43 of 52 (the "Company") is incorporated in the state of Nevada and is in the bis. 43 of 52 ng technical and creative expertise and software licensing related to Websil. e television development and related Internet strategies to assist the trad: . tional mass media corporations in accessing the World Wide Web, through set-top toxce and other interactive devices. The balance sheet, income statement, and cash flow statement found in the Blue Zong, Inc. 10K for fiscal year 2000 appear below and on pages 99 and 100 . Excerpts from the foof notes are also given. Blue Zone, Inc. Product and Service The Company generates product and service revenue through the following sources: interactive broadcasting development and maintenance, strategic consulting services for broadcasting and media companies, and software licensing from Blue Zone's family of MediaBZ software applications. Consulting service revenues are recognized upon delivery of the service. Interactive broadcasting maintenance is recognized over the term of the contracts, typically month to month. Software licensing revenue is recognized over the term of the license. Blue Zone recognized license fee revenue of $21,000 during the year, and $60,000 is recorded as deferred revenue at December 31,2000 , representing the unrecognized portion of the annual license fee. Btue Zone, Inc. Consolidated Statements of Operations (Expressed in U.S. dollars) Exchange Agreement On August 1, 1997, the Company entered into an agreement to exchange services with a British Columbia television station (BCTV). The Company provided Web site development and monthly maintenance services in exchange for daily television advertising. The Company recognized the revenues and advertising expenses from the barter transaction at the fair value of the advertising received. Blue Zone recorded no revenue under barter exchange agreements for the year ended December 31, 2000, compared to $505,000 for the year ended December 31 , 1999. This decrease was attributable to the completion of our three-year Web site evolution project contract with BCTV on December 31,1999 , as discussed above. As a result, revenue for which Blue Zone received cash consideration increased 209%, from $378,000 in 1999 to $1,169,000 in 2000. Exchange advertising dropped from $505,000 in 1999 to nil in 2000 as a result of the termination of the BCTV contract and the change in accounting principles applicable to barter transactions. Research and development and advertising costs are expensed as incurred. Advertising costs charged to selling and marketing expenses in 2000 total $4,993 (1999: $513,252;1998:$505,698 ). Advertising costs in 1999 and 1998 include the exchange advertising presented separately in the statement of operations Stock Options During the year ended December 31,2000 , the Company recorded non-cash compensation expense of $270,428(1999:$16,094;1998: nil) relating to the issuance of 2,083,500 (1999: 1,888,500; 1998: nil) common stock purchase options to certain employees, officers, and directors of the Company, representing the implicit benefit derived from the exercise price being less than fair market value. During the year ended December 31,2000 , the Company recorded non-cash compensation expense of $88,745 (1999: $280,917;1998: nil) relating to the issuance of 6,000 (1999: 106,500; 1998: nil) common stock purchase options to certain contractors of the Company, representing the fair value benefit of the options. 6 of 52 -term development projects such as the BCTV contract, revenue is recogiercentage completion basis, based upon achievement of specifically identifiable milestones. A total of $673,000 was earned during the year ended December 31,2000 relating to long-term Web site development for BCTV. Revenue that has been prepaid or invoiced but does not yet qualify for recognition under the Company's policies is reflected as deferred revenue. There was no deferred revenue recorded at December 31,2000 , other than the deferred licensing fee mentioned above. At December 31, 1999 there was unearned revenue of $180,000 relating mainly to payments received on the BCTV contract in advance of the Company satisfying recognition criteria. A significant proportion of Blue Zone's reported revenue for the three years ended December 31, 1999 was earned from a three-year barter exchange agreement with the Vancouver-based broadcaster, BCTV. The Company recorded exchange product and service revenue and recorded an equal amount as exchange advertising expense in the statement of operations. Under the BCTV contract, Blue Zone exchanged product and services for television airtime on BCTV, rather than receiving cash payment. The exchange revenue and the advertising expense were valued at the fair market value of the television airtime. The Company used this airtime to enhance Blue Zone's name recognition to assist in marketing products to current and potential clients. In fiscal 2000, the Company adopted EITF No 99-17 "Accounting for Advertising Barter Transactions." EITF 00-17 provides that the Company recognize revenue and advertising expenses from barter transactions at the fair value only when it has a historical practice of receiving or paying cash for similar transactions. The Company has not recorded barter transactions during the year ended December 31,2000 . Required: 1. Why is the $197,118 of Depreciation added back to net income in the statement of cash flows in order to obtain Net Cash Provided by (used in) Operating Activities? 2. Verify that the changes in Accounts Receivable, Work-in-Progress, and Prepaid Expenses shown as adjustments in the operating section of the cash flow statement agree with the differences between the beginning and ending balances shown in the balance sheets. Is this always true? If yes, why? If no, give an example of when it might not be true. 3. Explain in detail why the prepaid expenses are treated the way they are in the cash flow statement. 4. Why is Stock Based Compensation added to net income in arriving at Cash Provided by (used by) Operating Activities? Provide a journal entry to recognize Stock Based Compensation Expense. 5. In the 2000 fiscal year, how much more or less cash was collected than was recog nized as revenue for those items accounted for in the deferred revenue account? Ex. plain. What about during fiscal 1999 ? 6. To what do Exchange Product and Service Revenue and Exchange Advertising refer to in the 1998 and 1999 income statements? How was this transaction reported in the cash flow statement in 1998 and 1999? In your opinion, is there a better way to have reported this in the cash flow statement? Apparently such transactions would be required to be reported differently in 2000. If they engaged in such barter transactions in 2000 , how would they have been reported in the financial statements? 7. Comment in general about the cash flows in each of the categories (operations, in vesting, and financing) over the three-year period 1998 to 2000. 8. Fill in the question marks in the following T-accounts. Provide a journal entry to generate each of the numbers and an explanation of the transaction. 43 of 52 (the "Company") is incorporated in the state of Nevada and is in the bis. 43 of 52 ng technical and creative expertise and software licensing related to Websil. e television development and related Internet strategies to assist the trad: . tional mass media corporations in accessing the World Wide Web, through set-top toxce and other interactive devices. The balance sheet, income statement, and cash flow statement found in the Blue Zong, Inc. 10K for fiscal year 2000 appear below and on pages 99 and 100 . Excerpts from the foof notes are also given. Blue Zone, Inc. Product and Service The Company generates product and service revenue through the following sources: interactive broadcasting development and maintenance, strategic consulting services for broadcasting and media companies, and software licensing from Blue Zone's family of MediaBZ software applications. Consulting service revenues are recognized upon delivery of the service. Interactive broadcasting maintenance is recognized over the term of the contracts, typically month to month. Software licensing revenue is recognized over the term of the license. Blue Zone recognized license fee revenue of $21,000 during the year, and $60,000 is recorded as deferred revenue at December 31,2000 , representing the unrecognized portion of the annual license fee. Btue Zone, Inc. Consolidated Statements of Operations (Expressed in U.S. dollars) Exchange Agreement On August 1, 1997, the Company entered into an agreement to exchange services with a British Columbia television station (BCTV). The Company provided Web site development and monthly maintenance services in exchange for daily television advertising. The Company recognized the revenues and advertising expenses from the barter transaction at the fair value of the advertising received. Blue Zone recorded no revenue under barter exchange agreements for the year ended December 31, 2000, compared to $505,000 for the year ended December 31 , 1999. This decrease was attributable to the completion of our three-year Web site evolution project contract with BCTV on December 31,1999 , as discussed above. As a result, revenue for which Blue Zone received cash consideration increased 209%, from $378,000 in 1999 to $1,169,000 in 2000. Exchange advertising dropped from $505,000 in 1999 to nil in 2000 as a result of the termination of the BCTV contract and the change in accounting principles applicable to barter transactions. Research and development and advertising costs are expensed as incurred. Advertising costs charged to selling and marketing expenses in 2000 total $4,993 (1999: $513,252;1998:$505,698 ). Advertising costs in 1999 and 1998 include the exchange advertising presented separately in the statement of operations Stock Options During the year ended December 31,2000 , the Company recorded non-cash compensation expense of $270,428(1999:$16,094;1998: nil) relating to the issuance of 2,083,500 (1999: 1,888,500; 1998: nil) common stock purchase options to certain employees, officers, and directors of the Company, representing the implicit benefit derived from the exercise price being less than fair market value. During the year ended December 31,2000 , the Company recorded non-cash compensation expense of $88,745 (1999: $280,917;1998: nil) relating to the issuance of 6,000 (1999: 106,500; 1998: nil) common stock purchase options to certain contractors of the Company, representing the fair value benefit of the options. 6 of 52 -term development projects such as the BCTV contract, revenue is recogiercentage completion basis, based upon achievement of specifically identifiable milestones. A total of $673,000 was earned during the year ended December 31,2000 relating to long-term Web site development for BCTV. Revenue that has been prepaid or invoiced but does not yet qualify for recognition under the Company's policies is reflected as deferred revenue. There was no deferred revenue recorded at December 31,2000 , other than the deferred licensing fee mentioned above. At December 31, 1999 there was unearned revenue of $180,000 relating mainly to payments received on the BCTV contract in advance of the Company satisfying recognition criteria. A significant proportion of Blue Zone's reported revenue for the three years ended December 31, 1999 was earned from a three-year barter exchange agreement with the Vancouver-based broadcaster, BCTV. The Company recorded exchange product and service revenue and recorded an equal amount as exchange advertising expense in the statement of operations. Under the BCTV contract, Blue Zone exchanged product and services for television airtime on BCTV, rather than receiving cash payment. The exchange revenue and the advertising expense were valued at the fair market value of the television airtime. The Company used this airtime to enhance Blue Zone's name recognition to assist in marketing products to current and potential clients. In fiscal 2000, the Company adopted EITF No 99-17 "Accounting for Advertising Barter Transactions." EITF 00-17 provides that the Company recognize revenue and advertising expenses from barter transactions at the fair value only when it has a historical practice of receiving or paying cash for similar transactions. The Company has not recorded barter transactions during the year ended December 31,2000 . Required: 1. Why is the $197,118 of Depreciation added back to net income in the statement of cash flows in order to obtain Net Cash Provided by (used in) Operating Activities? 2. Verify that the changes in Accounts Receivable, Work-in-Progress, and Prepaid Expenses shown as adjustments in the operating section of the cash flow statement agree with the differences between the beginning and ending balances shown in the balance sheets. Is this always true? If yes, why? If no, give an example of when it might not be true. 3. Explain in detail why the prepaid expenses are treated the way they are in the cash flow statement. 4. Why is Stock Based Compensation added to net income in arriving at Cash Provided by (used by) Operating Activities? Provide a journal entry to recognize Stock Based Compensation Expense. 5. In the 2000 fiscal year, how much more or less cash was collected than was recog nized as revenue for those items accounted for in the deferred revenue account? Ex. plain. What about during fiscal 1999 ? 6. To what do Exchange Product and Service Revenue and Exchange Advertising refer to in the 1998 and 1999 income statements? How was this transaction reported in the cash flow statement in 1998 and 1999? In your opinion, is there a better way to have reported this in the cash flow statement? Apparently such transactions would be required to be reported differently in 2000. If they engaged in such barter transactions in 2000 , how would they have been reported in the financial statements? 7. Comment in general about the cash flows in each of the categories (operations, in vesting, and financing) over the three-year period 1998 to 2000. 8. Fill in the question marks in the following T-accounts. Provide a journal entry to generate each of the numbers and an explanation of the transaction