91Ó°ÊÓ

Question: (SCF Theory and Analysis of Transactions) Ashley Company is a young and growing producer of electronic measuring instruments and technical equipment. You have been retained by Ashley to advise it in the preparation of a statement of cash flows using the indirect method. For the fiscal year ended October 31, 2017, you have obtained the following information concerning certain events and transactions of Ashley.

1. The amount of reported earnings for the fiscal year was \(700,000, which included a deduction for a loss of \)110,000 (see item 5 below).

2. Depreciation expense of \(315,000 was included in the income statement.

3. Uncollectible accounts receivable of \)40,000 were written off against the allowance for doubtful accounts. Also, \(51,000 of bad debt expense was included in determining income for the fiscal year, and the same amount was added to the allowance for doubtful accounts.

4. A gain of \)6,000 was realized on the sale of a machine. It originally cost \(75,000, of which \)30,000 was undepreciated on the date of sale.

5. On April 1, 2017, lightning caused an uninsured building loss of \(110,000 (\)180,000 loss, less reduction in income taxes of \(70,000). This loss was included in determining income as indicated in item 1 above.

6. On July 3, 2017, building and land were purchased for \)700,000. Ashley gave in payment \(75,000 cash, \)200,000 market price of its unissued common stock, and signed a \(425,000 mortgage note payable.

7. On August 3, 2017, \)800,000 face value of Ashley’s 10% convertible debentures was converted into $150,000 par value of its common stock. The bonds were originally issued at face value.

Instructions

Explain whether each of the seven numbered items above is a cash inflow or outflow, and explain how it should be disclosed in Ashley’s statement of cash flows for the fiscal year ended October 31, 2017. If any item is neither an inflow nor an outflow of cash, explain why it is not, and indicate the disclosure, if any, that should be made of the item in Ashley’s statement of cash flows for the fiscal year ended October 31, 2017.

Step by step solution

01

Definition of Statement of Cash Flow

The schedule prepared by the business entity for providing a summary of all the transactions, including cash payments and receipts, is known as the statement of cash flow.

02

Deduction for loss

The deduction for the loss of $110,000 will be added to the adjustment to the net income under the operating section of the cash flow statement

03

Depreciation expenses

The depreciation expenses of $315,000 will be added back in the adjustment to the net income under the operating section of the cash flow statement.

04

Writing of uncollectible receivables and bad debt expenses

The uncollectible accounts do not affect the cash position of the business entity. Therefore, they will not be recorded. But the bad debt expenses of $51,000 deducted for calculating the net income will be added back to the operating section of the cash flow.

05

Sale of machine

A gain of $6,000 will be deducted in the adjustments to the net income under the operating section of the cash flow. $36,000 will be added to the investing section of the cash flow as the sale of the machine.

06

Uninsured building loss

The loss is abnormal and is deducted at the time of calculation of net income. Therefore, it will be added back to the adjustment to the net income under the operating section of the cash flow statement.

07

Purchase of building for cash and equity and debt securities

The business entity will report $75,000 as an outflow (deducted) of cash in the investing section of the cash flow statement. Issue of common stock and signing of mortgage note payable will be reported as significant non-cash financing and investing activity in a separate schedule at the end of the cash flow statement.

08

Conversion of convertible debentures

Conversion of convertible bonds into common equity shares does not involve a change in the cash position of the business entity. It is a significant non-cash financing activity.

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