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Financial Reporting and Analysis

Chapter 4 Solutions
Structure of the Balance Sheet and Statement of Cash Flows
Exercises
Exercises
E4-1. Determining collections on account
(AICPA adapted)
Cash receipts from sales include cash sales plus collections on account
computed as follows:
Cash sales
Beginning accounts receivable
Credit sales
Less: Ending accounts receivable
Total Cash receipts from sales

$ 200,000
400,000
3,000,000
__(485,000)
$3,115,000

Alternative Solution: T-account analysis of accounts receivable


Beginning balance
Sales on account
Ending balance

Accounts Receivable
$ 400,000
X
Collections on account
3,000,000
$ 485,000

$485,000 = $400,000 + $3,000,000 X


X = $2,915,000
Total cash receipts from sales:
Cash sales
Collections on accounts receivable
Total cash collected on sales

$ 200,000
_2,915,000
$3,115,000

E4-2. Determining cash from operations


(AICPA adapted)
Cash flows from operations:
Cash received from customers
Rent received
Taxes paid
Cash paid to employees and suppliers
Cash flows from operations

$870,000
10,000
(110,000)
(510,000)
$260,000

Notice that cash dividends paid arises from the issuance of stock, a financing
activity, and thus is not included in cash flows from operations.

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E4-3. Determining cash collections on account


(AICPA adapted)
The provision for bad debts and write-off for uncollectible credit sales are
non-cash expenses so they do not enter into the computation of cash
receipts. To compute cash receipts, we need only sum the cash collected
in May, as follows:
Collections of May credit sales (est.) 20% of $200,000 =
Collections of April credit sales (est.) 70% of $150,000 =
Collections of pre-April credit sales
Total cash receipts from accounts receivable in May

$ 40,000
105,000
12,000
$157,000

E4-4. Determining ending accounts receivable


(AICPA adapted)
This problem tests students understanding of the interrelationships between
various balance sheet and income statement accounts.
To solve for the ending accounts receivable (A/R) balance, one needs to
determine both sales on account (debit to A/R) and total purchases from an
analysis of accounts payable. Once these two amounts are determined, one
can conduct an analysis of the A/R T-account to deduce the ending A/R
balance.
Step 1: To determine sales on account, one must first determine cost of
goods sold as follows:
+
=
=
1

Beginning inventory (given)


Purchases1
Total cost of goods available for sale
Ending inventory (given)
Cost of goods sold

-0$240,000
240,000
(60,000)
$180,000

Total purchases is determined from T-account analysis of accounts payable.

Accounts Payable
-0Payments on account (given) $200,000
X
$40,000

Beginning balance
Solve for: Purchases on account
Ending balance

X = $240,000 for purchases


Step 2:

Sales on account = 130% of cost of goods sold


$234,000 = 1.3 $180,000
4-2

Step 3: T-account analysis of accounts receivable to deduce ending


balance:
Beginning balance
Sales on account (step 2)
Solve for: Ending balance

Accounts Receivable
$0
$170,000 Collections on account (given)
234,000
X

X = $234,000 - $170,000
= $64,000 Ending balance of A/R.
E4-5. Determining cash disbursements
(AICPA adapted)
To answer this question, one needs to first determine the accrual basis
expenses and then (1) subtract from this figure expenses not paid in cash;
and (2) add amounts paid out in cash not recorded as accrual expenses.
Total accrual basis expenses:
Cost of goods sold = 70% of sales
= 70% $700,000
Selling, general, & administrative expense
Fixed portion
Variable portion
= 15% of sales
= 15% $700,000
Total accrual basis expenses
Subtract: Noncash expenses
Depreciation expense
Charge for uncollectible accounts (1% x $700,000)
Add: Increase in inventory which represents a net
noncash deduction in determining cost of goods sold
(see below)
Total cash disbursements for June

$490,000
71,000
_105,000
$666,000
(40,000)
(7,000)
__10,000
$629,000

Cost of Goods Sold


Beginning Inventory
+ Purchases

- Ending Inventory increase by $10,000


= Cost of Goods Sold

If inventory increases by $10,000, this means that the non-cash subtraction


from cost of goods sold was bigger than the non-cash addition. Therefore, we
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need to add this inventory increase to the accrual basis expenses to get
cash basis expenses.
E4-6. Determining cash collections on account
(AICPA adapted)
Cash collected from customers can be determined by finding the change in
accounts receivable.
Beginning accounts receivable
Sales
Ending accounts receivable
Cash collections from customers for 2001

$ 21,600
438,000
__(30,400)
$429,200

Notice that no accounts were written off during the year so there was no
credit to accounts receivable for the $1,000 uncollectible accounts.
E4-7. Determining cash received from customers
(AICPA adapted)
Collections from customers equal sales revenue minus the increase in
accounts receivable, or $70,000 ($75,000 - $5,000).
E4-8. Determining cash from operations and reconciling with accrual net
income (CW)
Requirement 1:
Cash provided by operating activities:
Net income

$100,000

Noncash expenses:
Depreciation

_30,000
130,000

Changes in working capital accounts:


Increase in accounts receivable
Decrease in inventories
Increase in prepaid expenses
Decrease in accounts payable
Increase in salaries payable
Decrease in other current liabilities
Cash provided by operating activities

4-4

(110,000)
50,000
(15,000)
(150,000)
15,000
_(70,000)
(280,000)
($150,000)

Requirement 2:
Net income is $100,000, yet cash used by operating activities is ($150,000).
There are several reasons for the difference. Accounts receivable increased
by $110,000 (i.e., not all of the sales reported in the 2001 income statement
were collected in cash in 2001). Inventories decreased by $50,000 (i.e., part
of the cost of goods sold appearing in the 2001 income statement consists of
inventory that was paid for in an earlier year (i.e., 2000). Accounts payable
decreased by $150,000 (i.e., the firm paid cash for all of its 2001 purchases
of merchandise from suppliers, as well as $150,000 for purchases made in
2000). Other current liabilities decreased by $70,000 (i.e., the firm paid cash
for the various operating expenses it incurred in 2001 as well as $70,000 of
operating expenses that were incurred, but not paid in cash in 2000). The
changes in the prepaid expenses and the salaries payable accounts, along
with the depreciation expense, explain the remaining difference between the
firms net income and its cash flow from operating activities.
Note: This problem demonstrates that a firm can be profitable under the
accrual basis even though it does not generate positive cash flow from
operating activities.
E4-9. Determining cash from operations and reconciling with accrual net
income (CW)
Requirement 1:
Cash provided by operating activities:
Net income (loss)

($200,000)

Noncash expenses:
Depreciation

__50,000
(150,000)

Changes in working capital accounts:


Decrease in accounts receivable
Increase in inventories
Increase in other current assets
Increase in accounts payable
Decrease in accrued payables
Increase in interest payable
Cash provided by operating activities

4-5

140,000
(25,000)
(10,000)
120,000
(25,000)
__50,000
_250,000
$100,000

Requirement 2:
Net income (loss) is ($200,000), yet cash provided by operating activities is
a positive $100,000. There are several reasons for the difference. Accounts
receivable decreased by $140,000 (i.e., the firm collected all of 2001s sales
in cash as well as some of the sales made in 2000, but not collected in
2000). Inventories increased by $25,000 (i.e., the acquisition of merchandise
inventory in 2001 exceeded the amount reported in the income statement for
cost of goods sold). Accounts payable increased by $120,000 (i.e., the firm
did not pay for all of the merchandise purchases made from suppliers during
2001, thus the amount reported in the income statement for cost of goods
sold is an overstatement of cash payments for purchases in 2001). Interest
payable increased by $50,000 (i.e., the amount of interest paid in cash in
2001 is less than the amount of interest expense reported in the firms 2001
income statement). The changes in the other current assets and accrued
payables accounts, along with the depreciation expense explain the
remaining difference between the firms net income and its cash flow from
operating activities.
Note: This problem demonstrates that a firm can be unprofitable under the
accrual basis even though it generates positive cash flow from operating
activities.

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E4-10. Determining amounts shown on statement of cash flows


Treatment in Statement of Cash Flows
Cost of goods sold
Acquisitions of property, plant,
and equipment
Decrease in inventories
Repayments of obligations under
long-term lease obligations
Decrease in salaries payable
Gain on sale of land
Increase in receivables
Purchases of long-term investment
securities
Repayments of long-term borrowings
Increase in accrued payables
Proceeds from short-term borrowings
Decrease in accounts payable
Sales of property, plant,
and equipment
Proceeds from the sale of long-term
borrowings
Proceeds from sales of long-term
investment securities
Decrease in other current assets
Purchases of common stock
for treasury
Increase in prepaid expenses
Dividends paid
Sales
Depreciation and amortization
Repayments of shorter-term
borrowings
Increase in current assets
Proceeds from the exercise of
executive stock options

4-7

Not part of the cash flow statement


Cash flows from investing activities
Cash flows from operating activities
Cash flows from financing activities
Cash flows from operating activities
Cash flows from operating activities
Cash flows from operating activities
Cash flows
Cash flows
Cash flows
Cash flows
Cash flows

from investing activities


from financing activities
from operating activities
from financing activities
from operating activities

Cash flows from investing activities


Cash flows from financing activities
Cash flows from investing activities
Cash flows from operating activities
Cash flows from financing activities
Cash flows from operating activities
Cash flows from financing activities
Not part of the cash flow statement
Cash flows from operating activities
Cash flows from financing activities
Cash flows from operating activities
Cash flows from financing activities

Financial Reporting and Analysis


Chapter 4 Solutions
Structure of the Balance Sheet and Statement of Cash Flows
Problems
Problems
P4-1. Preparing income statement and statement of cash flows
Requirement 1:
Accrual Accounting
Sales revenue

$115,000

Cash Flow Accounting


Cash collected from
customers

$115,000
-85,000

- Cost of goods sold


Net income

-90,000
$25,000

- Cash paid to suppliers


Cash flow from
operations

$30,000

Computation of cash flow from operations under the indirect method:


Net income (sales - cost of goods sold)
Increase in inventory
+ Increase in accounts payable
Cash flow from operations (sales - cash paid to suppliers)

$25,000
(10,000)
_15,000
$30,000

Requirement 2:
Since all sales are cash sales, sales revenue equals cash collected from
customers. Consequently, the adjustments made for changes in inventory and
accounts payable must convert the accrual accounting expense of cost of
goods sold to its cash flow counterpart, i.e., cash paid to suppliers. The
following table illustrates that adjusting for change in inventory converts cost
of goods sold to cost of purchases, and further adjusting for change in
accounts payable converts the cost of purchases to cash paid to suppliers.

4-8

Computation of Cash Flow from Operations under the Direct Method


Sales (= cash from customers)
$115,000
Cost of goods sold
-$90,000
- Increase in inventory
-10,000
Cost of purchases
-100,000
+ Increase in accounts payable
+15,000
Cash paid to suppliers
-85,000
Cash flow from operations
$ 30,000

P4-2. Explaining differences between cash flow from operations and accrual
net income
(CFA adapted)
Requirement 1:
Net income reflects (1) accrual accounting, (2) estimates of certain
expenses, (3) and management discretion in certain items.
Net income is not necessarily correlated to cash flows from operations
because of accrual accounting. The recording of revenues when earned, and
not received in the form of cash, and the recording of expenses in one period,
but actually paid in another, are examples of how accrual accounting can
result in net income figures that have no correlation to cash flows from
operations. Charges for noncash items (depreciation expense and
amortization of goodwill) will affect net income but have no effect on cash flows
from operations.
Estimates for items such as bad debts expense, depreciation expense and
the amortization of intangible assets are largely up to management to
determine. These items all lower net income but have no effect on cash flows
from operations. Examples include: restructuring of debt, gains and losses on
the sale of assets, discontinued operations, extraordinary items, and
changes in accounting principles. All of these items affect net income, but not
cash flows from operations.
Requirement 2:
The cash flow from operations (CFO) focuses on the liquidity aspect of
operations and not on measuring the profitability. If used as a measure of
performance, the CFO is less subject to distortion than the net income figure.
Analysts use the CFO as a check on the quality of earnings. The CFO then
is acting as a check on the reported net earnings figure but not as a
substitute for net earnings. Firms with high net earnings and low CFO may be
using income recognition techniques that are suspect. The ability for a firm to
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generate CFO on a consistent basis is an indication of the financial health of


the firm. For most firms, CFO is the lifeblood of the firm. Analysts search for
trends in CFO to indicate future cash conditions and the potential for cash
flow troubles.
P4-3. Common-size financial statements
Company C has a high amount of its assets in cash and marketable
securities. It has no accounts receivable and the smallest proportion of
property, plant and equipment (PP&E). In addition, it is the only organization
with a deficit in retained earnings. The lack of inventory, accounts receivable
and small amount of PP&E rules out Alcoa as a possibility. Moreover, one
would expect Delta or Wendy's to have significantly more fixed assets, which
suggests that Company C is Amazon.Com. This can be confirmed when we
realize that Amazon.Com is a relatively new company that has yet to post
positive earnings, resulting in a retained earnings deficit.
Companies A, B and D all have accounts receivable; however, Company As
balance is considerably higher than Companies Bs or Ds receivable
balance. Company As accounts receivable balances are more in line with a
manufacturing firm that would be selling its product on credit. Whereas
Companies B and D appear to sell their products primarily for cash or by
accepting third party credit cards (Visa, Mastercharge). This denotes that
Alcoa is Company A. In addition, Company As higher inventory levels would
be required to meet manufacturing operations and seems to further suggest
that this is Alcoa.
Companies B and D both have balances consistent with organizations that
have high cash or third party credit card sales. Both companies have fairly
large PP&E balances, which appear to be consistent with the capital
requirements of major airlines or a chain of fast-food restaurants. However,
Company B has more than double the long-term liabilities of Company D. This
would be consistent with an airline that acquires its flight equipment through
the use of capital leases (the long-term liabilities appear to be capital lease
obligations), thus suggesting that Company B is Delta Air Lines and
Company D is Wendy's. This is further confirmed when you look at inventory
levels, Company B at zero and Company D at two percent. One would expect
a fast food restaurant business, Wendy'sCompany D, to maintain inventory,
but at minimal levels, while a service organization, DeltaCompany B, would
require no investment in inventory.

4-10

P4-4. Common-size financial statements


A quick review of the financials tells us that Companies A and B have a heavy
investment in current assets with inventory making up a significant portion of
Company As position. Company A and Company C each has a significant
investment in property, plant & equipment (PP&E). Company C appears to be
highly leveraged when compared to the other three companies. Companies B
and D are both reporting significant goodwill and intangibles and both have
significantly higher retained earnings.
Goodwill arises when one company acquires another and pays more than the
fair market value of the net assets acquired. Likewise, intangible assets will
increase by the direct purchase of intangibles. Gannett has a record of
acquiring and disposing of newspapers and television companies.
Consequently, one can assume that Gannett would have goodwill on its
balance sheet. Similarly, Merck is a highly successful pharmaceutical
company that also acquires organizations and purchases intangibles such as
patents and customer relationships, so it appears likely that Merck will report
intangible assets on its balance sheet. As a result, we can conclude that
Gannett and Merck are either Company B or D. Looking closer at Company B,
we see slightly higher accounts receivable than Company D which may be
more indicative of a manufacturing and marketing operation whose customer
base would include hospitals, drug retailers (pharmacies) and other trade
customers who might need extended credit terms versus subscription
services, newspaper and television advertisers. Further examination
indicates that Company B has significantly higher inventory requirements than
Company D. Since Merck is manufacturer and distributor of health related
products, and as such, would require higher inventory levels, one can
conclude that Company B is Merck and Company D is Gannett. One may
argue that Gannett will need inventory to supports its publishing business;
however, those requirements would be proportionally lower in total when
combined with the broadcasting business, whose inventory requirements
would be non-existent.
As stated above, Companies A and C both have significant PP&E and that
Company C is highly leveraged when compared to Company A. Utility
companies are regulated and as such, have a fairly conventional earnings
stream; as a result, utility companies tend to use long-term debt to finance
their PP&E investments. It appears that Company C is Wisconsin Electric
Power Company, while Company A is Target. This is further confirmed when
inventory levels are examined. Company As (Target) inventory levels are
seven times higher than Company D (Wisconsin Electric Power). One can
conclude that the higher inventory levels are necessary to support Company
As (Target) retail sales.

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P4-5. Determining cash flows from operating and investing activities


(AICPA adapted)
Requirements 1 and 2:
Cash flow from operations and investing activities are computed below.
Karr Inc.
Partial Statement of Cash Flows
Operations
Net income
Depreciation
Decrease in inventory
Increase in accounts receivable
Decrease in accounts payable
Gain on sale of equipment
Cash flows from operations

$300,000
52,000
20,000
(15,000)
(5,000)
__(5,000)
$347,000

Investing activities
Sales of equipment
Purchase of equipment
Cash flows from investing

18,000
_(20,000)
($2,000)

Notice that the $30,000 increase in Notes payable is not included in cash
flows from investing activities. It is not a cash transaction if issued in
exchange for asset purchases. In the actual cash flow statement, an
exchange of notes payable for fixed assets may be included in the notes as a
significant noncash transaction. If the notes payable were issued in
exchange for cash, then it would be shown as a source of cash in the
financing activities section of the cash flow statement.

4-12

P4-6. Determining operating cash flow components


(AICPA adapted)
Requirement 1:
Cash collected during 2002 can be shown by a T-account analysis:
Beginning balance
Sales on account in 1999

Ending balance

Accounts Receivable
$ 84,000
1,200,000
$5,000 Accounts written off
X
Cash collections on account
$ 78,000

$78,000 = $84,000 + $1,200,000 - $5,000 X


X = $1,201,000 cash collections on account
Requirement 2:
Cash disbursed for purchases of merchandise can be derived by using
two T-accounts, inventory and accounts payable.
Beginning inventory
Purchases (plug to balance)
Ending inventory

Inventory
$150,000
$840,000
830,000
$140,000

Cost of goods sold

Using the purchases on account we can analyze accounts payable to


determine cash disbursed for merchandise purchases.

Solve for: Payments

Accounts Payable
$ 95,000
830,000
X
$ 98,000

Beginning balance
Purchase account
Ending balance

$98,000 = $95,000 + $830,000 X


X = $827,000
So cash disbursed for the purchase of merchandise is $827,000.

4-13

Requirement 3:
Cash Disbursed for general and administrative expenses in 2002 is computed
below.
For expenses incurred in 2001
Variable G&A ($110,000 X 50% in 2002)
Fixed G&A:
Less Depreciation
Bad debts
Amount paid in 2002
For expenses incurred in 2002
Variable G&A ($120,000 X 50% paid in 2002)
Fixed G&A:
Less Depreciation
Bad debts
Amount paid in 2002
Cash disbursement for G&A in 2002

4-14

$55,000
$100,000
(35,000)
(5,000)
60,000
X 20%

12,000
60,000

100,000
(35,000)
(5,000)
60,000
X 80%

48,000
$175,000

P4-7. Understanding the relation between income statement, cash flow


statement, and changes in balance sheet accounts
Requirement 1:
Income statement
Sales:
Cash collections from customers
+ Increase in accounts receivable
Cost of goods sold:
Cash payments to suppliers
- Increase in inventory
- Decrease in accounts payable
Gross Profit
Operating expenses:
Cash payments for operating expenses
- Decrease in accrued operating expenses
Depreciation of equipment
Amortization of patents
Loss on sale of equipment
Income before taxes
Income tax expense:
Cash payments for current income taxes
+ Increase in deferred taxes payable
Net income

$16,670
+ 3,630
$19,428
(3,250)
(3,998)
$7,148
(2,788)

$200
+ 127

$20,300

(12,180)
$8,120
(4,360)
(2,256)
(399)
(169)
936
(327)
$609

Requirement 2:
Cash provided by operating activities:
Net income
Plus/minus noncash items:
+ Depreciation of equipment
+ Amortization of patents
+ Loss on sales of equipment
+ Increase in deferred taxes payable

$609
$2,256
399
169
__127
2,951

Plus/minus changes in current asset and liability accounts:


- Increase in accounts receivable
(3,630)
- Increase in inventory
(3,250)
- Decrease in accounts payable
(3,998)
- Decrease in accrued operating expenses
(2,788)
Cash provided by operating activities

4-15

_(13,666)
($10,106)

Requirement 3:
Explanation for differences between accrual earnings and operating cash
flows:
Net income is $609, yet cash provided by operating activities is ($10,106).
There are several causes of the difference. Accounts receivable increased
during the year (i.e., not all 2001 sales were collected in cash in 2001),
inventories increased in 2001 (i.e., more inventory was purchased than is
reported as cost of goods sold in the income statement), accounts payable
decreased in 2001 (i.e., cash paid to suppliers covered 2001 purchases as
well as some purchases that were made, but not paid for, in 2000), and
accrued operating expenses decreased in 2001 (i.e., cash paid for operating
expenses in 2001 included all the expenses incurred in 2001 as well as
some that were incurred, but not paid, in 2000).

4-16

P4-8. Understanding the relation between income statement, cash flow


statements, and changes in balance sheet accounts
Requirement 1:
Income statement.
Sales:
Cash collections from customers
- Decrease in accounts receivable
Cost of goods sold:
Cash payments to suppliers
- Increase in inventory
+ Increase in accounts payable
Gross profit
Selling and administrative expenses:
Cash payments for selling and
administrative expenses
+ Increase in the accrued selling
and administrative expenses account
Depreciation of equipment
Interest expense:
Cash payments for interest
+ Increase in accrued interest payable

$72,481
_(4,603)
51,768
(7,400)
_3,146

$67,878

47,514
$20,364

9,409
__772

10,181
7,380

1,344
__117

1,461
__327
$1,669

Gain on sale of equipment


Income before taxes
Income tax expense:
Cash payments for current income taxes
- Decrease in deferred taxes payable
Net income (given)

4-17

671
__(87)

___584
$1,085

Requirement 2:
Cash provided by operating activities:
Net income
Plus/minus noncash items:
+ Depreciation of equipment
- Gain on sale of equipment
- Decrease in deferred taxes payable
Plus/minus changes in current
asset and liability accounts:
+ Decrease in accounts receivable
- Increase in inventory
+ Increase in accounts payable
+ Increase in accrued selling and
administrative expenses
+ Increase in accrued interest payable
Cash provided by operating activities

$1,085
7,380
(327)
___(87)
$8,051
4,603
(7,400)
3,146
72
___117
$1,238
$9,289

Requirement 3:
Explanation for difference between accrual and cash flow from operations:
Net income is $1,085, while cash provided by operating activities is much
larger $9,289. There are several causes of the difference. First, $7,380 of
depreciation expense reduced income, but it did not reduce cash flow, so it is
added back to net income to obtain cash from operations. Accounts
receivable decreased during the year (i.e., all 2001 sales were collected in
cash in 2001 as well as some sales made in 2000, but not collected in 2000),
accounts payable increased in 2001 (i.e., cash paid to suppliers in 2001 was
less than the cost of merchandise purchased and sold in 2001). These three
items are more than enough to offset the increase in the inventory account of
$7,400 (i.e., more inventory was acquired in 2001 than was sold to customers).

4-18

P4-9. Understanding the relation between operating cash flows and accrual
earnings
Requirement 1:
Sales1 ($28,000 + $3,000)
$31,000
Less:
Cost of goods sold2 ($13,000 + $2,000 - $3,000) (12,000)
Operating expenses3 ($9,000 - $2,000)
(7,000)
Depreciation expense
(4,000)
Income tax expense4 ($4,000 + $1,000)
(5,000)
Amortization expense
(1,000)
Gain on sale of equipment
2,000
Net income
$ 4,000
1

Collections from customers + decrease in accounts receivable.


Payment to suppliers for purchases + increase in accounts payable
increase in inventory.
3
Payments for operating expenses decrease in accrued payables.
4
Payment for taxes in current period + increase in deferred taxes payable.
2

Requirement 2:
Net income
Plus/minus adjustments to reach cash flows
Operating activities:
(+) Depreciation
(+) Amortization of goodwill
(-) Gain on sale of equipment
(-) Increase in inventory
(+) Increase in accounts payable
(-) Increase in accounts receivable
(-) Decrease in accrued payables
(+) Increase in deferred income taxes payable
Cash flows from operating activities

$4,000
4,000
1,000
(2,000)
(3,000)
2,000
(3,000)
(2,000)
1,000
$2,000

P4-10. Finding missing values on a classified balance sheet and analyzing


balance sheet changes (CW)
Requirement 1:
Microsoft's Year 2 balance sheet appears on the following page. The Year 1
balance sheet is also included to facilitate responding to the remaining parts
of the question.

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Microsoft Corporation
Consolidated Balance Sheet
($ in Millions)

June 30
Year 2
Year 1

Assets
Current assets
Cash and short-term investments
Accounts receivable, net
Other
Total current assets

$ 13,927
1,460
502
15,889

Property, plant and equipment, net


Equity investment
Other assets
Total assets

1,505
4,703
260
$ 22,357

1,465
2,346
203
$ 14,387

Liabilities and stockholders' equity


Current liabilities
Accounts payable
Accrued compensation
Income taxes payable
Unearned revenue
Other
Total current liabilities
Stockholders' equity
Convertible preferred stock:
shares authorized 100;
issued and outstanding 13
Common stock and paid-in-capital:
shares authorized 8,000;
issued and outstanding 2,408
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity

4-20

759
359
915
2,888
809
5,730

8,966
980
427
10,373

721
336
466
1,418
669
3,610

980

980

8,025
7,622
16,627
$ 22,357

4,509
5,288
10,777
$ 14,387

The unknowns in the Year 2 balance sheet are:

Other current assets


Equity investments
Common stock and paid-in-capital
Total stockholders' equity
Unearned revenue
Total assets

They may be solved for as follows (all amounts in millions).


a) Total assets: Since total liabilities and stockholders' equity is given
($22,357), total assets is just this number, $22,357.
b) Other current assets: Total current assets is given as $15,889 as all
are of its components except other current assets. The sum of the given
components is $15,387 (cash and short-term investments is $13,927 and
accounts receivable (net) is $1,460). Subtracting the sum of these
components from total current assets leaves $502 for other current
assets .
Total current assets = Cash and short-term investments + Accounts receivable +
Other Current Assets
$15,889 = $13,927 + $1,460 + X
X = $502 = Other current assets

c) Equity investments: To obtain equity investments, subtract total current


assets of $15,889, property, plant, and equipment of $1,505 and other
assets of $260 from total assets of $22,357. This yields $4,703 for other
equity investments.
d) Unearned revenue: Total current liabilities is given as $5,730 as is all of
its components except unearned revenue. The sum of the given
components is $2,842 (accounts payable is $759, accrued compensation
is $359, income tax payable is $915, and other current liabilities are $809).
Subtracting the sum of these components from total current liabilities
leaves $2,888 for unearned revenues.
Total current liabilities = Accounts payable + Accrued compensation + Income taxes payable +
Unearned revenue + Other current liabilities
$5,730 = $759 + $359 + $915 + X + $809
X = $2,888 = Unearned revenue

4-21

e) Total stockholder's equity: Since Microsoft has no long-term debt, total


stockholders' equity is just total liabilities and stockholders' equity of
$22,357 minus total current liabilities of $5,730. Doing the subtraction
yields $16,627 for total stockholders' equity.
f) Common stock and paid-in-capital: It can be derived by subtracting
retained earnings of $7,622 and preferred stock of $980 from total
stockholders' equity of $16,627. Doing so yields $8,025 for common stock
and paid-in-capital.
Requirement 2:
The firm appears to be in quite good financial health. Here are a couple of
reasons why.
a) The firm's current assets of $15,889 are 2.77 times its current liabilities of
$5,730 (i.e., the firm's current ratio is about 2.77). Thus, the firm is unlikely
to face any type of liquidity crisis.
b) Related to (a), the firm's cash and short-term investments of $13,927 far
exceed its total current liabilities of $5,730. This is further evidence that
the firm has very good short-term liquidity.
Requirement 3:
In general, the changes in Microsoft's balance sheet from Year 1 to Year 2
are favorable. Several notable changes include (amounts in millions):
a) Cash and short-term investments increased by about 55%.
($13,927/$ 8,966)
b) Current assets increased by about 53%
($15,889/$10,373)
c) Microsoft appears to have had a substantial increase in the equity
investment account as evidenced by an increase of $2,357 million.
d) Retained earnings increased by about $2,334 million. This suggests that
the firm was quite profitable in Year 2 (the income statement could be
examined to verify this).
e) Microsoft had no long-term debt in Year 1 or Year 2. One might suspect
that Microsoft's operations generate more than enough cash flow for the
firm (the cash flow statement could be examined to verify this).

4-22

Requirement 4:
Perhaps, the best answer to this question is to say that Microsoft's solid
balance sheets provide no obvious reason not to invest in the firm. However,
it would be unwise to base an investment recommendation solely on balance
sheet information. Moreover, other information about Microsoft should be
gathered and analyzed (see the next question).
Requirement 5:
At a minimum the following information should be obtained:
a) The firm's income statements for the past 4-5 years. These data would be
used to assess Microsoft's recent profitability and potential future
profitability.
b) The firm's cash flow statements for the past 4-5 years. These data would
be used to assess Microsoft's recent cash-flow generating ability and what
the cash flows were used for, as well as to help project the firm's potential
future cash flow generating ability.
c) Other information that the analyst might seek to obtain includes:
projections of future earnings and/or sales made by Microsoft
management,
projections about future demand for Microsoft's products from the firm or
from industry trade publication or other independent sources.
information about new products that Microsoft has in development and
the projected introduction dates for these products.
Other student responses are possible.

4-23

P4-11. Finding missing values on a classified balance sheet and analyzing


balance sheet accounts
Requirement 1:
HEWLETT-PACKARD COMPANY
Consolidated Balance Sheet
($ in millions)
Assets
Current assets
Cash and cash equivalents
Short-term investments
Accounts and notes receivable
Inventories:
Finished goods
Purchased parts and fabricated assemblies
Other current assets
Total current assets
Property, plant, and equipment
Land
Buildings and leasehold improvements
Machinery and equipment
Less
Accumulated depreciation

625
495
2,976

1,100
1,173
__347
6,716
390
2,779
_2,792
5,961

Long-term receivables and other assets


Total assets

_(2,616)
3,345
__1,912
$11,973

Liabilities and shareholders equity


Current liabilities
Notes payable and short-term borrowings
Accounts payable
Employee compensation and benefits payable
Taxes payable
Deferred revenues
Other accrued liabilities
Total current liabilities

$ 1,201
686
837
381
375
__583
4,063

Long-term debt
Other liabilities
Deferred taxes payable
Total liabilities

188
210
__243
4,704

Shareholders equity
Common stock and capital in excess of $ 1 par value
(authorized: 600,000,000 shares; issued and
outstanding: 251,547,000)
Retained earnings
Total shareholders equity

1,010
__6,259
__7,269

Total liabilities and shareholders equity

$11,973

4-24

The unknowns in the balance sheet are:

Total liabilities and shareholders equity


Land
Long-term debt
Notes payable and short-term borrowings
Retained earnings
Accounts and notes receivable

They may be solved for as follows (amounts in millions).


a)

Total liabilities + Shareholders equity = Total assets (given) = $11,973

b)

Land: $390

The following amounts, which are given in the problem, are needed to derive
the balance in the land account: Total assets of $11,973, total current assets
of $6,716, and the balances of all long-term asset accounts except land
(buildings and leasehold improvements $2,779, machinery and equipment
$2,792, accumulated depreciation ($2,616), and long-term receivables and
other Assets $1,912). Thus, the balance in the land account is:
Total assets = Current assets + Land + Buildings and leasehold improvements + Machinery and
equipment - Accumulated depreciation + Long-term receivables and other assets

$11,973 = $6,716 + land + $2,779 + $2,792 - $2,616 + $1,912.


Land = $390.
c) Long-term debt: $188
The following information ($ in millions) in the problem can be used to derive
the long-term debt: Total liabilities and shareholders equity (i.e., total assets)
of $11,973, total current liabilities of $4,063, total shareholders equity of
$7,269, other liabilities of $210, and deferred taxes payable of $243.
Long-term debt = Total liabilities and shareholders equity - Total shareholders equity Other liabilities - Deferred taxes payable - Total current liabilities

Long-term debt = $11,973 - $7,269 - $210 - $243 - $4,063.


Long-term debt = $188.

4-25

d)

Notes payable and short-term borrowings: $1,201.

The given information includes total current liabilities as well as all of its
underlying components except for notes payable and short-term borrowings.
To solve for notes payable and short-term borrowings simply subtract all of
the given current liability components from total current liabilities. Specifically:
Notes payable and short-term borrowings = Total current liabilities - Accounts payable - Employee
compensation and benefits payable - Taxes payable - Deferred revenues Other accrued liabilities

Notes payable and short-term borrowings =


$4,063 - $686 - $837 - $381 - $375 - $583.
Notes payable and short-term borrowings = $1,201.
e) Retained Earnings: $6,259
The following information given in the case can be used to derive the retained
earnings balance: Total shareholders equity of $7,269 and common stock
and capital in excess of $1 par value of $1,010. The balance in the retained
earnings account is just the difference between these two figures:
Retained earnings = $7,269 - $1,010
Retained earnings = $6,259.
f)

Accounts and notes receivable: $2,976

The given information includes total current assets as well as all of its underlying components except for accounts and notes receivable. To solve for
accounts and notes receivable, simply subtract all of the given current asset
components from total current assets. Specifically:
Accounts and notes receivable = Total current assets - Cash and cash equivalents - Short-term
investments - Finished goods - Purchased parts and fabricated assemblies Other current assets

A ccounts and notes receivable = $6,716 - $625 - $495 - $1,100 - $1,173 - $347.
Accounts and notes receivable = $2,976.

4-26

Requirement 2:
One way to answer this question is to calculate the ratio of total Stockholders
equity to total assets. Specifically:
$7,269/$11,973 = 60.7%.
This suggests that Hewlett-Packard finances itself by relying slightly more on
investment by shareholders rather than creditors.
Of note is that what financing that is provided by creditors is primarily shortterm. Moreover, current liabilities are $4,063, while long-term liabilities are
only $641.
Requirement 3:
Hewlett-Packards largest current asset is accounts and notes receivable of
$2,976.
Requirement 4:
Hewlett-Packards largest current liability is notes and short-term borrowings
of $1,201.
Requirement 5:
Current ratio = Current assets/Current liabilities.
= $6,716/$4,063
= 1.65.
This means that Hewlett-Packard has $1.65 of current assets for each $1.00
of current liabilities. A simple rule of thumb for the current ratio is that it should
be greater than one. Thus, Hewlett-Packard appears to have adequate shortterm liquidity.
A better way to gauge the adequacy of a firms current ratio is to compare it to
prior years values for the firm, as well as with the values for other firms in the
industry.
Requirement 6:
Other current assets may consist of items such as prepaid expenses like
insurance, rent, advertising, etc.

4-27

P4-12. Analyzing the difference between operating cash flows and accrual earnings
Requirement 1:
(a)
Item:
Operating Activities
Sales
Cost of goods sold
Selling and admin. expenses
Interest expense

(b)
Non-cash Accruals
Revenue Earned or
Expenses Incurred

Accrual
Income
$6,438,507
- 5,102,977
- 855,809

- 34,436 12

Depreciation expense

- 104,614 15

Provision for income taxes

- 135,500 16

Net income

- $20,145

(c)
Prepayments/
Buildups/Other
Adjustments
- $170,933
+ 53,099

+ 45,096

- 2,327 13
+ 104,614
- 5,568 17

(d)
(a+b+c)
Cash Received (+)
or Paid (-)
+ $6,418,362

- 5,220,811

5
6

+ 7,283 10

- 803,430 11
- 36,763 14
-- 141,068 18

205,171 19

Operating cash flow

+ 216,290 20

Investing activities
Capital expenditures

- 352,092 21

Net investing cash flows

- 352,092

Financing activities
Sale of stock
Issuance of long-term debt
Dividends
Net financing cash flows
Net cash flow

+ 100,857 22
+ 89,352 23
__- 48,031 24
+142,178
$6,376

Beginning cash
Ending cash
Change in cash

$428
_6,804
$6,376

4-28

Notes:
1.

Sales from the income statement.

2.

The increase in the accounts receivable account (i.e., sales not collected
in cash during the year), $97,106 - $76,961.

3.

Cash collected during the year.

4.

Cost of goods sold from the income statement.

5.

The increase in the inventory account (i.e., $844,539 - $673,606).

6.

The increase in the accounts payable account for the year


(i.e., $343,163 - $290,064).

7.

Payments for inventory during the year.

8.

Selling and administrative expenses from the income statement.

9.

The increase in the accrued expenses account (i.e., $184,017 $138,921).

10. The decrease in the prepaid expenses account for the year

(i.e., $16,684 - $9,401).


11. Selling and administrative expenses paid in cash during the year.
12. Interest expense from the income statement.
13. The decrease in the accrued interest payable account for the year

(i.e., $1,067 - $3,394).


14. Interest paid in cash during the year.
15. Depreciation expense from the income statement. Depreciation is a non-

cash expense.
16. Accrual accounting income tax expense from the income statement.
17. The decrease in the income tax payable account, (i.e., $37,390 - $42,958).
18. Cash paid for income taxes during the year.
19. From the income statement.
20. By calculation.

4-29

21. The change in the property account.


22. The change in the common stock account.
23. The change in the long-term debt account.
24. Given.

Requirement 2:
Food Tiger
Statement of Cash Flows
For the Year Ended December 31, 2001
Operating cash flows
Net income
Plus
Depreciation
Increase in accounts payable
Increase in accrued expenses
Decrease in prepaid expenses
Minus
Increase in accounts receivable
Increase in inventory
Decrease in accrued interest payable
Decrease in income taxes payable
Net operating cash flows
Investing cash flows
Capital expenditures
Net investing cash flows

$205,171
104,614
53,099
45,096
_7,283
20,145
170,933
2,327
__5,568

105,478

(198,973)
$216,290

(352,092)
(352,092)

Financing cash flows


Sale of stock
Issuance of long-term debt
Dividends
Net financing cash flows
Net cash flow

100,857
89,352
(48,031)
142,178
$6,376

Beginning cash balance


Ending cash balance
Change in cash

$428
_6,804
$6,376

4-30

P4-13 Preparing balance sheet and income statement


(AICPA adapted)
Requirement 1:
Vanguard Corporation
Balance Sheet
December 31, 2001
Assets
Current assets:
Cash1
Accounts receivable (given)
Allowance for doubtful accounts (3% of $3,350,000)
Inventories (obtained from cost of sales section of
the income statement)
Total current assets
Fixed assets2
Accumulated depreciation3
Total assets

$ 3,566,040
$3,350,000
(100,500)

3,249,500
2,750,000
9,565,540

4,000,000
(1,774,500)

2,225,500
$11,791,040

Liabilities and Stockholders' Equity


Current Liabilities:
Notes Payable due within one year4
Accounts payable and accrued liabilities (given)
Federal income taxes payable5
Total current liabilities
Notes payable due after one year6
Stockholders' equity:
Capital stock7
Additional paid-in capital8
Retained earnings (per statement of retained earnings)
Total stockholders' equity
Total liabilities and stockholders' equity

Cash :
Cash balance at December 31, 2000
Add:
2001 net sales
Less: 12/31/01 accounts receivable
Accounts receivable at 12/31/00
Less: accounts charged off in 2001

$1,000,000
2,221,000
130,000
3,351,000
3,000,000
$1,050,000
1,800,000
2,590,040
5,440,040
$11,791,040

$4,386,040
$15,650,000
(3,350,000)
3,150,000
(50,000)

4-31

12,300,000
3,100,000
19,786,040

Less:
Purchases and freight-in
Other administrative, selling and general expenses
Less: 12/31/01 accounts payable and accrued liabilities
12/31/00 current liabilities
Interest expense
Fixed assets purchased in 2001($4,000,000 less $3,300,000)
Dividends paid (see statement of retained earnings)
Installment of 2001 tax paid prior to 12/31/01
Cash Balance at 12/31/01
2

Fixed assets:
Depreciation expense in 2001 (given)
Less: Depreciation on 12/31/00 fixed assets (13% of 3,300,000)
Depreciation on fixed asset additions in 2001
One-half years depreciation taken in year fixed assets
acquired. Full years depreciation = $45,500 X 2
Depreciation rate 13% - 2001 fixed asset additions ($91,000 .13)
Add: Fixed assets on 12/31/00
Fixed assets on 12/31/01

10,905,000
2,403,250
13,308,250
2,221,000
11,087,250
3,391,500
700,000
410,000
400,000

16,220,000
$ 3,566,040

474,500
(429,000)
$
45,500
$

91,000

700,000
3,300,000
$ 4,000,000

Accumulated depreciation:
Balance 12/31/00
Add: Depreciation expense in 2001 (given)
Accumulated depreciation

$ 1,300,000
474,500
$ 1,774,500

Notes payable due within one year:


Face value of note
Due in twenty equal installments
Quarterly installment
Four installments due in 2002
Notes payable due within one year

$ 5,000,000
20
$ 250,000
X 4
$ 1,000,000

Federal income taxes payable:


Provision for taxes on 2001 earnings per income statement
Less: 2001 Estimated tax payment
Balance 12/31/01
Notes payable due after one year:
Balance 12/31/00
Less: Amount due within one year at 12/31/01
Balance 12/31/01

4-32

530,000
(400,000)
$ 130,000

$ 4,000,000
(1,000,000)
$ 3,000,000

Capital stock:
Balance 12/31/00
Add: Stock dividend of 5%
Balance 12/31/01

$1,000,000
50,000
$1,050,000

Additional paid-in capital:


Balance 12/31/00
Add: [50,000 sh. x $7 = $350,000 - ( 50,000 sh. x $1) = $300,000 increase ]

$1,500,000
300,000

Balance 12/31/01

$1,800,000

Requirement 2:
Vanguard Corporation
Income Statement
Year ended December 31, 1999
Net sales (given)
Cost of sales
Beginning inventory (given)
Purchases & freight (given)

$15,650,000
$ 2,800,000
10,905,000
13,705,000

Less: Ending inventory (plug necessary for 30%


gross profit)
Gross profit (30% of $15,650,000)
Operating and other expenses
Interest1
Depreciation and amortization (given)
Provision for doubtful accounts2
Other administrative, selling, and general expenses (given)
Net income before income taxes
Income tax expense (given)
Net income
1

(2,750,000)

231,250
474,500
56,000
2,403,250

5% per year on notes adjusted for four 2001 quarterly payments of $250,000.
($62,500 + $59,375 + $56,250 + $53,125)
2
Balance at 12/31/01 (3% of $3,350,000)
$100,500
Balance at 12/31/00 (given)
$94,500
Amounts written off (given)
(50,000 )
44,500
Amount required
$ 56,000

4-33

10,955,000
4,695,000

3,165,000
1,530,000
( 530,000)
$ 1,000,000

Vanguard Corporation
Statement of Retained Earnings
Year Ended December 31, 1999
Beginning retained earnings (given)
Net earnings for the year (from Income Statement)
Less cash dividends paid:
1st quarter 1,000,000 shares @.10
2nd quarter 1,000,000 shares @.10
3rd quarter
1,050,000 shares @.10
4th quarter 1,050,000 shares @.10
Total cash dividends paid

$2,350,040
1,000,000
$3,350,040
$100,000
100,000
105,000
105,000
410,000

Fair value of 50,000 shares


of common stock issued as stock dividend
(50,000 shares @ $7)

350,000
760,000
$2,590,040

Ending retained earnings

4-34

Financial Reporting and Analysis


Chapter 4 Solutions
Structure of the Balance Sheet and Statement of Cash Flows
Cases
Cases
C4-1. Debbie Dress Shops: Determining cash flow amounts from comparative
balance sheets and income statement
(AICPA adapted)
Requirement 1:
Cash collected during 2001 from accounts receivable is calculated below.
Beginning accounts receivable
Net credit sales
Ending accounts receivable
Cash collected during 2001

$ 580,000
6,400,000
_(840,000)
$6,140,000

Requirement 2:
To find cash payments during 2001 on accounts payable to suppliers, we first
must compute purchases.
Beginning inventory
+ Purchases (plug figure)
- Ending inventory
= Cost of goods sold (given)

$ 420,000
5,240,000
_(660,000)
$5,000,000

We then use the purchases amount to compute cash payments made to


suppliers.
Ending accounts payable
Purchases
Beginning accounts payable
Cash payments to suppliers

(530,000)
5,240,000
__440,000
$5,150,000

4-35

Requirement 3:
Cash provided by operations can be seen by looking at the 2001 statement
of cash flows for Debbie Dress Shops.
Debbie Dress Shops
Statement of Cash Flows
Net income
Depreciation ($110,000 - $50,000)
Increase in accounts payable
Increase in accrued expenses
Increase in accounts receivable
Increase in inventory
Increase in prepaid expenses
Cash flows from operating activities
Purchase of land, buildings, and fixtures
Purchase of long-term investment
Cash flows from investing activities

$400,000
60,000
90,000
10,000
(260,000)
(240,000)
(50,000)
$10,000
(530,000)
(80,000)
($610,000)

Issuance of common stock


Issuance of long-term debt
Payment of cash dividends**
Cash flows from financing activities

300,000
500,000
(100,000)
$700,000

Net cash flows for 2001

$100,000

** The amount listed for payment of cash dividends can be computed using T-account analysis
as follows:

4-36

Retained Earnings
$330,000
400,000
Dividends declared

Beginning
balance
Net income

$170,000
$560,000

Ending balance

Using the dividends declared amount we found above, we can find the actual
cash paid out for dividends by looking at the dividends payable account.

Cash paid out in


dividends

Dividends payable

Beginning balance
$170,000 Dividends declared
$100,000
$70,000 Ending balance

Requirement 4: see above


Requirement 5: see above
C4-2. Snap-on-Tools Corp. (CW): Determining missing amounts on cash flow
statement
Required:
Snap-on-Tools 19X2 cash flow statement appears below. The unknowns are:
net cash provided by operating activities, net cash used in investing
activities, net cash provided by (used in) financing activities, increase in
cash and cash equivalents, and cash and cash equivalents at end of year.
These amounts may be solved for as follows (all in thousands).
a)

Net cash provided by operating activities:

Cash provided by operating activities = Net earnings + Depreciation + Amortization - Decrease in


deferred income taxes - Gain on sale of assets - Increase in receivables + Decrease in inventories Increase in prepaid expenses - Decrease in accounts payable + Increase in accruals, deposits, and
Other Liabilities.

Cash provided by operating activities ($ in 000) = $65,975 + $25,484 +


$3,973 - $ 6,005 - $250 - $5,458 + $5,928 - $4,829 - $8,202 + $23,330
Cash provided by operating activities = $99,946.

4-37

b)

Net cash used in investing activities:

Cash used by investing activities = Capital expenditures + Acquisition of Sun Electric, net of cash
acquired + Increase in other noncurrent assets - Disposal of property and equipment.

Cash used by investing activities = $21,081 + $110,719 + $3,609 - $3,379.


Cash used by investing activities = $132,030.
c)

Net cash provided by (used in) financing activities:

Cash provided by financing activities = Increase in notes payable - Payment of long -term debt +
Increase in long-term debt + Proceeds from stock option plans - Cash dividends paid.

Cash provided by financing activities = $52,503 - $8,332 + $78,650 + $4,940


- $45,718
Cash provided by financing activities = $82,043.
d)

Increase in cash and cash equivalents:

Increase in cash and cash equivalents = Cash provided by operating activities - Cash used by
investing activities + Cash provided by financing activities - Effect of exchange rate changes.

Increase in cash and cash equivalents = $99,946 - $132,030+$82,043 $1,916.


Increase in cash and cash equivalents = $48,043.
e)

Cash and cash equivalents at end of year:

Cash and cash equivalents at end of year = Cash and cash equivalents at beginning of
year + Increase in cash and cash equivalents.

Cash and cash equivalents at end of year = $10,930 + $48,043


Cash and cash equivalents at end of year = $58,973.

4-38

($ in 000)

Snap-on Tools Corporation


Consolidated Statement of Cash Flows
Year 2

Operating Activities
Net earnings
Adjustments to reconcile net earnings to net
Cash provided by operating activities:
Depreciation
Amortization
Deferred income taxes
Gain on sale of assets
Changes in operating assets and liabilities:
(Increase) decrease in receivables
(Increase) decrease in inventories
Increase in prepaid expenses
Decrease in accounts payable
Increase in accruals, deposits, and other
long-term liabilities
Net cash provided by operating activities

$65,975
25,484
3,973
(6,005)
(250)
(5,458)
5,928
(4,829)
(8,202)
_23,330
99,946

Investing Activities
Capital expenditures
Acquisition of Sun Electric, net of cash acquired
Disposal of property and equipment
(Increase) decrease in other noncurrent assets
Net cash used in investing activities

(21,081)
(110,719)
3,379
__(3,609)
(132,030)

Financing Activities
Payment of long-term debt
Increase in long-term debt
Increase (decrease) in notes payable
Proceeds from stock option plans
Cash dividends paid
Net cash provided by (used in) financing activities
Effect of exchange rate changes
Increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year

(8,332)
78,650
52,503
4,940
(45,718)
82,043
_(1,916)
48,043
_10,930
$58,973

4-39

C4-3. Drop Zone Corp. (CW): Understanding the relation between successive
balance sheets and cash flow statement
Drop Zone Corporation
Balance Sheet
For the Year Ended December 31, 2001

Assets
Current assets
Cash
Accounts receivable, net
Inventory
Prepaid assets
Total current assets

2000 Amount
Plus/Minus
__Change__

2001
Amount

($7,410 + $2,565)
(6,270 + 3,990)
(13,395 - 1,425)
(1,995 - 855)

$9,975
10,260
11,970
__1,140

29,070

Land
Buildings and equipment
Less: Accumulated depreciation,
buildings and equipment

(27,930 - 8,550)
(194,655 + 39,615)

19,380
234,270

_(40,185 + 5,415)

__45,600

Total assets

$211,470

Liabilities and stockholders equity


Current liabilities
Accounts payable
Accrued payables

33,345

($11,400 - $2,850)
(3,135 + 1,140)

Total current liabilities

14,535

Long-term debt

$241,395

$8,550
___4,275
12,825

(19,950 + 16,245)

36,195

Stockholders equity
Common stock $10.00 par value
(18,525 + 5,000)
Paid-in capital
(31,920 + 12,825 - 5,000)

23,525
39,745

Retained earnings

(144,780 + 11,400 - 6,270)

149,910

__(18,240 + 2,565)

20,805

Less: Treasury stock

Total liabilities and stockholders equity

4-40

$211,470

$241,395

The details underlying the calculation of the 2001 amounts are as follows:
a) The ending cash account balance of $9,975 is equal to the beginning
balance of $7,410 plus the increase in cash of $2,565 reported in the cash
flow statement.
b) The ending balance in accounts receivable, net, of $10,260 is equal to
beginning balance of $6,270 plus the increase in the accounts balance of
$3,990 reported in the cash flow statement.
c) The ending inventory account balance of $11,970 is equal to the beginning
balance of $13,395 minus the decrease in the account balance of $1,425
reported in the cash flow statement.
d) The ending balance in the prepaid assets account of $1,140 is equal to
the beginning balance of $1,995 minus the decrease in the account
balance of $855 reported in the cash flow statement.
e) The ending balance in the land account of $19,380 is equal to the
beginning balance of $27,930 minus the cost of the land that was sold of
$8,550.
f) The ending balance in the buildings and equipment account of $234,270 is
equal to the beginning balance of $194,655 plus the acquisitions of
$39,615.
g) The ending balance in the accumulated depreciation, buildings and
equipment account of $45,600 is the beginning balance of $40,185 plus the
depreciation of $5,415 for the current year.
h) The ending balance in accounts payable of $8,550 is equal to the
beginning balance of $11,400 minus the decrease in the account balance
of $2,850.
i) The ending balance in the accrued payables account of $4,275 is equal to
the beginning balance of $3,135 plus the increase in the account balance
of $1,140 reported in the cash flow statement.
j) The ending balance in long-term debt account of $36,195 is the beginning
balance of $19,950 plus the amount of long-term debt issued during the
year of $16,245.
k) The ending balance in the common stock account of $23,525 is equal to
the beginning balance of $18,525 plus the par value of the shares issued
during the year of $5,000.

4-41

l) The ending balance in the paid-in capital account of $39,745 is equal to


the beginning balance of $31,920 plus the proceeds from the common
stock issue of $12,825, net of the $5,000 that went to the common stock
account (i.e., $7,825).
m) The ending balance of retained earnings of $149,910 is equal to the
beginning balance of $144,780 plus net income of $11,400 minus
dividends of $6,270.
n) The ending balance in the treasury stock account of $20,805 is the
beginning balance of $18,240 plus the cost of the additional shares
acquired during 2001 of $2,565.

4-42

C4-4. Long Distance Runner Corporation (CW): Understanding the relation


between successive balance sheets and cash flow statement
Long Distance Runner Corporation
Balance Sheet
For the Year Ended December 31, 2000
2001 Amount
Plus/Minus
Change
Assets
Current assets
Cash
Accounts receivable, net
Inventory
Prepaid expenses
Total current assets
Land
Buildings
Equipment
Less: Accumulated depreciation,
buildings and equipment
Patents, net
Total assets

2000
Amount

($39,825 + $14,175)
(147,825 - 73,575)
(27,000 - 6,750)
(6,750 + 6,750)

$54,000
74,250
20,250
__13,500

221,400

162,000

(202,500 - 67,500)
(202,500 - 202,500)
(40,500 + 13,500)

135,000
0
54,000

(27,000 - 16,875 + 3,375)

13,500

(40,500 + 13,500)

__54,000

$680,400

$391,500

Liabilities and stockholders equity


Current liabilities
Accounts payable
Accrued salaries payable
Accrued interest payable

($62,100 + $22,275)
(20,250 - 13,500)
(20,250 + 10,125)

$84,375
6,750
__30,375

102,600

121,500

(148,500 + 6,750)
(158,625 - 158,625)

155,250
0

(23,500 - 7,500)
(233,000 - 168,000)
(14,175 - 20,925 + 47,250)

16,000
65,000
40,500

Less: Treasury stock

(0 + 6,750)

___6,750

Total liabilities and stockholders equity

$680,400

$391,500

Total current liabilities


Notes payablelong term
Long-term debt
Stockholders' equity
Common stock $1.00 par value
Paid-in capital
Retained earnings

4-43

The details underlying the calculation of the 2000 amounts are as follows (all
amounts are obtained by simply working backwards from the ending balances):
a) The beginning balance in the cash account of $54,000 is equal to the
ending balance of $39,825 plus the decrease in cash reported in the cash
flow statement of $14,175.
b) The beginning balance in accounts receivable, net, of $74,250 is equal to
the ending balance $147,825 minus the increase in the account balance of
$73,575 during 2001.
c) The beginning balance in the inventory account of $20,250 is equal to the
ending balance of $27,000 minus the increase in the account balance of
$6,750.
d) The beginning balance in the prepaid expenses account of $13,500 is
equal to the ending balance of $6,750 plus the decrease in the account
balance during the year of $6,750.
e) The beginning balance in the land account of $135,000 is equal to the
ending balance of $202,500 minus the cash paid to acquire land during
2001 of $67,500.
f) The beginning balance in the buildings account of $0.0 is equal to the
ending balance of $202,500 minus the cost of the buildings acquired
during the year of $202,500.
g) The beginning balance in the equipment account of $54,000 is equal to the
ending balance of $40,500 plus the cost of the equipment sold during the
year of $13,500.
h) The beginning balance in the accumulated depreciation, buildings and
equipment account of $13,500 is equal to the ending balance of $27,000
minus the depreciation expense for the year of $16,875 plus the
accumulated depreciation on the equipment that was sold in 2001 of
$3,375.
i) The beginning balance in the patents, net account of $54,000 is equal to
the ending balance of $40,500 plus the amortization expense taken in 2001
of $13,500.
j) The beginning balance in accounts payable of $84,375 is equal to the
ending balance of $62,100 plus the decrease in the account balance of
$22,275.

4-44

k) The beginning balance in the accrued salaries payable account of $6,750


is equal to the ending balance of $20,250 minus the increase in the
account balance of $13,500 during 2001.
l) The beginning balance in the accrued interest payable account of $30,375
is equal to the ending balance of $20,250 plus the decrease in the account
balance of $10,125.
m) The beginning balance in the notes payablelong-term account of
$155,250 is equal to the ending balance of $148,500 plus the cash paid to
reduce notes payable during 2001 of $6,750.
n) The beginning balance in the long-term debt account of $0. is equal to the
ending balance of $158,625 minus the long-term debt issued during 2001
of $158,625.
o) The beginning balance in the common stock account of $16,000 is equal
to the ending balance of $23,500 minus the par value of the shares issued
during 2001 of $7,500.
p) The beginning balance in the paid-in capital account of $65,000 is equal to
the ending balance of $233,000 minus the proceeds from the stock issued
during 2001, net of the increase in the common stock account (i.e.,
$175,500 - $7,500 = $168,000).
q) The beginning balance in the retained earnings account of $40,500 is
equal to the ending balance of $14,175 minus 2001 net income of $20,925
plus cash dividends paid in 2001 of $47,250.
r) The beginning balance in the treasury stock account of $6,750 is equal to
the ending balance of $0 plus the cost of the treasury stock that was
resold during 2001 of $6,750.
C4-5. Kellogg Company (CW): Determining missing amounts on cash flow
statement and explaining causes for change in cash
Requirement 1:
Kelloggs Year 1 cash flow statement appears below.
The unknowns are: additions to properties, cash and temporary investments
at end of year, cash dividends, cash used by financing activities, and net
earnings.

4-45

These amounts may be solved for as follows ($ in millions).


a) Additions to properties:
Cash used by investing activities of ($319.9) is given as are its components
(except additions to properties). Property disposals generated $25.2 while
other acquisitions used $11.6 of cash. Working backwards from the total
investing outflow of $319.9 yields a figure of $333.5 for additions to properties.
Specifically:
Total investing outflows = Additions to properties - Property disposals + Other acquisitions.

$319.9 = X - $25.2 + $11.6


X = $333.5 = Additions to properties.
b) Cash and temporary investments at end of year:
Cash and temporary investments at the beginning of the year is given as
$100.5, and so is the increase in cash and temporary investments for the
year of $77.5. Cash and temporary investments at end of year is just the sum
of the two, or $178.0.
c) Cash used by financing activities:
The following given information is used to solve for this unknown:
Cash provided by operations is $934.4,
Cash used by investing activities is ($319.9).
Effect of exchange rate changes on cash $0.7, and
Increase in cash and temporary investments is $77.5.
To find cash used by financing activities:
Increase in cash = Cash provided by operations - Cash used by investing activities - Cash used by
financing activities + the Effect of exchange rate change on cash.

$77.5 = $934.4 - $319.9 - X + $0.7


X = $537.7 = Cash used by financing activities.

4-46

d) Cash dividends:
Cash used by financing activities of ($537.7) is obtained from (c). Its
components (except cash dividends) are all given in the case: Issuance of
common stock $17.7, purchase of treasury stock $83.6, borrowings of notes
payable $182.1, issuance of long-term debt $4.3, other financing activities
$1.1, reduction of long-term debt $126.0, and reduction of notes payable
$274.0. Cash dividends may be derived as follows:
Cash used by financing activities = Issuance of common stock - Purchase of treasury stock +
Borrowings of notes payable + Issuance of long-term debt + Other financing activities - Reduction of
long-term debt - Reduction of notes payable - Cash dividends.

-$537.7 = $17.7 - $83.6 + $182.1 + $ 4.3 + $1.1 - $126.0 - $274.0 - X


= $259.3 = Cash Dividends.
e) Net earnings:
Net earnings may be derived by taking cash provided by operations of $934.4
and working backwards through the adjustments to net income that are
required to arrive at cash provided by operations.
The necessary adjustments (are given as):
Other noncash expenses $16.8, decrease in accounts receivable $10.2,
depreciation $222.8, increase in prepaid expenses $22.9, decrease in
deferred income taxes $5.4, increase in accounts payable $42.7, increase in
inventories $41.4, and increase in accrued liabilities $105.6.
Net earnings may be derived as follows:
Cash provided by operations = Net earnings + Other noncash expenses + Decrease in accounts
receivable + Depreciation - Increase in prepaid expenses - Decrease in deferred income taxes +
Increase in accounts payable - Increase in inventories + Increase in accrued liabilities.

$934.4 = X + $16.8 + $10.2 + $222.8 - $22.9 - $5.4 + $42.7 - $41.4 + $105.6.


X = net earnings = $606.0.
Having derived the unknowns, all that remains is assembling the cash flow
statement in good form. The correct cash flow statement appears on the next
page.
Requirement 2:
Kelloggs cash provided by operations of $934.4 was more than enough to
cover the firms investing outflows of $319.9.

4-47

Requirement 3:
This is a trick question. Depreciation is not a source of cash (i.e., reporting
more depreciation does not increase cash flow). Depreciation is a noncash
expense which needs to be added back to net income to derive Cash
Provided by Operations when a firm uses the indirect method to report
operating cash flows in its cash statement.
Requirement 4:
There are two primary reasons for the difference. They are that Kelloggs
financing activities (e.g., cash dividends, reduction of notes payable, etc.)
used $537.7 million of cash and that the firms investing activities (e.g.,
additions to properties) used $319.9 million of cash. Together these outflows
total $857.6 which, when subtracted from the $934.4 cash inflow from
operations, leaves an increase in cash of about $77.5.

4-48

Kellogg Company and Subsidiaries


Consolidated Statement of Cash Flows
($ in millions)
Year Ended December 31, Year 2
Year 2
Operating Activities
Net earnings
Items in net earnings not requiring (providing) cash
Depreciation
Deferred income taxes
Other noncash expenses
Change in operating assets and liabilities
Accounts receivable
Inventories
Prepaid expenses
Accounts payable
Accrued liabilities
Cash provided by operations

$606.0
222.8
(5.4)
16.8
10.2
(41.4)
(22.9)
42.7
105.6
934.4

Investing Activities
Additions to properties
Property disposals
Other acquisitions
Cash used by investing activities

(333.5)
25.2
_(11.6)
(319.9)

Financing Activities
Borrowings of notes payable
Reduction of notes payable
Issuance of long-term debt
Reduction of long-term debt
Issuance of common stock
Purchase of treasury stock
Cash dividends
Other
Cash used by financing activities

182.1
(274.0)
4.3
(126.0)
17.7
(83.6)
(259.3)
__1.1
(537.7)

Effect of exchange rate changes on cash


Increase (decrease) in cash and temporary investments
Cash and temporary investments at beginning of year
Cash and temporary investments at end of year

_0.7
77.5
100.5
$178.0

4-49