Financial reporting financial statement analysis and valuation 8th edition test bank CH3

Financial Reporting, Financial Statement Analysis and Valuation 8th Edition Test Bank Download:

Chapter 3—Income Flows versus Cash Flows: Understanding the Statement of Cash
Flows
MULTIPLE CHOICE
1. One rationale for the statement of cash flows is to
a. ensure that the cash account balances at year-end.
b. reconcile differences between net income and cash receipts and disbursements.
c. calculate the company’s free cash flow.
d. examine the cash effects of income from discontinued operations, extraordinary items and
changes in accounting principles.
ANS: B

PTS: 1

2. Which of the following is not one of the reasons why net income differs from cash flows from
operations under the indirect method of calculating cash flows?
a. non-cash items, such as depreciation and amortization
b. changes in working capital accounts
c. gains and losses related to the sale of plant, property and equipment
d. sale or repurchase of capital stock
ANS: D

PTS: 1

3. A company in the growth phase of its product life cycle will normally have the following pattern of
cash flows
a. Negative cash flows from operations, negative cash flows from investing and positive cash
flows from financing.
b. Negative or positive cash flows from operations, negative cash flows from investing and
positive cash flows from financing.

c. Positive cash flows from operations, positive cash flows from investing and positive cash
flows from financing.
d. Negative or positive cash flows from operations, negative cash flows from investing and
negative cash flows from financing.

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ANS: B

PTS: 1

4. Which of the following is an adjustment that would need to be made to net income when calculating
cash flows from operations under the indirect method?
a. Subtract amortization expense
b. subtract gain on sale of subsidiary
c. add an increase in accounts receivable
d. add a decrease in accounts payable
ANS: B

PTS: 1

5. If a firm is growing and expanding its accounts receivable and inventories faster than its current
operating liabilities its cash flow from operation will normally be
a. greater than net income
b. less than net income
c. greater than the change in working capital from operations
d. greater than the change in cash
ANS: B

PTS: 1

6. Firms with short operating cycles will experience less of a lag between the creation and delivery of
their products and the collection of cash from customers because
a. their cash flow from operations will be much greater than their working capital from
operations.
b. their cash flow from operations will not differ much from their working capital from
operations.
c. their cash flow from operations will be much less than their working capital from
operations.
d. there will be no relation between their cash flow from operations and working capital from
operations.
ANS: B

PTS: 1

7. Normally, cash flows from operations will peak during which phase of the product life cycle?
a. Introduction
b. Growth
c. Maturity
d. Decline
ANS: C

PTS: 1

8. Normally, cash flows from investing activities will start providing cash during which phase of the
product life cycle?
a. Introduction
b. Growth
c. Maturity

d. Decline
ANS: C

PTS: 1

9. Normally, cash flows from financing will start using cash during which phase of the product life
cycle?
a. Introduction
b. Growth

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c. Maturity
d. Decline
ANS: C

PTS: 1

10. Free cash flows to all debt and common equity shareholders represents the excess of cash flows from
a. operating activities over cash flows for financing activities
b. investing over cash flows for operating activities
c. investing over cash flows for financing activities
d. operating activities over cash flows for investing activities
ANS: D

PTS: 1

11. When preparing the statement of cash flows using the indirect method, an increase in inventories
would appear as

a. a decrease in the operating activities section
b. an increase in the operating activities section
c. a use of cash in the investing activities section
d. a source of cash in the investing activities section
ANS: A

PTS: 1

12. When preparing the statement of cash flows using the indirect method, an increase in accounts payable
would appear as
a. a decrease in the operating activities section
b. an increase in the operating activities section
c. a use of cash in the investing activities section
d. a source of cash in the investing activities section
ANS: B

PTS: 1

13. When preparing the statement of cash flows using the indirect method, the payment of dividends
would appear as
a. a decrease in the operating activities section
b. an increase in the operating activities section
c. a use of cash in the financing activities section
d. a source of cash in the financing activities section
ANS: C

PTS: 1

14. When preparing the statement of cash flows using the indirect method, the sale of marketable
securities would appear as

a.
b.
c.
d.

a use of cash in the investing activities section
a source of cash in the investing activities section
a use of cash in the financing activities section
a source of cash in the financing activities section

ANS: B
PTS:

1

15. In a statement of cash flows, interest received from sources other than a company’s investments
would be classified as cash inflows from
a. lending activities.
b. operating activities.

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c. investing activities.
d. financing activities.
ANS: B

PTS: 1

16. An example of an item that is deducted from net income when preparing the operating activities

section of the statement of cash using the indirect method is
a. depreciation expense.
b. compensation expense related to stock option plans.
c. income from an investment accounted for using the equity method.
d. unrealized losses on trading investments
ANS: C

PTS: 1

17. Which of the following is not an expense excluded when calculating EBITDA?
a. depreciation expense
b. administrative expense
c. interest expense
d. tax expense
ANS: B

PTS: 1

18. Which of the following is the correct formula for calculating cash collections from customers?
a. sales for the period plus accounts receivable at the beginning of the period
b. sales for the period plus accounts receivable at the beginning of the period minus accounts
receivable at the end of the period
c. sales for the period plus accounts receivable at the end of the period
d. sales for the period plus accounts receivable at the end of the period minus accounts
receivable at the beginning of the period
ANS: B

PTS: 1

19. Outback Corp. recorded sales of $1,300,000 in 2010, in addition the company’s accounts receivable

balance grew from $120,000 at the beginning of 2010 to $165,000 at the end of 2010. How much cash
did Outback collect from customers in 2010?
a. $1,300,000
b. $1,345,000
c. $1,255,000
d. $1,135,000
ANS: C
$1,300,000 + $120,000 - $165,000
PTS: 1
20. Toro Company recognized $655,000 of cost of goods sold in 2010, in addition its implementation of a
just-in-time inventory system allowed it to reduce its inventory from $325,000 at the beginning of the
year to $230,000 at the end of 2010. How much cash did Toro spend for inventory in 2010?
a. $655,000
b. $980,000
c. $560,000
d. $620,000
ANS: C
$655,000 + $230,000 - $325,000 = $560,000

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PTS: 1
21. Fizzzle Inc. sold a piece of equipment during the period for $230,000 and recorded a gain of $45,000
on the sale. How should this gain be treated when preparing the operating activities section of the
statement of cash flows using the indirect method?
a. A sale of equipment is an investing activity; the transaction will not affect the operating
activities section.
b. The gain is added back to net income in the operating activities section.
c. The gain is subtracted from net income in the operating activities section.

d. The entire sales price is subtracted from net income in the operating activities section.
ANS: C

PTS: 1

22. The expense incurred by issuing stock options should be
a. classified as a financing activity.
b. added back to net income in the operating activities section.
c. subtracted from net income in the operating activities section.
d. does not appear in the statement of cash flows.
ANS: B

PTS: 1

23. Lagos Corp. recorded sales of $345,000 in 2010, in addition its accounts receivable and accounts
payable balances at the beginning and end of 2010 were as follows:

Accounts Receivable
Accounts Payable

Jan. 1, 2010
$65,000
$32,000

Dec. 31, 2010
$90,000
$28,000

How much cash did Lagos collect from customers in 2010?
a. $345,000

b. $320,000
c. $324,000
d. $316,000
ANS: B
$345,000 +$65,000 - $90,000 = $320,000
PTS: 1
24. Which of the following companies would you expect to report significant amounts of cash provided by
financing activities?
a. A yet-to-be-profitable biotechnology company.
b. A mature company operating in the oil refinery industry.
c. A profitable established company in the retail industry.
d. A large multinational pharmaceutical company.
ANS: A

PTS: 1

25. A firm’s cash flows will differ from net income each period for all of the following reasons except:
a. cash receipts from customers do not necessarily occur in the same period in which a firm
recognizes revenues.
b. cash expenditures to employees, suppliers, and governments do not necessarily occur in
the same period in which a firm recognizes expenses.
c. the company is sustaining losses each period.

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d. cash inflows and outflows that pertain to investing and financing activities do not
immediately flow through the income statement.
ANS: C

PTS: 1

26. As products move through the maturity phase, companies invest to ___________ productive capacity.
a. increase
b. decrease
c. maintain
d. Not enough information to answer this question.
ANS: C

PTS: 1

27. Under the indirect method of preparing the statement of cash flows, add backs to net income include
all of the following except:
a. depreciation expense
b. deferred tax expense
c. gains on sale of equipment
d. share-based compensation
ANS: C

PTS: 1

28. All of the following are firms that may experience a long lag between the expenditures of cash and the
receipt of cash from customers, except:
a. restaurants
b. wineries
c. construction companies
d. aerospace manufacturers
ANS: A

PTS: 1

29. Which of the following is an approximation of a cash-based measure of pretax operating earnings?
a. Net sales less income taxes
b. EBITDA
c. Net income
d. Gross profit
ANS: B

PTS: 1

30. Academic research has found that market rates of return on common stock are the most highly
correlated with
a. net income.
b. cash flow from operations.
c. EBITDA.
d. cash flow from investing activities.
ANS: A

PTS: 1

31. When net income is high relative to operating cash flows, we describe the firm as having recorded
a. income-decreasing accruals.
b. income-increasing accruals.
c. income-neutral accruals.
d. abnormal accruals.
ANS: B

PTS: 1

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32. When net income is low relative to operating cash flows, we describe the firm as having
recorded
a. income-decreasing accruals.
b. income-increasing accruals.
c. income neutral accruals.
d. abnormal accruals.
ANS: A

PTS: 1

33. As a complement to the balance sheet and the income statement, the statement of cash
flows is an informative statement for analysts for all the following reasons except:
a. The statement of cash flows provides information to assess the financial health of a firm.
Analysts increasingly recognize that cash flows do not necessarily track income flows. A
firm with a healthy income statement is not necessarily financially healthy, and vice versa.
Cash requirements to service debt, for example, may outstrip the ability of operations to
generate cash.
b. The existence of negative cash flows from operations can be eliminated by using this
financial statement.
c. The statement of cash flows highlights accounting accruals, which can provide insight into
the overall sustainability and quality of a firm’s reported earnings.
d. Analysts who understand the types of information this statement presents and the kinds of
interpretations that are appropriate find that the statement of cash flows reveals
information about the economic characteristics of a firm’s industry, its strategy,
and the stage in its life cycle.
ANS: B

PTS: 1

34. Which of the following transactions would not create a cash flow?
a. Payment of a cash dividend.
b. The company purchased some of its own stock from a stockholder.
c. Amortization of patent for the period.
d. Sale of equipment at book value (i.e. no gain or loss).
ANS: C

PTS: 1

35. Which of the following would not be a cash flow from investing activities?
a. Sale of a patent.
b. Collection of interest revenue on a long-term note receivable.
c. Collection of principal of a note receivable.
d. Purchase of long-term investments.
ANS: B

PTS: 1

36. Which of the following is a cash flow from operating activities?
a. Sale of long-term investments in common stock.
b. Purchase of merchandise for resale.
c. Payment of a note payable.
d. Sale of a piece of land no longer used in operations.
ANS: B

PTS: 1

37. A cash inflow from financing activities includes:
a. receipt of interest payments.

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b. proceeds from selling equipment.
c. proceeds from issuance of bonds payable.
d. proceeds from selling investments in equity securities of another company.
ANS: C

PTS: 1

38. Kraco Corporation reported 2010 net income of $450,000, including the effects of

depreciation expense of $60,000, and amortization expense on a patent of $10,000. Also, cash
of $50,000 was borrowed on a 5-year note payable. Based on this data, total cash inflow from
operating activities using the indirect method for 2010 was
a.
b.
c.
d.

$570,000
$520,000
$470,000
$440,000

ANS: B

PTS: 1

39. Adophus, Inc.’s 2010 income statement reported total revenues of $850,000 and total expenses

(including $40,000 depreciation) of $720,000. The 2010 balance sheet reported the following:
accounts receivable beginning balance of $50,000 and ending balance of $40,000; accounts
payable beginning balance of $22,000 and ending balance of $28,000. Therefore, based only
on this information and using the indirect method, the 2010 net cash inflow from operating
activities was
a.
b.
c.
d.

$126,000
$186,000
$166,000
$174,000

ANS: B

PTS: 1

40. Tinker Company reported sales revenue of $500,000 and total expenses of $450,000

(including depreciation) for the year ended December 31, 2010. During 2010, accounts
receivable decreased by $5,000, merchandise inventory increased by $4,000, accounts payable
increased by $6,000, and depreciation expense of $10,000 was recorded. Assuming no other
data is needed and using the indirect method, the net cash inflow from operating activities for
2010 was
a.
b.

c.
d.

$60,000
$67,000
$44,000
$51,000

ANS: B

PTS: 1

41. Which of the following statements about the statement of cash flows is correct?
a. A purchase of equipment is classified as a cash inflow from investing activities.
b. Cash dividends paid are classified as cash flows from operating activities.
c. Cash dividends received on stock investments are classified as cash flows from

operating activities.
d. A company with a net loss on the income statement will always have a net cash

outflow from operating activities.
ANS: C

PTS: 1

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42. Norton Company reported total sales revenue of $55,000, total expenses of $45,000, and net

income of $10,000 on its income statement for the year ended December 31, 2010. During
2010, accounts receivable increased by $4,000, merchandise inventory increased by $6,000,
accounts payable decreased by $2,000, and depreciation of $18,000 was recorded. Therefore,
based only on this information, the net cash flow from operating activities using the indirect
method for 2010 was:
a.
b.
c.
d.

$30,000
$10,000
$16,000
$19,000

ANS: C

PTS: 1

43. Krenshaw Company reported total sales revenue of $80,000, total expenses of $72,000, and

net income of $8,000 for the year ended December 31, 2009. During 2009, accounts
receivable increased by $3,000, merchandise inventory decreased by $2,000, accounts payable
increased by $1,000, and $5,000 in depreciation expense was recorded. Assuming no other
adjustments to net income are needed, the net cash inflow from operating activities using the
indirect method was
a.
b.
c.
d.

$19,000
$13,000
$10,000
$11,000

ANS: B

PTS: 1

44. Which statement is false regarding the preparation of the indirect method of the statement of

cash flows?
a. An increase in merchandise inventory is subtracted from net income.
b. Depreciation expense is added to net income.
c. An increase in accounts receivable is added to net income.
d. An increase in accounts payable is added to net income.
ANS: C

PTS: 1

45. Lui Company's 2010 income statement reported total sales revenue of $350,000. The 2009-

2010 comparative balance sheets showed that accounts receivable increased by $20,000. The
2010 "cash receipts from customers" would be
a.
b.
c.
d.

$270,000
$250,000
$330,000
$40,000

ANS: C
PTS:

1

46. The financial statements for Warren Company show the following:

Cost of goods sold

$725,000

Merchandise Inventory

Beginning Balance
$45,000

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Ending Balance
$56,000


Accounts Receivable
Accounts Payable

53,000
37,000

50,000
42,000

Based on this information, cash paid for merchandise was
a.
b.
c.
d.

$736,000
$719,000
$731,000
$741,000

ANS: C

PTS: 1

47. Which of the following statements is true?
a. A cash dividend is an operating cash outflow.
b. Cash paid to repurchase treasury stock is an investing cash outflow.
c. Cash paid to acquire stock in another company is a financing outflow.
d. Purchase of a patent is an investing cash outflow.
ANS: D

PTS: 1

48. Which of the following statements is false?
a. Purchase of equipment is an investing cash outflow.
b. Sale of equipment creates investing cash outflow equal to its selling price.
c. Purchase of short-term investments is an investing cash outflow.
d. Purchase of a patent is an investing cash outflow.
ANS: B

PTS: 1

COMPLETION
1. Under the _________________________, firms begin with net income to calculate cash flow from
operations for the period.
ANS: indirect method
PTS: 1
2.
A decrease in accounts receivable during a period indicates that a firm collected more
____________________ as the amount of revenues included in net income.
ANS: cash
PTS: 1
3. The period in which a firm commences the manufacture of its product to the time it receives cash is
called the ______________________________.
ANS: operating cycle
PTS: 1

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4. The length of the operating cycle is another factor that may cause cash flow from operations to differ
from __________________________________________________.
ANS: working capital from operations

PTS: 1
5.

Amortization of bond discount and premiums would be additions or subtractions from net income in
the ___________________________ section of the statement of cash flows
ANS: operating activities
PTS: 1

6. Cash flows from ____________________ activities will normally be negative during the introduction
and growth phase of the product life cycle.
ANS: investing
PTS: 1
7. ____________________ activities relate to the normal operations of the firm, selling goods and
providing services.
ANS: Operating
PTS: 1
8. ____________________ activities relate to the acquisition and sale of noncurrent assets, particularly
property, plant and equipment.
ANS: Investing
PTS: 1
9. ____________________ ___________________ equals current assets minus current liabilities
ANS: Working capital
PTS: 1
10. Free cash flows to all debt and common equity shareholders represents the excess of cash flow from
operations over cash flows from ___________________________________.
ANS: investing activities
PTS: 1
11. Interest expense and interest revenue would be classified as ____________________ activities in the
statement of cash flows.
ANS: operating

PTS: 1
12. The acquisition of new investments would be classified as ____________________ activities in the
statement of cash flows.

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ANS: investing
PTS: 1
13. The receipt of dividends from an investee would be classified as ____________________ activities in
the statement of cash flows.
ANS: operating
PTS: 1
14. The payment of dividends would be classified as ____________________ activities in the statement of
cash flows.
ANS: financing
PTS: 1
15. Under the ______________________________ of preparing the statement of cash flow’s operating
activities section firms list the cash flows from selling goods and services and then subtract the cash
outflows to providers of goods and services.
ANS: direct method
PTS: 1
16. One factor that may cause cash flow from operations to differ from net income is the length of the
______________________________.
ANS: operating cycle
PTS: 1
17. Many analysts use ____________________ as a crude measure of a firm’s ability to pay down debt.
ANS: EBITDA
PTS: 1
18. EBITDA not only ignores four expenses but also ignores changes in

__________________________________________________ accounts.
ANS: operating working capital
PTS: 1
19. Cash flow from operations should include none of the cash flows associated with marketable securities
if such transactions are viewed as ___________________________________.
ANS: investing activities
PTS: 1

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20. The issuance of debt would be classified as a (an) ____________________ activity in the statement of
cash flows.
ANS: financing
PTS: 1
21. Cash collected from customers would appear in the operating activities section of a statement of cash
flows prepared using the ____________________ method
ANS: direct
PTS: 1
22. The receipt of cash when employees exercise stock options is a (an) ____________________ activity.
ANS: financing
PTS: 1
SHORT ANSWER
1. The calculation of cash flow from operations under the indirect method involves two types of
adjustments. Discuss each type of adjustment and provide an example of each type of adjustment.
ANS:
1. Adjusting revenues and expenses for changes in non-working capital accounts, for example
depreciation, amortization and deferred income tax.
2. Adjusting revenues and expenses for changes in operating working capital accounts, for
example accounts receivable and accounts payable, inventories.

PTS: 1
2. Discuss operating, investing, and financing cash flows in relation to the various stages of the product
life cycle.
ANS:
1. Operating cash flows begin negative in the introduction phase and start becoming positive
in the growth phase. Operating cash flows reach their peak in the maturity phase and start to
decrease at the end of the maturity phase and into the decline phase.
2. Investing cash flows begin negative in the introduction phase and stays negative in the
growth phase. Investing cash flows become positive in the maturity phase and start to
decrease at the end of the maturity phase and into the decline phase.
3. Financing cash flows are positive in the introduction and growth phase. Financing cash
flows start to decrease at the end of the maturity phase and continue to decrease in the
decline phase.
PTS: 1
3. What is working capital from operations? Discuss what types of firms will have similar net income
and working capital from operations? For which types of firms will net income and working capital
from operations be significantly different?

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ANS:
Working capital from operations is defined as net income adjusted for changes in non-working capital
accounts. These changes include depreciation, amortization, the equity method, deferred tax amounts,
the minority interest in the earnings of consolidated subsidiaries and some restructuring charges.
Companies that have mostly current operating assets, such as retailers who rent their space, will likely
have similar net income and working capital from operations. Capital-intensive firms are more likely
to have significantly different net incomes and working capital from operations.
PTS: 1
4. For the following types of companies, discuss whether you think their cash flows from operations,

investing, and financing will be positive (the activity provides cash) or negative (the activity uses
cash). Provide support for your answer.
1.

2.

3.

Tech Corporation is a developer of computer software for the gaming industry. The
company recently launched its first software title. The company is expanding its operations
by hiring additional developers and administrative staff. The company is not yet profitable,
but expects to break even within two years. Investors view it as having a first mover
advantage and have been happy to invest in the company.
Midwest Corporation is a supplier to the agricultural industry. The company is experiencing
its 25th year of profitability, but is concerned that sales have contracted for the fifth year in
a row. Midwest prides itself in paying dividends and having no debt on its balance sheet.
Semi Inc. manufactures semiconductors. The company has just introduced its ninth new
product and is the leader in market share for the industry. The company continues to invest
in research and development and expand by purchasing competitors. The company has yet
to pay dividends, but is considering it in the future. The company’s largest current asset is
cash, due to its high profit margin.

ANS:
1. This company is in the introduction phase. CFO--negative, CFI--negative, CFF--positive
2. This company is in the late mature to early decline phase. CFO--positive and declining,
CFI--positive and declining, CFF--negative due to dividends.
3. This company is in the growth phase. CFO--positive, CFI--negative, CFF--positive maybe
starting to turn negative.
PTS: 1
5. Cilca Corporation is a supplier to the pulp and paper industry. Selected financial information about

Cilca is listed below:









Purchased real estate for $440,000 in cash. The cash was borrowed from a bank.
Sold investments for $400,000.
Paid dividends of $480,000.
Issued shares of common stock for $200,000.
Purchased machinery and equipment for $100,000 cash.
Paid $360,000 on a bank loan.
Reduced accounts receivable by $80,000.
Increased accounts payable $160,000.
Sales for the period were $450,000

Use the above information to calculate Cilca’s:
a. cash used or provided by operating activities
b. cash used or provided by financing activities

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ANS:
a. cash used or provided by operating activities:
Sales for the period 450,000

+reduction- in accounts receivable $80,000
= $690,000
b.

cash used or provided by investing activities
+Received $440,000 of cash that was borrowed from a bank to purchase real estate
+Issued shares of common stock for $200,000
- Paid dividends of $480,000
- Paid $360,000 on a bank loan.
= $200,000 cash used by financing activities

PTS: 1
6. Luke Corporation is a manufacturer of home furnishings. Selected financial information about Luke is
listed below:











Borrowed $850,000 from a bank.
Purchased equipment for $210,000 in cash.
Purchase investments for $285,000.
Received dividends of $51,000 from an investment in Davis Corp.
Paid dividends of $55,000.

Issued shares of preferred stock for $500,000.
Repurchased outstanding common shares using $100,000 in cash.
Purchased land for $100,000 cash.
Paid $36,000 interest expense on a bank loan.
Increased Inventories by $320,000
Increased accounts receivable by $217,000.
Increased accounts payable $85,000.

Use the above information to calculate Luke’s:
a. cash used or provided by investing activities
b. cash used or provided by financing activities
ANS:
a. cash used or provided by investing activities:
-Purchased investments for $285,000
- Purchased land for $100,000
- Purchased equipment for $210,000 cash.
= ($595,000) cash used by investing activities.
b.

cash used or provided by investing activities
+Received $850,000 from bank borrowing
+Issued shares of preferred stock for $500,000
- Paid dividends of $55,000
- Paid $100,000 to repurchase outstanding common stock
= $1,1950,000 cash provided by financing activities

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PTS: 1

7. Discuss the correlations that have been found between net income, net income plus or minus Type 1
adjustments (i.e., adjustments to net income for revenues, expenses, gains, and losses that are
recognized in income and are associated with changes in noncurrent assets, noncurrent liabilities, and
shareholders’ equity, but do not affect cash by the same amounts for the period), and cash flow from
operations.
ANS:
The study by Robert M. Bowen, David Burgstahler, and Lane A. Daley, “Evidence on the
Relationships Between Earnings and Various Measures of Cash Flow,” Accounting Review (October,
1986) revealed (1) a high correlation between net income and net income plus or minus Type 1
adjustments, and (2) a low correlation between net income and cash flow from operations, and (3) a
low correlation between cash flow from operations and net income plus or minus Type 1 adjustments
over time
PTS: 1
8. Selected financial statement information for Filmco appears below:
Balance Sheet accounts

Jan. 1, 2010

Inventory
Accounts Receivable
Income Statement (partial)

Dec. 31, 2010

$210,000
$85,000

$90,000
$45,000

For the year ended Dec. 31, 2010

Sales
Cost of Goods Sold
Gross Profit

$900,000
$730,000
$170,000

Calculate the amount of cash collected from customers and the amount of cash spent on inventory for
2010 by Filmco.
ANS:
Cash collected from customers: $ 900,000+85,000-45,000=$940,000
Cash spent on inventory: $730,000 + $90,000 - $210,000=$610,000
PTS: 1
PROBLEM
1. J. Jill is a women’s clothing retailer. The company started as a mail order company and has expanded
into mall department stores. The company now receives approximately half of its revenues from mail
order and half from retail outlets. Over the time period 2010 to 2012, sales increased approximately
25%.
Discuss the relationship between net income, working capital from operations, and cash flow
from operations, and between cash flows from operating, investing, and financing activities over the
three-year period.
CASH FLOW STATEMENT (in thousands)
Cash from operations

12/25/2012

3-16

12/27/2011

12/28/2010


Net income
Depreciation & amortization
Net increase (decrease) in assets & liab.
Other adjustments, net
Net cash provided by (used in) operations
Cash from investments
(Increase) decrease in property & plant
Other cash inflow (outflow)
Net cash provided by (used in) investing
Cash from financing
Issuances (purchases) of equity shares
Increase (decrease) in borrowings
Net cash provided by (used in) financing
Net change cash & cash equivalents
Cash and cash equivalents at start of year
Cash and cash equivalents at year end

8,706
18,663
6,696
1,396
35,461

7,025

16,131
26,659
924
50,739

18,434
12,672
10,623
3,996
45,725

-28,784
-35,434
-64,218

-34,265
-1,143
-35,408

-34,734
-2,454
-37,188

3,142
-1,706
1,436
-27,321
59,287
31,966

870
-1,648
-778
14,553
44,734
59,287

7,800
-1,755
6,045
14,582
30,152
44,734

ANS:
Some points that may be addressed:
1.

2.
3.

4.

J. Jill is expanding into retail space which results in additional capital expenditures to
construct the interiors of the company’s retail space. From J. Jill’s annual report
management estimates that the company spends approximately $1 million dollars decorating
each store to its uniform design. These cash flows can be observed by recognizing the cash
used by property and equipment investing activities section of the cash flow statement. We
can also observe increasing depreciation charges, which is consistent with larger amounts of
property and equipment.

As sales have increased so has its need for working capital. It is important to ensure that the
company has adequate controls over its working capital.
J. Jill is experiencing a net growth in current operating liabilities (as can be noted in the
operating activities section of the cash flow statement). This is attributable to expansion into
retail space as rental commitments and other store opening costs are accrued for.
J. Jill is still issuing equity (but to a lesser degree than in 2012 and 2011) and paying down
debt.

PTS: 1
2. Olive Corporation manufactures food processing equipment. Use Olive Corporation’s two most recent
balance sheets and most recent income statement to prepare a statement of cash flows for 2010. The
company paid dividends of $6,250 during 2010.
Olive Corporation
Balance Sheet
As of December 31,
Assets:
Cash and cash equivalents
Accounts Receivable
Inventory
Current Assets

3-17

2010

2009

$41,900
24,000
30,000

95,900

$25,000
6,250
36,000
67,250


Equipment
Less: Accumulated depreciation
Land

42,000
-14,000
25,000

38,500
-7,000
10,000

$148,900

$108,750

$17,500
5,500
2,200
6,900
32,100

$22,500
8,000
1,000
4,000
35,500

Long-term note payable
Total Liabilities

50,000
82,100

30,000
65,500

Stockholders’ Equity:
Common stock
Retained earnings

42,000
24,800

30,000
13,250

$148,900

$108,750

Total assets

Liabilities
Accounts Payable
Accrued Salaries Payable
Rent Expense Payable
Income Tax Payable
Current Liabilities

Total liabilities and stockholders’ equity
Olive Corporation
Income Statement
For the year ended December 31, 2010
Revenues
Cost of goods sold
Gross Profit

$147,000
-84,000
$63,000

Operating Expenses
Depreciation expense
Salary expense
Insurance Expense
Rent Expense
Interest Expense
Total Operating Expenses

-7,000
-14,600
-2,500

-10,000
-4,200
-38,300

Income from Operations
Income Tax Expense

24,700
-6,900

Net income

$17,800

ANS:
Olive Corporation
Statement of Cash Flows
For the year ended December 31, 2010
Operations

3-18


Net income

$17,800

Depreciation Expense
Increase in Accounts Receivable
Decrease in Inventory

Decrease in Accounts Payable
Decrease in Salaries Payable
Increase in Rent Payable
Increase in Taxes Payable

$ 7,000
(17,750)
6,000
(5,000)
(2,500)
1,200
2,900

Cash Flow from Operations

(8,150)
$ 9,650

Investing
Purchases of Equipment
Purchase of land
Cash Flows from Investing

(3,500)
(15,000)
(18,500)

Financing
Sale of common stock
Issuance of Long-Term Debt

Payment of dividends
Cash Flows from Financing

12,000
20,000
(6,250)
25,750

Net change in cash
Cash balance at beginning of year
Cash balance at end of year

16,900
25,000
$41,900

PTS: 1
3. Listed below is a list of cash inflows and cash outflows for Toggle Inc.
1. Cash received from issuing debt
2. Cash received from interest earned on a bond investment
3. Cash used to purchase property
4. Cash used to repay debt
5. Cash received from collections of loans
6. Cash paid for retiring common stock
7. Cash paid to employees for salaries
8. Cash from the sale of marketable securities
9. Cash used to pay dividends
10. Cash from the sale of services to customers
11. Cash paid to government agencies for taxes
12. Cash received from the sale of equipment

For each item indicate where it should appear on Toggle’s statement of cash flows. Select from:
a.
b.
c.
d.
e.

Cash inflows from operating activities
Cash outflows from operating activities
Cash inflows from investing activities
Cash outflows from investing activities
Cash inflows from financing activities

3-19


f. Cash outflows from financing activities
ANS:
1.e
2.a
3.d
4.f
5.c
6.f
7.b
8.c
9.f
10.a
11.b
12.c

Cash received from issuing debt - Cash inflows from financing activities
Cash received from interest earned on a bond investment - Cash inflows from
operating activities
Cash used to purchase property - Cash outflows from investing activities
Cash used to repay debt - Cash outflows from financing activities
Cash received from collections of loans - Cash inflows from investing activities
Cash paid for retiring common stock - Cash outflows from financing activities
Cash paid to employees for salaries - Cash outflows from operating activities
Cash from the sale of marketable securities - Cash inflows from investing activities
Cash used to pay dividends - Cash outflows from financing activities
Cash from the sale of services to customers - Cash inflows from operating activities
Cash paid to government agencies for taxes - Cash outflows from operating
activities
Cash received from the sale of equipment - Cash inflows from investing activities

PTS: 1
4. Plano Corporation presented the following account balances for 2010 and 2009:
December 31, 2010
December 31, 2009
Dividends payable
Additional Paid-in-Capital
Treasury Stock
Equipment
Accumulated Depreciation
Common Stock
Long-Term Notes Payable

$ 20,000
$580,000

$185,000
$800,000
$225,000
$630,000
$225,000

$ 25,000
$230,000
$100,000
$700,000
$140,000
$560,000
$125,000

Additional information:
1.
Cash dividends of $20,000 were declared on December 15, 2010, payable on January
15, 2011.
2.
The company issued 70,000 shares of $1 par value common stock during 2010.
3.
The company repurchased 34,000 shares of its own common stock during the period.
No treasury stock was sold during the period.
4.
Additional equipment was purchased by issuing a $100,000 long-term note payable.
Required:
1. Prepare the financing section of Plano’s 2010 statement of cash flows.
2. Indicate if any of the events will be reported as a significant noncash transaction.
ANS:
1.

Plano Corporation
Partial Statement of Cash Flows
For the period ended December 31, 2010

Financing
Cash dividends paid
Repurchase of treasury stock
Sale of Common Stock
Cash Flow from Financing
$310,000

($25,000)
($85,000)
$420,000

3-20


2.

The issuance of the $100,000 long-term note in exchange for equipment should be
disclosed as a significant non-cash transaction.

PTS: 1
5. Clarion Industries manufactures computer equipment and provides financing for purchases by its
customers. Clarion reported sales and interest revenues of $79,500 million for 2010. The
balance sheet showed current and noncurrent receivables of $ 30,750 million at the beginning
of 2010 and $ 26,900 million at the end of 2010. Compute the amount of cash collected
from customers during 2010.

ANS:

(in $millions)
Sales and Interest Revenues for 2010.................................................... $ 79,500
Plus Receivables at Beginning of 2010 ................................................... 30,750
Less Receivables at End of 2010
(26,900)
Cash Collections from Customers during 2010 .................................... $ 83,350
PTS: 1
6. Jarrett Company, home improvement retailer, reported cost of goods sold of $33,729 million for the
fiscal year ended January 30, 2010. It reported merchandise inventories of $9,611 million at the
beginning of fiscal 2010 and $10,209 million at the end of fiscal 2010. It reported
accounts payable to suppliers of $5,713 million at the beginning of fiscal 2010 and $6,109
million at the end of fiscal 2010. Compute the amount of cash paid to merchandise suppliers
during fiscal 2010.
ANS:

(amounts in $millions)
Cost of Goods Sold for 2010 ................................................................. $
Plus Inventory at End of 2010 .................................................................
Less Inventory at Beginning of 2010 ......................................................
Equals Purchases during 2010 ............................................................... $
Plus Accounts Payable at Beginning of 2010 .........................................
Less Accounts Payable at End of 2010 ...................................................
Equals Cash Payments to Suppliers during 2010 .................................. $

33,729
10,209
(9,611)
34,327

5,713
(6,109)
33,931

PTS: 1
7. Krenzer, Inc., a financial company, reported income tax expense of $2,648 million for 2010,
comprising $2,346 million of current taxes and $302 million of deferred taxes. The balance sheet
showed income taxes payable of $222 million at the beginning of 2010 and $427 million at the end of
2010. Compute the amount of income taxes paid in cash during 2010.
ANS:

Income Tax Payable at the Beginning of 2010 ..................................... $
Plus Current Portion of Income Tax Expense for 2010 ..........................
Less Income Tax Payable at the End of 2010 .........................................
3-21

222
2,346
(427)


Equals Cash Payments for Income Taxes during 2010 ......................... $

2,141

Note that the deferred portion of income taxes expense relates to various deferred income tax
accounts, not to Income Tax Payable. Also note that computations such as this one are
approximations (due to acquisitions, divestitures, and other miscellaneous events that affect
the ability to reconcile balance sheet changes with information on the statement of cash
flows). Cash paid for income taxes is a required disclosure. Many firms include this (as well

as cash paid for interest) as a supplemental disclosure at the bottom of the statement of cash
flows; however, many firms include the amount of cash paid for income taxes in the income
taxes footnote or in another footnote that reports supplemental information.
PTS: 1

8. In 2010, Lamar Industries reported the following: Sales $700,000 ; Accounts receivable

beginning of 2010 $450,000; Accounts receivable end of 2010 $369,200; Depreciation
expense $55,400; Rent Expense $30,000. What is the net cash provided (used) by operating
activities

ANS: $750,800
PTS: 1
9. While preparing a statement of cash flows, you encountered the following transaction:

February 1, 2011: Galvinize Corporation acquired a small office building in exchange for
5,000 shares of its own common stock; par value $10 per share; market value $15 per share.
A. Should this transaction be shown on the statement of cash flows?
B. Why or why not?
ANS:
A. Yes
B. Because it is a direct exchange, it is reported on the statement of cash flows in a supplemental
schedule or note as "Office building, acquired for 5,000 shares of Galvinize Corporation's common
stock, $75,000."
PTS: 1
10. Bankers Company reported net income of $40,000, which included depreciation expense and

depletion expense of $21,000 and $18,000, respectively. The following changes also occurred
during 2010:
Inventory

$10,000
decrease
Accounts payable
5,000
decrease
Notes payable (long-term)
15,000
decrease
Income taxes payable
7,000
increase
Accounts receivable
10,000
increase
Required:
3-22


Calculate cash flows from operating activities.
ANS:

$40,000 + $21,000 + $18,000 + $10,000 - $5,000 + $7,000 – $10,000 = $81,000

PTS: 1
11. Use the following information to prepare a statement of cash flows (indirect method) for Sink

Industries for the year ended December 31, 2010:
Net income for the year 2010 was $5,000. Accounts receivable decreased $2,000, while
inventories increased $4,000, and accounts payable decreased $7,000. Depreciation expense
included in net income was $8,000.

During the year, a piece of land held for future expansion was sold for its book value of
$8,000 and a new service truck was purchased for $14,000.
The company borrowed $18,000 on a two-year note from the bank. Dividends of $6,000 were
paid in cash. Preferred stock was issued to retire $7,000 of long-term notes payable.
The beginning cash balance was $10,000 and the ending balance was $20,000.
ANS:
Sink Industries
Statement of Cash flows
For the Year Ended December 31, 2010
Cash flows from operating activities:
Net income
$5,000
Add or deduct items not affecting cash:
Depreciation expense
8,000
Accounts receivable decrease
2,000
Inventory increase
(4,000)
Accounts payable decrease
(7,000)
Net cash flow from operating activities
Cash flows from investing activities:
Cash received from sale of land
8,000
Cash paid for new truck
(14,000)
Net cash flow from investing activities
Cash flows from financing activities:
Cash paid for dividends

(6,000)
Cash received from note payable borrowing
18,000
Net cash flow from financing activities
Net increase in cash during 2010
Beginning cash balance
Ending cash balance

3-23

$4,000

(6,000)

12,000
10,000
10,000
$20,000


Schedule of Noncash Investing and Financing Activities:
Issued preferred stock to retire long-term notes payable
$7,000
PTS: 1

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