Cash Flow Analysis

CHAPTER 12
The Statement of Cash Flows

OVERVIEW OF EXERCISES, PROBLEMS, AND CASES
Estimated
Time in
Learning Outcomes Exercises Minutes Level
1. Explain the purpose of a statement of cash flows. 15* 60 Diff
2. Explain what cash equivalents are and how they are treated on 1 5 Easy
the statement of cash flows. 12* 10 Easy
3. Describe operating, investing, and financing activities, and give 2 10 Easy

examples of each. 3 10 Mod
12* 10 Easy
13* 10 Easy
14* 25 Diff
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 5 Mod

direct method to determine cash flow from operating activities. 5 10 Mod
6 20 Mod
7 20 Mod
8 10 Mod
13* 10 Easy
15* 60 Diff
6. Use T accounts to prepare a statement of cash flows, using 9 10 Easy

the indirect method to determine cash flow from operating 10 15 Mod
activities. 14* 25 Diff
7. Use cash flow information to help analyze a company. 11 15 Mod
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)
12-1
12-2 FINANCIAL ACCOUNTING SOLUTIONS MANUAL
Problems Estimated
and Time in
Learning Outcomes Alternates Minutes Level
1. Explain the purpose of a statement of cash flows.
2. Explain what cash equivalents are and how they are treated on 13* 30 Diff
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 indirect 11* 30 Mod
methods of computing cash flow from operating activities. 12* 30 Mod
5. Use T accounts to prepare a statement of cash flows, using the 3 45 Mod

direct method to determine cash flow from operating activities. 6 30 Mod
11* 30 Mod
13* 30 Diff
6. Use T accounts to prepare a statement of cash flows, using 1 30 Mod

activities. 7 30 Mod
9 45 Diff
12* 30 Mod
7. Use cash flow information to help analyze a company.
8. Use a work sheet to prepare a statement of cash flows, using 2 60 Mod

activities. (Appendix) 8 60 Mod
10 60 Diff

CHAPTER 12 THE STATEMENT OF CASH FLOWS 12-3
Estimated
Time in
Learning Outcomes Cases Minutes Level
1. Explain the purpose of a statement of cash flows. 4* 60 Diff
5* 25 Mod
6* 25 Mod
2. Explain what cash equivalents are and how they are treated on 1* 30 Mod
the statement of cash flows. 7* 20 Mod
3. Describe operating, investing, and financing activities, and give 1* 30 Mod

examples of each. 2 20 Mod
7* 20 Mod
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* 60 Diff

direct method to determine cash flow from operating activities.
6. Use T accounts to prepare a statement of cash flows, using 5* 25 Mod

the indirect method to determine cash flow from operating 6* 25 Mod
activities.
7. Use cash flow information to help analyze a company. 3 20 Mod
8. Use a work sheet to prepare a statement of cash flows, using

the indirect method to determine cash flow from operating
activities. (Appendix)

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 payments X
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 Depreciation 14,000*
Loss on Sale 2,000**
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.
EXERCISES
LO 2 EXERCISE 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 fund 105,000
90-day Treasury bills 75,000
Cash equivalents at December 31, 2007 $215,000
LO 3 EXERCISE 12-2 CLASSIFICATION OF ACTIVITIES
1. F 8. F
2. S 9. S
3. F 10. I
4. F 11. I or O*
5. O 12. O
6. O 13. 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 3 EXERCISE 12-3 RETIREMENT OF BONDS PAYABLE ON THE STATEMENT OF

CASH FLOWSINDIRECT METHOD
1. Journal entry:
2007
Dec. 31 Bonds Payable 500,000
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.
510,000 500,000 50,000
+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 5 EXERCISE 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 2007 1,450,000
Less cash collections during 2007 (X)
Accounts receivable, December 31, 2007 $ 101,100
$80,800 + $1,450,000 X = $101,100
X = $1,429,700
LO 5 EXERCISE 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 2007 X
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 2007 751,300
Less cash payments during 2007 (X)
Accounts payable, December 31, 2007 $ 39,200
$57,700 + $751,300 X = $39,200
X=$769,800
LO 5 EXERCISE 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:
1
Cash collections from customers:
Sales revenue $ 100,000
Add: Decrease in accounts receivable 2,000
Cash collections $ 102,000
2
Payments for inventory:
Cost of goods sold $ 75,000
Add: Increase in inventory 7,000
Less: Increase in accounts payable (3,000)
Cash payments $ 79,000
3
For 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
4
For interest:
Interest expense $ 3,000
Add: Decrease in interest payable 500
5
For taxes:
Income tax expense $ 5,000
Less: Increase in income taxes payable (1,500)
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 5 EXERCISE 12-7 DETERMINATION OF MISSING AMOUNTSCASH FLOW FROM

OPERATING ACTIVITIES
Case 1:
Accounts Receivable
Beginning balance 150,000
Credit sales 175,000 35,000 Write-offs
X = Cash collections
Ending balance 100,000
$150,000 + $175,000 $35,000 X = $100,000

X = $190,000
$190,000 + $60,000 (Cash sales) = $250,000
Case 2:
Inventory
X = Purchases 175,000 Cost of goods
sold expense
$80,000 + X $175,000 = $55,000

X = $150,000
Accounts Payable
25,000 Beginning
balance
X = Cash payments 150,000 Purchases
15,000 Ending
balance
$25,000 + $150,000 X = $15,000

X = $160,000
Case 3:
Prepaid Insurance
X = Cash payments 15,000 Insurance
expense
$17,000 + X $15,000 = $20,000

X = $18,000
Case 4:
Income Taxes Payable
95,000 Beginning
balance
X = Cash payments 300,000 Tax expense
115,000 Ending
balance
$95,000 + $300,000 X = $115,000

X = $280,000
LO 5 EXERCISE 12-8 DIVIDENDS ON THE STATEMENT OF CASH FLOWS
1. First, determine the amount of dividends declared:

Retained Earnings
250,000 Beginning
Stock dividend 50,000 balance
X = Dividends declared 285,000 Net income
375,000 Ending
balance
$250,000 + $285,000 $50,000 X = $375,000

X = $110,000
Then, solve for the amount of dividends paid:

Dividends Payable
20,000 Beginning
balance
X = Dividends paid 110,000 Dividends
declared
30,000 Ending
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 6 EXERCISE 12-9 ADJUSTMENTS TO NET INCOME WITH THE INDIRECT METHOD
1. A 6. A
2. D 7. D
3. A 8. A
4. A 9. NR
5. NR 10. A
LO 6 EXERCISE 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 expense 20,000
Increase in accounts receivable (8,000)
Decrease in inventory 10,000
Increase in prepaid rent (2,000)
Increase in accounts payable 7,000
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 7 EXERCISE 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 EXERCISES
LO 2,3 EXERCISE 12-12 CLASSIFICATION OF ACTIVITIES
1. OI 6. CE
2. CE 7. II
3. IF 8. OI
4. OI 9. IF
5. OF 10. OF
LO 3,5 EXERCISE 12-13 CLASSIFICATION OF ACTIVITIES
1. IO 7. OO
2. OO 8. OI
3. NR 9. OF
4. IF 10. NR
5. IO 11. OF
6. NR 12. II
LO 3,6 EXERCISE 12-14 LONG-TERM ASSETS ON THE STATEMENT OF CASH FLOWS

INDIRECT METHOD
First, determine the accumulated depreciation on the assets sold so that the book value
of those sold can be found:
Accumulated Depreciation
200,000 Beginning
balance
X = Accumulated 50,000 Depreciation
depreciation on assets sold expense
160,000 Ending
balance
$200,000 + $50,000 X = $160,000

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

Cash 64,000
Accumulated Depreciation 90,000
Plant and Equipment 150,000
Gain on Sale 4,000
To record sale of plant and equipment at a gain.
+64,000 +4,000
+90,000
150,000
Plant and Equipment

X = Acquisitions 150,000 Sale of plant
and equipment
$500,000 + X $150,000 = $750,000

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

Patents
X = Acquisitions 8,000 Amortization
expense
$80,000 + X $8,000 = $92,000

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

Net income $ 200,000
Amortization expense 8,000
Gain on sale of plant and equipment (4,000)
Cash Flows from Investing Activities
Sale of plant and equipment 64,000
Acquisition of plant and equipment (400,000)
Acquisition of patents (20,000)
LO 1,5 EXERCISE 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 patent 10,0001
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:

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 3
$150,000 $40,000 $80,000 $12,000 $10,000
2 4
$40,000 $10,000 $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 patent 10,000
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:

BALANCE SHEET
AS OF XX/XX/XX
Assets
Current Assets:
Cash (from Part 2.) $78,000
Accounts receivable 10,000
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
2
Net income of $70,000 less cash dividends of $20,000.
PROBLEMS
LO 6 PROBLEM 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 receivable 5
Inventory (10)
Prepaid rent 3
Land 0
Plant and equipment 100 Purchase
Accumulated depreciation (35) Depreciation expense
Accounts payable (2)
Income taxes payable 2
Short-term notes payable (10) Issuance
Bonds payable 25 Retirement
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 expense 35
Increase in accounts receivable (5)
Decrease in inventory 10
Increase in prepaid rent (3)
Increase in accounts payable 2
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 payable 10
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 8 PROBLEM 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)

Accounts 12/31/07 12/31/06 Changes Operating Investing Financing
Cash 8 10 (2)
Accounts receivable 20 15 5 (5)
Inventory 15 25 (10) 10
Prepaid rent 9 6 3 (3)
Land 75 75
Plant and equipment 400 300 1001 (100)
Accumulated
depreciation (65) (30) (35)2 35
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)6 26
Totals 0 0 0 63 (100) 35
Net increase
(decrease) in cash (2)
1 4
Purchase of equipment. Retirement of bonds.
2 5
Depreciation expense. Issuance of common stock.
3 6
Proceeds from note. Net income.
CHRISMAN COMPANY
Net income $ 26
Acquisition of plant and equipment $(100)
Retirement of bonds payable $ (25)
Issuance of short-term notes payable 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 5 PROBLEM 12-3 STATEMENT OF CASH FLOWSDIRECT METHOD
Net Change
Cash (38)
Inventory 30
Prepayments (10)
Land 150 Purchase (c)
Plant and equipment 200 Purchase (c)
Accumulated depreciation (50) Depreciation expense (b)
Accounts payable 18
Other accrued liabilities (5)
Income tax payable 20
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 Statement Amount Adjustment Cash Flows
Sales revenue $1,250 $1,250
Cash collected $1,200
Cost of goods sold 700 $ 700
+ Increase in inventory 30
+ Decrease in accounts payable 18
Cash payments $ 748
Operating expenses 150 $ 150
Decrease in prepayments (10)
Depreciation expense (50)
Increase in accrued liabilities (5)
Cash payments $ 85
Interest expense 25 $ 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 $ 225 Net cash flow from operations $ 172
PEORIA CORP.
Cash collections from customers $ 1,200
Cash payments for:
Inventory $ (748)
Operating expenses (85)
Interest (25)
Income taxes (170)
Total cash payments $(1,028)
Acquisition of land $ (150)
Acquisition of plant and equipment (200)
Net cash used by investing activities $ (350)
Additional long-term borrowings $ 50
Cash dividends paid (60)
Net decrease in cash $ (38)
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.
Net Change
Cash (38)
Inventory 30
Prepayments (10)
Accounts payable 18
Long-term bank loan payable (50) Proceeds from bank loan (c)
(225) Net income
Total 0
PEORIA CORP.
Net income $ 225
Adjustments to reconcile net income to net
cash provided by operating activities:
Increase in inventories (30)
Decrease in prepayments 10
Decrease in accounts payable (18)
Increase in other accrued liabilities 5
Acquisition of land $(150)
Net cash used by investing activities $(350)

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.

METHOD (Appendix)

Cash 52 90 (38)
Inventory 230 200 30 (30)
Prepayments 15 25 (10) 10
Land 750 600 1501 (150)
Accumulated
depreciation (250) (200) (50)3 50
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)7 225
Totals 0 0 0 172 (350) 140
Net increase
1 5
Purchase of land. Issuance of common stock.
2 6
Purchase of plant and equipment. Dividends.
3 7
Depreciation expense. Net income.
4
Proceeds from bank loan.
PEORIA CORP.
Net income $ 225

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 5 PROBLEM 12-6 STATEMENT OF CASH FLOWSDIRECT METHOD
Net Change
Cash 15
Accounts receivable (25)
Inventory (50)
Prepayments 10
Other accrued liabilities 10
Interest payable (5)
Retained earnings 135 35 Dividends (a)
100 Net loss
Total 0

Sales revenue $ 500 $500
+ Decrease in accounts receivable 25
Cash collected $525
Cost of goods sold 400 $400
Decrease in inventory (50)
Increase in accounts payable (25)
Cash payments $325
Operating expenses 180 $180
+ Increase in prepayments 10
+ Decrease in accrued liabilities 10
Cash payments $130
Increase in interest payable (5)
Cash payments $ 15
Net income (loss) $(100) Net cash flow from operations $ 55
ASTRO INC.
Cash collections on account $ 525
Cash payments for:
Inventory $(325)
Interest (15)
Total cash payments $(470)
Net increase in cash $ 15

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.
Net Change
Cash 15
Inventory (50)
Prepayments 10
100 Net loss
Total 0
ASTRO INC.
(AMOUNTS IN THOUSANDS OF DOLLARS)
Net loss $(100)
Decrease in accounts receivable 25
Decrease in inventories 50
Increase in prepayments (10)
Decrease in other accrued liabilities (10)
Increase in interest payable 5

FROM: Students name
SUBJECT: Cash flows
2007 in spite of the net increase in cash during the year. Following are my thoughts,
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.
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.

METHOD (APPENDIX)

Cash 95 80 15
Accounts receivable 50 75 (25) 25
Inventory 100 150 (50) 50
Prepayments 55 45 10 (10)
Land 475 400 751 (75)
Accumulated
depreciation (370) (300) (70)3 70
Other accrued
liabilities (35) (45) 10 (10)
Interest payable (15) (10) (5) 5
Long-term loan
payable (340) (250) (90)4 90
Common stock (450) (400) (50)5 50
357 (35)
Totals 0 0 0 55 (145) 105
Net increase
(decrease) in cash 15
1
Purchase of land.
2
Purchase of plant and equipment.
3
Depreciation expense.
4
Proceeds from borrowings.
5
Issuance of common stock.
6
Net loss.
7
Cash dividends paid.
ASTRO INC.
(AMOUNTS IN THOUSANDS OF DOLLARS)
Net loss $(100)
Decrease in inventories 50

FROM: Students name
SUBJECT: Cash flows
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.
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 6 PROBLEM 12-9 YEAR-END BALANCE SHEET AND STATEMENT OF CASH FLOWS

INDIRECT METHOD
Net Change
Cash ?
Accounts receivable 10 h. sales exceeded cash
collections
Land 100 g. bonds were exchanged
for landa noncash
activity
Plant and equipment 200 f. purchase
Accumulated depreciation (20) b. depreciation expense
Investments 0 no change given
Current liabilities 0 i. no change
Bonds payable (250) d. 150 issued for cash and
g. 100 issued for land
Common stock 50 e. 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
Acquisitions of plant and equipment $(200)
Payment of cash dividends $ (25)
Issuance of additional bonds 150
Acquisition and retirement of stock (50)
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
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
1 5
$140 $45 $150 + $20
2 6
$155 + $10 $300 + $250
3 7
$300 + $100 $400 $50
4 8
$500 + $200 $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.
LO 8 PROBLEM 12-10 STATEMENT OF CASH FLOWS USING A WORK SHEET

INDIRECT METHOD (Appendix)
1. Balance sheet:
TERRIER COMPANY
BALANCE SHEET
DECEMBER 31, 2007
Cash $ 951
Land $ 4003
Investments 100
Total long-term assets $1,030
Total assets $1,290
Bonds payable $ 5506
Common stock $ 3507
1 5
$140 $45 $150 + $20
2 6
$155 + $10 $300 + $250
3 7
$300 + $100 $400 $50
4 8
$500 + $200 $140 + $45

Cash 95 140 (45)
Land 400 300 1001
Accumulated
depreciation (170) (150) (20)3 20
Investments 100 100 0
Current liabilities (205) (205) 0
Bonds payable (550) (300) (100)1
(150)4 150
Common stock (350) (400) 505 (50)
257 (25)
Totals 0 0 0 80 (200) 75
Net increase
1
Acquisition of land in exchange for bonds (noncash transaction).
2
3
4
Proceeds from issuance of additional bonds.
5
Acquisition and retirement of common stock.
6
Net income.
7
TERRIER COMPANY
Net income $ 70
Acquisitions of plant and equipment $(200)
Issuance of additional bonds 150
Acquisition and retirement of stock (50)
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 4,5 PROBLEM 12-11 STATEMENT OF CASH FLOWSDIRECT METHOD
Net Change
Cash (9)
Inventory (15)
Prepaid rent (4)
Land 80 Purchase
Plant and equipment 150 Purchase of 195 and sale of (45)
Accumulated depreciation (60) 15 sale of asset (cost of 45 less
book value of 30) and (75)
depreciation;
Long-term bank loan payable 30 Repayment
Common stock (150) Issuance of common stock
Retained earnings (26) 7 Dividends
(33) Net income
Total 0

Sales revenue $550 $550
Cash collected $535
Decrease in inventory (15)
Cash payments $328
General and
administrative 55 $ 55
Decrease in prepaid rent (4)
Cash payments $ 45
Depreciation expense 75 No cash flow effect $ 0
Loss on sale of Not an operating activity $ 0
plant assets 5
Interest expense 15 No interest payable
Cash payments $ 15
+ Decrease in income
taxes payable 2
Cash payments $ 19
Net income $ 33 Net cash flow from operations $128
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 stock 150
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 4,6 PROBLEM 12-12 STATEMENT OF CASH FLOWSINDIRECT METHOD
Net Change
Cash (9)
Inventory (15)
Prepaid rent (4)
Land 80 Purchase
depreciation;
Common stock (150) Issuance of common stock
(33) Net income
Total 0
GLENDIVE CORP.
Net income $ 33
Loss on sale of plant assets 5*
Decrease in prepaid rent 4
*Book value $30 proceeds $25
Sale of plant assets $ 25
Acquisition of new plant assets (195)
Issuance of additional stock 150
LO 2,5 PROBLEM 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
Inventory 120
Land 10 Purchase
Buildings and equipment 110 Purchase
Patents (25) Amortization
Taxes payable (5)
Notes payable 0
Term notes payable 0
Common stock (130) (130) Stock dividend
Retained earnings 20 (110) Net income
130 Stock dividend
Total 0

Cost of goods sold 1,100 $1,100
Cash payments $1,160
Salaries & benefits 850 No payable $ 850
Heat, light, and power 75 No payable $ 75
Depreciation 60 No cash flow effect
Property taxes 18 No payable* $ 18
Patent amortization 25 No cash flow effect
Miscellaneous expenses 10 No payable $ 10
Interest expense 55 No payable $ 55
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)
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.
A L T E R N AT E P R O B L E M S
LO 6 PROBLEM 12-1A STATEMENT OF CASH FLOWSINDIRECT METHOD
1. Account changes Dr (Cr) and Explanations:

Cash 2,000
Accounts receivable (2,000)
Inventory 1,000
Prepaid rent 200
Land 0
Plant and equipment 50,000 Purchase
Accumulated depreciation (50,000) Depreciation expense
Accounts payable 0
Income taxes payable (500)
Short-term notes payable 2,500 Repayment
Bonds payable (25,000) Issuance
Common stock 0
Retained earnings 21,800 Net loss
Total 0
MADISON COMPANY
Net loss $(21,800)
Decrease in accounts receivable 2,000
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
Cash balance, December 31, 2006 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 8 PROBLEM 12-2A STATEMENT OF CASH FLOWS USING A WORK SHEET

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

Cash 12.0 10.0 2.0
Accounts receivable 10.0 12.0 (2.0) 2.0
Inventory 8.0 7.0 1.0 (1.0)
Prepaid rent 1.2 1.0 0.2 (0.2)
Land 75.0 75.0 0.0
Plant and equipment 200.0 150.0 50.01 (50)
Accumulated
depreciation (75.0) (25.0) (50.0)2 50.0
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 2.0
1
Purchase of equipment.
2
3
Retirement of note.
4
Issuance of bonds.
5
Net loss.
MADISON COMPANY
Net loss $(21,800)
Decrease in accounts receivable 2,000
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
Cash balance, December 31, 2006 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 5 PROBLEM 12-3A STATEMENT OF CASH FLOWSDIRECT METHOD
Net Change
Cash (70)
Inventory 20
Prepayments (10)
Land (100) Sale (c)
Long-term bank loan payable 50 Retirement of bank loan (d)
Common stock (50) Issuance of common stock (d)
(350) Net income
Total 0

Cash payments $1,400
Operating expenses 460 $ 460
+ Decrease in accrued liabilities 5
Cash payments $ 430
No interest payable 0
Cash payments $ 100
+ Decrease in income tax payable 35
WABASH CORP.
Cash payments for:
Inventory $(1,400)
Interest (100)
Income taxes (185)
Sale of land $ 100
Repayment of long-term borrowings $ (50)
Net cash used by financing activities $ (350)

TO: President of Wabash Corp.
FROM: Students name
SUBJECT: Cash flows
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.
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.
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.
Net Change
Cash (70)
Inventory 20
Prepayments (10)
Land (100) Sale (c)
Long-term bank loan payable 50 Retirement of bank loan (d)
Common stock (50) Issuance of common stock (d)
(350) Net income
Total 0
WABASH CORP.
Net income $ 350
Sale of land $ 100
Net cash used by financing activities $(350)

FROM: Students name
SUBJECT: Cash flows


Cash 140 210 (70)
Inventory 200 180 20 (20)
Prepayments 15 25 (10) 10
Land 600 700 (100)1 100
Accumulated
depreciation (225) (200) (25)3 25
Accrued liabilities (50) (55) 5 (5)
Long-term loan
payable (200) (250) 504 (50)
Common stock (450) (400) (50)5 50
(350)7 350
Totals 0 0 0 430 (150) (350)
Net increase
1 5
Sale of land. Issuance of common stock.
2 6
Purchase of plant and equipment. Dividends.
3 7
Depreciation expense. Net income.
4
Retirement of bank loan.
WABASH CORP.
Net income $ 350
Sale of land $ 100

FROM: Students name
SUBJECT: Cash flows
LO 5 PROBLEM 12-6A STATEMENT OF CASH FLOWSDIRECT METHOD
Net Change
Cash 15
Inventory 0
Prepayments 1
Common stock 0
60 Net loss
Total 0

Cash collected $400
No change in inventory
Cash payments $110
Operating expenses 250 $250
+ Increase in prepayments 1
Cash payments $191
Increase in interest payable (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)
Total cash payments $
(301)

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.
Net Change
Cash 15
Inventory 0
Prepayments 1
Common stock 0
60 Net loss
Total 0
PLUTO INC.
Net loss $ (60)

FROM: Students name
SUBJECT: Cash flows
actions.

Cash 25 10 15
Inventory 100 100 0
Prepayments 36 35 1 (1)
Land 300 200 1001 (100)
Accumulated
depreciation (90) (50) (40)3 40
Other accrued
liabilities (40) (20) (20) 20
Interest payable (22) (12) (10) 10
Long-term loan
payable (450) (100) (350)4 350
Common stock (300) (300) 0
846 (84)
Totals 0 0 0 99 (350) 266
Net increase
(decrease) in cash 15
1 4
Purchase of land. Proceeds from borrowings.
2 5
Purchase of plant and equipment. Net loss.
3 6
Depreciation expense. Cash dividends paid.
PLUTO INC.
Net loss $ (60)

FROM: Students name
SUBJECT: Cash flows
actions.
LO 6 PROBLEM 12-9A YEAR-END BALANCE SHEET AND STATEMENT OF CASH

FLOWSINDIRECT METHOD

Net Change
Cash ?
Accounts receivable 15 h. sales exceeded cash
collections
Land 200 g. note was exchanged for land,
a noncash activity
Plant and equipment 60 f. purchase
Accumulated depreciation (25) b. depreciation expense
Investments 0 no change given
Current liabilities 20 i. decrease
Long-term note payable (200) g. note was exchanged for land,
a noncash activity
Bonds payable 100 e bonds retired
Common stock (50) d. common stock issued
Retained earnings (10) c. dividends of 40
a. income of (50)
Total without cash 110 dr.
Thus, the change in cash must be 110 cr. (decrease) to balance the total changes in
the accounts.
POODLE COMPANY
Net income $ 50
Decrease in current liabilities (20)
Acquisitions of plant and equipment $ (60)
Retirement of bonds (100)
Net increase (decrease) in cash $(110)
Acquisition of land in exchange for note $ 200
2. Balance sheet:
POODLE COMPANY
BALANCE SHEET
DECEMBER 31, 2007
Cash $ 451
Land $ 3003
Investments 125
Total long-term assets $ 985
Total assets $1,185
Long-term note payable $ 200
Common stock $ 5507
1 5
$155 $110 $175 + $25
2 6
$140 + $15 $325 $20
3 7
$100 + $200 $500 + $50
4 8
$700 + $60 $120 + $10
3. Poodles cash from operations of $40,000 was insufficient to cover its acquisitions of
new plant and equipment of $60,000 and the payment of cash dividends of $40,000.
Common stock of $50,000 was issued, but this was more than offset by the
$100,000 needed to retire the bonds. The lack of cash from operations to cover
acquisitions, pay dividends, and retire the bonds are all responsible for the large
decrease in the companys cash balance at the end of the year.

1. Balance sheet:
POODLE COMPANY
BALANCE SHEET
DECEMBER 31, 2007
Cash $ 451
Land $ 3003
Investments 125
Total long-term assets $ 985
Total assets $ 1,185
Long-term note payable $ 200
Common stock $ 5507
Total liabilities and stockholders equity $ 1,185
1 5
$155 $110 $175 + $25
2 6
$140 + $15 $325 $20
3 7
$100 + $200 $500 + $50
4 8
$700 + $60 $120 + $10

Cash 45 155 (110)
Land 300 100 2001
Accumulated
depreciation (200) (175) (25)3 25
Investments 125 125 0
Current liabilities (305) (325) 20 (20)
Long-term note
payable (200) 0 (200)1
Bonds payable 0 (100) 1004 (100)
Common stock (550) (500) (50)5 50
407 (40)
Totals 0 0 0 40 (60) (90)
Net increase
1
Acquisition of land in exchange for note (noncash transaction).
2
3
4
Retirement of bonds payable.
5
Issuance of common stock.
6
Net income.
7
POODLE COMPANY
Net income $ 50
Decrease in current liabilities (20)
Acquisitions of plant and equipment $ (60)
Retirement of bonds (100)
Net increase (decrease) in cash $(110)
Acquisition of land in exchange for note $ 200
4. Poodles cash from operations of $40,000 was insufficient to cover its acquisitions of
new plant and equipment of $60,000 and the payment of cash dividends of $40,000.
Common stock of $50,000 was issued, but this was more than offset by the
$100,000 needed to retire the bonds. The lack of cash from operations to cover
acquisitions, pay dividends, and retire the bonds are all responsible for the large
decrease in the companys cash balance at the end of the year.
ALTERNATE MULTI-CONCEPT PROBLEMS
LO 4,5 PROBLEM 12-11A STATEMENT OF CASH FLOWSDIRECT METHOD
Net Change
Cash (15)
Inventory 25
Prepaid rent (16)
Land (90) Sale
book value of 30) and
(80) depreciation;
Common stock 0
(10) Net income
Total 0

Cash collected $389
Cash payments $260
General and
administrative 40 $ 40
Decrease in prepaid rent (16)
Cash payments $ 19
Depreciation expense 80 (No cash flow effect) $ 0
Loss on sale of
plant assets 10 Not an operating activity $ 0
Interest expense 15 No interest payable
Cash payments $ 15
+ Decrease in income taxes payable 10
Cash payments $ 15
BANNACK CORP.
Cash collections from customers $ 389
Cash payments for:
Inventory $(260)
General and administrative (19)
Interest (15)
Income taxes (15)
Sale of land $ 90
Purchase of plant and equipment (125)
Sale of plant and equipment 20
LO 4,6 PROBLEM 12-12A STATEMENT OF CASH FLOWSINDIRECT METHOD
1.Changes in account balances and explanations (in thousands of dollars):
Net Change
Cash (15)
Inventory 25
Prepaid rent (16)
Land (90) Sale
depreciation;
Common stock 0
(10) Net income
Total 0
BANNACK CORP.
Net income $ 10
Loss on sale of plant assets 10
Increase in inventory (25)
Decrease in prepaid rent 16
Sale of land $ 90
Purchase of plant and equipment (125)
Sale of plant and equipment 20
Net cash used by investing activities $
(15)
Repayment of long-term loan $(75)
Net decrease in cash $
(15)
LO 2,5 PROBLEM 12-13A 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 (25)
U.S. Treasury bills 25
Inventory 25
Land 20 Purchase
Buildings and equipment 60 Purchase
Taxes payable 10
Notes payable 100 Retirement of note
Term notes payable 0
Common stock (20) (20) Stock dividend
Retained earnings (20) (40) Net income
20 Stock dividend
Total 0

Cost of goods sold 990 $ 990
Cash payments $ 975
Salaries and benefits 195 No payable $ 195
Heat, light, and power 70 No payable $ 70
Depreciation 40 No cash flow effect
Property taxes 2 No payable* $ 2
Patent amortization 20 No cash flow effect
Miscellaneous expense 2 No payable $ 2
Interest expense 45 No payable $ 45
+ Decrease in income tax payable* 10
Cash payments $ 22
*The current liability Taxes Payable is assumed to relate entirely to income taxes
rather than property taxes.
SHEPARD COMPANY
Cash payments for:
Inventory $ (975)
Salaries and benefits (195)
Heat, light, and power (70)
Property taxes (2)
Miscellaneous activities (2)
Interest (45)
Income taxes (22)
Purchase of U.S. Treasury bills $ (25)
Acquisition of buildings and equipment (60)
Retirement of notes payable $ (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.
D E C IS ION C AS E S
READING AND INTERPRETING FINANCIAL STATEMENTS
LO 2,3 DECISION CASE 12-1 READING AND INTERPRETING LIFE TIME FITNESSS
STATEMENT OF CASH FLOWS: OPERATING ACTIVITIES
1. The second note in the report includes a section titled Cash and Cash Equivalents.
Cash equivalents include unrestricted cash accounts and highly liquid debt
instruments purchased with original maturities of three months or less.
2. Life Time Fitness uses the indirect method to prepare the operating activities section
of its statement of cash flows. The first item on the statement is net income and then
various adjustments are made to reconcile this amount to the net cash provided by
3. Net income amounts to $28,908,000 and net cash provided by operating activities is
$80,431,000, resulting in a difference of $51,523,000. The largest adjustment to
reconcile net income to net cash provided by operating activities is depreciation and
amortization of $29,655,000. Depreciation and amortization are expenses that have
been deducted in the determination of net income. However, they do not decrease
the amount of cash and therefore they must be added back in reconciling net income
to net cash provided by operating activities.
4. A loss on disposing of property is added back for the same reason that depreciation
and amortization are added back. The loss is deducted to arrive at net income but
because it does not use any cash it is added back.
5. Changes in operating assets and liabilities is the last adjustment to reconcile net
income to net cash provided by operating activities. The various current assets and
liabilities, such as accounts receivable, inventory, and accounts payable have a
different effect on net income than they do on cash. For example, a decrease in
accounts receivable for the period is an indication that a company collected more in
cash from its customers than in sales to them. Thus, a decrease in accounts
receivable requires an addition to net income to arrive at net cash provided by
operating activities. Life Time Fitness chooses to net all of these items in one
adjustment on its statement of cash flows.
LO 3 DECISION CASE 12-2 READING AND INTERPRETING LIFE TIME FITNESSS

STATEMENT OF CASH FLOWS: INVESTING AND FINANCING ACTIVITIES
1. Purchases of property and equipment are the companys largest use of cash in the
investing activities section of the statement. Purchases increased by $156,674,000
$41,315,000, or $115,359,000, from the prior year. Purchases of additional land,
construction of new fitness centers and the addition of more fitness equipment are
all crucial to the companys strategy to grow its business.
2. Repayments on long-term borrowings are the largest use of cash in the financing
activities section of Life Time Fitnesss statement of cash flows. Repayments
increased by $68,986,000 $18,119,000, or $50,867,000, from the prior year.
3. Proceeds from borrowings and proceeds from an initial public offering are the two
largest sources of cash from financing activities. The former increased by
$44,853,000 $1,925,000, or $42,928,000. Because the initial public offering was in
2004, this amount increased by $80,398,000 $0, or $80,398,000. Purchases of
property and equipment require large amounts of cash and it can be seen that much
of the cash needed to grow the business came from borrowing and the initial public
offering of stock.
LO 7 DECISION CASE 12-3 COMPUTING AND INTERPRETING LIFE TIME FITNESSS

CASH FLOW ADEQUACY
1. Cash flow adequacy ratio: (Net cash provided by operations Capital expenditures)/
Average annual debt maturing over next five years
= ($80,431,000 $156,674,000)/($35,949,000 + $6,040,000 + $13,327,000 +
$6,251,000 + $8,853,000)/5)
= ($76,243)/$14,084
= (5.4)
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. The companys ratio is negative in 2004 because it invested large
amounts in property and equipment to open new fitness centers. These large
purchases are balanced by the stock issued to the public for the first time and long-
term borrowings which were significantly larger than in the prior year. In both of the
two prior years the net cash provided by operating activities was larger than
purchases of property and equipment, resulting in positive cash flow adequacy ratios
in those years.
MAKING FINANCIAL DECISIONS
LO 1,5 DECISION CASE 12-4 DIVIDEND DECISION AND THE STATEMENT OF CASH
FLOWSDIRECT METHOD
Net Change
Cash 30
Inventory 150
Prepayments (15)
Land 1,055 Issued bonds to acquire 700 and
cash for 355
Plant and Equipment 1,700 Purchase
Long-term investments (400) Sale
Taxes payable (70)
Dividends payable 200 Paid dividends
Short-term Notes payable (200) Reclassification of note
Long-term Notes payable 200 Reclassification of note
Bonds payable (700) Issued for land
Common stock (500) Issued stock
Retained earnings (1,020) 1,020 Net income
Total 0

Cash collected from customers $7,950
Cash paid to suppliers $4,580
Operating expenses 1,450 $1,450
Depreciation included on
income statement (250)
Amortization included on
income statement (100)
Cash paid for operating expenses $1,025
Interest expense 350 No interest payable $ 350
Increase in taxes payable (70)
Net income $1,020 Net cash flow from operations $1,385
BAILEY CORP.
Cash collected from customers $ 7,950
Cash payments:
For inventory $
(4,580)
For operating expenses (1,025)
For interest (350)
For income taxes (610)
Total cash payments $ 6,565
Sale of long-term investments $ 400
Acquisition of plant and equipment (1,700)
Net cash used by investing activities $(1,655)
Issuance of additional common stock $ 500
Payment of 2006 cash dividend (200)
Supplemental Schedule of Noncash Investing and
Financing Activities
Acquisition of land by issuance of bonds $ 700
Reclassification of long-term notes due within next year $ 200
3. Bailey Corp. should be able to safely pay a cash dividend in 2008 of $250,000 (note
that there are now 250,000 shares of stock outstanding). The cash provided by
operating activities of $1,385,000 indicates that the company is generating a very
significant amount of cash from the business. Because the company invested
heavily in new plant and equipment during 2007, it should not need to reserve large
amounts of cash for capital expenditures in the near future. The profit margin of
12.75% indicates that management is doing a good job of controlling costs.
Bailey will need to pay $200,000 in 2008 to retire the short-term notes payable. In
assessing the companys cash needs in future years, it would be important to know
how soon any of the bonds payable will be due for retirement. Assuming that a large
portion of the bonds is not due to be retired in 2008, Bailey should have no problem
in paying its tenth annual dividend of $1 per share.
LO 1,6 DECISION CASE 12-5 EQUIPMENT REPLACEMENT DECISION AND CASH FLOWS
FROM OPERATIONS
1. Cash flow from operations Year 1 Year 2 Year 3 Year 4

Net income (loss) $(10) $ (2) $15 $20
Adjustments:
Depreciation expense 30 25 15 14
Increase in accounts receivable (32) (5) (12) (20)
Increase in inventories (26) (8) (5) (9)
Increase in prepayments 0 0 (10) (5)
Increase in accounts payable 15 3
Decrease in accounts payable (5) (4)
Net cash flow from operations $(23) $13 $ (2) $ (4)
2. Memo to the president:

TO: President
FROM: Students name
DATE: XX/XX/XX
SUBJECT: Cash flow
As you are aware, our company has made significant strides in improving our
profitability. Our net losses in the first two years have been replaced with profits of
$15 million and $20 million, respectively, for the last two years. We are all also
aware, however, of the need to generate sufficient cash flow operations to make the
necessary capital expenditures to replace existing equipment.
I have enclosed for your review a four-year summary of cash flow from
operations. The summary shows that in our second year we did a good job of
generating cash from operations but that the results have not been as good in the
last two years. Specifically, our operations have drained $2 million and $4 million of
cash from the treasury in these years rather than the desired result of generating
cash to help pay for capital expenditures.
The buildup of various current assets, such as accounts receivable, inventories,
and prepayments, is the main reason for our problems. First, we need to do a better
job of collecting our receivables in a timely fashion. Second, we must find ways to
limit our purchases of inventory and maintain products on hand at a minimum. Third,
whenever possible, we should limit the amount of items we prepay, such as office
supplies and rent. Finally, the company needs to take full advantage of the credit
terms offered by our suppliers and not pay open accounts any sooner than is
necessary.
Please call me at your earliest convenience to discuss how we can improve our
efforts in this critical area.
ETHICAL DECISION MAKING
LO 1,6 DECISION CASE 12-6 LOAN DECISION AND THE STATEMENT OF CASH FLOWS
INDIRECT METHOD
1. Mega reported the sale of the business by netting the gain against the cash
proceeds and thus reporting the book value of $300 million as an investing activity
inflow. This is not in accordance with generally accepted accounting principles,
which require that the actual amount of cash received from the sale of $450 million
be shown as an investing activity inflow. The gain of $150 million should have been
deducted from net income to arrive at cash flow from operations.
The net approach to reporting the transaction, as opposed to the correct
approach under GAAP, does not have an effect on the increase or decrease in cash
for the period. The issue involves the appropriate reporting and disclosure of the
transaction rather than the net change in cash for the period.
2. Revised statement:
MEGA ENTERPRISES
(IN MILLIONS OF DOLLARS)
Net income $ 65
Gain on sale of California business (150)
Depreciation and amortization 56
Net cash used by operating activities $ (45)
Acquisitions of other businesses $(234)
Acquisitions of plant and equipment (125)
Sale of other businesses 450
Net cash provided by investing activities $ 91
Additional borrowings $ 150
Repayments of borrowings (180)
3. The controller has not acted ethically in this situation. The officer is aware that the
bank intends to rely on cash generated from operations for repayment of the loans.
As shown in 2. above, the netting of the sale transaction grossly overstates the cash
flow from operating activities and understates the cash flow from investing activities.
It appears that the controller intentionally misreported the transaction on the
statement of cash flows to influence the banks appraisal of the ability of Mega to
generate cash from its ongoing operations.
LO 2,3 DECISION CASE 12-7 CASH EQUIVALENTS AND THE STATEMENT OF CASH
FLOWS
1. According to current accounting standards, only those investments in highly liquid

securities with an original maturity to the investor of three months or less should be
classified as cash equivalents. Because the Treasury notes do not mature until ten
months after they are purchased, their purchase should be classified as an investing
activity for purposes of preparing a statement of cash flows. (Note: The notes would
be classified as held to maturity securities because Rangers expects to hold them
until maturity.)
2. As controller, you need to explain to the treasurer that accounting standards do not
allow the company to classify the treasury notes as cash equivalents. You are
sympathetic to his desire to minimize the net cash outflow for investing activities, but
the company does not have a choice in its presentation of the notes, nor does the
decision on classification rest with you as controller. Rangers must report the
purchase on the statement of cash flows as a cash outflow from investing activities.
REAL WORLD PRACTICE 12.1
Best Buy uses the indirect method in the operating activities section of the statement of
cash flows. The first line on the statement is net income and the necessary adjustments
are made to reconcile net income to net cash provided by operating activities.
Best Buys receivables increased during the year that ended February 26, 2005. An
increase in receivables means that the company sold more than it collected in cash
during the year, and therefore the difference must be deducted from net income in the
operating activities section of the statement.
Best Buy paid $241,000,000 in income taxes during the year that ended February 26,
2005. This is not necessarily the amount that appears as expense on the income
statement for the year. The amount of income tax expense on the income statement is
based on accrual accounting concepts. For example, any taxes owed at the end of the
year would be included in the tax expense but would not be considered a cash outflow.

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Cash Flow Analysis

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CHAPTER 12

The Statement of Cash Flows

3. Describe operating, investing, and financing activities, and give 2 10 Easy

4. Describe the difference between the direct and the indirect

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

6. Use T accounts to prepare a statement of cash flows, using 9 10 Easy

7. Use cash flow information to help analyze a company. 11 15 Mod

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

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

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

5. Use T accounts to prepare a statement of cash flows, using the 3 45 Mod

6. Use T accounts to prepare a statement of cash flows, using 1 30 Mod

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

8. Use a work sheet to prepare a statement of cash flows, using 2 60 Mod

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

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

4. Describe the difference between the direct and the indirect

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

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

7. Use cash flow information to help analyze a company. 3 20 Mod

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

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

LO 2 EXERCISE 12-1 CASH EQUIVALENTS

LO 3 EXERCISE 12-2 CLASSIFICATION OF ACTIVITIES

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

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

LO 5 EXERCISE 12-4 CASH COLLECTIONSDIRECT METHOD

Cash collections to be reported in the operating activities section of Stanleys 2007

LO 5 EXERCISE 12-5 CASH PAYMENTSDIRECT METHOD

Accounts payable, December 31, 2006 $ 57,700

LO 5 EXERCISE 12-6 OPERATING ACTIVITIES SECTIONDIRECT METHOD

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

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

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

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

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

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

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

LO 5 EXERCISE 12-8 DIVIDENDS ON THE STATEMENT OF CASH FLOWS

1. First, determine the amount of dividends declared:

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

Then, solve for the amount of dividends paid:

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

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

LO 6 EXERCISE 12-10 OPERATING ACTIVITIES SECTIONINDIRECT METHOD

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

LO 7 EXERCISE 12-11 CASH FLOW ADEQUACY

1. Cash flow adequacy ratio:

LO 2,3 EXERCISE 12-12 CLASSIFICATION OF ACTIVITIES

LO 3,5 EXERCISE 12-13 CLASSIFICATION OF ACTIVITIES

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

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

Thus, the entry to record the sale would be

Plant and Equipment

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

Similarly, acquisitions of new patents can be determined:

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

These items would appear on the statement of cash flows as follows:

LO 1,5 EXERCISE 12-15 INCOME STATEMENT, STATEMENT OF CASH FLOWS

HANDSOME HOUNDS GROOMING COMPANY

2. Statement of cash flows:

HANDSOME HOUNDS GROOMING COMPANY

HANDSOME HOUNDS GROOMING COMPANY

LO 6 PROBLEM 12-1 STATEMENT OF CASH FLOWSINDIRECT METHOD