Cash Flows - II - NBA 500: Intermediate Accounting Mark W....

Info iconThis preview shows pages 1–6. Sign up to view the full content.

View Full Document Right Arrow Icon
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 2
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 4
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 6
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: NBA 500: Intermediate Accounting Mark W. Nelson CASH FLOWS II 1. Aldila: Practice tying together the statement of cash flows with the balance sheet and income statement; understanding how acquisitions and equity- method accounting affect the statement. Effects of a restatement on classifications in the statement of cash flows. 2. Is That Revenue For Real? A common check for aggressive revenue recognition is to see if cash flow tracks revenue and income. However, cash flow can be manipulated too. The key is to identify cash flow that is sustainable, and not be fooled by cash flow that is transitory or misclassified. 3. How is Tyco Accounting for Its Cash Flow. Two problems: a) In valuations we tend to define “free cash flow” as net non-financing- related cash flows, but various firms define it differently. For example, Tyco doesn’t include cash spent on acquisitions among the capital expenditures subtracted to obtain “free cash flow,” creating an incentive to maximize free cash flows by obtaining new customers via acquisition (see attached Tyco Says It Will Likely Alter...). Since there is no GAAP definition of free cash flow, it is always important to understand what is included. b) Tyco twice changed how it accounts for “dealer reimbursements” (see attached excerpt from Tyco financial statement). Before their final change, their accounting for reimbursements had the effect of reducing expense (and therefore increasing income and cash from operations) by increasing the amount attributed to acquired contracts. Be careful of the accounting for transactions in which cash flows are moving in both directions — maybe they should be netted. c) Note: Both attachments illustrate a firm reducing aggressiveness in response to pressure from investors. 4. Tyco Inflated Cash Flow of Acquisition: One way to appear to be a successful turnaround artist is to force acquirees to accelerate expense recognition and cash payments so they look worse pre-acquisition and better post-acquisition. 5. Securitization: Cash Flow on Tap: Firms can increase cash from operations by changing the balance in their working-capital accounts. a. Factoring or securitizing receivables accelerates recognition of cash from operations. In some circumstances the firm acts as a residual guarantor so it is not clear that the receivables should be viewed as collected (and the residual retained by the firm may be of particularly low quality). Indeed, some firms choose to treat these as financing transactions, but most view these as operating transactions. So long as the level of factoring stays constant, there is no change in level of receivables, and so no effect on current period cash flow from operations, but be vigilant for changes in the level of factoring/securitization. b. More generally, cash flow can be improved by one-time events like improvements in working-capital management (e.g., transitioning to collecting receivables faster or taking longer to pay bills). It is fine for firms to manage cash flow, but don’t assume that one-time changes in the level of cash flows from liquidating receivables or stretching payables are likely to persist. Improvements only directly affect cash flow in the period of the improvement. Aldila’s Cash Flows* Solution Assume that Aldila had no acquisitions or dispositions other than their joint venture, and that they account for their joint venture under the equity method. a: 1. From the income statement, balance sheet and statement of cash flows, calculate the missing items. a. Inventory, as of the 12/31/06 Balance Sheet. $13,691 (ending balance of$13,861 less increase of$170) Marketable securities, as of the 12/31/07 Balance Sheet. $0 (beginning balance of $11,300 + purchases of $14,200 — proceeds from sales of $25,500) Changes in Accounts receivable during 2007 on the Statement of Cash Flows. $178 (the decrease in net A/R that occurred from the beginning balance of $8,862 to the ending balance of $8,684). Note that they do not separately break out bad debt expense in the operations section of their statement of cash flows, so we can unambiguously infer that they would include the entire change in the net A/R account on the accounts receivable line of the statement of cash flows, and that the $178 includes both the difference between sales and collections and any bad debt expense recognized during 2007. Prepared Erorn publier available information by Mark W. Nelson, Johnson Graduate School of Management, Cornell University. d. How would your answer to lo change if you had seen an add back of $100 of “bad debt expense” in the operations section of the 2007 statement of cash flows? If $100 of bad debt expense is already added back, we would have to remove it from the $178 to avoid double accounting, so the answer would be $78. To see this, consider the following T account for net A/R: Net AIR 8862 sales collections writeoffs writeoffs 100 bad debts exp 8684 Writeoffs cancel, so ignore them, leaving us with 8862 + sales — collections — 100 of bad debts expense = 8684. 8862 + (sales — collections) # 100 = 8684 (sales — collections) = 8684 + 100 a 8862 = -78, indicating that collections exceeded sales by $78. 2. Assume that all of Aldila’s 2007 transactions are unchanged except that on 12/31/07 they made the following purchase-method acquisition (in thousands), paying $500 of cash (net of $50 cash acquired) and assuming $300 of the acquiree’s accounts payable and $1500 of the acquiree’s long-term debt: NR 400 Inventory 500 PP&E 800 Goodwill 600 Accounts payable 300 Cash 500 Long-term debt 1500 Note: this purchase transaction would change the ending balances of the accounts that are involved on the 12/31/07 balance sheet. For example, inventory would have an ending balance of$14,361 (= $13,861 + $500) after the purchase. a. What would be the effect of this transaction on the financing section of the statement of cash flows? No effect (the $1500 of long-term debt was not issued for cash, so not a financing inflow) b. What would be the effect of this transaction on the investing section of the statement of cash flows? There would be a $500 cash outflow for the acquisition. c. What would be the effect of this transaction on the operating section of the statement of cash flows? No effect (these amounts would not affect operations, as they would be represented in the investing section). Put differently, had this transaction occurred, the ending balances of the accounts in the transaction would have been affected on the balance sheet, but that wouldn’t change the operations section of the statement of cash flows. For example, inventory would have an ending balance of $13,861 + 500 = $14,361, but the amount shown on the statement of cash flows would still be ($170). 3. How would your answer to question 2 change if, rather than the $1500 being from Aldila assuming the acquiree’s long term debt, the $1500 was actually long term debt Aldila sold to a 3rd part to pay cash for the acquisition? In this case we really have two transactions: Cash 1500 Long-term debt 1500 NR 400 Inventory 500 PP&E 800 Goodwill 600 Accounts payable 300 Cash 2000 a. What would be the effect of this transaction on the financing section of the statement of cash flows? $1500 inflow from issuing long-term debt b. What would be the effect of this transaction on the investing section of the statement of cash flows? There would be a $2000 cash outflow for the acquisition. c. What would be the effect of this transaction on the operating section of the statement of cash flows? Same as question 2 — no effect. 4. Ignore taxes. How much cash did Aldila receive from its joint venture during 2007? $53 distributed earnings (: $435 equity in earnings - $3 82 undistributed earnings). In addition, they indicate cash inflows in the investing section of their statement of cash flows associated with a distribution from the joint venture of $286 (likely a return of some of their investment) and proceeds from selling the joint venture of $19,521. ...
View Full Document

Page1 / 6

Cash Flows - II - NBA 500: Intermediate Accounting Mark W....

This preview shows document pages 1 - 6. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online