CH 14

CHAPTER 14
THE STATEMENT OF CASH FLOWS
BRIEF EXERCISES
BE14–1
a. Depreciation expense is shown as an adjustment to net income to calculate cash flow. Depreciation
expense is added back to net income because it is a non-cash expense. This means that it is deducted in
the calculation of net income but there is no cash expenditure related to depreciation.
b. Net income plus depreciation does not equal net cash provided by operating activities because all of the
changes in current assets and current liabilities are also shown in the cash provided by operating
activities section. Increases in current asset accounts represent a use of cash and increases in current
liabilities present a source of cash.
c. The estimated net change in current assets and current liabilities is $0.2 billion. This is calculated by
taking $10.6 billion net cash provided by operating activities minus (net income of -$12.7 billion plus
$5.1 billion of depreciation and amortization plus the $18.0 non-cash impairment expense).
BE14–2
During 2012 Pier One collected $1,694 million from its customers. This can be calculated as follows:
Accounts receivable, beginning balance $ 16.3 million

Add: 2012 Sales 1.7 billion
Less: Accounts receivable, ending balance 22.3 million
Cash collected during 2012 $1,694 million
BE14–3
a. Cost of inventories purchased during 2012 equals:
Inventory, ending balance $356 million

Add: 2012 Cost of sales 962 million
Less: Inventory, beginning balance 322 million
Inventory purchased in 2012 $996 million
b. Cash payments made to suppliers during 2012 equals:
Accounts payable, beginning balance $ 64 million

Add: 2012 inventory purchases 996million
Less: Accounts payable, ending balance – 59 million
Cash payments to suppliers made in 2012 $ 1,001 million
BE14–4
a. Agilent AMD
1
Cash from operations $1,228 $ (338)
Cash from investing (2,372) (19)
Cash from financing (31) 37
Change in cash $(1,175) $ (320)
b. AMD is generating cash from financing activities—that is, the company is raising cash from equity
and/or debt issuances. Agilent, on the other hand, is using cash to return to shareholders and/or repay
debt. Both companies are investing cash in long-term assets. Finally, Agilent is generating cash from
operations, while AMD’s core business is losing cash balances. Overall, AMD is only generating cash
through financing, while Agilent is increasing cash balances from its daily operations.
c. Cash from operations exceeds the net income(loss) figure due to depreciation, other non-cash expenses
and the change to operating accounts (such as receivables, payables). The difference in Cash from
Financing Activities tells you that AMD is having to supplement its cash balance deficits (from
operations) through borrowings and/or equity issuances while Agilent is able to use the positive cash
generated by its operations to pay dividends and/or repurchase shares and/or reduce debt.
BE14–5
a. In 2011 profit was below operating cash flows because the change in operating accounts (such as
receivables and payables) acted as a source of cash balances. Receivables decreased and/or payables
increased, increasing cash balances as the cash was freed up from the operating account line(s). In
2012, when profits exceeded operating cash flows, the change in account balances reversed from what
happened in the prior year. The operating accounts in 2012 were a use of cash, with receivables
increasing and/or payables decreasing (which tied up cash in the operating account line).
b. In 2011 the company used its cash flow from operations and combined it with the proceeds from long
term asset assets to fund a rather large return of cash to debt and equity providers. In 2012, the
company sold off more long term assets and used that cash to cover shortfalls from operations and to
pay dividends, repurchase shares, and/or reduce debt.
EXERCISES
E14–1
1. Investing activity
2. Financing activity
3. Operating activity
6. Investing activity (for the cash paid for the building)
Financing activity (for the mortgage payable)
7. Financing activity (for the principal payment)
Operating activity (for the interest payment)
E14–2
1. Not included on the statement of cash flows because it does not affect cash. As proof, the entry for
this event would be:
Allowance for Doubtful Accounts (+A)................................ XX

Accounts Receivable (–A).............................................. XX
Wrote off uncollectible accounts.
4. Any gain or loss would be adjusted out of operating activities. The exchange of notes for the
building would have no net impact on the statement of cash flows because it does not affect cash.
As proof, the entry for this event would be:
Notes Receivable (+A)........................................................... XX

Accumulated Depreciation: Building (+A)........................... XX
Building (–A)................................................................... XX
Sold a building in exchange for a five year note.
Dividend (–SE)....................................................................... XX
Dividend Payable (+L).................................................... XX
Declared a dividend.
Bonds Payable (–L)................................................................ XX

Common Stock (+SE)..................................................... XX
Retired bonds with common stock.
E14–2 Concluded
Dividend (–SE)....................................................................... XX
Common Stock (+SE)..................................................... XX
Additional Paid-in Capital, Common Stock (+SE)......... XX
Declared and issued a stock dividend.
Depreciation Expense (E, –SE)............................................. XX

Accumulated Depreciation (–A)..................................... XX
Depreciated fixed assets.
10.Operating activity
Inventory (+A)........................................................................ XX
Accounts Payable (+L).................................................... XX
Purchased inventory on account.
13. Any gain or loss would be included in operating activities only to adjust Net Income. The balance
of the transaction would not be included on the statement of cash flows because it does not affect
cash. As proof, the entry for this event would be:
Land (+A)............................................................................... XX
Accumulated Depreciation: Building (+A)........................... XX
Building (–A)................................................................... XX
Exchanged a building for land.
E14–3
Cash Provided (Used) by Net Increase
Company Operations Investments Financing (Decrease)
AAA 320 (178) $(180) $ (38)
BBB 219 (450) 190 (41)
CCC 197 (414) 80 (137)
DDD 120 (130) 430 420
EEE 290 (120) (100) 70
AAA
This company appears to be following a policy of maintaining a relatively constant cash balance. The
company also appears to be relying primarily on operating activities to provide cash to finance the
acquisition of nonoperating assets and to finance the repayment of debt and/or acquisition of treasury stock.
BBB
Similar to AAA, this company appears to be following a policy of maintaining a relatively constant cash
balance. This company also appears to be using cash from operating activities and from borrowings to
purchase nonoperating assets.
CCC
CCC appears to be using large amounts of cash generated in both the current and prior periods to acquire
nonoperating assets. This company also appears to disdain borrowing money.
DDD
DDD appears to be following a policy of acquiring large amounts of cash in the current period. The
company acquired this cash primarily through borrowings.
EEE
EEE appears to be acquiring moderate amounts of cash in the current period through operating activities.
Similar to Company AAA, Company EEE used some of this cash to acquire nonoperating assets and to
repay existing debts and/or to acquire treasury stock.
E14–4
Kraft Foods – Cash from Investments ($422): the company was able to generate cash from operations and
used much of this increase in cash to repay debt, pay dividends, and/or repurchase equity. The company
also used cash to purchase long-term assets and build up its cash position.
Kellogg’s – Net Change in Cash ($170): the company was able to generate cash from operations and from
debt and equity issuances. The company used that cash to reinvest heavily in long-term assets.
General Mills– Cash from Operations $2,384: the company was able to generate a significant amount of
cash from operations and used that cash to reinvest in long-term assets and to repay debt, pay dividends,
and/or repurchase equity.
E14–5
Assets = Liabilities + Owners’ Equity
1. Depreciation expense –170,000 = –170,000
2. Issue of common stock +180,000 = +180,000
3. Purchase IBM stock 375,000 (securities)

–375,000 (cash)
4. Purchase insurance +27,000 (ppd insurance)

–27,000 (cash)
5. Purchase of building +200,000 (building)

– 40,000 (cash) = +160,000 (mortgage)
1. Under the direct method, depreciation expense is not included on the statement of cash flows because it
does not affect cash. However, under the indirect method, depreciation expense is included under
operating activities as an adjustment to net income to arrive at net cash flows from operating activities.
2. Issuance of common stock, $180,000, increases cash. The $180,000 would be included in the
financing activities section.
3. Purchase of marketable securities, $375,000, decreases cash. Marketable securities are nonoperating
assets for most businesses. Consequently, the purchase of these securities for cash would be disclosed in
the investing activities section.
4. Prepaid insurance, $27,000, decreases cash. The $27,000 would be included in the operating activities
section.
5. Down payment on building, $40,000, decreases cash. The $40,000 would be included under investing
activities. (The mortgage would be disclosed in the footnotes to the financial statements or in a
supplemental schedule to the statement of cash flows.)
E14–6
a. 1. Merchandise Inventory and Accounts Payable
2. Prepaid Insurance
3. Unearned Sales Revenue, Accounts Receivable and Allowance for Doubtful Accounts
4. Rent Payable and Prepaid Rent
5. Dividends Receivable
6. Wages Payable
7. Supplies Inventory
8. Interest Payable, Prepaid Interest, Premium on Bonds Payable, and Discount on Bonds Payable.
Note that if a company does not use a Premium on Bonds Payable account for bonds issued at a
premium or a Discount on Bonds Payable account for bonds issued at a discount, it would be
necessary to use the Bonds Payable account to analyze cash flows associated with interest.
9. Unearned Rent
10. Accumulated Depreciation
E14–6 Concluded
b. Sales Revenue
1. Unearned Sales Revenue would increase when a company collects cash from a customer in
advance of providing goods or services. Since this amount would not be reflected in Sales Revenue
until the company provided goods or services, the amount of the increase in Unearned Sales
Revenue would have to be added to accrual-basis sales.
2. Accounts Receivable would increase when a company makes credit sales. The amount of the
increase would be reflected in Sales Revenue, yet the company would not have collected any cash.
Thus, the amount of the increase in Accounts Receivable would have to be deducted from accrual-
basis sales.
3. An increase in Allowance for Doubtful Accounts by itself has no effect on accrual-basis sales.
However, one must analyze the account to determine whether the company had any write-offs or
recoveries of previously written off accounts during the year. Write-offs would be deducted from
accrual-basis sales, while recoveries would be added to accrual-basis sales to arrive at cash
collections from sales.
Cost of Goods Sold

Adjusting the balance in Cost of Goods Sold for changes in Merchandise Inventory and Accounts
Payable will convert COGS from the accrual-basis to the cash outflow for inventory. An increase in
Merchandise Inventory means that the company purchased more inventory than it sold during the year.
An increase in the balance of Merchandise Inventory is added to COGS because it is assumed that the
company paid cash for the inventory it acquired during the year. However, an increase in the balance of
Accounts Payable indicates that this assumption is not
valid. That is, an increase in Accounts Payable implies that the company purchased some of its
inventory on account rather than for cash. Thus, the increase in Accounts Payable has to be
deducted from COGS to offset the increase in Merchandise Inventory added to COGS that did not really
reflect cash outflows.
Interest Expense
1. An increase in Interest Payable would be deducted from accrual-basis interest expense because the
increase implies that the company incurred interest expense, but has not yet paid it. Thus, the
balance in Interest Expense overstates the amount of cash disbursed during the year for interest.
2. An increase in Prepaid Interest implies that the company disbursed cash during the year to cover
future interest expense. Since the cash disbursement is not reflected in the current period's interest
expense, the increase in Prepaid Interest would be added to accrual-basis interest expense to arrive
at cash outflows associated with interest.
3. An increase in Discount on Bonds Payable does not affect interest expense per se; it indicates that
the company issued additional bonds at less than face value. However, the net increase in the
discount is comprised of two components. First, the discount balance increases for the discount
associated with the new bonds issued. Second, the discount balance decreases for the amount of the
discount balance amortized during the accounting period. Since the amount of the amortized
discount flows into interest expense, the amount of the discount amortized would be deducted from
accrual-basis interest expense. Consequently, the discount account would have to be analyzed in
depth to determine the magnitude of these two components. Similarly, the balance in Premium on
Bonds Payable would have to be analyzed in depth.
E14–7
a. Hamilton Watson
Direct method
Cash collections from customers $ 900,000 $ 900,000
Cash paid for inventory (400,000) (400,000)
Cash paid for other expenses (200,000) (200,000)
Net cash flow from operating activities $ 300,000 $ 300,000
Indirect method
Net income $ 250,000 $ 200,000
Adjustments:
Depreciation expense 50,000 100,000
Net cash flow from operating activities $ 300,000 $ 300,000
b. Cash flows from operating activities measures all the cash inflows and cash outflows associated with a
company's operating assets and liabilities. Alternatively, net income measures the inflows and outflows
of operating assets and liabilities, not just the cash associated with operating assets and liabilities. Thus,
cash flows from operating activities can differ from net income due to items affecting net income that
do not affect cash and due to cash flows that do not affect net income. In this particular case, the
difference is due to depreciation expense. Depreciation is the systematic allocation of the cost of fixed
assets. Since depreciation is simply the allocation of the asset's cost, depreciation does not affect cash
flows. The indirect method more clearly shows that net income is different from cash flows because this
method explicitly reconciles the difference between the two.
c. Disagree. Many people think that depreciation expense represents a fund established to finance future
acquisitions of fixed assets. If this were true, it would follow that companies using accelerated
depreciation methods would have more cash available than companies that use straight-line
depreciation. However, as demonstrated in part (a), depreciation expense has absolutely no effect on the
cash flows from operating activities. Both companies have the same cash flows, even though each
company uses a different method to compute depreciation. One must remember that depreciation is
simply the allocation of the net cost of fixed assets. Cash flows associated with fixed assets arise when
fixed assets are acquired or sold, not when the cost of the fixed asset is allocated to expenses.
E14–8
a. 1. Cash (+A)........................................................................................ 20,000
Contributed Capital (+SE)....................................................... 20,000
Owner contributed capital.
2. Cash (+A)........................................................................................ 60,000

Notes Payable (+L).................................................................. 60,000
Borrowed money from the bank.
3. Property, Plant, & Equipment (+A)................................................ 25,000

Cash (–A)................................................................................. 25,000
Purchased long-lived assets.
4. Inventory (+A) 40,000

Cash (–A)................................................................................. 25,000
Accounts Payable (+L)............................................................ 15,000
Purchased inventory.
E14–8 Continued
5. Cash (+A)........................................................................................ 20,000

Accounts Receivable (+A).............................................................. 60,000
Sales (R, +SE).......................................................................... 80,000
Made sale.
Cost of Goods Sold (E, –SE).......................................................... 25,000

Inventory (–A).......................................................................... 25,000
Recognized cost of inventory sold.
6. Operating Expenses (E, –SE)......................................................... 18,000
Payable to Bank (–L)...................................................................... 5,000
Dividend (–SE)................................................................................ 2,000
Cash (–A)................................................................................. 25,000
Made cash disbursements.
7. Operating Expenses (E, –SE)......................................................... 15,000

Operating Expenses Payable (+L)........................................... 15,000
Incurred, but did not pay, expenses.
b.
Tony’s Business
Income Statement
For the Year Ended December 31, 2015
Sales............................................................................................................. $ 80,000
Cost of goods sold....................................................................................... (25,000)
Operating expenses..................................................................................... (33,000)
Net income.................................................................................................. $ 22,000
Tony's Business
Statement of Retained Earnings
Beginning retained earnings balance: January 1, 2015.............................. $ 0
Plus: Net income......................................................................................... 22,000
Less: Dividends........................................................................................... (2,000)
Ending retained earnings, December 31, 2015.......................................... $ 20,000
E14–8 Continued
Tony's Business
Balance Sheet
December 31, 2015
Assets Liabilities & Stockholders' Equity
Cash....................................................... $ 25,000 Accounts payable...................... $ 15,000
Accounts receivable.............................. 60,000 Operating expenses payable.... 15,000
Inventory................................................ 15,000 Payable to bank......................... 55,000
Property, plant & equipment................. 25,000 Contributed capital.................... 20,000
Retained earnings...................... 20,000
Total liabilities and
Total assets............................................ $ 125,000 stockholders' equity................. $ 125,000
c. Cash
Beginning balance 0
Owner's contribution 20,000 Purchase of fixed assets 25,000
Proceeds from bank loan 60,000 Purchase of inventory 25,000
Proceeds from sale 20,000 Operating expenses 18,000
Principal payment 5,000
Dividend payment 2,000
Ending balance 25,000
Tony's Business
Statement of Cash Flows
Cash from operating activities:
Cash collections from sales...................................................... $ 20,000
Cash paid for inventory............................................................ (25,000)
Cash paid for expenses............................................................. (18,000)
Net cash increase (decrease) due to operating
activities........................................................................... $ (23,000)
Cash from investing activities:

Purchase of fixed assets........................................................... (25,000)
Cash from financing activities:

Proceeds from owner's contribution........................................ $ 20,000
Proceeds from bank loan.......................................................... 60,000
Principal repayment on debt.................................................... (5,000)
Payment of dividend................................................................ (2,000)
Net cash increase (decrease) due to financing
activities........................................................................... 73,000
Net increase (decrease) in cash.................................................... $ 25,000
Beginning cash balance, January 1, 2015..................................... 0

Ending cash balance, December 31, 2015.................................... $ 25,000
E14–8 Concluded
d.
Tony's Business
Net income.................................................................. $ 22,000
Adjustments:
Increase in accounts receivable............................ $ (60,000)
Increase in inventory............................................. (15,000)
Increase in accounts payable................................ 15,000
Increase in operating expense payable................. 15,000
Total adjustments............................................. (45,000)
Net cash increase (decrease) due
to operating activities............................ $ (23,000)

Purchase of fixed assets............................................. (25,000)

Proceeds from owner's contribution.......................... $ 20,000
Proceeds from bank loan............................................ 60,000
Principal repayment on debt...................................... (5,000)
Payment of dividend................................................... (2,000)
Net cash increase (decrease) due to
financing activities.............................................. 73,000
Net increase (decrease) in cash....................................... $ 25,000
Beginning cash balance, January 1, 2015....................... 0

Ending cash balance, December 31, 2015...................... $ 25,000
E14–9
a. 1. Cash (+A)........................................................................................ 6,000
Common Stock (+SE).............................................................. 6,000
Issued common stock.
2. Inventory (+A)................................................................................ 6,000

3. Equipment (+A).............................................................................. 5,000

Cash (–A)................................................................................. 5,000
Purchased equipment.
4. Cash (+A)........................................................................................ 10,000

Accounts Receivable (–A)....................................................... 10,000
Collected cash from customers.
E14–9 Continued
5. Accounts Payable (–L).................................................................... 5,000
Cash (–A)................................................................................. 5,000
Made payment to suppliers.
6. Dividend (–SE)................................................................................ 2,000

Cash (–A)................................................................................. 2,000
Declared and paid cash dividend.
7. Rent Expense (E, –SE).................................................................... 6,000

Prepaid Rent (+A)........................................................................... 6,000
Cash (–A)................................................................................. 12,000
Disbursed cash for rent.
8. Cash (+A)........................................................................................ 65,000

Accounts Receivable (+A).............................................................. 35,000
Sales (R, +SE).......................................................................... 100,000
Made sales.
9. Miscellaneous Expenses (E, –SE).................................................. 40,000

Cash (–A)................................................................................. 40,000
Incurred and paid miscellaneous expenses.
10. Cash (+A)........................................................................................ 25,000

Marketable Securities (–A)...................................................... 20,000
Gain on Sale of Marketable Securities (Ga, +SE)................... 5,000
Sold marketable securities.
b. Cash
(B.B.) 25,000
(1) 6,000 (3) 5,000
(4) 10,000 (5) 5,000
(8) 65,000 (6) 2,000
(10) 25,000 (7) 12,000
(9) 40,000
(E.B.) 67,000
E14–9 Concluded
c.
Driftwood Shipbuilders
Cash flows from operating activities:
Cash collections from customers.......................................... $ 75,000
Cash payments for rent......................................................... (12,000)
Cash payments for miscellaneous expenses........................ (40,000)
Cash payments for inventory................................................ (5,000)
Net cash increase due to operating activities.................. $ 18,000
Cash flows from investing activities:

Proceeds from sale of marketable securities........................ $ 25,000
Purchase of equipment.......................................................... (5,000)
Net cash increase due to investing activities.................. 20,000
Cash flows from financing activities:

Proceeds from issue of common stock................................. $ 6,000
Dividend payment................................................................. (2,000)
Net cash increase due to financing activities.................. 4,000
Net increase in cash................................................................... $ 42,000
Beginning cash balance, January 1, 2015................................. 25,000

Ending cash balance, December 31, 2015................................ $ 67,000
E14–10
Insurance
2015 Ending prepaid insurance = 2015 Beginning prepaid insurance + Insurance purchases
during 2015– 2015 Insurance expense
$7,000 = $4,200 + Insurance purchases – $3,000
Insurance purchases = $5,800
Wages
2015 Ending wages payable = 2015 Beginning wages payable + 2015 Wage expense –
Wages paid during 2015
$6,000 = $0 + $8,500 – Wages paid
Wages paid = $2,500
E14–11
a. 2015 Ending machinery = 2015 Beginning machinery + Cost of machinery purchased
during 2015 – Cost of machinery sold during 2015
$45,000 = $20,000 + Machinery purchased – $8,000
Machinery purchased = $33,000
b. When the machinery was sold during 2015, Dylan’s Toys, would prepare the appropriate entry using
the following format.
Cash (+A)................................................................ XX
Accumulated Depreciation (+A)............................ XX
Machinery (–A)............................................... XX
Gain on Sale of Machinery (Ga, +SE)............ XX
We can find the cash collected for the sale of the machinery by first calculating the other three amounts.
Machinery
It is given in the exercise that the cost of the machinery sold was $8,000.
Gain on Sale of Machinery

It is given in the exercise that the gain on the sale was $2,000.
Accumulated Depreciation
2015 Ending accumulated depreciation = 2015 Beginning accumulated depreciation +
2015 Depreciation expense – Accumulated
depreciation on items sold
$15,000 = $10,000 + $7,000 – Accumulated
depreciation on items sold
Accumulated depreciation on items sold = $2,000
From the entry given above,

Cash = Cost of machinery sold + Gain on sale of machinery – Accumulated depreciation on
machinery sold
= $8,000 + $2,000 – $2,000
= $8,000
c. Cash (+A).................................................................................................... 8,000

Accumulated Depreciation (+A)................................................................ 2,000
Machinery (–A).................................................................................... 8,000
Gain on Sale of Machinery (Ga, +SE)................................................ 2,000
Sold machinery.
E14–12
Cash Receipts Cash Payments
12/31/11 accounts receivable $ 499 Change in payables (‘12-‘11) $ 79
2012 Sales 17,097 2012 cost of sales 14,803
12/31/12 accounts receivable (466) Change in inventory (‘11-’12) (54)
2012 cash receipts $17,130 2012 cash payments $ 14,828
E14–13
1. Direct method
The first step in calculating the cash flows from operating activities is to calculate the cash inflows and
outflows associated with each income statement account. These calculations are given below.
Cash collections from customers:

Cash collections from customers = Sales – Ending accounts receivable + Beginning
accounts receivable + Ending deferred revenues –
Beginning deferred revenues
= $48,000 – $4,000 + $5,000 + $0 – $3,000
= $46,000
Cash paid for inventory:

a. Inventory purchased
2015 Ending inventory = 2015 Beginning inventory + Net inventory purchased during
2015 – 2015 Cost of goods sold
$9,000 = $11,000 + Net purchases – $30,000
Net purchases = $28,000
b. Disbursements for inventory

2015 Ending accounts payable = 2015 Beginning accounts payable + Net inventory
purchased during 2015 – Payments for inventory
during 2015
$3,000 = $4,000 + $28,000 – Payments
Payments = $29,000
Cash paid for wages:

2015 Ending wages payable = 2015 Beginning wages payable + 2015 Wage Expense –
Wages paid during 2015
$1,800 = $900 + $4,000 – Wages paid
Wages paid = $3,100
Cash paid for advertising:

2015 Ending prepaid advertising = 2015 Beginning prepaid advertising + Advertising paid –
2015 Advertising expense
$3,000 = $1,200 + Advertising paid – $1,000
Advertising paid = $2,800

Cash collections from customers......................................................... $ 46,000
Payments for inventory........................................................................ (29,000)
Payments for wages............................................................................. (3,100)
Payments for advertising...................................................................... (2,800)
Net cash increase due to operating activities...................................... $ 11,100
E14–13 Concluded
2. Indirect method

Net income.............................................................................. $ 11,000
Adjustments:
Depreciation...................................................................... $ 2,000
Decrease in accounts receivable....................................... 1,000
Decrease in inventory........................................................ 2,000
Increase in wages payable................................................. 900
Increase in prepaid advertising......................................... (1,800)
Decrease in deferred revenues.......................................... (3,000)
Decrease in accounts payable........................................... (1,000)
Total adjustments......................................................... 100
Net cash increase due to operating
activities............................................................... $ 11,100
E14–14
Grimes Pools

Cash paid on operating liabilities............................................. (6,000)
activities........................................................................... $ (5,000)

Proceeds from sale of nonoperating assets.............................. 8,000a

Proceeds from issuing debt...................................................... $ 2,000b
Payment of dividends............................................................... (3,000)
Repurchase of contributed capital........................................... (4,000)c
activities........................................................................... (5,000)
Net increase (decrease) in cash.................................................... $ (2,000)
Beginning cash balance, January 1, 2015..................................... 6,000

a Proceeds from sale of nonoperating assets equals the decrease in nonoperating assets. Since no gain
on sale of assets or loss on sale of assets is reported, one must assume that the book value of the
assets sold equaled the proceeds from the sale.
b Proceeds from issue of debt = Increase in nonoperating liabilities
c Repurchase of contributed capital = Decrease in contributed capital
E14–15
Romora Supply House

Cash from decrease in noncash operating assets..................... 5,000
Cash from increase in operating liabilities.............................. 5,000
activities........................................................................... $ 13,000

Purchase of nonoperating assets.............................................. (4,000)a

Proceeds from contributed capital........................................... $ 3,000b
Payment on debt....................................................................... (2,000)c
Payment of dividends............................................................... (3,000)
activities........................................................................... (2,000)
Net increase (decrease) in cash.................................................... $ 7,000

a Purchase of nonoperating assets = Increase in nonoperating assets

b Proceeds from contributed capital = Increase in contributed capital
c Payment on nonoperating debt = Decrease in nonoperating liabilities
E14–16
Accrual-Basis Sales
2015 Sales = Cash inflows from sales made during 2015 + 2015 Ending accounts
receivable – 2015 Beginning accounts receivable – 2015 Ending deferred
revenue + 2015 Beginning deferred revenue
= $65,000 + $3,000 – $9,000 – $4,000 + $1,000
= $56,000
Accrual-Basis COGS
2015 COGS = Cash disbursements during 2015 for inventory – 2015 Ending inventory +
2015 Beginning inventory + 2015 Ending accounts payable – 2015
Beginning accounts payable
= $40,000 – $18,000 + $10,000 + $7,000 – $3,000
= $36,000
E14–16 Concluded
Accrual-Basis Wage Expense
2015 Wage expense = Cash disbursements during 2015 for wages + 2015 Ending wages
payable – 2015 Beginning wages payable
= $6,000 + $2,100 – $1,300
= $6,800
Accrual-Basis Advertising Expense

2015 Advertising expense = Cash disbursement during 2015 for advertising – 2015 Ending
prepaid advertising + 2015 Beginning prepaid advertising
= $1,000 – $5,000 + $8,000
= $4,000
Depreciation Expense
2015 Depreciation expense = 2015 Ending accumulated depreciation – 2015 Beginning
accumulated depreciation
= $8,000 – $5,000
= $3,000
Schlee and Associates

Income Statement
Sales................................................................................................................ $ 56,000
Cost of goods sold.......................................................................................... (36,000)
Wage expense................................................................................................. (6,800)
Advertising expense....................................................................................... (4,000)
Depreciation expense..................................................................................... (3,000)
Net income...................................................................................................... $ 6,200
E14–17
L.L. Beeno
Operating Section – Statement of Cash Flows (Direct Method)

Cash receipts from revenues.................................................... $ 45,900
Cash payments for inventory................................................... (26,400)
Cash payments for wages......................................................... (5,100)
Cash payments for insurance................................................... (3,900)
Cash payments for interest....................................................... (1,600)
Cash payments for taxes.......................................................... _(1,200)
activities........................................................................... $ 7,700
E14–17 Concluded
L.L. Beeno
Operating Section – Statement of Cash Flows (Indirect Method)

Net income.............................................................................. $ 5,500
Adjustments:
Depreciation expense........................................................ $ 3,300
Increase in accounts receivable........................................ (1,100)
Decrease in inventory........................................................ 300
Decrease in prepaid insurance.......................................... 300
Increase in wages payable................................................. 1,100
Total adjustments......................................................... 2,200
activities............................................................... $ 7,700
E14–18
Martland Stores

Cash payments for insurance................................................... (8,900)
Cash payments for interest....................................................... _(2,100)
activities........................................................................... $ 10,800
E14–18 Concluded
Martland Stores

Net income.............................................................................. $ (3,600)
Adjustments:
Decrease in prepaid insurance.......................................... 300
Decrease in accounts payable........................................... (500)
Increase in wages payable................................................. 2,100
activities............................................................... $ 10,800
E14–19
Mako Retail

Cash payments for rent............................................................ (8,400)
Cash payments for taxes.......................................................... _ (4,400)
activities........................................................................... $ 20,500
E14–19 Concluded
Mako Retail

Net income.............................................................................. $ 11,200
Adjustments:
Loss on sale of equipment................................................. 4,200
Increase in accounts receivable........................................ (2,200)
Decrease in inventory........................................................ 600
Decrease in prepaid rent................................................... 600
Increase in wages payable................................................ 2,200
Decrease in interest payable............................................. (700)
Increase in unearned revenue........................................... _ 1,800
activities............................................................... $ 20,500
E14–20
Steeler and Jones

activities........................................................................... $ 2,300
E14–20 Concluded
Steeler and Jones


Net income.............................................................................. $ 9,300
Adjustments:
Gain on sale of equipment................................................ (5,200)
Decrease in inventory....................................................... 1,500
Increase in prepaid rent..................................................... (400)
Decrease in wages payable............................................... (2,300)
Increase in interest payable............................................... 200
Decrease in unearned revenue.......................................... _ (2,200)
Total adjustments......................................................... (7,000)
activities............................................................... $ 2,300
E14–21
Harbaugh Auto Supply


Cash receipts from sales revenue............................................. $ 47,000
Cash receipts from service revenues....................................... 32,400
Cash receipts from interest revenue........................................ 9,600
Cash payments for taxes.......................................................... (10,300)
activities........................................................................... $ 10,900
E14–21 Concluded
Harbaugh Auto Supply


Net income.............................................................................. $ 24,300
Adjustments:
Gain on sale of investments.............................................. (13,200)
Increase in accounts receivable........................................ (500)
Increase in inventory......................................................... (2,900)
Decrease in interest receivable......................................... 300
Increase in prepaid rent..................................................... (1,200)
Decrease in wages payable............................................... (1,400)
Increase in interest payable............................................... 600
Decrease in taxes payable................................................. (1,200)
Decrease in unearned revenue.......................................... (2,800)
Total adjustments......................................................... (13,400)
activities............................................................... $ 10,900
E14–22
Standard Center Manufacturing

Cash receipts from sales revenue............................................. $ 73,500
Cash receipts from service revenue......................................... 25,800
Cash receipts from interest revenue........................................ 9,500
activities........................................................................... $ 30,300
E14–22 Concluded
Standard Center Manufacturing


Net income.............................................................................. $2,800
Adjustments:
Loss on sale of investments.............................................. 17,900
Decrease in interest receivable......................................... 2,200
Increase in prepaid rent..................................................... (2,700)
Increase in accounts payable............................................ 3,900
Decrease in wages payable............................................... (400)
Decrease in interest payable............................................. (300)
Decrease in taxes payable................................................. (2,000)
Decrease in unearned revenue.......................................... _(2,400)
activities............................................................... $30,300
E14–23
An estimate of net cash from operations would be:
Income before tax 552

Less: Tax (543)
Plus: Provision for Dep. & Amortization 1,610
Less: Net gains on sales of assets (186)
Plus: Provision for impairment 719
Less: Net increase in working capital (42)
Cash from operations 2,110
Taxes are deducted because they represent an operating cash outflow, while the non-cash charges for
depreciation/amortization and impairment are added back. The sale of assets is an investing activity, so it
should not be included in the operating section, while the increase in working capital represents a use of
cash and is therefore deducted.
PROBLEMS
P14–1
a., b., and c.
Transaction Section Inflow Outflow Amount
1. Operating X $ 60,000
2. N/A
3. Operating X 40,000
4. Investing X 94,000
Financing X 75,000
6. N/A
7. Financing X 150,000
8. N/A
11. N/A
P14–2
a., b., and c.
Transaction Section Inflow Outflow Amount
1. Operating X $ 52,000
4. N/A
Investing X 90,000
11. N/A
12. N/A
13. N/A
P14–3
a. Transaction Cash Affected Type of Effect Dollar Amount

1. Yes Provided $ 1,200
2. Yes Used 13,000
3. Yes Used 9,000
4. Yes Provided 7,000
7. No
8. Yes Used 7,000
9. Yes Used 5,000
10. No
11. No
12. No
13. No
b. 1. Investing
2. Investing
3. Operating
4. Financing
5. Operating (for the interest)
Investing or Operating (for the principal) depending on how the company acquired the note. If
it was accepted in a sales transaction, it could be argued that collecting the principal is an
operating activity. If the company acquired the note in any other way, the collection of the
principal would be considered an investing activity.
6. Operating
7. N/A
8. Financing
9. Operating
10. N/A
11. N/A
12. N/A
13. N/A
P14–4
The two most notable similarities among all three companies are that they have generated increasing
amounts of cash from their operating activities and that they all have used cash to invest in long-term
assets. Two of the three companies also look very similar from a financing perspective. Priceline and
Amazon typically generated cash from financing activities, meaning the firms issued equity and/or debt
to raise cash. On the other hand, eBay used cash in its financing activities, which indicates either
dividends have been paid, debt has been retired, or equity has been repurchased.
P14–5
Transaction Effect on Cash Section of Statement Explanation
1. $50,000 Operating Operations is defined in terms of
inventory activity.
2. (55,000) Operating Cash payments for operating
expenses.
3. 100,000 Investing Sale of a nonoperating asset.
Note: If the company uses the indirect method to prepare its statement of cash flows, the $15,000 loss
on sale of fixed assets would be included in the operating activities section as an adjustment to net
income to arrive at net cash flow from operating activities.
4. (70,000) Financing Dividend payment.

5. (500,000) Financing Stock repurchase.
6. (100,000) Operating Cash payment associated with
operating assets.
7. No effect N/A No effect on cash.
8. (500,000) Investing Cash payment for an investment
in equity securities,
a nonoperating asset.
9. $202,000 Financing Issuing debt provides financing
to the company.
10. No effect Operating Net income would be lower but
would be offset by an increase in
rent payable. The net of these
two is a zero effect on cash.
P14–6
2015 2014 2013
a. Cash from operating activities $ X $ (202) $ X

Cash from investing activities 160 X (500)
Cash from financing activities (150) 280 900
Increase (decrease) in cash $ X $ (24) $ 110
Cash balance at beginning of year 86 X 0
Cash balance at end of year $ 176 $ 86 $ X
Missing values $ 80 $ (102) $ (290)
90 110 110
b. Ruttman Enterprises began operations during 2013. As part of its start-up phase, the company appears
to have issued large amounts of stock and/or debt to finance the acquisition of nonoperating assets, to
cover the cash used by operating activities during the start-up phase, and to provide a cash surplus for
future years. During 2014, the company once again issued large amounts of stock and/or debt to finance
the acquisition of nonoperating assets and to cover the cash used by operating activities. However, the
company acquired only enough additional financing to meet these needs; it did not acquire an excessive
amount of capital through financing activities. By 2015 the company was generating cash from its
operating activities and was able to dispose of some of its nonoperating assets. These cash inflows were
then used to retire some of the company's debt and/or to reacquire some of its outstanding stock.
P14–7
a. 2012 2011 2010
Cash provided (used) by operating activities $10,571 $12,639 $11,922
Cash provided (used) by investing activities (3,453) (13,959) (11,359)
Cash provided (used) by financing activities (3,860) (1,566) (2,913)
Increase (decrease) in cash 3,258 (2,886) (2,350)
Cash balance at beginning of year 8,043 10,929 13,279
Cash balance at end of year $ 11,301 $ 8,043 $10,929
b. Cash from operations has been consistently strong over the three-year period. H-P uses this cash flow
to invest in its growing business (negative cash from investing activities in all three years) and is still
able to return cash to shareholders and repay any debt (negative cash from financing activities in all
three years). The company’s strong cash flow from operations allows it to continue to fund its growth
and to return cash to the sources of funding (debt and equity providers).
P14–8
a. Case 1:
Based on the $820,000 beginning balance in the Buildings account and the purchase during 2015 of a
building for $60,000, one would expect the Buildings account to have a balance of $880,000 at the end
of 2015. The fact that its balance is only $750,000 implies that Webb Industries must have sold a
building that originally cost $130,000. Similarly, based on the beginning balance of $80,000 in the
Accumulated Depreciation: Buildings account and the $40,000 of depreciation taken on the building
during 2015, one would expect the Accumulated Depreciation: Buildings account to have a balance of
$120,000 at the end of 2015. The fact that its balance is only $100,000 implies that the accumulated
depreciation associated with the building that Webb Industries sold during 2015 must have been
$20,000. This information is summarized in the following T accounts.
Buildings Accumulated Depreciation
B.B. 820,000 B.B. 80,000

Purchase 60,000 Sale X Sale Y Depr. Exp. 40,000
E.B. 750,000 E.B. 100,000
X = Cost of building sold = $130,000

Y = Accumulated depreciation on building sold = $20,000
Case 2:
Based on the $380,000 beginning balance in the Equipment account and the sale during 2015 of
equipment that originally cost $50,000, one would expect the Equipment account to have a balance at
the end of 2015 of $330,000. The fact that its balance is $500,000 implies that Webb Industries must
have purchased some equipment for $170,000. Similarly, based on the beginning balance of $85,000 in
the Accumulated Depreciation: Equipment account and the $15,000 of depreciation taken on the
equipment during 2015, one would expect the Accumulated Depreciation: Equipment account to have a
balance at the end of 2015 of $100,000. The fact that its balance is only $75,000 implies that the
accumulated depreciation associated with the equipment that Webb Industries sold during 2015 must
have been $25,000. This information is summarized in the following T accounts.
P14–8 Continued
Equipment Accumulated Depreciation
B.B. 380,000 B.B. 85,000
Purchase X Sale 50,000 Sale Y Depr. Exp. 15,000
E.B. 500,000 E.B. 75,000
X = Cost of equipment purchased = $170,000

Y = Accumulated depreciation on equipment sold = $25,000
Case 3:
Based on the $250,000 beginning balance in the Land account and the sale of land during 2015, one
would expect the balance in the Land account to decrease. The fact that its balance is still $250,000 at
the end of 2015 implies that (1) Webb Industries must have purchased some land during 2015 and (2)
the cost of the land purchased exactly equaled the original cost of the land that was sold. Since a gain on
the sale of land equals the excess of the proceeds over the cost of the land, it can be inferred that the
land that Webb Industries sold during 2015 originally cost $225,000 (i.e., proceeds of $300,000 less
gain of $75,000). Thus, the cost of the land that Webb Industries purchased during 2015 was $225,000.
This information is summarized in the following T account.
Land
B.B. 250,000
Purchase Y Sale X
E.B. 250,000
Y = Cost of land purchased = $225,000 X = Cost of land sold = $225,000
Case 4:
In exchange between two independent parties, one would expect the fair market value of the item given
up by one of the parties to equal the fair market value of the item that party is to receive. Thus, it is
probably safe to assume that the fair market value of the new building is $600,000. Based on the
$820,000 beginning balance in the Buildings account and the acquisition during 2015 of a new building
for $600,000, one would expect the Buildings account to have a balance of $1,420,000 at the end of
2015. The fact that its balance is only $750,000 implies that Webb Industries must have disposed of a
building during 2015 that originally cost $670,000. Similarly, based on the beginning balance of
$80,000 in the Accumulated Depreciation: Buildings account and the $40,000 of depreciation taken on
buildings during 2015, one would expect the Accumulated Depreciation: Buildings account to have a
balance at the end of 2015 of $120,000. The fact that its balance is only $100,000 implies that the
accumulated depreciation associated with the building that Webb Industries sold during 2015 must have
been $20,000.
Further, based on the $250,000 beginning balance in the Land account and the disposal during 2015 of
land that had a book value of $150,000, one would expect the Land account to have a balance of
$100,000 at the end of 2015. The fact that its balance is $250,000 implies that Webb Industries must
have acquired some land during 2015 that cost $150,000. This information is summarized in the
following T accounts.
P14–8 Continued
Buildings Accumulated Depreciation

B.B. 820,000 B.B. 80,000
Purchase 600,000 Sale X Sale Y Depr. Exp. 40,000
E.B. 750,000 E.B. 100,000
X = Cost of building sold = $670,000

Y = Accumulated depreciation on building sold = $20,000
Land
B.B. 250,000
Purchase Z Sale 150,000
E.B. 250,000
Z = Cost of land purchased = $150,000
b. Case 1:
Proceeds from sale = Cost of building sold – Related accumulated depreciation
= $130,000 – $20,000
= $110,000
Note: This solution assumes that there was no gain or loss on the sale of the building, since no such
information was given in the problem.
In the statement of cash flows for 2015, Webb Industries would report the following items under cash
flows from investing activities.
Proceeds from sale of building $ 110,000

Purchase of building (60,000)
Case 2:
Proceeds from sale = Book value of equipment sold + Gain on sale
= ($50,000 – $25,000) + $5,000
= $30,000
Proceeds from sale of equipment $ 30,000

Purchase of equipment (170,000)
Case 3:
Proceeds from the sale of land $300,000

Purchase of land (225,000)
P14–8 Concluded
Case 4:
Since Webb Industries exchanged land for a building, this transaction did not affect cash and would not
be disclosed in the body of the statement of cash flows. However, Webb Industries did collect $650,000
from the building it sold ($670,000 cost of building sold – $20,000 accumulated depreciation on the
building), which Webb Industries would report under cash flows from investing activities.
P14–9
Total number of shares issued during 2015 = Change in balance of common stock account
÷ Par value per share of common stock
= ($128,000 – $100,000) ÷ $1 per share
= 28,000 shares
Number of shares issued for cash = Total number of shares issued – (Shares issued as
stock dividend + Shares issued in exchange for land)
= 28,000 shares – [(100,000 shares outstanding on
1/1/15  20%) + 6,000 shares exchanged for land]
= 28,000 shares – (20,000 shares + 6,000 shares)
= 2,000 shares
Cash received = Change in common stock account due to issue of common stock for cash +
Change in additional paid-in capital, common stock account due to issue of common stock for
cash
= (2,000 shares  $1 par value per share) + [($95,000 – $12,000) –
$40,000a + $12,000b]
= $2,000 + $31,000
= $33,000
a $40,000 represents the additional paid-in capital from the 20% stock dividend. The company distributed
20,000 shares, and the fair market value at the time was $3 per share. One dollar was allocated to the
Common Stock account, and the remaining $2 was allocated to the Additional Paid-in Capital, Common
Stock account.
b $12,000 represents the additional paid-in capital from exchanging stock for land.
P14–10
a. Ending accounts receivable = Beginning accounts receivable + (Gross sales – Sales
returns) – Cash collections
2014
$95,000 = $0 + (Gross sales – $20,000) – $350,000
Gross sales = $465,000
2015
$150,000 = $95,000 + (Gross sales – $25,000) – $500,000
Gross sales = $580,000
P14–10Concluded
b. 2015 Ending inventory = 2015 Beginning inventory + Net purchases of inventory
during 2015 – 2015 Cost of goods sold
$110,000 = $130,000 + Net purchases – $375,000
Net purchases = $355,000
2015 Ending accounts payable = 2015 Beginning accounts payable + Net purchases of
inventory during 2015 – Cash payments for inventory
during 2015
$115,000 = $105,000 + $355,000 – Cash payments
Cash payments = $345,000
c. Ending prepaid insurance = Beginning prepaid insurance + Insurance purchased during

the year – Insurance expense
2014
Ending prepaid insurance = $0 + $65,000 – $35,000 = $30,000
2015
Ending prepaid insurance = $30,000 + $90,000 – $50,000 = $70,000
P14–11
Accrual sales = Collections from customers + Increase in accounts receivable
= $26,000 + $3,000
= $29,000
Accrual COGS = Payments to suppliers – Increase in inventory + Increase in accounts

payable
= $13,000 – $3,000 + $1,000
= $11,000
Accrual operating expenses = Payments for expenses – Decrease in accrued payables

= $10,000 – $2,000
= $8,000
Battery Builders, Inc.

Income Statement
Sales.................................................................................................................... $ 29,000
Cost of goods sold.............................................................................................. (11,000)
Depreciation expense......................................................................................... (3,000)
Other operating expenses................................................................................... (8,000)
Gain on sale of equipment................................................................................. 2,000
Net income......................................................................................................... $ 9,000
P14–12
a.
Pendleton Enterprises
Statement of Cash Flows from Operating Activities
For the Years Ended December 31, 2013, 2014, and 2015
2015 2014 2013
Cash collections from customers and sales*.............................. $ 9,000 $ 13,000 $ 4,000
Cash payments for expenses and to suppliers**........................ (12,000) (8,000) (4,000)
activities.................................................................................. $ (3,000) $ 5,000 $ 0
*Revenues minus increase in Accounts Receivable
**Expenses minus increase in Accounts Payable
b.
2015 2014 2013
Cash collections from customers and sales................................ $ 9,000 $ 9,000 $ 8,000
Cash payments for expenses and to suppliers............................. (12,000) (8,000) (4,000)
activities.................................................................................. $ (3,000) $ 1,000 $ 4,000
c.
2015 2014 2013
Cash collections from customers and sales................................ $ 9,000 $ 13,000 $ 4,000
Cash payments for expenses and to suppliers............................. (12,000) (11,000) (1,000)
activities.................................................................................. $ (3,000) $ 2,000 $ 3,000
d. Managers can manipulate cash flows from operating activities by manipulating the timing of cash
collections and cash payments associated with operating activities. By comparing parts (b) and (c) with
part (a), it is obvious that these types of manipulations offset themselves in the next period. So if a
manager wants to continue manipulating cash flows from operating activities, the manager will have to
manipulate the timing of cash inflows and outflows every year.
P14–13
Watson and Holmes Detective Agency
Statement of Cash Flows – Direct Method
Cash collections from customers............................................. $ 34,500*
Cash paid for inventory............................................................ (23,000)
Cash paid for interest............................................................... (2,800)
Cash paid for other expenses................................................... (9,000)
activities........................................................................... $ (300)

Purchase of long-lived assets................................................... $ (1,000)
Net cash increase (decrease) due to investing
activities........................................................................... (1,000)

Cash paid for dividends............................................................ $ (700)
Proceeds from issuance of common stock............................... 6,000
activities........................................................................... 5,300
Net increase in cash...................................................................... $ 4,000

* $35,500 = $42,000 revenues – $5,000 increase in accounts receivable + $500

increase in allowance for doubtful accounts – $2,000 bad debt expense –
$1,000 decrease in deferred revenues
P14–13 Concluded
Watson and Holmes Detective Agency
Statement of Cash Flows – Direct Method
Net income.................................................................. $ 2,000
Adjustments:
Depreciation.......................................................... $ 2,000
Increase in allowance for doubtful accounts........ 500
Decrease in accounts payable............................... (1,000)
Decrease in discount on note payable.................. 200
Increase in accounts receivable............................ (5,000)
Decrease in inventory........................................... 2,000
Decrease in deferred revenues............................. (1,000)
Total adjustments............................................. (2,300)
Net cash increase (decrease) due
to operating activities.............................. $ (300)
Purchase of long-lived assets..................................... $ (1,000)
investing activities............................................. (1,000)
Cash paid for dividends.............................................. $ (700)
Proceeds from issuance of common stock................. 6,000
financing activities............................................. 5,300
Net increase in cash......................................................... $ 4,000
Beginning cash balance, January 1, 2015....................... 6,000
Ending cash balance, December 31, 2015...................... $ 10,000
P14–14
a. 1. Cash (+A)........................................................................................ 60,000
Common Stock (+SE).............................................................. 60,000
2. Inventory (+A)................................................................................ 20,000

3. Prepaid Rent (+A)........................................................................... 7,000

Cash (–A)................................................................................. 7,000
Prepaid rent.
4. Furniture (+A)................................................................................. 30,000

Cash (–A)................................................................................. 20,000
Long-Term Note Payable (+L)................................................ 10,000
Purchased furniture.
P14–14 Continued
5a. Accounts Receivable (+A).............................................................. 35,200
Sales (R, +SE).......................................................................... 35,200
Made sales on account.
5b. Cost of Goods Sold (E, –SE).......................................................... 8,800

Inventory (–A).......................................................................... 8,800
6. Accounts Payable (–L).................................................................... 10,000

Cash (–A)................................................................................. 10,000
7. Cash (+A)........................................................................................ 12,000

Accounts Receivable (–A)....................................................... 12,000
8. Miscellaneous Expenses (E, –SE).................................................. 10,000

Cash (–A)................................................................................. 10,000
9. Depreciation Expense (E, –SE)...................................................... 5,000

Accumulated Depreciation (–A).............................................. 5,000
Depreciated furniture.
10. Interest Expense (E, –SE)............................................................... 1,000

Accrued Interest Payable (+L)................................................. 1,000
Incurred, but did not pay, interest.
11. Dividends (–SE).............................................................................. 3,000

Dividends Payable (+L)........................................................... 3,000
Declared dividends.
12. Rent Expense (E, –SE).................................................................... 3,000

Prepaid Rent (–A).................................................................... 3,000
Used portion of prepaid rent.
b.
ISS, Inc.
Income Statement
Sales.................................................................................................................... $ 35,200
Cost of goods sold.............................................................................................. (8,800)
Depreciation expense......................................................................................... (5,000)
Rent expense...................................................................................................... (3,000)
Interest expense.................................................................................................. (1,000)
Miscellaneous expenses..................................................................................... (10,000)
Net income......................................................................................................... $ 7,400
P14–14 Continued
ISS, Inc.
Statement of Retained Earnings
Beginning retained earnings balance: January 1, 2015..................................... $ 0
Plus: Net income................................................................................................ 7,400
Less: Dividends.................................................................................................. (3,000)
Ending retained earnings balance: December 31, 2015.................................... $ 4,400
ISS, Inc.
Balance Sheet
December 31, 2015
Assets Liabilities & Stockholders' Equity
Cash............................................... $ 25,000 Accounts payable...................... $ 10,000
Accounts receivable...................... 23,200 Accrued interest payable........... 1,000
Inventory....................................... 11,200 Dividend payable....................... 3,000
Prepaid rent................................... 4,000 Long-term note payable............ 10,000
Furniture........................................ 30,000 Common stock........................... 60,000
Accumulated depreciation............ (5,000) Retained earnings...................... 4,400
Total liabilities and
Total assets.................................... $ 88,400 stockholders' equity................. $ 88,400
ISS, Inc.
Statement of Cash Flows – Indirect Method
Net income....................................................................... $ 7,400
Adjustments:
Depreciation............................................................. $ 5,000
Increase in accounts receivable............................... (23,200)
Increase in inventory................................................ (11,200)
Increase in prepaid rent............................................ (4,000)
Increase in accounts payable.................................... 10,000
Increase in accrued interest payable........................ 1,000
Total adjustments............................................... (22,400)
Net cash increase (decrease)
due to operating activities......................... $ (15,000)
Purchase of furniture....................................................... $ (20,000)
investing activities................................................. (20,000)
Proceeds from issuance of common stock...................... $ 60,000
financing activities................................................ 60,000
Net increase (decrease) in cash.............................................. $ 25,000
Beginning cash balance, January 1, 2015.............................. 0
Ending cash balance, December 31, 2015............................. $ 25,000
P14–14 Concluded
c. Working capital = Current assets – Current liabilities
= ($25,000 + $23,200 + $11,200 + $4,000) – ($10,000 +
$1,000 + $3,000)
= $63,400 – $14,000
= $49,400
Current ratio = Current assets ÷ Current liabilities

= $63,400 ÷ $14,000
= 4.53
d. Working capital = ($63,400 – $10,000 cash) – ($14,000 – $10,000 accounts

payable)
= $53,400 – $4,000
= $49,400
Current ratio = $53,400 ÷ $4,000

= 13.35
Net cash flow used by operating activities = ($15,000) from part (b) + ($10,000)
= ($25,000)
P14–15
a. Marketing revenue
2015 Ending accounts receivable = 2015 Beginning accounts receivable + 2015
Marketing revenue – Cash collections during 2015
$150,000 = $105,000 + $1,000,000 – Cash collections
Cash collections = $955,000
Salary expense
Since no related balance sheet account exists as of December 31, 2014 or as of December 31, 2015, it is
safe to assume that the entire balance in Salary Expense was paid in cash. Therefore, the cash paid for
salaries equals $250,000.
Supplies expense
2015 Ending office supply inventory = 2015 Beginning office supply inventory + Office
supplies purchased during 2015 – 2015 Office
supplies expense
$75,000 = $85,000 + Supplies purchased – $175,000
Office supply purchases = $165,000
Depreciation expense
Depreciation is the allocation of the cost of a fixed asset. Depreciation does not provide cash or use
cash; hence, the cash flow associated with depreciation is zero.
Insurance expense
2015 Ending prepaid insurance = 2015 Beginning prepaid insurance + Insurance
purchased during 2015 – 2015 Insurance expense
$50,000 = $10,000 + Insurance purchased – $60,000
Insurance purchases = $100,000
P14–15 Concluded
Rent Expense
2015 Ending rent payable = 2015 Beginning rent payable + 2015 Rent expense – Rent
paid during 2015
$20,000 = $8,000 + $120,000 – Rent paid
Rent paid = $108,000
This method would be similar to directly computing net cash flow from operating activities since the
actual cash flow for each component of operating activities is being computed. Under the indirect
method, net cash flow from operating activities is computed by adjusting net income.
b. Net income.................................................................................... $ 295,000

Adjustments:
Depreciation expense............................................................... $ 100,000
Decrease in office supplies inventory...................................... 10,000
Increase in rent payable........................................................... 12,000
Increase in accounts receivable............................................... (45,000)
Increase in prepaid insurance.................................................. (40,000)
Total adjustments................................................................ 37,000
Net cash increase due to operating activities.............. $ 332,000
This method is similar to the indirect method since net income is adjusted for the change in each
operating account on the balance sheet to arrive at cash flows from operating activities. The magnitudes
of these adjustments are the same as in part (a). However, in part (a) each of these adjustments was
related to an individual operating activity to determine the actual cash inflow or actual cash outflow
associated with the individual operating activity; whereas in part (b) each adjustment is related to net
income to arrive at the overall net cash flow associated with all operating activities.
c. Operating Cash Flows

Income Statement Adjustments Direct Method
Marketing revenue $ 1,000,000 Increase in accts. receivable $(45,000) $ 955,000
Salary expense (250,000) None 0 (250,000)
Office supplies exp. (175,000) Decrease in office supplies
inventory 10,000 (165,000)
Depreciation exp. (100,000) Depreciation expense 100,000 0
Insurance expense (60,000) Increase in prepaid insurance (40,000) (100,000)
Rent expense (120,000) Increase in rent payable 12,000 (108,000)
Cash provided by operating
Net income $ 295,000 activities $ 332,000
P14–16
Direct method
Bower Manufacturing Industries

Cash collections from sales and accounts receivable.............. $ 90,000a
Cash paid to suppliers for inventory........................................ (90,000)
Cash paid for wages................................................................. (12,000)
Cash paid for supplies.............................................................. (5,000)
Net cash decrease due to operating activities.................... $ (22,000)

Proceeds from sale of fixed assets........................................... $ 125,000b
Proceeds from sale of marketable securities........................... 51,000c
Net cash increase due to investing activities...................... 176,000
Net cash flow from financing activities........................................ 0


a Cash collections include changes in both Accounts and Notes Receivable.

b Proceeds from sale of fixed assets is computed as follows:
Cost of machinery and equipment sold................................................. $ 150,000
Less: Related accumulated depreciation............................................... 15,000
Book value of machinery and equipment sold...................................... $ 135,000
Less: Loss on sale of fixed assets (per income statement)................... 10,000
Proceeds from sale of fixed assets......................................................... $ 125,000
c Proceeds from sale of marketable securities is computed as
follows:
Decrease in marketable securities......................................................... $ 55,000
Less: Loss on sale of marketable securities (per income
statement)............................................................................................ 4,000
Proceeds from sale of marketable securities......................................... $ 51,000
P14–16 Concluded
Indirect method
Bower Manufacturing Industries

Net income....................................................................... $ 37,000
Adjustments:
Decrease in inventory............................................... $ 25,000
Depreciation............................................................. 30,000
Decrease in discount on bonds payable................... 5,000
Decrease in supplies inventory................................ 2,000
Loss on sale of fixed assets...................................... 10,000
Loss on sale of marketable securities...................... 4,000
Increase in accounts receivable............................... (50,000)
Increase in notes receivable..................................... (50,000)
Decrease in accounts payable.................................. (35,000)
Total adjustments............................................... (59,000)
Net cash decrease due to operating
activities.................................................... $ (22,000)

Proceeds from sale of fixed assets.................................. $ 125,000
Proceeds from sale of marketable securities.................. 51,000
Net cash increase due to investing activities........... 176,000
Net cash flow from financing activities................................. 0

Net increase in cash................................................................ $ 154,000
Beginning cash balance, January 1, 2015.............................. 593,000

Ending cash balance, December 31, 2015............................. $ 747,000
P14–17
Direct method
Price Restaurant Supply Company


Cash collections from customers............................................. $ 165,000
Cash paid to suppliers for inventory........................................ (199,000)
Net cash decrease due to operating activities.................... $ (47,000)

Proceeds from sale of plant equipment................................... $ 90,000a
Purchase of plant equipment.................................................... (25,000)a
Net cash increase due to investing activities...................... 65,000

Proceeds from common stock issue......................................... $ 65,000b
Payment of dividends............................................................... (30,000)c
Net cash increase due to financing activities..................... 35,000

a Explanation of activity involving plant equipment:

Ending plant equipment = Beginning plant equipment + Equipment purchased –
Equipment sold
$275,000 = $350,000 + Equipment purchased – $100,000
Equipment purchased = $25,000
Proceeds from sale of equipment = Book value of assets sold + Gain on the sale
= [(Asset cost – Accumulated depreciation on asset
sold) + Gain on the sale]
= [($100,000 – $20,000) + $10,000]
= $90,000
b Proceeds from issue of common stock = Increase in common stock + Increase in

additional paid-in capital (common stock)
= $35,000 + $30,000
= $65,000
c Dividends = Beginning retained earnings + Net income – Ending retained earnings

= $204,000 + $37,000 – $211,000
= $30,000
P14–17 Concluded
Indirect method
Price Restaurant Supply Company

Net income............................................................ $ 37,000
Adjustments:
Depreciation..................................................... $ 12,000
Decrease in accounts receivable..................... 5,000
Decrease in prepaid insurance......................... 10,000
Increase in accounts payable........................... 1,000
Increase in inventory....................................... (100,000)
Decrease in premium on bonds payable......... (2,000)
Gain on sale of plant equipment...................... (10,000)
Total adjustments........................................ (84,000)
Net cash decrease due to
operating activities........................... $ (47,000)

Proceeds from sale of plant equipment................ $ 90,000
Purchase of plant equipment................................. (25,000)
Net cash increase due to
investing activities........................................ 65,000

Proceeds from common stock issue...................... $ 65,000
Payment of dividends............................................ (30,000)
Net cash increase due to financing
activities........................................................ 35,000
Net increase in cash................................................... $ 53,000
Beginning cash balance, January 1, 2015.................. 120,000

Ending cash balance, December 31, 2015................. $ 173,000
P14–18
a. 2014
Sales for cash..................................................................... $ 3,633,500a
Cash collections from accounts receivable...................... 4,936,500b
Total cash collections from customers...................... $ 8,570,000c
Cash payments for:
Salary................................................................................. $ 1,649,000d
Advertising........................................................................ 710,000
Administrative expenses................................................... 832,000
Janitorial expense.............................................................. 120,000
Supplies............................................................................. 232,000e
Total cash paid for expenses...................................... (3,543,000)
Net cash increase due to operating activities......................... $ 5,027,000
a $3,633,500 = 2014 sales of $5,590,000  65%

b Cash collections = Sales on account + Decrease in accounts receivable
= ($5,590,000  35%) + $2,980,000
= $4,936,500
c An alternative approach to calculating the $8,570,000 is to add the decrease in Accounts Receivable
during 2014 of $2,980,000 to the 2014 sales of $5,590,000.
d $1,649,000 = Salary expense of $1,794,000 – Salary payable of $145,000
e $232,000 = Supplies expense of $299,000 – Supply inventory payable of $67,000
2015
Sales for cash.......................................................................... $ 1,491,750a
Cash collections from accounts receivable............................ 2,803,500b
Total cash collections from customers........................... $ 4,295,250c
Cash payments for:
Salary...................................................................................... $ 2,145,000d
Advertising............................................................................. 705,000e
Administrative expenses........................................................ 898,000
Janitorial expense................................................................... 132,000
Supplies................................................................................... 348,000f
Total cash paid for expenses........................................... (4,228,000)
Net cash increase due to operating activities.............................. $ 67,250
a $1,491,750 = 2015 sales of $5,967,000  25%

b $2,803,500 = Sales on account – Increase in accounts receivable
= ($5,967,000  75%) – $1,671,750
c This amount can also be calculated as 2015 sales of $5,967,000 less the increase in Accounts
Receivable of $1,671,750 during 2015.
d $2,145,000 = Salary expense of $2,025,000 – Ending salary payable of $25,000
+ Beginning salary payable of $145,000
e $705,000 = Advertising expense of $755,000 – Advertising payable of $50,000
f $348,000 = Supplies expense of $281,000 + Beginning supply inventory payable
of $67,000
P14–18 Concluded
b. The first thing that must be explained to the stockholders is the nature of dividends. Dividends are paid
out of assets, not out of net income. If a company has insufficient assets or has alternative uses for its
assets, it will be unable to declare a cash dividend. Although net income is a measure of the net assets
that have flowed into the company during the year from operations, these net assets may be in a form,
such as inventory or accounts receivable, that cannot be easily distributed to stockholders. Thus, net
income provides only a low-quality indication of potential dividends. A better indication of a company's
potential ability to declare and pay cash dividends is the net cash flows from operating activities.
In this particular case, 2014 was a good year for the Lynch Engineering Firm. The company generated
$597,000 in net income and $5,027,000 in cash flows from operating activities [see part (a)]. The large
cash flows are due primarily to the collection of receivables that were outstanding at the beginning of
the year and were not associated at all with 2014 net income. 2015 was also a good year with respect to
net income; the company generated income of $638,000. However, the company realized only a net
cash flow from operating activities of $67,250. The low cash flows, in comparison to 2014's net cash
flows, are due to (1) a larger proportion of sales being on account in 2015 and (2) customers not paying
their accounts promptly. As a board member, you felt that the 2015 cash flows were insufficient to both
fund future operations and pay a dividend.
P14–19
a. Original entries
1a. Cash (+A)...................................................................................... 1,500,000
Common Stock (+SE)............................................................ 750,000
Additional Paid-In Capital, Common Stock (+SE)............... 750,000
1b. Cash (+A)...................................................................................... 102,000

Preferred Stock (+SE)............................................................ 100,000
Additional Paid-In Capital, Preferred Stock (+SE)............... 2,000
Issued preferred stock.
2. Fixed Assets (+A)......................................................................... 750,000

Cash (–A)................................................................................ 750,000
Purchased fixed assets.
3. Cash (+A)...................................................................................... 29,200a

Bonds Payable (+L)................................................................ 20,000b
Premium on Bonds Payable (+L)........................................... 9,200
Issued bonds.
a $29,200 = 20 bonds  $1,000 face value per bond  146%

b $20,000 = 20 bonds  $1,000 face value per bond
4. Land (+A)...................................................................................... 40,000

Common Stock (+SE)............................................................ 15,000
Additional Paid-In Capital, Common Stock (+SE)............... 25,000
Purchased land in exchange for common stock.
P14–19 Continued
5a. Inventory (+A).............................................................................. 2,000,000
Accounts Payable (+L).......................................................... 2,000,000
5b. Accounts Payable (–L).................................................................. 1,075,000
Cash (–A)................................................................................ 1,075,000
6a. Cash (+A)...................................................................................... 2,050,000

Sales (R, +SE)........................................................................ 2,050,000
Made sales.
6b. Cost of Goods Sold (E, –SE)........................................................ 875,000

Inventory (–A)........................................................................ 875,000
7. Prepaid Insurance (+A)................................................................. 80,000

Cash (–A)................................................................................ 80,000
Purchased two-year insurance policy.
8. Marketable Securities (+A)........................................................... 250,000

Cash (–A)................................................................................ 250,000
Purchased marketable securities.
9a. Accounts Receivable (+A)............................................................ 880,000

Sales (R, +SE)........................................................................ 880,000
Made sales on account.
9b. Cost of Goods Sold (E, –SE)........................................................ 490,000

Inventory (–A)........................................................................ 490,000
9c. Cash (+A)...................................................................................... 500,000

Accounts Receivable (–A)..................................................... 500,000
10. Miscellaneous Expenses (E, –SE)................................................ 500,000

Cash (–A)................................................................................ 500,000
11. Dividends (–SE)............................................................................ 100,000

Dividends Payable (+L)......................................................... 100,000
Declared dividends.
12. Interest Expense (E, –SE)............................................................. 1,460a

Premium on Bonds Payable (–L).................................................. 140
Cash (–A)................................................................................ 1,600b
Incurred and paid interest.
_____________________
a $1,460 = Book value of $29,200  Effective rate per six-month period of 5%
b $1,600 = Face value of $20,000  Stated rate per six-month period of 8%
P14–19 Continued
Adjusting entries
(a) Depreciation Expense (E, –SE).................................................... 140,000*
Accumulated Depreciation (–A)............................................ 140,000
Depreciated fixed assets.
* $140,000 = ($750,000 Cost – $50,000 Salvage value) ÷ 5 year useful life
(b) Insurance Expense (E, –SE)......................................................... 20,000

Prepaid Insurance (–A).......................................................... 20,000
Expiration of a portion of insurance policy.
(c) Unrealized Loss on Marketable Securities (Lo, –SE).................. 25,000

Allowance for Unrealized Loss on
Marketable Securities (–A).................................................... 25,000
Adjusted short-term portfolio to LCM.
(d) Miscellaneous Expenses (E, –SE)................................................ 75,000

Miscellaneous Payables (+L)................................................. 75,000
Incurred, but did not pay, miscellaneous expenses.
(e) Bad Debt Expense (E, –SE).......................................................... 70,400*

Allowance for Doubtful Accounts (–A)................................ 70,400
Estimated bad debts.
* $70,400 = Credit sales of $880,000  Uncollectible percentage of 8%
(f) Loss on Inventory Write-down (Lo, –SE).................................... 5,000

Inventory (–A)........................................................................ 5,000
Adjusted inventory to LCM.
Cash Marketable Securities Allow. for Unr. Loss on M. S.
B.B. 0 B.B. 0 B.B. 0

(1a) 1,500,000 (2) 750,000 (8) 250,000 (c) 25,000
(1b) 102,000 (5b) 1,075,000
(3) 29,200 (7) 80,000
(6a) 2,050,000 (8) 250,000
(9c) 500,000 (10) 500,000
(12) 1,600
E.B. 1,524,600 E.B. 250,000 E.B. 25,000
Accounts Receivable Allowance for D. A. Inventory
B.B. 0 B.B. 0 B.B. 0

(9a) 880,000 (9c) 500,000 (e) 70,400 (5a) 2,000,000 (6b) 875,000
(9b) 490,000
(f) 5,000
E.B. 380,000 E.B. 70,400 E.B. 630,000

P14–19 Continued
Prepaid Insurance Land Fixed Assets
B.B. 0 B.B. 0 B.B. 0

(7) 80,000 (4) 40,000 (2) 750,000
(b) 20,000
E.B. 60,000 E.B. 40,000 E.B. 750,000
Accumulated Depreciation Accounts Payable Miscellaneous Payables
B.B. 0 B.B. 0 B.B. 0

(a) 140,000 (5b) 1,075,000 (5a) 2,000,000 (d) 75,000
E.B. 140,000 E.B. 925,000 E.B. 75,000
Dividends Payable Bonds Payable Premium on Bonds Pay.
B.B. 0 B.B. 0 B.B. 0

(11) 100,000 (3) 20,000 (12) 140 (3) 9,200
E.B. 100,000 E.B. 20,000 E.B. 9,060
Preferred Stock APIC: Preferred Stock Common Stock
B.B. 0 B.B. 0 B.B. 0

(1b) 100,000 (1b) 2,000 (1a) 750,000
(4) 15,000
E.B. 100,000 E.B. 2,000 E.B. 765,000
APIC: Common Stock Retained Earnings Dividends
B.B. 0 B.B. 0 B.B. 0

(1a) 750,000 (c4) 100,000 (c3) 728,140 (11) 100,000
(4) 25,000 (c4) 100,000
E.B. 775,000 E.B. 628,140 E.B. 0
Sales Cost of Goods Sold Miscellaneous Expenses
B.B. 0 B.B. 0 B.B. 0

(6a) 2,050,000 (6b) 875,000 (10) 500,000
(9a) 880,000 (9b) 490,000 (d) 75,000
(c1) 2,930,000 (c2) 1,365,000 (c2) 575,000
E.B. 0 E.B. 0 E.B. 0
Interest Expense Bad Debt Expense Insurance Expense
B.B. 0 B.B. 0 B.B. 0

(12) 1,460 (e) 70,400 (b) 20,000
(c2) 1,460 (c2) 70,400 (c2) 20,000
E.B. 0 E.B. 0 E.B. 0

Depreciation Expense Loss on Inv. Write-down Unrealized loss on Mkt. Sec.
B.B. 0 B.B. 0 B.B. 0

(a) 140,000 (f) 5,000 (c) 25,000
(c2) 140,000 (c2) 5,000 (c2) 25,000
E.B. 0 E.B. 0 E.B. 0

P14–19 Continued
b. Closing entries
(c1) Sales............................................................................................... 2,930,000
Income Summary................................................................... 2,930,000
Closed revenues into Income Summary.
(c2) Income Summary.......................................................................... 2,201,860

Miscellaneous Expenses........................................................ 575,000
Cost of Goods Sold................................................................. 1,365,000
Interest Expense..................................................................... 1,460
Bad Debt Expense.................................................................. 70,400
Depreciation Expense............................................................ 140,000
Insurance Expense.................................................................. 20,000
Loss on Inventory Write-down.............................................. 5,000
Unrealized Loss on Marketable Securities............................ 25,000
Closed expenses into Income Summary.
(c3) Income Summary.......................................................................... 728,140

Retained Earnings.................................................................. 728,140
Closed Income Summary into Retained Earnings.
(c4) Retained Earnings......................................................................... 100,000

Dividends................................................................................ 100,000
Closed Dividends into Retained Earnings.
c.
Mick’s Photographic Equipment
Income Statement
Sales revenue............................................................ $ 2,930,000
Cost of goods sold.................................................... 1,365,000
Gross profit............................................................... $ 1,565,000
Operating expenses:
Depreciation expense........................................ $ 140,000
Bad debt expense............................................... 70,400
Insurance expense............................................. 20,000
Miscellaneous expenses.................................... 575,000
Total operating expenses............................ 805,400
Income from operations........................................... $ 759,600
Interest expense........................................................ (1,460)
Loss on write-down of inventory............................. (5,000)
Unrealized loss on marketable securities................. (25,000)
Net income................................................................ $ 728,140
P14–19 Continued
Balance Sheet
December 31, 2014
Assets
Current assets:
Cash............................................................................................... $ 1,524,600
Marketable securities (net of allowance for
unrealized losses of $25,000)................................................. 225,000
Accounts receivable (net of allowance for doubtful
accounts of $70,400).............................................................. 309,600
Inventory....................................................................................... 630,000
Prepaid insurance.......................................................................... 60,000
Total current assets................................................................. $ 2,749,200
Land…................................................................................................. 40,000
Fixed assets (net of accumulated depreciation of $140,000).............. 610,000
Total assets........................................................................................... $ 3,399,200
Liabilities and Stockholders' Equity

Current liabilities:
Accounts payable.......................................................................... $ 925,000
Miscellaneous payables................................................................ 75,000
Dividends payable......................................................................... 100,000
Total current liabilities........................................................... $ 1,100,000
Bonds payable (including associated premium of $9,060)................. 29,060
Stockholders' equity:
Preferred stock.............................................................................. $ 100,000
Common stock............................................................................... 765,000
Additional paid-in capital:
Preferred stock........................................................................ 2,000
Common stock........................................................................ 775,000
Retained earnings.......................................................................... 628,140
Total stockholders' equity...................................................... 2,270,140
Total liabilities and stockholders' equity............................................. $ 3,399,200
51
P14–19 Continued
d. Direct method

Cash collections from customers.......................................... $ 2,550,000
Cash paid for inventory........................................................ (1,075,000)
Cash paid for insurance........................................................ (80,000)
Cash paid for interest............................................................ (1,600)
Cash paid for miscellaneous expenses................................. (500,000)
activities....................................................................... $ 893,400

Purchase of marketable securities........................................ $ (250,000)
Purchase of fixed assets........................................................ (750,000)
investing activities....................................................... (1,000,000)

Proceeds from bond issue..................................................... $ 29,200
Proceeds from preferred stock issue.................................... 102,000
Proceeds from common stock issue..................................... 1,500,000
activities....................................................................... 1,631,200
Net increase in cash................................................................... $ 1,524,600
Beginning cash balance, January 1, 2014................................. 0

Ending cash balance, December 31, 2014................................ $ 1,524,600
P14–19 Concluded
Indirect method

Net income....................................................................... $ 728,140
Adjustments:
Increase in accounts receivable................................. $ (380,000)
Increase in inventory.................................................. (630,000)
Increase in prepaid insurance..................................... (60,000)
Decrease in premium on bonds payable.................... (140)
Increase in accounts payable...................................... 925,000
Increase in miscellaneous payables........................... 75,000
Depreciation expense................................................. 140,000
Bad debt expense........................................................ 70,400
Unrealized loss on mkt. securities............................. 25,000
Total adjustments.................................................. 165,260
operating activities...................................... $ 893,400

Purchase of marketable securities................................... $ (250,000)
Purchase of fixed assets.................................................. (750,000)
investing activities.................................................. (1,000,000)

Proceeds from bond issue................................................ $ 29,200
Proceeds from preferred stock issue............................... 102,000
Proceeds from common stock issue................................ 1,500,000
financing activities.................................................. 1,631,200
Net increase in cash................................................................ $ 1,524,600
Beginning cash balance, January 1, 2014.............................. 0

Ending cash balance, December 31, 2014............................. $ 1,524,600
ISSUES FOR DISCUSSION
ID14–1
a. Quality of earnings and earnings persistence have to do with the sustainability of the earnings as well as
nearness of the earnings to the cash generated by operating activities. The indirect method of preparing
the statement of cash flows is especially helpful in spotting the noncash adjustments to net income. This
information helps investors identify the companies that use aggressive accounting choices, since the
magnitude of such adjustments, in general, would be higher in these cases.
b. In the case of Mattel, the changes in accounts receivable were certainly positive, which indicated that
the majority of the sales were on credit with no contributions to cash. The change in the inventory could
have been attributed to either: 1. matching the old production and currents sales or 2. purchasing new
inventory on credit. Similarly, an increase in deferred taxes and translation gains would indicate no
related cash effect except an adjustment to earnings due to (i.e., changes in tax rates) and foreign
currency exchange rates.
c. Wall Street firms employ various models to identify over- and under-valued stocks. The choice of
accounting policies by a firm is just one variable in the whole equation. Therefore, the choice of
accounting policy may have some explanatory power, but alone it would not provide sufficient
information to differentiate among the stocks.
ID14–2
a. The Washington Post will use the equity method to record the accounting transactions related to the
other companies because it holds “significant influence” over those companies. The equity method
means that the Washington Post will record its ownership percentage times the companies’ net income
as equity income on the Washington Post’s income statement; if the other companies lose money, the
Washington Post will show a net loss from equity investments on its income statement (its ownership
percentage times the companies’ net losses). If the companies pay dividends, then the Washington Post
would record this amount as an increase in cash and a reduction to the investment account.
b. Losses in these investments are shown as losses on the income statement of the Washington Post.
However, these are non-cash losses, so these losses are added back to the net income of the Washington
Post to determine the cash changes for the year. (The treatment is similar to that of depreciation
expense, another non-cash deduction to earnings.)
c. “Net of distributions” means the amount of income or loss that did not involve the exchange of cash
between the Washington Post and the investment companies. The companies may have paid cash
dividends to their owners, including the Washington Post, so these cash payments are deducted from the
non-cash losses that are added back to net income to determine the Post’s operating cash flow.
d. Again, these transactions were of a non-cash nature. The Washington Post Company determined that
the value of property, plant & equipment was permanently different from that shown on its balance
sheet and recorded a loss to more correctly disclose the balance sheet value. However, this loss was not
an outflow of cash, so the adjustment on the statement of cash flow was necessary to convert accrual
net income into the Washington Post Company’s cash generation. The balance sheet now is more
accurate in its value disclosure of the long term assets, the income statement shows a deduction in
profitability due to the loss to reflect the new balance sheet value, and the statement of cash flow shows
the adjustment for the conversion of net income into cash flow.
ID14–3
a. The capitalization and matching process is not very useful for assessing the cash available to a company
because disbursing cash and consuming an item are two very different concepts. In order to measure
performance, it is necessary to match the costs that were incurred to generate benefits against the
benefits. Under accrual accounting, costs should be capitalized if they are expected to provide benefits
in the future. Thus, when a company disburses cash to acquire an item expected to provide a future
benefit, the company should capitalize the cost of the item as an asset. As the company uses the item
over time to help generate revenue, the item will be expensed and matched against the revenue it helped
generate. Thus, through the process of capitalizing costs and then expensing them when the cost helps
generate revenue, revenues and expenses are closely matched. In this manner, the capitalization and
matching process make it difficult to assess a company’s cash performance.
b. Solvency refers to a company’s ability to pay its obligations as they come due, and earning power refers
to a company’s ability to generate net assets through operating activities. The two concepts are closely
related in that a company will not remain solvent if it is unable to generate net assets through
operations. That is, a company cannot stay in business indefinitely if its operations fail to generate
sufficient net assets to allow the company to pay back debt or pay dividends. Similarly, a company will
not have very good earning power if it is not solvent. If a company is having solvency problems, it will
have to divert cash away from operations and toward paying creditors.
Information that is useful for assessing a company’s solvency can be found in both the balance sheet
and statement of cash flows. The balance sheet lists the company’s obligations and the assets currently
available to the company to use to pay off the liabilities. In addition, the balance sheet indicates which
liabilities are expected to mature in the near future and which assets are more liquid. The statement of
cash flows provides information about where the company is getting its cash and how it is using it. Of
particular interest is the net cash generated or used by operating activities.
The income statement is the primary source to assess a company’s earning power. Net income
represents the net assets the company generated during the year from operations. By comparing net
income to certain balance sheet amounts, such as average stockholders’ equity or average total assets,
one can assess how effectively a company is using its assets to generate returns.
c. Bankruptcies usually imply that a company was unable to pay its debts. Because cash is the most
common medium of exchange in the United States, creditors expect to receive interest and principal
payments in cash. Thus, a wave of bankruptcies implies that companies were having cash flow
problems, which, in turn, increases interest in assessing nonbankrupt companies’ cash flows to avoid
other problem loans.
ID14–4
a. SuperValu paid out cash when it acquired fixed and intangible assets. Depreciation and amortization of
these assets simply represent the allocation of the assets' cost to particular accounting periods. There is
no cash outflow or inflow associated with depreciation and amortization.
SuperValu is adding depreciation and amortization back to net income to arrive at net cash flow from
operating activities because it uses the indirect method to report cash flows from operating activities.
With the indirect method, a company begins with net income and then reconciles (i.e., explains) why
net income is different from cash flows from operating activities. Since depreciation and amortization
reduced SuperValu's net income but did not have any effect on cash, SuperValu needs to add
depreciation and amortization back to net income to adjust net income to net cash flow from operating
activities.
b. Impairment charges are recorded when the company determines that the carrying value of an asset is
greater than that asset’s fair value. If an asset has changed from the time of acquisition, or if business
conditions have changed the effectiveness of that asset, the company will determine that the asset is
overvalued. The charge is added back to net income for the same reason SuperValu added back
depreciation and amortization. That is, recording the impairment expense reduces net income but has no
effect on cash.
c. The “gain on the sale of assets” is subtracted from net earnings and “loss on sale” is added back
because both of these items are non-recurring in nature and so the intent is to eliminate these from the
calculation of cash from operating activities. (The cash flow related to the sale of assets belongs in the
Investing section.) To reverse these out from net income, they have to be offset by the opposite of how
they affect net income on the income statement. Therefore losses are added back and gains are
subtracted away.
d. Receivables, in the two earliest years shown, were a use of cash for SuperValu, meaning that the
change in accounts receivable had been an increase each year, which is tying up the company’s cash.
More receivables (as compared to the prior year) indicate less cash flowing into the company. In the
latest year, though, the receivable balance declined, indicating that more cash is flowing into the
company (as SuperValu collects cash from this year’s sales, as well as last year’s.) Inventory grew in
2011, using up company cash balances, but then declined in the latest two years, freeing up cash that
had formerly been tied up in groceries on the shelf.
e. One of the first tipoffs that there may be some problems with the quality of earnings is if cash provided
by operating activities is lower than net income. This is not the case with SuperValu and so there is no
indication that earnings are being managed by the timing of transactions. SuperValu has shown
significantly higher cash from operations than net income in all three years. Even if the large
impairment charge in 2013 is adjusted out, earnings would have been less than cash from operations.
ID14–5
Shortcuts to “cash flow”, such as adding back depreciation and amortization (non-cash expenses) to net
income, do not take into consideration all of the changes that affect cash. The indirect statement of
cash flow starts by adding back these non-cash expenses, but the statement continues with the cash flow
adjustments. Changes to working accounts are also included in the calculation to come up with the
operating cash flow number. The most prominent example of the shortcoming of simply adding
depreciation expense to earnings to calculate cash flow is the case of slowing receivables. If a company
is growing rapidly because of additional credit sales, net income should also grow (holding all other
factors
ID14–5 Concluded
constant). However, if those credit sales were made to companies without the ability or willingness to
pay, net income will overstate the company’s ultimate cash position. As
receivables become stagnant and build up on the balance sheet, the statement of cash flow would deduct
this increase from net income to arrive at the cash flow number. The shortcut of simply adding back
depreciation to net income will not reflect the problem with collections. Not including the changes to
the current accounts (such as accounts receivable) runs the risk that the reader of the financial
statements will not get a true picture of the company’s cash position.
ID14–6
a. The annual depreciation expense is decreasing, which would imply that the company has less long
lived assets that require annual cost allocation. The company appears to not be investing in its fixed
asset base, with long term assets becoming fully depreciated and not being replaced with new
assets.
b. The issuance of stock to employees as a form of compensation does not require the outlay of cash.
There is a theoretical cost to the company in the form of the opportunity cost of not being able to
sell those shares on the open market, but the granting of shares does not directly cost the company
cash. Therefore, the expense associated with issuing those shares is a non-cash charge, and similar
to depreciation expense, is added back to net income in the calculation of changes in cash balances.
c. Inventory decreased somewhat in 2010, giving the company over $16 million of cash. In 2011 the
trend reversed, draining over $12 million of cash as the company saw increased investment in its
inventories. But 2012 changed again, back to a source of cash from inventory (much larger this
time). No consistent trend can be documented.
d. The asset impairment charges are non-cash expenses (debit expense, credit asset to lower the
carrying value of the asset and decreases earnings/equity) and, similar to depreciation expense, are
added back to net income in the calculation of changes in cash balances. The treatment of
inventory that is no longer fit for sale is similar; the asset is adjusted down to zero, an expense is
recorded, but there is no outflow of cash (so an adjustment on the statement of cash flows is
necessary).
ID14–7
The statement of cash flows for Danone lists the company’s various sources of net income with an
adjustment for non-cash charges, such as depreciation expense (similar to the setup in U.S. GAAP for
the indirect format). Then the statement deals with changes in operating accounts that affect operating
cash flow, again in a similar approach to U.S. GAAP. After totaling operating cash flow (from income,
non-cash expenses and other changes, and working capital adjustments), Danone lists its investing
activities (mainly the purchase and sale of long-term assets). Finally, sources and uses of debt and
equity capital are totaled in the financing section. Of note, the company lists changes to marketable
securities (short term, operating investments) in its financing section. The changes in cash from the
three areas are tabulated to show the overall increase/decrease to company cash balances from the
previous year.
Company cash management practices were very similar in 2011 to 2012. The company generated over
2.5 billion euros from operations and then spent nearly a billion euros on new fixed assets (investing
activities) and still had approximately 1.5 billion euros to pay down liabilities, repurchase shares and
make dividend payments to shareholders.
ID14–8
a. Over the three-year time period Eli Lilly’s general cash management profile has remained similar, but
the results are trending in the wrong direction. The company generates cash from its operations (in
excess of its profit levels) and uses that cash to invest in long term assets and to repay debt and return
cash to shareholders. But in 2012 the cash from operations is down significantly from prior years (as is
profitability), which seems to have limited the cash the company can invest in long term assets;
however, the amount of cash used by financing activities jumped, draining the company cash balances
by year end (a $1.9 billion decline).
b. More than likely the decline in profitability affected the drop in operating cash, which in turn affected
the capacity with which the company could make long-term investments for its future. The increased
move to return cash to shareholders and retire debt, however, occurred in the same time period as the
drop in operating cash, reducing the company’s cash position (in a time when other companies have
been bulking up cash balances). To address the cash management concerns, the company might first
have to address the profitability issues (as well as the policies regarding share buybacks and dividends,
as well as debt repayments).
ID14–9
a. Starbucks has been incredibly consistent in its generation of cash from operating activities over the
time period. It has used this cash to open additional stores (cash from investing activities) and has still
had excess balances allowing it to repay debt and return cash to shareholders.
b. The heavy use of cash for investing signals this profile as one of a growing company. Starbucks differs
from many other growth companies in that it does not have to look to financing sources (debt and/or
equity) to fund the investments; the operations are strong enough to provide the funding for the growth.
c. At this point the company is quite strong. Fast growth can often hurt companies, but Starbucks is not
leveraging up its balance sheet or diluting its existing owners to fund the growth. The consistent cash
flow from operations given the economic climate of the Great Recession and the relatively soft
economic recovery is quite impressive.
d. At some point, the company’s growth will slow, meaning that the use of cash for investing will not be
as much a drag for the company. If operations remain strong, the company might divert the cash (that
in other years would have gone to new stores) to shareholders in the form of larger dividends or
increased share repurchases. On the negative side, if the operations face increased competition (from
competitors such as McDonald’s, from new coffee chains or from substitution products if the coffee
fad fades), cash flow could decrease and limit the company’s ability to grow and return cash to its
financiers.
ID14–10
When an acquisition is recorded, any cash outflow (credit) is considered an investing activity, with the
assets acquired booked (debit) onto the balance sheet. If in subsequent periods (as happened to Hewlett
Packard), the value of the assets acquired is deemed to be less than the carrying value on the balance sheet,
the company lessens the carrying value (credit) and books an accompanying impairment expense (debit).
No cash flow is involved in the correction of the carrying amount of the acquired business, so the statement
of cash flows remains the same, even though the income statement is affected (dramatically in HP’s case)
by the impairment expense.
ID14–11
a. Google’s major sources of cash are cash from operations. This cash is primarily used to fund investing
activities as the company purchases property, plant and equipment and acquires other companies
(especially the large Motorola acquisition in 2012). In addition the company generates cash from
financing activities, mainly debt issuances due to the extremely low interest rate environment in 2010-
2012.
b. Depreciation and amortization expenses and stock-based compensation expenses appear to be the
largest transactions that were non-cash in nature.
c. The gain on divestitures in 2012 is shown as a negative number in the operating section because the sale
of long term assets is an investing activity and the associated cash inflow is accounted for in the
investing section (see “proceeds received from divestiture”). The gain increased profits and therefore
needs to be backed out in the calculation of operating cash flow.
d. In each of the three years shown, accounts receivable have grown, acting as a drain (a “use”) on
company cash balances. The growth in receivables can indicate that some of the company’s sales
growth (29% in 2011, 32% in 2012) is coming in the form of receivables that might not be collected, or
from receivables that will be very slow to be collected. It is possible that the company’s top line in
sales contains receivables that will not convert in the near future to cash collections.
e. Over the three-year period, Google’s incredibly strong operating cash flow has been able to fund the
company’s capital spending (additions to property, plant & equipment) and acquisitions. Like other
technology growth companies, Google has not used cash to pay dividends to its shareholders, as it feels
it can generate superior returns by investing those amounts into the growing businesses it operates.
Cash balances, therefore, are very high ($48 billion between cash and marketable securities), giving the
company massive funds to build existing and new businesses. At some stage in the future, investors
may demand a return of cash in the form of dividends and share buybacks, but for now all are satisfied
with Google’s investment strategies for the cash.

CH 14

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CH 14

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CHAPTER 14

THE STATEMENT OF CASH FLOWS

Accounts receivable, beginning balance $ 16.3 million

Inventory, ending balance $356 million

b. Cash payments made to suppliers during 2012 equals:

Accounts payable, beginning balance $ 64 million

Allowance for Doubtful Accounts (+A)................................ XX

Notes Receivable (+A)........................................................... XX

Bonds Payable (–L)................................................................ XX

Depreciation Expense (E, –SE)............................................. XX

12. Operating activity

14. Financing activity

15. Operating activity

2. Issue of common stock +180,000 = +180,000

3. Purchase IBM stock 375,000 (securities)

4. Purchase insurance +27,000 (ppd insurance)

5. Purchase of building +200,000 (building)

Cost of Goods Sold

2. Cash (+A)........................................................................................ 60,000

3. Property, Plant, & Equipment (+A)................................................ 25,000

4. Inventory (+A) 40,000

5. Cash (+A)........................................................................................ 20,000

Cost of Goods Sold (E, –SE).......................................................... 25,000

7. Operating Expenses (E, –SE)......................................................... 15,000

Ending balance 25,000

Cash from investing activities:

Cash from financing activities:

Beginning cash balance, January 1, 2015..................................... 0

Cash from investing activities:

Cash from financing activities:

Beginning cash balance, January 1, 2015....................... 0

2. Inventory (+A)................................................................................ 6,000

3. Equipment (+A).............................................................................. 5,000

4. Cash (+A)........................................................................................ 10,000

6. Dividend (–SE)................................................................................ 2,000

7. Rent Expense (E, –SE).................................................................... 6,000

8. Cash (+A)........................................................................................ 65,000

9. Miscellaneous Expenses (E, –SE).................................................. 40,000

10. Cash (+A)........................................................................................ 25,000

Cash flows from investing activities:

Cash flows from financing activities:

Beginning cash balance, January 1, 2015................................. 25,000

Gain on Sale of Machinery

From the entry given above,

c. Cash (+A).................................................................................................... 8,000

Cash collections from customers:

Cash paid for inventory:

b. Disbursements for inventory

Cash paid for wages:

Cash paid for advertising:

Cash flows from operating activities:

Cash flows from operating activities:

Cash from operating activities:

Cash from investing activities:

Cash from financing activities:

Beginning cash balance, January 1, 2015..................................... 6,000

Cash from operating activities:

Cash from investing activities:

Cash from financing activities:

Beginning cash balance, January 1, 2015..................................... 5,000

a Purchase of nonoperating assets = Increase in nonoperating assets

Accrual-Basis Advertising Expense

Schlee and Associates