Cash Flows - Chapter 13 PDF

1 Click to edit Master title style 1 Statement 4 of Cash Flows 1  2 Click to edit Master title style Af...

1 Click to edit Master title style 1 Statement 4 of Cash Flows 1  2 Click to edit Master title style After studying this chapter, you should be able to: 1. Summarize the types of cash flow activities reported in the statement of cash flows. 2. Prepare a statement of cash flows, using the indirect method. 3. Prepare a statement of cash flows, using the direct method. 2  3 Click to edit Master title style 14- 1 Objective Objective 11 Summarize the types of cash flow activities reported in the statement of cash flows. 3  4 Click to edit Master title style 14- 1 The statement of cash flows reports a firm’s major cash inflows and outflows for a period. It provides useful information about a firm’s ability to generate cash from operations, maintain and expand its operating capacity, meet its financial obligations, and pay dividends. 4  5 Click to edit Master title style Reporting Cash Flows 14- 1 The statement of cash flows reports cash flows from three types of activities: 1. Cash flows from operating activities are cash flows from transactions that affect net income. 2. Cash flows from investing activities are cash flows from transactions that affect the investments in noncurrent assets. 3. Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the business. 5  6 Click to edit Master title style Statement of Cash Flows— NetSolutions 14- 1 66  7 Click to edit Master title style Cash Flows 14- 1 Sources (increases) of Cash Uses (decreases) of Cash Operating Operating (receipts from (payments for revenues) expenses) Investing Investing (receipts from sales of (payments for noncurrent assets) acquiring noncurrent assets) Financing Financing (receipts from issuing equity and debt (payments for treasury stock, dividends, securities) and redemption of debt securities) 77  8 Click to edit Master title style Cash Flows from Operating Activities 14- 1 The direct method reports the sources of operating cash and the uses of operating cash. 88  9 Click to edit Master title style 14- 1 The indirect method reports the operating cash flows by beginning with net income and adjusting it for revenues and expenses that do not involve the receipt or payment of cash. 99  10 Click to edit Master title style 14- 1  Cash inflows from operating activities normally arise when cash is received from customers.  Cash outflows from operating activities normally arise when cash is paid to suppliers for merchandise, supplies, services and to employees for salaries and wages. 10  11 Click to edit Master title style 14- 1 A primary advantage of the direct method is that it reports the sources and uses of operating cash flows in the statement of cash flow. A primary disadvantage of the direct method is that the necessary data may not be readily available and may be costly to gather. 11  12 Click to edit Master title style 14- 1 A primary advantage of the indirect method is that it focuses on the differences between net income and cash flows from operations. Because the data are readily available, another advantage of the indirect method is that it is normally less costly to use than the direct method. 12  13 ClickDirect to and edit Master title style 3 Cash Flows from Operations: Indirect Methods— 14- 1 NetSolutions same amount 13 13  14 Click to edit Master title style Cash Flows from Investing Activities 14- 1  Cash inflows from investing activities normally arise from selling fixed assets, investments, and intangible assets.  Cash outflows from investing activities normally include payments to acquire fixed assets, investments, and intangible assets. 14  15 Click to edit Master title style Cash Flows from Financing Activities 14- 1  Cash inflows from financing activities normally arise from issuing debt or equity securities.  Cash outflows from financing activities normally include paying cash dividends, repaying debt, and acquiring treasury stock. 15  16 Click to edit Master title style Noncash Investing and Financing Activities 14- 1 Noncash investing and financing activities are transactions that do not involve cash. The effect of such transactions is recorded in a separate schedule that appears at the bottom of the statement of cash flows. 16  17 Click to edit Master title style 14- 1 IMPORTANT The financial statements, including the statement of cash flows, should not report cash flow per share. 17  18 14- 1 Click to edit Example Exercise 14-1 Master title style For each of the following, identify whether it would be disclosed as an operating, financing, or investing activity on the statement of cash flows under the indirect method. a. Purchase patent d. Net income b. Pay cash dividend e. Purchase treasury stock c. Disposal of f. Depreciation expense equipment 18 18  19 14- 1 Click to edit Master title style Follow My Example 14-1 a. Investing d. Operating b. Financing e. Financing c. Investing f. Operating For Practice: PE 14-1A, PE 14-1B 19 19  20 Click to edit Master title style 14- 2 Objective Objective 22 Prepare a statement of cash flows, using the indirect method. 20  21 Click to edit Master title style 14- 2 An efficient approach to preparing the statement of cash flows is to analyze the changes in the noncash balance sheet accounts. The logic of this approach is that a change in any balance sheet account (including Cash) can be analyzed in terms of changes in the other balance sheet accounts. 21  22 Click to edit Master title style 14- 2 The analysis of Retained Earnings provides a good starting point for determining the cash flows from operating activities, which is the first section of the statement of cash flows. 22  23 Click to edit Master title style Comparative Balance Sheet 14- 2 23 23 (Continued)  24 Click to edit Master title style Comparative Balance Sheet 14- 2 24 24 (Concluded)  25 Click to edit Master title style Retained Earnings 14- 2 The Retained Earnings account for Rundell Inc. reveals that the balance increased $80,000 during the year. ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 202,300.00 Dec. 31 Net income 108,000.00 310,300.00 31 Cash dividends 28,000.00 282,300.00 25 25  26 Click to edit Master title style 14- 2 The net income of $108,000 is entered on the statement (or working papers). ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit To statement Credit Debit Credit 2008 To statement Jan. 1 Balance 202,300.00 Dec. 31 Net income 108,000.00 310,300.00 31 Cash dividends 28,000.00 282,300.00 26 26  27 Click to edit Master Operating Activities— Rundell Inc. Cash flows from operating activities: title style 14- 2 Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: This Thisphrase phraseisisadded addedtotoindicate indicate that thataccrual accrualbasis basisnet netincome incomeisis being beingadjusted adjustedto toarrive arriveatatcash cash flows flowsfrom fromoperations. operations. 27 27 18  28 Click to edit Master title style Depreciation 14- 2 Next, we need to determine depreciation expense for the year. If it isn’t given in the income statement, sometimes it can be found by analyzing the various accumulated depreciation accounts. 28  29 Click to edit Master title style 14- 2 The comparative balance sheet (Exhibit 4: Slides 23 and 24) indicates that Accumulated Depreciation—Building increased by $7,000. By analyzing the account we can see that the increase is the result of the year-end adjusting entry. ACCOUNT Accumulated Depreciation—Building ACCT. NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 58,300.00 Dec. 31 Depr. for year 7,000.00 65,300.00 to to statement statement 29 29  30 Click to edit Master title style 14- 2 The offsetting $7,000 debit is to an expense for depreciation. The effect on the income statement was to reduced net income; however, this expense did not require an outflow of cash. Therefore, the $7,000 is added back to net income in determining cash flows from operating activities. 30  31 Click to edit Master Operating Activities—Rundell Inc. Cash flows from operating activities: title style 14- 2 Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Amortization is treated in the same manner as depreciation. 31 31  32 Click to edit Master title style Gain on Sale of Land 14- 2 The ledger or income statement of Rundell Inc. indicates that the sale of land resulted in a gain of $12,000. This gain increased net income by $12,000, yet cash flows was provided by an investing activity (selling land) rather than an operating activity, so the gain is deducted from net income on the statement of cash flows. 32  33 Click to edit Master Operating Activities—Rundell Inc. Cash flows from operating activities: title style 14- 2 Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Gain on sale of land (12,000) 33 33  34 14- 2 Click to edit Example Exercise 14-2 Master title style Omni Corporation’s accumulated depreciation increased by $12,000, while patents decreased by $3,400 between balance sheet dates. There were no purchases or sales of depreciable or intangible assets during the year. In addition, the income statement showed a gain of $4,100 from sale of land. Reconcile a net income of $50,000 to net cash flow from operating activities. 34 34  35 14- 2 Click to edit Master title style Follow My Example 14-2 Net income $50,000 Adjustments to reconcile net income from operating activities: Depreciation 12,000 Amortization 3,400 Gain on sale of land (4,100) Net cash flow from operating activities $61,300 For Practice: PE 14-2A, PE 14-2B 35 35  36 Click to edit Master title style Changes in Current Operating Assets and Liabilities 14- 2 Next, select current assets and current liabilities that impact cash flows and determine their increases and decreases. Exhibit 5 in (Slide 37) may prove to be helpful in determining how to treat increases and decreases in noncash current operating assets and current operating liabilities. 36  37 Click to edit Master title style Adjustments to Net Income (Loss) Using the Indirect Method 14- 2 37 37  38 Click to edit Master title style 14- 2 Changes in Current Accounts December 31 Increase Accounts 2008 2007 Decrease* Accounts receivable (net) $ 74,000 $ 65,000 9,000 Inventories 172,000 180,000 8,000* Accounts payable (mdse.) 43,500 46,700 3,200* Accrued expenses payable 26,500 24,300 2,200 Income taxes payable 7,900 8,400 500* Note that Cash and Dividends Payable are not included in this analysis. 38 38  39 Click to edit Master Operating Activities—Indirect Method Cash flows from operating activities: title style 14- 2 Net income $108,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 7,000 Gain on sale of land (12,000) Changes in current operating assets and liabilities: Increase in accounts receivable (9,000) Decrease in inventory 8,000 Decrease in accounts payable (3,200) Increase in accrued expenses 2,200 Decrease in income taxes payable (500) You will notice that increases actually decrease cash flows from 39 39 operating activities, and decreases do just the opposite.  40 Click to edit Master title style Statement of Cash Flows— Indirect Method for Rundell Inc. 14- 2 (Operating Activities Section) 40 40 Same information as Slide 39, only in final form.  41 14- 2 Click to edit Example Exercise 14-3 Master title style Victor Corporation’s comparative balance sheet for current assets and current liabilities was as follows: Dec. 31, 2009 Dec. 31, 2008 Accounts receivable $ 6,500 $ 4,900 Inventory 12,300 15,000 Accounts payable 4,800 5,200 Dividends payable 5,000 4,000 Adjust net income of $70,000 for changes in operating assets and liabilities. 41 41  42 14- 2 Click to edit Master title style Follow My Example 14-3 Net income $70,000 Adjustments to reconcile net income to net cash from from operating activities: Increase in accounts receivable (1,600) Decrease in inventory 2,700 Decrease in accounts payable (400) Net cash flow from operating activities $70,700 For Practice: PE 14-3A, PE 14-3B 42 42  43 14- 2 Click to edit Example Exercise 14-4 Master title style Omicron, Inc. reported the following data: Net income $120,000 Depreciation expense 12,000 Loss on disposal of equipment 15,000 Increase in Accounts receivable 5,000 Decrease in Accounts payable (2,000) Prepare the cash flow for operating activities section of the statement of cash flows using the indirect method. 43 43  44 14- Follow My Example 14-4 2 Click to edit Master title style Cash flows from operating activities: Net income $120,000 Adjustments to reconcile net income to net cash flow from operating activities: Depreciation 12,000 Loss from disposal of equipment 15,000 Changes in current operating assets and liabilities: Increase in accounts receivable (5,000) Decrease in accounts payable (2,000) Net cash flow from operating activities $140,000 44 44 For Practice: PE 14-4A, PE 14-4B  45 Click to edit Master title style Cash Flows Used for Payment of Dividends 14- 2 ACCOUNT Dividends Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 10,000 10 Cash paid 10,000 — June 20 Dividends declared 14,000 14,000 July 10 Cash paid 14,000 — Dec. 20 Dividends declared 14,000 14,000 Note that while $28,000 in dividends were declared, only $24,000 were paid during the year. 45 45  46 Click to edit Master title style 14- 2 Because paying of dividends affects equity and is an outflow of cash, it is a negative $24,000 cash flows from financing activities transaction. 46  47 Click to edit Master title style Common Stock 14- 2 Common Stock increased by $8,000. ACCOUNT Common Stock ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 16,000 Nov. 1 4,000 shares issued/cash 8,000 24,000 47 47  48 Click to edit Master title style 14- 2 Analyzing the two accounts together, we can determine that the 4,000 shares were sold for $48,000. ACCOUNT Paid-in Capital in Excess of Par—Common Stock Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 80,000 Nov. 1 4,000 shares issued/cash 40,000 120,000 48 48  49 Click to edit Master title style 14- 2 Issuing common stock affects equity; therefore, we have a positive $48,000 cash flows from financing activities item. 49  50 Click to edit Master title style Bonds Payable 14- 2 Bonds Payable decreased by $50,000. ACCOUNT Bonds Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 150,000 June 30 Retired by payment of cash at face amount 50,000 100,000 50 50  51 Click to edit Master title style 14- 2 Retiring bonds is a cash outflow reported as a negative item under cash flows from financing activities. 51  52 Click to edit Master title style Building 14- 2 By examining the Building account, we can determine that Rundell Inc. bought a building for $60,000 cash. ACCOUNT Building ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 200,000 Dec. 27 Purchased for cash 60,000 260,000 52  53 Click to edit Master title style 14- 2 Purchasing a building involves a noncurrent asset, so this is a negative cash flows from investing activity. 53  54 Click to edit Master title style Land 14- 2 The $45,000 decline in the Land account resulted from two separate transactions: a sale and a purchase. ACCOUNT Land ACCOUNT NO. Balance Date Item Debit Credit Debit Credit 2008 Jan. 1 Balance 125,000 June 8 Sold for $72,000 cash 60,000 65,000 Oct. 12 Purchased for $15,000 cash 15,000 80,000 54  55 Click to edit Master title style 14- 2 The first transaction, the sale of land, is classified as a positive cash flows from investing activity because land is a noncash asset. 55  56 Click to edit Master title style 14- 2 The $12,000 gain was recorded earlier on Slide 33 as an operating activity. The purchase of land also is an investing activity. Click the button to view Slide 33. To return to this slide, type “56” and press the “Enter” key. 56  57 Click to edit Master title style 14- 2 The second transaction is the purchase of land for cash of $15,000. This transaction is reported as an outflow of cash in the cash flows from investing activities section. 57  58 Click to edit Master title style Statement of Cash Flows— Indirect Method for Rundell Inc. 14- 2 (Partial Statement) 58 58  59 Click to edit Master title style Statement of Cash Flows— Indirect Method for Rundell Inc. 14- 2 (Partial Statement) The ending balance in the Cash account 59 59 should match this amount.  60 14- 2 Click to edit Example Exercise 14-5 Master title style Alpha Corporation purchased land for $125,000. Later in the year the company sold land with a book value of $165,000 for $200,000. How are the effects of these transactions are reported on the statement of cash flows? 60 60  61 14- 2 Click to edit Master title style Follow My Example 14-5 The gain on sale of land is deducted from net income as shown below: Gain on sale of land The purchase and sale of land is $(35,000) reported as part of cash inflow form investing activities as shown below: Cash received for sale of land $200,000 Cash paid for purchase of land (125,000) 61 61 For Practice: PE 14-5A, PE 14-5B  62 Click to edit Master title style 14- 3 Objective Objective 33 Prepare a statement of cash flows, using the direct method. 62  63 Click to edit Master title style The Direct Method 14- 3 The final amount for cash flows from operating activities will be the same whether the direct or indirect approach is used. The methods differ in how the data are obtained, analyzed, and reported. 63  64 Click to edit Master title style Data for Direct Method 14- 3 Rundell Inc. Schedule of Changes in Current Accounts December 31 Increase Accounts 2008 2007 Decrease* Cash $ 97,500 $ 26,000 $71,500 Accounts receivable (net) 74,000 65,000 9,000 Inventories 172,000 180,000 8,000* Accounts payable (merchandise creditors) 43,500 46,700 3,200* Accrued expenses payable (operating expenses) 26,500 24,300 2,200 Income taxes payable 7,900 8,400 500* Dividends payable 14,000 10,000 4,000 64 (Continued) 64  65 Rundell Inc. Click to edit Master title style Income Statement For the Year Ended December 31, 2008 14- 3 Sales $1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 (Concluded) 65 65 Other expense: Interest expense 8,000 4,000  66 Click to edit Master title style Cash Received from Customers 14- 3 The $1,180,000 of sales for Rundell Inc. is reported using the accrual method. An adjustment is necessary to convert the sales reported on the income statement to the cash method. 66  67 Click to edit Master title Cash Received from Customers Rundell Inc. style 14- 3 Income Statement For the Year Ended December 31, 2008 Sales $1,180,000 Cost of merchandiseCash sold received 790,000 from customers Changes Gross profit $ 390,000 Operating expenses: Sales $1,180,000 Depreciation expense $ 7,000 Increase in accounts rec. (9,000) Other operatingCash expenses received 196,000 from customers $1,171,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 67 67 Other expense: Interest expense 8,000 4,000  68 Click to edit Master title Cash Received from Customers Rundell Inc. style CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 Cost of merchandiseCash sold received 790,000 from customers Changes Gross profit $ 390,000 Operating expenses: Sales $1,180,000 Depreciation expense $ 7,000 Increase in accounts rec. (9,000) Other operatingCash expenses received 196,000 from customers $1,171,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 68 68 Other expense: Interest expense 8,000 4,000  69 14- 3 Click to edit Master title style Example Exercise 14-6 Sales reported on the income statement were $350,000. The accounts receivable balance declined $8,000 over the year. Determine the amount of cash received from customers. Follow My Example 14-6 Sales $350,000 Add decrease in accounts receivable 8,000 Cash received from customer $358,000 69 69 For Practice: PE 14-6A, PE 14-6B  70 Click to edit Master title Cash Payments for Merchandise Rundell Inc. style CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 Cost of merchandise sold 790,000 Cash payments for Gross profit merchandise $ 390,000 Changes Operating expenses: Depreciation expense Cost $ 7,000$790,000 of merchandise sold Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 70 70 Other expense: Interest expense 8,000 4,000  71 Click to edit Master Rundell Inc. title style CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 Cost of merchandise sold 790,000 Cash payments for Gross profit merchandise $ 390,000 Changes Operating expenses: Depreciation expense Cost $ 7,000$790,000 of merchandise sold Decrease in inventories (8,000) Other operating expenses 196,000 Decrease in accounts payable 3,200 Cash payments Total operating expensesfor 203,000 merchandise Income from operations $785,200 $ 187,000 Other income: Gain on sale of land $ 12,000 71 71 Other expense: Interest expense 8,000 4,000  72 Click to edit Master Rundell Inc. title style CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 (785,200) Cost of merchandise sold 790,000 Cash payments for Gross profit merchandise $ 390,000 Changes Operating expenses: Depreciation expense Cost $ 7,000$790,000 of merchandise sold Decrease in inventories (8,000) Other operating expenses 196,000 Decrease in accounts payable 3,200 Cash payments Total operating expensesfor 203,000 merchandise Income from operations $785,200 $ 187,000 Other income: Gain on sale of land $ 12,000 72 72 Other expense: Interest expense 8,000 4,000  73 14- 3 Click to edit Master title style Example Exercise 14-7 Cost of merchandise sold reported on the income statement was $145,000. The accounts payable balance increased $4,000, and the inventory balance increased by $9,000 over the year. Determine the amount of cash paid for merchandise. Follow My Example 14-7 Cost of merchandise sold $145,000 Add increase in inventories 9,000 Deduct increase in accounts payable (4,000) Cash payments for merchandise $150,000 73 73 For Practice: PE 14-7A, PE 14-7B  74 Click to edit Master title style Cash Payments for Operating Expenses Rundell Inc. CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 (785,200) Cost of merchandise sold 790,000 Gross profit $ 390,000 Operating expenses: Depreciation expense $ 7,000 Other operating expenses 196,000 Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 74 74 Other expense: Interest expense 8,000 4,000  75 Click to edit Master Rundell Inc. title style CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 (785,200) Cost of merchandise sold 790,000 Gross profit $ 390,000 0 Operating expenses: Depreciation expense $ 7,000 There Thereisisno nocash cashflow flowfor for Other operating expenses depreciation depreciationexpense. 196,000 expense. Total operating expenses 203,000 Income from operations $ 187,000 Other income: Gain on sale of land $ 12,000 75 75 Other expense: Interest expense 8,000 4,000  76 Click to edit Master Rundell Inc. title style CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 (785,200) Cost of merchandise sold 790,000 Gross profit $ 390,000 0 Operating expenses: (193,800) Depreciation expense $ 7,000 Cash payments for operating Other expenses operating expenses 196,000 Changes Changes Operating expenses Total operating (other than expenses 203,000 Incomedepreciation) from operations $196,000$ 187,000 Other income: in accrued expenses Increase (2,200) Gain onpayments sale of landfor operating $ 12,000 76 76 Cash Other expenses expense: $193,800 Interest expense 8,000 4,000  77 Click to edit Gain on Sale of Land Master Rundell Inc. title style CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 The Thegaingainononsale saleof ofland landof of$12,000 $12,000isis (785,200) Costincluded included in inthe of merchandise the proceeds proceedsfrom sold fromthe thesale sale 790,000 of of land, land, which which isisreported reported as aspart part of of $ Gross profit 390,000 0 cash flows flowsfrom cashexpenses: Operating frominvesting investingactivities. activities. (193,800) Depreciation expense $ 7,000 Other operating expenses 196,000 0 Total operating expenses 203,000 To avoid Income from operations $ 187,000 confusion, page Other income: numbers for the Gain on sale of land $ 12,000 remaining 77slides 77 are centered on the slides. Other expense: Interest expense 8,000 4,000  78 Click to edit Master Gain on Sale of Land Rundell Inc. title style CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 (785,200) Cash paid for Cost of merchandise sold 790,000 interest expense Changes Gross profit Interest expense 8,000 $ 390,000 0 Operating expenses: (193,800) +/- decrease/increase Depreciation expense in $ 7,000 payable 0 Other operating expenses 196,000 Cash payments for interest $8,000 0 Total operating expenses 203,000 Income from operations $ 187,000 (8,000) Other income: Gain on sale of land $ 12,000 78 78 Other expense: Interest expense 8,000 4,000  79 Click to edit Master title Cash Payments for Income Taxes Rundell Inc. style CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 (785,200) Cost of merchandise sold 790,000 Gross profit Cash payments $ 390,000 0 for income taxes Operating expenses: Changes (193,800) Depreciation Incomeexpense tax expense $ 7,000 $83,000 Add decrease in income Other operating expenses 196,000 taxes payable 500 0 Total Cashoperating payments expenses for income tax $83,500 203,000 Income from operations $ 187,000 (8,000) Other income: Gain on sale of land $ 12,000 79 (83,500) 79 Other expense: Interest expense 8,000 4,000  80 Click to edit Master title Cash Payments for Income Taxes Rundell Inc. style CASH 14- 3 Income Statement For the Year Ended December 31, 2008 BASIS Sales $1,180,000 $1,171,000 (785,200) Cost of merchandise sold 790,000 Gross profit $ 390,000 0 Operating expenses: (193,800) Depreciation expense $ 7,000 Other operating expenses 196,000 0 Total operating expenses 203,000 Income from operations $ 187,000 (8,000) Other income: Gain on sale of land $ 12,000 80 (83,500) 80 $ 100,500 Other expense: Interest expense 8,000 4,000  81 Click to edit Master title style Statement of Cash Flows— Direct Method (Operating 14- 3 Activities Section) 81 81 (Continued)  82 Click to edit Master title style Statement of Cash Flows— Direct Method (Reconciliation) 14- 3 A reconciliation is required when 82 82 the direct method is used.  83 Click to edit Master title style Financial Analysis and Interpretation 14- 3 Free cash flow is a measure of operating cash flow available for corporate purposes after providing sufficient fixed asset additions to maintain current productive capacity and dividends. 83  84 Click to edit Master title style Free Cash Flow 14- 3 Cash flow from operations Less: Investments in fixed assets to maintain current production Free cash flow Positive free cash flow is considered favorable. A company that has free cash flow is able to fund internal growth, retire debt, pay dividends, and enjoy financial flexibility. 84