CH4!

Cambridge Business Publishers, 2014 Solutions Manual, Chapter 4 4-1

Chapter 4

Reporting and Analyzing Cash Flows Learning Objectives coverage by question

Mini-Exercises Exercises Problems

Cases and Projects

LO1 Explain the purpose of the statement of cash flows and how it complements the income statement and balance sheet.

21, 22, 24 38, 39, 44 47, 51, 54 57 - 59

LO2 Construct and explain the statement of cash flows.

21 - 31 34 - 44 45 - 56 57 - 59

LO3 Compute and interpret ratios that reflect a companys liquidity and solvency.

32, 33,

35, 43

46, 48, 50,

52, 55, 56 59

LO4 Appendix 4A: Use a spreadsheet to construct the statement of cash flows.

55

Cambridge Business Publishers, 2014 4-2 Financial Accounting, 4th Edition

DISCUSSION QUESTIONS Q4-1. Cash equivalents are short-term, highly liquid investments that firms acquire

with temporarily idle cash to earn interest on these excess funds. To qualify as a cash equivalent, an investment must (1) be easily convertible into a known cash amount and (2) be close enough to maturity so that its market value is not sensitive to interest rate changes (generally, investments with initial maturities of three months or less). Three examples of cash equivalents are treasury bills, commercial paper, and money market funds.

Q4-2. Cash equivalents are included with cash in a statement of cash flows because the purchase and sale of such investments are considered to be part of a firm's overall management of cash rather than a source or use of cash. Similarly, as statement users evaluate cash flows, it may matter very little to them whether the cash is on hand, deposited in a bank account, or invested in cash equivalents.

Q4-3. Operating activities Inflow: Cash received from customers Outflow: Cash paid to suppliers

Investing activities

Inflow: Sale of equipment Outflow: Purchase of stocks and bonds

Financing activities Inflow: Issuance of common stock Outflow: Payment of dividends


Q4-4. a. Investing; outflow. b. Investing; inflow. c. Financing; outflow. d. Operating (direct method, not shown separately under indirect method);

inflow. e. Financing; inflow. f. Operating (direct method, not shown separately under indirect method);

inflow. g. Operating (direct method, not shown separately under indirect method);

outflow. h. Operating (direct method, not shown separately under indirect method);

inflow. Q4-5. This is a noncash investing and financing event. It must be reported in a

supplementary schedule to the statement of cash flows. Q4-6. Noncash investing and financing transactions are disclosed as supplemental

information to a statement of cash flows because a secondary objective of cash flow reporting is to present information about investing and financing activities. Noncash investing and financing transactions, generally, affect future cash flows. Issuing bonds payable to acquire equipment, for example, requires future cash payments for interest and principal on the bonds. On the other hand, converting bonds payable into common stock eliminates future cash payments related to the bonds. Knowledge of these types of events, therefore, should be helpful to users of cash flow data who wish to assess a firm's future cash flows.

Q4-7. A statement of cash flows helps external users assess the amount, timing, and uncertainty of future cash flows to the enterprise. These assessments help users evaluate their own future cash receipts from their investments in, or loans to, the firm. A statement of cash flows shows the periodic cash effects of a firm's operating, investing, and financing activities. Distinguishing among these different categories of cash flows helps users compare, evaluate, and predict cash flows. With cash flow information, creditors and investors are better able to assess a firm's ability to settle its liabilities and pay its dividends. Over time, the statement of cash flows permits users to observe and analyze management's investing and financing policies. A statement of cash flows also provides information useful in evaluating a firm's financial flexibility (which is its ability to generate cash to respond to unanticipated needs and opportunities).

Q4-8. The direct method presents the net cash flow from operating activities by showing the major categories of operating cash receipts and cash payments (such as cash received from customers, cash paid to employees and suppliers, cash paid for interest, and cash paid for income taxes). The indirect (or reconciliation) method, in contrast, presents the net cash flow from operating activities by applying a series of adjustments to the accrual net income to convert it to a cash basis.


Q4-9. Under the indirect method, depreciation is added to net income because, as a noncash expense, it was deducted in computing net income. Adding depreciation to net income, therefore, eliminates it from the cash-basis income amount. Amortization and depletion expenses are handled the same way.

Q4-10. Under the indirect method, the $98,000 cash received from the sale of the land will appear in the cash flows from investing activities section of the statement of cash flows. In addition, the $28,000 gain from the sale will be deducted from net income as one of the adjustments made to determine the net cash flow from operating activities.

Q4-11. Net income $ 88,000 Add (deduct) items to convert net income to cash basis Depreciation expense 6,000 Subtract change in accounts receivable 13,000 Subtract change in inventory (9,000) Add change in accounts payable (3,500) Add change in income tax payable 1,500 Net cash provided by operating activities $ 96,000

Q4-12. The separate disclosures required for a company using the indirect method in the statement of cash flows are (1) cash paid during the year for interest (net of amount capitalized) and for income taxes, (2) all noncash investing and financing transactions, and (3) the policy for determining which highly liquid, short-term investments are treated as cash equivalents.

Q4-13. The statement of cash flows will show a positive net cash flow from operating activities if operating cash receipts exceed operating cash payments. This could happen, for example, if noncash expenses (such as depreciation and amortization) exceed the net loss. It would also happen if operating cash receipts exceed sales by more than the loss or if operating cash payments are less than accrual expenses by more than the loss (or some combination of these events).

Q4-14. Sales $925,000 + Accounts receivable decrease 14,000 = Cash received from customers $939,000 Q4-15. Wages expense $ 86,000 + Wages payable decrease 1,100 = Cash paid to employees $ 87,100 Q4-16. Advertising expense $ 43,000 + Prepaid advertising increase 1,600 = Cash paid for advertising $ 44,600 Q4-17. Under the direct method, the $5,100 cash received from the sale of equipment

will appear in the cash flows from investing activities section of the statement of cash flows.


Q4-18. The separate disclosures required for a company using the direct method in the statement of cash flows are (1) a reconciliation of net income to net cash flow from operating activities, (2) all noncash investing and financing transactions, and (3) the policy for determining which highly liquid, short-term investments are treated as cash equivalents.

Q4-19. The operating cash flow to current liabilities ratio is calculated by dividing net cash flow from operating activities by average current liabilities. This ratio is a measure of a firm's ability to liquidate its current liabilities.

Q4-20. The operating cash flow to capital expenditures ratio is calculated by dividing a firm's cash flow from operating activities by its annual capital expenditures. A ratio below 1.00 means that the firm's current operating activities are not providing enough cash to cover the capital expenditures. A ratio above 1.0 is normally considered a sign of financial strength.


MINI EXERCISES M4-21. (5 minutes) a. Positive adjustment b. Negative adjustment c. Negative adjustment d. Positive adjustment e. Positive adjustment M4-22. (10 minutes) a. Cash flow from an operating activity. b. Cash flow from an investing activity. c. Cash flow from an investing activity. d. Cash flow from an operating activity. e. Cash flow from a financing activity. f. Cash flow from a financing activity. g. Cash flow from an investing activity. M4-23. (15 minutes)

DOLE FOOD COMPANY, INC. Selected Items from the Cash Flow Statement

1 Long-term debt repayments Financing 2 Change in receivables Operating 3 Depreciation and amortization Operating 4 Change in accrued liabilities Operating 5 Dividends paid Financing 6 Change in income taxes payable Operating 7 Cash received from sales of assets and businesses Investing 8 Net income Operating 9 Change in accounts payable Operating

10 Short-term debt borrowings Financing 11 Capital expenditures Investing


M4-24. (10 minutes) a. (3) Cash flow from a financing activity. b. (1) Cash flow from an operating activity. c. (4) Noncash investing and financing activity. d. (1) Cash flow from an operating activity. e. (1) Cash flow from an operating activity. f. (5) None of the above (a change in the composition of cash and cash equivalents). M4-25. (30 minutes) a.

Balance Sheet Income Statement Trans- action

Cash Asset

+

Accts. Receiv-

able + Inven-tories =

Accts. Payable +

Contrib. Capital +

Earned Capital Revenue - Expenses =

Net Income

(1) + +507,400 + = + + +507,400 +507,400 - = +507,400

(2) +91,500 + + = + + +91,500 +91,500 - = +91,500

(3) + + 320,100 = + + 320,100 - +320,100 = 320,100

(4) + + 63,400 = + + 63,400 - +63,400 = 63,400

(5) + + +351,600 = +351,600 + + - =

(6) -47,700 + + +47,700 = + + - =

(7) +483,400 + 483,400 + = + + - =

(8) 340,200 + + = 340,200 + + - =

(9) -172,300 + + = + + -172,300 - +172,300 = -172,300

Total +14,700 + +24,000 + +15,800 = +11,400 + + +43,100 +598,900 - +555,800 = +43,100

b. Net income was 43,100 (from the net income column), and cash flow from

operating activities was 14,700 (from the cash column). c. 1. Accounts receivable increased by 24,000,

2. Inventories increased by 15,800, and 3. Accounts payable increased by 11,400.

continued next page


M4-25. concluded d. The accounting equation is kept with every entry, so it is kept for the totals over the

period.

Cash flow + change in accounts receivable + change in inventory = Change in accounts payable + net income.

This relationship can be presented in the following indirect method cash flow from operating activities.

Net income 43,100 - Change in accounts receivable 24,000 - Change in inventories 15,800

+ Change in accounts payable +11,400 Cash flow from operating activities 14,700 M4-26. (15 minutes INDIRECT METHOD) Net income $ 45,000 Add (deduct) items to convert net income to cash basis Add back depreciation 8,000 Subtract gain on sale of investments (9,000) Subtract change in operating assets: Accounts receivable (9,000) Inventory (6,000) Prepaid rent 2,000 Add change in operating liabilities: Accounts payable 4,000 Income tax payable (2,000) Net cash provided by operating activities $ 33,000


M4-27. (30 minutes) a.

Balance Sheet Income Statement Trans- action

Cash Asset +

Accts. Receiv-

able

+ Prepaid Rent -

Accum. Deprec. =

Wages Payable +

Contr. Capital +

Earned Capital Revenue - Expenses =

Net Income

(1) + +769,200 + - = + + +769,200 +769,200 - = +769,200 (2) +46,200 + + - = + + +46,200 +46,200 - = +46,200 (3) + + - = +526,700 + + 526,700 - +526,700 = 526,700 (4) 149,100 + + +149,100 - = + + - = (5) 521,600 + + - = 521,600 + + - = (6) + + 117,900 - = + + 117,900 - +117,900 = 117,900 (7) +724,100 + 724,100 + - = + + - = (8) 122,800 + + - = + + 122,800 - +122,800 = 122,800 (9) + + - +23,000 = + + -23,000 - +23,000 = -23,000 Total 23,200 + +45,100 + +31,200 - +23,000 = +5,100 + + +25,000 +815,400 - +790,400 = +25,000

b. Net income was $25,000 (from the net income column), and cash flow from

operating activities was $23,200 (from the cash column). c. 1. Accounts receivable increased by $45,100,

2. Prepaid rent increased by $31,200, 3. Accumulated depreciation (a contra-asset) increased by $23,000 due to

depreciation expense. and 4. Wages payable increased by $5,100.

d. The accounting equation is kept with every entry, so it is kept for the totals over the

period.

Cash flow + change in accounts receivable + change in prepaid rent change in accumulated depreciation = Change in wages payable + net income.

This relationship can be presented in the following indirect method cash flow from

operating activities. Net income $ 25,000 + Depreciation expense 23,000

Change in accounts receivable 45,100 Change in prepaid rent 31,200 + Change in wages payable +5,100

Cash flow from (used in) operating activities ($ 23,200)


M4-28. (15 minutesINDIRECT METHOD) Net loss $(21,000) Add (deduct) items to convert net loss to cash basis Add back depreciation 8,600 Subtract change in operating assets: Accounts receivable 9,000 Inventory 3,000 Prepaid expenses 3,000 Add change in operating liabilities: Accounts payable 4,000 Accrued liabilities (2,600) Net cash provided by operating activities $ 4,000 Weber Company's 2013 operating activities provided $4,000 cash. The dividend paid to shareholders affects cash flows from financing activities. M4-29. (20 minutes) A + indicates that the amount is added and a - indicates that it is subtracted when preparing the cash flow statement using the indirect method.

NORDSTROM, INC. Consolidated Statement of Cash Flows Selected Items

1 Increase in accounts receivable Operating - 2 Capital expenditures Investing - 3 Proceeds from long-term borrowings Financing + 4 Increase in deferred income tax net liability Operating + 5 Principal payments on long-term borrowings Financing - 6 Increase in merchandise inventories Operating - 7 Decrease in prepaid expenses and other assets Operating + 8 Proceeds from issuances under stock compensation plans Financing + 9 Increase in accounts payable Operating + 10 Net earnings Operating + 11 Payments for repurchase of common stock Financing - 12 Increase in accrued salaries, wages and related benefits Operating + 13 Cash dividends paid Financing - 14 Depreciation and amortization expenses Operating +


M4-30. (15 minutesDIRECT METHOD) a. Rent expense $ 60,000 Prepaid rent decrease (2,000) = Cash paid for rent $ 58,000

Balance Sheet Income Statement

Transaction Cash + Noncash Assets = Liabilities + Contr. Capital +

Earned Surplus Revenue - Expenses =

Net Income

Begin Balance +

10,000 Prepaid

rent = + + - =

Make rent payment -X +

+X Prepaid

Rent = + + - =

Record rent expense +

-60,000 Prepaid

Rent = + +

-60,000 Retained Earnings

- 60,000 Rent

Expense = -60,000

End Balance + 8,000 = + + - = X must equal $58,000 to make the FSET balance.

b. Interest income $ 16,000 Interest receivable increase (700) = Cash received as interest $ 15,300




Net Income

Begin Balance +

3,000 Interest

receivable = + + - =

Record interest income

+ +16,000 Interest

receivable = + +

+16,000 Retained Earnings

+16,000 Interest income

- = +16,000

Receive interest payment

+X + -X = + + - =

End Balance + 3,700 = + + - =

X must equal $15,300 to make the FSET balance.

continued next page


M4-30. concluded c. Cost of goods sold $ 98,000 + Inventory increase 3,000 + Accounts payable decrease 4,000 = Cash paid for merchandise purchased $105,000




Net Income

Begin Balance

+ 19,000 Inventory

= 11,000

Accounts Payable

+ + - = Purchase inventory

+ +X = +X + + - = Pay supplier -Y

+ = -Y

Accounts Payable

+ + - =

Recognize Cost of Goods Sold

+ -98,000 Inventory = + +

-98,000 Retained Earnings

- 98,000 Cost of Goods Sold

= -98,000

End Balance + 22,000 = 7,000 + + - = To make the inventory account work properly, X (purchases) must equal $101,000. If purchases were $101,000, then Y (payments to suppliers) must equal $105,000.

M4-31. (15 minutesDIRECT METHOD) Operating cash flow + change in operating assets

= net income + change in operating liabilities or

Net income - change in operating assets + change in operating liabilities

= operating cash flow

Effect of sales on net income $825,000 Change in accounts receivable (11,000) = Effect of customers on cash $814,000 Effect of cost of goods sold on net income ($550,000) - Change in inventory (13,000) + Change in accounts payable (6,000) = Effect of merchandise purchases on cash ($569,000) Howell Company received $814,000 in cash from its customers and paid $569,000 in cash to its suppliers.


EXERCISES E4-32. (20 minutes) (All dollar amounts in millions)

a. Merck: $12,383/$15,943 = 0.78 Pfizer: $20,240/$28,353 = 0.71 Abbott Labs: $8,970/$16,371 = 0.55 Johnson & Johnson: $14,298/$22,942 = 0.62 b. Merck: $12,383 ($1,723 $0) = $10,660 Pfizer: $20,240 ($1,660 $0) = $18,580 Abbott Labs: $8,970 ($1,492 $0) = $7,478 Johnson & Johnson: $14,298 ($2,893 1,342) = $12,747

c. None of the firms has sufficient cash flow to cover their current liabilities although

none of the ratios is of major concern. The industry ratios shown in Chapter 5 on page 233 show that only Abbott Labs is below median. Pfizer is the largest of these three companies and has relatively more cash left over after capital expenditures to consider using on other activities that could strengthen the firms operating or financial position. But all four have significant free cash flow that could be invested or returned to shareholders in the form of dividends or stock repurchases. Given that these firms are of different sizes and have different research program success, it is difficult to generalize further.

E4-33. (20 minutes) (All dollar amounts in millions)

a. Wal-Mart: $24,255/$60,452 = 0.40 Coca-Cola: $9,474/$21,396 = 0.44 ExxonMobil: $55,345/$70,069 = 0.79 b. Wal-Mart: $24,255 ($13,510 $580) = $11,325 Coca-Cola: $9,474 ($2,920 $101) = $6,655 ExxonMobil: $55,345 ($30,975 $7,533) = $31,903

c. All three companies are producing much more cash than needed for capital

expenditures. All of them are returning substantial amounts of cash to shareholders through dividends and share repurchases (more than $11 billion for Wal-Mart, almost $9 billion for Coca-Cola and more than $31 billion for ExxonMobil. ExxonMobil appears to be in the best position with respect to OCFCL, but it is lower than the industry average reported in Chapter 5 on page 233. Wal-Mart and Coca-Cola have lower ratios, and are also below the average ratio for their industries.


E4-34. (30 minutesINDIRECT METHOD)

MASON CORPORATION Statement of Cash Flows

For Year Ended December 31, 2013 Cash flows from operating activities Cash received from customers $194,000 Cash received as interest 6,000 Cash paid to employees and suppliers (148,000) Cash paid as income taxes (11,000) Net cash provided by operating activities $ 41,000 Cash flows from investing activities Sale of land 40,000 Purchase of equipment (89,000) Net cash used by investing activities (49,000) Cash flows from financing activities Issuance of bonds payable 30,000 Acquisition of treasury stock (10,000) Payment of dividends (16,000) Net cash provided by financing activities 4,000 Net decrease in cash (4,000) Cash at beginning of year 16,000 Cash at end of year $ 12,000

E4-35. (15 minutesINDIRECT METHOD) a. Net income $113,000

Add (deduct) items to convert net income to cash basis Accounts receivable increase (5,000) Inventory decrease 6,000 Prepaid insurance increase (1,000) Accounts payable increase 4,000 Wages payable decrease (2,000) Net cash provided by operating activities $115,000 b. $115,000/[($31,000 + $29,000)/2] =3.83


E4-36. (15 minutesINVESTING ACTIVITIES) The basic approach here is to use the beginning and ending balances and the additional information to reconstruct what must have happened during 2013. Begin by setting up the T-accounts for property, plant and equipment with the beginning and ending balances.

+ Property, plant and equipment at cost (A) - - Accumulated

depreciation (XA) +

Beg. balance 1000 350 Beg. balance Ending balance 1,200 390 Ending balance

At this point in the book, we know four entries that can affect these two accounts (1) acquisitions using cash, (2) acquisitions without cash (other financing), (3) disposals, and (4) depreciation expense. The journal entries for these entries are given below, with amounts given in the problem filled in. (1) Property, plant and equipment at cost (+A) 300

Cash (-A) 300 To record purchase of property, plant and equipment with cash.

(2) Property, plant and equipment at cost (+A) 100

Mortgage payable (+L) 100 To record purchase of property, plant and equipment with financing. (3) Cash (+A) 100

Accumulated depreciation (-XA, +A) Y Property, plant and equipment at cost (-A) X Gain on equipment disposal (+R, +SE) 20 To record sale of used equipment. (4) Depreciation expense (+E, -SE) Z

Accumulated depreciation (+XA, -A) Z To record depreciation expense. The three unknowns in the journal entries correspond to the three questions in the problem. We begin by putting the journal entry amounts into the T-accounts.

continued next page


E4-36. concluded


depreciation (XA) +

Beg. balance 1000 350 Beg. balance (1) 300 (2) 100 (3) X Y (3) Z (4) Ending balance 1,200 390 Ending balance

a. The PPE at cost account will only balance if the value X equals 200. So, the original cost of the used equipment that was sold is 200. We can put that amount in the T-account (so it balances) and also in Journal entry (3).

b. Now, looking at journal entry (3), we see that there is only one unknown left the

depreciation that had accumulated on the used equipment. In order for the entry to balance (with debits equal to credits), the accumulated depreciation must have been 120 (= Y). Cost of 200 and accumulated depreciation of 120 would produce a net book value of 80, so when Meubles Fischer sold it for 100, they recorded a gain of 20 on the disposal.

c. Back at the Accumulated depreciation T-account, we can fill in the entry for (3),

leaving only the depreciation expense to determine for entry (4). Knowing that the disposal reduced the contra-asset by 120, and that the contra-asset increased by 40 over the year, we can infer than the depreciation expense must have been 160 (= Z).

E4-37. (15 minutesINVESTING ACTIVITIES)

The basic approach here is to use the beginning and ending balances and the additional information to reconstruct what must have happened during 2013. Begin by setting up the T-accounts for property, plant and equipment with the beginning and ending balances.


depreciation (XA) +

Beg. balance 175 78 Beg. balance Ending balance 183 83 Ending balance

continued next page


E4-37. concluded At this point in the course, we know four entries that can affect these two accounts (1) acquisitions using cash, (2) acquisitions without cash (other financing), (3) disposals, and (4) depreciation expense. The journal entries for these entries are given below, with amounts given in the problem filled in. (1) Property, plant and equipment at cost (+A) 28

Cash (-A) 28 To record purchase of property, plant and equipment with cash.

(2) Property, plant and equipment at cost (+A) 0 Mortgage payable (+L) 0 To record purchase of property, plant and equipment with financing.

(3) Cash (+A) Z Accumulated depreciation (-XA, +A) Y Loss on equipment disposal (+E, -SE) 5

Property, plant and equipment at cost (-A) X To record sale of used equipment.

(4) Depreciation expense (+E, -SE) 17 Accumulated depreciation (+XA, -A) 17 To record depreciation expense. The three unknowns in the journal entries correspond to the three questions in the problem. We begin by putting the journal entry amounts into the T-accounts.


depreciation (XA) +

Beg. balance 175 78 Beg. balance (1) 28 (2) 0 (3) X Y (3) 17 (4) Ending balance 183 83 Ending balance

a. The PPE at cost account will only balance if the value X equals 20. So, the original

cost of the used equipment that was sold is 20. We can put that amount in the T-account (so it balances) and also in Journal entry (3).

b. The accumulated depreciation account will only balance if the value Y equals 12.

So, the accumulated depreciation on the used equipment sold must be 12, and that amount can be entered into transaction (3) above.

c. Now, looking at journal entry (3), we see that there is only one unknown left the amount of cash received from disposal of the used equipment. In order for the entry to balance (with debits equal to credits), the cash amount must have been 3 million (= Z). Cost of 20 and accumulated depreciation of 12 would produce a net book value of 8, so when Kasznik Ltd. sold it for 3, they recorded a loss of 5 on the disposal.


E4-38. (30 minutes) a. The analysis on page ***160*** on the text shows that

Cash flow (payments) +

Change in inventory =

Change in accounts payable +

Net income (COGS

expense)

X + 666 (=8,044-7,378) = 225

(=4,810-4,585) + -51,692

The solution to this is that X = -$51,692 666 + 225 = -$52,133. So, the payments to

suppliers reduced cash by $52,133 million in fiscal year 2011. b. The net property and equipment account increased by $342 million (=$11,526

11,184). Depreciation expense would have decreased this balance by $809 million in fiscal year 2011, so the net investment must have been $1,151 million (=$342 + 809) to result in the ending balance of $11,526 million.

c. With the beginning balance of $16,848 million in retained earnings, net earnings of

$2,714 would have increased retained earnings to $19,562 million. But the ending balance in retained earnings is $18,877 million, so Walgreens must have paid $685 million in dividends (=$19,562 - $18,877).

E4-39. (15 minutes) a. Cash flows from investing activities will show: Purchase of stock investments $ (80,000) Sale of stock investments 59,000 b. Cash flows from financing activities will show: Issuance of bonds $130,000 Retirement of bonds (131,000)


E4-40. (20 minutes) a. The net increase in property and equipment was $4,635,377 (= $84,767,771 -

$80,132,394), and the expenditures should have increased this by $5,559,183. Therefore the original cost of the property and equipment sold must have been 923,806 (= $5,559,183 - $4,635,377).

Depreciation expense should have increased the accumulated depreciation account by

$3,174,956, but the account increased by only $2,268,583. The accumulated depreciation on the property and equipment sold must account for the difference, making it $906,373 (= $3,174,956 2,268,583).

b. The book value of the property and equipment sold was $17,433 (=$923,806

906,373), and the reported gain on sale of the property and equipment was $79,483. Therefore, the cash proceeds must have been $96,916 (= $17,433 + 79,483), which is the amount reported in Golden Enterprises cash flows from investing activities.

c.

Cash (+A) $ 96,916 Accumulated depreciation (-XA, +A) 906,373 Property and equipment, cost (-A) $ 923,806 Gain on sale of property and equipment

(+R, +SE) 79,483

d. Retained earnings increased by $1,547,261 (= $18,866,264 17,319,003), and net

income was $3,014,768. The difference would be accounted for by cash dividends paid to shareholders, and the amount is $1,467,507.

E4-41. (20 minutesDIRECT METHOD) a. Advertising expense $ 62,000 + Prepaid advertising increase 4,000 = Cash paid for advertising $ 66,000 b. Income tax expense $ 29,000 + Income tax payable decrease 2,200 = Cash paid for income taxes $ 31,200 c. Cost of goods sold $180,000 Inventory decrease (5,000) Accounts payable increase (2,000) = Cash paid for merchandise purchased $173,000


E4-42.

HOSKINS CORPORATION Statement of Cash Flows

Year ended December 31, 2013 Cash Flows from Operations: Net income $ 700 Adjustments: Add back Depreciation 350 Change in Accounts Receivable (900) Change in Inventory (100) Change in Prepaid Expenses 250 + Change in Accounts Payable 400 + Change in Income Taxes Payable (100) Cash Flows from Operating Activities $ 600 Cash Flows from Investing: Purchases of Equipment (1,200) Proceeds from Disposal of Equipment 600 Cash Flows from Investing Activities (600) Cash Flows from Financing: Dividends Paid (250) Increase in Short-term Debt 1,500 Decrease in Long-term Debt (1,000) Cash Flows from Financing Activities 250 Net Change in Cash 250 Beginning Cash Balance 300 Ending Cash Balance $ 550


E4-43. (30 minutesDIRECT METHOD) a.

Sales $750,000 Accounts Receivable Increase (5,000) = Cash Received from Customers $745,000 Cost of Goods Sold $470,000 Inventory Decrease (6,000) Accounts Payable Increase (4,000) = Cash Paid for Merchandise Purchased $460,000 Wages Expense $110,000 + Wages Payable Decrease 2,000 = Cash Paid to Employees $112,000 Insurance Expense $ 15,000 + Prepaid Insurance Increase 1,000 = Cash Paid for Insurance $ 16,000 Cash Flows from Operating Activities Cash Received from Customers $745,000 Cash Paid for Merchandise Purchased $460,000 Cash Paid to Employees 112,000 Cash Paid for Rent 42,000 Cash Paid for Insurance 16,000 630,000 Net Cash Provided by Operating Activities $115,000

b. $115,000/[($31,000 + $29,000)/2] =3.83 E4-44. (15 minutes) 1. True ---

2. False $25

3. False $10

4. False $0


PROBLEMS P4-45. (20 minutes) Cash flows from operating activities

Net income ........................................................................................... $135,000

Adjustments to reconcile net income to operating cash flows

Add back depreciation expense ...................................................... $25,000

Gain on sale of assets (5,000)

Subtract changes in:

Accounts receivable........................................................................ (10,000)

Prepaid expenses ........................................................................... 3,000

Add changes in:

Accounts payable ........................................................................... 6,000

Wages payable ............................................................................... (4,000) 15,000

Net cash provided from operating activities ......................................... $150,000

P4-46. (45 minutesINDIRECT METHOD) a. Cash, December 31, 2013 ........................................................ $11,000 Cash, December 31, 2012 ........................................................ 5,000 Cash increase during 2013 ....................................................... $ 6,000

continued next page


P4-46. concluded b. STATEMENT OF CASH FLOWS (INDIRECT METHOD)

WOLFF COMPANY Statement of Cash Flows

For Year Ended December 31, 2013 Net Cash Flow from Operating Activities Net Income $56,000 Add (Deduct) Items to Convert Net Income to Cash Basis Depreciation 17,000 Accounts Receivable Increase (9,000) Inventory Increase (30,000) Prepaid Insurance Decrease 2,000 Accounts Payable Decrease (3,000) Wages Payable Increase 3,000 Income Tax Payable Decrease (1,000) Net Cash Provided by Operating Activities $35,000 Cash Flows from Investing Activities Purchase of Plant Assets (55,000) Cash Flows from Financing Activities Issuance of Bonds Payable 55,000 Payment of Dividends (29,000) Net Cash Provided by Financing Activities 26,000 Net Increase in Cash 6,000 Cash at Beginning of Year 5,000 Cash at End of Year $11,000

c. (1) $35,000/(($23,000 + $24,000)/2) = 1.49

(2) $35,000/$55,000 = 0.64

Wolffs cash flow ratios indicate that, while the company has sufficient cash flow to cover its current obligations, it must rely on external financing to pay for capital expenditures.


P4-47. (30 minutes) a.

Adjustments to Convert Income Statement Items to Operating Activity Cash Flows

Net income

$ 56,000 = Sales

revenue

$635,000

Cost of goods sold

430,000

Wage expenses

86,000

Insurance expense

8,000

Depreciation expense

17,000

Interest expense

9,000

+Gains

0

Losses

0

Income tax expense

29,000

Adjustments:

Add back depreciation expense

+Depreciation

expense

+17,000

Subtract (add) non-operating gains (losses)

Gains

0

+Losses

0

Subtract the change in operating assets (operating investments)

change in

accounts receivable

-9,000

change in

inventory

-30,000

change in prepaid

insurance

-(-2,000)

Add the change in operating liabilities (operating financing)

+change in accounts payable

+(-3,000)

+change in wages

payable

+3,000

+change in income tax

payable

+(-1,000)

Cash from operations

$ 35,000

=

Receipts from

customers

$626,000

Payments for

merchandise

-463,000

Payments for

Wages

-83,000

Payments for

insurance

-6,000

(zero) 0

Payments for

interest

-9,000

(zero) +0

(zero) 0

Payments for

income tax

30,000

b. Computing cash flows from operating activities using the direct method provides

additional detail about the specific cash flows that occurred during the period. For example, the indirect method does not reveal that Wolff paid $463,000 for merchandise during 2013, or $83,000 for wages. Because this detail is missing, the FASB requires supplemental disclosure of two specific (and important) cash payments interest and taxes if the indirect method is used.


P4-48. (45 minutesINDIRECT METHOD) a. Cash, December 31, 2013 $49,000 Cash, December 31, 2012 28,000 Cash increase during 2013 $21,000 b. STATEMENT OF CASH FLOWS (INDIRECT METHOD)

ARCTIC COMPANY Statement of Cash Flows

For Year Ended December 31, 2013 Net Cash Flow from Operating Activities Net Loss $ (42,000) Add (Deduct) Items to Convert Net Loss to Cash Basis Depreciation 22,000 Gain on Sale of Land (25,000) Accounts Receivable Decrease 8,000 Inventory Decrease 6,000 Prepaid Advertising Decrease 3,000 Accounts Payable Decrease (14,000) Interest Payable Increase 6,000 Net Cash Used by Operating Activities $ (36,000) Cash Flows from Investing Activities Sale of Land 70,000 Purchase of Equipment (183,000)* Net Cash Used by Investing Activities (113,000) Cash Flows from Financing Activities Issuance of Bonds Payable 200,000 Purchase of Treasury Stock (30,000) Net Cash Provided by Financing Activities 170,000 Net Increase in Cash 21,000 Cash at Beginning of Year 28,000 Cash at End of Year $ 49,000

* The sum of the increase in PPE assets account ($138,000) and the book value of the land sold ($45,000). c. - $36,000/(($23,000 + $31,000)/2) = -1.33

- $36,000/$183,000 = -0.20

Arctics operating cash flows are negative, primarily because the firm reported a net loss for the year. As a consequence, its cash flow ratios indicate insufficient cash flows to fund operations and capital expenditures.



Adjustments to Convert Income Statement Items to Operating Activity Cash Flows Net income (loss) $ 42,000

Sales

revenue $728,000

Cost of goods sold 534,000

Wage expenses 190,000

Advertising expense 31,000

Depreciation expense 22,000

Interest expense 18,000

+Gains

+25,000

Losses 0

Income tax expense

0

Adjustments:

Add back depreciation expense

+Depreciation

expense +22,000

Subtract (add) non-operating gains (losses)

Gains 25,000

+Losses 0

Subtract the change in operating assets (operating investments)

change

in accounts receivable -(-8,000)

change in

inventory -(-6,000)

change in prepaid

advertising -(-3,000)

Add the change in operating liabilities (operating financing)

+change in accounts payable

+(-14,000)

+change in wages

payable +0

+change in interest payable +6,000

+change in income tax

payable +0

Cash from operations $ 36,000

= Receipts

from customers $736,000

Payments for

merchandise 542,000

Payments for

Wages 190,000

Payments for

advertising 28,000

(zero) 0

Payments for

interest 12,000

(zero) +0

(zero) 0

Payments for income

tax 0

b. Computing cash flows from operating activities using the direct method provides

additional detail about the specific cash flows that occurred during the period. For example, the indirect method does not reveal that Arctic paid $542,000 for merchandise during 2013, or $28,000 for advertising. Because this detail is missing, the FASB requires supplemental disclosure of two specific (and important) cash payments interest and taxes if the indirect method is used.


P4-50. (50 minutesINDIRECT METHOD) a. Cash, December 31, 2013 ................................................ $27,000 Cash, December 31, 2012 ................................................ 18,000 Cash increase during 2013 ............................................... $ 9,000 b. STATEMENT OF CASH FLOWS (INDIRECT METHOD)

DAIR COMPANY Statement of Cash Flows

For Year Ended December 31, 2013

Net Cash Flow from Operating Activities Net Income $ 85,000 Add (deduct) items to convert net income to cash basis Depreciation 22,000 Amortization of intangible assets 7,000 Loss on bond retirement 5,000 Accounts receivable increase (5,000) Inventory decrease 6,000 Prepaid expenses increase (2,000) Accounts payable increase 6,000 Interest payable decrease (3,000) Income tax payable decrease (2,000) Net cash provided by operating activities $119,000 Cash flows from investing activities Sale of equipment 17,000 Cash flows from financing activities Retirement of bonds payable (125,000) Issuance of common stock 24,000 Payment of dividends (26,000) Net cash used by financing activities (127,000) Net increase in cash 9,000 Cash at beginning of year 18,000 Cash at end of year $ 27,000

continued next page


P4-50. concluded c. (1) Supplemental cash flow disclosures Cash paid for interest ............................................................................ $ 13,000* Cash paid for income taxes................................................................... $ 38,000

* Interest expense $10,000 + Interest payable decrease 3,000 Cash paid for interest $13,000 Income tax expense $36,000 + Income tax payable decrease 2,000 Cash paid for income taxes $38,000

(2) Schedule of noncash investing and financing activities Issuance of bonds payable to acquire equipment ................................. $ 60,000 d. (1) $119,000/[($42,000 + $41,000)/2] = 2.87. (2) The firm did not spend any cash on capital investments. The firm did issue debt

for equipment, but this is not a capital expenditure. (3) $119,000 + $17,000 = $136,000 P4-51. (45 minutes) a. Depreciation and amortization are a noncash expenses that are deducted in the

computation of net income. The depreciation and amortization add-back zeros these expenses out of the income statement to focus on cash profitability. The positive amount for depreciation and amortization does not mean that the company is generating cash from depreciation and amortization, a common misconception. It is merely an adjustment to remove these expenses from the computation of profit.

b. The adjustments must be interpreted relative to the amounts included in net income.

The $(73,670,000) adjustment for receivables means that Staples collected this much less than it recognized as revenue. The adjustment for accrued expenses implies that Staples paid $117,389,000 more than the expenses already recognized in net income.

c. Acquisition of property and equipment are less than the depreciation and amortization

recognized for the year. Unless the prices for property and equipment are falling, that relationship implies that Staples may not be replacing its capacity. A growing company will have capital expenditures that exceed the depreciation on its existing property and equipment.

continued next page


P4-51. concluded d. Staples operates businesses in 26 countries outside of the U.S. including businesses

in Europe, Asia, South America, Australia, and Canada. This means that some of its cash transactions occur in currencies other than the U.S. dollar. This fact requires the company to hold cash in other currencies that may be revalued relative to the dollar from one period to the next. When foreign cash balances are revalued in foreign exchange markets relative to the U.S. dollar, the dollar value of the companys cash balance changes even though there was no actual cash flow. Hence, this exchange rate effect is listed in the cash flow statement to explain the change in the cash balance.

e. Although net cash decreased during the period, Staples presents a healthy cash flow

picture for the year. It generated almost $1.6 billion of operating cash flow. Most of this amount was returned to lenders and shareholders, rather than being used to grow the business. Staples returned over $900 million to shareholders in the form of dividends and share repurchases, plus it reduced its net borrowings by about $500,000.

P4-52. (50 minutesINDIRECT METHOD) a. Cash and cash equivalents, December 31, 2013 ............................ $19,000 Cash and cash equivalents, December 31, 2012 ............................ 25,000 Cash and cash equivalents decrease during 2013.......................... $ 6,000 b. See the cash flow statement provided on the following page. c. (1) Supplemental Cash Flow Disclosures Cash paid for interest $ 12,000* Cash paid for income taxes $ 46,000 * Interest expense $13,000 - Interest payable increase (1,000) Cash paid for interest $12,000

Income tax expense $44,000 + Income tax payable decrease 2,000

Cash paid for income taxes $46,000 (2) Schedule of noncash investing and financing activities Issuance of preferred stock to acquire patent $ 25,000 d. (1) $101,000/[($34,000 + $31,000)/2] = 3.11. (2) $101,000/($185,000) = 0.55. (3): $101,000 ($90,000 + $95,000 - $14,000) = -$70,000


P4-52. concluded b.

RAINBOW COMPANY Statement of Cash Flows

For Year Ended December 31, 2013

Net cash flow from operating activities Net income $ 90,000 Add (deduct) items to convert net income to cash basis Depreciation 39,000 Patent amortization 7,000 Loss on sale of equipment 5,000 Gain on sale of investments (3,000) Accounts receivable increase (10,000) Inventory increase (26,000) Prepaid expenses increase (4,000) Accounts payable increase 4,000 Interest payable increase 1,000 Income tax payable decrease (2,000) Net cash provided by operating activities $101,000 Cash flows from investing activities Sale of investments 60,000 Purchase of land (90,000) Improvements to building (95,000) Sale of equipment 14,000 Net cash used by investing activities (111,000) Cash flows from financing activities Issuance of bonds payable 30,000 Issuance of common stock 24,000 Payment of dividends (50,000) Net cash provided by financing activities 4,000 Net decrease in cash and cash equivalents (6,000) Cash and cash equivalents at beginning of year . 25,000 Cash and cash equivalents at end of year $ 19,000


P4-53. (35 minutes) a. Cash and cash equivalents, December 31, 2013 .. $19,000 Cash and cash equivalents, December 31, 2012 .. 25,000 Cash and cash equivalents decrease during 2013 .. $ 6,000 b.

RAINBOW COMPANY Statement of Cash Flows (Direct Method)

For Year Ended December 31, 2013 Cash flows from operating activities Cash received from customers $740,000 Cash received as dividends .. 15,000 $755,000 Cash paid for merchandise purchased .. 462,000 Cash paid for wages and other operating expenses 134,000 Cash paid for interest .. 12,000 Cash paid for income taxes 46,000 (654,000) Net cash provided by operating activities .. 101,000

Cash flows from investing activities Sale of investments .. 60,000 Purchase of land (90,000) Improvements to building (95,000) Sale of equipment .. 14,000 Net cash used by investing activities ... (111,000)

Cash flows from financing activities Issuance of bonds payable . 30,000 Issuance of common stock . 24,000 Payment of dividends (50,000) Net cash provided by financing activities 4,000 Net decrease in cash and cash equivalents .. (6,000) Cash and cash equivalents at beginning of year . 25,000 Cash and cash equivalents at end of year . $ 19,000

continued next page


P4-53. concluded c. (1) Reconciliation of net income to net cash flow from operating activities Net income $ 90,000 Add (deduct) items to convert net income to cash basis Depreciation 39,000 Patent amortization 7,000 Loss on sale of equipment 5,000 Gain on sale of investments (3,000) Accounts receivable increase (10,000) Inventory increase (26,000) Prepaid expenses increase (4,000) Accounts payable increase 4,000 Interest payable increase 1,000 Income tax payable decrease (2,000) Net cash provided by operating activities $101,000 (2) Schedule of noncash investing and financing activities Issuance of preferred stock to acquire patent $ 25,000 P4-54. (30 minutes) Operating cash flow + change in operating assets

= net income + change in operating liabilities or

Net income - change in operating assets + change in operating liabilities

= operating cash flow

a. Apples adjustment for accounts receivable is (plus) $143 million. This adjustment represents minus the change in receivables, so Apples accounts receivable must have gone down by $143 million.

($ millions)

Net sales $108,249 - Change in accounts receivable +143 + Change in deferred revenue +1,654 Cash collected from customers .. $110,046

b. ($ millions)

- Cost of goods sold . ($64,431) - Change in inventories .. +275 + Change in accounts payable 2,515 - Cash paid for purchases of inventories ($61,641)

continued next page


P4-54. concluded

c. ($ billions)

Property, plant and equipment, ending balance $7.8 - Purchases of property, plant and equipment (4.3) + Book value of PPE assets sold ... none + Depreciation of property, plant and equipment 1.6 Property, plant and equipment, beginning balance $5.1

d. Stock-based compensation expense is deducted when calculating net income similar

to cash compensation. The only difference is that the compensation is paid in shares of stock (or stock options) instead of cash. Because stock-based compensation does not require the payment of cash, it is treated as a noncash expense, much like depreciation, and added back to net income when the indirect method is used in the cash flow statement. Generally speaking, compensation cost is classified as part of operating activities whether or not the compensation is paid in cash.



P4-55. concluded b. The following statement of cash flows from operations combines the effects of the

income tax asset and liability and combines the effects of the deferred tax asset and liability. In addition, the effects of changes in current and noncurrent salary continuation plan liabilities have been combined in the operating cash flow.

GOLDEN ENTERPRISES, INC. Consolidated Statement of Cash Flows

Year ended June 3, 2011 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,014,768 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 3,174,956 Deferred income taxes 1,329,868 Gain on sale of property and equipment (79,483) - Change in receivables, net (685,678) - Change in inventories (94,964) - Change in prepaid expenses (230,574) - Change in cash surrender value of insurance 364,240 - Change in other assets (167,256) + Change in accounts payable 186,036 + Change in accrued expenses 138,626 + Change in salary continuation plan (92,506) + Change in accrued income taxes (1,103,498) Net cash provided by operating activities 5,754,535 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property, plant and equipment (5,559,183) Proceeds from sale of property, plant and equipment 96,916 Net cash used in investing activities (5,462,267) CASH FLOWS FROM FINANCING ACTIVITIES: Debt proceeds 38,903,745 Debt repayments (36,328,583) Change in checks outstanding in excess of bank balances (85,126) Purchase of treasure shares (36,960) Cash dividends paid (1,467,507) Net cash provided by financing activities 985,569 NET INCREASE IN CASH AND CASH EQUIVALENTS 1,277,837 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,443,801 CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,721,638

c. OCFCL = $5,754,535 [(14,216,457 + 14,212,044) 2] = 0.40 OCFCX = $5,754,535 5,559,183 = 1.04


P4-56. (20 minutes) a. The positive adjustment of $314,872 thousand (say, $315 million) is caused by the

change in the amount that Groupon owes its merchants. When a customer purchases, Groupon gets the cash quickly and then waits to pay the merchants (recognizing the accrued merchant payable liability). If we add the fact that Groupon is growing very quickly, it means that the accrued merchant payable grows over the period. The adjustment reflects the fact that the merchant share of the amount collected from customers is $315 million more than the amount that Groupon paid to the merchants.

Will this continue into the future? Only if Groupon continues to grow and if its

payment terms to merchants remain unchanged. If Groupons growth went to zero, then the accrued merchant payable would level out and the change would go to zero. Likewise, if competitors forced Groupon to speed up its payments to merchants, the accrued merchant payable liability would decrease, and the companys ability to generate a positive cash flow from operations would be impaired.

In the risk factors section of the SEC document, Groupon states Our operating cash

flow and results of operations could be adversely impacted if we change our merchant payment terms or our revenue does not continue to grow.

b. While Groupon used $121 million in cash for investing activities, most of this was for

acquisitions of businesses and investments, rather than for capital expenditures (only about $30 million). The OCFCX ratio was $129,511 $29,825 = 4.34. Groupon appears to be growing more by acquisition than by organic growth.

c. Groupon used $353,550 thousand to repurchase its own common stock and another

$35,221 to redeem its own preferred stock, a total of about $389 million. This might prompt a financial statement reader to look at the related party transactions section of the companys filing with the SEC prior to its initial public offering. For example, in December 2010 and January 2011, Groupon issued new preferred stock in exchange for $942.2 million in cash. Of this amount, $132.4 million was retained in the company. The remaining $809.8 million was used to redeem shares of common and preferred stock, mostly from current and former board members and from entities that they control.

In the use of proceeds section of the SEC document, Groupon states Based on our

current cash and cash equivalents, together with cash generated from operations, we do not expect that we will utilize any of the net proceeds of this offering to fund operationsduring the next twelve months.


CASES AND PROJECTS C4-57. (30 minutes) The required debt to equity ratio allows for total liabilities to be up to $477 million. That is $477 / ($125+$148) =1.747 < 1.75. This implies total short-term borrowing of $107 million and an ending cash balance of $70 million.

LAMBERT CO. Statement of Cash Flows (projected)

Cash from operations Net income $ 18 Depreciation expense 120 Increase in accounts receivable . (40)

Decrease in inventory 20 Increase accounts payable .. 30 Decrease in income taxes payable . (10) Cash provided by (used in) operations .. $ 138

Cash from investing Acquisitions of property, plant and equipment (225) Disposal proceeds .. 75 Cash provided by (used in) investing . (150)

Cash from financing Issue long-term debt .. 80 Repay long-term debt .. (100) Common stock issue .. 25 Shareholder dividends (30) Increase (decrease) in short-term borrowing 57 Cash provided by (used in) financing .. 32 Net change in cash .. 20 Beginning cash balance . 50 Ending cash balance .. $ 70


C4-58. (45 minutes) a.

1 Accounts receivable (+A) 3,800 Sales revenue (+R,+SE) 3,800

2 Cash (+A) 3,500 Accounts receivable (-A) 3,500

3 Cost of goods sold (+E,-SE) 1,800 Inventory (-A) . 1,800

4 Inventory (+A) 1,200 Accounts payable (+L) .... 1,200

5 Accounts payable (-L) .. 1,100 Cash (-A) ... 1,100

6 Salaries and wages expense (+E,-SE) . 700 Salaries and wages payable (+L) . 700

7 Salaries and wages payable (-L) 730 Cash (-A) .... 730

8 Rent expense (+E,-SE). 200 Prepaid rent (-A) .. 200

9 Prepaid rent (+A) .. 600 Cash (-A) ... 600

10 Depreciation expense (+E,-SE) . 150 Accumulated depreciation (+XA,-A) . 150

11 Cash (+A) . 10 Accumulated depreciation (-XA,+A) 70 Fixtures and equipment (-A) 80

12 Fixtures and equipment (+A) .. 800 Cash (-A) .. 800

13 Interest expense (+E,-SE) .... 16 Cash (-A) .. 16

14 Bank loan payable (-L) ... 1,600 Cash (-A) .. 1,600

15 Cash (+A) .. 2,000 Long-term loan payable (+L) 2,000

continued next page


C4-58. continued

16 Income tax expense (+E,-SE) . 374 Taxes payable (+L) .. 374

17 Retained earnings (-SE) . 80 Cash (-A) 80

18 Revenue (-R) . 3,800 Cost of goods sold (-E) . 1,800 Salaries and wages expense (-E) 700 Rent expense (-E) 200 Depreciation expense (-E) 150 Interest expense (-E) .. 16 Income tax expense (-E) 374 Retained earnings (+SE) 560

Entry 18 closes revenue and expense accounts to retained earnings.

b.

+ Cash (A) - - Accounts Payable (L) + - Common Stock (SE) + 600 3,000 4,600

2 3,500 5 1,100 1,200 4 4,600 Bal 1,100 5 3,100 Bal 730 7 600 9 - Retained Earnings (SE)+

11 10 - Salaries and Wages + 1,300 800 12 Payable (L) 17 80 560 18 16 13 100 1,780 Bal 1,600 14 7 730 700 6

15 2,000 70 Bal 80 17 - Revenue (R) +

Bal 1,184 3,800 1 - Taxes Payable (L) + 18 3,800

0 0 Bal 374 16

+ Accounts Rec. (A) - 374 Bal + Cost of Goods Sold (E) - 6,500 3 1,800

1 3,800 3,500 2 - Bank Loan Payable (L) + 1,800 18 Bal 6,800 1,600 Bal 0

14 1,600 0 Bal + Salaries & Wages (E) -

+ Inventory (A) - 6 700 2,400 - Long-term Loan (L) + 700 18

4 1,200 1,800 3 0 Bal 0 Bal 1,800 2,000 15

2,000 Bal

continued next page


C4-58. concluded

+ Prepaid Rent (A) - + Rent Expense (E) - 0 8 200

9 600 200 8 200 18 Bal 400 Bal 0

+ Depreciation Exp. (E) -

10 150 150 18

+ Fixtures and - Bal 0 Equipment (A)

1,900 + Interest Expense (E) - 12 800 80 11 13 16

Bal 2,620 16 18 Bal 0

- Accum. Deprec. (XA) + + Income Tax Exp (E) -

800 16 374 11 70 150 10 374 18

880 Bal Bal 0 C4-59. (30 minutes) a. Depreciation and amortization are noncash expenses that are deducted in the

computation of net income. The depreciation and amortization add-back zeros these expenses out of the income statement to focus on operating cash flow. The positive amount for depreciation and amortization does not mean that the company is generating cash from depreciation and amortization, a common misconception. It is merely an adjustment to remove these expenses from net income to convert profit to cash flow.

b. Gains on disposals of asset are the result of investing activity, not operating activity,

but these gains are recognized in net income. When we start with net income in an indirect method cash from operations, subtracting the gain removes this investing item from the determination of cash from operations.

Daimler reports cash proceeds from disposals of PPE and intangible assets of 252

million. If the recognized gain is 102 million, then the book value of the assets disposed would be 150 million (= 252 million 102 million).

c. It does not. The adjustments can only be interpreted relative to the amounts that are

included in net income. The negative 2,328 million inventory adjustment means that Daimlers cost to acquire inventory for the year exceeded its cost of goods sold for the year by 2,328 million.

continued next page


C4-59. concluded d. Free cash flow ( millions): 696 $(4,158 252) = -4,602. Daimlers operating cash flow is negative, as is its free cash flow. We did not include

acquisition of intangible assets in the calculation. Doing so would have reduced free cash flow by another 1.7 billion. Daimler financed its investing activities by additions to long-term financing.

e. Daimlers cash flow from operating activities is negative, as is its cash flow from

investing activities. It generated a positive cash flow of 5,842 million from financing activities. As a result, the net decrease in cash was 1,327million. Daimler appears to be strong enough to withstand a reduction in cash of this magnitude, especially given that it has a record (in 2010 and 2009) of reporting very positive cash flows from operations.

To be thorough in analyzing Daimlers liquidity and solvency, one would want to ask

why operating cash flows were negative. A closer look at the companys business segments reveals that the Industrial Business had cash from operations of 7.3 billion and free cash flow of about 3.4 billion. Daimler Financial Services had cash from operations of (8.0) billion, resulting from large increases in financial services receivables and vehicles on operating leases. In its analysis of cash flows, Daimler reports that The positive effect from the improvement in net profit before income taxes was reduced in particular by increased new business in leasing and sales financing as well as by significantly higher allocations to the pension funds.

CH4!

Documents

Transcript of CH4!