Chapter 10
Statement of Cash Flows
TO THE NET
1. a. 3812 Search, Detection, Navigation, Guidance, Aeronautical Systems
b. Northrop Grumman Corporation (Northrop Grumman or the company) provides technologically advanced, innovative products, services, and solutions in defense and commercial electronics, nuclear and nonnuclear shipbuilding, information technology, mission systems, systems integration, and space technology.
c. Direct Method. It provides a clear picture of cash inflow and outflow from operations.
d. Noncash Investing and Financing Activities
Conversion of debt to equity
Settlement of note receivable in lieu of payment
Sale of business
Note receivable, net of discount
Investment in unconsolidated affiliate
Purchase of business
Fair value of assets acquired
Cash paid, net of cash acquired
Noncash stock compensation
Common stock issued
Liabilities assumed
All of these noncash transactions involving investing and financing activities are important to understanding investing and financing activities but they are not part of cash flow.
The conversion of debt to equity is an important financing activity that did not involve cash flow.
2. a. 3571 Electronic Computers
b. Dell Inc., with fiscal 2005 net revenue of $49.2 billion, is a premier provider of products and services worldwide that enable customers to build their information-technology and Internet infrastructures.
c.
January 28, 2005 / January 30, 2004(In millions)
Accounts receivable, net / $4,414 / $3,635
Inventories / 459 / 327
Accounts payable / 8,895 / 7,316
d.
January 28, 2005 / January 30, 2004(Percentage)
Accounts receivable, net / 121.8 / 100.0
Inventories / 140.4 / 100.0
Accounts payable / 121.6 / 100.0
e.
January 28, 2005 / January 30, 2004 / January 31, 2003(In millions)
Net revenue / 49,205 / 41,444 / 35,404
Net income / 3,043 / 2,645 / 2,122
Net cash provided by operating activities / 5,310 / 3,670 / 3,539
f.
January 28, 2005 / January 30, 2004 / January 31, 2003(Percentage)
Net revenue / 139.0 / 117.1 / 100.0
Net income / 143.4 / 124.6 / 100.0
Net cash provided by operating activities / 150.1 / 103.7 / 100.0
g. (c) and (d) indicate that Inventories went up more than Accounts Receivable, Net and Accounts Payable. This could indicate that inventories are getting ahead of sales.
Net Income increased slightly faster than Net Revenue. This is a good indication.
A review of net cash provided by operating activities would be needed to determine the reasons for the slight increase in 2004 and the material increase in 2005.
3. a. 2082 Malt Beverages
b. On February 9, 2005, Adolph Coors Company merged with Molson Inc. (“Molson”).
c. 1. Operating Cash Flow/Current Maturities of Long-Term Debt and Current Notes Payable
December 26, 2004 / December 28, 2003(In thousands)
$499,908 / $528,828
($12,500 + $26,028) / ($21,309 + $69,856)
13.0 times / 5.8 times
2. Operating Cash Flow/Total Debt
$499,908 / $528,828($4,657,524 − $1,601,166) / ($4,444,740 − $1,267,376)
16.4% / 16.6%
3. Operating Cash Flow per Share
$499,908 / $528,828($1,260 + $36,392) / ($1,260 + $35,154)
$13.28 / $14.52
4. Operating Cash Flow/Cash Dividends
$499,908 / $528,828($30,535 + $7,218) / $29,820
13.2 times / 17.7 times
d. 1. Operating Cash Flow/Cash Dividends is very good.
2. Material increase Operating Cash Flow/Current Maturities of Long-Term Debt and Notes Payable.
3. Adequate coverage of Operating Cash Flow/Total Debt. We would like to see this coverage higher.
4. Operating Cash Flow per Share is very good.
4. a. 5621 Retail—Women’s Clothing Stores
b. Ann Taylor Stores Corporation (the “Company”), through its wholly-owned subsidiaries, is a leading national specialty retailer of better quality women’s apparel, shoes and accessories sold primarily under the “Ann Taylor” and “Ann Taylor Loft” brands.
c.
Fiscal Year EndedJanuary 29, 2005 / January 31, 2004 / February 1, 2003
(In thousands)
Net sales / $1,853,583 / $1,587,708 / $1,380,966
Gross margin / 947,548 / 866,245 / 747,493
Operating income / 104,958 / 171,287 / 134,795
Net cash provided by operating activities / 169,259 / 215,499 / 234,417
d. Gross Margin did not keep up with Net Sales.
Operating Income and Net Cash Provided by Operating Activities actually declined.
e. 1. Depreciation and amortization are added back to net income because they reduced net income but did result in cash outflow.
2. Change in Inventories is subtracted from Net Income for the year ended January 29, 2005, because it represented an increase in inventories and therefore used cash flow.
3. Change in Accounts Payable and Accrued Expenses is added to Net Income for the year ended January 29, 2005, because these current liabilities increased and therefore provided cash flow.
QUESTIONS
10-1. The basic justification for a statement of cash flows is that the balance sheet and the income statement do not adequately indicate changes in cash.
The balance sheet indicates the position of the firm at a particular point of time. Some idea of how the changes in cash occurred can be obtained by comparing consecutive balance sheets, but only a limited amount of information can be obtained this way.
The income statement shows the income or loss for a period of time, but it does not indicate cash generated by operations. Neither the balance sheet nor the income statement summarize the cash flows related to investing or financing activities. Neither presents such items as sale of stock, retirement of bonds, purchase of machinery, or sale of a subsidiary. Thus, there is a need to summarize the cash flows in another statement.
10-2. 1. Cash flows from operating activities
2. Cash flows from investing activities
3. Cash flows from financing activities
10-3. The cash inflows (outflows) will be determined by analyzing all balance sheet accounts other than the cash and cash equivalent accounts. The cash inflows will be generated from the following accounts:
1. Decreases in assets
2. Increases in liabilities
3. Increases in stockholders’ equity
The cash outflows will be generated from the following accounts.
1. Increases in assets
2. Decreases in liabilities
3. Decreases in stockholders’ equity
10-4. This statement is not correct. The land account may contain an explanation of a source and use of cash.
10-5. 1. Visual method
2. T-account method
3. Worksheet method
10-6. For the direct approach, the revenue and expense accounts on the income statement are presented on a cash basis. For this purpose, the accrual basis income statement is adjusted to a cash basis. For the indirect approach, start with net income and add back or deduct adjustments necessary to change the income on an accrual basis to income on a cash basis after eliminating gains or losses that relate to investing or financing activities.
10-7. Items have been included in income that did not provide cash and items have been deducted from income that did not use cash. Net income must be converted to a cash-from-operations figure for the statement of cash flows.
10-8. Cash and short-term highly liquid investments. This would include cash on hand, cash on deposit, and investments in short-term, highly liquid investments.
10-9. The purpose of the statement of cash flows is to provide information on why the cash position of the company changed during the period.
10-10. These transactions represent significant investing and/or financing activities, and one purpose of the statement of cash flows is to present investing and financing activities.
10-11. No. The write-off of uncollectible accounts against allowance for doubtful accounts would reduce accounts receivable and the allowance for doubtful accounts. It would relate to operations and be a noncash item. The net receivables amount would not change.
10-12. Discarding a fully depreciated asset with no salvage value will not result in cash flow.
10-13. This may be the result of noncash charges for depreciation, amortization, and depletion. Also, receivables or inventory may have decreased or accounts payable may have increased.
10-14. An increase in accounts payable would be considered to be an increase in cash from operations.
10-15. Investments in receivables, inventories, fixed assets, and the paying off of debt are examples of situations where cash will be used but will not reduce profits.
10-16. Depreciation is not a source of funds. Depreciation has been deducted on the income statement in arriving at income. Since depreciation is a nonfund charge to the income statement, it is added back to income to compute cash from operations.
10-17. The decrease in accounts receivable would increase cash from operations.
10-18. This is an example of noncash investing and financing. As such, it should be disclosed on a schedule that accompanies the statement of cash flows.
10-19. Cash flow per share is not as good an indicator of profitability as earnings per share. In the short run, cash flow per share is a better indicator of liquidity and ability to pay dividends.
10-20. Since cash flow from operating activities is substantially greater than the cash paid out for dividends, it appears that the company can maintain and possibly increase dividend payments in the future, depending also on its investing and financing goals.
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PROBLEMS
PROBLEM 10-1
Cash Flows Classification / Effect on Cash______Data______/ Operating
Activity / Investing
Activity / Financing
Activity / Increase / Decrease / Noncash
Trans-
action
a. Net Loss
b. Increase in inventory
c. Decrease in receivables
d. Increase in prepaid
insurance
e. Issuance of common
stock
f. Acquisition of land
using notes payable
g. Purchase of land,
using cash
h. Paid cash dividend
i. Payment of income
taxes
j. Retirement of bonds,
using cash
k. Sale of equipment for
cash / X
X
X
X
X / X
X / X
X
X / X
X
X / X
X
X
X
X
X
X / X
PROBLEM 10-2
Data / Operating
Activity / Investing
Activity / Financing
Activity / Increase / Decrease / Noncash
Trans-
action
a. Net income
b. Paid cash dividend
c. Increase in receivables
d. Retirement of debt,
paying cash
e. Purchase of treasury
stock
f. Purchase of equipment
g. Sale of equipment
h. Decrease in inventory
i. Acquisition of land,
using common stock
j. Retired bonds, using
common stock
k. Decrease in accounts
payable / X
X
X
X / X
X / X
X
X / X
X
X / X
X
X
X
X
X / X
X
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PROBLEM 10-3
a.
BBB COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2005
Cash flows from operating activities:
Net income $ 500
Noncash expenses, revenues, losses, and
gains included in income:
Depreciation $ 2,800
Gain on sale of land (800)
Decrease in accounts receivable 400
Decrease in inventory 500
Increase in accounts payable 800
Increase in wages payable 50
Decrease in taxes payable (1,000) 2,750
Net cash flow from operating activities $ 3,250
Cash flows from investing activities:
Land was sold for 1,800
Equipment was purchased for (3,500)
Net cash used for investing activities $ (1,700)
Cash flows from financing activities:
Dividends declared and paid (4,350)
Common stock was sold for 3,800
Net cash used for financing activities $ (550)
Net increase in cash and marketable securities $ 1,000
b. Net cash flow from operating activities was substantially more than the net income. Cash dividends were greater than the net cash flow from operating activities.
The cash from issuing the common stock was sufficient to cover the net cash used for investing activities, increase the cash and marketable securities accounts, and partially cover the large cash dividend.
The fact that a long-term source of funds (common stock) was used to cover part of the cash dividends is a negative observation. The large cash dividend in relation to net cash flow from operating activities would also be considered a negative situation.
PROBLEM 10-4
a.
FRISH COMPANY
Schedule of Change from Accrual to
Cash Basis Income Statement
For Year Ended December 31, 2005
Accrual Basis Adjustments Add(Subtract) Cash Basis
Net sales $640,000 Increase in accounts
receivable $ (27,000) $ 613,000
Less expenses:
Cost of goods
sold 360,000 Increase in accounts
payable (15,000)
Increase in inven-
tories 35,000
Depreciation expense (15,000) 365,000
Selling and
administrative
expense 43,000 Decrease in prepaid
expenses $ (1,000)
Increase in accrued
liabilities (3,000)
Depreciation expense (5,000) 34,000
Other expense 2,000 Amortization of
patent $ (3,000)
Amortization of bond
premium 1,000 0
Income before
income
taxes $ 235,000 $ 214,000
Income tax 92,000 Decrease in income
taxes payable 10,000 102,000
Net income $143,000 $ 112,000
b. 1. Direct Approach
Receipts from customers $ 613,000
Payments to suppliers (365,000)
Selling and administrative expenses (34,000)
Income taxes paid (102,000)
Cash flows from operating activities $ 112,000
2. Indirect Approach
Net income $ 143,000
Add (deduct) items not affecting cash
Depreciation 20,000
Amortization of patent 3,000
Amortization of bond premium (1,000)
Increase in accounts receivable (27,000)
Increase in accounts payable 15,000
Increase in inventories (35,000)
Decrease in prepaid expenses 1,000
Increase in accrued liabilities 3,000
Decrease in income taxes payable (10,000)
Cash flow from operating activities $ 112,000
PROBLEM 10-5
a.
BOYER COMPANY
Schedule of Change from Accrual to
Cash Basis Income Statement
For the Year Ended December 31, 2005
Accrual Basis / Adjustments / Add(Subtract) / Cash
Basis
Sales / $19,000 / Increase in receivables / $ (400) / $18,600
Less operating expenses:
Depreciation / 2,300 / Depreciation expense / (2,300) / 0
Other operating expenses /
12,000 / Increase in inventories
Increase in accounts
payable / 800
(500) / 12,300
Operating income / $ 4,700 / $ 6,300
Loss on sale of land / 1,500 / Loss on sale of land / (1,500) / _ _0
$ 6,300
Income before tax
expense / $ 3,200
Tax expense / 1,000 / Decrease in income
taxes payable / 400 / 1,400
Net income / $ 2,200 / $ 4,900
b. 1. Direct Approach
Receipts from customers $ 18,600
Payments to suppliers (12,300)
Income taxes paid (1,400)
Cash flow from operating activities $ 4,900
2. Indirect Approach
Net income $ 2,200
Add (deduct) items not