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1. (TCO F) What is the primary purpose of the statement of cash flows?

(Points : 5)
a) Show the companys ability to meet its obligations, pay dividends, and any
needs for financing.
b) Show the companys cash flow prospects.
c) Show the cash payments and cash receipts for the period.
d) Show the operating, financing, and investing activities for the period.

2. (TCO F) Which of the following is not true? (Points : 5)


a) Companies classify some cash transactions relating to investing or financing
activities as operating activities.
b) Net income is not usually the same as net cash flow from operating activities
under the accrual basis of accounting.
c) The FASB encourages the use of the indirect method over the direct method
for the statement of cash flows.
d) Companies report cash flows from purchases and sales of securities as
operating activities.
Reasoning: FASB encourages the direct method, but does not require it
necessarily to report it using the direct method.
Point 1:
Option c) is not true as FASB encourages the use of direct method. The proof for
the same is given in the following links:
http://www.inc.com/encyclopedia/cash-flow-statement.html (Under Methods of
preparing the cash flow statement)
http://www.nysscpa.org/cpajournal/2004/1004/essentials/p58.htm (1st para)
http://books.google.co.in/books?id=KzcGWju3OHgC&pg=PA33-IA30&lpg=PA33IA30&dq=fasb+encourages+direct+method&source=bl&ots=Xx7tFIZZCR&sig=h
8OUyx9f_hRHcxHu735JLiFdWLM&hl=en&sa=X&ei=fT8kUfn6LMWrrAeSvICIAg&ved
=0CEgQ6AEwBA#v=onepage&q=fasb%20encourages%20direct
%20method&f=false (3rd para)
As per the above links, FASB is encouraging direct method and hence I have
marked option c) as answer.

Point 2:
The cash flows from purchase or sale of securities need to be reported under
Investing activities and NOT operating activities. Only the gain or loss from
sale of securities will come under operating activities as adjustment to net
income. So, as per the wording given, option d) is also a not true statement and
can be marked as an answer. But, till now, if I mark 2 answers, students come to
me saying that only one answer should be marked. So, I guess there is a printing
error in the options. Please check for printing errors as your query of option d)
answer is also right. There can be printing errors because even in question 3, as I
have mentioned below, the answer is $276,500 but the option has only $276,000.
So, kindly check.

3. (TCO F) Glitter Girl, Inc. recognized net income of $205,000 including $60,000 in
depreciation expense.
Additional changes from the balance sheet are as follows.
Accounts Receivable

$2,000

decrease

Prepaid Expenses

$15,500

decrease

Inventory

$36,000

increase

Accrued Liabilities

$10,000

decrease

Accounts Payable

$40,000

increase

Compute the net cash from operating activities based on the above information.
(Points : 5)
a) $156,000
b) $117,000
c) $276,000 (Answer is actually $276,500 as shown below)
d) $281,000
Please note: As per the figures given, the answer is $276,500 as
shown below. Please check if there are any printing errors in the
question figures or in the answer options.

Workings:
Net income

$205,000

Add: Depreciation expense (non-cash item)


Add: Decrease in accounts receivable
Add: Decrease in Prepaid expenses
Add: Increase in Accounts payable

$60,000
$2,000
$15,500
$40,000

Less: Increase in Inventory

($36,000)

Less: Decrease in Accrued liabilities

($10,000)

Net cash flow from operating activities

$276,500

Note: We add any decrease in current assets as it indicates release of cash. We


deduct increase in current assets as it indicates blockage of cash. We deduct
decrease in current liabilities as it indicates payment of cash. We add increase in
current liabilities as it indicates postponement of payment and hence cash
availability for other purposes.

4. (TCO F) Pig Builder's, Inc. shows the following as of December 31, 2012.
- Acquired 50% of Wolf Corp's common stock for $160,000 cash, which was
borrowed from Granny's Bank.
- Issued 5,000 shares of its preferred stock for land having a fair value of
$320,000
- Issued 500 of its 11% debenture bonds, due 2017, for $392,000 cash
- Paid $120,000 toward bank loan.
- Purchased a patent for $220,000 cash
- Sold available for sales securities for $796,000
- Recognized $88,000 net increase in returnable long term customer deposits
Pig's net cash provided by investing activities for 2012 is (Points : 5)
a) $476,000.
b) $636,000.
c) $316,000.

d) $416,000.
Workings:
Purchase of 50% of Wolf Corps common stock

($160,000)

Purchase of Patent

($220,000)

Cash inflow from sale of available for sale securities


Net cash provided by investing activities

$796,000
$416,000

5. (TCO F) Dasher Builder's, Inc. shows the following as of December 31, 2012.
- Sold available for sales securities for $650,000
- Acquired 50% of Elven Corp's common stock for $310000 cash which was
borrowed from Peppermint's Bank.
- Issued 2,000 shares of its preferred stock for land having a fair value of $50,000
- Purchased a patent for $170,000 cash
- Issued 1,000 of its 12% debenture bonds, due 2017, for $225,000 cash
- Paid $130,000 toward bank loan.
- Recognized $79,000 net increase in returnable long term customer deposits
Dasher's net cash provided by financing activities for 2012 is (Points : 5)
a) $614,000.
b) $535,000.
c) $484,000.
d) $405,000.
Workings:
Finance from Peppermint bank

$310,000

Cash from issuance of debenture bonds

$225,000

Less: Payment of bank loan

($130,000)

Cash received from long term customer deposits


Net cash provided by financing activities

$79,000
$484,000

6. (TCO F)
Cash flows from operating activities (indirect and direct methods).
Presented below is the income statement of Smiling Tiger, Inc.
Sales

$250,000

Cost of goods sold

109,000

Gross profit

$141,000

Operating expenses

85,000

Income before income taxes

56,000

Income taxes

22,400

Net income

$33,600

In addition, the following information related to net changes in working capital is


presented.
Debit

Credit

Cash

$10,600

Accounts receivable
Inventories

2,400

$3,600

Salaries payable (operating expenses) 12,000


Accounts payable 15,000
Income taxes payable

1,400

Depreciation expense for the year was


Deferred tax liability account increased

$14,700
$1,800

Required:
Prepare a schedule computing the net cash flow from operating activities that would
be shown on a statement of cash flows:
(a)

using the indirect method

(b)

using the direct method. (Points : 15)

Solution:
(a) Indirect method
Net Income
Add: Depreciation expense
Add: Decrease in Accounts receivable
Add: Decrease in Inventories
Less: Decrease in Salaries payable
Add: Increase in accounts payable
Less: Decrease in Tax payable
Add: Increase in deferred tax liability

$33,600
$14,700
$48,300
$2,400
$3,600
($12,000)
$15,000
($1,400)
$1,800

Net cash flows from operating activities

$57,700

(b) Direct method


Calculations required to proceed with direct method
Collection from customers = Sales+ Decrease in Accounts receivable
=250,000 + 2400
252,400
Purchases = Cost of goods sold - Decrease in Inventories
=109,000 - 3,600
=105,400
Payments to suppliers = Purchases - Increase in Accounts payable
=105,400 - 15,000
=90,400
Payments towards operating expenses =
Operating expenses + Decrease in Salaries payable
-Depreciation expense
=85,000 + 12,000 - 14,700
=82,300
Payment towards income tax =
Income tax expense - Increase in deferred tax liability
+ Income tax payable
=22,400 - 1,800 + 1,400
=22,000

Direct method:
Cash receipts:

Collection from customers


Less: Cash payments:
Payment to suppliers
Payment towards operating expenses
Payment for income tax
Net cash flows from operating activities

$252,400
($90,400)
($82,300)
($22,000)
$57,700