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 resource requirements and to pay principal and interest on its debt. Consequently, a profitable business that does not collect cash on a timely basis from its customers or that creates large amounts of debt can fail even though it is profitable. The primary cause of business failure for most companies is having inadequate cash flow. Financial statements are useful for identifying a companys sources and uses of cash and the demands on future cash flows associated with debt. QUESTIONS Q5-1 The direct format statement of cash flows answers the questions where did cash come from? and where did cash go? It lists sources and uses of cash for each of the three types of activitiesoperating, investing, and financing. Q5-2 The acquisition of machinery typically involves cash. Nevertheless, the acquisition of machinery is always an investing activity. How it was paid for makes no difference. Long-term notes payable are generally issued in exchange for cash. Nevertheless, the issuance of a note payable is always a financing activity. What the firm got in return makes no difference. Therefore, the direct exchange of a note payable for machinery is both a financing activity and an investing activity at the same time. Q5-3 GAAP require that the issuance of either debt or equity in exchange for long-term assets be disclosed, but not necessarily on the statement of cash flows. Even though no cash is involved, most companies report this information at the bottom of the statement of cash flows as an addendum. Companies also have the option of reporting this information in 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 identify all material financing and investing activities of the fiscal period. Q5-4 The usual presentation of investing activity and financing activity information on a statement of cash flows is consistent with the direct format that is occasionally used in the operating activities section. Q5-5 Interest is included as an operating activity because interest expense is included on the income statement. The FASB decided that cash paid for interest should be an operating item for consistency. One could argue that interest is logically a financing activity. Nevertheless, GAAP require that it be included as an operating activity. Q5-6 The indirect format is a reconciliation of revenues and expenses measured by accrual accounting (net income) and revenues and expenses measured using cash basis accounting (cash flow from operations). The approach is to start with accrual basis net income and adjust for revenues and expenses that had different cash flow consequences than accrual consequences. Depreciation expense and amortization expense are examples of this situation. Both reduce net income, but neither reduces cash flow. That is, these expenses have zero cash flow consequences. Therefore, concerning these two items, net income understates the amount of cash flow. To obtain cash flow, these amounts must 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 cash collected from receivables. Therefore, the amount of revenue recognized on the income statement is greater than the amount of cash collected from customers. To reconcile net income to cash from operations, the increase in accounts receivable must be subtracted. Q5-8 The operating section of the indirect method statement of cash flows answers the question what caused net income for the period to be different from net cash flow? The investing and financing sections report sources and uses of cash, just as reported if using the direct method. The indirect method is a reconciliation of net income to cash flow. Certain items of revenue and expense have different effects on net income during a period than they have on cash flow. For example, when sales are made on credit they affect net income (through sales revenue) but have no effect on cash flow. Therefore, when sales on credit exceed cash collections from customers, the difference must be deducted from net income to arrive at cash flow. Q5-9 To grow significantly, a company usually must expand its set of operating assets such as land, buildings, and machinery. The acquisition of these

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long-term assets generally requires the outlay of cash, which causes cash flow from investing activities to be negative. Q5-10 Operations consist of the primary activities that the company was set up to perform. If the firms primary operations consume cash, rather than generate 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 from operations, why are you in this business? Over a relatively short period of time (perhaps during the startup period or during a period of major strategy or market changes), a company might be able to endure a cash outflow from operations. In the long run, however, creditors will not lend money 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 the company is selling off its long-term assets and reducing its productive capacity. A company that has a profitable and successful future typically is buying new long-term assets rather than selling off the ones it already has. In most cases, positive cash flow from investing activities is not a positive sign. Q5-12 The most frequent uses of cash generated by operations are as follows: a. payment of dividends b. repayment of debt c. repurchase of the companys own stock (treasury stock) d. expansionacquisition of new productive assets such as plant and equipment e. expansioninvestments in, or acquisitions of, other companies Q5-13 There are two possibilities. First, the company may be so profitable that it can finance all growth out of operating cash flow and still have cash left over to reduce debt and buy back equity. Second, the company may have few profitable new investment opportunities and, therefore, no need for the cash. In this case, cash is being returned to those who loaned it to the firm and to those who purchased stock in the firm (in the form of dividends and/or by repurchasing its own stock). Q5-14 It suggests that this company is in serious difficulty. To observe this situation 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 from its primary activities is very bad news. If this cant be turned around quickly there is no future for this firm. Second, the positive cash flow from investing activities means that the firm is selling off its long-term assets 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 of debt 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 likely postpone them rather than sell off assets. Q5-15 For most corporations, two of the major differences between net income and 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 major differences between net income and cash flow. Thus, a company may have a net loss but have an increase in cash flow from operating activities. The cash flow may result from transactions of prior periods that produce cash flow during the current period or that reduce income without using cash during the current period. Q5-16 First, a company that does not have profitable opportunities in which to reinvest its earnings has little choice but to distribute those earnings to stockholders via dividends. Second, if the businesss activities are declining, 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 back its own stock. All three situations lead to negative cash flow from financing activities. EXERCISES E5-1 a. Operating Activities: Received from customers Paid for advertising Paid for income taxes Paid for insurance Paid for interest Paid for utilities Paid to employees Paid to suppliers Total payments Net cash flow from operating activities Financing Activities: Received from issuing long-term debt Paid to owners Net cash flow from financing activities Investing Activities: Received from sale of land Paid for equipment Net cash flow from investing activities Net Change in Cash for the Period: Net cash flow from operating activities $ 87,500 $ 300 3,000 200 450 790 18,000 39,000 (61,740) $ 25,760 $ 23,000 (12,000) $ 11,000 $ 19,500 (42,000) $(22,500) $ 25,760

b.

c.

d.

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Net cash flow from financing activities Net cash flow from investing activities Net change in cash E5-2 a. b. c. d. e. f. g. h. i. j. k. E5-3 Item Purchase of plant assets Cash paid to suppliers Cash collected from customers Payment of long-term debt Net income Depreciation expense Payment of dividends Issuing stock Cash paid to employees Cash paid for income taxes Disposal of plant assets Cash collected from customers Cash paid to suppliers Cash paid for utilities Cash paid for insurance Cash paid to employees Cash paid for interest Net cash from operating activities

11,000 (22,500) $ 14,260

Type of Activity Add or Subtract Investing Subtract Operating Subtract Operating Add Financing Subtract Not included Not included Not included Not included Financing Subtract Financing Add Operating Subtract Operating Subtract Investing Add $247,000 (81,400) (18,200) (23,000) (60,400) (9,000) $ 55,000

E5-4

a. $17,700; Cash received from customers $187,200 Cash 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 dividends c. ($27,100); Cash received from disposal of equipment Cash paid for equipment Net cash flow from investing activities $ 38,000 (65,100) $ (27,100)

E5-5

a. Cash flows from financing activities: Debt issued Payments of debt Net cash used for financing activities b. Cash flows from investing activities:

$ 13,057 (83,000) $ (69,943)

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Proceeds from sales of businesses $ 30,957 Proceeds from sales of plant and equipment 1,986 Additions to plant and equipment (5,500) Net cash provided by investing activities $ 27,443 E5-6 a. b. c. d. e. f. g. h. i. j. E5-7 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. E5-8
Item Purchase of plant assets Increase in accounts payable Decrease in accounts receivable Payment of long-term debt Net income Depreciation expense Payment of dividends Issuing stock Increase in inventory Type of Activity Investing Operating Operating Financing Operating Operating Financing Financing Operating Add or Subtract Subtract Add Add Subtract Add Add Subtract Add Subtract

D I I I I D D B D B Statement Section Decrease in taxes payable O Cash paid to suppliers of inventory O Dividends declared and paid F Depreciation expense O Sale of stock F Increase in accounts receivable O Cash collected from customers O Purchase of plant assets I Payments on long-term debt F Cash paid for taxes O Increase in wages payable O Purchase of treasury stock F B Statement Added or Format Subtracted? I D B I + B + I D + B B D I +

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Decrease in taxes payable Disposal of plant assets

Operating Investing

Subtract Add

E5-9

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

E5-10

a.

b.

c.

d.

Cash paid to suppliers $37,500 Decrease 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 accounts payable decreased. Cash was paid to creditors. Also more cash was paid than the cost of goods sold because inventory increased. Cash was used to pay for extra inventory. Interest paid $ 4,000 Interest payable decreased (1,200) Interest expense $ 2,800 Expense was less than the amount paid because some of the cash was used to reduce the payable. Cash flow from operations $ 28,000 Decrease in current assets (6,000) Decrease in current liabilities 2,000 Net income $ 24,000 Net income is less than cash flow when current assets are consumed but are not replaced (current assets decreased). Net income is greater than cash flow when cash is used to pay off current liabilities (current liabilities decreased). Cash collected from customers $ 27,000 Increase in accounts receivable 3,000 Sales revenue $ 30,000 More goods were sold than cash collected because receivables increased.

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E5-11

a.

Net cash flow from operations $ 30,000 Noncash revenues 11,000 Noncash expenses (13,200) Net income $ 27,800 Net income includes noncash revenues and noncash expenses that are not included in cash flow from operations. Revenues increase and expenses decrease net income. Wages expense $ 69,000 Increase in wages payable (10,500) Cash paid to employees $ 58,500 More employee labor was used than paid for when wages payable increased during a period. Sales revenue $ 241,000 Cash collected from customers (224,500) Increase in accounts receivable $ 16,500 Beginning accounts receivable 36,000 Ending accounts receivable $ 52,500 If sales revenue is greater than cash collected during a period, accounts receivable must have increased by the difference. The increase is added to the beginning balance. Net income $ 45,000 Increase in current assets (7,500) Increase in current liabilities 10,000 Cash flow from operations $ 47,500 Cash flow is less than net income when more current assets are acquired than are consumed (current assets increase). Cash flow is greater than net income when more resources are used than are paid for (current liabilities increase).

b.

c.

d.

E5-12 a. Account Balance Accounts receivable increased $10,000 Accounts payable increased $7,500 Adjustment and Reason Subtract $10,000 from net income because cash collected from customers was $10,000 less than sales for the period. Add $7,500 to net income because inventory was acquired for sale (increase in cost of goods sold and decrease in net income) but was not paid for during the period. Add $50,000 to net income because inventory was consumed (increase in cost of goods sold and decrease in net income) that was not paid for during the period. No effect because notes payable result from a financing activity, not an operating

b.

c.

Inventory decreased $50,000

d.

Notes payable increased $100,000

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e.

Equipment decreased $80,000 Prepaid insurance decreased $22,000

f.

g.

Wages payable decreased $8,000

h.

Unearned revenue increased $13,000

activity. No effect because equipment results from an investing activity, not an operating activity. Add $22,000 to net income because insurance was consumed (increase in expense and decrease in net income) that was not paid for during the period. Subtract $8,000 from net income because wages were paid during the period that were not expenses (did not reduce net income) during the period. Add $13,000 to net income because cash was received during the period for revenues that were not earned (did not increase net income) during the period.

E5-13 Cash flow from operating activities (in millions): Net earnings Depreciation and amortization Decrease in inventories Increase in prepaid expenses Increase in accounts payable Increase in accounts receivable Increase in income taxes payable Other additions to net income Cash flow from operating activities E5-14 Martha Rosenbloom 945 Oak Lane Anytown, USA Dear Ms. Rosenbloom: Our mutual friend, Mr. Arthur Doyle, has asked if I can provide you assistance in understanding the statement of cash flows in corporate annual reports. 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 results of operations. Net income is an accrual measure that recognizes revenues when earned and expenses when incurred. Not all items included on the income statement in calculating net income result in cash flows during the current fiscal period, however. Some revenues and expenses recognized during the current fiscal period are associated with cash received or paid in past or future fiscal periods. $3,458 1,412 611 (4,355) 862 (241) 1,086 625 $3,458

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For example, assume a company purchases plant assets and pays cash 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 in 2007, no cash flow is associated with the expense. Thus, the amount of depreciation expense for a period is added to net income in computing cash flow from operating activities. Differences also exist between the amount of revenue or expense recognized 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 sales revenue recognized during a fiscal period and the amount collected from customers often differs. This difference is equal to the amount of change in accounts receivable for the period. The cash collected from customers can be determined by adjusting net income for the change in accounts receivable. Other adjustments are made in a similar manner for differences between cost of goods sold and cash paid for inventory and for other expense items such as wages, interest, and taxes. The cash flow statement provides an indirect calculation of cash from operating activities by adjusting net income for amounts on the income statement that do not affect cash. These noncash items include depreciation and amounts equal to changes in current asset and liability accounts. A more direct method would be to simply report cash received from customers, cash paid to suppliers, etc. Only a small percentage of companies report cash flows in this direct manner, however. I hope my explanations are useful. Please let me know if I can be of further assistance. Sincerely, (students name) E5-15 a. The additions and subtractions are caused by events in which the amount of revenue or expense generated was different from the amount of cash flow. For example, if merchandise is sold for $10,000 on credit, it generates $10,000 of revenue (and increases net income) but generates zero cash flow. 1. Depreciation expense is added because it decreased net income but did not affect cash. 2. If accounts receivable increased by $2,500, this means that sales revenue exceeded cash collections by this amount. Therefore, cash flow was $2,500 less than sales revenue and must be subtracted from net income. 3. If inventory increased, this means that more inventory was purchased than was sold. Therefore, the amount of cash spent for inventory exceeded the cost of goods sold. The extra expenditure used cash and is subtracted. 4. A decrease in accounts payable means the company paid more cash to suppliers than the amount of expense reflected in cost of goods sold. Therefore, in reconciling net income to cash flows

b.

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from operating activities, the decrease in accounts payable is subtracted. E5-16 a. b. Co. B had the largest cash flow from operating activities at $15,200. Co. C had the smallest at $2,304. Cash flow associated with investing activities should be negative because most companies will purchase more long-term assets than they will dispose of during a period. Only when companies are downsizing or needing cash and selling off major components would they have large cash inflows from investing activities. Cash flow from operating activities was sufficient to provide the needed cash for all three companies. Co. A used large amounts of cash 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 and equity. Thus, they were shrinking, rather than expanding.

c.

E5-17 Landsdowne Company has shown a steady increase in net income over the six-year period, with the exception of year 6. Its cash flow from operating activities has steadily declined since year 2, however. The difference between net income and cash flow can be explained by the increases in current asset and liability accounts. The company has grown and expanded its investment in working capital. Perhaps the expansion has been too rapid. The company appears to be facing a cash flow problem. The increase in payables may signal an impending difficulty in meeting obligations unless receivables can be collected and inventory can be sold. Landsdowne Company is an example of an organization that has demonstrated earnings growth but may not remain viable because of cash flow problems. Failure to maintain adequate cash flows has resulted in 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, the company would have had net income in each year. The company has maintained a steady growth in cash flows from operating activities. These cash flows are much higher than the investments the company is making in plant assets. Therefore, the company has a large amount of cash flow that could be used for other purposes. Apparently, Fischer believes he can manage the company to make use of its cash flow potential. A number of takeovers have occurred in recent years in situations similar to the one illustrated in this exercise. Cash flows may be a better signal of a companys potential value than net income, under certain circumstances. Much depends on whether the cash flows have to be reinvested in a company to maintain it or whether the cash flows can be used for discretionary purposes.

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E5-19 a. Account and balance Accounts receivable, $12,000 Anticipated future event and cash flow $12,000 cash should be received from customers during the next fiscal year. Operating activities section. Insurance coverage costing $22,000 is expected to be used up within the coming fiscal year. No further cash flow expected. Merchandise that cost the company $50,000 is available to be sold during the next fiscal year. Operating activities section. The company has repurchased some of its own shares at a cost of $33,000. The shares might be resold sometime in the future, maybe not. If sold, it would be reported in the financing activities section. Currently, $6,500 is owed to short-term creditors that will be repaid during the next fiscal year. Operating activities section. Machinery with an original cost of $92,000 is available for use by the firm in the future. No cash flow expected from machinery until it is sold. The depreciation expense, a noncash item, would appear in the operating activities section under the indirect format. The company borrowed $88,000 in the past and is expected to repay it sometime after the next fiscal year. A financing activity. (Any interest paid on the borrowing appears in the operating activities section.) The company has received $10,000 for goods and services that it should provide during the next fiscal period. No further cash flow expected. Currently the company owes $7,800 to the government, which it expects to pay during the next fiscal period. An operating activity. The firms undistributed profits total $56,000. If any portion of this is distributed in the future it will be a financing activity.

b. Prepaid insurance, $22,000 c. Merchandise, $50,000

d. Treasury stock, $33,000

e.

Accounts payable, $6,500

f.

Machinery, $92,000

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

h. Unearned revenue, $10,000 i. Taxes payable, $7,800

j.

Retained earnings, $56,000

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PROBLEMS P5-1 San Garza Statement of Cash Flows For the Month of January 2007 Operating Activities Receipts: Collections from customers Payments: To suppliers of inventory For interest For advertising For rent Total cash payments Net cash flow for operating activities Investing Activities Purchase of office furniture Purchase of computer equipment Net cash flow for investing activities Financing Activities Proceeds from bank loan Proceeds from sale of stock Payment of dividends Payment on bank loan Net cash flow from financing activities Net increase in cash Cash balance, December 31, 2006 Cash balance, January 31, 2007 P5-2 A. Properties (direct format)

$ 8,100 $ (7,000) (135) (2,200) (3,000) (12,335) $ (4,235) $ (5,500) (4,800) (10,300) $ 18,000 10,000 (2,000) (5,000) 21,000 $ 6,465 9,121 $ 15,586

1. $134,850 ($135,800 Sales $950 increase in Accounts Receivable) 2. $55,800 ($54,300 Cost of Goods Sold + $1,500 increase in Inventories) 3. $4,900 ($4,800 Insurance Expense + $100 increase in Prepaid 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) Purchase of property, plant and equipment Purchase of land $(5,015) (1,000)

B.

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C.

Addition to loan payable Sale of common stock Purchase of treasury stock Payment of dividends

$4,000 1,000 (3,000) (1,000)

D.

Planet Accessories Company Statement 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 $ 5,288 Investing Activities: Purchase of property, plant and equipment $ (5,015)6 7 Purchase of land (1,000)_ 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 1,000 Net increase in cash during the year $ 273 Beginning cash balance 553 Ending cash balance $ 826 1 proof given in part A 2 proof given in part A 3 proof given in part A 4 proof given in part A 5 proof given in part A 6 (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) CGS ($200,000 + $57,400) Gross profit Operating expenses Net income Cash received from customers: Cash sales $ 88,250 Collections on account 321,000

$ 395,650 (257,400) 138,250 (93,500) $ 44,750

2. Cash flow from operations = ($25,950)

$409,250 Cash paid to suppliers: Cash purchases $ (48,100) Payments on account (293,600) (341,700) Cash paid for operating expenses (93,500) Cash flow from operating activities $ (25,950) B. 1. Decrease in accounts receivable = $13,600 Credit sales to customers Collections from customers on account Net decrease in accounts receivable $307,400 (321,000) $ (13,600) $281,800 (257,400) $ 24,400 $233,700 (293,600) $ (59,900) Enterprises Flow Method)

2. Increase in merchandise Purchases ($233,700 + $48,100) inventory = $24,400 CGS ($200,000 + $57,400) Net increase in inventory 3. Decrease in accounts payable = $59,900 Purchases on credit Cash payments on accounts payable Net decrease in accounts payable

C.

Dollar Sine Statement of Cash (Operating Activities OnlyIndirect For the Year Just Ended Net income Add (deduct): Decrease in accounts receivable Increase in merchandise inventory Decrease in accounts payable Cash flow for operating activities

$ 44,750 $ 13,600 (24,400) (59,900)

(70,700) $ (25,950)

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P5-4

Reuben Corporation Statement of Cash Flows (Indirect Format) For the Year Ended December 31, 2007 Operating Activities Net income Add (deduct): Adjustments to convert net income to cash flow from operating activities: Depreciation expense Decrease in accounts receivable Increase in inventory Decrease in prepaid advertising Increase in rent payable Decrease in taxes payable Increase in wages payable Cash provided by operating activities Investing Activities Purchase of land Cash used by investing activities Financing Activities Repayment on loan Sale of common stock Payment of dividends Cash used by financing activities Net increase in cash Beginning cash balance Ending cash balance $ 7,000

$ 1,000 1,200 (1,600) 300 200 (400) 1,100

1,800 $ 8,800

$ (4,000) (4,000) $(8,250) 6,000 (1,700) (3,950) $ 850 3,550 $ 4,400

P5-5

A.

1. 2. 3. 4. 5. 6. 7.

$6,738 $1,000 ($950) ($1,500) ($100) ($250) $350

(from the income statement) (from the income statement) (subtract increase in accounts receivable) (subtract increase in inventories) (subtract increase in prepaid insurance) (subtract decrease in rent payable) (add increase in wages payable) $(5,015) (1,000)

B. C.

Purchase of property, plant and equipment Purchase of land Addition to loan payable Sale of common stock Purchase of treasury stock Payment of dividends $4,000 1,000 (3,000) (1,000)

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D.

Planet Accessories Statement of Cash Flows (Indirect For the Year Ended December 31, 2007 Operating Activities Net income Add/deduct items to reconcile net income to cash flow from operating activities: Depreciation Increase in accounts receivable Increase in inventories Increase in prepaid insurance Decrease in rent payable Increase in wages payable Cash flow from operating activities Investing Activities Purchase of property, plant and equipment Purchase of land Cash flow for investing activities Financing Activities Addition to loan payable Sale of common stock Purchase of treasury stock Payment of dividends Cash flow from financing activities Net increase in cash during the year Beginning cash balance Ending cash balance

Company Format)

$ 6,738 $ 1,000 1 (950) 2 (1,500) 3 (100) 4 (250) 5 350 6

(1,450) $ 5,288

$(5,015)7 (1,000)8 (6,015) $ 4,000 9 1,000 10 (3,000) 11 (1,000) 1,000 273 553 $ 826 $

1 2 3 4 5 6 7 8 9 10 11

proof given in part A proof given in part A proof given in part A proof given in part A proof given in part A proof given in part A (Increase in property, plant and equipment account = $5,015) (Increase in land account = $1,000) (Increase in loan payable account = $4,000) (Increase in common stock account = $1,000) (Increase in treasury stock account = $3,000)

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P5-7

A.

1. Cash received from customers is incorrect. It has been reported as 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 accrual basis 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 Rent Payable. But, the $400 decrease should have been added to $24,000, not subtracted. When Rent Payable decreases, this means that the cash paid for rent is more than the amount of rent expense. 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 wages are correct.

B.

Starkovich Architects, Operating Activities (Direct For the Year Ending December 31, 2007

Inc. Format)

Operating Activities Cash received from customers ($73,000 + $42,100 $1,500) $ 113,600 Cash 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. B. Indirect format The colleagues thinking is incorrect. Using a depreciation method that reports a higher amount of depreciation expense for financial reporting purposes will have no direct effect on cash flow. However, there can be a positive effect on cash flow if the company uses a depreciation method for tax purposes that increases depreciation because it would decrease income taxes owed. In the first column hypothetical data is shown. The second column shows the data assuming that depreciation expense for the period had been twice as high as reported. Cash flow from operating activities is the same under either option.

C.

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Original Data Operating Activities Net income Add: Depreciation expense Decrease in accounts receivable Increase in wages payable Cash provided by operating activities
1

Adjusted Data $ 74,0961 21,0022 4,157 2,924 $102,179

$ 84,597 10,501 4,157 2,924 $102,179

If depreciation expense had been twice as high ($10,501 higher), net income would have been $10,501 lower ($84,597 $10,501 = $74,096). $10,501 2 = $21,002. AutoZone uses the indirect method for reporting cash flows. The operating section begins with net income and provides a variety of reconciling items to arrive at cash flow from operations. AutoZone reported higher sales and net income for each year reported. The trend is encouraging because the company is enjoying profitable growth. For each year reported, the cash flow from operating activities exceeds net income. Cash flow from operating activities declines each year, whereas net income increases each year. The primary difference between net income and operating cash flow is the increase in inventory. Cash and cash equivalents: decreased (see the bottom of the cash flow statement) Accounts receivable and prepaid expenses: increased (increases are subtracted from net income) Merchandise inventory: increased (increases are subtracted from net income Accounts payable and accrued expenses: increased (increases are added to net income) The major use of cash for investing activities has been capital expenditures. AutoZone is expanding and opening new stores. This is consistent with evidence from our earlier analysis. When a company is increasing sales each year and expanding its number of retail locations, we expect to see increases in inventory. All of these factors are shown on AutoZones cash flow statement. The major use of cash for financing activities has been the purchase of treasury stock. In addition, the company has repaid debt each year. There is no evidence on the statement of cash flows that the company paid dividends.

P5-9

A.

B.

C.

D.

E.

F.

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P5-10

A.

Circuit Citys income declined each year between 2002 and 2004, although in years 2002 and 2003 the company was profitable. The company reported a loss of $89,269,000 in 2004. Circuit Citys cash flow from operating activities declined from 2002 to 2003, becoming negative during 2003. The most significant reasons for negative cash flow from operations in 2004 were a net loss, increases in securitized receivables, and increases in merchandise inventory. In 2004 and 2003, the companys depreciation exceeded its purchases of property and equipment. Thus, Circuit City is using up its assets faster than it is replacing them. The company seems to be shrinking in size; however, one may argue that the rate of change is small.

B.

C.

Reporting Cash Flows

139

P5-11 For

Office Decor Statement of Cash the Year Ended December (in thousands) $ 2,000 (2,400) (4,400) 1,200 (3,600) 4,000 (1,000) 3,000 $ (600) 1,940 $ 1,340

Company Flows 31, 2007

Operating Activities Net income Increase in accounts receivable Increase in inventories Increase in accounts payable Cash flow for operating activities Financing Activities Increase in notes payable Payment of dividends Cash flow from financing activities Decrease in cash Beginning cash balance Ending cash balance

Office Decor reported net income of $2,000,000 for 2007. The companys 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 the near future. Accounts receivable and inventories increased substantially during the year. These increases suggest that customers are not paying for their purchases on a timely basis. The company appears to be building a large inventory that it is not able to sell. It has financed these activities by issuing additional debt. This financing might support the companys operations in the short run but will not ensure long-term survival. The increase in accounts receivable may reflect pressure to sell inventory, even when prospective buyers are poor credit risks. The company may be granting very favorable payment terms to buyers, resulting in a slowdown of cash receipts. The payment of dividends during this period is questionable, unless management believes the cash flow problems are temporary. P5-12 A. B. McDonalds cash and cash equivalents increased $887 million during 2004. The primary sources of cash were profitable operations. Other sources of cash include sales of restaurant property, long-term and short-term financing, and proceeds from the exercise of stock options. The primary uses of cash include the purchase of property and equipment, and long-term financing repayments. Other uses of cash include treasury stock purchases and dividends. (continued)

C.

140

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D.

Depreciation and amortization are noncash expenses that reduce net income, but have no effect on cash. Therefore, when reconciling net income to cash flow from operations, these noncash expenses are added back to net income. An increase in accounts receivable means that credit sales exceeded cash collections. Thus, the company recorded revenue for which no cash was collected. Therefore, in reconciling net income to cash flow provided by operations, the company subtracts the increase in accounts receivable from net income. Purchases of property and equipment are listed as investing activities 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 occur when a company disposes of long-term assets. Because these assets are not held for resale, their disposal is not an operating activity. Acquisition of other companies results in additional longterm assets. These purchases are similar to capital expenditures. McDonalds acquired restaurant businesses at a cost of $149,700,000 during 2004. McDonalds issued $225,600,000 of long-term debt during 2004 and repaid $1,077,000,000 of long-term debt. The company is not facing a cash flow problem. The ending cash balance has grown in each year presented. In addition, the company produced enough cash from operations in 2004 and 2003 to provide for its investing and financing activities.

E.

F.

G. H.

P5-13 There are three primary factors that caused the rapid decrease in cash provided by operating activities. First, the companys profits have fallen about 16% [($467 $391) $467] over the three years. Second, despite decreased profits, the firms accounts receivable are increasing rapidly. (One might wonder why.) An increase in receivables reduces the amount of cash flowing in to the firm. Third, there has been a large increase in inventories over the three years. (Again, one might wonder why.) Building up 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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141

P5-14 Items from the income statement (IS) and cash flow from operating activities (CF) can be used to answer each question (in millions): A. Revenues (IS) Increase in accounts receivable Cash collected from customers Cost of goods sold (IS) Increase in accounts payable (CF) Increase in inventory (CF) Cash paid for inventory SGA expense (IS) Increase in other assets (CF) Increase in accrued expenses (CF) Depreciation (IS) Cash paid for SGA expense $ 24,547 (27) $ 24,520 $(18,350) 318 (507) $(18,539) $ (4,893) (22) 447 405 $ (4,063)

B.

C.

P5-15 The cash flow patterns of Dell and Apple Computer are remarkably similar. For example, both companies earned a positive net income during the year. In addition, both companies increased the account balance of accounts receivable, inventories, and other assets during the year. Both companies increased the balance of their payables account. Though Dells earnings and cash flows are larger in scale than Apple Computers, both companies produced net cash inflows from operations. In addition, both Apple Computer and Dell used cash for investing activities. Dell used cash to reduce debt, while Apple Computer increased its debt during 2004. Overall, Dells cash balance increased by $430 million during 2004, while Apple Computers cash balance declined by $427 million. P5-16 A. False. Depreciation expense is added to net income because depreciation reduces net income but not cash flow. Therefore, to determine cash flow from operating activities, depreciation must be added back to net income. The two accounts affected by recording depreciation are Depreciation Expense and Accumulated Depreciation. Notice, therefore, that neither the cash account nor cash flow are affected by the recording of depreciation expense. True. An increase in Accounts Receivable means that a company collected less cash from customers than the amount of sales revenue. Therefore, cash flow would be less than operating revenue by the amount of increase in Accounts Receivable. If $20 of goods were sold but only $18 was collected so far, Accounts Receivable would have increased by $2. So, cash flow ($18) would be less than sales ($20) by $2. (continued)

B.

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C.

False. An increase in accounts payable indicates that some of the goods purchased have not yet been paid for. When accounts payable increases, cash has been conserved (not paid out). Therefore, an increase in accounts payable should be added back to net income. The adjustment would be to add $3 million rather than to subtract it. True. An increase in merchandise inventory indicates that a company purchased more inventory than it sold during a period. Therefore, Delta must have purchased $8 million more in inventory than the $27 million of inventory it sold. This totals $35 million and was all paid to suppliers in cash. True. Gammas operating activities are generating a negative cash flow. (Note: The $80 is a net outflowNet cash for operating activities.) Thus, it is not generating enough cash to cover expenses, 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 doubt unless it can create positive cash flows from operating activities.

D.

E.

Reporting Cash Flows

143

P5-17 A. and B.
Type of Activity operating operating operating financing operating Effect on Marchs Net Income +$18,000 0 0 0 $1,200 Effect on Marchs Cash Flow +$4,500 $500 +$3,000 +$80,000 $3,600

1. 2. 3. 4. 5. 6.

7. 8. 9. 10.

11. 12. 13. 14.

Event Sold $18,000 of goods on credit to customers. Received a 25% down payment with the balance on account. Paid $500 cash for office supplies that will be used during April. Received $3,000 from a customer in full payment of her account balance. Borrowed $80,000 from a local bank to be repaid in monthly installments plus interest starting in April. Paid rent on the office space ($1,200 per month) for the months of February, March, and April. Distributed monthly paychecks to employees totaling $13,300. 30% was for work performed in February and the balance for work performed in March. Purchased new Internet server equipment at a cost of $50,000. Purchased a 3-year fire insurance policy at a total cost of $10,800. Its coverage began on March 1. Purchased merchandise from suppliers on credit at a cost of $70,000. Collected $22,000 from customers in payment of their accounts. 80% of this amount was from sales recorded in February and the balance was from sales recorded previously in March.* Collected four months rent in advance (at $700 per month) from a tenant who will move in on April 1. Paid $45,000 to suppliers in partial payment for goods purchased in #9 above. Sold $33,000 of merchandise to customers on credit. Sold an investment in stocks and bonds for $28,000; the same amount that had been paid for it. A 3-year, 9% note receivable was accepted in full payment. Totals for March

operating investing operating operating

$9,310 0 $300 0

$13,300 $50,000 $10,800 0

operating operating operating operating

0 0 0 +$33,000

+$22,000 +$2,800 $45,000 0

investing

0 $40,190

0 $10,900

*March sales are indicated in event 1. Event 10 is indicating collection of some of the receivables from those sales.

(continued)

144

Chapter 5

C.

Student responses will vary. One possible response is as follows. It is foolish to try to manage an organization with accrual-basis accounting information only. As illustrated by this problem, a company can be profitable on the accrual basis but be running a deficit in cash. A manager must closely monitor both profits and cash flow. Failure to manage cash flow will result in an inability to pay obligations as scheduled. Neither suppliers, employees, nor government tax authorities will long put up with a failure to receive cash when it is due. Sheiks cash flow information is characterized by steady and reliable cash flow from operations over the past five years. Profits are probably relatively steady also. The firm is not using the cash flow from operations to finance growth. Very few new long-term assets are being acquired. Maybe not even enough new assets to replace equipment when it wears out. The firm is not growing its operations, and it may even be shrinking. It appears that the company does not have attractive growth opportunities in which to invest its profits. So, the company is paying off debt, buying back stock, or paying large dividends to stockholders. Speers cash flow information is not encouraging. First, cash flow from operations has swung from quite favorable 5 years ago to quite unfavorable today. If this situation cant be corrected rather quickly, the company is headed for disaster. Because of the deteriorating operating cash flow situation, the company has had to abandon its expansion and reinvestment plans. Five years ago, it was expanding rapidly and using its operating cash flow and cash from financing activities to pay for it. Now, the company is selling off long-term assets just to pay the bills. In addition, any monies raised by financing activities are being used to cover operating cash flow deficits. The situation does not look encouraging. Loves cash flow from operations is growing rapidly. While smaller than the other two firms, it is growing the most rapidly. Further, the company appears to plan on even more expansion as the investment in new long-term assets continues to rise. Because the cash flow from operations is not yet large enough to fully finance all the expansion plans, the firm is raising cash through financing activities such as selling stock or borrowing. Of the three firms, this one appears to have

P5-18

Sheik Company:

Speer Company:

Love Company:

Reporting Cash Flows

145

the brightest future. Cash from operations is growing rapidly, investment in long-term assets continues to grow, and the company appears able to attract continued 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 and the sale of investments provided $206. A large contributor to the net loss was depreciation and amortization expense of $592. This expense did not consume any cash. The primary uses of cash were for the repurchase of common stock ($740), for the purchase of investments and acquisitions ($424), and for dividends paid ($402). Receivables decreased; the cash inflow from customers was greater than the amount of sales revenue. Inventories decreased; the amount of cash paid for inventories was less than the cost of goods sold. Accounts payable increased; the amount paid for inventory was less than the amount of inventory purchased and sold. Revenues Decrease in accounts receivable Cash collected from customers 1. Net income: $3,960 172 $4,132

B. C.

D.

E.

P5-20

A.

The purpose of the operating activities section under the indirect format is to show why cash flow differed from net income. Therefore, the starting point is net income. Items or events that generated (or consumed) a different amount of cash than revenue (or expense) are added to (or deducted from) net income to obtain cash flow from operations. 2. Depreciation expense: Depreciation expense consumes zero cash. Therefore, the entire amount of depreciation expense is added back to net income in the determination of cash flow from operations. 1. Accounts receivable: The increase in accounts receivable balance is deducted from net income because some of the sales revenues were not collected in cash. (continued)

B.

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2. Inventory:

3. Prepaid advertising:

4. Rent payable:

5. Wages payable:

The decrease in inventory is added to net income because some of the inventory that was sold was not replaced. Hence, the cash expended to replenish inventory was less than the expense recorded as cost of goods sold. The increase in prepaid advertising is deducted from net income because more advertising was purchased and paid for than was consumed. The decrease in rent payable is deducted from net income because cash payments for rent exceeded the amount of rent expense. In effect, all of the current periods rent expense was paid plus a portion of rent payable from the previous period was also paid. The increase in wages payable is added to net income because not all wages (expense) consumed cash. Some wages were not paid in cash. They are still payable.

C. D.

No income statement items or events will appear under investing activities on the statement of cash flows. 1. Buildings and equipment: The increase in account balance during the year indicates that additional buildings and equipment were purchased. Most likely, cash was involved. A smaller amount of buildings or equipment could also have been sold, but we cannot tell. 2. Land: The increase in the account balance indicates that additional land was purchased. Most likely, cash was involved. 3. Investments, long-term: The decrease in the account balance indicates that a portion of investments were sold. Most likely cash was received. No income statement items or events will appear under financing activities on the statement of cash flows.

E.

Reporting Cash Flows

147

F.

1. Notes payable, long-term: The increase in the account balance indicates that additional financing was obtained in exchange for a note payable. Most likely, cash was obtained. 2. Common stock: The increase in the account balance indicates that additional financing was obtained by selling common stock. Most likely, cash was obtained. 3. Retained earnings: Although retained earnings itself does not appear on the cash flow statement, the fact that retained earnings increased by an amount less than net income indicates dividends were paid. Dividends appear in the financing activities section. Beltway Distributors, Statement of Cash the Year Ended January (In thousands) $ 5,300 2,900 4,800 3,600 (200) 16,400 (11,300) (5,000) (16,300) $ 100 1,950 $ 2,050 Inc. Flows 2007

P5-21

A. For

30,

Operating Activities Net income Add/Deduct: Depreciation expense Decrease in accounts receivable Decrease in inventories Decrease in accounts payable Cash flow from operating activities Financing Activities Decrease in bank loan payable Payment of dividends Cash flow for financing activities Increase in cash Beginning cash balance Ending cash balance 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 dividends and reduce debt. It may be that the firm is in a declining industry that does not have significant growth opportunities. So far, operations are still profitable but the company is reducing its investment in receivables and inventories and using the cash to liquidate debt.

148

Chapter 5

P5-22

The Book Statement of Cash For the Month Ended November 30, 2007 Indirect Method Operating Cash Flow: Net income $ Depreciation expense Decrease in accts. rec. Increase in supplies Increase in inventory Increase in accts. payable Increase in wages payable Net operating cash flow Investing Cash Flow: Purchase of equipment Financing Cash Flow: Payment of debt Payment of dividends Net financing cash flow Net change in cash Beginning cash balance Ending cash balance

Wermz Flows

Direct Method Operating Cash Flow: From customers $ 45,003.48 For merchandise (33,243.92) For supplies (2,576.93) For wages (4,073.79) For rent (1,738.15) For interest (932.03) For taxes (897.45) Net operating cash flow 1,541.21 Investing Cash Flow: Purchase of equipment Financing Cash Flow: Payment of debt Payment of dividends Net financing cash flow (2,000.00) (1,122.77) (1,500.00) (2,622.77)

2,447.45 817.20 125.00 (165.40) (8,438.37) 6,131.77 623.56 1,541.21 (2,000.00) (1,122.77) (1,500.00) (2,622.77) (3,081.56) 15,389.55 $ 12,307.99

Net change in cash (3,081.56) Beginning cash balance 15,389.55 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 a 2 a 3 d 4 d 5 b 6 d 7 c 8 c 9 b 10 b

Reporting Cash Flows

149

CASES C5-1 A. The three categories of cash flows are from operating activities, investment activities, and financing activities. 2004 2003 2002 Net income $1,055 $ 917 $458 Cash FlowsOperating activities 1,461 1,631 913 In each year, cash flows from operating activities exceeded net income. The major explanation is that depreciation (a noncash expense) reduces net income but does not affect cash. C. In years 2004 and 2003, cash flows from operating activities were sufficient to meet cash flow needs for investing activities. The excess cash flow generated by operating activities was used to reduce debt and pay dividends as shown in the financing activities section of the cash flow statement. In 2002, cash flows from operating activities were not sufficient to provide for all investing activities. Thus, the company generated cash inflows from financing activities to make up the difference. The dividend payout ratio is 0.39 ($413 $1,055 = 0.39). Thus, in 2004, General Mills distributed approximately 39% of its earnings to shareholders. General Mills operating activities during 2004 included sales of goods for $11,070 million that cost the company $6,594 million. Selling and administrative activities resulted in expenses of $2,443 million. The major difference between the accrual and cash flow effects 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 liability accounts reduced cash by $186 million, but had no effect on income. Return on total assets 2004 5.7% ($1,055 $18,448) 2003 5.0% ($917 $18,227)

B.

D.

C5-2

A.

B.

Return on assets improved from 2003 to 2004. C. Your 2004 claim on the companys earnings (10,000 shares) would be $28,200 (10,000 $2.82 earnings per share = $28,200). The 2003 claim on the companys earnings would be $24,900 (10,000 $2.49 earnings per share = $24,900). Your claim in 2004 is larger. In 2004, the companys major source of cash was from successful operating activities. In general, the cash was used to: (continued)

D.

150

Chapter 5

E.

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

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. Financing activities have varied greatly over the three years. In 2002, the company increased its liabilities by issuing notes payable and longterm debt (presumably in connection with the acquisition of Pillsbury). The companys most important reported assets were goodwill and other intangible assets ($10,325 million); and land, buildings, and equipment ($3,111 million). Assets that may be important to the company but are not reported on its balance sheet include investment in employee and management skills, investment in research and development, and brand names. The source of goodwill (reported on the balance sheet) may represent the value of these items at Pillsbury and other companies that have been acquired by General Mills. General Mills statement of cash flows reveals that its net earnings were $1,055 million for 2004. Its cash flow from operating activities was $1,461 million. The difference between these two measures results from noncash expenses, such as depreciation and amortization, and an increase in working capital (current assets current liabilities), and various other items. Increased Cash Accounts receivable Prepaid expenses Current portion of long-term debt Decreased Inventories Deferred income taxes Accounts payable Notes payable Other current liabilities

F.

C5-3

A.

B.

Since accounts receivable increased between 2003 and 2004, the company did not collect all of the credit sales made in 2004. We may determine 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 the beginning and ending balance of Accounts Receivable, and the Sales revenue, we can calculate the amount of collections as shown above by solving the unknown. (Alternatively, sales of $11,070

Reporting Cash Flows

151

million the increase in accounts receivable of $30 million = cash collected of $11,040 million.) C. The overall trend in operating cash flow is positive; however, cash flow from operating activities declined in 2004. Also, cash flow from operating activities exceeds net earnings in each year reported. The major reason cash flow from operating activities exceeds net earnings is the noncash charge for depreciation. Earnings improved each year between 2002 and 2004. The companys financial performance is strong. Each year sales and earnings improved. In addition, the company is generating sufficient cash to meet its investing and financing needs.

D.

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COMPREHENSIVE REVIEW A. Alice Springs Income For the Year Ended January 31 Sales revenue Cost of goods sold Gross profit Operating expenses: Wages expense Rent expense Depreciation expense Supplies expense Net income B. Alice 2007 $ 589,351 (359,504) $ 229,847 (123,764) (30,116) (24,871) (13,555) $ 37,541 2006 $ 530,666 (328,343) $ 202,323 (117,136) (28,052) (22,628) (10,751) $ 23,756 Merchandise Sheet 2006 $ 57,845 43,106 117,202 2,314 952 $221,419 328,563 (18,977) $531,005 Merchandise Statement

Springs Balance At January 31 2007

Assets Current assets: Cash Accounts receivable Merchandise inventory Prepaid rent Supplies Total current assets Property and equipment Accumulated depreciation Total assets Liabilities and Equity Current liabilities: Accounts payable Wages payable Unearned revenue Notes payable, current Total current liabilities Notes payable, long-term Common stock Retained earnings Total liabilities and equity

$ 63,168 48,386 130,247 2,530 1,129 $245,460 365,398 (43,848) $567,010

$ 25,953 10,272 12,966 47,249 $ 96,440 214,838 102,629 153,103 $567,010

$ 23,674 9,500 11,675 44,249 $ 89,098 222,467 95,581 123,859 $531,005

Reporting Cash Flows

153

C. Sales revenue Accounts receivable Unearned revenue Cash collected from customers Cost of goods sold Merchandise inventory Accounts payable Cash paid for merchandise Wages expense Wages payable Cash paid for wages Rent expense Prepaid rent Cash paid for rent Depreciation expense Adjustment for noncash expense Cash paid for depreciation Supplies expense Supplies Cash paid for supplies Net income Total adjustments Operating cash flow

Accrual $589,351

Adjustments $ (5,280) 1,291

Cash Flow

$ 585,362 (359,504) (13,045) 2,279 (370,270) (123,764) 772 (122,992) (30,116) (216) (30,332) (24,871) 24,871 0 (13,555) (177) (13,732) $ 37,541 $ 10,495 $ 48,036

(continued)

154

Chapter 5

D.

Alice Springs Merchandise Statement of Cash Flows For the Year Ended January 31, 2007 Operating Activities: Cash collected from customers Cash paid for merchandise Cash paid for wages Cash paid for rent Cash paid for supplies Net cash from operating activities Investing Activities: Paid for property and equipment Sale of property and equipment Net cash for investing activities Financing Activities: Notes payable, current Notes payable, long-term Common stock Dividends paid Net cash for financing activities Net change in cash Cash, January 31, 2006 Cash, January 31, 2007 $ 585,362 (370,270) (122,992) (30,332) (13,732) 48,036 (38,802) 1,967 (36,835) 3,000 (7,629) 7,048 (8,297) (5,878) 5,323 57,845 $ 63,168

Reporting Cash Flows

155

E.

Alice Springs Statement of For the Year Ended January 31, 2007 Operating Activities: Net income Adjustments: Depreciation expense Accounts receivable Unearned revenue Merchandise inventory Accounts payable Wages payable Prepaid rent Supplies Net cash from operating activities Investing Activities: Paid for property and equipment Sale of property and equipment Net cash for investing activities Financing Activities: Notes payable, current Notes payable, long-term Common stock Dividends paid Net cash for financing activities Net change in cash Cash, January 31, 2006 Cash, January 31, 2007 $ 37,541 24,871 (5,280) 1,291 (13,045) 2,279 772 (216) (177) 48,036 (38,802) 1,967 (36,835) 3,000 (7,629) 7,048 (8,297) (5,878) 5,323 57,845 $ 63,168

Cash

Merchandise Flows