REVIEW PROBLEM

Rockford Company’s comparative balance sheet for 2012 and the company’s income statement for the year follow:

Additional data:
1. Rockford paid a cash dividend in 2012.
2. The $4 million loss on sale of equipment reflects a transaction in which equipment with an original cost of
$12 million and accumulated depreciation of $5 million was sold for $3 million in cash.
 3. Rockford did not purchase any long-term investments during the year. There was no gain or loss on the sale
of long-term investments.
4. Rockford did not retire any bonds payable during 2012, or issue or repurchase any common stock.
Required:
1. Using the indirect method, determine the net cash provided by operating activities for 2012.
2. Construct a statement of cash flows for 2012.

Solution to Review Problem

The first task you should complete before turning your attention to the problem’s specific requirements is to compute
the changes in each balance sheet account as shown below (all amounts are in millions):

Requirement 1:
You should perform three steps to compute the net cash provided by operating activities.
Step 1: Add depreciation to net income.
To complete this step, apply the equation on page 543 as follows:

Step 2: Analyze net changes in noncash balance sheet accounts that affect net income. To complete this step, apply
the logic from Exhibit 12–2 as follows:
Step 3: Adjust for gains/losses included in the income statement. Rockford's $4 million loss on the sale of equipment
must be added to net income.
Having completed these three steps, the operating activities section of the statement of cash flows would appear as
follows:

Requirement 2:
To finalize the statement of cash flows, we must complete the investing and financing sections of the statement. This
requires analyzing the Property, Plant, and Equipment; Long-Term Investments; Bonds Payable; Common Stock; and
Retained Earnings accounts. The table below is based on Exhibit 12–3 and it captures the changes in four account
balances for Rockford.
The data at the beginning of the problem state that Rockford did not purchase any long-term investments during the
year and that there was no gain or loss on the sale of long-term investments. This means that the $15 million
decrease in Long-Term Investments corresponds with a $15 million cash inflow from the sale of long-term
investments that is recorded in the investing section of the statement of cash flows. The data also state that Rockford
did not retire any bonds payable during the year; therefore, the $95 million increase in Bonds Payable must be due to
issuing bonds payable. This cash inflow is recorded in the financing section of the statement of cash flows.
The Common Stock account had no activity during the period, so it does not impact the statement of cash flows.
This leaves two accounts that require further analysis—Property, Plant, and Equipment and Retained Earnings.
The company sold equipment that had an original cost of $12 million for $3 million in cash. The cash proceeds
from the sale need to be recorded in the investing activities section of the statement of cash flows. The cash outflows
related to Rockford’s investing activities can be computed using the basic equation for assets mentioned on page
540:

Rockford’s Retained Earnings account and the basic equation for stockholders’ equity (introduced on page 540) can
be used to compute the company’s dividend payment as follows:

The company’s complete statement of cash flows is shown below. Notice that the net increase in cash and cash
equivalents ($16 million) equals the change in the Cash and Cash Equivalents account balance.
THE FOUNDATIONAL 15

Ravenna Company is a merchandiser that uses the indirect method to prepare the operating activities section of its
statement of cash flows. Its balance sheet for this year is as follows:

During the year Ravenna paid a $6,000 cash dividend and it sold a piece of equipment for $3,000 that had originally
cost $6,000 and had accumulated depreciation of $4,000. The company did not retire any bonds or repurchase any of
its own common stock during the year.
Required:
1. What is the amount of the net increase or decrease in cash and cash equivalents that would be shown on
the company’s statement of cash flows?
2. What net income would the company include on its statement of cash flows?
3. How much depreciation would the company add to net income on its statement of cash flows?
4. (To help answer this question, create an Accounts Receivable T-account and insert the beginning and
ending balances.) If the company credited sales and debited accounts receivable for $600,000 during the
year, what is the total amount of credits recorded in accounts receivable during the year? What does the
amount of these credits represent?
5. What is the amount and direction (+ or -) of the accounts receivable adjustment to net income in the
operating activities section of the statement of cash flows? What does this adjustment represent?
6. (To help answer this question, create T-accounts for Inventory and Accounts Payable and insert their
beginning and ending balances.) If the company debited cost of goods sold and credited inventory for
$400,000 during the year, what is the total amount of inventory purchases recorded on the debit side of the
Inventory T-account and the credit side of the Accounts Payable T-account? What is the total amount of the
debits recorded in the Accounts Payable T-account during the year? What does the amount of these debits
represent?
7. What is the combined amount and direction (+ or -) of the inventory and accounts payable adjustments to
net income in the operating activities section of the statement of cash flows? What does this amount
represent?
8. (To help answer this question, create an Income Taxes Payable T-account and insert the beginning and
ending balances.) If the company debited income tax expense and credited income taxes payable $700
during the year, what is the total amount of the debits recorded in the Income Taxes Payable account? What
does the amount of these debits represent?
9. What is the amount and direction (+ or -) of the income taxes payable adjustment to net income in the
operating activities section of the statement of cash flows? What does this adjustment represent?
10. Would the operating activities section of the company’s statement of cash flows contain an adjustment for a
gain or a loss? What would be the amount and direction (+ or -) of the adjustment?
11. What is the amount of net cash provided by operating activities in the company’s statement of cash flows?
12. What is the amount of gross cash outflows reported in the investing section of the company’s statement of
cash flows?
13. What is the company’s net cash provided by (used in) investing activities?
14. What is the amount of gross cash inflows reported in the financing section of the company’s statement of
cash flows?
15. What is the company’s net cash provided by (used in) financing activities?
EXERCISES
EXERCISE 12–1 Classifying Transactions [LO1]
Below are certain events that took place at Hazzard, Inc., last year:
a. Paid bills to insurers and utility providers.
b. Purchased equipment with cash.
c. Paid wages and salaries to employees.
d. Paid taxes to the government.
e. Loaned money to another entity.
f. Sold common stock.
g. Paid a cash dividend to stockholders.
h. Paid interest to lenders.
i. Repaid the principal amount of a debt.
j. Paid suppliers for inventory purchases.
k. Borrowed money from a creditor.
l. Paid cash to repurchase its own stock.
m. Collected cash from customers.
Required:
Prepare an answer sheet with the following headings:

Enter the cash inflows and outflows above on your answer sheet and indicate how each of them would be classified
on a statement of cash flows. Place an X in the Operating, Investing, or Financing column as appropriate.

EXERCISE 12–2 Net Cash Provided by Operating Activities [LO2]

For the just completed year, Strident Company had net income of $84,000. Balances in the company’s current asset
and current liability accounts at the beginning and end of the year were as follows:

The Accumulated Depreciation account had total credits of $50,000 during the year.
Required:
Using the indirect method, determine the net cash provided by operating activities for the year.
EXERCISE 12–3 Calculating Free Cash Flow [LO3]
Paisley Company prepared the following statement of cash flows for the current year:

Required:
Compute Paisley Company’s free cash flow for the current year.

EXERCISE 12–4 Prepare a Statement of Cash Flows; Free Cash Flow[LO1, LO2, LO3]
Comparative financial statement data for Holly Company are given below:
For this year, the company reported net income as follows:

This year Holly declared and paid a cash dividend. There were no sales of plant and equipment during this year. The
company did not repurchase any of its own stock this year.
Required:
1. Using the indirect method, prepare a statement of cash flows for this year.
2. Compute Holly’s free cash flow for this year.

PROBLEM 12–8A Prepare a Statement of Cash Flows [LO1, LO2]

A comparative balance sheet and income statement for Eaton Company follow:
 During 2011, Eaton sold some equipment for $18 that had cost $30 and on which there was accumulated
depreciation of $10. In addition, the company sold long-term investments for $12 that had cost $7 when purchased
several years ago. A cash dividend was paid during 2011 and the company, repurchased $40 of its own stock. Eaton
did not retire any bonds during 2011.
Required:
1. Using the indirect method, determine the net cash provided by operating activities for 2011.
2. Using the information in (1) above, along with an analysis of the remaining balance sheet accounts, prepare
a statement of cash flows for 2011.