Corporations, form a corporation, public corporation, private corporation, stockholders, corporation management, unlimited life, goverment regulations, double taxation, forming a corporation, advantages of corportations, disadvantages of corportations, stocks, forming a corporations, jose cintron, advance business consulting, http://mba4help.com

1. Accounting Principles 2
Jose Cintron, MBA-CPC
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http://www.linkedin.com/in/josecintron

2. Corporation is created by law
A corporation is created by law, and its continued existence depends
upon the statutes of the state in which it is incorporated. As a legal entity,
a corporation has most of the rights and privileges of a person.
A corporation is subject to the same duties and responsibilities as a
person. For example, it must abide by the laws, and it must pay taxes.
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3. Publicly held and Privately
Classification by ownership distinguishes between publicly held and
privately held corporations.
Publicly held corporation may have thousands of stockholders. Its
stock is regularly traded on a national securities exchange such as the
New York Stock Exchange. Most of the largest U.S. corporations are
publicly held. Examples are IBM, Google, General Electric & Facebook.
Privately held corporation usually has only a few stockholders, and
does not offer its stock for sale to the general public.
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4. Separate Legal Existence
As an entity separate and distinct from its owners, the corporation acts
under its own name rather than in the name of its stockholders. Ford
Motor Company may buy, own, and sell property. It may borrow money,
and may enter into legally binding contracts in its own name. It may also
sue or be sued, and it pays its own taxes. The acts of its owners
(stockholders) do not bind the corporation unless such owners are agents
of the corporation
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5. Limited Liability of
Stockholders
Corporation is a separate legal entity, creditors have recourse only to
corporate assets to satisfy their claims. The liability of stockholders is
normally limited to their investment in the corporation. Even in the event
of bankruptcy, stockholders' losses are generally limited to their capital
investment in the corporation.
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6. Transferable Ownership Rights
Shares of capital stock give ownership in a corporation. These shares are
transferable units. Stockholders may dispose of part or all of their interest
in a corporation simply by selling their stock.
The transfer of ownership rights between stockholders normally has no
effect on the daily operating activities of the corporation.
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7. Ability to Acquire Capital
It is relatively easy for a corporation to obtain capital through the
issuance of stock. Investors buy stock in a corporation to earn money
over time as the share price grows, and because a stockholder has limited
liability and shares of stock are readily transferable. Also, individuals can
become stockholders by investing relatively small amounts of money.
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8. Continuous Life
Since a corporation is a separate legal entity, its continuance as a going
concern is not affected by the withdrawal, death, or incapacity of a
stockholder, employee, or officer. As a result, a successful enterprise can
have a continuous and perpetual life.
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9. Unlimited Life
Hoshi Ryokan – founded in 718.
The company was founded in Komatsu, Japan in 718.
The firm is operated by the family's members, who represent its
46th generation. Since then his family, who was known as Hoshi,
have managed a hotel in Komatsu. The structure that stands
today is able to house 450 people, in its 100 rooms.
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10. Corporation Management
As in Ford Motor Company, stockholders legally own the corporation.
But they manage the corporation indirectly through a board of directors
they elect. The board, in turn, formulates the operating policies for the
company. The board also selects officers, such as a president.
The chief executive officer (CEO) has overall responsibility for
managing the business.
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11. Structure
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12. Government Regulations
A corporation is subject to numerous state and federal regulations. State
laws usually prescribe the requirements for issuing stock, the
distributions of earnings permitted to stockholders, and the effects of
retiring stock. Federal securities laws govern the sale of capital stock to
the general public. They are required to make extensive disclosure of
their financial affairs to the Securities and Exchange Commission (SEC).
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13. Doble Taxation
In addition, stockholders must pay taxes on cash dividends (pro rata
distributions of net income). Thus, many argue that the government taxes
corporate income twice (double taxation)—once at the corporate level,
and again at the individual level.
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14. Advantages vs. Disadvantages
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15. Forming a Corporation
The initial step in forming a corporation is to file an application with the
Secretary of State in the state in which incorporation is desired. The
application contains such information as: (1) the name and purpose of the
proposed corporation; (2) amounts, kinds, and number of shares of
capital stock to be authorized; (3) the names of the incorporators; and (4)
the shares of stock to which each has subscribed.
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16. Forming a Corporation
After the state approves the application, it grants a charter. The issuance
of the charter creates the corporation. Upon receipt of the charter, the
corporation develops its by-laws. The by-laws establish the internal rules
and procedures for conducting the affairs of the corporation. They also
indicate the powers of the stockholders, directors, and officers of the
enterprise.
The charter is often referred to as the articles of incorporation.
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17. Forming a Corporation
Regardless of the number of states in which a corporation has operating
divisions, it is incorporated in only one state. It is to the company's
advantage to incorporate in a state whose laws are favorable to the
corporate form of business organization.
Corporations engaged in interstate commerce must also obtain a license
from each state in which they do business.
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18. Cost to Incorporate
Costs incurred in the formation of a corporation are called organization
costs. These costs include legal and state fees, and promotional
expenditures involved in the organization of the business. Corporations
expense organization costs as incurred.
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19. Ownership Rights of
Stockholders
When chartered, the
corporation may begin
selling ownership rights in
the form of shares of stock.
When a corporation has only
one class of stock, it is
common stock.
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20. Authorized Stock
The charter indicates the amount of stock that a corporation is
authorized to sell. The total amount of authorized stock at the time of
incorporation normally anticipates both initial and subsequent capital
needs. As a result, the number of shares authorized generally exceeds the
number initially sold. If it sells all authorized stock, a corporation must
obtain consent of the state to amend its charter before it can issue
additional shares.
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21. Authorized Stock
The authorization of capital stock does not result in a formal accounting
entry. This event has no immediate effect on either corporate assets or
stockholders' equity. However, the number of authorized shares is often
reported in the stockholders' equity section.
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22. Issuance of Stock
A corporation can issue common stock directly to
investors. Or it can issue the stock indirectly
through an investment banking firm that specializes
in bringing securities to market. Direct issue is
typical in closely held companies. Indirect issue is
customary for a publicly held corporation.
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23. Issuance of Stock
In an indirect issue, the investment banking firm may agree to
underwrite the entire stock issue. In this arrangement, the investment
banker buys the stock from the corporation at a stipulated price and
resells the shares to investors. The corporation thus avoids any risk of
being unable to sell the shares. Also, it obtains immediate use of the cash
received from the underwriter. The investment banking firm, in turn,
assumes the risk of reselling the shares, in return for an underwriting fee.
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24. How does a corporation
set the price
How does a corporation set the price for a new issue of stock? Among
the factors to be considered are: (1) the company's anticipated future
earnings, (2) its expected dividend rate per share, (3) its current financial
position, (4) the current state of the economy, and (5) the current state of
the securities market. The calculation can be complex and is properly the
subject of a finance course.
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25. Market Value of Stock
The stock of publicly held companies is traded on organized exchanges.
The interaction between buyers and sellers determines the prices per
share. In general, the prices set by the marketplace tend to follow the
trend of a company's earnings and dividends.
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26. Capital Stock
The trading of capital stock on securities exchanges involves the transfer
of already issued shares from an existing stockholder to another investor.
These transactions have no impact on a corporation's stockholders'
equity.
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27. Market Value of Stock
The interaction between buyers and sellers determines the prices per
share. The prices set by the marketplace tend to follow the trend of a
company's earnings and dividends. But, factors beyond a company's
control, such as an changes in interest rates, and the outcome of a
presidential election, may cause day-to-day fluctuations in market prices.
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28. Market Value of Stock
A recent stock quote for PepsiCo, listed on the NYSE under the ticker
symbol PEP, is shown below.
Stock Volume High Low Close Net Change
PepsiCo 4,305,600 60.30 59.32 60.02 +0.41
These numbers indicate that PepsiCo's trading volume was 4,305,600
shares. The high, low, and closing prices for that date were $60.30,
$59.32, and $60.02, respectively. The net change for the day was an
increase of $0.41 per share.
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29. Par and No-Par Value Stocks
Par value stock is capital stock to which the charter has assigned a value
per share.
Par value was often immaterial relative to the value of the company's
stock—even at the time of issue. Thus, its usefulness as a protective
device to creditors was questionable.
No-par value stock is capital stock to which the charter has not assigned
a value. No-par value stock is quite common today
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30. Paid-in capital and
retained earning
Owners' equity is identified by various names: stockholders' equity,
shareholders' equity.
Stockholders' equity section of a corporation's balance sheet consists of
two parts: (1) paid-in (contributed) capital and (2) retained earnings
(earned capital).
Paid-in capital and retained earnings- Corporations can make
distributions of earnings (declare dividends) out of retained earnings in
all states. However, in many states they cannot declare dividends out of
paid-in capital.
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31. Paid-in capital
Retained Earning
Paid-in capital is the total amount of cash and other assets paid in to the
corporation by stockholders in exchange for capital stock. As noted
earlier, when a corporation has only one class of stock, it is common
stock.
Retained earnings is net income that a corporation retains for future use.
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32. Retained earnings
Net income is recorded in Retained Earnings by a closing entry that
debits Income Summary and credits Retained Earnings. For example,
assuming that net income for ABC in its first year of operations is
$130,000, the closing entry is:
Income Summary 130,000
Retained Earnings 130,000
(To close Income Summary and transfer net income to retained earnings)
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33. Journal entry
ABC Inc.'s $9 par value common stock is actively traded at a market
value of $16 per share. ABC issues 5,280 shares to purchase land
advertised for sale at $86,740.
Journalize the issuance of the stock in acquiring the land.
Land 84,480
Common Stock 47,520
Paid-in cap. in excess of par value 36,960
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34. Stockholders' equity section
If Delta Robotics has a balance of
$800,000 in common stock at the end
of its first year, its stockholders' equity
section is as follows.
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35. Comparison of owners'
equity accounts
The following illustration compares the owners' equity (stockholders'
equity) accounts reported on a balance sheet for a proprietorship, a
partnership, and a corporation.
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36. Issuing Par Value Common
Stock for Cash
Par value does not indicate a stock's market value. Therefore, the cash
proceeds from issuing par value stock may be equal to, greater than, or
less than par value. When the company records issuance of common
stock for cash, it credits to Common Stock the par value of the shares. It
records in a separate paid-in capital account the portion of the proceeds
that is above or below par value.
Cash 1,000
Common Stock 1,000
(To record issuance of 1,000 shares of $1 par common
stock at par)
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37. Issuing Par Value Common
Stock for Cash
If ABC issues an additional 1,000 shares of the $1 par value common
stock for cash at $5 per share, the entry is:
Cash 5,000
Common Stock 1,000
Paid-in Capital in Excess of Par Value 4,000
(To record issuance of 1,000 shares of $1 par common stock)
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38. Issuing Par Value Common
Stock for Cash
The total paid-in capital from these two transactions is $6,000, and the
legal capital is $2,000. Assuming Hydro-Slide, Inc. has retained earnings
of $27,000,
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39. Issuing No-Par Common
Stock for Cash
When no-par common stock has a stated value, the entries are similar to
those illustrated for par value stock
Assume that instead of $1 par value stock, Hydro-Slide, Inc. has $5
stated value no-par stock and the company issues 5,000 shares at $8 per
share for cash.
Cash 40,000
Common Stock 25,000
Paid-in Capital in Excess of Stated Value 15,000
(To record issue of 5,000 shares of $5 stated value no-par stock)
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40. No par No stated value
What happens when no-par stock does not have a stated value? In that
case, the corporation credits the entire proceeds to Common Stock. Thus,
if Hydro-Slide does not assign a stated value to its no-par stock, it would
record the issuance of the 5,000 shares at $8 per share for cash as
follows.
Cash 40,000
Common Stock 40,000
(To record issue of 5,000 shares of no-par stock)
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41. Issuing Common Stock
for Services
Corporations also may issue stock for services (compensation to
attorneys or consultants) or for noncash assets (land, buildings, and
equipment). To comply with the cost principle, in a noncash transaction
cost is the cash equivalent price. Thus, cost is either the fair market value
of the consideration given up, or the fair market value of the
consideration received, whichever is more clearly determinable.
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42. Issuing Common Stock
for Services
Assume that attorneys have helped ABC Company incorporate. They
have billed the company $5,000 for their services. They agree to accept
4,000 shares of $1 par value common stock in payment of their bill. At
the time of the exchange, there is no established market price for the
stock. In this case, the market value of the consideration received,
$5,000, is more clearly evident.
Organization Expense 5,000
Common Stock 4,000
Paid-in Capital in Excess of Par Value 1,000
(To record issuance of 4,000 shares of $1 par value stock to attorneys)
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43. Common Stock for Land
Assume that ABC Inc. is an existing publicly held corporation. Its $5 par
value stock is actively traded at $8 per share. The company issues 10,000
shares of stock to acquire land recently advertised for sale at $90,000.
The most clearly evident value in this noncash transaction is the market
price of the consideration given, $80,000.
Land 80,000
Common Stock 50,000
Paid-in Capital in Excess of Par Value 30,000
(To record issuance of 10,000 shares of $5 par value stock for land)
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44. Treasury Stocks
Treasury stock is a corporation's own stock that it has issued and
subsequently reacquired from shareholders, but not retired. A corporation
may acquire treasury stock for various reasons:
1. To reissue the shares to officers and employees under bonus and
stock compensation plans.
2. To signal to the stock market that management believes the stock is
underpriced, in the hope of enhancing its market value.
3. To have additional shares available for use in the acquisition of other
companies.
4. To reduce the number of shares outstanding and thereby increase
earnings per share.
5. To rid the company of disgruntled investors, perhaps to avoid a
takeover.
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45. Treasury Stocks
Companies generally account for treasury stock by the cost method. This
method uses the cost of the shares purchased to value the treasury stock.
Under the cost method, the company debits Treasury Stock for the price
paid to reacquire the shares.
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46. Treasury Stocks
When the company disposes of the shares, it credits to Treasury Stock
the same amount it paid to reacquire the shares. To illustrate, assume that
on January 1, 2010, the stockholders' equity section of Mead, Inc. has
100,000 shares of $5 par value common stock outstanding (all issued at
par value) and Retained Earnings of $200,000. The stockholders' equity
section before purchase of treasury stock is as follows.
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47. Treasure Stocks
On February 1, 2010, Mead acquires 4,000 shares of its stock at $8 per
share. The entry is:
Feb. 1 Treasury Stock 32,000
Cash 32,000
(To record purchase of 4,000 shares of treasury stock at $8 per share)
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48. Treasury Stocks
Note that Mead debits Treasury Stock for the cost of the shares
purchased. Is the original paid-in capital account, Common Stock,
affected? No, because the number of issued shares does not change. In
the stockholders' equity section of the balance sheet, Mead deducts
treasury stock from total paid-in capital and retained earnings. Treasury
Stock is a contra stockholders' equity account. Thus, the acquisition of
treasury stock reduces stockholders' equity.
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49. Treasure Stocks
In the balance sheet, Mead discloses both the number of shares issued
(100,000) and the number in the treasury (4,000). The difference
between these two amounts is the number of shares of stock outstanding
(96,000). The term outstanding stock means the number of shares of
issued stock that are being held by stockholders.
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50. Sale of treasury stocks
If the selling price of the treasury shares is equal to their cost, the
company records the sale of the shares by a debit to Cash and a credit to
Treasury Stock. When the selling price of the shares is greater than their
cost, the company credits the difference to Paid-in Capital from Treasury
Stock.
Mead sells for $10 per share the 1,000 shares of its treasury stock,
previously acquired at $8 per share. The entry is as follows.
July 1 Cash 10,000
Treasury Stock 8,000
Paid-in Capital from Treasury Stock 2,000
(To record sale of 1,000 shares of treasury stock above cost)
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51. Treasury Stocks Below Cost
Sale of Treasury Stock Below Cost
When a company sells treasury stock below its cost, it usually debits to
Paid-in Capital from Treasury Stock the excess of cost over selling price.
Thus, if Mead, Inc. sells an additional 800 shares of treasury stock on
October 1 at $7 per share, it makes the following entry.
Oct. 1 Cash 5,600
Paid-in Capital from Treasury Stock 800
Treasury Stock 6,400
(To record sale of 800 shares of treasury stock below cost)
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52. Preferred Stocks
To appeal to more investors, a corporation may issue an additional class
of stock, called preferred stock. Preferred stock has provisions that give
it some preference or priority over common stock. Typically, preferred
stockholders have a priority as to (1) distributions of earnings
(dividends) and (2) assets in the event of liquidation. However, they
generally do not have voting rights.
Cash 120,000
Preferred Stock 100,000
Paid-in Capital in Excess of Par Value–Preferred Stock 20,000
(To record the issuance of 10,000 shares of $10 par value preferred
stock)
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53. Preferred Tocks Dividends
Preferred stockholders have the right to receive dividends before
common stockholders. For example, if the dividend rate on preferred
stock is $5 per share, common shareholders will not receive any
dividends in the current year until preferred stockholders have received
$5 per share. The first claim to dividends does not, however, guarantee
the payment of dividends. Dividends depend on many factors, such as
adequate retained earnings and availability of cash.
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54. Cumulative Dividend
Preferred stock often contains a cumulative dividend feature. This means
that preferred stockholders must be paid both current-year dividends and
any unpaid prior-year dividends before common stockholders receive
dividends. When preferred stock is cumulative, preferred dividends not
declared in a given period are called dividends in arrears.
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55. The stockholders' equity
section
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56. Usefulness of the
Statement of Cash Flows
The balance sheet, income statement, and retained earnings statement
provide only limited information about a company's cash flows (cash
receipts and cash payments). For example, comparative balance sheets
show the increase in property, plant, and equipment during the year. But
they do not show how the additions were financed or paid for.
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57. Statement of Cash Flows
Cash flow from operations
Cash generated by selling goods & services
Cash flow from investing activities
Cash used/generated by changes in long-term assets
Cash flow from financing activities
Cash used/generated by changes in equity & debt.
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58. Non-cash items
•Non-cash items (depreciation, amortization) are expenses that do not
have to be ―paid‖ to outside entities. In the indirect method,
depreciation has already been subtracted to compute net income, so
we must add it back to compute cash from operations.
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59. Usefulness of the
Statement of Cash Flows
 The income statement shows net income. But it does not indicate the
amount of cash generated by operating activities.
 The retained earnings statement shows cash dividends declared but
not the cash dividends paid during the year.
 None of these statements presents a detailed summary of where cash
came from and how it was used.
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60. Usefulness of the
Statement of Cash Flows
The statement of cash flows reports the cash receipts, cash payments, and
net change in cash resulting from operating, investing, and financing
activities during a period. Help investors, creditors, and others assess:
1. The entity's ability to generate future cash flows. Investors can make
predictions of the amounts, timing, and uncertainty of future cash flows..
2. The entity's ability to pay dividends and meet obligations. If a Co.
does not have adequate cash, it cannot pay employees or dividends.
3. The reasons for the difference between net income and net cash
provided (used) by operating activities.
4. The cash investing and financing transactions during the period.
during the period.
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61. Cash Flow Statement
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62. Classification of Cash Flows
Statement of cash flows classifies cash receipts and cash payments as;
1. Operating activities include the cash effects of transactions that
create revenues and expenses. They thus enter into the determination of
net income.
2. Investing activities include (a) acquiring and disposing of
investments and property, plant, and equipment, and (b) lending money
and collecting the loans.
3. Financing activities include (a) obtaining cash from issuing debt and
repaying the amounts borrowed, and (b) obtaining cash from
stockholders, repurchasing shares, and paying dividends.
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63. Classification of Cash Flows
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64. Cash flow operating
Companies classify as operating activities some cash flows related to
investing or financing activities. For example, receipts of investment
revenue (interest and dividends) are classified as operating activities. So
are payments of interest to lenders. Why are these considered operating
activities? Because companies report these items in the income
statement, where results of operations are shown.
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65. Why do differences exist?
Company Net Income Net Cash Provided by Operating
Kohl's Corporation $ 1,083 $ 1,234
Wal-Mart Stores, Inc. 11,284 20,164
J. C. Penney Inc. 1,153 1,255
Costco Corp. 1,082 2,076
Target Corporation 2,849 4,125
The differences are explained by differences in the timing of the
reporting of revenues and expenses under accrual accounting versus
cash. Under accrual accounting, companies report revenues when earned,
even if cash hasn't been received, and they report expenses when
incurred, even if cash hasn't been paid.
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66. Format of the Statement
of Cash Flows
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67. Preparing the Statement
of Cash Flows
Companies prepare the statement of cash flows differently from the three
other basic financial statements. (not from trial balance)
The statement of cash flows deals with cash receipts and payments. As a
result, the company must adjust the effects of the use of accrual
accounting to determine cash flows.
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68. Statement of cash flow
The information to prepare this statement usually comes from three
sources:
1. Comparative balance sheets. Information in the comparative balance
sheets indicates the amount of the changes in assets, liabilities, and
stockholders' equities from the beginning to the end of the period.
2. Current income statement. Information in this statement helps
determine the amount of cash provided or used by operations during the
period.
3. Additional information. Such information includes transaction data
that are needed to determine how cash was provided or used during the
period.
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69. Statement of cash flows
involves three major steps
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70. Indirect and Direct
Methods
In order to perform step 1, a company must convert net income from an
accrual basis to a cash basis.
The indirect method adjusts net income for items that do not affect cash.
A great majority of companies (98.8%) use this method, as shown in the
nearby chart.1 Companies favor the indirect method for two reasons: (1)
It is easier and less costly to prepare, and (2) it focuses on the differences
between net income and net cash flow from operating activities.
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71. Cash flow -Teamwork
The net income for Adcock Co. for 2010 was $279,013. For 2010
depreciation on plant assets was $65,978, and the company incurred a
loss on sale of plant assets of $13,993. Compute net cash provided by
operating activities under the indirect method.
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72. Solution
Cash flows from operating income
Net income $279,013
Adjustments to reconcile net income
to net cash provided by operating activities
Depreciation expense $65,978
Loss on sale of plant assets 13,993
79,971
Net cash provided by operating activities $358,984
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73. Cashflow -Teamwork
The T accounts for Equipment and the related Accumulated Depreciation
for ABC Company at the end of 2010 are shown here.
Equipment Accumulated Depreciation
Beg. bal. 80,201 Disposals 20,876 Disposals 5,947 Beg. bal. 47,452
Acquisitions 42,657 Depr. exp. 13,918
End. bal. 101,982 End. bal. 55,423
In addition, ABC Company's income statement reported a loss on the
sale of equipment of $5,071. What amount was reported on the statement
of cash flows as "cash flow from sale of equipment"?
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74. Solution
Original cost of equipment sold $20,876
Less: Accumulated depreciation 5,947
Book value of equipment sold 14,929
Less: Loss on sale of equipment 5,071
Cash received from sale of equipment $9,858
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75. Cash flow –Teamwork
Classify each item as an operating, investing, or financing activity.
Assume all items involve cash unless there is information to the contrary.
(a) Purchase of equipment.
(b) Sale of building.
(c) Redemption of bonds.
(d) Depreciation.
(e) Payment of dividends.
(f) Issuance of capital stock.
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76. Solution
(a) Purchase of equipment. Investing activity
(b) Sale of building. Investing activity
(c) Redemption of bonds. Financing activity
(d) Depreciation. Operating activity
(e) Payment of dividends. Financing activity
(f) Issuance of capital stock. Financing activity
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77. Operating Activities
Determine Net Cash Provided/Used by Operating Activities by
Converting Net Income from an Accrual Basis to a Cash Basis
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78. Depreciation Expense
Depreciation is similar to any other expense in that it reduces net income.
It differs in that it does not involve a current cash outflow; that is why it
must be added back to net income to arrive at cash provided by operating
activities.
Income statement reports depreciation expense of $9,000. Although
depreciation expense reduces net income, it does not reduce cash.
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79. Loss on Sale of Equipment
Companies must eliminate from net income all gains and losses related
to the disposal of plant assets, to arrive at cash provided by operating
activities.
Income statement reports a $3,000 loss on the sale of equipment (book
value $7,000, less $4,000 cash received from sale of equipment).
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80. Changes in Noncash
Current Assets
Deduct from net income increases in current asset accounts, and add to
net income decreases in current asset accounts, to arrive at net cash
provided by operating activities.
Accounts receivable decreased by $10,000 (from $30,000 to $20,000)
during the period. For Computer Services this means that cash receipts
were $10,000 higher than revenues. Had $507,000 in revenues (as
reported on the income statement), but it collected $517,000 in cash.
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81. Changes in Noncash
Current Assets
To adjust net income to net cash provided by operating activities, the
company adds to net income the decrease of $10,000 in A/R
When the Accounts Receivable balance increases, cash receipts are
lower than revenue earned under the accrual basis. Therefore, the
company deducts from net income the amount of the increase in accounts
receivable, to arrive at net cash provided by operating activities.
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82. Increase in Merchandise
Inventory.
Inventory balance increased $5,000 (from $10,000 to $15,000) during
the period. The change in the Merchandise Inventory account reflects the
difference between the amount of inventory purchased and the amount
sold. This means that the cost of merchandise purchased exceeded the
cost of goods sold by $5,000. As a result, cost of goods sold does not
reflect $5,000 of cash payments made for merchandise. The company
deducts from net income this inventory increase of $5,000 during the
period, to arrive at net cash provided by operating
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83. Increase in Prepaid
Expenses
Computer Services' prepaid expenses increased during the period by
$4,000. This means that cash paid for expenses is higher than expenses
reported on an accrual basis. In other words, the company has made cash
payments in the current period, but will not charge expenses to income
until future periods (as charges to the income statement). To adjust net
income to net cash provided by operating activities, the company deducts
from net income the $4,000 increase in prepaid expenses
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84. Decrease in Prepaid
Expenses
If prepaid expenses decrease, reported expenses are higher than the
expenses paid. Therefore, the company adds to net income the decrease
in prepaid expenses, to arrive at net cash provided by operating activities
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85. Changes in Current Liabilities
Add to net income increases in current liability accounts, and deduct
from net income decreases in current liability accounts, to arrive at net
cash provided by operating activities.
Accounts Payable increased by $16,000 (from $12,000 to $28,000)
during the period. That means the company received $16,000 more in
goods than it actually paid for.
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86. Decrease in Income
Taxes Payable
A change in the Income Tax Payable account reflects the difference
between income tax expense incurred and income tax actually paid.
Computer Services' Income Tax Payable account decreased by $2,000.
That means the $47,000 of income tax expense reported on the income
statement was $2,000 less than the amount of taxes paid during the
period of $49,000. to adjust net income to a cash basis, the company
must reduce net income by $2,000
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87. Conversion to Net Cash Provided by
Operating Activities—Indirect Method
The statement of cash flows prepared by the indirect method starts with
net income. It then adds or deducts items to arrive at net cash provided
by operating activities.
1. Noncash charges such as depreciation, amortization, and depletion.
2. Gains and losses on the sale of plant assets.
3. Changes in noncash current asset and current liability accounts.
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88. Convert net income to net cash
provided by operating activities
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89. Cash from Operating
Activities- Team
ABC's Photo Plus reported net income of $73,000 for 2010. Included in
the income statement were depreciation expense of $7,000 and a gain on
sale of equipment of $2,500. ABC's comparative balance sheets show the
following balances.
12/31/09 12/31/10
Accounts receivable $17,000 $21,000
Accounts payable 6,000 2,200
Calculate net cash provided by operating activities for ABC's Photo Plus.
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90. Solution
Cash flows from operating activities
Net income $73,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense $7,000
Gain on sale of equipment (2,500)
Increase in accounts receivable (4,000)
Decrease in accounts payable (3,800) (3,300)
Net cash provided by operating activities $69,700
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91. Cash flow from operating
Why does GM's cash provided by operating activities drop so
precipitously when the company's sales figures decline?
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92. Cash Flow - Team work
The net income for ABC Co. for 2010 was $273,229. For 2010
depreciation on plant assets was $69,321, and the company incurred a
loss on sale of plant assets of $10,249. Compute net cash provided by
operating activities under the indirect method.
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93. Solution
Cash flows from operating income
Net income $273,229
Adjustments to reconcile net income
to net cash provided by operating activities
Depreciation expense $69,321
Loss on sale of plant assets 10,249
79,570
Net cash provided by operating activities $352,799
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94. Conclusion
A company can use a cash flow statement to predict future cash flow,
which helps with matters in budgeting. For investors, the cash flow
reflects a company's financial health: basically, the more cash available
for business operations, the better. However, this is not a hard and fast
rule. Sometimes a negative cash flow results from a company's growth
strategy in the form of expanding its operations.
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