Ch_04

Ch_04 - CHAPTER 4 STATEMENT OF CASH FLOWS: REPORTING THE...

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4-1 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. 4.2 One can criticize a single income statement using a cash basis of accounting from two standpoints: (1) it provides a poor measure of operating performance each period because of the inaccurate matching of revenues and expenses (see discussion in Chapter 3), and (2) it excludes important investing (acquisitions and sales of long-lived assets) activities and financing (issuance or redemption of bonds or capital stock) activities of a firm that affect cash flow. 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. 4.4 The statement of cash flows reports changes in the investing and financing activities of a firm. Significant changes in property, plant, and equipment affect the maturity structure of assets on the balance sheet. Significant changes in long-term debt or capital stock affect both the maturity structure of equities as well as the mix of debt versus shareholder financing. 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
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Solutions 4-2 4.5 continued. 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.
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This note was uploaded on 04/23/2010 for the course B 101 taught by Professor Mcafee during the Winter '10 term at UMBC.

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Ch_04 - CHAPTER 4 STATEMENT OF CASH FLOWS: REPORTING THE...

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