understanding cash flow statements(Reading 27)

Exercise Problems:

1. A firm sells 20-year bond at a premium. Relative to a bond issued at par, the cumulative effect over the first two years on cash flow from financing activities (CFF) and cash flow from operations (CFO) (assuming that cash paid for interest is reported in CFO) will be:

Ans:C

Interest expense=market rate at issue * bond liability

Since the liability with a discount premium is more than that with a par bond, interest expense in all years will be more than with a par bond. Therefore, assuming that cash paid for interest is reported in CFO, CFO with premium bond will be understated.

On the other hand, CFF with premium bonds will be overstated relative to CFF with par bonds. At issue date, CFF will be higher since more cash is received. Subsequent to issuance, there is no additional CFF effect. Thus, the total CFF in the first two years will be higher due to issuance premium.

2. Compared to a firm that appropriately expenses recurring maintenance costs, a firm that capitalizes these costs will most likely have cash flow from operations (CFO) that are:

A. Lower

B. Higher

C. The same

Ans: B

Capitalizing costs takes them out of expenses, which results in increased CFO and will be subtracted from Cash Flow from Investments. So CFO will be higher.

3. Under IFRS, interest paid and dividends paid can be categorized as either:

A. Operating or financing section of the cash flow statement.

B. Operating or investing section of the cash flow statement.

C. Investing or financing section of the cash flow statement.

Ans: A.

The following table indicates the cash flow classification differences between U.S.GAAP and IFRS:

4. Huskie Company reported the following amounts on its most recent financial statements:

Cash paid to suppliers during 20x4 is closet to:

A. $4,180,000

B. $4,620,000

C. $4,675,000

Ans: C.

Cash paid to suppliers is calculated as:

Cash paid to suppliers

=COGS+?Inventory- ?Accounts payable

=$4,400,000+(740,000-520,000)-(320,000-375,000)

=$4,675,000

5. Selected information from a company’s comparative income statements and balance sheets is presented below.

The cash collected from customers in 2011 is closest to:

A. $88,500.

B. $96,100.

C. $111,500.

Ans: A.

Cash collected from customers

= Revenues – Increase in accounts receivable

= $100,000 – (25,000 – 13,500)

= 88,500

6. Selected data for a company is presented below:

The company’s cash conversion cycle for 20x3 is closest to:

A. 58 days.

B. 100 days.

C. 104 days.

Ans: C.

The cash conversion cycle measures the average time between the outlay of cash to purchase inventory and the cash recovery from collecting accounts receivable. The cash conversion cysle is calculated using the following formulas:

cash conversion cycle=days of inventory on hand (DOH)

+das of sales outstanding (DSO)

                                   -number of days of payables

DOH=365/()=365/()=81.1

DSO=365/()=365/()=76.1

Number of days of payable=365/ ()

                                            =365/()=53.1

*purchases=ending inventory – beginning inventory + COGS

                      =$275-201+1,071 =1,145

NOTE: it is preferable to use Purchases rather tan COGS to calculate days of payables, if it is available or can be calculated.

cash conversion cycle= 81.1 +76.1 – 53.1 =104

A is incorrect. This choice was probably derived by incorrectly subtracting DSO and adding the number of days of payables in calculating the cash conversion cycle.

B is incorrect. This choice is derived by incorrectly calculating the number of days of payables using the COGS rather than inventory purchase. Purchasing should be used when it can be derived from the available data.

7. Under U.S. GAAP, interest paid is most likely included in which of the following cash flow activities?

A. Operating only

B. Financing only

C. Either operating or financing

Ans: A.

The following table indicates the cash flow classification differences between U.S.GAAP and IFRS:

*under IFRS, bank overdrafts are considered part of cash equivalents and are not reported on the cash flow statement.

8.The following items are from a company’s cash flow statement.

Which of the following standards and formats did the company most likely use in the preparation of its financial statements?

A. IFRS, direct format

B. IFRS, indirect format

C. Either IFRS or U.S. GAAP, direct format

Ans: A.

The direct method of cash flow statement presentation shows the specific cash inflows and outflows that result in reported cash flow from operating activities (cash from customers, cash to suppliers, etc.). Companies using IFRS can decide to report interest and dividend receipts as either an investing or operating activity, whereas under U.S. GAAP, they must report such income as an operating activity. The listed operating and investment activities indicate that the company reports under IFRS, using the direct method.

9. Which of the following is least likely a benefit of the direct method for reporting cash flow from operating activities? Compared with the indirect method, the direct method provides:

A. supplementary data under U.S. GAAP.

B. details on the specific sources of operating receipts and payments.

C. insight on differences between net income and operating cash flows.

Ans: C.

Under the direct method, cash flow from operations accumulates cash received from customers, cash paid to suppliers, cash paid to employees, cash paid for interest, etc. This method provides specific detail on a firm’s operating cash receipts and cash payments for a given reporting period, while eliminating the effects of accrual accounting. It provides supplementary data under U.S. GAAP.

Providing insight on the differences between net income and cash flow is a benefit of the indirect method. The indirect method starts with net income and integrates a series of adjustments to calculate cash flow from operations.

10. A firm reported the following financial statement items:

The free cash flow to the firm is closest to:

A. €2,110.

B. €2,470.

C. €2,590.

Ans: B.

11. Which of the following statements is most accurate regarding cash flow statements prepared under IFRS and U.S. GAAP?

A. Under U.S. GAAP, bank overdrafts should be classified as a financing cash flow.

B. Under IFRS, interest paid can be reported either as an operating or an investing cash flow.

C. Both the direct and indirect formats of cash flow statements are allowed under IFRS and U.S. GAAP, but indirect is encouraged under IFRS only.

Ans: A.

Under U.S. GAAP, bank overdrafts are not considered part of cash and cash equivalents and are classified as financing cash flows.

The following table indicates the cash flow classification differences between U.S.GAAP and IFRS:

*under IFRS, bank overdrafts are considered part of cash equivalents and are not reported on the cash flow statement.

12. The following is selected data from a company’s operations:

The cash flow from operations is closest to:

A. $89,000.

B. $105,000.

C. $111,000.

Ans. B.

13. A company reports its interest payments on long-term debt as a financing activity under IFRS. If the company reports under U.S. GAAP, the most likely effect would be:

A. an increase in cash flow from operations.

B. a decrease in cash flow from investing activities.

C. an increase in cash flow from financing activities.

Ans: C.

Interest payments can be reported either as operating or financing cash flow under IFRS, but can only be reported as operating cash flow under U.S. GAAP. The interest payment was originally reported as financing activity under IFRS, but under U.S. GAAP, it would be an operating activity. Therefore, cash flow from financing activities would increase, and operating cash flows decrease by the same amount.

The following table indicates the cash flow classification differences between U.S.GAAP and IFRS:

*under IFRS, bank overdrafts are considered part of cash equivalents and are not reported on the cash flow statement.

14. The following information (in millions) on a company is available:

The amount of cash (in millions) that the company paid to its suppliers is closest to:

A. $445.

B. $495.

C. $505.

Ans: B.

15. Which of the following statements is most accurate regarding cash flow ratios?

A. Interest coverage ratio is calculated as operating cash flow over interest payments.

B. Debt payment ratio measures the firm’s ability to pay debts with operating cash flows.

C. Reinvestment ratio measures the firm’s ability to acquire assets with investing cash flows.

Ans: B.

Debt payment ratio measures the firm’s ability to satisfy long-term debt with operating cash flow.

Debt payment=

A is incorrect. The interest coverage ratio measures the firm’s ability to meet its interest obligations.

Interest coverage ratio=

Note: if interest paid was classified as a financing activity under IFRS, no interest adjustment is necessary.

C is incorrect. The reinvestment ratio measures the firm’s ability to acquire long-term assets with operating cash flow.

Reinvestment ratio=

16. A firm reports sales of €50,000,000 for the year ended December 31, 2009. Its accounts receivable balances were €6,000,000 at January 1, 2009 and €7,500,000 at December 31, 2009. The company’s cash collections from sales (€) for 2009 is closest to:

A. 42,500,000.

B. 48,500,000.

C. 51,500,000.

Ans: B.

The cash collections from sales is equal to sales less the change in receivables: €50,000,000 - (€7,500,000-€6,000,000) = €48,500,000.

17. A company issued shares to acquire a large tract of undeveloped land for future development. The most likely recording of this transaction in the cash flow statement is as a(n):

A. disclosure in a note or supplementary schedule.

B. outflow from investing activities, and an inflow from financing activities.

C. outflow from operating activities, and an inflow from financing activities.

Ans. A.

Non-cash transactions are not reported in the cash flow statement but if they are significant they are reported in a note or supplementary schedule.

18. The following information is available about a company ($ millions):

During 2011 the company most likely decreased the:

A. proportion of sales made on a cash basis.

B. inventory, anticipating lower demand for its products in 2012.

C. proportion of interest-bearing debt relative to trade accounts payable.

Ans: A.

Sales, net income, and net margin are relatively constant for the two years. The substantial drop in cash flow from operations could be attributed to an increase in receivables and/or inventory. A decrease in the proportion of cash sales implies an increase in the proportion of credit sales, increasing accounts receivable. An increase in accounts receivable would decrease cash flow from operations.

19. A company accrued wages of $2,000 and collected accounts receivable of $10,000. Which of the following best describes the effect of these two transactions on the company?

A. Net income will increase

B. Current ratio will decrease

C. Cash from operations will decrease

Ans: B.

Accruing wages increases current liabilities, but collecting receivables has no effect on current assets therefore the current ratio decrease.

A is incorrect. Accruing wages increases expenses, but collecting receivables has no effect on sales therefore the net income decrease.

C is incorrect. Collecting accounts receivable increases cash flow from operations and accruing wages increases current liabilities, which also increases cash flow from operations so cash from operations will increase not decrease.

20. A company is buying back its stocks to offset the dilution of earnings from its stock option program. Which of the following statements best describes the effect on the financial statements of the amount spent to buy back the stocks? The amount spent reduces:

A. net income.

B. cash from operating activities.

C. cash from financing activities.

Ans: C.

Financing activities include cash flows that result from: borrowing or repaying debt principal, issuing or repurchasing equity capital, and paying cash dividends.

The amount spent to buy back stocks to offset dilution is classified as a financing activity on the cash flow statement and therefore cash from financing decreases.

A is incorrect. Net income is calculated by taking revenues and adjusting for the cost of doing business, depreciation, interest, taxes and other expenses. Buying back stock will not affect the net income.

B is incorrect. Operating activities include cash flows from the sale of a company’s goods/services, the cash impact of changes in operating assets and liabilities, and adjustments for noncash items reported on the income statement (using the indirect method).

21. If a company has a current ratio of 2.0, the effect of repaying $150,000 in short-term borrowing will most likely decrease:

A. the current ratio, but not the cash flow from operations.

B. the cash flow from operations, but not the current ratio.

C. neither the current ratio nor the cash flow from operations.

Ans: C.

Financing activities include cash flows that result from: borrowing or repaying debt principal, issuing or repurchasing equity capital, and paying cash dividends. Operating activities include cash flows from the sale of a company’s goods/services, the cash impact of changes in operating assets and liabilities, and adjustments for noncash items reported on the income statement (using the indirect method).

The repayment of short-term debt would reduce cash flow from financing, not cash flow from operations.

Current ratio=

 Any time the current ratio is above 1, equal changes in a current asset and a current liability will result in an increase in the current ratio: if current assets = 550 and current liabilities are 275, current ratio = 550/275 = 2.0. After the bank borrowing has been paid, the ratio becomes (550-150)/(275-150) = 3.2. Had the ratio initially been below 1, current assets = 250 and current liabilities are 275, current ratio = 250/275 = 0.91, the equal change in current assets and liabilities would decrease the current ratio: 100/125=0.80.

22. At the end of the year, a company sold equipment for $30,000 cash. The company paid $110,000 for the equipment several years ago and had recorded accumulated depreciation of $70,000 at the time of its sale. All else equal, the equipment sale will result in the company’s cash flow from:

A. investing activities increasing by $30,000.

B.  B. investing activities decreasing by $10,000.

C.  C. operating activities being $10,000 less than net income.

Ans: A.

The book value of the equipment at the time of sale is $110,000 - $70,000 = $40,000.

The proceeds are $30,000; therefore a loss of $10,000 is reported on the income statement. The loss reduces net income, but it is a non-cash amount, so is added back to net income in the calculation of the cash from operations. Therefore, cash from operations is higher than net income, not lower. The total amount of the proceeds, $30,000, is the cash inflow from the transaction and is shown as a cash inflow from investing activities.

23.An analyst gathers the following annual information ($ millions) about a company that pays no dividends and has no debt:

The company’s annual free cash flow to equity ($ millions) is closest to:

A. 53.1.

B. 58.4.

C. 61.6.

Ans: C.

Free cash flow to equity in a company without any debt is equal to cash flow from operations (CFO) less capital expenditures.

 CFO = net income

+ depreciation

+ loss on sale of equipment

+ decrease in accounts receivable

– increase in inventories

+ increase in accounts payable.

 (The loss on sale of equipment is added back when calculating CFO. It would have been deducted in the calculation of net income but the loss is not the cash impact of the transaction (the proceeds received, if any, would be the cash effect) and cash flows related to equipment transactions are investing activities, not operating activities.

 CFO = 45.8 + 18.2 +1.6 + 4.2 – 3.4 +2.5 = $68.9 million

$68.9 – $7.3 = $61.6 million free cash flow to equity.

24. An analyst gathers the following information about three equipment sales that a

company made at the end of the year:

All else equal for that year, the company’s cash flow from operations will most likely be:

A. the same as net income.

B. $40,000 less than net income

C. $140,000 less than net income.

Ans: B.

The net gain is $40,000. The amount that would

be deducted from net income to determine cash flow from operations is equal to the net gain of $40,000.

25. An analyst has gathered the following information about a company:

The cash flow debt coverage ratio for the year is closest to:

A.    20.6%.

B.     23.7%.

C.     27.4%.

Ans: A.

cash flow debt coverage ratio

=CFO/Total debt

=105.9/512.8=20.6%

26. If a company has a current ratio of 2.0, that company’s repayment of $510,000 in short-term borrowing obtained from a bank would most likely decrease:

A. current ratio, but not cash flow from operations.

B. cash flow from operations, but not current ratio.

C. neither current ratio nor cash flow from operations

Ans: D.

The current ratio is above 1.0, so the payment of short-term borrowing would increase the current ratio; it would reduce both the numerator ad denominator by the same amount. The repayment of short-term debt would reduce cash flow from financing, not cash flow from operations.

27. At the end of the year, a company sold equipment for $30,000 cash. The company paid $110,000 for the equipment several years ago and had accumulated depreciation of $70,000 doe the equipment at the time of sale. All else equal, the equipment sale will result in the company’s cash flow:

A. investing activities decreasing by $10,000.

B. investing activities increasing by $30,000.

C. operating activities being $10,000 less than net income.

Ans: B.

Investing activities include cash flows that result from the purchase or sale of any long-term assets, including fixed assets, long-term investments, and business acquisitions.

The total amount of the proceeds ($30,000) would be shown as a cash inflow from investing activities.

A is incorrect. The cash proceeds received from the sale of long-term assets should be recorded as CFI.

A is incorrect. The book value of the equipment would been $110,000-$70,000=$40,000 at the time of the sale, so a loss of $10,000 (=$30,000-40,000) for financial statement purposes would be realized. The net loss would reduce net income and would be adjusted in the statement of cash flow by adding the net loss to net income. So CFO would be $10,000 more that net income.

27. In 2012, a company reported net income of $130 million and cash flow from operations of $120 million. All else equal, the most likely explanation for the difference between net income and CFO in 2012 is that the company:

A. tightened credit policies and increased collection efforts during the year.

B. purchased new PP&E at the beginning of the year.

C. increased raw material inventory in anticipation of increased sales at the end of the year.

Ans: C.

The increase in inventory (working capital investment) would reduce CFO relative to net income.

Reference: question 23.

A is incorrect. This would increase CFO relative to net income.

B is incorrect. This would decrease CFI.

28. an analyst gathered the following annual information ($millions) about a company that pays no dividends and has no debt:

The company’s annual free cash flow to equity ($million) is closet to:

A.    53.1.

B.     58.4.

C.     61.6.

Ans: C.

FIFE=CFO-Capital expenditures+/-net borrowing

CFO

=Net income + depreciation + loss on sale of equipment +decrease in AR- increase in inventories + increase in AP

=45.8+18.2+1.6+4.2-3.4+2.5

=$68.9million

FCFE=68.9-7.3=$61.6.

29. Financial data for Woodview Corporation, a company that uses U.S.GAAP, are as follows:

*Cost basis of equipment sold was $5,000.

Using the information above, cash from operations and cash from financing activities reported on the company’s statement of cash flows for 2012 would be closest to?

A.    $66,500 for CFO and $5,000 for CFF.

B.     $65,000 for CFO and -$15,000 for CFF.

C.     $66,500 for CFO and -$15,000 for CFF.

Ans: A.

Cash from operating activities:

*Loss on sale of equipment

Cash from financing activities:

30. Selected financial data for Janko, Inc, for 2012 follow. Assume the company pays no taxes.

Under U.S.GAAP, what is Janko’s cash outflow from investing activities for 2012?

A.    $3,030,000.

B.     $3,014,000.

C.     $2,970,000.

Ans: A.

The cash outflow from investing activities is:

Note. Under U.S.GAAP, interest received and paid and dividends received are reported in operating activities.

31. A company has the following changes and cash flows for 2012.

Under U.S.GAAP, what was its cash flow from financing activities in 2012?

A.    $220,000.

B.     $300,000.

C.     $320,000.

Ans: C.

Cash from financing activities:

32. Which of the items below are included in the calculation of both free cash flow to the firm (FCFF) and free cash flow to equity (FCFE) if you start with CFO?

A. Interest paid.

B. Net borrowing.

 C. Capital expenditures.

Ans: C.

FCFF and FCFE are both calculated net of capital expenditures (FCInv) as indicated in the following formulas:

FCFF = CFO + INT (1-t) – FCInv

FCFE = CFO – FCInv ±Net borrowing

A is incorrect. Interest payments are reflected in the calculation of FCFE as they are already reflected in CFO (under U.S.GAAP). However, the after-tax cost of interest is added back to CFO when calculating FCFF. Note: capital expenditures are subtracted in calculating FCFF and FCFE, however, dividends paid are not subtracted when calculating either FCFF or FCFE.

B is incorrect. Net borrowing is an addition in arriving at FCFE, but is not included in the FCFF calculation.

33. Included below are several financial line item excerpts from the 2012 financial statements of a company reporting under IFRS:

The company’s cash flow from operations for 2012 was closest to ($000):

A.    $1,220.

B.     $1,261.

C.     $1,313.

Ans: B.

The answer is derived based on the following indirect method formula calculation:

34. How would cash flows from operating activities (CFO), investing activities (CFI), and financing activities (CFF) under U.S.GAAP and IFRS be affected by interest received on investment?

A. Under U.S.GAAP CFO increases and Under IFRS CFO increases.

B. Under U.S.GAAP CFO increases and Under IFRS CFO or CFI increases.

C. Under U.S.GAAP CFO or CFI increases and Under IFRS CFO increases.

And: B.

Under U.S.GAAP, interest received is included in CFO. Under IAS GAAP, it can be classified as either CFO or CFI.

Reference: question 3.

35. The following information is from a company’s 2012 financial statements ($ millions):

The company declared and paid cash dividends of $5 million in 2012 and recorded depreciation expense in the amount of $25 million for 2012. Under U.S.GAAP, the company’s 2012 cash flow from operations ($ million) was closest to:

A.    25.

B.     30.

C.     35.

Ans: C.

The change in retained earnings is $20 and dividends are paid from retained earnings. 2012 net income would equal the change in retained earnings plus dividends paid during 2012. Depreciation expense would be added to net income and the changes in balance sheet account would also be considered to determine cash flow from operations.

36. On a cash flow statement prepared using the indirect method, which of the following would most likely increases the cash from investing activities?

A. Sale of a long-term receivable.

B. Sale of held-for-trading securities.

C. Securitization of accounts receivable.

Ans: A.

The sale of a long-term receivable would increase cash from investing activities; the other two activities mentioned are operating activities.

37. If a company chooses to capitalize an expenditure related to capital assets instead of expensing it, ignoring taxes, the company will most likely report:

A. a lower cash flow per share in that period.

B. a higher earnings per share in future periods.

C. the same free cash flow to the firm in that period.

Ans: C.

Example: Capitalizing delivery cost as opposed to expensing it.

FCFF=CFO + interest × (1– t) – capital expenditures

If capitalized, the amount capitalized increases capital expenditures and is recorded as a cash outflow from investing activities.

The CFO will be higher by amount capitalized, i.e., the amount not expensed.

Since capital expenditures and CFO increase by the same amount, FCFF is unchanged.

A is incorrect. Since CFO would be higher, cash flow per share in that period would be higher.

B is incorrect. Capitalizing an expenditure related to capital assets will lead to an increase in the depreciation expense in future period. So the EPS in future period will be lower since net income will be lower.

38. A company recorded the following events in 2012:

On the 2012 statement of cash flows, the company’s cash flow from investing activities (in ‘000) is closest to:

A.    -$275.

B.     -$215.

C.     $285.

Ans: A.

Only the cash flows for the purchase of the shares in an affiliated company are cash from investing activities; therefore the net amount is -$275,000. Cash flows from trading securities are operating activities.

39. Selected information for a company is provided below.

The company’s cash conversion cycle (in days) is closest to:

A.    84.

B.     120.

C.     138.

Ans: B.

Cash conversion cycle

= Days sales outstanding + Days of inventory on hand – Days of payables

Cash conversion cycle = DSO + DOH – Days in Payables = 48 + 90 – 18 = 120 days

40. A cash flow statement where the cash from operations was prepared under the direct method will most likely contain which of the following account titles?

A. Cash received from customers.

B. Increase in accounts receivable.

C. Cash received from accounts receivable collections.

Ans: A.

The following figure contains an example of a presentation of operating cash flow for Bao Company using the direct method.

The following figure contains an example of a presentation of operating cash flow for Bao Company using the indirect method.

41. A company’s financial statement data for the most recent year include the following:

Based only on these items, cash flow from financing activities is closest to:

A. $70.

B. $85.

C. $140.

Ans: A.

42. An analyst gather the following information about a company:

The company has a tax rate of 35% and prepares its financial statements under U.S.GAAP.

The company’s free cash flow to the firm (FCFF) is closest to:

A. $840.

B. $870.

C. $940.

Ans: A.

FCFF

= CFO + interest expense net of tax – net capital expenditures

= $800+80x(1-0.35)-40+30

=$842

Depreciation and amortization do not have to be added when calculating FCFF from CFO. They are added when calculating FIFF from net income.

FCFF= net income+ noncash charges + interest expense x (1-tax rate)- fixed capital investment – working capital investment

43. For which of the following balance sheet items is a change in market value most likely to affect net income?

A. Debt securities issued by the firm.

B. Debt securities that the firm intends to hold until maturity.

C. Securities held with the intent to profit over the short term.

Ans: C.

Securities held with the intent to profit over the short term are classified as trading securities, and the changes in their market values are reflected in their balance sheet values and also reported on the income statement.

A and B are incorrect. Debt securities issued by the firm, and debt securities that the firm intends to hold until maturity, are both reported at amortized cost, not market value. Debt and equity securities that the firm does not except to hold to maturity or to sell in the near term are marked to market on the balance sheet, but unrealized gains and losses do not affect the income statement.

44. An analyst gathers the following information:

Based on the above information, the company’s cash flow from operations under U.S.GAAP is:

A. $155.

B. $165.

C. $182.

Ans: A.

Dividends paid are CFF, not CFO.

45. Which of the following statements about cash flow is least accurate?

Under U.S.GAAP, cash flow from:

A. Operations includes cash operating expenses and changes in working capital accounts.

B. Financing includes the proceeds of debt issued and from the sale of the company’s common stock.

C. Investing includes interest income from investment in debt securities.

Ans: C.

Interest income is considered an operating cash flow under U.S.GAAP.

46. An analyst gathered the following data about a company:

If inventory increases over the period by $800, cash flow from operations equals:

A. $1,600.

B. $2,400.

C. $3,000.

Ans: C.

Use the direct method.

Cash expenses are given. If you had been given COGS, you would need to adjust that for inventory changes to get cash expenses for inputs. Depreciation is a non-cash change.

Changes in depreciation are used with the indirect method. Net change in cash will reflect CFI and CFF, not just CFO.

47. Which of the following statements about the indirect method of calculating cash flow from operations is least accurate?

A. Depreciation is added back to net income because it is an expense not requiring cash.

B. No adjustment is needed to account for changes in accounts receivable because no cash is involved.

C. No adjustment is needed for the payment of taxes because the tax payment is already in net income.

Ans: B.

Using the indirect method requires adjusting for change in working capital accounts such as accounts receivable, inventory, and account payable.

48. Under U.S.GAAP, which of the following statements about classifying cash flows is least accurate?

A. Cash received from issuing long-term debt or stock is considered a financing cash flow.

B. All income taxes paid are considered operating cash flows, even if some arise from financing and investing activities.

C. Dividend payments made are financing cash flows, while interest payments received are investing cash flows.

Ans: C.

Interest and dividends received and interest paid are considered operating cash flows under U.S.GAAP, but dividends paid are considered financing cash flows.

Reference: Question 3.

49. Bao Technologies reported the following information for the year ending December 31:

If the cash balance increased $13,000 over the year, cash flow from operations (CFO) is closest to:

A.    $21,250.

B.     $21,750.

C.     $22,250.

Ans: A.

The easiest way to calculate CFO here is

total cash flow-CFI-CFF

=$13,000+5,000+4,250

=$22,250.

Alternatively,

CFO =$50,000-3,250-17,000-7,000-500

         =$22,250.

50. How will a firm’s operating cash flow be affected by a decrease in accounts receivable and by an increase in accounts payable?

A. Both will increase operating cash flow.

B. Both will decrease operating cash flow.

C. One will increase operating cash flow and one will decrease operating cash flow.

Ans: A.

A decrease in the accounts receivable amount on the balance sheet indicates that cash collections exceed revenues (sales). This increases operating cash flow because receivables are being collected. An increase in the accounts payable amount on the balance sheet indicates that purchases form suppliers exceed cash payments. This increases operating cash flow because the cash was not used to pay the suppliers.

51. An analyst gather the following data about a company:

The company’s CFO, based on these data only, is:

A.    $1,200.

B.     $1,500.

C.     $1,575.

D.   

Ans: B.

52. Bao Inc. is involved in an exchange of debt for equity. In which of the following sections of the cash flow statement would Bao record this transaction?

A. Investing activities section.

B. Financing activities section.

C. Footnotes to the cash flow statement.

Ans: C.

This transaction results in a reduction of debt and an increase in equity. However, since no cash is involved, it is reported as a financing activity in the cash flow statement, but will be disclosed in the notes to the cash flow statement.

53. Which of the following statements about the analysis of cash flows is least accurate?

A. Interest payments on debt are not a financing cash flow under U.S.GAAP.

B. Both the direct and indirect methods involve adding back noncash items such as depreciation and amortization.

C. When using the indirect method, an analyst should add any losses on the sales of fixed assets to net income.

Ans: B.

When using the direct method of calculating operating cash flows, depreciation and amortization are not “added back” (to net income) because we don’t begin with net income under the direct method. Depreciation and amortization are noncash charges and are not used under the direct method. The other statements are true. Interest payments on debt affect cash flow from operations. When using the indirect method, an analyst should add any losses on sales of fixed assets to net income since they are not operating cash flow.

54.  Bao Inc. had $4 million in bonds outstanding that were convertible into common stock at a conversion rate of 100 shares per $1,000 bond. In 2012, all of the outstanding bonds were converted into common stock. Bao’s average share price for 2012 was $15. Bao’s statement of cash flows for the year ended December 31, 2012, should most likely include:

A. a footnote describing the conversion of the bonds into common stock.

B. cash flows from financing of +$4 million from issuance of common stock and -$4 million from retirement of bonds.

C. cash flows from financing of +$6 million from issuance of common stock and -$4 million from retirement of bonds and cash flows from investing of -$2 million for a loss on retirement of bonds.

Ans: A.

Conversion of bonds into common stock is a non-cash transaction, but the conversion should be disclosed in a footnote to the statement of cash flows.

55. In the statement of cash flows, a company is allowed to classify interest paid:

A. in either the operating or financing section under IFRS.

B. in either the operating or financing section under U.S. GAAP.

C. only in the financing section under both IFRS and U.S. GAAP.

Ans: A.

US GAAP requires that interest paid be classified as an operating cash flow; IFRS allows interest paid to be classified as either an operating or financing activity.

Reference: question 3.