Chapter 23 Intermediate Accounting: Review

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1. The primary purpose of the statement of cash flows is to provide information (LO 1) (a)about the operating, investing, and financing activities of an entity during a period. (b)that is useful in assessing cash flow prospects. (c)about the cash receipts and cash payments of an entity during a period. (d)about the entity’s ability to meet its obligations, its ability to pay dividends, and its needs for external financing.
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(c)about the cash receipts and cash payments of an entity during a period. The primary purpose of the statement of cash flows is to provide information about the cash receipts and cash payments of an entity during a period.
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2. All of the following would be classified as financing cash flows except: (LO 1) (a)purchases of treasury stock. (b)proceeds from the sale of stock. (c)interest paid on long-term debt. (d)dividends paid on preferred stock.
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(c)interest paid on long-term debt. Interest paid on long-term debt is not a financing cash flow.
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3. Activities involving the cash effects of transactions that enter into the determination of net income are: (LO 1) (a)financing activities. (b)investing activities. (c)noncash investing and financing activities. (d)operating activities.
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(d)operating activities. Operating activities involve the cash effects of transactions that enter into the determination of net income.
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4. All of the following would be considered investing activities except: (LO 1) (a)purchase of equipment for cash. (b)sale of land for cash. (c)purchase on 25% interest in the stock of a supplier. (d)receipt of cash dividends from investments.
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(d)receipt of cash dividends from investments. The receipt of dividends from investments is not an investing activity.
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5. To arrive at net cash provided by operating activities, it is necessary to report revenues and expenses on a cash basis. This is done by (LO 2) (a)re-recording all income statement transactions that directly affect cash in a separate cash flow journal. (b)estimating the percentage of income statement transactions that were originally reported on a cash basis and projecting this amount to the entire array of income statement transactions. (c)eliminating the effects of income statement transactions that did not result in a corresponding increase or decrease in cash. (d)eliminating all transactions that have no future effect on cash from the net income computation.
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(c)eliminating the effects of income statement transactions that did not result in a corresponding increase or decrease in cash. This is done by eliminating the effects of income statement transactions that did not result in a corresponding increase or decrease in cash.
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6. Net cash flow from operating activities is determined by eliminating (LO 2) (a)earned revenues from net income. (b)incurred expenses from net income. (c)cash expenses and cash revenues from net income. (d)noncash expenses and noncash revenues from net income.
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(d)noncash expenses and noncash revenues from net income. Eliminating noncash expenses and noncash revenues from net income produces net cash flow from operating activities.
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7. The method of calculating net cash flow from operating activities that results in the presentation of a condensed cash receipts and cash disbursements statement is the: (LO 3) (a)reconciliation method. (b)indirect method. (c)direct method. (d)cash flow method.
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(c)direct method. The direct method results in presenting condensed cash receipts and cash disbursements statement.
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8. Which method adjusts net income for items that affected reported net income but did not affect cash? (LO 3) (a)Direct. (b)Adjustment. (c)Accrual. (d)Indirect.
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(d)Indirect. The indirect method starts with net income and then adjusts it for noncash items that affected net income.
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9. Spruce Pine Co. provided the following information on selected transactions during 2017: Repayment of bond principal…$450,000 Proceeds from issuing common stock…760,000 Purchases of inventory…940,000 Proceeds from the sale of treasury stock…120,000 Purchase of 10% interest in stock of Hindi Corp…220,000 Dividends paid to common & preferred stockholders…80,000 Proceeds from issuing preferred stock…150,000 Proceeds from sale of land…380,000 The net cash provided (used) by investing activities during 2017 is (LO 2) (a)$140,000. (b)$160,000. (c)$280,000. (d)$(780,000).
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(b)$160,000. $(220,000) + $380,000 = $160,000.
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10. Mazzeo Co. provided the following information on selected transactions during 2017: Purchase of land by issuing bonds $650,000 Proceeds from issuing stock 520,000 Purchases of inventory 950,000 Purchases of treasury stock 350,000 Loans made to affiliated corporations 175,000 Dividends paid to preferred stockholders 100,000 Proceeds from issuing preferred stock 210,000 Proceeds from sale of land 325,000 The net cash provided (used) by investing activities during 2017 is (LO 2) (a)$150,000. (b)$(500,000). (c)$(325,000). (d)$(900,000).
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(a)$150,000. $325,000 ? $175,000 = $150,000.
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11. Ando Company sold some of its plant assets during 2017. The original cost of the plant assets was $500,000 and the accumulated depreciation at date of sale was $325,000. The proceeds from the sale of the plant assets were $150,000. The information concerning the sale of the plant assets should be shown on Caraway’s statement of cash flows (indirect method) for the year ended December 31, 2017, as a (n) (LO 2) (a)subtraction from net income of $150,000 and a $175,000 increase in cash flows from financing activities. (b)addition to net income of $25,000 and a $175,000 increase in cash flows from investing activities. (c)subtraction from net income of $25,000 and a $150,000 increase in cash flows from investing activities. (d)addition of $150,000 to net income.
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(c)subtraction from net income of $25,000 and a $150,000 increase in cash flows from investing activities. $150,000 ? ($500,000 ? $325,000) = $25,000 loss, $150,000 (proceeds).
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12. Anna Maria Island Co. provided the following information on selected transactions during 2017: Purchase of land by issuing bonds $1,550,000 Proceeds from sale of land 925,000 Proceeds from issuing bonds 1,900,000 Purchases of inventory 2, 975,000 Purchases of treasury stock 190,000 Loans made to affiliated corporations 525,000 Dividends paid to preferred stockholders 120,000 Proceeds from issuing preferred stock 325,000 Proceeds from sale of equipment 650,000 The net cash provided by financing activities during 2017 is (LO 2) (a)$1,725,000. (b)$1,915,000. (c)$2,040,000. (d)$2,465,000.
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(b)$1,915,000. $1,900,000 ? $190,000 ? $120,000 + $325,000 = $1,915,000.
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13. Acquiring land and a building by issuing common stock would be reported as: (LO 4) (a)an investing activity. (b)a financing activity. (c)both an investing activity and a financing activity. (d)a noncash investing and financing activity.
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(d)a noncash investing and financing activity. Acquiring assets by issuing equity securities would be reported as a noncash investing and financing activity.
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14. All of the following adjustments would be deducted in determining net cash flow from operating activities except: (LO 4) (a)amortization of bond premium. (b)decrease in deferred income tax liability. (c)gain on sale of plant assets. (d)increase in accrued liabilities.
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(d)increase in accrued liabilities. All of the options are deducted in determining net cash flow from operating activities except an increase in accrued liabilities.
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15. Mott Company sold some of its plant assets during 2017. The original cost of the plant assets was $1,500,000 and the accumulated depreciation at date of sale was $1,300,000. The proceeds from the sale of the plant assets were $310,000. The information concerning the sale of the plant assets should be shown on Mott’s statement of cash flows (indirect method) for the year ended December 31, 2017, as a (n) (LO 2) (a)subtraction from net income of $110,000 and a $200,000 increase in cash flows from financing activities. (b)addition to net income of $110,000 and a $310,000 increase in cash flows from investing activities. (c)subtraction from net income of $110,000 and a $310,000 increase in cash flows from investing activities. (d)addition of $310,000 to net income.
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(c)subtraction from net income of $110,000 and a $310,000 increase in cash flows from investing activities. $310,000 ? ($1,500,000 ? $1,300,000) = $110,000, $310,000 (proceeds).
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16. An analysis of the machinery accounts of Newport Company for 2017 is as follows: Machinery, net of Machinery/Accumulated Depreciation/Accumulated Depreciation Balance at January 1, 2017 $1,600,000…$850,000…$750,000 Purchases of new machinery in 2017 for cash 450,000…0…450,000 Depreciation in 2017 0…250,000…(250,000) Balance at December 31, 2017 $2,050,000…0…0 Totals 0…$1,100,000…$950,000 The information concerning Newport’s machinery accounts should be shown in Newport’s statement of cash flows (indirect method) for the year ended December 31, 2017, as a (n) (LO 2) (a)subtraction from net income of $450,000 and a $250,000 decrease in cash flows from financing activities. (b)addition to net income of $250,000 and a $450,000 decrease in cash flows from investing activities. (c)$450,000 increase in cash flows from financing activities. (d)$250,000 decrease in cash flows from investing activities.
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(b)addition to net income of $250,000 and a $450,000 decrease in cash flows from investing activities. The information should be shown as an addition to net income of $250,000 and a $450,000 decrease in cash flows from investing activities.
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17. The sources of information used to prepare the statement of cash flows includes all of the following except (LO 2) (a)comparative balance sheets. (b)last year’s income statement. (c)this year’s retained earnings statement. (d)other selected transaction data.
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(b)last year’s income statement. The sources of information include all of the options except last year’s income statement
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18. A statement of cash flows typically would not disclose the effects of (LO 4) (a)capital stock issued at an amount greater than par value. (b)stock dividends declared. (c)cash dividends paid. (d)a purchase and immediate retirement of treasury stock.
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(b)stock dividends declared. A statement of cash flows typically would not disclose the effects of stock dividends declared.
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19. Which of the following statements related to a worksheet used for the preparation of a statement of cash flows is not correct? (LO 5) (a)Accounts with debit balances are listed separately from those with credit balances in the balance sheet accounts section. (b)Inflows of cash are entered as debits and outflows as credits in the reconciling columns. (c)The reconciling items shown in the worksheet are entered in a journal and posted to the appropriate accounts. (d)The bottom portion of the worksheet consists of the operating, investing, and financing activities sections.
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(c)The reconciling items shown in the worksheet are entered in a journal and posted to the appropriate accounts. The reconciling items shown in the worksheet are not journalized or posted.
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20. Which of the following statements related to a worksheet used for preparation of the statement of cash flows is not correct? (LO 5) (a)Accounts with debit balances are listed separately from those with credit balances in the balance sheet accounts section. (b)Inflows of cash are entered as debits and outflows of cash are entered as credits in the reconciling columns. (c)The reconciling items shown in the work sheet are entered in a journal and posted to appropriate accounts. (d)All of these answers are correct.
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(c)The reconciling items shown in the work sheet are entered in a journal and posted to appropriate accounts. All of the options are correct except the reconciling items are not entered in any journal or posted to any account.
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1. Serius Corporation is preparing its 2017 statement of cash flows, using the direct method. Presented below is a list of items that may affect the statement. Using the code below, indicate how each item will affect Sirius’ 2017 statement of cash flows. Code Letter…Effect R-O…Cash receipt in operating section P-O…Cash payment in operating section R-I…Cash receipt in investing section P-I…Cash payment in investing section R-F…Cash receipt in financing section P-F…Cash payment in financing section N…Noncash investing and financing activity NA…Not included in statement of cash flows (a)Purchase of land and building. ________(b)Customers’ payments on account. ________(c)Issuance of preferred stock. ________(d)Depreciation expense. ________(e)Sale of land at book value. ________(f)Sale of land at a loss. ________(g)Payment of dividends. ________(h)Cash sales. ________(i)Purchase of available-for-sale investment. ________(j)Pay weekly salaries. ________(k)Pay outstanding accounts payable. ________(l)Loan from bank by signing note. ________(m)Purchase of equipment using a note. ________(n)Purchase of inventory on account. ________(o)Issuance of bonds payable. ________(p)Redemption of bonds payable. ________(q)Sale of equipment at a gain. ________(r)Purchase of treasury stock.
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a)P-I (b)R-O (c)R-F (d)NA (e)R-I (f)R-I, NA (g)P-F (h)R-O (i)P-I (j)P-O (k)P-O (l)R-F (m)N (n)NA (o)R-F (p)P-F (q)R-I, NA (r)P-F
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2. Eos World Corporation had the following activities in 2017. 1.Receipt on accounts receivable $1,685,000. 2.Purchase treasury stock $63,000. 3.Payment of dividends $175,000. 4.Purchase of equipment $82,000. 5.Redemption of bonds payable $260,000. 6.Issuance of preferred stock $325,000. Compute the amount Eos World should report as net cash provided (used) by financing activities in its 2017 statement of cash flows.
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Cash flows from financing activities Issuance of preferred stock…$325,000 Redemption of bonds payable…(260,000) Payment of dividends…(175,000) Purchase of treasury stock…(63,000) Net cash used in financing activities…$(173,000)
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3. At January 1, 2017, LifePhoto Inc. had accounts receivable of $167,000. At December 31, 2017, accounts receivable is $151,000. Sales revenue for 2017 total $968,000. Compute LifoPhoto’s 2017 cash receipts from customers.
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Sales revenue…$968,000 Add: Decrease in accounts receivable ($167,000 ? $151,000)…16,000 = Cash receipts from customers…$984,000
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4. In 2017, Transroute Inc. issued 50,000 shares of $2 par value preferred stock for five semi-trucks worth $260,000. (a)Prepare Transroute’s journal entry to record the transaction. (b)Indicate the effect the transaction has on cash. (c)Indicate how the transaction is reported on the statement of cash flows.
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(a)Equipment…260,000 …..Common Stock…100,000 …..Paid-in Capital in Excess of Par—Common Stock…160,000 (b)No effect (c)Noncash investing and financing activities: …..Purchase equipment through issuance of common stock…$260,000
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5. Indicate in general journal form how the items below would be entered in a worksheet for the preparation of the statement of cash flows. (a)Net income is $594,000. (b)Cash dividends declared, but not paid of $40,000. (c)Redemption of bonds payable of $300,000. (d)Purchase of equipment using a note payable of $56,000.
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(a) Operating—Net Income…594,000 …..Retained Earnings…594,000 (b) Retained Earnings…40,000 …..Dividends Payable…40,000 (c) Bonds Payable…300,000 …..Financing-Redemption of Bonds…300,000 (d) Equipment…56,000 …..Notes Payable…56,000
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Short-term, highly liquid investments that are both (a) readily convertible to known amounts of cash, and (b) so near their maturity that they present insignificant risk of changes in fair value due to changes in interest rates. Generally, only investments with original maturities of 3 months or less qualify under this definition. Examples are Treasury bills, commercial paper, and money market funds purchased with cash that is in excess of immediate needs.
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cash equivalents
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Method of preparing the cash flow statement, which reports cash receipts and cash disbursements from operating activities. This results in the presentation of a condensed cash receipts and cash disbursements statement.
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direct method
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Cash flow activities that include (1) obtaining cash from issuing debt and repaying the amounts borrowed, and (2) obtaining cash from stockholders and paying them dividends.
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financing activities
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Method of preparing the cash flow statement that starts with net income and converts it to net cash provided by operating activities, by adjusting net income for items that affected reported net income but did not affect cash. Also called the reconciliation method.
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indirect method
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Cash flow activities that include (1) purchasing and disposing of investments and productive long-lived assets using cash, and (2) lending money and collecting the loans.
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investing activities
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Cash flow activities include the cash effects of transactions that create revenues and expenses, and thus enter into the determination of net income.
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operating activities
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Transactions and events that are investing or financing activities but that do not involve cash and thus are omitted from the statement of cash flows. These include acquisition of assets by assuming liabilities or by issuing equity securities, exchanges of nonmonetary assets, refinancing of long-term debt, conversion of debt or preferred stock to common stock, and issuance of equity securities to retire debt. Companies either disclose these transactions in a separate schedule on the statement of cash flows or in a separate note to the financial statements.
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significant noncash transactions
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The basic financial statement that reports cash receipts, cash payments, and net change in cash resulting from operating, investing, and financing activities, in a format that reconciles the beginning and ending cash balances.
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statement of cash flows
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1. (L.O. 1) The information in a statement of cash flows should help investors, creditors, and others to assess the reasons for the difference between net income and net cash flow from operating activities. True or False
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1. (T)
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2. (L.O. 1) Operating activities as defined by GAAP, involve the cash effects of transactions that enter into the determination of net income. True or False
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2. (T)
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3. (L.O. 1) The statement of cash flows provides information not available from other financial statements. True or False
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3. (T)
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4. (L.O. 1) Financing activities include (a) making and collecting loans and (b) acquiring and disposing of investments and productive longlived assets. True or False
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4. (F) This is the definition of investing activities.
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5. (L.O. 1) The cash received from the sale of property, plant, and equipment at a gain, although reported in the income statement, is classified as an investing activity.
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5. (T)
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6. (L.O. 2) To prepare the statement of cash flows, only comparative balance sheets and a current income statement are needed.
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6. (F) To prepare the statement of cash flows, comparative balance sheets, the current income statement, and selected transaction data are needed
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7. (L.O. 2) Determining net cash provided by operating activities involves analysis of the income statement alone as it is the statement that reflects the amount of cash generated from operations as well as the amount of cash used to conduct the operations. True or False
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7. (F) Determining net cash provided by operating activities involves analyzing not only the current year’s income statement but also comparative balance sheets as well as selected transaction data.
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8. (L.O. 1) If a cash inflow and a cash outflow result from similar type transactions, such as the purchase and sale of property, plant, and equipment or the issuance and repayment of debt, they may be shown as a net amount from the two transactions in the statement of cash flows. True or False
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8. (F) Individual inflows and outflows from investing and financing activities are reported separately. Thus, cash outflow from the purchase of property, plant, and equipment is reported separately from the cash inflow from the sale of property, plant, and equipment.
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9. (L.O. 1) Unlike the other financial statements, the statement of cash flows is not prepared from the adjusted trial balance. True or False
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9. (T)
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10. (L.O. 1) The redemption of bonds would be classified as an investing activity. True or False
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10. (F) The redemption of bonds would be classified as a financing activity.
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11. (L.O. 2) If a company records a loss on the sale of equipment, the amount of the loss must be added back to net income to determine the proper amount of net cash provided by operating activities. True or False
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11. (T)
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12. (L.O. 2) Because the payment of cash dividends reduces both cash and retained earnings by a similar amount, this transaction has no effect on the statement of cash flows. True or False
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12. (F) The payment of dividends obviously has an impact on the statement of cash flows as it is an outflow of cash. Dividends are reported as an outflow in the financing activities section of the statement of cash flows.
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13. (L.O. 2) The amortization of a bond premium should be handled in the same manner as depreciation of a plant asset, that is, added to net income when determining net cash provided by operating activities. True or False
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13. (F) The amortization of bond premium reduces the amount of interest expense reported on the income statement, but it does not reduce the amount of cash flowing out of the business. Thus, the amount of premium amortization must be deducted from net income to arrive at cash provided by operating activities.
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14. (L.O. 2) When a repair to equipment is debited to accumulated depreciation because it extends the asset’s useful life, the transaction is considered neither an increase nor a decrease in cash for the period. True or False
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14. (F) The debit to accumulated depreciation as a result of an equipment repair is most likely offset by a credit to cash. Thus, such a transaction would cause a decrease in cash and be shown as an outflow on the statement of cash flows.
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15. (L.O. 2) When accounts payable increase during a period, cost of goods sold on an accrual basis is lower than cost of goods sold on a cash basis. True or False
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15. (F) Cost of goods sold is the same under either basis. Even if items for which cash has not been expended are eliminated from the computation, the amount of cost of goods sold remains the same.
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16. (L.O. 3) The direct method is more consistent with the objective of the statement of cash flows because it shows operating cash receipts and payments where the indirect method does not. True or False
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16. (T)
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17. (L.O. 3) The principal advantage of the indirect method is that it focuses on the difference between net income and net cash provided by operating activities, thus providing a useful link between the statement of cash flows, the income statement, and the balance sheet. True or False
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17. (T)
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18. (L.O. 3) The conversion of net income to net cash provided by operating activities may be accomplished using either the direct method or the indirect method. True or False
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18. (T)
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19. (L.O. 3) As its name implies, the indirect method is not directly involved with the computation of accrual based net income because it results in the presentation of a condensed cash basis income statement. True or False
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19. (F) It is the direct method that results in the presentation of a condensed cash basis income statement.
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20. (L.O. 2) When computing net cash provided by operating activities under the indirect method, an increase in accounts receivable (net) during the year must be added to accrual based net income because more sales were made then those reflected in the income statement. True or False
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20. (F) When accounts receivable increase during the year, revenues on an accrual basis are higher than revenues on a cash basis because goods sold on account are reported as revenues. In other words, sales for the period led to increased revenue, but not all of those sales resulted in an increase in cash.
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21. (L.O. 3) When the direct method is used in determining cash provided by operating activities, users of the statement of cash flows are unable to reconcile the net income to the net cash provided by operations because this is only provided when the indirect method is used. True or False
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21. (F) If the direct method of reporting net cash provided by operating activities is used, the FASB requires that the reconciliation of net income to net cash provided by operating activities be provided in a separate schedule.
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22. (L.O. 4) Stock dividends and stock splits are classified as financing activities. True or False
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22. (F) Stock dividends and stock splits are significant noncash transactions that generally are not reported in conjunction with the statement of cash flows.
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23. (L.O. 4) Some changes in working capital, although they affect cash, do not affect net income. True or False
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23. (T)
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24. (L.O. 4) Cash flows from events whose effects are included in net income, but which are not related to operations, should be reported either as investing activities or as financing activities. True or False
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24. (T)
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25. (L.O. 5) The reconciling items in the work sheet are not entered in any journal or posted to any account. True or False
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25. (T)
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1. (L.O. 1) Which of the following is not one of the benefits investors and creditors can expect as a result of the presentation of the statement of cash flows? A. Assess the enterprise’s ability to meet its obligations, its ability to pay dividends, and its need for external financing. B. Assess the effects on an enterprise’s financial position of both its cash and noncash investing and financing transactions during a period. C. Assess the enterprise’s ability to expand its operating facilities through the issuance of long-term debt. D. Assess the reasons for differences between net income and associated cash receipts and payments.
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1. (C) Alternatives (A), (B), and (D) are examples of the information an investor or creditor derives from use of the statement of cash flows. Alternative (C) requires a greater amount of in-depth information that is not available in the statement of cash flows alone.
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2. (L.O. 1) Of the following questions, which one would not be answered by the statement of cash flows? A. Where did the cash come from during the period? B. What was the cash used for during the period? C. Were all the cash expenditures of benefit to the company during the period? D. What was the change in the cash balance during the period?
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2. (C) The statement of cash flows, like the balance sheet and income statement, reflects the results of transactions entered into by the entity during the preceding year. The statement of cash flows could include the results of some cash flow transactions that were of great benefit and some that were of little benefit. The purpose of the statement is to reflect cash inflows and cash outflows, not to evaluate the benefits derived from the transactions. A great deal of additional information would have to be included in the statement of cash flows for a reader to evaluate the benefit of each cash receipt or expenditure recorded.
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3. (L.O. 1) The basis recommended by the FASB for the statement of cash flows is “cash and cash equivalents.” As described by GAAP, cash equivalents are: A. All current assets that have no realization problems associated with them. B. Shortterm, highly liquid investments that are both readily convertible to known amounts of cash, and so near their maturity that they present insignificant risk of changes in interest rates. C. All cash and near cash items that will be turned into cash within one operating period or one year, whichever is shorter. D. All cash and investments in shortterm securities that have a maturity of three months or less from the date of the financial statements.
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3. (B) Alternative (B) is the definition of “cash and cash equivalents.” The definition also includes the requirement that only investments with original maturities of three months or less qualify as cash equivalents.
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4. (L.O. 1) In general, financing activities as used in the statement of cash flows refer to: A. liability and owners’ equity items and include (a) obtaining cash from creditors and repaying the amounts borrowed and (b) obtaining capital from owners and providing them with a return on, and a return of, their investment. B. transactions involving long-term assets and include (a) making and collecting loans and (b) acquiring and disposing of investments and productive long-lived assets. C. only debt transactions that result from longterm borrowings from financial institutions. D. the cash effect of transactions that enter into the determination of net income and, thus, help finance the operations of the business through the generation of cash.
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4. (A) Liability and owners’ equity items which include borrowing money from creditors and owners and repaying the borrowings along with a return on the borrowings represent financing activities. Alternative B refers to investing activities as defined by the statement of cash flows, and alternative D is a partial explanation of operating activities.
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5. (L.O. 1) The cash received from the sale of property, plant, and equipment at no gain or loss is classified as what type of activity on the statement of cash flows? Investing…Financing…Operating A. Yes Yes No B. No No Yes C. No Yes No D. Yes No No
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5. (D) The cash received from the sale of property, plant, and equipment at no gain or loss is classified as an investing activity.
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6. (L.O. 1) Which of the following activities is classified as an investing activity on the statement of cash flows? A. Cash received from the sale of goods and services. B. Cash paid to suppliers for inventory. C. Cash paid to lenders for interest. D. Cash received from the sale of property, plant, and equipment.
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6. (D) Investing activities include (a) making and collecting loans and (b) acquiring and disposing of investments and productive assets. Thus, the cash received from the sale of property, plant, and equipment represents the disposal of productive assets.
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7. (L.O. 1) In a statement of cash flows, the cash flows from investing activities section should report: A. the issuance of common stock in exchange for legal services. B. a stock split. C. the assignment of accounts receivable. D. a payment of dividends.
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7. (C) In a statement of cash flows, an assignment of accounts receivable is classified as an investing activity. The issuance of common stock in exchange for legal services and a stock split (A and B) are noncash transactions that would not be reported on the statement of cash flows. A payment of dividends (D) is classified as a financing activity.
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8. (L.O. 1) The first step in the preparation of the statement of cash flow requires the use of information included in which comparative financial statements? A. Statements of Cash Flows. B. Balance Sheets. C. Income Statements. D. Statements of Retained Earnings.
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8. (B) The first step in the preparation of the statement of cash flows is to compute the change in cash. The change can be determined by a comparison of comparative balance sheets which would show the beginning and ending cash balances.
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9. (L.O. 2) The amortization of bond premium on longterm debt should be presented in a statement of cash flows (using the indirect method for operating activities) as a(n): A. Addition to net income. B. Deduction from net income. C. Investing activity. D. Financing activity.
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9. (B) When a bond premium exists the amortization causes the bond interest expense reported on the income statement to be smaller than the interest paid or becoming payable. Thus, because the cash outflow is larger than the deduction in arriving at net income, a deduction from net income is necessary to determine cash provided by operating activities under the indirect approach.
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10. (L.O. 2) Schroeder Company uses the indirect method in computing net cash provided by operating activities. How would reported net income be adjusted for the following items? Loss on Sale of Machinery…Increase in Inventories A. Added To…Deducted From B. Deducted From…Added To C. Added To…Added To D. Deducted From…Deducted From
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10. (A) A loss on the sale of machinery is a deduction from net income without a corresponding outflow of cash from operations. Thus, the loss would be added back to net income in computing net cash provided by operating activities. The increase in inventories indicates that cost of goods sold on an accrual basis would be less than it would have been if it were computed on a cash basis. In converting to the cash basis, the increase in inventory would be subtracted from net income to arrive at net cash provided by operating activities.
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11. (L.O. 3) Crabbe Company reported $80,000 of selling and administrative expenses on its income statement for the past year. The Company had depreciation expense and an increase in prepaid expenses associated with the selling and administrative expense for the year. Assuming use of the direct method, how would these items be handled in converting the accrual based selling and administrative expense to the cash basis? Depreciation Increase in Prepaid Expenses A. Deducted From…Deducted From B. Added To…Added To C. Deducted From…Added To D. Added To…Deducted From
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11. (C) The noncash depreciation charge should be deducted from the selling and administrative expense in converting it to the cash basis. The increase in the prepaid expense would be added to selling and administrative expense as it represents a cash outflow that was not charged to an expense account.
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12. (L.O. 2) During 2017, Greta Company reported net income of $128,000 which included depreciation expense of $26,000. In addition, the Company experienced the following changes in the account balances listed below: Increases: Accounts payable ……………………………………….. $15,000 Inventory ……………………………………………………. 12,000 Decreases: Accounts receivable …………………………………….. $ 4,000 Prepaid expenses ……………………………………….. 11,000 Accrued liabilities 8,000 Based upon this information what amount will be shown for net cash provided by operating activities for 2017. A. $ 89,000. B. $ 95,000. C. $155,000. D. $164,000.
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12. (D) Net income $128,000 Increase in accounts payable 15,000 Increase in inventory (12,000) Depreciation expense 26,000 Decrease in accounts receivable 4,000 Decrease in prepaid expenses 11,000 Decrease in accrued liabilities (8,000) = Net cash provided by operating activities $164,000
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13. (L.O. 3) When preparing a statement of cash flows, an increase in accounts receivable during the period would cause which one of the following adjustments in determining cash flows from operating activities? Direct Method…Indirect Method A. Increase…Decrease B. Decrease…Increase C. Increase…Increase D. Decrease…Decrease
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13. (D) An increase in accounts receivable during the period would indicate that the amount of cash received during the period was less than the amount of sales reported as earned? therefore, under both the direct and indirect methods, there would be an adjustment decreasing the cash flows from operating activities.
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14. (L.O. 2) Cashman Company reported net income after taxes of $85,000 for the year ended 12/31/17. Included in the computation of net income were: depreciation expense, $15,000? amortization of a patent, $8,000? income from an investment in common stock of Linda Inc., accounted for under the equity method, $12,000? and amortization of a bond premium, $3,000. Cashman also paid a $20,000 dividend during the year. The net cash provided by operating activities would be reported at: A. $57,000. B. $73,000. C. $77,000. D. $93,000.
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14. (D) Net income $ 85,000 Depreciation expense 15,000 Amortization of patent 8,000 Amortization of bond premium (3,000) Investment income (12,000) = Net cash provided by operating activities $ 93,000
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15. (L.O. 4) In its first year of operations Trumbo Company reported net income of $257,000. Total sales, all on account, amounted to $486,000, and collections of receivables during the year totaled $396,500. Trumbo uses the allowance method in accounting for bad debts expense and during the year recorded bad debt expense of $21,000. Based on these facts alone, what is the net cash provided by operating activities? A. $146,500 B. $188,500 C. $236,000 D. $325,500
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15. (B) Increase in receivables (sales) $486,000 Decrease in receivables (collections) 396,500 = Net increase in receivables $ 89,500 Net income $257,000 Increase in receivables (89,500) Bad debt expense 21,000 = Cash flow from operations $188,500
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16. (L.O. 2) To arrive at net cash provided by operating activities, it is necessary to report revenues and expenses on a cash basis. This is done by: A. rerecording all income statement transactions that directly affect cash in a separate cash flow journal. B. estimating the percentage of income statement transactions that were originally reported on a cash basis and projecting this amount to the entire array of income statement transactions. C. eliminating the effects of income statement transactions that did not result in a corresponding increase or decrease in cash. D. eliminating all transactions that have no current or future effect on cash, such as depreciation, from the net income computation.
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16. (C) By eliminating the effects of income statement transactions that did not result in a corresponding increase or decrease in cash, the accrual based net income is changed to a cash basis. This procedure includes items that have no impact on cash, like depreciation, and items that have a future impact on cash, like sales on account.
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Questions 17 through 20 are based on the data shown below related to the statement of cash flows for Jeannie Western Stores, Inc.: Jeannie Western Stores, Inc. Comparative Balance Sheets December 31, 2016 2017 Assets Current Assets: Cash $ 180,000 $ 230,000 Accounts Receivable (net) 360,000 520,000 Merchandise Inventory 420,000 650,000 Prepaid Expense 105,000 117,000 Total Current Assets 1,065,000 1,517,000 LongTerm Investments 75,000 Fixed Assets: Property, Plant & Equipment 480,000 730,000 Accumulated Depreciation (90,000) (150,000) Total Fixed Assets 390,000 580,000 Total Assets $1,455,000 $2,172,000 Equities: Current Liabilities: Accounts Payable $ 365,000 $ 425,000 Accrued Expenses 94,000 103,000 Dividends Payable ________ 67,000 Total Current Liabilities 459,000 595,000 LongTermNotes Payable 275,000 Stockholders’ Equity: Common Stock 800,000 1,000,000 Retained Earnings 196,000 302,000 Total Equities $1,455,000 $2,172,000 Jeannie Western Stores, Inc. Comparative Income Statements December 31, 2016 2017 Net Credit Sales $1,251,000 $2,340,000 Cost of Goods Sold 627,000 1,305,000 Gross Profit 624,000 1,035,000 Expenses (including Income Tax) 458,000 862,000 Net Income $ 166,000 $ 173,000 Additional Information: a. Accounts receivable and accounts payable relate to merchandise held for sale in the normal course of business. The allowance for bad debts was the same at the end of 2017 and 2016, and no receivables were charged against the allowance. Accounts payable are recorded net of any discount and are always paid within the discount period. 17. (L.O. 2) What amount of cash was paid on accounts payable to suppliers during 2017? A. $1,245,000 B. $1,365,000 C. $1,475,000 D. $1,535,000
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17. (C) The following “T” account analysis shows the amounts that need to be determined in answering this question: Accounts Payable Beginning Balance…365,000 (Cr) Payments ? (Dr) Purchases ? (Cr) Ending Balance…425,000(Cr) An analysis of Cost of Goods Sold is required to determine the purchases: Beginning Inventory $ 420,000 Plus Purchases ? Less Ending Inventory (650,000) Cost of Goods Sold $1,305,000 Thus, purchases are equal to: $1,305,000 ? $420,000 + $650,000 = $1,535,000 Now substituting the amount for purchases in the “T” account above, cash payments on accounts payable are: $365,000 + $1,535,000 $ 425,000 = $1,475,000
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Questions 17 through 20 are based on the data shown below related to the statement of cash flows for Jeannie Western Stores, Inc.: Jeannie Western Stores, Inc. Comparative Balance Sheets December 31, 2016 2017 Assets Current Assets: Cash $ 180,000 $ 230,000 Accounts Receivable (net) 360,000 520,000 Merchandise Inventory 420,000 650,000 Prepaid Expense 105,000 117,000 Total Current Assets 1,065,000 1,517,000 LongTerm Investments 75,000 Fixed Assets: Property, Plant & Equipment 480,000 730,000 Accumulated Depreciation (90,000) (150,000) Total Fixed Assets 390,000 580,000 Total Assets $1,455,000 $2,172,000 Equities Current Liabilities: Accounts Payable $ 365,000 $ 425,000 Accrued Expenses 94,000 103,000 Dividends Payable ________ 67,000 Total Current Liabilities 459,000 595,000 LongTerm Notes Payable 275,000 Stockholders’ Equity: Common Stock 800,000 1,000,000 Retained Earnings 196,000 302,000 Total Equities $1,455,000 $2,172,000 Jeannie Western Stores, Inc. Comparative Income Statements December 31, 2016 2017 Net Credit Sales $1,251,000 $2,340,000 Cost of Goods Sold 627,000 1,305,000 Gross Profit 624,000 1,035,000 Expenses (including Income Tax) 458,000 862,000 Net Income $ 166,000 $ 173,000 Additional Information: a. Accounts receivable and accounts payable relate to merchandise held for sale in the normal course of business. The allowance for bad debts was the same at the end of 2017 and 2016, and no receivables were charged against the allowance. Accounts payable are recorded net of any discount and are always paid within the discount period. 18. (L.O. 2) What amount of cash was collected from 2017 accounts receivable? A. $1,090,000 B. $2,180,000 C. $2,340,000 D. $2,500,000
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18. (B) The following “T” account analysis shows the amount that needs to be determined in answering this question: Accounts Payable Beginning Balance 360,000 Net Credit Sales 2,340,000 ? Cash Collections Ending Balance 520,000 The computation of cash collections is: $360,000 + $2,340,000 $ 520,000 = $2,180,000
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Questions 17 through 20 are based on the data shown below related to the statement of cash flows for Jeannie Western Stores, Inc.: Jeannie Western Stores, Inc. Comparative Balance Sheets December 31, 2016…2017 Assets…Current Assets: Cash $ 180,000 $ 230,000 Accounts Receivable (net) 360,000 520,000 Merchandise Inventory 420,000 650,000 Prepaid Expense 105,000 117,000 Total Current Assets 1,065,000 1,517,000 Long-Term Investments 75,000 Fixed Assets: Property, Plant & Equipment 480,000 730,000 Accumulated Depreciation (90,000) (150,000) Total Fixed Assets 390,000 580,000 Total Assets $1,455,000 $2,172,000 Equities…Current Liabilities: Accounts Payable $ 365,000 $ 425,000 Accrued Expenses 94,000 103,000 Dividends Payable ________ 67,000 Total Current Liabilities 459,000 595,000 Long-Term Notes Payable 275,000 Stockholders’ Equity: Common Stock 800,000 1,000,000 Retained Earnings 196,000 302,000 Total Equities $1,455,000 $2,172,000 Jeannie Western Stores, Inc. Comparative Income Statements December 31, 2016…2017 Net Credit Sales $1,251,000 $2,340,000 Cost of Goods Sold 627,000 1,305,000 Gross Profit 624,000 1,035,000 Expenses (including Income Tax) 458,000 862,000 Net Income $ 166,000 $ 173,000 Additional Information: a. Accounts receivable and accounts payable relate to merchandise held for sale in the normal course of business. The allowance for bad debts was the same at the end of 2017 and 2016, and no receivables were charged against the allowance. Accounts payable are recorded net of any discount and are always paid within the discount period. 19. (L.O. 2) The amount to be shown on the cash flow statement as cash outflows from investing activities would total what amount? A. $(325,000) B. $(265,000) C. $(250,000) D. $( 75,000)
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19. (A) The items shown on Jeannie’s balance sheet that reflect investing activities are the increases in: Long-Term Investments $ (75,000) Property, Plant & Equipment (250,000) = Cash Outflows From Investing $(325,000)
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Questions 17 through 20 are based on the data shown below related to the statement of cash flows for Jeannie Western Stores, Inc.: Jeannie Western Stores, Inc. Comparative Balance Sheets December 31, 2016 2017 Assets Current Assets: Cash $ 180,000 $ 230,000 Accounts Receivable (net) 360,000 520,000 Merchandise Inventory 420,000 650,000 Prepaid Expense 105,000 117,000 Total Current Assets 1,065,000 1,517,000 Long-Term Investments 75,000 Fixed Assets: Property, Plant & Equipment 480,000 730,000 Accumulated Depreciation (90,000) (150,000) Total Fixed Assets 390,000 580,000 Total Assets $1,455,000 $2,172,000 Equities Current Liabilities: Accounts Payable $ 365,000 $ 425,000 Accrued Expenses 94,000 103,000 Dividends Payable ________ 67,000 Total Current Liabilities 459,000 595,000 Long-Term Notes Payable 275,000 Stockholders’ Equity: Common Stock 800,000 1,000,000 Retained Earnings 196,000 302,000 Total Equities $1,455,000 $2,172,000 Jeannie Western Stores, Inc. Comparative Income Statements December 31, 2016 2017 Net Credit Sales $1,251,000 $2,340,000 Cost of Goods Sold 627,000 1,305,000 Gross Profit 624,000 1,035,000 Expenses (including Income Tax) 458,000 862,000 Net Income $ 166,000 $ 173,000 Additional Information: a. Accounts receivable and accounts payable relate to merchandise held for sale in the normal course of business. The allowance for bad debts was the same at the end of 2017 and 2016, and no receivables were charged against the allowance. Accounts payable are recorded net of any discount and are always paid within the discount period. 20. (L.O. 2) The amount to be shown on the cash flow statement as inflows from financing activities would total what amount? A. $136,000 B. $200,000 C. $275,000 D. $475,000
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20. (D) The items shown on Jeannie’s balance sheet that reflect cash inflows from financing activities are: Proceeds From Long-Term Note $275,000 Proceeds From Issuance of Common Stock 200,000 = Cash Inflows From Financing $475,000
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21. (L.O. 2) During 2017, Osborn Corporation, which uses the allowance method of accounting for doubtful accounts, recorded a provision for bad debt expense of $75,000 and in addition it wrote off, as uncollectible, accounts receivable of $23,000. As a result of these transactions, net cash provided by operating activities would be calculated (indirect method) by adjusting net income with a(n): A. $23,000 increase. B. $52,000 increase. C. $52,000 decrease. D. $75,000 increase.
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21. (D) The provision for bad debt expense is a noncash transaction that had decreased the amount of net income (or increased the amount of net loss) by $75,000. The write-off of the uncollectible accounts receivable did not affect net income (loss) or cash flow. Thus, to reflect the net cash provided by operating activities, $75,000 should be added back to net income.
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22. (L.O. 2) The method used to compute net cash provided by operating activities that adjusts net income for items that affected reported net income but did not affect cash is known as the: A. Indirect method. B. Direct method. C. Adjustment method. D. Income statement method.
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22. (A) The question reflects the definition of the indirect method.
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Hyasaki Company provided the following information on selected transactions during 2017: Purchase of land by issuing bonds $200,000 Proceeds from sale of equipment 300,000 Proceeds from issuing bonds 600,000 Purchases of inventories 800,000 Purchases of treasury stock 400,000 Loans made to affiliated corporations 500,000 Dividends paid to preferred stockholders 100,000 Proceeds from issuing preferred stock 700,000 23. (L.O. 2) The net cash provided (used) by investing activities during 2017 is: A. $300,000 B. $100,000 C. $(200,000) D. $(400,000)
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23. (C) The net cash used by investing activities during 2017 of $(200,000) is the result of the proceeds from the sale of equipment, $300,000, and the loans made to affiliated corporations, $(500,000).
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Hyasaki Company provided the following information on selected transactions during 2017: Purchase of land by issuing bonds $200,000 Proceeds from sale of equipment 300,000 Proceeds from issuing bonds 600,000 Purchases of inventories 800,000 Purchases of treasury stock 400,000 Loans made to affiliated corporations 500,000 Dividends paid to preferred stockholders 100,000 Proceeds from issuing preferred stock 700,000 24. (L.O. 2) The net cash provided (used) by financing activities during 2017 is: A. $800,000 B. $500,000 C. $300,000 D. $(1,100,000)
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24. (A) The net cash provided by financing activities during 2017 of $800,000 is the result of the proceeds from issuing bonds, $600,000, the purchase of the treasury stock, $(400,000), the payment of dividends to preferred stockholders $(100,000) and the proceeds from issuing preferred stock, $700,000.
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25. (L.O. 4) How should significant noncash transactions (purchase of equipment in exchange for common stock) be reported in the statement of cash flows according to GAAP? A. They should be incorporated in the statement of cash flows in a section labeled, “Significant Noncash Transactions.” B. Such transactions should be incorporated in the section (operating, financing, or investing) that is most representative of the major component of the transaction. C. These noncash transactions are not to be incorporated in the statement of cash flows. They may be summarized in a separate schedule at the bottom of the statement or appear in a separate supplementary schedule to the financials. D. They should be handled in a manner consistent with the transactions that affect cash flows.
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25. (C) According to GAAP, significant noncash transactions are not included in the statement of cash flows. The FASB indicates that such transactions can be summarized at the bottom of the statement of cash flows or appear in a separate schedule as a part of the financial statements.
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23 Statement of Cash Flows CHAPTER LEARNING OBJECTIVES 1. Describe the usefulness and format of the statement of cash flows. 2. Prepare a statement of cash flows. 3. Contrast the direct and indirect methods of calculating net cash flow from operating activities. 4. Discuss special problems in preparing a statement of cash flows. 5. Explain the use of a work sheet in preparing a statement of cash flows. *6. Compare the statement of cash flows under GAAP and IFRS.
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CHAPTER REVIEW 1. Corporate investors and potential investors seek information about the financial position, results of operations, and cash flow. Chapter 23 describes the significance of the statement of cash flows and all aspects of its preparation. Numerous examples are included which assist in an understanding of how the statement is prepared and presented.
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Usefulness of the Statement of Cash Flows 2. (L.O. 1) The information in a statement of cash flows should help investors, creditors, and others to assess: (1) the entity’s ability to generate future cash flows? (2) the entity’s ability to pay dividends and meet obligations? (3) the reasons for the difference between net income and net cash flow from operating activities? and (4) the cash and noncash investing and financing transactions during the period.
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Classification of Cash Flows 3. The statement of cash flows classifies cash receipts and cash payments by operating, investing, and financing activities. Operating activities include all transactions and events that are not investing and financing activities. Operating activities include cash effects of transactions that enter into the determination of net income, such as cash receipts from the sales of goods and services and cash payments to suppliers and employees for acquisitions of inventory and expenses. Investing activities include (a) making and collecting loans and (b) acquiring and disposing of investments and productive long-lived assets. Financing activities involve liability and owners’ equity items and include (a) obtaining cash from creditors and repaying the amounts borrowed and (b) obtaining capital from owners and providing them with a return on, and return of, their investment.
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4. The typical cash receipts and cash payments of a business entity classified according to operating, investing, and financing activities are shown below. Operating Activities: Cash inflows -From sale of goods or services. -From returns on loans (interest) and on equity securities (dividends). Cash outflows -To suppliers for inventory. -To employees for services. -To government for taxes. -To lenders for interest. -To others for expenses. Investing Activities: Cash inflows -From sale of property, plant, and equipment. -From sale of debt or equity securities of other entities. -From collection of principal on loans to other entities. Cash outflows -To purchase property, plant, and equipment. -To purchase debt or equity securities of other entities. -To make loans to other entities. Financing Activities: Cash inflows -From sale of equity securities. -From issuance of debt (bonds and notes). Cash outflows -To shareholders as dividends. -To redeem long-term debt or reacquire capital stock. It should be noted that (1) operating activities involve income determination items, (2) investing activities involve cash flows generally resulting from changes in long-term asset items, and (3) financing activities involve cash flows generally resulting from changes in long-term liability and stockholders’ equity items.
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5. Some cash flows relating to investing or financing activities are classified as operating activities. For example, receipts of investment income (interest and dividends) and payments of interest to lenders are classified as operating activities. Conversely, some cash flows relating to operating activities are classified as investing or financing activities. For example, the cash received from the sale of property, plant, and equipment at a gain, although reported in the income statement, is classified as an investing activity, and the effect of the related gain would not be included in net cash flow from operating activities. Likewise a gain or loss on the payment of debt would generally be part of the cash outflow related to the repayment of the amount borrowed and, therefore, is a financing activity.
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Preparing the Statement of Cash Flows 6. (L.O. 2) The information used to prepare the statement of cash flows generally comes from three major sources: (a) comparative balance sheets, (b) the current income statement, and (c) selected transaction data. Actual preparation of the statement of cash flows involves three steps: (1) Determine the change in cash. This procedure is straightforward because the difference between the beginning and ending cash balance can be easily computed from an examination of the comparative balance sheets. (2) Determine the net cash flow from operating activities. This procedure is complex? it involves analyzing not only the current year’s income statement but also comparative balance sheets as well as selected transaction data. (3) Determine cash flows from investing and financing activities. All other changes in the balance sheet accounts must be analyzed to determine their effect on cash.
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Preparing the Statement of Cash Flows 7. To compute net cash flows from operating activities it is necessary to report revenues and expenses on a cash basis. This is done by eliminating the effects of income statement transactions that did not result in a corresponding increase or decrease in cash. The conversion of accrual-based net income to net cash flow from operating activities may be done through either the direct method or the indirect method.
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Indirect Method Disclosures 8. Under the indirect method (also called the reconciliation method), computation of net cash flows from operating activities begins with net income. This accrual based amount is then converted to net cash provided by operating activities by adding back noncash expenses and charges and deducting noncash revenues. For example, an increase in accounts receivable during the year means that sales for the year increased receivables without a corresponding increase in cash. Thus, the increase in accounts receivable must be deducted from net income to arrive at cash provided by operations. Similarly, if an entry was made at the end of the year for accrued wages, the wages expense would increase without a corresponding decrease in cash. Thus, the increase in accrued wages would have to be added back to net income to arrive at cash provided by operations.
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Indirect Method Disclosures 9. The schedule shown below presents the common types of adjustments that are made to net income to arrive at net cash flow provided by operating activities under the indirect method. Additions to Net Income: Depreciation expense. Amortization of intangibles and deferred charges. Amortization of bond discount. Increase in deferred income tax liability. Loss on sale of plant assets. Decrease in receivables. Decrease in inventories. Decrease in prepaid expenses. Increase in accounts payable. Increase in accrued liabilities. Deductions from Net Income: Amortization of bond premium. Decrease in deferred income tax liability. Income on investment in common stock using equity method. Gain on sale of plant assets. Increase in receivables. Increase in inventories. Increase in prepaid expenses. Decrease in accounts payable. Decrease in accrued liabilities.
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Net Cash Flow from Operating Activities – Direct Method 10. (L.O. 3) Under the direct method cash receipts and cash disbursement from operating activities are determined. The difference between these two amounts represents net cash flows from operating activities.
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Net Cash Flow from Operating Activities – Direct Method 11. The FASB encourages the use of the direct method when preparing the statement of cash flows, use of the indirect method is also permitted. However, if the direct method is used the FASB requires that a reconciliation of net income to net cash flow from operating activities shall be provided in a separate schedule. Therefore, under either method, the indirect (reconciliation) approach must be presented. The text book includes comprehensive illustrations which provide a detailed explanation of the preparation and presentation of the statement of cash flows. These illustrations should be studied prior to attempting the assigned problem material.
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Special Reporting Rules for Direct and Indirect Methods 12. Minimum disclosure requirements for companies which use the direct method include the following. Receipts a. Cash collected from customers. b. Interest and dividends received. c. Other operating cash receipts, if any. Payments a. Cash paid to suppliers and employees for goods and services. b. Interest paid. c. Income taxes paid. d. Other operating cash payments, if any. Use of the indirect method requires separate disclosure of changes in inventory, receivables, and payables relating to operating activities. In addition, companies must disclose interest paid and income taxes paid. Such disclosures are required for the purpose of aiding users in approximating the direct method.
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13. Both the direct method and the indirect method have distinct advantages which should be considered when deciding on the method to be used in presenting the statement of cash flows. The principal advantage of the direct method is that it shows operating cash receipts and payments. Supporters contend that this is useful in estimating future cash flows and in assessing an entity’s ability to (a) generate sufficient cash flow from operations for the payment of debt, (b) reinvest in its operations, and (c) make distributions to owners. Proponents of the indirect method cite the fact that it focuses on the difference between net income and net cash flow from operations as its principal advantage. Also, supporters of the indirect method contend that it is less costly to present the statement of cash flows using this method.
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Special Problems 14. (L.O. 4) Five items, described as special problems related to preparing the statement of cash flows, are presented in the text material. These items relate to various aspects of the statement of cash flows and should be understood for accurate preparation of the statement. (a) Adjustments to net income: (i) Depreciation expense is added back to net income to arrive at net cash provided by operating activities. Likewise, amortization of intangible assets and amortization of deferred costs are also added back to net income. (ii) Postretirement benefit costs are adjusted when the cash flow differs from the expense charged to the income statement. (iii) Changes in deferred income taxes affect net income but not cash and therefore require an adjustment. (iv) The equity method of accounting reports income based on accrual accounting concepts, and ignores cash dividends received in the computation of income. Therefore, an adjustment is necessary. (v) Gains and losses are reported in income, however the cash flow these transactions should be reported as part of either investing or financing activities. The gain or loss is removed from cash flow from operating activities, and the entire cash flow is reported as either investing of financing. (vi) Unrealized gains and losses are removed from net income since they do not result in cash flow. (vii) Share-based compensation expense impacts net income but does not impact cash flow. Therefore, the company must increase net income by the amount of compensation expense recorded. (viii) Unusual and infrequent items that result in cash flow should be reported either as investing or as financing activities.
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Special Problems 14. (L.O. 4) Five items, described as special problems related to preparing the statement of cash flows, are presented in the text material. These items relate to various aspects of the statement of cash flows and should be understood for accurate preparation of the statement. (b) Accounts receivable (net) with the indirect method, the change in net accounts receivable can be analyzed. When the direct method is used, the allowance account should not be netted against accounts receivable. Instead the change in accounts receivable should be analyzed in connection with reporting cash received from customers, and the allowance account is analyzed in connection with cash payments for operating expense (omit bad debt expense – a noncash expense). (c) Other working capital changes some changes in working capital, although they affect cash, do not affect net income. Generally, these are investing or financing activities of a current nature such as the purchase of short-term nontrading equity investment or short-term nontrade notes payable. (d) Net losses-if an enterprise reports a net loss instead of net income, the net loss must be adjusted for those items that do not result in a cash inflow or outflow. As a result of such adjustments, the net loss may turn out to be a positive cash flow from operating activities. (e) Significant noncash transactions: Significant noncash investing and financing activities (such as purchasing an asset by assuming long-term debt), if material in amount, should be disclosed in a separate schedule or narrative disclosure. These items are not to be incorporated in the statement of cash flows.
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Worksheet and T-Account Approach 15. (L.O. 5) Near the end of Chapter 24 a comprehensive illustration of the statement of cash flows is presented. This illustration includes an explanation of how a work sheet can be used in preparing the statement.
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IFRS Insights *16. (L.O. 6) IFRS requires that noncash investing and financing activities be excluded from the statement of cash flows. Instead, these noncash activities should be reported elsewhere. This requirement is interpreted to mean that noncash investing and financing activities should be disclosed in the notes to the financial statements instead of in the financial statements. Under GAAP, companies may present this information in the cash flow statement. IFRS provides more alternatives for disclosing items like interest, dividends, and taxes. GAAP requires that except for dividends paid, these items are all reported as operating activities.
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Post Lecture Question 01 Which of the following is not one of the benefits that creditors and investors can derive from the statement of cash flows? 1.Assess the company’s ability to generate future cash flows. 2. Explain the difference between net income and net cash flow from operating activities. 3. Asses the company’s ability to pay future cash dividends. 4. Assess the effectiveness of management’s borrowing policy.
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4 Assessing the effectiveness of management’s borrowing policy is not a benefit that creditors and investors can derive from the statement of cash flows.
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Post Lecture Question 02 Which of the following is not one of the three activities classified on the statement of cash flows? 1. Financing. 2. Investing. 3. Operating. 4. Managing.
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4
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Post Lecture Question 03 Which method adjusts net income to net cash flows from operating activities? 1. Indirect. 2. Direct. 3. Adjustment. 4. Accrual.
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1 The indirect method starts with net income and then adjusts it for noncash items that affect net income.
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Post Lecture Question 04 The operating activities section of a statement of cash flows would include cash spent to acquire new equipment. True False
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F The investing activities, not the operating activities, section of a statement of cash flows would include cash spent to acquire new equipment.
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Post Lecture Question 05 Under the direct method of preparing the statement of cash flows, cash receipts from customers is equal to: 1. Sales revenues – Decrease in accounts receivable. 2. Net sales revenue. 3. Sales revenues + Increase in accounts receivable. 4. Sales revenues – Increase in accounts receivable.
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4 When accounts receivable increase, cash is not received. Therefore, the cash received from customers must be equal to sales revenue less the increase in accounts receivable.
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Post Lecture Question 06 The financing activities section of a statement of cash flows would include interest paid on bonds and long-term notes payable. True False
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F The operating activities, not the financing activities, section of a statement of cash flows would include interest paid on bonds and long-term notes payable.
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Post Lecture Question 07 Which of the following activities would be classified as an investing activity? 1. Cash received from interest revenue. 2. Cash paid to purchase land to be held for future use. 3. Cash paid on account. 4. Cash received for dividends.
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2 The purchase of land to be held for future use qualifies as an investing activity.
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Post Lecture Question 08 If a plant asset is sold for cash and a loss results, which sections are affected in the statement of cash flows under the indirect method? 1. Operating and financing. 2. Investing only. 3. Operating and investing. 4. Financing only.
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3 The cash received from the sale of a plant asset is an investing activity cash receipt and the loss is an addition to net income under operating activities when using the indirect method.
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Post Lecture Question 09 Which of the following is not needed in order to prepare a statement of cash flows? 1. Selected transaction data. 2. Comparative balance sheets. 3. Last year’s statement of cash flows. 4. Current year’s income statement.
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3 Comparative balance sheets, current income statement data, and selected transaction data are needed to prepare a statement of cash flows. The previous year’s statement of cash flows would not be needed to prepare a statement of cash flows.
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Post Lecture Question 10 The issuance of a stock split would be classified as a (n) 1. investing activity. 2. financing activity. 3. significant noncash transaction. 4. operating activity.
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3 The issuance of a stock split would be classified as a significant noncash transaction.
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Post Lecture Question 11 The last step in the preparation of the statement of cash flows work sheet is to enter the: 1. balance sheet accounts and their ending balances in the balance sheet accounts section. 2. balance sheet accounts and their beginning balances in the balance sheet accounts section. 3. increase or decrease in cash on the cash line and at the bottom of the work sheet. 4. data which explain the changes in the balance sheet accounts in the reconciling columns of the work sheet.
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3 The first step in the preparation of the statement of cash flows worksheet includes entering balance sheet accounts and their beginning balances in the balance sheet accounts section and entering balance sheet accounts and their ending balances in the balance sheet accounts section. The second step includes entering data which explain the changes in the balance sheet accounts in the reconciling columns of the work sheet. The last step in the preparation of the statement of cash flows worksheet is to enter the increase (decrease) in cash on the cash line and at the bottom of the worksheet.
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Post Lecture Question 12 Which of the following items might be classified differently in a statement of cash flows prepared using IFRS rather than GAAP? 1. Interest expense paid on bonds. 2. Interest revenue received from notes receivable. 3. Dividends paid to preferred shareholders. 4. All of these answer choices are correct.
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4 IAS 7 indicates that cash flows related to interest received and paid, and dividends received and paid, should be separately disclosed in the statement of cash flows. IFRS allows flexibility in how these items are classified in the statement of cash flows. However, each item should be classified in a consistent manner from period to period as operating, investing, or financing cash flows. This is the best answer.
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Practice Question 01 The primary purpose of the statement of cash flows is to provide information 1. that is useful in assessing cash flow prospects. 2. about the entity’s ability to meet its obligations, its ability to pay dividends, and its needs for external financing. 3. about the cash receipts and cash payments of an entity during a period. 4. about the operating, investing, and financing activities of an entity during a period.
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3
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Practice Question 03 All of the following would be considered investing activities except: 1. receipt of cash dividends from investments. 2. purchase of equipment for cash. 3. sale of land for cash. 4. purchase of 25% interest in the stock of a supplier.
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1 The purchase of equipment for cash, the sale of land for cash, and the purchase of 25% interest in the stock of a supplier are all considered investing activities. The receipt of dividends from investments is not an investing activity.
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Practice Question 05 An increase in short-term notes receivable will be added to net income under the indirect method of preparing the statement of cash flows. True False
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F Increases in current assets, represented by the increase in short-term notes receivable, are deducted from (not added to) net income in the operating activities section.
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Practice Question 07 The method of calculating net cash flow from operating activities that results in the presentation of a condensed cash receipts and cash disbursements statement is the: 1. direct method. 2. cash flow method. 3. reconciliation method. 4. indirect method.
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1 The direct method results in presenting condensed cash receipts and cash disbursements statement.
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Practice Question 09 Spruce Pine Co. provided the following information on selected transactions during 2017: Repayment of bond principal…………………………………$450,000 Proceeds from issuing common stock…………………….760,000 Purchases of inventory…………………………………………………940,000 Proceeds from the sale of treasury stock……………….120,000 Purchase of 10% interest in stock of Hindi Corp…..220,000 Dividends paid to common & preferred stockholders.80,000 Proceeds from issuing preferred stock…………………..150,000 Proceeds from sale of land……………………………………….380,000 The net cash provided (used) by investing activities during 2017 is 1. $160,000. 2. $280,000. 3. $(780,000). 4. $140,000.
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1 The net cash provided (used) by investing activities during 2017 is computed as follows: Proceeds from sale of land, $380,000 less Purchase of 10% interest in stock of Hindi Corp., $220,000 = $160,000.
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Practice Question 11 Ando Company sold some of its plant assets during 2017. The original cost of the plant assets was $500,000 and the accumulated depreciation at date of sale was $325,000. The proceeds from the sale of the plant assets were $150,000. The information concerning the sale of the plant assets should be shown on Ando’s statement of cash flows (indirect method) for the year ended December 31, 2017, as a (n) 1. addition to net income of $25,000 for gain on sale and a $175,000 increase in cash flows from investing activities. 2. subtraction from net income of $25,000 for gain on sale and a $150,000 for cash proceeds as an increase in cash flows from investing activities. 3. addition of $150,000 for cash proceeds to net income. 4. subtraction from net income of $150,000 for cash proceeds and a $175,000 increase in cash flows from financing activities.
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2 This transaction affects two sections in the statement of cash flows. First, the cash proceeds from the sale of plant assets would be reflected as a $150,000 increase in cash flows from investing activities. Then the cash proceeds must be compared to the book value of the asset sold to determine if a gain/loss was recognized in the transaction. The gain/loss on the sale of the plant assets is computed as follows: Cash Proceeds from Sale, $150,000 – Book Value, $125,000 or (Cost of assets sold, $500,000 – Accumulated depreciation on assets sold, $325,000) = $25,000 Gain on Sale of Plant Assets which would be subtracted from net income to determine cash flows from operating activities.
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Practice Question 13 All of the following adjustments would be deducted in determining net cash flow from operating activities using the indirect method except: 1. amortization of bond premium. 2. gain on the sale of plant assets. 3. decrease in deferred income tax liability. 4. increase in accrued liabilities.
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4 All of the options (amortization of bond premium, decrease in deferred income tax liability, and a gain on the sale of plant assets) are deducted in determining net cash flow from operating activities except an increase in accrued liabilities which would be added to net income.
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Practice Question 15 A statement of cash flows typically would not disclose the effects of 1. stock dividends declared. 2. cash dividends paid. 3. a purchase and immediate retirement of treasury stock. 4. capital stock issued at an amount greater than par value.
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1 A statement of cash flows typically would disclose the effects of capital stock issued at an amount greater than par value, cash dividends paid, and a purchase and immediate retirement of treasury stock but would not disclose the effects of stock dividends declared.
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Practice Question 17 IFRS allows both interest paid and interest received to be classified as either operating or investing cash flows. True False
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F Under IFRS, interest paid can be classified as either an operating or a financing cash flow, not as either operating or investing cash flow.
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Practice Question 19 All of the following would be classified as financing cash flows except: 1. proceeds from the sale of stock. 2. interest paid on long-term debt. 3. dividends paid on preferred stock. 4. purchases of treasury stock.
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2 Purchases of treasury stock, proceeds from the sale of stock, and dividends paid on preferred stock are classified as financing cash flows but interest paid on long-term debt is not a financing cash flow. It is classified as an operating cash flow.

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