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Cambridge Bu siness Publ is hers, 2014

Solut ions Manual, Chapter 4 4-1

Chapter 4

Reporting and Analyzing Cash Flows

Learning Objectives coverage by questionMini-

ExercisesExercises Problems

Cases andProjects

LO1 Explain the purpose of thestatement of cash flows and how it

complements the income statementand balance sheet.

21, 22, 24 38, 39, 44 47, 51, 54 57 - 59

LO2 Construct and explain thestatement of cash flows.

21 - 31 34 - 44 45 - 56 57 - 59

LO3 Compute and interpret ratiosthat reflect a companys liquidity andsolvency.

32, 33,

35, 43

46, 48, 50,

52, 55, 5659

LO4Appendix 4A: Use a

spreadsheet to construct thestatement of cash flows. 55

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Cambridge Bu siness Pub l ishers, 2014

4-2 Financial Acco unting, 4thEdit ion

DISCUSSION QUESTIONS

Q4-1. Cash equivalents are short-term, highly liquid investments that firms acquirewith temporarily idle cash to earn interest on these excess funds. To qualify asa cash equivalent, an investment must (1) be easily convertible into a known

cash amount and (2) be close enough to maturity so that its market value is notsensitive to interest rate changes (generally, investments with initial maturitiesof three months or less). Three examples of cash equivalents are treasury bills,commercial paper, and money market funds.

Q4-2. Cash equivalents are included with cash in a statement of cash flows becausethe purchase and sale of such investments are considered to be part of a firm'soverall management of cash rather than a source or use of cash. Similarly, asstatement users evaluate cash flows, it may matter very little to them whetherthe cash is on hand, deposited in a bank account, or invested in cashequivalents.

Q4-3. Operating activities

Inflow: Cash received from customers

Outflow: Cash paid to suppliers

Investing activities

Inflow: Sale of equipment

Outflow: Purchase of stocks and bonds

Financing activities

Inflow: Issuance of common stock

Outflow: Payment of dividends

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Q4-4. a. Investing; outflow.

b. Investing; inflow.

c. Financing; outflow.

d. Operating (direct method, not shown separately under indirect method);

inflow.e. Financing; inflow.

f. Operating (direct method, not shown separately under indirect method);inflow.

g. Operating (direct method, not shown separately under indirect method);outflow.

h. Operating (direct method, not shown separately under indirect method);inflow.

Q4-5. This is a noncash investing and financing event. It must be reported in a

supplementary schedule to the statement of cash flows.

Q4-6. Noncash investing and financing transactions are disclosed as supplementalinformation to a statement of cash flows because a secondary objective of cashflow reporting is to present information about investing and financing activities.Noncash investing and financing transactions, generally, affect future cashflows. Issuing bonds payable to acquire equipment, for example, requires futurecash payments for interest and principal on the bonds. On the other hand,converting bonds payable into common stock eliminates future cash paymentsrelated to the bonds. Knowledge of these types of events, therefore, should behelpful to users of cash flow data who wish to assess a firm's future cash flows.

Q4-7. A statement of cash flows helps external users assess the amount, timing, anduncertainty of future cash flows to the enterprise. These assessments helpusers evaluate their own future cash receipts from their investments in, or loansto, the firm. A statement of cash flows shows the periodic cash effects of afirm's operating, investing, and financing activities. Distinguishing among thesedifferent categories of cash flows helps users compare, evaluate, and predictcash flows. With cash flow information, creditors and investors are better ableto assess a firm's ability to settle its liabilities and pay its dividends. Over time,the statement of cash flows permits users to observe and analyzemanagement's investing and financing policies. A statement of cash flows alsoprovides information useful in evaluating a firm's financial flexibility(which is its

ability to generate cash to respond to unanticipated needs and opportunities).Q4-8. The direct method presents the net cash flow from operating activities by

showing the major categories of operating cash receipts and cash payments(such as cash received from customers, cash paid to employees and suppliers,cash paid for interest, and cash paid for income taxes). The indirect (orreconciliation) method, in contrast, presents the net cash flow from operatingactivities by applying a series of adjustments to the accrual net income toconvert it to a cash basis.

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Q4-9. Under the indirect method, depreciation is added to net income because, as anoncash expense, it was deducted in computing net income. Addingdepreciation to net income, therefore, eliminates it from the cash-basis incomeamount. Amortization and depletion expenses are handled the same way.

Q4-10. Under the indirect method, the $98,000 cash received from the sale of the land

will appear in the cash flows from investing activities section of the statement ofcash flows. In addition, the $28,000 gain from the sale will be deducted fromnet income as one of the adjustments made to determine the net cash flowfrom operating activities.

Q4-11. Net income $ 88,000Add (deduct) items to convert net income to cash basis

Depreciation expense 6,000Subtract change in accounts receivable 13,000Subtract change in inventory (9,000)

Add change in accounts payable (3,500)Add change in income tax payable 1,500

Net cash provided by operating activities $ 96,000

Q4-12. The separate disclosures required for a company using the indirect method inthe statement of cash flows are (1) cash paid during the year for interest (net ofamount capitalized) and for income taxes, (2) all noncash investing andfinancing transactions, and (3) the policy for determining which highly liquid,short-term investments are treated as cash equivalents.

Q4-13. The statement of cash flows will show a positive net cash flow from operatingactivities if operating cash receipts exceed operating cash payments. Thiscould happen, for example, if noncash expenses (such as depreciation andamortization) exceed the net loss. It would also happen if operating cash

receipts exceed sales by more than the loss or if operating cash payments areless than accrual expenses by more than the loss (or some combination ofthese events).

Q4-14. Sales $925,000+ Accounts receivable decrease 14,000= Cash received from customers $939,000

Q4-15. Wages expense $ 86,000+ Wages payable decrease 1,100= Cash paid to employees $ 87,100

Q4-16. Advertising expense $ 43,000+ Prepaid advertising increase 1,600= Cash paid for advertising $ 44,600

Q4-17. Under the direct method, the $5,100 cash received from the sale of equipmentwill appear in the cash flows from investing activities section of the statement ofcash flows.

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Q4-18. The separate disclosures required for a company using the direct method in thestatement of cash flows are (1) a reconciliation of net income to net cash flowfrom operating activities, (2) all noncash investing and financing transactions,and (3) the policy for determining which highly liquid, short-term investmentsare treated as cash equivalents.

Q4-19. The operating cash flow to current liabilities ratio is calculated by dividing netcash flow from operating activities by average current liabilities. This ratio is ameasure of a firm's ability to liquidate its current liabilities.

Q4-20. The operating cash flow to capital expenditures ratio is calculated by dividing afirm's cash flow from operating activities by its annual capital expenditures. Aratio below 1.00 means that the firm's current operating activities are notproviding enough cash to cover the capital expenditures. A ratio above 1.0 isnormally considered a sign of financial strength.

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MINI EXERCISES

M4-21. (5 minutes)

a. Positive adjustmentb. Negative adjustment

c. Negative adjustment

d. Positive adjustment

e. Positive adjustment

M4-22. (10 minutes)

a. Cash flow from an operating activity.

b. Cash flow from an investing activity.

c. Cash flow from an investing activity.

d. Cash flow from an operating activity.

e. Cash flow from a financing activity.

f. Cash flow from a financing activity.

g. Cash flow from an investing activity.

M4-23. (15 minutes)

DOLE FOOD COMPANY, INC.Selected Items from the Cash Flow Statement

1 Long-term debt repayments Financing

2 Change in receivables Operating

3 Depreciation and amortization Operating

4 Change in accrued liabilities Operating

5 Dividends paid Financing

6 Change in income taxes payable Operating

7 Cash received from sales of assets and businesses Investing8 Net income Operating

9 Change in accounts payable Operating

10 Short-term debt borrowings Financing

11 Capital expenditures Investing

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M4-24. (10 minutes)

a. (3) Cash flow from a financing activity.

b. (1) Cash flow from an operating activity.

c. (4) Noncash investing and financing activity.

d. (1) Cash flow from an operating activity.

e. (1) Cash flow from an operating activity.

f. (5) None of the above (a change in the composition of cash and cash equivalents).

M4-25. (30 minutes)

a.Balance Sheet Income Statement

Trans-action CashAsset +

Accts.

Receiv-able

+ Inven-tories = Accts.Payable + Contrib.Capital + EarnedCapital Revenue - Expenses = NetIncome

(1) + +507,400 + = + + +507,400 +507,400 - = +507,400

(2) +91,500 + + = + + +91,500 +91,500 - = +91,500

(3) + + 320,100 = + + 320,100 - +320,100 = 320,100

(4) + + 63,400 = + + 63,400 - +63,400 = 63,400

(5) + + +351,600 = +351,600 + + - =

(6) -47,700 + + +47,700 = + + - =

(7) +483,400 + 483,400 + = + + - =

(8) 340,200 + + = 340,200 + + - =

(9) -172,300 + + = + + -172,300 - +172,300 = -172,300

Total +14,700 + +24,000 + +15,800 = +11,400 + + +43,100 +598,900 - +555,800 = +43,100

b. Net income was43,100 (from the net income column), and cash flow fromoperating activities was14,700 (from the cash column).

c. 1. Accounts receivable increased by24,000,2. Inventories increased by 15,800, and3. Accounts payable increased by 11,400.

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M4-25. concluded

d. The accounting equation is kept with every entry, so it is kept for the totals over theperiod.

Cash flow + change in accounts receivable + change in inventory

= Change in accounts payable + net income.

This relationship can be presented in the following indirect method cash flow fromoperating activities.

Net income 43,100- Change in accounts receivable 24,000- Change in inventories 15,800+ Change in accounts payable +11,400Cash flow from operating activities 14,700

M4-26. (15 minutes

INDIRECT METHOD)

Net income $ 45,000Add (deduct) items to convert net income to cash basis

Add back depreciation 8,000Subtract gain on sale of investments (9,000)Subtract change in operating assets:

Accounts receivable (9,000)Inventory (6,000)Prepaid rent 2,000

Add change in operating liabilities:

Accounts payable 4,000Income tax payable (2,000)Net cash provided by operating activities $ 33,000

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M4-27. (30 minutes)

a.Balance Sheet Income Statement

Trans-action

CashAsset

+Accts.

Receiv-able

+Prepaid

Rent-

Accum.Deprec.

=Wages

Payable+

Contr.Capital

+EarnedCapital

Revenue - Expenses =Net

Incom

(1) + +769,200 + - = + + +769,200 +769,200 - = +769,

(2) +46,200 + + - = + + +46,200 +46,200 - = +46,

(3) + + - = +526,700 + + 526,700 - +526,700 = 526,

(4) 149,100 + + +149,100 - = + + - =

(5) 521,600 + + - = 521,600 + + - =

(6) + + 117,900 - = + + 117,900 - +117,900 = 117,

(7) +724,100 + 724,100 + - = + + - =

(8) 122,800 + + - = + + 122,800 - +122,800 = 122,

(9) + + - +23,000 = + + -23,000 - +23,000 = -23,Total 23,200 + +45,100 + +31,200 - +23,000 = +5,100 + + +25,000 +815,400 - +790,400 = +25,

b. Net income was $25,000 (from the net income column), and cash flow fromoperating activities was$23,200 (from the cash column).

c. 1. Accounts receivable increased by $45,100,2. Prepaid rent increased by $31,200,3. Accumulated depreciation (a contra-asset) increased by $23,000 due to

depreciation expense. and4. Wages payable increased by $5,100.

d. The accounting equation is kept with every entry, so it is kept for the totals over theperiod.

Cash flow + change in accounts receivable + change in prepaid rent change in accumulated depreciation= Change in wages payable + net income.

This relationship can be presented in the following indirect method cash flow fromoperating activities.

Net income $ 25,000+ Depreciation expense 23,000

Change in accounts receivable 45,100 Change in prepaid rent 31,200+ Change in wages payable +5,100Cash flow from (used in) operating activities ($ 23,200)

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M4-28. (15 minutesINDIRECT METHOD)

Net loss $(21,000)Add (deduct) items to convert net loss to cash basis

Add back depreciation 8,600

Subtract change in operating assets:Accounts receivable 9,000Inventory 3,000Prepaid expenses 3,000

Add change in operating liabilities:Accounts payable 4,000Accrued liabilities (2,600)

Net cash provided by operating activities $ 4,000

Weber Company's 2013 operating activities provided $4,000 cash. The dividend paid toshareholders affects cash flows from financing activities.

M4-29. (20 minutes)

A + indicates that the amount is added and a - indicates that it is subtracted whenpreparing the cash flow statement using the indirect method.

NORDSTROM, INC.Consolidated Statement of Cash Flows Selected Items

1 Increase in accounts receivable Operating -

2 Capital expenditures Investing -

3 Proceeds from long-term borrowings Financing +4 Increase in deferred income tax net liability Operating +

5 Principal payments on long-term borrowings Financing -

6 Increase in merchandise inventories Operating -

7 Decrease in prepaid expenses and other assets Operating +

8 Proceeds from issuances under stock compensation plans Financing +

9 Increase in accounts payable Operating +

10 Net earnings Operating +

11 Payments for repurchase of common stock Financing -

12 Increase in accrued salaries, wages and related benefits Operating +

13 Cash dividends paid Financing -

14 Depreciation and amortization expenses Operating +

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M4-30. (15 minutesDIRECT METHOD)

a. Rent expense $ 60,000 Prepaid rent decrease (2,000)= Cash paid for rent $ 58,000

Balance Sheet Income Statement

Transaction Cash +NoncashAssets

= Liabilities +Contr.Capital

+EarnedSurplus


Income

Begin

Balance+

10,000

Prepaid

rent

= + + - =

Make rent

payment-X +

+X

Prepaid

Rent

= + + - =

Record rent

expense+

-60,000

Prepaid

Rent

= + +

-60,000

Retained

Earnings

-

60,000

Rent

Expense

= -60,000

End Balance + 8,000 = + + - =

X must equal $58,000 to make the FSET balance.

b. Interest income $ 16,000 Interest receivable increase (700)= Cash received as interest $ 15,300

Balance Sheet Income Statement



+EarnedSurplus


Income

Begin

Balance

+

3,000

Interest

receivable

= + + - =

Record

interest

income

+

+16,000

Interest

receivable

= + +

+16,000

Retained

Earnings

+16,000

Interest

income- = +16,000

Receive

interest

payment

+X + -X = + + - =

End Balance + 3,700 = + + - =

X must equal $15,300 to make the FSET balance.

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M4-30. concluded

c. Cost of goods sold $ 98,000+ Inventory increase 3,000+ Accounts payable decrease 4,000

= Cash paid for merchandise purchased $105,000Balance Sheet Income Statement



+EarnedSurplus


Income

Begin

Balance+

19,000

Inventory=

11,000

Accounts

Payable

+ + - =

Purchase

inventory+ +X = +X + + - =

Pay

supplier-Y + =

-Y

Accounts

Payable

+ + - =

Recognize

Cost of

Goods Sold

+ -98,000Inventory

= + +

-98,000

Retained

Earnings

-

98,000

Cost ofGoods

Sold

= -98,000

End Balance + 22,000 = 7,000 + + - =

To make the inventory account work properly, X (purchases) must equal $101,000. Ifpurchases were $101,000, then Y (payments to suppliers) must equal $105,000.

M4-31. (15 minutesDIRECT METHOD)

Operating cash flow + change in operating assets= net income + change in operating liabilities

or

Net income - change in operating assets + change in operating liabilities= operating cash flow

Effect of sales on net income $825,000 Change in accounts receivable (11,000)= Effect of customers on cash $814,000

Effect of cost of goods sold on net income ($550,000)- Change in inventory (13,000)+ Change in accounts payable (6,000)= Effect of merchandise purchases on cash ($569,000)

Howell Company received $814,000 in cash from its customers and paid $569,000in cash to its suppliers.

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EXERCISES

E4-32. (20 minutes)

(All dollar amounts in millions)

a. Merck: $12,383/$15,943 = 0.78Pfizer: $20,240/$28,353 = 0.71

Abbott Labs: $8,970/$16,371 = 0.55Johnson & Johnson: $14,298/$22,942 = 0.62

b. Merck: $12,383 ($1,723 $0) = $10,660Pfizer: $20,240 ($1,660 $0) = $18,580

Abbott Labs: $8,970 ($1,492 $0) = $7,478Johnson & Johnson: $14,298 ($2,893 1,342) = $12,747

c. None of the firms has sufficient cash flow to cover their current liabilities althoughnone of the ratios is of major concern. The industry ratios shown in Chapter 5 onpage 233 show that only Abbott Labs is below median. Pfizer is the largest of thesethree companies and has relatively more cash left over after capital expenditures toconsider using on other activities that could strengthen the firms operating orfinancial position. But all four have significant free cash flow that could be investedor returned to shareholders in the form of dividends or stock repurchases. Giventhat these firms are of different sizes and have different research program success,it is difficult to generalize further.

E4-33. (20 minutes)

(All dollar amounts in millions)

a. Wal-Mart: $24,255/$60,452 = 0.40Coca-Cola: $9,474/$21,396 = 0.44ExxonMobil: $55,345/$70,069 = 0.79

b. Wal-Mart: $24,255 ($13,510 $580) = $11,325Coca-Cola: $9,474 ($2,920 $101) = $6,655ExxonMobil: $55,345 ($30,975 $7,533) = $31,903

c. All three companies are producing much more cash than needed for capitalexpenditures. All of them are returning substantial amounts of cash to shareholdersthrough dividends and share repurchases (more than $11 billion for Wal-Mart,almost $9 billion for Coca-Cola and more than $31 billion for ExxonMobil.ExxonMobil appears to be in the best position with respect to OCFCL, but it is lowerthan the industry average reported in Chapter 5 on page 233. Wal-Mart and Coca-Cola have lower ratios, and are also below the average ratio for their industries.

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E4-34. (30 minutesINDIRECT METHOD)

MASON CORPORATIONStatement of Cash Flows

For Year Ended December 31, 2013

Cash flows from operating activitiesCash received from customers $194,000Cash received as interest 6,000Cash paid to employees and suppliers (148,000)Cash paid as income taxes (11,000)Net cash provided by operating activities $ 41,000

Cash flows from investing activitiesSale of land 40,000Purchase of equipment (89,000)Net cash used by investing activities (49,000)

Cash flows from financing activitiesIssuance of bonds payable 30,000Acquisition of treasury stock (10,000)Payment of dividends (16,000)Net cash provided by financing activities 4,000

Net decrease in cash (4,000)Cash at beginning of year 16,000Cash at end of year $ 12,000

E4-35. (15 minutesINDIRECT METHOD)

a. Net income $113,000Add (deduct) items to convert net income to cash basis

Accounts receivable increase (5,000)Inventory decrease 6,000Prepaid insurance increase (1,000)

Accounts payable increase 4,000Wages payable decrease (2,000)Net cash provided by operating activities $115,000

b. $115,000/[($31,000 + $29,000)/2] =3.83

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E4-36. (15 minutesINVESTING ACTIVITIES)

The basic approach here is to use the beginning and ending balances and theadditional information to reconstruct what must have happened during 2013. Begin bysetting up the T-accounts for property, plant and equipment with the beginning and

ending balances.

+Property, plant and

equipment at cost (A)Accumulated

depreciation (XA)+

Beg. balance 1000 350 Beg. balance

Ending balance 1,200 390 Ending balance

At this point in the book, we know four entries that can affect these two accounts (1)acquisitions using cash, (2) acquisitions without cash (other financing), (3) disposals,

and (4) depreciation expense. The journal entries for these entries are given below,with amounts given in the problem filled in.

(1) Property, plant and equipment at cost (+A) 300Cash (-A) 300

To record purchase of property, plant and equipment with cash.

(2) Property, plant and equipment at cost (+A) 100Mortgage payable (+L) 100

To record purchase of property, plant and equipment with financing.

(3) Cash (+A) 100

Accumulated depreciation (-XA, +A) YProperty, plant and equipment at cost (-A) XGain on equipment disposal (+R, +SE) 20

To record sale of used equipment.

(4) Depreciation expense (+E, -SE) ZAccumulated depreciation (+XA, -A) Z

To record depreciation expense.

The three unknowns in the journal entries correspond to the three questions in theproblem. We begin by putting the journal entry amounts into the T-accounts.

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E4-36. concluded



depreciation (XA)+

Beg. balance 1000 350 Beg. balance

(1) 300(2) 100(3) X Y (3)

Z (4)

Ending balance 1,200 390 Ending balance

a. The PPE at cost account will only balance if the value X equals 200. So, the originalcost of the used equipment that was sold is200. We can put that amount in the T-account (so it balances) and also in Journal entry (3).

b. Now, looking at journal entry (3), we see that there is only one unknown left the

depreciation that had accumulated on the used equipment. In order for the entry tobalance (with debits equal to credits), the accumulated depreciation must have been120 (= Y). Cost of 200 and accumulated depreciation of 120 would produce a netbook value of 80, so when Meubles Fischer sold it for 100, they recorded a gain of20 on the disposal.

c. Back at the Accumulated depreciation T-account, we can fill in the entry for (3),leaving only the depreciation expense to determine for entry (4). Knowing that thedisposal reduced the contra-asset by 120, and that the contra-asset increased by 40over the year, we can infer than the depreciation expense must have been 160 (=Z).

E4-37. (15 minutesINVESTING ACTIVITIES)

The basic approach here is to use the beginning and ending balances and theadditional information to reconstruct what must have happened during 2013. Begin bysetting up the T-accounts for property, plant and equipment with the beginning andending balances.



depreciation (XA)+

Beg. balance

175 78Beg. balance

Ending balance 183 83 Ending balance

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E4-37. concluded

At this point in the course, we know four entries that can affect these two accounts (1)acquisitions using cash, (2) acquisitions without cash (other financing), (3) disposals,and (4) depreciation expense. The journal entries for these entries are given below,with amounts given in the problem filled in.

(1) Property, plant and equipment at cost (+A) 28Cash (-A) 28

To record purchase of property, plant and equipment with cash.

(2) Property, plant and equipment at cost (+A) 0Mortgage payable (+L) 0

To record purchase of property, plant and equipment with financing.

(3) Cash (+A) ZAccumulated depreciation (-XA, +A) YLoss on equipment disposal (+E, -SE) 5

Property, plant and equipment at cost (-A) XTo record sale of used equipment.

(4) Depreciation expense (+E, -SE) 17Accumulated depreciation (+XA, -A) 17

To record depreciation expense.

The three unknowns in the journal entries correspond to the three questions in theproblem. We begin by putting the journal entry amounts into the T-accounts.



depreciation (XA)+

Beg. balance 175 78 Beg. balance(1) 28(2) 0(3) X Y (3)

17 (4)

Ending balance 183 83 Ending balance

a. The PPE at cost account will only balance if the value X equals 20. So, the originalcost of the used equipment that was sold is 20. We can put that amount in the T-account (so it balances) and also in Journal entry (3).

b. The accumulated depreciation account will only balance if the value Y equals 12.So, the accumulated depreciation on the used equipment sold must be 12, and thatamount can be entered into transaction (3) above.

c. Now, looking at journal entry (3), we see that there is only one unknown left theamount of cash received from disposal of the used equipment. In order for the entry tobalance (with debits equal to credits), the cash amount must have been 3 million (= Z).Cost of 20 and accumulated depreciation of 12 would produce a net book value of 8, sowhen Kasznik Ltd. sold it for 3, they recorded a loss of 5 on the disposal.

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E4-38. (30 minutes)

a. The analysis on page ***160*** on the text shows that

Cash flow

(payments)+

Change in

inventory=

Change in accounts

payable+

Net income(COGS

expense)

X +666

(=8,044-7,378)=

225(=4,810-4,585)

+ -51,692

The solution to this is that X = -$51,692 666 + 225 = -$52,133. So, the payments tosuppliers reduced cash by $52,133 million in fiscal year 2011.

b. The net property and equipment account increased by $342 million (=$11,526 11,184). Depreciation expense would have decreased this balance by $809 million infiscal year 2011, so the net investment must have been $1,151 million (=$342 + 809)to result in the ending balance of $11,526 million.

c. With the beginning balance of $16,848 million in retained earnings, net earnings of$2,714 would have increased retained earnings to $19,562 million. But the endingbalance in retained earnings is $18,877 million, so Walgreens must have paid $685million in dividends (=$19,562 - $18,877).

E4-39. (15 minutes)

a. Cash flows from investing activities will show:Purchase of stock investments $ (80,000)

Sale of stock investments 59,000

b. Cash flows from financing activities will show:Issuance of bonds $130,000Retirement of bonds (131,000)

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E4-40. (20 minutes)

a. The net increase in property and equipment was $4,635,377 (= $84,767,771 -$80,132,394), and the expenditures should have increased this by $5,559,183.Therefore the original cost of the property and equipment sold must have been

923,806 (= $5,559,183 - $4,635,377).

Depreciation expense should have increased the accumulated depreciation account by$3,174,956, but the account increased by only $2,268,583. The accumulateddepreciation on the property and equipment sold must account for the difference,making it $906,373 (= $3,174,956 2,268,583).

b. The book value of the property and equipment sold was $17,433 (=$923,806 906,373), and the reported gain on sale of the property and equipment was $79,483.Therefore, the cash proceeds must have been $96,916 (= $17,433 + 79,483), which isthe amount reported in Golden Enterprises cash flows from investing activities.

c.Cash (+A) $ 96,916

Accumulated depreciation (-XA, +A) 906,373Property and equipment, cost (-A) $ 923,806Gain on sale of property and equipment(+R, +SE)

79,483

d. Retained earnings increased by $1,547,261 (= $18,866,264 17,319,003), and netincome was $3,014,768. The difference would be accounted for by cash dividendspaid to shareholders, and the amount is $1,467,507.

E4-41. (20 minutesDIRECT METHOD)

a. Advertising expense $ 62,000+ Prepaid advertising increase 4,000= Cash paid for advertising $ 66,000

b. Income tax expense $ 29,000+ Income tax payable decrease 2,200= Cash paid for income taxes $ 31,200

c. Cost of goods sold $180,000 Inventory decrease (5,000) Accounts payable increase (2,000)= Cash paid for merchandise purchased $173,000

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E4-42.

HOSKINS CORPORATIONStatement of Cash Flows

Year ended December 31, 2013

Cash Flows from Operations:Net income $ 700Adjustments:

Add back Depreciation 350 Change in Accounts Receivable (900) Change in Inventory (100) Change in Prepaid Expenses 250+ Change in Accounts Payable 400+ Change in Income Taxes Payable (100)

Cash Flows from Operating Activities $ 600

Cash Flows from Investing:Purchases of Equipment (1,200)Proceeds from Disposal of Equipment 600

Cash Flows from Investing Activities (600)

Cash Flows from Financing:Dividends Paid (250)Increase in Short-term Debt 1,500Decrease in Long-term Debt (1,000)

Cash Flows from Financing Activities 250

Net Change in Cash 250Beginning Cash Balance 300Ending Cash Balance $ 550

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E4-43. (30 minutesDIRECT METHOD)

a.Sales $750,000

Accounts Receivable Increase (5,000)

= Cash Received from Customers $745,000

Cost of Goods Sold $470,000 Inventory Decrease (6,000) Accounts Payable Increase (4,000)= Cash Paid for Merchandise Purchased $460,000

Wages Expense $110,000+ Wages Payable Decrease 2,000= Cash Paid to Employees $112,000

Insurance Expense $ 15,000+ Prepaid Insurance Increase 1,000= Cash Paid for Insurance $ 16,000

Cash Flows from Operating ActivitiesCash Received from Customers $745,000Cash Paid for Merchandise Purchased $460,000Cash Paid to Employees 112,000Cash Paid for Rent 42,000Cash Paid for Insurance 16,000 630,000Net Cash Provided by Operating Activities $115,000

b. $115,000/[($31,000 + $29,000)/2] =3.83

E4-44. (15 minutes)

1. True ---

2. False $25

3. False $10

4. False $0

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PROBLEMS

P4-45. (20 minutes)

Cash flows from operating activities

Net income ......................................................................................... $135,000

Adjustments to reconcile net income to operating cash flows

Add back depreciation expense .................................................... $25,000

Gain on sale of assets (5,000)

Subtract changes in:

Accounts receivable...................................................................... (10,000)

Prepaid expenses ......................................................................... 3,000

Add changes in:

Accounts payable ......................................................................... 6,000

Wages payable ............................................................................. (4,000) 15,000

Net cash provided from operating activities ....................................... $150,000

P4-46. (45 minutesINDIRECT METHOD)

a. Cash, December 31, 2013 ........................................................ $11,000Cash, December 31, 2012 ........................................................ 5,000Cash increase during 2013 ....................................................... $ 6,000

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P4-46. concluded

b. STATEMENT OF CASH FLOWS (INDIRECT METHOD)

WOLFF COMPANY

Statement of Cash FlowsFor Year Ended December 31, 2013

Net Cash Flow from Operating ActivitiesNet Income $56,000

Add (Deduct) Items to Convert Net Income to Cash Basis

Depreciation 17,000

Accounts Receivable Increase (9,000)

Inventory Increase (30,000)

Prepaid Insurance Decrease 2,000

Accounts Payable Decrease (3,000)Wages Payable Increase 3,000

Income Tax Payable Decrease (1,000)

Net Cash Provided by Operating Activities $35,000

Cash Flows from Investing Activities

Purchase of Plant Assets (55,000)

Cash Flows from Financing Activities

Issuance of Bonds Payable 55,000

Payment of Dividends (29,000)

Net Cash Provided by Financing Activities 26,000Net Increase in Cash 6,000

Cash at Beginning of Year 5,000

Cash at End of Year $11,000

c. (1) $35,000/(($23,000 + $24,000)/2) = 1.49

(2) $35,000/$55,000 = 0.64

Wolffs cash flow ratios indicate that, while the company has sufficient cash flow tocover its current obligations, it must rely on external financing to pay for capitalexpenditures.

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P4-47. (30 minutes)

a.

Adjustments to Convert Income Statement Items to Operating Activity Cash Flows

Net income

$ 56,000

Salesrevenue

$635,000

Cost ofgoods sold

430,000

Wageexpenses

86,000

Insuranceexpense

8,000

Depreciationexpense

17,000

Interestexpense

9,000

+Gains

0

Losses

0

Incometax expense

29,000

Adjustments:

Add backdepreciationexpense

+Depreciationexpense

+17,000

Subtract (add)non-operatinggains (losses)

Gains

0

+Losses

0

Subtract thechange inoperatingassets(operatinginvestments)

changein

accountsreceivable

-9,000

changein

inventory

-30,000

change inprepaid

insurance

-(-2,000)

Add thechange inoperatingliabilities(operatingfinancing)

+change inaccountspayable

+(-3,000)

+change inwages

payable

+3,000

+change inincome tax

payable

+(-1,000)

Cashfromoperations

$ 35,000

Receiptsfrom

customers

$626,000

Paymentsfor

merchandise

-463,000

Paymentsfor

Wages

-83,000

Paymentsfor

insurance

-6,000

(zero)0

Paymentsfor

interest

-9,000

(zero)+0

(zero)0

Paymentsfor

income tax

30,000

b. Computing cash flows from operating activities using the direct method providesadditional detail about the specific cash flows that occurred during the period. Forexample, the indirect method does not reveal that Wolff paid $463,000 for merchandiseduring 2013, or $83,000 for wages. Because this detail is missing, the FASB requires

supplemental disclosure of two specific (and important) cash payments interest andtaxes if the indirect method is used.

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a. Cash, December 31, 2013 $49,000Cash, December 31, 2012 28,000Cash increase during 2013 $21,000


ARCTIC COMPANYStatement of Cash Flows


Net Cash Flow from Operating ActivitiesNet Loss $ (42,000)

Add (Deduct) Items to Convert Net Lossto Cash Basis

Depreciation 22,000

Gain on Sale of Land (25,000)Accounts Receivable Decrease 8,000Inventory Decrease 6,000Prepaid Advertising Decrease 3,000

Accounts Payable Decrease (14,000)Interest Payable Increase 6,000

Net Cash Used by Operating Activities $ (36,000)Cash Flows from Investing Activities

Sale of Land 70,000Purchase of Equipment (183,000)*Net Cash Used by Investing Activities (113,000)

Cash Flows from Financing ActivitiesIssuance of Bonds Payable 200,000Purchase of Treasury Stock (30,000)Net Cash Provided by Financing Activities 170,000

Net Increase in Cash 21,000Cash at Beginning of Year 28,000Cash at End of Year $ 49,000

* The sum of the increase in PPE assets account ($138,000) and the book value of the land sold ($45,000) .

c. - $36,000/(($23,000 + $31,000)/2) = -1.33

- $36,000/$183,000 = -0.20

Arctics operating cash flows are negative, primarily because the firm reported a netloss for the year. As a consequence, its cash flow ratios indicate insufficient cashflows to fund operations and capital expenditures.

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P4-49. (30 minutes)

a.

Adjustments to Convert Income Statement Items to Operating Activity Cash Flows

Net income(loss)$ 42,000

Salesrevenue$728,000

Cost ofgoods sold534,000

Wageexpenses190,000

Advertisingexpense31,000

Depreciationexpense22,000

Interestexpense18,000

+Gains

+25,000

Losses

0

Income taxexpense

0

Adjustments:

Add backdepreciationexpense

+Depreciationexpense+22,000

Subtract (add)non-operatinggains (losses)

Gains25,000

+Losses

0

Subtract thechange inoperatingassets(operatinginvestments)

changein accountsreceivable-(-8,000)

changein

inventory-(-6,000)

change inprepaid

advertising-(-3,000)

Add thechange inoperatingliabilities(operatingfinancing)

+change inaccountspayable

+(-14,000)

+change inwages

payable+0

+change ininterestpayable+6,000

+change inincome tax

payable+0

Cashfromoperations$ 36,000

Receiptsfrom

customers$736,000

Paymentsfor

merchandise542,000

Paymentsfor

Wages190,000

Paymentsfor

advertising28,000

(zero)0

Paymentsfor

interest12,000

(zero)+0

(zero)0

Paymentsfor income

tax0

b. Computing cash flows from operating activities using the direct method providesadditional detail about the specific cash flows that occurred during the period. Forexample, the indirect method does not reveal that Arctic paid $542,000 formerchandise during 2013, or $28,000 for advertising. Because this detail is missing,the FASB requires supplemental disclosure of two specific (and important) cashpayments interest and taxes if the indirect method is used.

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a. Cash, December 31, 2013 ................................................ $27,000Cash, December 31, 2012 ................................................ 18,000Cash increase during 2013 ............................................... $ 9,000


DAIR COMPANYStatement of Cash Flows


Net Cash Flow from Operating ActivitiesNet Income $ 85,000

Add (deduct) items to convert net incometo cash basis

Depreciation 22,000Amortization of intangible assets 7,000

Loss on bond retirement 5,000

Accounts receivable increase (5,000)

Inventory decrease 6,000

Prepaid expenses increase (2,000)

Accounts payable increase 6,000

Interest payable decrease (3,000)

Income tax payable decrease (2,000)

Net cash provided by operating activities $119,000Cash flows from investing activities

Sale of equipment 17,000

Cash flows from financing activities

Retirement of bonds payable (125,000)

Issuance of common stock 24,000

Payment of dividends (26,000)

Net cash used by financing activities (127,000)

Net increase in cash 9,000

Cash at beginning of year 18,000Cash at end of year $ 27,000

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P4-50. concluded

c. (1) Supplemental cash flow disclosuresCash paid for interest ............................................................................ $ 13,000*Cash paid for income taxes................................................................... $ 38,000

* Interest expense $10,000+ Interest payable decrease 3,000

Cash paid for interest $13,000 Income tax expense $36,000

+ Income tax payable decrease 2,000Cash paid for income taxes $38,000

(2) Schedule of noncash investing and financing activitiesIssuance of bonds payable to acquire equipment ................................. $ 60,000

d. (1) $119,000/[($42,000 + $41,000)/2] = 2.87.(2) The firm did not spend any cash on capital investments. The firm did issue debtfor equipment, but this is not a capital expenditure.

(3) $119,000 + $17,000 = $136,000

P4-51. (45 minutes)

a. Depreciation and amortization are a noncash expenses that are deducted in thecomputation of net income. The depreciation and amortization add-back zeros theseexpenses out of the income statement to focus on cash profitability. The positiveamount for depreciation and amortization does not mean that the company isgenerating cash from depreciation and amortization, a common misconception. It ismerely an adjustment to remove these expenses from the computation of profit.

b. The adjustments must be interpreted relative to the amounts included in net income.The $(73,670,000) adjustment for receivables means that Staples collected this muchless than it recognized as revenue. The adjustment for accrued expenses implies thatStaples paid $117,389,000 more than the expenses already recognized in net income.

c. Acquisition of property and equipment are less than the depreciation and amortizationrecognized for the year. Unless the prices for property and equipment are falling, thatrelationship implies that Staples may not be replacing its capacity. A growing companywill have capital expenditures that exceed the depreciation on its existing property andequipment.

continued next page

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P4-51. concluded

d. Staples operates businesses in 26 countries outside of the U.S. including businessesin Europe, Asia, South America, Australia, and Canada. This means that some of itscash transactions occur in currencies other than the U.S. dollar. This fact requires the

company to hold cash in other currencies that may be revalued relative to the dollarfrom one period to the next. When foreign cash balances are revalued in foreignexchange markets relative to the U.S. dollar, the dollar value of the companys cashbalance changes even though there was no actual cash flow. Hence, this exchangerate effect is listed in the cash flow statement to explain the change in the cashbalance.

e. Although net cash decreased during the period, Staples presents a healthy cash flowpicture for the year. It generated almost $1.6 billion of operating cash flow. Most of thisamount was returned to lenders and shareholders, rather than being used to grow thebusiness. Staples returned over $900 million to shareholders in the form of dividends

and share repurchases, plus it reduced its net borrowings by about $500,000.


a. Cash and cash equivalents, December 31, 2013 ............................ $19,000Cash and cash equivalents, December 31, 2012 ............................ 25,000Cash and cash equivalents decrease during 2013.......................... $ 6,000

b. See the cash flow statement provided on the following page.

c. (1) Supplemental Cash Flow DisclosuresCash paid for interest $ 12,000*Cash paid for income taxes $ 46,000

* Interest expense $13,000- Interest payable increase (1,000)

Cash paid for interest $12,000

Income tax expense $44,000+ Income tax payable decrease 2,000

Cash paid for income taxes $46,000

(2) Schedule of noncash investing and financing activitiesIssuance of preferred stock to acquire patent $ 25,000

d. (1) $101,000/[($34,000 + $31,000)/2] = 3.11.(2) $101,000/($185,000) = 0.55.(3): $101,000 ($90,000 + $95,000 - $14,000) = -$70,000

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P4-52. concluded

b.

RAINBOW COMPANYStatement of Cash Flows


Net cash flow from operating activitiesNet income $ 90,000

Add (deduct) items to convert net incometo cash basisDepreciation 39,000Patent amortization 7,000Loss on sale of equipment 5,000Gain on sale of investments (3,000)

Accounts receivable increase (10,000)

Inventory increase (26,000)Prepaid expenses increase (4,000)Accounts payable increase 4,000Interest payable increase 1,000Income tax payable decrease (2,000)

Net cash provided by operating activities $101,000Cash flows from investing activities

Sale of investments 60,000Purchase of land (90,000)Improvements to building (95,000)Sale of equipment 14,000

Net cash used by investing activities (111,000)Cash flows from financing activitiesIssuance of bonds payable 30,000Issuance of common stock 24,000Payment of dividends (50,000)Net cash provided by financing activities 4,000

Net decrease in cash and cash equivalents (6,000)Cash and cash equivalents at beginning of year. 25,000Cash and cash equivalents at end of year $ 19,000

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P4-53. (35 minutes)

a. Cash and cash equivalents, December 31, 2013 .. $19,000Cash and cash equivalents, December 31, 2012 .. 25,000Cash and cash equivalents decrease during 2013 .. $ 6,000

b.

RAINBOW COMPANYStatement of Cash Flows (Direct Method)


Cash flows from operating activitiesCash received from customers $740,000Cash received as dividends .. 15,000 $755,000

Cash paid for merchandise purchased .. 462,000Cash paid for wages and other operating expenses 134,000Cash paid for interest .. 12,000

Cash paid for income taxes 46,000 (654,000)Net cash provided by operating activities .. 101,000

Cash flows from investing activitiesSale of investments .. 60,000Purchase of land (90,000)Improvements to building (95,000)Sale of equipment .. 14,000Net cash used by investing activities ... (111,000)

Cash flows from financing activitiesIssuance of bonds payable . 30,000

Issuance of common stock . 24,000Payment of dividends (50,000)Net cash provided by financing activities 4,000

Net decrease in cash and cash equivalents .. (6,000)Cash and cash equivalents at beginning of year. 25,000Cash and cash equivalents at end of year. $ 19,000

continued next page

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P4-53. concluded

c. (1) Reconciliation of net income to net cash flow from operating activities

Net income $ 90,000Add (deduct) items to convert net income to cash basis

Depreciation 39,000Patent amortization 7,000Loss on sale of equipment 5,000Gain on sale of investments (3,000)

Accounts receivable increase (10,000)Inventory increase (26,000)Prepaid expenses increase (4,000)

Accounts payable increase 4,000Interest payable increase 1,000Income tax payable decrease (2,000)Net cash provided by operating activities $101,000

(2) Schedule of noncash investing and financing activitiesIssuance of preferred stock to acquire patent $ 25,000

P4-54. (30 minutes)

Operating cash flow + change in operating assets= net income + change in operating liabilities

or

Net income - change in operating assets + change in operating liabilities= operating cash flow

a. Apples adjustment for accounts receivable is (plus) $143 million. This adjustmentrepresents minus the change in receivables, soApples accounts receivable must havegone down by $143 million.

($ millions)

Net sales $108,249

- Change in accounts receivable +143

+ Change in deferred revenue +1,654

Cash collected from customers .. $110,046

b. ($ millions)

- Cost of goods sold . ($64,431)- Change in inventories .. +275+ Change in accounts payable 2,515

- Cash paid for purchases of inventories ($61,641)

continued next page

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P4-54. concluded

c. ($ billions)

Property, plant and equipment, ending balance $7.8

- Purchases of property, plant and equipment (4.3)+ Book value of PPE assets sold ... none

+ Depreciation of property, plant and equipment 1.6

Property, plant and equipment, beginning balance $5.1

d. Stock-based compensation expense is deducted when calculating net income similarto cash compensation. The only difference is that the compensation is paid in sharesof stock (or stock options) instead of cash. Because stock-based compensation doesnot require the payment of cash, it is treated as a noncash expense, much likedepreciation, and added back to net income when the indirect method is used in the

cash flow statement. Generally speaking, compensation cost is classified as part ofoperating activities whether or not the compensation is paid in cash.

P4-55. (75 minutes)

a.

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P4-55. concluded

b. The following statement of cash flows from operations combines the effects of theincome tax asset and liability and combines the effects of the deferred tax asset andliability. In addition, the effects of changes in current and noncurrent salary

continuation plan liabilities have been combined in the operating cash flow.

GOLDEN ENTERPRISES, INC.Consolidated Statement of Cash Flows

Year ended June 3, 2011

CASH FLOWS FROM OPERATING ACTIVITIES:Net income $ 3,014,768Adjustments to reconcile net income to net cash provided by operating activities:Depreciation 3,174,956Deferred income taxes 1,329,868Gain on sale of property and equipment (79,483)- Change in receivables, net (685,678)- Change in inventories (94,964)- Change in prepaid expenses (230,574)- Change in cash surrender value of insurance 364,240- Change in other assets (167,256)+ Change in accounts payable 186,036+ Change in accrued expenses 138,626+ Change in salary continuation plan (92,506)+ Change in accrued income taxes (1,103,498)

Net cash provided by operating activities 5,754,535

CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property, plant and equipment (5,559,183)

Proceeds from sale of property, plant and equipment 96,916Net cash used in investing activities (5,462,267)

CASH FLOWS FROM FINANCING ACTIVITIES:Debt proceeds 38,903,745Debt repayments (36,328,583)Change in checks outstanding in excess of bank balances (85,126)Purchase of treasure shares (36,960)Cash dividends paid (1,467,507)

Net cash provided by financing activities 985,569NET INCREASE IN CASH AND CASH EQUIVALENTS 1,277,837CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 1,443,801CASH AND CASH EQUIVALENTS AT END OF YEAR $ 2,721,638

c. OCFCL = $5,754,535 [(14,216,457 + 14,212,044) 2] = 0.40

OCFCX = $5,754,535 5,559,183 = 1.04

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P4-56. (20 minutes)

a. The positive adjustment of $314,872 thousand (say, $315 million) is caused by thechange in the amount that Groupon owes its merchants. When a customerpurchases, Groupon gets the cash quickly and then waits to pay the merchants

(recognizing the accrued merchant payable liability). If we add the fact that Grouponis growing very quickly, it means that the accrued merchant payable grows over theperiod. The adjustment reflects the fact that the merchant share of the amountcollected from customers is $315 million more than the amount that Groupon paid tothe merchants.

Will this continue into the future? Only if Groupon continues to grow and if itspayment terms to merchants remain unchanged. If Groupons growth went to zero,then the accrued merchant payable would level out and the change would go tozero. Likewise, if competitors forced Groupon to speed up its payments tomerchants, the accrued merchant payable liability would decrease, and the

companys ability to generate a positive cash flow from operations would beimpaired.

In the risk factors section of the SEC document, Groupon states Our operating cashflow and results of operations could be adversely impacted if we change ourmerchant payment terms or our revenue does not continue to grow.

b. While Groupon used $121 million in cash for investing activities, most of this was foracquisitions of businesses and investments, rather than for capital expenditures(only about $30 million). The OCFCX ratio was $129,511 $29,825 = 4.34.Groupon appears to be growing more by acquisition than by organic growth.

c. Groupon used $353,550 thousand to repurchase its own common stock and another$35,221 to redeem its own preferred stock, a total of about $389 million. This mightprompt a financial statement reader to look at the related party transactions sectionof the companys filing with the SEC prior to its initial public offering. For example, inDecember 2010 and January 2011, Groupon issued new preferred stock inexchange for $942.2 million in cash. Of this amount, $132.4 million was retained inthe company. The remaining $809.8 million was used to redeem shares of commonand preferred stock, mostly from current and former board members and fromentities that they control.

In the use of proceeds section of the SEC document, Groupon states Based on ourcurrent cash and cash equivalents, together with cash generated from operations,we do not expect that we will utilize any of the net proceeds of this offering to fundoperationsduring the next twelve months.

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CASES AND PROJECTS

C4-57. (30 minutes)

The required debt to equity ratio allows for total liabilities to be up to $477 million. That is$477 / ($125+$148) =1.747 < 1.75. This implies total short-term borrowing of $107 millionand an ending cash balance of $70 million.

LAMBERT CO.Statement of Cash Flows (projected)

Cash from operationsNet income $ 18Depreciation expense 120Increase in accounts receivable . (40)Decrease in inventory 20Increase accounts payable .. 30Decrease in income taxes payable . (10)

Cash provided by (used in) operations .. $ 138

Cash from investingAcquisitions of property, plant and equipment (225)Disposal proceeds .. 75

Cash provided by (used in) investing . (150)

Cash from financingIssue long-term debt .. 80Repay long-term debt .. (100)

Common stock issue .. 25Shareholder dividends (30)Increase (decrease) in short-term borrowing 57

Cash provided by (used in) financing .. 32Net change in cash .. 20Beginning cash balance . 50Ending cash balance .. $ 70

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C4-58. (45 minutes)

a.1 Accounts receivable (+A) 3,800

Sales revenue (+R,+SE) 3,800

2 Cash (+A) 3,500Accounts receivable (-A) 3,500

3 Cost of goods sold (+E,-SE) 1,800Inventory (-A) . 1,800

4 Inventory (+A) 1,200Accounts payable (+L) .... 1,200

5 Accounts payable (-L) .. 1,100Cash (-A) ... 1,100

6 Salaries and wages expense (+E,-SE) . 700Salaries and wages payable (+L) . 700

7 Salaries and wages payable (-L) 730Cash (-A) .... 730

8 Rent expense (+E,-SE). 200Prepaid rent (-A) .. 200

9 Prepaid rent (+A) .. 600Cash (-A) ... 600

10 Depreciation expense (+E,-SE) . 150Accumulated depreciation (+XA,-A) . 150

11 Cash (+A) . 10Accumulated depreciation (-XA,+A) 70

Fixtures and equipment (-A) 80

12 Fixtures and equipment (+A) .. 800Cash (-A) .. 800

13 Interest expense (+E,-SE) .... 16Cash (-A) .. 16

14 Bank loan payable (-L) ... 1,600Cash (-A) .. 1,600

15 Cash (+A) .. 2,000Long-term loan payable (+L) 2,000

continued next page

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C4-58. concluded

+ Prepaid Rent (A) - + Rent Expense (E) -

0 8 2009 600 200 8 200 18

Bal 400 Bal 0

+ Depreciation Exp. (E) -

10 150150 18

+ Fixtures and - Bal 0Equipment (A)

1,900 + Interest Expense (E) -12 800 80 11 13 16

Bal 2,620 16 18Bal 0

- Accum. Deprec. (XA) + + Income Tax Exp (E) -

800 16 374

11 70 150 10 374 18880 Bal Bal 0

C4-59. (30 minutes)

a. Depreciation and amortization are noncash expenses that are deducted in thecomputation of net income. The depreciation and amortization add-back zeros theseexpenses out of the income statement to focus on operating cash flow. The positiveamount for depreciation and amortization does not mean that the company isgenerating cash from depreciation and amortization, a common misconception. It is

merely an adjustment to remove these expenses from net income to convert profit tocash flow.

b. Gains on disposals of asset are the result of investing activity, not operating activity,but these gains are recognized in net income. When we start with net income in anindirect method cash from operations, subtracting the gain removes this investing itemfrom the determination of cash from operations.

Daimler reports cash proceeds from disposals of PPE and intangible assets of 252million. If the recognized gain is 102 million, then the book value of the assetsdisposed would be 150 million (= 252 million 102 million).

c. It does not. The adjustments can only be interpreted relative to the amounts that areincluded in net income. The negative 2,328 million inventory adjustment means thatDaimlers cost to acquire inventory for the year exceeded its cost of goods sold for theyear by 2,328 million.

continued next page

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C4-59. concluded

d. Free cash flow ( millions):696 $(4,158 252) = -4,602.

Daimlers operating cash flow is negative, as is its free cash flow. We did not include

acquisition of intangible assets in the calculation. Doing so would have reduced freecash flow by another 1.7 billion. Daimler financed its investing activities by additionsto long-term financing.

e. Daimlers cash flow from operating activities is negative, as is its cash flow frominvesting activities. It generated a positive cash flow of5,842 million from financingactivities. As a result, the net decrease in cash was1,327million. Daimler appearsto be strong enough to withstand a reduction in cash of this magnitude, especiallygiven that it has a record (in 2010 and 2009) of reporting very positive cash flowsfrom operations.

To be thorough in analyzing Daimlers liquidity and solvency, one would want to askwhy operating cash flows were negative. A closer look at the companys businesssegments reveals that the Industrial Business had cash from operations of 7.3billion and free cash flow of about 3.4 billion. Daimler Financial Services had cashfrom operations of (8.0) billion, resulting from large increases in financial servicesreceivables and vehicles on operating leases. In its analysis of cash flows, Daimlerreports that The positive effect from the improvement in net profit before incometaxes was reduced in particular by increased new business in leasing and salesfinancing as well as by significantly higher allocations to the pension funds.

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Fa4e Sm Ch04