Bad5shah

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.

Bad5shah

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) $12,000,000.

B) $8,000,000.

C) $13,000,000.

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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.

Bad5shah

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.

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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.

Bad5shah

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.

Bad5shah

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

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

Bad5shah

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) -$50.

B) +$105.

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.

Bad5shah

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

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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).

Bad5shah

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.

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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.

Bad5shah

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.

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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.

Bad5shah

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
	12-31-04	12-31-05
Cash	32	52
Accounts Receivable	18	22
Inventory	46	44
Property, Plant & Equip. (net)	182	160
Total Assets	278	278
Accounts Payable	28	33
Long-term Debt	145	135
Common Stock	70	70
Retained Earnings	35	40
Total Liabilities & Equity	278	278

Cash flow from operations (CFO) for Eagle Company for the year ended December 31, 2005 was (in $ millions).

A) $29.

B) $41.

C) $37.

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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