Darlena Albrecht

Study Questions and Problems

4.1 Why is the statement of cash flows a useful document?
The statement of cash flows is important because it shows how cash has been
generated during a year or a quarter, and how it has been used.
4.2 Define the following terms as they relate to the statement of cash flows: cash, operating
activities, investing activities, and financing activities.
Cash includes cash and highly liquid short-term marketable securities, also called
cash equivalents. They include U.S. Treasury bills, certificates, notes, and bonds;
negotiable certificates of deposit at financial institutions; and commercial paper.
Operating activities include delivering or producing goods for sale and providing
services and the cash effects of transactions and other events that enter into the
determination of income.
Investing activities include 1) acquiring and selling or otherwise disposing of a)
securities that are not cash equivalents and b) productive assets that are expected
to benefit the firm for long periods of time and 2) lending money and collecting
on loans.
Financing activities include borrowing from creditors and repaying the principal
and obtaining resources from owners and providing them with a return on the
investment.
4.3 How does the direct method differ from the indirect method?
The direct method shows cash collections from customers, interest and dividends
collected, other operating cash receipts, cash paid to suppliers and employees,
interest paid, taxes paid, and other operating cash payments.
The indirect method is the most common and starts with net income and adjusts
for deferrals; accruals; noncash items, such as depreciation and amortization; and
nonoperating items, such as gains and losses on asset sales.
4.4 What can creditors, investors, and other users learn from an analysis of cash flows
statement?
It helps them determine the firm’s ability to generate cash flows in the future, its
capacity to meet obligations for cash, its future external financing needs, its
success in productively managing investing activities, and its effectiveness in
implementing financing and investing strategies.
4.5 Identify the following as financing activities (F) or investing activities (I):
(a) Purchase of equipment - I
(b) Purchase of treasury stock – F
(c) Reduction of long-term debt – F
(d) Sale of building – I
(e) Resale of treasury stock - F
(f) Increase in short-term debt - I
(g) Issuance of common stock - F
(h) Purchase of land - I
(i) Purchase of common stock of another firm - I
(j) Payment of cash dividends - F
(k) Gain on sale of land - I
(l) Repayment of debt principal – I
4.6 Indicate which of the following current assets and current liabilities are operating
accounts (O) and thus included in the adjustment of net income to cash flow from
operating activities and which are cash (C), investing (I), or financing (F) accounts.
(a) Accounts payable - O
(b) Accounts receivable - O
(c) Notes payable (to bank) - F
(d) Marketable securities - C
(e) Accrued expenses - O
(f) Inventory - O
(g) Prepaid expenses - I
(h) Current portion of long-term debt - F
(i) Dividends payable - F
(j) Income taxes payable - O
(k) Interest payable - O
(l) Certificates of deposit – C
4.7 Indicate whether each of the following items would result in net cash flow from operating
activities being higher (H) or lower (L) than net income.
(a) Decrease in accounts payable - L
(b) Depreciation expense - H
(c) Decrease in inventory - H
(d) Gain on sale of assets - L
(e) Increase in accounts receivable - L
(f) Increase in deferred tax liabilities - H
(g) Decrease in accrued liabilities - L
(h) Increase in prepaid expenses - L
(i) Increase in deferred revenue - H
(j) Decrease in interest receivable – H
4.8 Indicate whether each of the following events would cause an inflow or an outflow of
cash and whether it would affect the investing (I) or financing (F) activities on the
statement of cash flows.
(a) Repayments of long-term debt – Outflow, F
(b) Sales of marketable securities – Inflow, I
(c) Repurchase of company’s common stock – Outflow, F
(d) Sales of common stock to investors – Inflow, F
(e) Purchase of equipment – Outflow, I
(f) Payment of dividends – Outflow, F
(g) Purchase of marketable securities – Outflow, F
(h) Borrowing from bank – Outflow, I
(i) Sale of building – Inflow, I
(j) Acquisition of company – Outflow, I
4.9 Condensed financial statements for Dragoon Enterprises follow.
(a) Calculate the amount of dividends Dragoon paid using the information given.
$5,500
(b) Prepare a statement of cash flows using the indirect method.
 Dragoon Enterprises Consolidated Statements of
Cash Flows for the Year Ended December 31, 2012
2012
Cash Flows from Operating Activities – Indirect Method
Net income $ 1,050
Adjustments to reconcile net income to cash provided (used)
by operating activities
Depreciation 1,200
Cash provided (used) by current assets and liabilities
Accounts receivable (550)
Inventories 110
Accounts payable (300)
Income taxes payable (150)
Net cash provided (used) by operating activities $ 1,360
Cash Flows from Investing Activities
Additions to property, plant, and equipment (700)
Net cash provided (used) by investing activities $ (700)
Cash Flows from Financing Activities
Sales of common stock (60)
Increase (decrease) in short-term borrowings (140)
(includes current maturities of long-term debt)
Dividends paid 3,400
Net cash provided (used) by financing activities $ 3,200
Increase (decrease) in cash and cash equivalents (350)
Cash and cash equivalents, beginning of year 850
Cash and cash equivalents, end of year $ 1,200
Supplemental cash flow information:
Cash paid for interest $ 50
Cash paid for taxes (150)
4.10 The following income statement and balance sheet information are available for 2 firms,
Firm A and Firm B.
(a) Calculate the amount of dividends Firm A and Firm B paid using the information
given.
Firm A: $5,000; Firm B: $35,000
(b) Prepare a statement of cash flows for each firm using the indirect method.
Operating Firm A Firm B
Net income $75,000 $75,000
Depreciation Expense 10,000 30,000
Accounts Receivable (40,000) (5,000)
Inventory (40,000) 10,000
Accounts Payable (20,000) (5,000)
Net Cash Provided by Operating activities $(15,000) $105,000

Investing Firm A Firm B

Property, Plant, and Equipment $(20,000) $(70,000)
Net Cash Provided by Investing activities $(20,000) $(70,000)

Financing Firm A Firm B

Note Payable $17,000 $ 2,000
Debt 20,000 (10,000)
Tax 3,000 18,000
 Dividends (5,000) (35,000)
Net Cash Flow from Financing activities $35,000 $(25,000)
(c) Analyze the differences in the 2 firms.
Firm A has a negative operational cash flow showing that the company cannot
cover operations solely from running the business. Firm B is doing very well in
this aspect. Both firms have a negative investing cash flow. This is not very good
for either firm but is especially not good for Firm A since its operational cash
flow is also negative. Firm A shows a positive financial cash flow which means
that the company is most likely struggling and they may be selling assets in order
to cover operations and debt repayments. In other words, Firm B is doing much
better than Firm A.
4.11 The following comparative balance sheets and income statement are available for Little
Bit Inc. Prepare a statement of cash flows for 2012 using the indirect method and analyze
the statement.
Little Bit, Inc.
Statement of Cash Flows
For Year Ended December 31, 2012

Cash flow from operating activities

Net income $ 5,500
Non-cash expenses included in net income:
Depreciation 18,000
Deferred income taxes 500
Cash provided (used for) current assets and liabilities
Accounts receivable (6,500)
Inventory (8,500)
Prepaid expenses (4,000)
Accounts payable 2,000
Accrued liabilities (16,000)
Net cash used by operating activities $ (9,000)
Cash flows from investing activities
Purchase of plant and equipment (6,000)
Purchase of long-term investments (1,000)
Net cash used by investing activities $ (7,000)
Cash flows from financing activities
Additions to long-term debt 17,000
Sale of common stock 15,000
Net cash provided by financing activities $ 32,000
4.12 The following cash flows were reported by Techno Inc. in 2012 and 2011.
(a) Explain the difference between net income and cash flow from operating activities for
Techno in 2012.
Net income differs from operating activities for various reasons. One reason
includes non-cash expenses that occur from the depreciation and amortization of
intangible assets. The statement reports net income figures of around $242,000 for
2011 and $316,000 in 2012. However after including depreciation, amortization,
and deferred taxes those balances elevated to around $328,000 in 2011 and
$400,000 in 2012. This is because depreciation and amortization reduce income,
 but have no effect on net cash flows. Another reason net income differs from
operating cash flows is due to the various time differences that exist between the
recognition of revenue and expense, as opposed to the actual occurrence of cash
inflows. The 2012 accounts receivable figures reveal an increase from the 2011
figures and are calculated as deductions. This indicates that further revenue from
sales was included in the net income figures than had been collected from
consumers in the form of cash.
(b) Analyze Techno Inc.’s cash flows for 2012 and 2011.
In Techno’s cash flows for years 2011 and 2012, we can see that during this
accounting period the company generated enough cash from operations to cover
their investing activities. In Techno’s financial and cash flow statements we can
see that they can generate positive cash flows that pay their dividends while they
continue to experience financial growth.