income $109,000

2011 2010

Accounts receivable $50,000 $70,000 Accounts payable 30,000 51,000 Income taxes payable 10,000 4,000

ORTEGA COMPANY Comparative Balance Sheets

December 31

Assets 2011 2010

Cash $ 24,000 $ 33,000 Accounts receivable 25,000 14,000 Merchandise inventory 41,000 25,000 Property, plant, and equipment $ 70,000 $ 78,000 Less: Accumulated depreciation 27,000 43,000 24,000 54,000

Total $133,000 $126,000

Liabilities and Stockholders’ Equity

Accounts payable $ 31,000 $ 43,000 Income taxes payable 24,000 20,000 Bonds payable 20,000 10,000 Common stock 25,000 25,000 Retained earnings 33,000 28,000

Total $133,000 $126,000

ORTEGA COMPANY Income Statement

For the Year Ended December 31, 2011

Sales $286,000 Cost of goods sold 204,000

Gross profit 82,000

Brislin’s balance sheet contained these comparative data at December 31.

Brislin has no depreciable assets. Accounts payable pertain to operating expenses.

Instructions Prepare the operating activities section of the statement of cash flows using the indirect method.

*P13-6B Data for Brislin Inc. are presented in P13-5B.

Instructions Prepare the operating activities section of the statement of cash flows using the direct method.

P13-7B Presented below are the financial statements of Ortega Company.

Cash from operations $114,000

Prepare the operating activities section—indirect method.

(SO 3)

Prepare the operating activities section—direct method.

(SO 6)

Prepare a statement of cash flows—indirect method, and compute free cash flow.

(SO 3, 4)

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Problems: Set B 667

Operating expenses 37,000

Income from operations 45,000 Interest expense 7,000

Income before income taxes 38,000 Income tax expense 10,000

Net income $ 28,000

ZIEBERT COMPANY Comparative Balance Sheets

December 31

Assets 2011 2010

Cash $102,700 $ 33,400 Accounts receivable 60,800 37,000 Inventories 126,900 102,650 Investments 79,500 107,000 Plant assets 315,000 205,000 Accumulated depreciation (44,500) (40,000)

Total $640,400 $445,050

Liabilities and Stockholders’ Equity

Accounts payable $ 57,700 $ 48,280 Accrued expenses payable 15,100 18,830 Bonds payable 145,000 70,000 Common stock 250,000 200,000 Retained earnings 172,600 107,940

Total $640,400 $445,050

ZIEBERT COMPANY Income Statement

For the Year Ended December 31, 2011

Sales $297,500 Gain on sale of plant assets 5,000

302,500

Prepare a statement of cash flows—direct method, and compute free cash flow.

(SO 4, 6)

Additional data:

1. Dividends of $23,000 were declared and paid. 2. During the year equipment was sold for $10,000 cash. This equipment cost $15,000 originally

and had a book value of $10,000 at the time of sale. 3. All depreciation expense, $8,000, is in the operating expenses. 4. All sales and purchases are on account. 5. Additional equipment was purchased for $7,000 cash.

Instructions (a) Prepare a statement of cash flows using the indirect method. (b) Compute free cash flow.

*P13-8B Data for Ortega Company are presented in P13-7B. Further analysis reveals the following.

1. Accounts payable pertains to merchandise creditors. 2. All operating expenses except for depreciation are paid in cash.

Instructions (a) Prepare a statement of cash flows using the direct method. (b) Compute free cash flow.

P13-9B Condensed financial data of Ziebert Company are shown below.

(a) Cash from operations $1,000

Prepare a statement of cash flows—indirect method.

(SO 3)

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Additional information:

1. New plant assets costing $146,000 were purchased for cash during the year. 2. Investments were sold at cost. 3. Plant assets costing $36,000 were sold for $15,000, resulting in a gain of $5,000. 4. A cash dividend of $48,000 was declared and paid during the year.

Instructions Prepare a statement of cash flows using the indirect method.

*P13-10B Data for Ziebert Company are presented in P13-9B. Further analysis reveals that accounts payable pertain to merchandise creditors.

Instructions Prepare a statement of cash flows for Ziebert Company using the direct method.

P13-11B Presented below are the comparative balance sheets for Marin Company at December 31.

Less: Cost of goods sold $99,460 Operating expenses, excluding

depreciation expense 19,670 Depreciation expense 30,500 Income taxes 37,270 Interest expense 2,940 189,840

Net income $112,660

MARIN COMPANY Comparative Balance Sheets

December 31

Assets 2011 2010

Cash $ 41,000 $ 57,000 Accounts receivable 77,000 64,000 Inventory 172,000 140,000 Prepaid expenses 12,140 16,540 Land 110,000 150,000 Equipment 215,000 175,000 Accumulated depreciation—equipment (70,000) (42,000) Building 250,000 250,000 Accumulated depreciation—building (70,000) (50,000)

Total $737,140 $760,540

Liabilities and Stockholders’ Equity

Accounts payable $ 58,000 $ 45,000 Bonds payable 235,000 265,000 Common stock, $1 par 280,000 250,000 Retained earnings 164,140 200,540

Total $737,140 $760,540

Cash from operations $95,800

Additional information:

1. Operating expenses include depreciation expense $55,000 and charges from prepaid expenses of $4,400.

2. Land was sold for cash at cost. 3. Cash dividends of $84,290 were paid. 4. Net income for 2011 was $47,890. 5. Equipment was purchased for $80,000 cash. In addition, equipment costing $40,000 with a

book value of $33,000 was sold for $37,000 cash. 6. Bonds were converted at face value by issuing 30,000 shares of $1 par value common stock.

Instructions Prepare a statement of cash flows for 2011 using the indirect method.

Cash from operations $71,290

Prepare a statement of cash flows—direct method.

(SO 6)

Prepare a statement of cash flows—indirect method.

(SO 3)

668 Chapter 13 Statement of Cash Flows

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Financial Reporting Problem: PepsiCo, Inc. BYP13-1 Refer to the financial statements of PepsiCo’s, presented in Appendix A, and answer the following questions.

(a) What was the amount of net cash provided by operating activities for the year ended December 27, 2008? For the year ended December 29, 2007?

(b) What was the amount of increase or decrease in cash and cash equivalents for the year ended December 27, 2008? For the year ended December 29, 2007?

(c) Which method of computing net cash provided by operating activities does PepsiCo use? (d) From your analysis of the 2008 statement of cash flows, did the change in accounts and notes

receivable require or provide cash? Did the change in inventories require or provide cash? Did the change in accounts payable and other current liabilities require or provide cash?

(e) What was the net outflow or inflow of cash from investing activities for the year ended December 27, 2008?

(f) What was the amount of interest paid in the year ended December 27, 2008? What was the amount of income taxes paid in the year ended December 27, 2008? (See Note 14.)

Comparative Analysis Problem: PepsiCo, Inc. vs. The Coca-Cola Company BYP13-2 PepsiCo’s financial statements are presented in Appendix A. Financial statements of The Coca-Cola Company are presented in Appendix B.

Instructions (a) Based on the information contained in these financial statements, compute free cash flow for

each company. (b) What conclusions concerning the management of cash can be drawn from these data?

Exploring the Web BYP13-3 Purpose: Learn about the SEC.

Address: www.sec.gov/index.html, or go to www.wiley.com/college/weygandt

From the SEC homepage, choose About the SEC.

FINANCIAL REPORTING AND ANALYSIS

B R O A D E N I N G Y O U R P E R S P E C T I V E

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Broadening Your Perspective 669

Visit the book’s companion website at www.wiley.com/college/weygandt and choose the Student Companion site to access Problem Set C.

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(Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 12.)

CCC13 Natalie has prepared the balance sheet and income statement of Cookie & Coffee Creations Inc. and would like you to prepare the cash flow statement.

CONTINUING COOKIE CHRONICLE

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Go to the book’s companion website, www.wiley.com/college/weygandt, to see the completion of this problem.

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670 Chapter 13 Statement of Cash Flows

Instructions Answer the following questions.

(a) How many enforcement actions does the SEC take each year against securities law violators? What are typical infractions?

(b) Congress passed the Securities Acts of 1933 and 1934 to improve investor confidence in the markets. What two “common sense” notions are these laws based on?

(c) Who was the President of the United States at the time of the creation of the SEC? Who was the first SEC Chairperson?

BYP13-4 Purpose: Use the Internet to view SEC filings.

Address: biz.yahoo.com/i, or go to www.wiley.com/college/weygandt

Steps 1. Type in a company name. 2. Choose Profile. 3. Choose SEC Filings. (This will take you to Yahoo-Edgar Online.)

Instructions Answer the following questions.

(a) What company did you select? (b) Which filing is the most recent? What is the date? (c) What other recent SEC filings are available for your viewing?

Decision Making Across the Organization BYP13-5 Ron Nord and Lisa Smith are examining the following statement of cash flows for Carpino Company for the year ended January 31, 2011.

CARPINO COMPANY Statement of Cash Flows

For the Year Ended January 31, 2011

Sources of cash From sales of merchandise $380,000 From sale of capital stock 420,000 From sale of investment (purchased below) 80,000 From depreciation 55,000 From issuance of note for truck 20,000 From interest on investments 6,000

Total sources of cash 961,000

Uses of cash For purchase of fixtures and equipment 330,000 For merchandise purchased for resale 258,000 For operating expenses (including depreciation) 160,000 For purchase of investment 75,000 For purchase of truck by issuance of note 20,000 For purchase of treasury stock 10,000 For interest on note payable 3,000

Total uses of cash 856,000

Net increase in cash $ 105,000

CRITICAL THINKING

Ron claims that Carpino’s statement of cash flows is an excellent portrayal of a superb first year with cash increasing $105,000. Lisa replies that it was not a superb first year. Rather, she says, the year was an operating failure, that the statement is presented incorrectly, and that $105,000 is not the actual increase in cash. The cash balance at the beginning of the year was $140,000.

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Broadening Your Perspective 671

Instructions With the class divided into groups, answer the following.

(a) Using the data provided, prepare a statement of cash flows in proper form using the indirect method. The only noncash items in the income statement are depreciation and the gain from the sale of the investment.

(b) With whom do you agree, Ron or Lisa? Explain your position.

Communication Activity BYP13-6 Kyle Benson, the owner-president of Computer Services Company, is unfamiliar with the statement of cash flows that you, as his accountant, prepared. He asks for further explanation.

Instructions Write him a brief memo explaining the form and content of the statement of cash flows as shown in Illustration 13-13 (page 628).

Ethics Case BYP13-7 Tappit Corp. is a medium-sized wholesaler of automotive parts. It has 10 stockhold- ers who have been paid a total of $1 million in cash dividends for 8 consecutive years. The board’s policy requires that, for this dividend to be declared, net cash provided by operating activities as reported in Tappit’s current year’s statement of cash flows must exceed $1 million. President and CEO Willie Morton’s job is secure so long as he produces annual operating cash flows to support the usual dividend.

At the end of the current year, controller Robert Jennings presents president Willie Morton with some disappointing news: The net cash provided by operating activities is calculated by the indirect method to be only $970,000. The president says to Robert, “We must get that amount above $1 million. Isn’t there some way to increase operating cash flow by another $30,000?” Robert answers, “These figures were prepared by my assistant. I’ll go back to my office and see what I can do.” The president replies, “I know you won’t let me down, Robert.”

Upon close scrutiny of the statement of cash flows, Robert concludes that he can get the operating cash flows above $1 million by reclassifying a $60,000, 2-year note payable listed in the financing activities section as “Proceeds from bank loan—$60,000.” He will report the note instead as “Increase in payables—$60,000” and treat it as an adjustment of net income in the operating activities section. He returns to the president, saying, “You can tell the board to de- clare their usual dividend. Our net cash flow provided by operating activities is $1,030,000.” “Good man, Robert! I knew I could count on you,” exults the president.

Instructions (a) Who are the stakeholders in this situation? (b) Was there anything unethical about the president’s actions? Was there anything unethical

about the controller’s actions? (c) Are the board members or anyone else likely to discover the misclassification?

“All About You” Activity BYP13-8 In this chapter you learned that companies prepare a statement of cash flows in order to keep track of their sources and uses of cash and to help them plan for their future cash needs. Planning for your own short- and long-term cash needs is every bit as important as it is for a company.

Instructions Read the article (“Financial Uh-Oh? No Problem”) provided at www.fool.com/personal-finance/ saving/index.aspx, and answer the following questions.

(a) Describe the three factors that determine how much money you should set aside for short- term needs.

(b) How many months of living expenses does the article suggest to set aside? (c) Estimate how much you should set aside based upon your current situation. Are you closer

to Cliff’s scenario or to Prudence’s?

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672 Chapter 13 Statement of Cash Flows

FASB Codification Activity BYP13-9 Access the FASB Codification at http://asc.fasb.org to prepare responses to the following. Use the Master Glossary to determine the proper definitions. (a) What are cash equivalents? (b) What are financing activities? (c) What are investing activities? (d) What are operating activities? (e) What is the primary objective for the statement of cash flows? Is working capital the basis for

meeting this objective? (f) Do companies need to disclose information about investing and financing activities that do

not affect cash receipts or cash payments? If so, how should such information be disclosed?

Answers to Insight and Accounting Across the Organization Questions p. 617 Net What? Q: In general, why do differences exist between net income and net cash provided by operating

activities? A: The differences are explained by differences in the timing of the reporting of revenues and

expenses under accrual accounting versus cash. Under accrual accounting, companies report revenues when earned, even if cash hasn’t been received, and they report expenses when in- curred, even if cash hasn’t been paid.

p. 619 Cash Flow Isn’t Always What It Seems Q: For what reasons might managers at WorldCom and at Dynegy take the actions noted above? A: Analysts increasingly use cash-flow-based measures of income, such as cash flow provided by

operations, in addition to net income. More investors now focus on cash flow from operations, and some compensation contracts now have bonuses tied to cash-flow numbers. Thus, some managers have taken actions that artificially increase cash flow from operations.

p. 626 GM Must Sell More Cars Q: Why does GM’s cash provided by operating activities drop so precipitously when the com-

pany’s sales figures decline? A: GM’s cash inflow is directly related to how many cars it sells. But many of its cash outflows are

not tied to sales—they are “fixed.” For example, many of its employee payroll costs are very rigid due to labor contracts. Therefore, even though sales (and therefore cash inflows) fall, these cash outflows don’t decline.

Authors’ Comments on All About You: Where Does the Money Go?, p. 633 There are really two issues to consider here. The first centers on the problems associated with ac- cumulating debt to support discretionary expenditures. If you think that you will simply pay off your debts when you graduate, consider the fact that it is not unusual for people to spend 10 years to pay off the debts they accumulated during college.

A second issue relates to the impact that working so many hours can have on your academic performance. Research shows that college students today spend more hours working at jobs and fewer hours studying than at any time in the past. This same research shows that academic perform- ance declines when students work too many hours at their jobs. If you could cut back on your dis- cretionary expenditures, you could quit working so many hours, which would mean that you would do better in school, which would mean that you would have a better shot at a good job after college.

The bottom line: While we think that borrowing to invest in yourself through your education makes good sense, we think that borrowing to support a Starbucks habit is a bad idea. For more ideas on how to get your cash flow under control, see http://financialplan.about.com/cs/college/ a/MoneyCollege.htm.

Answers to Self-Study Questions 1. c 2. a 3. b 4. a 5. c 6. d 7. b 8. c 9. d 10. b 11. b 12. a 13. b 14. a 15. d *16. b *17. b *18. c *19. d

Remember to go back to the Navigator box on the chapter-opening page and check off your completed work.✓

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