Question

1. List the three sections of the Statement of Cash Flows and briefly explain what activities are included in each section.

2. What can creditors, investors, and other users learn from the analysis of the cash flow statements?

3. Explain why depreciation expense, depletion expense, and amortization expense are added to net income in the operating activities section of the statement of cash flows when using the indirect method.

4. Leather Shop earned net income of $57,000 after deducting depreciation of $5,000 and all other expenses, Current assets decreased by $4,000, and current liabilities increased by $8,000. How much was Leather Shop's cash provided by operating activities (indirect method)?

5. How does the direct method differ from the indirect method?

Answer 1

1. List the three sections of the Statement of Cash Flows and briefly explain what activities are included in each section.

Answer:-

The three sections of Statment of Cash Flows are as follows:

a) Cash flows from Operating activities:- This section contains all cash in flows from main business operations of the organization i.e cash sales and cash out flows for expenditure regarding Cost of goods sold, like purchase of raw material, labour, wages and all indirect expenses.

b) Cash flows from Investing activities:- This section contains all cash inflows form sale of capital asset and all cash out flows for purchase of capital assets. for example, purchase or sale of fixed assets, shares, bonds.

c) Cash flows from Financing activities:- This section contains all cash inflows from issue of shares and debentures, loans received from fianacing comapanies, bonds issued and cash out flows from redemption of share or debenture or repayment of loan from financing companies.

2. What can creditors, investors, and other users learn from the analysis of the cash flow statements?

Answer:-

Creditors of the company may get an idea about the in flow of cash into the organization and whether it is able to pay off liabilities. And on analysing the operating activities creidtors know inflow of cash from business activities and from analysing financing activities creditors may know whether they have enough money to pay the debt and whether they are properly paying the debt.

At the same time, for the Investor, inflows from operating activities gives an idea about the performance of the business organization, from investing activities he may know the capital expenditure expended by the business organization for expansion of business. And from financing activities investors know about the payment of dividend by the company if the investor is expecting a return from his investment in the form of dividend.

3. Explain why depreciation expense, depletion expense, and amortization expense are added to net income in the operating activities section of the statement of cash flows when using the indirect method.

Answer:-

The expenses like depreciation, depletion and amortization are non cash expenses. For these type of expenses actually the cash does not flow out of the business organization. While computing net profit all these non cash expense were also deducted form gross profit. So, to get correct cash profit in Cash flows from operating activities section, all the non cash expenses which were deducted from gross profit should be added back and all non cash income which were added should be deducted while using indirect method in preparing Cash flow statment.

4. Leather Shop earned net income of $57,000 after deducting depreciation of $5,000 and all other expenses, Current assets decreased by $4,000, and current liabilities increased by $8,000. How much was Leather Shop's cash provided by operating activities (indirect method)?

Answer:-

Indirect method

Cash flows from operating activities:-

Net income = $ 57,000

Add:- Depreciaton = $ 5,000

Add:- Changes in working capital   

Decrease in Cu. Assets = $ 4,000

Increase in Cu.Liabilities   = $ 8,000

Cash flows from operating activities = $ 74,000

5. How does the direct method differ from the indirect method?

Answer:-

Under direct method, Cash inflows from operating activities and cash outflows form operating activities are recorded in the statment and difference between the inflow and out flow of cash flows were shown as net cash in flow or net cash out flow from operating activities and same procedure will be used for cash flows from investing and financing activities.

Under indirectmethod, net profit is taken into consideration and all non cash expenses were added back to the net profit shown in the section of Cash flow from operating activities and change in working capital is also adjusted towards the net profit after adjusting the non cash items, to get net cash flows from operating activities.

This is the major difference between direct and indirect method in preparation of Statment of cash flow.