E-WAHLEN-09-1211-003.qxd:.

01/07/10 8:51 PM Page 208

208 Chapter 3 Income Flows versus Cash Flows: Understanding the Statement of Cash Flows

3.17 INTERPRETING THE STATEMENT OF CASH FLOWS. Gap Inc. oper-

ates chains of retail clothing stores under the names of Gap, Banana Republic, and Old
Navy. Exhibit 3.24 presents the statement of cash flows for Gap for Year 0 to Year 4.

EXHIBIT 3.24
Gap
Statement of Cash Flows
(amounts in millions)
(Problem 3.17)

Year 4 Year 3 Year 2 Year 1 Year 0

OPERATIONS
Net income (loss) $ 1,150 $ 1,031 $ 478 $ (8) $ 877
Depreciation 620 675 706 811 590
Other additions and subtractions (28) 180 166 30 92
(Increase) Decrease in inventories (90) 385 (258) 213 (455)
(Increase) Decrease in prepayments (18) 5 33 (13) (61)
Increase (Decrease) in
accounts payable 42 (10) (47) 42 250
Increase (Decrease) in other
current liabilities (56) (106) 165 243 (3)
Cash Flow from Operations $ 1,620 $ 2,160 $1,243 $1,318 $ 1,290

INVESTING
Fixed assets acquired $ (442) $ (261) $ (308) $ (940) $(1,859)
Changes in marketable securities 259 (2,063) (313) — —
Other investing transactions 343 6 (8) (11) (16)
Cash Flow from Investing $ 160 $(2,318) $ (629) $ (951) $(1,875)

FINANCING
Increase in short-term borrowing $ — $ — $ — $ — $ 621
Increase in long-term borrowing — 85 1,346 1,194 250
Issue of capital stock 130 26 153 139 152
Decrease in short-term borrowing — 0 (42) (735) —
Decrease in long-term borrowing (871) (668) — (250) —
Acquisition of capital stock (976) — — (1) (393)
Dividends (79) (79) (78) (76) (75)
Other financing transactions — 28 27 (11) (11)
Cash Flow from Financing $(1,796) $ (608) $1,406 $ 260 $ 544
Change in Cash $ (16) $ (766) $2,020 $ 627 $ (41)
Cash—Beginning of year 2,261 3,027 1,007 380 421
Cash—End of Year $ 2,245 $ 2,261 $3,0.27 $1,007 $ 380
Change in sales from previous year +2.6% +9.7% +4.4% +1.3% +17.5%
E-WAHLEN-09-1211-003.qxd:. 01/07/10 8:51 PM Page 209

Questions, Exercises, Problems, and Cases 209

Required
Discuss the relationship between net income and cash flow from operations and between cash
flows from operating, investing, and financing activities for the firm over the five-year period.

3.18 INTERPRETING THE STATEMENT OF CASH FLOWS. Sirius XM

Radio Inc. is a satellite radio company, formed from the merger of Sirius and XM in 2008.
Exhibit 3.25 presents a statement of cash flows for Sirius XM Radio for 2006, 2007, and
2008. Sirius XM and its predecessor, Sirius, realized revenue growth of 49 percent in 2007
and 81 percent in 2008. The merger was a stock-for-stock merger.
Required
Discuss the relation between net loss and cash flow from operations and the pattern of cash
flows from operating, investing, and financing activities during the three years.

EXHIBIT 3.25
Sirius XM Radio Inc.
Statement of Cash Flows
(amounts in thousands)
(Problem 3.18)

2008 2007 2006

CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $(5,313,288) $(565,252) $(1,104,867)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 203,752 106,780 105,749
Impairment loss 4,766,190 — 10,917
Non-cash interest expense, net of amortization of premium (6,311) 4,269 3,107
Provision for doubtful accounts 21,589 9,002 9,370
Non-cash loss from redemption of debt 98,203 — —
Loss on disposal of assets 4,879 (428) 1,661
Loss on investments, net 28,999 — 4,445
Share-based payment expense 87,405 78,900 437,918
Deferred income taxes 2,476 2,435 2,065
Other non-cash purchase price adjustments (67,843) — —
Changes in operating assets and liabilities, net of assets
and liabilities acquired:
Accounts receivable (32,121) (28,881) (1,871)
Inventory 8,291 4,965 (20,246)
Prepaid expenses and other current assets (19,953) 11,118 (42,132)
Other long-term assets (13,338) (729) (39,878)
Accounts payable and accrued expenses (65,481) 66,169 26,366
Accrued interest 23,081 (8,920) 1,239
Deferred revenue 55,778 169,905 181,003
Other long-term liabilities 64,895 1,901 3,452
Net Cash Used in Operating Activities $ (152,797) $(148,766) $ (421,702)

(Continued)
E-WAHLEN-09-1211-003.qxd:. 01/07/10 8:51 PM Page 210

210 Chapter 3 Income Flows versus Cash Flows: Understanding the Statement of Cash Flows

EXHIBIT 3.25 (Continued)

2008 2007 2006

CASH FLOWS FROM INVESTING ACTIVITIES
Additions to property and equipment $ (130,551) $ (65,264) $ (92,674)
Sales of property and equipment 105 641 127
Purchases of restricted and other investments (3,000) (310) (12,339)
Acquisition of acquired entity cash 819,521 — —
Merger-related costs (23,519) (29,444) —
Purchase of available-for-sale securities — — (123,500)
Sale of restricted and other investments 65,869 40,191 255,715
Net Cash Provided by (Used in) Investing Activities $ 728,425 $ (54,186) $ 27,329
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from exercise of warrants and stock options
and from share/borrow arrangement $ 471 $ 4,097 $ 25,787
Long-term borrowings, net of related costs 531,743 244,879 —
Payment of premiums on redemption of debt and payments
to minority interest holder (20,172) — —
Repayment of long-term borrowings (1,146,044) (625) —
Net Cash (Used in) Provided by Financing Activities $ (634,002) $248,351 $ 25,787
Net (Decrease) Increase in Cash and Cash Equivalents $ (58,374) $ 45,399 $(368,586)
Cash and cash equivalents at beginning of period 438,820 393,421 762,007
Cash and Cash Equivalents at End of Period $ 380,446 $438,820 $ 393,421

3.19 INTERPRETING THE STATEMENT OF CASH FLOWS. Sunbeam

Corporation manufactures and sells a variety of small household appliances, including toast-
ers, food processors, and waffle grills. Exhibit 3.26 presents a statement of cash flows for
Sunbeam for Year 5, Year 6, and Year 7. After experiencing decreased sales in Year 5, Sunbeam
hired Albert Dunlap in Year 6 to turn the company around. Albert Dunlap, known in the indus-
try as “Chainsaw Al,” had previously directed restructuring efforts at Scott Paper Company. The
restructuring effort at Sunbeam generally involved firing employees and cutting costs aggres-
sively. Most of these restructuring efforts took place during Year 6. The market expected signifi-
cantly improved results in Year 7. Reported sales increased 18.7 percent between Year 6 and
Year 7, and net income improved. However, subsequent revelations showed that almost half of
the sales increase resulted from fraudulent early recognition of revenues in the fourth quarter
of Year 7 that the firm should have recognized in the first quarter of Year 8. Growth in revenues
for Years 5, 6, and 7 was ⫺2.6 percent, ⫺3.2 percent, and 18.7 percent, respectively.
Required
a. Using the information provided and the statement of cash flows for Year 5 in
Exhibit 3.26, identify any signals before the turnaround effort that Sunbeam was
experiencing operating difficulties and was in need of restructuring.
b. Using information in the statement of cash flows for Year 6, identify indicators of the
turnaround efforts and any relations between cash flows that trouble you.
c. Using information in the statement of cash flows for Year 7, indicate any signals that
the firm might have engaged in aggressive revenue recognition and had not yet fixed
its general operating problems.
E-WAHLEN-09-1211-003.qxd:. 01/07/10 8:51 PM Page 211

Questions, Exercises, Problems, and Cases 211

EXHIBIT 3.26
Sunbeam Corporation
Statement of Cash Flows
(amounts in millions)
(Problem 3.19)

Year 7 Year 6 Year 5

OPERATIONS
Net income (loss) $109.4 $(228.3) $ 50.5
Depreciation and amortization 38.6 47.4 44.2
Restructuring and asset impairment charges — 283.7 —
Deferred income taxes 57.8 (77.8) 25.1
Other additions 13.7 46.2 10.8
Other subtractions (84.6) (27.1) (21.7)
(Increase) Decrease in accounts receivable (84.6) (13.8) (4.5)
(Increase) Decrease in inventories (100.8) (11.6) (4.9)
(Increase) Decrease in prepayments (9.0) 2.7 (8.8)
Increase (Decrease) in accounts payable (1.6) 14.7 9.2
Increase (Decrease) in other current liabilities 52.8 (21.9) (18.4)
Cash Flow from Operations $ (8.3) $ 14.2 $ 81.5

INVESTING
Fixed assets acquired $ (58.3) $ (75.3) $(140.1)
Sale of businesses 91.0 — 65.3
Acquisitions of businesses — (.9) (33.0)
Cash Flow from Investing $ 32.7 $ (76.2) $(107.4)

FINANCING
Increase (Decrease) in short-term borrowing $ 5.0 $ 30.0 $ 40.0
Increase in long-term debt — 11.5 —
Issue of common stock 26.6 9.2 9.8
Decrease in long-term debt (12.2) (1.8) (5.4)
Acquisition of common stock — — (13.0)
Dividends (3.4) (3.3) (3.3)
Other financing transactions .5 (.4) (.2)
Cash Flow from Financing $ 16.5 $ 45.2 $ 27.9
Change in Cash $ 40.9 $ (16.8) $ 2.0
Cash—Beginning of year 11.5 28.3 26.3
Cash—End of Year $ 52.4 $ 11.5 $ 28.3

3.20 INTERPRETING THE STATEMENT OF CASH FLOWS. Montgomery

Ward operates a retail department store chain. It filed for bankruptcy during the first
quarter of Year 12. Exhibit 3.27 presents a statement of cash flows for Montgomery Ward
for Year 7 to Year 11. The firm acquired Lechmere, a discount retailer of sporting goods
E-WAHLEN-09-1211-003.qxd:. 01/07/10 8:51 PM Page 216

216 Chapter 3 Income Flows versus Cash Flows: Understanding the Statement of Cash Flows

debt or a common stock issue. Exhibit 3.29 also shows the compound annual rate of
growth in revenues over the three-year period. The eight companies are as follows:
• Biogen creates and manufactures biotechnology drugs. Many drugs are still in the
development phase in this high-growth, relatively young industry. Research and manu-
facturing facilities are capital-intensive, although the research process requires skilled
scientists.
• ChevronTexaco explores, extracts, refines, and markets petroleum products.
Extraction and refining activities are capital-intensive. Petroleum products are in the
mature phase of their product life cycle.
• H. J. Heinz manufactures and markets branded consumer food products. Heinz has
acquired several other branded food products companies in recent years.
• Home Depot sells home improvement products. Home Depot competes in a new retail
category known as “category killer” stores. Such stores offer a wide selection of prod-
ucts in a particular product category (for example, books, pet products, or office prod-
ucts). In recent years, these stores have taken away significant market share from more
diversified department and discount stores.
• Inland Steel manufactures steel products. Although steel plants are capital-intensive,
they also use unionized workers to process iron into steel products. Demand for steel
products follows cyclical trends in the economy. Steel manufacturing in the United
States is in the mature phase of its life cycle.
• Pacific Gas & Electric provides electric and gas utility services. The electric utility indus-
try in the United States has excess capacity. Increased competition from less regulated,
more open markets has forced down prices and led some utilities to reduce their capacity.
• ServiceMaster provides home cleaning and restoration services. ServiceMaster has
recently acquired firms offering cleaning services for health care facilities and has
broadened its home services to include termite protection, garden care, and other ser-
vices. ServiceMaster operates as a partnership. Partnerships do not pay income taxes
on their earnings each year. Instead, partners (owners) include their share of the earnings
of ServiceMaster in their taxable income.
• Sun Microsystems creates, manufactures, and markets computers, primarily to the sci-
entific and engineering markets and to network applications. Sun follows an assembly
strategy in manufacturing computers, outsourcing the components from other firms
worldwide. In recent years, Sun has been rumored to be a takeover target by larger
technology companies, and during January 2010, Oracle Corporation acquired Sun
Microsystems.

Required
Use the clues in the common-size statements of cash flows to match the companies in
Exhibit 3.29 with the companies listed here. Discuss the reasoning for your selection in
each case.

3.23 PREPARING A STATEMENT OF CASH FLOWS FROM BALANCE

SHEETS AND INCOME STATEMENTS. Fuso Pharmaceutical Industries develops,
manufactures, and markets pharmaceutical products in Japan. Its main product is a solution
used by individuals with artificial kidneys. Most individuals in Japan are covered by a
national health insurance system. The Japanese government sets the policies for the propor-
tion of health care costs covered by the government versus the proportion that is the respon-
sibility of the individual. The government also establishes the prices for prescription drugs.
The Japanese economy experienced recessionary conditions in recent years. In response to
E-WAHLEN-09-1211-003.qxd:. 01/07/10 8:51 PM Page 217

Questions, Exercises, Problems, and Cases 217

these conditions, the Japanese government increased the proportion of medical costs that is
the patient’s responsibility and lowered the prices for prescription drugs. Exhibit 3.30 pre-
sents the firm’s balance sheets on March 31 of Year 1 to Year 4, and Exhibit 3.31 presents the
firm’s income statements for the years ending March 31, Year 2 to Year 4.

EXHIBIT 3.30
Fuso Pharmaceutical Industries
Balance Sheets
(amounts in millions)
(Problem 3.23)

March 31: Year 4 Year 3 Year 2 Year 1

ASSETS
Cash ¥ 6,233 ¥ 4,569 ¥ 4,513 ¥ 5,008
Accounts and notes receivable—Trade 19,003 17,828 19,703 19,457
Inventories 7,693 7,948 8,706 8,607
Deferred income taxes 1,355 1,192 948 824
Prepayments 432 325 640 634
Total Current Assets ¥34,716 ¥31,862 ¥34,510 ¥34,530
Investments 3,309 2,356 3,204 4,997
Property, plant, and equipment, at cost 71,792 71,510 71,326 71,018
Less accumulated depreciation (40,689) (38,912) (36,854) (35,797)
Deferred income taxes 236 1,608 1,481 494
Other assets 4,551 3,904 3,312 3,463
Total Assets ¥73,915 ¥72,328 ¥76,979 ¥78,705
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts and notes payable—Trade ¥10,087 ¥ 9,629 ¥10,851 ¥10,804
Notes payable to banks 10,360 10,328 9,779 10,023
Current portion of long-term debt 100 200 — —
Other current liabilities 7,200 6,170 9,779 7,565
Total Current Liabilities ¥27,747 ¥26,327 ¥30,409 ¥28,392
Long-term debt 8,140 7,889 6,487 8,147
Deferred income taxes 3,361 — — —
Employee retirement benefits 809 905 1,087 1,166
Other noncurrent liabilities 175 174 200 216
Total Liabilities ¥40,232 ¥35,295 ¥38,183 ¥37,921
Common stock ¥10,758 ¥10,758 ¥10,758 ¥10,758
Additional paid-in capital 15,012 15,012 15,012 15,012
Retained earnings 9,179 11,838 13,697 15,014
Accumulated other comprehensive income (342) (490) (659) —
Treasury stock (924) (85) (12) —
Total Shareholders’ Equity ¥33,683 ¥37,033 ¥38,796 ¥40,784
Total Liabilities and Shareholders’ Equity ¥73,915 ¥72,328 ¥76,979 ¥78,705
E-WAHLEN-09-1211-003.qxd:. 01/07/10 8:51 PM Page 218

218 Chapter 3 Income Flows versus Cash Flows: Understanding the Statement of Cash Flows

EXHIBIT 3.31
Fuso Pharmaceutical Industries
Income Statements
(amounts in millions)
(Problem 3.23)

Year Ended March 31: Year 4 Year 3 Year 2

Sales ¥41,352 ¥41,926 ¥44,226
Cost of goods sold (27,667) (27,850) (28,966)
Selling and administrative expenses (13,396) (15,243) (15,283)
Interest expense (338) (364) (368)
Income tax expense (1,823) 443 34
Net Income ¥(1,872) ¥(1,088) ¥ (357)

Required
a. Prepare a worksheet for the preparation of a statement of cash flows for Fuso
Pharmaceutical Industries for each of the years ending March 31, Year 2 to Year 4.
Follow the format of Exhibit 3.13 in the text. Notes to the financial statements indi-
cate the following:
(1) The changes in Accumulated Other Comprehensive Income relate to revalu-
ations of Investments in Securities to market value. The remaining changes in
Investments in Securities result from purchases and sales. Assume that the sales
occurred at no gain or loss.
(2) No sales of property, plant, and equipment took place during the three-year period.
(3) The changes in Other Noncurrent Assets are investing activities.
(4) The changes in Employee Retirement Benefits relate to provisions made for
retirement benefits net of payments made to retired employees, both of which
the statement of cash flows classifies as operating activities.
(5) The changes in Other Noncurrent Liabilities are financing activities.
b. Prepare a comparative statement of cash flows for Year 2, Year 3, and Year 4.
c. Discuss the relation between net income and cash flow from operations and the pat-
tern of cash flows from operating, investing, and financing transactions for Year 2,
Year 3, and Year 4.

3.24 PREPARING A STATEMENT OF CASH FLOWS FROM BALANCE

SHEETS AND INCOME STATEMENTS. Flight Training Corporation is a privately
held firm that provides fighter pilot training under contracts with the U.S. Air Force and the
U.S. Navy. The firm owns approximately 100 Lear jets that it equips with radar jammers and
other sophisticated electronic devices to mimic enemy aircraft. The company recently expe-
rienced cash shortages to pay its bills. The owner and manager of Flight Training Corporation
stated, “I was just dumbfounded. I never had an inkling that there was a problem with cash.”
Exhibit 3.32 presents comparative balance sheets for Flight Training Corporation on
December 31, Year 1 through Year 4, and Exhibit 3.33 presents income statements for Year
2 through Year 4.