5.04 Analyzing Statements of Cash Flows I - Answers
5.04 Analyzing Statements of Cash Flows I - Answers
5.04 Analyzing Statements of Cash Flows I - Answers
£ millions
Revenues 25
The company had no investing or financing activities during this time. The amount of cash that it collected from customers is closest to:
A. £13 million
B. £27 million
C. £37 million
Explanation
Cash collected from customers in each accounting period is classified as cash from operations (CFO). Collections are calculated using
revenues (found on the income statement) and the change in accounts receivable (found on the balance sheet). When a company makes a
credit sale, accounts receivable increases by the amount of the sale. When customers pay, accounts receivable decreases, and cash increases,
by the amount of payment.
If cash collected equals revenues, then the beginning and ending accounts receivable are identical. Any difference between beginning and
ending receivables results when cash collected differs from revenues. If cash collected exceeds revenues, then beginning accounts receivable is
greater than ending accounts receivable. The reverse is true if revenues are greater than cash collected.
In this question, revenues, beginning accounts receivable, and ending accounts receivable are all known. The calculations shown in the left table
above can be rearranged in the right table to solve for the unknown variable (cash collected).
(Choice A) £13 million results from subtracting the change in accounts receivable from revenue rather than adding it.
(Choice B) £27 million results from subtracting cost of goods sold from total revenues. Cost of goods sold impacts inventory, not changes in
accounts receivable.
Things to remember:
Cash from operations (CFO) can be derived from a company's revenue and the changes in its accounts receivable. There are two balance-sheet
variables (beginning and ending accounts receivable), one income-statement variable (revenues), and one cash-flow variable (CFO). Knowing
any three allows the fourth to be derived by rearranging the calculations.
Describe how the cash flow statement is linked to the income statement and the balance sheet
LOS
If all sales and purchases were made on credit, then based on this information, which of the following is the accountant's most appropriate
conclusion?
Explanation
Cash flow from operating activities (CFO) can be presented using the indirect method (as shown in the question) or the direct method. The
indirect method reconciles an accrual-based net income to CFO by adjusting net income for:
In contrast, the direct method (see example) groups types of cash transactions (eg, cash received from customers, cash paid to suppliers) with
each line item representing an actual cash receipt or payment.
To derive the amounts on the direct statement, the accountant can adjust certain income statement items for changes in working capital.
Changes in working capital can be derived from the information provided on the indirect statement.
In this scenario, wages payable (WP) provided a $3 million "source" of funds on the indirect statement, which implies that WP (a liability) increased
by $3 million on the balance sheet. The company accrued a wage expense of $70 million for the period but WP increased by $3 million, so only
$67 million in wages were paid for the period.
Things to remember:
The direct method for presenting cash from operating activities groups cash transactions by source, with each line item representing an actual
cash receipt or payment. To derive direct method cash flows from an indirect cash flow statement, income statement items are adjusted for the
changes to working capital shown on the indirect statement.
Demonstrate the conversion of cash flows from the indirect to direct method
LOS
Explanation
Cash from operations (CFO) refers to cash inflows or outflows related to day-to-day activities that create revenues for the company. These
activities include receiving cash from sales, as well as cash payments for items such as inventory, salaries, insurance, and rent. However, under
US GAAP, short-term bank loans that cover overdrafts on checking accounts are classified as cash from financing (CFF) rather than CFO.
Sales revenue comprises both cash and noncash (ie, credit) transactions. Credit sales reduce the amount of cash collected in a period, so the
analyst needs to know the change in accounts receivable for a period to derive CFO (Choice C).
Similarly, interest paid is a component of CFO. Since interest expense can consist of cash and accrual items, adjustments to interest expense are
required to calculate both cash interest paid and CFO (Choice A).
Things to remember:
Cash from operations includes inflows and outflows related to a company's generation of revenues. However, under US GAAP, short-term bank
loans used to cover overdrafts are considered cash from financing rather than cash from operations.
Describe the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income
statement and balance sheet data
LOS
Based on only this information, the cash paid to suppliers (in $ millions) reported on the company's cash flow statement in the direct format would
be closest to:
A. 785
B. 805
C. 815
Explanation
Note: Δ reflects changes to balances, so signs may differ from indirect cash flow statement.
Cash flow from operating activities can be presented in a company's cash flow statement using either the direct or indirect method. The direct
method displays cash inflows (eg, cash received from customers) and cash outflows (eg, cash paid to suppliers). An indirect cash flow
statement can be converted to the direct format by adjusting for the changes in working capital items found on the statement.
To solve this question, the sources and uses of cash on the indirect cash flow statement must be converted to changes of balances on the balance
sheet, which are then used in the equations in the main image. On the indirect cash flow statement:
A net negative cash flow from inventory indicates an increase (ie, a positive change) in inventory as purchases (ie, a use of cash)
exceeded COGS. In this case, the change in inventory of −10 on the indirect cash flow statement indicates an increase in the inventory
balance on the balance sheet. This results in an increase to cash paid to suppliers of 10.
A net negative cash flow from accounts payable indicates a decrease (ie, a negative change) in accounts payable as the company paid
more to suppliers (ie, a use of cash) than it purchased on credit (ie, a source of cash). In this case, a change of accounts payable of −5 is a
decrease in the accounts payable balance. This results in an increase to cash paid to suppliers of 5.
Note: since inventories are an asset while accounts payable are a liability, their signs on the cash flow statement indicate different directions for
the change in cash.
Demonstrate the conversion of cash flows from the indirect to direct method
LOS
5. For the current year, a company recorded a RUB 2 million gain on sale of equipment and RUB 20 million in depreciation expense. The
company also purchased new equipment for RUB 50 million that will not begin depreciating until next year. Additional information is provided:
Given the information above, and assuming that no other assets were sold, the cash received from the sale of equipment (in RUB millions) is
closest to:
A. 12
B. 22
C. 32
Explanation
Investing activities on the cash flow statement involve the purchase and sale of long-term assets (eg, equipment) and securities (other companies'
stocks). When a company sells (disposes of) equipment, the cash received (ie, sales proceeds) is recorded as an inflow for investing activities.
The disposal may result in a gain or loss, which is the difference between the cash received and the equipment's net book value (historical book
value less accumulated depreciation).
In this scenario, the company recorded a gain, meaning that the sales proceeds exceeded net book value. To calculate the sales proceeds, follow
the steps below:
Long-term capital assets are presented on the balance sheet at net book value (gross value less accumulated depreciation). Understanding the
relationship between beginning net PPE and ending net PPE allows one to determine the amount of equipment disposed.
(Choice B) 22 results from applying gross equipment amounts instead of net equipment amounts in the formula.
Things to remember:
When a company sells (disposes of) equipment, the sales proceeds are recorded as a cash inflow under investing activities. The disposal may
result in a gain or loss, which equals the difference between the cash received and the equipment's net book value (historical book value less
accumulated depreciation).
Describe how the cash flow statement is linked to the income statement and the balance sheet
LOS
Based on only this information, the gain on the sale of the equipment (in € millions) is closest to:
A. 10
B. 30
C. 40
Explanation
When companies sell equipment, they report a noncash gain (loss) equal to the difference between the cash received from the sale and
current net book value (BV) of the equipment. When the net BV of the equipment sold is not provided, financial statement items can be used to
estimate the cost.
In this scenario, to calculate the BV of the disposed equipment, use the relationship between the change in the equipment's net BV and factors
that account for that change: capital expenditures (ie, increases to BV) and depreciation expense and disposals of equipment (ie, decreases to
BV). The net BV of the disposed equipment can be derived as follows:
Since the cash received from the sale is 55, the gain from the sale is 40 (55 − 15).
Describe the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income
statement and balance sheet data
LOS
7. Using IFRS, a company reports the following in its year-end financial data:
The company sells its products and purchases its supplies only on credit. In 20X3, it paid, in cash, taxes of €350,000 and interest of €165,000,
reported as an operating cash flow. There are no other cash receipts or expenditures. Using the direct method to determine operating cash flows,
the company's net cash flow provided by operating activities for 20X3 is closest to:
A. €0
B. €200,000
C. €600,000
Explanation
Net cash provided by operating activities is the net amount of cash received from customers and paid to suppliers, lenders (ie, interest),
employees, and governments (ie, taxes). It is part of a company's cash flow statement and uses the direct method of reporting cash flow.
Cash received from customers is derived from credit sales and changes in accounts receivable (AR). All revenue is generated by extending credit
to customers. During 20X3 the company received more cash from customers than it recorded as credit sales, since AR decreased by 200, from
650 to 450. Cash received from customers is 1,000 + 650 - 450 = 1,200.
Cash paid to suppliers is calculated using cost of goods sold (COGS) and the changes in accounts payable (AP) and inventory (INV). AP
increased by 165, from 435 to 600, and INV declined by 300, from 800 to 500. Since AP increased, the company made more credit purchases
than it paid to its suppliers. A decline in INV implies that the company's credit purchases are less than its COGS. Cash paid to suppliers is 550 –
(500 – 800) – (600 – 435) = 85.
Using the given cash payments for taxes (350) and interest (165), respectively, net cash provided by operating activities is €600,000.
Note that under IFRS, cash paid for interest can be reported as a cash flow from either operations or financing.
(Choice A) €0 is the result of mistakenly increasing the cash paid to suppliers since AP increased, not decreased.
(Choice B) €200,000 is the result of incorrectly decreasing, not increasing, cash received from customers due to a decrease in accounts
receivable.
Things to remember:
Net cash provided by operating activities is the net amount of cash received from customers and paid to suppliers, lenders (ie, interest),
employees, and governments (ie, taxes). It is part of a company's cash flow statement and uses the direct method of reporting cash flow.
Describe the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income
statement and balance sheet data
LOS
8. A company reports the following information under US GAAP:
In 20X2, all dividends declared were paid to shareholders. Based on only the data above, if net income for 20X2 is USD 55 million, 20X2 cash
flow from financing activities (in USD millions) is closest to:
A. 60
B. 65
C. 85
Explanation
A company's cash flows from financing activities are related to obtaining or repaying capital. Such activities may include issuing or repurchasing
common stock, paying dividends to shareholders, and borrowing or repaying debt. In this question, the net cash from financing activities
includes the proceeds from issuing common stock (a cash inflow) and the payment of dividends (a cash outflow).
As in most cases, the proceeds from issuing common stock are the total changes in common stock and additional paid-in capital. Dividend
payments can be determined from the change to retained earnings, after accounting for net income.
Cash flow from financing activities is USD 65 million, including total proceeds from issuing common stock of 75 million less dividends paid of 10
million.
(Choice A) 60 million results from subtracting the increase in accumulated other comprehensive income (AOCI). AOCI mainly includes
unrealized gains and losses from securities, which do not represent actual cash flows. Since cash flow from financing activities is prepared under
the direct method, only actual cash flows are included.
Things to remember:
A company's cash flows from financing activities are related to obtaining or repaying capital. Such activities may include issuing or repurchasing
common stock, paying dividends to shareholders, and borrowing or repaying debt. In most cases, the proceeds from issuing common stock are
the total change in common stock and additional paid-in capital. Dividend payments can be determined from the change to retained earnings,
after accounting for net income.
Describe how the cash flow statement is linked to the income statement and the balance sheet
LOS
A. SGD 4 million.
B. SGD 5 million.
C. SGD 6 million.
Explanation
Under accrual basis accounting, for any period, the recorded interest expense may differ from actual interest payments: Interest expense can
be fully recorded in one period while portions of it may be payable in a future period. Interest paid for a period is equal to the interest expense
adjusted for the changes in interest payable, a current liability.
In this question, the company must have reduced its outstanding interest payable balance by 0.5 million for the period since it made interest
payments of 5.5 million while incurring interest expense of only 5.0 million. Reducing the beginning interest payable balance of 4.5 million by 0.5
million results in an ending interest payable balance of 4.0 million.
(Choice B) SGD 5 million results from adding the 0.5 million to the beginning interest payable balance instead of subtracting it.
(Choice C) SGD 6 million results from adding 0.5 million to interest payments of 5.5 million.
Things to remember:
Under accrual basis accounting, for any period, the recorded interest expense may differ from actual interest payments. Interest paid for a period
is equal to the interest expense adjusted for the changes in interest payable, a current liability.
Describe how the cash flow statement is linked to the income statement and the balance sheet
LOS
A. IFRS only.
B. US GAAP only.
Explanation
Differences between US GAAP and IFRS for cash flow statement items
US GAAP IFRS
Taxes paid Operating Typically operating, but specific portions can be classified as financing or investing
US GAAP and IFRS have different rules for how interest received and interest paid are reported on a company's statement of cash flows.
IFRS usually grant companies more flexibility in the classification of certain activities. In this scenario, IFRS allows the company to treat interest
received as a cash flow from investing activities.
(Choices B and C) US GAAP classify interest received as operating cash flow only.
Things to remember:
US GAAP and IFRS have different rules for how interest received and interest paid are reported on a company's statement of cash flows. US
GAAP classify interest received as an operating cash flow, whereas IFRS classify it as an operating or investing cash flow. US GAAP classify
interest paid as an operating cash flow, whereas IFRS classify it as an operating or financing cash flow.
Contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting
principles (US GAAP)
LOS
Explanation
US GAAP IFRS
Investment
CFO CFO or CFI
income
Cash flow statements divide cash inflows and outflows into three categories: cash from operations (CFO), cash from investing (CFI), and cash
from financing (CFF). CFO encompasses cash inflows and outflows related to a company's daily activities. In contrast, CFI refers to inflows and
outflows from noncore activities, such as passive investments in other companies. There are no income tax implications for CFF.
In most cases, IFRS classify all taxes paid as CFO regardless of the underlying source of income. However, when a portion of the taxes can be
specifically identified as paid on investment income, IFRS permit (but do not require) the company to classify that portion of the taxes as CFI.
This company attributes €3 million of its total taxes paid to the rental income, which is not part of its core operations. The rents received constitute
CFI, and the company may classify the taxes associated with those rents as CFI. The balance of the tax payment is classified as CFO.
(Choices A and C) Financing activities that give rise to CFF entries include borrowing or repaying debt, issuing stock, and paying dividends.
None of the taxes paid relate to any type of financing activity, so none can be classified as CFF.
Things to remember:
In most cases, all taxes paid are classified as CFO under IFRS. If the company can identify a portion of taxes as attributable to income that would
be classified as CFI, IFRS permit the company to classify those taxes as CFO or CFI.
Contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting
principles (US GAAP)
LOS
Explanation
Difference between US GAAP and IFRS for cash flow statement items
Taxes paid Operating Typically operating (specific portions can be classified as financing or investing)
US GAAP and IFRS have different guidelines for how dividend receipts and dividend payments are reported on a company's statement of cash
flows:
Dividends received by the company are classified as operating cash flows under US GAAP but as operating or investing cash flows
under IFRS.
Dividends paid by the company are classified as financing activities under US GAAP but as financing or operating cash flows under
IFRS.
IFRS commonly grant companies more reporting flexibility in the classification of certain activities. In this scenario, a company can report
dividends paid under operating activities or financing activities under IFRS.
(Choice A) Neither IFRS nor US GAAP allow companies to report dividends paid under investing activities.
(Choice C) Under US GAAP, companies may report dividends paid only under financing activities.
Things to remember:
US GAAP and IFRS have different rules for how dividend payments may be classified on the cash flow statement. US GAAP consider dividends
paid as financing cash flows, whereas IFRS consider them financing or operating cash flows. IFRS commonly grant companies more reporting
flexibility in the classification of certain activities.
Contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting
principles (US GAAP)
LOS
A. Only IFRS
B. Only US GAAP
Explanation
Differences between US GAAP and IFRS for cash flow statement items
US GAAP IFRS
Taxes paid Operating Typically operating, but specific portions can be classified as financing or investing
US GAAP and IFRS have different rules for how certain financial items are classified on a company's statement of cash flows. In general, US
GAAP has more stringent rules and IFRS allows more flexibility. For example, IFRS allows a choice of classification for interest and dividends
(paid or received) and for taxes paid.
In this scenario, the company has classified its interest paid and interest received as operating activities and its dividends paid to shareholders as
a financing activity. These classifications are allowed under both US GAAP and IFRS (Choices A and B).
Things to remember:
US GAAP and IFRS have different rules for how certain financial items are reported on a company's statement of cash flows. In general, US
GAAP has more stringent rules and IFRS allows more flexibility.
Contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting
principles (US GAAP)
LOS
If the accountant accurately prepares the cash flow statement under the direct format, then it most likely reports:
Explanation
Cash flow from operating activities (CFO) can be presented using either the direct or indirect method. The direct format displays various
categories of cash transactions (eg, cash received from customers, cash paid to suppliers). To create a direct presentation, the accountant
should:
2. Convert the remaining income statement revenue and expense items to cash amounts (from accrual amounts) by adjusting for the change
in working capital.
3. Itemize the components of cash from operating activities with the amounts calculated in step 2.
Cash received from customers (198) equals revenue (200) minus the change in accounts receivable (2). Accounts receivable increased by 2
million, so revenue exceeded cash receipts by that amount. Cash paid for taxes (9) equals tax expense (10) minus the change in taxes payable
(1). Taxes payable increased by 1 million, so tax expense exceeded taxes paid by that amount.
(Choice A) Cash paid to employees should be USD 69 million, not USD 71 million. USD 71 million results from incorrectly adding the increase in
wages payable, instead of subtracting, to wage expense.
(Choice B) Cash paid to suppliers should be USD 83 million, not USD 82 million. USD 82 million results from ignoring the increase in inventory,
which understates the amount of purchases. Purchases equals COGS plus the change in inventory.
Things to remember:
To derive the direct presentation format for cash from operating activities: (1) Remove non-cash items from the income statement, (2) convert the
remaining income statement to a cash basis by adjusting for changes in working capital amounts, and (3) display the itemized individual
components in the operating cash flow section.
Demonstrate the conversion of cash flows from the indirect to direct method
LOS
Revenues 41.8
A. €28.7 million
B. €43.5 million
C. €48.8 million
Explanation
The amount of cash payments to suppliers is a function of the company's cost of goods sold (COGS), the change in its inventories, and the
change in its accounts payable.
Inventory is a current asset, so purchasing inventory increases assets. If the company buys the inventory on credit instead of paying cash, an
account payable equal to the purchase price is created. The increase in liabilities exactly offsets the increase in assets, so the company has
obtained inventory with no cash outlay.
In this question, the unknown variable is the ending accounts payable, which is solved by rearranging the above equation:
(Choice A) This incorrect answer is obtained by subtracting, rather than adding, the change in inventory to COGS.
(Choice C) This incorrect answer is found by using revenue instead of COGS as the first element of the equation. This is an easy mistake to
make since the formula for calculating cash received (rather than paid) in CFO uses revenue.
Things to remember:
Cash paid to suppliers is a function of cost of goods sold, changes in inventory, and changes in accounts payable for the accounting period. The
basic formula to calculate cash payments can be rearranged to derive any variable in the equation.
Describe the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income
statement and balance sheet data
LOS
If all company purchases are made on credit, the cash paid to suppliers in 20X3 is closest to:
A. $540,000
B. $660,000
C. $1,260,000
Explanation
Cash paid to suppliers is one element of operating cash flow using the direct method. Companies track credit purchases and cash payments
to vendors in accounts payable (AP). AP increases when credit purchases are recorded and decreases when the company pays its bills.
Payments to suppliers during a period can be calculated if the change in AP, the change in inventory (INV), and COGS are known.
Here, the increase in inventory (325 − 250 = 75) means purchases were greater than COGS. An increase (150 − 135 = 15) in AP indicates that
the company purchased more inventory on credit than it paid cash to suppliers during the same period. Cash paid to suppliers is $660,000.
(Choice A) $540,000 results from decreasing, not increasing, cash paid to suppliers for the change in inventory and adding, not subtracting, it for
the increase in AP.
(Choice C) $1,260,000 is found by using revenue, not COGS, in the cash paid to suppliers formula.
Things to remember:
Cash paid to suppliers is one element of operating cash flow using the direct method. It is calculated from the change in accounts payable, the
change in inventory, and cost of goods sold.
Describe the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income
statement and balance sheet data
LOS
A. 15
B. 20
C. 25
Explanation
Under accrual basis accounting, a company records all the dividends declared on its balance sheet for the current period, regardless of when all
the dividends will be paid. If a portion of the dividends is to be paid during a future period, that amount is recorded as dividends payable,
which is a current liability.
In this question, HKD 20 million in dividends declared is derived from retained earnings and net income. Dividends payable increased by HKD 5
million, indicating the company deferred HKD 5 million in dividend payments to a future period. Therefore, only HKD 15 million in dividends was
paid out during the current period.
(Choice C) 25 results from incorrectly adding, instead of subtracting, the increase in dividends payable.
Things to remember:
Under accrual basis accounting, a company records all the dividends declared on its balance sheet for the current period, regardless of when all
the dividends will be paid. If a portion of the dividends is to be paid during a future period, that amount is recorded as dividends payable, which is
a current liability.
Describe how the cash flow statement is linked to the income statement and the balance sheet
LOS
Explanation
Under accrual accounting, a company incurs wage expense each period regardless of when wages are actually paid. If actual payment will occur
in a later period, the obligation is entered as wages payable—a current liability—on the balance sheet. Wages paid are a component of cash flow
from operations (CFO). Calculating CFO using the direct method requires analysis of both the expense and the current liability.
Cash paid to employees in any period is a function of wage expense and the change in wages payable for that period. Increasing wages payable
means that the company is deferring cash payments until a later period, so the amount of cash paid in the current period decreases.
Subtracting this increase from the reported wage expense results in cash paid for wages that is less than the wage expense.
This equation has four variables. When three of the four variables are known, the equation can be rearranged algebraically to solve for the
unknown:
(Choice B) ZAR 25.6 million uses only the wage expense without considering the change in wages payable.
(Choice C) ZAR 27.1 million is the result of the change in wages payable being subtracted from—instead of added to—cash wages in the
rearranged formula.
Things to remember:
Cash wages paid equals the wage expense shown on the income statement minus the change in wages payable for the period.
Describe how the cash flow statement is linked to the income statement and the balance sheet
LOS