Solman 12 Second Ed

CHAPTER 12 STATEMENT OF CASH FLOWS QUESTIONS 1. Though the profit and loss statement provides information about an enterprise's financial performance during a period, it does not show the cash generated through an enterprise's operations because earnings are measured by accrual accounting. The   balance sheet provides information about an enterprise's asset and how these assets have been financed by owned and borrowed funds at a point of time, but it does not explain the changes during a period in assets, obligations, and owner's equity resulting from an enterprise's activities. Therefore, a statement providing information on the major sources of cash receipts and cash outlays is nee ded. 2. Cash equivalents are short-term, highly liquid investments, including Treasury bills, certificates of deposit, commercial paper, and money market deposits. 3. The primary purpose of the statement of cash flows is to provide relevant information about the cash receipts and cash payments of an enterprise during a period. 4. The information in the statement of cash flows will help financial statement users to assess the amounts, timing, and uncertainty of prospective cash flows to the enterprise. The statement of cash flows is useful to investors, lenders, analysts, and others in assessing an enterprise's liquidity, financial flexibility, profitability, and risk. It also  provides a feedback about previous assessments of these factors. 5. Cash flows are classified into three categories: Operating, Investing, Financing activities. Examples for each category are as follows:

Operating activities : Cash receipts from customers for sale of goods and services and cash payments to suppliers for purchase of materials. Investing activities: Cash receipts from collections of loans and cash payments for  disbursements of loans. Financing activities: Proceeds from issuing equity instruments and payment of  dividends. 6. Although non cash transactions do not result in cash inflows or outflows in the period in which they occur, they generally have a significant effect on the prospective cash flows of a company. For example, conversion of debt to equity will eliminate payments of interest on the debt and a finance lease obligation requires future lease payments in cash. Therefore, information about major non cash investing and financing activities is usually provided in a note or schedule to the statement of cash flows. 7. The direct method shows major classes of operating cash receipts and payments, such as cash received from customers, customers, cash paid to suppliers and employees, and income tax Statement of Cash Flows   Chapter 12 p.1

 paid, the sum of which is net cash flow from operating activities. The indirect method starts with net profit and adjusts it for revenue and expense expense items that did not involve operating cash receipts or cash payments in the current period to arrive at net cash flow from operating activities. Both methods result in the same figure of net cash flow from operating activities. 8. Possible sources of the difference include: increase in debtors, increase in inventory, gain on sale of fixed assets or investments, decrease in creditors, and decrease in bills  payable. 9. Classification of items:

a.  b. c. d. e.

A cash outflow from financing activities. A cash inflow from investing activities. A cash outflow from financing activities. A cash inflow from investing activities. A part of the the sale price of of related investments, hence hence a cash inflow from investing investing activities, Under the indirect method, the gain is deducted deducted from net profit. profit. f. Does not involve any cash flow. g. A part of the cash outflow for redemption redemption of debentures, hence hence a cash outflow from financing financing activities. Under the indirect method, the the gain is deducted from net profit.

10. Adjustment of items:

a.   b. c. d. e. f.

Add to net profit. Deduct from net profit. Deduct from net profit. Add to net profit. Add to net profit. Add to net profit.

11. The sale price of Rs 29,000 will appear as a cash inflow in the investing activities section of the statement of cash flows. 12. None of a, b, and c involves any cash inflow or outflow. All of them will be shown in the supplemental schedule of non-cash n on-cash transactions. 13. Possible reasons include: increase in debtors , increase in inventory, decrease in creditors, decrease in bills payable, net purchase of plant and machinery, net of   purchase of investments, payment of dividends, and redemption of debentures. 14. If the sum of net cash flows from investing and financing activities is negative and it exceeds net cash flow from operating activities, it can be generally inferred that shortterm, operating cash flows have been used for long-term purposes.

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EXERCISES Exercise 12.1: Classification of Activities

a. None of the above. e. Non cash activity.   b. Financing activity. f. Financing activity. c. Investing activity. d. Investing activity.

g. Investing activity. h. Financing activity.

i. Investing activity. m. Financing activity. j. Operating activity, extraordinary item. k. Operating activity. l. Non cash activity.

Exercise 12.2: Classification of Activities

a. None of the above.

e. Operating activity.

  b. Operating activity. f. Operating activity. c. Non cash activity. g. None of the above. d. Operating activity. h. Non cash activity.

i. Non cash activity.

m. Operating activity.

j. Financing activity. k. None of the above. l. Non cash activity.

Exercise 12.3: Determining Net Cash Flow from Operating Activities     D   irect Method Praveen Company Cash Flow from Operating Activities For the Year Ended December 31, 20X5 Cash Flow from Operating Activities Cash Received from Customers (1) Rs 4,74,000 Cash Paid to Suppliers and Employees (2) (2,71,000) Income Tax Paid (3) (56,000)   Net Cash Provided by Operating Activities

Rs 1,47,000

(1) (25,000 + 4,36,000 + 78,000 − 49,000 − 16,000). (2) (2,69,000 + 61,000 − 43,000 − 7,000 + 62,000 + 51,000 + 3,000 − 67,000 − 39,000 − 19,000). (3) (53,000 + 14,000 − 11,000). Exercise 12.4: Determining Net Cash Flow from Operating Activities     I  ndirect Method Ajay Company Cash Flow from Operating Activities For the Year Ended December 31, 20X7 Cash Flow from Operating Activities   Net Profit Adjustments to Reconcile Net profit to Cash Flow from Operating Activities Depreciation Expense 49,000 Gain on Sale of Investments (8,000) Decrease in Inventory 13,000 Increase in Debtors (33,000) Statement of Cash Flows   Chapter 12 p.3

Rs 3,40,000

Increase in Prepaid Expenses Increase in Creditors Decrease in Income Tax Payable Total Adjustments   Net Cash Provided by Operating Activities

(11,000) 4,000 (6,000) 8,000 3,48,000

Exercise 12.5: Determining Net Cash Flow from operating Activities     D   irect Method Abhijit Company Cash Flow from Operating Activities For the Year Ended December 31, 20X5 Cash Flow from Operating Activities Cash Received from Customers (1) Rs 7,20,000 Cash Paid to Suppliers and Employees (2) (5,98,000) Income Tax Paid (3) (52,000)   Net Cash Provided by Operating Activities

Rs 70,000

(1) (7,29,000 + 92,000 − 97,000 − 4,000). (2) (4,85,000 + 56,000 − 45,000 − 29,000 + 68,000 + 81,000 + 74,000 + 21,000 − 57,000 − 41,000 − 15,000). (3) (67,000 + 33,000 − 48,000). Exercise 12.6: Determining Net Cash Flow from Operating Activities  Indirect Method Dutt Company Cash Flow from Operating Activities For the Year Ended December 31, 20X2 Cash Flow from Operating Activities   Net Profit Adjustments to Reconcile Net Profit to Cash Flow from Operating Activities Depreciation Expense Rs 67,000 Provision for Doubtful Debts 15,000 Gain on Sale of Investments (12,000) Dividend from Subsidiaries (3,000) Loss on Sale of Plant & Machinery 8,000 Increase in Inventory (14,000) Increase in Debtors (28,000) Increase in Prepaid Expenses (3,000) Increase in Creditors 21,000 Interest Income (9,000) Interest Expense 11,000 Decrease in Bills Payable (44,000) Decrease in Income Tax Payable (7,000) Total Adjustments   Net Cash Provided by Operating Activities

p.4 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

Rs 89,000

2,000 91,000

Exercise 12.7: Determining Net Cash Flow from Investing Activities Haveli Company Cash Flow from Operating Activities For the Year Ended March 31, 20X7 Cash Flow from Investing Activities a. Purchase of Investments Rs (65,000)   b. Proceeds from Sale of Investments 34,000 c. Purchase of Plant & Machinery (1,58,000) d. Construction of Building (78,000) e. Proceeds from Sale of Plant and Machinery 52,000   Net Cash Used in Investing Activities

Rs (2,15,000)

Exercise 12.8: Determining Net Cash Flow from Financing Activities Supra Corporation Cash Flow from Operating Activities For the Year Ended November 30, 20X9 Cash Flow from Financing Activities a. Dividend Paid Rs (12,000)   b. Redemption of Secured Debentures (47,000) c. Payment of Unsecured Loans (21,000) d. Proceeds from Issuance of Secured Convertible 1,70,000 Debentures   Net Cash Provided by Financing Activities

Rs 90,000

Item e is a non cash transaction t o be shown in a supplement schedule. Exercise 12.9: Preparing the Statement of Cash Flows Sikandar Company Statement of Cash Flows For the Year Ended March 31, 20X4 Cash Flow from Operating Activities Cash Received from Customers (1) Rs 9,20,000 Cash Paid to Suppliers and Employees (2) (7,75,000) Income Tax Paid (3) (68,000)   Net Cash Provided by Operating Activities Cash Flow from Investing Activities Purchase of Investments Rs (1,87,000) Proceeds from Sale of Plant and Machinery 41,000 Proceeds from Sale of Patents 4,000 Purchase of Investments (23,000) Proceeds from Sale of Investments 42,000 Interest Received 8,000   Net Cash Used in Investing Activities Cash Flow from Financing Activities Proceeds from Issuance of Share Capital Rs 75,000

Rs 77,000

(1,15,000)

Statement of Cash Flows   Chapter 12 p.5

Dividend Paid Interest Paid   Net Cash Provided by Financing Activities   Net Decrease in Cash and Cash Equivalents Cash and Cash Equivalent at Beginning of Period Cash and Cash Equivalents at End of Period

(45,000) (18,000) 12,000 (26,000) 70,000 44,000

(1) 9,73,000 + 1,56,000 − 2,09,000 = 9,20,000 (2) 6,85,000 + 53,000 − 49,000 − 14,000 + 194,000 + 15,000 + 1,06,000 + 12,000 − 1,98,000 − 29,000 = 7,75,000 (3) 67,000 + 7,000 − 6,000 = 68,000

PROBLEM SET A Problem A-1: Classification of Activities

a. Operating activity.   b. Investing activity. c. Investing activity. d. Investing activity. e. Non cash activity. f. Financing activity.

g. Non cash activity. h. Operating activity. i. Investing activity. j. None of the above. k. Investing activity. l. None of the above.

m. Investing activity. s. Operating activity. n. Operating activity. t. Operating activity. o. Investing activity. u. Operating activity.  p. Non cash activity. q. Investing activity. r. Financing activity.

Problem A-2: Cash Flow from Operating Activities

1. Cash Flow from Operating Activities  -Direct Method Gopal Dairy Company Cash Flow from Operating Activities For the Year Ended September 30, 20X7 Cash Flow from Operating Activities Cash Received from Customers (1) Rs 2,57,000 Cash Paid to Suppliers and Employees (2) (1,99,000) Income Tax Paid (3) (5,000)   Net Cash Provided by Operating Activities

(1) (2,71,000 − 12,000 − 2,000). (2) (1,86,000 + 19,000 − 9,000 + 7,000 − 4,000). (3) (8,000 − 3,000).

p.6 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

Rs 53,000

2. Cash Flow from Operating Activities  -Indirect Method Gopal Dairy Company Cash Flow from Operating Activities For the Year Ended September 30, 20X7 Cash Flow from Operating Activities   Net Profit Adjustments to Reconcile Net profit to Cash Flow from Operating Activities Depreciation Expense Rs 48,000 Provision for Doubtful Debts 4,000 Gain on Sale of Investments (1,000) Loss on Sale of Plant and Equipment 2,000 Decrease in Inventory 9,000 Increase in Debtors (14,000) Decrease in Creditors (7,000) Interest Income (4,000) Interest Expense 6,000 Increase in Income Tax Payable 3,000 Total Adjustments   Net Cash Provided by Operating Activities

Rs 7,000

46,000 53,000

Problem A-3: Cash Flow from Operating Activities

1. Cash Flow from Operating Activities  -Indirect Method Vijaya Company Cash Flow from Operating Activities For the Year Ended August 31, 20X3 Cash Flow from operating Activities Cash Received from Customers (1) Rs 9,67,000

Cash Paid to Suppliers and Employees (2) Income Tax Paid (3   Net Cash Provided by Operating Activities

(7,64,000) (53,000) Rs 1,50,000

(1) (9,28,000 + 46,000 − 7,000). (2) (8,12,000 + 43,000 + 73,000 − 59,000 − 87,000 − 18,000). (3) (39,000 + 14,000).

Statement of Cash Flows   Chapter 12 p.7 

2. Cash Flow from Operating Activities  -Indirect Method Vijaya Company Cash Flow from Operating Activities For the Year Ended August 31, 20X3 Cash Flow from Operating Activities   Net Profit Adjustments to Reconcile Net Profit to Cash Flow from Operating Activities Depreciation Expense Provision for Doubtful Debts Gain on Sale of Plant Loss on Sale of Investments Increase in Inventory Decrease in Debtors Increase in Creditors Interest Received Interest Paid Decrease in Income Tax Payable Total Adjustments   Net Cash Provided by Operating Activities

Rs 59,000

Rs 87,000 18,000 (11,000) 8,000 (73,000) 39,000 59,000 (32,000) 10,000 (14,000) 91,000 1,50,000

Problem A-4: Preparing and Interpreting the Statement of Cash Flows

1. Statement Cash Flows  -Direct Method Pioma Plastics Company Statement of Cash Flows For the Year Ended April 30, 20X3 Cash Flow from Operating Activities Cash Received from Customers (a) Rs 6,46,000 Cash Paid to Suppliers and Employees (b) (8,51,000) Income Tax Paid (c) (1,16,000) Insurance Proceeds Received 76,000   Net Cash Used in Operating Activities Cash Flow from Investing Activities Purchase of Plant and Machinery Rs (53,000) Proceeds from Sale of Plant and Machinery 19,000 Proceeds from Sale of Land 1,33,000 Interest Received 54,000 Dividend Received 20,000   Net Cash Provided by Investing Activities Cash Flow from Financing Activities Proceeds from Issuance of Share Capital Rs 90,000 Dividend Paid (65,000) Interest Paid (57,000) Proceeds from Issuance of Secured Debentures 6,000 Proceeds from Issuance of Unsecured Loans 48,000   Net Cash Provided by Financing Activities p.8 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

Rs (2,45,000)

1,73,000

22,000

 

Net Decrease in Cash and Cash Equivalents Cash and Cash equivalent at Beginning of Period Cash and Cash Equivalents at End of Period

(50,000) 1,33,000 83,000

Supplemental Schedule of Non-cash Investing and Financing Activities: During the year, the company purchased machinery for Rs 78,000 in exchange for secured debentures. (a) (7,58,000 + 1,18,000 − 2,16,000 − 14,000) (b) 5,37,000 + 1,23,000 − 93,000 − 11,000 + 63,000 + 1,47,000 + 1,65,000 + 8,000 − 19,000 − 11,000 − 38,000 − 20,000 (c) (98,000 + 41,000 − 23,000) 2. Statement of Cash Flows  Indirect Method Pioma Plastics Company Statement of Cash Flows For the Year Ended April 30, 20X3 Cash Flow from Operating Activities   Net Profit Adjustments to Reconcile Net Profit to Cash Flow from Operating Activities Depreciation Expense Rs 38,000 Provision for Doubtful Debts 20,000 Gain on Sale of Land (63,000) Loss on Sale of Plant 38,000 Increase in Inventory (72,000) Increase in Debtors (1,12,000) Decrease in Creditors (1,36,000) Interest Income (54,000) Dividend Income (20,000) Interest Expense 57,000 Decrease in Prepaid Expenses 3,000 Decrease in Bills Payable (44,000) Decrease in Income Tax Payable (18,000) Total Adjustments   Net Cash Used in Operating Activities Cash flows from Investing Activities Purchase of Plant and Machinery Rs (53,000) Proceeds from Sale of Plant and Machinery 19,000 Proceeds from Sale of Land 1,33,000 Interest Received 54,000 Dividend Received 20,000   Net Cash Provided by Investing Activities Cash Flow from Financing Activities Proceeds from Issuance of Share Capital Rs 90,000 Dividend Paid (65,000) Interest Paid (57,000) Proceeds from Issuance of Secured Debentures 6,000

Rs 1,18,000

3,63,000 (2,45,000)

1,73,000

Statement of Cash Flows   Chapter 12 p.9

Proceeds from Issuance of Unsecured Loans   Net Cash Provided by Financing Activities   Net Decrease in Cash and Cash Equivalents Cash and Cash Equivalent at Beginning of Period Cash and Cash Equivalents at End of Period

48,000 22,000 (50,000) 1,33,000 83,000

Supplemental Schedule of Non-cash Investing and Financing Activities: During the year, the company purchased machinery for Rs 78,000 in exchange for secured debentures. 3. The statement of cash flows reveals a net cash outflow from operations of Rs 2,45,000, where as the profit and loss account shows a net profit of Rs 1,18,000. Sharp increases in debtors and inventory, coupled with sharp decreases in creditors and bills payable, contributed to the cash deficit from operations. Further, a net gain of Rs 25,000 from disposal of assets appears in the profit and loss account, but is excluded from cash flows from operating activities in the statement of cash flows. There is a net inflow of Rs 1,95,000 from investing and financing operating activities. In sum, Pioma Plastics Company used more cash in operations than all of the cash it received from its investing and financing activities, resulting in a net decrease in cash. Problem A-5: Preparing and Interpreting the Statement of Cash Flows

1. Statement Cash Flows  Direct Method Arun Music Company Statement of Cash Flows For the Year Ended October 31, 20X5 Cash Flow from Operating Activities Cash Received from Customers (a) Rs 8,40,000 Cash Paid to Suppliers and Employees (b) (8,06,000) Income Tax Paid (c) (29,000)   Net Cash Used in Operating Activities Cash Flow from Investing Activities Purchase of Plant and Machinery Rs (1,99,000) Proceeds from Sale of Plant and Machinery 50,000 Purchase of Investments (19,000) Proceeds from Sale of Investments 96,000 Interest Received 12,000 Dividend Received 18,000   Net Cash Used in Investing Activities Cash Flow from Financing Activities Proceeds from Issuance of Share Capital Rs 80,000 Redemption of Secured Debentures (6,000) Repayment of Unsecured Loans (41,000) Interest Paid (22,000)   Net Cash Provided by Financing Activities   Net Decrease in Cash and Cash Equivalents Cash and Cash Equivalent at Beginning of Period Cash and Cash Equivalents at End of Period p.10 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

Rs 5,000

(42,000)

11,000 (26,000) 38,000 12,000

Supplemental Schedule of Non-cash Investing and Financing Activities: During the year, the company purchased machinery for Rs 55,000 on l ong-term, unsecured credit. (a) (9,27,000 + 61,000 − 1,27,000 − 21,000) (b) (7,51,000 + 1,45,000 − 1,64,000 − 15,000 + 27,000 + 21,000 + 2,13,000 + 24,000 − 39,000 − 64,000 − 61,000 − 32,000 (c) (19,000 + 19,000 − 9,000) 2. Statement of Cash Flows  Indirect Method Arun Music Company Statement of Cash Flows For the Year Ended October 31, 20X5 Cash Flow from Operating Activities   Net Profit Adjustments to Reconcile Net Profit to Cash Flow from Operating Activities Depreciation Expense Rs 61,000 Provision for Doubtful Debts 32,000 Gain on Sale of Plant (23,000) Loss on Sale of Investments 14,000 Dividend Income (18,000) Interest Income (12,000) Interest Expense 22,000 Increase in Inventory (49,000) Increase in Debtors (87,000) Increase in Prepaid Expenses (9,000) Increase in Bills Payable 12,000 Increase in Creditors 43,000 Decrease in Income Tax Payable (10,000) Total Adjustments   Net Cash Used in Operating Activities Cash Flow from Investing Activities Purchase of Plant and Machinery Rs (1,99,000) Proceeds from Sale of Plant and Machinery 50,000 Purchase of Investments (19,000) Proceeds from Sale of Investments 96,000 Interest Received 12,000 Dividend Received 18,000   Net Cash Used in Investing Activities Cash Flow from Financing Activities Proceeds from Issuance of Share Capital Rs 80,000 Redemption of Secured Debentures (6,000) Repayment of Unsecured Loans (41,000) Interest Paid (22,000)   Net Cash Provided by Financing Activities   Net Decrease in Cash and Cash Equivalents Cash and Cash Equivalent at Beginning of Period

Rs 29,0

(24,000) 5,000

(42,000)

11,000 (26,000) 38,000

Statement of Cash Flows   Chapter 12 p.11

Cash and Cash Equivalents at End of Period

12,000

Supplemental Schedule of Non-cash Investing and Financing Activities: During the year, the company purchased machinery for Rs 55,000 on l ong-term, unsecured credit. 3. The statement of cash flows reveals a net cash inflow from operations of Rs 5,000, whereas the profit and loss account shows a net profit of Rs 29,000. There were sizeable additions to debtors and inventory, but creditors and bills payable decreased. Further, a gain of Rs 9,000 (net) from disposal of assets appears in the profit and loss account, but is excluded from cash flows. The outflow of Rs 42,000 from investing and financing activities exceeded the net inflow from operating activities. In sum, Arun Music Company used more cash in its investing activities than all of the cash it received from its operating and financing activities, resulting in a decrease in cash.

PROBLEM SET B Problem B-1: Classification of Activities

a. Operating activity.

g. None of the above.   b. Operating activity. h. Investing activity. c. Non-cash activity. i. Non-cash activity. d. Operating activity. j. Investing activity. e. Financing activity. k. Financing activity. f. Financing activity.

l. Non-cash activity.

m. None of the above. n. Investing activity. o. Non-cash activity. p. Financing activity. q. None of the above. r. Operating activity.

s. Financing activity. t. Investing activity. u. Investing activity.

Problem B-2: Cash Flows from Operating Activities

1. Cash Flows from Operating Activities  Direct Method Shamsher Leather Company Cash Flow from Operating Activities For the Year Ended July 31, 20X8 Cash Flow from Operating Activities Cash Received from Customers (1) Rs 7,89,000 Cash Paid to Suppliers and Employees (2) (6,34,000) Income Tax Paid (3) (33,000)   Net Cash Provided by Operating Activities

(1) (7,69,000 + 23,000 − 3,000). (2) (5,83,000 + 27,000 + 15,000 + 16,000 − 7,000). (3) (28,000 + 5,000).

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Rs 1,22,000

2. Cash Flow from Operating Activities  Indirect Method Shamsher Leather Company Cash Flow from Operating Activities For the Year Ended July 31, 20X8 Cash Flow from Operating Activities   Net Profit Adjustments to Reconcile Net Profit to Cash Flow from Operating Activities Depreciation Expense Rs 95,000 Provision for Doubtful Debts 7,000 Gain on Sale of Plant and Equipment (8,000) Loss on Sale of Investments 3,000 Increase in Inventory (15,000) Decrease in Debtors 20,000 Decrease in Creditors (16,000) Interest Income (2,000) Interest Expense 9,000 Dividend Income (3,000) Decrease in Income Tax Payable (5000) Total Adjustments   Net Cash Provided by Operating Activities

Rs 37,000

85,000 1,22,000

Problem B-3: Cash Flow from Operating Activities

1. Cash Flow from Operating Activities  Indirect Method Saleem Steel Company Cash Flow from Operating Activities For the Year Ended November 30, 20X9 Cash Flow from Operating Activities Cash Received from Customers (1) Rs 8,17,000 Cash Paid to Suppliers and Employees (2) (7,61,000) Income Tax Paid (3) (47,000)   Net Cash Provided by Operating Activities

Rs 9,000

(1) (9,69,000 − 1,41,000 − 11,000) (2) (7,69,000 + 55,000 − 1,18,000 + 49,000 + 1,53,000 − 1,34,000 − 13,000) (3) (76,000 − 29,000)

Statement of Cash Flows   Chapter 12 p.13

2. Cash Flow from Operating Activities  Indirect Method Saleem Steel Company Cash Flow from Operating Activities For the Year Ended November 30, 20X9   Net Profit Adjustments to Reconcile Net Profit to Cash Flow from Operating Activities Depreciation Expense Rs 1,34,000 Provision for Doubtful Debts 13,000 Loss of Sale of Trademarks 72,000 Gain on Sale of Investments (96,000) Decrease in Inventory 1,18,000 Increase in Debtors (1,52,000) Increase in Prepaid Expenses (49,000) Decrease in Creditors (1,53,000) Interest Income (91,000) Interest Expense (23,000) Increase in Income Tax Payable 29,000 Total Adjustments   Net Cash Provided by Operating Activities

Rs 1,61,000

(1,52,000) 9,000

Problem B-4: Preparing and Interpreting the Statement of Cash Flows

1. Statement Cash Flows  Direct Method Vinay Electronics Company Statement of Cash Flows For the Year Ended July 31, 20X7 Cash Flow from Operating Activities Cash Received from Customers (a) Cash Paid to Suppliers and Employees (b) Income Tax Paid (c) Insurance Proceeds Received   Net Cash Provided by Operating Activities Cash Flow from Investing Activities Purchase of Plant and Machinery Proceeds from Sale of Patents Purchase of Investments Proceeds from Sale of Investments Interest Received Dividend Received   Net Cash Used in Investing Activities Cash Flow from Financing Activities Proceeds from Issuance of Share Capital Interest Paid Proceeds from Issuance of Secured Debentures Proceeds from Issuance of Unsecured Loans Redemption of Secured Debentures

Rs 3,73,000 (3,70,000) (15,000) 17,000 Rs 5,000 (1,39,000) 3,000 (13,000) 68,000 14,000 12,000 (55,000) 20,000 (64,000) 1,50,000 1,10,000 (24,000)

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Repayment of Unsecured Loans   Net Cash Provided by Financing Activities   Net Increase in Cash and Cash Equivalents Cash and Cash equivalent at Beginning of Period Cash and Cash Equivalents at End of Period

(14,000) 1,78,000 1,28,000 33,000 1,61,000

Supplemental Schedule of Non-cash Investing and Financing Activities: During the year, the company purchased machinery for Rs 63,000 on l ong-term, unsecured credit. (a) (4,39,000 + 1,04,000 − 1,54,000 − 16,000) (b) (3,84,000 + 75,000 − 1,37,000 − 16,000 + 15,000 + 1,12,000 + 79,000 + 19,000 − 47,000 − 71,000 − 21,000 − 22,000). (c) ( 20,000 − 5,000). 2. Statement of Cash Flows  Indirect Method Vinay Electronics Company Statement of Cash Flows For the Year Ended July 31, 20X7 Cash Flow from Operating Activities   Net Profit Adjustments to Reconcile Net Profit to Cash Flow from Operating Activities Depreciation Expense Rs 21,000 Provision for Doubtful Debts 22,000 Gain on Sale of Investments (19,000) Loss on Sale of Patent 26,000 Decrease in Inventory 58,000 Increase in Debtors (66,000) Increase in Prepaid Expenses (3,000) Increase in Bills Payable 32,000 Decrease in Creditors (41,000) Interest Income (14,000) Dividend Income (12,000) Interest Expense 64,000 Decrease in Income Tax Payable (15,000) Total Adjustments 53,000   Net Cash Used in Operating Activities 5,000 Cash Flow from Investing Activities Purchase of Plant and Machinery Rs (1,39,000) Proceeds from Sale of Patents 3,000 Purchase of Investments (13,000) Proceeds from Sale of Investments 68,000 Interest Received 14,000 Dividend Received 12,000   Net Cash Used in Investing Activities (55,000) Cash Flow from Financing Activities Proceeds from Issuance of Share Capital Rs 20,000 Statement of Cash Flows   Chapter 12 p.15

Rs (48,000

Interest Paid Proceeds from Issuance of Secured Debentures Proceeds from Issuance of Unsecured Loans Redemption of Secured Debentures Repayment of Unsecured Loans   Net Cash Provided by Financing Activities   Net Increase in Cash and Cash Equivalents Cash and Cash Equivalent at Beginning of Period Cash and Cash Equivalents at End of Period

(64,000) 1,50,000 1,10,000 (24,000) (14,000) 1,78,000 1,28,000 33,000 1,61,000

Supplemental Schedule of Non-cash Investing and Financing Activities: During the year, the company purchased machinery for Rs 63,000 on l ong-term, unsecured credit. 3. The statement of cash flows reveals a net cash inflow from operations of Rs 5,000, though the profit and loss account shows a net loss of Rs 48,000. It is strange for the company to experience an increase in cash. But a careful analysis of the statement of cash flows shows that cash increased as a result of the issuance of share capital, secured debentures and unsecured loans, which together resulted in an inflow of Rs 2,42,000, net of loan payments. When the net outflow of Rs 55,000 from investing activities is deducted, there is still a net inflow of Rs 1,23,000. After considering the net inflow from operating activities of Rs 5,000, there is a net increase in cash of Rs 1,28,000. Thus, it is clear that the increase in cash is due to issuance of equity and debt during the period. Problem B-5: Preparing and Interpreting the Statement of Cash Flows

1. Statement Cash Flows  Direct Method Cochin Marine Foods Company Statement of Cash Flows For the Year Ended November 30, 20X7 Cash Flow from Operating Activities Cash Received from Customers (a) Rs 8,30,000 Cash Paid to Suppliers and Employees (b) (8,94,000) Income Tax Paid (c) (7,000)   Net Cash Used in Operating Activities Cash Flow from Investing Activities Purchase of Plant and Machinery (33,000) Proceeds from Sale of Plant and Machinery 3,000 Proceeds from Sale of Investments 54,000 Interest Received 1,000 Dividend Received 9,000   Net Cash Provided by Investing Activities Cash Flow from Financing Activities Proceeds from Issuance of Share Capital 20,000 Proceeds from Issuance of Secured Debentures 52,000 Proceeds from Issuance of Unsecured Loans 90,000 Interest Paid (43,000) Redemption of Secured Debentures (4,000)   Net Cash Provided by Financing Activities p.16 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

Rs (71,000)

34,000

1,15,000

 

Net Increase in Cash and Cash Equivalents Cash and Cash Equivalent at Beginning of Period Cash and Cash Equivalents at End of Period

78,000 69,000 1,47,000

(a) (8,58,000 + 65,000 − 93,000). (b) (8,61,000 + 1,12,000 − 71,000 − 12,000 + 86,000 + 76,000 + 5,000 − 1,18,000 − 45,000). (c) (8,000 − 1,000). 2. Statement of Cash Flows  Indirect Method Cochin Marine Foods Company Statement of Cash Flows For the Year Ended November 30, 20X7   Net Profit Adjustments to Reconcile Net Profit to Cash Flow from Operating Activities Depreciation Expense Rs 45,000 Gain on Sale of Investments (3,000) Loss on Sale of Plant and Machinery 11,000 Increase in Inventory (5,000) Increase in Debtors (28,000) Decrease in Prepaid Expenses 7,000 Increase in Creditors 32,000 Interest Income (1,000) Dividend Income (9,000) Interest Expense 43,000 Decrease in Income Tax Payable (7,000) Total Adjustments   Net Cash Used in Operating Activities Cash Flow from Investing Activities Purchase of Plant and Machinery Rs (33,000) Proceeds from Sale of Plant and Machinery 3,000 Proceeds from Sale of Investments 54,000 Interest Received 1,000 Dividend Received 9,000   Net Cash Used in Investing Activities Cash Flow from Financing Activities Proceeds from Issuance of Share Capital 20,000 Proceeds from Issuance of Secured Debentures 52,000 Proceeds from Issuance of Unsecured Loans 90,000 Interest Paid (43,000) Redemption of Secured Debentures (4,000)   Net Cash Provided by Financing Activities   Net Increase in Cash and Cash Equivalents Cash and Cash Equivalent at Beginning of Period Cash and Cash Equivalents at End of Period

Rs (1,56,000)

85,000 (71,000)

34,000

1,15,000 78,000 69,000 1,47,000

Statement of Cash Flows   Chapter 12 p.17 

3. The statement of cash flows reveals a net cash outflow from operations of Rs 71,000 and the profit and loss account shows a net loss of Rs 1,56,000. It is strange for the company to experience an increase in cash. But a careful analysis of the statement of cash flows shows that cash increased as a result of the issuance of share capital, secured debentures and unsecured loans, which together resulted in an inflow of Rs 1,62,000. The net outflow from operating activities totalled Rs 71,000. After considering the net inflow from investing activities of Rs 34,000, there is a net increase in cash of Rs 78,000. It is clear that the increase in cash is due to the issuance of equity and debt during the period.

Business Decision Cases I. RELIANCE STATIONERY COMPANY Teaching Notes Case Setting and Objectives

This case involves preparation of a statement of cash flows in a standard format and interpreting the statement. The focus of the case is that an increase in cash at the year-end does not imply that the operations are profitable. Suggested Solution

1. Reliance Stationery Company Statement of Cash Flows For the year Ended March 31, 20X4 Cash Flow from Operating Activities Cash Received from Customers Rs 2,89,600 Cash Paid to Suppliers and Employees (a) (2,74,400)   Net Cash Provided by Operating Activities Cash Flow from Investing Activities Purchase of Fixtures and Office Equipment (2,72,000) Proceeds from Sale of Investments 64,000 Interest Received 6,400 Purchase of Investments (68,000)   Net Cash Used in Investing Activities Cash Flow from Financing Activities Proceeds from Issuance of Share Capital 3,52,000 Interest Paid (2,400) Repayment of Loans (8,000)   Net Cash Provided by Financing Activities   Net Increase in Cash and Cash Equivalents

Rs 15,200

(2,69,600)

3,41,600 87,200

Supplemental Schedule of Non-cash Investing and Financing Activities: The company  purchased a delivery van for Rs 24,000 on long-term credit.

p.18 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

(a) (2,02,400 + 1,28,000 − 56,000) 2. The statement of cash flows shows that there is a net cash inflow of Rs 15,200 from operations. The net cash outflow from investing activities of Rs 2,69,600 resulted mainly from the purchase of fixtures and office equipment. The purchase was paid for from the   proceeds from issuance of share capital. The net increase in cash of Rs 87,200 comes mainly from two sources: from operations and from issuance of share capital. The operations of Reliance Stationery Company in the first year are profitable and the earnings are represented in cash. But this does not mean that the increase in cash of Rs 87,200 came entirely by way of cash flow from operating activities. Therefore, Uday's assessment that the Reliance Stationery Company had a successful first year is probably correct, although his assumption that all of the increase in cash came from the company's operations is not correct.

II. ANTARIKSH MATERIALS COMPANY Teaching Notes Case Setting and Objectives

This case illustrates the interpretation and use of the statement of cash flows in a lending context. 1. Antariksh Materials Company Statement of Cash Flows For the year Ended June 30, 20X8 (in thousands) Cash Flow from Operating Activities Cash Received from Customers (a) Rs 24,85,75 Cash Paid to Suppliers and Employees (b) (24,64,00) Income Tax Paid (c) (4,30,00)   Net Cash Used in Operating Activities Cash Flow from Investing Activities Proceeds from Sale of Plant and Machinery 21,00   Net Cash Provided by Investing Activities Cash Flow from Financing Activities Proceeds from Issuance of Share Capital 30,00 Dividend Paid (3,12,75) Interest Paid (20,00) Proceeds from Issuance of Secured Debentures 4,90,00 Repayment of Unsecured Loans (20,00)   Net Cash Provided by Financing Activities   Net Decrease in Cash and Cash Equivalents Cash and Cash Equivalents at the Beginning of the Period Cash and Cash Equivalents at the End of the Period

Rs (4,08,25)

21,00

1,67,25 2,20,00 2,90,00 70,00

Statement of Cash Flows   Chapter 12 p.19

(1) (29,00,00 + 5,40,00 − 9,54,25) (2) (16,78,00 + 2,05,00 − 8,50,00 − 80,00 + 1,80,00 + 15,30,00 + 11,00 − 1,20,00 − 90,00) (3) (4,20,00 + 50,00 − 40,00) Supplemental Schedule of Non-cash Investing and Financing Activities: The company  purchased a plant costing Rs 1,90,00,000 in exchange for equity shares. 2. From the statement of cash flows, Antariksh Materials Company had a net outflow of Rs 4,08,25,000 from operating activities. In other words, the company did not generate any cash from operations. Even then the company paid dividends of Rs 3,12,75,000 during the  period. 3. Though the Antariksh Materials Company earned a net profit of Rs 5,75,00,000 during the year ended June 30, 20X8, it lost cash of Rs 4,08,25,000 in its operations during the period. A study of the statement of cash flows shows that this resulted mainly from the large additions to inventory (Rs 6,80,00,000) and debtors (Rs 4,14,25,000). In spite of losing cash in operations, the company went ahead with paying a dividend of Rs 3,12,75,000, adding to its cash flow problems. It is clear from the statement of cash flows that the dividend could not have been disbursed had the company not borrowed cash to pay dividends. This is imprudent because dividends are supposed to be paid from profits represented by cash. What the company has done can be labelled as bad financial management. Coming to the company's investment plans, it needs about Rs 10 crore. If its performance during the year ended June 30, 20X8 is any indication, the company is unlikely to generate significant positive cash flow from operations in 20X9. Therefore, the entire finance will have to come from borrowings (at this time, the prospects for an equity issue do not seem to be too bright). Even though its current level of borrowings is not unreasonable, the company may not be much successful in raising additional loans if it continues to lose cash in its operations. Also, the planned expansion in operations will require additional working capital. In these circumstances, the company's investments plans appear to be over ambitious, What the company needs to do first is to manage its inventory and debtors more efficiently by reviewing its policies and practices in these areas. A bank lending officer will not be  justified in recommending the loan at this stage.

Interpreting Financial Reports I. NATIONAL THERMAL POWER CORPORATION Teaching Notes Case Setting and Objectives

This case looks at a certain action taken by a power generation company to collect the amounts receivable from its customer, a state electricity board (SEB) that has had difficulty in paying its dues on time. The case examines whether the action would have the expected p.20 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

results for NTPC. The case is significant in the context of the current debate on reforming the energy industry in India.

The case illustrates accounting practices purely for the purpose of classroom discussions and   should not be taken as a judgement on the practices followed by the organisations that are  featured in the case. Suggested Solution

1. The swap of the power plant for unpaid bills reduces the total dues of NTPC, as the following entry shows: Plant and Machinery (Power plant) Debtors

546,00,00,000 546,00,00,000

2. The swap will not be reflected in NTPC's statement of cash flows because it does not involve cash receipt. However, NTPC might like to mention the deal in the supplemental schedule. One effect of the plant-for-dues swap is the loss of cash inflow from UPSEB that might have paid at least a part of the dues in the near future. Of course, NTPC could be assumed to have considered the probability of that happening before agreeing to the deal. Also,  NTPC will end up paying the fuel, salaries and other expenses of the plant after it has been taken over. But the electricity generated by the plant will have to be sold to the UPSEB for  logistical as well as political reasons. It is not clear how the UPSEB plans to pay for the additional electricity purchased from NTPC, particularly when it has not been able to pay for its existing purchases. It is likely that the deal will not improve NTPC's cash flow and will end up further straining its cash flow. Furthermore, other SEBs may come up with offers of plant-for-dues swap and NTPC would be stuck with uneconomical and inefficient  power plants and a workforce that does not meet NTPC's expectations, while being unable to recover current and incremental dues for a long time to come. Eventually, NTPC could very well end up in the unenviable position of having to face the problems that affect the functioning of SEBs. In other words, the deal will spread to NTPC the malaise that affects SEBs rather than solve it. 3. NTPC's main problem was that it was not able to collect its receivables from SEBs. Much of the billings ended up increasing the year-end balance of debtors rather than getting converted into cash. As a result, there was a wide gap between its accrual-based profit and cash flow from operating activities.  NTPC has the following options: i.

Stop sale of power to defaulting SEBs and redirect the power to the SEBs that pay on time. This may not be feasible for logistical as well as political reasons. ii. Insist on advance payments or a revolving letter of credit from defaulting SEBs. iii. Sell or securitise its receivables at a discount, likely to be considerable. iv. Employ collection agents. This may not help much because the problem of non-payment has to do with the SEBs' inability, not reluctance, to pay. Statement of Cash Flows   Chapter 12 p.21

v. Ask the Central Government to divert its Plan allocations to the States concerned to  NTPC in settlement of the dues of the SE Bs of the respective States. The ICAI's AS 9   Revenue Recognition states that it may be more appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made. In the case of SEBs' dues while there is no uncertainty about the ultimate collection of the amounts  because the SEBs are government organisations and will eventually pay, considerable delay is likely given the financial position of these organisations. So the question whether NTPC was proper in recognising the dues as revenues cannot be answered categorically.

II. STEEL AUTHORITY OF INDIA LIMITED Teaching Notes Case Setting and Objectives

This case examines the reconciliation of net profit and cash flow from operating activities. Many users of financial statements are puzzled when a company reports a loss, yet has a   positive cash flow from operating activities. By reviewing on the fundamentals of accrual accounting and the cash flow statement, this case can help in understanding how such a situation is not impossible. The items that explain the difference between the two can tell us a lot about a company’s earnings quality. Also, the cash flow statement can provide insights into how a company manages its finances.

The case illustrates accounting practices purely for the purpose of classroom discussions and   should not be taken as a judgement on the practices followed by the organisations that are  featured in the case. Suggested Solution

1. It is possible for an enterprise to have a positive cash flow from operating activities despite a net loss. The difference can be due to one or more of the following reasons (amounts are in crores of rupees): 

 Net profit or net loss is calculated using accrual accounting, whereas cash flow from operating activities is determined on the cash receipts and cash payments. Some accrual items, such as depreciation expense, do not involve cash flow. SAIL has the following non-cash items: o o o o



depreciation, Rs 1164.12;  provision for diminution in value of assets, Rs 0.02;  bad debt expenses written off, Rs 7.08; deferred revenue expenditure, Rs 232.54.

Items of gains and losses that do not pertain to operating activities are excluded from net profit or net loss to determine cash flow from operating activities. An example is  profit on sale of assets. SAIL has the following items of this kind:

p.22 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

o o o o



 profit on sale of fixed assets, Rs 662.47; interest expenses, Rs 1562.03; interest income, Rs 105.30; dividend income, Rs 5.74.

Cash flow from operating activities is determined after adjusting net profit or net loss for changes in current assets and current liabilities. For example, increase in inventories does not affect the profit and loss account in accordance but it is treated as a cash flow. In the case of SAIL, we fi nd the following items: o o o o o

decrease in inventories, Rs 477.16; decrease in debtors, Rs 291.10; decrease in loans and advances, Rs 138.53; increase in current liabilities and provisions, Rs 132.96; deferred charges incurred during the year but not expensed, Rs 438.20;

2. The company's cash came from operating activities and, to a lesser extent, reduction of  cash and cash equivalents. The major uses of cash were payment of interest and finance charges and repayment of borrowings. There was net inflow from investing activities which suggests that the company sold more assets than it acquired. While the company incurred a net loss in 2001-2002, it managed pay its obligations. The high level of borrowings was responsible for the huge interest payment which hurt the company in a bad year. This raises the question whether the company had excessive debt. Also, we should remember that the steel industry is cyclical and this year might have been the bottom of the cycle. To confirm this we should look at the performance of other steel companies in the year. In part, the company managed its problem by selling of (conceivably excess or spare) assets. 3. From the profit and loss account and the cash flow statement, it appears that there were many one-time or non operating items that raise questions about the company's quality of  earnings. These include the following: o

o o

 profit on sale of fixed assets, Rs 662.47 that is much higher than in the previous year (this item is probably included in other revenues in the profit and loss account);  provision no longer required written back that is higher than in the previous year; a large addition to deferred revenue expenditure that is carried on the balance sheet.

Statement of Cash Flows   Chapter 12 p.23