In its 2005 Annual Report to Shareholders, Henchman & Co. Provided the following Statement of Cash Flows:

Years ended December 31, $ in millions	2005		2004
Operating Activities
Sources of Cash
Cash received from customers
Progress payments	$3,102		$ 1,438
Other collections	11,148		7,003
Proceeds from litigation settlement	220
Interest received	17		17
Income tax refunds received	23		15
Other cash receipts	24		10
Cash provided by operating activities	14,534		8,483
Uses of Cash
Cash paid to suppliers and employees	13,251		7,250
Interest paid	333		165
Income taxes paid	126		57
Other cash payments	7		1
Cash used in operating activities	13,717		7,473
Net cash provided by operating activities	817		1,010

Investing Activities
Payment for businesses purchased, net of	(3,061	)	(510	)
cash acquired
Additions to property, plant and equipment	(393	)	(274	)
Collection of note receivable	148
Proceeds from sale of property, plant and	86		44
equipment
Proceeds from sale of businesses	18		668
Other investing activities	(2	)	(6	)
Net cash used in investing activities	(3,204	)	(78	)
Financing Activities
Proceeds from issuance of long-term debt	1,491
Proceeds from equity security units	690
Borrowings under lines of credit	1,173
Repayment of borrowings under lines of	(1,306	)	(175	)
credit
Principal payments of long-term debt/	(119	)	(485	)
capital leases
Proceeds from issuance of stock	825		19
Dividends paid	(158	)	(114	)
Other financing activities	(64	)	_____
Net cash provided by (used in) financing	2,532		(755	)
activities
Increase in cash and cash equivalents	145		177
Cash and cash equivalents at beginning of year	319		142
Cash and cash equivalents at end of year	$ 464		$ 319

130. What method (direct or indirect) does Henchman & Co. use to present its Statement of Cash Flows? Explain how you can tell.

Answer: Henchman & Co. uses the direct method, one of very few companies that do. One can tell this by the fact that they simply list sources and uses of cash in the operating activities section, rather than starting with net income and making the series of adjustments necessary to work back to operating cash flows.

Learning Objective: 1 Level of Learning: 3

131. What was the net change in cash and cash equivalents experienced by Henchman & Co. during 2005? Was it positive or negative?

Answer: $145 million positive change (increase).

Learning Objective: 2 Level of Learning: 3

132. Which type of activity (operating, investing, financing) was most responsible for the net change in cash and cash equivalents experienced by Henchman & Co. during 2005?

Answer: Financing activities were most responsible.

Learning Objective: 3 Level of Learning: 3

133. (a.) What is the most significant change in operating cash outflow activity in 2005 relative to

2004?

(b.) What balance sheet accounts would likely have changed during 2005 in relation to the

cash flow change that you identify in (a)?

Answer:

1. Cash payments to suppliers and employees increased from $7,250 million to $13,251 million.

2. Accounts Payable and Wages/Salaries Payable probably are the accounts that would have changed.

Learning Objective: 3 Level of Learning: 3

134. What was most responsible for the negative cash flow from financing activities during 2004? What amount was paid?

Answer: Principal payments on long-term debt and capital leases were $485 million.

Learning Objective: 6 Level of Learning: 3

135. What was most responsible for the positive cash flow from financing activities during 2005? What amount was received?

Answer: Proceeds from issuance of long-term debt were $1,491 million.

Learning Objective: 6 Level of Learning: 3

Use the following to answer questions 136-139:

In its 2005 Annual Report to Shareholders, Kinney Inc. reported the following Consolidated Statement of Cash Flows:

For the years ended December 31,

	2005	2004
Cash flow from operations:
Cash received from customers	$197,942,040	$211,773,952
Cash paid to suppliers and employees	-191,276,791	-200,474,336
Interest paid, net	-1,563,990	-2,098,523
Income taxes paid	-406,650	-542,250
Cash provided by operations	4,694,609	8,658,843
Cash flow from investing activities:
Capital expenditures and acquisitions	-3,003,579	-1,667,382
Expenditures for other assets	-43,560	137,420
Cash used in investing activities	-3,047,139	-1,804,802
Cash flow from financing activities:
Principal payments of long-term debt and capitalized leases	-2,062,485	-6,370,175
Addition to long-term debt and capitalized leases	5,817,348	1,434,847
Changes in restricted unexpended IRB cash	-2,748,970	-
Purchase of common stock and other capital transactions	-1,605,906	-908,231
Payment of dividends	-855,558	-1,021,968
Cash provided by (used in) financing activities	-1,455,571	-6,865,527
Net increase (decrease) in cash	191,899	-11,486
Cash at beginning of year	192,615	204,101
Cash at end of year	$ 384,514	$ 192,615

	2005	2004
Reconciliation of net income to net cash provided by operations:
Net income	$1,747,833	$2,382,027
Depreciation and amortization	3,505,504	3,525,087
Deferred income taxes	205,000	344,766
Changes in assets and liabilities, net of acquisitions:
Decrease (increase) in receivables	-2,897,353	4,120,668
Decrease (increase) in inventories	-355,508	6,041,490
Increase (decrease) in prepaid expenses	361,648	-94,350
Increase (decrease) in controlled disbursements	373,394	83,718
Increase (decrease) in accounts payable	1,768,676	-8,164,148
Increase (decrease) in accrued expenses	-14,585	417,616
Other, net		1,969
Cash provided by operations	$4,694,609	$8,658,843

136. Assuming the decrease in accrued expenses during fiscal year 2005 included a $20,000 reduction due to taxes, compute the income tax expense for Kinney in that year.

Answer:

The reduction in accrued taxes is actually a reduction in taxes payable, a liability. Therefore, beg. taxes payable + income tax expense – income tax deferred – income taxes paid = end. taxes payable

Therefore, income tax expense = (end. taxes payable - beg. taxes payable) + income taxes deferred + income taxes paid = $(20,000) + $205,000 + $406,650

= $591,650

Learning Objective: 3 Level of Learning: 3

137. Assuming the decrease in accrued expenses during fiscal year 2005 included a $14,000 reduction due to interest on debt, compute the interest expense (net) for Kinney in that year.

Answer:

The reduction in accrued expenses is actually a reduction in interest payable, a liability. Therefore,

beg. interest payable + interest expense (net) – interest paid = end. interest payable

Therefore, interest expense =

(end. interest payable – beg. interest payable) + interest paid

= $(14,000) + 1,563,990

= $1,549,990

Learning Objective: 3 Level of Learning: 3

138. Kinney reported cost of goods sold of $168,114,150 in its fiscal 2005 income statement. Compute its net inventory purchases during the year.

Answer:

Assuming that there were no inventory impairments, the computation is as follows:

CGS = beg. inventory + net purchases – end. inventory. Therefore,

net purchases = CGS + (end. inventory – beg. inventory)

= $168,114,150 + 355,508

= $168,469,658

Learning Objective: 3 Level of Learning: 3

139. Kinney reported cost of goods sold of $168,114,150 in its fiscal 2005 income statement. Assuming that Kinney uses accounts payable strictly for inventory purchases and that all such purchases are on credit, how much cash did Kinney pay during the year for inventories:

1. to inventory suppliers?

2. to employees?

Answer:

1. Assuming that there were no inventory impairments, the computation is as follows:

CGS = beg. inventory + net purchases – end. inventory. Therefore,

net purchases = CGS + (end. inventory – beg. inventory)

= $168,114,150 + 355,508

= $168,469,658

end. acct. payable = beg. acct. payable + net inventory purchases – cash paid to suppliers

Therefore,

(end. acct. payable - beg. acct. payable) + cash paid to suppliers = net inventory purchases $1,768,676 + cash paid to suppliers = $168,469,658

Cash paid to suppliers = $168,469,658 - $1,768,676

= $166,700,982

2. Cash paid to suppliers and employees is $191,276,791. Therefore,

Cash paid to employees

= $191,276,791 - $166,700,982

= $24,575,809

Learning Objective: 3 Level of Learning: 3

Essay

Instructions:

The following answers point out the key phrases that should appear in students' answers. They are not intended to be examples of complete student responses. It might be helpful to provide detailed instructions to students on how brief or in-depth you want their answers to be.

140. Since the statement of cash flows has been required only since 1988, is the reporting of cash flows a new concept? Explain.

Answer: No. Financial reporting on a cash basis was common several decades ago. The requirement for a cash flow statement represents a renewed emphasis on cash flow reporting. Prior to the mid-1930s, preparing financial statements on the cash basis, rather than the accrual basis, was a common practice.

Learning Objective: 1 Level of Learning: 1

141. Is depreciation a source of cash? Explain.

Answer: No. Depreciation is simply the systematic and rational allocation of an asset's cost. The expenditure to acquire the item being depreciated was a use of cash. When the indirect method is used to determine cash flows from operating activities, depreciation is added back to net income on the statement of cash flows because it was deducted on the accrual basis income statement but it did not require the use of cash.

Learning Objective: 4 Level of Learning: 1

142. Why is the statement of cash flows required as part of the set of external financial statements?

Answer: The FASB in statement No. 95 requires the statement of cash flows in direct response to FASB Concept Statement No. 1, which states as the primary objective of financial reporting to "provide information to help investors and creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise."

Learning Objective: 1 Level of Learning: 2

143. Why are "cash equivalents" included as part of cash on the statement of cash flows?

Answer: Skilled managers will invest temporarily idle cash in short-term investments to earn a return on those funds, rather than maintaining an unnecessarily large checking account. The FASB views short-term, highly liquid investments that can be easily converted into cash, with little risk of loss, to be the equivalent of cash.

Learning Objective: 2 Level of Learning: 2

144. What are the general guidelines for an investment to be considered a cash equivalent?

Answer: To be classified as a cash equivalent, an investment must have a maturity date not longer than three months from the date of purchase. The investment must be easily convertible into cash, with little risk of loss on the conversion. However, flexibility is permitted in designating cash equivalents. Each company must establish a policy regarding which short-term, highly liquid investments it classifies as cash equivalents. The policy should be consistent with the company's customary motivation for acquiring various investments and should be disclosed in the notes accompanying the financial statements.

Learning Objective: 2 Level of Learning: 1

145. What activities are included on the statement of cash flows under the section entitled "Cash flows from investing activities"?

Answer: Cash flows from investing activities include the sale or purchase of operating assets, the sale or purchase of nontrading investments, and the collection or making of loans to others.

Learning Objective: 5 Level of Learning: 1

146. What activities are included on the statement of cash flows under the section entitled "Cash flows from financing activities"?

Answer: Cash flows from financing activities include the issuance and repurchase of stock, the issuance and repayment of bonds and notes, and the payment of cash dividends.

Learning Objective: 6 Level of Learning: 1

147. Do "cash flows from operating activities" report all the elements of the income statement on a cash basis? Explain.

Answer: Although the cash flows from operating activities section of a statement of cash flows reports income statement elements on a cash basis, not all the elements from the income statement are necessarily reported on a cash basis. No cash effects are reported for depreciation and amortization. Further, no cash effect is reported for gains or losses from the sale of operational assets. When these operational assets are bought and sold, the effect is reported under "cash flows from investing activities."

Learning Objective: 1 Level of Learning: 2

148. Does the statement of cash flows report only transactions that cause an increase or decrease in cash? Explain.

Answer:

A statement of cash flows reports transactions that cause an increase or decrease in cash. However, some transactions that do not increase or decrease cash, but which result in significant investing and financing activities, must be reported in related disclosure notes. Examples of noncash transactions that are important or significant enough to be reported include:

1. Acquiring an asset by incurring debt or issuing stock,

2. Acquiring an asset by entering into a capital lease,

3. Converting debt into common stock,

4. Exchanging noncash assets or liabilities for other noncash assets or liabilities.

Learning Objective: 1 Level of Learning: 2

Use the following to answer questions 149-150:

In its 2005 Annual; Report to Shareholders, Netherlands Corporation included the following information on cash flows from operations:

CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
	2005		2004
Operating activities:
Net income	$ 10,680		$30,100
Adjustments to reconcile to net cash provided
by operating activities:
Depreciation and amortization	25,734		20,051
Deferred income taxes	5,156		9,885
Equity income	(486	)	(864	)
Changes in operating assets and liabilities:
Receivables	17,888		(33,018	)
Inventories	39,331		(10,173	)
Accounts payable and accrued expenses	(23,737	)	13,515
Prepaids and other-net	(10,913	)	5,893
Net Cash Provided By Operating Activities	63,653		35,389

149. Explain why Netherlands Corporation subtracts equity income from its net income in its measurement of operating cash flows.

Answer: Under the equity method, income accrues to the investor company when it is earned by the investee company, not when dividends are distributed. In effect, Netherlands Corporation has earned investment revenue that has been included in its income statement. However, this amount does not involve cash until PVH receives dividends (that will be reported as investment inflows). Therefore, Netherlands Corporation makes an adjustment to eliminate this non-cash equity income from the company's operating cash flows.

Learning Objective: 4 Level of Learning: 3

150. Did accounts receivable increase or decrease during 2005?

Answer: The accounts receivable balance decreased during 2005. This is apparent because adjustments for current assets are inversely related to the direction of the change in balance. Because the adjustment for accounts receivable was positive, its balance must have decreased.

Learning Objective: 4 Level of Learning: 3

Spiceland/Sepe/Tomassini, Intermediate Accounting, Fourth Edition 157