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Chapter Fifteen
“How Well Am I Doing?”
Cash Flow Statement
4 Chapter 15
Definition of Cash
In preparing a cash flow statement, the term cash is broadly defined to include both cash
and cash equivalents. Cash equivalents consist of short-term, highly liquid investments,
such as Treasury bills, commercial paper, and money market funds. Such investments are
made solely for the purpose of generating a return on funds that are temporarily idle.
Instead of simply holding cash, most companies invest their excess cash reserves in these
types of interest-bearing assets that can be easily converted into cash. These short-term,
liquid assets are usually included in marketable securities on the balance sheet. Since
such assets are equivalent to cash, they are included with cash in preparing a cash flow
statement.
6 Chapter 15
Exhibit 15–1
Explaining Net Cash Flow by Analysis of the Noncash Balance Sheet Accounts
Net income increases shareholders’ equity, while dividends reduce shareholders’ equity.
To get from line 6 of the exhibit to line 7, a few terms on the right-hand side of the equa-
tion are rearranged.
According to equation 7 in Exhibit 15–1, the net cash flow for a period can be deter-
mined by starting with net income, then deducting changes in noncash assets, adding
changes in liabilities, deducting dividends paid to shareholders, and finally adding
changes in capital shares It is important to realize that changes in accounts can be either
increases (positive) or decreases (negative), and this affects how we should interpret equa-
tion 7 in Exhibit 15–1. For example, increases in liabilities are added back to net income,
whereas decreases in liabilities are deducted from net income to arrive at the net cash
flow. On the other hand, increases in noncash assets are deducted from net income, while
decreases in noncash assets are added back to net income. Exhibit 15–2 summarizes the
appropriate classifications—in terms of sources and uses—of net income, dividends, and
changes in the noncash balance sheet accounts.
The classifications in Exhibit 15–2 seem to make sense. Positive net income generates
cash, whereas a net loss consumes cash. Decreases in noncash assets, such as sale of
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inventories or property, are a source of cash. Increases in noncash assets, such as purchase
of inventories or property, are a use of cash. Increases in liabilities, such as taking out a
loan, are a source of cash. Decreases in liabilities, such as paying off a loan, are a use of
cash. Increases in capital shares accounts, such as sale of common shares, are a source
of cash. And payments of dividends to shareholders use cash.
Constructing a simple cash flow statement is a straightforward process. Begin with net
income (or net loss) and then add to it everything listed as sources in Exhibit 15–2 and
subtract from it everything listed as uses. This will be illustrated with an example in the
next section.
*This statement is loosely based on an actual income statement published by Nordstrom. Among
other differences, there was no “Gain on sale of store” in the original statement. This “gain” has
been included here to illustrate how to handle gains and losses on a cash flow statement.
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8 Chapter 15
*This statement differs in a few details from the actual statement published by Nordstrom.
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Exhibit 15–6
NORDSTROM INC.
Simplified Cash Flow Statement
(dollars in millions)
Note: This simplified statement is for illustration purposes only. It should not be used to
complete end-of-chapter homework assignments or for preparing an actual cash flow
statement. See Exhibit 15–12 for the proper format for a cash flow statement.
Sources
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $140
Decreases in noncash assets:
Decrease in accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . 17
Increases in liabilities (and contra asset accounts):
Increase in accumulated depreciation and amortization . . . . . . . 93
Increase in accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
Increase in accrued wages and salaries . . . . . . . . . . . . . . . . . . . . 3
Increase in accrued income taxes . . . . . . . . . . . . . . . . . . . . . . . . 6
Increase in notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Increases in capital stock accounts:
Increase in common shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Total sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $307
Uses
Increases in noncash assets:
Increase in merchandise inventory . . . . . . . . . . . . . . . . . . . . . . . 49
Increase in property, buildings, and equipment . . . . . . . . . . . . . . 123
Decreases in liabilities:
Decrease in long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Decrease in deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . 2
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Total uses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245
Net cash flow . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 62
A simplified cash flow statement appears in Exhibit 15–6. This statement was con-
structed by gathering together all of the entries listed as sources in Exhibit 15–4 and all of
the entries listed as uses. The sources exceeded the uses by $62 million. This is the net
cash flow for the year and is also, by definition, the change in cash and cash equivalents
for the year. (Trace this $62 million figure back to Exhibit 15–4.)
Operating Activities
Generally, operating activities are those activities that enter into the determination of
net income. Generally speaking, this includes all transactions affecting current assets. It
Concept 15–1 also includes all transactions affecting current liabilities, except for issuing and repaying
Exhibit 15–7
Guidelines for Classifying Operating activities:
Transactions as Operating, • Net income
Investing, and Financing • Changes in current assets
Activities • Changes in noncurrent assets that affect net income (e.g., depreciation)
• Changes in current liabilities (except for debts to lenders and dividends payable)
• Changes in noncurrent liabilities that affect net income
Investing activities:
• Changes in noncurrent assets that are not included in net income
Financing activities:
• Changes in the current liabilities that are debts to lenders, rather than obligations to
suppliers, employees, or the government
• Changes in noncurrent liabilities that are not included in net income
• Changes in capital stock accounts
• Dividends
10
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a note payable. Operating activities also include changes in noncurrent balance sheet
accounts that directly affect net income, such as the Accumulated Depreciation and
Amortization account.
Investing Activities
Generally speaking, transactions that involve acquiring or disposing of noncurrent assets
are classified as investing activities. These transactions include acquiring or selling prop-
erty, plant, and equipment; acquiring or selling securities held for long-term investment,
such as bonds and shares of other companies; and lending money to another entity (such
as a subsidiary) and the subsequent collection of the loan. However, as previously dis-
cussed, changes in noncurrent assets that directly affect net income, such as depreciation
and amortization charges, are classified as operating activities.
Financing Activities
As a general rule, borrowing from creditors or repaying creditors as well as transactions
with the company’s owners are classified as financing activities. For example, when a com-
pany borrows money by issuing a bond, the transaction is classified as a financing activ-
ity. However, transactions with creditors that affect net income are classified as operating
activities. For example, interest on the company’s debt is included in operating activities,
rather than financing activities, because interest is deducted as an expense in computing
net income. In contrast, dividend payments to owners do not affect net income and there-
fore are classified as financing, rather than operating, activities.
Most changes in current liabilities are considered to be operating activities unless the
transaction involves borrowing money directly from a lender, as with a note payable, or
repaying such a debt. Transactions involving accounts payable, wages payable, and taxes
payable are included in operating activities, rather than financing activities, since these
transactions occur on a routine basis and involve the company’s suppliers, employees, and
the government, rather than lenders.
12 Chapter 15
Exhibit 15–8
Add () or
General Model: Indirect Method
Deduct ()
to Adjust of Determining the “Net Cash
Net Provided by Operating Activities”
Income
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $XXX
Adjustments needed to convert net income to a cash basis:
Depreciation, depletion, and amortization charges . . . . . . . . . . . . . . . . . . . . ⫹
Add (deduct) changes in current asset accounts affecting revenue
or expense:*
Increase in the account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ⫺
Decrease in the account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ⫹
Add (deduct) changes in current liability accounts affecting revenue
or expense:†
Increase in the account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ⫹
Decrease in the account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ⫺
Add (deduct) gains or losses on sales of assets:
Gain on sales of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ⫺
Loss on sales of assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ⫹
Add (deduct) changes in the Deferred Income Taxes account:
Increase in the account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ⫹
Decrease in the account . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ⫺
Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $XXX
*Examples include accounts receivable, accrued receivables, inventory, and prepaid expenses.
†Examples include accounts payable, accrued liabilities, and taxes payable.
13
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14 Chapter 15
Exhibit 15–9
Explanation of Adjustments for Changes in Current Asset and Current Liability Accounts (see Exhibit 15–8)
Therefore, to Adjust
Change to a Cash Basis under
in the This Change the Indirect Method,
Account Means That… We Must…
Increase Sales (revenues) have been reported for Deduct the amount from net income to
Accounts
which no cash has been collected. show that cash-basis sales are less
Receivable
than reported sales (revenues).
and
Accrued Decrease Cash has been collected for which no Add the amount to net income to show
Receivables sales (revenues) have been reported that cash-basis sales are greater than
for the current period. reported sales (revenues).
Increase Goods have been purchased that are Deduct the amount from net income to
not included in cost of goods sold show that cash-basis COGS is
(COGS). greater than reported COGS.
Inventory
Decrease Goods have been included in COGS Add the amount to net income to show
that were purchased in a prior period. that cash-basis COGS is less than
reported COGS.
Increase More cash has been paid out for services Deduct the amount from net income to
than has been reported as expense. show that cash-basis expenses are
Prepaid greater than reported expenses.
Expenses Decrease More has been reported as expense for Add the amount to net income to show
services than has been paid out that cash-basis expenses are less
in cash. than reported expenses.
Increase More has been reported as expense for Add the amount to net income to show
goods and services than has been that cash-basis expenses for goods
Accounts
paid out in cash. and services are less than reported
Payable
expenses.
and
Accrued Decrease More cash has been paid out for goods Deduct the amount from net income to
Liabilities and services than has been reported show that cash-basis expenses for
as expense. goods and services are greater than
reported expenses.
Increase More income tax expense has been Add the amount to net income to show
reported than has been paid out that cash-basis expenses are less
Taxes in cash. than reported expenses.
Payable Decrease More cash has been paid to the tax Deduct the amount from net income to
authorities than has been reported show that cash-basis expenses are
as income tax expense. greater than reported expenses.
sometimes slippery, but commonly given explanations are listed in Exhibit 15–9 for some
of these adjustments. For example, Exhibit 15–9 suggests that an increase in Accounts
Receivable is deducted from net income because sales have been recorded for which no
cash has been collected. Therefore, to adjust net income to a cash basis, the increase in the
Accounts Receivable account must be deducted from net income to show that cash-basis
sales are less than reported sales. However, we can state more simply that an increase in
Accounts Receivable is deducted when computing net cash flows because, according to
the logic of Exhibits 15–1 and 15–2, increases in all noncash assets must be deducted.
Exhibit 15–10
NORDSTROM, INC.
Cash Flow Statement Worksheet
(dollars in millions)
(1) (2) (3) (4) (5) (6)
Cash Adjusted
Source Flow Adjust- Effect Classi-
Change or Use? Effect ments (3) (4) fication*
Assets (except cash and cash equivalents)
Current assets:
Accounts receivable . . . . . . . . . . . . . . . . . . . . . $ ⫺17 Source $ ⫹17 $ ⫹17 Operating
Merchandise inventory . . . . . . . . . . . . . . . . . . . ⫹49 Use ⫺49 ⫺49 Operating
Noncurrent assets:
Property, buildings, and equipment . . . . . . . . . . ⫹123 Use ⫺123 $⫺15 ⫺138 Investing
Contra Assets, Liabilities, and
Shareholders’ Equity
Contra assets:
Accumulated depreciation and amortization . . . ⫹93 Source ⫹93 ⫹10 ⫹103 Operating
Current liabilities:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . ⫹44 Source ⫹44 ⫹44 Operating
Accrued wages and salaries payable . . . . . . . . . ⫹3 Source ⫹3 ⫹3 Operating
Accrued income taxes payable . . . . . . . . . . . . . ⫹6 Source ⫹6 ⫹6 Operating
Notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . ⫹2 Source ⫹2 ⫹2 Financing
Noncurrent liabilities:
Long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . ⫺43 Use ⫺43 ⫺43 Financing
Deferred income taxes . . . . . . . . . . . . . . . . . . . . ⫺2 Use ⫺2 ⫺2 Operating
Shareholders’ equity:
Common shares . . . . . . . . . . . . . . . . . . . . . . . . . ⫹2 Source ⫹2 ⫹2 Financing
Retained earnings:
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . ⫹140 Source ⫹140 ⫹140 Operating
Dividends . . . . . . . . . . . . . . . . . . . . . . . . . . . ⫺28 Use ⫺28 ⫺28 Financing
Additional Entries
Proceeds from sale of store . . . . . . . . . . . . . . . . . . ⫹8 ⫹8 Investing
Gain on sale of store . . . . . . . . . . . . . . . . . . . . . . . ⫺3 ⫺3 Operating
Total (net cash flow) . . . . . . . . . . . . . . . . . . . . . . . $ ⫹62 $ 0 $ ⫹62
*See Exhibit 15–11 (page 18) for the reasons for these classifications.
in Exhibit 15–10, to prepare a cash flow statement. Another technique relies on the use of
T-accounts. The use of the T-account approach to prepare the cash flow statement is dis-
cussed and illustrated in Appendix 15B at the end of the chapter. You may find it helpful
to review the illustration of the T-account approach in Appendix 15B, even if your instruc-
tor does not cover this appendix in class.
As noted above, we will use the worksheet approach to illustrate the preparation of the
cash flow statement in this chapter. The worksheet in Exhibit 15–10 and cash flow state-
ment can be prepared using the eight steps that follow. This brief summary of the steps
will be followed by more detailed explanations later.
1. Copy onto the worksheet the title of each account appearing on the comparative
balance sheet, except for cash and cash equivalents and retained earnings. To avoid
confusion, contra asset accounts, such as the Accumulated Depreciation and
Amortization account, should be listed with the liabilities. Contra asset accounts are
treated the same way as liabilities on the cash flow statement.
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16 Chapter 15
2. Compute the change from the beginning balance to the ending balance in each bal-
ance sheet account. Break the change in retained earnings down into net income and
dividends paid to shareholders.
3. Using Exhibit 15–2 as a guide, code each entry on the worksheet as a source or a use.
4. Under the Cash Flow Effect column, write sources as positive numbers and uses as
negative numbers.
5. Make any necessary adjustments to reflect gross, rather than net, amounts involved in
transactions—including adjustments for gains and losses. Some of these adjustments
may require adding new entries to the bottom of the worksheet. The net effect of all
such adjusting entries must be zero.
6. Classify each entry on the worksheet as an operating activity, investing activity, or
financing activity according to the criteria given in Exhibit 15–7.
7. Copy the data from the worksheet to the cash flow statement section by section, start-
ing with the operating activities section.
8. At the bottom of the cash flow statement, prepare a reconciliation of the beginning
and ending balances of cash and cash equivalents. The net change in cash and cash
equivalents shown at the bottom of this statement should equal the change in the Cash
and Cash Equivalents accounts during the year.
On the following pages, we will apply these eight steps to the data contained in the
comparative balance sheet for Nordstrom Inc., found in Exhibit 15–4. As we discuss each
step, refer to Exhibit 15–4, and trace the data from this exhibit into the worksheet in
Exhibit 15–10.
illustrate, suppose that Nordstrom decided to sell an old store and move its retail opera-
tions to a new location. Assume that the original cost of the old store was $15 million, its
accumulated depreciation was $10 million, and that it was sold for $8 million in cash. The
journal entry to record this transaction (in millions) appears below:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Accumulated Depreciation and Amortization . . . . . 10
Property, Buildings, and Equipment . . . . . . 15
Gain on Sale . . . . . . . . . . . . . . . . . . . . . . . . 3
Accumulated Depreciation
Property, Buildings, and Equipment and Amortization
According to the rules, the gross additions of $138 million to the Property, Buildings, and
Equipment account should be disclosed on the cash flow statement, rather than the net
change in the account of $123 million ($1,517 million ⫺ $1,394 million ⫽ $123 million).
Likewise, the gross depreciation charges of $103 million should be disclosed, rather than
the net change in the Accumulated Depreciation and Amortization account of $93 million
($654 million ⫺ $561 million ⫽ $93 million). And the cash proceeds of $8 million from
sale of the building should also be disclosed on the cash flow statement. All of this is
accomplished, while preserving the correct overall net cash flows on the statement, by
using the above journal entry to make adjusting entries on the worksheet. As indicated in
Exhibit 15–2, the debits are recorded as positive adjustments, and the credits are recorded
as negative adjustments. These adjusting entries are recorded under the Adjustments
column in Exhibit 15–10.
It may not be clear why the gain on the sale is deducted in the operating activities
section of the cash flow statement. The company’s $140 million net income, which is
part of the operating activities section, includes the $3 million gain on the sale of the
store. But this $3 million gain must be reported in the investing activities section of the
cash flow statement as part of the $8 million proceeds from the sale transaction. There-
fore, to avoid double counting, the $3 million gain is deducted from net income in the
operating activities section of the statement. The adjustments we have made on the
worksheet accomplish this. The $3 million gain will be deducted in the operating activ-
ities section, and all $8 million of the sale proceeds will be shown as an investing item.
As a result, all of the gain will be included in the investing section of the cash flow
statement and none of it will be in the operating activities section. There will be no
double counting of the gain.
In the case of a loss on the sale of an asset, we do the opposite. The loss is added back
to the net income figure in the operating activities section of the cash flow statement.
Whatever cash proceeds are received from the sale of the asset are reported in the invest-
ing activities section.
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18 Chapter 15
Before turning to step 6 in the process of building the cash flow statement, one small
step is required. Add the Adjustments in column (4) to the Cash Flow Effect in column
(3) to arrive at the Adjusted Effect in column (5).
Exhibit 15–11
Classifications of Entries on Nordstrom’s Cash Flow Statement
• Change in Property, Investing Changes in noncurrent assets that do not directly affect net
Buildings, and Equipment activity income are included in investing activities.
• Change in Accumulated Operating Depreciation and amortization directly affect net income and
Depreciation and activity are therefore included in operating activities.
Amortization
• Changes in Accounts Operating Changes in current liabilities (except for notes payable) are
Payable, Accrued Wages activity included in operating activities.
and Salaries Payable, and
Accrued Income Taxes
Payable
• Change in Notes Payable Financing Issuing or repaying notes payable is classified as a financing
activity activity.
• Change in Long-Term Debt Financing Changes in noncurrent liabilities that do not directly affect
activity net income are included in financing activities.
• Change in Deferred Operating Deferred income taxes result from income tax expense that
Income Taxes activity directly affects net income. Therefore, this entry is included
in operating activities.
• Change in Common Shares Financing Changes in capital stock accounts are always included in
activity financing activities.
• Proceeds from sale of store Investing The gross amounts received on disposal of noncurrent assets
activity are included in investing activities.
• Gains from sale of store Operating Gains and losses directly affect net income and are therefore
activity included in operating activities.
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income statement often differs from the taxes that are actually owed to the government.
Usually, the income tax expense overstates the company’s actual income tax liability for
the year. When this happens, the journal entry to record income taxes includes a credit to
Deferred Income Taxes:
Since deferred income taxes arise directly from the computation of an expense, the
change in the Deferred Income Taxes account is included in the operating activities sec-
tion of the cash flow statement.
In the case of Nordstrom, the Deferred Income Taxes account decreased during the
year, and so income tax expense was apparently less than the company’s income tax lia-
bility for the year by $2 million. In other words, for some reason Nordstrom had to pay
the government $2 million more than the income tax expense recorded on the income
statement, and therefore this additional cash outflow must be deducted to convert net
income to a cash basis. Or, looking back again to Exhibit 15–2, Deferred Income Taxes is
a liability account for Nordstroms. Since this liability account decreased during the year,
the change is counted as a use of cash and is deducted in determining net cash flow for
the year.
20 Chapter 15
Exhibit 15–12
NORDSTROM INC.*
Cash Flow Statement—Indirect Method
(dollars in millions)
Operating Activities
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 140
Adjustments to convert net income to a cash basis:
Depreciation and amortization charges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
Decrease in accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Increase in merchandise inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (49)
Increase in accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
Increase in accrued wages and salaries payable . . . . . . . . . . . . . . . . . . . . . . . . . 3
Increase in accrued income taxes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Decrease in deferred income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (2)
Gain on sale of store . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (3)
Net cash provided by operating activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 259
Investing Activities
Additions to property, buildings, and equipment . . . . . . . . . . . . . . . . . . . . . . . . . . (138)
Proceeds from sale of store . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (130)
Financing Activities
Increase in notes payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Decrease in long-term debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (43)
Increase in common shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Cash dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (28)
Net cash used in financing activities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (67)
Summary
LO1 Know how to classify changes in noncash balance sheet accounts as sources or uses
of cash.
The cash flow statement is one of the three major financial statements prepared by organizations. It
explains how cash was generated and how it was used during the period. The cash flow statement is widely
used as a tool for assessing the financial health of organizations. In general, sources of cash include net
income, decreases in assets, increases in liabilities, and increases in shareholders’ capital accounts. Uses of
cash include increases in assets, decreases in liabilities, decreases in shareholders’ capital accounts, and
dividends. A simplified form of the cash flow statement can be easily constructed using just these defini-
tions and a comparative balance sheet.
LO2 State the general rules for determining whether transactions should be classified as
operating activities, investing activities, or financing activities.
For external reporting purposes, the cash flow statement must be organized in terms of operating, invest-
ing, and financing activities. While there are some exceptions, operating activities include net income and
changes in current assets and current liabilities. And, with a few exceptions, changes in noncurrent assets
are generally included in investing activities and changes in noncurrent liabilities are generally included in
financing activities.
LO3 Prepare a cash flow statement using the indirect method to determine the net cash
provided by operating activities.
The operating activities section of the cash flow statement can be constructed using the indirect method
(discussed in the main body of the chapter) or the direct method (discussed in Appendix 15A). Although
the Accounting Standards Board prefers the use of the direct method, most companies use the indirect
method, which is easier. Both methods report the same amount of net cash provided by operating activities.
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22 Chapter 15
When the indirect method is used, the operating activities section of the cash flow statement starts with
net income and shows the adjustments required to adjust net income to a cash basis. A worksheet can be
used to construct the cash flow statement. After determining the change in each balance sheet account,
adjustments are made to reflect gross, rather than net, amounts involved in selected transactions, and each
entry on the worksheet is labelled as an operating, investing, or financing activity. The data from the
worksheet is then used to prepare each section of the cash flow statement, beginning with the operating
activities section.
Review Problem
Rockford Company’s comparative balance sheet for 2004 and the company’s income statement for the
year follow:
ROCKFORD COMPANY
Comparative Balance Sheet
December 31, 2004, and 2003
(dollars in millions)
2004 2003
Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 26 $ 10
Accounts receivable . . . . . . . . . . . . . . . . . . . 180 270
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . 205 160
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . . 17 20
Plant and equipment . . . . . . . . . . . . . . . . . . . 430 309
Less accumulated depreciation . . . . . . . . . (218) (194)
Long-term investments . . . . . . . . . . . . . . . . . 60 75
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . $ 700 $ 650
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ROCKFORD COMPANY
Income Statement
For the Year Ended December 31, 2004
(dollars in millions)
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,000
Less cost of sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 530
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 470
Less operating expenses . . . . . . . . . . . . . . . . . . . . . . . . . 352
Net operating income . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
Nonoperating items:
Loss on sale of equipment . . . . . . . . . . . . . . . . . . . . . (4)
Income before taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114
Less income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 66
Notes: Dividends of $48 million were paid in 2003. The loss on sale of
equipment of $4 million reflects a transaction in which equipment with
an original cost of $12 million and accumulated depreciation of $5 mil-
lion was sold for $3 million in cash.
Required:
Using the indirect method, determine the net cash provided by operating activities for 2003 and construct
a cash flow statement for the year.
ROCKFORD COMPANY
Cash Flow Statement Worksheet
For the Year Ended December 31, 2004
(dollars in millions)
(1) (2) (3) (4) (5) (6)
Cash Adjusted
Source Flow Adjust- Effect Classi-
Change or Use? Effect ments (3) (4) fication
Assets (except cash and cash
equivalents)
Current assets:
Accounts receivable . . . . . . . . . . . . . . . $ ⫺90 Source $ ⫹90 $ ⫹90 Operating
Inventory . . . . . . . . . . . . . . . . . . . . . . . . ⫹45 Use ⫺45 ⫺45 Operating
Prepaid expenses . . . . . . . . . . . . . . . . . ⫺3 Source ⫹3 ⫹3 Operating
Noncurrent assets:
Property, buildings, and equipment . . . ⫹121 Use ⫺121 $⫺12 ⫺133 Investing
Long-term investments . . . . . . . . . . . . . ⫺15 Source ⫹15 ⫹15 Investing
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24 Chapter 15
Additional Entries
Proceeds from sale of equipment . . . . . . . ⫹3 ⫹3 Investing
Loss on sale of equipment . . . . . . . . . . . . ⫹4 ⫹4 Operating
Total (net cash flow) . . . . . . . . . . . . . . . . . $ ⫹16 $ 0 $ ⫹16
ROCKFORD COMPANY
Cash Flow Statement—Indirect Method
For the Year Ended December 31, 2004
(dollars in millions)
Operating Activities
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 66
Adjustments to convert net income to a cash basis:
Depreciation and amortization charges . . . . . . . . . . . . . . . . . . 29
Decrease in accounts receivable . . . . . . . . . . . . . . . . . . . . . . . . 90
Increase in inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (45)
Decrease in prepaid expenses . . . . . . . . . . . . . . . . . . . . . . . . . 3
Decrease in accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . (80)
Increase in accrued liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Increase in deferred income taxes . . . . . . . . . . . . . . . . . . . . . . 7
Loss on sale of equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Net cash provided by operating activities . . . . . . . . . . . . . . . . . . 84
Investing Activities:
Additions to property, buildings, and equipment . . . . . . . . . . . . . (133)
Decrease in long-term investments . . . . . . . . . . . . . . . . . . . . . . . 15
Proceeds from sale of equipment . . . . . . . . . . . . . . . . . . . . . . . . . 3
Net cash used in investing activities . . . . . . . . . . . . . . . . . . . . . . (115)
Financing Activities:
Increase in bonds payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
Cash dividends paid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (48)
Net cash provided by financing activities . . . . . . . . . . . . . . . . . . 47
Net increase in cash and cash equivalents . . . . . . . . . . . . . . . . 16
Cash and cash equivalents at beginning of year . . . . . . . . . . . . . . 10
Cash and cash equivalents at end of year . . . . . . . . . . . . . . . . . . . $ 26
Note that the $16 increase in cash and cash equivalents agrees with the $16 increase in the company’s
Cash account shown on the balance sheet, and it agrees with the total in column (5) in the above worksheet.
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Glossary
Cash equivalents Short-term, highly liquid investments, such as Treasury bills, commercial paper, and
money market funds, that are made solely for the purpose of generating a return on funds that are
temporarily idle. (p. 5)
Cash flow statement A financial statement that highlights the major activities that directly and indirectly
impact cash flows and hence affect the overall cash balance. (p. 4)
Direct exchange transactions Transactions involving only noncurrent balance sheet accounts. For
example, a company might issue common shares that are directly exchanged for property. (p. 12)
Direct method A method of computing the cash provided by operating activities in which the income
statement is reconstructed on a cash basis from top to bottom. (p. 12)
Financing activities All transactions (other than payment of interest) involving borrowing from creditors
or repaying creditors as well as transactions with the company’s owners (except stock dividends and
stock splits). (p. 11)
Indirect method A method of computing the cash provided by operating activities that starts with net
income and adjusts it to a cash basis. It is also known as the reconciliation method. (p. 12)
Investing activities Transactions that involve acquiring or disposing of noncurrent assets. (p. 11)
Net cash provided by operating activities The net result of the cash inflows and outflows arising from
day-to-day operations. (p. 12)
Operating activities Transactions that enter into the determination of net income. (p. 10)
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As stated in the main body of the chapter, to compute the “Net cash provided by operat-
Learning Objective 4 ing activities” under the direct method, we must reconstruct the income statement on a
Use the direct method to cash basis from top to bottom. A model is presented in Exhibit 15A–1 that shows the
determine the net cash adjustments that must be made to adjust sales, expenses, and so forth, to a cash basis. To
provided by operating illustrate, we have included in the exhibit the Nordstrom data from the chapter.
activities. Note that the “Net cash provided by operating activities” figure ($259 million) agrees
with the amount computed in the chapter by the indirect method. The two amounts agree,
since the direct and indirect methods are just different roads to the same destination. The
investing and financing activities sections of the statement will be exactly the same as
shown for the indirect method in Exhibit 15–12. The only difference between the indirect
and direct methods is in the operating activities section.
26
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Exhibit 15A–1
Add () or
General Model: Direct Method of
Deduct () to Illustration—
Adjust to a Nordstrom Determining the “Net Cash
Revenue or Expense Item Cash Basis (in millions) Provided by Operating Activities”
of sales, cost of goods sold, operating expenses, or income taxes. Observe that in Exhibit
15A–1, Nordstrom’s $3 million gain on the sale of the store is not listed as an adjustment
in the operating activities section.
28 Chapter 15
A worksheet approach was used to prepare the cash flow statement in the chapter. The
Learning Objective 5
T-account approach is an alternative technique that is sometimes used to prepare the
Prepare a cash flow
cash flow statement. To illustrate the T-account approach, we will again use the data for
Nordstrom Inc. (the same company used to illustrate the worksheet approach). statement using the
T-account approach.
RETAINED EARNINGS The Retained Earnings account is generally the most useful
starting point when developing a cash flow statement. Details of the change in Nordstrom’s
Retained Earnings account are presented in Exhibit 15–5. Note from the exhibit that net
income of $140 million was added to Retained Earnings and dividends of $28 million
29
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30 Chapter 15
Exhibit 15B–1
T-Accounts Showing Changes in Account Balances––Nordstrom Inc. (in millions)
Cash
Provided Used
were charged against Retained Earnings during the year. The entries to record these
changes and their effects on Cash are shown below. (The dollar amounts are in millions.)
The entry to record net income and the effect on Cash would be:
(1)
Cash––Provided . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 140
Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . 140
Recall that net income is converted to a cash basis when the indirect method is used to
prepare the operating activities section of the cash flow statement. Since net income is the
starting point, the cash effect is included in the upper portion of the Cash T-account.
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Exhibit 15B–2
T-Accounts after Posting of Account Changes––Nordstrom Inc. (in millions)
Cash
Provided Used
The entry to record the dividends paid and the effect on Cash would be:
(2)
Retained Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Cash––Used . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
Since the payment of cash dividends is classified as an investing activity, the cash effect
is included in the lower portion of the Cash T-account along with the other investing and
financing items.
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32 Chapter 15
Once posted to the Retained Earnings T-account in Exhibit 15B–2, these two entries
fully explain the change that took place in the Retained Earnings account during the
year. We can now proceed through the remainder of the balance sheet accounts in
Exhibit 15B–2, analyzing the change between the beginning and ending balances in each
account, and recording the appropriate entries in the T-accounts.
(3)
Cash––Provided . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . 17
The merchandise inventory account increased by $49 million during the year. The
entry to record this change and its effect on Cash would be:
(4)
Merchandise Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Cash––Used . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49
Note that these two entries result in the correct adjusting entries in the current asset
T-accounts so as to reconcile the beginning and ending balances. Also note that the
changes in these two current asset accounts are included in the upper portion of the Cash
T-account. This is because changes in current assets are considered part of operations and
therefore are used to convert net income to a cash basis in the operating activities section
of the cash flow statement.
(5)
Cash––Provided . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Accumulated Depreciation . . . . . . . . . . . . . . . . . . . . . . . 10
Property, Buildings, and Equipment . . . . . . . . . . . . 15
Gain on Sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Since the sale of property, buildings, and equipment is classified as an investing activity,
the cash effect is included in the lower portion of the Cash T-account along with the other
investing and financing items. The proceeds from the sale, which will be reported in the
investing activities section of the cash flow statement, includes the gain that was recog-
nized on the sale of the store. However, this gain was reported on Nordstrom’s income
statement in Exhibit 15–3 as part of the net income figure, which is the starting point for
the operating activities section. As a result, to avoid double counting, the gain must be
chapter 15.qxd 11/13/2004 3:10 PM Page 33
subtracted (or removed) from net income in the operating activities section of the cash
flow statement. Accordingly, the gain is recorded in the “Used” column in the upper
portion of the Cash T-account along with the other operating items.
The entry to record the purchase of property, buildings, and equipment and its effect on
Cash would be:
(6)
Property, Buildings, and Equipment . . . . . . . . . . . . . . . . 138
Cash––Used . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138
(7)
Cash––Provided . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
Accumulated Depreciation . . . . . . . . . . . . . . . . . . . 103
Note that depreciation and amortization expense does not involve an actual outflow of
cash. Consequently, depreciation and amortization expense must be added to net income
to convert it to a cash basis in the operating activities section of the cash flow statement.
Note that the depreciation and amortization expense is recorded in the “Provided” column
in the upper portion of the Cash T-account along with the other operating items. Entry (7),
along with entry (5) above, explains the change in the Accumulated Depreciation account
during the year.
CURRENT LIABILITIES The T-accounts in Exhibit 15B–1 show that Nordstrom has
four current liability accounts. Three of the four current liability accounts (Accounts
Payable, Accrued Wages and Salaries Payable, and Accrued Income Taxes Payable) relate
to the company’s operating activities. In the entries that follow, increases in current
liabilities are recorded as credits, with the offsetting entry being “Cash—Provided.”
Decreases in current liabilities are recorded as debits, with the offsetting entry being
“Cash—Used.”
Accounts Payable increased by $44 million during the year. The entry to record this
change and its effect on Cash would be:
(8)
Cash––Provided . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 44
Accounts Payable . . . . . . . . . . . . . . . . . . . . . . . . . . 44
The Accrued Wages and Salaries Payable account increased by $3 million during the
year. The entry to record this change and its effect on Cash would be:
(9)
Cash––Provided . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Accrued Wages and Salaries Payable . . . . . . . . . . . 3
The Accrued Income Taxes Payable account increased by $6 million during the year.
The entry to record this change and its effect on Cash would be:
(10)
Cash––Provided . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Accrued Income Taxes Payable . . . . . . . . . . . . . . . . 6
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34 Chapter 15
Since the changes in these three current liability accounts are considered to be part of
operations, their cash effects are included in the upper portion of the Cash T-account
along with the other operating items.
The Notes Payable account increased by $2 million during the year. Nordstrom’s finan-
cial statements give no indication that payments were made on the notes payable during
the year. Therefore, we must assume that the increase represents an issuance of notes
payable for cash. The entry to record the issuance and its effect on Cash would be:
(11)
Cash––Provided . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Notes Payable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Since transactions involving notes payable are classified as financing activities, their cash
effects are included in the lower portion of the Cash T-account along with the other invest-
ing and financing items.
(12)
Long-Term Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Cash––Used . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
Since transactions involving long-term debt are classified as financing activities, their
cash effects are included in the lower portion of the Cash T-account along with the other
investing and financing items.
(13)
Deferred Income Taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Cash––Used . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Since changes in the Deferred Income Taxes account are classified as part of opera-
tions, its cash effects are included in the upper portion of the Cash T-account along with
the other operating items.
(14)
Cash––Provided . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Common Shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
With this entry, our analysis of changes in Nordstrom’s balance sheet accounts is com-
plete. At this point, the subtotal titled “Net cash provided by operating activities” can be
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computed. To ensure that all activity has been properly recorded in the Cash T-account,
the total titled “Net increase in cash and cash equivalents” should also be computed (by
adding the investing and financing items in the lower portion of the Cash T-account to the
subtotal of the upper portion). The $62 million net increase in cash and cash equivalents
that is detailed in the Cash T-account in Exhibit 15A–2 equals the increase in cash and
cash equivalents shown on Nordstrom’s comparative balance sheet in Exhibit 15–4.
36 Chapter 15
15–10 A business executive once stated, “Depreciation is one of our biggest sources of cash.” Do you
agree that depreciation is a source of cash? Explain.
15–11 If the balance in Accounts Receivable increases during a period, how will this increase be
handled under the indirect method when computing the cash provided by operating activities?
15–12 (Appendix 15A) If the balance in Accounts Payable decreases during a period, how will this
decrease be handled under the direct method in computing the cash provided by operating activities?
15–13 During the current year, a company declared and paid a $60,000 cash dividend and a 10% stock
dividend. How will these two items be treated on the current year’s cash flow statement?
15–14 Would a sale of equipment for cash be considered a financing activity or an investing
activity? Why?
15–15 (Appendix 15A) A merchandising company showed $250,000 in cost of goods sold on its income
statement. The company’s beginning inventory was $75,000, and its ending inventory was $60,000. The
accounts payable balance was $50,000 at the beginning of the year and $40,000 at the end of the year.
Using the direct method, adjust the company’s cost of goods sold to a cash basis.
BRIEF EXERCISE 15–3 Cash Provided by Operating Activities (Indirect Method) (LO3)
For the just completed year, Hanna Company reported a net income of $35,000. Balances in the company’s
current asset and current liability accounts at the beginning and end of the year were:
The Deferred Income Taxes liability account on the balance sheet increased by $4,000 during the year, and
depreciation charges were $20,000.
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Required:
Using the indirect method, determine the cash provided by operating activities for the year.
BRIEF EXERCISE 15–4 Cash Provided by Operating Activities (Direct Method) (LO4)
(Appendix 15A) Refer to the data for Hanna Company in Brief Exercise 15–3. The company’s income
statement for the year appears below:
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $350,000
Less cost of goods sold . . . . . . . . . . . . . . . 140,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . 210,000
Less operating expenses . . . . . . . . . . . . . . 160,000
Income before taxes . . . . . . . . . . . . . . . . . . 50,000
Less income taxes (30%) . . . . . . . . . . . . . . 15,000
Net income . . . . . . . . . . . . . . . . . . . . . . . . . $ 35,000
Required:
Using the direct method (and the data from Brief Exercise 15–3), convert the company’s income statement
to a cash basis.
Item Amount
Accounts Receivable . . . . . . . . . . . . . . $ 90,000 decrease
Accrued Interest Receivable . . . . . . . . . 4,000 increase
Inventory . . . . . . . . . . . . . . . . . . . . . . . 120,000 increase
Prepaid Expenses . . . . . . . . . . . . . . . . . 3,000 decrease
Accounts Payable . . . . . . . . . . . . . . . . . 65,000 decrease
Accrued Liabilities . . . . . . . . . . . . . . . . 8,000 increase
Deferred Income Taxes Liability . . . . . 12,000 increase
Sale of equipment . . . . . . . . . . . . . . . . . 7,000 gain
Sale of long-term investments . . . . . . . 10,000 loss
Required:
Prepare an answer sheet using the following column headings:
On your answer sheet, enter the items and amounts. For each item, place an X in the Add or Deduct column
to indicate whether the dollar amount should be added to or deducted from net income under the indirect
method when computing the cash provided by operating activities for the year.
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38 Chapter 15
2004 2003
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 3 $ 6
Accounts receivable . . . . . . . . . . . . . . . . . . . . . 22 24
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 40
Plant and equipment . . . . . . . . . . . . . . . . . . . . . 240 200
Less accumulated depreciation . . . . . . . . . . . (65) (50)
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . $250 $220
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . $ 40 $ 36
Common shares . . . . . . . . . . . . . . . . . . . . . . . . . 150 145
Retained earnings . . . . . . . . . . . . . . . . . . . . . . . 60 39
Total liabilities and shareholders’ equity . . . . . $250 $220
Sales . . . . . . . . . . . . . . . . . . . . . . . $275
Cost of goods sold . . . . . . . . . . . . 150
Gross margin . . . . . . . . . . . . . . . . 125
Operating expenses . . . . . . . . . . . 90
Net income . . . . . . . . . . . . . . . . . . $ 35
EXERCISE 15–3 Convert Income Statement to a Cash Basis (Direct Method) (LO4)
(Appendix 15A) Refer to the data for Carmono Company in Exercise 15–2.
Required:
Using the direct method, convert the company’s income statement to a cash basis.
Long-term investments that had cost the company $6 were sold during the year for $16, and land that
had cost $15 was sold for $9. In addition, the company declared and paid $30 in cash dividends during the
year. No sales or retirements of plant and equipment took place during the year.
chapter 15.qxd 11/13/2004 3:10 PM Page 39
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . $700
Less cost of goods sold . . . . . . . . . . . 400
Gross margin . . . . . . . . . . . . . . . . . . . 300
Less operating expenses . . . . . . . . . . . 184
Net operating income . . . . . . . . . . . . . 116
Nonoperating items:
Gain on sale of investments . . . . . . $10
Loss on sale of land . . . . . . . . . . . . 6 4
Income before taxes . . . . . . . . . . . . . . 120
Less income taxes . . . . . . . . . . . . . . . 36
Net income . . . . . . . . . . . . . . . . . . . . . $ 84
The company’s beginning cash balance was $90, and its ending balance was $85.
Required:
1. Use the indirect method to determine the cash provided by operating activities for the year.
2. Prepare a cash flow statement for the year.
EXERCISE 15–5 Convert Income Statement to Cash Basis (Direct Method) (LO4)
(Appendix 15A) Refer to the data for Pavolik Company in Exercise 15–4.
Required:
Use the direct method to convert the company’s income statement to a cash basis.
Activity Reported in
Source, Use, a Separate Not on the
Transaction or Neither Operating Investing Financing Schedule Statement
Enter the letter of the transaction in the left column and indicate whether the transaction would be a source,
use, or neither. Then place an X in the appropriate column to show the proper classification of the transac-
tion on the cash flow statement or to show if it would not appear on the statement at all.
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40 Chapter 15
CHECK FIGURE PROBLEM 15–2 Prepare a Cash Flow Statement (Indirect Method) (LO3)
(1) Net cash used for Joyner Company has provided the following spreadsheet containing the balances in its balance sheet
investing activities: accounts for year 1 and year 2.
$172,000
Year 2 Year 1
Debit Balance Accounts
Cash $ 4,000 $ 21,000
Accounts Receivable 250,000 170,000
Inventory 310,000 260,000
Prepaid Expenses 7,000 14,000
Loan to Hymas Company 40,000 -
Plant and Equipment 510,000 400,000
Total $1,121,000 $ 865,000
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $900,000
Less cost of goods sold . . . . . . . . . . . . . . . 500,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . 400,000
Less operating expenses . . . . . . . . . . . . . . 328,000
Net operating income . . . . . . . . . . . . . . . . 72,000
Gain on sale of equipment . . . . . . . . . . . . 8,000
Income before taxes . . . . . . . . . . . . . . . . . 80,000
Less income taxes . . . . . . . . . . . . . . . . . . . 24,000
Net income . . . . . . . . . . . . . . . . . . . . . . . . $ 56,000
Equipment that had cost $40,000 and on which there was accumulated depreciation of $30,000 was sold
during year 2 for $18,000. Cash dividends totalling $15,000 were declared and paid during year 2.
Required:
1. Using the indirect method, compute the cash provided by operating activities for year 2.
2. Prepare a cash flow statement for year 2.
3. Prepare a brief explanation as to why cash declined so sharply during the year.
CHECK FIGURE PROBLEM 15–3 Prepare and Interpret a Cash Flow Statement (Direct Method) (LO4)
(1) Net cash provided by (Appendix 15A) Refer to the financial statement data for Joyner Company in Problem 15–2. Sam Conway,
operating activities: president of the company, considers $15,000 to be a minimum cash balance for operating purposes. As can
$20,000 be seen from the balance sheet data, only $4,000 in cash was available at the end of the current year. The
sharp decline is puzzling to Mr. Conway, particularly since sales and profits are at a record high.
chapter 15.qxd 11/13/2004 3:10 PM Page 41
Required:
1. Using the direct method, adjust the company’s income statement to a cash basis for year 2.
2. Using the data from (1) above and other data from the problem as needed, prepare a cash flow
statement for year 2.
3. Explain to Mr. Conway why cash declined so sharply during the year.
PROBLEM 15–4 Prepare a Cash Flow Statement (Indirect Method) (LO3) CHECK FIGURE
Comparative financial statements for Weaver Company follow: (1) Net cash provided
by operating
activities: $104
WEAVER COMPANY
Comparative Balance Sheet
December 31, 2004, and 2003
2004 2003
S
Assets
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 9 $ 15
Accounts receivable . . . . . . . . . . . . . . . . . . . 340 240
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 175
Prepaid expenses . . . . . . . . . . . . . . . . . . . . . 10 6
Plant and equipment . . . . . . . . . . . . . . . . . . 610 470
Less accumulated depreciation . . . . . . . . (93) (85)
Long-term investments . . . . . . . . . . . . . . . . 16 19
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . $1,017 $840
WEAVER COMPANY
Income Statement
For the Year Ended December 31, 2004
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $800
Less cost of goods sold . . . . . . . . . . . . . . . . . . . 500
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . 300
Less operating expenses . . . . . . . . . . . . . . . . . . 213
Net operating income . . . . . . . . . . . . . . . . . . . . 87
Nonoperating items:
Gain on sale of investments . . . . . . . . . . . . . . $7
Loss on sale of equipment . . . . . . . . . . . . . . . 4 3
Income before taxes . . . . . . . . . . . . . . . . . . . . . . 90
Less income taxes . . . . . . . . . . . . . . . . . . . . . . . 27
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 63
During 2004, the company sold some equipment for $20 that had cost $40 and on which there was accu-
mulated depreciation of $16. In addition, the company sold long-term investments for $10 that had cost $3
when purchased several years ago. Cash dividends totalling $30 were paid during 2004.
chapter 15.qxd 11/13/2004 3:10 PM Page 42
42 Chapter 15
Required:
1. Using the indirect method, determine the cash provided by operating activities for 2004.
2. Use the information in (1) above, along with an analysis of the remaining balance sheet accounts, and
prepare a cash flow statement for 2004.
CHECK FIGURE PROBLEM 15–5 Prepare a Cash Flow Statement (Direct Method) (LO4)
(2) Net decrease in cash: $6 (Appendix 15A) Refer to the financial statement data for Weaver Company in Problem 15–4.
Required:
1. Using the direct method, adjust the company’s income statement for 2004 to a cash basis.
2. Use the information obtained in (1) above, along with an analysis of the remaining balance sheet
accounts, and prepare a cash flow statement for 2004.
CHECK FIGURE PROBLEM 15–6 Prepare and Interpret a Cash Flow Statement (Indirect Method) (LO3)
(1) Net cash provided by Mary Walker, president of Rusco Products, considers $14,000 to be the minimum cash balance for operat-
operating activities: ing purposes. As can be seen from the statements below, only $8,000 in cash was available at the end of
$18,000 2004. Since the company reported a large net income for the year, and also issued both bonds and common
shares, the sharp decline in cash is puzzling to Ms. Walker.
RUSCO PRODUCTS
Comparative Balance Sheet
July 31, 2004, and 2003
S Current assets:
Assets
2004 2003
RUSCO PRODUCTS
Income Statement
For the Year Ended July 31, 2004
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $500,000
Less cost of goods sold . . . . . . . . . . . . . . . . . . . . . . 300,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 200,000
Less operating expenses . . . . . . . . . . . . . . . . . . . . . 158,000
Net operating income . . . . . . . . . . . . . . . . . . . . . . . 42,000
Nonoperating items:
Gain on sale of investments . . . . . . . . . . . . . . . . $10,000
Loss on sale of equipment . . . . . . . . . . . . . . . . . 2,000 8,000
Income before taxes . . . . . . . . . . . . . . . . . . . . . . . . 50,000
Less income taxes . . . . . . . . . . . . . . . . . . . . . . . . . . 20,000
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 30,000
PROBLEM 15–7 Prepare and Interpret a Cash Flow Statement (Direct Method) (LO4) CHECK FIGURE
(Appendix 15A) Refer to the financial statements for Rusco Products in Problem 15–6. Since the Cash (2) Net cash used for
account decreased so dramatically during 2004, the company’s executive committee is anxious to see how investing activities:
the income statement would appear on a cash basis. $112,000
Required:
1. Using the direct method, adjust the company’s income statement for 2004 to a cash basis.
2. Using the data from (1) above, and other data from the problem as needed, prepare a cash flow
statement for 2004.
3. Prepare a brief explanation for the executive committee setting forth the major reasons for the sharp
S
decline in cash during the year.
PROBLEM 15–8 Worksheet; Prepare and Interpret Cash Flow Statement (Indirect Method) (LO3) CHECK FIGURE
“See, I told you things would work out,” said Barry Kresmier, president of Lomax Company. “We (2) Net cash used for
expanded sales from $1.6 million to $2 million in 2004, nearly doubled our warehouse space, and ended investing activities:
the year with more cash in the bank than we started with. A few more years of expansion like this and we’ll $570,000
be the industry leaders.”
“Yes, I’ll admit our statements look pretty good,” replied Sheri Colson, the company’s vice-president.
“But we’re doing business with a lot of companies we don’t know much about and that worries me. I’ll
admit, though, that we’re certainly moving a lot of merchandise; our inventory is actually down from
last year.”
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44 Chapter 15
A comparative balance sheet for Lomax Company containing data for the last two years follows:
LOMAX COMPANY
Comparative Balance Sheet
December 31, 2004, and 2003
2004 2003
Assets
Current assets:
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 42,000 $ 27,000
Marketable securities . . . . . . . . . . . . . . . . . 19,000 13,000
Accounts receivable . . . . . . . . . . . . . . . . . . 710,000 530,000
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . 848,000 860,000
Prepaid expenses . . . . . . . . . . . . . . . . . . . . 10,000 5,000
Total current assets . . . . . . . . . . . . . . . . . . . . 1,629,000 1,435,000
Long-term investments . . . . . . . . . . . . . . . . . 60,000 110,000
Loans to subsidiaries . . . . . . . . . . . . . . . . . . . 130,000 80,000
Plant and equipment . . . . . . . . . . . . . . . . . . . 3,170,000 2,600,000
Less accumulated depreciation . . . . . . . . . 810,000 755,000
Net plant and equipment . . . . . . . . . . . . . . . . 2,360,000 1,845,000
Goodwill . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84,000 90,000
Total assets . . . . . . . . . . . . . . . . . . . . . . . . . . . $4,263,000 $3,560,000
The following additional information is available about the company’s activities during 2004:
a. Cash dividends declared and paid to the common shareholders totalled $75,000.
b. Long-term notes with a value of $380,000 were repaid during the year.
c. Equipment was sold during the year for $70,000. The equipment had cost $130,000 and had $40,000
in accumulated depreciation on the date of sale.
d. Long-term investments were sold during the year for $110,000. These investments had cost $50,000
when purchased several years ago.
e. The company’s income statement for 2004 follows:
Sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,000,000
Less cost of goods sold . . . . . . . . . . . . . . . . . 1,300,000
Gross margin . . . . . . . . . . . . . . . . . . . . . . . . . 700,000
Less operating expenses . . . . . . . . . . . . . . . . 490,000
Net operating income . . . . . . . . . . . . . . . . . . . 210,000
chapter 15.qxd 11/13/2004 3:10 PM Page 45
Nonoperating items:
Gain on sale of investments . . . . . . . . . . . . $60,000
Loss on sale of equipment . . . . . . . . . . . . . 20,000 40,000
Income before taxes . . . . . . . . . . . . . . . . . . . . 250,000
Less income taxes . . . . . . . . . . . . . . . . . . . . . 80,000
Net income . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 170,000
Required:
1. Prepare a worksheet like Exhibit 15–10 for Lomax Company.
2. Using the indirect method, prepare a cash flow statement for the year 2004.
3. What problems relating to the company’s activities are revealed by the cash flow statement that you
have prepared?
PROBLEM 15–9 Adjust Income Statement to Cash Basis (Direct Method) (LO4) CHECK FIGURE
(Appendix 15A) Refer to the data for the Lomax Company in Problem 15–8. All of the long-term notes Net cash provided by
issued during 2004 are being held by Lomax’s bank. The bank’s management wants the income operating activities:
statement adjusted to a cash basis so that it can compare the cash basis statement to the accrual basis $356,000
statement.
Required:
Use the direct method to convert Lomax Company’s 2004 income statement to a cash basis.
S
Net Increase
(Decrease)
Debit Balance Accounts
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ (10,000)
Accounts Receivable . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (81,000)
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 230,000
Prepaid Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (6,000)
Long-Term Loans to Subsidiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100,000
Long-Term Investments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (120,000)
Plant and Equipment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 500,000
Net increase . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 613,000
46 Chapter 15
Ending Beginning
Plant and Equipment . . . . . . . . . $3,200,000 $2,700,000
Accumulated Depreciation . . . . . 1,500,000 1,410,000
g. If data are not given explaining the change in an account, make the most reasonable assumption as to
the cause of the change.
Required:
Using the indirect method, prepare a cash flow statement for the past year. Show all computations for items
that appear on your statement.
Do not forget to check out Taking It to the Net and other quizzes and resources at the Online Learning
Centre at www.mcgrawhill.ca/college/garrison.