110. (CMA adapted, Jun 94 #4) Marathon Corporation, a public company, has prepared all of its year-end
financial statements with the exception of the statement of cash flows. Presented below is condensed financial
information for the years ended May 31, Year 3 and Year 4, as well as supplemental data on certain transactions
that occurred during the year ended May 31, Year 4.
Marathon Corporation
Statement of Financial Position
at May 31, Year 3 and Year 4
Year 3
Year 4
Cash
$ 4,300
$ 5,100
Accounts receivable
3,700
4,200
Inventories
34,200
31,700
Prepaid expenses
1,800
2,100
Land
38,000
27,000
Buildings (net)
126,800
117,700
Equipment (net)
50,500
66,800
Leased equipment
–
7,700
Total assets
$259,300
$262,300
Accounts payable
$ 5,900
$ 3,400
Income taxes payable
2,600
2,100
Obligation under capital lease
–
7,700
Bonds payable
50,000
60,000
Deferred income taxes
2,200
2,400
Common stock, $10 par
125,000
135,000
Paid-in capital in excess of par
12,000
14,000
Retained earnings
61,600
37,700
Total liabilities and shareholders’ equity
$259,300
$262,300
Marathon Corporation
Income Statement
For the Year Ended May 31, Year 4
Sales
$127,900
Cost of goods sold
$69,800
Selling expense
21,000
Administrative expense
20,000
Deprec. expense-buildings
700
Deprec. expense-equipment
1,200
Bond interest expense
4,000
116,700
Income before gain & tax
$ 11,200
Gain on sale of land
3,500
Less: Income tax expense
800
Income from operations
$ 13,900
Extraordinary loss (net of tax)
2,600
Net income
$ 11,300
Marathon Corporation
Retained Earnings Statement
at May 31, Year 4
Beginning retained earnings
$61,600
Net income
11,300
Stock dividends
(12,000)
Cash dividends
(23,200)
Ending retained earnings
$37,700
Supple
mental
Inform
ation
For
Fiscal
Year
Ended
May
31,
Year 4
(a)
Land costing $11,000 was sold for $14.500, resulting in a $3,500 gain.
(b)
During the year, a fire completely destroyed a building with an original cost of $24,000 and a net
book value of $8,400. The insurance settlement resulted in after-tax cash proceeds of $5,800 and an
extraordinary loss (net of income taxes) of $2,600.
(c)
Equipment was purchased for cash at a cost $17,500.
(d)
On May 31, Year 4, the company leased equipment under a long-term capital lease, recording the
lease at $7,700.
(e)
At the end of the year, bonds payable with a face value of $10,000 were issued at par.
(f)
A stock dividend was declared and issued during the year. The dividend involved 1,000 shares of $10
par common stock; the market value of the stock on the date of issuance was $12 per share.
(g)
Taxable Income was less than pretax accounting income for the year, resulting in an increase in
deferred income taxes payable of $200.
Required:
Using the indirect method, prepare the Statement of Cash Flows for Marathon Corporation for the year ended
May 31, Year 4. The statement should comply with the requirements of Statements of Financial Accounting
Standards No. 95, ‘Statement of Cash Flows,’ and be supported by appropriate calculations.
Marathon Corporation’s statement of cash flows, prepared under the indirect method, for the year ended May
31, Year 4, is presented below.
Marathon Corporation
Statement of Cash Flows
For the Year Ended May 31,
Year 4
Cash flows from operating
activities
Net income
$ 11,300
Adjustments to reconcile net
income to net cash from
operating activities:
Depreciation expense
– buildings
700
– equipment
1,200
Increase in deferred taxes
200
Extraordinary loss (net) from
fire
2,600
Changes in assets and liabilities,
net of acquisitions:
Increase in accounts
receivable
(500)
Decrease in inventories
2,500
Increase in prepaid expenses
(300)
Decrease in accounts payable
(2,500)
Decrease in income taxes
payable
(500)
Gain on sale of land
(3,500)
Net cash provided by
operating activities
$ 11,200
Cash flows from investing
activities
Payment for purchase of
equipment
(17,500)
Proceeds from sale of land
14,500
Proceeds from building
destroyed by fire
5,800
Net cash provided by
investing activities
$ 2,800
Cash flows from financing
activities
Proceeds from issuance of
bonds
$ 10,000
Payment of cash dividends
(23,200)
Net cash used for
financing activities
$(13,200)
Net increase in cash and cash
equivalents
800
Cash at the beginning of year
4,300
Cash at the end of year
$ 5,100
Supplemental Schedule of
Noncash Investing and
Financing Activities
Financing activities
Issuance of capital lease
obligation for equipment
$ 7,700
Supporting Calculations
Increases (decreases) in the
balance sheet accounts are
derived from the comparative
Statement of Financial Position
shown below.
Marathon Corporation
Comparative Statement of Financial Position
May 31, Year 4
Year 3
Year 4
Change
Cash
$ 4,300
$ 5,100
$ 800
Accounts receivable
3,700
4,200
500
Inventory
34,200
31,700
(2,500)
Prepaid expenses
1,800
2,100
300
Land
38,000
27,000
(11,000)
Buildings (net)
126,800
117,700
(9,100)
Equipment (net)
50,500
66,800
16,300
Leased equipment
–
7,700
7,700
Total assets
$259,300
$262,300
$ 3,000
Accounts payable
$ 5,900
$ 3,400
$ (2,500)
Income taxes payable
2,600
2,100
(500)
Obligation under capital lease
–
7,700
7,700
Bonds payable
50,000
60,000
10,000
Deferred income tax
2,200
2,400
200
Common stock, $10 par
125,000
135,000
10,000
Paid-in capital in excess of par
12,000
14,000
2,000
Retained earnings
61,600
37,700
(23,900)
Total liabilities and equity
$259,300
$262,300
$ 3,000
111. Discuss the concepts underlying the statement of cash flows:
1. The statement of cash flows explains the reasons for the change in cash and cash equivalents during a period.
This statement classifies the reasons as relating to operating or investing or financing decisions.
112. Discuss the indirect and direct methods in deriving cash flow from operations.
The direct method’s presentation of cash flow requires less understanding of the contrast between cash and
accrual accounting, but its derivation requires the same understanding as does the indirect method. Every
addback and subtraction in the indirect presentation appears in the direct method’s derivation.
113. Discuss the relation between net income and cash flow from operations when interpreting the statement of
cash flows
INTERPRETING THE STATEMENT OF CASH FLOWS
RELATION BETWEEN NET INCOME AND CASH FLOW FROM OPERATIONS
Net income (Revenues minus Expenses) differs from Cash Flow from Operations (Receipts from operations
Expenditures for operations). The balance sheet reflects these differences in the changes in current and
noncurrent accounts:
114. Discuss the relations among cash flows from operating, investing, and financing activities for firms in the
introduction, growth, mature, late maturity, and decline phases.
RELATIONS AMONG CASH FLOWS FROM OPERATING, INVESTING, AND FINANCING
ACTIVITIES
The product life-cycle concept from microeconomics and marketing provides useful insights
into the relations among cash flows from operating, investing, and financing activities.
During the introduction phase, cash outflow exceeds cash inflow from operations because operations are not yet
earning profits while the firm must invest in accounts receivable and inventories. Investing activities result in a
net cash outflow to build productive capacity. Firms must rely on external financing during this phase to
overcome the negative cash flow from operations and investing.
Weakening profitability—from reduced sales or reduced profit margins on existing sales—
signals the beginning of the decline phase, but ever-declining accounts receivable and inventories can produce
positive cash flow from operations. In addition, sales of unneeded property, plant, and equipment can result in
positive cash flow from investing activities. Firms can use the excess cash flow to repay remaining debt or
diversify into other areas of business.
115. Discuss the effects of transactions involving derivatives and the fair value option on the statements of cash
flows.
THE EFFECTS OF TRANSACTIONS INVOLVING DERIVATIVES AND THE FAIR VALUE OPTION ON
THE STATEMENT OF CASH FLOWS
Firms engage in transactions involving derivatives. For the most part, the complex parts of these transactions
occur after the firm has acquired the derivative, but those subsequent transactions do not affect cash flows until,
possibly, their settlement. The following discussion refers to a statement of cash flows that uses the indirect
method for presenting cash flows from operations.
There is a fair value option for marketable securities and derivatives. Firms using the fair value option mark the
carrying value of the asset to fair value each period.
116. Describe the effects of transactions involving investments on the statement of cash flows.
THE EFFECTS OF TRANSACTIONS INVOLVING INVESTMENTS ON THE STATEMENT OF CASH
FLOWS
The effects of transactions involving investments on the statement of cash flows in U.S. GAAP are as follows.
Accounting Method Effects on Statement of Cash Flows
minority’s interest in income of less than 100%owned subsidiaries.
Dividends received from investee included in investor’s cash flow from operations. In indirect
method, add back realized holding losses, and subtract realized holding gains included in income for the period
to derive cash flow from operations.
All proceeds of sale of securities available for sale appear as (dis)investing source of cash.