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Chapter 23: Q5CA (page 1393)

Question: CA23-5 (Purpose and Elements of SCF) GAAP requires the statement of cash flows be presented when financial statements are prepared.

Instructions

(a) Explain the purposes of the statement of cash flows.

(b) List and describe the three categories of activities that must be reported in the statement of cash flows.

(c) Identify and describe the two methods that are allowed for reporting cash flows from operations.

(d) Describe the financial statement presentation of noncash investing and financing transactions. Include in your description an example of a noncash investing and financing transaction.

Short Answer

Expert verified

Answer

  1. Cash flow statement is prepared to provideinformation to the investors and the creditors.
  2. Cash flow statement has three sections: investing,operating, andfinancing.
  3. There aretwo methods to prepare a cash flow statement: direct and indirect.
  4. Non-cash investing and financing transactions are reported by preparing a separate schedule at the bottom of the cash flow statement.

Step by step solution

01

Definition of Statement of Cash Flow

The schedule prepared by the business entity for providing a summary of all the transactions, including cash payments and receipts, is known as the statement of cash flow.

02

Purpose of the statement of cash flows

The cash flow statement is prepared for:

  1. Determining the ability of the business entity to generate cash.
  2. Determining the potential of the business entity to pay dividends and meet other cash obligations.
  3. To determine the reason behind the difference between the cash flow from operating and net income.
  4. To identify the cash and non-cash transactions related to investing and financing transactions.
03

Categories of activities reported in the statement of cash flows

Operating activities: This section of the cash flow statement reports the cash effect of all the transactions that are reported for the calculation of the net income of the business entity.

Investing activities: This section reports the transactions related to the long-term assets of the business entity affecting the cash position.

Financing activities: This section reports the transaction relating to the equity and liability affecting the cash position of the business entity.

04

Methods for reporting cash flow

Direct Method: Under the direct method, the business entity calculates the net cash flow from operation by taking the difference between the operating cash receipts and operating cash disbursement.

Indirect Method: Under the indirect method, the business entity calculates the net cash flow from operating activities by adjusting the net income with the transactions that will affect net income without affecting the cash position. After adjusting net income, the business entity adds and deducts the investing and financing transactions affecting the cash position. After this, the investing and financing transaction affecting the cash position is reported.

05

Presentation of non-cash investing and financing transaction

The business entity's non-cash investing and financing activities are reported in a separate schedule prepared at the bottom of the cash flow statement.

Example of transactions:

  1. Investing transaction: Acquisition of any fixed asset by issuing securities.
  2. Financing transaction: Conversion of debt securities into equity.

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Most popular questions from this chapter

Question: . Classify the following items as (1) operating, (2) investing, (3) financing, or (4) significant noncash investing and financing activities, using the direct method.

(a) Cash payments to employees.

(b) Redemption of bonds payable.

(c) Sale of building at book value.

(d) Cash payments to suppliers.

(e) Exchange of equipment for furniture.

(f) Issuance of preferred stock.

(g) Cash received from customers.

(h) Purchase of treasury stock.

(i) Issuance of bonds for land.

(j) Payment of dividends.

(k) Purchase of equipment.

(l) Cash payments for operating expenses.

Stan Conner and Mark Stein were discussing the statement of cash flows of Bombeck Co. In the notes to the statement of cash flows was a schedule entitled “Non-cash investing and financing activities.” Give three examples of significant non-cash transactions that would be reported in this schedule.

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 \(317,000.

(b) Cash dividends declared and paid totaled \)120,000.

(c) Equipment was purchased for \(114,000.

(d) Equipment that originally cost \)40,000 and had accumulated depreciation of \(32,000 was sold for \)10,000.

The transactions below took place during the year 2017.

1. Convertible bonds payable with a par value of \(300,000 were exchanged for unissued common stock with a par value of \)300,000. The market price of both types of securities was par.

2. The net income for the year was \(410,000.

3. Depreciation expense for the building was \)90,000.

4. Some old office equipment was traded in on the purchase of some dissimilar office equipment, and the following entry was made.

Equipment 50,000

Accum. Depreciation—Equipment 30,000

Equipment 40,000

Cash 34,000

Gain on Disposal of Plant Assets 6,000

The Gain on Disposal of Plant Assets was included in income before income taxes.

5. Dividends in the amount of $123,000 were declared. They are payable in January of next year.

Instructions

Show by journal entries the adjustments that would be made on a worksheet for a statement of cash flows.

(Schedule of Net Cash Flow from Operating Activities—Indirect Method)

Ballard Co. reported \(145,000 of net income for 2017. The accountant, in preparing the statement of cash flows, noted the following items occurring during 2017 that might affect cash flows from the operating activities.

  1. Ballard purchases 100 shares of treasury stock at a cost of \)20 per share. These shares are then resold at \(25 per share.
  2. Ballard sold 100 shares of IBM common at \)200 per share. The acquisition cost of these shares was \(145 per share. There were no unrealized gains or losses recorded on this investment in 2017.
  3. Ballard revised its estimates for bad debts. Before 2017, Ballard’s bad debt expenses was 1% of its net sales. In 2017, this percentage was increased to 2%. Net sales for 2017 were \)500,000 and net accounts receivable decreased by \(12,000 during 2017.
  4. Ballard issued 500 shares of its \)10 par common stock for a patent. The market price of the shares on the date of the transaction was \(23 per share.
  5. Depreciation expense is \)39,000.
  6. Ballard Co. holds 40% of the Nirvana company’s common stock as a long-term investment. Nirvana company reported \(27,000 of net income for 2017.
  7. Nirvana company paid a total of \)2,000 of cash dividend to all investees in 2017.
  8. Ballard declared a 10% stock dividend. One thousand shares of \(10 par common stock were distributed. The market price at date of issuance was \)20 per share.

Instructions

Prepare a schedule that shows the net cash flow from operating activities using the indirect method. Assume no items other than those listed above affected the computation of 2017 net cash flow from operating activities.
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