Dmp3e Ch04 Solutions 03.03.10 Final

7/27/2019 Dmp3e Ch04 Solutions 03.03.10 Final

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Chapter 4

Reporting and Analyzing Cash Flows

Learning Objectives coverage by question

Mini-exercises Exercises Problems Cases

LO1 Explain the purpose ofthe statement of cash flows and

how it complements the incomestatement and balance sheet.

21, 22, 24, 25 34, 36, 38, 39 44, 47, 51, 55 57, 58, 59

LO2 Construct and explainthe statement of cash flows.

21, 22, 23, 24,

25, 26, 27, 28,

29, 30, 31

34, 35, 36, 37,

38, 39, 40, 41,

42, 43

44, 45, 46, 47,

48, 49, 50, 51,

52, 53, 54, 55,

56

57, 58

LO3 Compute andinterpret ratios that reflecta companys liquidity andsolvency.

32, 33, 35, 4346, 48, 50, 52,

5659

LO4 Appendix 4A: Use aspreadsheet to construct thestatement of cash flows.

56

Cambridge Business Publishers, 2011

Solutions Manual, Chapter 4 4-1


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Q4-6 Noncash investing and financing transactions are disclosed as supplementalinformation to a statement of cash flows because a secondary objective ofcash flow reporting is to present information about investing and financingactivities. Noncash investing and financing transactions, generally, affectfuture cash flows. Issuing bonds payable to acquire equipment, for example,requires future cash payments for interest and principal on the bonds. On the

other hand, converting bonds payable into common stock eliminates futurecash payments related to the bonds. Knowledge of these types of events,therefore, should be helpful to users of cash flow data who wish to assess afirm's future cash flows.

Q4-7 A statement of cash flows helps external users assess the amount, timing,and uncertainty of future cash flows to the enterprise. These assessmentshelp users evaluate their own future cash receipts from their investments in,or loans to, the firm. A statement of cash flows shows the periodic casheffects of a firm's operating, investing, and financing activities.Distinguishing among these different categories of cash flows helps users

compare, evaluate, and predict cash flows. With cash flow information,creditors and investors are better able to assess a firm's ability to settle itsliabilities and pay its dividends. Over time, the statement of cash flowspermits users to observe and analyze management's investing and financingpolicies. A statement of cash flows also provides information useful inevaluating a firm's financial flexibility(which is its ability to generate cash torespond to unanticipated needs and opportunities).

Q4-8 The direct method presents the net cash flow from operating activities byshowing the major categories of operating cash receipts and cash payments(such as cash received from customers, cash paid to employees and

suppliers, cash paid for interest, and cash paid for income taxes). Theindirect (or reconciliation) method, in contrast, presents the net cash flowfrom operating activities by applying a series of adjustments to the accrualnet income to convert it to a cash basis.

Q4-9 Under the indirect method, depreciation is added to net income because, asa noncash expense, it was deducted in computing net income. Addingdepreciation to net income, therefore, eliminates it from the cash-basisincome amount. Amortization and depletion expenses are handled the sameway.

Q4-10 Under the indirect method, the $98,000 cash received from the sale of theland will appear in the cash flows from investing activities section of thestatement of cash flows. In addition, the $28,000 gain from the sale will bededucted from net income as one of the adjustments made to determine thenet cash flow from operating activities.




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Q4-11 Net income $ 88,000Add (deduct) items to convert net income to cash basis

Depreciation 6,000Accounts receivable decrease 13,000Inventory increase (9,000)Accounts payable decrease (3,500)

Income tax payable increase 1,500Net cash provided by operating activities $ 96,000

Q4-12 The separate disclosures required for a company using the indirect methodin the statement of cash flows are (1) cash paid during the year for interest(net of amount capitalized) and for income taxes, (2) all noncash investingand financing transactions, and (3) the policy for determining which highlyliquid, short-term investments are treated as cash equivalents.

Q4-13 The statement of cash flows will show a positive net cash flow fromoperating activities if operating cash receipts exceed operating cash

payments. This could happen, for example, if noncash expenses (such asdepreciation and amortization) exceed the net loss. It would also happen ifoperating cash receipts exceed sales by more than the loss or if operatingcash payments are less than accrual expenses by more than the loss (orsome combination of these events).

Q4-14 Sales $925,000+ Accounts receivable decrease 14,000= Cash received from customers $939,000

Q4-15 Wages expense $ 86,000

+ Wages payable decrease 1,100= Cash paid to employees $ 87,100

Q4-16 Advertising expense $ 43,000+ Prepaid advertising increase 1,600= Cash paid for advertising $ 44,600

Q4-17 Under the direct method, the $5,100 cash received from the sale ofequipment will appear in the cash flows from investing activities section ofthe statement of cash flows.

Q4-18 The separate disclosures required for a company using the direct method inthe statement of cash flows are (1) a reconciliation of net income to net cashflow from operating activities, (2) all noncash investing and financingtransactions, and (3) the policy for determining which highly liquid,short-term investments are treated as cash equivalents.


Financial Accounting, 3rd Edition4-4


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Q4-19 The operating-cash-flow-to-current-liabilities ratio is calculated by dividingnet cash flow from operating activities by average current liabilities. Thisratio is a measure of a firm's ability to liquidate its current liabilities.

Q4-20 The operating-cash-flow-to-capital-expenditures ratio is calculated bydividing a firm's cash flow from operating activities by its annual capital

expenditures. A ratio below 1.00 means that the firm's current operatingactivities are not providing enough cash to cover the capital expenditures.A ratio above 1.0 is normally considered a sign of financial strength.




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MINI EXERCISES

M4-21 (5 minutes)

a. __+__$823 increase in accounts payable

b. __+__$319 increase in accrued liabilitiesc. __+__$853 decrease in inventoryd. __+__$448 decrease in accounts receivablee. __+__$1,259 increase in depreciation and amortization

M4-22 (10 minutes)

a. Cash flow from an operating activity.b. Cash flow from an investing activity.

c. Cash flow from an investing activity.d. Cash flow from an operating activity.e. Cash flow from a financing activity.f. Cash flow from a financing activity.g. Cash flow from an investing activity.

M4-23 (15 minutes)

Dole Food Company, Inc.

Selected Items from the Cash Flow Statement

1 Cash dividends paid Financing

2 Change in inventories Operating

3 Depreciation and amortization Operating

4 Long-term debt repayments Financing

5 Change in accounts payable and accrued liabilities Operating

6 Net income Operating

7 Proceeds from sales of assets Investing

8 Change in provision for deferred income taxes Operating

9 Change in prepaid expenses and other assets Operating10 Short-term debt borrowings Financing

11 Capital additions Investing




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M4-24 (10 minutes)

a. Cash flow from a financing activity.b. Cash flow from an operating activity.c. Noncash investing and financing activity.d. Cash flow from an operating activity.

e. Cash flow from an operating activity.f. None of the above (a change in the composition of cash and cash equivalents).

M4-25 (15 minutes)

Pacific Sunwear of California, Inc.

Selected Items from the Cash Flow Statement

1 Depreciation and amortization Operating

2Proceeds from sale of common stock and exerciseof stock options Financing

3 Loss on disposal of equipment Operating

4 Change in accrued liabilities Operating

5 Repayments of long-term debt obligations Financing

6Changes in income taxes payable and deferredincome taxes

Operating

7 Change in accounts receivable Operating

8 Purchases of property and equipment Investing

9 Repurchase and retirement of common stock Financing

10 Purchases of short-term investments Investing

M4-26 (15 minutes INDIRECT METHOD)

Net income $ 45,000Add (deduct) items to convert net income to cash basis

Depreciation 8,000Gain on sale of investments (9,000)Accounts receivable increase (9,000)Inventory increase (6,000)

Prepaid rent decrease 2,000Accounts payable increase 4,000Income tax payable decrease (2,000)Net cash provided by operating activities $ 33,000




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M4-27 (20 minutes)

A + indicates that the amount is added and a - indicates that it is subtractedwhen preparing the cash flow statement using the indirect method.

Ethan Allen Interiors Inc. And Subsidiaries

Consolidated Statements of Cash Flows Selected Items

1 Purchases of short-term investments Investing -2 Payment of cash dividends Financing -3 Depreciation and amortization Operating +4 Increase in deferred income tax liability Operating +5 Decrease in customer deposits Operating -6 Capital expenditures Investing -7 Increase in income taxes and accounts payable Operating +8 Payments on long-term debt and capital leases Financing -

9 Gain on disposal of property, plant and equipment Operating -10 Increase in prepaid and other current assets Operating -11 Net proceeds from issuance of common stock Financing +12 Proceeds from the disposal of property, plant and

equipment Investing +13 Net income Operating +14 Decrease in inventories Operating +15 Borrowings on revolving credit facility Financing +

M4-28 (15 minutesINDIRECT METHOD)

Net loss $(21,000)Add (deduct) items to convert net loss to cash basis

Depreciation 8,600Accounts receivable decrease 9,000Inventory decrease 3,000Prepaid expenses decrease 3,000Accounts payable increase 4,000

Accrued liabilities decrease (2,600)Net cash provided by operating activities $ 4,000

Cairo Company's 2010 operating activities provided $4,000 cash.




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M4-29 (20 minutes)

A + indicates that the amount is added and a - indicates that it is subtractedwhen preparing the cash flow statement using the indirect method.

Nordstrom, Inc.

Consolidated Statement of Cash Flows Selected Items1 Increase in accounts receivable Operating -2 Capital expenditures Investing -3 Purchases of short-term investments Investing -4 Increase in deferred income tax liability Operating +5 Principal payments on long-term debt Financing -6 Increase in merchandise inventories Operating -7 Decrease in income taxes payable Operating -8 Proceeds from employee stock purchase plan Financing +9 Increase in accounts payable Operating +10 Net earnings Operating +11 Repurchase of common stock Financing -12 Increase in accrued salaries, wages and related

benefits Operating +13 Proceeds from sale of assets Investing +14 Cash dividends paid Financing -15 Depreciation and amortization of buildings and

equipment Operating +

M4-30 (15 minutesDIRECT METHOD)

a. Rent expense $ 60,000 Prepaid rent decrease (2,000)= Cash paid for rent $ 58,000

b. Interest income $ 16,000 Interest receivable increase (700)= Cash received as interest $ 15,300

c. Cost of goods sold $ 98,000+ Inventory increase 3,000+ Accounts payable decrease 4,000= Cash paid for merchandise purchased $105,000




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M 4-31 (15 minutesDIRECT METHOD)

Sales $825,000 Accounts receivable increase (11,000)= Cash received from customers $814,000

Cost of goods sold $550,000+ Inventory increase 13,000+ Accounts payable decrease 6,000= Cash paid for merchandise purchased $569,000




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EXERCISES

E4-32 (20 minutes)

a. Merck: $3,364/$5,618 = 0.60

Pfizer: $18,238/$24,422 = 0.75

Abbot Labs: $6,995/$10,347 = 0.68

b. Merck: $3,364 ($747 $44) = $2,661

Pfizer: $18,238 ($1,701 $0) = $16,537

Abbott Labs: $6,995 ($1,288 $0) = $5,707

c. None of the firms has sufficient cash flow to cover their current liabilitiesalthough none of the ratios is of major concern. Pfizer is the largest of these

three companies and has relatively more cash left over after capitalexpenditures to consider using on other activities that could strengthen thefirms operating or financial position. Given that these firms are of differentsizes and have different research program success, it is difficult to generalizefurther.

E4-33 (20 minutes)

a. Wal-Mart: $23,147/$56,934 = 0.41

General Electric: $48,601/$246,925 = 0.20

Exxon: $59,725/$53,706 = 1.11

b. Wal-Mart: $23,147 ($11,499 $714) = $12,362

General Electric: $48,601 ($16,010 $10,975) = $43,566

Exxon: $59,725 ($19,318 $5,985) = $46,392

c. General Electric reports substantial current liabilities and its operating cashflow produces only 20% of what is needed to cover its obligations. Exxonappears to be in the best position, with a substantial amount of its operational

cash flows available for dividends, expansion, and other business pursuits.The situation has improved as Exxons profits have increased substantiallywith higher oil prices. Extra cash does not earn any return, which providesExxon a problem or, better, an opportunity. Because the firm is so large, it isunlikely that an acquirer may look with interest at the large cash position ofthe company.




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E4-34 (30 minutes)

(a) Items from the table have been grouped into operating, investing, andfinancing categories in (b) the cash flow statement below.

(c) The cash balance at the end of the period is $864 million.

Target Corporation

Consolidated Statement Of Cash Flows

($ millions)

Net earnings . $2,214

Loss on disposal of property and equipment . 33

Depreciation and amortization 1,826

Deferred income taxes .. 91

Stock based compensation . 72

Decrease in accounts receivable, net ... 793

Decrease in inventory 77

Decrease in accounts payable (389)

Decrease in accrued liabilities (230)

Other operating cash flow adjustments (57)

Total cash flow from operating activities . 4,430

Expenditures for property and equipment .. (3,547)

Other investments .. (865)

Proceeds from disposals of property and equipment .. 39

Cash flow used for investing activities . (4,373)

Additions to long-term debt . 3,557

Reductions of long-term debt . (1,455)

Reduction of short-term debt . (500)

Stock issued and other . 35

Repurchase of common stock (2,815)

Dividends paid . (465)

Cash flow used for financing activities . (1,643)

Net change in cash .. (1,586)

Cash balance, beginning of the period .. 2,450

Cash balance, end of the period .. $ 864




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E 4-35 (15 minutesINDIRECT METHOD)

a.Net income $113,000Add (deduct) items to convert net income to cash basis

Accounts receivable increase (5,000)

Inventory decrease 6,000Prepaid insurance increase (1,000)Accounts payable increase 4,000Wages payable decrease (2,000)Net cash provided by operating activities $115,000

b. $115,000/[($31,000 + $29,000)/2] =3.83

E4-36 (30 minutes)

(a) Items from the table have been grouped into operating, investing, andfinancing categories in (b) the cash flow statement below.

(c) The cash balance at the end of the period is $31,313,000.

(d) It is not unusual for companies like Oakley to borrow money from banks forshort periods of time. For example, these borrowings may be needed tofinance seasonal fluctuations in working capital. In many cases, cash mightbe borrowed and then repaid before the end of the accounting period, andconsequently, never be reported on the year-end balance sheet. Bypresenting the amount borrowed andthe amount repaid in the cash flowstatement (rather than merely the net increase or decrease), the financialstatements provide investors and creditors with potentially usefulinformation about Oakleys short-term financing needs. The net change inbank borrowings is an increase of $22,538,000 ($254,211,000 - $231,673,000).




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E4-36continued.

Oakley, Inc. And SubsidiariesConsolidated Statements Of Cash Flows

($ thousands)

Net income $44,788Depreciation and amortization 37,571Loss on sale of equipment .. 460Loss on investment 4,329Noncash compensation 3,081Deferred income taxes .. (11,222)Increase in accounts receivable . (1,611)Increase in inventories . (23,177)Increase in prepaid expenses and other current assets . (2,268)Increase in accounts payable . 10,135Increase in accrued expenses and other current liabilities........ 14,886

Increase in accrued income taxes 4,937Cash flow from operating activities .. 81,909

Purchases of property and equipment . (52,527)Proceeds from sale of property and equipment . 221Acquisitions of other businesses .. (86,751)Purchase of investments .. (705)Cash used for investing activities .. (139,762)

Proceeds from bank borrowings . 254,211Repayments of bank borrowings (231,673)

Stock issued and other . 5,774Repurchase of common stock (10,351)Payment of cash dividends . (10,952)Cash provided by financing activities ... 7,009

Net increase in cash (50,844)Cash and cash equivalents, beginning . 82,157Cash and cash equivalents, end .. $31,313




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E4-37 (30 minutesINDIRECT METHOD)

LUND CORPORATIONSTATEMENTOF CASH FLOWS

FOR YEAR ENDED DECEMBER 31, 2010

Net Cash Flow from Operating ActivitiesNet Income $76,000Add (Deduct) Items to Convert

Net Income to Cash BasisDepreciation 29,000Amortization 6,000Gain on Sale of Equipment (4,000)Accounts Receivable Increase (4,000)Inventory Decrease 13,000Prepaid Expenses Increase (2,000)Accounts Payable Increase 9,000

Accrued Liabilities Decrease (3,000)Net Cash Provided by Operating Activities .. $120,000

Cash Flows from Investing ActivitiesSale of Equipment 17,000Purchase of Land (90,000)Net Cash Used by Investing Activities ... (73,000)

Cash Flows from Financing ActivitiesIssuance of Common Stock 35,000Retirement of Bonds Payable (60,000)Payment of Dividends (29,000)Net Cash Used by Financing Activities (54,000)

Net Decrease in Cash (7,000)Cash at Beginning of Year 22,000Cash at End of Year $ 15,000




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E4-38 (30 minutes)

a.Merchandise inventories, 2008 $ 8,209less Merchandise inventories, 2007 .. (7,611)

Increase in merchandise inventories . 598Cost of merchandise sold . 31,729

Inventory purchases ... 32,327Accounts payable, 2007 . 3,713less Accounts payable, 2008 (4,109)

Cash paid for inventory . $31,931

b.Property, net of depreciation, 2008 . $22,722Less, Property, net of depreciation, 2007 . (21,361)

Net increase in property 1,361

Depreciation expense . 1,539Net property acquired $ 2,900

c.Retained earnings, 2007 $ 15,345Net income 2,195Less Retained earnings, 2008 . (17,049)Dividends paid . $ 491

E4-39 (15 minutes)

a. Cash flows from investing activities will show:

Purchase of stock investments $ (80,000)

Sale of stock investments 59,000

b. Cash flows from financing activities will show:

Issuance of bonds $130,000Retirement of bonds (131,000)




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E4-40 (30 minutes)

a.Merchandise inventories, 2008 $ 915.2

Less merchandise inventories, 2007 (1,242.0)

Decrease in merchandise inventories (326.8)Cost of merchandise sold 2,484.8

Inventory purchases 2,158.0Trade accounts payable, 2007 511.9Less trade accounts payable, 2008 (350.0)

Cash paid for merchandise inventory $ 2,319.9

b.Property and equipment, 2007 $ 592.8

Expenditures for property and equipment 79.9Less depreciation expense (107.1)

Less property and equipment, 2008 (494.2)Book value of property and equipment sold in 2008 71.4Loss on sale of property and equipment (57.1)Cash proceeds from the sale of property and equipment . $ 14.3

c.Retained earnings, 2007 $ 250.5Less net loss (186.7)Less retained earnings, 2008 (63.8)Dividends paid $ 0

d.Merchandise inventory (+A) .... 2,158.0

Trade accounts payable )+L) 2,158.0

Trade accounts payable (-L) 2,319.9Cash (-A) 2,319.9

Cash (-A) ... 14.3Loss on sale of property and equipment (+E, -SE) 57.1

Property and equipment, net (-A) .. 71.4




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E4-41 (20 minutesDIRECT METHOD)

a. Advertising expense $ 62,000+ Prepaid advertising increase 4,000= Cash paid for advertising $ 66,000

b. Income tax expense $ 29,000+ Income tax payable decrease 2,200= Cash paid for income taxes $ 31,200

c. Cost of goods sold $180,000 Inventory decrease (5,000) Accounts payable increase (2,000)= Cash paid for merchandise purchased $173,000


MASON CORPORATIONSTATEMENTOF CASH FLOWS


Cash flows from operating activitiesCash received from customers $194,000Cash received as interest 6,000 $200,000Cash paid to employees and suppliers 148,000

Cash paid as income taxes 11,000 (159,000 )Net cash provided by operating activities 41,000

Cash flows from investing activitiesSale of land 40,000Purchase of equipment (89,000)Net cash used by investing activities (49,000)

Cash flows from financing activitiesIssuance of bonds payable 30,000Acquisition of treasury stock (10,000)Payment of dividends (16,000)Net cash provided by financing activities 4,000

Net decrease in cash (4,000)Cash at beginning of year 16,000Cash at end of year $ 12,000




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a.Sales $750,000

Accounts Receivable Increase (5,000)= Cash Received from Customers $745,000

Cost of Goods Sold $470,000 Inventory Decrease (6,000) Accounts Payable Increase (4,000)= Cash Paid for Merchandise Purchased $460,000

Wages Expense $110,000+ Wages Payable Decrease 2,000= Cash Paid to Employees $112,000

Insurance Expense $ 15,000

+ Prepaid Insurance Increase 1,000= Cash Paid for Insurance $ 16,000

Cash Flows from Operating ActivitiesCash Received from Customers $745,000Cash Paid for Merchandise Purchased $460,000Cash Paid to Employees 112,000Cash Paid for Rent 42,000Cash Paid for Insurance 16,000 630,000Net Cash Provided by Operating Activities $115,000

b. $115,000/[($31,000 + $29,000)/2] =3.83

E4-44 (15 minutes)

1. True ---

2. False $25

3. False $10

4. False $0




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PROBLEMS

P4-45 (20 minutes)

Cash flows from operating activities

Net income....................................................................................... $135,000

Adjustments to reconcile net income to operating cash flows

Depreciation............................................................................... $25,000

Accounts receivable increase.................................................. (10,000)

Prepaid expenses decrease...................................................... 3,000

Accounts payable increase...................................................... 6,000

Wages payable decrease.......................................................... (4,000)

Gain on sale of assets............................................................... (5,000 ) 15,000

Net cash provided from operating activities................................ $150,000




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P4-46 (45 minutesINDIRECT METHOD)

a. Cash, December 31, 2010...................................................... $11,000Cash, December 31, 2009...................................................... 5,000Cash increase during 2010................................................... $ 6,000

b. STATEMENTOF CASH FLOWS (INDIRECT METHOD)

WOLFF COMPANYSTATEMENTOF CASH FLOWS


Net Cash Flow from Operating ActivitiesNet Income $56,000Add (Deduct) Items to Convert Net Income to Cash Basis

Depreciation 17,000

Accounts Receivable Increase (9,000)

Inventory Increase (30,000)

Prepaid Insurance Decrease 2,000

Accounts Payable Decrease (3,000)

Wages Payable Increase 3,000

Income Tax Payable Decrease (1,000)

Net Cash Provided by Operating Activities $35,000

Cash Flows from Investing Activities

Purchase of Plant Assets (55,000)

Cash Flows from Financing Activities

Issuance of Bonds Payable 55,000

Payment of Dividends (29,000)

Net Cash Provided by Financing Activities 26,000

Net Increase in Cash 6,000

Cash at Beginning of Year 5,000

Cash at End of Year $11,000

c. (1) $35,000/(($23,000 + $24,000)/2) = 1.49

(2) $35,000/$55,000 = 0.64

Wolffs cash flow ratios indicate that, while the company has sufficient cashflow to cover its current obligations, it must rely on external financing to payfor capital expenditures.




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P4-47 (30 minutes)

a.Wolff Company

Cash Flow from Operations Direct MethodRevenue or

Expense Adjustments

Operating

Cash FlowRevenues/Cash Receipts:Sales revenue $635,000- Increase in accounts receivable ($9,000)Cash received from customers $626,000

Less Expenses/Cash Payments:Cost of goods sold .. 430,000+ Increase in inventory 30,000+ Decrease in accounts payable 3,000Cash paid for merchandise 463,000

Wages expense 86,000- Increase in wages payable (3,000)Cash paid for wages 83,000

Insurance expense 8,000- Decrease in prepaid insurance (2,000)Cash paid for insurance 6,000

Interest expense 9,000Cash paid for interest 9,000

Depreciation expense 17,000

- Depreciation expense (17,000)Cash paid for deprecation 0

Income tax expense 29,000+ Decrease in income tax payable 1,000Cash paid for income taxes 30,000

Net income $56,000Total adjustments ($ 21,000)Cash flow from operating activities $35,000

b. Computing cash flows from operating activities using the direct methodprovides additional detail about the specific cash flows that occurred during theperiod. For example, the indirect method does not reveal that Wolff paid $463,000for merchandise during 2010, or $83,000 for wages. Because this detail is missing,the FASB requires supplemental disclosure of two specific (and important) cashpayments interest and taxes if the indirect method is used.




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a. Cash, December 31, 2010 $49,000Cash, December 31, 2009 28,000Cash increase during 2010 $21,000


ARCTIC COMPANYSTATEMENTOF CASH FLOWS


Net Cash Flow from Operating ActivitiesNet Loss $ (42,000)Add (Deduct) Items to Convert Net Lossto Cash Basis

Depreciation 22,000

Gain on Sale of Land (25,000)Accounts Receivable Decrease 8,000Inventory Decrease 6,000Prepaid Advertising Decrease 3,000Accounts Payable Decrease (14,000)Interest Payable Increase 6,000

Net Cash Used by Operating Activities $ (36,000)Cash Flows from Investing Activities

Sale of Land 70,000Purchase of Equipment (183,000)*Net Cash Used by Investing Activities (113,000)

Cash Flows from Financing ActivitiesIssuance of Bonds Payable 200,000Purchase of Treasury Stock (30,000)Net Cash Provided by Financing Activities 170,000

Net Increase in Cash 21,000Cash at Beginning of Year 28,000Cash at End of Year $ 49,000

* The sum of the increase in PPE assets account ($138,000) and the book value of the land sold ($45,000).

c. -$36,000/(($23,000 + $31,000)/2) = -1.33

-$36,000/$183,000 = -0.20Arctics operating cash flows are negative, primarily because the firm reporteda net loss for the year. As a consequence, its cash flow ratios indicateinsufficient cash flows to fund operations and capital expenditures.




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P4-49 (30 minutes)a.

Arctic CompanyCash Flow from Operations Direct Method

Revenue orExpense

AdjustmentsOperatingCash Flow

Revenues/Cash Receipts:Sales revenue .. $728,000+ Decrease in accounts receivable . 8,000Cash received from customers $736,000

Gain on sale of land 25,000- Gain on sale of land . (25,000)Cash flow from gain 0

753,000 (17,000) 736,000

Less Expenses/Cash Payments:Cost of goods sold . 534,000

- Decrease in inventory (6,000)+ Decrease in accounts payable . 14,000Cash paid for merchandise .. 542,000

Wages expense 190,000Cash paid for wages 190,000

Advertising expense .. 31,000- Decrease in prepaid insurance . (3,000)Cash paid for advertising . 28,000

Interest expense . 18,000

- Increase in interest payable .................... (6,000)Cash paid for interest 12,000

Depreciation expense 22,000- Depreciation expense . (22,000)Cash paid for deprecation .. 0

795,000 (23,000) 772,000

Net loss . ($42,000)Total adjustments .. $ 6,000Cash flow from operating activities .. ($36,000)

b. Computing cash flows from operating activities using the direct methodprovides additional detail about the specific cash flows that occurred duringthe period. For example, the indirect method does not reveal that Arctic paid$542,000 for merchandise during 2010, or $28,000 for advertising. Becausethis detail is missing, the FASB requires supplemental disclosure of twospecific (and important) cash payments interest and taxes if the indirectmethod is used.




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a. Cash, December 31, 2010............................................. $27,000Cash, December 31, 2009............................................. 18,000Cash increase during 2010........................................... $ 9,000


DAIR COMPANYSTATEMENTOF CASH FLOWS


Net Cash Flow from Operating ActivitiesNet Income $ 85,000Add (deduct) items to convert net incometo cash basis

Depreciation 22,000

Amortization of intangible assets 7,000

Loss on bond retirement 5,000

Accounts receivable increase (5,000)

Inventory decrease 6,000

Prepaid expenses increase (2,000)

Accounts payable increase 6,000

Interest payable decrease (3,000)

Income tax payable decrease (2,000)

Net cash provided by operating activities $119,000Cash flows from investing activities

Sale of equipment 17,000

Cash flows from financing activities

Retirement of bonds payable (125,000)

Issuance of common stock 24,000

Payment of dividends (26,000)

Net cash used by financing activities (127,000)

Net increase in cash 9,000

Cash at beginning of year 18,000Cash at end of year $ 27,000




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P4-50continued

c.(1) Supplemental cash flow disclosures

Cash paid for interest........................................................................ $ 13,000*Cash paid for income taxes.............................................................. $ 38,000

* Interest expense $10,000+Interest payable decrease 3,000

Cash paid for interest $13,000 Income tax expense $36,000

+Income tax payable decrease 2,000Cash paid for income taxes $38,000

(2) Schedule of noncash investing and financing activities

Issuance of bonds payable to acquire equipment.......................... $ 60,000

d. (1) $119,000/[($42,000 + $41,000)/2] = 2.87.(2) The firm did not spend any cash on capital investments. The firm did issue

debt for equipment, but this is not a capital expenditure.(3) $119,000 + $17,000 = $136,000




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P4-51 (45 minutes)

a. Depreciation is a noncash expense that is deducted in the computation of netincome. The depreciation add-back zeros this expense out of the incomestatement to focus on cash profitability. The positive amount for depreciationdoes not mean that the company is generating cash from depreciation, a

common misconception. It is merely an adjustment to remove that expense fromthe computation of profit.

b. The positive amount relating to merchandise inventories indicates that the dollaramount of inventories on hand has declined during the period. This is positive ifdecline is the result of the elimination of excess inventories, but is worrisome ifthe company is reducing inventories below the level necessary to maintain itscompetitive position in an effort to temporarily boost its operating cash flow.

c. The $4.7 billion outflow for investing activities relates to the purchase ofproperty, plant and equipment (PPE) and short-term investments. The company

is growing its infrastructure and building liquidity, both of which are positive(provided that its PPE purchases are for new stores in good locations).

d. Staples operates businesses in 26 countries outside of the U.S. including

businesses in Europe, Asia, South America, Australia, and Canada. This meansthat some of its cash transactions occur in currencies other than the U.S. dollar.This fact requires the company to hold cash in other currencies that may berevalued relative to the dollar from one period to the next. When foreign cashbalances are revalued in foreign exchange markets relative to the U.S. dollar, thedollar value of the companys cash balance changes even though there was noactual cash flow. Hence, this exchange rate effect is listed in the cash flow

statement to explain the change in the cash balance.e. Although net cash decreased during the period, Staples presents a healthy

cash flow picture for the year. It generated almost $1.7 billion of operating cashflow and raised $2.5 billion through financing transactions but spent $4.7 billionto grow its infrastructure.




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a. Cash and cash equivalents, December 31, 2010........................ $19,000Cash and cash equivalents, December 31, 2009........................ 25,000Cash and cash equivalents decrease during 2010.................... $ 6,000

b. See the cash flow statement provided on the following page.

c. (1) Supplemental Cash Flow DisclosuresCash paid for interest $ 12,000*Cash paid for income taxes $ 46,000

* Interest expense $13,000- Interest payable increase (1,000)

Cash paid for interest $12,000

Income tax expense $44,000+ Income tax payable decrease 2,000Cash paid for income taxes $46,000

(2) Schedule of noncash investing and financing activitiesIssuance of preferred stock to acquire patent $ 25,000

d. (1) $101,000/[($34,000 + $31,000)/2] = 3.11.

(2) $101,000/($185,000) = 0.55.

(3): $101,000 ($90,000 + $95,000 - $14,000) = -$70,000




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P4-52continuedb.

RAINBOW COMPANYSTATEMENTOF CASH FLOWS


Net cash flow from operating activitiesNet income $ 90,000Add (deduct) items to convert net income

to cash basisDepreciation 39,000Patent amortization 7,000Loss on sale of equipment 5,000Gain on sale of investments (3,000)Accounts receivable increase (10,000)Inventory increase (26,000)Prepaid expenses increase (4,000)

Accounts payable increase 4,000Interest payable increase 1,000Income tax payable decrease (2,000)

Net cash provided by operating activities $101,000Cash flows from investing activities

Sale of investments 60,000Purchase of land (90,000)Improvements to building (95,000)Sale of equipment 14,000Net cash used by investing activities (111,000)

Cash flows from financing activities

Issuance of bonds payable 30,000Issuance of common stock 24,000Payment of dividends (50,000)Net cash provided by financing activities 4,000

Net decrease in cash and cash equivalents (6,000)Cash and cash equivalents at beginning of year . 25,000Cash and cash equivalents at end of year $ 19,000




30/42

P4-53 (35 minutes)

a. Cash and cash equivalents, December 31, 2010 .. $19,000Cash and cash equivalents, December 31, 2009 .. 25,000Cash and cash equivalents decrease during 2010 .. $ 6,000

b.RAINBOW COMPANY

STATEMENTOF CASH FLOWS (DIRECT METHOD)FOR YEAR ENDED DECEMBER 31, 2010

Cash flows from operating activitiesCash received from customers $740,000Cash received as dividends .. 15,000 $755,000

Cash paid for merchandise purchased .. 462,000Cash paid for wages and other operating expenses 134,000Cash paid for interest .. 12,000Cash paid for income taxes 46,000 (654,000)Net cash provided by operating activities .. 101,000

Cash flows from investing activitiesSale of investments .. 60,000Purchase of land (90,000)Improvements to building (95,000)Sale of equipment .. 14,000Net cash used by investing activities ... (111,000)

Cash flows from financing activitiesIssuance of bonds payable . 30,000Issuance of common stock . 24,000Payment of dividends (50,000)Net cash provided by financing activities 4,000

Net decrease in cash and cash equivalents .. (6,000)Cash and cash equivalents at beginning of year . 25,000Cash and cash equivalents at end of year . $ 19,000




31/42

P4-53continued.

c. (1) Reconciliation of net income to net cash flow from operating activities

Net income $ 90,000Add (deduct) items to convert net income to cash basis

Depreciation 39,000Patent amortization 7,000Loss on sale of equipment 5,000Gain on sale of investments (3,000)Accounts receivable increase (10,000)Inventory increase (26,000)Prepaid expenses increase (4,000)Accounts payable increase 4,000Interest payable increase 1,000Income tax payable decrease (2,000)Net cash provided by operating activities $101,000

(2) Schedule of noncash investing and financing activitiesIssuance of preferred stock to acquire patent $ 25,000




32/42

P4-54 (30 minutes)

($ millions)

a.

Net sales $36,537

- Increase in accounts receivable (939 )

Cash collected from customers .. $35,598

b.

Cost of goods sold . $23,397

- Decrease in inventories .. (54 )

Purchases . 23,343

- Increase in accounts payable (92 )

Cash paid for purchases of inventories $23,251

c.

Property, plant and equipment, ending balance . $2,954

- Purchases of property, plant and equipment (1,144)

+ Book value of PPE assets sold ($42 + 26) . 68

+ Depreciation of property, plant and equipment 577Property, plant and equipment, beginning balance $2,455

d.Stock-based compensation expense is deducted when calculating net incomesimilar to cash compensation. The only difference is that the compensation is paidin shares of stock (or stock options) instead of cash. Because stock-basedcompensation does not require the payment of cash, it is treated as a noncashexpense, much like depreciation, and added back to net income when the indirectmethod is used in the cash flow statement. Generally speaking, compensation cost

is classified as part of operating activities whether or not the compensation is paidin cash.




33/42

P4-55 (60 minutes)

($ millions)

a.

Sales revenue $71,288

+ Decrease in accounts receivable .. 287

- Decrease in deferred revenue . (309 )

Cash collected from customers $71,266

b.

Cost of sales . $47,298

- Decrease in merchandise inventories ($11,731-$10,673) ........ (1,058 )

Purchases . 46,240

+ Decrease in accounts payable ($5,732-$4,822) ........ 910

Cash paid for purchases of merchandise inventory $47,150

c.

Property and equipment, at cost, beginning balance . $36,412

+ Purchases of property and equipment 1,884

- Property and equipment, at cost, ending balance . (36,477 )

Original cost of property and equipment sold .. $ 1,819

d.Property and equipment (+A) .. 37

Long-term debt (+L) .. 37

e.Long-term debt, including current maturities, beginning balance

($11,383+$300) .$11,683

+ Increase from purchase of property and equipment .. 37- Long-term debt, including current maturities, ending balance

($9,667+$1,767) .......(11,434)

Long-term debt repaid .. $ 286




34/42

P4-55 (continued)

f.

Provision for income taxes (income tax expense) .. $ 1,278

- Increase in income taxes payable ($289-$60) (229)+ Decrease in deferred income taxes ($688-$369) .. 319

Income taxes paid .. $ 1,368

g.

Retained earnings, beginning balance $11,388

+ Net income .. 2,260

- Retained earnings, ending balance (12,093)

Dividends declared and paid . $ 1,555




35/42

P4-56 (60 minutes)

a. Home Depot cash flow spreadsheet:

A B C D E F G H

Assets: 2010 2009 ChangeEffect of change on cash flow No effect

on cashOperating Investing FinancingCash & equivalents 519 445 74

S.T. investments 6 12 (6) (168)

S.T. invest. sold 174

Accounts receivable 972 1,259 (287) 287

Merchandiseinventory

10,673 11,731 (1,058) 1,058

Other current assets 1,192 1,227 (35) 35

Property & equipment,net

26,234 27,476 (1,242)

Depreciation 1,785

Prop. & equip.purchased (1,847) (37)

Prop. & equip. sold: 580 761

Goodwill and other 1,568 2,174 (606) 606

Liabilities:

Current installmentsof L.T. debt

1,767 300 1,467 1,467

S.T. debt 0 1,747 (1,747) (1,747)

Accounts payable 4,822 5,732 (910) (910)

Accrued salaries andrelated expenses

1,129 1,094 35 35

Deferred revenue 1,165 1,474 (309) (309)

Sales taxes payable 337 445 (108) (108)Income tax payable 289 60 229 229

Other accruedexpenses

1,644 1,854 (210) (210)

L.T. debt 9,667 11,383 (1,716) (1,753) 37

Other L.T liabilities 2,198 1,833 365 365

Deferred income taxes 369 688 (319) (319)

Equity:

Common stock 6,133 5,885 248 176 72

Treasury stock (372) (314) (58) (58)

Retained earnings 12,093 11,388 705

Net income 2,260Dividends (1,555)

Accumulated othercomprehensive inc.

(77) 755 (832) (832)

Totals 4,728 (1,080) (3,574) 0

P4-56 (continued)




36/42

b.

The Home Depot, Inc. and SubsidiariesConsolidated Statement of Cash Flows

Year ended February 1, 2009 ($ millions)

Operating activities:Net income $ 2,260

Depreciation . 1,785

Loss on property and equipment 580

Deferred income taxes .. (319)

Stock-based compensation . 176

Changes in assets and liabilities affecting operations:

Accounts receivable .. 287

Merchandise inventory . 1,058

Other current assets . 35

Goodwill and other assets 606

Accounts payable (910)

Accrued salaries and related expenses 35

Deferred revenue (309)

Sales taxes payable (108)

Income tax payable . 229

Other accrued expenses .. (210)

Other long-term liabilities . 365

Accumulated other comprehensive income (832)

Cash flow from operating activities 4,728

Investing activities:Purchase of short-term investments . (168)

Proceeds from the sale of short-term investments 174

Purchases of property and equipment .. (1,847)

Proceeds from the sale of property and equipment 761

Cash flow used for investing activities .. (1,080)

Financing activities:Short-term debt repaid .. (1,747)

Long-term debt repaid (includes current installments) . (286)

Issuance of common stock .. 72

Purchases of treasury stock (58)Dividends paid . (1,555)

Cash used for financing activities (3,574)

Net increase in cash 74

Cash balance, beginning of period .. 445

Cash balance, end of period . $ 519




37/42

P4-56 (continued)

c.

Operating cash flow to current liabilities ($ millions):

$4,728 / [($11,153 + $12,706) / 2] = 0.396

Operating cash flow to capital expenditures ($ millions):

$4,728 / $1,847 = 2.56




38/42

CASES AND PROJECTS

C4-57 (30 minutes)The required debt to equity ratio allows for total liabilities to be up to $477 million.That is $477 / ($125+$148) =1.747 < 1.75. This implies total short-term borrowing of

$107 million and an ending cash balance of $70 million.

Lambert Co.Statement of Cash Flows (projected)

Cash from operations

Net income $ 18

Depreciation expense 120

Increase in accounts receivable . (40)

Decrease in inventory 20

Increase accounts payable .. 30

Decrease in income taxes payable . (10)

Cash provided by (used in) operations .. $ 138

Cash from investing

Acquisitions of property, plant and equipment (225)

Disposal proceeds .. 75

Cash provided by (used in) investing . (150)

Cash from financing

Issue long-term debt .. 80

Repay long-term debt .. (100)

Common stock issue .. 25

Shareholder dividends (30)

Increase (decrease) in short-term borrowing 57

Cash provided by (used in) financing .. 32

Net change in cash .. 20

Beginning cash balance . 50

Ending cash balance .. $ 70




39/42


40/42

C4-58 (continued)

16 Income tax expense (+E,-SE) . 374Taxes payable (+L) .. 374

17 Retained earnings (-SE) . 80Cash (-A) 80

18 Revenue (-R) . 3,800Cost of goods sold (-E) . 1,800Salaries and wages expense (-E) 700Rent expense (-E) 200Depreciation expense (-E) 150Interest expense (-E) .. 16Income tax expense (-E) 374Retained earnings (+SE) 560

Entry 18 closes revenue and expense accounts to retained earnings.




41/42

b.+ Cash (A) - - Accounts Payable (L) + - Common Stock (SE) +

600 3,000 4,6002 3,500 5 1,100 1,200 4 4,600 Bal

1,100 5 3,100 Bal

730 7

600 9 - Retained Earnings (SE)+11 10 - Salaries and Wages + 1,300

800 12 Payable (L) 17 80 560 1816 13 100 1,780 Bal

1,600 14 7 730 700 615 2,000 70 Bal

80 17 - Revenue (R) +Bal 1,184 3,800 1

- Taxes Payable (L) + 18 3,8000 0 Bal

374 16+ Accounts Rec. (A) - 374 Bal + Cost of Goods Sold (E) -

6,500 3 1,8001 3,800 3,500 2 - Bank Loan Payable (L) + 1,800 18

Bal 6,800 1,600 Bal 014 1,600

0 Bal + Salaries & Wages (E) -+ Inventory (A) - 6 700

2,400 - Long-term Loan (L) + 700 184 1,200 1,800 3 0 Bal 0

Bal 1,800 2,000 152,000 Bal + Rent Expense (E) -

8 200+ Prepaid Rent (A) - 200 18

0 Bal 09 600 200 8

Bal 400 + Depreciation Exp. (E) -10 150

150 18+ Fixtures and - Bal 0

Equipment (A)1,900 + Interest Expense (E) -

12 800 80 11 13 16Bal 2,620 16 18

Bal 0

- Accum. Deprec. (XA) + + Income Tax Exp (E) -800 16 374

11 70 150 10 374 18880 Bal Bal 0




42/42

C4-59 (30 minutes)

a. Depreciation is a noncash expense that is deducted in the computation of netincome. The depreciation add-back zeros this expense out of the incomestatement to focus on operating cash flow. The positive amount for depreciationdoes not mean that the company is generating cash from depreciation, a

common misconception. It is merely an adjustment to remove that expense fromnet income to convert profit to cash flow.

b. Share based compensation expense is deducted when calculating net incomesimilar to cash compensation. The only difference is that the compensation ispaid in shares of stock (or stock options) instead of cash. Because share basedcompensation does not require the payment of cash, it is treated as a noncashexpense, much like depreciation, and added back to net income when the indirectmethod is used in the cash flow statement. Generally speaking, compensationcost is classified as part of operating activities whether or not the compensationis paid in cash.

c. In a sale-leaseback transaction, a long-term asset is sold and then immediatelyleased (or rented) from the party it was sold to. The transaction is considered tobe a financing transaction, so the proceeds from the sale are listed as financingcash flows. This is because there is no net change in assets (the original asset isreplaced with a capital lease asset) but long-term liabilities (in the form of capitallease obligations) are increased. Any gain recognized in the income statementon a sale-leaseback transaction is noncash and nonoperating and must bededucted when calculating cash flow from operating activities. (Gains on thesale of the asset are normally deferred and amortized over the term of the lease.)

d. Free cash flow ($ millions): $1,521 $923 = -$2,444.

Southwests operating cash flow is negative, as is its free cash flow.

e. Southwests cash flow from operating activities is negative, as is its cash flowfrom investing activities. It generated a positive cash flowof $1,654 million fromfinancing activities. As a result, the net decrease in cash was $845 million.Southwest appears to be strong enough to withstand a reduction in cash ofthis magnitude, especially given that it has a record (in 2007 and 2006) ofreporting positive cash flows from operations.

To be thorough in analyzing Southwests liquidity and solvency, one wouldwant to ask why operating cash flows were negative. The cash flow statementis useful here. The largest negative adjustment is for a decrease in accountspayable and accrued liabilities. This adjustment is considerably larger thanothers listed, and to better understand what it represents, one would need tosearch the notes to find an explanation. As it turns out, a substantial portion ofthis adjustment was to pay amounts owed to counterparties for fuelderivatives. Hence, we suspect that this is a nonrecurring cash outflow.

In its 2009 cash flow statement (released after the text was completed)

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