Question

Alternative Treatments of Items of the Statement of Cash Flows

The statement of cash flows is intended to provide information about the investing,

financing, and operating activities of an enterprise during an accounting period. In

a statement of cash flows, cash inflows and outflows for interest expense, interest

revenue, and dividend revenue and payments to the government are considered

operating activities.

Required:

a. Do you believe that cash inflows and outflows associated with nonoperating

items, such as interest expense, interest revenue, and dividend revenue, should

be separated from operating cash flows? Explain.

b. Do you believe that the cash flows from investing activities should include

not only the return of investment but also the return on investment—that

is, the interest and dividend revenue? Explain.

c. Do you believe that the cash flows from the sale of an investment should

also include the tax effect of the sale? Explain. Do you believe that cash

flows from sales of investments should be net of their tax effects, or do you

believe that the tax effect should remain an operating activity because it is a

part of “payments to the government”? Explain.

Answer 1

Answer to part a:

Yes, I do believe that cash inflows and outflows associated with nonoperating items, such as interest expense, interest revenue, and dividend revenue, should be separated from operating cash flows, because operating cash flows are those that arise from the operating activities of any business. Items such as interest income, if treated as operating items, would imply that the core business activity of the business is that of money lending, which ofcourse is not true. Similarly, dividend income comes from making investments and when investing is not the main business activity, they must not be classified under operating activities. Thus, dividend and interest income and expenses must not be categorised under operating activities.

Answer to part b:

Yes, I believe that the cash flows from investing activities should include not only the return of investment but also the return on investment—that is, the interest and dividend revenue. This is because interest and revenue income is earned from making investments and classifying them under any other head would imply something different.

Answer to part c:

The cash flows from the sale of an investment should also include the tax effect of the sale. This is because, tax expenses on income is ultimately an expense that goes to the government and is a cash outflow for any entity. Thus, it is not because of its nature of payment being a payment to government that it should remain an operating activity.