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Mark Industries' income statement and related notes for the year ended December 31 are as follows (in $):

Sales	42,000,000
Cost of Goods Sold	(32,000,000)
Wages Expense	(1,500,000)
Depreciation Expense	(2,500,000)
Interest Expense	(1,000,000)
Income Tax Expense	(2,000,000)
Net Income	3,000,000

During the year:

• Wages Payable increased $100,000.
• Accumulated Depreciation increased $2,500,000.
• Interest Payable decreased $200,000.
• Income Taxes Payable increased $500,000.
• Dividends of $100,000 were declared and paid.

Mark Industries’ cash flow from operations (CFO) for the year ended December 31 was:

A) $4,800,000.

B) $5,900,000.

C) $4,400,000.

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Using the indirect method, net income is increased by depreciation expense, the increase in wages payable and the increase in income taxes payable, and then is reduced by the decrease in interest payable. Dividends paid are financing activities. $3,000,000 + $2,500,000 + $100,000 + $500,000 - $200,000 = $5,900,000.

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What is the impact on accounts receivable if sales exceed cash collections and what is the impact on accounts payable if cash paid to suppliers exceeds purchases?

A) Both accounts payable and accounts receivable will increase.

B) Only accounts receivable will increase.

C) Only accounts payable will increase.

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If a firm sells more than it collects, accounts receivable will increase. If a firm pays suppliers more than it purchases, accounts payable will decrease.

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Murray Company reported the following revenues and expenses for the year ended 2007:

Sales revenue	$200,000
Wage expense	89,000
Insurance expense	17,000
Interest expense	10,400
Depreciation expense	50,000

Following are the related balance sheet accounts:

	2007	2006
Unearned revenue	$15,600	$13,200
Wages payable	5,400	6,600
Prepaid insurance	1,200	0
Interest payable	500	1,600
Accumulated depreciation	95,000	45,000

Calculate cash collections and cash expenses.

Cash collections

Cash expenses

A) $202,400 $119,900

B) $202,400 $58,100

C) $197,600 $119,900

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Cash collections are $202,400 ($200,000 sales + $2,400 increase in unearned revenue). Cash expenses are $119,900 (–$89,000 wages expense – $1,200 decrease in wages payable – $17,000 insurance expense – $1,200 increase in prepaid insurance – $10,400 interest expense – $1,100 decrease in interest payable). Depreciation expense is a non-cash expense.

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Maverick Company reported the following financial information for 2007:

	in millions
Beginning accounts receivable	$180
Ending accounts receivable	225
Sales	11,000
Beginning inventory	2,000
Ending inventory	2,300
Purchases	8,100
Beginning accounts payable	1,600
Ending accounts payable	1,200

Calculate Maverick’s cost of goods sold and cash paid to suppliers for 2007.

Cost of goods sold

Cash paid to suppliers

A) $7,800 million $8,500 million

B) $7,800 million $7,100 million

C) $3,800 million $8,500 million

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Cost of goods sold is equal to $7,800 million ($2,000 million beginning inventory + $8,100 million purchases – $2,300 million ending inventory). Cash paid to suppliers is equal to $8,500 million (–$7,800 COGS – $300 million increase in inventory – $400 million decrease in accounts payable). Alternate solution: Cash paid to suppliers is equal to $8,500 million (–$8,100 million purchases – $400 decrease in accounts payable).

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Darth Corporation’s most recent income statement shows net sales of $6,000, and Darth’s marginal tax rate is 40%. The total expenses reported were $3,200, all of which were paid in cash. In addition, depreciation expense was reported at $800. A further examination of the most recent balance sheets reveals that accounts receivable during that period increased by $1,000. The cash flow from operating activities reported by Darth should be:

A) $1,200.

B) $1,000.

C) $2,200.

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Net income is ($6,000 – 3,200 – 800)(1 – 0.4) = $1,200. Adjustments to reconcile net income to cash flow from operating activities will require that depreciation ($800) be added back, and increase in accounts receivable ($1,000) be subtracted: $1,200 + 800 – 1,000 = $1,000.

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Use the following financial data for Moose Printing Corporation to calculate the cash flow from operations (CFO) using the indirect method.

• Net income: $225

• Increase in accounts receivable: $55

• Decrease in inventory: $33

• Depreciation: $65

• Decrease in accounts payable: $25

• Increase in wages payable: $15

• Decrease in deferred taxes: $10

• Purchase of new equipment: $65

• Dividends paid: $75

A) Increase in cash of $173.

B) Increase in cash of $248.

C) Increase in cash of $183.

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CFO for Moose Printing Corporation is calculated as follows:

+Net Income $225 ? A/R $55 + Inventory $33 + Depreciation $65 ? A/P $25 + Wages Payable $15 ? Deferred taxes $10 = $248.

The purchase of new equipment would be an investing activity and, therefore, would not be included in the CFO. Dividends paid would be a financing activity and would not be included in the CFO.

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Use the following information to calculate cash flows from operations using the indirect method.

• Net Income: $12,000

• Depreciation Expense: $1,000

• Loss on sale of machinery: $500

• Increase in Accounts Receivable: $2,000

• Decrease in Accounts Payable: $1,500

• Increase in Income taxes payable: $500

• Repayment of Bonds: $3,000

A) Increase in cash of $7,500.

B) Increase in cash of $9,500.

C) Increase in cash of $10,500.

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Cash flow from operations would be calculated as +Net Income $12,000 + Depreciation $1,000 + Loss on sale of machinery $500 ? A/R $2,000 ? A/P $1,500 + Income taxes payable $500 = $10,500.

Repayment of Bonds is a financing activity and would not be included with operating activities. Depreciation is not a cash flow activity and is therefore always added back to net income to calculate CFO. The loss on the sale of machinery is not a cash outflow so it is also added back to calculate CFO. Accounts receivable is subtracted when there is an increase as this increases net income but does not affect cash.

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An analyst compiled the following information for Universe, Inc. for the year ended December 31, 20X4:

• Net income was $850,000.
• Depreciation expense was $200,000.
• Interest paid was $100,000.
• Income taxes paid were $50,000.
• Common stock was sold for $100,000.
• Preferred stock (eight percent annual dividend) was sold at par value of $125,000.
• Common stock dividends of $25,000 were paid.
• Preferred stock dividends of $10,000 were paid.
• Equipment with a book value of $50,000 was sold for $100,000.

Using the indirect method and assuming U.S. GAAP, what was Universe Inc.’s cash flow from operations (CFO) for the year ended December 31, 20X4?

A) $1,050,000.

B) $1,015,000.

C) $1,000,000.

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Cash flow from operations (CFO) using the indirect method is computed by taking net income plus non-cash expenses (i.e. depreciation) less gains from the equipment sale. Note that cash flow from operations must be adjusted downward for the amount of the gain on the sale of the equipment. Cash flow from operations is ($850,000 + $200,000 – ($100,000 ? $50,000)) = $1,000,000. Note that interest and income taxes paid are expenses shown on the income statement and will already be factored into net income. The other information relates to financial and investing cash flows.

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When using the indirect method for computing cash flow from operating activities, a change in accounts payable will require which of the following?

A) A negative (positive) adjustment to net income when accounts payable increases (decreases).

B) A negative adjustment to net income regardless of whether accounts payable increases or decreases.

C) A positive (negative) adjustment to net income when accounts payable increases (decreases).

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A decrease in accounts payable represents an outflow. Hence, a negative adjustment will be required. Conversely, an increase represents an inflow and a positive adjustment.

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Given the following information, what is the adjustment to net income when calculating cash flow from operations using the indirect method?

• Increase in accounts payable of $25.
• Sold one share of stock for $15.
• Paid dividends of $10 to shareholders.
• Depreciation expense of $100.
• Increase in inventory of $20.

A) +$105.

B) -$50.

C) -$95.

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Using the indirect method, the increase in accounts payable is a source of cash from operations (+25), depreciation expense is a non-cash expense added back in computing cash from operations (+100), and increase in inventory is a use of cash from operations (-20) = 25 + 100 - 20 = 105. The sale of stock and the dividends paid are financing cash flows that are not included in net income, so they do not require adjustment when calculating CFO.