Financial Accounting_ch12-Solutions
CHAPTER 12
Statement of Cash Flows
Study Objectives
1. Indicate the usefulness of the statement of cash flows.
2. Distinguish among operating, investing, and financing activities.
3. Explain the impact of the product life cycle on a company’s cash flows.
4. Prepare a statement of cash flows using the indirect method.
5. Use the statement of cash flows to evaluate a company.
*6. Prepare a statement of cash flows using the direct method.
Summary of Questions by Study Objectives and Bloom’s Taxonomy
ASSIGNMENT CHARACTERISTICS TABLE
Problem
Number Description Difficulty
Level
Time
Allotted (min.)
1A Distinguish among operating, investing, and financing
activities.
Simple 10–15 2A Determine cash flow effects of changes in equity accounts. Simple 10–15
3A Prepare the operating activities section—indirect method. Simple 20–30 *4A Prepare the operating activities section—direct method. Simple 20–30 5A Prepare the operating activities section—indirect method. Simple 20–30 *6A Prepare the operating activities section—direct method. Simple 20–30
7A Prepare a statement of cash flows—indirect method, and
compute cash-based ratios.
Moderate 40–50
*8A Prepare a statement of cash flows—direct method, and
compute cash-based ratios.
Moderate 40–50 9A Prepare a statement of cash flows—indirect method. Moderate 40–50 *10A Prepare a statement of cash flows—direct method. Moderate 40–50 11A Prepare a statement of cash flows—indirect method. Moderate 40–50 12A Identify the impact of transactions on ratios. Moderate 25–35
1B Distinguish among operating, investing, and financing
activities.
Simple 10–15
2B Determine cash flow effects of changes in plant asset
accounts.
Simple 10–15 3B Prepare the operating activities section—indirect method. Simple 20–30 *4B Prepare the operating activities section—direct method. Simple 20–30 5B Prepare the operating activities section—indirect method. Simple 20–30 *6B Prepare the operating activities section—direct method. Simple 20–30
7B Prepare a statement of cash flows—indirect method, and
compute cash-based ratios.
Moderate 40–50
ASSIGNMENT CHARACTERISTICS TABLE (Continued)
Problem
Number Description Difficulty
Level
Time
Allotted (min.)
*8B Prepare a statement of cash flows—direct method, and
compute cash-based ratios.
Moderate 40–50 9B Prepare a statement of cash flows—indirect method. Moderate 40–50 *10B Prepare a statement of cash flows—direct method. Moderate 40–50 11B Prepare a statement of cash flows—indirect method. Moderate 40–50
ANSWERS TO QUESTIONS
1.(a) The statement of cash flows reports the cash receipts, cash payments, and net change in cash
resulting from the operating, investing, and financing activities of a company during a period in a format that reconciles the beginning and ending cash balances.
(b) Disagree. The statement of cash flows is required. It is the fourth basic financial statement.
2.The statement of cash flows answers the following questions about cash: (a) Where did the cash
come from during the period? (b) What was the cash used for during the period? and (c) What was the change in the cash balance during the period?
3.The three activities are:
Operating activities include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income.
Investing activities include: (a) purchasing and disposing of investments and productive long-lived assets and (b) lending money and collecting loans.
Financing activities include: (a) obtaining cash from issuing debt and repaying amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying them dividends.
4.(a) Major sources of cash in a statement of cash flows include cash from operations; issuance of debt;
collection of loans; issuance of capital stock; sale of investments; and the sale of property, plant, and equipment.
(b) Major uses of cash include purchase of inventory, payment of cash dividends; redemption of
debt; purchase of investments; making loans; redemption of capital stock; and the purchase of property, plant, and equipment.
5.The statement of cash flows presents investing and financing activities so that even noncash
transactions of an investing and financing nature are disclosed in the financial statements. If they affect financial conditions significantly, the FASB requires that they be disclosed in either a separate schedule at the bottom of the statement of cash flows or in a separate note or supplementary schedule to the financial statements.
6.Examples of significant noncash activities are: (1) issuance of stock for assets, (2) conversion of
bonds into common stock, (3) issuance of bonds or notes for assets, and (4) noncash exchanges of property, plant, and equipment.
https://www.sodocs.net/doc/4a1760418.html,parative balance sheets, a current income statement, and certain transaction data all provide
information necessary for preparation of the statement of cash flows. Comparative balance sheets indicate how assets, liabilities, and equities have changed during the period. A current income statement provides information about the amount of cash provided or used by operations. Certain transactions provide additional detailed information needed to determine how cash was provided or used during the period.
8.(a) The phases of the corporate life cycle are the introductory phase, growth phase, maturity phase,
and decline phase.
(b) During the introductory phase, cash from operations and investing would be expected to be
negative, and cash from financing would be positive.
Questions Chapter 12 (Continued)
During the growth phase, a company would be expected to show some small amounts of cash from operations while continuing to show negative cash from investing and positive cash from financing.
During the maturity phase, cash from operations, investing, and financing would all be expected to be positive while in the decline phase, cash from operations and investing would continue to be positive while cash from financing would be negative.
9. Tootsie Roll has positive cash from operations that exceeds its net income. Cash from operations
exceeded its investing needs and it retired shares of stock and paid dividends. Tootsie Roll appears to be in the middle to late maturity phase.
10.The advantage of the direct method is that it presents the major categories of cash receipts and
cash payments in a format that is similar to the income statement and familiar to statement users. Its principal disadvantage is that the necessary data can be expensive and time-consuming to accumulate.
The advantage of the indirect method is it is often considered easier to prepare, and it provides a reconciliation of net income to net cash provided by operating activities. It also tends to reveal less company information to competitors. Its primary disadvantage is the difficulty in understanding the adjustments that comprise the reconciliation.
Both methods are acceptable but the FASB expressed a preference for the direct method. Yet, the indirect method is the overwhelming favorite of companies.
11.When total cash inflows exceed total cash outflows, the excess is identified as a ―net increase in
cash‖ near the bottom of the statement of cash flows.
12.The indirect method involves converting accrual net income to net cash provided by operating
activities. This is done by starting with accrual net income and adjusting for items that do not affect cash. Examples of adjustments include depreciation and other noncash expenses, gains and losses on the sale of noncurrent assets, and changes in the balances of current asset and current liability accounts from one period to the next.
13.It is necessary to convert accrual-based net income to cash-basis income because the unadjusted net
income includes items that do not provide or use cash. An example would be an increase in accounts receivable. If accounts receivable increased during the period, revenues reported on the accrual basis would be higher than the actual cash revenues received. Thus, accrual-basis net income must be adjusted to reflect the net cash provided by operating activities.
14. A number of factors could have caused an increase in cash despite the net loss. These are (1) high
cash revenues relative to low cash expenses; (2) sales of property, plant, and equipment; (3) sales of investments; (4) issuance of debt or capital stock, and (5) differences between cash and accrual accounting, e.g. depreciation.
15.Depreciation expense.
Gain or loss on sale of a noncurrent asset.
Increase/decrease in accounts receivable.
Increase/decrease in inventory.
Increase/decrease in accounts payable.
Questions Chapter 12 (Continued)
16.Under the indirect method, depreciation is added back to net income to reconcile net income to net
cash provided by operating activities because depreciation is an expense but not a cash payment.
17.The statement of cash flows is useful because it provides information to the investors, creditors, and
other users about: (1) the company’s ability to generate future cash flows, (2) the company’s ability to pay dividends and meet obligations, (3) the reasons for the difference between net income and net cash provided by operating activities, and (4) the cash and noncash financing and investing transactions during the period.
18.T his transaction is reported in the note or schedule entitled ―Noncash investing and financing activities‖
as follows: ―Retirement of bonds payable through issuance of common stock, $1,700,000.‖
19.(a) The current ratio is an accrual-based ratio that measures liquidity while the current cash debt
coverage ratio is a cash-based ratio that measures liquidity.
(b) Solvency can be measured by the debt to total assets ratio (accrual-based) or the cash debt
coverage ratio (cash-based).
*https://www.sodocs.net/doc/4a1760418.html, cash provided by operating activities under the direct approach is the difference between cash revenues and cash expenses. The direct approach adjusts the revenues and expenses directly to reflect the cash basis. This results in cash net income, which is equal to ―net c ash provided by operating activities.‖
*21.(a)
– Increase in accounts receivable
(b)
– Decrease in inventory
– Increase in accounts payable
*22.Sales ..................................................................................................................... $2,000,000 Add: Decrease in accounts receivables ................................................................ 100,000
Cash receipts from customers ............................................................................... $2,100,000
*23.Depreciation expense is not listed in the direct method operating activities section because it is not a cash flow item—it does not affect cash.
SOLUTIONS TO BRIEF EXERCISES
BRIEF EXERCISE 12-1
(a) Cash inflow from financing activity, $200,000.
(b) Cash outflow from investing activity, $150,000.
(c) Cash inflow from investing activity, $20,000.
(d) Cash outflow from financing activity, $50,000.
BRIEF EXERCISE 12-2
(a) Investing activity. (d) Operating activity.
(b) Investing activity. (e) Financing activity.
(c) Financing activity. (f) Financing activity.
BRIEF EXERCISE 12-3
Cash flows from financing activities
Proceeds from issuance of bonds payable ........................ $300,000
Payment of dividends .......................................................... (70,000) Net cash provided by financing activities ................... $230,000) BRIEF EXERCISE 12-4
(a) Cash from operations would be lower than net income during the growth
phase because inventory must be purchased for future projected sales.
Since sales during the growth phase are projected to be increasing, in-ventory purchases must increase and inventory expensed on an accrual basis would be less than inventory purchased on a cash basis. Also, collections on accounts receivable would lag behind sales; thus, accrual sales would exceed cash collections during the period.
(b) Cash from investing is often positive during the late maturity phase and
the decline phase because the firm may sell off excess long-term assets that are no longer needed for productive purposes.
BRIEF EXERCISE 12-5
Net cash provided by operating activities is $2,680,000. Using the indirect approach, the solution is:
Net income ................................................... $2,500,000
Adjustments to reconcile net income
to net cash provided by operating
activities
Depreciation expense .......................... $110,000
Accounts receivable decrease ............ 350,000
Accounts payable decrease ................ (280,000) 180,000
Net cash provided by operating
activities ............................................ $2,680,000
BRIEF EXERCISE 12-6
Cash flows from operating activities
Net income ................................................... $280,000
Adjustments to reconcile net income
to net cash provided by operating
activities
Depreciation expense .......................... $70,000
Loss on sale of plant assets ................ 22,000 92,000
Net cash provided by operating
activities ............................................ $372,000
BRIEF EXERCISE 12-7
Net income ........................................................... $200,000 Adjustments to reconcile net income to net
cash provided by operating activities
Decrease in accounts receivable ................ $80,000
Increase in prepaid expenses ..................... (28,000)
Increase in inventories ................................ (40,000) 12,000
Net cash provided by operating
activities ................................................... $212,000
BRIEF EXERCISE 12-8
Original cost of equipment sold ................................................. $22,000 Less: Accumulated depreciation ............................................... 5,500 Book value of equipment sold .................................................... 16,500 Less: Loss on sale of equipment............................................... 3,500 Cash flow from sale of equipment .............................................. $13,000 BRIEF EXERCISE 12-9
(a) Free cash flow = $127,260,000 – $221,160,000 – $0 = ($93,900,000)
(b) Current cash debt coverage ratio = $127,260,000 ÷ $243,668,000 =
.52 times
(c) Cash debt coverage ratio = $127,260,000 ÷ $928,464,500 = .14 times BRIEF EXERCISE 12-10
(a) Free cash flow = $405,000 – $200,000 – $0 = $205,000
(b) Current cash debt coverage ratio = $405,000 ÷ $150,000 = 2.7 times
(c) Cash debt coverage ratio = $405,000 ÷ $225,000 = 1.8 times
BRIEF EXERCISE 12-11
Free cash flow = $123,100,000 – $20,800,000 = $102,300,000
BRIEF EXERCISE 12-12
Free cash flow is cash provided by operations less capital expenditures and cash dividends paid. For Payne Inc. this would be $364,000 ($734,000 –$280,000 –$90,000). Since it has positive free cash flow that far exceeds its dividend, an increase in the dividend might be possible. However, other factors should be considered. For example, it must have adequate retained earnings, and it should be convinced that a larger dividend can be sustained over future years. It should also use the free cash flow to expand its operations or pay down its debt.
*BRIEF EXERCISE 12-13
Receipts from customers =
Sales revenues – Increase in accounts receivable
$1,285,759,000 = $1,287,672,000 – $1,913,000 (Increase in accounts receivable)
*BRIEF EXERCISE 12-14
Cash payment for income taxes =
Income Tax
Expense – Increase in income taxes payable
$125,000,000 = $370,000,000 – $245,000,000*
*$522,000,000 – $277,000,000 = $245,000,000 (Increase in income taxes payable)
*BRIEF EXERCISE 12-15
Cash payments for operating expenses = Operating expenses, excluding depreciation – Decrease in prepaid expenses
and
– Increase in accrued expenses payable
$79,000 = $90,000 – $6,600 – $4,400
SOLUTIONS TO DO IT! REVIEW EXERCISES
DO IT! 12-1
(1) Financing activity (2) Operating activity (3) Financing activity (4) Investing activity (5) Investing activity
DO IT! 12-2
Cash flows from operating activities
Net income ................................................................. $100,000 Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense ........................................... $6,000
Patent amortization expense ............................... 2,000
Gain on sale of equipment ................................... (3,600)
Decrease in accounts receivable ......................... 6,000
Increase in accounts payable .............................. 3,200 13,600 Net cash provided by operating activities .... $113,600 DO IT! 12-3
(a) Free cash flow = $73,700 – $27,000 –$15,000 = $31,700
(b) Cash provided by operating activities fails to take into account that a
company a must invest in new plant assets just to maintain the current level of operations. Companies must also maintain dividends at current levels to satisfy investors. The measurement of free cash flow provides additional insight regarding a company’s cash-generating ability.
SOLUTIONS TO EXERCISES EXERCISE 12-1
(a) Noncash investing and financing activities.
(b) Financing activities.
(c) Noncash investing and financing activities.
(d) Financing activities.
(e) Investing activities.
(f) Operating activities.
(g) Operating activities.
EXERCISE 12-2
(a)
(b)
(c)
(d)
(e)
(f)
(g) Operating activity.
Noncash investing and
financing activity.
Investing activity.
Financing activity.
Operating activity.
Noncash investing and
financing activity.
Operating activity.
(h)
(i)
(j)
(k)
(l)
(m)
(n)
Financing activity.
Operating activity.
Noncash investing and financing
activity.
Investing activity.
Operating activity.
Operating activity (loss); investing
activity (cash proceeds from sale).
Financing activity.
EXERCISE 12-3
Point in Time Phase
A B C D Introductory phase Decline phase Maturity phase Growth phase
During the introductory phase (point A), cash from operations and investing are expected to be negative while cash from financing would be positive. In the growth phase (point D), a company would continue to show negative cash from operations and investing and positive cash from financing.
EXERCISE 12-3 (Continued)
During the maturity phase (point C), cash from operations and net income would be approximately the same. Cash from operations would exceed investing needs. In the decline phase (point B), cash from operations would diminish while cash from financing would be negative.
EXERCISE 12-4
JEREZ COMPANY
Partial Statement of Cash Flows
For the Year Ended December 31, 2010
Cash flows from operating activities
Net income ........................................................ $190,000
Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation expense ............................... $35,000
Loss on sale of equipment ....................... 5,000
Increase in accounts payable .................. 17,000
Decrease in accounts receivable ............. 15,000
Decrease in prepaid expenses ................ 4,000 76,000
Net cash provided by operating
activities ................................................ $266,000
EXERCISE 12-5
KITSELTON INC.
Partial Statement of Cash Flows
For the Year Ended December 31, 2010
Cash flows from operating activities
Net income ....................................................... $153,000 Adjustments to reconcile net income to net
cash provided by operating activities
Depreciation expense .............................. $34,000
Increase in accrued expenses payable ... 10,000
Decrease in inventory .............................. 4,000
Increase in prepaid expenses ................. (5,000)
Decrease in accounts payable ................ (7,000)
Increase in accounts receivable .............. (11,000) 25,000
Net cash provided by operating
activities ................................................ $178,000
EXERCISE 12-6
FELIX CORPORATION
Statement of Cash Flows—Indirect Method
For the Year Ended December 31, 2010
Cash flows operating activities
Net income .................................................................. $284,100 Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation expense.......................................... $187,000
Increase in income tax payable .......................... 4,700
Decrease in accounts payable ............................ (3,700)
Increase in accounts receivable ......................... (8,200)
Increase in inventory ........................................... (11,000) 168,800 Net cash provided by operating activities ... 452,900 Cash flows from investing activities
Sale of land .......................................................... 35,000
Purchase of building ........................................... (129,000)
Net cash used by investing activities .......... (94,000) Cash flows from financing activities
Issuance of bonds ............................................... 200,000
Payment of dividend ........................................... (12,000)
Purchase of treasury stock ................................. (32,000)
Net cash provided by financing activities .... 156,000 Net increase in cash ................................................... 514,900 Cash at beginning of period ....................................... 45,000 Cash at end of period ................................................. $559,900
EXERCISE 12-7
TOVAR CORP
Partial Statement of Cash Flows
For the Year Ended December 31, 2010
Cash flows from operating activities
Net income ....................................................... $ 72,000 Adjustments to reconcile net income
to net cash provided by operating
activities
Depreciation expense .............................. $28,000
Loss on sale of equipment ...................... 8,000)36,000)
Net cash provided by operating
activities ................................................ 108,000 Cash flows from investing activities
Sale of equipment ............................................ 11,000*
Purchase of equipment ................................... (70,000)
Construction of equipment ............................. (53,000)
Net cash used by investing activities ..... (112,000) Cash flows from financing activities
Payment of cash dividends ............................. (19,000) *Cost of equipment sold .................................. $49,000
Accumulated depreciation ............................. (30,000)
Book value ...................................................... 19,000
Loss on sale of equipment ............................ (8,000)
Cash proceeds ................................................ $11,000)
EXERCISE 12-8
(a) MATSUI COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2010
Cash flows from operating activities
Net income ................................................ $ 93,000
Adjustments to reconcile net income
to net cash provided by operating
activities
Depreciation expense ....................... $34,000
Decrease in inventory ....................... 19,000
Increase in accounts receivable ...... (9,000)
Decrease in accounts payable ......... (8,000) 36,000)
Net cash provided by operating
activities ......................................... 129,000 Cash flows from investing activities
Sale of land ............................................... 20,000
Purchase of equipment ............................ (60,000)
Net cash used by investing
activities ......................................... (40,000) Cash flows from financing activities
Issuance of common stock ...................... 42,000
Payment of cash dividends ...................... (35,000)
Redemption of bonds ............................... (50,000)
Net cash used by financing
activities ......................................... (43,000) Net increase in cash ......................................... 46,000 Cash at beginning of period ............................ 22,000) Cash at end of period ....................................... $ 68,000)
EXERCISE 12-8 (Continued)
(b) 1. Current cash debt coverage ratio:
Net cash provided by operating activities ÷
Average current
liabilities
$129,000 [Per Part (a)] ÷
$47,000+$39,000
2
= 3.0 times
2. Cash debt coverage ratio:
Net cash provided by operating activities ÷
Average total
liabilities
$129,000 ÷$247,000*+$189,000**
2
= .59 times
*$47,000 + $200,000 **$39,000 + $150,000 EXERCISE 12-9
PepsiCo Coca-Cola (a) Liquidity
Current cash debt coverage ratio $6,084
$8,133
= .75 times
$5,957
$9,363
= .64 times
(b) Solvency
Cash debt coverage ratio $6,084
$16,019
= .38 times
$5,957
$13,058
= .46 times
Free cash flow $6,084 – $2,068 – $1,854
= $2,162
$5,957 – $1,407 – $2,911
= $1,639
PepsiCo’s liquidity is higher (better) than Coca-Cola’s. PepsiCo’s current cash debt coverage ratio is 17% higher than Coca-Cola’s. Coca-Cola’s solvency is slightly higher than PepsiCo’s since its cash debt coverage ratio is higher but its free cash flow smaller.
EXERCISE 12-10
Hoyt Corporation
Rex Corporation
(a)Liquidity
Current cash debt coverage ratio $100,000
$50,000
= 2.0 times
$100,000
$100,000
= 1.0 times
(b) Solvency
Cash debt coverage ratio $100,000
$200,000
= .50 times
$100,000
$250,000
= 0.40 times
Free cash flow $100,000 – $40,000 – $5,000
= $55,000
$100,000 – $70,000 – $10,000
= $20,000
Hoyt’s liquidity and solvency ratios are higher (better) than Rex’s comparable ratios. In particular, Hoyt’s current cash debt coverage ratio is twice as high as Rex’s. This ratio indicates that Hoyt is substantially more liquid than Rex. Hoyt’s solvency, as measured by the cash debt coverage ratio and free cash flow, is also better than Rex’s.
*EXERCISE 12-11
Revenues ................................................................. $192,000
Deduct: Increase in accounts receivable ............. (70,000)
Cash receipts from customers* ..................... $122,000 Operating expenses................................................ 83,000
Deduct: Increase in accounts payable ................. (23,000)
Cash payments for operating expenses** ..... 60,000 Net cash provided by operating activities ............ $ 62,000
*EXERCISE 12-12
(a) Cash payments to suppliers
Cost of goods sold ........................ $5,349.7 million
Add: Increase in inventory .......... 4.7
Cost of purchases ......................... $5,354.4 million
Deduct: Increase in accounts
payable ........................... (156.1) Cash payments to suppliers ......... $5,198.3 million (b) Cash payments for operating expenses
Operating expenses exclusive
of depreciation
($11,791.6 – $1,249.9) ................ $10,541.7 million Deduct: Decrease in prepaid
expenses ........................ $(204.5)
Increase in accrued
expenses payable ..................... (37.0) (241.5) Cash payments for operating
expenses .................................... $10,300.2 million *EXERCISE 12-13
Cash flows from operating activities
Cash receipts from
Customers ................................................ $240,000*
Dividend revenue ..................................... 18,000*
258,000 Less cash payments:
To suppliers for merchandise ................. $105,000
For salaries and wages ............................ 53,000
For operating expenses ........................... 28,000
For income taxes ...................................... 12,000
For interest ............................................... 10,000 208,000*
Net cash provided by operating
activities ................................................ $ 50,000* *$48,000 + $192,000