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.


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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


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.

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