Financial and Managerial Accounting

ACCT 652 Session 3 Practice Problems

M2-21. (20 minutes)

a. Net income computation

Service revenue (record when earned) ................................. $200,000

Wages expense (record when incurred, even if unpaid) .........

(40,000) ($25,000 + $15,000)

Net income ............................................................................. $160,000

b. Net cash flow computation

Cash inflow from services rendered .......................................

Cash outflow for wages paid ..................................................

Net cash inflow .......................................................................

$50,000 ($30,000 + $20,000)

(25,000)

$25,000

Cash inflow from services rendered will be $150,000 less than service revenue per

the income statement because Penno only collected $50,000 of revenues in cash but

reported $200,000 as revenue. Cash outflow for wages paid will be $15,000 less

than wages expense on the income statement because $15,000 remained unpaid at

year-end. The combined effects of these two items yields an overall difference of

$135,000 between net income and net cash inflow [$160,000 net income and

$25,000 net cash inflows].

P2-43. (40 minutes)

a. Depreciation is added back to undo the effect it had on the income statement. Wal-Mart

deducted $8,501 million of depreciation (and amortization) expense in computing net

income. Depreciation is a noncash expense so Wal-Mart did not actually use $8,501

million of cash to pay depreciation expense. Thus, to determine how much cash was

generated, net income is too low by the depreciation amount of $8,501 million. The

depreciation add-back is NOT a source of cash as some mistakenly believe. Cash is,

ultimately, generated by profitable operations, not by depreciation.

b. Revenue is recognized, and profit increased, when it is earned, whether or not cash is

received. Sales on account, therefore, increase profit, and the deduction for the increase

in receivables...