[sundarak]

Twin House Inc. reported net income of $753,000 for the current year-ended December 31. Twin House’s financial statements reflected the following information:

Depreciation expense = $150,000

Gain on sale of trading securities = $6,000

Goodwill impairment = $75,000

Decrease in accounts receivable = $48,000

Increase in inventory= $33,000

Decrease in trading securities = $50,000

Increase in available-for-sale securities = 62,000

Increase in accounts payable = $70,000

Decrease in taxes payable = $15,000

Dividend paid = $200,000

Dividend received = $27,000

What should Twin House report as net cash provided by operating activities on the statement of cash flows, assuming that Twin House classifies the proceeds from the sale of the trading securities as an operating cash inflow?

a. $1,119,000

b. $1,092,000

c. $1,030,000

d. $892,000

Explanation

Choice “b” is correct. Based on the information given, operating cash flow must be calculated using the indirect method:

Net income $ 753,000

Adjustments to reconcile net income to net

cash provided by operating activities:

Depreciation expense $ 150,000

Goodwill impairment 75,000

Gain on sale of trading securities (6,000)

Changes in current assets and liabilities:

Decrease in accounts receivable 48,000

Increase in inventory (33,000)

Decrease in trading securities 50,000 ???

Increase in accounts payable 70,000

Decrease in taxes payable (15,000)

Total Adjustments 339,000

Net cash provided by operating activities $ 1,092,000

*My Argument:*

I agree with everything except the +50,000 due to the decrease in trading securities. Shouldn’t it be a +56,000 because this is the PROCEEDS from the sale of the security since there was a 6,000 gain. The journal entry would have been:

DR: Cash 56,000

CR: Trading Securities 50,000

CR: Gain on sale of T/S 6,000

So currently I think the answer provided by Becker has cash understated by 6,000. Can anyone confirm this for me??

[M.O.D.]

You are using reasoning which you would apply to a direct method which you would use on the investing and financing section of the statement of cash flows.

Because this is the indirect method, only differences in accounts are counted. The adjustments are necessary because net income is itself the difference between accounts. If you were to count the 6, you would be double counting, because the 6 is already in one of the asset accounts. You have to have faith on this, because it is the indirect method and you only count the difference in accounts…

You suppose that the proceeds were 56, given a cost of 50, and a gain of 6, reflected in net income. What would prevent that 56 from being in AR? Or anywhere else in the accounts.

Your transaction analysis only works for the direct method, which is used for investment and financing sections.

Imagine you are selling inventory instead of securities. If you sell them through (for) AR then you have to back out your entire net income to calculate a cash flow of 0.

The selling for cash is only used in the direct method.

Also note that the cash account is not listed in your chart of accounts. Unless you are specifically given that information you assume there was no activity in the cash account, and you have to recreate all of the activity, indirectly.

BA Mathematics, UC Berkeley
Certificates in CPA and EA preparation, College of San Mateo
CMA I 420, II 470
FAR 91, AUD Feb 2015 (Gleim self-study)

[sundarak]

Thanks a lot for that explanation. At first I was sure my reasoning was right, but it makes sense that based on the information they have provided us, we have to trust that the decrease in Trading Securities was the cash flow (especially since they did not give us a cash balance account).

Like you said, the question never said that all the proceeds are in cash. It must have been in A/R and cash.

[Anonymous]

I thought under GAAP rules Dividends Received was to be reported in the operating section of the cash-flow statement

[sundarak]

@CPAbyGodsGrace Yes that is correct. However, since we are using the indirect method, the dividends received are already included in Net Income. Thus, we do not have to make any adjustments.

If this was the direct method, we would need to include dividends received as a separate line in the operating section.

[monicasanta]

PLEASE HELP

I think becker changed the answer again this time… for the last question I posted, gain from sale of trading securities are NOT subtracted from net income under the indirect method. Does anyone know why??

From becker “The $6,000 gain on the sale of trading securities does not need to be subtracted from net income because the cash flow from the sale of the trading security should be included in operating cash flows.”

Twin House Inc. reported net income of $753,000 for the current year-ended December 31. Twin House's financial statements reflected the following information:
Depreciation expense $ 150,000
Gain on sale of trading securities 6,000
Goodwill impairment 75,000
Decrease in accounts receivable 48,000
Increase in inventory 33,000
Decrease in trading securities 50,000
Increase in available-for-sale securities 62,000
Increase in accounts payable 70,000
Decrease in taxes payable 15,000
Dividend paid 200,000
Dividend received 27,000
What should Twin House report as net cash provided by operating activities on the statement of cash flows, assuming that Twin House classifies the proceeds from the sale of the trading securities as an operating cash inflow?

a. $1,125,000

b. $1,036,000

c. $898,000

d. $1,098,000

Net income $ 753,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense $ 150,000
Goodwill impairment 75,000
Changes in current assets and liabilities:
Decrease in accounts receivable 48,000
Increase in inventory (33,000)
Decrease in trading securities 50,000
Increase in accounts payable 70,000
Decrease in taxes payable (15,000)
Total Adjustments 345,000
Net cash provided by operating activities $ 1,098,000

[Author]

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