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Chapter 3—Income Flows versus Cash Flows: Understanding the Statement of Cash
Flows
MULTIPLE CHOICE
1. One rationale for the statement of cash flows is to
a.
ensure that the cash account balances at year-end.
b.
reconcile differences between net income and cash receipts and disbursements.
c.
calculate the company’s free cash flow.
d.
examine the cash effects of income from discontinued operations, extraordinary items and
changes in accounting principles.
2. Which of the following is not one of the reasons why net income differs from cash flows from
operations under the indirect method of calculating cash flows?
a.
non-cash items, such as depreciation and amortization
b.
changes in working capital accounts
c.
gains and losses related to the sale of plant, property and equipment
d.
sale or repurchase of capital stock
3. A company in the growth phase of its product life cycle will normally have the following pattern of
cash flows
a.
Negative cash flows from operations, negative cash flows from investing and positive cash
flows from financing.
b.
Negative or positive cash flows from operations, negative cash flows from investing and
positive cash flows from financing.
c.
Positive cash flows from operations, positive cash flows from investing and positive cash
flows from financing.
d.
Negative or positive cash flows from operations, negative cash flows from investing and
negative cash flows from financing.
4. Which of the following is an adjustment that would need to be made to net income when calculating
cash flows from operations under the indirect method?
a.
Subtract amortization expense
b.
subtract gain on sale of subsidiary
c.
add an increase in accounts receivable
d.
add a decrease in accounts payable
5. If a firm is growing and expanding its accounts receivable and inventories faster than its current
operating liabilities its cash flow from operation will normally be
a.
greater than net income
b.
less than net income
c.
greater than the change in working capital from operations
d.
greater than the change in cash
6. Firms with short operating cycles will experience less of a lag between the creation and delivery of
their products and the collection of cash from customers because
a.
their cash flow from operations will be much greater than their working capital from
operations.
b.
their cash flow from operations will not differ much from their working capital from
operations.
c.
their cash flow from operations will be much less than their working capital from
operations.
d.
there will be no relation between their cash flow from operations and working capital from
operations.
7. Normally, cash flows from operations will peak during which phase of the product life cycle?
a.
Introduction
b.
Growth
c.
Maturity
d.
Decline
8. Normally, cash flows from investing activities will start providing cash during which phase of the
product life cycle?
a.
Introduction
b.
Growth
c.
Maturity
d.
Decline
9. Normally, cash flows from financing will start using cash during which phase of the product life
cycle?
a.
Introduction
b.
Growth
c.
Maturity
d.
Decline
10. Free cash flows to all debt and common equity shareholders represents the excess of cash flows from
a.
operating activities over cash flows for financing activities
b.
investing over cash flows for operating activities
c.
investing over cash flows for financing activities
d.
operating activities over cash flows for investing activities
11. When preparing the statement of cash flows using the indirect method, an increase in inventories
would appear as
a.
a decrease in the operating activities section
b.
an increase in the operating activities section
c.
a use of cash in the investing activities section
d.
a source of cash in the investing activities section
12. When preparing the statement of cash flows using the indirect method, an increase in accounts payable
would appear as
a.
a decrease in the operating activities section
b.
an increase in the operating activities section
c.
a use of cash in the investing activities section
d.
a source of cash in the investing activities section
13. When preparing the statement of cash flows using the indirect method, the payment of dividends
would appear as
a.
a decrease in the operating activities section
b.
an increase in the operating activities section
c.
a use of cash in the financing activities section
d.
a source of cash in the financing activities section
14. When preparing the statement of cash flows using the indirect method, the sale of marketable
securities would appear as
a.
a use of cash in the investing activities section
b.
a source of cash in the investing activities section
c.
a use of cash in the financing activities section
d.
a source of cash in the financing activities section
15. In a statement of cash flows, interest received from sources other than a company’s investments
would be classified as cash inflows from
a.
lending activities.
b.
operating activities.
c.
investing activities.
d.
financing activities.
16. An example of an item that is deducted from net income when preparing the operating activities
section of the statement of cash using the indirect method is
a.
depreciation expense.
b.
compensation expense related to stock option plans.
c.
income from an investment accounted for using the equity method.
d.
unrealized losses on trading investments
17. Which of the following is not an expense excluded when calculating EBITDA?
a.
depreciation expense
b.
administrative expense
c.
interest expense
d.
tax expense
18. Which of the following is the correct formula for calculating cash collections from customers?
a.
sales for the period plus accounts receivable at the beginning of the period
b.
sales for the period plus accounts receivable at the beginning of the period minus accounts
receivable at the end of the period
c.
sales for the period plus accounts receivable at the end of the period
d.
sales for the period plus accounts receivable at the end of the period minus accounts
receivable at the beginning of the period
19. Outback Corp. recorded sales of $1,300,000 in 2010, in addition the company’s accounts receivable
balance grew from $120,000 at the beginning of 2010 to $165,000 at the end of 2010. How much cash
did Outback collect from customers in 2010?
a.
$1,300,000
b.
$1,345,000
c.
$1,255,000
d.
$1,135,000
20. Toro Company recognized $655,000 of cost of goods sold in 2010, in addition its implementation of a
just-in-time inventory system allowed it to reduce its inventory from $325,000 at the beginning of the
year to $230,000 at the end of 2010. How much cash did Toro spend for inventory in 2010?
a.
$655,000
b.
$980,000
c.
$560,000
d.
$620,000
21. Fizzzle Inc. sold a piece of equipment during the period for $230,000 and recorded a gain of $45,000
on the sale. How should this gain be treated when preparing the operating activities section of the
statement of cash flows using the indirect method?
a.
A sale of equipment is an investing activity; the transaction will not affect the operating
activities section.
b.
The gain is added back to net income in the operating activities section.
c.
The gain is subtracted from net income in the operating activities section.
d.
The entire sales price is subtracted from net income in the operating activities section.
22. The expense incurred by issuing stock options should be
a.
classified as a financing activity.
b.
added back to net income in the operating activities section.
c.
subtracted from net income in the operating activities section.
d.
does not appear in the statement of cash flows.
3-5
23. Lagos Corp. recorded sales of $345,000 in 2010, in addition its accounts receivable and accounts
payable balances at the beginning and end of 2010 were as follows:
Jan. 1, 2010
Dec. 31, 2010
Accounts Receivable
$65,000
$90,000
Accounts Payable
$32,000
$28,000
How much cash did Lagos collect from customers in 2010?
a.
$345,000
b.
$320,000
c.
$324,000
d.
$316,000
24. Which of the following companies would you expect to report significant amounts of cash provided by
financing activities?
a.
A yet-to-be-profitable biotechnology company.
b.
A mature company operating in the oil refinery industry.
c.
A profitable established company in the retail industry.
d.
A large multinational pharmaceutical company.
25. A firm’s cash flows will differ from net income each period for all of the following reasons except:
a.
cash receipts from customers do not necessarily occur in the same period in which a firm
recognizes revenues.
b.
cash expenditures to employees, suppliers, and governments do not necessarily occur in
the same period in which a firm recognizes expenses.
c.
the company is sustaining losses each period.
d.
cash inflows and outflows that pertain to investing and financing activities do not
immediately flow through the income statement.
26. As products move through the maturity phase, companies invest to ___________ productive capacity.
a.
increase
b.
decrease
c.
maintain
d.
Not enough information to answer this question.
27. Under the indirect method of preparing the statement of cash flows, add backs to net income include
all of the following except:
a.
depreciation expense
b.
deferred tax expense
c.
gains on sale of equipment
d.
share-based compensation
3-6
28. All of the following are firms that may experience a long lag between the expenditures of cash and the
receipt of cash from customers, except:
a.
restaurants
b.
wineries
c.
construction companies
d.
aerospace manufacturers
29. Which of the following is an approximation of a cash-based measure of pretax operating earnings?
a.
Net sales less income taxes
b.
EBITDA
c.
Net income
d.
Gross profit
30. Academic research has found that market rates of return on common stock are the most highly
correlated with
a.
net income.
b.
cash flow from operations.
c.
EBITDA.
d.
cash flow from investing activities.
31. When net income is high relative to operating cash flows, we describe the firm as having recorded
a.
income-decreasing accruals.
b.
income-increasing accruals.
c.
income-neutral accruals.
d.
abnormal accruals.
32. When net income is low relative to operating cash flows, we describe the firm as having
recorded
a.
income-decreasing accruals.
b.
income-increasing accruals.
c.
income neutral accruals.
d.
abnormal accruals.
33. As a complement to the balance sheet and the income statement, the statement of cash
flows is an informative statement for analysts for all the following reasons except:
a.
The statement of cash flows provides information to assess the financial health of a firm.
Analysts increasingly recognize that cash flows do not necessarily track income flows. A
firm with a healthy income statement is not necessarily financially healthy, and vice versa.
Cash requirements to service debt, for example, may outstrip the ability of operations to
generate cash.
b.
The existence of negative cash flows from operations can be eliminated by using this
financial statement.
c.
The statement of cash flows highlights accounting accruals, which can provide insight into
the overall sustainability and quality of a firm’s reported earnings.
d.
Analysts who understand the types of information this statement presents and the kinds of
interpretations that are appropriate find that the statement of cash flows reveals
information about the economic characteristics of a firm’s industry, its strategy,
and the stage in its life cycle.
34. Which of the following transactions would not create a cash flow?
a.
Payment of a cash dividend.
b.
The company purchased some of its own stock from a stockholder.
c.
Amortization of patent for the period.
d.
Sale of equipment at book value (i.e. no gain or loss).
35. Which of the following would not be a cash flow from investing activities?
a.
Sale of a patent.
b.
Collection of interest revenue on a long-term note receivable.
c.
Collection of principal of a note receivable.
d.
Purchase of long-term investments.
36. Which of the following is a cash flow from operating activities?
a.
Sale of long-term investments in common stock.
b.
Purchase of merchandise for resale.
c.
Payment of a note payable.
d.
Sale of a piece of land no longer used in operations.
37. A cash inflow from financing activities includes:
a.
receipt of interest payments.
b.
proceeds from selling equipment.
c.
proceeds from issuance of bonds payable.
d.
proceeds from selling investments in equity securities of another company.
38. Kraco Corporation reported 2010 net income of $450,000, including the effects of
depreciation expense of $60,000, and amortization expense on a patent of $10,000. Also, cash
of $50,000 was borrowed on a 5-year note payable. Based on this data, total cash inflow from
operating activities using the indirect method for 2010 was
a.
$570,000
b.
$520,000
c.
$470,000
d.
$440,000
39. Adophus, Inc.’s 2010 income statement reported total revenues of $850,000 and total expenses
(including $40,000 depreciation) of $720,000. The 2010 balance sheet reported the following:
accounts receivable beginning balance of $50,000 and ending balance of $40,000; accounts
payable beginning balance of $22,000 and ending balance of $28,000. Therefore, based only
on this information and using the indirect method, the 2010 net cash inflow from operating
activities was
a.
$126,000
b.
$186,000
c.
$166,000
d.
$174,000
40. Tinker Company reported sales revenue of $500,000 and total expenses of $450,000
(including depreciation) for the year ended December 31, 2010. During 2010, accounts
receivable decreased by $5,000, merchandise inventory increased by $4,000, accounts payable
increased by $6,000, and depreciation expense of $10,000 was recorded. Assuming no other
data is needed and using the indirect method, the net cash inflow from operating activities for
2010 was
a.
$60,000
b.
$67,000
c.
$44,000
d.
$51,000
41. Which of the following statements about the statement of cash flows is correct?
a.
A purchase of equipment is classified as a cash inflow from investing activities.
b.
Cash dividends paid are classified as cash flows from operating activities.
c.
Cash dividends received on stock investments are classified as cash flows from
operating activities.
d.
A company with a net loss on the income statement will always have a net cash
outflow from operating activities.
42. Norton Company reported total sales revenue of $55,000, total expenses of $45,000, and net
income of $10,000 on its income statement for the year ended December 31, 2010. During
2010, accounts receivable increased by $4,000, merchandise inventory increased by $6,000,
accounts payable decreased by $2,000, and depreciation of $18,000 was recorded. Therefore,
based only on this information, the net cash flow from operating activities using the indirect
method for 2010 was:
a.
$30,000
b.
$10,000
c.
$16,000
d.
$19,000
3-9
43. Krenshaw Company reported total sales revenue of $80,000, total expenses of $72,000, and
net income of $8,000 for the year ended December 31, 2009. During 2009, accounts
receivable increased by $3,000, merchandise inventory decreased by $2,000, accounts payable
increased by $1,000, and $5,000 in depreciation expense was recorded. Assuming no other
adjustments to net income are needed, the net cash inflow from operating activities using the
indirect method was
a.
$19,000
b.
$13,000
c.
$10,000
d.
$11,000
44. Which statement is false regarding the preparation of the indirect method of the statement of
cash flows?
a.
An increase in merchandise inventory is subtracted from net income.
b.
Depreciation expense is added to net income.
c.
An increase in accounts receivable is added to net income.
d.
An increase in accounts payable is added to net income.
45. Lui Company's 2010 income statement reported total sales revenue of $350,000. The 2009-
2010 comparative balance sheets showed that accounts receivable increased by $20,000. The
2010 "cash receipts from customers" would be
a.
$270,000
b.
$250,000
c.
$330,000
d.
$40,000
46. The financial statements for Warren Company show the following:
Cost of goods sold $725,000
Beginning Balance
Ending Balance
Merchandise Inventory
$45,000
$56,000
Accounts Receivable
53,000
50,000
Accounts Payable
37,000
42,000
Based on this information, cash paid for merchandise was
a.
$736,000
b.
$719,000
c.
$731,000
d.
$741,000
47. Which of the following statements is true?
3-10
a.
A cash dividend is an operating cash outflow.
b.
Cash paid to repurchase treasury stock is an investing cash outflow.
c.
Cash paid to acquire stock in another company is a financing outflow.
d.
Purchase of a patent is an investing cash outflow.
48. Which of the following statements is false?
a.
Purchase of equipment is an investing cash outflow.
b.
Sale of equipment creates investing cash outflow equal to its selling price.
c.
Purchase of short-term investments is an investing cash outflow.
d.
Purchase of a patent is an investing cash outflow.
COMPLETION
1. Under the _________________________, firms begin with net income to calculate cash flow from
operations for the period.
2.
A decrease in accounts receivable during a period indicates that a firm collected more
____________________ as the amount of revenues included in net income.
3. The period in which a firm commences the manufacture of its product to the time it receives cash is
called the ______________________________.
4. The length of the operating cycle is another factor that may cause cash flow from operations to differ
from __________________________________________________.
5. Amortization of bond discount and premiums would be additions or subtractions from net income in
the ___________________________ section of the statement of cash flows
6. Cash flows from ____________________ activities will normally be negative during the introduction
and growth phase of the product life cycle.
3-11
7. ____________________ activities relate to the normal operations of the firm, selling goods and
providing services.
8. ____________________ activities relate to the acquisition and sale of noncurrent assets, particularly
property, plant and equipment.
9. ____________________ ___________________ equals current assets minus current liabilities
10. Free cash flows to all debt and common equity shareholders represents the excess of cash flow from
operations over cash flows from ___________________________________.
11. Interest expense and interest revenue would be classified as ____________________ activities in the
statement of cash flows.
12. The acquisition of new investments would be classified as ____________________ activities in the
statement of cash flows.
13. The receipt of dividends from an investee would be classified as ____________________ activities in
the statement of cash flows.
14. The payment of dividends would be classified as ____________________ activities in the statement of
cash flows.
15. Under the ______________________________ of preparing the statement of cash flow’s operating
activities section firms list the cash flows from selling goods and services and then subtract the cash
outflows to providers of goods and services.
16. One factor that may cause cash flow from operations to differ from net income is the length of the
______________________________.
17. Many analysts use ____________________ as a crude measure of a firm’s ability to pay down debt.
18. EBITDA not only ignores four expenses but also ignores changes in
__________________________________________________ accounts.
19. Cash flow from operations should include none of the cash flows associated with marketable securities
if such transactions are viewed as ___________________________________.
20. The issuance of debt would be classified as a (an) ____________________ activity in the statement of
cash flows.
21. Cash collected from customers would appear in the operating activities section of a statement of cash
flows prepared using the ____________________ method
