Overview of direct and indirect methods

Reference no: EM13785775

Please complete the following 5 exercises below in either Excel or a word document (but must be single document). You must show your work where appropriate (leaving the calculations within Excel cells is acceptable).

1. Critical Thinking Question:

Answer the following questions:

Why are noncash transactions, such as the exchange of common stock for a building for example, included on a statement of cash flows? How are these noncash transactions disclosed?

2. Classification of activities

Classify each of the following transactions as arising from an operating (O), investing (I), financing (F), or noncash investing/financing (N) activity.

a. ________ Received $80,000 from the sale of land.

b. ________ Received $3,200 from cash sales.

c. ________ Paid a $5,000 dividend.

d. ________ Purchased $8,800 of merchandise for cash.

e. ________ Received $100,000 from the issuance of common stock.

f. ________ Paid $1,200 of interest on a note payable.

g. ________ Acquired a new laser printer by paying $650.

h. ________ Acquired a $400,000 building by signing a $400,000 mortgage note.

3. Overview of direct and indirect methods

Evaluate the comments that follow as being True or False. If the comment is false, briefly explain why.

a. Both the direct and indirect methods will produce the same cash flow from operating activities.

b. Depreciation expense is added back to net income when the indirect method is used.

c. One of the advantages of using the direct method rather than the indirect method is that larger cash flows from financing activities will be reported.

d. The cash paid to suppliers is normally disclosed on the statement of cash flows when the indirect method of statement preparation is employed.

e. The dollar change in the Merchandise Inventory account appears on the statement of cash flows only when the direct method of statement preparation is used.

4. Equipment transaction and cash flow reporting

	Dec. 31, 20X4	Dec. 31, 20X3
Property, Plant & Equipment: Land	$94,000	$94,000
Equipment	652,000	527,000
Less: Accumulated depreciation	-316,000	-341,000

New equipment purchased during 20x4 totaled $280,000. The 20x4 income statement disclosed equipment depreciation expense of $41,000 and a $9,000 loss on the sale of equipment.

a. Determine the cost and accumulated depreciation of the equipment sold during 20X4.

b. Determine the selling price of the equipment sold.

c. Show how the sale of equipment would appear on a statement of cash flows prepared by using the indirect method.

5. Cash flow information: Direct and indirect methods
The comparative year-end balance sheets of Sign Graphics, Inc., revealed the following activity in the company's current accounts:

	20X5	20X4	Increase / Decrease)
Current assets
Cash	$55,400	$35,200	$20,200
Accounts receivable (net)	83,800	88,000	-4,200
Inventory	243,400	233,800	9,600
Prepaid expenses	25,400	24,200	1,200

Current liabilities
Accounts payable	$123,600	$140,600	($17,000)
Taxes payable	43,600	49,200	-5,600
Interest payable	9,000	6,400	2,600
Accrued liabilities	38,800	60,400	-21,600
Note payable	44,000	-	44,000

The accounts payable were for the purchase of merchandise. Prepaid expenses and accrued liabilities relate to the firm's selling and administrative expenses. The company's condensed income statement follows.

SIGN GRAPHICS INC.
Income Statement
for the Year Ended December 31, 20x5

Sales		$713,800
Less: Cost of goods sold		323,000
Gross profit		$390,800

Less: Selling & administrative expenses	$186,000
Depreciation expense	17,000
Interest expense	27,000	230,000

Add: gain on sale of land		$160,800
		21,800
Income before taxes		$182,600
Income taxes		36,800
Net income		$145,800

Other data:

1. Long-term investments were purchased for cash at a cost of $74,600.

2. Cash proceeds from the sale of land totaled $76,200.

3. Store equipment of $44,000 was purchased by signing a short-term note payable. Also, a $150,000 telecommunications system was acquired by issuing 3,000 shares of preferred stock.

4. A long-term note of $49,400 was repaid.

5. Twenty thousand shares of common stock were issued at $5.19 per share.

6. The company paid cash dividends amounting to $128,600.

Instructions:

a. Prepare the operating activities section of the company's statement of cash flows, assuming use of:

1. The direct method.

2. The indirect method.

b. Prepare the investing and financing activities sections of the statement of cash flows.

Reference no: EM13785775

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