Classify each item as an operating, investing, or financing activity. Assume all items involve cash unless there is information to the contrary.
Purchase of equipment.
Sale of building.
Redemption of bonds.
Depreciation.
Payment of dividends.
Issuance of capital stock.
The correct answer and explanation is :
Here is the correct classification for each item:
- Purchase of equipment – Investing Activity
- Sale of building – Investing Activity
- Redemption of bonds – Financing Activity
- Depreciation – Operating Activity (Non-cash, added back to net income in indirect method)
- Payment of dividends – Financing Activity
- Issuance of capital stock – Financing Activity
Explanation (Approx. 300 words):
Cash flow activities are classified into three categories under the statement of cash flows: operating, investing, and financing. Each category reflects a different aspect of a company’s cash management and financial strategy.
Operating activities relate to the primary revenue-generating activities of a business. This includes cash transactions involved in producing and delivering goods or services. Depreciation, although non-cash, is included in the operating section when using the indirect method. It is added back to net income because it reduces taxable income but doesn’t impact cash directly.
Investing activities concern the acquisition and disposal of long-term assets and investments. The purchase of equipment and sale of a building both fall into this category. These transactions reflect changes in the company’s investment in productive capacity. When a business purchases equipment, it’s using cash to invest in future operations. When it sells a building, it’s liquidating an asset, bringing cash back in.
Financing activities deal with the inflow and outflow of cash from transactions involving the company’s own equity or debt. Redemption of bonds (paying off debt), payment of dividends (returns to shareholders), and issuance of capital stock (raising funds through equity) are all financing activities. These reflect how the company funds its operations and growth—either through borrowing, repaying, paying returns to shareholders, or issuing new ownership shares.
Understanding how each cash flow item is categorized helps stakeholders evaluate a company’s liquidity, financial flexibility, and long-term viability. For instance, consistent outflows in financing activities, coupled with strong investing activity, might signal a company is growing while responsibly managing debt.
