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Chapter 23: Q20Q (page 1372)

Question: What are some of the arguments in favor of using the indirect (reconciliation) method as opposed to the direct method for reporting a statement of cash flows?

Short Answer

Expert verified

Answer

The indirect method is preferred over the direct method of cash flow because it does not require additional efforts for preparation; it is according to the accrual basis of accounting and also defines the difference between the net income and cash from operations.

Step by step solution

01

Definition of Cash Flow Statement

The statement prepared by the business entity providing the information regarding all the transactions that increase or decrease the cash balance is known as the cash flow statement. Such a statement is prepared in three sections.

02

Arguments in favor of using the indirect method

  1. The indirect method highlights the difference between the net income of the business entity and the cash generated from the operations.
  2. The direct method statement of cash flow confuses the financial statement's users with knowledge of only the accrual basis of accounting.
  3. Direct method cannot be justified based on cost-benefit analysis because it will require additional efforts as all other statements are prepared based on accrual accounting.

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Most popular questions from this chapter

Data for Krauss Company are presented in E23-5.

Instructions

Prepare the operating activities section of the statement of cash flows using the indirect method.

Question: GROUPWORK (Analysis of Transactions’ Effect on SCF) Each of the following items must be considered in preparing a statement of cash flows for Cruz Fashions Inc. for the year ended December 31, 2017.

  1. Fixed assets that had cost \(20,000 6½ years before and were being depreciated on a 10-year basis, with no estimated scrap value, were sold for \)4,750.
  2. During the year, goodwill of \(15,000 was considered impaired and was completely written off to expense.
  3. During the year, 500 shares of common stock with a stated value of \)25 a share were issued for \(32 a share.
  4. The company sustained a net loss for the year of \)2,100. Depreciation amounted to \(2,000 and patent amortization was \)400.
  5. Uncollectible accounts receivable in the amount of \(2,000 were written off against Allowance for Doubtful Accounts.
  6. Investments (available-for-sale) that cost \)12,000 when purchased 4 years earlier were sold for \(10,600.
  7. Bonds payable with a par value of \)24,000 on which there was an unamortized bond premium of $2,000 were redeemed at 101.

Instructions

For each item, state where it is to be shown in the statement and then how you would present the necessary information, including the amount. Consider each item to be independent of the others. Assume that correct entry were made for all transactions as they took place.

Jobim Inc. had the following condensed balance sheet at the end of operations for 2016.

JOBIM INC.

BALANCE SHEET

DECEMBER 31, 2016

Cash \( 8,500 Current liabilities \) 15,000

Current assets other than cash 29,000 Long-term notes payable 25,500

Equity investments 20,000 Bonds payable 25,000

Plant assets (net) 67,500 Common stock 75,000

Land 40,000 Retained earnings 24,500

\(165,000 \)165,000

During 2017, the following occurred.

1. A tract of land was purchased for \(9,000.

2. Bonds payable in the amount of \)15,000 were redeemed at par.

3. An additional \(10,000 in common stock was issued at par.

4. Dividends totaling \)9,375 were paid to stockholders.

5. Net income was \(35,250 after allowing depreciation of \)13,500.

6. Land was purchased through the issuance of \(22,500 in bonds.

7. Jobim Inc. sold part of its investment portfolio for \)12,875. This transaction resulted in a gain of $2,000 for the company. No unrealized gains or losses were recorded on these investments in 2017.

8. Both current assets (other than cash) and current liabilities remained at the same amount.

Instructions

(a) Prepare a statement of cash flows for 2017 using the indirect method.

(b) Prepare the condensed balance sheet for Jobim Inc. as it would appear at December 31, 2017

Unlike the other major financial statements, the statement of cash flows is not prepared from the adjusted trial balance. From what sources does the information to prepare this statement come, and what information does each source provide?

Wainwright Corporation had the following activities in 2017:

1. Sale of land \(180,000.

4. Purchase of equipment \)415,000.

2. Purchase of inventory \(845,000.

5. Issuance of common stock \)320,000.

3. Purchase of treasury stock \(72,000.

6. Purchase of available-for-sale debt securities \)59,000.

Compute the amount Wainwright should report as net cash provided (used) by investing activities in its 2017 statement of cash flows.
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