Intermediate accounting answer chap021

CHAPTER 21THE STATEMENT OF CASH FLOWS REVISITEDAACSB assurance of learning standards in accounting and business education require documentation of outcomes assessment. Although schools, departments, and faculty may approach assessment and its documentation differently, one approach is to provide specific questions on exams that become the basis for assessment. To aid faculty in this endeavor, we have labeled each question, exercise and problem in Intermediate Accounting, 5e with the following AACSB learning skills:QuestionsAACSB TagsExercises (cont.)AACSB Tags21-1Reflective thinking21-15Analytic21-2Reflective thinking21-16Analytic21-3Reflective thinking21-17Communications21-4Reflective thinking21-18Analytic21-5Reflective thinking21-19Analytic21-6Reflective thinking21-20Communications21-7Reflective thinking21-21Analytic, Communications21-8Reflective thinking21-22Communications21-9Reflective thinking21-23Communications21-10Reflective thinking21-24Communications21-11Reflective thinking21-25Communications21-12Reflective thinking21-26Communications21-13Analytic21-27Analytic21-14Reflective thinking21-28Analytic21-15Reflective thinking21-29Analytic21-16Reflective thinking21-30Communications21-17Reflective thinkingCPA/CMA21-18Reflective thinking21-1Reflective thinking21-19Reflective thinking21-2Analytic21-20Reflective thinking21-3AnalyticBrief Exercises21-4Reflective thinking21-1Analytic21-5Reflective thinking21-2Analytic21-6Analytic21-3Analytic21-1Reflective thinking21-4Analytic21-2Analytic21-5Analytic21-3Analytic21-6AnalyticProblems21-7Analytic21-1Reflective thinking21-8Analytic21-2Analytic, Communications21-9Analytic21-3Analytic, Communications21-10Analytic21-4Analytic, Communications21-11Analytic21-5Analytic, Communications21-12Analytic21-6Analytic, CommunicationsExercises21-7Analytic, Communications21-1Reflective thinking21-8Analytic, Communications21-2Analytic21-9Analytic, Communications21-3Analytic21-10AnalyticExercises (cont.)Problems (cont.)21-4Analytic21-11Analytic, Communications21-5Analytic21-12Analytic, Communications21-6Analytic21-13Analytic21-7Analytic21-14Analytic, Communications21-8Analytic21-15Analytic21-9Analytic21-16Analytic, Communications21-10Analytic21-17Analytic21-11Analytic21-18Analytic, Communications21-12Analytic21-19Analytic, Communications21-13Analytic21-20Analytic, Communications21-14Analytic21-21Analytic, CommunicationsQUESTIONS FOR REVIEW OF KEY TOPICSQuestion 21-1Every cash flow eventually affects the balance of one or more accounts on the balance sheet, and the cash flows related to income-producing activities also are represented on the income statement. The cash flows, though, are not necessarily reported in the period the cash flows occur. This is because the income statement measures activities on an accrual basis rather than a cash basis. The Statement of Cash Flows fills the information gap by reporting the cash flows directly and in the period the cash flows occur.Question 21-2No. Although the Statement of Cash Flows has been a required financial statement only since 1988, the relatively recent requirement completes a full-cycle movement of accounting thought back to cash flow reporting, which was common practice several decades ago. Prior to the mid-1930s, the preparation of financial statements on a cash basis was common although todays cash flow reporting requirements are quite different from the cash flow reporting practiced during that earlier period (when emphasis was placed on cash-based income determination). Later, in 1971, APB Opinion 19 required a Statement of Changes in Financial Position that reported “funds flows that could be defined as either cash or working capital.Question 21-3No, an investment in treasury bills need not always be classified as a cash equivalent. A guideline not a rule for cash equivalents is that these investments must have a maturity date not longer than three months from the date of purchase. However, flexibility is permitted and each company must establish a policy regarding which short-term, highly liquid investments it classifies as cash equivalents. The designation must be consistent with the companys customary motivation for acquiring various investments and the policy should be described in disclosure notes.Question 21-4Transactions that involve merely transfers from cash to cash equivalents such as the purchase of a three-month treasury bill, or from cash equivalents to cash such as the sale of a treasury bill, should not be reported on the Statement of Cash Flows. A dollar amount is simply transferred from one “cash account to another “cash account so that the total of cash and cash equivalents is not altered by such transactions. An exception is the sale of a cash equivalent at a gain or loss. In this case, the total of cash and cash equivalents actually increases or decreases. The increase or decrease is reported as a cash flow from operating activities. Answers to Questions (continued)Question 21-5Cash flows from operating activities are both inflows and outflows of cash that result from the same activities that are reported on the income statement. However, the income statement reports the activities on an accrual basis (revenues earned during the reporting period, regardless of when cash is received, and the expenses incurred in generating those revenues, regardless of when cash is paid). Cash flows from operating activities, on the other hand, report those activities when the cash is exchanged (on a cash basis).Question 21-6The generalization that cash flows from operating activities report all the elements of the income statement on a cash basis is not strictly true for all elements of the income statement. No cash effects are reported for depreciation and amortization neither of operational assets, nor for gains and losses from the sale of those assets. Cash outflows occur when operational assets are acquired, and cash inflows occur when the assets are sold. However, the acquisition and subsequent resale of operational assets are classified as investing activities, rather than as operating activities.Question 21-7Cash flows from investing activities are both outflows and inflows of cash due to the acquisition and disposition of assets. This classification includes cash payments to acquire (1) property, plant and equipment and other productive assets (2) investments in securities, and (3) nontrade receivables. When these assets later are liquidated, any cash receipts from their disposition also are classified as investing activities. The four specific examples can come from any combination of these categories.Two exceptions are inventories and cash equivalents. The purchase and sale of inventories are not considered investing activities because inventories are purchased for the purpose of being sold as part of the firms primary operations and are classified as operating activities. The purchase and sale of assets classified as cash equivalents are not reported on the Statement of Cash Flows unless the total of cash and cash equivalents changes from the sale of a cash equivalent at a gain or loss.Question 21-8The payment of cash dividends to shareholders is classified as a financing activity, but paying interest to creditors is classified as an operating activity. This is because cash flows from operating activities should reflect the cash effects of items that enter into the determination of net income. Interest expense is a determinant of net income. A dividend, on the other hand, is a distribution of net income and not an expense.Answers to Questions (continued)Question 21-9A Statement of Cash Flows reports transactions that cause an increase or a decrease in cash. However, some transactions that do not increase or decrease cash, but which result in significant investing and financing activities, must be reported in related disclosures. Entering a significant investing activity and a significant financing activity as two parts of a single transaction does not limit the value of reporting these activities. Examples of noncash transactions that would be reported:1.Acquiring an asset by incurring a debt payable to the seller.2.Acquiring an asset by entering into a capital lease.3.Converting debt into common stock or other equity securities.4.Exchanging noncash assets or liabilities for other noncash assets or liabilities.Question 21-10The acquisition of a building purchased by issuing a mortgage note payable in addition to a significant cash down payment is an example of a transaction involving an investing and financing activity that is part cash and part noncash. The cash portion would be reported under the caption Cash flows from investing activities, and the noncash portion of the transaction would be reported as a noncash investing and financing activity. Question 21-11Perhaps the most noteworthy item reported on an income statement is net incomethe amount by which revenues exceed expenses. The most noteworthy item reported on a Statement of Cash Flows is not the amount of net cash flows. In fact, this may be the least important number on the statement. The increase or decrease in cash can be seen easily on comparative balance sheets. The purpose of the Statement of Cash Flows is not to report that cash increased or decreased by a certain amount, but why cash increased or decreased by that amount. The individual cash inflows and outflows provide that information.Question 21-12The spreadsheet entries shown in the two changes columns, which separate the beginning and ending balances, explain the increase or decrease in each account balance. Spreadsheet entries duplicate the actual journal entries used to record the transactions as they occurred during the year Recording spreadsheet entries simultaneously identifies and classifies the activities to be reported on the Statement of Cash Flows because in order for cash to increase or decrease, there must be a corresponding change in a noncash account. Thus, if we can identify the events and transactions that caused the change in each noncash account during the period, we will have identified all the operating, investing, and financing activities.Answers to Questions (continued)Question 21-13If sales revenue is $200,000, this does not necessarily mean that $200,000 cash was received from customers. Amounts reported on the income statement usually do not represent the cash effects of the items reported. By referring to the beginning and ending balances in accounts receivable, we see whether cash received from customers was more or less than $200,000. If accounts receivable increased during the year, some of the sales revenue earned must not yet have been collected. On the other hand, if accounts receivable decreased during the year, more must have been collected than the sales revenue earned. Question 21-14When an asset is sold at a gain, the gain is not reported as a cash inflow from operating activities. A gain (or loss) is simply the difference between cash received in the sale of an asset and the book value of the asset not a cash flow. The cash effect of the sale is reported as an investing activity. To report the gain as a cash flow from operating activities, in addition to reporting the entire cash flow from investing activities, would be to report the gain twice.Question 21-15Whether or not a loss is extraordinary, it is not reported on the statement of cash flows, but the cash inflow from the sale is reported as an investing activity. However, the spreadsheet entry would be affected if the loss is extraordinary. The income tax effect of an extraordinary item is not reflected in income tax expense, but instead is separately reported as a reduction in the extraordinary item. For example, if a loss on the sale of an asset was due to an extraordinary event, the tax savings from that loss would be reported as a reduction in the extraordinary loss rather than as a reduction in income tax expense. This must be considered when determining the cash paid for income taxes.Question 21-16When determining the amount of cash paid for income taxes, an increase in the deferred income tax liability account would indicate that less cash had been paid than the income tax expense reported. The difference represents the portion of the income tax expense whose payment is deferred to a later year. Notice that precisely the same analysis would apply for an increase in current income tax payable.Question 21-17When using the indirect method of determining net cash flows from operating activities, the net cash increase or decrease from operating activities is derived indirectly by starting with reported net income and working backwards to convert that amount to a cash basis. Amounts that were subtracted in determining net income, but which did not reduce cash, are added back to net income to reverse the effect of the amounts having been subtracted. Bad debt expense is one example. Other examples are depreciation expense, amortization of other intangibles, depletion, and a loss on the sale of assets.Answers to Questions (concluded)Question 21-18When using the indirect method of determining net cash flows from operating activities, when components of net income increase or decrease cash, but by an amount different from that reported on the income statement, net income is adjusted for changes in the balances of related balance sheet accounts to convert the effects of those items to a cash basis. For components of net income that increase or decrease cash by an amount exactly the same as that reported on the income statement, no adjustment of net income is required. Question 21-19Either the direct method or the indirect method is permitted, but the FASB strongly encourages companies to report cash flows from operating activities by the direct method. The direct method reports specific operating cash receipts and operating cash payments, consistent with the primary objective of the Statement of Cash Flows. This allows investors and creditors to gain additional insight into the specific sources of cash receipts and payments from operating activities. Users also can more easily interpret and understand the information presented because the direct method avoids the confusion caused by reporting noncash items and other reconciling adjustments under the caption cash flows from operating activities.Question 21-20The direct and indirect methods are alternative approaches to deriving net cash flows from operating activities only. Regardless of which method is used for that purpose, the way cash flows from investing and financing activities are presented is precisely the same.BRIEF EXERCISES Brief Exercise 21-1Summary Entry ($ in millions)Cash (received from customers)38Accounts receivable5Sales revenue33Brief Exercise 21-2Summary Entry ($ in millions)Cash (received from customers)39Accounts receivable4Bad debt expense2Allowance for uncollectible accounts1Sales revenue44Brief Exercise 21-3Summary Entry ($ in millions)Cost of goods sold25Inventory6Accounts payable5Cash (paid to suppliers of goods)26Brief Exercise 21-4Summary Entry ($ in millions)Salaries expense17Salaries payable3Cash (paid to employees)14Brief Exercise 21-5($ in millions)Interest expense (10% x 1/2 x $380)19Discount on bonds payable1Cash (paid to bondholders) (9% x 1/2 x $400)18Agee would report the cash inflow of $380 million from the sale of the bonds as a cash inflow from financing activities in its statement of cash flows.The $18 million cash interest paid is cash outflow from operating activities because interest is an income statement (operating) item.Brief Exercise 21-6($ in millions)Interest expense (10% x 1/2 x $380)19Discount on bonds payable1Cash (paid to bondholders) (9% x 1/2 x $400)18Agee would report the cash inflow of $380 million from the sale of the bonds as a cash inflow from financing activities in its statement of cash flows.The $1 million amortization of the discount would be added back to net income as a noncash adjustment because the interest expense ($19 million) was subtracted in calculating net income and yet the cash interest paid was only $18 million.Brief Exercise 21-7Merit would report the cash inflow of $41 million from the borrowing as a cash inflow from financing activities in its statement of cash flows.Each installment payment includes both an amount that represents interest and an amount that represents a reduction of principal. In its statement of cash flows, then, Merit reports the interest portion ($2,870,000*) as a cash outflow from operating activities and the principal portion ($7,130,000*) as a cash outflow from financing activities. *December 31, 2021Interest expense (7% x outstanding balance)2,870,000Note payable (difference)7,130,000Cash (given)10,000,000Brief Exercise 21-8($ in millions)Cash35Gain on sale of land (difference)13Land (cost)22Morgan would report the cash inflow of $35 million from the sale as a cash inflow from investing activities in its statement of cash flows.The $13 million gain is not a cash flow and would not be reported when using the direct method. For that reason, when using the indirect method, the gain would be subtracted from net income (which includes the gain) to avoid double-counting it.Brief Exercise 21-9Cash Flows From Investing Activities: Proceeds from sale of marketable securities$30Proceeds from sale of land15Purchase of equipment for cash (25)Purchase of patent(12)Net cash inflows from investing activities$ 8Brief Exercise 21-10Cash Flows From Financing Activities: Sale of common shares $40Purchase of treasury stock(21)Net cash inflows from financing activities$19Brief Exercise 21-11Net income$90Adjustments for noncash effects:Depreciation expense3Loss on sale of equipment2Increase in accounts receivable(1)Increase in accounts payable 4Increase in inventory (3) Net cash flows from operating activities$95Brief Exercise 21-12Net income$60Adjustments for noncash effects:Amortization expense2Gain on sale of equipment(1)Decrease in accounts receivable2Decrease in accounts payable (5)Decrease in inventory 4 Net cash flows from operating activities$62EXERCISES Exercise 21-1Example F 1.Sale of common stock I 2.Sale of land F 3.Purchase of treasury stock O 4.Merchandise sales F 5.Issuance of a long-term note payable O 6.Purchase of merchandise F 7.Repayment of note payable O 8.Employee salaries I 9.Sale of equipment at a gain F 10.Issuance of bonds I 11.Acquisition of bonds of another corporation O 12.Payment of semiannual interest on bonds payable F 13.Payment of a cash dividend I 14.Purchase of building I 15.Collection of nontrade note receivable (principal amount) I 16.Loan to another firm F