An analysis of comparative balance sheets, the current year’s income statement, and the general ledger accounts of Hailey Corp. uncovered the following items. Assume all items involve cash unless there is information to the contrary.
a. Exchange of land for patent.
b. Sale of building at book value.
c. Payment of dividends.
d. Depreciation of plant assets.
e. Conversion of bonds into common stock.
f. Issuance of capital stock.
g. Amortization of patent.
h. Issuance of bonds for land.
I. Retirement of bonds.
j. Loss on disposal of plant assets.
The correct answer and explanation is:
The items listed in the problem involve various transactions and their effects on the financial statements. Here is the breakdown of each item, indicating whether it involves cash or not and the related accounting impact:
a. Exchange of land for a patent
This is a non-cash transaction. It involves the exchange of one asset (land) for another (patent). The impact is reflected in the balance sheet, as the value of land decreases and the value of the patent increases. There is no effect on cash flows here.
b. Sale of building at book value
This transaction involves a cash inflow. When a building is sold at book value, cash is received, and the building is removed from the balance sheet at its book value. There is no gain or loss in this transaction.
c. Payment of dividends
This is a cash outflow. Dividends are paid out of the company’s earnings to shareholders. The payment reduces the cash balance, and it is reflected as a financing activity in the cash flow statement.
d. Depreciation of plant assets
Depreciation is a non-cash expense. It reduces the book value of the plant assets on the balance sheet but does not affect cash. It is an expense on the income statement, and since it is non-cash, it is added back in the operating activities section of the cash flow statement.
e. Conversion of bonds into common stock
This is a non-cash financing activity. The company exchanges its bonds for common stock, which results in a reduction of liabilities (bonds) and an increase in equity (common stock). There is no cash flow involved in this transaction.
f. Issuance of capital stock
This is a cash inflow, assuming the capital stock is issued for cash. It increases the equity section of the balance sheet and results in a cash inflow, which is reflected in the financing activities section of the cash flow statement.
g. Amortization of patent
Amortization of the patent is a non-cash expense. Similar to depreciation, it reduces the book value of the patent but does not involve any cash flow. It is an expense on the income statement and added back in the operating activities section of the cash flow statement.
h. Issuance of bonds for land
This is a non-cash transaction. Bonds are issued, but no cash changes hands since the bonds are exchanged for land. The transaction affects the balance sheet by increasing both liabilities (bonds payable) and assets (land), but no cash flow is involved.
i. Retirement of bonds
The retirement of bonds usually involves a cash outflow. If the bonds are redeemed for cash, the company will pay out cash to extinguish its bond liabilities. This transaction is reflected in the financing activities section of the cash flow statement as a cash outflow.
j. Loss on disposal of plant assets
The loss on the disposal of plant assets is a non-cash item. The loss is recognized on the income statement, but it does not affect cash directly. In the cash flow statement, the loss is added back to the net income under operating activities since it was subtracted when calculating net income.
In summary, cash-related transactions include the sale of the building at book value, the payment of dividends, the issuance of capital stock, the retirement of bonds, and possibly the sale of land. Non-cash transactions involve the exchange of assets (land for patent, bonds for land), the amortization of patents, depreciation, the conversion of bonds into stock, and the loss on disposal of plant assets. Each transaction must be accurately recorded in the financial statements to reflect the company’s true cash position and financial health.