Guidance

The exhibit following lists the issues and how they were resolved.

Issue 6 Detail

As noted above, Issue 6 allows for a choice of two different approaches:

• The cumulative earnings approach. In this approach, the investor compares the distribution received with its cumulative equity method earnings since inception. Distributions received up to the amount of cumulative earnings are a return on investment classified in operating activities. Excess distributions are considered a return on interest, classified as investing activities.
• Nature of distribution approach. The entity classifies distributions based on the nature of the investee's activities that generated the distribution. If the information necessary to implement this approach is not available, the investor should use the cumulative earnings approach and report a change in accounting principe.

Effective Date

ASU 2016-15 is effective as follows:

• For public business entities, fiscal year beginning after December 15, 2017 and interim periods therein.
• All other entities: fiscal years beginning after December 15, 2018 and interim periods within fiscal years beginning after December 15, 2019.

Early adoption is permitted, but all provisions of the ASU must be adopted at the same time.

Transition

Retrospective application is required.

Guidance

ASU 2016–18 requires entities to explain the changes in the combined total of restricted and unrestricted cash. Entities must combine restricted cash with unrestricted cash and cash equivalents in the statement of cash flows and entities will no longer present transfers between cash and cash equivalents and restricted cash and restricted cash equivalents. (ASC 230-10-45-4 and 45-6)

The ASU does not provide a formal definition of unrestricted cash, but entities will be required to disclose information about the nature of the restriction. Companies generally present restricted cash separately from cash and cash equivalents. However, the line item may not be titled restricted cash.

This ASU also requires two new disclosures—ASC 230-10-50-7 and 50-8, which can be found in the disclosure checklist at www.wiley.com/go/GAAP2018.

Effective Date

ASU 2016-18 is effective as follows:

• For public business entities, fiscal year beginning after December 15, 2017 and interim periods therein.
• All other entities: fiscal years beginning after December 15, 2018 and interim periods within fiscal years beginning after December 15, 2019.

Early adoption is permitted.

Transition. Retrospective application is required.

Additional Information (all Relating to 20X2)

1. Equipment costing $6,000 with a book value of $2,000 was sold for $5,000.
2. The company received a $3,000 dividend from its investment in XYZ, accounted for under the equity method and recorded income from the investment of $5,000 that is included in other income.
3. The company issued 200 shares of common stock for $5,000.
4. The company signed a note payable for $9,000.
5. Equipment was purchased for $8,000.
6. The company converted $15,000 bonds payable into 500 shares of common stock. The book value method was used to record the transaction.
7. A dividend of $12,000 was declared.
8. Equipment was leased on December 31, 20X2. The principal portion of the first payment due December 31, 20X3, is $700.
9. The company sold half of their available-for-sale investments during the year for $8,000. The fair value of the remaining available-for-sale investments was $8,500 on December 31, 20X2.
10. The income tax rate is 36%.

Explanation of entries to compile the statement of cash flows

1. Cash and Cash Equivalents—Operating Activities is debited for $16,320 (net income) and the credit is to Retained Earnings.
2. Depreciation is not a cash flow; however, depreciation expense was deducted to arrive at net income. Therefore, Accumulated Depreciation is credited and Cash and Cash Equivalents—Operating Activities is debited.
3. Amortization of patents is another expense not requiring cash; therefore, Cash and Cash Equivalents—Operating Activities is debited and Patent is credited.
4. The sale of equipment (additional information, item 1) resulted in a $3,000 gain. The gain is computed by comparing the book value of $2,000 with the sales price of $5,000. Cash proceeds of $5,000 are an inflow of cash. Since the gain was included in net income, it must be deducted from net income to determine cash provided by operating activities. This is necessary to avoid counting the $3,000 gain both in cash provided by operating activities and in investing activities. The following entry would have been made on the date of sale:

   Cash	5,000
   Accumulated depreciation ($6,000 − $2,000)	4,000
   Property, plant, and equipment		6,000
   Gain on sale of equipment ($5,000 − $2,000)		3,000

   Adjust the T-accounts as follows: debit Summary of Cash and Cash Equivalents for $5,000, debit Accumulated Depreciation for $4,000, credit Property, Plant, and Equipment for $6,000, and credit Cash and Cash Equivalents—Operating Activities for $3,000.

5. The deferred income tax liability account shows an increase of $4,440. The $3,000 increase that pertains to amounts reported in the income statement must be added to income from operations. Although the $3,000 was deducted as part of income tax expense in determining net income, it did not require an outflow of cash. Therefore, debit Cash and Cash Equivalents—Operating Activities and credit Deferred Taxes. The other two amounts in the deferred tax liability account are covered below, under paragraph “p.”
6. Item 2 under additional information indicates that the investment in XYZ is accounted for under the equity method. The investment in XYZ had a net increase of $2,000, which is the result of the equity in the earnings of XYZ of $5,000 and the receipt of a $3,000 dividend. Dividends received (an inflow of cash) would reduce the investment in XYZ, while the equity in the income of XYZ would increase the investment without affecting cash. The journal entries would have been:

   Cash (dividend received)	3,000
   Investment in XYZ		3,000
   Investment in XYZ	5,000
   Equity in earnings of XYZ		5,000

   The dividend received ($3,000) is an inflow of cash, and the equity earnings are not. Debit Investment in XYZ for $5,000, credit Cash and Cash Equivalents—Operating Activities for $5,000, debit Cash and Cash Equivalents—Operating Activities for $3,000, and credit Investment in XYZ for $3,000.

7. The Property, Plant, and Equipment account increased because of the purchase of $8,000 (additional information, item 5). The purchase of assets is an outflow of cash. Debit Property, Plant, and Equipment for $8,000 and credit Summary of Cash and Cash Equivalents.
8. The company sold 200 shares of common stock during the year (additional information, item 3). The entry for the sale of stock was:

   Cash	5,000
   Common stock (200 shares × $10)		2,000
   Additional paid-in capital		3,000

   This transaction resulted in an inflow of cash. Debit Summary of Cash and Cash Equivalents $5,000, credit Common Stock $2,000, and credit Additional Paid-in Capital $3,000.

9. Dividends of $12,000 were declared (additional information, item 7). Only $9,000 was actually paid in cash, resulting in an ending balance of $5,000 in the Dividends Payable account. Therefore, the following entries were made during the year:

   Retained earnings	12,000
   Dividends payable		12,000
   Dividends payable	9,000
   Cash		9,000

   These transactions result in an outflow of cash. Debit Retained Earnings $12,000 and credit Dividends Payable $12,000. Additionally, debit Dividends Payable $9,000 and credit Summary of Cash and Cash Equivalents $9,000 to indicate the cash dividends paid during the year.

10. Accounts Receivable (net) decreased by $2,000. This is added as an adjustment to net income in the computation of cash provided by operating activities. The decrease of $2,000 means that an additional $2,000 cash was collected on account above and beyond the sales reported in the income statement. Debit Cash and Cash Equivalents—Operating Activities and credit Accounts Receivable for $2,000.
11. Inventories increased by $5,000. This is subtracted as an adjustment to net income in the computation of cash provided by operating activities. Although $5,000 additional cash was spent to increase inventories, this expenditure is not reflected in accrual-basis cost of goods sold. Debit Inventory and credit Cash and Cash Equivalents—Operating Activities for $5,000.
12. Prepaid Expenses decreased by $3,000. This is added back to net income in the computation of cash provided by operating activities. The decrease means that no cash was spent when incurring the related expense. The cash was spent when the prepaid assets were purchased, not when they were expensed on the income statement. Debit Cash and Cash Equivalents—Operating Activities and credit Prepaid Expenses for $3,000.
13. Accounts Payable decreased by $10,000. This is subtracted as an adjustment to net income. The decrease of $10,000 means that an additional $10,000 of purchases were paid for in cash; therefore, income was not affected but cash was decreased. Debit Accounts Payable and credit Cash and Cash Equivalents—Operating Activities for $10,000.
14. Notes Payable increased by $9,000 (as listed under additional information, item 4). This is an inflow of cash and would be included in the financing activities. Debit Summary of Cash and Cash Equivalents and credit Notes Payable for $9,000.
15. Interest Payable increased by $1,000, but interest expense reported on the income statement was $2,000. Therefore, although $2,000 was expensed, only $1,000 cash was paid ($2,000 expense – $1,000 increase in interest payable). Debit Cash and Cash Equivalents—Operating Activities for $1,000 for the noncash portion, debit Interest Payable for $1,000 for the cash portion, and credit Interest Payable for $2,000 for the expense.
16. The following entry was made to record the incurrence of the tax liability:

    Income tax expense	9,180
    Income taxes payable		6,180
    Deferred tax liability		3,000

    Therefore, $9,180 was deducted in arriving at net income. The $3,000 credit to Deferred Income Taxes was accounted for in entry e above. The $6,180 credit to Taxes Payable does not, however, indicate that $6,180 cash was paid for taxes. Since Taxes Payable increased $1,180, only $5,000 must have been paid and $1,180 remains unpaid. Debit Cash and Cash Equivalents—Operating Activities for $1,180, debit Income Taxes Payable for $5,000, and credit Income Taxes Payable for $6,180.

17. Item 6 under the additional information indicates that $15,000 of bonds payable were converted to common stock. This is a noncash financing activity and should be reported in a separate schedule. The following entry was made to record the transaction:

    Bonds payable	15,000
    Common stock (500 shares × $10 par)		5,000
    Additional paid-in capital		10,000

    Adjust the T-accounts with a debit to Bonds Payable, $15,000; a credit to Common Stock, $5,000; and a credit to Additional Paid-in Capital, $10,000.

18. Item 8 under the additional information indicates that leased equipment was acquired on the last day of 20X2. The entity classified that lease as a finance lease. This is also a noncash financing activity and should be reported in a separate schedule. The following entry was made to record the lease transaction:

    Leased asset	5,000
    Lease obligation		5,000

19. The company sold half of its available-for-sale investments during the year for $8,000 (additional information, item 9). The entry for the sale of the investments was:

    Cash	8,000
    Investment in available-for-sale securities		7,500
    Gain on sale of investments		500

    This transaction resulted in an inflow of cash. Debit Summary of Cash and Cash Equivalents $8,000, credit Investment in Available-for-Sale Securities $7,500, and credit Cash and Cash Equivalents—Operating Activities $500. The following additional journal entries were made:

    Adjustment for changes in FV	1,500
    Other comprehensive income ($1,500 × 64%)		960
    Deferred tax liability ($1,500 × 36%)		540

    To adjust the allowance account for the sale, one-half of the amounts provided at the end of 20X2 must be taken off the books when the related securities are sold.

    Adjustment for changes in FV	2,500
    Unrealized gain on available-for-sale securities ($2,500 × 64%)		1,600
    Deferred tax liability ($2,500 × 36%)		900

    The change in fair value of the remaining securities at year-end (as listed under additional information, item 9) must be adjusted. The book value of the securities before the adjustment above is $6,000 ($7,500 − $1,500). The fair value of the securities is $8,500. An adjustment of $2,500 is necessary.

20. The cash and cash equivalents from operations ($15,000) is transferred to the Summary of Cash and Cash Equivalents.

All of the changes in the noncash accounts have been accounted for and the balance in the Summary of Cash and Cash Equivalents account of $25,000 is the amount of the year-to-year increase in cash and cash equivalents. The formal statement may now be prepared using the T-account, Summary of Cash and Cash Equivalents. The alphabetic characters in the statement below refer to the entries in that T-account. The following statement of cash flows is prepared under the direct method. The calculations for gross receipts and gross payments needed for the direct method are shown below the statement.

Calculation of amounts for operating activities section

Cash received from customers = Net sales + Beginning A/R − Ending A/R

Cash paid to suppliers = Cost of goods sold + Beginning A/P − Ending A/P + Ending inventory − Beginning inventory

Cash paid for operating expenses = Operating expenses + Ending prepaid expenses − Beginning prepaid expenses − Depreciation expense (and other noncash operating expenses)

Interest paid = Interest expense + Beginning interest payable − Ending interest payable

Taxes paid = Income taxes + Beginning income taxes payable − Ending income taxes payable − Change in deferred income taxes—operating portion

When a statement of cash flows is prepared using the direct method of reporting operating cash flows, the reconciliation of net income to operating cash flows must also be provided. The T-account, Cash and Cash Equivalents—Operating Activities is used to prepare the reconciliation. The alphabetic characters in the reconciliation below refer to the entries in the T-account.