Solutions manual intermediate accounting 18e by stice and stice ch05

To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com CHAPTER QUESTIONS Cash flow from operations can offer a clearer picture of a company's performance than does net income when: • A company reports large noncash expenses, such as write-offs, depreciation, and provisions for future obligations Earnings may give an overly pessimistic view of the firm • A company is growing rapidly Reported earnings may be positive, but operations are actually consuming rather than generating cash • A company badly needs to report favorable earnings, as is the case before a major loan application or before a stock offering In these cases, cash flow from operations provides an excellent reality check for reported earnings To qualify as a cash equivalent when preparing a statement of cash flows, an item must be (a) readily convertible to cash, and (b) so near its maturity that there is insignificant risk of changes in value due to changes in interest rates As a general rule, only investments with original maturities of three months or less qualify The original maturity is determined from the date of acquisition of the investment by the entity, not the date of original issuance of the security Operating activities include those transactions and events that enter into the determination of net income Cash receipts from selling goods or from providing services are the major cash inflow for most businesses Major cash outflows include payments to purchase inventory and to pay wages, taxes, interest, utilities, rent, and similar expenses Investing activities are the purchase and sale of land, buildings, and equipment and the purchase and sale of financial instruments not intended for trading purposes Financing activities include transactions and events whereby cash is obtained from or repaid to owners (equity financing) and creditors (debt financing) The normal pattern of cash flow is • Operating—positive • Investing—negative • Financing—either positive or negative The direct method reports all operating cash receipts and cash payments The difference between cash receipts and payments is the net cash flow from operations The indirect method begins with net income as reported on the income statement, adjusts for any noncash items (such as depreciation), and converts the accrual amounts to a cash basis The result of this reconciliation process is net cash flow from operations, which will be exactly the same amount as derived using the direct method Many users favor the direct method because it is a straightforward approach that is easy to understand Most accountants prefer the indirect method because it is easy to apply and because it helps explain or reconcile the differences between net cash flow from operations and net income Because accountants already have to report net income, it is easier for them to start with that number and convert it to net cash flow from operations rather than use the direct method When the direct method is used, depreciation expense is omitted from the calculation of cash from operating activities because it is a noncash expense When the indirect method is used, depreciation expense is added back to net income because depreciation was subtracted in the original computation of net income The statement, “Cash flow is equal to net income plus depreciation” is wrong because it ignores the impact on cash from operating activities of all the changes in current operating assets and current operating liabilities 145 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 146 The FASB treats interest payments as an operating activity in order to be consistent with the income statement presentation The FASB defines interest payments as operating activities because interest expense enters into the calculation of net income The FASB considered classifying interest payments as financing activities but ultimately decided on the operating activity classification 10 The “target number” is the net change in the cash balance, as shown in the balance sheet The sum of cash flows from operating, investing, and financing activities should equal the net change in cash 11 Cost of goods sold, combined with the change in the inventory balance, reveals how much inventory was purchased during the year Inventory purchases, coupled with the change in the accounts payable balance for the year, are used to calculate the amount of cash paid for inventory purchases 12 A loss on the sale of a long-term asset is omitted from the calculation of cash from operating activities when using the direct method When the indirect method is used, the loss is added back to net income because the loss was subtracted in the original computation of net income In both cases, any effects of the sale of the longterm asset are removed from the computation of operating cash flow; cash received from the sale of long-term assets is reported as an investing activity 13 The FASB has defined all transactions involving available-for-sale and held-tomaturity securities as investing activities Transactions involving trading securities are usually included in the Operating Activities section 14 If the direct method is used, a separate schedule must be presented to reconcile net income to net cash provided by (used in) operating activities If a company elects to use the indirect method, the amounts paid during the period for interest and income taxes should be disclosed Regardless of the method used for reporting operating cash flows, companies must disclose any significant noncash investing and financing transactions The supplemental disclosures required by FASB ASC Topic Chapter 15 16 17 18 19 20 21 230 can be provided in the notes to the financial statements or in separate schedules accompanying the statement of cash flows Significant noncash investing and financing transactions (e.g., the purchase of land by issuing capital stock) are to be reported in the notes to the financial statements or in a separate schedule accompanying the cash flow statement Because these transactions not affect cash, they should not be reported on the statement of cash flows itself Under FASB ASC Topic 230, interest paid is classified as an operating activity Cash from operations is usually larger than net income This is because of the large number of noncash expenses included in the income statement, such as depreciation, write-downs, and restructuring charges When the value of a company’s cash flow adequacy ratio is less than 1.0, that company is not generating enough cash from operations to pay for all new plant and equipment purchases Accordingly, the company has no cash left over to repay loans or to distribute to investors The income statement details the transactions that occurred in temporary accounts that are summarized in the retained earnings account The statement of cash flows provides information relating to transactions that occurred in the cash account for the period A forecasted statement of cash flows allows management to see the relationship between forecasted operating cash flow and the cash needed for investing activities If there is an expected shortfall in available cash, a company can either use the forecasted information in obtaining additional financing or the company can scale back its expansion plans in order to reduce the drain on cash Lenders can use a forecasted statement of cash flows to see whether it seems likely that a company can continue to meet its existing debt obligations An investor can use the projected cash flow statement to evaluate the likelihood that a company will be able to continue making dividend payments To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 147 PRACTICE EXERCISES PRACTICE 5–1 CASH AND CASH EQUIVALENTS (a) Not cash equivalent because it is an equity investment; no maturity date (b) Cash equivalent of $7,250 because time to maturity at date of purchase was less than three months (c) Cash of $3,400 (d) Not cash equivalent because time to maturity at date of purchase was greater than three months $7,250 + $3,400 = $10,650 PRACTICE 5–2 THREE CATEGORIES OF CASH FLOWS Cash Inflow (Outflow) Operating (d) Cash collected from customers (b) Cash paid for interest (f) Cash paid for income taxes Total $13,400 (600) (1,850) $10,950 Investing (a) Cash received from sale of a building $ 4,200 Financing (c) Cash paid to repurchase shares of stock (treasury stock) (e) Cash paid for dividends Total PRACTICE 5–3 CASH FLOW PATTERNS Company A Company B Company C steady state start-up, high growth cash cow $ (1,100) (930) $ (2,030) To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 148 PRACTICE 5–4 Chapter NONCASH INVESTING AND FINANCING ACTIVITIES (a) (b) (c) (d) Investing $(40,000) 0 Total $(40,000) PRACTICE 5–5 Financing $ 0 56,000 (30,000) $ 26,000 Noncash (Disclose only) $ 80,000 67,000 100,000 GENERAL FORMAT FOR A STATEMENT OF CASH FLOWS Cash flow from operating activities Cash flow from investing activities Cash flow from financing activities Net decrease in cash Cash balance, beginning of year Cash balance, end of year PRACTICE 5–6 CASH COLLECTED FROM CUSTOMERS Accounts receivable, beginning Plus: Sales Cash available for collection Less: Accounts receivable, ending Cash collected from customers PRACTICE 5–7 $ 6,200 (9,400) 5,000 $ 1,800 2,800 $ 4,600 $ 1,400 10,000 $11,400 (1,375) $10,025 CASH PAID FOR INVENTORY PURCHASES Inventory, ending Plus: Cost of goods sold Required inventory Less: Beginning inventory Inventory purchased this year $ 2,100 5,300 $ 7,400 (2,500) $ 4,900 Accounts payable, beginning Plus: Inventory purchased this year Accounts to be paid Less: Accounts payable, ending Cash paid for inventory purchases $ 1,350 4,900 $ 6,250 (1,200) $ 5,050 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 149 PRACTICE 5–8 CASH PAID FOR OPERATING EXPENSES Prepaid operating expenses, ending Plus: Operating expenses Required cash outlay for operating expenses Less: Prepaid operating expenses, beginning Cash paid for operating expenses this year PRACTICE 5–9 DIRECT METHOD Income Statement Sales Cost of goods sold $ 7,800 (3,100) Interest expense Depreciation expense Net income (450) (600) $ 3,650 Adjustments Statement of Cash Flows + 320 + 180 – 210 + 80 + 600 Direct Method: Cash collected from customers Cash paid for inventory purchases Cash paid for interest Net cash flow from operating activities PRACTICE 5–10 $ 700 3,800 $ 4,500 (1,000) $ 3,500 $ 8,120 (3,130) (370) $ 4,620 $ 8,120 (3,130) (370) $ 4,620 INDIRECT METHOD Income Statement Sales Cost of goods sold $ 7,800 (3,100) Interest expense Depreciation expense Net income (450) (600) $ 3,650 Adjustments Statement of Cash Flows + 320 + 180 – 210 + 80 + 600 Indirect Method: Net income Plus: Depreciation Plus: Decrease in accounts receivable Plus: Decrease in inventory Less: Decrease in accounts payable Plus: Increase in interest payable Net cash flow from operating activities $ 8,120 (3,130) (370) $ 4,620 $3,650 600 320 180 (210) 80 $4,620 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 150 PRACTICE 5–11 Chapter COMPLETE STATEMENT OF CASH FLOWS FROM DETAILED DATA Operating activities: (f) Cash collected from customers (b) Cash paid to purchase inventory (d) Cash paid for interest (j) Cash paid for income taxes Net cash flow from operating activities $11,200 (7,800) (450) (1,320) $ 1,630 Investing activities: (c) Cash received from sale of a building (k) Cash paid to purchase machinery Net cash flow from investing activities $ 4,750 (1,950) $ 2,800 Financing activities: (e) Cash paid to repay a loan (h) Cash received from issuance of new shares of common stock (i) Cash paid for dividends Net cash flow from financing activities $ (1,000) 1,200 (780) $ (580) Net increase in cash Cash balance, beginning of year Cash balance, end of year $ 3,850 1,500 $ 5,350 PRACTICE 5–12 OPERATING CASH FLOW: GAINS AND LOSSES Net income Plus: Depreciation Less: Gain on sale of equipment Plus: Loss on sale of building Less: Increase in accounts receivable Less: Decrease in income taxes payable Net cash flow from operating activities PRACTICE 5–13 $ 250 1,000 (440) 210 (300) (170) $ 550 OPERATING CASH FLOW: RESTRUCTURING CHARGES Net income Plus: Depreciation Plus: Restructuring charge Plus: Decrease in inventory Plus: Increase in wages payable Net cash flow from operating activities $ 500 1,000 2,300 300 170 $4,270 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter PRACTICE 5–14 151 OPERATING CASH FLOW: DEFERRED INCOME TAXES Reported income tax expense Less: Increase in deferred tax liability Taxes owed for current year operations Less: Increase in income taxes payable Cash paid for income taxes PRACTICE 5–15 OPERATING CASH FLOW: DEFERRED, OR UNEARNED, SALES REVENUE Sales Plus: Accounts receivable, beginning Less: Deferred sales revenue, beginning (cash already collected) Cash available for collection this year Less: Accounts receivable, ending Plus: Deferred sales revenue, ending (collected for future years) Total cash collections from customers PRACTICE 5–16 $35,500 (3,500) $32,000 (390) $31,610 $10,000 1,430 (750) $10,680 (1,250) 1,000 $10,430 OPERATING CASH FLOW: PREPAID OPERATING EXPENSES Cash paid for depreciation $ Cash paid for insurance: Prepaid insurance, ending Plus: Insurance expense Required cash outlay for insurance Less: Prepaid insurance, beginning Cash paid for insurance this year $ 1,500 7,500 $ 9,000 (1,430) $ 7,570 Cash paid for wages: Wages payable, beginning Plus: Wage expense this year Wages to be paid Less: Wages payable, ending Cash paid for wages this year $ 750 14,600 $15,350 (600) $14,750 Cash paid for operating expenses: $0 + $7,570 + $14,750 = $22,320 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 152 PRACTICE 5–17 Chapter COMPUTING CASH PAID TO PURCHASE PROPERTY, PLANT, AND EQUIPMENT PPE, beginning Less: PPE sold during the year Ending PPE without purchase of new PPE $124,000 28,000 $ 96,000 PPE, ending Less: Ending PPE without purchase of new PPE Cash paid to purchase new PPE $134,000 96,000 $ 38,000 This assumes that all PPE purchases were for cash PRACTICE 5–18 COMPUTING CASH RECEIVED FROM THE SALE OF PROPERTY, PLANT, AND EQUIPMENT Accumulated depreciation, beginning Plus: Depreciation expense Ending accumulated depreciation without PPE sale Less: Actual ending accumulated depreciation Accumulated depreciation associated with PPE sold $41,000 9,700 $50,700 32,000 $18,700 Original cost of PPE sold Accumulated depreciation associated with PPE sold Book value of PPE sold $28,000 18,700 $ 9,300 Book value of PPE sold Plus: Gain on sale of PPE Cash received from sale of PPE $ 9,300 6,500 $15,800 PRACTICE 5–19 COMPUTING CASH PAID FOR DIVIDENDS Retained earnings, beginning Plus: Net income Ending retained earnings without dividend declarations Less: Actual ending retained earnings Dividends declared during the year $106,000 10,000 $116,000 112,000 $ 4,000 Dividends declared during the year Plus: Decrease in dividends payable Cash paid for dividends this year $ $ 4,000 250 4,250 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter PRACTICE 5–20 153 COMPUTING CASH FLOW RATIOS Cash-flow-to-net-income Cash flow from operating activities Net income Cash-flow-to-net-income ratio Cash flow adequacy Cash paid for capital expenditures Cash paid for acquisitions Cash required for investing activities $ Cash flow from operating activities Cash required for investing activities Cash flow adequacy ratio $ 21,000 ÷ $34,500 0.61 $ 23,500 11,000 34,500 Cash times interest earned Cash flow from operating activities Cash paid for interest Cash paid for income taxes Operating cash flow before interest and taxes Cash paid for interest Cash times interest earned ratio PRACTICE 5–21 a $ 21,000 ÷ $18,000 1.17 $ 21,000 3,800 6,700 $ 31,500 ÷ $3,800 8.29 ARTICULATION Cash increased by $10,500 during the year ($22,500 – $12,000) Cash from operating activities Cash from investing activities Cash from financing activities Increase in cash $ ? (25,000) (8,000) $ 10,500 Cash from operating activities = $43,500 b At the beginning of the year: Assets = Liabilities + Owners’ equity $239,000 = $117,000 + ? Owners’ equity at the start of the year = $122,000 of which $21,000 represents common stock and $101,000 represents retained earnings Dec 31 Retained earnings = Jan Retained earnings + Net income – Dividends $105,000 = $101,000 + Net income – $8,000 Net income = $12,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 154 PRACTICE 5–22 Chapter PREPARING A FORECASTED STATEMENT OF CASH FLOWS Operating activities: Net income Plus: Depreciation Less: Increase in accounts receivable Less: Increase in inventory Plus: Increase in accounts payable Net cash flow from operating activities $ 2,275 1,200 (180) (390) 150 $ 3,055 Investing activities: Cash paid for PPE purchases ($1,300 PPE increase + $1,200 depreciation replacement) Financing activities: New long-term debt New paid-in capital Cash paid for dividends ($1,500 + $2,275 − $1,850 = $1,925) Net cash flow from financing activities Net increase in cash Cash, beginning Cash, ending (2,500) $ 1,000 400 (1,925) (525) $ 30 100 $ 130 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 178 Chapter 5–48 (Concluded) COMPUTATIONS: (a) Cash receipts from sale of long-term investments: Long-term investments at beginning of year Less: Long-term investments at end of year Long-term investments sold during year Add: Gain on sale of long-term investments Total cash receipts on sale of long-term investments $16,800 6,000 $10,800 2,000 $12,800 (b) Cash receipts from sale of equipment* $ 3,000 *As given in problem, loss on sale ($1,000) would affect net income but not cash flow from sale (c) Cash payments to purchase equipment: Equipment at beginning of year Less: Equipment sold Total Equipment at end of year Difference is amount of equipment purchased Paid for by issuing common stock ($10,000 + $2,000) Total cash paid to purchase equipment $66,000 10,000 $56,000 80,000 $24,000 12,000* $12,000 *Note: The issuance of common stock (including the increase in Paid-ln Capital) is a significant financing activity but does not involve cash, and so it is not reported directly on the cash flow statement (d) Cash receipts from sale of treasury stock: Treasury stock (at cost) at beginning of year Less: Treasury stock (at cost) at end of year Treasury stock sold during year Less: Reduction in retained earnings because treasury stock sold at less than cost Total cash receipts from sale of treasury stock (e) Cash payments to reduce long-term notes payable: Long-term notes payable at beginning of year Long-term notes payable at end of year Total cash payments to reduce principal amounts of long-term notes $20,000 10,000 $10,000 4,000 $ 6,000 $24,000 16,000 $ 8,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 179 5–49 Dec 31 Prepaid rent = Jan Prepaid rent + Cash paid for rent – Rent expense Dec 31 Prepaid rent = $8,000 + $27,000 – $22,000 Dec 31 Prepaid rent = $13,000 Note that wages payable increased by $6,000 during the year This is evidenced by the addition of the change in wages payable As a result, the beginning balance in the wages payable account was $17,000 ($23,000 – $6,000) Dec 31 Inventory = Jan Inventory + Inventory purchased on account – Cost of goods sold $54,000 = $41,000 + $230,000 – Cost of goods sold Cost of goods sold = $217,000 Dec 31 Wages payable = Jan Wages payable + Wages expense – Cash paid for wages $23,000 = $17,000 + Wages expense – $81,000 Wages expense = $87,000 Net income = Sales – Cost of goods sold – Wages expense – Rent expense – Other expenses Net income = $485,000 – $217,000 [from part (3)] – $87,000 [from part (4)] – $22,000 – $121,000 Net income = $38,000 Dec 31 Accounts receivable = Jan Accounts receivable + Sales on account – Cash collected from customers $72,000 = $65,000 + $485,000 – Cash collected from customers Cash collected from customers = $478,000 Dec 31 Accounts payable = Jan Accounts payable + Inventory purchased on account – Cash paid for inventory $44,000 = $52,000 + $230,000 – Cash paid for inventory Cash paid for inventory = $238,000 To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 180 Chapter 5–50 Net income + Depreciation expense – Increase in other current assets/ + Decrease in other current assets + Increase in current liabilities/ – Decrease in current liabilities Net cash from operating activities Cash Other current assets Current liabilities Net income + Depreciation expense – Increase in other current assets/ + Decrease in other current assets + Increase in current liabilities/ – Decrease in current liabilities Net cash from operating activities Cash Other current assets Current liabilities Net income + Depreciation expense – Increase in other current assets/ + Decrease in other current assets + Increase in current liabilities/ – Decrease in current liabilities Net cash from operating activities 2013 $ 59,000 57,000 2012 $ 50,000 51,000 (60,000) (30,000) 55,000 $111,000 (20,000) $ 51,000 2013 $ 85,000 480,000 325,000 2012 $115,000 420,000 310,000 2013 $ 59,000 57,000 2012 $ 50,000 51,000 (60,000) (30,000) 15,000 $ 71,000 20,000 $ 91,000 2013 $ 85,000 480,000 325,000 2012 $115,000 380,000 270,000 2013 $ 59,000 57,000 2012 $ 50,000 51,000 (100,000) 10,000 55,000 $ 71,000 (20,000) $ 91,000 As these examples illustrate, cash from operations can be manipulated easily by delaying payments or purchases until after the end of the period However, the examples also illustrate that total cash flow cannot be manipulated—total cash flow for the years 2013 and 2012 is $162,000 in all three examples The manipulations only have the effect of shifting cash flow from one period to another To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 181 5–51 Net income + Depreciation expense ± Change in accounts receivable ± Change in inventory ± Change in accounts payable Net cash from operating activities 2013 $ 90 40 (15) (10) 30 $135 2012 $ 90 40 30 25 $185 2011 $ 90 40 (15) (20) $ 95 2010 $ 90 40 (20) 15 $130 “Cash flow” (net income + depreciation) is $130 each year When working capital (current assets – current liabilities) is relatively constant, the net cash from operations is about the same as the cash flow measure This is the case in 2013 and 2010 in the example Firms that are not growing would expect to have a stable level of working capital For such firms, “net income + depreciation” is a reasonable approximation for cash flow from operations If working capital is increasing, part of the cash generated by operations must be used to finance the additional working capital This will cause cash flow from operations to be less than “net income + depreciation.” This is the case in 2011 in the example Working capital is often increasing in high-growth firms and in firms that are having trouble collecting receivables or moving inventory If working capital is decreasing, extra cash is freed up in addition to the cash generated by operations This will cause cash flow from operations to be greater than “net income + depreciation.” This is the case in 2012 in the example Working capital can be decreased by any combination of the following actions: increase receivable collection efforts, reduce inventory levels, allow payable levels to increase To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 182 Chapter 5–52 a b c d e f Return on sales Return on assets Return on equity Cash-flow-to-net-income ratio Cash flow adequacy ratio Cash times interest earned ratio 2013 10.2% 8.8% 27.1% 1.34 0.77 9.7 2012 10.0% 8.7% 26.6% 2.36 1.46 16.4 According to the traditional accrual accounting measures, Drury Lane performed better in 2013—return on sales, assets, and equity are all higher in 2013 than in 2012 However, using the cash flow ratios, Drury Lane performed better in 2012 From an operating cash flow perspective, Drury Lane’s performance deteriorated significantly in 2013 When companies are preparing to issue stock or apply for new loans, they have an incentive to bias the financial statements to look as good as possible One way to detect this bias is to examine the relationship between net income, which can be influenced by accrual accounting assumptions, and cash from operating activities, which is not affected by accrual accounting assumptions It appears that Drury Lane’s net income increased in 2013 even while cash from operating activities was decreasing It is important that Drury Lane be able to explain this divergence to potential investors To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 183 5–53 Balance Sheet 2014 2013 Forecasted Cash Other current assets Property, plant, and equipment, net $ Total assets $1,390 48 20% natural increase 420 20% natural increase 800 $1,000 – $200; no replacements $1,268 Accounts payable Bank loans payable Paid-in capital Retained earnings Total liabilities and stockholders’ equity $ 100 1,000 100 190 $1,390 $ 120 1,000 (147) 295 $1,268 Income Statement Sales Cost of goods sold Gross profit Depreciation expense Other operating expenses Operating profit Interest expense Income before taxes Income taxes Net income 40 350 1,000 $ 20% natural increase no new loans, item (c) to balance $190 + $120 – $15 2014 2013 Forecasted $1,000 $1,200 given, item (a) 350 420 35% of sales, same as last year $ 650 $ 780 200 200* same as last year; no replacements 250 300 25% of sales, same as last year $ 200 $ 280 120 120 12% of bank loan, same as last year $ 80 $ 160 20 40 25% of pretax, same as last year $ 60 $ 120 *One could also argue that depreciation expense will be lower in 2014 because the net amount of property, plant, and equipment will decline To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 184 Chapter 5–53 (Concluded) Cash flows from operating activities: Net income Adjustments: Depreciation expense Increase in other current assets Increase in accounts payable Net cash provided by operating activities Cash flows from investing activities: Purchase of property, plant, and equipment Net cash used in investing activities Cash flows from financing activities: New bank loans payable Repurchase of common stock Payment of cash dividends Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year $ 120 $ 200 (70) 20 $ 150 $ 270 (0) (a) (0) $ (247) (b) (15) (262) $ 40 $ 48 COMPUTATIONS: (a) Beginning property, plant, and equipment Less: Depreciation expense Less: Ending property, plant, and equipment Difference (assets purchased) $1,000 200 $ 800 800 $ (b) Beginning paid-in capital Ending paid-in capital Change (common stock repurchased) $ 100 (147) $ (247) Payment of cash dividends involves distributing an equal amount of cash for each share owned Repurchase of shares of stock channels the cash to shareholders who are the least optimistic about the prospects of the company Because they are the least optimistic, they are the shareholders who offer their shares for sale when the company announces a stock repurchase To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 185 5–54 The correct answer is c Because accounts receivable increased during the period, that indicates that the amount collected was less than the amount sold during the period—in this case, by $12,000 Ending accounts receivable = Beginning accounts receivable + Sales – Cash collected from customers $437,000 = $425,000 + Sales – $1,263,000 Sales = $1,275,000 The correct answer is b A decrease in accounts receivable is added to net income indicating that more cash was collected than was reported on the income statement An increase in inventory is subtracted from net income indicating that more inventory was purchased than was reported as Cost of Goods Sold on the income statement An increase in Accounts Payable is added to net income indicating that less inventory was paid for than was reported on the income statement Net income + decrease in A/R – increase in Inventory + increase in A/P = Cash from operations $174,000 + $2,000 – $16,000 + $10,000 = $170,000 The correct answer is b An increase in interest payable indicates that less interest was paid during the period than was reported as interest expense on the income statement Interest expense was determined by the FASB to be an operating activity To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 186 Chapter CASES Discussion Case 5–55 This case provides an opportunity to clarify several points with respect to the preparation of a statement of cash flows First, no cash is associated with depreciation if taxes are ignored Depreciation is the writeoff of the cost of a depreciable asset The entry debiting Depreciation Expense and crediting Accumulated Depreciation does not involve cash Cash was involved when the asset was acquired and will be if the asset is later sold, but the entry to record depreciation is a noncash item Second, depreciation must be added back to cash from operations if net income is used as a beginning point because it has been subtracted as an expense in deriving net income If only expenses involving cash have been subtracted from revenues, depreciation would not need to be considered at all This is also true for other noncash items, such as a restructuring charge The finance professor is probably thinking of depreciation as a source of cash in the sense that depreciation expense reduces taxable income, which conserves cash because less taxes are paid However, even when taxes are considered, depreciation is not a source of cash It may be considered a “conserver” of cash, but the source of cash is revenues from operations Otherwise, if there were no revenues, there would not be any taxable income and, thus, no taxes to be paid The finance professor might also be confused because depreciation is added to net income in calculating cash flow from operations when using the indirect method This would not be the first time that accounting has confused a finance professor Discussion Case 5–56 This case provides an opportunity to contrast income with cash flows and to discuss the importance of the cash flow statement Even if a company is profitable, if it is investing its cash in additional inventory, buildings, and so on, it could find itself in a tight cash position Several factors would have to be examined, especially those dealing with the major inflows and outflows of cash For example, what obligations are outstanding? Is equity financing being used? Has the cash balance increased or decreased significantly during the last year? How was the new store financed? Can profit distributions to the owners be postponed? Also, the timing of cash flows would be important Two specific recommendations might deal with the need for a periodic statement of cash flows and perhaps a cash flow projection statement Such statements are likely to be needed more than annually, especially if the business activity is seasonal Discussion Case 5–57 The accumulation of cash despite paying dividends equal to earnings, could be explained by two factors: Cash from operations and net income will differ to the extent that revenues are not received in cash or expenses are not paid in cash For example, the existence of a large amount of depreciation expense causes cash from operations to be greater than net income Other activities in addition to operations can affect the Cash balance For example, cash is increased by borrowing, issuing stock, and selling assets Cash can be decreased by debt repayment, distributions to owners, and purchase of assets This is the reason that a statement of cash flows shows cash inflows and outflows classified by operating, investing, and financing activities To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 187 Discussion Case 5–58 This case focuses on the most controversial issue the FASB faced when it issued pre-codification Statement No 95 (now FASB ASC Topic 230): whether to require the direct method or the indirect method in determining net cash flow from operations The FASB finally decided, by a 4–3 vote, to allow either method In making that decision, the FASB disappointed some financial statement users who argued strongly that the direct method should be required because it is more easily understood Company management, accountants, and other preparers, on the other hand, argued that the indirect method is easier to apply and that it helps explain or reconcile the differences between net income and net cash flow from operations In discussing the case, students should recognize both the pros and cons of the two alternative methods They should also recognize that the two methods produce the same result: the same amount of net cash flow from operations Another point to be made is that the rest of the statement of cash flows, other than the Operations section, will be identical regardless of which method is selected A final point to be made is that certain disclosures are required, depending on which method is selected If the direct method is used, a separate schedule must be provided that reconciles net income to net cash flow from operations In effect, this is what the indirect method does If the indirect method is used, the amount of interest and income taxes paid must be disclosed This information is supplied directly when the direct method is used Most preparers would recommend the indirect method because it is easier (and probably less costly) to apply By choosing the indirect method, the reconciliation schedule is already prepared and the additional required disclosures for interest and taxes paid can be supplied without much additional effort In the United States, approximately 95% of large corporations use the indirect method Discussion Case 5–59 Roberts should explain to Dennis that net income and cash flow are not the same thing Net income is measured on an accrual basis, not a cash basis Roberts could prepare a statement of cash flows to support the explanation As shown in the statement, depreciation of $5,000 did not require a cash outlay and is thus added back to net income in determining operating cash flows Changes in the current operating accounts, however, must be subtracted in deriving the amount of cash from operations The increase in receivables indicates that collections from customers were $10,000 less than sales reported in the income statement The $5,000 increase in inventory and the $5,000 decrease in accounts payable indicate that the amount paid to suppliers during the year was $10,000 more than cost of goods sold on the income statement The net effect of depreciation and changes in current operating accounts is net cash provided by operating activities of $5,000 The statement of cash flows also shows that while Dennis obtained $40,000 from borrowing, $32,000 was paid to purchase equipment and $15,000 was used to pay dividends to stockholders When cash flows from operating, investing, and financing activities are combined, the $2,000 net decrease in cash is fully explained To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 188 Discussion Case 5–59 Chapter (Concluded) Dennis, Inc Statement of Cash Flows For the Year Ended December 31, 2013 Cash flows from operating activities: Net income Adjustments: Depreciation expense Increase in accounts receivable Increase in inventory Decrease in accounts payable Net cash provided by operating activities Cash flows from investing activities: Purchase of equipment Net cash used in investing activities Cash flows from financing activities: Issuance of long-term note Payment of dividends Net cash provided by financing activities Net decrease in cash Cash at beginning of year Cash at end of year $ 20,000 $ 5,000 (10,000) (5,000) (5,000) (15,000) $ 5,000 $(32,000) (32,000) $ 40,000 (15,000) 25,000 $ (2,000) 5,000 $ 3,000 Discussion Case 5–60 Atlas Security has gone from a company producing positive cash flows to one using cash to operate the company The negative cash flows from operations preceded the reporting of negative income by one year This indicates that perhaps current noncash operating assets, such as accounts receivable, were increasing and producing net income but not producing cash The positive financing cash flows mean that Atlas Security is either borrowing or selling stock to provide cash to run the business Financing inflows can continue only so long If the inflows are from debt, the source of debt will diminish If the inflows are from stock, the decline in income will make the sale of stock less desirable The positive investing cash flows mean that the financing inflows are not being used to make additional investments Instead, the investment assets are being liquidated to provide operating cash In summary, Atlas Security seems to be heading into difficult financial times Cash is being obtained from whatever sources possible to meet operating needs To completely analyze the company, Kara should obtain and review the balance sheet and the income statement These statements can be used to determine the reasonableness of the assumptions made earlier All three statements are useful for analyzing a company Each one provides information that can be used to analyze the health of an organization To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 189 Discussion Case 5–61 The “net income + depreciation” definition of cash flow has been widely used The W T Grant case illustrates that, in some circumstances, this “cash flow” measure can be very misleading For the fiscal year ended January 31, 1973, W T Grant experienced sharp increases in receivables and inventory These increases combined to cause Grant’s cash flow from operations to be negative even though “net income + depreciation” was positive In general, defining cash flow as “net income + depreciation” ignores the important impact that changes in current operating assets and current operating liabilities can have on cash flow generated by operations When working capital (current assets – current liabilities) is relatively constant, cash from operations is about the same as “net income + depreciation.” Firms that are not growing would be expected to have a stable level of working capital If working capital is increasing, part of the cash generated by operations must be used to finance the additional working capital This will cause cash flow from operations to be less than “net income + depreciation.” Working capital is usually increasing in high-growth firms and in firms, such as W T Grant, that are having trouble collecting receivables or moving inventory If working capital is decreasing, extra cash is freed up in addition to the cash generated by operations This will cause cash flow from operations to be higher than “net income + depreciation.” Case 5–62 Disney uses the indirect method The statement begins with net income and then makes adjustments for noncash items and for changes in balance sheet accounts related to operations Disney has the normal pattern of positive cash from operations and negative cash from investing activities in each of the three years In all three years, Disney's cash from operations was large enough to pay for all investing activities However, for the year 2008, Disney’s cash from operations was not large enough to pay for all investing AND financing activities As a result, Disney has a net decrease in cash and cash equivalents for 2008 In Note to the financial statements, Disney reports that cash and cash equivalents “consist of cash on hand and marketable securities with original maturities of three months or less.” The largest dollar item in the Operating Activities section of Disney’s 2009 statement of cash flows is the $1.631 billion addition labeled “depreciation and amortization.” This represents the expensing of property, plant, and equipment and intangible assets over their useful lives for the current year, but it does not involve any outflow of cash Operating cash flow for 2009 would have been $7.158 billion ($5.064 + $0.485 + $1.609) if interest and taxes paid were not classified as operating items EBITDA can be computed as follows (in billions): Income from continuing operations before income taxes (from the income statement) Add back net interest expense (from the income statement) Add back depreciation and amortization (from the cash flow statement) EBITDA $5.658 0.466 1.631 $7.755 The EBITDA of $7.755 billion differs from the $7.158 billion answer in (5) because the computation of EBITDA does not take into consideration many of the accruals associated with the computation of net income Changes in receivables, inventories, and payables are ignored in the computation of EBITDA To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com 190 Chapter Case 5–63 a Net income plus depreciation b Cash flow from operating activities c Cash flow from operating activities Plus cash paid for interest Plus cash paid for income taxes d Cash flow from operating activities Less capital expenditures Less dividends 2009 $3,774 3,173 2008 $3,944 4,421 2007 $3,699 4,238 4,445 5,975 5,696 1,413 2,758 2,683 In order to maintain its long-run potential, a company must consistently replace property, plant, and equipment and maintain a stable cash dividend level for investors The cash flow number computed in part (1)(d)—cash flow from operating activities – capital expenditures – dividends—is a measure of how much free cash flow Lockheed generates after maintaining its long-run potential Someone considering a leveraged buyout (LBO) is interested in the cash flow from the operations of the business before payment of financing costs This is the cash flow before payments for interest and income taxes are subtracted So, an LBO candidate would be particularly interested in the cash flow numbers calculated in part (1)(c)—cash flow from operating activities + cash paid for interest + cash paid for income taxes Case 5–64 a Increases and decreases in Cash for each year are as follows: Cash from operating activities Cash from investing activities Cash from financing activities Net increase (decrease) in cash 2009 2008 $ 8,186 $ 7,571 (4,149) (2,363) (2,293) (3,985) $ 1,744 $ 1,223 2007 $ 7,150 (6,719) 973 $ 1,404 2006 $ 5,957 (1,700) (6,583) $(2,326) Cash balance at December 31, 2009, approximately equals the balance at January 1, 2006, plus the four yearly changes: $4,701 – $2,326 + $1,404 + $1,223 + $1,744 = $6,746 b Paid-In Capital from Common Stock at December 31, 2009, approximately equals the balance at January 1, 2006, plus the four yearly amounts of common stock issued: $6,369 + $148 + $1,619 + $586 + $662 = $9,384 c Retained Earnings at December 31, 2009, equals the balance at January 1, 2006, plus the four yearly net income amounts less the four yearly cash dividend amounts: 4-year net income: $5,080 + $6,027 + $5,874 + $6,906 = $23,887 4-year dividends: $2,911 + $3,149 + $3,521 + $3,800 = $13,381 December 31, 2009, retained earnings: $31,299 + $23,887 – $13,381 = $41,805 d Treasury Stock at December 31, 2009, approximately equals the balance at January 1, 2006, plus the four yearly amounts of treasury stock purchases: $19,644 + $2,416 + $1,838 + $1,079 + $1,518 = $26,495 The December 31, 2009, balance in the treasury stock account exceeds the total paid-in capital from common stock account by approximately $17.1 billion This means that the amount used to repurchase Coca-Cola shares is almost three times the amount that Coca-Cola shareholders invested in the first place And this is in addition to the cash dividends received by shareholders Another way to think of this is that net Paid-In Capital from Common Stock (Paid-In Capital from Common Stock less Treasury Stock) is a negative $17.1 billion To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com Chapter 191 Case 5–65 TO: President, Moran Auto Sales FROM: Senior Credit Analyst, Far West Bank RE: Need for Statement of Cash Flows Your loan application is being held up while we await the arrival of your statement of cash flows A modern set of financial statements is not complete without a statement of cash flows And, in your case, the statement of cash flows is particularly important because it will reveal exactly why you have been profitable in recent years but are currently running short of cash In a recent memo, your accountant reminded me that most of the information for the statement of cash flows can be deduced from the income statement and from changes in the balance sheet accounts I believe we would all be better off if you were to prepare the statement and send me a copy instead of having me figure out the information from your balance sheet and income statement My reasons for thinking this are as follows: You have access to the raw data and can prepare a much more complete statement of cash flows Offsetting events can hide some cash flows, and the cash flow effects of some complex transactions are difficult to deduce If I am asked to prepare your statement of cash flows myself, I will bill you at my normal consulting rate, which is $500 per hour Case 5–66 This is an ethical dilemma with no neat or tidy solution It seems clear that you cannot give the presentation to the investment bankers Your analysis strongly suggests that the earnings numbers have been manipulated, so you cannot in good conscience present the proposal to the investment bankers without voicing your concerns You should notify the board of directors immediately, so that they can have sufficient time to find someone else to make the presentation You should offer to brief the new presenter on the results of your analysis Before rendering a harsh judgment against the board for engaging in earnings manipulation, realize that earnings numbers in an IPO serve much the same purpose as advertising does in the selling of cars Everyone knows that the numbers have been puffed up and beautified as much as possible The investment bankers, if they are experienced, will look at all of the financial statement numbers with healthy skepticism Case 5–67 Solutions to this problem can be found on the Instructor’s Resource CD-ROM or downloaded from the Web at www.cengage.com/accounting/stice To download more slides, ebook, solutions and test bank, visit http://downloadslide.blogspot.com ... plant, and equipment in (5), this transaction would be a noncash transaction and would be disclosed separately from the cash flow statement To download more slides, ebook, solutions and test... common stock Net cash provided by financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year... cash dividends Net cash used by financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year