17.3 Flashcards
How should a gain from the sale of used equipment for cash be reported in a statement of cash flows using the indirect method?
In operating activities as a deduction of income.
Cash received from the sale of equipment is ordinarily classified in a statement of cash flows as a cash inflow from an investing activity. The cash inflow is equal to the carrying amount of the equipment plus any gain or minus any loss realized. Because the gain will be included in the determination of income from continuing operations, it must be subtracted from the net income figure presented in the statement of cash flows (indirect method) in the reconciliation of net income to net cash flow from operating activities. The purpose of the adjustment is to remove the effect of the gain from both net income and the cash inflows from operating activities. In the cash flows from investing activities section, the amount reported is the sum of the gain and the carrying amount of the equipment.
For the year ended December 31, Ion Corp. had cash inflows of $25,000 from the purchases, sales, and maturities of held-to-maturity debt securities and $40,000 from the purchases, sales, and maturities of available-for-sale debt securities. What amount of net cash from investing activities should Ion report in its cash flow statement?
$65,000
Investing activities include purchases, sales, and maturities of available-for-sale debt securities ($40,000) and held-to-maturity debt securities ($25,000), for a total cash inflow from investing activities of $65,000. These amounts are reported gross for each classification of security in the cash flow statement.
In accordance with IFRS, in the statement of cash flows, the payment of cash dividends appears in the activities section as a of cash.
List A:
List B:
Operating or Financing
Use
According to IAS 7, dividends paid may be treated as a cash outflow from financing activities because they are a cost of obtaining resources from owners. However, they also may be treated as operating items to help determine the entity’s ability to pay dividends from operating cash flows.
Compared with the accrual basis of accounting, the cash basis of accounting understates income by the net decrease during the accounting period of
Accounts Receivable:
Accrued Expenses:
No
Yes
A net decrease in accounts receivable indicates that cash collected exceeded accrual-basis revenue from receivables in the current period. A net decrease in accrued expenses indicates that cash paid for expenses exceeded the current period’s accrual-basis expenses. Thus, a net decrease in receivables results in an overstatement of cash-basis income compared with accrual-basis income, and a net decrease in accrued expenses results in an understatement.
Paper Co. had net income of $70,000 during the year. Dividend payment was $10,000. The following information is available:
Mortgage repayment: $20,000 Available-for-sale securities purchased: 10,000 increase Bonds payable-issued: 50,000 increase Inventory: 40,000 increase Accounts payable: 30,000 decrease
What amount should Paper report as net cash provided by operating activities in its statement of cash flows for the year?
$0
The payment of dividends, the repayment of debt (the mortgage), and the issuance of debt (the bonds) are financing activities. The purchase of debt or equity instruments the (available-for-sale securities) is an investing activity. Operating cash flows exclude these financing and investing cash flows. Moreover, these items do not affect net income. Consequently, net cash provided by operating activities can be determined by adjusting net income for the changes in inventory and accounts payable. To account for the difference between cost of goods sold (a deduction from income) and cash paid to suppliers, a two-step adjustment is necessary. The difference between cost of goods sold and purchases is the change in inventory. The difference between purchases and the amount paid to suppliers is the change in accounts payable. Accordingly, the conversion of cost of goods sold to cash paid to suppliers requires subtracting the inventory increase and the accounts payable decrease. The net cash provided by operating activities is therefore $0 ($70,000 net income – $40,000 inventory increase – $30,000 accounts payable decrease).
A company is preparing its year-end cash flow statement using the indirect method. During the year, the following transactions occurred:
Dividends paid: $300
Proceeds from the issuance of common stock: 250
Borrowings under a line of credit: 200
Proceeds from the issuance of convertible bonds: 100
Proceeds from the sale of a building: 150
What is the company’s increase in cash flows provided by financing activities for the year?
$250
Cash flows from financing activities generally involve the cash effects of transactions and other events that relate to the issuance, settlement, or reacquisition of the entity’s debt and equity instruments. The proceeds from the sale of a building is an investing cash flow. All of the other transactions represent cash flows from financing activities. Thus, the company’s increase in cash flows provided by financing activities is $250 [($300) + $250 + $200 + $100].
When using the statement of cash flows to evaluate a company’s continuing solvency, the most important factor to consider is the cash
Flows from (used for) operating activities.
Solvency is the ability of an entity to pay its noncurrent debts as they become due. A statement of cash flows provides information about, among other things, an entity’s activities in generating cash through operations (operating activities) to (1) repay debt, (2) distribute dividends, or (3) reinvest to maintain or expand operating capacity. Thus, cash flows from operating activities (net operating cash inflows), which are generated by an entity’s ongoing major or central activities, are the best indicator of its ability to remain solvent over the long term.
All of the following are classifications on the statement of cash flows except
Equity activities.
The three classifications used on the statement of cash flows are operating activities, investing activities, and financing activities.
Fact Pattern:
Selected financial information for Kristina Company for the year just ended is shown below.
Net income: $2,000,000
Increase in net accounts receivable: 300,000
Decrease in inventory: 100,000
Increase in accounts payable: 200,000
Depreciation expense: 400,000
Gain on the sale of available-for-sale securities; 700,000
Cash receivable from the issue of common stock: 800,000
Cash paid for dividends: 80,000
Cash paid for the acquisition of land: 1,500,000
Cash received from the sale of available-for-sale securities: 2,800,000
Assuming the indirect method is used, Kristina’s cash flow from operating activities for the year is
$1,700,000
The following is the net cash flow from operating activities calculated using the indirect method:
Net income: $2,000,000
Add: Decrease in inventory: 100,000
Add: Increase in accounts payable: 200,000
Add: Depreciation expense: 400,000
Minus: Increase in net accounts receivable: (300,000)
Minus: Gain on sale of securities: (700,000)
Net cash provided by operating activities: $1,700,000
The adjustment from cost of goods sold (an accrual accounting amount used to calculate net income) to cash paid to suppliers requires two steps: (1) from cost of goods sold to purchases and (2) from purchases to cash paid to suppliers. The $100,000 decrease in inventory is added to net income. It indicates that purchases were $100,000 less than cost of goods sold. The $200,000 increase in accounts payable is added to net income. It indicates that cash paid to suppliers was $200,000 less than purchases. Thus, the net effect of the changes in inventory and accounts payable is that cash paid to suppliers was $300,000 ($100,000 + $200,000) less than the accrual basis cost of goods sold. Depreciation expense ($400,000) is a noncash item included in net income. Hence, it is subtracted from net income. The net accounts receivable balance increased by $300,000, implying that cash collections were less than sales. If sales, collections, write-offs, and recognition of bad debt expense were the only relevant transactions, $300,000 should be subtracted from net income. Use of the change in net accounts receivable as a reconciliation adjustment is a short-cut method. It yields the same net adjustment to net income as separately including the effects of the change in gross accounts receivable, bad debt expense (a noncash item resulting in an addition), and bad debt write-offs (a subtraction to reflect that write-offs did not result in collections). The sale of securities is an investing activity. It also is subtracted from net income.
During Year 6, Xan, Inc., had the following activities related to its financial operations:
Payment for the early retirement of long-term
bonds payable (carrying amount $370,000): $375,000
Distribution in Year 6 of cash dividend declared in Year 5 to preferred shareholders: 31,000
Carrying amount of convertible preferred stock in Xan, converted into common shares: 60,000
Proceeds from sale of treasury stock (carrying amount at cost, $43,000): 50,000
In Xan’s Year 6 statement of cash flows, net cash used in financing activities should be
$356,000
Financing activities include the issuance of stock, the payment of dividends and other distributions to owners, treasury stock transactions, the issuance of debt, and the repayment or other settlement of debt obligations. The conversion of preferred stock to common stock is a noncash transaction, but the early retirement of bonds, the payment of the cash dividend, and the sale of treasury stock are financing activities that affect cash flow. Thus, the net cash used in financing activities is $356,000 ($375,000 + $31,000 – $50,000).
Fact Pattern:
Selected financial information for Kristina Company for the year just ended is shown below.
Net income: $2,000,000
Increase in net accounts receivable: 300,000
Decrease in inventory: 100,000
Increase in accounts payable: 200,000
Depreciation expense: 400,000
Gain on the sale of available-for-sale securities: 700,000
Cash receivable from the issue of common stock: 800,000
Cash paid for dividends: 80,000
Cash paid for the acquisition of land: 1,500,000
Cash received from the sale of available-for-sale securities: 2,800,000
Kristina’s cash flow from investing activities for the year is
$1,300,000
Cash flows from investing activities for the year include the $2,800,000 inflow from the sale of available-for-sale securities and the $1,500,000 cash outflow for the purchase of land ($2,800,000 − $1,500,000 = $1,300,000 net cash inflow).
Reed Co.’s Year 1 statement of cash flows reported cash provided from operating activities of $400,000. For Year 1, depreciation of equipment was $190,000, impairment of goodwill was $5,000, and dividends paid on common stock were $100,000. In Reed’s Year 1 statement of cash flows, what amount was reported as net income?
$205,000
Depreciation expense and the loss from goodwill impairment are noncash items that are added to net income to arrive at net cash provided by operating activities. Hence, they are subtracted from net cash provided by operating activities to arrive at net income. The payment of cash dividends is not a reconciling item because it is a financing cash flow that does not affect net income. Net income was therefore $205,000 ($400,000 net cash provided by operating activities – $190,000 depreciation – $5,000 goodwill impairment).
Sanni Co. had $150,000 in cash-basis pretax income for the year. At the current year end, accounts receivable decreased by $20,000 and accounts payable increased by $16,000 from their previous year-end balances. Compared with the accrual-basis method of accounting, Sanni’s cash-basis pretax income is
Higher by $36,000.
The $20,000 decrease in accounts receivable was included in accrual-basis pretax income for a prior period. Thus, it must be subtracted from the $150,000 of cash-basis pretax income to determine accrual basis pretax income. The increase in accounts payable is not included in cash-basis income because this expense has not been paid. It is included in accrual-basis pretax income as an expense and must be subtracted to determine accrual basis pretax income. The cash-basis pretax income therefore exceeds accrual-basis pretax income by $36,000 ($150,000 cash basis – $20,000 – $16,000 = $114,000 accrual basis).
Fact Pattern:
Flax Corp. uses the direct method to prepare its statement of cash flows. Flax’s trial balances at December 31, Year 6 and Year 5, are as follows:
Cash Year 6: $35,000 Year 5: $32,000 Accounts receivable Year 6: 33,000 Year 5: 30,000 Inventory Year 6: 31,000 Year 5: 47,000 Property, plant, & equipment Year 6: 100,000 Year 5: 95,000 Unamortized bond discount Year 6: 4,500 Year 5: 5,000 Cost of goods sold Year 6: 250,000 Year 5: 380,000 Selling expenses Year 6: 141,500 Year 5: 172,000 General and administrative expenses Year 6: 137,000 Year 5: 151,300 Interest expense Year 6: 4,300 Year 5: 2,600 Income tax expense Year 6: 20,400 Year 5: 61,200 Year 6 total: $756,700 Year 5 total: $976,100
Credits Year 6: Year 5: Allowance for uncollectible accounts $ 1,300 $ 1,100 Accumulated depreciation 16,500 15,000 Trade accounts payable 25,000 17,500 Income taxes payable 21,000 27,100 Deferred income taxes 5,300 4,600 8% callable bonds payable 45,000 20,000 Common stock 50,000 40,000 Additional paid-in capital 9,100 7,500 Retained earnings 44,700 64,600 Sales Year 6 total: 538,800 Year 5 total: 778,700
- Flax purchased $5,000 in equipment during Year 6.
- Flax allocated one-third of its depreciation expense to selling expenses and the remainder to general and administrative expenses, which include the provision for uncollectible accounts.
What amount should Flax report in its statement of cash flows for the year ended December 31, Year 6, for cash paid for goods sold?
$226,500
To reconcile cost of goods sold to cash paid for goods sold, a two-step adjustment is needed. The first step is to determine purchases by subtracting the decrease in inventory from cost of goods sold. The second step is to determine cash paid for goods sold by subtracting the increase in trade accounts payable from purchases. Thus, cash paid for goods sold equals $226,500 [$250,000 – ($47,000 – $31,000) – ($25,000 – $17,500)].
In a statement of cash flows prepared using the indirect method, a gain on the sale of a long-term investment should be
Deducted from income from continuing operations.
Cash received from the sale of an investment is classified in a statement of cash flows as a cash inflow from an investing activity unless the investment was classified as a trading security. The cash inflow is equal to the carrying amount of the investment plus any gain or minus any loss realized. Because the gain will be included in the determination of income from continuing operations, it must be subtracted from the net income figure presented in the statement of cash flows (indirect method) in the reconciliation of net income to net cash flow from operating activities. The purpose of the adjustment is to remove the effect of the gain from both net income and the cash inflows from operating activities. In the cash flows from investing activities section, the amount reported is the sum of the gain and the carrying amount of the investment.
