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 5,000 shares of \(\$ 30\) par common stock for \(\$ 90\) per share. b. Sold equipment with a book value of \(\$ 42,500\) for \(\$ 36,000\). c. Purchased land for \(\$ 250,000\) cash. d. Purchased 5,000 shares of \(\$ 30\) par common stock as treasury stock at \(\$ 60\) per share. e. Sold a new issue of \(\$ 100,000\) of bonds at 98 . f. Paid dividends of \(\$ 1.50\) per share. There were 40,000 shares issued and 5,000 shares of treasury stock. g. Retired \(\$ 500,000\) of bonds, on which there was \(\$ 2,500\) of unamortized discount, for \(\$ 500,500\). \(\mathrm{h}\). Purchased a building by paying \(\$ 40,000\) cash and issuing a \(\$ 90,000\) mortgage note payable.

Step-by-Step Solution

Answer

Receipts: a) $450,000, b) $36,000, e) $98,000. Payments: c) $250,000, d) $300,000, f) $52,500, g) $500,500, h) $40,000.

Step 1: Calculate Cash Receipt from Selling Common Stock

The company sold 5,000 shares at \(90 each. To find the cash receipt, multiply the number of shares by the selling price per share: \[5000 \times 90 = 450,000\]Thus, the cash receipt is \)450,000.

Step 2: Determine Cash Flow from Selling Equipment

The equipment was sold for $36,000. Since it is a cash sale, this amount is a cash receipt, even though the sale is at a loss if considering the book value.

Step 3: Calculate Cash Payment for Purchasing Land

The land was purchased for $250,000 cash. Therefore, this amount represents a cash payment.

Step 4: Determine Cash Outflow for Purchasing Treasury Stock

The company purchased 5,000 shares of its own stock at \(60 each. Calculate the payment:\[5000 \times 60 = 300,000\]This is a cash payment of \)300,000.

Step 5: Calculate Cash Inflow from Bond Issuance

The company sold a new issue of \(100,000 bonds at 98. Calculate the cash inflow:\[100,000 \times 0.98 = 98,000\]Cash receipt is \)98,000.

Step 6: Calculate Cash Dividends Paid

The company paid dividends of \(1.50 per share on 35,000 shares (40,000 issued minus 5,000 treasury). Calculate this payment:\[35,000 \times 1.50 = 52,500\]This results in a cash payment of \)52,500.

Step 7: Determine Cash Flow from Retiring Bonds

The bonds retired were $500,000 with $2,500 unamortized discount, retired for $500,500. The actual cash paid is $500,500, which is a cash payment.

Step 8: Calculate Cash Payment for Building Purchase

The building was purchased by paying $40,000 cash and issuing a $90,000 mortgage. Only the cash portion affects cash flows, thus it's a cash payment of $40,000.

Key Concepts

Financial Transactions

In accounting, financial transactions are ways in which businesses interact financially, such as sales, purchases, or other money transfers. These transactions can occur in different forms and significantly impact a company's cash flow. Each transaction might increase or decrease the cash available, and understanding these effects is vital for robust financial management.

• Cash Receipts: This represents money entering the business, increasing cash flow.
• Cash Payments: Represents money leaving the business, decreasing cash flow.

Every financial transaction is recorded with precision, often through formal documents like invoices or contracts, ensuring accuracy and adherence to financial principles. These transactions include buying and selling of stock, purchasing assets, issuing bonds, and paying dividends.

Accounting Exercises

Accounting exercises help students and professionals understand financial principles by analyzing real-world scenarios. They reinforce concepts like cash flow, asset management, and liabilities through practical application. Exercises might involve calculating the effects of financial transactions on cash flow, examining the financial impact of asset purchases, or assessing the implications of issuing stock or bonds. In any accounting exercise, the goal is to understand the financial outcome of various transactions. This might include determining whether a given action results in a cash inflow or outflow and accurately recording these movements in the accounting records.

Cash Receipts and Payments

Cash receipts and payments are at the heart of cash flow analysis. They tell you how much cash is coming in or going out at any given time, which is vital for understanding and managing a company's liquidity.

• Cash Receipts: Inflows like selling stock or issuing bonds increase cash available for operations.
• Cash Payments: Outflows such as purchasing assets or paying dividends decrease available cash.

Understanding these concepts is crucial as they affect a company’s ability to meet its short-term obligations and invest in opportunities. Carefully managing cash receipts and payments helps in maintaining overall financial health.

Treasury Stock

Treasury stock refers to a corporation’s own shares that it has reacquired from shareholders but not retired. Reacquiring these shares, as in the given exercise where the company buys back its stock, represents a cash payment, which can help support the stock price or be used for future corporate actions. Treasury stock transactions affect equity on the balance sheet but not the income statement. Instead, they reduce the number of outstanding shares, impacting financial ratios and earnings per share calculations. Companies might buy back shares for various reasons, including consolidating ownership or utilizing excess cash effectively.

Bond Issuance

Issuing bonds is a way for companies to raise capital through debt. When companies issue bonds like in step 5 of the exercise, they are effectively borrowing money from investors. This results in a cash receipt, inflowing funds to the company.

• Cash Inflow: When a bond is issued, it brings in funds that the company can use for various projects or operations.
• Repaying the Bond: Eventually, the company needs to repay this amount along with interest, impacting future cash flows.

Bond issuance must be carefully managed to maintain a balance between leveraging financial growth and maintaining financial health.

Building Purchase

Purchasing a building is a significant financial move for many companies, often involving substantial cash payments and long-term financing. In the given exercise, the building purchase involved a partial cash payment and a mortgage note payable.

• Cash Payment: Immediate outlay of cash (as in the $40,000 cash payment) affects cash flow.
• Long-term Liability: The mortgage note represents a long-term liability that will affect future financial planning.

The purchase impacts both assets and liabilities on the balance sheet, influencing future business operations and potential expansions.

Dividends Payment

Dividends are payments made to shareholders from the company's earnings. They reflect the company’s profit-sharing approach, distributing earned profits back to the owners. Paying dividends, as explained in the exercise, results in a cash outflow for the company. When a company decides on dividend payments, they must balance rewarding shareholders with retaining enough earnings to fund future growth or investments. This decision affects the amount of cash required and impacts shareholder satisfaction and retention. Calculating the payment accurately ensures fair and effective disbursement.