The quoted statement is not accurate.

In their work on cash, auditors are primarily

concerned with the risk of an overstatement of the cash balance. The listing of aEx. 2-148—
Examination of the conceptual framework.

Users of financial statements can face different questions about the recognition and

measurement of financial items. To help develop the type of financial information that can be

used to answer these questions financial accounting and reporting rules on a conceptual

framework.

Instructions

1. What are the basic components of the conceptual framework?

2. What are your views about the success of the conceptual framework?

Solution 2-148

1. The basic components of the conceptual framework are:

a. Objective provides the foundation for the conceptual framework.

b. Qualitative characteristics—the characteristics that make accounting information useful.

c. Elements—provide the definitions of the broad classifications of items found in financial

statements.

d. Operational guidelines (recognition measurement and disclosure concepts)—recommend

concepts to guide decisions concerning the display and disclosure of information about

income, cash flows, and financial position. The operational guidelines are composed of

three parts:

(1) Basic assumptions F 1. Primary purpose of the statement of cash flows.

T 2. Information provided by statement of cash flows.

T 3. Classification of operating activities.

F 4. First step in cash flow statement preparation.

T 5. Reconciling beginning and ending cash balances.

F 6. Net income and net cash flow from operating activities.

T 7. Converting net income to net cash flow from operating activities.

F 8. Reporting cash receipts/disbursements in direct method.

 T 9. Indirect method adjustments.

F 10. FASB’s recommended method.

T 11. Decrease in accounts receivable and cash-basis revenues.

F 12. Decrease in prepaid expenses.

F 13. Income from equity method investment.

T 14. Computing cash receipts from customers.

F 15. Computing cash payments for operating expenses.

F 16. Amortization of bond premium.

T 17. Purchases and sales of trading securities.

T 18. Disclosing noncash investing and financing activities.

F 19. Use of cash flow worksheet.

T 20. Reporting stock dividends on worksheet.

MULTIPLE CHOICE—Conceptual
Answer No. Description

c 21. Objective of the statement of cash flows.

c 22. Primary purpose of the statement of cash flows.

S23.
c Answers provided by the statement of cash flows.

S24.
b First step in cash flow statement preparation.

d 25. Definition of cash equivalents.

d 26. Cash flow effect of a short-term nontrade note payable.

S
c 27. Reporting revenues and expenses on a cash basis.

b 28. The effect of an inventory increase on cash flows from operating

activities.

b 29. Cash flow effects of a stock dividend.

b 30. Effect of a change in dividends payable.

d 31. Effect of cash dividend declaration on operating cash flows.

c 32. Cash flow effects of major repairs on machinery.

 P
c 33. Classifying items as investing activities.

b P34. Classification of a financing activity.

S
b 35. Reporting amortization of bond premium.

S
c 36. Converting accrual based expense to cash basis.

b 37. Adjustment to income for inventory increase.

c 38. Adjustment under the direct and indirect methods.

c 39. Adjustment to cost of goods sold under the direct method.

MULTIPLE CHOICE—Conceptual (cont.)

Answer No. Description

a 40. Adjustment for an increase in accounts payable.

a 41. Adjustment for a decrease in prepaid insurance.

b 42. Direct method vs. indirect method.

c 43. Direct method vs. indirect method.

c 44. Addition to net income under indirect method.

b 45. Deduction from net income under indirect method.

b 46. Statement of cash flows information.

d 47. Adjustment for equity method investment income.

a 48. Reporting extraordinary transactions.

d 49. Events not shown on statement of cash flows.

S50.
c Reporting significant noncash transactions.

P
These questions also appear in the Problem-Solving Survival Guide.

S
These questions also appear in the Study Guide.

MULTIPLE CHOICE—Computational
Answer No. Description

b 51. Determine net cash flow from investing activities.

b 52. Determine net cash flow from financing activities.

 c 53. Determine net cash flow from operating activities.

d 54. Determine net cash flow from investing activities.

c 55. Determine net cash flow from financing activities..

(2) Accounting principles.

(3) Constraints.

2. In general, the success of the conceptual framework will be determined by its acceptance in

practice. The acceptance in practice will be based in large part upon the IASB's solution of

practical problems on a timely basis.

It is a matter of opinion and yet to be seen whether or not the conceptual framework will bring

about the following benefits.

a. The IASB should be able to issue more useful and consistent standards in the future.

b. New practice problems should be solved more rapidly by reference to an existing

framework.

c. Better understanding of and confidence in the financial reporting process by financial

statement users should result.

d. Enhanced comparability among companies' financial statements should result.

non-existent or fictitious check on the outstanding list would have the effect of

understating the client’s cash position, because too large an amount for

outstanding checks would be deducted from the balance per bank, resulting in

understatement of the adjusted balance. The primary purpose of the statement of cash flows
is to provide cash-basis information about the company’s operating, investing, and
financing activities.

2. The statement of cash flows provides information to help investors and creditors assess
the cash and noncash investing and financing transactions during the period.

3. Companies classify some cash flows relating to investing or financing activities as

operating activities.
 4. The first step in the preparation of the statement of cash flows is to determine the net
cash flow from operating activities.

5. The net increase (decrease) in cash reported on the statement of cash flows should
reconcile the beginning and ending cash balances reported in the comparative balance
sheets.

6. Under the accrual basis of accounting, net income is usually the same as net cash flow
from operating activities.

7. A company can convert net income to net cash flow from operating activities through
either the direct method or the indirect method.

8. The direct method, also called the reconciliation method, reports cash receipts and cash
disbursements from operating activities.

9. The indirect method adjusts net income for items that affected reported net income but
did not affect cash.

10. The FASB encourages the use of the indirect method over the direct method.

11. When accounts receivable decrease during a period, cash-basis revenues are higher than
revenues reported on an accrual basis.

12. When prepaid expenses decrease during a period, expenses on the accrual-basis are
lower than they are on a cash-basis.

13. Income from an investment in common stock using the equity method is added to net
income in computing net cash provided from operating activities.
 14. Cash receipts from customers are computed by adding a decrease in accounts receivable
to revenue from sales.

15. Cash payments for operating expenses are computed by subtracting an increase in
prepaid expenses and a decrease in accrued expenses payable from operating expenses.

16. A company should add back bond premium amortization to net income to arrive at net
cash flow from operating activities.

The other element of the quoted statement relating to the auditors’ concern over

the possible omission of a deposit in transit is also in error. To omit a deposit in

transit would cause an understatement of the year-end cash balance.

If the quoted statement were revised into acceptable form, it would read along the

following lines: “When auditors are verifying a client’s bank reconciliation, they

are particularly concerned with the possibility that an outstanding check may be

omitted or that a non-existent deposit in transit may be included.

7-2. There is no assurance that the lapping activities of the cashier will be discovered

during the annual audit. Since no shortage exists as of the balance sheet date, the

only procedure which might disclose the irregularities would be a comparison of

the individual checks listed on duplicate deposit tickets with the credits to

customers’ accounts. Since a test of this nature would probably not be made for

more than a small sample of control listings it is likely that the “borrowing” and

subsequent restoration of borrowed funds might go undetected.

7-3. (a) “Lapping” is a defalcation in which a cash shortage is concealed by delaying

the crediting of cash receipts to the proper accounts receivable. The first step

in the fraud is to withhold from a bank deposit cash remitted by a customer.

A few days later, because the customer must receive credit for his remittance,

the first customer’s account is credited with an amount from a remittance

made by a second customer. The process requires the continuous shifting of

shortages from account to account and the crediting of subsequent receipts to

the wrong account receivable.

(b) The following audit procedure1. The primary purpose of the statement of cash flows is to
provide cash-basis information

about the company’s operating, investing, and financing activities.

2. The statement of cash flows provides information to help investors and creditors assess

the cash and noncash investing and financing transactions during the period.

3. Companies classify some cash flows relating to investing or financing activities as

operating activities.

4. The first step in the preparation of the statement of cash flows is to determine the net cash

flow from operating activities.

5. The net increase (decrease) in cash reported on the statement of cash flows should

reconcile the beginning and ending cash balances reported in the comparative balance

sheets.

6. Under the accrual basis of accounting, net income is usually the same as net cash flow

from operating activities.

7. A company can convert net income to net cash flow from operating activities through

either the direct method or the indirect method.

8. The direct method, also called the reconciliation method, reports cash receipts and cash

disbursements from operating activities.

9. The indirect method adjusts net income for items that affected reported net income but did

not affect cash.

10. The FASB encourages the use of the indirect method over the direct method.

11. When accounts receivable decrease during a period, cash-basis revenues are higher than

revenues reported on an accrual basis.

12. When prepaid expenses decrease during a period, expenses on the accrual-basis are

lower than they are on a cash-basis.

13. Income from an investment in common stock using the equity method is added to net
income in computing net cash provided from operating activities.

14. Cash receipts from customers are computed by adding a decrease in accounts receivable

to revenue from sales.

15. Cash payments for operating expenses are computed by subtracting an increase in

prepaid expenses and a decrease in accrued expenses payable from operating expenses.

16. A company should add back bond premium amortization to net income to arrive at net

cash flow from operating activities.s would be used to uncover lapping:

(1) Compare the detail of mailroom control listings (if prepared) to entries in

the cash receipts journal, postings to the accounts receivable subsidiary

ledger, and the detail of authenticated duplicate deposit slips. This depositing incoming cash
receipts.

(2) If control listings are not prepared, compare the remittance advices

received with customers’ checks to the cash journal entries, postings to

accounts receivable, and deposit slips. If the client stamps remittance

advices with the date received, particular attention should be given to

comparing this date with the date of the related journal entry and posting.

(3) Confirm accounts receivable and give close attention to exceptions made

by customers about payment dates. The confirmation procedure is better

applied as a surprise at an interim date so that a person engaged in

lapping will not have been able to bring the “lapped” accounts up to date.

If the confirmations are always prepared at year-end, the confirmation

procedure may be anticipated by the person doing the l

shortage given a different form such as kiting of checks. (Confirmation

of accounts receivables has not been discussed in this chapter, but some

students may be familiar enough with this procedure to include it in their

answer.)

7-4. West, Inc.

The outstanding checks said by the controller to have been distributed after
December 31 should be reversed to the extent that they were actually distributed

after that date. An actual overdraft should be revealed and not eliminated by

improper journal entries. The primary purpose of the reversal is to properly cut

off the cash and show the proper cash balance. Showing the correct cash balance

eliminates “window dressing”; recorded but undistributed checks would distort

the current ratio by reducing both cash and accounts payable.

7-5. Cavite Company

Requirement (a) Adjusting Journal Entries - 12.31.05

AJE (1) Gas and oil 320

Supplies expense 260

Delivery expense 320

Repairs and maintenance 600

Advances to employees 400

Petty cash fund 1,900

(2) Advances to employees 200

Petty cash fund 200

(3) Accounts receivable - cashier 100

Petty cash fund 10

a. Cashed checks

1. Examine checks as to payee, date, endorsements and subsequent

deposit.

2. Determine if checks were cashed with prior approval of a responsible

official.

b. Vouchers not yet replenished

1. Vouch supporting documents, invoices, etc.

2. Examine vouchers as to approval by authorized officials, signature of

payee, etc.

c. NSF checks
1. Determine reason why NSF checks are still on hand.

2. Confirm directly with drawers.

d. Return of excess travel advance

1. Examine liquidation of travel advance as reported and determine

accuracy of the amount returned.

2. Vouch supporting invoices.

e. Sale of money orders

1. Examine latest report of the Pampanga Co. to establish proper

accountability.

2. Confirm directly with the Pampanga Co. all unreported money orders

sold as well as unissued as of November 10.

f. Vouchers subsequently presented

1. Examine vouchers as to date, approval, amount and nature of

expenditures.

2. Confirm directly with employees those items representing wage

advance.

g. Book balance of the Petty Cash Fund.

1. Trace to the general ledger the balance of the fund.

240,000 + $$370,000 + $226,000 = $836,000.

90. a $480,000 + $740,000 + $452,000 = $1,672,000.

91. a $37,500 – $11,250 = $26,250.

92. b $26,250 + ($750,000 × 0.70) = $551,250.

93. c $1,800,000 – $1,500,000 = $300,000.

94. b ($1,000,000 – $250,000) ÷ 250,000 sh. = $3.00.

95. d $1,000,000 ÷ 400,000 sh. = $2.50.

96. d $350,000 ÷ 100,000 sh. = $3.50.

97. c ($500,000 – $60,000) ÷ 125,000 = $3.52.

98. c ($500,000 – $60,000) ÷ 250,000 = $1.76.

99. b (₤1,000,000 – ₤100,000) ÷ 150,000 = ₤6.00.

100. d ($800,000 – X) ÷ 160,000 = $4.25.

$800,000 – X = $680,000 = $120,000.

101. a (₤3,900,000 – ₤10,000 – ₤7,500) × 0.20 = ₤776,500.

102. b ₤30,000 – (₤30,000 0.20) = ₤24,000.

103. c [(₤3,900,000 – ₤10,000 – ₤7,500) 0.20] + (₤30,000 0.20) = ₤782,500.

104. c $100,000 × 0.60 = $60,000.

105. c $300,000 × 0.60 = $180,000.

106. b ($262,000 – $37,000 + $8,000) × 0.40 = $93,200.

107. a ($377,000 + $23,000 + $6,000) × 0.30 = $121,800.

108. a ($110,000 – $60,000 – $8,000 – $11,000 + $9,000 – $1,000 – $2,000) x

0.40 = $14,800.

109. a $2,500,000 – $430,000 = $2,070,000.

110. b $2,500,000 – $430,000 + $1,000,000 – $320,000 = $2,750,000.

111. c $1,200,000 + $215,000 = $1,415,000.

112. d $1,200,000 + $215,000 + $500,000

STATEMENT OF CASH FLOWS

IFRS questions are available at the end of this chapter.

TRUE-FALSE—Conceptual
Answer No. Description

F 1. Primary purpose of the statement of cash flows.

T 2. Information provided by statement of cash flows.

T 3. Classification of operating activities.

F 4. First step in cash flow statement preparation.

T 5. Reconciling beginning and ending cash balances.

 F 6. Net income and net cash flow from operating activities.

T 7. Converting net income to net cash flow from operating activities.

F 8. Reporting cash receipts/disbursements in direct method.

T 9. Indirect method adjustments.

F 10. FASB’s recommended method.

T 11. Decrease in accounts receivable and cash-basis revenues.

F 12. Decrease in prepaid expenses.

F 13. Income from equity method investment.

T 14. Computing cash receipts from customers.

F 15. Computing cash payments for operating expenses.

F 16. Amortization of bond premium.

T 17. Purchases and sales of trading securities.

T 18. Disclosing noncash investing and financing activities.

F 19. Use of cash flow worksheet.

T 20. Reporting stock dividends on worksheet.

MULTIPLE CHOICE—Conceptual
Answer No. Description

c 21. Objective of the statement of cash flows.

c 22. Primary purpose of the statement of cash flows.

S23.
c Answers provided by the statement of cash flows.

S
b 24. First step in cash flow statement preparation.

d 25. Definition of cash equivalents.

d 26. Cash flow effect of a short-term nontrade note payable.

S27.
c Reporting revenues and expenses on a cash basis.

b 28. The effect of an inventory increase on cash flows from operating

activities.

b 29. Cash flow effects of a stock dividend.

 b 30. Effect of a change in dividends payable.

d 31. Effect of cash dividend declaration on operating cash flows.

c 32. Cash flow effects of major repairs on machinery.

P
c 33. Classifying items as investing activities.

P
b 34. Classification of a financing activity.

S
b 35. Reporting amortization of bond premium.

c S36. Converting accrual based expense to cash basis.

b 37. Adjustment to income for inventory increase.

c 38. Adjustment under the direct and indirect methods.

c 39. Adjustment to cost of goods sold under the direct method.

MULTIPLE CHOICE—Conceptual (cont.)

Answer No. Description

a 40. Adjustment for an increase in accounts payable.

a 41. Adjustment for a decrease in prepaid insurance.

b 42. Direct method vs. indirect method.

c 43. Direct method vs. indirect method.

c 44. Addition to net income under indirect method.

b 45. Deduction from net income under indirect method.

b 46. Statement of cash flows information.

d 47. Adjustment for equity method investment income.

a 48. Reporting extraordinary transactions.

d 49. Events not shown on statement of cash flows.

S50.
c Reporting significant noncash transactions.

P
These questions also appear in the Problem-Solving Survival Guide.

S
These questions also appear in the Study Guide.

MULTIPLE CHOICE—Computational
Answer No. Description

b 51. Determine net cash flow from investing activities.

b 52. Determine net cash flow from financing activities.

c 53. Determine net cash flow from operating activities.

d 54. Determine net cash flow from investing activities.

c 55. Determine net cash flow from financing activities.

a 56. Determine cash flows from investing activities.

d 57. Determine cash flows from financing activities.

a 58. Determine net cash flow from operating activities.

c 59. Determine net cash flow from investing activities.

b 60. Determine cash received from customers (direct method).

d 61. Determine taxes paid (direct method).

c 62. Determine net cash flow from financing activities.

c 63. Compute net cash used in financing activities.

c 64. Sale of fixed assets at a gain/cash flow effects.

b 65. Analysis of plant asset account/cash flow presentation.

c 66. Sale of equipment at a gain/cash flow effects.

c 67. Determine depreciation expense for the year.

b 68. Determine depreciation expense for the year.

a 69. Calculate equipment purchased during the year.

c 70. Calculate cost of equipment sold.

a 71. Determine book value of equipment at end of year.

b 72. Determine ending balance of accounts payable.

c 73. Determine ending balance of retained earnings.

d 74. Determine ending balance of capital stock.

b 75. Determine the amount of a cash dividend.

d 76. Reporting a stock dividend.

c 77. Compute proceeds from issuance of bonds payable.

 a 78. Compute net cash provided by operating activities.

a 79. Determine net income for period.

a 80. Compute net cash provided by operating activities.

a 81. Compute net cash provided by operating activities.

MULTIPLE CHOICE—Computational (cont.)

Answer No. Description

a 82. Compute cash flow from investing activities.

c 83. Compute cash flow from financing activities.

d 84. Compute cash provided by operating activities.

c 85. Compute cash provided by investing activities.

a 86. Compute cash used by financing activities.

a 87. Compute net cash provided by operating activities.

a 88. Compute net cash provided by operating activities.

d 89. Determine net income for period.

c 90. Compute cash payments for operating expenses.

a 91. Compute cash payments to suppliers.

c 92. Compute cash collections from customers.

a 93. Compute cash payments to suppliers.

c 94. Determine cash collected from accounts receivable.

b 95. Determine cash paid on accounts payable to suppliers.

d 96. Compute net cash provided by investing activities.

a 97. Compute net cash provided by financing activities.

 b 98. Compute net cash flow from investingHunter Company and Moss Company both
produce and purchase fabric for resale each period and frequently sell to each other. Since
Hunter Company holds 80 percent ownership of Moss Company, Hunter's controller compiled the
following information with regard to intercompany transactions between the two companies in
2007 and 2008:

Required:
a. Give the eliminating entries required at December 31, 2008, to eliminate the effects of the
inventory transfers in preparing a full set of consolidated financial statements.
b. Compute the amount of cost of goods sold to be reported in the consolidated income
statement for 2008.