1

FAR516442

Flax Corp. uses the direct method to prepare its statement of cash flows. Flax's
trial balances at December 31, 20X1 and 20X0, are as follows:

December 31
Debits 20X1 20X0
Cash $35,000 $32,000
Accounts receivable $33,000 $30,000
Inventory $31,000 $47,000
Property, plant & equipment $100,000 $95,000
Unamortized bond discount $4,500 $5,000
Cost of goods sold $250,000 $380,000
Selling expenses $141,500 $172,000
General and administrative expenses $137,000 $151,300
Interest expense $4,300 $2,600
Income tax expense $20,400 $61,200
$756,700 $976,100
Credits
Allowance for uncollectible accounts $1,300 $1,100
Accumulated depreciation $16,500 $15,000
Trade accounts payable $25,000 $17,500
Income taxes payable $21,000 $27,100
Deferred income taxes $5,300 $4,600
8% callable bonds payable $45,000 $20,000
Common stock $50,000 $40,000
Additional paid-in capital $9,100 $7,500
Retained earnings $44,700 $64,600
Sales $538,800 $778,700
$756,700 $976,100
Additional information
Flax purchased $5,000 in equipment during 20X1.
Flax allocated one-third of its depreciation expense to selling expenses and the
remainder to general and administrative expenses.

What amounts should Flax report in its statement of cash flows for the year ended
December 31, 20X1, for cash paid for income tax?

$25,800

$20,400

$19,700

$15,000

The correct answer is (a).

The income tax expense for the year is recorded at $20,400. An increase in deferred
income taxes payable of $700 (it is a payable because it is given as a credit
balance) implies that $700 of the income tax expense was not paid this year. This
will be deducted from the income tax expense to get the cash paid for income tax. A
decrease in income taxes payable indicates that income taxes payable of previous
years were paid this year. Apart from the cash paid for income tax expense of this
year, the cash paid on income taxes for previous years should also be added to get
the total cash paid on income taxes. The journal entry would be:-

Income Tax Expense $20,400

Decrease in Income Tax Payable $6,100
Increase in Def Tax Payable $700
Cash paid for Income tax (plug) $25,800

Options (b) is incorrect because this represents the income tax expense for the
current year.

Option (c) is incorrect because this does not give the impact on account of income
taxes payable.

Option (d) is incorrect because this gives the opposite impact of income taxes
payable (net) and deferred income taxes payable.

2
FAR517299

During the year, Marco Corp. had the following transactions:

1/2/2XX1 – Conversion of long-term debt to common stock,

1/4/2XX1 - Conversion of preferred stock to common stock and

1/6/2XX1 - Purchased PP&E fully financed by loan.

When preparing the statement of cash flows, which of the above transactions would
be considered?

Long-term debt to common stock Preferred stock to common stock PPE financed
by loan

No Yes Yes

Yes No No

No No No

Yes Yes Yes

The correct answer is (d).
The primary objective of the statement of cash flows is to provide relevant
information about the operating, financing and investing cash receipts and cash
payments of an entity during a period. However, there are some investing and
financing activities that do not flow through the statement of cash flow because
they do not require the use of cash (non-cash items).
Examples include:

Conversion of debt to equity.

Conversion of preferred equity to common equity.
Acquisition of assets through capital leases.
Acquisition of long-term assets by issuing notes payable.
Acquisition of non-cash assets (patents, licenses) in exchange for shares or debt
securities.
Though the above items are typically not included in the main section of the
statement of cash flows as they do not affect cash receipts or cash payments during
the period, however they would be considered and be disclosed under “required
supplementary disclosures” in the statement of cash flows.

Options (a), (b) and (c) are incorrect based on the above explanation.

3
FAR516979

The differences in Beal Inc.'s balance sheet accounts at December 31, year 2 and
year 1, are presented below:

Particulars Increase / (Decrease) ($)

Assets
Cash and cash equivalents 120,000
Short-term investments 300,000
Accounts receivable, net -----
Inventory 80,000
Long-term investments (100,000)
Plant assets 700,000
Accumulated depreciation -----
$1,100,000
Liabilities and stockholders' equity
Accounts payable and accrued liabilities (5,000)
Dividends payable 160,000
Short-term bank debt 325,000
Long-term debt 110,000
Common stock, $10 par 100,000
Additional paid-in capital 120,000
Retained earnings 290,000
$1,100,000
The following additional information relates to year 2:

The short-term investments were classified as securities available for sale.

Net income was $790,000.

Cash dividends of $500,000 were declared.
The building costing $600,000 and having a carrying amount of $350,000 was sold for
$350,000.
Equipment costing $110,000 was acquired through the issuance of long-term debt.
A long-term investment was sold for $135,000. There were no other transactions
affecting long-term investments.
In Beal's year 2 statement of cash flows.

Net cash used by investing activities.

$1,005,000

$1,190,000

$1,275,000
$1,600,000

The correct answer is (a).

Investing activities for the purposes of the statement of cash flows generally
include:

Loans to others or collection of principal.

Acquisition / disposal of available to sale or held to maturity investments.
Acquisition / disposal of plant, property and equipment and intangibles.
Beal Inc.’s net cash inflow / (outflow) from investing activities during Year 2 are
as follows:

Activity

Amount

Increase in short term investments (classified as available for sale)

$(300,000)

Proceeds from sale of building

$350,000

Sale of long term investment

$135,000

Plant assets $700,000

Add: building sold at cost $600,000
------------------
$1,300,000
Less: non cash activity (equipment
acquired through issuance
of long-term debt) ($110,000)
--------------------
Net outflow in respect plant $1,190,000

$(1,190,000)

Net cash inflow / (outflow) from investing activity

$(1,005,000)

Option (b) is incorrect because plant assets are not the only investing activity.
Change in long and short term investments should also be included for computing the
net cash used by investing activity.

Option (c) is incorrect because sale of long term investments is a cash inflow and
not a cash outflow.
Option (d) is incorrect because non cash activity of purchase of plant by issuance
of long term debt must be excluded from the statement of cash flows. Also, proceeds
from the sale of building and long term investment should be included in cash flow
from investing activities.

4
FAR511547

Which of the following would be reported as an investing activity in a company's

statement of cash flows?

Collection of proceeds from a note payable.

Collection of a note receivable from a related party.

Collection of an overdue account receivable from a customer.

Collection of a tax refund from the government.

The correct answer is (b).

Collection of a note receivable from a related party is a cash inflow from
investing activities.

Option (a) is incorrect because principal collections or loans taken by the entity
are included in the cash flows from financing activities.

Option (c) is incorrect because a collection on sales from customers is a part of

operating activity.

Option (d) is incorrect because payment or refund of taxes is a part of operating

activities.

5
FAR511512

Paper Co. had net income of $70,000 during the year. Dividend payment was $10,000.
The following information is available:

Mortgage repayment 20,000

Available-for-sale securities purchased 10,000 increase
Bonds payable issued 50,000 increase
Inventory 40,000 increase
Accounts payable 30,000 decrease

What amount should Paper report as net cash provided by operating activities in its
statement of cash flows for the year?

$0

$10,000
$20,000

$30,000

The correct answer is (a).

Indirect Method (Reconciliation Approach) - Income from continuing operations is
reconciled to net cash flows from operating activities. When applying indirect
method, begin with net income and make 3 types of adjustments.

Non-cash items are adjusted

Non-operating items are adjusted
Changes in balances of accrual related accounts are adjusted.
Net cash flows provided by operating activities is reported at $0.

Operating Activities (Indirect metod) Dr Cr Change

Net Income $70,000

Increase in inventory
40,000
Decrease in A/P
30,000
Net cash provided (used) by operating activities $70,000 $70,000

Option (b) is incorrect because purchase of available-for-sale securities is use of

cash by investing activities.

Option (c) is incorrect because mortgage repayment is a use of cash by financing

activities.

Option (d) is incorrect because proceeds from bonds Issued is a cash inflow
provided by financing activity and mortgage repayment is a use of cash by financing
activities.

6
FAR516457

Fara Co. reported bonds payable of $47,000 at December 31, 20X2, and $50,000 at
December 31, 20X3. During 20X3, Fara issued $20,000 of bonds payable in exchange
for equipment. There was no amortization of bond premium or discount during the
year. What amount should Fara report in its 20X3 statement of cash flows for
redemption of bonds payable?

$3,000

$17,000

$20,000

$23,000

The correct answer is (b).

In the statement of cash flow, Fara Co., should report redemption of bonds payable
under financing activities at $17,000.

Fara Co's Bonds Payable Amount

B Beginning balance as on December 31, 20X2 $47,000
A Add: Bonds payable issued for equipment 20,000
S Subtract: Redemption of bonds payable (plug) (17,000)
E Ending balance as on December 31, 20X3 $50,000

Option (a) is incorrect because it fails to consider the bonds issued in exchange
for equipment (i.e. $3,000 = $50,000 - $47,000).

Option (c) is incorrect because bonds payable for $20,000 are issued in exchange
for equipment and cannot be directly considered as redemption of bonds payable.

Option (d) is incorrect because bonds payable issued during the year should be
added to the opening balance and not the ending balance. (i.e. $23,000 = $50,000 +
$20,000 - $47,000).

7
FAR517010

Top Trades Co. has been trading for a number of years and is currently going
through a period of expansion.
An extract from the statement of cash flows for the year ended December 31, 20X7
for Top Trades Co is presented as follows:

Particulars $’000
Net cash flow from operating activities 995
Net cash used in investing activities (540)
Net cash used in financing activities (200)
Net increase in cash and cash equivalents 255
Cash and cash equivalents at the beginning of the period 200
Cash and cash equivalents at the end of the period 455
Which of the following statements is correct according to the extract of Top Trades
Co’s statement of cash flows?

The company has good working capital management.

Net cash generated from financing activities has been used to fund the additions to
non-current assets.

Net cash generated from operating activities has been used to fund the additions to
non-current assets.

Existing non-current assets have been sold to cover the cost of the additions to
non-current assets.

The correct answer is (c).

There has been inflow of cash due to operating activities and outflow of cash due
to investing activities.

From the outflow of cash due to investing activities means funds have been deployed
for the addition of non-current asset. Thus, statement “net cash generated from
operating activities has been used to fund the additions to non-current assets” is
correct.

Option (a) is incorrect because the primary purpose of working capital management
is to make sure the company always maintains sufficient cash flow to meet its short
term operating cost and short-term debt obligations. There is no information
provided in question regarding company’s short-term operating cost and short-term
debt obligation.

Option (b) is incorrect because there has not been any cash generated through
financing activities, in fact there has been cash used for financing activities.

Option (d) is incorrect because existing non-current assets have been purchased
over the sale of non-current asset as there is outflow of cash flow due to
investing activities. By outflow means more cash has been expensed to purchase the
non-current assets than sale of non-current assets.

8
FAR516434

Class Corp. maintains its accounting records on the cash basis but restates its
financial statements to the accrual method of accounting. Class had $60,000 in
cash-basis pretax income for 20X2. The following information pertains to Class's
operations for the years ended December 31, 20X2 and 20X1:

20X2 20X1
Accounts receivable $40,000 $20,000
Accounts payable $15,000 $30,000

Under the accrual method, what amount of income before taxes should Class report in
its December 31, 20X2, income statement?

$25,000

$55,000

$65,000

$95,000

The correct answer is (d).

Under the cash basis, income is recorded when cash is received and expense is
recorded when cash is paid. Cash basis pretax income of $60,000 means that cash
received - cash payments = $60,000. Accounts receivable shows a increase of $20,000
(i.e. $40,000 - $20,000). This indicates that for a sale worth $20,000 cash has not
yet been received. This $20,000 worth of sale would have not been included as
income under the cash basis accounting. This has to be added back under the accrual
basis accounting.

Accounts payable shows a decrease of $15,000 (i.e. $30,000 - $15,000). This

indicates out of the total cash paid, recorded as expense under the cash basis,
$15,000 pertains to expenses relating to prior years and is not to be recorded as
an expense under the accrual basis of account. This has to be added back.

Accrual basis income would be $60,000 + $20,000 + $15,000 or $95,000.

Options (a), (b) and (c) are incorrect due to inaccurate calculations.

9
FAR511933

Tam Co. reported the following items in its year-end financial statements:

Capital expenditures $1,000,000

Finance lease payments 125,000
Income taxes paid 325,000
Dividends paid 200,000
Net interest payments 220,000

What amount should Tam report as supplemental disclosures in its statement of cash
flows prepared using the indirect method?

$545,000

$745,000

$1,000,000

$1,870,000

The correct answer is (a).

Supplementary disclosure required when indirect method is used:

Cash payment for interest and income taxes must be disclosed.

Schedule of non-cash investing and financing activities.
Accordingly income taxes paid and net interest payments are disclosed. In
supplementary disclosures, Tam Co. should report $545,000 ($325,000 + $220,000).

Option (b) is incorrect because it includes dividends paid which is use of cash by
financing activities ($745,000 = $325,000 + $220,000 + $200,000).

Option (c) is incorrect because capital expenditures is use of cash by investing

activities.

Option (d) is incorrect because capital expenditures is use of cash by investing

activities and finance lease payments & dividend paid is use of cash by financing
activities ($1,870,000 = $1,000,000 + $125,000 + 325,000 + $220,000 + $200,000).

10
FAR517224

Stock dividends are reported in connection with a statement of cash flows as:

An investing activity.

A financing activity.

An operating activity.

Not reported on the statement of cash flows.

The correct answer is (d).

Cash dividends paid to shareholders are shown as a financing activity in the
statement of cash flows. A stock dividend is a non-cash transaction that only
affects stockholders’ equity accounts. Thus, a stock dividend is not reported on a
company’s statement of cash flows.

Options (a), (b) and (c) are incorrect because stock dividends are not reported on
the statement of cash flows.

11
FAR516459

Which of the following should not be disclosed in an enterprise’s statement of cash

flows prepared using the indirect method?

Interest paid, net of amounts capitalized.

Income taxes paid.

Cash flow per share.

Dividends paid on preferred stock.

The correct answer is (c).

In the statement of cash flows, the change in cash and cash equivalents is
measured. Cash equivalents are short- term highly liquid investments that have both
of the following characteristics-

Readily convertible to cash (highly liquid) &

So near to their maturity that they present insignificant risk of changes in value
because of changes in interest rates. Generally, only investments with an original
maturity of three months or less from the purchase date qualify to be cash
equivalents.
Cash flow per share is a measure of a firm's financial strength and represents the
net cash a firm produces, on a per share basis, which is not disclosed in statement
of cash flows.

Option (a) and (b) are incorrect because both interest paid and taxes paid are
shown under operating activities.

Option (d) is incorrect because dividends paid on preferred stock will be reported
as a cash outflow under financing activities.

12
FAR517312

In determining cash flows from operating activities using the indirect method,
adjustments to net income should not include:

Addition for depreciation expense.

Deduct gain from sale of available for sale debt securities.

Addition for increase in allowance for uncollectible.

Addition for decrease in deferred tax liability.

The correct answer is (d).

Under the indirect method, the following adjustments are made to net income:

Non-cash items are adjusted (depreciation and amortization expenses are added back,
equity in earnings is deducted).
Non-operating items are adjusted (deduct the gain from sale of available for sale
debt security as this is an investing activity).
Changes in the balances of accrual related accounts are adjusted (accounts
receivable, inventory, accounts payable, allowance for uncollectible accounts
receivable, amortization of discount, taxes).
Decrease in deferred tax liability should be deducted from net income and not
added. Non-cash expenses like depreciation expense is to be added. Gains are to be
subtracted (gain from available-for-sale debt security) and increase in a credit
account (allowance for uncollectible accounts) is to be added.

Options (a), (b) and (c) are incorrect based on the above explanation.

13
FAR516428

Alp, Inc. had the following activities during 20X3:

Acquired 2,000 shares of stock in Maybel, Inc. for $26,000. Alp intends to hold the
stock as a long-term investment.
Sold an investment in Rate Motors for $35,000 when the carrying value was $33,000.
Acquired a $50,000, four-year certificate of deposit from a bank. (During the year,
interest of $3,750 was paid to Alp.)
Collected dividends of $1,200 on stock investments.
In Alp’s 20X3 statement of cash flows, net cash used in investing activities should
be:

$37,250

$38,050

$39,800

$41,000

The correct answer is (d).

Investing activities includes inflows and outflows of cash generally related to

long term investments or non-current assets.

Outflows to be considered:-

2,000 shares of stock in Maybel, Inc. for $26,000.

Four-year certificate of deposit from a bank for $50,000.
Note that certificate of deposit is for four years and hence would not be regarded
as a cash equivalent.

Inflows to be considered:-

Sale of investment in Rate Motors for $35,000.

Dividend of $1,200 and interest of $3,750 will be considered as inflows from
operating activities.
In Alp’s 20X3 statement of cash flows, net cash used in investing activities should
be = $35,000 - $26,000- $50,000 = Outflow of $41,000.

Options (a), (b) and (c) are incorrect based on inaccurate calculations.

14
FAR516447

Lance Corp.'s statement of cash flows for the year ended September 30, 20X2, was
prepared using the indirect method and included the following:

Net income $60,000

Non-cash adjustments
Depreciation expense 9,000
Increase in accounts receivable (5,000)
Decrease in inventory 40,000
Decrease in accounts payable (12,000)
Net cash flows from operating activities $92,000

Lance reported revenues from customers of $75,000 in its 20X2 income statement.
What amount of cash did Lance receive from its customers during the year ended
September 30, 20X2?
$80,000

$70,000

$65,000

$55,000

The correct answer is (b).

Lance corp., should report cash collected at $70,000, which is revenue for the year
reduced by the increase in accounts receivables (i.e. $75,000 - $5,000).

Dr: Cash (plug) $70,000

Dr: A/R (change) $5,000

Cr: Revenue $75,000

Depreciation is a non-cash adjustment, while the decrease in inventory and accounts

payable do not impact cash collections from customers, hence not relevant in
arriving at cash collected by Lance Corp.

Option (a) is incorrect because increase in accounts receivable is added instead of

deducting (i.e. $80,000 = $75,000 + $5,000).

Option (c) is incorrect because net income and increase in accounts receivable are
added instead of considering the revenue at $75,000 and deducting the increase in
accounts receivable from it (i.e. $65,000 = $60,000 + $5,000).

Option (d) is incorrect because net income is used instead of the revenue to
determine the cash collection (i.e. $55,000 = $60,000 - $5,000).

15
FAR516460

Which of the following information should be disclosed as supplemental information

in the statement of cash flows?

I. Cash flow per share.

II. Conversion of debt to equity.

I only.

II only.
Both I and II.

Neither I nor II.

The correct answer is (b).

Cash flow per share is a measure of a firm's financial strength and represents the
net cash a firm produces, on a per share basis, which is not disclosed in statement
of cash flows.

Conversion of debt to equity is disclosed as supplemental information in the

statement of cash flows.

Options (a), (c) & (d) are incorrect per above explanation.

16
FAR517310

Which of the following statements are true?

Cash flow reveals only the inflow of cash.

Cash flow statement is useful only for internal analysis.

Cash flow is a substitute for statement of income.

Cash flow statement is not a replacement of funds flow statement.

The correct answer is (d).

Funds Flow Statement is a statement prepared to analyze the reasons for changes in
the financial position of a company between two balance sheet dates. It shows the
inflow and outflow of funds i.e. sources and applications of funds for a particular
period.
A cash flow statement, also known as statement of cash flows, is a financial
statement that shows how changes in balance sheet accounts and income affect cash
and cash equivalents and breaks the analysis down to operating, investing and
financing activities.
Cash flow statement cannot be a substitute for funds flow statement. They are
mutually exclusive.

Option (a) is incorrect because cash flow reveals both inflows and outflows.

Option (b) is incorrect because cash flow can be used also for external analysis.

Option (c) is incorrect because cash flow cannot be a substitute for statement of
income.

17
FAR511541

Baler Co. prepared its statement of cash flows at year end using the direct method.
The following amounts were used in the computation of cash flows from operating
activities

Beginning inventory $200,000

Ending inventory 150,000
Cost of goods sold 1,200,000
Beginning account payable 300,000
Ending account payable 200,000

What amount should Baler report as cash paid to suppliers for inventory purchases?

$1,200,000

$1,250,000

$1,300,000

$1,350,000

The correct answer is (b).

Cash paid to suppliers = COGS - Decrease in inventory + Decrease in accounts
payable.
Cash paid to the suppliers for inventory purchases is reported at $1,250,000
($1,200,000 - $50,000 + $100,00).
Decrease in inventory is $50,000 ($150,000 - $200,000).
Decrease in accounts payable is $100,000 ($200,000 - $300,000).

Option (a) is incorrect because it fails to include the impact of change in the
inventory and accounts payable.

Option (c) is incorrect because it does not include the change in inventory
($1,300,000 = $1,200,000 + $100,000).

Option (d) is incorrect because it adds the decrease in inventory, instead of

adding it. ($1,350,000 = $1,200,000 + 50,000 + $100,000).

18
FAR516868

A company reports the following information for year 1:

Sale of equipment $20,000

Issuance of the company’s bonds $10,000
Dividends paid $5,000
Purchase of stock of another company $2,000
Purchase of U.S. Treasury note $2,000
Income taxes paid $2,000
Interest income received $500
What is the company's net cash flow from financing activities?
($9,000)

$5,000

$5,500

$15,000

The correct answer is (b).

Net flows from financing activities includes an inflow of $10,000 from issuance of
company's bonds and an outflow of $5,000 from dividends paid. Thus, there is a net
inflow of $5,000 from financing activity. Sale of equipment and purchase of stock
of another company are cash flows from investing activities. A U.S. Treasury note
is a cash equivalent. In the statement of cash flows, the change in cash and cash
equivalent is measured. Thus, even though a purchase of a 3 month U. S. Treasury
bill decreases cash, a cash equivalents increases. There is no net change in the
amount of cash and cash equivalents hence the transaction is not reported on the
statement of cash flows. Income taxes paid and interest income received are cash
flows from operating activities.

Options (a), (c) and (d) are incorrect based on the above explanation.

19
FAR517235

Cash flow is

Linked to the balance sheet and the statement of income.

Linked only to the statement of income.

Linked only to the balance sheet.

Not linked to the balance sheet or statement of income.

The correct answer is (a).

The three financial statements: Statement of income, Balance sheet, Statement of
cash flows are all linked and dependent on each other. Net income from the bottom
of the statement of income links to the balance sheet and cash flow statement. On
the balance sheet, it feeds into retained earnings and on the cash flow statement
it is the starting point for the cash from operations section (i.e. operating
activity based on the indirect method). Depreciation is added back. Financing
activities mostly affect the balance sheet. The sum of last period’s closing cash
plus this period’s cash from operations, investing and financing is the closing
cash balance on the balance sheet.

Options (b), (c) and (d) are incorrect based on the above explanation.
20
FAR517305

The net income for Wonton Ltd. was $700,000 for the year ended December 31, Y1.
Related information follows:

Amortization of patent $50,000

Cash dividends paid $33,000
Increase in accounts receivable $13,200

Decrease in rent payable $21,450

Depreciation expense $20,800
Increase in bonds payable $70,000
Sale of preferred stock $82,000

Calculate the cash flow from operating activities:

$736,150

$769,150

$806,150

$888,150

The correct answer is (a).

Under the indirect method, the following adjustments are made to net income:

Non-cash items are adjusted (depreciation and amortization expenses are added back,
equity in earnings is deducted).
Non-operating items are adjusted (deduct the gain from sale of available-for-sale
debt security as this is an investing activity).
Changes in the balances of accrual related accounts are adjusted (accounts
receivable, inventory, accounts payable, allowance for uncollectible accounts
receivable, amortization of discount, taxes).
Operating activities (indirect method)

Particulars

Dr. ($)

Cr. ($)

Change ($)

Net income

700,000

Amortization of patent
50,000

Increase in accounts receivable

13,200

Decrease in rent payable

21,450

Depreciation expense

20,800

Net cash provided (used) from operating activities

770,800

34,650

736,150

Option (b) is incorrect because cash dividends paid have been wrongly added. Cash
dividends paid will be part of cash flow from financing activities only.

Option (c) is incorrect because increase in bonds payable has wrongly been added in
the operating activities. This should only be part of cash flow from financing
activities.

Option (d) is incorrect because sale of preferred stock and increase in bonds
payable has wrongly been added in the operating activities. This should only be
part of cash flow from investing and financing activities respectively.

21
FAR516455

In preparing its cash flow statement for the year ended December 31, 20X4, Reve Co.
collected the following data:
Gain on sale of equipment $(6,000)
Proceeds from sale of equipment 10,000
Purchase of A.S., Inc. bonds (par value $200,000) (180,000)
Amortization of bond discount 2,000
Dividends declared (45,000)
Dividends paid (38,000)
Proceeds from sale of treasury stock (carrying amt $65,000)75,000

In its December 31, 20X4, statement of cash flows, what amount should Reve report
as net cash used in investing activities?

$170,000

$176,000

$188,000

$194,000

The correct answer is (a).

Investing activities includes inflow and outflow of cash generally related to long
term investments or non-current assets. Primarily it includes the following:

Principal collections or loans made by the entity (interest and dividends received
are operating).
Acquisition or disposal of available-for-sale or held-to-maturity investments (not
trading).
Acquisition or disposal of PP&E and intangibles.
In its December 31, 20X4, statement of cash flows, Reve Co. should report net cash
used in investing activities of $170,000. Amortization of bond discount is a non-
cash item and gain on sale of equipment should be reported under operating
activities. Dividends paid and proceeds from sale of treasury stock will be
reported under financing activity.

Ref December 31, 20X4, Reve Co Amount

a Proceeds from sale of equipment $10,000
b Purchase of A.S., Inc. bonds (par value $200,000) (180,000)
c Net cash used in investing activities (a+b) $(170,000)

Option (b) is incorrect because gain on sale of equipment should be adjusted in

operating activities because proceeds from the sale of equipment includes carrying
value of the equipment and gain [i.e. $(176,000) = $(6,000) + $10,000 +
$(180,000)].

Option (c) is incorrect because it fails to consider proceeds from sale of

equipment. Gain on sale of equipment and amortization of bond discount should be
adjusted as part of operating activities [i.e. $(188,000) = $(6,000) - $2,000 +
$(180,000)].
Option (d) is incorrect because proceeds from sale of equipment which includes
carrying value of the equipment plus the gain on sale of equipment is considered as
outflow of cash instead of inflow. Gain on sale of equipment and amortization of
bond discount should be adjusted as part of operating activities [$(194,000) =
$(6,000) - $(10,000) + $2,000 + $(180,000)].

22
FAR516436

The following information pertains to Eagle Co.'s 20X3 sales:

Cash sales
Gross $80,000
Returns and allowances 4,000
Credit sales
Gross 120,000
Discounts 6,000
On January 1, 20X3, customers owed Eagle $40,000. On December 31, 20X3, customers
owed Eagle $30,000. Eagle uses the direct write-off method for bad debts. No bad
debts were recorded in 20X3. Under the cash basis of accounting, what amount of net
revenue should Eagle report for 20X3?

$76,000

$170,000

$190,000

$200,000

The correct answer is (d).

Under cash basis: of accounting-

Net Revenue = Net cash sales + Collections from credit sales.

Net Cash Sales = Gross - Returns and Allowances = $80,000 - $4,000 = $76,000.

Collections from credit sales = Opening accounts receivables + Net credit sales -
Closing accounts receivables.

Opening accounts receivables = $40,000.

Closing accounts receivables = $30,000.

Net credit sales = Gross minus discounts = $120,000 - $6000 = $114,000.

The collection from credit sales would be $124,000 (i.e. $40,000 + $114,000 -
$30,000).

Therefore, net revenue that Eagle should report for 20X3 = Net cash sales +
Collections from credit sales = $76,000 + $124,000 = $200,000.
Option (a) is incorrect because it takes into consideration only the net cash
sales. We need to calculate collection from credit sales as well, as explained
above.

Options (b) and (c) are incorrect because of improper calculations.

23
FAR511934

Baker Co. began its operations during the current year. The following is Baker's
balance sheet at December 31:

Baker Co. Balance Sheet

Assets
Cash $192,000
Accounts receivable 82,000
Total assets 274,000
Liabilities and stockholders' equity
Accounts payable 24,000
Common stock 200,000
Retained earnings 50,000
Total liabilities and stockholders' equity $274,000

Baker's net income for the current year was $78,000 and dividends of $28,000 were
declared and paid. Common stock was issued for $200,000. What amount should Baker
report as cash provided by operating activities in its statement of cash flows for
the current year?

$20,000

$50,000

$192,000

$102,000

The correct answer is (a).

Indirect Method (Reconciliation Approach) - Income from continuing operations is
reconciled to net cash flows from operating activities. When applying indirect
method, begin with net income and make 3 types of adjustments.

Non-cash items are adjusted

Non-operating items are adjusted
Changes in balances of accrual related accounts are adjusted.
Net cash flows from operating activities is reported at $20,000.

Operating Activities Dr Cr Change

Net Income $78,000

Increase in A/R
82,000
 Increase in A/P 24,000

Net Cash provided (used) by operating activities $102,000 $82,000

$20,000

Dividends paid is use of cash and the issuance of stock is the cash provided by
financing activities.

Option (b) is incorrect because it is retained earnings.

Option (c) is incorrect because it is the cash balance.

Option (d) is incorrect because it is the sum of common stock and retained earnings
($250,000 = $200,000 + $50,000).

24
FAR517300

Company X has the following information regarding its salaries and wages for the
year ended 2XX1:

Wages payable amount as of 1/1/2XX1 - $10,000.

Wages payable amount as of 12/31/2XX1 - $20,000.

Salaries expense for the year - $80,000.

If the company prepares its statement of cash flows using the direct method, what
should it present as the 'Cash paid for wages' under the operating activities?

$20,000

$80,000

$90,000

$70,000

The correct answer is (d).

In order to calculate the actual cash paid for wages, salaries and other employee
entitlements under the direct method, Company X should:

Take the salaries expense amount.

(+/-) Decrease / increase in the wages payment amount on account of the year-end
balances.

The end of the year balances are more than the beginning balances leading to a
decrease. The resulting amount of $70,000 (i.e. $80,000 - $10,000) should be
presented as cash paid for wages during the period.

Option (a) is incorrect because this is the balance of wages payable at the end of
year. Company X, should take into consideration the increase in wages payable
amount of $10,000 that further needs to be deducted from salary expense amount.

Option (b) is incorrect because it does not take into consideration the increase in
wages payable amount of $10,000 (i.e. $20,000 - $10,000).

Option (c) is incorrect because while calculating the amount of “cash paid for
wages” Company X, has incorrectly added (rather subtracted) the increase in the
wages payable amount for the year ended 2XX1.

25
FAR516450

Compared to its 20X2 cash basis net income, Potoma Co.'s 20X2 accrual basis net
income increased when it

Declared a cash dividend in 20X1 that it paid in 20X2.

Wrote off more accounts receivable balances than it reported as uncollectible

accounts expense in 20X2.

Had lower accrued expenses on December 31, 20X2, than on January 1, 20X2.

Sold used equipment for cash at a gain in 20X2.

The correct answer is (c).

A decrease in accrued expenses means cash was paid for expenses accrued of previous
years. While this expense would have reflected in the previous years under accrual
basis of accounting, this would have been an expense for the current year under the
cash basis accounting. As a result, the net income under the cash basis would
include higher expenses and would be lower than under the accrual basis of
accounting.

Option (a) is incorrect because a cash dividend is not an expense and would not be
reflected in the income statement. It only decreases retained earnings and would
have no effect either on the cash basis or the accrual basis net income.

Option (b) is incorrect because uncollectible accounts and bad debts are recorded
only under accrual basis and not under cash basis. Writing off accounts receivable
as bad debts would lead to a lesser net income under accrual basis compared to the
cash basis.

Option (d) is incorrect because sale of equipment for cash at a gain would increase
the net income both under the accrual basis and the cash basis.

26
FAR517307
Cash Flow Statement is also known as

Statement of changes in financial position on cash basis.

Statement of accounting for variation in cash.

Both (a) and (b).

None of the above.

The correct answer is (c).

Cash Flow Statement is also called as Statement of Changes in Financial Position on
Cash Basis or Statement of Accounting for Variation in Cash.

Options (a), (b) and (d) are incorrect based on the above explanation.

27
FAR516431

The primary purpose of a statement of cash flows is to provide relevant information

about:

Differences between net income and associated cash receipts and disbursements.

An enterprise's ability to generate future positive net cash flows.

The cash receipts and cash disbursements of an enterprise during a period.

An enterprise's ability to meet cash operating needs.

The correct answer is (c).

The Statement of Cash Flows is a required financial statement whenever a company is

presenting the results of operations for a year. Their primary purpose is to:-

Provide detailed information about the entity's cash inflows and outflows (sources
and uses).
Disclose information about financing and investing activities
Help users make assessments.
Option (a) is incorrect because providing differences between net income and
associated cash receipts and disbursements is not the primary purpose. Income from
continuing operation is reconciled to net cash flow from operating activities by
adjusting for differences related to changes in the balance sheet operating
accounts (such as accounts receivable, inventory, accounts payable etc.) and non-
cash items (such as depreciation, amortization, deferred income taxes etc.).

Option (b) is incorrect because an enterprise's ability to generate future positive

net cash flows, is not determined by cash flow statement rather it provides
detailed information about the entity's cash inflows and outflows (sources and
uses).

Option (d) is incorrect because an enterprise's ability to meet cash operating

needs is determined by proper working capital management.

28
FAR517222

Cash equivalents have each of the following characteristics except:

Short-term.

Highly liquid.

Maturity of at least 3 months.

Little risk of loss.

The correct answer is (c).

Cash equivalents are short-term, highly liquid investments that have both of the
following characteristics:-
a) Readily convertible to cash (highly liquid), and
b) So near their maturity that they present insignificant risk of changes in value
because of changes in interest rates (little risk of loss). Generally, only
investments with an original maturity of three month or less from the purchase date
qualify to be cash equivalents.
Thus, maturity period should be three months or less, not at least three months.

Options (a), (b) and (d) are incorrect based on the above explanation.

29
FAR516435

Compared to the accrual basis of accounting, the cash basis of accounting

understates income by the net decrease during the accounting period of

I. Accounts receivable.
II. Accrued expenses.

I only.

II only.

Both I and II.

Neither I nor II.

The correct answer is (b).

Decrease in accounts receivable signifies that collections were more and exceeded
sales for the period, which means income under cash basis of accounting will be
higher or overstated, not understated compared to accrual basis of accounting.

Decrease in accrued expenses signifies payments exceeded expenses for the period
which means income under cash basis of accounting will be lower or understated
compared to accrual basis of accounting.

Options (a), (c) and (d) are incorrect based on the above explanation.

30
FAR517871

The following information is available from the records of Cook. Inc, a tax-free
company:
Income statement as on 12/31/X4:

Particulars Amount
EBITDA $300,000
Depreciation (10,000)
EBIT 290,000
Interest (20,000)
EBT 270,000
Tax (Nil)
Net Income 270,000
Appropriations:
Dividend paid to equity shareholders
Dividend paid to preference shareholders 4,500
2,250
Cook Inc., net income includes the dividend received from one of its subsidiary
company of $500 and investment income from equity instrument held as available for
sale security of $1,500.
The working capital details are as follows:

Particulars 1/1/X4 12/31/X4

Current assets $150,000 $162,000
Current liabilities 84,000 90,000
Working capital 66,000 72,000
The cash flows from operating activities for 12/31/X4 are:

$267,250

$274,000

$272,000

$277,250

The correct answer is (b).

Cash flows from operating activities are:
Particulars Amount
Net income $270,000
Add: Depreciation 10,000
Less: Increase in current assets (12,000)
Add: Increase in current liability 6,000
Cash flow from operations $274,000
1. Depreciation is a non-cash item and it should be added back.
2. Increase in current asset reduces cash and is deducted from net income.
3. Increase in current liabilities increases cash and is added to net income.
4. Interest of $20,000 is not adjusted because it is considered as part of
operating activities.
5. Dividend income from subsidiary $500 and investment income $1,500 both are
included in cash flow from operating activities. No further adjustment is required
as they are already included in the net income.
6. Dividends paid to equity and preference shareholders are financing activities.
No adjustment is required as they are appropriated out of profits in this case and
are not included in the net income.

Option (a) is incorrect because it wrongly includes dividends paid to equity and
preference shareholders under operating activities.

Option (c) is incorrect because the amount is wrongly adjusted by deducting

dividend income and investment income.

Option (d) is incorrect because it wrongly adds back changes in working capital and
also wrongly includes the items that should be part of financing activities. It
also negates dividend and investment income.

31
FAR516463

In a statement of cash flows, which of the following items is reported as a cash

outflow from financing activities?
I. Payments to retire mortgage notes.
II. Interest payments on mortgage notes.
III. Dividend payments.

I, II, and III.

II and III.

I only.

I and III.

The correct answer is (d).

Cash flows from financing activities include issuing debt or equity.

Proceeds from issuing or payments for retiring bonds.

Issuance or re-acquisition of stock or treasury stock.
Borrowing or repaying of loan.
Dividends paid to shareholders.
Bank overdrafts which are excluded from cash.
Payments to retire mortgage notes and dividend payments will be considered as
outflow under financing activities.

Interest payments on mortgage notes will be considered as outflow from operating

activities.

Options (a), (b) & (c) are incorrect based on the above explanation.

32
FAR516452

How should a gain from the sale of used equipment for cash be reported in a
statement of cash flows using the indirect method?

In investment activities as a reduction of the cash inflow from the sale.

In investment activities as a cash outflow.

In operating activities as a deduction from income.

In operating activities as an addition to income.

The correct answer is (c).

Investing activities includes inflows and outflows of cash generally related to

long term investments or non-current assets. The cash inflow should include both
the carrying amount of the equipment plus the gain. We need to consider the total
inflow that takes place, ideally the actual amount received as part of sale.

When using the indirect method, the gain is deducted from net income under
operating activities, so that its not double counted.

Option (a) is incorrect because gain will form part of total inflow under investing
activity. The cash inflow should include both the carrying amount of the equipment
plus the gain.

Option (b) is incorrect because gain from sale will be deducted from net income
under operating activity and not regarded as outflow under investing.

Option (d) is incorrect because gain is shown as deduction to net income under
operating activity and not as an addition.

33
FAR511514
During the current year, Ace Co. amortized a bond discount. Ace prepares its
statement of cash flows using the indirect method. In which section of the
statement should Ace report the amortization of the bond discount?

Financing activities.

Operating activities.

Investing activities.

Supplemental disclosures.

The correct answer is (b).

Indirect Method (Reconciliation Approach) - Income from continuing operations is
reconciled to net cash flows from operating activities. When applying indirect
method, begin with net income and make 3 types of adjustments.

Non-cash items are adjusted

Non-operating items are adjusted
Changes in balances of accrual related accounts are adjusted.
The amortization of bond discount is a non-cash expense and should be added back to
the net income.

Options (a) (c) and (d) are incorrect as per the above explanation.

34
FAR517009

A company acquired a building, paying a porting of the purchase price in cash and
issuing a mortgage note payable to the seller for the balance.

In the statement of cash flows, what amount is included in financing activities for
the above transaction?

Cash payment.

Acquisition price.

Zero.

Mortgage amount.

The correct answer is (c).

Cash flows from financing activity reflects cash inflows and outflows from issuance
of equity or debt. Acquiring a building is acquisition of PP&E and is disclosed as
investing activities of the statement of cash flow. If a company acquires PP&E
through issuance of debt, it is non-cash investing and a financing activity. Such
non-cash activities are not included in the statement of cash flow but are
disclosed in the supplementary disclosures to the statement of cash flow.

The company has purchased the building paying a portion in cash and issued a
mortgage note payable for the balance. It is a cash activity to the extent it is
paid for by cash and non cash activity to the extent financed by the notes payable.
The issue of notes payable is a non-cash financing activity, no amount is reported
as cash flow from financing activities for this transaction.

Options (a) and (b) are incorrect because acquisition in the building is an
investing activity and not a financing activity. The amount paid in cash for the
PP&E shall be reported as cash outflow for investing activities and the amount
financed by notes payable shall be disclosed as a non-cash investing activity.

Option (d) is incorrect because though financing activity reflects cash inflows and
outflows from issuance of equity or debt, issuance of notes payable for purchase of
building is a non cash activity and shall be disclosed as such in the supplementary
disclosures to the statement of cash flow.

35
FAR516456

On July 1, 20X2, Dewey Co. signed a 20-year building lease that it reported as a
capital lease. Dewey paid the monthly lease payments when due. How should Dewey
report the effect of the lease payments in the financing activities section of its
20X2 statement of cash flows?

An inflow equal to the present value of future lease payments at July 1, 20X2, less
20X2 principal and interest payments.

An outflow equal to the 20X2 principal and interest payments on the lease.

An outflow equal to the 20X2 principal payments only.

The lease payments should not be reported in the financing activities section.

The correct answer is (c).

Financing activities in the statement of cash flows include issuing debt or equity.
In case of lease or debt, consider both the principal and interest portion of
payments. In Dewey's 20X2 statement of cash flows, portion of payment allocated to
interest will be reported as a cash outflow from operating activities, while the
principal portion will be reported as a cash outflow from financing activities.

Option (a) is incorrect because payment on lease is an outflow of cash, while

principal payments are reported as part of financing activities and interest
payment is reported under operating activities.
Option (b) is incorrect because interest payment on the lease is part of operating
activities and not reported in financing activities.

Option (d) is incorrect because principal payment on the lease is reported as part
of financing activities.

36
FAR511574

For the year ended December 31, Ion Corp. had cash inflows of $25,000 from the
purchases, sales, and maturities of held-to-maturity securities and $40,000 from
the purchases, sales, and maturities of available-for-sale debt securities. What
amount of net cash from investing activities should Ion report in its cash flow
statement?

$0

$25,000

$40,000

$65,000

The correct answer is (d).

Investing activities include the following:

Principal collections or loans made by the entity (interest and dividends received
are operating).
Acquisition or disposal of Available-for-Sale (AFS) debt securities or Held-to-
Maturity (HTM) investments (not trading).
Acquisition or disposal of PP&E and intangibles.
The net cash from investing activities is reported at $65,000.

Ref Cash flows from investing activities Change

a Purchases, sales and maturities of HTM $25,000
b Purchases, sales and maturities of AFS debt securities 40,000
c Net cash provided (used) by investing activities (a+b) $65,000

Option (a) is incorrect because net cash inflow from investing activities is
reported at $65,000.

Option (b) is incorrect because it does not include cash inflow from AFS debt
securities.

Option (c) is incorrect because it does not include cash inflow from HTM
securities.