Financial Accounting Chapter 12- Self Study

Identify five items that are adjustments to convert net income to net cash provided by operating activities under the indirect method.

-depreciation expense -increase/decrease in inventory -increase/decrease in accounts payable -increase/decrease in accounts receivable -gain or loss on disposal of a concurrent asset

Why is the statement of cash flows useful?

The statement of cash flows is useful because it provides information to the investors, creditors, and other users about: (1) the company's ability to generate future cash flows, (2) the company's ability to pay dividends and meet obligations, (3) the reasons for the difference between net income and net cash provided by operating activities, and (4) the cash investing and financing transactions during the period.

When the total cash inflows exceed the total cash outflows in the statement of cash flows, how and where is this excess identified?

When total cash inflows exceed total cash outflows, the excess is identified as a "net increase in cash" near the bottom of the statement of cash flows.

Distinguish among the three types of activities reported in the statement of cash flows.

-Operating activities include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income. -Investing activities include: (a) acquiring and disposing of investments and property, plant and equipment and (b) lending money and collecting loans. -Financing activities include: (a) obtaining cash from issuing debt and repaying amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying dividends.

The president of Merando Company is puzzled. During the last year, the company experienced a net loss of $800,000, yet its cash increased $300,000 during the same period of time. Explain to the president how this could occur.

A number of factors could have caused an increase in cash despite the net loss. These are (1) high cash revenues relative to low cash expenses; (2) sales of property, plant, and equipment; (3) sales of investments; (4) issuance of debt or capital stock, and (5) differences between cash and accrual accounting, e.g. depreciation.

Diane Hollowell and Terry Parmenter were discussing the format of the statement of cash flows of Snow Candy Co. At the bottom of Snow Candy's statement of cash flows was a separate section entitled "Noncash investing and financing activities." Give three examples of significant noncash transactions that would be reported in this section.

Examples of significant noncash activities are: (1) issuance of stock for assets, (2) conversion of bonds into common stock, (3) issuance of bonds or notes for assets, and (4) noncash exchanges of property, plant, and equipment.

Why is it necessary to convert accrual-basis net income to cash-basis income when preparing a statement of cash flows?

It is necessary to convert accrual-based net income to cash-basis income because the unadjusted net income includes items that do not provide or use cash. An example would be an increase in accounts receivable. If accounts receivable increased during the period, revenues reported on the accrual basis would be higher than the actual cash revenues received. Thus, accrual-basis net income must be adjusted to reflect the net cash provided by operating activities.

What are the major sources (inflows) of cash in a statement of cash flows

Major inflows of cash in a statement of cash flows include cash from operations; issuance of debt; collection of loans; issuance of capital stock; sale of investments; and the sale of property, plant, and equipment.

What are the major uses (outflows) of cash?

Major outflows of cash include purchase of inventory, payment of wages and other operating expenses, payment of cash dividends; redemption of debt; purchase of investments; making loans; redemption of capital stock; and the purchase of property, plant, and equipment.

Describe the indirect method for determining net cash provided (used) by operating activities.

The indirect method involves converting accrual net income to net cash provided by operating activities. This is done by starting with accrual net income and adding or subtracting noncash items included in net income. Examples of adjustments include depreciation and other noncash expenses, gains and losses on the disposal of noncurrent assets, and changes in the balances of current asset and current liability accounts from one period to the next.

What questions about cash are answered by the statement of cash flows?

The statement of cash flows answers the following questions about cash: (a) Where did the cash come from during the period? (b) What was the cash used for during the period? and (c) What was the change in the cash balance during the period?

Why is it important to disclose certain noncash transactions? How should they be disclosed?

The statement of cash flows presents investing and financing activities so that even noncash transactions of an investing and financing nature are disclosed in the financial statements. If they affect financial conditions significantly, the FASB requires that they be disclosed in either a separate schedule at the bottom of the statement of cash flows or in a separate note or supplementary schedule to the financial statements.

What is a statement of cash flows?

The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from the operating, investing, and financing activities of a company during a period.

During 2015, Doubleday Company converted $1,700,000 of its total $2,000,000 of bonds payable into common stock. Indicate how the transaction would be reported on a statement of cash flows, if at all.

This transaction is reported in the note or schedule entitled "Noncash investing and financing activities" as follows: "Retirement of bonds payable through issuance of common stock, $1,700,000."

Why and how is depreciation expense reported in a statement prepared using the indirect method?

Under the indirect method, depreciation is added back to net income to reconcile net income to net cash provided by operating activities because depreciation is an expense but not a cash payment.