CHAPTER 4
STRUCTURE OF THE BALANCE SHEET
AND STATEMENT OF CASH FLOWS
LEARNING OBJECTIVES:
1.
How the various asset, liability, and stockholders’ equity accounts found on a
typical corporate balance sheet are measured and classified.
2.
How to use balance sheet information to understand key differences in the nature
of firms’ operations and how those operations are financed.
3.
Differences in balance sheet terminology and presentation format in countries
outside the United States.
4.
How successive balance sheets and the income statement can be used to
determine cash inflows and outflows for a period.
5.
How information provided in the cash flow statement can be used to explain
changes in noncash accounts on the balance sheet.
6.
The distinction between operating, investing, and financing sources and uses of
cash.
7.
How changes in current asset and liability accounts can be used to adjust accrual
earnings to obtain cash flows from operations.
69
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
Multiple-Choice Questions
Select the best answer from those provided.
1.
Easy
LO1
(b)
Page 131
The balance sheet is an expression of
a.
a combination of all financial statements.
b.
the accounting equation.
c.
all prior income statements.
d.
the current value of a company.
2.
Easy
LO1
(a)
Page 131
Probable future economic benefits obtained or controlled by an entity as
a result of past transactions or events define
a.
assets.
b.
liabilities.
c.
equity.
d.
retained earnings.
3.
Easy
LO1
(c)
Page 131
The residual interest in the resources of an entity that remains after
deducting its debts to third parties defines
a.
assets.
b.
liabilities.
c.
equity.
d.
retained earnings.
4.
Easy
LO1
(b)
Page 131
Probable future sacrifices of economic benefits arising from an entity’s
present obligations to transfer resources or provide services to other
entities in the future as a result of past transactions or events define
a.
assets.
b.
liabilities.
c.
equity.
d.
retained earnings.
5.
Medium
LO1
(d)
Page 131
The balance sheet provides information on all of the following except for
a.
how management invested its money.
b.
where the money came from.
c.
assessing rates of return.
d.
ascertaining stock market prices.
6.
Difficult
LO1
(a)
Page 132
By comparing return on assets to return on common equity, statement
users can determine
a.
if debt financing is being used to enhance the return earned by
shareholders.
b.
past patterns of profitability within divisions.
c.
if return on investments exceed the current market yield.
d.
management’s investment strategies.
70
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
7.
Medium
LO1
(b)
Page 132
How far into the future the obligations of a company will come due refers
to the company’s
a.
capital structure.
b.
maturity structure.
c.
solvency.
d.
liquidity.
8.
Medium
LO1
(a)
Page 132
How much of a company’s assets are financed from debt versus equity
sources refers to the company’s
a.
capital structure.
b.
maturity structure.
c.
solvency.
d.
liquidity.
9.
Medium
LO1
(d)
Page 132
Which of the following measures how readily assets can be converted to
cash relative to how soon liabilities will have to paid in cash?
a.
Capital structure.
b.
Maturity structure.
c.
Solvency.
d.
Liquidity.
10.
Medium
LO1
(c)
Page 132
The ability of a company to generate sufficient cash flows to maintain its
productive capacity and still meet interest and principal payments on
long-term debt refers to
a.
capital structure.
b.
maturity structure.
c.
solvency.
d.
liquidity.
11.
Medium
LO1
(a)
Page 132
Operating and financial flexibility refers to a company’s ability to
a.
adjust to unexpected downturns in the economic environment in
which it operates or to take advantage of profitable investment
opportunities as they arise.
b.
generate sufficient cash flows to maintain its productive capacity
and still meet interest and principal payments on long-term debt
c.
readily convert assets to cash relative to how soon liabilities will
have to paid in cash.
d.
finance debt in ratio to financing through equity sources .
12.
Medium
LO1
(d)
Page 132
Balance sheets prepared in compliance with GAAP reflect a mixture of
a.
historical cost and future cash values.
b.
current value and discounted future cash flows.
c.
discounted cash flows and future values.
d.
historical cost, fair value, net realizable value, and discounted
present values.
71
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
13.
Medium
LO1
(b)
Page 132
The elapsed time beginning with the initiation of production and ending
with the cash collection of the receivables from the sale of the product
refers to the company’s
a.
production cycle.
b.
operating cycle.
c.
cash cycle.
d.
liquidation cycle.
14.
Medium
LO1
(b)
Page 132
Current assets are assets expected to
a.
be converted to cash within twelve months.
b.
be converted to cash within twelve months or one operating cycle if
it is longer than twelve months.
c.
remain on the books for at least twelve months.
d.
remain on the books for at least twelve months or one operating
cycle if longer than twelve months.
15.
Easy
LO1
(c)
Page 132
Current assets are listed on the balance sheet in descending order of
a.
importance.
b.
magnitude.
c.
liquidity.
d.
profitability.
16.
Easy
LO1
(c)
Page 132
Current liabilities are liabilities expected to be settled
a.
after one year.
b.
within twelve months or one operating cycle if it is longer.
c.
within twelve months or one operating cycle if it is longer, from
current assets.
d.
after twelve months or one operating cycle if it is longer.
17.
Difficult
LO1
(b)
Page 133
Cash is always measured for the balance sheet at
a.
historical transaction value.
b.
current market price.
c.
realizable future value.
d.
historical cost.
18.
Difficult
LO1
(d)
Page 134
Monetary assets denominated in foreign currency units are translated into
U. S. dollars for balance sheet presentation at the
a.
historical rate of exchange at the time of each transaction.
b.
current rate of exchange at the time of each transaction.
c.
average rate of exchange for the year.
d.
current rate of exchange at the balance sheet date.
72
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
19.
Difficult
LO1
(c)
Page 134
Monetary assets are comprised of
a.
cash and cash equivalents.
b.
cash, cash equivalents, and accounts receivable.
c.
cash, cash equivalents, accounts receivable, and notes receivable.
d.
cash, accounts receivable, notes receivable, and inventory.
20.
Medium
LO1
(a)
Page 134
Marketable debt and equity securities that a firm expects to hold as a
short-term investment are reported on the balance sheet at
a.
current market value.
b.
historical cost.
c.
amortized current market value.
d.
amortized historical cost.
21.
Medium
LO1
(c)
Page 135
Accounts Receivable are shown on the balance sheet at
a.
current market value.
b.
historical cost.
c.
net realizable value.
d.
amortized historical cost.
22.
Easy
LO1
(b)
Page 135
The value of Accounts Receivable is adjusted on the balance sheet by the
contra-asset account
a.
Allowance for Amortization.
b.
Allowance for Doubtful Accounts.
c.
Bad Debt Expense.
d.
Doubtful Accounts Expense.
Table 4-1
Romero Corporation recorded sales of $270,000 for the current year. It was determined
that in the past approximately 2% of sales prove to be uncollectible. Having recorded the
proper amount of Bad Debt Expense, the year-end balances are:
Accounts Receivable
$37,000
Allowance for Doubtful Accounts
4,000
23.
Medium
LO1
(b)
Pages
134-135
Refer to Table 4-1. What is the net amount of Accounts Receivable that
will appear on Romero's balance sheet at year end?
a.
$31,600
b.
$33,000
c.
$37,000
d.
$41,000
73
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
24.
Medium
LO1
(c)
Pages
134-135
Refer to Table 4-1. What is the amount of bad debt expense that appears
on Romero’s income statement?
a.
$1,400
b.
$4,000
c.
$5,400
d.
$9,400
25.
Easy
LO1
(b)
Page 135
Refer to Table 4-1. What type of account is Allowance for Doubtful
Accounts?
a.
Current asset
b.
Contra-asset (current)
c.
Expense
d.
Contra-equity
26.
Medium
LO1
(d)
Page 135
Inventories are reported on the balance sheet at
a.
current market value.
b.
historical cost.
c.
net realizable value.
d.
the lower of cost or market.
27.
Medium
LO1
(c)
Page 135
Property, plant and equipment are reported on the balance sheet at
a.
current market value.
b.
historical cost.
c.
historical cost minus accumulated depreciation.
d.
net realizable value.
28.
Easy
LO1
(b)
Page
Current liabilities are reported on the balance sheet at
a.
current market value.
b.
historical cost.
c.
discounted present value.
d.
future value.
29.
Difficult
LO1
(c)
Page 136
Long-term debt is reported on the balance sheet at
a.
current market value.
b.
net realizable value.
c.
discounted present value.
d.
future value.
30.
Medium
LO1
(a)
Page 136
Book income is the basis for
a.
tax expense.
b.
deferred income tax.
c.
income tax payable.
d.
the company’s tax return.
74
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
31.
Medium
LO1
(d)
Page 136
The balance sheet amount reported for a long-term debt on the issue date
is the
a.
discounted present value of the future principal repayment.
b.
discounted present value of the periodic interest payments.
c.
sum of the future value of principal repayment and the periodic
interest payments.
d.
sum of the discounted present values of the future principal
repayments and the periodic interest payments.
32.
Medium
LO1
(b)
Page 136
The unpaid amount of income taxes due to the government for a given
year are found on the
a.
balance sheet in the account Deferred Income Taxes.
b.
balance sheet in the account Income Taxes Payable.
c.
income statement in the account Income Tax Expense Current.
d.
income statement in the account Income Tax Expense Deferred.
33.
Medium
LO1
(a)
Page 136
The amount of income taxes recognized on the income statement but not
yet payable to the government are found on the
a.
balance sheet in the account Deferred Income Taxes.
b.
balance sheet in the account Income Taxes Payable.
c.
income statement in the account Income Tax Expense Current.
d.
income statement in the account Income Tax Expense Deferred.
34.
Medium
LO1
(b)
Page 137
Deferred Income Taxes are reported on the balance sheet at
a.
current market value.
b.
undiscounted historic amounts.
c.
discounted present value of future payments.
d.
future value of future payments.
35.
Difficult
LO1
(c)
Page 137
All of the following are true for trust preferred securities (TPS) except
a.
shares pay monthly or quarterly dividends.
b.
there is a mandatory redemption feature.
c.
they are classified in current liabilities.
d.
they are considered a hybrid security.
36.
Medium
LO1
(a)
Page138
The Common Stock account is reported on the balance sheet at the
a.
historical par value of the stock.
b.
current market value of the stock.
c.
net realizable value of the stock.
d.
discounted present value of the future dividends.
75
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
37.
Medium
LO1
(b)
Page 138
The Additional Paid-In Capital account is reported on the balance sheet
at the
a.
current market value of the stock minus par value.
b.
historical sales price of the stock minus the par value.
c.
net realizable value of the stock minus par value.
d.
discounted present value of the future dividends minus par value.
38.
Medium
LO1
(c)
Page 138
The Retained Earnings account is comprised of
a.
cash retained in the business.
b.
cash reinvested in the business by shareholders.
c.
the cumulative earnings less dividends since the inception of the
corporation.
d.
the earnings of the corporation for the current year.
39.
Medium
LO1
(d)
Page 138
Retained earnings are reported on the balance sheet at
a.
historical cost.
b.
current market value.
c.
net realizable value.
d.
a mixture of different bases.
40.
Difficult
LO2
(b)
Page 138
In a common-size balance sheet, each balance sheet is expressed as a
percentage of total
a.
liabilities.
b.
assets.
c.
shareholders’ equity.
d.
assets plus shareholders’ equity.
41
Medium
LO3
(a)
Page141
In the United States, assets are presented in decreasing order of liquidity.
In the United Kingdom and other European countries
a.
fixed assets are presented first followed by the current assets
displayed in increasing order of liquidity.
b.
the current assets are displayed in increasing order of liquidity.
c.
investments are listed first in descending order of maturity.
d.
each company decides on the order of its own assets.
42.
Difficult
LO3
(d)
Page142
The British capital redemption reserve is equivalent to the United States
a.
accumulated other comprehensive income account.
b.
treasury stock account.
c.
common stock account.
d.
has no equivalent account.
76
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
43.
Medium
LO4
(c)
Page 143
Which one of the following equations explains why successive balance
sheets can be used to prepare a firm's cash flow statement?
a.
Assets = Liabilities – Equity
b.
Cash –Non-cash Assets = Liabilities –Equity
c.
Δ Cash = Δ Liabilities – Δ Non-cash Assets + Δ Stockholders'
equity
d.
Δ Cash = Δ Liabilities + Δ Stockholders' Equity
44.
Medium
LO4
(c)
Page 143
The change in cash during a period is
a.
equal to the net income for the period.
b.
equal to the change in stockholders' equity for the period.
c.
never equal to net income for the period if dividends are paid.
d.
always equal to the net income for the period if no dividends are
paid.
45.
Medium
LO6
(a)
Page 143
Operating activities result from the cash effects of
a.
producing and delivering goods and services.
b.
purchasing and disposing of fixed assets used in production of
revenue.
c.
borrowing and repaying loans used in the production of revenue.
d.
selling stocks and bonds to raise capital for the production of
revenue.
46.
Medium
LO6
(b)
Page 143
Investing activities include the cash effects of
a.
producing and delivering goods and services.
b.
purchasing and disposing of fixed assets used in production of
revenue.
c.
borrowing and repaying loans used to purchase fixed assets.
d.
selling stocks and bonds to raise capital to purchase fixed assets.
47.
Medium
LO6
(d)
Page 143
Financing activities include the cash effects of
a.
producing and delivering goods and services.
b.
purchasing and disposing of fixed assets used in production of
revenue.
c.
purchasing and disposing of debt securities.
d.
selling stocks and bonds to raise capital for the production of
revenue.
48.
Difficult
LO6
(a)
Page 144
Companies that are considered to be in stronger financial health and
better credit risks, are able to satisfy most of their cash needs from
a.
operating activities.
b.
investing activities.
c.
financing activities.
d.
investing and financing activities.
77
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
Table 4-2
Selected data the Catalog Corporation's comparative balance sheets for Year 1 and Year 2
are as follows:
Assets
Cash
Accounts Receivable (net)
Inventory
Equipment (net)
Total Assets
Year 1
$100,000
50,000
200,000
300,000
$550,000
Year 2
$(50,000)
100,000
250,000
350,000
$650,000
Liabilities and Equity
Accounts Payable
Income Taxes Payable
Bonds Payable
Common Stock
Retained Earnings
Total Liabilities and Equity
$150,000
80,000
100,000
100,000
120,000
$550,000
$100,000
30,000
80,000
200,000
240,000
$650,000
A brief income statement for Year 2 shows the following:
Sales
Cost of Goods Sold
Operating Expenses
Depreciation
Income Tax Expense
Net Income
$900,000
$500,000
100,000
50,000
100,000
750,000
$150,000
49.
Medium
LO5
(c)
Page 147
Refer to Table 4-2. How much cash did Catalog collect from
customers during Year 2?
a.
$150,000
b.
$750,000
c.
$850,000
d.
$900,000
50.
Difficult
LO5
(d)
Pages
147-153
Refer to Table 4-2. How much cash did Catalog pay to suppliers for
inventory during Year 2?
a.
$150,000
b.
$400,000
c.
$500,000
d.
$600,000
78
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
51.
Difficult
LO5
(a)
Pages
147-153
Refer to Table 4-2. How much did Catalog pay in dividends to
shareholders in Year 2?
a.
$ 30,000
b.
$120,000
c.
$150,000
d.
$330,000
52.
Medium
LO5
(d)
Pages
147-153
Refer to Table 4-2. How much did Catalog pay in income taxes to
the government in Year 2?
a.
$ 30,000
b.
$ 80,000
c.
$110,000
d.
$150,000
53.
Difficult
LO5
(a)
Pages
147-153
Refer to Table 4-2. What are Catalog's cash flows from operating
activities for Year 2?
a.
$
0
b.
$ 50,000 outflow
c.
$150,000 outflow
d.
$400,000 inflow
54.
Difficult
LO5
(c)
Pages
147-153
Refer to Table 4-2. What are Catalog's cash flows from investing
activities for Year 2?
a.
$
0
b.
$100,000 inflow
c.
$100,000 outflow
d.
$350,000 outflow
55.
Difficult
LO5
(b)
Pages
147-153
Refer to Table 4-2. What are Catalog’s cash flows from financing
Activities for Year 2?
a.
$
0
b.
$ 50,000 inflow
c.
$ 50,000 outflow
d.
$150,000 outflow
79
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
Table 4-3
The Lexmark Company provides the following information from its
Year 3 and Year 4 balance sheets:
Year 3
$115,000
120,000
7,500
40,000
55,000
Accounts Receivable
Inventory
Prepaid Insurance
Prepaid Rent
Accounts Payable
Year 4
$97,500
130,000
1,500
15,000
65,000
The following information is available from the Year 4 income statement:
Sales
Cost of Goods Sold
Insurance Expense
Rent Expense
$425,000
225,000
12,000
25,000
56.
Medium
LO7
(d)
Pages
147-153
Refer to Table 4-3. How much cash did Lexmark collect from customers
in Year 4?
a.
$115,000
b.
$407,500
c.
$425,000
d.
$442,500
57.
Medium
LO7
(c)
Pages
147-153
Refer to Table 4-3. How much cash did Lexmark pay for inventory
during Year 4?
a.
$130,000
b.
$215,000
c.
$225,000
d.
$235,000
58.
Medium
LO7
(a)
Pages
147-153
Refer to Table 4-3. How much cash did Lexmark pay for insurance
during Year 4?
a.
$ 6,000
b.
$ 9,000
c.
$12,000
d.
$18,000
59.
Medium
LO7
(a)
Pages
147-153
Refer to Table 4-3. How much cash did Lexmark pay for rent during
Year 4?
a.
$ 0
b.
$15,000
c.
$25,000
d.
$40,000
80
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
60.
Difficult
LO7
(b)
Pages
147-153
Refer to Table 4-3. Assuming that the information provided from the
income statement represents all of the pre-tax income of Lexmark
Company, what is the difference between the accrual-basis and cashbasis income in Year 4?
a.
Accrual exceeds cash basis by $16,500.
b.
Cash exceeds accrual basis by $23,500.
c.
Accrual exceeds cash basis by $25,000.
d.
Cash exceeds accrual basis by $48,500.
Table 4-4
Soccer Magic Company reported the following items on its Year 2 and Year 3 balance
sheet:
Year 3
Year 2
Accounts Receivable
$40,000
$30,000
Supplies Inventory
15,000
12,000
Prepaid Rent
6,000
5,000
Salaries Payable
17,000
11,500
Utilities Payable
1,500
1,000
Supplies Payable
4,500
5,500
Interest Payable
8,500
7,000
The following information is from the income statement for Year 3:
Service Revenue
Rent Expense
Salaries Expense
Utilities Expense
Supplies Expense
Interest Expense
$160,000
12,000
52,500
16,000
32,500
21,000
61.
Medium
LO7
(b)
Pages
147-151
Refer to Table 4-4. How much cash did Soccer Magic collect from
customers in Year 3?
a.
$ 40,000
b.
$150,000
c.
$160,000
d.
$170,000
62.
Medium
LO7
(d)
Pages
147-151
Refer to Table 4-4. How much cash did Soccer Magic pay for supplies
during Year 3?
a.
$28,500
b.
$30,500
c.
$32,500
d.
$36,500
81
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
63.
Medium
LO7
(b)
Pages
147-151
Refer to Table 4-4. How much cash did Soccer Magic pay for salaries
during Year 3?
a.
$17,000
b.
$47,000
c.
$52,500
d.
$58,000
64.
Medium
LO7
(b)
Pages
147-151
Refer to Table 4-4. How much cash did Soccer Magic pay for utilities
expense in Year 3?
a.
$ 1,000
b.
$15,500
c.
$16,000
d.
$16,500
65.
Medium
LO7
(d)
Pages
147-151
Refer to Table 4-4. How much cash did Soccer Magic pay for rent during
Year 3?
a.
$ 6,000
b.
$ 11,000
c.
$ 12,000
d.
$ 13,000
66.
Medium
LO7
(b)
Pages
147-151
Refer to Table 4-4. How much cash did Soccer Magic pay for interest
during Year 3?
a.
$ 8,500
b.
$ 19,500
c.
$ 21,000
d.
$ 22,000
67.
Difficult
LO7
(a)
Pages
147-151
Refer to Table 4-4. Assuming that the information provided from the
income statement represents all of the pre-tax income of the Soccer
Magic Company, what is the difference between the accrual-basis and
cash-basis income in Year 3?
a.
Accrual exceeds cash basis by $ 7,500.
b.
Cash exceeds accrual basis by $ 7,500.
c.
Accrual exceeds cash basis by $11,500.
d.
Cash exceeds accrual basis by $20,000.
82
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
Table 4-5
The following information is available from the S.P. Harris, Inc. comparative balance
sheets for Years 7 and 8:
Year 8
Year 7
Land
$260,000
$210,000
Buildings (net)
972,000
647,000
Notes Payable to Bank
589,000
611,000
Common Stock
700,000
600,000
Additional Paid-in Capital
390,000
160,000
Retained Earnings
625,000
500,000
Additional information for Year 8 is available:
1.
The income statement shows Depreciation Expense of $70,000.
2.
Net income is $225,000.
3.
Harris issued 2,000 shares of common stock with a market price of $25 per share in
exchange for land. The stock has a $10 par value.
4.
Harris borrowed $150,000 during the year from the bank.
68.
Difficult
LO7
(a)
Pages
147-153
Refer to Table 4-5. How much cash did Harris pay to purchase land if no
land was disposed of during Year 8?
a.
$ 0
b.
$20,000
c.
$25,000
d.
$50,000
69.
Difficult
LO7
(b)
Pages
147-153
Refer to Table 4-5. How much cash did Harris repay to the bank on loans
during Year 8?
a.
$150,000
b.
$172,000
c.
$589,000
d.
$611,000
70.
Difficult
LO7
(b)
Pages
147-153
Refer to Table 4-5. How much cash did Harris pay to purchase buildings
if no building was disposed of during the year?
a.
$325,000
b.
$395,000
c.
$465,000
d.
$647,000
83
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
71.
Difficult
LO7
(d)
Pages
147-153
Refer to Table 4-5. What was the sales price per share of Harris's
common stock sold in Year 8?
a.
$10
b.
$20
c.
$25
d.
$35
72.
Difficult
LO7
(b)
Pages
147-153
Refer to Table 4-5. How much cash did Harris pay to stockholders in the
form of dividends during Year 8?
a.
$
0
b.
$100,000
c.
$125,000
d.
$225,000
Explanation to Selected Multiple-Choice Questions
23.
Accounts Receivable
Less: Allowance for Doubtful Accounts
Accounts Receivable, net
24.
$270,000 sales X 2% = $5,400
49.
$900,000 sales – $50,000 increase in A/R = $850,000
50.
$500,000 +
$50,000
+ $50,000
= $600,000
COGS
inventory increase A/P increase
51.
$120,000
beg. bal. R/E
52.
$100,000 tax expense + $50,000 decrease in taxes payable = $150,000
53.
Net income
Depreciation
Increase in A/R
Increase in Inventory
Decrease in A/P
Decrease in Taxes Payable
Operating Cash Flow
54.
$350,000 + $50,000
end. equip.
depre.
+ $150,000 – $240,000
net income
end. bal. R/E
$37,000
4,000
$33,000
= $30,000
$150,000
50,000
(50,000)
(50,000)
(50,000)
(50,000)
$
–0–
– $300,000 = $100,000 outflow for
beg. equip.
equipment purchase
84
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
55.
Sale of Stock
Payment of Bonds
Dividends Paid
Financing Cash Inflows
$100,000
(20,000)
(30,000)
$ 50,000)
56.
$425,000 sales + $17,500A/R decrease = $442,500
57.
$225,000 – $10,000 + $10,000
COGS
increase in
increase in
inventory
A/P
58.
$12,000
–
$6,000
=
insurance
decrease in
expense
prepaid insurance
59.
$25,000 rent expense – $25,000 decrease in prepaid insurance = $0
60.
= $225,000
$6,000
Accrual Basis
$425,000
(225,000)
(12,000)
(25,000)
$163,000
Revenue
Cost of Goods Sold
Insurance
Rent
Net Income
Cash Basis
$442,500
(225,000)
(6,000)
-0$211,500
Cash basis net income is $48,500 more than accrual basis.
61.
$160,000 sales – $10,000 increase in A/R = $150,000
62.
$32,500 + $3,000
+
$1,000
supplies
supplies
supplies
expense
inv. increase
pay. Decrease
63.
$52,500 salaries expense – $5,500 increase in salaries payable = $47,000
64.
$16,000 utilities expense – $500 increase in utilities payable = $15,500
65.
$12,000 rent expense + $1,000 increase in prepaid rent = $13,000
66.
$21,000 interest expense – $1,500 increase in interest payable = $19,500
85
= $36,500
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
67.
Cash Basis
$150,000
(13,000)
(47,000)
(15,500)
(36,500)
(19,500)
$ 18,500
Revenue
Rent expense
Salaries
Utilities
Supplies
Interest
Income
Accrual Basis
$160,000
(12,000)
(52,500)
(16,000)
(32,500)
(21,000)
$ 26,000
Accrual basis income is $7,500 more than cash basis.
68.
$50,000
–
common stock
[2,000 shares @ $25]
69.
$611,000
+
N/P beg. bal
70.
$972,000 + $70,000
end. bldg.
depreciation
balance
expense
71.
Common stock ending balance
Additional paid in capital ending balance
Land
Common stock beginning balance
Additional paid in capital beginning balance
Cash received for stock sold
$700,000
390,000
(50,000)
(600,000)
(160,000)
$280,000
Change in common stock account
Common stock for land1
$100,000
20,000
$ 80,000
$50,000
net change
in account
$150,000
borrowing
–
= $0
– $589,000 = $172,000
ending N/P
Balance
$647,000
beg. bldg.
balance
=
$395,000
$80,000 / $10 Par value = 8,000 shares issued.
$280,000 amount received / 8,000 shares = $35 per share
1
72.
2,000 shares X $10 par value = $20,000
$500,000
beg.R/E
balance
+
–
$225,000
net income
86
$625,000
end. R/E
balance
= $100,000
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
Exercises
73.
Medium
LO1
Pages
133-138
For each balance sheet item listed below, indicate how it is measured on
the year-end balance sheet. Select the appropriate letter from the
following list:
A Historic Cost
B Amortized (or Depreciated) Cost
C Market (Fair) Value
D Lower of Cost or Market
E Discounted Present Value
_____ 1. Cash
_____ 2. Held-to-Maturity Debt Securities
_____ 3. Short-term Investment in Equity Securities
_____ 4. Short-term Investment in Debt Securities
_____ 5. Merchandise Inventory
_____ 6. Property, Plant and Equipment
_____ 7. Impaired Property, Plant and Equipment
_____ 8. Accounts Payable
_____ 9. Long-term Debt at issuance
_____ 10. Common Stock
_____ 11. Land
_____ 12. Deferred Income Taxes
74.
Medium
LO4
Pages 150151
During 2003 DeSanto Corporation had $750,000 in credit sales and
$225,000 in cash sales. The accounts receivable balances were $112,500
and $182,500 at December 31, 2002 and 2003, respectively.
Required: What was DeSanto Corporation’s cash receipts from sales in
2003? Show all computations.
87
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
75.
Difficult
LO4
Pages
150-151
The following information is available for Atlas Company’s first year of
operations:
Payment for merchandise purchases
$197,500
Collections from customers
200,000
Ending merchandise inventory
25,000
Accounts Payable (balance at end of year)
12,500
All merchandise items were marked to sell 40% above cost. Collection
of all accounts receivable is reasonably assured.
Required: What should be the ending balance in accounts receivable?
Show all computations.
76.
Medium
LO5
Pages 143147
Nikolai Company is a sole proprietorship that retails computer systems
for college computer labs. The following are the comparative balance
sheets for Years 8 and 9 with additional information.
Nikolai Company
Comparative Balance Sheets
For the Years Ended December 31, Year 8 and Year 9
Assets
Cash
Accounts Receivable
Inventory
Prepaid Expenses
Plant & Equipment (net)
Total Assets
Year 8
$ 15,000
25,000
120,000
5,000
250,000
$415,000
Year 9
$ 12,000
38,000
115,000
7,000
240,000
$412,000
Liabilities and Capital
Accounts Payable
$ 8,000
Accrued Liabilities
3,000
Long-term Debt
85,000
Capital
316,000
Total Liabilities & Capital $415,000
$ 14,000
2,000
85,000
311,000
$412,000
Additional Information for Year 9:
Depreciation Expense
Net Loss for Year 9
$ 6,500
(18,000)
Required: Prepare the indirect method operating activities section of the
Cash Flow Statement for Year 9.
88
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
77.
Medium
LO6
Pages
143-147
The following information was taken from the 2003 financial statements
of Sundem Corporation.
Increase (Decrease) in account balance
Cash
Accounts receivable
Inventory
Prepaid expenses
Accounts payable
Wages payable
Long-term debt
Common stock
Retained earnings
Net income
Depreciation
Amortization
$ 20,000
(400,000)
300,000
40,000
30,000
(40,000)
(20,000)
600,000
70,000
$ 170,000
50,000
25,000
Required: Prepare the cash flow from operations section of the
Statement of Cash Flows using the indirect method.
78.
Medium
LO6
Pages
143-147
Moore Corporation had the following transactions during 2002:
Cash purchase of land
Long-term mortgage increase
Sale of 10-year bonds
Purchase of treasury stock
Declaration of cash dividend
Cash purchase of long-term debt securities
Payment of cash dividend
Acquisition of equipment in exchange for
common stock
$300,000
250,000
400,000
50,000
100,000
60,000
70,000
200,000
Required: Prepare the investing and financing sections of the Statement
of Cash Flows for the Moore Corporation for 2002.
89
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
79.
Medium
LO6
Page144
For each of the following items of Jaegar Corporation, indicate whether
the transaction is an operating activity (O), investing activity (I),
financing activity (F), or other activity (N).
_____ 1. Purchase of a subsidiary company.
_____ 2. Sale of common stock.
_____ 3. Payment of accounts payable.
_____ 4. Purchase of equity securities classified as current assets.
_____ 5. Purchase of office equipment.
_____ 6. Conversion of bonds into common stock.
_____ 7. Purchase of common stock for treasury.
_____ 8. Payment of a cash dividend declared in a prior year.
_____ 9. Sale of inventory.
_____ 10. Borrowing from the bank.
_____ 11. Exchange of common stock for the acquisition of computers.
_____ 12. Collection of an account receivable.
Solutions to Exercises
73.
1.
2.
3.
4.
C
B
C
C
5.
6.
7.
8.
D
B
C
A
9. E
10. A
11. A
12. A
74.
Cash Sales
Collections on A/R
Cash receipts from customers
$225,000
680,000
$905,000
Collections on A/R:
Beginning Balance
Credit Sales
Ending Balance
Collections on A/R
$112,500
750,000
(182,500)
$680,000
90
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
75.
76.
Beginning Inventory
Purchases ($200,000 + $12,500)
Goods Available for Sale
Ending Inventory
Cost of Goods Sold
Markup on cost
Sales
Collections on A/R
Accounts Receivable Balance
-0+ 212,500
$212,500
– 25,000
$187,500
x 1.40
$262,500
– 197,500
$ 65,000
NikolaiCompany
Statement of Cash Flows
For the Year Ended December 31, Year 9
Operating Cash Flows:
Net Income (Loss)
Plus:
Depreciation
Decrease in Inventory
Increase in Accounts Payable
Minus:
Increase in Accounts Receivable
Increase in Prepaid Expenses
Decrease in Accrued Liabilities
Cash Flow from Operations
77.
$
$(18,000)
$ 6,500
5,000
6,000
$(13,000)
(2,000)
(1,000)
17,500
(16,000)
$(16,500)
Sundem, Inc.
Statement of Cash Flows
For the Year Ended December 31, 2003
Operating Cash Flows:
Net Income
Plus:
Depreciation
$ 50,000
Amortization
25,000
Decrease in Accounts receivable
400,000
Increase in Accounts payable
30,000
Minus:
Increase in Inventory
$(300,000)
Increase in Prepaid assets
(40,000)
Decrease in Wages payable
(40,000)
Cash flow from operations
91
$170,000
505,000
(380,000)
$295,000
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
78.
79.
Moore Corporation
Statement of Cash Flows
For the Year Ended December 31, 2002
Investing Cash Flows:
Purchase of land
Purchase of securities
Investing Cash Flow
$(300,000)
(60,000)
Financing Cash Flows:
Mortgage increase
Sale of bonds
Purchase of treasury stock
Payment of cash dividends
Financing Cash Flows
$ 250,000
400,000
(50,000)
(70,000)
1.
2.
3.
4.
I
F
O
I
5.
6.
7.
8.
I
N
F
F
9.
10.
11.
12.
O
F
N
O
92
$(360,000)
530,000
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
Problems
80.
Difficult
LO1
Pages
133-138
The following information was taken from Universal Corporation’s 2003
balance sheet.
Total current liabilities
$ 50,000
Total current assets
310,000
Total Assets
460,000
Inventory
A
Common stock
B
Cash
10,000
Accounts payable
20,000
Total stockholders’ equity
335,000
Accrued liabilities
C
Accounts receivable, net
50,000
Total liabilities and stockholders’ equity
D
Retained earnings
235,000
Total property, plant, and equipment
150,000
Bonds payable
E
Equipment, net
100,000
Short-term equity securities
30,000
Land
F
Required: Solve for the missing values and present Universal’s balance
sheet in good form.
93
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
81.
Difficult
LO4,5,6
Pages
143-153
Presented below are the comparative balance sheets for 2001 and 2002
for Birney, Inc.
Birney, Inc.
Comparative Balance Sheets
December 31, 2001 and 2002
Assets
2001
2002
Current Assets
Cash
$ 50,000 $ 85,000
Accounts Receivable
250,000
295,000
Inventory
300,000
265,000
Total Current Assets
$600,000 $ 645,000
Plant, Property and Equipment
Land
$ 50,000 $ 75,000
Building
100,000
100,000
Less: Accumulated Depreciation
(50,000)
(60,000)
Equipment
400,000
475,000
Less: Accumulated Depreciation
(200,000) (225,000)
Total Plant, Property and Equipment
$300,000 $ 365,000
Total Assets
$900,000 $1,010,000
Liabilities and Stockholders' Equity
Current Liabilities
Accounts Payable
Accrued Liabilities
Total Current Liabilities
Long-term Liabilities
Notes Payable
Stockholders' Equity
Common Stock ($1 Par Value)
Additional Paid-In Capital
Retained Earnings
Total Stockholders' Equity
Total Liabilities and Stockholders' Equity
$ 56,000
34,000
$ 90,000
$ 78,000
28,000
$ 106,000
$200,000 $ 150,000
$100,000 $ 150,000
25,000
75,000
485,000
529,000
$610,000 $ 754,000
$900,000 $1,010,000
Additional Information:
a.
Net income for the year was $75,000.
b.
Cash dividends of $31,000 were declared and paid.
c.
Equipment with a cost of $25,000 that was fully depreciated was
sold for $10,000.
d.
Land was purchased during the year.
e.
An additional 50,000 shares of stock were sold for cash.
Required: Prepare a statement of cash flows (indirect method) for
Birney, Inc. for 2002.
94
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
82.
Difficult
LO1,4,5
Pages
All
Below are the condensed balance sheet for the Marrone Corporation at
December 31, 2002 and the statement of cash flows for the year ended
December 31,2003.
Marrone Corporation
Balance Sheet (in $ Thousands)
December 31, 2002
Assets
Cash
Accounts Receivable (net)
Inventory
Land
Building
Accumulated Depreciation
Equipment
Accumulated Depreciation
$ 50
250
300
50
$100
(50)
$400
(200)
Total Assets
50
200
$900
Liabilities and Stockholders' Equity
Accounts Payable
Accrued Liabilities
Long-Term Notes Payable
Common Stock ($1 Par Value)
Additional Paid-in Capital
Retained Earnings
Total Liabilities and Stockholders' Equity
95
$ 56
34
200
100
25
485
$900
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
82. continued
Marrone Corporation
Statement of Cash Flows (in $ Thousands)
For the Year Ended December 31, 2003
Operating Cash Flows:
Net Income
Add: Depreciation ($10,000 for Building) $ 60
Decrease in Inventory
35
Increase in Accounts Payable
22
Less: Gain on sale of equipment
$ ( 10)
Increase in Accounts Receivable
( 45)
Decrease in Accrued Liabilities
( 6)
Cash Flow from Operations
Investing Cash Flows:
Purchase of equipment
$(100)
Purchase of land
(25)
Sale of equipment (Cost $25,000)
10
Cash Flow from Investing
Financing Cash Flows:
Payment of long-term debt
$( 50)
Sale of common stock (50,000 shares)
100
Payment of dividend
(31)
Cash Flow from Financing
Net Change in Cash
$ 75
117
(61)
$131
(115)
19
$ 35
Required: From the financial statements provided, prepare the balance
sheet for December 31, 2003.
96
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
Solutions to Problems
80.
Universal Corporation
Balance Sheet
December 31, 2003
Assets
Cash
$ 10,000
Short-term Equity Investments
30,000
Accounts Receivable (net)
50,000
Inventory
220,000
Total Current Assets
Land
$ 50,000
Equipment, net
100,000
Total property, plant, & equipment
Total Assets
Liabilities & Stockholders' Equity
Accounts Payable
$ 20,000
Accrued Liabilities
30,000
Total Current Liabilities
Bonds Payable
Common Stock
$100,000
Retained Earnings
235,000
Total Stockholders’ Equity
Total Liabilities & Stockholders' Equity
A.
B.
C.
Inventory:
Total current assets
Less: Cash
Short-term equity investments
A/R
Inventory
$310,000
150,000
$460,000
$ 50,000
75,000
335,000
$460,000
$280,000
$10,000
30,000
50,000
90,000
$220,000
Common Stock:
Total stockholders’ equity
Less: Retained earnings
Common stock
$335,000
235,000
$100,000
Accrued Liabilities:
Total current liabilities
Less: Accounts payable
Accrued liabilities
$ 50,000
20,000
$ 30,000
97
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
80. continued
D.
E.
F.
81.
Total Liabilities & Stockholders’ Equity:
Equals total assets
Bonds Payable:
Total Liabilities & Stockholders' Equity
Less: Current liabilities
$ 50,000
Total stockholders’ equity
335,000
Bonds payable
Land:
Total property, plant, & equipment
Less: Equipment, net
Land
Birney, Inc.
Statement of Cash Flows
For the Year Ended December 31, 2002
Operating Cash Flows:
Net income
Add: Depreciation (1)
$ 60,000
Decrease in Inventory
35,000
Increase in Accounts Payable
22,000
Less: Gain on sale of equipment
$ (10,000)
Increase in Accounts Receivable
(45,000)
Decrease in Accrued Liabilities
(6,000)
Cash Flow from Operations
Investing Cash Flows:
Purchase of equipment (2)
$(100,000)
Purchase of land
(25,000)
Sale of equipment
10,000
Cash Flow from Investing
Financing Cash Flows:
Payment of long-term debt
$ (50,000)
Sale of common stock (3)
100,000
Payment of dividend
(31,000)
Cash Flow from Financing
Net Change in Cash
$460,000
$460,000
385,000
$ 75,000
$150,000
100,000
$ 50,000
$ 75,000
117,000
(61,000)
$131,000
(115,000)
19,000
$ 35,000
Explanations:
(1)
Accumulated Depreciation—Equipment
ÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÂÄÄÄÄÄÄÄÄÄÄÄÄÄ
³ 200,000 Beg.
Depreciation Expense
Sold
25,000
| 50,000 Current = $50,000+ $10,000
ÄÄÄÄÄÄÄÄÄÄÄÄÄÄijÄÄÄÄÄÄÄÄÄÄÄÄÄ = $60,000
98
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
81. continued
³ 225,000 Ending
Accumulated Depreciation—Building
ÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÂÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄ
³
50,000 Beg.
³
10,000 Current
ÄÄÄÄÄÄÄÄÄÄÄÄÄÄijÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄ
³
60,000 Ending
(2)
Equipment
ÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÂÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄ
Beg.
400,000 ³
Purchase 100,000
25,000 Sale
ÄÄÄÄÄÄÄÄÄÄÄÄÄÄijÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄÄ
Ending
475,000 ³
(3)
Common Stock
Additional Paid-in Capital
ÄÄÄÄÄÄÄÄÄÂÄÄÄÄÄÄÄÄÄÄ
ÄÄÄÄÄÄÄÄÄÂÄÄÄÄÄÄÄÄÄ
³100,000 Beg.
³ 25,000 Beg.
| 50,000 Issued
| 50,000 Issued
| 150,000 Ending
| 75,000 Ending
Stock sale = Par value + Paid-in capital
$100,000 = $50,000 + $50,000
82.
Marrone Corporation
Balance Sheet (in $ Thousands)
December 31, 2003
Assets
Cash
Accounts Receivable (net)
Inventory
Land
Building
Allowance for Depreciation
Equipment
Allowance for Depreciation
Total Assets
Liabilities and Stockholders' Equity
Accounts Payable
Accrued Liabilities
99
$
$100
(60)
$475
(225)
85
295
265
75
40
250
$1,010
$
78
28
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
Long-Term Notes Payable
Common Stock ($1 Par Value)
Additional Paid-in Capital
Retained Earnings
Total Liabilities and Stockholders' Equity
150
150
75
529
$1,010
82. continued
Explanations:
Beginning
Balance
Cash
$ 50
Accounts Receivable
250
Inventory
300
Land
50
Building
100
Accum. Depr.
50
Equipment
400
Accum. Depr.
200
Accounts Payable
56
Accrued Liabilities
34
Long-term Notes
200
Common Stock
100
Paid-in Capital
25
Retained Earnings
485
Change
+ $ 35
+ 45
– 35
+ 25
+ 0
+ 10
+ 100 – 25
+ 50 – 25
+ 22
– 6
– 50
+ 50
+ 50
+ 75 – 31
Ending
Balance
$ 85
295
265
75
100
60
475
225
78
28
150
150
75
529
Discussion Questions
82.
Medium
LO1
Page 134
Discuss how debt and equity securities considered to be short-term
investments are measured.
83.
Medium
LO1
Pages
134-135
Explain how to report net trade accounts receivable on the balance sheet.
84.
Medium
LO2
Pages
138-140
Discuss how a common-size balance sheet helps a reader of financial
statements understand the nature of a firm’s business.
85.
Using the basic accounting equation explain why the change in a firm's
100
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
Difficult
LO4
Page 143
cash position between successive balance sheet dates will not equal the
reported earnings for the period.
101
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
86.
Easy
LO4 & LO5
Pages
143-144
Explain the transactions that could be included in the financing activities
section of the cash flow statement for the current year.
87.
Easy
LO4 & LO5
Pages
143-144
Explain the transactions that could be included in the investing activities
section of the cash flow statement..
88.
Difficult
LO5 & LO6
Pages
144-146
The cash flow statements for the past three years of a company have
shown that the majority of positive cash flow has been derived from
financing and investing activities. Also during these three years the cash
flow from operations has been negative. Comment on the company's
financial health.
89.
Easy
LO6 & LO7
Page150
Discuss the impact of changes in current assets, specifically accounts
receivable, on the determination of cash flow from operations.
90.
Easy
LO6 & LO7
Page 151
Discuss the impact of changes in current liabilities, specifically accounts
payable, on the determination of cash flow from operations.
Answers to Discussion Questions
82.
Debt and equity securities that are held for short-term investment
purposes are reported at market value on the date of the balance sheet.
The market value should be reported whether market is above or below
cost. The investments are recorded on the books at cost and a valuation
account is used to adjust the cost to market for the portfolio. Any
holding gains or losses resulting from the conversion to market value of
trading securities are reported as unrealized holding gains and losses in
the income statement for the period. When available-for-sale securities
are marked-to-market, the offsetting gain or loss goes directly to
stockholders’ equity rather than through the income statement.
102
Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
83.
Accounts Receivable should be reported on the balance sheet at net
realizable value. However, gross accounts receivable are recorded at their
historic cost or the transaction face value. The Allowance for Doubtful
Accounts reduces the gross accounts receivable to an amount that
represents the net realizable value. Management determines net realizable
value by computing its best estimate of the bad debt expense associated
with sales for the period. The bad debt expense is recognized under the
matching principle as a reduction of income for the period and the
allowance account is increased by the same amount. As individual
accounts are proven to be bad debts, the bad debt reduces both the
accounts receivable and allowance accounts.
84.
One tool for gaining insights into the nature of a company’s operations
and for analyzing its asset and financial structure is a common-size
balance sheet, where each balance sheet account is expressed as a
percentage of total assets or, equivalently, as a percentage of total
liabilities plus shareholders’ equity. Statement readers can extract useful
information from common-size balance sheets to learn about the
underlying economics of an industry and the nature of a firm’s
operations.
85.
The basic accounting equation Assets = Liabilities + Stockholders Equity
can be stated as
Cash + Non-Cash Assets = Liabilities + Stockholders Equity.
The statement of cash flows is based on the change in the cash account.
We can restate the equation again to state
Cash = Liabilities – Non-Cash Assets + Stockholders Equity.
The final statement of this equation can be restated to reflect the change
in each side of the equation as
ΔCash = ΔLiabilities – ΔNon-Cash Assets + ΔStockholders Equity.
As can be seen by the equation, the change in a firm's cash position is
determined by three different activities: the change in liabilities, the
change in non-cash assets and the change in stockholders' equity. Part of
the change in stockholders' equity is from income. The only way the
change in cash can possibly be the same as the income is if there is no
change in liabilities, non-cash assets, or stockholders' equity other than
income and if no dividends are paid. If
ΔStockholders Equity = ΔPaid-in Capital + Income – Dividends,
then
ΔCash = ΔLiabilities –ΔNon-Cash Assets + ΔPaid-in Cap. + Income –
Dividends and
ΔCash = Income
only when there is the change in liabilities, non-cash assets, paid-in
capital, and dividends are zero. This is virtually impossible in a dynamic
organization.
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Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
86.
The financing activities section of the cash flow statement generally
reflects changes in borrowed funds and shareholders' equity. Financing
cash inflows include cash received from new issues of common or
preferred stocks or bonds, sale of treasury stock, and borrowing cash
from lenders. Financing cash outflows include the payment of dividends,
repayment on debt, and the repurchase of the company's own stock
(treasury stock).
Most of the financing activities are found in the liabilities and
stockholders' equity sections of the balance sheet. By analyzing current
notes payable, and each of the accounts in long-term liabilities, and
stockholders' equity, the accountant will find the necessary information
to complete the financing section of the cash flow statement.
87.
The investing section of the cash flow statement generally reflects
changes in investments and property, plant, and equipment. Investing
cash inflows include collecting loans, selling debt or equity securities
held as investments, and selling property, plant, and equipment. Investing
cash outflows include purchasing debt or equity securities held for
investments, purchasing property, plant, and equipment used in the
production of goods and services, investing in long-term investments in
subsidiaries, and purchase of intangible assets.
Most of the investing activities of the firm are found in the non-current
asset section of the balance sheet plus the current investments and nontrade receivables. By analyzing each of the accounts in these sections, the
accountant will find the necessary information to complete the investing
section of the cash flow statement.
88.
It is important for any company to generate the majority of its cash flows
from operations so that it may preserve and improve its overall financial
health and maintain its desirability as a credit risk. Operating cash flows
normally provide the bulk of the cash to finance investment in assets,
repay debt, and pay dividends to stockholders. Cash flow from operations
is the only renewable source of cash inflow because the ability to borrow
money and sell assets is finite.
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Chapter 4—Structure of the Balance Sheet and Statement of Cash Flow
88. continued
In a healthy growing company, cash flows are usually positive for
operating activities, negative for investing activities, and either positive,
neutral, or negative for financing activities. A healthy company is
generating profitable sales and managing their working capital (current
assets and current liabilities) to maintain positive cash flow. If the
company is growing, management is expanding fixed assets to continue
to produce more sales and, therefore, using cash for investments.
Growing companies are able to sell stocks and bonds and borrow monies
to finance investment. Management will be careful to repay loans timely
and keep debt in check while returning dividends to stockholders. It is
difficult to determine if in any given year a company will have positive
or negative financing cash flows. There should be some years of each.
When a company is generating the majority of cash flows from financing
and investing activities it is either in financial jeopardy or growing at a
very rapid rate. In either case, the company is a high risk for lenders or
investors.
89.
Changes in the current asset accounts are crucial to the conversion of the
income statement from the accrual basis to the cash basis. An increase in
accounts receivable would indicate that more sales have been recorded
under the accrual method than we have actually collected in cash.
Therefore, the increase in accounts receivable must be subtracted from
net income to convert to a cash basis.
A decrease in accounts receivable would indicate that the firm has
collected more cash than it reported in sales and then the decrease in
accounts receivable would be added to net income in the determination of
cash flow from operations.
90.
Changes in the current liability accounts are crucial to the conversion of
the income statement from the accrual basis to the cash basis. An
increase in accounts payable (and other current liabilities) would indicate
that fewer purchases (or expenses) had been paid for than had been
recorded under the accrual method and, therefore, the increase in
accounts payable for the year should be added to the accrual basis income
to arrive at cash flow from operations.
A decrease in accounts payable (and other current liabilities) would
indicate that more cash was expended to pay for the payables than
purchases (or expenses) recorded for the year. Therefore, the decrease in
payables should be subtracted from accrual income to arrive at cash flow
from operations.
105