CAsh Flow Statements

The following is taken from Schweser… In preparing its cash flow statement for the year ended December 31, 2004, Giant Corporation collected the following data: Gain on sale of equipment :$6,000 Proceeds from sale of equipment :10,000 Purchase of Zip Co. bonds for :180,000 (maturity value $200,000) Amortization of bond discount :2,000 Dividends paid :(75,000) Proceeds from sale of Treasury stock :38,000 In its December 31, 2004, statement of cash flows, what amounts should Giant report as net cash used in investing activities and net cash used in financing activities? Investing Activities Financing Activities A) $178,000 -$38,000 B) $170,000 -$38,000 C) $178,000 -$37,000 D) $170,000 $37,000 This is their anwser: D Click for Answer and Explanation Investing Activities: $10,000 – $180,000 = -$170,000 cash flow from investing or $170,000 used Financing Activities: $38,000 − $75,000 = -$37,000 cash flow from financing or $37,000 used Note that the question asked for net cash used therefore this is a positive cash outflow. Now what i dont understand is that, why is the Amortization of bond discount 2,000, not included in the calculation of the CFF. When it states that it should be? Any ideas? Thanks

amortization, if it needs to be included, is usually part of CFO, not CFF.

Amortisation has not cashflow impact … like depreciation.

The amortized portion of the bond premium will be included in cash flow from financing. This will cause the reported cash flow from financing to be overstated relative to that of a company that sold its bond at par. That was taken from Investopedia??? So yeah you can see why i’m confussed

I think Joshua’s right. It’s a paper transaction so that the bond receivable will be $200K at maturity which is when the cash flow occurs.

Note that the company has purchased the bond and should be treated as Held to Maturity asset. Any amortization will be treated as if it was a depreciation for a fixed asset. Cheers Sumo

ok, then if the indirect method was used we would add back the amortized portion?

That’s correct.

So the extract from Investopedia is refering to indirect cash flow?? and could the opposite be said if the bond was issued at a discount…ie we would subtract the amount when calculating indirect CFF

No, I don’t think so. Assuming it’s not a finance company, I think the premium amortization bypasses the income statement through other comprehensive income like an unrealized gain/loss. And if I’m wrong I’m sure Joey will chastise me appropriately.

Please remember – Amortization is ADDED back only in INDIRECT Method. And this is only to CFO. Never to CFF. CFF and CFI remain the same whether we use Direct or Indirect method. Reneir what you have stated about it showing up on the CFF is not correct.

correct me if i am wrong… Amortization of bond discount/premium is not considered as CFO in Indirect/Direct method. Amortization of intangible is considered for CFO calculation though… Amortization of bond discount/premium is not charged on income statement so need to add back to NI under indirect method. This will be considered when the debt is finally paid off.

Thanks guys, but i really have no idea whats going on anymore, you say CFO and Investopedia says CFF ?? Man this is crazy !!! its so annoying.

I think the source of your confusion is that investopedia is referring your own bonds you sell as opposed to buying bonds of another company. If you float bonds then the discount/premium is treated as an increase/decrease in your interest expense and that is on the income statement and it’s cash flow is CFF. Your example was buying a different companies bonds, which gets a different treatment. If your company is in the business of buying and selling bonds (although the example didn’t sound like it was) then it’s operating income/expense and a CFO cash flow. If you’re company’s business isn’t buying and selling bonds, then it’s an investment of surplus funds and CFI.

Yes please!!! Thank you Paul. Man that really clears the issue up. : ) Very much appreciated!!!