Cash Flow Statement
Hard Practice Test
Intermediate Accounting 2
Hard Practice Test
Click the “Check Your Answer” box below each problem to reveal the correct answer and explanation.
1. In order for a company to stay in business long term, cash must be generated from
a. operating activities
b. investing activities
c. financing activities
d. any of the above, it doesn’t matter long term
Check Your Answer
A. Cash from operations is used to pay for ongoing expenses of the company. If the company does not generate enough cash to pay day to day expenses it will only be able to stay in business by borrowing. Borrowing money (financing activities) can not continue indefinitely when the company does not have the ability to repay. Investing activities typically consume cash and do not consume cash flow.
2. Which of the following is done to convert sales to cash received from customers?
a. add the decrease in accounts payable
b. add the increase in accounts receivable
c. subtract the increase in accounts receivable
d. none of the above
Check Your Answer
C. An increase in accounts receivable indicates that less cash was received than sales. Sales less the increase gives less cash collected than sales. The amount not yet collected was added to accounts receivable.
3. Which of the following would be done to convert income statement items to cash
paid or received?
a. add increases in prepaid expenses to operating expenses
b. add increases in accrued liabilities to operating expenses
c. add increases in tax payable to tax expense
d. none of the above
Check Your Answer
A. Increases to prepaid expenses require that more cash was paid than was expensed. This would be added to the operating expense to get to cash paid for operating activities. An increase to a payable indicates that less cash was paid than the expense this period. If less cash was paid than expensed it would be subtracted from the expense to get to cash.
4. How does the direct method differ from the indirect method?
a. interest expense is reported in different sections
b. depreciation is reported as an investing activity for the direct method
c. gains and losses are reported separately for the indirect method and not reported on the direct method
d. the direct method does not consider all changes in current assets and current liabilities.
Check Your Answer
C. Gains and losses are subtracted/added to net income to get to cash on the indirect method statement. Gains and losses are ignored on the direct method statement because they do not impact cash and only items that directly impact cash are reported on the direct statement. Depreciation is a non cash item reported in the operating section of the indirect cash flow statement. Both statements consider all changes in all assets and liabilities; the direct method matches them to a revenue or expense and the indirect method includes them in the reconciliation to net income.
5. Declaring a cash dividend
a. increases retained earnings
b. does not create a liability for the company
c. does not get recorded on the cash flow statement until cash is paid
d. is reported in the investing section of the cash flow statement
Check Your Answer
C. Cash dividends are not reported on the cash flow statement until they are paid and impact cash. When cash is paid it is reported in the financing section of the cash flow statement (d.) Declaring a dividend decreases retained earnings (a.) and increases dividends payable (b.)
6. The company had the following information available:
| Current Year | Prior Year | |
| Accounts Receivable | 29,000 | 32,000 |
| Inventory | 63,000 | 49,000 |
| Prepaid Insurance | 1,000 | 1,500 |
| Accounts Payable | 36,000 | 39,000 |
| Interest Payable | 400 | 600 |
| Salaries Payable | 2,200 | 3,300 |
| Income Tax Payable | 14,100 | 15,800 |
The direct cash flow statement reported the following:
| Cash collected from customers | 226,000 |
| Cash paid to suppliers | 89,000 |
| Cash paid for salaries | 19,000 |
| Cash paid for insurance | 3,600 |
| Cash paid for interest | 6,200 |
| Cash paid for taxes | 16,200 |
| Cash paid for equipment | 22,000 |
| Cash paid for dividends | 10,000 |
| Cash received from bank | 50,000 |
Prepare the cash flow statement using the indirect method and the following.
- the change in accumulated depreciation totaled $14,000 for the year
- the company sold equipment for $12,000 that had a cost of $20,000 and accumulated depreciation of $13,600
Check Your Answer
First, you must use the formulas that determine cash and work backwards to get revenues and expenses so that you can determine net income:
| Sales | 223,000 | Cost of Goods Sold | 72,000 | |
| + Beg A/R | 32,000 | – Beg Inventory | 63,000 | |
| – End A/R | 29,500 | + End Inventory | 49,000 | |
| Cash from customers | 226,000 | + Beg A/P | 39,000 | |
| – End A/P | 36,000 | |||
| Cash paid to suppliers | 89,000 | |||
| Salary Expense | 17,900 | Insurance Expense | 4,100 | |
| + Beg salary payable | 3,300 | – Beg P/P expense | 1,500 | |
| – End salary payable | 2,200 | + End P/P expense | 1,000 | |
| Cash paid | 19,000 | Cash paid | 3,600 | |
| Interest Expense | 6,000 | Tax Expense | 14,500 | |
| + Beg interest payable | 600 | + Beg tax payable | 15,800 | |
| – End interest payable | 400 | – End tax payable | 14,100 | |
| Cash paid | 6,200 | Cash paid | 16,200 |
The sale of equipment is recorded:
| Cash | 12,000 |
| Accumulated Depreciation | 13,600 |
| Equipment | 20,000 |
| Gain on Sales | 5,600 |
| Increase in Accumulated Depreciation | 14,000 |
| + Sold accumulated depreciation | 13,600 |
| = Depreciation expense | 27,600 |
Net Income (see below) 86,500
+Depreciation expense 27,600
– Gain on sale of equipment ( 5,600)
Change in current assets and current liabilities:
Accounts receivable 3,000
Inventory (14,000)
Prepaid insurance 500
Accounts payable (3,000)
Interest payable (200)
Salaries payable (1,100)
Taxes payable (1,700)
Cash from operating activities: 92,000
Investing:
Purchase of equipment (22,000)
Proceeds from sale of equip. 12,000
Cash from investing activities (10,000)
Financing:
Paid dividends (10,000)
Borrowed on notes payable 50,000
Cash from financing activities 40,000
Total change in cash 122,000
Net Income = 223K – 72K -17.9K – 4.1K – 6K – 14.5K -27.6K + 5.6K = 86,500
| Current Year | Prior Year | |
| Cash | 22 | 16 |
| Accounts Receivable, net | 200 | 250 |
| Inventory | 125 | 95 |
| Prepaid Expenses | 18 | 10 |
| Plant Assets | 1,019 | 1,000 |
| Accumulated Deprec | 527 | 587 |
| Accounts Payable | 75 | 50 |
| Interest Payable | 10 | 8 |
| Income Tax Payable | 90 | 107 |
| Bonds Payable, net | 117 | 77 |
| Common Stock | 338 | 300 |
| Retained Earnings | 227 | 242 |
| Sales | 1,300 | |
| CGS | 880 | |
| Depreciation Exp | 70 | |
| General Exp | 240 | |
| Interest Exp | 15 | |
| Income Tax Exp | 35 |
a. Plant assets were sold for their book value of $200 during the year. The assets had an original cost of $330.
b. Bond discount was amortized for $1.5 in the current year.
c. Bad debt expense (included in general expense) was $8 and $4 was written off.
Prepare a statement of cash flows using the indirect method:
Check Your Answer
Record the sale of plant assets as follows:
Cash 200
Accumulated Depreciation 130
Plant Assets 330
(Assets – A/D = book value of 200)
Discount amortization occurs when a cash payment for interest does not equal interest expense:
Interest Expense
Discount
Cash
Add a discount of 1.5 because the cash paid was less than the expense
Bad debt expense is a non cash expense
| Change in accounts receivable | 50 |
| Change not impacting cash | (8) increase in allowance |
| Change in A/R impacting cash | 42 collected |
The write off of $4 does not change net accounts receivable, it is an decrease to the allowance and a decrease to accounts receivable resulting in 0 change to net
| Change in plant assets | 19 |
| + amount sold | 330 |
| Total purchases of equipment | 349 |
| + depreciation expense | 70 |
| + accumulated depreciation sold | (130) |
| Change in Accumulated depreciation | (60) |
| Change in bonds payable, net | 40 |
| less discount amortized | (1.5) |
| Borrowed on Bonds | 38.5 |
| Decrease in retained earnings | 15 |
| plus income | 60 |
| Dividends paid | 75 |
| Cash Flow Statement: | |
| Net Income | 60 |
| + Depreciation expense | 70 |
| + Bad debt expense | 8 |
| + Bond discount amortization | 1.5 |
| Change in current assets and current liabilities: | |
| Accounts receivable, net | 42 |
| Inventory | (30) |
| Prepaid Insurance | (8) |
| Accounts Payable | 25 |
| Interest payable | 2 |
| Taxes payable | (17) |
| Cash from operating activities: | 153.5 |
| Investing: | |
| Purchase of plant assets | (349) |
| Proceeds from sale of equip. | 200 |
| Cash from investing activities | (149) |
| Financing: | |
| Paid dividends | (75) |
| Borrowed on bonds payable | 38.5 |
| Issued common stock | 38 |
| Cash from financing activities | 1.5 |
| Total change in cash | 6 |
| Debits | Current Year | Prior Year |
| Cash | 166,400 | 48,000 |
| Accounts Receivable | 32,000 | 36,600 |
| Inventory | 21,000 | 25,400 |
| Prepaid Insurance | 5,600 | 4,800 |
| Long-term Investments (cost) | 6,000 | 16,000 |
| Equipment | 90,000 | 66,000 |
| Treasury stock (cost) | 10,000 | 20,000 |
| Cost of Goods Sold | 368,000 | |
| Operating Expenses | 185,000 | |
| Income Tax Expense | 37,600 | |
| Loss on sale of Equipment | 1,000 | |
| Credits: | ||
| Accumulated depreciation | 19,000 | 18,000 |
| Accounts Payable | 7,000 | 11,200 |
| Interest Payable | 1,000 | 2,000 |
| Income Tax Payable | 12,000 | 8,000 |
| Notes Payable – Long Term | 16,000 | 24,000 |
| Common Stock | 110,000 | 100,000 |
| Paid in Capital | 32,000 | 30,000 |
| Retained Earnings | 19,600 | 23,600 |
| Sales | 704,000 | |
| Gain on sale of long term investment | 2,000 |
Additional information:
a) long term investments costing $10,000 was sold for $12,000
b) operating expenses, among other things, included $2,800 of interest expense and $2,400 insurance expense
c) equipment was purchased during the year by issuing common stock and paying the balance in cash.
d) treasury stock was sold for $4,000 less than its cost and retained earnings was decreased.
e) equipment that cost $10,000 was sold for $3,000
f) no dividends were paid
Prepare a statement of cash flows using the indirect method
Check Your Answer
First: Make the entries for the additional information so that you can determine the cash related to the transactions. Only the cash amount is reported in the investing and financing sections.
Sales of L/T investments would be recorded as follows:
Cash 12,000
L/T Investments 10,000
Gain on Sale of Investment 2,000
b) This information would only be used when preparing a direct statement to match the current assets and current liabilities with the different expenses.
Equipment Purchases:
Equipment 12,000
Common Stock 10,000
Paid in Capital – C.S. 2,000
Sale of Treasury Stock:
Cash 6,000
Retained Earnings 4,000
Treasury Stock 10,000
Second: Post the entries in the accounts to make sure that you have identified all of the transactions that change each long-term account. You may want to do this in a T account.
Assume a change is a cash change ONLY if you have no other information.
| Sale of Equipment: | |
| Cash | 3,000 |
| Loss | 1,000 |
| Accumulated Depreciation | 6,000 plug |
| Equipment | 10,000 |
|
Depreciation Expense: |
|
| Difference in accumulated depreciation: | 1,000 |
| + accumulated depreciation sold | 6,000 |
| = Depreciation expense | 7,000 |
|
Purchase of Equipment: |
|
| Change in equipment | 24,000 |
| + cost of equipment sold | 10,000 |
| Purchases | 34,000 |
| – paid for with common stock (diff in CS and PIC) |
(12,000) |
| = Paid for with cash | 22,000 |
|
Computation of Dividends Paid: |
|
| Change in retained earnings | 110,400 |
| + Loss on sale of treasury stock | 4,000 |
| – Net Income | (114,400) |
| Dividends Paid | 0 |
| Cash Flow Statement: | |
| Net Income | 114,400 |
| Depreciation expense | 7,000 |
| Loss on sale | 1,000 |
| Gain on sale | (2,000) |
| Change in current assets and current liabilities: | |
| Accounts receivable | 4,600 |
| Inventory | 4,400 |
| Prepaid Insurance | (800) |
| Accounts payable | (4,200) |
| Interest payable | (1,000) |
| Taxes payable | 4,000 |
| Cash from operating activities | 127,400 |
| Investing: | |
| Proceeds from sale of L/T Invest | 12,000 |
| Purchase of equipment | (22,000) |
| Proceeds from sale of equip. | 3,000 |
| Cash from investing activities | 7,000 |
| Financing: | |
| Proceeds from sale of treasury stock | 6,000 |
| Repayment on notes payable | (8,000) |
| Cash from financing activities | (2,000) |
| Total change in cash | 118,400 |