Chapter 5

Question 1

pro forma cash flow state

Answer 1

a prediction of what the future statement of cash flow statement will look like in future years if the OIF plans are implemented

Question 2

statement of cash flow

Answer 2

explains the change during the period in cash and cash equivalents

Question 3

cash equivalent

Answer 3

short term, HIGHLY liquid investments that can easily be converted to cash

Question 4

Operating Activities

Answer 4

include those transactions that are associated with the revenues and expenses that enter into the determination of net income

• Cash receipts from selling goods or from providing services.
• Receipts from Interest, dividends, and similar items.
• Payments to purchase inventory and to pay wages, taxes, and similar expenses.

Question 5

categories of cash flows

Answer 5

operating activities
investing activities
finance activities

Question 6

“bottom line” of cash flow statement

Answer 6

net cash from operating activites

Question 7

guiding principal of the Operating Activities section

Answer 7

It contains cash flow effects of revenues and expenses included on the income statement

Question 8

Investing Activities

Answer 8

the purchase and sale of land, buildings, equipment and other assets not generally held for sale. It also includes the purchase and sale if financial instruments not intended for trading purposes as well as the making and collections of loans

They are Indirectly related to the central ongoing operation of a business

Question 9

Financing Activities

Answer 9

include transactions and events whereby cash is obtained from or repaid to owners (equity financing) and creditors (debt financing)

• Cash proceeds from issuing stocks or bonds.
• Payments to reacquire stock (treasury stock) or to retire bonds.
• Payment of dividends.

Question 10

Non Investing and Financing Activities

Answer 10

Equipment purchased with a note payable
Land acquired by issuing stock

Significant transactions should be disclosed separately.
These transactions do not appear in the statement of cash flows.

Question 11

Direct Method

Answer 11

The direct method is a reexamination of each income statement item with the objective of reporting how much cash was received or disbursed in association with the item.
To prepare the operating section, each income statement item must be adjusted for the effects of accruals.

Question 12

Indirect Method

Answer 12

begins with net income as reported on the income statement and adjusts the accrual amount for any items that do NOT affect cash flow.

Question 13

Adjustments for the Indirect Method

Answer 13

• Adjustments for changes in current operating assets and liabilities that indicate noncash sources of revenues and expenses.
• Gains and losses associated with investing or financing activities.

-Revenues and expenses that do not involve cash inflow or outflow.

Question 14

Cash paid for interest and income taxes

Answer 14

Direct Method: part of the Operating Activities section

Indirect Method: separate disclosure

Question 15

cash flow to net income ratio

Answer 15

cash from operations/ net income

Question 16

cash flow adequacy ratio

Answer 16

cash from operations/ expenditures for fixed asset additions and new business aquisitions

Question 17

cash times interest earned ratio

Answer 17

cash before taxes and interest/ cash paid for interes

Question 18

Under what circumstances does cash flow from operations offer a clearer picture of a companys performance than does the net income?

Answer 18

• When a company reports large noncash expenses: write-offs, depreciation and provisions of future obligations
• A company is growing rapidly
• A company needs to report favorable earnings. The cash flow from operations provides a reality check of actualreported earning

Question 19

What criteria must be met for an item to be considered a cash equivalent in preparing a statement of cash flows?

Answer 19

1. Readily converted ti cash

2. Near its maturity that there is insignificant risk of changes in value due to changes in interest rate

Question 20

What are the three categories in a statement of cash flows? What types of items are included in each?

Answer 20

1. Operating Activities: Includes current liabilities and current assets;
2. Investing Activities: Includes purchase or sale of land, buildings, equipment etc.
3. Financing Activites: equity and debt financing; cash is optained and repaid to owners; retire bonds; payment of dividends; treasury stock

Question 21

What is the normal pattern of cash flows for operating, investing and financing activities?

Answer 21

Operating +
Investing -
Financing +/-

Question 22

Either the direct method or the indirect method may be used to report cash flows from operating activities. What is the difference in approach for the two methods?

Answer 22

The direct method reports ALL operating receipts and cash payments. The difference is then the net cash flow from operations. And the indirect method begins with the NI and includes the adjustments for any non-cash items and converts the accrual amounts to a cash basis.

Question 23

Why do many users prefer the direct method? Why do majority of preparers prefer the indirect?

Answer 23

Users prefer the direct method because it is straightforward and easy to understand. Accountants prefer the indirect method because it is easier to prepare.

Question 24

How is depreciation expense handled when the direct method is used? The indirect method?

Answer 24

It is added back to net income with the indirect method. With the direct method it is ommitted

Question 25

Why does the FASB treat interest payments as an operating activities rather than a financing activity?

Answer 25

Because interest expense enters into the calculation of net income.

Question 26

What is the target number?

Answer 26

it is the net change in the cash balance from the balance sheet. It is derived from the sum of OIF cash flows.

Question 27

When using the direct method what items must be considered in the calculation of cash paid for inventory purchases?

Answer 27

• Cost of goods sold (-)
• Account Payable
• Inventory

Question 28

How is a loss on the sale of a long term asset treated when using the direct method? The indirect method?

Answer 28

It is added back to Net income when using the indirect method. And it is omitted when using the direct method. In both the effects is reported in the investing activities section

Question 29

Is the purchase of securities an operating activity or investing? Explain.

Answer 29

All transactions involving available for sale and held to maturity securities as investing. Transactions including trading securities are included in the operating activities section

Question 30

What does it mean when the value of a companys cash flow adequacy is less than 1.0?

Answer 30

This means that the company is not generating enough cash from operations to pay for all new plant equipment and purchases or cash to repay loan or to distribute to investors.

Question 31

what information is contained in the forecasted statement that can be used for planning purposes?

Answer 31

Allows management to see the relationship between forecasted operating cash flow and cash needed for investing activities. A company can use this to obtain additional financing or the company can scale back its expansion plans in order to reduce the drain on cash.