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Impala Corporation reported the following financial information:

2006

2007


Balance sheet values as of December 31:



Prepaid insurance

$650,000

$475,000


Interest payable

250,000

300,000


Cash flows for the year ended December 31:



Insurance premiums paid

$845,000

$750,000


Interest paid

900,000

900,000


Calculate Impala’s insurance expense and interest expense for the year ended December 31, 2007.
Insurance expense Interest expense
A)
$1,020,000 $950,000
B)
$925,000 $950,000
C)
$925,000 $850,000



Cash paid for insurance = insurance expense + change in prepaid insurance, so insurance expense = cash paid for insurance – change in prepaid insurance. Insurance expense for 2007 is equal to $925,000 [($750,000 cash paid for insurance – (–$175,000)]. Interest expense for 2007 is equal to $950,000 ($900,000 cash interest paid + $50,000 increase in interest payable).

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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)
Only accounts receivable will increase.
B)
Both accounts payable and accounts receivable will increase.
C)
Only accounts payable will increase.



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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Pacific, Inc.’s financial information includes the following, with “change” referring to the difference from the prior year (in $ millions):

Net Income

27


Change in Accounts Receivable

+4


Change in Accounts Payable

+1


Change in Inventory

+5


Loss on sale of equipment

-8


Gain on sale of real estate

+4


Change in Retained Earnings

+21


Dividends declared and paid

+4


Pacific, Inc.’s cash flow from operations (CFO) in millions was:
A)
$23.
B)
$27.
C)
$15.



Using the indirect method, cash flow from operations is net income less increase in accounts receivable, plus increase in accounts payable, less increase in inventory, plus loss on sale of equipment, less gain on sale of real estate. 27 – 4 + 1 – 5 + 8 – 4 = $23 million.

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Eagle Company’s financial statements for the year ended December 31, 2005 were as follows (in $ millions):

Income Statement




Sales

150


Cost of Goods Sold

(48)


Wages Expense

(56)


Interest Expense

(12)


Depreciation

(22)


Gain on Sale of Equipment

6


Income Tax Expense

( 8)


Net Income

10


Balance Sheet
12-31-0412-31-05
Cash3252
Accounts Receivable1822
Inventory4644
Property, Plant & Equip. (net)182160
Total Assets278278
Accounts Payable2833
Long-term Debt145135
Common Stock7070
Retained Earnings3540
Total Liabilities & Equity278278

Cash flow from operations (CFO) for Eagle Company for the year ended December 31, 2005 was (in $ millions).
A)
$29.
B)
$41.
C)
$37.



Using the indirect method:

Add: Net Income

$10


Add: Depreciation Expense

22


Less: Gain from Sale of Equip.

(6)


Less: Increase in Accounts Receivable

(4)


Add: Decrease in Inventory

2


Add: Increase in Accounts Payable

5


Cash flow from operations (CFO)

29

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When calculating cash flow from operations (CFO) using the indirect method which of the following is most accurate?
A)
The indirect method requires an additional schedule to reconcile net income to cash flow.
B)
In using the indirect method, each item on the income statement is converted to its cash equivalent.
C)
When recognizing a gain on the sale of fixed assets, the amount is a deduction to operating cash flows.



When recognizing a gain on the sale of fixed assets, the amount is a deduction to operating cash flows. This is because the gain would be double counted in the investing section and in net income. Therefore, the gain must be removed from net income. The direct method of cash flow calculation converts the income statement items to their cash equivalents, not the indirect method. Also, depreciation is added to net income in order to calculate CFO using the indirect method.

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A company has the following changes in its balance sheet accounts:

Net Sales

$500


An increase in accounts receivable

20


A decrease in accounts payable

40


An increase in inventory

30


Sale of common stock

100


Repayment of debt

10


Depreciation

2


Net Income

100


Interest expense on debt

5


The company’s cash flow from financing is:
A)
$100.
B)
$90.
C)
-$10.



Sale of common stock $100
Repayment of debt (10)
Financing cash flows $ 90

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Which of the following statements about accounting procedures and their impact on the statement of cash flows is least valid? All else equal:
A)
A nonprofitable company that uses LIFO to account for inventory will have higher total cash flow than a nonprofitable company that uses FIFO during a period of rising prices.
B)
Cash flow from financing (CFF) is higher over the life of a bond if a firm issues the bond at a premium, compared to issuing the bond at par.
C)
A company that finances through common stock issues may have the same cash flow from financing (CFF) as a firm that issues debt.


Because of the impact of income taxes, a profitable company that accounts for inventory using LIFO will have higher total cash flow than a profitable company that uses FIFO. The company that uses LIFO will have higher cost of goods sold, resulting in lower net income and thus lower taxes. The other statements are accurate:
  • A company that issues common stock is not required to pay dividends (which would reduce cash flow from financing). Thus, it may have the same CFF as a firm that issues debt since interest paid on debt is a component of CFO.
  • When a company issues bonds at a premium, the proceeds raised at issuance (CFF inflow) are greater than the par value repaid at maturity (CFF outflow). For bonds issued at par, the CFF inflow at issuance is equal to the CFF outflow at maturity.

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The net income for Miller Bat Company was $3 million for the year ended December 31, 2004. Additional information is as follows:
  • Depreciation on fixed assets $1,500,000

  • Gain from cash sales of land 200,000

  • Increase in accounts payable 300,000

  • Dividends paid on preferred stock 400,000

The net cash provided by operating activities in the statement of cash flows for the year ended December 31, 2004 is:
A)
$4,800,000.
B)
$4,600,000.
C)
$4,200,000.



$3,000,000 + $1,500,000 − $200,000 + $300,000 = $4,600,000.

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Galaxy, Inc.’s U.S. GAAP balance sheet as of December 31, 2004 included the following information (in $):

12-31-03

12-31-04


Accounts Payable

300,000

500,000


Dividends Payable

200,000

300,000


Common Stock

1,000,000

1,000,000


Retained Earnings

700,000

1,000,000


Galaxy’s net income in 2004 was $800,000. What was Galaxy’s cash flow from financing (CFF) in 2004?
A)
-$300,000.
B)
-$500,000.
C)
-$400,000.



Dividends declared in 2004 are net income less the increase in retained earnings ($800,000 - $300,000 = $500,000). Dividends declared less the increase in dividends payable is dividends paid ($500,000 – ($300,000 - $200,000) = $400,000). This is a cash outflow so it is a negative number. Dividends paid are always cash flow from financing under U.S. GAAP. Note that accounts payable changes are included in cash flow from operations (CFO).

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Determine the cash flow from investing given the following table:
ItemAmount
Cash payment of dividends$30
Sale of equipment$25
Net income$25
Purchase of land$15
Increase in accounts payable$20
Sale of preferred stock$25
Increase in deferred taxes$5
A)
-$5.
B)
-$10.
C)
$10.


ItemAmount
Cash payment of dividendsCFF-$30
Sale of equipmentCFI+$25
Net incomeCFO+$25
Purchase of landCFI-$15
Increase in accounts payableCFO+$20
Sale of preferred stockCFF+$25
Increase in deferred taxesCFO+$5

CFI = Sale of Equipment (+25) + Purchase of Land (–15) = $10.

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