CHAPTER 34

Statement of Cash Flows

Questions

Q34-1 Cash flow from operations can offer a clearer picture of a company's
performance than does net income when:
A company reports large noncash expenses, such as write-offs,
depreciation, and provisions for future obligations. Earnings may give
an overly pessimistic view of the firm.
A company is growing rapidly. Reported earnings may be positive, but
operations are actually consuming rather than generating cash.
A company badly needs to report favorable earnings, as is the case
before a major loan application or before a stock offering. In these
cases, cash flow from operations provides an excellent reality check
for reported earnings

Q34-2 Operating activities include those transactions and events that enter into the
determination of net income. Cash receipts from selling goods or from
providing services are the major cash inflows for most businesses. Major cash
outflows include payments to purchase inventory and to pay wages, taxes,
interest, utilities, rent, and similar expenses.
Investing activities are the purchase and sale of land, buildings, and equipment
and the purchase and sale of financial instruments not intended for trading
purposes.
Financing activities include transactions and events whereby cash is obtained
from or repaid to owners (equity financing) and creditors (debt financing).

Q34-3 The normal pattern of cash flow is

Operatingpositive
Investingnegative
Financingeither positive or negative

Q34-4 The direct method reports all operating cash receipts and cash payments. The
difference between cash receipts and payments is the net cash flow from
operations. The indirect method begins with net income as reported on the
statement of profit or loss and other comprehensive income, adjusts for any
noncash items (such as depreciation), and converts the accrual amounts to a
cash basis. The result of this reconciliation process is net cash flow from
operations, which will be exactly the same amount as derived using the direct
method.
34-2 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Q34-5 Many users favor the direct method because it is a straightforward approach
that is easy to understand. Most accountants prefer the indirect method because
it is easy to apply and because it helps explain or reconcile the differences
between net cash flow from operations and net income. Because accountants
already have to report net income, it is easier for them to start with that number
and convert it to net cash flow from operations rather than use the direct method

Q34-6 When the direct method is used, depreciation expense is omitted from the
calculation of cash from operating activities because it is a noncash expense.
When the indirect method is used, depreciation expense is added back to net
income because depreciation was subtracted in the original computation of net
income.

Q34-7 A loss on the sale of a long-term asset is omitted from the calculation of cash
from operating activities when using the direct method. When the indirect
method is used, the loss is added back to net income because the loss was
subtracted in the original computation of net income. In both cases, any effects
of the sale of the long-term asset are removed from the computation of
operating cash flow; cash received from the sale of long-term assets is reported
as an investing activity.

Q34-8 Significant noncash investing and financing transactions (e.g., the purchase of
land by issuing capital stock) are to be reported in the notes to the financial
statements or in a separate schedule accompanying the cash flow statement.
Because these transactions do not affect cash, they should not be reported on the
statement of cash flows itself.

Q34-9 The statement of profit or loss and other comprehensive income details the
transactions that occurred in temporary accounts that are summarized in the
retained earnings account. The statement of cash flows provides information
relating to transactions that occurred in the cash account for the period.

Q34-10 Cost of goods sold, combined with the change in the inventory balance, reveals
how much inventory was purchased during the year. Inventory purchases,
coupled with the change in the accounts payable balance for the year, are used
to calculate the amount of cash paid for inventory purchases.

Q34-11 The purpose of a statement of cash flows is to provide relevant information

about the cash receipts and cash payments of an enterprise during a period. It
differs from the statement of financial position and the statement of profit or
loss and other comprehensive income in that it reports the sources and uses of
cash by operating, investing, and financing activity classifications. While the
statement of profit or loss and other comprehensive income and the statement of
financial position are accrual basis statements, the statement of cash flows is a
cash basis statementnoncash items are omitted.
 Statement of Cash Flows 34-3
Q34-12 Operating activities involve the cash effects of transactions that enter into the
determination of net income. Investing activities include making and collecting
loans and acquiring and disposing of debt and equity instruments; property, plant,
and equipment and intangibles. Financing activities involve liability and equity
items and include obtaining capital from owners and providing them with a
return on (dividends) and a return of their investment and borrowing money
from creditors and repaying the amounts borrowed.

Q34-13 Net income is adjusted downward by deducting P5,000 from P90,000

and reporting cash provided by operating activities as P85,000.
The issuance of the share capital is a financing activity. The issuance is
reported as follows:
Cash flows from financing activities
Issuance of share capital P1,150,000
Net income is adjusted as follows:
Cash flows from operating activities
Net income P90,000
Adjustments to reconcile net income to
net cash provided by operating activities:
Depreciation expense 14,000
Amortization 5,000
Net cash provided by operating activities P109,000
The increase of P20,000 reflects a noncash investing and financing
activity. The increase in Land is reported in a footnote to the statement of
cash flows as follows:
Noncash investing and financing activities were the purchase of land
through issuance of P20,000 of long-term debt.

Q34-14 Free cash flow = P860,000 P75,000 P30,000 = P755,000.

34-4 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Exercises

E34-1 Cash Inflow

Operating (Outflow)
(d) Cash collected from customers P13,400
(b) Cash paid for interest (600)
(f) Cash paid for income taxes (1,850)
Total P10,950

Investing
(a) Cash received from sale of a building P4,200

Financing
(c) Cash paid to repurchase shares of stock (treasury P(1,100)
stock)
(e) Cash paid for dividends (930)
Total P(2,030)

E34-2 Noncash
Investing Financing (Disclose only)
(a) P(40,000) P0 P80,000
(b) 0 0 67,000
(c) 0 0 100,000
(d) 0 56,000
(30,000)
Total P(40,000) P26,000

E34-3 Accounts receivable, beginning P1,375

Plus: Sales 10,000
Cash available for collection P11,375
Less: Accounts receivable, ending (1,400)
Cash collected from customers P9,975

E34-4 Statement of Profit or Loss and Other Statement of

Comprehensive Income Adjustments Cash Flows
Sales P7,800 + 320 P8,120
Cost of goods sold (3,100) + 180 (3,130)
210
Interest expense (450) + 80 (370)
Depreciation expense (600) + 600 0
Net income P3,650 P4,620
 Statement of Cash Flows 34-5

Direct Method:
Cash collected from customers P8,120
Cash paid for inventory purchases (3,130)
Cash paid for interest (370)
Net cash flow from operating activities P4,620

E34-5 Statement of Profit or Loss and Other Statement of

Comprehensive Income Adjustments Cash Flows
Sales P7,800 + 320 P8,120
Cost of goods sold (3,100) + 180 (3,130)
210
Interest expense (450) + 80 (370)
Depreciation expense (600) + 600 0
Net income P3,650 P4,620
Indirect Method:
Net income P3,650
Plus: Depreciation 600
Plus: Decrease in accounts receivable 320
Plus: Decrease in inventory 180
Less: Decrease in accounts payable (210)
Plus: Increase in interest payable 80
Net cash flow from operating activities P4,620

E34-6 Reported income tax expense P32,000

Less: Increase in deferred tax liability (3,500)
Taxes owed for current year operations P28,500
Less: Increase in income taxes payable (390)
Cash paid for income taxes P28,110

E34-7 PPE, beginning P124,000

Less: PPE sold during the year 28,000
Ending PPE without purchase of new PPE P96,000

PPE, ending P134,000

Less: Ending PPE without purchase of new PPE 96,000
Cash paid to purchase new PPE P38,000
This assumes that all PPE purchases were for cash.

E34-8 Retained earnings, beginning P106,000

Plus: Net income 10,000
Ending retained earnings without dividend declarations P116,000
Less: Actual ending retained earnings 112,000
Dividends declared during the year P4,000
34-6 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Dividends declared during the year P4,000

Plus: Decrease in dividends payable 250
Cash paid for dividends this year P4,250

E34-9 (a) P14,000 of cash used to purchase equipment; P16,000 of cash provided
from sale of equipment. Both are investing activities. (Note: The P2,000
loss on sale would be added to net income when using the indirect
method.)
Equipment
Beginning balance 62,000 Sale of equipment 21,000
Purchase of equipment 14,000
Ending balance 55,000

(b) No cash is provided or used by depreciation; however, P4,100 is added to

net income for yearly depreciation in showing net cash flow provided by
operations when using the indirect method
Accumulated Depreciation
Sale of equipment 3,000 Beginning balance 12,800
Depreciation for year 4,100
Ending balance 13,900

(c) P5,000 (P25,000 P20,000) of cash used to pay off a portion of long-term
debt, a financing activity.
(d) P4,000 (P16,000 P12,000) of cash provided from issuance of common
stock, a financing activity.

E34-10 Cash flows from operating activities:

Net income P35,500
Adjustments:
Depreciation expense P7,000
Increase in accounts receivable (2,150)
Decrease in accounts payable (2,500)
Increase in inventories (4,500)
Increase in other current liabilities 2,000
Decrease in prepaid insurance 800 650
Net cash provided by operating activities P36,150
 Statement of Cash Flows 34-7
E34-11 Cash Flow Statement
Operating Activities
Net income P40,000
Depreciation expense P4,000
Increase in accounts receivable (10,000)
Increase in accounts payable 7,000 1,000
Net cash provided by operating activities 41,000

Investing Activities
Purchase of equipment (8,000)

Financing Activities
Issue notes payable P20,000
Dividends (5,000)
Net cash flow from financing activities 15,000
Net change in cash (P41,000 P8,000 + P15,000) P48,000
Free Cash Flow = P41,000 (Net cash provided by operating activities) P8,000
(Purchase of equipment) P5,000 (Dividends) = P28,000.

E34-14 Sale of land and building P191,000

Purchase of land (37,000)
Purchase of equipment (53,000)
Net cash provided by investing activities P101,000

Problems

P34-1 Aranes and Cruz

Statement of Cash Flows (Indirect Method)
For the Year Ended December 31, 2016
Cash flows from operating activities:
Net income P22,000
Adjustments:
Depreciation expense 15,000
Decrease in accounts receivable 2,800
Increase in inventory (14,400)
Decrease in prepaid expenses 1,250
Increase in accrued expenses 2,300
Decrease in accounts payable (10,450)
Net cash flow provided by operating activities P18,500
Cash flows from investing activities:
Purchase of furniture* P(3,200)
34-8 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Net cash used in investing activities (3,200)

Cash flows from financing activities:
Investment by Ryan Bond P2,200
Withdrawal by Trent Wallin (15,000)
Net cash used in financing activities (12,800)
Net increase in cash and cash equivalents P2,500
Cash and cash equivalents at beginning of year 12,500
Cash and cash equivalents at end of year P15,000
* Total cost of furniture was $24,500; a long-term note for $21,300 was issued for
the balance.

P34-2 1. Dec. 31 Prepaid rent = Jan. 1 Prepaid rent + Cash paid for rent Rent
expense
Dec. 31 Prepaid rent =P8,000 + P27,000 P22,000
Dec. 31 Prepaid rent = P13,000
2. Note that wages payable increased by $6,000 during the year. This is
evidenced by the addition of the change in wages payable. As a result, the
beginning balance in the wages payable account was P17,000 (P23,000
P6,000).
3. Dec. 31 Inventory = Jan. 1 Inventory + Inventory purchased on account
Cost of goods sold
P54,000 = P41,000 + P230,000 Cost of goods sold
Cost of goods sold = P217,000
4. Dec. 31 Wages payable = Jan. 1 Wages payable + Wages expense Cash paid
for wages
P23,000 = P17,000 + Wages expense P81,000
Wages expense = P87,000
5. Net income = Sales Cost of goods sold Wages expense Rent expense
Other expenses
Net income = P485,000 P217,000 [from part (3)] P87,000 [from part (4)]
P22,000 P121,000
Net income = P38,000
6. Dec. 31 Accounts receivable = Jan. 1 Accounts receivable + Sales on account
Cash collected from customers
P72,000 = P65,000 + P485,000 Cash collected from customers
Cash collected from customers = P478,000
7. Dec. 31 Accounts payable = Jan. 1 Accounts payable + Inventory purchased
on account Cash paid for inventory
P44,000 = P52,000 + P230,000 Cash paid for inventory
Cash paid for inventory = P238,000
 Statement of Cash Flows 34-9

P34-3 1. 2016 2015

Net income P59,000 P50,000
+Depreciation expense 57,000 51,000
Increase in other current assets/
+Decrease in other current assets (60,000) (30,000)
+Increase in current liabilities/
Decrease in current liabilities 55,000 (20,000)
Net cash from operating activities P111,000 P51,000

2. 2016 2015
Cash P85,000 P115,000
Other current assets 480,000 420,000
Current liabilities 325,000 310,000

2016 2015
Net income 59,000 50,000
+Depreciation expense 57,000 51,000
Increase in other current assets/
+Decrease in other current assets (60,000) (30,000)
+Increase in current liabilities/
Decrease in current liabilities 15,000 20,000
Net cash from operating activities P71,000 P91,000

3. 2016 2015
Cash P85,000 P115,000
Other current assets 480,000 380,000
Current liabilities 325,000 270,000

2016 2015
Net income P59,000 50,000
+Depreciation expense 57,000 51,000
+Decrease in other current assets (100,000) 10,000
+Increase in current liabilities/
Decrease in current liabilities 55,000 (20,000)
Net cash from operating activities P71,000 P91,000

4.
As these examples illustrate, cash from operations can be manipulated easily by
delaying payments or purchases until after the end of the period. However, the
34-10 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

examples also illustrate that total cash flow cannot be manipulatedtotal cash
flow for the years 2016 and 2015 is P162,000 in all three examples. The
manipulations only have the effect of shifting cash flow from one period to
another.

P34-4 1. 2016 2015 2014 2013

Net income P90 P90 P90 P90
+Depreciation expense 40 40 40 40
Change in accounts receivable (15) 30 0 (20)
Change in inventory (10) 25 (15) 5
Change in accounts payable 30 0 (20) 15
Net cash from operating activities P135 P185 P95 P130

2. Cash flow (net income + depreciation) is P130 each year.

3. When working capital (current assets current liabilities) is relatively constant,

the net cash from operations is about the same as the cash flow measure. This is
the case in 2016 and 2013 in the example. Firms that are not growing would
expect to have a stable level of working capital. For such firms, net income +
depreciation is a reasonable approximation for cash flow from operations.
If working capital is increasing, part of the cash generated by operations must be
used to finance the additional working capital. This will cause cash flow from
operations to be less than net income + depreciation. This is the case in 2009 in
the example. Working capital is often increasing in high-growth firms and in
firms that are having trouble collecting receivables or moving inventory.
If working capital is decreasing, extra cash is freed up in addition to the cash
generated by operations. This will cause cash flow from operations to be greater
than net income + depreciation. This is the case in 2010 in the example.
Working capital can be decreased by any combination of the following
actions: increase receivable collection efforts, reduce inventory levels,
allow payable levels to increase.

P34-5 1. Nova, Inc.

Statement of Cash Flows (Direct Method)
For the Year Ended December 31, 2016
Cash flows from operating activities:
Cash receipts from customers P698,600(a)
Cash payments for:
Inventory P367,800 (b)
Operating expenses 176,800 (c)
Interest expense 3,800 (d)
Income taxes 33,600 (e) 582,000
 Statement of Cash Flows 34-11
Net cash provided by operating activities P116,600

Cash flows from investing activities:

Sale of long-term investments P12,800 (f)
Sale of equipment 3,000 (g)
Purchase of equipment (12,000)(h)
Net cash provided by investing activities 3,800

Cash flows from financing activities:

Sale of treasury stock P6,000 (i)
Long-term note principal payment (8,000)(j)
Net cash used by financing activities (2,000)
Net increase in cash and cash equivalents P118,400
Cash and cash equivalents at beginning of year 58,000
Cash and cash equivalents at end of year P176,400

COMPUTATIONS:
(a) Cash receipts from customers:
Accounts receivable at beginning of year P26,600
Add: Sales on account 704,000
Total accounts to be collected P730,600
Less: Accounts receivable at the end of year 32,000
Total cash received from customers P698,600

(b) Cash payments for inventory:

Inventory at end of year P21,000
Add: Cost of goods sold 368,000
Total goods available for sale P389,000
Less: Inventory at beginning of year 25,400
Purchases for the year on account P363,600
Add: Accounts payable at the beginning of year 11,200
Total accounts to be paid 374,800
Less: Accounts payable at the end of year 7,000
Total cash paid for inventory P367,800

(c) Cash payments for operating expenses:

Operating expenses P185,000
34-12 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Less: Noncash item: Depreciation expense (7,000)

Less: Interest expense reported separately (2,800)
Add: Prepaid insurance at the end of year 5,600
Less: Prepaid insurance at beginning of year (4,000)
Total cash paid for operating expenses P176,800

(d) Cash payments for interest:

Interest expense P2,800
Add: Interest payable at beginning of year 2,000
Less: Interest payable at end of year (1,000)
Total cash paid for interest P3,800

(e) Cash payments for income taxes:

Income tax expense P37,600
Add: Income taxes payable at beginning of year 8,000
Less: Income taxes payable at end of year (12,000)
Total cash paid for income taxes P33,600

(f) Cash receipts from sale of long-term investments:

Long-term investments at beginning of year P16,800
Less: Long-term investments at end of year 6,000
Long-term investments sold during year P10,800
Add: Gain on sale of long-term investments 2,000
Total cash receipts on sale of long-term investments P12,800

(g) Cash receipts from sale of equipment P3,000

[As given in problem, loss on sale (P1,000) would affect net
income but not cash flow from sale.]

(h) Cash payments to purchase equipment:

Equipment at beginning of year P66,000
Less: Equipment sold 10,000
Total P56,000
Equipment at end of year 80,000
Difference is amount of equipment purchased P24,000
Paid for by issuing common stock (P10,000 + P2,000) 12,000*
Total cash paid to purchase equipment P12,000
* The issuance of common stock (including the increase in Paid-ln Capital) is
a significant financing activity but does not involve cash, and so it is not
reported directly on the cash flow statement.
 Statement of Cash Flows 34-13

(i) Cash receipts from sale of treasury stock:

Treasury stock (at cost) at beginning of year P20,000
Less: Treasury stock (at cost) at end of year 10,000
Treasury stock sold during year P10,000
Less: Reduction in retained earnings since treasury stock
sold at less than cost 4,000
Total cash receipts from sale of treasury stock P6,000

(j) Cash payments to reduce long-term notes payable:

Long-term notes payable at beginning of year P24,000
Long-term notes payable at end of year 16,000
Total cash payments to reduce principal amounts of long- P8,000
term

2. The lack of dividend payment may not seem appropriate under the current
circumstances for Nova, Inc. The cash balance has increased to more than three
times the beginning-of-the-year balance. Furthermore, this increase has
resulted primarily from operating activities, and the receivable and payable
balances seem reasonable. It appears that Nova has the necessary cash and is
in a good cash flow position to consider paying a cash dividend. It may be,
however, that the company is planning other future activities, such as plant
expansion, that would require considerable cash. Under those circumstances, the
company may not wish to pay cash dividends this year.

P34-6 (a) LOEL CORPORATION

Statement of Cash Flows
For the Year Ended December 31, 2015
Cash flows from operating activities
Net income P55,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense P13,000
Patent amortization 2,500
Loss on sale of equipment 3,000*
Increase in current liabilities 13,000
Increase in current assets (other than cash) (25,000) 6,500
Net cash provided by operating activities 61,500

Cash flows from investing activities

Sale of equipment 9,000
Addition to building (27,000)
34-14 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Investment in debt securities (16,000)

Net cash used by investing activities (34,000)

Cash flows from financing activities

Issuance of bonds 50,000
Payment of dividends (25,000)
Purchase of treasury shares (11,000)
Net cash provided by financing activities 14,000
Net increase in cash P41,500a
* [P9,000 (P20,000 P8,000)]
a
An additional proof to arrive at the increase in cash is provided as follows:

Total current assetsend of period P301,500 [from part (b)]

Total current assetsbeginning of period (235,000)
Increase in current assets during the period 66,500
Increase in current assets other than cash (25,000)
Increase in cash during year P 41,500

(b) LOEL CORPORATION

Statement of Financial Position
December 31, 2015
Assets
Non-currents assets
Long-term investments P6,000
Property, plant, and equipment
Land P30,000
Building (P20,000 + P7,000) P47,000
Less: Accum. Depreciation (P0,000
+ P,000) 34,000 113,000
Equipment (P0,000 P0,000) 70,000
Less: Accum. Depreciation (P1,000
P,000 + P,000) 12,000 58,000
Total property, plant, and equipment 201,000
Intangible assets
Patents (P0,000 P,500) 37,500
Total non-current assets 254,500
Current assets 301,500b
Total assets P556,000

Equity and Liabilities

Equity
Share capitalordinary P180,000
Retained earnings (P4,000 + P5,000 P5,000) 74,000
Less: Treasury shares 11,000
 Statement of Cash Flows 34-15
Total shareholders equity P243,000

Non-current liabilities
Bonds payable (P00,000 + P0,000) P150,000
Current liabilities (P50,000 + P3,000) 163,000
Total liabilities 313,000
Total equity and liabilities P556,000

Au: Is it correct. Pls confirm

b
The amount determined for current assets could be computed last and then is a
plug figure. That is, total liabilities and equity is computed because
information is available to determine this amount. Because the total assets
amount is the same as total liabilities and equity amount, the amount of total
assets is determined. Information is available to compute all the asset amounts
except current assets and therefore current assets can be determined by deducting
the total of all the other asset balances from the total asset balance (i.e., P556,000
P37,500 P201,000 P16,000). Another way to compute this amount, given the
information, is that beginning current assets plus the P25,000 increase in current
assets other than cash plus the P41,500 increase in cash equals P301,500.

P34-7 (a) LILY INC.

Statement of Cash Flows
For the Year Ended December 31, 2015
Cash flows from operating activities
Net income P32,000
Adjustments to reconcile net income to
net cash provided by operating activities
Depreciation expense P11,000
Gain on sale of investments (3,400)
Increase in account receivable (P41,600 P21,200) (20,400) (12,800)
Net cash provided by operating activities 19,200

Cash flows from investing activities

Sale of investments 15,000
Purchase of land (18,000)
Net cash used by investing activities (3,000)

Cash flows from financing activities

Issuance of ordinary shares 20,000
Retirement of notes payable (16,000)
Payment of cash dividends (8,200)
Net cash used by financing activities (4,200)

Net increase in cash 12,000

34-16 Solutions Manual to Accompany Financial Accounting and Reporting (Volume III)

Cash at beginning of year 20,000

Cash at end of year P32,000

Noncash investing and financing activities were the purchase of land through
issuance of P30,000 of bonds.

(b) LILY INC.

Statement of Financial Position
December 31, 2010
Assets Equity and Liabilities
Investments P20,400 (1) Share capital
Plant assets (net) 70,000 (2) ordinary P120,000 (6)
Land 88,000 (3) Retained earnings 47,000 (7)
Accounts receivable 41,600 Long-term notes
Cash 32,000 payable 25,000 (4)
P252,000 Bonds payable 30,000 (5)
Accounts payable 30,000
P252,000

(1) P32,000 (P15,000 P3,400)

(2) P81,000 P11,000
(3) P40,000 + P18,000 + P30,000
(4) P41,000 P16,000
(5) P0 + P30,000
(6) P100,000 + P20,000
(7) P23,200 + P32,000 P8,200

(c) Cash flow information is useful for assessing the amount, timing, and
uncertainty of future cash flows. For example, by showing the specific inflows
and outflows from operating activities, investing activities, and financing
activities, the user has a better understanding of the liquidity and financial
flexibility of the enterprise. Similarly, these reports are useful in providing
feedback about the flow of enterprise resources. This information should help
users make more accurate predictions of future cash flow. In addition, some
individuals have expressed concern about the quality of the earnings because
the measurement of the income depends on a number of accruals and estimates
which may be somewhat subjective. As a result, the higher the ratio of cash
provided by operating activities to net income, the more comfort some users
have in the reliability of the earnings. In this problem the ratio of cash provided
by operating activities to net income is 60% (P19,200 P32,000).
Statement of Cash Flows 34-17