Chapter 14 Statement Cash of Flow

ANSWERS TO QUESTIONS

1. The statement of cash flows explains how a company obtained and used cash during some period of time. Understanding the cash flows of a business is important in assessing the company's ability to pay its bills and fund operations in the future.

2. The three categories of cash inflows and outflows are operating activities, investing activities, and financing activities.

Operating activities include cash inflows and outflows that are generated by operating the business. Example: Cash received from the sale of goods; cash paid for salaries.

Investing activities include cash inflows and outflows that are generated by the purchase and sale of long-term operational assets, investments in other companies, and lending activities. Example: Cash received from the sale of equipment previously used by the business; cash paid for the purchase of new equipment.

Financing activities include cash inflows and outflows associated with a company's own equity transactions and borrowing activities. Example: Cash received from the sale of stock; cash paid for the repayment of a loan.

3. Noncash investing and financing activities are transactions that do not require the receipt or payment of cash. For example, a company may purchase an operating asset with a small down payment and finance the balance. If only cash transactions are included, then significant transactions would be omitted from the statement of cash flows. These transactions are shown in a separate schedule included in the statement of cash flows.

4. Since the ending balance of accounts receivable exceeded the beginning balance by $2,000, more sales were made than collected. The amount of cash collected would equal $108,000, the amount of sales of $110,000 less the increase in the accounts receivable balance of $2,000.

5. Since the ending balance of utilities payable exceeded the beginning balance by $1,900, more utility cost was used than paid for. The amount of cash paid was $85,100, the amount of utility expense of $87,000 less the increase in utilities payable of $1,900.

6. Since the ending balance of unearned revenue was greater than the beginning balance by $1,400, more cash was received in advance than was earned. The amount of cash received was $17,000, the $15,600 revenue earned plus the $1,400 increase in unearned revenue.

7. a. Payment of accounts payable - operating activity.

b. Payment of interest on bonds - operating activity.

c. Sale of common stock - financing activity.

d. Sale of preferred stock at a premium - financing activity.

e. Payment of dividend on the stock - financing activity.

c, d, and e are financing activities.

8. Depreciation expense is an allocation of the cost of an asset over its estimated useful life; thus, the allocation does not affect cash flows. Cash flows are affected at the purchase or sale of the asset.

9. Cost of Land $4,200

Gain on Sale 500

Sales Price $4,700

10. Cost of Office Equipment $7,500

Accumulated Depreciation (7,200)

Book Value 300

Loss on Sale (100)

Selling Price $ 200

11. a. operating activities

b. investing activities, or operating activities if trading securities

c. investing activities

d. operating activities

e. financing activities

f. operating activities

g. financing activities

h. financing activities

i. investing activities

j. operating activities

12. When the direct method of preparing the statement of cash flows is used, each transaction that affects cash is analyzed. One method of doing this is called the T-account approach. When this approach is used, each balance sheet account is analyzed. This is the method recommended by the FASB. When the indirect method is used, net income as reported on the income statement is the starting point. Adjustments are made to net income to convert the accrual net income amount to a cash net income amount. Cash flows from investing and financing activities are determined in the same manner as under the direct method, by analyzing each of the balance sheet accounts except for the current assets and current liabilities.

13. The direct method is more logical because it analyzes each of the changes to the cash account.

14. The primary advantage of using the indirect method is the fact that it requires less time to start with the net income amount and simply make conversion adjustments from the accrual basis to the cash basis of accounting.

15. The primary advantage of using the direct method is that it is more logical and presents the actual amount of cash inflows and outflows from each operating activity. The indirect method only shows net income and the related increases and decreases in the current asset and liability accounts.

16. a. Cash outflow of $46,000 as an investing activity.

b. Cash inflow of $8,700 as an investing activity.

17. Yes, it is possible for a company to have negative operating cash flow and net income in the same period. As is illustrated in Exhibit 14-9 for Toll Brothers, a company may use operating and borrowed cash to support sales growth by purchasing inventory, property, plant, and equipment. Thus cash may be going out currently to help generate future cash inflows.

18. NOTE: FASB's reasons for precluding disclosure of cash flow per share are not discussed in the text.

SFAS #95, Paragraph 33 states:

Neither cash flow nor any component of it is an alternative to net income as an indicator of an enterprise's performance, as reporting per share amounts might