Registered bonds are issued in the name of the owner and require surrender of the certificate and issuance of a new certificate to complete the sale. A bearer or coupon bond is not recorded in the name of the owner and may be transferred from one investor to another by mere delivery.
Convertible bonds can be converted into other securities of the issuing corporation for a specified time after issuance. Commodity-backed bonds also called asset-linked bonds are redeemable in measures of a commodity. A discount on bonds payable results when investors demand a rate of interest higher than the rate stated on the bonds. The investors are not satisfied with the nominal interest rate because they can earn a greater rate on alternative investments of equal risk.
They refuse to pay par for the bonds and cannot change the nominal rate. However, by lowering the amount paid for the bonds, investors can alter the effective rate of interest. A premium on bonds payable results from the opposite conditions. That is, when investors are satisfied with a rate of interest lower than the rate stated on the bonds, they are willing to pay more than the face value of the bonds in order to acquire them, thus reducing their effective rate of interest below the stated rate.
Discount premium on bonds payable should be reported in the balance sheet as a direct deduction from addition to the face amount of the bond. Both are liability valuation accounts. Bond discount and bond premium may be amortized on a straight-line basis or on an effective- interest basis. The profession recommends the effective-interest method but permits the straight- line method when the results obtained are not materially different from the effective-interest method.
The straight-line method results in an even or average allocation of the total interest over the life of the notes or bonds. The effective-interest method results in an increasing or decreasing amount of interest each period. This is because interest is based on the carrying amount of the bond issuance at the beginning of each period.
The straight-line method results in a constant dollar amount of interest and an increasing or decreasing rate of interest over the life of the bonds. The effective-interest method results in an increasing or decreasing dollar amount of interest and a constant rate of interest over the life of the bonds. The annual interest expense will decrease each period throughout the life of the bonds. Under the effective-interest method the interest expense each period is equal to the effective or yield interest rate times the book value of the bonds at the beginning of each interest period.
When bonds are sold at a premium, their book value declines to face value over their life; therefore, the interest expense declines also. Bond issuance costs should be recorded as a reduction to the issue amount and then amortized into expense over the life of the bond. Amortization of Discount on Bonds Payable will increase interest expense. However, by lowering the amount paid for the bonds, investors can increase the effective rate of interest. The call feature of a bond issue grants the issuer the privilege of purchasing, after a certain date at a stated price, outstanding bonds for the purpose of reducing indebtedness or taking advantage of lower interest rates.
The call feature does not affect the amortization of bond discount or premium; because early redemption is not a certainty, the life of the bonds should be used for amortization purposes. It is sometimes desirable to reduce bond indebtedness in order to take advantage of lower prevailing interest rates. Also the company may not want to make a very large cash outlay all at once when the bonds mature. Bond indebtedness may be reduced by either issuing bonds callable after a certain date and then calling some or all of them, or by purchasing bonds on the open market and then retiring them.
When a portion of bonds outstanding is going to be retired, it is necessary for the accountant to make sure any corresponding discount or premium is properly amortized. When the bonds are extinguished, any gain or loss should be reported in income. Gains or losses from extinguishment of debt should be aggregated and reported in income. For extinguishment of debt transactions disclosure is required of the following items: 1 A description of the transactions, including the sources of any funds used to extinguish debt if it is practicable to identify the sources.
The entire arrangement must be evaluated and an appropriate interest rate imputed. This is done by 1 determining the fair value of the property, goods, or services exchanged or 2 determining the fair value of the note, whichever is more clearly determinable. If a note is issued for cash, the present value is assumed to be the cash proceeds. If a note is issued for noncash consideration, the present value of the note should be measured by the fair value of the property, goods, or services or by an amount that reasonably approximates the fair value of the note whichever is more clearly determinable.
Imputed interest is the interest factor a rate or amount assumed or assigned which is different from the stated interest factor. It is necessary to impute an interest rate when the stated interest rate is presumed to be unreasonable. The imputed interest rate is used to establish the present value of the debt instrument by discounting, at that imputed rate, all future payments on the debt instrument. In imputing interest, the objective is to approximate the rate which would have resulted if an independent borrower and an independent lender had negotiated a similar transaction under comparable terms and conditions with the option to pay the cash price upon purchase or to give a note for the amount of the purchase which bears the prevailing rate of interest to maturity.
In order to accomplish that objective, consideration must be given to 1 the credit standing of the issuer, 2 restrictive covenants, 3 collateral, 4 payment and other items pertaining to the debt, 5 the existing prime interest rate, and 6 the prevailing rates for similar instruments of issuers with similar credit ratings.
A fixed-rate mortgage is a note that requires payment of interest by the mortgagor at a rate that does not change during the life of the note. A variable-rate mortgage is a note that features an interest rate that fluctuates with the market rate; the variable rate generally is adjusted periodically as specified in the terms of the note and is usually limited in the amount of each change in the rate up or down and in the total change that can be made in the rate.
The fair value option is an accounting option where the company can elect to record fair values in their accounts for most financial assets and liabilities, including bonds and notes payable. With bonds at fair value, we assume that the decline in value of the bonds is due to an interest rate increase. If not related to changes in credit risks, these gains and losses are recorded in income.
In other situations, the decline may occur because the issuer become more likely to default on the bonds. That is, if the creditworthiness of the issuer declines, the value of its debt also declines.
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If its creditworthiness declines, its bond investors are receiving a lower rate relative to investors with similar-risk investments. Thus, changes in the fair value of bonds payable for a decline in creditworthiness are included as part of other comprehensive income. The required disclosures at the balance sheet date are future payments for sinking fund requirements and the maturity amounts of long-term debt during each of the next five years. Off-balance-sheet financing is an attempt to borrow monies in such a way that the obligations are not recorded.
Reasons for off-balance sheet financing are: 1 Many believe removing debt enhances the quality of the balance sheet and permits credit to be obtained more readily and at less cost. As a result, not reporting certain debt transactions offsets the nonrecognition of fair values on certain assets. Forms of off-balance-sheet financing include 1 investments in non-consolidated subsidiaries for which the parent is liable for the subsidiary debt; 2 use of special purpose entities SPEs , which are used to borrow money for special projects resulting in take-or-pay contracts ; 3 operating leases, which when structured carefully give the company the benefits of ownership without reporting the liability for the lease payments.
Under GAAP, a parent company does not have to consolidate a subsidiary company that is less than 50 percent owned. In such cases, the parent therefore does not report the assets and liabilities of the subsidiary. All the parent reports on its balance sheet is the investment in the subsidiary. As a result, users of the financial statements may not understand that the subsidiary has considerable debt for which the parent may ultimately be liable if the subsidiary runs into financial difficulty.
Two different types of situations result with troubled debt: 1 Impairments, and 2 Restructurings. Restructurings can be further classified into: a Settlements. When a debtor company runs into financial difficulty, creditors may recognize an impairment on a loan extended to that company. Subsequently, the creditor may modify the terms of the loan, or settles it on terms unfavorable to the creditor.
In unusual cases, the creditor forces the debtor into bankruptcy in order to ensure the highest possible collection on the loan. In these situations, the noncash assets or equity interest given should be accounted for at fair value. The debtor is required to determine the excess of the carrying amount of the payable over the fair value of the assets or equity transferred gain. Likewise, the creditor is required to determine the excess of the receivable over the fair value of those same assets or equity interests transferred loss. The debtor recognizes a gain equal to the amount of the excess and the creditor normally would charge the excess loss against Allowance for Doubtful Accounts.
In addition, the debtor recognizes a gain or loss on disposition of assets to the extent that the fair value of those assets differs from their carrying amount book value. Reduce the face amount of the debt. Accept noncash assets or equity interests in lieu of cash in settlement. Reduce the stated interest rate. Extend the maturity date of the face amount of the debt. Reduce or defer any accrued interest. When a loan is restructured, the creditor should calculate the loss due to restructuring by sub- tracting the present value of the restructured cash flows using the historical effective rate from the carrying value of the loan.
Interest revenue is calculated at the original effective rate applied towards the new carrying value. The debtor will record a gain only if the undiscounted restructured cash flows are less than the carrying value of the loan. If a gain is recognized, subsequent payments will be all principal. There is no interest component. If the undiscounted cash flows exceed the carrying amount, no gain is recognized, and a new imputed interest rate must be calculated in order to recognize interest expense in subsequent periods.
Impairments are nonsymmetrical because, while the creditor records a loss, the debtor makes no entry at all. Troubled debt restructurings are nonsymmetrical because creditors calculate their losses using the discounted present value of future cash flows, while debtors calculate their gains using the undiscounted cash flows. In addition to the situation created by the use of discounted versus undiscounted cash flows by creditors and debtors, this situation can occur when a debtor or creditor has been substituted for one of the parties to the original transaction. June 30, Cash December 31, Interest Expense June 30, Interest Expense Interest expense for the period from January 1 to June 30, from a 3.
The amount of bond interest expense reported in will be greater than the amount that would be reported if the straight- line method of amortization were used. Determine cash flow from investing activities. Determine cash flow from financing activities. Determine net cash used in investing activities. Determine net cash used in financing activities. Determine net cash provided by investing activities. E Effects of transactions on statement of cash flows. E Calculations for statement of cash flows.
E Statement of cash flows indirect method. E Preparation of statement of cash flows format provided. E Classification of cash flows. E Classification of cash flows and transactions. P A complex statement of cash flows indirect method. Describe the usefulness and format of the statement of cash flows.
Contrast the direct and indirect methods of calculating net cash flow from operating activities. The statement of cash flows provides information to help investors and creditors assess the cash and noncash investing and financing transactions during the period. Companies classify some cash flows relating to investing or financing activities as operating activities.
The first step in the preparation of the statement of cash flows is to determine the net cash flow from operating activities. The net increase decrease in cash reported on the statement of cash flows should reconcile the beginning and ending cash balances reported in the comparative balance sheets. The FASB encourages the use of the indirect method over the direct method. When accounts receivable decrease during a period, cash-basis revenues are higher than revenues reported on an accrual basis. When prepaid expenses decrease during a period, expenses on the accrual-basis are lower than they are on a cash-basis.
Under the accrual basis of accounting, net income is usually the same as net cash flow from operating activities. A company can convert net income to net cash flow from operating activities through either the direct method or the indirect method. Income from an investment in common stock using the equity method is added to net income in computing net cash provided from operating activities. Cash receipts from customers are computed by adding a decrease in accounts receivable to revenue from sales.
Cash payments for operating expenses are computed by subtracting an increase in prepaid expenses and a decrease in accrued expenses payable from operating expenses. The direct method, also called the reconciliation method, reports cash receipts and cash disbursements from operating activities. The indirect method adjusts net income for items that affected reported net income but did not affect cash.
A company should add back bond premium amortization to net income to arrive at net cash flow from operating activities. Companies report the cash flows from purchases and sales of trading securities as cash flows from operating activities. Noncash investing and financing activities are disclosed either in a separate schedule or in a separate note to the financial statements. When numerous adjustments are necessary, companies often use a cash flow worksheet instead of preparing a statement of cash flows.
The issuance of stock dividends is entered on the cash flow worksheet, but is not reported in the statement of cash flows. Item Ans. An objective of the statement of cash flows is to a. None of these answers are correct. The primary purpose of the statement of cash flows is to provide information a. Of the following questions, which one would not be answered by the statement of cash flows? Where did the cash come from during the period? What was the cash used for during the period? Were all the cash expenditures of benefit to the company during the period?
What was the change in the cash balance during the period? The first step in the preparation of the statement of cash flows requires the use of information included in which comparative financial statements? Statements of cash flows b. Balance sheets c. Income statements d. Cash equivalents are a. All of these answers are correct. In preparing a statement of cash flows indirect method , this event would be reflected as a n a. Xanthe Corporation had the following transactions occur in the current year: 1. Cash sale of merchandise inventory.
Sale of delivery truck at book value. Sale of Xanthe common stock for cash. Issuance of a note payable to a bank for cash. Sale of a security held as an available-for-sale investment. Collection of loan receivable. How many of the above items will appear as a cash inflow from investing activities on a statement of cash flows for the current year? Five items b.
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Four items c. Three items d. Which of the following would be classified as a financing activity on a statement of cash flows? Declaration and distribution of a stock dividend b. Payment of a bond payable c. Sale of a loan receivable d. The amortization of bond premium on long-term debt should be presented in a statement of cash flows using the indirect method for operating activities as a n a.
The company had depreciation expense and an increase in prepaid expenses associated with the selling and administrative expenses for the year. Assuming use of the direct method, how would these items be handled in converting the accrual based selling and administrative expenses to the cash basis? Increase in Depreciation Prepaid Expenses a. Deducted From Deducted From b. Added To Added To c. Deducted From Added To d. To arrive at net cash provided by operating activities, it is necessary to report revenues and expenses on a cash basis.
This is done by a. In a statement of cash flows, the cash flows from investing activities section should report a. When preparing a statement of cash flows indirect method , an increase in ending inventory over beginning inventory will result in an adjustment to reported net earnings because a. When preparing a statement of cash flows, a decrease in accounts receivable during a period would cause which one of the following adjustments in determining cash flow from operating activities?
Direct Method Indirect Method a. Increase Decrease b. Decrease Increase c. Increase Increase d. In determining net cash flow from operating activities, a decrease in accounts payable during a period a. When preparing a statement of cash flows, an increase in accounts payable during a period would require which of the following adjustments in determining cash flows from operating activities? Indirect Method Direct Method a. When preparing a statement of cash flows, a decrease in prepaid insurance during a period would require which of the following adjustments in determining cash flows from operating activities?
When preparing a statement of cash flows, the following are used for which method in determining cash flows from operating activities? Indirect Direct b. Direct Indirect c. Direct Direct d. Which of the following statements about the statement of cash flows is correct? The indirect method starts with income from continuing operations. The direct method is known as the reconciliation method. The direct method is more consistent with the primary purpose of the statement of cash flows. Increase in accounts receivable. Gain on sale of land.
Amortization of patent. All of these are added to net income to arrive at cash flow from operating activities. Decrease in accounts receivable. All of these are deducted from net income to arrive at cash flow from operating activities. Which of the following is false concerning the statement of cash flows? When pension expense exceeds cash funding, the difference is deducted from investing activities on the statement of cash flows.
The FASB requires companies to classify all income taxes paid as operating cash outflows. Under GAAP, the purchase of land by issuing stock will be shown as a cash outflow under investing activities and a cash inflow under financing activities. All of these are true concerning the statement of cash flows.
An increase in inventory balance would be reported in a statement of cash flows using the indirect method reconciliation method as a n a. A statement of cash flows typically would not disclose the effects of a. When preparing a statement of cash flows indirect method , which of the following is not an adjustment to reconcile net income to net cash provided by operating activities? A change in interest payable b. A change in dividends payable c.
A change in income taxes payable d. All of these are adjustments. Declaration of a cash dividend on common stock affects cash flows from operating activities under the direct and indirect methods as follows: Direct Method Indirect Method a. Outflow Inflow b. Inflow Inflow c. Outflow Outflow d. In reporting unusual items on a statement of cash flows indirect method , the a. Which of the following is shown on a statement of cash flows?
A stock dividend b. A stock split c.
An appropriation of retained earnings d. How should significant noncash transactions be reported in the statement of cash flows according to FASB Statement No. They should be incorporated in the statement of cash flows in a section labeled, "Significant Noncash Transactions.
Such transactions should be incorporated in the section operating, financing, or investing that is most representative of the major component of the transaction. These noncash transactions are not to be incorporated in the statement of cash flows. They may be summarized in a separate schedule at the bottom of the statement or appear in a separate supplementary schedule to the financials.
They should be handled in a manner consistent with the transactions that affect cash flows. Harlan Mining Co. One statement that the enterprise is anxious to have prepared is a statement of cash flows. Financial statements of Harlan Mining Co. The loss on sale was incorrectly charged to cost of sales.
All depreciation expense is in the selling expense category. The net cash provided by operating activities is a. The Accounting Information System 3 - The net cash provided used by investing activities is a. Under the direct method, the cash received from customers is a. Under the direct method, the total taxes paid is a. The net cash provided used by financing activities is a. During , Stout Inc. Hager Company sold some of its plant assets during The information concerning the sale of the plant assets should be shown on Hager's statement of cash flows indirect method for the year ended December 31, , as a n a.
The information concerning Noller's machinery accounts should be shown in Noller's statement of cash flows indirect method for the year ended December 31, , as a n a. This transaction should be shown on the statement of cash flows indirect method as a n a. Depreciation expense for was a. Equipment purchased during was a. When the equipment was sold, the Buildings and Equipment account received a credit of a.
The book value of the buildings and equipment at December 31, was a. The accounts payable at December 31, were a. The balance in the Retained Earnings account at December 31, was a. Capital stock plus any additional paid-in capital at December 31, was a. A cash dividend was declared and paid. The amount of the cash dividend was a. The stock dividend should be reported on the statement of cash flows indirect method as a. Stock dividends are not shown on a statement of cash flows. In its statement of cash flows for the year ended December 31, , what amount should Dunlop report as proceeds from issuance of bonds payable?
Based upon this information what amount will be shown for net cash provided by operating activities for ? The net cash provided by operating activities would be reported at a. In preparing Titan Inc.
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Jarvis, Inc. What is the amount of cash provided by operating activities for Jarvis, Inc. Howell, Inc. Each of the following accounts increased during What is the amount of cash provided by or used by investing activities for Jarvis, Inc. In addition, the company experienced the following changes in the account balances listed below:. Decreases Increases Accounts receivable The net cash provided by operating activities would be reported at. Napier Co. Proceeds from issuing preferred stock 1,, Proceeds from sale of equipment , The net cash provided used by investing activities during is a.
The net cash provided by financing activities during is a. In the statement of cash flows for the year ended December 31, , for Naley Company:. The net cash provided by operating activities was a. The net cash provided used by investing activities was a. In the statement of cash flows for the year ended December 31, , for Naley Company: The net cash provided used by financing activities was a.
The following information was taken from the financial statements of Jenny Gardner Corporation:. Alex Company prepares its statement of cash flows using the direct method for operating activities. Putnam, Inc. Comparative Balance Sheets. Additional Information: a. Accounts receivable and accounts payable relate to merchandise held for sale in the normal course of business.
The allowance for bad debts was the same at the end of and , and no receivables were charged against the allowance. Accounts payable are recorded net of any discount and are always paid within the discount period. The proceeds from the note payable were used to finance the acquisition of property, plant, and equipment. Capital stock was sold to provide additional working capital. What amount of cash was collected from accounts receivable? What amount of cash was paid on accounts payable to suppliers during ? The amount to be shown on the cash flow statement as net cash provided by investing activities would total what amount?
The amount to be shown on the cash flow statement as net cash provided by financing activities would total what amount? The net cash provided used by financing activities during is a. As a result of these transactions, net cash flows from operating activities would be calculated indirect method by adjusting net income with a a. A flood damaged a building and contents. On the statement of cash flows indirect method , the receipts from insurance companies should a.
On the statement of cash flows indirect method , the flood loss should a. What should be the net cash provided by operating activities in the statement of cash flows for the year ended December 31, , based solely on the above information? There were no other transactions affecting long-term investments in Jamison Corp. Foxx Corp. Depreciation charged to operations in was a.
Nagel Co. What amount of cash disbursements for insurance would be reported in Nagel's net cash provided by operating activities presented on a direct basis? A company acquired a building, paying a portion of the purchase price in cash and issuing a mortgage note payable to the seller for the balance. In a statement of cash flows, what amount is included in investing activities for the above transaction? Cash payment b. Acquisition price c.
Zero d. In a statement of cash flows, what amount is included in financing activities for the above transaction? Smiley Corp. Smiley's net cash used in investing activities for was a. Smiley's net cash used in financing activities for was a. Peavy Corp. Answer Derivation Compare the direct method and the indirect method by explaining each method.
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Solution The direct method adjusts revenues and expenses to a cash basis. The difference between cash revenues and cash expenses is cash net income, which is equal to the net cash flow from operating activities. The indirect method involves adjusting accrual net income to a cash basis. This is done by starting with accrual net income and adding or subtracting noncash items included in net income.
Examples of adjustments include depreciation, amortization, other noncash expenses and revenues, gains and losses, and changes in the balances of current assets and current liabilities during the year.
Indicate for each of the following what should be disclosed on a statement of cash flows indirect method. If not disclosed, write "Not shown. For an item that is added to net income, write "Add," and for an item that is deducted from net income, write "Deduct. Show the amount, too. Indicate for each of the following what should be disclosed on a statement of cash flows SCF indirect method. There is more than one answer for some items. A tornado damaged a building and its contents. Show calculation of the cash dividend and indicate how it and the stock dividend would be shown on the SCF.
Show the amount also. Instructions What three items would be shown on a statement of cash flows indirect method from this information? Show your calculations. Milner Co. Instructions What four items should be shown on a statement of cash flows indirect method from this information? Presented below is the income statement of Cowan, Inc. Instructions Prepare a schedule computing the net cash flow from operating activities that would be shown on a statement of cash flows: a using the indirect method.
Solution a Cowan, Inc. The following information is taken from French Corporation's financial statements:. Instructions Prepare a statement of cash flows for French Corporation for the year Use the indirect method. Net cash provided by operating activities 93, Cash flows from investing activities Purchase of land 40, Purchase of buildings 50, Sale of patents 10, Net cash used by investing activities 80, Cash flows from financing activities Sale of bonds 65, Purchase of treasury stock 7, Payment of cash dividends 35, Net cash provided by financing activities 23, The balance sheets for Kinder Company showed the following information.
Additional information concerning transactions and events during are presented below. Additional data: 1.
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Instructions Using the format provided on the next page, prepare a statement of cash flows using the indirect method for for Kinder Company. Cash flows from investing activities Sale of long-term investments 33, Purchase of machinery 26, Net cash provided by investing activities 6, Cash flows from financing activities Paid dividends 20, Net cash used by financing activities 20, Note that X in the following statement of cash flows identifies a dollar amount and the letters A through F identify specific items which appear in the major sections of the statement prepared using the indirect method.
Statement of Cash Flows. Net cash provided by operating activities X. Net cash provided used by investing activities X.
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