Indirect Method vs. Direct Method and Horizontal vs. Vertical Analysis

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12

Statement of Cash Flows

 CHAPTER PREVIEW 

The balance sheet, income statement, and retained earnings statement do not always show the whole picture of the �inancial condition of a company or institution. In fact, looking at the �inancial statements of some well-known companies, a thoughtful investor might ask questions like these: How did Eastman Kodak �inance cash dividends of $649 million in a year in which it earned only $17 million? How could United Air Lines purchase new planes that cost $1.9 billion in a year in which it reported a net loss of over $2 billion? How did the companies that spent a combined fantastic $3.4 trillion on mergers and acquisitions in a recent year �inance those deals? Answers to these and similar questions can be found in this chapter, which presents the statement of cash �lows.

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Got Cash?

Companies must be ready to respond to changes quickly in order to survive and thrive. This requires careful management of cash. One company that managed cash successfully in its early years was Microsoft. During those years, the company paid much of its payroll by giving employees stock options (rights to purchase company stock in the future at a given price) instead of cash. This conserved cash and turned more than a thousand of its employees into millionaires.

In recent years, Microsoft has had a different kind of cash problem. Now that it has reached a more “mature” stage in life, it generates so much cash—roughly $1 billion per month—that it cannot always �igure out what to do with it. At one time, Microsoft had accumulated $60 billion.

The company said it was accumulating cash to invest in new opportunities, buy other companies, and pay off pending lawsuits. Microsoft's stockholders complained that holding all this cash was putting a drag on the company's pro�itability. Why? Because Microsoft had the cash invested in very low-yielding government securities. Stockholders felt that the company either should �ind new investment projects that would bring higher returns, or return some of the cash to stockholders.

Finally, Microsoft announced a plan to return cash to stockholders by paying a special one-time $32 billion dividend. This special dividend was so large that, according to the U.S. Commerce Department, it caused total personal income in the United States to rise by 3.7% in one month—the largest increase ever recorded by the agency. (It also made the holiday season brighter, especially for retailers in the Seattle area.) Microsoft also doubled its regular annual dividend to $3.50 per share. Further, it announced that it would spend another $30 billion buying treasury stock.

Apple has also encountered this cash “problem.” Apple recently had nearly $100 billion in liquid assets (cash, cash equivalents, and investment securities). It was generating $37 billion of cash per year from its operating activities but spending only about $7 billion on plant assets and purchases of patents. In response to shareholder pressure, Apple announced that it would begin to pay a quarterly dividend of $2.65 per share and buy back up to $10 billion of its stock. Analysts noted that the dividend consumes only $10 billion of cash per year. This leaves Apple wallowing in cash. The rest of us should have such problems.

Source: “Business: An End to Growth? Microsoft's Cash Bonanza,” The Economist (July 23, 2005), p. 61.

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LEARNING OBJECTIVE 1

Discuss the usefulness and format of the statement of cash �lows. 

The balance sheet, income statement, and retained earnings statement provide only limited information about a company's cash �lows (cash receipts and cash payments). For example, comparative balance sheets show the increase in property, plant, and equipment during the year. But, they do not show how the additions were �inanced or paid for. The income statement shows net income. But, it does not indicate the amount of cash generated by operating activities. The retained earnings statement shows cash dividends declared but not the cash dividends paid during the year. None of these statements presents a detailed summary of where cash came from and how it was used.

USEFULNESS OF THE STATEMENT OF CASH FLOWS The statement of cash �lows reports the cash receipts and cash payments from operating, investing, and �inancing activities during a period, in a format that reconciles the beginning and ending cash balances. The information in a statement of cash �lows helps investors, creditors, and others assess the following.

1. The entity's ability to generate future cash �lows. By examining relationships between items in the statement of cash �lows, investors make predictions of the amounts, timing, and uncertainty of future cash �lows better than they can from accrual-basis data.

2. The entity's ability to pay dividends and meet obligations. If a company does not have adequate cash, it cannot pay employees, settle debts, or pay dividends. Employees, creditors, and stockholders should be particularly interested in this statement because it alone shows the �lows of cash in a business.

3. The reasons for the difference between net income and net cash provided (used) by operating activities. Net income provides information on the success or failure of a business enterprise. However, some �inancial statement users are critical of accrual-basis net income because it requires many estimates. As a result, users often challenge the reliability of the number. Such is not the case with cash. Many readers of the statement of cash �lows want to know the reasons for the difference between net income and net cash provided by operating activities. Then they can assess for themselves the reliability of the income number.

4. The cash investing and �inancing transactions during the period. By examining a company's investing and �inancing transactions, a �inancial statement reader can better understand why assets and liabilities changed during the period.

ETHICS NOTE

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Though we would discourage reliance on cash �lows to the exclusion of accrual accounting, comparing net cash provided by operating activities to net income can reveal important information about the “quality” of reported net income. Such a comparison can reveal the extent to which net income provides a good measure of actual performance.

CLASSIFICATION OF CASH FLOWS The statement of cash �lows classi�ies cash receipts and cash payments as operating, investing, and �inancing activities. Transactions and other events characteristic of each kind of activity are as follows.

1. Operating activities include the cash effects of transactions that create revenues and expenses. They thus enter into the determination of net income.

2. Investing activities include (a) cash transactions that involve the purchase or disposal of investments and property, plant, and equipment, and (b) lending money and collecting the loans.

3. Financing activities include (a) obtaining cash from issuing debt and repaying the amounts borrowed, and (b) obtaining cash from stockholders, repurchasing shares, and paying dividends.

The operating activities category is the most important. It shows the cash provided by company operations. This source of cash is generally considered to be the best measure of a company's ability to generate suf�icient cash to continue as a going concern.

Illustration 12-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo1#c12-�ig-0001) lists typical cash receipts and cash payments within each of the three classi�ications. Study the list carefully. It will be very useful in solving homework exercises and problems.

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ILLUSTRATION 12-1 Typical receipt and payment classi�ications

Note the following general guidelines:

1. Operating activities involve income statement items.

2. Investing activities involve cash �lows resulting from changes in investments and long-term asset items.

3. Financing activities involve cash �lows resulting from changes in long-term liability and stockholders' equity items.

Companies classify as operating activities some cash �lows related to investing or �inancing activities. For example, receipts of investment revenue (interest and dividends) are classi�ied as operating activities. So

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are payments of interest to lenders. Why are these considered operating activities? Because companies report these items in the income statement, where results of operations are shown.

SIGNIFICANT NONCASH ACTIVITIES Not all of a company's signi�icant activities involve cash. Examples of signi�icant noncash activities are:

1. Direct issuance of common stock to purchase assets.

2. Conversion of bonds into common stock.

3. Direct issuance of debt to purchase assets.

4. Exchanges of plant assets.

Companies do not report in the body of the statement of cash �lows signi�icant �inancing and investing activities that do not affect cash. Instead, they report these activities in either a separate schedule at the bottom of the statement of cash �lows or in a separate note or supplementary schedule to the �inancial statements. The reporting of these noncash activities in a separate schedule satis�ies the full disclosure principle.

In solving homework assignments, you should present signi�icant noncash investing and �inancing activities in a separate schedule at the bottom of the statement of cash �lows. (See the last entry in Illustration 12-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo1#c12-�ig-0002) for an example.)

 ACCOUNTING ACROSS THE ORGANIZATION 

Target Corporation

Net What?

Net income is not the same as net cash provided by operating activities. Below are some results from recent annual reports (dollars in millions), including Target Corporation. Note how the numbers differ greatly across the list even though all these companies engage in retail merchandising.

Company Net Income

Net Cash Provided by Operating Activities

Kohl's Corporation $    889 

$ 1,884 

Wal-Mart Stores, Inc.

 16,669   25,591

J. C. Penney Company, Inc.

 (1,388)  (1,814)

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Company Net Income

Net Cash Provided by Operating Activities

Costco Wholesale Corp.

 20,391    3,437 

Target Corporation   1,971    6,520 

In general, why do differences exist between net income and net cash provided by operating activities? (Go to WileyPLUS for this answer and additional questions.)

INTERNATIONAL NOTE The statement of cash �lows is very similar under GAAP and IFRS. One difference is that, under IFRS, noncash investing and �inancing activities are not reported in the statement of cash �lows but instead are reported in the notes to the �inancial statements.

▼ HELPFUL HINT

Do not include noncash investing and �inancing activities in the body of the statement of cash �lows. Report this information in a separate schedule below the statement of cash �lows.

FORMAT OF THE STATEMENT OF CASH FLOWS The general format of the statement of cash �lows presents the results of the three activities discussed previously—operating, investing, and �inancing—plus the signi�icant noncash investing and �inancing activities. Illustration 12-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo1#c12-�ig-0002) shows a widely used form of the statement of cash �lows.

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ILLUSTRATION 12-2 Format of statement of cash �lows

The cash �lows from operating activities section always appears �irst, followed by the investing activities section and then the �inancing activities section. The sum of the operating, investing, and �inancing activities sections equals the net increase or decrease in cash for the period. This amount is added to the beginning cash balance to arrive at the ending cash balance—the same amount reported on the balance sheet.

DO IT! 1

Cash Flow Activities

During its �irst week, Duffy & Stevenson Company had these transactions.

1. Issued 100,000 shares of $5 par value common stock for $800,000 cash.

2. Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest.

3. Purchased two semi-trailer trucks for $170,000 cash.

4. Paid employees $12,000 for salaries and wages.

5. Collected $20,000 cash for services performed.

Classify each of these transactions by type of cash �low activity. (Hint: Refer to Illustration 12-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo1#c12-�ig- 0001) .)

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Action Plan ✓ Identify the three types of activities used to report all cash

in�lows and out�lows.

✓ Report as operating activities the cash effects of transactions that create revenues and expenses and enter into the determination of net income.

✓ Report as investing activities transactions that (a) acquire and dispose of investments and productive long-lived assets and (b) lend money and collect loans.

✓ Report as �inancing activities transactions that (a) obtain cash from issuing debt and repay the amounts borrowed and (b) obtain cash from stockholders and pay them dividends.

SOLUTION

1. Financing activity

2. Financing activity

3. Investing activity

4. Operating activity

5. Operating activity

Related exercise material: BE12-1, BE12-2, BE12-3, DO IT! 12-1, E12-1, and E12-2.

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LEARNING OBJECTIVE 2

Prepare a statement of cash �lows using the indirect method. 

Companies prepare the statement of cash �lows differently from the three other basic �inancial statements. First, it is not prepared from an adjusted trial balance. It requires detailed information concerning the changes in account balances that occurred between two points in time. An adjusted trial balance will not provide the necessary data. Second, the statement of cash �lows deals with cash receipts and payments. As a result, the company adjusts the effects of the use of accrual accounting to determine cash �lows.

The information to prepare this statement usually comes from three sources:

Comparative balance sheets. Information in the comparative balance sheets indicates the amount of the changes in asset, liability, and stockholders' equity accounts from the beginning to the end of the period.

Current income statement. Information in this statement helps determine the amount of net cash provided or used by operating activities during the period.

Additional information. Such information includes transaction data that are needed to determine how cash was provided or used during the period.

Preparing the statement of cash �lows from these data sources involves three major steps, explained in Illustration 12-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0003) .

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ILLUSTRATION 12-3 Three major steps in preparing the statement of cash �lows

INDIRECT AND DIRECT METHODS In order to perform Step 1, a company must convert net income from an accrual basis to a cash basis. This conversion may be done by either of two methods: (1) the indirect method or (2) the direct method. Both methods arrive at the same total amount for “Net cash provided by operating activities.” They differ in how they arrive at the amount.

The indirect method adjusts net income for items that do not affect cash to determine net cash provided by operating activities. A great majority of companies (98%) use this method. Companies favor the indirect method for two reasons: (1) it is easier and less costly to prepare, and (2) it focuses on the differences between net income and net cash �low from operating activities.

The direct method shows operating cash receipts and payments. It is prepared by adjusting each item in the income statement from the accrual basis to the cash basis. The FASB has expressed a preference for the direct method but allows the use of either method.

The next section illustrates the more popular indirect method. Appendix 12A illustrates the direct method. Appendix 12B demonstrates an approach that employs T-accounts to prepare the statement of cash �lows. Many students �ind the T-account approach provides a useful structure. We encourage you to give it a try as you walk through the Computer Services example.

INDIRECT METHOD—COMPUTER SERVICES COMPANY To explain how to prepare a statement of cash �lows using the indirect method, we use �inancial information from Computer Services Company. Illustration 12-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0004) presents Computer Services' current- and previous-year balance sheets, its current-year income statement, and related �inancial information.

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ILLUSTRATION 12-4 Comparative balance sheets, income statement, and additional information for Computer Services Company

Additional information for 2017:

1. Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.

2. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated depreciation $1,000) for $4,000 cash.

3. Issued $110,000 of long-term bonds in direct exchange for land.

4. A building costing $120,000 was purchased for cash. Equipment costing $25,000 was also purchased for cash.

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5. Issued common stock for $20,000 cash.

6. The company declared and paid a $29,000 cash dividend.

We now apply the three steps to the information provided for Computer Services.

STEP 1: OPERATING ACTIVITIES DETERMINE NET CASH PROVIDED/USED BY OPERATING ACTIVITIES BY CONVERTING NET INCOME FROM AN ACCRUAL BASIS TO A CASH BASIS

To determine net cash provided by operating activities under the indirect method, companies adjust net income in numerous ways. A useful starting point is to understand why net income must be converted to net cash provided by operating activities.

Under generally accepted accounting principles, most companies use the accrual basis of accounting. As you have learned, this basis requires that a company record revenue when the performance obligation is satis�ied and record expenses when incurred. Revenues include credit sales for which the company has not yet collected cash. Expenses incurred include some items that it has not yet paid in cash. Thus, under the accrual basis of accounting, net income is not the same as net cash provided by operating activities.

Therefore, under the indirect method, companies must adjust net income to convert certain items to the cash basis. The indirect method (or reconciliation method) starts with net income and converts it to net cash provided by operating activities. Illustration 12-5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0005) lists the three types of adjustments.

ILLUSTRATION 12-5 Three types of adjustments to convert net income to net cash provided by operating activities

We explain the three types of adjustments in the next three sections.

▼ HELPFUL HINT

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Depreciation is similar to any other expense in that it reduces net income. It differs in that it does not involve a current cash out�low. That is why it must be added back to net income to arrive at net cash provided by operating activities.

Depreciation Expense

Computer Services' income statement reports depreciation expense of $9,000. Although depreciation expense reduces net income, it does not reduce cash. In other words, depreciation expense is a noncash charge. The company must add it back to net income to arrive at net cash provided by operating activities. Computer Services reports depreciation expense as follows in the statement of cash �lows.

ILLUSTRATION 12-6 Adjustment for depreciation

As the �irst adjustment to net income in the statement of cash �lows, companies frequently list depreciation and similar noncash charges such as amortization of intangible assets and bad debt expense.

Loss on Disposal of Plant Assets

Illustration 12-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo1#c12-�ig-0001) states that cash received from the sale of plant assets is reported in the investing activities section. Because of this, companies eliminate from net income all gains and losses resulting from investing activities, to arrive at net cash provided by operating activities.

In our example, Computer Services' income statement reports a $3,000 loss on the disposal of plant assets (book value $7,000, less cash received from sale of equipment $4,000). The company's loss of $3,000 is eliminated in the operating activities section of the statement of cash �lows. Illustration 12-7 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0007) shows that the $3,000 loss is eliminated by adding $3,000 back to net income to arrive at net cash provided by operating activities.

ILLUSTRATION 12-7 Adjustment for loss on disposal of plant assets

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If a gain on sale occurs, the company deducts the gain from net income in order to determine net cash provided by operating activities. In the case of either a gain or a loss, companies report the actual amount of cash received from the sale, in this case $4,000, as a source of cash in the investing activities section of the statement of cash �lows.

Changes to Noncash Current Asset and Current Liability Accounts

A �inal step to reconcile net income to net cash provided by operating activities involves examining all changes in current asset and current liability accounts. The accrual-accounting process records revenues in the period in which the performance obligation is satis�ied and expenses in the period incurred. For example, Accounts Receivable re�lects amounts owed to the company for sales that have been made but for which cash collections have not yet been received. Prepaid Insurance re�lects insurance that has been paid for but which has not yet expired and therefore has not been expensed. Similarly, Salaries and Wages Payable re�lects salaries expense that has been incurred but has not been paid.

As a result, we need to adjust net income for these accruals and prepayments to determine net cash provided by operating activities. Thus, we must analyze the change in each current asset and current liability account to determine its impact on net income and cash.

CHANGES IN NONCASH CURRENT ASSETS.

The adjustments required for changes in noncash current asset accounts are as follows. Deduct from net income increases in current asset accounts, and add to net income decreases in current asset accounts, to arrive at net cash provided by operating activities. We observe these relationships by analyzing the accounts of Computer Services.

DECREASE IN ACCOUNTS RECEIVABLE

Computer Services' accounts receivable decreased by $10,000 (from $30,000 to $20,000) during the period. This means that cash receipts were $10,000 higher than sales revenue. The analysis of the Accounts Receivable account in Illustration 12-8 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0008) reveals this $10,000 difference. Computer Services had $507,000 in sales revenue (as reported on the income statement), but it collected $517,000 in cash.

ILLUSTRATION 12-8 Analysis of accounts receivable

As shown in Illustration 12-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0009) , to adjust net income to net cash provided by operating activities, the company adds to net income the decrease of $10,000 in accounts receivable.

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ILLUSTRATION 12-9 Adjustments for changes in current asset accounts

When the Accounts Receivable balance increases, cash receipts are lower than revenue recorded under the accrual basis. Therefore, the company deducts from net income the amount of the increase in accounts receivable, to arrive at net cash provided by operating activities.

INCREASE IN INVENTORY

Computer Services' inventory increased $5,000 (from $10,000 to $15,000) during the period. The change in the Inventory account re�lects the difference between the amount of inventory purchased and the amount sold. For Computer Services, this means that the cost of merchandise purchased exceeded the cost of goods sold by $5,000. As a result, cost of goods sold does not re�lect $5,000 of cash payments made for merchandise. The company deducts from net income this inventory increase of $5,000 during the period, to arrive at net cash provided by operating activities (see Illustration 12-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0009) ). If inventory decreases, the company adds to net income the amount of the change, to arrive at net cash provided by operating activities.

INCREASE IN PREPAID EXPENSES

Computer Services' prepaid expenses increased during the period by $4,000. This means that cash paid for expenses is higher than expenses reported on an accrual basis. In other words, the company has made cash payments in the current period but will not charge expenses to income until future periods (as charges to the income statement). To adjust net income to net cash provided by operating activities, the company deducts from net income the $4,000 increase in prepaid expenses (see Illustration 12-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0009) ).

If prepaid expenses decrease, reported expenses are higher than the expenses paid. Therefore, the company adds to net income the decrease in prepaid expense, to arrive at net cash provided by operating activities.

CHANGES IN CURRENT LIABILITIES.

The adjustments required for changes in current liability accounts are as follows. Add to net income increases in current liability accounts, and deduct from net income decreases in current liability accounts, to arrive at net cash provided by operating activities.

INCREASE IN ACCOUNTS PAYABLE

For Computer Services, accounts payable increased by $16,000 (from $12,000 to $28,000) during the period. That means the company received $16,000 more in goods than it actually paid for. As shown in

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Illustration 12-10 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig- 0010) , to adjust net income to determine net cash provided by operating activities, the company adds to net income the $16,000 increase in the Accounts Payable account.

DECREASE IN INCOME TAXES PAYABLE

When a company incurs income tax expense but has not yet paid its taxes, it records income taxes payable. A change in the Income Taxes Payable account re�lects the difference between income tax expense incurred and income taxes actually paid. Computer Services' Income Taxes Payable account decreased by $2,000. That means the $47,000 of income tax expense reported on the income statement was $2,000 less than the amount of taxes paid during the period of $49,000. As shown in Illustration 12-10 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0010) , to adjust net income to a cash basis, the company must reduce net income by $2,000.

ILLUSTRATION 12-10 Adjustments for changes in current liability accounts

Illustration 12-10 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig- 0010) shows that after starting with net income of $145,000, the sum of all of the adjustments to net income was $27,000. This resulted in net cash provided by operating activities of $172,000.

SUMMARY OF CONVERSION TO NET CASH PROVIDED BY OPERATING ACTIVITIES—INDIRECT METHOD As shown in the previous illustrations, the statement of cash �lows prepared by the indirect method starts with net income. Items are then added or deducted to arrive at net cash provided by operating activities. The required adjustments are of three types:

1. Noncash charges such as depreciation and amortization.

2. Gains and losses from investing and �inancing transactions, such as the sale of plant assets.

3. Changes in noncash current asset and current liability accounts.

Illustration 12-11 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig- 0011) provides a summary of these changes.

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ILLUSTRATION 12-11 Adjustments required to convert net income to net cash provided by operating activities

ANATOMY OF A FRAUD

For more than a decade, the top executives at the Italian dairy products company Parmalat engaged in multiple frauds that overstated cash and other assets by more than $1 billion while understating liabilities by between $8 and $12 billion. Much of the fraud involved creating �ictitious sources and uses of cash. Some of these activities incorporated sophisticated �inancial transactions with subsidiaries created with the help of large international �inancial institutions. However, much of the fraud employed very basic, even sloppy, forgery of documents. For example, when outside auditors requested con�irmation of bank accounts (such as a fake $4.8 billion account in the Cayman Islands), documents were created on scanners, with signatures that were cut and pasted from other documents. These were then passed through a fax machine numerous times to make them look real (if dif�icult to read). Similarly, �ictitious bills were created in order to divert funds to other businesses owned by the Tanzi family (who controlled Parmalat).

Total take: Billions of dollars

THE MISSING CONTROL

Independent internal veri�ication. Internal auditors at the company should have independently veri�ied bank accounts and major transfers of cash to outside companies that were controlled by the Tanzi family.

DO IT! 2a

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Net Cash Provided by Operating Activities

Josh's PhotoPlus reported net income of $73,000 for 2017. Included in the income statement were depreciation expense of $7,000 and a gain on disposal of plant assets of $2,500. Josh's comparative balance sheets show the following balances.

12/31/17 12/31/16 Accounts Receivable $21,000 $17,000 Accounts Payable 2,200 6,000

Calculate net cash provided by operating activities for Josh's PhotoPlus.

Action Plan ✓ Add noncash charges such as depreciation back to net income

to compute net cash provided by operating activities.

✓ Deduct gains and add back losses from the disposal of plant assets to compute net cash provided by operating activities.

✓ Use changes in noncash current asset and current liability accounts to compute net cash provided by operating activities.

Related exercise material: BE12-4, BE12-5, BE12-6, DO IT! 12-2a, E12-3, and E12-4.

STEP 2: INVESTING AND FINANCING ACTIVITIES ANALYZE CHANGES IN NONCURRENT ASSET AND LIABILITY ACCOUNTS AND RECORD AS INVESTING AND FINANCING ACTIVITIES, OR DISCLOSE AS NONCASH TRANSACTIONS

INCREASE IN LAND

As indicated from the change in the Land account and the additional information, Computer Services purchased land of $110,000 by directly exchanging bonds for land. The exchange of bonds payable for land

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has no effect on cash. But, it is a signi�icant noncash investing and �inancing activity that merits disclosure in a separate schedule. (See Illustration 12-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0013) .)

▼ HELPFUL HINT

The investing and �inancing activities are measured and reported the same under both the direct and indirect methods.

INCREASE IN BUILDINGS

As the additional data indicate, Computer Services acquired an of�ice building for $120,000 cash. This is a cash out�low reported in the investing activities section. (See Illustration 12-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0013) .)

ETHICS NOTE

Because investors and management bonus contracts often focus on cash �low from operations, some managers have taken unethical actions to arti�icially increase cash �low from operations. For example, Dynegy restated its statement of cash �lows because it had improperly included in operating activities $300 million that should have been reported as �inancing activities. This increased cash from operating activities by 37%.

INCREASE IN EQUIPMENT

The Equipment account increased $17,000. The additional information explains that this was a net increase that resulted from two transactions: (1) a purchase of equipment of $25,000, and (2) the sale for $4,000 of equipment costing $8,000. These transactions are both investing activities. The company should report each transaction separately. Thus, it reports the purchase of equipment as an out�low of cash for $25,000. It reports the sale as an in�low of cash for $4,000. The T-account below shows the reasons for the change in this account during the year.

ILLUSTRATION 12-12 Analysis of equipment

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The following entry shows the details of the equipment sale transaction.

INCREASE IN BONDS PAYABLE

The Bonds Payable account increased $110,000. As indicated in the additional information, the company acquired land by directly exchanging bonds for land. It reports this noncash transaction in a separate schedule at the bottom of the statement.

INCREASE IN COMMON STOCK

The balance sheet reports an increase in Common Stock of $20,000. The additional information section notes that this increase resulted from the issuance of new shares of stock. This is a cash in�low reported in the �inancing activities section.

▼ HELPFUL HINT

When companies issue stocks or bonds for cash, the actual proceeds will appear in the statement of cash �lows as a �inancing in�low (rather than the par value of the stocks or face value of bonds).

INCREASE IN RETAINED EARNINGS

Retained earnings increased $116,000 during the year. This increase can be explained by two factors: (1) net income of $145,000 increased retained earnings, and (2) dividends of $29,000 decreased retained earnings. The company adjusts net income to net cash provided by operating activities in the operating activities section. Payment of the dividends (not the declaration) is a cash out�low that the company reports as a �inancing activity.

Statement of Cash Flows—2017

Using the previous information, we can now prepare a statement of cash �lows for 2017 for Computer Services Company, as shown in Illustration 12-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0013) .

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ILLUSTRATION 12-13 Statement of cash �lows, 2017—indirect method

▼ HELPFUL HINT

Note that in the investing and �inancing activities sections, positive numbers indicate cash in�lows (receipts), and negative numbers indicate cash out�lows (payments).

STEP 3: NET CHANGE IN CASH COMPARE THE NET CHANGE IN CASH ON THE STATEMENT OF CASH FLOWS WITH THE CHANGE IN THE CASH ACCOUNT REPORTED ON THE BALANCE SHEET TO MAKE SURE THE AMOUNTS AGREE

Illustration 12-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig- 0013) indicates that the net change in cash during the period was an increase of $22,000. This agrees with the change in Cash account reported on the balance sheet in Illustration 12-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0004) (page 597).

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ACCOUNTING ACROSS THE ORGANIZATION Burning Through Our Cash

Box (cloud storage), Cyan (game creator), Fireeye (cyber security), and Mobile Iron (mobile security of data) are a few of the tech companies that recently have issued or are about to issue stock to the public. Investors now have to determine whether these tech companies have viable products and high chances for success.

An important consideration in evaluating a tech company is determining its �inancial �lexibility—its ability to withstand adversity if an economic setback occurs. One way to measure �inancial �lexibility is to assess a company's cash burn rate, which determines how long its cash will hold out if the company is expending more cash than it is receiving.

Fireeye, for example, burned cash in excess of $50 million in 2013. But the company also had over $150 million as a cash cushion, so it would take over 30 months before it runs out of cash. And even though Box has a much lower cash burn rate than Fireeye, it still has over a year's cushion. Compare that to the tech companies in 2000, when over one-quarter of them were on track to run out of cash within a year. And many did. Fortunately, the tech companies of today seem to be better equipped to withstand an economic setback.

Source: Shira Ovide, “Tech Firms' Cash Hoards Cool Fears of a Meltdown,” Wall Street Journal (May 14, 2014).

What implications does a company's cash burn rate have for its survival? (See WileyPLUS for this answer and additional questions.)

DO IT! 2b

Indirect Method

Use the following information to prepare a statement of cash �lows using the indirect method.

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Additional information:

1. Operating expenses include depreciation expense of $33,000.

2. Land was sold at its book value for cash.

3. Cash dividends of $55,000 were declared and paid in 2017.

4. Equipment with a cost of $166,000 was purchased for cash. Equipment with a cost of $41,000 and a book value of $36,000 was sold for $34,000 cash.

5. Bonds of $40,000 were redeemed at their face value for cash.

6. Common stock ($1 par) of $160,000 was issued for cash.

Action Plan

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✓ Determine net cash provided/used by operating activities by adjusting net income for items that did not affect cash.

✓ Determine net cash provided/used by investing activities and �inancing activities.

✓ Determine the net increase/decrease in cash.

Related exercise material: BE12-4, BE12-5, BE12-6, BE12-7, DO IT! E12-2b, E12-5, E12-6, and E12-7.

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LEARNING OBJECTIVE 3

Use the statement of cash �lows to evaluate a company. 

Traditionally, investors and creditors used ratios based on accrual accounting. These days, cash-based ratios are gaining increased acceptance among analysts. In this section, we review the corporate life cycle and free cash �low.

THE CORPORATE LIFE CYCLE All products go through a series of phases called the product life cycle. The phases (in order of their occurrence) are introductory phase, growth phase, maturity phase, and decline phase. The introductory phase occurs at the beginning of a company's life, when it purchases �ixed assets and begins to produce and sell products. During the growth phase, the company strives to expand its production and sales. In the maturity phase, sales and production level off. During the decline phase, sales of the product decrease due to a weakening in consumer demand.

In the same way that products have life cycles, companies have life cycles as well. Companies generally have more than one product, and not all of a company's products are in the same phase of the product life cycle at the same time. This sometimes makes it dif�icult to classify a company's phase. Still, we can characterize a company as being in one of the four phases because the majority of its products are in a particular phase.

Illustration 12-14 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo3#c12-�ig- 0014) shows that the phase a company is in affects its cash �lows. In the introductory phase, we expect that the company will not generate positive cash from operations. That is, cash used in operations will exceed cash generated by operations in the introductory phase. Also, the company spends considerable amounts to purchase productive assets such as buildings and equipment. To support its asset purchases, the company issues stock or debt. Thus, during the introductory phase, we expect negative cash from operations, negative cash from investing, and positive cash from �inancing.

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ILLUSTRATION 12-14 Impact of product life cycle on cash �lows

During the growth phase, we expect to see the company start to generate small amounts of cash from operations. During this phase, net cash provided by operating activities on the statement of cash �lows is less than net income. One reason net income exceeds cash �low from operations during this period is explained by the difference between the cash paid for inventory and the amount expensed as cost of goods sold. Since the company projects increasing sales, the size of inventory purchases increases. Thus, in the growth phase, the company expenses less inventory on an accrual basis than it purchases on a cash basis. Also, collections on accounts receivable lag behind sales, and accrual sales during a period exceed cash collections during that period. Cash needed for asset acquisitions will continue to exceed net cash provided by operating activities. The company makes up the de�iciency by issuing new stock or debt. Thus, in the growth phase, the company continues to show negative cash from investing activities and positive cash from �inancing activities.

During the maturity phase, net cash provided by operating activities and net income are approximately the same. Cash generated from operations exceeds investing needs. Thus, in the maturity phase, the company starts to pay dividends, retire debt, or buy back stock.

Finally, during the decline phase, net cash provided by operating activities decreases. Cash from investing activities might actually become positive as the company sells off excess assets. Cash from �inancing activities may be negative as the company buys back stock and redeems debt.

Consider Microsoft. During its early years, it had signi�icant product development costs and little revenue. Microsoft was lucky in that its agreement with IBM to provide the operating system for IBM PCs gave it an early steady source of cash to support growth. As noted in the Feature Story, Microsoft conserved cash by paying employees with stock options rather than cash. Today, Microsoft could be characterized as being in the maturity phase. It continues to spend considerable amounts on research and development and investment in new assets. In recent years, though, its net cash provided by operating activities has exceeded its net income. Also, cash from operations over this period exceeded cash used for investing, and common stock repurchased exceeded common stock issued. For Microsoft, as for any large company, the challenge is to maintain its growth. In the software industry, where products become obsolete very quickly, the challenge is particularly great.

INVESTOR INSIGHT   Operating with Negative Cash

Listed here are amounts (in millions) of net income and net cash provided (used) by operating, investing, and �inancing activities for a variety of companies at one time. The �inal column suggests the companies' likely phases in the life cycle based on these �igures.

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Why do companies have negative net cash provided by operating activities during the introductory phase? (Go to WileyPLUS for this answer and additional questions.)

FREE CASH FLOW In the statement of cash �lows, net cash provided by operating activities is intended to indicate the cash- generating capability of the company. Analysts have noted, however, that cash provided by operating activities fails to take into account that a company must invest in new �ixed assets just to maintain its current level of operations. Companies also must at least maintain dividends at current levels to satisfy investors. As we discussed in Chapter 2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch02#ch02) , the measurement of free cash �low provides additional insight regarding a company's cash-generating ability. Free cash �low describes the net cash provided by operating activities after adjustment for capital expenditures and dividends.

Consider the following example. Suppose that MPC produced and sold 10,000 personal computers this year. It reported $100,000 cash provided by operating activities. In order to maintain production at 10,000 computers, MPC invested $15,000 in equipment. It chose to pay $5,000 in dividends. Its free cash �low was $80,000 ($100,000−$15,000−$5,000). The company could use this $80,000 either to purchase new assets, pay off debt, or pay an $80,000 dividend. In practice, free cash �low is often calculated with the formula in Illustration 12-15 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo3#c12-�ig- 0015) . Alternative de�initions also exist.

ILLUSTRATION 12-15 Free cash �low

Illustration 12-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo3#c12-�ig- 0016) provides basic information excerpted from the 2014 statement of cash �lows of Apple (prior to the payment of its �irst dividends).

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ILLUSTRATION 12-16 Apple's cash �low information ($ in millions)

Apple's free cash �low is calculated as shown in Illustration 12-17 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo3#c12-�ig-0017) (in millions). Apple generated approximately $39 billion of free cash �low. This is a tremendous amount of cash generated in a single year. It is available for the acquisition of new assets, the buyback and retirement of stock or debt, or the payment of dividends.

ILLUSTRATION 12-17 Calculation of Apple's free cash �low ($ in millions)

Also note that Apple's cash from operations of $59.7 billion exceeds its 2014 net income of $39.5 billion by $20.2 billion. This lends additional credibility to Apple's income number as an indicator of potential future performance. If anything, Apple's net income might understate its actual performance.

KEEPING AN EYE ON CASH Cash �low is closely monitored by analysts and investors for many reasons and in a variety of ways. One measure that is gaining increased attention is “price to cash �low.” This is a variant of the price to earnings (P-E) ratio, which has been a staple of analysts for a long time. The difference is that rather than divide the company's stock price by its earnings per share (an accrual-accounting–based number), the price to cash �low ratio divides the company's stock price by its cash �low per share. A high measure suggests that the stock price is high relative to the company's ability to generate cash. A low measure indicates that the company's stock might be a bargain.

The following table provides values for some well-known companies in a recent year. While you should not use this measure as the sole factor in choosing a stock, it can serve as a useful screen by which to identify companies that merit further investigation.

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Company Price/Cash Flow Price/EPS Microsoft 55.6 62.5 Apple 11.1 12.5 Nike 19.1 24.8 Wal-Mart  9.0 15.7 Jet Blue  7.9 11.1

DO IT! 3

Free Cash Flow

Chicago Corporation issued the following statement of cash �lows for 2017.

(a) Compute free cash �low for Chicago Corporation.

(b) Explain why free cash �low often provides better information than “Net cash provided by operating activities.”

Action Plan ✓ Compute free cash �low as Net cash provided by operating

activities−Capital expenditures−Cash dividends.

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SOLUTION (a) Free cash �low=$29,300−$19,000−$9,000=$1,300

(b) Net cash provided by operating activities fails to take into account that a company must invest in new plant assets just to maintain the current level of operation. Companies must also maintain dividends at current levels to satisfy investors. The measurement of free cash �low provides additional insight regarding a company's cash-generating ability.

Related exercise material: BE12-9, BE12-10, BE12-11, BE12-12, DO IT! 12-3, E12-9, and E12-10.

USING DECISION TOOLS—INTEL CORPORATION Intel Corporation is the leading producer of computer chips for personal computers. Its primary competitor is AMD. Financial statement data for Intel are provided below.

INSTRUCTIONS

Calculate free cash �low for Intel and compare it with that of AMD (−$193 million).

SOLUTION

Intel's free cash �low is $5,904 million ($20,418−$10,105−$4,409). AMD's is −$193 million. This gives Intel a huge advantage in the ability to move quickly to invest in new projects.

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DECISION TOOLS

Free cash �lows helps users determine the amount of cash the company generated to expand operations or pay dividends.

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LEARNING OBJECTIVE *4

APPENDIX 12A: Prepare a statement of cash �lows using the direct method. 

To explain and illustrate the direct method, we will use the transactions of Computer Services Company for 2017 to prepare a statement of cash �lows. Illustration 12A-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0018) (page 612) presents information related to 2017 for the company.

ILLUSTRATION 12A-1 Comparative balance sheets, income statement, and additional information for Computer Services Company

To prepare a statement of cash �lows under the direct approach, we will apply the three steps outlined in Illustration 12-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0003) (page 596).

STEP 1: OPERATING ACTIVITIES

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DETERMINE NET CASH PROVIDED/USED BY OPERATING ACTIVITIES BY CONVERTING NET INCOME FROM AN ACCRUAL BASIS TO A CASH BASIS

Under the direct method, companies compute net cash provided by operating activities by adjusting each item in the income statement from the accrual basis to the cash basis. To simplify and condense the operating activities section, companies report only major classes of operating cash receipts and cash payments. For these major classes, the difference between cash receipts and cash payments is the net cash provided by operating activities. These relationships are as shown in Illustration 12A-2 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0019) .

ILLUSTRATION 12A-2 Major classes of cash receipts and payments

An ef�icient way to apply the direct method is to analyze the items reported in the income statement in the order in which they are listed. We then determine cash receipts and cash payments related to these revenues and expenses. The following pages present the adjustments required to prepare a statement of cash �lows for Computer Services Company using the direct approach.

CASH RECEIPTS FROM CUSTOMERS

The income statement for Computer Services reported sales revenue from customers of $507,000. How much of that was cash receipts? To answer that, companies need to consider the change in accounts receivable during the year. When accounts receivable increase during the year, revenues on an accrual basis are higher than cash receipts from customers. Operations led to revenues, but not all of these revenues resulted in cash receipts.

To determine the amount of cash receipts, the company deducts from sales revenue the increase in accounts receivable. On the other hand, there may be a decrease in accounts receivable. That would occur if cash receipts from customers exceeded sales revenue. In that case, the company adds to sales revenue the decrease in accounts receivable. For Computer Services, accounts receivable decreased $10,000. Thus, cash receipts from customers were $517,000, computed as shown in Illustration 12A-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0020) .

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ILLUSTRATION 12A-3 Computation of cash receipts from customers

Computer Services can also determine cash receipts from customers from an analysis of the Accounts Receivable account, as shown in Illustration 12A-4 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0021) .

ILLUSTRATION 12A-4 Analysis of accounts receivable

Illustration 12A-5 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig- 0022) shows the relationships among cash receipts from customers, sales revenue, and changes in accounts receivable.

ILLUSTRATION 12A-5 Formula to compute cash receipts from customers— direct method

▼ HELPFUL HINT

The T-account shows that sales revenue plus decrease in accounts receivables equals cash receipts.

CASH PAYMENTS TO SUPPLIERS

Computer Services reported cost of goods sold of $150,000 on its income statement. How much of that was cash payments to suppliers? To answer that, it is �irst necessary to �ind purchases for the year. To �ind purchases, companies adjust cost of goods sold for the change in inventory. When inventory increases during the year, purchases for the year have exceeded cost of goods sold. As a result, to determine the amount of purchases, the company adds to cost of goods sold the increase in inventory.

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In 2017, Computer Services' inventory increased $5,000. It computes purchases as follows.

ILLUSTRATION 12A-6 Computation of purchases

After computing purchases, a company can determine cash payments to suppliers. This is done by adjusting purchases for the change in accounts payable. When accounts payable increase during the year, purchases on an accrual basis are higher than they are on a cash basis. As a result, to determine cash payments to suppliers, a company deducts from purchases the increase in accounts payable. On the other hand, if cash payments to suppliers exceed purchases, there may be a decrease in accounts payable. In that case, a company adds to purchases the decrease in accounts payable. For Computer Services, cash payments to suppliers were $139,000, computed as follows.

ILLUSTRATION 12A-7 Computation of cash payments to suppliers

Computer Services also can determine cash payments to suppliers from an analysis of the Accounts Payable account, as shown in Illustration 12A-8 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0025) .

ILLUSTRATION 12A-8 Analysis of accounts payable

Illustration 12A-9 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig- 0026) shows the relationships among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable.

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ILLUSTRATION 12A-9 Formula to compute cash payments to suppliers—direct method

▼ HELPFUL HINT

The T-account shows that purchases less increase in accounts payable equals payments to suppliers.

CASH PAYMENTS FOR OPERATING EXPENSES

Computer Services reported on its income statement operating expenses of $111,000. How much of that amount was cash paid for operating expenses? To answer that, we need to adjust this amount for any changes in prepaid expenses and accrued expenses payable. For example, if prepaid expenses increased during the year, cash paid for operating expenses is higher than operating expenses reported on the income statement. To convert operating expenses to cash payments for operating expenses, a company adds the increase in prepaid expenses to operating expenses. On the other hand, if prepaid expenses decrease during the year, it deducts the decrease from operating expenses.

Companies must also adjust operating expenses for changes in accrued expenses payable. When accrued expenses payable increase during the year, operating expenses on an accrual basis are higher than they are in a cash basis. As a result, to determine cash payments for operating expenses, a company deducts from operating expenses an increase in accrued expenses payable. On the other hand, a company adds to operating expenses a decrease in accrued expenses payable because cash payments exceed operating expenses.

Computer Services' cash payments for operating expenses were $115,000, computed as follows.

ILLUSTRATION 12A-10 Computation of cash payments for operating expenses

Illustration 12A-11 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig- 0028) shows the relationships among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable.

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ILLUSTRATION 12A-11 Formula to compute cash payments for operating expenses—direct method

DEPRECIATION EXPENSE AND LOSS ON DISPOSAL OF PLANT ASSETS

Computer Services' depreciation expense in 2017 was $9,000. Depreciation expense is not shown on a statement of cash �lows under the direct method because it is a noncash charge. If the amount for operating expenses includes depreciation expense, operating expenses must be reduced by the amount of depreciation to determine cash payments for operating expenses.

The loss on disposal of plant assets of $3,000 is also a noncash charge. The loss on disposal of plant assets reduces net income, but it does not reduce cash. Thus, the loss on disposal of plant assets is not shown on the statement of cash �lows under the direct method.

Other charges to expense that do not require the use of cash, such as the amortization of intangible assets and bad debt expense, are treated in the same manner as depreciation.

CASH PAYMENTS FOR INTEREST

Computer Services reported on the income statement interest expense of $42,000. Since the balance sheet did not include an accrual for interest payable for 2016 or 2017, the amount reported as expense is the same as the amount of interest paid.

CASH PAYMENTS FOR INCOME TAXES

Computer Services reported income tax expense of $47,000 on the income statement. Income taxes payable, however, decreased $2,000. This decrease means that income taxes paid were more than income taxes reported in the income statement. Cash payments for income taxes were, therefore, $49,000 as shown below.

ILLUSTRATION 12A-12 Computation of cash payments for income taxes

Illustration 12A-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig- 0030) shows the relationships among cash payments for income taxes, income tax expense, and changes in income taxes payable.

ILLUSTRATION 12A-13 Formula to compute cash payments for income taxes— direct method

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The operating activities section of the statement of cash �lows of Computer Services is shown in Illustration 12A-14 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig- 0031) .

ILLUSTRATION 12A-14 Operating activities section of the statement of cash �lows

When a company uses the direct method, it must also provide in a separate schedule (not shown here) the net cash �lows from operating activities as computed under the indirect method.

STEP 2: INVESTING AND FINANCING ACTIVITIES ANALYZE CHANGES IN NONCURRENT ASSET AND LIABILITY ACCOUNTS AND RECORD AS INVESTING AND FINANCING ACTIVITIES, OR DISCLOSE AS NONCASH TRANSACTIONS

INCREASE IN LAND

As indicated from the change in the Land account and the additional information, Computer Services purchased land of $110,000 by directly exchanging bonds for land. The exchange of bonds payable for land has no effect on cash. But, it is a signi�icant noncash investing and �inancing activity that merits disclosure in a separate schedule. (See Illustration 12A-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0033) , page 618.)

▼ HELPFUL HINT

The investing and �inancing activities are measured and reported the same under both the direct and indirect methods.

INCREASE IN BUILDINGS

As the additional data indicate, Computer Services acquired an of�ice building for $120,000 cash. This is a cash out�low reported in the investing activities section. (See Illustration 12A-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0033) , page 618.)

INCREASE IN EQUIPMENT

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The Equipment account increased $17,000. The additional information explains that this was a net increase that resulted from two transactions: (1) a purchase of equipment of $25,000, and (2) the sale for $4,000 of equipment costing $8,000. These transactions are investing activities. The company should report each transaction separately. The statement in Illustration 12A-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0033) reports the purchase of equipment as an out�low of cash for $25,000. It reports the sale as an in�low of cash for $4,000. The T-account below shows the reasons for the change in this account during the year.

ILLUSTRATION 12A-15 Analysis of equipment

The following entry shows the details of the equipment sale transaction.

INCREASE IN BONDS PAYABLE

The Bonds Payable account increased $110,000. As indicated in the additional information, the company acquired land by directly exchanging bonds for land. Illustration 12A-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0033) reports this noncash transaction in a separate schedule at the bottom of the statement.

INCREASE IN COMMON STOCK

The balance sheet reports an increase in Common Stock of $20,000. The additional information section notes that this increase resulted from the issuance of new shares of stock. This is a cash in�low reported in the �inancing activities section in Illustration 12A-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0033) (page 618).

INCREASE IN RETAINED EARNINGS

Retained earnings increased $116,000 during the year. This increase can be explained by two factors: (1) net income of $145,000 increased retained earnings, and (2) dividends of $29,000 decreased retained earnings. The company adjusts net income to net cash provided by operating activities in the operating activities section. Payment of the dividends (not the declaration) is a cash out�low that the company reports as a �inancing activity in Illustration 12A-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0033) .

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▼ HELPFUL HINT

When companies issue stocks or bonds for cash, the actual proceeds will appear in the statement of cash �lows as a �inancing in�low (rather than the par value of the stocks or face value of bonds).

Statement of Cash Flows—2017

Illustration 12A-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig- 0033) (page 618) shows the statement of cash �lows for Computer Services Company.

ILLUSTRATION 12A-16 Statement of cash �lows, 2017—direct method

STEP 3: NET CHANGE IN CASH COMPARE THE NET CHANGE IN CASH ON THE STATEMENT OF CASH FLOWS WITH THE CHANGE IN THE CASH ACCOUNT REPORTED ON THE BALANCE SHEET TO MAKE SURE THE AMOUNTS AGREE

Illustration 12A-16 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig- 0033) indicates that the net change in cash during the period was an increase of $22,000. This agrees with the change in balances in the Cash account reported on the balance sheets in Illustration 12A-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo4#c12-�ig-0018) (page 612).

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LEARNING OBJECTIVE *5

APPENDIX 12B: Use the T-account approach to prepare a statement of cash �lows. 

Many people like to use T-accounts to provide structure to the preparation of a statement of cash �lows. The use of T-accounts is based on the accounting equation that you learned in Chapter 1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01#ch01) . The basic equation is:

Assets=Liabilities+Equity

Now, let's rewrite the left-hand side as:

Cash+Noncash Assets=Liabilities+Equity

Next, rewrite the equation by subtracting Noncash Assets from each side to isolate Cash on the left-hand side:

Cash=Liabilities+Equity−Noncash Assets

Finally, if we insert the Δ symbol (which means “change in”), we have:

Δ Cash=Δ Liabilities+Δ Equity−Δ Noncash Assets

What this means is that the change in cash is equal to the change in all of the other balance sheet accounts. Another way to think about this is that if we analyze the changes in all of the noncash balance sheet accounts, we will explain the change in the Cash account. This, of course, is exactly what we are trying to do with the statement of cash �lows.

To implement this approach, �irst prepare a large Cash T-account with sections for operating, investing, and �inancing activities. Then, prepare smaller T-accounts for all of the other noncash balance sheet accounts. Insert the beginning and ending balances for each of these accounts. Once you have done this, then walk through the steps outlined in Illustration 12-3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0003) (page 596). As you walk through the steps, enter debit and credit amounts into the affected accounts. When all of the changes in the T-accounts have been explained, you are done. To demonstrate, we will apply this approach to the example of Computer Services Company that is presented in the chapter. Each of the adjustments in Illustration 12B-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo5#c12-�ig- 0034) is numbered so you can follow them through the T-accounts.

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ILLUSTRATION 12B-1 T-account approach

1. Post net income as a debit to the operating section of the Cash T-account and a credit to Retained Earnings. Make sure to label all adjustments to the Cash T-account. It also helps to number each adjustment so you can trace all of them if you make an error.

2. Post depreciation expense as a debit to the operating section of Cash and a credit to each of the appropriate accumulated depreciation accounts.

3. Post any gains or losses on the sale of property, plant, and equipment. To do this, it is best to �irst prepare the journal entry that was recorded at the time of the sale and then post each element of the journal entry. For example, for Computer Services the entry was:

The $4,000 cash entry is a source of cash in the investing section of the Cash account. Accumulated Depreciation—Equipment is debited for $1,000. The Loss on Disposal of Plant Assets is a debit to the operating section of the Cash T-account. Finally, Equipment is credited for $8,000.

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4-8 Next, post each of the changes to the noncash current asset and current liability accounts. For example, to explain the $10,000 decline in Computer Services' accounts receivable, credit Accounts Receivable for $10,000 and debit the operating section of the Cash T-account for $10,000.

9. Analyze the changes in the noncurrent accounts. Land was purchased by issuing bonds payable. This requires a debit to Land for $110,000 and a credit to Bonds Payable for $110,000. Note that this is a signi�icant noncash event that requires disclosure at the bottom of the statement of cash �lows.

10. Buildings is debited for $120,000, and the investing section of the Cash T-account is credited for $120,000 as a use of cash from investing.

11. Equipment is debited for $25,000 and the investing section of the Cash T-account is credited for $25,000 as a use of cash from investing.

12. Common Stock is credited for $20,000 for the issuance of shares of stock, and the �inancing section of the Cash T-account is debited for $20,000.

13. Retained Earnings is debited to re�lect the payment of the $29,000 dividend, and the �inancing section of the Cash T-account is credited to re�lect the use of Cash.

At this point, all of the changes in the noncash accounts have been explained. All that remains is to subtotal each section of the Cash T-account and compare the total change in cash with the change shown on the balance sheet. Once this is done, the information in the Cash T-account can be used to prepare a statement of cash �lows.

REVIEW AND PRACTICE

LEARNING OBJECTIVES REVIEW 1. Discuss the usefulness and format of the statement of cash �lows. The

statement of cash �lows provides information about the cash receipts, cash payments, and net change in cash resulting from the operating, investing, and �inancing activities of a company during the period.

Operating activities include the cash effects of transactions that enter into the determination of net income. Investing activities involve cash �lows resulting from changes in investments and long-term asset items. Financing activities involve cash �lows resulting from changes in long-term liability and stockholders' equity items.

2. Prepare a statement of cash �lows using the indirect method. The preparation of a statement of cash �lows involves three major steps. (1) Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis. (2) Analyze changes in noncurrent asset and liability

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accounts and record as investing and �inancing activities, or disclose as noncash transactions. (3) Compare the net change in cash on the statement of cash �lows with the change in the Cash account reported on the balance sheet to make sure the amounts agree.

3. Use the statement of cash �lows to evaluate a company. During the introductory stage, net cash provided by operating activities and net cash provided by investing activities are negative, and net cash provided by �inancing activities is positive. During the growth stage, net cash provided by operating activities becomes positive but is still not suf�icient to meet investing needs. During the maturity stage, net cash provided by operating activities exceeds investing needs, so the company begins to retire debt. During the decline stage, net cash provided by operating activities is reduced, net cash provided by investing activities becomes positive (from selling off assets), and net cash provided by �inancing activities becomes more negative.

Free cash �low indicates the amount of cash a company generated during the current year that is available for the payment of dividends or for expansion.

4. Prepare a statement of cash �lows using the direct method. The preparation of the statement of cash �lows involves three major steps. (1) Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis. (2) Analyze changes in noncurrent asset and liability accounts and record as investing and �inancing activities, or disclose as noncash transactions. (3) Compare the net change in cash on the statement of cash �lows with the change in the Cash account reported on the balance sheet to make sure the amounts agree. The direct method reports cash receipts less cash payments to arrive at net cash provided by operating activities.

5. Use the T-account approach to prepare a statement of cash �lows. To use T- accounts to prepare the statement of cash �lows: (1) prepare a large Cash T- account with sections for operating, investing, and �inancing activities; (2) prepare smaller T-accounts for all other noncash accounts; (3) insert beginning and ending balances for all accounts; and (4) follows the steps in Illustration 12- 3 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12- �ig-0003) (page 596), entering debit and credit amounts as needed.

DECISION TOOLS REVIEW

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GLOSSARY REVIEW Direct method A method of determining net cash provided by operating activities by

adjusting each item in the income statement from the accrual basis to the cash basis. The direct method shows operating cash receipts and payments.

Financing activities Cash �low activities that include (a) obtaining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying dividends.

Free cash �low Net cash provided by operating activities after adjusting for capital expenditures and cash dividends paid.

Indirect method A method of preparing a statement of cash �lows in which net income is adjusted for items that do not affect cash, to determine net cash provided by operating activities.

Investing activities Cash �low activities that include (a) cash transactions that involve the purchase or disposal of investments and property, plant, and equipment using cash, and (b) lending money and collecting the loans.

Operating activities Cash �low activities that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income.

Product life cycle A series of phases in a product's sales and cash �lows over time. These phases, in order of occurrence, are introductory, growth, maturity, and decline.

Statement of cash �lows A basic �inancial statement that provides information about the cash receipts and cash payments of an entity during a period, classi�ied as operating, investing, and �inancing activities, in a format that reconciles the beginning and ending cash balances.

PRACTICE MULTIPLE-CHOICE QUESTIONS (LO 1)

1. Which of the following is incorrect about the statement of cash �lows?

(a) It is a fourth basic �inancial statement.

(b) It provides information about cash receipts and cash payments of an entity during a period.

(c) It reconciles the ending cash account balance to the balance per the bank statement.

(d) It provides information about the operating, investing, and �inancing activities of the business.

(LO 1)

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2. Which of the following will not be reported in the statement of cash �lows?

(a) The net change in stockholders' equity during the year.

(b) Cash payments for plant assets during the year.

(c) Cash receipts from sales of plant assets during the year.

(d) Sources of �inancing during the period.

(LO 1)

3. The statement of cash �lows classi�ies cash receipts and cash payments by these activities:

(a) operating and nonoperating.

(b) operating, investing, and �inancing.

(c) �inancing, operating, and nonoperating.

(d) investing, �inancing, and nonoperating.

(LO 1)

4. Which is an example of a cash �low from an operating activity?

(a) Payment of cash to lenders for interest.

(b) Receipt of cash from the sale of common stock.

(c) Payment of cash dividends to the company's stockholders.

(d) None of the above.

(LO 1)

5. Which is an example of a cash �low from an investing activity?

(a) Receipt of cash from the issuance of bonds payable.

(b) Payment of cash to repurchase outstanding common stock.

(c) Receipt of cash from the sale of equipment.

(d) Payment of cash to suppliers for inventory.

(LO 1)

6. Cash dividends paid to stockholders are classi�ied on the statement of cash �lows as:

(a) operating activities.

(b) investing activities.

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(c) a combination of (a) and (b).

(d) �inancing activities.

(LO 1)

7. Which is an example of a cash �low from a �inancing activity?

(a) Receipt of cash from sale of land.

(b) Issuance of debt for cash.

(c) Purchase of equipment for cash.

(d) None of the above

(LO 1)

8. Which of the following is incorrect about the statement of cash �lows?

(a) The direct method may be used to report net cash provided by operating activities.

(b) The statement shows the net cash provided (used) for three categories of activity.

(c) The operating activities section is the last section of the statement.

(d) The indirect method may be used to report net cash provided by operating activities.

Use the indirect method to solve Questions 9 through 11 .

(LO 2)

9. Net income is $132,000, accounts payable increased $10,000 during the year, inventory decreased $6,000 during the year, and accounts receivable increased $12,000 during the year. Under the indirect method, what is net cash provided by operating activities?

(a) $102,000.

(b) $112,000.

(c) $124,000.

(d) $136,000.

(LO 2)

10. Items that are added back to net income in determining net cash provided by operating activities under the indirect method do not include:

(a) depreciation expense.

(b) an increase in inventory.

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(c) amortization expense.

(d) loss on disposal of equipment.

(LO 2)

11. The following data are available for Bill Mack Corporation.

Net income $200,000 Depreciation expense 40,000 Dividends paid 60,000 Gain on sale of land 10,000 Decrease in accounts receivable 20,000 Decrease in accounts payable 30,000

Net cash provided by operating activities is:

(a) $160,000.

(b) $220,000.

(c) $240,000.

(d) $280,000.

(LO 2)

12. The following are data concerning cash received or paid from various transactions for Orange Peels Corporation.

Sale of land $100,000 Sale of equipment 50,000 Issuance of common stock 70,000 Purchase of equipment 30,000 Payment of cash dividends 60,000

Net cash provided by investing activities is:

(a) $120,000.

(b) $130,000.

(c) $150,000.

(d) $190,000.

(LO 2)

13. The following data are available for Retique!

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Increase in accounts payable $ 40,000 Increase in bonds payable 100,000 Sale of investment 50,000 Issuance of common stock 60,000 Payment of cash dividends 30,000

Net cash provided by �inancing activities is:

(a) $90,000.

(b) $130,000.

(c) $160,000.

(d) $170,000.

(LO 3)

14. Free cash �low provides an indication of a company's ability to:

(a) manage inventory.

(b) generate cash to pay dividends.

(c) generate cash to invest in new capital expenditures.

(d) both (b) and (c).

(LO 3)

15. During the introductory phase of a company's life cycle, one would normally expect to see:

(a) negative cash from operations, negative cash from investing, and positive cash from �inancing.

(b) negative cash from operations, positive cash from investing, and positive cash from �inancing.

(c) positive cash from operations, negative cash from investing, and negative cash from �inancing.

(d) positive cash from operations, negative cash from investing, and positive cash from �inancing.

Use the direct method to solve Questions 16 and 17.

(LO 4)

*16. The beginning balance in accounts receivable is $44,000, the ending balance is $42,000, and sales during the period are $129,000. What are cash receipts from

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customers?

(a) $127,000.

(b) $129,000.

(c) $131,000.

(d) $141,000.

(LO 4)

*17. Which of the following items is reported on a statement of cash �lows prepared by the direct method?

(a) Loss on disposal of building.

(b) Increase in accounts receivable.

(c) Depreciation expense.

(d) Cash payments to suppliers.

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SOLUTIONS

1. (c) The statement of cash �lows does not reconcile the ending cash balance to the balance per the bank statement. The other choices are true statements.

2. (a) The net change in stockholders' equity during the year is not reported in the statement of cash �lows. The other choices are true statements.

3. (b) Operating, investing, and �inancing activities are the three classi�ications of cash receipts and cash payments used in the statement of cash �lows. The other choices are therefore incorrect.

4. (a) Payment of cash to lenders for interest is an operating activity. The other choices are incorrect because (b) receipt of cash from the sale of common stock is a �inancing activity, (c) payment of cash dividends to the company's stockholders is a �inancing activity, and (d) there is a correct answer.

5. (c) Receipt of cash from the sale of equipment is an investing activity. The other choices are incorrect because (a) the receipt of cash from the issuance of bonds payable is a �inancing activity, (b) payment of cash to repurchase outstanding common stock is a �inancing activity, and (d) payment of cash to suppliers for inventory is an operating activity.

6. (d) Cash dividends paid to stockholders are classi�ied as a �inancing activity, not (a) an operating activity, (b) an investing activity, or (c) a combination of (a) and (b).

7. (b) Issuance of debt for cash is a �inancing activity. The other choices are incorrect because (a) the receipt of cash for the sale of land is an investing activity, (c) the purchase of equipment for cash is an investing activity, and (d) there is a correct answer.

8. (c) The operating section of the statement of cash �lows is the �irst, not the last, section of the statement. The other choices are true statements.

9. (d) Net cash provided by operating activities is computed by adjusting net income for the changes in the three current asset/current liability accounts listed. An increase in accounts payable ($10,000) and a decrease in inventory ($6,000) are added to net income ($132,000), while an increase in accounts receivable ($12,000) is subtracted from net income, or $132,000+$10,000+$6,000−$12,000=$136,000, not (a) $102,000, (b) $112,000, or (c) $124,000.

10. (b) An increase in inventory is subtracted, not added, to net income in determining net cash provided by operating activities. The other choices are incorrect because (a) depreciation expense, (c) amortization expense,

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and (d) loss on disposal of equipment are all added back to net income in determining net cash provided by operating activities.

11. (b) Net cash provided by operating activities is $220,000 (Net income $200,000+Depreciation expense $40,000−Gain on disposal of land $10,000+Decrease in accounts receivable $20,000−Decrease in accounts payable $30,000), not (a) $160,000, (c) $240,000, or (d) $280,000.

12. (a) Net cash provided by investing activities is $120,000 (Sale of land $100,000+Sale of equipment $50,000−Purchase of equipment $30,000), not (b) $130,000, (c) $150,000, or (d) $190,000. Issuance of common stock and payment of cash dividends are �inancing activities.

13. (b) Net cash provided by �inancing activities is $130,000 (Increase in bonds payable $100,000+Issuance of common stock $60,000−Payment of cash dividends $30,000), not (a) $90,000, (c) $160,000, or (d) $170,000. Increase in accounts payable is an operating activity, and sale of investment is an investing activity.

14. (d) Free cash �low provides an indication of a company's ability to generate cash to pay dividends and to invest in new capital expenditures. Choice (a) is incorrect because other measures besides free cash �low provide the best measure of a company's ability to manage inventory. Choices (b) and (c) are true statements, but (d) is the better answer.

15. (a) During the introductory phase of a company's life cycle, the company will most likely �inance its operations and investing activities through borrowing or the issuance of stock. This means negative cash from operations and investing, and positive cash from �inancing. The other choices are incorrect because during the introductory phase of a company's life cycle, the company will most likely (b) purchase long-term assets which requires a cash out�low, (c) �inance its operations and investing activities through borrowing or the issuance of stock which generates cash in�lows from �inancing, and (d) use cash to fund operations until it establishes a customer base.

16. (c) Cash receipts from customers amount to $131,000 ($129,000+$2,000). The other choices are therefore incorrect.

17. (d) Cash payments to suppliers are reported on a statement of cash �lows prepared by the direct method. The other choices are incorrect because (a) loss on disposal of building, (b) increase in accounts receivable, and (c) depreciation expense are reported in the operating activities section of the statement of cash �lows when the indirect, not direct, method is used.

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PRACTICE EXERCISES

Prepare journal entries to determine effect on statement of cash �lows.

(LO 2)

1. Furst Corporation had the following transactions.

1. Paid salaries of $14,000.

2. Issued 1,000 shares of $1 par value common stock for equipment worth $16,000.

3. Sold equipment (cost $10,000, accumulated depreciation $6,000) for $3,000.

4. Sold land (cost $12,000) for $16,000.

5. Issued another 1,000 shares of $1 par value common stock for $18,000.

6. Recorded depreciation of $20,000.

INSTRUCTIONS

For each transaction above, (a) prepare the journal entry and (b) indicate how it would affect the statement of cash �lows. Assume the indirect method.

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Prepare statement of cash �lows and compute free cash �low.

(LO 2, 3)

2. Strong Corporation's comparative balance sheets are presented below.

Additional information:

1. Net income was $28,300. Dividends declared and paid were $26,400.

2. Equipment which cost $10,000 and had accumulated depreciation of $1,200 was sold for $4,300.

3. All other changes in noncurrent account balances had a direct effect on cash �lows, except the change in accumulated depreciation.

INSTRUCTIONS (a) Prepare a statement of cash �lows for 2017 using the indirect method.

(b) Compute free cash �low.

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PRACTICE PROBLEMS

Prepare statement of cash �lows using indirect and direct methods.

(LO 2, 4)

The income statement for Kosinski Manufacturing Company contains the following condensed information.

The $24,000 loss resulting from the sale of machinery resulted from selling equipment for $270,000 cash. Machinery was purchased at a cost of $750,000. The following balances are reported on Kosinski's comparative balance sheets at December 31.

2017 2016 Cash $672,000 $130,000

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2017 2016 Accounts receivable 775,000 610,000 Inventory 834,000 867,000 Accounts payable 521,000 501,000

Income tax expense of $353,000 represents the amount paid in 2017. Dividends declared and paid in 2017 totaled $200,000.

INSTRUCTIONS (a) Prepare the statement of cash �lows using the indirect method.

*(b) Prepare the statement of cash �lows using the direct method.

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WileyPLUS Brief Exercises, DO IT! Exercises, Exercises, Problems, and many additional resources are available for practice in WileyPLUS.

NOTE: All asterisked Questions, Exercises, and Problems relate to material in the appendices to the chapter.

QUESTIONS 1. (a) What is a statement of cash �lows?

(b) Pat Marx maintains that the statement of cash �lows is an optional �inancial statement. Do you agree? Explain.

2. What questions about cash are answered by the statement of cash �lows?

3. Distinguish among the three activities reported in the statement of cash �lows.

4. (a) What are the sources (in�lows) of cash in a statement of cash �lows?

(b) What are the uses (out�lows) of cash?

5. Why is it important to disclose certain noncash transactions? How should they be disclosed?

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6. Helen Powell and Paul Tang were discussing the format of the statement of cash �lows of Baumgarten Co. At the bottom of Baumgarten's statement of cash �lows was a separate section entitled “Noncash investing and �inancing activities.” Give three examples of signi�icant noncash transactions that would be reported in this section.

7. Why is it necessary to use comparative balance sheets, a current income statement, and certain transaction data in preparing a statement of cash �lows?

8. Contrast the advantages and disadvantages of the direct and indirect methods of preparing the statement of cash �lows. Are both methods acceptable? Which method is preferred by the FASB? Which method is more popular?

9. When the total cash in�lows exceed the total cash out�lows in the statement of cash �lows, how and where is this excess identi�ied?

10. Describe the indirect method for determining net cash provided (used) by operating activities.

11. Why is it necessary to convert accrual-basis net income to cash-basis net income when preparing a statement of cash �lows?

12. The president of Murquery Company is puzzled. During the last year, the company experienced a net loss of $800,000, yet its cash increased $300,000 during the same period of time. Explain to the president how this could occur.

13. Identify �ive items that are adjustments to convert net income to net cash provided by operating activities under the indirect method.

14. Why and how is depreciation expense reported in a statement of cash �lows prepared using the indirect method?

15. Why is the statement of cash �lows useful?

16. During 2017, Slivowitz Company exchanged $1,700,000 of its common stock for land. Indicate how the transaction would be reported on a statement of cash �lows, if at all.

17.

(a) What are the phases of the corporate life cycle?

(b) What effect does each phase have on the amounts reported in a statement of cash �lows?

18. Based on its statement of cash �lows, in what stage of the product life cycle is Apple?

19. Describe the direct method for determining net cash provided by operating activities.

20. Give the formulas under the direct method for computing (a) cash receipts from customers and (b) cash payments to suppliers.

21. Harbinger Inc. reported sales of $2 million for 2017. Accounts receivable decreased $150,000 and accounts payable increased $300,000. Compute cash receipts from customers, assuming that the receivable and payable transactions are related to operations.

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22. In the direct method, why is depreciation expense not reported in the cash �lows from operating activities section?

BRIEF EXERCISES

Indicate statement presentation of selected transactions.

(LO 1), K

BE12-2 Each of these items must be considered in preparing a statement of cash �lows for Irvin Co. for the year ended December 31, 2017. For each item, state how it should be shown in the statement of cash �lows for 2017.

(a) Issued bonds for $200,000 cash.

(b) Purchased equipment for $180,000 cash.

(c) Sold land costing $20,000 for $20,000 cash.

(d) Declared and paid a $50,000 cash dividend.

Classify items by activities.

(LO 1), C

BE12-3 Classify each item as an operating, investing, or �inancing activity. Assume all items involve cash unless there is information to the contrary.

(a) Purchase of equipment.

(b) Sale of building.

(c) Redemption of bonds.

(d) Cash received from sale of goods.

(e) Payment of dividends.

(f) Issuance of capital stock.

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Identify �inancing activity transactions.

(LO 1), AP

BE12-4 The following T-account is a summary of the Cash account of Alixon Company.

What amount of net cash provided (used) by �inancing activities should be reported in the statement of cash �lows?

Compute net cash provided by operating activities—indirect method.

(LO 2), AP

BE12-5 Miguel, Inc. reported net income of $2.5 million in 2017. Depreciation for the year was $160,000, accounts receivable decreased $350,000, and accounts payable decreased $280,000. Compute net cash provided by operating activities using the indirect approach.

Compute net cash provided by operating activities—indirect method.

(LO 2), AP

BE12-6 The net income for Mongan Co. for 2017 was $280,000. For 2017, depreciation on plant assets was $70,000, and the company incurred a loss on disposal of plant assets of $28,000. Compute net cash provided by operating activities under the indirect method, assuming there were no other changes in the company's accounts.

Compute net cash provided by operating activities—indirect method.

(LO 2), AP

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BE12-7 The comparative balance sheets for Gale Company show these changes in noncash current asset accounts: accounts receivable decreased $80,000, prepaid expenses increased $28,000, and inventories increased $40,000. Compute net cash provided by operating activities using the indirect method, assuming that net income is $186,000.

Determine cash received from sale of equipment.

(LO 2), AN

BE12-8 The T-accounts for Equipment and the related Accumulated Depreciation—Equipment for Goldstone Company at the end of 2017 are shown here.

In addition, Goldstone's income statement reported a loss on the disposal of plant assets of $3,500. What amount was reported on the statement of cash �lows as “cash �low from sale of equipment”?

Answer questions related to the phases of product life cycle.

(LO 3), C

(a) Why is net cash provided by operating activities likely to be lower than reported net income during the growth phase?

(b) Why is net cash from investing activities often positive during the late maturity phase and during the decline phase?

Calculate free cash �low.

(LO 3), AP

BE12-9 Suppose during 2017 that Cypress Semiconductor Corporation reported net cash provided by operating activities of $89,303,000, cash used in investing of $43,126,000, and cash used in �inancing of

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$7,368,000. In addition, cash spent for �ixed assets during the period was $25,823,000. No dividends were paid. Calculate free cash �low.

Calculate free cash �low.

(LO 3), AP

BE12-10 Sprouts Corporation reported net cash provided by operating activities of $412,000, net cash used by investing activities of $250,000, and net cash provided by �inancing activities of $70,000. In addition, cash spent for capital assets during the period was $200,000. No dividends were paid. Calculate free cash �low.

Calculate cash-based ratios.

(LO 3), AP

BE12-11 Suppose Canwest Global Communications Corp. reported net cash used by operating activities of $104,539,000 and sales revenue of $2,867,459,000 during 2017. Cash spent on plant asset additions during the year was $79,330,000. Calculate free cash �low.

Calculate and analyze free cash �low.

(LO 3), AN

BE12-12 The management of Uhuru Inc. is trying to decide whether it can increase its dividend. During the current year, it reported net income of $875,000. It had net cash provided by operating activities of $734,000, paid cash dividends of $92,000, and had capital expenditures of $310,000. Compute the company's free cash �low, and discuss whether an increase in the dividend appears warranted. What other factors should be considered?

Compute receipts from customers—direct method.

(LO 4), AP

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*BE12-13 Suppose Columbia Sportswear Company had accounts receivable of $299,585,000 at January 1, 2017, and $226,548,000 at December 31, 2017. Assume sales revenue was $1,244,023,000 for the year 2017. What is the amount of cash receipts from customers in 2017?

Compute cash payments for income taxes—direct method.

(LO 4), AP

*BE12-14 Hoffman Corporation reported income taxes of $370,000,000 on its 2017 income statement and income taxes payable of $277,000,000 at December 31, 2016, and $528,000,000 at December 31, 2017. What amount of cash payments were made for income taxes during 2017?

Compute cash payments for operating expenses—direct method.

(LO 4), AP

*BE12-15 Pietr Corporation reports operating expenses of $90,000, excluding depreciation expense of $15,000, for 2017. During the year, prepaid expenses decreased $7,200 and accrued expenses payable increased $4,400. Compute the cash payments for operating expenses in 2017.

DO IT! EXERCISES

Classify transactions by type of cash �low activity.

(LO 1), C

DO IT! 12-1 Moss Corporation had the following transactions.

1. Issued $160,000 of bonds payable.

2. Paid utilities expense.

3. Issued 500 shares of preferred stock for $45,000.

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4. Sold land and a building for $250,000.

5. Loaned $30,000 to Dead End Corporation, receiving Dead End's 1-year, 12% note.

Classify each of these transactions by type of cash �low activity (operating, investing, or �inancing). (Hint: Refer to Illustration 12-1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo1#c12-�ig-0001) .)

Calculate net cash from operating activities.

(LO 2), AP

DO IT! 12-2a PK Photography reported net income of $100,000 for 2017. Included in the income statement were depreciation expense of $6,300, patent amortization expense of $4,000, and a gain on disposal of plant assets of $3,600. PK's comparative balance sheets show the following balances.

12/31/17 12/31/16 Accounts receivable $21,000 $27,000 Accounts payable 9,200 6,000

Calculate net cash provided by operating activities for PK Photography.

Prepare statement of cash �lows—indirect method.

(LO 2), AP

DO IT! 12-2b Alex Company reported the following information for 2017.

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Additional information:

1. Operating expenses include depreciation expense of $40,000.

2. Land was sold at its book value for cash.

3. Cash dividends of $85,000 were declared and paid in 2017.

4. Equipment with a cost of $166,000 was purchased for cash. Equipment with a cost of $51,000 and a book value of $36,000 was sold for $34,000 cash.

5. Bonds of $50,000 were redeemed at their face value for cash.

6. Common stock ($1 par) of $170,000 was issued for cash.

Use this information to prepare a statement of cash �lows using the indirect method.

Compute and discuss free cash �low.

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(LO 3), AP

DO IT! 12-3 Moskow Corporation issued the following statement of cash �lows for 2017.

(a) Compute free cash �low for Moskow Corporation.

(b) Explain why free cash �low often provides better information than “Net cash provided by operating activities.”

EXERCISES

Classify transactions by type of activity.

(LO 1), C

E12-1 Kiley Corporation had these transactions during 2017.

(a) Purchased a machine for $30,000, giving a long-term note in exchange.

(b) Issued $50,000 par value common stock for cash.

(c) Issued $200,000 par value common stock upon conversion of bonds having a face value of $200,000.

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(d) Declared and paid a cash dividend of $13,000.

(e) Sold a long-term investment with a cost of $15,000 for $15,000 cash.

(f) Collected $16,000 from sale of goods.

(g) Paid $18,000 to suppliers.

Instructions

Analyze the transactions and indicate whether each transaction is an operating activity, investing activity, �inancing activity, or noncash investing and �inancing activity.

Classify transactions by type of activity.

(LO 1), C

E12-2 An analysis of comparative balance sheets, the current year's income statement, and the general ledger accounts of Hailey Corp. uncovered the following items. Assume all items involve cash unless there is information to the contrary.

(a) Payment of interest on notes payable.

(b) Exchange of land for patent.

(c) Sale of building at book value.

(d) Payment of dividends.

(e) Depreciation.

(f) Conversion of bonds into common stock.

(g) Receipt of interest on notes receivable.

(h) Issuance of capital stock.

(i) Amortization of patent.

(j) Issuance of bonds for land.

(k) Purchase of land.

(l) Receipt of dividends on investment in stock.

(m) Loss on disposal of plant assets.

(n) Retirement of bonds.

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Instructions

Indicate how each item should be classi�ied in the statement of cash �lows (indirect method) using these four major classi�ications: operating activity (that is, the item would be listed among the adjustments to net income to determine net cash provided by operating activities under the indirect method), investing activity, �inancing activity, or signi�icant noncash investing and �inancing activity.

Prepare the operating activities section—indirect method.

(LO 1), C

E12-3 Sosa Company reported net income of $190,000 for 2017. Sosa also reported depreciation expense of $35,000 and a loss of $5,000 on the disposal of plant assets. The comparative balance sheets show an increase in accounts receivable of $15,000 for the year, a $17,000 increase in accounts payable, and a $4,000 increase in prepaid expenses.

Instructions

Prepare the operating activities section of the statement of cash �lows for 2017. Use the indirect method.

Prepare the operating activities section—indirect method.

(LO 2), AP

E12-4 The current sections of Sunn Inc.'s balance sheets at December 31, 2016 and 2017, are presented here. Sunn's net income for 2017 was $153,000. Depreciation expense was $27,000.

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Instructions

Prepare the net cash provided by operating activities section of the company's statement of cash �lows for the year ended December 31, 2017, using the indirect method.

Prepare statement of cash �lows—indirect method.

(LO 2), AP

E12-5 The following information is available for Stamos Corporation for the year ended December 31, 2017.

Beginning cash balance $ 45,000 Accounts payable decrease 3,700 Depreciation expense 162,000 Accounts receivable increase 8,200 Inventory increase 11,000 Net income 284,100 Cash received for sale of land at book value 35,000 Cash dividends paid 12,000 Income taxes payable increase 4,700 Cash used to purchase building 289,000 Cash used to purchase treasury stock 26,000 Cash received from issuing bonds 200,000

Instructions

Prepare a statement of cash �lows using the indirect method.

Prepare partial statement of cash �lows—indirect method.

(LO 2), AN

E12-6 The following three accounts appear in the general ledger of Beiber Corp. during 2017.

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Instructions

From the postings in the accounts, indicate how the information is reported on a statement of cash �lows using the indirect method. The loss on disposal of plant assets was $8,000. (Hint: Cost of equipment constructed is reported in the investing activities section as a decrease in cash of $53,000.)

Prepare a statement of cash �lows—indirect method.

(LO 2), AP

E12-7 The following are comparative balance sheets for Mitch Company.

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Additional information:

1. Net income for 2017 was $93,000.

2. Depreciation expense was $34,000.

3. Cash dividends of $39,000 were declared and paid.

4. Bonds payable amounting to $50,000 were redeemed for cash $50,000.

5. Common stock was issued for $42,000 cash.

6. No equipment was sold during 2017.

7. Land was sold for its book value.

Instructions

Prepare a statement of cash �lows for 2017 using the indirect method.

Identify phases of product life cycle.

(LO 3), C

E12-8 The information in the table is from the statement of cash �lows for a company at four different points in time (M, N, O, and P). Negative values are presented in parentheses.

Instructions

For each point in time, state whether the company is most likely in the introductory phase, growth phase, maturity phase, or decline phase. In each case, explain your choice.

Compare free cash �low of two companies.

(LO 3), AN

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E12-9 Suppose the following is 2017 information for PepsiCo, Inc. and The Coca-Cola Company.

($ in millions) PepsiCo Coca-Cola Net cash provided by operating activities $ 6,796 $ 8,186  Average current liabilities 8,772 13,355  Net income 5,979 6,906  Sales revenue 43,232 30,990  Capital expenditures 2,128 1,993  Dividends paid 2,732 3,800 

Instructions

Compute free cash �low for both companies and compare.

Compare free cash �low of two companies.

(LO 3), AN

E12-10 Information for two companies in the same industry, Merrill Corporation and Wingate Corporation, is presented here.

Merrill Corporation Wingate Corporation Net cash provided by operating activities $ 80,000 $100,000 Average current liabilities   50,000  100,000 Net income  200,000  200,000 Capital expenditures   40,000   70,000 Dividends paid    5,000   10,000

Instructions

Compute free cash �low for both companies and compare.

Compute cash provided by operating activities—direct method.

(LO 4), AP

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*E12-11 Zimmer Company completed its �irst year of operations on December 31, 2017. Its initial income statement showed that Zimmer had sales revenue of $198,000 and operating expenses of $83,000. Accounts receivable and accounts payable at year-end were $60,000 and $23,000, respectively. Assume that accounts payable related to operating expenses. Ignore income taxes.

Instructions

Compute net cash provided by operating activity using the direct method.

Compute cash payments—direct method.

(LO 4), AP

*E12-12 Suppose the 2017 income statement for McDonald's Corporation shows cost of goods sold $5,178.0 million and operating expenses (including depreciation expense of $1,216.2 million) $10,725.7 million. The comparative balance sheets for the year show that inventory decreased $5.3 million, prepaid expenses increased $42.2 million, accounts payable (merchandise suppliers) increased $15.6 million, and accrued expenses payable increased $199.8 million.

Instructions

Using the direct method, compute (a) cash payments to suppliers and (b) cash payments for operating expenses.

Compute cash �low from operating activities—direct method.

(LO 4), AP

*E12-13 The 2017 accounting records of Megan Transport reveal these transactions and events.

Payment of interest $ 10,000 Payment of salaries and wages $ 53,000 Cash sales 48,000 Depreciation expense 16,000 Receipt of dividend revenue 18,000 Proceeds from sale of vehicles 812,000 Payment of income taxes 12,000 Purchase of equipment for cash 22,000 Net income 38,000 Loss on sale of vehicles 3,000 Payment for merchandise 97,000 Payment of dividends 14,000 Payment for land 74,000 Payment of operating expenses 28,000 Collection of accounts receivable 195,000

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Instructions

Prepare the cash �lows from operating activities section using the direct method.

Prepare statement of cash �lows—direct method.

(LO 4), AP

*E12-14 The following information is available for Balboa Corp. for 2017.

Cash used to purchase treasury stock $ 48,100 Cash dividends paid 21,800 Cash paid for interest 22,400 Net income 464,300 Sales revenue 802,000 Cash paid for taxes 99,000 Cash received from customers 566,100 Cash received from sale of building (at book value) 197,600 Cash paid for operating expenses 77,000 Beginning cash balance 11,000 Cash paid for goods and services 279,100 Cash received from issuing common stock 355,000 Cash paid to redeem bonds at maturity 200,000 Cash paid to purchase equipment 113,200

Instructions

Prepare a statement of cash �lows using the direct method.

Calculate cash �lows—direct method.

(LO 4), AN

*E12-15 The following information is taken from the 2017 general ledger of Preminger Company.

Rent Rent expense $ 30,000 Prepaid rent, January 1 5,900

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Prepaid rent, December 31 7,400 Salaries Salaries and wages expense $ 54,000 Salaries and wages payable, January 1 2,000 Salaries and wages payable, December 31 8,000 Sales Sales revenue $160,000 Accounts receivable, January 1 16,000 Accounts receivable, December 31 7,000

Instructions

In each case, compute the amount that should be reported in the operating activities section of the statement of cash �lows under the direct method.

EXERCISES: SET B AND CHALLENGE EXERCISES Visit the book's companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , and choose the Student Companion site to access Exercises: Set B and Challenge Exercises.

PROBLEMS: SET A

Distinguish among operating, investing, and �inancing activities.

(LO 1, 2), AP

P12-1A You are provided with the following information regarding events that occurred at Moore Corporation during 2017 or changes in account balances as of December 31, 2017.

Instructions

Moore prepares its statement of cash �lows using the indirect approach. Complete the �irst column of the table, indicating whether each item affects the operating activities section (O) (that is, the item would be listed among the adjustments to net income to determine net cash provided by operating activities under the indirect approach), investing activities section (I), �inancing activities section (F), or is a noncash (NC)

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transaction reported in a separate schedule. For those items classi�ied as operating activities (O), indicate whether the item is added (A) or subtracted (S) from net income to determine net cash provided by operating activities.

Determine cash �low effects of changes in equity accounts.

(LO 2), AN

P12-2A The following account balances relate to the stockholders' equity accounts of Molder Corp. at year-end.

2017 2016 Common stock, 10,500 and 10,000 shares, respectively, for 2017 and 2016 $160,800 $140,000 Preferred stock, 5,000 shares  125,000  125,000 Retained earnings  300,000  270,000

A small stock dividend was declared and issued in 2017. The market price of the shares was $8,800. Cash dividends were $20,000 in both 2017 and 2016. The common stock has no par or stated value.

Instructions (a) What was the amount of net income reported by Molder Corp. in 2017?

(b) Determine the amounts of any cash in�lows or out�lows related to the common stock and dividend accounts in 2017.

(c) Indicate where each of the cash in�lows or out�lows identi�ied in (b) would be classi�ied on the statement of cash �lows.

Net income $58,800

Prepare the operating activities section—indirect method.

(LO 2), AP

P12-3A The income statement of Munsun Company is presented here.

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Additional information:

1. Accounts receivable decreased $380,000 during the year, and inventory decreased $300,000.

2. Prepaid expenses increased $150,000 during the year.

3. Accounts payable to suppliers of merchandise decreased $350,000 during the year.

4. Accrued expenses payable decreased $100,000 during the year.

5. Administrative expenses include depreciation expense of $110,000.

Instructions

Prepare the operating activities section of the statement of cash �lows for the year ended November 30, 2017, for Munsun Company, using the indirect method.

Net cash provided $1,940,000

Prepare the operating activities section—direct method.

(LO 4), AP

*P12-4A Data for Munsun Company are presented in P12-3A.

Instructions

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Prepare the operating activities section of the statement of cash �lows using the direct method.

Net cash provided—oper. act. $1,940,000

Prepare the operating activities section—indirect method.

(LO 2), AP

P12-5A Rewe Company's income statement contained the condensed information below.

Rewe's balance sheet contained following comparative data at December 31.

2017 2016 Accounts receivable $70,000 $60,000 Accounts payable  41,000  32,000 Income taxes payable  13,000   7,000

Accounts payable pertain to operating expenses.

Instructions

Prepare the operating activities section of the statement of cash �lows using the indirect method.

Net cash provided $305,000

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Prepare the operating activities section—direct method.

(LO 4), AP

*P12-6A Data for Rewe Company are presented in P12-5A.

Instructions

Prepare the operating activities section of the statement of cash �lows using the direct method.

Prepare a statement of cash �lows—indirect method, and compute free cash �low.

(LO 2, 3), AP

P12-7A Presented below are the �inancial statements of Warner Company.

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Additional data:

1. Depreciation expense was $17,500.

2. Dividends declared and paid were $20,000.

3. During the year equipment was sold for $8,500 cash. This equipment cost $18,000 originally and had accumulated depreciation of $9,500 at the time of sale.

Instructions (a) Prepare a statement of cash �lows using the indirect method.

(b) Compute free cash �low.

Net cash provided—oper. act. $38,500 Net cash provided $305,000

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Prepare a statement of cash �lows—direct method, and compute free cash �low.

(LO 3, 4), AP

*P12-8A Data for Warner Company are presented in P12-7A. Further analysis reveals the following.

1. Accounts payable pertain to merchandise suppliers.

2. All operating expenses except for depreciation were paid in cash.

3. All depreciation expense is in the selling expense category.

4. All sales and purchases are on account.

Instructions (a) Prepare a statement of cash �lows for Warner Company using the direct method.

(b) Compute free cash �low.

Net cash provided—oper. act. $38,500

Prepare a statement of cash �lows—indirect method.

(LO 2), AP

P12-9A Condensed �inancial data of Granger Inc. follow.

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Additional information:

1. New plant assets costing $100,000 were purchased for cash during the year.

2. Old plant assets having an original cost of $57,500 and accumulated depreciation of $48,500 were sold for $1,500 cash.

3. Bonds payable matured and were paid off at face value for cash.

4. A cash dividend of $26,030 was declared and paid during the year.

Instructions

Prepare a statement of cash �lows using the indirect method.

Net cash provided—oper. act. $176,930

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Prepare a statement of cash �lows—direct method.

(LO 4), AP

*P12-10A Data for Granger Inc. are presented in P12-9A. Further analysis reveals that accounts payable pertain to merchandise creditors.

Instructions

Prepare a statement of cash �lows for Granger Inc. using the direct method.

Net cash provided—oper. act. $176,930

Prepare a statement of cash �lows—indirect method.

(LO 2), AP

P12-11A The comparative balance sheets for Spicer Company as of December 31 are presented below.

Additional information:

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1. Operating expenses include depreciation expense of $42,000.

2. Land was sold for cash at book value.

3. Cash dividends of $12,000 were paid.

4. Net income for 2017 was $37,000.

5. Equipment was purchased for $92,000 cash. In addition, equipment costing $22,000 with a book value of $10,000 was sold for $8,000 cash.

6. 40,000 shares of $1 par value common stock were issued in exchange for land with a fair value of $40,000.

Instructions

Prepare a statement of cash �lows for the year ended December 31, 2017, using the indirect method.

Net cash provided—oper. act. $94,000

Identify the impact of transactions on free cash �low.

(LO 3), C

P12-12A You are provided with the following transactions that took place during the year.

Transactions Free Cash Flow ($125,000)

(a) Recorded credit sales $2,500.

(b) Collected $1,900 owed by customers.

(c) Paid amount owed to suppliers $2,750.

(d) Recorded sales returns of $500 and credited the customer's account.

(e) Purchased new equipment $5,000; signed a long-term note payable for the cost of the equipment.

(f) Purchased a patent and paid $65,000 cash for the asset.

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Instructions

For each transaction listed, indicate whether it will increase (I), decrease (D), or have no effect (NE) on free cash �low.

PROBLEMS: SET B AND SET C Visit the book's companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , and choose the Student Companion site to access Problems: Set B and Set C.

CONTINUING PROBLEM Cookie Creations

(Note: This is a continuation of the Cookie Creations problem from Chapters 1 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch01#ch01) through 11 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch11#ch11) .)

CC12 Natalie has prepared the balance sheet and income statement of Cookie & Coffee Creations Inc. and would like you to prepare the statement of cash �lows.

Go to the book's companion website, at www.wiley.com/college/kimmel (http://www.wiley.com/college/kimmel) , to �ind the completion of this problem.

EXPAND YOUR | CRITICAL THINKING

FINANCIAL REPORTING PROBLEM: Apple Inc.

CT12-1 The �inancial statements of Apple Inc. are presented in Appendix A (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a01#a01) .

E

Answer the following questions.

Instructions (a) What was the amount of net cash provided by operating activities for the year ended

September 27, 2014? For the year ended September 28, 2013?

(b) What was the amount of increase or decrease in cash and cash equivalents for the year ended September 27, 2014?

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(c) Which method of computing net cash provided by operating activities does Apple use?

(d) From your analysis of the September 27, 2014, statement of cash �lows, was the change in accounts receivable a decrease or an increase? Was the change in inventories a decrease or an increase? Was the change in accounts payable a decrease or an increase?

(e) What was the net cash used by investing activities for the year ended September 27, 2014?

(f) What was the amount of interest paid in the year ended September 27, 2014? What was the amount of income taxes paid for the same period?

COMPARATIVE ANALYSIS PROBLEM: Columbia Sportswear Company vs. VF Corporation

E

CT12-2 Columbia Sportswear Company's �inancial statements are presented in Appendix B (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a02#a02) . Financial statements of VF Corporation are presented in Appendix C (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a03#a03) .

Instructions (a) Based on the information contained in these �inancial statements, compute free cash �low

for each company.

(b) What conclusions concerning the management of cash can be drawn from these data?

COMPARATIVE ANALYSIS PROBLEM: Amazon.com, Inc. vs. Wal-Mart Stores, Inc.

E

CT12-3 Amazon.com, Inc.'s �inancial statements are presented in Appendix D (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a04#a04) . Financial statements of Wal-Mart Stores, Inc. are presented in Appendix E (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a05#a05) .

Instructions (a) Based on the information contained in these �inancial statements, compute free cash �low

for each company.

(b) What conclusions concerning the management of cash can be drawn from these data?

REAL-WORLD FOCUS

AN

CT12-4 Purpose: Use the Internet to view SEC �ilings.

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Address: biz.yahoo.com/i

Steps

1. Enter a company's name.

2. Choose Quote. Answer questions (a) and (b).

3. Choose Pro�ile; then choose SEC. Answer questions (c) and (d).

Instructions

Answer the following questions.

(a) What company did you select?

(b) What is its stock symbol? What is its selling price?

(c) What recent SEC �ilings are available for your viewing?

(d) Which �iling is the most recent? What is the date?

CT12-5 The March 4, 2010, edition of the Wall Street Journal Online contains an article by Jeffrey McCracken and Tom McGinty entitled “With Fistfuls of Cash, Firms on Hunt.”

AP

Instructions

Read the article and answer the following questions.

(a) How much cash did the non�inancial (that is, nonbank-like) �irms in the Standard & Poor's 500 have at the end of 2009? How big an increase in cash did this represent over the prior year?

(b) What reasons are given in the article for why companies might not want to keep hoarding cash?

(c) What steps did Alcoa take to try to increase the company's cash? Were these efforts successful?

(d) Often, companies issue shares of stock to acquire other companies. This represents a signi�icant noncash transaction. At the time the article was written, why were many companies using cash rather than stock to acquire other companies?

(e) In addition to acquisitions, what other steps can companies take to reduce their cash balances?

CT12-6 The November 23, 2011, edition of the Wall Street Journal Online contains an article by John Jannarone entitled “Backlash from Net�lix Buybacks.”

AP

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Instructions

Read the article and answer the following questions.

(a) What was the stock price for the shares of common stock issued by Net�lix in the article? What was the price of the stock a few months previously?

(b) Why did Net�lix issue new shares at a time when its stock price was so depressed relative to previous valuations for its stock?

(c) What previous actions had Net�lix taken to reduce its cash balance?

(d) What does the article say is the lesson that growth companies should learn from the Net�lix example?

DECISION-MAKING ACROSS THE ORGANIZATION

CT12-7 Pete Kent and Maria Robles are examining the following statement of cash �lows for Sullivan Company for the year ended January 31, 2017.

E

Pete claims that Sullivan's statement of cash �lows is an excellent portrayal of a superb �irst year with cash increasing $95,000. Maria replies that it was not a superb �irst year. Rather, she says, the year was an operating failure, that the statement is presented incorrectly, and that $95,000 is not the actual increase in cash. The cash balance at the beginning of the year was $140,000.

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Instructions

With the class divided into groups, answer the following.

(a) Using the data provided, prepare a statement of cash �lows in proper form using the indirect method. The only noncash items in the income statement are depreciation and the gain from the sale of the investment.

(b) With whom do you agree, Pete or Maria? Explain your position.

COMMUNICATION ACTIVITY

CT12-8 Walt Jax, the owner-president of Computer Services Company, is unfamiliar with the statement of cash �lows that you, as his accountant, prepared. He asks for further explanation.

E

Instructions

Write him a brief memo explaining the form and content of the statement of cash �lows as shown in Illustration 12-13 (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/ch12lo2#c12-�ig-0013) (page 604).

ETHICS CASE

CT12-9 Pendleton Automotive Corp. is a medium-sized wholesaler of automotive parts. It has 10 stockholders who have been paid a total of $1 million in cash dividends for 8 consecutive years. The board's policy requires that, for this dividend to be declared, net cash provided by operating activities as reported in Pendleton Automotive's current year's statement of cash �lows must exceed $1 million. President and CEO Hans P�izer's job is secure so long as he produces annual operating cash �lows to support the usual dividend.

E

At the end of the current year, controller Kurt Nolte presents president Hans P�izer with some disappointing news. The net cash provided by operating activities is calculated by the indirect method to be only $970,000. The president says to Kurt, “We must get that amount above $1 million. Isn't there some way to increase operating cash �low by another $30,000?” Kurt answers, “These �igures were prepared by my assistant. I'll go back to my of�ice and see what I can do.” The president replies, “I know you won't let me down, Kurt.”

Upon close scrutiny of the statement of cash �lows, Kurt concludes that he can get the operating cash �lows above $1 million by reclassifying a $60,000, 2-year note payable listed in the �inancing activities section as “Proceeds from bank loan—$60,000.” He will report the note instead as “Increase in payables—$60,000” and treat it as an adjustment of net income in the operating activities section. He returns to the president, saying, “You can tell the board to declare their usual dividend. Our net cash �low provided by operating activities is $1,030,000.” “Good man, Kurt! I knew I could count on you,” exults the president.

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Instructions (a) Who are the stakeholders in this situation?

(b) Was there anything unethical about the president's actions? Was there anything unethical about the controller's actions?

(c) Are the board members or anyone else likely to discover the misclassi�ication?

ALL ABOUT YOU

CT12-10 In this chapter, you learned that companies prepare a statement of cash �lows in order to keep track of their sources and uses of cash and to help them plan for their future cash needs. Planning for your own short- and long-term cash needs is every bit as important as it is for a company.

E

Instructions

Read the article “Financial ‘Uh-oh’? No Problem,” at www.fool.com/savings/shortterm/02.htm (http://www.fool.com/savings/shortterm/02.htm) , and answer the following questions.

(a) Describe the three factors that determine how much money you should set aside for short- term needs.

(b) How many months of living expenses does the article suggest to set aside?

(c) Estimate how much you should set aside based upon your current situation. Are you closer to Cliff 's scenario or to Prudence's?

FASB CODIFICATION ACTIVITY

CT12-11 If your school has a subscription to the FASB Codi�ication, go to http://aaahq.org/ascLogin.cfm (http://aaahq.org/ascLogin.cfm) to log in and prepare responses to the following. Use the Master Glossary to determine the proper de�initions.

AN

(a) What are cash equivalents?

(b) What are �inancing activities?

(c) What are investing activities?

(d) What are operating activities?

(e) What is the primary objective for the statement of cash �low? Is working capital the basis for meeting this objective?

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(f) Do companies need to disclose information about investing and �inancing activities that do not affect cash receipts or cash payments? If so, how should such information be disclosed?

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LEARNING OBJECTIVE 6

Compare the procedures for the statement of cash �lows under GAAP and IFRS. 

As in GAAP, the statement of cash �lows is a required statement for IFRS. In addition, the content and presentation of an IFRS statement of cash �lows is similar to the one used for GAAP. However, the disclosure requirements related to the statement of cash �lows are more extensive under GAAP. IAS 7 (“Cash Flow Statements”) provides the overall IFRS requirements for cash �low information.

RELEVANT FACTS

Following are the key similarities and differences between GAAP and IFRS as related to the statement of cash �lows.

Similarities

Companies preparing �inancial statements under IFRS must also prepare a statement of cash �lows as an integral part of the �inancial statements.

Both IFRS and GAAP require that the statement of cash �lows should have three major sections— operating, investing, and �inancing activities—along with changes in cash and cash equivalents.

Similar to GAAP, the statement of cash �lows can be prepared using either the indirect or direct method under IFRS. In both U.S. and international settings, companies choose for the most part to use the indirect method for reporting net cash �lows from operating activities.

The de�inition of cash equivalents used in IFRS is similar to that used in GAAP. A major difference is that in certain situations, bank overdrafts are considered part of cash and cash equivalents under IFRS (which is not the case in GAAP). Under GAAP, bank overdrafts are classi�ied as �inancing activities in the statement of cash �lows and are reported as liabilities on the balance sheet.

Differences

IFRS requires that noncash investing and �inancing activities be excluded from the statement of cash �lows. Instead, these noncash activities should be reported elsewhere. This requirement is interpreted to mean that noncash investing and �inancing activities should be disclosed in the

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notes to the �inancial statements instead of in the �inancial statements. Under GAAP, companies may present this information on the face of the statement of cash �lows.

One area where there can be substantial differences between IFRS and GAAP relates to the classi�ication of interest, dividends, and taxes. The following table indicates the differences between the two approaches.

Item IFRS GAAP

Interest paid Operating or �inancing Operating

Interest received Operating or investing Operating

Dividends paid Operating or �inancing Financing

Dividends received

Operating or investing Operating

Taxes paid Operating—unless speci�ic identi�ication with �inancing or investing activity

Operating

Under IFRS, some companies present the operating section in a single line item, with a full reconciliation provided in the notes to the �inancial statements. This presentation is not seen under GAAP.

LOOKING TO THE FUTURE

Presently, the FASB and the IASB are involved in a joint project on the presentation and organization of information in the �inancial statements. One interesting approach, revealed in a published proposal from that project, is that in the future the income statement and balance sheet would adopt headings similar to those of the statement of cash �lows. That is, the income statement and balance sheet would be broken into operating, investing, and �inancing sections.

IFRS PRACTICE IFRS SELF-TEST QUESTIONS

1. Under IFRS, interest paid can be reported as: (a) only a �inancing activity.

(b) a �inancing activity or an investing activity.

(c) a �inancing activity or an operating activity.

(d) only an operating activity.

2. IFRS requires that noncash items: (a) be reported in the section to which they relate, that is, a noncash investing activity would be

reported in the investing section.

(b) be disclosed in the notes to the �inancial statements.

(c) do not need to be reported.

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(d) be treated in a fashion similar to cash equivalents.

3. In the future, it appears likely that: (a) the income statement and balance sheet will have headings of operating, investing, and

�inancing activities, much like the statement of cash �lows.

(b) cash and cash equivalents will be combined in a single line item.

(c) the IASB will not allow companies to use the direct approach to the statement of cash �lows.

(d) None of the above.

4. Under IFRS: (a) taxes are always treated as an operating activity.

(b) the income statement uses the headings operating, investing, and �inancing activities.

(c) dividends received can be either an operating or investing activity.

(d) dividends paid can be either an operating or investing activity.

5. Which of the following is correct? (a) Under IFRS, the statement of cash �lows is optional.

(b) IFRS requires use of the direct approach in preparing the statement of cash �lows.

(c) The majority of companies following GAAP and the majority following IFRS employ the indirect approach to the statement of cash �lows.

(d) Under IFRS, companies offset �inancing activities against investing activities.

IFRS EXERCISES

IFRS 12-1 Discuss the differences that exist in the treatment of bank overdrafts under GAAP and IFRS.

IFRS 12-2 Describe the treatment of each of the following items under IFRS versus GAAP.

(a) Interest paid.

(b) Interest received.

(c) Dividends paid.

(d) Dividends received.

INTERNATIONAL FINANCIAL REPORTING PROBLEM: Louis Vuitton

IFRS 12-3 The �inancial statements of Louis Vuitton are presented in Appendix F (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a06#a06) . Instructions for accessing and using the company's complete annual report, including the notes to its �inancial statements, are also provided in Appendix F (http://content.thuzelearning.com/books/Kimmel.2745.17.1/sections/a06#a06) .

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Instructions

Use the company's annual report to answer the following questions.

(a) In which section (operating, investing, or �inancing) does Louis Vuitton report interest paid (�inance costs)?

(b) In which section (operating, investing, or �inancing) does Louis Vuitton report dividends received?

(c) If Louis Vuitton reported under GAAP rather than IFRS, how would its treatment of bank overdrafts differ?

Answers to IFRS Self-Test Questions

1. c 2. b 3. a 4. c 5. c