Problem 2 - Accounting

Question

State the effect (cash receipt or payment and amount) of each of the following transactions, considered individually, on cash flows: a. Sold a new issue of \(\$ 200,000\) of bonds at 99 . b. Purchased 4,000 shares of \(\$ 35\) par common stock as treasury stock at \(\$ 70\) per share. c. Sold 10,000 shares of \(\$ 20\) par common stock for \(\$ 50\) per share. d. Purchased a building by paying \(\$ 60,000\) cash and issuing a \(\$ 100,000\) mortgage note payable. e. Retired \(\$ 250,000\) of bonds, on which there was \(\$ 2,500\) of unamortized discount, for \(\$ 260,000\). f. Purchased land for \(\$ 320,000\) cash. g. Paid dividends of \(\$ 2.00\) per share. There were 25,000 shares issued and 4,000 shares of treasury stock. h. Sold equipment with a book value of \(\$ 50,000\) for \(\$ 72,000\).

Step-by-Step Solution

Answer

a: Cash receipt $198,000, b: Cash payment $280,000, c: Cash receipt $500,000, d: Cash payment $60,000, e: Cash payment $260,000, f: Cash payment $320,000, g: Cash payment $42,000, h: Cash receipt $72,000.

Step 1

Analyze transaction (a): Selling bonds at 99 means each bond of face value $1 is sold for $0.99. Therefore, cash received is $200,000 x 0.99 = $198,000. As a result, this transaction is a cash receipt of $198,000.

Step 2

Analyze transaction (b): Purchasing treasury stock involves spending cash. The cost is 4,000 shares x $70 per share = $280,000. This is a cash payment of $280,000.

Step 3

Analyze transaction (c): Selling common stock generates cash. The total cash received is 10,000 shares x $50 per share = $500,000. This is a cash receipt of $500,000.

Step 4

Analyze transaction (d): Purchasing a building involves paying $60,000 in cash while the rest is financed by a mortgage. This results in a cash payment of $60,000.

Step 5

Analyze transaction (e): Retiring bonds at $260,000 means paying this amount to settle a liability of $250,000 with a $2,500 discount. The cash flow is a cash payment of $260,000.

Step 6

Analyze transaction (f): Purchasing land for $320,000 results in the total amount paid in cash. This is a cash payment of $320,000.

Step 7

Analyze transaction (g): Paying dividends involves cash outflow. Calculate total shares with dividends: 25,000 - 4,000 = 21,000 shares. Then, 21,000 shares x $2.00 per share = $42,000. This is a cash payment of $42,000.

Step 8

Analyze transaction (h): Selling equipment results in cash received. The sale amount is $72,000, making this a cash receipt of $72,000.

Key Concepts

Understanding Financial Transactions

In business, financial transactions are the movements of money or assets that keep the operations running. They are important as they affect a company's cash flows. A financial transaction can involve cash inflows, like receiving money from selling products, or cash outflows, like paying suppliers. These transactions are often recorded in books and include different activities such as sales, purchases, and payments.

Whether a transaction results in an increase or decrease in cash depends on its nature. For instance:

• Selling bonds or stock often results in receiving cash.
• Buying assets like land or treasury stock requires spending cash.
• Paying off debt, like retiring bonds, usually leads to cash outflow.

Understanding these transactions helps in managing and forecasting cashflows more effectively.

Treasury Stock Transactions

Treasury stock refers to shares that a company has repurchased from investors. These shares are held in the company's treasury and are not considered outstanding, meaning they do not receive dividends or have voting rights.

When a company buys back its stock, like in the exercise where 4,000 shares were purchased at $70 each, it is spending cash. This results in a cash outflow amounting to $280,000.

Treasury stock transactions can impact a company’s financials as they reduce shareholders' equity and the number of shares in circulation. This can potentially increase earnings per share, giving an appearance of boosted profitability.

Dividends and Their Impact on Cash Flows

Dividends are distributions of a company's earnings to its shareholders. They can be issued in cash or additional shares. In our exercise, dividends were cash payouts of $2.00 per share. Calculating the cash outflow involves accounting for only the outstanding shares, excluding any treasury stock.

For instance, with 25,000 total shares and 4,000 treasury shares, there are 21,000 shares receiving dividends. The total cash payment for dividends thus amounts to $42,000 (21,000 shares x $2.00).

Paying dividends results in cash outflows, but it can positively impact shareholder satisfaction, especially when regular and consistent, indicating a company's robust financial health.

The Process of Bond Retirement

Bond retirement involves paying off a bond obligation before or at maturity. It requires managing cash to settle liabilities which could include the bond's face value and any associated premiums or discounts. In our example, bonds worth $250,000 with a $2,500 discount were retired for $260,000. This resulted in a cash outflow of $260,000.

Retiring bonds can affect a company's leverage and cash flow. Bonds retired at a discount mean less cash spent, but retiring them at a premium or higher market value like in the example can lead to additional expenses. Still, it helps in managing debt levels and improving creditworthiness.