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198 CHAPTER 6 Financial Statements

SU M M A R Y OF STUDY OBJECTIVES
1. Distinguish between multiple-step and single-step income 5. Indicate the primary purpose of the statement of cash flows.
statements. A multiple-step income statement shows numer- The primary purpose of the statement of cash flows is to pro-
ous steps in determining net income, including nonoperating vide information about the cash receipts and cash payments
activities sections. In a single-step income statement, all data during a period. A secondary objective is to provide informa-
are classified under two categories (revenues or expenses), tion about the operating, investing, and financing activities dur-
and net income is determined in one step. ing the period.
2. Explain the computation and importance of gross profit. 6. Distinguish among operating, investing, and financing
Gross profit is computed by subtracting cost of goods sold from activities. Operating activities include the cash effects of
net sales. Gross profit represents the merchandising profit of transactions that enter into the determination of net income.
a company. The amount and trend of gross profit are closely Investing activities involve cash flows resulting from changes
watched by management and other interested parties. in investments and long-term asset items. Financing activities
3. Distinguish between departmental and consolidated income involve cash flows resulting from changes in long-term liabil-
statements. A consolidated income statement is a summary ity and stockholders’ equity items.
statement of all the departmental income statements of a 7. Prepare a statement of cash flows using the indirect
property. method. The preparation of a statement of cash flows in-
4. Understand the relationship between the income statement volves three major steps: (1) Determine the net increase or
and the balance sheet. Any dollar a business makes as net in- decrease in cash. (2) Determine net cash provided (used) by
come will flow from the income statement as profit to the bal- operating activities. (3) Determine net cash flows provided
ance sheet to add into the retained earnings or equity account. (used) by investing and financing activities. Under the indi-
These funds flow into cash as a debit and retained earnings rect method, accrual basis net income is ad-
justed to net cash provided by operating ac-
or equity as a credit. The business will then have more cash
tivities.
✓THE
for investment in the future to buy more assets and to gener- NAVIGATOR
ate more revenues. The cycle keeps on going.

GL O S S A R Y
Administrative expenses Expenses relating to general oper- Nonoperating activities Revenues and expenses from aux-
ating activities such as personnel management, accounting, iliary operations and gains and losses unrelated to the com-
and store security (p. 174). pany’s operations (p. 172).
Consolidated income statement A combined income statement Operating activities Cash flow activities that include the
of all departmental income statements of an entity (p. 176). cash effects of transactions that create revenues and ex-
Financing activities Cash flow activities that include (a) ob- penses and thus enter into the determination of net income
taining cash from issuing debt and repaying the amounts bor- (p. 179).
rowed and (b) obtaining cash from stockholders and pro- Other expenses and losses A nonoperating activities section
viding them with a return on their investment (p. 179). of the income statement that shows expenses from auxiliary
Income from operations Income from a company’s principal operations and losses unrelated to the company’s operations
operating activity; determined by subtracting cost of goods (p. 172).
sold and operating expenses from net sales (p. 174). Other revenues and gains A nonoperating activities section
Indirect method A method of preparing a statement of cash of the income statement that shows revenues from auxiliary
flows in which net income is adjusted for items that did not operations and gains unrelated to the company’s operations
affect cash, to determine net cash provided by operating ac- (p. 172).
tivities (p. 186). Selling expenses Expenses associated with making sales
Investing activities Cash flow activities that include (a) ac- (p. 174).
quiring and disposing of investments and productive long- Single-step income statement An income statement that
lived assets and (b) lending money and collecting on those shows only one step in determining net income (or net loss)
loans (p. 179). (p. 174).
Multiple-step income statement An income statement that Statement of cash flows A financial statement that provides
shows numerous steps in determining net income (or net information about the cash receipts and cash payments of
loss) (p. 170). an entity during a period, classified as operating, investing,
Net sales Sales less sales returns and allowances and sales dis- and financing activities, in a format that reconciles the be-
counts (p. 171). ginning and ending cash balances (p. 178).
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Exercises 199

EX E R C I S E S
6-1 Explain where each of the following items would appear (1) on a multiple-step income Contrast presentation in
statement and (2) on a single-step income statement: (a) gain on sale of equipment, (b) casu- multiple-step and single-step
alty loss from vandalism, and (c) cost of goods sold. income statements.
(SO 1)
6-2 Presented below are the components in Clearwater Seafood’s income statement. Deter- Compute missing amounts in
mine the missing amounts. determining net income.
(SO 2)
Cost of Gross Operating Net
Sales Goods Sold Profit Expenses Income
(a) $75,000 ? $28,600 ? $10,800
(b) $108,000 $70,000 ? ? $29,500
(c) ? $71,900 $99,600 $39,500 ?

6-3 In its income statement for the year ended December 31, 2008, Bach Resort & Spa reported Prepare multiple-step and
the following condensed data. single-step income statements.
(SO 1)
Administrative expenses $ 435,000 Selling expenses $ 490,000
Cost of goods sold 1,289,000 Loss on sale of equipment 10,000
Interest expense 70,000 Net sales 2,342,000
Interest revenue 28,000
Instructions
(a) Prepare a multiple-step income statement.
(b) Prepare a single-step income statement.
6-4 The T-accounts for Equipment and the related Accumulated Depreciation for Stone Determine cash received in
Kitchen Equipment Company at the end of 2008 are as follows. sale of equipment.
(SO 6, 7)

Equipment Accumulated Depreciation

Beg. bal. 80,000 Disposals 22,000 Disposals 5,500 Beg. bal. 44,500
Acquisitions 41,600 Depr. 12,000
End. bal. 99,600 End. bal. 51,000

Stone Kitchen Equipment Company’s income statement reported a loss on the sale of equip-
ment of $4,900. What amount was reported on the statement of cash flows as “cash flow from
sale of equipment”?
6-5 Blair Restaurant Supply reported net income of $2.5 million in 2008. Depreciation for the Compute cash provided by
year was $180,000, accounts receivable decreased $350,000, and accounts payable decreased operating activities—indirect
$310,000. Compute net cash provided by operating activities using the indirect method. method.
(SO 7)
6-6 The net income for Karen Gourmet Foods for 2008 was $280,000. For 2008, depreciation Compute cash provided by
on plant assets was $60,000, and the company incurred a loss on sale of plant assets of $10,000. operating activities—indirect
Compute net cash provided by operating activities under the indirect method. method.
(SO 7)
6-7 Each of the following items must be considered in preparing a statement of cash flows for Indicate statement presentation
Janeway Travel for the year ended December 31, 2008. For each item, state how it should be of selected transactions.
shown in the statement of cash flows for 2008. (SO 6)

(a) Issued bonds for $300,000 cash.

(b) Purchased equipment for $140,000 cash.
(c) Sold land costing $20,000 for $20,000 cash.
Compute net cash provided by
(d) Declared and paid a $50,000 cash dividend.
operating activities using
6-8 The comparative balance sheets for Mogilny Tours show the following changes in noncash indirect method.
current asset accounts:Accounts receivable decrease $75,000; prepaid expenses increase $16,000; (SO 6)
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200 CHAPTER 6 Financial Statements

and inventories increase $30,000. Compute net cash provided by operating activities using the
indirect method, assuming that net income is $250,000.
Classify items by activities. 6-9 Classify the following items as an operating, an investing, or a financing activity. Assume
(SO 6) all items involve cash unless there is information to the contrary.
(a) Purchase of equipment.
(b) Sale of building.
(c) Redemption of bonds.
(d) Depreciation.
(e) Payment of dividends.
(f) Issuance of capital stock.
Classify transactions by type of 6-10 Antoine Winery had the following transactions during 2008:
activity. 1. Issued $50,000 par value common stock for cash.
(SO 6)
2. Collected $11,000 of accounts receivable.
3. Declared and paid a cash dividend of $25,000.
4. Sold a long-term investment with a cost of $15,000 for $15,000 cash.
5. Issued $200,000 par value common stock upon conversion of bonds having a face value
of $200,000.
6. Paid $14,000 on accounts payable.
7. Purchased a machine for $30,000, giving a long-term note in exchange.
Instructions
Analyze the seven transactions, and indicate whether each transaction resulted in a cash flow
from (a) operating activities, (b) investing activities, (c) financing activities, or (d) noncash
investing and financing activities.
Prepare the operating activities 6-11 Duggan Sports Bar reported net income of $195,000 for 2008. Duggan also reported
section—indirect method. depreciation expense of $25,000, and a loss of $5,000 on the sale of equipment. The compara-
(SO 6) tive balance sheets show an increase in accounts receivable of $15,000 for the year, an $8,000
increase in accounts payable, and a decrease in prepaid expenses of $7,000.
Instructions
Prepare the operating activities section of the statement of cash flows for 2008 using the indi-
rect method.
Prepare the operating activities 6-12 The current sections of Blues Traveler Co. balance sheets at December 31, 2007 and 2008,
section—indirect method. are presented below.
(SO 3)
BLUES TRAVELER CO.
Comparative Balance Sheets (partial)
December 31
2008 2007
Current assets
Cash $105,000 $ 99,000
Accounts receivable 110,000 85,000
Inventory 171,000 186,000
Prepaid expenses 27,000 32,000
Total current assets $413,000 $402,000
Current liabilities
Accrued expenses payable $ 15,000 $ 5,000
Accounts payable 88,000 92,000
Total current liabilities $103,000 $ 97,000

Blues Traveler’s net income for 2008 was $163,000. Depreciation expense was $30,000.
Instructions
Prepare the operating activities section of Blues Traveler’s statement of cash flows for the year
ended December 31, 2008, using the indirect method.
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Exercises 201

FINANCIAL REPORTING PROBLEM: PepsiCo

6-13 The financial statements of PepsiCo are presented in Appendix A at the end of this text-
book.
Instructions
Answer the following questions using the Consolidated Statement of Income:
(a) What was the percentage change in (1) sales and (2) net income from 2004 to 2005 and
from 2005 to 2006?
(b) What was the company’s gross profit rate in 2004, 2005, and 2006?
(c) What was the company’s percentage of net income to net sales in 2004, 2005, and 2006?
Comment on any trend in this percentage.

FINANCIAL REPORTING PROBLEM: PepsiCo

6-14 Refer to the financial statements of PepsiCo, presented in Appendix A, and answer the
following questions:
(a) What was the amount of net cash provided by operating activities for the year ended De-
cember 30, 2006? For the year ended December 31, 2005?
(b) What was the amount of increase or decrease in cash and cash equivalents for the year
ended December 30 2006? For the year ended December 31, 2005?
(c) Which method of computing net cash provided by operating activities does PepsiCo use?
(d) From your analysis of the 2006 statement of cash flows, did the change in accounts and
notes receivable require or provide cash? Did the change in inventories require or provide
cash? Did the change in accounts payable and other current liabilities require or provide
cash?
(e) What was the net outflow or inflow of cash from investing activities for the year ended
December 30, 2006?
(f) What was the amount of interest paid in the year ended December 30, 2006? What was the
amount of income taxes paid in the year ended December 30, 2006? (See Note 14.)

EXPLORING THE WEB

6-15 Purpose: Learn about the Securities and Exchange Commission (SEC).
Address: www.sec.gov/index.html
Step
From the SEC homepage, choose About the SEC.
Instructions
Answer the following questions:
(a) How many enforcement actions does the SEC take each year against securities law viola-
tors? What are typical infractions?
(b) After the Great Depression, Congress passed the Securities Acts of 1933 and 1934 to im-
prove investor confidence in the markets. On which two commonsense notions are these
laws based?
(c) Who was the president of the United States at the time of the creation of the SEC? Who
was the first SEC chairperson?

ETHICS CASE

6-16 Puebla Corporation is a medium-sized hotel corporation. It has ten stockholders, who have
been paid a total of $1 million in cash dividends for eight consecutive years. The policy of the
board of directors requires that in order for this dividend to be declared, net cash provided by
operating activities as reported in Puebla’s current year’s statement of cash flows must be in
excess of $1 million. President and CEO Phil Monat’s job is secure so long as he produces an-
nual operating cash flows to support the usual dividend.
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202 CHAPTER 6 Financial Statements

At the end of the current year, controller Rick Rodgers presents President Monat with
some disappointing news: The net cash provided by operating activities is calculated, by the in-
direct method, to be only $970,000. The president says to Rick, “We must get that amount above
$1 million. Isn’t there some way to increase operating cash flow by another $30,000?” Rick an-
swers, “These figures were prepared by my assistant. I’ll go back to my office and see what I
can do.” The president replies, “I know you won’t let me down, Rick.”
Upon close scrutiny of the statement of cash flows, Rick concludes that he can get the op-
erating cash flows above $1 million by reclassifying a $60,000, two-year note payable listed in
the financing activities section as “Proceeds from bank loan—$60,000.” He will report the note
instead as “Increase in payables—$60,000” and treat it as an adjustment of net income in the
operating activities section. He returns to the president saying, “You can tell the board to de-
clare their usual dividend. Our net cash flow provided by operating activities is $1,030,000.”
“Good man, Rick! I knew I could count on you,” exults the president.
Instructions
(a) Who are the stakeholders in this situation?
(b) Was there anything unethical about the president’s actions? Was there anything unethical
about the controller’s actions?
(c) Are the board members or anyone else likely to discover the misclassification?

✓
■
■ Remember to go back to the Navigator box on the chapter-opening page and
check off your completed work.