Chapter 16: Reporting the Statement of Cash Flows

Question 1

What is the purpose of the statement of for cash flows?

Answer 1

To report cash receipts (inflows) and cash payments (outflows) during the beginning and ending balances of cash and cash equivalents.

This includes identifying the cash flows related to operating, investing, and financing activities.

It does more than simply reporting changes in cash. It is the detailed disclosure of individual cash flows that make this statement useful to users.

Question 2

What questions do the statement of cash flows help answer?

Answer 2

How does a company obtain its cash?

Where does a company spend its cash?

What explains the change in the cash balance?

This is done by summarizing, classifying, and reporting a company’s cash inflows and cash outflows for each period.

Question 3

How can cash flows influence decision makers?

Answer 3

Companies are favored when they finance its expenditures with cash from operations than ones that do it by selling its assets.

Helps users decide whether a company has enough cash to pay its existing debts as they mature.

To see if the company has the ability to meet unexpected obligations and pursue unexpected opportunities.

Question 4

What do external information want to accomplish?

Answer 4

To assess a company’s ability to take advantage of new business opportunities.

Question 5

What do internal information want to accomplish?

Answer 5

Managers, for example, use cash flow information to plan day-to-day operating activities and make long-term investment decisions.

Question 6

What do cash flows include?

Answer 6

Cash and cash equivalents.

Question 7

What are two criteria that cash equivalents must satisfy?

Answer 7

1. be readily convertible to a known amount of cash

2. sufficiently close to its maturity so its market value is unaffected by interest rate changes.

Question 8

Why are individual cash receipts/payments labeled?

Answer 8

To identify their originating transactions or events.

Question 9

What is a net cash inflow (source)?

Answer 9

Occurs when the receipts in a category exceed the payments.

Question 10

What is a net cash outflow (use)?

Answer 10

Occurs when the payments in a category exceed the receipts.

Question 11

What are operating activities?

Answer 11

Transactions and events that determine net income.

Example: production and purchase of merchandise, he sale of goods, and services to customers, and the expenditures to administer the business. cash payments

Question 12

What is not included as an operating activities?

Answer 12

Unusual gains and losses

Question 13

What are financing activities?

Answer 13

Transactions and events that affect long-term liabilities and equity.

Question 14

What are examples of financing activities?

Answer 14

1. obtaining cash from issuing debt and paying the amounts borrowed
2. receiving cash from or distributing cash to owners.

Question 15

Who requires that payments of interest expense be classified as operating activites?

Answer 15

GAAP

Question 16

Which of the following items are classified as non-cash investing and financing activities?

Answer 16

Retirement of debt by issuing stock.

Purchase of a building with a note.

Issuance of common stock in exchange for land.

Question 17

Which question could not be answered from the statement of cash flows?

Answer 17

What are the earnings-per share of common stock?

Question 18

What is the full-disclosure principle?

Answer 18

Requires that important investing and financing activities that do NOT affect cash receipts or payments must be disclosed at the bottom of the statement of cash flows, or in a note to the financial statements.

Question 19

What are the commonly disclosed noncash investing and financing activities?

Answer 19

Retirement of debt by issuing equity stock.

Conversion of preferred stock to common stock.

Lease of assets in a capital lease transaction.

Purchase of long-term assets by issuing a note or bond.

Exchange of noncash assets for other noncash assets.

Purchase of noncash assets by issuing equity or debt.

Question 20

What three ways must a company report cash flows

Answer 20

Operating, investing, and financing.

Question 21

How do you prepare a statement of cash flows?

Answer 21

1. Compute net increase or decrease in cash.
2. Compute net cash from operating activities.
3. Compute net cash from investing activities.
4. Compute net cash from financing activities.
5. Prove and report beginning and ending cash balances.

Question 22

How do you compute net increase or net decrease?

Answer 22

current period’s cash balance-prior period’s cash balance.

This is the bottom-line figure for the statement of cash flows and is a check on accuracy.

Question 23

Where does the information come from in order to prepare a statement of cash flows?

Answer 23

Comparative balance sheets at the beginning and end of the period, and an income statement for the period.

Question 24

How can prepare a statement of cash flows?

Answer 24

Analyze the cash account and analyze noncash accounts.

Question 25

What is reported in the cash account?

Answer 25

A company’s cash receipts and cash payments.

Question 26

How are cash flows provided by operating activities reported?

Answer 26

The direct method and the indirect method

Question 27

What is the direct method?

Answer 27

Separately lists each major item of operating cash receipts (such as cash received from customers) and each major item of operating cash payments (such as cash paid for merchandise). The cash payments are subtracted from cash receipts to determine the net cash provided by operating activities.

Question 28

What is the indirect method?

Answer 28

Reports net income and then adjusts it for items necessary to obtain net cash provided or used by operating activities. It does not report individual items of cash inflows and cash outflows from operating activities. Instead, the indirect method reports the necessary adjustments to reconcile net income to net cash provided or used by operating activities.

Question 29

Is the net cash amount provided by operating activities identical under both the direct and indirect methods?

Answer 29

Yes, the equality always exists. The difference in the methods are the computation and presentation of the amount.

Question 30

What method does the FASB recommend?

Answer 30

Direct method, because it is not required and the indirect method is arguably easier to compute, nearly all companies report operating cash flows using the indirect method.

Question 31

How is net income computed?

Answer 31

Using accrual accounting, which recognizes revenues when earned and expenses when incurred.
Revenues and expenses do not necessarily reflect the receipt and payment of cash.

Question 32

Formula to compute net cash flows through the indirect method?

Answer 32

net income-noncash increases+noncash charges

Question 33

Examples of changes in noncash current assets

Answer 33

sales affecting accounts receivable and building usage affecting prepaid rent.

Question 34

What is account analysis?

Answer 34

setting up a t-account and reconstructing its major entries to compute cash receipts or payments.

Question 35

Explain the adjustments for operating items not providing or using cash

Answer 35

The income statement usually includes some expenses that do not reflect cash outflows in the period.

Examples are depreciation, amortization, depletion, and a bad debts expense.

Question 36

Explain adjustments for nonoperating items.

Answer 36

Net income often includes losses that are not part of operating activities but are part of either investing or financing activities.

Examples are a loss from the sale of a plant asset and a loss from retirement of notes payable.

Question 37

How is net income adjusted when computing net cash provided or used by operating activities under the indirect method?

Answer 37

+decrease in noncash current asset
-increase in noncash current asset
+increase in current liability*
-decrease in current liability*

+Depreciation, depletion, and amortization

+losses from disposal of long-term assets and retirement of debt
-gains from disposal of long-term assets and retirement of debt.

Question 38

What is the difference between net income and operating cash flows?

Answer 38

operating cash flows can be either higher or lower than net income.

Question 39

What is the fourth major step in preparing the statement of cash flows?

Answer 39

To compute and report cash flows from financing activities.

Question 40

How do you compute and report cash flows from financing activities?

Answer 40

Identify changes in all noncurrent liability accounts and the equity accounts. These accounts include long-term debt, notes payable bonds payable, common stock, and retained earnings.

Question 41

What is the fifth and final step in preparing the statement?

Answer 41

Report the beginning and ending cash balance and prove that the net change in cash is explained by operating, investing, and financing cash flows.

Question 42

How do you compute cash flow on total assets?

Answer 42

Cash flow from operations/average total assets

Question 43

Which of the following items would be added to net income when reporting cash flows from operating activities, using the indirect method?

Answer 43

increase in unearned fees and increase in accounts payable.

Question 44

A loss from the sale of an investment would be ___ to (from) net income when computing cash flow from operations, using the indirect method.

Answer 44

added

Question 45

A gain from the sale of equipment would be ____ to (from) net income, when computing cash flows from operations using the indirect method.

Answer 45

subtracted