Answers to Questions

ANSWERS TO QUESTIONS

1. The main purpose of the statement of cash flows is to show the change in cash of a company from one period to the next. The statement of cash flows provides information about a company's operating, financing, and investing activities. More precisely, it provides information about the company's cash inflows and outflows for the period.

2. Some uses of this statement are:

Assessing future cash flows: Income data when augmented with current cash flow data provide a better basis for assessing future cash flows.

Assessing quality of income: Some believe that cash flow information is more reliable than

income information because income involves a number of assumptions, estimates and valuations.

Assessing operating capability: Whether an enterprise is able to maintain its operating capability, provide for future growth, and distribute dividends to the owners depends on whether adequate cash is being or will be generated.

Assessing financial flexibility and liquidity: Cash flow data indicate whether a company should be able to survive adverse operating problems and whether a company might have difficulty in meeting obligations as they become due, paying dividends, or meeting other recurring costs.

Providing information on financing and investing activities: Cash flows are classified by their effect on statement of financial position items; investing activities affect assets while financing activities affect liabilities and equity.

3. Investing activities generally involve non-current assets and include (1) lending money and collecting on those loans and (2) acquiring and disposing of investments and productive long-lived assets. Financing activities, on the other hand, involve liability and equity items and include (1) obtaining cash from creditors and repaying the amounts borrowed and (2) obtaining capital from owners and providing them with a return on their investment. Operating activities include all transactions and events that are not investing and financing activities. Operating activities involve the cash effects of transactions that enter into the determination of net income.

4. Examples of sources of cash in a statement of cash flows include cash from operating activities, issuance of debt, issuance of ordinary shares, sale of investments, and the sale of property, plant, and equipment. Examples of uses of cash include cash used in operating activities, payment of cash dividends, redemption of debt, purchase of investments, redemption of ordinary shares, and the purchase of property, plant, and equipment.

5. Preparing the statement of cash flows involves three major steps:

(1) Determine the change in cash. This is simply the difference between the beginning and ending cash balances.

(2) Determine the net cash flow from operating activities. This involves analyzing the current year's income statement, comparative statements of financial position and selected transaction data.

(3) Determine cash flows from investing and financing activities. All other changes in statement of financial position accounts are analyzed to determine their effect on cash.

6. Purchase of land--investing;

Payment of dividends--financing;

Cash sales--operating;

Purchase of treasury shares--financing.

7. Comparative statements of financial position, a current income statement, and certain transaction data all provide information necessary for preparation of the statement of cash flows. Comparative statements of financial position indicate how assets, liabilities, and equities have changed during the period. A current income statement provides information about the amount of cash provided from operating activities. Certain transactions provide additional detailed information needed to determine whether cash was provided or used during the period.

Questions Chapter 23 (Continued)

8. It is necessary to convert accrual-based net income to a cash basis because 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 would be higher than the actual cash revenues received. Thus, accrual basis net income must be adjusted to reflect the net cash flow from operating activities.

9. Net cash flow from operating activities under the direct method is the difference between cash revenues and cash expenses. The direct method adjusts the revenues and expenses directly to reflect the cash basis. This results in cash net income, which is equal to "net cash flow from operating activities."

The indirect method involves adjusting accrual net income. This is done by starting with accrual net income and adding or subtracting non-cash items included in net income. Examples of adjustments include depreciation and other non-cash expenses and changes in the balances of current asset and current liability accounts from one period to the next.

10. Net cash flow from operating activities is $3,820,000. Using the indirect method, the solution is:

Net income $3,500,000

Adjustments to reconcile net income to net cash

provided by operating activities:

Depreciation expense $ 520,000

Accounts receivable increase (500,000)

Accounts payable increase 300,000 320,000

Net cash provided by operating activities $3,820,000

11. Accrual basis sales £100,000

Less: Increase in accounts receivable 30,000

70,000

Less: Writeoff of accounts receivable 2,000

Cash sales £ 68,000

12. 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, and (4) issuance of debt or ordinary shares.