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Chapter 23: Q5CA (page 1393)

Question: CA23-5 (Purpose and Elements of SCF) GAAP requires the statement of cash flows be presented when financial statements are prepared.

Instructions

(a) Explain the purposes of the statement of cash flows.

(b) List and describe the three categories of activities that must be reported in the statement of cash flows.

(c) Identify and describe the two methods that are allowed for reporting cash flows from operations.

(d) Describe the financial statement presentation of noncash investing and financing transactions. Include in your description an example of a noncash investing and financing transaction.

Short Answer

Expert verified

Answer

  1. Cash flow statement is prepared to provideinformation to the investors and the creditors.
  2. Cash flow statement has three sections: investing,operating, andfinancing.
  3. There aretwo methods to prepare a cash flow statement: direct and indirect.
  4. Non-cash investing and financing transactions are reported by preparing a separate schedule at the bottom of the cash flow statement.

Step by step solution

01

Definition of Statement of Cash Flow

The schedule prepared by the business entity for providing a summary of all the transactions, including cash payments and receipts, is known as the statement of cash flow.

02

Purpose of the statement of cash flows

The cash flow statement is prepared for:

  1. Determining the ability of the business entity to generate cash.
  2. Determining the potential of the business entity to pay dividends and meet other cash obligations.
  3. To determine the reason behind the difference between the cash flow from operating and net income.
  4. To identify the cash and non-cash transactions related to investing and financing transactions.
03

Categories of activities reported in the statement of cash flows

Operating activities: This section of the cash flow statement reports the cash effect of all the transactions that are reported for the calculation of the net income of the business entity.

Investing activities: This section reports the transactions related to the long-term assets of the business entity affecting the cash position.

Financing activities: This section reports the transaction relating to the equity and liability affecting the cash position of the business entity.

04

Methods for reporting cash flow

Direct Method: Under the direct method, the business entity calculates the net cash flow from operation by taking the difference between the operating cash receipts and operating cash disbursement.

Indirect Method: Under the indirect method, the business entity calculates the net cash flow from operating activities by adjusting the net income with the transactions that will affect net income without affecting the cash position. After adjusting net income, the business entity adds and deducts the investing and financing transactions affecting the cash position. After this, the investing and financing transaction affecting the cash position is reported.

05

Presentation of non-cash investing and financing transaction

The business entity's non-cash investing and financing activities are reported in a separate schedule prepared at the bottom of the cash flow statement.

Example of transactions:

  1. Investing transaction: Acquisition of any fixed asset by issuing securities.
  2. Financing transaction: Conversion of debt securities into equity.

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Most popular questions from this chapter

Question: (SCF Theory and Analysis of Improper SCF) Teresa Ramirez and Lenny Traylor are examining the following statement of cash flows for Pacific Clothing Store’s first year of operations.


PACIFIC CLOTHING STORE

STATEMENT OF CASH FLOWS

FOR THE YEAR ENDED JANUARY 31, 2017

Sources of cash

From sales of merchandise

\(382,000

From sale of common stock

380,000

From sale of investment

120,000

From depreciation

80,000

From issuance of note for truck

30,000

From interest on investments

8,000

Total sources of cash

1,000,000

Uses of cash

For purchase of fixtures and equipment

330,000

For merchandise purchased for resale

253,000

For operating expenses (including depreciation)

170,000

For purchase of investment

95,000

For purchase of truck by issuance of note

30,000

For purchase of treasury stock

10,000

For interest on note

3,000

Total uses of cash

891,000

Net increase in cash

\)109,000

Teresa claims that Pacific’s statement of cash flows is an excellent portrayal of a superb first year, with cash increasing \(109,000. Lenny replies that it was not a superb first year—that the year was an operating failure, the statement was incorrectly presented, and \)109,000 is not the actual increase in cash.

Instructions

(a) With whom do you agree, Teresa or Lenny? Explain your position.

(b) Using the data provided, prepare a statement of cash flows in proper indirect method form. The only noncash items in income are depreciation and the gain from the sale of the investment (purchase and sale are related).


Question: (SCF Theory and Analysis of Transactions) Ashley Company is a young and growing producer of electronic measuring instruments and technical equipment. You have been retained by Ashley to advise it in the preparation of a statement of cash flows using the indirect method. For the fiscal year ended October 31, 2017, you have obtained the following information concerning certain events and transactions of Ashley.

1. The amount of reported earnings for the fiscal year was \(700,000, which included a deduction for a loss of \)110,000 (see item 5 below).

2. Depreciation expense of \(315,000 was included in the income statement.

3. Uncollectible accounts receivable of \)40,000 were written off against the allowance for doubtful accounts. Also, \(51,000 of bad debt expense was included in determining income for the fiscal year, and the same amount was added to the allowance for doubtful accounts.

4. A gain of \)6,000 was realized on the sale of a machine. It originally cost \(75,000, of which \)30,000 was undepreciated on the date of sale.

5. On April 1, 2017, lightning caused an uninsured building loss of \(110,000 (\)180,000 loss, less reduction in income taxes of \(70,000). This loss was included in determining income as indicated in item 1 above.

6. On July 3, 2017, building and land were purchased for \)700,000. Ashley gave in payment \(75,000 cash, \)200,000 market price of its unissued common stock, and signed a \(425,000 mortgage note payable.

7. On August 3, 2017, \)800,000 face value of Ashley’s 10% convertible debentures was converted into $150,000 par value of its common stock. The bonds were originally issued at face value.

Instructions

Explain whether each of the seven numbered items above is a cash inflow or outflow, and explain how it should be disclosed in Ashley’s statement of cash flows for the fiscal year ended October 31, 2017. If any item is neither an inflow nor an outflow of cash, explain why it is not, and indicate the disclosure, if any, that should be made of the item in Ashley’s statement of cash flows for the fiscal year ended October 31, 2017.

The following data are taken from the records of Alee Company

December 31, December 31,

2017 2016

Cash \( 15,000 \) 8,000

Current assets other than cash 85,000 60,000

Long-term debt investments 10,000 53,000

Plant assets 335,000 215,000

\(445,000 \)336,000

December 31, December 31,

2017 2016

Accumulated depreciation \( 20,000 \) 40,000

Current liabilities 40,000 22,000

Bonds payable 75,000 –0–

Common stock 254,000 254,000

Retained earnings 56,000 20,000

\(445,000 \)336,000

Additional information:

1. Held-to-maturity securities carried at a cost of \(43,000 on December 31, 2016, were sold in 2017 for \)34,000. The loss (not unusual) was incorrectly charged directly to Retained Earnings.

2. Plant assets that cost \(50,000 and were 80% depreciated were sold during 2017 for \)8,000. The loss was incorrectly charged directly to Retained Earnings.

3. Net income as reported on the income statement for the year was \(57,000.

4. Dividends paid amounted to \)10,000.

5. Depreciation charged for the year was $20,000.

Instructions

Prepare a statement of cash flows for the year 2017 using the indirect method

Of what use is the statement of cash flows?

Stansfield Corporation had the following activities in 2017.

1. Payment of accounts payable \(770,000.

4. Collection of note receivable \)100,000.

2. Issuance of common stock \(250,000.

5. Issuance of bonds payable \)510,000.

3. Payment of dividends \(350,000.

6. Purchase of treasury stock \)46,000.

Compute the amount Stansfield should report as net cash provided (used) by financing activities in its 2017 statement of cash flows.
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