Intermediate Accounting

INSTRUCTOR’S

S

OLUTIONS MANUAL

Intermediate Accounting Fourth Edition Volume 2

Kin Lo George Fisher

Last Updated: 04 April 2019

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Chapter 20 Statement of Cash Flows

• Problems

P20-1. Suggested solution:

The statement of cash flows (SCF) is a required financial statement that explains the reported change in an entity’s cash and cash equivalents during the period. The SCF categorizes the sources and uses of cash so as to assist investors, creditors, and other interested parties in assessing the company’s ability to make payments when due and pay dividends. The SCF is also used to ascertain the firm’s quality of earnings.Income statements are prepared on an accrual basis and consequently net income seldom equals the change in cash during the period. Net income is an important metric as it measures the financial performance of the company. The firm’s ability to generate cash is equally important, though, as cash— not net income—pays bills. If a company generates insufficient cash to meet its obligations, creditors will eventually force it into bankruptcy.

P20-2. Suggested solution:

Stakeholders may use the statement of cash flows to:

• analyze the company’s liquidity (its ability to meet its obligations when due);

ii) prepare more accurate forecasts of future cash flows than those based solely on income statements; and iii) evaluate the firm’s quality of earnings.

P20-3. Suggested solution:

• Cash equivalents are short-term, highly liquid investments that are readily convertible to known

amounts of cash and which are subject to an insignificant risk of changes in value. IAS 7 suggests that only short-term investments that mature in three months or less can be classified as cash equivalents.This category typically includes treasury bills, bankers’ acceptances, and money market funds. Equity instruments, even if readily marketable, cannot be treated as cash equivalents because the risk of a change in value is not insignificant. Indeed, the market value of equities fluctuates on an ongoing basis.

• When an investment in a qualifying security is held for the purpose of meeting short-term cash

commitments it is reported as a cash equivalent. Cash inflows and outflows arising from investments designated as cash equivalents are not reported as cash flows. Rather, they are part of the change in cash and cash equivalents that must be explained. If, however, the qualifying investment is held for other reasons, then the cash flows resulting from the purchase and sale of the investment are classified as: an operating activity if the investment is held for trading purposes; or as an investing activity if the investment is not held for trading purposes.

• Bank borrowings, including those by way of overdraft, are generally classified as financing activities.

In Canada and some other countries, bank overdrafts frequently form an integral part of a company’s cash management strategy. In these circumstances, and if the balance often fluctuates between a positive balance and an overdraft, bank overdrafts are included as a component of cash and cash equivalents, the change in which must be explained.

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ISM for Lo/Fisher, Intermediate Accounting, Vol. 2, Fourth Edition

P20-4. Suggested solution:

• Operating activities are the principal revenue-producing activities of the entity and other activities

that are not investing or financing activities. Cash flows from operating activities arise from the day- to-day running of the business.Operating activities include: cash sales; payment and collection of accounts receivable; receipt of rents, royalties, and fees; receipt of deposits; payment of salaries and wages; payment of income tax and other tax payments; receipt and payment of interest and dividends*; and the purchase and sale of investments held for trading purposes.(*Alternative classifications are permitted.) Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. There are two distinct components to investing activities. The first is the acquisition and disposal of fixed assets, the second investing in the more traditional sense:

i) To establish and maintain the infrastructure necessary to run the business, companies purchase

and sell fixed assets.ii) Investing in the more traditional sense involves buying and selling debt and equity securities, with certain exceptions. For example, investments that are reported as cash equivalents (part of the cash being explained), and investments held for trading purposes (recorded as an operating activity) are not recorded as an investing activity.Investing activities include: the sale of property, plant, and equipment; purchase and sale of investments other than those held for trading purposes or reported as cash equivalents; the making of loans and the collection of loans receivable; the purchase of property, plant, and equipment; and the receipt of interest and dividends.* (*Alternative classifications are permitted.) Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.Companies raise money by issuing debt and selling equity, using the proceeds to acquire fixed assets.Financing activities record the cash flows associated with the issuance and retirement of debt and equity. This comment applies only to the capital flows, as there are some options available with respect to the payment of interest and dividends. Cash flows arising from supplier-provided financing including accounts payable are an operating activity, however.Financing activities include: issuing and repurchasing shares; issuing debt, including bonds, mortgages, and notes; repayment of the principal amount of lease liabilities, bonds, mortgages, and notes; borrowing and repaying the principal of bank loans; and the payment of interest and dividends.* (*Alternative classification options are available.)

• Cash flows from operating activities give considerable insight into a firm’s ability to generate

sufficient cash to maintain its business, repay loans, and make new investments without having to arrange external financing.Cash flows related to investing summarize net expenditures for assets meant to generate future income.Financing-related cash flows gauge future claims on cash flows by both debt and equity holders.

• IAS 7 permits a business entity to classify the receipt of interest and dividends as either an operating

or an investing activity. The standard also permits companies to report the payment of interest and dividends as either an operating or a financing activity. Once the business chooses its accounting policy it must apply it consistently to all similar transactions. ASPE does not permit a choice. The receipt of interest and dividends and the payment of interest must normally be classified as an operating activity; the payment of dividends a financing activity.

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Chapter 20: Statement of Cash Flows

P20-5. Suggested solution:

Item Transaction Categorization on the statement of cash flows

• Receipt of dividends H (cash inflow from operating activities or investing)
• Increase in accounts receivable B
• Decrease in deferred income taxes

payable B (not reported on the statement of cash flows when the direct method is used)

• Sale of a at fair value through profit

or loss investment held for trading purposes A (cash inflow from operating activities)

• Issuing (selling) shares E
• Depreciation expense A (not reported on the statement of cash flows when the

direct method is used)

• Loss on the sale of a financial asset at

amortized cost investment A (not reported on the statement of cash flows when the direct method is used)

• Payment of interest H (cash outflow from operating activities or financing)
• Goodwill impairment loss A (not reported on the statement of cash flows when the

direct method is used)

• Purchase of an at fair value through

other comprehensive income investment D

• Decrease in accounts payable B
• Conversion of bonds to ordinary

shares G (reported in the notes to the financial statements)

• Borrowing money from the bank E
• Sale of a computer at book value C
• Retirement of bonds F

P20-6. Suggested solution:

Item Transaction Categorization on the statement of cash flows

• Sale of land at a loss C
• Gain on the sale of equipment G (deducted from net income in the operating activities

section when the indirect method is used)

• Repurchasing own shares F
• Receipt of interest H (cash inflow from operating activities or investing)
• Purchase of an investment that meets

the criteria of a cash equivalent held to meet short-term cash commitments I (this forms part of cash and cash equivalents, the change of which must be explained)

• Depreciation expense G (added to net income in the operating activities

section when the indirect method is used)

• Leased right-of-use equipment G (reported in the notes to the financial statements)
• Payment of dividends H (cash outflow from operating activities or financing)
• Other comprehensive income G
• Impairment loss on a patent G (added to net income in the operating activities

section when the indirect method is used)

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