Study Probes for Statement of Cash Flows and Long-Term Asset Transactions -Solution

1. For purposes of a statement of cash flows, cash is defined to include cash and investments such as those in stock of other companies. 2. A firm may have a significant amount of net income, as computed under the accrual basis of accounting, yet have an insignificant net inflow of cash. 3. A statement of cash flows provides information on cash inflows and outflows for a specified period of time. 4. Cash equivalents are short-term investments that are highly liquid and can be readily converted into cash. 5. Cash proceeds from issuing a long-term note payable is classified as an operating activity. 6. Cash used to retire long-term debt that was used to build a new factory is classified as an investing activity. 7. Cash payments for salaries to employees are classified as an operating activity. 8. Financing activities are presented as the first classification on a statement of cash flows because a company must first obtain financing when it begins operations before it can acquire assets to start operations. 9. Financial statement users focus a great deal of attention on cash flows related to operating activities, because, over the long run, a business must generate positive cash flows from its profit-oriented activities to be successful. 10. Cash received from customers includes cash from current period sales plus cash from customer payments on account. 11. Cash paid for interest expense is shown as an operating activity under the direct method. 12. Under the direct method, a gain on the sale of equipment is included in net income and subtracted in the operating activities section of the statement of cash flows because it is not a cash flow. 13. The format of a statement of cash flows prepared using the direct method is much like an income statement prepared on the cash-flow basis. 14. When the indirect method is used, GAAP requires a separate schedule reconciling cash flows from operating activities to net income. 15. Cost of goods sold less any increase in accounts payable equals cash paid for inventory. 16. A loss on the sale of a building is added to net income in the operating activities section of the statement of cash flows under the direct method. 17. Cash paid for wages and salaries is determined by adding a decrease in wages payable or subtracting an increase in wages payable to the amount of wages and salaries expense. 18. When the direct method of preparing the statement of cash flows is used, the payment of dividends to stockholders appears in the operating activities section. 19. Proceeds from the sale of equipment is reported as an investing activity when using the direct method to prepare the statement of cash flows. 20. A decrease in inventory is added to net income when preparing the operating activities section under the indirect method. 21. Issuing common stock is an investing activity. 22. Depreciation expense is added to net income when determining net cash provided by operating activities under the indirect method. 23. Under the indirect method of preparing the statement of cash flows, a loss on the sale of equipment is added to net income in the investing activities section. 24. The presentation of each the three sections of the statement of cash flows will differ when comparing the format of the direct and indirect methods of preparing the statement of cash flows. 25. Increases in receivables and prepaid expenses are added to net income to determine cash provided/ (used) by operating activities when using the indirect method. 26. An increase in accounts receivable is subtracted from net income to determine cash provided/(used) by operating activities when using the indirect method. 27. An increase in accounts payable is added to net income to determine cash provided/(used) by operating activities when using the indirect method. 28. Both the direct and indirect method yield the same total amount for net cash provided or used by operating activities. 29. Generally, the most important section of the statement of cash flows is operating activities because a company is required to have positive cash flows according to GAAP. 30. If cash flows provided by operating activities are a relatively small amount, a company may offset this problem on a short-term basis by cutting back on capital expenditures or by borrowing funds or issuing stock.

1 F 7 T 13 T 19 T 25 F 2 T 8 F 14 F 20 T 26 T 3 T 9 T 15 F 21 F 27 T 4 T 10 T 16 F 22 T 28 T 5 F 11 T 17 T 23 F 29 F 6 F 12 F 18 F 24 F 30 T

31. What primary information is provided in the statement of cash flows? A. The amount of profits earned during a period B. The source and uses of a company’s money C. Estimates of future cash flows D. Cash receipts and cash payments of an entity’s profitable activities during a period

32. Which one of the following is an important reason to evaluate a company’s cash flow? A. Without positive cash flows, a company is unable to recognize a positive net income. B. Minimum cash balances must be maintained by all companies. C. Stockholders want to know that the company can generate cash consistent with earning a reasonable return on their investments. D. Creditors want to be assured that the company has significant cash inflows from financing activities.

33. Watley Surf Shop provided the following information for the current year: Proceeds from sale of equipment $120,000 Dividends paid to stockholders 16,000 Purchase of inventories on account 92,000 Borrowing a long-term loan 60,000 Loan principal payments made 14,000 Interest paid on loan payments 1,000 Purchase of land for cash 65,000 Payment for inventory previously acquired on account 85,000 Cash collected from customers 450,000 How much is the net cash provided/(used) by investing activities during the year? Answer: $55,000

34. Watley Surf Shop provided the following information for the current year: Proceeds from sale of equipment $120,000 Dividends paid to stockholders 16,000 Purchase of inventories on account 92,000 Borrowing a long-term loan 60,000 Loan principal payments made 14,000 Interest paid on loan payments 1,000 Purchase of land for cash 65,000 Payment for inventory previously acquired on account 85,000 Cash collected from customers 450,000 How much is the net cash provided/(used) by financing activities during the year? Answer: $30,000 35. Randolph Retail reported the following results during 2014: Cash collected from accounts receivable $56,000 Cash paid to purchase office supplies 2,000 Cash collected from customers for current period sales 98,000 Cash paid for dividends 12,000 Cash paid for inventory acquisitions 87,000 Cash collected from the issuance of common stock 50,000 Cash paid to purchase equipment with a 5-year life 80,000 How much is the company’s net cash provided by operating activities? Answer: $65,000

26. Euclid Brewery reported the following balances in its Equipment and Accumulated Depreciation accounts during 2014: January 1 December 31 Equipment $115,000 $140,000 Accumulated depreciation, equipment 30,000 12,000 During 2014, Euclid sold equipment for $18,500 that originally cost $35,000. The book value of the equipment at the time of sale was $9,000. Net income for 2014 was $380,000. A. How much depreciation expense was recorded for equipment by Euclid Brewery during 2014? B. What was the cost of equipment purchased during the year? C. Show how the effects of these transactions will be reported by preparing Euclid Brewery’s operating and investing activities sections of its statement of cash flows.

Answer A. Beginning accumulated depreciation $ 30,000 Plus depreciation expense for the year ? Less accumulated depreciation on the sale (26,000 ) Ending accumulated depreciation $ 12,000 Depreciation expense = $8,000

B. Beginning equipment $115,000 Plus purchases of equipment ? Less cost of equipment sold (35,000 ) Ending equipment $140,000 Cost = $60,000

C. Operating Activities Net income $380,000 Adjustments of net income to cash basis: Depreciation 8,000 Gain on sale of equipment ($18,500 – $9,000) (9,500 ) Net cash provided by operating activities $378,500

Investing Activities Purchase of equipment ($60,000) Cash received from sale of equipment 18,500 Net cash used in investing activities ( $41,500 ) 37. Speedy Supermarket reported net income of $24,000 in 2014. No dividends were declared nor paid during the year. Changes in the selected accounts during the year are: Increase/(Decrease) Accounts receivable $16,200 Inventory 11,800 Prepaid expenses (4,000) Accounts payable 27,300 Salaries payable (3,000) How much is the company’s net cash provided by operating activities? Answer: $24,300

38. Classify each of the following items based on the section of the statement of cash flows in which it will be reported if the direct method is used, using the respective letter for each activity below: Operating activities = O; Investing activities = I; Financing activities = F If an item is not reported in any of these activity sections, place an X in the space provided. ______1. Paid cash dividends to stockholders ______2. Purchased of a building by issuing a mortgage payable ______3. Paid interest that had been accrued in a previous period ______4. Purchased another business for cash ______6. Paid suppliers for inventory ______7. Received interest revenue ______8. Collected cash from customers ______9. Collected a principal payment on a long-term note ______10. Paid cash to retire long-term debt ______11. Paid income taxes ______12. Received cash from the sale of a machine no longer in use

1. F 2. X 3. O 4. I 6. O 7. O 8. O 9. I 10. F 11. O 12. I

39. Harnett Enterprises had a net loss of $14,000 in 2014. Dividends of $15,000 were declared and paid during the year and the company reported depreciation expense of $15,000. Changes in the following selected accounts occurred during the year: Increase/(Decrease) Accounts receivable ($3,000) Long-term investments 16,000 Interest payable (2,000) Notes payable 65,000 Property, plant, and equipment 42,000

No property, plant, and equipment items were sold during the year. How much is the company’s net cash provided/(used) by financing activities? Answer: ($80,000) 40. Harnett Enterprises had a net loss of $14,000 in 2014. Dividends of $15,000 were declared and paid during the year and the company reported depreciation expense of $15,000. Changes in the following selected accounts occurred during the year: Increase/(Decrease) Accounts receivable ($3,000) Long-term investments 16,000 Interest payable (2,000) Notes payable 65,000 Property, plant, and equipment 42,000 No property, plant, and equipment were sold during the year. How much is the company’s net cash provided (used) by investing activities? Answer: ($58,000)

41. The following information concerning property, plant, and equipment appeared in Quick Wash Laundry’s 2014 balance sheet: December 31 January 1 Equipment $228,000 $211,000 Accumulated depreciation (48,900) (42,600) Net property, plant, and $179,100 $168,400 equipment During 2014, Quick Wash sold equipment that had an original cost of $23,000 and a current book value of $3,500 for a loss of $2,100. In addition, the company purchased a new machine by making a down payment of $6,000 and financing the balance by issuing a long-term note payable. Net income for 2014 was $89,000. a. How much depreciation expense did Quick Wash Laundry record during 2014? b. Prepare the investing activities section of the statement of cash flows for Quick Wash Laundry for 2014. c. Show how the effects of the transactions related to the accounts of the Quick Wash Laundry presented will be reported in the operating activities section of the statement of cash flows for 2014.

Answer a. $42,600 – $48,900 – $19,500 = $25,800 b. Purchase of equipment: $211,000 – $23,000 – $228,000 = $40,000 Proceeds from sale of equipment: $2,100 + ($23,000 – $3,500) – $23,000 = $1,400 Investing Activities Proceeds from sale of equipment $ 1,400 Purchase of equipment (down payment) (6,000) Net cash used by investing activities ($4,600) c. Operating Activities Net income $ 89,000 Depreciation expense 25,800 Loss on sale of equipment 2,100 Net cash provided by operating activities $116,900 42. Indicate how each item listed below should be reported in the operating activities section of the statement of cash flows under the indirect method using the coding that follows: A. Added to net income D. Deducted from net income X. Item does not appear in the operating activities section under the indirect method ______1. Gain on sale of equipment ______2. Loss on sale of building ______3. Depreciation expense ______4. Amortization expense

Answer 1. D 2. A 3. A 4. A

43. A company purchased factory equipment on April 1, 2014, for $96,000. It is estimated that the equipment will have a $12,000 salvage value at the end of its 10-year useful life. Using the straight-line method of depreciation, the amount to be recorded as depreciation expense at December 31, 2014, is a. $9,600. b. $8,400. c. $6,300. d. $7,200.

44. Mitchell Corporation bought equipment on January 1, 2014 .The equipment cost $180,000 and had an expected salvage value of $30,000. The life of the equipment was estimated to be 6 years. The depreciable cost of the equipment is a. $180,000. b. $150,000. c. $30,000. d. $25,000.

45.Mitchell Corporation bought equipment on January 1, 2014. The equipment cost $180,000 and had an expected salvage value of $30,000. The life of the equipment was estimated to be 6 years. The book value of the equipment at the beginning of the third year would be a. $180,000. b. $150,000. c. $130,000. d. $50,000.

46. Pearson Company bought a machine on January 1, 2014. The machine cost $144,000 and had an expected salvage value of $24,000. The life of the machine was estimated to be 5 years. The book value of the machine at the beginning of the third year would be a. $144,000. b. $120,000. c. $96,000. d. $48,000.

47. Stine Company purchased machinery with a list price of $64,000. They were given a 10% discount by the manufacturer. They paid $400 for shipping and sales tax of $3,000. Stine estimates that the machinery will have a useful life of 10 years and a residual value of $20,000. If Stine uses straight-line depreciation, annual depreciation will be a. $4,100. b. $4,072. c. $6,100. d. $3,760. 48. In 2014, Blanchard Corporation has plant equipment that originally cost $90,000 and has accumulated depreciation of $36,000. A new processing technique has rendered the equipment obsolete, so it is retired. Which of the following entries should Blanchard use to record the retirement of the equipment? a. Loss on Disposal of Plant Assets 54,000 Equipment 54,000 b. Accumulated Depreciation – Equipment 36,000 Loss on Disposal of Plant Assets 54,000 Equipment 90,000 c. Loss on Disposal of Plant Assets 54,000 Accumulated Depreciation – Equipment 54,000 d. Plant Equipment 90,000 Accumulated Depreciation – Equipment 36,000 Loss on Disposal of Plant Assets 54,000

49.A gain or loss on disposal of a plant asset is determined by comparing the a. replacement cost of the asset with the asset's original cost. b. book value of the asset with the asset's original cost. c. original cost of the asset with the proceeds received from its sale. d. book value of the asset with the proceeds received from its sale. 50. When an asset is sold, a gain occurs when the a. sale price exceeds the book value of the asset sold. b. sale price exceeds the original cost of the asset sold. c. book value exceeds the sale price of the asset sold. d. sale price exceeds the depreciable cost of the asset sold. 51. The book value of a plant asset is the difference between the a. replacement cost of the asset and its historical cost. b. cost of the asset and the amount of depreciation expense for the year. c. cost of the asset and the accumulated depreciation to date. d. proceeds received from the sale of the asset and its original cost. 52. A company sells a plant asset that originally cost $225,000 for $75,000 on December 31, 2014. The accumulated depreciation account had a balance of $90,000 after the current year's depreciation of $22,500 had been recorded. The company should recognize a a. $150,000 loss on disposal. b. $60,000 gain on disposal. c. $60,000 loss on disposal. d. $37,500 loss on disposal. 54. A company sells a plant asset that originally cost $240,000 for $80,000 on December 31, 2014. The accumulated depreciation account had a balance of $120,000 after the current year's depreciation of $20,000 had been recorded. The company should recognize a a. $40,000 loss on disposal. b. $40,000 gain on disposal. c. $80,000 loss on disposal. d. $80,000 gain on disposal.