17.9 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.
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).
Savor Co. had $100,000 in cash-basis pretax income for Year 2. At December 31, Year 2, accounts receivable had increased by $10,000 and accounts payable had decreased by $6,000 from their December 31, Year 1, balances. Compared to the accrual basis method of accounting, Savor’s cash pretax income is
Lower by $16,000.
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 in an earlier period (Year 2) than 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 in Year 2, but the related expense was accrued in Year 1. Hence, cash pretax income is lower than accrual-basis income by $16,000.
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.
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)
During the current year, Ace Co. amortized a bond discount. Ace prepares its statement of cash flows using the indirect method. In which section of the statement should Ace report the amortization of the bond discount?
Operating activities.
The statement of cash flows may be presented in either a direct or an indirect (reconciliation) format. In which of these formats would cash collected from customers be presented as a gross amount?
Direct:
Indirect:
Yes
No
The statement of cash flows may report cash flows from operating activities in either an indirect (reconciliation) or a direct format. The direct format reports the major classes of operating cash receipts and cash payments as gross amounts. The indirect presentation reconciles net income to the same amount of net cash flow from operations that would be determined in accordance with the direct method. To arrive at net operating cash flow, the indirect method adjusts net income by removing the effects of (1) all deferrals of past operating cash receipts and payments, (2) all accruals of expected future operating cash receipts and payments, (3) all financing and investing activities, and (4) all noncash operating transactions.
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.
Payne Co. prepares its statement of cash flows using the indirect method. Payne’s unamortized bond discount account decreased by $25,000 during the year. How should Payne report the change in unamortized bond discount in its statement of cash flows?
As an addition to net income in the operating activities section.
The amortization of bond discount (debit interest expense, credit discount) is a noncash item that reduces net income. In a statement of cash flows prepared using the indirect method, net operating cash flow is determined by adjusting 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. Thus, bond discount amortization should be added to net income in the reconciliation to net operating cash flow.
During Year 1, a company had the following cash transactions:
Interest paid: $1,000
Interest received: 800
Dividend paid: 350
Dividend received: 100
Which of the following cannot be the effect of the transactions above on the company’s Year 1 statement of cash flows?
Under IFRS:
Net cash used in operating activities: $1,350
Net cash provided by financing activities: $900
Under IFRS, interest and dividends received may be classified as cash flows from either operating or investing activities but not financing activities.
With respect to the content and form of the statement of cash flows,
The direct method of reporting cash flows from operating activities includes disclosing the major classes of gross cash receipts and gross cash payments.
Use of the direct method of reporting major classes of operating cash receipts and payments is encouraged, but the indirect method may be used. The minimum disclosures of operating cash flows under the direct method are (1) cash collected from customers, (2) interest and dividends received (unless donor-restricted to long-term purposes), (3) other operating cash receipts, (4) cash paid to employees and other suppliers of goods or services, (5) interest paid, (6) income taxes paid (and the amount that would have been paid if excess tax benefits from share-based payment arrangements had not been available), and (7) other operating cash payments.
In a statement of cash flows, interest payments to lenders and other creditors should be classified as cash outflows for
Operating Activities.
Cash receipts from sales of goods and services, interest on loans, and dividends on equity securities are from operating activities. Cash payments to (1) suppliers for inventory; (2) employees for services; (3) other suppliers for other goods and services; (4) governments for taxes, duties, fines, and fees; and (5) lenders for interest are also from operating activities.
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.
The following data were extracted from the financial statements of a company for the year ended December 31:
Net income: $70,000 Depreciation expense: 14,000 Amortization of intangible assets: 1,000 Decrease in accounts receivable: 2,000 Increase in inventories: 9,000 Increase in accounts payable: 4,000 Increase in plant assets: 47,000 Increase in contributed capital: 31,000 Decrease in short-term notes payable: 55,000
There were no disposals of plant assets during the year. Based on the above, a statement of cash flows will report a net increase in cash of
$11,000
Depreciation and amortization are noncash expenses and are added to net income. A decrease in receivables indicates that cash collections exceed sales on an accrual basis, so it is added to net income. To account for the difference between cost of goods sold (a reduction of income) and cash paid to suppliers, a two-step adjustment of net income 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 deducting the inventory increase and adding the accounts payable increase. An increase in plant assets indicates an acquisition of plant assets, causing a decrease in cash, so it is deducted. An increase in contributed capital represents a cash inflow and is added to net income. A decrease in short-term notes payable is deducted from net income because it reflects a cash outflow. Thus, cash increased by $11,000 ($70,000 NI + $14,000 + $1,000 + $2,000 – $9,000 + $4,000 – $47,000 + $31,000 – $55,000).
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.
