Critical Thinking Question

Critical Thinking Question

ACC 206 Week Assignment




Critical Thinking Question:Why are noncash transactions, such as the exchange of common stock for a building for example, included on a statement of cash flows? How are these noncash transactions disclosed?

Cash Flow statement represents the comprehensive statement that outlines the sources of cash funds and their application for an entity over a given accounting period. It is therefore an analytical tool that determines the liquidity position of a firm/entity. Its preparation is founded on the international accounting standards (IAS) 7. Cash flow statements provide a detailed analysis of the financial and non-financial transactions reported in the operations of an entity over a specified period of time. Both cash and non-cash transactions are included in the cash flow statements. The inclusion of the non-cash transactions is founded on the “cash and cash equivalents” principle of the cash flow statement. According to this principle, non-cash transactions that are highly liquid and convertible to known monetary amounts of cash are accorded the same accounting treatment as other cash transactions, hence their inclusion in the cash flow statements. Some non-cash transactions are included in the cash flow statement in the account that they constitute investing or financing activities that are not directly related to the firm’s operating activities. Non-cash transactions mainly fall under this category of financing or investing activities that have no effect on the firm’s cash outlay or inflows. However, these transactions involves long-term resources and owner’s equity, hence the justification for their inclusion in the cash flow statements. IAS (7) and the General Accepted Accounting Principles (GAAP) outlines the disclosure principle for these non-cash financing and investing activities. The two principles state that non-cash transactions should be disclosed in footnotes of the financial statements for the same accounting period. In most occasions, these financing and investing activities are disclosed in a separate schedule to enhance accountability during the preparation of financial statements.

Classification of activitiesClassify each of the following transactions as arising from an operating (O), investing (I), financing (F), or noncash investing/financing (N) activity.

________ Received $80,000 from the sale of land – Investing Activity

________ Received $3,200 from cash sales – Operating Activity

________ Paid a $5,000 dividend – Financing Activity

________ Purchased $8,800 of merchandise for cash – Investing Activity

________ Received $100,000 from the issuance of common stock – Financing Activity

________ Paid $1,200 of interest on a note payable – Financing Activity

________ Acquired a new laser printer by paying $650 – Investing Activity

________ Acquired a $400,000 building by signing a $400,000 mortgage note Non-cash Investing Activity

Overview of direct and indirect methods

Evaluate the comments that follow as being True or False. If the comment is false, briefly explain why.

Both the direct and indirect methods will produce the same cash flow from operating activities – False. This because direct method is not adjusted for other cash flow items including depreciation and exchange loss.

Depreciation expense is added back to net income when the indirect method is used – True.

One of the advantages of using the direct method rather than the indirect method is that larger cash flows from financing activities will be reported – True.

The cash paid to suppliers is normally disclosed on the statement of cash flows when the indirect method of statement preparation is employed – True.

The dollar change in the Merchandise Inventory account appears on the statement of cash flows only when the direct method of statement preparation is used – False; exchange losses adjustment are common with indirect method rather direct method.

Equipment transaction and cash flow reporting

Dec. 31, 20X4 Dec. 31, 20X3

Property, Plant & Equipment:

Land $94,000 $94,000

Equipment 652,000 527,000

Less: Accumulated depreciation -316,000 -341,000

New equipment purchased during 20×4 totaled $280,000. The 20×4 income statement disclosed equipment depreciation expense of $41,000 and a $9,000 loss on the sale of equipment.

Determine the cost and accumulated depreciation of the equipment sold during 20X4.

Determine the selling price of the equipment sold.

Show how the sale of equipment would appear on a statement of cash flows prepared by using the indirect method.


DR. Equipment Account As at 31st Dec. 2004 CR.

Bal. b/d 527,000

Purchases/Cash 280,000

Acc. Depreciation (2003) 341,000 Provision for Dep. (2004) 316,000

Sales/Cash 180,000

Bal. c/d 652,000

$1,148,000 $1,148,000

Disposal A/C

DR. As at 31st Dec. 2004 CR.

Equipment 180,000

Acc. Depreciation 41,000

Proceed from Sales 130,000

Loss on Disposal 9,000

$180,000 $180,000

Cost of the Equipment = $180,000

Accumulated Depreciation = $41,000

Selling Price = $130,000

Sample Cash Flow Statement

Cash Flow from Operating Activities

Net Profit before Tax xxxx

Adjusted for:

Depreciation $41,000

Loss on disposal of Equipment $9,000$50,000

Cash Flow from Investing Activities

Purchase of Equipment (280,000)

Proceeds from Disposal of Equipment 130,000

Cash flow information: Direct and indirect methods The comparative year-end balance sheets of Sign Graphics, Inc., revealed the following activity in the company’s current accounts:

20X5 20X4 Increase / Decrease)

Current assets Cash $55,400 $35,200 $20,200

Accounts receivable (net) 83,800 88,000 -4,200

Inventory 243,400 233,800 9,600

Prepaid expenses 25,400 24,200 1,200

Current liabilities Accounts payable $123,600 $140,600 ($17,000)

Taxes payable 43,600 49,200 -5,600

Interest payable 9,000 6,400 2,600

Accrued liabilities 38,800 60,400 -21,600

Note payable 44,000 — 44,000

The accounts payable were for the purchase of merchandise. Prepaid expenses and accrued liabilities relate to the firm’s selling and administrative expenses. The company’s condensed income statement follows.


Income Statement

for the Year Ended December 31, 20×5


Sales $713,800  

Less: Cost of goods sold 323,000  

Gross profit $390,800  


Less: Selling & administrative expenses $186,000  

Depreciation expense 17,000  

Interest expense 27,000 230,000  


Add: gain on sale of land $160,800  


Income before taxes $182,600  

Income taxes 36,800  

Net income $145,800  


Other data:

Long-term investments were purchased for cash at a cost of $74,600.

Cash proceeds from the sale of land totaled $76,200.

Store equipment of $44,000 was purchased by signing a short-term note payable. Also, a $150,000 telecommunications system was acquired by issuing 3,000 shares of preferred stock.

A long-term note of $49,400 was repaid.

Twenty thousand shares of common stock were issued at $5.19 per share.

The company paid cash dividends amounting to $128,600.


Prepare the operating activities section of the company’s statement of cash flows, assuming use of:

The direct method.

The indirect method.

Prepare the investing and financing activities sections of the statement of cash flows.

Sign Graphics, Inc.

Cash Flow Statement

As at 31st Dec., 2005

Cash Flow from Operating Activities

Cash Receipts from customers $713,800

Cash paid to suppliers ($323,000)

Cash Generated from Operations $390,800

Interest Paid (27,000)

Income Tax Paid (36,800)

Depreciation Expense (17,000)

Net Cash Flow from Operating Activities $310,000

Indirect Method

Sign Graphics, Inc.

Cash Flow Statement

As at 31st Dec., 2005

Cash Flow from Operating Activities

Net Profit before Tax $182,600

Adjusted for:

Depreciation expense 17,000

Gain on Sale of Land (21,800)

Interest Expense 27,00022,200

Operating Profit before changes in Working Capital 204,800

Increase in Cash (20,000)

Increase in Account Receivable (4,200)

Increase in Inventory (9,600)

Increase in Prepaid Exp (1,200)

Decrease in A/c Payables (17,000)

Tax Payable decrease (5,600)

Increase in Interest Payable 2,600

Accrued liability (21,600)

Increase in Notes Payable 44,000(32,000)

Cash Generated from Operating Activities 172,200