Chapter 12 – Reporting and Analyzing Cash Flows
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Solutions Manual, Chapter 12
49
Ethics Challenge — BTN 12-3
1. The business actions available include
a. Encourage early collection of receivables to reduce the accounts
receivable balance.
2. As a business owner, Katie Murphy certainly can exercise discretion over
business actions. However, the underlying economic realities should
support any proposed actions. It is not ethical to pursue actions that
purposely mislead users of financial statements.
In addition, Katie Murphy’s actions may be transparent to the banker when
© 2015 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Financial Accounting, 7th Edition
50
I am pleased to hear your business is more profitable this year than last.
However, I have been thinking about what you said regarding the statement of
cash flows and have some thoughts as to why you found it confusing.
The statement of cash flows (operating section) can be prepared using either
of two methods—the direct or the indirect method. From what you describe,
cash flow by directly subtracting the total of these operating outflows from the
inflows. You should find this format more understandable.
Note that good cash management is essential to business success and
growth. The statement of cash flows will provide you with a lot more
information regarding your cash than a balance sheet can offer. It will allow
1. Mendocino Brewing Company uses the indirect method to construct the
2. The largest reconciling item is for depreciation and amortization totaling
3. The following table shows the net income (or net loss) and the cash flows
from operations for Mendocino Brewing for 2010 and 2011. Over this two–
year period, Mendocino has generated more positive cash flows from
Chapter 12 – Reporting and Analyzing Cash Flows
Teamwork in Action — BTN 12–6
Part 1
a. The reporting objective of the statement of cash flows is to provide
investing categories.
• Both methods provide exactly the same information in the financing and
investing categories.
• Both identify the change in cash, beginning cash, and ending cash.
• Both are acceptable methods for financial reporting.
*
Chapter 12 – Reporting and Analyzing Cash Flows
Teamwork in Action (Continued)
c. Steps to prepare the statement of cash flows:
(i) Compute the net increase or decrease in cash using comparative
balance sheet data. This is the target number or the number the
d. Common analyses made from information in the statement of cash flows
include assessing a company’s:
• Ability to generate future cash flows.
• Ability to pay dividends.
• Ability to meet obligations.
Teamwork in Action (Concluded)
Part 3
a. Cash receipts from customers = Sales – Increase in Accounts Receivable,
or, + Decrease in Accounts Receivable.
Explanation: Sales reflects what is earned during the period. If Accounts
Receivable increases, that increase represents earnings not yet collected,
Explanation for (2): If Accounts Payable decreases, the entity paid for more
than the period’s purchases, so we add it. If Accounts Payable increases,
the entity paid for less than the period’s purchases, so we subtract it.
c. Cash paid for wages and operating expenses = Wages and other operating
expenses [+ Increase in prepaid expenses, or, – Decrease in prepaid
© 2015 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Solutions Manual, Chapter 12
55
1. It is common that small businesses must pay cash in advance for items such
as rent, advertising, supplies, and facilities expansion. Consequently, those
2. The company can potentially raise cash financing for expansion by selling
additional shares in the company or by borrowing the money. Potential lenders
will want to evaluate the future profitability, cash flows, and solvency of the
company before lending money. In addition, the company could get ‘creative’
with other forms of financing such as leasing or joint ventures.
extraordinary loss. Absent this extraordinary loss, Mountain High would report a
$75,000 net income. Using year–end total assets, Mountain High’s return on
assets would be roughly 9.4% (computed as $75,000 divided by $800,000). This
return is reasonable for a company in its second year of operations.
Second, with respect to its net cash outflow of $(5,000), please note that this is
© 2015 by McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
Financial Accounting, 7th Edition
56
1. The Motley Fool’s Website defines cash flow as earnings before interest,
taxes, depreciation, and amortization (EBITDA). The school’s justification
for this definition includes: “Interest income and expense, as well as taxes, are
all tossed aside because cash flow is designed to focus on the operating business
2. Some analysts tend to focus on this particular earnings definition
(earnings before interest and taxes or EBIT) as it purportedly allows a
3. Answer depends on the links visited and chosen for the report.
1. Samsung’s cash flow on total assets ratio follows (in KRW millions):
Current Year = Operating cash flows / Average total assets
2. For the current and prior years, Samsung’s ratios (22.5% and 15.8%,
(20.0%) and in the prior year Samsung’s ratio (15.8%) was lower than