Chapter 6– Cash Flow Statement NCERT SOLUTION CLASS 12TH ACCOUNTS | EDUGROWN NOTES

Short Answer Type Question:

Q.1 What is a Cash Flow Statement?

ANSWER: A Cash Flow Statement is a statement showing inflows and outflows of cash and cash equivalents from operating, investing and financing activities of a company during a particular period. It explains the reasons of receipts and payments in cash and change in cash balances during an accounting year in a company.

Q.2 How are the various activities classified (as per AS-3 revised) while preparing cash flow statement?

ANSWER: As per the Revised Accounting Standard 3 (AS-3), preparation of Cash Flow Statement for each period is mandatory. AS-3 also specifies the classification of all inflows and outflows basically under the following heads:

1. Cash Flow from Operating Activities

2. Cash Flow from Investing Activities

3. Cash Flow from Financing Activities

Q.3 State the uses of cash flow statement?

ANSWER: The uses of cash flow statement are as follows:

1. It is useful for short term financial planning about inflows and outflow of cash.

2. It helps in analysing the reason for the change in cash and cash equivalent balances of a company

3. It assists in determining and assessing liquidity and solvency positions of a company.

4. It enables to analyse and study the trends of receipts and payments of cash from various activities of a company and thereby helps in drafting various policy measures and short term planning.

5. It enables the segregation of cash flows from operating, investing and financing activities of the business separately.

6. It assists in making decision about distribution of profit with reference to the availability of cash.

Q.4 What are the objectives of preparing cash flow statement?

ANSWER: The important objectives for preparing Cash Flow Statement are as follows:

1. The most important objective that is fulfilled by preparing Cash Flow Statement is to ascertain the gross inflows and outflows of cash and cash equivalents from various activities.

2. Secondly, Cash Flow Statement helps in analysing various reasons responsible for change in the cash balances during an accounting year.

3. This statement helps in analysing and understanding the liquidity and solvency of a company , thereby, depicting the true liquidity position to the creditors and the investors.

4. Cash Flow Statement also helps in ascertaining the requirement and availability of cash in near future.

Q.5 State the meaning of the terms: Cash Equivalents, Cash flows.

ANSWER: Cash equivalents are short term, highly liquid investments that are easily convertible into cash and which are subject to an insignificant risk of change in value. In other words, cash equivalents are held for the purpose of meeting short term cash commitments rather than for investment or any other purpose. An investment held for short-term maturity, say three months can be regarded as cash equivalent. Some examples of cash equivalents are treasury bills, commercial papers, etc. On the other hand, cash flows are inflows and outflows of cash and cash equivalents. A cash inflow results in increase in the total cash balance and a cash outflow results in decrease in the total cash balance.

Q.6 Prepare a format of cash flow from operating activities under indirect method.

ANSWER: The format of cash flow from operating activities under Indirect method is as follows:  

Indirect Method
Cash Flow from Operating Activities:
Net Profit before tax and extraordinary items		***
	Add:	Non-Cash Expenses and Non-Operating Expenses
		Depreciation	**
		Goodwill	**
		Interest paid	**
		Loss on sale of fixed assets	**
		Foreign exchange	**	**
	Less:	Non Operating Incomes.
		Dividend received	**
		Profit on sale of fixed assets	**
		Interest received	**	**
Operating profit before working capital changes		***
	Add: Decrease in Current Assets	***
		Increase in Current Liabilities	***	***
	Less: Increase in Current Assets	***
		Decrease in Current Liabilities	***	***
Cash generated from Operating Activities		***
Income tax paid		***
Cash Flow before Extraordinary Items		***
	Add/Less: Extra ordinary Items		***
Net Cash Flow from Operating Activities		***

Note: Preparation of Cash Flow Statement using Direct Method has been excluded from the prescribed syllabus. The format is given since the question has not specified the method explicitly. Students can refer to the direct method for the knowledge purpose.

Q.7 State clearly what would constitute the operating activities for each of the follow in the following of enterprises:

(i) Hotel

(ii) Film production house

(iii) Financial enterprise

(iv) Media enterprise

(v) Steel manufacturing unit

(vi) Software development business unit.

ANSWER:

(i) Hotels

1. Receipts from sale of goods to customer.

2. Payment of wages and salaries, electricity, food items and other items used in accommodation.

(ii) Film Production House:

1. Receipts from selling film rights of a film to the distributors.

2. Payment to the staff, actors, actresses, directors, etc.

(ii) Financial Enterprises:

1. Receipts from repayment of loans, interest incomes from investments, etc.

2. Repayment of loans, recovery expenditure for recover of loans etc, salaries of employees.

(iv) Media Enterprises:

1. Receipts from advertisements.

2. Payments to staff, reporters, photographers, etc.

(v) Steel Manufacturing Unit:

1. Receipts from sale of steel sheets, steel castings, steel rods, etc.

2. Payment for iron, coal, salaries to staff, etc.

(vi) Software Development Business Unit:

1. Receipts from sale of software and renewal of licenses.

2. Payment of salaries to their employees, etc.

“Q.8 The nature/type of enterprise can change altogether the category into which a particular activity may be classified.” Do you agree? Illustrate your answer.

ANSWER: Yes, the nature or type of an enterprise can change the category into which a particular activity may be classified. This can be better understood with the help of an example of two firms. One engaged in financial services and the other engaged in manufacturing services. For the firm that is engaged in financial services, interests received or paid are classified under operating activities whereas for the firm that is engaged in manufacturing business, interests paid are classified under financing activities and interest received as investing activities. Therefore, the classification of activities depends on the nature and type of enterprise.

LONG ANSWER TYPE QUESTIONS:

Q.1 Describe the procedure to prepare cash flow statement.
  ANSWER: The procedure for preparing cash flow statement is as follows
Step 1 First of all cash flows from operating activities is ascertain.
Step 2 After that cash flows from investing activities is ascertain.
Step 3 The third step is to ascertain the cash flows from financing activities.
Step 4 Sum up the total of all the three steps and ascertain net increase or decrease.
Step 5 Write the opening balance of cash and cash equivalents and deduct it from the amount ascertained in Step 4. The resulting figure arrived is the closing balance of cash and cash equivalents.
There are two methods viz Direct Method and Indirect Method for the preparation of cash flow statement. The main difference in direct and indirect method is to calculate the cash flow from operating activities. Computation of rest of the two activities will remain same. Here are the Proforma of cash flow statement from both the methods.

Q.2 Describe “Direct” and “Indirect” method of ascertaining cash flow from operating activities.
Answer
Computation of Cash Flow From Operating Activities
The first section of cash flow statement, known as cash flow from operating activities, can be prepared by two methods known as direct method and indirect method.
(i) Direct Method :In the direct method format, each line of the operating activities section represents a sum of all cheques or deposits in a particular category, e.g., the operating activities section would include such items as cash received from customers; cash paid to suppliers; cash paid for interest; cash paid for wages; cash paid for research and development; cash paid for selling, general, and administrative costs; and any other relevant summary lines.
Direct Method Format: Cash flow from operating activities is calculated by direct method as follows

(ii) Indirect Method: In indirect method, the net income figure from the income statement is used to calculate the amount of net cash flow from operating activities. Since income statement is prepared on accrual basis in which revenue is recognised when earned and not when received therefore net income does not represent the net cash flow from operating activities and is necessary to adjust EBIT for those items which effect net income although no actual cash has been paid or received against them.
Indirect Method :Following is the indirect method formula which is used to calculate cash flow from operating activities

Q.3 Explain the major cash inflows and outflows from investing activities.
ANSWER: Cash Flows from Investing Activities: The next step in building cash flow statement is to look at money a company spent on new capital investments. If a company capitalizes an investment, then that outflow of money does not show up on the income statement. That’s because accounting rules allow the company to depreciate (expense) the cost of the investment over time.
From a practical standpoint, if a company purchase an asset such as new plant equipment or machinery, then they most likely paid for that asset in cash. When monpy leaves a company, we have an outflow of cash that we need to show in our statement.
Example In this example, let’s say ‘X’ Company purchased a new computer system for Rs. 15,00,000 along with an assembly line machine for Rs. 20,00,000. These were the only two capital investments made by ‘X’ Company for the year. In this example, the company was also required to buy a new Machinery worth Rs. 5,00,000 into a special decommissioning fund.
Normally, a company might show one line item for the capital investments and label that line item as additions to plant. In this example, we are going to show these items separately

In the above example, we saw that the company made investment in fixed assets and used Rs.40,00,000.

Q.4 Explain the major Cash inflows and outflows from financing activities.
ANSWER:
Cash Flows from Financing Activities :The final category of adjustments we need to address on a statement of cash flows is money raised by financing activities. As was the case with cash from operations, we can have both positive and negative adjustments to cash flow depending on the financing activities the company is engaged during the year.

Typical adjustments appearing here include changes in long and short term debt (issuing and redemption), issuing of preferred stock, issuing of common stock, retirement of stock, and stock dividends paid in cash.
Example In our example, ‘X’ Company decided to raise Rs. 2,50,000 by issuing common stock. They also issued around Rs.5,00,000 in preference share, and redeemed around Rs. 3,00,000 in long term debt. Finally, they paid a cash

In this example, ‘X’ Company used less money in their financing activities than they generated during the year.