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Chapter 14
The Statement of Cash Flows
Review Questions
1. What does the statement of cash flows report?
2. How does the statement of cash flows help users of financial statements?
The statement of cash flows helps users do the following:
3. Describe the three basic types of cash flow activities.
The three basic types of cash flow activities are: operating, investing, and financing.
4. What types of transactions are reported in the non-cash investing and financing activities
section of the statement of cash flows?
Investing and financing transactions that do not involve cash are called non-cash investing
5. Describe the two formats for reporting operating activities on the statement of cash flows.
The two formats for reporting the operating activities section are the indirect and direct
6. Describe the five steps used to prepare the statement of cash flows by the indirect method.
The five steps used to prepare the statement of cash flows by the indirect method are:
STEP 1: Complete the cash flows from operating activities section using net income and
adjusting for increases or decreases in current assets (other than cash) and current
liabilities. Also, adjust for gains or losses on long-term assets and non-cash expenses such
as depreciation expense.
STEP 2: Complete the cash flows from investing activities section by reviewing the
7. 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.
Depreciation expense, depletion expense, and amortization expense all impact the income
8. 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.
Depreciation expense, depletion expense, and amortization expense all impact the income
9. If a company experienced a loss on disposal of long-term assets, how would this be reported
in the operating activities section of the statement of cash flows when using the indirect
method? Why?
A loss on disposal of long-term assets would be removed from the net income on the
10. If current assets other than cash increase, what is the effect on cash? What about a decrease
in current assets other than cash?
An increase in a current asset other than cash causes a decrease adjustment to net income in
11. If current liabilities increase, what is the effect on cash? What about a decrease in current
liabilities?
12. What accounts on the balance sheet must be evaluated when completing the investing
activities section of the statement of cash flows?
The long-term asset accounts must be evaluated when completing the investing activities
section of the statement of cash flows.
13. What accounts on the balance sheet must be evaluated when completing the financing
activities section of the statement of cash flows?
The long-term liability accounts and the equity accounts must be evaluated when completing
the financing activities section of the statement of cash flows.
14. What should the net change in cash section of the statement of cash flows always reconcile
with?
15. What is free cash flow, and how is it calculated?
Free cash flow is the amount of cash available from operating activities after paying for
15A. How does the direct method differ from the indirect method when preparing the operating
activities section of the statement of cash flows?
In the indirect method, start with net income and then adjust it to cash basis through a series
16B. Why might a spreadsheet be helpful when completing the statement of cash flows?
Companies face complex situations, and a spreadsheet can help in preparing the cash flow
Short Exercises
S14-1 Describing the purposes of the statement of cash flows
Learning Objective 1
Financial statements all have a goal. The statement of cash flows does as well. Describe how the
statement of cash flows helps investors and creditors perform each of the following functions:
a. Predict future cash flows.
b. Evaluate management decisions.
c. Predict the ability to make debt payments to lenders and pay dividends to stockholders.
SOLUTION
a. The statement of cash flows helps predict future cash flows by reporting past
S14-2 Classifying items on the statement of cash flows
Learning Objective 1
Cash flow items must be categorized into one of four categories. Identify each item as operating
(O), investing (I), financing (F), or non-cash (N).
a. Cash purchase of merchandise inventory
b. Cash payment of dividends
c. Cash receipt from the collection of long-term notes receivable
d. Cash payment for income taxes
e. Purchase of equipment in exchange for notes payable
f. Cash receipt from the sale of land
g. Cash received from borrowing money
h. Cash receipt for interest income
i. Cash receipt from the issuance of common stock
j. Cash payment of salaries
S14-2, cont.
SOLUTION
S14-3 Classifying items on the indirect statement of cash flows
Learning Objective 1, 2
Destiny Corporation is preparing its statement of cash flows by the indirect method. Destiny has
the following items for you to consider in preparing the statement:
a. Increase in accounts payable
b. Payment of dividends
c. Decrease in accrued liabilities
d. Issuance of common stock
e. Gain on sale of building
f. Loss on sale of land
g. Depreciation expense
h. Increase in merchandise inventory
i. Decrease in accounts receivable
j. Purchase of equipment
Identify each item as a(n):
• Operating activity—addition to net income
( )
O+
or subtraction from net income
( )
O-
• Investing activity—cash inflow
( )
I+
or cash outflow
( )
I-
• Financing activity—cash inflow
( )
F+
or cash outflow
( )
F-
• Activity that is not used to prepare the indirect statement of cash flows (N)
SOLUTION
S14-4 Computing cash flows from operating activities—indirect method
Learning Objective 2
DVR Equipment, Inc. reported the following data for 2018:
Income Statement:
Net Income $ 43,000
Depreciation Expense 6,000
Balance Sheet:
Increase in Accounts
Receivable
6,000
Decrease in Accounts
Payable
2,000
Compute DVR’s net cash provided by operating activities—indirect method.
SOLUTION
S14-5 Computing cash flows from operating activities—indirect method
Learning Objective 2
Winding Road Cellular accountants have assembled the following data for the year ended April
30, 2018:
Cash receipt from sale of land $
27,000
Net income $ 55,000
Depreciation expense 2,000 Cash purchase of
equipment
44,000
Cash payment of dividends 5,800 Decrease in current
liabilities
20,000
Cash receipt from issuance of
common stock
17,000 Increase in current assets
other than cash
27,000
Prepare the operating activities section using the indirect method for Winding Road Cellular’s
statement of cash flows for the year ended April 30, 2018.
SOLUTION
Note: Short Exercise S14-5 must be completed before attempting Short Exercise S14-6.
S14-6 Computing cash flows from investing and financing activities
Learning Objective 2
Use the data in Short Exercise S14-5 to complete this exercise. Prepare Winding Road Cellular’s
statement of cash flows using the indirect method for the year ended April 30, 2018. Assume
beginning and ending Cash are $48,000 and $52,200, respectively.
S14-7 Computing investing and financing cash flows
Learning Objective 2
Preston Media Corporation had the following income statement and balance sheet for 2018:
S14-7, cont.
Requirements
1. Compute the acquisition of plant assets for Preston Media Corporation during 2018. The
business sold no plant assets during the year. Assume the company paid cash for the
acquisition of plant assets.
2. Compute the payment of a long-term note payable. During the year, the business issued a
$4,400 note payable.
SOLUTION
Requirement 1
Requirement 2
Note: Short Exercise S14-7 must be completed before attempting Short Exercise S14-8.
S14-8 Preparing the statement of cash flows—indirect method
Learning Objective 2
Use the Preston Media Corporation data in Short Exercise S14-7 and the results you calculated
from the requirements. Prepare Preston Media’s statement of cash flows—indirect method—for
the year ended December 31, 2018.
SOLUTION
S14-8, cont.
