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Unformatted text preview: 4-1Odd-numbered SolutionsCHAPTER 4STATEMENT OF CASH FLOWS:REPORTING THE EFFECTS OF OPERATING,INVESTING, AND FINANCING ACTIVITIESON CASH FLOWSQuestions, Short Exercises, Exercises, Problems, and Cases: Answers and Solutions4.1See the text or the glossary at the end of the book.4.3Accrual accounting attempts to provide a measure of operatingperformance that relates inputs to output without regard to when a firmreceives or disburses cash. Accrual accounting also attempts to portraythe resources of a firm and the claims on those resources without regardto whether the firm holds the resource in the form of cash. Althoughaccrual accounting may satisfy user’s needs for information aboutoperating performance and financial position, it does not providesufficient information about the cash flow effects of a firm’s operating,investing, and financing activities. The latter is the objective of thestatement of cash flows.4.5The indirect method reconciles net income, the primary measure of afirm’s profitability, with cash flow from operations. Some argue that therelation between net income and cash flow from operations is less evidentwhen a firm reports using the direct method. More likely, the frequentuse of the indirect method prior to the issuance of FASB Statement No. 95probably explains its continuing popularity. Why might accountants havepreferred the indirect method before FASB Statement No. 95? We haveheard the following, but cannot vouch for this from first-hand experience:The direct method’s format resembles the income statement. Where theincome statement has a line for revenues, the direct method has a line forcash collections from customers. Where the income statement has a linefor cost of goods sold, the direct method might have a line for payments tosuppliers of income. Where the income statement has a line for incometax expense, the direct method has a line for income tax payments. Theold-timers thought the resemblance of the two statements, the incomestatement and the direct method, but lack of identity, would causeconfusion. They were likely right, but we think its confusion is less thanthe confusion resulting from the indirect method. Some argue thatpreparing the direct method costs more. But you can see how easy prepar-Odd-numbered Solutions4-24.5 continued.ing the direct method’s version is; you learn how in this chapter. We havetold those who say it’s costly that they can hire any one of our students todo this for under $100. Are yours available?4.7The classification in the statement of cash flows parallels that in theincome statement, where interest on debt is an expense but dividends area distribution of earnings, not an expense. This is, in our opinion, a feebleexplanation. The overarching rule seems to be that ‘if it’s in the incomestatement, it’s operating.’ We think that dividends on shares and intereston borrowings are both financing transactions, but we are in the minority....
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This note was uploaded on 05/31/2008 for the course ORIE 310 taught by Professor Callister during the Fall '07 term at Cornell University (Engineering School).
- Fall '07