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STATEMENT OF CASH FLOWS

TRUE-FALSE STATEMENTS

1. The statement of cash flows is a required statement that must be prepared along with an income statement, balance sheet, and retained earnings statement.

2. For external reporting, a company must prepare either an income statement or a statement of cash flows, but not both.

3. A primary objective of the statement of cash flows is to show the income or loss on investing and financing transactions.

4. A statement of cash flows indicates the sources and uses of cash during a period.

5. Operating activities include the cash effects of transactions that create revenues and expenses.

6. In preparing a statement of cash flows, the issuance of debt should be reported separately from the retirement of debt.

7. Noncash investing and financing activities must be reported in the body of a statement of cash flows.

8. The statement of cash flows classifies cash receipts and payments as operating, nonoperating, financial, and extraordinary activities.

9. The sale of land for cash would be classified as a cash inflow from an investing activity.

10. Cash flow from investing activities is considered the most important category on the statement of cash flows because it is considered the best measure of expected income.

11. The receipt of dividends from long-term investments in stock is classified as a cash inflow from investing activities.

12. The payment of interest on bonds payable is classified as a cash outflow from operating activities.

13. Any item that appears on the income statement would be considered as either a cash inflow or a cash outflow from operating activities.

14. The acquisition of a building by issuing bonds would be considered an investing and financing activity that did not affect cash.

15. The growth phase of the product life cycle occurs when the company is purchasing

fixed assets and beginning to produce and sell.

16. During the maturity phase, cash provided by operating activities and net income are approximately the same.

17. A loss on sale of equipment is added to net income in determining cash provided by operations under the indirect method.

18. Cash provided by operating activities is generally equal to operating income.

19. Using the indirect method, an increase in accounts receivable during a period is deducted from net income in calculating cash provided by operations.

20. Using the indirect method, an increase in accounts payable during a period is deducted from net income in calculating cash provided by operations.

21. In preparing a statement of cash flows, an increase in the Common Stock and Treasury Stock accounts during a period would be an investing activity.

22. During a period, cost of goods sold + an increase in inventory + an increase in accounts payable = cash paid to suppliers.

23. During the year, Income Tax Expense amounted to $30,000 and Income Taxes Payable increased by $3,000; therefore, the cash paid for income taxes was $27,000.

24. In computing net cash flow from operating activities using the direct method, each item in the income statement is adjusted from the accrual basis to the cash basis.

25. Using the direct method, major classes of investing and financing activities are listed in the operating activities section.

26. Free cash flow is cash from operations less dividends.

27. The current cash debt coverage ratio is computed by dividing net cash provided by operations by average total liabilities.

28. The cash return on sales ratio is used to evaluate a company’s profitability.

29. The cash basis measure of liquidity is the cash debt coverage ratio.

30. The capital expenditure ratio is calculated as cash from operations divided by capital expenditures.

Answers to True-False Statements

Item Ans. Item Ans. Item Ans. Item Ans. Item

Test Bank for Managerial Accounting, Second Edition

1. T 6. T 11. F 16.2. F 7. F 12. T 17.3. F 8. F 13. F 18.4. T 9. T 14. T 19.5. T 10. F 15. F 20.

MULTIPLE CHOICE QUESTIONS

31. The statement of cash flowsa. must be prepared on a daily basis.b. summarizes the operating, financing, and investing activities of an entity.c. is another name for the income statement.d. is a special section of the income statement.

32. Which one of the following items is not generally used in preparing a statement of cash flows?a. Adjusted trial balanceb. Comparative balance sheetsc. Current income statementd. Additional information

33. The primary purpose of the statement of cash flows is toa. provide information about the investing and financing activities during a period.b. prove that revenues exceed expenses if there is a net income.c. provide information about the cash receipts and cash payments during a period.d. facilitate banking relationships.

34. If a company reports a net loss, ita. may still have a net increase in cash.b. will not be able to pay cash dividends.c. will not be able to get a loan.d. will not be able to make capital expenditures.

35. In addition to the three basic financial statements, which of the following is also a required financial statement?a. the "Cash Budget"b. Statement of Cash Flowsc. Statement of Cash Inflows and Outflowsd. the "Cash Reconciliation"

36. The statement of cash flows will not report thea. amount of checks outstanding at the end of the period.b. sources of cash in the current period.c. uses of cash in the current period.d. change in the cash balance for the current period.

37. The acquisition of land by issuing common stock isa. a noncash transaction that is not reported in the body of a statement of cash flows.

b. a cash transaction and would be reported in the body of a statement of cash flows.c. a noncash transaction and would be

reported in the body of a statement of cash flows.

d. only reported if the statement of cash flows is prepared using the direct method.

38. The order of presentation of activities on the statement of cash flows isa. operating, investing, and financing.b. operating, financing, and investing.c. financing, operating, and investing.d. financing, investing, and operating.

39. Financing activities involvea. lending money.b. acquiring investments.c. issuing debt.d. acquiring long-lived assets.

40. Investing activities includea. collecting cash on loans made.b. obtaining cash from creditors.c. obtaining capital from owners.d. repaying money previously borrowed.

41. Generally, the most important category on the statement of cash flows is cash flows froma. operating activities.b. investing activities.c. financing activities.d. significant noncash activities.

42. The category that is generally considered to be the best measure of a company's ability to continue as a going concern isa. cash flows from operating activities.b. cash flows from investing activities.c. cash flows from financing activities.d. usually different from year to year.

43. Cash receipts from interest and dividends are classified asa. financing activities.b. investing activities.c. operating activities.d. either financing or investing activities.

44. If a company has both an inflow and outflow of cash related to property, plant, and equipment, thea. two cash effects can be netted and

presented as one item in the investing activities section.

b. cash inflow and cash outflow should be reported separately in the investing activities section.

c. two cash effects can be netted and presented as one item in the financing activities section.

d. cash inflow and cash outflow should be reported separately in the financing activities section.

45. Of the items below, the one that appears

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Statement of Cash Flows 12-3

first on the statement of cash flows isa. noncash investing and financing activities.b. net increase (decrease) in cash.c. cash at the end of the period.d. cash at the beginning of the period.

46. Which of the following transactions does not affect cash during a period?a. Write-off of an uncollectible accountb. Collection of an accounts receivablec. Sale of treasury stockd. Exercise of the call option on bonds payable

47. Significant noncash transactions would not includea. conversion of bonds into common stock.b. asset acquisition through bond issuance.c. treasury stock acquisition.d. exchange of plant assets.

48. In preparing a statement of cash flows, a conversion of bonds into common stock will be reported ina. the financing section.b. the "extraordinary" section.c. a separate schedule or note to the financial statements.d. the stockholders' equity section.

49. A company would be expected to generate small amounts of cash provided by operating activities during thea. introductory phase.b. growth phase.c. maturity phase.d. decline phase.

50. The phase in the product life cycle when a company is purchasing fixed assets and beginning to produce and sell is thea. introductory phase.b. growth phase.c. maturity phase.d. decline phase.

51. Cash provided by operating activities and net income are approximately the same during thea. introductory phase.b. growth phase.c. maturity phase.d. decline phase.

52. Which one of the following items is not necessary in preparing a statement of cash flows?a. Determine the change in cashb. Determine the cash provided by operationsc. Determine cash from financing and investing activitiesd. Determine the cash in all bank accounts

53. If accounts receivable have increased during the period,a. revenues on an accrual basis are less than revenues on a cash basis.b. revenues on an accrual basis are greater than revenues on a cash basis.c. revenues on an accrual basis are the same as revenues on a cash basis.d. expenses on an accrual basis are greater than expenses on a cash basis.

54. If accounts payable have increased during a period,a. revenues on an accrual basis are less than revenues on a cash basis.b. expenses on an accrual basis are less than expenses on a cash basis.c. expenses on an accrual basis are greater than expenses on a cash basis.d. expenses on an accrual basis are the same as expenses on a cash basis.

55. Which one of the following affects cash during a period?a. Recording depreciation expenseb. Declaration of a cash dividendc. Write-off of an uncollectible account receivabled. Payment of an accounts payable

56. In calculating cash flows from operating activities using the indirect method, a gain on the sale of equipment isa. added to net income.b. deducted from net income.c. ignored because it does not affect cash.d. not reported on a statement of cash flows.

57. Meyer Company reported net income of $40,000 for the year. During the year, accounts receivable increased by $14,000, accounts payable decreased by $6,000 and depreciation expense of $10,000 was recorded. Net cash provided by operating activities for the year isa. $30,000.b. $70,000.c. $38,000.d. $40,000.

58. Flynn Company reported a net loss of $10,000 for the year ended December 31, 2002. During the year, accounts receivable decreased $10,000, merchandise inventory increased $16,000, accounts payable increased by $20,000, and depreciation expense of $10,000 was recorded. During 2002, operating activitiesa. used net cash of $14,000.b. used net cash of $24,000.c. provided net cash of $14,000.d. provided net cash of $24,000.

59. Starting with net income and adjusting it


for items that affected reported net income but which did not affect cash is called thea. direct method.b. indirect method.c. working capital method.d. cost-benefit method.

60. In calculating net cash provided by operating activities using the indirect method, an increase in prepaid expenses during a period isa. deducted from net income.b. added to net income.c. ignored because it does not affect income.d. ignored because it does not affect expenses.

61. Using the indirect method, patent amortization expense for the perioda. is deducted from net income.b. causes cash to increase.c. causes cash to decrease.d. is added to net income.

62. In developing the cash flows from operating activities, most companies in the U. S.a. use the direct method.b. use the indirect method.c. present both the indirect and direct methods in their financial reports.d. prepare the operating activities section on the accrual basis.

63. Which of the following would be subtracted from net income using the indirect method?a. Depreciation expenseb. An increase in accounts receivablec. An increase in accounts payabled. A decrease in prepaid expenses

64. Which of the following would be added to net income using the indirect method?a. An increase in accounts receivableb. An increase in prepaid expensesc. Depreciation expensed. A decrease in accounts payable

65. Which of the following would not be an adjustment to net income using the indirect method?a. Depreciation Expenseb. An increase in Prepaid Insurancec. Amortization Expensed. An increase in Land

66. In calculating cash flows from operating activities using the indirect method, a loss on the sale of equipment will appear asa. a subtraction from net income.b. an addition to net income.c. an addition to cash flow from investing activities.d. a subtraction from cash flow from

investing activities.

67. Which of the following adjustments to convert net income to net cash provided by operating activities is correct?

Add to NI Deduct from NIa. AR Increase decreaseb. PE increase decreasec. Inv decrease increased. Taxes Pay decrease increase

68. Which of the following adjustments to convert net income to net cash provided by operating activities is incorrect?

Add to NI Deduct from NIa. AR decrease increaseb. PE increase decreasec. Inv decrease increased. AP increase decrease

69. Which of the following adjustments to convert net income to net cash provided by operating activities is not added to net income?

a. Gain on Sale of Equipmentb. Depreciation Expensec. Patent Amortization Expensed. Depletion Expense

70. Using the indirect method, if equipment is sold at a gain, thea. sale proceeds received are deducted in the operating activities section.b. sale proceeds received are added in the operating activities section.c. amount of the gain is added in the operating activities section.d. amount of the gain is deducted in the operating activities section.

71. A company had net income of $420,000. Depreciation expense is $52,000. During the year, Accounts Receivable and Inventory increased $30,000 and $80,000, respectively. Prepaid Expenses and Accounts Payable decreased $4,000 and $8,000, respectively. There was also a loss on the sale of equipment of $6,000. How much cash was provided by operating activities?a. $352,000.b. $364,000.c. $512,000.d. $536,000.

72. On the statement of cash flows using the indirect method, patent amortization expense willa. be added to net income in the operating section.b. be deducted from net income in the operating section.c. appear as an inflow of cash in the investing section.d. appear as an outflow of cash in the

12-4


investing section.

73. The indirect and direct methods of preparing the statement of cash flows are identical except for thea. significant noncash activity section.b. operating activities section.c. investing activities section.d. financing activities section.

74. Under the indirect method, a gain on sale of an investment is reported as a(n)a. addition to net income.b. deduction from net income.c. addition to net cash flow from investing activities.d. deduction to net cash flow from investing activities.

75. Which of the following changes in retained earnings during a period will be reported in the financing activities section of the statement of cash flows?

1. Declaration of a cash

dividend paid during the period.2. Net income for the period.

a. 1b. 2c. Neither 1 nor 2.d. Both 1 and 2.

76. The statement of cash flowsa. is prepared instead of an income

statement under generally accepted accounting principles.

b. is used to assess an entity's ability to pay dividends and meet obligations.

c. is prepared from comparative income statements.

d. reflects earnings per share figures on a cash basis and on an accrual basis in the body of the statement.

77. In preparing the statement of cash flows, determining the net increase or decrease in cash requires the use ofa. the adjusted trial balance.b. the current period's retained earnings statement.c. a comparative balance sheet.d. a comparative income statement.

78. To determine the net cash provided (used) by operating activities, it is necessary to analyzea. the current year's income statement.b. a comparative balance sheet.c. additional information.d. all of these.

79. Which of the following would not be needed to determine net cash provided by operating activities?a. Depreciation expenseb. Change in accounts receivable

c. Payment of cash dividendsd. Change in prepaid expenses

80. When equipment is sold for cash, the amount received is reflected as a casha. inflow in the operating section.b. inflow in the financing section.c. inflow in the investing section.d. outflow in the operating section.

81. The statement of cash flows will not provide insight intoa. why dividends were not increased.b. whether cash flow is greater than net income.c. the exact proceeds of a future bond issue.d. how the retirement of debt was accomplished.

82. The first step in preparing a statement of cash flows is to determine thea. net cash provided/used by operating activities.b. net cash provided/used by investing activities.c. net cash provided/used by financing activities.d. net increase or decrease in cash.

83. All of the following are reported as financing activities except thea. issuance of bonds payable.b. issuance of common stock.c. payment of cash dividends.d. payment of interest.

84. If $500,000 of bonds are issued during the year but $300,000 of old bonds are retired during the year, the statement of cash flows will show a(n)a. net increase in cash of $200,000.b. net decrease in cash of $200,000.c. increase in cash of $500,000 and a decrease in cash of $300,000.d. net gain on retirement of bonds of $200,000.

85. Stapp Company had an increase in inventory of $40,000. The cost of goods sold was $120,000. There was a $5,000 decrease in accounts payable from the prior period. What were Stapp's cash payments to suppliers?a. $165,000.b. $115,000.c. $155,000.d. $125,000.

86. Which of the following items does not appear in the statement of cash flows under the direct method?a. Cash payments to suppliersb. Cash collections from customersc. Depreciation Expensed. Cash from the sale of equipment

87. Norton Company has other operating


expenses of $80,000. There has been a decrease in prepaid expenses of $4,000 during the year, and accrued liabilities are $6,000 larger than in the prior period. What were Norton's cash payments for operating expenses?a. $82,000.b. $78,000.c. $70,000.d. $90,000.

88. Abbott Corporation shows income tax expense of $90,000. There has been a $5,000 decrease in federal income taxes payable and a $7,000 increase in state income taxes payable during the year. What was Abbott's cash payment for income taxes?a. $90,000.b. $88,000.c. $85,000.d. $92,000.

89. Which of the following would not appear in the operating activities section of a statement of cash flows prepared under the direct method?a. Cash receipts from customersb. Cash paid for income taxesc. Gain on sale of equipmentd. Cash paid to employees

90. Gant Company reports a $30,000 increase in inventory and a $10,000 increase in accounts payable during the year. Cost of Goods Sold for the year was $500,000. The cash payments made to suppliers werea. $500,000.b. $520,000.c. $460,000.d. $490,000.

91. Rodman Company had credit sales of $650,000. The beginning accounts receivable balance was $40,000 and the ending accounts receivable balance was $140,000. What were the cash collections from customers during the period?a. $750,000.b. $650,000.c. $550,000.d. $690,000.

92. Cash receipts from customers are greater than sales revenues when there is a(n)a. increase in accounts receivable.b. decrease in accounts receivable.c. increase in cost of goods sold.d. decrease in cost of goods sold.

93. Cash payments to suppliers is computed by analyzing thea. Accounts Payable account only.b. Inventory account only.c. Accounts Payable and the Supplies accounts.d. Accounts Payable and the Inventory

accounts.

94. Cash payments for operating expenses are operating expensesa. less an increase in prepaid expenses.b. plus an increase in accrued expenses payable.c. less an increase in prepaid expenses plus an increase in accrued expenses payable.d. less a decrease in prepaid expenses plus a decrease in accrued expenses payable.

95. All of the following are reported as cash payments under operating activities except payments fora. interest.b. taxes.c. dividends.d. operating expenses.

96. Which of the following statements concerning the statement of cash flows is true?a. The statement of cash flows is usually more accurate when using the indirect method.b. If the direct method is used, a

supplementary schedule reconciling the net income to a net cash from operating activities must still be provided.

c. The statement of cash flows reflects both earnings per share and cash per share.

d. The statement of cash flows is an optional financial statement for external reporting purposes.

97. Carter Company reports the following:

End of Year Beginning of Year

Inventory $25,000$40,000Accounts Payable 30,00010,000

If cost of goods sold for the year is $250,000, the amount of cash paid to suppliers isa. $255,000.b. $245,000.c. $215,000.d. $285,000.

98. During the year, Salaries Payable decreased by $8,000. If Salary Expense amounted to $160,000 for the year, the cash paid to employees (including deductions from gross pay) isa. $168,000.b. $160,000.c. $152,000.d. $176,000.

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99. A cash-based measure of performance is thea. current cash debt coverage ratio.b. cash return on sales ratio.c. cash debt coverage ratio.d. free cash flow.

100. A measure of solvency that uses cash figures is thea. current cash debt coverage ratio.b. cash return on sales ratio.c. cash debt coverage ratio.d. free cash flow.

101. The current cash debt coverage ratio is used to evaluatea. solvency.b. profitability.c. liquidity.d. earning power.

102. A measure that shows how much cash a company generated to expand operations or pay dividends is thea. capital expenditure ratio.b. cash provided by operating activities.c. cash return on sales ratio.d. free cash flow.

103. The cash debt coverage ratio is computed by dividing net cash provided by operating activities bya. average current liabilities.b. net sales.c. average long-term liabilities.d. average total liabilities.

104. Free cash flow is cash provided by operations lessa. capital expenditures.b. cash dividends.c. capital expenditures and cash dividends.d. cash used by investing and financing activities.

105. An indicator of a company’s ability to generate sufficient cash to finance new fixed assets is thea. free cash flow.b. cash return on sales ratio.c. cash debt coverage ratio.d. capital expenditure ratio.

Answers to Multiple Choice Questions

31. b 42.

a 53.

b 64.

c 75.

a 86.

c 97

32. a 43.

c 54.

c 65.

d 76.

b 87.

c 98

33. c 44.

b 55.

d 66.

b 77.

c 88.

b 99

34. a 45.

b 56.

b 67.

c 78.

d 89.

c 100

35. b 46.

a 57.

a 68.

b 79.

c 90.

b 101

36. a 47.

c 58.

c 69.

a 80.

c 91.

c 102.

d

37. a 48.

c 59.

b 70.

d 81.

c 92.

b 103.

d

38. a 49.

b 60.

a 71.

b 82.

d 93.

d 104.

c

39. c 50.

a 61.

d 72.

a 83.

d 94.

d 105.

d

40. a 51.

c 62.

b 73.

b 84.

c 95.

c

41. a 52.

d 63.

b 74.

b 85.

a 96.

b

EXERCISES

Ex. 106

Selected transactions of Eller Company are listed below.

1. Common stock is sold for cash above par value.

2. Bonds payable are issued for cash at a discount.

3. Interest on a short-term note receivable is collected.

4. Merchandise is sold to customers for cash.5. Cash is paid to purchase inventory.6. Equipment is purchased by signing a 3-

year, 10% note payable.7. Cash dividends on common stock are

declared and paid.8. 100 shares of XYZ common stock are

purchased for cash.9. Land is sold for cash at book value.

10. Bonds payable are converted into common stock.

InstructionsClassify each transaction as either (a) an operating activity, (b) an investing activity, (c) a financing activity, or (d) a noncash investing and financing activity.

Solution 106 (8-11 min.)

1. (c) Financing activity 6.(d)Noncash activity

2. (c) Financing activity 7.(c)Financing activity

3. (a) Operating activity 8.(b)Investing activity

4. (a) Operating activity 9.(b)Investing activity

5. (a) Operating activity 10.(d)Noncash activity

Ex. 107

(a) Identify several alternatives for presenting significant noncash activities in financial statements.

(b) Give three examples of significant noncash transactions.


(a) Significant noncash transactions may appear at the bottom of the statement of cash flows


as a separate schedule under the heading "Noncash investing and financing activities." They may also be presented in a separate note or supplementary schedule to the financial statements.

(b) 1. Issuance of stock for assets2. Issuance of stock to liquidate debt3. Issuance of bonds or notes for assets4. Noncash exchanges of property, plant, and equipment

Ex. 108

Robinson, Inc. had the following transactions in 2003:a. Issued common stock for cash.b. Retired mortgage bonds.c. Received cash for sale of equipment.d. Sold long-term investments.e. Declared and paid cash dividends.f. Purchased land, giving a long-term note to

seller.g. Purchased equipment for cash.h. Purchased stock in another company.i. Bonds, due in 10 years, were issued.j. Common stock purchased, to be held as

treasury stock.

InstructionsAnalyze the transactions and indicate whether each transaction represents a source of cash, use of cash, or neither a source nor a use of cash. In addition, indicate whether the transaction resulted in a cash flow from operating activities, investing activities, financing activities, on non-cash investing and financing activities.


a. Source – Financing f. Neither source nor use - noncsh

b. Use – Financing g. Use - Investingc. Source – Investing h. Use - Investingd. Source – Investing i. Source - Financinge. Use – Financing j. Use - Financing

Ex. 109

Prince Company reported net income of $150,000 for the current year. Depreciation recorded on buildings and equipment amounted to $80,000 for the year. Balances of the current asset and current liability accounts at the beginning and end of the year are as follows:

End of Year Beg of Year

Cash $20,000 $15,000AR 19,000 30,000Inventories 55,000 65,000PE 7,500 5,000AP 12,000 16,000Income taxes 1,600 1,300Ex. 109 (cont.)

Instructions

Prepare the cash flows from the operating activities section of the statement of cash flows using the indirect method.


Net income $150,000Adj to reconcile NI to net cash provided by operating activities:

Dep exp 80,000

Dec in AR 11,000

Dec in inventories 10,000

Inc in prepaid expenses (2,500)

Dec in accounts payable (4,000)

Inc in income taxes payable 300

Net cash provided by oper act $244,800

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Ex. 110

Assuming a statement of cash flows is prepared, indicate the reporting of the transactions and events listed below by major categories on the statement. Use the following code letters to indicate the appropriate category under which the item would appear on the statement of cash flows.

CodeCash Flows From Operating Activities

Add to Net Income ADeduct from Net Income D

Cash Flows From Investing Activities IACash Flows From Financing Activities FA

Category1. Common stock is issued for cash at an amount above par value. _________ 2. Merchandise inventory increased during the period. _________3. Depreciation expense recorded for the period. _________4. Building was purchased for cash. _________5. Bonds payable were acquired and retired at their carrying value. _________ 6. Accounts payable decreased during the period. _________7. Prepaid expenses decreased during the period. _________8. Treasury stock was acquired for cash. _________9. Land is sold for cash at an amount equal to book value. _________

10. Patent amortization expense recorded for a period. _________


Category1. Common stock is issued for cash at an amount above par value. FA

2. Merchandise inventory increased during the period. D 3. Depreciation expense recorded for the period. A 4. Building was purchased for cash. IA 5. Bonds payable were acquired and retired at their carrying value. FA 6. Accounts payable decreased during the period. D 7. Prepaid expenses decreased during the period. A 8. Treasury stock was acquired for cash. FA 9. Land is sold for cash at an amount equal to book value. IA

10. Patent amortization expense recorded for a period. A

Ex. 111

Recent balance sheets of Duncan Company are presented below, along with an income statement for the most recent year.

DUNCAN COMPANYComparative Balance Sheet

December 31, 2003 2002

AssetsCash $ 25,000 $ 13,300Accounts receivable 84,000 68,000Inventories 14,300 10,800Prepaid expenses 2,000 1,200Land 80,000 30,000Plant and equipment 300,000 300,000Accumulated depreciation—plant and equipment (45,000) (37,500)Total assets $460,300 $385,800

Liabilities and Stockholders’ EquityAccounts payable 24,200 42,000Accrued expenses payable 1,500 3,800Mortgage payable 80,000 50,000Common stock ($5 par) 200,000 150,000Retained earnings 154,600 140,000Total $460,300 $385,800

DUNCAN COMPANYIncome Statement

For the Year Ended December 31, 2003

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Revenues $135,000Cost of goods sold $57,250Operating expenses 28,750Interest expense 6,800 92,800Income from operations $ 42,200Income tax expense 12,600Net income $ 29,600Ex. 111 (cont.)

Additional information:1. Operating expenses include depreciation expense of $7,500.2. Cash dividends of $15,000 were declared and paid in 2003.3. Interest expense amounting to $6,800 was paid in cash.4. Land costing $50,000 was purchased. Duncan paid $20,000 in cash and borrowed the remaining $30,000,

giving a mortgage on the land for collateral.5. Common stock ($5 par) of $50,000 was issued for cash.6. All accounts payable pertain to merchandise purchases on account.

InstructionsPrepare a statement of cash flows for Duncan using the indirect method.


DUNCAN COMPANYStatement of Cash Flows – Indirect Method


Cash flows from operating activitiesNet income ................................................................................................ $29,600Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation expense ....................................................................... $ 7,500Increase in accounts receivable ....................................................... (16,000)Increase in inventories ..................................................................... (3,500)Increase in prepaid expenses ........................................................... (800)Decrease in accounts payable .......................................................... (17,800)Decrease in accrued expenses payable............................................ (2,300) (32,900)

Net cash used by operating activities ................................................................... (3,300)

Cash flows from investing activitiesPurchase of land ......................................................................................... (50,000)

Net cash used by investing activities ................................................................... (50,000)

Cash flows from financing activitiesIncrease in mortgage payable .................................................................... 30,000Sale of common stock ................................................................................ 50,000Payment of dividends ................................................................................. (15,000)

Net cash provided by financing activities ............................................................. 65,000Net increase in cash ............................................................................................. 11,700Cash at beginning of period .................................................................................. 13,300Cash at end of period ........................................................................................... $25,000


Ex. 112

The comparative balance sheet for Lang Company appears below:

LANG COMPANYComparative Balance Sheet

December 31, 2002 2001

AssetsCash $ 27,000 $12,000Accounts receivable 18,000 14,000Prepaid expenses 6,000 9,000Inventory 27,000 18,000Long-term investments -0- 18,000Equipment 62,000 30,000Accumulated depreciation—equipment (20,000) (14,000)

Total assets $120,000 $87,000

Liabilities and Stockholders' Equity

Accounts payable $ 19,000 $ 9,000Bonds payable 35,000 43,000Common stock 40,000 25,000Retained earnings 26,000 10,000 Total liabilities and stockholders' equity $120,000 $87,000

Additional information:1. Net income for the year ending December 31, 2002 was $40,000.2. Cash dividends of $24,000 were declared and paid during the year.3. Long-term investments that had a book value of $18,000 were sold for $14,000.4. Sales for 2002 are $120,000.

Instructions1. Prepare a statement of cash flows for the year ended December 31, 2002, using the indirect method.

2. Compute the following cash based ratios:a. Current cash debt coverage ratio.b. Cash return on sales ratio.c. Cash debt coverage ratio.


1. LANG COMPANYStatement of Cash Flows – Indirect Method

For the Year Ended December 31, 2002———————————————————————————————————————————Cash flows from operating activities

Net income ................................................................................................ $40,000Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation expense ....................................................................... $ 6,000Loss on sale of long-term investment in bonds................................. 4,000Increase in accounts receivable ....................................................... (4,000)Decrease in prepaid expenses .......................................................... 3,000Increase in inventories ..................................................................... (9,000)Increase in accounts payable ........................................................... 10,000 10,000

Net cash provided by operating activities ............................................................ 50,000

Cash flows from investing activitiesSale of long-term investments .................................................................... 14,000Purchase of equipment ............................................................................... (32,000)

Net cash used by investing activities ................................................................... (18,000)

Cash flows from financing activitiesIssuance of common stock ......................................................................... 15,000Retirement of bonds payable ..................................................................... (8,000)Payment of cash dividends ......................................................................... (24,000)

Net cash used by financing activities ............................................... (17,000)Net increase in cash ............................................................................................. 15,000

12-12


Cash at beginning of period .................................................................................. 12,000Cash at end of period ........................................................................................... $27,000

Net cash provided by operating activities2. a. Current cash debt coverage ratio = ——————————————————

Average current liabilities

$50,000= ——————————— = 3.57 times

($9,000 + $19,000) ÷ 2

Net cash provided by operating activitiesb. Cash return on sales ratio = ——————————————————

Net sales

$50,000= ————— = 41.7%

$120,000

Net cash provided by operating activitiesc. Cash debt coverage ratio = ——————————————————

Average total liabilities

$50,000= ——————————— = .94 times

($52,000 + $54,000) ÷ 2

Ex. 113

A comparative balance sheet for Joseph Corporation is presented below:

JOSEPH CORPORATIONComparative Balance Sheet

2002 2001 Assets

Cash $ 51,000 $ 31,000Accounts receivable (net) 75,000 60,000Prepaid insurance 22,000 17,000Land 22,000 40,000Equipment 70,000 60,000Accumulated depreciation (20,000) (13,000)

Total assets $220,000 $195,000

Liabilities and Stockholders' EquityAccounts payable $ 13,000 $ 6,000Bonds payable 30,000 19,000Common stock 140,000 115,000Retained earnings 37,000 55,000

Total liabilities and stockholders' equity $220,000 $195,000

Additional information:1. Net loss for 2002 is $14,000. Net sales for 2002 are $250,000.2. Cash dividends of $4,000 were declared and paid in 2002.3. Land was sold for cash at a loss of $5,000. This was the only land transaction during the year.4. Equipment with a cost of $15,000 and accumulated depreciation of $10,000 was sold for $5,000 cash.5. $14,000 of bonds were retired during the year at carrying (book) value.6. Equipment was acquired for common stock. The fair market value of the stock at the time of the

exchange was $25,000.

Instructions1. Prepare a statement of cash flows for the year ended 2002, using the indirect method.2. Compute the following cash based ratios:

a. Current cash debt coverage ratio.b. Cash return on sales ratio.c. Cash debt coverage ratio.



1. JOSEPH CORPORATIONStatement of Cash Flows – Indirect Method


Net loss ................................................................................................ $(14,000)Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation (a) ................................................................................ $17,000Loss on sale of land (b) ..................................................................... 5,000Increase in accounts receivable ....................................................... (15,000)Increase in prepaid insurance ........................................................... (5,000)Increase in accounts payable ........................................................... 7,000 9,000

Net cash used by operating activities ................................................................... (5,000)

Cash flows from investing activities Proceeds from the sale of land (b) .............................................................. 13,000Proceeds from the sale of equipment ......................................................... 5,000

Net cash provided by investing activities ............................................................. 18,000

Cash flows from financing activitiesRetirement of bonds payable ..................................................................... (14,000)Issuance of bonds payable ......................................................................... 25,000Payment of dividends ................................................................................. (4,000)

Net cash provided by financing activities ............................................................. 7,000Net increase in cash ............................................................................................. 20,000Cash at beginning of period .................................................................................. 31,000Cash at end of period ........................................................................................... $51,000

Noncash investing and financing activitiesPurchase of equipment through issuance of common stock ...................... $25,000

(a) Accumulated Depreciation 12/31/01 13,000Accumulated Depreciation 12/31/02 20,000Difference 7,000Add: Accumulated depreciation on equipment sold 10,000Depreciation expense 17,000

(b) Cost of land sold 18,000Less: Loss on sale of land (5,000)Proceeds from sale of land 13,000

2. a. Current cash debt coverage ratio =

= = (.53) times

b. Cash return on sales ratio = =

= (2%)

12-14


Solution 113 (cont.)

c. Cash debt coverage ratio =

= = (.15) times

Ex. 114

The following information is available for Garrett Corporation for the year ended December 31, 2002:

Collection of principal on long-term loan to a supplier $30,000Acquisition of equipment for cash 10,000Proceeds from the sale of long-term investment at book value 32,000Issuance of common stock for cash 20,000Depreciation expense 15,000Redemption of bonds payable at carrying (book) value 24,000Payment of cash dividends 22,000Net income 20,000Purchase of land by issuing bonds payable 40,000

In addition, the following information is available from the comparative balance sheet for Garrett at the end of 2001 and 2002:

2002 2001 Cash $ 69,000 $14,000Accounts receivable (net) 25,000 15,000Prepaid insurance 17,000 13,000Total current assets $111,000 $42,000

Accounts payable $ 30,000 $19,000Salaries payable 4,000 7,000Total current liabilities $ 34,000 $26,000

InstructionsPrepare Garrett's statement of cash flows for the year ended December 31, 2002 using the indirect method.


GARRETT CORPORATIONStatement of Cash Flows – Indirect Method


Net income ............................................................................................. $20,000Adjustments to reconcile net income to net cash provided by operating activities

Depreciation ..................................................................................... $15,000Increase in accounts receivable ....................................................... (10,000)Increase in prepaid insurance ........................................................... (4,000)Increase in accounts payable ........................................................... 11,000Decrease in salaries payable ............................................................ (3,000) 9,000

Net cash provided by operating activities ............................................................ 29,000

Cash flows from investing activitiesCollection of long-term loan ....................................................................... 30,000Proceeds from the sale of investments ...................................................... 32,000Purchase of equipment ............................................................................... (10,000)

Net cash provided by investing activities ............................................................. 52,000

Cash flows from financing activitiesIssuance of common stock ......................................................................... 20,000Redemption of bonds ................................................................................. (24,000)Payment of dividends ................................................................................. (22,000)

Net cash used by financing activities ................................................................... (26,000)Increase in Cash ............................................................................................. 55,000Cash at beginning of period .................................................................................. 14,000Cash at end of period ........................................................................................... $69,000


Noncash investing and financing activitiesPurchase of land by issuing bonds .............................................................. $40,000

Ex. 115

Upshaw Company prepared the tabulation below at December 31, 2002.

Net Income ............................................................................................................................... $250,000

Adjustments to reconcile net income to net cash provided by operating activities:

Depreciation expense, $30,000 ...................................................................................... ___________

Increase in accounts receivable, $60,000 ...................................................................... ___________

Decrease in inventory, $13,000 ..................................................................................... ___________

Amortization of patent, $4,000 ....................................................................................... ___________

Increase in accounts payable, $3,600 ............................................................................ ___________

Decrease in interest receivable, $4,000 ......................................................................... ___________

Increase in prepaid expenses, $6,000 ............................................................................ ___________

Decrease in income taxes payable, $1,500 .................................................................... ___________

Gain on sale of land, $8,000 ........................................................................................... ___________

Net cash provided (used) by operating activities ........................................................... ___________

InstructionsShow how each item should be reported in the statement of cash flows. Use parentheses for deductions.


Net Income ............................................................................................................................... $250,000

Adjustments to reconcile net income to net cash provided by operating activities:Depreciation expense ..................................................................................................... 30,000Increase in accounts receivable ..................................................................................... (60,000)Decrease in inventory .................................................................................................... 13,000Amortization of patent .................................................................................................... 4,000Increase in accounts payable ......................................................................................... 3,600Decrease in interest receivable ...................................................................................... 4,000Increase in prepaid expenses ......................................................................................... (6,000)Decrease in income taxes payable ................................................................................. (1,500)Gain on sale of land ........................................................................................................ (8,000)

Net cash provided (used) by operating activities ................................................. $229,100

Ex. 116

Baxter Company had total operating expenses of $150,000 in 2002, which included Depreciation Expense of $20,000. Also, during 2002, prepaid expenses increased by $5,000 and accrued expenses decreased by $8,700.

InstructionsCalculate the amount of cash payments for operating expenses in 2002 using the direct method.


Operating expenses ......................................................................... $150,000Less: Noncash depreciation expense ................................................ (20,000)Add: Increase in prepaid expenses ................................................... 5,000Add: Decrease in accrued liabilities .................................................. 8,700

12-16


Cash payments for operating expenses ........................................... $143,700

Ex. 117

The general ledger of the Lopez Company provides the following information:

End of Year Beginning of YearAccounts Receivable $ 60,000 $ 94,000Inventory 350,000 230,000Accounts Payable 40,000 65,000

The company's net sales for the year was $1,000,000 and cost of goods sold amounted to $700,000.

InstructionsCompute the following:(a) Cash receipts from customers.(b) Cash payments to suppliers.


(a) Cash receipts from customersSales + Decrease in Accounts Receivable$1,000,000 + $34,000 = $1,034,000

(b) Cash payments to suppliersFirst calculate the amount of purchases:Beginning inventory $230,000Add: Purchases ?

?Less: Ending Inventory 350,000Cost of goods sold $700,000

$230,000 + Purchases – $350,000 = $700,000Purchases = $820,000

Amount of cash payments to suppliers = Purchases + Decrease in accounts payable= $820,000 + $25,000 = $845,000

Ex. 118

The income statement of Pine Inc. for the year ended December 31, 2002, reported the following condensed information:

Service revenue $550,000Operating expenses 330,000Income from operations 220,000Income tax expense 90,000Net income $130,000

Pine's balance sheet contained the following comparative data at December 31:

2002 2001 Accounts receivable $60,000 $40,000Accounts payable 35,000 41,000Income taxes payable 6,000 3,000

Pine has no depreciable assets. Accounts payable pertains to operating expenses.InstructionsPrepare the operating activities section of the statement of cash flows using the direct method.


PINE INC.Statement of Cash Flows – Direct MethodFor the Year Ending December 31, 2002

Cash flows from operating activitiesCash receipts from customers ($550,000 – $20,000) $530,000Cash payments:


For operating expenses ($330,000 + $6,000) $336,000For income taxes ($90,000 – $3,000) 87,000 423,000Net cash provided by operating activities $107,000

Ex. 119

The income statement of Trahan Company is shown below:

TRAHAN COMPANYIncome Statement


Sales $6,000,000Cost of goods sold 4,200,000Gross profit 1,800,000Operating expenses

Selling expenses $400,000Administrative expense 700,000Depreciation expense 90,000Amortization expense 30,000 1,220,000

Net income $ 580,000Ex. 119 (cont.)

Additional information:1. Accounts receivable increased $400,000 during the year.2. Inventory increased $200,000 during the year.3. Prepaid expenses increased $200,000 during the year.4. Accounts payable to merchandise suppliers increased $100,000 during the year.5. Accrued expenses payable increased $180,000 during the year.

InstructionsPrepare the operating activities section of the statement of cash flows for the year ended December 31, 2002, for Trahan Company, using the direct method.


TRAHAN COMPANYStatement of Cash Flows – Direct MethodFor the Year Ended December 31, 2002

Cash flows from operating activitiesCash receipts from customers $5,600,000 (1)Cash payments:

To suppliers $4,300,000 (2)For operating expenses 1,120,000 (3) 5,420,000Net cash provided by operations $ 180,000

(1) Sales $6,000,000Deduct: Increase in accounts receivable 400,000Cash receipts from customers $5,600,000

(2) Cost of goods sold $4,200,000Add: Increase in inventory 200,000Purchases 4,400,000Deduct: Increase in accounts payable 100,000Cash payments to suppliers $4,300,000

(3) Operating expenses exclusive of depreciation and amortization $1,100,000Add: Increase in prepaid expenses 200,000Deduct: Increase in accrued expenses payable (180,000)Cash payments for operating expenses $1,120,000

Ex. 120

The financial statements of Melton Company appear below:

12-18


MELTON COMPANYComparative Balance Sheet

December 31, 2002 2001

AssetsCash $ 44,000 $ 23,000Accounts receivable 26,000 34,000Merchandise inventory 25,000 15,000Property, plant, and equipment 50,000 78,000Accumulated depreciation (20,000) (24,000)

Total $125,000 $126,000


Accounts payable $ 18,000 $ 23,000Income taxes payable 13,000 8,000Bonds payable 7,000 33,000Common stock 41,000 24,000Retained earnings 46,000 38,000

Total $125,000 $126,000

MELTON COMPANYIncome Statement


Sales $400,000Cost of goods sold 280,000Gross profit 120,000Selling expenses $20,000Administrative expenses 26,000 46,000Income from operations 74,000Interest expense 4,000Income before income taxes 70,000Income tax expense 28,000Net income $ 42,000

The following additional data were provided:1. Dividends declared and paid were $34,000.2. During the year equipment was sold for $15,000 cash. This equipment cost $28,000 originally and had a

book value of $15,000 at the time of sale.3. All depreciation expense is in the selling expense category.4. All sales and purchases are on account.5. Accounts payable pertain to merchandise suppliers.6. All operating expenses except for depreciation were paid in cash.

InstructionsPrepare a statement of cash flows for Melton Company using the direct method.


MELTON COMPANYStatement of Cash Flows – Direct MethodFor the Year Ended December 31, 2002

Cash flows from operating activitiesCash receipts from customers ($400,000 + $8,000) $408,000Cash payments:

To suppliers $295,000 (1)For operating expenses 37,000 (2)For interest expense 4,000For income taxes ($28,000 – $5,000) 23,000 359,000Net cash provided by operating activities 49,000

Cash flows from investing activitiesSale of equipment 15,000

Net cash provided by investing activities 15,000


Cash flows from investing activitiesRedemption of bonds payable (26,000)Issuance of common stock 17,000Payment of cash dividend (34,000)

Net cash used by financing activities (43,000)Net increase in cash 21,000Cash at beginning of period 23,000Cash at end of period $ 44,000

(1) Cost of goods sold $280,000Add: Increase in inventory 10,000Purchases 290,000Add: Decrease in accounts payable 5,000Cash payments to suppliers $295,000

(2) Operating expenses $46,000Less: Depreciation expense (9,000)*Cash payments for operating expenses $37,000

*$24,000 – $13,000 = $11,000 balance in accumulated depreciation after sale.Ending balance, $20,000 – $11,000 = $9,000 depreciation expense.

Ex. 121

Condensed financial data of Ritter Company appear below:

RITTER COMPANYComparative Balance Sheet

December 31, 2002 2001

AssetsCash $ 55,000 $ 35,000Accounts receivable 85,000 53,000Inventories 120,000 132,000Prepaid expenses 15,000 25,000Investments 85,000 75,000Plant assets 315,000 250,000Accumulated depreciation (65,000) (60,000)

Total $610,000 $510,000


Accounts payable $ 85,000 $ 75,000Accrued expenses payable 29,000 24,000Bonds payable 130,000 160,000Common stock 245,000 170,000Retained earnings 121,000 81,000

Total $610,000 $510,000

RITTER COMPANYIncome Statement


Sales $420,000Less:

Cost of goods sold $250,000Operating expenses (excluding depreciation) 60,000Depreciation expense 17,000Income taxes 22,000Interest expense 16,000Loss on sale of plant assets 5,000 370,000

Net income $ 50,000

Additional information:1. New plant assets costing $90,000 were purchased for cash in 2002.2. Old plant assets costing $25,000 were sold for $8,000 cash when book value was $13,000.3. Bonds with a face value of $30,000 were converted into $30,000 of common stock.4. A cash dividend of $10,000 was declared and paid during the year.

12-20


5. Accounts payable pertain to merchandise purchases.

Instructions1. Prepare a statement of cash flows for the year using the direct method.2. Compute the following cash basis ratios:

a. Current cash debt coverage ratio.b. Cash return on sales ratio.c. Cash debt coverage ratio.


1. RITTER COMPANYStatement of Cash Flows – Direct MethodFor the Year Ended December 31, 2002

Cash flows from operating activitiesCash receipts from customers ($420,000 – $32,000) $388,000

Cash payments:To suppliers $228,000 (1)For operating expenses 45,000 (2)For income taxes 22,000For interest 16,000 311,000Net cash provided by operating activities 77,000

Cash flows from investing activitiesPurchase of investments (10,000)Purchase of plant assets (90,000)Sale of plant assets 8,000

Net cash used by investing activities (92,000)Cash flows from financing activities

Issuance of common stock 45,000Payment of cash dividends (10,000)

Net cash provided by financing activities 35,000Net increase in cash 20,000Cash at beginning of period 35,000Cash at end of period $ 55,000

Noncash investing and financing activitiesConversion of bonds payable into common stock $ 30,000

(1) Cost of goods sold $250,000Deduct: Decrease in inventory (12,000)Purchases 238,000Deduct: Increase in accounts payable (10,000)Cash payments to suppliers $228,000

(2) Operating expenses $60,000Deduct: Decrease in prepaid expenses (10,000)Deduct: Increase in accrued expenses payable (5,000)Cash payments for operating expenses $45,000

2. Cash basis ratios:$77,000

a. Current cash debt coverage ratio = ——————————— = .72 : 1($99,000 + $114,000) ÷ 2

$77,000b. Cash return on sales ratio = ———— = 18.3%

$420,000

$77,000c. Cash debt coverage ratio = ———————————— = .31 times

($259,000 + $244,000) ÷ 2Ex. 122

The following information is available from recent annual reports of J.C. Penney and Sears:(Amounts in millions)

J.C. Penney Sears Average current liabilities $ 5,993 $14,779Average total liabilities 13,677 29,984


Cash provided by operations 382 1,189Net income 565 1,271Net sales 22,653 33,812

Instructions(a) Based on the preceding information, compute the following ratios for each company:

1. Current cash debt coverage2. Cash return on sales3. Cash debt coverage

(b) What conclusions concerning the management of cash can be drawn from these data?

Solution 122 (15 min.)

(a) J.C. Penney Sears

1. Current cash debt coverage ratio = .06 times = .08 times

2. Cash return on sales ratio = 1.7% = 3.5%

3. Cash debt coverage ratio = .03 times = .04 times

(b) With the current cash debt coverage ratio and the cash debt coverage ratio, the higher the ratio the better the liquidity and solvency respectively. Sears’ two coverage ratios are both one-third higher than Penney’s coverage ratios. Sears’ cash return on sales ratio is twice as high as Penney’s ratio, which indicates Sears is more efficient in turning sales into cash from operations.

12-22


COMPLETION STATEMENTS

123. A statement of cash flows summarizes the operating, ____________, and ___________ activities of an entity.

124. The cash effects of selling goods and services appears in the ______________ activities section of a statement of cash flows.

125. Net cash provided/used by operating activities can be determined using the ____________ method or the ______________ method.

126. During the _______________, cash provided by operating activities and net income are approximately the same.

127. During the growth phase, a company will start to generate small amounts of cash _______________.

128. Using the indirect approach, noncash charges in the income statement are ___________ to net income and noncash credits are ______________ to compute cash provided by operations.

129. If accounts receivable increase during a period, revenues on an accrual basis are ______________ than revenues on a cash basis.

130. The sale of equipment at less than its book value is a(an) ______________ of cash that is reported in the ______________ activities section.

131. Cost of goods sold for the year amounted to $100,000, and during the year, accounts payable ______________ by $8,000 and inventory ______________ by $7,000 resulting in cash paid to suppliers of $85,000.

132. In computing cash payments for operating expenses, a decrease in prepaid expenses is ______________ and an increase in accrued expenses payable is ______________ to (from) operating expenses, exclusive of depreciation.

133. In computing cash payments for income taxes, a decrease in income taxes payable is ______________ to (from) income tax expense.

134. Under the direct method, the two largest classes of items in the operating activities section for a merchandising company are cash ________________________ and cash _________________________.

135. The current cash debt coverage ratio is computed by dividing net cash provided by operating activities by _________________ liabilities.

136. The cash ______________ ratio indicates the company’s ability to turn sales into dollars.

Answers to Completion Statements

123. financing, investing (or vice versa) 131. increased, decreased 124. operating 132. deducted, deducted125. indirect, direct (or vice versa) 133. added126. maturity phase 134. receipts from customers, payments to suppliers127. provided by operating activities (or vice versa)128. added, deducted 135. average current129. higher (greater) 136. return on sales130. inflow, investing

MATCHING

Set 1 — Indirect Method

137. For each of the following items, indicate by using the appropriate code letter, how the item should be reported in the statement of cash flows, using the indirect method.

A. Added to net incomeB. Deducted from net incomeC. Cash outflow—investing activityD. Cash inflow—investing activityE. Cash outflow—financing activityF. Cash inflow—financing activityG. Significant noncash investing and financing activity

____ 1. Decrease in accounts payable during a period____ 2. Declaration and payment of a cash dividend.____ 3. Loss on sale of land.____ 4. Decrease in accounts receivable during a period.


____ 5. Redemption of bonds for cash.____ 6. Proceeds from sale of equipment at book value.____ 7. Issuance of common stock for cash.____ 8. Purchase of a building for cash.____ 9. Acquisition of land in exchange for common stock.____ 10. Increase in merchandise inventory during a period.

Answers to Matching

1. B 6. D2. E 7. F3. A 8. C4. A 9. G5. E 10. B

Set 2 — Direct Method

138. For each of the following items, indicate by using the appropriate code letter, how the item should be reported in the statement of cash flows, using the direct method.

A. Added in determining cash receipts from customersB. Deducted in determining cash receipts from customersC. Added in determining cash payments to suppliersD. Deducted in determining cash payments to suppliersE. Cash outflow—investing activityF. Cash inflow—investing activityG. Cash outflow—financing activityH. Cash inflow—financing activityI. Significant noncash investing and financing activityJ. Is not shown

____ 1. Decrease in accounts payable during a period.____ 2. Declaration and payment of a cash dividend.____ 3. Decrease in accounts receivable during a period.____ 4. Depreciation expense.____ 5. Conversion of bonds payable into common stock.____ 6. Decrease in merchandise inventory during a period.____ 7. Sale of equipment for cash at book value.____ 8. Issuance of preferred stock for cash.____ 9. Purchase of land for cash.____ 10. Loss on sale of a plant asset.

Answers to Matching

1. C 6. D2. G 7. F3. A 8. H4. J 9. E5. I 10. J

12-24


ACTIVITY-BASED COSTING

TRUE-FALSE STATEMENTS

1. Traditional costing systems use multiple predetermined overhead rates.

2. Traditionally, overhead is allocated based on direct labor cost or direct labor hours.

3. Current trends in manufacturing include less direct labor and more overhead.

4. Activity-based costing allocates overhead to multiple cost pools and assigns the cost pools to products using cost drivers.

5. A cost driver does not generally have a direct cause-effect relationship with the resources consumed.

6. The first step in activity-based costing is to assign overhead costs to products, using cost drivers.

7. To achieve accurate costing, a high degree of correlation must exist between the cost driver and the actual consumption of the activity cost pool.

8. Low-volume products often require more special handling than high-volume products.

9. When overhead is properly assigned in ABC, it will usually decrease the unit cost of high-volume products.

10. ABC leads to enhanced control over overhead costs.

11. ABC usually results in less appropriate management decisions.

12. ABC is generally more costly to implement than traditional costing.

13. ABC eliminates all arbitrary cost allocations.

14. ABC is particularly useful when product lines differ greatly in volume and manufacturing complexity.

15. ABC is particularly useful when overhead costs are an insignificant portion of total costs.

16. Activity-based management focuses on reducing costs and improving processes.

17. Any activity that increases the cost of producing a product is a value-added activity.

18. Engineering design is a value-added activity.

19. Nonvalue-added activities increase the cost of a product but not its market value.

20. Machining is a nonvalue-added activity.

21. Not all activities labeled nonvalue-added are totally wasteful, nor can they be totally eliminated.

22. The overall objective of installing ABC in service firms is no different than it is in a manufacturing company.

23. What sometimes makes implementation of activity-based costing difficult in service industries is that a smaller proportion of overhead costs are company-wide costs.

24. The general approach to identifying activities, activity cost pools, and cost drivers is used by a service company in the same manner as a manufacturing company.

25. Inventory storage costs are reduced in just-in-time processing.

26. Rework costs typically increase in just-in-time processing.

27. Just-in-time strives to eliminate inventories by using a pull approach.

28. Quality control is less important in just-in-time than in traditional manufacturing philosophies.

*29. Plant management is a batch-level activity.

*30. Painting is a product-level activity.

Answers to True-False Statements

1. F 6. F 11.

F 16.

T 21.

T 26. F

2. T 7. T 12.

T 17.

F 22.

T 27. T

3. T 8. T 13.

F 18.

T 23.

F 28. F

4. T 9. F 14.

T 19.

T 24.

T *29.

F

5. F 10. T 15 F 20 F 25 T *30 F


. . . .

12-26

MULTIPLE CHOICE QUESTIONS

31. Which of the following is not typical of traditional costing systems?a. Use of a single predetermined overhead rate.b. Use of direct labor hours or direct labor cost to assign overhead.c. Assumption of correlation between direct labor and incurrence of overhead cost.d. Use of multiple cost drivers to allocate overhead.

32. In traditional costing systems, overhead is generally applied based ona. direct labor.b. machine hours.c. direct material dollars.d. units of production.

33. An activity that has a direct cause-effect relationship with the resources consumed is a(n)a. cost driver.b. overhead rate.c. cost pool.d. product activity.

34. Which best describes the flow of overhead costs in an activity-based costing system?a. Overhead costs direct labor cost or hours productsb. Overhead costs productsc. Overhead costs activity cost pools cost drivers productsd. Overhead costs machine hours products

35. The first step in activity-based costing is toa. assign manufacturing overhead costs

for each activity cost pool to products.b. compute the activity-based overhead

rate per cost driver.c. identify and classify the major

activities involved in the manufacture of specific products.

d. identify the cost driver that has a strong correlation to the activity cost pool.

36. A well-designed activity-based costing system starts witha. identifying the activity-cost pools.b. computing the activity-based overhead rate.c. assigning manufacturing overhead costs for each activity cost pool to products.d. analyzing the activities performed to manufacture a product.

37. One of Lara Dole Company's activity cost pools is machine setups, with estimated overhead of $300,000. Dole produces flares (400 setups) and health packs (600 setups). How much of the machine setup cost pool should be assigned to flares?

a. $0.b. $120,000.c. $150,000.d. $180,000.

38. Which would be an appropriate cost driver for the ordering and receiving activity cost pool?a. Machine setupsb. Purchase ordersc. Machine hoursd. Inspections

39. As compared to a high-volume product, a low-volume producta. usually requires less special handling.b. is usually responsible for more overhead costs per unit.c. requires relatively fewer machine setups.d. requires use of direct labor hours as

the primary cost driver to ensure proper allocation of overhead.

40. In Japan,a. activity-based costing is used more than in the U.S.b. companies prefer volume measures

such as direct labor hours to assign overhead costs.

c. labor cost reduction is less of a priority.

d. developing more

accurate product costs is more of a priority.

Use the following information to answer questions 41–44.

Robot Toy Company manufactures two products, X-O-Tron and Mechoman. Robot's overhead costs consist of setting up machines, $400,000; machining, $900,000; and inspecting, $300,000. Information on the two products is:

X-O-Tron MechomanDirect labor hours 15,000 25,000Machine setups 600 400Machine hours 24,000 26,000Inspections 800 700

41. Overhead applied to X-O-Tron using traditional costing isa. $600,000.b. $768,000.c. $832,000.d. $960,000.

42. Overhead applied to Mechoman using traditional costing isa. $640,000.b. $768,000.c. $832,000.d. $1,000,000.

43. Overhead applied to X-O-Tron using activity-based costing isa. $600,000.b. $768,000.


c. $832,000.d. $960,000.

44. Overhead applied to Mechoman using activity-based costing isa. $640,000.b. $768,000.c. $832,000.d. $1,000,000.

45. Which of the following is a limitation of activity-based costing?a. More cost poolsb. Less control over overhead costsc. Poorer management decisionsd. Some arbitrary allocations continue

46. Which of the following factors would suggest a switch to activity-based costing?a. Product lines similar in volume and manufacturing complexity.b. Overhead costs constitute a significant portion of total costs.c. The manufacturing process has been stable.d. Production managers use data provided by the existing system.

47. Which of the following is true of activity-based costing?a. More cost poolsb. Same base as traditional costingc. Less costly to used. Eliminates arbitrary allocations

48. The primary benefit of ABC is it provides a. better management decisions.b. enhanced control over overhead costs.c. more cost pools.d. more accurate product costing.

49. Which of the following is not a benefit of activity-based costing?a. More accurate product costingb. Enhanced control over overhead costsc. Better management decisionsd. Less costly to use

50. Each of the following is a limitation of activity-based costing except thata. it can be expensive to use.b. it is more complex than traditional costing.c. more cost pools are used.d. some arbitrary allocations continue.

51. The presence of any of the following factors would suggest a switch to ABC except whena. product lines differ greatly in volume.b. overhead costs constitute a minor portion of total costs.c. the manufacturing process has changed significantly.d. production managers are ignoring data provided by the existing system.

52. Which of the following is a value-added activity?a. Engineering designb. Machinery repairc. Inventory storaged. Inspections

53. Which of the following is a nonvalue-added activity?a. Engineering designb. Machiningc. Inspectiond. Packaging

54. A nonvalue-added activity in a service enterprise isa. taking appointments.b. traveling.c. advertising.d. all of these.

55. Value-added activitiesa. should be reduced or eliminated.b. involve resource usage customers are willing to pay for.c. add cost to a product without affecting selling price.d. cannot be differentiated from nonvalue-added activities.

56. All of the following are examples of a value-added activity in a service company excepta. delivering packages by a delivery service.b. ordering supplies.c. performing surgery.d. providing legal research for legal services.

57. Activity-based costing has been found to be useful in each of the following service industries excepta. banks.b. hospitals.c. telephone companies.d. ABC has been useful in any of these industries.

58. What sometimes makes implementation of activity-based costing difficult in service industries isa. the labeling of activities as value-added.b. identifying activities, activity cost plus, and cost drivers.c. that a larger proportion of overhead costs are company-wide costs.d. attempting to reduce or eliminate nonvalue-added activities.

59. All of the following statements are correct except thata. activity-based costing has been widely

adopted in service industries.b. the objective of installing ABC in

service firms is different than it is in a manufacturing firm.

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Activity-Based Costing

c. A larger proportion of overhead costs are company-wide costs in service industries.

d. the general approach to identifying activities and activity cost pools is the same in a service company as in a manufacturing company.

60. The use of activity-based costing in service industriesa. has the same objective as in manufacturing.b. results in improved costing of services provided.c. uses cost pools to assign overhead.d. all of these.

61. Just-in-time processinga. is based on a just-in-case philosophy.b. results in a push approach.c. minimizes inventory storage and waiting time.d. all of these.

62. An element of just-in-time processing isa. dependable suppliers who are willing to deliver on short notice.b. a multi-skilled workforce.c. a total quality control system.d. all of these.

63. Which of the following is not a benefit of just-in-time processing?a. Control of significant inventory balancesb. Enhanced product qualityc. Reduction of rework costsd. Production cost savings

64. Which account is used in just-in-time processing?a. Raw materials inventoryb. Work-in-process inventoryc. Merchandise inventoryd. Raw and In-Process inventory

65. Under just-in-time processing, all of the following are received or completed “just in time” excepta. finished goods.b. raw materials.c. subassembly parts.d. supplies.

*66. Which of the following is not a facility-level activity?a. Plant managementb. Product designc. Personnel administrationd. Training

*67. Which of the following is not a product-level activity?a. Product designb. Engineering changesc. Inventory managementd. Equipment setups

*68. Which of the following is not a batch-level activity?a. Engineering changesb. Equipment setupsc. Inspectiond. Materials handling

*69. Which of the following is not a unit-level activity?a. Purchase orderingb. Assemblingc. Paintingd. Sewing

*70. Which of the following is a batch-level activity?a. Plant managementb. Product designc. Equipment setupsd. Assembling

Answers to Multiple Choice Questions

31. d 37. b 43. c 49.

d 55.

b 61. c *67

d

32. a 38. b 44. b 50.

c 56.

b 62. d *68

a

33. a 39. b 45. d 51.

b 57.

d 63. a *69

a

34. c 40. b 46. b 52.

a 58.

c 64. d *70

c

35. c 41. a 47. a 53.

c 59.

b 65. d

36. d 42. d 48. d 54.

d 60.

d *66.

b

EXERCISES

Ex. 71

Reese Corporation manufactures easy chairs and recliners. The following information is available: Easy Chairs Recliners

Total CostMachine setups 200 600$16,000

Inspections 250 500$27,000

Labor hours 2,600 2,400

Reese is considering switching from one overhead rate based on labor hours to activity-based costing.

InstructionsPerform the following analyses for these two components of overhead:1. Compute total machine setups and inspection

costs assigned to each product, using a single overhead rate.

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2. Compute total machine setups and inspection costs assigned to each product, using activity-based costing.

3. Comment on your findings.

Solution 71 (8–12 min.)

1. Single overhead rate($16,000 + $27,000) ÷ 5,000 = $8.60 per labor hour

Easy chairs: 2,600 × $8.60 = $22,360Recliners: 2,400 x $8.60 = 20,640

$43,000

2. Activity-based costingMachine setups: $16,000 ÷ 800 = $20 per setup

Inspections: $27,000 ÷ 750 = $36 per inspection

Easy chairs: (200 × $20) + (250 × $36) =$13,000Recliners: (600 × $20) + (500 × $36) = 30,000

$43,000

Solution 71 (cont.)

3. The use of activity-based costing resulted in the allocation of less cost to easy chairs and more cost to recliners. The change in cost allocation reflects a more accurate allocation based on cause and effect.

Ex. 72

Ms. Bentley owns a small department store in a metropolitan area. For twenty years, the accountant has applied overhead to the various departments—Women's Apparel, Men's Apparel, Cosmetics, Housewares, Shoes, and Electronics—based on the basis of employee hours worked. Ms. Bentley's daughter, who is an accounting student at a local university, has suggested her mother should consider using activity-based costing (ABC). In an attempt to implement ABC, Ms. Bentley and her daughter have identified the following activities.

InstructionsDetermine a cost driver for each of the activities listed below.

Cost Pool Cost Driver

a. Placing orders_____________________________

b. Stocking merchandise______________________________

c. Waiting on customers______________________________

d. Janitorial and Maintenance______________________________

e. Training employees______________________________

f. Administrative______________________________

g. Advertising and Marketing______________________________

h. Accounting and Legal Services______________________________

i. Wrapping packages______________________________


Cost Pool Cost Driver

a. Placing orders number of orders; volume of individual orders

b. Stocking merchandise number of orders; dollar volume of orders

c. Waiting on customers number of customers; dollar volume of sales

d. Janitorial and Maintenance square feet occupied; traffic through area

e. Training employees total number of employees; number of new employees

f. Administrative number of employees; dollar volume of business

g. Advertising and Marketing number of ad campaigns

h. Accounting and Legal Services dollar volume of sales

i. Wrapping packages number of packages

Ex. 73

A list of possible cost drivers is presented below:

Code CodeA Engineering hoursD Number of subassembliesB SetupsE BoxesC Machine hoursF Orders

InstructionsFor each of the following activity cost pools, select the most appropriate cost driver:

Code Cost Pool

_____ 1. Machine setup

_____ 2. Ordering and receiving

_____ 3. Packaging and shipping

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_____ 4. Engineering design

_____ 5. Machining

_____ 6. Assembly


1. B 4. A2. F 5. C3. E 6. D

Ex. 74

Identify appropriate cost drivers for the following activity cost pools:1. Human resources2. Security3. Receiving4. Data processing


1. Number of employees, number of hires2. Square footage3. Shipments received4. Lines printed, CPU minutes, storage units

Ex. 75

Two of the activity cost pools for Sabrina Company are (a) machining ($800,000) and (b) inspections ($84,000). Possible cost drivers are direct labor hours (5,000), machine hours (25,000), square footage (4,000), and number of inspections (300).

InstructionsCompute the overhead rate for each activity.


$800,000(a) Machining: —————————— = $32 per machine hour

25,000 machine hours

$84,000(b) Inspections: ———————- = $280 per inspection

300 inspections

Ex. 76

Tanner, Inc. produces two models of cameras, Standard and Luxury. They sell 100,000 Standard cameras and 15,000 Luxury cameras annually. Tanner switched from traditional costing to activity-based costing and discovered that the cost allocated to Luxury cameras increased so dramatically that the Luxury was now only marginally profitable.

InstructionsGive a probable explanation for this shift.


Low-volume products often require more special handling, such as more machine setups and

inspections, than high-volume products. Also, the overhead costs incurred by the low-volume product are often disproportionate to a traditional allocation base such as direct labor hours.

Ex. 77

Compute activity-based costing rates from the following budgeted data for Freddy's Fashions:

Activity Cost Pool Budgeted Cost Budgeted Cost Driver Cutting and stitching $5,100,000

150,000machine hours

Trimming and packing 1,050,00042,000

operator hoursDesigning 930,000

62,000designer hours


Cutting and stitching ($5,100,000 ÷ 150,000)= $34

Trimming and packing ($1,050,000 ÷ 42,000)=$25

Designing ($930,000 ÷ 62,000) = $15

Ex. 78

Cool Designs manufactures metal trim used for a variety of projects. Cool Designs' activity-based costing overhead rates are:

Purchasing$170 per orderStoring$1 per square foot/daysMachining$50 per machine hourSupervision$2 per direct labor hour

Job 319 involved three purchase orders, 4,000 square feet/days, 60 machine hours, and 30 direct labor hours. The cost of direct materials on the job was $8,500 and the direct labor rate is $15 per hour.

InstructionsDetermine the total cost of Job 319.

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Direct materials $ 8,500Direct labor (30 × $15) 450450Factory overhead

Purchasing (3 × $170) $ 510Storing (4,000 × $1) 4,000Machining (60 × $50) 3000 3,000Supervision (30 × $2) 60 7570

60 7,570Total cost 16520$16,520

Ex. 79

Label the following costs as value-adding (VA) or nonvalue-adding (NVA):

____ 1. Engineering design

____ 2. Machine repair

____ 3. Inventory storage

____ 4. Machining

____ 5. Assembly

____ 6. Painting

____ 7. Inspections

____ 8. Packaging


1. VA 5. VA2. NVA 6. VA3. NVA 7. NVA4. VA 8. VA

Ex. 80

Borke and Falvery is a law firm that uses activity-based costing. Classify these activities as value-added or nonvalue-added:

______________________1.Taking appointments

______________________2.Reception

______________________3.Meeting with clients

______________________4.Bookkeeping

______________________5.Court time

______________________6.Meeting with opposing attorneys

______________________ 7.Billing

______________________ 8.Advertising


1. Nonvalue-added 5.Value-added2. Nonvalue-added 6.Value-added3. Value-added 7.Nonvalue-added4. Nonvalue-added 8.Nonvalue-added

Tim Taylor Tool Company manufactures small tools. Classify each of the following activity costs of the tool company as either unit level, batch level, product level, or facility level:

______________________ 1. Plant management

______________________ 2. Drilling

______________________ 3. Painting

______________________ 4. Machine setups

______________________ 5. Product design

______________________ 6. Cutting

______________________ 7. Inspection

______________________ 8. Inventory management

Solution *83 (4–6 min.)

1. Facility 5. Product2. Unit 6. Unit3. Unit 7. Batch4. Batch 8. Product

COMPLETION STATEMENTS

84. In traditional costing systems, direct labor cost is often used for the assignment of all ____________________.

85. A __________________ is any activity that has a direct cause-effect relationship with the resources consumed.

86. In activity-based costing, overhead costs are allocated to ____________________, then assigned to products.

87. The number of ___________________ is an appropriate cost driver for the ordering and receiving activity cost pool.

88. The primary benefit of activity-based costing is ___________________ product costing.

89. When product lines differ greatly in volume and manufacturing complexity, a switch from traditional costing to ___________________ is indicated.

90. ______________________ increase the worth of a product or service to customers.

91. A primary objective of __________________ processing is to eliminate all manufacturing inventories.

92. Dependable suppliers, a multi-skilled workforce, and a __________________________ are necessary elements of just-in-time processing.

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*93. In the hierarchy of activity levels, the four levels are __________, ___________, ____________, and _____________.

*94. Equipment setups are a ______________-level activity.

Answers to Completion Statements

84. overhead costs85. cost driver86. activity cost pools87. purchase orders88. more accurate89. activity-based costing90. value-added activities91. just-in-time92. total quality control system

*93. unit, batch, product, facility*94. batch

MATCHING

95. Match the items in the two columns below by entering the appropriate code letter in the space provided.

A. Pull approach F.Just-in-time processing

B. Cost driver G.Batch-level activity

C. Facility-level activity H.Product-level activity

D. Unit-level activity I.Nonvalue-added activity

E. Activity-based costing J.Value-added activity

_______ 1. Allocates overhead to multiple activity cost pools, then assigns the activity cost pools to products.

_______ 2. An activity that has a direct cause-effect relationship with the resources consumed.

_______ 3. Increases the worth of a product or service to customers.

_______ 4. Should be eliminated or reduced.

_______ 5. Plant management.

_______ 6. Engineering changes.

_______ 7. Equipment setups.

_______ 8. Assembling.

_______ 9. Primary objective is to eliminate all manufacturing inventories.

_______ 10. Used to initiate manufacturing under JIT processing.

Answers to Matching

1. E 6. H2. B 7. G3. J 8. D4. I 9. F5. C 10. A

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Test Bank for Managerial Accounting, Second Edition4-8