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# Test Your Cash Flow IQ

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So you know cash flow statement (i.e. elements listed in the statement, grouping items and make the cash flow statement). This post contains 12 questions about cash flow statement. It is by no meant all inclusive. But, if you can really answer the questions correctly with relevant arguments, I believe you really understand cash flow statement—and are able to address most issues around cash flow statement.

Each question is accompanied by the correct answer with necessary explanation. My suggestion is, try to answer with your own knowledge and skill first (without reading the answer). After you complete your answer, you can compare with the actual answer and its explanation. Continue until finish.

I personally prefer the habit of looking around, digging and obtaining more knowledge with “what else?” and “have I missed something?” mental, rather than the “I—know—this—already.”  So take this test and find out something more about cash flow statement. Here are 12 questions you can try

1. At December 31, 2009, Lie Co. had the following balances in the accounts it maintains at First State Bank:

Checking account #101 = \$175,000
Checking account #201 = (10,000)
Money market account = 25,000
90-day certificate of deposit, due 2/28/10 = 50,000
180-day certificate of deposit, due 3/15/10 = 80,000

Lie classifies investments with original maturities of three months or less as cash equivalents. In its December 31, 2009 balance sheet. What amount should Lie report as cash and cash equivalents?

a. \$190,000
b. \$200,000
c. \$240,000
d. \$320,000

The 12/31/09 cash and cash equivalents balance is \$240,000, as computed below.

Checking account #101                = \$175,000
Checking account #201                =   (10,000)
Money market account                  =    25,000
90-day CD                                    =     50,000
Total cash and cash equivalents   =   240,000

Bank overdrafts (like account #201) are normally reported as a current liability. However, when available cash is present in another account in the same bank, as in this case, offsetting is required. The money market account of \$25,000 and the 90-day CD of \$50,000 are considered cash equivalents because they had original maturities of three months or less. The 180-day CD of \$80,000 is excluded because its original maturity was more than three months.

2. The primary purpose of a statement of cash flows is to provide relevant information about:

a. Differences between net income and associated cash receipts and disbursements.
b. An enterprise’s ability to generate future positive net cash flows.
c. The cash receipts and cash disbursements of an enterprise during a period.
d. An enterprise’s ability to meet cash operating needs.

Per SFAS 95, the primary purpose of a statement of cash flows is to provide relevant information about the enterprise’s cash receipts and cash payments during a period. Answers (a), (b), and (d) are incorrect because, although they represent uses of the statement of cash flows, they are not the primary use.

3. Dharma Co. purchased a three-month US Treasury bill. Dharma’s policy is to treat as cash equivalents all highly liquid investments with an original maturity of three months or less when purchased. How should this purchase be reported in Dharma’s statement of cash flows?

a. As an outflow from operating activities.
b. As an outflow from investing activities.
c. As an outflow from financing activities.
d. Not reported.

The statement of cash flows is required to be prepared based on inflows and outflows of cash and cash equivalents during the period. The purchase of a cash equivalent using cash is not an outflow of cash and cash equivalents; it is merely a change in the composition of cash and cash equivalents. Cash has decreased and cash equivalents have increased, but total cash and cash equivalents is unchanged. Therefore this purchase is not reported in the statement of cash flows.

4. Lou, Inc. had the following activities during 2010:

• Acquired 2,000 shares of stock in Lie, Inc. for \$26,000. Lou intends to hold the stock as a long-term investment.
• Sold an investment in Kim Motors for \$35,000 when the carrying value was \$33,000.
• Acquired a \$50,000, four-year certificate of deposit from a bank. (During the year, interest of \$3,750 was paid to Lou.)
• Collected dividends of \$1,200 on stock investments.

In Lou’s 2010 statement of cash flows, net cash used in investing activities should be:

a. \$37,250
b. \$38,050
c. \$39,800
d. \$41,000

Investing activities include all cash flows involving assets, other than operating items. The investing activities are:

Purchase of inv. in stock = \$(26,000)
Sale of inv. in stock         = \$  35,000
Acquisition of CD            = \$(50,000)
Net cash used                  = \$(41,000)

The gain on sale of investment in Kim Motors (\$35,000 – \$33,000 = \$2,000), the interest earned (\$3,750), and dividends earned (\$1,200) are all operating items. Note that the sale of investment is reported in the investing section at the cash inflow amount (\$35,000), not at the carrying value of the investment (\$33,000). If the CD had been for three months instead of four years, it would be part of “Cash and Cash equivalents” and would not be shown under investing activities.

5. In 2010, a tornado completely destroyed a building belonging to Rockburnt Corp. The building cost \$100,000 and had accumulated depreciation of \$48,000 at the time of the loss. Rockburnt received a cash settlement from the insurance company and reported an extraordinary loss of \$21,000. In Rockburnt’s 2003 cash flow statement, the net change reported in the cash flows from investing activities section should be:

a. \$10,000 increase.
b. \$21,000 decrease.
c. \$31,000 increase.
d. \$52,000 decrease.

The building which was destroyed had a book value of \$52,000 (\$100,000 – \$48,000). The cash settlement from the insurance company resulted in a loss of \$21,000. Therefore, the cash inflow from this investing activity must be \$31,000 as shown below.

Proceeds  – Book value  = Loss
?           – \$52,000      = (\$21,000)
\$31,000   – \$52,000      = (\$21,000)

Note that the \$21,000 extraordinary loss must be before any income tax effect because SFAS 95 requires that any tax effect be left in operating activities.

6. In a statement of cash flows, if used equipment is sold at a gain, the amount shown as a cash inflow from investing activities equals the carrying amount of the equipment:

a. Plus the gain.
b. Plus the gain and less the amount of tax attributable to the gain.
c. Plus both the gain and the amount of tax attributable to the gain.
d. With no addition or subtraction.

The cash inflow from the sale of equipment is the carrying amount plus the gain. Answers (b) and (c) are incorrect because the tax attributable to the gain is a cash outflow in the operating activities section of the statement of cash flows. Note that when using the indirect method, the gain is deducted from operating activities, as to not double count the gain.

7. On September 1, 2010, Legacy Co. sold used equipment for a cash amount equaling its carrying amount for both book and tax purposes. On September 15, 2010, Legacy replaced the equipment by paying cash and signing a note payable for new equipment. The cash paid for the new equipment exceeded the cash received for the old equipment. How should these equipment transactions be reported in Legacy’s 2010 statement of cash flows?

a. Cash outflow equal to the cash paid less the cash received.
b. Cash outflow equal to the cash paid and note payable less the cash received.
c. Cash inflow equal to the cash received and a cash outflow equal to the cash paid and note payable.
d. Cash inflow equal to the cash received and a cash outflow equal to the cash paid.

The requirement is to determine how the equipment transactions should be reported in the statement of cash flows. Per SFAS 95, companies are required to report the gross amounts of cash receipts and cash payments, rather than net amounts. Therefore, the gross cash inflow from the sale of equipment and the gross outflow for the payment of new equipment should be reported. Answer (a) is incorrect because both gross inflow and outflow should be reported, rather than reporting the net cash flow from the transaction. Answer (b) is incorrect because gross cash flows, not net, are reported and because a note payable is not reported since the transaction results in no actual inflow or outflow in the period in which the payable occurs. This non-cash activity would be reported in a separate schedule or in the footnotes. Non-cash transactions commonly recognized in a separate schedule in the financial statements include: conversion of debt to equity and acquisition of assets by assuming liabilities, including lease obligations. Answer (c) is incorrect because the note payable is not reported on the statement of cash flows; rather it is shown in a separate schedule.
8. A company acquired a building, paying a portion of the purchase price in cash and issuing a mortgage note payable to the seller for the balance. In a statement of cash flows, what amount is included in investing activities for the above transaction?

a. Cash payment.
b. Acquisition price.
c. Zero.
d. Mortgage amount.

Per SFAS 95, payments at the time of purchase or soon before or after purchase to acquire property, plant, and equipment and other productive assets are categorized as cash outflows for investing activities. Generally, these payments only include advance payments, down payments, or payments made at the time of purchase or soon before or after purchase. Therefore, only the cash payment is considered a cash outflow for investing activities.

9. Using the same case as above #8. In a statement of cash flows, what amount is included in financing activities for the above transaction?

a. Cash payment.
b. Acquisition price.
c. Zero.
d. Mortgage amount.

Per SFAS 95, non-cash investing and financing activities include acquiring assets by assuming directly related liabilities, such as purchasing a building by incurring a mortgage to the seller. This type of transaction does not involve the flow of cash. Therefore, cash flows for financing activities related to this transaction would be zero. Note that the cash down payment would be reported as a cash outflow for investing activities. The amount of the mortgage payment would be included in the non-cash activities at the bottom of the statement of cash flows.

10. Lie Dharma Co. reported bonds payable of \$47,000 at December 31, 2009, and \$50,000 at December 31, 2010. During 2010, Lie Dharma issued \$20,000 of bonds payable in exchange for equipment. There was no amortization of bond premium or discount during the year. What amount should Lie Dharma report in its 2010 statement of cash flows for redemption of bonds payable?

a. \$ 3,000
b. \$17,000
c. \$20,000
d. \$23,000

To determine the cash paid for redemption of bonds payable, the solutions approach is to set up a T account for bonds payable.

Bonds Payable
Debit                  Credit
47,000     12/31/09
Bonds redeemed          ?                        20,000     Bonds issued
50,000     12/31/10

The amount of bonds redeemed can be computed as \$17,000. (\$47,000 + \$20,000 – \$50,000 = \$17,000)

Next question#11 and #12 are based on the following:

In preparing its cash flow statement for the year ended December 31, 2010, StreamZ Co. collected the following data:

Gain on sale of equipment                                      = \$ (6,000)
Proceeds from sale of equipment 10,000
Purchase of XYZ, Inc. bonds (par value \$200,000)  = (180,000)
Amortization of bond discount                               = 2,000
Dividends declared                                                 = (45,000)
Dividends paid                                                        = (38,000)
Proceeds from sale of treasury stock
(carrying amount \$65,000)                                      = 75,000

In its December 31, 2010 statement of cash flows,

11. What amount should StreamZ report as net cash used in investing activities?

a. \$170,000
b. \$176,000
c. \$188,000
d. \$194,000

Investing activities include all cash flows involving assets other than operating items. The investing activities are:

Proceeds from sale of equipment       = \$     10,000
Purchase of XYZ, Inc. bonds               =  \$ (180,000)
Net cash used in investing activities  = \$ (170,000)

The gain on sale of equipment (\$6,000) and amortization of bond discount (\$2,000) are net income adjustments in the operating section, while dividends paid (\$38,000) and proceeds from sale of treasury stock (\$75,000) are financing items. The excess of dividends declared over dividends paid is a non-cash financing activity.

12. What amount should StreamZ report as net cash provided by financing activities?

a. \$20,000
b. \$27,000
c. \$30,000
d. \$37,000

Financing activities include all cash flows involving liabilities and owners’ equity other than operating items. The financing activities are:

Dividends paid                                           \$ (38,000)
Proceeds from sale of treasury stock         \$   75,000
Net cash provided by financing activities  \$   37,000

The excess of dividends declared over dividends paid is a non-cash financing activity. The gain on sale of equipment (\$6,000) and amortization of bond discount (\$2,000) are net income adjustments in the operating section, while the proceeds from sale of equipment (\$10,000) and purchase of XYZ, Inc. bonds (\$180,000) are investing items.

1. BENJAMIN ANSU-APPIAH

May 14, 2011 at 9:59 am

I want to be very strong in accounting and banking aspect so I need an advice which will help me achieve my aim

2. Akanisi Fatafeh

May 29, 2013 at 12:29 am

very educational indeed,

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