P14–19 Continued
Prepaid Insurance Land Fixed Assets
B.B. 0 B.B. 0 B.B. 0
(7) 80,000 (4) 40,000 (2) 750,000
(b) 20,000
B.B. 0 B.B. 0 B.B. 0
(11) 100,000 (3) 20,000 (12) 140 (3) 9,200
E.B. 100,000 E.B. 20,000 E.B. 9,060
(4) 15,000
E.B. 100,000 E.B. 2,000 E.B. 765,000
(4) 25,000 (c4) 100,000
E.B. 775,000 E.B. 628,140 E.B. 0
(c1) 2,930,000 (c2) 1,365,000 (c2) 575,000
(12) 1,460 (e) 70,400 (b) 20,000
(c2) 1,460 (c2) 70,400 (c2) 20,000
E.B. 0 E.B. 0 E.B. 0
P14–19 Continued
b. Closing entries
(c1) Sales ………………………………………………………………………………… 2,930,000
Income Summary ………………………………………………………… 2,930,000
Closed revenues into Income Summary.
(c2) Income Summary ………………………………………………………………. 2,201,860
Miscellaneous Expenses ………………………………………………. 575,000
Cost of Goods Sold ………………………………………………………. 1,365,000
(c3) Income Summary ………………………………………………………………. 728,140
Retained Earnings ……………………………………………………….. 728,140
c.
Mick’s Photographic Equipment
Income Statement
For the Year Ended December 31, 2014
Sales revenue …………………………………………………. $ 2,930,000
Cost of goods sold …………………………………………… 1,365,000
Gross profit ……………………………………………………. $ 1,565,000
Operating expenses:
55
P14–19 Continued
Mick’s Photographic Equipment
Balance Sheet
December 31, 2014
Assets
Current assets:
Cash …………………………………………………………………………………. $ 1,524,600
Marketable securities (net of allowance for
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable ………………………………………………………………. $ 925,000
Miscellaneous payables………………………………………………………. 75,000
Dividends payable …………………………..…………………………………. 100,000
Total current liabilities ………………………………………………….. $ 1,100,000
Bonds payable (including associated premium of $9,060) …………….. 29,060
P14–19 Continued
d. Direct method
Mick’s Photographic Equipment
Statement of Cash Flows
For the Year Ended December 31, 2014
Cash flows from operating activities:
Cash collections from customers …………………………………. $ 2,550,000
Cash paid for inventory ………………………………………………. (1,075,000)
Cash paid for insurance ………………………………………………. (80,000)
Cash paid for interest …………………………………………………. (1,600)
P14–19 Concluded
Indirect method
Mick’s Photographic Equipment
Statement of Cash Flows
For the Year Ended December 31, 2014
Cash flows from operating activities:
Net income …………………………………………………………… $ 728,140
Adjustments:
Increase in accounts receivable ………………………….. $ (380,000)
Increase in inventory …………………………..…………….. (630,000)
Increase in prepaid insurance …………………………….. (60,000)
Decrease in premium on bonds payable ………………. (140)
Increase in accounts payable ……………………………… 925,000
Increase in miscellaneous payables …………………….. 75,000
Cash flows from financing activities:
Proceeds from bond issue ………………………………………. $ 29,200
Proceeds from preferred stock issue ……………………….. 102,000
Proceeds from common stock issue…………………………. 1,500,000
ISSUES FOR DISCUSSION
ID14–1
a. Quality of earnings and earnings persistence have to do with the sustainability of the earnings as well
as nearness of the earnings to the cash generated by operating activities. The indirect method of
b. In the case of Mattel, the changes in accounts receivable were certainly positive, which indicated that
the majority of the sales were on credit with no contributions to cash. The change in the inventory
c. Wall Street firms employ various models to identify over- and under-valued stocks. The choice of
accounting policies by a firm is just one variable in the whole equation. Therefore, the choice of
ID14–2
a. The Washington Post will use the equity method to record the accounting transactions related to the
other companies because it holds “significant influence” over those companies. The equity method
b. Losses in these investments are shown as losses on the income statement of the Washington Post.
However, these are non-cash losses, so these losses are added back to the net income of the
ID14–3
a. The capitalization and matching process is not very useful for assessing the cash available to a company
because disbursing cash and consuming an item are two very different concepts. In order to measure
performance, it is necessary to match the costs that were incurred to generate benefits against the
benefits. Under accrual accounting, costs should be capitalized if they are expected to provide benefits
b. Solvency refers to a company’s ability to pay its obligations as they come due, and earning power refers
to a company’s ability to generate net assets through operating activities. The two concepts are closely
related in that a company will not remain solvent if it is unable to generate net assets through
operations. That is, a company cannot stay in business indefinitely if its operations fail to generate
c. Bankruptcies usually imply that a company was unable to pay its debts. Because cash is the most
common medium of exchange in the United States, creditors expect to receive interest and principal
ID14–4
a. SuperValu paid out cash when it acquired fixed and intangible assets. Depreciation and amortization of
these assets simply represent the allocation of the assets’ cost to particular accounting periods. There is
no cash outflow or inflow associated with depreciation and amortization.
b. Impairment charges are recorded when the company determines that the carrying value of an asset is
greater than that asset’s fair value. If an asset has changed from the time of acquisition, or if business
c. The “gain on the sale of assets” is subtracted from net earnings and “loss on sale” is added back
because both of these items are non-recurring in nature and so the intent is to eliminate these from
d. Receivables, in the two earliest years shown, were a use of cash for SuperValu, meaning that the
change in accounts receivable had been an increase each year, which is tying up the company’s cash.
had formerly been tied up in groceries on the shelf.
e. One of the first tipoffs that there may be some problems with the quality of earnings is if cash provided
by operating activities is lower than net income. This is not the case with SuperValu and so there is no
impairment charge in 2013 is adjusted out, earnings would have been less than cash from operations.
ID14–5
Shortcuts to “cash flow”, such as adding back depreciation and amortization (non-cash expenses) to net
income, do not take into consideration all of the changes that affect cash. The indirect statement of
ID14–5 Concluded
constant). However, if those credit sales were made to companies without the ability or willingness to
pay, net income will overstate the company’s ultimate cash position. As
receivables become stagnant and build up on the balance sheet, the statement of cash flow would
ID14–6
a. The annual depreciation expense is decreasing, which would imply that the company has less long
lived assets that require annual cost allocation. The company appears to not be investing in its
fixed asset base, with long term assets becoming fully depreciated and not being replaced with
new assets.
b. The issuance of stock to employees as a form of compensation does not require the outlay of cash.
There is a theoretical cost to the company in the form of the opportunity cost of not being able to
c. Inventory decreased somewhat in 2010, giving the company over $16 million of cash. In 2011 the
trend reversed, draining over $12 million of cash as the company saw increased investment in its
ID14–7
The statement of cash flows for Danone lists the company’s various sources of net income with an
adjustment for non-cash charges, such as depreciation expense (similar to the setup in U.S. GAAP for
the indirect format). Then the statement deals with changes in operating accounts that affect
operating cash flow, again in a similar approach to U.S. GAAP. After totaling operating cash flow (from
ID14–8
a. Over the three-year time period Eli Lilly’s general cash management profile has remained similar, but
the results are trending in the wrong direction. The company generates cash from its operations (in
excess of its profit levels) and uses that cash to invest in long term assets and to repay debt and return
b. More than likely the decline in profitability affected the drop in operating cash, which in turn affected
the capacity with which the company could make long-term investments for its future. The increased
move to return cash to shareholders and retire debt, however, occurred in the same time period as the
ID14–9
a. Starbucks has been incredibly consistent in its generation of cash from operating activities over the
time period. It has used this cash to open additional stores (cash from investing activities) and has still
had excess balances allowing it to repay debt and return cash to shareholders.
b. The heavy use of cash for investing signals this profile as one of a growing company. Starbucks differs
d. At some point, the company’s growth will slow, meaning that the use of cash for investing will not be
as much a drag for the company. If operations remain strong, the company might divert the cash (that
financiers.
ID14–10
When an acquisition is recorded, any cash outflow (credit) is considered an investing activity, with the
assets acquired booked (debit) onto the balance sheet. If in subsequent periods (as happened to Hewlett
Packard), the value of the assets acquired is deemed to be less than the carrying value on the balance sheet,
the company lessens the carrying value (credit) and books an accompanying impairment expense (debit).
ID14–11
a. Google’s major sources of cash are cash from operations. This cash is primarily used to fund investing
activities as the company purchases property, plant and equipment and acquires other companies
b. Depreciation and amortization expenses and stock-based compensation expenses appear to be the
largest transactions that were non-cash in nature.
c. The gain on divestitures in 2012 is shown as a negative number in the operating section because the
sale of long term assets is an investing activity and the associated cash inflow is accounted for in the
contains receivables that will not convert in the near future to cash collections.
e. Over the three-year period, Google’s incredibly strong operating cash flow has been able to fund the
company’s capital spending (additions to property, plant & equipment) and acquisitions. Like other
technology growth companies, Google has not used cash to pay dividends to its shareholders, as it feels