13
Statement Chapter of Cash Flows
ANSWERS TO QUESTIONS
1. The income statement reports revenues earned and expenses incurred during a period of time. It is prepared on an accrual basis. The balance sheet reports the assets, liabilities, and equity of a business at a point in time. The statement of cash flows reports cash receipts and cash payments of a business, from three broad categories of business activities: operating, investing, and financing. The statement of cash flows reports cash receipts and cash payments from three broad categories of business activities: operating, investing, and financing. While the income statement reports operating activities, it reports them on the accrual basis: revenues when earned, and expenses when incurred, regardless of the timing of the cash received or paid. The statement of cash flows reports the cash flows arising from operating activities. The balance sheet reports assets, liabilities, and equity at a point in time. The statement of cash flows and related schedules indirectly report changes in the balance sheet by reporting operating, investing, and financing activities during a period of time, which caused changes in the balance sheet from one period to the next. In this way, the statement of cash flows reports information to link together the financial statements from one period to the next, by explaining the changes in cash and other balance sheet accounts, while summarizing the information into operating, investing, and financing activities. Cash equivalents are short-term, highly liquid investments that are purchased within three months of the maturity date. The statement of cash flows does not separately report the details of purchases and sales of cash equivalents because these transactions affect only the composition of total cash and cash equivalents, not the total amount. The statement of cash flows reports the change in total cash and cash equivalents from one period to the next. The major categories of business activities reported on the statement of cash flows are operating, investing, and financing activities. Operating activities of a business arise from the production and sale of goods and/or services. Investing activities arise from acquiring and disposing of property, plant, and equipment and investments. Financing activities arise from transactions from investors and creditors.
2.
3.
4.
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5.
Cash inflows from operating activities include cash sales, collections on accounts, and notes receivable arising from sales, dividends on investments, and interest on loans and investments. Cash outflows from operating activities include payments to suppliers and employees, and payments for operating expenses, taxes, and interest. Depreciation expense is added to net income to adjust for the effects of a noncash expense that was deducted in determining net income. It does not involve an inflow of cash. Cash expenditures for purchases and salaries are not reported on the statement of cash flows, indirect method, because that method does not report cash inflows and outflows for each operating activity. Rather, it reports only net income, changes in accounts payable and wages payable, and net cash flow from operating activities. The $50,000 increase in inventory must be used in the statement of cash flows calculations because it increases the outflow of cash all other things equal. It is used as follows: Direct methodadded to cost of goods sold, accrual basis (the other adjustment would involve accounts payable) to compute cost of goods sold, cash basis. Indirect methodsubtracted from net income as a reconciling item to obtain cash flows from operating activities. The two methods of reporting cash flows from operating activities are the direct method and the indirect method. The direct method reports the gross amounts of cash receipts and cash payments arising from the revenues and expenses reported on the income statement. The indirect method reports the net amount of cash provided or used by operating activities, by reporting the adjustments to net income for the net effects of noncash revenues and expenses, and changes in accruals and deferrals. The two approaches differ in the way they report cash flows from operating activities, but are similar in that the final result, net cash provided by operating activities, is the same amount.
6.
7.
8.
9.
10. Cash inflows from investing activities include cash received from sale of operational assets, sale of investments, maturity value of bond investments, and principal collections on notes receivable. Cash outflows from investing activities include cash payments to purchase property, plant, and equipment and investments, and to make loans. 11. Cash inflows from financing activities include cash received from issuing stock, the sale of treasury stock, and borrowings. Cash outflows from financing activities include cash payments for dividends, the purchase of treasury stock, and principal payments on borrowing.
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12. Noncash investing and financing activities are activities that would normally be classified as investing or financing activities, except no cash was received or paid. Examples of noncash investing and financing include the purchase of assets by issuing stock or bonds, the repayment of loans using noncash assets, and the conversion of bonds into stock. Noncash investing and financing activities are not reported in the statement of cash flows, because there was no cash received or cash paid; however, the activities are disclosed in a separate schedule. 13. When equipment is sold, it is considered an investing activity, and any cash received is reported as a cash inflow from investing activities. When using the direct method, the cash received from the sale of equipment is reported as an investing cash inflow. When using the indirect method, the gain on sale of equipment must be reported as a deduction from net income, because the gain was included in net income, but did not provide any cash from operating activities. The cash received is reported in the investing activities section of the statement of cash flows. If the equipment was sold at a loss, the cash received is reported as a cash inflow from investing activities when using the direct method. When using the indirect method, the loss on sale of equipment is added to net income because the loss was included in net income but did not require an operating cash outflow. The cash received is reported as an investing cash inflow.
ANSWERS TO MULTIPLE CHOICE
1. b) 6. b) 2. d) 7. d) 3. d) 8. a) 4. a) 9. d) 5. a) 10.c)
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Authors' Recommended Solution Time
(Time in minutes) Alternate Problems No. Time 1 30 2 60 Cases and Projects No. Time 1 20 2 15 3 25 4 30 5 35 6 *
Mini-exercises No. Time 1 5 2 5 3 5 4 5 5 5 6 5 7 5
Exercises No. Time 1 10 2 15 3 15 4 15 5 15 6 15 7 20 8 20 9 10 10 15 11 20 12 20 13 25 14 20 15 25 16 20 17 15 18 10 19 20 20 40
Problems No. Time 1 25 2 45 3 25 4 30 5 55
* Due to the nature of these cases and projects, it is very difficult to estimate the amount of time students will need to complete the assignment. As with any open-ended project, it is possible for students to devote a large amount of time to these assignments. While students often benefit from the extra effort, we find that some become frustrated by the perceived difficulty of the task. You can reduce student frustration and anxiety by making your expectations clear. For example, when our goal is to sharpen research skills, we devote class time discussing research strategies. When we want the students to focus on a real accounting issue, we offer suggestions about possible companies or industries.
MINIEXERCISES
M131. I F O O O F
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1. 2. 3. 4. 5. 6.
Proceeds from sale of properties. Purchase of stock. (This involves repurchase of its own stock.) Depreciation, depletion, and amortization. Accounts payable (decrease). Inventories (decrease). Principal payment on long-term debt.
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M132. + + + M13-3. F F I O O F 1. 2. 3. 4. 5. 6. Repayments of borrowings (bank debt). Dividends paid. Proceeds from sale of property, plant and equipment. Net interest paid. Receipts from customers. Payment for share buy-back. 1. 2. 3. 4. 5. Depreciation, depletion, and amortization. Inventories (increase). Accounts payable (decrease). Accounts receivable (decrease). Accrued expenses (increase).
M134. Quality of income ratio = Cash flow from operations = $60,000 Net income $80,000
= 0.75 (75%)
The quality of income ratio measures the portion of income that was generated in cash. The low ratio indicates a likely need for external financing. M135. Investing Activities Sale of used equipment Purchase of short-term investments Cash used in investing activities M136. Financing Activities Additional short-term borrowing from bank Dividends paid Cash provided by financing activities $1,000 (800) $ 200 $ 250 (300) $ (50)
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M137. Yes No Yes No Purchase of equipment with short-term investments Dividends paid in cash Purchase of building with mortgage payable Additional short-term borrowing from bank
EXERCISES
E131. O I F O I F F O O F E132. 1. 2. 3. 4. 5. 6. 7. 8.
1. Depreciation. 2. Additions to property, plant, and equipment. 3. Increase (decrease) in notes payable. (The amount is owed to financial institutions.) 4. (Increase) decrease in other current assets. 5. Disposal of property, plant, and equipment. 6. Reductions in long-term debt including current portion. 7. Repurchase of stock. 8. (Increase) decrease in inventory. 9. Net income. 10. Additions to long-term debt.
NCFI NE + NCFO NE NCFO NCFF NCFO + NCFI
Plant and equipment Cash Inventory Accounts payable Cash Accounts receivable Salaries expense Accrued salaries payable Interest expense Cash Short-term debt Cash Prepaid expenses (rent) Cash Cash Accumulated depreciation Plant and equipment
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9. 10.
NCFO NCFF
Accounts payable Cash Retained earnings Cash
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E133. 1. 2. NCFO + NCFF Income tax expense Cash Cash Common stock Additional paid-in capital 3. 4. 5. 6. 7. 8. 9. 10. NCFO NE NCFI + NCFF + NCFO NE NCFO NE Prepaid expenses (rent) Cash Expense Prepaid expense Plant and equipment Cash Cash Long-term Debt Cash Accounts receivable Inventory Accounts payable Salary expense Cash Plant and equipment Note payable
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E134. While depreciation is indeed added to net income to compute cash flow from operating activities, the new controller's idea will not work. If depreciation expense is increased, net income will decrease by exactly the same amount. When depreciation is added to the new net income number, the sum will be exactly the same as the amount that was computed before depreciation was increased. The only way to increase cash flow is to increase revenues, decrease expenses (other than depreciation), or improve the efficiency of operations (such as collecting receivables more quickly or operating with less inventory). E135. Comparison of Statement of Cash Flows direct and indirect reporting Statement of Cash Flows Method (and related changes) Direct Indirect Cash collections from customers X Accounts receivable increase or decrease X Payments to suppliers X Inventory increase or decrease X Accounts payable increase or decrease X Payments to employees X Wages payable, increase or decrease X Depreciation expense X Net income X Cash flows from operating activities X X Cash flows from investing activities X X Cash flows from financing activities X X Net increase or decrease in cash during the period X X Cash flows
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.
The direct method reports cash flows from operating activities individually for each major revenue and expense. In contrast, the indirect method reports a reconciliation of net income to cash flow from operating activities. The two methods report the investing and financing activities in exactly the same way.
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E136. Cash flows from operating activitiesindirect method Net income................................................................................................. Depreciation expense................................................................................ Accounts receivable increase .................................................................. Merchandise inventory decrease.............................................................. Salaries payable increase......................................................................... Net cash provided by operating activities............................................ E137. Req. 1 Cash flows from operating activitiesindirect method Net loss...................................................................................................... Depreciation expense................................................................................ Amortization of copyrights......................................................................... Accounts receivable decrease ................................................................. Salaries payable increase......................................................................... Other accrued liabilities decrease............................................................ Net cash provided by operating activities............................................ Req. 2 The first reason for the net loss was the depreciation expense. This is a non-cash expense. Depreciation expense, along with decreased working capital requirements (current assets - current liabilities), turned the net loss into positive operating cash flow from operations. The reasons for the difference between net income and cash flow are important because they help the financial analyst to determine if the trends are sustainable or whether they represent one-time events. ($8,000) 7,000 300 12,000 9,000 (4,000) $16,300 $12,000 6,000 (5,000) 8,000 500 $21,500
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E138. Req. 1 Cash flows from operating activitiesindirect method Net loss..................................................................................................... Depreciation and amortization................................................................. Increase in receivables............................................................................ Decrease in inventories............................................................................ Increase in prepaid expense.................................................................... Decrease in accounts payable................................................................. Decrease in accrued liabilities................................................................. Increase in income taxes payable............................................................ Cash flows from operating activities................................................... ($9,482) 33,305 (170) 643 (664) (2,282) (719) 1,861 $22,492
Note: The reduction of long-term debt and additions to equipment do not affect cash flows from operating activities. Req. 2 The primary reason for the net loss was the depreciation and amortization expense. These represent non-cash expenses. Large depreciation and amortization expense, offset partially by increased working capital requirements, turned Sizzlers net loss into positive operating cash flow. The reasons for the difference between net income and cash flow from operations are important because they help the financial analyst to determine if the trends are sustainable or whether they represent one-time events.
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E139. Account Receivables Inventories Other current assets Payables E1310. Account Accounts receivable Inventories Other current assets Accounts payable Income taxes payable Other current liabilities E1311. Req. 1 Cash flows from operating activitiesdirect method Cash collected from customers1 Cash payments to employees2 Cash paid for other expenses3 Net cash provided by operating activities............................................ 1. Cash collected from customers = $50,000 + 12,000 = 62,000 2. Cash payments to employees = $42,000 9,000 = 33,000 3. Cash paid for other expenses = $7,000 + 1,700 + 4,000= 12,700 Req. 2 The first reason for the net loss was the depreciation expense. This is a non-cash expense. Depreciation expense, along with decreased working capital requirements (current assets - current liabilities), turned the net loss into positive operating cash flow. The reasons for the difference between net income and cash flow are important because they help the financial analyst to determine if the trends are sustainable or whether they represent one-time events. $62,000 (33,000) (12,700) $16,300 Change Increase Decrease Decrease Increase Increase Increase Change Increase Decrease Decrease Decrease
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E1312. Req. 1 Cash flows from operating activitiesdirect method Cash collected from customers1 Cash payments to employees Cash payments to suppliers2 Cash payments for other expenses3 Cash payments for income tax4 Net cash provided by operating activities 1. 2. 3. 4. Req. 2 The primary reason for the net loss was the depreciation and amortization expense. These represent non-cash expenses. Large depreciation and amortization expense, offset partially by increased working capital requirements, turned Sizzlers net loss into positive operating cash flow. The reasons for the difference between net income and cash flow from operations are important because they help the financial analyst to determine if the trends are sustainable or whether they represent one-time events. Cash collected from customers: $136,500 170 = 136,330 Cash payments to suppliers: 45,500 643 + 2,282 = 47,139 Cash payments for other expenses: 7,781 + 664 + 719 = 9,164 Cash payments for income taxes: 2,561 1,861 = 700 $136,330 (56,835) (47,139) (9,164) (700) $22,492
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E1313. Req. 1 Cash flows from operating activitiesindirect method Net income................................................................................................. Depreciation and amortization.................................................................. Increase in accounts receivable................................................................ Increase in inventory................................................................................. Decrease in prepaid expense................................................................... Increase in accounts payable................................................................... Decrease in taxes payable........................................................................ Decrease in other current liabilities.......................................................... Cash flows from operating activities................................................... $1,587.9 1,444.2 (161.0) (89.5) 3.3 143.2 (125.1) (96.7) $2,706.3
Note: The cash dividend paid and treasury stock purchased are not related to operating activities and do not affect cash flows from operating activities. The decrease in other current liabilities was not explained in the PepsiCo annual report, so its proper inclusion in this computation is a judgment call. If it was not related to operations, it should not be included in the previous computation. In reality, PepsiCo included the decrease on its statement of cash flows. Req. 2 Quality of income ratio = Cash flow from operations = $2,706.3 Net income $1,587.9 Req. 3 The reason the quality of income ratio was significantly greater than one was because of large non-cash depreciation charges, offset by modest increases in working capital. = 1.70
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E1314. The investing and financing sections of the statement of cash flows for Rowe Furniture: Cash flows from investing activities: Purchase of property, plant & equipment........................... Sale of marketable securities............................................... Proceeds from sale of property & equipment.................... Net cash flows from investing activities........................ Cash flows from financing activities: Borrowings under line of credit............................................ Proceeds from issuance of common stock........................ Payments on long term debt................................................ Payment of dividends............................................................ Purchase of treasury stock................................................... Net cash flows from financing activities....................... E1315. Req. 1 The investing and financing sections of the statement of cash flows for Gibraltar Steel Corporation: Cash flows from investing activities: Purchase of property, plant & equipment........................... (10,468) Sale of marketable securities............................................... 131 Proceeds from sale of property & equipment.................... 1,817 Net cash flows from investing activities........................ (8,520) Cash flows from financing activities: Proceeds from notes payable.............................................. 3,848 Proceeds from issuance of long-term debt........................ 10,242 Proceeds from initial public offering of common stock.... 26,061 Payments on long-term debt................................................ (17,832) Payment of notes payable.................................................... (8,598) Net cash flows from financing activities....................... 13,721 Req. 2 Gibraltars management is using the cash proceeds from the initial public offering for two purposes. First, it is using the funds to finance the Companys investment in property, plant & equipment. Second, some of the funds are being used to alter the Companys capital structure, as common stock is being used to pay down long-term debt. (871) 134 6,594 5,857 1,417 11 (46) (277) (1,583) (478)
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E1316. Req. 1 Capital acquisitions ratio = Cash flow from operations = Cash Paid for Plant & Equipment Req. 2 The capital acquisitions ratio measures the company's ability to finance plant and equipment purchases from operations. Since this amount was less than 1 (0.81), the remainder, or 19%, must have been financed from external sources or preexisting cash balances. Req. 3 During year 3, Petes completed an initial public offering of its common stock. $2,900 $3,581 = 0.81
E1317. Req. 1 Both of these transactions are considered noncash investing and financing activities, and are not reported on the statement of cash flows. The transactions must be disclosed in a separate schedule or in the footnotes. The information disclosed in the separate schedule would state: a. Equipment valued at $26,000 was acquired by giving a $15,000, 12%, two-year note, and common stock with a market value of $11,000. b. A machine valued at $8,700 was acquired by exchanging land with a book value of $8,700. Req. 2 The capital acquisitions ratio measures the company's ability to finance plant and equipment purchases from operations. Since neither of these transactions enters the numerator or denominator of the ratio, they would have no effect. Many analysts believe that these transactions represent important capital acquisitions, and thus should be included in the denominator of the ratio to indicate what portion of all (not just cash) acquisitions are being financed from operations.
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E1318. Proceeds from sale of property Year 3 $14,768 Year 2 $11,623 Year 1 $1,797
The amounts reported as proceeds from the sale of property are the cash flows for each year. The gain on the sale of property is subtracted from net income to avoid double counting of the gain. The amount reported in the cash flow from investing activities section of the statement of cash flows is the total cash flow associated with the sale. E1319. Equipment $12,500 $4,500*Sold $ 8,000 Accumulated Depreciation $2,000 Beg. Bal. $300* 700 Dep. Exp. $2,400 End. Bal.
Beg. Bal. End. Bal.
Sold
*plug figures Cost of equipment sold = $4,500 Accumulated depreciation on sold equipment = $300 Book value of sold equipment............... $4,200 Less: Loss on sale (given)..................... (3,000) Cash received from sale....................... $1,200
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E1320. Balances Item 12/31/2003 Cash plus short-term investments 20,500 Noncash accounts: Accounts receivable (net)............ 22,000 Merchandise inventory................ 68,000 Investments, long term................ Equipment.................................... 114,500 Total............................................ 225,000 Accumulated depreciation........... 32,000 Accounts payable........................ 17,000 Wages payable............................ 2,500 Income taxes payable.................. 3,000 Bonds payable............................. 54,000 Common stock, no par................. Retained earnings....................... Total............................................ 100,000 16,500 k 225,000 12,000 Inflows a c g 20,200 3,000 e f 1,500 h d i j l 6,000 6,000 k 1,300 ($1,300) 12,000 (6,000) 7,000 15,000 (9,000) $13,700 3,000 1,000 Analysis Debit Credit l 1,300 h d b i e f 7,000 15,000 20,000 15,000 3,000 1,000 Balances 12/31/2004 19,200 22,000 75,000 15,000 113,500 244,700 20,000 14,000 1,500 4,500 54,000 126,000 24,700 244,700
i c g j b a
21,000 3,000 1,500 6,000 20,000 20,200 Outflows
Statement of Cash Flows Conversion of net income to cash flow from operating activities: Net income Depreciation expense Accounts payable decrease Wages payable decrease Income taxes payable increase Inventory increase Cash flows from investing activities: Long-term investment purchased Sale of equipment Cash flows from financing activities: Sale of capital stock Dividends paid Net increase (decrease) in cash Totals
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PROBLEMS
P131. Frank Corporation Statement of Cash Flows For the Year Ended December 31, 2004 Cash flows from operating activities: Net income................................................................................................. $42,000 Add (deduct) to convert to cash basis: Depreciation expense............................................................................... Accounts 9,200 receivable increase ($17,000 $12,000)................................ (5,000) Accounts payable decrease ($10,000 $7,000)..................................... (3,000) Inventory decrease ($60,000 $52,000)................................................. 8,000 Wages payable decrease ($1,000 $800).............................................. (200) Income tax payable increase ($5,000 $3,000)...................................... 2,000 Net cash flow from operating activities................................................ Cash flows from investing activities: Machinery sold................................................................. 11,000 Machinery purchased*..................................................... (9,000) Investments purchased.................................................... (5,000) Net cash flow from investing activities................................................. Cash flows from financing activities: Borrowed on long-term note payable.............................. 15,000 Paid a cash dividend........................................................ (10,000) Net cash flow from financing activities........................ Net increase in cash during 2004.......................................... Cash, beginning of 2004........................................................ Cash, end of 2004.................................................................. ADDITIONAL CASH FLOW INFORMATION During 2004, the company also purchased machinery for $41,000 that was financed with a four-year note payable to the dealer. Income taxes paid were $9,800.** Interest paid was $12,200. *Note that the $41,000 non-cash portion of the purchase and the related financing are not reported in the statement. They are reported separately in the note. **Income taxes paid = Income tax expense Increase in income taxes payable.
$53,000
(3,000)
5,000 55,000 21,000 $76,000
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P132. ROCKY MOUNTAIN CHOCOLATE FACTORY, INC. Statement of Cash Flows For the Quarter Ended May 31, 1996 Cash flows from operating activities: Net income (accrual basis; from statement of income).... $ 163,837 Add (deduct) to reconcile net income to net cash flow: Depreciation expense.......................................................... 276,304 Amortization expense........................................................... 5,901 Accounts receivable increase............................................. (138,681) Inventories increase............................................................. (243,880) Other current assets increase............................................. (357,507) Accounts payable increase................................................. 280,935 Accrued liabilities increase.................................................. 164,087 Income taxes payable decrease......................................... (43,031) Long-term A/R decrease...................................................... 11,382 Net cash inflow from operating activities.................... Cash flows from investing activities: Fixed assets purchased.................................................. (1,081,121) Other assets decrease......................................................... 50,055 Net cash inflow from operating activities Cash flows from financing activities: Repayment of short-term debt........................................ (1,000,000) Repayment of long-term debt.............................................. (2,355,029) Issuance of long-term debt............................................. 4,659,466 Net cash inflow from financing activities..................... Net increase in cash during the quarter................................. Cash, February 29, 1996....................................................... Cash, May 31, 1996...............................................................
$ 119,347
(1,031,066)
1,304,437 392,718 528,787 $ 921,505
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P133. Frank Corporation Statement of Cash Flows For the Year Ended December 31, 2004 Cash flows from operating activities: $395,000 Cash collected from customers (400,000 5,000) Cash paid to suppliers (268,000 + 3,000 8,000) (263,000) Cash paid to employees (51,000 + 200) (51,200) Cash paid for rent (5,800) Cash paid for interest (12,200) Cash paid for income taxes (11,800 - 2,000) (9,800) Net cash flow from operating activities................................................ Cash flows from investing activities: Machinery sold................................................................. 11,000 Machinery purchased*..................................................... (9,000) Investments purchased.................................................... (5,000) Net cash flow from investing activities................................................. Cash flows from financing activities: Borrowed on long-term note payable.............................. 15,000 Paid a cash dividend........................................................ (10,000) Net cash flow from financing activities........................ Net increase in cash during 2004.......................................... Cash, beginning of 2004........................................................ Cash, end of 2004.................................................................. ADDITIONAL CASH FLOW INFORMATION During 2004, the company also purchased machinery for $41,000 that was financed with a four-year note payable to the dealer. Income taxes paid were $9,800.** Interest paid was $12,200. *Note that the $41,000 non-cash portion of the purchase and the related financing are not reported in the statement. They are reported separately in the note. **Income taxes paid = Income tax expense Increase in income taxes payable.
$53,000
(3,000)
5,000 55,000 21,000 $76,000
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P134. Req. 1 BETA COMPANY Cash Flows from Operating Activities Direct Method Cash flows from operating activities: Cash receipts from customers.................................................................. Cash payments to suppliers..................................................................... Cash payments for salaries...................................................................... Cash payments for rent............................................................................ Cash payments for insurance.................................................................. Cash payments for utilities....................................................................... Cash payments for bond interest............................................................. Net cash provided by operating activities.......................................... Req. 2 BETA COMPANY Cash Flows from Operating Activities Indirect Method Cash flows from operating activities: Net loss............................................................................ Adjustments to reconcile net loss to net cash provided by operating activities: Decrease in accounts receivable................................... Increase in merchandise inventory................................. Increase in accounts payable......................................... Depreciation expense..................................................... Increase in salaries payable........................................... Decrease in rent payable................................................ Decrease in prepaid rent................................................ Increase in prepaid insurance........................................ Loss on sale of investments........................................... Total adjustments........................................................... Net cash provided by operating activities..................
$20,670 (8,992) (4,991) (2,499) (809) (700) (600) $ 2,079
$ (400) $ 70 (22) 30 2,000 9 (4) 5 (9) 400 2,479 $2,079
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P135. Req.1 Statement of Cash Flows Spreadsheet Hunter Company For the Year Ended December 31, 2004 12-31-2003 BALANCE SHEET Cash Accounts receivable Merchandise inventory Fixed assets-net Total Accounts payable Wages payable Notes payable, long-term Common stock-no par Retained earnings Total 18,000 29,000 36,000 72,000 155,000 22,000 1,000 48,000 60,000 24,000 155,000 DR 26,000 (k) 9,000 (g) 2,000 (b) 6,000 (c) 6,000 (e) 3,000 (d) 200 (f) 10,000 (h) 3,800 (j) 49,000 20,000 (i) 12,000 (a) 49,000 CR 12-31-2004 44,000 27,000 30,000 75,000 176,000 25,000 800 38,000 80,000 32,200 176,000
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P135. (continued) STATEMENT OF CASH FLOWS-INDIRECT METHOD Inflow Cash flows from operating activities: Net income Adjustment to net income Decrease in accounts receivable Decrease in merchandise inventory Increase in accounts payable Depreciation expense Decrease in wages payable Cash flows from investing activities: Cash payment to purchase fixed assets Cash flows from financing activities: Cash payments on long-term note Cash receipts from issuing stock Cash payments for dividends Increase (decrease) in cash during the year Totals Cash balance, Jan. 1 Cash balance, Dec. 31 12,000 (a) 2,000 6,000 3,000 6,000 (b) (c) (d) (e) 200 (f) 9,000 (g) 10,000 (h) 20,000 (i) 3,800 (j) 49,000 26,000 (k) 49,000 6,200 26,000 28,800 (9,000) Outflow
18,000 44,000
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P35. (continued) Req. 2 HUNTER COMPANY Statement of Cash Flows For the Year Ended December 31, 2004 Cash flows from operating activities: Net income....................................................................... Adjustments to reconcile net income to net cash provided by operating activities: Decrease in accounts receivable................................... Decrease in merchandise inventory............................... Increase in accounts payable......................................... Depreciation expense..................................................... Decrease in wages payable........................................... Total adjustments............................................................. Net cash provided by operating activities.................. Cash flows from investing activities: Cash payments to purchase fixed assets........................ Cash flows from financing activities: Cash payments on long-term note.................................. Cash receipts from issuing stock..................................... Cash payments for dividends.......................................... Net cash provided by financing activities................... Net increase in cash during the year..................................... Cash balance, January 1, 2004............................................. Cash balance, December 31, 2004....................................... Req. 3 There were no noncash investing and financing activities during 2004. $12,000 $ 2,000 6,000 3,000 6,000 (200) 16,800 28,800 (9,000) (10,000) 20,000 (3,800) 6,200 26,000 18,000 $44,000
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ALTERNATE PROBLEMS
AP131. STONEWALL COMPANY Statement of Cash Flows For the Year Ended December 31, 2003 Cash flows from operating activities: Net income (accrual basis; from statement of income)... Add (deduct) to reconcile net income to net cash flow: Accounts receivable increase.......................................... Inventory increase........................................................... Accounts payable increase.............................................. Accrued expenses payable increase............................... Depreciation expense...................................................... Net cash inflow from operating activities.................... Cash flows from investing activities: Machinery purchased...................................................... Cash flows from financing activities: Issuance of capital stock................................................. Borrowed on short-term note payable............................. Paid a cash dividend........................................................ Net cash inflow from financing activities..................... Net increase in cash during 2003.......................................... Cash, beginning of 2003........................................................ Cash, end of 2003*................................................................. ADDITONAL CASH FLOW INFORMATION During 2003, the company also exchanged plant machinery with a book value of $2,000 for office machines with a market value of $2,000. $ 9,000 (18,000) (15,000) 10,000 21,000 4,000 $11,000 (29,000) 54,000 15,000 (3,000) 66,000 48,000 0 $48,000
*Because this is the first year of operations, all account balances are zero at the beginning of the year; therefore, the changes in the account balances were equal to the ending balances. The $48,000 agrees with the cash account.
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AP132. Req.1. Statement of Cash Flows Spreadsheet Ellington Company For the Year Ended December 31, 2004 BALANCE SHEET Cash Accounts receivable Inventory Prepaid insurance Investments, long term Fixed assets-net Patent Total Accounts payable Wages payable Income tax payable Note payable, long-term Common stock-$10 par Contributed capital Retained earnings Total 12-31-2003 21,000 18,000 35,000 2,400 12,500 31,100 2,000 122,000 27,000 4,000 2,000 20,000 50,000 3,000 16,000 122,000 DR 1,400 (n) 3,000 (b) CR 3,000 1,000 3,200 4,500 500 (h) (e) (j) (c) (d) 12-31-2004 22,400 21,000 32,000 1,400 9,300 59,600 1,500 147,200 15,000 1,000 2,200 10,000 80,000 6,000 33,000 147,200
33,000 (k)
12,000 (i) 3,000 (f) 200 (g) 10,000 (l) 8,500 (m) 70,900 30,000 (k) 3,000 (k) 25,500 (a) 70,900
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AP132. (continued) STATEMENT OF CASH FLOWS-INDIRECT METHOD Inflow DR Cash flows from operating activities: Net income Adjustment to net income: Increase in accounts receivable Depreciation expense Patent amortization Decrease in prepaid insurance Decrease in wages payable Increase in income tax payable Decrease in inventory Decrease in accounts payable Cash flows from investing activities: Cash receipts from sale of longterm investments Cash flows from financing activities: Cash payments on long-term note payable Cash payments for dividends Increase (decrease) in cash during the year Totals Cash balance, Jan. 1, 2004 Cash balance, Dec. 31, 2004 25,500 (a) 3,000 (b) 4,500 (c) 500 (d) 1,000 (e) 3,000 (f) 200 (g) 3,000 (h) 12,000 (i) 16,700 Outflow CR
3,200 (j)
3,200
10,000 (l) 8,500 (m) 1,400 (n) 37,900
( 18,500) 1,400 21,000 22,400
37,900
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AP132. (continued) Req. 2 ELLINGTON COMPANY Statement of Cash Flows For the Year Ended December 31, 2004 Cash flows from operating activities: Net income....................................................................... Adjustments to reconcile net income to net cash............ provided by operating activities: Increase in accounts receivable..................................... Depreciation expense..................................................... Patent amortization......................................................... Decrease in prepaid insurance....................................... Decrease in wages payable........................................... Increase in income tax payable...................................... Decrease in inventory..................................................... Decrease in accounts payable....................................... Total adjustments............................................................. Net cash provided by operating activities.................. Cash flows from investing activities: Cash receipts from sale of long-term investments.......... Cash flows from financing activities: Cash payments on long-term note payable..................... Cash payments for dividends.......................................... Net cash used by financing activities......................... Net increase in cash during the year..................................... Cash balance, January 1, 2004............................................. Cash balance, December 31, 2004....................................... Req. 3 Schedule of Noncash Investing and Financing Activities The company issued common stock with a market value of $33,000 in exchange for fixed assets. $25,500 $ (3,000) 4,500 500 1,000 (3,000) 200 3,000 (12,000) (8,800) 16,700 3,200 (10,000) (8,500) (18,500) 1,400 21,000 $22,400
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CASES AND PROJECTS
FINANCIAL REPORTING AND ANALYSIS CASES CP131. 1. 2. 3. The company uses the indirect method. Tax payments of $37,362 thousand were made (Note 2, Supplemental Disclosures of Cash Flow Information). Stock compensation is a noncurrent accrued expense (an expense paid with common stock) like depreciation expense. It was added back to net income because this type of expense does not cause a cash outflow when it is recorded. Loss on impairment and write-off of fixed assets relates to an investing activity and did not affect cash. Like noncurrent accrued expenses, this loss must be added back to net income because it does not cause a cash outflow when it is recorded. Free Cash Flow was $62,766 thousand, calculated as (in thousands): Cash Flows from Operating Activities less Dividends less Capital Expenditures Free Cash Flow 5. $150,59 1 0 87,825 $62,766
4.
No, the company has not paid cash dividends during the last three years. There are no dividend payments listed under the Financing section of the statement of cash flows.
CP132. 1. The three largest Adjustments to reconcile net income to net cash provided by operating activities were: (a) Increase in inventories: the increase of $45,735 was subtracted from net income in the reconciliation because purchases of inventories were greater than the amount of inventory sold. (b) Depreciation and amortization: the $30,731 expense was added to net income in the reconciliation because it is a noncurrent accrued expense, which does not cause a cash outflow when it is recorded. (c) Increase in accounts payable and accrued liabilities: the $21,626 increase is added back to net income because actual payments were less than the expense recognized.
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CP132. (continued) 2. Abercrombie & Fitchs major uses of cash over the past three years have been capital expenditures, repurchases of treasury stock, and purchases of inventories. The major source of cash for these activities has been cash flow provided by operating activities. Over the next few years, the company expects to incur additional capital expenditures to support its planned expansion. The primary sources of financing these future expenditures are expected to be future cash flows provided by operating activities (as well as existing cash and cash equivalents). This is discussed in the capital expenditures section of Managements Discussion and Analysis. Free Cash Flow was $5,723 thousand, calculated as (in thousands): Cash Flows from Operating Activities less Dividends less Capital Expenditures Free Cash Flow $151,18 9 0 153,481 $(2,292)
3.
This implies that the company is limited in its financial flexibility, although the negative free cash flow balance is mitigated by the high level of current cash and cash equivalents.
CP133. 1. Quality of = Cash flow from operations income ratio Net income Abercrombie & Fitch $151,189 = 0.96 158,133 American Eagle Outfitters $150,591 = 1.61 93,758
American Eagle Outfitters has a higher quality of income ratio than does Abercrombie & Fitch. This difference might be explained by fact that American Eagle significantly increased its short-term liabilities in the 2000 fiscal year (they increased from $88,425 to $149,147, or 69%), while Abercrombie & Fitch did not have a similar dramatic increase.
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CP133. (continued) 2. Quality of Income = Industry Average 1.61 Abercrombie & Fitch 0.96 American Eagle Outfitters 1.61
Abercrombie & Fitchs quality of income ratio is below the industry average, while American Eagle Outfitters quality of income ratio is equal to the industry average. Two things affect this ratio: the fact that these two companies are growing rapidly (see below), and the effect of operating leases on the cash flow statement. Because these companies rely primarily on operating leases for their stores, all of rent expense is included in Operating Cash Flows, whereas for other companies in the industry that own their stores, depreciation is added back to CFO. Industry Average 9.04% Abercrombie & Fitch 20.1%* American Eagle Outfitters 31.4%**
Sales Growth =
* ($1,237,604 1,030,858) / 1,030,858 ** ($1,093,477 832,104) / 832,104 Sales growth helps us explain some of the difference in the quality of income ratio. Both of these companies are in high growth mode, and are spending cash to advertise and build inventories in anticipation of higher sales in the future. 3. Capital = Cash flow from operations acquisitions Cash Paid for Plant & ratio Equipment Abercrombie & Fitch $151,189 = 0.99 153,481 American Eagle Outfitters $150,591 = 1.72 87,825
American Eagle Outfitters has a higher capital acquisitions ratio than does Abercrombie & Fitch. This implies that American Eagle Outfitters has a greater ability to fund additional capital expenditures from the cash flow provided by its operating activities. 4. Capital Acquisitions = Industry Average 0.65 Abercrombie & Fitch 0.99 American Eagle Outfitters 1.71
Both American Eagle Outfitters and Abercrombie & Fitchs Capital Acquisitions ratios are higher than the industry average. This implies that both companies have a greater ability to fund additional capital expenditures from the cash flow provided by their operating activities than the average company in the industry.
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CP134. 1. The company uses an indirect method to present the operating section of the cash flow statement. Note 32 presents the reconciliation of income (in this case, beginning with operating profit) to cash flows from operating activities. Some of the terms used in the statement may be unfamiliar to U.S. students. The statement itself is a "group cash flow statement, compared to Boston Beers consolidated statement. In the reconciliation of net income to cash flow from operations, the changes in the typical balance sheet accounts are listed but may not be easily identified as such: decrease in stocks (inventory), decrease in debtors (accounts receivable), and decrease in creditors (accounts payable). Differences also exist in the structure of the statement. Consider cash flows from operating activities. Cash flow from operating activities is presented in a note to the financial statements, not on the statement itself. Cash flow from operating activities is divided between cash from ordinary operating activities and unusual items. Interest received and interest paid are listed under returns on investments and servicing of finance rather as part of operating activities. Taxation payments are also listed separately. In Boston Beers statement, interest and tax payments are not readily available from the statement itself, but are provided in supplemental disclosure. As such, Scottish & Newcastles presentation of operating activities is arguably a mixture of the indirect and direct methods. The investing section of the statement should look more familiar to U.S. students, with the exception that acquisitions and disposals are granted their own section on the statement. Under U.S. GAAP, these would be included as line items within the investing activities section. More differences are found between the financing sections of the statements. Recall that under U.S. GAAP, dividends are treated as a financing item. In the Scottish & Newcastle statement, dividends are listed in two different locations: preferred dividends are listed along with interest under returns on investments and servicing of finance and dividends on common stock is listed as a separate line item (equity dividends paid). A subtotal is provided before considering liquid resources and financing. Liquid resources are term deposits of less than one year. On Boston Beers statement, these would likely be listed as short-term investments (an investing activity). The effect of these differences is to focus the investors attention away from operating activities (highlighted on U.S. statements) and onto service payments (such as interest, taxation, and dividends), liquidity, and solvency (discussed further in Chapter 14). This redirection is also visible in the additional notes required reconciling net cash flow to movement in net debt and the analysis of net debt.
2.
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CRITICAL THINKING CASES CP135. Date: To: From: Re: (todays date) Supervising Analyst (your name) Evaluation of Carlyle Golf, Inc.s Planned Expansion
While many companies experience losses and negative cash flows during the early years of their operations, the cash situation for Carlyle Golf is a major concern. The company has announced plans to increase inventory by $2.2 million but there is no obvious source to finance the acquisition of this inventory. The statement of cash flows shows that the company has to make cash deposits with its suppliers. It is unlikely that these suppliers will be a major source of financing for Carlyle's inventory. The company obviously does not have enough cash on hand to finance its expansion of inventory. The planned expansion of inventory has additional implications. The company must have plans to expand its sales volume. There is no information in the company's report concerning whether this expansion will require additional expenditures, such as increased advertising or hiring new sales people. In any case, the expansion will most likely require an increase in accounts receivable. Most companies underestimate the amount of resources that must be tied up in inventory and accounts receivable when they expand sales volume. Carlyle should seek additional capital to support an increased level of operations. Without this extra capital, it is unlikely that Carlyle can continue in business. Instructor's note: Subsequent to September 1992, Carlyle sought new financing through an initial public offering. At the time of this writing, the company is still trying to develop a niche in a very competitive market.
FINANCIAL REPORTING AND ANALYSIS PROJECTS CP136. The solutions to this case will depend on the company and/or accounting period selected for analysis.
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