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Solution for Financial Accounting: The Impact on Decision Makers 7th Edition Chapter 12, Problem 2

by Gary A. Porter, Curtis L. Norton
315 Solutions 13 Chapters 30789 Studied ISBN: 9781439080528 Finance 5 (2)

Chapter 12, Problem PA 2 : 4.1.Ethical decision: Reporting of noncash investing and financing...

4.1.Ethical decision: Reporting of noncash investing and financing activities

When a significant liability is incurred to purchase an asset, the company must report this transaction in a footnote to the statement of cash flows, even though it involved no cash.

Why do you think this is true?

What impact does this transaction have on the company’s present or future cash position?

Suppose that the company believes the disclosure is important but prefers not to use a footnote to make this disclosure. They decide that even though the purchase of the asset in exchange for a liability was a single transaction, they will report it on the statement of cash flows as two transactions. In the Investing Activities section of the statement they will report the purchase of an asset as cash flow out. In the Financing Activities section they will report a cash inflow resulting from the issue of debt.

Will this result in an incorrect total for the net increase or decrease in cash for the period? Explain why or why not.

Will this treatment on the statement of cash flow distort, for the reader, the company’s present or future cash position or commitments?

Would it be dishonest, or unethical, to report the transaction in this way?

 

Step-By-Step Solution

4.1.

Solution

Significant noncash transactions are important because the debt involved may commit the company to material cash outflow in the future. Since the statement is intended not only to report the reasons for current changes in cash, but also to enable the reader to predict the company’s future cash flows, this information is necessary, and is more likely to be seen in its proper context if it is presented with the statement of cash flows.

The liability will involve both principal and interest payments in the future, potentially over a number of years. The reader concerned with the amount of principal and interest, and the terms of the liability, might want to read the footnote on long-term debt.

The net increase or decrease in cash will be unchanged. An amount will be deducted from cash flow from investing activities, and an equal amount will be added to cash flow from financing activities, with net cash flow of zero.

Unless the financing item was not described as debt, an unlikely event, there would be no distortion, since the reader would still learn about principal and interest commitments for the future. The company might even argue that the item is more likely to be noticed in the body of the statement than in a footnote.

It is inaccurate to report one transaction as two, but it is probably not dishonest or unethical, since no material distortion results, and there is no attempt to hide the transaction or any of its attributes or effects.

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