131
CHAPTER 5
Reporting Cash Flows
THINKING BEYOND THE QUESTION
How is cash flow information determined and reported to external users?
A business can fail when it has insufficient cash to pay for its resource
QUESTIONS
Q5-1 The direct format statement of cash flows answers the questions “where
Q5-2 The acquisition of machinery typically involves cash. Nevertheless, the
acquisition of machinery is always an investing activity. How it was paid
Q5-3 GAAP require that the issuance of either debt or equity in exchange for
long-term assets be disclosed, but not necessarily on the statement of
132 Chapter 5
Q5-4 The usual presentation of investing activity and financing activity infor-
Q5-5 Interest is included as an operating activity because interest expense is
included on the income statement. The FASB decided that cash paid for
Q5-6 The indirect format is a reconciliation of revenues and expenses meas-
ured by accrual accounting (net income) and revenues and expenses
Q5-7 When the balance in accounts receivable increases during a fiscal period,
it means that new sales on credit have exceeded the amount of cash col-
Q5-8 The operating section of the indirect method statement of cash flows an-
swers the question “what caused net income for the period to be different
from net cash flow?” The investing and financing sections report sources
Q5-9 To grow significantly, a company usually must expand its set of operating
assets such as land, buildings, and machinery. The acquisition of these
Reporting Cash Flows 133
Q5–10 Operations consist of the primary activities that the company was set up
to perform. If the firm’s primary operations consume cash, rather than
generate it, the company cannot survive in the long run. Another way of
Q5–11 When cash flow from investing activities is positive, it means that the
company is selling off its long-term assets and reducing its productive
Q5–12 The most frequent uses of cash generated by operations are as follows:
a. payment of dividends
Q5–13 There are two possibilities. First, the company may be so profitable that it
can finance all growth out of operating cash flow and still have cash left
Q5–14 It suggests that this company is in serious difficulty. To observe this sit-
uation in any one year is bad enough; to see it consistently over a
3-year period is very worrisome. First, the inability to generate cash from
134 Chapter 5
Q5–15 For most corporations, two of the major differences between net income
and cash flow from operating activities are depreciation and amortization.
These often are large expenses on the income statement but do not re-
Q5–16 First, a company that does not have profitable opportunities in which to
EXERCISES
E5-1 a. Operating Activities:
Received from customers $ 87,500
b. Financing Activities:
Received from issuing long-term debt $ 23,000
Paid to owners (12,000)
Net cash flow from financing activities $ 11,000
Reporting Cash Flows 135
E5–2
Item
Type of Activity
Add or Subtract
a.
Purchase of plant assets
Investing
Subtract
b.
Cash paid to suppliers
Operating
Subtract
E5–3 Cash collected from customers $247,000
Cash paid to suppliers (81,400)
E5-4 a. $17,700; Cash received from customers $187,200
Cash paid to suppliers of inventory (119,850)
Cash paid to employees (31,500)
E5-5 a. Cash flows from financing activities:
Debt issued $ 13,057
Payments of debt (83,000)
c.
Cash collected from customers
Operating
Add
d.
Payment of long-term debt
Financing
Subtract
e.
Net income
Not included
Not included
Depreciation expense
Not included
Not included
g.
Payment of dividends
Financing
Subtract
h.
Issuing stock
Financing
Add
Cash paid to employees
Operating
Subtract
Cash paid for income taxes
Operating
Subtract
k.
Disposal of plant assets
Investing
Add
136 Chapter 5
E5-6 a. D
b. I
E5-7
Statement Statement Added or
Section Format Subtracted?
1. Decrease in taxes payable O I −
2. Cash paid to suppliers of inventory O D −
E5-8
Item
Type of
Activity
Add or
Subtract
Purchase of plant assets
Investing
Subtract
Increase in accounts payable
Operating
Add
Decrease in accounts receivable
Operating
Add
Payment of long-term debt
Financing
Subtract
Net income
Operating
Add
Depreciation expense
Operating
Add
Payment of dividends
Financing
Subtract
Issuing stock
Financing
Add
Increase in inventory
Operating
Subtract
Decrease in taxes payable
Operating
Subtract
Disposal of plant assets
Investing
Add
Reporting Cash Flows 137
E5-9 Net income ($17,000 − $8,000)* $ 9,000
Depreciation expense 1,100
Patent amortization expense 250
E5–10 a. Cash paid to suppliers $37,500
Decrease in accounts payable (3,000)
b. Interest paid $ 4,000
Interest payable decreased (1,200)
Interest expense $ 2,800
d. Cash collected from customers $ 27,000
E5–11 a. Net cash flow from operations $ 30,000
Noncash revenues 11,000
138 Chapter 5
b. Wages expense $ 69,000
increased during a period.
c. Sales revenue $ 241,000
Cash collected from customers (224,500)
d. Net income $ 45,000
E5–12
Account Balance
Adjustment and Reason
Accounts receivable
increased $10,000
Subtract $10,000 from net income because
cash collected from customers was $10,000
Reporting Cash Flows 139
Prepaid insurance
decreased $22,000
Add $22,000 to net income because insur-
ance was consumed (increase in expense
and decrease in net income) that was not
paid for during the period.
E5–13 Cash flow from operating activities (in millions):
Net earnings $3,458
Depreciation and amortization 1,412
E5–14 (date)
Martha Rosenbloom
945 Oak Lane
Anytown, USA
Dear Ms. Rosenbloom:
Our mutual friend, Mr. Arthur Doyle, has asked if I can provide you assis-
tance in understanding the statement of cash flows in corporate annual
140 Chapter 5
Differences also exist between the amount of revenue or expense rec-
ognized during a period and the amount of cash flow for items such as
The cash flow statement provides an indirect calculation of cash from
operating activities by adjusting net income for amounts on the income
statement that do not affect cash. These noncash items include deprecia-
E5–15 a. The additions and subtractions are caused by events in which the
amount of revenue or expense generated was different from the
b. 1. Depreciation expense is added because it decreased net income
but did not affect cash.
2. If accounts receivable increased by $2,500, this means that sales
3. If inventory increased, this means that more inventory was pur-
4. A decrease in accounts payable means the company paid more
cash to suppliers than the amount of expense reflected in cost of
Reporting Cash Flows 141
E5–16 a. Co. B had the largest cash flow from operating activities at $15,200.
Co. C had the smallest at $2,304.
b. Cash flow associated with investing activities should be negative
E5–17 Landsdowne Company has shown a steady increase in net income over
the six-year period, with the exception of year 6. Its cash flow from oper-
ating activities has steadily declined since year 2, however. The differ-
ence between net income and cash flow can be explained by the increas-
E5–18 Sommer Company has incurred losses in its last two years of operations.
Without the large amount of depreciation recorded each year, the compa-
ny would have had net income in each year. The company has maintained
a steady growth in cash flows from operating activities. These cash flows
142 Chapter 5
E5–19
Account and balance
Anticipated future event and cash flow
a.
Accounts receivable,
$12,000
$12,000 cash should be received from cus-
tomers during the next fiscal year. Operat-
ing activities section.
e.
Accounts payable, $6,500
Currently, $6,500 is owed to short-term
creditors that will be repaid during the
next fiscal year. Operating activities sec-
tion.
g.
Notes payable, long-term,
$88,000
The company borrowed $88,000 in the past
and is expected to repay it sometime after
the next fiscal year. A financing activity.
(Any interest paid on the borrowing ap-
pears in the operating activities section.)
Taxes payable, $7,800
Currently the company owes $7,800 to the
government, which it expects to pay dur-
ing the next fiscal period. An operating ac-
Retained earnings,
$56,000
$56,000. If any portion of this is distributed
in the future it will be a financing activity.
Prepaid insurance,
Insurance coverage costing $22,000 is ex-
Reporting Cash Flows 143
PROBLEMS
P5-1 San Garza Properties
Statement of Cash Flows (direct format)
For the Month of January 2007
Operating Activities
Receipts:
Collections from customers $ 8,100
Payments:
To suppliers of inventory $ (7,000)
P5-2 A. 1. $134,850 ($135,800 Sales − $950 increase in Accounts
Receivable)
B. Purchase of property, plant and equipment $(5,015)
Purchase of land (1,000)
144 Chapter 5
D. Planet Accessories Company
Statement of Cash Flows (Direct Format)
For the Year Ended December 31, 2007
Operating Activities:
Cash collections from customers $ 134,850 1
Cash paid to suppliers of inventory (55,800) 2
Financing Activities:
Addition to loan payable $ 4,000 8
Sale of common stock 1,000 9
1 proof given in part A
2 proof given in part A
Reporting Cash Flows 145
2. Cash flow from Cash received from customers:
operations = ($25,950) Cash sales $ 88,250
Collections on account 321,000
B. 1. Decrease in accounts Credit sales to customers $ 307,400
receivable = $13,600 Collections from customers
3. Decrease in accounts Purchases on credit $ 233,700
payable = $59,900 Cash payments on
C. Dollar Sine Enterprises
Statement of Cash Flow
(Operating Activities Only—Indirect Method)
For the Year Just Ended
Net income $ 44,750
Add (deduct):
146 Chapter 5
P5-4 Reuben Corporation
Statement of Cash Flows (Indirect Format)
For the Year Ended December 31, 2007
Operating Activities
Net income $ 7,000
Add (deduct):
Investing Activities
Financing Activities
Repayment on loan $ (8,250)
P5-5 A. 1. $6,738 (from the income statement)
B. Purchase of property, plant and equipment $(5,015)
Purchase of land (1,000)
C. Addition to loan payable $4,000
Reporting Cash Flows 147
D. Planet Accessories Company
Statement of Cash Flows (Indirect Format)
For the Year Ended December 31, 2007
Operating Activities
Net income $ 6,738
Add/deduct items to reconcile net income
to cash flow from operating activities:
Financing Activities
Addition to loan payable $ 4,000 9
1 proof given in part A
2 proof given in part A
148 Chapter 5
P5-6 A. Harley-Davidson also provides financing services to customers who
E. Harley-Davidson is a growing, profitable company. In 2004 and 2003,
the company produced sufficient cash from operations to provide for
P5-7 A. 1. Cash received from customers is incorrect. It has been reported
as the accrual basis sum of revenues ($73,000 + $42,100 =
2. Cash paid for rent is incorrect. Accrual basis rent expense of
$24,000 apparently was adjusted for the $400 decrease in Rent
3. Cash paid for taxes is incorrect. The accrual basis Tax Expense
The amounts reported as cash payments for advertising and wages
are correct.
Reporting Cash Flows 149
B. Starkovich Architects, Inc.
Operating Activities (Direct Format)
For the Year Ending December 31, 2007
Operating Activities
P5-8 A. Indirect format
C. In the first column hypothetical data is shown. The second column
shows the data assuming that depreciation expense for the period
had been twice as high as reported. Cash flow from operating activi-
ties is the same under either option.
Original Adjusted
Data Data
Operating Activities
P5-9 A. AutoZone uses the indirect method for reporting cash flows. The op-
erating section begins with net income and provides a variety of rec-
150 Chapter 5
D. Cash and cash equivalents: decreased (see the bottom of the cash
flow statement)
E. The major use of cash for investing activities has been capital ex-
F. The major use of cash for financing activities has been the purchase
P5–10 A. Circuit City’s income declined each year between 2002 and 2004, alt-
hough in years 2002 and 2003 the company was profitable. The com-
pany reported a loss of $89,269,000 in 2004. Circuit City’s cash flow