FAR SEC 16

Question 1

What was the consequence of the W.T. Grant bankruptcy?

Answer 1

In 1969, in a desperate attempt to boost sales, the department store chain W.T. Grant drastically lowered its credit standards. As a result, sales boomed. However, during the economic downturn of 1970-71, customer accounts began to turn delinquent and cash inflows dried up. The company finally collapsed in 1974. Grant’s creditors were caught completely unaware because the company’s accrual-basis income statement had shown consistently positive results and Grant had never stopped paying a dividend. The Grant bankruptcy made the inadequacy of the traditional income statement for assessing liquidity glaringly obvious. This incident was one reason for the FASB’s decision to require presentation of a statement of cash flows.

Question 2

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

Answer 2

The primary purpose of a statement of cash flows is to provide information about the cash receipts and payments of an entity during a period. To achieve its primary purpose, the statement should provide information about cash inflows and outflows from operating, investing, and financing activities of an entity. This is the accepted order of presentation.
-The format reconciles the cash and cash equivalents balance at the beginning of the period with the balance at the end of the period.

Question 3

What is the basic format of the statement of cash flows?

Answer 3

The format reconciles the cash and cash equivalents balance at the beginning of the period with the balance at the end of the period.

Question 4

What are the reporting requirements for the statement of cash flows? (3 elements)

Answer 4

1) A statement of cash flows is required as part of a full set of financial statements of most business and not-for-profit entities.
2) If an entity reports financial position and results of operations, it must present a statement of cash flows for any period for which results of operations are presented.
3) Cash flow per share is not reported.

Question 5

What are the names of the two methods of presenting the statement of cash flows?

Answer 5

The two ways of presenting the statement of cash flows are the direct method and the indirect method.
-The only difference between these two methods is their presentation of net cash flows from operating activities. The total cash flows from operating activities is the same regardless of which method is used.

Question 6

What is the only difference between the direct and indirect methods of presenting the statement of cash flows?

Answer 6

The only difference between these two methods is their presentation of net cash flows from operating activities. The total cash flows from operating activities is the same regardless of which method is used.

Question 7

What are the three attributes for the treatment of cash and cash equivalents on the statement of cash flows?

Answer 7

1) If an entity invests its cash in cash equivalents, it should use the descriptive term “cash and cash equivalents.” Otherwise, the term “cash” is acceptable.
2) Cash equivalents are readily convertible to known amounts of cash and are so near maturity that they present insignificant risk of changes in value because of changes in interest rates.
i) Usually, investments with original maturities of 3 months or less qualify. Thus, a 3-year Treasury note meets the definition if purchased 3 months from maturity. However, if the note was purchased 3 years ago, it does not meet the definition when its remaining maturity is 3 months.
a) Other examples of cash equivalents are Treasury bills, commercial paper, and money market funds.
b) The statement of cash flows explains the change in cash, cash equivalents, and restricted cash during the period. However, exchanges of items within the category of cash, cash equivalents, and restricted cash need not be reported in the statement of cash flows.
3) Not all qualifying investments must be classified as cash equivalents. An entity should consistently apply a policy for classifying cash equivalents.
i) For example, an entity with operations that primarily involve investing in short-term, highly liquid investments may choose not to treat them as cash equivalents.
ii) Any change in policy is a change in accounting principle that requires retrospective application.
iii) The policy for determining which items are cash equivalents must be disclosed.

Question 8

For the statement of cash flows, when should the term “cash and cash equivalents” be used?

Answer 8

If an entity invests its cash in cash equivalents, it should use the descriptive term “cash and cash equivalents.” Otherwise, the term “cash” is acceptable.

Question 9

What are cash equivalents? (2 elements)

Answer 9

1) Cash equivalents are readily convertible to known amounts of cash and are so near maturity that they present insignificant risk of changes in value because of changes in interest rates.
2) Usually, investments with original maturities of 3 months or less qualify. Thus, a 3-year Treasury note meets the definition if purchased 3 months from maturity. However, if the note was purchased 3 years ago, it does not meet the definition when its remaining maturity is 3 months.
i) Other examples of cash equivalents are Treasury bills, commercial paper, and money market funds.
ii) The statement of cash flows explains the change in cash, cash equivalents, and restricted cash during the period. However, exchanges of items within the category of cash, cash equivalents, and restricted cash need not be reported in the statement of cash flows.

Question 10

For the statement of cash flows, what are the attributes for the policy for classifying cash equivalents? (4 elements)

Answer 10

1) Not all qualifying investments must be classified as cash equivalents. An entity should consistently apply a policy for classifying cash equivalents.
2) For example, an entity with operations that primarily involve investing in short-term, highly liquid investments may choose not to treat them as cash equivalents.
3) Any change in policy is a change in accounting principle that requires retrospective application.
4) The policy for determining which items are cash equivalents must be disclosed.

Question 11

What are operating activities (statement of cash flows)?

Answer 11

Operating activities are all transactions and other events that are not financing or investing activities. Cash flows from operating activities are primarily derived from the principal revenue-producing activities of the entity. They generally result from transactions and other events that enter into the determination of net income.

Question 12

What are four examples of cash inflows from operating activities?

Answer 12

The following are examples of cash inflows from operating activities:
1) Cash receipts from the sale of goods and services (including collections of accounts receivable)
2) Cash receipts from royalties, fees, commissions, and other revenue
3) Cash received in the form of interest or dividends
4) Cash receipts from certain loans and other debt and equity instruments of other entities that are acquired specifically for resale in the short term

Question 13

What are four examples of cash outflows from operating activities?

Answer 13

The following are examples of cash outflows from operating activities:
1) Cash payments to suppliers for goods and services
2) Cash payments to employees
3) Cash payments to government for taxes, duties, fines, and other fees or penalties
4) Payments of interest on debt

Question 14

What are cash flows from investing activities as shown on the statement of cash flows?

Answer 14

Cash flows from investing activities represent the extent to which expenditures have been made for resources intended to generate future income and cash flows.

Question 15

What are three examples of cash outflows (and inflows) from investing activities as shown on the statement of cash flows?

Answer 15

The following are examples of cash outflows (and inflows) from investing activities:
1) Cash payments to acquire (cash receipts from sale of) property, plant and equipment; intangible assets; and other long lived assets
2) Cash payments to acquire (cash receipts from sale and maturity of) equity and debt instruments of other entities for investing purposes
-Cash flows from purchases, sales, and maturities of available-for-sale debt securities and held-to-maturity debt securities are from investing activities.
3) Cash advances and loans made to other parties (cash receipts from repayment of advances and loans made to other parties)

Question 16

Which transactions are excluded from investing activities on the statement of cash flows?

Answer 16

Investing activities exclude transactions in cash equivalents and certain loans or other debt or equity instruments acquired specifically for resale in the short-term. These transactions are classified as operating activities.

Question 17

What are cash flows from financing activities on the statement of cash flows?

Answer 17

Cash flows from financing activities generally involve the cash effects of transactions and other events that relate to the issuance, settlement, or reacquisition of the entity’s debt and equity instruments.

Question 18

What are two examples of cash inflows from financing activities?

Answer 18

The following are examples of cash inflows from financing activities:
1) Cash proceeds from issuing shares and other equity instruments (obtaining resources from owners)
2) Cash proceeds from issuing loans, notes, bonds, and other short-term or long-term borrowings

Question 19

What are four examples of cash outflows from financing activities?

Answer 19

The following are examples of cash outflows from financing activities:
1) Cash repayments of amounts borrowed
2) Payments of cash dividends
3) Cash payments to acquire or redeem the entity’s own shares
4) Cash payments by a lessee for a reduction of the outstanding liability relating to a finance lease

Question 20

On the statement of cash flows, what are noncash investing and financing activities?

Answer 20

Information about all investing and financing activities that affect recognized assets or liabilities but not cash flows must be disclosed. Given only a few transactions, disclosure may be on the same page as the statement of cash flows. Otherwise, they may be reported elsewhere in the statements with a clear reference to the statement of cash flows.

Question 21

What are four examples of noncash investing and financing activities as shown on the statement of cash flows?

Answer 21

The following are examples of noncash investing and financing activities:
1) Conversion of debt to equity
2) Acquisition of assets either by assuming directly related liabilities or by means of a finance lease
3) Exchange of a noncash asset or liability for another
4) Obtaining a building or investment asset by gift

Question 22

What are the three steps for the direct method of presenting operating cash flows?

Answer 22

1) Under the direct method, the entity presents major classes of gross operating cash receipts and payments and their sum (net cash flow from operating activities). At a minimum, the following must be presented:
i) Cash collected from customers
ii) Interest and dividends received
iii) Other operating cash receipts, if any
iv) Cash paid to employees and other suppliers of goods and services
v) Interest paid
vi) Income taxes paid
vii) Other operating cash payments, if any
2) If the direct method is used, the reconciliation of net income to net cash flow from operating activities (the operating section of the indirect method format) must be provided in a separate schedule.
3) The direct method is preferable but not required. Although the FASB encourages use of the direct method, most entities apply the indirect method because the reconciliation must be prepared regardless of the method chosen.

Question 23

What are the three steps for the direct method of presenting operating cash flows?

Answer 23

1) Under the indirect method (also called the reconciliation method), the net cash flow from operating activities is determined by adjusting the net income of a business (or the change in the net assets of a not-for-profit entity) for the effect of the following:
i) Noncash revenue and expenses that were included in net income, such as depreciation and amortization expenses, impairment losses, undistributed earnings of equity method investments, and amortization of discount and premium on bonds
ii) Items included in net income whose cash effects relate to investing or financing cash flows, such as gains or losses on sales of PPE items (related to investing activities) and gains or losses on extinguishment of debt (related to financing activities)
iii) All deferrals of past operating cash flows, such as changes during the period in inventory and deferred income
iv) All accruals of expected future operating cash flows, such as changes during the period in accounts receivable and accounts payable
2) The reconciliation of net income to net cash flow from operating activities must disclose all major classes of reconciling items. For example, major classes of deferrals or accruals of operating cash flows must be separately disclosed. At a minimum, this disclosure reports changes in (1) accounts receivable and accounts payable related to operating activities and (2) inventories.
NOTE: The net cash flow from operating activities is the same under both methods. The only difference is the presentation.
3) Under the indirect method, an entity must provide a supplemental disclosure of the following amounts paid during the period:
i) Interest paid (net of amounts capitalized)
ii) Income taxes paid

Question 24

The following rules will help you to reconcile the net income to net cash flow from operating activities under the indirect method: [IMAGE]

Answer 24

Question 25

The following rules will help you to reconcile net income to net cash flow from operating activities under the indirect method: [IMAGE]

Answer 25