Chapter 11 The Statement of Cash Flows

CHAPTER 11
Updated from the Twelfth Edition. Great Valu Variety Stores has been
dropped.
Approach
This is a topic that has always been difcult for students. The indirect
method of developing the amount of cash fow from operating activities is
particularly difcult. The hearings prior to FASB 95 indicated that the
investment analyst community would press companies to continue using the
indirect reconciliation! method" the primary supporters of the direct method
were ban#ers. Thus$ it appears that students will not be well served in this
sub%ect area unless they gain an understanding of the indirect method.
Since students were introduced to the di&erence between cash fows and
accrual accounting's revenues and e(penses way bac# in )hapter *$ this
should be reinforcement at this point$ but it usually seems to be a new
revelation to at least a subset of the class. +or those who never succeed in
fully understanding the rationale for the ad%ustments$ ,llustration --./ now
gives them a rote approach to which they can revert.
Cases
Medieval Adventures Company is an armchair case intended to dramati0e
the di&erence between operating cash fow and income.
Amerbran Company (A) illustrates preparation of the cash fow statement
from the other two statements and supplemental information.
Problems
Problem 11-1
12-2 sales 34$**5$22
2
6ess7 )hange in accounts receivable -*2$222!
)ash generated from sales during 122* 34$125$22
2
Problem 11-2
a. Use of 31 million cash to purchase e8uipment is an investment use of
cash.
b. )ash proceeds from the issuance of common stoc# is a 9nancing source of
cash. The use of cash to retire mortgage bonds is a 9nancing use of cash.
c. :o cash e&ect.
d. :o cash e&ect.
e. )ash proceeds from the sale of machinery is an investment source of
cash.
11-1
Chapter 11 The Statement of Cash Flows
The above responses assume the direct method is used to present its
cash fow of statement.
11-2
Chapter 11 The Statement of Cash Flows
Problem 11-3
Kidsn Caboodle
Statement of Cash lo!s
)ash received from customers 3-;;$222
)ash used in operations -/<$=22!
)ash from operations 34$-22
E8uipment -2$;22!
)ash used for investments -2$;22!
6oan 1-$222
)ash from 9nancing 1-$222
,ncrease in cash 3 -4$<22
Problem 11-"
:et loss 3--$222!
>epreciation 1<$/22
-;$/22
?ccounts receivable reduced! -5$<22
?ccounts payable increased! 4$422
?ccrued salaries increased! *$*22
@ther accruals increased! 1$122
)ash fow from operations /5$*22
,nvestments 2
6ong.term debt reduced! 1=$522!
)hange in cash -5$<22
Aeginning cash /$/22
Ending cash 311$222
Problem 11-#
@perating ?ctivities
)ash received from customers 3<1$-22
,nterest received */;
@perating cash payments ;/$-<;!
,nterest payment -$2*;!
:et cash provided by operations 5$1/;
,nvesting ?ctivities
Sale of old machine *$-2;
>own payment on new truc# *$/;2!
11-3
Chapter 11 The Statement of Cash Flows
:et cash used in investing
activities
*/;!
+inancing ?ctivities
Bayment of debt *$/;2!
:et cash used in 9nancing
activities
*$/;2!
,ncrease in cash *$/;2
Aeginning cash *$/;2
Ending cash 3 <$=22
Cases
Case 11-1 Medieval Adventures Company
*
$ote% This case is unchanged rom the T!elth "dition.
Approach
This obviously! is an armchair case$ intended to show dramatically the
di&erence between pro9t and cash fow from operations. The case has
mechanistic patterns built into it to help students see what is going on7
relatively rapid growth is causing cash to be tied up in receivables and
inventories faster than it is regenerated from collections. ?lthough the case
may seem trivial at least after the calculations have been made! because of
these mechanistic patterns$ in fact many businesses have had severe
sometimes fatal! 9nancial crises because management did not anticipate
*
This teaching note was prepared by Robert N !nthony Copyright " Robert N !nthony
11-#
Medieval Adventures Company
-100,000
0
100,000
200,000
300,000
400,000
500,000
600,000
Jan Feb March April May June July Aug Sep Oct
Sales
Net !nc"#e
Net Operating $ash Fl"%
$ash &alance %'" ("an
Acc"unts )ecei*able
Chapter 11 The Statement of Cash Flows
the basic phenomenon that this case develops. The graph included herein
can be used in class to help illustrate this phenomenon.
11-$
Chapter 11 The Statement of Cash Flows
#uestion $
The re8uired monthly statements are shown on the following pages. The
pea# need comes by the end of Culy$ when a 3/2$222 loan would be needed
to maintain a 0ero cash balance. ,n ?ugust$ cash generated by operations
9nally turns positive$ enabling partial repayments of the loan. @ctober's
315$;22 cash generated by operations enables ma#ing the 9nal 3-;$222
loan repayment and ending the month with a 3-1$;22 cash balance.
#uestion %
This 8uestion is the #ey one in terms of student insight from this case. The
company has been paying its costs currently$ but allowing customers two
months to pay. This$ coupled with constant growth$ causes large net
operating outfows for several months$ which collectively eat up the 9rm's
initial capital. ,t is important for students to understand why it is that this
situation eventually turns around7 the unit margin is 312 and the monthly
nonproduction costs are 9(ed at 3-2$222" thus$ the continued unit sales
growth eventually in ?ugust! causes the current infows from sales two
months ago! to e(ceed the current outfows production costs for ne(t
month's sales plus 3-2$222!. ,n other words$ as the income statement shows$
the 9rm is pro9table$ and eventually those pro9ts get reali0ed in cash.
This need could have been avoided by pro%ecting the cash fow 9gures that
the students have developed after the fact. Then the company could have
arranged the necessary line of credit. Aan#s are happy to provide such funds
for companies that anticipate the need because that anticipation refects
good 9nancial management. @n the other hand$ ban#s are hesitant to lend to
a 9rm that has been ta#en by surprise by a cash shortage. @f course$ a no.
cost method to avoid the problem was also probably feasible. The company
could have arranged credit with vendors to help 9nance the inventory$ and
could have been more aggressive in collecting from its customers in accord
with the stated *2.day terms. ,f the company delayed its payments by *2
days and accelerated receivable collections from <2 to *2 days thus
shortening its Dcash cycleE by <2 days!$ the operating cash fow would have
turned positive in Farch and no cash crisis would have occurred.
#uestion &
The purpose of this 8uestion is to give students practice in deriving a cash
fow statement from the income statement and balance sheets. Aecause of
the wor# done in 8uestion -$ where cash fows were dealt with directly$
students can gain some con9dence in these derivation procedures before
they apply the procedures in more comple( and realistic cases. The
statements are as follows in somewhat simpli9ed format$ be9tting this
introductory problem!7
11-%
Chapter 11 The Statement of Cash Flows
&arch &a' ()l'
:et income 3*2$222 3;2$222 352$222
,ncrease in accounts receivable ;;$222
!
;;$222
!
;;$222
!
,ncrease in inventory -5$;22
!
-5$;22
!
-5$;22
!
)ash from operations /1$;22
!
11$;22
!
1$;22!
Broceeds of debt .2. 11$;22 1$;22
)ash increase decrease! /1$;22
!
2 2
Aeginning of month cash balance 51$;22 2 2
End of month cash balance 3*2$222 3 2 3 2
*PERAT+$, -./,ET
(an0 eb0 &ar0 Apr0 &a' ()ne ()l' A)10 Sept0 *ct0
Sales 3;;$22
2
341$;2
2
3--2$2
22
3-*5$;
22
3-<;$2
22
3-=1$;
22
3112$2
22
31/5$;
22
315;$2
22
3*21$;
22
)ost of Sales *;$222 ;1$;22 52$222 45$;22 -2;$22
2
-11$;2
2
-/2$22
2
-;5$;2
2
-5;$22
2
-=1$;2
2
Gross Fargin 12$222 *2$222 /2$222 ;2$222 <2$222 52$222 42$222 =2$222 -22$22
2
--2$22
2
@ther E(penses -2$222 -2$222 -2$222 -2$222 -2$222 -2$222 -2$222 -2$222 -2$222 -2$222
:et ,ncome -2$222 12$222 *2$222 /2$222 ;2$222 <2$222 52$222 42$222 =2$222 -22$22
2
CASH -./,ET
Cash ln'o!s(
)ash forwarded 3-/<$1
;2
3---$1
;2
3
51$;22
3
*2$222
3.2. 3.2. 3.2. 3.2. 3.2. 3.2.
)ollections 15$;22 /-$1;2 ;;$222 41$;22 --2$22
2
-*5$;2
2
-<;$22
2
-=1$;2
2
112$22
2
1/5$;2
2
6oan from ... ... ... 1$;22 11$;22 -1$;22 1$;22 ... ... ...
11-$
Chapter 11 The Statement of Cash Flows
ban#
Total 3-5*$5
;2
3-;1$;
22
3-15$;
22
3--;$2
22
3-*1$;
22
3-;2$2
22
3-<5$;
22
3-=1$;
22
3112$2
22
31/5$;
22
Cash )ut'o!s(
)osts G
e(penses
3
<1$;22
3
42$222
3
=5$;22
3--;$2
22
3-*1$;
22
3-;2$2
22
3-<5$;
22
3-4;$2
22
3121$;
22
3112$2
22
6oan paybac# ... ... ... ... ... ... ... 5$;22 -5$;22 -;$222
)ash balance 3---$1
;2
3
51$;22
3
*2$222
3 2 3 2 3 2 3 2 3 2 3 2 3
-1$;22
Femo7
:et operating
cash fow 3*;$22
2!
3*4$5
;2!
3/1$;
22!
3*1$;
22!
311$;
22!
3-1$;
22!
31$;2
2!
3
5$;22
3
-5$;22
3
15$;22
)ash balance
wHo loan
3---$1
;2
3
51$;22
3
*2$222
3
1$;22!
31;$2
22!
3*5$;
22!
3/2$2
22!
3*1$;
22!
3-;$2
22!
3
-1$;22
-A2A$CE SHEET
/ec0
31st
(an0
31st
eb0
23th
&ar
31st
Apr0
34
th
&a'
31st
()ne
34th
()l'
31st
A)10
31st
Sept0
34th
4ct0
31st
Assets(
)ash 3-/<$1
;2
3---$1
;2
3
51$;22
3
*2$222
3 2 3 2 3 2 3 2 3 2 3 2 3
-1$;22
?ccounts Ieceivable <4$5;2 =<$1;2 -*5$;2
2
-=1$;2
2
1/5$;2
2
*21$;2
2
*;5$;2
2
/-1$;2
2
/<5$;2
2
;11$;2
2
;55$;2
2
,nventory *;$222 ;1$;22 52$222 45$;22 -2;$22
2
-11$;2
2
-/2$22
2
-;5$;2
2
-5;$22
2
-=1$;2
2
1-2$22
2
Total 31;2$2 31<2$2 3142$2 3*-2$2 3*;1$; 3/1;$2 3/=5$; 3;52$2 3</1$; 35-;$2 3422$2
11-%
Chapter 11 The Statement of Cash Flows
22 22 22 22 22 22 22 22 22 22 22
*iabilities and "+uity(
:ote Bayable 3 ... 3 ... 3 ... 3 ... 3
1$;22
3
1;$222
3
*5$;22
3
/2$222
3
*1$;22
3
-;$222
3 ...
)ommon Stoc# 1;2$22
2
1;2$22
2
1;2$22
2
1;2$22
2
1;2$22
2
1;2$22
2
1;2$22
2
1;2$22
2
1;2$22
2
1;2$22
2
1;2$22
2
Ietained Earnings JJJJJJJ -2$222 *2$222 <2$222 -22$22
2
-;2$22
2
1-2$22
2
142$22
2
*<2$22
2
/;2$22
2
;;2$22
2
Total 31;2$2
22
31<2$2
22
3142$2
22
3*-2$2
22
3*;1$;
22
3/1;$2
22
3/=5$;
22
3;52$2
22
3</1$;
22
35-;$2
22
3422$2
22
11-&
Chapter 11 The Statement of Cash Flows
11-'