Chapter 5 HW Solutions

7/29/2019 Chapter 5 HW Solutions

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CHAPTER 5

Reporting Cash Flows

THINKING BEYOND THE QUESTION

How is cash flow information determined and reported to external users?

A business can fail when it has insufficient cash to pay for its resourcerequirements and to pay principal and interest on its debt. Consequently,a profitable business that does not collect cash on a timely basis from itscustomers or that creates large amounts of debt can fail even though it isprofitable.

The primary cause of business failure for most companies is having inad-equate cash flow. Financial statements are useful for identifying a com-panys sources and uses of cash and the demands on future cash flowsassociated with debt.

QUESTIONS

Q5-1 The direct format statement of cash flows answers the questions wheredid cash come from? and where did cash go? It lists sources anduses of cash for each of the three types of activitiesoperating,investing, and financing.

Q5-2 The acquisition of machinery typically involves cash. Nevertheless, theacquisition of machinery is always an investing activity. How it was paidfor makes no difference. Long-term notes payable are generally issued inexchange for cash. Nevertheless, the issuance of a note payable isalways a financing activity. What the firm got in return makes nodifference. Therefore, the direct exchange of a note payable formachinery is both a financing activity and an investing activity at thesame time.

Q5-3 GAAP require that the issuance of either debt or equity in exchange forlong-term assets be disclosed, but not necessarily on the statement ofcash flows. Even though no cash is involved, most companies report thisinformation at the bottom of the statement of cash flows as anaddendum. Companies also have the option of reporting this informationin a separate schedule. Regardless of the disclosure method chosen, the

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requirement is that a user of the financial statements be able to identifyall material financing and investing activities of the fiscal period.

Q5-4 The usual presentation of investing activity and financing activityinformation on a statement of cash flows is consistent with the directformat that is occasionally used in the operating activities section.

Q5-5 Interest is included as an operating activity because interest expense isincluded on the income statement. The FASB decided that cash paid forinterest should be an operating item for consistency. One could arguethat interest is logically a financing activity. Nevertheless, GAAP requirethat it be included as an operating activity.

Q5-6 The indirect format is a reconciliation of revenues and expenses measuredby accrual accounting (net income) and revenues and expensesmeasured using cash basis accounting (cash flow from operations). Theapproach is to start with accrual basis net income and adjust for

revenues and expenses that had different cash flow consequences thanaccrual consequences. Depreciation expense and amortization expenseare examples of this situation. Both reduce net income, but neitherreduces cash flow. That is, these expenses have zero cash flowconsequences. Therefore, concerning these two items, net incomeunderstates the amount of cash flow. To obtain cash flow, these amountsmust be added back to net income.

Q5-7 When the balance in accounts receivable increases during a fiscal period,it means that new sales on credit have exceeded the amount of cashcollected from receivables. Therefore, the amount of revenue recognized

on the income statement is greater than the amount of cash collectedfrom customers. To reconcile net income to cash from operations, theincrease in accounts receivable must be subtracted.

Q5-8 The operating section of the indirect method statement of cash flowsanswers the question what caused net income for the period to bedifferent from net cash flow? The investing and financing sectionsreport sources and uses of cash, just as reported if using the directmethod. The indirect method is a reconciliation of net income to cashflow. Certain items of revenue and expense have different effects on netincome during a period than they have on cash flow. For example, whensales are made on credit they affect net income (through sales revenue)but have no effect on cash flow. Therefore, when sales on credit exceedcash collections from customers, the difference must be deducted fromnet income to arrive at cash flow.

Q5-9 To grow significantly, a company usually must expand its set of operatingassets such as land, buildings, and machinery. The acquisition of these


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Reporting Cash Flows 133

long-term assets generally requires the outlay of cash, which causescash flow from investing activities to be negative.

Q5-10 Operations consist of the primary activities that the company was set up toperform. If the firms primary operations consume cash, rather thangenerate it, the company cannot survive in the long run. Another way of

looking at it is to ask the question, If you cant generate cash fromoperations, why are you in this business? Over a relatively short periodof time (perhaps during the startup period or during a period of majorstrategy or market changes), a company might be able to endure a cashoutflow from operations. In the long run, however, creditors will not lendmoney to a firm that does not generate cash from its primary activities.Similarly, investors will not invest in such a firm.

Q5-11 When cash flow from investing activities is positive, it means that thecompany is selling off its long-term assets and reducing its productivecapacity. A company that has a profitable and successful future typically

is buying new long-term assets rather than selling off the ones it alreadyhas. In most cases, positive cash flow from investing activities is not apositive sign.

Q5-12 The most frequent uses of cash generated by operations are as follows:a. payment of dividendsb. repayment of debtc. repurchase of the companys own stock (treasury stock)d. expansionacquisition of new productive assets such as plant and

equipmente. expansioninvestments in, or acquisitions of, other companies

Q5-13 There are two possibilities. First, the company may be so profitable that itcan finance all growth out of operating cash flow and still have cash leftover to reduce debt and buy back equity. Second, the company may havefew profitable new investment opportunities and, therefore, no need forthe cash. In this case, cash is being returned to those who loaned it to thefirm and to those who purchased stock in the firm (in the form ofdividends and/or by repurchasing its own stock).

Q5-14 It suggests that this company is in serious difficulty. To observe thissituation in any one year is bad enough; to see it consistently over a

3-year period is very worrisome. First, the inability to generate cash fromits primary activities is very bad news. If this cant be turned aroundquickly there is no future for this firm. Second, the positive cash flowfrom investing activities means that the firm is selling off its long-termassets to cover the cash requirements of operations and financing. Third,the negative cash flow from financing activities, coupled with the above,implies that the firm is short of cash. There are required repayments ofdebt to be repaid and the company can only do so by selling off its long-


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term assets. If the debt repayments were voluntary, the firm would likelypostpone them rather than sell off assets.

Q5-15 For most corporations, two of the major differences between net incomeand cash flow from operating activities are depreciation and amortization.These often are large expenses on the income statement but do not

reduce cash flow. Changes in working capital also can account for majordifferences between net income and cash flow. Thus, a company mayhave a net loss but have an increase in cash flow from operatingactivities. The cash flow may result from transactions of prior periodsthat produce cash flow during the current period or that reduce incomewithout using cash during the current period.

Q5-16 First, a company that does not have profitable opportunities in which toreinvest its earnings has little choice but to distribute those earnings tostockholders via dividends. Second, if the businesss activities aredeclining, the firm will not need as much financing and will pay back its

loans (perhaps ahead of time). Third, a company may begin to buy backits own stock. All three situations lead to negative cash flow fromfinancing activities.

EXERCISES

E5-1 a. Operating Activities:Received from customers $ 87,500Paid for advertising $ 300Paid for income taxes 3,000

Paid for insurance 200Paid for interest 450Paid for utilities 790Paid to employees 18,000Paid to suppliers 39,000Total payments (61,740 )Net cash flow from operating activities $ 25,760

b. Financing Activities:Received from issuing long-term debt $ 23,000Paid to owners (12,000 )Net cash flow from financing activities $ 11,000

c. Investing Activities:Received from sale of land $ 19,500Paid for equipment (42,000 )Net cash flow from investing activities $(22,500)

d. Net Change in Cash for the Period:Net cash flow from operating activities $ 25,760


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Net cash flow from financing activities 11,000Net cash flow from investing activities (22,500 )Net change in cash $ 14,260

E5-2

Item Type of Activity Add or Subtract

a. Purchase of plant assets Investing Subtract

b. Cash paid to suppliers Operating Subtract

c. Cash collected from customers Operating Add

d. Payment of long-term debt Financing Subtract

e. Net income Not included Not included

f. Depreciation expense Not included Not included

g. Payment of dividends Financing Subtract

h. Issuing stock Financing Add

i. Cash paid to employees Operating Subtract

j. Cash paid for income taxes Operating Subtract

k. Disposal of plant assets Investing Add

E5-3 Cash collected from customers $247,000Cash paid to suppliers (81,400)Cash paid for utilities (18,200)Cash paid for insurance (23,000)Cash paid to employees (60,400)Cash paid for interest (9,000 )Net cash from operating activities $ 55,000

E5-4 a. $17,700; Cash received from customers $187,200Cash paid to suppliers of inventory (119,850)Cash paid to employees (31,500)Cash paid for insurance (5,000)Cash paid for interest (3,750)Cash paid for utilities (9,400 )Net cash flow from operating activities $ 17,700

b. ($22,600); Cash paid for dividendsc. ($27,100); Cash received from disposal of equipment $ 38,000

Cash paid for equipment (65,100 )

Net cash flow from investing activities $ (27,100 )

E5-5 a. Cash flows from financing activities:

Debt issued $ 13,057Payments of debt (83,000 )Net cash used for financing activities $ (69,943 )

b. Cash flows from investing activities:


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Proceeds from sales of businesses $ 30,957Proceeds from sales of plant and equipment 1,986Additions to plant and equipment (5,500 )Net cash provided by investing activities $ 27,443

E5-6 a. D

b. Ic. Id. Ie. If. Dg. Dh. Bi. D

j. B

E5-7

Statement Statement Added or Section Format Subtracted?

1. Decrease in taxes payable O I 2. Cash paid to suppliers of inventory O D 3. Dividends declared and paid F B 4. Depreciation expense O I +5. Sale of stock F B +6. Increase in accounts receivable O I 7. Cash collected from customers O D +8. Purchase of plant assets I B 9. Payments on long-term debt F B

10. Cash paid for taxes O D 11. Increase in wages payable O I +12. Purchase of treasury stock F B

E5-8

Item

Type of

Activity

Add or

Subtract

Purchase of plant assets Investing Subtract

Increase in accounts payable Operating Add

Decrease in accounts receivable Operating AddPayment of long-term debt Financing Subtract

Net income Operating Add

Depreciation expense Operating Add

Payment of dividends Financing Subtract

Issuing stock Financing Add

Increase in inventory Operating Subtract


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Decrease in taxes payable Operating Subtract

Disposal of plant assets Investing Add

E5-9 Net income ($17,000 $8,000)* $ 9,000Depreciation expense 1,100Patent amortization expense 250Increase in accounts receivable (800)Decrease in inventory 1,200Decrease in supplies 400Increase in accounts payable 1,050Decrease in wages payable (900 )Net cash flow from operating activities $ 11,300*The $8,000 includes depreciation and patent expenses.

E5-10 a. Cash paid to suppliers $37,500Decrease in accounts payable (3,000)Increase in inventory (3,500 )Cost of goods sold $31,000

More cash was paid than the cost of goods sold because accountspayable decreased. Cash was paid to creditors. Also more cash waspaid than the cost of goods sold because inventory increased. Cashwas used to pay for extra inventory.

b. Interest paid $ 4,000

Interest payable decreased (1,200 )Interest expense $ 2,800

Expense was less than the amount paid because some of the cashwas used to reduce the payable.

c. Cash flow from operations $28,000Decrease in current assets (6,000)Decrease in current liabilities 2,000Net income $ 24,000

Net income is less than cash flow when current assets are con-sumed but are not replaced (current assets decreased). Net income

is greater than cash flow when cash is used to pay off current liabili-ties (current liabilities decreased).

d. Cash collected from customers $27,000Increase in accounts receivable 3,000Sales revenue $ 30,000

More goods were sold than cash collected because receivables in-creased.


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E5-11 a. Net cash flow from operations $30,000Noncash revenues 11,000Noncash expenses (13,200 )Net income $ 27,800

Net income includes noncash revenues and noncash expenses thatare not included in cash flow from operations. Revenues increase

and expenses decrease net income.

b. Wages expense $69,000Increase in wages payable (10,500 )Cash paid to employees $ 58,500

More employee labor was used than paid for when wages payable in-creased during a period.

c. Sales revenue $ 241,000Cash collected from customers (224,500 )Increase in accounts receivable $ 16,500Beginning accounts receivable 36,000Ending accounts receivable $ 52,500

If sales revenue is greater than cash collected during a period, ac-counts receivable must have increased by the difference. The in-crease is added to the beginning balance.

d. Net income $45,000Increase in current assets (7,500)Increase in current liabilities 10,000Cash flow from operations $ 47,500

Cash flow is less than net income when more current assets are ac-quired than are consumed (current assets increase). Cash flow isgreater than net income when more resources are used than are paidfor (current liabilities increase).

E5-12

Account Balance Adjustment and Reasona. Accounts receivable

increased $10,000Subtract $10,000 from net income becausecash collected from customers was $10,000less than sales for the period.

b. Accounts payableincreased $7,500

Add $7,500 to net income because inventorywas acquired for sale (increase in cost of

goods sold and decrease in net income) butwas not paid for during the period.

c. Inventory decreased$50,000

Add $50,000 to net income because invento-ry was consumed (increase in cost of goodssold and decrease in net income) that wasnot paid for during the period.

d. Notes payable in-creased $100,000

No effect because notes payable result froma financing activity, not an operating


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activity.e. Equipment de-

creased $80,000No effect because equipment results froman investing activity, not an operating

activity.f. Prepaid insurance

decreased $22,000Add $22,000 to net income because insur-ance was consumed (increase in expenseand decrease in net income) that was notpaid for during the period.

g. Wages payable de-creased $8,000

Subtract $8,000 from net income becausewages were paid during the period that werenot expenses (did not reduce net income)during the period.

h. Unearned revenueincreased $13,000

Add $13,000 to net income because cashwas received during the period for revenuesthat were not earned (did not increase netincome) during the period.

E5-13 Cash flow from operating activities (in millions):

Net earnings $3,458Depreciation and amortization 1,412Decrease in inventories 611Increase in prepaid expenses (4,355)Increase in accounts payable 862Increase in accounts receivable (241)Increase in income taxes payable 1,086Other additions to net income 625Cash flow from operating activities $3,458

E5-14 Martha Rosenbloom945 Oak LaneAnytown, USA

Dear Ms. Rosenbloom:

Our mutual friend, Mr. Arthur Doyle, has asked if I can provide you assis-tance in understanding the statement of cash flows in corporate annualreports. I am currently enrolled in an accounting course at the university,and I am pleased to respond to Mr. Doyles request.

The cash flow from operating activities section of the statement of

cash flows provides a reconciliation between accrual and cash flow re-sults of operations. Net income is an accrual measure that recognizesrevenues when earned and expenses when incurred. Not all items includ-ed on the income statement in calculating net income result in cash flowsduring the current fiscal period, however. Some revenues and expensesrecognized during the current fiscal period are associated with cash re-ceived or paid in past or future fiscal periods.


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For example, assume a company purchases plant assets and payscash during 2006. The assets are not expensed until they are used.Depreciation expense is recognized over the useful life of the assets.


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Therefore, while depreciation expense is recognized on the assets in2007, no cash flow is associated with the expense. Thus, the amount ofdepreciation expense for a period is added to net income in computingcash flow from operating activities.

Differences also exist between the amount of revenue or expense rec-ognized during a period and the amount of cash flow for items such as

sales. For example, customers often purchase merchandise on credit,paying for their purchases at a later time. Therefore, the amount of salesrevenue recognized during a fiscal period and the amount collected fromcustomers often differs. This difference is equal to the amount of changein accounts receivable for the period. The cash collected from customerscan be determined by adjusting net income for the change in accounts re-ceivable. Other adjustments are made in a similar manner for differencesbetween cost of goods sold and cash paid for inventory and for other ex-pense items such as wages, interest, and taxes.

The cash flow statement provides an indirect calculation of cash fromoperating activities by adjusting net income for amounts on the income

statement that do not affect cash. These noncash items include deprecia-tion and amounts equal to changes in current asset and liability ac-counts. A more direct method would be to simply report cash receivedfrom customers, cash paid to suppliers, etc. Only a small percentage ofcompanies report cash flows in this direct manner, however.

I hope my explanations are useful. Please let me know if I can be offurther assistance.

Sincerely,(students name)

E5-15 a. The additions and subtractions are caused by events in which theamount of revenue or expense generated was different from theamount of cash flow. For example, if merchandise is sold for $10,000on credit, it generates $10,000 of revenue (and increases net income)but generates zero cash flow.

b. 1. Depreciation expense is added because it decreased net incomebut did not affect cash.

2. If accounts receivable increased by $2,500, this means that salesrevenue exceeded cash collections by this amount. Therefore,cash flow was $2,500 less than sales revenue and must be sub-tracted from net income.

3. If inventory increased, this means that more inventory was pur-chased than was sold. Therefore, the amount of cash spent for in-ventory exceeded the cost of goods sold. The extra expenditureused cash and is subtracted.

4. A decrease in accounts payable means the company paid morecash to suppliers than the amount of expense reflected in cost ofgoods sold. Therefore, in reconciling net income to cash flows


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from operating activities, the decrease in accounts payable issubtracted.

E5-16 a. Co. B had the largest cash flow from operating activities at $15,200.Co. C had the smallest at $2,304.

b. Cash flow associated with investing activities should be negativebecause most companies will purchase more long-term assets thanthey will dispose of during a period. Only when companies aredownsizing or needing cash and selling off major components wouldthey have large cash inflows from investing activities.

c. Cash flow from operating activities was sufficient to provide theneeded cash for all three companies. Co. A used large amounts ofcash for investing activities during the year, unlike Co. B and Co. C.Co. B and Co. C used their operating cash flows to reduce debt andequity. Thus, they were shrinking, rather than expanding.

E5-17 Landsdowne Company has shown a steady increase in net income over thesix-year period, with the exception of year 6. Its cash flow from operatingactivities has steadily declined since year 2, however. The differencebetween net income and cash flow can be explained by the increases incurrent asset and liability accounts. The company has grown andexpanded its investment in working capital. Perhaps the expansion hasbeen too rapid. The company appears to be facing a cash flow problem.The increase in payables may signal an impending difficulty in meetingobligations unless receivables can be collected and inventory can besold.

Landsdowne Company is an example of an organization that hasdemonstrated earnings growth but may not remain viable because ofcash flow problems. Failure to maintain adequate cash flows has resultedin bankruptcy for many businesses.

E5-18 Sommer Company has incurred losses in its last two years of operations.Without the large amount of depreciation recorded each year, thecompany would have had net income in each year. The company hasmaintained a steady growth in cash flows from operating activities. Thesecash flows are much higher than the investments the company is makingin plant assets. Therefore, the company has a large amount of cash flow

that could be used for other purposes. Apparently, Fischer believes hecan manage the company to make use of its cash flow potential.

A number of takeovers have occurred in recent years in situationssimilar to the one illustrated in this exercise. Cash flows may be a bettersignal of a companys potential value than net income, under certain cir-cumstances. Much depends on whether the cash flows have to be rein-vested in a company to maintain it or whether the cash flows can be usedfor discretionary purposes.


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E5-19Account and balance Anticipated future event and cash flow

a. Accounts receivable,$12,000

$12,000 cash should be received fromcustomers during the next fiscal year.Operating activities section.

b. Prepaid insurance,

$22,000

Insurance coverage costing $22,000 is

expected to be used up within the comingfiscal year. No further cash flow expected.

c. Merchandise, $50,000 Merchandise that cost the company$50,000 is available to be sold during thenext fiscal year. Operating activitiessection.

d. Treasury stock, $33,000 The company has repurchased some of itsown shares at a cost of $33,000. Theshares might be resold sometime in thefuture, maybe not. If sold, it would bereported in the financing activities section.

e. Accounts payable, $6,500 Currently, $6,500 is owed to short-termcreditors that will be repaid during thenext fiscal year. Operating activitiessection.

f. Machinery, $92,000 Machinery with an original cost of $92,000is available for use by the firm in thefuture. No cash flow expected frommachinery until it is sold. The depreciationexpense, a noncash item, would appear inthe operating activities section under theindirect format.

g. Notes payable, long-term,$88,000

The company borrowed $88,000 in thepast and is expected to repay it sometimeafter the next fiscal year. A financingactivity. (Any interest paid on theborrowing appears in the operatingactivities section.)

h. Unearned revenue,$10,000

The company has received $10,000 forgoods and services that it should provideduring the next fiscal period. No furthercash flow expected.

i. Taxes payable, $7,800 Currently the company owes $7,800 to thegovernment, which it expects to pay

during the next fiscal period. An operatingactivity.

j. Retained earnings,$56,000

The firms undistributed profits total$56,000. If any portion of this is distributedin the future it will be a financing activity.


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PROBLEMS

P5-1 San Garza PropertiesStatement of Cash Flows (direct format)

For the Month of January 2007

Operating ActivitiesReceipts:

Collections from customers $ 8,100Payments:

To suppliers of inventory $ (7,000)For interest (135)For advertising (2,200)For rent (3,000 )

Total cash payments (12,335 )Net cash flow for operating activities $ (4,235)

Investing ActivitiesPurchase of office furniture $ (5,500)Purchase of computer equipment (4,800 )Net cash flow for investing activities (10,300)

Financing ActivitiesProceeds from bank loan $18,000Proceeds from sale of stock 10,000Payment of dividends (2,000)Payment on bank loan (5,000 )

Net cash flow from financing activities 21,000

Net increase in cash $ 6,465Cash balance, December 31, 2006 9,121Cash balance, January 31, 2007 $ 15,586

P5-2 A. 1. $134,850 ($135,800 Sales $950 increase in AccountsReceivable)

2. $55,800 ($54,300 Cost of Goods Sold + $1,500 increase inInventories)

3. $4,900 ($4,800 Insurance Expense + $100 increase inPrepaid Insurance)

4. $14,505 ($14,255 Rent Expense + $250 decrease in Rent

Payable)5. $0 (Depreciation does not consume cash.)6. $33,050 ($33,400 Wages Expense $350 increase in Wages

Payable)

B. Purchase of property, plant and equipment $(5,015)Purchase of land (1,000)


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C. Addition to loan payable $4,000Sale of common stock 1,000Purchase of treasury stock (3,000)Payment of dividends (1,000)

D. Planet Accessories CompanyStatement of Cash Flows (Direct Format)For the Year Ended December 31, 2007

Operating Activities:Cash collections from customers $134,850 1

Cash paid to suppliers of inventory (55,800)2

Cash paid for advertising (17,029)Cash paid for insurance (4,900)3

Cash paid for rent (14,505)4

Cash paid for wages (33,050)5

Cash paid for interest (650)Cash paid for taxes (3,628 )

Cash flow from operating activities $ 5,288Investing Activities:

Purchase of property, plant and equipment $ (5,015)6

Purchase of land (1,000 )_ 7

Cash flow from investing activities (6,015)Financing Activities:

Addition to loan payable $ 4,000 8

Sale of common stock 1,000 9

Purchase of treasury stock (3,000)10

Payment of dividends (1,000 )Cash flow from financing activities 1,000Net increase in cash during the year $ 273Beginning cash balance 553Ending cash balance $ 826

1 proof given in part A2 proof given in part A3 proof given in part A4 proof given in part A5 proof given in part A6 (Increase in property, plant and equipment account = $5,015)7

(Increase in land account = $1,000)8 (Increase in loan payable account = $4,000)9 (Increase in common stock account = $1,000)

10 (Increase in treasury stock account = $3,000)


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P5-3 A. 1. Net income = $44,750 Sales ($307,400 + $88,250) $ 395,650CGS ($200,000 + $57,400) (257,400 )Gross profit 138,250Operating expenses (93,500 )Net income $ 44,750

2. Cash flow from Cash received from customers:operations = ($25,950) Cash sales $ 88,250

Collections on account 321,000$409,250

Cash paid to suppliers:Cash purchases $ (48,100)Payments on account (293,600 ) (341,700)

Cash paid for operatingexpenses (93,500 )

Cash flow from operatingactivities $ (25,950 )

B. 1. Decrease in accounts Credit sales to customers $307,400receivable = $13,600 Collections from customers

on account (321,000 )Net decrease in accounts

receivable $ (13,600 )

2. Increase in merchandise Purchases ($233,700 + $48,100) $281,800inventory = $24,400 CGS ($200,000 + $57,400) (257,400 )

Net increase in inventory $ 24,400

3. Decrease in accounts Purchases on credit $233,700

payable = $59,900 Cash payments onaccounts payable (293,600 )

Net decrease inaccounts payable $ (59,900 )

C. Dollar Sine EnterprisesStatement of Cash Flow

(Operating Activities OnlyIndirect Method)For the Year Just Ended

Net income $ 44,750Add (deduct):

Decrease in accounts receivable $ 13,600Increase in merchandise inventory (24,400)Decrease in accounts payable (59,900 ) (70,700 )Cash flow for operating activities $ (25,950 )


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P5-4 Reuben CorporationStatement of Cash Flows (Indirect Format)

For the Year Ended December 31, 2007

Operating ActivitiesNet income $ 7,000

Add (deduct):Adjustments to convert net incometo cash flow from operating activities:

Depreciation expense $ 1,000Decrease in accounts receivable 1,200Increase in inventory (1,600)Decrease in prepaid advertising 300Increase in rent payable 200Decrease in taxes payable (400)Increase in wages payable 1,100 1,800

Cash provided by operating activities $ 8,800

Investing ActivitiesPurchase of land $ (4,000 )

Cash used by investing activities (4,000)

Financing ActivitiesRepayment on loan $(8,250)Sale of common stock 6,000Payment of dividends (1,700 )Cash used by financing activities (3,950 )Net increase in cash $ 850

Beginning cash balance 3,550Ending cash balance $ 4,400

P5-5 A. 1. $6,738 (from the income statement)2. $1,000 (from the income statement)3. ($950) (subtract increase in accounts receivable)4. ($1,500) (subtract increase in inventories)5. ($100) (subtract increase in prepaid insurance)6. ($250) (subtract decrease in rent payable)7. $350 (add increase in wages payable)

B. Purchase of property, plant and equipment $(5,015)Purchase of land (1,000)

C. Addition to loan payable $4,000Sale of common stock 1,000Purchase of treasury stock (3,000)Payment of dividends (1,000)


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D. Planet Accessories CompanyStatement of Cash Flows (Indirect Format)

For the Year Ended December 31, 2007


Add/deduct items to reconcile net incometo cash flow from operating activities:

Depreciation $ 1,000 1

Increase in accounts receivable (950)2

Increase in inventories (1,500)3

Increase in prepaid insurance (100)4

Decrease in rent payable (250)5

Increase in wages payable 350 6 (1,450 )Cash flow from operating activities $ 5,288

Investing Activities

Purchase of property, plant and equipment $(5,015)7

Purchase of land (1,000 )8

Cash flow for investing activities (6,015)

Financing ActivitiesAddition to loan payable $ 4,000 9

Sale of common stock 1,000 10

Purchase of treasury stock (3,000)11

Payment of dividends (1,000 )Cash flow from financing activities 1,000

Net increase in cash during the year $ 273

Beginning cash balance 553Ending cash balance $ 826

1 proof given in part A2 proof given in part A3 proof given in part A4 proof given in part A5 proof given in part A6 proof given in part A7 (Increase in property, plant and equipment account = $5,015)8 (Increase in land account = $1,000)9

(Increase in loan payable account = $4,000)10 (Increase in common stock account = $1,000)11 (Increase in treasury stock account = $3,000)


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P5-7 A. 1. Cash received from customers is incorrect. It has been reportedas the accrual basis sum of revenues ($73,000 + $42,100 =$115,100). But, Accounts Receivable increased by $1,500 ($5,800

$4,300) meaning that collections were $1,500 less than accrualbasis sales. Therefore, collections should have been reported at$113,600 ($115,100 $1,500 = $113,600).

2. Cash paid for rent is incorrect. Accrual basis rent expense of$24,000 apparently was adjusted for the $400 decrease in RentPayable. But, the $400 decrease should have been added to$24,000, not subtracted. When Rent Payable decreases, thismeans that the cash paid for rent is more than the amount of rentexpense. Therefore, the correct amount of cash paid for rent is$24,400 ($24,000 + $400).

3. Cash paid for taxes is incorrect. The accrual basis Tax Expense

was $12,000. Because there was no change in Taxes Payable, the$12,000 amount is also the amount of cash that was paid.

The amounts reported as cash payments for advertising and wagesare correct.

B. Starkovich Architects, Inc.Operating Activities (Direct Format)

For the Year Ending December 31, 2007

Operating ActivitiesCash received from customers ($73,000 + $42,100 $1,500) $

113,600Cash paid for advertising (OK as reported) (13,400)Cash paid for rent ($24,000 + $400) (24,400)Cash paid for wages (OK as reported) (40,450)Cash paid for taxes ($12,000 + $0) (12,000 )Cash provided by operating activities $ 23,350

P5-8 A. Indirect format

B. The colleagues thinking is incorrect. Using a depreciation methodthat reports a higher amount of depreciation expense for financialreporting purposes will have no direct effect on cash flow. However,

there can be a positive effect on cash flow if the company uses adepreciation method for tax purposes that increases depreciationbecause it would decrease income taxes owed.

C. In the first column hypothetical data is shown. The second columnshows the data assuming that depreciation expense for the periodhad been twice as high as reported. Cash flow from operatingactivities is the same under either option.


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Original AdjustedData Data

Operating ActivitiesNet income $ 84,597 $ 74,0961

Add: Depreciation expense 10,501 21,0022

Decrease in accounts receivable 4,157 4,157

Increase in wages payable 2,924 2,924Cash provided by operating activities $102,179 $102,179

1 If depreciation expense had been twice as high ($10,501 higher), netincome would have been $10,501 lower ($84,597 $10,501 =$74,096).

2 $10,501 2 = $21,002.

P5-9 A. AutoZone uses the indirect method for reporting cash flows. Theoperating section begins with net income and provides a variety ofreconciling items to arrive at cash flow from operations.

B. AutoZone reported higher sales and net income for each yearreported. The trend is encouraging because the company is enjoyingprofitable growth.

C. For each year reported, the cash flow from operating activitiesexceeds net income. Cash flow from operating activities declineseach year, whereas net income increases each year. The primarydifference between net income and operating cash flow is theincrease in inventory.

D. Cash and cash equivalents: decreased (see the bottom of the cashflow statement)

Accounts receivable and prepaid expenses: increased (increases aresubtracted from net income)

Merchandise inventory: increased (increases are subtracted from netincome

Accounts payable and accrued expenses: increased (increases areadded to net income)

E. The major use of cash for investing activities has been capitalexpenditures. AutoZone is expanding and opening new stores. Thisis consistent with evidence from our earlier analysis. When acompany is increasing sales each year and expanding its number of

retail locations, we expect to see increases in inventory. All of thesefactors are shown on AutoZones cash flow statement.

F. The major use of cash for financing activities has been the purchaseof treasury stock. In addition, the company has repaid debt eachyear. There is no evidence on the statement of cash flows that thecompany paid dividends.


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138 Chapter 5

P5-10 A. Circuit Citys income declined each year between 2002 and 2004,although in years 2002 and 2003 the company was profitable. Thecompany reported a loss of $89,269,000 in 2004. Circuit Citys cashflow from operating activities declined from 2002 to 2003, becomingnegative during 2003.

B. The most significant reasons for negative cash flow from operationsin 2004 were a net loss, increases in securitized receivables, andincreases in merchandise inventory.

C. In 2004 and 2003, the companys depreciation exceeded itspurchases of property and equipment. Thus, Circuit City is using upits assets faster than it is replacing them. The company seems to beshrinking in size; however, one may argue that the rate of change issmall.


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P5-11 Office Decor CompanyStatement of Cash Flows

For the Year Ended December 31, 2007(in thousands)


Increase in accounts receivable (2,400)Increase in inventories (4,400)Increase in accounts payable 1,200Cash flow for operating activities (3,600 )

Financing ActivitiesIncrease in notes payable 4,000Payment of dividends (1,000 )Cash flow from financing activities 3,000Decrease in cash $ (600)Beginning cash balance 1,940Ending cash balance $ 1,340

Office Decor reported net income of $2,000,000 for 2007. The com-panys cash flow from operating activities was a cash outflow of$3,600,000, however. Thus, though the company appears to be profitable,it may be facing some major cash flow and operating problems in thenear future. Accounts receivable and inventories increased substantiallyduring the year. These increases suggest that customers are not payingfor their purchases on a timely basis. The company appears to be build-ing a large inventory that it is not able to sell. It has financed these activi-ties by issuing additional debt. This financing might support the com-panys operations in the short run but will not ensure long-term survival.

The increase in accounts receivable may reflect pressure to sell inven-tory, even when prospective buyers are poor credit risks. The companymay be granting very favorable payment terms to buyers, resulting in aslowdown of cash receipts. The payment of dividends during this periodis questionable, unless management believes the cash flow problems aretemporary.

P5-12 A. McDonalds cash and cash equivalents increased $887 million during2004.

B. The primary sources of cash were profitable operations. Other

sources of cash include sales of restaurant property, long-term andshort-term financing, and proceeds from the exercise of stockoptions.

C. The primary uses of cash include the purchase of property andequipment, and long-term financing repayments. Other uses of cashinclude treasury stock purchases and dividends.

(continued)


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140 Chapter 5

D. Depreciation and amortization are noncash expenses that reduce netincome, but have no effect on cash. Therefore, when reconciling netincome to cash flow from operations, these noncash expenses areadded back to net income.

E. An increase in accounts receivable means that credit sales exceeded

cash collections. Thus, the company recorded revenue for which nocash was collected. Therefore, in reconciling net income to cashflow provided by operations, the company subtracts the increase inaccounts receivable from net income.

F. Purchases of property and equipment are listed as investingactivities because cash was used to purchase long-term (capital)assets. These assets were not purchased for resale and, therefore,were not directly part of operating activities. Sales of property occurwhen a company disposes of long-term assets. Because theseassets are not held for resale, their disposal is not an operatingactivity. Acquisition of other companies results in additional long-

term assets. These purchases are similar to capital expenditures.McDonalds acquired restaurant businesses at a cost of$149,700,000 during 2004.

G. McDonalds issued $225,600,000 of long-term debt during 2004 andrepaid $1,077,000,000 of long-term debt.

H. The company is not facing a cash flow problem. The ending cashbalance has grown in each year presented. In addition, the companyproduced enough cash from operations in 2004 and 2003 to providefor its investing and financing activities.

P5-13 There are three primary factors that caused the rapid decrease in cashprovided by operating activities. First, the companys profits have fallenabout 16% [($467 $391) $467] over the three years. Second, despitedecreased profits, the firms accounts receivable are increasing rapidly.(One might wonder why.) An increase in receivables reduces the amountof cash flowing in to the firm. Third, there has been a large increase ininventories over the three years. (Again, one might wonder why.) Buildingup inventory holdings is a drain on cash when the purchases are paid for.The firms accounts payable have fluctuated some but are quite stable.Therefore, the buildup of inventory has consumed large amounts of cash.The other items reported have had little material impact on cash.


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P5-14 Items from the income statement (IS) and cash flow from operatingactivities (CF) can be used to answer each question (in millions):

A. Revenues (IS) $ 24,547Increase in accounts receivable (27 )Cash collected from customers $ 24,520

B. Cost of goods sold (IS) $(18,350)Increase in accounts payable (CF) 318Increase in inventory (CF) (507 )Cash paid for inventory $ (18,539 )

C. SGA expense (IS) $ (4,893)Increase in other assets (CF) (22)Increase in accrued expenses (CF) 447Depreciation (IS) 405Cash paid for SGA expense $ (4,063 )

P5-15 The cash flow patterns of Dell and Apple Computer are remarkably similar.For example, both companies earned a positive net income during theyear. In addition, both companies increased the account balance ofaccounts receivable, inventories, and other assets during the year. Bothcompanies increased the balance of their payables account.

Though Dells earnings and cash flows are larger in scale than AppleComputers, both companies produced net cash inflows from operations.In addition, both Apple Computer and Dell used cash for investing activi-ties. Dell used cash to reduce debt, while Apple Computer increased itsdebt during 2004. Overall, Dells cash balance increased by $430 millionduring 2004, while Apple Computers cash balance declined by $427 mil-

lion.

P5-16 A. False. Depreciation expense is added to net income becausedepreciation reduces net income but not cash flow. Therefore, todetermine cash flow from operating activities, depreciation must beadded back to net income. The two accounts affected by recordingdepreciation are Depreciation Expense and AccumulatedDepreciation. Notice, therefore, that neither the cash account norcash flow are affected by the recording of depreciation expense.

B. True. An increase in Accounts Receivable means that a companycollected less cash from customers than the amount of sales

revenue. Therefore, cash flow would be less than operating revenueby the amount of increase in Accounts Receivable. If $20 of goodswere sold but only $18 was collected so far, Accounts Receivablewould have increased by $2. So, cash flow ($18) would be less thansales ($20) by $2.

(continued)


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142 Chapter 5

C. False. An increase in accounts payable indicates that some of thegoods purchased have not yet been paid for. When accountspayable increases, cash has been conserved (not paid out).Therefore, an increase in accounts payable should be added back tonet income. The adjustment would be to add $3 million rather than tosubtract it.

D. True. An increase in merchandise inventory indicates that a companypurchased more inventory than it sold during a period. Therefore,Delta must have purchased $8 million more in inventory than the $27million of inventory it sold. This totals $35 million and was all paid tosuppliers in cash.

E. True. Gammas operating activities are generating a negative cashflow. (Note: The $80 is a net outflowNet cash for operatingactivities.) Thus, it is not generating enough cash to coverexpenses, meet debt requirements, pay dividends, or replace assets.To meet its cash requirements, the company is selling assets and

issuing debt (or stock). Its ability to continue is in serious doubtunless it can create positive cash flows from operating activities.


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P5-17 A. and B.

EventType

of Activity

Effect onMarchs

Net Income

Effect onMarchs

CashFlow

1. Sold $18,000 of goods on credit to

customers. Received a 25% down paymentwith the balance on account. operating +$18,000 +$4,5002. Paid $500 cash for office supplies that will be

used during April. operating 0 $5003. Received $3,000 from a customer in full

payment of her account balance. operating 0 +$3,0004. Borrowed $80,000 from a local bank to be

repaid in monthly installments plus intereststarting in April. financing 0 +$80,000

5. Paid rent on the office space ($1,200 permonth) for the months of February, March,and April. operating $1,200 $3,600

6. Distributed monthly paychecks to employeestotaling $13,300. 30% was for workperformed in February and the balance forwork performed in March. operating $9,310 $13,300

7. Purchased new Internet server equipment ata cost of $50,000. investing 0 $50,000

8. Purchased a 3-year fire insurance policy at atotal cost of $10,800. Its coverage began onMarch 1. operating $300 $10,800

9. Purchased merchandise from suppliers oncredit at a cost of $70,000. operating 0 0

10. Collected $22,000 from customers in

payment of their accounts. 80% of thisamount was from sales recorded in Februaryand the balance was from sales recordedpreviously in March.* operating 0 +$22,000

11. Collected four months rent in advance (at$700 per month) from a tenant who will movein on April 1. operating 0 +$2,800

12. Paid $45,000 to suppliers in partial paymentfor goods purchased in #9 above. operating 0 $45,000

13. Sold $33,000 of merchandise to customerson credit. operating +$33,000 0

14. Sold an investment in stocks and bonds for

$28,000; the same amount that had beenpaid for it. A 3-year, 9% note receivable wasaccepted in full payment. investing 0 0

Totals for March $40,190 $10,900

*March sales are indicated in event 1. Event 10 is indicating

collection of some of the receivables from those sales. (continued)


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144 Chapter 5

C. Student responses will vary. One possible response is as follows. Itis foolish to try to manage an organization with accrual-basisaccounting information only. As illustrated by this problem, acompany can be profitable on the accrual basis but be running adeficit in cash. A manager must closely monitor both profits andcash flow. Failure to manage cash flow will result in an inability to

pay obligations as scheduled. Neither suppliers, employees, norgovernment tax authorities will long put up with a failure to receivecash when it is due.

P5-18 Sheik Company: Sheiks cash flow information is characterized bysteady and reliable cash flow from operations over thepast five years. Profits are probably relatively steadyalso. The firm is not using the cash flow fromoperations to finance growth. Very few new long-termassets are being acquired. Maybe not even enoughnew assets to replace equipment when it wears out.

The firm is not growing its operations, and it may evenbe shrinking. It appears that the company does nothave attractive growth opportunities in which to investits profits. So, the company is paying off debt, buyingback stock, or paying large dividends to stockholders.

Speer Company: Speers cash flow information is not encouraging.First, cash flow from operations has swung from quitefavorable 5 years ago to quite unfavorable today. Ifthis situation cant be corrected rather quickly, thecompany is headed for disaster. Because of the deteri-

orating operating cash flow situation, the companyhas had to abandon its expansion and reinvestmentplans. Five years ago, it was expanding rapidly and us-ing its operating cash flow and cash from financingactivities to pay for it. Now, the company is selling offlong-term assets just to pay the bills. In addition, anymonies raised by financing activities are being used tocover operating cash flow deficits. The situation doesnot look encouraging.

Love Company: Loves cash flow from operations is growing rapidly.

While smaller than the other two firms, it is growingthe most rapidly. Further, the company appears to planon even more expansion as the investment in newlong-term assets continues to rise. Because the cashflow from operations is not yet large enough to fully fi-nance all the expansion plans, the firm is raising cashthrough financing activities such as selling stock orborrowing. Of the three firms, this one appears to have


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the brightest future. Cash from operations is growingrapidly, investment in long-term assets continues togrow, and the company appears able to attract contin-ued financing.

P5-19 A. The primary source of cash inflow was $1,014 provided by an

increase in long-term debt. Operating activities provided $278 andthe sale of investments provided $206.

B. A large contributor to the net loss was depreciation and amortizationexpense of $592. This expense did not consume any cash.

C. The primary uses of cash were for the repurchase of common stock($740), for the purchase of investments and acquisitions ($424), andfor dividends paid ($402).

D. Receivables decreased; the cash inflow from customers was greaterthan the amount of sales revenue. Inventories decreased; theamount of cash paid for inventories was less than the cost of goodssold. Accounts payable increased; the amount paid for inventorywas less than the amount of inventory purchased and sold.

E. Revenues $3,960Decrease in accounts receivable 172Cash collected from customers $4,132

P5-20 A. 1. Net income: The purpose of the operating activitiessection under the indirect format is toshow why cash flow differed from netincome. Therefore, the starting point is

net income. Items or events thatgenerated (or consumed) a differentamount of cash than revenue (orexpense) are added to (or deducted from)net income to obtain cash flow fromoperations.

2. Depreciation expense: Depreciation expense consumes zerocash. Therefore, the entire amount of de-preciation expense is added back to netincome in the determination of cash flowfrom operations.

B. 1. Accounts receivable: The increase in accounts receivablebalance is deducted from net incomebecause some of the sales revenueswere not collected in cash.

(continued)


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146 Chapter 5

2. Inventory: The decrease in inventory is added to netincome because some of the inventorythat was sold was not replaced. Hence,the cash expended to replenish inventorywas less than the expense recorded ascost of goods sold.

3. Prepaid advertising: The increase in prepaid advertising is de-ducted from net income because moreadvertising was purchased and paid forthan was consumed.

4. Rent payable: The decrease in rent payable is deductedfrom net income because cash paymentsfor rent exceeded the amount of rent ex-pense. In effect, all of the current period-s rent expense was paid plus a portion ofrent payable from the previous periodwas also paid.

5. Wages payable: The increase in wages payable is addedto net income because not all wages(expense) consumed cash. Some wageswere not paid in cash. They are stillpayable.

C. No income statement items or events will appear under investingactivities on the statement of cash flows.

D. 1. Buildings and equipment: The increase in account balanceduring the year indicates thatadditional buildings and equipment

were purchased. Most likely, cash wasinvolved. A smaller amount ofbuildings or equipment could alsohave been sold, but we cannot tell.

2. Land: The increase in the account balanceindicates that additional land was pur-chased. Most likely, cash was in-volved.

3. Investments, long-term: The decrease in the account balanceindicates that a portion of invest-ments were sold. Most likely cash was

received.

E. No income statement items or events will appear under financingactivities on the statement of cash flows.


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F. 1. Notes payable, long-term: The increase in the account balanceindicates that additional financingwas obtained in exchange for a notepayable. Most likely, cash wasobtained.

2. Common stock: The increase in the account balanceindicates that additional financingwas obtained by selling commonstock. Most likely, cash was obtained.

3. Retained earnings: Although retained earnings itself doesnot appear on the cash flow state-ment, the fact that retained earningsincreased by an amount less than netincome indicates dividends were paid.Dividends appear in the financing ac-tivities section.

P5-21 A. Beltway Distributors, Inc.Statement of Cash Flows

For the Year Ended January 30, 2007(In thousands)

Operating ActivitiesNet income $ 5,300Add/Deduct:

Depreciation expense 2,900Decrease in accounts receivable 4,800Decrease in inventories 3,600Decrease in accounts payable (200 )

Cash flow from operating activities 16,400

Financing ActivitiesDecrease in bank loan payable (11,300)Payment of dividends (5,000 )Cash flow for financing activities (16,300 )Increase in cash $ 100Beginning cash balance 1,950Ending cash balance $ 2,050

B. It appears that the company is slowly decreasing the size of its

operations. No new investment in long-term assets is occurring.Cash flows from operating activities are being used to pay dividendsand reduce debt. It may be that the firm is in a declining industry thatdoes not have significant growth opportunities. So far, operationsare still profitable but the company is reducing its investment inreceivables and inventories and using the cash to liquidate debt.


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148 Chapter 5

P5-22 The Book WermzStatement of Cash Flows

For the Month Ended November 30, 2007

Direct Method Indirect Method

Operating Cash Flow: Operating Cash Flow:From customers $45,003.48 Net income $ 2,447.45For merchandise (33,243.92) Depreciation expense 817.20For supplies (2,576.93) Decrease in accts. rec. 125.00For wages (4,073.79) Increase in supplies (165.40)For rent (1,738.15) Increase in inventory (8,438.37)For interest (932.03) Increase in accts. payable 6,131.77For taxes (897 .45 ) Increase in wages payable 623 .56Net operating cash flow 1,541 .21 Net operating cash flow 1,541 .21

Investing Cash Flow: Investing Cash Flow:Purchase of equipment (2,000 .00 ) Purchase of equipment (2,000 .00 )

Financing Cash Flow: Financing Cash Flow:Payment of debt (1,122.77) Payment of debt (1,122.77)Payment of dividends (1,500 .00 ) Payment of dividends (1,500 .00 )Net financing cash flow (2,622 .77 ) Net financing cash flow (2,622 .77 )

Net change in cash (3,081.56) Net change in cash (3,081.56)Beginning cash balance 15,389 .55 Beginning cash balance 15,389 .55Ending cash balance $ 12,307 .99 Ending cash balance $ 12,307 .99

If net income had been $2,600 and cash received from customers had been$45,156.03, net operating cash flow would have been $1,693.76.

P5-23

1 2 3 4 5 6 7 8 9 10

a a d d b d c c b b


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CASES

C5-1 A. The three categories of cash flows are from operating activities, in-vestment activities, and financing activities.

2004 2003 2002B. Net income $1,055 $ 917 $458

Cash FlowsOperating activities 1,461 1,631 913

In each year, cash flows from operating activities exceeded net in-come. The major explanation is that depreciation (a noncash ex-pense) reduces net income but does not affect cash.

C. In years 2004 and 2003, cash flows from operating activities weresufficient to meet cash flow needs for investing activities. Theexcess cash flow generated by operating activities was used toreduce debt and pay dividends as shown in the financing activitiessection of the cash flow statement. In 2002, cash flows fromoperating activities were not sufficient to provide for all investing

activities. Thus, the company generated cash inflows from financingactivities to make up the difference.

D. The dividend payout ratio is 0.39 ($413 $1,055 = 0.39). Thus, in2004, General Mills distributed approximately 39% of its earnings toshareholders.

C5-2 A. General Mills operating activities during 2004 included sales ofgoods for $11,070 million that cost the company $6,594 million.Selling and administrative activities resulted in expenses of $2,443million. The major difference between the accrual and cash floweffects of these activities were as follows:

(1) Depreciation and amortization reduced income by $399 million(before taxes) but had no effect on cash flows.

(2) The net changes in current asset accounts and current liabilityaccounts reduced cash by $186 million, but had no effect on in-come.

B. 2004 2003Return on total assets 5.7% 5.0%

($1,055 $18,448) ($917 $18,227)

Return on assets improved from 2003 to 2004.

C. Your 2004 claim on the companys earnings (10,000 shares) wouldbe $28,200 (10,000 $2.82 earnings per share = $28,200). The 2003claim on the companys earnings would be $24,900 (10,000 $2.49earnings per share = $24,900). Your claim in 2004 is larger.

D. In 2004, the companys major source of cash was from successfuloperating activities. In general, the cash was used to:

(continued)


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150 Chapter 5

purchase land, buildings, and equipment reduce debt, and pay dividends.

E. In 2004, the company used cash to reduce notes payable.Management also issued additional long-term debt and common

stock, purchased treasury stock, and paid dividends. Financingactivities have varied greatly over the three years. In 2002, thecompany increased its liabilities by issuing notes payable and long-term debt (presumably in connection with the acquisition ofPillsbury).

F. The companys most important reported assets were goodwill andother intangible assets ($10,325 million); and land, buildings, andequipment ($3,111 million). Assets that may be important to thecompany but are not reported on its balance sheet includeinvestment in employee and management skills, investment inresearch and development, and brand names. The source of goodwill

(reported on the balance sheet) may represent the value of theseitems at Pillsbury and other companies that have been acquired byGeneral Mills.

C5-3 A. General Mills statement of cash flows reveals that its net earningswere $1,055 million for 2004. Its cash flow from operating activitieswas $1,461 million. The difference between these two measuresresults from noncash expenses, such as depreciation andamortization, and an increase in working capital (current assets current liabilities), and various other items.

B.

Increased DecreasedCash InventoriesAccounts receivable Deferred income taxesPrepaid expenses Accounts payableCurrent portion of long-term debt Notes payable

Other current liabilities

Since accounts receivable increased between 2003 and 2004, thecompany did not collect all of the credit sales made in 2004. We maydetermine the amount of cash collected from customers as follows:

Beginning accounts receivable $ 980

(plus) Sales 11,070(less) Ending accounts receivable (1,010 )Collections $ 11,040 *

*Cash collections from customers is $11,040. Since we know thebeginning and ending balance of Accounts Receivable, and theSales revenue, we can calculate the amount of collections as shownabove by solving the unknown. (Alternatively, sales of $11,070


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million the increase in accounts receivable of $30 million = cashcollected of $11,040 million.)

C. The overall trend in operating cash flow is positive; however, cash flowfrom operating activities declined in 2004. Also, cash flow fromoperating activities exceeds net earnings in each year reported. Themajor reason cash flow from operating activities exceeds net earningsis the noncash charge for depreciation. Earnings improved each yearbetween 2002 and 2004.

D. The companys financial performance is strong. Each year sales andearnings improved. In addition, the company is generating sufficientcash to meet its investing and financing needs.


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152 Chapter 5

COMPREHENSIVE REVIEW

A. Alice Springs MerchandiseIncome Statement

For the Year Ended January 31

2007 2006Sales revenue $ 589,351 $ 530,666Cost of goods sold (359,504 ) (328,343 )Gross profit $ 229,847 $ 202,323Operating expenses:

Wages expense (123,764) (117,136)Rent expense (30,116) (28,052)Depreciation expense (24,871) (22,628)Supplies expense (13,555 ) (10,751 )

Net income $ 37,541 $ 23,756

B. Alice Springs MerchandiseBalance SheetAt January 31

2007 2006AssetsCurrent assets:

Cash $ 63,168 $ 57,845Accounts receivable 48,386 43,106Merchandise inventory 130,247 117,202Prepaid rent 2,530 2,314Supplies 1,129 952

Total current assets $245,460 $221,419Property and equipment 365,398 328,563Accumulated depreciation (43,848 ) (18,977 )Total assets $ 567,010 $531,005

Liabilities and EquityCurrent liabilities:

Accounts payable $ 25,953 $ 23,674Wages payable 10,272 9,500Unearned revenue 12,966 11,675Notes payable, current 47,249 44,249

Total current liabilities $ 96,440 $ 89,098Notes payable, long-term 214,838 222,467Common stock 102,629 95,581Retained earnings 153,103 123,859Total liabilities and equity $ 567,010 $531,005


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C. Accrual Adjustments Cash FlowSales revenue $589,351Accounts receivable $ (5,280)Unearned revenue 1,291Cash collected from customers $ 585,362

Cost of goods sold (359,504)Merchandise inventory (13,045)Accounts payable 2,279Cash paid for merchandise (370,270)

Wages expense (123,764)Wages payable 772Cash paid for wages (122,992)

Rent expense (30,116)Prepaid rent (216 )

Cash paid for rent (30,332)

Depreciation expense (24,871)Adjustment for noncash expense 24,871Cash paid for depreciation 0

Supplies expense (13,555)Supplies (177)Cash paid for supplies (13,732 )

Net income $ 37,541Total adjustments $ 10,495Operating cash flow $ 48,036

(continued)


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154 Chapter 5

D. Alice Springs MerchandiseStatement of Cash Flows

For the Year Ended January 31, 2007

Operating Activities:Cash collected from customers $ 585,362

Cash paid for merchandise (370,270)Cash paid for wages (122,992)Cash paid for rent (30,332)Cash paid for supplies (13,732 )Net cash from operating activities 48,036Investing Activities:Paid for property and equipment (38,802)Sale of property and equipment 1,967Net cash for investing activities (36,835 )Financing Activities:Notes payable, current 3,000

Notes payable, long-term (7,629)Common stock 7,048Dividends paid (8,297 )Net cash for financing activities (5,878 )Net change in cash 5,323Cash, January 31, 2006 57,845Cash, January 31, 2007 $ 63,168


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E. Alice Springs MerchandiseStatement of Cash Flows

For the Year Ended January 31, 2007

Operating Activities:Net income $37,541

Adjustments:Depreciation expense 24,871Accounts receivable (5,280)Unearned revenue 1,291Merchandise inventory (13,045)Accounts payable 2,279Wages payable 772Prepaid rent (216)Supplies (177 )Net cash from operating activities 48,036Investing Activities:

Paid for property and equipment (38,802)Sale of property and equipment 1,967Net cash for investing activities (36,835 )Financing Activities:Notes payable, current 3,000Notes payable, long-term (7,629)Common stock 7,048Dividends paid (8,297 )Net cash for financing activities (5,878 )Net change in cash 5,323Cash, January 31, 2006 57,845

Cash, January 31, 2007 $ 63,168

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