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Chapter Twelve
Challenge Exercise 1
An analysis of comparative balance sheets, the current year’s income statement, and the general ledger
accounts of Guillen Corp. uncovered the following items. Assume all items involve cash unless there is
information to the contrary.
(a) Payment of interest on notes payable.
(b) Exchange of land for patent.
(c) Sale of building for an amount greater than book value.
(d) Payment of dividends.
(e) Depreciation.
(f) Receipt of dividends on investment in stock.
(g) Sales.
(h) Issuance of capital stock.
(i) Amortization of patent.
(j) Issuance of bonds for land.
(k) Purchase of land.
(l) Conversion of bonds into common stock.
(m) Sale of land for an amount less than cost.
(n) Retirement of bonds.
(o) Cost of goods sold.
(p) Purchase of treasury stock.
(q) Increase in accounts receivable.
Instructions:
Indicate where each item should be reported in the statement of cash flows (indirect method), using
these categories: (1) operating activity (added to net income), (2) operating activity (deducted from net
income), (3) investing activity, (4) financing activity, (5) significant noncash investing and financing
activity, or (6) not separately reported in the statement of cash flows. More than one number can be
used per item.
Challenge Exercise 1 – Solution
(a) Payment of interest on notes payable. (6) not separately reported in the statement of
cash flows.
Challenge Exercise 1 – Solution (Continued)
Challenge Exercise 2
Pancho Company reported net income of $245,000 for 2014. Pancho sold equipment that cost $100,000 and
had a book value of $60,000 for $52,000. The comparative balance sheet shows a decrease in accounts
receivable of $19,000 for the year, a $13,000 increase in accounts payable, a $4,000 increase in prepaid
expenses, and a $17.000 increase in accumulated depreciation.
Instructions:
Prepare the operating activities section of the statement of cash flows for 2014. Use the indirect method.
Challenge Exercise 2 – Solution
PANCHO COMPANY
Partial Statement of Cash Flows
For the Year Ended December 31, 2014
Cash flows from operating activities
Net income ........................................................................................ $245,000
Adjustments to reconcile net income to net cash provided by operating activities:
Challenge Exercise 3
The current sections of Birmingham Inc.’s balance sheets at December 31, 2013 and 2014, are presented
here.
Birmingham’s net income for 2014 was $193,000. The income statement included depreciation expense,
$25,000, amortization expense, $10,000, and a gain on disposal of equipment, $7,000. The equipment was
sold for $47,000. Birmingham also issued bonds for $60,000.
2014 2013
Current assets
Cash $417,000 $ 99,000
Accounts receivable 120,000 93,000
Inventory 159,000 176,000
Prepaid expenses 29,000 24,000
Total current assets $725,000 $392,000
Current liabilities
Accrued expenses payable $ 17,000 $ 6,000
Accounts payable 88,000 94,000
Total current liabilities $105,000 $100,000
Instructions :
Prepare the net cash provided by operating activities section of the company’s statement of cash flows for the
year ended December 31, 2014, using the indirect method.
Challenge Exercise 3 – Solution
BIRMINGHAM INC.
Partial Statement of Cash Flows
For the Year Ended December 31, 2014
Cash flows from operating activities
Net income ............................................................................................ $193,000
Adjustments to reconcile net income to net
cash provided by operating activities
Challenge Exercise 4
Here are comparative balance sheets for Migitsu Company. Prepare a statement of cash flows—indirect
method.
MIGITSU COMPANY
Comparative Balance Sheets
December 31
Assets 2014 2013
Cash $ 73,000 $ 22,000
Accounts receivable 87,000 76,000
Inventories 170,000 191,000
Land 72,000 100,000
Equipment 260,000 200,000
Accumulated depreciation (66,000) (32,000)
Total $596,000 $557,000
Liabilities and Stockholders’ Equity
Accounts payable $ 37,000 $ 47,000
Bonds payable 150,000 210,000
Common stock ($1 par) 216,000 174,000
Retained earnings 193,000 126,000
Total $596,000 $557,000
Additional information:
1. Net income for 2014 was $100,000.
2. Cash dividends of $33,000 were declared and paid.
3. Bonds payable amounting to $60,000 were redeemed for cash $60,000.
4. Common stock was issued for $42,000 cash.
5. Equipment that cost $50,000 and had a book value of $30,000 was sold for $36,000 during 2014; land was
sold at cost.
Instructions:
(a) Prepare a statement of cash flows for 2014 using the indirect method.
(b) Compute free cash flow for 2014.
Challenge Exercise 4 – Solution
MIGITSU COMPANY
Statement of Cash Flows
For the Year Ended December 31, 2014
Cash flows from operating activities
Net income ........................................................................ $100,000 )
Adjustments to reconcile net income
to net cash provided by operating
activities
Cash flows from investing activities
Sale of land ....................................................................... 28,000 )
Sale of equipment ............................................................. 36,000
Purchase of equipment ..................................................... (110,000 )
Net cash used by investing
activities ............................................................... (46,000 )
Challenge Exercise 5
For 2014, the income statement of George Corporation had revenues of $172,000 and operating expenses of
$88,000. Accounts receivable and accounts payable at year-end were $60,000 and $23,000, respectively. At
the beginning of the year, the balances were $39,000 for accounts receivable and $15,000 for accounts
payable. Assume that accounts payable related to operating expenses. Ignore income taxes.
Instructions:
Compute net cash provided by operating activities using the direct method.
Challenge Exercise 5 – Solution
Revenues ............................................................................................ $172,000)
Deduct: Increase in accounts receivable ........................................... (21,000 )
Cash receipts from customers* ................................................. $151,000
Challenge Exercise 6
The following information is taken from the 2014 general ledger of AJ Company.
Sales: Sales Revenue $200,000
Accounts receivable, January 1 36,000
Accounts receivable, December 31 10,000
CGS: Cost of goods sold $120,000
Accounts payable, January 1 16,000
Accounts payable, December 31 20,000
Inventory, January 1 26,000
Inventory, December 31 17,000
Rent: Rent expense $ 15,000
Prepaid rent, January 1 4,900
Prepaid rent, December 31 6,000
Salaries: Salaries and wages expense $ 48,000
Salaries and wages payable, January 1 5,000
Salaries and wages payable, December 31 4,000
Instructions:
In each case, compute the amount that should be reported in the operating activities section of the statement
of cash flows under the direct method.
Challenge Exercise 6 – Solution
Cash receipts from customers
Sales revenue ............................................................................. $200,000*
Cash payments for cost of goods sold
Cost of goods sold ...................................................................... $120,000*
Deduct: Increase in accounts payable ........................................ (4,000)
Cash payments for salaries
Salaries and wages expense ...................................................... $ 48,000*
