Solution manual financial accounting 4e by wild chapter12

The direct method of reporting cash flows from operating activities itemizes the major classes of cash receipts such as sales to customers, and also itemizes the major classes of cash pa

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How does a company obtain its cash?

Where does a company spend its cash?

What explains the change in the cash balance?

2 The direct method of reporting cash flows from operating activities itemizes the major classes of cash receipts such as sales to customers, and also itemizes the major classes of cash payments such as for merchandise, interest, taxes, and other operating expenses

3 On a statement of cash flows prepared according to the direct method, operating activities generally include cash receipts from the sale of goods and services, cash dividends received from stock investments in other entities, and interest on loans to others Operating activities also include cash outflows such as payments for merchandise, salaries, rent, income taxes, utilities, and other operating expense items

4 The indirect method of reporting cash flows from operating activities begins with net income and then adjusts it for items that are necessary to reconcile net income to the net cash provided or used by operating activities

5 On a statement of cash flows, investing activities include cash outflows from purchases of long-term investments such as stocks and bonds, from purchases of plant assets such as land, buildings, and machinery, and from purchases of other noncurrent assets such as natural resources and intangible assets When these types of assets are sold, the cash inflows from the sales are also reported as investing activities

6 On a statement of cash flows, financing activities include cash inflows such as those that result from issuing preferred or common stock, and from borrowing by issuing bonds or signing long-term or short-term notes payable Financing activities also include cash outflows such as dividend payments to stockholders, purchases of treasury stock, and repayments of debt

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8 The amount of the land purchase that was paid for in cash ($20,000) should be

reported on the statement of cash flows as an investing activity Also, a schedule of noncash investing and financing activities or the notes to the statement should

show the $100,000 land investment, the $80,000 financing in the form of a long-term note payable, and the net $20,000 cash outflow

9 Since this cash inflow results from borrowing money, it is reported on the statement

of cash flows as a financing activity

10 Yes; even though a company reports positive net income for the year, it may still show a net cash outflow from operating activities When net income is reconciled to the net cash flow from operating activities, the net effect of all the adjustment items may be a subtraction from net income (examples of such adjustments are accrued revenues, prepaid expenses, and other gains) If the amount of this net subtraction

is larger than the net income, the result is net cash used by operating activities

11 Depreciation is not a source or a use of cash, even though it must be added to net income when the net cash flow from operating activities is calculated by the indirect method (Note: When depreciation is deducted on the tax return of a corporation, the effect is to reduce taxable income and reduce the cash outflow for income taxes But this is driven by the activity of purchasing the asset.)

12 (a) Best Buy uses the indirect method This is apparent from its adjustments to net income when its reports net cash provided by operating activities

(b) The increase in receivables represents an amount by which sales for the period were more than cash receipts from customers Since sales are a positive number in the calculation of net income, an increase in the amounts not yet received from

customers (the increase in receivables) must be deducted from sales to determine the net amount of cash provided by operations

13 Circuit City’s statement of cash flows shows five major financing activities for the year ended February 28, 2005:

Payments on short-term debt $ (1,853,000) Principal payments of long-term debt (28,008,000) Repurchases of common stock (259,832,000) Issuances of Circuit City common stock, net 27,156,000 Dividends paid (13,848,000) Net cash used for financing activities $(276,385,000)

14 Apple’s two investing activities yielding cash outflows for the year ended September

25, 2004, are ($ millions):

Purchases of short-term investments $ 3,270 Purchases of property, plant, and equipment 176

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QUICK STUDIES Quick Study 12-1 (20 minutes)

1 The statement of cash flows reports the cash (and cash equivalent) activities of a business for a specific accounting period The cash flows are classified into operating, investing, and financing activities The net change in cash as well as the beginning and ending cash balances are also reported on the statement

2 Examples of transactions classified as investing activities

Plant asset purchases

Plant asset sales

Investment in debt and equity securities (except trading securities)

Intangible asset acquisitions and disposals

Purchases and sales of natural resources

3 Examples of transactions classified as financing activities

Bond retirement and issuance

Issuance and settlement of notes payable

Common stock issuance

Cash paid for dividends

Treasury stock acquisitions

Owner contributions and withdrawals

4 Examples of significant noncash financing and investing activities

Exchange of stock or debt securities for noncash assets

Conversion of bonds into stock

Purchase of long-term assets by issuing notes payable to seller

Quick Study 12-2 (10 minutes)

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Cash flows from operating activities

Net income $18,200 Adjustments to reconcile net income to operating cash flow

Depreciation $36,000

Accounts receivable decrease 7,000

Inventory increase (5,900)

Accounts payable increase 4,700

Income taxes payable decrease (150) 41,650 Net cash provided from operating activities $59,850

Computation of cash inflow from sale of furniture

Cost of furniture sold (given) $52,500 Accumulated depreciation at beginning of year (given) $110,700

Increase from depreciation expense (given) 18,000

Total ―expected‖ accumulated depreciation 128,700

Actual accumulated depreciation at end of year (given) (88,700)

Accumulated depreciation on sold furniture 40,000 Cash received from sale of furniture at book value $12,500

Part 1

Computation of cash received from the sale of common stock

Increase in Common stock ($105,000 - $100,000) $ 5,000 Increase in Paid-in capital in excess of par value

($567,000 - $342,000) 225,000 Cash received from the sale of common stock $230,000

Part 2

Computation of cash paid for dividends

Beginning retained earnings $287,500 Net income 48,000 Total ―expected‖ retained earnings 335,500 Actual ending retained earnings (313,500)

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Net income $30,000 Adjustments to reconcile net income to operating cash flow

Accounts receivable decrease 10,000

Inventory decrease 10,000

Prepaid expense increase (1,200)

Accounts payable decrease (6,000)

Wages payable increase 4,000

Income taxes payable decrease (1,200) 53,200 Net cash provided from operating activities $83,200

Computation of cash inflow from sale of furniture

Cost of furniture sold (given) $55,000 Accumulated depreciation at beginning of year (given) $ 9,000

Increase from depreciation expense (given) 37,600

Total ―expected‖ accumulated depreciation 46,600

Actual accumulated depreciation at end of year (given) (17,000)

Accumulated depreciation on sold furniture 29,600 Cash received from sale of furniture at book value $25,400

1 Computation of cash paid for dividends

Beginning retained earnings $ 8,400

Net income 30,000

Total ―expected‖ retained earnings 38,400

Actual ending retained earnings (35,600)

Decrease from (cash paid for) dividends $ 2,800

2 Computation of cash payments for notes

Beginning notes payable $69,000

Increases to notes (given) 0

Total ―expected‖ notes payable 69,000

Actual ending notes payable (29,000)

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Quick Study 12-9 B (10 minutes)

1 Cash received from customers = Sales + Accounts receivable decrease

= $488,000 + ($51,000 - $41,000)

= $498,000

2 Net increase in cash = $94,800 - $24,000 = $70,800

1 Cash paid for merchandise

= Cost of goods sold - Inventory decrease + Accounts payable decrease

= $314,000 - ($95,800 - $85,800) + ($21,000 - $15,000)

= $310,000

2 Cash paid for operating expenses

= Operating expenses (excluding depreciation)

+ Prepaid expenses increase - Wages payable increase

= $89,100 + ($5,400 - $4,200) - ($9,000 - $5,000)

= $86,300

Receipts from sales to customers a $498,000

Payments for merchandise inventory b (310,000)

Payments for other expenses c (86,300)

Payments for taxes d (18,500)

Net cash provided by operating activities $ 83,200

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1 Pena is probably in the strongest position of the three competing companies on the basis of the statement of cash flows Pena’s cash flows from operations are able to finance reinvestment in operating assets as well as help in paying down some debt Garcia is in the second strongest position as it is able to reinvest 57% of its operating cash flows into new productive assets Piniella is the weakest as it experienced negative cash flows from operations and generates cash by selling productive assets and

by taking on new debt

2 Garcia’s cash flow on total assets ratio is slightly stronger than that for Pena Garcia has a 9.6% ratio ($60,000/$625,000) compared to Pena’s 8.9% ratio ($70,000/$790,000)

Quick Study 12-13 A (10 minutes)

The balance sheet equation can be arranged so that the algebraic total of all noncash items is equal to cash (see Exhibit 12.8) It follows that when all changes in noncash balance sheet items are explained, the corresponding change in cash is also explained On the spreadsheet, when the changes in all noncash balance sheet items have been accounted for, we can be confident that the change in cash also has been fully accounted for

Cash Flows from Operating Activities (Indirect)

Case A Case B Case C Net Income $ 4,000 $100,000 $72,000 Adjustments to reconcile net income to net

cash provided by operations

Depreciation 30,000 8,000 24,000 Changes in assets and liabilities

Accounts receivable (40,000) (20,000) 4,000 Inventories 20,000 10,000 (10,000) Accounts payable 24,000 (22,000) 14,000 Accrued liabilities (44,000) 12,000 (8,000) Cash provided by (used for) operations $ (6,000) $ 88,000 $96,000

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Investing Activities

Purchase of used equipment $(5,000) Sale of short-term investments 6,000 Cash provided by investing activities $ 1,000

Financing Activities

Additional short-term borrowings $20,000 Cash dividends paid (16,000) Cash provided by financing activities $ 4,000

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EXERCISES Exercise 12-1 (10 minutes)

Net income $400,000 Adjustments to reconcile net income to operating cash

flow

Accounts receivable increase (40,000)

Prepaid expense decrease 12,000

Accounts payable increase 6,000

Wages payable decrease (2,000)

Gain on sale of machinery (20,000) 36,000 Net cash provided from operating activities $436,000

Exercise 12-2 (25 minutes)

Operating Activities

Investing &

d Sold equipment for

e Recorded

f Income taxes payable

g Declared and paid a

h Accounts payable

i Paid cash to settle

j Prepaid expenses

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Exercise 12-3 B (15 minutes)

Operating Activities

Investing &

Not reported

on Statement

or in Notes

a Retired long-term bonds

b Depreciation expense

c Paid cash dividend that

was declared in a prior

period

X

e Borrowed cash from bank

by signing a 9-month note

payable

X

f Paid cash to purchase a

g Accepted six-month note

receivable in exchange for

plant assets

X

h Paid cash toward

j Paid cash to acquire

Net income $374,000

Adjustments to reconcile net income to net cash

provided by operating activities

Decrease in accounts receivable 17,100

Decrease in merchandise inventory 42,000

Increase in prepaid expenses (4,700)

Decrease in accounts payable (8,200)

Increase in other payables 1,200

Depreciation expense 44,000

Amortization expense 7,200

Gain on sale of plant assets (6,000)

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Case A: Sales revenue $515,000

Accounts receivable, Dec 31, 2007 $ 27,200 Accounts receivable, Dec 31, 2008 (33,600) Less increase in accounts receivable (6,400) Cash received from customers $508,600

Case B: Rent expense $139,800

Rent payable, Dec 31, 2007 $ 7,800 Rent payable, Dec 31, 2008 (6,200) Plus decrease in rent payable 1,600 Cash paid for rent $141,400

Case C: Cost of goods sold $525,000

Merchandise inventory, Dec 31, 2008 $130,400 Merchandise inventory, Dec 31, 2007 (158,600) Less decrease in merch inventory (28,200) Cost of goods purchased 496,800 Accounts payable, Dec 31, 2008 82,000

Accounts payable, Dec 31, 2007 (66,700) Less increase in accounts payable (15,300) Cash paid for merchandise $481,500

Net income $ 481,540

Adjustments to reconcile net income to net cash

Increase in accounts receivable (30,500)

Increase in merchandise inventory (25,000)

Decrease in accounts payable (12,500)

Decrease in salaries payable (3,500)

Amortization expense—Patents 4,200

Gain on sale of equipment (6,200)

Net cash provided by operating activities $ 452,240

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Receipts from customers (see note a) $1,797,500 Payments for merchandise (see note b) (1,028,500) Payments for salaries (see note c) (249,035) Payments for rent (49,600) Payments for utilities (18,125) Net cash provided by operating activities $ 452,240

Note a: Sales – Increase in receivables

Cash flows from investing activities

Cash received from the sale of equipment* $ 51,300 Cash paid for new truck (89,000) Cash received from the sale of land 198,000 Cash received from the sale of long-term investments 60,800 Net cash provided by investing activities $221,100

* Cash received from sale of equipment = Book value - loss = $65,300 - $14,000 = $51,300

Cash flows from financing activities

Sale of common stock $ 64,000 Paid cash dividend (14,600) Repaid bond payable (50,000) Purchased treasury stock (12,000) Net cash used by financing activities $(12,600)

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Part 1

IKIBAN, INC

Statement of Cash Flows (Indirect Method)

For Year Ended June 30, 2008

Net income $ 99,510 Adjustments to reconcile net income to net cash

Increase in accounts receivable (14,000) Decrease in merchandise inventory 22,700 Decrease in prepaid expenses 1,000 Decrease in accounts payable (5,000)

Decrease in income taxes payables (400) Depreciation expense 58,600 Gain on sale of plant assets (2,000) Net cash provided by operating activities $151,410

Cash received from sale of equip (Note 1) 10,000 Cash paid for equipment (Note 1) (57,600) Net cash used in investing activities (47,600)

Cash received from stock issuance 60,000 Cash paid to retire notes (Note 2) (30,000) Cash paid for dividends (Note 3) (90,310) Net cash used in financing activities (60,310) Net increase in cash $ 43,500 Cash balance at prior year-end 44,000 Cash balance at current year-end $ 87,500

(Notes 1, 2, and 3 on next page.)

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Exercise 12-10 (Part 1 continued)

(1) Cost of equipment sold $ 48,600 Accumulated depreciation of equipment sold (40,600) Book value of equipment sold 8,000 Gain on sale of equipment 2,000 Cash receipt from sale of equipment $ 10,000 Cost of equipment sold $ 48,600 Plus increase in the equipment account balance 9,000 Cash paid for new equipment (given) $ 57,600

Interpretation: A 49.6% result on the cash flow on total assets ratio is

indicative of very good performance Also, this favorably compares to its return on assets figure of 32.6% (high quality earnings)

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Part 1

IKIBAN, INC

Statement of Cash Flows (Direct Method)

For Year Ended June 30, 2008

Cash received from customers (Note 1) $664,000 Cash paid for merchandise (Note 2) (393,300) Cash paid for operating expenses (Note 3) (75,000) Cash paid for income taxes (Note 4) (44,290) Net cash provided by operating activities $151,410

Cash received from sale of equip (Note 5) 10,000 Cash paid for equipment (Note 5) (57,600) Net cash used in investing activities (47,600)

Cash received from stock issuance 60,000 Cash paid to retire notes (Note 6) (30,000) Cash paid for dividends (Note 7) (90,310) Net cash used in financing activities (60,310) Net increase in cash $ 43,500 Cash balance at prior year-end 44,000 Cash balance at current year-end $ 87,500 (See notes on next page)

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Exercise 12-11 B (continued)

Notes

(1) Sales $678,000 Less increase in accounts receivable (14,000) Cash received from customers $664,000 (2) Cost of goods sold $411,000 Less decrease in merchandise inventory (22,700) Purchases 388,300 Plus decrease in accounts payable 5,000 Cash paid for merchandise $393,300 (3) Other operating expenses $ 67,000 Plus decrease in wages payable 9,000 Less decrease in prepaid expenses (1,000) Cash paid for other operating expenses $ 75,000 (4) Income taxes expense $ 43,890 Plus decrease in income taxes payable 400 Cash paid for income taxes $ 44,290 (5) Cost of equipment sold $ 48,600 Accumulated depreciation of equipment sold (40,600) Book value of equipment sold 8,000 Gain on sale of equipment 2,000 Cash receipt from sale of equipment $ 10,000 Cost of equipment sold $ 48,600 Plus increase in the equipment account balance 9,000 Cash paid for new equipment (given) $ 57,600

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FERRON COMPANY Statement of Cash Flows For Year Ended December 31, 2008 Cash flows from operating activities

Receipts from customers $ 495,000

Receipts of interest 3,500

Payments for merchandise (254,500)

Payments for salaries (76,500)

Payments for other expenses (20,000)

Net cash provided by operating activities $147,500 Cash flows from investing activities

Receipt from sale of equipment 60,250

Payment for store equipment (24,750)

Net cash provided by investing activities 35,500 Cash flows from financing activities

Payment to retire long-term notes payable (100,000)

Receipt from borrowing on six-month note 35,000

Payment of cash dividends (10,000)

Net cash used in financing activities (75,000) Net increase in cash and cash equivalents $108,000 Cash and cash equivalents at prior year-end 40,000 Cash and cash equivalents at current year-end $148,000

Note No _

Noncash investing and financing activities

(1) Issued common stock to retire $185,500 of bonds payable

(2) Purchased land financed with a $105,250 long-term note payable

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1

THOMAS CORPORATION Statement of Cash Flows For Year Ended December 31, 2008

Cash received from customers $ 6,000,000 Cash received from dividends 208,400 Cash paid for merchandise (1,590,000) Cash paid for wages (550,000)

Cash paid for rent (320,000)

Cash paid for interest (218,000)

Cash paid for taxes (450,000)

Net cash provided by operating activities $3,080,400

Cash paid for purchases of machinery (2,236,000)

C ash paid for purchases of long-term investments (2,260,000)

Cash received from sale of land 220,000

Cash received from sale of machinery 710,000

Net cash used in investing activities (3,566,000)

Cash received from issuing stock 1,540,000 Cash received from borrowing 2,600,000

Cash paid for note payable (386,000)

Cash paid for dividends (500,000)

Cash paid for treasury stock purchases (218,000)

Net cash provided by financing activities 3,036,000 Net increase in cash $2,550,400 Cash at prior year-end 135,200 Cash at current year-end $2,685,600

c Proceeds for issuing notes are larger at $2,600,000 than for issuing

stock equity at $1,540,000 (see financing section)

d The company has a net cash inflow from borrowing This is computed

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Net income $24,000 Depreciation expense 12,000 Accounts receivable increase (10,000 ) Inventory decrease 16,000 Salaries payable increase 1,000 Net cash provided by operating activities $43,000

Exercise 16–15 (30 minutes)

1 Cash flows from operating activities—indirect method

Net income (loss) $(16,000 ) Depreciation expense 14,600 Accounts receivable decrease 24,000 Salaries payable increase 18,000 Accrued liabilities decrease (8,000 ) Net cash provided by operating activities $32,600

2 One reason for the net loss was depreciation expense Depreciation expense is added to net income to adjust for the effects of a noncash expense that was deducted in determining net income It does not involve an inflow of cash Depreciation expense, along with a decrease

in accounts receivable and an increase in salaries payable, turned the net loss into positive operating cash flow

3 Differences between cash flow from operations and net income can be caused by various items The most important causes for investors are differences arising from: (1) changes in management of operating activities and (2) changes in revenue and expense recognition

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PROBLEM SET A

Problem 12-1A (50 minutes)

Part 1

FORTEN COMPANY Statement of Cash Flows For Year Ended December 31, 2008 Cash flows from operating activities

Net income $114,975

Adjustments to reconcile net income to net

cash provided by operating activities:

Increase in accounts receivable ($65,810- $50,625) (15,185)

Increase in inventory ($275,656 - $251,800) (23,856)

Decrease in prepaid expenses ($1,875 - $1,250) 625

Decrease in accounts payable ($114,675 - $53,141) (61,534)

Loss on disposal of equipment 5,125

Net cash provided by operating activities $ 40,900 Cash flows from investing activities

Cash received from sale of equipment 11,625

Cash paid for equipment (30,000)

Net cash used in investing activities (18,375) Cash flows from financing activities

Cash borrowed on short-term note 4,000

Cash paid on long-term note (50,125)

Cash received from issuing stock (2,500 x $20) 50,000

Cash paid for dividends (50,100)

Net cash used in financing activities (46,225) Net decrease in cash $(23,700) Cash balance at December 31, 2007 73,500 Cash balance at December 31, 2008 $ 49,800

Purchased equipment for $96,375 by signing a $66,375 long-term note

payable and paying $30,000 in cash

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Problem 12-1A (Concluded)

Part 2

Forten Company's operations provide a positive net cash inflow of $40,900—a good result At the same time, the cash balance decreased by $23,700 (32%) during the year Two major cash outflows are the retirement of debt ($50,125) and the dividend payment ($50,100), which together represent 87% of net income Also, the $30,000 cash investment in equipment is presumably necessary to replace the older equipment sold

Helping fund these cash outflows is $50,000 cash from issuance of stock Moreover, the company took on additional debt (more than 30% increase in indebtedness); namely, $66,375 in long-term notes The company must recognize that that the debt must eventually be repaid with interest

In summary, perhaps the company should review the wisdom of paying cash dividends that are considerably larger than cash provided from operations, especially when the payment also results in a deteriorating cash position and when the company is taking on additional debt

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Problem 12-2A A (60 minutes)

FORTEN COMPANY Spreadsheet for Statement of Cash Flows For Year Ended December 31, 2008

Long-term notes payable 48,750 (k) 50,125 (i) 66,375 65,000

Paid-in capital in excess of

Retained earnings 120,125 (m) 50,100 (a) 114,975 185,000

Statement of cash flows

Operating activities

Net income (a) 114,975

Depreciation expense (f) 20,750

Loss on sale of equipment (g) 5,125

Investing activities

Receipt from sale of equipment (g) 11,625

Financing activities

Noncash investing and

financing activities

Purchase of equip financed

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Problem 12-3A B (40 minutes)

FORTEN COMPANY Statement of Cash Flows For Year Ended December 31, 2008 Cash flows from operating activities

Cash received from customers (Note 1) $567,315

Cash paid for merchandise (Note 2) (370,390)

Cash paid for other expenses (Note 3) (131,775)

Cash paid for income taxes (24,250)

Net cash provided by operating activities $ 40,900 Cash flows from investing activities

Cash received from sale of equipment 11,625

Cash paid for equipment (30,000) Net cash used in investing activities (18,375)

Cash borrowed on short-term note 4,000 Cash paid on long-term note (50,125) Cash received from issuing stock (2,500 x $20) 50,000 Cash paid for dividends (50,100) Net cash used in financing activities (46,225) Net decrease in cash $(23,700) Cash balance at December 31, 2007 73,500 Cash balance at December 31, 2008 $ 49,800

Purchased equipment for $96,375 by signing a $66,375 long-term note

payable and paying $30,000 in cash

Supporting calculations

(1) Sales - Increase in receivables = $582,500 - ($65,810 - $50,625) = $567,315

(2) Cost of Increase in Decrease in

goods sold inventory payables =

$285,000 + ($275,656 - $251,800) + ($114,675 - $53,141) = $370,390 (3) Other expenses - Decrease in prepaid expenses = $132,400 - ($1,875 - $1,250)

= $131,775

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