CHAPTER 16

the cash flow statement

Summary of Questions by STUDY Objectives
and Bloom’s Taxonomy

Note: AN = Analysis AP = Application E = Evaluation

summary of questions by level of difficulty (lod)

Note: E = Easy M = Medium H=Hard

CHAPTER STUDY OBJECTIVES

1. Describe the purpose and content of the cash flow statement. The cash flow statement gives information about the cash receipts and cash payments resulting from a company’s operating, investing, and financing activities during the period.

In general, operating activities include the cash effects of transactions that affect profit. Investing activities generally include cash flows resulting from changes in long-term asset items. Financing activities generally include cash flows resulting from changes in long-term liability and shareholders’ equity items.

2. Prepare a cash flow statement using either the indirect or the direct method. There are four steps to prepare a cash flow statement: (1) Determine the net cash provided (used) by operating activities. In the indirect method, this is done by converting profit from an accrual basis to a cash basis. In the direct method, this is done by converting each revenue and expense from an accrual basis to a cash basis. (2) Analyze the changes in long-term asset accounts and record them as investing activities, or as significant noncash transactions. (3) Analyze the changes in long-term liability and equity accounts and record them as financing activities, or as significant noncash transactions. (4) Prepare the cash flow statement and determine the net increase or decrease in cash.

3. Analyze the cash flow statement. The cash flow statement must be read along with the other financial statements in order to adequately assess a company’s financial position. In addition, it is important to understand how the net change in cash is affected by each type of activity—operating, investing, and financing—especially when different companies are being compared. Free cash flow is a measure of solvency: it indicates how much of the cash that was generated from operating activities during the current year is available after making necessary payments for capital expenditures. It is calculated by subtracting the cash used by investing activities from the cash provided by operating activities.

Exercises

Exercise 1

Selected transactions of Sternberg, a private corporation, reporting under ASPE, are listed below:

1. Common shares are sold for cash.

2. Bonds payable are issued for cash at a discount.

3. Interest receivable on a short-term note receivable is collected.

4. Merchandise is sold to customers for cash.

5. Accounts payable are paid in cash.

6. Equipment is purchased by signing a 3-year, 6% note payable.

7. Cash dividends on common shares are declared and paid.

8. 100 shares of XYZ common shares are purchased for cash.

9. Land is sold for cash at carrying amount.

10. Bonds payable are converted into common shares.

Instructions

Classify each transaction as either

a. an operating activity,

b. an investing activity,

c. a financing activity, or

d. a noncash investing and financing activity.

Exercise 2

Grand Investments Inc., a public corporation, had the following transactions:

Instructions

Complete the above table (as demonstrated by item 1) indicating:

a. Whether each transaction should be classified as an Operating (O), Investing (I) or Financing (F) activity; and

b. The amount of cash inflow (+), outflow (–) or if it has no effect on cash (NE).

Exercise 3

Assuming a cash flow statement is prepared using the indirect method, indicate the reporting of the transactions and events listed below by major categories on the statement. Use the following code letters to indicate the appropriate category under which the item would appear on the cash flow statement.

Code

Cash flows from operating activities

A Add to profit

D Deduct from profit

IA Cash flows from investing activities

FA Cash flows from financing activities

Category

1. Common shares are issued for cash.

2. Merchandise inventory increased during the period.

3. Depreciation expense recorded for the period.

4. Building was purchased for cash.

5. Bonds payable were acquired and retired at their carrying value.

6. Accounts payable decreased during the period.

7. Prepaid expenses decreased during the period.

8. Investment in common shares of another company were acquired for

cash.

9. Land is sold for cash at an amount equal to carrying amount.

Exercise 4

Nevada Steamships Inc. reported retained earnings of $463,600 at June 30, 2015, its most recent year end. On July 1, 2014, the opening retained earnings had been $475,000. During the year, ended June 30, 2015, Nevada declared stock dividends on common shares and cash dividends on preferred shares. The stock dividends resulted in a reduction of retained earnings of $200,000. Profit for the year was $225,000 and total comprehensive income was $248,500.

Instructions

Calculate the amount of cash dividends on the preferred shares.

Exercise 5

Killarney Holdings Ltd’s comparative balance sheet at December 31, 2014 is presented below. Killarney’s profit for the year was $88,510. Land was acquired for future expansion. Equipment and a long-term investment were purchased during the year, but none were sold. Dividends were paid to the common shareholders.

KILLARNEY HOLDINGS LTD.

Balance Sheet

December 31, 2014

2014 2013

Assets

Cash $ 148,220 $ 65,000

Accounts receivable 82,100 68,900

Prepaid expenses 8,300 6,300

Land 50,000 –

Building and equipment 72,000 60,000

Less: accumulated depreciation (17,000) (12,000)

Long term investment 14,000 –

Total assets $357,620 $188,200

Liabilities and Shareholders' Equity

Accounts payable $ 47,000 $ 52,900

Interest payable 250 –

Salaries payable 510 950

Long-term debt 108,000 16,000

Common shares 10,000 10,000

Retained earnings 191,860 108,350

Total liabilities and shareholders' equity $357,620 $188,200

Instructions

a. Determine cash flow provided (used) by operating activities. Show all calculations.

b. Determine cash flow provided (used) by investing activities. Show all calculations.

c. Determine cash flow provided (used) by financing activities. Show all calculations.

Exercise 6

Prince Incorporated reported profit of $250,000 for the current year. Depreciation recorded on buildings and equipment amounted to $80,000 for the year. Balances of the current asset and current liability accounts at the beginning and end of the year are as follows:

End of Year Beginning of Year

Cash $20,000 $15,000

Accounts receivable 19,000 32,000

Inventories 50,000 65,000

Prepaid expenses 7,500 5,000

Accounts payable 12,000 18,000

Income taxes payable 1,600 1,200

Instructions

Prepare the operating activities section of the cash flow statement, using the indirect method.

Exercise 7

Continental Merchandising Inc.’s current assets and liabilities at December 31, 2014 are as follows:

Continental had profit of $83,500 in 2014. Included in the calculation of profit is depreciation of building and equipment in the amount of $45,000 and amortization of a patent in the amount of $1,000.

Instructions

Prepare the operating section of Continental’s cash flow statement for the year ended December 31, 2014, using the indirect method.

Exercise 8

Upshaw Corporation prepared the tabulation below for the current year:

Profit $400,000

Adjustments to reconcile profit to net cash provided by operating activities:

Depreciation expense, $35,000

Increase in accounts receivable, $80,000

Decrease in inventory, $13,000

Loss on sale of equipment, $4,000

Increase in accounts payable, $5,600

Decrease in interest receivable, $4,000

Increase in prepaid expenses, $6,000

Decrease in income taxes payable, $1,500

Gain on sale of land, $5,000

Net cash provided (used) by operating activities

Instructions

Show how each item should be reported in the cash flow statement and the total cash provided (used) by operating activities prepared using the indirect method. Use parentheses for deductions.

Exercise 9

The comparative balance sheets for Kessler Corporation appear below:

KESSLER CORPORATION

Comparative Balance Sheet

Dec. 31, 2014 Dec. 31, 2013

Assets

Cash $ 23,000 $12,000

Accounts receivable 18,000 14,000

Prepaid expenses 6,000 9,000

Inventory 27,000 18,000

Long-term investment in bonds -0- 18,000

Equipment 60,000 30,000

Accumulated depreciation—equipment (18,000) (14,000)

Total assets $116,000 $87,000

Liabilities and Shareholders' Equity

Accounts payable $ 21,000 $ 9,000

Bonds payable 37,000 45,000

Common shares 40,000 23,000

Retained earnings 18,000 10,000

Total liabilities and shareholders' equity $116,000 $87,000

Additional information:

1. Profit for the year ending December 31, 2014 was $20,000.

2. Cash dividends of $12,000 were declared and paid during the year.

3. Long-term investments in bonds that had an amortized cost of $18,000 were sold for $16,000.

Instructions

Prepare a cash flow statement for the year ended December 31, 2014, using the indirect method.

Exercise 10

The following information is available for Malson Corporation for the year ended December 31, 2014:

Collection of principal on long-term loan to a supplier $40,000

Acquisition of equipment for cash 15,000

Proceeds from the redemption of long-term investment at carrying value 27,000

Issue of common shares for cash 25,000

Depreciation expense 25,000

Redemption of bonds payable at amortized cost 24,000

Payment of cash dividends 14,000

Profit 30,000

Purchase of land by issuing bonds payable 40,000

In addition, the following information is available from the comparative balance sheet for Malson at the end of 2013 and 2014:

2014 2013

Cash $102,000 $14,000

Accounts receivable (net) 20,000 15,000

Prepaid insurance 17,000 13,000

Total current assets $139,000 $42,000

Accounts payable $ 25,000 $19,000

Salaries payable 4,000 7,000

Total current liabilities $ 29,000 $26,000

Instructions

Prepare Malson's cash flow statement for the year ended December 31, 2014, using the indirect method.

Exercise 11

The Fisheries Processing Corporation prepared the following income statement and comparative balance sheet for 2014:

FISHERIES PROCESSING CORPORATION

Income Statement

Year Ended December 31, 2014

Sales $1,800,000

Cost of goods sold 880,000

Gross profit 920,000

Depreciation expense 227,000

Other operating expenses 197,000

Interest expense 160,000

Loss on sale of land 125,000

Income before taxes 211,000

Income taxes 70,800

Profit $ 140,200

FISHERIES PROCESSING CORPORATION

Comparative Balance Sheet

2014 2013

Assets

Cash $385,200 $200,000

Accounts receivable 180,000 350,000

Merchandise inventory 2,336,000 2,090,000

Property, plant, and equipment 1,340,000 1,120,000

Less: Accumulated depreciation (787,000) (560,000)

Goodwill 219,000 219,000

Total Assets $3,673,200 $3,419,000

Liabilities and Shareholders' Equity

Accounts payable $389,000 $265,000

Other accrued payables 160,000 240,000

Dividends payable 80,000 80,000

Income taxes payable 27,000 42,000

Note payable (long-term) 180,000 560,000

Bonds payable 900,000 400,000

Common shares 1,600,000 1,600,000

Retained earnings 337,200 232,000

Total Liabilities & Shareholders' Equity $3,673,200 $3,419,000

Additional data:

1. Equipment was purchased for $545,000.

2. Land was sold for cash proceeds of $200,000.

3. The company sold bonds of $500,000 and made $380,000 of principal payments on notes payable.

Instructions

Prepare a cash flow statement for 2014, using the indirect method.

Exercise 12

A comparative balance sheet for Debits Corporation is presented below:

DEBITS CORPORATION

Comparative Balance Sheet

2014 2013

Assets

Cash $ 19,000 $ 14,000

Accounts receivable (net) 80,000 60,000

Inventory 20,000 24,000

Prepaid insurance 22,000 10,000

Land 18,000 40,000

Equipment 70,000 60,000

Accumulated depreciation (20,000) (13,000)

Total Assets $209,000 $195,000

Liabilities and Shareholders' Equity

Accounts payable $ 11,000 $ 6,000

Bonds payable 27,000 19,000

Common shares 140,000 115,000

Retained earnings 31,000 55,000

Total liabilities and shareholders' equity $209,000 $195,000

Additional information:

1. Loss for 2014 is $20,000.

2. Cash dividends of $4,000 were declared and paid in 2014.

3. Land was sold for cash at a loss of $10,000. This was the only land transaction during the year.

4. Equipment with a cost of $15,000 and accumulated depreciation of $10,000 was sold for $5,000 cash.

5. $12,000 of bonds were retired during the year at carrying value.

6. Equipment was acquired for common shares. The fair value of the equipment at the time of the exchange was $25,000.

Instructions

Prepare a cash flow statement for the year ended 2014, using the indirect method.

Exercise 13

Patton Industries Ltd.’s 2014 single step income statement and comparative balance sheet are provided below:

PATTON INDUSTRIES LTD.

Income Statement

Year Ended December 31, 2014

Revenue $920,000

Expenses

Cost of goods sold $ 493,500

Salaries 189,000

Depreciation expense 25,000

Other operating expenses 73,500

Interest expense 13,000

Income taxes 18,000 812,000

Profit $108,000

PATTON INDUSTRIES LTD.

Balance Sheet

December 31, 2014

2014 2013

Assets

Cash $ 14,000 $ 10,000

Accounts receivable 29,000 24,000

Inventory 13,500 17,000

Prepaid expenses 2,000 2,000

Land 250,000 250,000

Building and equipment 497,000 422,000

Accumulated depreciation (150,000) (125,000)

Total assets $ 655,500 $ 600,000

Liabilities and Shareholders' Equity

Accounts payable $ 25,900 $ 22,400

Taxes payable 1,000 3,000

Interest payable 1,500 2,500

Salaries payable 8,000 5,000

Long-term debt 234,000 260,000

Common shares 120,000 100,000

Retained earnings 265,100 207,100

Total liabilities and shareholders' equity $ 655,500 $ 600,000

Additional information:

1. No new long-term debt was taken during the year.

2. New equipment was purchased, and none was sold.

3. Common shares were issued for cash.

4. Cash dividends were paid to common shareholders.

Instructions

Prepare the cash flow statement for 2014, using the indirect method.

Exercise 14

Lazarus Ltd. had total operating expenses of $120,000 in 2014, which included depreciation expense of $20,000. Also, during 2014, prepaid expenses increased by $5,000 and accrued liabilities decreased by $6,700.

Instructions

Calculate the amount of cash payments for operating expenses in 2014, using the direct method.

Exercise 15

The general ledger of Hubert Corporation provides the following information:

End of Year Beginning of Year

Accounts Receivable $125,000 $ 94,000

Inventory 280,000 210,000

Accounts Payable 130,000 65,000

The company's net sales for the year were $2,850,000 and cost of goods sold amounted to $1,650,000.

Instructions

Calculate the following:

a. Cash receipts from customers.

b. Cash payments to suppliers.

Exercise 16

The following information has been gathered by the accountant for Sangsters’ Clothing Ltd.:

Information related to sales and customers:

Credit sales made in the year $200,000

Cash sales in the year 19,500

Accounts receivable, beginning 8,200

Accounts receivable, ending 9,900

Information related to merchandise:

Cost of goods sold $71,000

Inventory, beginning 2,500

Inventory, ending 5,400

Accounts payable to suppliers, beginning 3,800

Accounts payable to suppliers, ending 3,100

Information related to employees:

Salaries expense reported $40,000

Vacation pay expense reported 2,600

Accrued salaries payable, beginning 1,750

Accrued salaries payable, ending 1,800

Accrued vacation pay payable, beginning 0

Accrued vacation pay payable, ending 800

Instructions

a. Determine cash received from customers.

b. Determine cash paid to suppliers.

c. Determine cash paid to employees.

Exercise 17

The income statement of Meaney Inc. for the year ended December 31, 2014, reported the following condensed information:

Service revenue 600,000

Operating expenses 360,000

Profit from operations 240,000

Income tax expense 60,000

Profit $180,000

Meaney's balance sheet contained the following comparative data at December 31:

2014 2013

Accounts receivable $50,000 $65,000

Accounts payable 35,000 30,000

Income taxes payable 1,000 3,000

Meaney has no depreciable assets. Accounts payable pertains to operating expenses.

Instructions

Prepare the operating activities section of the cash flow statement, using the direct method.

Exercise 18

The income statement of Stewart Limited is shown below:

STEWART LIMITED

Income Statement

Year Ended December 31, 2014

Sales $9,000,000

Cost of goods sold 5,400,000

Gross profit 3,600,000

Operating expenses

Selling and administrative expenses $1,400,000

Depreciation expense 120,000 1,520,000

Profit $2,080,000

Additional information:

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

2. Inventory decreased $175,000 during the year.

3. Prepaid expenses increased $200,000 during the year.

4. Accounts payable to merchandise suppliers increased $160,000 during the year.

5. Accrued expenses payable increased $120,000 during the year.

Instructions

Prepare the operating activities section of the cash flow statement for the year ended December 31, 2014, for Stewart Limited, using the direct method.

Exercise 19

During 2014, McBride Distributors Inc. had the following transactions and events:

Accounts payable paid $ 199,300

Accounts receivables collected 479,700

Depreciation expense 13,500

Cash, January 1, 2014 82,000

Cash, December 31, 2014 23,500

Cash sales 90,000

Interest paid on mortgage payable 16,000

Income taxes paid 4,800

Inventory purchased on credit 207,400

Issued a long-term note payable 240,000

Profit for the year 82,200

Operating expenses paid 72,000

Principal payments made on mortgage payable 8,500

Proceeds on sale of used equipment 2,500

Purchased a new building 384,000

Salaries and wages paid 186,100

Signed operating lease, annual payments will be 45,000

Stock dividend declared 46,000

Instructions

Prepare McBride’s cash flow statement for the year ended December 31, 2014, using the direct method.

Exercise 20

Willets Wholesale Corp.’s 2014 single step income statement and comparative balance sheet are provided below:

WILLETS WHOLESALE CORP.

Income Statement

Year Ended December 31, 2014

Revenue $ 920,000

Expenses

Cost of goods sold $ 493,500

Salaries 189,000

Other operating expense 73,500

Depreciation expense 25,000

Interest 13,000

Income taxes 18,000 812,000

Profit $ 108,000

WILLETS WHOLESALE CORP.

Balance Sheet

December 31, 2014

2014 2013

Assets

Cash $ 14,000 $ 10,000

Accounts receivable 29,000 24,000

Inventory 13,500 17,000

Prepaid expenses 2,000 2,000

Land 250,000 250,000

Building and equipment – cost 497,000 422,000

Accumulated depreciation (150,000) (125,000)

Total assets $ 655,500 $ 600,000

Liabilities and Shareholders' Equity

Accounts payable $ 25,900 $ 22,400

Taxes payable 1,000 3,000

Interest payable 1,500 2,500

Salaries payable 8,000 5,000

Long-term debt 234,000 260,000

Common shares 120,000 100,000

Retained earnings 265,100 207,100

Total liabilities and shareholders' equity $ 655,500 $ 600,000

Additional information:

1. No new long-term debt was taken during the year.

2. New equipment was purchased, and none was sold.

3. Common shares were issued for cash.

4. Cash dividends were paid to common shareholders.

5. All operating expenses were paid in the period incurred.

Instructions

Prepare the cash flow statement for 2014, using the direct method.

Exercise 21

The financial statements of Granger Inc. appear below:

GRANGER INC.

Comparative Balance Sheet

December 31

2014 2013

Assets

Cash $ 27,000 $ 23,000

Accounts receivable 31,000 34,000

Merchandise inventory 32,000 15,000

Property, plant, and equipment 50,000 78,000

Accumulated depreciation (20,000) (24,000)

Total $120,000 $126,000

Liabilities and Shareholders' Equity

Accounts payable $ 20,000 $ 23,000

Income taxes payable 10,000 8,000

Bonds payable 7,000 33,000

Common shares, 10,000 shares issued 39,000 24,000

Retained earnings 44,000 38,000

Total $120,000 $126,000

GRANGER INC.

Income Statement

Year Ended December 31, 2014

Sales $470,000

Cost of goods sold 400,000

Gross profit 70,000

Operating expenses 36,000

Profit from operations 34,000

Interest expense 4,000

Profit before income taxes 30,000

Income tax expense 10,000

Profit $ 20,000

The following additional data were provided:

1. Dividends declared and paid were $14,000.

2. During the year, equipment was sold for $12,000 cash. This equipment cost $28,000 originally and had a carrying amount of $12,000 at the time of sale.

3. All depreciation expense is in the operating expenses category.

4. All sales and purchases are on account.

5. Accounts payable pertain to merchandise suppliers.

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

Instructions

a. Prepare a cash flow statement for Granger Inc., using the direct method.

b. Calculate free cash flow.

Exercise 22

Condensed financial data of Shannon Corporation appear below:

SHANNON CORPORATION

Comparative Balance Sheet

December 31

2014 2013

Assets

Cash $ 82,000 $ 35,000

Accounts receivable 25,000 53,000

Inventories 180,000 132,000

Prepaid expenses 19,000 25,000

Investments 90,000 75,000

Property, plant, and equipment 310,000 250,000

Accumulated depreciation (65,000) (60,000)

Total $641,000 $510,000

Liabilities and Shareholders' Equity

Accounts payable $ 93,000 $ 75,000

Accrued expenses payable 19,000 24,000

Bonds payable 140,000 160,000

Common shares, 100,000 shares issued 245,000 170,000

Retained earnings 144,000 81,000

Total $641,000 $510,000

SHANNON CORPORATION

Income Statement

Year Ended December 31, 2014

Sales $490,000

Less:

Cost of goods sold $290,000

Operating expenses (excluding depreciation) 60,000

Depreciation expense 17,000

Income taxes 15,000

Interest expense 18,000

Loss on sale of equipment 3,000 403,000

Profit $ 87,000

Additional information:

1. New equipment costing $85,000 was purchased for cash in 2014.

2. Old equipment costing $25,000 was sold for $10,000 cash when carrying amount was $13,000.

3. Bonds with a face value of $20,000 were converted into $20,000 of common shares.

4. A cash dividend of $24,000 was declared and paid during the year.

5. Accounts payable pertain to merchandise purchases.

Instructions

a. Prepare a cash flow statement for the year, using the direct method.

b. Calculate free cash flow.

Exercise 23

The following information is taken from the cash flow statements for two competing companies in the same industry, one of which is approximately 10 times larger than the other:

Instructions

Which company do you believe is in better financial condition? Which company appears to be in a growth phase, and which is not growing? Explain the basis for your conclusions.

Exercise 24

The following information is taken from the financial statements for two competing companies in the same industry:

Instructions

Calculate the free cash flow for each company. Explain the significance of this figure in evaluating the relative financial strength of the two companies.

Exercise 25

For the years ended December 31, 2015, and 2014, Janelle Corporation reported the following selected information in its financial statements:

Instructions

a. Calculate free cash flow for 2015 and 2014.

b. How is it possible that Janelle Corporation can have cash provided by operating activities of $400,000 for 2015 and only report profit of $154,000?

c. Comment on the changes in free cash flow from 2014 to 2015 and suggest how the company might improve its free cash flow in the future.