Chapter 13: Statement of Cash Flow

Question 1

Three major financial statements are required for external reports:

Answer 1

an (1) income statement,
(2) a balance sheet, and
(3) a statement of cash flows.

Question 2

highlights the major activities that impact cash flows and, hence, affect the overall cash balance.

Answer 2

Statement of Cash Flow

Question 3

the change in the cash balance must equal the changes in all other balance sheet accounts besides cash.

Answer 3

double-entry bookkeeping

Question 4

This principle ensures that properly analyzing the changes in all noncash balance sheet accounts always quantifies the cash inflows and outflows that explain the change in the cash balance.

Answer 4

double-entry bookkeeping

Question 5

Summarizes all of a company’s cash inflows and outflows during a period, thereby explaining the change in its cash balance.

Answer 5

Statement of Cash Flow

Question 6

consist of short-term, highly liquid investments such as Treasury bills, commercial paper, and money market funds that are made solely for the purpose of generating a return on temporarily idle funds.

Answer 6

Cash equivalents

Question 7

U.S. GAAP and IFRS allow companies to compute the net amount of cash inflows and outflows resulting from operating activities, which is known formally as the

Answer 7

net cash provided by operating activities

Question 8

generate cash inflows and outflows related to revenue and expense transactions that affect net income.

Answer 8

Operating Activities

Question 9

T/F

To make it easier to compare data from different companies, U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS) require companies to follow prescribed rules when preparing the statement of cash flows.

Answer 9

True

Question 10

the income statement is reconstructed on a cash basis from top to bottom.

Answer 10

Direct Method

Question 11

et income is adjusted to a cash basis. That is, rather than directly computing cash sales, cash expenses, and so forth, these amounts are derived indirectly by removing from net income any items that do not affect cash flows.

Answer 11

Indirect method

Question 12

The Indirect Method: A Three-Step Process:

• Analyze net changes in noncash balance sheet accounts that impact net income.

Answer 12

Step 2

Question 13

The Indirect Method: A Three-Step Process:

• The _______ step in computing the net cash provided by operating activities is to adjust for gains/losses included in the income statement.

Answer 13

Third Step

Question 14

4. Which of the following statements is false? (You may select more than one answer.)

a. Depreciation charges are subtracted from net income.
b. An increase in inventory is subtracted from net income.
c. A loss on the sale of an asset is subtracted from net income.
d. A decrease in accrued liabilities is subtracted from net income.

Answer 14

A, C

Depreciation charges are added to net income. A loss on the sale of an asset should be added to net income.

Question 15

4. Which of the following statements is false? (You may select more than one answer.)

a. Depreciation charges are subtracted from net income.
b. An increase in inventory is subtracted from net income.
c. A loss on the sale of an asset is subtracted from net income.
d. A decrease in accrued liabilities is subtracted from net income.

Answer 15

A, C

Choices a and c. Depreciation charges are added to net income. A loss on the sale of an
asset should be added to net income.

Question 16

The Indirect Method: A Three-Step Process:

The ______ is to add depreciation charges to net income.

Answer 16

First Step

Question 17

7. Assume that a company’s beginning and ending balances in its Property, Plant, and Equipment account are $5,000 and $6,000, respectively. Also assume that the company sold a piece of equipment that originally cost $700 and had accumulated depreciation of $450 for cash proceeds of $500. Based solely on the available infor-
   mation, what is the company’s net cash provided by (used in) investing activities?

a. $1,200
b. $1,500
c. $(1,200)
d. $(1,500)

Answer 17

C

Choice c. Using the basic equation for assets, $5,000 + Debits − $700 = $6,000. The debits
equal $1,700 and this amount relates to purchases of noncurrent assets. Since the company
sold an asset for $500 and it purchased noncurrent assets for $1,700, its net cash provided by
(used in) investing activities is $(1,200).

Question 18

5. Assume that a company’s beginning and ending balances in its Accumulated Depreciation account are $2,000 and $2,900, respectively. Also assume that the company sold a piece of equipment that had an original cost of $400 and accumulated depreciation of $350 for cash proceeds of $75. How much depreciation would the company
   add to net income in the operating activities section of its statement of cash flows?

a. $550
b. $500
c. $1,300
d. $1,250

Answer 18

D

Choice d. Using the basic equation for contra assets, $2,000 − $350 + Credits = $2,900.
The credits = $1,250.

Question 19

6. Refer to the data in question 5 above. Which of the following choices is true?

a. The company should subtract a gain of $25 from net income.

b. The company should add a gain of $25 to net income.

c. The company should subtract a loss of $25 from net income.

d. The company should add a loss of $25 to net income.

Answer 19

A

The cash proceeds from the sale of the asset were $75 and the book value of the asset that was sold is $50 (= $400 − $350). The $25 difference between these two amounts
is the gain on the sale of the asset and it should be subtracted from net income in the operating activities section of the statement of cash flows.

Question 20

1. Which of the following statements is true about the basic equation for asset accounts? (You may select more than one answer.)

a. Debits are added to the beginning balance.
b. Debits are subtracted from the beginning balance.
c. Credits are added to the beginning balance.
d. Credits are subtracted from the beginning balance.

Answer 20

A, D

Question 21

2. Which of the following is not a cash equivalent? (You may select more than one answer.)

a. Accounts receivable
b. Treasury bills
c. Commercial paper
d. Money market funds

Answer 21

A

Question 22

3. Which of the following statements is true? (You may select more than one answer.)

a. The direct method of preparing the operating activities section of the statement of cash flows starts with net income and adjusts it to a cash basis.

b. The basic equations for contra-assets and liabilities are the same.

c. Investing activities generate cash inflows and outflows related to acquiring or disposing of noncurrent assets.

d. Financing activities include paying dividends.

Answer 22

B, C, D

Question 23

is a measure used by managers to look at the relationship among three numbers from the statement of cash flows—net cash provided by operating activities, additions to property, plant, and equipment (also called capital expenditures), and dividends.

Answer 23

Free Cash Flow

Question 24

measures a company’s ability to fund its capital expenditures for property, plant, and equipment and its cash dividends from its net cash provided by operating activities.

Answer 24

Free Cash Flow

Question 25

8. Which of the following statements is true with respect to earnings quality? (You may select more than one answer.)

a. Managers generally perceive that earnings are of higher quality when earnings are not unduly influenced by inflation.

b. Managers generally perceive that earnings are of higher quality when earnings are computed using aggressive estimates.

c. Managers generally perceive that earnings are of higher quality when earnings move in the opposite direction to net cash provided by operating activities.

d. Managers generally perceive that earnings are of higher quality when earnings are computed using conservative accounting principles.

Answer 25

A, D

Earnings quality is higher when managers use conservative estimates.

It is also higher when earnings move in the same direction as net cash provided by operating activities.