ACCT 201 Principles of Financial Accounting
Practice Exam - Chapter 12
Reporting & Analyzing Cash Flows
Dr. Fred Barbee

Solution to Problem #1

Solution

This problem is different from that which you have seen on prior practice exams. The purpose of this is to help solidify your understanding of the Statement of Cash Flows (SCF). Listed below are a series of questions about the SCF. Respond to each of them briefly. So . . . How well do you understand the Statement of Cash Flows?

  1. What are the statement's reporting objectives?

    2. The reporting objectives of the statement of cash flows is to provide information about important cash inflows and outflows for business decision makers. It answers specific questions such as: (1) how does a company obtain its cash? (2) Where does a compay spend its cash? (3)What is the change in the cash balance?

  2. What two methods are used to prepare it? Identify similarities and differences between them.

    3. The statement can be prepared using the direct method or the indirect method for reporting cash flows from operating activities.

    • Similarities:

      • Both methods report the same net cash flow from operating activities.
      • Both methods classify cash flows into operating, financing, and investing categories.
      • Both methods provide exactly the same information in the financing and investing categories.
      • Both identify the change in cash, beginning cash, and ending cash.
      • Both are acceptable methods for financial reporting.

    • Differences:

      • Cash flow from operating activities is determined differently. The direct method determines all operating cash inflows and outflows, and then subtracts total operating outflows from inflows. The indirect methodstarts with net income and applies a series of adjustments to reconcile this accrual basis number to a cash basis number.
      • The direct method requires an extra section reconciling net income to cash flows from operating activities.
      • The direct method is recommended by the FASB.
      • The indirect method is more widely used.

  3. What steps are followed to prepare the statement?

    4. The steps to preparing the statement of cash flows are:

    1. Compute the net increase or decrease in cash using comparative balance sheet data. This is the target number or the number the statement will explain and prove.
    2. Compute net cash flow from operating activities using the direct or indirect method.
    3. Computenet cash flows from investing activities.
    4. Computenet cash flows from financing activities.Prove that the net cash flow from the three categories combined equals the net change in cash. List the beginning and ending cash balances to prove this.

    Also, identify and list noncash financing and investing activities in aseparate schedule or note.

  4. What types of analyses are often made from the statement's information?

    5. Common analyses made from information in the statement of cash flows include assessing a company's:

    • Ability to generate future cash flows.
    • Ability to pay dividends.
    • Ability to meet obligations
    • Ability to expand operations.
    • Ability to obtain financing.
    • Cash flow on total assets ratio.
    • Sources and uses of cash flows.

  5. Identify and explain the adjustment from net income to obtain cash flows from operating activities using the indirect method for each of the following items:

    1. Noncash operating revenues and expenses.
    2. Nonoperating gains and losses.
    3. Increases and decreases in noncash current assets.
    4. Increases and decreases in current liabilities.

Adjusting Net Income to Cash Flow From Operating Activities
  Items to Add Items to Subtract
a. Noncash expenses Noncash Revenues
b. Losses Gains
c. Decreases in Current Assets Increases in Current Assets
d. Increases in Current Liabilities Decreases in Current Liabilities