Answer of ch 2 Cash flow

E12-2 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Suppose your company sells services of $150 in exchange for $100 cash and $50 on account. Required: 1.Show the journal entry to record this transaction. 2. Identify the amount that should be reported as net cash flows from operating activities. Record The $100 increase in cash is reported as net cash flows from operating activities. 12-2

E12-2 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Required: 3. Identify the amount that would be included in net income. 4. Show how the indirect method would convert net income (requirement 3) to net cash flows from operating activities (requirement 2). 5. What general rule about converting net income to operating cash flows is revealed by your answer to requirement 4? $150 of service revenue would be included in net income. When Accounts Receivable increases, Sales Revenue is greater than cash received, so subtract the increase to convert Net Income to Cash Flow from Operating Activities. 12-3

E12-3 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Suppose your company sells services for $300 cash this month. Your company also pays $100 in wages, which includes $20 that was payable at the end of the previous month and $80 for wages of this month. Required: 1.Show the journal entries to record these transactions. Record 12-4

E12-3 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Required: 2. Identify the amount that should be reported as Net Cash Flows from Operating Activities. 3. Identify the amount that would be included in Net Income. 4. Show how the indirect method would convert Net Income (requirement 3) to Net Cash Flows from Operating Activities (requirement 2). The $200 increase in Cash ($300 – $100) should be reported as Net Cash Inflow from Operating Activities. $300 of Service Revenue would be included along with Wages Expense of $80, for a Net Income of $

E12-3 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Required: 5. What general rule about converting Net Income to operating cash flows is revealed by your answer to requirement 4? When Wages Payable decreases, subtract that decrease to convert Net Income to Cash Flow from Operating Activities. 12-6

E12-4 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Suppose your company sells services of $150 in exchange for $100 cash and $50 on account. Depreciation of $40 also is recorded. Required: 1.Show the journal entries to record these transactions. Record 12-7

E12-4 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Required: 2. Identify the amount that should be reported as Net Cash Flows from Operating Activities. 3. Identify the amount that would be included in Net Income. 4. Show how the indirect method would convert Net Income (requirement 3) to Net Cash Flows from Operating Activities (requirement 2). The $100 increase in cash should be reported as Net Cash Flows from Operating Activities. Net Income would include $150 of Service Revenue and $40 of Depreciation Expense, or $110 in total. 12-8

E12-4 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Required: 5. What general rules about converting Net Income to operating cash flows are revealed by your answer to requirement 4? Two general rules are revealed: 1.Always add back the amount of depreciation subtracted in the Income Statement to convert Net Income to Cash Flow from Operating Activities. 2.When Accounts Receivable increases, Sales Revenue is greater than cash received, so subtract the increase to convert Net Income to Cash Flow from Operating Activities. 12-9

E12-5 Understanding the Computation of Cash Flows from Operating Activities Indirect Method) Suppose your company sells goods for $300, of which $200 is received in cash and $100 is on account. The goods cost your company $125. Your company also recorded wages of $70, of which only $30 has been paid in cash. Required: 1. Show the journal entries to record these transactions Record 12-10

E12-5 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Required: 1. Show the journal entries to record these transactions 2. Identify the amount that should be reported as Net Cash Flows from Operating Activities. 3. Identify the amount that would be included in Net Income. Net Cash Flows from Operating Activities would be $170, which equals the $200 received from customers minus the $30 paid to employees. Net income would be $105, which equals $300 of Sales Revenue minus Cost of Goods Sold ($125) and Wages Expense ($70). Record 12-11

E12-5 Understanding the Computation of Cash Flows from Operating Activities (Indirect Method) Required: 4. Show how the indirect method would convert Net Income (requirement 3) to Net Cash Flows from Operating Activities (requirement 2). 5. What general rules about converting Net Income to operating cash flows are revealed by your answer to requirement 4? Three general rules are revealed: 1.Add back decreases in noncash Current Assets. 2.Add back increases in Current Liabilities 3.Deduct increases in noncash current Assets

E12-6 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Suppose your company’s Income Statement reports $105 of Net Income, and its comparative Balance Sheet indicates the following. Required: 1. Prepare the operating activities section of the Statement of Cash Flows, using the indirect method. 2. Identify the most important cause of the difference between the company’s Net Income and Net Cash Flows from Operating Activities

E12-6 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Required: 1. Prepare the operating activities section of the Statement of Cash Flows, using the indirect method. First, let’s determine the changes in Balance Sheet accounts

E12-6 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Required: 1. Prepare the operating activities section of the Statement of Cash Flows, using the indirect method

E12-6 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Required: 2. Identify the most important cause of the difference between the company’s Net Income and Net Cash Flows from Operating Activities. The Inventory decrease indicates that Cost of Goods Sold (deducted in the Income Statement) was $125 more than the cash paid to purchase Inventory. In other words, the company sold Inventory but did not replace it, creating a net cash inflow for the period. The most important cause of the difference is the $125 decrease in Inventory

E12-7 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Suppose the income statement for Goggle Company reports $70 of net income, after deducting depreciation of $35. The company bought equipment costing $60 and obtained a long-term bank loan for $60. The company’s comparative balance sheet, at December 31, indicates the following

E12-7 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Required: 1. Calculate the change in each balance sheet account, and indicate whether each account relates to operating, investing, and/or financing activities

E12-7 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Required: 2. Prepare a statement of cash flows using the indirect method

E12-7 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Required: 3. In one sentence, explain why an increase in Accounts Receivable is subtracted. 4. In one sentence, explain why a decrease in Inventory is added. The increase in Accounts Receivable indicates that sales on account were greater than cash collections. A decrease in Inventory indicates that Cost of Goods Sold (subtracted in the Income Statement) was greater than Inventory purchases

E12-7 Preparing and Evaluating a Simple Statement of Cash Flows (Indirect Method) Required: 5. In one sentence, explain why an increase in Wages Payable is added. 6. Are the cash flows typical of a start-up, healthy, or troubled company? Explain. The Wages Payable increase is added because more wages were subtracted when calculating net income than actually paid. A healthy company since operating cash flows are positive and financing inflows are sufficient to cover investing outflows