17.7 Flashcards
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 Accounts Payable:
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.
Savor Co. had $100,000 in accrual basis pretax income for the year. At year end, accounts receivable had increased by $10,000 and accounts payable had decreased by $6,000 from their prior year-end balances. Under the cash basis of accounting, what amount of pretax income should Savor report for the year?
$84,000
The increase in accounts receivable indicates that cash-basis pretax income is $10,000 lower than accrual-basis pretax income. Revenues from the increase in receivables are reported as earned prior to the future related cash inflows. The decrease in accounts payable indicates that cash-basis pretax income is $6,000 lower than accrual-basis pretax income. The cash outflows related to the increase in payables occurred, but the related expense was accrued in a prior year. Thus, cash pretax income is $84,000 ($100,000 – $10,000 – $6,000). When reconciling net income to net cash flows provided by operating activities, the increase in current operating assets and the decrease in current operating liabilities must be subtracted from net income.
In its Year 6 income statement, Kilm Co. reported cost of goods sold (COGS) of $450,000. Changes occurred in several balance sheet accounts as follows:
Inventory: $160,000 decrease
Accounts payable – suppliers: 40,000 decrease
What amount should Kilm report as cash paid to suppliers in its Year 6 cash flow statement, prepared under the direct method?
$330,000
COGS is included in the determination of net income. Cash paid to suppliers, however, is the amount included in determining net cash flows from operating activities. To determine cash paid to suppliers, a two-step adjustment to COGS is necessary. The first step adjusts for the difference between COGS and purchases. The second step adjusts for the difference between purchases and the amounts disbursed to suppliers. The decrease in inventory is therefore subtracted from COGS to arrive at purchases. The decrease in accounts payable is then added to purchases to determine cash paid to suppliers. Accordingly, cash paid to suppliers equals $330,000 ($450,000 COGS – $160,000 + $40,000).
Carlson Company has the following payments recorded for the current period:
Dividends paid to Carlson shareholders: $150,000
Interest paid on bank loan: 250,000
Purchase of equipment: 350,000
The total amount of the above items to be shown in the operating activities section of Carlson’s statement of cash flows should be
$250,000
Cash flows from operating activities include cash flows from all activities not classified as investing or financing. Their effects normally are reported in earnings. Operating cash flows include the payment and collection of interest, dividends paid are a financing cash outflow, and the purchase of equipment is an investing activity. Thus, the total amount to be reported in the operating activities section of the statement of cash flows is $250,000.
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 interest?
$3,800
Interest expense is $4,300. This amount includes $500 of discount amortization, a noncash item. Hence, the cash paid for interest was $3,800 ($4,300 – $500).
During the year, Deltech, Inc., acquired a long-term productive asset for $5,000 and also borrowed $10,000 from a local bank. These transactions should be reported on Deltech’s statement of cash flows as
Outflows for investing activities, $5,000; inflows from financing activities, $10,000.
The acquisition and disposal of property, plant, equipment, and other productive assets are investing activities. Borrowing money is a financing activity. Deltech’s transactions should therefore be reported on its statement of cash flows as a $5,000 outflow for investing activities and a $10,000 inflow from financing activities.
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.
Royce Company uses the indirect method to prepare its Year 2 statement of cash flows. It reports a(n)
Addition of $2,000 in the operating section for the $2,000 loss on the sale of the truck.
The indirect method determines net operating cash flow by adjusting net income for items that did not affect cash. Under the indirect method, the $5,000 cash inflow from the sale of the truck is shown in the investing section. A $2,000 loss was recognized and properly subtracted to determine net income. This loss, however, did not require the use of cash and should be added to net income in the operating section.
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 financing activities for the year is
$(80,000)
Cash flows from financing activities for the year consist of the $80,000 outflow for dividends paid. The issue of common stock is a financing activity, but the $800,000 of proceeds have not yet been received.
Lino Co.’s worksheet for the preparation of its current-year statement of cash flows included the following:
Accounts receivable 12/31: $29,000 1/1: $23,000 Allowance for uncollectible accounts 12/31: 1,000 1/1: 800 Prepaid rent expense 12/31: 8,200 1/1: 12,400 Accounts payable 12/31: 22,400 1/1: 19,400
Lino’s current-year net income is $150,000. What amount should Lino include as net cash provided by operating activities in the statement of cash flows?
$151,400
Net cash flow from operating activities may be reported indirectly by removing from net income the effects of (1) all deferrals of past operating cash receipts and cash payments, (2) all accruals of expected future operating cash receipts and cash payments, (3) all financing and investing activities, and (4) all noncash operating transactions. The increase in net accounts receivable [($29,000 – $1,000) – ($23,000 – $800) = $5,800] is a deduction from net income because it reflects noncash revenue. The decrease in prepaid expenses ($12,400 – $8,200 = $4,200) is a noncash expense and should be added. The increase in accounts payable ($22,400 – $19,400 = $3,000) is an amount not yet paid to suppliers and should be added. Thus, the net operating cash inflow is $151,400 ($150,000 – $5,800 + $4,200 + $3,000).
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
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.
Which of the following should not be disclosed in an enterprise’s statement of cash flows prepared using the indirect method?
Cash Flow per Share.
Cash flow per share is not presented in financial statements. Doing so might imply that cash flow is an alternative to net income as an indicator of performance.
Alp, Inc., had the following activities during the current year:
- Acquired 2,000 shares of stock in Maybel, Inc., for $26,000
- Sold an investment in bonds classified as available for sale for $35,000 when the carrying amount was $33,000
- Acquired a $50,000, 4-year certificate of deposit from a bank that was classified as held to maturity. (During the year, interest of $3,750 was paid to Alp.)
- Collected dividends of $1,200 on stock investments
In Alp’s current-year statement of cash flows, net cash used in investing activities should be
$41,000
Investing activities include the lending of money; the collection of those loans; and the acquisition, sale, or other disposal of (1) loans and other securities that are not cash equivalents and that have not been acquired specifically for resale and (2) property, plant, equipment, and other productive assets. Thus, the purchase of debt and equity securities, sale of debt and equity securities, and acquisition of a long-term certificate of deposit (not a cash equivalent) are investing activities assuming the debt securities are not trading securities. The receipts of interest and dividends are cash flows from operating activities. The net cash used in investing activities therefore equals $41,000 ($26,000 – $35,000 + $50,000).
n its statement of cash flow for the current year, Ness Co. reported cash paid for interest of $70,000. Ness did not capitalize any interest during the current year. Changes occurred in several balance sheet accounts as follows:
Accrued interest payable: $17,000 decrease
Prepaid interest: 23,000 decrease
In its income statement for the current year, what amount should Ness report as interest expense?
$76,000
To reconcile cash paid for interest ($70,000) to interest expense, the decrease in interest payable (a prior-period expense and a current-period cash outflow) is subtracted. The decrease in prepaid interest (a prior-period cash outflow and a current-period expense) is added. Current interest expense is $76,000 ($70,000 – $17,000 + $23,000).
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.
Which of the following should be disclosed as supplemental information in the statement of cash flows?
Cash Flow Per Share:
Debt-to-Equity Ratio:
No
Yes
Financial statements must not report cash flow per share. Reporting a per-share amount might improperly imply that cash flow is an alternative to net income as a performance measure. Conversion of debt to equity is a noncash financing activity. Information about all material investing and financing activities that affect recognized assets or liabilities but not cash flows must be disclosed. Given only a few transactions, disclosure may be on the same page as the statement of cash flows. Otherwise, disclosure may be elsewhere in the statements with a clear reference to the statement of cash flows.
