appendix b

Appendix B

Constructing the Statement of Cash Flows

QUESTIONS

Q B-1 Cash equivalents are short-term, highly liquid investments that firms acquire with temporarily idle cash to earn interest on these excess funds. To be classified as a 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 not sensitive to interest rate changes (generally, investments with initial maturities of three months or less). Three examples of cash equivalents are Treasury bills, commercial paper, and money market funds.

Q B-2 Cash equivalents are included with cash in a statement of cash flows because the purchase and sale of such investments are considered to be part of a firm's overall management of cash rather than a source or use of cash. Similarly, as statement users evaluate cash flows, it may matter very little to them whether the cash is on hand, deposited in a bank account, or invested in cash equivalents.

Q B-3 Operating activitiesInflow: Cash received from customersOutflow: Cash paid to suppliers and service providers

Investing activitiesInflow: Sale of equipment or investments such as stocks and bondsOutflow: Purchase of equipment or stocks and bonds

Financing activitiesInflow: Issuance of stock or debtOutflow: Payment of dividends, repurchase of stock, or repayment of debt

Q B-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, shown as supplemental information under indirect

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

Q B-5 This is a noncash investing and financing event. It must be reported in a supplementary schedule to the statement of cash flows.

©Cambridge Business Publishers, 2010

Solutions Manual, Appendix B B-1

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

Q B-7 A statement of cash flows helps external users assess the amount, timing, and uncertainty of future cash flows to the enterprise. These assessments help users evaluate their own future cash receipts from their investments in, or loans to, the firm. A statement of cash flows shows the periodic cash effects of a firm's operating, investing, and financing activities. Distinguishing among these different categories of cash flows helps users compare, evaluate, and predict cash flows. With cash flow information, creditors and investors are better able to 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 analyze management's investing and financing policies. A statement of cash flows also provides information useful in evaluating a firm's financial flexibility (which is its ability to generate cash to respond to unanticipated needs and opportunities).

Q B-8B1 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 (or reconciliation) method, in contrast, presents the net cash flow from operating activities by applying a series of adjustments to the accrual net income to convert it to a cash basis.

Q B-9 Under the indirect method, depreciation is added to net income because as a noncash expense, it was deducted in computing net income. Adding depreciation to net income, therefore, eliminates it from the cash basis income amount. Amortization and depletion expenses are also added back to net income under the indirect method.

Q B-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 of cash flows. In addition, the $28,000 gain from the sale will be deducted from net income as one of the adjustments made to determine the net cash flow from operating activities.


Financial Accounting for MBAs, 4th EditionB-2

Q B-11 Net Income......................................................................................................... $ 88,000Add (Deduct) Items to Convert Net Income to Cash Basis

Depreciation.................................................................................................... 6,000Accounts Receivable Decrease..................................................................... 13,000Inventory Increase.......................................................................................... (9,000)Accounts Payable Decrease.......................................................................... (3,500)Income Tax Payable Increase........................................................................ 1,500

Net Cash Provided by Operating Activities...................................................... $ 96,000

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

Q B-13 The statement of cash flows will show a positive net cash flow from operating activities if operating cash receipts exceed operating cash payments. This could happen, for example, if noncash expenses (such as depreciation and amortization) exceed the net loss. It would also happen if operating cash receipts exceed sales by more than the loss or if operating cash payments are less than accrual expenses by more than the loss (or some combination of these events).

Q B-14B1 Sales $925,000+ Accounts receivable decrease 14,000 = Cash received from customers $939,000

Q B-15 B1 Wages expense $ 86,000+ Wages payable decrease 1,100 = Cash paid to employees $ 87,100

Q B-16B1 Advertising expense $ 43,000+ Prepaid advertising increase 1,600 = Cash paid for advertising $ 44,600

Q B-17B1 Under the direct method, the $5,100 cash received from the sale of equipment will appear in the cash flows from investing activities section of the statement of cash flows. There is loss on disposal reported in the operating activities section because the direct method is used. However, this loss would be included as a reconciling item under the indirect method.

Q B-18B1 The separate disclosures required for a company using the direct method in the statement of cash flows are (1) a reconciliation of net income to net cash flow from operating activities, (2) all noncash investing and financing transactions, and (3) the policy for determining which highly liquid, short-term investments are treated as cash equivalents.



Q B-19 The operating cash flow to current liabilities ratio is calculated by dividing net cash flow from operating activities by average current liabilities. This ratio is a measure of a firm's ability to liquidate its current liabilities with cash generated from operations.

Q B-20 The operating cash flow to capital expenditures ratio is calculated by dividing a firm's cash flow from operating activities by its annual capital expenditures. A ratio below 1.00 means that the firm's current operating activities do not provide enough cash to cover the capital expenditures. A ratio above 1.0 is normally considered a sign of financial strength.

Q B-21 a. The revenue recognition principle states that, in general, revenues are recognized when services are performed or goods are sold. The matching concept states that to the extent possible, all expenses related to a given revenue are matched with and deducted from that revenue in the determination of net income.

b. The revenue recognition principle and the matching concept define the essence of accrual accounting. In accrual accounting, revenues are recognized when they are both earned and realized or realizable (revenue recognition principle) and expenses are recorded in the period they help to generate the recorded revenues (matching concept). As such, accrual revenues are a better indicator of periodic financial accomplishment than are cash inflows, and accrual expenses are a better indicator of the financial effort needed to generate the revenues than are the period's cash outflows. Receipts and payments of cash, while important, do not necessarily represent the period's financial accomplishments and the cost of the associated financial efforts. An income statement prepared under accrual accounting, therefore, is a better report on periodic financial performance than a statement of cash flows.



MINI EXERCISES

M B-22 (10 minutes)

a. Cash inflow from an operating activity.b. Cash inflow from an investing activity.c. Cash outflow from an investing activity.d. Cash outflow from an operating activity.e. Cash inflow from a financing activity.f. Cash outflow from a financing activity.g. Cash outflow from an investing activity.

M B-23 (10 minutes)

a. Cash outflow from a financing activity.b. Cash inflow from an operating activity.c. Noncash investing and financing activity.d. Cash inflow from an operating activity.e. Cash outflow from an operating activity.f. None of the above (a change in the composition of cash and cash

equivalents).

M B-24 (15 minutes)—INDIRECT METHOD

Net Income $ 45,000Add (Deduct) Items to Convert Net Income to Cash Basis

Depreciation 8,000Gain on Sale of Investments (9,000)Accounts Receivable Increase (9,000)Inventory Increase (6,000)Prepaid Rent Decrease 2,000Accounts Payable Increase 4,000Income Tax Payable Decrease (2,000)Net Cash Provided by Operating Activities $ 33,000



M B-25 (15 minutes)—INDIRECT METHOD

Net Loss $(21,000)Add (Deduct) Items to Convert Net Loss to Cash Basis

Depreciation 8,600Accounts Receivable Decrease 9,000Inventory Decrease 3,000Prepaid Expenses Decrease 3,000Accounts Payable Increase 4,000Accrued Liabilities Decrease (2,600)Net Cash Provided by Operating Activities $ 4,000

Cairo Company's 2009 operating activities provided $4,000 cash.

M B-26 (15 minutes)—DIRECT METHOD

a. Rent Expense $ 60,000– Prepaid Rent Decrease (2,000)= Cash Paid for Rent $ 58,000

b. Interest Income $ 16,000– Interest Receivable Increase (700)= Cash Received as Interest $ 15,300

c. Cost of Goods Sold $ 98,000+ Inventory Increase 3,000+ Accounts Payable Decrease 4,000= Cash Paid for Merchandise Purchased $105,000

M B-27 (15 minutes)—DIRECT METHOD

Sales $825,000– Accounts Receivable Increase (11,000)= Cash Received from Customers $814,000

Cost of Goods Sold $550,000+ Inventory Increase 13,000+ Accounts Payable Decrease 6,000= Cash Paid for Merchandise Purchased $569,000



EXERCISESE B-28 (15 minutes)—INDIRECT METHOD

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

E B-29 (30 minutes)—INDIRECT METHOD

LUND CORPORATION

STATEMENT OF CASH FLOWS

FOR YEAR ENDED DECEMBER 31, 2009Operating Activities

Net Income $76,000Add (Deduct) Items to Convert Income to Cash Basis

Depreciation 29,000Amortization 6,000Gain on Sale of Equipment (4,000)Accounts Receivable Increase (4,000)Inventory Decrease 13,000Prepaid Expenses Increase (2,000)Accounts Payable Increase 9,000Accrued Liabilities Decrease (3,000)

Net Cash Provided by Operating Activities $120,000Investing Activities

Sale of Equipment 17,000Purchase of Land (90,000)Net Cash Used by Investing Activities (73,000)

Financing ActivitiesIssuance of Common Stock 35,000Retirement of Bonds Payable (60,000)Payment of Dividends (29,000)Net Cash Used by Financing Activities (54,000)

Net Decrease in Cash (7,000)Cash at Beginning of Year 22,000Cash at End of Year $ 15,000



E B-30 (20 minutes)—INDIRECT METHOD

Nike, Inc.STATEMENT OF CASH FLOWS ($ MILLIONS)

Forecasted FOR YEAR ENDED May 31, 2009

Net income.....................................................................................$2,130.2 Add (Deduct) Items to Convert Net Income to Cash Basis

Depreciation.............................................................................. 345.0 Amortization............................................................................. 39.0 Accounts receivable................................................................ (392.7)Inventories................................................................................ (345.6)Deferred Income taxes*........................................................... 15.1 Prepaid expenses and other current assets.......................... (77.7)Accounts payable..................................................................... 178.4 Accrued liabilities..................................................................... 257.1 Income taxes payable.............................................................. 12 .0

Net cash flow from operating activities $2,160.8

*Deferred income taxes (in millions) = $120.5 - $31.8– $73.6 = $15.1

EB-31 (15 minutes)—INDIRECT METHOD

General Mills, Inc.STATEMENT OF CASH FLOWS ($ MILLIONS)

Forecasted FOR YEAR ENDED May 25, 2009Net earnings.................................................................................. $1,444 Add (Deduct) Items to Convert Net Income to Cash Basis

Depreciation.............................................................................. 479 Amortization............................................................................. 5 Receivables............................................................................... (101)Inventories................................................................................ (131)Accounts Payable.................................................................... 96

Net cash flow from operating activities $1,792



E B-32B1 (20 minutes)—DIRECT 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


MASON CORPORATION


FOR YEAR ENDED DECEMBER 31, 2009

Cash Flows from Operating ActivitiesCash Received from Customers $194,000Cash Received as Interest 6,000 $200,000Cash Paid to Employees and Suppliers 148,000Cash Paid as Income Taxes 11,000 (159,000)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




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

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

E B-35 (20 minutes)

a. Cash flows from investing activities will showPurchase of Stock Investments.............................................. $ (80,000)Sale of Stock Investments....................................................... 59,000

b. Cash flows from financing activities will showIssuance of Bonds................................................................... $103,000Retirement of Bonds............................................................... (131,000)



PROBLEMS

P B-36 (45 minutes)—INDIRECT METHOD

a. Cash, December 31, 2009............................................................ $11,000Cash, December 31, 2008............................................................ 5,000Cash increase during 2009.......................................................... $ 6,000

b. (INDIRECT METHOD)WOLFF COMPANY



Net Cash Flow from Operating ActivitiesNet Income $56,000Add (Deduct) Items to Convert Net Income to Cash Basis

Depreciation 17,000Accounts Receivable Increase (9,000)Inventory Increase (30,000)Prepaid Insurance Decrease 2,000Accounts Payable Decrease (3,000)Wages Payable Increase 3,000Income Tax Payable Decrease (1,000)Net Cash Provided by Operating Activities $35,000

Cash Flows from Investing ActivitiesPurchase of Plant Assets (55,000)

Cash Flows from Financing ActivitiesIssuance of Bonds Payable 55,000Payment of Dividends (29,000) Net Cash Provided by Financing Activities 26,000

Net Increase in Cash 6,000Cash at Beginning of Year 5,000Cash at End of Year $11,000




Best Buy Co., Inc.STATEMENT OF CASH FLOWS ($ MILLIONS)

Forecasted FOR YEAR ENDED March 1, 2009

Net Cash Flow from Operating ActivitiesNet income.......................................................................$1,563 Add (Deduct) Items to Convert Net Income to Cash Basis

Depreciation................................................................. 98 Receivables.................................................................. (63)Inventories.................................................................... (537)Accounts payable........................................................ 490 Accrued expenses....................................................... 154 Income taxes payable.................................................. 45 Net cash flow from operating activities..................... $1,750

Cash Flows from Investing ActivitiesPurchase of Plant Assets................................................ (888)

Cash Flows from Financing ActivitiesLong-term debt................................................................ (189)Dividends......................................................................... (227)Net cash flows from financing activities....................... (416)

Net increase in cash............................................................. 446 Beginning cash..................................................................... 1,438 Ending cash.......................................................................... $1,884




a. Cash, December 31, 2009......................................................... $49,000Cash, December 31, 2008......................................................... 28,000Cash increase during 2009....................................................... $21,000

b. (INDIRECT METHOD)

ARCTIC COMPANY



Operating ActivitiesNet Loss $ (42,000)Add (Deduct) Items to Convert Net Lossto Cash Basis

Depreciation 22,000Gain on Sale of Land (25,000)Accounts Receivable Decrease 8,000Inventory Decrease 6,000Prepaid Advertising Decrease 3,000Accounts Payable Decrease (14,000)Interest Payable Increase 6,000

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

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

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

Net Increase in Cash 21,000

Cash at Beginning of Year 28,000Cash at End of Year $ 49,000

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




a. Cash, December 31, 2009......................................................... $27,000Cash, December 31, 2008......................................................... 18,000Cash increase during 2009....................................................... $ 9,000

b. (INDIRECT METHOD)

DAIR COMPANY



Net Cash Flow from Operating ActivitiesNet Income $ 85,000Add (Deduct) Items to Convert Net Incometo Cash Basis

Depreciation 22,000Goodwill Amortization 7,000Loss on Bond Retirement 5,000Accounts Receivable Increase (5,000)Inventory Decrease 6,000Prepaid Expenses Increase (2,000)Accounts Payable Increase 6,000Interest Payable Decrease (3,000)Income Tax Payable Decrease (2,000)

Net Cash Provided by Operating Activities 119,000

Cash Flows from Investing ActivitiesSale of Equipment 17,000

Cash Flows from Financing ActivitiesRetirement of Bonds Payable (125,000)Issuance of Common Stock 24,000Payment of Dividends (26,000)Net Cash Used by Financing Activities (127,000)

Net Increase in Cash 9,000Cash at Beginning of Year 18,000Cash at End of Year $ 27,000



P B-39—continued

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......................................... 2,000

Cash paid for income taxes............................................$38,000

(2) Schedule of Noncash Investing and Financing ActivitiesIssuance of Bonds Payable to Acquire Equipment................ $ 60,000



P 40 (50 minutes)—INDIRECT METHOD

Cisco Systems, Inc.STATEMENT OF CASH FLOWS ($ MILLIONS)

Forecasted FOR YEAR ENDED July 26, 2009

Net Cash Flow from Operating ActivitiesNet income........................................................................$9,037 Add (Deduct) Items to Convert Net Income

to Cash BasisDepreciation................................................................. 1,954 Amortization................................................................. 732 Receivables.................................................................. (504)Inventories.................................................................... (163)Accounts payable........................................................ 115 Income taxes payable.................................................. 14 Accrued compensation............................................... 320 Deferred revenue......................................................... 818 Net cash flow from operating activities..................... $12,323

Cash Flows from Investing ActivitiesPurchase of property, plant and equipment............. (1,435)

Cash Flows from Financing ActivitiesPayment of long-term debt......................................... (500)

Net increase in cash......................................................... 10,388 Cash at Beginning of Year............................................... 5,191 Cash at End of Year $15,579




a. Cash and Cash Equivalents, December 31, 2009...................... $19,000Cash and Cash Equivalents, December 31, 2008...................... 25,000 Cash and Cash Equivalents decrease during 2009................... $ 6,000

b.RAINBOW COMPANY



Operating ActivitiesNet Income................................................................... $ 97,000Add (Deduct) Items to Convert Net Income

to Cash BasisDepreciation............................................................ 39,000Patent Amortization................................................ 7,000Loss on Sale of Equipment.................................... 5,000Gain on Sale of Investments.................................. (10,000)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

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)

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



P B-41—continued

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



P B-42 (35 minutes)—DIRECT METHOD

a. Cash, December 31, 2009 $11,000Cash, December 31, 2008 5,000 Cash increase during 2009 $ 6,000

b.Wolff COMPANY



Cash Flows from Operating Activities

Cash Received from Customers $626,000

Cash Paid for Merchandise Purchased $ 463,000

Cash Paid to Employees 83,000

Cash Paid for Insurance 6,000

Cash Paid for Interest 9,000

Cash Paid for Income Taxes 30,000 591,000

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 26,000

Net Increase in Cash 6,000

Cash at Beginning of Year 5,000

Cash at End of Year $ 11,000



P B-43B1 (50 minutes)—DIRECT METHOD

a. Cash, December 31, 2009................................................... $49,000Cash, December 31, 2008................................................... 28,000 Cash increase during 2009................................................. $21,000

b.ARCTIC COMPANY



Operating ActivitiesCash Received from Customers $736,000Cash Paid for Merchandise Purchased $ 542,000Cash Paid to Employees 190,000Cash Paid for Advertising 28,000Cash Paid for Interest 12,000 772,000Net Cash Used by Operating Activities (36,000)

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

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 equipment purchased is equal to the sum of the increase in PPE assets account ($138,000) and the book value of the land sold ($45,000).




a. Cash, December 31, 2009......................................................... $27,000Cash, December 31, 2008......................................................... 18,000 Cash increase during 2009....................................................... $ 9,000

b.DAIR COMPANY



Cash Flows from Operating ActivitiesCash Received from Customers..................................... $695,000Cash Paid for Merchandise Purchased..........................$428,000Cash Paid for Wages and Other Operating Expenses... 97,000Cash Paid for Interest...................................................... 13,000Cash Paid for Income Taxes........................................... 38,000 (576,000)Net Cash Provided by Operating Activities.................... 119,000

Cash Flows from Investing ActivitiesSale of Equipment............................................................ 17,000

Cash Flows from Financing ActivitiesRetirement of Bonds Payable.......................................... (125,000)Issuance of Common Stock............................................ 24,000Payment of Dividends...................................................... (26,000)Net Cash Used by Financing Activities.......................... (127,000)

Net Increase in Cash............................................................. 9,000Cash at Beginning of Year.................................................... 18,000Cash at End of Year............................................................... $ 27,000



P B-44—continued

c.

(1) Reconciliation of Net Income to Net Cash Flow from Operating Activities

Operating ActivitiesNet Income $ 85,000Add (Deduct) Items to Convert Net Income

to Cash BasisDepreciation 22,000

Goodwill Amortization 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 $119,000

(2) Schedule of Noncash Investing and Financing Activities

Issuance of Bonds Payable to Acquire Equipment $ 60,000




a. Cash and Cash Equivalents, December 31, 2009 $19,000Cash and Cash Equivalents, December 31, 2008 25,000 Cash and Cash Equivalents decrease during 2009 $ 6,000

b.RAINBOW COMPANY



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..................................................... 12,000Cash Paid for Income Taxes.......................................... 46,000 (654,000)Net Cash Provided by Operating Activities................... 101,000

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)

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



P B-45—continued

c.

(1) Reconciliation of Net Income to Net Cash Flow from Operating Activities

Net Income $ 97,000Add (Deduct) Items to Convert Net Income

to Cash BasisDepreciation 39,000

Patent Amortization 7,000

Loss on Sale of Equipment 5,000

Gain on Sale of Investments (10,000)

Accounts Receivable Increase (10,000)

Inventory Increase (26,000)

Prepaid Expenses Increase (4,000)

Accounts Payable Increase 4,000

Interest Payable Increase 1,000

Income 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



P B-46 (45 minutes)

a. Depreciation is a noncash expense that is deducted in the computation of net income. The depreciation add-back zeros this expense out of the income statement to focus on cash profitability. The positive amount for depreciation does not mean that the company is generating cash from depreciation, a common misconception. It is merely an adjustment to remove that expense from the computation of profit.

b. Under current GAAP, companies are required to estimate the expense related to stock compensation expense and include that expense in the computation of net income. That form of compensation, however, is paid with stock, not with cash. As a result, this is a noncash expense. The addition of $263 million eliminates that expense from the statement of cash flows in much the same way that the addition of depreciation expense eliminates that expense in part a above.

c. When employees exercise stock options, the company receives a tax benefit that reduces taxes paid and increases after-tax cash flow (under current GAAP, this cash inflow is reported as a financing activity). The cash flow benefit, however, only occurs if employees exercise their stock options, and the size of the tax benefit will depend on the market price of the stock. The implication is an important one: we cannot forecast a continuation of the cash inflows relating to the tax benefits of stock options because we cannot predict what the market price of the stock will be when the options are exercised.

d. The positive sign on accounts receivable indicates that accounts receivable decreased during the year. The negative sign in the previous two years indicates that receivables increased in each of those years.

e. The expense relates to the write-down of PPE that Amgen deemed to be impaired. This is a noncash expense. The add-back of $404 million zeros out this expense in much the same way that the add-back of depreciation expense zeros out that noncash expense.



P B-46—continued

f. During 2007, Amgen generated $5,401 million in cash flows from operating activities. It used $1,992 million for investing activities, primarily to purchase property, plant and equipment (PPE) and to acquire other companies. The company also used $2,668 million for financing activities, primarily relating to the repurchase of common stock. In sum, the cash flow picture of the company is healthy. It is generating significant operating cash flows and is using that source of funds to grow the infrastructure (PPE) of the business and to acquire other businesses as well as to purchase its common stock.



P B-47 (45 minutes)

a. Depreciation is a noncash expense that is deducted in the computation of net income. The depreciation add-back zeros this expense out of the income statement to focus on cash profitability. The positive amount for depreciation does not mean that the company is generating cash from depreciation, a common misconception. It is merely an adjustment to remove that expense from the computation of profit.

b. Under current GAAP, companies are required to estimate the expense related to stock compensation expense and include that expense in the computation of net income. That form of compensation, however, is paid by stock, not by cash. As a result, this is a noncash expense. The addition of $173,343 thousand eliminates that expense from the statement of cash flows in much the same way that the addition of depreciation expense eliminates that expense in part a above.

c. The $470,377 thousand outflow relating to the purchase of property, plant and equipment (PPE) should not be a source of concern provided that the PPE acquisitions are related to the company’s operating activities. If so, the company is growing its infrastructure and this should be considered positively.

d. The $(966,187) thousand in cash used for financing activities primarily

results from a cash outflow of $760,977 thousand relating to the purchase of common (treasury) stock and the $(207,552) thousand payment of dividends. This should not necessarily be viewed negatively provided that the company is otherwise healthy. If it is not, however, the distribution of cash to the shareholders may come at the expense of creditors and will not be viewed positively from their perspective. In this case, the payment of nearly $1 billion of cash to the shareholders does not appear to be damaging the company as Staples’ cash flow from operating activities is strong. The company also reduced debt by nearly $200,000 thousand.

e. Staples presents a “healthy” cash flow picture in 2007. It generated

$1,361,016 thousand of operating cash flow and used $470,377 thousand to grow its infrastructure. The company also used the remaining cash to pay to repurchase common stock, to pay down debt, and to pay dividends to shareholders.



appendix b

Documents

known cash

idle cash

net cash flow

cash basis income

cash flow information

future cash payments

future cash receipts

firms future cash flows