Chapter 17: Questions & Answers

CHAPTER 17

Statement of
Cash Flows

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Questions & Answers

1a What is the statement of cash flow?

Answer: Statement of Cash Flows: The statement of cash flows is the

financial statement that provides information about the cash receipts, cash
payments, and net change in cash resulting from the operating, investing, and
financing activities of an enterprise during a period in a format that reconciles
the beginning and ending cash balances,

1b Pat Marx maintains that the statement of cash flows is an optional

financial statement. Is this true? Explain why or why not.

Answer: We are disagreed with the statement. The statement of cash flows is
required. It is the fourth basic financial statement.

2 What questions about cash are answered by the statement of cash flows?

Answer: The statement of cash flows answers the following questions about
cash: (a) Where did the cash come from during the period? (b) What was the
cash used for during the period? and (c) What was the change in the cash
balance during the period?

3 Distinguish among the three types of activities reported in the statement

of cash flows.

Answer: The distinctions among the three activities are:

(1) Operating Activities: Operating activities include the cash effects of
transactions that create revenues and expenses and thus enter into the
determination of net income.
(2) Investing Activities: Investing activities include: (a) acquiring and
disposing of investments and productive long-lived assets and (b) lending
money and collection loans.
(3) Financial Activities: Financial activities include: (a) obtaining cash from
issuing debt and repaying the amounts borrowed and (b) obtaining cash from
stockholders and providing them with a return on their investment.
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4a What are the major sources (inflows) of cash?

Answer: Major inflows of cash in a statement of cash flows include cash from
operations; issuance of debt; collection of loans; issuance of capital stock; sale
of investments; and the sale of property, plant, and equipment.

4b What are the major uses (outflows) of cash?

Answer: Major outflows of cash include purchase of inventory, payment of

wages and other operating expenses, payment of cash dividends; redemption of
debt; purchase of investments; making loans; redemption of capital stock; and
the purchase of property, plant, and equipment.

5 Why is it important to disclose certain noncash transactions? How should

they be disclosed?

Answer: The statement of cash flows presents investing and financing

activities so that even noncash transactions of an investing and financing nature
are disclosed in the financial statements. If they affect financial conditions
significantly, the FASB requires that they be disclosed in either a separate
schedule at the bottom of the statement cash flows or in a separate note or
supplementary schedule to the financial statements.

6 Helen Powell and Paul Tang were discussing the format of the statement
of cash flows of Baumgarten Co. At the bottom of Baumgarten’s statement
of cash flows was a separate section entitled “Noncash investing and
financing activities.” Give three examples of significant noncash
transactions that would be reported in this section.

Answer: Three examples of significant noncash transactions are as follows:

(1) Issuance of stock for assets.
(2) Conversion of bonds into common stock.
(3) Issuance of bonds or notes for assets.

7 Why is it necessary to use comparative balance sheets, a current income

statement, and certain transaction data in preparing a statement of cash
flows?

Answer: Comparative balance sheets, a current income statement, and certain

transaction data all provide information necessary for preparation of the
statement of cash flows. Comparative balance sheets indicate how assets,
liabilities, and equities have changed during the period. A current income
statement provides information about the amount of cash provided from

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operations. Certain transactions provide additional detailed information needed
to determine whether cash was provided or used during the period.

8 Contrast the advantages and disadvantages of the direct and indirect

methods. Are both methods acceptable? Which method is preferred by the
FASB? Which method is more popular?

Answer: The advantage of the direct method is that it presents the major
categories of cash receipts and cash payments in a format that is similar to the
income statement and familiar to statement users. Its principal disadvantage is
that the necessary data can be expensive and time-consuming to accumulate.

The advantage of indirect method is its reconciliation of net income to net cash
provided by operating activities, while its primary disadvantage is the difficulty
in understanding the adjustments that comprise the reconciliation.

Both methods are acceptable but the FASB expressed a preference for the direct
method. Yet, the indirect method is the overwhelming favorite of companies.

9 When the total cash inflows exceed the total cash outflows in the
statement of cash flows, how and where is this excess identified?

Answer: When total cash inflows exceed total cash outflows, the excess is
identified as a “net increase in cash” near the bottom of the statement of cash
flows.

10 Describe the indirect method for determining net cash provided (used)
by operating activities.

Answer: The indirect approach involves converting accrual net income to net
cash provided by operating activities. This is done by starting with accrual net
income and adding or subtracting noncash items included in net income.
Examples of adjustments include depreciation and other noncash expenses and
changes in the balances of current asset and current liability accounts from one
period to the next.

11 Why is it necessary to convert accrual-based net income to cash-basis

income when preparing a statement of cash flows?

Answer: It is necessary to convert accrual-based net income to cash basis

income because the unadjusted net income includes items that do not provide or
use cash. An example would be an increase in accounts receivable. If accounts
receivable increased during the period, revenues reported on the accrual basis

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would be higher than the actual cash revenues received. Thus, accrual basis net
income must be adjusted to reflect the net cash provided by operating activities.

12 The president of Murquery Company is puzzled. During the last year,

the company experienced a net loss of $800,000, yet its cash increased
$300,000 during the same period of time. Explain to the president how this
could occur.

Answer: A number of factors could have caused an increase in cash despite the
net loss. These are (1) high cash revenues relative to low cash expenses; (2)
sales of property, plant, and equipment; (3) sales of investments; (4) issuance of
debt or capital stock, and (5) differences between cash and accrual accounting,
e.g. depreciation.

13 Identify five items that are adjustments to reconcile net income to net
cash provided by operating activities under the indirect method.

Answer: Required five items are as follows:

(1) Depreciation expense.
(2) Gain or loss on sale of a noncurrent asset.
(3) Increase/decrease in accounts receivable.
(4) Increase/decrease in accounts payable.
(5) Increase/decrease in inventory.

14 Why and how is depreciation expense reported in a statement prepared

using the indirect method?

Answer: Under the indirect method, depreciation is added back to net income
to reconcile net income to net cash provided by operating activities because
depreciation is an expense but not a cash payment.

15 Why is the statement of cash flows useful?

Answer: The statement of cash flows is useful because it provides information

to the investors, creditors, and other users about: (1) the entity’s ability to
generate further cash flows, (2) the entity’s ability to pay dividends and meet
obligations, and (3) the reasons for the difference between net income and net
cash provided by operating activities, and (4) the cash and noncash investing
and financing transactions during the period.

16 During 2022, Slivowitz Doubleday Company converted $1,700,000 of its

total $2,000,000 of bonds payable into common stock. Indicate how the
transaction would be reported on a statement of cash flows, if at all.

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Answer: This transaction is reported in the note or schedule entitled “Noncash
investing and financing activities” as follows: “Retirement of bonds payable
through issuance of common stock, $1,700,000.”

17 In its 2011 statement of cash flows, what amount did Apple report for net
cash (a) provided by operating activities, (b) used for investing activities, and (c)
used for financing activities?

Answer: In its 2011 statement of cash flows, Apple reported $37,529 million
net cash provided by operating activities, $40,419 million used for investing
activities, and $1,444 million provided by financing activities.

18 Describe the direct method for determining net cash provided by

operating activities.

Answer: Net cash provided by operating activities under the direct approach is
the difference between cash revenues and cash expenses. The direct approach
adjusts the revenues and expenses directly to reflect the cash basis. This results
in cash net income, which is equal to “net cash provided by operating
activities.”

19 Give the formulas under the direct method for computing (a) cash
receipts from customers, and (b) cash payments to suppliers.

Answer:
(a) Cash receipts from customers = Revenues from sales
[+ Decrease in accounts receivable
– Increase in accounts receivable]

(b) Purchase = Cost of goods sold [+ Increase in inventory

– Decrease in inventory]

Cash payments to suppliers = Purchases [+ Decrease in accounts payable

– Increase in accounts payable]

20 Harbinger Inc. reported sales of $2 million for 2022. Accounts receivable

decreased $150,000 and accounts payable increased $300,000. Compute
cash receipts from customers, assuming that the receivable and payable
transactions are related to operations.

Answer: Cash receipts from customers is calculated as follows:

Sales $2000000
Add: Decrease in accounts receivable 150000
Cash receipts from customers $2150000
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21 In the direct method, why is depreciation expense not reported in the
cash flows from operating activities section?

Answer: Depreciation expense is not listed in the direct method operating

activities section because it is not a cash flow item – it does not affect cash.

22 Why is it advantageous to use a work sheet when preparing a statement

of cash flows? Is a work sheet required to prepare a statement of cash
flows?
Answer: A work sheet is desirable because it allows the accumulation and
classification of data that will appear on the statement of cash flows. It is an
optional but efficient device that aids in the preparation of the statement of cash
flows.

*Additional questions with answers:

*23 What does free cash flow indicate, and how is it calculated?

Answer: Free cash flow indicates the cash remaining from operations after
adjustment for capital expenditures and dividends. It is calculated by using the
following formula:

Free cash flow = Cash provided by operations – Capital expenditures – Cash dividends.

*24 Identify two noncash charges other than depreciation expense that are
treated like depreciation expense in a statement of cash flows.

Answer: Two noncash charges are:

(1) Loss on sale of asset.
(2) Decrease in accounts receivable.

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