Question

100 Required Abbreviated income statements for The GAP appear below: a. Why might Tang's loan officer be concerned about the com- Year 7 Year 8 pany's ability to repay the loan? b. What steps can Tang management take to reduce the bank's Sales $5,284 $6,508 risk on the loan? Cost of goods sold -3,285 -4,022 Selling and administrative -1,250 -1,632 expenses 5.8 Preparing and Interpreting the Statement of Cash Flows Income tax expense -296 -320 The annual reports from Year 7 and Year 8 of The GAP, a global Net income $453 $534 clothing retailer, indicate the following changes in its balance sheet accounts (amounts in millions): Additional data: Year 7 Year 8 • The cash balance was $486 at the end of Year 7 and $914 at the end of Year 8. Cash $2 decrease $428 increase • The firm did not sell property, plant and equipment in either Marketable securities (current 46 decrease 46 decrease asset) year. Merchandise inventories 96 increase 154 increase Changes in other noncurrent assets resulted from investing Prepaid expenses 1 increase 56 increase activities. Property, plant and equipment 372 increase 466 increase Required (at cost) Accumulated depreciation a. Prepare statements of cash flows for Year 7 and Year 8. 215 increase 270 increase Other noncurrent assets 51 increase 15 increase b. Comment on the relationship between net income and CFFO, and on the relationship between operating, investing, and Accounts payable 114 increase 134 increase financing cash flows. Compare Year 7 with Year 8. Notes payable to banks 18 increase 45 increase (current liability) Income taxes payable 26 increase 7 decrease Other current liabilities 90 increase 123 increase Bonds payable 577 increase Common stock 360 decrease 524 decrease Retained earnings 369 increase 455 increase +

Answer 1

Working notes: Net income Increase in Retained earnings balance Cash dividend paid in millions Year 7 Year 8 $453 $534 $369 $455 $84 $79 in millions THE GAP Statement of Cash flows (Indirect method) For The Year Ended Year 7 Cash flows from Operating Activities Net Income $453 Adjustments to reconcile net profit to net cash provided by Operating Activities Depreciation and amortization $215 Change in operating current assets and liabilities Increase in Inventory -$96 Increase in Prepaid expense -$1 Increase in Accounts payable $114 Increase in Income tax payable $261 Increase in other current liabilities $90 $348 Net Cash from Operating Activities $801 Cash flows from Investing Activities Sale of marketable securities $46 Increase in non current assets -$51 purchase of PPE -$372 Net Cash from Investing Activities -$377 Cash flows from Financing Activities Borrowing through short term note payable $18 Repurchase of common stock -$360 Cash dividend paid -$84 Net Cash from Financing Activities -$426 Net increase (decrease) in cash -$2 Cash balance at beginning of the year $488 Cash balance at end of the year $486 in millions THE GAP Statement of Cash flows (Indirect method) For The Year Ended Year 8 Cash flows from Operating Activities Net Income $534 Adjustments to reconcile net profit to net cash provided by Operating Activities Depreciation and amortization $270 Change in operating current assets and liabilities Increase in Inventory -$154 Increase in Prepaid expense -$56 Increase in Accounts payable $134 Decrease in Income tax payable -$7 Increase in other current liabilities $123 $310 Net Cash from Operating Activities $844 Cash flows from Investing Activities Sale of marketable securities $461 Increase in non current assets -$15 purchase of PPE -$466 Net Cash from Investing Activities -$435 Cash flows from Financing Activities Issue of bonds payable $577 Borrowing through short term note payable $45 Repurchase of common stock -$5241 Cash dividend paid -$79 Net Cash from Financing Activities $19 Net increase (decrease) in cash $428 Cash balance at beginning of the year $486 Cash balance at end of the year $914 b The Net income is prepared on accrual basis concept. The cash flows are prepared through movement in cash balances The cash flow adds back non cash expense and considers operating current assets changes for cash inflows and outflows from operating activities. In Year 7 there is cash inflow from operating activities mainly from current liabilities increase The cash flow from operating activities has been used for purchase of fixed assets and repurchase of common stock In Year 8, Additional financing has been arranged through bonds payable which increase the overall cash position of the firm