Chapter 12, Problem 4E

To determine

Indicate whether each of the following transactions is classified as net cash inflows (outflows) from operating activities (NCFO), Investing activities (NCFI), or financing activity (NCFF) and to determine whether the effect is an inflow of cash (+) or outflow of cash (-), or use (NE) if the transaction has no effect.

Explanation of Solution

Statement of cash flows:

Statement of cash flow is a financial statement that shows the cash and cash equivalents of a company for a particular period of time. It shows the net changes in cash, by reporting the sources and uses of cash as a result of operating, investing, and financing activities of a company.

Operating activities:

Operating activities refer to the normal activities of a company to carry out the business. The examples for operating activities are purchase of inventory, payment of salary, sales, and others. Operating cash flows affects current assets and liabilities.

Investing activities:

Investing activities refer to the activities carried out by a company for acquisition of long term assets. The examples for investing activities are purchase of equipment, long term investment, sale of land, and others. Investing cash flows causes changes in non-current assets.

Financing activities:

Financing activities refer to the activities carried out by a company to mobilize funds to carry out the business activities. The examples for financing activities are purchase of bonds, issuance of common shares, and others. Financing cash flows have an impact on non-current liabilities and stockholders’ equity.

Prepare journal entries for the first year transactions.

1. 1. Purchased raw materials inventory on account

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Inventory		xxx
	Accounts payable			xxx
	(To record purchase of  inventory on account)

Table (1)

• Inventory is an asset and it is decreased. Therefore, debit inventory account.
• Accounts payable is a liability and it is increased. Therefore, credit accounts payable account.

The given transaction is matched with the cash flow activity and the related effects on cash.

Transaction	Cash Flow Activity	Effect on Cash
Purchased raw materials inventory on account	No effect (NA)	No effect (NA)

Table (2)

2. Prepaid rent for the following period.

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Prepaid expense (rent)		xxx
	cash			xxx
	(To record the payment of prepaid rent)

Table (3)

• Prepaid expense is an asset and it is increased. Therefore, debit prepaid expense account.
• Cash is an asset and it is decreased. Therefore, credit cash account.

The given transaction is matched with the cash flow activity and the related effects on cash.

Transaction	Cash Flow Activity	Effect on Cash
Prepaid rent for the following period	Net cash flow from operating activity (NCFO)	Outflow (-)

Table (4)

3. Purchased new equipment by signing a three-year note.

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Plant and equipment		xxx
	Note payable			xxx
	(To record the purchase of equipment)

Table (5)

• Plant and equipment is an asset and it is increased. Therefore, debit plant and equipment account.
• Note payable is a liability and it is increased. Therefore, credit note payable account.

The given transaction is matched with the cash flow activity and the related effects on cash.

Transaction	Cash Flow Activity	Effect on Cash
Purchased new equipment by signing a three-year note	No effect (NE)	No effect (NE)

Table (6)

4. Recorded an adjusting entry for expiration of a prepaid expense.

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Expense		xxx
	Prepaid expense			xxx
	(To record adjusting entry for expiration of prepaid expense)

Table (7)

• Expense is a component of stockholders’ equity. There is an increase in the expense account which decreases the stockholders’ equity. Therefore, debit expense account.
• Prepaid expense is an asset and it is decreased. Therefore, credit prepaid expense account.

The given transaction is matched with the cash flow activity and the related effects on cash.

Transaction	Cash Flow Activity	Effect on Cash
Recorded an adjusting entry for expiration of a prepaid expense	No effect (NE)	No effect (NE)

Table (8)

5. Recorded and paid income taxes to the federal government.

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Income tax expense		xxx
	Cash			xxx
	(To record payment of income tax)

Table (9)

• Income tax expense is a component of stockholders’ equity. There is an increase in the expense account which decreases the stockholders’ equity. Therefore, debit income tax expense account.
• Cash is an asset and it is decreased. Therefore, credit cash account.

The given transaction is matched with the cash flow activity and the related effects on cash.

Transaction	Cash Flow Activity	Effect on Cash
Recorded and paid income taxes to the federal government	Net cash flow from operating activity (NCFO)	Outflow (-)

Table (10)

6. Purchased investment securities for cash.

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Investment securities
	Cash			xxx
	(To record purchase of investment securities for cash)

Table (11)

• Investment securities are an asset and it is increased. Therefore, debit investment securities account.
• Cash is an asset and it is decreased. Therefore, credit cash account

The given transaction is matched with the cash flow activity and the related effects on cash.

Transaction	Cash Flow Activity	Effect on Cash
Purchased investment securities for cash	Net cash flow from investing activity (NCFI)	Outflow (-)

Table (12)

7. Issued common stock for cash.

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Cash		xxx
	Common stock			xxx
	Additional paid-in capital
	(To record issuance of common stock for cash)

Table (13)

• Cash is an asset and it is increased. Therefore, debit cash account.
• Common stock is a component of stockholders’ equity and there is a decrease in the common stock which increases the stockholder’s equity. Therefore, credit stockholders’ equity account.
• Additional paid-in capital is a component of stockholders’ equity and there is a decrease in the common stock which increases the stockholders’ equity. Therefore, credit stockholders’ equity account.

The given transaction is matched with the cash flow activity and the related effects on cash.

Transaction	Cash Flow Activity	Effect on Cash
Issued common stock for cash	Net cash flow from financing activity (NCFF)	Inflow (+)

Table (14)

8. Collected payments on account from customers.

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Cash		xxx
	Accounts receivable			xxx
	(To record collections from customers on account)

Table (15)

• Cash is an asset and it is increased. Therefore, debit cash account.
• Accounts receivable is an asset and it is decreased. Therefore, credit accounts receivable account.

The given transaction is matched with the cash flow activity and the related effects on cash.

Transaction	Cash Flow Activity	Effect on Cash
Collected payments on account from customers	Net cash flow from operating activity (NCFO)	Inflow (+)

Table (16)

9. Sold equipment for cash equal to its net book value.

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Cash		xxx
	Plant and equipment			xxx
	(To record sale of equipment for cash)

Table (17)

• Cash is an asset and it is increased. Therefore, debit cash account.
• Plant and equipment is an asset and it is decreased. Therefore, credit plant and equipment account.

The given transaction is matched with the cash flow activity and the related effects on cash.

Transaction	Cash Flow Activity	Effect on Cash
Sold equipment for cash equal to its net book value.	Net cash flow from investing activity (NCFI)	Inflow (+)

Table (18)

10. Issued long-term debt for cash.

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Cash		xxx
	Long-term debt			xxx
	(To record issuance of long-term debt for cash)

Table (19)

• Cash is an asset and it is increased. Therefore, debit cash account.
• Long-term debt is a liability and it is increased. Therefore, credit long-term debt account.

The given transaction is matched with the cash flow activity and the related effects on cash.

Transaction	Cash Flow Activity	Effect on Cash
Issued long-term debt for cash	Net cash flow from financing activity (NCFF)	Inflow (+)

Table (20)