solution

Interpreting Cash Flow Effects of Transactions

Complete the requirements of Problem 7–6 using the business activities listed below:

Part I

a. An annual installment of $100,000 due on long-term debt is paid on its due date.

b. Equipment originally costing $12,000 with $7,000 of accumulated depreciation is sold for $4,000 cash.

c. Obsolete inventory costing $75,000 is written down to zero.

d. Treasury stock costing $30,000 is sold for $28,000 cash.

e. A plant is acquired by issuing a $300,000 mortgage payable due in equal installment over six years.

f. The company’s 30 percent-owned unconsolidated subsidiary earns $100,000 and pays dividends of $20,000. The company recorded its 30 percent share of these items using the equity method.

g. A product is sold for $40,000, to be paid with $10,000 down plus $10,000 each year for three years. Interest at 10 percent of the outstanding balance is due. Consider only the effect at the time of sale (the company’s operating cycle is less than one year).

h. The company uses a periodic inventory method. Certain inventory is mistakenly valued at $1,000—it should have been valued at $10,000. Show the effect of correcting the error.

i. Cash of $400,000 is used to acquire 100 percent of ZXY Manufacturing Company. At date of acquisition, ZXY has current assets of $300,000 (including $40,000 in cash); plant and equipment of $670,000; current liabilities of $160,000; and long-term debt of $410,000.

j. A provision for bad debt expense of $60,000 is made (calculated as a percent of sales for the period).

Part II

a. Cash of $120,000 is invested in a 30-percent-owned company.

b. A 30 percent-owned subsidiary earns $25,000 (in total) and pays no dividends.

c. A 30 percent-owned subsidiary earns $30,000 (in total) and pays dividends of $10,000 (in total).

d. Equipment with an original cost of $15,000 and accumulated depreciation of $12,000 is sold for $4,000 cash.

e. The company borrows $60,000 from its banks on November 30 payable on June 30 of next year.

f. Convertible bonds with a face value of $9,000 are converted into 1,000 shares of common stock with a par value of $2 per share.

g. Treasury stock with a cost of $4,000 is sold for $6,000 cash.

h. Common stock (par value $2) with a fair market value of $100,000 plus $100,000 cash are given to acquire 100 percent of ZXY Mfg. Co. At date of acquisition ZXY had current assets of $120,000 (including $40,000 cash); plant and equipment of $180,000; current liabilities of $60,000; and long-term debt of $40,000.

(1) Identify the effect on the parent’s statement.

(2) Identify the effect on the consolidated statement.

i. The minority’s share of income is $4,000.

j. Inventory with a cost of $80,000 is written down to its market value of $30,000.

k. Accounts receivable for $1,200 are written off. The company uses an allowance for doubtful accounts.

l. A noncancelable lease of equipment for 10 years with a present value of $120,000 is capitalized.

m. A 15 percent stock dividend is declared. The 60,000 shares of common stock issued to cover the dividend have

a par value of $2 per share and a fair market value of $3 per share.

n. A provision of $27,000 for uncollectible accounts is made (calculated as a percent of sales for the period).

Problem 7–6

Interpreting Cash Flow Effects of Transactions

An ability to visualize quickly the effect of a transaction on the cash resources of a company is a useful analytical skill. This visualization requires an understanding of the economics underlying transactions and how they are accounted for. Expressing transactions in entry form can help one understand business activities.

Required:

A schematic statement of cash flows is reproduced below. The titles of lines in the schematic are given labels (letters). Several business activities are listed below the schematic. For each of the activities listed, identify the lines affected and by what amount. Each activity is separate and unrelated to another. The company closes its books once each year on December 31. Do not consider subsequent activities. Use the labels (letters) shown below. Do not indicate the effect on any line not given a label. If a transaction has no effect, write none. In indicating effects for lines labeled Y and C, use a to indicate an increase and a to indicate a decrease. (Hint: Every activity with an effect, affects at least two lines—equal debits and credits. An analytical entry can aid in arriving at a solution.)

Schematic Statement of Cash Flows

Examples:

a. Sales of $10,000 are made on credit.

b. Cash dividends of $4,000 are paid.

c. Entered into long-term capital lease obligation (present value $60,000).

Answers in the Form [Line, Amount]:

a. [DC, $10,000], [ Y, $10,000]

b. [ID, $4,000], [ C, $4,000]

c. [NAA, $60,000], [NDE, $60,000]

Business activities:

a. Provision for bad debts of $11,000 for the year is included in selling expenses.

b. Depreciation of $16,000 is charged to cost of goods sold.

c. Company acquires a building by issuance of a long-term mortgage note for $100,000.

d. Treasury stock with a cost of $7,000 is retired and canceled.

e. The company has outstanding 50,000 shares of common stock with par value of $1. The company declares a

20 percent stock dividend at the end of the year when the stock is selling for $16 a share.

f. Inventory costing $12,000 is destroyed by fire. The insurance company pays only $10,000 toward this loss, although the market value of the inventory is $15,000.

g. Inventories originally costing $25,000 are used by production departments in producing finished goods that are sold for $35,000 in cash and $5,000 in accounts receivable.

h. Accounts receivable of $8,000 are written off. There is an allowance for doubtful accounts balance of $5,000 prior to the write off.

i. Long-lived assets are acquired for $100,000 cash on January 1. The company decides to depreciate $20,000 each year.

j. A machine costing $15,000 with accumulated depreciation of $6,000 is sold for $8,000 cash.