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				$327,150^a
	Cash paid to suppliers		149,000^b
	Cash paid for operating expenses		89,000^c
	Cash paid for interest		11,400^c
	Cash paid for taxes		8,750^d		258,150^a
	Net cash provided by operating activities				$ 69,000^a
	Cash flows from investing activities
	Sale of equipment		8,000^c
	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	$1,155,450^a
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.