Chapter 13 | Statement of Cash Flows |
Learning Objectives
After studying this chapter, you should be able to:
1 Indicate the usefulness of the statement of cash flows.
2 Distinguish among operating, investing, and financing activities.
3 Prepare a statement of cash flows using the indirect method.
4 Analyze the statement of cash flows.
Feature Story
In today's environment, companies must be ready to respond to changes quickly in order to survive and thrive. This requires that they manage their cash very carefully. A company's cash needs, and how it addresses them, depend on a lot of factors. For example, many high-tech companies need significant cash in order to grow, especially in their early years. To conserve cash, some young companies pay their employees with company shares, or share options. Not only does this conserve cash, but it creates an incentive for employees to work hard. If the company succeeds, then the value of their company shares will increase.
Successful mature companies frequently generate lots of cash—often exceeding their immediate needs. This excess cash is often referred to as “free cash flow.” A company with lots of free cash flow must decide what to do with this cash. If it doesn't want to expand its capacity in its existing product lines, it might decide to acquire businesses in other industries. Or, it might increase its dividend payments, buy back shares, or pay down its debt.
In some instances, management will simply accumulate mass amounts of cash, which can result in shareholder criticism. For example, Keyence (JPN), a manufacturer of sensors and measuring instruments, generated significant amounts of cash for many years. The company is debt-free and not inclined toward acquisitions. But, it also has been reluctant to pay out dividends. Some have suggested that its aversion to dividend payments is due to the fact that the company's chairman and largest shareholder does not want to incur the personal income tax that would result if he received dividends on his 25% share ownership. At a recent shareholder meeting, many of the company's other shareholders complained loudly that the company's returns were being dragged down because it was accumulating so much cash and investing it in low-paying government securities. They demanded that the company increase its dividend.
It appears that there is a general movement in Japan and other maturing Asian economies to begin to pay higher dividends. Many suffer from excess productive capacity, so it makes sense for them to use their excess cash to either pay higher dividends or buy back shares. As this occurs, the percentage of cash flow paid out in dividends may well begin to approach about 50%, which is common in mature markets such as Europe.
After the financial crisis, emerging-market companies and developed-market companies had quite different philosophies regarding cash flows. Companies in developed countries accumulated cash and paid down debt. In contrast, companies in developing countries continued to spend cash to expand operations as well as borrow it to finance their expansion.
Preview of Chapter 13
The statement of financial position, income statement, and retained earnings statement do not always show the whole picture of the financial condition of a company or institution. In fact, looking at the financial statements of some well-known companies, a thoughtful investor might ask questions like these: How did Anheuser-Busch InBev (BEL) finance cash dividends of €2.1 billion in a year? How could Cathay Pacific Airways (HKG) purchase new assets that cost HK$9.2 billion in a year in which it reported a net loss of over HK$8.6 billion? How did the companies that spent a combined fantastic $3.4 trillion on mergers and acquisitions in a recent year finance those deals? Answers to these and similar questions can be found in this chapter, which presents the statement of cash flows.
The content and organization of this chapter are as follows.
The statement of financial position, income statement, and retained earnings statement provide only limited information about a company's cash flows (cash receipts and cash payments). For example, comparative statements of financial position show the increase in property, plant, and equipment during the year. But, they do not show how the additions were financed 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.
LEARNING OBJECTIVE 1
Indicate the usefulness of the statement of cash flows.
The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from operating, investing, and financing activities during a period. The information in a statement of cash flows should help investors, creditors, and others assess:
Ethics Note
Though we would discourage reliance on cash flows to the exclusion of accrual accounting, comparing cash from operations 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.
LEARNING OBJECTIVE 2
Distinguish among operating, investing, and financing activities.
The statement of cash flows classifies cash receipts and cash payments as operating, investing, and financing activities. Transactions and other events characteristic of each kind of activity are as follows.
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 sufficient cash to continue as a going concern.
Illustration 13-1 lists typical cash receipts and cash payments within each of the three classifications. Study the list carefully. It will prove very useful in solving homework exercises and problems.1
Note the following general guidelines:
IFRS requires that the amount of cash paid for taxes, as well as cash flows from interest and dividends received and paid, be disclosed. The category (operating, investing, or financing) that each item was included in must be disclosed as well. An example of such a disclosure from the notes to Daimler's (DEU) financial statements is provided in Illustration 13-2.
Not all of a company's significant activities involve cash. Examples of significant non-cash activities are:
Helpful Hint
Do not include non-cash investing and financing activities in the body of the statement of cash flows. Report this information in a separate schedule.
Companies do not report in the body of the statement of cash flows significant financing and investing activities that do not affect cash. Instead, they report these activities in either a separate note or supplementary schedule to the financial statements.
In solving homework assignments, you should present significant non-cash investing and financing activities in a separate note to the financial statements. (See the last entry in Illustration 13-3, on page 627, for an example.)
ACCOUNTING ACROSS THE ORGANIZATION
Net What?
Net income is not the same as net cash provided by operating activities. Below are some results from recent annual reports (currencies in millions). Note the wide disparity among these companies, all of which engaged in retail merchandising.
In general, why do differences exist between net income and net cash provided by operating activities? (See page 682.)
The general format of the statement of cash flows presents the results of the three activities discussed previously—operating, investing, and financing—plus the significant non-cash investing and financing activities. Illustration 13-3 shows a widely used form of the statement of cash flows.
The cash flows from operating activities section always appears first, followed by the investing activities section, and then the financing activities section. The sum of the operating, investing, and financing sections equals the net increase or decrease in cash for the period. This amount is combined with the beginning cash balance to arrive at the ending cash balance—the same amount reported on the statement of financial position.
DO IT!
Classification of Cash Flows
During its first week, Hu Na Company had these transactions.
Classify each of these transactions by type of cash flow activity.
Action Plan
Solution
Related exercise material: BE13-1, BE13-2, BE13-3, E13-1, E13-2, E13-3, and 13-1.
Companies prepare the statement of cash flows differently from the three other basic financial 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 flows deals with cash receipts and payments. As a result, the company must adjust the effects of the use of accrual accounting to determine cash flows.
The information to prepare this statement usually comes from three sources:
Preparing the statement of cash flows from these data sources involves three major steps, explained in Illustration 13-4 on the next page.
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. A great majority of companies 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 flow from operating activities.
The direct method shows operating cash receipts and payments, making it more consistent with the objective of a statement of cash flows. The IASB 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 13B illustrates the direct method.
LEARNING OBJECTIVE 3
Prepare a statement of cash flows using the indirect method.
To explain how to prepare a statement of cash flows using the indirect method, we use financial information from Computer Services Company. Illustration 13-5 presents Computer Services' current- and previous-year statements of financial position, its current-year income statement, and related financial information for the current year.
We will now apply the three steps to the information provided for Computer Services Company. (Appendix 13C demonstrates an approach that employs T-accounts to prepare the statement of cash flows. Many students find this approach helpful. We encourage you to give it a try as you walk through the Computer Services example.)
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 IFRS, companies use the accrual basis of accounting. This basis requires that companies record revenue when their performance obligation is satisfied and record expenses when incurred. Revenues may include credit sales for which the company has not yet collected cash. Expenses incurred may include some items that the company has not yet paid in cash. Thus, net income under the accrual basis 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 13-6 lists the three types of adjustments.
Helpful Hint
Depreciation is similar to any other expense in that it reduces net income. It differs in that it does not involve a current cash outflow. That is why it must be added back to net income to arrive at cash provided by operating activities.
We explain the three types of adjustments in the next three sections.
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 non-cash charge. The company must add it back to net income to arrive at net cash provided by operating activities. Computer Services reports depreciation expense in the statement of cash flows as shown below.
As the first adjustment to net income in the statement of cash flows, companies frequently list depreciation and similar non-cash charges such as amortization of intangible assets, depletion expense, and bad debt expense.
Illustration 13-1 (page 625) states that cash received from the sale (disposal) of plant assets should be reported in the investing activities section. Because of this, companies must eliminate from net income all gains and losses related to the disposal of plant assets, to arrive at cash provided by operating activities.
In our example, Computer Services' income statement reports a €3,000 loss on disposal of plant assets (book value €7,000, less €4,000 cash received from disposal of plant assets). The company's loss of €3,000 should not be included in the operating activities section of the statement of cash flows. Illustration 13-8 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.
If a gain on disposal occurs, the company deducts the gain from its 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 as a source of cash in the investing activities section of the statement of cash flows.
A final adjustment in reconciling 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 a company's performance obligation is satisfied and expenses in the period incurred. For example, companies use Accounts Receivable to record amounts owed to the company for sales that have been made but for which cash collections have not yet been received. They use the Prepaid Insurance account to reflect insurance that has been paid for but which has not yet expired and therefore has not been expensed. Similarly, the Salaries and Wages Payable account reflects salaries and wages expense that has been incurred by the company 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 NON-CASH CURRENT ASSETS. The adjustments required for changes in non-cash 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 can observe these relationships by analyzing the accounts of Computer Services Company.
DECREASE IN ACCOUNTS RECEIVABLE Computer Services Company's accounts receivable decreased by €10,000 (from €30,000 to €20,000) during the period. For Computer Services, this means that cash receipts were €10,000 higher than sales revenue. The Accounts Receivable account in Illustration 13-9 shows that Computer Services Company had €507,000 in sales revenue (as reported on the income statement), but it collected €517,000 in cash.
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 (see Illustration 13-10). When the Accounts Receivable balance increases, cash receipts are lower than sales revenue 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 Company's inventory balance increased €5,000 (from €10,000 to €15,000) during the period. The change in the Inventory account reflects 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 reflect €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 13-10). 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 13-10).
If prepaid expenses decrease, reported expenses are higher than the expenses paid. Therefore, the company adds to net income the decrease in prepaid expenses, 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 Company, 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 Illustration 13-11 (page 634), to adjust net income to determine net cash provided by operating activities, the company adds to net income the €16,000 increase in Accounts Payable.
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 reflects the difference between income tax expense incurred and income tax 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 13-11, to adjust net income to a cash basis, the company must reduce net income by €2,000.
Illustration 13-11 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.
As shown in the previous illustrations, the statement of cash flows prepared by the indirect method starts with net income. It then adds or deducts items to arrive at net cash provided by operating activities. The required adjustments are of three types:
Illustration 13-12 provides a summary of these changes.
ETHICS INSIGHT
Cash Flow Isn't Always What It Seems
Some managers have taken actions that artificially increase cash flow from operating activities. They do this by moving negative amounts out of the operating section and into the investing or financing section.
For example, WorldCom, Inc. (USA) disclosed that it had improperly capitalized expenses: It had moved $3.8 billion of cash outflows from the “Cash from operating activities” section of the statement of cash flows to the “Investing activities” section, thereby greatly enhancing cash provided by operating activities. Similarly, Dynegy, Inc. (USA) restated its statement of cash flows because it had improperly included in operating activities, instead of in financing activities, $300 million from natural gas trading. The restatement resulted in a drop of 37% in cash flow from operating activities.
Source: Henny Sender, “Sadly, These Days Even Cash Flow Isn't Always What It Seems to Be,” Wall Street Journal (May 8, 2002).
For what reasons might managers at WorldCom and at Dynegy take the actions noted above? (See page 683.)
DO IT!
Cash from Operating Activities
Josh's PhotoPlus reported net income of £73,000 for 2014. 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 statements of financial position show the following balances.
Calculate net cash provided by operating activities for Josh's PhotoPlus.
Action Plan
Solution
Related exercise material: BE13-4, BE13-5, BE13-6, E13-4, E13-5, E13-6, E13-7, E13-8, and 13-2.
INCREASE IN LAND As indicated from the change in the Land account and the additional information, the company purchased land of €110,000 through the issuance of long-term bonds. The issuance of bonds payable for land has no effect on cash. But, it is a significant non-cash investing and financing activity that merits disclosure in a separate schedule. (See Illustration 13-14 on pages 637–638.)
INCREASE IN BUILDINGS As the additional data indicate, Computer Services Company acquired an office building for €120,000 cash. This is a cash outflow reported in the investing section. (See Illustration 13-14 on pages 637–638.)
INCREASE IN EQUIPMENT The Equipment account increased €17,000. The additional information explains that this net increase 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. Thus, it reports the purchase of equipment as an outflow of cash for €25,000. It reports the sale as an inflow of cash for €4,000. The T-account below shows the reasons for the change in this account during the year.
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 from the issuance of these bonds. It reports this non-cash transaction in a separate schedule at the bottom of the statement.
Helpful Hint
When companies issue shares or bonds for cash, the actual proceeds will appear in the statement of cash flows as a financing inflow (rather than the par value of the shares or face value of bonds).
INCREASE IN SHARE CAPITAL—ORDINARY The statement of financial position reports an increase in Share Capital—Ordinary of €20,000. The additional information section notes that this increase resulted from the issuance of new shares. This is a cash inflow reported in the financing section.
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. (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 outflow that the company reports as a financing activity.
For more than a decade, the top executives at the Italian dairy products company Parmalat (ITA) engaged in multiple frauds which 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 fictitious sources and uses of cash. Some of these activities incorporated sophisticated financial transactions with subsidiaries created with the help of large international financial institutions. However, much of the fraud employed very basic, even sloppy, forgery of documents. For example, when outside auditors requested confirmation 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 difficult to read). Similarly, fictitious bills were created in order to divert funds to other businesses owned by the Tanzi family (who controlled Parmalat).
Total take: Billions of euros
THE MISSING CONTROL
Independent internal verification. Internal auditors at the company should have independently verified bank accounts and major transfers of cash to outside companies that were controlled by the Tanzi family.
Using the previous information, we can now prepare a statement of cash flows for 2014 for Computer Services Company as shown in Illustration 13-14.
Illustration 13-14 indicates that the net change in cash during the period was an increase of €22,000. This agrees with the change in the Cash account reported on the statement of financial position in Illustration 13-5 (page 629).
DO IT!
Use the information below and on the next page to prepare a statement of cash flows using the indirect method.
Action Plan
Solution
Related exercise material: BE13-4, BE13-5, BE13-6, BE13-7, E13-4, E13-5, E13-6, E13-7, E13-8, and E13-9.
Traditionally, investors and creditors have most commonly used ratios based on numbers derived from accrual accounting. These days, cash-based ratios are gaining increased acceptance among analysts.
In the statement of cash flows, 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 fixed assets just to maintain its current level of operations. Companies also must at least maintain dividends at current levels to satisfy investors. The measurement of free cash flow provides additional insight regarding a company's cash-generating ability. Free cash flow describes the cash remaining from operations 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 HK$1,000,000 cash provided by operating activities. In order to maintain production at 10,000 computers, MPC invested HK$150,000 in equipment. It chose to pay HK$50,000 in dividends. Its free cash flow was HK$800,000 (HK$1,000,000 − HK$150,000 − HK$50,000). The company could use this HK$800,000 either to purchase new assets to expand the business or to pay an HK$800,000 dividend and continue to produce 10,000 computers. In practice, free cash flow is often calculated with the formula in Illustration 13-15. (Alternative definitions also exist.)
Illustration 13-16 provides basic information (in millions) excerpted from a recent statement of cash flows of Anheuser-Busch InBev (BEL).
Anheuser-Busch InBev's free cash flow is calculated as shown in Illustration 13-17.
The company generates a significant amount of cash from its operations, but it spent most of it to buy property, plant, and equipment, and to pay dividends.
DO IT!
Free Cash Flow
Luó Corporation issued the following statement of cash flows for 2014.
(a) Compute free cash flow for Luó Corporation. (b) Explain why free cash flow often provides better information than “Net cash provided by operating activities.”
Action Plan
Solution
(a) Free cash flow (¥ in thousands) = ¥29,300 − ¥19,000 − ¥9,000 = ¥1,300
(b) 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 operations. Companies must also maintain dividends at current levels to satisfy investors. The measurement of free cash flow provides additional insight regarding a company's cash-generating ability.
Related exercise material: BE13-8, BE13-9, BE13-10, BE13-11, E13-7, E13-9, and 13-3.
Comprehensive DO IT! 1
The income statement for the year ended December 31, 2014, for Kosinski Company contains the following condensed information.
Included in operating expenses is a €24,000 loss resulting from the sale of machinery for €270,000 cash. Machinery was purchased at a cost of €750,000.
The following balances are reported on Kosinski's comparative statements of financial position at December 31.
Income tax expense of €353,000 represents the amount paid in 2014. Dividends declared and paid in 2014 totaled €200,000.
Instructions
Prepare the statement of cash flows using the indirect method.
Action Plan
Solution to Comprehensive 1
SUMMARY OF LEARNING OBJECTIVES
1 Indicate the usefulness of the statement of cash flows. The statement of cash flows provides information about the cash receipts, cash payments, and net change in cash resulting from the operating, investing, and financing activities of a company during the period.
2 Distinguish among operating, investing, and financing activities. Operating activities include the cash effects of transactions that enter into the determination of net income. Investing activities involve cash flows resulting from changes in investments and non-current asset items. Financing activities involve cash flows resulting from changes in non-current liability and equity items.
3 Prepare a statement of cash flows using the indirect method. The preparation of a statement of cash flows 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 non-current asset and liability accounts and record as investing and financing activities, or disclose as non-cash transactions. (3) Compare the net change in cash on the statement of cash flows with the change in the Cash account reported on the statement of financial position to make sure the amounts agree.
4 Analyze the statement of cash flows. Free cash flow indicates the amount of cash a company generated during the current year that is available for the payment of additional dividends or for expansion.
GLOSSARY
Direct method A method that shows operating cash receipts and payments, making it more consistent with the objective of the statement of cash flows. (p. 628).
Financing activities Cash flow activities that include (a) obtaining cash from issuing debt and repaying the amounts borrowed and (b) obtaining cash from shareholders, repurchasing shares, and paying dividends. (p. 625).
Free cash flow Cash provided by operating activities adjusted for capital expenditures and dividends paid. (p. 640).
Indirect method A method of preparing a statement of cash flows in which net income is adjusted for items that do not affect cash, to determine net cash provided by operating activities. (p. 628).
Investing activities Cash flow activities that include (a) acquiring and disposing of investments and property, plant, and equipment and (b) lending money and collecting the loans. (p. 624).
Operating activities Cash flow activities that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income. (p. 624).
Statement of cash flows A basic financial statement that provides information about the cash receipts, cash payments, and net change in cash during a period, resulting from operating, investing, and financing activities. (p. 624).
LEARNING OBJECTIVE 5
Explain how to use a worksheet to prepare the statement of cash flows using the indirect method.
When preparing a statement of cash flows, companies may need to make numerous adjustments of net income. In such cases, they often use a worksheet to assemble and classify the data that will appear on the statement. The worksheet is merely an aid in preparing the statement. Its use is optional. Illustration 13A-1 shows the skeleton format of the worksheet for preparation of the statement of cash flows.
The following guidelines are important in preparing a worksheet.
After all reconciling items have been entered, each line pertaining to a statement of financial position account should “foot across.” That is, the beginning balance plus or minus the reconciling item(s) must equal the ending balance. When this agreement exists for all statement of financial position accounts, all changes in account balances have been reconciled.
As in the case of worksheets illustrated in earlier chapters, preparing a worksheet involves a series of prescribed steps. The steps in this case are:
To illustrate the preparation of a worksheet, we will use the 2014 data for Computer Services Company. Your familiarity with these data (from the chapter) should help you understand the use of a worksheet. For ease of reference, the comparative statements of financial position, income statement, and selected data for 2014 are presented in Illustration 13A-2 (page 646).
Companies can use one of several approaches to determine the reconciling items. For example, they can first complete the changes affecting net cash provided by operating activities, and then can determine the effects of financing and investing transactions. Or, they can analyze the statement of financial position accounts in the order in which they are listed on the worksheet. We will follow this latter approach for Computer Services, except for cash. As indicated in Step 3, cash is handled last.
ACCOUNTS RECEIVABLE The decrease of €10,000 in accounts receivable means that cash collections from sales revenue are higher than the sales revenue reported in the income statement. To convert net income to net cash provided by operating activities, we add the decrease of €10,000 to net income. The entry in the reconciling columns of the worksheet is:
INVENTORY Computer Services Company's inventory balance increases €5,000 during the period. The Inventory account reflects the difference between the amount of inventory that the company purchased and the amount that it sold. For Computer Services, this means that the cost of merchandise purchased exceeds the cost of goods sold by €5,000. As a result, cost of goods sold does not reflect €5,000 of cash payments made for merchandise. We deduct this inventory increase of €5,000 during the period from net income to arrive at net cash provided by operating activities. The worksheet entry is:
PREPAID EXPENSES An increase of €4,000 in prepaid expenses means that expenses deducted in determining net income are less than expenses that were paid in cash. We deduct the increase of €4,000 from net income in determining net cash provided by operating activities. The worksheet entry is:
Helpful Hint
These amounts are asterisked in the worksheet to indicate that they result from a significant non-cash transaction.
LAND The increase in land of €110,000 resulted from a purchase through the issuance of long-term bonds. The company should report this transaction as a significant non-cash investing and financing activity. The worksheet entry is:
BUILDINGS The cash purchase of a building for €120,000 is an investing activity cash outflow. The entry in the reconciling columns of the worksheet is:
EQUIPMENT The increase in equipment of €17,000 resulted from a cash purchase of €25,000 and the sale of equipment costing €8,000. The book value of the equipment was €7,000, the cash proceeds were €4,000, and a loss of €3,000 was recorded. The worksheet entries are:
ACCOUNTS PAYABLE We must add the increase of €16,000 in accounts payable to net income to determine net cash provided by operating activities. The worksheet entry is:
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 reflects the difference between income tax expense incurred and income tax actually paid. Computer Services' Income Taxes Payable account decreases 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. To adjust net income to a cash basis, we must reduce net income by €2,000. The worksheet entry is:
BONDS PAYABLE The increase of €110,000 in this account resulted from the issuance of bonds for land. This is a significant non-cash investing and financing activity. Worksheet entry (d) above is the only entry necessary.
SHARE CAPITAL—ORDINARY The statement of financial position reports an increase in Share Capital—Ordinary of €20,000. The additional information section notes that this increase resulted from the issuance of new shares. This is a cash inflow reported in the financing section. The worksheet entry is:
ACCUMULATED DEPRECIATION—BUILDINGS, AND ACCUMULATED DEPRECIATION—EQUIPMENT Increases in these accounts of €6,000 and €3,000, respectively, resulted from depreciation expense. Depreciation expense is a non-cash charge that we must add to net income to determine net cash provided by operating activities. The worksheet entries are:
RETAINED EARNINGS The €116,000 increase in retained earnings resulted from net income of €145,000 and the declaration and payment of a €29,000 cash dividend. Net income is included in net cash provided by operating activities, and the dividends are a financing activity cash outflow. The entries in the reconciling columns of the worksheet are:
DISPOSITION OF CHANGE IN CASH The firm's cash increased €22,000 in 2014. The final entry on the worksheet, therefore, is:
As shown in the worksheet, we enter the increase in cash in the reconciling credit column as a balancing amount. This entry should complete the reconciliation of the changes in the statement of financial position accounts. Also, it should permit the totals of the reconciling columns to be in agreement. When all changes have been explained and the reconciling columns are in agreement, the reconciling columns are ruled to complete the worksheet. The completed worksheet for Computer Services Company is shown in Illustration 13A-3.
SUMMARY OF LEARNING OBJECTIVE FOR APPENDIX 13A
5 Explain how to use a worksheet to prepare the statement of cash flows using the indirect method. When there are numerous adjustments, a worksheet can be a helpful tool in preparing the statement of cash flows. Key guidelines for using a worksheet are: (1) List accounts with debit balances separately from those with credit balances. (2) In the reconciling columns in the bottom portion of the worksheet, show cash inflows as debits and cash outflows as credits. (3) Do not enter reconciling items in any journal or account, but use them only to help prepare the statement of cash flows.
The steps in preparing the worksheet are: (1) Enter beginning and ending balances of statement of financial position accounts. (2) Enter debits and credits in reconciling columns. (3) Enter the increase or decrease in cash in two places as a balancing amount.
LEARNING OBJECTIVE 6
Prepare a statement of cash flows using the direct method.
To explain and illustrate the direct method, we will use the transactions of Computer Services Company for 2014, to prepare a statement of cash flows. Illustration 13B-1 presents information related to 2014 for Computer Services Company.
To prepare a statement of cash flows under the direct approach, we will apply the three steps outlined in Illustration 13-4 (page 629).
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 13B-2 (page 652).
An efficient 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 flows for Computer Services Company using the direct approach.
CASH RECEIPTS FROM CUSTOMERS The income statement for Computer Services Company reported revenues 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 Company, accounts receivable decreased €10,000. Thus, cash receipts from customers were €517,000, computed as shown in Illustration 13B-3.
Computer Services can also determine cash receipts from customers from an analysis of the Accounts Receivable account, as shown in Illustration 13B-4.
Illustration 13B-5 shows the relationships among cash receipts from customers, sales revenue, and changes in accounts receivable.
CASH PAYMENTS TO SUPPLIERS Computer Services Company 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 first necessary to find purchases for the year. To find 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.
In 2014, Computer Services Company's inventory increased €5,000. It computes purchases as follows.
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 is a decrease in accounts payable. In that case, a company adds to purchases the decrease in accounts payable. For Computer Services Company, cash payments to suppliers were €139,000, computed as follows.
Computer Services also can determine cash payments to suppliers from an analysis of the Accounts Payable account, as shown in Illustration 13B-8.
Helpful Hint
The T-account shows that purchases less increase in accounts payable equal payments to suppliers.
Illustration 13B-9 shows the relationships among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable.
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 Company's cash payments for operating expenses were €115,000, computed as follows.
Illustration 13B-11 shows the relationships among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable.
DEPRECIATION EXPENSE AND LOSS ON DISPOSAL OF PLANT ASSETS Computer Services' depreciation expense in 2014 was €9,000. Depreciation expense is not shown on a statement of cash flows under the direct method because it is a non-cash 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 non-cash 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 flows under the direct method.
Other charges to expense that do not require the use of cash, such as the amortization of intangible assets, depletion expense, 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 statement of financial position did not include an accrual for interest payable for 2013 or 2014, 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 on the next page.
Illustration 13B-13 shows the relationships among cash payments for income taxes, income tax expense, and changes in income taxes payable.
The operating activities section of the statement of cash flows of Computer Services Company is shown in Illustration 13B-14.
When a company uses the direct method, it must also provide in a separate schedule (not shown here) the net cash flows from operating activities as computed under the indirect method.
Helpful Hint
The investing and financing activities are measured and reported the same under both the direct and indirect methods.
INCREASE IN LAND As indicated from the change in the Land account and the additional information, the company 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 significant non-cash investing and financing activity that merits disclosure in a note to the financial statements. (See Illustration 13B-16 on page 657.)
INCREASE IN BUILDINGS As the additional data indicate, Computer Services Company acquired an office building for €120,000 cash. This is a cash outflow reported in the investing section. (See Illustration 13B-16.)
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 investing activities. The company should report each transaction separately. The statement in Illustration 13B-16 reports the purchase of equipment as an outflow of cash for €25,000. It reports the sale as an inflow of cash for €4,000. The T-account on the next page shows the reasons for the change in this account during the year.
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 13B-16 reports this non-cash transaction in a separate note at the bottom of the statement.
INCREASE IN SHARE CAPITAL—ORDINARY The statement of financial position reports an increase in Share Capital—Ordinary of €20,000. The additional information section notes that this increase resulted from the issuance of new shares. This is a cash inflow reported in the financing section in Illustration 13B-16.
Helpful Hint
When companies issue shares or bonds for cash, the actual proceeds will appear in the statement of cash flows as a financing inflow (rather than the par value of the shares 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 outflow that the company reports as a financing activity in Illustration 13B-16.
Illustration 13B-16 shows the statement of cash flows for Computer Services Company.
Illustration 13B-16 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 statements of financial position in Illustration 13B-1 (page 650).
SUMMARY OF LEARNING OBJECTIVE FOR APPENDIX 13B
6 Prepare a statement of cash flows using the direct method. The preparation of the statement of cash flows 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 non-current asset and liability accounts and record as investing and financing activities, or disclose as non-cash transactions. (3) Compare the net change in cash on the statement of cash flows with the change in the Cash account reported on the statement of financial position to make sure the amounts agree. The direct method reports cash receipts less cash payments to arrive at net cash provided by operating activities.
GLOSSARY FOR APPENDIX 13B
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. (p. 651).
Comprehensive DO IT! 2
The income statement for Taipei Company contains the following condensed information.
Included in operating expenses is a NT$24,000 loss resulting from the sale of machinery for NT$270,000 cash. Machinery was purchased at a cost of NT$750,000. The following balances are reported on Taipei's comparative statements of financial position at December 31.
Income tax expense of NT$353,000 represents the amount paid in 2014. Dividends declared and paid in 2014 totaled NT$200,000.
Instructions
Prepare the statement of cash flows using the direct method.
Action Plan
Solution to Comprehensive 2
Many people like to use T-accounts to provide structure to the preparation of a statement of cash flows. The use of T-accounts is based on the accounting equation. The basic equation is:
Now, let's rewrite the left-hand side as:
Next, rewrite the equation by subtracting Non-Cash Assets from each side to isolate Cash on the left-hand side:
Finally, if we insert the Δ symbol (which means “change in”), we have:
What this means is that the change in cash is equal to the change in all of the other statement of financial position accounts. Another way to think about this is that if we analyze the changes in all of the non-cash statement of financial position 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 flows.
To implement this approach, first prepare a large Cash T-account, with sections for operating, investing, and financing activities. Then, prepare smaller T-accounts for all of the other non-cash statement of financial position accounts. Insert the beginning and ending balances for each of these accounts. Once you have done this, then walk through the steps outlined below and on the next page. 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 13C-1 (page 660) is numbered so you can follow them through the T-accounts.
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 first 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.
4–8. Next, post each of the changes to the non-cash 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 non-current 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 significant non-cash event that requires disclosure in a note at the bottom of the statement of cash flows.
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. Share Capital—Ordinary is credited for €20,000 for the issuance of ordinary shares, and the financing section of the Cash T-account is debited for €20,000.
13. Retained Earnings is debited to reflect the payment of the €29,000 dividend, and the financing section of the Cash T-account is credited to reflect the use of Cash.
At this point, all of the changes in the non-cash accounts have been explained. All that remains is to subtotal each section of the Cash T-account and agree the total change in cash with the change shown on the statement of financial position. Once this is done, the information in the Cash T-account can be used to prepare a statement of cash flows.
Self-Test, Brief Exercises, Exercises, Problem Set A, and many more resources are available for practice in WileyPLUS.
Note: All Questions, Exercises, and Problems marked with an asterisk relate to material in the appendices to the chapter.
SELF-TEST QUESTIONS
Answers are on page 683.
(a) It is a fourth basic financial 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 financing activities of the business.
(a) The net change in plant assets during the year.
(b) Cash payments for plant assets purchased during the year.
(c) Cash receipts from sales of plant assets during the year.
(d) Cash payments for dividends.
(a) operating and non-operating.
(b) investing, financing, and operating.
(c) financing, operating, and non-operating.
(d) investing, financing, and non-operating.
(a) Payment of cash to lenders for interest.
(b) Receipt of cash from the sale of ordinary shares.
(c) Payment of cash to reacquire shares.
(d) None of the above.
(a) Receipt of cash from the issuance of bonds payable.
(b) Payment of cash to repurchase outstanding shares.
(c) Receipt of cash from the sale of equipment.
(d) Payment of cash to suppliers for inventory.
(a) operating activities.
(b) investing activities.
(c) a combination of (a) and (b).
(d) financing activities.
(a) Receipt of cash from sale of land.
(b) Issuance of debt for cash.
(c) Purchase of equipment for cash.
(d) Receipt of interest.
(a) The direct method may be used to report cash provided by operations.
(b) The statement shows the cash provided (used) for three categories of activity.
(c) The operating section is the last section of the statement.
(d) The indirect method may be used to report cash provided by operations.
Questions 9 through 11 apply only to the indirect method.
(a) £102,000.
(b) £112,000.
(c) £124,000.
(d) £136,000.
(a) depreciation expense.
(b) an increase in inventory.
(c) amortization expense.
(d) loss on sale of equipment.
Net income | HK$2,000,000 |
Depreciation expense | 400,000 |
Dividends paid | 600,000 |
Gain on disposal of land | 100,000 |
Decrease in accounts receivable | 200,000 |
Decrease in accounts payable | 300,000 |
Net cash provided by operating activities is:
(a) HK$1,600,000.
(b) HK$2,200,000.
(c) HK$2,400,000.
(d) HK$2,800,000.
Sale of land | $100,000 |
Sale of equipment | 50,000 |
Issuance of ordinary shares | 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.
Increase in accounts payable | € 40,000 |
Increase in bonds payable | 100,000 |
Sale of investment | 50,000 |
Issuance of ordinary shares | 60,000 |
Payment of cash dividends | 30,000 |
Net cash provided by financing activities is:
(a) €90,000.
(b) €130,000.
(c) €160,000.
(d) €170,000.
(a) earn net income.
(b) generate future cash flows.
(c) pay dividends.
(d) meet obligations.
(a) generate net income.
(b) sell its equipment.
(c) generate cash to invest in new capital expenditures.
(d) purchase treasury shares.
(a) investing activities section.
(b) operating activities section.
(c) financing activities section.
(d) None of the choices is correct.
(a) credit in the operating section and a debit in another section.
(b) debit in the operating section.
(c) debit in the investing section.
(d) debit in the financing section.
Questions 18 and 19 apply only to the direct method.
(a) $127,000.
(b) $129,000.
(c) $131,000.
(d) $141,000.
(a) Loss on sale of building.
(b) Increase in accounts receivable.
(c) Depreciation expense.
(d) Cash payments to suppliers.
Go to the book's companion website, www.wiley.com/college/weygandt, for additional Self-Test Questions.
QUESTIONS
(a) What is a statement of cash flows?
(b) Nick Johns maintains that the statement of cash flows is an optional financial statement. Do you agree? Explain.
(a) What are the major sources (inflows) of cash in a statement of cash flows?
(b) What are the major uses (outflows) of cash?
BRIEF EXERCISES
Indicate statement presentation of selected transactions. (LO 2)
BE13-1 Each of the items below must be considered in preparing a statement of cash flows for Aksu Co. for the year ended December 31, 2014. For each item, state how it should be shown in the statement of cash flows for 2014.
(a) Issued bonds for 150,000 cash.
(b) Purchased equipment for 200,000 cash.
(c) Sold land costing 50,000 for 50,000 cash.
(d) Declared and paid a 20,000 cash dividend.
Classify items by activities. (LO 2)
BE13-2 Classify each item as an operating, investing, or financing 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) Depreciation.
(e) Payment of dividends.
(f) Issuance of ordinary shares.
Identify financing activity transactions. (LO 2)
BE13-3 The following T-account is a summary of the Cash account of Wiegman Company.
What amount of net cash provided (used) by financing activities should be reported in the statement of cash flows?
Compute cash provided by operating activities—indirect method. (LO 3)
BE13-4 Mokena, Inc. reported net income of €2.0 million in 2014. Depreciation for the year was €160,000, accounts receivable increased €350,000, and accounts payable increased €280,000. Compute net cash provided by operating activities using the indirect method.
Compute cash provided by operating activities—indirect method. (LO 3)
BE13-5 The net income for Lodi Co. for 2014 was $250,000. For 2014, depreciation on plant assets was $70,000, and the company incurred a gain on disposal of plant assets of $12,000. Compute net cash provided by operating activities under the indirect method.
Compute net cash provided by operating activities—indirect method. (LO 3)
BE13-6 The comparative statements of financial position for Sergipe Company show these changes in non-cash current asset accounts: accounts receivable increase R$80,000, prepaid expenses decrease R$28,000, and inventories decrease R$30,000. Compute net cash provided by operating activities using the indirect method assuming that net income is R$250,000.
Determine cash received from sale of equipment. (LO 3)
BE13-7 The T-accounts for Equipment and the related Accumulated Depreciation—Equipment for Ada Company at the end of 2014 are shown here.
In addition, Ada Company's income statement reported a loss on disposal of plant assets of $6,500. What amount was reported on the statement of cash flows as “cash flow from disposal of plant assets”?
Calculate free cash flow. (LO 4)
BE13-8 In a recent year, Cypress Semiconductor Corporation (USA) reported cash provided by operating activities of $155,397,000, cash used in investing of $207,628,000, and cash used in financing of $33,372,000. In addition, cash spent for fixed assets during the period was $130,820,000. No dividends were paid. Calculate free cash flow.
Calculate free cash flow. (LO 4)
BE13-9 Wruck Company reported cash provided by operating activities of £450,000, cash used by investing activities of £150,000, and cash provided by financing activities of £80,000. In addition, cash spent for capital assets during the period was £250,000. No dividends were paid. Calculate free cash flow.
Calculate free cash flow. (LO 4)
BE13-10 In a recent quarter, Alliance Atlantis Communications Inc. (USA) reported cash provided by operating activities of $45,000,000 and revenues of $265,800,000. Cash spent on plant asset additions during the quarter was $1,400,000. No dividends were paid. Calculate free cash flow.
Calculate and analyze free cash flow. (LO 4)
BE13-11 The management of Russel Ltd. is trying to decide whether it can increase its dividend. During the current year, it reported net income of €875,000. It had cash provided by operating activities of €643,000, paid cash dividends of €80,000, and had capital expenditures of €280,000. Compute the company's free cash flow, and discuss whether an increase in the dividend appears warranted. What other factors should be considered?
Indicate entries in worksheet. (LO 5)
*BE13-12 During the year, prepaid expenses decreased £6,500, and accrued expenses increased £2,000. Indicate how the changes in prepaid expenses and accrued expenses payable should be entered in the reconciling columns of a worksheet. Assume that beginning balances were prepaid expenses £18,600 and accrued expenses payable £8,200.
Compute receipts from customers—direct method. (LO 6)
*BE13-13 Columbia Sportswear Company (USA) had accounts receivable of $205,025,000 at the beginning of a recent year, and $267,653,000 at year-end. Sales revenue was $1,085,307,000 for the year. What is the amount of cash receipts from customers?
Compute cash payments for income taxes—direct method. (LO 6)
*BE13-14 Kinsey Corporation reported income taxes of $360,000,000 on its 2014 income statement, income taxes payable of $277,000,000 at December 31, 2013, and $525,000,000 at December 31, 2014. What amount of cash payments were made for income taxes during 2014?
Compute cash payments for operating expenses—direct method. (LO 6)
*BE13-15 Yaddof Corporation reports operating expenses of €70,000 excluding depreciation expense of €15,000 for 2014. During the year, prepaid expenses decreased €6,800 and accrued expenses payable increased €4,500. Compute the cash payments for operating expenses in 2014.
DO IT! REVIEW
Classify transactions by type of cash flow activity. (LO 2)
13-1 Piekarski Company had the following transactions.
Classify each of these transactions by type of cash flow activity (operating, investing, or financing).
Calculate net cash from operating activities. (LO 3)
13-2 Muniz Photography reported net income of R$100,000 for 2014. Included in the income statement were depreciation expense of R$4,000, amortization expense of R$3,000, and a gain on disposal of plant assets of R$3,900. Muniz's comparative statements of financial position are shown on the following page.
Calculate net cash provided by operating activities for Muniz Photography.
Compute and discuss free cash flow. (LO 4)
13-3 Zielinski Company issued the following statement of cash flows for 2014.
(a) Compute free cash flow for Zielinski Company. (b) Explain why free cash flow often provides better information than “Net cash provided by operating activities.”
EXERCISES
Classify transactions by type of activity. (LO 2)
E13-1 Laurent Company had these transactions during 2014.
(a) Issued CHF50,000 par value ordinary shares for cash.
(b) Purchased a machine for CHF30,000, giving a long-term note in exchange.
(c) Issued CHF200,000 par value ordinary shares upon conversion of bonds having a face value of CHF200,000.
(d) Declared and paid a cash dividend of CHF18,000.
(e) Sold a long-term investment with a cost of CHF15,000 for CHF15,000 cash.
(f) Collected CHF16,000 of accounts receivable.
(g) Paid CHF18,000 on accounts payable.
Instructions
Analyze the transactions and indicate whether each transaction resulted in a cash flow from operating activities, investing activities, financing activities, or non-cash investing and financing activities.
E13-2 An analysis of comparative statements of financial position, the current year's income statement, and the general ledger accounts of Solomon Co. 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) Receipt of dividends on investment in shares.
(g) Receipt of interest on notes receivable.
(h) Issuance of share capital—ordinary.
(i) Amortization of patent.
(j) Issuance of bonds for land.
(k) Purchase of land.
(l) Conversion of bonds into ordinary shares.
(m) Loss on sale of land.
(n) Retirement of bonds.
Instructions
Indicate how each item should be classified in the statement of cash flows using these four major classifications: operating activity (indirect method), investing activity, financing activity, and significant non-cash investing and financing activity.
Prepare journal entry and determine effect on cash flows. (LO 2)
E13-3 Tim Latimer Company had the following transactions.
Instructions
For each transaction above, (a) prepare the journal entry, and (b) indicate how it would affect the statement of cash flows under the indirect method.
Prepare the operating activities section—indirect method. (LO 3)
E13-4 Bracewell Company reported net income of $195,000 for 2014. Bracewell also reported depreciation expense of $40,000 and a gain of $5,000 on disposal of plant assets. The comparative statements of financial position show an increase in accounts receivable of $15,000 for the year, a $17,000 increase in accounts payable, and a $4,000 decrease in prepaid expenses.
Instructions
Prepare the operating activities section of the statement of cash flows for 2014. Use the indirect method.
Prepare the operating activities section—indirect method. (LO 3)
E13-5 The current sections of Nasreen Co.'s statements of financial position at December 31, 2013 and 2014, are presented here. Nasreen's net income for 2014 was €153,000. Depreciation expense was €24,000.
Instructions
Prepare the net cash provided by operating activities section of the company's statement of cash flows for the year ended December 31, 2014, using the indirect method.
E13-6 The three accounts shown below appear in the general ledger of Chaudry Co. during 2014.
Instructions
From the postings in the accounts, indicate how the information is reported on a statement of cash flows using the indirect method. The loss on disposal of plant assets was $5,000. (Hint: Cost of equipment constructed is reported in the investing activities section as a decrease in cash of $53,000.)
Prepare statement of cash flows and compute free cash flow. (LO 3, 4)
E13-7 Meera Company's comparative statements of financial position are presented below.
Additional information:
Instructions
(a) Prepare a statement of cash flows for 2014 using the indirect method.
(b) Compute free cash flow.
E13-8 Here are comparative statements of financial position for Syal Company.
Additional information:
Instructions
Prepare a statement of cash flows for 2014 using the indirect method.
Prepare statement of cash flows and compute free cash flow. (LO 3, 4)
E13-9 Cassandra Company's comparative statements of financial position are presented below.
Additional information:
Instructions
(a) Prepare a statement of cash flows for 2014 using the indirect method.
(b) Compute free cash flow.
*E13-10 Comparative statements of financial position for Erisa Magambo Company are presented below.
Additional information:
Instructions
Prepare a worksheet for a statement of cash flows for 2014 using the indirect method. Enter the reconciling items directly on the worksheet, using letters to cross-reference each entry.
Compute cash provided by operating activities—direct method. (LO 6)
*E13-11 Recife Company completed its first year of operations on December 31, 2014. Its initial income statement showed that Recife had revenues of R$195,000 and operating expenses of R$78,000. Accounts receivable and accounts payable at year-end were R$60,000 and R$25,000, respectively. Assume that accounts payable related to operating expenses. (Ignore income taxes.)
Instructions
Compute net cash provided by operating activities using the direct method.
Compute cash payments—direct method. (LO 6)
*E13-12 A recent income statement for McDonald's Corporation (USA) shows cost of goods sold $4,527.8 million and operating expenses (including depreciation expense of $1,120 million) $10,517.6 million. The comparative statements of financial position for the year show that inventory increased $17.1 million, prepaid expenses increased $65.3 million, accounts payable (merchandise suppliers) increased $139.6 million, and accrued expenses payable increased $190.6 million.
Instructions
Using the direct method, compute (a) cash payments to suppliers and (b) cash payments for operating expenses.
Compute cash flow from operating activities—direct method. (LO 6)
*E13-13 The 2014 accounting records of Liz Ten Transport reveal these transactions and events.
Payment of interest | £10,000 |
Cash sales | 50,000 |
Receipt of dividend revenue | 18,000 |
Payment of income taxes | 16,000 |
Net income | 38,000 |
Payment of accounts payable for merchandise | 115,000 |
Payment for land | 74,000 |
Collection of accounts receivable | £190,000 |
Payment of salaries and wages | 57,000 |
Depreciation expense | 16,000 |
Proceeds from disposal of plant assets | 12,000 |
Purchase of equipment for cash | 22,000 |
Loss on disposal of plant assets | 3,000 |
Payment of dividends | 14,000 |
Payment of operating expenses | 28,000 |
Prepare the cash flows from operating activities section using the direct method. (Not all of the items will be used.)
Calculate cash flows—direct method. (LO 6)
*E13-14 The following information is taken from the 2014 general ledger of Okonedo Company.
Instructions
In each case, compute the amount that should be reported in the operating activities section of the statement of cash flows under the direct method.
PROBLEMS: SET A
Distinguish among operating, investing, and financing activities. (LO 2)
P13-1A You are provided with the following transactions that took place during a recent fiscal year.
Instructions
Complete the table indicating whether each item (1) affects operating (O) activities, investing (I) activities, financing (F) activities, or is a non-cash (NC) transaction reported in a separate schedule; and (2) represents a cash inflow or cash outflow or has no cash flow effect. Assume use of the indirect approach.
Determine cash flow effects of changes in equity accounts. (LO 3)
P13-2A The following account balances relate to the equity accounts of Chipo Co. at year-end.
A small share dividend was declared and issued in 2014. The market value of the shares was $11,200. Cash dividends were $16,000 in both 2014 and 2013. The ordinary shares have no par or stated value.
(a) Net income $77,200
(a) What was the amount of net income reported by Chipo Co. in 2014?
(b) Determine the amounts of any cash inflows or outflows related to the ordinary shares and dividend accounts in 2014.
(c) Indicate where each of the cash inflows or outflows identified in (b) would be classified on the statement of cash flows.
Prepare the operating activities section—indirect method. (LO 3)
P13-3A The income statement of Toby Zed Company is presented here.
Additional information:
Instructions
Prepare the operating activities section of the statement of cash flows for the year ended November 30, 2014, for Toby Zed Company, using the indirect method.
Cash from oper. €1,215,000
Prepare the operating activities section—direct method. (LO 6)
*P13-4A Data for Toby Zed Company are presented in P13-3A.
Instructions
Prepare the operating activities section of the statement of cash flows using the direct method.
Cash from oper. €1,215,000
Prepare the operating activities section—indirect method. (LO 3)
P13-5A Rattigan Company's income statement contained the condensed information below.
Rattigan's statement of financial position contained the comparative data at December 31, shown below.
Accounts payable pertain to operating expenses.
Prepare the operating activities section of the statement of cash flows using the indirect method.
Cash from operations $311,000
Prepare the operating activities section—direct method. (LO 6)
*P13-6A Data for Rattigan Company are presented in P13-5A.
Instructions
Prepare the operating activities section of the statement of cash flows using the direct method.
Cash from oper. $311,000
Prepare a statement of cash flows—indirect method, and compute free cash flow. (LO 3, 4)
P13-7A Presented below are the financial statements of Rajesh Company.
Additional data:
Instructions
(a) Cash from operations £29,300
(a) Prepare a statement of cash flows using the indirect method.
(b) Compute free cash flow.
Prepare a statement of cash flows—direct method, and compute free cash flow. (LO 4, 6)
*P13-8A Data for Rajesh Company are presented in P13-7A. Further analysis reveals the following.
(a) Cash from operations £29,300
(a) Prepare a statement of cash flows for Rajesh Company using the direct method.
(b) Compute free cash flow.
Prepare a statement of cash flows—indirect method. (LO 3)
P13-9A Condensed financial data of Sinjh Ltd. follow.
Additional information:
Instructions
Prepare a statement of cash flows using the indirect method.
Cash from operations $184,350
Prepare a statement of cash flows—direct method. (LO 6)
*P13-10A Data for Sinjh Ltd. are presented in P13-9A. Further analysis reveals that accounts payable pertain to merchandise creditors.
Instructions
Prepare a statement of cash flows for Sinjh Ltd. using the direct method.
Cash from operations $184,350
Prepare a statement of cash flows—indirect method. (LO 3)
P13-11A The comparative statements of financial position for Amaral Reis Company as of December 31 are presented on the next page.
Additional information:
Instructions
Prepare a statement of cash flows for the year ended December 31, 2014, using the indirect method.
Cash from operations R$108,520
Prepare a worksheet—indirect method. (LO 5)
*P13-12A Condensed financial data of Jhutti Company appear below.
Additional information:
Instructions
Prepare a worksheet for the statement of cash flows using the indirect method. Enter the reconciling items directly in the worksheet columns, using letters to cross-reference each entry.
Reconciling items total $580,910
PROBLEMS: SET B
Distinguish among operating, investing, and financing activities. (LO 2)
P13-1B You are provided with the following transactions that took place during a recent fiscal year.
Instructions
Complete the table indicating whether each item (1) affects operating (O) activities, investing (I) activities, financing (F) activities, or is a non-cash (NC) transaction reported in a separate schedule; and (2) represents a cash inflow or cash outflow or has no cash flow effect. Assume use of the indirect approach.
P13-2B The following selected account balances relate to the plant asset accounts of Raji Ltd. at year-end.
Additional information:
Instructions
(a) Cash proceeds €21,000
(a) Determine the amounts of any cash inflows or outflows related to the plant asset accounts in 2014.
(b) Indicate where each of the cash inflows or outflows identified in (a) would be classified on the statement of cash flows.
Prepare the operating activities section—indirect method. (LO 3)
P13-3B The income statement of Asquith Company is presented below.
Additional information:
Instructions
Prepare the operating activities section of the statement of cash flows for the year ended December 31, 2014, for Asquith Company, using the indirect method.
Cash from operations $1,185,000
Prepare the operating activities section—direct method. (LO 6)
*P13-4B Data for Asquith Company are presented in P13-3B.
Instructions
Prepare the operating activities section of the statement of cash flows using the direct method.
Cash from operations $1,185,000
P13-5B The income statement of Anne Droid Co. reported the following condensed information.
Anne Droid's statement of financial position contained these comparative data at December 31.
Anne Droid has no depreciable assets. Accounts payable pertain to operating expenses.
Instructions
Prepare the operating activities section of the statement of cash flows using the indirect method.
Cash from operations £127,000
Prepare the operating activities section—direct method. (LO 6)
*P13-6B Data for Anne Droid Co. are presented in P13-5B.
Instructions
Prepare the operating activities section of the statement of cash flows using the direct method.
Cash from operations £127,000
Prepare a statement of cash flows—indirect method, and compute free cash flow. (LO 3, 4)
P13-7B Presented below are the financial statements of Rocastle Company.
Additional data:
Instructions
(a) Cash from operations $(5,000)
(a) Prepare a statement of cash flows using the indirect method.
(b) Compute free cash flow.
Prepare a statement of cash flows—direct method, and compute free cash flow. (LO 4, 6)
*P13-8B Data for Rocastle Company are presented in P13-7B. Further analysis reveals the following.
Instructions
(a) Cash from operations $(5,000)
(a) Prepare a statement of cash flows using the direct method.
(b) Compute free cash flow.
Prepare a statement of cash flows—indirect method. (LO 3)
P13-9B Condensed financial data of Keller Minden Company are shown below.
Additional information:
Instructions
Prepare a statement of cash flows using the indirect method.
Cash from operations €94,700
Prepare a statement of cash flows—direct method. (LO 6)
*P13-10B Data for Keller Minden Company are presented in P13-9B. Further analysis reveals that accounts payable pertain to merchandise creditors.
Instructions
Prepare a statement of cash flows for Keller Minden Company using the direct method.
Cash from operations €94,700
Prepare a statement of cash flows—indirect method. (LO 3)
P13-11B Presented below are the comparative statements of financial position for Vernet Company at December 31.
Additional information:
Instructions
Prepare a statement of cash flows for 2014 using the indirect method.
Cash from operations $75,400
(Note: This is a continuation of the Cookie Chronicle from Chapters 1–12.)
CCC13 Natalie has prepared the statement of financial position and income statement of Cookie & Coffee Creations Inc. and would like you to prepare the statement of cash flows.
Go to the book's companion website, www.wiley.com/college/weygandt, to see the completion of this problem.
Broadening Your PERSPECTIVE
Financial Reporting and Analysis
Financial Reporting Problem: Samsung Electronics Co., Ltd.
BYP13-1 Refer to the financial statements of Samsung presented in Appendix A, and answer the following questions. The complete annual report, including notes to the financial statements, is available in the Investor Relations section of the company's website at www.samsung.com.
(a) What was the amount of net cash provided by operating activities for the year ended December 31, 2010? For the year ended December 31, 2009?
(b) What was the amount of increase or decrease in cash and cash equivalents for the year ended December 31, 2010? For the year ended December 31, 2009?
(c) Which method of computing net cash provided by operating activities does Samsung use?
(d) From your analysis of the 2010 statement of cash flows, did the change in accounts and notes receivable require or provide cash? Did the change in inventories require or provide cash? Did the change in accounts payable and other current liabilities require or provide cash?
(e) What was the net outflow or inflow of cash from investing activities for the year ended December 31, 2010?
(f) What was the amount of interest paid in the year ended December 31, 2010? What was the amount of income taxes paid in the year ended December 31, 2010? (See Note 14.)
Comparative Analysis Problem: Nestlé S.A. vs Zetar plc
BYP13-2 Nestlé's financial statements are presented in Appendix B. Financial statements of Zetar are presented in Appendix C.
Instructions
(a) Based on the information contained in these financial statements, compute free cash flow for each company for the most recent fiscal year shown.
(b) What conclusions concerning the management of cash can be drawn from these data?
BYP13-3 Purpose: Learn about the U.S. Securities and Exchange Commission (SEC).
Address: www.sec.gov/index.html, or go to www.wiley.com/college/weygandt
From the SEC homepage, choose About the SEC.
Instructions
Answer the following questions.
(a) How many enforcement actions does the SEC take each year against securities law violators? What are typical infractions?
(b) After the Depression, Congress passed the Securities Acts of 1933 and 1934 to improve investor confidence in the markets. What two “common sense” notions are these laws based on?
(c) Who was the President of the United States at the time of the creation of the SEC? Who was the first SEC Chairperson?
BYP13-4 Purpose: Use the Internet to view U.S. SEC filings.
Address: biz.yahoo.com/i/ or go to www.wiley.com/college/weygandt
Steps:
Instructions
Answer the following questions.
(a) What company did you select?
(b) Which filing is the most recent? What is the date?
(c) What other recent SEC filings are available for your viewing?
Critical Thinking
Decision-Making Across the Organization
BYP13-5 Norman Roads and Sara Mesa are examining the following statement of cash flows for Del Carpio Company for the year ended January 31, 2014.
Norman claims that Del Carpio's statement of cash flows is an excellent portrayal of a superb first year with cash increasing $101,000. Sara replies that it was not a superb first year. Rather, she says, the year was an operating failure, the statement is presented incorrectly, and $101,000 is not the actual increase in cash. The cash balance at the beginning of the year was $140,000.
Instructions
With the class divided into groups, answer the following.
(a) Using the data provided, prepare a statement of cash flows in proper form using the indirect method. The only non-cash items in the income statement are depreciation and the gain from the sale of the investment.
(b) With whom do you agree, Norman or Sara? Explain your position.
Communication Activity
BYP13-6 Bart Sampson, the owner-president of Computer Services Company, is unfamiliar with the statement of cash flows that you, as his accountant, prepared. He asks for further explanation.
Instructions
Write him a brief memo explaining the form and content of the statement of cash flows as shown in Illustration 13-14 (pages 637–638).
Ethics Case
BYP13-7 Babbit Corp. is a medium-sized wholesaler of automotive parts. It has 10 shareholders 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 Babbit's current year's statement of cash flows must exceed $1 million. President and CEO Milton Williams's job is secure so long as he produces annual operating cash flows to support the usual dividend.
At the end of the current year, controller Jerry Roberts presents president Milton Williams 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 Jerry, “We must get that amount above $1 million. Isn't there some way to increase operating cash flow by another $30,000?” Jerry answers, “These figures were prepared by my assistant. I'll go back to my office and see what I can do.” The president replies, “I know you won't let me down, Jerry.”
Upon close scrutiny of the statement of cash flows, Jerry concludes that he can get the operating cash flows above $1 million by reclassifying a $60,000, 2-year note payable listed in the financing 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 flow provided by operating activities is $1,030,000.” “Good man, Jerry! I knew I could count on you,” exults the president.
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 misclassification?
Answers to Chapter Questions
Answers to Insight and Accounting Across the Organization Questions
p. 626 Net What? Q: In general, why do differences exist between net income and net cash provided by operating activities? A: The differences are explained by differences in the timing of the reporting of revenues and expenses under accrual accounting versus cash. Under accrual accounting, companies report revenues when their performance obligation is satisfied, even if cash hasn't been received, and they report expenses when incurred, even if cash hasn't been paid.
p. 635 Cash Flow Isn't Always What It Seems Q: For what reasons might managers at WorldCom and at Dynegy take the actions noted above? A: Analysts increasingly use cash flow-based measures of income, such as cash flow provided by operations, in addition to net income. More investors now focus on cash flow from operations, and some compensation contracts now have bonuses tied to cash flow numbers. Thus, some managers have taken actions that artificially increase cash flow from operations.
Answers to Self-Test Questions
1. c 2. a 3. b 4. a 5. c 6. d 7. b 8. c 9. d (£132,000 + £10,000 + £6,000 − £12,000) 10. b 11. b (HK$2,000,000 + HK$400,000 − HK$100,000 + HK$200,000 − HK$300,000) 12. a ($100,000 + $50,000 − $30,000) 13. b (€100,000 + €60,000 − €30,000) 14. a 15. c *16. b *17. b *18. c [$129,000 + ($44,000 − $42,000)] *19. d
As in IFRS, the statement of cash flows is a required statement for GAAP. In addition, the content and presentation of a GAAP statement of cash flows is similar to the one used for IFRS. However, the disclosure requirements related to the statement of cash flows are more extensive under GAAP. IAS 7 (“Cash Flow Statements”) provides the overall IFRS requirements for cash flow information.
Key Points
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 financial statements. One interesting approach, revealed in a published proposal from that project, is that in the future the income statement and statement of financial position (balance sheet) would adopt headings similar to those of the statement of cash flows. That is, the income statement and statement of financial position would be broken into operating, investing, and financing sections.
With respect to the cash flow statement specifically, the notion of cash equivalents will probably not be retained. That is, cash equivalents will not be combined with cash but instead will be reported as a form of highly liquid, low-risk investment. The definition of cash in the existing literature would be retained, and the statement of cash flows would present information on changes in cash only. In addition, the FASB favors presentation of operating cash flows using the direct method only. However, the majority of IASB members express a preference for not requiring use of the direct method of reporting operating cash flows. The two Boards will have to resolve their differences in this area in order to issue a converged standard for the statement of cash flows.
GAAP Practice
GAAP Self-Test Questions
(a) only a financing element.
(b) a financing element or an investing element.
(c) a financing element or an operating element.
(d) only an operating element.
(a) be reported in the section to which they relate, that is, a non-cash investing activity would be reported in the investing section.
(b) be disclosed in the notes to the financial statements.
(c) do not need to be reported.
(d) be treated in a fashion similar to cash equivalents.
(a) the income statement and statement of financial position (balance sheet) will have headings of operating, investing, and financing, much like the statement of cash flows.
(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 flows.
(d) None of the above.
(a) taxes are always treated as an operating item.
(b) the income statement uses the headings operating, investing, and financing.
(c) dividends received can be either an operating or investing item.
(d) dividends paid can be either an operating or investing item.
(a) Under GAAP, the statement of cash flows is optional.
(b) GAAP requires use of the direct approach in preparing the statement of cash flows.
(c) The majority of companies following GAAP and the majority following IFRS employ the indirect approach to the statement of cash flows.
(d) Cash and cash equivalents are reported as separate line items under GAAP.
GAAP Exercises
GAAP13-1 Discuss the differences that exist in the treatment of bank overdrafts under GAAP and IFRS.
GAAP13-2 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.
GAAP13-3 Explain how the treatment of cash equivalents will probably change in the future.
GAAP Financial Reporting Problem: Tootsie Roll Industries, Inc.
GAAP13-4 The financial statements of Tootsie Roll are presented in Appendix D. The company's complete annual report, including the notes to its financial statements, is available at www.tootsie.com.
Instructions
Use the company's financial statements to answer the following questions.
(a) What was the amount of net cash provided by operating activities for 2010? For 2009?
(b) What was the amount of increase or decrease in cash and cash equivalents for the year ended December 31, 2010?
(c) Which method of computing net cash provided by operating activities does Tootsie Roll use?
(d) From your analysis of the 2010 statement of cash flows, 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 2010?
(f) What was the amount of interest paid in 2010? What was the amount of income taxes paid in 2010?
Answers to GAAP Self-Test Questions
1. d 2. b 3. a 4. a 5. c
Remember to go back to The Navigator box on the chapter opening page and check off your completed work.
1IFRS allows companies some flexibility regarding the classification of certain items. Interest and dividends paid can be classified as either operating or financing, depending on what treatment the company thinks is most appropriate. Similarly, interest and dividends received can be classified as either operating or investing. Taxes paid are classified as operating except in circumstances where they can be identified with specific investing or financing activities. In order to limit the complexity of our presentation and to avoid ambiguity in assignment material, in Illustration 13-1 we have identified specific treatment for each of these items rather than allowing choices. All assignment and testing material is based on this treatment.