chapter 04

Chapter 13

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LEARNING OBJECTIVES

Explain the purposes of the statementof cash flows and describe itselements.

Distinguish among operating,investing, and financing cash flows.

Prepare a statement of cash flows bythe indirect method.

Prepare a statement of cash flows bythe direct method.

Special SectionTo demonstrate the projects inthis chapter, use the SpecialSection located at the end ofthis binder. Included in thissection are Demo Docs andTextbook Exercises.

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Look Back

In previous chapters, you examined the accounting forassets, liabilities, and equity of business organizations.You witnessed how these items are reported on thebalance sheet, and how the accounting for these bal-ance sheet elements affects the income statement.

Look Ahead

Switching focus, you will discover how cash flows arereported on the statement of cash flows. You will con-sider the various elements of cash flows, and see howincreases and decreases in cash from operations canbe presented by two different methods.

The Statement of Cash Flows

A recent commercial for a credit card company asked, “What’s in your wallet?” Credit cardsare a convenient way to buy what you want or need, but it ultimately takes cash to pay thebills. Do you know how much cash you have in your checking and savings accounts? Do youknow how much cash you received last year? On what did you spend your cash? You may bor-row money for a large purchase, like a car, but if you have to borrow money for everyday livingexpenses, you are in trouble.

Businesses face the same issues that individuals do. They need enough cash flowing in to paythe bills and run their operations. When companies want to purchase land, a building, or equip-ment, they need to determine the source of the funds they will use to make the investment. Ifbusinesses want to finance the investment by borrowing money or issuing stock, they need toshow lenders and stockholders that they can manage their cash well. •

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Cash $22,000 $42,000 $(20,000)

Increase(Decrease)20072008

IncomeStatement

BalanceSheet

BalanceSheet

December 31, 2007(a point in time)

For the Year EndedDecember 31, 2008(a period of time)

December 31, 2008(a point in time)

Statement ofCash Flows

Statement ofStockholders’

Equity

Exhibit 13-1 Timing of the Financial Statements

Recall from Chapter 1 that liquidity, the ability to pay bills in a timely manner, is one of

the primary goals of businesses, and that business activity is divided among operating,

investing, and financing activities. With the importance of this goal in mind, we study

cash flows in this chapter because understanding cash flows is vital for making good busi-

ness decisions. We will see how to prepare the statement of cash flows by categorizing

cash receipts and disbursements into the three areas of business activity. We first explain

the format for the statement of cash flows used by the vast majority of companies, called

the indirect method, then turn our attention to the alternate format, the direct method.

Finally, using the statement as the basis for cash flow analysis, we will discuss how to

interpret cash flow information.

A balance sheet reports financial position, and balance sheets for two periodsshow whether cash increased or decreased. For example, Avery Corporation’scomparative balance sheet reported the following:

1 Explain the purposesof the statement ofcash flows anddescribe its elements.

Basic Concepts: Statement of Cash Flows

You can see that Avery’s cash decreased by $20,000 during 2008, but the bal-ance sheet doesn’t show why cash decreased.

The statement of cash flows introduced in Chapter 1 reports cash flows,cash receipts and cash payments, during the period. It shows where cash camefrom and where it went. It explains the causes of the change in cash during anygiven time period and is therefore dated “Year Ended December 31, 2008” or“Month Ended June 30, 2008.” Exhibit 13-1 illustrates the time element of eachfinancial statement.

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The Statement of Cash Flows 691

2 Distinguish amongoperating, investing,and financing cashflows.

Consider that businesses engage in three types of activities affecting cash flows:

• Operating activities create revenues, expenses, gains, and losses, and thusinclude the daily activities of buying and selling products and services. Inaddition to staying liquid, the other, major goal of businesses is to operateprofitably; these operating activities are the business events that affect netincome on the income statement as the result of accrual accounting.Because companies use resources and incur debt to run on a daily basis,operating activities also affect the current assets and current liabilitiesshown on the balance sheet.

Operating activities are the most important of the three categories of cashflows. A successful business must generate most of its cash from day-to-dayoperations. Individuals can only borrow money without repayment or sellassets for a limited amount of time before they find that no one is willing tolend to them any longer or before they run out of items to sell. Accordingly,to survive, businesses need to be able to generate cash from profitable opera-tions. The statement of cash flows reports the cash effects of these operat-ing activities.

• Investing activities increase and decrease long-term assets, such as land,buildings, and equipment, and even stock investments in other entities.The purchases and sales of these assets are investing activities. Loans toothers and collections of loans are also investing activities. Investing activi-ties are less vital to the life of the business than operating activities.

• Financing activities obtain cash to launch a business and keep it running.Financing includes issuing stock, borrowing money, buying and selling

The statement of cash flows serves several purposes:

1. Predicts future cash flows. Past cash receipts and payments are good pre-dictors of future cash flows.

2. Evaluates management decisions. If managers make wise decisions, thebusiness prospers. If they make unwise choices, the business suffers. Thestatement of cash flows reports cash flows resulting from the operating,investing, and financing decisions the company is making. Stakeholdersuse cash flow information to evaluate managers’ decisions.

3. Predicts ability to make debt payments to lenders and to pay dividends tostockholders. Lenders want to collect interest and principal on their loans.Stockholders want dividends on their investments. The statement of cashflows helps predict whether the business can make these payments.

On a statement of cash flows, Cash means more than just cash on hand and cashin the bank. Recall from Chapter 6 that it includes cash equivalents, highly liquidshort-term investments that can be readily converted into cash. Examples of cashequivalents are money-market funds, certificates of deposit, and investments inU.S. government securities. Businesses invest cash in liquid assets rather thanlet the cash remain idle. Throughout this chapter, the term cash refers to cashand cash equivalents.

Operating, Investing, and Financing Activities

In Class Tip• Cash equivalents must beable to be converted intoknown amounts of cash andmature within three months ofpurchase. Stocks and bondswould not be considered cashequivalents because theamount of cash they can beconverted into varies from dayto day.

Pitfalls to AvoidTransactions that create gainsand losses often include thesale of property, plant, andequipment. The proceeds fromthese activities are investingactivities. Losses and gainsmay appear under theoperating activities section toeliminate them from netincome as per Exhibit 13-4 (p. 694).

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treasury stock, and paying dividends. Paying off borrowings is anotherfinancing activity. Financing cash flows relate to long-term liabilities andowners’ equity. They are the least important of the three categories of cashflows, which is why they are reported last.

Exhibit 13-2 shows the relationship between operating, investing, andfinancing activities and the various parts of the balance sheet.

Current Assets

Long-Term Assets

Current Liabilities

Long-Term Liabilities

Owners’ Equity

OperatingCash Flows

InvestingCash Flows

OperatingCash Flows

FinancingCash Flows

Exhibit 13-2 Operating, Investing, and Financing Cash Flows and the

Balance Sheet Accounts

Indirect Method Direct Method

Net income ................................ $300 Collections from customers ................. $ 900

Adjustments: Deductions:

Depreciation, etc ................... 100 Payments to suppliers, etc. ............. (500)

Net cash provided by Net cash provided byoperating activities............... $400 operating activities.......................... $ 400

Two Formats for Operating ActivitiesAccountants can report operating activities on the statement of cash flows ineither or two formats:

• The indirect method, which reconciles net income to net cash provided byoperating activities.

• The direct method, which reports all cash receipts and cash paymentsfrom operating activities.

The two methods use different computations but produce the same amount ofcash flows from operations. The indirect and direct methods have no effect oninvesting or financing activities. The following table uses assumed dollar amountsto summarize the differences between these approaches for operating activities:

Noncash Investing and FinancingActivitiesCompanies sometimes make investments that do not require cash. They alsofinance without exchanging cash. Examples of investing and financing activitiesthat do not require cash include:

• Acquisition of an asset by issuing common stock

Pitfalls to AvoidPaying off the loan is afinancing activity, but theinterest payment related to theloan is an operating activity.Operating activities includethe cash flow impact of transactions that affect net income, such as interest expense.

Pitfalls to AvoidThe purchase of some stocksand bonds would also bereported as an investingactivity. But the relateddividend and interest receivedmust be included as anoperating activity. Operatingactivities include the cash flowimpact of transactions thataffect net income, such asdividend and interest revenue.

FYIGAAP requires that the indirectmethod be shown in aseparate schedule if the directmethod is chosen to beincluded in the statement ofcash flows.

In Class Tip• Operating activities aresimilar to the routine inflowsand outflows studentsexperience in their personallives. They need to receiveenough cash from their jobs tocover everyday expenditures.When a shortfall occurs,options may include borrowingmoney or selling some of theirassets as a temporary stopgapmeasure. Because theseoptions are short-lived, it iscritical to maintain a positiveoperating cash inflow.

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Assets Current: Cash $ 22 $ 42 $ (20) Accounts receivable 96 81 15 Inventory 143 145 (2) Plant assets, net of depreciation 464 219 245 Total assets $725 $487 $238 Liabilities Current: Accounts payable $ 91 $ 57 $ 34 Accrued liabilities 5 9 (4) Long-term notes payable 160 77 83 Stockholders’ Equity Common stock 359 258 101 Retained earnings 110 86 24 Total liabilities and stockholder’s

equity $725 $487 $238

AVERY CORPORATIONComparative Balance Sheet December 31, 2008 and 2007

(In thousands) Type of ActivityIncrease

(Decrease)2008 2007

Changes in current assets—Operating

Changes in current liabilities—Operating

Changes in long-term liabilities andcommon stock—Financing

Changes in noncurrent assets—Investing

Change due to net income—OperatingChange due to dividends—Financing


• Acquisition of an asset by issuing a note payable

• Payment of note payable by issuing common stock

These transactions are not reflected on the statement of cash flows, but theyare important business events. Noncash investing and financing activities can bereported in a separate schedule that accompanies the statement of cash flows ordisclosed in a note.

To prepare the statement of cash flows, you need data from the income statementand the balance sheet. Imagine Avery Corporation, an office and home furnitureretailer. Suppose Exhibit 13-3 shows Avery’s balance sheet as of December 31,2007 and 2008. Also suppose that Exhibit 13-4 presents Avery’s income state-ment for the year ended December 31, 2008.

Prepare a statementof cash flows by theindirect method.

3

Preparing the Statement of Cash Flows by the Indirect Method

Exhibit 13-3 Comparative Balance Sheet

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(In thousands) Revenues and gains: Sales revenue $284 Interest revenue 12 Dividend revenue 9 Gain on sale of plant assets 8 Total revenues and gains $313 Expenses: Cost of goods sold $150 Salary and wage expense 56 Depreciation expense 18 Other operating expenses 17 Interest expense 16 Income tax expense 15 Total expenses 272 Net income $ 41

AVERY CORPORATIONIncome Statement

Year Ended December 31, 2008

694 Chapter 13

To prepare the statement of cash flows by the indirect method, use informa-tion from preceding financial statements to perform the following steps:

STEP 1Lay out the template as shown in Exhibit 13-5. The exhibit is comprehensive.Steps 2 to 4 will complete the statement of cash flows.

STEP 2Use the comparative balance sheet to determine the increase or decrease incash. The change in cash is the “check figure” for the statement of cash flows.Exhibit 13-3 gives the comparative balance sheet of Avery Corporation atDecember 31, 2008 and 2007, with cash highlighted. Avery’s cash decreased by$20,000 during 2008.

STEP 3From the income statement, take net income, depreciation, depletion, and amor-tization expense, and any gains or losses on the sale of assets. Exhibit 13-4 givesthe income statement of Avery Corporation for the year ended December 31,2008, with relevant items highlighted.

STEP 4Use data from the income statement and balance sheet to complete the state-ment of cash flows. The statement is complete only after the year-to-year changesin all balance sheet accounts have been explained.

Let’s apply these steps to prepare the operating activities section of AveryCorporation’s statement of cash flows. Exhibit 13-6 gives the operating activitiessection of the statement.

FYIMany transactions affect theCash account, which makes itdifficult to obtain thenecessary information fromanalyzing that one account.Double-entry accountingensures that if Cash isaffected by a transaction, thenanother balance sheet accountis also affected. It’s moreefficient to analyze the year-to-year changes in the otherbalance sheet accounts.

Exhibit 13-4 Income Statement

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Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: + Depreciation/amortization/depletion expense + Loss on sale of long-term assets – Gain on sale of long-term assets – Increases in current assets other than cash + Decreases in current assets other than cash + Increases in current liabilities – Decreases in current liabilities Net cash provided by (used for) operating activities Cash flows from investing activities: Proceeds from sale of long-term assets – Purchase of long-term assets Net cash provided by (used for) investing activities Cash flows from financing activities: Proceeds from issuance of stock + Proceeds from sale of treasury stock – Purchase of treasury stock + Proceeds from issuance of notes or bonds payable – Payment of notes or bonds payable – Payment of dividends Net cash provided by (used for) financing activities Net increase (decrease) in cash during the year + Cash at December 31, 2007 = Cash at December 31, 2008

AVERY CORPORATIONStatement of Cash Flows


Exhibit 13-5 Template of the Statement of Cash Flows: Indirect Method

Cash flows from operating activities: Net income $41 Adjustments to reconcile net income to net Cash provided by operating activities: Depreciation $18 Gain on sale of plant assets (8) Increase in accounts receivable (15) Decrease in inventory 2 Increase in accounts payable 34

Decrease in accrued liabilities (4) 27 Net cash provided by operating activities $68

AVERY CORPORATIONStatement of Cash Flows: Operating Activities Only


(In thousands)

1

2

3

Exhibit 13-6 Statement of Cash Flows—Operating Activities:

Indirect Method

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You can see that recording depreciation does not affect cash. However,depreciation, like all other expenses, decreases net income. Therefore, inconverting accrual basis net income to net cash provided by operatingactivities, we add depreciation back to net income. The add-back cancelsthe earlier deduction of the expense.

Let’s consider this issue further through an example. Suppose a companyhad only two transactions during the period, a $1,000 cash sale to a cus-tomer and depreciation expense of $300. Net income is $700 ($1,000 �$300), but cash flow from operations is $1,000. To reconcile net income of$700 to the cash flow of $1,000, add back depreciation of $300. Similarly,depletion and amortization must also be added back to net income.

2. Gains and Losses on the Sale of Long-Term Assets

Sales of long-term assets are investing activities. A gain or loss on a sale is included in net income in the operating activities section and there-fore must be adjusted out of net income on the statement of cash flows.Exhibit 13-6 includes an adjustment for a gain. Suppose that, during 2008,Avery sold equipment for $62,000. The equipment’s book value was $54,000,so Avery realized a gain of $8,000.

The $62,000 sale is an investing cash flow, so the $8,000 gain on the salemust be removed from operating cash flow to show the entire proceeds fromthe sale in one section, as an investing activity cash flow. By making thisadjustment, we avoid showing the $8,000 twice, once as part of the netincome and again as part of the $62,000 proceeds from the sale. We explaininvesting activities in the next section.

A loss on the sale of plant assets would be added back to net income. Thecash received from selling the plant assets is then reported under investingactivities.

3. Changes in the Current Asset and Current Liability Accounts

Most current assets and current liabilities result from operating activities.For example, accounts receivable result from sales, inventory relates tocost of goods sold, and so on. Changes in the current accounts are reported

Cash Flows from Operating ActivitiesThe operating section of the cash flow statement begins with net income, takenfrom the income statement (Exhibit 13-4). Additions and subtractions, which fol-low, are labeled “Adjustments to reconcile net income to net cash provided byoperating activities.” Operating activities are related to the transactions that de-termine net income: Revenues, expenses, gains, and losses.

1. Depreciation, Depletion, and Amortization Expenses

These expenses do not affect cash, and are sometimes referred to as “non-cash expenses.” They are added back to net income to reconcile net incometo cash flow. To see why, let’s examine the journal entry for depreciation.Depreciation, for example, is recorded as follows:

Journal Entry:

Dec. 31 Depreciation Expense 18,000 Accumulated Depreciation 18,000 Record depreciation.

PostDate Accounts Ref. Dr. Cr.

In Class Tip• Use another example toillustrate the need to reduce again. Land with a cost of$54,000 was sold for $62,000cash. The entry requiredwould be:

Cash 62,000Land 54,000Gain on Sale 8,000

The entire cash flow effect of$62,000 is shown as aninvesting activity (Exhibit 13-7,p. 698). An $8,000 reduction(see Exhibit 13-6, p. 695) isneeded to eliminate the$8,000 gain (see Exhibit 13-4,p. 694) included in the netincome of $41,000.

In Class Tip• Gains and losses on the saleof assets pertain to investingactivities. We must deletethem from the operatingsection.

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as adjustments to net income on the cash flow statement. The reasoningfollows:

1. An increase in a current asset other than cash means a decrease incash. It takes cash to acquire assets. If Accounts Receivable,Inventory, or Prepaid Expenses increase during the period, subtractthe increase from net income to measure cash flow from operations.True, current assets like inventory may be purchased on credit, butthis increase in liabilities would be captured separate from theincrease in assets.

2. A decrease in a current asset other than cash means an increase incash. Suppose Avery’s Accounts Receivable decreased by $4,000. Averymust have collected on the Accounts Receivable. Therefore, adddecreases in Accounts Receivable and the other current assets to netincome.

3. A decrease in a current liability means a decrease in cash. The pay-ment of a current liability causes cash to decrease. Therefore, subtractdecreases in current liabilities from net income.

4. An increase in a current liability means an increase in cash. Avery’sAccounts Payable increased, which means that cash was not spent topay this liability, so Avery has more cash on hand. Thus, increases incurrent liabilities are added to net income.

EVALUATING CASH FLOWS FROM OPERATING ACTIVITIESDuring 2008, Avery Corporation’s operations provided net cash flow of $68,000.This amount exceeds net income, as it should because of the add-back of deprecia-tion and other adjustments. However, to fully evaluate a company’s cash flows,you must also examine its investing and financing activities. Let’s see how toreport those cash flows, as shown in Exhibit 13-7, which imagines Avery’s com-plete statement of cash flows using the indirect method for presenting cash flowsfrom operating activities.

Cash Flows from Investing ActivitiesInvesting activities affect long-term asset accounts, such as Plant Assets andInvestments. Let’s see how to compute the investing cash flows.

COMPUTING ACQUISITIONS AND SALES OF PLANT ASSETSCompanies keep separate accounts for Land, Buildings, Equipment, and otherplant assets. But for computing investing cash flows, it is helpful to combinethese accounts into a single Plant Assets account. Also, we subtract accumulateddepreciation from the assets’ cost and work with a single net figure for plantassets. This practice simplifies the computations.

To understand this concept, observe the following about Avery Corporation’sfinancial statements:

• The comparative balance sheet reports beginning plant assets, net of depre-ciation, of $219,000 and an ending net amount of $464,000 (Exhibit 13-3).Remember that the beginning balance for the current year is the endingbalance for the previous year, 2007.

• The income statement shows depreciation expense of $18,000 and an$8,000 gain on sale of plant assets (Exhibit 13-4).

Q & AQ: A company in financialdistress might sell off one ofits profitable divisions to boostnet income. How would thestatement of cash flows helpan investor to recognize thisevent as a one-time boost?A: The large cash inflow wouldbe in the investing sectionrather than the operatingsection.

On the WebStudents don’t need to memorize these rules if theyuse T-accounts to determinethe required adjustment to netincome. Indicate the increaseor decrease in the CurrentAsset and Liability accounts.Using a system of equal debitsand credits, the offsettingentry is the adjustmentrequired to reconcile netincome to cash from operatingactivities. For an example ofthis, visit www.prenhall.comand retrieve ReferenceDocument 13-1.

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• Further, Avery knows the acquisitions of plant assets total $317,000.What we don’t know, however, is the amount of the cash proceeds from thesale of plant assets. To determine this, we first find the book value ofplant assets sold, as follows:

Plant Assets (Net of Depreciation)

Beginning Book EndingBalance + Acquisitions � Depreciation � Value of = Balance

Assets Sold

$219,000 + $317,000 � $18,000 � x = $464,000

� x = $464,000 � $219,000 � $317,000 + $18,000

x = $54,000

Sale Book Value of Assets + Gain, � LossProceeds = Sold or

= $54,000 + $8,000 � $0

= $62,000

Now we can compute the sale proceeds:

Trace the sale proceeds of $62,000 to the statement of cash flows in Exhibit 13-7.If the sale resulted in a loss of $3,000, the sale proceeds would be $51,000 ($54,000 �$3,000), and the statement of cash flows would report $51,000 as a cash receipt fromthis investing activity.

The Plant Assets T-account provides another look at the computation of thebook value of the assets sold:

Plant Assets (Net of Depreciation)

Beginning balance 219,000 Depreciation 18,000Acquisitions 317,000 Book value of assets sold 54,000

Ending balance 464,000

Proceeds from the sale of an asset can be computed as follows:

Proceeds = Book Value of Assets Sold + Gain, or � Loss

The information used to find the book value of the assets sold comes from the bal-ance sheet; the gain or loss comes from the income statement. Exhibit 13-8 sum-marizes the computation of the investing cash flows.

Cash Flows from Financing ActivitiesFinancing activities affect the liability and stockholders’ equity accounts, such asLong-Term Notes Payable, Bonds Payable, Common Stock, and Retained Earnings.

COMPUTING ISSUANCES AND PAYMENTS OF LONG-TERM NOTES PAYABLEIn computing the cash flows related to the issuance and payment of long-termdebt, the beginning and ending balances of Long-Term Notes Payable or Bonds

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Receipts

Payments

From sale of plant assetsBeginning Plant

Assets (net) � � � �Book Value ofAssets Sold

Ending PlantAssets (net)Acquisitions Depreciation

For acquisition of plant assetsBeginning Plant

Assets (net) � � � �Book Value ofAssets Sold

Ending PlantAssets (net)Acquisitions Depreciation

Sale proceeds or�

�Book Value ofAssets Sold

Gain on Sale

� Loss on Sale

Exhibit 13-8 Computing Cash Flows from Investing Activities

Payable are taken from the balance sheet. If either the amount of newissuances or the payments is known, the other amount can be calculated. ForAvery Corporation, suppose new issuances of notes payable total $94,000. Tocompute the amount of debt payments, we use the Long-Term Notes Payableaccount, with amounts from Avery Corporation’s balance sheet in Exhibit 13-3:

Cash flows from operating activities: Net income $41 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation $18

Gain on sale of plant assets (8) Increase in accounts receivable (15) Decrease in inventory 2 Increase in accounts payable 34 Decrease in accrued liabilities (4) 27

Net cash provided by operating activities 68 Cash flows from investing activities: Acquisition of plant assets $(317) Proceeds from sale of plant assets 62 Net cash used for investing activities (255) Cash flows from financing activities: Proceeds from issuance of common stock $101 Proceeds from issuance of long-term notes payable 94 Payment of long-term notes payable (11) Payment of dividends (17) Net cash provided by financing activities 167

Net decrease in cash $(20) Cash balance, December 31, 2007 42 Cash balance, December 31, 2008 $ 22



(In thousands)

1

2

3

Exhibit 13-7 Statement of Cash Flows: Indirect Method

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700 Chapter 13

Another view:

Long-Term Notes Payable

Beginning Issuance Payment EndingBalance + of New Notes Payable � of Notes = Balance

Payable

$77,000 + $94,000 � x = $160,000

� x = $160,000 � $77,000 � $94,000

x = $11,000


Beginning balance 77,000Payment of notes payable 11,000 Issuance of new notes

payable 94,000


Common Stock

Beginning Issuance EndingBalance

+of New Stock

=Balance

$ 258,000 + $101,000 = $359,000

Common Stock

Beginning balance 258,000Issuance of new stock 101,000


Treasury Stock (Amounts assumed for illustration only)

Beginning Purchase EndingBalance + of Treasury = Balance

Stock

$16,000 + $3,000 = $19,000

Treasury Stock

Beginning balance 16,000Purchase of treasurystock 3,000


COMPUTING ISSUANCES OF STOCK AND PURCHASES OF TREASURY STOCKCash flows for these financing activities can be determined by analyzing thestock accounts. For example, the amount of a new issuance of common stock isdetermined from Common Stock. Using data from Exhibits 13-4 and 13-7:

Another view:

Although the Avery Corporation example does not show any treasury stocktransactions, cash flows affecting Treasury Stock can be analyzed as followsusing amounts assumed just for this illustration:

Another view:

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COMPUTING DIVIDEND PAYMENTSThe amount of dividend payments can be computed by analyzing RetainedEarnings.

Retained Earnings

Beginning Net EndingBalance

+Income � Dividends = Balance

$86,000 + $41,000 � x = $110,000

� x = $110,000 � $86,000 � $41,000

x = $17,000

Retained Earnings

Beginning balance 86,000Dividends 17,000 Net income 41,000


The following T-accounts provide another view:

Recall from Chapter 11 that a stock dividend is a distribution of stock shares.Hence, a stock dividend has no effect on Cash and is not reported on the cash flowstatement. Exhibit 13-9 summarizes the computation of cash flows from financ-ing activities, highlighted in color.

Receipts

Payments

From issuance of long-termnotes payable

BeginningNotes Payable � � �

Ending NotesPayable

Issuance of NewNotes Payable

Of long-term notes payable BeginningNotes Payable � � �

Ending Long-TermNotes Payable

Issuance of NewNotes Payable

Payment ofNotes Payable

Of dividends BeginningRetained Earnings � � �

EndingRetained EarningsNet Income Dividends

For purchase of treasury stock BeginningTreasury Stock � �

Purchase ofTreasury Stock

EndingTreasury Stock

Beginning StockIssuance of New StockFrom issuance of stock �

Payment ofNotes Payable

Ending Stock�

Exhibit 13-9 Computing Cash Flows from Financing Activities

Noncash Investing and FinancingActivitiesOur examples thus far included transactions that affect cash. Now suppose thatAvery Corporation issued common stock of $320,000 to acquire a building. Averywould journalize this transaction as follows:

Pitfalls to AvoidStudents should be remindedthat dividends may bedeclared but unpaid at thefinancial statement date.Changes in the DividendsPayable account, if any, willneed to be analyzed todetermine the amount ofdividends paid.

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702 Chapter 13

Journal Entry:

Building 320,000 Common Stock 320,000 Record acquisition of a building in exchange for common stock.


Noncash investing and financing activities: Acquisition of building by issuing common stock $320 Acquisition of land by issuing note payable 70 Payment of note payable by issuing common stock 100 Total noncash investing and financing activities $490

(in thousands)

Exhibit 13-10 Noncash Investing and Financing Activities

(All amounts assumed)

The Financial Accounting Standards Board (FASB), mentioned in Chapter 1 asthe organization that determines how accounting is practiced in the UnitedStates, has expressed a preference for the direct method of reporting cash flowsfrom operating activities. Unfortunately, few companies use this method becauseit takes more computations than the indirect method. A recent survey indicatedthat almost 80% of managers, investors, and analysts polled preferred the indirectmethod. However, the direct method provides clearer information about thesources and uses of cash. Remember that investing and financing cash flows areexactly the same regardless of whether the direct or indirect method is used toreport operating cash flows.

To illustrate the preparation of the statement of cash flows by the directmethod, we will assume the same financial statement information for AveryCorporation. We need information from Avery’s comparative balance sheet(Exhibit 13-3), income statement (Exhibit 13-4), and cash-related transactionssummarized in Exhibit 13-11.

4 Prepare a statementof cash flows by thedirect method.

This transaction would not be reported on the cash flow statement becauseAvery paid no cash. But the company’s exchange of common stock for a building is animportant transaction because of the large value of the exchange. Noncash investingand financing activities can be reported in a separate schedule that accompanies thestatement of cash flows, as Exhibit 13-10 illustrates using amounts assumed for thepurpose of creating an example. This information follows the cash flow statement orcan be disclosed in a note that accompanies the financial statements.

Preparing the Statement of Cash Flows by the Direct Method

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1 Collections from customers, $269,000 2 Cash receipt of interest revenue, $12,000 3 Cash receipt of dividend revenue, $9,000 4 Payments to suppliers, $135,000 5 Salary expense and payments, $56,000 6 Interest expense and payments, $16,000 7 Income tax expense and payments, $15,000 Investing Activities 8 Cash payments to acquire plant assets, $317,000 9 Proceeds from sale of plant assets, $62,000, including $8,000 gain Financing Activities 10 Proceeds from issuance of common stock, $101,000 11 Proceeds from issuance of long-term note payable, $94,000 12 Payment of long-term note payable, $11,000 13 Payment of cash dividends, $17,000

Operating Activities

Exhibit 13-11 Summary of Avery Corporation’s 2008 Cash-Related

Transactions

To help you see cash inflows and outflows for the direct method, think aboutthe business activities that will increase or decrease the cash balance of a com-pany. Exhibit 13-12 links Avery’s cash activity to the statement of cash flows.

• The cash activities are grouped by type of activity, as operating, investing,or financing activities.

• Each activity group’s net cash amount equals its cash inflows minus itscash outflows. For example, net cash used for investing activities is $255.Avery’s cash outflow related to the acquisition of plant assets exceeded itscash inflow from the sales of plants assets ($317 � $62).

• The net change in cash is the sum of the changes for each activity group. In2008, Avery’s net cash flow decreased by $20 because the net cash used forinvesting activities, $255, exceeded the net cash provided by operating andfinancing activities, $68 + $167 = $235, by $20.

• The ending cash balance is the beginning cash balance adjusted for the netchange in cash during the year. Avery’s ending cash balance of $22 equalsthe beginning cash balance of $42 less $20 for the net decrease in cashresulting from 2008’s operating, investing, and financing activities.

Now, let’s take the following steps to prepare the statement of cash flows usingthe direct method to report cash flow from operating activities:

STEP 1Lay out the template of the statement of cash flows by the direct method, asshown in Exhibit 13-13. The format for the cash flows from operating activities isdifferent from the format used in the indirect method, as shown in Exhibit 13-5.

STEP 2Use the comparative balance sheet to determine the increase or decrease incash. The change in cash is the “check figure” for the statement of cash flows.

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Format for theStatement of Cash Flows:

Direct Method

Cash Inflows Outflows � �

Collections from customers 269 To suppliers 135Interest received 12 To employees 56Dividends received 9 For interest 16 For income tax 15

Sale of plant assets 62 Acquisition of plant assets 317

Issued stock 101 Payment of long-term note 11Issued notes payable 94 Payment of dividends 17

� Net cash provided from operations $ 68

� Net cash used for investing activities (255)

� Net cash provided by financing activities 167 � Net decrease $(20)

� Beginning cash balance 42

� Ending cash balance $ 22

Exhibit 13-12 Linking Avery Corporation’s Cash Activity to the Statement of Cash Flows:

Direct Method

The comparative balance sheet of Avery Corporation at December 31, 2008 and2007, shows that Avery’s cash decreased by $20,000 during 2008. See Exhibit 13-3.

STEP 3Use the available data, including the summary of Avery’s 2008 cash-relatedtransactions as shown in Exhibit 13-11, to prepare the statement of cash flows.

The statement of cash flows reports only those transactions with cash effects.Exhibit 13-14 gives Avery Corporation’s statement of cash flows for 2008 usingthe direct method to present cash flows from operating activities. Let’s compareExhibit 13-14 to Exhibit 13-7. Investing and financing cash flows are the same, sowe do not need to review these two sections again. Instead, let’s examine the cashflows from operating activities using the direct method, since this is the only sec-tion that differs between the two methods.

Cash Flows from Operating ActivitiesAgain, operating cash flows are listed first because they are the most importantsource of cash. Exhibit 13-14 shows that Avery is sound; its operating activitieswere the largest source of cash receipts, $290,000 in total. Depreciation, deple-tion, and amortization expense are not listed on this version of the statement ofcash flows because they do not affect cash.

How did we compute the operating cash flows needed for the direct methodand shown in Exhibit 13-11? We used the income statement and the changes inthe related balance sheet accounts, as diagrammed in Exhibit 13-15.

Data for computing Avery Corporation’s operating cash flows come from theincome statement in Exhibit 13-4 and comparative balance sheet in Exhibit 13-3.

COMPUTING CASH COLLECTIONS FROM CUSTOMERSCollections from customers can be computed by converting sales revenue, anamount computed according to the accrual basis of accounting, to the cash basis

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Cash flows from operating activities: Receipts: Collections from customers

Interest received Dividends received

Total cash receipts Payments:

To suppliers To employees For interest For income tax Total cash payments Net cash provided by (used for) operating activities Cash flows from investing activities: Proceeds from sale of long-term assets

– Purchase of long-term assets Net cash provided by (used for) investing activities Cash flows from financing activities:

Proceeds from issuance of stock + Proceeds from sale of treasury stock – Purchase of treasury stock + Proceeds from issuance of notes or bonds payable – Payment of notes or bonds payable – Payment of dividends Net cash provided by (used for) financing activities Net increase (decrease) in cash during the year + Cash at december 31, 2007 = Cash at december 31, 2008



Exhibit 13-13 Template of the Statement of Cash Flows:

Direct Method

amount. Avery Corporation’s income statement in Exhibit 13-4 reports sales of$284,000. But cash collections are different. Exhibit 13-3 shows that AccountsReceivable increased from $81,000 at the beginning of the year to $96,000 at year-end, a $15,000 increase. Based on those amounts, cash collections equal $269,000.

COMPUTING PAYMENTS TO SUPPLIERSThis computation includes two parts:

• Payments for inventory: Convert cost of goods sold to the cash basis usingthe amount from the income statement as well as Inventory and AccountsPayable information from the balance sheet.

• Payments for operating expenses: Convert other operating expenses fromthe income statement to the cash basis using accrued liabilities from thebalance sheet. Throughout, all amounts come from Exhibits 13-3 and 13-4.

Collections Increase in from = Sales – Accounts

Customers Revenue Receivable

$269,000 = $284,000 – $15,000

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Cash flows from operating activities: Receipts: Collections from customers $ 269 Interest received 12 Dividends received 9 Total cash receipts $290 Payments: To suppliers $(135) To employees (56) For interest (16) For income tax (15) Total cash payments (222) Net cash provided by operating activities 68 Cash flows from investing activities: Acquisition of plant assets $(317) Proceeds from sale of plant assets 62 Net cash used for investing activities (255) Cash flows from financing activities: Proceeds from issuance of common stock $ 101 Proceeds from issuance of long-term notes payable 94 Payment of long-term notes payable (11) Payment of dividends (17) Net cash provided by financing activities 167 Net decrease in cash $ (20) Cash balance, December 31, 2007 42 Cash balance, December 31, 2008 $ 22



(In thousands)

Exhibit 13-14 Statement of Cash Flows: Direct Method

Receipts/Payments Income Statement Account� or �

Change in Related Balance Sheet Account�

Payments:

Receipts:

From customers � Sales Revenue � Decrease in Accounts Receivable� Increase in Accounts Receivable

To suppliers � Cost of Goods Sold� Increase in Inventory� Decrease in Inventory

� Decrease in Accounts Payable� Increase in Accounts Payable

Operating Expense� Increase in Prepaids� Decrease in Prepaids

� Decrease in Accrued Liabilities� Increase in Accrued Liabilities

Exhibit 13-15 Computing Cash Flows from Operating Activities: Direct Method

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Keep in mind that Avery’s Statement of Cash Flows for 2008 shows the sameinformation for cash flows from investing and financing activities when you com-pare Exhibit 13-7 prepared using the indirect method to Exhibit 13-14 assembledaccording to the direct method.

Cost of Decrease Increase inPayments for = Goods – in – Accounts

Inventory Sold Inventory Payable$114,000 = $150,000 – $2,000 – $34,000

Payments for Other Decrease inOperating = Operating + AccruedExpenses Expense Liabilities$21,000 = $17,000 + $4,000

Payments to Payments for Payments forSuppliers = Inventory + Operating

Expenses$135,000 = $114,000 + $21,000

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708 Chapter 13

Preparing the Statement of Cash FlowsUsing the Indirect MethodLearning Objectives 1–3

Cassidy Inc. has the following information for 2008:

Demo Doc

Sales revenue $550,000 Costs of goods sold 320,000 Gross profit 230,000 Operating expenses: Salary expense $165,000 Depreciation expense 21,000 Insurance expense 19,000 Total operating expense 205,000 Income from operations 25,000 Other items: Gain on sale of furniture 3,000 Net income $ 28,000

CASSIDY INC.Income Statement


CASSIDY INC.Balance Sheet

December 31, 2008 and 2007

Assets Liabilities Current: Current: Cash $ 28,000 $ 33,000 Accounts payable $ 20,000 $23,000 Accounts receivable 26,000 15,000 Salary payable 10,000 8,000 Prepaid insurance 30,000 42,000 Total current liabilities 30,000 31,000 Total current assets 84,000 90,000 Notes payable 40,000 50,000 Furniture, net 90,000 74,500 Stockholders’ equity Common stock (no par) 4,000 3,500 Retained earnings 100,000 80,000 Total liabilities and Total assets $174,000 $164,500 stockholder’s equity $174,000 $164,500

2008 2007 2008 2007

During 2008 Cassidy:

• Sold furniture with a book value of $15,000 for cash. New furniture was pur-chased for cash.

• Repaid notes payable with a principal value of $22,000. Issued new notes for cash.

• Issued new common shares for cash.

• Paid cash dividends.

Requirement

Prepare Cassidy’s statement of cash flows using the indirect method.

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Requirement

Prepare Cassidy’s statement of cash flows using the indirect method.

Demo Doc Solution

Part 1 Part 2 Part 3 Part 4Demo DocComplete

Operating Activities

When answering this question, refer to the template shown in Exhibit 13-5 (p. 695).This guide will help you structure the statement of cash flows.

As with income statements and balance sheets, every cash-flow statementneeds a proper title. The first line of the title is the company name, next is thename of the statement (statement of cash flows), and last is the date (year endedDecember 31, 2008). Put all together, the title is:

CASSIDY INC.

Statement of Cash Flows


The first section of the statement of cash flows is operating activities. Thissection begins with net income. We can find net income on the income statement.According to Cassidy’s income statement, net income for the year is $28,000.

Items are added or subtracted on the statement of cash flows based on theirimpact to cash. In this case, net income increases cash, so it is added on thestatement of cash flows.

Next, we must take a quick look through the income statement and look forany noncash items there. Noncash items are not part of cash flow, so any noncashitems in net income must be removed.

The most frequent noncash item on the income statement is depreciationexpense. Depreciation expense is subtracted to calculate net income (if you lookat the income statement, you will see a subtraction for depreciation expense), soto remove its impact, the opposite must be done: Depreciation expense of $21,000must be added back to net income.


3 Prepare a statement ofcash flows by the indi-rect method.

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The other noncash item that you will see on many income statements isgains/losses on sale of assets. In this example, Cassidy has a gain on sale offurniture of $3,000. As you can see on the income statement, this gain was addedto calculate net income. To remove its effect, we do the opposite: subtract it. So thegain of $3,000 is subtracted.

Now that we have gotten all necessary information from the incomestatement, we can turn to the balance sheet.

Operating activities deal with everyday transactions of the business, thekind of things the company normally does to earn a profit. What kinds ofaccounts do businesses deal with on a daily basis? Some accounts are AccountsReceivable, Accounts Payable, Inventory, and so forth. In other words, they arethe current assets and current liabilities of the company.

Other than Cash (which we are trying to analyze in preparing the statementof cash flows), what is the first current asset on the balance sheet? It is AccountsReceivable. What happened to Accounts Receivable during the year? It increasedfrom $15,000 to $26,000. This increase affected Cash, but was it in a positive ornegative way? An increase in Accounts Receivable indicates that we did notcollect cash, so cash was impacted negatively.

So the increase of $11,000 ($26,000 � $15,000) to Accounts Receivable isessentially a decrease to Cash, which means that this amount is subtracted onthe statement of cash flows.

The other current asset is Prepaid Insurance. This account decreased from$42,000 to $30,000. A decrease to Prepaid Insurance indicates that we usedsomething we had prepaid—that is something we had already paid for, so cash isconserved. So the decrease of $12,000 ($42,000 � $30,000) will be added on thestatement of cash flows.

So far, operating activities show the following information:

Cash flows from operating activities: Net income $28,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $21,000 Gain on sale of plant assets (3,000) Increase in accounts receivable (11,000) Decrease in prepaid insurance 12,000

Now that we have looked at the current assets, we can look at the cur-rent liabilities. The first current liability is Accounts Payable. During the

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year, Accounts Payable decreased from $23,000 to $20,000. This amount would be a debit. To balance out with Cash, Cash would be credited, which is a de-crease. So $3,000 ($23,000 � $20,000) will be subtracted on the statement of cash flows.

The other current liability is Salary Payable. During the year, SalaryPayable increased from $8,000 to $10,000. The increase in this payable accountshows that this amount of salaries were unpaid, an increase to Cash. So $2,000($10,000 � $8,000) will be added on the statement of cash flows.

Now that we have looked at all of the current assets and liabilities, we cantotal the operating activities section:

Cash flows from operating activities: Net income $28,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $21,000 Gain on sale of plant assets (3,000) Increase in accounts receivable (11,000) Decrease in prepaid insurance 12,000 Decrease in accounts payable (3,000) Increase in salary payable 2,000 18,000 Net cash provided by operating activities 46,000

Investing Activities


Investing activities deal with long-term assets. The only long-term asset isFurniture. Unfortunately, we cannot just say “increase in Furniture” or “decreasein Furniture” and look at the overall change because Furniture is a major account.We must look at each significant transaction affecting the account.

From the additional information we were given with the question, we knowthat Cassidy purchased furniture and sold furniture during the year. Each of these

3 Prepare a statement ofcash flows by the indirect method.


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transactions will be a separate line in investing activities. Looking at Exhibit 13-5(p. 695), we can set up a framework for the investing activities section:

Cash flows from investing activities: Acquisition of furniture ??? Proceeds from sale of furniture ??? Net cash used for investing activities ???

We do not know these totals, but we can calculate them with the informationwe already have.

First, we should analyze the Furniture, Net T-account. From the balancesheet, we know that in 2008, Furniture, net has a beginning balance of $74,500and an ending balance of $90,000. During the year, Furniture (Net) increased anddecreased.

Furniture (Net) increases when new furniture is purchased (acquisitions).Furniture (Net) decreases by the book value of furniture sold and whendepreciation expense is recorded. Putting these items into the T-account:

Furniture, Net

Beginning balance 74,500Increases ??? Decreases ???


Furniture, Net

Beginning balance 74,500 Depreciation 21,000Acquisitions X Book value of assets sold 15,000


Depreciation expense of $21,000 can be obtained from the income statement(or the operating activities section of the statement of cash flows). The book valueof $15,000 for the assets sold was given in the problem.

We can use this information to calculate the cost of furniture purchased(acquisitions), X.

$74,500 � $21,000 � $15,000 + X = $90,000

X = $90,000 � $74,500 + $21,000 + $15,000 = $51,500

So acquisitions of furniture were $51,500. Purchasing furniture caused Cashto decrease, so the $51,500 will be subtracted on the statement of cash flows.

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We still need to determine the cash received when furniture was sold(proceeds). We can use the gain/loss formula for this calculation:

Proceeds = Book Value of Assets Sold + Gain, or � Loss

Proceeds = $15,000 Book Value of Assets Sold + Gain of $3,000 = $18,000

So the proceeds from sale of furniture were $18,000. Selling furniture causedCash to increase, so the $18,000 will be added on the statement of cash flows.

Filling this information into the investing activities, we have:

Cash flows from investing activities: Acquisition of furniture $(51,500) Proceeds from sale of furniture 18,000 Net cash used for investing activities $(33,500)


Financing Activities

Financing activities deal with long-term liabilities (that is, debt financing) andequity (that is, equity financing).

Cassidy only has one long-term liability: Notes Payable. As with furniture,we know that we must report the major transactions in this account separately.

From the additional information we were given with the question, we knowthat Cassidy paid off notes payable and issued new notes payable during theyear. Each of these transactions will be a separate line in financing activities.Looking at Exhibit 13-5 (p. 695), we can set up a framework for the beginning ofthe financing activities section:

Cash flows from financing activities: Proceeds from issuance of long-term notes payable ??? Payment of long-term notes payable ???

From the additional information given in the problem, we know that $22,000of notes were paid off.

We need to calculate the value of new notes issued. As we did with furniture,we can make this calculation by analyzing the T-account. In 2008, Notes Payablehad a beginning balance of $50,000 and an ending balance of $40,000.


3 Prepare a statement ofcash flows by the indi-rect method.

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Notes Payable is increased when new notes are issued and is decreasedwhen notes are paid off. Putting this information into the T-account, we have:

Notes Payable

Beginning balance 50,000Decreases ??? Increases ???


Notes Payable

Beginning balance 50,000Payments 22,000 Issuance of new notes payable X


We can use this information to calculate the value of new notes issue,

$50,000 – $22,000 + X = $40,000 X = $40,000 – $50,000 + $22,000 = $12,000

So issuance of notes payable was $12,000. Because issuing notes payableincreased Cash, $12,000 will be added on the statement of cash flows.

Putting this information into the financing activities section, we have:

Now that we have examined the long-term liabilities, we only have equityremaining. The first account in equity is Common Stock. From the additionalinformation, we know that new common stock (no par) was issued during theyear. Because this is the only transaction affecting Common Stock, we know thatthe change in the Common Stock account represents the issuance of these shares.Using the T-account:

Cash flows from financing activities: Proceeds from issuance of long-term notes payable $12,000 Payment of long-term notes payable (22,000)

We use this information to calculate the value of new common stock issued, X.

$3,500 + X = $4,000

X = $4,000 � $3,500 = $500

So issuance of common stock (proceeds) was $500. Because issuing commonstock increases Cash, $500 will be added on the statement of cash flows.

The last account in equity is Retained Earnings. This account changedduring 2008. Looking at the T-account:

Common Stock (no par)

Beginning balance 3,500Issuance of new stock X


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Retained Earnings

Beginning balance 80,000Decreases ??? Increases ???


Retained Earnings

Beginning balance 80,000Dividends X Net income 28,000


Retained Earnings is increased when the company earns net income and isdecreased when the company pays dividends. Putting this information into the T-account, we have:

We use this information to calculate the amount of cash dividends paid, X.

$80,000 + $28,000 � X = $100,000

X = $80,000 + $28,000 � $100,000 = $8,000

So cash dividends paid were $8,000. Because the payment of dividendsdecreased Cash, $8,000 will be subtracted on the statement of cash flows.

Notice that we do not record net income in the financing activities (eventhough it affects Retained Earnings), because net income was already accountedfor in the operating activities section.

Putting all of this information into the financing activities section, we have:

Cash flows from financing activities: Proceeds from issuance of long-term notes payable $12,000 Payment of long-term notes payable (22,000) Proceeds from issuance of common stock 500 Payment of dividends (8,000) Net cash used for financing activities $(17,500)

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Net decrease in cash $ (5,000) Cash balance, December 31, 2007 33,000 Cash balance, December 31, 2008 $28,000

716 Chapter 13

Now that we have completed the three main sections of the statement ofcash flows, we can add the totals of the three sections together to determine cashflow (the net change in cash).

Net Change in Cash = Cash Provided by Operating Activities + Cash Provided by Investing Activities + Cash Provided by Financing Activities

Net Change in Cash = $46,000 � $33,500 � $17,500 = $(5,000)

Because the change in cash is negative, we know that it means a netdecrease in cash.

The statement began with net income (from the income statement). Now wetie it to the balance sheet to bring cash flows full circle. We add the decrease of$5,000 in cash to the cash balance at the beginning of the year of $33,000 (fromCassidy’s balance sheet). This equation gives us the cash balance at the end ofthe year of $(5,000) + $33,000 = $28,000.

Putting this information in statement of cash flows format:

This section of the statement is also a nice check to ensure that ourcalculations are correct. The $28,000 calculated is the number reported for cashon the balance sheet at December 31, 2008.

To finish the statement of cash flows, we just put all of these pieces together:


3 Prepare a statement ofcash flows by the indirect method.

Finishing the Statement of Cash Flows


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Cash flows from operating activities: Net income $28,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense $21,000 Gain on sale of plant assets (3,000) Increase in accounts receivable (11,000) Decrease in prepaid insurance 12,000 Decrease in accounts payable (3,000)

Increase in salary payable 2,000 18,000 Net cash provided by operating activities $46,000

Cash flows from investing activities: Acquisition of furniture (51,500) Proceeds from sale of furniture 18,000

Net cash used for investing activities (33,500) Cash flows from financing activities: Proceeds from issuance of long-term notes payable 12,000 Payment of long-term notes payable (22,000) Proceeds from issuance of common stock 500 Payment of dividends (8,000) Net cash used for financing activities (17,500) Net decrease in cash $ (5,000) Cash balance, December 31, 2007 33,000 Cash balance, December 31, 2008 $28,000

CASSIDY INC.Statement of Cash Flows



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718 Chapter 13

Accounting in ActionTHE STATEMENT OF CASH FLOWS

Imagine that you start your own business, and based on youraccounting knowledge, you choose to prepare the financialstatements for your company. What decision would you face inpreparing and interpreting its statement of cash flows?

Decision Guidelines

Where is most of the company’s cash coming from? Operating activities: Company is generating positive cash flows from day-to-day operations.Investing activities: Company is producing positive cash flows from selling investments for cash.Financing activities: Company is creating positive cashflows by obtaining cash from long-term creditors or owners.

Which set of activities is most important when Operating activities must be the main source of cash for considering cash flow? long-term success.What is cash? Cash includes both cash and cash equivalents, highly

liquid short-term investments.What is the statement of cash flows? Statement of cash flows is the financial statement showing

inflows and outflows of cash for a period of time. It reconciles the cash balance at the beginning of the periodto the cash balance at the end of that period.

How is the operating activities section of the statement 2 choices:prepared? • Indirect method, the more popular choice,

reconciles net income as reported on the income statement to net cash provided by operating activities.• Direct method shows all cash receipts and cash payments form operating activities.

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The Statement of Cash FlowsWord Power

Review

Cash flows Cash receipts and cash payments.

Direct method Format of the operating activities section ofthe statement of cash flows that lists the major categoriesof operating cash receipts and cash payments.

Indirect method Format of the operating activities section ofthe statement of cash flows that starts with net income andreconciles it to net cash provided by operating activities.

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720 Chapter 13

Quick Check1. The three main categories of cash flows are:

a. Direct, indirect, and hybridb. Current, long-term, and fixedc. Operating, investing, and financingd. Short-term, long-term, and equity

2. The purposes of the cash flow statement are to:

a. Predict future cash flowsb. Evaluate management decisionsc. Predict ability to make payments to lendersd. All of the above

3. Financing activities are most closely related to

a. Current assets and current liabilitiesb. Long-term assetsc. Long-term liabilities and owner’s equityd. Net income and dividends

4. Which item does not appear on a statement of cash flows prepared by theindirect method?

a. Collections from customersb. Net incomec. Depreciationd. Gain on sale of land

5. Artoo Detoo Robotics earned net income of $60,000 after deducting deprecia-tion of $4,000 and all other expenses. Current assets increased by $3,000 andcurrent liabilities decreased by $5,000. Using the indirect method, how muchwas Artoo Detoo’s cash flows from operating activities?

a. $48,000b. $50,000c. $52,000d. $56,000

6. The Plant Assets account of C. Threepio, Inc., shows the following:

Plant Assets, Net

Beginning Balance 100,000 Depreciation 30,000Purchase 400,000 Sale ?

Ending Balance 420,000

C. Threepio sold plant assets at a $10,000 gain. Where on the statement ofcash flows should C. Threepio report the sale of plant assets? How muchshould C. Threepio report for the sale?

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a. Cash flows from investing activities, $40,000b. Cash flows from investing activities, $50,000c. Cash flows from investing activities, $60,000d. Cash flows from financing activities, $60,000

7. Wookie Corporation borrowed $15,000, issued common stock of $10,000, andpaid dividends of $25,000. What was Wookie’s net cash provided or used byfinancing activities?

a. $0b. $25,000c. $(25,000)d. $50,000

8. Which item does not appear on a statement of cash flows prepared by thedirect method?

a. Net incomeb. Payment to suppliersc. Collections from customersd. Payment of income tax

9. H. Solo Systems Incorporated had accounts receivable of $20,000 at thebeginning of the year and $50,000 at year-end. Revenue for the year totaled$100,000. How much cash did H. Solo Systems collect from customers?

a. $170,000b. $150,000c. $120,000d. $70,000

10. Skywalker Enterprises had operating expenses of $40,000. At the beginningof the year, Skywalker owed $5,000 on accrued liabilities. At year-end,accrued liabilities were $8,000. How much cash did Skywalker pay for operat-ing expenses?

a. $35,000b. $37,000c. $43,000d. $45,000

Answers are given after Apply Your Knowledge (p. 745).

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✓

722 Chapter 13

S13-1. Describe how the statement of cash flows helps investors and creditorsperform each of the following functions:

1. Predict future cash flows

2. Evaluate management decisions

3. Predict the ability to make debt payments to lenders and pay divi-dends to stockholders

S13-2. Answer these questions about the statement of cash flows:

1. What is the “check figure” for the statement of cash flows? Wheredo you get this check figure?

2. List the categories of cash flows in order of importance.

3. What is the first dollar amount reported using the indirectmethod?

4. What is the first dollar amount reported using the direct method?

S13-3. Spock Spaceships is preparing its statement of cash flows by the indi-rect method. Identify each of the following transactions as

• Operating activity: addition to net income (O+) or subtraction fromnet income (O–)

• Investing activity (I)

• Financing activity (F)

• Activity that is not used to prepare the cash flow statement (N)

____ a. Loss on sale of land

____ b. Depreciation expense

____ c. Increase in inventory

____ d. Decrease in accounts receivable

____ e. Purchase of equipment

____ f. Increase in accounts payable

____ g. Payment of dividends

____ h. Decrease in accrued liabilities

____ i. Issuance of common stock

____ j. Gain on sale of building

Short Exercises

Accounting Practice

1 Explaining the pur-poses of the statementof cash flows anddescribing itselements.

2 Distinguishing amongoperating, investing,and financing cashflows.

3 Preparing a statementof cash flows by theindirect method.

4 Preparing a statementof cash flows by thedirect method.


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S13-4. C. Kirk Corporation reported this data for 2007: 3 Preparing a statementof cash flows by theindirect method.


Income statement: Net income..................................... $50,000

Depreciation .................................. 8,000

Balance sheet: Increase in accounts receivable.... 6,000

Decrease in accounts payable....... 4,000

Compute Kirk’s net cash provided by operating activities according tothe indirect method.

S13-5. Scotty Inc.’s accountants assembled the following data for the yearended June 30, 2008.

Net income ....................................................... $60,000 Purchase of equipment................. $40,000

Proceeds from issuance of common stock....... 20,000 Decrease in current liabilities ..... 5,000

Payment of dividends ...................................... 6,000 Payment of note payable.............. 30,000

Increase in current assets other than cash.... 30,000 Proceeds from sale of land ........... 60,000

Purchase of treasury stock.............................. 5,000 Depreciation expense ................... 15,000

Prepare the operating activity section of Scotty’s statement of cash flowsfor the year ended June 30, 2008. Scotty Inc. uses the indirect method.

S13-6. Use the data in S13-5 to prepare Scotty’s statement of cash flows for theyear ended June 30, 2008. Scotty Inc. uses the indirect method for pre-senting its operating activities related to cash flows. Use Exhibit 13-7 asa guide, but stop after determining the net increase or decrease in cash.

S13-7. McCoy Medical Company reported the following financial statementsfor 2008:


Revenue: Sales revenue $710 Expenses: Cost of goods sold $340 Depreciation expense 60 Other expenses 200 Total expense 600 Net income $110

MCCOY MEDICAL COMPANYIncome Statement



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724 Chapter 13

Use the information in the financial statements to compute theamount of plant assets acquired by McCoy, assuming McCoy sold noplant assets in 2008.

S13-8. Use the McCoy Medical Company data in S13-7 to compute the follow-ing amounts for 2008:

1. Borrowing or payment of long-term notes payable, assuming McCoyhad only one long-term note payable transaction during the year.

2. Issuance of common stock, assuming McCoy had only one commonstock transaction during the year.

3. Payment of cash dividends.

S13-9. Uhura Health Spas began 2008 with cash of $104,000. During theyear, Uhura earned service revenue of $600,000 and collected$590,000 from customers. Expenses for the year totaled $420,000, ofwhich Uhura paid $410,000 in cash to suppliers and employees. Uhuraalso paid $140,000 to purchase equipment and paid a cash dividend of$50,000 to its stockholders during 2008. Prepare the company’s state-ment of cash flows for the year ended December 31, 2008. Format cashflows from operating activities by the direct method.

S13-10. Scotty Inc. assembled the following data related to its cash transac-tions for the year ended June 30, 2008:

MCCOY MEDICAL COMPANYComparative Balance Sheet December 31, 2008 and 2007

Assets Liabilities Current: Current: Cash $ 19 $ 16 Accounts payable $ 47 $ 42 Accounts receivable 54 48 Salary payable 23 21 Inventory 80 84 Accrued liabilities 8 11 Prepaid expenses 3 2 Long-term notes payable 66 68 Long-term investments 75 90 Stockholders’ Equity Plant assets, net 225 185 Common stock 40 37 Retained earnings 272 246 Total liabilities and Total assets $456 $425 stockholders’ equity $456 $425

2008 2007 2008 2007(in thousands)




Payment of dividends ............................. $ 6,000

Proceeds from issuance of stock ............. 20,000

Collections from customers .................... 200,000

Proceeds from sale of land ..................... 60,000

Payments to suppliers ............................ 80,000

Purchase of equipment ........................... 40,000

Payments to employees .......................... 70,000

Payment of note payable ........................ 30,000

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Prepare the operating activities section of Scotty’s statement of cashflows for the year ended June 30, 2008. Scotty Inc. uses the directmethod for cash flows from operating activities.

S13-11. Use the data in S13-10 to prepare Scotty’s statement of cash flows forthe year ended June 30, 2008. Scotty uses the direct method for cashflows from operating activities. Use Exhibit 13-14 as a guide, but stopafter determining the net increase or decrease in cash.

S13-12. Use the McCoy Medical Company data in S13-7 to compute the following:

1. Collections from customers

2. Payments for inventory

Exercises

E13-13. S. Cowell, Inc., experienced an unbroken string of 10 years of growth innet income. Nevertheless, the business is facing bankruptcy. Creditorsare calling all of S. Cowell’s outstanding loans for immediate payment,and Cowell has no cash available to make these payments becausemanagers placed undue emphasis on net income and gave too littleattention to cash flows.

Requirements

Write a brief memo in your own words to explain to the managers of S. Cowell, Inc., the purposes of the statement of cash flows.

E13-14. Identify each of the following transactions as

• Operating activity (O)



• Noncash investing and financing activity (NIF)

For each item, indicate whether it represents an increase (+) or adecrease (–) in cash. The indirect method is used to report cash flowsfrom operating activities.

____ a. Cash sale of land

____ b. Issuance of long-term note payable in exchange for cash

____ c. Depreciation of equipment

____ d. Purchase of treasury stock



1 Explaining the pur-poses of the state-ment of cash flowsand describing its elements.


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726 Chapter 13

____ e. Issuance of common stock for cash

____ f. Increase in accounts payable

____ g. Net income

____ h. Payment of cash dividend

____ i. Decrease in accrued liabilities

____ j. Loss on sale of land

____ k. Acquisition of building by issuance of notes payable

____ l. Payment of long-term debt

____ m. Acquisition of building by issuance of common stock

____ n. Decrease in accounts receivable

____ o. Decrease in inventory

____ p. Increase in prepaid expenses

E13-15. Indicate whether each of the following transactions would result in anoperating activity, an investing activity, a financing activity, or a trans-action that does affect cash for a statement of cash flows prepared bythe indirect method.

a. Equipment 18,000 Cash 18,000 b. Cash 7,200 Long-Term Investment 7,200 c. Bonds Payable 45,000 Cash 45,000 d. Building 164,000 Notes Payable, Long-Term 164,000 e. Loss on Disposal of Equipment 1,400 Equipment 1,400 f. Dividend Payable 16,500 Cash 16,500 g. Cash 81,000 Common Stock 81,000 h. Treasury Stock 13,000 Cash 13,000 i. Cash 60,000 Sales Revenue 60,000 j. Land 87,700 Cash 87,700 k. Depreciation 9,000 Accumulated Depreciation 9,000


Journal Entry:


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Accounts Receivable

Mar. 1 18,000 Collections 447,000Sales 443,000

Mar. 31 14,000

Accounts Payable

Payments 332,000 Mar. 1 14,000Purchases 337,000

Mar. 31 19,000

Retained Earnings

Dividends 18,000 Mar. 1 64,000Net income 69,000

Mar. 31 115,000


E13-16. The accounting records of P. Abdul Talent Agency reveal the following: 3 Preparing a statementof cash flows by theindirect method.

Net income ………………………………………............ $22,000

Depreciation ………………………………………......... 12,000

Sales revenue ……………………………………........... 9,000

Decrease in current liabilities ……………………...... 20,000

Loss on sale of land ………………………………........ 5,000

Increase in current assets other than cash ………… 27,000

Acquisition of land ……………………………….......... 37,000

Requirements

Compute cash flows from operating activities by the indirect method.Use the format of the operating activities section shown in Exhibit 13-7.Also evaluate the operating cash flow of P. Abdul Talent Agency. Givethe reason for your evaluation.

E13-17. The March accounting records of R. Jackson Record Company includethese accounts:

Cash

Mar. 1 5,000 Payments 448,000Receipts 447,000

Mar. 31 4,000

Inventory

Mar. 1 19,000 Cost of goods Purchases 337,000 sold 335,000

Mar. 31 21,000

Accumulated Depreciation

Mar.1 52,000Depreciation 3,000

Mar. 31 55,000

Compute Jackson’s net cash provided by operating activities duringMarch. Use the indirect method.

E13-18. The income statement and additional data of Seacrest Services, Inc.,follow:


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728 Chapter 13

Additional data:

1. Acquisition of plant assets totaled $116,000. Of this amount,$101,000 was paid in cash and a $15,000 note payable was signedfor the remainder.

2. Proceeds from sale of land totaled $24,000. No gain was recognizedon the sale.

3. Proceeds from issuance of common stock totaled $30,000.

4. Payment of long-term note payable was $15,000.

5. Payment of dividends was $11,000.

6. Data from the comparative balance sheet follows:


Sales revenue $237,000 Cost of goods sold 103,000 Gross profit 134,000 Other expenses: Salary expense $58,000 Depreciation expense 29,000 Income tax expense 9,000 Total expenses 96,000 Net income $ 38,000

SEACREST SERVICES INCORPORATEDIncome Statement

Year Ended June 30, 2008

June 30 2008 2007

Current Assets:Cash ............................................... $27,000 $20,000Accounts Receivable ...................... 43,000 58,000Inventory ....................................... 92,000 85,000Current Liabilities:Accounts Payable ........................... $35,000 $22,000Accrued Liabilities ........................ 13,000 21,000

Requirements

1. Prepare Seacrest’s statement of cash flows for the year ended June 30, 2008, using the indirect method.

2. Evaluate Seacrest’s cash flows for the year. In your evaluation,mention all three categories of cash flows and give the reason foryour evaluation.

E13-19. Compute the following items for the statement of cash flows:

1. The beginning and ending Retained Earnings balances are $45,000and $73,000, respectively. Net income for the period is $62,000.How much are cash dividends?


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2. The beginning and ending Plant Assets, net, balances are $103,000and $107,000, respectively. Depreciation for the period is $16,000,and acquisitions of new plant assets total $27,000. Plant assetswere sold at a $1,000 loss. What were the cash proceeds of the sale?

E13-20. Identify each of the following transactions as:

• Operating activity (O)



• Noncash investing and financing activity (NIF)

For each cash item, indicate whether it represents an increase (+) or adecrease (–) in cash. The direct method is used for cash flows fromoperating activities.

____ a. Collections from customers

____ b. Issuance of long-term note payable in exchange for cash

____ c. Depreciation of equipment

____ d. Purchase of treasury stock

____ e. Issuance of common stock for cash

____ f. Payment to suppliers

____ g. Issuance of preferred stock for cash

____ h. Payment of cash dividend

____ i. Sale of land

____ j. Acquisition of building by issuance of note payable

____ k. Payment of long-term debt

____ l. Acquisition of building by issuance of common stock

____ m. Purchase of equipment for cash

____ n. Payment of wages to employees

____ o. Collection of interest revenue

____ p. Sale of building

E13-21. Indicate whether each of the following transactions would result in anoperating activity, an investing activity, a financing activity, or a trans-action that does affect cash for a statement of cash flows prepared bythe direct method.



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730 Chapter 13

E13-22. The accounting records of A. Idol, Inc., reveal the following:4 Preparing a statementof cash flows by thedirect method.

a. Equipment 18,000 Cash 18,000 b. Cash 7,200 Long-Term Investment 7,200 c. Bonds Payable 45,000 Cash 45,000 d. Building 164,000 Notes Payable, Long-Term 164,000 e. Cash 1,400 Accounts Receivable 1,400 f. Dividend Payable 16,500 Cash 16,500 g. Salary Expense 4,300 Cash 4,300 h. Cash 81,000 Common Stock 81,000 i. Treasury Stock 13,000 Cash 13,000 j. Cash 2,000 Interest Revenue 2,000 k. Land 87,700 Cash 87,700 l. Accounts Payable 8,300 Cash 8,300


Journal Entry:

Net income ................................... $22,000 Payment of salaries and wages ... $ 34,000

Payment of income tax................ 13,000 Depreciation.................................. 12,000

Collection of dividend revenue ... 7,000 Payment of interest...................... 16,000

Payment to suppliers................... 54,000 Payment of dividends................... 7,000

Collections from customers ......... 102,000

Requirements

Compute cash flows from operating activities by the direct method.Use the format of the operating activities section shown in Exhibit 13-14.Also evaluate the operating cash flow of A. Idol, Inc. Give the reasonfor your evaluation.

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Requirements

For each account, identify the item or items that should appear on astatement of cash flows prepared by the direct method. State in whichsection the item should be reported.

E13-24. The income statement and additional data of Seacrest Services, Inc.,follow:



Dividends Receivable

Beginning balance 9,000 Cash receipts of dividends 38,000Dividend revenue 40,000


Land

Beginning balance 90,000Acquisition by cash payment 18,000



Payments 69,000 Beginning balance 273,000Issuance for cash 83,000


Revenues: Sales revenue $229,000 Dividend revenue 8,000 Total revenues $237,000 Expenses: Cost of goods sold $103,000 Salary expense 45,000 Depreciation expense 28,000 Advertising expense 12,000 Interest expense 2,000 Income tax expense 9,000 Total expenses 199,000 Net income $ 38,000

SEACREST SERVICES INCORPORATEDIncome Statement

Year Ended June 30, 2008

Additional data:

a. Collections from customers are $15,000 more than sales.

b. Payments to suppliers are the sum of cost of goods sold plus adver-tising expense.

E13-23. Selected accounts of Auditions, Inc., show the following:

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732 Chapter 13

c. Payments to employees are $1,000 more than salary expense.

d. Dividend revenue, interest expense, and income tax expense equaltheir cash amounts.

e. Acquisition of plant assets for cash is $101,000.

f. Proceeds from sale of land total $24,000.

g. Proceeds from issuance of common stock for cash total $30,000.

h. Payment of long-term note payable is $15,000.

i. Payment of dividends is $11,000.

j. Cash balance, June 30, 2007, was $20,000.

Prepare Seacrest’s statement of cash flows for the year ended June 30,2008. Use the direct method.

E13-25. Compute the following items for the statement of cash flows:

1. The beginning and ending Accounts Receivable balances are$22,000 and $18,000, respectively. Credit sales for the period total$81,000. How much are cash collections?

2. Cost of goods sold is $90,000. Beginning Inventory balance is$25,000, and ending Inventory balance is $21,000. Beginning andending Accounts Payable are $11,000 and $8,000, respectively. Howmuch are cash payments for inventory?

E13-26. Top Ten Corporation, a nationwide insurance chain, reported the fol-lowing selected amounts in its financial statements for the year endedAugust 31, 2008 (adapted, in millions):

Income Statement

2008 2007

Net Sales $24,623 $21,207

Cost of Goods Sold 18,048 15,466

Depreciation Expense 269 230

Other Expenses 4,883 4,248

Income Tax Expense 537 486

Net Income 886 777



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Determine the following for Top Ten Corporation during 2008:

a. Collections from customers

b. Payments for inventory

c. Payments of operating expenses

d. Acquisitions of property and equipment. No sales were made dur-ing 2008.

e. Long-term borrowing, assuming Top Ten made no payments onlong-term liabilities

f. Proceeds from issuance of common stock

g. Payment of cash dividends

Problems (Group A)

P13-27A. Top managers of Greys and Atomy, Inc., are reviewing company perfor-mance for 2008. The income statement reports a 20% increase in netincome over 2007. However, most of the increase resulted from anextraordinary gain on insurance proceeds from storm damage to abuilding. The balance sheet shows a large increase in receivables. Thecash flow statement, in summarized form, reports the following:

Balance Sheet

2008 2007

Cash and Cash Equivalents $ 17 $ 13

Accounts Receivable 798 615

Inventories 3,482 2,831

Property and Equipment, Net 4,345 3,428

Accounts Payable 1,547 1,364

Accrued Liabilities 938 848

Long-Term Liabilities 478 464

Common Stock 676 446

Retained Earnings 4,531 3,788

1 Explaining the pur-poses of the state-ment of cash flowsand describing its elements.


Net cash used for operating activities ............................... $(80,000)

Net cash provided by investing activities.......................... 40,000

Net cash provided by financing activities.......................... 50,000

Increase in cash during 2008 ............................................. $ 10,000

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734 Chapter 13

Requirements

Write a memo giving Greys and Atomy’s managers your assessment of2008 operations as it relates to cash flows. Also provide your outlookfor the future.

P13-28A. O’Malley Corporation accountants assembled the following data forthe year ended December 31, 2008:


O’Malley Corporation

December 31 2008 2007

Current assets:

Cash and cash equivalents $85,000 $22,000

Accounts receivable 69,200 64,200

Inventory 80,000 83,000

Current liabilities:

Accounts payable $57,800 $55,800

Income tax payable 14,700 16,700

Transaction Data for 2008:

Net income ................................................................................... $ 57,000

Purchase of treasury stock.......................................................... 14,000

Issuance of common stock for cash ............................................. 41,000

Loss on sale of equipment ........................................................... 11,000

Payment of cash dividends.......................................................... 18,000

Depreciation expense .................................................................. 21,000

Issuance of long-term note payable in exchange for cash ......... 34,000

Purchase of building for cash...................................................... 125,000

Retirement of bonds payable by issuing common stock ............ 65,000

Sale of equipment for cash .......................................................... 58,000

Requirements

Prepare O’Malley Corporation’s statement of cash flows using the indi-rect method to report operating activities. List noncash investing andfinancing activities on an accompanying schedule.

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Izzie’s transactions during the year ended March 31, 2009, includedthe following:



March 31 2009 2008

Current assets:



Inventory 63,200 60,600



Accrued liabilities 10,700 11,100


P13-29A. Data from the comparative balance sheet of Izzie Company at March 31,2009, follows:

Payment of cash dividend ............................. $30,000 Depreciation expense .................. $ 17,300

Purchase of equipment for cash ................... 78,700 Purchase of building for cash ..... 47,000

Issuance of long-term note payable Net income ................................... 70,000in exchange for cash ..................................... 50,000 Issuance of common stock ........... 11,000

Requirements

1. Prepare Izzie’s statement of cash flows for the year ended March 31,2009, using the indirect method to report cash flows from operatingactivities.

2. Evaluate Izzie’s cash flows for the year. Mention all three cate-gories of cash flows and give the reason for your evaluation.

P13-30A. The 2008 comparative balance sheet and income statement of A. KarevMedical Supplies follow on the next page.

A. Karev had no noncash investing and financing transactions during2008. During the year, A. Karev made no sales of land or equipment, noissuance of notes payable, no retirement of stock, and no treasury stocktransactions.

Requirements

1. Prepare the 2008 statement of cash flows, formatting operatingactivities by the indirect method.

2. How will what you learned in this problem help you evaluate aninvestment?

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736 Chapter 13

P13-31A. The accounting records for R. Webber Associates, Inc., for the yearended April 30, 2008, contain the following information:

a. Purchase of plant assets for cash, $59,400

b. Proceeds from issuance of common stock, $8,000

Current assets: Cash and cash equivalents $ 6,700 $ 5,300 $ 1,400 Accounts receivable 25,300 26,900 (1,600) Inventory 91,800 89,800 2,000 Plant assets: Land 89,000 60,000 29,000 Equipment, net 53,500 49,400 4,100 Total assets $266,300 $231,400 $34,900

Current liabilities: Accounts payable $ 30,900 $ 35,400 $ (4,500) Accrued liabilities 30,600 28,600 2,000 Long-term liabilities: Notes payable 75,000 100,000 (25,000) Stockholders’ equity: Common stock 88,300 64,700 23,600 Retained earnings 41,500 2,700 38,800 Total liabilities and stockholders’ equity $266,300 $231,400 $34,900

A. KAREV MEDICAL SUPPLIESComparative Balance Sheet December 31, 2008 and 2007

2008 2007Increase

(Decrease)

Revenues: Sales revenue $213,000 Interest revenue 8,600 Total revenues $221,600 Expenses: Cost of goods sold $ 70,600 Salary expense 27,800 Depreciation expense 4,000 Other operating expenses 10,500 Interest expense 11,600 Income tax expense 29,100 Total expenses 153,600 Net income $ 68,000

A. KAREV MEDICAL SUPPLIESIncome Statement



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c. Payment of dividends, $48,400

d. Collection of interest, $4,400

e. Payment of salaries, $93,600

f. Proceeds from sale of plant assets, $22,400

g. Collections from customers, $620,500

h. Cash receipt of dividend revenue, $4,100

i. Payments to suppliers, $368,500

j. Depreciation expense, $59,900

k. Proceeds from issuance of long-term notes, $19,600

l. Payments of long-term notes payable, $50,000

m. Interest expense and payments, $13,300

n. Income tax expense and payments, $37,900

o. Cash balances: April 30, 2007, $39,300; April 30, 2008, $47,200

Requirements

Prepare R. Webber Associates’ statement of cash flows for the yearended April 30, 2008. Use the direct method for cash flows from operat-ing activities. Follow the format of Exhibit 13-1.

P13-32A. Use the A. Karev Medical Supplies data from P13-30A. The cashamounts for Interest Revenue, Salary Expense, Interest Expense, andIncome Tax Expense are the same as the accrual amounts for theseitems.

Requirements

1. Prepare the 2008 statement of cash flows by the direct method.


P13-33A. To prepare the statement of cash flows, accountants for C. Yang, Inc.,summarized 2008 activity in the Cash account as follows:


Cash

Beginning balance 53,600 Payment on accounts payable 399,100Receipts of interest 17,100 Payment of dividends 27,200Collections from customers 673,700 Payment of salaries and wages 143,800Issuance of common stock 47,300 Payment of interest 26,900

Payment for equipment 10,200Payment of operating expenses 34,300Payment of notes payable 67,700Payment of income tax 18,900



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738 Chapter 13

Requirements

Prepare the statement of cash flows of C. Yang, Inc., for the year endedDecember 31, 2008, using the direct method for operating activities.

Problems (Group B)

P13-34B. Top managers of Super Hair Replacements, Inc., are reviewing com-pany performance for 2008. The income statement reports a 15%increase in net income, the fifth consecutive year with an incomeincrease above 10%. The income statement includes a loss not expectedto occur again, without which net income would have increased by16%. The balance sheet shows modest increases in assets, liabilities,and stockholders’ equity. The assets posting the largest increases areplant and equipment because the company is halfway through a 5-yearexpansion program. No other assets and no liabilities are increasingdramatically. A summarized version of the cash flow statement reportsthe following:

1 Explaining the pur-poses of the statementof cash flows anddescribing itselements.


Net cash provided by operating activities .......................... $310,000

Net cash used for investing activities ................................. ( 290,000)

Net cash provided by financing activities........................... 70,000

Increase in cash during 2008 .............................................. $ 90,000

Requirements

Write a memo giving top managers of Super Hair Replacements yourassessment of 2008 operations as it relates to cash flows. Also provideyour outlook for the future. Focus on the information content of thecash flow data.

P13-35B. Accountants for Gray Lantern, Inc., assembled the following data forthe year ended December 31, 2008:

December 31 2008 2007

Current assets:



Inventory 90,600 86,600





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Requirements

Prepare Gray Lantern’s statement of cash flows using the indirectmethod to report operating activities. List noncash investing andfinancing activities on an accompanying schedule.

P13-36B. The comparative balance sheet of Justice League, Inc., at December 31,2008, reported the following:

Depreciation expense ............................................................................ $ 30,200Payment of cash dividends.................................................................... 48,300Purchase of equipment for cash............................................................ 109,000Issuance of note payable in exchange for cash .................................... 71,000Acquisition of land by issuing long-term note payable ....................... 118,000Net income............................................................................................. 50,500Payment of note payable ....................................................................... 47,900Issuance of preferred stock for cash ..................................................... 36,200Gain on sale of equipment .................................................................... 3,500Proceeds from sale of equipment.......................................................... 40,000

December 31 2008 2007

Current assets:Cash and cash equivalents $12,500 $22,500Accounts receivable 26,600 29,300Inventory 54,600 53,000

Current liabilities:Accounts payable $29,100 $28,000Accrued liabilities 14,300 16,800

Justice League’s transactions during 2008 included the following:

Payment of cash dividends .......................... $17,000 Purchase of building for cash................. $124,000Purchase of equipment for cash .................. 55,000 Net income .............................................. 31,600Issuance of long-term note payable in Issuance of common stock for cash ........ 105,000

exchange for cash ......................................... 32,000 Depreciation expense ............................. 17,700

Requirements

1. Prepare the statement of cash flows of Justice League, Inc., for theyear ended December 31, 2008. Use the indirect method to reportcash flows from operating activities.

2. Evaluate Justice League’s cash flows for the year. Mention all threecategories of cash flows and give the reason for your evaluation.

P13-37B. The 2008 comparative balance sheet and income statement ofWaterman, Inc., follow on the next page.

Waterman had no noncash investing and financing transactions dur-ing 2008. During the year, Waterman made no sales of land or equip-ment, no issuance of notes payable, no retirement of stock, and no trea-sury stock transactions.



Transaction Data for 2008:

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740 Chapter 13

Requirements

1. Prepare the 2008 statement of cash flows, formatting operatingactivities by the indirect method.


Current assets: Cash and cash equivalents $21,000 $18,700 $ 2,300 Accounts receivable 46,500 43,100 3,400 Inventory 84,300 89,900 (5,600) Plant assets: Land 35,100 10,000 25,100 Equipment, net 100,900 93,700 7,200 Total assets $287,800 $255,400 $32,400 Current liabilities: Accounts payable $ 31,100 $ 29,800 $ 1,300 Accrued liabilities 18,100 18,700 (600) Long-term liabilities: Notes payable 55,000 65,000 (10,000) Stockholders’ equity: Common stock 131,100 122,300 8,800 Retained earnings 52,500 19,600 32,900 Total liabilities and stockholders’ equity $287,800 $255,400 $32,400

WATERMAN, INCORPORATEDComparative Balance Sheet December 31, 2008 and 2007

2008 2007Increase

(Decrease)

Revenue: Sales revenue $438,000 Interest revenue 11,700 Total revenues $449,700 Expenses: Cost of goods sold $205,200 Salary expense 76,400 Depreciation expense 15,300 Other operating expenses 49,700 Interest expense 24,600 Income tax expense 16,900 Total expenses 388,100 Net income $ 61,600

WATERMAN, INCORPORATEDIncome Statement


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P13-38B. Blue Vulcan, Inc., has developed the following data from the company’saccounting records for the year ended July 31, 2008:

a. Purchase of plant assets for cash, $100,000

b. Proceeds from issuance of long-term notes payable, $44,100

c. Payments of long-term notes payable, $18,800

d. Proceeds from sale of plant assets, $59,700

e. Cash receipt of dividends, $2,700

f. Payments to suppliers, $673,300

g. Interest expense and payments, $37,800

h. Collection of interest revenue, $11,700

i. Payment of salaries, $104,000

j. Income tax expense and payments, $56,400

k. Depreciation expense, $27,700

l. Collections from customers, $827,100

m. Proceeds from issuance of common stock, $116,900

n. Payment of cash dividends, $50,500

o. Cash balances: July 31, 2007, $53,800; July 31, 2008, $75,200

Requirements

Prepare Blue Vulcan’s statement of cash flows for the year ended July 31,2008. Use the direct method for cash flows from operating activities.Follow the format of Exhibit 13-14.

P13-39B. Use the Waterman, Inc., data from P13-37B. The cash amounts forInterest Revenue, Salary Expense, Interest Expense, and Income TaxExpense are the same as the accrual amounts for these items.

Requirements

1. Prepare the 2008 statement of cash flows by the direct method.




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Requirements

Prepare Flash Fireworks’ statement of cash flows for the year endedDecember 31, 2008, using the direct method to report operatingactivities.

Cash

Beginning balance 87,100 Payment of operating expenses 46,100Collections from customers 60,800 Payment of notes payable 89,300Receipts of interest 14,100 Payment of income taxes 8,000Issuance of common stock 308,100 Payment on accounts payable 101,600

Payment of dividends 1,800Payment of wages and salaries 67,500Payment of interest 21,800Payment for equipment 51,500



P13-40B. To prepare the statement of cash flows, accountants for FlashFireworks Company summarized 2008 activity in the cash account asfollows:

for 24/7 practice, visit

www.MyAccountingLab.com

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Case 1. Design Incorporated experienced a downturn in December sales. Tomake matters worse, many of the recent sales were on account and because manycustomers were not paying on their accounts, the ending balance of AccountsReceivable at December 31 was higher than the beginning balance. Because thebusiness had a dramatic need for cash, a prime piece of land owned by thecompany was sold for cash in December at a substantial gain. Design hadpurchased the land 10 years earlier and properly classified it as a long-terminvestment. The CEO, Slim Shady, was looking over the financial statements andsaw the company’s weak operating cash flows. He approached the accountant toask why the December cash flows provided from operations were so weak, giventhat the land had been sold. The accountant explained that because the indirectmethod was used in preparing the cash flow statement, certain adjustments tonet income were required. To begin with, the increase in accounts receivable wasa decreasing adjustment made in arriving at the net cash provided fromoperating activities. Next, the large gain recognized on the sale of land had to beadjusted by subtracting it from the net income in arriving at the cash provided byoperating activities. These large negative adjustments drastically reduced thereported cash provided from that category of cash flows. The accountant thenexplained that all the cash proceeds from the land sale were included as cashinflows in the investing activities section.

Slim became worried because he remembered the bank telling him about theimportance of strong operating cash flows, so he told the accountant to redo thestatement but not to reduce the net income by the accounts receivable increase orthe gain on the land sale. The accountant refused, because these adjustmentswere necessary in order to properly arrive at the net cash provided from operat-ing activities. If these adjustments were not made, then the net change in cashcould not be reconciled. Slim finally agreed but then told the accountant to justinclude the cash proceeds from the sale of land in the operating activities ratherthan in the investing activities. The accountant said that would be wrong, andbesides, everyone would be able to see that, as proceeds from the sale of land, itshould be an investing activity. Slim then suggested listing it as “other” in theoperating section so no one would ever know that it wasn’t an operating cash flow.

Why didn’t Slim want the accountant to decrease the net income by theincrease in accounts receivable and the gain on the land sale? Why do you thinkSlim finally agreed with the accountant? Could the operating cash flows beincreased by including the cash proceeds from the sale but listing them as “other”rather than as land sale proceeds? What ethical concerns are involved? Do youhave any other thoughts?

Case 2. Kevin Sailors, the CEO of Candle Corporation, was discussing thefinancial statements with the company accountant. Weak cash flows had resultedin the company borrowing a lot of money. Kevin wanted to know why the moneyborrowed was included as cash inflows in the financing section of the statementof cash flows but the interest paid on the amounts borrowed was not. Theaccountant replied that the interest paid on loans was an expense included in thecalculation of net income, which was in the operating activities section. Kevinthen asked why the dividends Candle Corporation paid to stockholders wereincluded as an outflow of cash in the financing section. The accountant then

BE ON GUARD

Apply Your Knowledge

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explained that dividends paid, unlike interest paid, were a return to stockholdersand not an expense; therefore it would not be included in net income, nor would itappear in the operating activities section. Kevin replied that he did not care, andinstructed the accountant to include both the interest paid and the dividendspaid in the financing section. The accountant said that such a move would not beproper. Kevin then said to not provide the statement of cash flows at all becausetoo many people would see the weakening operating cash flows. He further statedthat investors and creditors who really analyzed the income statements andbalance sheets would be able to understand the company without the need for astatement of cash flows spelling out the net changes in cash flows.

Why would Kevin want the interest paid to be included in the financing activ-ities section? Why would the accountant state that interest paid should not beincluded in the financing activities section? Can the statement of cash flows beomitted? What ethical issues are involved? Do you have any additional thoughts?

KNOW YOUR BUSINESS

This case focuses on the cash flows of the Target Corporation. Recall that inflowsand outflows of cash are classified as operating activities, investing activities, orfinancing activities. The statement of cash flows presents cash flows from each ofthese three activities. It is therefore important to understand the informationprovided in this revealing financial statement. The statement of cash flows andadditional related information for Target are disclosed in its annual report. Referto the Target Corporation financial statements found in Appendix A. Also, con-sider the following footnote excerpt from the annual report.

Cash Equivalents

Cash equivalents represent short-term investments with a maturity of threemonths or less from the time of purchase and were $1,732 million, $244 millionand $357 million in 2004, 2003 and 2002, respectively. The increase of $1,488 in2004 compared to 2003 is primarily due to investment of the remaining proceedsat year end from the divestitures of Marshall Field’s and Mervyn’s.

Requirements

1. Look at the operating activities section of the statements of cash flows.Compare the net earnings (net income) for each of the three fiscal years pre-sented. Are the net income amounts reported on the cash flow statement thesame as on the income statement? How does the total cash flows provided byoperations compare to the net income? Why do they differ? Is this differencegood or bad? Have the cash flows provided from operations been increasingor decreasing? What is the largest adjustment item in the operating cashflows section? Why is this amount added back each year?

2. Look at the investing activities section of the statements of cash flows. Canyou determine whether Target has been spending money to purchase moreproperty and equipment? Are the amounts increasing or decreasing? Whatis the significance of this item? Did investing activities provide or requirecash for the three fiscal years presented?

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3. Look at the financing activities section of the statements of cash flows. Didfinancing activities provide or require cash for the three fiscal years pre-sented? What is the significance of this information? What are the stockrepurchase and dividend trends? What was the largest item in the financingsection for the most recent year?

4. How do you feel about the overall sufficiency of cash flows? Does the cashprovided from operations cover the cash required for investing activities?Does the cash provided from operations cover the cash required for financ-ing activities?

5. What was the net change in cash and cash equivalents for the most recentfiscal year? Does this amount agree with the cash and cash equivalentsreported on the balance sheet? What are the cash equivalents? Do you haveany other observations about the statement of cash flows?

For Internet Exercises, Excel in Practice, and additional online activities,

go to the Web site www.prenhall.com/pollard.

Quick Check Answers

1. c 2. d 3. c 4. a 5. d 6. c 7. a 8. a 9. d 10. b

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chapter 04

Documents

financing cash flows

statementof cash flows

understanding cash flows

various elements of

cash flow analysis

tointerpret cash flow

income statement

calledthe indirect method