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Need serious, but honest help to meet my dead line.  Instruction as following questions using grammatically correct language and appropriate APA citations. All questions need to be answer and with APA citations. All material MUST come from the book only. (The book that used is Finance by Cornett, Adair, & Nofsinger, 2016).  Chapter 13 Weighting Net Present Value and Other Capital Budgeting Criteria, Pages 310-335.  Be sure when solving the problems algebraically, be sure to show your computations.  If using Excel spreadsheet, show your input values and formula.  If using financial calculator, show your input values. There are TWO hints/suggestions for certain questions in this assignment to ensure you have the right answer. 

**Note: In addition to your solution to each computational problem, you must show the supporting work leading to your solute.****

Question 1

Proficient-level: Describe the Net Present Value (NPV) method for determining a capital budgeting project’s desirability. What is the acceptance benchmark when using NPV?

Distinguished-level: Identify the NPV method’s strengths and weaknesses.

Question 2

Proficient-level: What is the payback period statistic? What is the acceptance benchmark when using the payback period statistic?

Distinguished-level: Identify what problem of the Payback Period method is corrected by using the Discounted Payback Period method.

Question 3

Proficient-level: Describe the Internal Rate of Return (IRR) method for determining a capital budgeting project’s desirability. What is the acceptance benchmark when using IRR?

Distinguished-level: Explain how the NPV and IRR methods are similar and how they are different.

Question 4

Proficient-level: Describe the Modified Internal Rate of Return (MIRR) method for determining a capital budgeting project’s desirability. What are MIRR’s strengths and weaknesses?

Distinguished-level: Explain the differences in the reinvestment rate assumption that distinguishes MIRR from IRR.

Question 5 HINT-The correct NPV statistic for Project Y falls within the range of -$1,000 and +$1,999. Do not forget to advise whether this project should be accepted or rejected. (Reminder: you are also required to identify the known variables in order to obtain the correct response to this, and in all, quantitative problems.)

Proficient-level: Compute the NPV statistic for Project Y and tell [advise] whether the firm should accept or reject the project with the cash flows shown in the chart if the appropriate cost of capital is 12 percent.

Distinguished-level: Explain how decreases in the cost of capital lead to an increase in the number of approved projects.  Show solving problem

Project Y

Time

0

1

2

3

4

Cash Flow

-$8,000

$3,350

$4,180

$1,520

$300

(Cornett, Adair, & Nofsinger, 2016, p. 332).

Question 6 HINT-To calculate a payback period, one must take the set of given cash flows and construct and analyze a listing of CUMULATIVE cash flows. A good example is reviewed in the M:Finance, 3rd edition text in Table 13.2, page 315. [VERY IMPORTANT POINT: There is a typo in some editions in the text’s example problem, as the Year 2 cash flow listed as -3,500 is actually a POSITIVE 3,500. So, treat the second year’s cash flow in the example as POSITIVE 3,500. All other numbers in the Table are correct.] Use this text example as a guide in solving this assignment problem. The correct Payback Period statistic for Project A falls within the range of 2.0 years and 5.5 years. Do not forget to advise whether this project should be accepted or rejected. (reminder: show your work.)

Proficient-level: Compute the payback period statistic for Project A and recommend whether the firm should accept or reject the project with the cash flows shown in the chart if the maximum allowable payback is four years.

Distinguished-level: If the discounted payback period were computed, identify if it would be less than, equal to, or greater than the non-discounted payback period.  Show solving problem

Project A

Time

0

1

2

3

4

5

Cash Flow

-$1,000

$350

$480

$520

$300

$100

(Cornett, Adair, & Nofsinger, 2016).

Question 7

Chapter 13 in the M: Finance textbook by Cornett, Adair, and Nofsinger discusses various criteria for calculating and analyzing the desirability of a capital budgeting project. This task is extremely important as these projects often entail very large cash outflows and may significantly determine the future profitability of the firm. Examine Chapter 13, with particular emphasis on each of the six capital budgeting techniques reviewed. Assume the role of chief financial executive of a firm that is analyzing a major project that entails a large initial cash outflow at time point zero and has future expected cash inflows occurring over the next 10-year period.

-If you could select only three techniques to analyze this project’s desirability, which three techniques would you select? Why?

-When analyzing a project’s desirability, which factor do you believe is more important: the technique to analyze investment acceptability, or the use of the most accurate projections of cash flows? Why?

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a
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Exercise 7-1Recognizing accrued interest expense
Harveys Corporation borrowed $60,000 from the bank on November 1, 2014. The note had a 6 percent annual rate of interes
What amount of interest expense was paid in cash in 2014?
What amount of interest expense was reported on the 2014 income statement?
What amount of total liabilities was reported on the December 31, 2014, balance sheet?
What total amount of cash was paid to the bank on April 30, 2015, for principal and interest?
What amount of interest expense was reported on the 2015 income statement?
Exercise 7-18Determining the amount of bond premiums and discounts
For each of the following situations, calculate the amount of bond discount or premium, if any:
Wolfe Co. issued $120,000 of 6 percent bonds at 101.
Riley, Inc., issued $80,000 of 10-year, 8 percent bonds at 98.
Rais, Inc., issued $200,000 of 15-year, 9 percent bonds at 102¼.
Beaux Co. issued $400,000 of 20-year, 8 percent bonds at 99¾.
Exercise 8-4Effect of issuing common stock on the balance sheet
Newly formed Electronics Services Corporation has 100,000 shares of $10 par common stock authorized. On
March 1, 2014, Electronics Services issued 20,000 shares of the stock for $12 per share. On May 2 the company
issued an additional 30,000 shares for $15 per share. Electronics Services was not affected by other events
during 2014.
Record the transactions in a horizontal statements model like the following one. In the Cash Flow column,
indicate whether the item is an operating activity (OA), investing activity (IA), or financing activity (FA). Use NA to
indicate that an element was not affected by the event.
Determine the amount Electronics Services would report for common stock on the December 31, 2014, balance sheet.
Determine the amount Electronics Services would report for paid-in capital in excess of par.
What is the total amount of capital contributed by the owners?
What amount of total assets would Electronics Services report on the December 31, 2014, balance sheet?
Exercise 9-12Ratio analysis
During 2014, Desny Corporation reported after-tax net income of $3,890,000. During the year, the number of shares of stock
Compute the following by rounding to two decimal points.
Earnings per share
Book value per share of common stock
Price-earnings ratio
Dividend yield
nse
nt annual rate of interest and matured on April 30, 2015. Interest and principal were paid in cash on the maturity date.
4, balance sheet.
mber of shares of stock outstanding remained constant at 10,000 of $100 par, 9 percent preferred stock and 400,000 shares of common s
maturity date.
and 400,000 shares of common stock. The company’s total stockholders’ equity is $20,000,000 at December 31, 2014. Desny Corporatio
mber 31, 2014. Desny Corporation’s common stock was selling at $52 per share at the end of its fiscal year. All dividends for the year hav
ear. All dividends for the year have been paid, including $4.80 per share to common stockholders.

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ACC201
Final Project
Current year:
Sales
Inventory purchases
Sales and marketing expenses
Accounts receivable
Accumulated depreciation
Accrued expenses
Interest expense
Inventory – current year
Dividends
Shares outstanding
540,000
162,000
49,000
23,000
23,000
5,000
5,000
25,000
none
50,000
Prior year:
Accounts receivable
Inventory
Total assets
Common stock
Retained earnings
Shares outstanding
18,000
23,000
174,000
50,000
26,000
50,000
Current year:
Operating expenses
Cash
Prepaid expenses
Note payable – current
Administrative expenses
Common stock
Equipment
Accounts payable
Long-term note payable
Supplies
Beginning inventory
Goods available
Cost of goods sold
The Coffee Hut
Balance Sheet
The Coffee Hut
Income Statement
Current
Current assets:
Current
Revenue:
Gross profit
Expenses:
Total current assets
Property, plant and equipment:
Net equipment
Total assets
229,000
33,000
9,000
10,000
60,000
50,000
108,000
13,000
45,000
11,000
Total expenses
Operating income
Other expenses:
Net income
Current liabilities:
Total current liabilities
Long-term liabilities:
Total liabilities
Stockholders’ equity:
Total stockholders’ equity
Total liabilities and equity
Ratio
Current ratio
Quick ratio
Accounts receivable turnover
Inventory turnover
Debt to assets
Debt to equity
Return on sales
Asset turnover
Return on investment
Return on equity
Earnings per share
Analysis
If cost of goods sold is the only variable cost, and the contribution margin
per drink was $3.40, how many coffee drinks were sold during the year,
and what was the average selling price per drink?
Number of drinks sold
Average selling price
ysis
Exercise 11-5
a.
b.
Exercise 11-17
Exercise 11-18

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13
Statement of
Cash Flows
Chapter
STUDY
OBJECTIVES
After studying this chapter, you should be
able to:
1 Indicate the usefulness of the statement
of cash flows.
2 Distinguish among operating, investing,
and financing activities.
3 Prepare a statement of cash flows using
the indirect method.
4 Analyze the statement of cash flows.
✓
The Navigator
✓ The Navigator
Scan Study Objectives
■
Read Feature Story
■
Read Preview
■
Read text and answer
p. 617
■
p. 625
■
Work Comprehensive
Do it!
p. 628
Do it!
■
p. 632
p. 634
■
■
Review Summary of Study Objectives
■
Work Comprehensive
■
Do it!
p. 648
Answer Self-Study Questions
■
Complete Assignments
■
Feature Story
GOT CASH?
In today’s environment, companies must be ready to respond to changes
quickly in order to survive and thrive. They need to produce new products
and expand into new markets continually. To do this takes cash—lots and
lots of cash. Keeping lots of cash available is a real challenge for a young
company. It requires careful cash management and attention to cash flow.
One company that managed cash successfully in its early years was
Microsoft (www.microsoft.com). During those years the company paid much
of its payroll with stock options (rights to purchase company stock in the
future at a given price) instead of cash. This strategy conserved cash, and
turned more than a thousand of its employees into millionaires during the
company’s first 20 years of business.
612
In recent years Microsoft has had a different kind of cash problem. Now that
it has reached a more “mature” stage in life, it generates so much cash—
roughly $1 billion per month—that it cannot always figure out what to do
with it. By 2004 Microsoft had accumulated $60 billion.
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The company said it was accumulating cash to invest in new opportunities, buy other companies, and
pay off pending lawsuits. But for
years, the federal government has
blocked attempts by Microsoft to
buy anything other than small firms
because it feared that purchase of
a large firm would only increase
Microsoft’s monopolistic position.
In addition, even the largest estimates of Microsoft’s legal obligations
related to pending lawsuits would use up only about $6 billion in cash.
Microsoft’s stockholders have complained for years that holding all this cash
was putting a drag on the company’s profitability. Why? Because Microsoft
had the cash invested in very low-yielding government securities. Stockholders felt that the company either should find new investment projects that
would bring higher returns, or return some of the cash to stockholders.
Finally, in July 2004 Microsoft announced a plan to return cash to stockholders, by paying a special one-time $32 billion dividend in December 2004.
This special dividend was so large that, according to the U.S. Commerce
Department, it caused total personal income in the United States to rise
by 3.7% in one month—the largest monthly increase ever recorded by the
agency. (It also made the holiday season brighter, especially for retailers in
the Seattle area.) Microsoft also doubled its regular annual dividend to $3.50
per share. Further, it announced that it would spend another $30 billion over
the next four years buying treasury stock. In addition, in 2008 Microsoft
offered to buy Yahoo! for $44.6 billion (Yahoo! declined the offer). These
actions will help to deplete some of its massive cash horde, but as you will
see in this chapter, for a cash-generating machine like Microsoft, the company
will be anything but cash-starved.
Source: “Business: An End to Growth? Microsoft’s Cash Bonanza,” The Economist, July 23,
2005, p. 61.
✓
The Navigator
Inside Chapter 13…
• Net What?
(p. 617)
• Cash Flow Isn’t Always What It Seems
• GM Must Sell More Cars
(p. 619)
(p. 626)
• All About You: Where Does the Money Go?
(p. 633)
613
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Preview of Chapter 13
The balance sheet, income statement, and retained earnings statement do not always show the whole
picture of the financial condition of a company or institution. In fact, looking at the financial statements of
some well-known companies, a thoughtful investor might ask questions like these: How did Eastman Kodak
finance cash dividends of $649 million in a year in which it earned only $17 million? How could United
Airlines purchase new planes that cost $1.9 billion in a year in which it reported a net loss of over $2 billion?
How did the companies that spent a combined fantastic $3.4 trillion on mergers and acquisitions in a recent
year finance those deals? Answers to these and similar questions can be found in this chapter, which
presents the statement of cash flows.
The content and organization of this chapter are as follows.
Statement of Cash Flows
The Statement of Cash Flows:
Usefulness and Format
•
•
•
•
•
•
Usefulness
Classifications
Significant noncash activities
Format
Preparation
Indirect and direct methods
Preparing the Statement of
Cash Flows—Indirect Method
• Step 1: Operating activities
• Step 2: Investing and financing
activities
• Step 3: Net change in cash
Using Cash Flows to Evaluate
a Company
• Free cash flow
✓
The Navigator
THE STATEMENT OF CASH FLOWS: USEFULNESS AND FORMAT
The balance sheet, income statement, and retained earnings statement provide
only limited information about a company’s cash flows (cash receipts and cash payments). For example, comparative balance sheets show the increase in property,
plant, and equipment during the year. But they do not show how the additions were
financed or paid for. The income statement shows net income. But it does not indicate the amount of cash generated by operating activities. The retained earnings
statement shows cash dividends declared but not the cash dividends paid during
the year. None of these statements presents a detailed summary of where cash
came from and how it was used.
Usefulness of the Statement of Cash Flows
STUDY OBJECTIVE 1
Indicate the usefulness of the
statement of cash flows.
The statement of cash flows reports the cash receipts, cash payments, and
net change in cash resulting from operating, investing, and financing activities during a period. The information in a statement of cash flows should
help investors, creditors, and others assess:
1. The entity’s ability to generate future cash flows. By examining relationships
between items in the statement of cash flows, investors can make predictions of
the amounts, timing, and uncertainty of future cash flows better than they can
from accrual basis data.
614
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The Statement of Cash Flows: Usefulness and Format
615
2. The entity’s ability to pay dividends and meet obligations. If a company does
not have adequate cash, it cannot pay employees, settle debts, or pay dividends.
Employees, creditors, and stockholders should be particularly interested in this
statement, because it alone shows the flows of cash in a business.
3. The reasons for the difference between net income and net cash provided
(used) by operating activities. Net income provides information on the success
or failure of a business enterprise. However, some financial statement
ETHICS NOTE
users are critical of accrual-basis net income because it requires many
Though we would discourestimates.As a result, users often challenge the reliability of the number.
age reliance on cash flows to
Such is not the case with cash. Many readers of the statement of cash
the exclusion of accrual accountflows want to know the reasons for the difference between net income ing, comparing cash from operaand net cash provided by operating activities. Then they can assess for tions to net income can reveal
themselves the reliability of the income number.
important information about
4. The cash investing and financing transactions during the period. By the “quality” of reported net
examining a company’s investing and financing transactions, a finan- income. Such a comparison can
cial statement reader can better understand why assets and liabilities reveal the extent to which net
income provides a good meachanged during the period.
sure of actual performance.
Classification of Cash Flows
The statement of cash flows classifies cash receipts and cash payments as
operating, investing, and financing activities.Transactions and other events
characteristic of each kind of activity are as follows.
STUDY OBJECTIVE 2
Distinguish among operating,
investing, and financing
activities.
1. Operating activities include the cash effects of transactions that create
revenues and expenses. They thus enter into the determination of net
income.
2. Investing activities include (a) acquiring and disposing of investments and
property, plant, and equipment, and (b) lending money and collecting the
loans.
3. Financing activities include (a) obtaining cash from issuing debt and repaying
the amounts borrowed, and (b) obtaining cash from stockholders, repurchasing
shares, and paying dividends.
The operating activities category is the most important. It shows the cash provided by company operations. This source of cash is generally considered to be the
best measure of a company’s ability to generate sufficient cash to continue as a
going concern.
Illustration 13-1 (page 616) lists typical cash receipts and cash payments within
each of the three classifications. Study the list carefully. It will prove very useful in
solving homework exercises and problems.
Note the following general guidelines:
1. Operating activities involve income statement items.
2. Investing activities involve cash flows resulting from changes in investments
and long-term asset items.
3. Financing activities involve cash flows resulting from changes in long-term liability and stockholders’ equity items.
Companies classify as operating activities some cash flows related to investing or financing activities. For example, receipts of investment revenue (interest
and dividends) are classified as operating activities. So are payments of interest
to lenders. Why are these considered operating activities? Because companies
report these items in the income statement, where results of operations are
shown.
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Chapter 13 Statement of Cash Flows
Illustration 13-1
Typical receipt and payment
classifications
Operating
activities
J AVA
J AVA
TIME
TIME
Investing activities
S T O CK
BOND
Financing
activities
TYPES OF CASH INFLOWS AND OUTFLOWS
Operating activities—Income statement items
Cash inflows:
From sale of goods or services.
From interest received and dividends received.
Cash outflows:
To suppliers for inventory.
To employees for services.
To government for taxes.
To lenders for interest.
To others for expenses.
Investing activities—Changes in investments and long-term assets
Cash inflows:
From sale of property, plant, and equipment.
From sale of investments in debt or equity securities of other entities.
From collection of principal on loans to other entities.
Cash outflows:
To purchase property, plant, and equipment.
To purchase investments in debt or equity securities of other entities.
To make loans to other entities.
Financing activities—Changes in long-term liabilities and stockholders’ equity
Cash inflows:
From sale of common stock.
From issuance of long-term debt (bonds and notes).
Cash outflows:
To stockholders as dividends.
To redeem long-term debt or reacquire capital stock (treasury stock).
Significant Noncash Activities
Not all of a company’s significant activities involve cash. Examples of significant
noncash activities are:
1.
2.
3.
4.
Direct issuance of common stock to purchase assets.
Conversion of bonds into common stock.
Direct issuance of debt to purchase assets.
Exchanges of plant assets.
INTERNATIONAL NOTE
The statement of cash flows
is very similar under GAAP and
IFRS. One difference is that,
under IFRS, noncash investing
and financing activities are not
reported in the statement of cash
flows but instead are reported in
the notes to the financial
statements.
Companies do not report in the body of the statement of cash flows
significant financing and investing activities that do not affect cash.
Instead, they report these activities in either a separate schedule at the
bottom of the statement of cash flows or in a separate note or supplementary schedule to the financial statements. The reporting of these noncash
activities in a separate schedule satisfies the full disclosure principle.
In solving homework assignments you should present significant noncash investing and financing activities in a separate schedule at the bottom
of the statement of cash flows. (See the last entry in Illustration 13-2, on
page 617, for an example.)
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The Statement of Cash Flows: Usefulness and Format
617
ACCOUNTING ACROSS THE ORGANIZATION
Net What?
Net income is not the same as net cash provided by operating activities. Below
are some results from recent annual reports (dollars in millions). Note the wide
disparity among these companies, all of which engaged in retail merchandising.
Company
Net Income
Kohl’s Corporation
Wal-Mart Stores, Inc.
J. C. Penney Company, Inc.
Costco Wholesale Corp.
Target Corporation
$ 1,083
11,284
1,153
1,082
2,849
Net Cash Provided by
Operating Activities
$ 1,234
20,164
1,255
2,076
4,125
In general, why do differences exist between net income and net cash provided by
operating activities?
Format of the Statement of Cash Flows
The general format of the statement of cash flows presents the results of the three
activities discussed previously—operating, investing, and financing—plus the significant noncash investing and financing activities. Illustration 13-2 shows a widely
used form of the statement of cash flows.
Illustration 13-2
Format of statement of cash
flows
COMPANY NAME
Statement of Cash Flows
Period Covered
Cash flows from operating activities
(List of individual items)
Net cash provided (used) by operating activities
Cash flows from investing activities
(List of individual inflows and outflows)
Net cash provided (used) by investing activities
Cash flows from financing activities
(List of individual inflows and outflows)
XX
XXX
XX
XXX
XX
Net cash provided (used) by financing activities
XXX
Net increase (decrease) in cash
Cash at beginning of period
XXX
XXX
Cash at end of period
XXX
Noncash investing and financing activities
(List of individual noncash transactions)
XXX
The cash flows from operating activities section always appears first, followed by
the investing activities section and then the financing activities section.
before you go on…
Do it!
During its first week, Duffy & Stevenson Company had these transactions.
1. Issued 100,000 shares of $5 par value common stock for $800,000 cash.
2. Borrowed $200,000 from Castle Bank, signing a 5-year note bearing 8% interest.
Classification of Cash Flows
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Chapter 13 Statement of Cash Flows
Action Plan
• Identify the three types of
activities used to report all
cash inflows and outflows.
• Report as operating activities
the cash effects of transactions
that create revenues and
expenses and enter into the
determination of net income.
• Report as investing activities
transactions that (a) acquire
and dispose of investments and
long-term assets and (b) lend
money and collect loans.
• Report as financing activities
transactions that (a) obtain
cash from issuing debt and
repay the amounts borrowed
and (b) obtain cash from stockholders and pay them dividends.
3. Purchased two semi-trailer trucks for $170,000 cash.
4. Paid employees $12,000 for salaries and wages.
5. Collected $20,000 cash for services provided.
Classify each of these transactions by type of cash flow activity.
Solution
1. Financing activity
2. Financing activity
3. Investing activity
4. Operating activity
5. Operating activity
Related exercise material: BE13-1, BE13-2, BE13-3, E13-1, E13-2, E13-3, and Do it! 13-1.
✓
The Navigator
Preparing the Statement of Cash Flows
Companies prepare the statement of cash flows differently from the three
other basic financial statements. First, it is not prepared from an adjusted
trial balance. It requires detailed information concerning the changes in
account balances that occurred between two points in time.An adjusted trial
balance will not provide the necessary data. Second, the statement of cash
flows deals with cash receipts and payments. As a result, the company must
adjust the effects of the use of accrual accounting to determine cash flows.
The information to prepare this statement usually comes from three sources:
• Comparative balance sheets. Information in the comparative balance sheets
indicates the amount of the changes in assets, liabilities, and stockholders’ equities from the beginning to the end of the period.
• Current income statement. Information in this statement helps determine the
amount of cash provided or used by operations during the period.
• Additional information. Such information includes transaction data that are
needed to determine how cash was provided or used during the period.
Preparing the statement of cash flows from these data sources involves three
major steps, as explained in Illustration 13-3 on the next page.
INTERNATIONAL NOTE
Companies preparing financial statements under IFRS must
prepare a statement of cash
flows as an integral part of the
financial statements.
Usage of Methods
99%
Indirect Method
1% Direct Method
Indirect and Direct Methods
In order to perform step 1, a company must convert net income from an accrual
basis to a cash basis. This conversion may be done by either of two methods: (1) the
indirect method or (2) the direct method. Both methods arrive at the same total
amount for “Net cash provided by operating activities.” They differ in how they
arrive at the amount.
The indirect method adjusts net income for items that do not affect cash. A
great majority of companies (98.8%) use this method, as shown in the nearby
chart.1 Companies favor the indirect method for two reasons: (1) It is easier and
1
Accounting Trends and Techniques—2007 (New York: American Institute of Certified Public
Accountants, 2007).
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The Statement of Cash Flows: Usefulness and Format
Step 1: Determine net cash provided/used by operating activities by converting
net income from an accrual basis to a cash basis.
This step involves analyzing not only
the current year’s income statement
but also comparative balance sheets
and selected additional data.
Buying & selling
goods
Step 2: Analyze changes in noncurrent asset and liability accounts and record as
investing and financing activities, or disclose as noncash transactions.
Inve
g
ncin
stin
g
Fina
This step involves analyzing comparative
balance sheet data and selected additional
information for their effects on cash.
Step 3: Compare the net change in cash on the statement of cash flows with the
change in the cash account reported on the balance sheet to make sure
the amounts agree.
+
or
–
The difference between the beginning
and ending cash balances can be easily
computed from comparative balance
sheets.
less costly to prepare, and (2) it focuses on the differences between net income and
net cash flow from operating activities.
The direct method shows operating cash receipts and payments, making it
more consistent with the objective of a statement of cash flows. The FASB has
expressed a preference for the direct method, but allows the use of either method.
The next section illustrates the more popular indirect method. Appendix 13B
illustrates the direct method.
I N V E S T O R
I N S I G H T
Cash Flow Isn’t Always What It Seems
Some managers have taken actions that artificially increase cash flow from operating
activities. They do this by moving negative amounts out of the operating section and into the
investing or financing section.
For example, WorldCom, Inc. disclosed that it had improperly capitalized expenses: It had
moved $3.8 billion of cash outflows from the “Cash from operating activities” section of the cash
flow statement to the “Investing activities” section, thereby greatly enhancing cash provided by
operating activities. Similarly, Dynegy, Inc. restated its cash flow statement because it had improperly included in operating activities, instead of in financing activities, $300 million from natural gas
trading. The restatement resulted in a drop of 37% in cash flow from operating activities.
Source: Henny Sender, “Sadly, These Days Even Cash Flow Isn’t Always What It Seems to Be,” Wall Street Journal,
May 8, 2002.
For what reasons might managers at WorldCom and at Dynegy take the actions noted
above?
619
Illustration 13-3
Three major steps in
preparing the statement
of cash flows
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Chapter 13 Statement of Cash Flows
PREPARING THE STATEMENT OF CASH
FLOWS—INDIRECT METHOD
To explain how to prepare a statement of cash flows using the indirect
method, we use financial information from Computer Services Company.
Illustration 13-4 presents Computer Services’ current and previous-year
balance sheets, its current-year income statement, and related financial information for the current year.
STUDY OBJECTIVE 3
Prepare a statement of cash
flows using the indirect method.
Illustration 13-4
Comparative balance
sheets, income statement,
and additional information
for Computer Services
Company
COMPUTER SERVICES COMPANY
Comparative Balance Sheets
December 31
Assets
Current assets
Cash
Accounts receivable
Merchandise inventory
Prepaid expenses
Property, plant, and equipment
Land
Building
Accumulated depreciation—building
Equipment
Accumulated depreciation—equipment
Total assets
2011
2010
$ 55,000
20,000
15,000
5,000
$ 33,000
30,000
10,000
1,000
130,000
160,000
(11,000)
27,000
(3,000)
20,000
40,000
(5,000)
10,000
(1,000)
Change in
Account Balance
Increase/Decrease
$ 22,000
10,000
5,000
4,000
Increase
Decrease
Increase
Increase
110,000
120,000
6,000
17,000
2,000
Increase
Increase
Increase
Increase
Increase
$398,000
$138,000
$ 28,000
6,000
$ 12,000
8,000
130,000
20,000
110,000 Increase
70,000
164,000
50,000
48,000
20,000 Increase
116,000 Increase
$398,000
$138,000
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable
Income tax payable
Long-term liabilities
Bonds payable
Stockholders’ equity
Common stock
Retained earnings
Total liabilities and stockholders’ equity
$ 16,000 Increase
2,000 Decrease
COMPUTER SERVICES COMPANY
Income Statement
For the Year Ended December 31, 2011
Revenues
Cost of goods sold
Operating expenses (excluding depreciation)
Depreciation expense
Loss on sale of equipment
Interest expense
Income before income tax
Income tax expense
Net income
$507,000
$150,000
111,000
9,000
3,000
42,000
315,000
192,000
47,000
$145,000
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Preparing the Statement of Cash Flows—Indirect Method
Additional information for 2011:
1. The company declared and paid a $29,000 cash dividend.
2. Issued $110,000 of long-term bonds in direct exchange for land.
3. A building costing $120,000 was purchased for cash. Equipment costing $25,000 was also
purchased for cash.
4. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated
depreciation $1,000) for $4,000 cash.
5. Issued common stock for $20,000 cash.
6. Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.
621
Illustration 13-4
(continued)
We will now apply the three steps to the information provided for Computer
Services Company.
Step 1: Operating Activities
DETERMINE NET CASH PROVIDED/USED BY OPERATING ACTIVITIES BY
CONVERTING NET INCOME FROM AN ACCRUAL BASIS TO A CASH BASIS
To determine net cash provided by operating activities under the indirect method,
companies adjust net income in numerous ways. A useful starting point is to understand why net income must be converted to net cash provided by operating activities.
Under generally accepted accounting principles, most companies use the accrual basis of accounting. This basis requires that companies record revenue when
earned and record expenses when incurred. Earned revenues may include credit
sales for which the company has not yet collected cash. Expenses incurred may include some items that it has not yet paid in cash. Thus, under the accrual basis, net
income is not the same as net cash provided by operating activities.
Therefore, under the indirect method, companies must adjust net income to
convert certain items to the cash basis. The indirect method (or reconciliation
method) starts with net income and converts it to net cash provided by operating
activities. Illustration 13-5 lists the three types of adjustments.
Net Income
ⴙⲐⴚ
Adjustments
ⴝ
Net Cash Provided/
Used by Operating
Activities
• Add back noncash
expenses, such as
depreciation, amortization,
or depletion.
Illustration 13-5
Three types of adjustments
to convert net income to
net cash provided by
operating activities
• Deduct gains and add
losses that resulted from
investing and financing
activities.
• Analyze changes to noncash
current asset and current
liability accounts.
DEPRECIATION EXPENSE
Computer Services’ income statement reports depreciation expense of $9,000.
Although depreciation expense reduces net income, it does not reduce cash. In other
words, depreciation expense is a noncash charge. The company must add it back to
net income to arrive at net cash provided by operating activities. Computer Services
reports depreciation expense in the statement of cash flows as shown on page 622.
HELPFUL HINT
Depreciation is similar
to any other expense
in that it reduces net
income. It differs in that
it does not involve a
current cash outflow; that
is why it must be added
back to net income to
arrive at cash provided
by operating activities.
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Chapter 13 Statement of Cash Flows
Illustration 13-6
Adjustment for depreciation
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
Net cash provided by operating activities
$145,000
9,000
$154,000
As the first adjustment to net income in the statement of cash flows, companies
frequently list depreciation and similar noncash charges such as amortization of
intangible assets, depletion expense, and bad debt expense.
LOSS ON SALE OF EQUIPMENT
Illustration 13-1 (page 616) states that the investing activities section should report
cash received from the sale of plant assets. Because of this, companies must eliminate
from net income all gains and losses related to the disposal of plant assets, to arrive
at cash provided by operating activities.
In our example, Computer Services’ income statement reports a $3,000 loss on
the sale of equipment (book value $7,000, less $4,000 cash received from sale of
equipment). The company’s loss of $3,000 should not be included in the operating
activities section of the statement of cash flows. Illustration 13-7 shows that the
$3,000 loss is eliminated by adding $3,000 back to net income to arrive at net cash
provided by operating activities.
Illustration 13-7
Adjustment for loss on sale
of equipment
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense
Loss on sale of equipment
Net cash provided by operating activities
$145,000
$9,000
3,000
12,000
$157,000
If a gain on sale occurs, the company deducts the gain from its net income in
order to determine net cash provided by operating activities. In the case of either
a gain or a loss, companies report as a source of cash in the investing activities
section of the statement of cash flows the actual amount of cash received from
the sale.
CHANGES TO NONCASH CURRENT ASSET AND CURRENT
LIABILITY ACCOUNTS
A final adjustment in reconciling net income to net cash provided by operating
activities involves examining all changes in current asset and current liability
accounts. The accrual accounting process records revenues in the period earned
and expenses in the period incurred. For example, companies use Accounts
Receivable to record amounts owed to the company for sales that have been
made but for which cash collections have not yet been received. They use the
Prepaid Insurance account to reflect insurance that has been paid for, but which
has not yet expired, and therefore has not been expensed. Similarly, the Salaries
Payable account reflects salaries expense that has been incurred by the company
but has not been paid.
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Preparing the Statement of Cash Flows—Indirect Method
As a result, we need to adjust net income for these accruals and prepayments
to determine net cash provided by operating activities. Thus we must analyze the
change in each current asset and current liability account to determine its impact
on net income and cash.
CHANGES IN NONCASH CURRENT ASSETS. The adjustments required for changes
in noncash current asset accounts are as follows: Deduct from net income increases
in current asset accounts, and add to net income decreases in current asset accounts, to arrive at net cash provided by operating activities. We can observe these
relationships by analyzing the accounts of Computer Services Company.
Decrease in Accounts Receivable. Computer Services Company’s accounts
receivable decreased by $10,000 (from $30,000 to $20,000) during the period. For
Computer Services this means that cash receipts were $10,000 higher than revenues. The Accounts Receivable account in Illustration 13-8 shows that Computer
Services Company had $507,000 in revenues (as reported on the income statement),
but it collected $517,000 in cash.
Accounts Receivable
1/1/11
12/31/11
Balance
Revenues
Balance
30,000
507,000
Receipts from customers
517,000
20,000
To adjust net income to net cash provided by operating activities, the company
adds to net income the decrease of $10,000 in accounts receivable (see Illustration 13-9, page 624). If the Accounts Receivable balance increases, cash receipts are
lower than revenue earned under the accrual basis.Therefore, the company deducts
from net income the amount of the increase in accounts receivable, to arrive at net
cash provided by operating activities.
Increase in Merchandise Inventory. Computer Services Company’s
Merchandise Inventory balance increased $5,000 (from $10,000 to $15,000) during
the period. The change in the Merchandise Inventory account reflects the difference between the amount of inventory purchased and the amount sold. For
Computer Services this means that the cost of merchandise purchased exceeded
the cost of goods sold by $5,000. As a result, cost of goods sold does not reflect
$5,000 of cash payments made for merchandise. The company deducts from net
income this inventory increase of $5,000 during the period, to arrive at net cash
provided by operating activities (see Illustration 13-9, page 624). If inventory decreases, the company adds to net income the amount of the change, to arrive at net
cash provided by operating activities.
Increase in Prepaid Expenses. Computer Services’ prepaid expenses increased during the period by $4,000. This means that cash paid for expenses is
higher than expenses reported on an accrual basis. In other words, the company
has made cash payments in the current period, but will not charge expenses
to income until future periods (as charges to the income statement). To adjust
net income to net cash provided by operating activities, the company deducts
from net income the $4,000 increase in prepaid expenses (see Illustration 13-9,
page 624).
If prepaid expenses decrease, reported expenses are higher than the expenses
paid. Therefore, the company adds to net income the decrease in prepaid expenses,
to arrive at net cash provided by operating activities.
Illustration 13-8
Analysis of accounts
receivable
623
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Chapter 13 Statement of Cash Flows
Illustration 13-9
Adjustments for changes
in current asset accounts
Cash flows from operating activities
Net income
Adjustments to reconcile net income to net cash