Exercises: Chapter 14

SHORT ANSWER QUESTIONS, EXERCISES AND PROBLEMS

Questions

➢  What are the purposes of the statement of cash flows?

➢  What are some of the uses of the statement of cash flows?

➢  What information is contained in the statement of cash flows?

➢  Which activities are generally included in operating activities?

➢  Which activities are included in investing activities?

➢  Which activities are included in financing activities?

➢  Where should significant investing and financing activities that do not involve cash flows be reported?

➢  Explain the difference between the direct and indirect methods for computing cash flows from operating activities.

➢  What are noncash expenses? How are they treated in computing cash flows from operating activities?

➢  Describe the treatment of a gain on the sale of equipment in preparing a statement of cash flows under the indirect method.

➢  Depreciation is sometimes referred to as a source of cash. Is it a source of cash? Explain.

➢  Why is it unlikely that cash flows from operating activities will be equal to net income for the sameperiod?

➢  If the net income for a given period is $25,000, does this mean there is an increase in cash of the same amount? Why or why not?

➢  Why might a company have positive cash flows from operating activities even though operating at a net loss?

➢  Indicate the type of activity each of the following transactions represents (operating, investing, or financing) and whether it is an inflow or an outflow.

  • Sold goods.
  • Purchased building.
  • Issued capital stock.
  • Received cash dividends.
  • Paid cash dividends.
  • Purchased treasury stock.
  •  Sold available-for-sale securities.
  •  Made a loan.
  •  Paid interest on loan.
  •  Paid bond principal.
  •  Received proceeds of insurance settlement.
  •  Made contribution to charity.


Exercises

Exercise A Indicate how the following data should be reported in a statement of cash flows. A company paid $500,000 cash for land. A building was acquired for $2,500,000 by assuming a mortgage on the building.

Exercise B Cost of goods sold in the income statement for the year ended 2010 was $260,000. The balances in Merchandise Inventory and Accounts Payable were:

  2010 January 1 2010 December 31
Merchandise inventory $160,000 $180,000
Accounts payable 44,000 36,000
Calculate the amount of cash paid for merchandise for 2010.

Exercise C Fill in the following chart, showing how increases and decreases in these accounts affect the conversion of accrual basis income to cash basis income:

  Add Deduct
Accounts receivable
Merchandise inventory
Prepaid expenses
Accounts payable
Accrued liabilities payable
Exercise D The income statement of a company shows net income of $200,000; merchandise inventory on January 1 was $76,500 and on December 31 was $94,500; accounts payable for merchandise purchases were $57,000 on January 1 and $68,000 on December 31. Compute the cash flows from operating activities under the indirect method.

Exercise E The operating expenses and taxes (including $80,000 of depreciation) of a company for a given year were $600,000. Net income was $350,000. Prepaid insurance decreased from $18,000 to $14,000 during the year, while wages payable increased from $22,000 to $36,000 during the year. Compute the cash flows from operating activities under the indirect method.

Exercise F Dividends payable increased by $20,000 during a year in which total dividends declared were $120,000. What amount appears for dividends paid in the statement of cash flows?

Exercise G Following are balance sheet data for Quality Merchandise, Inc.:

  December 31  
  2011 2010
Cash $ 47,000 $ 26,000
Accounts receivable, net 141,000 134,000
Merchandise inventory 83,000 102,000
Prepaid expenses 9,000 11,000
Plant assets (net of accumulated depreciation) 235,000 230,000
Accounts payable 122,000 127,000
Accrued liabilities payable 40,000 41,000
Capital stock 300,000 300,000
Retained earnings 53,000 35,000
Assume that the depreciation recorded in 2011 was $15,000. Compute the cash spent to purchase plant assets, assuming no assets were sold or scrapped in 2011.

Exercise H Use the data in the previous exercise. Assume the net income for 2011 was $24,000, depreciation was $15,000, and dividends declared and paid were $6,000. The company paid interest of $2,000 and income taxes of $14,000. Prepare a statement of cash flows—indirect method. Also prepare any necessary supplemental schedule(s).

Exercise I The following data are from a company's Automobile and the Accumulated Depreciation—Automobile accounts:

Date Automobile Debit Credit Balance
Jan. 1 Balance brought forward 16,000
July 1 Traded for new auto 16,000 -0-
New auto 31,000
Accumulated depreciation - Automobile    
Jan. 1 Balance brought forward 12,000
July 1 One-half year's depreciation 2,000 14,000
Auto traded 14,000 -0-
Dec. 31 One-half year's depreciation 4,000 4,000
The old auto was traded for a new one, with the difference in values paid in cash. The income statement for the year shows a loss on the exchange of autos of $1,200.

Indicate the dollar amounts, the descriptions of these amounts, and their exact locations in a statement of cash flows—indirect method.

Problems

Problem A The income statement and other data of Dunbar Carpet Outlet, Inc., follow:

Dunbar Carpet Outlet, Inc.

Income statement

For the Year Ended 2010 December 31

Sales $920,000
Cost of goods sold 380,000
Gross margin $540,000
Operating expenses (other than depreciation) $140,000
Depreciation expense 40,000 180,000
Net income $360,000
Changes in current assets (other than cash) and current liabilities during the year were:

Increase Decrease
Accounts receivable $20,000
Merchandise inventory $16,000
Prepaid insurance 8,000
Accounts payable 28,000
Accrued liabilities payable 4,000
Depreciation was the only noncash item affecting net income.

  1. Prepare a working paper to calculate cash flows from operating activities under the direct method.
  2. Prepare the cash flows from operating activities section of the statement of cash flows under the direct method.
  3. Prove that the same cash flows amount will be obtained under the indirect method by preparing the cash flows from operating activities section of the statement of cash flows under the indirect method. You need not prepare a working paper.


Problem B The following comparative balance sheets and other data are for Cellular Telephone Sales, Inc.:

Cellular Telephone Sales, Inc.

Comparative balance sheets

2011 December 31 and 2010

2011 2010
Assets    
Cash $76,105 $51,000
Accounts receivable, net 26,075 24,250
Merchandise inventory 30,000 35,000
Supplies on hand 1,750 2,550
Prepaid expenses 1,400 1,200
Land 180,000 142,500
Equipment 270,000 300,000
Accumulated depreciation – equipment (75,000) (67,500)
Total assets $510,330 $489,000
Liabilities and stockholders' equity
Accounts payable $ 45,330 $ 76,300
Salaries payable 4,000 2,000
Accrued liabilities payable 2,000 8,250
Long-term note payable 150,000 150,000
Common stock ($5 par) 185,000 165,000
Paid-in capital in excess of par 32,500 -0-
Retained earnings 91,500 87,450
Total liabilities and stockholders' equity $510,330 $489,000
Land was bought for $37,500 cash. The company intends to build a building on the land. Currently the company leases a building for its operations.

Equipment costing $50,000 with accumulated depreciation of $30,000 was sold for $23,500 (a gain of $3,500), and equipment costing $20,000 was purchased for cash.

Depreciation expense for the year was $37,500.

Common stock was issued for $52,500 cash.

Dividends declared and paid in 2011 totaled $32,950.

Net income was $37,000.

The company paid interest of $3,000 and income taxes of $17,000.

Prepare a statement of cash flows under the indirect method. Also prepare any necessary supplemental schedule(s).

Problem C Computer Associates International, Inc., is leading business software company. The company was founded in 1977 with four employees and has grown to 18,200 employees and about 4.2 billion in revenues.

The company's statements of cash flows for the years 2002 through 2004 follow. Then the relevant portion of Management's Discussion and Analysis of the statement of cash flows is provided.

Consolidated statements of cash flows

  Year Ended March 31  
Operating activities: 2004 2003 2002
  (In millions)
Net (loss) income $ (591) $ 696 $ 626
Adjustments to reconcile net (loss) income to net cash provided by operating activities:  
Depreciation and amortization 1,110 594 325
Provision for deferred income taxes (benefit) (350) 412 107
Charge for purchased research and development --- 795 ---
Compensation (gain) expense related to stock pension plants (146) 30 778
Decrease (increase) in noncurrent installment accounts receivable, net 956 (1,039) (422)
Decrease (increase) in deferred maintenance revenue (3) 113 43
Foreign currency transaction loss – before taxes 14 5 11
Charge for investment write-off --- 50 ---
Gain on sale of property and equipment --- (5) (14)
Changes in other operating assets and liabilities, net of effects of acquisitions:  
  Decrease (increase) in trade and installment receivables 418 83 (169)
  Other changes in operating assets and liabilities (25) (168) (18)
Net cash provided by operating activities $ 1,383 $ 1,566 $ 1,267
Investing activities:      
Acquisitions, primarily purchased software, marketing rights and intangibles, net of cash acquired  

$ (174)
$ (3,049) $ (610)
Settlements of purchases accounting liabilities (367) (429) (57)
Purchases of property and equipment (89) (198) (222)
Proceeds from sale of property and equipment 5 12 38
Disposition of businesses 158 --- ---
Purchases of marketable securities (48) (95) (2,703)
Sales of marketable securities 40 189 2,639
Increase in capitalized development costs and other (49) (36) (29)
Net cash used in investing activities $ (524) $ (3,606) $ (944)
Financing activities:      
Dividends $ (47) $ (43) $ (44)
Purchases of treasury stock (449) --- (1,090)
Proceeds from borrowings 1,049 3,672 2,141
Repayment of borrowings (1,981) (776) (1,216)
Exercise of common stock options and other 50 96 38
Net cash provided by (used in) financing activities $ (1,378) $ 2,949 $ (171)
(Decrease) Increase in cash and cash equivalents before effect of exchange rate changes on cash $ (519) $ 909 $ 152
Effect of exchange rate changes on cash (25) (1) (4)
(Decrease) Increase in cash and cash equivalents $ (544) $ 908 $ 148
Cash and cash equivalents – Beginning of year 1,307 399 251
Cash and cash equivalents – End of the year $ 763 $ 1,307 $ 399
Management's discussion and analysis

Liquidity and capital resources

Cash, cash equivalents and marketable securities totaled $850 million at 2004 March 31, a decrease of $537 million from the 2003 March 31 balance of $1,387 million. During fiscal year 2004, the Company used cash on hand to repay over $900 million in debt and repurchase approximately $450 million in treasury stock. Cash generated from operations for fiscal year 2001 was $1,383 million, a decrease of $183 million from the prior year's cash from operations of $1,566 million. Cash from operations was unfavorably impacted this current fiscal year due to higher costs associated with increased headcount and other expenses related to the Sterling acquisition.

The Company's bank credit facilities consist of a $1 billion four-year revolving credit facility, a $2 billion four-year term loan, and a 75 million British Pound Sterling denominated 364-day term loan. During the year, the Company repaid all outstanding amounts under both its $1 .3 billion 364-day and four-year revolving credit agreements. As a reflection of its continued reduced need for bank borrowings, emphasis on debt reduction, and overall expected ability to generate cash from operations, the Company did not renew its $1 .3 billion 364-day revolving credit facility when it expired in May 2004.

As of 2004 March 31, $2 billion remained outstanding under the four-year term loan and approximately  $124 million was outstanding under the pound sterling term loan at various interest rates. There are no drawings under the Company's $1 billion four-year revolving credit facility. The interest rates on such debt are determined based on a ratings grid, which applies a margin to the prevailing London InterBank Offered Rate ("LIBOR"). In addition, the Company established a $1 billion US Commercial Paper ("CP") program in the first quarter of this year to refinance some of its debt at more attractive interest levels. As of 2004 March 31, $340 million was outstanding under the CP program.

The Company also utilizes other financial markets in order to maintain its broad sources of liquidity. In fiscal 2002, $1 .75 billion of unsecured Senior Notes were issued in a transaction governed by Rule 144A of the Securities Act of 1933. Amounts borrowed, rates and maturities for each issue were $575 million at 6.25 per cent due 2006 April 15, $825 million at 6.375 per cent due 2008 April 15 and $350 million at 6.5 per cent due 2011 April 15. As of 2004 March 31, $192 million was outstanding under the Company's 6.77 per cent Senior Notes. These Notes call for annual repayment of $64 million each April until final maturity in 2006.

Unsecured and uncommitted multicurrency lines of credit are available to meet any short-term working capital needs for subsidiaries operating outside the US. These lines total $56 million, of which $14 million was drawn as of 2004 March 31.

Debt ratings for the Company's senior unsecured notes and its bank credit facilities are BBB+ and Baa1 from Standard & Poor's and Moody's Investor Services, respectively. The Company's Commercial Paper program is rated A-2 from Standard & Poor's and P-2 from Moody's. Peak borrowings under all debt facilities during fiscal year 2004 totaled approximately $5 .4 billion with a weighted-average interest rate of 7.2 per cent.

As of 2004 March 31, the cumulative number of shares purchased under the Company's various open market Common Stock repurchase programs, including almost 16 million shares purchased in the current fiscal year, was 166 million. The remaining number of shares authorized for repurchase is approximately 34 million.

Capital resource requirements as of 2004 March 31 consisted of lease obligations for office space, computer equipment, mortgage or loan obligations and amounts due as a result of product and company acquisitions. It is expected that existing cash, cash equivalents, marketable securities, the availability of borrowings under credit lines and cash provided from operations will be sufficient to meet ongoing cash requirements.

The Company expects its long-standing history of providing extended payment terms to customers to continue under the new business model and thus does not expect a change to its future cash flow, since customers are expected to continue to finance their purchases over the contract period.

  1. Explain how the company could have a net loss in 2004 and yet have a positive net cash provided by operating activities.
  2. What was the reason given by management for repaying all outstanding amounts under revolving credit agreements.
  3. What is the interest rate on borrowings?
  4. What information would normally appear immediately below the statement of cash flows that seems to be missing?
  5. Does the amount of cash provided by operating activities seem large enough to continue the present dividend payments?
  6. Given the following data, calculate the cash flow per share of common stock ratio, the cash flow margin ratio, and cash flow liquidity ratio.


  (in millions)
Average number of shares of common stock outstanding 583
Net sales 4,198
Cash and marketable securities 850
Current liabilities 2,286
Problem D Mechan Company develops, manufactures, markets, installs and supports a wide range of standards-based LAN and WAN connectivity hardware and software products. The company's statements of cash flow for the years 2008-2010 follow. Then the relevant portion of Management's Discussion and Analysis of the statement of cash flows is provided.

Consolidated statements of cash flows

Years ended 2010 February 29, and 2009 February 28 and 2008

(In thousands)

  2010 2009 2008
Cash flows from operating activities:      
 Net income $ 164,418 $ 161,974 $ 119,218
 Adjustments to reconcile net income to net cash provided by operating activities:  
  Depreciation and amortization 32,061 26,832 17,335
  Provision for losses on accounts receivable 356 72 1,734
  Loss on disposals of property, plant and equipment 93 174 113
  Deferred taxes (38,766) (4,434) (6,151)
  Changes in assets and liabilities:  
   Accounts receivables (55,101) (27,698) (17,707)
   Inventories (50,483) (23,080) (8,758)
   Prepaid expenses and other assets (18,844) (3,123) 1,211
   Accounts payable and accrued expenses 62,908 11,336 22,003
   Income taxes payable 3,705 10,476 (3,924)
     Net cash provided by operating activities $100,347 $152,529 $125,074
Cash flows from investing activities:      
  Capital expenditures $ (65,035) $ (63,091) $ (39,399)
  Purchase of available-for-sale securities (79,427) (71,598) (30,097)
  Purchase of held-to-maturity securities (205,852) (282,712) (258,517)
  Materials of marketable securities 208,922 323,682 197,406
     Net cash used in investing activities $(141,392) $ (93,719) $(130,607)
Cash flows from financing activities:      
  Repayment of notes receivable from stockholders $ 174 $ 131 $ 66
  Repurchase of common stock (1,173) (13,070) ---
  Tax benefit of options exercised 7,215 5,712 6,980
  Common stock issued to employee stock purchase plan 3,323 2,287 1,637
  Proceeds from stock option exercise 16,021 4,887 7,185
     Net cash provided by (used for) financing activities $ 25,560 $ (53) $ 15,868
Effect of exchange rate changes on cash $ 166 $ 712 $ 161
Net increase (decrease) in cash and cash equivalents $ (15,319) $ 59,469 $ 10,469
Cash and cash equivalents, beginning of year 114,032 54,563 44,067
Cash and cash equivalents, end of year $ 98,713 $ 114,032 $ 54,563
Cash paid during the year for:      
  Income taxes $ 105,233 $ 68,420 $ 67,263
Management's discussion and analysis

Net cash provided by operating activities was $100.3 million in fiscal 2010, compared to $152.5 million in fiscal 2009 and $125.1 million in fiscal 2008.

Capital investment for fiscal 2010 of $65.0 million included $9 .8 million for building costs of which $3 .4 was for the purchase of an engineering building, $21.4 million for engineering computer and computer related software and equipment, $5 .5 million for manufacturing and related equipment and $19.0 million for expanding global sales operations. During fiscal 2009, capital expenditures of $63.1 million included approximately $8 .2 million for building costs related to expanding manufacturing and distribution capacities and enlarging worldwide sales operations, $12.5 million for manufacturing and manufacturing support equipment and $15.0 million for engineering computer and computer related equipment. Another $15.0 million was spent in support of expanded global sales activities. During fiscal 2008, capital expenditures of $39.4 million included $3 .9 million on buildings, $10.1 million on engineering equipment, $7 .8 million on manufacturing capacity expansions and $2 .0 million to equip new sales offices.

Cash, cash equivalents and marketable securities increased during fiscal 2010 to $407.0 million, from $345.9 million in the prior fiscal year. State and local municipal bonds of approximately $264.2 million, maturing in approximately 1.5 years, were being held by the Company at 2010 February 29.

At 2010 February 29, the Company did not have any short or long term borrowing or any significant financial commitments outstanding, other than those required in the normal course of business.

In the opinion of management, internally generated funds from operations and existing cash, cash equivalents and marketable securities will be adequate to support the Company's working capital and capital expenditures requirements for both short and long term needs.

  1. Which method did the company use in arriving at net cash flows from operating activities?
  2. Did current assets other than cash increase or decrease during the year ended 2010 February 29?
  3. Did current liabilities increase or decrease during the year ended 2010 February 29?
  4. What were the main investing activities during this three-year period?
  5. What was the main source of cash from financing activities during the three-year period?
  6. Did the company pay any interest expense during the year ended 2010 February 19?
  7. Given the following data, calculate the cash flow per share of common stock ratio, the cash flow margin ratio, and the cash flow liquidity ratio. How do these ratios compare with the ratios shown for other companies in the chapter?


(in thousands)  
Average number of shares of common stock outstanding 71,839
Net sales $ 1,069,715
Cash and marketable securities 253,540
Current liabilities 164,352
Problem E The following comparative balance sheets and other data are for Dayton Tent & Awning Sales, Inc.:

Dayton Tent & Awning Sales, Inc.

Comparative Balance Sheets

2011 June 30 and 2010

  2011 2010
Assets
Cash $ 441,800 $ 332,600
Accounts receivable, net 750,750 432,900
Merchandise inventory 819,000 850,200
Prepaid insurance 3,900 5,850
Land 312,000 351,000
Buildings 2,184,000 1,209,000
Machinery and tools 858,000 468,000
Accumulated depreciation – machinery and tools (809,250) (510,900)
Total assets $ 4,560,200 $ 3,138,650
Liabilities and stockholders' equity
Accounts payable $ 226,750 $ 275,500
Accrued liabilities payable 185,800 111,700
Bank loans (due in 2009) 56,550 66,300
Mortgage bonds payable 382,200 185,250
Common stock - $100 par 1,755,000 585,000
Paid-in capital in excess of par 58,500 -0-
Retained earnings 1,895,400 1,914,900
Total liabilities and stockholders' equity $ 4,560,200 $ 3,138,650
Net income for the year was $128,000.

Depreciation for the year was $356,850.

There was a gain of $7,800 on the sale of land. The land was sold for $46,800.

The additional mortgage bonds were issued at face value as partial payment for a building valued at $975,000. The amount of cash paid was $778,050.

Machinery and tools were purchased for $448,500 cash.

Fully depreciated machinery with a cost of $58,500 was scrapped and written off.

Additional common stock was issued at $105 per share. The total proceeds were $1,228,500.

Dividends declared and paid were $147,500.

A payment was made on the bank loan, $9,750.

The company paid interest of $9,000 and income taxes of $75,000.

  1. Prepare a working paper for a statement of cash flows.
  2. Prepare a statement of cash flows under the indirect method. Also prepare any necessary supplemental schedule(s).


Alternate problem A The following income statement and other data are for Kennesaw Auto Glass Specialists, Inc..

Kennesaw auto glass specialists, Inc.

Income Statement

For the year ended 2010 December 31

Sales $450,000
Cost of goods sold 125,000
Gross margin $325,000
Operating expenses (other than depreciation) $60,000
Depreciation expense 20,000 80,000
Net income $245,000
Changes in current assets (other than cash) and current liabilities during the year were:

  Increase Decrease
Accounts receivable $15,000
Merchandise inventory $25,000
Prepaid insurance 8,000
Accounts payable 15,000
Accrued liabilities payable 4,000
Depreciation was the only noncash item affecting net income.

  1. Prepare a working paper to calculate cash flows from operating activities under the direct method.
  2. Prepare the cash flows from operating activities section of the statement of cash flows under the direct method.
  3. Prove that the same cash flows amount is obtained under the indirect method by preparing the cash flows from operating activities section of the statement of cash flows under the indirect method. You need not prepare a working paper.


Alternate problem B The following information relates to Dunwoody Nursery & Garden Center, Inc. The company leases a building adjacent to its land.

Dunwoody Nursery & Garden Center, Inc.

Comparative Balance Sheets

2011 December 31 and 2010

  2011 2010
Assets
Cash $44,500 $ 52,000
Accounts receivable, net 59,000 60,000
Merchandise inventory 175,000 120,000
Equipment 412,500 315,000
Accumulated depreciation – equipment (120,000) (105,000)
Land 75,000 15,000
Total assets $646,000 $457,000
Liabilities and stockholders' equity
Accounts payable $ 43,750 $40,750
Accrued liabilities payable 2,250 3,750
Capital stock – common - $10 par 375,000 300,000
Paid-in capital in excess of par 150,000 75,000
Retained earnings 75,000 37,500
Total liabilities and stockholders' equity $646,000 $457,000
Net income was $97,500 for the year.

Fully depreciated equipment costing $15,000 was sold for $3,750 (a gain of $3,750), and equipment costing $112,500 was purchased for cash.

Depreciation expense for the year was $30,000.

Land was purchased, $60,000.

An additional 7,500 shares of common stock were issued for cash at $20 per share (total proceeds, $150,000).

Cash dividends of $60,000 were declared and paid.

The company paid interest of $6,000 and income taxes of $65,000. Prepare a statement of cash flows under the indirect method. Also prepare any necessary supplemental schedule(s).

Alternate problem C Drexler, Inc., is an independent service organization that markets and services electronic credit card authorization and payment systems to small retail, wholesale, and professional businesses located throughout the United States. Prior to installing the company's electronic system, most of these businesses have used manual, paper-based systems to process credit card transactions or have not accepted credit cards at all. As the use of credit cards has significantly expanded, electronic processing has proven more convenient by accelerating customer purchases, lowering processing expenses, and reducing losses from fraudulent cards.

The company's account portfolio has grown through the purchase of account portfolios as well as through the internal development of accounts using telemarketing and field sales. With approximately 90,000 accounts at 2010 July 31, the company is one of the largest independent service organizations in the country.

The company's statements of cash flows for the years 2008-2010 follow. Then the relevant portion of Management's Discussion and Analysis of the statement of cash flows is provided.

Consolidated statement of cash flows      
  Year ended July 31,    
  2008 2009 2010
Cash flows from operating activities:
  Net cash received from merchants $ 19,657,697 $ 34,353,326 $ 67,313,124
  Cash paid to vendors and employees (14,758,040) (28,467,472) (49,128,150)
  Interest received 22,262 310,136 1,672,714
  Interest paid (268,586) (198,485) (505,856)
  Income taxes paid (994,969) (1,600,405) (5,630,881)
    Net cash provided by operating activities $ 3,658,354 $ 4,397,100 $ 13,720,951
Cash flows from investing activities:
  Purchase of merchant portfolios $ (8,415,055) $(24,576,426) $(31,787,725)
  Purchase of property and equipment (1,465,984) (1,917,395) (1,777,955)
    Net cash used in investing activities $(9,881,039) $(26,493,821) $(33,565,680)
Cash flows from financing activities:
  Proceeds from issuance of long-term debt $ 7,650,000 $ 16,450,000 $ 305,000
  Payments on long-term debt (1,163,170) (12,828,503) (16,545,500)
  Proceeds from issuance of common stock --- 17,098,894 140,963,115
  Payments to repurchase treasury stock (45,000) (32,500) (12,000)
  Proceeds from minority shareholder contribution --- --- 120,000
    Net cash provided by financing activities $6,441,830 $ 20,687,891 $124,830,615
Net increase (decrease) in cash and cash equivalents $ 219,145 $ (1,408,830) $(104,985,886)
Cash and cash equivalents at beginning of year 1,664,830 1,883,975 475,145
Cash and cash equivalents at end of year $ 1,883,975 $ 475,145 $105,461,031
Supplemental schedule of noncash activities:

In connection with the purchase of merchant portfolios in fiscal years 2008 and 2009, the Company issued promissory notes totaling $5,061,804 and $80,500, respectively.

The company recognized a tax benefit of $318,517 for the year ended 2010 July 31, for the excess of the fair market value at the exercise date over that at the award date for stock options exercised.

In connection with the purchase of merchant portfolio in March 2008, the Company issued 312,500 shares of common stock.

In connection with an agreement between the Company and a processing back entered into simultaneously with the purchase of a merchant portfolio in March 2008, the Company issued warrants to purchase 120,000 shares of common stock.

Reconciliation of net income to net cash provided by operating activities:
  Net income $2,592,444 $3,640,155 $ 8,625,376
  Martin Howe fiscal year converstion --- --- (356,914)
  Adjustments:
    Depreciation and amortization expense 1,648,023 3,517,852 7,509,630
    Provision for merchant losses 484,993 483,245 654,705
    Stock award compensation and other 239,659 241,477 120,395
    Deferred income taxes (453,658) 35,982 (761,705)
    Changes in assets and liabilities:
     Accounts receivable (1,562,961) (1,459,799) (2,125,510)
     Inventory (50,235) (157,087) (186,289)
     Other assets (1,716,464) (1,895,097) (501,353)
     Accounts payable 1,557,611 44,106 587,784
     Accrued liabilities 975,065 (223,411) 210,064
     Deferred revenues (56,123) 169,677 (55,232)
Net cash provided by operating activities $ 3,658,354 $ 4,397,100 $ 13,720,951
Management's discussion and analysis

Capital expenditures and investing activities

Capital expenditures were approximately $1 .8 million for fiscal year 2010 as compared to $1 .9 million for fiscal year 2009 and $1 .5 million for fiscal year 2008. The increase in capital expenditures was primarily the result of additional expenditures related to the Company's management information system, the purchase of additional credit card terminals, the Company's relocation of its office facilities and the purchase of peripheral equipment for lease to merchants. In addition to the increase in capital expenditures, the Company used $8 .4 million, $24.6 million and $31.8 million for the purchase of merchant portfolios in fiscal years 2008, 2009 and 2010, respectively. The Company purchased five merchant portfolios in fiscal 2008, nine merchant portfolios in fiscal year 2009 and five in fiscal year 2010.

Financing activities

The significant increase in cash provided by financing activities for fiscal year 2009 resulted from the consummation of the Company's initial public offering in August 2008. Cash provided by financing activities for fiscal year 2009 was $20.7 million which reflects the net proceeds of the initial public offering after retirement of the Company's outstanding indebtedness. Additionally, the Company issued $15.3 million of long-term debt in connection with three of the nine merchant portfolios purchased in fiscal year 2009.

The cash provided by financing activities for fiscal 2010 reflects the Company's consummation of its second and third public offerings in October 2009 and April 2010, respectively. Net cash provided by financing activities was $124.8 million in fiscal 2010 which reflects the net proceeds from the offerings after retirement of the Company's outstanding bank indebtedness.

Future capital needs

Management believes that significant expenditures for the purchase of additional merchant portfolios may be required for the Company to sustain its growth in the future. Management expects to fund such purchases primarily through cash generated from operations and additional bank borrowings. Management believes the combination of these sources will be sufficient to meet the Company's anticipated liquidity needs and its growth plans through fiscal year 2008. The Company, however, may pursue additional expansion opportunities, including purchases of additional merchant portfolios, which may require additional capital, and the Company may incur, from time to time, additional short-term and long-term indebtedness or issue, in public or private transactions, equity or debt securities, the availability and terms of which will depend upon then prevailing market and other conditions.

The Company's revolving credit facility was amended and restated during fiscal year 2009 to increase the line of credit to $17.5 million. The Company repaid all outstanding debt related to this credit facility with the proceeds from its second public offering during fiscal year 2010. The amended agreement expires 2010 November 1, with all amounts then outstanding under the agreement due on 2010 November 1, unless the agreement is extended or the outstanding amounts have been converted to a term loan requiring equal monthly payments for 48 months.

Borrowings under the amended revolving credit facility are used to finance purchases of merchant portfolios and equipment and for working capital purposes. Borrowings are secured by substantially all the Company's assets and life insurance policies on the lives of two of the Company's executive officers.

  1. Which method is the company using to determine net cash provided by operating activities?
  2. Why does the company show the indirect method below the statement of cash flows?
  3. What is the trend of net cash provided by operating activities over the three years?
  4. How has the company increased its merchant portfolios?
  5. What items of property and equipment were acquired during the three-year period?
  6. What was the major source of the huge increase in cash and cash equivalents over the three-year period? How were the proceeds used?
  7. How does the company expect to finance future expenditures to acquire additional merchant portfolios?
  8. How are amounts secured that are borrowed under the line of credit?
  9. Given the following data, calculate the cash flow per share of common stock ratio, the cash flow margin ratio, and the cash flow liquidity ratio. (Round the net cash provided from operating activities to the nearest thousand before you calculate the ratios.) How do the ratios compare with the ones for companies illustrated in the chapter?


  (in thousands)
Average number of shares of common stock outstanding 28,539
Net sales $149,840
Cash and marketable securities 105,461
Current liabilities 6,862
Alternate problem D Founded in 1901, The Gillette Company is the world leader in male grooming products, a category that includes blades and razors, shaving preparations and electric shavers. Gillette also holds the number one position worldwide in selected female grooming products, such as wet shaving products and hair epilation devices. The Company is the world's top seller of writing instruments and correction products, toothbrushes and oral care appliances. In addition, the Company is the world leader in alkaline batteries.

Gillette manufacturing operations are conducted at 38 facilities in 19 countries, and products are distributed through wholesalers, retailers, and agents in over 200 countries and territories.

The company's statements of cash flows for the years 2001-2003 follow. Then the relevant portion of Management's Discussion and Analysis of the statement of cash flows is provided.

Consolidated statement of cash flows (millions of dollars)

Years ended 2003,2002, 2001 December 31 2003 2002 2001
Operating activities
Income from continuing operations $ 832 $1,248 $1,073
Adjustments to reconcile net income to net cash provided by operating activities:
  Provision of restructuring and asset impairment 572 --- 440
  Depreciation and amortization 535 464 421
  Other 5 (7) (46)
  Changes in assets and liabilities, excluding effects from acquisition and divestitures:
   Accounts receivable (100) (48) (442)
   Inventories 149 (140) (62)
   Accounts payable and accrued liabilities (45) 65 72
   Other working capital items (136) 97 (104)
   Other noncurrent assets and liabilities (197) (252) (142)
   Funding German pension plans --- --- (252)
    Net cash provided by operating activities $ 1,604 $1,427 $ 958
Investing activities
 Additions to property, plant and equipment $ (793) $ (889) $ (952)
 Disposals of property, plant and equipment 41 124 65
 Acquisitions of businesses, less cash acquired --- --- (91)
 Sale of businesses 539 --- 200
 Other (1) 2 5
     Net cash used in investing act $(214) $ (763) $ (773)
Financing activities
  Purchase of treasury stock $ (944) $(2,021) $(1,066)
  Proceeds from sale of put options 23 72 56
  Proceeds from exercise of stock options and purchase plans 36 149 126
  Proceeds from long-term debt 494 1,105 500
  Repayment of long-term debt (365) --- (12)
  Increase (decrease) in loans payable (385) 484 708
  Dividends paid (671) (626) (552)
  Settlements of debt-related derivative contracts 279 42 9
     Net cash used in financing activities $ (1,553) $ (795) $ (231)
Effect of exchange rate changes on cash $ (5) $ (2) $ (2)
Net cash provided by discontinued operations 130 111 45
Decrease in cash and cash equivalents $ (18) $ (22) $ (3)
Cash and cash equivalents at beginning of year 80 102 105
Cash and cash equivalents at end of year $ 62 $ 80 $ 102
  Supplemental disclosure of cash paid for:
   Interest $ 243 $ 126 $ 120
   Income taxes $ 480 $ 457 $ 473
  Noncash investing and financing activities:
   Acquisition of businesses
    Fair value of assets acquired $--- $--- $ 100
    Cash paid --- --- 91
     Liabilities assumed $ --- $ ---- $ 9
Management's discussion and analysis*

Financial condition

The Company's financial condition continued to be strong in 2003. Net debt (total debt net of associated swaps, less cash and cash equivalents) decreased $82 million during 2003, despite additional spending under the Company's share repurchase program, due to improved cash flow from operations, proceeds from the sale of the Stationery Products business and the favorable exchange impact on foreign currency debt. Net debt at 2003 December 31, amounted to $4 .45 billion, compared with $4 .53 billion and $3 .18 billion at 2002 December 31 and 2001, respectively. The market value of Gillette equity was $38 billion at the end of 2003, compared with $43 billion at the end of 2002. The Company's book equity position amounted to $1 .92 billion at the end of 2003, compared with $3 .06 billion at the end of 2002 and $4 .54 billion at the end of 2001. The decreases in book equity in 2003 and 2002 were due primarily to the Gillette share repurchase program, as well as to the effect of foreign currency translation.

Net cash provided by operating activities in 2003 was $1 .60 billion, compared with $1 .43 billion in 2002 and USD .96 billion in 2001. The current ratio of the Company was .86 for 2003, compared with ratios of 1.39 for 2002 and 1.40 for 2001. The decrease in the 2003 current ratio was primarily attributable to the Company's reclassification of all commercial paper borrowings to short-term debt, due to the Company's credit facility agreements expiring within 2001. Capital spending in 2003 amounted to $793 million, compared with $889 million in 2002 and $952 million in 2001. Spending in all three years reflected substantial investments in the blade and razor, Duracell and Braun Products segments.

In 2003, the Company sold the Stationery Products business for $528 million. In 2001, the Company made acquisitions in the Duracell Products segment for $100 million and sold the Jafra business for $200 million.

Share repurchase funding in 2003, net of proceeds received from the sale of put options on Company stock, amounted to $921 million, compared with $1,949 million in 2002 and $1,010 million in 2001.

Strong cash inflows from operations, proceeds from the sale of the Stationery Products business and alternate financing sources enabled the Company to reduce its $2 .0 billion revolving credit facility in 2003 to $1 .4 billion, expiring October 2004, and its $1 .1 billion credit facility, expiring December 2004, to $550 million in January 2004. Both facilities are used by the Company to complement its commercial paper program.

In order to increase flexibility in sourcing short-term borrowing, the Company launched a $1 billion Euro commercial paper program in 2003. At year-end 2003, there was $586 million outstanding under this program and $1 .45 billion outstanding under the US program, compared with $2 .41 billion at the end of 2002 and $1 .66 billion at the end of 2001.

During 2003, the Company issued Euro-denominated notes for $228 million, due December 2005, and entered into a $264 million Euro-denominated debt obligation, with redemption rights in December 2004. During 2002, the Company issued Euro-denominated notes for $343 million, due February 2007, and entered into a $325 million Euro-denominated debt obligation, with redemption rights in March 2005, and a $437 million Euro-denominated debt obligation, with redemption rights in January 2007. The net proceeds were used to refinance existing short-term debt associated with the Company's share repurchase program.

During 2003, both Standard & Poor's and Moody's maintained the Company's current credit ratings. Standard & Poor's rates the Company's long-term debt at AA, while Moody's rating is Aa3. The commercial paper rating is A1+ by Standard & Poor's and P1 by Moody's.

Gillette will continue to have capital available for growth through both internally generated funds and significant credit resources. The Company has substantial unused lines of credit and access to worldwide financial market sources for funds.

Source: The Gillette Company's 2000 annual report, p. 22.

  1. Does the company use the direct or indirect method of calculating net cash provided by operating activities?
  2. Determine whether each of the current assets (other than cash) and current liabilities increased or decreased during 2003.
  3. How is the company expanding its asset base?
  4. How much greater is the total market value of the company's outstanding shares of common stock than the book equity (stockholders; equity)?
  5. What is the likelihood that the company will be able to pay at least the current level of dividends in the future?
  6. Do you expect to see purchases of treasury stock increase or decrease in the future?
  7. Given the following data, calculate the cash flow per share of common stock ratio, the cash flow margin ratio, and the cash flow liquidity ratio. (Round the net cash provided by operating activities to the nearest million before you calculate the ratios.) How do the ratios compare with the ones for companies illustrated in the chapter?


  (in millions)
Average number of shares of common stock outstanding 1,059
Net sales 9,295
Cash and marketable securities 62
Current liabilities 5,471
Alternate problem E The following information is from the accounting records of Wescott Office Supplies, Inc., for the fiscal years 2011 and 2010:

  2011 2010
Assets
Cash $ 66,250 $ 61,000
Accounts receivable, net 84,000 42,000
Merchandise inventory 42,000 48,250
Prepaid expenses 7,875 12,125
Land 94,500 78,750
Buildings 199,500 147,000
Accumulated depreciation – buildings (31,500) (26,250)
Equipment 257,250 210,000
Accumulated depreciation- equipment (78,750) (63,000)
Total assets $641,125 $509,875
Liabilities and stockholders' equity
Accounts payable $73,500 $ 47,250
Accrued liabilities payable 50,500 55,750
Five-year note payable 52,500 -0-
Capital stock -$50 par 420,000 367,500
Retained earnings 39,375
Total liabilities and stockholders' equity $641,125 $509,875
Net income for year ended 2011 June 30, was $56,250.

Additional land was acquired for cash, $15,750.

No equipment or building retirements occurred during the year.

Equipment was purchased for cash, $47,250.

The five-year note for $52,500 was issued to pay for a building erected on land leased by the company.

Stock was issued at par for cash, $52,500.

Dividends declared and paid were $51,000.

The company paid interest of $10,000 and income taxes of $40,000.

  1. Prepare a working paper for a statement of cash flows.
  2. Prepare a statement of cash flows under the indirect method. Also prepare any necessary supplemental schedule(s).


Beyond the numbers—Critical thinking

Business decision A National Sports, Inc., is a sports equipment sales company. During 2011, the company replaced $18,000 of its fully depreciated equipment with new equipment costing $23,000. Although a midyear dividend of $5,000 was paid, the company found it necessary to borrow $5,000 from its bank on a two-year note. Further borrowing may be needed since the Cash account is dangerously low at year-end.

Following are the income statement and "cash flow statement", as the company's accountant calls it, for 2011.

National sports, Inc.

Income Statements

For the year ended 2011 December 31

Sales $195,000
Cost of goods sold $140,000
Operating expense and taxes 49,700 189,700
Net income $5,300
National Sports, Inc.

Cash flow Statement

For the Year ended 2011 December 31

Cash received:
  From operations:
   Net income $5,300
   Depreciation 5,000
   Total cash from operations $10,300
Note issued to back 5,000
Mortgage note issued 16,000
   Total funds provided $31,300
Cash paid:
  New equipment $23,000
  Dividends 5,000 28,000
Increase in cash $ 3,300
The company's president is very concerned about what he sees in these statements and how it relates to what he knows has actually happened. He turns to you for help. Specifically, he wants to know why the cash flow statement shows an increase in cash of $3,300 when he knows the cash balance decreased from $15,000 to $500 during the year. Also, why is depreciation shown as providing cash?

You believe you can answer the president's questions after receiving the following condensed balance sheet data:

National Sports, Inc.

Comparative Balance Sheets

2011 December 31, and 2010

  December 31  
  2011 2010
Assets
Current assets:
 Cash $ 500 $ 15,000
 Accounts receivable, net 17,800 13,200
 Merchandise inventory 28,500 17,500
 Prepaid expenses 700 300
     Total current assets $ 47,500 $ 46,000
Property, plant, and equipment:
 Equipment $40,000 $35,000
 Accumulated depreciation – equipment (11,000) (24,000)
     Total property, plant, and equipment $ 29,000 $ 11,000
Liabilities and stockholders' equity
Current liabilities:
 Accounts payable $ 8,700 $ 10,000
 Accrued liabilities payable 600 1,100
     Total current liabilities $ 9,300 $ 11,100
Long-term liabilities:
 Notes payable 5,000 -0-
 Mortgage note payable 16,000 -0-
     Total liabilities $ 30,300 $ 11,100
Stockholders' equity:
 Common stock $ 40,000 $ 40,000
 Retained earnings 6,200 5,900
     Total stockholders' equity $ 46,200 $ 45,900
Total liabilities and stockholders' equity $ 76,500 $ 57,000
Prepare a correct statement of cash flows using the indirect method that shows why National Sports, Inc., is having such a difficult time keeping sufficient cash on hand. Also, answer the president's questions. The company paid interest of $400 and income taxes of $3,000.

Business decision case B Following are comparative balance sheets for Hardiplank Siding, Inc.:

Hardiplank Siding, Inc.

Comparative Balance Sheets

2011 December 31, and 2010

  2011 2010
Assets
Cash $ 80,000 $ 57,500
Accounts receivable, net 60,000 45,000
Merchandise inventory 90,000 52,500
Land 67,500 60,000
Buildings 90,000 90,000
Accumulated depreciation- buildings (30,000) (27,000)
Equipment 285,000 225,000
Accumulated depreciation – equipment (52,500) (48,000)
Goodwill 120,000 150,000
Total assets $710,000 $605,000
Liabilities and stockholders' equity
Accounts payable $ 95,000 $ 65,000
Accrued liabilities payable 30,000 22,500
Capital stock 315,000 300,000
Paid-in capital – stock dividends 75,000 67,500
Paid-in capital – land donations 15,000 -0-
Retained earnings 180,000 150,000
Total liabilities and stockholders' equity $710,000 $605,000
An analysis of the Retained Earnings account for the year reveals the following:

Balance, 2011 January 1 $150,000
Add: Net income for the year 107,500
$257,500
Less: cash dividends $55,000
        Stock dividends 22,500 77,500
Balance, 2011 December 31 $180,000
  1. Equipment with a cost of $30,000 on which $27,000 of depreciation had been accumulated was sold during the year at a loss of $1,500. Included in net income is a gain on the sale of land of $9,000.
  2. The president of the company has set two goals for 2012: (1) increase cash by $40,000 and (2) increase cash dividends by $35,000. The company's activities in 2012 are expected to be quite similar to those of 2011, and no new fixed assets will be acquired.


Prepare a schedule showing cash flows from operating activities under the indirect method for 2011. Can the company meet its president's goals for 2012? Explain.

Annual report analysis C Refer to the Annual report appendix. Evaluate the ease with which The Limited will be able to maintain its dividend payments in the future at 2006 amounts. (Hint: Compare current dividend amount with net cash provided by operating activities.)

Annual report analysis D Refer to "A broader perspective: Johnson & Johnson" and answer the following questions:

  1. Over the last three years from which major activities (operations, investing, financing) has Johnson & Johnson received net cash inflows and on which major activities have they spent the funds?
  2. What relationship do you see between "Depreciation and amortization of property and intangibles" and "Additions of property, plant, and equipment"?
  3. What were the two major sources of cash outflows to stockholders and which was larger?
  4. By how much did the investments in marketable securities grow or shrink over the three-year period?
  5. By how much did long-term debt grow or shrink over the three-year period?
  6. If you were a stockholder, would you feel uncertain or confident that this company will be able to pay future dividends at the same rate as in the past?
  7. For what reason or reasons might the company be buying back its own stock?
  8. For the latest year, did the current assets (other than cash) and current liabilities go up or down?
  9. From the information that is available, does it appear that the company is performing well or poorly?


Group project E In groups of two or three students write a two-page, double-spaced paper on one of the following topics:

Which Is Better, the Direct or Indirect Method (of calculating net cash provided by operating activities)?

Analysis of the Johnson & Johnson Cash Flow Statement (shown in "A broader perspective" in this chapter)

Analysis of Cash Flow Statement for The Limited (shown in the Annual Report Appendix)

Your analysis should be convincing and have no spelling or grammatical errors. Your paper should be neat and the result of several drafts. The paper should have a cover page with the title and the authors' names. Use a word processing program if possible.

Group project F In a group of one or two other students, go to the library and locate Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows", published by the Financial Accounting Standards Board. Write a report to your instructor answering the following questions:

Why did the Board settle on cash flows instead of working capital flows?

Why did the Board strongly recommend use of the direct method?

Why did some members of the Board dissent from the final statement?

Group project G In a group of one or two other students, go to the library and locate Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows", published by the Financial Accounting Standards Board. Write a report to your instructor covering the following points:

Describe the controversy over how to treat interest and dividends received.

What is the Board's position on reporting cash flow per share? Why did they take that position?

What is the Board's position on noncash transactions? Why did they take that position?

Using the Internet—A view of the real world

Visit the following website for the Eastman Kodak Company:

http://www.kodak.com By following the instructions on the screen, locate the latest statement of cash flows and then print it. Analyze the statement and write a report to your instructor summarizing your analysis.

Visit the following website for Verizon:

http://www.verizon.com By following the information on the screen, locate the latest statement of cash flows and then print it. Analyze the statement and then write a report to your instructor summarizing your analysis.

 

  1. [1]FASB, Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows" (Stamford, Conn., 1987). Copyright by the Financial Accounting Standards Board, High Ridge Park, Stamford, Connecticut 06905. U.S.A. Quoted (or excerpted) with permission. Copies of the complete document are available from the FASB.


Licenses and Attributions