Chapter 14
Statement of Cash Flows
Solutions to Questions
14-1 The statement of cash flows highlights
14-2 Cash equivalents are short-term, highly
liquid investments such as Treasury bills,
commercial paper, and money market funds.
14-3 (1) Operating activities: Include cash
inflows and outflows related to revenue and
expense transactions that affect net income.
(2) Investing activities: Include cash
inflows and outflows related to acquiring or
disposing of noncurrent assets.
(3) Financing activities: Include cash
inflows and outflows related to borrowing from
14-4 The company’s specific circumstances
should be considered when interpreting the
14-5 Since the entire proceeds from a sale of
an asset (including any gain) appear as a cash
14-6 Transactions involving accounts payable
are not considered to be financing activities
because such transactions relate to a company’s
day–to-day operating activities rather than to its
financing activities.
14-7 The repayment of $300,000 and the
provided by financing activities and then show
$300,000 of cash used by financing activities.
activities.
14-9 Depreciation is not a cash inflow, even
though it is added to net income on the
statement of cash flows. Adding depreciation to
net income to compute the amount of net cash
provided by operating activities creates the
illusion
that depreciation is a cash inflow. It isn’t.
increase in a noncash asset.
an investing activity.
Exercise 14-1 (15 minutes)
Activity
Transaction
Operating
Investing
Financing
a.
Paid bills to insurers and utility providers …………..
X
b.
Purchased equipment with cash ………………………
X
c.
Paid wages and salaries to employees ………………
X
d.
Paid taxes to the government …………………………
X
Loaned money to another entity ……………………..
X
Sold common stock ………………………………………
X
g.
Paid a cash dividend to stockholders ………………..
X
Paid interest to lenders …………………………………
X
Repaid the principal amount of a debt ………………
X
Paid suppliers for inventory purchases ………………
X
Borrowed money from a creditor …………………….
X
Paid cash to repurchase its own stock ………………
X
Collected cash from customers ……………………….
X
Exercise 14-2 (15 minutes)
The guidelines from Exhibit 14-2 can be used to analyze the changes in
noncash balance sheet accounts that impact net income as follows:
Increase
in Account
Decrease
in Account
– 20,000
– 4,000
+ 6,000
The net cash provided by operating activities is computed as follows:
Exercise 14-3 (5 minutes)
Free cash flow computation:
Exercise 14-4 (30 minutes)
1. Prepare a statement of cash flows:
Operating activities:
Step 1: The following equation can be applied to the Accumulated
Depreciation account to compute the depreciation to add back to net
income:
Beginning balance – Debits + Credits = Ending balance
$30 – $0 + Credits = $40
Credits = $40 – $30
Credits = $10
Exercise 14-4 (continued)
Investing and Financing activities:
The guidelines from Exhibit 14-3 can be used to analyze the changes in
noncash balance sheet accounts that impact investing and financing
cash flows as follows:
Increase
in Account
Balance
Decrease
in Account
Balance
Noncurrent Assets
Property, plant, and equipment …………..
– 30
Common stock ………………………………..
Exercise 14-4 (continued)
Holly Company
Statement of Cash Flows
For This Year Ended December 31
Operating activities:
Net income ……………………………………………………..
$20
Adjustments to convert net income to a cash basis:
Depreciation …………………………………………………
$10
Increase in accounts receivable …………………………
(7)
Increase in inventory …………………………..………….
(14)
Increase in accounts payable …………………………...
6
(5)
Net cash provided by operating activities ……………….
Increase in plant and equipment ………………………….
Net cash used in investing activities ……………………..
(30)
Financing activities:
Increase in common stock ………………………………….
Cash dividends ………………………………………………..
Net cash provided by financing activities ……………….
Net decrease in cash …………………………………………
(3)
Cash, December 31 of last year …………………………..
Cash, December 31 of this year …………………………..
2. Free cash flow computation:
Net cash provided by operating activities ….
$ 15
Capital expenditures ………………………….
Dividends ……………………………………….
Free cash flow ……………………………………
Exercise 14-5 (30 minutes)
Net cash provided by operating activities:
Step 1: The company did not sell or retire any plant and equipment
during the year (land is not depreciated); therefore, the $40 increase in
Accumulated Depreciation equals the credit to the account that is added
to net income.
Step 2: The guidelines from Exhibit 14-2 can be used to analyze the
changes in noncash balance sheet accounts that impact net income as
Exercise 14-5 (continued)
The net cash provided by operating activities is computed as follows:
Net income …………………………………………………..
$75
Adjustments to convert net income to a cash basis:
Net cash provided by operating activities …………….
$90
2. Prepare a statement of cash flows for the year
Investing and Financing activities:
The guidelines from Exhibit 14-3 can be used to analyze the changes in
noncash balance sheet accounts that impact investing and financing
cash flows as follows:
Exercise 14-5 (continued)
Because Herald did not issue any bonds or repurchase any of its own
stock during the year, the corresponding amounts in the table on the
prior page represent the gross cash flows that are included in the
statement of cash flows. Property, plant, and equipment, long-term
investments, and retained earnings require further analysis as follows:
Property, Plant, and Equipment
Additions
150
Sale of land
30
Change
120
Change
30
Dividends
Net income
75
Exercise 14-5 (continued)
Herald Company
Statement of Cash Flows
Operating activities:
Net cash provided by operating activities …………………..
$ 90
Investing activities:
Proceeds from sale of long-term investments ……………..
Additions to property, plant & equipment …………………..
Net cash used in investing activities ………………………….
Financing activities:
Retirement of bonds payable …………………………………..
Net cash used in financing activities …………………………
Net increase in cash (net cash flow) …………………………
Cash balance, beginning ………………………………………..
Cash balance, ending ……………………………………………
Exercise 14-6 (10 minutes)
Item
Amount
Add
Subtract
Accounts Receivable ……………….
$70,000
decrease
X
Inventory …………………………….
$110,000
increase
X
Sale of equipment ………………….
gain
X
Problem 14–7 (60 minutes)
The forthcoming explanation is broken down into eight steps.
1. The statement of cash flows summarizes all of a company’s cash inflows
and outflows during a period, thereby explaining the difference between
its beginning and ending cash balance.
2. The statement is divided into three sections—operating activities,
investing activities, and financing activities. The operating activities
section summarizes the cash inflows and outflows related to revenue
3. The indirect method of preparing the operating activities section of the
statement of cash flows begins with net income and adjusts it to a cash
basis. The first step in completing the indirect method is to add
depreciation to net income. The total credits to Logan’s Accumulated
Depreciation account equal $108, so this amount is added to net
income. Because Logan is a merchandiser, the $108 corresponds to its
depreciation expense, which is a noncash expense that must be added
to net income to translate to a cash basis.
4. The second step is to analyze net changes in noncash balance sheet
accounts that impact the computation of net income. For Logan, this
includes Accounts Receivable, Inventory, Accounts Payable, Accrued
Problem 14–7 (continued)
The inventory balance decreased by $39. This means that Logan’s
inventory purchases were less than its cost of goods sold by $39.
Logan’s cost of goods sold was $2,890; therefore, its inventory
purchases were $2,851. The company’s accounts payable balance
decreased by $50. This means that Logan’s inventory purchases were
The income taxes payable balance increased by $5. This means that
Logan’s accrued income tax expense is $5 greater than its tax payments
to governmental bodies. Because the income statement records income
tax expense and not tax payments, $5 must be added to net income to
translate it to a cash basis.
5. The third step of the indirect method is to adjust for gains/losses
included in the income statement. This adjustment is necessary because
Problem 14–7 (continued)
6. The investing activities section of Logan’s statement of cash flows
records the gross cash flows related to its property, plant, and
7. The financing activities section of Logan’s statement of cash flows
records the gross cash flows related to its bonds payable, common
8. The net increase in cash and cash equivalents ($132) explains the
difference between the beginning and ending cash balances.
Problem 14-8 (30 minutes)
1. Net cash provided by operating activities:
Step 1: The following equation can be applied to the Accumulated
Depreciation account to compute the depreciation to add back to net
Increase in
Account
Balance
Decrease in
Account
Balance
Current Assets
Accounts receivable ……..
– 80
Inventory ………………….
+ 35
Prepaid expenses ………..
Current Liabilities
Accounts payable ………..
Accrued liabilities ………..
Income taxes payable ….
Problem 14-8 (continued)
The net cash provided by operating activities is computed as follows:
Net income …………………………..…………………….
$ 56
Adjustments to convert net income to cash basis:
Net cash provided by operating activities …………..
2. Prepare a statement of cash flows.
Investing and Financing activities:
The guidelines from Exhibit 14-3 can be used to analyze the changes in
noncash balance sheet accounts that impact investing and financing
Problem 14-8 (continued)
The decrease in the long-term investments account ($7) equals the cost
of the long-term investment sold; therefore, Eaton did not purchase any
long-term investments during the year. The proceeds from the sale of a
long-term investment ($12) should be recorded as a cash inflow in the
investing activities section of the statement.
Property, plant, and equipment:
Beginning balance + Debits – Credits = Ending balance
$420 + Debits – $30 = $500
Debits = $500 – $420 + $30
Debits = $110
The additions to property, plant, and equipment ($110) are recorded as
a cash outflow and the proceeds from the sale of equipment ($18) are
recorded as a cash inflow.
Retained earnings:
Problem 14-8 (continued)
Eaton Company
Statement of Cash Flows
For the Year Ended December 31, 2011
Operating activities:
Net income ………………………………………………….
$ 56
Adjustments to convert net income to cash basis:
Depreciation ……………………………………………
$ 25
(2)
Increase in accounts payable ………………………
75
Decrease in accrued liabilities ……………………..
(5)
Net cash provided by operating activities …………..
104
Investing activities:
Proceeds from sale of long-term investments ……..
12
Proceeds from sale of equipment ……………………..
18
Additions to plant and equipment …………………….
(110)
Net cash used in investing activities ………………….
(80)
Financing activities:
Issuance of bonds payable ……………………………..
Decrease in common stock ……………………………..
Cash dividends …………………………………………….
Net cash used in financing activities ………………….
Net decrease in cash ……………………………………..
Cash balance, January 1, 2011 ………………………..
Cash balance, December 31, 2011 ……………………
$ 4
Problem 14-9 (45 minutes)
1. Net cash provided by operating activities:
Step 1: The following equation can be applied to the Accumulated
Depreciation account to compute the depreciation to add back to net
income:
Increase
in Account
Balance
Decrease
in Account
Balance
Current Assets
Accounts receivable …………
– 70,000
Inventory ………………………
– 48,000
Prepaid expenses …………….
+ 9,000
Current Liabilities
Accounts payable …………….
Accrued liabilities …………….
Income taxes payable ………