McGraw-Hill /Irwin © 2009 The McGraw-Hill Companies, Inc.

THE STATEMENT OF THE STATEMENT OF CASH FLOWS CASH FLOWS REVISITEDREVISITED

Chapter 21

Slide 2

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Investing ActivitiesOperating Activities Financing ActivitiesSale of operational assets

Sale of investments

Collections of loans

Cash received from revenues

Issuance of stock

Issuance of bonds and notes

CASH INFLOWS

Business

CASH OUTFLOWS

Purchase of operational assets

Purchase of investmentsLoans to others

Cash paid for expenses

Payment of dividends

Repurchase of stock

Repayment of debt

Slide 3

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Role of the Statement of Cash FlowsRole of the Statement of Cash Flows

The Statement helps users assess . . . a firm’s ability to generate cash. a firm’s ability to meet its obligations. the reasons for differences between income

and associated cash flows. the effect of cash and noncash investing and

financing activities on a firm’s financial position.

The Statement helps users assess . . . a firm’s ability to generate cash. a firm’s ability to meet its obligations. the reasons for differences between income

and associated cash flows. the effect of cash and noncash investing and

financing activities on a firm’s financial position.

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Role of the Statement of Cash FlowsRole of the Statement of Cash Flows

Lists inflows and outflows of cash and cash

equivalents by category

Explains the change in cash during the period

Required by SFAS No. 95

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Cash and Cash EquivalentsCash and Cash Equivalents

Resources immediately available to

pay obligations.

Resources immediately available to

pay obligations.

Short-term, highly liquid investments.

Readily convertible into known, fixed amounts of cash.

So near maturity that there is insignificant risk of market value fluctuation from interest rate changes.

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Primary Elements of the Statement of Cash Flows Primary Elements of the Statement of Cash Flows (SCF)(SCF)

Operating Activities

Investing Activities

Financing Activities

Reconciliation of the Net Increase or Decrease in

Cash with the Change in the Balance of the Cash

Account

Noncash Investing and Financing

Activities

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Primary Elements of the Statement of Cash Flows Primary Elements of the Statement of Cash Flows (SCF)(SCF)

Operating Activities

Reports the cash effects of the elements of net income.

Investing Activities

Reports the cash effects of the acquisition and disposition of assets

(other than inventory and cash equivalents).

Financing Activities

Reports the cash effects of the sale or repurchase of shares, the

issuance or repayment of debt securities, and the payment of cash

dividends.

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Cash Flows from Operating ActivitiesCash Flows from Operating Activities

Cash Flows from

Operating Activities

+

Inflows from: Sales to customers. Interest and dividends

received.

_

Outflows to: Purchase of inventory. Salaries, wages, and other

operating expenses. Interest on debt. Income taxes.

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Direct Method or Indirect Method of Reporting Cash Direct Method or Indirect Method of Reporting Cash Flows from Operating ActivitiesFlows from Operating Activities

Two Formats for Reporting Operating Activities

Reports the cash effects of each

operating activity

Direct Method

Starts with accrual net income and

converts to cash basis

Indirect Method

Note that no matter which format is used, the same amount of net cash flows operating activities is generated.

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Direct Method or Indirect Method of Reporting Cash Direct Method or Indirect Method of Reporting Cash Flows from Operating ActivitiesFlows from Operating Activities

Cash Inflows: From customers 98$ From investment revenue 3 Cash Outflows: To suppliers of goods (50) To employees (11) To bondholders (3) For insurance expense (4) For income taxes (11) Net cash flows from operating activities 22$

Cash Flows from Operating Activities--Direct Method

The cash effect of each operating activity is reported directly on

the statement of cash flows.

Net Income 12$ Adjustments for noncash effects: Gain on sale of land (8) Depreciation expense 3 Loss on sale of equipment 2 Changes in operating assets and liabilities: Increase in accounts receivable (2) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Discount on bonds payable 2 Decrease in prepaid insurance 3 Decrease in income tax payable (2) Net cash flows from operating activities 22$

Cash Flows from Operating Activities--Indirect Method

The net cash increase or decrease from operating

activities is derived indirectly by starting with reported net income on an accrual basis and working backwards to

convert that amount to a cash basis.

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Cash Flows from

Investing Activities

+

Cash Flows from Investing ActivitiesCash Flows from Investing Activities

Inflows from:Sale of long-term assets used in

the business.Sale of investment securities

(stocks and bonds).Collection of nontrade

receivables.

_

Outflows to: Purchase of long-term assets

used in the business. Purchase of investment

securities (stocks and bonds). Loans to other entities.

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21-12

Cash Flows from

Financing Activities

+

_

Cash Flows from Financing ActivitiesCash Flows from Financing Activities

Inflows from:Sale of shares to owners.Borrowing from creditors

through notes, loans, mortgages, and bonds.

Outflows to: Owners in the form of dividends

or other distributions. Owners for the reacquisition of

shares previously sold. Creditors as repayment of the

principal amounts of debt.

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Reconciliation with Change in Cash BalanceReconciliation with Change in Cash Balance

The net amount of cash inflows and outflows reconciles the change in the

company’s beginning and ending cash balances.

Net increase in Cash 9,000,000$ Cash balance, January 1 20,000,000 Cash balance, December 31 29,000,000$

For example, assume the net increase in cash is $9 million and the Cash beginning balance is $20 million. The cash reconciliation would be as

follows:

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Noncash Investing and Financing ActivitiesNoncash Investing and Financing Activities

Significant investing and financing transactions not involving cash also are reported (usually in a disclosure note).

1. Acquiring an asset by incurring a debt payable to the seller.

2. Acquiring an asset by entering into a capital lease.

3. Converting debt into common stock or other equity securities.

4. Exchanging noncash assets or liabilities for other noncash assets or liabilities.

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Preparation of the Statement of Cash FlowsPreparation of the Statement of Cash Flows

A spreadsheet can be used to ensure that no reportable activities are inadvertently

overlooked.

Reconstructing the events and transactions that occurred during the period helps identify the

operating, investing and financing activities to be reported.

Let’s see how to use a spreadsheet to prepare a Statement of Cash Flows on the next few slides.

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Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Balance SheetAssets:Cash 20 29 Accounts receivable 30 32 Short-term investments - 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 81 Less: Accumulated depreciation (20) (16)

221 267

Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)

Shareholders' Equity:Common stock 100

130 Paid-in capital 20

29 Retained earnings 25

19 221 267

UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows

Changes We begin by entering the

beginning and ending balances for each account

on the comparative

balance sheet and income statement.

The changes columns will be

used later to explain the increase or

decrease in each account balance.

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21-17

The beginning balances for income statement accounts are always zero.

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Income StatementRevenues:Sales revenue 100 Investment revenue 3 Gain on sale of land 8

Expenses:Cost of good sold (60) Salaries expense (13) Depreciation expense (3) Bond interest expense (5) Insurance expense (7) Loss on sale of equipment (2) Income tax expense (9) Net income 12

Changes

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21-18

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Statement of Cash FlowsOperating Activities:

Investing Activities:

Financing Activities:

Changes

Next we allocate space

on the spreadsheet

for the statement of cash flows.

Spreadsheet entries duplicate the actual journal entries used to record the transactions as they occurred during the year.

They are only entered on the spreadsheet and are not recorded in the accounting records.

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21-19

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Balance SheetAssets:Cash 20 29 Accounts receivable 30 32 Short-term investments - 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 81 Less: Accumulated depreciation (20) (16)

221 267

Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)

Shareholders' Equity:Common stock 100

130 Paid-in capital 20

29 Retained earnings 25

19 221 267

UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows

Changes Let’s start by analyzing Sales Revenue and its related account

Accounts Receivable by looking at the

relationship in a T-account format.

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Income StatementRevenues:Sales revenue 100 Investment revenue 3 Gain on sale of land 8

Expenses:Cost of good sold (60) Salaries expense (13) Depreciation expense (3) Bond interest expense (5) Insurance expense (7) Loss on sale of equipment (2) Income tax expense (9) Net income 12

Changes

Beg. bal. 30Credit sales 100 ? Cash receivedEnd. bal. 32

Accounts Receivable

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21-20

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Balance SheetAssets:Cash 20 29 Accounts receivable 30 32 Short-term investments - 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 81 Less: Accumulated depreciation (20) (16)

221 267

Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)

Shareholders' Equity:Common stock 100

130 Paid-in capital 20

29 Retained earnings 25

19 221 267

UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows

Changes We can see from this analysis that

cash received from customers must have been $98

million.

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Income StatementRevenues:Sales revenue 100 Investment revenue 3 Gain on sale of land 8

Expenses:Cost of good sold (60) Salaries expense (13) Depreciation expense (3) Bond interest expense (5) Insurance expense (7) Loss on sale of equipment (2) Income tax expense (9) Net income 12

Changes

Beg. bal. 30Credit sales 100 98 Cash receivedEnd. bal. 32

Accounts Receivable

Let’s see how to post this entry to the spreadsheet.

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21-21

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Balance SheetAssets:Cash 20 29 Accounts receivable 30 (1) 2 32 Short-term investments - 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 81 Less: Accumulated depreciation (20) (16)

221 267

Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)

Shareholders' Equity:Common stock 100

130 Paid-in capital 20

29 Retained earnings 25

19 221 267

UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows

Changes First, $2 million is debited to Accounts

Receivable to account for the

total change in the account.

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Income StatementRevenues:Sales revenue (1) 100 100 Investment revenue 3 Gain on sale of land 8

Expenses:Cost of good sold (60) Salaries expense (13) Depreciation expense (3) Bond interest expense (5) Insurance expense (7) Loss on sale of equipment (2) Income tax expense (9) Net income 12

Changes

Beg. bal. 30Credit sales 100 98 Cash receivedEnd. bal. 32

Accounts ReceivableThen, $100 million is credited to Sales

Revenue to account for the

total change in the account.

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21-22

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Statement of Cash FlowsOperating Activities:Cash Inflows: From customers (1) 98

Investing Activities:

Financing Activities:

Changes

The final part of this entry is a $98 million entry on the Statement of Cash Flows under Cash Inflows from Customers.

Beg. bal. 30Credit sales 100 98 Cash receivedEnd. bal. 32

Accounts Receivable

Let’s skip ahead and look at the analysis of Short-term

Investments.

Slide 23

21-23

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Balance SheetAssets:Cash 20 29 Accounts receivable 30 (1) 2 32 Short-term investments - (12) 12 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 81 Less: Accumulated depreciation (20) (16)

221 267

Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)

Shareholders' Equity:Common stock 100

130 Paid-in capital 20

29 Retained earnings 25

19 221 267

UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows

Changes

In the textbook, entry number 12 illustrates the

analysis of the Short-term Investment account.

The $12 million increase in the

Short-term Investments

account is due to the purchase of

short-term investments

during the year.

Beg. bal. 0Purchases 12End. bal. 12

Short-term Investments

Slide 24

21-24

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Statement of Cash FlowsOperating Activities:Cash Inflows: From customers (1) 98

Investing Activities:

Purchase of S-T investment (12) 12

Financing Activities:

Changes

The final part of this entry is a $12 million entry on the Statement of Cash Flows

under Investing

Activities.

Now, let’s look at a noncash transaction.

Beg. bal. 0Purchases 12End. bal. 12

Short-term Investments

Slide 25

21-25

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Balance SheetAssets:Cash 20 29 Accounts receivable 30 (1) 2 32 Short-term investments - (12) 12 12 Inventory 50 46 Prepaid insurance 6 3 Land 60 80 Buildings and equipment 75 (14) 20 81 Less: Accumulated depreciation (20) (16)

221 267

Liabilities:Accounts payable 20 26 Salaries payable 1 3 Income tax payable 8 6 Notes payable - (14) 20 20 Bonds payable 50 35 Less: Discount on bonds payable (3) (1)

Shareholders' Equity:Common stock 100

130 Paid-in capital 20

29 Retained earnings 25

19 221 267

UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows

Changes

In entry number 14, we find that a note

payable was issued as payment for a

building.

Investing in a new building is a

significant investing activity and

financing the acquisition with

long-term debt is a significant financing

activity.

x denotes a noncash transaction

x

x

Slide 26

21-26

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Balance SheetAssets:Cash 20 (19) 9 29 Accounts receivable 30 (1) 2 32 Short-term investments - (12) 12 12 Inventory 50 (4) 4 46 Prepaid insurance 6 (8) 3 3 Land 60 (13) 30 (3) 10 80 Buildings and equipment 75 (14) 20 (9) 14 81 Less: Accumulated depreciation (20) (9) 7 (6) 3 (16)

221 267

Liabilities:Accounts payable 20 (4) 6 26 Salaries payable 1 (5) 2 3 Income tax payable 8 (10) 2 6 Notes payable - (14) 20 20 Bonds payable 50 (15) 15 35 Less: Discount on bonds payable (3) (7) 2 (1)

Shareholders' Equity:Common stock 100 (16) 10

(17) 20 130 Paid-in capital 20 (16) 3

(17) 6 29 Retained earnings 25 (16) 13

(18) 5 (11) 12 19 221 267

UNITED BRANDS CORPORATIONSpreadsheet for the Statement of Cash Flows

Changes

x

x

After entering all the transactions, this is what the balance sheet portion of the

spreadsheet looks like.

Slide 27

21-27

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Income StatementRevenues:Sales revenue (1) 100 100 Investment revenue (2) 3 3 Gain on sale of land (3) 8 8

Expenses:Cost of good sold (4) 60 (60) Salaries expense (5) 13 (13) Depreciation expense (6) 3 (3) Bond interest expense (7) 5 (5) Insurance expense (8) 7 (7) Loss on sale of equipment (9) 2 (2) Income tax expense (10) 9 (9) Net income (11) 12 12

Changes

After entering all the transactions, this is what the income statement portion of the

spreadsheet looks like.

Slide 28

21-28

Dec. 31, 2008 Debits Credits

Dec. 31, 2009

Statement of Cash FlowsOperating Activities:Cash Inflows: From customers (1) 98 From investment revenue (2) 3 Cash Outflows: To suppliers of goods (4) 50 To employees (5) 11 To bondholders (7) 3 For insurance expense (8) 4 For income taxes (10) 11 Net cash flows 22 Investing Activities: Sale of land (3) 18 Sale of equipment (9) 5 Purchase of S-T investment (12) 12 Purchase of land (13) 30 Net cash flows (19) Financing Activities: Retirement of bonds payable (15) 15 Sale of common stock (17) 26 Payment of cash dividends (18) 5 Net cash flows 6 Net increase in cash (19) 9 9 Totals 376 376

Changes

After entering all the

transactions, this is what

the statement of cash flows portion of the spreadsheet looks like.

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Cash Flows from Operating Activities:Cash Inflows: From customers 98$ From investment revenue 3 Cash Outflows: To suppliers of goods (50) To employees (11) To bondholders (3) For insurance expense (4) For income taxes (11) Net cash flows from operating activities 22$ Cash Flows from Investing Activities: Sale of land (30) Sale of equipment (12) Purchase of S-T investment 18 Purchase of land 5 Net cash flows from investing activities (19) Cash Flows from Financing Activities: Retirement of bonds payable 26 Sale of common stock (15) Payment of cash dividends (5) Net cash flows from financing activities 6 Net increase in cash 9 Cash balance, January 1 20Cash balance, December 31 29$

UNITED BRANDS CORPORATIONStatement of Cash Flows

For the Year Ended December 31, 2009($ in millions)

Here is the Statement of Cash Flows

prepared using the direct method.

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Preparing an SCF: The Indirect MethodPreparing an SCF: The Indirect Method

The indirect method derives the net cash

increases or decreases from operating activities indirectly by starting with reported net income and “working backwards” to convert that amount to a

cash basis.

Net Income 12$ Adjustments for noncash effects: Increase in accounts receivable (2) Gain on sale of land (8) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Depreciation expense 3 Discount on bonds payable 2 Decrease in prepaid insurance 3 Loss on sale of equipment 2 Decrease in income tax payable (2) Net cash flows from operating activities 22$

Cash Flows from Operating Activities--Indirect Methodand

Reconciliation of Net Income to Net Cash Flows from Operating Activities

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Components of Net Income that Do Not Increase or Components of Net Income that Do Not Increase or Decrease CashDecrease Cash

Depreciation Expense

Loss on Sale of Equipment

Adding these items back to net income restores net income to what it would have been had

depreciation and the loss not been subtracted at all.

Subtracting the gain reverses the effect of the gain having been

added to net income.

Gain on Sale of Land

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Components of Net Income that Do Increase or Components of Net Income that Do Increase or Decrease CashDecrease Cash

Note: Cash and cash equivalents, short-term investments in securities available for sale, dividends payable, and short-term payables to financial institutions are excluded from this category.

For components of net income that increase or decrease cash, but by an amount different from that reported on the

income statement, net income is adjusted for changes in the balances of related balance sheet accounts to convert the

effects of those items to a cash basis.

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Comparison with the Direct MethodComparison with the Direct Method

Net income 12$ Adjustments

Sales $ 100 Increase in accounts receivable (2) Cash received from customers $ 98 Investment revenue 3 (No adjustment--no investment

revenue receivable or long-term investments)

Cash received from investments

3

Gain on sale of land 8 Gain on sale of land (8) (Not reported--no cash effect)Cost of goods sold (60) Decrease in inventory 4

Increase in accounts payable 6 Cash paid to suppliers (50)Salaries expense (13) Increase in salaries payable 2 Cash paid to employees (11)Depreciation expense (3) Depreciation expense 3 (Not reported--no cash effect)Interest expense (5) Decrease n bond discount 2 Cash paid for interest (3)Insurance expense (7) Decrease in prepaid insurance 3 Cash paid for insurance (4)Loss on sale of equipment (2) Loss on sale of equipment 2 (Not reported--no cash effect)Income tax expense (9) Decrease in income tax payable (2) Cash paid for income taxes (11)

Net income $ 12 Net cash flow from operating activities $ 22

Net cash flow from operating activities $ 22

Income Statement Indirect Method Direct MethodCash Flows from Operating Activities

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Appendix 21A: Spreadsheet for the Indirect MethodAppendix 21A: Spreadsheet for the Indirect Method

A spreadsheet is equally useful in

preparing a statement of cash

flows whether we use the direct or the

indirect method of determining cash

flows from operating activities.

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Appendix 21B: The T-Account Method of Preparing Appendix 21B: The T-Account Method of Preparing the Statement of Cash Flowsthe Statement of Cash Flows

The T-Account method serves the same purpose as a

spreadsheet in assisting in the preparation of a

statement of Cash Flows.

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Appendix 21B: The T-Account Method of Preparing Appendix 21B: The T-Account Method of Preparing the Statement of Cash Flowsthe Statement of Cash Flows

1. Draw a T-account for each income statement and balance sheet account.

2. The T-account for cash should be drawn considerably larger.

3. Enter each account’s net change on the appropriate side (debit or credit) of the uppermost portion of each T-account.

4. Reconstruct the transactions that caused changes in each account balance during the year and record the entries for those transactions directly in the T-accounts.

5. After all account balances have been explained by T-account entries, prepare the statement of cash flows from the cash T-account, being careful also to report noncash investing and financing activities.

McGraw-Hill /Irwin © 2009 The McGraw-Hill Companies, Inc.

End of Chapter 21End of Chapter 21