Chapter 6, Problem 1UTI

a.

To determine

Book value:

Book value of the asset is found out after deducting accumulated depreciation from the recorded value of the asset. Recorded value is the value at asset enters the books of account of the organization.

The fair value of the asset:

The fair value of the asset is the amount at which two parties may enter into an agreement with an open hand.

Cash flow:

Cash flow is the receipt or payment by the organization. It may be related to the current period or any other period. It shows the cash position of the organization.

Cash flow from operating activities:

Cash flow from the operating activities shows the receipt and payment regarding the business activity only.

Cash flow from investing activities:

Cash flow from the investing activities shows the receipt and payment regarding the investment activity only.

Cash flow from financing activities:

Cash flow from the financing activities shows the receipt and payment regarding the financing activity only.

Cash flow statement:

Cash flow statement is a statement that reports the cash inflow or outflow in operating, investing, and financing activities of a company for a particular period. This statement represents the sources and applications or uses of cash. Statement of cash flows tells about the liquidity position of the company. It tells about the amount of cash available to meet the obligations of the company.

The effect of the given transaction on the cash flow statement of the consolidated firm in the period of the purchase if Company P pays $900,000 cash to purchase the stock.

Explanation of Solution

The cash flow from investing activities is affected when the company purchases the stock. The cash and cash equivalents of the subsidiary are $50,000.

Compute cash flow from investing activities:

  $\begin{array}{c}Cashflowfrominvestingactivities=\$50,000-\$900,000\\ =\left(\$850,000\right)\end{array}$

Thus, the cash outflow from investing activities is $850,000 when Company P pays $900,000 cash to purchase the stock. Thus, the effect on the cash flow statement will be under the investing activities as payment made to purchase Company S $(850,000).

b.

To determine

Cash flow from investing activities:

Cash flow from the investing activities shows the receipt and payment regarding the investment activity only.

To explain:

The effect of the given transaction on the cash flow statement of the consolidated firm in the period of the purchase if Company P pays $500,000 cash and signs a 5-year note for $400,000.

Explanation of Solution

The cash flow from investing activities is affected when the company purchases the stock. The cash and cash equivalents of the subsidiary are $50,000.

Compute cash flow from investing activities:

  $\begin{array}{c}Cashflowfrominvestingactivities=\$50,000-\$500,000\\ =\left(\$450,000\right)\end{array}$

Thus, the cash flow from investing activities is $450,000 when Company P pays $500,000 cash to purchase the stock. The Company has signed the notes for 5 years which will not affect the cash flow statement as it is a non-cash payment. It will be shown as a non-cash financing activity. Thus, the effect on the cash flow statement will be under the investing activities as Payment made to purchase Company S $(450,000).

c.

To determine

Cash flow from investing activities:

Cash flow from the investing activities shows the receipt and payment regarding the investment activity only.

The effect of the given transaction on the cash flow statement of the consolidated firm in the period of the purchase if Company P exchanges only common stock with the shareholders of Company S.

Explanation of Solution

The cash flow from investing activities is affected when the company purchases the stock. The cash and cash equivalents of the subsidiary are $50,000.

Compute cash flow from investing activities:

  $\begin{array}{c}Cashflowfrominvestingactivities=\$50,000-\$0\\ =\$50,000\end{array}$

Thus, the cash flow from investing activities is $50,000 when Company P exchanges only common stock with the shareholders of Company S. The Company has exchanged the common stock worth $900,000 which will not affect the cash flow statement as it is a non-cash payment. It will be shown as a non-cash financing activity. Thus, the effect on the cash flow statement will be under the investing activities as Proceeds from investment in Company S $50,000.