17.5 Flashcards
Fara Co. reported bonds payable of $47,000 on December 31, Year 1, and $50,000 on December 31, Year 2. During Year 2, Fara issued $20,000 of bonds payable in exchange for equipment. There was no amortization of bond premium or discount during the year. What amount should Fara report in its Year 2 statement of cash flows for redemption of bonds payable?
$17,000
Assuming no amortization of premium or discount, the net amount of bonds payable reported was affected solely by the issuance of bonds for equipment and the redemption of bonds. Given that $20,000 of bonds were issued and that the amount reported increased by only $3,000, $17,000 of bonds must have been redeemed. This amount should be reported in the statement of cash flows as a cash outflow from a financing activity.
The primary purpose of a statement of cash flows is to provide relevant information about
The cash receipts and cash disbursements of an entity during a period.
The primary purpose is to provide information about the cash receipts and cash payments of a business entity during a period. This information helps investors, creditors, and other users to assess the entity’s ability to generate net cash inflows, meet its obligations, pay dividends, and secure external financing. It also helps assess reasons for the differences between net income and net cash flow and the effects of cash and noncash financing and investing activities.
Metro, Inc., reported net income of $150,000 for the current year. Changes occurred in several balance sheet accounts during the current year as follows:
Investment in Videogold, Inc., stock, all of which was acquired in the previous year, carried on the equity basis: $5,500 increase
Accumulated depreciation, caused by major repair to projection equipment: 2,100 decrease
Premium on bonds payable: 1,400 decrease
Deferred income tax liability (long-term): 1,800 increase
In Metro’s current-year cash flow statement, the reported net cash provided by operating activities should be
$144,900
The increase in the equity-based investment reflects the investor’s share of the investee’s net income after adjustment for dividends received. Thus, it is a noncash revenue and should be subtracted in the reconciliation of net income to net operating cash inflow. A major repair provides benefits to more than one period and therefore should not be expensed. One method of accounting for a major repair is to charge accumulated depreciation if the useful life of the asset has been extended, with the offsetting credit to cash, a payable, etc. However, the cash outflow, if any, is from an investing activity. The item has no effect on net income and no adjustment is necessary. Amortization of bond premium is a noncash income statement item that reduces accrual-basis expenses and therefore must be subtracted from net income to arrive at net cash flow from operating activities. The increase in the deferred tax liability is a noncash item that reduces net income and should be added in the reconciliation. Accordingly, net cash provided by operations is $144,900 ($150,000 – $5,500 – $1,400 + $1,800).
Kresley Co. has provided the following current account balances for the preparation of the annual statement of cash flows:
January 1 Accounts receivable $11,500 Allowance for uncollectible accounts $400 Prepaid rent expense $6,200 Accounts payable $9,700
December 31 Accounts receivable $14,500 Allowance for uncollectible accounts $500 Prepaid rent expense $4,100 Accounts payable $11,200
Kresley’s current-year net income is $75,000. Net cash provided by operating activities in the statement of cash flows should be
$75,700
The net income of a business should be adjusted for the effects of items properly included in the determination of net income but having either a different effect or no effect on net operating cash flow. The increase in gross accounts receivable should be subtracted from net income. The increase indicates that sales exceeded cash received. The increase in the allowance for uncollectible accounts should be added to net income. This amount reflects a noncash expense. The decrease in prepaid rent expense should be added to net income. The cash was disbursed in a prior period, but the expense was recognized currently as a noncash item. The increase in accounts payable indicates that liabilities and related expenses were recognized without cash outlays. Thus, the change in this account should be added to net income. The net cash provided by operating activities is $75,700 ($75,000 NI – $3,000 change in A/R + $100 change in allowance + $2,100 decrease in prepaid rent + $1,500 increase in A/P).
In a statement of cash flows (indirect method) of a business, an increase in inventories should be presented as a(n)
Deduction from income from continuing operations.
The objective of a statement of cash flows is to explain the cash receipts and cash disbursements of an entity during an accounting period. In a statement of cash flows of a business in which operating activities are presented on an indirect or reconciliation basis, cash flows from operating activities are determined by adjusting net income (which includes income from continuing operations) to remove the effects of all (1) non-cash items, (2) deferrals of past operating cash receipts and payments, (3) accruals of expected future operating cash receipts and payments, and (4) items whose cash effects are investing or financing activities. Cost of goods sold is included in the determination of net income. Cash paid to suppliers, however, should be the amount included in determining net cash flows from operating activities. To adjust net income to cash flow from operating activities for the difference between cost of goods sold and cash paid to suppliers, a two-step adjustment is necessary. The first step is to adjust net income for the change in the inventory account. This step adjusts for the difference between cost of goods sold and purchases. The second step is to adjust for the changes in the accounts payable account. This step adjusts for the difference between purchases and the amounts disbursed to suppliers. An increase in inventories indicates that purchases were greater than cost of goods sold. Thus, as part of the first step, an increase in inventories should be presented in a statement of cash flows (indirect method) as a deduction from net income.
A statement of cash flows prepared using the indirect method would have cash activities listed in which one of the following orders?
Operating, investing, financing.
A statement of cash flows prepared using either the direct or the indirect method lists the categories of cash flows in the following order: operating, investing, and financing.
Dee’s inventory and accounts payable balances at December 31, Year 2, increased over their December 31, Year 1, balances. Should these increases be added to or deducted from cash payments to suppliers to arrive at Year 2 cost of goods sold?
Increase in Inventory:
increase in A/P:
Deducted from
Added to
A two-step adjustment is needed. The first step is to adjust for the difference between cash paid to suppliers and purchases. Because accounts payable increased, purchases must have been greater than cash paid to suppliers. Thus, the increase in accounts payable is an addition. The second step adjusts for the difference between purchases and cost of goods sold. Given that inventory increased, purchases must have exceeded cost of goods sold. Hence, the increase in inventories is a subtraction.
In a statement of cash flows, proceeds from issuing equity instruments should be classified as cash inflows from
Financing activities.
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. It also includes receiving restricted resources that by donor stipulation must be used for long-term purposes.
Depreciation expense is added to net income under the indirect method of preparing a statement of cash flows in order to
Reverse noncash charges deducted from net income.
The indirect method begins with net income and then removes the effects of (1) deferrals of past operating cash receipts and payments, (2) accruals of estimated future operating cash receipts and payments, and (3) net income items not affecting operating cash flows (e.g., depreciation).
Lane Company acquired copyrights from authors, in some cases paying advance royalties and in others paying royalties within 30 days of year-end. Lane reported royalty expense of $375,000 for the year ended December 31, Year 2. The following data are included in Lane’s balance sheet:
Year 1
Prepaid Royalties: $60,000
Royalties Payable: $75,000
Year 2
Prepaid Royalties: $50,000
Royalties Payable: $90,000
In its Year 2 statement of cash flows, Lane should report cash payments for royalties of
$350,000
A decrease in a prepaid royalties asset account implies that royalty expense was greater than the related cash payments. Similarly, an increase in a royalties payable liability account indicates that royalties expense exceeded cash payments. Royalty expense therefore exceeds the amount of cash payments for royalty payments by the amount of the decrease in the prepaid royalties account plus the increase in the royalties payable account. Thus, Lane’s Year 2 cash payments for royalty payments total $350,000 ($375,000 royalty expense – $10,000 decrease in prepaid royalties – $15,000 increase in royalties payable).
Fact Pattern:
- Royce Company had the following transactions during the fiscal year ended December 31, Year 2:
Accounts receivable decreased from $115,000 on December 31, Year 1, to $100,000 on December 31, Year 2.
- Royce’s board of directors declared dividends on December 31, Year 2, of $.05 per share on the 2.8 million shares outstanding, payable to shareholders of record on January 31, Year 3. The company did not declare or pay dividends for fiscal Year 1.
- Sold a truck with a net carrying amount of $7,000 for $5,000 cash, reporting a loss of $2,000.
- Paid interest to bondholders of $780,000.
- The cash balance was $106,000 on December 31, Year 1, and $284,000 on December 31, Year 2.
The total of cash provided (used) by operating activities plus cash provided (used) by investing activities plus cash provided (used) by financing activities is
Cash provided of $178,000.
The total of cash provided (used) by the three activities (operating, investing, and financing) should equal the increase or decrease in cash for the year. During Year 2, the cash balance increased from $106,000 to $284,000. Thus, the sources of cash must have exceeded the uses by $178,000.
Abbott Co. is preparing its statement of cash flows for the year. Abbott’s cash disbursements during the year included the following:
Payment of interest on bonds payable: $500,000
Payment of dividends to stockholders: 300,000
Payment to acquire 1,000 shares of Marks Co. common stock: 100,000
What should Abbott report as total cash outflows for financing activities in its statement of cash flows under U.S. GAAP?
$300,000
The $300,000 dividend should be classified as a financing cash outflow. The payment of interest is an operating cash outflow under U.S. GAAP, and the payment to acquire the common stock of Marks is an investing cash outflow. Under IFRS, payment of dividends may be classified as an operating or a financing activity.
Dannon Co. mistakenly reported its expenses of $35,200 on the cash basis. Corporate records revealed the following information:
Beginning prepaid expense: $1,300
Beginning accrued expense: $1,650
Ending prepaid expense: $1,800
Ending accrued expense; $1,200
What amount of expense should the Dannon report on its books under the accrual basis?
$34,250.
The beginning balance of net expense payable is $350 ($1,650 accrued expense – $1,300 prepaid expense). The ending balance of net expense payable is -$600 ($1,200 accrued expense – $1,800 prepaid expense). The $35,200 cash expense paid during the period decreases the expense payable account. The expense recognized under the accrual method increases the expense payable account. Thus, the expense that should be reported by Dannon in its books under the accrual method can be derived from the following equation:
Beginning expense payable: $350
(Expense paid during the period): (35,200)
Expense recognized under accrual method: 34,250
Ending expense payable: $(600)
Which of the following statements is true regarding a statement of cash flows prepared under IFRS?
Certain bank overdrafts may be classified as cash and cash equivalents.
Under IFRS, bank overdrafts may be classified as cash and cash equivalents if they are (1) repayable on demand and (2) part of an entity’s cash management.
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 collected from customers?
$535,800
Collections from customers equal sales minus the increase in gross accounts receivable, or $535,800 ($538,800 – $33,000 + $30,000).