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Chapter 23: Q9Q (page 1372)
Differentiate between the direct method and the indirect method by discussing each method
The incomes and costs are straightforwardly balanced by the direct method to coordinate the cash basis. Altering accrual net income could be a component of the indirect approach.
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Red Hot Chili Peppers Co. had the following activity in its most recent year of operations.
(a) Purchase of equipment. (g) Amortization of intangible assets.
(b) Redemption of bonds payable. (h) Purchase of treasury stock.
(c) Sale of building. (i) Issuance of bonds for land.
(d) Depreciation. (j) Payment of dividends.
(e) Exchange of equipment for the furniture. (k) Increase in interest receivable on notes receivable.
(f) Issuance of common stock. (l) Pension expense exceeds the amount funded.
Instructions
Classify the items as (1) operating—add to net income; (2) operating—deduct from net income; (3) investing; (4) financing; or (5) significant noncash investing and financing activities. Use the indirect method.
Question: Your roommate is puzzled. During the last year, the company in which she is a stockholder reported a net loss of \(675,000, yet its cash increased \)321,000 during the same period of time. Explain to your roommate how this situation could occur.
Question: (SCF Theory and Analysis of Improper SCF) Teresa Ramirez and Lenny Traylor are examining the following statement of cash flows for Pacific Clothing Store’s first year of operations.
PACIFIC CLOTHING STORE STATEMENT OF CASH FLOWS FOR THE YEAR ENDED JANUARY 31, 2017 | |
Sources of cash | |
From sales of merchandise | \(382,000 |
From sale of common stock | 380,000 |
From sale of investment | 120,000 |
From depreciation | 80,000 |
From issuance of note for truck | 30,000 |
From interest on investments | 8,000 |
Total sources of cash | 1,000,000 |
Uses of cash | |
For purchase of fixtures and equipment | 330,000 |
For merchandise purchased for resale | 253,000 |
For operating expenses (including depreciation) | 170,000 |
For purchase of investment | 95,000 |
For purchase of truck by issuance of note | 30,000 |
For purchase of treasury stock | 10,000 |
For interest on note | 3,000 |
Total uses of cash | 891,000 |
Net increase in cash | \)109,000 |
Teresa claims that Pacific’s statement of cash flows is an excellent portrayal of a superb first year, with cash increasing \(109,000. Lenny replies that it was not a superb first year—that the year was an operating failure, the statement was incorrectly presented, and \)109,000 is not the actual increase in cash.
Instructions
(a) With whom do you agree, Teresa or Lenny? Explain your position.
(b) Using the data provided, prepare a statement of cash flows in proper indirect method form. The only noncash items in income are depreciation and the gain from the sale of the investment (purchase and sale are related).
Question: ETHICS (Cash Flow Reporting)
Brockman Guitar Company is in the business of manufacturing top-quality, steelstring folk guitars. In recent years, the company has experienced working capital problems resulting from the procurement of factory equipment, the unanticipated buildup of receivables and inventories, and the payoff of a balloon mortgage on a new manufacturing facility. The founder and president of the company, Barbara Brockman, has attempted to raise cash from various financial institutions, but to no avail because of the company’s poor performance in recent years. In particular, the company’s lead bank, First Financial, is especially concerned about Brockman’s inability to maintain a positive cash position. The commercial loan officer from First Financial told Barbara, “I can’t even consider your request for capital financing unless I see that your company is able to generate positive cash flows from operations.” Thinking about the banker’s comment, Barbara came up with what she believes is a good plan: With a more attractive statement of cash flows, the bank might be willing to provide long-term financing. To “window dress” cash flows, the company can sell its accounts receivables to factors and liquidate its raw materials inventories. These rather costly transactions would generate lots of cash. As the chief accountant for Brockman Guitar, it is your job to tell Barbara what you think of her plan.
Instructions
Answer the following questions.
(a) What are the ethical issues related to Barbara Brockman’s idea?
(b) What would you tell Barbara Brockman?
Question: Collinsworth Co. reported sales on an accrual basis of \(100,000. If accounts receivable increased \)30,000 and the allowance for doubtful accounts increased \(9,000 after a write-off of \)2,000, compute cash sales.
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