CHAPTER 23

Statement of Cash Flows

ANSWERS TO QUESTIONS

1. The main purpose of the statement of cash flows is to show the change in cash of a company from
one period to the next. The statement of cash flows provides information about a company’s
operating, financing, and investing activities. More precisely, it provides information about the
company’s cash inflows and outflows for the period.

2. Some uses of this statement are:

Assessing future cash flows: Income data when augmented with current cash flow data provide a
better basis for assessing future cash flows.
Assessing the quality of income: Some believe that cash flow information is more reliable than
income information because income involves a number of assumptions, estimates and valuations.
Assessing operating capability: Whether an enterprise is able to maintain its operating capability,
provide for future growth, and distribute dividends to the owners depends on whether adequate
cash is being or will be generated.
Assessing financial flexibility and liquidity: Cash flow data indicate whether a company should
be able to survive adverse operating problems and whether a company might have difficulty in
meeting obligations as they become due, paying dividends, or meeting other recurring costs.
Providing information on financing and investing activities: Cash flows are classified by their
effect on the statement of financial position items; investing activities affect assets while financing
activities affect liabilities and equity.

3. Investing activities generally involve non-current assets and include (1) lending money and
collecting on those loans and (2) acquiring and disposing of investments and productive long-lived
assets. Financing activities, on the other hand, involve liability and equity items and include (1)
obtaining cash from creditors and repaying the amounts borrowed and (2) obtaining capital from
owners and providing them with a return on their investment. Operating activities include all

1
 transactions and events that are not investing and financing activities. Operating activities involve
the cash effects of transactions that enter into the determination of net income.

4. Examples of sources of cash in a statement of cash flows include cash from operating activities,
issuance of debt, issuance of ordinary shares, sale of investments, and the sale of property, plant,
and equipment. Examples of uses of cash include cash used in operating activities, payment of
cash dividends, the redemption of debt, purchase of investments, redemption of ordinary shares,
and the purchase of property, plant, and equipment.

5. Preparing the statement of cash flows involves three major steps:

(1) Determine the change in cash. This is simply the difference between the beginning and ending
cash balances.
(2) Determine the net cash flow from operating activities. This involves analyzing the current year’s
income statement, comparative statements of financial position, and selected transaction data.
(3) Determine cash flows from investing and financing activities. All other changes in the statement
of financial position accounts are analyzed to determine their effect on cash.

6. Purchase of land—investing;
Payment of dividends-financing;
Cash sales—operating;
Purchase of treasury shares—financing.

7. Comparative statements of financial position, a current income statement, and certain transaction
data all provide information necessary for the preparation of the statement of cash flows.
Comparative statements of financial position indicate how assets, liabilities, and equities have
changed during the period. A current income statement provides information about the amount of
cash provided from operating activities. Certain transactions provide additional detailed information
needed to determine whether cash was provided or used during the period.

8. It is necessary to convert accrual-based net income to a cash basis because net income includes
items that do not provide or use cash. An example would be an increase in accounts receivable.
If accounts receivable increased during the period, revenues reported on the accrual basis would

2
 Sale of ordinary shares.................................................... €330,000

(c) The write-off of the uncollectible accounts receivable of €27,000 is not

reported on the statement of cash flows. The write-off reduces the
Allowance for Doubtful Accounts balance and the Accounts Receivable
balance. It does not affect cash flows.

Note: The change in net accounts receivable is some- times used to

compute an adjustment to net income under the indirect method.

(d) The net loss of €50,000 should be reported in the operating activities
section of the statement of cash flows. A depreciation of €22,000 is
reported in the operating activities section of the statement of cash
flows. The gain on the sale of land also appears in the operating
activities section of the statement of cash flows. The proceeds from the
sale of land of €39,000 are reported in the investing activities section
of the statement of cash flows. These four items might be reported as
follows:

Cash flows from operating activities

Net loss ............................................................ €(50,000)
Adjustments to reconcile net income
to net cash used in operating activities*:
Depreciation............................................. €22,000
Gain on sale of land ................................ (9,000)

*Either net cash used or provided depending upon other adjustments.

Given only the adjustments in (d), the ―net cash used‖ should be
employed.

Cash flows from investing activities

Sale of land ..................................................... . €39,000

12
 (e) The purchase of the certificate of deposit is not reported in the
statement of cash flows. This instrument is considered a cash
equivalent and therefore cash and cash equivalents have not changed
as a result of this transaction.

(f) Patent amortization of €20,000 is reported in the operating activities

section of the statement of cash flows. It is added to the net income in
arriving at net cash provided by operating activities.

(g) The exchange of ordinary shares for investment in Plumlee is reported

as a ―non-cash investing and financing activity. It can be shown in a
note as follows:

Non-cash investing and financing activities

Purchase of investment by the issuance
of ordinary shares................................... €900,000

(h) The purchase of treasury shares is reported as a cash payment in the

financing activities section of the statement of cash flows.

(i) The unrealized holding gains on a debt investment not held for collection
increases net income but not net cash provided by operating activities.
As a result, the unrealized holding gain is shown as a deduction from
net income to compute cash flows from operating activities.

EXERCISE: 23-3
RODRIQUEZ COMPANY Partial
Statement of Cash Flows
For the Year Ended December 31, 2010

13
 Cash flows from operating activities
Net income.............................................................. $1,050,000
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation expense .................................... $ 60,000
Decrease in accounts receivable .................. 310,000
Decrease in inventory .................................... 300,000
Increase in prepaid expenses........................ (170,000)
Decrease in accounts payable ...................... (275,000)
Decrease in accrued expenses payable ....... (120,000) 105,000
Net cash provided by operating activities .... $1,155,000

14
 RODRIQUEZ COMPANY Partial
Statement of Cash Flows
For the Year Ended December 31, 2010
Cash flows from operating activities

Cash receipts from customers .............. $7,210,000 (a)

Cash payments .......................................

To suppliers ..................................... $4,675,000 (b)
For operating expenses .................. 1,380,000 (c) 6,055,000
Net cash provided by operating
activities .............................................. $1,155,000

Computations:
(a) Cash receipts from customers
Sales ................................................. $6,900,000
Add: Decrease in accounts
receivable ............................... 310,000
Cash receipts from customers ....... $7,210,000

(b) Cash payments to suppliers

Cost of goods sold .......................... $4,700,000
Deduct: Decrease in inventories .... 300,000
Purchases ........................................ 4,400,000
Add: Decrease in accounts
payable ................................... 275,000
Cash payments to suppliers ........... $4,675,000

(c) Cash payments for operating

expenses
Operating expenses, exclusive
of depreciation ............................. $1,090,000*
Add: Increase in prepaid
expenses ................................ $170,000
Decrease in accrued
expenses payable .............. 120,000 290,000
Cash payments for operating
expenses ...................................... $1,380,000

*$450,000 + ($700,000 – $60,000

15