Make your own free website on Tripod.com

EXERCISE 23-1

(a)                 Investing activity.

(b)                 Financing activity.

(c)                 Investing activity.

(d)                 Operating—add to net income.

(e)                 Significant noncash investing and financing activity.

(f)                   Financing activity.

(g)                 Operating—add to net income.

(h)                 Financing activity.

(i)                   Significant noncash investing and financing activity.

(j)                   Financing activity.

(k)                 Operating—deduct from net income.

(l)                   Operating—add to net income.

EXERCISE 23-5

Alison Krauss Company

Partial Statement of Cash Flows

For the Year Ended December 31, 2004

Cash flows from operating activities

 

 

 

 

            Cash receipts from customers

 

 

$857,000

(a)

            Cash payments

 

 

 

 

                     For operating expenses

$614,000

(b)

 

 

                     For income taxes

    44,500

(c)

  658,500

 

            Net cash provided by operating

 

 

 

 

               activities

 

 

$198,500

 

 

 

 

 

 

(a)

Computation of cash receipts from customers:

 

 

 

 

Revenue from fees

 

 

$840,000

 

 

Add: Decrease in accounts receivable

 

 

 

 

 

Add:     ($54,000 – $37,000)

 

 

    17,000

 

 

Cash receipts from customers

 

 

$857,000

 

 

 

 

 

 

 

(b)

Computation of cash payments:

 

 

 

 

Operating expenses per income statement

 

 

$624,000

 

 

Deduct: Increase in accounts payable

 

 

 

 

 

Deduct:     ($41,000 – $31,000)

 

 

    10,000

 

 

Cash payments for operating expenses

 

 

$614,000

 

 

 

 

 

 

 

(c)

Income tax expense per income statement

 

 

$  40,000

 

 

Add: Decrease in income taxes payable

 

 

 

 

 

Add:     ($8,500 – $4,000)

 

 

      4,500

 

 

Cash payments for income taxes

 

 

$  44,500

 

 

 

 

 

 

 

EXERCISE 23-13

 

Brecker Inc.

 

 

STATEMENT OF CASH FLOWS

 

 

For the Year Ended December 31, 2005

 

 

Cash flows from operating activities

 

 

 

 

            Less:  Cash received from customers

 

$327,150a

 

 

            Cash paid to suppliers

149,000b

 

 

 

            Cash paid for operating expenses

89,000c

 

 

 

            Cash paid for interest

11,400c

 

 

 

            Cash paid for taxes

    8,750d

  258,150a

 

 

            Net cash provided by operating activities

 

$  69,000a

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

            Sale of equipment

8,000c

 

 

 

            Purchase of equipment

(44,000)

 

 

 

            Purchase of available-for-sale investments

 (17,000)

 

 

 

            Net cash used by investing activities

 

(53,000)

 

Cash flows from financing activities

 

 

 

 

            Principal payment on short-term loan

(2,000)

 

 

 

            Principal payment on long-term loan

(9,000)

 

 

 

            Dividend payments

  (6,000)

 

 

 

            Net cash used by financing activities

 

 (17,000)

 

 

 

 

 

 

 

Net increase in cash

 

(1,000)

 

 

Cash, January 1, 2005

 

    7,000

 

 

Cash, December 31, 2005

 

$  6,000

 

 

 

 

 

 

 

aSales

$338,150

 

 

 

– Increase in accounts receivable

   (11,000)

 

 

 

Cash received from customers

$327,150

 

 

 

 

 

 

 

 

bCost of goods sold

$175,000

 

 

 

– Increase in accounts payable

(6,000)

 

 

 

– Decrease in inventories

   (20,000)

 

 

 

Cash paid to suppliers

$149,000

 

 

cOperating expenses

$120,000

 

 

+ Increase in prepaid rent

1,000

 

 

– Depreciation expense

        $35,000 – [$25,000 – ($20,000 X .70)]

(24,000)

 

 

– Amortization of copyright

(4,000)

 

 

– Increase in wages payable

    (4,000)

 

 

Cash paid operating expenses

$  89,000

 

 

 

 

 

 

dTax expense

$6,750

 

 

+ Decrease in income taxes payable

  2,000

 

 

Cash paid for taxes

$8,750

 

 

EXERCISE 23-20

 

1.

Bonds Payable....................................................................................

300,000

 

 

            Common Stock.......................................................................

 

300,000

 

                (Noncash financing activity)

 

 

 

 

 

 

2.

Operating—Net income........................................................................

410,000

 

       

            Retained Earnings...................................................................

 

410,000

 

 

 

 

3.

Operating—Depreciation Expense.........................................................

90,000

 

 

            Accumulated Depreciation—Building.........................................

 

90,000

 

 

 

 

4.

Accumulated Depreciation—Office Equipment........................................

30,000

 

 

Office Equipment.................................................................................

10,000

 

 

            Operating—Gain on Exchange of Office

 

 

 

                Equipment..........................................................................

 

6,000

 

            Investing—Purchase of Office Equipment...................................

 

34,000

 

 

 

 

5.

Retained Earnings...............................................................................

123,000

 

 

            Cash Dividend Payable.............................................................

 

123,000

 

                (Noncash financing activity)

 

 

EXERCISE 23-21

 

Stevie Wonder Corporation

WORK SHEET FOR PREPARATION OF STATEMENT OF CASH FLOWS

For the Year Ended December 31, 2005

 

Acct. Bal. At end of 2004

 

Reconciling Trans-

Acct. Bal. At end of 2005

 

 

actions During 2005

 

 

 

 

 

Debits

 

Debit

 

Credit

Cash

$  21,000

 

 

(17)

$  4,500

$16,500

Short-term

 

 

 

 

 

 

    investments

19,000

(2)

$  6,000

 

 

25,000

Accounts receivable

45,000

 

 

(3)

2,000

43,000

Prepaid expenses

2,500

(4)

1,700

 

 

4,200

Inventories

65,000

(5)

16,500

 

 

81,500

Land

50,000

 

 

 

 

50,000

Buildings

73,500

(10)

51,500

 

 

125,000

Equipment

46,000

(11)

7,000

 

 

53,000

Delivery equipment

39,000

 

 

 

 

39,000

Patents

_______

(12)

15,000

 

 

    15,000

    Total debits

$361,000

 

 

 

 

$452,200

 

 

 

 

 

 

 

Credits

 

 

 

 

 

 

Accounts payable

$  16,000

 

 

(6)

$10,000

$  26,000

Short-term notes

 

 

 

 

 

 

    payable

6,000

(7)

$  2,000

 

 

4,000

Accrued payables

4,600

(8)

1,600

 

 

3,000

Allowance for doubtful

 

 

 

 

 

 

    accounts

2,000

(3)

200

 

 

1,800

Accum. depr.—bldg.

23,000

 

 

(13)

7,000

30,000

Accum. depr.—equip.

15,500

 

 

(13)

3,500

19,000

Accum. depr.—del.

 

 

 

 

 

 

    equip.

20,500

 

 

(13)

1,500

22,000

Mortgage payable

53,400

 

 

(14)

19,600

73,000

Bonds payable

62,500

(16)

12,500

 

 

50,000

Capital stock

102,000

 

 

(15)

38,000

140,000

Addtl. paid-in capital

4,000

 

 

(15)

6,000

10,000

Retained earnings

    51,500

(9)

15,000

(1)

36,900

    73,400

    Total credits

$361,000

 

 

 

 

$452,200

 

Statement of Cash Flows Effects

 

 

 

 

 

 

 

 

 

 

 

 

Operating activities

 

 

 

 

 

 

    Net income

 

(1)

36,900

 

 

 

    Depreciation

 

(13)

12,000

 

 

 

    Dec. in accounts

 

 

 

 

 

 

       receivable (net)

 

(3)

1,800

 

 

 

    Inc. in prepaid expenses

 

 

(4)

1,700

 

    Inc. in inventories

 

 

 

(5)

16,500

 

    Inc. in accounts payable

(6)

10,000

 

 

 

    Dec. in notes payable

 

 

(7)

2,000

 

    Dec. in accrued payables

 

 

(8)

1,600

 

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

 

    Purchase of available-for-sale investments

(2)

6,000

 

    Purchase of building

 

 

(10)

51,500

 

    Purchase of equipment

 

 

(11)

7,000

 

    Purchase of patents

 

 

 

(12)

15,000

 

 

 

 

 

 

 

 

Financing activities

 

 

 

 

 

 

    Payment of cash dividends

 

 

(9)

15,000

 

    Issuance of mortgage payable

(14)

19,600

 

 

 

    Sale of stock

 

(15)

44,000

 

 

 

    Retirement of bonds

 

 

_______

(16)

    12,500

 

         Totals

 

 

253,300

 

257,800

 

 

 

 

 

 

 

 

Decrease in cash

 

(17)

      4,500

 

_______

 

        Totals

 

 

$257,800

 

$257,800

 

 

 

 

PROBLEM 23-4

 

 

Ashley Cleveland Company

STATEMENT OF CASH FLOWS

For the Year Ended December 31, 2004

(Direct Method)

Cash flows from operating activities

 

 

          Cash received from customers

$1,155,450a

 

          Dividends received

2,400

 

          Cash paid to suppliers

(760,000) b

 

Cash paid for operating expenses

(226,350) c

 

          Taxes paid

(38,400) d

 

          Interest paid

(57,300) e

 

          Net cash provided by operating activities

 

$75,800

 

 

 

Cash flows from investing activities

 

 

          Sale of available-for-sale investments

14,000

 

          Sale of land

58,000

 

          Purchase of equipment

   (125,000)

 

          Net cash used by investing activities

 

(53,000)

 

 

 

Cash flows from financing activities

 

 

          Proceeds from issuance of common stock

22,500

 

          Principal payment on long-term debt

(10,000)

 

          Dividends paid

      (24,300)

 

          Net cash used by financing activities

 

 (11,800)

 

 

 

Net increase in cash

 

11,000

Cash, January 1, 2004

 

    4,000

Cash, December 31, 2004

 

$15,000

 

 

 

aSales Revenue

$1,160,000

 

– Increase in Accounts Receivable

        (4,550)

 

Cash received from customers

$1,155,450

 

 

 

 

bCost of Goods Sold

$748,000

 

+ Increase in Inventory

7,000

 

+ Decrease in Accounts Payable

      5,000

 

Cash paid to suppliers

$760,000

 

 

cOperating Expenses

$276,400

 

– Depreciation/Amortization Expense

(40,500)

 

–Decrease in Prepaid Rent

(9,000)

 

+ Increase in Prepaid Insurance

1,200

 

+ Increase in Office Supplies

250

 

– Increase in Wages Payable

     (2,000)

 

Cash paid for Operating Expenses

$226,350

 

 

 

 

dTax Expense

$39,400

 

– Increase in Taxes Payable

   (1,000)

 

          Taxes paid

$38,400

 

 

 

 

eInterest Expense

$51,750

 

+ Decrease in Bond Premium

     5,550

 

          Interest paid

$57,300

 

 

 

 

Reconciliation of Net Income to Net Cash

Provided by Operating Activities:

 

 

 

 

 

Net income

 

$58,850

Adjustments to reconcile net income to net

 

 

   cash provided by operating activities:

 

 

          Depreciation/amortization expense

$40,500

 

          Decrease in prepaid rent

9,000

 

          Increase in taxes payable

1,000

 

          Increase in wages payable

2,000

 

          Increase in accounts receivable

(4,550)

 

          Increase in inventory

(7,000)

 

          Increase in prepaid insurance

(1,200)

 

          Increase in office supplies

(250)

 

          Decrease in accounts payable

(5,000)

 

          Gain on sale of land

(8,000)

 

          Gain on sale of short-term investments

(4,000)

 

          Amortization of bond premium

  (5,550)

 

                  Total adjustments

 

  16,950

          Net cash provided by operating activities

 

$75,800

 

 

PROBLEM 23-9

 

 

(a)        Seneca Corporation

    STATEMENT OF CASH FLOWS

     For the Year Ended December 31, 2004

                     

 

          Cash flows from operating activities

                    Net income(a)                     $15,750 

                    Adjustments to reconcile net income to net

                        cash provided by operating activities:

                              Loss on sale of equipment (b)          $   4,100

                              Gain from flood damage (13,250)

                              Depreciation expense (c)          1,900

                              Copyright amortization          250

                              Gain on sale of investment          (2,500)

                              Increase in accounts receivable (net)          (3,750)

                              Increase in inventory          (2,000)

                              Increase in accounts payable             1,000  (14,250)

                    Net cash flow provided by operating

                        activities                     1,500 

 

          Cash flows from investing activities

                    Sale of investments          5,500

                    Sale of equipment          2,500

                    Purchase of equipment (cash) (10,000)

                    Proceeds from flood damage to building           37,000

                    Net cash provided by investing activities                     35,000   

 

          Cash flows from financing activities

                    Payment of dividends          (5,000)             

                    Payment of short-term note payable          (1,000)             

                    Net cash used by financing activities                        (6,000)

 

          Increase in cash                       30,500   

          Cash, January 1, 2004                       13,000         

          Cash, December 31, 2004                       $43,500 

 

          Supplemental disclosures of cash flow information:

                    Cash paid during the year for:

                              Interest          $2,000

                              Income taxes  $5,000

 

 

          Noncash investing and financing activities:

                    Retired note payable by issuing common stock  $  5,000

                    Purchased equipment by issuing note payable           16,000

                                  $21,000

 

          Supporting Computations:

 

          (a)          Ending retained earnings          $20,750

                    Beginning retained earnings           (5,000)

                              Net income          $15,750

 

          (b)          Cost          $11,000

                    Accumulated depreciation (40% X $11,000)             (4,400)

                    Book value   $  6,600

                    Proceeds from sale          (2,500)

                              Loss on sale    $  4,100

 

          (c)          Accumulated depreciation on equipment sold          $4,400

                    Decrease in accumulated depreciation   (2,500)

                              Depreciation expense          $1,900

 

 

(b)      (1)                For a severely financially troubled firm:

 

          Operating: Probably a small cash inflow or a cash outflow.

          Investing: Probably a cash inflow as assets are sold to provide needed cash.

          Financing: Probably a cash inflow from debt financing (borrow­ing funds) as a source of cash at high interest cost.

 

          (2)          For a recently formed firm which is experiencing rapid growth:

 

          Operating: Probably a cash inflow.

          Investing: Probably a large cash outflow as the firm expands.

          Financing: Probably a large cash inflow to finance expansion.

 

CASE 23-3

 

1.           The earnings are treated as a source of cash and should be reported as part of the net cash flow from operating activities in the statement of cash flows. There should be $910,000 of income before extraordinary items because extraordinary items should be separated from operating activities.

 

2.           The $315,000 depreciation expense is neither a source nor a use of cash. Because depreciation is an expense, it was deducted in the computation of net income. Accordingly, the $315,000 must be added back to income before extraordinary items in the operating section because it was deducted in determining earnings, but it was not a use of cash.

 

3.           The writeoff of uncollectible accounts receivable against the allowance account has no effect on cash because the net accounts receivable remain unchanged. An adjustment to income is only necessary if the net receivable amount increases or decreases. Because the net receivable amount is the same before and after the writeoff, an adjustment to income would not be made.

 

The $51,000 of bad debt expense does not affect cash would be added back to income because it affects the amount of net accounts receivable. The recording of bad debt expense reduces the net receivable because the allowance account increases. Although bad debt expense is not usually treated as a separate item to be added back to income from operations, it is accounted for by analyzing the accounts receivable at the net amount and then making the necessary adjustment to income based on the change in the net amount of receivables.

 

4.           The $9,000 gain realized on the sale of the machine is an ordinary gain, not an extraordinary gain, for accounting purposes as outlined in Accounting Principles Board Opinion No. 30. This $9,000 gain must be deducted from net income to arrive at net cash provided by operations. The proceeds of $39,000 are shown as a cash inflow from investing activities.

 

5.           Generally, extraordinary items are investing or financing activities and the cash inflow or outflow resulting from such events should be reported in the investing or financing activities section of the statement of cash flows. In this case, no cash flow resulted from the lightning damage. The net loss (a noncash event) must be added back to net income (under the indirect method) as one of the adjustments to reconcile net income to net cash flow from operating activities.

 

6.           The $75,000 use of cash should be reported as a cash outflow from investing activities. The $200,000 issuance of common stock and the $425,000 issuance of the mortgage note, neither of which affects cash, should be reported as noncash financing and investing activities.

 

7.           This conversion is not a source or use of cash, but it is a significant noncash financing activity and should be reported in a separate schedule or note.

 

 

 

CASE 23-6

 

(a)        It is true that selling current assets, such as receivables and notes to factors, will generate cash flows for the company, but this practice does not cure the systemic cash problems for the organization. In short, it may be a bad business practice to liquidate assets, incurring expenses and losses, in order to “window dress” the cash flow statement.

 

        The ethical implications are that Durocher creates a short-term cash flow at the longer-term expense of the company’s operations and financial position. Laraine’s idea creates the deceiving illusion that the company is successfully generating positive cash flows.

 

(b)        Laraine Durocher should be told that if she executes her plan, the company may not survive. While the factoring of receivables and the liquidation of inventory will indeed generate cash, the actual amount of cash the company receives will be less than the carrying value of the receivables and the raw materials. In addition, the company would still have the future expenditure of replenishing its raw materials inventories, at a cost higher than the sales price.

 

        As chief accountant for Durocher Guitar, it is your responsibility to work with the company’s chief financial officer to devise a coherent strategy for improving the company’s cash flow problems. One strategy may be to downsize the organization by selling excess property, plant, and equipment to repay long-term debt. In addition, Durocher Guitar may be a good candidate for a quasi-reorganization.

 

 

FINANCIAL REPORTING PROBLEM

 

 

(a)                 3M Corporation uses the indirect method to compute and report net cash provided by operating activities. The amounts of net cash provided by operating activities for 1999, 2000, and 2001 are $3,081 million, $2,326 million, and $3,078 million, respectively. The two items most responsible for the decrease in cash provided by operating activities in 2001 are a decrease in inventories ($194 million) and receivables ($345 million).

 

(b)                 The most significant item in the investing activities section is the $980 million that 3M spent on “purchases of property, plant and equipment.” The most significant item in the financing activities section is the $1,693 million that 3M received from proceeds from long term debt.

 

(c)                 Deferred taxes are reported in the operating activities section of 3M’s statement of cash flows. The $1 million is reported as an add back to net income because it is a noncash charge in the income statement.

(d)                 Depreciation is reported in the operating section of 3M’s statement of cash flows as an add back to net income because it is a noncash charge in the income statement.

 

 

FINANCIAL STATEMENT ANALYSIS CASE

 

 

VERMONT TEDDY BEAR CO.

 

(a)                 Even though prior year income exceeded the current year income by $821,432, the current year cash flow from operations exceeded prior year’s cash flow from operations by $937,437. This apparent paradox can be explained by evaluating the components of cash from operations. Significant contributors to the positive cash flow figure in the current year were (1) the depreciation and amortization add-back of $316,416 versus $181,348 in the prior year, and (2) accounts payable increase of $2,017,059 in the current year versus a decline of $284,567 in the prior year. An increase in accounts payable causes an increase in cash from operations; thus, the majority of the in­crease in cash is explained by the company’s dramatic increase in accounts payable. An investor or creditor would want to investigate this increase to ensure that the company is not delinquent on its payments. However, it should be noted that inventories did increase by $1,599,014.

 

(b)                 Liquidity: current cash debt coverage ratio (cash flow from opera- tions ÷ average current liabilities)

 

                  $236,480 ÷ (($4,055,465 + $1,995,600) ÷ 2) = .078:1

 

            Solvency: cash debt coverage ratio (cash flow from operations ÷ average total liabilities)

 

                        $236,480 ÷ (($4,620,085 + $2,184,386) ÷ 2) = .070:1

 

            Profitability: cash return on sales ratio (cash flow from operations ÷ net sales)

 

                        $236,480 ÷ $20,560,566 = .012:1

 

            All of these ratios are very low. This is not surprising, however, for a company like the Vermont Teddy Bear Company that is in the early stages of its life. When a company is in the introductory phase of its main product, it will not typically generate significant cash flow from operations. However, because of the precarious nature of companies in this stage of their lives, the company’s cash position should be monitored closely to ensure that it does not slide into a distress financial state due to cash shortages.