Cash Flow Statement

Hard Test

Hard 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.  

  1. the change in accumulated depreciation totaled $14,000 for the year
  2. 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

Purchase of equipment                  (22,000)
Proceeds from sale of equip.           12,000
Cash from investing activities        (10,000)

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


7.  A company had the following information available:

   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

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 represents cash collected
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
Purchase of plant assets (349)
Proceeds from sale of equip.   200
Cash from investing activities (149)
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
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)
= 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
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
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