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# Reading 34: Understanding the Cash Flow Statement - LOS f,

Q1. The following information is from the balance sheet of Silverstone Company:

Net Income for 5/1/05 to 5/31/05: \$8,000

 Balance 5/01/05 Account Balance 5/31/05 \$2,000 Inventory \$1,750 \$1,200 Prepaid exp. \$1,700 \$800 Accum. Depr. \$975 \$425 Accounts payable \$625 \$650 Bonds payable \$550

Using the indirect method, calculate the cash flow from operations for Silverstone Company as of 5/31/05:

A)   Increase in cash of \$7,725.

B)   Increase in cash of \$8,125.

C)   Increase in cash of \$8,025.

Q2. Convenience Travel Corp.’s financial information for the year ended December 31, 2004 included the following:

Property Plant & Equipment       \$15,000,000

Accumulated Depreciation         9,000,000

The only asset owned by Convenience Travel in 2005 was a corporate jet airplane. The airplane was being depreciated over a 15-year period on a straight-line basis at a rate of \$1,000,000 per year. On December 31, 2005 Convenience Travel sold the airplane for \$10,000,000 cash. Net income for the year ended December 31, 2005 was \$12,000,000. Based on the above information, and ignoring taxes, what is cash flow from operations (CFO) for Convenience Travel for the year ended December 31, 2005?

A)   \$8,000,000.

B)   \$12,000,000.

C)   \$13,000,000.

Q3. 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)   \$2,200.

C)   \$1,000.

Q4. 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 \$248.

B)   Increase in cash of \$173.

C)   Increase in cash of \$183.

Q1. The following information is from the balance sheet of Silverstone Company:

Net Income for 5/1/05 to 5/31/05: \$8,000

 Balance 5/01/05 Account Balance 5/31/05 \$2,000 Inventory \$1,750 \$1,200 Prepaid exp. \$1,700 \$800 Accum. Depr. \$975 \$425 Accounts payable \$625 \$650 Bonds payable \$550

Using the indirect method, calculate the cash flow from operations for Silverstone Company as of 5/31/05:

A)   Increase in cash of \$7,725.

B)   Increase in cash of \$8,125.

C)   Increase in cash of \$8,025.

Correct answer is B)

Silverstone Company’s cash flow from operations would be calculated as +Net Income \$8,000 + Inventory \$250 - Prepaid exp. \$500 + Depreciation \$175 + A/P \$200 = \$8,125.

Bonds payable is a financing activity and would not be included in the cash flow from operations. The indirect method takes the change in the non-cash accounts and decreases or increases net income to get to the change in cash flow.

Q2. Convenience Travel Corp.’s financial information for the year ended December 31, 2004 included the following:

Property Plant & Equipment       \$15,000,000

Accumulated Depreciation         9,000,000

The only asset owned by Convenience Travel in 2005 was a corporate jet airplane. The airplane was being depreciated over a 15-year period on a straight-line basis at a rate of \$1,000,000 per year. On December 31, 2005 Convenience Travel sold the airplane for \$10,000,000 cash. Net income for the year ended December 31, 2005 was \$12,000,000. Based on the above information, and ignoring taxes, what is cash flow from operations (CFO) for Convenience Travel for the year ended December 31, 2005?

A)   \$8,000,000.

B)   \$12,000,000.

C)   \$13,000,000.

Correct answer is A)

Using the indirect method, CFO is net income increased by 2005 depreciation (\$1,000,000) and decreased by the gain recognized on the sale of the plane [\$10,000,000 sale price − (\$15,000,000 original cost − \$10,000,000 accumulated depreciation including 2005) = \$5,000,000]. \$12,000,000 + \$1,000,000 − \$5,000,000 = \$8,000,000.

Q3. 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)   \$2,200.

C)   \$1,000.

Correct answer is C)

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.

Q4. 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 \$248.

B)   Increase in cash of \$173.

C)   Increase in cash of \$183.

Correct answer is A)

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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