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4-1 Odd-numbered Solutions CHAPTER 4 STATEMENT OF CASH FLOWS: REPORTING THE EFFECTS OF OPERATING, INVESTING, AND FINANCING ACTIVITIES ON CASH FLOWS Questions, Short Exercises, Exercises, Problems, and Cases: Answers and Solutions 4.1 See the text or the glossary at the end of the book. 4.3 Accrual accounting attempts to provide a measure of operating performance that relates inputs to output without regard to when a firm receives or disburses cash. Accrual accounting also attempts to portray the resources of a firm and the claims on those resources without regard to whether the firm holds the resource in the form of cash. Although accrual accounting may satisfy user’s needs for information about operating performance and financial position, it does not provide sufficient information about the cash flow effects of a firm’s operating, investing, and financing activities. The latter is the objective of the statement of cash flows. 4.5 The indirect method reconciles net income, the primary measure of a firm’s profitability, with cash flow from operations. Some argue that the relation between net income and cash flow from operations is less evident when a firm reports using the direct method. More likely, the frequent use of the indirect method prior to the issuance of FASB Statement No. 95 probably explains its continuing popularity. Why might accountants have preferred the indirect method before FASB Statement No. 95 ? We have heard the following, but cannot vouch for this from first-hand experience: The direct method’s format resembles the income statement. Where the income statement has a line for revenues, the direct method has a line for cash collections from customers. Where the income statement has a line for cost of goods sold, the direct method might have a line for payments to suppliers of income. Where the income statement has a line for income tax expense, the direct method has a line for income tax payments. The old-timers thought the resemblance of the two statements, the income statement and the direct method, but lack of identity, would cause confusion. They were likely right, but we think its confusion is less than the confusion resulting from the indirect method. Some argue that preparing the direct method costs more. But you can see how easy prepar-
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Odd-numbered Solutions 4-2 4.5 continued. ing the direct method’s version is; you learn how in this chapter. We have told those who say it’s costly that they can hire any one of our students to do this for under $100. Are yours available? 4.7 The classification in the statement of cash flows parallels that in the income statement, where interest on debt is an expense but dividends are a distribution of earnings, not an expense. This is, in our opinion, a feeble explanation. The overarching rule seems to be that ‘if it’s in the income statement, it’s operating.’ We think that dividends on shares and interest on borrowings are both financing transactions, but we are in the minority.
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