chapter 12 solutions

Chapter 12: The Statement of Cash Flows

12-84Financial accounting solutions manual

chapter 12 The Statement of cash flows12-85

CHAPTER 12The Statement of Cash FlowsOVERVIEW OF EXERCISES, PROBLEMS, AND CASES

Estimated

Time in

Learning OutcomesExercisesMinutesLevel

1.Explain the purpose of a statement of cash flows.15*60Diff

2.Explain what cash equivalents are and how they are treated on 15Easy

the statement of cash flows.12*10Easy

3.Describe operating, investing, and financing activities, and give 210Easy

examples of each.310Mod

12*10Easy

13*10Easy

14*25Diff

4.Describe the difference between the direct and the indirect

methods of computing cash flow from operating activities.

5.Use T accounts to prepare a statement of cash flows, using the 45Mod

direct method to determine cash flow from operating activities.510Mod

620Mod

720Mod

810Mod

13*10Easy

15*60Diff

6.Use T accounts to prepare a statement of cash flows, using 910Easy

the indirect method to determine cash flow from operating 1015Mod

activities.14*25Diff

7.Use cash flow information to help analyze a company. 1115Mod

8.Use a work sheet to prepare a statement of cash flows, using

the indirect method to determine cash flow from operating

activities. (Appendix)*Exercise, problem, or case covers two or more learning outcomes

Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

ProblemsEstimated

andTime in

Learning OutcomesAlternatesMinutesLevel

1.Explain the purpose of a statement of cash flows.

2.Explain what cash equivalents are and how they are treated on 13*30Diff

the statement of cash flows.

3.Describe operating, investing, and financing activities, and give

examples of each.

4.Describe the difference between the direct and the indirect11*30Mod

methods of computing cash flow from operating activities.12*30Mod

5.Use T accounts to prepare a statement of cash flows, using the 345Mod

direct method to determine cash flow from operating activities.630Mod

11*30Mod

13*30Diff

6.Use T accounts to prepare a statement of cash flows, using 130Mod


activities.730Mod

945Diff

12*30Mod

7.Use cash flow information to help analyze a company.

8.Use a work sheet to prepare a statement of cash flows, using 260Mod


activities. (Appendix)860Mod

1060Diff

*Exercise, problem, or case covers two or more learning outcomes

Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)

Estimated

Time in

Learning OutcomesCasesMinutesLevel

1.Explain the purpose of a statement of cash flows.4*60Diff

5*25Mod

6*25Mod

2.Explain what cash equivalents are and how they are treated on 1*30Mod

the statement of cash flows.7*20Mod

3.Describe operating, investing, and financing activities, and give 1*30Mod

examples of each.220Mod

7*20Mod

4.Describe the difference between the direct and the indirect

methods of computing cash flow from operating activities.

5.Use T accounts to prepare a statement of cash flows, using the 4*60Diff

direct method to determine cash flow from operating activities.

6.Use T accounts to prepare a statement of cash flows, using 5*25Mod

the indirect method to determine cash flow from operating 6*25Mod

activities.

7.Use cash flow information to help analyze a company.320Mod

8.Use a work sheet to prepare a statement of cash flows, using

the indirect method to determine cash flow from operating

activities. (Appendix)*Exercise, problem, or case covers two or more learning outcomes

Level = Difficulty levels: Easy; Moderate (Mod); Difficult (Diff)questions

1.The purpose of the statement of cash flows is to summarize an entitys cash flows from operating, investing, and financing activities during a period. Because it is concerned with activity for a specific period of time, the statement is similar to the income statement. However, they differ in two important respects. First, with a few exceptions, the income statement deals only with operating activities. Second, the income statement is on an accrual basis, while the statement of cash flows reports operating activities on a cash basis.

2.A cash equivalent is an item that is readily convertible to a known amount of cash and has an original maturity of three months or less. These items, such as Treasury bills and money market funds, present very little risk to the holder, and therefore they are included with cash for the purpose of preparing the statement of cash flows. That is, purchases and sales of cash equivalents are not considered significant activities to be separately reported on the statement.

3.The down payment of $20,000 is a cash outflow that would be reported in the investing activities section of the statement of cash flows. The issuance of the promissory note for $60,000 would appear in a supplemental schedule of noncash investing and financing activities.

4.A 60-day Treasury bill would be classified as a cash equivalent and combined with cash on the balance sheet. Therefore, the purchase of the treasury bill would not be reported as an investing activity. However, the purchase of Motorola stock would appear as a cash outflow in the investing activities section of the statement of cash flows.

5.Companies cannot continue in business if they do not generate positive cash flows from operating activities. Also, over a period of years, a company cannot continue to borrow more than it repays, nor can it issue capital stock indefinitely. Thus, you would not expect a net cash outflow from financing activities over a sustained period of time. However, many companies regularly experience a net cash outflow from investing activities. A company must at a minimum replace existing assets and in many cases acquire additional plant and equipment to remain competitive. At the same time, disposals of long-term assets may be fairly common, but usually they will not generate significant amounts of cash inflow.

6.The student is correct in that it is simple enough to find the net inflow or outflow of cash during the period. But this is only the starting point in preparing the statement of cash flows. First, all of the balance sheet accounts must be analyzed to find the explanations for the increases and decreases in cash during the period. Second, each of these inflows and outflows must be classified as either operating, investing, or financing activities.

7.The only accurate part of this statement is that depreciation is often one of the largest items in the Operating Activities section of the statement. However, this is merely a result of using the indirect method to prepare this section. In computing net income, depreciation is deducted. Therefore, under the indirect method it must be added back to net income because it is a noncash expense. Depreciation does not in any way generate cash.

8.There is considerable debate over which method is most useful. Many accountants, as well as users of the statements, believe that the direct method, with its emphasis on cash receipts and cash payments, provides the most information. Others believe that the indirect method is better because it focuses attention on the differences between net income and net cash provided by operations. Accounting standards allow the use of either method, but companies are strongly encouraged to use the direct method.

9.Under the indirect method, net income is reported at the top of the Operating Activities section, and adjustments are made to convert income to a cash basis. Sales revenue is included in net income. However, on a cash basis we are interested in cash collections from sales, not the sales on an accrual basis. A decrease in accounts receivable indicates that cash collections exceeded sales revenue. Therefore, the excess is added back to the net income of the period.

10.Inventory is analyzed to determine the purchases of the period. Cost of goods sold decreases the Inventory account, and purchases increases it. After the purchases of the period are found, they are added to the beginning balance in the Accounts Payable account. The difference between the addition of these amounts and the ending balance in Accounts Payable is the amount of cash payments.

11.A profitable year does not guarantee a large cash balance at the end of the year. A large share of the profits may be returned to the stockholders in the form of cash dividends. Investments in new plant and equipment require significant amounts of cash, as does the repayment of various forms of borrowing.

12.Yes, it is possible to report a net loss and still experience a net increase in cash. First, a company could report large noncash charges against net income, such as depreciation and various types of losses. Thus, it is possible that net cash provided by operating activities is positive even though a net loss is reported. Second, the net loss deals only with operating activities. It is possible that a net cash inflow was provided by either investing or financing activities, or both.

13.Regardless of which method is used, a decrease in income taxes payable means that cash paid to the government during the period exceeded income tax expense on the income statement. Under the direct method, the amount of cash paid is reported as a cash outflow in the Operating Activities section of the statement. If the indirect method is used, the decrease in taxes payable is deducted from net income to arrive at net cash flow from operations.

14.The requirement to separately disclose income taxes paid and interest paid when the indirect method is used is a compromise. Accounting standards strongly encourage companies to use the direct method because each major operating cash receipt and payment is reported in the Operating Activities section of the statement. However, if a company chooses to use the indirect approach, they are still required to report separately how much cash was actually paid to the government in taxes and to creditors in interest.

15.An argument can be made that it is inconsistent to report interest paid in the operating section and dividends paid in the financing section. Both represent returns to providers of capital: interest to creditors and dividends to stockholders. Furthermore, the cash raised from each of these sourcesthe amounts borrowed from creditors and the amounts contributed by stockholdersis classified as an inflow in the financing section of the statement. The rationale normally given for this treatment is that interest enters into the determination of net income, and thus the cash expended in interest should appear in the operating section. Many believe that this is illogical and that both interest paid and dividends paid belong in the financing section.

16.An analysis of the Prepaid Rent account can be used to find the amount of cash paid for rent:

Beginning Prepaid Rent$9,600

+ Cash paymentsX

Rent Expense

45,900

= Ending Prepaid Rent$7,300

$9,600 + X $45,900 = $7,300

X = $43,600

17.The purchase of 2,000 shares of treasury stock at $20 per share would be reflected on the statement of cash flows as a cash outflow of $40,000 in the financing activities section of the statement.

18.The entry to record the sale of the truck is:

Cash

9,000

Accumulated Depreciation14,000*

Loss on Sale2,000**

Delivery Truck

25,000

To record sale of truck at a loss.

*$25,000 $11,000

**$11,000 $9,000

Assets=Liabilities+ Owners Equity

+9,000

2,000

+14,000

25,000

Two items would be reported on a statement of cash flows using the indirect method. First, the loss of $2,000 would be added back to net income in the operating activities section. Second, the cash received of $9,000 would be reported as a cash inflow in the investing activities section.

19.Since the company neither bought nor sold any patents during the year, the decrease in the balance in the account of $4,000 represents the amortization of the patent for the year. Amortization is a noncash expense, as is depreciation, and is added back to net income under the indirect method.

20.A stock dividend does not involve the inflow or outflow of cash and therefore is not reported on a statement of cash flows. It is questionable whether it is even a significant noncash activity that should be reported in the supplemental schedule. It could be argued that the issuance of stock in connection with a stock dividend is a financing activity and that it should be included on the schedule. If a 10% stock dividend is included on the schedule it would be reported at the market value of the shares issued.

21.The information needed to determine a companys cash flow adequacy comes from two sources. The numbers in the numerator of the ratio, net cash provided by operating activities and capital expenditures, appear on the statement of cash flows. The amount of average annual debt maturing over the next five years in the denominator can be found in a note to the financial statements.

exercisesLO 2EXERCISE 12-1 CASH EQUIVALENTS

Investments made during December 2007 that qualify as cash equivalents at December 31, 2007:

Certificate of deposit, due January 31, 2008$35,000

Money Market fund105,000

90-day Treasury bills

75,000Cash equivalents at December 31, 2007$215,000LO 3EXERCISE 12-2 CLASSIFICATION OF ACTIVITIES

1.F8.F

2.S9.S

3.F10.I

4.F11.I or O*

5.O12.O

6.O13.O

7.O

*Investing activity if stock is classified as an available-for-sale security; operating activity if it is classified as a trading security.

LO 3EXERCISE 12-3 RETIREMENT OF BONDS PAYABLE ON THE STATEMENT OF CASH FLOWSINDIRECT METHOD

1.Journal entry:

2007

Dec. 31Bonds Payable500,000

Loss on Retirement of Bonds 50,000

Discount on Bonds Payable

40,000

Cash

510,000

To record retirement of bonds:

$510,000 $460,000.

Assets=Liabilities+ Owners Equity

510,000500,00050,000

+40,000

2.The $510,000 in cash paid to retire the bonds would be reported as a cash outflow in the financing activities section. Assuming the company uses the indirect method, the loss of $50,000 would be added back in the operating activities section.

LO 5EXERCISE 12-4 CASH COLLECTIONSDIRECT METHOD

Cash collections to be reported in the operating activities section of Stanleys 2007 statement of cash flows (direct method):

Accounts receivable, December 31, 2006$80,800

Plus sales during 20071,450,000

Less cash collections during 2007

(X)

Accounts receivable, December 31, 2007$101,100

$80,800 + $1,450,000 X = $101,100

X = $1,429,700LO 5EXERCISE 12-5 CASH PAYMENTSDIRECT METHOD

Cash payments for inventory to be reported in the operating activities section of Lester Enterprises 2007 statement of cash flows (direct method):

Inventory, December 31, 2006$90,200

Plus purchases during 2007X

Less cost of goods sold during 2007

(770,900)

Inventory, December 31, 2007$70,600

$90,200 + X $770,900 = $70,600

X = $751,300

Accounts payable, December 31, 2006$57,700

Plus purchases during 2007751,300

Less cash payments during 2007

(X)

Accounts payable, December 31, 2007$39,200

$57,700 + $751,300 X = $39,200

X=$769,800LO 5EXERCISE 12-6 OPERATING ACTIVITIES SECTIONDIRECT METHOD

1.Operating activities section of the statement of cash flows:LABRADOR COMPANY

PARTIAL STATEMENT OF CASH FLOWS

FOR THE YEAR ENDED DECEMBER 31, 2007

Cash Flows from Operating Activities

Cash collected from customers $102,0001

Cash payments for:

Inventory$(79,000)2

General and administrative(6,000)3

Interest(3,500)4

Taxes

(3,500)5

Total Cash Payments$(92,000)

Net Cash Provided by Operating Activities$10,000

Footnotes:

1Cash collections from customers:

Sales revenue$100,000

Add: Decrease in accounts receivable

2,000

Cash collections$102,000

2Payments for inventory:

Cost of goods sold$75,000

Add: Increase in inventory7,000

Less: Increase in accounts payable

(3,000)

Cash payments$79,000

3For general and administrative expenses:

General and administrative expense$8,000

Less: Decrease in office supplies(3,000)

Add: Decrease in salaries and wages payable

1,000

Cash payments$6,000

4For interest:

Interest expense$3,000

Add: Decrease in interest payable

500

Cash payments$3,500

5For taxes:

Income tax expense$5,000

Less: Increase in income taxes payable

(1,500)

Cash payments$3,500

2.The use of the direct method reveals the amounts collected from customers and the amounts paid for inventory, interest, taxes, and other operating purposes. The indirect method simply reconciles the net income of the period to the net cash flow from operations. The direct method shows the reader of the statement the specific amounts collected and paid for operating purposes.

LO 5EXERCISE 12-7 DETERMINATION OF MISSING AMOUNTSCASH FLOW FROM OPERATING ACTIVITIES

Case 1:

Accounts Receivable

Beginning balance150,000

Credit sales175,00035,000Write-offs

X = Cash collections

Ending balance100,000

$150,000 + $175,000 $35,000 X = $100,000

X = $190,000

$190,000 + $60,000 (Cash sales) = $250,000Case 2:Inventory


X = Purchases175,000Cost of goods

sold expense


$80,000 + X $175,000 = $55,000

X = $150,000Accounts Payable

25,000Beginning

balance

X = Cash payments150,000Purchases

15,000Ending

balance

$25,000 + $150,000 X = $15,000

X = $160,000Case 3:

Prepaid Insurance


X = Cash payments15,000Insurance

expense


$17,000 + X $15,000 = $20,000

X = $18,000Case 4:

Income Taxes Payable

95,000Beginning

balance

X = Cash payments300,000Tax expense

115,000Ending

balance

$95,000 + $300,000 X = $115,000

X = $280,000LO 5EXERCISE 12-8 DIVIDENDS ON THE STATEMENT OF CASH FLOWS

1.First, determine the amount of dividends declared:

Retained Earnings

250,000Beginning

Stock dividend50,000

balance

X = Dividends declared285,000Net income

375,000Ending

balance

$250,000 + $285,000 $50,000 X = $375,000

X = $110,000

Then, solve for the amount of dividends paid:

Dividends Payable

20,000Beginning

balance

X = Dividends paid110,000Dividends

declared

30,000Ending

balance

$20,000 + $110,000 X = $30,000

X = $100,000

2.Because a stock dividend does not involve cash, it is not reported on the statement of cash flows. It is questionable whether or not a stock dividend is a significant noncash activity that should be reported on a supplemental schedule.

LO 6EXERCISE 12-9 ADJUSTMENTS TO NET INCOME WITH THE INDIRECT METHOD

1.A6.A

2.D7.D

3.A8.A

4.A9.NR

5.NR10.ALO 6EXERCISE 12-10 OPERATING ACTIVITIES SECTIONINDIRECT METHOD

1.Operating activities section of the statement of cash flows:SUFFOLK COMPANY

PARTIAL STATEMENT OF CASH FLOWS


Cash Provided by Operating Activities

Net income$40,000

Adjustments to reconcile net income to net cash

provided by operating activities:

Depreciation expense20,000

Increase in accounts receivable(8,000)

Decrease in inventory 10,000

Increase in prepaid rent(2,000)

Increase in accounts payable7,000

Decrease in income taxes payable(4,000)

Increase in interest payable

3,000

Net cash inflow from operating activities$66,000

2.The primary reason that net cash inflow from operating activities of $66,000 is more than net income of $40,000 is depreciation of $20,000. It is deducted on the income statement but it does not require the use of cash. Other reasons for the higher amount of net cash inflow from operating activities are the decrease in inventory (the company is not buying as much inventory) and the increase in accounts payable (the company is slowing down payments to its creditors).

LO 7EXERCISE 12-11 CASH FLOW ADEQUACY

1.Cash flow adequacy ratio: (Net cash provided by operations Capital expenditures)/Average annual debt maturing over next five years

= ($12,000,000 $2,000,000)/($20,000,000/5)

= $10,000,000/$4,000,000

= 2.5

2.The cash flow adequacy ratio gives the user an indication of whether or not the company is generating sufficient cash from its operations to repay its debts, after taking into consideration the need to make necessary expenditures on new plant and equipment. It would appear that a ratio of 2.5 is reasonable; however, other factors should be considered, including how the ratio compares with prior years as well as with competitors.

MULTI-CONCEPT EXERCISESLO 2,3EXERCISE 12-12 CLASSIFICATION OF ACTIVITIES

1.OI6.CE

2.CE7.II

3.IF8.OI

4.OI9.IF

5.OF10.OF

LO 3,5EXERCISE 12-13 CLASSIFICATION OF ACTIVITIES

1.IO7.OO

2.OO8.OI

3.NR9.OF

4.IF10.NR

5.IO11.OF

6.NR12.II

LO 3,6EXERCISE 12-14 LONG-TERM ASSETS ON THE STATEMENT OF CASH FLOWSINDIRECT METHOD

First, determine the accumulated depreciation on the assets sold so that the book value of those sold can be found:

Accumulated Depreciation

200,000Beginning

balance

X =Accumulated50,000Depreciation

depreciation on assets sold

expense

160,000Ending

balance

$200,000 + $50,000 X = $160,000

X = $90,000Thus, the entry to record the sale would be

Cash

64,000

Accumulated Depreciation90,000

Plant and Equipment

150,000

Gain on Sale

4,000

To record sale of plant and equipment at a gain.

Assets=Liabilities+Owners Equity

+64,000

+4,000

+90,000

150,000

Plant and Equipment


X = Acquisitions150,000Sale of plant

and equipment


$500,000 + X $150,000 = $750,000

X = $400,000Similarly, acquisitions of new patents can be determined:

Patents


X = Acquisitions8,000Amortization

expense


$80,000 + X $8,000 = $92,000

X = $20,000These items would appear on the statement of cash flows as follows:


Net income$200,000




Amortization expense8,000

Gain on sale of plant and equipment(4,000)

Cash Flows from Investing Activities

Sale of plant and equipment64,000

Acquisition of plant and equipment(400,000)

Acquisition of patents(20,000)LO 1,5EXERCISE 12-15 INCOME STATEMENT, STATEMENT OF CASH FLOWS (DIRECT METHOD), AND BALANCE SHEET

1.Income statement:HANDSOME HOUNDS GROOMING COMPANY

INCOME STATEMENT

FOR THE YEAR ENDED XX/XX/XX

Grooming service revenue

$150,000

Expenses:

Rent expense$12,000

Amortization of patent10,0001

Other operating expenses

58,0002

80,000

Net income

$70,000

1$100,000/10 years

2$80,000 $10,000 $12,000

2.Statement of cash flows:HANDSOME HOUNDS GROOMING COMPANY

STATEMENT OF CASH FLOWS

FOR THE YEAR ENDED XX/XX/XX


Cash receipts from:

Cash sales$110,0001

Collections on account

30,0002

Total cash receipts $140,000

Cash payments for:

Rent$(12,000)

Security deposit(2,000)

Other operating expenses

(58,000)3

Total cash payments$(72,000)

Net cash provided by operating activities$68,000


Down payment on patent$(20,000)4

Cash Flows from Financing Activities

Issuance of common stock$50,000

Cash dividends paid

(20,000)

Net cash provided by financing activities$30,000

Net increase in cash$78,000

Cash balance, beginning of year

0

Cash balance, end of year$78,000

Supplemental Schedule of Noncash Activities

Acquisition of patent in exchange for four-year note$80,000

1$150,000 $40,0003$80,000 $12,000 $10,000

2$40,000 $10,0004$100,000 20%

3.The company generated slightly less cash flow from operations, $68,000, than it earned in net income, $70,000. The differences between the two can be reconciled as follows:

Net income$70,000

Add:

Amortization of patent10,000

Deduct:

Security deposit (not yet an expense)(2,000)

Uncollected accounts receivable

(10,000)

Net cash flow from operating activities$68,000

4.Balance sheet:HANDSOME HOUNDS GROOMING COMPANY

BALANCE SHEET

AS OF XX/XX/XX

Assets

Current Assets:

Cash (from Part 2.)$78,000

Accounts receivable10,000

Security deposit

2,000

Total current assets

$90,000

Long-term Assets:

Patent

90,0001

Total Assets

$180,000

Liabilities and Stockholders Equity

Long-term liabilities:

Notes payable

$80,000

Stockholders Equity:

Common stock$50,000

Retained earnings

50,0002

Total stockholders equity

100,000

Total liabilities and stockholders equity

$180,000

1$100,000 $10,000

2Net income of $70,000 less cash dividends of $20,000.

problemsLO 6PROBLEM 12-1 STATEMENT OF CASH FLOWSINDIRECT METHOD

1.Changes in account balances and explanations (in thousands of dollars):

Net Change

Dr. (Cr.)Explanation

Cash(2)

Accounts receivable5

Inventory(10)

Prepaid rent3

Land0

Plant and equipment100Purchase

Accumulated depreciation(35)Depreciation expense

Accounts payable(2)

Income taxes payable2

Short-term notes payable(10)Issuance

Bonds payable25Retirement

Common stock(50)Issuance

Retained earnings

(26)Net income

Total

0

Statement of cash flows:CHRISMAN COMPANY



(IN THOUSANDS OF DOLLARS)


Net income$26

Adjustments to reconcile net income to net cash provided

by operating activities:

Depreciation expense35

Increase in accounts receivable(5)

Decrease in inventory10

Increase in prepaid rent(3)

Increase in accounts payable2

Decrease in income taxes payable

(2)

Net cash provided by operating activities$63


Acquisition of plant and equipment$(100)


Retirement of bonds payable$(25)

Issuance of short-term notes payable10

Issuance of common stock

50

Net cash provided by financing activities$35

Net increase (decrease) in cash$(2)

Cash balance, December 31, 2006

10

Cash balance, December 31, 2007$8

2.No, Chrisman did not generate enough cash from its operations to pay for its investing activities. Cash flow from operating activities amounted to only $63,000, while the company spent $100,000 to acquire plant and equipment. The additional cash needed to finance the acquisition was raised by issuing a note for $10,000 and issuing common stock for $50,000.

LO 8PROBLEM 12-2 STATEMENT OF CASH FLOWS USING A WORK SHEETINDIRECT METHOD (Appendix)

1.Statement of cash flows work sheet (all amounts are in thousands of dollars):

Balances

Cash Inflows (Outflows)

Accounts12/31/0712/31/06ChangesOperatingInvestingFinancing

Cash810(2)

Accounts receivable20155(5)

Inventory1525(10)10

Prepaid rent963(3)

Land7575

Plant and equipment4003001001

(100)

Accumulated

depreciation(65)(30)(35)235

Accounts payable(12)(10)(2)2

Income tax payable(3)(5)2(2)

Short-term notes

payable(35)(25)(10)3

10

Bonds payable(75)(100)254

(25)

Common stock(200)(150)(50)5

50

Retained earnings

(137)(111)

(26)626

Totals

0

0

063(100)35

Net increase

(decrease) in cash

(2)

1Purchase of equipment.4Retirement of bonds.

2Depreciation expense.5Issuance of common stock.

3Proceeds from note.6Net income.

2.Statement of cash flows:CHRISMAN COMPANY





Net income$26









(2)



Acquisition of plant and equipment$(100)


Retirement of bonds payable$(25)

Issuance of short-term notes payable10


50




10


3.No, Chrisman did not generate enough cash from its operations to pay for its investing activities. Cash flow from operating activities amounted to only $63,000, while the company spent $100,000 to acquire plant and equipment. The additional cash needed to finance the acquisition was raised by issuing a note for $10,000 and issuing common stock for $50,000.

LO 5PROBLEM 12-3 STATEMENT OF CASH FLOWSDIRECT METHOD


Net Change


Cash(38)


Inventory30

Prepayments(10)

Land150Purchase (c)

Plant and equipment200Purchase (c)

Accumulated depreciation(50)Depreciation expense (b)

Accounts payable18

Other accrued liabilities(5)

Income tax payable20

Long-term bank loan

payable(50)Proceeds from bank loan (c)

Common stock(150)Issuance of common stock (c)

Retained earnings

(165)60 Dividends (a)

(225) Net income

Total

0

Conversion of income statement items to a cash basis (in thousands of dollars):

Income StatementAmountAdjustmentCash Flows

Sales revenue$1,250

$1,250

Increase in accounts receivable

(50)

Cash collected$1,200

Cost of goods sold700

$700

+ Increase in inventory30

+ Decrease in accounts payable

18

Cash payments$748

Operating expenses150

$150

Decrease in prepayments(10)

Depreciation expense(50)

Increase in accrued liabilities

(5)

Cash payments$85

Interest expense25

$25

No interest payable

0

Cash payments$25

Income tax expense

150

$150

+ Decrease in income tax payable

20

Cash paid for taxes$170

Net income$225Net cash flow from operations$172

Statement of cash flows:PEORIA CORP.





Cash collections from customers$1,200

Cash payments for:

Inventory$(748)

Operating expenses(85)

Interest(25)

Income taxes

(170)


Net cash provided by operating activities $172


Acquisition of land$(150)

Acquisition of plant and equipment

(200)

Net cash used by investing activities$(350)


Additional long-term borrowings$50

Issuance of common stock150

Cash dividends paid

(60)


Net decrease in cash$(38)


90


2.Memorandum to the president:

TO:President of Peoria Corp.

FROM:Students name

DATE:January 20, 2008

SUBJECT:Cash flows

You recently expressed concern that in spite of the profitable year according to the income statement, cash decreased during 2007. Furthermore, there was a concern about the decrease in the companys cash balance during 2007 to $52,000 at year-end, given that existing loan covenants require a $50,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.

Although net income on an accrual basis was $225,000, net cash flow from operating activities was only $172,000. One of the reasons is that cash collections were only $1,200,000 even though sales were $1,250,000. Also, inventory was increased by $30,000 during the period, and accounts payable was reduced by $18,000. Similarly, taxes payable was reduced by $20,000, resulting in a further drain on cash. Finally, two major acquisitions were made during the year: $200,000 was spent on new plant and equipment and another $150,000 to acquire new land. These were only partially offset by the sale of additional stock for $150,000 and the issuance of additional notes in the amount of $50,000. Finally, cash dividends amounted to $60,000, a further drain on cash.

Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. We can also improve our operating cash flow by accelerating the collection of receivables as much as possible. Similarly, we should be able to reduce the amount of inventory on hand at any one time and over the long run reduce the cash paid for inventory purchases.

LO 6PROBLEM 12-4 STATEMENT OF CASH FLOWSINDIRECT METHOD


Net Change


Cash(38)


Inventory30

Prepayments(10)

Land150Purchase (c)



Accounts payable18



Long-term bank loan payable(50)Proceeds from bank loan (c)


Retained earnings(165)60 Dividends (a)

(225) Net income

Total

0

Statement of cash flows:PEORIA CORP.





Net income$225

Adjustments to reconcile net income to net

cash provided by operating activities:



Increase in inventories(30)

Decrease in prepayments10

Decrease in accounts payable(18)

Increase in other accrued liabilities5


(20)





(200)





Cash dividends paid

(60)




90




FROM:Students name


SUBJECT:Cash flows

You recently expressed concern regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern about the decrease in the companys cash balance during 2007 to $52,000 at year-end, given that existing loan covenants require a $50,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.

Although net income on an accrual basis was $225,000, changes in various noncash working capital accounts resulted in net cash flow from operating activities of only $172,000. For example, $50,000 less was collected in cash than the sales of the period. Accounts payable was reduced by $18,000 and taxes payable by $20,000, both resulting in a drain on cash. Finally, two major acquisitions were made during the year: $200,000 was spent on new plant and equipment and another $150,000 to acquire new land. These were only partially offset by the sale of additional stock for $150,000 and the issuance of additional notes in the amount of $50,000. Finally, cash dividends amounted to $60,000, a further drain on cash.




Balances



Cash5290(38)


Inventory23020030(30)

Prepayments1525(10)10

Land7506001501

(150)


(200)

Accumulated


Accounts payable(130)(148)18(18)

Accrued liabilities(68)(63)(5)5


Long-term loan

payable(350)(300)(50)4

50

Common stock(550)(400)(150)5

150

Retained earnings(489)(324)606

(60)

(225)7225

Totals

0

0

0172(350)140

Net increase

(decrease) in cash

(38)

1Purchase of land.5Issuance of common stock.

2Purchase of plant and equipment.6Dividends.

3Depreciation expense.7Net income.

4Proceeds from bank loan.

2.Statement of cash flows:PEORIA CORP.





Net income$225

Adjustments to reconcile net income to net

cash provided by operating activities:





Decrease in accounts payable(18)



(20)





(200)





Cash dividends paid

(60)




90




FROM:Students name


SUBJECT:Cash flows

You recently expressed concern to me regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern about the decrease in the companys cash balance during 2007 to $52,000 at year-end, given that existing loan covenants require a $50,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.

Although net income on an accrual basis was $225,000, changes in various noncash working capital accounts resulted in net cash flow from operating activities of only $172,000. For example, $50,000 less was collected in cash than the sales of the period. Accounts payable was reduced by $18,000 and taxes payable by $20,000, both resulting in a drain on cash. Finally, two major acquisitions were made during the year: $200,000 was spent on new plant and equipment and another $150,000 to acquire new land. These were only partially offset by the sale of additional stock for $150,000 and the issuance of additional notes in the amount of $50,000. Finally, cash dividends amounted to $60,000, a further drain on cash.


LO 5PROBLEM 12-6 STATEMENT OF CASH FLOWSDIRECT METHOD


Net Change


Cash15

Accounts receivable(25)

Inventory(50)

Prepayments10

Land75Purchase (c)



Accounts payable(25)

Other accrued liabilities10

Interest payable(5)



Retained earnings13535 Dividends (a)

100 Net loss

Total

0



Sales revenue$500

$500

+ Decrease in accounts receivable

25

Cash collected$525


$400

Decrease in inventory(50)

Increase in accounts payable

(25)

Cash payments$325


$180

+ Increase in prepayments

10


+ Decrease in accrued liabilities

10

Cash payments$130

Interest expense20

$20


(5)

Cash payments$15

Net income (loss)$(100)Net cash flow from operations$55

Statement of cash flows:ASTRO INC.





Cash collections on account$525

Cash payments for:

Inventory$(325)


Interest

(15)

Total cash payments$(470)





(70)





Cash dividends paid

(35)


Net increase in cash$15


80



TO:President of Astro Inc.

FROM:Students name


SUBJECT:Cash flows

You recently expressed concern to me regarding the large loss we sustained during 2007 in view of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference.

Astro was able to generate a significant amount of cash from operations even though we incurred the large net loss of $100,000. One reason for the difference between cash generated from operations and the net loss was the large amount of depreciation expense on the income statement. This noncash expense reduced net income, but without a corresponding effect on cash flow. Further, the decrease in accounts receivable indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the combined effect of a reduction in inventory and an increase in the amounts owed suppliers (accounts payable) added to the cash generated.

Operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. The gross profit percentage of 20% appears reasonable, although this depends on many factors, including how our competitors are doing in this area. A significant portion of the operating expenses is the depreciation of $70,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added to our base of long-term assets. I would recommend that we explore ways to reduce our other operating expenses. I look forward to hearing from you before moving forward with any actions.

LO 6PROBLEM 12-7 STATEMENT OF CASH FLOWSINDIRECT METHOD


Net Change


Cash15


Inventory(50)

Prepayments10

Land75Purchase (c)





Interest payable(5)




100 Net loss

Total

0

Statement of cash flows:ASTRO INC.



(AMOUNTS IN THOUSANDS OF DOLLARS)


Net loss$(100)




Decrease in accounts receivable25

Decrease in inventories50

Increase in prepayments(10)


Decrease in other accrued liabilities(10)


5





(70)





Cash dividends paid

(35)




80




FROM:Students name


SUBJECT:Cash flows

You recently expressed concern to me regarding the large loss we sustained during 2007 in spite of the net increase in cash during the year. Following are my thoughts, along with a copy of the 2007 statement of cash flows for your reference.

Astro was able to generate a significant amount of cash from operations even though we incurred the large net loss of $100,000. One reason for the difference between cash generated from operations and the net loss was the large amount of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Further, the decrease in accounts receivable indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the combined effect of a reduction in inventory and an increase in the amounts owed suppliers (accounts payable) added to the cash generated.

Operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. The gross profit percentage of 20% appears reasonable, although this depends on many factors, including how our competitors are doing in this area. A significant portion of the operating expenses is the depreciation of $70,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added to our base of long-term assets. I would recommend that we explore ways to reduce our other operating expenses. I look forward to hearing from you before moving forward with any actions.

LO 8PROBLEM 12-8 STATEMENT OF CASH FLOWS USING A WORK SHEETINDIRECT METHOD (APPENDIX)


Balances



Cash958015

Accounts receivable5075(25)25

Inventory100150(50)50

Prepayments 554510(10)

Land475400751

(75)


(70)

Accumulated



Other accrued

liabilities(35)(45)10(10)

Interest payable(15)(10)(5)5

Long-term loan

payable(340)(250)(90)4

90


50

Retained earnings(310)(445)1006(100)

357

(35)

Totals

0

0

0

55(145)105

Net increase

(decrease) in cash

15

1Purchase of land.

2Purchase of plant and equipment.

3Depreciation expense.

4Proceeds from borrowings.

5Issuance of common stock.

6Net loss.

7Cash dividends paid.

2.Statement of cash flows:ASTRO INC.



(AMOUNTS IN THOUSANDS OF DOLLARS)


Net loss$(100)





Decrease in inventories50





5





(70)





Cash dividends paid

(35)




80




FROM:Students name


SUBJECT:Cash flows


Astro was able to generate a significant amount of cash from operations even though we incurred the large net loss of $100,000. One reason for the difference between cash generated from operations and the net loss was the large amount of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Furthermore, the decrease in accounts receivable indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the combined effect of a reduction in inventory and an increase in the amounts owed suppliers (accounts payable) added to the cash generated.

Operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. The gross profit percentage of 20% appears reasonable, although this depends on many factors, including how our competitors are doing in this area. A significant portion of the operating expenses is the depreciation of $70,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added to our base of long-term assets. I recommend that we explore ways to reduce our other operating expenses. I look forward to hearing from you before moving forward with any actions.

LO 6PROBLEM 12-9 YEAR-END BALANCE SHEET AND STATEMENT OF CASH FLOWSINDIRECT METHOD


Net Change


Cash?

Accounts receivable10h.sales exceeded cash

collections

Land100g.bonds were exchanged

for landa noncash

activity

Plant and equipment200f.purchase

Accumulated depreciation(20)b.depreciation expense

Investments0

no change given

Current liabilities0i.no change

Bonds payable(250)d.150 issued for cash and

g.100 issued for land

Common stock50e.common stock retired

Retained earnings

(45)c.dividends of 25

a.net income of (70)

Total without cash

45 dr.

Thus, the change in cash must be 45 cr. (decrease) to balance the total changes in the accounts.

Statement of Cash Flows:TERRIER COMPANY





Net income$70





(10)



Acquisitions of plant and equipment$(200)


Payment of cash dividends$(25)

Issuance of additional bonds150

Acquisition and retirement of stock

(50)




140


Schedule of Noncash Investing and Financing Activities

Acquisition of land in exchange for bonds$100

2.Balance sheet:TERRIER COMPANY

BALANCE SHEET

DECEMBER 31, 2007


Cash$951

Accounts receivable

1652

Total current assets$260

Land$4003

Plant and equipment

7004

Accumulated depreciation

(170)5

Investments

100

Total long-term assets$1,030

Total assets$1,290

Current liabilities$205

Bonds payable$5506

Common stock$3507

Retained earnings

1858

Total stockholders equity$535

Total liabilities and stockholders equity$1,290

1$140 $455$150 + $20

2$155 + $106$300 + $250

3$300 + $1007$400 $50

4$500 + $2008$140 + $45

3.In addition to the bonds issued in exchange for land, Terrier issued $150,000 of bonds for cash. The money raised from this issuance was needed to help finance the addition of $200,000 in plant and equipment.


1.Balance sheet:

TERRIER COMPANY

BALANCE SHEET

DECEMBER 31, 2007


Cash$951

Accounts receivable

1652

Total current assets$260

Land$4003

Plant and equipment

7004

Accumulated depreciation

(170)5

Investments

100

Total long-term assets$1,030

Total assets$1,290Current liabilities$205Bonds payable$5506Common stock$3507Retained earnings

1858

Total stockholders equity$535

Total liabilities and stockholders equity$1,290

1$140 $455$150 + $20

2$155 + $106$300 + $250

3$300 + $1007$400 $50

4$500 + $2008$140 + $45


Balances



Cash95140(45)


Land4003001001


(200)

Accumulated


Investments1001000

Current liabilities(205)(205)0

Bonds payable(550)(300)(100)1

(150)4

150

Common stock(350)(400)505

(50)

Retained earnings(185)(140)(70)670

257

(25)

Totals

0

0

0

80(200)

75

Net increase

(decrease) in cash

(45)

1Acquisition of land in exchange for bonds (noncash transaction).

2Purchase of plant and equipment.


4Proceeds from issuance of additional bonds.

5Acquisition and retirement of common stock.

6Net income.

7Cash dividends paid.

3.Statement of cash flows:

TERRIER COMPANY





Net income$70





(10)



Acquisitions of plant and equipment$(200)


Payment of cash dividends$(25)

Issuance of additional bonds150

Acquisition and retirement of stock

(50)




140


Schedule of Noncash Investing and Financing Activities

Acquisition of land in exchange for bonds$100

4.In addition to the bonds issued in exchange for land, Terrier issued $150,000 of bonds for cash. The money raised from this issuance was needed to help finance the addition of $200,000 in plant and equipment.

MULTI-CONCEPT PROBLEMS

LO 4,5PROBLEM 12-11 STATEMENT OF CASH FLOWSDIRECT METHOD


Net Change


Cash(9)


Inventory(15)

Prepaid rent(4)

Land80Purchase

Plant and equipment150Purchase of 195 and sale of (45)

Accumulated depreciation(60)15 sale of asset (cost of 45 less

book value of 30) and (75)

depreciation;

Accounts payable(7)


Income tax payable2

Long-term bank loan payable30Repayment

Common stock(150)Issuance of common stock

Retained earnings

(26)7 Dividends

(33) Net income

Total

0



Sales revenue$550

$550


(15)

Cash collected$535


$350

Decrease in inventory(15)


(7)

Cash payments$328

General and

administrative55

$55

Decrease in prepaid rent(4)


(6)

Cash payments$45

Depreciation expense75No cash flow effect$0

Loss on sale of

Not an operating activity$0

plant assets5

Interest expense15No interest payable

Cash payments$15

Income tax expense

17

$17

+ Decrease in income

taxes payable

2

Cash payments$19


Statement of cash flows:

GLENDIVE CORP.


FOR THE YEAR ENDED JUNE 30, 2007


Cash Flow from Operating Activities

Cash collections from customers$535

Cash payments for:

Inventory$(328)

General and administrative(45)

Interest(15)

Income taxes

(19)



Cash Flow from Investing Activities

Sale of plant assets$25

Acquisition of land(80)

Acquisition of new plant assets

(195)


Cash Flow from Financing Activities

Repayment of long-term loan$(30)

Issuance of additional stock150

Payment of cash dividends

(7)



Cash balance, June 30, 2006

40

Cash balance, June 30, 2007$31

2.It is true that the amount of cash flow from operating activities is the same regardless of which method (direct or indirect) is used. The two methods, however, differ in the information reported to the reader of the statement of cash flows. The direct method shows the actual inflows and outflows of cash, while the indirect method arrives at the same amount by reconciling net income to cash flow from operating activities.

LO 4,6PROBLEM 12-12 STATEMENT OF CASH FLOWSINDIRECT METHOD


Net Change


Cash(9)


Inventory(15)

Prepaid rent(4)

Land80Purchase

Plant and equipment150Purchase of 195 and sale of (45)

Accumulated depreciation(60)15 sale of asset (cost of 45 less

book value of 30) and (75)

depreciation;

Accounts payable(7)


Income tax payable2

Long-term bank loan payable30 Repayment

Common stock(150)Issuance of common stock

Retained earnings

(26)7 Dividends

(33) Net income

Total

0


GLENDIVE CORP.


FOR THE YEAR ENDED JUNE 30, 2007


Cash Flow from Operating Activities

Net income$33




Loss on sale of plant assets5*



Decrease in prepaid rent4




(2)


*Book value $30 proceeds $25

Cash Flow from Investing Activities

Sale of plant assets$25


Acquisition of new plant assets

(195)


Cash Flow from Financing Activities

Repayment of long-term loan$(30)

Issuance of additional stock150

Payment of cash dividends

(7)



Cash balance, June 30, 2006

40

Cash balance, June 30, 2007$31

2.It is true that the amount of cash flow from operating activities is the same regardless of which method (direct or indirect) is used. The two methods, however, differ in the information reported to the reader of the statement of cash flows. The direct method shows the actual inflows and outflows of cash, while the indirect method arrives at the same amount by reconciling net income to cash flow from operating activities.

LO 2,5PROBLEM 12-13 STATEMENT OF CASH FLOWSDIRECT METHOD

1.No, the U.S. Treasury bills are not cash equivalents, because they have a maturity in excess of three months. Instead, the six-month Treasury bills are properly classified as current assets.


Net Change


Cash(40)

U.S. Treasury bills(50)Sale


Inventory120

Land10 Purchase

Buildings and equipment110Purchase

Accumulated depreciation(60)Depreciation expense

Patents(25)Amortization


Taxes payable(5)

Notes payable0

Term notes payable0

Common stock(130)(130) Stock dividend

Retained earnings

20(110) Net income

130 Stock dividend

Total

0



Sales revenue$2,408

$2,408


(110)


Cost of goods sold1,100

$1,100



(60)

Cash payments$1,160

Salaries & benefits850No payable$850

Heat, light, and power75No payable$75

Depreciation60No cash flow effect

Property taxes18No payable*$18

Patent amortization25No cash flow effect

Miscellaneous expenses10No payable$10

Interest expense55No payable$55

Income tax expense

105

$105

Increase in income tax payable*

(5)

Cash payments$100


*The current liability Taxes Payable is assumed to relate entirely to income taxes rather than property taxes.


LANG COMPANY






Cash payments for:

Inventory $(1,160)

Salaries and benefits(850)

Heat, light, and power(75)

Property taxes(18)

Miscellaneous activities(10)

Interest(55)

Income taxes

(100)




Sale of U.S. Treasury bills$50


Acquisition of buildings and equipment

(110)




100


Note: It is questionable whether or not the stock dividend is a significant noncash activity. If it is determined to be significant, it should be shown on a supplemental schedule of noncash activities.

alternate problemsLO 6PROBLEM 12-1A STATEMENT OF CASH FLOWSINDIRECT METHOD

1.Account changes Dr (Cr) and Explanations:

Cash2,000

Accounts receivable(2,000)

Inventory1,000

Prepaid rent200

Land0

Plant and equipment50,000Purchase

Accumulated depreciation(50,000)Depreciation expense

Accounts payable0

Income taxes payable(500)

Short-term notes payable2,500Repayment

Bonds payable(25,000)Issuance

Common stock0

Retained earnings

21,800Net loss

Total

0


MADISON COMPANY




Net loss$(21,800)




Decrease in accounts receivable2,000

Increase in inventory(1,000)


Increase in income taxes payable

500



Acquisition of plant and equipment$(50,000)


Issuance of bonds payable$25,000

Repayment of short-term notes payable

(2,500)


Net increase in cash$2,000


10,000

Cash balance, December 31, 2007$12,000

2.Madison was able to increase its cash balance even though it incurred a net loss primarily because it had one very large expense that did not require the use of any cash: depreciation of $50,000. This one adjustment is the major difference between the net loss of $21,800 and the net cash flow from operating activities of $29,500.LO 8PROBLEM 12-2A STATEMENT OF CASH FLOWS USING A WORK SHEETINDIRECT METHOD (Appendix)

1.Statement of cash flows work sheet (all amounts are in thousands of dollars)

Balances



Cash12.010.02.0

Accounts receivable10.012.0(2.0)2.0

Inventory8.07.01.0(1.0)

Prepaid rent1.21.00.2(0.2)

Land75.075.00.0

Plant and equipment200.0150.050.01

(50)

Accumulated

depreciation(75.0)(25.0)(50.0)250.0

Accounts payable(15.0)(15.0)0.0

Income tax payable(2.5)(2.0)(0.5)0.5

Short-term notes

payable(20.0)(22.5)2.53

(2.5)

Bonds payable(75.0)(50.0)(25.0)4

25.0

Common stock(100.0)(100.0)0.0

Retained earnings

(18.7)

(40.5)

21.85(21.8)

Totals

0.0

0.0

0.0

29.5(50)

22.5

Net increase

(decrease) in cash

2.01Purchase of equipment.


3Retirement of note.

4Issuance of bonds.

5Net loss.


MADISON COMPANY




Net loss$(21,800)




Decrease in accounts receivable2,000

Increase in inventory(1,000)


Increase in income taxes payable

500



Acquisition of plant and equipment$(50,000)


Issuance of bonds payable$25,000

Repayment of short-term notes payable

(2,500)


Net increase (decrease) in cash$2,000


10,000

Cash balance, December 31, 2007$12,000

3.Madison was able to increase its cash balance even though it incurred a net loss primarily because it had one very large expense that did not require the use of any cash: depreciation of $50,000. This one adjustment is the major difference between the net loss of $21,800 and the net cash flow from operating activities of $29,500.

LO 5PROBLEM 12-3A STATEMENT OF CASH FLOWSDIRECT METHOD


Net Change


Cash(70)


Inventory20

Prepayments(10)

Land(100)Sale (c)






Long-term bank loan payable50Retirement of bank loan (d)

Common stock(50)Issuance of common stock (d)

Retained earnings


(350) Net income

Total

0



Sales revenue$2,460

$2,460


85


Cost of goods sold1,400

$1,400



(20)

Cash payments$1,400


$460

Decrease in prepayments(10)


+ Decrease in accrued liabilities

5

Cash payments$430

Interest expense100

$100

No interest payable

0

Cash payments$100

Income tax expense

150

$150

+ Decrease in income tax payable

35

Cash paid for taxes$185



WABASH CORP.






Cash payments for:

Inventory$(1,400)


Interest(100)

Income taxes

(185)




Sale of land$100


(250)



Repayment of long-term borrowings$(50)


Cash dividends paid

(350)

Net cash used by financing activities$(350)



210



TO:President of Wabash Corp.

FROM:Students name


SUBJECT:Cash flows

You recently expressed concern to me regarding the decrease in cash during 2007 in spite of the profitable year shown on the income statement. Furthermore, there was a concern regarding the decline in our cash balance during the year, given that existing loan covenants require a $100,000 minimum balance at all times. My thoughts and a copy of the 2007 statement of cash flows follow.

Although net income on an accrual basis was $350,000, net cash flow from operating activities was even higher, $430,000. However, the favorable cash flow during the year was used for various purposes. First, significant additions were made to plant and equipment, $250,000, and this drain on cash was only partially offset by the sale of land for $100,000. Additional stock was sold for $50,000, which was the amount needed to repay an existing bank loan. The major reason, however, for the drain on cash is the size of our dividend payments. Dividends of $350,000 were paid during the year, which is equal to the income of the period.

Our cash flow should improve in future years without the need to invest so heavily in new property, plant, and equipment. At the same time, I recommend that we limit the amount paid in any one year for dividends as a way to keep our cash balance at a sufficient level to satisfy the bank.

LO 6PROBLEM 12-4A STATEMENT OF CASH FLOWSINDIRECT METHOD


Net Change


Cash(70)


Inventory20

Prepayments(10)

Land(100)Sale (c)






Long-term bank loan payable50Retirement of bank loan (d)

Common stock(50)Issuance of common stock (d)

Retained earnings


(350) Net income

Total

0


WABASH CORP.





Net income$350










(35)



Sale of land$100


(250)





50

Cash dividends paid

(350)




210




FROM:Students name


SUBJECT:Cash flows




LO 8PROBLEM 12-5A STATEMENT OF CASH FLOWS USING A WORK SHEETINDIRECT METHOD (Appendix)


Balances



Cash140210(70)

Accounts receivable60145(85)85

Inventory20018020(20)

Prepayments 1525(10)10

Land600700(100)1

100


(250)

Accumulated



Accrued liabilities(50)(55)5(5)


Long-term loan

payable(200)(250)504

(50)


50

Retained earnings(720)(720)3506

(350)

(350)7350

Totals

0

0

0430(150)(350)

Net increase

(decrease) in cash

(70)

1Sale of land.5Issuance of common stock.

2Purchase of plant and equipment.6Dividends.3Depreciation expense.7Net income.

4Retirement of bank loan.


WABASH CORP.





Net income$350










(35)



Sale of land$100


(250)





Cash dividends paid

(350)




210




FROM:Students name


SUBJECT:Cash flows




LO 5PROBLEM 12-6A STATEMENT OF CASH FLOWSDIRECT METHOD


Net Change


Cash15


Inventory0

Prepayments1

Land100Purchase (c)





Interest payable(10)


Common stock0


60 Net loss

Total

0



Sales revenue$350

$350


50

Cash collected$400


$150

No change in inventory


(40)

Cash payments$110


$250

+ Increase in prepayments1



(20)

Cash payments$191

Interest expense

10

$10


(10)

Cash payments$0

Net income (loss)$(60)Net cash flow from operations$99


PLUTO INC.





Cash collections on account$400

Cash payments for:

Inventory$(110)

Operating expenses

(191)






(250)




Cash dividends paid

(84)




10



TO:President of Pluto, Inc.

FROM:Students name


SUBJECT:Cash flows


Pluto was able to generate a significant amount of cash from operations even though we incurred a net loss of $60,000. One reason for the difference between cash generated from operations and the net loss was the $40,000 of depreciation expense on the income statement. This noncash expense reduced reported net income without a corresponding effect on cash flow. Furthermore, the large decrease in accounts receivable of $50,000 indicates that we collected more cash from our customers during the year than the amount of sales to them. Finally, the large buildup of our accounts payable by $40,000 had the effect of improving our cash flow for the year.

The gross profit percentage of 57% is very strong. However, operating expenses need to be decreased relative to gross profit if we are to improve our bottom line in the future. A portion of the operating expenses is the depreciation of $40,000. Because this represents the write-off of a sunk cost (the cost of plant and equipment acquired already), we cannot reduce the amount of this expense unless we decide to sell fixed assets. In fact, during 2007 we actually added $350,000 to our base of long-term assets, in the form of land and plant and equipment acquisitions. You will note on the statement of cash flows that these acquisitions were entirely financed with the issuance of a long-term bank loan.

I recommend two immediate courses of action. First, we must find ways to reduce our operating expenses. Second, until we see an improvement in the bottom line, it is imperative that we cut back, if not eliminate entirely, our dividends. A dividend payment of $84,000 in a year in which we sustained a net loss of $60,000 is not prudent. I look forward to hearing from you before moving forward with any actions.

LO 6PROBLEM 12-7A STATEMENT OF CASH FLOWSINDIRECT METHOD


Net Change


Cash15


Inventory0

Prepayments1

Land100Purchase (c)





Interest payable(10)


Common stock0


60 Net loss

Total

0

Statement of cash flows:PLUTO INC.





Net loss$(60)









10





(250)

Net c

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