17.2 Flashcards
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:
Prepaid Royalties
Year 1: $60,000
Year 2: $50,000
Royalties Payable
Year 1: $75,000
Year 2: $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).
Duke Co. reported cost of goods sold of $270,000 for the current year. Additional information is as follows:
Inventory
December 31:
January 1:
Accounts Payable
December 31:
January 1:
If Duke uses the direct method, what amount should Duke report as cash paid to suppliers in its current year statement of cash flows?
$298,000
To reconcile cost of goods sold to cash paid to suppliers, a two-step adjustment is needed. First, determine purchases by adding the increase in inventory to cost of goods. Second, determine cash paid for goods sold by adding the decrease in accounts payable to purchases. Thus, cash paid for goods sold equals $298,000 [$270,000 + ($60,000 – $45,000) + ($39,000 – $26,000)].
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).
Kelli Company acquired land by assuming a mortgage for the full acquisition cost. This transaction should be disclosed on Kelli’s statement of cash flows as a(n)
Noncash financing and investing activity.
The exchange of debt for a long-lived asset does not involve a cash flow. It is therefore classified as a noncash financing and investing activity.
The net income for Cypress, Inc., was $3,000,000 for the year ended December 31. Additional information is as follows:
Depreciation on fixed assets: $1,500,000
Gain from cash sale of land: 200,000
Increase in accounts payable: 300,000
Dividends paid on preferred stock: 400,000
The net cash provided by operating activities in the statement of cash flows for the year ended December 31 is
$4,600,000
Net operating cash flow may be determined by adjusting net income for items that did not affect cash (the indirect method). Depreciation is an expense not directly affecting cash flows that should be added back to net income. The increase in accounts payable is added to net income because it indicates that an expense has been recorded but not paid. The gain on the sale of land is an inflow from an investing, not an operating, activity and should be subtracted from net income. The dividends paid on preferred stock are cash outflows from financing, not operating, activities and do not require an adjustment. Thus, net cash flow from operations is $4,600,000 ($3,000,000 + $1,500,000 – $200,000 + $300,000).
Which one of the following should be classified as a cash flow from an operating activity on the statement of cash flows?
A decrease in accounts payable during the year.
Operating activities are all transactions and other events that are not financing or investing activities. In general, operating activities involve the production and delivery of goods and the provision of services. Their effects normally are reported in earnings. A decrease in accounts payable indicates a cash outflow to the entity’s suppliers in payment for goods or services.
Fact Pattern:
Karr, Inc. reported net income of $300,000 for the current year. Changes occurred in several balance sheet accounts as follows:
Equipment: $25,000 increase
Accumulated depreciation: 40,000 increase
Note payable: 30,000 increase
Additional information:
- During the current year, Karr sold equipment costing $25,000, with accumulated depreciation of $12,000, for a gain of $5,000.
- In December of the current year, Karr purchased equipment costing $50,000 with $20,000 cash and a 12% note payable of $30,000.
- Depreciation expense for the year was $52,000.
In Karr’s current-year statement of cash flows, net cash used in investing activities should be
$2,000
The cash flows from investing activities include the cash effects of the sale of equipment and the purchase of equipment. The issuance of a note payable as part of the acquisition price of equipment does not involve cash but should be classified as a noncash financing activity. The cash inflow from the sale of equipment (carrying amount + gain) is $18,000 [($25,000 – $12,000) + $5,000]. The cash outflow from the purchase of equipment is $20,000 cash. The $30,000 note payable is included elsewhere. Thus, net cash used is $2,000 ($20,000 – $18,000).
Green Co. had the following transactions at December 31:
Cash proceeds from sale of investment in bonds of Blue Co. classified as available-for-sale (carrying amount = $60,000): $75,000
Dividends received on Grey Co. stock: 10,500
Common stock purchased from Brown Co.: 38,000
What amount should Green recognize as net cash from investing activities in its statement of cash flows at December 31?
$37,000
The sale proceeds of available-for-sale debt securities ($75,000) are a cash inflow from an investing activity. Cash outflows from acquiring equity instruments ($38,000) also are from an investing activity. But cash inflows from operating activities include cash receipts in the form of dividends ($10,500). Thus, the net cash flow from investing activities is $37,000 ($75,000 – $38,000).
During the current year, a tornado completely destroyed a building belonging to Holland Corp. The building cost $100,000 and had accumulated depreciation of $48,000 at the time of the loss. Holland received a cash settlement from the insurance company and reported a loss of $21,000. In Holland’s current-year cash flow statement, the net change reported in the cash flows from investing activities section should be a
$31,000 increase.
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. The building had a carrying amount of $52,000 ($100,000 – $48,000), and the loss was $21,000. Hence, the cash inflow from the involuntary conversion (a disposal of property) must have been $31,000 ($52,000 – $21,000).
Which of the following should be disclosed as supplemental information in the statement of cash flows?
Cash Flow per Share:
Conversions of debt to equity:
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.
In 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).
For the fiscal year just ended, Doran Electronics had the following results:
Net income: $920,000
Depreciation expense: 110,000
Increase in accounts payable: 45,000
Increase in net accounts receivable: 73,000
Increase in deferred income tax liability: 16,000
`Doran’s net cash flow from operating activities is
The following is the net cash flow from operating activities calculated using the indirect method:
Net income: $920,000
Add: Increase in accounts payable: 45,000
Add: Increase in deferred tax liability: 16,000
Add: Depreciation expense: 110,000
Minus: Increase in net accounts receivable; (73,000)
Net cash provided by operating activities; $1,018,000
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. An increase in inventory is subtracted from net income. It indicates that purchases were greater than cost of goods sold. A decrease in inventory is added to net income. It indicates that purchases were less than cost of goods sold. However, the change in inventory is not given, so it is assumed to be zero. The increase in accounts payable is added to net income. It indicates that cash paid to suppliers was $45,000 less than purchases. Thus, the net effect of the changes in inventory and accounts payable is that cash paid to suppliers was $45,000 ($0 + $45,000) less than the accrual basis cost of goods sold. The increase in a deferred income tax liability (debit income tax expense, credit deferred liability) is a noncash item. The adjustment is a $16,000 addition to net income. Depreciation ($110,000) also is a noncash item that is added to net income. The net accounts receivable balance increased by $73,000, implying that cash collections were less than sales. If sales, collections, write-offs, and recognition of bad debt expense were the only relevant transactions, $73,000 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 (reflecting that write-offs did not result in collections).
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.
Lino Co.’s worksheet for the preparation of its current-year statement of cash flows included the following:
Accounts receivable
December 31:$29,000
January 1: $23,000
Allowance for uncollectible accounts
December 31: 1,000
January 1: 800
Prepaid rent expense
December 31: 8,200
January 1: 12,400
Accounts payable
December 31: $22,400
January 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).
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.
