5-1 Solutions
CHAPTER 5
STATEMENT OF CASH FLOWS:
REPORTING THE EFFECTS OF OPERATING,
INVESTING, AND FINANCING ACTIVITIES
ON CASH FLOWS
Questions, Exercises, and Problems: Answers and Solutions
5.1 See the text or the glossary at the end of the book.
5.2 One can criticize a single income statement using a cash basis of
accounting from two standpoints: (1) it provides a poor measure of
5.3 Accrual accounting attempts to provide a measure of operating
performance that relates inputs to output without regard to when a firm
receives or disburses cash. Accrual accounting also attempts to portray
5.4 The statement of cash flows reports changes in the investing and
financing activities of a firm. Significant changes in property, plant, and
5.5 The indirect method reconciles net income, the primary measure of a
firm’s profitability, with cash flow from operations. Some argue that the
relation between net income and cash flow from operations is less evident
Solutions 5-2
when a firm reports using the direct method. More likely, the frequent
use of the indirect method prior to the issuance of FASB Statement No. 95
5-3 Solutions
5.5 continued.
5.6 The classification in the statement of cash flows parallels that in the
income statement, where interest on debt is an expense but payments on
5.7 The classification in the statement of cash flows parallels that in the
income statement, where interest on debt is an expense but dividends are
5.8 Firms generally use accounts payable directly in financing purchases of
inventory and other operating costs. Firms might use short-term bank
financing indirectly in financing accounts receivable, inventories, or
Solutions 5-4
5.9 This is an investing and financing transaction whose disclosure helps the
statement user understand why property, plant and equipment and long-
term debt changed during the period. Because the transaction does not
affect cash directly, however, firms must distinguish it from investing and
5-5 Solutions
5.9 continued.
5.10 Both are correct, but the writer’s point is not expressed clearly.
Depreciation expense is a charge to operations, but does not require cash.
If revenues precisely equal total expenses, there will be a retention of net
funds in the business equal to the amount of the depreciation. As long as
replacement of the depreciating assets is not necessary, it is possible to
5.11 The firm must have increased substantially its investment in accounts
receivable or inventories or decreased substantially its current liabilities.
5.12 The firm might be capital intensive and, therefore, subtracted substantial
amounts of depreciation expense in computing net income. This
5.13 Direct Method: The accountant classifies the entire cash proceeds from
the equipment sale as an investing activity. Indirect Method: As above,
Solutions 5-6
5.14 (Microsoft; derive sales revenue from data in the statement of cash flows
and balance sheet.) (Amounts in Millions)
Cash Collections for the Year ………………………….. $ 33,551
Accounts Receivable, End of Year ……………………. $ 5,334
5.15 (General Electric; derive cost of goods sold from data in the statement of
cash flows.) (Amounts in Millions)
Cash Payments for Inventories for the Year …………………………. $ 64,713
5.16 (Ann Taylor Stores; derive cost of goods sold from data in the statement of
cash flows.) (Amounts in Millions)
Cash Payments for Inventories for the Year …………………………. $ 646.9
Add: Increase in Accounts Payable for Inventories ………………. 5.9
5.17 (AMR; derive wages and salaries expense from data in the statement of
cash flows.) (Amounts in Millions)
Cash Payments for Wages and Salaries for the Year …………….. $ 8,853
5.18 (Johnson & Johnson; derive cash disbursements for dividends.) (Amounts
in Millions)
Net Income for the Year …………………………………………… $ 5,030
Retained Earnings, End of Year ……………………………….. $ 28,132
Retained Earnings, Beginning of Year ………………………. (26,571)
5-7 Solutions
Solutions 5-8
5.19 (Gillette; effect of borrowing and interest on statement of cash flows.)
(Amounts in Millions)
Cash …………………………………………………………………….. 250.00
Bonds Payable …………………………………………………… 250.00
Change
in Cash
=
Change in
Liabilities
+
Change in
Shareholders’
Equity
–
Change in
Non-cash
Assets
+250.0
+250.0
Finan
October 1 bond issue. Refer to Exhibit 5.16. Line (11)
increases by $250. Line (8) increases by $250.
Change
in Cash
=
Change in
Liabilities
+
Change in
Shareholders’
Equity
–
Change in
Non-cash
Assets
+3.75
–3.75
Refer to Exhibit 5.16. Line (3) decreases by $3.75. Line (4)
increases by $3.75.
5.20 (Radio Shack; effect of income taxes on statement of cash flows.)
(Amounts in Millions)
Income Taxes Payable ……………………………………………. 18.0
Cash …………………………………………………………………. 179.5
Change
in Cash
=
Change in
Liabilities
+
Change in
Shareholders’
Equity
–
Change in
Non-cash
Assets
–179.5
–18.0
–161.5
Opns
18.0 = 78.1 – 60.1. Refer to Exhibit 5.16. Line (2)
increases by $179.5. Line (3) decreases by $161.5. Line (5)
increases by $18.0. Line (11) decreases by $179.5.
5-9 Solutions
5.21 (Effect of rent transactions on statement of cash flows.)
Rent Expense ………………………………………………………… 1,200
Prepaid Rent ……………………………………………………… 1,200
Change
in Cash
=
Change in
Liabilities
+
Change in
Shareholders’
Equity
–
Change in
Non-cash
Assets
–1,200
–1,200
January rent expense.
Prepaid Rent …………………………………………………………. 18,000
Cash …………………………………………………………………. 18,000
Change
in Cash
=
Change in
Liabilities
+
Change in
Shareholders’
Equity
–
Change in
Non-cash
Assets
–18,000
+18,000
Opns
Payment on February 1.
Rent Expense ………………………………………………………… 16,500
Prepaid Rent ……………………………………………………… 16,500
Change
in Cash
=
Change in
Liabilities
+
Change in
Shareholders’
Equity
–
Change in
Non-cash
Assets
–16,500
–16,500
Rent expense for February through December; $18,000/12
per month = $1,500. 11 X $1,500 = $16,500.
All of these combine as:
Rent Expense ………………………………………………………… 17,700
Prepaid Rent …………………………………………………………. 300
Cash …………………………………………………………………. 18,000
Change
in Cash
=
Change in
Liabilities
+
Change in
Shareholders’
Equity
–
Change in
Non-cash
Assets
–18,000
–17,700
+300
Opns
Solutions 5-10
5-11 Solutions
5.22 (Information Technologies; calculating components of cash inflow from
operations.) (Amounts in Thousands)
Sales for the Year ………………………………………………………………. $ 14,508
5.23 (Information Technologies; calculating components of cash outflow from
operations.) (Amounts in Thousands)
a. Cost of Goods Sold for the Year …………………………………….. $ 11,596
b. Other Expenses, Total ……………………………………………………… $ 2,276
Subtract: Decrease in Prepayments for Other Costs ………….. (102)
5.24 (Spread sheet for understanding the relation between changes in income
statement items and changes in items in the statement of cash flows.)
a. S1 changes from $10 to $12.
b. Lines [1], [2], and [4] of the statement of cash flows do not change.
5.25 (American Airlines; working backwards from changes in buildings and
equipment account.) (Amounts in Millions)
Buildings and Equipment
(Original Cost) Accumulated Depreciation
Balance, 1/1 …………………… $ 16,825 Balance, 1/1 ………………….. $ 4,914
Outlays during Year ……….. 1,314 Depreciation during Year . 1,253
Solutions 5-12
5-13 Solutions
5.26 (Southwest Airlines; preparing a statement of cash flows from changes in
balance sheet accounts.)
a. SOUTHWEST AIRLINES
Statement of Cash Flows
For the Year
(Amounts in Thousands)
Operations:
Net Income ……………………………………………………….. $ 474,378
Additions:
Depreciation Expense ………………………………………. 264,088
Decrease in Accounts Receivable ………………………. 15,351
Increase in Other Current Liabilities ………………… 114,596
Subtractions:
Investing:
Acquisition of Property, Plant and Equipment ……… $ (1,134,644)
Financing:
Increase in Long-term Debt ………………………………… $ 244,285
Increase in Common Stock …………………………………. 96,991
Payment of Dividendsa ………………………………………. (133,499)
aNet Income of $474,378 less Increase in Retained Earnings of $340,879
= Dividends of $133,499.
b. Cash flow from operations exceeds net income primarily because of
the addback for depreciation expense and increases in other current
Solutions 5-14
5.27 (Bamberger Enterprises; calculating and interpreting cash flow from
operations.)
a. Net Income ………………………………………………………………….. $ 290
Additions:
Depreciation Expense ……………………………………………….. 210
Decrease in Accounts Receivable ……………………………….. 780
b. Bamberger Enterprises decreased its noncash current assets,
particularly accounts receivable, generating positive cash flows.
5.28 (Finnish cellular phone manufacturer; calculating and interpreting cash
flow from operations.) (Amounts in Millions of ¤)
a. 2008 2007 2006 2005
Net Income……………… ¤ 3,847 ¤ 2,542 ¤ 1,689 ¤ 1,032
Depreciation
Expense ………………. 1,009 665 509 465
(Inc.) Dec. in Accounts
Inc. (Dec.) in Accounts
Payable ………………. 458 312 140 90
Inc. (Dec.) in Other
b. The addback for depreciation, a noncash expense, causes cash flow
from operations to exceed net income each year, except 2008.
Inventories increased in line with increases in net income. The
company increases its accounts payable to finance the increased
5-15 Solutions
inventories. The firm also increased other current liabilities to
finance growing operations. Variations in the relation between net in-
Solutions 5-16
5.28 b. continued.
5.29 (Marketing Communications; calculating and interpreting cash flows.)
a. MARKETING COMMUNICATIONS
Comparative Statement of Cash Flows
(Amounts in Millions)
2008 2007 2006
Operations
Net Income ……………………………. $ 499 $ 363 $ 279
Depreciation and Amortization .. 226 196 164
(Inc.) Dec. in Accounts Receiv-
able ……………………………………. (514) (648) (238)
(Inc.) Dec. in Inventories …………. (98) (13) (35)
Investing
Acquisition of Property, Plant
and Equipment …………………… $ (150) $ (130) $ (115)
Acquisition of Investments in
Securities …………………………... (885) (643) (469)
Cash Flow from Investing ……. $ (1,035) $ (773) $ (584)
Financing
Long-term Debt Issued …………… $ 599 $ 83 $ 208
5-17 Solutions
5.29 continued.
b. Interpreting cash flow from operations for a marketing services firm
requires a comparison of the change in accounts receivable from
clients and accounts payable to various media. Marketing services
firms act as agents between these two constituents. In Year 2006 and
Year 2007, the increase in accounts payable slightly exceeded the
increase in accounts receivable, indicating that Marketing
Communications used the media to finance its accounts receivable. In
Year 2008, however, accounts payable did not increase nearly as much
5.30 (Largay Corporation; effects of gains and losses from sales of equipment
on cash flows.) (Amounts in Thousands)
a. b. c.
Operations:
Net Income………………………………………….. $ 100 $ 102 $ 98
Depreciation Expense ………………………….. 15 15 15
Gain on Sale of Equipment …………………… — (2) —
Financing:
Solutions 5-18
Repayment of Long-term Debt ……………… $ (40) $ (40) $ (40)
Change in Cash …………………………..………….. $ 15 $ 17 $ 13
5-19 Solutions
5.30 continued.
5.31 (Effect of various transactions on statement of cash flows.)
Note to instructors: If you use transparencies in class, it is effective to
flash onto the screen the answer transparency for some problem showing
a comprehensive statement of cash flows. Then you can point to the lines
affected as the students attempt to answer the question. It helps them by
a. Amortization Expense ……………………………………… 600
Patent ………………………………………………………….. 600
Change
in Cash
=
Change in
Liabilities
+
Change in
Shareholders’
Equity
–
Change in
Non-cash
Assets
–600
–600
(3) Decreases by $600; reduces net income through amortization
expense.
in deriving cash flow from operations.
No effect on net cash flow from operations or cash.
b. Factory Site …………………………………………………….. 50,000
Common Stock ……………………………………………… 50,000
Change
in Cash
=
Change in
Liabilities
+
Change in
Shareholders’
Equity
–
Change in
Non-cash
Assets
+50,000
+50,000
Solutions 5-20