STATEMENT OF CASH FLOWS

TUTORIAL

Statement of Cash Flows-Overview

Since 1988, the Financial Accounting Standards Board (FASB) has required companies to include a statement of cash flows in their financial statements. (Before 1988, companies provided funds flow statements explaining changes in working capital.)

Cash flows provide useful information to financial statement users. Accrual accounting involves making many judgments-such as the allowance for uncollectible accounts (to calculate bad debt expense) and useful lives of assets (to calculate depreciation expense). Thus, net income calculations involve many managerial judgments. Cash flows are less subject to manipulation by managers than the net income number reported using accrual accounting.

From the perspective of an investor or financial analyst, cash flows are important because a firm’s value depends on the discounted present value of its cash flows.

From the perspective of a creditor, cash flows are important because amounts owed must be paid with cash. Even if a firm is profitable, if there is insufficient cash flow, the firm could experience problems paying off its obligations as they become due.

Cash flow statements include three sections in the following order of presentation:1. Operating activities2. Investing activities3. Financing activities

Cash Flows… From Operating Activities

OPERATING ACTIVITIES include normal, recurring activities engaged in by the company on a regular basis, that is, activities related to the production and delivery of goods and services to customers.

Changes involving current assets (other than cash) and current liabilities are usually included in the operating activities section.

Cash inflows from operating activities include collections from customers for the sale of goods or services. They also include interest revenue and dividend revenue received by the company from other entities.

Cash outflows from operating activities include payments made to suppliers, employees, operating expenses (such as rent, utilities), interest payments, and taxes.

When a company invests in the stocks and bonds of other companies, it may receive dividend revenue and interest revenue from such investments. Under SFAS No. 95,

these types of revenue, although associated with investment activities by the company, must be included in the cash flows from the operating activities section of the Statement of Cash Flows.

Cash Flows From Investing Activities

INVESTING ACTIVITIES involve the purchase and sale of noncurrent assets, including the purchase and sale of financial instruments (such as stocks and bonds issued by other entities).

In general, changes involving noncurrent assets are usually included in the investing activities section. This is only a general rule of thumb and may change, depending on the nature of the business or activity, for example, if a manufacturing firm purchases or sells some machinery that would be included in the investing activities section. However, if a company that is in the business of buying and selling such machinery makes a purchase or sale of machinery, that would be included in the operating activities section.

Cash inflows from investing activities include collections from sale of property, plant, and equipment; sale of a business segment, or sale of stocks or bonds issued by other entities.

Cash outflows from investing activities include payments made for the purchase of property, plant, and equipment and stocks or bonds issued by other entities.

Cash Flows From Financing Activities

FINANCING ACTIVITIES include transactions between the company and its owners and creditors. That is, they include the sale or buyback of stocks or bonds issued by the company and dividend payments by the company to its shareholders.

In general, changes involving noncurrent liabilities and stockholders’ equity are reported in the financing activities section.

Note the difference between investing and financing activities in the context of the purchase and sale of stocks and bonds. When you buy or sell the stock or bond issued by someone else, that is considered an investing activity. When you issue (sell) or buy back stock or bonds that you had issued, that is considered part of a financing activity.

Cash inflows from financing activities arise when the company issues stock or borrows (by issuing a bond or by signing a note, or otherwise).

Cash outflows from financing activities arise when the company buys back its own stock or bonds, repays loans, or pays dividends to shareholders.

Note that dividends paid to shareholders are considered to be part of financing activities-but interest paid to bondholders is included only as an operating activity.

Furthermore, as noted earlier, both dividend and interest revenues received by the company are included in cash flows from operating activities section.

NONCASH INVESTING AND FINANCING ACTIVITIES include noncash transactions that affect both noncurrent assets and noncurrent liabilities or owners’ equity.

Review Questions-1

1. Cash collected from customers will normally be reported in the _________ activities section of the statement of cash flows.

2. Changes involving _________________ are usually reflected in the operating activities section of the statement of cash flows.

3. Cash flows related to the purchase of property, plant and equipment are reported in the _________ activities section of the statement of cash flows.

4. Changes involving _________________ are usually reflected in the investing activities section of the statement of cash flows.

5. Cash flows related to the payment of dividends to stockholders are reported in the _________ activities section of the statement of cash flows.

6. Changes involving _________________ are usually reflected in the financing activities section of the statement of cash flows.

ANSWERS: 1. operating 2. current assets and current liabilities 3. investing 4. noncurrent assets 5. financing 6. noncurrent liabilities and stockholders’ equity

Cash Flow Statement Methods

Two methods are used in reporting cash flows. They are (1) the direct method and (2) the indirect method.

The difference between the two methods affects only the operating activities section of the Statement of Cash Flows. The investing activities section and the financing activities section will be the same under these two methods.

The direct method gives information about the cash collections from customers and others, as well as the cash payments made to suppliers, employees, and others.

The indirect method does not directly give information about cash collections and cash payments for operating activities. Instead, it starts with the net income (as reported in the income statement) and adjusts this amount for accruals that do not affect cash flows. There are two types of adjustments, described later.

Cash Flows From Operating Activities-Direct Method

Operating activities of an enterprise include production and delivery of goods and services to customers. One way to examine them is to look at them in the sequence in which they appear in an income statement. Thus, an entity will bothCollect cash from sales of goods and services to customers Pay cash to (1) outsiders for any purchases of goods and services and (2) employees for services rendered.

We will first examine the direct method and then the indirect method.

Sales and CollectionsWe need to know the amount of cash collected from customers. To get this information, we have to look at accounts receivable. Specifically, we can calculate cash collections from credit sales as follows:

Cash collected = Beginning accounts receivable + Credit sales Ending accounts receivable

If there are any cash sales during the period, we need to add them to the cash collected from credit sales (calculated as above) to get the total cash collected from sales during the period.

ExampleThe beginning and ending balances in Accounts Receivable of Smith Company were $3,000 and $2,500, respectively. Credit sales during the period were $24,000. What is the total cash collected from sales to customers during the period?

AnswerCash collected from sales to customers = $3,000 + $24,000 - $2,500

= $24,500

Purchases and PaymentsThe logic about payments on accounts payable is the exact reverse of collections from accounts receivable. That is, we can calculate payments to suppliers (for credit purchases) as follows:

Cash payments = Beginning accounts payable + Purchases Ending accounts payable

If any cash purchases occur during the period, we need to add them to the cash payments for credit purchases (calculated as above) to get the total cash payments for purchases during the period.

The same approach can be used to calculate payments made to other outsiders (for other expenses, such as utilities or rent.)

ExampleThe beginning and ending balances in Accounts Payable of Jackson Company were $6,000 and $8,000, respectively. Purchases during the period were $45,000. What is the total cash paid to suppliers during the period?

Cash payments to suppliers = $6,000 + $45,000 - $8,000= $43,000

Salaries and Wages PaidCash payments to employees are calculated exactly the way the payments to suppliers and other outsiders are determined. Cash payments for employees are calculated as follows:

Cash payments = Beginning salaries payable + Salary expense for the period Ending salaries payable

ExampleThe beginning and ending balances in Salaries Payable of Logan Company were $12,000 and $9,000, respectively. Salaries expense during the period was $70,000. What is the total cash paid to suppliers during the period?

Cash paid as salaries = $12,000 + $70,000 - $9,000= $73,000

Cash Flows From Operating Activities-Indirect Method

The first type of adjustment to cash flows from operating expenses involves revenues (or gains) and expenses (or losses) that do not involve operating cash inflows or outflows. For example, depreciation is an expense item, but it does not involve any cash payments. Similarly, to calculate depreciation we subtract from net income any gains on sale of equipment or add back any losses on sale of equipment. (The reason for this is explained in detail later under the cash flows from investing activities section).

The second type of adjustment involves changes in current assets or liabilities. This is best explained using the basic accounting equation, as below.We know that:

Assets = Liabilities + Owners’ equity, or

Current assets + Noncurrent assets = Current liabilities + Noncurrent liabilities + Owners’ equity

Cash + Other current assets + Noncurrent assets = Current liabilities + Noncurrent liabilities + Owners’ equity

This means that if some current asset (such as inventory) increases and all other accounts stay the same, cash must decrease.

For example, if inventory at the end of the period is higher than that at the beginning of the period (and if accounts payable stays the same), some cash has been spent on inventory purchases. Purchase of inventory is an operating activity, so more cash has been spent on an operating activity as compared to the situation when the inventory has remained the same at the beginning and the end of the period.

ExampleThe net income of Helen Company for the year ended December 31, 2002, was $25,000. The depreciation expense for the period was $5,000. The beginning and ending balances of Accounts Receivable for the year ended December 31, 2002, were $7,000 and $5,000, respectively. Assuming the company had no other current asset or current liability account, what was the cash flow from operations for the year ended December 31, 2002?

Net income for the period $25,000Plus: Depreciation expense 5,000Plus: Decrease in accounts receivable 2,000Total cash flow from operations $32,000

Cash Flows From Investing Activities

The first thing to note is that there are no differences between the direct and indirect methods when it comes to reporting cash flows from investing activities.

To obtain cash flows from investing activities, we need to look at those accounts affected by investing activities-that is, noncurrent assets (and the related contra asset account, namely accumulated depreciation) and any nonoperating current assets (that is, current assets not used in our operations such as investments in stocks and bonds of other entities).

Sale of Noncurrent Assets

Assume that we sold some equipment. How do we obtain cash inflows from such sale of equipment? We need to look at the equipment account to obtain this information.

ExampleThe balances in some accounts for Bledsoe Company were as follows:Equipment, 1/1/2002 $40,000Equipment, 12/31/2002 28,000Accumulated depreciation, 1/1/2002 6,000Accumulated depreciation, 12/31/2002 5,000Depreciation expense, year ended 12/31/2002 3,000Gain on sale of equipment 2,000

First, the balance in the equipment account has declined from $40,000 at the beginning of the period to $28,000 at the end of the period. This indicates that the historical cost of the equipment sold during the period is $12,000 ($40,000 $28,000).

Next, we examine the accumulated depreciation account. If no equipment had been sold, then the ending balance in this account would be $9,000 ($6,000 beginning balance plus $3,000 depreciation expense during the period). However, the ending balance in this account is only $5,000. This means that the accumulated depreciation of the equipment that was sold must be $9,000 $5,000 = $4,000.

Thus, the net book value of the equipment sold during the period = $8,000 ($12,000 historical cost $4,000 accumulated depreciation). Furthermore, we know that the gain on the sale was $2,000. Hence, the equipment must have been sold for $10,000 ($8,000 net book value plus $2,000 gain on sale). Assuming it was sold for cash, cash inflow from sale of equipment is $10,000.

Note also the following. The net income number includes the gain of $2,000 from the sale of this equipment. Furthermore, we are reporting the entire $10,000 (including the gain of $2,000) in the cash flows from investing activities section. This means that the $2,000 of gain could be double counted if we are using the indirect method to report the cash flows from operating activities-included once in the net income number with which we start the operating activities section if we use the indirect method and again in the investing activities section. This is why it is important that we subtract the gain of $2,000 in the cash flows from operating activities section when using the indirect method. This avoids double counting gains from the sale of equipment.

Why don’t we subtract gains (or add losses) from the sale of equipment in the cash flows from operating activities section if we use the direct method?Because we do not begin with net income if we use the direct method. So there is no double counting problem, and hence there is no need for any adjustment there.

Purchase of Noncurrent Assets

Assume that we bought some equipment during the period. How do we calculate the amount spent to purchase the equipment?

First, if you are preparing the financial statements, you will have access to the relevant records, which will tell you exactly how much the company spent on the purchase of new equipment. However, even if you do not have access to such records, you can calculate how much was spent to purchase new equipment. An analysis of the equipment account will enable us to do so.

ExampleThe beginning and ending balances in the equipment account of Glenn Company were $30,000 and $35,000, respectively. Equipment with a book value of $3,000 was sold during the period. How much was spent on purchase of new equipment?

Note that

Beginning balance of equipment (at cost) + Cost of new purchases Cost of equipment sold = Ending balance of equipment (at cost)

SoCost of new purchases = Ending balance of equipment + Cost of equipment sold Beginning balance of equipment

Thus, in the example above, cost of new purchases = $35,000 + $3,000 $30,000

= $8,000

Cash Flows From Financing Activities

Financing activities involve the following the issue of company stock or bonds (or, other borrowing), buyback of stock or bonds (or other repayment of debt), and payment of dividends.

The amount of cash collected from issuing of stock or bonds or other borrowing can be calculated by examining the common stock (and additional paid-in capital) or bonds payable (or other long-term debt) accounts.

Cash dividend payments can be calculated by examining the retained earnings, net income, and dividends payable accounts.

ExampleThe beginning and ending balances in the Retained Earnings account of Walter Company were $25,000 and $30,000, respectively. Net income for the period was $12,000, and all dividends declared during the period were paid before the fiscal year-end. What amount of cash was used to pay the dividends during the year?

We know thatBeginning retained earnings + Net income Dividends = Ending retained earnings.

SoDividends = Beginning retained earnings + Net income Ending retained earnings

= $25,000 + $12,000 - $30,000= $7,000

Thus, $7,000 was paid as cash dividends during the period.

Review Questions-2

1. The difference between the direct and indirect method is in the _________ activities section of the statement of cash flows.

2. The ______ method starts with net income and adjusts for accruals that do not affect cash flows.

3. The ______ method will not have an adjustment for depreciation in the operating activities section of the statement of cash flows.

4. Gains or losses from sale of equipment are included as an adjustment in the ________ of preparing the statement of cash flows.

5. When a company buys back its own stock, the cash flows will be reflected in the _______ activities section of the statement of cash flows.

6. Cash flows related to the purchase of long-term bonds issued by another company are reflected in the _______ activities section of the statement of cash flows.

ANSWERS: 1. operating 2. indirect 3. direct 4. indirect method 5. financing 6. investing

Glossary

Direct method is one of two methods used to calculate and report the statement of cash flows. The direct method gives information about the cash collections from customers and others, as well as the cash payments made to suppliers, employees, and others.

Financing activities include transactions between the company and its owners and creditors. That is, these activities include the sale or buyback of stocks or bonds issued by the company and dividend payments by the company to its shareholders.

Indirect method is one of two methods used to calculate and report the statement of cash flows. The indirect method starts with the net income (as reported in the income statement) and adjusts this amount for accruals that do not affect cash flows.

Investing activities are the purchase and sale of noncurrent assets, including the purchase and sale of financial instruments (such as stocks and bonds issued by other entities).

Operating activities include the normal, recurring activities engaged in by the company on a regular basis–the production and delivery of goods and services to customers.

Demonstration Problem 1Montana Company

The income statement of Montana Company (a merchandising firm) for the year ended 12/31/2002 is as follows:

Sales $250,000Dividend revenue 10,000Cost of Goods Sold (120,000)Salaries expense (50,000)Depreciation expense (30,000)Income tax expense (20,000)Net income $ 40,000

The beginning and ending balances in some accounts of Montana Company were as follows:Account 1/1/2002 12/31/2002Accounts Receivable $20,000 $25,000Inventory 16,000 15,000Accounts Payable 8,000 10,000Salaries payable 6,000 3,000

Calculate cash flow from operating activities using (a) the indirect method and (b) the direct method.

Solution to Demonstration Problem 1, Montana Company

a. Cash flow from operating activities-Indirect method:Net income $40,000Add: Depreciation expense 30,000Plus: Decrease in inventory 1,000 Increase in accounts payable 2,000Less: Increase in accounts receivable (5,000) Decrease in salaries payable (3,000)Cash flow from operating activities $65,000

b. Cash flow from operating activities-Direct method:Cash collected from customers

= Beg. Accts. Receivable + Sales - Ending Accts. Receivable

= $20,000 + $250,000 - $25,000 = $245,000

Inventory purchases = Ending inventory + Cost of goods sold - Beginning inventory= $15,000 + $120,000 - $16,000 = $119,000

Cash payments to suppliers

= Beg. Accts. Payable + Purchases - Ending Accts. Payable

= $8,000 + $119,000 - $10,000 = $117,000

Salary payments = Beg. salaries payable + Salaries expense - Ending salaries payable

= $6,000 + $50,000 - $3,000 = $53,000

Since there is no income tax payable given at either the beginning or the end of the year, the amount of income taxes paid must equal the income tax expense of $20,000.

Cash flow from operating activities-Direct method

Cash collected from customers $245,000Plus: Dividend revenue 10,000Less: Cash payments to suppliers (117,000)Less: Salary payments (53,000)Less: Income tax payments (20,000)Cash flow from operating activities $ 65,000

Demonstration Problem 2Gifford Company

The beginning and ending balances in some accounts of Gifford Company were as follows:Account 1/1/2002 12/31/2002Land $ 80,000 $ 60,000Buildings and equipment 240,000 260,000Accumulated depreciation-buildings and equipment 60,000 58,000Bonds payable 50,000 45,000Dividends payable 10,000 12,000Common stock 30,000 40,000Retained earnings 90,000 120,000

Net income for the year ended 12/31/2002 was $45,000. During the year, the following transactions took place: (1) Land with a book value of $20,000 was sold for $47,000, (2) equipment with a cost of $40,000 and accumulated depreciation of $12,000 was sold for a gain of $7,000, and (3) a new building was bought.

Required: Prepare the cash flows from (a) investing activities and (b) financing activities.

Solution to Demonstration Problem 2 Gifford Company

a. Cash flow from investing activities:

Cash inflow from sale of land = $47,000(Since we are interested only in the investing and financing activities, we need not look further into the gains from the sale of land.)

Net book value of equipment sold = $40,000 $12,000 = $28,000.Gain on sale of equipment = $7,000Hence, cash inflow from sale of equipment = $35,000 ($28,000 + $7,000)

We know thatBeginning balance of buildings and equipment + Cost of buildings and equipment purchased = Ending balance of buildings and equipment + Cost of buildings and equipment sold

Hence,Cost of new equipment bought = Ending balance of buildings and equipment + Cost of items sold Beginning balance of buildings and equipment

= $260,000 + $40,000 - $240,000= $60,000

Cash flow from investing activities

Cash inflow from sale of land $47,000Plus: Cash inflow from sale of building 10,000Less: Cash payments to suppliers (117,000)Less: Salary payments (53,000)Less: Income tax payments (20,000)Cash flow from investing activities $ 65,000

b. Cash flow from financing activities:

Bonds payable have decreased from $50,000 to $45,000.Hence, cash outflow to buyback bonds = $5,000 ($50,000 $45,000)

Common stock has increased from $30,000 to $40,000.Hence, cash inflow from sale of common stock = $10,000

Dividends declared = Beginning retained earnings + Net income Ending retained earnings

= $90,000 + $45,000 $120,000 = $15,000Dividends paid = Beginning dividends payable + Dividends declared Ending dividends payable

= $10,000 + $15,000 $12,000 = $13,000

Cash flow from financing activitiesCash collected from customers $245,000Plus: Dividend revenue 10,000Less: Cash payments to suppliers (117,000)Less: Salary payments (53,000)Less: Income tax payments (20,000)Cash flow from financing activities $ 65,000

Practice Problem 1Slade Company

The beginning and ending balances of some accounts of Slade Company for the year ended December 31, 2002, are given below. Sales revenue recognized during the year was $900,000, and cost of goods sold during the year as $600,000. Using the data, calculate (a) cash payments to suppliers of Slade Company and (b) cash collected from sales to customers of Slade Company.

Beginning balance Ending balanceAccounts Payable $60,000 $50,000Inventory 100,000 120,000Accounts Receivable 80,000 90,000

Solution to Practice Problem 1, Slade Company

a. Cash payments to suppliersCost of goods sold = Beginning inventory + Purchases – Ending inventoryPurchases = Beginning inventory + Cost of goods sold – Ending inventory

= $100,000 + $600,000 - $120,000= $580,000

Cash payments = Beginning Accts. Payable + Purchases – Ending Accts. Payable= $60,000 + $580,000 - $50,000= $590,000

b. Cash collected from sales to customerCash collections = Beginning Accts. Receivable + Sales – Ending Accts.

Receivable= $80,000 + $900,000 - $90,000= $890,000

Practice Problem 2Bishop Company

The income statement of Bishop Company for the year ended December 31, 2002, is given below.Sales $500,000Cost of goods sold 240,000Gross profit $260,000Expenses:Sales commission $60,000Administrative salaries 80,000Depreciation 50,000Interest expense 20,000

210,000Net income $ 50,000

The beginning and ending balances of some accounts of Bishop Company during 2002 were as follows:

Beginning balance Ending balanceAccounts Payable $30,000 $26,000Inventory 35,000 40,000Accounts Receivable 50,000 46,000

Prepare the cash flows from operating activities of Bishop Company for the year ended December 31, 2002.

Solution to Practice Problem 2, Bishop Company

Cash collections = Beginning Accts. Receivable + Sales – Ending Accts. Receivable

= $50,000 + $500,000 - $46,000= $504,000

Purchases = Beginning inventory + Cost of goods sold – Ending inventory= $35,000 + $240,000 - $40,000= $235,000

Cash payments = Beginning Accts. Payable + Purchases – Ending Accts. Payable

= $30,000 + $235,000 - $26,000= $239,000

Cash flows from operating activitiesCash collected from customers = $504,000 Cash payments to suppliers = (239,000)Cash payments–sales commission = (60,000)Cash payments–admininstrative salaries = (80,000)Cash payments–interest expense = (20,000)Cash flows from operating activities = $105,000

Practice Problem 3Simms Company

The beginning and ending balances of some accounts of Simms Company for the year ended December 31, 2002, are given below. During the year, Simms Company declared and paid dividends of $40,000. There were no gains or losses from sales of noncurrent accounts during the year. Using the data, prepare a statement of cash flows for Simms Company.

Beginning balance

Ending balance

Cash $12,000 $15,000Accounts Receivable 36,000 33,000Inventory 44,000 56,000Prepaid rent 3,000 1,000Equipment 75,000 90,000Accumulated depreciation–equipment (25,000) (34,000)Total assets $145,000 $161,000

Accounts Payable $35,000 $38,000Salaries payable 5,000 3,000Notes Payable 25,000 22,000Common stock 10,000 18,000Retained earnings 70,000 80,000Total liabilities and equities $145,000 $161,000

Solution to Practice Problem 3, Simms Company

Beginning retained earnings + Net income – Dividends = Ending retained earningsNet income = Ending retained earnings + Dividends – Beginning retained earnings = $80,000 + $40,000 - $70,000

= $50,000

Cash flows from operations Net income $ 50,000 Adjustments for noncash items Depreciation expense 9,000 Decrease in accounts receivable 3,000 Increase in inventory (12,000) Decrease in prepaid rent 2,000 Increase in accounts payable 3,000 Decrease in salaries payable (2,000)Cash flows from operating activities $ 53,000

Cash flows from investing Purchase of equipment (15,000)Cash flows from investing activities $(15,000)

Cash flows from financing Payment of notes payable (3,000) Payment of dividends (40,000) Sale of common stock 8,000Cash flows from financing activities $(35,000)

Net increase in cash $ 3,000Cash at beginning of year 12,000Cash at end of year $ 15,000

Practice Problem 4

1. The difference between the direct and indirect methods of preparing the statement of cash flows is only in the a. operating activities section of the statement of cash flows.b. investing activities section of the statement of cash flows.c. financing activities section of the statement of cash flows.d. operating and investing activities sections.

2. The direct method of preparing the statement of cash flows results in:a. starts with sales revenue and adds back noncash expenses.b. starts with collections from customers and subtracts cash paid for expensec. starts with net income and adjusts for differences between accrual-basis and cash- basis accounting.d. starts with sales revenue and adjusts for differences between accrual-basis and cash-basis accounting.

3. Which of the following will be reported in the investing activities section of the statement of cash flows?a. issuance of common stock to new stockholdersb. purchase of treasury stockc. purchase of an intangible assetd. adjustment for gains from sale of noncurrent assets

4. Which of the following will be added in calculating the cash flows from operating activities using the indirect method?a. increase in inventory.b. depreciation expense.c. decrease in salaries payable.d. Both a and c.

5. Which of the following items will be reported in the operating activities section of the statement of cash flows when using the direct method?a. dividend revenueb. interest revenuec. dividends paidd. Both a and b.

6. Jones Company sold some land with a book value of $50,000 to Smith Company for $80,000. The amount reported by Jones Company in the investing activities section of the statement of cash flows for this transaction, when using the direct method isa. cash payment of $80,000.b. the book value of $50,000.c. cash receipt of $80,000.

d. gain from sale of $30,000.

7. The accounts receivable balances of Carrol Company as of 1/1/2002 and 12/31/2002 were $100,000 and $115,000, respectively. Sales during the year ended 12/31/2002 (all on credit) were $800,000. If the accounts receivable written off during the year were $10,000, what was the amount of cash collected from customers during the year?a. $775,000b. $785,000c. $815,000d. $805,000

8. Hess Company reported cash flows from operating activities of $370,000 for the year ended 12/31/2002. For 2002, depreciation expense was $120,000, amortization expense was $30,000, and dividends payments to common stockholders were $60,000. Based solely on the data, the net income of Hess Company for the year ended 12/31/2002 must bea. $160,000.b. $550,000.c. $220,000.d. $520,000.

9. Sharpe Company had net income of $120,000 for the year ended 12/31/2002. During the year, Sharpe Company had amortization expense of $12,000, interest expense of $13,000, loss on sale of equipment of $8,000, and an increase in accounts receivable of $9,000. Based solely on these data, the cash flows from operating activities of Sharpe Company for the year ended 12/31/2002 must bea. $144,000.b. $146,000.c. $149,000.d. $131,000.

10. During the year ended 12/31/2002, Moss Company had the following transactions: equipment with a book value of $72,000 (original cost $85,000) was sold for $95,000; bought shares of Carter Company for $35,000 last year were sold for $44,000; new machines were bought for $36,000; inventories worth $36,000 were bought; and bonds issued by the company (face value $100,000) were bought back for $80,000. The cash flow from investing activities for the year werea. $23,000.b. $(9,000).c. $(13,000).

d. $4,000.

Homework Problem 1(Langer Company-Indirect Method)

The income statement of Langer Company for the year ended 12/31/2002 is as follows:

Sales $600,000Cost of goods sold 300,000Gross Profit $300,000Operating expenses Selling expense $75,000 Administrative expense 66,000 Rent expense 24,000 Depreciation expense 50,000

215,000Income from operations $ 85,000Other revenues and expenses Gain on sale of equipment $10,000 Dividend revenue 7,000 Interest expense (12,000)

5,000 Net income before taxes $ 90,000 Income tax expense (30,000)Net income $60,000

The beginning and ending balances in some accounts of Langer Company were as follows:Account 1/1/2002 12/31/2002Cash $ 15,000 $ 11,000Accounts Receivable 20,000 25,000Inventory 16,000 22,000Prepaid rent 5,000 3,000Property, plant and equipment 300,000 350,000Accumulated depreciation (80,000) (90,000)Total assets $276,000 $321,000

Accounts Payable $ 34,000 $ 25,000Notes payable 50,000 40,000Common stock 100,000 115,000Retained earnings 92,000 141,000Liabilities and stockholders’ equity $276,000 $321,000

Old equipment costing $60,000 with a book value of $20,000 was sold for $30,000, and new equipment was purchased for $110,000. Calculate cash flow from operating activities using the indirect method. (Hint: You need to calculate dividends paid during the year before you can calculate cash flows from financing activities.)

Solution to Homework Problem 1, Langer Company-Indirect Method

Cash flows from operating activitiesNet income $60,000Add: Depreciation expense $50,000Subtract: Gain on sale of equipment (10,000)

40,000Plus: Decrease in prepaid rent 2,000Less: Increase in accounts receivable (5,000) Increase in inventory (6,000) Decrease in accounts payable (9,000)

(18,000)Cash provided by operating activities $82,000

Cash flow from investing activities Sale of equipment $30,000 Purchase of equipment (110,000)Cash used for investing activities $(80,000)

Cash flow from financing activities Cash used for paying notes payable $(10,000) Sale of stock 15,000 Dividend payments (11,000)Cash provided by financing activities $(6,000)

Net decrease in cash $(4,000)Beginning cash balance 15,000Ending cash balance $11,000

Homework Problem 2(Langer Company-Direct Method)

The income statement of Langer Company for the year ended 12/31/2002 is as follows:

Sales $600,000Cost of goods sold 300,000Gross Profit $300,000Operating expenses Selling expense $ 75,000 Administrative expense 66,000 Rent expense 24,000 Depreciation expense 50,000

215,000Income from operations $ 85,000Other revenues and expenses Gain on sale of equipment $ 10,000 Dividend revenue 7,000 Interest expense (12,000)

5,000Net income before taxes $ 90,000Income tax expense (30,000)Net income $ 60,000

The beginning and ending balances in some accounts of Langer Company were as follows:Account 1/1/2002 12/31/2002Cash $ 15,000 $ 11,000Accounts Receivable 20,000 25,000Inventory 16,000 22,000Prepaid rent 5,000 3,000Property, plant and equipment 300,000 350,000Accumulated depreciation (80,000) (90,000)Total assets $276,000 $321,000

Accounts payable $ 34,000 $ 25,000Notes payable 50,000 40,000Common stock 100,000 115,000Retained earnings 92,000 141,000Liabilities and stockholders’ equity $276,000 $321,000

Old equipment costing $60,000 with a book value of $20,000 was sold for $30,000, and new equipment was purchased for $110,000. Calculate cash flow from operating activities using the direct method. (Hint: You need to calculate dividends paid during the year, before you can calculate cash flows from financing activities.)

Solution to Homework Problem 2, Langer Company-Direct Method:

Cash collected from customers

= Beginning accounts receivable + Sales - Ending accounts receivable

= $20,000 + $600,000 $25,000 = $595,000

Inventory purchases = Ending inventory + Cost of goods sold - Beginning inventory= $22,000 + $300,000 $16,000 = $306,000

Cash payments to suppliers

= Beginning accounts payable + Purchases - Ending accounts payable

= $34,000 + $306,000 $25,000 = $315,000

Cash flow from operating activities Cash collections from customers $ 595,000 Cash collected from dividends 7,000 Cash paid to suppliers (315,000) Cash paid-selling expenses (75,000) Cash paid-administrative expenses (66,000) Cash paid-rent (22,000) Cash paid-interest expense (12,000) Cash paid-income tax expense (30,000)Cash provided by operating activities $ 82,000

Cash flow from investing activities Sale of equipment $ 30,000 Purchase of equipment (110,000)Cash used for investing activities $(80,000)

Cash flow from financing activities Cash used for paying notes payable $ (10,000) Sale of stock 15,000 Dividend payments (11,000)Cash provided by financing activities $ (6,000)

Net decrease in cash $ (4,000)Beginning cash balance 15,000Ending cash balance $ 11,000

Homework Problem 3

1. The order of presentation in the statement of cash flows isa. operating activities, financing activities, investing activities.b. investing activities, financing activities, operating activities.c. financing activities, operating activities, investing activities.d. operating activities, investing activities, financing activities.

2. Which of the following will not be reported in the operating activities section of the statement of cash flows prepared using the indirect method?a. collections from customersb. adjustment for depreciation expensec. increase in accounts receivabled. both b and c

3. Which of the following will be subtracted in calculating the cash flows from operating activities using the indirect method?a. increase in inventoryb. depreciation expensec. decrease in salaries payabled. both a and c

4. Which of the following items will be included in preparing the statement of cash flows using the direct method?a. gain on sale of property, plant, and equipmentb. increase in accounts receivablec. salaries paid to employeesd. depreciation expense

5. Which of the following will not be reported as an adjustment increasing the cash flows from operating activities when using the indirect method?a. decrease in inventoryb. increase in prepaid rentc. increase in accounts payabled. loss on sale of land

6. Cordero Company sold buildings with a book value of $80,000 to Oliver Company for $60,000. The amount reported by Cordero Company in the investing activities section of the statement of cash flows for this transaction, when using the indirect method, is:a. cash payment of $60,000 b. the book value of $80,000c. cash receipt of $60,000 d. loss from sale of $20,000

7. Which of the following will be reported as an investing activity on the statement of cash flows?a. depreciation of equipmentb. purchase of treasury stockc. purchase of an intangible assetd. adjustment for gains from sale of noncurrent assets

8. The inventory balances of Kraft Company as of 1/1/2002 and 12/31/2002 were $40,000 and $45,000, respectively. The beginning and ending balances of accounts payable were $60,000 and $75,000, respectively. Cost of goods sold during the year ended 12/31/2002 as $340,000. What was the amount of cash paid to suppliers during the year?a. $330,000b. $360,000c. $335,000d. $350,000

9. Elway Company had net income of $400,000 for the year ended 12/31/2002. During the year, Elway Company had depreciation expense of $33,000, gain on sale of equipment of $12,000, increase in inventory of $8,000, and dividend payments to common stockholders of $20,000. Based solely on these data, the cash flows from operating activities of Elway Company for the year ended 12/31/2002 must bea. $367,000.b. $387,000. c. $413,000.d. $393,000.

10. During the year ended 12/31/2002, Lucas Company had the following transactions: equipment with a book value of $45,000 (original cost $50,000) was sold for $42,000; shares of Otis Company bought for $25,000 last year were sold for $21,000; dividend payments to common stockholders were $18,000; bonds were issued to investors for $50,000; and, treasury stock purchases were for $30,000 (par value $12,000). The cash flow from financing activities for the year werea. $23,000.b. $2,000.c. $(19,000).d. $20,000.

Homework Problem 4

1. The indirect method of preparing the statement of cash flowsa. starts with sales revenue and adds back noncash expenses.b. starts with collections from customers and subtracts cash paid for expenses.c. starts with net income and adjusts for differences between accrual-basis and cash-basis accounting.d. starts with sales revenue and subtracts cash paid for expenses.

2. Which of the following will not be reported in the operating activities section of the statement of cash flows prepared using the direct method?a. collections from customersb. adjustment for depreciation expensec. purchase of equipmentd. both b and c

3. Which of the following will be reported in the financing activities section of the statement of cash flows?a. purchase of bonds issued by another companyb. purchase of treasury stockc. sales of intangible assetsd. adjustment for gains from sale of noncurrent assets

4. Which of the following will not be subtracted in calculating the cash flows from operating activities using the indirect method?a. cash payments to suppliersb. gain on sale of landc. increase in accounts receivabled. decrease in accounts payable

5. James Company got some machines from Clifford Company and in return gave some land to Clifford Company. This transaction would be reported on the statement of cash flows asa. an investing activity.b. a financing activity.c. both investing and financing activities.d. neither an investing nor financing activity.

6. Buford Company sold machinery with a book value of $70,000 to Read Company for $65,000. The amount reported by Buford Company in the operating activities section of the statement of cash flows for this transaction, when using the indirect method, isa. cash receipt of $65,000. b. loss from sale of $5,000.

c. the book value of $70,000.d. $0.

7. Gibbs Company sold land with a book value of $55,000 to Nance Company for $70,000. The amount reported by Gibbs Company in the operating activities section of the statement of cash flows for this transaction, when using the direct method, isa. cash receipt of $70,000. b. gain from sale of $15,000.c. the book value of $55,000.d. $0.

8. The accounts payable balances of Jones Company as of 1/1/2002 and 12/31/2002 were $45,000 and $30,000, respectively. Jones Company’s cost of goods sold and purchases during the year ended 12/31/2002 were $420,000 and 360,000, respectively. What was the amount of cash paid to suppliers during the year?a. $435,000b. $375,000c. $405,000d. $345,000

9. Marino Company had net income of $200,000 for the year ended 12/31/2002. The retained earnings as of 1/1/2002 and 12/31/2002 were $800,000 and $940,000, respectively. The dividends payable as of 1/1/2202 and 12/31/2002 were $30,000 and $35,000, respectively. Cash used to pay dividends during the year werea. $55,000.b. $205,000. c. $65,000.d. $135,000.

10. During 2002, Garcia Company sold machinery with an original cost of $180,000 and a book value of $40,000 for $35,000. The beginning and ending balances of the machinery account during the year were $700,000 and $780,000, respectively; furthermore, the accumulated depreciation as of 1/1/2002 and 12/31/2002 as $210,000 and $240,000, respectively. What was the cost of machinery purchased during 2002?a. $250,000b. $120,000 c. $260,000d. $115,000